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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- --------- EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2002
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: 0-5519
ASSOCIATED BANC-CORP
(Exact name of registrant as specified in its charter)
Wisconsin 39-1098068
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
1200 Hansen Road
Green Bay, Wisconsin 54304
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (920) 491-7000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT
Common stock, par value - $0.01 per share
(Title of Class)
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (ss.229.405 of this chapter) is not contained herein, and will
not be contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes X No
----- -----
As of February 28, 2003, 74,185,883 shares of Common Stock were outstanding. As
of June 28, 2002, (the last business day of the Registrant's most recently
completed second fiscal quarter) the aggregate market value of the voting stock
held by nonaffiliates of the Registrant was approximately $2,748,105,000.
Excludes approximately $108,263,000 of market value representing the outstanding
shares of the Registrant owned by all directors and officers who individually,
in certain cases, or collectively, may be deemed affiliates. Includes
approximately $200,130,000 of market value representing 7.01% of the outstanding
shares of the Registrant held in a fiduciary capacity by the trust company
subsidiary of the Registrant.
DOCUMENTS INCORPORATED BY REFERENCE
Part of Form 10-K Into Which
Document Portions of Documents are Incorporated
Proxy Statement for Annual Meeting of Part III
Shareholders on April 23, 2003
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ASSOCIATED BANC-CORP
2002 FORM 10-K TABLE OF CONTENTS
Page
PART I ----
Item 1. Business 3
Item 2. Properties 7
Item 3. Legal Proceedings 8
Item 4. Submission of Matters to a Vote of Security Holders 8
PART II
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters 10
Item 6. Selected Financial Data 11
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk 48
Item 8. Financial Statements and Supplementary Data 49
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure 87
PART III
Item 10. Directors and Executive Officers of the Registrant 87
Item 11. Executive Compensation 87
Item 12. Security Ownership of Certain Beneficial Owners and
Management 87
Item 13. Certain Relationships and Related Transactions 87
Item 14. Controls and Procedures 88
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 88
Signatures 90
Special Note Regarding Forward-Looking Statements
Statements made in this document and in documents that are incorporated by
reference which are not purely historical are forward-looking statements, as
defined in the Private Securities Litigation Reform Act of 1995, including any
statements regarding descriptions of management's plans, objectives, or goals
for future operations, products or services, and forecasts of its revenues,
earnings, or other measures of performance. Forward-looking statements are based
on current management expectations and, by their nature, are subject to risks
and uncertainties. These statements may be identified by the use of words such
as "believe," "expect," "anticipate," "plan," "estimate," "should," "will,"
"intend," or similar expressions.
Shareholders should note that many factors, some of which are discussed
elsewhere in this document and in the documents that are incorporated by
reference, could affect the future financial results of Associated Banc-Corp and
could cause those results to differ materially from those expressed in
forward-looking statements contained or incorporated by reference in this
document. These factors, many of which are beyond Associated Banc-Corp's
control, include the following:
- - operating, legal, and regulatory risks;
- - economic, political, and competitive forces affecting Associated
Banc-Corp's banking, securities, asset management, and credit services
businesses; and
- - the risk that Associated Banc-Corp's analyses of these risks and forces
could be incorrect and/or that the strategies developed to address them
could be unsuccessful.
These factors should be considered in evaluating the forward-looking statements,
and undue reliance should not be placed on such statements. Forward-looking
statements speak only as of the date they are made. Associated Banc-Corp
undertakes no obligation to update or revise any forward looking statements,
whether as a result of new information, future events, or otherwise.
PART I
ITEM 1 BUSINESS
General
Associated Banc-Corp (the "parent company") is a bank holding company registered
pursuant to the Bank Holding Company Act of 1956, as amended (the "Act"). It was
incorporated in Wisconsin in 1964 and was inactive until 1969 when permission
was received from the Board of Governors of the Federal Reserve System to
acquire three banks. At December 31, 2002, the parent company owned four
commercial banks located in Illinois, Minnesota, and Wisconsin serving their
local communities and, measured by total assets held at December 31, 2002, was
the second largest commercial bank holding company headquartered in Wisconsin.
The parent company also owned 22 limited purpose banking and nonbanking
subsidiaries located in Arizona, California, Illinois, Minnesota, Nevada, and
Wisconsin. The parent company, together with all its subsidiaries is hereinafter
referred to as the "Corporation."
Services
The parent company provides advice and specialized services to its subsidiaries
in banking policy and operations, including auditing, data processing,
marketing/advertising, investing, legal/compliance, personnel services, trust
services, risk management, facilities management, security, purchasing,
treasury, finance, accounting, and other financial services functionally related
to banking.
Responsibility for the management of the subsidiaries remains with their
respective Boards of Directors and officers. Services rendered to the
subsidiaries by the parent company are intended to assist the local management
of these subsidiaries to expand the scope of services offered by them. At
December 31, 2002, bank subsidiaries of the parent company provided services
through 221 locations in 153 communities.
3
The Corporation provides a complete range of banking services to individuals and
businesses. These services include checking, savings, and money market deposit
accounts, business, personal, educational, residential, and commercial mortgage
loans, other consumer-oriented financial services, including IRA and Keogh
accounts, lease financing for a variety of capital equipment for commerce and
industry, and safe deposit and night depository facilities. Automated Teller
Machines (ATMs), which provide 24-hour banking services to customers, are
installed in many locations in the Corporation's service areas. The Corporation
participates in an interstate shared ATM network, which allows customers to
perform banking transactions from their checking, savings, or credit card
accounts at ATMs in a multi-state environment. Among the services designed
specifically to meet the needs of businesses are various types of specialized
financing, cash management services, and transfer/collection facilities.
The Corporation provides lending, depository, and related financial services to
individual, commercial, industrial, financial, and governmental customers. Term
loans, revolving credit arrangements, letters of credit, inventory and accounts
receivable financing, real estate construction lending, and international
banking services are available.
The Corporation is involved in the origination, servicing, and warehousing of
mortgage loans, and the sale of such loans to investors. The primary focus is on
one- to four-family residential and multi-family properties, which are generally
salable into the secondary mortgage market. The principal mortgage lending areas
are Wisconsin, Minnesota, and Illinois. Nearly all long-term, fixed-rate real
estate mortgage loans generated are sold in the secondary market and to other
financial institutions, with the servicing of those loans retained.
In addition to real estate loans, the Corporation originates and/or services
consumer loans, business credit card loans, and student loans. Consumer, home
equity, and student lending activities are principally conducted in Wisconsin,
Minnesota, and Illinois, while the credit card base and resulting loans are
principally centered in the Midwest.
Lending involves credit risk. Credit risk is controlled and monitored through
active asset quality management and the use of lending standards, thorough
review of potential borrowers, and active asset quality administration. Active
asset quality administration, including early problem loan identification and
timely resolution of problems, further ensures appropriate management of credit
risk and minimization of loan losses. The allowance for loan losses represents
management's estimate of an amount adequate to provide for probable losses
inherent in the loan portfolio. Management's evaluation of the adequacy of the
allowance for loan losses is based on management's ongoing review and grading of
the loan portfolio, consideration of past loan loss experience, trends in past
due and nonperforming loans, risk characteristics of the various classifications
of loans, current economic conditions, the fair value of underlying collateral,
and other qualitative and quantitative factors which could affect potential
credit losses. Credit risk management is discussed under sections "Critical
Accounting Policies," "Loans," "Allowance for Loan Losses," and "Nonperforming
Loans, Potential Problem Loans, and Other Real Estate Owned" in "Management's
Discussion and Analysis of Financial Condition and Results of Operations," and
under Note 1, "Summary of Significant Accounting Policies," and Note 5, "Loans,"
in the notes to consolidated financial statements.
Additional emphasis is given to noncredit services for commercial customers,
such as advice and assistance in the placement of securities, corporate cash
management, and financial planning. The bank subsidiaries make available check
clearing, safekeeping, loan participations, lines of credit, portfolio analyses,
and other services to approximately 120 correspondent financial institutions.
A trust company subsidiary and an investment management subsidiary offer a wide
variety of fiduciary, investment management, advisory, and corporate agency
services to individuals, corporations, charitable trusts, foundations, and
institutional investors. They also administer (as trustee and in other fiduciary
and representative capacities) pension, profit sharing and other employee
benefit plans, and personal trusts and estates.
4
Investment subsidiaries provide discount and full-service brokerage services,
including the sale of fixed and variable annuities, mutual funds, and
securities, to customers and the general public. Insurance subsidiaries
headquartered in Arizona and Wisconsin provide commercial and individual
insurance services and engage in reinsurance. Various life, property, casualty,
credit, and mortgage insurance products are available to the subsidiaries'
customers and the general public. Three investment subsidiaries located in
Nevada hold, manage, and trade cash, stocks, and securities and reinvest
investment income. Three additional investment subsidiaries formed in Nevada and
headquartered and domiciled in the Cayman Islands provide investment services
for their parent bank, as well as provide management of their respective Real
Estate Investment Trust ("REIT") subsidiaries. An appraisal subsidiary provides
real estate appraisals for customers, government agencies, and the general
public. The Corporation does not engage in any material operations in foreign
countries.
The Corporation is not dependent upon a single or a few customers, the loss of
which would have a material adverse effect on the Corporation. No material
portion of the business of the Corporation is seasonal.
Employees
At December 31, 2002, the Corporation had 4,085 full-time equivalent employees.
Competition
The financial services industry is highly competitive. The Corporation competes
for loans, deposits, and financial services in all of its principal markets. The
Corporation competes directly with other bank and nonbank institutions located
within its markets, with out-of-market banks and bank holding companies that
advertise or otherwise serve the Corporation's markets, money market and other
mutual funds, brokerage houses, and various other financial institutions.
Additionally, the Corporation competes with insurance companies, leasing
companies, regulated small loan companies, credit unions, governmental agencies,
and commercial entities offering financial services products. Competition
involves efforts to obtain new deposits, the scope and type of services offered,
interest rates paid on deposits and charged on loans, as well as other aspects
of banking. The Corporation also faces direct competition from members of bank
holding company systems that have greater assets and resources than those of the
Corporation.
Supervision and Regulation
Financial institutions are highly regulated both at the federal and state level.
Numerous statutes and regulations presently affect the business of the
Corporation.
As a registered bank holding company under the Act, the parent company and its
nonbanking subsidiaries are regulated and supervised by the Board of Governors
of the Federal Reserve System (the "Board"). The bank subsidiaries with a
national bank charter are supervised and examined by the Comptroller of the
Currency. The bank subsidiary with a state bank charter is supervised and
examined by its state banking agency and by the Federal Deposit Insurance
Corporation (the "FDIC"). All subsidiaries that accept insured deposits are
subject to examination by the FDIC.
The Gramm-Leach-Bliley Act of 1999 made major amendments to the Act. The
amendments, among other things, allow certain qualifying bank holding companies
to engage in activities that are financial in nature and that explicitly include
the underwriting and sale of insurance. The amendments also amend the Act
provisions governing the scope and manner of the Board's supervision of bank
holding companies, the manner in which activities may be found to be financial
in nature, and the extent to which state laws on insurance will apply to
insurance activities of banks and bank subsidiaries. The Board has issued
regulations implementing these provisions. The amendments allow for the
expansion of activities by banking organizations and permit consolidation among
financial organizations generally. The parent company is required to act as a
source of financial strength to each of its subsidiaries pursuant to which it
may be required to commit financial resources to support such subsidiaries in
circumstances when, absent such requirements, it might not do so. The Act also
requires the prior approval of the Board to
5
enable the parent company to acquire direct or indirect control of more
than five percent of any class of voting shares of any bank or bank holding
company. Further restrictions imposed by the Act include capital requirements,
transactions with affiliates, securities issuances, dividend payments,
inter-affiliate liabilities, extensions of credit, and expansion through merger
and acquisition.
The federal regulatory authorities have broad authority to enforce the
regulatory requirements imposed on the Corporation. In particular, the Financial
Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") and the
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), and
their implementing regulations, carry greater enforcement powers. Under FIRREA,
all commonly controlled FDIC insured depository institutions may be held liable
for any loss incurred by the FDIC resulting from a failure of, or any assistance
given by the FDIC to, any commonly controlled institutions. Pursuant to certain
provisions under FDICIA, the federal regulatory agencies have broad powers to
take prompt corrective action if a depository institution fails to maintain
certain capital levels. Prompt corrective action may include the inability of
the Corporation to pay dividends, restrictions in acquisitions or activities,
limitations on asset growth, and other restrictions.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 contains
provisions which amended the Act to allow an adequately-capitalized and
adequately-managed bank holding company to acquire a bank located in another
state as of September 29, 1995. Effective June 1, 1997, interstate branching was
permitted. The Riegle-Neal Amendments Act of 1997 clarifies the applicability of
host state laws to any branch in such state of an out-of-state bank.
The FDIC maintains the Bank Insurance Fund (BIF) and the Savings Association
Insurance Fund (SAIF) by assessing depository institutions an insurance premium
twice a year. The amount each institution is assessed is based both on the
balance of insured deposits held during the preceding two quarters, as well as
on the degree of risk the institution poses to the insurance fund. FDIC assesses
higher rates on those institutions that pose greater risks to the insurance
funds. Effective April 1, 2000, the FDIC Board of Directors (FDIC Board) adopted
revisions to the FDIC's regulation governing deposit insurance assessments which
it believes enhance the present system by allowing institutions with improving
capital positions to benefit from the improvement more quickly while requiring
those whose capital is failing to pay a higher assessment sooner. The Federal
Deposit Insurance Act governs the authority of the FDIC Board to set BIF and
SAIF assessment rates and directs the FDIC Board to establish a risk-based
assessment system for insured depository institutions and set assessments to the
extent necessary to maintain the reserve ratio at 1.25%.
The Sarbanes-Oxley Act of 2002 addresses, among other issues, corporate
governance, auditing and accounting, executive compensation, and enhanced and
timely disclosure of corporate information. The New York Stock Exchange and
Nasdaq have also proposed corporate governance rules that were presented to the
Securities and Exchange Commission for review and approval. The proposed changes
are intended to allow stockholders to more easily and efficiently monitor the
performance of companies and directors. Effective August 29, 2002, as directed
by Section 302(a) of Sarbanes-Oxley, the parent company's chief executive
officer and chief financial officer are each required to certify that the
Corporation's quarterly and annual reports do not contain any untrue statement
of a material fact. The rules have several requirements, including having these
officers certify that they are responsible for establishing, maintaining, and
regularly evaluating the effectiveness of the Corporation's internal controls;
they have made certain disclosures to the Corporation's auditors and the audit
committee of the Board of Directors about the Corporation's internal controls;
and they have included information in the Corporation's quarterly and annual
reports about their evaluation and whether there have been significant changes
in the Corporation's internal controls or in other factors that could
significantly affect internal controls subsequent to the evaluation. At its
January 22, 2003, meeting, the Corporation's Board of Directors approved a
series of actions to strengthen its corporate governance practices, including
the adoption of a Code of Ethics for Directors and Executive Officers and
revised charter for its Audit Committee. More information regarding the
Corporation's corporate governance practices is available on its web site at
www.associatedbank.com.
6
The laws and regulations to which the Corporation is subject are constantly
under review by Congress, the federal regulatory agencies, and the state
authorities. These laws and regulations could be changed drastically in the
future, which could affect the profitability of the Corporation, its ability to
compete effectively, or the composition of the financial services industry in
which the Corporation competes.
Government Monetary Policies and Economic Controls
The earnings and growth of the banking industry and the Corporation are affected
by the credit policies of monetary authorities, including the Federal Reserve
System. An important function of the Federal Reserve System is to regulate the
national supply of bank credit in order to combat recession and curb
inflationary pressures. Among the instruments of monetary policy used by the
Federal Reserve to implement these objectives are open market operations in U.S.
government securities, changes in reserve requirements against member bank
deposits, and changes in the Federal Reserve discount rate. These means are used
in varying combinations to influence overall growth of bank loans, investments,
and deposits, and may also affect interest rates charged on loans or paid for
deposits. The monetary policies of the Federal Reserve authorities have had a
significant effect on the operating results of commercial banks in the past and
are expected to continue to have such an effect in the future.
In view of changing conditions in the national economy and in the money markets,
as well as the effect of credit policies by monetary and fiscal authorities,
including the Federal Reserve System, no prediction can be made as to possible
future changes in interest rates, deposit levels, and loan demand, or their
effect on the business and earnings of the Corporation.
Available Information
The Corporation files annual, quarterly, and current reports, proxy statements,
and other information with the Securities and Exchange Commission (the "SEC").
These filings are available to the public over the Internet at the SEC's web
site at www.sec.gov. You may also read and copy any document that the
Corporation files at the SEC's public reference room located at 450 Fifth
Street, NW, Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for
further information on the public reference room.
The Corporation's principal Internet address is www.associatedbank.com. The
Corporation makes available free of charge on www.associatedbank.com its Code of
Ethics for Directors and Executive Officers and its annual report, as soon as
reasonably practicable after the Corporation electronically files such material
with, or furnishes it to, the SEC. In addition, you may request a copy of any of
the Corporation's filings (excluding exhibits) at no cost by writing,
telephoning, faxing, or e-mailing the Corporation at the following address,
telephone number, fax number or e-mail address: Associated Banc-Corp, Attn:
Shareholder Relations, 1200 Hansen Road, Green Bay, WI 54304; phone
920-491-7006; fax 920-491-7010; or e-mail to shareholders@associatedbank.com.
ITEM 2 PROPERTIES
The parent company's headquarters are located in the Village of Ashwaubenon,
Wisconsin, in a leased facility with approximately 30,000 square feet of office
space. The space is subject to a five-year lease with two consecutive five-year
extensions.
At December 31, 2002, the bank subsidiaries occupied 221 offices in 153
different communities within Illinois, Minnesota, and Wisconsin. The main office
of Associated Bank, National Association, is owned. The bank subsidiary main
offices in downtown Chicago, Rockford, and Minneapolis are located in the
lobbies of multistory office buildings. Most subsidiary branch offices are
freestanding buildings that provide adequate customer parking, including
drive-in facilities of various numbers and types for customer convenience. Some
bank subsidiaries also have branch offices in supermarket locations or in
retirement communities. In addition, the Corporation owns other real property
that, when considered in the aggregate, is not material to its financial
position.
7
ITEM 3 LEGAL PROCEEDINGS
There are legal proceedings pending against the Corporation that arose in the
normal course of business. Although litigation is subject to many uncertainties
and the ultimate exposure with respect to these matters cannot be ascertained,
management believes, based upon discussions with counsel, that the Corporation
has meritorious defenses, and any ultimate liability would not have a material
adverse effect on the consolidated financial position or results of operations
of the Corporation.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 2002.
Executive Officers of the Corporation
Pursuant to General Instruction G of Form 10-K, the following list is included
as an unnumbered item in Part I of this report in lieu of being included in the
Proxy Statement for the Annual Meeting of Shareholders to be held April 23,
2003.
The following is a list of names and ages of executive officers of the
Corporation indicating all positions and offices held by each such person and
each such person's principal occupation(s) or employment during the past five
years. The Date of Election refers to the date the person was first elected an
officer of the Corporation. Officers are appointed annually by the Board of
Directors at the meeting of directors immediately following the Annual Meeting
of Shareholders. There are no family relationships among these officers nor any
arrangement or understanding between any officer and any other person pursuant
to which the officer was selected. No person other than those listed below has
been chosen to become an Executive Officer of the Corporation.
Name Offices and Positions Held Date of Election
Robert C. Gallagher Chairman of the Board, President, and Chief April 28, 1982
Age: 64 Executive Officer of Associated Banc-Corp;
Chairman and President of Associated Bank,
National Association (subsidiary); Director of
Associated Bank Illinois, National Association
(subsidiary); Director of Associated Trust
Company, National Association (subsidiary)
Prior to January 2003, President, Chief
Executive Officer, and Director of Associated
Banc-Corp; Chairman and President of Associated
Bank, National Association (subsidiary)
Prior to April 2000, President, Chief Operating
Officer, and Vice Chairman of Associated
Banc-Corp
From April 1996 to October 1998, Vice Chairman
of Associated Banc-Corp; Chairman and Chief
Executive Officer of Associated Bank Green Bay,
N.A. (former subsidiary)
Brian R. Bodager Chief Administrative Officer, General Counsel, July 22, 1992
Age: 47 and Corporate Secretary of Associated
Banc-Corp; Director of Associated Bank,
National Association (subsidiary); Director of
Associated Bank Illinois, National Association
(subsidiary); Executive Vice President,
Secretary, and Director of Associated Trust
Company, National Association (subsidiary)
8
Name Offices and Positions Held Date of Election
Mark J. McMullen Director, Wealth Management, of Associated June 2, 1981
Age: 53 Banc-Corp; Director of Associated Bank,
National Association (subsidiary); Chairman and
Chief Executive Officer of Associated Trust
Company, National Association (subsidiary)
Prior to July 1999, Senior Executive Vice
President and Director of Associated Bank Green
Bay, N.A. (former subsidiary)
Donald E. Peters Director, Systems and Operations, of Associated October 27, 1997
Age: 53 Banc-Corp; Director of Associated Bank,
National Association (subsidiary); Director of
Associated Trust Company, National Association
(subsidiary)
From October 1997 to November 1998, Director of
Systems and Operations of Associated Banc-Corp;
Executive Vice President of First Financial
Bank (former subsidiary)
Joseph B. Selner Chief Financial Officer of Associated January 25, 1978
Age: 56 Banc-Corp; Director of Associated Bank,
National Association (subsidiary); Director of
Associated Trust Company, National Association
(subsidiary)
Gordon J. Weber Director, Corporate Banking, of Associated January 1, 1973
Age: 54 Banc-Corp; Director of Associated Bank,
National Association (subsidiary); Director of
Associated Bank Illinois, National Association
(subsidiary); Director of Associated Bank
Minnesota, National Association (subsidiary);
Director of Associated Trust Company, National
Association (subsidiary)
Prior to April 2001, President, Chief Executive
Officer, and Director of Associated Bank
Milwaukee (former subsidiary); Director of
Associated Bank South Central (former
subsidiary)
William M. Bohn Director, Legal, Compliance, and Risk April 23, 1997
Age: 36 Management, of Associated Banc-Corp
Robert J. Johnson Director, Corporate Human Resources, of January 22, 1997
Age: 57 Associated Banc-Corp
Gordon C. King Chief Credit Officer of Associated Banc-Corp January 22, 2003
Age: 41
From October 2001 to January 2003, Chief Credit
Officer of Associated Banc-Corp
From 1996 to October 2001, Senior Vice
President and Credit Administration Manager of
Associated Bank Milwaukee (former subsidiary)
Arthur E. Olsen, III General Auditor of Associated Banc-Corp July 28, 1993
Age: 51
Teresa A. Rosengarten Treasurer of Associated Banc-Corp October 25, 2000
Age: 42
From March 1994 to August 2000, Treasurer of a
Tennessee-based bank holding company
9
PART II
ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Information in response to this item is incorporated by reference to the table
"Market Information" on Page 87 and the discussion of dividend restrictions in
Note 12, "Stockholders' Equity," of the notes to consolidated financial
statements included under Item 8 of this document. The Corporation's common
stock is currently being traded on The Nasdaq Stock Market under the symbol
ASBC.
The approximate number of equity security holders of record of common stock,
$.01 par value, as of February 28, 2003, was 9,807. Certain of the Corporation's
shares are held in "nominee" or "street" name and the number of beneficial
owners of such shares is approximately 26,312.
Payment of future dividends is within the discretion of the Corporation's Board
of Directors and will depend, among other factors, on earnings, capital
requirements, and the operating and financial condition of the Corporation. At
the present time, the Corporation expects that dividends will continue to be
paid in the future.
10
ITEM 6 SELECTED FINANCIAL DATA
TABLE 1: EARNINGS SUMMARY AND SELECTED FINANCIAL DATA
(In Thousands, except per share data)
% 5-Year
Change Compound
2001 to Growth
Years ended December 31, 2002 2002 2001 2000 1999 1998 Rate (5)
- ----------------------------------------------------------------------------------------------------------------------
Interest income $ 792,106 (10.1)% $ 880,622 $ 931,157 $ 814,520 $ 785,765 0.1%
Interest expense 290,840 (36.6) 458,637 547,590 418,775 411,028 (6.7)
-----------------------------------------------------------------------------------
Net interest income 501,266 18.8 421,985 383,567 395,745 374,737 5.9
Provision for loan losses 50,699 79.7 28,210 20,206 19,243 14,740 9.9
-----------------------------------------------------------------------------------
Net interest income after
provision for loan losses 450,567 14.4 393,775 363,361 376,502 359,997 5.5
Noninterest income 220,308 12.6 195,603 184,196 165,906 167,928 18.4
Noninterest expense 374,549 10.7 338,369 317,736 305,092 294,962 3.0
-----------------------------------------------------------------------------------
Income before income taxes 296,326 18.1 251,009 229,821 237,316 232,963 20.6
Income tax expense 85,607 19.8 71,487 61,838 72,373 75,943 6.0
-----------------------------------------------------------------------------------
NET INCOME $ 210,719 17.4% $ 179,522 $ 167,983 $ 164,943 $ 157,020 32.1%
===================================================================================
Basic earnings per share (1) $ 2.82 14.2% $ 2.47 $ 2.24 $ 2.15 $ 2.06 32.5%
Diluted earnings per share (1) 2.79 13.9 2.45 2.23 2.13 2.03 32.6
Cash dividends per share (1) 1.21 9.3 1.11 1.01 0.96 0.86 10.7
Weighted average shares
outstanding: (1)
Basic 74,685 2.9 72,587 75,005 76,844 76,382 (0.4)
Diluted 75,493 3.2 73,167 75,251 77,514 77,185 (0.5)
SELECTED FINANCIAL DATA
Year-End Balances:
Loans $10,303,225 14.2% $ 9,019,864 $ 8,913,379 $ 8,343,100 $ 7,272,697 7.8%
Allowance for loan losses 162,541 26.8 128,204 120,232 113,196 99,677 11.9
Investment securities 3,362,669 5.2 3,197,021 3,260,205 3,270,383 2,907,735 2.7
Total assets 15,043,275 10.6 13,604,374 13,128,394 12,519,902 11,250,667 7.1
Deposits 9,124,852 5.9 8,612,611 9,291,646 8,691,829 8,557,819 1.7
Long-term debt 1,906,845 72.8 1,103,395 122,420 24,283 26,004 162.6
Company-obligated mandatorily
redeemable preferred 190,111 N/M --- --- --- --- N/M
securities
Stockholders' equity 1,272,183 18.8 1,070,416 968,696 909,789 878,721 9.3
Book value per share (1) 17.13 15.0 14.89 13.32 11.90 11.55 9.9
-----------------------------------------------------------------------------------
Average Balances:
Loans $10,002,478 10.0% $ 9,092,699 $ 8,688,086 $ 7,800,791 $ 7,255,850 7.5%
Investment securities 3,262,843 3.8 3,143,786 3,317,499 3,119,923 2,737,556 2.3
Total assets 14,297,418 9.1 13,103,754 12,810,235 11,698,104 10,628,695 6.6
Deposits 8,912,534 3.9 8,581,233 9,102,940 8,631,652 8,430,701 1.9
Stockholders' equity 1,231,977 18.8 1,037,158 920,169 914,082 856,425 8.0
-----------------------------------------------------------------------------------
Financial Ratios: (2)
Return on average equity 17.10% (21) 17.31% 18.26% 18.04% 18.33%
Return on average assets 1.47 10 1.37 1.31 1.41 1.48
Net interest margin (taxable
equivalent) 3.95 33 3.62 3.36 3.74 3.79
Average equity to average assets 8.62 71 7.91 7.18 7.81 8.06
Dividend payout ratio (3) 42.97 (193) 44.90 45.09 44.65 41.75
-----------------------------------------------------------------------------------
Selected Financial Data: (4)
Net income $ 210,719 13.5% $ 185,679 $ 173,944 $ 169,376 $ 158,912
Basic earnings per share (1) 2.82 10.3 2.56 2.32 2.20 2.08
Diluted earnings per share (1) 2.79 10.0 2.54 2.31 2.19 2.06
===================================================================================
(1) Per share data adjusted retroactively for stock splits and stock dividends.
(2) Change in basis points.
(3) Ratio is based upon basic earnings per share.
(4) Selected financial data has been adjusted to exclude the amortization of
goodwill in years prior to 2002 affected by adopting Statement of Financial
Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible
Assets" and SFAS No. 147, "Acquisitions of Certain Financial Institutions,"
effective January 1, 2002. (5) Base year used in 5-year compound growth
rate is 1997 consolidated financial data.
N/M = not meaningful
11
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion is management's analysis to assist in the understanding
and evaluation of the consolidated financial condition and results of operations
of Associated Banc-Corp (the "parent company"), together with all its
subsidiaries (the "Corporation"). It should be read in conjunction with the
consolidated financial statements and footnotes and the selected financial data
presented elsewhere in this report.
During the second quarter of 2002, the parent company merged its Minnesota bank
subsidiaries (Associated Bank Minnesota; Signal Bank National Association; and
Signal Bank South National Association) into a single national banking charter
under the name Associated Bank Minnesota, National Association. During 2001, the
Corporation merged its Wisconsin bank subsidiaries (Associated Bank South
Central; Associated Bank North; Associated Bank Milwaukee; Associated Bank,
National Association; Associated Bank Lakeshore, National Association; and
Associated Bank Green Bay, National Association) into a single national banking
charter, headquartered in Green Bay, Wisconsin, under the name Associated Bank,
National Association. Certain nonbank subsidiaries (Associated Leasing, Inc.,
Associated Banc-Corp Services, Inc., and Associated Commercial Mortgage, Inc.)
also merged with and into the resultant bank, becoming operating divisions of
Associated Bank, National Association.
The financial discussion that follows may refer to the effect of the
Corporation's business combination activity, detailed under section, "Business
Combinations," and Note 2, "Business Combination," of the notes to consolidated
financial statements. The detailed financial discussion focuses on 2002 results
compared to 2001. Discussion of 2001 results compared to 2000 is predominantly
in section "2001 Compared to 2000."
Critical Accounting Policies
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the balance sheet and revenues and expenses for
the period. Actual results could differ significantly from those estimates.
Estimates that are particularly susceptible to significant change include the
determination of the allowance for loan losses, mortgage servicing rights,
derivative financial instruments and hedging activities, and income taxes.
The consolidated financial statements of the Corporation are prepared in
conformity with accounting principles generally accepted in the United States of
America and follow general practices within the industries in which it operates.
This preparation requires management to make estimates, assumptions, and
judgments that affect the amounts reported in the financial statements and
accompanying notes. These estimates, assumptions, and judgments are based on
information available as of the date of the financial statements; accordingly,
as this information changes, actual results could differ from the estimates,
assumptions, and judgments reflected in the financial statements. Certain
policies inherently have a greater reliance on the use of estimates,
assumptions, and judgments and, as such, have a greater possibility of producing
results that could be materially different than originally reported. Management
believes the following policies are both important to the portrayal of the
Corporation's financial condition and results and require subjective or complex
judgments and, therefore, management considers the following to be critical
accounting policies.
Allowance for Loan Losses: Subject to the use of estimates, assumptions, and
judgments is management's evaluation process used to determine the adequacy of
the allowance for loan losses which combines several factors: management's
ongoing review and grading of the loan portfolio, consideration of past loan
loss experience, trends in past due and nonperforming loans, risk
characteristics of the various classifications of loans, existing economic
conditions, the fair value of underlying collateral, and other qualitative and
quantitative factors which could affect probable credit losses. Because current
economic
12
conditions can change and future events are inherently difficult to
predict, the anticipated amount of estimated loan losses, and therefore the
adequacy of the allowance, could change significantly. As an integral part of
their examination process, various regulatory agencies also review the allowance
for loan losses. Such agencies may require that certain loan balances be charged
off when their credit evaluations differ from those of management, based on
their judgments about information available to them at the time of their
examination. The Corporation believes the allowance for loan losses is adequate
and properly recorded in the financial statements. See Note 1, "Summary of
Significant Accounting Policies," and Note 5, "Loans," of the notes to
consolidated financial statements and section "Allowance for Loan Losses."
Mortgage Servicing Rights Valuation: The fair value of the Corporation's
mortgage servicing rights asset is important to the presentation of the
consolidated financial statements in that mortgage servicing rights are subject
to a fair value-based impairment standard. Mortgage servicing rights do not
trade in an active open market with readily observable prices. As such, like
other participants in the mortgage banking business, the Corporation relies on
an internal discounted cash flow model to estimate the fair value of its
mortgage servicing rights. While the Corporation believes that the values
produced by its internal model are indicative of the fair value of its mortgage
servicing rights portfolio, these values can change significantly depending upon
the then current interest rate environment, estimated prepayment speeds of the
underlying mortgages serviced, and other economic conditions. The proceeds that
might be received should the Corporation actually consider a sale of the
mortgage servicing rights portfolio could differ from the amounts reported at
any point in time. The Corporation believes the mortgage servicing rights asset
is properly recorded in the financial statements. See Note 1, "Summary of
Significant Accounting Policies," and Note 6, "Goodwill and Other Intangible
Assets," of the notes to consolidated financial statements and section
"Noninterest Expense."
Derivative Financial Instruments and Hedge Accounting: In various aspects of its
business, the Corporation uses derivative financial instruments to modify
exposures to changes in interest rates and market prices for other financial
instruments. Substantially all of these derivative financial instruments are
designated as hedges for financial reporting purposes. The application of the
hedge accounting policy requires judgment in the assessment of hedge
effectiveness, identification of similar hedged item groupings, and measurement
of changes in the fair value of hedged items. However, if in the future the
derivative financial instruments used by the Corporation no longer qualify for
hedge accounting treatment and, consequently, the change in the fair value of
hedged items could be recognized in earnings, the impact on the consolidated
results of operations and reported earnings could be significant. The
Corporation believes hedge effectiveness is evaluated properly in the
consolidated financial statements. See Note 1, "Summary of Significant
Accounting Policies," and Note 16, "Derivative and Hedging Activities," of the
notes to consolidated financial statements.
Income Tax Accounting: The assessment of tax liabilities involves the use of
estimates, assumptions, interpretations, and judgments concerning certain
accounting pronouncements and federal and state tax codes. There can be no
assurance that future events, such as court decisions or positions of federal
and state taxing authorities, will not differ from management's current
assessment, the impact of which could be significant to the consolidated results
of operations and reported earnings. The Corporation believes the tax
liabilities are adequate and properly recorded in the consolidated financial
statements. See Note 1, "Summary of Significant Accounting Policies," and Note
14, "Income Taxes," and section "Income Taxes."
Segment Review
As described in Note 21, "Segment Reporting," the Corporation's primary
reportable segment is banking, conducted through its bank and lending
subsidiaries. Banking includes: a) community banking - lending and deposit
gathering to businesses (including business-related services such as cash
management and international banking services) and to consumers (including
mortgages and credit cards); and b) corporate banking - specialized lending
(such as commercial real estate), lease financing, and banking to larger
businesses and metro or niche markets; and the support to deliver banking
services.
13
The Corporation's profitability is primarily dependent on net interest income,
noninterest income, the level of the provision for loan losses, noninterest
expense, and taxes of its banking segment. The consolidated discussion is
therefore predominantly describing the banking segment results.
Performance Summary
The Corporation recorded net income of $210.7 million for the year ended
December 31, 2002, an increase of $31.2 million or 17.4% over the $179.5 million
earned in 2001. Basic earnings per share for 2002 were $2.82, a 14.2% increase
over 2001 basic earnings per share of $2.47. Earnings per diluted share were
$2.79, a 13.9% increase over 2001 diluted earnings per share of $2.45. With the
required adoption of Statement of Financial Accounting Standards ("SFAS") 142
and SFAS 147, which eliminated the amortization of goodwill effective January 1,
2002, basic earnings per share of $2.82 in 2002 represented a 10.3% increase
over 2001 and diluted earnings per share of $2.79 in 2002 were 10.0% higher than
2001 (as presented in Table 1). Return on average assets and return on average
equity for 2002 were 1.47% and 17.10%, respectively, compared to 1.37% and
17.31%, respectively, for 2001. Cash dividends of $1.21 per share paid in 2002
increased by 9.3% over 2001. Key factors behind these results were:
- - Taxable equivalent net interest income was $525.3 million for 2002, $81.1
million or 18.3% higher than 2001. Although taxable equivalent interest
income decreased $86.7 million, interest expense decreased by $167.8
million. The increase in taxable equivalent net interest income was due to
changes in interest rates (adding $45.8 million) and increased volume of
earning assets and liabilities, together with changes in product mix
(adding $35.3 million). Average earning assets increased $1.0 billion to
$13.3 billion, including the impact of the acquisition of Signal Financial
Corporation ("Signal") on February 28, 2002 (see section "Business
Combinations").
- - Net interest income and net interest margin were impacted in 2002 by the
low interest rate environment, competitive pricing pressures, higher
earning asset balances, and funding strategies to take advantage of lower
interest rates. While the Federal Reserve lowered interest rates eleven
times during 2001, producing an average Federal funds rate of 3.88% for
2001, interest rates in 2002 remained level at 1.75% until November when
the Federal Reserve reduced the rate by 50 basis points ("bp"), for an
average rate of 1.67% in 2002.
- - The net interest margin for 2002 was 3.95%, compared to 3.62% in 2001. The
33 bp increase in net interest margin is attributable to the net of a 50 bp
increase in interest rate spread (the net of a 172 bp lower cost of
interest-bearing liabilities offset by a 122 bp decrease in the yield on
earning assets), and a 17 bp lower contribution from net free funds.
- - Total loans were $10.3 billion at December 31, 2002, an increase of $1.3
billion or 14.2% over December 31, 2001, attributable in large part to the
Signal acquisition, which added $760 million in loans at consummation date.
Commercial loan balances grew $1.1 billion (20.4%) and represented 61% of
total loans at December 31, 2002, compared to 58% at year-end 2001. Total
deposits were $9.1 billion at December 31, 2002, including $785 million
acquired with the Signal acquisition. To take advantage of the lower rate
environment, the Corporation increased long-term debt by $803 million and
issued $175 million of company-obligated mandatorily redeemable preferred
securities.
- - Asset quality was affected by the impact of challenging economic conditions
on customers. The provision for loan losses increased to $50.7 million
compared to $28.2 million in 2001. Net charge offs were $28.3 million, an
increase of $8.1 million over 2001, due primarily to the charge off of
several commercial credits. Net charge offs were 0.28% of average loans
compared to 0.22% in 2001. The ratio of allowance for loan losses to loans
was 1.58% and 1.42% at December 31, 2002 and 2001, respectively.
Nonperforming loans were $99.3 million, representing 0.96% of total loans
at year-end 2002, compared to $52.1 million or 0.58% of total loans last
year.
- - Noninterest income was $220.3 million for 2002, $24.7 million or 12.6%
higher than 2001, led by strong results in mortgage banking and service
charge revenue. Mortgage banking revenue increased by $17.2 million (32.0%)
driven by strong secondary mortgage production, while service charges on
deposit accounts were up $8.2 million (21.8%) over 2001.
14
- - Noninterest expense was $374.5 million, up $36.2 million or 10.7% over
2001. Adjusting for goodwill amortization, as described above, noninterest
expense was $42.7 million or 12.9% higher in 2002, due principally to the
Corporation's larger operating base and increases in mortgage servicing
rights expense. Personnel expense rose $21.6 million or 12.6%, reflecting
the expanded employee base, as well as higher base salaries and fringe
benefit costs. Mortgage servicing rights expense increased $10.5 million, a
function of increases to both the valuation allowance and higher
amortization of the mortgage servicing rights asset.
- - Income tax expense increased to $85.6 million, up $14.1 million from 2001.
The increase was primarily attributable to higher net income before tax.
The effective tax rate in 2002 was 28.9% compared to 28.5% for 2001.
Business Combinations
On February 28, 2002, the Corporation consummated its acquisition of 100% of the
outstanding common shares of Signal, a financial holding company headquartered
in Mendota Heights, Minnesota. Signal operated banking branches in nine
locations in the Twin Cities and Eastern Minnesota. As a result of the
acquisition, the Corporation expanded its Minnesota presence, particularly in
the Twin Cities area. The Signal transaction was consummated through the
issuance of approximately 4.1 million shares of common stock and $58.4 million
in cash for a purchase price of $192.5 million. The value of the shares was
determined using the closing stock price of the Corporation's stock on September
10, 2001, the initiation date of the transaction. There were no business
combinations during 2001 or 2000. The Corporation's business combination
activity is further summarized in Note 2, "Business Combination," of the notes
to consolidated financial statements.
INCOME STATEMENT ANALYSIS
Net Interest Income
Net interest income is the primary source of the Corporation's revenue. Net
interest income is the difference between interest income on earning assets,
such as loans and securities, and the interest expense on interest-bearing
deposits and other borrowings, used to fund interest earning and other assets or
activities. The amount of net interest income is affected by changes in interest
rates and by the amount and composition of earning assets and interest-bearing
liabilities. Additionally, net interest income is impacted by the sensitivity of
the balance sheet to changes in interest rates which factors in characteristics
such as the fixed or variable nature of the financial instruments, contractual
maturities, and repricing frequencies.
Net interest income in the consolidated statements of income (which excludes the
taxable equivalent adjustment) was $501.3 million, compared to $422.0 million
last year. The taxable equivalent adjustments (the adjustments to bring
tax-exempt interest to a level that would yield the same after-tax income had
that income been subject to taxation using a 35% tax rate) of $24.0 million for
2002 and $22.2 million for 2001 resulted in fully taxable equivalent net
interest income of $525.3 million and $444.2 million, respectively.
Taxable equivalent net interest income was $525.3 million for 2002, an increase
of $81.1 million or 18.3% from 2001. The increase in taxable equivalent net
interest income was attributable to both lower interest rates, particularly on
the cost of interest-bearing liabilities, and a higher level of earning assets.
The net interest margin for 2002 was 3.95%, compared to 3.62% in 2001. The 33 bp
increase in net interest margin is attributable to the net of a 50 bp increase
in interest rate spread (the net of a 172 bp lower cost of interest-bearing
liabilities offset by a 122 bp decrease in the yield on earning assets), and a
17 bp lower contribution from net free funds. Interest rates were generally
stable and low during 2002, but were higher and steadily falling during 2001.
Comparatively, the Federal funds rate at December 31, 2002, was 50 bp lower than
at December 31, 2001, while the average Federal funds rate for 2002 was 221 bp
lower than for 2001.
15
Interest rate spread and net interest margin are utilized to measure and explain
changes in net interest income. Interest rate spread is the difference between
the yield on earning assets and the rate paid for interest-bearing liabilities
that fund those assets. The net interest margin is expressed as the percentage
of net interest income to average earning assets. The net interest margin
exceeds the interest rate spread because noninterest-bearing sources of funds
(net free funds), principally demand deposits and stockholders' equity, also
support earning assets. To compare tax-exempt asset yields to taxable yields,
the yield on tax-exempt loans and securities is computed on a taxable equivalent
basis. Net interest income, interest rate spread, and net interest margin are
discussed on a taxable equivalent basis.
Table 2 provides average balances of earning assets and interest-bearing
liabilities, the associated interest income and expense, and the corresponding
interest rates earned and paid, as well as net interest income, interest rate
spread, and net interest margin on a taxable equivalent basis for the three
years ended December 31, 2002. Tables 3 through 5 present additional information
to facilitate the review and discussion of taxable equivalent net interest
income, interest rate spread, and net interest margin.
As shown in the rate/volume analysis in Table 3, changes in the rates resulted
in a $45.8 million increase to taxable equivalent net interest income, while
increases in volume and changes in the mix of both earning assets and
interest-bearing liabilities added $35.3 million, for a combined increase of
$81.1 million. Rate changes on interest-bearing liabilities lowered interest
expense by $190.2 million, while the changes in rates on earning assets reduced
interest income by $144.4 million, for a net favorable impact of $45.8 million.
For 2002, the cost of interest-bearing liabilities decreased 172 bp to 2.55%,
aided by the low rate environment. The combined average cost of interest-bearing
deposits was 2.28%, down 175 bp, with the most significant rate decreases seen
in deposit categories with the highest balances, namely money market accounts
(down 193 bp to 1.32%) and non-brokered time deposits (down 177 bp to 3.74%).
The cost of wholesale funds (comprised of all short-term borrowings and
long-term funding) decreased 172 bp to 3.06% for 2002, with the Corporation
implementing a number of funding strategies to take advantage of the low
interest rate environment. The interest-bearing liability rate changes resulted
in $190.2 million lower interest expense, with $129.9 million attributable to
interest-bearing deposits and $60.3 million due to wholesale funding.
For 2002, the yield on earning assets fell 122 bp to 6.14%, driven primarily by
a 136 bp decline in the loan yield. The average loan yield was 6.27%. The lower
rate environment for new originations, competitive pricing pressure and
refinancing in many loan categories put downward pressure on loan yields in
2002. The yield on securities and short-term investments combined was down 85 bp
to 5.73%. The earning asset rate changes reduced interest income by $144.4
million, a combination of $118.3 million lower interest on loans and $26.1
million lower interest on securities and short-term investments combined.
From a volume perspective, the growth and composition change of earning assets
contributed an additional $57.7 million to taxable equivalent net interest
income, while the growth and composition of interest-bearing liabilities cost an
additional $22.4 million, netting a $35.3 million increase to taxable equivalent
net interest income.
Average earning assets were $13.3 billion in 2002, an increase of $1.0 billion,
or 8.3%, from 2001, including the impact of the Signal acquisition on February
28, 2002. Loans accounted for the majority of the growth in earning assets,
increasing by $910 million, or 10.0%, to $10.0 billion on average in 2002 and
representing 75.2% of average earning assets compared to 74.1% for 2001. For
2002, taxable equivalent interest income on loans increased $52.0 million from
growth, but decreased $118.3 million from the impact of the rate environment (as
noted above), for a net decrease of $66.3 million versus last year (See Table
3). Securities and short-term investments combined increased $113 million on
average. Taxable equivalent interest income on securities and short-term
investments for 2002 increased $5.7 million from volume changes, but decreased
$26.1 million from the impact of the rate environment, for a net $20.4 million
decrease to taxable equivalent interest income.
16
Average interest-bearing liabilities were $11.4 billion in 2002, an increase of
$643 million, or 6.0%, from 2001. The growth in earning assets was also
supported by a $332 million, or 28.4%, increase in average noninterest-bearing
deposits (a component of net free funds). The growth in interest-bearing
liabilities came from increases in wholesale funding sources, as average
interest-bearing deposits were level in 2002 compared to 2001. Average wholesale
funding sources increased by $644 million, representing 34.9% of average
interest-bearing liabilities for 2002, versus 31.0% last year. Furthermore, to
take advantage of the lower rate environment, the Corporation shifted funds from
short-term borrowing sources to long-term funding, increasing its long-term
funding by $1.1 billion to 14.7% of average interest-bearing liabilities
(compared to 5.3% for 2001). Therefore, for 2002, interest expense on wholesale
funding increased by $22.4 million due to volume changes (the net of a $47.3
million increase from additional average long-term funding offset by a $24.9
million decrease of short-term borrowings) and decreased by $60.3 million from
lower rates. With no volume change in total interest-bearing deposits, the
$129.9 million reduction in interest expense on those deposits was attributable
to the favorable impact of the lower rate environment.
17
TABLE 2: Average Balances and Interest Rates (interest and rates on a taxable equivalent basis)
Years Ended December 31,
-----------------------------------------------------------------------------------------------
2002 2001 2000
-----------------------------------------------------------------------------------------------
Average Average Average Average Average Average
Balance Interest Rate Balance Interest Rate Balance Interest Rate
-----------------------------------------------------------------------------------------------
($ in Thousands)
ASSETS
Earning assets:
Loans: (1)(2)(3)
Residential real estate $ 3,362,179 $223,314 6.64% $ 3,546,204 $271,039 7.64% $ 3,152,128 $243,986 7.74%
Commercial 5,929,113 348,082 5.87 4,898,895 366,495 7.48 4,313,271 376,068 8.72
Consumer 711,186 56,106 7.89 647,600 56,246 8.69 1,222,687 108,074 8.84
-----------------------------------------------------------------------------------------------
Total loans 10,002,478 627,502 6.27 9,092,699 693,780 7.63 8,688,086 728,128 8.38
Investment securities:
Taxable 2,431,713 125,299 5.15 2,306,444 146,170 6.34 2,523,492 163,768 6.49
Tax exempt(1) 831,130 62,719 7.55 837,343 61,507 7.35 794,007 58,233 7.33
Short-term investments 29,270 658 2.25 35,380 1,421 4.02 41,309 2,775 6.72
-----------------------------------------------------------------------------------------------
Securities and short-term
investments 3,292,113 188,676 5.73 3,179,167 209,098 6.58 3,358,808 224,776 6.69
-----------------------------------------------------------------------------------------------
Total earning assets $13,294,591 $816,178 6.14% $12,271,866 $902,878 7.36% $12,046,894 $952,904 7.91%
-----------------------------------------------------------------------------------------------
Allowance for loan losses (148,801) (125,790) (115,580)
Cash and due from banks 302,856 279,363 268,267
Other assets 848,772 678,315 610,654
-----------------------------------------------------------------------------------------------
Total assets $14,297,418 $13,103,754 $12,810,235
===============================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Savings deposits $ 891,105 $ 6,813 0.76% $ 839,417 $ 11,812 1.41% $ 956,177 $ 19,704 2.06%
Interest-bearing demand deposits 1,118,546 9,581 0.86 799,451 7,509 0.94 803,779 11,091 1.38
Money market deposits 1,876,988 24,717 1.32 1,722,242 55,999 3.25 1,407,502 65,702 4.67
Time deposits, excluding
Brokered CDs 3,263,766 122,181 3.74 3,648,942 201,035 5.51 4,008,382 228,191 5.69
-----------------------------------------------------------------------------------------------
Total interest-bearing
deposits, excluding
Brokered CDs 7,150,405 163,292 2.28 7,010,052 276,355 3.94 7,175,840 324,688 4.52
Brokered CDs 264,023 5,729 2.17 404,686 22,575 5.58 840,518 55,204 6.57
-----------------------------------------------------------------------------------------------
Total interest-bearing
deposits 7,414,428 169,021 2.28 7,414,738 298,930 4.03 8,016,358 379,892 4.74
Federal funds purchased and
securities Sold under
agreements to repurchase 2,058,163 42,143 2.05 1,839,336 77,011 4.19 1,724,291 107,732 6.25
Other short-term borrowings 250,919 9,229 3.68 924,420 53,535 5.79 816,553 52,698 6.45
Long-term funding 1,673,071 70,447 4.21 574,753 29,161 5.07 114,374 7,268 6.35
-----------------------------------------------------------------------------------------------
Total wholesale funding 3,982,153 121,819 3.06 3,338,509 159,707 4.78 2,655,218 167,698 6.32
-----------------------------------------------------------------------------------------------
Total interest-bearing
liabilities $11,396,581 $290,840 2.55% $10,753,247 $458,637 4.27% $10,671,576 $547,590 5.13%
-----------------------------------------------------------------------------------------------
Noninterest-bearing demand
deposits 1,498,106 1,166,495 1,086,582
Accrued expenses and other
liabilities 170,754 146,854 131,908
Stockholders' equity 1,231,977 1,037,158 920,169
-----------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity $14,297,418 $13,103,754 $12,810,235
===============================================================================================
Net interest income and rate
spread (1) $525,338 3.59% $444,241 3.09% $405,314 2.78%
===============================================================================================
Net interest margin (1) 3.95% 3.62% 3.36%
===============================================================================================
Taxable equivalent adjustment $ 24,072 $ 22,256 $ 21,747
===============================================================================================
(1) The yield on tax exempt loans and securities is computed on a taxable
equivalent basis using a tax rate of 35% for all periods presented and is
net of the effects of certain disallowed interest deductions.
(2) Nonaccrual loans and loans held for sale have been included in the average
balances.
(3) Interest income includes net loan fees.
18
TABLE 3: Rate/Volume Analysis (1)
2002 Compared to 2001 2001 Compared to 2000
Increase (Decrease) Due to Increase (Decrease) Due to
---------------------------------------------------------------------------
Volume Rate Net Volume Rate Net
---------------------------------------------------------------------------
($ in Thousands)
Interest income:
Loans: (2)
Residential real estate $ (12,535) $ (35,190) $ (47,725) $ 35,017 $ (7,964) $ 27,053
Commercial 63,495 (81,908) (18,413) 46,979 (56,552) (9,573)
Consumer 1,035 (1,175) (140) (50,910) (918) (51,828)
---------------------------------------------------------------------------
Total loans 51,995 (118,273) (66,278) 31,086 (65,434) (34,348)
Investment securities:
Taxable 6,320 (27,191) (20,871) (13,844) (3,754) (17,598)
Tax-exempt (2) (536) 1,748 1,212 3,183 91 3,274
Short-term investments (94) (669) (763) (354) (1,000) (1,354)
---------------------------------------------------------------------------
Securities and short-term investments 5,690 (26,112) (20,422) (11,015) (4,663) (15,678)
---------------------------------------------------------------------------
Total earning assets (2) $ 57,685 $(144,385) $ (86,700) $ 20,071 $ (70,097) $ (50,026)
---------------------------------------------------------------------------
Interest expense:
Savings deposits $ 395 $ (5,394) $ (4,999) $ (2,194) $ (5,698) $ (7,892)
Interest-bearing demand deposits 2,733 (661) 2,072 (59) (3,523) (3,582)
Money market deposits 2,038 (33,320) (31,282) 12,800 (22,503) (9,703)
Time deposits, excluding Brokered CDs (2,121) (76,733) (78,854) (19,977) (7,179) (27,156)
---------------------------------------------------------------------------
Total interest-bearing deposits, 3,045 (116,108) (113,063) (9,430) (38,903) (48,333)
excluding Brokered CDs
Brokered CDs (3,053) (13,793) (16,846) (25,284) (7,345) (32,629)
---------------------------------------------------------------------------
Total interest-bearing deposits (8) (129,901) (129,909) (34,714) (46,248) (80,962)
Federal funds purchased and securities
sold under Agreements to repurchase (3,482) (31,386) (34,868) 6,588 (37,309) (30,721)
Other short-term borrowings (21,456) (22,850) (44,306) 6,421 (5,584) 837
Long-term funding 47,351 (6,065) 41,286 23,479 (1,586) 21,893
---------------------------------------------------------------------------
Total wholesale funding 22,413 (60,301) (37,888) 36,488 (44,479) (7,991)
---------------------------------------------------------------------------
Total interest-bearing liabilities $ 22,405 $(190,202) $(167,797) $ 1,774 $ (90,727) $ (88,953)
---------------------------------------------------------------------------
Net interest income (2) $ 35,280 $ 45,817 $ 81,097 $ 18,297 $ 20,630 $ 38,927
===========================================================================
(1) The change in interest due to both rate and volume has been allocated in
proportion to the relationship to the dollar amounts of the change in each.
(2) The yield on tax-exempt loans and securities is computed on a fully taxable
equivalent basis using a tax rate of 35% for all periods presented and is
net of the effects of certain disallowed interest deductions.
19
TABLE 4: Interest Rate Spread and Interest Margin (on a taxable equivalent basis)
2002 Average 2001 Average 2000 Average
---------------------------------------------------------------------------------------------
% of % of % of
Earning Yield Earning Yield Earning Yield
Balance Assets /Rate Balance Assets /Rate Balance Assets /Rate
---------------------------------------------------------------------------------------------
($ in Thousands)
Earning assets $13,294,591 100.0% 6.14% $12,271,866 100.0% 7.36% $12,046,894 100.0% 7.91%
---------------------------------------------------------------------------------------------
Financed by:
Interest-bearing funds $11,396,581 85.7% 2.55% $10,753,247 87.6% 4.27% $10,671,576 88.6% 5.13%
Noninterest-bearing
funds 1,898,010 14.3% 1,518,619 12.4% 1,375,318 11.4%
----------------------------------------------------------------------------------------------
Total funds sources $13,294,591 100.0% 2.19% $12,271,866 100.0% 3.74% $12,046,894 100.0% 4.55%
=============================================================================================
Interest rate spread 3.59% 3.09% 2.78%
Contribution from net
free funds .36% .53% .58%
----- ----- -----
Net interest margin 3.95% 3.62% 3.36%
=============================================================================================
Average prime rate* 4.68% 6.91% 9.23%
Average federal funds
rate* 1.67% 3.88% 6.26%
Average spread 301bp 303bp 297bp
=============================================================================================
*Source: Bloomberg
TABLE 5: Selected Average Balances
Percent 2002 as % of 2001 as % of
2002 2001 Change Total Assets Total Assets
-------------------------------------------------------------------------
($ in Thousands)
ASSETS
Loans $10,002,478 $ 9,092,699 10.0% 70.0% 69.4%
Investment securities
Taxable 2,431,713 2,306,444 5.4 17.0 17.6
Tax-exempt 831,130 837,343 (0.7) 5.8 6.4
Short-term investments 29,270 35,380 (17.3) 0.2 0.3
--------------------------------------------------------------------------
Total earning assets 13,294,591 12,271,866 8.3 93.0 93.7
Other assets 1,002,827 831,888 20.5 7.0 6.3
-------------------------------------------------------------------------
Total assets $14,297,418 $13,103,754 9.1% 100.0% 100.0%
=========================================================================
LIABILITIES & STOCKHOLDERS' EQUITY
Interest-bearing deposits $ 7,414,428 $ 7,414,738 ---% 51.8% 56.6%
Short-term borrowings 2,309,082 2,763,756 (16.5) 16.2 21.1
Long-term funding 1,673,071 574,753 191.1 11.7 4.4
-------------------------------------------------------------------------
Total interest-bearing liabilities 11,396,581 10,753,247 6.0 79.7 82.1
Noninterest-bearing demand deposits 1,498,106 1,166,495 28.4 10.5 8.9
Accrued expenses and other liabilities 170,754 146,854 16.3 1.2 1.1
Stockholders' equity 1,231,977 1,037,158 18.8 8.6 7.9
-------------------------------------------------------------------------
Total liabilities and stockholders' equity $14,297,418 $13,103,754 9.1% 100.0% 100.0%
=========================================================================
Provision for Loan Losses
The provision for loan losses in 2002 was $50.7 million. The provision for loan
losses for 2001 was $28.2 million, and $20.2 million for 2000. The provision for
loan losses is predominantly a function of the methodology and other qualitative
and quantitative factors used to determine the adequacy of the
20
allowance for loan losses which focuses on changes in the size and
character of the loan portfolio, changes in levels of impaired and other
nonperforming loans, historical losses on each portfolio category, the risk
inherent in specific loans, concentrations of loans to specific borrowers
or industries, existing economic conditions, the fair value of underlying
collateral, and other factors which could affect potential credit losses.
At December 31, 2002, the allowance for loan losses was $162.5 million, compared
to $128.2 million at December 31, 2001, and $120.2 million at December 31, 2000.
Net charge offs were $28.3 million for 2002, compared to $20.2 million for 2001
and $9.0 million for 2000. The ratio of the allowance for loan losses to total
loans was 1.58%, up from 1.42% at December 31, 2001, and up from 1.35% at
December 31, 2000. Nonperforming loans at December 31, 2002, were $99.3 million,
compared to $52.1 million at December 31, 2001, and $47.7 million at December
31, 2000. See additional discussion under sections, "Allowance for Loan Losses,"
and "Nonperforming Loans, Potential Problem Loans, and Other Real Estate Owned."
Noninterest Income
Noninterest income was $220.3 million for 2002, $24.7 million or 12.6% higher
than 2001. Primary categories that have attributed to the change between
comparable periods were mortgage banking and service charges on deposit
accounts. Fee income as a percentage of total revenues (defined as total
noninterest income less gains or losses on asset and investment sales ("fee
income") divided by taxable equivalent net interest income plus fee income) was
29.5% for 2002 compared to 30.3% last year.
TABLE 6: Noninterest Income
% Change From
Years Ended December 31, Prior Year
--------------------------------------------------------
2002 2001 2000 2002 2001
--------------------------------------------------------
($ in Thousands)
Trust service fees $ 27,875 $ 29,063 $ 37,617 (4.1)% (22.7)%
Service charges on deposit accounts 46,059 37,817 33,296 21.8 13.6
Mortgage banking 70,903 53,724 19,944 32.0 169.4
Credit card and other nondeposit fees 27,492 26,731 25,739 2.8 3.9
Retail commissions 18,264 16,872 20,187 8.3 (16.4)
Bank owned life insurance income 13,841 12,916 12,377 7.2 4.4
Asset sale gains, net 657 1,997 24,420 (67.1) (91.8)
Other 15,644 15,765 18,265 (0.8) (13.7)
--------------------------------------------------------
Subtotal $220,735 $194,885 $191,845 13.3% 1.6%
Investment securities gains (losses), net (427) 718 (7,649) N/M N/M
--------------------------------------------------------
Total noninterest income $220,308 $195,603 $184,196 12.6% 6.2%
========================================================
Subtotal, net of asset sale gains ("fee
income") $220,078 $192,888 $167,425 14.1% 15.2%
========================================================
N/M = not meaningful
21
Trust service fees for 2002 were $27.9 million, down $1.2 million (4.1%) from
last year. The change was predominantly the result of decreases in servicing
fees on personal and employee benefit plans due to the 8% lower average market
value of assets under management, reflecting market conditions, offset partly by
fee increases for other trust services. The market value of assets under
management was $3.5 billion at December 31, 2002 compared to $4.0 billion at
December 31, 2001.
Service charges on deposit accounts were $46.1 million, $8.2 million (21.8%)
higher than 2001, due in part to higher volumes associated with a larger account
base. The increase was a function of lower earnings credit rates, higher service
charges on business accounts, higher fees on overdrafts/nonsufficient funds, and
an increase in service charge fees during the first quarter of 2002.
Mortgage banking income consists of servicing fees, the gain or loss on sales of
mortgage loans to the secondary market, gains on sales of servicing, and
production-related fees (origination, underwriting, and escrow waiver fees).
Mortgage banking income was $70.9 million in 2002, an increase of $17.2 million
or 32.0% over 2001. The increase was primarily a result of increased income
associated with higher production volumes. Secondary mortgage loan production
(mortgage loan production to be sold to the secondary market) was $3.2 billion
for 2002, up 38.2% over $2.3 billion for 2001. As a result, production-related
fees were up $8.0 million. Gains on sales of loans were up $12.1 million, a
function of the volume and loan sale pricing. Servicing fees on the portfolio
serviced for others were up $1.3 million between comparable periods, in line
with the increase in the portfolio serviced for others ($5.4 billion at December
31, 2002, versus $5.2 billion at December 31, 2001). Offsetting these increases
was $4.3 million in gains on the sales of mortgage servicing rights in 2001
versus none in 2002.
Credit card and other nondeposit fees were $27.5 million for 2002, an increase
of $0.8 million or 2.8% over 2001, primarily due to increased merchant and other
credit card revenues. In February 2003, the Corporation entered into a 10-year
agreement with an outside vendor to provide merchant processing services for the
Corporation's merchant customers. The agreement will result in after tax income
of approximately $2.0 million in the first quarter of 2003 and revenue sharing
on new and existing merchant business over the life of the agreement.
Retail commission income (which includes commissions from insurance and
brokerage product sales) was $18.3 million, up $1.4 million or 8.3% compared to
last year. This increase was attributable to insurance commissions, up $2.6
million, predominantly in commissions on fixed annuities, a more attractive
product given the lower interest rate environment. Brokerage commissions,
including variable annuities, were down $1.2 million, affected largely by the
weaker financial markets. During fourth quarter 2002, legislation became
effective requiring single premium credit insurance premiums on loans with real
estate collateral to be collected based on monthly outstanding balances. This
new requirement is expected to reduce credit insurance premiums somewhat in the
early periods of adoption.
Bank owned life insurance income was $13.8 million, up $0.9 million or 7.2% over
last year due to the larger bank owned life insurance asset. Asset sale gains
for 2002 were $0.7 million, while asset sale gains for 2001 were $2.0 million.
Other noninterest income was $15.6 million for 2002, down slightly ($0.1
million) from 2001, due to the sale of stock in a regional ATM network that
resulted in a gain of $0.5 million during 2002, while a similar transaction on a
different ATM network stock resulted in a gain of $2.6 million during 2001.
The 2002 investment securities net losses of $0.4 million included an $0.8
million other than temporary write down on a security. Investment securities net
gains for 2001 were $0.7 million from various securities sold.
Noninterest Expense
Total noninterest expense for 2002 was $374.5 million, a $36.2 million or 10.7%
increase over 2001 noninterest expense, influenced by the Corporation's larger
operating base with the February 28, 2002, acquisition of Signal. Adjusting for
goodwill amortization, which ceased on January 1, 2002, as a result of adopting
SFAS 142 and SFAS 147, noninterest expense was up $42.7 million or 12.9%. Larger
22
increases were in mortgage servicing rights expense, loan expense, and in
personnel and occupancy costs, given a larger employee base and broader branch
network as the Corporation assimilated Signal's businesses and operations.
During the second quarter of 2002, the Corporation completed its integration of
Signal's banking subsidiaries with Associated Bank Minnesota, to operate under a
single national charter named Associated Bank Minnesota, National Association.
TABLE 7: Noninterest Expense
% Change
From Prior
Years Ended December 31, Year
---------------------------------------------------
2002 2001 2000 2002 2001
---------------------------------------------------
($ in Thousands)
Personnel expense $192,918 $171,362 $157,007 12.6% 9.1%
Occupancy 26,049 23,947 23,258 8.8 3.0
Equipment 14,835 14,426 15,272 2.8 (5.5)
Data processing 21,024 19,596 22,375 7.3 (12.4)
Business development and advertising 13,812 13,071 13,359 5.7 (2.2)
Stationery and supplies 7,044 6,921 7,961 1.8 (13.1)
FDIC expense 1,533 1,661 1,818 (7.7) (8.6)
Mortgage servicing rights expense 30,473 19,987 9,406 52.5 112.5
Core deposit intangible amortization 2,283 1,867 2,345 22.3 (20.4)
Loan expense 14,555 11,176 8,447 30.2 32.3
Legal and professional fees 6,075 4,394 7,595 38.3 (42.1)
Other 43,948 43,450 42,333 1.1 2.6
---------------------------------------------------
Subtotal $374,549 $331,858 $311,176 12.9% 6.6%
Goodwill amortization --- 6,511 6,560 (100.0) (0.7)
---------------------------------------------------
Total noninterest expense $374,549 $338,369 $317,736 10.7% 6.5%
===================================================
Personnel expense (including salary-related expenses and fringe benefit
expenses) increased $21.6 million or 12.6% over 2001, and represented 51.5% of
total noninterest expense in 2002 compared to 50.6% in 2001 (or 51.6% using
noninterest expense excluding goodwill amortization). Average full-time
equivalent employees were 4,072 for 2002 (with Signal adding approximately 350
at the time of acquisition or approximately 250 on average for the year),
compared to 3,849 for 2001. Total salary-related expenses increased $16.6
million or 12.5% in 2002, primarily a function of higher base salaries and
incentive compensation given the overall increase in full-time equivalent
employees, and merit increases between years. Fringe benefits increased $5.0
million or 12.9% in 2002, attributable also to the larger employee base and to
the increased cost of premium based benefits (up 11.9%), and other fringe
benefit expenses commensurate with the salary-related expense increase.
Occupancy expense increased 8.8% to support the larger branch network
attributable mostly to the Signal acquisition, while equipment expense was
minimally changed from last year, up 2.8%. Data processing costs increased to
$21.0 million, up $1.4 million or 7.3% over last year, due to Internet banking
enhancements, processing for a larger base operation, and for the conversion of
Signal to the Corporation's common operating platforms in the second quarter of
2002. Business development and advertising increased to $13.8 million for 2002,
up $0.7 million or 5.7% compared to 2001, primarily supporting the new business
production of the year and the newer markets acquired. Stationery and supplies
were relatively unchanged from last year, up 1.8%. FDIC expense was down $0.1
million, primarily a function of lower average insurance rates paid.
Mortgage servicing rights expense includes both the amortization of the mortgage
servicing rights asset and increases or decreases to the valuation allowance
associated with the mortgage servicing rights asset. Mortgage servicing rights
expense increased by $10.5 million between 2002 and 2001, including a $3.6
million increase in the amortization of the mortgage servicing rights asset and
a $6.9 million larger
23
addition to the valuation allowance between years. While the strong
mortgage refinance activity benefited mortgage banking income, it increased the
prepayment speeds of the Corporation's mortgage portfolio serviced for others, a
key factor behind the valuation of mortgage servicing rights. See Note 1,
"Summary of Significant Accounting Policies," of the notes to consolidated
financial statements for the Corporation's accounting policy for mortgage
servicing rights and section "Critical Accounting Policies." A valuation
allowance is established to the extent the carrying value of the mortgage
servicing rights exceeds the estimated fair value. Net income could be affected
if management's estimate of the prepayment speeds or other factors differ
materially from actual prepayments. Mortgage servicing rights, included in other
intangible assets on the consolidated balance sheet, were $32.3 million, net of
a $28.4 million valuation allowance at December 31, 2002 (see Note 6, "Goodwill
and Other Intangible Assets," of the notes to consolidated financial
statements).
Core deposit intangible amortization increased to $2.3 million, primarily due to
additional core deposit intangibles resulting from the Signal acquisition. Loan
expense was $14.6 million, up $3.4 million from 2001, due to increased costs
related to higher production of all loan types, primarily higher merchant
interchange costs and mortgage loan expenses. Legal and professional fees were
up $1.7 million over 2001 with most categories showing increases, including
legal costs related to loan production and loan quality, technology consulting,
and examinations. Goodwill amortization expense decreased $6.5 million due to
the adoption of SFAS 142 and SFAS 147, which ceased the amortization of goodwill
effective January 1, 2002. See Note 1, "Summary of Significant Accounting
Policies," Note 2, "Business Combination," and Note 6, "Goodwill and Other
Intangible Assets," of the notes to consolidated financial statements.
Income Taxes
Income tax expense for 2002 was $85.6 million, up $14.1 million from 2001 income
tax expense of $71.5 million. The Corporation's effective tax rate (income tax
expense divided by income before taxes) was 28.9% in 2002 compared to 28.5% in
2001. The increase was primarily attributable to the increase in net income
before tax.
See Note 1, "Summary of Significant Accounting Policies," of the notes to
consolidated financial statements for the Corporation's income tax accounting
policy and section "Critical Accounting Policies." Income tax expense recorded
in the consolidated income statement involves interpretation and application of
certain accounting pronouncements and federal and state tax codes, and is
therefore, considered a critical accounting policy. The Corporation undergoes
examination by various taxing authorities. Such taxing authorities may require
that changes in the amount of tax expense or valuation allowance be recognized
when their interpretations differ from those of management, based on their
judgments about information available to them at the time of their examinations.
See Note 14, "Income Taxes," of the notes to consolidated financial statements
for more information.
BALANCE SHEET ANALYSIS
Loans
Total loans were $10.3 billion at December 31, 2002, an increase of $1.3 billion
or 14.2% over December 31, 2001, largely attributable to the Signal acquisition,
which added $760 million in loans at consummation date. Commercial loans were
$6.3 billion, up $1.1 billion or 20.4%. Commercial loans grew to represent 61%
of total loans at the end of 2002, up from 58% at year-end 2001. Home equity and
other consumer loans combined grew $309 million or 24.3%, while residential
mortgage loans decreased 3.7%, strongly influenced by lower interest rates and
high refinance activity.
24
TABLE 8: Loan Composition
As of December 31,
-------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
-------------------------------------------------------------------------------------------------
% of % of % of % of % of
Amount Total Amount Total Amount Total Amount Total Amount Total
-------------------------------------------------------------------------------------------------
($ in Thousands)
Commercial, financial, and
agricultural $ 2,213,986 22% $1,783,300 20% $1,657,322 19% $1,412,338 17% $ 962,208 13%
Real estate construction 910,581 9 797,734 9 660,732 7 560,450 7 461,157 7
Commercial real estate 3,128,826 30 2,630,964 29 2,287,946 26 1,903,633 23 1,384,524 19
Lease financing 38,352 -- 11,629 -- 14,854 -- 23,229 -- 19,231 --
-------------------------------------------------------------------------------------------------
Commercial 6,291,745 61 5,223,627 58 4,620,854 52 3,899,650 47 2,827,120 39
Residential mortgage 2,430,746 24 2,524,199 28 3,158,721 35 3,274,767 39 3,362,885 46
Home equity 864,631 8 609,254 7 508,979 6 408,577 5 331,861 5
-------------------------------------------------------------------------------------------------
Residential real estate 3,295,377 32 3,133,453 35 3,667,700 41 3,683,344 44 3,694,746 51
Consumer 716,103 7 662,784 7 624,825 7 760,106 9 750,831 10
-------------------------------------------------------------------------------------------------
Total loans $10,303,225 100% $9,019,864 100% $8,913,379 100% $8,343,100 100% $7,272,697 100%
=================================================================================================
Commercial, financial, and agricultural loans were $2.2 billion at the end of
2002, up $431 million or 24.2% since year-end 2001, and comprised 22% of total
loans outstanding, up from 20% at the end of 2001. The commercial, financial,
and agricultural loan classification primarily consists of commercial loans to
middle market companies and small businesses. Loans of this type are in a
diverse range of industries. The credit risk related to commercial loans is
largely influenced by general economic conditions and the resulting impact on a
borrower's operations. Within the commercial, financial, and agricultural
classification, loans to finance agricultural production totaled only 0.3% of
total loans at December 31, 2002, compared to 0.2% at December 31, 2001.
Real estate construction loans grew $113 million or 14.1% to $911 million,
representing 9% of the total loan portfolio at the end of 2002, compared to $798
million or 9% at the end of 2001. Loans in this classification are primarily
short-term interim loans that provide financing for the acquisition or
development of commercial real estate, such as multifamily or other commercial
development projects. Real estate construction loans are made to developers and
project managers who are well known to the Corporation, have prior successful
project experience, and are well capitalized. Projects undertaken by these
developers are carefully reviewed by the Corporation to ensure that they are
economically viable. Loans of this type are primarily made to customers based in
the Corporation's tri-state market in which the Corporation has a thorough
knowledge of the local market economy. The credit risk associated with real
estate construction loans is generally confined to specific geographic areas,
but is also influenced by general economic conditions. The Corporation controls
the credit risk on these types of loans by making loans in familiar markets to
developers, underwriting the loans to meet the requirements of institutional
investors in the secondary market, reviewing the merits of individual projects,
controlling loan structure, and monitoring project progress and construction
advances.
Commercial real estate includes loans secured by farmland, multifamily
properties, and nonfarm/nonresidential real estate properties. Commercial real
estate totaled $3.1 billion at December 31, 2002, up $498 million or 18.9% over
last year and comprised 30% of total loans outstanding versus 29% at year-end
2001. Commercial real estate loans involve borrower characteristics similar to
those discussed above for commercial loans and real estate-construction
projects. Loans of this type are mainly for business and industrial properties,
multifamily properties, and community purpose properties. Loans are primarily
made to customers based in Wisconsin, Illinois, and Minnesota. Credit risk is
managed in a similar manner to commercial loans and real estate construction by
employing sound underwriting guidelines, lending to borrowers in local markets
and businesses, and formally reviewing the borrower's financial soundness and
relationship on an ongoing basis. In many cases the Corporation will take
additional real estate collateral to further secure the overall lending
relationship.
25
Residential real estate loans totaled $3.3 billion at the end of 2002, up $162
million or 5.2% from the prior year and comprised 32% of total loans outstanding
versus 35% at year-end 2001. Loans in this classification include residential
mortgage (which consists of conventional home mortgages and second mortgages)
and home equity lines. Residential mortgage loans generally limit the maximum
loan to 80% of collateral value. Residential mortgage loans were $2.4 billion at
December 31, 2002, down $93 million or 3.7% compared to last year, principally
due to high refinance activity prompted by lower interest rates and the
subsequent sale of newer, fixed-rate loan production into the secondary market.
Home equity lines grew by $255 million, or 41.9%, to $865 million in 2002, an
attractive product to consumers given the lower rate environment in 2002.
Consumer loans to individuals totaled $716 million at December 31, 2002, up $53
million or 8.0% compared to 2001, representing 7% of the year-end loan
portfolio. Consumer loans include short-term installment loans, direct and
indirect automobile loans, recreational vehicle loans, credit card loans (which
are primarily business-oriented), student loans, and other personal loans.
Individual borrowers may be required to provide related collateral or a
satisfactory endorsement or guaranty from another person, depending on the
specific type of loan and the creditworthiness of the borrower. Credit risk for
these types of loans is generally greatly influenced by general economic
conditions, the characteristics of individual borrowers, and the nature of the
loan collateral. Credit risk is primarily controlled by reviewing the
creditworthiness of the borrowers as well as taking appropriate collateral and
guaranty positions on such loans.
Factors that are critical to managing overall credit quality are sound loan
underwriting and administration, systematic monitoring of existing loans and
commitments, effective loan review on an ongoing basis, early identification of
potential problems, an adequate allowance for loan losses, and sound nonaccrual
and charge off policies.
An active credit risk management process is used for commercial loans to further
ensure that sound and consistent credit decisions are made. Credit risk is
controlled by detailed underwriting procedures, comprehensive loan
administration, and periodic review of borrowers' outstanding loans and
commitments. Borrower relationships are formally reviewed on an ongoing basis
for early identification of potential problems. Further analyses by customer,
industry, and geographic location are performed to monitor trends, financial
performance, and concentrations.
The loan portfolio is widely diversified by types of borrowers, industry groups,
and market areas within our primary three-state area. Significant loan
concentrations are considered to exist for a financial institution when there
are amounts loaned to numerous borrowers engaged in similar activities that
would cause them to be similarly impacted by economic or other conditions. At
December 31, 2002, no significant concentrations existed in the Corporation's
portfolio in excess of 10% of total loans.
TABLE 9: Loan Maturity Distribution and Interest Rate Sensitivity (1)
Maturity (2)
-----------------------------------------------------------
December 31, 2002 Within 1 Year 1-5 Years After 5 Years Total
-----------------------------------------------------------
($inThousands)
Commercial, financial, and
agricultural $1,761,903 $379,258 $72,825 $2,213,986
Real estate construction 748,742 114,368 47,471 910,581
-----------------------------------------------------------
Total $2,510,645 $493,626 $120,296 $3,124,567
===========================================================
Fixed rate $ 612,802 $439,117 $120,251 $1,172,170
Floating or adjustable rate 1,897,843 54,509 45 1,952,397
-----------------------------------------------------------
Total $2,510,645 $493,626 $120,296 $3,124,567
===========================================================
Percent 80% 16% 4% 100%
(1) Based upon scheduled principal repayments.
(2) Demand loans, past due loans, and overdrafts are reported in the "Within 1
Year" category.
26
Allowance for Loan Losses
The loan portfolio is the primary asset subject to credit risk. Credit risk is
controlled and monitored through the use of lending standards, a thorough review
of potential borrowers, and on-going review of loan payment performance. Active
asset quality administration, including early problem loan identification and
timely resolution of problems, further ensures appropriate management of credit
risk and minimization of loan losses. Credit risk management for each loan type
is discussed briefly in the section entitled "Loans."
The allowance for loan losses represents management's estimate of an amount
adequate to provide for probable credit losses in the loan portfolio at the
balance sheet date. Management's evaluation of the adequacy of the allowance for
loan losses is based on management's ongoing review and grading of the loan
portfolio, consideration of past loan loss experience, trends in past due and
nonperforming loans, risk characteristics of the various classifications of
loans, existing economic conditions, the fair value of underlying collateral,
and other factors which could affect probable credit losses. Assessing these
numerous factors involves significant judgment. Management considers the
allowance for loan losses a critical accounting policy (see section "Critical
Accounting Policies"). See management's allowance for loan losses accounting
policy in Note 1, "Summary of Significant Accounting Policies," of the notes to
consolidated financial statements and Note 5, "Loans," of the notes to
consolidated financial statements for certain additional allowance for loan
losses disclosures.
At December 31, 2002, the allowance for loan losses was $162.5 million, compared
to $128.2 million at December 31, 2001. The $34.3 million increase was the net
result of a $50.7 million provision for loan losses and $12.0 million acquired
with the Signal acquisition offset by $28.3 million of net charge offs. The
provision for loan losses in 2002 was $50.7 million. In comparison, the
provision for loan losses for 2001 was $28.2 million and $20.2 million in 2000.
The provision for loan losses is predominantly a function of the result of the
methodology and other qualitative and quantitative factors used to determine the
allowance for loan losses. As of December 31, 2002, the allowance for loan
losses to total loans was 1.58% and covered 164% of nonperforming loans,
compared to 1.42% and 246%, respectively, at December 31, 2001. Tables 10 and 11
provide additional information regarding activity in the allowance for loan
losses, and Table 12 provides additional information regarding nonperforming
loans.
Net charge offs were $28.3 million or 0.28% of average loans for 2002, compared
to $20.2 million or 0.22% of average loans for 2001, and were $9.0 million or
0.10% of average loans for 2000 (see Table 10). The $8.1 million increase in net
charge offs for 2002 compared to 2001 was primarily due to $5.0 million higher
net charge offs of commercial portfolio loans. Particularly, charge offs of
commercial, financial, and agricultural loans were $15.0 million, up $3.7
million over 2001, and charge offs of commercial real estate loans were $6.1
million, up $2.5 million, as shown in Table 10. During 2002, several commercial
credits were charged off, accountable for approximately $13.0 million of the
2002 commercial charge offs. During 2001, the charge off of a few commercial
credits accounted for approximately $10.7 million of 2001 commercial charge
offs. Loans charged off are subject to continuous review, and specific efforts
are taken to achieve maximum recovery of principal, accrued interest, and
related expenses.
27
TABLE 10: Loan Loss Experience
Years Ended December 31,
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2002 2001 2000 1999 1998