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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, 2003
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
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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
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As of February 29, 2004, 73,584,829 shares of common stock were outstanding. As
of June 30, 2003, (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 $2,588,597,000.
Excludes approximately $110,874,000 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 $187,813,000 of market value representing 6.96% 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 28, 2004
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ASSOCIATED BANC-CORP
2003 FORM 10-K TABLE OF CONTENTS
Page
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PART I
Item 1. Business 3
Item 2. Properties 8
Item 3. Legal Proceedings 8
Item 4. Submission of Matters to a Vote
of Security Holders 8
PART II
Item 5. Market for the Corporation's Common Equity
and Related Stockholder Matters 11
Item 6. Selected Financial Data 12
Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations 13
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk 49
Item 8. Financial Statements and Supplementary Data 50
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure 90
Item 9A. Controls and Procedures 90
PART III
Item 10. Directors and Executive Officers of the Corporation 90
Item 11. Executive Compensation 90
Item 12. Security Ownership of Certain Beneficial Owners and
Management 91
Item 13. Certain Relationships and Related Transactions 91
Item 14. Principal Accounting Fees and Services 91
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 91
Signatures 93
2
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:
o operating, legal, and regulatory risks;
o economic, political, and competitive forces affecting Associated
Banc-Corp's banking, securities, asset management, and credit services
businesses; and
o 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 (individually referred to herein as the "Parent Company,"
and together with all of its subsidiaries and affiliates, collectively referred
to herein as the "Corporation") 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, 2003, the Parent Company owned three
commercial banks located in Illinois, Minnesota, and Wisconsin serving their
respective local communities and, measured by total assets held at December 31,
2003, 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.
Services
The Parent Company provides advice and specialized services to its subsidiaries
in 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, 2003, bank subsidiaries of the Parent Company provided services
through 217 locations in 151 communities.
3
Through its banking subsidiaries and various nonbanking subsidiaries, the
Corporation provides a diversified range of banking and nonbanking 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 and international shared ATM
network, which allows its customers to perform banking transactions from their
checking, savings, or credit card accounts at ATMs in a multi-state and
international 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 4, "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.
The Corporation offers a wide variety of fiduciary, investment management,
advisory, and corporate agency services to individuals, corporations, charitable
trusts, foundations, and institutional investors. It also administers (as
trustee and in other fiduciary and representative capacities) pension, profit
sharing, and other employee benefit plans, and personal trusts and estates.
Discount and full-service brokerage services are offered by the Corporation
through registered broker-dealers. These services include the sale of fixed and
variable annuities, mutual funds, and securities.
4
Certain of the Corporation's subsidiaries headquartered in Arizona and Wisconsin
provide commercial and individual insurance services and engage in reinsurance
activities. Various life, property, casualty, credit, and mortgage insurance
products are also offered. Employment advisory and counseling services are
provided to the Parent Company's subsidiaries and customers through an
employment advisory subsidiary. Two 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 Associated Bank, National Association and Associated Bank Minnesota,
National Association. The investment subsidiaries also provide management
services to the Corporation's Real Estate Investment Trust ("REIT")
subsidiaries. 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, 2003, the Corporation had 4,091 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 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 "FRB"). The nationally chartered bank
subsidiaries are supervised and examined by the Comptroller of the Currency. The
sole state chartered bank subsidiary is supervised and examined by the
applicable Illinois state banking agency and by the Federal Deposit Insurance
Corporation (the "FDIC"). All subsidiaries of the Parent Company 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 Act's provisions governing the scope
and manner of the FRB'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 were also amended. The FRB has issued regulations implementing
these provisions. The Act, as amended, allows for the expansion of activities by
banking organizations and permits consolidation among financial organizations
generally. The Parent Company is required to act as a source of financial
strength to each of its subsidiaries
5
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 FRB to 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. The Act further
regulates the Corporation's activities, including requirements and limitations
relating to capital, transactions with officers, directors and affiliates,
securities issuances, dividend payments, inter-affiliate liabilities, extensions
of credit, and expansion through mergers and acquisitions.
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, without
limitation, restricting the ability of the Corporation to pay dividends,
restricting acquisitions or other activities, and placing limitations on asset
growth.
Pursuant to the Riegle-Neal Interstate Banking and Branching Efficiency Act of
1994 ("Riegle-Neal Act"), an adequately capitalized and managed bank holding
company may acquire banks in states other than its home state without regard to
the permissibility of such acquisitions under state law, but remain subject to
state requirements that a bank has been organized and operating for a period of
time. Subject to certain other restrictions, the Riegle-Neal Act also authorizes
banks to merge across state lines to create interstate branches. The Riegle-Neal
Amendments Act of 1997 provides guidance on the application of host state laws
to any branch located outside the host state.
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 with failing capital 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%.
In 2001, Congress enacted the Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism (USA Patriot Act)
Act of 2001 (the "Patriot Act"). The Patriot Act is designed to deny terrorists
and criminals the ability to obtain access to the United States' financial
system and has significant implications for depository institutions, brokers,
dealers, and other businesses involved in the transfer of money. The Patriot Act
mandates financial services companies to implement additional policies and
procedures with respect to additional measures designed to address any or all of
the following matters: money laundering, terrorist financing, identifying and
reporting suspicious activities and currency transactions, and currency crimes.
The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley") addresses, among other things,
corporate governance, auditing and accounting, executive compensation, and
enhanced and timely disclosure of corporate information. The New York Stock
Exchange and NASDAQ submitted corporate governance rules to the Securities and
Exchange Commission ("SEC") which were approved on November 4, 2003. These
changes are intended to allow stockholders to monitor the performance of
companies and directors more easily and efficiently. Effective August 29, 2002,
as prescribed by
6
Sections 302(a) and 906 (effective July 29, 2002) of Sarbanes-Oxley, the
Corporation's chief executive officer ("CEO") and chief financial officer
("CFO") each are required to certify that the Corporation's quarterly and annual
reports do not contain any untrue statement of a material fact. Section 404 of
Sarbanes-Oxley, which does not become effective until 2004, requires that the
CEO and CFO certify that they (i) are responsible for establishing, maintaining,
and regularly evaluating the effectiveness of the Corporation's internal
controls; (ii) have made certain disclosures to the Corporation's auditors and
the audit committee of the Corporation's board of directors ("Board of
Directors") about the Corporation's internal controls; and (iii) 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 such evaluation. The requirements under Sarbanes-Oxley
will not result in any significant changes to the Corporation's current
processes and procedures, and the Corporation is prepared to implement any
changes necessary within the specified timeframe. At its January 22, 2003, and
April 23, 2003, meetings, the 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, the establishment of a toll-free
ethics hotline (i.e., "whistle blower"), and the revision of the following
charters: Audit Committee, Administrative Committee, Nominating and Search
Committee, and Corporate Development Committee. Additional information regarding
the Corporation's corporate governance practices is available on its web site at
www.associatedbank.com.
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 ("Federal Reserve"). An important function of the Federal Reserve 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, 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 SEC. These filings are available to the public
over the Internet at the SEC's web site at www.sec.gov. Shareholders 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.
Shareholders may 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, shareholders may request a copy
of any
7
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 Corporation'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, 2003, the bank subsidiaries occupied 217 offices in 151
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 and Minneapolis are located in the lobbies of
multistory office buildings. Most bank subsidiary branch offices are
freestanding buildings that provide adequate customer parking, including
drive-through 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.
ITEM 3 LEGAL PROCEEDINGS
In the ordinary course of business, the Corporation may be named as defendant in
or be a party to various pending and threatened legal proceedings. In view of
the intrinsic difficulty in ascertaining the outcome of such matters, the
Corporation cannot state what the eventual outcome of any such proceeding will
be. Management believes, based upon discussions with legal counsel and current
knowledge, that liabilities arising out of any such proceedings (if any) will
not have a material adverse effect on the consolidated financial position,
results of operations or liquidity 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, 2003.
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 28,
2004.
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
---- -------------------------- ----------------
Paul S. Beideman President & Chief Executive Officer of Associated April 23, 2003
Age: 54 Banc-Corp; Chairman and President of Associated
Bank, National Association (subsidiary); Director
of Associated Trust Company, National Association
(subsidiary)
8
Name Offices and Positions Held Date of Election
---- -------------------------- ----------------
Robert C. Gallagher Chairman of the Board of Associated Banc-Corp April 28, 1982
Age: 65
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, and July 22, 1992
Age: 48 Corporate Secretary of Associated Banc-Corp;
Director of Associated Bank, National Association
(subsidiary); Director of Associated Bank Illinois,
National Association (former subsidiary); Executive
Vice President, Secretary, and Director of Associated
Trust Company, National Association (subsidiary);
Chairman of the Board, Associated Financial Group,
LLC (subsidiary)
Mark J. McMullen Director, Wealth Management, of Associated June 2, 1981
Age: 55 Banc-Corp; Director of Associated Bank, National
Association (subsidiary); Chairman and Chief
Executive Officer of Associated Trust Company,
National Association (subsidiary); Director,
Associated Financial Group, LLC (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: 54 Banc-Corp; Director of Associated Bank, National
Association (subsidiary); Director of Associated
Trust Company, National Association (subsidiary);
Chairman of the Board of Associated Card Services
Bank, National Association (former subsidiary);
Chairman of the Board of Associated Mortgage, Inc.
(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 Banc-Corp; January 25, 1978
Age: 57 Director of Associated Bank, National Association
(subsidiary); Director of Associated Trust
Company, National Association (subsidiary)
9
Name Offices and Positions Held Date of Election
---- -------------------------- ----------------
Gordon J. Weber Director, Corporate Banking, of Associated January 1, 1973
Age: 56 Banc-Corp; Director of Associated Bank, National
Association (subsidiary); Director of Associated
Bank Illinois, National Association (former
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 Management, April 23, 1997
Age: 37 of Associated Banc-Corp; Chief Executive Officer
and a Director of Associated Financial Group, LLC
(subsidiary)
Robert J. Johnson Director, Corporate Human Resources, of Associated January 22, 1997
Age: 58 Banc-Corp; Director, Associated Financial Group,
LLC (subsidiary)
Gordon C. King Chief Credit Officer of Associated Banc-Corp January 22, 2003
Age: 42
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: 52
Teresa A. Rosengarten Director of Consumer Banking of Associated October 25, 2000
Age: 43 Banc-Corp
From October 2000 to September 2003, Treasurer of
Associated Banc-Corp
From March 1994 to August 2000, Treasurer of a
Tennessee-based bank holding company
10
PART II
ITEM 5 MARKET FOR THE CORPORATION'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
Information in response to this item is incorporated by reference to the table
"Market Information" on Page 77 and the discussion of dividend restrictions in
Note 11, "Stockholders' Equity," of the notes to consolidated financial
statements included under Item 8 of this document. The Corporation's common
stock is 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 29, 2004, was 9,707. Certain of the Corporation's
shares are held in "nominee" or "street" name and the number of beneficial
owners of such shares is approximately 28,832.
Payment of future dividends is within the discretion of the 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.
11
ITEM 6 SELECTED FINANCIAL DATA
TABLE 1: EARNINGS SUMMARY AND SELECTED FINANCIAL DATA
(In Thousands, except per share data)
% 5-Year
Change Compound
2002 to Growth
Years ended December 31, 2003 2003 2002 2001 2000 1999 Rate (4)
- -----------------------------------------------------------------------------------------------------------------------
Interest income $ 727,364 (8.2)% $ 792,106 $ 880,622 $ 931,157 $ 814,520 (1.5)%
Interest expense 216,602 (25.5) 290,840 458,637 547,590 418,775 (12.0)
---------------------------------------------------------------------------------------
Net interest income 510,762 1.9 501,266 421,985 383,567 395,745 6.4
Provision for loan losses 46,813 (7.7) 50,699 28,210 20,206 19,243 26.0
---------------------------------------------------------------------------------------
Net interest income after
provision for loan losses 463,949 3.0 450,567 393,775 363,361 376,502 5.2
Noninterest income 246,435 14.2 215,820 192,342 183,600 164,592 8.2
Noninterest expense 388,668 5.0 370,061 335,108 317,140 303,778 5.8
---------------------------------------------------------------------------------------
Income before income taxes 321,716 8.6 296,326 251,009 229,821 237,316 6.7
Income tax expense 93,059 8.7 85,607 71,487 61,838 72,373 4.1
---------------------------------------------------------------------------------------
NET INCOME $ 228,657 8.5% $ 210,719 $ 179,522 $ 167,983 $ 164,943 7.8%
=======================================================================================
Basic earnings per share (1) $ 3.10 9.9% $ 2.82 $ 2.47 $ 2.24 $ 2.15 8.6%
Diluted earnings per share (1) 3.07 10.0 2.79 2.45 2.23 2.13 8.6
Cash dividends per share (1) 1.33 9.9 1.21 1.11 1.01 0.96 9.1
Weighted average shares
outstanding (1):
Basic 73,745 (1.3) 74,685 72,587 75,005 76,844 (0.7)
Diluted 74,507 (1.3) 75,493 73,167 75,251 77,514 (0.7)
SELECTED FINANCIAL DATA
Year-End Balances:
Loans $10,291,810 (0.1)% $10,303,225 $ 9,019,864 $ 8,913,379 $ 8,343,100 7.2%
Allowance for loan losses 177,622 9.3 162,541 128,204 120,232 113,196 12.2
Investment securities 3,773,784 12.2 3,362,669 3,197,021 3,260,205 3,270,383 5.4
Total assets 15,247,894 1.4 15,043,275 13,604,374 13,128,394 12,519,902 6.3
Deposits 9,792,843 7.3 9,124,852 8,612,611 9,291,646 8,691,829 2.7
Long-term debt 1,852,219 (2.9) 1,906,845 1,103,395 122,420 24,283 134.7
Company-obligated mandatorily
redeemable preferred
securities 181,941 (4.3) 190,111 --- --- --- N/M
Stockholders' equity 1,348,427 6.0 1,272,183 1,070,416 968,696 909,789 8.9
Book value per share (1) 18.39 7.4 17.13 14.89 13.32 11.90 9.8
---------------------------------------------------------------------------------------
Average Balances:
Loans $10,622,499 6.2% $10,002,478 $ 9,092,699 $ 8,688,086 $ 7,800,791 7.9%
Investment securities 3,302,460 1.2 3,262,843 3,143,787 3,317,499 3,119,923 3.8
Total assets 14,969,860 4.7 14,297,418 13,103,754 12,810,235 11,698,104 7.1
Deposits 9,299,506 4.3 8,912,534 8,581,233 9,102,940 8,631,652 2.0
Stockholders' equity 1,300,990 5.6 1,231,977 1,037,158 920,169 914,082 8.7
---------------------------------------------------------------------------------------
Financial Ratios: (2)
Return on average equity 17.58% 48 17.10% 17.31% 18.26% 18.04%
Return on average assets 1.53 6 1.47 1.37 1.31 1.41
Net interest margin 3.84 (11) 3.95 3.62 3.36 3.74
Average equity to average
assets 8.69 7 8.62 7.91 7.18 7.81
Dividend payout ratio (3) 42.90 (7) 42.97 44.90 45.09 44.65
(1) Share and 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) Base year used in 5-year compound growth rate is 1998 consolidated
financial data.
N/M = not meaningful
12
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 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 2003, the Corporation merged Associated Card Services Bank, National
Association, and Associated Bank Illinois, National Association, into Associated
Bank, National Association, to create a single national banking charter
headquartered in Green Bay, Wisconsin. Also during 2003, the Corporation merged
Wisconsin Finance Corporation, Citizens Financial Services, Inc., and Signal
Finance Company into a single finance company under the name Riverside Finance,
Inc. During the second quarter of 2002, the Corporation merged the 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.
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 Combinations," of the notes to consolidated
financial statements. The detailed financial discussion focuses on 2003 results
compared to 2002. Discussion of 2002 results compared to 2001 is predominantly
in section "2002 Compared to 2001."
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
valuation, 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. The critical accounting policies are discussed directly
with the Audit Committee of the Corporation.
Allowance for Loan Losses:
Management's evaluation process used to determine the adequacy of the allowance
for loan losses is subject to the use of estimates, assumptions, and judgments.
The evaluation process 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 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
13
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 consolidated financial statements. See Note 1,
"Summary of Significant Accounting Policies," and Note 4, "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 since the mortgage
servicing rights are carried on the consolidated balance sheet at the lower of
amortized cost or fair value. 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 and consults periodically with third parties as to the
assumptions used and that the resultant valuation is within the context of the
market. 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 consolidated financial statements. See Note 1, "Summary
of Significant Accounting Policies," and Note 5, "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 15, "Derivative and Hedging Activities," of the
notes to consolidated financial statements.
Income Tax Accounting:
The assessment of tax assets and 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 assets and liabilities are
adequate and properly recorded in the consolidated financial statements. See
Note 1, "Summary of Significant Accounting Policies," and Note 13, "Income
Taxes," of the notes to consolidated financial statements and section "Income
Taxes."
Segment Review
As described in Note 20, "Segment Reporting," of the notes to consolidated
financial statements, 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); b) corporate
banking - specialized lending (such as commercial real estate), lease financing,
and banking to larger businesses and metro or niche markets; and c) the support
to deliver banking services.
14
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. The critical
accounting policies primarily affect the banking segment, with the exception of
income tax accounting, which affects both the banking and other segments (see
section "Critical Accounting Policies").
Overview
The Corporation is a multi-bank holding company headquartered in Wisconsin,
providing a diversified range of banking and nonbanking services to individuals
and businesses primarily in its three-state footprint (Wisconsin, Illinois and
Minnesota).
The Corporation's primary sources of revenue are net interest income
(predominantly from loans and deposits, though also from investments and other
funding sources), and noninterest income, particularly fees and other revenue
from financial services provided to customers. Business volumes and pricing
drive revenue potential, and tend to be influenced by overall economic factors,
including market interest rates, business spending, consumer confidence,
economic growth, and competitive conditions within the marketplace as well.
Noninterest income growth in 2003 was led by mortgage banking income. During
2003, interest rates reached record lows, resulting in an unprecedented volume
of mortgage loan originations and refinances. As a result, mortgage banking
income was up 25% over 2002. A rapid rise in mortgage interest rates,
particularly during late third quarter, slowed mortgage loan volume. Industry
expectations are for mortgage originations to fall dramatically in 2004, and as
such the Corporation expects lower mortgage banking income for 2004. Noninterest
income sources continue to be diversified, including the Corporation's
acquisition of an insurance agency in 2003.
The Corporation's loan mix changed during 2003, though total loans were $10.3
billion at year-end 2003, unchanged from year-end 2002. Competitive pricing on
new and refinanced loans in the low rate environment put downward pressure on
loan yields and the net interest margin in 2003. Residential mortgage loans
decreased 11.7%, strongly influenced by high refinance activity. Home equity
(an area of emphasis for 2003 and an attractive product to consumers given the
low rate environment) and other consumer loans combined grew 5.4%, and
commercial loans grew 3.0%. Increases in business spending and consumer
confidence in 2004, along with an increase in interest rates, could create an
environment for increased earnings from loans for 2004.
Growth in deposits continued to be strong throughout 2003. This growth reflects
a number of strategic initiatives to grow the deposit base, as well as customer
preference to keep funds more liquid in this prolonged low interest rate
environment. Deposit growth initiatives will continue in 2004.
Asset quality administration was active during 2003 with early identification of
potential problems and progress on several larger problem credits. At year-end
2003 nonperforming loans were higher than historic levels, but a 1.73% allowance
for loan losses to loans ratio was deemed adequate by management. Certain
economic indicators suggest that business spending has begun to increase and
that business and consumer financial positions are improving in line with recent
economic improvements. While uncertainty exists as to how robust or sustainable
this trend may be, the impact of such improvements would likely be positive to
the Corporation's credit quality indicators and could lead to a lower provision
for loan losses in 2004 than in 2003.
The efficiency ratio (defined as noninterest expense divided by the sum of
taxable equivalent net interest income plus noninterest income, excluding net
asset and securities gains) was 49.84% for 2003 and 49.95% for 2002. The
Corporation has and will continue to monitor costs.
15
Performance Summary
The Corporation recorded net income of $228.7 million for the year ended
December 31, 2003, an increase of $18.0 million or 8.5% over the $210.7 million
earned in 2002. Basic earnings per share for 2003 were $3.10, a 9.9% increase
over 2002 basic earnings per share of $2.82. Earnings per diluted share were
$3.07, a 10.0% increase over 2002 diluted earnings per share of $2.79. Return on
average assets and return on average equity for 2003 were 1.53% and 17.58%,
respectively, compared to 1.47% and 17.10%, respectively, for 2002. Cash
dividends of $1.33 per share paid in 2003 increased by 9.9% over 2002. Key
factors behind these results were:
o Taxable equivalent net interest income was $535.7 million for 2003, $10.3
million or 2.0% higher than 2002. Although taxable equivalent interest
income decreased $63.9 million, interest expense decreased by $74.2
million. The increase in taxable equivalent net interest income was
attributable to favorable volume variances (with balance sheet growth and
differences in the mix of average earning assets and average
interest-bearing liabilities adding $21.6 million to taxable equivalent net
interest income), offset partly by unfavorable rate variances (as the
impact of changes in the interest rate environment reduced taxable
equivalent net interest income by $11.3 million). Average earning assets
increased $652 million to $13.9 billion, while interest-bearing liabilities
increased $459 million to $11.9 billion.
o Net interest income and net interest margin were impacted in 2003 by the
sustained low interest rate environment, competitive pricing pressures,
higher earning asset balances, and total deposit growth. The average
Federal funds rate of 1.12% in 2003 was 55 basis points ("bp") lower than
the 1.67% average rate in 2002.
o The net interest margin for 2003 was 3.84%, compared to 3.95% in 2002. The
11 bp decrease in net interest margin is attributable to the net of a 3 bp
decrease in interest rate spread (the net of a 75 bp decrease in the yield
on earning assets, substantially offset by a 72 bp lower cost of
interest-bearing liabilities), and an 8 bp lower contribution from net free
funds.
o Total loans were $10.3 billion at December 31, 2003, relatively unchanged
from December 31, 2002. Commercial loan balances grew $188 million (3.0%)
and represented 63% of total loans at December 31, 2003, compared to 61% at
year-end 2002. Total deposits were $9.8 billion at December 31, 2003, an
increase of $668 million or 7.3% from year-end 2002, particularly in
lower-costing deposits.
o Asset quality was affected by the impact of challenging economic conditions
on customers. Net charge offs were $31.7 million, an increase of $3.4
million over 2002, with the majority of the increase attributable to charge
offs in the commercial loan portfolio. Net charge offs were 0.30% of
average loans compared to 0.28% in 2002. The provision for loan losses
decreased to $46.8 million compared to $50.7 million in 2002. The ratio of
allowance for loan losses to loans was 1.73% and 1.58% at December 31, 2003
and 2002, respectively. Nonperforming loans were $121.5 million,
representing 1.18% of total loans at year-end 2003, compared to $99.3
million or 0.96% of total loans at year-end 2002.
o Noninterest income was $246.4 million for 2003, $30.6 million or 14.2%
higher than 2002, led by strong results in mortgage banking and retail
commissions. Mortgage banking revenue increased $16.6 million (25.0%) to
$83.0 million, driven by strong secondary mortgage production and resultant
loan sales. Retail commissions grew $7.3 million (40.0%) over 2002,
primarily attributable to the acquisition of CFG Insurance Services, Inc.
("CFG") in April 2003 (see section "Business Combinations").
o Noninterest expense was $388.7 million, up $18.6 million or 5.0% over 2002,
due principally to personnel expense. Personnel expense rose $19.0 million
or 10.0%, primarily due to the timing of acquisitions and merit increases
between the years.
o Income tax expense increased to $93.1 million, up $7.5 million from 2002.
The increase was primarily attributable to higher net income before tax as
the effective tax rate was unchanged at 28.9%.
16
Business Combinations
In 2003 there was one completed business combination. On April 1, 2003, the
Corporation consummated its cash acquisition of 100% of the outstanding shares
of CFG, a closely held insurance agency headquartered in Minnetonka, Minnesota.
Effective June 2003, CFG operated as Associated Financial Group, LLC. CFG, an
independent, full-line insurance agency, was acquired to enhance the growth of
the Corporation's existing insurance business. The acquisition was accounted for
under the purchase method of accounting; thus, the results of operations prior
to the consummation date were not included in the accompanying consolidated
financial statements. Goodwill of approximately $12 million and other
intangibles of approximately $15 million recognized in the transaction at
acquisition were assigned to the wealth management segment.
There was one completed business combination during 2002. On February 28, 2002,
the Corporation consummated its acquisition of 100% of the outstanding common
shares of Signal Financial Corporation ("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. Goodwill of approximately
$119.7 million and other intangibles of approximately $5.6 million recognized in
the transaction were assigned to the banking segment. The acquisition was
accounted for under the purchase method of accounting; thus, the results of
operations prior to the consummation date were not included in the accompanying
consolidated financial statements. There were no business combinations during
2001. The Corporation's business combination activity is further summarized in
Note 2, "Business Combinations," of the notes to consolidated financial
statements.
INCOME STATEMENT ANALYSIS
Net Interest Income
Net interest income in the consolidated statements of income (which excludes the
taxable equivalent adjustment) was $510.8 million, compared to $501.3 million in
2002. 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 $24.9 million for 2003 and
$24.0 million for 2002 resulted in fully taxable equivalent net interest income
of $535.7 million and $525.3 million, respectively.
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, repricing frequencies, and the use of interest rate swaps and caps.
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.
17
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, 2003. 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.
Taxable equivalent net interest income was $535.7 million for 2003, an increase
of $10.3 million or 2.0% from 2002. The increase in taxable equivalent net
interest income was a function of a higher level of earning assets, offset by
unfavorable interest rate changes. The net interest margin for 2003 was 3.84%,
compared to 3.95% in 2002. The 11 bp compression in net interest margin is
attributable to a 3 bp decrease in interest rate spread (with a 75 bp decrease
in the yield on earning assets, substantially offset by a 72 bp lower cost of
interest-bearing liabilities), and an 8 bp lower contribution from net free
funds (impacted by the lower 2003 rate environment, despite a $194 million
increase in average net free funds). Interest rates were generally stable and
historically low during both 2003 and 2002. Comparatively, the Federal funds
rate at December 31, 2003, was at a 45-year low of 1.00%, 25 bp lower than at
December 31, 2002, while the average Federal funds rate for 2003 was 55 bp lower
than for 2002.
As shown in the rate/volume analysis in Table 3, volume changes added $21.6
million to taxable equivalent net interest income, while rate changes resulted
in an $11.3 million decrease, for a net increase of $10.3 million. From a volume
perspective, the growth and composition change of earning assets added $31.3
million to taxable equivalent net interest income in 2003, while the growth and
composition of interest-bearing liabilities cost an additional $9.7 million,
netting a $21.6 million increase to taxable equivalent net interest income. Rate
changes on earning assets reduced interest income by $95.2 million, while the
changes in rates on interest-bearing liabilities lowered interest expense by
$83.9 million, for a net unfavorable impact of $11.3 million.
For 2003, the yield on earning assets fell 75 bp to 5.39%, driven primarily by
an 81 bp decline in the loan yield. The average loan yield was 5.46%.
Competitive pricing on new and refinanced loans and the repricing of variable
rate loans in the lower interest rate environment put downward pressure on loan
yields in 2003. The yield on securities and short-term investments combined was
down 54 bp to 5.19%. The earning asset rate changes reduced interest income by
$95.2 million, a combination of $77.5 million lower interest on loans and $17.7
million lower interest on securities and short-term investments combined.
For 2003, the cost of interest-bearing liabilities decreased 72 bp to 1.83%,
aided by the lower rate environment. The combined average cost of
interest-bearing deposits was 1.62%, down 66 bp from 2002, benefiting from a
larger mix of lower-costing transaction accounts, as well as from lower rates on
interest-bearing deposit products in general. The cost of wholesale funds
(comprised of all short-term borrowings and long-term funding) decreased 85 bp
to 2.21% for 2003, favorably impacted by lower rates year-over-year and the
maturity of higher-rate wholesale funds during the year. The interest-bearing
liability rate changes resulted in $83.9 million lower interest expense, with
$42.8 million attributable to interest-bearing deposits and $41.1 million due to
wholesale funding.
Average earning assets were $13.9 billion in 2003, an increase of $652 million,
or 4.9%, from 2002. Loans accounted for the majority of the growth in earning
assets, increasing by $620 million, or 6.2%, to $10.6 billion on average in 2003
and representing 76.2% of average earning assets compared to 75.2% for 2002. For
2003, taxable equivalent interest income on loans increased $29.9 million from
growth, but decreased $77.5 million from the impact of the low rate environment
(as noted above), for a net decrease of $47.6 million versus last year (See
Table 3). Balances of securities and short-term investments combined increased
$32 million on average. Taxable equivalent interest income on securities and
short-term investments for 2003 increased $1.4 million from volume changes, but
decreased $17.7 million from the impact of the rate environment, for a net $16.3
million decrease to taxable equivalent interest income.
18
Average interest-bearing liabilities increased $459 million, or 4.0%, from 2002,
while net free funds increased $194 million, both supporting the growth in
earning assets. Average noninterest-bearing demand deposits (a component of net
free funds) increased by $180 million, or 12.0%. Interest-bearing deposits grew,
on average, $207 million, or 2.8%, to $7.6 billion, the net result of increases
in interest-bearing demand and savings deposits and declines in money market
accounts and time deposits. Interest expense on interest-bearing deposits for
2003 decreased $42.8 million from the impact of the rate environment and
decreased $3.1 million from volume and mix changes, for a net $45.9 million
decrease to interest expense. Average wholesale funding sources increased by
$251 million. The Corporation continued its shift of funding (given the
continued low rate environment) from short-term borrowing sources to long-term
funding, increasing its average long-term funding by $424 million to 17.7% of
average interest-bearing liabilities (compared to 14.7% for 2002). For 2003,
interest expense on wholesale funding increased by $12.8 million due to volume
changes and decreased by $41.1 million from lower rates, for a net decrease of
$28.3 million versus the prior year.
19
TABLE 2: Average Balances and Interest Rates (interest and rates on a taxable
equivalent basis)
Years Ended December 31,
----------------------------------------------------------------------------------------------------
2003 2002 2001
----------------------------------------------------------------------------------------------------
Average Average Average Average Average Average
Balance Interest Rate Balance Interest Rate Balance Interest Rate
----------------------------------------------------------------------------------------------------
($ in Thousands)
ASSETS
Earning assets:
Loans: (1)(2)(3)
Commercial $ 6,450,523 $ 329,695 5.11% $ 5,929,113 $ 348,082 5.87% $ 4,898,895 $ 366,495 7.48%
Residential real estate 3,464,208 199,442 5.76 3,362,179 223,314 6.64 3,546,204 271,039 7.64
Consumer 707,768 50,725 7.17 711,186 56,106 7.89 647,600 56,246 8.69
----------------------------------------------------------------------------------------------------
Total loans 10,622,499 579,862 5.46 10,002,478 627,502 6.27 9,092,699 693,780 7.63
Investment securities:
Taxable 2,474,791 108,394 4.38 2,431,713 125,299 5.15 2,306,444 146,170 6.34
Tax exempt (1) 827,669 63,617 7.69 831,130 62,719 7.55 837,343 61,507 7.35
Short-term investments 21,873 394 1.80 29,270 658 2.25 35,380 1,421 4.02
----------------------------------------------------------------------------------------------------
Securities and short-term
investments 3,324,333 172,405 5.19 3,292,113 188,676 5.73 3,179,167 209,098 6.58
----------------------------------------------------------------------------------------------------
Total earning assets $13,946,832 $ 752,267 5.39% $13,294,591 $ 816,178 6.14% $12,271,866 $ 902,878 7.36%
----------------------------------------------------------------------------------------------------
Allowance for loan losses (174,703) (148,801) (125,790)
Cash and due from banks 289,866 302,856 279,363
Other assets 907,865 848,772 678,315
----------------------------------------------------------------------------------------------------
Total assets $14,969,860 $14,297,418 $13,103,754
====================================================================================================
LIABILITIES AND STOCKHOLDERS'
EQUITY
Interest-bearing liabilities:
Savings deposits $ 928,147 $ 4,875 0.53% $ 891,105 $ 6,813 0.76% $ 839,417 $ 11,812 1.41%
Interest-bearing demand
deposits 1,827,304 15,348 0.84 1,118,546 9,581 0.86 799,451 7,509 0.94
Money market deposits 1,623,438 15,085 0.93 1,876,988 24,717 1.32 1,722,242 55,999 3.25
Time deposits, excluding
Brokered CDs 3,063,873 84,957 2.77 3,263,766 122,181 3.74 3,648,942 201,035 5.51
----------------------------------------------------------------------------------------------------
Total interest-bearing
deposits, excluding
Brokered CDs 7,442,762 120,265 1.62 7,150,405 163,292 2.28 7,010,052 276,355 3.94
Brokered CDs 178,853 2,857 1.60 264,023 5,729 2.17 404,686 22,575 5.58
----------------------------------------------------------------------------------------------------
Total interest-bearing
deposits 7,621,615 123,122 1.62 7,414,428 169,021 2.28 7,414,738 298,930 4.03
Federal funds purchased and
securities sold under
agreements to repurchase 1,821,220 23,288 1.28 2,058,163 42,143 2.05 1,839,336 77,011 4.19
Other short-term borrowings 315,599 5,868 1.86 250,919 9,229 3.68 924,420 53,535 5.79
Long-term funding 2,096,802 64,324 3.07 1,673,071 70,447 4.21 574,753 29,161 5.07
----------------------------------------------------------------------------------------------------
Total wholesale funding 4,233,621 93,480 2.21 3,982,153 121,819 3.06 3,338,509 159,707 4.78
----------------------------------------------------------------------------------------------------
Total interest-bearing
liabilities $11,855,236 $ 216,602 1.83% $11,396,581 $ 290,840 2.55% $10,753,247 $ 458,637 4.27%
----------------------------------------------------------------------------------------------------
Noninterest-bearing demand
deposits 1,677,891 1,498,106 1,166,495
Accrued expenses and
other liabilities 135,743 170,754 146,854
Stockholders' equity 1,300,990 1,231,977 1,037,158
----------------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity $14,969,860 $14,297,418 $13,103,754
====================================================================================================
Net interest income and
rate spread (1) $ 535,665 3.56% $ 525,338 3.59% $ 444,241 3.09%
====================================================================================================
Net interest margin (1) 3.84% 3.95% 3.62%
====================================================================================================
Taxable equivalent adjustment $ 24,903 $ 24,072 $ 22,256
====================================================================================================
(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.
20
TABLE 3: Rate/Volume Analysis (1)
2003 Compared to 2002 2002 Compared to 2001
Increase (Decrease) Due to Increase (Decrease) Due to
---------------------------------------------------------------------------
Volume Rate Net Volume Rate Net
---------------------------------------------------------------------------
($ in Thousands)
Interest income:
Loans: (2)
Commercial $25,599 $(43,986) $(18,387) $ 63,495 $ (81,908) $(18,413)
Residential real estate 8,642 (32,514) (23,872) (12,535) (35,190) (47,725)
Consumer (4,360) (1,021) (5,381) 1,035 (1,175) (140)
---------------------------------------------------------------------------
Total loans 29,881 (77,521) (47,640) 51,995 (118,273) (66,278)
Investment securities:
Taxable 1,805 (18,710) (16,905) 6,320 (27,191) (20,871)
Tax-exempt (2) (259) 1,157 898 (536) 1,748 1,212
Short-term investments (92) (172) (264) (94) (669) (763)
---------------------------------------------------------------------------
Securities and short-term investments 1,454 (17,725) (16,271) 5,690 (26,112) (20,422)
---------------------------------------------------------------------------
Total earning assets (2) $31,335 $(95,246) $(63,911) $ 57,685 $(144,385) $(86,700)
---------------------------------------------------------------------------
Interest expense:
Savings deposits $ 195 $ (2,133) $ (1,938) $ 395 $ (5,394) $ (4,999)
Interest-bearing demand deposits 5,953 (186) 5,767 2,733 (661) 2,072
Money market deposits (2,356) (7,276) (9,632) 2,038 (33,320) (31,282)
Time deposits, excluding Brokered CDs (5,543) (31,681) (37,224) (2,121) (76,733) (78,854)
---------------------------------------------------------------------------
Total interest-bearing deposits,
excluding Brokered CDs (1,751) (41,276) (43,027) 3,045 (116,108) (113,063)
Brokered CDs (1,361) (1,511) (2,872) (3,053) (13,793) (16,846)
---------------------------------------------------------------------------
Total interest-bearing deposits (3,112) (42,787) (45,899) (8) (129,901) (129,909)
Federal funds purchased and securities
sold under agreements to repurchase (3,030) (15,825) (18,855) (3,482) (31,386) (34,868)
Other short-term borrowings 1,203 (4,564) (3,361) (21,456) (22,850) (44,306)
Long-term funding 14,639 (20,762) (6,123) 47,351 (6,065) 41,286
---------------------------------------------------------------------------
Total wholesale funding 12,812 (41,151) (28,339) 22,413 (60,301) (37,888)
---------------------------------------------------------------------------
Total interest-bearing liabilities $ 9,700 $(83,938) $(74,238) $ 22,405 $(190,202) $(167,797)
---------------------------------------------------------------------------
Net interest income (2) $21,635 $(11,308) $ 10,327 $ 35,280 $ 45,817 $ 81,097
===========================================================================
(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.
TABLE 4: Interest Rate Spread and Interest Margin
(on a taxable equivalent basis)
2003 Average 2002 Average 2001 Average
--------------------------------------------------------------------------------------------------------
% of % of % of
Earning Yield/ Earning Yield/ Earning Yield/
Balance Assets Rate Balance Assets Rate Balance Assets Rate
--------------------------------------------------------------------------------------------------------
($ in Thousands)
Earning assets $13,946,832 100.0% 5.39% $13,294,591 100.0% 6.14% $12,271,866 100.0% 7.36%
--------------------------------------------------------------------------------------------------------
Financed by:
Interest-bearing funds $11,855,236 85.0% 1.83% $11,396,581 85.7% 2.55% $10,753,247 87.6% 4.27%
Noninterest-bearing
funds 2,091,596 15.0% 1,898,010 14.3% 1,518,619 12.4%
--------------------------------------------------------------------------------------------------------
Total funds sources $13,946,832 100.0% 1.55% $13,294,591 100.0% 2.19% $12,271,866 100.0% 3.74%
========================================================================================================
Interest rate spread 3.56% 3.59% 3.09%
Contribution from net
free funds .28% .36% .53%
----- ----- -----
Net interest margin 3.84% 3.95% 3.62%
========================================================================================================
Average prime rate* 4.12% 4.68% 6.91%
Average federal funds
rate* 1.12% 1.67% 3.88%
Average spread 300bp 301bp 303bp
========================================================================================================
*Source: Bloomberg
21
TABLE 5: Selected Average Balances
Dollar Percent
2003 2002 Change Change
----------------------------------------------------
($ in Thousands)
ASSETS
Loans:
Commercial $ 6,450,523 $ 5,929,113 $ 521,410 8.8%
Residential real estate 3,464,208 3,362,179 102,029 3.0
Consumer 707,768 711,186 (3,418) (0.5)
----------------------------------------------------
Total loans 10,622,499 10,002,478 620,021 6.2
Investment securities:
Taxable 2,474,791 2,431,713 43,078 1.8
Tax-exempt 827,669 831,130 (3,461) (0.4)
Short-term investments 21,873 29,270 (7,397) (25.3)
----------------------------------------------------
Securities and short-term investments 3,324,333 3,292,113 32,220 1.0
----------------------------------------------------
Total earning assets 13,946,832 13,294,591 652,241 4.9
Other assets 1,023,028 1,002,827 20,201 2.0
----------------------------------------------------
Total assets $14,969,860 $14,297,418 $ 672,442 4.7%
====================================================
LIABILITIES & STOCKHOLDERS' EQUITY
Interest-bearing deposits:
Savings deposits $ 928,147 $ 891,105 $ 37,042 4.2%
Interest-bearing demand deposits 1,827,304 1,118,546 708,758 63.4
Money market deposits 1,623,438 1,876,988 (253,550) (13.5)
Time deposits, excluding Brokered CDs 3,063,873 3,263,766 (199,893) (6.1)
----------------------------------------------------
Total interest-bearing deposits, excluding 7,442,762 7,150,405 292,357 4.1
Brokered CDs
Brokered CDs 178,853 264,023 (85,170) (32.3)
----------------------------------------------------
Total interest-bearing deposits 7,621,615 7,414,428 207,187 2.8
Short-term borrowings 2,136,819 2,309,082 (172,263) (7.5)
Long-term funding 2,096,802 1,673,071 423,731 25.3
----------------------------------------------------
Total interest-bearing liabilities 11,855,236 11,396,581 458,655 4.0
Noninterest-bearing demand deposits 1,677,891 1,498,106 179,785 12.0
Accrued expenses and other liabilities 135,743 170,754 (35,011) (20.5)
Stockholders' equity 1,300,990 1,231,977 69,013 5.6
----------------------------------------------------
Total liabilities and stockholders' equity $14,969,860 $14,297,418 $ 672,442 4.7%
====================================================
Provision for Loan Losses
The provision for loan losses in 2003 was $46.8 million. The provision for loan
losses for 2002 was $50.7 million, and $28.2 million for 2001. At December 31,
2003, the allowance for loan losses was $177.6 million, compared to $162.5
million at December 31, 2002, and $128.2 million at December 31, 2001. Net
charge offs were $31.7 million for 2003, compared to $28.3 million for 2002 and
$20.2 million for 2001. Net charge offs as a percent of average loans were
0.30%, 0.28%, and 0.22% for 2003, 2002, and 2001, respectively. The ratio of the
allowance for loan losses to total loans was 1.73%, up from 1.58% at December
31, 2002, and 1.42% at December 31, 2001. Nonperforming loans at December 31,
2003, were $121.5 million, compared to $99.3 million at December 31, 2002, and
$52.1 million at December 31, 2001.
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
allowance for loan losses which focuses on
22
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. 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 $246.4 million for 2003, $30.6 million or 14.2% higher
than 2002. Fee income as a percentage of total revenues (defined as total
noninterest income less gains or losses on asset and investment sales ("fee
income") divided by taxable equivalent net interest income plus fee income) was
31.3% for 2003 compared to 29.1% for 2002.
TABLE 6: Noninterest Income
%Change From
Years Ended December 31, Prior Year
----------------------------------------------------------
2003 2002 2001 2003 2002
----------------------------------------------------------
($ in Thousands)
Trust service fees $ 29,577 $ 27,875 $ 29,063 6.1% (4.1)%
Service charges on deposit accounts 50,346 46,059 37,817 9.3 21.8
Mortgage banking 83,037 66,415 50,463 25.0 31.6
Credit card and other nondeposit fees 23,669 27,492 26,731 (13.9) 2.8
Retail commissions 25,571 18,264 16,872 40.0 8.3
Bank owned life insurance income 13,790 13,841 12,916 (0.4) 7.2
Other 18,174 15,644 15,765 16.2 (0.8)
----------------------------------------------------------
Subtotal ("fee income") $244,164 $215,590 $189,627 13.3% 13.7%
Asset sale gains, net 1,569 657 1,997 N/M N/M
Investment securities gains (losses),
net 702 (427) 718 N/M N/M
----------------------------------------------------------
Total noninterest income $246,435 $215,820 $192,342 14.2% 12.2%
==========================================================
N/M = not meaningful
Trust service fees for 2003 were $29.6 million, up $1.7 million (6.1%) from
2002. The change was predominantly the result of new business, increases in the
fee structure on personal trust accounts, and an improving stock market. The
market value of assets under management was $4.1 billion at December 31, 2003
compared to $3.5 billion at December 31, 2002, reflecting higher year-end equity
values compared to 2002.
Service charges on deposit accounts were $50.3 million, $4.3 million (9.3%)
higher than 2002. The increase was a function of higher volumes associated with
the larger deposit account base, higher service charges on business accounts
(attributable to lower earnings credit rates), and higher fees on
overdrafts/nonsufficient funds.
Mortgage banking income consists of servicing fees, the gain or loss on sales of
mortgage loans to the secondary market, and other related fees. Mortgage banking
income was $83.0 million in 2003, an increase of $16.6 million or 25.0% over
2002. The increase was primarily a result of increased income associated with
higher secondary mortgage loan production (mortgage loan production to be sold
to the secondary market) and resultant sales. Secondary mortgage loan production
was $4.3 billion for 2003, up 34.2% over the $3.2 billion for 2002. Gains on
loan sales were up $14.1 million (the net of realized gains up $20.3 million and
a $6.2 million decline in the fair value of the mortgage derivatives position).
The mortgage portfolio serviced for others was $5.9 billion and $5.4 billion at
December 31, 2003 and 2002, respectively.
23
Credit card and other nondeposit fees were $23.7 million for 2003, a decrease of
$3.8 million or 13.9% from 2002, primarily attributable to lower merchant fees,
given the merchant processing sale and services agreement consummated in March
2003. 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 resulted in a gain of $3.4 million (recorded
in other noninterest income) and replaces gross merchant discount fees with
revenue sharing on new and existing merchant business over the life of the
agreement. Thus, credit card fees were down $5.7 million versus 2002 (i.e.
reduced merchant discount fees, offset partly by increased inclearing fees),
while other nondeposit fees were up $1.9 million (primarily CFG-related advisory
fees).
Retail commission income (which includes commissions from insurance and
brokerage product sales) was $25.6 million, up $7.3 million or 40.0% compared to
2002. Other insurance revenues were up $8.6 million, while fixed annuities
commissions decreased $2.0 million. Other insurance revenue was favorably
impacted by the CFG acquisition but offset partly by lower loan insurance
commissions, which were affected by legislation in late 2002 requiring single
premium credit insurance premiums on loans with real estate to be collected
based on monthly outstanding balances. Fixed annuities commissions declined
during 2003, in part due to the prolonged low rate environment, customer
preference for more attractive rate-driven products, and the recent recovery in
the equity markets. Brokerage commissions, including variable annuities, were up
$0.7 million, reflecting recent renewed customer interest in the stock market.
Other income was $18.2 million for 2003, an increase of $2.5 million over 2002.
Other income for 2003 included a $1.5 million gain on the sale of out-of-market
credit card accounts and a $3.4 million gain recognized in connection with the
aforementioned credit card merchant processing sale and services agreement.
Change in vendor arrangements for both ATM services and check printing lowered
revenue (down $1.2 million and $0.6 million, respectively), while
correspondingly lowered ATM and check printing costs (included in Other
expense). Other income for 2002 included a $0.5 million gain on the sale of
stock in a regional ATM network.
Asset sale gains for 2003 were $1.6 million, including a $1.3 million net
premium on the sales of $17 million in deposits from two branches and a $0.4
million net gain on the sale of other real estate owned properties. Asset sale
gains for 2002 were $0.7 million. Investment securities net gains for 2003 were
$0.7 million, attributable to a $1.0 million gain on the sale of Sallie Mae
stock, partially offset by of a $0.3 million other-than-temporary write down on
a collateralized mortgage obligation ("CMO") security. The 2002 investment
securities net losses of $0.4 million included a $0.8 million
other-than-temporary write down on the same CMO security.
24
Noninterest Expense
Total noninterest expense for 2003 was $388.7 million, an increase of $18.6
million or 5.0% over 2002.
TABLE 7: Noninterest Expense
% Change
From Prior
Years Ended December 31, Year
----------------------------------------------------
2003 2002 2001 2003 2002
----------------------------------------------------
($ in Thousands)
Personnel expense $208,040 $189,066 $168,767 10.0% 12.0%
Occupancy 28,077 26,049 23,947 7.8 8.8
Equipment 12,818 14,835 14,426 (13.6) 2.8
Data processing 23,273 21,024 19,596 10.7 7.3
Business development and advertising 15,194 13,812 13,071 10.0 5.7
Stationery and supplies 6,705 7,044 6,921 (4.8) 1.8
FDIC expense 1,428 1,533 1,661 (6.8) (7.7)
Mortgage servicing rights expense 29,553 30,473 19,987 (3.0) 52.5
Intangible amortization expense 2,961 2,283 1,867 29.7 22.3
Loan expense 7,550 14,555 11,176 (48.1) 30.2
Other 53,069 49,387 47,178 7.5 4.7
----------------------------------------------------
Subtotal $388,668 $370,061 $328,597 5.0% 12.6%
Goodwill amortization --- --- 6,511 --- (100.0)
----------------------------------------------------
Total noninterest expense $388,668 $370,061 $335,108 5.0% 10.4%
====================================================
Personnel expense (including salary-related expenses and fringe benefit
expenses) increased $19.0 million or 10.0% over 2002 and represented 53.5% of
total noninterest expense in 2003 compared to 51.1% in 2002. Average full-time
equivalent employees were 4,123 for 2003, compared to 4,072 for 2002. Total
salary-related expenses increased $15.8 million or 10.9% in 2003, primarily due
to the timing of acquisitions, increased severance, and merit increases between
the years. Fringe benefits increased $3.2 million or 7.3% in 2003, attributable
to the increased cost of premium based benefits (up $1.2 million or 8.1%) and
other fringe benefit expenses commensurate with the salary-related expense
increase.
Occupancy expense increased 7.8% to support the larger branch and office
network, particularly attributable to the Signal and CFG acquisitions. Equipment
expense declined principally in computer depreciation expense due to aging
equipment and lower replacement costs. Data processing costs increased to $23.3
million, up $2.2 million or 10.7% over 2002, due to processing for a larger base
operation, as well as web-based and other technology enhancements. Business
development and advertising increased to $15.2 million for 2003, up $1.4 million
or 10.0% compared to 2002.
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 decreased by $0.9 million between 2003 and 2002, including a $12.3
million addition to the valuation allowance during 2003 (the net of a $15.8
million addition to the valuation allowance in the first nine months of 2003 and
a $3.5 million reversal to the valuation allowance in the fourth quarter of
2003) versus a $17.6 million addition to the valuation allowance during 2002 and
a $4.4 million increase in the amortization of the mortgage servicing rights
asset. 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. However, during the second half of 2003 (and particularly
fourth quarter 2003), mortgage interest rates began to rise, slowing both
prepayment speeds and mortgage refinance activity. 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
25
and section "Critical Accounting Policies." Mortgage servicing rights are
considered a critical accounting policy given that estimating the fair value of
the mortgage servicing rights involves judgment, particularly of estimated
prepayment speeds of the underlying mortgages serviced and the overall level of
interest rates. Loan type and note rate are the predominant risk characteristics
of the underlying loans used to stratify capitalized mortgage servicing rights
for purposes of measuring impairment. A valuation allowance is established to
the extent the carrying value of the mortgage servicing rights exceeds the
estimated fair value by stratification. Net income could be affected if
management's estimates of the prepayment speeds or other factors differ
materially from actual prepayments. An other-than-temporary impairment is
recognized as a write-down of the mortgage servicing rights asset and the
related valuation allowance (to the extent valuation reserve is available) and
then against earnings. A direct write-down permanently reduces the carrying
value of the mortgage servicing rights asset and valuation allowance, precluding
subsequent recoveries. Mortgage servicing rights, included in other intangible
assets on the consolidated balance sheet, were $42.5 million, net of a $22.6
million valuation allowance at December 31, 2003, and represented 72 bp of the
$5.9 billion portfolio of residential mortgage loans serviced for others. See
Note 5, "Goodwill and Other Intangible Assets," of the notes to consolidated
financial statements for additional disclosure.
Intangible amortization expense increased to $3.0 million, primarily due to
additional core deposit and other intangible assets resulting from the Signal
and CFG acquisitions. Loan expense was $7.6 million, down $7.0 million from
2002, predominantly due to lower merchant processing costs, given the sale of
the merchant processing during the first quarter of 2003 (as noted in section
"Noninterest Income"). Other expense was up $3.7 million over 2002, attributable
primarily to a $2.5 million charge on commercial letters of credit given the
deterioration of the financial condition of a borrower, and $1.1 million higher
foreclosure costs (including a $0.5 million write down on one commercial other
real estate owned property).
Income Taxes
Income tax expense for 2003 was $93.1 million, up $7.5 million from 2002 income
tax expense of $85.6 million. The Corporation's effective tax rate (income tax
expense divided by income before taxes) was 28.9% in both 2003 and 2002.
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 statements of income 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 13, "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, 2003, relatively unchanged (down
$11 million or 0.1%) from December 31, 2002. Commercial loans were $6.5 billion,
up $188 million or 3.0%. Commercial loans grew to represent 63% of total loans
at the end of 2003, up from 61% at year-end 2002. Home equity and other consumer
loans combined grew $86 million or 5.4%, while residential mortgage loans
decreased 11.7%, strongly influenced by lower interest rates and high refinance
activity.
26
TABLE 8: Loan Composition
As of December 31,
----------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
----------------------------------------------------------------------------------------------------
% of % of % of % of % of
Amount Total Amount Total Amount Total Amount Total Amount Total
----------------------------------------------------------------------------------------------------
($ in Thousands)
Commercial, financial, and
agricultural $2,116,463 21% $2,213,986 22% $1,783,300 20% $1,657,322 19% $1,412,338 17%
Real estate construction 1,077,731 10 910,581 9 797,734 9 660,732 7 560,450 7
Commercial real estate 3,246,954 32 3,128,826 30 2,630,964 29 2,287,946 26 1,903,633 23
Lease financing 38,968 -- 38,352 -- 11,629 -- 14,854 -- 23,229 --
---------------------------------------------------------------------------------------------------
Commercial 6,480,116 63 6,291,745 61 5,223,627 58 4,620,854 52 3,899,650 47
Residential mortgage 2,145,227 21 2,430,746 24 2,524,199 28 3,158,721 35 3,274,767 39
Home equity 968,744 9 864,631 8 609,254 7 508,979 6 408,577 5
---------------------------------------------------------------------------------------------------
Residential real estate 3,113,971 30 3,295,377 32 3,133,453 35 3,667,700 41 3,683,344 44
Consumer 697,723 7 716,103 7 662,784 7 624,825 7 760,106 9
---------------------------------------------------------------------------------------------------
Total loans $10,291,810 100% $10,303,225 100% $9,019,864 100% $8,913,379 100% $8,343,100 100%
===================================================================================================
Commercial, financial, and agricultural loans were $2.1 billion at the end of
2003, down $98 million or 4.4% since year-end 2002, and comprised 21% of total
loans outstanding, down from 22% at the end of 2002. 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. Borrower demand in this loan sector has been cautious
during 2003, and price competition has been strong. Within the commercial,
financial, and agricultural classification, loans to finance agricultural
production totaled only 0.3% of total loans at both December 31, 2003 and 2002.
Real estate construction loans grew $167 million or 18.4% to $1.1 billion,
representing 10% of the total loan portfolio at the end of 2003, compared to
$911 million or 9% at the end of 2002. 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 $3.2 billion at December 31, 2003, up $118 million or 3.8% over
December 31, 2002, and comprised 32% of total loans outstanding versus 30% at
year-end 2002. 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.
27
Residential real estate loans totaled $3.1 billion at the end of 2003, down $181
million or 5.5% from the prior year and comprised 30% of total loans outstanding
versus 32% at year-end 2002. 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 $2.1 billion at
December 31, 2003, down $285 million or 11.7% compared to the prior 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 $104 million, or 12.0%, to $969 million in
2003, an attractive product to consumers given the lower rate environment and an
area of emphasis in 2003.
Consumer loans to individuals totaled $698 million at December 31, 2003, down
$18 million or 2.6% compared to 2002, 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.
Factors that are important 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, 2003, 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
Maturity (1)
-------------------------------------------------------------
December 31, 2003 Within 1 Year (2) 1-5 Years After 5 Years Total
-------------------------------------------------------------
($in Thousands)
Commercial, financial, and agricultural $1,689,268 $382,076 $45,119 $2,116,463
Real estate construction 958,125 106,665 12,941 1,077,731
-------------------------------------------------------------
Total $2,647,393 $488,741 $58,060 $3,194,194
=============================================================
Fixed rate $1,384,682 $415,868 $58,060 $1,858,610
Floating or adjustable rate 1,262,711 72,873 --- 1,335,584
-------------------------------------------------------------
Total $2,647,393 $488,741 $58,060 $3,194,194
=============================================================
Percent by maturity distribution 83% 15% 2% 100%
(1) Based upon scheduled principal repayments.
(2) Demand loans, past due loans, and overdrafts are reported in the "Within 1
Year" category.
28
Allowance for Loan Losses
The loan portfolio is the primary asset subject to credit risk. Credit risks are
inherently different for each loan type. 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, aids in the 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. To assess the adequacy of the allowance for loan losses, an
allocation methodology is applied by the Corporation which focuses on changes in
the size and character of the loan portfolio, changes in levels of impaired or
other nonperforming loans, the risk inherent in specific loans, concentrations
of loans to specific borrowers or industries, existing economic conditions,
underlying collateral, historical losses on each portfolio category, and other
qualitative and quantitative factors which could affect probable credit losses.
Assessing these 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," and Note 4,
"Loans," of the notes to consolidated financial statements for additional
allowance for loan losses disclosures.
At December 31, 2003, the allowance for loan losses was $177.6 million, compared
to $162.5 million at December 31, 2002, and $128.2 million at year-end 2001. As
of December 31, 2003, the allowance for loan losses to total loans was 1.73% and
covered 146% of nonperforming loans, compared to 1.58% and 164%, respectively,
at December 31, 2002, and 1.42% and 246%, respectively, at December 31, 2001.
Total loans were relatively unchanged at $10.3 billion for both December 31,
2003 and 2002, though commercial loans (defined as commercial real estate;
commercial, financial and agricultural loans; real estate construction loans;
and lease financing) grew $188 million. From year-end 2001 to 2002, loans were
up $1.3 billion (with $760 million in loans from the Signal acquisition), with
growth particularly in commercial loans (up $1.1 billion). With this growth and
impacts of the sluggish economy on various borrowers, nonperforming loans
trended upward, to $121.5 million at December 31, 2003, from $99.3 million and
$52.1 million at year-end 2002 and 2001, respectively. Net charge offs were
$31.7 million, $28.3 million and $20.2 million for 2003, 2002 and 2001,
respectively. 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 adequacy of the allowance for loan losses. The provision for loan
losses was $46.8 million, $50.7 million and $28.2 million for 2003, 2002 and
2001, respectively. Tables 10 and 11 provide additional information regarding
activity in the allowance for loan losses, Table 12 provides additional
information regarding nonperforming loans, and Table 8 provides information on
loan growth and composition.
Net charge offs were $31.7 million or 0.30% of average loans for 2003, compared
to $28.3 million or 0.28% of average loans for 2002, and $20.2 million or 0.22%
of average loans for 2001 (see Table 10). The $3.4 million increase in net
charge offs for 2003 compared to 2002 was primarily due to commercial net charge
offs. Commercial net charge offs for 2003 were $24.3 million (up $4.0 million
compared to 2002) and as a percent of total net charge offs were 76%, 72% and
76% for 2003, 2002 and 2001, respectively. Specifically, net charge offs of
commercial real estate loans were $13.0 million, up $7.7 million over 2002,
while net charge offs of commercial, financial, and agricultural loans were $9.7
million, down $3.7 million. Five commercial credits in the construction and
hospitality industries accounted for approximately $16.5 million of the 2003 net
charge offs. Several commercial credits with greater than $0.5 million charged
off accounted for approximately $13.0 million of the 2002 net charge offs. Loans
charged off are subject to continuous review, and specific efforts are taken to
achieve maximum recovery of principal, accrued interest, and related expenses.
29
TABLE 10: Loan Loss Experience
Years Ended December 31,
--------------------------------------------------------------
2003 2002 2001 2000 1999
--------------------------------------------------------------
($ in Thousands)
Allowance for loan losses, at beginning of year $162,541 $128,204 $120,232 $113,196 $99,677
Balance related to acquisitions --- 11,985 --- --- 8,016
Decrease from sale of credit card receivables --- --- --- (4,216) ---
Provision for loan losses 46,813 50,699 28,210 20,206 19,243
Loans charged off:
Commercial, financial, and agricultural 12,780 14,994 11,268 1,679 2,222
Real estate construction 1,140 1,402 1,631 38 ---
Commercial real estate 13,659 6,124 3,578 795 927
Lease financing 385 268 78 3 2
Residential real estate 3,276 3,292 1,262 2,923 2,545
Consumer 5,867 6,099 4,822 5,717 10,925
--------------------------------------------------------------
Total loans charged off 37,107 32,179 22,639 11,155 6,621
Recoveries of loans previously charged off:
Commercial, financial, and agricultural 3,054 1,608 1,013 772 726
Real estate construction 3 3 --- --- 1
Commercial real estate 633 787 242 153 364
Lease financing --- 74 --- --- 35
Residential real estate 359 141 192 297 291
Consumer 1,326 1,219 954 979 1,464
--------------------------------------------------------------
Total recoveries 5,375 3,832 2,401 2,201 2,881
--------------------------------------------------------------
Net loans charged off 31,732 28,347 20,238 8,954 13,740
--------------------------------------------------------------
Allowance for loan losses, at end of year $177,622 $162,541 $128,204 $120,232 $113,196
==============================================================
Ratio of allowance for loan losses to
net chargeoffs 5.6 5.7 6.3 13.4 8.2
Ratio of net charge offs to average loans 0.30% 0.28% 0.22% 0.10% 0.18%
Ratio of allowance for loan losses to total
loans at end of year 1.73% 1.58% 1.42% 1.35% 1.36%
==============================================================
TABLE 11: Allocation of the Allowance for Loan Losses
As of December 31,
--------------------------------------------------------------------------------------------
% of % of % of % of % of
Loan Loan Loan Loan Loan
Type Type Type Type Type
to to to to to
Total Total Total Total Total
2003 Loans 2002 Loans 2001 Loans 2000 Loans 1999 Loans
--------------------------------------------------------------------------------------------
($ in Thousands)
Commercial real estate $ 69,947 32% $ 57,010 30% $ 47,810 29% $ 25,925 26% * *
Residential real estate 15,784 30 17,778 32 14,084 35 25,236 41 * *
--------------------------------------------------------------------------------------------
Real estate - mortgage 85,731 62 74,788 62 61,894 64 51,161 67 $ 50,267 67%
Commercial, financial, &
agricultural 63,939 21 64,965 22 44,071 20 45,571 19 31,648 17
Real estate construction 10,777 10 9,106 9 7,977 9 6,531 7 5,605 7
Consumer 7,449 7 4,613 7 5,683 7 6,194 7 14,904 9
Lease financing 234 -- 230 -- 327 -- 149 -- 184 --
Unallocated 9,492 -- 8,839 -- 8,252 -- 10,626 -- 10,588 --
--------------------------------------------------------------------------------------------
Total allowance for loan losses $177,622 100% $162,541 100% $128,204 100% $120,232 100% $113,196 100%
============================================================================================
* The additional breakdown between commercial and residential real estate was
not available.
30
The change in the allowance for loan losses is a function of a number of
factors, including but not limited to changes in the loan portfolio (see Table
8), net charge offs (see Table 10), and nonperforming loans (see Table 12). As
previously discussed, total loans from year-end 2002 to 2003 were relatively
flat (down $11 million or 0.1%); however, the loan mix shifted. During 2003 the
commercial loan portfolio grew to represent 63% of total loans at year-end 2003
compared to 61% last year-end. This segment of the loan portfolio carries
greater inherent credit risk (described under section "Loans"). With growth
particularly in commercial loans and impacts of the sluggish economy on various
borrowers, nonperforming loans to total loans grew to 1.18% for 2003 compared to
0.96% for 2002. Net charge offs for 2003 increased to $31.7 million, with the
majority of the increase attributable to charge offs in the commercial loan
portfolio.
The allocation of the Corporation's allowance for loan losses for the last five
years is shown in Table 11. The allocation methodology applied by the
Corporation, designed to assess the adequacy of the allowance for loan losses,
focuses on changes in the size and character of the loan portfolio, changes in
levels of impaired and other nonperforming loans, the risk inherent in specific
loans, concentrations of loans to specific borrowers or industries, existing
economic conditions, underlying collateral, historical losses on each portfolio
category, and other qualitative and quantitative factors. Because each of the
criteria used is subject to change, the allocation of the allowance for loan
losses is made for analytical purposes and is not necessarily indicative of the
trend of future loan losses in any particular loan category. The total allowance
is available to absorb losses from any segment of the portfolio. Management
continues to target and maintain the allowance for loan losses equal to the
allocation methodology plus an unallocated portion, as determined by economic
conditions and other qualitative and quantitative factors affecting the
Corporation's borrowers. Management allocates the allowance for loan losses for
credit losses by pools of risk. The commercial loan allocations are based on a
quarterly review of individual loans, loan types, and industries. The retail
loan (residential mortgage, home equity, and consumer) allocation is based
primarily on analysis of historical delinquency and charge off statistics and
trends. Minimum loss factors used by the Corporation for criticized loan
categories are consistent with regulatory agency factors. Loss factors for
non-criticized loan categories are based primarily on loan type, historical loan
loss experience, and industry statistics. The mechanism used to address
differences between estimated and actual loan loss experience includes review of
recent nonperforming loan trends, underwriting trends, external factors, and
management's judgment relating to current assumptions.
The allocation methods used for December 31, 2003 and 2002 were comparable.
Factors used for criticized loans (defined as specific loans warranting either
specific allocation or a criticized status of watch, special mention,
substandard, doubtful or loss), as well as for non-criticized loan categories,
were unchanged between the years. At both December 31, 2003 and 2002, current
economic conditions carried various uncertainties requiring management's
judgment as to the impact on the business results of numerous individual
borrowers and certain industries. Additionally, the pace at which the financial
results of a borrower's company can take a downturn from challenging and varied
economic conditions continued to be a factor for both years. At year-end 2003,
57% of the allowance (compared to 55% at year-end 2002) was allocated to
criticized loans, including $10 million of allowance identified for a previously
disclosed commercial manufacturing credit ($17 million outstanding at December
31, 2003) for which management had doubts concerning the future collectibility
of the loan. The primary shift in the allowance allocation was the amount
allocated to commercial real estate loans at year-end 2003, which was $69.9
million, representing 39% (compared to 35% at year-end 2002) of the allowance
for loan losses. A greater amount of these loans were in criticized categories
(10% versus 9% at year-end 2002); charge offs of this loan type increased (to
$13.7 million for 2003, more than double) between the years; these loans
represented 44% of nonperforming loans (compared to 24% at year-end 2002); and
commercial real estate loans grew to represent 32% of total loans at December
31, 2003 (compared to 30% at year-end 2002). As noted under the section "Loans,"
the credit risk of this loan category is largely influenced by the impact on
borrowers of general economic conditions, which have been noted to be
challenging and uncertain. The allowance allocated to commercial, financial, and
agricultural loans was $63.9 million at year-end 2003, representing 36% (versus
40% at year-end 2002) of the
31
allowance for loan losses. Commercial, financial and agricultural loans declined
4.4% since year-end 2002, to represent 21% of total loans at December 31, 2003
compared to 22% at December 31, 2002; net charge offs were $9.7 million (down
$3.7 million); and as a percent of nonperforming loans, these loans represented
36% (versus 48% at year-end 2002).
The allocation methods used for December 31, 2002 and 2001 were comparable.
Factors used for criticized loans, as well as for non-criticized loan
categories, were unchanged between the years. At both December 31, 2002 and
2001, current economic conditions carried various uncertainties requiring
management's judgment as to the possible impact to individual borrowers. Thus,
at year-end 2002, 55% of the allowance (compared to 48% at year-end 2001) was
allocated to criticized loans, including $10 million of allowance identified for
a $21 million commercial manufacturing credit for which management had doubts
concerning the future collectibility of the loan given current economic
conditions. While the payments for this credit were current during 2002, the
credit was added to nonaccrual loans during second quarter 2002. The primary
shift in the allowance allocation was the amount allocated to commercial,
financial, and agricultural loans at year-end 2002 which was $65.0 million,
representing 40% (compared to 34% at year-end 2001) of the allowance for loan
losses. A greater amount of these loans were in criticized categories (22%
versus 18% at year-end 2001); charge offs of this loan type have increased (to
$15.0 million for 2002, up 33%) between the years; these loans represented 48%
of nonperforming loans (compared to 26% last year-end); and commercial,
financial, and agricultural loans grew to represent 22% of total loans at
December 31, 2002 (compared to 20% at year-end 2001). The allowance allocated to
commercial real estate was 35% at year-end 2002, down from 37% at year-end 2001.
In 2001 for this category, a greater amount of these loans were in criticized
loan categories, which materialized into greater charge offs during 2002 (see
Table 10). While commercial real estate loans grew 18.9% since year-end 2001,
they represented 30% of total loans at December 31, 2002, relatively unchanged
from 29% last year.
Management believes the allowance for loan losses to be adequate at December 31,
2003.
Consolidated net income could be affected if management's estimate of the
allowance for loan losses is subsequently materially different, requiring
additional or less provision for loan losses to be recorded. Management
carefully considers numerous detailed and general factors, its assumptions, and
the likelihood of materially different conditions that could alter its
assumptions. While management uses currently available information to recognize
losses on loans, future adjustments to the allowance for loan losses may be
necessary based on changes in economic conditions and the impact of such change
on the Corporation's borrowers. 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.
Nonperforming Loans, Potential Problem Loans, and Other Real Estate Owned
Management is committed to an aggressive nonaccrual and problem loan
identification philosophy. This philosophy is implemented through the ongoing
monitoring and review of all pools of risk in the loan portfolio to ensure that
problem loans are identified quickly and the risk of loss is minimized.
Nonperforming loans are considered one indicator of potential future loan
losses. Nonperforming loans are defined as nonaccrual loans, loans 90 days or
more past due but still accruing, and restructured loans. The Corporation
specifically excludes from its definition of nonperforming loans student loan
balances that are 90 days or more past due and still accruing and that have
contractual government guarantees as to collection of principal and interest.
The Corporation had approximately $13.0 million and $20.2 million at December
31, 2003 and 2002, respectively, of nonperforming student loans.
Loans are generally placed on nonaccrual status when contractually past due 90
days or more as to interest or principal payments. Additionally, whenever
management becomes aware of facts or circumstances that may adversely impact the
collectibility of principal or interest on loans, it is
32
management's practice to place such loans on nonaccrual status immediately,
rather than delaying such action until the loans become 90 days past due.
Previously accrued and uncollected interest on such loans is reversed,
amortization of related loan fees is suspended, and income is recorded only to
the extent that interest payments are subsequently received in cash and a
determination has been made that the principal balance of the loan is
collectible. If collectibility of the principal is in doubt, payments received
are applied to loan principal.
Loans past due 90 days or more but still accruing interest are also included in
nonperforming loans. Loans past due 90 days or more but still accruing are
classified as such where the underlying loans are both well secured (the
collateral value is sufficient to cover principal and accrued interest) and are
in the process of collection. Also included in nonperforming loans are
"restructured" loans. Restructured loans involve the granting of some concession
to the borrower involving the modification of terms of the loan, such as changes
in payment schedule or interest rate.
TABLE 12: Nonperforming Loans and Other Real Estate Owned
December 31,
-------------------------------------------------------
2003 2002 2001 2000 1999
-------------------------------------------------------
($ in Thousands)
Nonaccrual loans $113,944 $ 94,132 $ 48,238 $ 41,045 $ 32,076
Accruing loans past due 90 days or more 7,495 3,912 3,649 6,492 4,690
Restructured loans 43 1,258 238 159 148
-------------------------------------------------------
Total nonperforming loans $121,482 $ 99,302 $ 52,125 $ 47,696 $ 36,914
Other real estate owned 5,457 11,448 2,717 4,032 3,740
-------------------------------------------------------
Total nonperforming assets $126,939 $110,750 $ 54,842 $ 51,728 $ 40,654
=======================================================
Ratios at year end:
Nonperforming loans to total loans 1.18% 0.96% 0.58% 0.54% 0.44%
Nonperforming assets to total assets 0.83% 0.74% 0.40% 0.39% 0.32%
Allowance for loan losses to
nonperforming loans 146% 164% 246% 252% 307%
Allowance for loan losses to total
loans at end of year 1.73% 1.58% 1.42% 1.35% 1.36%
=======================================================
Nonperforming loans at December 31, 2003, were $121.5 million, compared to $99.3
million at December 31, 2002, and $52.1 million at December 31, 2001. The ratio
of nonperforming loans to total loans at the end of 2003 was 1.18%, as compared
to 0.96% and 0.58% at December 31, 2002 and 2001, respectively. Of the $22.2
million increase in nonperforming loans between year-end 2002 and 2003,
nonaccrual loans increased $19.8 million and accruing loans past due 90 days or
more increased $3.6 million, while restructured loans decreased $1.2 million. Of
the $47.2 million increase in nonperforming loans between year-end 2001 and
2002, nonaccrual loans increased $45.9 million, restructured loans increased
$1.0 million, and accruing loans past due 90 days or more increased $0.3
million. The Corporation's allowance for loan losses to nonperforming loans was
146% at year-end 2003, down from 164% at year-end 2002 and 246% at year-end
2001.
The upward trend in nonperforming loans was primarily due to increases in
commercial nonperforming loans, and mostly due to specific larger commercial
credits. Commercial nonaccrual loans were $95.8 million at December 31, 2003 (up
$22.8 million from year-end 2002), and represented 84%, 78%, and 67% of total
nonaccrual loans at year-end 2003, 2002, and 2001, respectively. Additionally,
accruing commercial loans past due 90 days or more were $5.8 million at December
31, 2003, and represented 77%, 27%, and 47% of total accruing loans past due 90
days or more at year-end 2003, 2002 and 2001, respectively.
For year-end 2003 versus 2002, the $22.8 million increase in commercial
nonaccrual loans was predominantly attributable to the addition, during the
second quarter of 2003, of two large commercial credits (totaling approximately
$20 million at December 31, 2003, one in the construction industry and
33
one in the hospitality industry). The $3.6 million increase from year-end 2002
to year-end 2003 in accruing loans past due 90 days or more was primarily
attributable to one large commercial credit ($2.5 million at December 31, 2003),
while the decrease in restructured loans was due to one large commercial credit
that was transferred to nonaccrual status and subsequently charged off.
For year-end 2002 versus 2001, the increase in commercial nonaccrual loans was
predominantly attributable to the addition of a previously disclosed commercial
manufacturing relationship (totaling $21 million at year-end 2002) for which
payments were current; however, the Corporation had doubts concerning the future
collectibility of the loan and set aside $10 million of the allowance for loan
losses for this credit. This credit remains in the commercial portfolio at
December 31, 2003 ($17 million outstanding) with continued concerns of
collectibility and $10 million of the allowance for loan losses set aside. The
remaining rise in nonaccrual loans for 2002 was primarily attributable to the
commercial loan portfolio, but not concentrated within any industry.
Other real estate owned decreased to $5.5 million at December 31, 2003, compared
to $11.4 million and $2.7 million at year-end 2002 and 2001, respectively. The
change in other real estate owned was predominantly due to the addition and
subsequent sale of commercial real estate properties. An $8.0 million property
was added during 2002, while three other commercial properties (at $1.1 million,
$1.5 million, and $2.7 million) were added during 2003. The $1.5 million
property was sold during the second quarter of 2003 (at a net loss of $0.6
million), the $8.0 million property was sold during the third quarter of 2003
(at a net gain of $1.0 million), and the $2.7 million property was sold during
the fourth quarter of 2003 (at a small gain). Also during fourth quarter 2003, a
$0.5 million write down was recorded in other noninterest expense on another
commercial property in other real estate owned. Net gains on sales of other real
estate owned were $472,000, $53,000, and $643,000 for 2003, 2002, and 2001,
respectively. Management actively seeks to ensure properties held are monitored
to minimize the Corporation's risk of loss.
The following table shows, for those loans accounted for on a nonaccrual basis
and restructured loans for the years ended as indicated, the gross interest that
would have been recorded if the loans had been current in accordance with their
original terms and the amount of interest income that was included in interest
income for the period.
TABLE 13: Foregone Loan Interest
Years Ended December 31,
--------------------------------
2003 2002 2001
--------------------------------
($ in Thousands)
Interest income in accordance
with original terms $ 7,620 $ 6,866 $ 4,840
Interest income recognized (2,898) (4,313) (2,694)
--------------------------------
Reduction in interest income $ 4,722 $ 2,553 $ 2,146
================================
Potential problem loans are certain loans bearing risk ratings by management
that are not in nonperforming status but where there are doubts as to the
ability of the borrower to comply with present repayment terms. The decision of
management to include performing loans in potential problem loans does not
necessarily mean that the Corporation expects losses to occur but that
management recognizes a higher degree of risk associated with these loans. The
level of potential problem loans is another predominant factor in determining
the relative level of risk in the loan portfolio and in the determination of the
level of the allowance for loan losses. The loans that have been reported as
potential problem loans are not concentrated in a particular industry but
rather cover a diverse range of businesses. At December 31, 2003, potential
problem loans totaled $245 million, compared to $212 million at December 31,
2002. The $33 million increase from December 31, 2002 to December 31, 2003, is
primarily attributable to deterioration in certain loans in the commercial
manufacturing sector (accountable for approximately $28 million of the
increase).
34
Investment Securities Portfolio
The investment securities portfolio is intended to provide the Corporation with
adequate liquidity, flexibility in asset/liability management, a source of
stable income, and is structured with minimum credit exposure to the
Corporation. Investment securities classified as available for sale are carried
at fair market value in the consolidated balance sheet. At December 31, 2003,
the total carrying value of investment securities represented 25% of total
assets, compared to 22% at year-end 2002. On average, the investment portfolio
represented 24% and 25% of average earning assets for 2003 and 2002,
respectively.
The classification of securities as held to maturity or available for sale is
determined at the time of purchase. The Corporation generally classifies
investment purchases as available for sale, consistent with the Corporation's
investment philosophy of maintaining flexibility to manage the investment
portfolio, particularly in light of asset/liability management strategies,
possible securities sales in response to changes in interest rates or prepayment
risk, the need to manage liquidity or regulatory capital, and other factors.
TABLE 14: Investment Securities Portfolio
At December 31,
--------------------------------------
2003 2002 2001
--------------------------------------
($ in Thousands)
Investment Securities Available
for Sale:
U.S. Treasury securities $ 36,588 $ 44,967 $ 15,071
Federal agency securities 167,859 222,787 196,175
Obligations of state and political
subdivisions 868,974 851,710 847,887
Mortgage-related securities 2,232,920 1,672,542 1,642,851
Other securities (debt and equity) 368,388 440,126 414,399
--------------------------------------
Total amortized cost $3,674,729 $3,232,132 $3,116,383
======================================
Total fair value and carrying value $3,773,784 $3,362,669 $3,197,021
======================================
At December 31, 2003 and 2002, mortgage-related securities (which include
predominantly mortgage-backed securities and collateralized mortgage
obligations) represented 59.2% and 50.7%, respectively, of total investment
securities based on carrying value. The fair value of mortgage-related
securities are subject to inherent risks based upon the future performance of
the underlying collateral (i.e., mortgage loans) for these securities, such as
prepayment risk and interest rate changes.
At December 31, 2003, the Corporation's securities portfolio did not contain
securities of any single issuer that were payable from and secured by the same
source of revenue or taxing authority where the aggregate carrying value of such
securities exceeded 10% of stockholders' equity or approximately $135 million
(stockholders' equity was $1.3 billion at December 31, 2003).
During 2002, a CMO (included in mortgage-related securities) was determined to
have an other-than-temporary impairment that resulted in a write down on the
security of $0.8 million during 2002 and $0.3 million during 2003 based on
continued evaluation. See Note 3, "Investment Securities," of the notes to
consolidated financial statements for more information.
35
TABLE 15: Investment Securities Portfolio Maturity Distribution (1) -
At December 31, 2003
Investment Securities Available for Sale - Maturity Distribution and Weighted Average Yield
---------------------------------------------------------------------------------------------------------------------
After one After five Mortgate-related Total Total
but within but within After and equity Amortized Fair
Within one year five years ten years ten years securities Cost Value
---------------------------------------------------------------------------------------------------------------------
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield Amount
---------------------------------------------------------------------------------------------------------------------
($ in Thousands)
U. S. Treasury
securities $ 25,377 3.33% 11,211 1.88% --- --- --- --- --- --- $ 36,588 2.88% $ 36,759
Federal agency
securities 101,170 5.27 51,566 5.52 15,123 3.78% --- --- --- --- 167,859 5.21 172,713
Obligations of
states and
political
subdivisions
(2) 51,812 7.08 225,393 6.83 298,596 7.10 293,173 7.81% --- --- 868,974 7.27 927,485
Other debt
securities 62,258 3.21 143,671 6.14 --- --- 10,000 2.25 --- --- 215,929 5.11 228,505
Mortgage-
related
securities --- --- --- --- --- --- --- --- 2,232,920 4.43% 2,232,920 4.43 2,233,412
Equity
securities --- --- --- --- --- --- --- --- 152,459 6.28 152,459 6.28 174.910
---------------------------------------------------------------------------------------------------------------------
Total
amortized
cost $240,617 4.97% $431,841 6.22% $313,719 6.86% $303,173 7.63% $2,385,379 4.55% $3,674,729 5.24% $3,773,784
=====================================================================================================================
Total fair
value $245,135 $459,887 $334,387 $326,053 $2,408,322 $3,773,784
=====================================================================================================================
(1) Expected maturities will differ from contractual maturities, as borrowers
may have the right to call or repay obligations with or without call or
prepayment penalties.
(2) Yields on tax-exempt securities are computed on a taxable equivalent basis
using a tax rate of 35% and have not been adjusted for certain disallowed
interest deductions.
Deposits
Deposits are the Corporation's largest source of funds. See also section
"Liquidity." The Corporation competes with other bank and nonbank institutions,
as well as with investment alternatives such as money market or other mutual
funds and brokerage houses for deposits. The Corporation's nonbrokered deposit
growth was impacted by competitive factors, as well as other investment
opportunities available to customers. During both 2003 and 2002, the Corporation
has actively marketed its transaction accounts (business demand deposits,
interest-bearing demand deposits, and money market accounts), which offer
competitive, market-indexed rates and greater customer flexibility.
Additionally, customer preference to keep funds more liquid in this prolonged
low rate environment has aided general deposit growth.
At December 31, 2003, deposits were $9.8 billion, up $668 million or 7.3% over
December 31, 2002. The sale of two branches during 2003 reduced deposits by $17
million. Selected period-end deposit information is detailed in Note 7,
"Deposits," of the notes to consolidated financial statements, including a
maturity distribution of all time deposits at December 31, 2003. A maturity
distribution of certificates of deposit and other time deposits of $100,000 or
more at December 31, 2003, is shown in Table 17. Table 16 summarizes the
distribution of average deposit balances.
The mix of deposits changed during 2003 as customers reacted to prolonged low
and uncertain interest rates as well as unsteady market conditions. At December
31, 2003, noninterest-bearing demand deposits were 18% of deposits, compared to
19% at year-end 2002. Interest-bearing transaction accounts (savings,
interest-bearing demand, and money market deposits) grew to 49% of deposits
versus 45% at the end of 2002. Given the lower interest rate environment and
scheduled maturities, total time deposits declined to 33% of deposits at
year-end 2003 compared to 36% at year-end 2002.
On average, deposits were $9.3 billion for 2003, up $387 million or 4.3% over
the average for 2002. Average nonbrokered deposits for 2003 were $9.1 billion,
up $472 million or 5.5% compared to 2002.
36
TABLE 16: Average Deposits Distribution
2003 2002 2001
-------------------------------------------------------------------
% of % of % of
Amount Total Amount Total Amount Total
-------------------------------------------------------------------
($ in Thousands)
Noninterest-bearing demand deposits $1,677,891 18% $1,498,106 17% $1,166,495 14%
Interest-bearing demand deposits 1,827,304 20 1,118,546 12 799,451 9
Savings deposits 928,147 10 891,105 10 839,417 10
Money market deposits 1,623,438 17 1,876,988 21 1,722,242 20
Brokered certificates of deposit 178,853 2 264,023 3 404,686 5
Other time and certificates of
deposit 3,063,873 33 3,263,766 37 3,648,942 42
-------------------------------------------------------------------
Total deposits $9,299,506 100% $8,912,534 100% $ 8,581,233 100%
===================================================================
Nonbrokered deposits $9,120,653 98% $8,648,511 97% $ 8,176,547 95%
===================================================================
TABLE 17: Maturity Distribution-Certificates of Deposit and Other Time
Deposits of $100,000 or More
December 31, 2003
----------------------------------------------
Certificates of Deposit Other Time Deposits
----------------------------------------------
($ in Thousands)
Three months or less $457,495 $59,524
Over three months
through six months 112,144 34,575
Over six months through
twelve months 76,760 25,000
Over twelve months 233,051 ---
----------------------------------------------
Total $879,450 $119,099
==============================================
Other Funding Sources
Other funding sources, including short-term borrowings, long-term debt, and
company-obligated mandatorily redeemable preferred securities ("wholesale
funds"), were $4.0 billion at December 31, 2003, down $0.5 billion from $4.5
billion at December 31, 2002. See also section "Liquidity." Short-term
borrowings decreased $461 million, primarily in Federal funds purchased and
securities sold under agreements to repurchase. Short-term borrowings are
primarily comprised of Federal funds purchased; securities sold under agreements
to repurchase; short-term Federal Home Loan Bank advances; notes payable to
banks; and treasury, tax, and loan notes. The Federal Home Loan Bank advances
included in short-term borrowings are those with original maturities of less
than one year. The treasury, tax, and loan notes are demand notes representing
secured borrowings from the U.S. Treasury, collateralized by qualifying
securities and loans. The funds are placed with the subsidiary banks at the
discretion of the U.S. Treasury and may be called at any time. See Note 8,
"Short-term Borrowings," of the notes to consolidated financial statements for
additional information on short-term borrowings, and Table 18 for specific
disclosure required for major short-term borrowing categories. Long-term debt at
December 31, 2003, was $1.9 billion, down $55 million from December 31, 2002,
due primarily to the issuance of $50 million of bank notes, $203 million
of long-term repurchase agreements, and $250 million of long-term Federal Home
Loan Bank advances, net of the repayments of $302 million of long-term Federal
Home Loan Bank advances and $250 million of bank notes. See Note 9, "Long-term
Debt," of the notes to consolidated financial statements for additional
information on long-term debt. In addition, during 2002 the Corporation issued
$175 million of company-obligated mandatorily redeemable preferred securities.
See Note 10, "Company-Obligated Mandatorily Redeemable Preferred Securities," of
the notes to consolidated financial statements for additional information on the
preferred securities and details regarding the impact of recent accounting
pronouncements requiring the deconsolidation of the preferred securities.
37
Wholesale funds on average were $4.2 billion for 2003, up $251 million or 6.3%
over 2002. The mix of wholesale funding continued to shift toward longer-term
instruments, with average long-term funding representing 49.5% of wholesale
funds compared to 42.0% in 2002, in response to certain asset/liability
objectives and low interest rates. Within the short-term borrowing categories,
average Federal funds purchased and securities sold under agreements to
repurchase were down $237 million, while other short-term borrowing sources were
up $65 million.
TABLE 18: Short-Term Borrowings
December 31,
----------------------------------------
2003 2002 2001
----------------------------------------
($ in Thousands)
Federal funds purchased and securities sold
under agreements to repurchase:
Balance end of year $1,340,996 $2,240,286 $1,691,152
Average amounts outstanding during year 1,821,220 2,058,163 1,839,336
Maximum month-end amounts outstanding 2,235,928 2,264,557 2,298,320
Average interest rates on amounts
outstanding at end of year 1.05% 1.49% 2.22%
Average interest rates on amounts outstanding
during year 1.28% 2.05% 4.19%
Federal Home Loan Bank advances:
Balance end of year $--- $ 100,000 $ 300,000
Average amounts outstanding during year 76,441 147,945 722,466
Maximum month-end amounts outstanding 100,000 400,000 850,000
Average interest rates on amounts
outstanding at end of year -- 1.66% 3.15%
Average interest rates on amounts outstanding
during year 1.66% 1.91% 6.25%
Liquidity
The objective of liquidity management is to ensure that the Corporation has the
ability to generate sufficient cash or cash equivalents in a timely and
cost-effective manner to meet its commitments as they fall due. Funds are
available from a number of sources, primarily from the core deposit base and
from loans and securities repayments and maturities. Additionally, liquidity is
provided from sales of the securities portfolio, lines of credit with major
banks, the ability to acquire large and brokered deposits, and the ability to
securitize or package loans for sale.
The Corporation's liquidity management framework includes measurement of several
key elements, such as wholesale funding as a percent of total assets and liquid
assets to short-term wholesale funding. The Corporation's liquidity framework
also incorporates contingency planning to assess the nature and volatility of
funding sources and to determine alternatives to these sources. The contingency
plan would be activated to ensure the Corporation's funding commitments could be
met in the event of general market disruption or adverse economic conditions.
Strong capital ratios, credit quality, and core earnings are essential to
retaining high credit ratings and, consequently, cost-effective access to the
wholesale funding markets. A downgrade or loss in credit ratings could have an
impact on the Corporation's ability to access wholesale funding at favorable
interest rates. As a result, capital ratios, asset quality measurements, and
profitability ratios are monitored on an ongoing basis as part of the liquidity
management process.
TABLE 19: Credit Ratings at December 31, 2003
Moody's S&P Fitch Ratings
------- --- -------------
Bank short-term P1 A2 F1
Bank long-term A2 A- A-
Corporation short-term P2 A2 F1
Corporation long-term A3 BBB+ A-
Subordinated debt long-term Baa1 BBB BBB+
While core deposits and loan and investment repayment are principal sources of
liquidity, funding diversification is another key element of liquidity
management. Diversity is achieved by strategically
38
varying depositor type, term, funding market, and instrument. As noted above,
the Parent Company and certain subsidiary banks are rated by Moody's, Standard
and Poor's (S&P), and Fitch. These ratings, along with the Corporation's other
ratings, provide opportunity for greater funding capacity and funding
alternatives.
The Parent Company manages its liquidity position to provide the funds necessary
to pay dividends to shareholders, service debt, invest in subsidiaries,
repurchase common stock, and satisfy other operating requirements. The Parent
Company's primary funding sources to meet its liquidity requirements are
dividends and service fees from subsidiaries, borrowings with major banks,
commercial paper issuance, and proceeds from the issuance of equity. Dividends
received in cash from subsidiaries totaled $179.5 million in 2003 and represent
a primary funding source. At December 31, 2003, $136.8 million in dividends
could be paid to the parent by its subsidiaries without obtaining prior
regulatory approval, subject to the capital needs of the banks. As discussed in
Item 1, the subsidiary banks are subject to regulation and, among other things,
may be limited in their ability to pay dividends or transfer funds to the Parent
Company. Accordingly, consolidated cash flows as presented in the consolidated
statements of cash flows may not represent cash immediately available for the
payment of cash dividends to the shareholders or for other cash needs.
In addition to dividends and service fees from subsidiaries, the Parent Company
has multiple funding sources that could be used to increase liquidity and
provide additional financial flexibility. These sources include a revolving
credit facility, commercial paper, and two shelf registrations to issue debt and
preferred securities or a combination thereof. The Parent Company has available
a $100 million revolving credit facility with established lines of credit from
nonaffiliated banks, of which $100 million was available at December 31, 2003.
In addition, $200 million of commercial paper was available at December 31,
2003, under the Parent Company's $200 million commercial paper program.
In May 2002, the Parent Company filed a "shelf" registration statement under
which the Parent Company may offer up to $300 million of trust preferred
securities. In May 2002 $175 million of trust preferred securities were issued,
bearing a 7.625% fixed coupon rate. At December 31, 2003, $125 million was
available under the trust preferred shelf. In May 2001, the Parent Company filed
a "shelf" registration statement whereby the Parent Company may offer up to $500
million of any combination of the following securities, either separately or in
units: debt securities, preferred stock, depositary shares, common stock, and
warrants. In August 2001, the Parent Company issued $200 million in a
subordinated note offering, bearing a 6.75% fixed coupon rate and 10-year
maturity. At December 31, 2003, $300 million was available under the shelf
registration.
Investment securities are an important tool to the Corporation's liquidity
objective. As of December 31, 2003, all securities are classified as available
for sale and are reported at fair value on the consolidated balance sheet. Of
the $3.8 billion investment portfolio, $1.6 billion were pledged to secure
certain deposits, Federal Home Loan Bank advances, or for other purposes as
required or permitted by law. The remaining securities could be pledged or sold
to enhance liquidity, if necessary.
The bank subsidiaries have a variety of funding sources (in addition to key
liquidity sources, such as core deposits, loan and investment portfolio
repayments and maturities, and loan and investment portfolio sales) available to
increase financial flexibility. A $2 billion bank note program associated with
Associated Bank, National Association, was established during 2000. Under this
program, short-term and long-term debt may be issued. As of December 31, 2003,
$300 million of long-term bank notes and $200 million of short-term bank notes
were outstanding. At December 31, 2003, $1.5 billion was available under this
program. The banks have also established federal funds lines with major banks
totaling approximately $3.6 billion and the ability to borrow from the Federal
Home Loan Bank ($0.9 billion was outstanding at December 31, 2003). In addition,
the bank subsidiaries also accept Eurodollar deposits, issue institutional
certificates of deposit, and from time to time offer brokered certificates of
deposit.
As reflected in Table 22, the Corporation has various financial obligations,
including contractual obligations and other commitments, which may require
future cash payments. The relatively shorter
39
maturities in time deposits is not out of the ordinary to the Corporation's
experience of its customer base preference. While the time deposits indicate
shorter maturities and a declining trend (largely due to the reduced
attractiveness of time deposits in the prolonged low rate environment),
liquidity was supported by strong growth in non-time deposits. Continued
strategic emphasis on deposit growth should further support this liquidity
source. The Corporation has been purposely extending its long-term funding
sources primarily to take advantage of extending maturities in the low rate
environment. While this commits the Corporation contractually to future cash
payments, it is supportive of interest rate risk and liquidity management
strategies. As a financial services provider, the Corporation routinely enters
into commitments to extend credit. While contractual obligations represent
future cash requirements of the Corporation, a significant portion of
commitments to extend credit may expire without being drawn upon.
For the year ended December 31, 2003, net cash provided from operating and
financing activities was $496.8 million and $9.1 million, respectively, while
investing activities used net cash of $551.0 million, for a net decrease in cash
and cash equivalents of $45.1 million since year-end 2002. Generally, during
2003, deposit growth was strong, while net asset growth since year-end 2002 was
moderate (up 1.4%). Thus, the reliance on other funding sources was reduced,
particularly short-term borrowings and long-term debt. The deposit growth
provided for the repayment of short-term borrowings and long-term debt, common
stock repurchases, and the payment of cash dividends to the Corporation's
shareholders.
For the year ended December 31, 2002, net cash provided from operating and
financing activities was $298.6 million and $75.8 million, respectively, while
investing activities used net cash of $534.8 million, for a net decrease in cash
and cash equivalents of $160.4 million since year-end 2001. Generally, during
2002, anticipated maturities of time deposits occurred and net asset growth
since year-end 2001 was up due to the Signal acquisition. Other funding sources
were utilized, particularly long-term debt, to finance the Signal acquisition,
replenish the net decrease in deposits, repay short-term borrowings, provide for
common stock repurchases, and pay cash dividends to the Corporation's
shareholders.
Quantitative and Qualitative Disclosures about Market Risk
Market risk arises from exposure to changes in interest rates, exchange rates,
commodity prices, and other relevant market rate or price risk. The Corporation
faces market risk in the form of interest rate risk through other than trading
activities. Market risk from other than trading activities in the form of
interest rate risk is measured and managed through a number of methods. The
Corporation uses financial modeling techniques that measure the sensitivity of
future earnings due to changing rate environments to measure interest rate risk.
Policies established by the Corporation's Asset/Liability Committee and approved
by the Board of Directors limit exposure of earnings at risk. General interest
rate movements are used to develop sensitivity as the Corporation feels it has
no primary exposure to a specific point on the yield curve. These limits are
based on the Corporation's exposure to a 100 bp and 200 bp immediate and
sustained parallel rate move, either upward or downward.
Interest Rate Risk
In order to measure earnings sensitivity to changing rates, the Corporation uses
three different measurement tools: static gap analysis, simulation of earnings,
and economic value of equity. The static gap analysis starts with contractual
repricing information for assets, liabilities, and off-balance sheet
instruments. These items are then combined with repricing estimations for
administered rate (interest-bearing demand deposits, savings, and money market
accounts) and non-rate related products (demand deposit accounts, other assets,
and other liabilities) to create a baseline repricing balance sheet. In addition
to the contractual information, residential mortgage whole loan products and
mortgage-backed securities are adjusted based on industry estimates of
prepayment speeds that capture the expected prepayment of principal above the
contractual amount based on how far away the contractual coupon is from market
coupon rates.
40
The following table represents the Corporation's consolidated static gap
position as of December 31, 2003.
TABLE 20: Interest Rate Sensitivity Analysis
December 31, 2003
-----------------------------------------------------------------------------------------
Interest Sensitivity Period
Total Within
0-90 Days 91-180 Days 181-365 Days 1 Year Over 1 Year Total
-----------------------------------------------------------------------------------------
($ in Thousands)
Earning assets:
Loans held for sale $ 104,336 $ --- $ --- $ 104,336 $ --- $ 104,336
Investment securities,
at fair value 510,115 111,071 283,882 905,068 2,868,716 3,773,784
Loans 6,047,927 384,037 1,072,342 7,504,306 2,787,504 10,291,810
Interest rate swaps 352,983 --- --- 352,983 (352,983) ---
Other earning assets 10,724 --- --- 10,724 --- 10,724
-----------------------------------------------------------------------------------------
Total earning assets $ 7,026,085 $ 495,108 $ 1,356,224 $ 8,877,417 $ 5,303,237 $14,180,654
=========================================================================================
Interest-bearing liabilities:
Interest-bearing deposits(1) (2) $ 1,367,778 $ 966,325 $ 1,347,304 $ 3,681,407 $ 5,946,306 $ 9,627,713
Other interest-bearing
liabilities (2) 2,927,319 200,958 203,349 3,331,626 796,540 4,128,166
Interest rate swaps (3) 175,000 --- --- 175,000 (175,000) ---
-----------------------------------------------------------------------------------------
Total interest-bearing liabilities $ 4,470,097 $ 1,167,283 $ 1,550,653 $ 7,188,033 $ 6,567,846 $13,755,879
=========================================================================================
Interest sensitivity gap $ 2,555,988 $ (672,175) $ (194,429) $ 1,689,384 $(1,264,609) $ 424,775
Cumulative interest sensitivity gap $ 2,555,988 $ 1,883,813 $ 1,689,384
12 Month cumulative gap as a
percentage of earning assets at
December 31, 2003 18.0% 13.3% 11.9%
=========================================================================================
(1) The interest rate sensitivity assumptions for demand deposits, savings
accounts, money market accounts, and interest-bearing demand deposit
accounts are based on current and historical experiences regarding
portfolio retention and interest rate repricing behavior. Based on these
experiences, a portion of these balances are considered to be long-term and
fairly stable and are, therefore, included in the "Over 1 Year" category.
(2) For analysis purposes, Brokered CDs of $165 million have been included with
other interest-bearing liabilities and excluded from interest-bearing
deposits.
(3) Interest rate swaps on funding are presented on a net basis.
The static gap analysis in Table 20 provides a representation of the
Corporation's earnings sensitivity to changes in interest rates. It is a static
indicator that does not reflect various repricing characteristics and may not
necessarily indicate the sensitivity of net interest income in a changing
interest rate environment.
At the end of 2002, the Corporation's balance sheet was asset sensitive to
interest rate movements. (Asset sensitive means that assets will reprice faster
than liabilities. In a rising rate environment, an asset sensitive bank will
generally benefit.) During 2003, the Corporation remained asset sensitive as a
result of issuing long-term funding, growth in demand deposits, and shortening
of the mortgage portfolio and investment portfolio due to faster prepayment
experience.
Interest rate risk of embedded positions (including prepayment and early
withdrawal options, lagged interest rate changes, administered interest rate
products, and cap and floor options within products) require a more dynamic
measuring tool to capture earnings risk. Earnings simulation and economic value
of equity are used to more completely assess interest rate risk.
Along with the static gap analysis, determining the sensitivity of short-term
future earnings to a hypothetical plus or minus 100 bp and 200 bp parallel rate
shock can be accomplished through the use of simulation modeling. In addition to
the assumptions used to create the static gap, simulation of earnings includes
the modeling of the balance sheet as an ongoing entity. Future business
assumptions involving administered rate products, prepayments for future
rate-sensitive balances, and the reinvestment of maturing assets and liabilities
are included. These items are then modeled to project net interest income based
on a hypothetical change in interest rates. The resulting net interest income
41
for the next 12-month period is compared to the net interest income amount
calculated using flat rates. This difference represents the Corporation's
earnings sensitivity to a plus or minus 100 bp parallel rate shock.
The resulting simulations for December 31, 2003, projected that net interest
income would increase by approximately 1.7% of budgeted net interest income if
rates rose by a 100 bp shock, and projected that the net interest income would
decrease by approximately 1.1% if rates fell by a 100 bp shock. At December 31,
2002, the 100 bp shock up was projected to increase budgeted net interest income
by approximately 3.9%, and the 100 bp shock down was projected to decrease
budgeted net interest income by approximately 4.0%.
Economic value of equity is another tool used to measure the impact of interest
rates on the present value of assets, liabilities and off-balance sheet
financial instruments. This measurement is a longer-term analysis of interest
rate risk as it evaluates every cash flow produced by the current balance sheet.
The projected changes for earnings simulation and economic value of equity for
both 2003 and 2002 were within the Corporation's interest rate risk policy.
These results are based solely on immediate and sustained parallel changes in
market rates and do not reflect the earnings sensitivity that may arise from
other factors. These factors may include changes in the shape of the yield
curve, the change in spread between key market rates, or accounting recognition
of the impairment of certain intangibles. The above results are also considered
to be conservative estimates due to the fact that no management action to
mitigate potential income variances are included within the simulation process.
This action could include, but would not be limited to, delaying an increase in
deposit rates, extending liabilities, using financial derivative products to
hedge interest rate risk, changing the pricing characteristics of loans, or
changing the growth rate of certain assets and liabilities.
The Corporation uses interest rate derivative financial instruments as an
asset/liability management tool to hedge mismatches in interest rate exposure
indicated by the net interest income simulation described above. They are used
to modify the Corporation's exposures to interest rate fluctuations and provide
more stable spreads between loan yields and the rate on their funding sources.
In 2003, the Corporation entered into $96 million in notional amounts of new
interest rate swaps to reduce interest rate risk. Interest rate swaps involve
the exchange of fixed- and variable-rate payments without the exchange of the
underlying notional amount on which the interest payments are calculated.
Table 21: Interest Rate Swap Hedging Portfolio Notional Balances and
Yield by Maturity Date
Notional Weighted Average Weighted Average
Maturity Amount Rate Received Rate Paid
- -------------------------------------------------------------------------------
($ in Thousands)
Less than 1 year $ 22,148 3.30% 5.93%
1 - 5 years 232,176 3.41 6.25
5 - 10 years 500,134 3.81 4.61
Over 10 years 181,731 7.47 2.35
----------------------------------------------------
$936,189 4.41% 4.61%
====================================================
To hedge against rising interest rates, the Corporation may use interest rate
caps. Counterparties to these interest cap agreements pay the Corporation based
on the notional amount and the difference between current rates and strike
rates. At December 31, 2003, there were $200 million of interest rate caps
outstanding, which have a six month LIBOR strike of 4.72%. To hedge against
falling interest rates, the Corporation may use interest rate floors. Like caps,
counterparties to interest rate floor agreements pay the Corporation based on
the notional amount and the difference between current rates and strike rates.
There were no floors outstanding at December 31, 2003. Derivative financial
instruments are also discussed in Note 15, "Derivative and Hedging Activities,"
of the notes to consolidated financial statements.
42
Contractual Obligations, Commitments, Off-Balance Sheet Risk,
and Contingent Liabilities
Through the normal course of operations, the Corporation has entered into
certain contractual obligations and other commitments. Such obligations
generally relate to funding of operations through deposits or debt issuances, as
well as leases for premises and equipment. As a financial services provider, the
Corporation routinely enters into commitments to extend credit. While
contractual obligations represent future cash requirements of the Corporation, a
significant portion of commitments to extend credit may expire without being
drawn upon. Such commitments are subject to the same credit policies and
approval process accorded to loans made by the Corporation.
The following table summarizes significant contractual obligations and other
commitments at December 31, 2003. The payment amounts represent those amounts
contractually due to the recipient and do not include any unamoritized premiums
or discounts, hedge basis adjustments, or other similar carrying value
adjustments. Further discussion of the nature of each obligation is included in
the referenced note to the consolidated financial statements.
Table 22: Contractual Obligations and Other Commitments
Note One Year One to Three to Over
Reference or Less Three Years Five Years Five Years Total
------------------------------------------------------------------------------------------
($ in Thousands)
Time deposits 7 $2,008,241 $ 869,059 $237,388 $ 69,461 $3,184,149
Long-term funding 9 and 10 1,026,325 457,275 113,500 425,767 2,022,867
Operating leases 6 7,368 12,685 10,062 15,527 45,642
Commitments to extend credit 14 3,105,311 489,113 190,842 60,942 3,846,208
-----------------------------------------------------------------------------
Total $6,147,245 $1,828,132 $551,792 $571,697 $9,098,866
=============================================================================
The Corporation also has obligations under its retirement plans as described in
Note 12, "Retirement Plans," of the notes to consolidated financial statements.
The Corporation does not expect to make a contribution to its pension plan
during 2004 due to the funded status of the plan.
The Corporation also enters into derivative contracts under which the
Corporation is required to either receive cash from or pay cash to
counterparties depending on changes in interest rates. Derivative contracts are
carried at fair value on the consolidated balance sheet with the fair value
representing the net present value of expected future cash receipts or payments
based on market interest rates as of the balance sheet date. The fair value of
the contracts change daily as market interest rates change. Because the
derivative liabilities recorded on the balance sheet at December 31, 2003, do
not represent the amounts that may ultimately be paid under these contracts,
these liabilities are not included in the table of contractual obligations
presented above. Further discussion of derivative instruments is included in
Note 1, "Summary of Significant Accounting Policies," and Note 15, "Derivative
and Hedging Activities," of the notes to consolidated financial statements.
A summary of significant commitments at December 31, 2003, is as follows:
2003
------------------
($ in Thousands)
Commitments to extend credit, excluding
commitments to originate mortgage loans $3,732,150
Commitments to originate residential
mortgage loans held for sale 114,058
------------------
Total commitments to extend credit 3,846,208
Commercial letters of credit 19,665
Standby letters of credit 338,954
Forward commitments to sell loans $ 152,000
==================
Further discussion of these commitments is included in Note 14, "Commitments,
Off-Balance Sheet Risk, and Contingent Liabilities," of the notes to
consolidated financial statements.
43
The Corporation may also have liabilities under certain contractual agreements
contingent upon the occurrence of certain events. A discussion of significant
contractual arrangements under which the Corporation may be held contingently
liable, including guarantee arrangements, is included in Note 14, "Commitments,
Off-Balance Sheet Risk, and Contingent Liabilities," of the notes to
consolidated financial statements.
Capital
Stockholders' equity at December 31, 2003, increased $76 million to $1.3
billion, or $18.39 per share compared with $17.13 per share at the end of 2002.
Stockholders' equity is also described in Note 11, "Stockholders' Equity," of
the notes to consolidated financial statements.
The increase in stockholders' equity for 2003 was primarily composed of the
retention of earnings and the exercise of stock options, with offsetting
decreases to stockholders' equity from the payment of cash dividends and the
repurchase of common stock. Additionally, stockholders' equity at year-end 2003
included $52.1 million of accumulated other comprehensive income versus $60.3
million at December 31, 2002. The decrease in accumulated other comprehensive
income was predominantly related to a decrease in unrealized gains on securities
available for sale (due primarily to declines in the market value of
mortgage-related securities), lower unrealized losses on cash flow hedges, and a
change in the additional pension obligation (See Note 12, "Retirement Plans," of
the notes to consolidated financial statements), net of the related tax effect.
Stockholders' equity to assets at December 31, 2003 was 8.84%, compared to 8.46%
at the end of 2002.
TABLE 23: Capital
At December 31,
---------------------------------------
2003 2002 2001
---------------------------------------
(In Thousands, except per share data)
Total stockholders' equity $1,348,427 $1,272,183 $1,070,416
Tier 1 capital 1,221,647 1,165,481 924,871
Total capital 1,572,770 1,513,424 1,253,036
Market capitalization 3,137,696 2,521,083 2,305,698
---------------------------------------
Book value per common share $ 18.39 $ 17.13 $ 14.89
Cash dividends per common share 1.33 1.21 1.11
Stock price at end of period 42.80 33.94 32.08
Low closing price for the period 32.15 27.20 27.05
High closing price for the period 43.13 38.25 33.55
---------------------------------------
Total equity/assets 8.84% 8.46% 7.87%
Tier 1 leverage ratio 8.37 7.94 7.03
Tier 1 risk-based capital ratio 10.86 10.52 9.71
Total risk-based capital ratio 13.99 13.66 13.15
---------------------------------------
Shares outstanding (period end) 73,311 74,281 71,869
Basic shares outstanding (average) 73,745 74,685 72,587
Diluted shares outstanding (average) 74,507 75,493 73,167
=======================================
Cash dividends paid in 2003 were $1.33 per share, compared with $1.21 per share
in 2002, an increase of 9.9%. Cash dividends per share have increased at a 9.1%
compounded rate during the past five years.
The adequacy of the Corporation's capital is regularly reviewed to ensure that
sufficient capital is available for current and future needs and is in
compliance with regulatory guidelines. The assessment of overall capital
adequacy depends on a variety of factors, including asset quality, liquidity,
stability of earnings, changing competitive forces, economic condition in
markets served, and strength of management.
As of December 31, 2003 and 2002, the Corporation's Tier 1 risk-based capital
ratios, total risk-based capital (Tier 1 and Tier 2) ratios, and Tier 1 leverage
ratios were in excess of regulatory minimum and
44
well capitalized requirements. It is management's intent to exceed the minimum
requisite capital levels. Capital ratios are included in Note 18, "Regulatory
Matters," of the notes to consolidated financial statements. As discussed in
Note 10, "Company-Obligated Mandatorily Redeemable Preferred Securities," and
Note 18, "Regulatory Matters," of the notes to consolidated financial
statements, the preferred securities qualify as Tier 1 Capital for the
Corporation under Federal Reserve Board guidelines. As a result of recent
accounting pronouncements, the Federal Reserve Board is currently evaluating
whether deconsolidation of the trust will affect the qualification of the
preferred securities as Tier 1 capital. If it is determined that the preferred
securities no longer qualify as Tier 1 capital, the effect of such a change is
not expected to affect the Corporation's well-capitalized status.
The Board of Directors has authorized management to repurchase shares of the
Corporation's common stock each quarter in the market, to be made available for
issuance in connection with the Corporation's employee incentive plans and for
other corporate purposes. For the Corporation's employee incentive plans, the
Board of Directors authorized the repurchase of up to 1.6 million shares
(400,000 shares per quarter) in 2003 and 2002. Of these authorizations,
approximately 1.3 million shares were repurchased for $43.3 million during 2002
(with approximately 1.0 million shares reissued in connection with stock options
exercised), while none were repurchased during 2003 (with approximately 1.1
million shares reissued in connection with stock options exercised).
Additionally, under two separate actions in 2000 and one action in 2003, the
Board of Directors authorized the repurchase and cancellation of the
Corporation's outstanding shares, not to exceed approximately 11.0 million
shares on a combined basis. Under these authorizations, approximately 2.1
million shares were repurchased for $74.5 million during 2003 at an average cost
of $36.17 per share, while during 2002 approximately 1.3 million shares were
repurchased for $44.0 million at an average cost of $32.69 per share. At
December 31, 2003, approximately 3.7 million shares remain authorized to
repurchase. The repurchase of shares will be based on market opportunities,
capital levels, growth prospects, and other investment opportunities.
Shares repurchased and not retired are held as treasury stock and, accordingly,
are accounted for as a reduction of stockholders' equity.
Management believes that a strong capital position is necessary to take
advantage of opportunities for profitable geographic and product expansion, and
to provide depositor and investor confidence. Management actively reviews
capital strategies for the Corporation and each of its subsidiaries in light of
perceived business risks, future growth opportunities, industry standards, and
regulatory requirements. It is management's intent to maintain an optimal
capital and leverage mix for growth and for shareholder return.
Fourth Quarter 2003 Results
Net income for fourth quarter 2003 was $55.6 million, $2.2 million higher than
the $53.4 million earned in the fourth quarter of 2002. Basic and diluted
earnings per share for fourth quarter 2003 were $0.76 and $0.75, respectively,
compared to $0.72 and $0.71, respectively, for fourth quarter 2002.
Taxable equivalent net interest income for fourth quarter 2003 was $133.4
million, $2.3 million lower than fourth quarter 2002. Volume variances were
unfavorable by $0.6 million (primarily from lower average loans), while rate
variances were unfavorable by $1.7 million (primarily from unfavorable rate
variance on earning assets greater than favorable rate variance on
interest-bearing liabilities). Average earning assets declined $41 million
(0.3%) to $13.8 billion, the net of a $204 million decline in average loans and
a $163 million increase in average investments. Interest-bearing liabilities
decreased $155 million, the result of a $646 million growth in average
interest-bearing deposits (predominantly growth in interest-bearing demand
deposits), offset by an $801 million decline in average wholesale funding
(particularly short-term borrowings given deposit growth). The average Fed funds
rate for fourth quarter 2003 of 1.00% was 45 bp lower than fourth quarter 2002.
For fourth quarter 2003, net interest margin was 3.81%, 6 bp lower than fourth
quarter 2002, the result of a 6 bp lower contribution from net free funds (which
contributed less due to lower rates, despite increased balances). The yield
45
on earning assets for fourth quarter 2003 was 5.22% or 55 bp lower than fourth
quarter 2002, primarily attributable to lower loan yields. The rate on
interest-bearing liabilities also decreased 55 bp to 1.68%, also due principally
to the repricing of deposit products and wholesale funds in the lower interest
rate environment.
The provision for loan losses of $9.6 million in fourth quarter 2003 was $5.0
million lower than fourth quarter 2002. Less provision was provided in light of
flat loan growth as well asset quality differences between the quarters. The
allowance for loan losses to loans was 1.73% at December 31, 2003, compared to
1.58% at December 31, 2002 (see sections, "Loans," "Allowance for Loan Losses,"
and "Nonperforming Loans, Potential Problem Loans, and Other Real Estate
Owned.")
Noninterest income in fourth quarter 2003 was $10.2 million lower than the
comparable quarter in 2002, driven by a $16.7 million decrease in mortgage
banking income and a $3.9 increase in retail commissions. Although 2003
secondary mortgage production was up $1.1 billion from 2002, production declined
significantly in fourth quarter 2003, especially reflecting lower refinancing
activity due to the upward movement in mortgage rates. Secondary mortgage
production was $0.5 billion in fourth quarter 2003 versus $1.2 billion in fourth
quarter 2002, resulting in decreased gains on sales (down $13.2 million). Retail
commissions were up $3.9 million, with increases in insurance commissions (up
$3.4 million, attributable to the CFG acquisition) and brokerage commissions,
including variable annuities (up $0.5 million). Trust service fees increased
$2.1 million, reflecting new business, increases in the fee structure on
personal trust accounts, and improved equity markets. A $1.7 million increase in
asset sales gains was a result of a $1.4 million gain in fourth quarter 2003
(with $1.3 million gain from two branch sales) compared to a $0.4 million loss
in fourth quarter 2002. Credit card and other nondeposit fees were down $1.6
million, due to lower merchant fees related to the merchant processing sale in
March 2003.
Noninterest expense between the comparable quarters was down $6.9 million.
Mortgage servicing rights expense decreased by $9.6 million, due to a $3.5
million recovery of mortgage servicing rights valuation allowance in fourth
quarter 2003 versus a $6.7 million addition in fourth quarter 2002, a function
of the significant change in prepayment speeds in the servicing portfolio
between the fourth quarter periods. Loan expenses were down $2.8 million, with
credit card loan expenses down $1.9 million (due to the merchant processing sale
in March 2003) and mortgage loan expenses down $0.9 million (impacted by lower
secondary mortgage production between the comparable quarters). Personnel
expense was $4.3 million higher, with salary-related expenses up $4.4 million,
attributable to the expanded employee base from CFG and merit increases between
the years. Income tax expense was down $2.9 million between the fourth quarters
due to a decrease in the effective tax rate from 26.73% for fourth quarter 2003
compared to 30.3% for fourth quarter 2002, resulting from a beneficial
structural change within the Corporation's retirement plans, adjustments to the
valuation allowance, and state apportionment factors.
46
TABLE 24: Selected Quarterly Financial Data
The following is selected financial data summarizing the results of operations
for each quarter in the years ended December 31, 2003 and 2002:
2003 Quarter Ended
-----------------------------------------------
December 31 September 30 June 30 March 31
-----------------------------------------------
(In Thousands, except per share data)
Interest income $176,458 $181,819 $183,704 $185,383
Interest expense 49,321 52,843 56,509 57,929
-----------------------------------------------
Net interest income 127,137 128,976 127,195 127,454
Provision for loan losses 9,603 12,118 12,132 12,960
Investment securities gains
(losses), net --- 1 1,027 (326)
Income before income tax
expense 75,891 82,975 81,304 81,546
Net income 55,609 58,386 56,669 57,993
===============================================
Basic net income per share $ 0.76 $ 0.79 $ 0.77 $ 0.78
Diluted net income per share 0.75 0.79 0.76 0.77
Basic weighted average shares 73,310 73,473 73,959 74,252
Diluted weighted average shares 74,332 74,323 74,683 74,974
2002 Quarter Ended
-----------------------------------------------
December 31 September 30 June 30 March 31
-----------------------------------------------
(In Thousands, except per share data)
Interest income $196,178 $199,765 $201,857 $194,306
Interest expense 66,465 71,407 76,089 76,879
-----------------------------------------------
Net interest income 129,713 128,358 125,768 117,427
Provision for loan losses 14,614 12,831 12,003 11,251
Investment securities gains
(losses), net (801) 374 --- ---
Income before income tax
expense 76,685 76,000 72,481 71,160
Net income 53,441 53,472 52,344 51,462
===============================================
Basic net income per share $ 0.72 $ 0.71 $ 0.69 $ 0.70
Diluted net income per share 0.71 0.70 0.68 0.70
Basic weighted average shares 74,497 75,158 75,922 73,142
Diluted weighted average shares 75,202 76,047 77,041 74,042
2002 Compared to 2001
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. 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 are discussed below.
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 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
47
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 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. See Note 10,
"Company-Obligated Mandatorily Redeemable Preferred Securities," of the notes to
consolidated financial statements for additional information on the preferred
securities and details regarding the impact of recent accounting pronouncements
requiring the deconsolidation of the 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. See sections, "Allowance for Loan Losses" and
"Nonperforming Loans, Potential Problem Loans, and Other Real Estate Owned" for
more discussion.
Noninterest income was $215.8 million for 2002, $23.5 million or 12.2% higher
than 2001, led by strong results in mortgage banking and service charge revenue.
Mortgage banking revenue increased by $16.0 million (31.6%) driven by strong
secondary mortgage production ($3.2 billion for 2002 compared to $2.3 billion
for 2001), while service charges on deposit accounts were up $8.2 million
(21.8%) over 2001, due largely to higher volumes associated with a larger
account base.
Noninterest expense was $370.1 million, up $35.0 million or 10.4% over 2001, due
principally to the Corporation's larger operating base and increases in mortgage
servicing rights expense. Personnel expense rose $20.3 million or 12.0%,
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.
48
Subsequent Event
On January 28, 2004, the Board of Directors declared a $0.34 per share dividend
payable on February 16, 2004, to shareholders of record as of February 2, 2004.
Future Accounting Pronouncements
Note 1, "Summary of Significant Accounting Policies," of the notes to
consolidated financial statements discusses new accounting policies adopted by
the Corporation during 2003 and the expected impact of accounting policies
recently issued or proposed but not yet required to be adopted. To the extent
the adoption of new accounting standards materially affects the Corporation's
financial condition, results of operations, or liquidity, the impacts are
discussed in the applicable sections of this financial review and the notes to
consolidated financial statements.
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information required by this item is set forth in Item 7 under the captions
"Quantitative and Qualitative Disclosures About Market Risk" and "Interest Rate
Risk."
49
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ASSOCIATED BANC-CORP
CONSOLIDATED BALANCE SHEETS
December 31,
------------------------------
2003 2002
------------------------------
(In Thousands,
except share data)
ASSETS
Cash and due from banks $ 389,140 $ 430,691
Interest-bearing deposits in other
financial institutions 7,434 5,502
Federal funds sold and securities
purchased under agreements to resell 3,290 8,820
Investment securities available for sale,
at fair value 3,773,784 3,362,669
Loans held for sale 104,336 305,836
Loans 10,291,810 10,303,225
Allowance for loan losses (177,622) (162,541)
- -------------------------------------------------------------------------------
Loans, net 10,114,188 10,140,684
Premises and equipment 131,315 132,713
Goodwill 224,388 212,112
Other intangible assets 63,509 41,565
Other assets 436,510 402,683
- -------------------------------------------------------------------------------
Total assets $ 15,247,894 $ 15,043,275
===============================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Noninterest-bearing demand deposits $ 1,814,446 $ 1,773,699
Interest-bearing deposits, excluding
Brokered certificates of deposit 7,813,267 7,117,503
Brokered certificates of deposit 165,130 233,650
- -------------------------------------------------------------------------------
Total deposits 9,792,843 9,124,852
Short-term borrowings 1,928,876 2,389,607
Long-term debt 1,852,219 1,906,845
Company-obligated mandatorily redeemable
preferred securities 181,941 190,111
Accrued expenses and other liabilities 143,588 159,677
- -------------------------------------------------------------------------------
Total liabilities 13,899,467 13,771,092
- -------------------------------------------------------------------------------
Stockholders' equity
Preferred stock (Par value $1.00 per
share, authorized 750,000 shares,
no shares issued) --- ---
Common stock (Par value $0.01 per share,
authorized 100,000,000 shares, issued
73,442,555 and 75,503,410 shares at
December 31, 2003 and 2002, respectively) 734 755
Surplus 575,975 643,956
Retained earnings 724,356 607,944
Accumulated other comprehensive income 52,089 60,313
Deferred compensation (1,981) ---
Treasury stock, at cost (81,909 shares
in 2003 and 1,222,812 shares in 2002) (2,746) (40,785)
- -------------------------------------------------------------------------------
Total stockholders' equity 1,348,427 1,272,183
- -------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 15,247,894 $ 15,043,275
===============================================================================
See accompanying notes to consolidated financial statements.
50
ASSOCIATED BANC-CORP
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31,
-------------------------------------
2003 2002 2001
-------------------------------------
(In Thousands, except per share data)
INTEREST INCOME
Interest and fees on loans $ 578,816 $ 626,378 $ 692,646
Interest and dividends on investment
securities and deposits with other
financial institutions:
Taxable 108,624 125,568 146,548
Tax-exempt 39,761 39,771 40,385
Interest on federal funds sold and
securities purchased under agreements
to resell 163 389 1,043
- -------------------------------------------------------------------------------
Total interest income 727,364 792,106 880,622
- -------------------------------------------------------------------------------
INTEREST EXPENSE
Interest on deposits 123,122 169,021 298,930
Interest on short-term borrowings 29,156 51,372 130,546
Interest on long-term debt,
including preferred securities 64,324 70,447 29,161
- -------------------------------------------------------------------------------
Total interest expense 216,602 290,840 458,637
- -------------------------------------------------------------------------------
NET INTEREST INCOME 510,762 501,266 421,985
Provision for loan losses 46,813 50,699 28,210
- -------------------------------------------------------------------------------
Net interest income after provision
for loan losses 463,949 450,567 393,775
- -------------------------------------------------------------------------------
NONINTEREST INCOME
Trust service fees 29,577 27,875 29,063
Service charges on deposit accounts 50,346 46,059 37,817
Mortgage banking 83,037 66,415 50,463
Credit card and other nondeposit fees 23,669 27,492 26,731
Retail commissions 25,571 18,264 16,872
Bank owned life insurance income 13,790 13,841 12,916
Asset sale gains, net 1,569 657 1,997
Investment securities gains (losses), net 702 (427) 718
Other 18,174 15,644 15,765
- -------------------------------------------------------------------------------
Total noninterest income 246,435 215,820 192,342
- -------------------------------------------------------------------------------
NONINTEREST EXPENSE
Personnel expense 208,040 189,066 168,767
Occupancy 28,077 26,049 23,947
Equipment 12,818 14,835 14,426
Data processing 23,273 21,024 19,596
Business development and advertising 15,194 13,812 13,071
Stationery and supplies 6,705 7,044 6,921
FDIC expense 1,428 1,533 1,661
Mortgage servicing rights expense 29,553 30,473 19,987
Goodwill amortization --- --- 6,511
Intangible amortization expense 2,961 2,283 1,867
Loan expense 7,550 14,555 11,176
Other 53,069 49,387 47,178
- -------------------------------------------------------------------------------
Total noninterest expense 388,668 370,061 335,108
- -------------------------------------------------------------------------------
Income before income taxes 321,716 296,326 251,009
Income tax expense 93,059 85,607 71,487
- -------------------------------------------------------------------------------
Net income $ 228,657 $ 210,719 $ 179,522
===============================================================================
Earnings per share:
Basic $ 3.10 $ 2.82 $ 2.47
Diluted $ 3.07 $ 2.79 $ 2.45
Average shares outstanding:
Basic 73,745 74,685 72,587
Diluted 74,507 75,493 73,167
===============================================================================
See accompanying notes to consolidated financial statements.
51
ASSOCIATED BANC-CORP
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Accumulated
Other
Common Stock Retained Comprehensive Deferred Treasury
Shares Amount Surplus Earnings Income Compensation Stock Total
---------------------------------------------------------------------------------------
(In Thousands, except per share data)
---------------------------------------------------------------------------------------
Balance, December 31, 2000 66,402 $664 $296,479 $663,566 $15,581 $--- $(7,594) $968,696
Comprehensive income:
Net income --- --- --- 179,522 --- --- --- 179,522
Cumulative effect of accounting
change, net of taxes of $0.8 million --- --- --- --- (1,265) --- --- (1,265)
Net unrealized loss on derivative
instruments arising during the year,
net of taxes of $2.7 million --- --- --- --- (4,059) --- --- (4,059)
Add: reclassification adjustment to
interest expense
for interest differential, net of
taxes of $2.1 million --- --- --- --- 3,215 --- --- 3,215
Change in pension obligation,
net of taxes of $1.5 million --- --- --- --- (2,228) --- --- (2,228)
Net unrealized holding gains on
available for sale securities
arising during the year, net of
taxes of $20.3 million --- --- --- --- 36,363 --- --- 36,363
Less: reclassification adjustment for
net gains on available for sale
securities realized in net income,
net of taxes of $0.3 million --- --- --- --- (431) --- --- (431)
---------
Comprehensive income 211,117
---------
Cash dividends, $1.11 per share --- --- --- (80,553) --- --- --- (80,553)
Common stock issued:
Incentive stock options --- --- --- (2,504) --- --- 7,242 4,738
Purchase and retirement of treasury
stock in connection with
repurchase program (228) (2) (7,715) --- --- --- --- (7,717)
Purchase of treasury stock --- --- --- --- --- --- (26,852) (26,852)
Tax benefits of stock options --- --- 987 --- --- --- --- 987
---------------------------------------------------------------------------------------
Balance, December 31, 2001 66,174 $662 $289,751 $760,031 $47,176 $--- $(27,204) $1,070,416
---------------------------------------------------------------------------------------
Comprehensive income:
Net income --- --- --- 210,719 --- --- --- 210,719
Net unrealized loss on derivative
instruments arising
during the year, net of taxes of
$13.3 million --- --- --- --- (19,834) --- --- (19,834)
Add: reclassification adjustment to
interest expense for interest
differential, net of
taxes of $5.4 million --- --- --- --- 8,027 --- --- 8,027
Change in pension obligation,
net of taxes of $4.7 million --- --- --- --- (7,024) --- --- (7,024)
Net unrealized holding gains on
available for sale
securities arising during the
year, net of taxes of $18.1 million --- --- --- --- 31,712 --- --- 31,712
Add: reclassification adjustment for
net losses on available for sale
securities realized in net income,
net of taxes of $0.2 million --- --- --- --- 256 --- --- 256
---------
Comprehensive income 223,856
---------
Cash dividends, $1.21 per share --- --- --- (90,166) --- --- --- (90,166)
Common stock issued:
Business combinations 3,690 37 133,892 --- --- --- --- 133,929
Incentive stock options --- --- --- (14,000) --- --- 30,564 16,564
10% stock dividend 6,975 70 258,570 (258,640) --- --- --- ---
Purchase and retirement of treasury
stock in connection with
repurchase program (1,336) (14) (44,032) --- --- --- --- (44,046)
Purchase of treasury stock --- --- --- --- --- --- (44,145) (44,145)
Tax benefits of stock options --- --- 5,775 --- --- --- --- 5,775
----------------------------------------------------------------------------------------
Balance, December 31, 2002 75,503 $755 $643,956 $607,944 $60,313 $--- $(40,785) $1,272,183
----------------------------------------------------------------------------------------
(continued on next page)
52
ASSOCIATED BANC-CORP
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (continued)
Accumulated
Other
Common Stock Retained Comprehensive Deferred Treasury
Shares Amount Surplus Earnings Income Compensation Stock Total
---------------------------------------------------------------------------------------
(In Thousands, except per share data)
---------------------------------------------------------------------------------------
Balance, December 31, 2002 75,503 $755 $643,956 $607,944 $60,313 $--- $(40,785) $1,272,183
Comprehensive income:
Net income --- --- --- 228,657 --- --- --- 228,657
Net unrealized loss on derivative
instruments arising during the year,
net of taxes of $1.7 million --- --- --- --- (2,612) --- --- (2,612)
Add: reclassification adjustment to
interest expense
for interest differential, net of
taxes of $3.1 million --- --- --- --- 4,603 --- --- 4,603
Change in pension obligation,
net of taxes of $6.2 million --- --- --- --- 9,252 --- --- 9,252
Net unrealized holding losses on
available for sale
securities arising during the year,
net of taxes of $11.8 million --- --- --- --- (19,018) --- --- (19,018)
Less: reclassification adjustment for
net gains on available for sale
securities realized in net income,
net of taxes of $0.3 million --- --- --- --- (449) --- --- (449)
---------
Comprehensive income 220,433
---------
Cash dividends, $1.33 per share --- --- --- ( 98,169) --- --- --- (98,169)
Common stock issued:
Incentive stock options --- --- --- (14,076) --- --- 38,907 24,831
Purchase and retirement of treasury
stock in connection with repurchase
program (2,061) (21) (74,512) --- --- --- --- (74,533)
Purchase of treasury stock --- --- --- --- --- --- (868) (868)
Restricted stock awards granted, net of
amortization --- --- 313 --- --- (1,981) --- (1,668)
Tax benefits of stock options --- --- 6,218 --- --- --- --- 6,218
----------------------------------------------------------------------------------------
Balance, December 31, 2003 73,442 $734 $575,975 $724,356 $52,089 $(1,981) $(2,746) $1,348,427
========================================================================================
See accompanying notes to consolidated financial statements.
53
ASSOCIATED BANC-CORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31,
------------------------------------------
2003 2002 2001
------------------------------------------
($ in Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 228,657 $ 210,719 $ 179,522
Adjustments to reconcile net income
to net cash provided
by (used in) operating activities:
Provision for loan losses 46,813 50,699 28,210
Depreciation and amortization 16,364 18,696 18,616
Amortization (accretion) of:
Mortgage servicing rights 29,553 30,473 19,987
Goodwill and other intangible assets 2,961 2,283 8,378
Investment premiums and discounts 19,699 14,150 1,078
Deferred loan fees and costs (839) 711 2,225
Deferred income taxes (13,202) (14,878) 16,648
(Gain) loss on sales of investment
securities, net (702) 427 (718)
Gain on sales of assets, net (1,569) (657) (1,997)
Gain on sales of loans held for sale, net (55,500) (35,172) (21,111)
Mortgage loans originated and acquired for sale (4,273,406) (3,185,531) (2,305,059)
Proceeds from sales of mortgage loans held for sale 4,530,406 3,233,679 2,049,056
Increase in interest receivable and other assets (12,237) (13,351) (22,902)
Increase (decrease) in interest payable and
other liabilities (20,197) (13,664) 27,659
- -----------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 496,801 298,584 (408)
- -----------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Net increase in loans (36,062) (547,159) (132,845)
Capitalization of mortgage servicing rights (39,707) (30,730) (20,920)
Purchases of:
Securities available for sale (1,761,282) (1,621,096) (664,329)
Premises and equipment, net of disposals (13,290) (12,864) (7,702)
Proceeds from:
Sales of securities available for sale 1,263 27,793 135,627
Maturities of securities available for sale 1,298,426 1,626,013 647,626
Sales of other assets 17,650 5,214 13,762
Net cash received (paid) in acquisition of
subsidiaries (18,025) 17,982 --
- -----------------------------------------------------------------------------------------------------------
Net cash used in investing activities (551,027) (534,847) (28,781)
- -----------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits 685,143 (271,203) (667,235)
Net cash paid in sales of branch deposits (15,845) -- (10,899)
Net increase (decrease) in short-term borrowings (460,731) (357,007) 45,648
Repayment of long-term debt (558,114) (235,675) (907)
Proceeds from issuance of long-term funding 507,363 1,101,518 981,882
Cash dividends (98,169) (90,166) (80,553)
Proceeds from exercise of incentive stock options 24,831 16,564 4,738
Purchase and retirement of treasury stock (74,533) (44,046) (7,717)
Purchase of treasury stock (868) (44,145) (26,852)
- -----------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 9,077 75,840 238,105
- -----------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (45,149) (160,423) 208,916
Cash and cash equivalents at beginning of year 445,013 605,436 396,520
- -----------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 399,864 $ 445,013 $ 605,436
- -----------------------------------------------------------------------------------------------------------
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 223,233 $ 298,207 $ 478,128
Income taxes 110,423 91,098 58,129
Supplemental schedule of noncash investing activities:
Securities held to maturity transferred to securities --- --- 372,873
available for sale
Loans transferred to other real estate 11,654 14,158 3,897
Acquisitions:
Fair value of assets acquired, including cash
and cash equivalents $ 31,358 $ 1,155,200 ---
Value ascribed to intangibles 27,027 125,300 ---
Liabilities assumed 10,463 962,700 ---
===========================================================================================================
See accompanying notes to consolidated financial statements.
54
ASSOCIATED BANC-CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002, and 2001
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The accounting and reporting policies of the Corporation conform to accounting
principles generally accepted in the United States of America and to general
practice within the financial services industry. The following is a description
of the more significant of those policies.
Business
The Corporation provides a full range of banking and related financial services
to individual and corporate customers through its network of bank and nonbank
subsidiaries. The Corporation is subject to competition from other financial and
non-financial institutions that offer similar or competing products and
services. The Corporation is regulated by federal and state agencies and is
subject to periodic examinations by those agencies.
Basis of Financial Statement Presentation
The consolidated financial statements include the accounts of the Parent Company
and subsidiaries, all of which are wholly owned. All significant intercompany
balances and transactions have been eliminated in consolidation. Results of
operations of companies purchased and accounted for under the purchase method of
accounting are included from the date of acquisition. Certain amounts in the
2002 and 2001 consolidated financial statements, as well as certain amounts in
the previously issued 2003 earnings press release, have been reclassified to
conform with the 2003 Form 10-K presentation. In particular, for presentation
purposes and greater comparability with industry practice, certain loan
origination costs in the consolidated statements of income were reclassified
against gains on the sales of mortgage loans for 2003, 2002, and 2001. These
reclassifications resulted in an equal decrease to both noninterest income and
noninterest expense of $6.1 million in 2003, $4.5 million in 2002, and $3.3
million in 2001. The reclassifications had no effect on stockholders' equity or
net income as previously reported.
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.
Investment Securities
Securities are classified as held to maturity, available for sale, or trading at
the time of purchase. In 2003 and 2002, all securities purchased were classified
as available for sale. Investment securities classified as held to maturity,
which management has the positive intent and ability to hold to maturity, are
reported at amortized cost, adjusted for amortization of premiums and accretion
of discounts, using a method that approximates level yield. The amortized cost
of debt securities classified as held to maturity or available for sale is
adjusted for amortization of premiums and accretion of discounts to the earlier
of call date or maturity, or in the case of mortgage-related securities, over
the estimated life of the security. Such amortization and accretion is included
in interest income from the related security. Available for sale securities are
reported at fair value with unrealized gains and losses, net of related deferred
income taxes, included in stockholders' equity as a separate component of other
comprehensive income. The cost of securities sold is based on the specific
identification method. Any security for which there has been an
other-than-temporary impairment of value is written down to its estimated fair
value through a charge to earnings and a new cost basis is established. Realized
securities
55
gains or losses and declines in value judged to be other-than-temporary are
included in investment securities gains (losses), net, in the consolidated
statements of income.
Loans
Loans and leases are carried at the principal amount outstanding, net of any
unearned income. Unearned income from direct leases is recognized on a basis
that generally approximates a level yield on the outstanding balances
receivable. Loan origination fees and certain direct loan origination costs are
deferred, and the net amount is amortized over the contractual life of the
related loans or over the commitment period as an adjustment of yield.
Loans are generally placed on nonaccrual status when contractually past due 90
days or more as to interest or principal payments. Additionally, whenever
management becomes aware of facts or circumstances that may adversely impact the
collectibility of principal or interest on loans, it is management's practice to
place such loans on nonaccrual status immediately, rather than delaying such
action until the loans become 90 days past due. Previously accrued and
uncollected interest on such loans is reversed, amortization of related loan
fees is suspended, and income is recorded only to the extent that interest
payments are subsequently received in cash and a determination has been made
that the principal balance of the loan is collectible. If collectibility of the
principal is in doubt, payments received are applied to loan principal. A
nonaccrual loan is returned to accrual status when the obligation has been
brought current and the ultimate collectibility of the total contractual
principal and interest is no longer in doubt.
Loans Held for Sale
Loans held for sale are recorded at the lower of cost or market as determined on
an aggregate basis and generally consist of current production of certain
fixed-rate first mortgage loans. Holding costs are treated as period costs.
Allowance for Loan Losses
The allowance for loan losses is a reserve for estimated credit losses. Actual
credit losses, net of recoveries, are deducted from the allowance for loan
losses. A provision for loan losses, which is a charge against earnings, is
recorded to bring the allowance for loan losses to a level that, in management's
judgment, is adequate to absorb probable losses in the loan portfolio.
The allocation methodology applied by the Corporation, designed to assess the
adequacy of the allowance for loan losses, 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.
Management maintains the allowance for loan losses using an allocation
methodology plus an unallocated portion, as determined by economic conditions
and other qualitative and quantitative factors affecting the Corporation's
borrowers. Management allocates the allowance for loan losses by pools of risk.
The commercial loan (commercial, financial, and agricultural; real estate
construction; commercial real estate; and lease financing) allocation is based
on a quarterly review of individual loans, loan types, and industries. The
retail loan (residential mortgage, home equity, and consumer) allocation is
based on analysis of historical delinquency and charge off statistics and
trends. Minimum loss factors used by the Corporation for criticized loan
categories are consistent with regulatory agency classifications and factors.
Loss factors for non-criticized loan categories are based primarily on
historical loan loss experience.
Management, considering current information and events regarding the borrowers'
ability to repay their obligations, considers a loan to be impaired when it is
probable that the Corporation will be unable to collect all amounts due
according to the contractual terms of the note agreement, including principal
and interest. Management has determined that commercial, financial, and
agricultural loans,
56
commercial real estate loans, and real estate construction loans that are on
nonaccrual status or have had their terms restructured meet this definition.
Large groups of homogeneous loans, such as mortgage and consumer loans, are
collectively evaluated for impairment. The amount of impairment is measured
based upon the loan's observable market price, the estimated fair value of the
collateral for collateral-dependent loans, or alternatively, the present value
of expected future cash flows discounted at the loan's effective interest rate.
Interest income on impaired loans is recorded when cash is received and only if
principal is considered to be fully collectible.
Management believes that the allowance for loan losses is adequate. While
management uses available information to recognize losses on loans, future
additions to the allowance for loan losses may be necessary based on changes in
economic conditions. In addition, various regulatory agencies, as an integral
part of their examination process, periodically review the Corporation's
allowance for loan losses. Such agencies may require the Corporation to
recognize additions to the allowance for loan losses or 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 examinations.
Other Real Estate Owned
Other real estate owned is included in other assets in the consolidated balance
sheets and is comprised of property acquired through a foreclosure proceeding or
acceptance of a deed-in-lieu of foreclosure, and loans classified as
in-substance foreclosure. Other real estate owned is recorded at the lower of
recorded investment in the loans at the time of acquisition or the fair value of
the properties, less estimated selling costs. Any write-down in the carrying
value of a property at the time of acquisition is charged to the allowance for
loan losses. Any subsequent write-downs to reflect current fair market value, as
well as gains and losses on disposition and revenues and expenses incurred in
maintaining such properties, are treated as period costs. Other real estate
owned totaled $5.5 million and $11.4 million at December 31, 2003 and 2002,
respectively.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation and amortization are computed on the straight-line
method over the estimated useful lives of the related assets or the lease term.
Maintenance and repairs are charged to expense as incurred, while additions or
major improvements are capitalized and depreciated over their estimated useful
lives. Estimated useful lives of the assets are 3 to 20 years for land
improvements, 5 to 40 years for buildings, 3 to 5 years for computers, and 3 to
20 years for furniture, fixtures, and other equipment. Leasehold improvements
are amortized on a straight-line basis over the lesser of the lease terms or the
estimated useful lives of the improvements.
Goodwill and Other Intangible Assets
The excess of the cost of an acquisition over the fair value of the net assets
acquired consist primarily of goodwill, core deposit intangibles, and other
intangibles (primarily related to customer relationships acquired). Core deposit
intangibles have finite lives and are amortized on an accelerated basis to
expense over periods of 7 to 10 years. The other intangibles have finite lives
and are amortized on an accelerated basis to expense over a weighted average
life of 16 years. The Corporation reviews long-lived assets and certain
identifiable intangibles for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable, in which case an impairment charge would be recorded.
Prior to January 1, 2002, goodwill was amortized to expense over periods up to
40 years for acquisitions made before 1983 and for periods up to 25 years for
acquisitions made after 1982. The Corporation adopted SFAS No. 142, "Goodwill
and Other Intangible Assets," ("SFAS 142") and SFAS No. 147, "Acquisitions of
Certain Financial Institutions," ("SFAS 147") effective January 1, 2002. Under
SFAS 142, goodwill and indefinite life intangibles are no longer amortized but
are subject to
57
impairment tests on at least an annual basis. Any impairment of goodwill or
intangibles will be recognized as an expense in the period of impairment. The
Corporation was required to complete the transitional goodwill impairment test
within six months of adoption of SFAS 142 and to record the impairment, if any,
by the end of the fiscal year. The Corporation completed the transitional
goodwill impairment test in the second quarter of 2002 as of January 1, 2002. No
impairment loss was recorded as of January 1, 2002. No impairment loss was
necessary from the January 1, 2002, and May 1, 2002 and 2003, impairment tests
described above under the Corporation's adoption of SFAS 142, including the $7.4
million of goodwill related to SFAS 147. Note 5 includes a summary of the
Corporation's goodwill, core deposit intangibles, and other intangibles. Note 19
provides disclosures regarding the impact of SFAS 142 and SFAS 147 on the
Corporation's consolidated financial statements.
SFAS 147 amends SFAS No. 72, "Accounting for Certain Acquisitions of Banking or
Thrift Institutions," ("SFAS 72") to remove the acquisition of financial
institutions from the scope of that statement and provides guidance on the
accounting for the impairment or disposal of acquired long-term
customer-relationship intangible assets. Except for transactions between two or
more mutual enterprises, SFAS 147 requires acquisitions of financial
institutions that meet the definition of a business combination to be accounted
for in accordance with SFAS No. 141, "Business Combinations," ("SFAS 141") and
SFAS 142. The provisions of SFAS 147 were effective on October 1, 2002, with
earlier application permitted. The Corporation adopted SFAS 147 effective
September 30, 2002. At January 1, 2002, the Corporation had $7.4 million of
goodwill from certain business combinations that was continuing to be amortized
in 2002 under SFAS 72, prior to the issuance of SFAS 147. With the adoption of
SFAS 147, which removed certain acquisitions from the scope of SFAS 72 and
included them under SFAS 142, the Corporation ceased such amortization. The
amount of such amortization was $0.25 million pre-tax per quarter, or
approximately 0.3 of a cent of diluted earnings per share per quarter in 2002.
The Corporation discontinued such amortization effective January 1, 2002, the
same date as the Corporation's adoption of SFAS 142, and has restated any prior
financial information as required by SFAS 147.
Mortgage Servicing Rights
The Corporation sells residential mortgage loans in the secondary market and
typically retains the right to service the loans sold. Upon sale, a mortgage
servicing rights asset is capitalized, which represents the then current fair
value of future net cash flows expected to be realized for performing servicing
activities. Mortgage servicing rights, when purchased, are initially recorded at
cost. Mortgage servicing rights are carried at the lower of the initial
capitalized amount, net of accumulated amortization, or fair value, and are
included in other intangible assets in the consolidated balance sheets. Mortgage
servicing rights are amortized in proportion to and over the period of estimated
servicing income.
The Corporation periodically evaluates its mortgage servicing rights asset for
impairment. Impairment is assessed using stratifications based on the risk
characteristics of the underlying loans, such as bulk acquisitions versus
loan-by-loan, loan type, interest rate, and estimated prepayment speeds of the
underlying mortgages serviced. The value of mortgage servicing rights is
adversely affected when mortgage interest rates decline and mortgage loan
prepayments increase. A valuation allowance is established to the extent the
carrying value of the mortgage servicing rights exceeds the estimated fair value
by stratification. If it is later determined all or a portion of the temporary
impairment no longer exists for a stratification, the valuation allowance is
reduced through a recovery to earnings. An other-than-temporary impairment
(i.e., recoverability is considered remote when considering interest rates and
loan pay off activity) is recognized as a write-down of the mortgage servicing
rights asset and the related valuation allowance (to the extent a valuation
reserve is available) and then against earnings. A direct write-down permanently
reduces the carrying value of the mortgage servicing rights asset and valuation
allowance, precluding subsequent recoveries.
58
Income Taxes
Amounts provided for income tax expense are based on income reported for
financial statement purposes and do not necessarily represent amounts currently
payable under tax laws. Deferred income taxes, which arise principally from
temporary differences between the period in which certain income and expenses
are recognized for financial accounting purposes and the period in which they
affect taxable income, are included in the amounts provided for income taxes. In
assessing the realizability of deferred tax assets, management considers whether
it is more likely than not that some portion or all of the deferred tax assets
will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income,
and tax planning strategies in making this assessment. Based upon the level of
historical taxable income and projections for future taxable income over the
period which the deferred tax assets are deductible, management believes it is
more likely than not the Corporation will realize the benefits of these
deductible differences, net of the existing valuation allowances at December 31,
2003.
The Corporation files a consolidated federal income tax return and individual
Parent Company and subsidiary state income tax returns. Accordingly, amounts
equal to tax benefits of those subsidiaries having taxable federal losses or
credits are offset by other subsidiaries that incur federal tax liabilities.
Derivative Financial Instruments and Hedging Activities
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as
amended by SFAS No. 138, "Accounting for Certain Derivative Instruments and
Certain Hedging Activities," and SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities," (collectively referred to as
"SFAS 133") requires derivative instruments, including derivative instruments
embedded in other contracts, to be carried at fair value on the balance sheet
with changes in the fair value recorded directly in earnings. As required, the
Corporation adopted SFAS 133 on January 1, 2001. In accordance with the
transition provisions of SFAS 133, upon adoption the Corporation recorded a
cumulative effect of $1.3 million, net of taxes of $843,000, in accumulated
other comprehensive income to recognize at fair value all derivatives that are
designated as cash flow hedge instruments. Due to immateriality, net gains on
derivatives designated as fair value hedges were recorded in earnings at
adoption.
All derivatives are recognized on the consolidated balance sheet at their fair
value. On the date the derivative contract is entered into, the Corporation
designates the derivative, except for mortgage banking derivatives for which
changes in fair value of the derivative is recorded in earnings, as either a
fair value hedge (i.e., a hedge of the fair value of a recognized asset or
liability) or a cash flow hedge (i.e., a hedge of the variability of cash flows
to be received or paid related to a recognized asset or liability). The
Corporation formally documents all relationships between hedging instruments and
hedging items, as well as its risk management objective and strategy for
undertaking various hedge transactions. This process includes linking all
derivatives that are designated as fair value hedges or cash flow hedges to
specific assets or liabilities on the balance sheet. The Corporation also
formally assesses, both at the hedge's inception and on an ongoing basis,
whether the derivatives that are used in hedging transactions are highly
effective in offsetting changes in fair values or cash flows of hedged items. If
it is determined that a derivative is not highly effective as a hedge or that it
has ceased to be a highly effective hedge, the Corporation discontinues hedge
accounting prospectively.
For a derivative designated as a fair value hedge, the changes in the fair value
of the derivative and of the hedged item attributable to the hedged risk are
recognized in earnings. If the derivative is designated as a cash flow hedge,
the effective portions of changes in the fair value of the derivative are
recorded in other comprehensive income and the ineffective portions of changes
in the fair value of cash flow hedges are recognized in earnings.
The Corporation discontinues hedge accounting prospectively when it is
determined that the derivative is no longer effective in offsetting changes in
the fair value or cash flows of the hedged item,
59
the derivative expires or is sold, terminated, or exercised, the derivative is
dedesignated as a hedging instrument, or management determines that designation
of the derivative as a hedging instrument is no longer appropriate. When hedge
accounting is discontinued because it is determined that the derivative no
longer qualifies as an effective fair value hedge, the Corporation continues to
carry the derivative on the balance sheet at its fair value and no longer
adjusts the hedged asset or liability for changes in fair value. The adjustment
of the carrying amount of the hedged asset or liability is accounted for in the
same manner as other components of the carrying amount of that asset or
liability.
Stock-Based Compensation
As allowed under SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123") and SFAS No. 148, "Accounting for Stock-Based Compensation - Transition
and Disclosure - an amendment of SFAS 123," the Corporation accounts for
stock-based compensation cost under the intrinsic value method of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB
25), and related Interpretations, under which no compensation cost has been
recognized for any periods presented, except with respect to restricted stock
awards. Compensation expense for employee stock options is generally not
recognized if the exercise price of the option equals or exceeds the fair value
of the stock on the date of grant, as such options would have no intrinsic value
at the date of grant.
The Corporation may issue common stock with restrictions to certain key
employees. The shares are restricted as to transfer but are not restricted as
to dividend payment or voting rights. Transfer restrictions lapse over three or
five years, depending upon whether the award is fixed or performance-based, are
contingent upon continued employment, and for performance awards are based on
earnings per share performance goals. The Corporation amortizes the expense over
the vesting period. During 2003, 50,000 restricted stock shares were awarded,
and expense of approximately $451,000 was recorded for the year ended December
31, 2003.
For purposes of providing the pro forma disclosures required under SFAS 123, the
fair value of stock options granted in 2003, 2002, and 2001 was estimated at the
date of grant using a Black-Scholes option pricing model, which was originally
developed for use in estimating the fair value of traded options that have
different characteristics from the Corporation's employee stock options. The
model is also sensitive to changes in the subjective assumptions that can
materially affect the fair value estimate. As a result, management believes the
Black-Scholes model may not necessarily provide a reliable single measure of the
fair value of employee stock options. The following table illustrates the effect
on net income and earnings per share if the Corporation had applied the fair
value recognition provisions of SFAS 123.
For the Years Ended December 31,
---------------------------------------------
2003 2002 2001
---------------------------------------------
($ in Thousands, except per share amounts)
Net income, as reported $228,657 $210,719 $179,522
Add: Stock-based employee compensation expense
included in reported net income, net of related tax effects 271 --- ---
Less: Total stock-based compensation expense determined under fair
value based method for all awards, net of related tax effects (2,956) (3,156) (3,484)
---------------------------------------------
Net income, as adjusted $225,972 $207,563 $176,038
============================= ===============
Basic earnings per share, as reported $ 3.10 $ 2.82 $ 2.47
Add: Stock-based employee compensation expense included in reported
net income, net of related tax effects --- --- ---
Less: Total stock-based compensation expense determined under fair
value based method for all awards, net of related tax effects (0.04) (0.04) (0.04)
---------------------------------------------
Basic earnings per share, as adjusted $ 3.06 $ 2.78 $ 2.43
=============================================
60
For the Years Ended December 31,
--------------------------------------------
2003 2002 2001
--------------------------------------------
($ in Thousands, except per share amounts)
Diluted earnings per share, as reported $3.07 $2.79 $2.45
Add: Stock-based employee compensation expense included in reported
net income, net of related tax effects --- --- ---
Less: Total stock-based compensation expense determined under fair
value based method for all awards, net of related tax effects (0.04) (0.04) (0.04)
--------------------------------------------
Diluted earnings per share, as adjusted $3.03 $2.75 $2.41
============================================
The following assumptions were used in estimating the fair value for options
granted in 2003, 2002, and 2001:
2003 2002 2001
--------------------------------------------
Dividend yield 3.18% 3.65% 3.51%
Risk-free interest rate 3.27% 4.58% 5.09%
Weighted average expected life 7 yrs 7 yrs 7 yrs
Expected volatility 28.29% 28.35% 26.07%
The weighted average per share fair values of options granted in 2003, 2002, and
2001 were $8.08, $7.73, and $7.06, respectively. The annual expense allocation
methodology prescribed by SFAS 123 attributes a higher percentage of the
reported expense to earlier years than to later years, resulting in an
accelerated expense recognition for proforma disclosure purposes.
Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, cash and cash
equivalents are considered to include cash and due from banks, interest-bearing
deposits in other financial institutions, and federal funds sold and securities
purchased under agreements to resell.
Per Share Computations
Basic earnings per share is calculated by dividing net income by the weighted
average number of common shares outstanding. Diluted earnings per share is
calculated by dividing net income by the weighted average number of shares
adjusted for the dilutive effect of outstanding stock options. Also see Notes 11
and 19.
Recent Accounting Pronouncements
In December 2003, the FASB issued SFAS No. 132 (revised December 2003),
"Employers' Disclosures about Pensions and Other Postretirement Benefits, an
amendment of FASB Statements No. 87, 88, and 106," ("SFAS 132"). SFAS 132
revises employers' disclosures about pension plans and other postretirement
benefit plans. This Statement does not change the measurement or recognition of
pension plans and other postretirement benefit plans required by FASB Statements
No. 87, "Employers' Accounting for Pensions," No. 88, "Employers' Accounting for
Settlements and Curtailments of Defined Benefit Pension Plans and for
Termination Benefits," and No. 106, "Employers' Accounting for Postretirement
Benefits Other Than Pensions." The revised SFAS 132 retains the disclosure
requirements contained in the original SFAS 132 and requires additional
disclosures about the assets, obligations, cash flows, and net periodic benefit
cost of defined benefit pension plans and other defined benefit postretirement
plans. In general, the annual provisions of SFAS 132 are effective for fiscal
years ending after December 15, 2003, and the interim-period disclosures are
effective for interim periods beginning after December 15, 2003. The adoption
had no effect on the Corporation's results of operations, financial position, or
liquidity.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150").
SFAS 150 establishes standards for how
61
an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. SFAS 150 is effective for
financial instruments, except mandatorily redeemable financial instruments,
entered into or modified after May 31, 2003. For certain mandatorily redeemable
financial instruments the effective date has been deferred indefinitely. The
adoption had no effect on the Corporation's results of operations, financial
position, or liquidity.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS 149"). SFAS 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities under SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities." This Statement amends SFAS No. 133 for decisions made
as part of the Derivatives Implementation Group process and in connection with
implementation issues raised in relation to the application of the definition of
a derivative. SFAS 149 is effective for contracts entered into or modified after
June 30, 2003. The adoption had no material impact on the Corporation's results
of operations, financial position, or liquidity.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). This interpretation provides guidance on
how to identify a variable interest entity and determine when the assets,
liabilities, noncontrolling interests, and results of operations of a variable
interest entity are to be included in an entity's consolidated financial
statements. A variable interest entity exists when either the total equity
investment at risk is not sufficient to permit the entity to finance its
activities by itself, or the equity investors lack one of three characteristics
associated with owning a controlling financial interest. Those characteristics
include the direct or indirect ability to make decisions about an entity's
activities through voting rights or similar rights, the obligation to absorb the
expected losses of an entity if they occur, or the right to receive the expected
residual returns of the entity if they occur. The adoption had no material
impact on the Corporation's results of operations, financial position, or
liquidity.
In December 2003, the FASB reissued FIN 46 ("FIN 46R") with certain
modifications and clarifications. Application of FIN 46R was effective for
interests in certain variable interest entities as of December 31, 2003, and for
all other types of variable interest entities for periods ending after March 15,
2004, unless FIN 46 was previously applied. The application of FIN 46R will
result in the deconsolidation of a subsidiary relating to the issuance of trust
preferred securities. The assets and liabilities of the subsidiary trust were
deconsolidated in the first quarter of 2004 and totaled $180 million. See Note
10 for further discussion of this trust and the Corporation's related
obligations. The Corporation does not believe that the application of FIN 46R
had a material impact on the results of operations, financial position, or
liquidity.
In December 2003, the AICPA's Accounting Standards Executive Committee issued
Statement of Position ("SOP") 03-3, "Accounting for Certain Loans or Debt
Securities Acquired in a Transfer," ("SOP 03-3"). SOP 03-3 addresses accounting
for differences between contractual cash flows and cash flows expected to be
collected from an investor's initial investment in loans or debt securities
acquired in a transfer if those differences are attributable, at least in part,
to credit quality. The provisions of this SOP are effective for loans acquired
in fiscal years beginning after December 15, 2004. The Corporation does not
expect the requirements of SOP 03-3 to have a material impact on the results of
operations, financial position, or liquidity.
NOTE 2 BUSINESS COMBINATIONS:
In 2003 there was one completed business combination. On April 1, 2003, the
Corporation consummated its cash acquisition of 100% of the outstanding shares
of CFG, a closely-held insurance agency headquartered in Minnetonka, Minnesota.
Effective in June 2003, CFG operated as Associated Financial Group, LLC. CFG, an
independent, full-line insurance agency, was acquired to enhance the growth of
the Corporation's existing insurance business. The acquisition was accounted for
under the purchase method of accounting; thus, the results of operations prior
to the consummation date were not included in the accompanying consolidated
financial statements. The acquisition is individually
62
immaterial to the consolidated financial results. Goodwill of approximately $12
million and other intangibles of approximately $15 million recognized in the
transaction at acquisition were assigned to the wealth management segment.
There was one completed business combination during 2002. On February 28, 2002,
the Corporation consummated its acquisition of 100% of the outstanding common
shares of Signal. 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 banking presence, particularly in the Twin Cities area.
The Signal transaction was accounted for under the purchase method of
accounting; thus, the results of operations prior to the consummation date were
not included in the accompanying consolidated financial statements. 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.
The following table summarizes the estimated fair value of the assets acquired
and liabilities assumed of Signal at the date of the acquisition.
$ in Millions
---------------
Investment securities available for sale $ 163.8
Loans 760.0
Allowance for loan losses (12.0)
Other assets 118.1
Intangible asset 5.6
Goodwill 119.7
-----------
Total assets acquired $ 1,155.2
-----------
Deposits $ 784.8
Borrowings 165.5
Other liabilities 12.4
-----------
Total liabilities assumed $ 962.7
-----------
Net assets acquired $ 192.5
===========
The other intangible asset represents a core deposit intangible with a ten-year
estimated life. The $119.7 million of goodwill was assigned to the banking
segment.
The following represents required supplemental pro forma disclosure of total
revenue, net income, and earnings per share as though the Signal acquisition had
been completed at the beginning of the year of acquisition.
Year ended December 31,
2002 2001
----------------------------
(In Thousands,
except per share data)
Total revenue $731,398 $673,363
Net income 209,829 190,444
Basic earnings per share 2.78 2.48
Diluted earnings per share 2.75 2.45
63
NOTE 3 INVESTMENT SECURITIES:
The amortized cost and fair values of securities available for sale at December
31, 2003 and 2002, were as follows:
2003
--------------------------------------------------------
Gross Gross
Unrealized Unrealized
Amortized Holding Holding Fair
Cost Gains Losses Value
--------------------------------------------------------
($ in Thousands)
U. S. Treasury securities $ 36,588 $ 171 $ --- $ 36,759
Federal agency securities 167,859 4,944 (90) 172,713
Obligations of state and political
subdivisions 868,974 58,579 (68) 927,485
Mortgage-related securities 2,232,920 12,128 (11,636) 2,233,412
Other securities (debt and equity) 368,388 36,040 (1,013) 403,415
--------------------------------------------------------
Total securities available for sale $ 3,674,729 $ 111,862 $(12,807) $3,773,784
========================================================
2002
--------------------------------------------------------
Gross Gross
Unrealized Unrealized
Amortized Holding Holding Fair
Cost Gains Losses Value
--------------------------------------------------------
($ in Thousands)
U. S. Treasury securities $ 44,967 $ 915 $ --- $ 45,882
Federal agency securities 222,787 11,143 --- 233,930
Obligations of state and political
subdivisions 851,710 52,316 (3) 904,023
Mortgage-related securities 1,672,542 33,491 (797) 1,705,236
Other securities (debt and equity) 440,126 33,473 (1) 473,598
--------------------------------------------------------
Total securities available for sale $3,232,132 $131,338 $ (801) $3,362,669
========================================================
Equity securities include Federal Reserve and Federal Home Loan Bank stock which
had a fair value of $25.3 million and $112.5 million, respectively, at December
31, 2003, and $28.4 million and $103.4 million, respectively, at December 31,
2002.
The following represents gross unrealized losses and the related fair value of
securities available for sale, aggregated by investment category and length of
time that individual securities have been in a continuous unrealized loss
position, at December 31, 2003.
Less than 12 months 12 months or more Total
------------------------------------------------------------------------------------
Unrealized Unrealized Unrealized
Losses Fair Value Losses Fair Value Losses Fair Value
------------------------------------------------------------------------------------
($inThousands)
Federal agency securities $ (90) $ 14,986 $ --- $ --- $ (90) $ 14,986
Obligations of state and political
subdivisions (68) 4,007 --- --- (68) 4,007
Mortgage-related securities (11,619) 1,036,040 (17) 2,630 (11,636) 1,038,670
Other securities (equity) --- --- (1,013) 7,649 (1,013) 7,649
------------------------------------------------------------------------------------
Total $(11,777) $1,055,033 $(1,030) $10,279 $(12,807) $1,065,312
====================================================================================
Management does not believe any individual unrealized loss as of December 31,
2003 represents an other-than-temporary impairment. The unrealized losses
reported for mortgage-related securities relate primarily to securities issued
by government agencies such as the Federal National Mortgage Association and
Federal Home Loan Mortgage Corporation ("FHLMC"). These unrealized losses are
primarily attributable to changes in interest rates and individually were 4% or
less of their respective amortized cost basis. Not included in the above table
is a CMO (included in mortgage-related securities) determined to have an
other-than-temporary impairment that resulted in a write-down on the security of
$0.8 million during 2002 and $0.3 million during 2003 based on continued
evaluation. As
64
of December 31, 2003, this CMO had a carrying value of $1.8 million. The
unrealized losses associated with the other equity securities are comprised
primarily of FHLMC preferred stock and is predominantly attributable to changes
in interest rates. At December 31, 2003, the amortized cost of these FHLMC
preferred shares was $8.7 million, based on $50 per share, while the market
value per share was approximately $44. The Corporation currently has both the
intent and ability to hold the securities contained in the previous table for a
time necessary to recover the amortized cost.
The amortized cost and fair values of investment securities available for sale
at December 31, 2003, by contractual maturity, are shown below. Expected
maturities will differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call or prepayment
penalties.
2003
----------------------------
Amortized Fair
Cost Value
----------------------------
($ in Thousands)
Due in one year or less $ 240,617 $ 245,135
Due after one year through five years 431,841 459,887
Due after five years through ten years 313,719 334,387
Due after ten years 303,173 326,053
----------------------------
Total debt securities 1,289,350 1,365,462
Mortgage-related securities 2,232,920 2,233,412
Equity securities 152,459 174,910
----------------------------
Total securities available for sale $3,674,729 $3,773,784
============================
Total proceeds and gross realized gains and losses from sale of securities
available for sale (with other-than-temporary write-downs on securities included
in gross losses) for each of the three years ended December 31 were:
2003 2002 2001
----------------------------------
($ in Thousands)
Proceeds $1,263 $27,793 $135,627
Gross gains 1,029 374 1,322
Gross losses (327) (801) (604)
Pledged securities with a carrying value of approximately $1.6 billion and $1.8
billion at December 31, 2003, and December 31, 2002, respectively, were pledged
to secure certain deposits, Federal Home Loan Bank advances, or for other
purposes as required or permitted by law.
NOTE 4 LOANS:
Loans at December 31 are summarized below.
2003 2002
----------------------------
($ in Thousands)
Commercial, financial, and agricultural $ 2,116,463 $ 2,213,986
Real estate construction 1,077,731 910,581
Commercial real estate 3,246,954 3,128,826
Lease financing 38,968 38,352
----------------------------
Commercial 6,480,116 6,291,745
Residential mortgage 2,145,227 2,430,746
Home equity 968,744 864,631
----------------------------
Residential real estate 3,113,971 3,295,377
Consumer 697,723 716,103
----------------------------
Total loans $10,291,810 $10,303,225
============================
65
A summary of the changes in the allowance for loan losses for the years
indicated is as follows:
2003 2002 2001
-------------------------------------
($ in Thousands)
Balance at beginning of year $ 162,541 $ 128,204 $ 120,232
Balance related to acquisition --- 11,985 ---
Provision for loan losses 46,813 50,699 28,210
Charge offs (37,107) (32,179) (22,639)
Recoveries 5,375 3,832 2,401
-------------------------------------
Net charge offs (31,732) (28,347) (20,238)
-------------------------------------
Balance at end of year $ 177,622 $ 162,541 $ 128,204
=====================================
The following table presents nonperforming loans at December 31:
December 31,
------------------------
2003 2002
------------------------
($ in Thousands)
Nonaccrual loans $113,944 $94,132
Accruing loans past due 90 days or more 7,495 3,912
Restructured loans 43 1,258
-------------------------
Total nonperforming loans $121,482 $99,302
=========================
Management has determined that commercial, financial, and agricultural loans,
commercial real estate loans, and real estate construction loans that have
nonaccrual status or have had their terms restructured are impaired loans. The
following table presents data on impaired loans at December 31:
2003 2002
--------------------
($ in Thousands)
Impaired loans for which an allowance has been provided $68,571 $42,574
Impaired loans for which no allowance has been provided 29,079 33,603
--------------------
Total loans determined to be impaired $97,650 $76,177
====================
Allowance for loan losses related to impaired loans $33,497 $20,579
====================
2003 2002 2001
---------------------------------
For the years ended December 31: ($ in Thousands)
Average recorded investment in impaired loans $83,106 $60,247 $28,319
=================================
Cash basis interest income recognized from impaired loans $ 2,489 $ 3,849 $ 1,795
=================================
The Corporation has granted loans to their directors, executive officers, or
their related subsidiaries. These loans were made on substantially the same
terms, including rates and collateral, as those prevailing at the time for
comparable transactions with other unrelated customers, and do not involve more
than a normal risk of collection. These loans to related parties are summarized
as follows:
2003
-----------------
($ in Thousands)
Balance at beginning of year $ 33,054
New loans 46,096
Repayments (48,782)
Changes due to status of executive officers and directors (882)
-----------
Balance at end of year $ 29,486
===========
The Corporation serves the credit needs of its customers by offering a wide
variety of loan programs to customers, primarily in Wisconsin, Illinois, and
Minnesota. The loan portfolio is widely diversified by
66
types of borrowers, industry groups, and market areas. Significant loan
concentrations are considered to exist for a financial institution when there
are amounts loaned to a multiple number of borrowers engaged in similar
activities that would cause them to be similarly impacted by economic or other
conditions. At December 31, 2003, no significant concentrations existed in the
Corporation's loan portfolio in excess of 10% of total loans.
NOTE 5 GOODWILL AND OTHER INTANGIBLE ASSETS:
Goodwill:
Goodwill is not amortized but is subject to impairment tests on at least an
annual basis. No impairment loss was necessary in 2003, 2002, or 2001. Goodwill
of $212 million is assigned to the banking segment and goodwill of $12 million
is assigned to the wealth management segment. The change in the carrying amount
of goodwill was as follows.
Goodwill 2003 2002
- -------- ---------------------
($ in Thousands)
Balance at beginning of year $212,112 $ 92,397
Goodwill acquired 12,276 119,715
---------------------
Balance at end of year $224,388 $212,112
=====================
Goodwill amortization expense was zero for the years ended December 31, 2003 and
2002, and $6.5 million for the year ended December 31, 2001. See Note 19 for the
disclosure of net income and per share amounts excluding goodwill amortization,
net of any income tax effects, due to the adoption of SFAS 142 and SFAS 147 in
2002.
Other Intangible Assets:
- -----------------------
The Corporation has other intangible assets that are amortized, consisting of
core deposit intangibles, other intangibles (primarily related to customer
relationships acquired in connection with the CFG acquisition), and mortgage
servicing rights. The core deposit intangibles and mortgage servicing rights are
assigned to the Corporation's banking segment, while the other intangibles are
assigned to the Corporation's wealth management segment.
For core deposit intangibles and other intangibles, changes in the gross
carrying amount, accumulated amortization, and net book value were as follows.
2003 2002
----------------------
($ in Thousands)
Core deposit intangibles:
- ------------------------
Gross carrying amount $ 28,165 $ 28,165
Accumulated amortization (20,682) (18,923)
----------------------
Net book value $ 7,483 $ 9,242
======================
Additions during the period $ --- $ 5,600
Amortization during the period (1,759) (2,283)
Other intangibles:
- -----------------
Gross carrying amount $ 14,751 $ ---
Accumulated amortization (1,202) ---
----------------------
Net book value $ 13,549 $ ---
======================
Additions during the period $ 14,751 $ ---
Amortization during the period (1,202) ---
Mortgage servicing rights are amortized in proportion to and over the period of
estimated servicing income. The Corporation periodically evaluates its mortgage
servicing rights asset for impairment. A valuation allowance is established to
the extent the carrying value of the mortgage servicing rights
67
exceeds the estimated fair value by stratification. An other-than-temporary
impairment is recognized as a write-down of the mortgage servicing rights asset
and the related valuation allowance (to the extent valuation reserve is
available) and then against earnings. During the second and third quarters of
2003 mortgage rates fell to record lows. Given the extended period of
historically low interest rates and the impact on mortgage banking volumes,
refinances, and secondary markets, the Corporation evaluated its mortgage
servicing rights asset for possible other-than-temporary impairment. As a
result, $18.1 million was determined to be other than temporarily impaired
during 2003. A summary of changes in the balance of the mortgage servicing
rights asset and the mortgage servicing rights valuation allowance was as
follows.
Mortgage servicing rights 2003 2002
- ------------------------- -----------------------
($ in Thousands)
Mortgage servicing rights at beginning of year $60,685 $42,786
Additions 39,707 30,730
Amortization (17,212) (12,831)
Other-than-temporary impairment (18,118) ---
-----------------------
Mortgage servicing rights at end of year $65,062 $60,685
-----------------------
Valuation allowance at beginning of year (28,362) (10,720)
Additions (15,832) (17,642)
Reversals 3,491 ---
Other-than-temporary impairment 18,118 ---
-----------------------
Valuation allowance at end of year (22,585) (28,362)
----------------------
Mortgage servicing rights, net $42,477 $32,323
=======================
At December 31, 2003, the Corporation was servicing one- to four-family
residential mortgage loans owned by other investors with balances totaling $5.93
billion compared to $5.44 billion and $5.23 billion at December 31, 2002 and
2001, respectively. The fair value of mortgage servicing rights was
approximately $42.5 million (representing 72 bp of loans serviced) at December
31, 2003, compared to $32.3 million (representing 59 bp of loans serviced) at
December 31, 2002, and $32.1 million (representing 61 bp of loans serviced) at
December 31, 2001.
Mortgage servicing rights expense, which includes the amortization of the
mortgage servicing rights and increases or decreases to the valuation allowance
associated with the mortgage servicing rights, was $29.6 million, $30.5 million,
and $20.0 million for the years ended December 31, 2003, 2002, and 2001,
respectively.
The following table shows the estimated future amortization expense for
amortizing intangible assets. The projections of amortization expense for the
next five years are based on existing asset balances, the current interest rate
environment, and prepayment speeds as of December 31, 2003. The actual
amortization expense the Corporation recognizes in any given period may be
significantly different depending upon changes in interest rates, market
conditions, regulatory requirements, and events or circumstances that indicate
the carrying amount of an asset may not be recoverable.
Estimated amortization expense
Core Deposit Intangibles Other Intangibles Mortgage Servicing Rights
----------------------------------------------------------------------------
Year ending December 31, ($ in Thousands)
2004 $1,500 $1,500 $15,500
2005 1,000 1,200 12,800
2006 1,000 1,000 10,500
2007 1,000 900 8,500
2008 1,000 800 6,500
===========================================================================
68
NOTE 6 PREMISES AND EQUIPMENT:
A summary of premises and equipment at December 31 is as follows:
2003 2002
--------------------------------------------------------------
Estimated Accumulated Net Book Net Book
Useful Lives Cost Depreciation Value Value
--------------------------------------------------------------
($ in Thousands)
Land --- $ 27,595 $ --- $ 27,595 $ 27,496
Land improvements 3 - 20 years 3,205 2,336 869 734
Buildings 5 - 40 years 148,952 76,953 71,999 74,388
Computers 3 - 5 years 39,743 33,531 6,212 4,204
Furniture, fixtures and other
equipment 3 - 20 years 99,452 80,239 19,213 20,177
Leasehold improvements 5 - 30 years 16,888 11,461 5,427 5,714
--------------------------------------------------------------
Total premises and equipment $335,835 $204,520 $131,315 $132,713
==============================================================
Depreciation and amortization of premises and equipment totaled $15.1 million in
2003, $17.1 million in 2002, and $16.2 million in 2001.
The Corporation and certain subsidiaries are obligated under a number of
noncancelable operating leases for other facilities and equipment, certain of
which provide for increased rentals based upon increases in cost of living
adjustments and other operating costs. The approximate minimum annual rentals
and commitments under these noncancelable agreements and leases with remaining
terms in excess of one year are as follows:
($ in Thousands)
----------------
2004 $ 7,368
2005 6,793
2006 5,892
2007 5,558
2008 4,504
Thereafter 15,527
---------
Total $45,642
=========
Total rental expense under leases, net of sublease income, totaled $9.2 million
in 2003, $8.3 million in 2002, and $7.3 million in 2001.
NOTE 7 DEPOSITS:
The distribution of deposits at December 31 is as follows.
2003 2002
---------------------------
($ in Thousands)
Noninterest-bearing demand deposits $1,814,446 $1,773,699
Savings deposits 890,092 895,855
Interest-bearing demand deposits 2,330,478 1,468,193
Money market deposits 1,573,678 1,754,313
Brokered certificates of deposit 165,130 233,650
Other time deposits 3,019,019 2,999,142
--------------------------
Total deposits $9,792,843 $9,124,852
==========================
69
Time deposits of $100,000 or more were $999 million and $856 million at December
31, 2003 and 2002, respectively. Aggregate annual maturities of all time
deposits at December 31, 2003, are as follows:
Maturities During Year Ending December 31, ($ in Thousands)
- -------------------------------------------------------------------------------
2004 $2,008,241
2005 711,562
2006 157,497
2007 191,291
2008 46,097
Thereafter 69,461
----------
Total $3,184,149
==========
NOTE 8 SHORT-TERM BORROWINGS:
Short-term borrowings at December 31 are as follows:
2003 2002
--------------------------
($ in Thousands)
Federal funds purchased and securities sold under
agreements to repurchase $1,340,996 $2,240,286
Bank notes 200,000 ---
Federal Home Loan Bank advances --- 100,000
Treasury, tax, and loan notes 361,894 38,450
Other borrowed funds 25,986 10,871
--------------------------
Total short-term borrowing $1,928,876 $2,389,607
==========================
Included in short-term borrowings are Federal Home Loan Bank advances with
original maturities of less than one year. The short-term bank notes are
variable rate and mature in the first quarter of 2004. The treasury, tax, and
loan notes are demand notes representing secured borrowings from the U.S.
Treasury, collateralized by qualifying securities and loans.
At December 31, 2003, the Parent Company had $100 million of established lines
of credit with various nonaffiliated banks, which were not drawn on at December
31, 2003. Borrowings under these lines accrue interest at short-term market
rates. Under the terms of the credit agreement, a variety of advances and
interest periods may be selected by the Parent Company. During 2000, a $200
million commercial paper program was initiated, of which, no amounts were
outstanding at December 31, 2003 or 2002.
NOTE 9 LONG-TERM DEBT:
Long-term debt (debt with original contractual maturities greater than one year)
at December 31 is as follows:
2003 2002
--------------------------
($ in Thousands)
Federal Home Loan Bank advances (1) $ 912,138 $ 964,931
Bank notes (2) 300,000 500,000
Subordinated debt, net (3) 204,351 208,356
Repurchase agreements (4) 429,175 226,175
Other borrowed funds 6,555 7,383
--------------------------
Total long-term debt $1,852,219 $1,906,845
==========================
(1) Long-term advances from the Federal Home Loan Bank had maturities through
2017 and had weighted-average interest rates of 2.96% at December 31, 2003,
and 3.74% at December 31, 2002. These advances had a combination of fixed
and variable rates, predominantly fixed. Of the balances outstanding at
December 31, 2003, $24 million is callable by the Federal Home Loan Bank
during the first quarter of 2004.
70
(2) The long-term bank notes had maturities through 2007 and had
weighted-average interest rates of 2.20% at December 31, 2003, and 2.15% at
December 31, 2002. These advances had a combination of fixed and variable
rates.
(3) In August 2001, the Corporation issued $200 million of 10-year subordinated
debt. This debt was issued at a discount and has a fixed interest rate of
6.75%. During 2001, the Corporation entered into a fair value hedge to
hedge the interest rate risk on the subordinated debt. As of December 31,
2003 and 2002, the fair value of the derivative was a $5.5 million gain and
a $9.6 million gain, respectively. The subordinated debt qualifies under
the risk-based capital guidelines as Tier 2 supplementary capital for
regulatory purposes.
(4) The long-term repurchase agreements had maturities through 2006 and had
weighted-average interest rates of 1.67% at December 31, 2003 and 2.36% at
December 31, 2002. These advances had a combination of fixed and variable
rates, predominantly fixed. Of the balances outstanding at December 31,
2003, $229 million is callable during the first quarter of 2004.
The table below summarizes the maturities of the Corporation's long-term debt at
December 31, 2003:
Year ($ in Thousands)
- -------------------------------------------------------------------------------
2004 $1,026,325
2005 300,000
2006 157,275
2007 100,000
2008 13,500
Thereafter 255,119
-----------
Total long-term debt $1,852,219
===========
Under agreements with the Federal Home Loan Banks of Chicago and Des Moines,
Federal Home Loan Bank advances (short-term and long-term) are secured by the
subsidiary banks' qualifying mortgages (such as residential mortgage,
residential mortgage loans held for sale, home equity, and commercial real
estate) and by specific investment securities for certain Federal Home Loan Bank
advances.
Note 10 COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES:
On May 30, 2002, ASBC Capital I (the "ASBC Trust"), a Delaware business trust
wholly owned by the Corporation, completed the sale of $175 million of 7.625%
preferred securities (the "Preferred Securities"). The Preferred Securities are
traded on the New York Stock Exchange under the symbol "ABW PRA." The ASBC Trust
used the proceeds from the offering to purchase a like amount of 7.625% Junior
Subordinated Debentures (the "Debentures") of the Corporation. The Debentures
are the sole assets of the ASBC Trust and are eliminated, along with the related
income statement effects, in the consolidated financial statements. The
Corporation used the proceeds from the sales of the Debentures for general
corporate purposes.
Effective in the first quarter of 2004, in accordance with recent guidance
provided on the application of FIN 46R, the Corporation will be required to
deconsolidate the ASBC Trust from its consolidated financial statements.
Accordingly, the Debentures issued by the Corporation to ASBC Trust (as opposed
to the trust preferred securities issued by the ASBC Trust) will be reflected in
the Corporation's consolidated balance sheet as long-term debt. The
deconsolidation of the net assets and results of operations of this trust will
have virtually no impact on the Corporation's financial statements since the
Corporation continues to be obligated to repay the Debentures held by the ASBC
Trust and guarantees repayment of the Preferred Securities issued by the ASBC
Trust. The consolidated long-term debt obligation related to the ASBC Trust will
increase from $175 million to $180 million upon deconsolidation, with the
difference representing the Corporation's common ownership interest in the ASBC
Trust recorded in investment securities available for sale.
The Preferred Securities accrue and pay dividends quarterly at an annual rate of
7.625% of the stated liquidation amount of $25 per Preferred Security. The
Corporation has fully and unconditionally guaranteed all of the obligations of
the ASBC Trust. The guarantee covers the quarterly distributions and payments on
liquidation or redemption of the Preferred Securities, but only to the extent of
funds held by the ASBC Trust.
71
The Preferred Securities are mandatorily redeemable upon the maturity of the
Debentures on June 15, 2032, or upon earlier redemption as provided in the
Indenture. The Corporation has the right to redeem the Debentures on or after
May 30, 2007.
The Preferred Securities qualify under the risk-based capital guidelines as Tier
1 capital for regulatory purposes. As discussed in Note 18, as a result of FIN
46R, the Federal Reserve Board is currently evaluating whether deconsolidation
of the trust will affect the qualification of the preferred securities as Tier 1
capital. If it is determined that the preferred securities no longer qualify as
Tier 1 capital, the effect of such a change is not expected to affect the
Corporation's well-capitalized status.
During May 2002, the Corporation entered into a fair value hedge to hedge the
interest rate risk on the Debentures. The fair value of the derivative was a
$6.9 million gain at December 31, 2003, and a $15.1 million gain at December 31,
2002. Given the fair value hedge, the Preferred Securities are carried on the
balance sheet at fair value.
Note 11 Stockholders' Equity:
On April 24, 2002, the Board of Directors declared a 10% stock dividend, payable
May 15 to shareholders of record at the close of business on April 29. All share
and per share data in the accompanying consolidated financial statements has
been adjusted to reflect the 10% stock dividend paid. As a result of the stock
dividend, the Corporation distributed approximately 7.0 million shares of common
stock. Any fractional shares resulting from the dividend were paid in cash.
Share and price information has been adjusted to reflect all stock splits and
dividends.
The Corporation's Articles of Incorporation authorize the issuance of 750,000
shares of preferred stock at a par value of $1.00 per share. No shares have been
issued.
At December 31, 2003, subsidiary net assets equaled $1.3 billion, of which
approximately $136.8 million could be transferred to the Corporation in the form
of cash dividends without prior regulatory approval, subject to the capital
needs of each subsidiary.
The Board of Directors has authorized management to repurchase shares of the
Corporation's common stock each quarter in the market, to be made available for
issuance in connection with the Corporation's employee incentive plans and for
other corporate purposes. For the Corporation's employee incentive plans, the
Board of Directors authorized the repurchase of up to 1.6 million shares
(400,000 shares per quarter) in 2003 and 2002. Of these authorizations,
approximately 1.3 million shares were repurchased for $43.3 million during 2002
(with approximately 1.0 million shares reissued in connection with stock options
exercised), while none were repurchased during 2003 (with approximately 1.1
million shares reissued in connection with stock options exercised).
Additionally, under two separate actions in 2000 and one action in 2003, the
Board of Directors authorized the repurchase and cancellation of the
Corporation's outstanding shares, not to exceed approximately 11.0 million
shares on a combined basis. Under these authorizations, approximately 2.1
million shares were repurchased for $74.5 million during 2003 at an average cost
of $36.17 per share, while during 2002 approximately 1.3 million shares were
repurchased for $44.0 million at an average cost of $32.69 per share. At
December 31, 2003, approximately 3.7 million shares remain authorized to
repurchase. The repurchase of shares will be based on market opportunities,
capital levels, growth prospects, and other investment opportunities.
The Board of Directors approved the implementation of a broad-based stock option
grant effective July 28, 1999. This stock option grant provided all qualifying
employees with an opportunity and an incentive to buy shares of the Corporation
and align their financial interest with the growth in value of the Corporation's
shares. These options have 10-year terms, fully vest in two years, and have
exercise prices equal to 100% of market value on the date of grant. As of
December 31, 2003, approximately 1.8 million shares remain available for
granting.
In January 2002, the Board of Directors, with subsequent approval of the
Corporation's shareholders, approved an amendment, increasing the number of
shares available to be issued by an additional
72
3.3 million shares, to the Amended and Restated Long-Term Incentive Stock Plan
("Stock Plan"). The Stock Plan was adopted by the Board of Directors and
originally approved by shareholders in 1987 and amended in 1994, 1997, and 1998.
Options are generally exercisable up to 10 years from the date of grant and vest
over two to three years. As of December 31, 2003, approximately 3.2 million
shares remain available for grants.
The stock incentive plans of acquired companies were terminated at each
respective merger date. Option holders under such plans received the
Corporation's common stock, or options to buy the Corporation's common stock,
based on the conversion terms of the various merger agreements. The historical
option information presented below has been restated to reflect the options
originally granted under the acquired companies' plans.
--------------------------------------------------------------------------------------------------
2003 2002 2001
--------------------------------------------------------------------------------------------------
Options Weighted Average Options Weighted Average Options Weighted Average
Outstanding Exercise Price Outstanding Exercise Price Outstanding Exercise Price
--------------------------------------------------------------------------------------------------
Outstanding, January 1 4,748,494 $26.12 4,020,017 $26.10 3,639,292 $24.85
Granted 702,175 34.50 765,290 31.93 772,090 29.36
Options from acquisition --- --- 1,076,460 14.15 --- ---
Exercised (1,100,509) 20.59 (979,785) 16.90 (275,363) 17.19
Forfeited (99,508) 32.61 (133,488) 30.09 (116,002) 29.56
------------- ------------ ------------
Outstanding, December 31 4,250,652 $28.78 4,748,494 $26.12 4,020,017 $26.10
============= ============ ============
Options exercisable at year-end 2,956,389 3,373,253 2,649,051
============= ============ ============
The following table summarizes information about the Corporation's stock options
outstanding at December 31, 2003:
-----------------------------------------------------------------------------------
Options Weighted Average Remaining Options Weighted Average
Outstanding Exercise Price Life (Years) Exercisable Exercise Price
-----------------------------------------------------------------------------------
Range of Exercise Prices:
$ 8.90 - $11.42 27,731 $ 10.09 1.11 27,731 $ 10.09
$13.13 - $15.98 218,306 15.06 2.06 218,306 15.06
$17.77 - $21.93 223,765 19.95 3.46 223,765 19.95
$22.44 - $26.92 1,042,519 24.82 5.15 1,042,519 24.82
$29.20 - $31.86 1,222,531 30.65 7.60 628,284 30.33
$32.10 - $34.94 1,515,800 33.63 6.88 815,784 32.94
----------- -----------
TOTAL 4,250,652 $28.78 6.20 2,956,389 $27.00
=========== ===========
The pro forma disclosures required under SFAS 123, as amended by SFAS 148, are
included in Note 1.
73
NOTE 12 RETIREMENT PLANS:
The Corporation has a noncontributory defined benefit retirement plan (the
"Plan") covering substantially all full-time employees. The benefits are based
primarily on years of service and the employee's compensation paid. The
Corporation's funding policy is to pay at least the minimum amount required by
the funding requirements of federal law and regulations.
The following tables set forth the Plan's funded status and net periodic benefit
cost:
2003 2002
------------------------
($ in Thousands)
Change in Fair Value of Plan Assets
Fair value of plan assets at beginning of year $45,429 $32,336
Actual gain (loss) on plan assets 9,795 (3,784)
Employer contributions 17,542 19,489
Gross benefits paid (3,382) (2,612)
------------------------
Fair value of plan assets at end of year $69,384 $45,429
========================
Change in Benefit Obligation
Net benefit obligation at beginning of year $54,464 $45,767
Service cost 5,857 4,582
Interest cost 3,603 3,257
Plan amendments --- 206
Actuarial loss 2,283 3,264
Gross benefits paid (3,382) (2,612)
------------------------
Net benefit obligation at end of year $62,825 $54,464
========================
Funded Status
Excess (deficit) of plan assets over
(under) benefit obligation $ 6,559 $(9,035)
Unrecognized net actuarial loss 15,762 18,046
Unrecognized prior service cost 589 663
Unrecognized net transition asset (736) (1,060)
------------------------
Net prepaid asset at end of year
in the balance sheet $22,174 $8,614
========================
Amounts Recognized in the Statement of
Financial Position Consists of
Prepaid benefit cost $22,174 $ ---
Accrued benefit cost --- (7,503)
Intangible assets --- 663
Accumulated other comprehensive income --- 15,454
------------------------
Net amount recognized $22,174 $8,614
========================
The accumulated benefit obligation for the Plan was $61.2 million and $52.9
million at December 31, 2003 and 2002, respectively.
74
2003 2002 2001
-----------------------------------
($ in Thousands)
Components of Net Periodic
Benefit Cost
Service cost $5,857 $4,582 $3,950
Interest cost 3,603 3,257 2,889
Expected return on plan assets (5,301) (3,963) (3,474)
Amortization of:
Transition asset (324) (323) (324)
Prior service cost 74 74 63
Actuarial gain 73 --- ---
-----------------------------------
Total net periodic benefit cost $3,982 $3,627 $3,104
===================================
Weighted average assumptions used to
determine benefit obligations:
Discount rate 6.25% 6.75%
Rate of increase in compensation levels 5.00 5.00
Weighted average assumptions used to
determine net periodic benefit costs:
Discount rate 6.75% 7.25% 7.50%
Rate of increase in compensation levels 5.00 5.00 5.00
Expected long-term rate of return on
plan assets 8.75 9.00 9.00
===================================
The overall expected long-term rate of return on assets was 8.75% and 9.00% as
of December 31, 2003 and 2002, respectively. The expected long-term rate of
return was estimated using market benchmarks for equities and bonds applied to
the plan's anticipated asset allocations. The expected return on equities was
computed utilizing a valuation framework, which projected future returns based
on current equity valuations rather than historical returns.
The asset allocation for the Plan as of the measurement date by asset category
was as follows:
2003 2002
-------------------------
Asset Category
Equity securities 66% 60%
Debt securities 32 38
Other 2 2
-------------------------
Total 100% 100%
=========================
The asset classes used to manage plan assets will include common stocks, fixed
income or debt securities, and cash equivalents. A diversified portfolio using
these assets will provide liquidity, current income, and growth of income and
growth of principal. The anticipated asset allocation ranges are equity
securities of 55-65%, debt securities of 35-45%, and other cash equivalents of
0-5%.
The Corporation and its subsidiaries also have a Profit Sharing/Retirement
Savings Plan (the "plan"). The Corporation's contribution is determined annually
by the Administrative Committee of the Board of Directors, based in part on
performance-based formulas provided in the plan. Total expense related to
contributions to the plan was $12.3 million, $11.8 million, and $10.5 million in
2003, 2002, and 2001, respectively.
An additional pension obligation is required when the accumulated benefit
obligation exceeds the sum of the fair value of plan assets and the accrued
pension expense. At December 31, 2003, the Corporation's additional pension
obligation was zero, while at December 31, 2002, the Corporation's additional
pension obligation was $16.1 million, of which $9.2 million was included as a
reduction in accumulated other comprehensive income, net of tax benefit of $6.2
million, and $0.7 million was included as an intangible asset as part of other
assets in the consolidated balance sheet.
75
At this time, the Corporation does not expect to make a contribution to its
pension plan in 2004. The Corporation regularly reviews the funding of its
pension plans. Therefore, it is possible that after that review, the Corporation
may decide to make a contribution to the pension plan at that time.
NOTE 13 INCOME TAXES:
The current and deferred amounts of income tax expense (benefit) are as follows:
Years ended December 31,
2003 2002 2001
---------------------------------------
($ in Thousands)
Current:
Federal $103,321 $99,730 $54,726
State 2,940 755 113
---------------------------------------
Total current 106,261 100,485 54,839
Deferred:
Federal (12,793) (16,214) 14,947
State (409) 1,336 1,701
---------------------------------------
Total deferred (13,202) (14,878) 16,648
---------------------------------------
Total income tax expense $93,059 $85,607 $71,487
=======================================
Temporary differences between the amounts reported in the financial statements
and the tax bases of assets and liabilities resulted in deferred taxes. Deferred
tax assets and liabilities at December 31 are as follows:
2003 2002
------------------------
($ in Thousands)
Gross deferred tax assets:
Allowance for loan losses $ 74,497 $ 67,900
Accrued liabilities 6,079 5,946
Deferred compensation 10,304 9,310
Securities valuation adjustment 10,214 8,893
Deposit base intangible 3,078 3,370
Mortgage banking activity --- 1,552
Benefit of tax loss carryforwards 16,971 15,323
Other 4,828 5,825
------------------------
Total gross deferred tax assets 125,971 118,119
Valuation allowance for deferred tax assets (8,445) (12,149)
------------------------
117,526 105,970
Gross deferred tax liabilities:
Real estate investment trust income 27,612 41,330
Prepaids 6,552 251
Mortgage banking activity 3,297 ---
Deferred loan fee income and other
loan yield adjustment 7,494 6,927
State income taxes 13,127 11,928
Other 7,467 6,860
------------------------
Total gross deferred tax liabilities 65,549 67,296
------------------------
Net deferred tax assets 51,977 38,674
Tax effect of unrealized gain related to available
for sale securities (35,843) (48,879)
Tax effect of unrealized loss related to derivative
instruments 7,991 9,326
Tax effect of additional pension obligation --- 6,167
------------------------
(27,852) (33,386)
------------------------
Net deferred tax assets including tax effected items $ 24,125 $ 5,288
========================
76
Components of the 2002 net deferred tax assets have been adjusted to reflect the
filing of corporate income tax returns.
For financial reporting purposes, a valuation allowance has been recognized to
offset deferred tax assets related to state net operating loss carryforwards of
certain subsidiaries and other temporary differences due to the uncertainty that
the assets will be realized. If it is subsequently determined that all or a
portion of these deferred tax assets will be realized, the tax benefit for these
items will be used to reduce deferred tax expense for that period.
At December 31, 2003, the Corporation had state net operating losses of $209
million and federal net operating losses of $1.3 million that will expire in the
years 2004 through 2017.
The effective income tax rate differs from the statutory federal tax rate. The
major reasons for this difference are as follows:
2003 2002 2001
-------------------------
Federal income tax rate at statutory rate 35.0% 35.0% 35.0%
Increases (decreases) resulting from:
Tax-exempt interest and dividends (4.2) (4.6) (5.1)
State income taxes (net of federal
income taxes) 0.5 0.5 0.5
Increase in cash surrender value of
life insurance (1.5) (1.6) (1.8)
Other (0.9) (0.4) (0.1)
-------------------------
Effective income tax rate 28.9% 28.9% 28.5%
=========================
A savings bank acquired by the Corporation in 1997 qualified under provisions of
the Internal Revenue Code that permitted it to deduct from taxable income an
allowance for bad debts that differed from the provision for such losses charged
to income for financial reporting purposes. Accordingly, no provision for income
taxes has been made for $79.2 million of retained income at December 31, 2003.
If income taxes had been provided, the deferred tax liability would have been
approximately $31.8 million. Management does not expect this amount to become
taxable in the future, therefore no provision for income taxes has been made.
NOTE 14 COMMITMENTS, OFF-BALANCE SHEET RISK, AND CONTINGENT LIABILITIES:
Commitments and Off-Balance Sheet Risk
The Corporation utilizes a variety of financial instruments in the normal course
of business to meet the financial needs of its customers and to manage its own
exposure to fluctuations in interest rates. These financial instruments include
lending-related commitments.
Lending-related Commitments
Through the normal course of operations, the Corporation has entered into
certain contractual obligations and other commitments. As a financial services
provider, the Corporation routinely enters into commitments to extend credit.
While contractual obligations represent future cash requirements of the
Corporation, a significant portion of commitments to extend credit may expire
without being drawn upon. Such commitments are subject to the same credit
policies and approval process accorded to loans made by the Corporation.
Lending-related commitments include commitments to extend credit, commitments to
originate residential mortgage loans held for sale, commercial letters of
credit, and standby letters of credit. Commitments to extend credit are
agreements to lend to customers at predetermined interest rates as long as there
is no violation of any condition established in the contracts. Commercial and
standby letters of credit are conditional commitments issued to guarantee the
performance of a customer to a third party. Commercial letters of credit are
issued specifically to facilitate commerce and typically result in the
commitment being drawn on when the underlying transaction is consummated between
77
the customer and the third party, while standby letters of credit generally are
contingent upon the failure of the customer to perform according to the terms of
the underlying contract with the third party.
Under SFAS 133, commitments to originate residential mortgage loans held for
sale and forward commitments to sell residential mortgage loans are defined as
derivatives and are therefore required to be recorded on the consolidated
balance sheet at fair value. The Corporation's derivative and hedging activity,
as defined by SFAS 133, is further summarized in Note 15. The following is a
summary of lending-related commitments at December 31:
2003 2002
-------------------------
($ in Thousands)
Commitments to extend credit, excluding
commitments to originate mortgage loans (1) $3,732,150 $3,559,497
Commercial letters of credit (1) 19,665 59,186
Standby letters of credit (2) 338,954 267,858
(1) These off-balance sheet financial instruments are exercisable at the market
rate prevailing at the date the underlying transaction will be completed
and thus are deemed to have no current fair value, or the fair value is
based on fees currently charged to enter into similar agreements and is not
material at December 31, 2003 or 2002.
(2) As required by FASB Interpretation No. 45, an interpretation of FASB
Statements No. 5, 57, and 107, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness
of Others," the Corporation has established a liability of $2.3 million at
December 31, 2003, as an estimate of the fair value of these financial
instruments. No fair value liability was required at December 31, 2002.
The Corporation's exposure to credit loss in the event of nonperformance by the
other party to these financial instruments is represented by the contractual
amount of those instruments. The commitments generally have fixed expiration
dates or other termination clauses and may require payment of a fee. The
Corporation uses the same credit policies in making commitments and conditional
obligations as it does for extending loans to customers. The Corporation
evaluates each customer's creditworthiness on a case-by-case basis. The amount
of collateral obtained, if deemed necessary by the Corporation upon extension of
credit, is based on management's credit evaluation of the customer. Since many
of the commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements.
Contingent Liabilities
In the ordinary course of business, the Corporation may be named as defendant in
or be a party to various pending and threatened legal proceedings. In view of
the intrinsic difficulty in ascertaining the outcome of such matters, the
Corporation cannot state what the eventual outcome of any such proceeding will
be. Management believes, based upon discussions with legal counsel and current
knowledge, that liabilities arising out of any such proceedings (if any) will
not have a material adverse effect on the consolidated financial position,
results of operations, or liquidity of the Corporation.
As part of the Corporation's agency agreement with an outside vendor, the
Corporation has guaranteed certain credit card accounts provided the cardholder
is unable to meet the credit card obligations. At December 31, 2003, the
Corporation's estimated maximum exposure was approximately $1 million.
A contingent liability is required to be established if it is probable that the
Corporation will incur a loss on the performance of a letter of credit. During
the second quarter of 2003, given the deterioration of the financial condition
of a borrower, the Corporation established a $2.5 million liability for
commercial letters of credit, of which $2.2 million remained at December 31,
2003.
78
NOTE 15 DERIVATIVE AND HEDGING ACTIVITIES:
The Corporation uses derivative instruments primarily to hedge the variability
in interest payments or protect the value of certain assets and liabilities
recorded on its consolidated balance sheet from changes in interest rates. The
contract or notional amount of a derivative is used to determine, along with the
other terms of the derivative, the amounts to be exchanged between the
counterparties. Because the contract or notional amount does not represent
amounts exchanged by the parties, it is not a measure of loss exposure related
to the use of derivatives nor of exposure to liquidity risk. The Corporation is
exposed to credit risk in the event of nonperformance by counterparties to
financial instruments. As the Corporation generally enters into transactions
only with high quality counterparties, no losses with counterparty
nonperformance on derivative financial instruments has occurred. Further, the
Corporation obtains collateral and uses master netting arrangements when
available. To mitigate counterparty risk, interest rate swap agreements
generally contain language outlining collateral pledging requirements for each
counterparty. Collateral must be posted when the market value exceeds a certain
threshold. The threshold limits are determined from the credit ratings of each
counterparty. Upgrades or downgrades to the credit ratings of either
counterparty would lower or raise the threshold limits. Market risk is the
adverse effect on the value of a financial instrument that results from a change
in interest rates, currency exchange rates, or commodity prices. The market risk
associated with interest rate contracts is managed by establishing and
monitoring parameters that limit the types and degree of market risk that may be
undertaken.
Interest rate swap contracts are entered into primarily as an asset/liability
management strategy to modify interest rate risk. Interest rate swap contracts
are exchanges of interest payments, such as fixed rate payments for floating
rate payments, based on a notional principal amount. Payments related to the
Corporation's swap contracts are made monthly, quarterly, or semi-annually by
one of the parties depending on the specific terms of the related contract. The
primary risk associated with all swaps is the exposure to movements in interest
rates and the ability of the counterparties to meet the terms of the contract.
At December 31, 2003 and 2002, the Corporation had $936 million and $854
million, respectively, of interest rate swaps outstanding. Included in this
amount were $361 million and $279 million, respectively, at December 31, 2003
and 2002, in receive variable/pay fixed interest rate swaps used to convert
specific fixed rate loans into floating rate assets. The remaining swap
contracts used for interest rate risk management of $575 million at December 31,
2003 and 2002, were used to hedge interest rate risk of various other specific
liabilities. At December 31, 2003, the Corporation pledged $24.8 million of
collateral for swap agreements compared to $24.0 million at December 31, 2002.
Weighted Average
Notional Fair Value ------------------------------------------
Amount Gain/(Loss) Receive Rate Pay Rate Maturity
--------------------------------------------------------------------
December 31, 2003 ($ in Thousands)
- ------------------
Interest Rate Risk Management Hedges:
Swaps-receive variable/pay fixed (1), (3) $200,000 $(21,132) 1.15% 5.03% 89 months
Swaps-receive fixed/pay variable (2), (4) 375,000 12,432 7.21% 2.79% 211 months
Caps-written (1), (3) 200,000 1,222 Strike4.72% --- 32 months
Swaps-receive variable / pay fixed (2), (5 361,189 (9,876) 3.31% 6.27% 50 months
====================================================================
December 31, 2002
Interest Rate Risk Management Hedges:
Swaps-receive variable/pay fixed (1), (3) $200,000 $(25,750) 1.77% 5.03% 101 months
Swaps-receive fixed/pay variable (2), (4) 375,000 24,757 7.21% 3.19% 223 months
Caps-written (1), (3) 200,000 2,513 Strike4.72% --- 44 months
Swaps-receive variable / pay fixed (2), (5) 279,487 (14,806) 3.63% 6.52% 58 months
====================================================================
(1) Cash flow hedges
(2) Fair value hedges
(3) Hedges variable rate long-term debt
(4) Hedges fixed rate long-term debt
(5) Hedges specific longer-term fixed rate commercial loans
79
Not included in the above table for December 31, 2003, were three customer swaps
with a notional amount of $20.7 million for which the Corporation has mirror
swaps. There were no such customer swaps at December 31, 2002. The fair value of
these customer swaps is recorded in earnings and the net impact for 2003 was
immaterial.
Interest rate floors and caps are interest rate protection instruments that
involve the payment from the seller to the buyer of an interest differential.
This differential represents the difference between a short-term rate (e.g.,
six-month LIBOR) and an agreed upon rate (the strike rate) applied to a notional
principal amount. By buying a cap, the Corporation will be paid the differential
by a counterparty should the short-term rate rise above the strike level of the
agreement. The primary risk associated with purchased floors and caps is the
ability of the counterparties to meet the terms of the agreement. As of December
31, 2003 and 2002, the Corporation had purchased caps for asset/liability
management of $200 million.
The Corporation measures the effectiveness of its hedges on a periodic basis.
Any difference between the fair value change of the hedge versus the fair value
change of the hedged item is considered to be the "ineffective" portion of the
hedge. The ineffective portion of the hedge is recorded as an increase or
decrease in the related income statement classification of the item being
hedged. For the mortgage derivatives, which are not accounted for as hedges,
changes in the fair value are recorded as an adjustment to mortgage banking
income.
At December 31, 2003, the estimated fair value of the interest rate swaps and
the cap designated as cash flow hedges was a $19.9 million unrealized loss, or
$11.9 million, net of tax benefit of $8.0 million, carried as a component of
accumulated other comprehensive income. At December 31, 2002, the estimated fair
value of the interest rate swaps and the cap designated as cash flow hedges was
a $23.2 million unrealized loss, or $13.9 million, net of tax benefit of $9.3
million, carried as a component of accumulated other comprehensive income. These
instruments are used to hedge the exposure to the variability in interest
payments of variable rate liabilities. The ineffective portion of the hedges
recorded through the statements of income was immaterial. For the years ended
December 31, 2003 and 2002, the Corporation recognized interest expense of $7.7
million and $13.4 million, respectively, for interest rate swaps accounted for
as cash flow hedges. As of December 31, 2003, approximately $7.8 million of the
deferred net losses on derivative instruments that are recorded in accumulated
other comprehensive income are expected to be reclassified to interest expense
within the next twelve months. Currently, none of the existing amounts within
accumulated other comprehensive income are expected to be reclassified into
earnings for ineffectiveness during 2003.
At December 31, 2003 and 2002, the estimated fair value of the interest rate
swaps designated as fair value hedges was an unrealized gain of $2.6 million and
an unrealized gain of $10.0 million, respectively, carried as a component of
other liabilities. These swaps hedge against changes in the fair value of
certain loans and long-term debt.
The fair value of the mortgage derivatives at December 31, 2003, was a net loss
of $0.2 million, a decrease of $5.2 million from the December 31, 2002, net gain
of $5.0 million, and is recorded in mortgage banking income. The $0.2 million
net fair value loss for mortgage derivatives is composed of the net loss on
commitments to sell approximately $152.0 million of loans to various investors
and the net gain on commitments to fund approximately $114.1 million of loans to
individual borrowers. The $5.0 million net fair value gain for mortgage
derivatives is comprised of the net loss on commitments to sell approximately
$538.3 million of loans to various investors and the net gain on commitments to
fund approximately $550.1 million of loans to individual borrowers.
80
NOTE 16 PARENT COMPANY ONLY FINANCIAL INFORMATION:
Presented below are condensed financial statements for the Parent Company:
BALANCE SHEETS
---------------------------
2003 2002
---------------------------
($ in Thousands)
ASSETS
Cash and due from banks $ 924 $ 638
Notes receivable from subsidiaries 374,878 281,258
Investment in subsidiaries 1,316,773 1,377,239
Other assets 103,837 101,304
---------------------------
Total assets $1,796,412 $1,760,439
===========================
LIABILITY AND STOCKHOLDERS' EQUITY
Long-term debt $ 391,705 $ 403,880
Accrued expenses and other liabilities 56,280 84,376
---------------------------
Total liabilities 447,985 488,256
Stockholders' equity 1,348,427 1,272,183
---------------------------
Total liabilities and stockholders' equity $1,796,412 $1,760,439
===========================
STATEMENTS OF INCOME
For the Years Ended December 31,
-------------------------------
2003 2002 2001
-------------------------------
($ in Thousands)
INCOME
Dividends from subsidiaries $179,500 $172,000 $ 90,000
Management and service fees
from subsidiaries 43,146 35,346 26,482
Interest income on notes receivable 9,172 5,641 4,590
Other income 2,464 3,510 3,428
-------------------------------
Total income 234,282 216,497 124,500
-------------------------------
EXPENSE
Interest expense on borrowed funds 11,474 12,627 8,107
Provision for loan losses --- 500 (800)
Personnel expense 29,219 22,918 19,766
Other expense 20,241 15,191 11,379
-------------------------------
Total expense 60,934 51,236 38,452
-------------------------------
Income before income tax benefit
and equity in undistributed income 173,348 165,261 86,048
Income tax benefit (1,093) (1,759) (48)
-------------------------------
Income before equity in undistributed net
income of subsidiaries 174,441 167,020 86,096
Equity in undistributed net income of
subsidiaries 54,216 43,699 93,426
-------------------------------
Net income $228,657 $210,719 $179,522
===============================
81
STATEMENTS OF CASH FLOWS
For the Years Ended December 31,
--------------------------------------
2003 2002 2001
--------------------------------------
($ in Thousands)
OPERATING ACTIVITIES
Net income $228,657 $210,719 $179,522
Adjustments to reconcile net income to net
cash provided by operating activities:
Increase in equity in undistributed
net income of subsidiaries (54,216) (43,699) (93,426)
Depreciation and other amortization 378 335 439
Amortization of goodwill --- --- 397
(Gain) loss on sales of assets, net 2 2 (8)
Increase in interest receivable and
other assets (269) (41,651) (6,763)
Increase (decrease) in interest payable
and other liabilities (24,392) (14,351) 45,474
Capital received from (contributed to)
subsidiaries 95,470 (12,997) 41,617
--------------------------------------
Net cash provided by operating activities 245,630 98,358 167,252
--------------------------------------
INVESTING ACTIVITIES
Purchase of available for sale securities --- (319) ---
Net cash paid in acquisition of subsidiary --- (78,055) ---
Net increase in notes receivable (95,630) (79,551) (120,474)
Purchase of premises and equipment,
net of disposals (975) (614) (134)
--------------------------------------
Net cash used in investing activities (96,605) (158,539) (120,608)
--------------------------------------
FINANCING ACTIVITIES
Net decrease in short-term borrowings --- --- (118,044)
Net increase in long-term debt --- 221,998 181,882
Cash dividends paid (98,169) (90,166) (80,553)
Proceeds from exercise of stock options 24,831 16,564 4,738
Purchase and retirement of treasury stock (74,533) (44,046) (7,717)
Purchase of treasury stock (868) (44,145) (26,852)
--------------------------------------
Net cash provided by (used in) financing
activities (148,739) 60,205 (46,546)
--------------------------------------
Net increase in cash and cash equivalents 286 24 98
Cash and cash equivalents at beginning of year 638 614 516
--------------------------------------
Cash and cash equivalents at end of year $ 924 $ 638 $ 614
======================================
NOTE 17 FAIR VALUE OF FINANCIAL INSTRUMENTS:
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires
that the Corporation disclose estimated fair values for its financial
instruments. Fair value estimates, methods, and assumptions are set forth below
for the Corporation's financial instruments.
82
The estimated fair values of the Corporation's financial instruments on the
balance sheet at December 31 are as follows:
2003 2002
-----------------------------------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
-----------------------------------------------------
($ in Thousands)
Financial assets:
Cash and due from banks $ 389,140 $ 389,140 $ 430,691 $ 430,691
Interest-bearing deposits in other financial 7,434 7,434 5,502 5,502
institutions
Federal funds sold and securities purchased under
purchase under agreements to resell 3,290 3,290 8,820 8,820
Accrued interest receivable 67,264 67,264 74,077 74,077
Investment securities available for sale 3,773,784 3,773,784 3,362,669 3,362,669
Loans held for sale 104,336 104,504 305,836 317,942
Loans 10,291,810 10,503,111 10,303,225 10,650,774
Financial liabilities:
Deposits 9,792,843 9,855,813 9,124,852 9,225,812
Accrued interest payable 22,006 22,006 28,636 28,636
Short-term borrowings 1,928,876 1,928,876 2,389,607 2,389,607
Long-term debt 1,852,219 1,872,603 1,906,845 1,963,756
Company-obligated manditorily redeemable
preferred securities 181,941 192,491 190,111 206,662
Interest rate swap and cap agreements (1) 17,354 17,354 13,286 13,286
Standby letters of credit (2) 2,275 2,275 --- ---
Commitments to originate mortgage loans held for 680 680 7,141 7,141
sale -----------------------------------------------------
Forward commitments to sell residential
mortgage loans (905) (905) (2,095) (2,095)
=====================================================
(1) At both December 31, 2003 and 2002, the notional amount of non-trading
interest rate swap and cap agreements was $1.1 billion. See Notes 14 and 15
for information on the fair value of lending-related commitments and
derivative financial instruments.
(2) At both December 31, 2003 and 2002, the commitment on standby letters of
credit was $0.3 billion. See Note 14 for additional information on the
standby letters of credit.
Cash and due from banks, interest-bearing deposits in other financial
institutions, federal funds sold and securities purchased under agreements to
resell, and accrued interest receivable - For these short-term instruments, the
carrying amount is a reasonable estimate of fair value.
Investment securities held to maturity, investment securities available for
sale, and trading account securities - The fair value of investment securities
held to maturity, investment securities available for sale, and trading account
securities, except certain state and municipal securities, is estimated based on
bid prices published in financial newspapers or bid quotations received from
securities dealers. The fair value of certain state and municipal securities is
not readily available through market sources other than dealer quotations, so
fair value estimates are based on quoted market prices of similar instruments,
adjusted for differences between the quoted instruments and the instruments
being valued. There were no investment securities held to maturity or trading
account securities at December 31, 2003 or 2002.
Loans held for sale - Fair value is estimated using the prices of the
Corporation's existing commitments to sell such loans and/or the quoted market
prices for commitments to sell similar loans.
Loans - Fair values are estimated for portfolios of loans with similar financial
characteristics. Loans are segregated by type such as commercial, commercial
real estate, residential mortgage, credit card, and other consumer. The fair
value of other types of loans is estimated by discounting the future cash
83
flows using the current rates at which similar loans would be made to borrowers
with similar credit ratings and for similar maturities. Future cash flows are
also adjusted for estimated reductions or delays due to delinquencies,
nonaccruals, or potential charge offs.
Deposits - The fair value of deposits with no stated maturity such as
noninterest-bearing demand deposits, savings, interest-bearing demand deposits,
and money market accounts, is equal to the amount payable on demand as of
December 31. The fair value of certificates of deposit is based on the
discounted value of contractual cash flows. The discount rate is estimated using
the rates currently offered for deposits of similar remaining maturities.
Accrued interest payable and short-term borrowings - For these short-term
instruments, the carrying amount is a reasonable estimate of fair value.
Long-term debt and company-obligated mandatorily redeemable preferred securities
- - Rates currently available to the Corporation for debt with similar terms and
remaining maturities are used to estimate fair value of existing borrowings.
Interest rate swap and cap agreements - The fair value of interest rate swap and
cap agreements is obtained from dealer quotes. These values represent the
estimated amount the Corporation would receive or pay to terminate the
agreements, taking into account current interest rates and, when appropriate,
the current creditworthiness of the counterparties.
Standby letters of credit - The fair value of standby letters of credit
represent deferred fees arising from the related off-balance sheet financial
instruments. These deferred fees approximate the fair value of these instruments
and are based on several factors, including the remaining terms of the agreement
and the credit standing of the customer.
Commitments to originate mortgage loans held for sale - The fair value of
commitments to originate mortgage loans held for sale is estimated by comparing
the Corporation's cost to acquire mortgages and the current price for similar
mortgage loans, taking into account the terms of the commitments and the
creditworthiness of the counterparties.
Forward commitments to sell residential mortgage loans - The fair value of
forward commitments to sell residential mortgage loans is the estimated amount
that the Corporation would receive or pay to terminate the forward delivery
contract at the reporting date based on market prices for similar financial
instruments.
Limitations - Fair value estimates are made at a specific point in time, based
on relevant market information and information about the financial instrument.
These estimates do not reflect any premium or discount that could result from
offering for sale at one time the Corporation's entire holdings of a particular
financial instrument. Because no market exists for a significant portion of the
Corporation's financial instruments, fair value estimates are based on judgments
regarding future expected loss experience, current economic conditions, risk
characteristics of various financial instruments, and other factors. These
estimates are subjective in nature and involve uncertainties and matters of
significant judgment and, therefore, cannot be determined with precision.
Changes in assumptions could significantly affect the estimates.
NOTE 18 REGULATORY MATTERS:
Restrictions on Cash and Due From Banks
The Corporation's bank subsidiaries are required to maintain certain vault cash
and reserve balances with the Federal Reserve Bank to meet specific reserve
requirements. These requirements approximated $6.0 million at December 31, 2003.
Regulatory Capital Requirements
The Corporation and the subsidiary banks are subject to various regulatory
capital requirements administered by the federal banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if
84
undertaken, could have a direct material effect on the Corporation's financial
statements. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Corporation must meet specific capital guidelines
that involve quantitative measures of the Corporation's assets, liabilities, and
certain off-balance sheet items as calculated under regulatory accounting
practices. The Corporation's capital amounts and classification are also subject
to qualitative judgments by the regulators about components, risk weightings,
and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Corporation to maintain minimum amounts and ratios (set forth in the
table below) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as defined). Management believes, as of December 31, 2003, that the
Corporation meets all capital adequacy requirements to which it is subject.
As of December 31, 2003 and 2002, the most recent notifications from the Office
of the Comptroller of the Currency and the Federal Deposit Insurance Corporation
categorized the subsidiary banks as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well capitalized,
the subsidiary banks must maintain minimum total risk-based, Tier I risk-based,
and Tier I leverage ratios as set forth in the table. There are no conditions or
events since that notification that management believes have changed the
institutions' category.
The actual capital amounts and ratios of the Corporation and its significant
subsidiaries are presented below. No deductions from capital were made for
interest rate risk in 2003 or 2002.
As discussed in Note 10, the preferred securities held by the ASBC Trust qualify
as Tier 1 Capital for the Corporation under Federal Reserve Board guidelines. As
a result of the issuance of FIN 46, the Federal Reserve Board is currently
evaluating whether deconsolidation of the ASBC Trust will affect the
qualification of the preferred securities as Tier 1 capital. If it is determined
that the preferred securities no longer qualify as Tier 1 capital, the effect of
such a change is not expected to affect the Corporation's well-capitalized
status.
To Be Well
Capitalized Under Prompt
For Capital Corrective Action
($ In Thousands) Actual Adequacy Purpose Provisions: (2)
- ---------------------------------------------------------------------------------------------------------
Amount Ratio (1) Amount Ratio (1) Amount Ratio (1)
- ---------------------------------------------------------------------------------------------------------
As of December 31, 2003:
-----------------------
Associated Banc-Corp
- --------------------
Total Capital $1,572,770 13.99% $899,596 =>8.00%
Tier I Capital 1,221,647 10.86 449,798 =>4.00%
Leverage 1,221,647 8.37 584,108 =>4.00%
Associated Bank, N.A.
- --------------------
Total Capital 980,318 10.63 737,810 =>8.00% $922,262 =>10.00%
Tier I Capital 784,263 8.50 368,905 =>4.00% 553,357 =>6.00%
Leverage 784,263 6.34 495,138 =>4.00% 618,923 =>5.00%
Associated Bank Minnesota, N.A.
- ------------------------------
Total Capital 156,196 11.94 104,688 =>8.00% 130,860 =>10.00%
Tier I Capital 139,692 10.67 52,344 =>4.00% 78,516 =>6.00%
Leverage 139,692 8.29 67,424 =>4.00% 84,279 =>5.00%
85
As of December 31, 2002:
-----------------------
Associated Banc-Corp
- --------------------
Total Capital $1,513,424 13.66% $886,289 =>8.00%
Tier I Capital 1,165,481 10.52 443,144 =>4.00%
Leverage 1,165,481 7.94 587,214 =>4.00%
Associated Bank, N.A.
- --------------------
Total Capital 790,198 10.70 591,075 =>8.00% $738,844 =>10.00%
Tier I Capital 692,207 9.37 295,538 =>4.00% 443,306 =>6.00%
Leverage 692,207 7.03 394,070 =>4.00% 492,588 =>5.00%
Associated Bank Illinois, N.A. (3)
- -----------------------------
Total Capital 173,249 10.98 126,178 =>8.00% 157,722 =>10.00%
Tier I Capital 159,735 10.13 63,089 =>4.00% 94,633 =>6.00%
Leverage 159,735 5.99 106,731 =>4.00% 133,413 =>5.00%
Associated Bank Minnesota, N.A.
Total Capital 157,299 11.22 112,132 =>8.00% 140,165 =>10.00%
Tier I Capital 139,730 9.97 56,066 =>4.00% 84,099 =>6.00%
Leverage 139,730 8.46 66,086 =>4.00% 82,608 =>5.00%
(1) Total Capital ratio is defined as Tier 1 Capital plus Tier 2 Capital
divided by total risk-weighted assets. The Tier 1 Capital ratio is defined
as Tier 1 capital divided by total risk-weighted assets. The leverage ratio
is defined as Tier 1 capital divided by the most recent quarter's average
total assets.
(2) Prompt corrective action provisions are not applicable at the bank holding
company level.
(3) During 2003, the Corporation merged Associated Card Services Bank, National
Association, and Associated Bank Illinois, National Association, into
Associated Bank, National Association, to create a single national banking
charter headquartered in Green Bay, Wisconsin.
NOTE 19 EARNINGS PER SHARE:
Basic earnings per share is calculated by dividing net income by the weighted
average number of common shares outstanding. Diluted earnings per share is
calculated by dividing net income by the weighted average number of shares
adjusted for the dilutive effect of outstanding stock options.
On April 24, 2002, the Board of Directors declared a 10% stock dividend, payable
May 15 to shareholders of record at the close of business on April 29. All share
and per share data in the accompanying consolidated financial statements has
been adjusted to reflect the declaration of the 10% stock dividend. As a result
of the stock dividend, the Corporation distributed approximately 7.0 million
shares of common stock. Any fractional shares resulting from the dividend were
paid in cash.
86
Presented below are the calculations for basic and diluted earnings per share as
reported, as well as adjusted to exclude the amortization of goodwill affected
by adopting SFAS 142 and SFAS 147 in 2001.
For the Years Ended December 31,
----------------------------------------
2003 2002 2001
----------------------------------------
(In Thousands, except per share data)
Net income, as reported $228,657 $210,719 $179,522
Adjustment: Goodwill amortization, net of tax --- --- 6,158
----------------------------------------
Net income, adjusted $228,657 $210,719 $185,680
========================================
Weighted average shares outstanding 73,745 74,685 72,587
Effect of dilutive stock options outstanding 762 808 580
----------------------------------------
Diluted weighted average shares outstanding 74,507 75,493 73,167
Basic earnings per share:
Basic earnings per share, as reported $ 3.10 $ 2.82 $ 2.47
Adjustment: Goodwill amortization, net of tax --- --- 0.09
----------------------------------------
Basic earnings per share, adjusted $ 3.10 $ 2.82 $ 2.56
========================================
Diluted earnings per share:
Diluted earnings per share, as reported $ 3.07 $ 2.79 $ 2.45
Adjustment: Goodwill amortization, net of tax --- --- 0.09
----------------------------------------
Diluted earnings per share, adjusted $ 3.07 $ 2.79 $ 2.54
========================================
NOTE 20 SEGMENT REPORTING
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," requires selected financial and descriptive information about
reportable operating segments. The statement uses a "management approach"
concept as the basis for identifying reportable segments. The management
approach is based on the way that management organizes the segments within the
enterprise for making operating decisions, allocating resources, and assessing
performance. Consequently, the segments are evident from the structure of the
enterprise's internal organization, focusing on financial information that an
enterprise's chief operating decision-makers use to make decisions about the
enterprise's operating matters.
The Corporation's primary segment is banking, conducted through its bank and
lending subsidiaries. For purposes of segment disclosure under this statement,
these have been combined as one segment, as these segments have similar economic
characteristics and the nature of their products, services, processes,
customers, delivery channels, and regulatory environment are similar. 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); b)
corporate banking - specialized lending (such as commercial real estate), lease
financing, and banking to larger businesses and metro or niche markets; and c)
the support to deliver banking services.
The "Other" segment is comprised of wealth management (including insurance,
brokerage, and trust/asset management), as well as intersegment eliminations and
residual revenues and expenses, representing the difference between actual
amounts incurred and the amounts allocated to operating segments.
87
The accounting policies of the segments are the same as those described in Note
1. Selected segment information is presented below.
Consolidated
Banking Other Total
------------------------------------------
($ in Thousands)
2003
Net interest income $ 510,213 $ 549 $ 510,762
Provision for loan losses 46,813 --- 46,813
Noninterest income 194,186 52,249 246,435
Depreciation and amortization 47,307 1,571 48,878
Other noninterest expense 297,314 42,476 339,790
Income taxes 93,227 (168) 93,059
-----------------------------------------
Net income $ 219,738 $ 8,919 $ 228,657
==========================================
Total assets $15,195,428 $ 52,466 $15,247,894
==========================================
2002
Net interest income $ 501,244 $ 22 $ 501,266
Provision for loan losses 50,699 --- 50,699
Noninterest income 186,001 29,819 215,820
Depreciation and amortization 51,230 222 51,452
Other noninterest expense 298,370 20,239 318,609
Income taxes 86,345 (738) 85,607
------------------------------------------
Net income $ 200,601 $ 10,118 $ 210,719
==========================================
Total assets $15,015,136 $ 28,139 $15,043,275
==========================================
2001
Net interest income $ 421,253 $ 732 $ 421,985
Provision for loan losses 28,210 --- 28,210
Noninterest income 161,730 30,612 192,342
Depreciation and amortization 46,616 365 46,981
Other noninterest expense 256,290 31,837 288,127
Income taxes 71,893 (406) 71,487
------------------------------------------
Net income (loss) $ 179,974 $ (452) $ 179,522
==========================================
Total assets $13,578,328 $ 26,046 $13,604,374
==========================================
88
INDEPENDENT AUDITORS' REPORT
ASSOCIATED BANC-CORP
The Board of Directors
Associated Banc-Corp:
We have audited the accompanying consolidated balance sheets of Associated
Banc-Corp and subsidiaries as of December 31, 2003 and 2002, and the related
consolidated statements of income, changes in stockholders' equity, and cash
flows for each of the years in the three-year period ended December 31, 2003.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Associated Banc-Corp
and subsidiaries as of December 31, 2003 and 2002, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2003 in conformity with accounting principles generally
accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, the Company
changed its method of accounting for goodwill in 2002.
/s/ KPMG LLP
KPMG LLP
Chicago, Illinois
March 8, 2004
89
Market Information
Market Price Range
Sales Prices
Dividends ----------------------------
Paid Book Value High Low Close
- -------------------------------------------------------------------------------
2003
4th Quarter $0.34 $18.39 $43.13 $38.81 $42.80
3rd Quarter 0.34 17.77 38.90 37.12 37.89
2nd Quarter 0.34 17.88 38.41 32.15 36.61
1st Quarter 0.31 17.41 35.22 32.33 32.33
- -------------------------------------------------------------------------------
2002
4th Quarter $0.31 $17.13 $34.21 $27.20 $33.94
3rd Quarter 0.31 17.03 36.96 30.64 31.73
2nd Quarter 0.31 16.84 38.25 33.63 37.71
1st Quarter 0.28 16.23 35.29 30.37 34.57
- -------------------------------------------------------------------------------
Annual dividend rate: $1.36
Market information has been restated for the 10% stock dividend declared April
24, 2002, paid on May 15, 2002, to shareholders of record at the close of
business on April 29, 2002.
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
ITEM 9A CONTROLS AND PROCEDURES
The Corporation maintains a system of internal controls and procedures designed
to provide reasonable assurance as to the reliability of its published financial
statements and other disclosures included in this report. Within the 90-day
period prior to the date of this report, the Corporation evaluated the
effectiveness of the design and operation of its disclosure controls and
procedures pursuant to Rule 13a-14 of the Securities Exchange Act of 1934. Based
upon that evaluation, the Corporation's CEO and CFO concluded that the
Corporation's disclosure controls and procedures are effective in timely
alerting them to material information relating to the Corporation required to be
included in this annual report on Form 10-K.
There have been no significant changes in the Corporation's internal controls or
in other factors which could significantly affect internal controls subsequent
to the date of such evaluation.
PART III
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE CORPORATION
The information in the Corporation's definitive Proxy Statement, prepared for
the 2004 Annual Meeting of Shareholders, which contains information concerning
directors of the Corporation, under the caption "Election of Directors," is
incorporated herein by reference. The information concerning "Executive Officers
of the Corporation," as a separate item, appears in Part I of this document.
ITEM 11 EXECUTIVE COMPENSATION
The information in the Corporation's definitive Proxy Statement, prepared for
the 2004 Annual Meeting of Shareholders, which contains information concerning
this item, under the caption "Executive Compensation," is incorporated herein by
reference.
90
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information in the Corporation's definitive Proxy Statement, prepared for
the 2004 Annual Meeting of Shareholders, which contains information concerning
this item, under the captions "Stock Ownership," and "Equity Compensation Plan
Information," is incorporated herein by reference.
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information in the Corporation's definitive Proxy Statement, prepared for
the 2004 Annual Meeting of Shareholders, which contains information concerning
this item under the caption "Interest of Management in Certain Transactions," is
incorporated herein by reference.
ITEM 14 PRINCIPAL ACCOUNTING FEES AND SERVICES
The information in the Corporation's definitive Proxy Statement, prepared for
the 2004 Annual Meeting of Shareholders, which contains information concerning
this item under the caption "Audit and Non-Audit Fees," is incorporated herein
by reference.
PART IV
ITEM 15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1 and 2 Financial Statements and Financial Statement Schedules
The following financial statements and financial statement
schedules are included under a separate caption "Financial
Statements and Supplementary Data" in Part II, Item 8 hereof and
are incorporated herein by reference.
Consolidated Balance Sheets - December 31, 2003 and 2002
Consolidated Statements of Income - For the Years Ended December
31, 2003, 2002, and 2001
Consolidated Statements of Changes in Stockholders' Equity - For
the Years Ended December 31, 2003, 2002, and 2001
Consolidated Statements of Cash Flows - For the Years Ended
December 31, 2003, 2002, and 2001
Notes to Consolidated Financial Statements
Independent Auditors' Report
(a) 3 Exhibits Required by Item 601 of Regulation S-K
Sequential Page Number or
Exhibit Number Description Incorporate by Reference to
- ------------------------------------------------------------------------------------------------------
(3)(i) Articles of Incorporation Exhibit (3)(a) to Report on Form 10-K
for fiscal year ended December 31, 1999
(3)(ii) Bylaws Exhibit (3)(b) to Report on Form 10-K
for fiscal year ended December 31, 1999
(4) Instruments Defining the Rights of
Security Holders, Including Indentures
The Parent Company, by signing this
report, agrees to furnish the SEC, upon
its request, a copy of any instrument
that defines the rights of holders of
long-term
91
Sequential Page Number or
Exhibit Number Description Incorporate by Reference to
- -----------------------------------------------------------------------------------------------------------
debt of the Corporation for
which consolidated or unconsolidated
financial statements are required to be
filed and that authorizes a total amount
of securities not in excess of 10% of the
total assets of the Corporation on a
consolidated basis
*(10)(a) The 1982 Incentive Stock Option Plan of Exhibit (10) to Report on Form 10-K
the Parent Company for fiscal year ended December 31, 1987
*(10)(b) The Restated Long-Term Incentive Stock Exhibits filed with the Corporation's
Plan of the Corporation registration statement (333-46467) on Form
S-8 filed under the Securities Act of 1933
*(10)(c) Change of Control Plan of the Corporation Exhibit (10)(d) to Report on Form
effective April 25, 1994 10-K for fiscal year ended December 31, 1994
*(10)(d) Deferred Compensation Plan and Deferred Exhibit (10)(e) to Report on Form
Compensation Trust effective as of 10-K for fiscal year ended December 31, 1994
December 16, 1993, and Deferred
Compensation Agreement of the Corporation
dated December 31, 1994
*(10)(e) Incentive Compensation Agreement (form) Exhibit (10)(e) to Report on Form
and schedules dated as of October 1, 2001 10-K for fiscal year ended December 31, 2001
*(10)(f) Employment Agreement between the Parent Exhibit (10) to Report on Form
Company and Paul S. Beideman effective 10-Q for quarter ended June 30, 2003
April 28, 2003
(11) Statement Re Computation of Per Share See Note 19 in Part II Item 8
Earnings
(21) Subsidiaries of the Parent Company Filed herewith
(23) Consent of Independent Auditors Filed herewith
(24) Power of Attorney Filed herewith
(31.1) Certification Under Section 302 of Filed herewith
Sarbanes-Oxley by Paul S. Beideman, Chief
Executive Officer
(31.2) Certification Under Section 302 of Filed herewith
Sarbanes-Oxley by Joseph B. Selner, Chief
Financial Officer
(32) Certification by the CEO and CFO Pursuant Filed herewith
to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of Sarbanes-Oxley
* Management contracts and arrangements.
Schedules and exhibits other than those listed are omitted for the reasons that
they are not required, are not applicable or that equivalent information has
been included in the financial statements, and notes thereto, or elsewhere
herein.
(b) Reports on Form 8-K
A report on Form 8-K dated October 16, 2003, was filed under Item 12, Results of
Operations and Financial Condition, reporting Associated Banc-Corp released its
earnings for the quarter ended September 30, 2003.
A report on Form 8-K dated October 22, 2003, was filed under Item 5, Other
Events, announcing the Associated Banc-Corp Board of Directors declared its
third quarter dividend.
92
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
ASSOCIATED BANC-CORP
Date: March 15, 2004 By: /s/ PAUL S. BEIDEMAN
----------------------- -----------------------------------------
Paul S. Beideman
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
/s/ PAUL S. BEIDEMAN /s/ Ronald R. Harder*
- ------------------------------------- ------------------------------------
Paul S. Beideman Ronald R. Harder
President and Chief Executive Officer Director
/s/ JOSEPH B. SELNER /s/ William R. Hutchinson *
- ------------------------------------- ------------------------------------
Joseph B. Selner William R. Hutchinson
Chief Financial Officer Director
Principal Financial Officer
and Principal Accounting Officer
/s/ H.B. Conlon * /s/ Dr. George R. Leach *
- ------------------------------------- ------------------------------------
H. B. Conlon Dr. George R. Leach
Director Director
/s/ Ruth M. Crowley * /s/ John C. Meng *
- ------------------------------------- ------------------------------------
Ruth M. Crowley John C. Meng
Director Director
/s/ Robert S. Gaiswinkler * /s/ J. Douglas Quick *
------------------------------------ ------------------------------------
Robert S. Gaiswinkler J. Douglas Quick
Director Director
/s/ Robert C. Gallagher* /s/ John C. Seramur *
- ------------------------------------- ------------------------------------
Robert C. Gallagher John C. Seramur
Director Vice Chairman
* /s/ BRIAN R. BODAGER
--------------------
Brian R. Bodager
Attorney-in-Fact
Date: March 15, 2004
93