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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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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, 1998
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period 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 54304
Green Bay, Wisconsin (Zip code)
(Address of principal executive
offices)
Registrant's telephone number, including area code: (920) 491-7000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT
Common stock, par value--$0.01 per share
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K ((S)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. [_]
As of March 1, 1999, 63,361,693 shares of Common Stock were outstanding and
the aggregate market value of the voting stock held by nonaffiliates of the
Registrant was approximately $1,859,721,000. Excludes approximately
$96,572,000 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
$161,436,000 of market value representing 8.25% of the outstanding shares of
the Registrant held in a fiduciary capacity by the trust departments of three
wholly-owned subsidiaries 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, 1999
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ASSOCIATED BANC-CORP
1998 FORM 10-K TABLE OF CONTENTS
Page
----
PART I
Item 1. Business 3
Item 2. Properties 6
Item 3. Legal Proceedings 7
Item 4. Submission of Matters to a Vote of Security Holders 7
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters 9
Item 6. Selected Financial Data 10
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 11
Item 7a. Quantitative and Qualitative Disclosures About Market Risk 38
Item 8. Financial Statements and Supplementary Data 39
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure 71
PART III
Item 10. Directors and Executive Officers of the Registrant 71
Item 11. Executive Compensation 71
Item 12. Security Ownership of Certain Beneficial Owners and Management 71
Item 13. Certain Relationships and Related Transactions 71
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 72
Signatures
2
Special Note Regarding Forward-Looking Statements
Forward-looking statements have been made in this document, and in documents
that are incorporated by reference, that are subject to risks and
uncertainties. These forward-looking statements, which are included in
Management's Discussion and Analysis and in the Chairman's letter, describe
future plans or strategies and include Associated Banc-Corp's expectations of
future results of operations. The words "believes," "expects," "anticipates,"
or similar expressions identify forward-looking statements.
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 include the following:
. operating, legal, and regulatory risks;
. economic, political, and competitive forces affecting Associated Banc-
Corp's banking, securities, asset management, and credit services
businesses; and
. the risk that Associated Banc-Corp's analyses of these risks and forces
could be incorrect and/or that the strategies developed to address them
could be unsuccessful.
These factors should be considered in evaluating the forward-looking
statements, and undue reliance should not be placed on such statements.
PART I
ITEM 1 BUSINESS
General
Associated Banc-Corp (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. Currently, the Corporation owns ten commercial
banks located in Illinois, Minnesota, and Wisconsin (the "affiliates") serving
their local communities and, measured by total assets held at December 31,
1998, was the third largest commercial bank holding company headquartered in
Wisconsin. The Corporation also owns 30 nonbanking subsidiaries located in
Arizona, California, Delaware, Illinois, Missouri, Nevada, and Wisconsin.
The Corporation acquired Citizens Bankshares, Inc., and its wholly owned
subsidiary, Citizens Bank, National Association, and its wholly owned
subsidiaries, CB Investments, Inc. and Wisconsin Finance Corporation, and its
wholly owned subsidiary, Citizens Financial Services, Inc., on December 19,
1998. Further, the Corporation consummated the acquisition of Windsor
Bancshares, Inc. and its wholly owned subsidiary, Bank Windsor, on February 3,
1999.
Services
The Corporation provides advice and specialized services to its affiliates in
banking policy and operations, including auditing, data processing,
marketing/advertising, investing, legal/compliance, personnel services, trust
services, risk management, facilities management, security, corporate-wide
purchasing, treasury, finance, accounting, and other financial services
functionally related to banking.
Responsibility for the management of the affiliates remains with their
respective Boards of Directors and officers. Services rendered to the
affiliates by the Corporation are intended to assist the local management of
these affiliates to expand the scope of services offered by them. Bank
affiliates of the Corporation at December 31, 1998, provided services through
225 locations in 155 communities.
The Corporation, through its affiliates, provides a complete range of banking
services to individuals and small to medium-size businesses. These services
include checking, savings, NOW, Super NOW, and money market deposit accounts,
business, personal, educational, residential, and commercial mortgage loans,
MasterCard, VISA and other consumer-oriented financial services, including IRA
and Keogh
3
accounts, safe deposit and night depository facilities. Automated Teller
Machines (ATMs), which provide 24-hour banking services to customers of the
affiliates, are installed in many locations in the affiliates' service areas.
The affiliates are members of an interstate shared ATM network, which allows
their customers to perform banking transactions from their checking, savings,
or credit card accounts at ATMs in a multi-state environment. Among the
services designed specifically to meet the needs of small and medium-size
businesses are various types of specialized financing, cash management
services, and transfer/collection facilities.
The affiliates provide lending, depository, and related financial services to
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.
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 possible loan
losses ("AFLL") represents management's estimate of an amount adequate to
provide for potential losses inherent in the loan portfolio. Management's
evaluation of the adequacy of the AFLL 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 factors which could affect potential
credit losses, such as Year 2000 issues. Credit risk management is discussed
under sections "Loans," "Allowance for Possible Loan Losses," and
"Nonperforming Loans, Potential Problem Loans, and Other Real Estate Owned"
and under Notes 1 and 6 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 affiliates make available check
clearing, safekeeping, loan participations, lines of credit, portfolio
analyses, and other services to approximately 120 correspondent financial
institutions.
Three of the affiliates, a trust company subsidiary, and an investment
management subsidiary offer a wide variety of fiduciary, investment
management, advisory, and corporate agency services to individuals,
corporations, charitable trusts, foundations, and institutional investors.
They also administer (as trustee and in other fiduciary and representative
capacities) pension, profit sharing and other employee benefit plans, and
personal trusts and estates.
Investment subsidiaries provide discount and full-service brokerage services,
including the sale of fixed and variable annuities, mutual funds, and
securities, to the affiliates' customers and the general public. Insurance
subsidiaries provide commercial and individual insurance services, including
various life, property, casualty, credit, and mortgage products to the
affiliates' customers and the general public. Several investment subsidiaries
located in Nevada hold, manage, and trade cash, stocks, and securities
transferred from the affiliates and reinvest investment income. A leasing
subsidiary provides lease financing for a variety of capital equipment for
commerce and industry. An appraisal subsidiary provides real estate appraisals
for customers, government agencies, and the general public.
The mortgage banking subsidiaries are 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, all of which are generally salable into the secondary mortgage
market. The principal mortgage lending areas of these subsidiaries are
Wisconsin and Illinois. In addition to real estate loans, the Corporation's
affiliates and subsidiaries originate significant volumes of consumer loans,
credit card loans, and student loans. Consumer, home equity, and student
lending activities are principally conducted in Wisconsin and Illinois, while
the credit card base and resulting loans are principally centered in the
Midwest. Nearly all long-term, fixed-rate real estate mortgage loans generated
are sold in the secondary market and to other financial institutions, with the
subsidiaries retaining the servicing of those loans.
4
The Corporation, its affiliates, and subsidiaries are 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, its affiliates, or its subsidiaries is seasonal.
Foreign Operations
The Corporation, its affiliates, and subsidiaries do not engage in any
operations in foreign countries.
Employees
At December 31, 1998, the Corporation, its affiliates, and subsidiaries, as a
group, had 3,965 full-time equivalent employees.
Competition
Competition exists in all of the Corporation's principal markets. 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. Substantial competition exists from other financial
institutions engaged in the business of making loans, accepting deposits, and
issuing credit cards. All of the affiliates also face direct competition from
members of bank holding company systems that have greater assets and resources
than those of the Corporation.
Supervision and Regulation
Financial institutions are highly regulated both at the federal and state
level. Numerous statutes and regulations presently affect the business of the
Corporation, its affiliates, and its subsidiaries. Proposed comprehensive
statutory and regulatory changes could have an effect on the Corporation's
business.
As a registered bank holding company under the Act, the Corporation and its
nonbanking affiliates are regulated and supervised by the Board of Governors
of the Federal Reserve System (the "Board"). The affiliates of the Corporation
with a national charter are supervised and examined by the Comptroller of the
Currency. The affiliates with a state charter are supervised and examined by
their respective state banking agency, and either the Board, if such affiliate
is a member of the Federal Reserve System, or by the Federal Deposit Insurance
Corporation (the "FDIC"), if a nonmember. Currently, all affiliates are non-
member banks. The subsidiary thrift of the Corporation was supervised and
examined by the Office of Thrift Supervision until it was merged out of
existence in November 1998. All affiliates of the Corporation that accept
insured deposits are subject to examination by the FDIC.
The activities of the Corporation, and its affiliates and subsidiaries, are
limited by the Act to those activities that are banking, or those nonbanking
activities that are closely related or incidental to banking. The Corporation
is required to act as a source of financial strength to each of its affiliates
pursuant to which it may be required to commit financial resources to support
such affiliates in circumstances when, absent such requirements, it might not
do so. The Act also requires the prior approval of the Board for the
Corporation to acquire direct or indirect control of more than five percent of
any class of voting shares of any bank or bank holding company. Further
restrictions imposed by the Act include capital requirements, restrictions on
transactions with affiliates, on issuances of securities, on dividend
payments, on inter-affiliate liabilities, on extensions of credit, and on
expansion through merger and acquisition.
The federal regulatory authorities have broad authority to enforce the
regulatory requirements imposed on the Corporation, its affiliates, and
subsidiaries. In particular, the Financial Institutions Reform, Recovery and
Enforcement Act of 1989 ("FIRREA") and the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"), and their implementing
regulations, carry greater enforcement powers. Under FIRREA, all commonly
controlled FDIC insured depository institutions may be held liable for any
loss incurred by the FDIC resulting from a failure of, or any assistance given
by the FDIC to, any commonly controlled institutions. Pursuant to certain
provisions under FDICIA, the federal regulatory agencies have broad powers to
take prompt corrective action if a depository institution fails to maintain
certain capital levels. Prompt corrective action may include the inability of
the Corporation to pay dividends, restrictions in acquisitions or activities,
limitations on asset growth, and other restrictions.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
contains provisions which amended the Act to allow an adequately-capitalized
and adequately-managed bank holding company to
5
acquire a bank located in another state as of September 29, 1995. Effective
June 1, 1997, interstate branching was permitted. The Riegle-Neal Amendments
Act of 1997 clarifies the applicability of host state laws to any branch in
such state of an out-of-state bank.
The FDIC Board of Directors (the "FDIC Board") voted December 11, 1996, to
finalize a rule lowering the rates on assessments paid to the Savings
Association Insurance Fund ("SAIF"), effective as of October 1, 1996. As a
result of the special assessment required by the Deposit Insurance Funds Act
of 1996 ("Funds Act"), the SAIF was capitalized at the target Designated
Reserve Ratio ("DRR") of 1.25% of estimated insured deposits on October 1,
1996. The Funds Act required the FDIC to set assessments in order to maintain
the target DRR. The FDIC Board has, therefore, lowered the rates on
assessments paid to the SAIF, while simultaneously widening the spread between
the lowest and highest rates to improve the effectiveness of the FDIC's risk-
based premium system. The FDIC Board has also established a process, similar
to that which was applied to the Bank Insurance Fund ("BIF"), for adjusting
the rate schedules for both the SAIF and the BIF within a limited range,
without notice and comment, to maintain each of the fund balances at the
target DRR.
The laws and regulations to which the Corporation, its affiliates, and
subsidiaries are 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 affiliates of the
Corporation are affected by the credit policies of monetary authorities,
including the Federal Reserve System. An important function of the Federal
Reserve System is to regulate the national supply of bank credit in order to
combat recession and curb inflationary pressures. Among the instruments of
monetary policy used by the Federal Reserve to implement these objectives are
open market operations in U.S. government securities, changes in reserve
requirements against member bank deposits, and changes in the Federal Reserve
discount rate. These means are used in varying combinations to influence
overall growth of bank loans, investments, and deposits, and may also affect
interest rates charged on loans or paid for deposits. The monetary policies of
the Federal Reserve authorities have had a significant effect on the operating
results of commercial banks in the past and are expected to continue to have
such an effect in the future.
In view of changing conditions in the national economy and in the money
markets, as well as the effect of credit policies by monetary and fiscal
authorities, including the Federal Reserve System, no prediction can be made
as to possible future changes in interest rates, deposit levels, and loan
demand, or their effect on the business and earnings of the Corporation and
its affiliates.
ITEM 2 PROPERTIES
The Corporation's headquarters were relocated to the Village of Ashwaubenon,
Wisconsin, in a leased facility with approximately 30,000 square feet of
office space in September 1998. The space is currently subject to a five-year
lease with two consecutive five-year extensions.
The affiliates currently occupy 225 offices in 155 different communities
within Illinois, Minnesota, and Wisconsin. All affiliate main offices are
owned, except Associated Bank Milwaukee, Associated Bank Chicago, and
Associated Bank Illinois. The affiliate main offices in downtown Milwaukee,
Chicago, and Rockford are located in the lobbies of multi-story office
buildings. Most affiliate branch offices are free-standing buildings that
provide adequate customer parking, including drive-in facilities of various
numbers and types for customer convenience. Some affiliates also have branch
offices in various supermarket locations, as well as offices in retirement
communities. In addition, the Corporation owns other real property that, when
considered in the aggregate, is not material to its financial position.
6
ITEM 3 LEGAL PROCEEDINGS
There are legal proceedings pending against certain affiliates and
subsidiaries of the Corporation which arose in the normal course of their
business. Although litigation is subject to many uncertainties and the
ultimate exposure with respect to these matters cannot be ascertained,
management believes, based upon discussions with counsel, that the Corporation
has meritorious defenses, and any ultimate liability would not have a material
adverse effect on the consolidated financial position of the Corporation.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
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 Stockholders to be held April
28, 1999.
The following is a list of names and ages of executive officers of the
Corporation and affiliates 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 or its affiliates. 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
Harry B. Conlon Chairman and Chief Executive Officer of March 1, 1975
Age: 63 Associated Banc-Corp
Prior to October 1998, Chairman,
President, and Chief Executive Officer
of Associated Banc-Corp
Robert C. Gallagher President, Chief Operating Officer, and April 28, 1982
Age: 60 Director of Associated Banc-Corp
Prior to October 1998, Vice Chairman of
Associated Banc-Corp; Chairman and
Chief Executive Officer of Associated
Bank Green Bay (affiliate)
Prior to April 1996, Executive Vice
President and Director of Associated
Banc-Corp; Chairman, President and
Chief Executive Officer of Associated
Bank Green Bay (affiliate)
John C. Seramur Vice Chairman of Associated Banc-Corp October 27, 1997
Age: 56
From October 1997 to November 1998,
Vice Chairman of Associated Banc-Corp;
President, Chief Executive Officer, and
Director of First Financial Corporation
(former affiliate); President, Chief
Executive Officer, and Director of
First Financial Bank (former affiliate)
Prior to October 1997, President, Chief
Executive Officer, and Director of
First Financial Corporation (former
affiliate); President, Chief Executive
Officer, and Director of First
Financial Bank (former affiliate)
Brian R. Bodager Chief Administrative Officer, General July 22, 1992
Age: 43 Counsel and Corporate Secretary of
Associated Banc-Corp
Prior to July 1997, Senior Vice
President, General Counsel, and
Corporate Secretary of Associated Banc-
Corp
7
Name Offices and Positions Held Date of Election
Joseph B. Selner Chief Financial Officer of January 25, 1978
Age: 52 Associated Banc-Corp
Arthur E. Olsen, III General Auditor of Associated Banc- July 28, 1993
Age: 47 Corp
Mary Ann Bamber Director of Retail Banking of January 22, 1997
Age: 48 Associated Banc-Corp From January
1996 to January 1997, independent
consultant
From January 1996 to January 1997,
Senior Officer of an Iowa-based bank
Prior to January 1996, Senior
Officer of a Minnesota-based holding
company
Robert J. Johnson Director of Human Resources of January 22, 1997
Age: 53 Associated Banc-Corp
Prior to January 1997, Officer of a
Wisconsin manufacturing company
Donald E. Peters Director of Systems and Operations October 27, 1997
Age: 49 of Associated
Banc-Corp
From October 1997 to November 1998,
Director of Systems and Operations
of Associated Banc-Corp; Executive
Vice President of First Financial
Bank (former affiliate)
Prior to October 1997, Executive
Vice President of First Financial
Corporation (former affiliate);
Executive Vice President of First
Financial Bank (former affiliate)
Cindy K. Moon-Mogush Director of Marketing of Associated April 20, 1998
Age: 37 Banc-Corp
From July 1997 to April 1998, Senior
Vice President of a Michigan-based
bank holding company
From March 1995 to July 1997,
Officer of a Michigan-based bank
holding company
Prior to March 1995, Senior Officer
of a Michigan-based financial
institution
David S. Fisher Treasurer of Associated Banc-Corp May 18, 1998
Age: 43
Prior to May 18, 1998, Senior Vice
President of a Michigan-based bank
holding company
John P. Evans Chief Executive Officer and Director August 16, 1993
Age: 49 of Associated Bank North (affiliate)
David J. Handy President, Chief Executive Officer, May 31, 1991
Age: 59 and Director of Associated Bank,
National Association (affiliate)
David G. Krill President, Chief Executive Officer, November 3, 1997
Age: 56 and Director of Associated
Commercial Mortgage, Inc.
Prior to November 1997, Senior Vice
President of First Financial Bank
(former affiliate)
Michael B. Mahlik Executive Vice President, Managing January 1, 1991
Age: 46 Trust Officer, and Director of
Associated Bank, National
Association (affiliate)
George J. McCarthy President, Chief Executive Officer, November 11, 1983
Age: 48 and Director of Associated Bank
Chicago (affiliate)
8
Name Offices and Positions Held Date of Election
Mark J. McMullen Senior Executive Vice President and June 2, 1981
Age: 50 Director of Associated Bank Green Bay
(affiliate)
Prior to July 1996, Executive Vice
President and Director of Associated
Bank Green Bay (affiliate)
Randall J. Peterson President, Chief Executive Officer, August 2, 1982
Age: 53 and Director of Associated Bank Green
Bay (affiliate)
From July 1996 to October 1998,
President and Director of Associated
Bank Green Bay (affiliate)
Prior to July 1996, Executive Vice
President and Director of Associated
Bank Green Bay (affiliate)
Gary L. Schaefer President and Director of Associated March 1, 1995
Age: 49 Bank South Central (affiliate)
Prior to March 1995, Senior Officer of
a Wisconsin bank
Thomas R. Walsh President, Chief Executive Officer, January 1, 1994
Age: 41 and Director of Associated Bank
Illinois (affiliate)
From January 1994 to November 12,
1998, President, Chief Executive
Officer, and Director of Associated
Bank Lakeshore (affiliate)
From September 1992 to January 1994,
Senior Officer of Associated Bank
Lakeshore (affiliate)
Gordon J. Weber President, Chief Executive Officer, December 15, 1993
Age: 51 and Director of Associated Bank
Milwaukee (affiliate);
Director of Associated Bank South
Central (affiliate)
Prior to December 15, 1993, President,
Chief Executive Officer and Director
of Associated Bank Lakeshore
(affiliate)
Scott A. Yeoman President, Chief Executive Officer, October 1, 1994
Age: 41 and Director of Associated Bank
Lakeshore (affiliate)
From October 1, 1994, to September 15,
1998, Senior Vice President of
Associated Bank Lakeshore (affiliate)
Prior to October 1, 1994, Vice
President of an Illinois-based bank
PART II
ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Information in response to this item is incorporated by reference to the table
"Market Information" on Page 71 and the discussion of dividend restrictions in
Note 12 "Stockholders' Equity" of the notes to consolidated financial
statements included under Item 8 of this document. The Corporation's common
stock is currently being traded on The Nasdaq Stock Market under the symbol
ASBC.
The approximate number of equity security holders of record of common stock,
$.01 par value, as of March 1, 1999, was 10,400. Certain of the Corporation's
shares are held in "nominee" or "street" name and, accordingly, the number of
beneficial owners of such shares is not known nor included in the foregoing
number.
Payment of future dividends is within the discretion of the Corporation's
Board of Directors and will depend, among other factors, on earnings, capital
requirements, and the operating and financial condition of the Corporation. At
the present time, the Corporation expects that dividends will continue to be
paid in the future.
9
ITEM 6 SELECTED FINANCIAL DATA
TABLE 1: EARNINGS SUMMARY AND SELECTED FINANCIAL DATA(1)
($ in thousands, except per share data)
%
Change 5-Year
1997 Compound
to Growth
Years ended December 31, 1998 1998 1997 1996 1995 1994 1993 Rate
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Interest income $ 785,765 (0.3)% $ 787,919 $ 731,763 $ 696,858 $ 613,725 $ 586,567 6.0%
Interest expense 411,028 (0.1) 411,637 375,922 360,499 292,735 287,587 7.4
------------------------------------------------------------------------------------------
Net interest income 374,737 (0.4) 376,282 355,841 336,359 320,990 298,980 4.6
Provision for possible
loan losses 14,740 (53.5) 31,668 13,695 14,029 9,035 16,441 (2.2)
------------------------------------------------------------------------------------------
Net interest income
after provision for
possible loan losses 359,997 4.5 344,614 342,146 322,330 311,955 282,539 5.0
------------------------------------------------------------------------------------------
Noninterest income 167,951 76.2 95,302 116,274 104,989 84,155 95,713 11.9
Noninterest expense 294,985 (8.9) 323,648 293,231 252,927 245,310 240,318 4.2
------------------------------------------------------------------------------------------
Net noninterest expense 127,034 (44.4) 228,346 176,957 147,938 161,155 144,605 (2.6)
------------------------------------------------------------------------------------------
Income before income
taxes and extraordinary
item/cumulative effect
of an accounting change 232,963 100.4 116,268 165,189 174,392 150,800 137,934 11.1
Income tax expense 75,943 18.8 63,909 57,487 62,381 54,203 49,311 9.0
Extraordinary item -- -- N/M (686) -- -- -- N/M
------------------------------------------------------------------------------------------
NET INCOME $ 157,020 199.9% $ 52,359 $ 107,016 $ 112,011 $ 96,597 $ 88,623 12.1%
==========================================================================================
Basic earnings per
share(2)
Income before
extraordinary item $ 2.49 198.7% $ 0.83 $ 1.70 $ 1.82 $ 1.59 $ 1.50 10.6%
Net income 2.49 198.7 0.83 1.69 1.82 1.59 1.50 10.6
Diluted earnings per
share(2)
Income before
extraordinary item 2.46 200.6 0.82 1.67 1.79 1.55 1.44 11.3
Net income 2.46 200.6 0.82 1.66 1.79 1.55 1.44 11.3
Cash dividends per
share(2) 1.04 17.4 0.89 0.76 0.65 0.57 0.50 15.8
Weighted average shares
outstanding
Basic 63,125 0.4 62,884 63,205 61,386 60,747 59,005 1.4
Diluted 63,789 (0.2) 63,935 64,380 62,473 62,144 61,518 0.7
SELECTED FINANCIAL DATA
Year-End Balances:
Loans (including loans
held for sale) $ 7,437,867 3.5% $ 7,186,551 $ 6,697,404 $6,418,683 $5,995,964 $5,380,082 6.7%
Allowance for possible
loan losses 99,677 7.5 92,731 71,767 68,560 65,774 63,415 9.5
Investment securities 2,907,735 (1.1) 2,940,218 2,753,938 2,266,895 2,499,380 2,433,963 3.6
Assets 11,250,667 5.2 10,690,442 10,120,413 9,393,609 9,130,522 8,448,468 5.9
Deposits 8,557,819 1.9 8,395,277 7,959,240 7,570,201 7,334,240 7,063,481 3.9
Long-term borrowings 26,004 70.3 15,270 33,329 36,907 94,537 250,402 (36.4)
Stockholders' equity 878,721 8.0 813,692 803,562 725,211 626,591 560,722 9.4
Stockholders' equity per
share(2) 13.97 8.1 12.92 12.81 11.75 10.27 9.43 8.2
------------------------------------------------------------------------------------------
Average Balances:
Loans (including loans
held for sale) $ 7,255,850 4.3% $ 6,959,018 $ 6,583,572 $6,157,655 $5,636,601 $5,136,319 7.2%
Investment securities 2,737,556 (5.8) 2,905,921 2,523,757 2,421,379 2,536,133 2,444,255 2.3
Assets 10,628,695 2.3 10,391,718 9,640,471 9,123,981 8,737,231 8,228,145 5.3
Deposits 8,430,701 3.8 8,121,945 7,778,177 7,409,409 7,191,053 6,927,867 4.0
Stockholders' equity 856,425 2.0 839,859 775,180 674,368 596,365 511,737 10.8
------------------------------------------------------------------------------------------
Financial Ratios:
Return on average
equity(3) 18.33% 140 bp 16.93% 16.64% 17.21% 16.20% 17.32%
Return on average
assets(3) 1.48 11 1.37 1.35 1.27 1.11 1.08
Net interest margin,
tax-equivalent 3.79 (7) 3.86 3.95 3.95 3.93 3.91
Average equity to
average assets 8.06 (2) 8.08 8.04 7.39 6.83 6.22
Dividend payout
ratio(3)(4) 41.93 255 39.38 37.07 35.71 35.85 33.33
==========================================================================================
(1) All financial data adjusted retroactively for certain acquisitions
accounted for using the pooling-of-interests method.
(2) Per share data adjusted retroactively for stock splits and stock dividends.
(3) Ratio is based upon income prior to merger integration and other one-time
charges or extraordinary items.
(4) Ratio is based upon basic earnings per share.
N/M = not meaningful
10
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.
The financial discussion that follows refers to the impact of the
Corporation's business combination activity, detailed under the section,
"Business Combinations," and Note 2 of the notes to consolidated financial
statements. In particular, in October 1997 the Corporation merged with First
Financial Corporation ("FFC"), the parent company of a $6.0 billion federally
chartered thrift ("First Financial Bank" or "FFB"). The transaction was
accounted for as a pooling-of-interests, and thus, all consolidated financial
data was restated as though the entities had been combined for the periods
presented.
In addition, the following discussion focuses on "operating earnings." To
arrive at operating earnings, reported results of 1997 and 1996 were adjusted
by the following (no adjustments were made for 1998):
. 1997 operating earnings exclude the merger, integration, and other one-
time charges ("merger-related charges") recorded by the Corporation in
conjunction with the merger of FFC of $103.7 million, or $89.8 million
after tax. This pre-tax charge includes a $35.3 million adjustment to
securities for other than temporary impairment, $16.8 million of
conforming provision for loan losses, and $51.6 million of merger,
integration, and other one-time charges. These charges reduced basic
earnings per share by $1.43 and diluted earnings per share by $1.41. See
Note 3 of the notes to consolidated financial statements for additional
detail.
. 1996 operating earnings exclude a one-time pre-tax charge of $28.8
million associated with the recapitalization of the Savings Association
Insurance Fund ("SAIF"), a one-time pre-tax charge of $4.2 million
related to a change in accounting for the amortization of goodwill and
other intangible assets, and an extraordinary after-tax charge of
$686,000 related to early redemption costs on subordinated notes (all
recorded at FFC). These charges, $22.7 million after-tax, reduced basic
earnings per share by $0.35 and diluted earnings per share by $0.34. See
also Note 3 of the notes to consolidated financial statements.
Performance ratios for these periods are also calculated excluding these
items.
All per share information has been restated to reflect the 5-for-4 stock split
declared April 22, 1998, effected as a 25% stock dividend paid on June 12,
1998, to shareholders of record at the close of business on June 1, 1998.
Performance Summary
The Corporation recorded net income of $157.0 million for the year ended
December 31, 1998, an increase of $14.8 million or 10.4% over the operating
net income of $142.2 million earned in 1997. Basic earnings per share were
$2.49, a 10.2% increase over 1997 basic operating earnings per share of $2.26.
Earnings per diluted share were $2.46, a 10.8% increase over 1997 diluted
operating earnings per share of $2.22. Return on average assets and return on
average equity were 1.48% and 18.33% for 1998, compared to 1.37% and 16.93%,
respectively, for 1997. Key factors behind these results were:
. Taxable equivalent net interest income decreased by $519,000 between the
annual periods. The interest rate environment, affected by a flattening
yield curve, negatively impacted net interest income. Growth in earning
asset volume, and changes in mix toward higher yielding loans and toward
lower rate funding, countered the negative impact from the flattening
yield curve.
. Provision for loan losses was essentially unchanged at $14.7 million for
1998, decreasing $128,000 from the $14.9 million (excluding the merger-
related charge) in 1997. Net charge-offs were also unchanged at $11.4
million, or .16% of average loans, for both 1998 and 1997. The allowance
for possible loan losses to loans increased to 1.37% from 1.31% at
December 31, 1998 and 1997, respectively.
11
. Noninterest income was a strong contributor to earnings, increasing
$37.4 million or 28.6% over 1997. Excluding securities gains,
noninterest income increased $33.0 million or 25.8%. Mortgage banking
revenues, trust fees, credit card and related fees, and gains on asset
sales accounted for the majority of the increase.
. Noninterest expense increased $23.0 million, or 8.4% over 1997.
Personnel expense accounts for 62% of this increase up $14.2 million
over 1997. Mortgage servicing rights amortization and professional fees
are accountable for $11.5 million of increase, offset partially by
decreases in various other categories, particularly business development
and advertising.
Cash dividends paid in 1998 increased by 17.4% to $1.04 per share over the
$0.89 per share paid in 1997.
Business Combinations
The Corporation's business combination activity is summarized in Note 2 of the
notes to consolidated financial statements.
On December 19, 1998, the Corporation completed its acquisition of Citizens
Bankshares, Inc. ("Citizens"), which had $161 million in assets, and operated
Citizens Bank and two consumer finance companies. The merger, accounted for as
a purchase, was consummated through the issuance of 448,571 shares of common
stock and $16.2 million in cash. The purchase price exceeded the fair value of
net assets acquired, resulting in the recording of $11.9 million of goodwill.
At December 31, 1998, Citizens Bank and the consumer finance companies
continue operations as wholly-owned subsidiaries of the Corporation. In the
second quarter of 1999, the Corporation anticipates merging Citizens Bank into
its existing banks.
On October 29, 1997, the Corporation merged with the $6.0 billion FFC, which
had over 125 bank branches throughout Wisconsin and Illinois. FFC's retail
product mix had a concentration of real-estate mortgage products (both
traditional mortgage products and home equity loans), credit card and student
loans funded primarily with retail interest-bearing deposits. The 1997 merger
was consummated through the issuance of 34.8 million shares of common stock
and was accounted for as a pooling of interests. Thus, all consolidated
financial information was restated as if the transaction had been effected as
of the beginning of the earliest reporting period. FFB operated as a thrift
subsidiary of the Corporation until fourth quarter 1998. On November 12, 1998,
the Corporation completed the conversion of FFB systems and the distribution
of FFB assets into its various affiliates.
On February 21, 1997, the Corporation completed its merger with Centra
Financial, Inc., which had assets of approximately $76 million. The
transaction was consummated through the issuance of 517,956 shares of common
stock and was accounted for as a pooling of interests. However, the
transaction was not material to prior years' reported results, and
accordingly, previously reported results were not restated.
During 1996, the Corporation acquired $457 million in assets through four
acquisition transactions. Three were accounted for using the pooling-of
interests method. Goodwill of $1.9 million was recorded on the fourth
transaction, accounted for under the purchase method.
Subsequent Combination
On February 3, 1999, the Corporation consummated the acquisition of Windsor
Bancshares, Inc. ("Windsor"), a Minnesota bank holding company. Windsor's
principal subsidiary is Bank Windsor, which operates offices in the Minnesota
communities of Minneapolis, Nerstrand, Sleepy Eye and Chisholm. At December
31, 1998, Windsor had total consolidated assets of approximately $178 million.
The transaction was consummated through the issuance of 799,961 shares of
common stock and was accounted for under the purchase method. It is not
reflected in the accompanying consolidated financial statements.
INCOME STATEMENT ANALYSIS
Net Interest Income
Net interest income continues to be the largest component of the Corporation's
operating income (net interest income plus noninterest income), accounting for
69.1% of 1998 total operating income, compared
12
to 74.2% in 1997. The decline in this relationship was a combination of the
lower net interest income as further discussed below, and the increase in
noninterest income (discussed under "Noninterest Income").
Net interest income represents the difference between interest earned on
loans, securities and other interest-earning assets, and the interest expense
associated with the deposits and borrowings that fund them. Interest rate
fluctuations together with changes in volume and types of earning assets and
interest-bearing liabilities combine to affect total net interest income. The
remainder of this analysis discusses net interest income on a fully taxable
equivalent ("FTE") basis in order to provide comparability among the types of
interest earned. See also Tables 2 through 5 for additional information
related to net interest income and the net interest margin.
FTE net interest income was $381.4 million in 1998, down $519,000 from the
$382.0 million level in 1997. The interest rate environment, affected by a
flattening yield curve, and competitive pricing pressure negatively impacted
net interest income by $12.6 million. Growth in earning asset volume, and
changes in mix toward higher yielding loans and toward lower rate funding
countered the negative impact from the yield curve shift with a $12.1 million
increase to FTE net interest income.
The yield curve change and the low interest rate environment of residential
mortgage lending were factors causing prepayments of mortgage loans to
accelerate significantly during 1998. This accumulation of funds was invested
at lower yields than the assets that were prepaid. Thus, rates decreased
interest earned from earning assets by $16.9 million (mostly in loans, with a
$15.2 million decrease), while moderately decreasing interest paid on
interest-bearing liabilities ("IBLs") by $4.3 million, for a net $12.6 million
decrease to net interest income.
Volumes and changes in mix offset most of the impact from the interest rate
environment and competitive pricing changes. Earning asset volume increased
$166 million, the mix of earning assets shifted towards higher yielding loans
(average loans growing to represent 72.11% of average earning assets for 1998
versus 70.32% for 1997), IBLs volume increased $96 million, and the mix of
IBLs shifted towards lower rate deposits (average interest-bearing deposits
growing to represent 86.29% of average IBLs for 1998 compared to 84.88% for
1997). Thus, the growth and composition of earning assets contributed an
increase of $15.8 million to FTE net interest income, while the growth of IBLs
cost an additional $3.7 million, for a net $12.1 million increase to net
interest income.
The net interest margin, net taxable equivalent interest income divided by
average interest-earning assets, was 3.79% for 1998, a 7 basis point decline
from 3.86% in 1997. The interest spread, or difference between the yield on
earning assets and the rate on IBLs, decreased 9 basis points to 3.20% for
1998, offset by a 2 basis point larger contribution from net free funds. The
yield on earning assets decreased 14 basis points to 7.88%, while the rate on
IBLs decreased 5 basis points to 4.68% for 1998. The sensitivity of the asset
mix to the flattening of the yield curve described above was larger than the
benefit received from the re-pricing of liabilities. The larger contribution
from net free funds resulted primarily from a $69 million increase in average
balance. Combined, these factors decreased the net interest margin by 7 basis
points in 1998.
Loans are the largest component of earning assets. On average, loans grew $297
million, or 4.3%, to $7.3 billion for 1998, and represented 72.11% of earning
assets, compared to 70.32% for 1997. A change in the total yield on the loan
portfolio generally will have the largest impact on net interest income. The
yield on total loans decreased by 21 basis points to 8.32%, after decreasing 5
basis points in 1997 versus 1996. This was strongly impacted by the high
prepayment activity seen in mortgages during 1998, competitive pricing
pressure on new loans, and the impact of the flattening yield curve on the
yields of new loan production.
Deposits are the largest component of IBLs. On average, total deposits grew
$309 million, or 3.8%, to $8.4 billion. Interest-bearing deposits on average
grew $206 million to $7.6 billion for 1998, and represented 86.29% of IBLs,
compared to 84.88% for 1997. The deposit growth allowed a lower dependence on
costlier wholesale funding. The cost of interest-bearing deposits was down 2
basis points to 4.55% for 1998, compared to 4.57% for 1997. The cost of
wholesale funding was down 19 basis points to 5.45% for 1998. Thus, the total
cost of funds decreased 5 basis points to 4.68% for 1998. The growth of net
free funds (the difference between earning assets and interest-bearing
liabilities, or the amount of funding that does not have a specific interest
cost associated with them), and the subsequent contribution from these funds,
also increased in 1998. Combined, these factors helped to offset the decline
in the interest rate spread.
13
TABLE 2: Average Balances and Interest Rates (Income and rates on a tax-
equivalent basis)
Years Ended December 31,
-------------------------------------------------------------------------------------
1998 1997 1996
-------------------------------------------------------------------------------------
Average Average Average Average Average Average
Balance Interest Rate Balance Interest Rate Balance Interest Rate
-------------------------------------------------------------------------------------
($ in Thousands)
ASSETS
Earning assets:
Loans, net of unearned
income(1)(2)(3) $ 7,255,850 $603,423 8.32% $ 6,959,018 $593,660 8.53% $6,583,572 $565,141 8.58%
Investment securities:
Taxable 2,500,470 168,623 6.74 2,725,539 184,330 6.76 2,345,489 157,070 6.70
Tax exempt(1) 237,086 16,941 7.15 180,382 13,826 7.66 178,268 13,219 7.42
Interest-bearing
deposits in other
financial institutions 31,283 1,679 5.37 15,347 779 5.08 5,630 437 7.77
Federal funds sold and
securities purchased
under agreements to
resell 37,493 1,800 4.80 16,238 999 6.16 21,750 1,267 5.82
-------------------------------------------------------------------------------------
Total earning assets $10,062,182 $792,466 7.88% $ 9,896,524 $793,594 8.02% $9,134,709 $737,134 8.07%
-------------------------------------------------------------------------------------
Allowance for possible
loan losses (92,175) (73,748) (72,168)
Cash and due from banks 246,596 229,006 245,948
Other assets 412,092 339,936 331,982
-------------------------------------------------------------------------------------
Total Assets $10,628,695 $10,391,718 $9,640,471
=====================================================================================
LIABILITIES AND
STOCKHOLDERS' EQUITY
Interest-bearing
liabilities:
Savings deposits $ 1,011,947 $ 21,640 2.14% $ 1,073,244 $ 24,396 2.27% $1,121,531 $ 27,501 2.45%
NOW deposits 724,570 10,463 1.44 712,458 11,905 1.67 673,106 11,397 1.69
Money market deposits 1,095,739 42,351 3.87 902,186 34,054 3.77 799,795 28,229 3.53
Time deposits 4,753,959 270,938 5.70 4,692,333 267,088 5.69 4,486,355 253,788 5.66
Total interest-bearing
deposits 7,586,215 345,392 4.55 7,380,221 337,443 4.57 7,080,787 320,915 4.53
Federal funds purchased
and securities sold
under agreements to
repurchase 517,344 26,174 5.06 538,097 29,046 5.40 444,676 22,976 5.17
Other short-term
borrowings 660,761 37,600 5.69 749,803 43,463 5.80 484,266 29,207 6.03
Long-term borrowings 27,055 1,862 6.88 26,929 1,685 6.26 44,799 2,824 6.30
-------------------------------------------------------------------------------------
Total interest-bearing
liabilities $ 8,791,375 $411,028 4.68% $ 8,695,050 $411,637 4.73% $8,054,528 $375,922 4.67%
-------------------------------------------------------------------------------------
Demand deposits 844,486 741,724 697,390
Accrued expenses and
other liabilities 136,409 115,085 113,373
Stockholders' equity 856,425 839,859 775,180
-------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity $10,628,695 $10,391,718 $9,640,471
=====================================================================================
Net interest income and
rate spread(1) $381,438 3.20% $381,957 3.29% $361,212 3.40%
=====================================================================================
Net yield on earning
assets(1) 3.79% 3.86% 3.95%
=====================================================================================
(1) The yield on tax exempt loans and securities is computed on a tax-
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 have been included in the average balances.
(3) Interest income includes net loan fees.
14
TABLE 3: Rate/Volume Analysis(1)
1998 Compared to 1997 1997 Compared to 1996
Increase (Decrease) Due to Increase (Decrease) Due to
-----------------------------------------------------------
Volume Rate Net Volume Rate Net
-----------------------------------------------------------
(In Thousands)
Interest income:
Loans, net of unearned
income(2) $ 24,921 $ (15,158) $ 9,763 $ 32,049 $ (3,530) $ 28,519
Investment securities:
Taxable (15,178) (529) (15,707) 25,689 1,571 27,260
Tax-exempt(2) 4,104 (989) 3,115 158 449 607
Interest-bearing
deposits in other
financial institutions 853 47 900 537 (195) 342
Federal funds sold and
securities purchased
under agreements to
resell 1,062 (261) 801 (336) 68 (268)
------------------------------------------------
Total earning assets(2) $ 15,762 $ (16,890) $ (1,128) $ 58,097 $ (1,637) $ 56,460
------------------------------------------------
Interest expense:
Savings deposits $ (1,353) $ (1,403) $ (2,756) $ (1,152) $ (1,953) $ (3,105)
NOW deposits 199 (1,641) (1,442) 659 (151) 508
Money market deposits 7,464 833 8,297 3,777 2,048 5,825
Time deposits 3,511 339 3,850 11,716 1,584 13,300
Total interest-bearing
deposits 9,821 (1,872) 7,949 15,000 1,528 16,528
Federal funds purchased
and securities sold
under agreements to
repurchase (1,094) (1,778) (2,872) 5,005 1,065 6,070
Other short-term
borrowings (5,079) (784) (5,863) 15,434 (1,178) 14,256
Long-term borrowings 8 169 177 (1,118) (21) (1,139)
------------------------------------------------
Total interest-bearing
liabilities $ 3,656 $ (4,265) $ (609) $ 34,321 $ 1,394 $ 35,715
------------------------------------------------
Net interest income(2) $ 12,106 $ (12,625) $ (519) $ 23,776 $ (3,031) $ 20,745
------------------------------------------
------------------------------------------
(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 an FTE 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 tax-equivalent basis)
1998 Average 1997 Average 1996 Average
----------------------------------------------------------------------------
% of % of % of
Earning Earning Earning
Balance Assets Rate Balance Assets Rate Balance Assets Rate
----------------------------------------------------------------------------
($ in Thousands)
Earning assets $10,062,182 100.0% 7.88% $9,896,524 100.0% 8.02% $9,134,709 100.0% 8.07%
-----------------------------------------------------------
Financed by:
Interest-bearing funds $ 8,791,375 87.4% 4.68% $8,695,050 87.9% 4.73% $8,054,528 88.2% 4.67%
Noninterest-bearing funds $ 1,270,807 12.6% $1,201,474 12.1% $1,080,181 11.8%
-----------------------------------------------------------
Total funds sources $10,062,182 100.0% 4.09% $9,896,524 100.0% 4.16% $9,134,709 100% 4.12%
-----------------------------------------------------------
-----------------------------------------------------------
Interest rate spread 3.20% 3.29% 3.40%
Contribution from net free funds .59% .57% .55%
Net interest margin 3.79% 3.86% 3.95%
-----------------------------------------------------------
-----------------------------------------------------------
Average prime rate* 8.35% 8.44% 8.27%
Average fed funds rate* 5.36% 5.46% 5.30%
Average spread 299BP 298BP 297BP
-----------------------------------------------------------
-----------------------------------------------------------
*Source: Bloomberg
15
TABLE 5: Selected Average Balances
Percent 1998 as % of 1997 as % of
1998 1997 Change Total Assets Total Assets
--------------------------------------------------
($ in Thousands)
ASSETS
Loans, net of unearned income $ 7,255,850 $ 6,959,018 4.3% 68.3% 67.0%
Investment securities
Taxable 2,500,470 2,725,539 (8.3) 23.5 26.2
Tax-exempt 237,086 180,382 31.4 2.2 1.7
Interest-bearing deposits in other financial institutions 31,283 15,347 103.8 0.3 0.1
Federal funds sold and securities purchased under
agreements to resell 37,493 16,238 130.9 0.4 0.2
--------------------------------------------------
Total earning assets 10,062,182 9,896,524 1.7 94.7 95.2
Other assets 566,513 495,194 14.4 5.3 4.8
--------------------------------------------------
Total assets $10,628,695 $10,391,718 2.3% 100.0% 100.0%
--------------------------------------------------
--------------------------------------------------
LIABILITIES & STOCKHOLDERS' EQUITY
Interest-bearing deposits $ 7,586,215 $ 7,380,221 2.8% 71.4% 71.0%
Short-term borrowings 1,178,105 1,287,900 (8.5) 11.1 12.4
Long-term borrowings 27,055 26,929 0.5 0.2 0.3
--------------------------------------------------
Total interest-bearing liabilities 8,791,375 8,695,050 1.1 82.7 83.7
Demand deposits 844,486 741,724 13.9 7.9 7.1
Accrued expenses and other liabilities 136,409 115,085 18.5 1.3 1.1
Stockholders' equity 856,425 839,859 2.0 8.1 8.1
--------------------------------------------------
Total liabilities and stockholders' equity $10,628,695 $10,391,718 2.3% 100.0% 100.0%
--------------------------------------------------
--------------------------------------------------
As the largest component of operating income, improvements in the growth of
net interest income are important to the Corporation's earnings performance.
Growth in the Corporation's net interest income has historically been the
result of growth in the volume of earning assets. Given the 1997 merger with
FFC, the Corporation's balance sheet has higher reliance on mortgage-related
products (loans and mortgage-related securities), which has increased the
importance of managing interest rate risk, particularly in the rate
environment experienced during 1998. The Corporation uses certain modeling and
analysis techniques to manage net interest income and the related interest
rate risk position (See sections "Interest Rate Risk" and "Quantitative and
Qualitative Disclosures about Market Risk"). The Corporation seeks to meet the
needs of its customers, yet provide for stability in net interest income in
the event of significant interest rate changes.
Provision for Possible Loan Losses
The provision for possible loan losses ("PFLL") in 1998 was $14.7 million. In
comparison, the PFLL for 1997 was $14.9 million, excluding the $16.8 million
additional provision to conform FFC with the policies, practices, and
procedures of the Corporation, and $13.7 million in 1996. The PFLL is a
function of the methodology used to determine the adequacy of the allowance
for loan losses. The ratio of allowance for possible loan losses to total
loans was 1.37%, up from 1.31% and 1.08% at December 31, 1997 and 1996,
respectively. See additional discussion under section, "Allowance for Possible
Loan Losses."
Noninterest Income
Noninterest income ("NII") was a strong contributor to earnings, at $168.0
million for 1998, increasing $37.4 million or 28.6% over operating NII of
$130.6 million for 1997. NII as a percent of operating income grew to 30.9%
for 1998, compared to 25.8% for 1997. The growth in this relationship was
affected particularly by the increase in mortgage banking revenues and gains
on asset sales, and the decline in net interest income, as previously
discussed under "Net Interest Income." Excluding securities gains, operating
noninterest income increased $33.0 million or 25.8%. Trust fees, mortgage
banking revenues, credit card and related fees, and gains on asset sales
accounted for the majority of the increase.
16
TABLE 6: Noninterest Income
% Change
From Prior
Years Ended December 31, Year
----------------------------------------
1998 1997 1996 1998 1997
-------- ------- -------- ----- -----
($ in Thousands)
Trust service fees $ 33,328 $28,764 $ 25,185 15.9% 14.2%
Service charges on deposit
accounts 27,464 27,909 26,004 (1.6) 7.3
Mortgage banking income 46,128 25,709 23,873 79.4 7.7
Credit card and other nondeposit
fees 17,514 15,728 13,931 11.4 12.9
Retail commission income 14,823 15,444 12,734 (4.0) 21.3
Asset sale gains, net 7,166 852 12,520 741.1 N/M
Other 14,697 13,672 12,705 7.5 7.6
----------------------------------------
Total, excluding securities gains 161,120 128,078 126,952 25.8 0.9
Investment securities gains
(losses), net (operating) 6,831 2,514 (10,678) 171.7 N/M
Merger, integration, and other
one-time charges -- (35,290) -- N/M N/M
----------------------------------------
Total noninterest income $167,951 $95,302 $116,274 76.2% (18.0)%
========================================
N/M=not meaningful
Trust service fees for 1998 were $33.3 million, a $4.6 million or 15.9%
increase over last year. The increase is a function of continued improvement
in trust business volume and growth in assets under management. Trust assets
under management totaled $4.9 billion and $4.0 billion at December 31, 1998
and 1997, respectively.
While the prepayment of mortgages and the rate environment had negative
impacts on net interest income as previously described, the volume of mortgage
activity positively impacted other income from mortgage activity. Mortgage
banking income is comprised of mainly fees related to servicing mortgage
loans, residential loan origination fees, underwriting fees, escrow waiver
fees, and the gain or loss on sale of mortgage loans to the secondary market.
Mortgage banking income was $46.1 million for 1998, an increase of $20.4
million or 79.4% over 1997, resulting from high production levels. Mortgage
loan production for resale was $2.2 billion in 1998, compared to $1.1 billion
in 1997. Servicing revenue increased by $1.7 million to $15.8 million for
1998. The increase in servicing revenue reflects the Corporation's growing
servicing portfolio, as 1-4 family residential loans serviced for others
increased to $5.2 billion, up from $5.0 billion at year-end 1997. Other
volume-related fees were also up, with underwriting fees increasing $1.9
million, origination fees increasing $978,000, and escrow waiver fees
increasing $442,000. Net gains on sales of mortgage loans accounted for the
majority of the increase, growing $15.4 million over 1997. See also Note 7 of
the notes to consolidated financial statements.
Credit card and other nondeposit fees were $17.5 million for 1998, an increase
of $1.8 million or 11.4% over 1997. Credit cards accounted for $1.2 million of
the increase. Asset sale gains increased $6.3 million over last year, with a
$2.8 million gain on the sale of a branch building in Illinois, and a $3.0
million gain on the sale of an affinity credit card portfolio.
Investment securities gains for 1998 were $6.8 million, up from $2.5 million
in operating investment gains for 1997. In the fourth quarter of 1997, the
Corporation hedged certain agency issued zero-coupon bonds held by FFB by
executing various interest rate futures contracts. In the first quarter of
1998, these contracts were closed and the zero coupon bonds were sold. As a
result, a net gain of $5.1 million was recognized. See also the discussion
under "Interest Rate Risk" and Note 5 of the notes to consolidated financial
statements.
The Corporation made a $100 million investment in bank-owned life insurance in
October 1998 which contributed $1.2 million to 1998 NII, and is included in
other NII. Despite increases in deposit balances, service charges on deposits
decreased $445,000 and retail commission income (which includes commissions
from insurance product sales, equity brokerage product sales, and the sale of
annuities ) was down $621,000.
17
The merger, integration, and other one-time charges consist of writedowns
taken to record other than temporary impairment of value of securities.
Concurrent with the 1997 consummation of the FFC merger, the Corporation
transferred all nonagency mortgage-related securities and an agency security,
with a combined amortized cost of $251.9 million, from securities HTM to
securities AFS. These mortgage-related securities were transferred to maintain
the existing interest rate risk position and credit risk policy of the
Corporation.
Concurrent with the transfer, the Corporation recorded a $32.5 million pre-tax
charge to earnings relative to one agency security with an amortized cost of
$130.6 million. Management recorded this other than temporary impairment of
value in the fourth quarter of 1997. This security is highly complex,
comprised of multiple cash flows predominated by an inverse floater tied to
LIBOR, for which stress tests indicate that the cash flows are volatile in
higher interest rate environments. The estimated fair value of this security
at the time of the other than temporary impairment charge was based on quoted
prices of instruments with similar characteristics and cash flow valuation
techniques.
Additionally, the Corporation recorded a $2.8 million pre-tax charge on other
nonagency mortgage-related securities that were transferred to securities AFS,
with an amortized cost of $18.9 million, to reflect an other than temporary
impairment of value in the fourth quarter of 1997. These securities were
subsequently sold with no additional loss in January 1998.
Noninterest Expense
Total noninterest expense ("NIE") for 1998 was $295.0 million, a $23.0 million
or 8.4% increase over 1997 operating NIE (excluding merger, integration, and
other one-time charges). Personnel expense accounts for 62% of this increase,
up $14.2 million over 1997. Mortgage servicing rights ("MSRs") amortization
and professional fees are accountable for $9.7 million of the increase, offset
partially by decreases in various other categories, particularly business
development and advertising.
TABLE 7: Noninterest Expense
% Change
From Prior
Years Ended December 31, Year
----------------------------------------
1998 1997 1996 1998 1997
-------- -------- -------- ----- -----
($ in Thousands)
Salaries and employee benefits $148,490 $134,319 $126,696 10.6% 6.0%
Occupancy 20,205 20,296 19,563 (0.4) 3.8
Equipment 13,250 12,600 12,033 5.2 4.7
Data processing 18,714 16,928 15,907 10.6 6.4
Business development and advertising 13,177 15,936 14,754 (17.3) 8.0
Stationery and supplies 6,858 5,532 5,030 24.0 10.0
FDIC expense 3,267 3,284 9,675 (0.5) (66.1)
Professional fees 9,709 6,294 5,246 54.3 20.0
Other 61,315 56,837 51,322 7.9 10.7
----------------------------------------
Total noninterest expense
(operating) 294,985 272,026 260,226 8.4 4.5
Merger, integration, and other one-
time charges -- 51,622 33,005 N/M N/M
----------------------------------------
Total noninterest expense $294,985 $323,648 $293,231 (8.9)% 10.4%
========================================
N/M=not meaningful
Salaries and employee benefits increased $14.2 million or 10.6% compared to
1997. This category continues to be the largest component of NIE, representing
50.3%, 49.4%, and 48.7% of operating expenses in 1998, 1997, and 1996,
respectively. The increase in 1998 was comprised of higher salary expenses of
$11.8 million and higher fringe benefit costs of $2.4 million. The increase in
salary expense reflects base merit pay increases, variable pay increases
(commissions/incentives), transitional overlapping positions as support
functions were being centralized, and new positions added. The fringe benefit
increase is attributable to FICA taxes, pension and profit sharing expenses.
These fringe benefit increases were a result of higher levels of base
compensation. Full-time equivalent employees at December 31, 1998 were 3,965
18
compared to 3,679 at December 31, 1997, of which 130 were from the acquisition
of Citizens. As the Corporation continues to expand to take advantage of
business opportunities and the related revenues, management will continue to
review its significant investment in salaries and employee benefit expenses.
Professional fees were up $3.4 million primarily in due to Year 2000 efforts
and consulting assistance with the FFB conversion. MSRs amortization, included
in other expense, increased $6.3 million over 1997, a function of MSR
valuation in a high prepayment environment, and of the volume of mortgage
production and secondary market activity. See also Note 7 of the notes to
consolidated financial statements.
Increases in data processing expense and stationery and supplies were
principally the result of the fourth quarter 1998 conversion of FFB systems
and FFB branches into the Corporation's affiliates.
Income Taxes
Income tax expense was $75.9 million, down $1.9 million from 1997 income tax
expense, excluding tax effects of merger, integration and other one-time
charges. The Corporation's effective tax rate (operating income tax expense
divided by operating income before taxes) was 32.6% in 1998 compared to 39.4%
in 1997.
BALANCE SHEET ANALYSIS
Loans
Total loans, including loans held for sale, increased by $251 million, or
3.5%, to $7.4 billion at the end of 1998. The December 1998 acquisition of
Citizens accounted for $105 million of the loan growth. Increases were
experienced primarily in real estate lending, with a $125 million increase in
real estate construction, $51 million increase in mortgage loans held for
sale, $111 million increase in commercial real estate and a net increase of
$26 million in residential mortgages (conventional home loans, home equity
lines and second mortgages).
TABLE 8: Loan Composition
As of December 31,
------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
---------------- ---------------- ---------------- ---------------- ----------------
% of % of % of % of % of
Amount Total Amount Total Amount Total Amount Total Amount Total
---------- ----- ---------- ----- ---------- ----- ---------- ----- ---------- -----
($ in Thousands)
Commercial, financial,
and agricultural $ 962,208 13% $ 986,839 14% $ 841,145 13% $ 801,004 13% $ 710,285 12%
Real estate--
construction 461,157 6 335,978 5 235,478 3 217,223 3 199,376 3
Real estate--mortgage 5,244,440 71 5,056,238 70 4,796,457 72 4,569,362 71 4,278,825 71
Installment loans to
individuals 750,831 10 793,424 11 813,875 12 821,351 13 801,302 14
Lease financing 19,231 -- 14,072 -- 10,449 -- 9,743 -- 6,176 --
----------------------------------------------------------------------------------------
Total loans (including
loans held for sale) $7,437,867 100% $7,186,551 100% $6,697,404 100% $6,418,683 100% $5,995,964 100%
----------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------
Real estate-mortgage loans totaled $5.2 billion at the end of 1998 and $5.1
billion at the end of 1997. Loans in this classification in 1998 include $3.7
billion of loans secured by 1- to 4-family residential properties. Residential
real estate loans consist of conventional home mortgages, home equity lines,
and second mortgages. Loans of this type are primarily made to borrowers in
Wisconsin and Illinois. Residential real estate loans generally limit the
maximum loan to 75%-80% of collateral value.
The real estate-mortgage classification also includes commercial real estate,
i.e., loans secured by multifamily, nonfarm, and nonresidential real estate
properties. Loans in this group totaled $1.4 billion at December 31, 1998, up
$111.4 million or 8.7% over last year. Commercial real estate loans involve
borrower characteristics similar to those discussed below for commercial loans
and real estate-construction projects. Loans of this type are mainly for
business and industrial properties, multi-family properties, community purpose
properties, and similar properties. Loans are primarily made to borrowers in
Wisconsin and Illinois. Credit risk is managed in a similar manner to
commercial loans and real estate
19
construction by employing sound underwriting guidelines, lending to borrowers
in known markets and businesses, and formally reviewing the borrower's
financial soundness and relationship on an ongoing basis.
Commercial, financial, and agricultural loans were $962.2 million at the end
of 1998, down $24.6 million since year-end 1997, and comprising 13% of total
loans outstanding, down from 14% at the end of 1997. 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
broad range of industries. Borrowers are primarily concentrated in Wisconsin
and Illinois. The credit risk related to commercial loans is largely
influenced by general economic conditions and the resulting impact on a
borrower's operations. Within the commercial, financial, and agricultural
classification at December 31, 1998, loans to finance agricultural production
total $32.4 million or 0.4% of total loans.
An active credit risk management process is used for commercial loans to
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. 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, 1998, no
concentrations existed in the Corporation's portfolio in excess of 10% of
total loans, or $744 million.
Real estate-construction loans grew $125 million or 37% to $461 million,
representing 6% of the total loan portfolio at the end of 1998 compared to
$336 million, or 5% at the end of 1997. Loans in this classification are
primarily short-term interim loans that provide financing for the acquisition
or development of commercial real estate, such as multi-family or other
commercial development projects. Real estate construction loans are made to
developers and project managers who are well known to the Corporation, have
prior successful project experience, and are well capitalized. Projects
undertaken by these developers are carefully reviewed by the Corporation to
ensure that they are economically viable. Loans of this type are primarily
made in markets in Wisconsin and Illinois in which the Corporation has a
thorough knowledge of the local market economy. The credit risk associated
with real estate construction loans is generally confined to specific
geographic areas. The Corporation controls the credit risk on these types of
loans by making loans in familiar markets to developers, underwriting the
loans to meet the requirements of institutional investors in the secondary
market, reviewing the merits of individual projects, controlling loan
structure, and monitoring project progress and construction advances.
TABLE 9: Loan Maturity Distribution and Interest Rate Sensitivity(1)
Maturity(2)
---------------------------------------
Within 1-5 After
December 31, 1998 1 Year Years 5 Years Total
- ----------------- -------- -------- ------- ----------
($ in Thousands)
Commercial, financial, and
agricultural $692,271 $242,158 $27,779 $ 962,208
Real estate-construction 251,120 154,388 55,649 461,157
--------------------------
Total $943,391 $396,546 $83,428 $1,423,365
--------------------------
--------------------------
Fixed rate $299,364 $377,283 $79,382 $ 756,029
Floating or adjustable rate 644,027 19,263 4,046 667,336
--------------------------
Total $943,391 $396,546 $83,428 $1,423,365
--------------------------
--------------------------
Percent 66% 28% 6% 100%
(1) Based upon scheduled principal repayments.
(2) Demand loans, past due loans, and overdrafts are reported in the "Within 1
Year" category.
20
Installment loans to individuals totaled $751 million, down $42 million, or 5%
compared to 1997. The decline was principally in credit cards, impacted in
part by a 1998 sale of approximately $24 million of an affinity credit card
portfolio. Installment loans include short-term installment loans, direct and
indirect automobile loans, recreational vehicle loans, credit card loans,
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. Loans are made to individual borrowers
located primarily in Wisconsin and Illinois. Credit risk for these types of
loans is generally greatly influenced by general economic conditions, the
characteristics of individual borrowers and the nature of the loan collateral.
Credit risk is primarily controlled by reviewing the creditworthiness of the
borrowers as well as taking appropriate collateral and guaranty positions on
such loans.
Factors that are critical to managing overall credit quality are sound loan
underwriting and administration, systematic monitoring of existing loans and
commitments, effective loan review on an ongoing basis, early identification
of potential problems, an adequate allowance for possible loan losses, and
sound nonaccrual and charge-off policies.
Allowance for Possible Loan Losses
The investment and loan portfolios are the Corporation's primary interest
earning assets. While the investment portfolio is structured with minimum
credit exposure to the Corporation, the loan portfolio is the primary asset
subject to credit risk. Credit risk is controlled and monitored through the
use of lending standards, thorough review of potential borrowers, and on-going
review of loan payment performance. Active asset quality administration,
including early problem loan identification and timely resolution of problems,
further ensures appropriate management of credit risk and minimization of loan
losses. Credit risk management for each loan type is discussed briefly in the
section entitled "Loans."
As of December 31, 1998, the allowance for possible loan losses ("AFLL") grew
by 7.5% to $99.7 million, compared to $92.7 million last year. As of year-end
1998, the AFLL to total loans was 1.37% and covered 185% of nonperforming
loans, compared to 1.31% and 270%, respectively, at December 31, 1997. The
AFLL at year end 1997 was increased by a $16.8 million one-time charge related
to the merger with FFC to conform the level of the allowance to the policies,
practices and procedures of the Corporation. Tables 10 and 11 provide
additional information regarding activity in the AFLL.
21
TABLE 10: Loan Loss Experience
Years Ended December 31,
----------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
($ in Thousands)
AFLL at beginning of
year $ 92,731 $ 71,767 $ 68,560 $ 65,774 $ 63,415
Balance related to
acquisitions 3,636 728 3,511 -- 3,366
Provision for possible
loan losses 14,740 31,668 13,695 14,029 9,035
Loans charged off:
Commercial, financial,
and agricultural 3,533 1,327 2,916 3,356 2,593
Real estate--
construction 202 600 193 191 89
Real estate--mortgage 3,256 3,222 2,813 3,099 4,224
Installment loans to
individuals 9,839 9,900 11,693 9,221 9,038
Lease financing 209 -- 1 5 18
---------------------------------------------------
Total loans charged off 17,039 15,049 17,616 15,872 15,962
Recoveries of loans
previously charged off:
Commercial, financial,
and agricultural 2,384 513 1,255 1,856 3,086
Real estate--
construction -- -- 3 70 --
Real estate--mortgage 1,582 1,312 837 931 1,151
Installment loans to
individuals 1,641 1,792 1,514 1,764 1,676
Lease financing 2 -- 8 8 7
---------------------------------------------------
Total recoveries 5,609 3,617 3,617 4,629 5,920
---------------------------------------------------
Net loans charged off
(NCOs) 11,430 11,432 13,999 11,243 10,042
---------------------------------------------------
AFLL at end of year $ 99,677 $ 92,731 $ 71,767 $ 68,560 $ 65,774
==========================================================
Average loans
outstanding $7,255,850 $6,959,018 $6,583,572 $6,157,655 $5,636,601
Ratio of AFLL to NCOs 8.7 8.1 5.1 6.1 6.5
Ratio of NCOs to average
loans outstanding .16% .16% .21% .18% .18%
Ratio of AFLL to total
loans at end of period 1.37% 1.31% 1.08% 1.12% 1.16%
==========================================================
The AFLL represents management's estimate of an amount adequate to provide for
potential losses inherent in the loan portfolio. Management's evaluation of
the adequacy of the AFLL 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 factors which could affect potential credit
losses, such as Year 2000 issues relating to borrowers.
In general, the increase in the AFLL is a function of a number of factors.
First, while total loan growth was moderate (2.8% increase from year-end 1997
to 1998), there was stronger growth in commercial real estate and real estate
construction loans which carry greater inherent credit risk (described under
section "Loans"). Also, nonperforming loans have increased (further discussed
under section "Nonperforming Loans, Potential Problem Loans, and Other Real
Estate Owned"). Nonperforming loans are considered a key indicator of future
loan losses. Loans classified as potential problem loans have increased
slightly over last year. Loans under watch have increased over last year, in
part given consideration of possible Year 2000 issues of significant
customers. Net charge-offs have remained unchanged ($11.4 million for 1998 and
1997). Finally, $3.6 million of AFLL was acquired in the December 1998
Citizens acquisition.
The allocation of the Corporation's AFLL for the last five years is shown in
Table 11. The allocation methodology applied by the Corporation, designed to
assess the adequacy of the AFLL, 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 and historical
losses on each portfolio category. The indirect risk in the form of off-
balance sheet unfunded commitments is also taken into consideration. For 1998,
22
estimation methods and assumptions included consideration of Year 2000 issues
on significant customers. Management continues to target and maintain the AFLL
equal to the allocation methodology plus an unallocated portion, as determined
by economic conditions and emerging systemic factors, such as Year 2000
issues, on the Corporation's borrowers. Management allocates AFLL for credit
losses by pools of risk. The business loan (commercial mortgage; commercial,
industrial and agricultural; leases; and real estate construction) allocation
is based on a quarterly review of individual loans, loan types and industries.
The retail loan (residential mortgage, home equity, and installment)
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 agencies. Loss
factors for non-criticized loan categories are based primarily on historical
loan loss experience and peer group statistics. For 1998, increases were made
to the AFLL allocation for credit card and mobile homes based upon a
significantly higher risk profile than other consumer loan categories, and
increases in commercial categories were made given the growth in these loan
segments and Year 2000 issues. The mechanism used to address differences
between estimated and actual loan loss experience includes review of recent
nonperforming loan trends, underwriting trends and external factors.
Management believes the AFLL to be adequate at December 31, 1998. While
management uses available information to recognize losses on loans, future
adjustments to the AFLL 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 AFLL. Such agencies may require that changes in the AFLL be
recognized when their credit evaluations differ from those of management,
based on their judgments about information available to them at the time of
their examination.
TABLE 11: Allocation of the Allowance for Possible Loan Losses
As of December 31,
---------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
(In Thousands)
Commercial, financial and agricultural $25,385 $33,682 $27,943 $22,753 $21,279
Real estate--construction 3,369 2,016 1,047 929 1,133
Real estate--mortgage 40,216 30,360 19,116 22,331 23,254
Installment loans to individuals 16,924 16,870 16,239 14,848 14,896
Lease financing 426 493 530 460 331
Unallocated 13,357 9,310 6,892 7,239 4,881
--------------------------------------------
Total $99,677 $92,731 $71,767 $68,560 $65,774
--------------------------------------------
--------------------------------------------
The provision for possible loan losses ("PFLL") in 1998 was $14.7 million. In
comparison, the PFLL for 1997 was $14.9 million, excluding the $16.8 million
additional provision ("additional provision") to conform FFC with the
policies, practices and procedures of the Corporation, and $13.7 million in
1996. The PFLL exceeded net charge-offs by $3.3 million in 1998 and $3.4
million in 1997 (excluding the additional provision).
Net charge-offs were $11.4 million, or 0.16% of average loans, for both 1998
and 1997, and $14.0 million or 0.21% of average loans for 1996. Gross charge-
offs and gross recoveries for 1998 were both up by $2.0 million, principally
the result of a large commercial credit that was charged off and subsequently
recovered during 1998. Loans charged off are subject to continuous review and
specific efforts are taken to achieve maximum recovery of principal, accrued
interest, and related expenses.
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 embodied through the ongoing
monitoring and reviewing of all pools of risk in the loan portfolio to ensure
that all problem loans are identified quickly and the risk of loss is
minimized.
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.
Such student loans were approximately $13 million at December 31, 1998.
23
Loans are generally placed on nonaccrual status when contractually past due 90
days or more as to interest or principal payments. Additionally, whenever
management becomes aware of facts or circumstances that may adversely impact
on the collectibility of principal or interest on loans, it is management's
practice to place such loans on nonaccrual status immediately, rather than
delaying such action until the loans become 90 days past due. Previously
accrued and uncollected interest on such loans is reversed, amortization of
related loan fees is suspended, and income is recorded only to the extent that
interest payments are subsequently received in cash and a determination has
been made that the principal balance of the loan is collectible. If
collectibility of the principal is in doubt, payments received are applied to
loan principal.
Loans past due 90 days or more but still accruing interest are also included
in nonperforming loans. Loans past due 90 days or more but still accruing are
classified as such where the underlying loans are both well secured (the
collateral value is sufficient to cover principal and accrued interest) and in
the process of collection. Also included in nonperforming loans are
"restructured" loans. Restructured loans involve the granting of some
concession to the borrower involving the modification of terms of the loan,
such as changes in payment schedule or interest rate.
TABLE 12: Nonperforming Loans and Other Real Estate Owned
December 31,
-------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
($ in Thousands)
Nonaccrual loans $48,150 $32,415 $32,287 $28,787 $28,025
Accruing loans past due 90 days
or more 5,252 1,324 1,801 1,320 1,484
Restructured loans 485 558 534 1,704 1,888
-------------------------------------------
Total nonperforming loans $53,887 $34,297 $34,622 $31,811 $31,397
===========================================
Other real estate owned $ 6,025 $ 2,067 $ 1,939 $ 4,852 $ 6,172
===========================================
Ratio of nonperforming loans to
total loans at period end .74% .48% .52% .50% .53%
Ratio of the allowance for
possible loan losses to
nonperforming loans at period end 185% 270% 207% 216% 209%
===========================================
Nonperforming loans at December 31, 1998, were $53.9 million, an increase of
$19.6 million from December 31, 1997. The ratio of nonperforming loans to
total loans at the end of 1997 was .74%, as compared to .48% and .52% at
December 31, 1997 and 1996, respectively. Nonaccrual loans account for $15.7
million of the increase in nonperforming loans, of which $3.3 million was
acquired with the December 1998 acquisition of Citizens. Real estate
nonaccrual loans accounted for $10.3 million of the increase (of which $7.0
million was residential real estate), while commercial and industrial loan
nonaccruals increased by $4.0 million. The Corporation's AFLL to nonperforming
loans was 185% at year-end 1998, down from 270% and 207% at year ends 1997 and
1996, respectively.
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.
24
TABLE 13: Foregone Loan Interest
Years Ended December 31,
----------------------------
1998 1997 1996
-------- -------- --------
(In Thousands)
Interest income in
accordance with
original terms $ 5,046 $ 2,332 $ 2,764
Interest income
recognized (2,884) (1,215) (1,086)
----------------------------
Reduction in interest
income $ 2,162 $ 1,117 $ 1,678
============================
Potential problem loans are loans where there are doubts as to the ability of
the borrower to comply with present repayment terms. The decision of
management to place loans in this category does not necessarily indicate that
the Corporation expects losses to occur, but that management recognizes that a
higher degree of risk is associated with these performing loans.
At December 31, 1998, potential problem loans totaled $50.2 million. 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.
Management does not presently expect significant losses from credits in the
potential problem loan category.
Other real estate owned increased to $6.0 million at December 31, 1998,
compared to $2.1 million and $1.9 million at year ends 1997 and 1996,
respectively, in part due to the fourth quarter 1998 classification of certain
bank properties carried as real estate owned. Management actively seeks to
ensure properties held are administered to minimize the Corporation's risk of
loss.
Investment Securities Portfolio
The investment securities portfolio is intended to provide the Corporation
with adequate liquidity, flexibility in asset/liability management and a
source of stable income. Investment securities, at amortized cost, including
those HTM and AFS, totaled $2.9 billion at December 31, 1998 and 1997.
TABLE 14: Investment Securities Portfolio
Years Ended December 31,
--------------------------------
1998 1997 1996
---------- ---------- ----------
(In Thousands)
Investment Securities Held to Maturity (HTM):
U.S. Treasury securities $ -- $ 498 $ 4,204
Federal agency securities 66,204 146,259 143,927
Obligations of states and political
subdivisions 153,663 183,286 195,860
Mortgage-related securities 262,111 361,298 673,990
Other securities (debt) 68,797 81,183 61,768
--------------------------------
Total amortized cost $ 550,775 $ 772,524 $1,079,749
================================
Total fair market value $ 562,940 $ 782,240 $1,074,412
================================
Investment Securities Available for Sale
(AFS):
U.S. Treasury securities $ 68,488 $ 109,200 $ 149,314
Federal agency securities 248,697 324,708 326,049
Obligations of state and political
subdivisions 217,153 14,312 --
Mortgage-related securities 1,625,403 1,536,134 1,057,992
Other securities (debt and equity) 160,499 142,081 127,787
--------------------------------
Total amortized cost $2,320,240 $2,126,435 $1,661,142
================================
Total fair market value $2,356,960 $2,167,694 $1,674,189
================================
Mortgage-related securities are subject to inherent risks based upon the
future performance of the underlying collateral (i.e. mortgage loans) for
these securities. Among these risks are prepayment risk and interest rate
risk. Should general interest rate levels decline, the mortgage-related
securities portfolio would be subject to 1) prepayments as borrowers typically
would seek to obtain financing at lower rates, 2) a
25
decline in interest income received on adjustable-rate issuances, and 3) an
increase in the fair value of fixed rate issuances. Conversely, should general
interest rate levels increase, the mortgage-related securities portfolio would
be subject to 1) a longer term to maturity as borrowers would be less likely
to prepay their loans, 2) an increase in interest income received on
adjustable rate issuances, 3) a decline in the fair value of fixed rate
issuances, and 4) a decline in fair value of adjustable rate issuances to an
extent dependent upon the level of interest rate increases, the time period to
the next interest rate repricing date for the individual security and the
applicable periodic (annual and/or lifetime) cap which could limit the degree
to which the individual security could reprice within a given time period.
The mortgage-related security portfolio includes both U.S. Government agency
issuances and nonagency issuances. Unlike U.S. Government agency issued
mortgage-related securities which include a guarantee of principal and
interest payments on the underlying collateral, nonagency securities are
generally structured with a senior ownership position and subordinate
ownership position(s) providing credit support for the senior position. The
structure of nonagency mortgage-related securities may expose the Corporation
to credit risk in addition to interest rate risk and prepayment risk as
discussed above. Nonagency mortgage-related securities AFS were $102.7 million
and $179.8 million at December 31, 1998 and 1997, respectively.
Management monitors the major factors affecting the performance of nonagency
mortgage-related securities including, 1) delinquencies, foreclosures,
repossessions and recoveries relative to the underlying mortgage loans
collateralizing each security, 2) the level of available subordination or
other credit enhancements, 3) the competence of the servicer of the underlying
mortgage portfolio, and 4) the rating assigned to each security by independent
national rating agencies.
Concurrent with the 1997 consummation of the FFC merger, the Corporation
transferred all nonagency mortgage-related securities and an agency security,
with a combined amortized cost of $251.9 million from securities HTM to
securities AFS. These mortgage-related securities were transferred to maintain
the existing interest rate risk position and credit risk policy of the
Corporation.
Concurrent with the transfer, the Corporation recorded a $32.5 million pre-tax
charge to earnings relative to one agency security with an amortized cost of
$130.6 million. Management recorded this other than temporary impairment of
value in the fourth quarter of 1997. This security is highly complex,
comprised of multiple cash flows predominated by an inverse floater tied to
LIBOR, for which stress tests indicate that the cash flows are volatile in
higher interest rate environments. The estimated fair value of this security
at the time of the other than temporary impairment charge was based on quoted
prices of instruments with similar characteristics and cash flow valuation
techniques.
Additionally, the Corporation recorded a $2.8 million pre-tax charge on other
mortgage-related securities that were transferred to available for sale, with
an amortized cost of $18.9 million, to reflect an other than temporary
impairment of value. These securities were subsequently sold with no
additional loss in January 1998.
In November 1997, the Corporation hedged certain agency issued zero-coupon
bonds held by FFC, with a carrying value of $37.2 million and a market value
of $41.6 million, by executing various interest rate futures contracts. These
contracts had a notional value of $70.5 million and would mature in March
1998. Subsequently, in January 1998, the futures contracts were closed and the
zero-coupon bonds were sold. A net gain of $