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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the fiscal year ended December 31, 1998 Commission file number 333-60313
BANK ONE CORPORATION
(Exact name of registrant as specified in its charter)
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Delaware 31-0738296
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One First National Plaza
Chicago, Illinois 60670
(Address of principal executive offices including zip code)
Registrant's telephone number, including area code: (312) 732-4000
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on which Registered
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Common Stock, $0.01 par value New York Stock Exchange
Chicago Stock Exchange
Preferred Stock with Cumulative and Adjustable
Dividends, Series B ($100 stated value), $0.01 par
value New York Stock Exchange
Preferred Stock with Cumulative and Adjustable
Dividends, Series C ($100 stated value), $0.01 par
value New York Stock Exchange
7 1/2% Preferred Purchase Units New York Stock Exchange
7 1/4% Subordinated Debentures Due 2004 New York Stock Exchange
8.10% Subordinated Notes Due 2002 New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None.
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, 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 is not contained herein, and will not be contained, to
the best of the 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. [ ]
The aggregate market value of voting stock held by nonaffiliates of the
Corporation at December 31, 1998, was approximately $60,200,000,000 (based on
the average price of such stock on February 26, 1999). At December 31, 1998,
the Corporation had 1,177,310,348 shares of its Common Stock, $0.01 par value,
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Corporation's definitive proxy statement dated March 30,
1999, are incorporated by reference into Part III hereof.
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BANK ONE CORPORATION
Form 10-K Index
Page
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PART I
Item 1. Business..................................................... 2
Description of Business...................................... 2
Employees.................................................... 5
Competition.................................................. 5
Monetary Policy and Economic Controls........................ 5
Supervision and Regulation................................... 5
Financial Review............................................. 10
Item 2. Properties................................................... 87
Item 3. Legal Proceedings............................................ 87
Item 4. Submission of Matters to a Vote of Security Holders.......... 87
Executive Officers of the Registrant..................................... 87
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters..................................................... 88
Item 6. Selected Financial Data...................................... 88
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 88
Item 7A. Quantitative and Qualitative Disclosures About Market Risk... 88
Item 8. Financial Statements and Supplementary Data.................. 88
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 89
PART III
Item 10. Directors and Executive Officers of the Registrant........... 89
Item 11. Executive Compensation....................................... 89
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 89
Item 13. Certain Relationships and Related Transactions............... 89
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 89
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PART I
Item 1. Business
DESCRIPTION OF BUSINESS
General
BANK ONE CORPORATION (the "Corporation") is a multibank holding company
registered under the Bank Holding Company Act of 1956 (the "BHC Act"), and is
headquartered in Chicago, Illinois. The Corporation was incorporated in
Delaware on April 9, 1998, to effect the merger (the "Merger") of BANC ONE
CORPORATION ("BANC ONE"), an Ohio corporation and registered bank holding
company, and First Chicago NBD Corporation ("FCN"), a Delaware corporation and
registered bank holding company. The Merger was effected in two steps. First,
BANC ONE reincorporated in Delaware by merging with and into the Corporation,
its wholly owned subsidiary; immediately following that merger, FCN merged
with and into the Corporation. The Merger became effective on October 2, 1998.
Prior to the Merger, BANC ONE was a registered bank holding company that had
been incorporated in the State of Delaware in 1968 and reincorporated in Ohio
in 1989. FCN was the corporation resulting from the merger, effective December
1, 1995, of First Chicago Corporation, a Delaware corporation and registered
bank holding company, with and into NBD Bancorp, Inc., a Delaware corporation
and registered bank holding company. FCN had been incorporated under the laws
of the State of Delaware in 1972.
Through its bank subsidiaries (collectively, the "Banks"), the Corporation
provides domestic retail banking, finance and credit card services; worldwide
corporate and institutional banking services; and trust and investment
management services. The Corporation operates banking offices in Arizona,
Colorado, Florida, Illinois, Indiana, Kentucky, Louisiana, Michigan, Ohio,
Oklahoma, Texas, Utah, West Virginia and Wisconsin. The Corporation also owns
nonbank subsidiaries that engage in businesses related to banking and finance,
including credit card and merchant processing, consumer and education finance,
mortgage lending and servicing, insurance, venture capital, investment and
merchant banking, trust, brokerage, investment management, leasing, community
development and data processing.
Like its predecessors, the Corporation continually evaluates its business
operations and organizational structures, and routinely explores opportunities
to (i) acquire financial institutions and other financial services-related
businesses or assets, and (ii) enter into strategic alliances to expand the
scope of its services and its customer base. When consistent with its overall
business strategy, the Corporation also will sell assets or exit certain
businesses or markets. In June 1998, BANC ONE completed its acquisition of
First Commerce Corporation ("First Commerce"), a Louisiana-based multi-bank
holding company with total assets of approximately $9.3 billion. In December
1998, through a joint venture with Boston EquiServe Limited Partnership, the
Corporation formed EquiServe Limited Partnership, the largest provider of
corporate shareholder services in the United States. Pursuant to the
Corporation's strategy, begun in 1997, to streamline its retail delivery
structure (the "Retail Delivery Initiative"), the Corporation sold 117 banking
centers in 1998 and has entered into agreements to sell 22 banking centers
during the first half of 1999. Additional banking center sales will be
considered in the future. In addition, as a condition of regulatory approval
of the First Commerce acquisition, in September 1998, the Corporation sold 25
Louisiana banking centers. Similarly, as a condition of regulatory approval of
the Merger, the Corporation announced the sale of 51 banking centers in six
local banking markets in Indiana. That sale, to Union Planters Corporation,
was completed during the first quarter of 1999.
Lines of Business
The Corporation engages primarily in five lines of business--Commercial
Banking, Credit Card, Retail Banking, Finance One and Investment Management--
as well as proprietary investment activities.
Commercial Banking
The Commercial Banking Group provides a broad range of corporate financial
products to large and mid-sized corporations, financial institutions,
governmental entities, nonprofit organizations and private banking
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customers. The Corporation is one of the leading commercial banking
organizations in the United States, ranking as the number-one commercial and
middle market bank in the Midwest, and the number-three commercial bank in the
United States.
One of the Corporation's subsidiaries, First Chicago Capital Markets, Inc.,
is a primary government bond dealer and is principally responsible for
syndicating bank loans and for activities in the following types of
securities: corporate, asset backed, municipal and United States government
agency securities. Activities include
trading, sales, underwriting, research, and maintaining an active secondary
market with national sales distribution.
Through a number of its subsidiaries, the Corporation also develops, markets
and delivers cash management, operating, clearing and other noncredit products
and services, both overseas and domestically. These include money transfer,
collection, disbursement, documentary, remittance, trade finance, real estate
and lease financing, and international securities clearing services.
The Commercial Banking Group's customers include large and midsized
companies that have greater than $5 million in annual sales and are located in
various geographic segments throughout the United States and the world.
Commercial Banking specializes in creating custom banking solutions to meet
the unique financial needs of companies within the financial services, health
care, retailing, communications, energy and utilities, and auto industries.
Commercial Banking increasingly serves companies through its international
product delivery system, which provides them with the tools they need to
prosper in global markets. This global approach to relationship management and
customer service relies on a network of offices, branches, subsidiaries,
affiliates and representative offices across the United States and in 13
locations abroad.
The Commercial Banking Group also provides specialized financial solutions
and integrated wealth- management strategies to high net worth individuals,
their families and their businesses. Private banking services range from
traditional banking and credit services to custom-tailored financial planning,
tax counseling, investment advisory services, estate planning, and trust and
custody services.
Credit Card
The Corporation's Credit Card operations extend nationwide and to Canada and
the United Kingdom. A member of both the Visa(R) and MasterCard(R)
associations, the Corporation issues credit cards primarily through its
subsidiary, First USA Bank, N.A. ("First USA"). At December 31, 1998, Credit
Card had more than 56 million cardmembers; with more than $70 billion in
managed credit card receivables, the Corporation was the nation's largest
Visa(R) and MasterCard(R) lender.
Retail Banking
The Retail Group provides depository and related bank and financial products
and services to individuals and small business customers in 14 states. The
Group operates about 2,000 banking centers, providing a full range of consumer
loan, deposit and other credit-related products. In addition, services are
provided through 24-hour telephone banking centers, a nationwide network of
automated teller machines ("ATMs") and online banking. In 1998, the Retail
Group announced a strategic alliance with the Internet portal, Excite(R), to
expand its existing online banking services. The Corporation is the third
largest provider of loans to small businesses in the nation, and also provides
small businesses with credit, deposit and cash management services. Through
its consumer lending unit, the Retail Group delivers consumer loan products,
including home equity loans and lines. Home equity loans have become one of
the fastest-growing forms of personal credit in the United States, and the
Corporation is a major provider through services such as Bank One Loan-By-
Phone(R), which provides expedited approval of creditworthy applications. The
ONE Card, issued through the Retail Group, is one of the country's leading
debit cards for individuals, with 4.2 million cards in circulation.
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Finance One
The Finance One Group engages in consumer finance, mortgage lending, and
financing through third-party intermediaries, such as automobile dealers,
mortgage brokers and university financial aid offices, and does business in
all 50 states. The Group is organized into two divisions, consumer financial
services and indirect financial services.
The Consumer Financial Services Division includes Banc One Financial
Services, Inc., a consumer finance company that specializes in real estate-
secured debt consolidation loans, and Banc One Mortgage Corporation, which
originates residential first mortgages. Other businesses within this division
include broker-originated home equity loans, home improvement loans, student
loans and tax refund anticipation loans.
The Indirect Financial Services Division provides automobile loans and
leases, and recreational vehicle and marine loans, to consumers through a
nationwide network of dealers. The division also provides wholesale services
to the dealers, principally floor plan (inventory) financing and commercial
real estate loans.
Investment Management
The Investment Management Group provides investment and insurance services
to individuals and institutions. Asset management and financial planning are
among the Group's core activities. Assets are managed by the Group's
investment advisory firm, Banc One Investment Advisors Corporation, a
registered investment advisor. The Group also provides investment-related
services, including retirement and custody services, securities lending,
mortgage services and global corporate trust. The Group's insurance companies
make available a range of insurance products, such as credit insurance,
selected life insurance products, and annuities. The Group ranks as one of the
nation's top 30 asset managers, with more than $120 billion in assets under
management. After the investment management businesses of BANC ONE and FCN are
integrated, the Group will advise one of the 25 largest mutual fund complexes
in the country, the One Group Mutual Funds.
Proprietary Investments
Primarily through certain of its nonbank subsidiaries, the Corporation
engages in various noncustomer-oriented investment activities, including the
Corporate Investments growth equity, tax-oriented and value-oriented
portfolios.
Growth equity investments include various forms of equity funding for
acquisitions, management buyouts, growing businesses and small business
ventures. Tax-oriented investment activities include investing in and advising
on leases for commercial aircraft, and major industrial and power production
facilities and equipment. Investments also are made in alternative energy
programs and affordable housing projects qualifying for tax credits under
federal tax laws. Value-oriented investments include positions in value
investment markets, such as loans, trade claims and securities of distressed
companies. In addition, such activities include investing in securities of
companies whose debt trades below full face value of the claim, below-
investment-grade tranches of commercial mortgage-backed securities, asset-
backed securities, subordinated debt and other securities.
Risk Management Governance
The Corporation's risk management processes are governed by a decision-
making hierarchy that elevates key strategic and policy decisions to higher
authorities. The highest decision-making committee within the hierarchy
(excluding committees of the Board of Directors) is the Executive Risk
Management Committee, which determines the Corporation's risk/return profiles.
This committee includes, among others, the Chairman, the Chief Executive
Officer, the Vice Chairmen, the Chief Risk Management Officer and the Chief
Financial Officer.
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The Executive Risk Management Committee is supported by the Commercial
Banking Risk Management Committee, which approves material product risk and
portfolio management initiatives for large corporate and middle market
businesses; the Consumer Banking Risk Management Committee, which serves in a
similar role for consumer lines of business; the Market and Investment Risk
Management Committee, which approves policies for trading, investment and
capital markets activities; and the Operating Risk Forum, which assesses
operating risk issues for the Corporation.
EMPLOYEES
As of December 31, 1998, the Corporation and its subsidiaries had 91,310
employees on a full-time-equivalent basis.
COMPETITION
The Corporation and its subsidiaries face active competition in all of their
principal activities, not only from commercial banks, but also from savings
and loan associations, credit unions, finance companies, mortgage companies,
leasing companies, insurance companies, mutual funds, securities brokers and
dealers, other domestic and foreign financial institutions, and various
nonfinancial institutions.
MONETARY POLICY AND ECONOMIC CONTROLS
The earnings of the Banks, and therefore the earnings of the Corporation,
are affected by the policies of regulatory authorities, including the Board of
Governors of the Federal Reserve System (the "Federal Reserve Board"). An
important function of the Federal Reserve Board is to promote orderly economic
growth by influencing interest rates and the supply of money and credit. Among
the methods that have been used to achieve this objective are open market
operations in United States government securities, changes in the discount
rate for member bank borrowings, and changes in reserve requirements against
bank deposits. These methods are used in varying combinations to influence
overall growth and distribution of bank loans, investments and deposits,
interest rates on loans and securities, and rates paid for deposits.
The Federal Reserve Board's monetary policies strongly influence the
behavior of interest rates and can have a significant effect on the operating
results of commercial banks. Global financial market turmoil in 1998
contributed to the decision of the Federal Reserve Board to reduce short-term
interest rates somewhat toward the end of the year.
The effects of the various Federal Reserve Board policies on the future
business and earnings of the Corporation cannot be predicted. Other economic
controls also have affected the Corporation's operations in the past. The
Corporation cannot predict the nature or extent of any effects that possible
future governmental controls or legislation might have on its business and
earnings.
SUPERVISION AND REGULATION
The following discussion sets forth certain material elements of the
regulatory framework applicable to bank holding companies and their
subsidiaries and provides certain specific information relevant to the
Corporation. The regulatory framework is intended primarily to protect
depositors and the federal deposit insurance funds and not security holders.
To the extent that the following information describes statutory and
regulatory provisions, it is qualified in its entirety by reference to those
provisions. A change in the statutes, regulations or regulatory policies
applicable to the Corporation or its subsidiaries may have a material effect
on the business of the Corporation.
General
As a bank holding company, the Corporation is subject to regulation under
the BHC Act, and to inspection, examination and supervision by the Federal
Reserve Board. Under the BHC Act, bank holding companies
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generally may not own or control more than 5% of the voting shares or
substantially all the assets of any company, including a bank, without the
Federal Reserve Board's prior approval. In addition, bank holding companies
generally may engage, directly or indirectly, only in banking and such other
activities as are determined by the Federal Reserve Board to be closely
related to banking.
Various governmental requirements, including Sections 23A and 23B of the
Federal Reserve Act, as amended, limit borrowing by the Corporation and its
nonbank subsidiaries from the Banks. These requirements also limit various
other transactions between the Corporation and its nonbank subsidiaries, on
the one hand, and the Banks, on the other. For example, Section 23A limits to
no more than 10% of its total capital the aggregate outstanding amount of any
bank's loans and other "covered transactions" with any particular nonbank
affiliate, and limits to no more than 20% of its total capital the aggregate
outstanding amount of any bank's covered transactions with all of its nonbank
affiliates. Section 23A also generally requires that a bank's loans to its
nonbank affiliates be secured, and Section 23B generally requires that a
bank's transactions with its nonbank affiliates be on arm's-length terms.
Most of the Banks are national banking associations and, as such, are
subject to regulation primarily by the Office of the Comptroller of the
Currency ("OCC") and, secondarily, by the Federal Deposit Insurance
Corporation ("FDIC") and the Federal Reserve Board. The Corporation's state-
chartered Banks are subject to regulation by the Federal Reserve Board and the
FDIC and, in addition, by their respective state banking departments. The
Banks' operations in other countries are subject to various restrictions
imposed by the laws of those countries.
Liability for Bank Subsidiaries
The Federal Reserve Board has adopted a policy stating that a bank holding
company is expected to act as a source of financial and managerial strength to
each of its subsidiary banks and to maintain resources adequate to support
each such subsidiary bank. This support may be required at times when the
Corporation may not have the resources to provide it. In addition, Section 55
of the United States National Bank Act (the "NBA") permits the OCC to order
the pro rata assessment of shareholders of a national bank whose capital has
become impaired. If a shareholder fails within three months to pay such an
assessment, the OCC can order the sale of the shareholder's stock to cover the
deficiency. In the event of a bank holding company's bankruptcy, any
commitment by the bank holding company to a federal bank regulatory agency to
maintain the capital of a subsidiary bank would be assumed by the bankruptcy
trustee and entitled to priority of payment.
Under the terms of the Federal Deposit Insurance Act, the FDIC can hold any
FDIC-insured depository institution liable for any loss the FDIC incurs, or
reasonably expects to incur, in connection with (a) the "default" of any
commonly controlled FDIC-insured depository institution or (b) any assistance
provided by the FDIC to any commonly controlled depository institution that is
"in danger of default." An institution is deemed in "default," for this
purpose, if it is placed in conservatorship or receivership, and "in danger of
default" if a "default" is likely to occur absent regulatory assistance. All
of the Banks are FDIC-insured depository institutions.
Capital Requirements
The Corporation is subject to capital requirements and guidelines imposed on
bank holding companies by the Federal Reserve Board. The OCC, the FDIC and the
Federal Reserve Board impose similar capital requirements and guidelines on
the Banks within their respective jurisdictions. These capital requirements
establish higher capital standards for banks and bank holding companies that
assume greater risks. For this purpose, a bank holding company's or a bank's
assets and certain specified off-balance-sheet commitments are assigned to
four risk categories, each weighted differently based on the level of credit
risk that is ascribed to such assets or commitments. In addition, risk-
weighted assets are adjusted for low-level recourse and market-risk-equivalent
assets. A bank holding company's or a bank's capital, in turn, is divided into
three tiers: core
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("Tier 1") capital, which includes common equity, non-cumulative perpetual
preferred stock and a limited amount of cumulative perpetual preferred stock
and related surplus (excluding auction rate issues), and minority interests in
equity accounts of consolidated subsidiaries, less goodwill, certain
identifiable intangible assets and certain other assets; supplementary ("Tier
2") capital, which includes, among other items, perpetual preferred stock not
meeting the Tier 1 definition, mandatory convertible securities, subordinated
debt and allowances for loan and lease losses, subject to certain limitations,
less certain required deductions; and market risk ("Tier 3") capital, which
includes qualifying unsecured subordinated debt.
The Corporation, like other bank holding companies, is required to maintain
Tier 1 and total capital (the sum of Tier 1, Tier 2 and Tier 3 capital) equal
to at least 4% and 8% of its total risk-weighted assets, respectively. At
December 31, 1998, the Corporation met both requirements, with Tier 1 and
total capital equal to 7.9% and 11.3% of its total risk-weighted assets,
respectively. Each of the Banks was in compliance with its applicable minimum
capital requirement at December 31, 1998.
The Federal Reserve Board, the FDIC and the OCC have adopted rules to
incorporate market and interest-rate risk components into their risk-based
capital standards. Amendments to the risk-based capital requirements,
incorporating market risk, became effective January 1, 1998. Under these
market risk requirements, capital is allocated to support the amount of market
risk related to a financial institution's ongoing trading activities.
The Federal Reserve Board also requires bank holding companies to maintain a
minimum "leverage ratio" (Tier 1 capital to adjusted average assets). The
guidelines provide for a minimum leverage ratio of 3% for bank holding
companies that have the highest regulatory rating or have implemented the
risk-based capital measures for market risk, or 4% for holding companies that
do not meet either of these requirements. Each of the Banks is subject to
similar requirements adopted by the applicable federal regulatory agency. At
December 31, 1998, the Corporation's leverage ratio was 8.0%. Each of the
Banks was in compliance with its applicable leverage ratio requirement as of
December 31, 1998.
Each federal banking regulator may set capital requirements higher than the
minimums noted above for holding companies or institutions whose circumstances
warrant it. For example, institutions experiencing or anticipating significant
growth may be expected to maintain capital ratios, including tangible capital
positions, well above the minimum levels. Furthermore, the Federal Reserve
Board has indicated that it will consider a "tangible Tier 1 capital leverage
ratio" (deducting all intangibles) and other measures of capital strength in
evaluating proposals for expansion or new activities. No federal banking
regulator has, however, imposed any such special capital requirement on the
Corporation or the Banks.
Failure to meet capital requirements could subject a bank to a variety of
enforcement remedies, including the termination of deposit insurance by the
FDIC, and to certain restrictions on its business, which are described below.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"), among other things, identifies five capital categories for insured
depository institutions (well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized), and requires the respective federal regulatory agencies to
implement systems for "prompt corrective action" for insured depository
institutions that do not meet minimum capital requirements within such
categories. FDICIA imposes progressively more restrictive constraints on
operations, management and capital distributions depending on the category in
which an institution is classified. Failure to meet the capital guidelines
could also subject a depository institution to capital raising requirements.
An "undercapitalized" depository institution must develop a capital
restoration plan, and its parent holding company must guarantee that bank's
compliance with the plan. The liability of the parent holding company under
any such guarantee is limited to the lesser of 5% of the depository
institution's assets at the time it became "undercapitalized" or the amount
needed to comply with the plan. Furthermore, in the event of the bankruptcy of
the parent holding company, such guarantee would take priority over the
parent's general unsecured creditors. In addition, FDICIA requires the various
regulatory agencies to
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prescribe certain non-capital standards for safety and soundness relating
generally to operations and management, asset quality and executive
compensation, and it permits regulatory action against a financial institution
that does not meet such standards.
As of December 31, 1998, each Bank was "well capitalized," based on the
"prompt corrective action" ratios and guidelines described above. It should be
noted, however, that a Bank's capital category is determined solely for the
purpose of applying the OCC's (or the FDIC's) "prompt corrective action"
regulations; the capital category may not constitute an accurate
representation of the Bank's overall financial condition or prospects.
Dividend Restrictions
Various provisions of federal and state law limit the amount of dividends
the Banks can pay to the Corporation without regulatory approval. For example,
approval generally is required for any national bank, or any state chartered
bank that is a member of the Federal Reserve System, to pay any dividend that
would cause the bank's total dividends paid during any calendar year to exceed
the sum of the bank's net income during such calendar year plus the bank's
retained net income for the prior two calendar years. Such a bank also
generally may not pay any dividend exceeding its undivided profits then on
hand without regulatory approval. At January 1, 1999, $2.0 billion of the
total stockholders' equity of the Banks was available for payment of dividends
to the Corporation without approval by the applicable regulatory authority.
In addition, federal bank regulatory agencies have authority to prohibit the
Banks from engaging in unsafe or unsound practices in conducting their
business. The payment of dividends, depending upon the financial condition of
the bank in question, could be deemed to constitute an unsafe or unsound
practice. The ability of the Banks to pay dividends in the future is
currently, and could be further, influenced by bank regulatory policies and
capital guidelines.
Deposit Insurance Assessments
The deposits of each of the Banks are insured up to regulatory limits by the
FDIC and, accordingly, are subject to deposit assessments to maintain the Bank
Insurance Fund ("BIF") and the Savings Association Insurance Fund ("SAIF")
administered by the FDIC. The FDIC has adopted regulations establishing a
permanent risk-related deposit insurance assessment system. Under the system,
the FDIC places each insured bank in one of nine risk categories based on (a)
the bank's capitalization and (b) supervisory evaluations provided to the FDIC
by the institution's primary federal regulator. Each insured bank's insurance
assessment rate is then determined by the risk category in which it is
classified.
The annual insurance premiums on bank deposits insured by the BIF and the
SAIF vary, from $0.00 per $100 of deposits, for banks classified in the
highest capital and supervisory evaluation categories, to $0.27 per $100 of
deposits, for banks classified in the lowest capital and supervisory
evaluation categories.
The Deposit Insurance Funds Act of 1996 provides for assessment to be
imposed on insured depository institutions with respect to deposits insured by
the BIF and the SAIF (in addition to assessments currently imposed on
depository institutions with respect to BIF- and SAIF-insured deposits) to pay
for the cost of Financing Corporation ("FICO") funding. The FDIC's 1998 FICO
assessment rates were approximately $0.012 per $100 annually for BIF-
assessable deposits and $0.061 per $100 annually for SAIF-assessable deposits.
The Banks held approximately $10.7 billion of SAIF-assessable deposits as of
December 31, 1998. The FICO assessments do not vary depending upon a
depository institution's capitalization or supervisory evaluations.
Depositor Preference Statute
Federal legislation has been enacted providing that deposits and certain
claims for administrative expenses and employee compensation against an
insured depository institution would be afforded a priority over other general
unsecured claims against such institution, including federal funds and letters
of credit, in the liquidation or other resolution of the institution by any
receiver.
8
Brokered Deposits
Under FDIC regulations, no FDIC-insured depository institution can accept
brokered deposits unless it (a) is well capitalized, or (b) is adequately
capitalized and receives a waiver from the FDIC. In addition, these
regulations prohibit any depository institution that is not well capitalized
from (i) paying an interest rate on deposits in excess of 75 basis points over
certain prevailing market rates, or (ii) offering "pass through" deposit
insurance on certain employee benefit plan accounts unless it provides certain
notice to affected depositors.
Interstate Banking
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of
1994 ("Riegle-Neal"), subject to certain concentration limits and other
requirements, (a) bank holding companies such as the Corporation are permitted
to acquire banks and bank holding companies located in any state; (b) any bank
that is a subsidiary of a bank holding company is permitted to receive
deposits, renew time deposits, close loans, service loans and receive loan
payments as an agent for any other bank subsidiary of the holding company, and
(c) banks are permitted to acquire branch offices outside their home states by
merging with out-of-state banks, purchasing branches in other states, and
establishing de novo branch offices in other states; provided that, in the
case of any such purchase or opening of individual branches, the host state
has adopted legislation "opting in" to those provisions of Riegle-Neal; and,
provided that, in the case of a merger with a bank located in another state,
the host state has not adopted legislation "opting out" of that provision of
Riegle-Neal. The Corporation might use its authority under Riegle-Neal to
acquire banks in additional states and to consolidate its bank subsidiaries
under a smaller number of separate charters.
Other
The Corporation's nonbank subsidiaries and banking-related business units
are subject to regulation by various state and federal regulatory agencies and
self-regulatory organizations. Activities subject to such regulation include
investment management, investment advisory services, commodities and
securities brokerage, insurance services and products, municipal securities
dealing and transfer agency services.
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FINANCIAL REVIEW
Index To Financial Review
Page
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Selected Financial Data.................................................... 11
Earnings Analysis.......................................................... 12
Business Segments.......................................................... 19
Risk Management............................................................ 23
Liquidity Risk Management.................................................. 23
Market Risk Management..................................................... 24
Credit Risk Management..................................................... 28
Derivative Financial Instruments........................................... 34
Year 2000 Readiness Disclosure............................................. 36
Capital Management......................................................... 36
Forward-Looking Statements................................................. 39
Consolidated Financial Statements.......................................... 41
Notes to Consolidated Financial Statements................................. 45
Report of Independent Public Accountants................................... 76
Selected Statistical Information........................................... 77
10
Selected Financial Data
(In millions, except ratios 1998 1997 1996 1995 1994
and per-share data) -------- -------- -------- -------- --------
Income and Expense:
Net interest income--tax-
equivalent basis............ $ 9,469 $ 9,619 $ 9,417 $ 8,042 $ 7,917
Provision for credit losses.. 1,408 1,988 1,716 1,067 558
Noninterest income........... 8,071 6,694 5,994 5,478 4,327
Restructuring charges and
merger-related costs........ 1,231 337 -- 267 --
Operating expense (1)........ 10,314 9,403 8,681 7,948 7,729
Net income................... 3,108 2,960 3,231 2,675 2,493
Per Common Share Data:
Net income, basic............ $ 2.65 $ 2.48 $ 2.64 $ 2.17 $ 2.00
Net income, diluted.......... 2.61 2.43 2.57 2.12 1.96
Cash dividends declared...... 1.52 1.38 1.24 1.13 1.03
Book value................... 17.31 16.03 16.64 15.28 14.19
Balance Sheet:
Loans........................ 155,398 159,579 153,496 138,478 125,145
Deposits..................... 161,542 153,726 145,206 145,343 142,443
Long-term debt (2)........... 22,298 21,546 15,363 12,582 10,275
Total assets................. 261,496 239,372 225,822 228,298 215,860
Common stockholders' equity.. 20,370 18,724 18,856 17,345 15,647
Total stockholders' equity... 20,560 19,050 19,507 18,143 16,568
Performance Ratios:
Return on average assets..... 1.30% 1.29% 1.43% 1.19% 1.20%
Return on average common
equity...................... 15.9 15.8 17.5 15.7 15.6
Net interest margin.......... 4.52 4.75 4.70 4.07 4.30
Efficiency ratio............. 65.8 59.7 56.3 60.8 63.1
Credit Quality:
Net charge-offs to average
loans....................... 0.97% 1.21% 1.04% 0.59% 0.48%
Allowance for credit losses
to loans outstanding........ 1.46 1.77 1.75 1.75 1.75
Nonperforming assets to loans
and other real estate owned. 0.53 0.42 0.40 0.55 0.60
Common Stock Data:
Average shares outstanding,
basic....................... 1,170 1,176 1,199 1,198 1,211
Average shares outstanding,
diluted..................... 1,189 1,213 1,254 1,248 1,252
Stock price, year-end........ $ 51.06 $ 49.37 $ 39.09 $ 31.10 $ 20.97
Stock dividends.............. 10% -- 10% -- 10%
Dividend payout ratio........ 58% 61% 38% 40% 44%
- --------
(1) Noninterest expense reduced by restructuring charges and merger-related
costs, including certain integration costs.
(2) Includes trust preferred capital securities.
11
Earnings Analysis
Introduction
To better understand underlying trends and performance, the Corporation has
excluded restructuring and merger-related costs as well as the effects of
unusual events or transactions, to present financial performance on an
"operating" basis. Operating results should be reviewed in conjunction with
reported results.
For funding and risk-management purposes, the Corporation periodically
securitizes loans, primarily in support of credit card activities. The
accounting for securitizations complicates the understanding of underlying
trends in net interest income, net interest margin and noninterest income, as
well as the underlying growth rates of reported loans. For a more complete
understanding, these trends are also reviewed on a "managed" basis, which adds
data on securitized credit card loans to reported data on loans. Results on a
managed basis, where presented, should be read in conjunction with reported
results.
Management's discussion and analysis may contain forward-looking statements
that are provided to assist in the understanding of anticipated future
financial performance. However, such performance involves risks and
uncertainties that may cause actual results to differ materially from those
expressed in forward-looking statements. See pages 39-40 for a full discussion
of such factors.
Summary of Financial Results
The Corporation's reported 1998 net income was $3.108 billion, or $2.61 per
share, up from $2.960 billion, or $2.43 per share in 1997, and compared with
$3.231 billion, or $2.57 per share, in 1996. The following table summarizes
the key financial lines and ratios on a reported basis for the years
presented.
1998 1997 1996
(In millions, except per-share data) ------- ------ ------
Net interest income--tax-equivalent basis.............. $ 9,469 $9,619 $9,417
Provision for credit losses............................ 1,408 1,988 1,716
Noninterest income..................................... 8,071 6,694 5,994
Noninterest expense.................................... 11,545 9,740 8,681
Net income............................................. 3,108 2,960 3,231
Earnings per share
Basic................................................ 2.65 2.48 2.64
Diluted.............................................. 2.61 2.43 2.57
Return on assets....................................... 1.30% 1.29% 1.43%
Return on common equity................................ 15.9 15.8 17.5
Net interest margin.................................... 4.52 4.75 4.70
Efficiency ratio....................................... 65.8 59.7 56.3
Adjustments to Operating Results on a Managed Basis
In arriving at managed operating results for the periods presented, the
Corporation has adjusted reported results as follows:
. To reflect securitized credit card receivables as on-balance-sheet loans;
. To exclude restructuring and merger-related costs associated with the
FCN, First Commerce and First USA transactions, which totaled $1.166
billion in 1998 and $467 million in 1997, on a pretax basis;
. To exclude gains generated in 1998 from the sale of banking facilities
associated with the Retail Delivery Initiative totaling $259 million, on a
pretax basis; and
12
. To exclude other pretax charges of $175 million, associated with the
restructuring of the Corporation's Rapid Cash retail business initiative
and an impairment charge related to the Corporation's auto lease
portfolio.
The following table reconciles reported results with operating results for
the years presented.
1998 1997 1996
--------------- -------------- --------------
Net EPS, Net EPS, Net EPS,
(In millions, except per-share Income diluted Income diluted Income diluted
data) ------ ------- ------ ------- ------ -------
Reported......................... $3,108 $2.61 $2,960 $2.43 $3,231 $2.57
Restructuring and merger-related
costs........................... 824 0.69 329 0.27 -- --
Gains from Retail Delivery
Initiative...................... (181) (0.15) -- -- -- --
Other charges.................... 118 0.10 -- -- -- --
------ ----- ------ ----- ------ -----
Operating........................ $3,869 $3.25 $3,289 $2.70 $3,231 $2.57
====== ===== ====== ===== ====== =====
A more detailed discussion of restructuring and merger-related costs and
other charges begins on page 17.
Summary of Operating Results on a Managed Basis
Earnings on an operating basis were $3.869 billion, or $3.25 per share, in
1998, compared with $3.289 billion, or $2.70 per share, in 1997, up 18% and
20%, respectively. Operating earnings for 1996 were $3.231 billion or $2.57
per share. The following table summarizes the key financial lines from an
operating perspective on a managed basis.
1998 1997 1996
(In millions, except per-share data) ------- ------- -------
Net interest income--tax-equivalent basis............ $13,828 $12,950 $11,997
Provision for credit losses.......................... 3,914 3,869 3,172
Noninterest income................................... 6,070 5,380 4,859
Noninterest expense.................................. 10,315 9,409 8,670
Net income........................................... 3,869 3,289 3,231
Earnings per share
Basic.............................................. 3.29 2.76 2.64
Diluted............................................ 3.25 2.70 2.57
Return on assets..................................... 1.39% 1.26% 1.28%
Return on common equity.............................. 19.8 17.6 17.5
Net interest margin.................................. 5.56 5.50 5.28
Efficiency ratio..................................... 51.8 51.3 51.4
The Corporation's operating results for 1998 reflect positive fundamental
performance, including:
. Strong managed net interest margin of 5.56%, up from 5.50% in 1997 and
5.28% in 1996;
. Average managed loan growth of 6% over 1997 levels, with credit card
loans leading the increase;
. Sound credit quality, as exhibited by continued strong credit ratios; and
. Improved managed fee-based revenue, with overall growth of 13% generated
by increases in each major fee category.
Net Interest Income
Net interest income includes fundamental spreads on earning assets as well
as such items as loan fees, cash interest collections on problem loans,
dividend income, interest reversals, and income or expense on derivatives used
to manage interest rate risk. Net interest margin measures how efficiently the
Corporation uses its earning assets and underlying capital.
13
In order to understand fundamental trends in net interest income, average
earning assets and net interest margins, it is useful to analyze financial
performance on a managed portfolio basis, which treats loans sold in credit
card securitization transactions as if they had not been sold.
1998 1997 1996
(In millions) -------- -------- --------
Managed
Net interest income--tax-equivalent basis....... $ 13,828 $ 12,950 $ 11,997
Average earning assets.......................... 248,621 235,420 227,421
Net interest margin............................. 5.56% 5.50% 5.28%
Reported
Net interest income--tax-equivalent basis....... $ 9,469 $ 9,619 $ 9,417
Average earning assets.......................... 209,514 202,334 200,259
Net interest margin............................. 4.52% 4.75% 4.70%
Managed net interest income increased 7% in 1998 compared with 1997. This
growth was primarily attributable to a $13.2 billion, or 6%, increase in
average earning assets. In addition, net interest margin improved to 5.56%,
reflecting continued growth in higher-spread consumer loans, as well as
deposit growth. Average managed loans increased $11.9 billion, with higher-
margin credit card loans accounting for $5.7 billion of the increase. Average
commercial loans grew 7% in 1998, predominantly reflecting growth in the
middle market segment. Average other consumer loans were essentially flat
compared with 1997. Planned sales of residential mortgage loans were offset by
growth in other segments of the consumer loan portfolio.
Managed net interest income for 1997 increased $953 million, or 8%, from
1996, due primarily to an $8.0 billion increase in average earning assets. The
managed net interest margin for 1997 increased to 5.50% from 5.28% in 1996,
reflecting the growth in and positive effect of higher-margin credit card and
consumer loans, as well as a decline in the level of lower-margin investment
securities.
Noninterest Income
In order to provide more meaningful trend analysis, credit card fee revenue
and total noninterest income in the following table are shown on a managed
basis. Credit card fee revenue excludes the net credit card servicing revenue
(spread income less credit costs) associated with securitized credit card
receivables.
Percent
Increase (Decrease)
---------------------
1998 1997 1996 1997-1998 1996-1997
(Dollars in millions) ------ ------ ------ --------- ---------
Trading profits.................. $ 149 $ 117 $ 72 27% 63%
Equity securities gains.......... 250 334 332 (25) 1
Investment securities gains...... 155 101 44 53 130
------ ------ ------ --------- ---------
Market-driven revenue.......... 554 552 448 -- 23
Credit card revenue (1).......... 1,424 1,194 996 19 20
Fiduciary and investment
management fees................. 807 746 700 8 7
Service charges on deposits...... 1,255 1,219 1,129 3 8
Other service charges and
commissions..................... 1,390 1,172 1,037 19 13
------ ------ ------ --------- ---------
Managed fee-based revenue...... 4,876 4,331 3,862 13 12
Other............................ 640 497 549 29 (9)
------ ------ ------ --------- ---------
Managed noninterest income--
operating basis............... 6,070 5,380 4,859 13 11
Gains--Retail Delivery
Initiative...................... 259 -- -- N/M N/M
Other charges.................... (110) -- -- N/M N/M
------ ------ ------ --------- ---------
Managed noninterest income--
reported basis................ $6,219 $5,380 $4,859 16% 11%
====== ====== ====== ========= =========
- --------
(1) Net credit card servicing revenue totaled $1.852 billion in 1998, $1.314
billion in 1997 and $1.135 billion in 1996.
N/M--Not meaningful.
14
Managed noninterest income increased 16% in 1998, following an 11% increase
in 1997. In both periods, fee-based revenue contributed to the year-over-year
improvements in noninterest income. In 1998, $259 million in gains from
banking center sales associated with the Retail Delivery Initiative also
contributed to the growth in noninterest income.
Market-Driven Revenue
- ---------------------
Market-driven revenue for 1998 reflected an economic environment that
included global market volatility and uncertainty. The mix of market-driven
revenue changed compared with 1997, as improvements in both trading profits
and investment securities gains were offset by the year-over-year decline in
equity securities gains. While more sensitive to changes in market conditions
than other noninterest income components, market-driven revenue remains a core
component of the commercial business and an important contributor to overall
earnings growth.
Trading profits on an operating basis increased 27% to $149 million, up from
$117 million in 1997 and $72 million in 1996. Both derivative and foreign
exchange trading generated favorable results in 1998. Derivative trading
results in 1997 were negatively affected by losses recognized in specific
portfolio positions, as well as by a volatile interest rate environment.
Foreign exchange trading benefited from the volatility in foreign currency
markets experienced in 1998 and 1997. The following table provides additional
details on total revenue from trading businesses.
Trading Revenue (Including Related Net Interest Income)
1998 1997 1996
(In millions) ---- ---- ----
Foreign exchange and derivatives................................ $ 84 $ 72 $ 63
Fixed income and derivatives.................................... 51 11 48
Other trading................................................... 177 142 104
---- ---- ----
Total....................................................... $312 $225 $215
==== ==== ====
Equity securities gains totaled $250 million in 1998, down from $334 million
in 1997 and $332 million in 1996. Equity securities gains were particularly
strong in the first half of 1998, and included a $65 million gain on the sale
of a single investment in the electrical supply industry. Equity market
volatility and uncertainty in the second half of the year dampened full-year
1998 results. Investment securities gains totaled $155 million in 1998,
compared with $101 million in 1997 and $44 million in 1996. The higher
investment securities gains in 1998 and 1997 primarily resulted from more
active management of the investment portfolio, with a focus on government and
mortgage-backed securities.
Managed Fee-Based Revenue
- -------------------------
Managed fee-based revenue grew 13% in 1998, following 12% growth in 1997.
Each major category of fee-based revenue posted increases in both 1998 and
1997.
Credit card fees rose 19% to $1.424 billion in 1998, reflecting higher
levels of interchange and cardholder fees, partially offset by reduced gains
on credit card securitizations. Credit card receivables growth in both periods
produced higher levels of account- and transaction-based fee revenue. In
addition, ongoing pricing changes initiated in 1996 continued to generate
increased fee levels. Securitization-related gains totaled $134 million in
1998, $188 million in 1997 and $4 million in 1996. In December 1996, the
Corporation sold an interest in its merchant processing business to a third
party. As a result, the Corporation's remaining interest was recorded using
the equity method of accounting, and credit card fee revenue decreased by $93
million in 1997.
Fiduciary and investment management fees include revenue generated by
traditional trust products and services, investment management activities and
the shareholder services business. Revenues from the shareholder services
business were $94 million in 1998, $98 million in 1997 and $88 million in
1996. This relative
15
consistency was achieved despite industry consolidation and price competition.
In December 1998, the Corporation combined its shareholder services business
with that of Boston EquiServe Limited Partnership, creating the nation's
largest corporate shareholder services provider. The Corporation began
recognizing its proportionate share of the partnership's net earnings in other
noninterest income in December 1998. In 1996, the Corporation decided to exit
its stand-alone global custody and master trust businesses; the exit was
completed in the second quarter of 1997. Revenues from these activities
totaled approximately $11 million for 1997 and $54 million for 1996.
Service charges on deposit accounts, which include deficient balance fees,
increased 3% to $1.255 billion for 1998, following an 8% increase in 1997.
Growth in cash management fees was a contributing factor, due in part to the
extensive cross-selling of product offerings across various customer segments.
Other service charges and commissions increased 19% over 1997 levels. Loan
syndication fees increased, as transaction flow grew in late 1998 in response
to market liquidity concerns that affected commercial customers. Continued
growth in other fee revenue from retail product areas, including home mortgage
and investment management, also contributed to this excellent performance.
On an operating basis, other noninterest income increased $143 million or
29% from 1997, and included gains on sales of loans of $286 million for 1998,
$107 million for 1997 and $166 million for 1996. Other noninterest income for
1996 included a gain of $107 million from the sale of a portion of the
Corporation's investment in its merchant processing segment of the credit card
business. Reported other noninterest income in 1998 included $259 million in
gains from banking center sales associated with the Retail Delivery
Initiative, as well as charges totaling $110 million for asset valuation
adjustments, primarily associated with the Corporation's auto leasing
portfolio.
Noninterest Expense
On an operating basis, noninterest expense in 1998 was $10.314 billion, up
10% from $9.403 billion in 1997. Operating expense for 1997 was 8% higher than
in 1996. Growth in identified businesses, specifically credit card,
contributed to the year-over-year growth in operating expense. Technology
initiatives, including Year 2000 readiness, systems and other reengineering
projects, also added to the overall expense growth.
Percent
Increase (Decrease)
---------------------
1998 1997 1996 1997-1998 1996-1997
(Dollars in millions) ------- ------ ------ --------- ---------
Salaries and employee benefits
Salaries...................... $ 3,770 $3,551 $3,363 6% 6%
Employee benefits............. 707 673 663 5 2
------- ------ ------
Total salaries and employee
benefits................... 4,477 4,224 4,026 6 5
Net occupancy and equipment
expense........................ 845 739 738 14 --
Depreciation and amortization... 680 693 694 (2) --
Outside service fees and
processing..................... 1,349 1,145 956 18 20
Marketing and development....... 1,024 837 568 22 47
Communication and
transportation................. 781 711 652 10 9
Other........................... 1,262 1,054 1,047 20 1
Less: Merger-related integration
included above................. (104) -- -- N/M N/M
------- ------ ------ --------- ---------
Noninterest expense--operating
basis.......................... 10,314 9,403 8,681 10 8
Merger-related and restructuring
costs.......................... 1,166 337 -- N/M N/M
Other business restructuring
costs.......................... 65 -- -- N/M N/M
------- ------ ------ --------- ---------
Noninterest expense--reported
basis.......................... $11,545 $9,740 $8,681 19% 12%
======= ====== ====== ========= =========
- --------
N/M -- Not meaningful.
16
Salary and benefit costs were $4.477 billion in 1998, up 6% compared with
$4.224 billion in 1997. The increases in 1998 and 1997 reflect staffing
increases to support growth in certain business activities as well as annual
salary increases and higher performance-based initiatives in certain business
units.
Occupancy and equipment expense was up 14 percent over 1997 levels,
reflecting the outsourcing of various property management services and the
implementation and ongoing support of an expanded ATM delivery network,
including the Rapid Cash retail banking initiative. Expense growth in this
area was mitigated by banking center sales associated with the Retail Delivery
Initiative. This initiative was restructured at the end of 1998, resulting in
$65 million of restructuring costs, which should produce future expense
savings in this area.
Outside service fees and processing expense increased 18% in 1998 and 20% in
1997 and included consulting and implementation costs incurred to support Year
2000 readiness, as well as other technology and reengineering initiatives in
various businesses. Increased credit card transaction volume and account
generation required higher levels of support and processing costs.
Year 2000 readiness costs totaled $185 million in 1998 and $50 million in
1997, and are included in various noninterest expense categories. See "Year
2000 Readiness Disclosure" on page 36.
Marketing and development expense increased significantly in both 1998 and
1997. Credit card marketing efforts accounted for much of the increase. A
record 10.1 million new accounts were added in 1998, higher than the 9.7
million new accounts added in 1997.
Other operating expense increased significantly during 1998, reflecting the
cost to support growth in transaction-driven business activities and the
higher level of technology-driven and business reengineering project
initiatives.
Applicable Income Taxes
The following table shows the Corporation's income before income taxes,
applicable income taxes and effective tax rate for each of the past three
years.
1998 1997 1996
(Dollars in millions) ------ ------ ------
Income before income taxes.............................. $4,465 $4,427 $4,842
Applicable income taxes................................. 1,357 1,467 1,611
Effective tax rates..................................... 30.4% 33.1% 33.3%
Tax expense for all three years included benefits for tax-exempt income,
tax-advantaged investments and general business tax credits offset by the
effect of nondeductible expenses, including goodwill. An increasing level of
transaction activity in tax-advantaged products during 1998 produced a lower
effective tax rate than in prior periods.
Merger-Related Costs and Other Charges
BANC ONE/FCN Merger
- -------------------
The Corporation estimates that net restructuring charges and merger-related
costs of approximately $1.25 billion ($837 million after-tax) will be incurred
in connection with the BANC ONE/FCN Merger. Actions incorporated in the
business combination and restructuring plan are targeted for implementation
over a 12-18 month period following the Merger. Merger-related and
restructuring costs recorded in the fourth quarter of 1998 totaled $984
million ($697 million after-tax), or 59 cents per share, consisting of a
restructuring charge of $636 million and merger-related costs of $348 million.
An additional $526 million of merger-related costs is expected to be incurred
during 1999. Gains on the required Indiana banking center divestitures, which
were completed during the 1999 first quarter, were approximately $260 million.
The $636 million restructuring charge included $421 million of personnel-
related expenses, $80 million of transaction costs and $135 million of exit
costs, including asset write-offs and the settlement or recognition of
17
obligations under existing contractual arrangements. Personnel-related items
consisted primarily of severance and benefits costs for separated employees,
and costs associated with the "change in control" provisions included in
certain of the Corporation's stock plans. The benefit package available to
affected employees has been approved by management and communicated on a
corporate-wide basis. Trends in total headcount for the Corporation will
reflect growth in support of line of business strategies and reductions based
on eliminated positions resulting from the Merger. The net reduction in full-
time positions is expected to represent about 4-5% of September 30, 1998,
headcount over the next year. Facilities and equipment costs include the net
cost associated with the closing and divestiture of identified banking
facilities, and from the consolidation of headquarters and operational
facilities. Other merger-related transaction costs include investment banking
fees, registration and listing fees, and various accounting, legal and other
related transaction costs.
Merger-related costs of $348 million included $294 million related to the
accounting consequences of changes in business practices. Of this total, $260
million resulted from the modification, in light of the Merger, of a
contractual relationship to purchase credit card accounts. Previously
capitalized costs under this account sourcing agreement will be amortized over
a one-year period. On a going forward basis, such costs will be expensed as
incurred. Merger-related costs also included $54 million of business and
systems integration costs. Additional costs, totaling approximately $526
million, are estimated to be incurred during 1999.
First Commerce Corporation Acquisition
- --------------------------------------
In connection with the First Commerce acquisition, the Corporation
identified second quarter 1998 restructuring and merger-integration charges of
$182 million ($127 million after-tax), or 10 cents per share, of which $127
million was recorded as a restructuring charge, $44 million represented
integration costs and $11 million was associated with Year 2000 compliance.
The restructuring charge of $127 million associated with the First Commerce
acquisition consisted of employee benefits, severance and retention costs, and
other merger-related costs.
First USA, Inc. Acquisition
- ---------------------------
In connection with the First USA acquisition, the Corporation recognized
second quarter 1997 merger-related costs and restructuring charges of $371
million ($261 million after-tax), or 21 cents per share, of which $241 million
was recorded as a separate component of noninterest expense and $130 million
as additional provision for credit losses.
The restructuring costs associated with the First USA acquisition totaled
$241 million and consisted of employee benefits, severance and stock option
vesting costs; professional services costs; premiums to redeem preferred
securities of a subsidiary trust; asset-related write-downs and other
transaction-related costs.
The $130 million additional provision for credit losses primarily reflected
the reclassification of $2.0 billion of credit card loans previously
classified as held for sale to the loan portfolio, in connection with the
effort to consolidate the BANC ONE and First USA credit card master trusts,
and to conform credit card charge-off policies.
Other Charges
- -------------
The Corporation recorded other charges totaling $175 million ($118 million
after-tax), or 10 cents per share, in the fourth quarter of 1998, resulting
from its continuing review of the strategies and practices of its ongoing
businesses. These charges included $110 million in asset valuation
adjustments, primarily reflecting an estimate of impairment inherent in the
Corporation's auto lease portfolio, resulting from recent changes in both
business dynamics and economic factors. In addition, the Corporation
restructured its Rapid Cash business to position it for future growth and
profitability. Costs totaling $65 million were incurred, including write-offs
of certain ATM assets and the restructuring or settlement of vendor contracts.
In the second quarter of 1997, the Corporation recorded restructuring
charges totaling $96 million ($68 million after-tax), or 6 cents per share, to
streamline the retail delivery system by consolidating approximately 200
banking centers over a 12-month period and to halt development of the
Strategic Banking System, a retail deposit banking system.
18
Business Segments
Highlights
The 1998 financial performance of the Corporation's major business lines--
Commercial Banking, and the consumer units of Credit Card, Retail Banking and
Finance One--are summarized below. Detailed descriptions of the major business
lines can be found beginning on page 2. The results of Investment Management,
a key product line that includes insurance sales, are allocated to Commercial
Banking, Credit Card and Retail Banking where the relevant customer business
resides. For reference, the earnings of Investment Management are also shown
separately. Previous years' results for all business lines are not available.
Managed Average
Average Common
Net Assets Equity
Income ($MM) ROE ($B) ($B)
------------ --- ------- -------
Commercial Banking............................ $1,510 20% $146.7 $ 7.5
Credit Card................................... 1,162 20 62.7 5.7
Retail Banking................................ 592 21 32.8 2.9
Finance One................................... 313 18 34.1 1.7
Other activities/unallocated.................. 292 N/A 2.6 1.7
------ --- ------ -----
Total Operating............................. 3,869 20 278.9 19.5
Merger-related and special items.............. (761) -- -- --
------ --- ------ -----
Total BANK ONE.............................. $3,108 16% $278.9 $19.5
====== === ====== =====
Investment Management (included above)........ $ 250 35% $ -- $ 0.7
- --------
N/A--Not applicable
Business Segment Management
The Corporation manages its lines of business based on risk, return and
growth. The reported returns on equity are on a risk-adjusted basis, with risk
being differentiated through the capital allocation process. Therefore,
returns will tend to converge within a relatively limited range. The capital
framework is based on a targeted AA debt rating for the Corporation, which is
considerably more conservative than that of peer competitors in most business
lines. Ongoing capital allocation to business lines will be based not only on
risk, but on growth expectations as well. Businesses with higher growth
potential will attract more capital and resources than those with lower growth
rates. Overall, this discipline aims to support superior growth and superior
total returns for the Corporation.
Description of Methodology
Although the Corporation's internal profitability reporting systems were not
combined in 1998, the line-of-business results were developed under a
consistent management accounting framework. A comprehensive project was
initiated in the second half of 1998 to evaluate the management accounting
practices of both predecessor organizations against the industry's "best
practices." This study will continue in 1999 to achieve common standards for
management reporting across the Corporation. Where significant differences in
methodology existed, conforming adjustments were made in 1998 results. Further
policy refinements may cause restatements of 1998 data in future reporting
periods.
Key elements of the management reporting process include:
. Funds Transfer Pricing--To determine net interest income for the
business units, a detailed process of charging/crediting for
assets/liabilities is employed. This system is designed to be consistent
with the Corporation's asset and liability management principles.
19
. Cost Allocation--Costs of support units are fully allocated to the
business lines. Allocation processes will become more standardized in
1999 for these indirect expenses and overhead costs.
. Capital Attribution--Common equity is assigned to the business units
based on the underlying risk of their activities. Four forms of risk are
measured: credit, market, operational and lease residual. The risk
tolerance used in this framework is consistent with that required for a
AA debt rating. See page 37 for more information on economic capital.
Other Disclosure Issues
More detailed results for the lines of business follow, preceded by
explanatory comments.
. The merger-related and special charges, and banking center gains in 1998
totaling $1.082 billion pretax are not attributed to any line of
business; results are presented on an operating basis. See "Merger-
Related Costs and Other Charges" beginning on page 17 for additional
disclosure regarding these items.
. All disclosures are on a managed basis; securitized credit card
receivables, and related income statement line items, are presented as
if these were on-balance-sheet loans.
. The "other" category includes noncore business activities, predominantly
investments, as well as unallocated capital and certain one-time
corporate items.
The "Earnings Analysis" section beginning on page 12 provides more
information about the reconciliation of reported results to operating or
managed results.
Commercial Banking 1998 Results
- --------------------------------------------------------------------------------
(In millions)
Net interest income (FTE).......................................... $ 2,944
Provision for credit losses........................................ 224
Noninterest income................................................. 2,417
Noninterest expense................................................ 3,015
Net income......................................................... 1,510
Return on equity................................................... 20%
Efficiency ratio................................................... 56%
(In billions)
Average loans...................................................... $ 77.1
Average assets..................................................... 146.7
Average common equity.............................................. 7.5
- --------
FTE--Fully taxable equivalent.
Commercial Banking is the Corporation's largest earnings contributor,
serving business customers ranging in size from middle market to mid-sized
companies to large corporations. Commercial Banking also serves high-net-worth
customers in its private banking division. Product offerings in this business
line include traditional credit products, corporate finance, treasury
services, investment management and capital markets products. Other
contributors to Commercial Banking's earnings are the results of leveraged and
equipment leasing, proprietary investing and venture capital activities.
Credit risk constitutes the largest portion of the capital assigned to this
business.
For 1998, net income was $1.510 billion and return on equity reached 20%.
Looking ahead to the next two years, Commercial Banking aims to grow earnings
consistently 10-15% and produce returns of 15-20%.
20
Consumer Businesses
The Corporation serves a number of different consumer customer markets with
a variety of products and through multiple delivery channels. For 1998, this
business was managed in three separate segments: Credit Card, Retail Banking
and Finance One. As the Corporation's strategy evolves, changes may be made in
this organizational structure.
Credit Card 1998 Results
- -------------------------------------------------------------------------------
(In millions)
Net interest income (FTE)......................................... $ 6,450
Provision for credit losses....................................... 3,302
Noninterest income................................................ 1,473
Noninterest expense............................................... 2,847
Net income........................................................ 1,162
Return on managed receivables..................................... 1.9%
Return on equity.................................................. 20%
Efficiency ratio.................................................. 36%
(In billions)
Average loans..................................................... $61.0
Average assets.................................................... 62.7
Average common equity............................................. 5.7
The world's leading credit card company, First USA contributed $1.162
billion, or 30% of corporate earnings for 1998. Return on managed receivables
was 1.9%. Innovative marketing--including an aggressive Internet strategy--is
expected to generate continued double-digit growth in outstandings. Credit
Card's near-term earnings targets are net income growth of 15-20% and return
on equity of 20-25%.
Capital is maintained at 9% of managed receivables. Many competitors in the
credit card business have debt ratings well below AA and, on average, carry
capital ratios of 5-6% of managed receivables. On this capitalization basis,
the return on equity for Credit Card would have been about 30% for 1998.
Retail Banking 1998 Results
- --------------------------------------------------------------------------------
(In millions)
Net interest income (FTE).......................................... $3,159
Provision for credit losses........................................ 131
Noninterest income................................................. 1,449
Noninterest expense................................................ 3,573
Net income......................................................... 592
Return on equity................................................... 21%
Efficiency ratio................................................... 78%
(In billions)
Average loans...................................................... $ 28.3
Average assets..................................................... 32.8
Average deposits................................................... 91.4
Average common equity.............................................. 2.9
With average loans of more than $28 billion and deposits of $91 billion
generated through an extensive banking center network, ATMs, online banking
and other channels, the Retail Banking Group is one of the nation's premier
providers of financial services to individuals and small businesses. It earned
$592 million for 1998 and generated a 21% return on equity. More than half of
the capital allocation is related to operational risk and goodwill. Earnings
growth is targeted at 10-15% for the 1999 and 2000 time periods, which is
expected to be produced largely by merger synergies and gains in cost
efficiency. The return on equity goal is 15-20%.
21
Finance One 1998 Results
- --------------------------------------------------------------------------------
(In millions)
Net interest income (FTE).......................................... $1,131
Provision for credit losses........................................ 299
Noninterest income................................................. 338
Noninterest expense................................................ 691
Net income......................................................... 313
Return on equity................................................... 18%
Efficiency ratio................................................... 47%
(In billions)
Average loans...................................................... $33.3
Average assets..................................................... 34.1
Average common equity.............................................. 1.7
In 1998, the activities of Finance One--direct and indirect auto financing,
secured consumer finance, mortgage lending and other forms of secured
financing--produced net income of $313 million, or 8% of corporate operating
earnings. Return on equity was 18% and average loans grew to $33 billion.
Finance One looks for continued earnings growth of 15-20% in the next two
years and ongoing returns of 15-20%.
Investment Management 1998 Results
- --------------------------------------------------------------------------------
(In millions)
Total revenue...................................................... $1,194
Noninterest expense................................................ 811
Net income......................................................... 250
Return on equity................................................... 35%
Efficiency ratio................................................... 68%
(In billions)
Assets under management ........................................... $122.3
Average common equity.............................................. 0.7
(In millions)
Net income attribution:
Commercial......................................................... $ 135
Credit Card........................................................ 68
Retail Banking..................................................... 47
Investment Management products are sold to retail and institutional
customers across the Corporation's business lines. Mutual funds, insurance,
annuities, and personal and corporate trust services form the core of this
business, which produced $250 million in net income for 1998. This business
plans to grow earnings 20-25% and generate a return on equity of 25% or
greater. Investment Management attracts a small amount of operational risk
capital.
1998 Results
--------------------------------------
Other Activities and
Corporate/Unallocated Other Activities Corporate/Unallocated
- --------------------------------------- ---------------- ---------------------
(In millions)
Net interest income (FTE).............. $ 54 $ 90
Provision for credit losses............ -- (42)
Noninterest income..................... 251 142
Noninterest expense.................... 157 32
Net income............................. 97 195
(In billions)
Average loans.......................... 0.2 --
Average assets......................... 2.6 --
Average common equity.................. 0.2 1.5
22
The earnings of other activities totaled $97 million, derived principally
from noncore investing. Capital of $1.5 billion is not specifically assigned
to business units. This amount includes capital to cover corporate structural
interest-rate risk. Also, certain gains on sales of premises and other
corporate assets, as well as tax credits, are included in the
Corporate/Unallocated category.
See Note 6--Operating Segments for additional disclosure regarding the
Corporation's business segments.
Risk Management
The Corporation's various business activities generate liquidity, market and
credit risks.
. Liquidity risk is the possibility of being unable to meet all current and
future financial obligations in a timely manner.
. Market risk is the possibility that changes in future market rates or
prices will make the Corporation's positions less valuable.
. Credit risk is the possibility of loss from a customer's failure to
perform according to the terms of a transaction.
Compensation for assuming these risks is reflected in interest income,
trading profits and fee income. In addition, these risks are factored into the
allocation of capital to support various business activities, as discussed in
the "Capital Management" section, beginning on page 36.
The Corporation is a party to transactions involving financial instruments
that create risks that may or may not be reflected on a traditional balance
sheet. These financial instruments can be subdivided into three categories:
. Cash financial instruments, which are generally characterized as on-
balance-sheet transactions, and include loans, bonds, stocks and
deposits.
. Credit-related financial instruments, which include such instruments as
commitments to extend credit and standby letters of credit.
. Derivative financial instruments, which include such instruments as
interest rate, foreign exchange, equity price and commodity price
contracts, including forwards, swaps and options.
The Corporation's risk management policies are intended to identify, monitor
and limit exposure to liquidity, market and credit risks that arise from each
of these financial instruments.
Liquidity Risk Management
Liquidity is managed in order to preserve stable, reliable and cost-
effective sources of cash to meet all current and future financial obligations
in a timely manner. The Corporation considers strong capital ratios, credit
quality and core earnings as essential to retaining high credit ratings and,
consequently, cost-effective access to market liquidity. In addition, a
portfolio of liquid assets, consisting of federal funds sold, deposit
placements and selected highly marketable investment securities, is maintained
to meet short-term demands on liquidity.
The Consolidated Statement of Cash Flows, on page 44, presents data on cash
and cash equivalents provided and used in operating, investing and financing
activities.
The Corporation's ability to attract wholesale funds on a regular basis and
at a competitive cost is fostered by strong ratings from the major credit
rating agencies. As of December 31, 1998, the Corporation and its principal
banks had the following long- and short-term debt ratings.
Credit Ratings
Senior
Short-Term Long-
Debt Term Debt
December 31, 1998 ------------ -----------
S & S &
P Moody's P Moody's
---- ------- --- -------
The Corporation (Parent)............................... A-1 P-1 A+ Aa3
Principal Banks........................................ A-1+ P-1 AA- Aa2
The Treasury department is responsible for identifying, measuring and
monitoring the Corporation's liquidity profile. The position is evaluated
monthly by analyzing the composition of the liquid asset portfolio,
23
performing various measures to determine the sources and stability of the
wholesale purchased funds market, tracking the exposure to off-balance-sheet
draws on liquidity, and monitoring the timing differences in short-term cash
flow obligations.
Access to a variety of funding markets and customers in the retail and
wholesale sectors is vital both to liquidity management and to cost
minimization. A large retail customer deposit base is one of the significant
strengths of the Corporation's liquidity position. In addition, a diversified
mix of short- and long-term funding sources from the wholesale markets is
maintained through active participation in global capital markets and by
securitizing and selling assets such as credit card receivables.
The following table shows the total funding source mix for the periods
indicated.
Deposits and Other Purchased Funds
1998 1997 1996 1995 1994
December 31 (In millions) -------- -------- -------- -------- --------
Domestic offices
Demand........................... $ 39,854 $ 35,954 $ 33,479 $ 31,653 $ 30,463
Savings.......................... 62,645 58,946 56,359 52,463 51,637
Time
Under $100,000................. 24,483 28,815 30,955 31,184 29,267
$100,000 and over.............. 11,819 11,329 10,312 10,753 10,780
Foreign offices.................... 22,741 18,682 14,101 19,290 20,296
-------- -------- -------- -------- --------
Total deposits............... 161,542 153,726 145,206 145,343 142,443
Federal funds purchased and
securities under repurchase
agreements........................ 23,164 20,346 21,662 24,906 23,613
Commercial paper................... 2,113 1,507 2,446 941 1,479
Other short-term borrowings........ 14,824 11,299 10,593 12,781 12,006
Long-term debt (1)................. 22,298 21,546 15,363 12,582 10,275
-------- -------- -------- -------- --------
Total other purchased funds.. 62,399 54,698 50,064 51,210 47,373
-------- -------- -------- -------- --------
Total........................ $223,941 $208,424 $195,270 $196,553 $189,816
======== ======== ======== ======== ========
- --------
(1) Includes trust preferred capital securities.
Market Risk Management
Overview
Market risk refers to potential losses arising from changes in interest
rates, foreign exchange rates, equity prices, commodity prices and other
market-driven rates, prices or volatilities. The Corporation has developed
risk-management policies to monitor and limit exposure to market risk. Through
its trading activities, the Corporation strives to take advantage of profit
opportunities available in interest and exchange rate movements. In asset and
liability management activities, policies are in place that are designed to
closely manage structural interest rate and foreign exchange rate risk.
Disclosures about the fair value of financial instruments, which reflect
changes in market prices and rates, can be found in Note 21--Fair Value of
Financial Instruments.
Trading Activities
The Corporation's trading activities are primarily customer-oriented. Cash
instruments are sold to satisfy customers' investment needs. Derivative
contracts are initially entered into to satisfy the risk management needs of
customers. In general, the Corporation then enters into offsetting positions
to reduce market risk. In order to accommodate customers, an inventory of
capital markets instruments is carried, and access to market liquidity is
24
maintained by making bid-offer prices to other market makers. The Corporation
may also take proprietary positions in various capital markets cash
instruments and derivatives, and these positions are designed to profit from
anticipated changes in market factors.
Many trading positions are kept open for brief periods of time, often less
than one day. Other positions may be held for longer periods. Trading
positions are valued at estimated fair value. Realized and unrealized gains
and losses on these positions are included in noninterest income as trading
profits.
The Corporation manages its market risk through a value-at-risk measurement
and control system, through stress testing, and through dollar limits imposed
on trading desks and individual traders. Value-at-risk is intended to measure
the maximum fair value the Corporation could lose on a trading position, given
a specified confidence level and time horizon. The overall market risk that
any line of business can assume, as measured by value-at-risk, is approved by
the Risk Management Committee of the Board of Directors. Value-at-risk limits
and exposure are monitored on a daily basis for each significant trading
portfolio. Stress testing is similar to value-at-risk except that the
confidence level is geared to capture more extreme, less frequent market
events.
The following table shows average, high and low value-at-risk derived from
the four quarter-ends of 1998, along with value-at-risk figures for December
31, 1998, and December 31, 1997. The activities covered by the table include
trading activities and certain other activities, primarily investment
securities classified as available-for-sale, that are managed principally as
trading risk. During 1998, the Corporation modified the confidence level used
for the calculation of value-at-risk to 99% from 99.87%. This change was made
to make the value-at-risk figures more comparable to those of other financial
institutions, and to gain consistency with regulatory requirements. All
amounts in the following table are calculated at the 99% confidence level.
Value-At-Risk
1998 1998 1998 December 31, December 31,
Average High Low 1998 1997
(In millions) ------- ---- ---- ------------ ------------
Risk Type
Interest rate..................... $23 $27 $16 $27 $20
Exchange rate..................... 2 2 1 2 5
Equity............................ 2 3 1 2 2
Commodity......................... -- 1 -- -- 1
Diversification benefit........... (2) (2)
--- ---
Aggregate portfolio market risk..... $29 $26
=== ===
The Corporation's value-at-risk calculation measures potential losses in
fair value using a 99% confidence level and a one-day time horizon. Value-at-
risk is calculated using various statistical models and techniques for cash
and derivative positions including options. Through the use of observed
statistical correlations, the Corporation is able to recognize risk-reducing
diversification benefits across certain trading portfolios. However, the
reported value-at-risk remains somewhat overstated because not all offsets and
correlations are fully considered in the calculation.
Interest rate risk was the predominant type of market risk incurred during
1998. As of December 31, 1998, before taking diversification benefits into
account, approximately 87% of primary market risk exposures were related to
interest rate risk. Exchange rate, equity and commodity risks accounted for
6%, 6% and 1%, respectively, of primary market risk exposures.
Approximately 49% of interest rate risk was generated by U.S. Treasury
securities and mortgage-backed securities. Interest rate derivatives accounted
for 21% of total interest rate risk. About 11% of interest rate risk was
generated by municipal securities, and 10% by corporate securities. The
remaining interest rate risk was derived from money market, foreign exchange
and various other trading activities.
25
Within the category of exchange rate risk, 82% of the risk was generated by
foreign exchange spot, forward and option trading. Of the exchange rate risk
arising from these activities, 60% related to major currency exposures and 40%
to minor currencies. The remaining exchange rate risk was largely from
interest rate and equity derivatives trading.
Equity price risk was primarily generated by equity derivatives trading
activities in Chicago, London and Tokyo.
Commodity price risk was generated by the Corporation's commodity
derivatives desk in Chicago, which specializes in those products eligible for
bank trading under regulatory requirements.
At December 31, 1998, market risk exposures were 11% higher than at year-end
1997. This increase is attributable to a 35% increase in reported interest
rate risk, primarily reflecting increased positions in U. S. Treasury,
mortgage-backed and municipal securities. It should also be noted that
increased market volatility in the second half of 1998 had the effect of
increasing value-at-risk calculations, which are a function of historical
volatility.
Structural Interest Rate Risk Management
Interest rate risk exposure in the Corporation's non-trading activities
(i.e., asset liability management ("ALM") position) is created from repricing,
option and basis risks that exist in on- and off-balance-sheet positions.
Repricing risk occurs when interest-rate-sensitive financial asset or
liability positions reprice at different times as interest rates change. Basis
risk arises from a shift in the relationship of the rates on different
financial instruments. Option risk is due to "embedded options" often present
in customer products including interest rate, prepayment and early withdrawal
options; administered interest rate products; deposit products with no
contractual maturity structure; and certain off-balance sheet sensitivities.
These embedded option positions are complex risk positions that are difficult
to offset completely and, thus, represent the primary risk of loss to the
Corporation.
The Corporation's policies strictly limit which business units are permitted
to assume interest rate risk. The level of interest rate risk that can be
taken is closely monitored and managed by a comprehensive risk control
process. The Market and Investment Risk Management Committee, consisting of
senior executives of the finance group, credit and market risk oversight
units, and line of business units, are responsible for establishing the market
risk parameters acceptable for the Corporation's ALM position. Through these
parameters the Committee balances the return potential of the ALM position
against the desire to limit volatility in earnings and/or economic value. The
ALM position is measured and monitored using sophisticated and detailed risk
management tools, including earnings simulation modeling and economic value of
equity sensitivity analysis, to capture both near-term and longer-term
interest rate risk exposures. The Committee establishes the risk measures,
risk limits, policy guidelines and the internal control mechanisms
(collectively referred to as the Interest Rate Risk Policy) for managing
overall ALM exposure. The Interest Rate Risk Policy is reviewed and approved
by a committee of the Board of Directors.
Earnings simulation analysis, or earnings-at-risk, measures the sensitivity of
pretax earnings to various interest rate movements. The base-case scenario is
established using the forward yield curve. The comparative scenarios assume an
immediate parallel shock of the forward curve in increments of plus or minus 100
basis point rate movements. Additional scenarios are analyzed, including more
gradual rising or falling rate changes and non-parallel rate shifts. The
interest rate scenarios are used for analytical purposes and do not necessarily
represent management's view of future market movements. Estimated earnings for
each scenario are calculated over a forward-looking 12 month horizon.
26
The Corporation's earnings sensitivity profile as of year-end 1998 and 1997
is stated below.
Immediate
Change in Rates
---------------
-100 bp +100 bp
Pretax earnings change ------- -------
December 31, 1998............................................... 1.5% (1.8)%
==== ======
December 31, 1997............................................... 1.7% (1.4)%
==== ======
Assumptions are made in modeling the sensitivity of earnings to interest
rate changes. For residential mortgage whole loans, mortgage-backed securities
and collateralized mortgage obligations, the earnings simulation model
captures the expected prepayment behavior under changing interest rate
environments. Additionally, the model measures the impact of interest rate
caps and floors on adjustable-rate products. Assumptions regarding the
interest rate or balance behavior of indeterminate maturity products (savings,
money market, NOW and demand deposits) reflect management's best estimate of
expected future behavior. Sensitivity of service fee income to market interest
rate levels, such as those related to securitized credit card receivables and
cash management products, is included as well.
For some embedded option positions, the risk exposure occurs at a time
period beyond the 12 months captured in earnings sensitivity analysis.
Management utilizes a market value of equity sensitivity technique to capture
the risk in these longer-term risk positions. This analysis involves
calculating future cash flows over the full life of all current assets,
liabilities and off-balance-sheet positions under hundreds of different rate
paths. The discounted present value of all cash flows represents the
Corporation's economic value of equity. The change in this economic value of
equity to shifts in the yield curve allows management to measure longer-term
repricing and option risk in the portfolio. Interest rate risk in trading
activities and other activities, primarily certain investment securities
classified as available-for-sale, is managed principally as trading risk.
Access to the derivatives market is an important element in maintaining the
Corporation's desired interest rate risk position. In general, the assets and
liabilities generated through ordinary business activities do not naturally
create offsetting positions with respect to repricing, basis or maturity
characteristics. Using off-balance-sheet instruments, principally plain
vanilla interest rate swaps (ALM swaps), the interest rate sensitivity of
specific on-balance-sheet transactions, as well as pools of assets or
liabilities, is adjusted to maintain the desired interest rate risk profile.
At December 31, 1998, the notional value of ALM interest rate swaps totaled
$26.1 billion, including $13.5 billion against specific transactions and $12.6
billion against specific pools of assets or liabilities.
Asset and Liability Management Derivatives--Notional Principal
Pay Fixed
Receive Fixed Receive
December 31, 1998 (In Pay Floating Floating Basis Swaps
millions) --------------- --------------- ------------- Total
Specific Pool Specific Pool Specific Pool Swaps
-------- ------ -------- ------ -------- ---- -------
Swaps associated with:
Loans.................. $ -- $5,327 $ 341 $2,825 $ -- $400 $ 8,893
Investment securities.. 273 -- 1,213 -- 154 -- 1,640
Deposits............... 20 3,421 -- -- -- -- 3,441
Funds borrowed
(including long-term
debt)................. 11,060 -- 375 100 50 552 12,137
------- ------ ------ ------ ---- ---- -------
Total................ $11,353 $8,748 $1,929 $2,925 $204 $952 $26,111
======= ====== ====== ====== ==== ==== =======
27
Swaps used to adjust the interest rate sensitivity of specific transactions
will not need to be replaced at maturity, since the corresponding asset or
liability will mature along with the swap. However, swaps against the asset
and liability pools will have an impact on the overall risk position as they
mature and may need to be reissued to maintain the same interest rate risk
profile. These swaps could create modest earnings sensitivity to changes in
interest rates.
The notional amounts, expected maturity, and weighted average pay and
receive rates for the ALM swap position at December 31, 1998, are summarized
below. For generic swaps, the maturities are contractual. In the table below,
the variable interest rates--which generally are the prime rate, federal funds
rate or the one-month, three-month and six-month London interbank offered
rates ("LIBOR") in effect on the date of repricing--are assumed to remain
constant. However, interest rates will change and consequently will affect the
related weighted average information presented in the table.
Asset and Liability Management Swaps--Maturities and Rates
December 31, 1998 (Dollars 1999 2000 2001 2002 2003 Thereafter Total
in millions) ------- ------ ------ ------ ------ ---------- -------
Receive fixed/pay floating
swaps
Notional amount......... $ 8,452 $2,117 $1,754 $1,422 $2,056 $4,300 $20,101
Weighted average
Receive rate.......... 6.16% 6.27% 6.64% 6.84% 6.26% 6.70% 6.39%
Pay rate.............. 5.36% 5.22% 5.34% 5.48% 5.42% 5.41% 5.34%
Pay fixed/receive floating
swaps
Notional amount......... $ 1,622 $1,560 $ 305 $ 629 $ 266 $ 472 $ 4,854
Weighted average
Receive rate.......... 5.37% 5.38% 5.43% 5.39% 5.53% 5.25% 5.38%
Pay rate.............. 6.13% 6.10% 6.21% 5.89% 6.14% 6.05% 6.09%
Basis swaps
Notional amount......... $ 755 $ 197 $ 50 $ -- $ -- $ 154 $ 1,156
------- ------ ------ ------ ------ ------ -------
Total notional amount..... $10,829 $3,874 $2,109 $2,051 $2,322 $4,926 $26,111
======= ====== ====== ====== ====== ====== =======
Foreign Exchange Risk Management
Whenever possible, foreign currency-denominated assets are funded with
liability instruments denominated in the same currency. If a liability
denominated in the same currency is not immediately available or desired, a
forward foreign exchange contract is used to fully hedge the risk due to
cross-currency funding.
To minimize the earnings and capital impact of translation gains or losses
measured on an after-tax basis, the Corporation uses forward foreign exchange
contracts to hedge the exposure created by investments in overseas branches
and subsidiaries.
Credit Risk Management
The Corporation has developed policies and procedures to manage the level
and composition of risk in its credit portfolio. The objective of this credit
risk management process is to quantify and manage credit risk on a portfolio
basis as well as to reduce the risk of a loss resulting from a customer's
failure to perform according to the terms of a transaction.
Customer transactions create credit exposure that is reported both on and
off the balance sheet. On-balance-sheet credit exposure includes such items as
loans. Off-balance-sheet credit exposure includes unfunded credit commitments
and other credit-related financial instruments. Credit exposure resulting from
derivative financial instruments are reported both on and off the balance
sheet; see page 35 for more details.
28
Selected Statistical Information
1998 1997 1996 1995 1994
(Dollars in millions) -------- -------- -------- -------- --------
At year-end
Loans outstanding.......... $155,398 $159,579 $153,496 $138,478 $125,145
Nonperforming loans........ 729 609 536 661 614
Other real estate owned.... 90 61 71 99 140
Nonperforming assets....... 819 670 607 760 754
Allowance for credit
losses.................... 2,271 2,817 2,687 2,422 2,192
Nonperforming assets/loans
outstanding and other real
estate owned.............. 0.53% 0.42% 0.40% 0.55% 0.60%
Allowance for credit
losses/loans outstanding.. 1.46 1.77 1.75 1.75 1.75
Allowance for credit
losses/nonperforming
loans..................... 312 463 501 366 357
For the year
Average loans.............. $154,952 $155,926 $146,094 $130,614 $117,145
Net charge-offs............ 1,498 1,887 1,522 768 561
Net charge-offs/average
loans..................... 0.97% 1.21% 1.04% 0.59% 0.48%
For analytical purposes, the Corporation's portfolio is divided into
commercial, consumer and credit card segments.
Loan Composition
1998 1997 1996 1995 1994
December 31 (In millions) -------- -------- -------- -------- --------
Commercial
Domestic
Commercial..................... $ 53,362 $ 48,458 $ 44,791 $ 40,587 $ 36,914
Real estate
Construction................. 5,108 4,639 4,387 3,820 3,191
Other........................ 17,787 16,545 16,016 15,106 14,105
Lease financing................ 6,236 4,537 4,258 3,335 2,631
Foreign.......................... 5,945 5,127 4,160 3,984 3,452
-------- -------- -------- -------- --------
Total commercial........... 88,438 79,306 73,612 66,832 60,293
Consumer
Residential real estate.......... 12,215 15,221 14,862 14,665 13,651
Home equity...................... 13,589 12,867 12,079 9,384 7,823
Automotive (1)................... 20,634 17,998 17,293 15,946 16,030
Student.......................... 3,129 3,219 3,304 2,856 2,779
Other............................ 8,359 8,303 7,491 7,270 7,309
-------- -------- -------- -------- --------
Total consumer............. 57,926 57,608 55,029 50,121 47,592
Credit card (2).................... 9,034 22,665 24,855 21,525 17,260
-------- -------- -------- -------- --------
Total...................... $155,398 $159,579 $153,496 $138,478 $125,145
======== ======== ======== ======== ========
- --------
(1) Includes auto lease receivables.
(2) During 1998, the Corporation's certificated retained interest in credit
card securitizations were reclassified to investment securities--
available-for-sale. At December 31, 1998, the certificated retained
interest totaled $16.7 billion.
29
Allowance for Credit Losses
The allowance for credit losses is maintained at a level that in
management's judgment is adequate to provide for estimated probable credit
losses inherent in various on- and off-balance-sheet financial instruments.
The level of the allowance reflects management's formal review and analysis of
potential credit losses, as well as prevailing economic conditions.
Analysis of Allowance for Credit Losses
1998 1997 1996 1995 1994
(In millions) ------ ------ ------ ------ ------
Balance, beginning of year................ $2,817 $2,687 $2,422 $2,192 $2,222
Provision for credit losses............... 1,408 1,988 1,716 1,067 558
Charge-offs
Commercial
Domestic
Commercial.......................... 222 200 174 137 118
Real estate
Construction.......................