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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 1-9861
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FIRST EMPIRE STATE CORPORATION
(Exact name of registrant as specified in its charter)
NEW YORK 16-0968385
(State of incorporation) (I.R.S. Employer Identification No.)
ONE M&T PLAZA, BUFFALO, NEW YORK 14240
(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code:
(716)842-5445
Securities registered pursuant to Section 12(b) of the Act:
COMMON STOCK, $5 PAR VALUE AMERICAN STOCK EXCHANGE
(Title of each class) (Name of each exchange on which registered)
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
8.234% CAPITAL SECURITIES OF FIRST EMPIRE CAPITAL TRUST I
(AND THE GUARANTEE OF FIRST EMPIRE STATE CORPORATION WITH RESPECT THERETO)
(Title of class)
8.234% JUNIOR SUBORDINATED DEBENTURES OF
FIRST EMPIRE STATE CORPORATION
(Title of class)
8.277% CAPITAL SECURITIES OF FIRST EMPIRE CAPITAL TRUST II
(AND THE GUARANTEE OF FIRST EMPIRE STATE CORPORATION WITH RESPECT THERETO)
(Title of class)
8.277% JUNIOR SUBORDINATED DEBENTURES OF
FIRST EMPIRE STATE CORPORATION
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, 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 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. / /
Aggregate market value of the Common Stock, $5 par value, held by
non-affiliates of the registrant, computed by reference to the closing price as
of the close of business on March 5, 1998: $2,261,267,227.
Number of shares of the Common Stock, $5 par value, outstanding as of the
close of business on March 5, 1998: 6,666,230 shares.
DOCUMENTS INCORPORATED BY REFERENCE:
(1) PORTIONS OF THE PROXY STATEMENT FOR THE 1998 ANNUAL MEETING OF STOCKHOLDERS
OF FIRST EMPIRE STATE CORPORATION IN PART III.
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FIRST EMPIRE STATE CORPORATION
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1997
FORM
10-K
PAGE
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CROSS-REFERENCE SHEET
PART I
Item 1. Business........................................................................................ 5
Statistical disclosure pursuant to Guide 3
I. Distribution of assets, liabilities, and stockholders' equity; interest rates and interest
differential
A. Average balance sheets............................................................. 42-43
B. Interest income/expense and resulting yield or rate on average interest-earning
assets (including non-accrual loans) and interest-bearing liabilities.............. 42-43
C. Rate/volume variances.............................................................. 18
II. Investment portfolio
A. Year-end balances.................................................................. 15
B. Maturity schedule and weighted average yield....................................... 53
C. Aggregate carrying value of securities that exceed ten percent of stockholders'
equity............................................................................. 66
III. Loan portfolio
A. Year-end balances.................................................................. 15,68
B. Maturities and sensitivities to changes in interest rates.......................... 51
C. Risk elements......................................................................
Nonaccrual, past-due and renegotiated loans........................................ 48
Actual and pro forma interest on certain loans..................................... 68
Nonaccrual policy.................................................................. 61
Loan concentrations................................................................ 29
IV. Summary of loan loss experience...............................................................
A. Analysis of the allowance for loan losses.......................................... 46
Factors influencing management's judgment concerning the adequacy of the allowance
and provision...................................................................... 28,61
B. Allocation of the allowance for loan losses........................................ 47
V. Deposits
A. Average balances and rates......................................................... 42-43
B. Maturity schedule of domestic time deposits with balances of $100,000 or more...... 49
VI. Return on equity and assets................................................................... 17,23,33-34
2
FIRST EMPIRE STATE CORPORATION
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1997
FORM
10-K
PAGE
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CROSS-REFERENCE SHEET--continued
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PART I. continued
Item 1. Business, continued
VII. Short-term borrowings........................................................................... 71-72
Item 2. Properties...................................................................................... 19,69-70
Item 3. Legal Proceedings............................................................................... 19
Item 4. Submission of Matters to a Vote of Security Holders............................................. 19
Executive Officers of the Registrant............................................................ 19-21
PART II
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters..................................................................... 22
A. Principal market...................................................................
Market prices 22
B. Approximate number of holders at year-end.......................................... 37-38
C. Frequency and amount of dividends declared......................................... 15
D. Restrictions on dividends.......................................................... 10,89
Item 6. Selected Financial Data
A. Selected consolidated year-end balances............................................ 15
B. Consolidated earnings, etc......................................................... 16-17
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................................................... 22-53
Item 7A. Quantitative and Qualitative Disclosures About Market Risk...................................... 31,33,50
Item 8. Financial Statements and Supplementary Data
A. Report of Independent Accountants.................................................. 55
B. Consolidated Balance Sheet--
December 31, 1997 and 1996......................................................... 56
3
FIRST EMPIRE STATE CORPORATION
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1997
FORM
10-K
PAGE
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CROSS-REFERENCE SHEET--continued
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PART II. continued
Item 8. Financial Statements and Supplementary Data, continued
C. Consolidated Statement of Income--
Years ended December 31, 1997, 1996 and 1995....................................... 57
D. Consolidated Statement of Cash Flows--
Years ended December 31, 1997, 1996 and 1995....................................... 58
E. Consolidated Statement of Changes in
Stockholders' Equity--Years ended December 31,
1997, 1996 and 1995................................................................ 59
F. Notes to Financial Statements...................................................... 60-93
G. Quarterly Trends................................................................... 38
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure.......................................................... 94
PART III
Item 10. Directors and Executive Officers of the Registrant............................................. 94
Item 11. Executive Compensation......................................................................... 94
Item 12. Security Ownership of Certain Beneficial Owners and Management................................. 94
Item 13. Certain Relationships and Related Transactions................................................. 94
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K................................ 95
Signatures............................................................................................... 96-98
Exhibit Index............................................................................................ 99-101
4
PART I
ITEM 1. BUSINESS.
First Empire State Corporation ("Registrant" or "First Empire") is a New
York business corporation which is registered as a bank holding company under
the Bank Holding Company Act of 1956, as amended ("BHCA") and under Article
III-A of the New York Banking Law ("Banking Law"). The principal executive
offices of the Registrant are located at One M&T Plaza, Buffalo, New York 14240.
The Registrant was incorporated in November 1969. The Registrant and its direct
and indirect subsidiaries are collectively referred to herein as the "Company".
As of December 31, 1997, the Company had consolidated total assets of $14.0
billion, deposits of $11.2 billion and stockholders' equity of $1.0 billion. The
Company had 4,359 full-time and 724 part-time employees as of December 31, 1997.
At December 31, 1997, the Registrant had two wholly owned bank subsidiaries:
Manufacturers and Traders Trust Company ("M&T Bank") and M&T Bank, National
Association ("M&T Bank, N.A."). The banks offer a wide range of commercial
banking, trust and investment services to their customers. The East New York
Savings Bank ("East New York"), formerly a wholly owned savings bank subsidiary
of the Registrant, was merged with and into M&T Bank on May 24, 1997. At
December 31, 1997, M&T Bank represented 95% of consolidated assets of the
Company.
On October 28, 1997, First Empire entered into a definitive agreement with
ONBANCorp, Inc. ("ONBANCorp"), a bank holding company headquartered in Syracuse,
New York, for a merger between the two companies. ONBANCorp operates two wholly
owned banking subsidiaries, OnBank & Trust Co., which has 59 offices in upstate
New York, and Franklin First Savings Bank in Wilkes-Barre, Pennsylvania, which
has 19 offices in northeastern Pennsylvania. Upon consummation of the merger,
the banking subsidiaries of ONBANCorp will be merged into M&T Bank. At December
31, 1997, ONBANCorp had $5.3 billion of assets. The merger, which will be
accounted for as a purchase, is subject to a number of conditions, including the
approval of stockholders of both companies, and is currently expected to be
consummated on or about April 1, 1998. Under the terms of the merger agreement,
stockholders of ONBANCorp will have the option to receive .161 of a share of
First Empire common stock (and cash in lieu of any fractional share) or $69.50
in cash in exchange for each share of ONBANCorp common stock. The merger
agreement provides that a minimum of 60% and a maximum of 70% of the total
number of shares of ONBANCorp common stock issued and outstanding immediately
prior to the merger will be exchanged for shares of First Empire common stock.
In the event that ONBANCorp's stockholders as a whole elect to receive stock
consideration with respect to fewer than 60% or more than 70% of the total
number of outstanding shares of ONBANCorp common stock, the selection by
ONBANCorp's common stockholders of the method of payment is subject to
allocation and proration to ensure that the number of shares of ONBANCorp common
stock that are converted into shares of First Empire common stock will be not
less than 60% nor more than 70%, as the case may be, of the total number of
shares of ONBANCorp common stock issued and outstanding immediately prior to the
merger. At February 3, 1998 ONBANCorp had 12,712,196 shares of common stock
issued and outstanding. The merger is subject to the approval of stockholders of
both companies and is expected to be completed on or about April 1, 1998.
The Company from time to time considers acquiring banks, thrift
institutions, branch offices or other businesses within markets currently served
or in other nearby markets. The Company has pursued acquisition opportunities in
the past, continues to review different opportunities, including the possibility
of major acquisitions, and intends to continue this practice.
5
SUBSIDIARIES
M&T Bank is a banking corporation which is incorporated under the laws of
the State of New York. M&T Bank is a member of the Federal Reserve System and
the Federal Home Loan Bank System, and its deposits are insured by the Federal
Deposit Insurance Corporation ("FDIC") up to applicable limits. First
Empire acquired all of the issued and outstanding shares of the capital stock of
M&T Bank in December 1969. The stock of M&T Bank represents a major asset of
First Empire. M&T Bank operates under a charter granted by the State of New York
in 1892, and the continuity of its banking business is traced to the
organization of the Manufacturers and Traders Bank in 1856. The principal
executive offices of M&T Bank are located at One M&T Plaza, Buffalo, New York
14240. As of December 31, 1997, M&T Bank had 178 banking offices located
throughout New York State, plus a branch in Nassau, The Bahamas. As of December
31, 1997, M&T Bank had consolidated total assets of $13.4 billion, deposits of
$10.8 billion and stockholder's equity of $1.0 billion. The deposit liabilities
of M&T Bank are insured by the FDIC through either its Bank Insurance Fund
("BIF") or its Savings Association Insurance Fund ("SAIF"). Of M&T Bank's $10.8
billion in assessable deposits at December 31, 1997, 89% were assessed as
BIF-insured and the remainder as SAIF-insured deposits. As a commercial bank,
M&T Bank offers a broad range of financial services to a diverse base of
consumers, businesses, professional clients, governmental entities and financial
institutions located in its markets. Lending is largely focused on consumers
residing in New York State and on New York-based small and medium-size
businesses, however certain of M&T Bank's subsidiaries conduct lending
activities in markets outside of New York State. M&T Bank, or certain of its
subsidiaries, also offer commercial mortgage loans secured by income producing
properties or properties used by borrowers in a trade or business. Other
financial services are also provided through operating subsidiaries.
M&T Bank, N.A., a national bank and a member of the Federal Reserve System
and the FDIC, commenced operations on October 2, 1995. The deposit liabilities
of M&T Bank, N.A. are insured by the FDIC through the BIF. The main office of
M&T Bank, N.A. is located at 48 Main Street, Oakfield, New York 14125. M&T Bank,
N.A. offers selected deposit and loan products on a nationwide basis, primarily
through direct mail and telephone marketing techniques. M&T Bank, N.A. is also a
licensed insurance agency, and offers long-term care, disability and life
insurance services, primarily through banking offices of M&T Bank. As of
December 31, 1997, M&T Bank, N.A. had total assets of $703 million, deposits of
$651 million and stockholder's equity of $52 million.
M&T Capital Corporation ("M&T Capital"), a wholly owned subsidiary of M&T
Bank, was incorporated as a New York business corporation in January 1968.
M&T Capital is a federally-licensed small business investment company
operating under the provisions of the Small Business Investment Act of 1958,
as amended. During 1997, the Corporation's strategy was to continue the
liquidation of its investments, while managing the remainder of its existing
investment portfolio. Upon liquidation of its only significant remaining
portfolio investment, it is the Company's current intention to surrender its
license to the Small Business Administration. M&T Capital had assets and
stockholder's equity of approximately $2 million as of December 31, 1997, and
recorded approximately $2.9 million of revenues in 1997. The headquarters of
M&T Capital are located at One M&T Plaza, Buffalo, New York 14240.
M&T Credit Corporation ("M&T Credit"), a wholly owned subsidiary of M&T
Bank, was incorporated as a New York business corporation in April 1994. M&T
Credit is a consumer credit company with headquarters at One M&T Plaza, Buffalo,
New York 14240, and offices in Pennsylvania. As of December 31, 1997, M&T Credit
had assets of $291 million and stockholder's equity of $1.4 million. M&T Credit
recorded $24.9 million of revenues during 1997.
M&T Mortgage Corporation ("M&T Mortgage"), the wholly owned mortgage banking
subsidiary of M&T Bank, was incorporated as a New York business corporation
6
in November 1991. M&T Mortgage's principal activities are comprised of the
origination of residential mortgage loans and providing residential mortgage
loan servicing to M&T Bank, M&T Bank, N.A. and others. M&T Mortgage operates
throughout New York State, and also maintains branch offices in Arizona,
Colorado, Massachusetts, Ohio, Oregon, Utah and Washington. M&T Mortgage had
assets of $393 million and stockholder's equity of $101 million as of
December 31, 1997, and recorded approximately $82.0 million of revenues
during 1997. Residential mortgage loans serviced by M&T Mortgage for
non-affiliates totaled $7.5 billion at December 31, 1997. The headquarters of
M&T Mortgage are located at M&T Center, One Fountain Plaza, Buffalo, New York
14203.
M&T Financial Corporation ("M&T Financial"), a New York business
corporation, is a wholly owned subsidiary of M&T Bank which specializes in
capital-equipment leasing. M&T Financial was formed in October 1985, had assets
of $79 million and stockholder's equity of $17 million as of December 31, 1997,
and recorded approximately $1.0 million of revenues in 1997. The headquarters of
M&T Financial are located at One M&T Plaza, Buffalo, New York 14240.
M&T Real Estate, Inc.("M&T Real Estate") is a subsidiary of M&T Bank which
was incorporated as a New York business corporation in August 1995. M&T Bank
owns all of the outstanding common and 87.4% of the preferred stock of M&T Real
Estate. The remaining 12.6% of M&T Real Estate's preferred stock is owned by
officers or former officers of the Company. M&T Real Estate engages in
commercial real estate lending and servicing activities. As of December 31,
1997, M&T Real Estate had assets and stockholder's equity of $4.1 billion. M&T
Real Estate recorded $338 million of revenues in 1997. The headquarters of M&T
Real Estate are located at M&T Center, One Fountain Plaza, Buffalo, New York
14203.
M&T Securities, Inc. ("M&T Securities") is a wholly owned subsidiary of M&T
Bank which was incorporated as a New York business corporation in November 1985.
M&T Securities is registered as a broker/dealer under the Securities Exchange
Act of 1934, as amended, and as an investment advisor under the Investment
Advisors Act of 1940, as amended, and is licensed as an insurance agent. It
provides securities brokerage and investment advisory services. As of December
31, 1997, M&T Securities had assets of $7 million and stockholder's equity of $4
million. M&T Securities recorded $18 million of revenues during 1997. The
headquarters of M&T Securities are located at One M&T Plaza, Buffalo, New York
14240.
Highland Lease Corporation ("Highland Lease"), a wholly owned subsidiary of
M&T Bank, was incorporated as a New York business corporation in October 1994.
Highland Lease is a consumer leasing company with headquarters at One M&T Plaza,
Buffalo, New York 14240. As of December 31, 1997, Highland Lease had assets of
$136 million and stockholder's equity of $10 million. Highland Lease recorded
$10 million of revenues during 1997.
During 1997, the Company formed two Delaware business trusts to issue
preferred capital securities ("Capital Securities"). First Empire Capital Trust
I ("Trust I") issued $150 million of 8.234% Capital Securities on January 17,
1997, and First Empire Capital Trust II ("Trust II") issued $100 million of
8.277% Capital Securities on May 30, 1997. The common securities ("Common
Securities") of Trust I and Trust II are wholly owned by First Empire, and such
securities are the only class of each Trust's securities possessing general
voting powers. The Capital Securities represent preferred undivided interests in
the assets of the corresponding Trusts and are classified in the Company's
consolidated balance sheet as long-term borrowings, with accumulated
distributions on such securities included in interest expense. Under the Federal
Reserve Board's current risk-based capital guidelines, the Capital Securities
are includable in First Empire's Tier 1 capital. The proceeds from the issuance
of the Capital Securities
7
and the Common Securities were used by the Trusts to purchase junior
subordinated deferrable interest debentures issued by First Empire. The
junior subordinated debentures represent the sole assets of each Trust and
payments under the junior subordinated debentures are the sole source of cash
flow for each Trust. As of December 31, 1997, Trust I had assets of $160
million and stockholders' equity of $155 million, and during 1997 Trust I
recorded $11.7 million of revenues. Trust II had assets of $104 million and
stockholders' equity of $103 million at December 31, 1997, and during 1997
Trust II recorded $4.9 million of revenues.
The Registrant and its banking subsidiaries have a number of other
special-purpose or inactive subsidiaries. These other subsidiaries represented,
individually and collectively, an insignificant portion of the Company's
consolidated assets, net income and stockholders' equity at December 31, 1997.
LINES OF BUSINESS, PRINCIPAL SERVICES, INDUSTRY SEGMENTS AND FOREIGN OPERATIONS
Commercial and retail banking, with activities incidental thereto,
represents the sole significant line and/or segment of business of the Company.
The Company's international activities are discussed in note 14 of Notes to
Financial Statements filed herewith in Part II, Item 8, "Financial Statements
and Supplementary Data". The only activities that, as a class, contributed 10%
or more of the sum of consolidated interest income and other income in each of
the last three years were lending and investment securities transactions. The
amount of income from such sources during those years is set forth on the
Company's Consolidated Statement of Income filed herewith in Part II, Item 8,
"Financial Statements and Supplementary Data".
SUPERVISION AND REGULATION
The banking industry is subject to extensive state and federal regulation
and continues to undergo significant change. In 1991, the Federal Deposit
Insurance Corporation Improvement Act ("FDICIA") was enacted. FDICIA
substantially amended the Federal Deposit Insurance Act ("FDI Act") and certain
other statutes. Since FDICIA's enactment, the federal bank regulatory agencies
have adopted regulations to implement its statutory provisions.
The following discussion summarizes certain aspects of the banking laws and
regulations that affect the Company. Proposals to change the laws and
regulations governing the banking industry are frequently raised in Congress, in
state legislatures, and before the various bank regulatory agencies. The
likelihood and timing of any changes and the impact such changes might have on
the Company are impossible to determine with any certainty. A change in
applicable laws or regulations, or a change in the way such laws or regulations
are interpreted by regulatory agencies or courts, may have a material impact on
the business, operations and earnings of the Company. To the extent that the
following information describes statutory or regulatory provisions, it is
qualified entirely by reference to the particular statutory or regulatory
provision.
BANK HOLDING COMPANY REGULATION
As a registered bank holding company, the Registrant and its nonbank
subsidiaries are subject to supervision and regulation under the BHCA by the
Board of Governors of the Federal Reserve System ("Federal Reserve Board") and
the New York State Banking Superintendent ("Banking Superintendent"). The
Federal Reserve Board requires regular reports from the Registrant and is
authorized by the BHCA to make regular examinations of the Registrant and its
subsidiaries.
8
Under the BHCA, the Registrant may not acquire direct or indirect ownership
or control of more than 5% of the voting shares of any company, including a
bank, without the prior approval of the Federal Reserve Board, except as
specifically authorized under the BHCA. The Registrant is also subject to
regulation under the Banking Law with respect to certain acquisitions of
domestic banks. Under the BHCA, the Registrant, subject to the approval of the
Federal Reserve Board, may acquire shares of non-banking corporations the
activities of which are deemed by the Federal Reserve Board to be so closely
related to banking or managing or controlling banks as to be a proper incident
thereto.
The Federal Reserve Board has enforcement powers over bank holding companies
and their non-banking subsidiaries, among other things, to interdict activities
that represent unsafe or unsound practices or constitute violations of law,
rule, regulation, administrative orders or written agreements with a federal
bank regulator. These powers may be exercised through the issuance of
cease-and-desist orders, civil money penalties or other actions.
Under the Federal Reserve Board's statement of policy with respect to bank
holding company operations, a bank holding company is required to serve as a
source of financial strength to its subsidiary depository institutions and to
commit all available resources to support such institutions in circumstances
where it might not do so absent such policy. Although this "source of strength"
policy has been challenged in litigation, the Federal Reserve Board continues to
take the position that it has authority to enforce it. For a discussion of
circumstances under which a bank holding company may be required to guarantee
the capital levels or performance of its subsidiary banks, SEE CAPITAL ADEQUACY,
below. The Federal Reserve also has the authority to terminate any activity of a
bank holding company that constitutes a serious risk to the financial soundness
or stability of any subsidiary depository institution or to terminate its
control of any bank or nonbank subsidiaries.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, as
amended (the "Interstate Banking Act") generally permits bank holding companies
to acquire banks in any state, and preempts all state laws restricting the
ownership by a bank holding company of banks in more than one state. The
Interstate Banking Act also permits a bank to merge with an out-of-state bank
and convert any offices into branches of the resulting bank if both states have
not opted out of interstate branching; permits a bank to acquire branches from
an out-of-state bank if the law of the state where the branches are located
permits the interstate branch acquisition; and permits banks to establish and
operate DE NOVO interstate branches whenever the host state opts-in to DE NOVO
branching. Bank holding companies and banks seeking to engage in transactions
authorized by the Interstate Banking Act must be adequately capitalized and
managed.
The Banking Law authorizes interstate branching by merger or acquisition on
a reciprocal basis, and permits the acquisition of a single branch without
restriction, but does not provide for DE NOVO interstate branching.
Bank holding companies and their subsidiary banks are also subject to the
provisions of the Community Reinvestment Act of 1977 ("CRA"). Under the terms of
the CRA, the Federal Reserve Board (or other appropriate bank regulatory agency)
is required, in connection with its examination of a bank, to assess such bank's
record in meeting the credit needs of the community served by that bank,
including low-and moderate-income neighborhoods. Furthermore, such assessment is
also required of any bank that has applied, among other things, to merge or
consolidate with or acquire the assets or assume the liabilities of a
federally-regulated financial institution, or to open or relocate a branch
office. In the case of a bank holding company
9
applying for approval to acquire a bank or bank holding company, the Federal
Reserve Board will assess the record of each subsidiary bank of the applicant
bank holding company in considering the application. The Banking Law contains
provisions similar to the CRA which are applicable to New York-chartered
banks.
SUPERVISION AND REGULATION OF BANK SUBSIDIARIES
The Registrant's banking subsidiaries are subject to supervision and
regulation, and are examined regularly, by various bank regulatory agencies: M&T
Bank by the Federal Reserve Board and the Banking Superintendent; and M&T Bank,
N.A. by the Comptroller of the Currency (the "OCC"). The Registrant and its
direct non-banking subsidiaries are affiliates, within the meaning of the
Federal Reserve Act, of the Registrant's subsidiary banks and their
subsidiaries. As a result, the Registrant's subsidiary banks and their
subsidiaries are subject to restrictions on loans or extensions of credit to,
purchases of assets from, investments in, and transactions with the Registrant
and its direct non-banking subsidiaries and on certain other transactions with
them or involving their securities.
Under the "cross-guarantee" provisions of the FDI Act, insured depository
institutions under common control are required to reimburse the FDIC for any
loss suffered by either the BIF or SAIF of the FDIC as a result of the default
of a commonly controlled insured depository institution or for any assistance
provided by the FDIC to a commonly controlled insured depository institution in
danger of default. Thus, any insured depository institution subsidiary of First
Empire could incur liability to the FDIC in the event of a default of another
insured depository institution owned or controlled by First Empire. The FDIC's
claim under the cross-guarantee provisions is superior to claims of stockholders
of
the insured depository institution or its holding company and to most claims
arising out of obligations or liabilities owed to affiliates of the institution,
but is subordinate to claims of depositors, secured creditors and holders of
subordinated debt (other than affiliates) of the commonly controlled insured
depository institution. The FDIC may decline to enforce the cross-guarantee
provisions if it determines that a waiver is in the best interest of the BIF or
SAIF or both.
DIVIDENDS FROM BANK SUBSIDIARIES
M&T Bank and M&T Bank, N.A. are subject, under one or more of the banking
laws, to restrictions on the amount and frequency (no more often than quarterly)
of dividend declarations. Future dividend payments to the Registrant by its
subsidiary banks will be dependent on a number of factors, including the
earnings and financial condition of each such bank, and are subject to the
limitations referred to in note 19 of Notes to Financial Statements filed
herewith in Part II, Item 8, "Financial Statements and Supplementary Data," and
to other statutory powers of bank regulatory agencies.
Under FDICIA, an insured depository institution is prohibited from making
any capital distribution to its owner, including any dividend, if, after making
such distribution, the depository institution fails to meet the required minimum
level for any relevant capital measure, including the risk-based capital
adequacy and leverage standards discussed below.
10
CAPITAL ADEQUACY
The Federal Reserve Board, the FDIC and the OCC have adopted risk-based
capital adequacy guidelines for bank holding companies and banks under their
supervision. Under these guidelines, the so-called "Tier 1 capital" and "Total
capital" as a percentage of risk-weighted assets and certain off-balance sheet
instruments must be at least 4% and 8%, respectively.
The Federal Reserve Board, the FDIC and the OCC have also imposed a leverage
standard to supplement their risk-based ratios. This leverage standard focuses
on a banking institution's ratio of Tier 1 capital to average total assets,
adjusted for goodwill and certain other items. Under these guidelines, banking
institutions that meet certain criteria, including excellent asset quality, high
liquidity, low interest rate exposure and good earnings, and that have received
the highest regulatory rating must maintain a ratio of Tier 1 capital to total
adjusted average assets of at least 3%. Institutions not meeting these criteria,
as well as institutions with supervisory, financial or operational weaknesses,
along with those experiencing or anticipating significant growth are expected to
maintain a Tier 1 capital to total adjusted average assets ratio equal to at
least 4 to 5%.
As reflected in the following table, the risk-based capital ratios and
leverage ratios of the Registrant, M&T Bank and M&T Bank, N.A. as of December
31, 1997 exceeded the required capital ratios for classification as "well
capitalized," the highest classification under the regulatory capital
guidelines.
CAPITAL COMPONENTS AND RATIOS AT DECEMBER 31, 1997
(DOLLARS IN MILLIONS)
REGISTRANT M&T BANK,
(CONSOLIDATED) M&T BANK N.A.
------------- ----------- -------------
Capital Components
Tier 1 capital........................................................ $ 1,250 $ 1,001 $ 51
Total capital......................................................... 1,558 1,305 55
Risk-weighted assets and off-balance sheet instruments.................. $ 11,699 $ 11,359 $ 345
Risk-based Capital Ratio
Tier 1 capital........................................................ 10.69% 8.81% 14.73%
Total capital......................................................... 13.32% 11.48% 15.98%
Leverage Ratio.......................................................... 9.09% 7.63% 7.11%
FDICIA required the federal banking agencies, including the Federal Reserve
Board and the OCC, to revise their risk-based capital standards in order to
ensure that those standards take adequate account of interest rate risk,
concentration of credit risk and the risk of nontraditional activities, as well
as reflect the actual performance and expected risk of loss on certain
multifamily housing loans.
Bank regulators periodically propose amendments to the risk-based capital
guidelines and related regulatory framework. While the Company's management
studies such proposals, the timing of adoption, ultimate form and effect of such
proposed amendments on the Company's capital requirements and operations cannot
be predicted.
11
FDICIA requires the federal banking agencies to take "prompt corrective
action" in respect of depository institutions and their bank holding companies
that do not meet minimum capital requirements. FDICIA established five capital
tiers: "well capitalized", "adequately capitalized", "undercapitalized",
"significantly undercapitalized" and "critically undercapitalized". A depository
institution's capital tier, or that of its bank holding company, depends upon
where its capital levels are in relation to various relevant capital measures,
including a risk-based capital measure and a leverage ratio capital measure, and
certain other factors.
Under the implementing regulations adopted by the federal banking agencies,
a bank holding company or bank is considered "well capitalized" if it has (i) a
total risk-based capital ratio of 10% or greater, (ii) a Tier 1 risk-based
capital ratio of 6% or greater, (iii) a leverage ratio of 5% or greater and (iv)
is not subject to any order or written directive to meet and maintain a specific
capital level for any capital measure. An "adequately capitalized" bank holding
company or bank is defined as one that has (i) a total risk-based capital ratio
of 8% or greater, (ii) a Tier 1 risk-based capital ratio of 4% or greater and
(iii) a leverage ratio of 4% or greater (or 3% or greater in the case of a bank
with a composite CAMELS rating of 1). A bank holding company or bank is
considered (A) "undercapitalized" if it has (i) a total risk-based capital ratio
of less than 8%, (ii) a Tier 1 risk-based capital ratio of less than 4% or (iii)
a leverage ratio of less than 4% (or 3% in the case of a bank with a composite
CAMELS rating of 1); (B) "significantly undercapitalized" if the bank has (i) a
total risk-based capital ratio of less than 6%, or (ii) a Tier 1 risk-based
capital ratio of less than 3% or (iii) a leverage ratio of less than 3% and
(C)"critically undercapitalized" if the bank has a ratio of tangible equity to
total assets equal to or less than 2%. The Federal Reserve Board may reclassify
a "well capitalized" bank holding company or bank as "adequately capitalized" or
subject an "adequately capitalized" or "undercapitalized" institution to the
supervisory actions applicable to the next lower capital category if it
determines that the bank holding company or bank is in an unsafe or unsound
condition or deems the bank holding company or bank to be engaged in an unsafe
or unsound practice and not to have corrected the deficiency. First Empire, M&T
Bank and M&T Bank, N.A. currently meet the definition of "well capitalized"
institutions.
"Undercapitalized" depository institutions, among other things, are subject
to growth limitations, are prohibited, with certain exceptions, from making
capital distributions, are limited in their ability to obtain funding from a
Federal Reserve Bank and are required to submit a capital restoration plan. The
federal banking agencies may not accept a capital plan without determining,
among other things, that the plan is based on realistic assumptions and is
likely to succeed in restoring the depository institution's capital. In
addition, for a capital restoration plan to be acceptable, the depository
institution's parent holding company must guarantee that the institution will
comply with such capital restoration plan and provide appropriate assurances of
performance. If a depository institution fails to submit an acceptable plan,
including if the holding company refuses or is unable to make the guarantee
described in the previous sentence, it is treated as if it is "significantly
undercapitalized". Failure to submit or implement an acceptable capital plan
also is grounds for the appointment of a conservator or a receiver.
"Significantly undercapitalized" depository institutions may be subject to a
number of additional requirements and restrictions, including orders to sell
sufficient voting stock to become adequately capitalized, requirements to reduce
total assets and cessation of receipt of deposits from correspondent banks.
Moreover, the parent holding company of a significantly undercapitalized
depository institution may be ordered to divest itself of the institution or of
nonbank subsidiaries of the holding company. "Critically undercapitalized"
institutions, among other things, are prohibited from making any payments of
principal and interest on subordinated debt, and are subject to the appointment
of a receiver or conservator.
12
FDICIA directs, among other things, that each federal banking agency
prescribe standards for depository institutions and depository institution
holding companies relating to internal controls, information systems, internal
audit systems, loan documentation, credit underwriting, interest rate exposure,
asset growth, compensation, a maximum ratio of classified assets to capital,
minimum earnings sufficient to absorb losses, a minimum ratio of market value to
book value for publicly traded shares and other standards as they deem
appropriate. The Federal Reserve Board and OCC have adopted such standards.
FDICIA also contains a variety of other provisions that may affect the
operations of the Company, including new reporting requirements, regulatory
standards for real estate lending, "truth in savings" provisions, limitations on
the amount of capitalized mortgage servicing rights and purchased credit card
relationships includable in Tier 1 capital, and the requirement that a
depository institution give prior notice to customers and regulatory authorities
before closing any branch. FDICIA also contains a prohibition on the acceptance
or renewal of brokered deposits by depository institutions that are not "well
capitalized" or are "adequately capitalized" and have not received a waiver from
the FDIC.
FDIC DEPOSIT INSURANCE ASSESSMENTS
As institutions with deposits insured by the BIF and the SAIF, M&T Bank and
M&T Bank, N.A. are subject to FDIC deposit insurance assessments. Under current
law the regular insurance assessments to be paid by BIF-insured and SAIF-insured
institutions are specified in schedules issued by the FDIC that specify, at
semiannual intervals, target reserve ratios designed to maintain the reserve
ratios of each of those insurance funds at 1.25% of their estimated insured
deposits. The FDIC is also authorized to impose one or more special assessments.
The FDIC has implemented a risk-based deposit premium assessment system
under which each depository institution is placed in one of nine assessment
categories based on the institution's capital classification under the prompt
corrective action provisions described above, and whether such institution is
considered by its supervisory agency to be financially sound or to have
supervisory concerns. The adjusted assessment rates for both BIF-insured and
SAIF-insured institutions under the current system range from .00% to .31%
depending upon the assessment category into which the insured institution is
placed. Neither of the Company's banking subsidiaries paid regular insurance
assessments to the FDIC in 1997. However, the FDIC retains the ability to
increase regular BIF and SAIF assessments and to levy special additional
assessments.
In addition to deposit insurance fund assessments, beginning in 1997 the
FDIC assessed BIF-assessable and SAIF-assessable deposits to fund the repayment
of debt obligations of the Financing Corporation ("FICO"). FICO is a government
agency-sponsored entity that was formed to borrow the money necessary to carry
out the closing and ultimate disposition of failed thrift institutions by the
Resolution Trust Corporation. The FDIC is required to set FICO assessments for
BIF-assessable deposits at one-fifth the amount for SAIF-assessable deposits.
The current annualized rates established by the FDIC for BIF-assessable and
SAIF-assessable deposits are 1.26 basis points and 6.28 basis points,
respectively.
Any significant increases in assessment rates or additional special
assessments by the FDIC could have an adverse impact on the results of
operations and capital of M&T Bank or M&T Bank, N.A.
13
GOVERNMENTAL POLICIES
The earnings of the Company are significantly affected by the monetary and
fiscal policies of governmental authorities, including the Federal Reserve
Board. Among the instruments of monetary policy used by the Federal Reserve
Board to implement these objectives are open-market operations in U.S.
Government securities and Federal funds, changes in the discount rate on member
bank borrowings and changes in reserve requirements against member bank
deposits. These instruments of monetary policy are used in varying combinations
to influence the overall level of bank loans, investments and deposits, and the
interest rates charged on loans and paid for deposits. The Federal Reserve Board
frequently uses these instruments of monetary policy, especially its open-market
operations and the discount rate, to influence the level of interest rates and
to affect the strength of the economy, the level of inflation or the price of
the dollar in foreign exchange markets. The monetary policies of the Federal
Reserve Board have had a significant effect on the operating results of banking
institutions in the past and are expected to continue to do so in the future. It
is not possible to predict the nature of future changes in monetary and fiscal
policies, or the effect which they may have on the Company's business and
earnings.
COMPETITION
The Company competes in offering commercial and personal financial services
with other banking institutions and with firms in a number of other industries,
such as thrift institutions, credit unions, personal loan companies, sales
finance companies, leasing companies, securities brokers and dealers, insurance
companies and retail merchandising organizations. Furthermore, diversified
financial services companies are able to offer a combination of these services
to their customers on a nationwide basis. Compared to less extensively regulated
financial services companies, the Company's operations are significantly
impacted by state and federal regulations applicable to the banking industry.
Moreover, the provisions of the Interstate Banking Act and the Banking Law may
further ease entry into New York State by out-of-state banking institutions. As
a result, the number of banking organizations with which the Registrant's
subsidiary banks compete may grow in the future.
OTHER LEGISLATIVE INITIATIVES
From time to time, various proposals are introduced in the United States
Congress and in the New York Legislature and before various bank regulatory
authorities which would alter the powers of, and restrictions on, different
types of banking organizations and which would restructure part or all of the
existing regulatory framework for banks, bank holding companies and other
financial institutions.
Moreover, a number of other bills have been introduced in Congress which
would further regulate, deregulate or restructure the financial services
industry. It is not possible to predict whether these or any other proposals
will be enacted into law or, even if enacted, the effect which they may have on
the Company's business and earnings.
STATISTICAL DISCLOSURE PURSUANT TO GUIDE 3
See cross-reference sheet for disclosures incorporated elsewhere in this
Annual Report on Form 10-K. Additional information is included in the following
tables.
14
FIRST EMPIRE STATE CORPORATION AND SUBSIDIARIES
SELECTED CONSOLIDATED YEAR-END BALANCES
ITEM 1, TABLE 1
1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
DOLLARS IN THOUSANDS
Money-market assets
Interest-bearing deposits at banks............. $ 668 47,325 125,500 143 55,044
Federal funds sold and resell agreements....... 53,087 125,326 1,000 3,080 329,429
Trading account................................ 57,291 37,317 9,709 5,438 9,815
---------- ---------- ---------- ---------- ----------
Total money-market assets.................... 111,046 209,968 136,209 8,661 394,288
Investment securities
U.S. Treasury and federal agencies............. 1,081,247 1,023,038 1,087,005 999,407 1,387,395
Obligations of states and political
subdivisions................................. 38,018 41,445 35,250 55,787 49,230
Other.......................................... 605,953 507,215 647,040 735,846 992,527
---------- ---------- ---------- ---------- ----------
Total investment securities.................. 1,725,218 1,571,698 1,769,295 1,791,040 2,429,152
Loans and leases
Commercial, financial, leasing, etc............ 2,406,640 2,206,282 2,013,937 1,680,415 1,510,205
Real estate--construction...................... 254,434 90,563 77,604 53,535 51,384
Real estate--mortgage.......................... 6,765,408 6,199,931 5,648,590 5,046,937 4,540,177
Consumer....................................... 2,339,051 2,623,445 2,133,592 1,666,230 1,337,293
---------- ---------- ---------- ---------- ----------
Total loans and leases....................... 11,765,533 11,120,221 9,873,723 8,447,117 7,439,059
Unearned discount.............................. (268,965) (398,098) (317,874) (229,824) (177,960)
Allowance for possible credit losses........... (274,656) (270,466) (262,344) (243,332) (195,878)
---------- ---------- ---------- ---------- ----------
Loans and leases, net.......................... 11,221,912 10,451,657 9,293,505 7,973,961 7,065,221
Other real estate owned.......................... 8,413 8,523 7,295 10,065 12,222
Total assets..................................... 14,002,935 12,943,915 11,955,902 10,528,644 10,364,958
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Noninterest-bearing deposits..................... 1,458,241 1,352,929 1,184,359 1,087,102 1,052,258
NOW accounts..................................... 346,795 334,787 768,559 748,199 764,690
Savings deposits................................. 3,344,697 3,280,788 2,765,301 3,098,438 3,364,983
Time deposits.................................... 5,762,497 5,352,749 4,596,053 3,106,723 1,982,272
Deposits at foreign office....................... 250,928 193,236 155,303 202,611 189,058
---------- ---------- ---------- ---------- ----------
Total deposits............................... 11,163,158 10,514,489 9,469,575 8,243,073 7,353,261
Short-term borrowings............................ 1,097,324 1,150,187 1,273,206 1,364,850 2,101,667
Long-term borrowings............................. 427,819 178,002 192,791 96,187 75,590
Total liabilities................................ 12,972,669 12,038,256 11,109,649 9,807,648 9,640,964
---------- ---------- ---------- ---------- ----------
Stockholders' equity............................. 1,030,266 905,659 846,253 720,996 723,994
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
STOCKHOLDERS, EMPLOYEES AND OFFICES
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
NUMBER AT YEAR-END
Stockholders........................................................... 3,449 3,654 3,787 3,981 3,985
Employees.............................................................. 5,083 5,180 4,889 4,505 4,400
Offices................................................................ 210 202 181 168 145
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
15
FIRST EMPIRE STATE CORPORATION AND SUBSIDIARIES
CONSOLIDATED EARNINGS
ITEM 1, TABLE 2
1997 1996 1995 1994 1993
---------- --------- --------- --------- ---------
DOLLARS IN THOUSANDS
INTEREST INCOME
Loans and leases, including fees........................... $ 952,436 881,002 794,181 633,077 608,473
Money-market assets
Deposits at banks........................................ 2,475 2,413 8,181 2,212 6,740
Federal funds sold and resell agreements................. 2,989 2,985 3,007 4,751 20,403
Trading account.......................................... 1,781 980 1,234 361 1,242
Investment securities
Fully taxable............................................ 99,640 107,415 118,791 104,185 101,187
Exempt from federal taxes................................ 5,640 2,637 2,760 2,760 2,584
---------- --------- --------- --------- ---------
Total interest income.................................... 1,064,961 997,432 928,154 747,346 740,629
---------- --------- --------- --------- ---------
INTEREST EXPENSE
NOW accounts............................................... 3,455 9,430 11,902 11,286 13,113
Savings deposits........................................... 90,907 84,822 87,612 84,804 90,392
Time deposits.............................................. 327,611 286,088 239,882 97,067 98,508
Deposits at foreign office................................. 12,160 12,399 6,952 5,894 3,243
Short-term borrowings...................................... 44,341 59,442 84,225 73,868 58,459
Long-term borrowings....................................... 29,619 14,227 11,157 6,287 6,158
---------- --------- --------- --------- ---------
Total interest expense................................... 508,093 466,408 441,730 279,206 269,873
---------- --------- --------- --------- ---------
NET INTEREST INCOME........................................ 556,868 531,024 486,424 468,140 470,756
Provision for possible credit losses....................... 46,000 43,325 40,350 60,536 79,958
---------- --------- --------- --------- ---------
Net interest income after provision for possible credit
losses................................................... 510,868 487,699 446,074 407,604 390,798
---------- --------- --------- --------- ---------
OTHER INCOME
Mortgage banking revenues.................................. 51,547 44,484 37,142 16,002 12,776
Service charges on deposit accounts........................ 43,377 40,659 38,290 35,016 32,291
Trust income............................................... 30,688 27,672 25,477 22,574 23,865
Merchant discount and other credit card fees............... 19,395 18,266 10,675 8,705 7,932
Trading account and foreign exchange gains................. 3,690 2,421 2,783 738 3,518
Gain (loss) on sales of bank investment securities......... (280) (37) 4,479 128 870
Gain on sales of venture capital investments............... 2,677 3,175 2,619 802 2,896
Other revenues from operations............................. 41,973 33,608 28,073 39,774 26,396
---------- --------- --------- --------- ---------
Total other income....................................... 193,067 170,248 149,538 123,739 110,544
---------- --------- --------- --------- ---------
OTHER EXPENSE
Salaries and employee benefits............................. 220,017 208,342 188,222 161,221 154,340
Equipment and net occupancy................................ 53,299 51,346 50,526 49,132 47,823
Printing, postage and supplies............................. 13,747 15,167 14,442 13,516 13,021
Deposit insurance.......................................... 1,935 9,337 14,675 16,442 17,684
Other costs of operations.................................. 132,778 124,786 106,574 96,551 94,951
---------- --------- --------- --------- ---------
Total other expense...................................... 421,776 408,978 374,439 336,862 327,819
---------- --------- --------- --------- ---------
Income before income taxes................................. 282,159 248,969 221,173 194,481 173,523
Income taxes............................................... 105,918 97,866 90,137 77,186 71,531
---------- --------- --------- --------- ---------
NET INCOME................................................. $ 176,241 151,103 131,036 117,295 101,992
---------- --------- --------- --------- ---------
---------- --------- --------- --------- ---------
DIVIDENDS DECLARED
Common................................................... $ 21,207 18,617 16,224 14,743 13,054
Preferred................................................ -- 900 3,600 3,600 3,600
---------- --------- --------- --------- ---------
---------- --------- --------- --------- ---------
16
FIRST EMPIRE STATE CORPORATION AND SUBSIDIARIES
COMMON SHAREHOLDER DATA
ITEM 1, TABLE 3
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
Per Share
Net income
Basic......................................................... $ 26.60 22.54 19.61 16.90 14.32
Diluted....................................................... 25.26 21.08 17.98 15.73 13.42
Cash dividends declared......................................... 3.20 2.80 2.50 2.20 1.90
Stockholders' equity at year-end................................ 155.86 135.45 125.33 103.02 99.43
Dividend payout ratio............................................. 12.03% 12.39% 12.73% 12.97% 13.27%
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
17
FIRST EMPIRE STATE CORPORATION AND SUBSIDIARIES
CHANGES IN INTEREST INCOME AND EXPENSE*
ITEM 1, TABLE 4
1997 COMPARED WITH 1996 1996 COMPARED WITH 1995
-------------------------------- --------------------------------
RESULTING FROM RESULTING FROM
CHANGES IN: CHANGES IN:
TOTAL -------------------- TOTAL --------------------
CHANGE VOLUME RATE CHANGE VOLUME RATE
---------- --------- --------- ---------- --------- ---------
INCREASE (DECREASE) IN THOUSANDS
Interest income
Loans and leases, including fees................ $ 71,264 74,326 (3,062) $ 86,509 110,121 (23,612)
Money-market assets
Deposits at banks............................. 62 200 (138) (5,768) (4,669) (1,099)
Federal funds sold and agreements to resell
securities.................................. 4 19 (15) (22) 409 (431)
Trading account............................... 837 1,121 (284) (239) 107 (346)
Investment securities
U.S. Treasury and federal agencies............ (3,055) (4,941) 1,886 (225) (2,555) 2,330
Obligations of states and political
subdivisions................................ 154 137 17 (742) (584) (158)
Other......................................... (384) (1,980) 1,596 (10,390) (11,194) 804
---------- ----------
Total interest income......................... $ 68,882 $ 69,123
---------- ----------
---------- ----------
Interest expense
Interest-bearing deposits
NOW accounts.................................. $ (5,975) (5,416) (559) $ (2,472) (1,523) (949)
Savings deposits.............................. 6,085 12,622 (6,537) (2,790) 1,016 (3,806)
Time deposits................................. 41,523 38,400 3,123 46,206 57,335 (11,129)
Deposits at foreign office.................... (239) (474) 235 5,447 5,500 (53)
Short-term borrowings........................... (15,101) (14,539) (562) (24,783) (15,953) (8,830)
Long-term borrowings............................ 15,392 14,534 858 3,070 3,262 (192)
---------- ----------
Total interest expense........................ $ 41,685 $ 24,678
---------- ----------
---------- ----------
- ------------------------
* Interest income data are on a taxable-equivalent basis. The apportionment of
changes resulting from the combined effect of both volume and rate was based
on the separately determined volume and rate changes.
18
ITEM 2. PROPERTIES.
Both First Empire and M&T Bank maintain their executive offices at One M&T
Plaza in Buffalo, New York. This twenty-one story headquarters building,
containing approximately 276,000 rentable square feet of space, is owned in fee
by M&T Bank, and was completed in 1967 at a cost of approximately $17 million.
First Empire, M&T Bank and their subsidiaries occupy approximately 73% of the
building and the remainder is leased to non-affiliated tenants. At December 31,
1997, the cost of this property, net of accumulated depreciation, was $10.2
million.
In September 1992, M&T Bank acquired an additional facility in Buffalo, New
York with approximately 365,000 rentable square feet of space at a cost of
approximately $12 million. Approximately 85% of this facility, known as M&T
Center, is occupied by M&T Bank and its subsidiaries, with the remainder leased
to non-affiliated tenants. At December 31, 1997, the cost of this building,
including improvements made subsequent to acquisition and net of accumulated
depreciation, was $15.5 million.
M&T Bank also owns and occupies two separate facilities in the Buffalo area
which support certain back-office and operations functions of the Company. The
total square footage of these facilities approximates 223,000 square feet and
their combined cost, net of accumulated depreciation, was $12.8 million.
The cost, net of accumulated depreciation and amortization, of the Company's
premises and equipment is detailed in note 5 of Notes to Financial Statements
filed herewith in Part II, Item 8, "Financial Statements and Supplementary
Data". Of the 178 domestic banking offices of the Registrant's subsidiary banks,
53 are owned in fee and 125 are leased.
ITEM 3. LEGAL PROCEEDINGS.
First Empire and its subsidiaries are subject in the normal course of
business to various pending and threatened legal proceedings in which claims for
monetary damages are asserted. Management, after consultation with legal
counsel, does not anticipate that the aggregate ultimate liability, if any,
arising out of litigation pending against First Empire or its subsidiaries will
be material to First Empire's consolidated financial position, but at the
present time is not in a position to determine whether such litigation will have
a material adverse effect on First Empire's consolidated results of operations
in any future reporting period.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning the Registrant's executive officers is presented
below as of March 5, 1998. Shown parenthetically is the year since which the
officer has held the indicated position with the Registrant or its subsidiaries.
In the case of each such corporation, officers' terms run until the first
meeting of the board of directors after such corporation's annual meeting, and
until their successors are elected and qualified.
ROBERT G. WILMERS, age 63, is chairman of the board (1994), president
(1988), chief executive officer (1983) and a director (1982) of the
Registrant. He is chairman of the board, chief executive officer (1983) and
a director (1982) of M&T Bank, and served as president of M&T Bank from
March 1984 to June 1996. Mr. Wilmers is a director of M&T Financial (1985).
He is chairman of the board and a director of M&T Bank, N.A.(1995).
19
EMERSON L. BRUMBACK, age 46, is an executive vice president (1997) of
the Registrant and M&T Bank, and is in charge of the Company's Retail
Banking Division. Mr. Brumback is president and a director of Highland Lease
(1997). He is a director of M&T Credit (1997), M&T Mortgage (1997),
M&T Securities (1997), and M&T Bank, N.A. (1997). Mr. Brumback was executive
vice president, national retail distribution, at BancOne Corporation prior
to joining the Company
ATWOOD COLLINS, III, age 51, is president and chief executive officer,
and a member of the Directors Advisory Council (1997) of M&T Bank's New York
City Division. Previously, Mr. Collins served as president, chief executive
officer and a director (1995) of East New York. Mr. Collins is an executive
vice president of the Registrant (1997) and M&T Bank (1996). He is a
director of M&T Real Estate (1995). In addition to managing all of M&T
Bank's business segments in the New York City region, Mr. Collins has
responsibility for managing the Company's Facilities Management and Services
group.
MARK J. CZARNECKI, age 42, is an executive vice president of M&T Bank
(1997) and is in charge of M&T Bank's Trust and Investment Services
Division. Mr. Czarnecki is president of M&T Securities, Inc. (1996) and is
an executive vice president of M&T Bank, N.A. Mr. Czarnecki has held a
number of management positions with M&T Bank since 1977, most recently as
senior vice president of the private client services group of the Trust and
Investment Services Division (1994), and prior thereto as an administrative
vice president and regional manager for the Retail Banking Division.
BRIAN E. HICKEY, age 45, is president and a member of the Directors
Advisory Council (1994) of the Rochester Division of M&T Bank and is an
executive vice president of the Registrant (1997) and M&T Bank (1996). Mr.
Hickey is a director of M&T Financial (1996). In addition to managing all of
M&T Bank's business segments in the Rochester market, Mr. Hickey has
responsibility for managing the Company's Western New York Commercial
Banking Division.
JAMES L. HOFFMAN, age 58, is president (1992) of the Hudson Valley
Division of M&T Bank, and is an executive vice president of the Registrant
(1997) and M&T Bank (1996). Mr. Hoffman served as chairman of the board,
president, chief executive officer and a director (1983) of The First
National Bank of Highland, which had been a wholly owned subsidiary of the
Registrant prior to its merger with and into M&T Bank on February 29, 1992.
ADAM C. KUGLER, age 40, is an executive vice president and treasurer
(1997) of the Registrant and M&T Bank, and is in charge of the Company's
Treasury Division. Mr. Kugler is a director of M&T Financial (1997), M&T
Securities (1997) and is an executive vice president, Treasurer and a
director of M&T Bank, N.A. (1997). Mr Kugler was previously a senior vice
president in the Treasury Division of M&T Bank.
JOHN L. PETT, age 49, is an executive vice president (1997) and chief
credit officer (1995) of the Registrant and is an executive vice president
and chief credit officer of M&T Bank (1996). Mr. Pett is chairman of the
board and a director of Highland Lease(1997) and M&T Credit (1997). He is a
director of M&T Bank, N.A. (1996). Mr. Pett served as senior vice president
of the Registrant from 1991 to 1997.
20
MICHAEL P. PINTO, age 42, is an executive vice president and chief
financial officer of the Registrant (1997) and M&T Bank (1996), and is in
charge of the Company's Finance Division. Mr. Pinto is a director of M&T
Capital (1996), M&T Financial (1996), M&T Mortgage (1996) and M&T Real
Estate (1996). He is an executive vice president and chief financial officer
of M&T Bank, N.A. (1996). Mr. Pinto served as senior vice president and
controller of the Registrant from 1993 to 1997.
ROBERT E. SADLER, JR., age 52, is an executive vice president of the
Registrant (1990), president and a director of M&T Bank (1996), and is in
charge of the Company's Commercial Banking Division. Mr. Sadler is chairman
of the board (1987) and a director of M&T Capital (1983); chairman of the
board (1989) and a director of M&T Financial (1985); chairman of the board
and a director of M&T Mortgage (1991); chairman of the board and a director
of M&T Securities (1994); president, chief executive officer and a director
of M&T Bank, N.A.(1995); and chairman of the board, president and a director
of M&T Real Estate (1995).
21
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Registrant's common stock is traded under the symbol FES on the American
Stock Exchange. See cross-reference sheet for disclosures incorporated elsewhere
in this Annual Report on Form 10-K for market prices of the Registrant's common
stock, approximate number of common stockholders at year-end, frequency and
amounts of dividends on common stock and restrictions on the payment of
dividends.
ITEM 6. SELECTED FINANCIAL DATA.
See cross-reference sheet for disclosures incorporated elsewhere in this
Annual Report on Form 10-K.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
CORPORATE PROFILE AND SIGNIFICANT DEVELOPMENTS
First Empire State Corporation ("First Empire") is a bank holding company
headquartered in Buffalo, New York with consolidated assets of $14.0 billion at
December 31, 1997. First Empire and its consolidated subsidiaries are
hereinafter referred to collectively as "the Company." First Empire's banking
subsidiaries are Manufacturers and Traders Trust Company ("M&T Bank") and M&T
Bank, National Association ("M&T Bank, N.A."), which are wholly owned. M&T Bank,
with total assets of $13.4 billion at December 31, 1997, is a New York-chartered
commercial bank with 178 offices throughout New York State and an office in
Nassau, The Bahamas. M&T Bank, N.A., with $703 million in assets at December 31,
1997, is a national bank with an office in Oakfield, New York.
M&T Bank's subsidiaries include M&T Mortgage Corporation, a residential
mortgage banking company; M&T Securities, Inc., a broker/dealer; M&T Real
Estate, Inc., a commercial mortgage lender; M&T Financial Corporation, a
commercial leasing company; M&T Capital Corporation, a venture capital company;
M&T Credit Corporation, a consumer credit company; and Highland Lease
Corporation, a consumer leasing company.
In October 1997, First Empire entered into a definitive agreement with
ONBANCorp, Inc. ("ONBANCorp"), a bank holding company headquartered in Syracuse,
New York, for a merger between the two companies. ONBANCorp operates two
wholly-owned banking subsidiaries, OnBank & Trust Co., which has 59 offices in
upstate New York and Franklin First Savings Bank in Wilkes-Barre, Pennsylvania
which has 19 offices in Northeastern Pennsylvania. Upon consummation of the
merger, the banking subsidiaries of ONBANCorp will be merged into M&T Bank. At
December 31, 1997, ONBANCorp had approximately $5.3 billion of assets. Under the
terms of the merger agreement, stockholders of ONBANCorp will have the option to
receive .161 of a share of First Empire common stock (and cash in lieu of any
fractional share) or $69.50 in cash in exchange for each share of ONBANCorp
common stock. The merger agreement provides that a minimum of 60% and a maximum
of 70% of the total number of shares of ONBANCorp common stock issued and
outstanding immediately prior to the merger must be exchanged for shares of
First Empire common stock. In the event that ONBANCorp stockholders as a whole
elect to receive stock consideration with respect to fewer than 60% or more than
70% of the total number of outstanding shares of ONBANCorp common stock, the
selection by ONBANCorp common stockholders of the method of payment is subject
to allocation and proration to ensure that the number of shares of ONBANCorp
common stock that are converted into shares of First Empire common stock will be
60% or 70%, as the case may be, of the total number of shares of ONBANCorp
common stock issued and outstanding immediately prior to the merger. At
22
December 31, 1997 ONBANCorp had 12,721,689 shares of common stock issued and
outstanding. The merger, which will be accounted for as a purchase, is
subject to the approval of stockholders of both companies and is expected to
be completed on or about April 1, 1998.
In January and June 1997, First Empire completed separate offerings of trust
preferred securities raising a total of $250 million that qualifies as Tier 1 or
core capital under the Federal Reserve Board's risk-based capital guidelines.
The trust preferred securities are classified as long-term borrowings and
accumulated distributions on the securities are included in interest expense.
On May 24, 1997, The East New York Saving Bank ("East New York"), the former
savings bank subsidiary of First Empire, was merged with and into M&T Bank. East
New York's branch offices and business activities now operate as the New York
City Division of M&T Bank.
OVERVIEW
The Company's net income in 1997 was $176.2 million, representing diluted
earnings per common share of $25.26, increases of 17% and 20%, respectively,
from $151.1 million or diluted earnings per common share of $21.08 in 1996.
Basic earnings per common share rose 18% to $26.60 in 1997 from $22.54 in 1996.
In 1995, net income was $131.0 million while diluted and basic earnings per
common share were $17.98 and $19.61, respectively. The 1995 results include $4.5
million of gains from sales of bank investment securities. The impact from sales
of bank investment securities in 1997 and 1996 was negligible. Excluding the
after-tax impact of gains from sales of bank investment securities, net income
for 1995 was $128.4 million, representing diluted and basic earnings per share
of $17.62 and $19.21, respectively. All earnings per share amounts reflect the
implementation of Statement of Financial Accounting Standards ("SFAS") No. 128,
"Earnings Per Share." SFAS No. 128 establishes new standards for computing and
presenting earnings per share and is effective for financial statements for both
interim and annual periods ending after December 15, 1997. SFAS No. 128 requires
that all prior period earnings per share data be restated to conform with the
provisions of the statement.
Net income represented a return on average assets in 1997 of 1.32%, compared
with 1.21% in 1996 and 1.14% in 1995. The return on average common stockholders'
equity was 18.49% in 1997, 17.60% in 1996 and 17.16% in 1995. Excluding the
effects of the 1995 securities gains, the return on average assets in 1995 was
1.12% and the return on average common stockholders' equity was 16.81%.
Resulting largely from growth in average loans outstanding,
taxable-equivalent net interest income increased 5% in 1997 to $563 million from
$536 million in 1996. Average loans totaled $11.0 billion in 1997, up 8% from
$10.1 billion in 1996. Similarly, average earning assets increased 7%, to $12.8
billion in 1997 from $12.0 billion in 1996. A 9% increase in average earning
assets, primarily loans, in 1996 was also the most significant factor for the
rise in that year's net interest income from $491 million in 1995. Average loans
and average earning assets in 1995 were $8.9 billion and $11.1 billion,
respectively. Improvement in 1997's net interest income resulting from asset
growth was partially offset by a reduction of the Company's net interest margin,
or taxable-equivalent net interest income expressed as a percentage of average
earning assets. Net interest margin in 1997 was 4.38%, compared with 4.45% in
1996 and 4.43% in 1995.
The provision for possible credit losses was $46.0 million in 1997, compared
with $43.3 million in 1996 and $40.4 million in 1995. Net charge-offs in 1997
were $41.8 million, compared with $35.2 million in 1996 and $21.3 million in
1995. The increase in net charge-offs from prior years
23
reflects higher levels of net consumer loan charge-offs which totaled $35.8
million in 1997, $28.5 million in 1996 and $11.3 million in 1995.
Noninterest income for 1997 totaled $193 million, 13% above the $170 million
in 1996 and 33% above the $145 million in 1995 (excluding gains from sales of
bank investment securities). Higher revenues associated with mortgage banking,
trust activities, sales of mutual funds and annuities, and prior expansion of
the Company's credit card business contributed to the growth of noninterest
income. Noninterest expense was $422 million in 1997, up 3% from $409 million in
1996 and 13% from $374 million in 1995. Expenses associated with expansion of
businesses providing mortgage banking services, indirect automobile loans,
credit cards and the sale of mutual funds and annuities contributed to the rise
in noninterest expense since 1995.
NET INTEREST INCOME/LENDING AND FUNDING ACTIVITIES
Taxable-equivalent net interest income rose 5% to $563 million in 1997 from
$536 million in 1996, largely the result of growth in average earning assets,
which increased $794 million or 7% to $12.8 billion in 1997 from $12.0 billion
in 1996. Taxable-equivalent net interest income and average earning assets in
1995 were $491 million and $11.1 billion, respectively. The growth in average
earning assets in 1997 and 1996 was attributable to increases in average loans
outstanding. Average loans totaled $11.0 billion in 1997, up 8% from $10.1
billion in 1996. Average loans in 1996 were increased 14% from $8.9 billion in
1995. The accompanying table 4 summarizes average loans and leases outstanding
in 1997 and percentage changes in the major components of the loan and lease
portfolio over the past two years.
Loans secured by real estate, excluding $644 million of outstanding home
equity loans and lines of credit which are classified as consumer loans,
represented approximately 58% of the loan and lease portfolio during 1997,
unchanged from 1996, but down from 60% in 1995. At December 31, 1997, the
Company held approximately $4.4 billion of commercial real estate loans and $2.5
billion of consumer real estate loans, compared with $4.0 billion and $2.2
billion, respectively, at December 31, 1996.
Commercial real estate loans originated by the Company are predominately
secured by properties in the New York City metropolitan area, including areas in
neighboring states generally considered to be within commuting distance of New
York City, and Western New York, which includes Buffalo, Niagara Falls,
Rochester and surrounding areas. Commercial real estate loans are also
originated in the Hudson Valley and Southern Tier regions of New York State.
Most commercial real estate loans originated by the Company are fixed-rate
instruments with monthly payments and a balloon payment of the remaining
principal at maturity, usually five years after loan origination. For borrowers
in good standing, the customer may extend the terms of the loan agreement for an
additional five years at the then-current market rate of interest. The
accompanying table 5 presents commercial real estate loans at December 31, 1997
by geographic area, type of collateral and size of the loans outstanding. Of the
$2.4 billion of commercial real estate loans in the New York City metropolitan
area, approximately 62% were secured by multi-family residential properties, 19%
by retail space and 7% by office space. The Company's experience has been that
office space and retail properties tend to demonstrate more volatile
fluctuations in value through economic cycles and changing economic conditions
than do multi-family residential properties. Approximately 51% of the aggregate
dollar amount of New York City area loans were for $3 million or less, while
loans of more than $10 million were approximately 17% of the total. Commercial
real estate loans secured by properties elsewhere in New York State, mostly in
Western New York, tend to have a greater diversity of collateral types and
include a significant amount of lending to customers who use the mortgaged
property in their trade or business. Approximately 66% of the aggregate dollar
amount of loans in this segment of the portfolio were for $3 million or less.
24
Commercial real estate loans secured by properties located outside of New
York State and outside of areas of neighboring states considered to be part
of the New York City metropolitan area comprised less than 5% of total
commercial real estate loans.
The Company normally refrains from commercial construction lending, except
when the borrower has obtained a commitment for permanent financing upon project
completion. As a result, the portfolio of commercial construction loans for
which the Company has not committed to provide permanent financing totaled only
$158 million, or 1% of total loans and leases at December 31, 1997.
Real estate loans secured by one-to-four family residential properties
totaled $2.5 billion at December 31, 1997, approximately 62% of which were
secured by properties located in New York State. At December 31, 1997, $189
million of residential real estate loans were held for sale by the Company's
mortgage banking subsidiary, M&T Mortgage Corporation.
Consumer loans and leases represented approximately 21% of the loan
portfolio during 1997, compared with 22% in 1996 and 20% in 1995. Automobile
loans and home equity loans and lines of credit represent the largest
components of the consumer loan portfolio. At December 31, 1997, 66% of the
automobile loan portfolio was to borrowers in New York State, while the
remainder was primarily to borrowers in Pennsylvania. Automobile loans and
leases are generally originated through dealers, however, all applications
submitted by dealers are subject to the Company's normal underwriting and
loan approval procedures. During 1997, automobile loans and leases
represented approximately 9% of the Company's average loan portfolio, while
no other consumer loan product represented more than 6%. During 1997, the
Company securitized and sold $100 million of automobile loans, resulting in a
nominal gain. Growth in average credit card balances in recent years was the
result of direct mail marketing campaigns and co-branding initiatives. Such
initiatives involved developing relationships with retailers and other
enterprises and issuing co-branded credit cards that provide cardholders the
ability to earn rebates on purchases made with the cards. The Company bears
the cost of these rebates. As discussed later, during 1997 the Company either
terminated or agreed to terminate several co-branded credit card programs
that had been initiated in 1996 or late-1995. Average outstanding balances
related to these programs were $73 million in 1997, $76 million in 1996 and
$9 million in 1995. At December 31, 1997, 67% of outstanding credit card
balances were with customers in New York State.
The Company's portfolio of investment securities averaged $1.7 billion in
1997, $1.8 billion in 1996 and $2.0 billion in 1995. The size of the investment
securities portfolio is influenced by such factors as demand for loans, which
generally yield more than investment securities, ongoing repayments, the level
of deposits, and management of balance sheet size and resulting capital ratios.
The investment securities portfolio is largely comprised of adjustable-rate
mortgage-backed securities, collateralized mortgage obligations, and
shorter-term U.S. Treasury notes. When purchasing investment securities, the
Company considers its overall interest-rate risk profile as well as the adequacy
of expected returns relative to prepayment and other risks assumed. The Company
occasionally sells investment securities as a result of changes in interest
rates, actual or anticipated prepayments, or credit risk associated with a
particular security.
The average balance of money-market assets, which are comprised of
interest-bearing deposits at banks, trading account assets, Federal funds sold
and agreements to resell securities, was $165 million in 1997, compared with
$124 million in 1996 and $186 million in 1995.
Core deposits, consisting of noninterest-bearing deposits, interest-bearing
transaction accounts, savings deposits and nonbrokered domestic time deposits
under $100,000 represent the most significant source
25
of funding to the Company. Core deposits generally carry lower interest rates
than wholesale funds of comparable maturities. The Company's New York State
branch network is its principal source of core deposits. Certificates of
deposit under $100,000 generated on a nationwide basis by M&T Bank, N.A. are
also included in core deposits. In 1997, average core deposits totaled $8.3
billion, up from $8.0 billion in 1996 and $7.4 billion in 1995. Average core
deposits of M&T Bank, N.A., which began operations in the fourth quarter of
1995, were $432 million in 1997, $261 million in 1996 and $3 million in 1995.
Funding provided by core deposits totaled 65% of average earning assets in
1997, compared with 66% in 1996 and 67% in 1995. An analysis of changes in
the components of core deposits is presented in the accompanying table 7.
The Company also obtains funding through domestic time deposits of $100,000
or more, deposits originated through the Company's offshore branch office, and
brokered certificates of deposit. Domestic time deposits over $100,000,
excluding brokered certificates of deposit, averaged $1.0 billion in 1997,
compared with $892 million in 1996 and $625 million in 1995. Offshore deposits,
comprised primarily of accounts with balances of $100,000 or more, averaged $230
million in 1997, compared with $239 million and $133 million in 1996 and 1995,
respectively. Brokered deposits averaged $1.4 billion in 1997, $1.1 billion in
1996 and $874 million in 1995, and totaled $1.4 billion at December 31, 1997.
Brokered deposits are used as an alternative to short-term borrowings to
lengthen the average maturity of interest-bearing liabilities. The
weighted-average remaining term to maturity of brokered deposits at December 31,
1997 was 2.5 years. However, certain of the deposits have provisions that allow
early redemption. Additional amounts of brokered deposits may be solicited in
the future depending on market conditions and the cost of funds available from
alternative sources at the time.
In addition to deposits, the Company uses short-term borrowings from banks,
securities dealers, the Federal Home Loan Bank of New York ("FHLB") and others
as sources of funding. Short-term borrowings averaged $853 million in 1997, $1.1
billion in 1996 and $1.4 billion in 1995. In general, short-term borrowings have
been used to fund the Company's discretionary investments in money-market assets
and investment securities, and, if necessary, to replace deposit outflows. Also
providing funding in 1997 were two separate issuances of trust preferred
securities totaling $250 million. In January 1997, First Empire completed an
offering of trust preferred securities that raised $150 million of capital. The
30-year offering of 8.234% fixed-rate cumulative trust preferred securities was
sold through First Empire Capital Trust I. First Empire completed another
offering of trust preferred securities in June 1997 raising $100 million of
capital. This 30-year offering of 8.277% fixed-rate cumulative trust preferred
securities was sold through First Empire Capital Trust II. The preferred
securities provide investors with call protection for ten years. The trusts were
formed solely to issue the trust preferred securities and advance proceeds to
First Empire by purchasing First Empire's junior subordinated debt. The proceeds
of the trust preferred securities qualify as Tier 1 or core capital for First
Empire under the Federal Reserve Board's risk-based capital guidelines. Payments
on the junior subordinated debt of First Empire, which are in turn passed
through the trusts to the holders of the preferred securities, will be serviced
through existing liquidity and cash flow sources of First Empire. Under current
tax law, First Empire will be permitted to deduct interest payments on the
junior subordinated debt in computing taxable income. Further information
regarding the trust preferred securities is provided in note 7 of Notes to
Financial Statements. These securities, along with $175 million of subordinated
capital notes issued in prior years by M&T Bank, of which $75 million mature in
2002 and $100 million mature in 2005, are included in long-term borrowings.
Long-term borrowings averaged $373 million in 1997, $189 million in 1996 and
$146 million in 1995.
26
Net interest income is impacted by changes in the composition of the
Company's earning assets and interest-bearing liabilities, as described herein,
as well as changes in interest rates and spreads. Net interest spread, or the
difference between the yield on earning assets and the rate paid on
interest-bearing liabilities, was 3.70% in 1997, compared with 3.80% in 1996. A
greater proportion of loans, which typically yield more than money-market assets
and investment securities, in the composition of the earning asset portfolio
resulted in the yield on earning assets increasing slightly, to 8.34% in 1997
from 8.32% in 1996. The rate paid on interest-bearing liabilities increased 12
basis points (hundredths of one percent) to 4.64% in 1997 from 4.52% in 1996 due
to generally higher prevailing interest rates and the effect of the previously
discussed issuances of $250 million of trust preferred securities. In 1995, the
net interest spread was 3.77%, the yield on earning assets was 8.42% and the
rate paid on interest-bearing liabilities was 4.65%. A greater proportion of
loans in the composition of earning assets somewhat mitigated a general decrease
in market interest rates in 1996 compared with 1995. Largely due to the changes
in the net interest spread described herein, the Company's net interest margin
was 4.38% in 1997, compared with 4.45% in 1996 and 4.43% in 1995.
Interest-free funds, consisting largely of noninterest-bearing deposits and
stockholders' equity, contributed .68% to net interest margin in 1997, compared
with .65% in 1996 and .66% in 1995. Average interest-free funds were $1.9
billion in 1997, $1.7 billion in 1996 and $1.6 billion in 1995.
Future changes in market interest rates or spreads, as well as changes in
the composition of the Company's portfolios of earning assets and
interest-bearing liabilities that result in reductions in spreads could
adversely impact the Company's net interest margin and net interest income.
Management assesses the potential impact of future changes in interest rates
and spreads by projecting net interest income under a number of different
interest rate scenarios. As part of the management of interest rate risk, the
Company utilizes interest rate swap agreements to modify the repricing
characteristics of certain portions of the loan and deposit portfolios.
Revenue and expense arising from these agreements are reflected in either the
yields earned on loans or, as appropriate, the rates paid on interest-bearing
deposits. The notional amount of interest rate swaps entered into for
interest rate risk management purposes as of December 31, 1997 was
approximately $2.7 billion. In general, under the terms of these swaps, the
Company receives payments based on the outstanding notional amount of the
swaps at fixed rates of interest and makes payments at variable rates.
However, under terms of a $33 million swap, the Company pays a fixed rate of
interest and receives a variable rate. The average notional amounts of
interest rate swaps entered into for interest rate risk management purposes
and the related effect on net interest income and margin are presented in the
accompanying table 8.
The Company estimates that as of December 31, 1997 it would have received
approximately $16.4 million if all interest rate swap agreements entered into
for interest rate risk management purposes had been terminated. This estimated
fair value of the interest rate swap portfolio results from the effects of
changing interest rates and should be considered in the context of the entire
balance sheet and the Company's overall interest rate risk profile. Changes in
the estimated fair value of interest rate swaps entered into for interest rate
risk management purposes are not reflected in the consolidated financial
statements. Additional information about interest rate swaps is included in note
15 of Notes to Financial Statements.
The Financial Accounting Standards Board ("FASB") has issued a Proposed
Statement of Financial Accounting Standards ("Proposed Statement") that would
significantly change generally accepted accounting for interest rate swaps,
other derivative financial instruments and hedging activities. The Proposed
Statement would require that an entity recognize all derivatives (including
27
interest rate swaps)as either assets or liabilities on the balance sheet and
measure those instruments at fair value.
PROVISION FOR POSSIBLE CREDIT LOSSES
The purpose of the provision is to replenish or build the Company's
allowance for possible credit losses to a level necessary to maintain an
adequate reserve position. Management regularly assesses the adequacy of the
allowance by performing an ongoing evaluation of the loan and lease portfolio,
including such factors as the differing economic risks associated with each loan
category, the current financial condition of specific borrowers, the economic
environment in which the borrowers operate, the level of delinquent loans and
the value of any collateral. Significant loans are individually analyzed, while
other smaller balance loans are evaluated by loan category. Based upon the
results of such review, management believes that the allowance for possible
credit losses at December 31, 1997 was adequate to absorb credit losses from
existing loans and leases.
The provision for possible credit losses was $46.0 million in 1997, compared
with $43.3 million in 1996 and $40.4 million in 1995. Net charge-offs for 1997
were $41.8 million, compared with $35.2 million in 1996 and $21.3 million in
1995. As a percentage of average loans outstanding, net charge-offs were .38% in
1997, .35% in 1996 and .24% in 1995. Nonperforming loans totaled $80.7 million
or .70% of loans outstanding at December 31, 1997, compared with $97.9 million
or .91% of loans a year earlier and $93.1 million or .97% at December 31, 1995.
The allowance for possible credit losses was $274.7 million or 2.39% of net
loans and leases at the end of 1997, compared with $270.5 million or 2.52% at
December 31, 1996 and $262.3 million or 2.75% at December 31, 1995. The ratio of
the allowance to nonperforming loans was 341%, 276% and 282% at year-end 1997,
1996 and 1995, respectively.
The accompanying table 10 presents a comparative allocation of the allowance
for possible credit losses for each of the past five year-ends. Amounts were
allocated to specific loan categories based upon management's classification
of loans under the Company's internal loan grading system and assessment of
near-term charge-offs and losses existing in specific larger balance loans
that are reviewed in detail by the Company's internal loan review department
and pools of other loans that are not individually analyzed. The unallocated
portion of the allowance is intended to provide for probable losses that are
not otherwise identifiable resulting from (i) generally poor economic
conditions and an unfavorable business climate in market regions served by
the Company, (ii) portfolio concentrations regarding loan type, collateral
type and geographic location, (iii) the effect of expansion into new markets
and/or loan product types and, (iv) the possible use of imprecise estimates
in determining the allocated portion of the allowance. Nevertheless, the
allowance is general in nature and is available to absorb losses from any
loan category. Accordingly, the amounts presented in the table do not
necessarily indicate future losses within the individual loan categories.
Several factors influence the Company's credit loss experience, including
overall economic conditions affecting businesses and consumers, in general, and,
due to the size of the Company's commercial real estate loan portfolio, real
estate valuations, in particular. Nonperforming commercial real estate loans
totaled $17.4 million, $27.1 million and $42.3 million at December 31, 1997,
1996 and 1995, respectively. At December 31, 1997, $7.0 million of nonperforming
commercial real estate loans were secured by properties located in the New York
City metropolitan area, compared with $10.3 million and $16.8 million at
December 31, 1996 and 1995, respectively. Net charge-offs of commercial real
estate loans were $.9 million in 1997, $1.5 million in 1996 and $6.6 million in
1995. Included in these totals are net charge-offs of commercial real estate
loans secured by properties in the
28
New York City metropolitan area of $1.1 million, $.6 million and $3.2 million
in 1997, 1996 and 1995, respectively.
Net charge-offs of consumer loans totaled $35.8 million in 1997, or 1.55% of
average consumer loans outstanding during the year, compared with $28.5 million
or 1.30% in 1996 and $11.3 million or .65% in 1995. Higher charge-offs of credit
card balances and indirect automobile loans were the most significant factors
contributing to the increased level of consumer loan charge-offs in 1997 and
1996 compared with 1995. Net credit card and indirect automobile loan
charge-offs in 1997 were $19.0 million and $11.2 million, respectively, compared
with $15.9 million and $9.6 million, respectively, in 1996 and $6.1 million and
$3.1 million, respectively, in 1995. The increased levels of charge-offs of
credit card and indirect automobile loans in 1997 and 1996 as compared to prior
years can, in part, be attributed to higher levels of consumer bankruptcies and,
in general, is consistent with trends reported by other financial institutions.
Nonperforming consumer loans totaled $21.9 million or .99% of outstanding
consumer loans at December 31, 1997, compared with $17.6 million or .73% at
December 31, 1996 and $13.7 million or .70% at December 31, 1995.
Commercial real estate loans secured by multi-family properties in the New
York City metropolitan area were 13% of loans outstanding at December 31, 1997.
However, the Company had no concentrations of credit extended to any specific
industry that exceeded 10% of total loans at December 31, 1997. Furthermore, the
Company had no exposure to less developed countries, and only $5 million of
foreign loans in total.
Assets taken in foreclosure of defaulted loans totaled $8.4 million at
December 31, 1997, compared with $8.5 million and $7.3 million at the end of
1996 and 1995, respectively.
OTHER INCOME
Excluding the effect from sales of bank investment securities, other income
increased 14% to $193 million in 1997 from $170 million in 1996 and was 33%
higher than the $145 million earned in 1995.
Mortgage banking revenues, which consist of residential mortgage loan
servicing fee income, gains from sales of residential mortgage loans and loan
servicing rights, and other residential mortgage loan-related fees, increased to
$51.5 million in 1997 from $44.5 million in 1996 and $37.1 million in 1995.
Revenues from servicing residential mortgage loans for others were $25.7 million
in 1997, $20.9 million in 1996 and $19.3 million in 1995. Gains from sales of
residential mortgage loans and loan servicing rights increased to $23.1 million
in 1997, compared with $21.6 million and $16.4 million in 1996 and 1995,
respectively. The Company originates residential mortgage loans in New York
State, as well as in Arizona, Colorado, Massachusetts, Ohio, Oregon, Utah and
Washington. Originations of residential mortgage loans were $2.1 billion in
1997, $1.9 billion in 1996 and $1.3 billion in 1995. Residential mortgage loans
serviced for others totaled $7.5 billion, $5.8 billion and $5.7 billion at
December 31, 1997, 1996 and 1995, respectively. Capitalized servicing assets
were $61.1 million at December 31, 1997, compared with $37.8 million at December
31, 1996 and $34.5 million at December 31, 1995.
Service charges on deposit accounts increased 7% to $43.4 million in 1997
from $40.7 million in 1996, and 13% from $38.3 million in 1995. Trust income of
$30.7 million increased 11% from $27.7 million in 1996, and 20% from $25.5
million in 1995. Merchant discount and other credit card fees in 1997 totaled
$19.4 million, compared with $18.3 million in 1996 and $10.7 million in 1995.
Expansion of the Company's credit card business was the primary factor in the
improvement in 1996's fees from 1995. Due to poorer than expected results,
during 1997 the Company either terminated or agreed to
29
terminate during the first quarter of 1998 several of its co-branded credit
card programs. These programs were initiated during 1995 and 1996. Merchant
discount and other credit card fees earned in connection with the programs
were approximately $7 million, $8 million and $1 million in 1997, 1996 and
1995, respectively. Credit card balances related to these programs that
remained outstanding at December 31, 1997 were $61 million, compared with
$122 million a year earlier. Trading account and foreign exchange activity
resulted in gains of $3.7 million in 1997, $2.4 million in 1996 and $2.8
million in 1995. Other revenues from operations totaled $44.7 million in
1997, compared with $36.8 million in 1996 and $30.7 million in 1995. Such
amounts include revenues from sales of mutual funds and annuities of $15.3
million, $13.0 million and $9.4 million in 1997, 1996 and 1995, respectively.
Income earned from venture capital and other investments also contributed to
the increase in other revenues from operations in 1997.
OTHER EXPENSE
Other expense totaled $422 million in 1997, up from $409 million in 1996
when a $7 million charge was recognized for a special assessment to recapitalize
the Savings Association Insurance Fund of the Federal Deposit Insurance
Corporation ("FDIC"). Other expense totaled $374 million in 1995.
Salaries and employee benefits expense was $220 million in 1997, an increase
of $12 million or 6% from $208 million in 1996. The increase was due largely to
higher incentive-based compensation arrangements, including stock appreciation
rights, and merit salary increases. Personnel costs in 1996 increased $20
million or 11% from $188 million in 1995. Factors contributing to such increase
were merit salary increases, costs associated with the opening of 27 supermarket
banking locations in 1996 and the second half of 1995, and the expansion of
subsidiaries providing residential mortgage banking services, indirect
automobile loans and sales of mutual funds and annuities. The number of
full-time equivalent employees was 4,781 at December 31, 1997, down from 4,832
at December 31, 1996, but up from 4,546 at December 31, 1995.
Nonpersonnel expenses for 1997 totaled $202 million, little changed from
$201 million in 1996, but up 8% from $186 million in 1995. Excluding the $7
million charge in 1996 for the special assessment by the FDIC, nonpersonnel
expense increased 4% in 1997 from 1996. Higher costs associated with the
Company's mortgage banking business, including amortization of capitalized
servicing rights, contributed to the increase. The increase in nonpersonnel
expenses in 1996 from 1995 was largely caused by higher expenses associated with
the expansion of businesses providing mortgage banking services, indirect
automobile loans, credit cards and the sale of mutual funds and annuities,
partially offset by lower deposit insurance expense. Customer rebates and other
expenses based on card usage directly attributable to the terminated co-branded
credit card programs previously noted were approximately $9 million in 1997, $11
million in 1996 and $1 million in 1995.
INCOME TAXES
The provision for income taxes in 1997 was $105.9 million, up from $97.9
million in 1996 and $90.1 million in 1995. The effective tax rates were 38% in
1997, 39% in 1996 and 41% in 1995. A reconciliation of income tax expense to the
amount computed by applying the statutory federal income tax rate to pre-tax
income is provided in note 11 of Notes to Financial Statements.
INTERNATIONAL ACTIVITIES
The Company's net investment in international assets was $12 million and $55
million at December 31, 1997 and 1996, respectively. Total offshore deposits
30
were $251 million and $193 million at December 31, 1997 and 1996, respectively.
LIQUIDITY, MARKET RISK, AND INTEREST RATE SENSITIVITY
As a financial intermediary, the Company is exposed to various risks,
including liquidity and market risk. Liquidity risk arises whenever the
maturities of financial instruments included in assets and liabilities differ.
Accordingly, a critical element in managing a financial institution is ensuring
that sufficient cash flow and liquid assets are available to satisfy demands for
loans and deposit withdrawals, to fund operating expenses, and to be used for
other corporate purposes. The Company's core deposits have historically provided
a significant source of funds. Such deposits are generated from a large base of
consumer, corporate and institutional customers, which over the past several
years has become more geographically diverse as a result of acquisitions and
expansion of the Company's businesses. Nevertheless, in recent years the Company
has faced increased competition in offering services and products from a large
array of financial market participants, including banks, thrifts, mutual funds,
securities dealers and others. As a result, and consistent with banking industry
experience in general, the Company has experienced a reduction in the percentage
of earning assets funded by core deposits. Core deposits financed 64% of the
Company's earning assets at December 31, 1997, compared with 65% and 67% at
December 31, 1996 and 1995, respectively.
The Company supplements funding from core deposits with various wholesale
borrowings, such as Federal funds purchased and securities sold under agreements
to repurchase, and brokered certificates of deposit. Additionally, M&T Bank has
a credit facility with the FHLB aggregating $959 million, with any borrowings
secured by loans and investment securities. Borrowings outstanding under such
credit facility totaled $22 million and $2 million at December 31, 1997 and
1996, respectively. Although informal and sometimes reciprocal, sources of
funding are available to the Company through various arrangements for unsecured
short-term borrowings from a wide group of banks and other financial
institutions. In addition to deposits and borrowings, other sources of liquidity
include maturities of money-market assets, repayments of loans and investment
securities, and cash generated from operations, such as fees collected for
services.
First Empire's primary source of funds to pay for operating expenses,
dividends and treasury stock repurchases has historically been the receipt of
dividends from its banking subsidiaries, which are subject to various regulatory
limitations. As previously discussed, during 1997 First Empire issued junior
subordinated debt to two special purpose subsidiaries, which provided funding.
Additional information regarding the junior subordinated debt is included in
note 7 of Notes to Financial Statements. First Empire also maintains a $25
million line of credit with an unaffiliated commercial bank, all of which was
available for borrowing at December 31, 1997.
The Company expects to have access to sufficient liquid assets to fund the
cash portion of the previously discussed ONBANCorp acquisition and, accordingly,
management does not anticipate engaging in any activities, either currently or
in the long-term, which would cause a significant strain on liquidity at either
First Empire or its subsidiary banks. Furthermore, management closely monitors
the Company's liquidity position for compliance with internal policies and
believes that available