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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
- ----- OF THE SECURITIES EXCHANGEACT OF 1934
For the quarterly period ended June 30, 2003
------------------------------------------
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
- ----- ------------------ ------------------
Commission file number 0-5519
-------------------------------------------------------
Associated Banc-Corp
- ------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Wisconsin 39-1098068
- ------------------------------------------------------------------------------
(State or other jurisdiction of (IRS employer identification no.)
incorporation or organization)
1200 Hansen Road, Green Bay, Wisconsin 54304
- ------------------------------------------------------------------------------
(Address of principal executive offices) (Zip code)
(920)491-7000
- ------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
------- --------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
------- --------
APPLICABLE ONLY TO CORPORATE ISSUERS:
The number of shares outstanding of registrant's common stock, par value $0.01
per share, at July 31, 2003, was 73,549,989 shares.
1
ASSOCIATED BANC-CORP
TABLE OF CONTENTS
Page No.
-------
PART I. Financial Information
Item 1. Financial Statements (Unaudited):
Consolidated Balance Sheets -
June 30, 2003, June 30, 2002
and December 31, 2002 3
Consolidated Statements of Income -
Three and Six Months Ended June 30, 2003
and 2002 4
Consolidated Statement of Changes in
Stockholders' Equity - Six Months
Ended June 30, 2003 5
Consolidated Statements of Cash Flows -
Six Months Ended June 30, 2003 and 2002 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 18
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 38
Item 4. Controls and Procedures 38
PART II. Other Information
Item 4. Submission of Matters to a Vote of
Security Holders 39
Item 6. Exhibits and Reports on Form 8-K 40
Signatures 41
2
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements:
ASSOCIATED BANC-CORP
Consolidated Balance Sheets
(Unaudited)
June 30, June 30, December 31,
2003 2002 2002
----------------------------------------------
(In Thousands, except share data)
ASSETS
Cash and due from banks $ 393,882 $ 346,708 $ 430,691
Interest-bearing deposits in other financial institutions 13,456 11,853 5,502
Federal funds sold and securities purchased under
agreements to resell 14,550 51,275 8,820
Investment securities available for sale, at fair value 3,374,834 3,424,127 3,362,669
Loans held for sale 392,563 123,520 305,836
Loans 10,387,364 9,882,669 10,303,225
Allowance for loan losses (172,440) (148,733) (162,541)
--------------------------------------------
Loans, net 10,214,924 9,733,936 10,140,684
Premises and equipment 131,436 134,766 132,713
Goodwill 224,388 212,112 212,112
Other intangible assets 50,556 47,239 41,565
Other assets 408,227 391,457 402,683
--------------------------------------------
Total assets $ 15,218,816 $ 14,476,993 $ 15,043,275
============================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Noninterest-bearing deposits $ 1,833,703 $ 1,566,487 $ 1,773,699
Interest-bearing deposits, excluding Brokered CDs 7,456,729 7,225,789 7,117,503
Brokered CDs 163,028 233,968 233,650
--------------------------------------------
Total deposits 9,453,460 9,026,244 9,124,852
Short-term borrowings 2,079,371 2,301,853 2,389,607
Long-term debt 2,012,968 1,513,131 1,906,845
Company-obligated mandatorily redeemable
preferred securities 191,549 174,636 190,111
Accrued expenses and other liabilities 163,222 185,560 159,677
--------------------------------------------
Total liabilities 13,900,570 13,201,424 13,771,092
Stockholders' equity
Preferred stock --- --- ---
Common stock (par value $0.01 per share,
authorized 100,000,000 shares, issued
74,310,610, 76,727,110 and 75,503,410
shares, respectively) 743 767 755
Surplus 606,660 682,519 643,956
Retained earnings 664,280 552,554 607,944
Accumulated other comprehensive income 65,822 72,171 60,313
Deferred compensation (1,744) --- ---
Treasury stock, at cost (574,713, 326,759 and
1,222,812 shares, respectively) (17,515) (32,442) (40,785)
--------------------------------------------
Total stockholders' equity 1,318,246 1,275,569 1,272,183
--------------------------------------------
Total liabilities and stockholders' equity $15,218,816 $14,476,993 $15,043,275
============================================
See accompanying notes to consolidated financial statements.
3
ITEM 1. Financial Statements Continued:
ASSOCIATED BANC-CORP
Consolidated Statements of Income
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
----------------------------------------------------
(In Thousands, except per share data)
INTEREST INCOME
Interest and fees on loans $147,785 $158,321 $296,281 $309,670
Interest and dividends on investment securities
and deposits with other financial institutions:
Taxable 25,923 33,372 52,720 66,231
Tax exempt 9,942 9,988 19,997 19,968
Interest on federal funds sold and securities
purchased under agreements to resell 54 176 89 294
-----------------------------------------------
Total interest income 183,704 201,857 369,087 396,163
INTEREST EXPENSE
Interest on deposits 31,558 45,560 63,548 93,789
Interest on short-term borrowings 8,442 13,840 17,009 27,495
Interest on long-term debt, including preferred
securities 16,509 16,689 33,881 31,684
-----------------------------------------------
Total interest expense 56,509 76,089 114,438 152,968
-----------------------------------------------
NET INTEREST INCOME 127,195 125,768 254,649 243,195
Provision for loan losses 12,132 12,003 25,092 23,254
-----------------------------------------------
Net interest income after provision for loan losses 115,063 113,765 229,557 219,941
NONINTEREST INCOME
Trust service fees 7,796 7,722 14,426 15,093
Service charges on deposit accounts 12,462 11,733 24,273 21,613
Mortgage banking 28,845 9,637 54,948 22,241
Credit card and other nondeposit fees 5,192 7,094 12,588 13,166
Retail commissions 7,407 5,885 10,710 10,501
Bank owned life insurance income 3,450 3,469 6,841 6,739
Asset sale gains (losses), net (790) 41 (668) 372
Investment securities gains, net 1,027 --- 701 ---
Other 4,771 4,322 11,550 7,578
-----------------------------------------------
Total noninterest income 70,160 49,903 135,369 97,303
NONINTEREST EXPENSE
Personnel expense 53,245 48,764 103,480 93,758
Occupancy 7,151 6,650 14,266 12,787
Equipment 3,190 3,727 6,434 7,217
Data processing 5,602 5,304 11,220 10,107
Business development and advertising 3,553 3,126 6,916 6,572
Stationery and supplies 1,634 1,786 3,313 3,830
FDIC expense 359 402 725 774
Mortgage servicing rights expense 13,021 3,874 24,619 6,771
Intangible amortization expense 870 634 1,220 1,098
Loan expense 950 3,534 4,298 6,313
Other 14,344 13,386 25,585 24,376
-----------------------------------------------
Total noninterest expense 103,919 91,187 202,076 173,603
-----------------------------------------------
Income before income taxes 81,304 72,481 162,850 143,641
Income tax expense 24,635 20,137 48,188 39,835
-----------------------------------------------
NET INCOME $ 56,669 $ 52,344 $114,662 $103,806
===============================================
Earnings per share:
Basic $ 0.77 $ 0.69 $ 1.55 $ 1.39
Diluted $ 0.76 $ 0.68 $ 1.53 $ 1.37
Average shares outstanding:
Basic 73,959 75,922 74,104 74,540
Diluted 74,683 77,041 74,777 75,510
See accompanying notes to consolidated financial statements.
4
ITEM 1. Financial Statements Continued:
ASSOCIATED BANC-CORP
Consolidated Statement of Changes in Stockholders' Equity
(Unaudited)
Accumulated
Other
Common Retained Comprehensive Deferred Treasury
Stock Surplus Earnings Income Compensation Stock Total
------------------------------------------------------------------------------------
(In Thousands, except per share data)
Balance, December 31, 2002 $755 $643,956 $607,944 $60,313 $ --- $(40,785) $1,272,183
Comprehensive income:
Net income --- --- 114,662 --- --- --- 114,662
Net unrealized loss on derivative
instruments, net of tax of $2.7
million --- --- --- (4,339) --- --- (4,339)
Add: reclassification adjustment to
interest expense for interest
differential, net of tax of $88,000 --- --- --- 132 --- --- 132
Net change in unrealized holding gain
on securities available for sale,
net of tax of $4.3 million --- --- --- 9,716 --- --- 9,716
----------
Comprehensive income 120,171
-----------
Cash dividends, $0.65 per share --- --- (48,218) --- --- --- (48,218)
Common stock issued:
Incentive stock options and restricted
stock --- --- (10,108) --- --- 23,901 13,793
Purchase and retirement of treasury
stock in connection with repurchase
program (12) (41,328) --- --- --- --- (41,340)
Purchase of treasury stock --- --- --- --- --- (631) (631)
Restricted stock --- 76 --- --- (1,744) --- (1,668)
Tax benefit of stock options --- 3,956 --- --- --- --- 3,956
------------------------------------------------------------------------------------
Balance, June 30, 2003 $743 $606,660 $664,280 $65,822 $(1,744) $(17,515) $1,318,246
====================================================================================
See accompanying notes to consolidated financial statements.
5
ITEM 1. Financial Statements Continued:
ASSOCIATED BANC-CORP
Consolidated Statements Of Cash Flows
(Unaudited)
For the Six Months
Ended June 30,
2003 2002
--------------------------
($ in Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 114,662 $ 103,806
Adjustments to reconcile net income to
net cash provided by operating
activities:
Provision for loan losses 25,092 23,254
Depreciation and amortization 8,267 9,247
Amortization (accretion) of:
Mortgage servicing rights 24,619 6,771
Other intangible assets 1,220 1,098
Investment premiums and discounts 10,774 4,938
Deferred loan fees and costs (173) 419
Gain on sales of securities, net (701) --
Gain (loss) on sales of assets, net 668 (372)
Gain on sales of loans held for
sale, net (35,937) (12,051)
Mortgage loans originated and
acquired for sale (2,326,541) (1,099,984)
Proceeds from sales of mortgage loans
held for sale 2,275,751 1,307,327
Increase in interest receivable and
other assets (1,525) (27,458)
Increase (decrease) in interest payable
and other liabilities (8,936) 1,496
-------------------------
Net cash provided by operating activities 87,240 318,491
-------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Net increase in loans (101,965) (114,367)
Capitalization of mortgage servicing rights (20,080) (11,517)
Purchases of:
Securities available for sale (783,355) (575,928)
Premises and equipment, net of disposals (5,885) (6,106)
Proceeds from:
Sales of securities available for sale 1,263 --
Maturities of securities available for sale 773,134 551,932
Sales of other real estate owned and
other assets 3,327 2,239
Net cash acquired (paid) in
business combination (18,025) 17,982
-------------------------
Net cash used in investing activities (151,586) (135,765)
-------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits 328,608 (369,811)
Net decrease in short-term borrowings (310,235) (444,761)
Repayment of long-term debt (305,846) (27,262)
Proceeds from issuance of long-term debt 405,090 525,351
Cash dividends (48,218) (43,739)
Proceeds from exercise of incentive
stock options 13,793 12,097
Purchase and retirement of treasury stock (41,340) (3,962)
Purchase of treasury stock (631) (26,239)
-------------------------
Net cash provided by (used in) financing
activities 41,221 (378,326)
-------------------------
Net decrease in cash and cash equivalents (23,125) (195,600)
Cash and cash equivalents at beginning
of period 445,013 605,436
-------------------------
Cash and cash equivalents at end of period $ 421,888 $ 409,836
==========================
Supplemental disclosures of cash flow
information: Cash paid during the
period for:
Interest $ 117,068 $ 157,989
Income taxes 63,947 45,529
Supplemental schedule of noncash
investing activities:
Loans transferred to other real estate 7,670 1,873
See accompanying notes to consolidated financial statements.
6
ITEM 1. Financial Statements Continued:
ASSOCIATED BANC-CORP
Notes to Consolidated Financial Statements
These interim consolidated financial statements have been prepared according to
the rules and regulations of the Securities and Exchange Commission and,
therefore, certain information and footnote disclosures normally presented in
accordance with accounting principles generally accepted in the United States of
America have been omitted or abbreviated. The information contained in the
consolidated financial statements and footnotes in Associated Banc-Corp's 2002
annual report on Form 10-K, should be referred to in connection with the reading
of these unaudited interim financial statements.
NOTE 1: Basis of Presentation
In the opinion of management, the accompanying unaudited consolidated financial
statements contain all adjustments necessary to present fairly the financial
position, results of operations, changes in stockholders' equity, and cash flows
of Associated Banc-Corp and its subsidiaries (the "Corporation") for the periods
presented, and all such adjustments are of a normal recurring nature. The
consolidated financial statements include the accounts of all subsidiaries. All
material intercompany transactions and balances are eliminated. The results of
operations for the interim periods are not necessarily indicative of the results
to be expected for the full year.
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the balance sheet and revenues and expenses for
the period. Actual results could differ significantly from those estimates.
Estimates that are particularly susceptible to significant change include the
determination of the allowance for loan losses, mortgage servicing rights,
derivative financial instruments and hedging activities, and income taxes.
NOTE 2: Reclassifications
Certain items in the prior period consolidated financial statements have been
reclassified to conform with the June 30, 2003 presentation.
NOTE 3: New Accounting Pronouncements
In May 2003, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity" ("SFAS 150"). SFAS 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. SFAS
150 is effective for financial instruments entered into or modified after May
31, 2003. The adoption had no effect on the Corporation's results of operations,
financial position, or liquidity.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS 149"). SFAS 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities under SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities." This Statement amends SFAS No. 133 for decisions made
as part of the Derivatives Implementation Group process and in connection with
implementation issues raised in relation to the application of the definition of
a derivative. SFAS 149 is effective for contracts entered into or modified after
June 30, 2003. The Corporation does not expect the requirements of SFAS 149 to
have a material impact on the results of operations, financial position, or
liquidity.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). The objective of this interpretation is
to provide guidance on how to identify a variable interest entity
7
and determine when the assets, liabilities, noncontrolling interests, and
results of operations of a variable interest entity need to be included in a
company's consolidated financial statements. A company that holds variable
interests in an entity will need to consolidate the entity if the company's
interest in the variable interest entity is such that the company will absorb a
majority of the variable interest entity's losses and/or receive a majority of
the entity's expected residual returns, if they occur. FIN 46 also requires
additional disclosures by primary beneficiaries and other significant variable
interest holders. The provisions of this interpretation were effective upon
issuance for new variable interest entities and July 1, 2003, for existing
variable interest entities. The requirements of FIN 46 did not have a material
impact on the results of operations, financial position, or liquidity.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of SFAS 123" ("SFAS
148"). SFAS 148 permits two additional transition methods for entities that
adopt the fair value based method of accounting for stock-based employee
compensation. The Statement also requires new disclosures about the ramp-up
effect of stock-based employee compensation on reported results, and requires
that those effects be disclosed more prominently by specifying the form,
content, and location of those disclosures. The transition guidance and annual
disclosure provisions of SFAS 148 are effective for fiscal years ending after
December 15, 2002, with earlier application permitted in certain circumstances.
The interim disclosure provisions are effective for financial reports containing
financial statements for interim periods beginning after December 15, 2002 and
have been provided herein. The Corporation has decided preliminarily not to
adopt the fair value based method of accounting, but will continue to monitor
the accounting developments in this area.
In November 2002, the FASB issued Interpretation No. 45, an interpretation of
FASB Statements No. 5, 57, and 107, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others" ("FIN 45"). This Interpretation elaborates on the disclosures to be made
by a guarantor in its financial statements under certain guarantees that it has
issued. It also clarifies that a guarantor is required to recognize, at the
inception of a guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. The disclosure requirements of FIN 45 were
effective as of December 31, 2002, and require disclosure of the nature of the
guarantee, the maximum potential amount of future payments that the guarantor
could be required to make under the guarantee, and the current amount of the
liability, if any, for the guarantor's obligations under the guarantee. The
recognition requirements of FIN 45 were effective beginning January 1, 2003. The
requirements of FIN 45 did not have a material impact on the results of
operations, financial position, or liquidity.
NOTE 4: Earnings Per Share
Basic earnings per share is calculated by dividing net income by the weighted
average number of common shares outstanding. Diluted earnings per share is
calculated by dividing net income by the weighted average number of shares
adjusted for the dilutive effect of outstanding stock options.
Presented below are the calculations for basic and diluted earnings per share.
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
-----------------------------------------
(In Thousands, except per share data)
Net income $ 56,669 $ 52,344 $114,662 $103,806
=========================================
Weighted average shares outstanding 73,959 75,922 74,104 74,540
Effect of dilutive stock options outstanding 724 1,119 673 970
-----------------------------------------
Diluted weighted average shares outstanding 74,683 77,041 74,777 75,510
=========================================
Basic earnings per share $ 0.77 $ 0.69 $ 1.55 $ 1.39
=========================================
Diluted earnings per share $ 0.76 $ 0.68 $ 1.53 $ 1.37
=========================================
8
NOTE 5: Business Combinations
In 2003, through June 30, 2003, there was one completed business combination. On
April 1, 2003, the Corporation consummated its cash acquisition of 100% of the
outstanding shares of CFG Insurance Services, Inc. ("CFG"), a closely-held
insurance agency headquartered in Minnetonka, Minnesota. CFG, an independent,
full line insurance agency, was acquired to enhance the growth of the
Corporation's existing insurance business. The acquisition was accounted for
under the purchase method of accounting; thus, the results of operations prior
to the consummation date were not included in the accompanying consolidated
financial statements. The acquisition is individually immaterial to the
consolidated financial results. Goodwill of approximately $12 million and other
intangibles of approximately $15 million recognized in the transaction at
acquisition were assigned to the wealth management segment.
There was one completed business combination during 2002. On February 28, 2002,
the Corporation consummated its acquisition of 100% of the outstanding common
shares of Signal Financial Corporation ("Signal"), a financial holding company
headquartered in Mendota Heights, Minnesota. Signal operated banking branches in
nine locations in the Twin Cities and Eastern Minnesota. As a result of the
acquisition, the Corporation expanded its Minnesota banking presence,
particularly in the Twin Cities area. During the second quarter of 2002, the
Minnesota bank subsidiaries (Associated Bank Minnesota; Signal Bank National
Association and Signal Bank South National Association) were merged into a
single national banking charter under the name Associated Bank Minnesota,
National Association.
The Signal transaction was accounted for under the purchase method of
accounting; thus, the results of operations prior to the consummation date were
not included in the accompanying consolidated financial statements. The Signal
transaction was consummated through the issuance of approximately 4.1 million
shares of common stock and $58.4 million in cash for a purchase price of $192.5
million. The value of the shares was determined using the closing stock price of
the Corporation's stock on September 10, 2001, the initiation date of the
transaction.
The following table summarizes the estimated fair value of the assets acquired
and liabilities assumed of Signal at the date of the acquisition.
$ in Millions
---------------
Investment securities available for sale $ 163.8
Loans 760.0
Allowance for loan losses (12.0)
Other assets 118.1
Intangible asset 5.6
Goodwill 119.7
--------
Total assets acquired $1,155.2
--------
Deposits $ 784.8
Borrowings 165.5
Other liabilities 12.4
--------
Total liabilities assumed $ 962.7
--------
Net assets acquired $ 192.5
========
The intangible asset represents a core deposit intangible with a ten-year
estimated life. The $119.7 million of goodwill was assigned to the banking
segment upon acquisition.
9
The following represents required supplemental pro forma disclosure of total
revenue, net income, and earnings per share as though the Signal acquisition had
been completed at the beginning of the year of acquisition.
Six months ended
June 30, 2002
-------------------------
($ in Thousands, except
per share data)
Total revenue $350,322
Net income 102,592
Basic earnings per share 1.35
Diluted earnings per share 1.33
NOTE 6: Goodwill and Other Intangible Assets
Goodwill:
- --------
Goodwill is not amortized, but rather is subject to impairment tests on at least
an annual basis. No impairment loss was necessary in 2002 or through June 30,
2003. Goodwill of $212 million is assigned to the Corporation's banking segment
and goodwill of $12 million is assigned to the Corporation's wealth management
segment. The change in the carrying amount of goodwill was as follows.
As of and for the
As of and for the six months ended year ended
Goodwill June 30, 2003 June 30, 2002 December 31, 2002
- -------- --------------------------------------------------------
($ in Thousands)
Balance at beginning of period $212,112 $ 92,397 $ 92,397
Goodwill acquired 12,276 119,715 119,715
--------------------------------------------------------
Balance at end of period $224,388 $212,112 $212,112
========================================================
Other Intangible Assets:
- -----------------------
The Corporation has other intangible assets that are amortized, consisting of
core deposit intangibles, other intangibles (primarily related to customer
relationships acquired in connection with the CFG acquisition), and mortgage
servicing rights. The core deposit intangibles and mortgage servicing rights are
assigned to the Corporation's banking segment, while the other intangibles are
assigned to the Corporation's wealth management segment.
Core deposit intangibles have finite lives and are amortized on an accelerated
basis to expense over periods of 7 to 10 years. The other intangibles have
finite lives and are amortized on an accelerated basis over a weighted average
life of 16 years. For core deposit intangibles and other intangibles, changes in
the gross carrying amount, accumulated amortization, and net book value was as
follows:
As of and for the
As of and for the six months ended year ended
Core deposit intangibles: June 30, 2003 June 30, 2002 December 31, 2002
- ------------------------ --------------------------------------------------------
($ in Thousands)
Gross carrying amount $ 28,165 $ 28,165 $ 28,165
Accumulated amortization (19,743) (17,738) (18,923)
--------------------------------------------------------
Net book value $ 8,422 $ 10,427 $ 9,242
========================================================
Additions during the period $ --- $ 5,600 $ 5,600
Amortization during the period (820) (1,098) (2,283)
Other intangibles:
- -----------------
Gross carrying amount $ 14,750 $ --- $ ---
Accumulated amortization (400) --- ---
---------------------------------------------------------
Net book value $ 14,350 $ --- $ ---
=========================================================
Additions during the period $ 14,750 $ --- $ ---
Amortization during the period 400 --- ---
10
Mortgage servicing rights are amortized in proportion to and over the period of
estimated servicing income. The Corporation periodically evaluates its mortgage
servicing rights asset for impairment. Permanent impairment is recognized as a
write-down of the mortgage servicing rights asset and the related valuation
allowance. During second quarter 2003 mortgage rates fell to 45-year lows. Given
the extended period of low interest rates, historical low rates, and the impact
on mortgage banking volumes, refinances, and secondary markets, the Corporation
evaluated its mortgage servicing rights for possible permanent impairment. As a
result, $9.1 million was determined to be permanently impaired. A summary of
changes in the balance of the mortgage servicing rights asset and the mortgage
servicing rights valuation allowance was as follows:
As of and for the
As of and for the six months ended year ended
Mortgage servicing rights June 30, 2003 June 30, 2002 December 31, 2002
- ------------------------- --------------------------------------------------------
($ in Thousands)
Mortgage servicing rights at
beginning of year $ 60,685 $ 42,786 $ 42,786
Additions 20,080 11,517 30,730
Amortization (8,787) (6,021) (12,831)
Permanent impairment (9,076) --- ---
--------------------------------------------------------
Mortgage servicing rights at
end of period 62,902 48,282 60,685
--------------------------------------------------------
Valuation allowance at
beginning of year (28,362) (10,720) (10,720)
Additions (15,832) (750) (17,642)
Permanent impairment 9,076 --- ---
--------------------------------------------------------
Valuation allowance at end
of period (35,118) (11,470) (28,362)
--------------------------------------------------------
Mortgage servicing rights, net $ 27,784 $ 36,812 $ 32,323
========================================================
At June 30, 2003, the Corporation was servicing one- to four- family residential
mortgage loans owned by other investors with balances totaling $5.47 billion,
compared to $5.56 billion and $5.44 billion at June 30 and December 31, 2002,
respectively. The fair value of servicing was approximately $27.8 million
(representing 51 basis points ("bp") of loans serviced) at June 30, 2003,
compared to $36.8 million (or 66 bp of loans serviced) at June 30, 2002 and
$32.3 million (or 59 bp of loans serviced) at December 31, 2002.
Mortgage servicing rights expense, which includes the amortization of the
mortgage servicing rights and increases or decreases to the valuation allowance
associated with the mortgage servicing rights, was $24.6 million and $6.8
million for the six months ended June 30, 2003 and 2002, respectively, and $30.5
million for the year ended December 31, 2002.
The following table shows the estimated future amortization expense for
amortizing intangible assets. The projections of amortization expense for the
next five years are based on existing asset balances, the existing interest rate
environment, and prepayment speeds as of June 30, 2003. The actual amortization
expense the Corporation recognizes in any given period may be significantly
different depending upon changes in interest rates, market conditions,
regulatory requirements, and events or circumstances that indicate the carrying
amount of an asset may not be recoverable.
11
Estimated amortization expense:
Core Mortgage
Deposit Other Servicing
Intangibles Intangibles Rights
---------------------------------------
Six months ending December 31, 2003 $ 939 $ 802 $ 8,000
Year ending December 31, 2004 1,510 1,531 14,200
Year ending December 31, 2005 1,040 1,169 11,500
Year ending December 31, 2006 1,026 995 9,700
Year ending December 31, 2007 1,026 921 7,100
=======================================
NOTE 7: Derivatives and Hedging Activities
SFAS No. 133, as amended by SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities," (collectively referred to as "SFAS
133") establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. All derivatives, whether designated in hedging relationships
or not, are required to be recorded on the balance sheet at fair value.
In accordance with the statement, the Corporation measures the effectiveness of
its hedges on a periodic basis. Any difference between the fair value change of
the hedge versus the fair value change of the hedged item is considered to be
the "ineffective" portion of the hedge. The ineffective portion of the hedge is
recorded as an increase or decrease in the related income statement
classification of the item being hedged. Ineffective portions of changes in the
fair value of cash flow hedges are recognized in earnings. For the mortgage
derivatives, which are not accounted for as hedges, changes in fair value are
recorded as an adjustment to mortgage banking income.
The Corporation uses derivative instruments primarily to hedge the variability
in interest payments or protect the value of certain assets and liabilities
recorded in its consolidated balance sheet from changes in interest rates. The
predominant activities affected by the statement include the Corporation's use
of interest rate swaps, interest rate caps, and certain mortgage banking
activities.
Estimated Fair
Notional Market Value Weighted Average
Amount Gain/(Loss) Receive Rate Pay Rate Maturity
------------------------------------------------------------------------
June 30, 2003 ($ in Thousands)
- -------------
Interest Rate Risk Management hedges:
Swaps-receive variable / pay fixed (1), (3) $200,000 $(31,279) 1.39% 5.03% 95 months
Swaps-receive fixed / pay variable (2), (4) 375,000 32,793 7.21% 2.85% 217 months
Swaps-receive variable / pay fixed (2), (5) 326,639 (19,658) 3.48% 6.40% 54 months
Caps-written (1), (3) 200,000 1,015 Strike 4.72% --- 38 months
========================================================================
June 30, 2002
Interest Rate Risk Management hedges:
Swaps-receive variable / pay fixed (1), (3) $400,000 $(15,096) 1.98% 5.73% 55 months
Swaps-receive fixed / pay variable (2), (4) 375,000 (8,940) 7.21% 3.83% 230 months
Swaps-receive variable / pay fixed (2), (5) 163,203 (3,816) 4.07% 6.99% 56 months
Caps-written (1), (3) 200,000 5,499 Strike 4.72% --- 50 months
========================================================================
(1) Cash flow hedges
(2) Fair value hedges
(3) Hedges variable rate long-term debt
(4) Hedges fixed rate long-term debt
(5) Hedges longer-term fixed rate commercial loans
Commitments to sell residential mortgage loans to various investors and
commitments to fund such loans to individual borrowers represent the
Corporation's mortgage derivatives, the fair value of which are included in
other liabilities on the consolidated balance sheet. The net fair value of the
mortgage
12
derivatives at June 30, 2003 was $6.5 million, compared to $1.7 million at June
30, 2002. The net fair value change is recorded in mortgage banking income in
the consolidated statements of income. The $6.5 million net fair value of
mortgage derivatives at June 30, 2003, was comprised of the net gain on
commitments to fund approximately $1.1 billion of loans to individual borrowers
and the net loss on commitments to sell approximately $962 million of loans to
various investors. The $1.7 million net fair value of mortgage derivatives at
June 30, 2002, was composed of the net gain on commitments to fund approximately
$194 million of loans to individual borrowers and the net loss on commitments to
sell approximately $206 million of loans to various investors.
NOTE 8: Long-term Debt
Long-term debt at June 30 is as follows:
2003 2002
----------------------------
($ in Thousands)
Federal Home Loan Bank advances(1) $1,114,415 $1,065,537
Banknotes(2) 350,000 250,000
Subordinated debt, net(3) 215,030 190,059
Repurchase agreements(4) 331,175 ---
Other borrowed funds 2,348 7,535
---------- ----------
Total long-term debt $2,012,968 $1,513,131
========== ==========
(1) Long-term advances from the Federal Home Loan Bank had maturities from 2003
through 2017 and had weighted-average interest rates of 3.16% at June 30,
2003, and 4.18% at June 30, 2002. These advances had a combination of fixed
and variable rates, predominantly fixed.
(2) The long-term bank notes had maturities from 2003 through 2007 and had
weighted-average interest rates of 2.17% at June 30, 2003, and 2.20% at
June 30, 2002. These advances had a combination of fixed and variable
rates.
(3) In August 2001, the Corporation issued $200 million of 10-year subordinated
debt. This debt was issued at a discount and has a fixed interest rate of
6.75%. During 2001, the Corporation entered into a fair value hedge to
hedge the interest rate risk on the subordinated debt. As of June 30, 2003
and 2002, the fair value of the hedge was a $16.2 million gain and an $8.6
million loss, respectively. The subordinated debt qualifies under the
risk-based capital guidelines as Tier 2 supplementary capital for
regulatory purposes.
(4) The long-term repurchase agreements had maturities from 2004 through 2006
and had weighted-average interest rates of 1.77% at June 30, 2003. These
advances had a combination of fixed and variable rates, predominantly
fixed.
NOTE 9: Company-obligated Mandatorily Redeemable Preferred Securities
On May 30, 2002, ASBC Capital I (the "ASBC Trust"), a Delaware business trust
wholly owned by the Corporation, completed the sale of $175 million of 7.625%
preferred securities (the "Preferred Securities"). The Preferred Securities are
traded on the New York Stock Exchange under the symbol "ABW PRA." The ASBC Trust
used the proceeds from the offering to purchase a like amount of 7.625% Junior
Subordinated Debentures (the "Debentures") of the Corporation. The Debentures
are the sole assets of the ASBC Trust and are eliminated, along with the related
income statement effects, in the consolidated financial statements.
The Preferred Securities accrue and pay dividends quarterly at an annual rate of
7.625% of the stated liquidation amount of $25 per Preferred Security. The
Corporation has fully and unconditionally guaranteed all of the obligations of
the ASBC Trust. The guarantee covers the quarterly distributions and payments on
liquidation or redemption of the Preferred Securities, but only to the extent of
funds held by the ASBC Trust.
The Preferred Securities are mandatorily redeemable upon the maturity of the
Debentures on June 15, 2032 or upon earlier redemption as provided in the
Indenture. The Corporation has the right to redeem the Debentures on or after
May 30, 2007.
The Preferred Securities qualify under the risk-based capital guidelines as Tier
1 capital for regulatory purposes. The Corporation used the proceeds from the
sales of the Debentures for general corporate purposes. Also, during May 2002,
the Corporation entered into a fair value hedge to hedge the interest rate risk
on the Debentures. The fair value of the hedge was a $16.5 million gain at June
30, 2003 and $0.4 million loss at June 30, 2002. Given the fair value hedge, the
Preferred Securities are carried on the balance sheet at fair value.
13
NOTE 10: Stock-Based Compensation
As allowed under SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123"), the Corporation accounts for stock-based compensation cost under the
intrinsic value method of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB 25), and related
Interpretations, under which no compensation cost has been recognized for any
periods presented, except with respect to restricted stock awards. Compensation
expense for employee stock options is generally not recognized if the exercise
price of the option equals or exceeds the fair value of the stock on the date of
grant, as such options would have no intrinsic value at the date of grant.
The Corporation may issue common stock with restrictions to certain key
employees. The shares are restricted as to transfer, but are not restricted as
to dividend payment or voting rights. Transfer restrictions lapse over three or
five years, depending upon whether the award is fixed or performance-based, are
contingent upon continued employment, and for performance awards are based on
earnings per share performance goals. The Corporation amortizes the expense over
the vesting period. During 2003, 50,000 restricted stock shares were awarded,
and expense of $101,000 was recorded for the six months ended June 30, 2003.
For purposes of providing the pro forma disclosures required under SFAS 123, the
fair value of stock options granted in the comparable six month periods of 2003
and 2002 was estimated at the date of grant using a Black-Scholes option pricing
model which was originally developed for use in estimating the fair value of
traded options which have different characteristics from the Corporation's
employee stock options. The model is also sensitive to changes in the subjective
assumptions which can materially affect the fair value estimate. As a result,
management believes the Black-Scholes model may not necessarily provide a
reliable single measure of the fair value of employee stock options. The
following table illustrates the effect on net income and earnings per share if
the Corporation had applied the fair value recognition provisions of SFAS 123.
For the Three Months For the Six Months
Ended June 30, Ended June 30,
-----------------------------------------------------
2003 2002 2003 2002
-----------------------------------------------------
($ in Thousands, except per share amounts)
Net income, as reported $ 56,669 $ 52,344 $ 114,662 $ 103,806
Adjustment: pro forma expense
related to options granted, net of tax (740) (781) (1,444) (1,606)
--------------------------------------------------
Net income, as adjusted $ 55,929 $ 51,563 $ 113,218 $ 102,200
==================================================
Basic earnings per share, as reported $ 0.77 $ 0.69 $ 1.55 $ 1.39
Adjustment: pro forma expense
related to options granted, net of tax (0.01) (0.01) (0.02) (0.02)
--------------------------------------------------
Basic earnings per share, as adjusted $ 0.76 $ 0.68 $ 1.53 $ 1.37
==================================================
Diluted earnings per share, as reported $ 0.76 $ 0.68 $ 1.53 $ 1.37
Adjustment: pro forma expense
related to options granted, net of tax (0.01) (0.01) (0.02) (0.02)
--------------------------------------------------
Diluted earnings per share, as adjusted $ 0.75 $ 0.67 $ 1.51 $ 1.35
==================================================
The following assumptions were used in estimating the fair value for options
granted in 2003 and 2002:
2003 2002
----------------------------
Dividend yield 3.71% 3.29%
Risk-free interest rate 3.27% 4.58%
Weighted average expected life 7 yrs 7 yrs
Expected volatility 28.24% 26.38%
The weighted average per share fair values of options granted in the comparable
six month periods of 2003 and 2002 were $7.43 and $7.66, respectively. The
annual expense allocation methodology prescribed
14
by SFAS 123 attributes a higher percentage of the reported expense to earlier
years than to later years, resulting in an accelerated expense recognition for
proforma disclosure purposes.
NOTE 11: Segment Reporting
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," requires selected financial and descriptive information about
reportable operating segments. The statement uses a "management approach"
concept as the basis for identifying reportable segments. The management
approach is based on the way that management organizes the segments within the
enterprise for making operating decisions, allocating resources, and assessing
performance. Consequently, the segments are evident from the structure of the
enterprise's internal organization, focusing on financial information that an
enterprise's chief operating decision-makers use to make decisions about the
enterprise's operating matters.
The Corporation's primary segment is Banking, conducted through its bank and
lending subsidiaries. For purposes of segment disclosure under this statement,
these have been combined as one segment, as these segments have similar economic
characteristics and the nature of their products, services, processes,
customers, delivery channels, and regulatory environment are similar. Banking
includes: a) community banking - lending and deposit gathering to businesses
(including business-related services such as cash management and international
banking services) and to consumers (including mortgages and credit cards); and
b) corporate banking - specialized lending (such as commercial real estate),
lease financing, and banking to larger businesses and metro or niche markets;
and the support to deliver banking services.
The "Other" segment is comprised of Wealth Management (including insurance,
brokerage, and asset management), as well as intersegment eliminations and
residual revenues and expenses, representing the difference between actual
amounts incurred and the amounts allocated to operating segments.
Selected segment information is presented below.
Consolidated
Banking Other Total
- --------------------------------------------------------------------------------
As of and for the six months ended ($ in Thousands)
June 30, 2003
Total assets $15,159,125 $ 59,691 $15,218,816
========================================
Net interest income $ 254,351 $ 298 $ 254,649
Provision for loan losses 25,092 --- 25,092
Noninterest income 110,522 24,847 135,369
Depreciation and amortization 33,466 640 34,106
Other noninterest expense 149,056 18,914 167,970
Income taxes 47,969 219 48,188
----------------------------------------
Net income $ 109,290 $ 5,372 $ 114,662
========================================
As of and for the six months ended
June 30, 2002
Total assets $14,448,144 $ 28,849 $14,476,993
========================================
Net interest income $ 242,973 $ 222 $ 243,195
Provision for loan losses 23,254 --- 23,254
Noninterest income 73,702 23,601 97,303
Depreciation and amortization 16,990 126 17,116
Other noninterest expense 140,058 16,429 156,487
Income taxes 39,224 611 39,835
----------------------------------------
Net income $ 97,149 $ 6,657 $ 103,806
========================================
15
Consolidated
Banking Other Total
- --------------------------------------------------------------------------------
As of and for the three months ended ($ in Thousands)
June 30, 2003
Total assets $15,159,125 $ 59,691 $15,218,816
=======================================
Net interest income $ 127,057 $ 138 $ 127,195
Provision for loan losses 12,132 --- 12,132
Noninterest income 54,758 15,402 70,160
Depreciation and amortization 17,443 596 18,039
Other noninterest expense 75,111 10,769 85,880
Income taxes 24,001 634 24,635
----------------------------------------
Net income $ 53,128 $ 3,541 $ 56,669
========================================
As of and for the three months ended
June 30, 2002
Total assets $14,448,144 $ 28,849 $14,476,993
========================================
Net interest income $ 125,570 $ 198 $ 125,768
Provision for loan losses 12,003 --- 12,003
Noninterest income 37,366 12,537 49,903
Depreciation and amortization 9,212 77 9,289
Other noninterest expense 73,191 8,707 81,898
Income taxes 19,755 382 20,137
----------------------------------------
Net income $ 48,775 $ 3,569 $ 52,344
========================================
- --------------------------------------------------------------------------------
NOTE 12: Commitments, Off-Balance Sheet Risk, and Contingent Liabilities
Commitments and Off-Balance Sheet Risk
- --------------------------------------
The Corporation is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its customers
and to manage its own exposure to interest rate risk. These financial
instruments include lending-related commitments.
Lending-related Commitments
- ---------------------------
Through the normal course of operations, the Corporation has entered into
certain contractual obligations and other commitments. As a financial services
provider the Corporation routinely enters into commitments to extend credit.
While contractual obligations represent future cash requirements of the
Corporation, a significant portion of commitments to extend credit may expire
without being drawn upon. Such commitments are subject to the same credit
policies and approval process accorded to loans made by the Corporation.
Off-balance sheet lending-related commitments include commitments to extend
credit, commitments to originate residential mortgage loans held for sale,
commercial letters of credit, and standby letters of credit. Commitments to
extend credit are agreements to lend to customers at predetermined interest
rates as long as there is no violation of any condition established in the
contracts. Commercial and standby letters of credit are conditional commitments
issued to guarantee the performance of a customer to a third party. Commercial
letters of credit are issued specifically to facilitate commerce and typically
result in the commitment being drawn on when the underlying transaction is
consummated between the customer and the third party, while standby letters of
credit generally are contingent upon the failure of the customer to perform
according to the terms of the underlying contract with the third party. The
following is a summary of lending-related off-balance sheet financial
instruments at June 30:
16
June 30,
-------------------------
2003 2002
-------------------------
($ in Thousands)
Commitments to extend credit, excluding
commitments to originate residential
mortgage loans held for sale $3,337,320 $3,116,014
Commitments to originate residential mortgage
loans held for sale 1,112,089 194,342
-------------------------
Total commitments to extend credit 4,449,409 3,310,356
Commercial letters of credit 47,455 57,899
Standby letters of credit 299,815 223,683
Loans sold with recourse 1,130 1,564
Forward commitments to sell residential
mortgage loans $ 962,300 $ 205,500
For commitments to extend credit, commitments to originate residential mortgage
loans held for sale, commercial letters of credit, and standby letters of
credit, the Corporation's associated credit risk is essentially the same as that
involved in extending loans to customers and is subject to normal credit
policies. These financial instruments are exercisable at the market rate
prevailing at the date the underlying transaction will be completed, and thus
are deemed to have no current fair value, or the fair value is based on fees
currently charged to enter into similar agreements and is not material at June
30, 2003 or 2002. The Corporation's exposure to credit loss in the event of
nonperformance by the other party to these financial instruments is represented
by the contractual amount of those instruments. The commitments generally have
fixed expiration dates or other termination clauses and may require payment of a
fee. The Corporation uses the same credit policies in making commitments and
conditional obligations as it does for on-balance sheet instruments. The
Corporation evaluates each customer's creditworthiness on a case-by-case basis.
The amount of collateral obtained, if deemed necessary by the Corporation upon
extension of credit, is based on management's credit evaluation of the customer.
Since many of the commitments are expected to expire without being drawn upon,
the total commitment amounts do not necessarily represent future cash
requirements.
Under SFAS 133, commitments to originate residential mortgage loans held for
sale and forward commitments to sell residential mortgage loans are defined as
derivatives and are therefore required to be recorded on the consolidated
balance sheet at fair value. The Corporation's derivative and hedging activity,
as defined by SFAS 133, is further summarized in Note 7.
As part of the Corporation's agency agreement with an outside vendor, the
Corporation has guaranteed certain credit card accounts provided the cardholder
is unable to meet the credit card obligations. At June 30, 2003, the
Corporation's estimated maximum exposure was approximately $1 million.
Contingent Liabilities
- ----------------------
There are legal proceedings pending against the Corporation in the ordinary
course of business. Although litigation is subject to many uncertainties and the
ultimate exposure with respect to these matters cannot be ascertained,
management believes, based upon discussions with legal counsel, that the
Corporation has meritorious defenses, and any ultimate liability would not have
a material adverse affect on the consolidated financial position or results of
operations of the Corporation.
A contingent liability is required to be established if it is probable that the
Corporation will incur a loss on the performance of a letter of credit. During
the second quarter of 2003, the Corporation established a $2.5 million liability
for commercial letters of credit.
17
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Special Note Regarding Forward-Looking Statements
Statements made in this document which are not purely historical are
forward-looking statements, as defined in the Private Securities Litigation
Reform Act of 1995, including any statements regarding descriptions of
management's plans, objectives, or goals for future operations, products or
services, and forecasts of its revenues, earnings, or other measures of
performance. Forward-looking statements are based on current management
expectations and, by their nature, are subject to risks and uncertainties. These
statements may be identified by the use of words such as "believe," "expect,"
"anticipate," "plan," "estimate," "should," "will," "intend," or similar
expressions.
Shareholders should note that many factors, some of which are discussed
elsewhere in this document, could affect the future financial results of
Associated Banc-Corp and its subsidiaries ("the Corporation") and could cause
those results to differ materially from those expressed in forward-looking
statements contained in this document. These factors, many of which are beyond
the Corporation's control, include the following:
- - operating, legal, and regulatory risks;
- - economic, political, and competitive forces affecting the Corporation's
banking, securities, asset management, and credit services businesses; and
- - the risk that the Corporation's analyses of these risks and forces could be
incorrect and/or that the strategies developed to address them could be
unsuccessful.
These factors should be considered in evaluating the forward-looking statements,
and undue reliance should not be placed on such statements. Forward-looking
statements speak only as of the date they are made. The Corporation undertakes
no obligation to update or revise any forward looking statements, whether as a
result of new information, future events, or otherwise.
Overview
The following discussion and analysis is presented to assist in the
understanding and evaluation of the Corporation's financial condition and
results of operations. It is intended to complement the unaudited consolidated
financial statements, footnotes, and supplemental financial data appearing
elsewhere in this Form 10-Q and should be read in conjunction therewith. The
detailed discussion focuses on the six months ended June 30, 2003 and the
comparable period in 2002. Discussion of second quarter 2003 results compared to
second quarter 2002 is predominantly in section, "Comparable Second Quarter
Results."
The following discussion refers to the Corporation's business combination
activity that may impact the comparability of certain financial data (see Note
5, "Business Combinations," of the notes to consolidated financial statements).
In particular, consolidated financial results for 2003 reflect six month's
contribution from its February 28, 2002 purchase acquisition of Signal Financial
Corporation ("Signal") and three month's contribution from its April 1, 2003
purchase acquisition of CFG Insurance Services, Inc ("CFG"), while consolidated
financial results for 2002 reflect four month's contribution of Signal and no
contribution from CFG.
Critical Accounting Policies
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the balance sheet and revenues and expenses for
the period. Actual results could differ significantly from those estimates.
Estimates that are particularly susceptible to significant change include the
determination of the allowance for loan losses, mortgage servicing rights
valuation, derivative financial instruments and hedge accounting, and income tax
accounting.
18
The consolidated financial statements of the Corporation are prepared in
conformity with accounting principles generally accepted in the United States of
America and follow general practices within the industries in which it operates.
This preparation requires management to make estimates, assumptions, and
judgments that affect the amounts reported in the financial statements and
accompanying notes. These estimates, assumptions, and judgments are based on
information available as of the date of the financial statements; accordingly,
as this information changes, actual results could differ from the estimates,
assumptions, and judgments reflected in the financial statements. Certain
policies inherently have a greater reliance on the use of estimates,
assumptions, and judgments and, as such, have a greater possibility of producing
results that could be materially different than originally reported. Management
believes the following policies are both important to the portrayal of the
Corporation's financial condition and results and require subjective or complex
judgments and, therefore, management considers the following to be critical
accounting policies.
Allowance for Loan Losses: Subject to the use of estimates, assumptions, and
judgments is management's evaluation process used to determine the adequacy of
the allowance for loan losses which combines several factors: management's
ongoing review and grading of the loan portfolio, consideration of past loan
loss experience, trends in past due and nonperforming loans, risk
characteristics of the various classifications of loans, existing economic
conditions, the fair value of underlying collateral, and other qualitative and
quantitative factors which could affect probable credit losses. Because current
economic conditions can change and future events are inherently difficult to
predict, the anticipated amount of estimated loan losses, and therefore the
adequacy of the allowance, could change significantly. As an integral part of
their examination process, various regulatory agencies also review the allowance
for loan losses. Such agencies may require that certain loan balances be charged
off when their credit evaluations differ from those of management, based on
their judgments about information available to them at the time of their
examination. The Corporation believes the allowance for loan losses is adequate
and properly recorded in the financial statements. See section "Allowance for
Loan Losses."
Mortgage Servicing Rights Valuation: The fair value of the Corporation's
mortgage servicing rights asset is important to the presentation of the
consolidated financial statements in that mortgage servicing rights are subject
to a fair value-based impairment standard. Mortgage servicing rights do not
trade in an active open market with readily observable prices. As such, like
other participants in the mortgage banking business, the Corporation relies on
an internal discounted cash flow model to estimate the fair value of its
mortgage servicing rights. While the Corporation believes that the values
produced by its internal model are indicative of the fair value of its mortgage
servicing rights portfolio, these values can change significantly depending upon
the then current interest rate environment, estimated prepayment speeds of the
underlying mortgages serviced, and other economic conditions. The proceeds that
might be received should the Corporation actually consider a sale of the
mortgage servicing rights portfolio could differ from the amounts reported at
any point in time. The Corporation believes the mortgage servicing rights asset
is properly recorded in the financial statements. See Note 6, "Goodwill and
Other Intangible Assets," of the notes to consolidated financial statements and
section "Noninterest Expense."
Derivative Financial Instruments and Hedge Accounting: In various aspects of its
business, the Corporation uses derivative financial instruments to modify
exposures to changes in interest rates and market prices for other financial
instruments. The interest rate swaps and caps used by the Corporation are
designated as hedges for financial reporting purposes. The application of the
hedge accounting policy requires judgment in the assessment of hedge
effectiveness, identification of similar hedged item groupings, and measurement
of changes in the fair value of hedged items. However, if in the future the
derivative financial instruments used by the Corporation no longer qualify for
hedge accounting treatment and, consequently, the change in the fair value of
hedged items could be recognized in earnings, the impact on the consolidated
results of operations could be significant. The Corporation believes hedge
effectiveness is evaluated properly in the consolidated financial statements.
See Note 7, "Derivatives and Hedging Activities," of the notes to consolidated
financial statements.
Income Tax Accounting: The assessment of tax liabilities involves the use of
estimates, assumptions, interpretations, and judgments concerning certain
accounting pronouncements and federal and state tax
19
codes. There can be no assurance that future events, such as court decisions or
positions of federal and state taxing authorities, will not differ from
management's current assessment, the impact of which could be significant to the
consolidated results of operations. The Corporation believes the tax liabilities
are adequate and properly recorded in the consolidated financial statements. See
section "Income Taxes."
Segment Review
As described in Note 11, "Segment Reporting," of the notes to consolidated
financial statements, the Corporation's primary reportable segment is banking,
conducted through its bank and lending subsidiaries. Banking includes: a)
community banking - lending and deposit gathering to businesses (including
business-related services such as cash management and international banking
services) and to consumers (including mortgages and credit cards); and b)
corporate banking - specialized lending (such as commercial real estate), lease
financing, and banking to larger businesses and metro or niche markets; and the
support to deliver banking services.
The Corporation's profitability is primarily dependent on net interest income,
noninterest income, the level of the provision for loan losses, noninterest
expense, and taxes of its banking segment. The consolidated discussion is
therefore predominantly describing the banking segment results.
Results of Operations - Summary
Net income for the six months ended June 30, 2003 totaled $114.7 million, or
$1.55 and $1.53 for basic and diluted earnings per share, respectively.
Comparatively, net income for the six months ended June 30, 2002 was $103.8
million, or $1.39 and $1.37 for basic and diluted earnings per share,
respectively. Year-to-date 2003 results generated an annualized return on
average assets of 1.55% and an annualized return on average equity of 17.86%,
compared to 1.51% and 17.58%, respectively, for the comparable period in 2002.
The net interest margin for the first six months of 2003 was 3.83% compared to
3.94% for the first six months of 2002.
- -------------------------------------------------------------------------------------------------
TABLE 1
Summary Results of Operations: Trends
($ in Thousands, except per share data)
2nd Qtr. 1st Qtr. 4th Qtr. 3rd Qtr. 2nd Qtr.
2003 2003 2002 2002 2002
- -------------------------------------------------------------------------------------------------
Net income (Quarter) $ 56,669 $ 57,993 $ 53,441 $ 53,472 $ 52,344
Net income (Year-to-date) 114,662 57,993 210,719 157,278 103,806
Earnings per share - basic (Quarter) $ 0.77 $ 0.78 $ 0.72 $ 0.71 $ 0.69
Earnings per share - basic (Year-to-date) 1.55 0.78 2.82 2.10 1.39
Earnings per share - diluted (Quarter) $ 0.76 $ 0.77 $ 0.71 $ 0.70 $ 0.68
Earnings per share - diluted 1.53 0.77 2.79 2.08 1.37
(Year-to-date)
Return on average assets (Quarter) 1.51% 1.58% 1.42% 1.47% 1.47%
Return on average assets (Year-to-date) 1.55 1.58 1.47 1.49 1.51
Return on average equity (Quarter) 17.37% 18.36% 16.62% 16.73% 16.79%
Return on average equity (Year-to-date) 17.86 18.36 17.10 17.28 17.58
Efficiency ratio (Quarter)* 51.10% 49.29% 51.07% 51.14% 50.19%
Efficiency ratio (Year-to-date)* 50.21 49.29 50.25 49.94 49.29
Net interest margin (Quarter) 3.79% 3.87% 3.87% 3.96% 3.96%
Net interest margin (Year-to-date) 3.83 3.87 3.95 3.94 3.94
*Noninterest expense divided by sum of taxable equivalent net interest income plus noninterest
income, excluding investment securities gains(losses), net, and asset sales gains (losses), net.
- --------------------------------------------------------------------------------------------------
Net Interest Income and Net Interest Margin
Net interest income on a taxable equivalent basis for the six months ended June
30, 2003, was $267.2 million, an increase of $11.9 million or 4.6% over the
comparable period last year. As indicated in Tables 2 and 3, the
20
$11.9 million increase in taxable equivalent net interest income was
attributable to favorable volume variances (with balance sheet growth and
differences in the mix of average earning assets and average interest-bearing
liabilities adding $19.5 million to taxable equivalent net interest income),
offset partly by unfavorable rate variances (as the impact of changes in the
interest rate environment reduced taxable equivalent net interest income by $7.6
million).
The net interest margin for the first six months of 2003 was 3.83%, down 11
basis points ("bp") from 3.94% for the comparable period in 2002. This
comparable period decrease was attributable to a 1 bp decrease in interest rate
spread (the net of an 83 bp decrease in the yield on earning assets and an 82 bp
decrease in the cost of interest-bearing liabilities), and a 10 bp lower
contribution from net free funds (primarily reflecting the lower interest rate
environment in 2003).
Two interest rate decreases (totaling 75 bp) impacted the comparable six-month
periods. The average Federal funds rate of 1.24% for year-to-date 2003 was 51 bp
lower than the 1.75% average for year-to-date 2002. The Corporation positioned
the balance sheet during 2002 to be slightly asset sensitive (which means that
assets will reprice faster than liabilities); thus, the prolonged low interest
rate environment favorably lowered the cost of funding, but also lowered earning
asset yields, putting pressure on the net interest margin.
The yield on earning assets was 5.48% for year-to-date 2003, down 83 bp from the
comparable six-month period last year. Competitive pricing on new and refinanced
loans and the repricing of variable rate loans in the lower interest rate
environment put downward pressure on loan yields. The average loan yield was
5.56%, down 86 bp from year-to-date 2002. The average yield on investments and
other earning assets was 5.22%, down 76 bp, impacted by faster prepayments
(particularly on mortgage-related securities) and reinvestment in the lower rate
environment.
The cost of interest-bearing liabilities was 1.93% for year-to-date 2003, down
82 bp compared to the first six months of 2002, aided by the lower rate
environment. The average cost of interest-bearing deposits was 1.73%, down 79 bp
from year-to-date 2002, benefiting from a larger mix of lower-costing
transaction accounts, as well as from lower rates on all interest-bearing
deposit products in general. The cost of wholesale funds (comprised of
short-term borrowings and long-term funding) was 2.26%, down 96 bp from
year-to-date 2002, favorably impacted by lower rates between comparable periods.
Average earning assets increased by $980 million (7.6%) over the comparable
six-month period last year. Average loans represented 76.6% of average earning
assets for year-to-date 2003 compared to 74.7% for year-to-date 2002 and
accounted for the majority of the growth in earning assets. On average, loans
increased $1.0 billion (10.4%) since year-to-date 2002, primarily in commercial
loans (up $678 million). Commercial loans grew to represent 60.0% of average
loans for the first six months of 2003 compared to 59.2% for the comparable
period in 2002. Average investments and other earning assets decreased slightly
($26 million) to $3.3 billion.
Average interest-bearing liabilities increased $751 million (6.7%) over the
comparable period of 2002, and net free funds increased $229 million, both
supporting the growth in earning assets. Average noninterest-bearing demand
deposits (a component of net free funds) increased by $215 million, or 15.6%.
The growth in interest-bearing liabilities came from wholesale funding sources,
as average interest-bearing deposits were relatively unchanged (down $86 million
or 1.2%) between the comparable periods. Average wholesale funding sources
increased $837 million, representing 37.7% of average interest-bearing
liabilities for year-to-date 2003 compared to 32.7% for year-to-date 2002. To
take advantage of the lower rate environment, improve liquidity and mitigate
interest rate risk, the Corporation increased its long-term funding by $740
million (representing 18.1% of average interest-bearing liabilities, versus
12.7% for year-to-date 2002).
21
- ----------------------------------------------------------------------------------------------------------
TABLE 2
Net Interest Income Analysis-Taxable Equivalent Basis
($ in Thousands)
- ----------------------------------------------------------------------------------------------------------
Six Months ended June 30, 2003 Six Months ended June 30, 2002
---------------------------------- ----------------------------------
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
- ----------------------------------------------------------------------------------------------------------
Earning assets:
Loans: (1) (2) (3)
Commercial $ 6,399,244 $ 166,188 5.17% $ 5,720,820 $ 171,459 5.96%
Residential real estate 3,551,134 104,600 5.92 3,234,762 110,397 6.85
Consumer 711,008 26,003 7.37 700,044 28,393 8.17
------------------------ -------------------------
Total loans 10,661,386 296,791 5.56 9,655,626 310,249 6.42
Investments and other (1) 3,252,902 84,804 5.22 3,278,759 98,014 5.98
------------------------ -------------------------
Total earning assets 13,914,288 381,595 5.48 12,934,385 408,263 6.31
Other assets, net 1,028,042 972,877
----------- -----------
Total assets $14,942,330 $13,907,262
=========== ===========
Interest-bearing liabilities:
Interest-bearing deposits:
Savings deposits $ 927,413 $ 2,884 0.63% $ 864,914 $ 3,329 0.78%
Interest-bearing demand
deposits 1,591,942 6,925 0.88 983,399 3,427 0.70
Money market deposits 1,668,467 8,264 1.00 1,950,679 13,466 1.39
Time deposits, excluding
Brokered CDs 3,032,656 43,614 2.90 3,403,593 70,393 4.17
------------------------ -------------------------
Total interest-bearing
deposits, excluding
Brokered CDs 7,220,478 61,687 1.72 7,202,585 90,615 2.54
Brokered CDs 203,484 1,861 1.84 307,796 3,174 2.08
------------------------ -------------------------
Total interest-bearing
deposits 7,423,962 63,548 1.73 7,510,381 93,789 2.52
Wholesale funding 4,490,450 50,890 2.26 3,652,863 59,179 3.22
------------------------ -------------------------
Total interest-bearing
liabilities 11,914,412 114,438 1.93 11,163,244 152,968 2.75
------- -------
Demand, non-interest bearing 1,587,968 1,373,361
Other liabilities 145,146 179,594
Stockholders' equity 1,294,804 1,191,063
----------- ----------
Total liabilities and equity $14,942,330 $13,907,262
=========== ===========
Interest rate spread 3.55% 3.56%
Net free funds 0.28 0.38
---- ----
Net interest income, taxable
equivalent, and net
interest margin $267,157 3.83% $255,295 3.94%
================= ================
Taxable equivalent adjustment 12,508 12,100
-------- ------
Net interest income, as reported $254,649 $243,195
======== ========
(1) The yield on tax exempt loans and securities is computed on a taxable
equivalent basis using a tax rate of 35% for all periods presented and is
net of the effects of certain disallowed interest deductions.
(2) Nonaccrual loans and loans held for sale have been included in the average
balances.
(3) Interest income includes net loan fees.
- ---------------------------------------------------------------------------------------------------------
22
- ----------------------------------------------------------------------------------------------------------
TABLE 2 (continued)
Net Interest Income Analysis-Taxable Equivalent Basis
($ in Thousands)
- ----------------------------------------------------------------------------------------------------------
Three Months ended June 30, 2003 Three Months ended June 30, 2002
---------------------------------- ----------------------------------
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
- ----------------------------------------------------------------------------------------------------------
Earning assets:
Loans: (1) (2) (3)
Commercial $ 6,470,954 $ 83,333 5.10% $ 5,968,167 $ 89,365 5.93%
Residential real estate 3,564,125 51,778 5.81 3,217,681 54,540 6.78
Consumer 708,351 12,940 7.32 716,614 14,690 8.22
------------------------ ------------------------
Total loans 10,743,430 148,051 5.48 9,902,462 158,595 6.37
Investments and other (1) 3,248,185 41,884 5.16 3,346,128 49,299 5.89
------------------------ ------------------------
Total earning assets 13,991,615 189,935 5.41 13,248,590 207,894 6.25
Other assets, net 1,024,882 1,024,642
----------- -----------
Total assets $15,016,497 $14,273,232
=========== ===========
Interest-bearing liabilities:
Interest-bearing deposits:
Savings deposits $ 945,048 $ 1,431 0.61% $ 900,471 $ 1,769 0.79%
Interest-bearing demand
deposits 1,696,412 3,812 0.90 1,038,413 1,927 0.74
Money market deposits 1,632,710 3,999 0.98 1,992,669 6,751 1.36
Time deposits, excluding
Brokered CDs 3,052,513 21,549 2.83 3,411,891 33,580 3.95
------------------------ ------------------------
Total interest-bearing
deposits, excluding
Brokered CDs 7,326,683 30,791 1.69 7,343,444 44,027 2.40
Brokered CDs 174,748 767 1.76 289,676 1,533 2.12
------------------------ ------------------------
Total interest-bearing
deposits 7,501,431 31,558 1.69 7,633,120 45,560 2.39
Wholesale funding 4,440,446 24,951 2.23 3,767,182 30,529 3.21
------------------------ ------------------------
Total interest-bearing
liabilities 11,941,877 56,509 1.89 11,400,302 76,089 2.66
------ ------
Demand, non-interest bearing 1,619,773 1,448,314
Other liabilities 146,342 173,868
Stockholders' equity 1,308,505 1,250,748
----------- ----------
Total liabilities
and equity $15,016,497 $14,273,232
=========== ===========
Interest rate spread 3.52% 3.59%
Net free funds 0.27 0.37
---- ----
Net interest income, taxable
equivalent, and net
interest margin $ 133,426 3.79% $ 131,805 3.96%
================= ====================
Taxable equivalent adjustment 6,231 6,037
----- -----
Net interest income, as reported $ 127,195 $ 125,768
========= =========
- ----------------------------------------------------------------------------------------------------------
23
- --------------------------------------------------------------------------------
TABLE 3
Volume / Rate Variance - Taxable Equivalent Basis
($ in Thousands)
- --------------------------------------------------------------------------------
Comparison of
Six months ended June 30, 2003 versus 2002
------------------------------------------
Variance Attributable to
Income/Expense ------------------------
Variance (1) Volume Rate
- --------------------------------------------------------------------------------
INTEREST INCOME: (2)
Loans:
Commercial $ (5,271) $ 16,792 $(22,063)
Residential real estate (5,797) 10,412 (16,209)
Consumer (2,390) (1,557) (833)
---------------------------------
Total loans (13,458) 25,647 (39,105)
Investments and other (13,210) (576) (12,634)
---------------------------------
Total interest income (26,668) 25,071 (51,739)
INTEREST EXPENSE:
Interest-bearing deposits:
Savings deposits $ (445) $ 194 $ (639)
Interest-bearing demand deposits 3,498 2,647 851
Money market deposits (5,202) (1,398) (3,804)
Time deposits, excluding
brokered CDs (26,779) (5,334) (21,445)
---------------------------------
Interest-bearing deposits,
excluding brokered CDs (28,928) (3,891) (25,037)
Brokered CDs (1,313) (954) (359)
---------------------------------
Total interest-bearing deposits (30,241) (4,845) (25,396)
Wholesale funding (8,289) 10,405 (18,694)
---------------------------------
Total interest expense (38,530) 5,560 (44,090)
---------------------------------
Net interest income, taxable
equivalent $ 11,862 $ 19,511 $ (7,649)
=================================
(1) The change in interest due to both rate and volume has been allocated
proportionately to volume variance and rate variance based on the
relationship of the absolute dollar change in each.
(2) The yield on tax-exempt loans and securities is computed on a taxable
equivalent basis using a tax rate of 35% for all periods presented and is
net of the effects of certain disallowed interest deductions.
- --------------------------------------------------------------------------------
24
- --------------------------------------------------------------------------------
TABLE 3 (continued)
Volume / Rate Variance - Taxable Equivalent Basis
($ in Thousands)
- --------------------------------------------------------------------------------
Comparison of
Three months ended June 30, 2003 versus 2002
--------------------------------------------
Variance Attributable to
Income/Expense ------------------------
Variance (1) Volume Rate
- --------------------------------------------------------------------------------
INTEREST INCOME: (2)
Loans:
Commercial $ (6,032) $ 6,010 $(12,042)
Residential real estate (2,762) 5,777 (8,539)
Consumer (1,750) (1,158) (592)
---------------------------------
Total loans (10,544) 10,629 (21,173)
Investments and other (7,415) (1,092) (6,323)
---------------------------------
Total interest income (17,959) 9,537 (27,496)
INTEREST EXPENSE:
Interest-bearing deposits:
Savings deposits $ (338) $ 71 $ (409)
Interest-bearing demand deposits 1,885 1,485 400
Money market deposits (2,752) (868) (1,884)
Time deposits, excluding
brokered CDs (12,031) (2,471) (9,560)
---------------------------------
Interest-bearing deposits,
excluding brokered CDs (13,236) (1,783) (11,453)
Brokered CDs (766) (501) (265)
---------------------------------
Total interest-bearing deposits (14,002) (2,284) (11,718)
Wholesale funding (5,578) 3,771 (9,349)
---------------------------------
Total interest expense (19,580) 1,487 (21,067)
---------------------------------
Net interest income, taxable
equivalent $ 1,621 $ 8,050 $ (6,429)
=================================
- --------------------------------------------------------------------------------
Provision for Loan Losses
The provision for loan losses for the second quarter of 2003 was $12.1 million,
minimally changed from the second quarter of 2002 of $12.0 million. For the
first six months of 2003, the provision for loan losses was $25.1 million,
compared to $23.3 million for the same period in 2002. Annualized net charge
offs as a percent of average loans for year-to-date 2003 decreased to 0.29% from
0.31% for year-to-date 2002. Nonperforming loans were $117.2 million, $87.3
million and $99.3 million at June 30, 2003, June 30, 2002 and December 31, 2002,
respectively. The ratio of the allowance for loan losses to total loans was
1.66%, up from 1.50% at June 30, 2002 and 1.58% at December 31, 2002. See Table
8.
The provision for loan losses is predominantly a function of the methodology and
other qualitative and quantitative factors used to determine the adequacy of the
allowance for loan losses which focuses on changes in the size and character of
the loan portfolio, changes in levels of impaired and other nonperforming loans,
historical losses on each portfolio category, the risk inherent in specific
loans, concentrations of loans to specific borrowers or industries, existing
economic conditions, the fair value of underlying collateral, and other factors
which could affect potential credit losses. See additional discussion under
sections "Allowance for Loan Losses," and "Nonperforming Loans and Other Real
Estate Owned."
25
Noninterest Income
Year-to-date 2003 noninterest income was $135.4 million, up $38.1 million or
39.1% compared to $97.3 million for year-to-date 2002, influenced by a
significant increase in mortgage banking income (up $32.7 million). Continued
strong activity in mortgage origination and refinancing markets supported
mortgage banking income of $54.9 million in the first six months of 2003, more
than double that of the year-earlier period.
- ---------------------------------------------------------------------------------------------------------------------------
TABLE 4
Noninterest Income
($ in Thousands)
- --------------------------------------------------------------------------------------------------------------------------
2nd Qtr. 2nd Qtr. Dollar Percent YTD YTD Dollar Percent
2003 2002 Change Change 2003 2002 Change Change
- --------------------------------------------------------------------------------------------------------------------------
Trust service fees $ 7,796 $ 7,722 $ 74 1.0% $ 14,426 $ 15,093 $ (667) (4.4)%
Service charges on deposit 12,462 11,733 729 6.2 24,273 21,613 2,660 12.3
accounts
Mortgage banking 28,845 9,637 19,208 199.3 54,948 22,241 32,707 147.1
Credit card & other nondeposit 5,192 7,094 (1,902) (26.8) 12,588 13,166 (578) (4.4)
fees
Retail commissions 7,407 5,885 1,522 25.9 10,710 10,501 209 2.0
Bank owned life insurance 3,450 3,469 (19) (0.5) 6,841 6,739 102 1.5
income
Other 4,771 4,322 449 10.4 11,550 7,578 3,972 52.4
---------------------------------------------------------------------------------------
Subtotal $ 69,923 $ 49,862 $ 20,061 40.2% $135,336 $ 96,931 $ 38,405 39.6%
Asset sale gains (losses), net (790) 41 (831) N/M (668) 372 (1,040) N/M
Investment securities gains,
net 1,027 --- 1,027 N/M 701 --- 701 N/M
---------------------------------------------------------------------------------------
Total noninterest income $ 70,160 $ 49,903 $ 20,257 40.6% $135,369 $ 97,303 $ 38,066 39.1%
=======================================================================================
N/M - Not meaningful.
- --------------------------------------------------------------------------------------------------------------------------
Trust service fees decreased $0.7 million, or 4.4%, between the comparable
six-month periods. The change was predominantly the result of a decrease in the
average market value of assets under management (from an average of $3.9 billion
for year-to-date 2002 to $3.6 billion for year-to-date 2003), a function of the
continued weak stock market performance. Assets under management at June 30,
2003 and 2002 were $3.76 billion and $3.74 billion, respectively.
Service charges on deposit accounts were up $2.7 million, or 12.3%, between the
comparable six-month periods, due in part to higher volumes associated with a
larger account base. The increase was also a result of lower earnings credit
rates, higher service charges on business accounts, and higher fees on
overdrafts/nonsufficient funds, supported by pricing changes between the
periods.
Mortgage banking income consists of servicing fees, the gain or loss on sales of
mortgage loans to the secondary market, and production-related fees
(origination, underwriting and escrow waiver fees). Mortgage banking income was
$54.9 million, an increase of $32.7 million, more than double the comparable
six-month period in 2002. The increase was driven primarily by secondary
mortgage loan production (mortgage loan production to be sold to the secondary
market) which more than doubled between comparable periods ($2.3 billion in
year-to-date 2003 versus $1.1 billion in year-to-date 2002). The higher
production levels positively impacted production volume-related fees (up $4.6
million). Also, gains on sales of the increased production were up $27.8 million
(the combination of realized gains up $23.9 million and $3.9 million higher fair
value of mortgage derivatives). Servicing fees on the portfolio serviced for
others were up slightly ($0.3 million) between comparable periods, given the
minimal change in the average balance serviced. The mortgage portfolio serviced
for others at June 30, 2003 and 2002 was $5.47 billion and $5.56 billion,
respectively.
Credit card and other nondeposit fees were $12.6 million for the first six
months of 2003, a decrease of $0.6 million or 4.4% from year-to-date 2002,
primarily attributable to lower merchant fees, given the merchant processing
sale and services agreement signed in March 2003 (also noted below).
Retail commission income (which includes commissions from insurance and
brokerage product sales) was $10.7 million for the first six months of 2003.
While up modestly ($0.2 million) compared to the same period
26
a year ago, the components have shifted. Fixed annuities commissions decreased
$1.3 million, while other insurance revenues were up $1.7 million. Other
insurance revenues were impacted favorably by the CFG acquisition, but offset
partly by lower loan insurance commissions, which were affected by legislation
in late 2002 requiring single premium credit insurance premiums on loans with
real estate to be collected based on monthly outstanding balances. Brokerage
commissions (including variable annuities) declined $0.2 million, affected by
challenging market conditions.
Other noninterest income was $11.6 million for year-to-date 2003, an increase of
$4.0 million over the comparable period in 2002. Year-to-date 2003 included a
second quarter $1.5 million gain on the sale of out-of-market credit card
accounts and a first quarter $3.4 million gain recognized in connection with a
credit card merchant processing sale and services agreement, while the sale of
stock in a regional ATM network resulted in a gain of $0.5 million during
year-to-date 2002. The 2003 investment securities net gain of $0.7 million was
the net result of a second quarter $1.0 million gain on the sale of Sallie Mae
stock, net of a first quarter $0.3 million other than temporary write down on a
security.
Noninterest Expense
Noninterest expense was $202.1 million, up $28.5 million or 16.4% compared to
the first six months of 2002, reflecting higher mortgage servicing rights
expense, as well as the Corporation's larger operating base between comparable
periods.
- --------------------------------------------------------------------------------------------------------------------------
TABLE 5
Noninterest Expense
($ in Thousands)
- --------------------------------------------------------------------------------------------------------------------------
2nd Qtr. 2nd Qtr. Dollar Percent YTD YTD Dollar Percent
2003 2002 Change Change 2003 2002 Change Change
- --------------------------------------------------------------------------------------------------------------------------
Personnel expense $ 53,245 $ 48,764 $ 4,481 9.2% $103,480 $ 93,758 $ 9,722 10.4%
Occupancy 7,151 6,650 501 7.5 14,266 12,787 1,479 11.6
Equipment 3,190 3,727 (537) (14.4) 6,434 7,217 (783) (10.8)
Data processing 5,602 5,304 298 5.6 11,220 10,107 1,113 11.0
Business development &
advertising 3,553 3,126 427 13.7 6,916 6,572 344 5.2
Stationery and supplies 1,634 1,786 (152) (8.5) 3,313 3,830 (517) (13.5)
FDIC expense 359 402 (43) (10.7) 725 774 (49) (6.3)
Mortgage servicing rights
expense 13,021 3,874 9,147 236.1 24,619 6,771 17,848 263.6
Intangible amortization expense 870 634 236 37.2 1,220 1,098 122 11.1
Loan expense 950 3,534 (2,584) (73.1) 4,298 6,313 (2,015) (31.9)
Other 14,344 13,386 958 7.2 25,585 24,376 1,209 5.0
--------------------------------------------------------------------------------------
Total noninterest expense $103,919 $ 91,187 $ 12,732 14.0% $202,076 $173,603 $ 28,473 16.4%
======================================================================================
- --------------------------------------------------------------------------------------------------------------------------
Personnel expense (including salary-related expenses and fringe benefit
expenses) increased $9.7 million or 10.4% over the first six months of 2002.
Personnel expense represented 51.2% of total noninterest expense in year-to-date
2003 compared to 54.0% in year-to-date 2002. Salary-related expenses increased
$7.7 million or 10.6% between comparable periods, primarily a function of merit
increases between years, and higher base salaries and incentive compensation
given the overall increase in full-time equivalent employees (particularly
attributable to the timing of the Signal and CFG acquisitions). Average
full-time equivalent employees were 4,111 for year-to-date 2003 compared to
4,043 for year-to-date 2002, an increase of 2%. Fringe benefits increased $2.0
million or 9.5% over year-to-date 2002, attributable also to the larger employee
base and the increased cost of benefit plans and premium based benefits.
Occupancy expense increased 11.6% to support the larger branch network,
particularly attributable to the Signal and CFG acquisitions. Equipment expense
declined principally in computer depreciation expense. Data processing costs
increased to $11.2 million, up $1.1 million or 11.0% over the comparable period
in 2002, due to processing for a larger base operation, increased Internet
banking usage and other technology enhancements.
Mortgage servicing rights expense includes both the amortization of the mortgage
servicing rights asset
27
and increases or decreases to the valuation allowance associated with the
mortgage servicing rights asset. Mortgage servicing rights expense increased by
$17.8 million between comparable periods, including a $15.8 million addition to
the valuation allowance for year-to-date 2003 (compared to a $0.8 million
addition to the valuation allowance during year-to-date 2002) and a $2.8 million
increase in the amortization of the mortgage servicing rights asset. While the
strong mortgage refinance activity benefited mortgage banking income, it
increased the prepayment speeds of the Corporation's mortgage portfolio serviced
for others, a key factor behind the valuation of mortgage servicing rights. The
Corporation periodically evaluates its capitalized mortgage servicing rights for
impairment. Loan type and note rate are the predominant risk characteristics of
the underlying loans used to stratify capitalized mortgage servicing rights for
purposes of measuring impairment. Permanent impairment is recognized as a
write-down on the mortgage servicing rights asset and the related valuation
allowance. Mortgage servicing rights are considered a critical accounting policy
(see section "Critical Accounting Policies") given that estimating the fair
value of the mortgage servicing rights involves judgment, particularly of
estimated prepayment speeds of the underlying mortgages serviced and the overall
level of interest rates. A valuation allowance is established to the extent the
carrying value of the mortgage servicing rights exceeds the estimated fair
value. Net income could be affected if management's estimate of the prepayment
speeds or other factors differ materially from actual prepayments. Mortgage
servicing rights, included in other intangible assets on the consolidated
balance sheet, were $27.8 million, net of a $35.1 million valuation allowance at
June 30, 2003. See Note 6, "Goodwill and Other Intangible Assets," of the notes
to consolidated financial statements for additional disclosure.
Loan expense was $4.3 million, down $2.0 million between comparable periods,
primarily due to lower merchant processing costs, given the sale of the merchant
processing during the first quarter of 2003. Other expense was up $1.2 million
from year-to-date 2002, attributable to a $2.5 million charge in the second
quarter on commercial letters of credit, partially offset by declines in various
other expenses.
Income Taxes
Income tax expense for the first six months of 2003 was $48.2 million, up $8.4
million or 21.0% from the comparable period in 2002. The effective tax rate
(income tax expense divided by income before taxes) was 29.6% and 27.7% for
year-to-date 2003 and year-to-date 2002, respectively. The increase was
primarily attributable to the increase in net income before tax and a decrease
in tax valuation allowance adjustments.
Income tax expense recorded in the consolidated statement of income involves the
interpretation and application of certain accounting pronouncements and federal
and state tax codes, and is, therefore, considered a critical accounting policy
(see section "Critical Accounting Policies"). The Corporation undergoes
examination by various regulatory taxing authorities. Such agencies may require
that changes in the amount of tax expense or valuation allowance be recognized
when their interpretations differ from those of management, based on their
judgments about information available to them at the time of their examinations.
Balance Sheet
At June 30, 2003, total assets were $15.2 billion, an increase of $0.7 billion,
or 5.1%, over June 30, 2002. The growth in assets occurred primarily in loans,
which grew $505 million or 5.1% year over year, and loans held for sale, which
increased $269 million. The growth in loans was almost exclusively in commercial
loans, which grew $557 million (9.3% since June 30, 2002) and comprise 63% of
total loans at June 30, 2003. Home equity loans grew $119 million or 15.3%,
while residential mortgage loans decreased 6.8%, strongly influenced by lower
interest rates and high refinance activity. Total deposits of $9.5 billion at
June 30, 2003 were up $427 million, or 4.7%, compared to a year ago. Since June
30, 2002, noninterest-bearing demand deposits grew $267 million (17.1%), to
represent 19% of total deposits, compared to 17% a year earlier.
Interest-bearing transaction accounts (savings, interest-bearing demand, and
money market) grew by $424 million (10.8%). Brokered CDs and other-time deposits
combined (representing 35% of total deposits at June 30, 2003 compared to 40% of
total deposits at June 30, 2002) declined $264 million, impacted by the
prolonged lower interest rate environment and customer preference to keep funds
liquid. Since June 30, 2002, long-term debt grew $500 million due to the
28
issuance of $331 million of long-term repurchase agreements, $100 million of
bank notes, and the increased use of long-term Federal Home Loan Bank advances.
With deposits and long-term debt up, short-term borrowings decreased $222
million since June 30, 2002.
Since year-end 2002, total deposit growth was greater than total asset growth,
bringing wholesale funds (short-term borrowings and long-term debt combined)
down $203 million, particularly in short-term borrowings. Total assets grew $176
million since year-end 2002, with loans up $84 million and loans held for sale
up $87 million. The growth in loans was primarily in commercial loans, which
grew $290 million, while residential mortgage loans decreased $228 million.
Deposits increased $329 million to $9.5 billion at June 30, 2003, led by
interest-bearing transaction accounts, collectively up $219 million since
year-end 2002. See Tables 6 and 7 for period end loan and deposit composition,
respectively.
- -----------------------------------------------------------------------------------------------------------
TABLE 6
Period End Loan Composition
($ in Thousands)
- -----------------------------------------------------------------------------------------------------------
June 30, % of June 30, % of Dec. 31, % of
2003 Total 2002 Total 2002 Total
- -----------------------------------------------------------------------------------------------------------
Commercial, financial &agricultural $ 2,312,143 22% $ 2,127,665 21% $ 2,213,986 22%
Real estate-construction 975,415 10 821,658 8 910,581 9
Commercial real estate 3,255,918 31 3,037,284 31 3,128,826 30
Lease financing 38,666 -- 38,212 1 38,352 --
---------------------------------------------------------------------
Commercial 6,582,142 63 6,024,819 61 6,291,745 61
Residential mortgage 2,202,690 21 2,364,373 24 2,430,746 24
Home equity 895,952 9 777,347 8 864,631 8
---------------------------------------------------------------------
Residential real estate 3,098,642 30 3,141,720 32 3,295,377 32
Consumer 706,580 7 716,130 7 716,103 7
---------------------------------------------------------------------
Total loans $10,387,364 100% $ 9,882,669 100% $10,303,225 100%
====================================================================
- ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
TABLE 7
Period End Deposit Composition
($ in Thousands)
- ------------------------------------------------------------------------------------------------------------
June 30, % of June 30, % of Dec. 31, % of
2003 Total 2002 Total 2002 Total
- ------------------------------------------------------------------------------------------------------------
Noninterest-bearing demand $ 1,833,703 19% $1,566,487 17% $ 1,773,699 19%
Savings 942,027 10 912,019 10 895,855 10
Interest-bearing demand 1,797,065 19 1,113,342 12 1,468,193 16
Money market 1,598,317 17 1,888,165 21 1,754,313 19
Brokered CDs 163,028 2 233,968 3 233,650 3
Other time 3,119,320 33 3,312,263 37 2,999,142 33
-------------------------------------------------------------------
Total deposits $ 9,453,460 100% $9,026,244 100% $ 9,124,852 100%
===================================================================
Total deposits, excluding
Brokered CDs $ 9,290,432 98% $8,792,276 97% $ 8,891,202 97%
===================================================================
- -----------------------------------------------------------------------------------------------------------
Allowance for Loan Losses
The loan portfolio is the primary asset subject to credit risk. Credit risks are
inherently different for each different loan type. Credit risk is controlled and
monitored through the use of lending standards, a thorough review of potential
borrowers, and on-going review of loan payment performance. Active asset quality
administration, including early problem loan identification and timely
resolution of problems, aids in the management of credit risk and minimization
of loan losses.
29
- -------------------------------------------------------------------------------
TABLE 8
Allowance for Loan Losses and Nonperforming Assets
($ in Thousands)
- -------------------------------------------------------------------------------
At and for the At and for the
six months ended year ended
June 30, December 31,
- -------------------------------------------------------------------------------
2003 2002 2002
------------------------------------
Allowance for Loan Losses:
Balance at beginning of period $ 162,541 $ 128,204 $ 128,204
Balance related to acquisition -- 11,985 11,985
Provision for loan losses 25,092 23,254 50,699
Charge offs (17,291) (16,787) (32,179)
Recoveries 2,098 2,077 3,832
-----------------------------------
Net charge-offs (15,193) (14,710) (28,347)
-----------------------------------
Balance at end of period $ 172,440 $ 148,733 $ 162,541
===================================
Nonperforming Assets:
Nonaccrual loans $ 110,820 $ 82,474 $ 94,132
Accruing loans past due 90 days or more 6,311 4,683 3,912
Restructured loans 46 115 1,258
-----------------------------------
Total nonperforming loans 117,177 87,272 99,302
Other real estate owned 14,707 2,610 11,448
-----------------------------------
Total nonperforming assets $ 131,884 $ 89,882 $ 110,750
===================================
Ratios:
Allowance for loan losses to net
charge offs (annualized) 5.63x 5.01x 5.73x
Net charge offs to average loans
(annualized) 0.29% 0.31% 0.28%
Allowance for loan losses to total
loans 1.66% 1.50% 1.58%
Nonperforming loans to total loans 1.13% 0.88% 0.96%
Nonperforming assets to total assets 0.87% 0.62% 0.74%
Allowance for loan losses to
nonperforming loans 147% 170% 164%
- -------------------------------------------------------------------------------
As of June 30, 2003, the allowance for loan losses was $172.4 million,
representing 1.66% of loans outstanding, compared to $148.7 million, or 1.50% of
loans, at June 30, 2002, and $162.5 million, or 1.58% at year-end 2002. The
allowance for loan losses at June 30, 2003 increased $23.7 million since June
30, 2002 and $9.9 million since December 31, 2002. At June 30, 2003, the
allowance for loan losses was 147% of nonperforming loans compared to 170% and
164% at June 30 and December 31, 2002, respectively. Table 8 provides additional
information regarding activity in the allowance for loan losses and
nonperforming assets.
Gross charge offs were $17.3 million for the six months ended June 30, 2003,
which included an $8 million charge off related to a commercial loan
relationship in the construction industry. This compares to $16.8 million for
the six months ended June 30, 2002. Recoveries for the corresponding periods
were $2.1 million and $2.1 million, respectively. As a result, the ratio of net
charge offs to average loans on an annualized basis was 0.29% and 0.31% for the
periods ended June 30, 2003 and June 30, 2002, respectively.
The allowance for loan losses represents management's estimate of an amount
adequate to provide for probable credit losses in the loan portfolio at the
balance sheet date. To assess the adequacy of the allowance for loan losses, an
allocation methodology is applied by the Corporation, which focuses on changes
in the size and character of the loan portfolio, changes in levels of impaired
or other nonperforming loans, the risk inherent in specific loans,
concentrations of loans to specific borrowers or industries, existing economic
conditions, underlying collateral, historical losses on each portfolio category,
and other qualitative and quantitative factors which could affect probable
credit losses. Assessing these
30
numerous factors involves significant judgment. Management considers the
allowance for loan losses a critical accounting policy (see section "Critical
Accounting Policies"). Thus, in general, the change in the allowance for loan
losses is a function of a number of factors, including but not limited to
changes in the loan portfolio (see Table 6), net charge offs and nonperforming
loans (see Table 8).
The allocation methods used for June 30, 2003, June 30, 2002, and December 31,
2002 were comparable, using specific allocations, factors on loans bearing risk
ratings as determined by management, and factors on all other loans. Current
economic and political conditions at each period end carried various
uncertainties requiring management's judgment as to the possible impact on the
business results of numerous individual borrowers and certain industries. Total
loans at June 30, 2003, were up $505 million (5.1%) since June 30, 2002, with
commercial loans accounting for the majority of growth (up $557 million, or 9.3%
versus last year). Total loans compared to December 31, 2002, increased modestly
(up $84 million) to $10.4 billion; however, the commercial portfolio grew $290
million (9.3% annualized) to represent 63% of total loans versus 61% at December
31, 2002 (see Table 6). Commercial loans carry a higher inherent risk of credit
loss. Nonperforming loans grew $29.9 million since June 30, 2002 and grew $17.9
million since December 31, 2002, particularly from specific nonperforming
commercial loans (see Table 8 and detailed discussion in section "Nonperforming
Loans and Other Real Estate Owned"). In addition, a previously disclosed
commercial manufacturing relationship ($19 million at June 30, 2003), with $10
million allowance identified for this relationship, has been included in
nonaccrual loans for all periods presented. At June 30, 2003, this commercial
manufacturing relationship, remained current but management has continued doubts
concerning future collectibility. Finally, loans bearing risk ratings for June
30, 2003 increased from a year ago, in part from the large commercial credits
noted in section "Nonperforming Loans and Other Real Estate Owned" as well as a
larger portion of loans moved into higher-risk categories. Loans bearing risk
ratings were up modestly since December 31, 2002; however, several larger loans
moved to higher-risk categories due to deterioration, increasing overall
portfolio risk. Portfolio risk is a predominant characteristic in determining
the allowance for loan losses. The allowance for loan losses to loans was 1.66%,
1.50% and 1.58% for June 30, 2003, and June 30 and December 31, 2002,
respectively.
Management believes the allowance for loan losses to be adequate at June 30,
2003.
Consolidated net income could be affected if management's estimate of the
allowance for loan losses is subsequently materially different, requiring
additional provision for loan losses to be recorded. Management carefully
considers numerous detailed and general factors, its assumptions, and the
likelihood of materially different conditions that could alter its assumptions.
While management uses currently available information to recognize losses on
loans, future adjustments to the allowance for loan losses may be necessary
based on changes in economic conditions and the impact of such change on the
Corporation's borrowers. As an integral part of their examination process,
various regulatory agencies also review the allowance for loan losses. Such
agencies may require that certain loan balances be charged off when their credit
evaluations differ from those of management, based on their judgments about
information available to them at the time of their examination.
Nonperforming Loans and Other Real Estate Owned
Management is committed to an aggressive nonaccrual and problem loan
identification philosophy. This philosophy is implemented through the ongoing
monitoring and reviewing of all pools of risk in the loan portfolio to ensure
that problem loans are identified quickly and the risk of loss is minimized.
Nonperforming loans are considered one indicator of potential future loan
losses. Nonperforming loans are defined as nonaccrual loans, loans 90 days or
more past due but still accruing, and restructured loans. The Corporation
specifically excludes from its definition of nonperforming loans student loan
balances that are 90 days or more past due and still accruing and that have
contractual government guarantees as to collection of principal and interest.
The Corporation had $16 million, $20 million and $20 million of these loans at
June 30, 2003, June 30, 2002, and December 31, 2002, respectively.
31
Table 8 provides detailed information regarding nonperforming assets, which
include nonperforming loans and other real estate owned. Nonperforming assets to
total assets were 0.87%, 0.62%, and 0.74% at June 30, 2003, June 30, 2002, and
December 31, 2002, respectively.
Total nonperforming loans at June 30, 2003 were up $29.9 million from June 30,
2002 and up $17.9 million from year-end 2002. The ratio of nonperforming loans
to total loans was 1.13% at June 30, 2003, as compared to 0.88% and 0.96% at
June 30, 2002, and year-end 2002, respectively. The $29.9 million increase in
nonperforming loans was from nonaccrual loans (up $28.3 million) and accruing
loans past due 90 or more days (up $1.6 million), while restructured loans were
relatively level. The increase in nonaccrual loans between the comparable June
periods was predominantly attributable to the addition, during the second
quarter of 2003, of two large commercial credits (totaling approximately $25
million at June 30, 2003), one in the construction industry and one in the
hospitality industry. The $17.9 million increase in nonperforming loans since
year-end 2002 was from nonaccrual loans (up $16.7 million), accruing loans past
due 90 or more days (up $2.4 million), and restructured loans (down $1.2
million). The increase in nonaccrual loans since year-end 2002 was primarily
attributable to the two credits noted above, net of the transfer of one large
credit (totaling $2.7 million) to other real estate owned. In addition, a
previously disclosed commercial manufacturing relationship ($19 million at June
30, 2003), has been included in nonaccrual loans for all periods presented. Of
note, approximately 38% of nonperforming loans at June 30, 2003 are attributable
to the three specifically mentioned credits.
Other real estate owned increased to $14.7 million at June 30, 2003, compared to
$2.6 million at June 30, 2002, and $11.4 million at year-end 2002. The increases
are predominantly due to the addition of commercial real estate properties, an
$8.0 million property during the fourth quarter of 2002, a $1.5 million property
during the first quarter of 2003, and a $2.7 million property during the second
quarter of 2003. The $1.5 million commercial real estate property was sold
during the second quarter of 2003.
Potential problem loans are certain loans bearing risk ratings by management,
that are not in nonperforming status, but where there are doubts as to the
ability of the borrower to comply with present repayment terms. The decision of
management to include performing loans in potential problem loans does not
necessarily mean that the Corporation expects losses to occur, but that
management recognizes a higher degree of risk associated with these loans. The
level of potential problem loans is another predominate factor in determining
the relative level of risk in the loan portfolio and in the determination of the
level of the allowance for loan losses. The loans that have been reported as
potential problem loans are not concentrated in a particular industry, but
rather cover a diverse range of businesses. At June 30, 2003, potential problem
loans totaled $236 million, compared to $275 million at March 31, 2003 and $212
million at December 31, 2002. From December 31, 2002 to March 31, 2003, five
credit relationships accounted for $52 million of the $63 million increase,
including the $20 million commercial credit relationship in the construction
industry. During second quarter 2003, management charged off $8 million of this
relationship (as noted in section "Allowance for Loan Losses") and placed it on
nonaccrual status. The decline from March 31 to June 30, 2003, is primarily from
two credits that deteriorated and moved to nonaccrual status (including the
construction credit noted above), and one credit ($2.7 million at June 30, 2003)
to other real estate owned.
Liquidity
The objective of liquidity management is to ensure that the Corporation has the
ability to generate sufficient cash or cash equivalents in a timely and
cost-effective manner to meet its commitments as they fall due. Funds are
available from a number of sources, primarily from the core deposit base and
from loans and securities repayments and maturities. Additionally, liquidity is
provided from sales of the securities portfolio, lines of credit with major
banks, the ability to acquire large and brokered deposits, and the ability to
securitize or package loans for sale.
While core deposits and loan and investment repayment are principal sources of
liquidity, funding diversification is another key element of liquidity
management. Diversity is achieved by strategically varying depositor type, term,
funding market, and instrument. The parent company and certain banks are
32
rated by Moody's, Standard and Poor's (S&P), and Fitch. These ratings, along
with the Corporation's other ratings, provide opportunity for greater funding
capacity and funding alternatives.
The parent company manages its liquidity position to provide the funds necessary
to pay dividends to stockholders, service debt, invest in subsidiaries,
repurchase common stock, and satisfy other operating requirements. The parent
company's primary funding sources to meet its liquidity requirements are
dividends and service fees from subsidiaries, borrowings with major banks,
commercial paper issuance, and proceeds from the issuance of equity. The
subsidiary banks are subject to regulation and, among other things, may be
limited in their ability to pay dividends or transfer funds to the parent
company. Accordingly, consolidated cash flows as presented in the consolidated
statements of cash flows may not represent cash immediately available for the
payment of cash dividends to the Corporation's stockholders.
In addition to subsidiary dividends, the parent company has multiple funding
sources that could be used to increase liquidity and provide additional
financial flexibility. These sources include a revolving credit facility,
commercial paper, and two shelf registrations. The parent company has available
a $100 million revolving credit facility with established lines of credit from
nonaffiliated banks, of which $100 million was available at June 30, 2003. In
addition, $200 million of commercial paper was available at June 30, 2003, under
the parent company's commercial paper program.
In May 2002, the parent company filed a "shelf" registration statement under
which the parent company may offer up to $300 million of trust preferred
securities. In May 2002, the parent company issued $175 million of trust
preferred securities, bearing a 7.625% fixed coupon rate. At June 30, 2003, $125
million was available under the trust preferred shelf. In May 2001, the parent
company filed a "shelf" registration statement whereby the parent company may
offer up to $500 million of any combination of the following securities, either
separately or in units: debt securities, preferred stock, depositary shares,
common stock, and warrants. In August 2001, the parent company obtained $200
million in a subordinated note offering, bearing a 6.75% fixed coupon rate and
10-year maturity. At June 30, 2003, $300 million was available under the shelf
registration.
Investment securities are an important tool to the Corporation's liquidity
objective. All securities are classified as available for sale and are reported
at fair value on the consolidated balance sheet. Of the $3.4 billion investment
portfolio at June 30, 2003, $1.7 billion were pledged as collateral for
repurchase agreements, public deposits, treasury, tax and loan notes, and other
requirements. The remaining securities could be pledged or sold to enhance
liquidity if necessary.
The bank subsidiaries have a variety of funding sources (in addition to key
liquidity sources, such as core deposits, loan sales, loan repayments, and
investment portfolio sales) available to increase financial flexibility. A $2
billion bank note program associated with Associated Bank Illinois, National
Association, and Associated Bank, National Association, was established during
2000. Under this program, short-term and long-term debt may be issued. As of
June 30, 2003, $350 million of long-term bank notes and $200 million of
short-term bank notes were outstanding. At June 30, 2003, $1.45 billion was
available under this program. The banks have also established federal funds
lines with major banks totaling approximately $3.5 billion and the ability to
borrow approximately $1.7 billion from the Federal Home Loan Bank ($1.2 billion
was outstanding at June 30, 2003). In addition, the bank subsidiaries also
accept Eurodollar deposits, issue institutional certificates of deposit, and
from time to time offer brokered certificates of deposit.
For the six months ended June 30, 2003, net cash provided from operating and
financing activities was $87.2 million and $41.2 million, respectively, while
investing activities used net cash of $151.5 million, for a net decrease in cash
and cash equivalents of $23.1 million since year-end 2002. Generally, during
year-to-date 2003, deposit growth was strong (up $329 million), while net asset
growth since year-end 2002 was moderate (up $176 million or 2% annualized).
Thus, the reliance on other funding sources was reduced, particularly short-term
borrowings. The deposit growth provided for the repayment of short-term
borrowings and long-term debt, common stock repurchases, and the payment of cash
dividends to the Corporation's stockholders.
33
For the six months ended June 30, 2002, net cash provided from operating
activities was $318.5 million, while investing and financing activities used net
cash of $135.8 million and $378.3 million, respectively, for a net decrease in
cash and cash equivalents of $195.6 million since year-end 2001. Generally,
during year-to-date 2002, anticipated maturities of time deposits occurred and
net asset growth since year-end 2001 was up due to the Signal acquisition. Other
funding sources were utilized, particularly long-term debt, to finance the
Signal acquisition, replenish the net decrease in deposits, repay short-term
borrowings, to provide for common stock repurchases, and for payment of cash
dividends to the Corporation's stockholders.
Capital
Stockholders' equity at June 30, 2003 increased to $1.3 billion, up $42.7
million compared to June 30, 2002. The increase in equity between the two
periods was primarily composed of the retention of earnings and the exercise of
stock options, with offsetting decreases to equity from the payment of dividends
and the repurchase of common stock. Additionally, stockholders' equity at June
30, 2003, included $65.8 million of accumulated other comprehensive income
versus $72.2 million at June 30, 2002. The decrease in accumulated other
comprehensive income was predominantly related to higher unrealized losses on
cash flow hedges and partially offset by increased unrealized gains on
securities available for sale, net of the tax effect. The ratio of stockholders'
equity to assets was 8.66% and 8.81% at June 30, 2003 and 2002, respectively.
Stockholders' equity grew $46.1 million since year-end 2002. The increase in
equity between the two periods was primarily composed of the retention of
earnings and the exercise of stock options, with offsetting decreases to equity
from the payment of dividends and the repurchase of common stock. Additionally,
stockholders' equity at year-end 2002 included $60.3 million of accumulated
other comprehensive income versus $65.8 million at June 30, 2003. The increase
in accumulated other comprehensive income was predominantly related to
unrealized gains on securities available for sale, partially offset by higher
unrealized losses on cash flow hedges, net of the tax effect. Stockholders'
equity to assets at June 30, 2003 was 8.66%, compared to 8.46% at December 31,
2002.
Cash dividends of $0.65 per share were paid in year-to-date 2003, compared to
$0.59 per share in year-to-date 2002, representing an increase of 10.2%.
The Board of Directors has authorized management to repurchase shares of the
Corporation's common stock each quarter in the market, to be made available for
issuance in connection with the Corporation's employee incentive plans and for
other corporate purposes. The Board of Directors authorized the repurchase of up
to 300,000 shares per quarter in 2003. No shares were repurchased under this
authorization during 2003. During year-to-date 2002, 730,000 shares were
repurchased under this authorization, at an average cost of $34.78 per share.
Additionally, under two separate actions in 2000, the Board of Directors
authorized the repurchase and cancellation of the Corporation's outstanding
shares, not to exceed approximately 7.3 million shares on a combined basis.
Under these authorizations approximately 1.2 million shares were repurchased
during year-to-date 2003, at an average cost of $34.66 per share, while
approximately 124,000 shares were repurchased during year-to-date 2002, at an
average cost of $32.01 per share. At June 30, 2003, approximately 900,000 remain
authorized to repurchase. The repurchase of shares will be based on market
opportunities, capital levels, growth prospects, and other investment
opportunities. See section, "Subsequent Events," for new Board of Director share
repurchase authorizations.
The adequacy of the Corporation's capital is regularly reviewed to ensure that
sufficient capital is available for current and future needs and is in
compliance with regulatory guidelines. The assessment of overall capital
adequacy depends on a variety of factors, including asset quality, liquidity,
stability of earnings, changing competitive forces, economic conditions in
markets served and strength of management. The capital ratios of the Corporation
and its banking affiliates are greater than minimums required by regulatory
guidelines. The Corporation's capital ratios are summarized in Table 9.
34
- ----------------------------------------------------------------------------------------------------------
TABLE 9
Capital Ratios
(In Thousands, except per share data)
- ----------------------------------------------------------------------------------------------------------
June 30, March 31, Dec. 31, Sept. 30, June 30,
2003 2003 2002 2002 2002
- ----------------------------------------------------------------------------------------------------------
Total stockholders' equity $1,318,246 $1,285,866 $1,272,183 $1,270,691 $1,275,569
Tier 1 capital 1,177,457 1,180,593 1,165,481 1,147,045 1,155,995
Total capital 1,526,884 1,527,435 1,513,424 1,492,619 1,498,328
Market capitalization 2,699,475 2,388,217 2,521,097 2,366,995 2,856,382
----------------------------------------------------------------
Book value per common share $ 17.88 $ 17.41 $ 17.13 $ 17.03 $ 16.84
Cash dividend per common share 0.34 0.31 0.31 0.31 0.31
Stock price at end of period 36.61 32.33 33.94 31.73 37.71
Low closing price for the quarter 32.15 32.33 27.20 30.64 33.63
High closing price for the quarter 38.41 35.22 34.21 36.96 38.25
----------------------------------------------------------------
Total equity/assets 8.66% 8.52% 8.46% 8.45% 8.81%
Tier 1 leverage ratio 7.97 8.06 7.94 8.06 8.23
Tier 1 risk-based capital ratio 10.48 10.64 10.52 10.50 10.96
Total risk-based capital ratio 13.58 13.77 13.66 13.66 14.20
----------------------------------------------------------------
Shares outstanding (period end) 73,736 73,870 74,281 74,598 75,746
Basic shares outstanding (average) 73,959 74,252 74,497 75,158 75,922
Diluted shares outstanding (average) 74,683 74,974 75,202 76,047 77,041
- ----------------------------------------------------------------------------------------------------------
Contractual Obligations, Commitments, Off-Balance Sheet Risk, and Contingent
Liabilities
The Corporation utilizes a variety of financial instruments to meet the
financial needs of its clients and to reduce exposure to fluctuations in
interest rates. These financial instruments include commitments to extend
credit, commitments to originate residential mortgage loans held for sale,
commercial letters of credit, standby letters of credit, interest rate swaps,
and interest rate caps. Please refer to the Corporation's Annual Report on Form
10-K for the year ended December 31, 2002 for discussion with respect to the
Corporation's quantitative and qualitative disclosures about its fixed and
determinable contractual obligations. Items disclosed in the Annual Report on
Form 10-K have not materially changed since that report was filed. A discussion
of the Corporation's derivative instruments is included in Note 7, "Derivatives
and Hedging Activities," of the notes to consolidated financial statements and a
discussion of the Corporation's commitments is included in Note 12,
"Commitments, Off-Balance Sheet Risk, and Contingent Liabilities," of the notes
to consolidated financial statements.
Comparable Second Quarter Results
Net income for second quarter 2003 was $56.7 million, up $4.3 million or 8.3%
from second quarter 2002 net income of $52.3 million. Return on average equity
was 17.37%, up 58 bp from the second quarter of 2002, while return on average
assets increased by 4 bp to 1.51%. See Tables 1 and 10.
Taxable equivalent net interest income for the second quarter of 2003 was $133.4
million, $1.6 million higher than the second quarter of 2002. Volume variances
impacted taxable equivalent net interest income favorably by $8.0 million
(primarily from loan growth), while rate variances were unfavorable by $6.4
million (primarily from unfavorable rate variance on earning assets greater than
favorable rate variance on interest-bearing liabilities). See Tables 2 and 3.
Growth in average earning assets (up $743 million to $14.0 billion) was funded
by growth in interest-bearing liabilities (up $542 million to $11.9 billion) and
net free funds (led by average noninterest-bearing demand deposits, up $171
million or 11.8%). Average loans grew $841 million, or 8.5%, to $10.7 billion,
while average investments were $3.2 billion, down $98 million between the
comparable second quarter periods. Wholesale funding increased $673 million to
$4.4 billion (and represented 37.2% of interest-bearing liabilities for the
second quarter of 2003 compared to 33.0% for the second quarter of 2002). While
average interest-bearing deposits, excluding brokered CDs, were minimally
changed (down $17 million), the mix shifted with lower non-brokered time
deposits and money market
35
deposits and more interest-bearing demand and savings deposits. Average brokered
CDs were down between the comparable second quarter periods as the Corporation
continues to use other funding sources.
The net interest margin of 3.79% fell 17 bp from 3.96% for the second quarter of
2002, the net result of a 7 bp reduction in the interest rate spread (i.e. an 84
bp drop in the earning asset yield, net of a 77 bp decrease in the average cost
of interest-bearing liabilities) and a 10 bp lower contribution from net free
funds. The lower interest rate environment (the average Fed funds rate for the
second quarter of 2003 was 52 bp lower than the second quarter of 2002) on the
rate sensitive earning assets, as well as refinancing pressures and competition,
impacted the earning asset yields unfavorably (particularly in loan yields which
were down 89 bp). On the funding side, total interest-bearing deposits cost
1.69% on average for second quarter 2003, down 70 bp from the comparable quarter
in 2002, with the rate on wholesale funding down 98 bp.
The provision for loan losses for the second quarter of 2003 was $12.1 million,
up slightly from the second quarter of 2002 of $12.0 million. The allowance for
loan losses to loans at June 30, 2003 was 1.66% compared to 1.50% at June 30,
2002. Net charge offs were $10.1 million for the three months ended June 30,
2003 and $7.6 million for the comparable period in 2002. Annualized net charge
offs as a percent of average loans for second quarter were 0.38% versus 0.31%
for the comparable quarter of 2002. Total nonperforming loans were $117.2
million, up from $87.3 million at June 30, 2002. See Tables 6 and 8 and
discussion under sections "Provision for Loan Losses," "Allowance for Loan
Losses," and "Nonperforming Loans and Other Real Estate Owned."
Noninterest income was $70.2 million for the second quarter of 2003, up $20.3
million from the second quarter of 2002 (see Table 4), with the majority of the
increase from mortgage banking income. Mortgage banking income was up $19.2
million, primarily due to an increase in secondary mortgage loan production
($1.2 billion for the second quarter of 2003 versus $0.4 billion for the second
quarter of 2002), resulting in higher gains on the sale of mortgage loans (up
$15.8 million) and increased volume-related fees (up $3.3 million). Retail
commissions were up $1.5 million, with insurance commissions up $2.0 million
(positively impacted by the CFG acquisition, mitigated partly by the impact on
insurance commissions from legislation enacted in fourth quarter 2002 requiring
single premium credit insurance premiums to be collected based on monthly
outstanding balances), fixed annuities down $0.6 million, and variable annuities
and brokerage commissions were relatively level. Credit card and other
nondeposit fees decreased $1.9 million, primarily a direct result of the sale of
the credit card merchant processing in first quarter 2003.
Noninterest expense for the second quarter of 2003 was up $12.7 million over the
second quarter of 2002 (see Table 5), reflecting higher costs associated with
mortgage servicing rights as well as the company's larger operating base.
Mortgage servicing rights expense was up $9.1 million, the result of a $7.7
million larger addition to the valuation allowance and a $1.4 million increase
in the amortization of mortgage servicing rights. Personnel expense increased
$4.5 million (with increases of $3.3 million in salary-related expenses and $1.2
million in fringe benefits), particularly attributable to the CFG acquisition
and annual raises between the periods. Other expense was up $1.0 million,
including a $2.5 million charge on commercial letters of credit, net of
decreases in various other categories. The $2.6 million decrease in loan expense
was primarily due to lower merchant processing costs, given the sale of the
merchant processing during first quarter 2003.
Income taxes were up $4.5 million between comparable quarters, due to the
increase in income before tax and in the effective tax rate (primarily
attributable to a decrease in tax valuation allowance adjustments), at 30.3% for
the second quarter of 2003 compared to 27.8% for the second quarter of 2002.
Sequential Quarter Results
Net income for the second quarter of 2003 was $56.7 million, down $1.3 million
or 2.3% from first quarter 2003 net income of $58.0 million. Return on average
equity was 17.37%, down 99 bp from the first quarter of 2003, while return on
average assets decreased 7 bp to 1.51%. See Tables 1 and 10.
36
- ---------------------------------------------------------------------------------------------------
TABLE 10
Selected Quarterly Information
($ in Thousands)
- ---------------------------------------------------------------------------------------------------
For the Quarter Ended
---------------------------------------------------------------------
June 30, March 31, Dec. 31, Sept. 30, June 30,
2003 2003 2002 2002 2002
- ---------------------------------------------------------------------------------------------------
Summary of Operations:
Net interest income $ 127,195 $ 127,454 $ 129,713 $ 128,358 $ 125,768
Provision for loan losses 12,132 12,960 14,614 12,831 12,003
Noninterest income 70,160 65,209 64,349 58,656 49,903
Noninterest expense 103,919 98,157 102,763 98,183 91,187
Income taxes 24,635 23,553 23,244 22,528 20,137
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Net income $ 56,669 $ 57,993 $ 53,441 $ 53,472 $ 52,344
===================================================================
Taxable equivalent net
interest income $ 133,426 $ 133,731 $ 135,694 $ 134,349 $ 131,805
Net interest margin 3.79% 3.87% 3.87% 3.96% 3.96%
Average Balances:
Assets $15,016,497 $14,867,339 $14,901,747 $14,460,358 $14,273,232
Earning assets 13,991,615 13,836,102 13,870,491 13,427,986 13,248,590
Interest-bearing
liabilities 11,941,877 11,886,642 11,792,552 11,459,673 11,400,302
Loans 10,743,430 10,578,430 10,559,154 10,128,826 9,902,462
Deposits 9,121,204 8,901,441 8,934,668 8,947,047 9,081,434
Stockholders' equity 1,308,505 1,280,950 1,275,914 1,268,355 1,250,748
- ---------------------------------------------------------------------------------------------------
Taxable equivalent net interest income for the second quarter of 2003 was $133.4
million, $0.3 million lower than first quarter 2003. Volume variances impacted
taxable equivalent net interest income favorably by $2.8 million (primarily from
loan growth), as did the one additional day between the quarters ($0.8 million
favorable day variance), while rate variances were unfavorable by $3.9 million
(primarily from unfavorable rate variance on earning assets exceeding favorable
rate variance on interest-bearing liabilities). The net interest margin between
the second and first quarters of 2003 was down 8 bp, all from a lower interest
rate spread (i.e. a 15 bp drop in the earning asset yield, net of a 7 bp
decrease in the average cost of interest-bearing liabilities). Average earning
assets increased $156 million (4.5% annualized) between the sequential quarters,
attributable to a $165 million increase in average loans (the net of a $144
million increase in commercial loans, $26 million increase in residential real
estate loans, and a $5 million decrease in consumer loans), partially offset by
a $9 million decline in average investments. The earning asset growth was funded
by growth in average interest-bearing liabilities and net free funds. Average
interest-bearing liabilities were up $55 million, primarily in interest-bearing
deposits (up $156 million), net of lower wholesale funding (down $101 million,
predominantly in short-term borrowings). Net free funds were up $100 million,
led by increased average demand deposits (up $64 million, following the usual
cyclical first quarter downturn in these balances).
The provision for loan losses for the second quarter of 2003 was $12.1 million,
down from $13.0 million for the first quarter 2003. The allowance for loan
losses to loans at both June 30 and March 31, 2003 was 1.66%. Net charge offs
were $10.1 million for second quarter 2003, compared to $5.1 million for first
quarter 2003. Annualized net charge offs as a percent of average loans for
second quarter were 0.38% versus 0.20% for first quarter 2003. Total
nonperforming loans were $117.2 million, up from $94.7 million at March 31,
2003, attributable primarily to two larger commercial credits (totaling
approximately $25 million at June 30, 2003) moved to nonaccrual status during
second quarter 2003. See discussion under sections "Provision for Loan Losses,"
"Allowance for Loan Losses," and "Nonperforming Loans and Other Real Estate
Owned."
Noninterest income increased $5.0 million to $70.2 million between sequential
quarters. Mortgage banking income increased $2.7 million, primarily attributable
to continued strong mortgage banking originations and refinancing ($1.2 billion
secondary mortgage production for second quarter 2003 versus $1.1 billion for
first quarter 2003). Retail commission income was up $4.1 million, predominantly
in insurance and attributable to the CFG acquisition on April 1, 2003. Trust
service fees increased $1.2
37
million between sequential quarters, primarily due to seasonal tax return fee
revenue recognized in the second quarter. Credit card and other nondeposit fees
decreased $2.2 million, a direct result of the sale of the credit card merchant
processing in first quarter 2003.
On a sequential quarter basis, noninterest expense increased $5.8 million.
Personnel expense was up $3.0 million, particularly attributable to the CFG
acquisition. Mortgage servicing rights expense increased $1.4 million,
predominantly due to a $1.1 million larger addition to the valuation allowance.
Other expense was up $3.2 million, primarily due to a nonrecurring $2.5 million
charge on commercial letters of credit. These increases were mitigated, in part,
by a $2.4 million decrease in loan expense, primarily due to lower merchant
processing costs given the sale of the merchant processing during the first
quarter of 2003.
Recent Accounting Pronouncements
The recent accounting pronouncements have been described in Note 3, "New
Accounting Pronouncements," of the notes to consolidated financial statements.
Subsequent Events
On July 23, 2003, the Board of Directors declared a $0.34 per share dividend
payable on August 15, 2003, to shareholders of record as of August 1, 2003. This
cash dividend has not been reflected in the accompanying consolidated financial
statements.
On July 23, 2003, the Board of Directors authorized the repurchase of up to 5%
of the Corporation's outstanding shares, or approximately 3.7 million shares.
Shares repurchased under the new authorization will follow the completion of the
2000 authorizations for the repurchase of 7.3 million shares, of which
approximately 900,000 shares remain.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
The Corporation has not experienced any material changes to its market risk
position since December 31, 2002, from that disclosed in the Corporation's 2002
Form 10-K Annual Report.
ITEM 4. Controls and Procedures
We maintain a system of internal controls and procedures designed to provide
reasonable assurance as to the reliability of our published financial statements
and other disclosures included in this report. Within the 90-day period prior to
the date of this report, we evaluated the effectiveness of the design and
operation of our disclosure controls and procedures pursuant to Rule 13a-14 of
the Securities Exchange Act of 1934. Based upon that evaluation, our Chief
Executive Officer and our Chief Financial Officer concluded that our disclosure
controls and procedures are effective in timely alerting them to material
information relating to the Corporation required to be included in this
quarterly report on Form 10-Q.
There have been no significant changes in our internal controls or in other
factors that could significantly affect internal controls subsequent to the date
that we carried out our evaluation.
38
ASSOCIATED BANC-CORP
PART II - OTHER INFORMATION
ITEM 4: Submission of matters to a vote of security holders
(a) The corporation held its Annual Meeting of Shareholders on April
23, 2003. Proxies were solicited by corporation management
pursuant to Regulation 14A under the Securities Exchange Act of
1934.
(b) Directors elected at the Annual Meeting were Harry B. Conlon,
Ronald R. Harder, and J. Douglas Quick.
(c) The matters voted upon and the results of the voting were as
follows:
(i) Election of the below-named nominees to the Board of
Directors of the Corporation:
FOR WITHHELD
--- ---------
All Nominees: 186,218,578 3,092,814
By Nominee:
Harry B. Conlon 62,043,917 1,059,880
Ronald R. Harder 62,142,964 960,833
J. Douglas Quick 62,031,696 1,072,101
(ii) Approval of the 2003 Associated Banc-Corp Long-Term
Incentive Plan.
FOR AGAINST ABSTAIN
--- ------- -------
55,188,843 7,087,491 827,462
(iii) Approval of the Associated Banc-Corp Incentive Cash Plan.
FOR AGAINST ABSTAIN
--- ------- -------
57,149,651 5,147,406 806,739
(iv) Ratification of the selection of KPMG LLP as independent
auditors of Associated for the year ending December 31,
2003.
FOR AGAINST ABSTAIN
--- ------- -------
61,310,248 1,394,165 399,384
(d) Not applicable
39
ITEM 6: Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit 10, Employment Agreement between Associated Banc-Corp and
Paul S. Beideman effective April 17, 2003, filed herewith.
Exhibit 11, Statement regarding computation of per-share
earnings. See Note 4 of the notes to consolidated financial
statements in Part I Item I.
Exhibit 99 (a), Certification by the Chief Executive Officer and
Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, filed herewith.
Exhibit 99 (b), Certification Under Section 302 of the
Sarbanes-Oxley Act of 2002 by Paul S. Beideman, Chief Executive
Officer, filed herewith.
Exhibit 99 (c), Certification Under Section 302 of the
Sarbanes-Oxley Act of 2002 by Joseph B. Selner, Chief Financial
Officer, filed herewith.
(b) Reports on Form 8-K:
A report on Form 8-K dated April 1, 2003, was filed under Item 5,
Other Events, and under Item 7, Financial Statements and
Exhibits, announcing Associated Banc-Corp acquired 100% of the
outstanding shares of CFG Insurance Services, Inc.
A report on Form 8-K dated April 16, 2003, was filed under Item
5, Other Events, and under Item 7, Financial Statements and
Exhibits, announcing the Associated Banc-Corp Board of Directors
elected Paul S. Beideman President and Chief Executive Officer of
the Corporation effective April 28, 2003.
A report on Form 8-K/A dated April 24, 2003, was filed under Item
12, Results of Operations and Financial Condition, reporting
Associated Banc-Corp released its earnings for the quarter ended
March 31, 2003.
A report on Form 8-K dated April 24, 2003, was filed under Item
5, Other Events, announcing the Associated Banc-Corp Board of
Directors declared its first quarter dividend.
40
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
ASSOCIATED BANC-CORP
----------------------------------------
(Registrant)
Date: August 14, 2003 /s/ Paul S. Beideman
----------------------------------------
Paul S. Beideman
President and Chief Executive Officer
Date: August 14, 2003 /s/ Joseph B. Selner
----------------------------------------
Joseph B. Selner
Chief Financial Officer
41