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 EXCHANGE ACT OF 1934
For the quarterly period ended September 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
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Commission file number 0-5519
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Associated Banc-Corp
- ------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Wisconsin 39-1098068
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(State or other jurisdiction of (IRS employer identification no.)
of incorporation or organization
1200 Hansen Road, Green Bay, Wisconsin 54304
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(Address of principal executive offices) (Zip code)
(920) 491-7000
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(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
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APPLICABLE ONLY TO CORPORATE ISSUERS:
The number of shares outstanding of registrant's common stock, par value $0.01
per share, at October 31, 2003, was 73,294,160 shares.
ASSOCIATED BANC-CORP
TABLE OF CONTENTS
PART I. Financial Information
Item 1. Financial Statements (Unaudited):
Consolidated Balance Sheets -
September 30, 2003, September 30, 2002
and December 31, 2002
Consolidated Statements of Income -
Three and Nine Months Ended September 30,
2003 and 2002
Consolidated Statement of Changes in
Stockholders' Equity - Nine Months Ended
September 30, 2003
Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 2003 and 2002
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures
About Market Risk
Item 4. Controls and Procedures
PART II. Other Information
Item 6. Exhibits and Reports on Form 8-K
Signatures
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements:
ASSOCIATED BANC-CORP
Consolidated Balance Sheets
(Unaudited)
September 30, September 30, December 31,
2003 2002 2002
---------------------------------------------
(In Thousands, except share data)
ASSETS
Cash and due from banks $ 340,042 $ 404,660 $ 430,691
Interest-bearing deposits in other financial institutions 6,180 5,451 5,502
Federal funds sold and securities purchased under
agreements to resell 19,950 109,650 8,820
Investment securities available for sale, at fair value 3,415,574 3,432,758 3,362,669
Loans held for sale 390,332 379,136 305,836
Loans 10,289,242 10,086,510 10,303,225
Allowance for loan losses (176,223) (155,288) (162,541)
--------------------------------------------
Loans, net 10,113,019 9,931,222 10,140,684
Premises and equipment 131,873 133,596 132,713
Goodwill 224,388 212,112 212,112
Other intangible assets 58,565 39,869 41,565
Other assets 414,246 396,248 402,683
--------------------------------------------
Total assets $ 15,114,169 $ 15,044,702 $ 15,043,275
============================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Noninterest-bearing deposits $ 1,804,596 $ 1,740,932 $ 1,773,699
Interest-bearing deposits, excluding Brokered CDs 7,673,766 7,018,506 7,117,503
Brokered CDs 156,994 187,915 233,650
--------------------------------------------
Total deposits 9,635,356 8,947,353 9,124,852
Short-term borrowings 2,049,833 2,630,285 2,389,607
Long-term debt 1,806,316 1,830,260 1,906,845
Company-obligated mandatorily redeemable
preferred securities 186,788 186,739 190,111
Accrued expenses and other liabilities 134,928 179,374 159,677
--------------------------------------------
Total liabilities 13,813,221 13,774,011 13,771,092
Stockholders' equity
Preferred stock -- -- --
Common stock (par value $0.01 per share,
authorized 100,000,000 shares, issued
73,583,698, 75,885,210 and 75,503,410
shares, respectively) 736 759 755
Surplus 580,823 655,540 643,956
Retained earnings 695,076 581,145 607,944
Accumulated other comprehensive income 36,310 76,644 60,313
Deferred compensation (1,744) -- --
Treasury stock, at cost (306,804, 1,287,669
and 1,222,812 shares, respectively) (10,253) (43,397) (40,785)
--------------------------------------------
Total stockholders' equity 1,300,948 1,270,691 1,272,183
--------------------------------------------
Total liabilities and stockholders' equity $ 15,114,169 $ 15,044,702 $ 15,043,275
============================================
See accompanying notes to consolidated financial statements.
ITEM 1. Financial Statements Continued:
ASSOCIATED BANC-CORP
Consolidated Statements of Income
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
-----------------------------------------
(In Thousands, except per share data)
INTEREST INCOME
Interest and fees on loans $145,246 $158,886 $441,527 $468,556
Interest and dividends on investment
securities and
deposits with other financial institutions:
Taxable 26,710 30,918 79,430 97,149
Tax exempt 9,825 9,916 29,822 29,884
Interest on federal funds sold and securities
purchased under agreements to resell 38 45 127 339
-----------------------------------------
Total interest income 181,819 199,765 550,906 595,928
INTEREST EXPENSE
Interest on deposits 30,327 39,336 93,875 133,125
Interest on short-term borrowings 6,757 13,039 23,766 40,534
Interest on long-term debt,
including preferred securities 15,759 19,032 49,640 50,716
-----------------------------------------
Total interest expense 52,843 71,407 167,281 224,375
-----------------------------------------
NET INTEREST INCOME 128,976 128,358 383,625 371,553
Provision for loan losses 12,118 12,831 37,210 36,085
-----------------------------------------
Net interest income after provision
for loan losses 116,858 115,527 346,415 335,468
NONINTEREST INCOME
Trust service fees 7,001 6,722 21,427 21,815
Service charges on deposit accounts 13,338 12,261 37,611 33,874
Mortgage banking 23,635 20,468 78,583 42,709
Credit card and other nondeposit fees 5,435 7,045 18,023 20,211
Retail commissions 6,830 3,635 17,540 14,136
Bank owned life insurance income 3,532 3,545 10,373 10,284
Asset sale gains, net 871 658 203 1,030
Investment securities gains, net 1 374 702 374
Other 3,245 3,948 14,795 11,526
-----------------------------------------
Total noninterest income 63,888 58,656 199,257 155,959
NONINTEREST EXPENSE
Personnel expense 54,795 47,581 158,275 141,339
Occupancy 7,101 6,553 21,367 19,340
Equipment 3,178 3,909 9,612 11,126
Data processing 6,322 5,420 17,542 15,527
Business development and advertising 4,113 3,728 11,029 10,300
Stationery and supplies 1,651 1,395 4,964 5,225
FDIC expense 353 384 1,078 1,158
Mortgage servicing rights expense 4,199 13,372 28,818 20,143
Intangible amortization expense 871 576 2,091 1,674
Loan expense 1,806 3,967 6,104 10,280
Other 13,382 11,298 38,967 35,674
-----------------------------------------
Total noninterest expense 97,771 98,183 299,847 271,786
-----------------------------------------
Income before income taxes 82,975 76,000 245,825 219,641
Income tax expense 24,589 22,528 72,777 62,363
-----------------------------------------
NET INCOME $ 58,386 $ 53,472 $173,048 $157,278
=========================================
Earnings per share:
Basic $ 0.79 $ 0.71 $ 2.34 $ 2.10
Diluted $ 0.79 $ 0.70 $ 2.32 $ 2.08
Average shares outstanding:
Basic 73,473 75,158 73,892 74,748
Diluted 74,323 76,047 74,596 75,666
See accompanying notes to consolidated financial statements.
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 -- -- 173,048 -- -- -- 173,048
Net unrealized loss on derivative
instruments, net of tax of $824,000 -- -- -- (1,231) -- -- (1,231)
Add: reclassification adjustment to
interest expense for interest
differential, net of tax of $280,000 -- -- -- 420 -- -- 420
Net change in unrealized holding loss
on securities available for sale,
net of tax of $13.8 million -- -- -- (23,192) -- -- (23,192)
----------
Comprehensive income 149,045
----------
Cash dividends, $0.99 per share -- -- (73,232) -- -- -- (73,232)
Common stock issued:
Incentive stock options and
restricted stock -- -- -- (12,684) -- 31,264 18,580
Tax benefit of stock options -- 5,339 -- -- -- -- 5,339
Purchase and retirement of treasury
stock in connection with
repurchase program (19) (68,548) -- -- -- -- (68,567)
Purchase of treasury stock -- -- -- -- -- (732) (732)
Restricted stock -- 76 -- -- (1,744) -- (1,668)
---------------------------------------------------------------------------------------
Balance, September 30, 2003 $ 736 $ 580,823 $ 695,076 $ 36,310 $ (1,744) $ (10,253) $ 1,300,948
=======================================================================================
See accompanying notes to consolidated financial statements.
ITEM 1. Financial Statements Continued:
ASSOCIATED BANC-CORP
Consolidated Statements Of Cash Flows
(Unaudited)
Nine Months Ended September 30,
2003 2002
-------------------------------
($ in Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 173,048 $ 157,278
Adjustments to reconcile net income
to net cash provided by operating
activities:
Provision for loan losses 37,210 36,085
Depreciation and amortization 12,397 14,141
Amortization (accretion) of:
Mortgage servicing rights 28,818 20,143
Other intangible assets 2,091 1,674
Investment premiums and discounts 15,546 8,928
Deferred loan fees and costs (659) 613
Gain on sales of securities, net (702) (374)
Gain on sales of assets, net (203) (1,030)
Gain on sales of loans held for sale, net (58,142) (19,794)
Mortgage loans originated and acquired
for sale (3,749,288) (1,956,337)
Proceeds from sales of mortgage loans held
for sale 3,722,934 1,915,807
Increase in interest receivable and
other assets (15,590) (38,721)
Increase (decrease) in interest payable
and other liabilities (20,996) 13,398
--------------------------
Net cash provided by operating activities 146,464 151,811
--------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Net increase in loans (19,168) (315,701)
Capitalization of mortgage servicing rights (33,158) (18,095)
Purchases of:
Securities available for sale (1,180,342) (1,071,201)
Premises and equipment, net of disposals (10,256) (14,069)
Proceeds from:
Sales of securities available for sale 1,264 27,793
Maturities of securities available for sale 1,073,622 1,027,202
Sales of other real estate owned and
other assets 14,491 8,853
Net cash acquired (paid) in business
combinations (18,025) 17,982
--------------------------
Net cash used in investing activities (171,572) (337,236)
--------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits 510,503 (448,702)
Net decrease in short-term borrowings (339,773) (116,329)
Repayment of long-term debt (507,876) (35,414)
Proceeds from issuance of long-term debt 407,364 825,347
Cash dividends (73,232) (67,050)
Proceeds from exercise of incentive stock
options and restricted stock 18,580 13,655
Purchase and retirement of treasury stock (68,567) (31,435)
Purchase of treasury stock (732) (40,322)
--------------------------
Net cash provided by (used in)
financing activities (53,733) 99,750
--------------------------
Net decrease in cash and cash equivalents (78,841) (85,675)
Cash and cash equivalents at beginning
of period 445,013 605,436
--------------------------
Cash and cash equivalents at end of period $ 366,172 $ 519,761
==========================
Supplemental disclosures of cash
flow information:
Cash paid during the period for:
Interest $ 173,100 $ 230,194
Income taxes 83,553 60,616
Supplemental schedule of noncash
investing activities:
Loans transferred to other real estate 10,100 4,684
See accompanying notes to consolidated financial statements.
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 September 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, except mandatorily redeemable
financial instruments, entered into or modified after May 31, 2003. For
mandatorily redeemable financial instruments the effective date has been
deferred indefinitely. The adoption had no effect on the Corporation's results
of operations, financial position, or liquidity.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS 149"). SFAS 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities under SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities." This Statement amends SFAS No. 133 for decisions made
as part of the Derivatives Implementation Group process and in connection with
implementation issues raised in relation to the application of the definition of
a derivative. SFAS 149 is effective for contracts entered into or modified after
June 30, 2003. The adoption had no material impact on the Corporation's results
of operations, financial position, or liquidity.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). The objective of this interpretation is
to provide guidance on how to identify a variable interest entity
and determine when the assets, liabilities, noncontrolling interests, and
results of operations of a variable interest entity 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, as subsequently
amended, were effective upon issuance for new variable interest entities and for
fiscal years ending after December 15, 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. However, the
Corporation has a statutory trust for the purpose of issuing Company-obligated
Mandatorily Redeemable Preferred Securities (see Note 9) that will be subjected
to FIN 46 in the fourth quarter of 2003. While we currently believe the
continued consolidation of this trust is appropriate under FIN 46, the
application of FIN 46 to this type of trust is an emerging issue and a possible
unintended consequence of FIN 46 is the deconsolidation of this trust during the
fourth quarter of 2003. The deconsolidation of this statutory trust would 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 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 regarding 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 Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
-----------------------------------------
(In Thousands, except per share data)
Net income $ 58,386 $ 53,472 $173,048 $157,278
======== ======== ======== ========
Weighted average shares outstanding 73,473 75,158 73,892 74,748
Effect of dilutive stock options outstanding 850 889 704 918
-------- -------- -------- --------
Diluted weighted average shares outstanding 74,323 76,047 74,596 75,666
======== ======== ======== ========
Basic earnings per share $ 0.79 $ 0.71 $ 2.34 $ 2.10
======== ======== ======== ========
Diluted earnings per share $ 0.79 $ 0.70 $ 2.32 $ 2.08
======== ======== ======== ========
NOTE 5: Business Combinations
In 2003 there was one completed business combination. On April 1, 2003, the
Corporation consummated its cash acquisition of 100% of the outstanding shares
of CFG 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.
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)
Goodwill 119.7
Other intangible asset 5.6
Other assets 118.1
--------
Total assets acquired $ 1,155.2
--------
Deposits $ 784.8
Borrowings 165.5
Other liabilities 12.4
--------
Total liabilities assumed $ 962.7
--------
Net assets acquired $ 192.5
========
The other intangible asset represents a core deposit intangible with a ten-year
estimated life. The $119.7 million of goodwill was assigned to the banking
segment.
The following represents required supplemental pro forma disclosure of total
revenue, net income, and earnings per share as though the Signal acquisition had
been completed at the beginning of the year of acquisition.
Nine months ended
September 30, 2002
----------------------
($ in Thousands,
except per share data)
Total revenue $537,336
Net income 156,388
Basic earnings per share 2.07
Diluted earnings per share 2.04
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 September
30, 2003. Goodwill of $212 million is assigned to the banking segment and
goodwill of $12 million is assigned to the wealth management segment. The change
in the carrying amount of goodwill was as follows.
As of and for the
As of and for the nine months ended year ended
Goodwill September 30, 2003 September 30, 2002 December 31, 2002
- -------- ---------------------------------------------------------------
($ 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 $212,112
===============================================================
Other Intangible Assets:
- -----------------------
The Corporation has other intangible assets that are amortized, consisting of
core deposit intangibles, other intangibles (primarily related to customer
relationships acquired in connection with the CFG acquisition),
and mortgage servicing rights. The core deposit intangibles and mortgage
servicing rights are assigned to the Corporation's banking segment, while the
other intangibles are assigned to the Corporation's wealth management segment.
Core deposit intangibles have finite lives and are amortized on an accelerated
basis to expense over periods of 7 to 10 years. The other intangibles have
finite lives and are amortized on an accelerated basis over a weighted average
life of 16 years. For core deposit intangibles and other intangibles, changes in
the gross carrying amount, accumulated amortization, and net book value was as
follows:
As of and for the
As of and for the nine months ended year ended
September 30, 2003 September 30, 2002 December 31, 2002
---------------------------------------------------------------
($ in Thousands)
Core deposit intangibles:
- ------------------------
Gross carrying amount $ 28,165 $ 28,165 $ 28,165
Accumulated amortization (20,212) (18,314) (18,923)
---------------------------------------------------------------
Net book value $ 7,953 $ 9,851 $ 9,242
===============================================================
Additions during the period $ --- $ 5,600 $ 5,600
Amortization during the period (1,289) (1,674) (2,283)
Other intangibles:
Gross carrying amount $ 14,751 $ --- $ ---
Accumulated amortization (802) --- ---
----------------------------------------------------------------
Net book value $ 13,949 $ --- $ ---
================================================================
Additions during the period $ 14,751 $ --- $ ---
Amortization during the period (802) --- ---
Mortgage servicing rights capitalized are amortized in proportion to and over
the period of estimated servicing income. The Corporation periodically evaluates
its mortgage servicing rights asset for impairment. A valuation allowance is
established to the extent the carrying value of the mortgage servicing rights
exceeds the estimated fair value. Permanent impairment is recognized as a
write-down of the mortgage servicing rights asset and the related valuation
allowance (to the extent valuation reserve is available) and then against
current earnings, as needed. During the second and third quarters of 2003
mortgage rates fell to record 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, $15.6 million
was determined to be permanently impaired during the nine months ended September
30, 2003 ($9.1 million in second quarter 2003 and $6.5 million in third quarter
2003). A summary of changes in the balance of the mortgage servicing rights
asset and the mortgage servicing rights valuation allowance was as follows:
As of and for the
As of and for the nine months ended year ended
Mortgage servicing rights September 30, 2003 September 30, 2002 December 31, 2002
- ------------------------- ----------------------------------------------------------------
($ in Thousands)
Mortgage servicing rights at
beginning of year $ 60,685 $ 42,786 $ 42,786
Additions 33,158 18,095 30,730
Amortization (12,986) (9,251) (12,831)
Permanent impairment (15,583) --- ---
---------------------------------------------------------------
Mortgage servicing rights
at end of period 65,274 51,630 60,685
----------------------------------------------------------------
Valuation allowance at
beginning of year (28,362) (10,720) (10,720)
Additions (15,832) (10,892) (17,642)
Permanent impairment 15,583 --- ---
----------------------------------------------------------------
Valuation allowance at end of period (28,611) (21,612) (28,362)
----------------------------------------------------------------
Mortgage servicing rights, net $ 36,663 $ 30,018 $ 32,323
================================================================
At September 30, 2003, the Corporation was servicing one- to four- family
residential mortgage loans owned by other investors with balances totaling $5.59
billion, compared to $5.38 billion and $5.44 billion at September 30 and
December 31, 2002, respectively. The fair value of servicing, strongly
influenced by prepayment speeds, was approximately $36.7 million (representing
66 basis points ("bp") of loans serviced) at September 30, 2003, compared to
$30.0 million (or 56 bp of loans serviced) at September 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 $28.8 million and $20.1
million for the nine months ended September 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 current interest rate
environment, and prepayment speeds as of September 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.
Estimated amortization expense:
Core Deposit Other Intangibles Mortgage Servicing
Intangibles Rights
---------------------------------------------------------
Three months ending December 31, 2003 $ 500 $ 400 $ 4,000
Year ending December 31, 2004 1,500 1,500 14,200
Year ending December 31, 2005 1,000 1,200 11,700
Year ending December 31, 2006 1,000 1,000 9,500
Year ending December 31, 2007 1,000 900 7,700
Year ending December 31, 2008 1,000 800 5,600
========================================================
NOTE 7: Derivatives and Hedging Activities
SFAS No. 133, as amended by SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities" and SFAS 149, (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 statements, 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
-------------------------------------------------------------------------
September 30, 2003 ($ in Thousands)
- ------------------
Interest Rate Risk Management hedges:
Swaps-receive variable / pay fixed (1), (3) $200,000 $ (25,890) 1.11% 5.03% 92 months
Swaps-receive fixed / pay variable (2), (4) 375,000 21,136 7.21% 2.77% 214 months
Swaps-receive variable / pay fixed (2), (5) 365,063 (14,624) 3.29% 6.29% 53 months
Caps-written (1), (3) 200,000 1,298 Strike 4.72% --- 35 months
=========================================================================
September 30, 2002
- ------------------
Interest Rate Risk Management hedges:
Swaps-receive variable / pay fixed (1), (3) $400,000 $ (26,435) 1.85% 5.73% 52 months
Swaps-receive fixed / pay variable (2), (4) 375,000 20,710 7.21% 3.39% 226 months
Swaps-receive variable / pay fixed (2), (5) 219,261 (12,617) 4.03% 6.74% 55 months
Caps-written (1), (3) 200,000 3,477 Strike 4.72% --- 47 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 derivatives at September 30, 2003 was a $1.3 million loss, compared to
a $6.3 million gain at September 30, 2002. The net fair value change is recorded
in mortgage banking income in the consolidated statements of income. The $1.3
million net loss of mortgage derivatives at September 30, 2003, was comprised of
the net gain on commitments to fund approximately $226 million of loans to
individual borrowers and the net loss on commitments to sell approximately $432
million of loans to various investors. The $6.3 million net gain of mortgage
derivatives at September 30, 2002, was composed of the net gain on commitments
to fund approximately $819 million of loans to individual borrowers and the net
loss on commitments to sell approximately $693 million of loans to various
investors.
NOTE 8: Long-term Debt
Long-term debt at September 30 is as follows:
2003 2002
------------------------
($ in Thousands)
Federal Home Loan Bank advances (1) $ 912,386 $1,165,234
Bank notes (2) 350,000 350,000
Subordinated debt, net (3) 208,171 207,643
Repurchase agreements (4) 329,175 100,000
Other borrowed funds 6,584 7,383
-----------------------
Total long-term debt $1,806,316 $1,830,260
=======================
(1) Long-term advances from the Federal Home Loan Bank had maturities from 2003
through 2017 and had weighted-average interest rates of 2.96% at September
30, 2003, and 4.02% at September 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 2.07% at September 30, 2003, and 2.53%
at September 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 September 30, 2003 and 2002, the fair value of the hedge was a $9.3
million gain and a $9.0 million gain, respectively. The subordinated debt
qualifies under the risk-based capital guidelines as Tier 2 supplementary
capital for regulatory purposes.
(4) The long-term repurchase agreements had maturities from 2004 through 2006
and had weighted-average interest rates of 1.97% at September 30, 2003 and
3.65% at September 30, 2002. 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 an $11.8 million gain at
September 30, 2003 and an $11.7 million gain at September 30, 2002. Given the
fair value hedge, the Preferred Securities are carried on the balance sheet at
fair value.
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 approximately $259,000 was recorded for the nine months ended
September 30, 2003.
For purposes of providing the pro forma disclosures required under SFAS 123, the
fair value of stock options granted in the comparable three and nine month
periods of 2003 and 2002 was estimated at the date of grant using a
Black-Scholes option pricing model which was originally developed for use in
estimating the fair value of traded options which have different characteristics
from the Corporation's employee stock options. The model is also sensitive to
changes in the subjective assumptions which can materially affect the fair value
estimate. As a result, management believes the Black-Scholes model may not
necessarily provide a reliable single measure of the fair value of employee
stock options. The
following table illustrates the effect on net income and earnings per share if
the Corporation had applied the fair value recognition provisions of SFAS 123.
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
------------------------------------------------------
2003 2002 2003 2002
------------------------------------------------------
($ in Thousands, except per share amounts)
Net income, as reported $ 58,386 $ 53,472 $ 173,048 $ 157,278
Adjustment: pro forma expense related
to options granted, net of tax (710) (772) (2,137) (2,321)
------------------------------------------------------
Net income, as adjusted $ 57,676 $ 52,700 $ 170,911 $ 154,957
======================================================
Basic earnings per share, as reported $ 0.79 $ 0.71 $ 2.34 $ 2.10
Adjustment: pro forma expense related
to options granted, net of tax (0.01) (0.01) (0.03) (0.03)
------------------------------------------------------
Basic earnings per share, as adjusted $ 0.78 $ 0.70 $ 2.31 $ 2.07
======================================================
Diluted earnings per share, as reported $ 0.79 $ 0.70 $ 2.32 $ 2.08
Adjustment: pro forma expense related
to options granted, net of tax (0.01) (0.01) (0.03) (0.03)
------------------------------------------------------
Diluted earnings per share, as adjusted $ 0.78 $ 0.69 $ 2.29 $ 2.05
======================================================
The following assumptions were used in estimating the fair value for options
granted in 2003 and 2002:
2003 2002
-------------------------------
Dividend yield 3.59% 3.91%
Risk-free interest rate 3.27% 4.58%
Weighted average expected life 7 yrs 7 yrs
Expected volatility 28.30% 27.28%
The weighted average per share fair values of options granted in the comparable
nine month periods of 2003 and 2002 were $7.59 and $7.16, respectively. The
annual expense allocation methodology prescribed by SFAS 123 attributes a higher
percentage of the reported expense to earlier years than to later years,
resulting in an accelerated expense recognition for proforma disclosure
purposes.
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 nine months ended ($ in Thousands)
September 30, 2003
Total assets $ 15,058,447 $ 55,722 $ 15,114,169
================================================
Net interest income $ 383,177 $ 448 $ 383,625
Provision for loan losses 37,210 --- 37,210
Noninterest income 161,252 38,005 199,257
Depreciation and amortization 42,140 1,166 43,306
Other noninterest expense 225,968 30,573 256,541
Income taxes 72,872 (95) 72,777
------------------------------------------------
Net income $ 166,239 $ 6,809 $ 173,048
================================================
As of and for the nine months ended
September 30, 2002
Total assets $ 15,015,616 $ 29,086 $ 15,044,702
================================================
Net interest income $ 371,539 $ 14 $ 371,553
Provision for loan losses 36,085 --- 36,085
Noninterest income 122,933 33,026 155,959
Depreciation and amortization 35,781 177 35,958
Other noninterest expense 212,333 23,495 235,828
Income taxes 61,742 621 62,363
------------------------------------------------
Net income $ 148,531 $ 8,747 $ 157,278
================================================
- --------------------------------------------------------------------------------------------
Consolidated
Banking Other Total
- --------------------------------------------------------------------------------------------
As of and for the three months ended ($ in Thousands)
September 30, 2003
Total assets $ 15,058,447 $ 55,722 $ 15,114,169
================================================
Net interest income $ 128,826 $ 150 $ 128,976
Provision for loan losses 12,118 --- 12,118
Noninterest income 50,730 13,158 63,888
Depreciation and amortization 8,674 526 9,200
Other noninterest expense 76,912 11,659 88,571
Income taxes 24,903 (314) 24,589
------------------------------------------------
Net income $ 56,949 $ 1,437 $ 58,386
================================================
As of and for the three months ended
September 30, 2002
Total assets $ 15,015,616 $ 29,086 $ 15,044,702
================================================
Net interest income $ 128,566 $ (208) $ 128,358
Provision for loan losses 12,831 --- 12,831
Noninterest income 49,231 9,425 58,656
Depreciation and amortization 18,791 51 18,842
Other noninterest expense 72,275 7,066 79,341
Income taxes 22,518 10 22,528
------------------------------------------------
Net income $ 51,382 $ 2,090 $ 53,472
================================================
- --------------------------------------------------------------------------------------------
NOTE 12: Commitments, Off-Balance Sheet Risk, and Contingent Liabilities
Commitments and Off-Balance Sheet Risk
- --------------------------------------
The Corporation utilizes a variety of financial instruments in the normal course
of business to meet the financial needs of its customers and to manage its own
exposure to fluctuations in interest rates. These financial instruments include
lending-related commitments.
Lending-related Commitments
- ---------------------------
Through the normal course of operations, the Corporation has entered into
certain contractual obligations and other commitments. As a financial services
provider the Corporation routinely enters into commitments to extend credit.
While contractual obligations represent future cash requirements of the
Corporation, a significant portion of commitments to extend credit may expire
without being drawn upon. Such commitments are subject to the same credit
policies and approval process accorded to loans made by the Corporation.
Lending-related commitments include commitments to extend credit, commitments to
originate residential mortgage loans held for sale, commercial letters of
credit, and standby letters of credit. Commitments to extend credit are
agreements to lend to customers at predetermined interest rates as long as there
is no violation of any condition established in the contracts. Commercial and
standby letters of credit are conditional commitments issued to guarantee the
performance of a customer to a third party. Commercial letters of credit are
issued specifically to facilitate commerce and typically result in the
commitment being drawn on when the underlying transaction is consummated between
the customer and the third party, while standby letters of credit generally are
contingent upon the failure of the customer to perform according to the terms of
the underlying contract with the third party.
Under SFAS 133, commitments to originate residential mortgage loans held for
sale and forward commitments to sell residential mortgage loans are defined as
derivatives and are therefore required to be recorded on the consolidated
balance sheet at fair value. The Corporation's derivative and hedging activity,
as defined by SFAS 133, is further summarized in Note 7. The following is a
summary of lending-related commitments at September 30:
September 30,
------------------------------
2003 2002
--------------- --------------
($ in Thousands)
Commitments to extend credit, excluding
commitments to originate residential
mortgage loans held for sale (1) $ 3,575,438 $ 3,204,458
Commercial letters of credit (1) 44,241 61,090
Standby letters of credit (2) 306,610 233,511
(1) These off-balance sheet financial instruments are exercisable at the market
rate prevailing at the date the underlying transaction will be completed,
and thus are deemed to have no current fair value, or the fair value is
based on fees currently charged to enter into similar agreements and is not
material at September 30, 2003 or 2002.
(2) As required by FIN 45 (see Note 3), the Corporation has established a
liability of $1.6 million at September 30, 2003, as an estimate of the fair
value of these financial instruments. No fair value liability was required
at September 30, 2002.
The Corporation's exposure to credit loss in the event of nonperformance by the
other party to these financial instruments is represented by the contractual
amount of those instruments. The commitments generally have fixed expiration
dates or other termination clauses and may require payment of a fee. The
Corporation uses the same credit policies in making commitments and conditional
obligations as it does for extending loans to customers. The Corporation
evaluates each customer's creditworthiness on a case-by-case basis. The amount
of collateral obtained, if deemed necessary by the Corporation upon extension of
credit, is based on management's credit evaluation of the customer. Since many
of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
Contingent Liabilities
- ----------------------
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.
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 September 30, 2003, the
Corporation's estimated maximum exposure was approximately $1 million.
A contingent liability is required to be established if it is probable that the
Corporation will incur a loss on the performance of a letter of credit. During
the second quarter of 2003, the Corporation established a $2.5 million liability
for commercial letters of credit.
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:
o operating, legal, and regulatory risks;
o economic, political, and competitive forces; and
o 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 nine months ended September 30, 2003 and the
comparable period in 2002. Discussion of third quarter 2003 results compared to
third quarter 2002 is predominantly in section, "Comparable Third 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 nine month's
contribution from its February 28, 2002 purchase acquisition of Signal Financial
Corporation ("Signal") and six month's contribution from its April 1, 2003
purchase acquisition of CFG Insurance Services, Inc ("CFG"), while consolidated
financial results for 2002 reflect seven 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.
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 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 assets and 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 nine months ended September 30, 2003 totaled $173.0 million,
or $2.34 and $2.32 for basic and diluted earnings per share, respectively.
Comparatively, net income for the nine months ended September 30, 2002 was
$157.3 million, or $2.10 and $2.08 for basic and diluted earnings per share,
respectively. Year-to-date 2003 results generated an annualized return on
average assets of 1.54% and an annualized return on average equity of 17.82%,
compared to 1.49% and 17.28%, respectively, for the comparable period in 2002.
The net interest margin for the first nine months of 2003 was 3.82% compared to
3.94% for the first nine months of 2002.
- ---------------------------------------------------------------------------------------------------------------------
TABLE 1
Summary Results of Operations: Trends
($ in Thousands, except per share data)
3rd Qtr. 2nd Qtr. 1st Qtr. 4th Qtr. 3rd Qtr.
2003 2003 2003 2002 2002
- ---------------------------------------------------------------------------------------------------------------------
Net income (Quarter) $ 58,386 $ 56,669 $ 57,993 $ 53,441 $ 53,472
Net income (Year-to-date) 173,048 114,662 57,993 210,719 157,278
Earnings per share - basic (Quarter) $ 0.79 $ 0.77 $ 0.78 $ 0.72 $ 0.71
Earnings per share - basic (Year-to-date) 2.34 1.55 0.78 2.82 2.10
Earnings per share - diluted (Quarter) $ 0.79 $ 0.76 $ 0.77 $ 0.71 $ 0.70
Earnings per share - diluted (Year-to-date) 2.32 1.53 0.77 2.79 2.08
Return on average assets (Quarter) 1.53% 1.51% 1.58% 1.42% 1.47%
Return on average assets (Year-to-date) 1.54 1.55 1.58 1.47 1.49
Return on average equity (Quarter) 17.75% 17.37% 18.36% 16.62% 16.73%
Return on average equity (Year-to-date) 17.82 17.86 18.36 17.10 17.28
Efficiency ratio (Quarter) * 49.34% 51.10% 49.29% 51.07% 51.14%
Efficiency ratio (Year-to-date) * 49.92 50.21 49.29 50.25 49.94
Net interest margin (Quarter) 3.78% 3.79% 3.87% 3.87% 3.96%
Net interest margin (Year-to-date) 3.82 3.83 3.87 3.95 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 nine months ended
September 30, 2003, was $402.3 million, an increase of $12.7 million or 3.2%
over the comparable period last year. As indicated in Tables 2 and 3, the $12.7
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 $26.7
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 $14.0 million).
The net interest margin for the first nine months of 2003 was 3.82%, down 12
basis points ("bp") from 3.94% for the comparable period in 2002. This
comparable period decrease was attributable to a 3 bp decrease in interest rate
spread (the net of an 81 bp decrease in the yield on earning assets and a 78 bp
decrease in the cost of interest-bearing liabilities) and a 9 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 nine-month
periods. The average Federal funds rate of 1.16% for year-to-date 2003 was 59 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 5.41% for year-to-date 2003, down 81 bp from the
comparable nine-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 5.48%, down 86 bp from year-to-date 2002. The average yield on investments
and other earning assets was 5.18%, down 69 bp, impacted by faster prepayments
(particularly on mortgage-related securities) and reinvestment in the lower rate
environment.
The cost of interest-bearing liabilities was 1.87% for year-to-date 2003, down
78 bp compared to the first nine months of 2002, aided by the lower rate
environment. The average cost of interest-bearing deposits was 1.67%, down 71 bp
from year-to-date 2002, benefiting from a larger mix of lower-costing
transaction accounts, as well as from lower rates on interest-bearing deposit
products in general. The cost of wholesale funds (comprised of short-term
borrowings and long-term funding) was 2.20%, down 97 bp from year-to-date 2002,
favorably impacted by lower rates between comparable periods.
Average earning assets increased by $886 million (6.8%) over the comparable
nine-month period last year. Average loans represented 76.6% of average earning
assets for year-to-date 2003 compared to 74.9% for year-to-date 2002 and
accounted for the majority of the growth in earning assets. On average, loans
increased $898 million (9.1%) compared to year-to-date 2002, with commercial
loans up $616 million and residential real estate loans (including loans held
for sale) up $280 million. Average investments and other earning assets
decreased slightly ($12 million) to $3.3 billion.
Average interest-bearing liabilities increased $665 million (5.9%) over the
comparable period of 2002, and net free funds increased $221 million, both
supporting the growth in earning assets. Average noninterest-bearing demand
deposits (a component of net free funds) increased by $207 million, or 14.4%.
The growth in interest-bearing liabilities came from wholesale funding sources,
as average interest-bearing deposits were relatively unchanged (up $59 million
or 0.8%) between the comparable periods. Average wholesale funding sources
increased $606 million, representing 36.9% of average interest-bearing
liabilities for year-to-date 2003 compared to 33.7% for year-to-date 2002. The
Corporation increased its long-term funding by $599 million (representing 17.9%
of average interest-bearing liabilities, versus 13.7% for year-to-date 2002).
- ---------------------------------------------------------------------------------------------------------------------------
TABLE 2
Net Interest Income Analysis-Taxable Equivalent Basis
($ in Thousands)
- ---------------------------------------------------------------------------------------------------------------------------
Nine Months ended September 30, 2003 Nine Months ended September 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 $ 6,455,171 $ 249,509 5.10% $ 5,839,172 $ 261,173 5.90%
Residential real estate 3,547,875 154,138 5.80 3,268,018 165,944 6.77
Consumer 709,692 38,660 7.28 707,690 42,286 7.98
-------------------------- -------------------------
Total loans 10,712,738 442,307 5.48 9,814,880 469,403 6.34
Investments and other (1) 3,273,806 127,272 5.18 3,285,634 144,616 5.87
-------------------------- -------------------------
Total earning assets 13,986,544 569,579 5.41 13,100,514 614,019 6.22
Other assets, net 1,026,672 993,235
------------ ------------
Total assets $ 15,013,216 $ 14,093,749
============ ============
Interest-bearing liabilities:
Interest-bearing deposits:
Savings deposits $ 930,105 $ 3,997 0.57% $ 881,727 $ 5,147 0.78%
Interest-bearing demand deposits 1,708,600 10,995 0.86 1,053,748 6,268 0.80
Money market deposits 1,640,707 11,694 0.95 1,913,528 19,458 1.36
Time deposits, excluding Brokered CDs 3,062,576 64,825 2.83 3,330,936 97,622 3.92
-------------------------- -------------------------
Total interest-bearing deposits,
excluding Brokered CDs 7,341,988 91,511 1.67 7,179,939 128,495 2.39
Brokered CDs 184,494 2,364 1.71 287,199 4,630 2.16
-------------------------- -------------------------
Total interest-bearing deposits 7,526,482 93,875 1.67 7,467,138 133,125 2.38
Wholesale funding 4,402,081 73,406 2.20 3,796,002 91,250 3.17
-------------------------- -------------------------
Total interest-bearing liabilities 11,928,563 167,281 1.87 11,263,140 224,375 2.65
------- -------
Demand, non-interest bearing 1,644,871 1,437,938
Other liabilities 141,548 175,506
Stockholders' equity 1,298,234 1,217,165
------------ ------------
Total liabilities and equity $ 15,013,216 $ 14,093,749
============ ============
Interest rate spread 3.54% 3.57%
Net free funds 0.28 0.37
---- ----
Net interest income, taxable
equivalent, and net interest
margin $ 402,298 3.82% $ 389,644 3.94%
=================== ========= =====
Taxable equivalent adjustment 18,673 18,091
--------- ---------
Net interest income, as reported $ 383,625 $ 371,553
========= =========
(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.
- ---------------------------------------------------------------------------------------------------------------------------
TABLE 2 (continued)
Net Interest Income Analysis-Taxable Equivalent Basis
($ in Thousands)
- ---------------------------------------------------------------------------------------------------------------------------
Three Months ended September 30, 2003 Three Months ended September 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 $ 6,565,202 $ 83,321 4.97% $ 6,072,648 $ 89,715 5.80%
Residential real estate 3,541,464 49,538 5.55 3,333,818 55,546 6.62
Consumer 707,103 12,657 7.10 722,360 13,893 7.62
-------------------------- -------------------------
Total loans 10,813,769 145,516 5.30 10,128,826 159,154 6.20
Investments and other (1) 3,314,933 42,468 5.12 3,299,160 46,602 5.65
-------------------------- -------------------------
Total earning assets 14,128,702 187,984 5.26 13,427,986 205,756 6.06
Other assets, net 1,023,974 1,032,372
------------ ------------
Total assets $ 15,152,676 $ 14,460,358
============ ============
Interest-bearing liabilities:
Interest-bearing deposits:
Savings deposits $ 935,402 $ 1,113 0.47% $ 914,804 $ 1,819 0.79%
Interest-bearing demand deposits 1,938,111 4,070 0.83 1,192,154 2,841 0.95
Money market deposits 1,586,092 3,430 0.86 1,840,435 5,991 1.29
Time deposits, excluding Brokered CDs 3,120,919 21,213 2.70 3,187,992 27,229 3.39
-------------------------- -------------------------
Total interest-bearing
deposits, excluding Brokered CDs 7,580,524 29,826 1.56 7,135,385 37,880 2.11
Brokered CDs 146,670 501 1.36 246,676 1,456 2.34
-------------------------- -------------------------
Total interest-bearing deposits 7,727,194 30,327 1.56 7,382,061 39,336 2.11
Wholesale funding 4,228,226 22,516 2.09 4,077,612 32,071 3.09
-------------------------- -------------------------
Total interest-bearing liabilities 11,955,420 52,843 1.75 11,459,673 71,407 2.46
------ ------
Demand, non-interest bearing 1,757,806 1,564,986
Other liabilities 134,467 167,344
Stockholders' equity 1,304,983 1,268,355
----------- -----------
Total liabilities and equity $15,152,676 $14,460,358
=========== ===========
Interest rate spread 3.51% 3.60%
Net free funds 0.27 0.36
---- ----
Net interest income, taxable
equivalent, and net interest margin $ 135,141 3.78% $ 134,349 3.96%
==================== ====================
Taxable equivalent adjustment 6,165 5,991
--------- ---------
Net interest income, as reported $128,976 $128,358
========= =========
- --------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------
TABLE 3
Volume/Rate Variance - Taxable Equivalent Basis
($ in Thousands)
- -----------------------------------------------------------------------------------------------------
Comparison of
Nine months ended September 30, 2003 versus 2002
Variance Attributable to
------------------------
Income/Expense
Variance(1) Volume Rate
- -----------------------------------------------------------------------------------------------------
INTEREST INCOME: (2)
Loans:
Commercial $ (11,664) $ 22,752 $ (34,416)
Residential real estate (11,806) 14,387 (26,193)
Consumer (3,626) (2,974) (652)
--------------------------------------------
Total loans (27,096) 34,165 (61,261)
Investments and other (17,344) (492) (16,852)
--------------------------------------------
Total interest income (44,440) 33,673 (78,113)
INTEREST EXPENSE:
Interest-bearing deposits:
Savings deposits $ (1,150) $ 208 $ (1,358)
Interest-bearing demand deposits 4,727 4,214 513
Money market deposits (7,764) (1,945) (5,819)
Time deposits, excluding brokered CDs (32,797) (5,680) (27,117)
--------------------------------------------
Interest-bearing deposits, excluding brokered CDs (36,984) (3,203) (33,781)
Brokered CDs (2,266) (1,317) (949)
--------------------------------------------
Total interest-bearing deposits (39,250) (4,520) (34,730)
Wholesale funding (17,844) 11,549 (29,393)
--------------------------------------------
Total interest expense (57,094) 7,029 (64,123)
--------------------------------------------
Net interest income, taxable equivalent $ 12,654 $ 26,644 $ (13,990)
============================================
(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.
- ----------------------------------------------------------------------------------------------------
TABLE 3 (continued)
Volume/Rate Variance - Taxable Equivalent Basis
($ in Thousands)
- ----------------------------------------------------------------------------------------------------
Comparison of
Three months ended September 30, 2003 versus 2002
Variance Attributable to
------------------------
Income/Expense
Variance(1) Volume Rate
- ----------------------------------------------------------------------------------------------------
INTEREST INCOME: (2)
Loans:
Commercial $ (6,394) $ 6,021 $ (12,415)
Residential real estate (6,008) 4,033 (10,041)
Consumer (1,236) (1,362) 126
--------------------------------------------
Total loans (13,638) 8,692 (22,330)
Investments and other (4,134) 76 (4,210)
--------------------------------------------
Total interest income (17,772) 8,768 (26,540)
INTEREST EXPENSE:
Interest-bearing deposits:
Savings deposits $ (706) $ 27 $ (733)
Interest-bearing demand deposits 1,229 1,573 (344)
Money market deposits (2,561) (539) (2,022)
Time deposits, excluding brokered CDs (6,016) (397) (5,619)
--------------------------------------------
Interest-bearing deposits,
excluding brokered CDs (8,054) 664 (8,718)
Brokered CDs (955) (340) (615)
--------------------------------------------
Total interest-bearing deposits (9,009) 324 (9,333)
Wholesale funding (9,555) 803 (10,358)
--------------------------------------------
Total interest expense (18,564) 1,127 (19,691)
--------------------------------------------
Net interest income, taxable equivalent $ 792 $ 7,641 $ (6,849)
============================================
- --------------------------------------------------------------------------------------------------
Provision for Loan Losses
- -------------------------
For the first nine months of 2003, the provision for loan losses was $37.2
million, compared to $36.1 million for the same period in 2002. Net charge offs
were $23.5 million for the nine months ended September 30, 2003, compared to
$21.0 million for the nine months ended September 30, 2002. Annualized net
charge offs as a percent of average loans for year-to-date 2003 were 0.29%,
unchanged from year-to-date 2002. Nonperforming loans were $125.2 million,
$100.3 million, and $99.3 million at September 30, 2003, September 30, 2002, and
December 31, 2002, respectively. The ratio of the allowance for loan losses to
total loans was 1.71%, up from 1.54% at September 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."
Noninterest Income
- ------------------
Noninterest income grew to $199.3 million for year-to-date 2003, compared to
$156.0 million in the same period of 2002. The $43.3 million (or 27.8%) increase
between the comparable periods was primarily attributable to increases in
mortgage banking income, retail commission income, and service charges on
deposit accounts, partly offset by a decrease in credit card and other
nondeposit fees.
- --------------------------------------------------------------------------------------------------------------------------
TABLE 4
Noninterest Income
($ in Thousands)
- --------------------------------------------------------------------------------------------------------------------------
3rd Qtr. 3rd Qtr. Dollar Percent YTD YTD Dollar Percent
2003 2002 Change Change 2003 2002 Change Change
- --------------------------------------------------------------------------------------------------------------------------
Trust service fees $ 7,001 $ 6,722 $ 279 4.2% $ 21,427 $ 21,815 $ (388) (1.8)%
Service charges on deposit
accounts 13,338 12,261 1,077 8.8 37,611 33,874 3,737 11.0
Mortgage banking 23,635 20,468 3,167 15.5 78,583 42,709 35,874 84.0
Credit card & other nondeposit
fees 5,435 7,045 (1,610) (22.9) 18,023 20,211 (2,188) (10.8)
Retail commissions 6,830 3,635 3,195 87.9 17,540 14,136 3,404 24.1
Bank owned life insurance income 3,532 3,545 (13) (0.4) 10,373 10,284 89 0.9
Other 3,245 3,948 (703) (17.8) 14,795 11,526 3,269 28.4
-------------------------------------------------------------------------------------
Subtotal $ 63,016 $ 57,624 $ 5,392 9.4% $198,352 $154,555 $ 43,797 28.3%
Asset sale gains, net 871 658 213 N/M 203 1,030 (827) N/M
Investment securities gains, net 1 374 (373) N/M 702 374 328 N/M
-------------------------------------------------------------------------------------
Total noninterest income $ 63,888 $ 58,656 $ 5,232 8.9% $199,257 $155,959 $ 43,298 27.8%
=====================================================================================
N/M - Not meaningful.
- --------------------------------------------------------------------------------------------------------------------------
Trust service fees were $21.4 million, a decrease of $0.4 million, or 1.8%,
between the comparable nine-month periods. The change was predominantly the
result of a decrease in the average market value of assets under management (to
an average of $3.67 billion for year-to-date 2003 from $3.73 billion for
year-to-date 2002), primarily a function of competitive market conditions.
Assets under management at September 30, 2003 and 2002 were $3.85 billion and
$3.47 billion, respectively.
Service charges on deposit accounts were $37.6 million, up $3.7 million, or
11.0%, between the comparable nine-month periods, due in large part to higher
volumes associated with a larger account base. The increase was also a result of
higher service charges on business accounts (attributable to lower earnings
credit rates) 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
$78.6 million, an increase of $35.9 million between the comparable nine-month
periods. The increase was driven primarily by increased secondary mortgage loan
production (mortgage loan production to be sold to the secondary market), which
was nearly double the comparable 2002 period ($3.75 billion in year-to-date 2003
versus $1.96 billion in year-to-date 2002). The higher production levels
positively impacted production volume-related fees (up $5.8 million). Also,
gains on sales of the increased production were up $29.9 million (the net of
realized gains up $38.4 million and an $8.5 million decline in the fair value of
the mortgage derivatives position). Servicing fees on the portfolio serviced for
others were up slightly ($0.2 million) between comparable periods, given the
minimal change in the average balance serviced. The mortgage portfolio serviced
for others at September 30, 2003 and 2002 was $5.59 billion and $5.38 billion,
respectively.
Credit card and other nondeposit fees were $18.0 million for the first nine
months of 2003, a decrease of $2.2 million or 10.8% from year-to-date 2002,
primarily attributable to lower merchant fees, given the merchant processing
sale and services agreement consummated in March 2003 (also noted below).
Retail commission income (which includes commissions from insurance and
brokerage product sales) was $17.5 million for the first nine months of 2003, an
increase of $3.4 million compared to the same period a
year ago. Fixed annuities commissions decreased $2.1 million, while other
insurance revenues were up $5.3 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) increased $0.2 million, affected slightly by recent improvements in
the market.
Other noninterest income was $14.8 million for year-to-date 2003, an increase of
$3.3 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 asset sale net gains of $0.2 million for the nine months of 2003 was
primarily the net result of a $0.6 million second quarter loss on the sale of
other real estate owned and a $1.0 million third quarter gain on the sale of
other real estate owned. The asset sale net gains for year-to-date 2002 of $1.0
million was the net result of a first quarter gain on the sale of student loans
and a third quarter gain on the sale of mortgage portfolio loans. The investment
securities net gains for year-to-date 2003 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. The
2002 investment securities gain of $0.4 million was the result of a third
quarter gain on the sale of Sallie Mae securities.
Noninterest Expense
- -------------------
Noninterest expense for year-to-date 2003 was $299.8 million, up $28.1 million
or 10.3% compared to the first nine months of 2002, reflecting the Corporation's
larger operating base between comparable periods, as well as higher mortgage
servicing rights expense.
- --------------------------------------------------------------------------------------------------------------------------
TABLE 5
Noninterest Expense
($ in Thousands)
- --------------------------------------------------------------------------------------------------------------------------
3rd Qtr. 3rd Qtr. Dollar Percent YTD YTD Dollar Percent
2003 2002 Change Change 2003 2002 Change Change
- --------------------------------------------------------------------------------------------------------------------------
Personnel expense $ 54,795 $ 47,581 $ 7,214 15.2% $158,275 $141,339 $ 16,936 12.0%
Occupancy 7,101 6,553 548 8.4 21,367 19,340 2,027 10.5
Equipment 3,178 3,909 (731) (18.7) 9,612 11,126 (1,514) (13.6)
Data processing 6,322 5,420 902 16.6 17,542 15,527 2,015 13.0
Business development &
advertising 4,113 3,728 385 10.3 11,029 10,300 729 7.1
Stationery and supplies 1,651 1,395 256 18.4 4,964 5,225 (261) (5.0)
FDIC expense 353 384 (31) (8.1) 1,078 1,158 (80) (6.9)
Mortgage servicing rights
expense 4,199 13,372 (9,173) (68.6) 28,818 20,143 8,675 43.1
Intangible amortization expense 871 576 295 51.2 2,091 1,674 417 24.9
Loan expense 1,806 3,967 (2,161) (54.5) 6,104 10,280 (4,176) (40.6)
Other 13,382 11,298 2,084 18.4 38,967 35,674 3,293 9.2
------------------------------------------------------------------------------------
Total noninterest expense $ 97,771 $ 98,183 $ (412) (0.4)% $299,847 $271,786 $ 28,061 10.3%
====================================================================================
- --------------------------------------------------------------------------------------------------------------------------
Personnel expense (including salary-related expenses and fringe benefit
expenses) increased $16.9 million or 12.0% over the first nine months of 2002.
Personnel expense represented 52.8% of total noninterest expense in year-to-date
2003 compared to 52.0% in year-to-date 2002. Salary-related expenses increased
$13.6 million or 12.5% between comparable periods, primarily a function of merit
increases between years and incentive compensation given the overall increase in
full-time equivalent employees (particularly attributable to the timing of the
Signal and CFG acquisitions), and increased temporary help (particularly
supporting higher residential mortgage production). Average full-time equivalent
employees were 4,131 for year-to-date 2003 compared to 4,071 for year-to-date
2002. Fringe benefits increased $3.3 million or 10.3% over year-to-date 2002,
attributable also to the larger employee base, timing of the acquisitions, and
the increased cost of benefit plans and premium based benefits.
Occupancy expense increased 10.5% to support the larger branch and office
network, particularly attributable to the Signal and CFG acquisitions. Equipment
expense declined principally in computer depreciation expense. Data processing
costs increased to $17.5 million, up $2.0 million or 13.0% over the comparable
period in 2002, due to processing for a larger base operation, increased
Internet banking usage and other technology conversions and enhancements.
Mortgage servicing rights expense includes both the amortization of the mortgage
servicing rights asset and increases or decreases to the valuation allowance
associated with the mortgage servicing rights asset. Mortgage servicing rights
expense increased by $8.7 million between comparable periods, including a $15.8
million addition to the valuation allowance for year-to-date 2003 (compared to a
$10.8 million addition to the valuation allowance during year-to-date 2002) and
a $3.7 million increase in the amortization of the mortgage servicing rights
asset. While the strong mortgage refinance activity benefited mortgage banking
income, it increased the prepayment speeds of the Corporation's mortgage
portfolio serviced for others, a key factor behind the valuation of mortgage
servicing rights. However, at the end of the third quarter 2003, mortgage
interest rates began to rise, slowing both prepayment speeds and mortgage
refinance activity. The Corporation periodically evaluates its capitalized
mortgage servicing rights for impairment. 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. Loan type and note
rate are the predominant risk characteristics of the underlying loans used to
stratify capitalized mortgage servicing rights for purposes of measuring
impairment. A valuation allowance is established to the extent the carrying
value of the mortgage servicing rights exceeds the estimated fair value. Net
income could be affected if management's estimate of the prepayment speeds or
other factors differ materially from actual prepayments. Permanent impairment is
recognized as a write-down of the mortgage servicing rights asset and the
related valuation allowance (to the extent valuation reserve is available) and
then against current earnings, as needed. Mortgage servicing rights, included in
other intangible assets on the consolidated balance sheet, were $36.7 million,
net of a $28.6 million valuation allowance at September 30, 2003, and
represented 66 bp of the $5.59 billion portfolio of residential mortgage loans
serviced for others. See Note 6, "Goodwill and Other Intangible Assets," of the
notes to consolidated financial statements for additional disclosure.
Loan expense was $6.1 million, down $4.2 million between comparable periods,
predominantly due to lower merchant processing costs, given the sale of the
merchant processing during the first quarter of 2003. Other expense was up $3.3
million from year-to-date 2002, attributable primarily to a $2.5 million charge
in the second quarter of 2003 on commercial letters of credit.
Income Taxes
- ------------
Income tax expense for the first nine months of 2003 was $72.8 million, up $10.4
million or 16.7% from the comparable period in 2002. The effective tax rate
(income tax expense divided by income before taxes) was 29.6% and 28.4% 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 state income
tax expense.
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 September 30, 2003, total assets were $15.1 billion, an increase of $69
million, or 0.5%, over September 30, 2002. The growth in assets occurred
primarily in loans, which grew $203 million or 2.0% year over year. The growth
in loans was almost exclusively in commercial loans, which grew $354 million
(5.8% since September 30, 2002) and comprised 63% of total loans at September
30, 2003. Home equity loans grew $81 million or 9.7%, while residential mortgage
loans decreased 9.0%, strongly influenced by lower interest rates and high
refinance activity (with the majority of the refinanced loans sold to the
secondary market). Total deposits of $9.6 billion at September 30, 2003 were up
$688 million, or 7.7%, compared to a year ago. Interest-bearing transaction
accounts (savings, interest-bearing demand, and money market) grew by $682
million (17.5%). Since September 30, 2002, noninterest-bearing demand deposits
grew $64 million (3.7%), representing 19% of total deposits. Brokered CDs and
other-time deposits combined (representing 34% of total deposits at September
30, 2003 compared to 37% of total deposits at September 30, 2002) declined $57
million, impacted by the prolonged lower interest rate environment and customer
preference to keep funds liquid. With the increase in deposits, short-term
borrowings decreased $580 million and long-term debt declined $24 million since
September 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 $444 million, particularly in short-term borrowings. Total assets grew $71
million since year-end 2002, with loans down slightly ($14 million) and loans
held for sale up $84 million. The decline in loans was primarily in residential
mortgage loans, which decreased $265 million, while commercial loans grew $208
million and home equity loans increased $48 million. Deposits increased $511
million to $9.6 billion at September 30, 2003, led by interest-bearing
transaction accounts, collectively up $452 million since year-end 2002. See
Tables 6 and 7 for period end loan and deposit composition, respectively.
- ------------------------------------------------------------------------------------------------------------------------
TABLE 6
Period End Loan Composition
($ in Thousands)
- ------------------------------------------------------------------------------------------------------------------------
September 30, % of September 30, % of Dec. 31, % of
2003 Total 2002 Total 2002 Total
- ------------------------------------------------------------------------------------------------------------------------
Commercial, financial &agricultural $2,186,214 21% $ 2,175,931 22% $ 2,213,986 22%
Real estate-construction 1,035,674 10 850,287 8 910,581 9
Commercial real estate 3,240,757 32 3,082,890 31 3,128,826 30
Lease financing 37,193 -- 36,274 -- 38,352 --
---------------------------------------------------------------------------
Commercial 6,499,838 63 6,145,382 61 6,291,745 61
Residential mortgage 2,166,187 21 2,381,120 24 2,430,746 24
Home equity 912,142 9 831,169 8 864,631 8
---------------------------------------------------------------------------
Residential real estate 3,078,329 30 3,212,289 32 3,295,377 32
Consumer 711,075 7 728,839 7 716,103 7
---------------------------------------------------------------------------
Total loans $10,289,242 100% $10,086,510 100% $10,303,225 100%
===========================================================================
- -------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
TABLE 7
Period End Deposit Composition
($ in Thousands)
- -------------------------------------------------------------------------------------------------------------------------
September 30, % of September 30, % of Dec. 31, % of
2003 Total 2002 Total 2002 Total
- -------------------------------------------------------------------------------------------------------------------------
Noninterest-bearing demand $ 1,804,596 19% $ 1,740,932 19% $ 1,773,699 19%
Savings 924,036 9 916,039 10 895,855 10
Interest-bearing demand 2,086,964 22 1,212,672 14 1,468,193 16
Money market 1,559,769 16 1,760,334 20 1,754,313 19
Brokered CDs 156,994 2 187,915 2 233,650 3
Other time 3,102,997 32 3,129,461 35 2,999,142 33
----------------------------------------------------------------------------
Total deposits $ 9,635,356 100% $ 8,947,353 100% $ 9,124,852 100%
============================================================================
Total deposits, excluding Brokered CDs $ 9,478,362 98% $ 8,759,438 98% $ 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.
- --------------------------------------------------------------------------------
TABLE 8
Allowance for Loan Losses and Nonperforming Assets
($ in Thousands)
- --------------------------------------------------------------------------------
At and for the At and for the
Nine months ended year ended
September 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 37,210 36,085 50,699
Charge offs (26,631) (24,295) (32,179)
Recoveries 3,103 3,309 3,832
----------------------------------------
Net charge-offs (23,528) (20,986) (28,347)
----------------------------------------
Balance at end of period $ 176,223 $ 155,288 $ 162,541
========================================
Nonperforming Assets:
Nonaccrual loans $ 114,067 $ 93,250 $ 94,132
Accruing loans past due
90 days or more 11,055 5,981 3,912
Restructured loans 44 1,110 1,258
----------------------------------------
Total nonperforming loans 125,166 100,341 99,302
Other real estate owned 6,380 3,331 11,448
----------------------------------------
Total nonperforming assets $ 131,546 $ 103,672 $ 110,750
========================================
Ratios:
Allowance for loan losses
to net charge offs (annualized) 5.60x 5.53x 5.73x
Net charge offs to average loans
(annualized) 0.29% 0.29% 0.28%
Allowance for loan losses to
total loans 1.71% 1.54% 1.58%
Nonperforming loans to total loans 1.22% 0.99% 0.96%
Nonperforming assets to total assets 0.87% 0.69% 0.74%
Allowance for loan losses to
nonperforming loans 141% 155% 164%
- --------------------------------------------------------------------------------
As of September 30, 2003, the allowance for loan losses was $176.2 million,
representing 1.71% of loans outstanding, compared to $155.3 million, or 1.54% of
loans, at September 30, 2002, and $162.5 million, or 1.58% at year-end 2002. The
allowance for loan losses at September 30, 2003 increased $20.9 million since
September 30, 2002 and $13.7 million since December 31, 2002. At September 30,
2003, the allowance for loan losses was 141% of nonperforming loans compared to
155% and 164% at September 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 $26.6 million for the nine months ended September 30,
2003, primarily from an $8 million charge off during the second quarter and a $4
million charge off during the third quarter, both related to commercial loan
relationships in the construction industry. This compares to $24.3 million for
the nine months ended September 30, 2002, including several large commercial
credits (accountable for approximately $11 million of the charge offs).
Recoveries for the corresponding periods were $3.1 million
and $3.3 million, respectively. As a result, the ratio of net charge offs to
average loans on an annualized basis was 0.29% for both nine-month periods ended
September 30, 2003 and September 30, 2002.
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 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 September 30, 2003, September 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 September 30, 2003, were up $203 million (2.0%) since September
30, 2002, with commercial loans accounting for the majority of growth (up $354
million, or 5.8% versus last year). Total loans compared to December 31, 2002,
decreased slightly (down $14 million) to $10.3 billion; however, the commercial
portfolio grew $208 million (4.4% 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 $24.8 million since
September 30, 2002 and grew $25.9 million since December 31, 2002, particularly
from two specific nonperforming commercial loans, totaling approximately $23
million at September 30, 2003 (see Table 8 and detailed discussion in section
"Nonperforming Loans and Other Real Estate Owned"). In addition, a previously
disclosed commercial manufacturing relationship ($18 million outstanding at
September 30, 2003), with a $10 million allowance identified for this
relationship, has been included in nonaccrual loans for all periods presented.
At September 30, 2003, this commercial manufacturing relationship, remained
current but management has continued doubts concerning future collectibility.
Finally, loans bearing risk ratings for September 30, 2003 increased from
September 30, 2002 and December 31, 2002, in part from the large commercial
credits noted in section "Nonperforming Loans and Other Real Estate Owned," and
from a larger portion of loans rated in higher-risk categories, several larger
loans moved 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 1.71%, 1.54% and 1.58% for
September 30, 2003, and September 30 and December 31, 2002, respectively.
Management believes the allowance for loan losses to be adequate at September
30, 2003.
Consolidated net income could be affected if management's estimate of the
allowance for loan losses is subsequently materially different, requiring
additional or less provision for loan losses to be recorded. Management
carefully considers numerous detailed and general factors, its assumptions, and
the likelihood of materially different conditions that could alter its
assumptions. While management uses currently available information to recognize
losses on loans, future adjustments to the allowance for loan losses may be
necessary based on changes in economic conditions and the impact of such change
on the Corporation's borrowers. As an integral part of their examination
process, various regulatory agencies also review the allowance for loan losses.
Such agencies may require that certain loan balances be charged off when their
credit evaluations differ from those of management, based on their judgments
about information available to them at the time of their examination.
Nonperforming Loans 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 $14 million, $20 million and $20 million of these loans at
September 30, 2003, September 30, 2002, and December 31, 2002, respectively.
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%, 0.69%, and 0.74% at September 30, 2003, September 30,
2002, and December 31, 2002, respectively.
Total nonperforming loans at September 30, 2003 were up $24.8 million from
September 30, 2002 and up $25.9 million from year-end 2002. The ratio of
nonperforming loans to total loans was 1.22% at September 30, 2003, as compared
to 0.99% and 0.96% at September 30, 2002, and year-end 2002, respectively. The
$24.8 million increase in nonperforming loans was from nonaccrual loans (up
$20.8 million) and accruing loans past due 90 or more days (up $5.1 million,
particularly attributable to two large commercial credits), while restructured
loans declined (down $1.1 million). The increase in nonaccrual loans between the
comparable September periods was predominantly attributable to the addition,
during the second quarter of 2003, of two large commercial credits (totaling
approximately $23 million at September 30, 2003, one in the construction
industry and one in the hospitality industry), net of the transfer of one large
credit (totaling $2.7 million at September 30, 2003) to other real estate owned
in the second quarter of 2003. The $25.9 million increase in nonperforming loans
since year-end 2002 was from nonaccrual loans (up $19.9 million), accruing loans
past due 90 or more days (up $7.2 million), and restructured loans (down $1.2
million). The increase in nonperforming loans since year-end 2002 was primarily
attributable to the same activity noted above for the comparable September
periods. In addition, a previously disclosed commercial manufacturing
relationship ($18 million at September 30, 2003), has been included in
nonaccrual loans for all periods presented. Of note, approximately 38% of
nonperforming loans at September 30, 2003 are attributable to the five
specifically mentioned commercial credits.
Other real estate owned was $6.4 million at September 30, 2003, compared to $3.3
million at September 30, 2002, and $11.4 million at year-end 2002. The change in
other real estate owned was predominantly due to the addition and subsequent
sale of commercial real estate properties. An $8.0 million property was added
during the fourth quarter of 2002, a $1.5 million property was added during the
first quarter of 2003, and a $2.7 million property was added during the second
quarter of 2003. The $1.5 million commercial real estate property was sold
during the second quarter of 2003 (at a net loss of $0.6 million) and the $8.0
million commercial real estate property was sold during the third quarter of
2003 (at a net gain of $1.0 million).
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 September 30, 2003, potential
problem loans totaled $276 million, compared to $212 million at December 31,
2002. The $64 million increase from December 31, 2002 to September 30, 2003, is
primarily attributable to deterioration in certain loans in the commercial
manufacturing sector (accountable for approximately $37 million of the increase)
and real estate development (accountable for approximately $10 million of the
increase).
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 subsidiary banks
are rated by Moody's, Standard and Poor's (S&P), and Fitch. These ratings, along
with the Corporation's other ratings, provide opportunity for greater funding
capacity and funding alternatives.
The parent company manages its liquidity position to provide the funds necessary
to pay dividends to 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 dividends and service fees from subsidiaries, the parent company
has multiple funding sources that could be used to increase liquidity and
provide additional financial flexibility. These sources include a revolving
credit facility, commercial paper, and two shelf registrations. 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
September 30, 2003. In addition, $200 million of commercial paper was available
at September 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 September 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 issued
$200 million in a subordinated note offering, bearing a 6.75% fixed coupon rate
and 10-year maturity. At September 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 September 30, 2003, $1.6 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 and investment portfolio
repayments and maturities, and loan and investment portfolio sales) available to
increase financial flexibility. A $2 billion bank note program associated with
Associated Bank 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 September 30, 2003, $350 million of
long-term bank notes and $200 million of short-term bank notes were outstanding.
At September 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 ($1.0 billion was
outstanding at September 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 nine months ended September 30, 2003, net cash provided from operating
activities was $146.5 million, while investing activities and financing
activities used net cash of $171.6 million and $53.7 million, respectively, for
a net decrease in cash and cash equivalents of $78.8 million since year-end
2002. Generally, during year-to-date 2003, deposit growth was strong, while net
asset growth since year-end 2002 was moderate (up approximately 1% annualized).
Thus, the reliance on other funding sources was reduced, particularly short-term
borrowings. The deposit growth also 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.
For the nine months ended September 30, 2002, net cash provided from operating
and financing activities was $151.8 million and $99.7 million, respectively,
while investing activities used net cash of $337.2 million, for a net decrease
in cash and cash equivalents of $85.7 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 September 30, 2003 increased to $1.3 billion, up $30.3
million compared to September 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
September 30, 2003, included $36.3 million of accumulated other comprehensive
income versus $76.6 million at September 30, 2002. The decrease in accumulated
other comprehensive income was predominantly related to a decrease in unrealized
gains on securities available for sale (due primarily to declines in the market
value of mortgage-related securities) and higher unrealized losses on cash flow
hedges, net of the tax effect. The ratio of stockholders' equity to assets was
8.61% and 8.45% at September 30, 2003 and 2002, respectively.
Stockholders' equity grew $28.8 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 $36.3 million at September 30, 2003. The
decrease in accumulated other comprehensive income was predominantly related to
a decrease in unrealized gains on securities available for sale (due primarily
to declines in the market value of mortgage-related securities) and higher
unrealized losses on cash flow hedges, net of the tax effect. Stockholders'
equity to assets at September 30, 2003 was 8.61%, compared to 8.46% at December
31, 2002.
Cash dividends of $0.99 per share were paid in year-to-date 2003, compared to
$0.90 per share in year-to-date 2002, representing an increase of 10.0%.
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, approximately 1.1 million
shares were repurchased under this authorization, at an average cost of $34.93
per share. Additionally, under one action in 2003 and two separate actions in
2000, the Board of Directors authorized the repurchase and cancellation of the
Corporation's outstanding shares, not to exceed
approximately 11.0 million shares on a combined basis. Under these
authorizations approximately 1.9 million shares were repurchased during
year-to-date 2003, at an average cost of $35.72 per share, while approximately
1.0 million shares were repurchased during year-to-date 2002, at an average cost
of $32.55 per share. At September 30, 2003, approximately 3.9 million remain
authorized to repurchase. The repurchase of shares will be based on market
opportunities, capital levels, growth prospects, and other investment
opportunities.
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 for well-capitalized banks. The Corporation's capital ratios are
summarized in Table 9.
- -------------------------------------------------------------------------------------------------------------------------
TABLE 9
Capital Ratios
(In Thousands, except per share data)
- -------------------------------------------------------------------------------------------------------------------------
Sept. 30, June 30, March 31, Dec. 31, Sept. 30,
2003 2003 2003 2002 2002
- -------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity $1,300,948 $1,318,246 $1,285,866 $1,272,183 $1,270,691
Tier 1 capital 1,189,657 1,177,457 1,180,593 1,165,481 1,147,045
Total capital 1,538,751 1,526,884 1,527,435 1,513,424 1,492,619
Market capitalization 2,774,571 2,699,475 2,388,217 2,521,097 2,366,995
-------------------------------------------------------------------------
Book value per common share $ 17.77 $ 17.88 $ 17.41 $ 17.13 $ 17.03
Cash dividend per common share 0.34 0.34 0.31 0.31 0.31
Stock price at end of period 37.89 36.61 32.33 33.94 31.73
Low closing price for the quarter 37.12 32.15 32.33 27.20 30.64
High closing price for the quarter 38.90 38.41 35.22 34.21 36.96
-------------------------------------------------------------------------
Total equity / assets 8.61% 8.66% 8.52% 8.46% 8.45%
Tier 1 leverage ratio 7.98 7.97 8.06 7.94 8.06
Tier 1 risk-based capital ratio 10.64 10.48 10.64 10.52 10.50
Total risk-based capital ratio 13.76 13.58 13.77 13.66 13.66
-------------------------------------------------------------------------
Shares outstanding (period end) 73,227 73,736 73,870 74,281 74,598
Basic shares outstanding (average) 73,473 73,959 74,252 74,497 75,158
Diluted shares outstanding (average) 74,323 74,683 74,974 75,202 76,047
- -------------------------------------------------------------------------------------------------------------------------
Contractual Obligations, Commitments, Off-Balance Sheet Risk,
and Contingent Liabilities
- -------------------------------------------------------------
The Corporation utilizes a variety of financial instruments in the normal course
of business to meet the financial needs of its customers and to manage its own
exposure to fluctuations in interest rates. These financial instruments include
commitments to extend credit, commitments to originate residential mortgage
loans held for sale, commercial letters of credit, standby letters of credit,
forward commitments to sell residential mortgage loans, 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 Third Quarter Results
- --------------------------------
Net income for third quarter 2003 was $58.4 million, up $4.9 million or 9.2%
from third quarter 2002 net income of $53.5 million. Return on average equity
was 17.75%, up 102 bp from the third quarter of 2002,
while return on average assets increased by 6 bp to 1.53%. See Tables 1 and 10.
Taxable equivalent net interest income for the third quarter of 2003 was $135.1
million, $0.8 million higher than the third quarter of 2002. Volume variances
impacted taxable equivalent net interest income favorably by $7.6 million
(primarily from loan growth), while rate variances were unfavorable by $6.8
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 $701 million to $14.1 billion) was funded
by growth in interest-bearing liabilities (up $496 million to $12.0 billion) and
net free funds (up $205 million, led by average noninterest-bearing demand
deposits, which grew $193 million). Average loans grew $685 million, or 6.8%, to
$10.8 billion, while average investments were relatively unchanged at $3.3
billion (up $16 million) between the comparable third quarter periods. Average
interest-bearing deposits, excluding brokered CDs, were up $445 million with a
shift from money market deposits to interest-bearing demand and savings
deposits. Average brokered CDs were down $100 million between the comparable
third quarter periods as the Corporation continued to use other funding sources.
Wholesale funding increased $151 million to $4.2 billion.
The net interest margin was 3.78% compared to 3.96% for the third quarter of
2002. See Table 2. The 18 bp decline was the net result of a 9 bp reduction in
the interest rate spread (i.e. an 80 bp drop in the earning asset yield, net of
a 71 bp decrease in the average cost of interest-bearing liabilities) and a 9 bp
lower contribution from net free funds. The lower interest rate environment (the
average Fed funds rate for the third quarter of 2003 was 75 bp lower than the
third 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 90 bp). On the funding
side, total interest-bearing deposits cost 1.56% on average for third quarter
2003, down 55 bp from the comparable quarter in 2002, with the rate on wholesale
funding down 100 bp.
The provision for loan losses for the third quarter of 2003 was $12.1 million,
down slightly from the third quarter of 2002 of $12.8 million. The allowance for
loan losses to loans at September 30, 2003 was 1.71% compared to 1.54% at
September 30, 2002. Net charge offs were $8.3 million for the three months ended
September 30, 2003 and $6.3 million for the comparable period in 2002.
Annualized net charge offs as a percent of average loans for third quarter were
0.31% versus 0.25% for the comparable quarter of 2002. Total nonperforming loans
were $125.2 million, up from $100.3 million at September 30, 2002. See Tables 6
and 8 and discussion under sections "Allowance for Loan Losses," and
"Nonperforming Loans and Other Real Estate Owned."
Noninterest income was $63.9 million for the third quarter of 2003, compared to
$58.7 million in the comparable quarter of 2002 (see Table 4). The $5.2 million
increase was primarily attributable to mortgage banking income, retail
commissions and service charges on deposit accounts, partially offset by a
decrease in credit card and other nondeposit fees. Mortgage banking income was
up $3.2 million, primarily due to an increase in secondary mortgage loan
production ($1.4 billion for the third quarter of 2003 versus $0.9 billion for
the third quarter of 2002), resulting in higher gains on the sale of mortgage
loans (up $2.1 million) and increased volume-related fees (up $1.2 million).
Retail commissions were up $3.2 million, with insurance commissions up $2.8
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) and lower fixed annuities commissions. Service
charges on deposit accounts increased $1.1 million, a result of both higher
volumes (attributable to the large account base) and higher business service
charges (due to lower earnings credits). Credit card and other nondeposit fees
decreased $1.6 million, primarily impacted by the sale of the credit card
merchant processing in first quarter 2003.
Noninterest expense for the third quarter of 2003 declined slightly to $97.8
million, compared to $98.2 million for the third quarter of 2002 (see Table 5),
reflecting lower costs associated with mortgage servicing
rights, net of increases attributable to the company's larger operating base.
Mortgage servicing rights expense was down $9.2 million, primarily due to the
change in the valuation allowance ($10.2 million was added to the valuation
allowance during the third quarter of 2002 versus none in the third quarter of
2003). The $2.2 million decrease in loan expense was primarily due to lower
merchant processing costs, given the sale of the merchant processing during
first quarter 2003. Personnel expense increased $7.2 million (with increases of
$6.0 million in salary-related expenses and $1.2 million in fringe benefits),
particularly attributable to the CFG acquisition and annual merit increases
between the periods. Other expense was up $2.1 million, due principally to
increased consultant fees, loan collection and foreclosure expenses. Data
processing costs increased $0.9 million due to processing for a larger base
operation and technology conversions.
Income taxes were up $2.1 million between comparable quarters, due to the
increase in income before tax. The effective tax rate was relatively unchanged,
at 29.6% for both the third quarter of 2003 and 2002.
Sequential Quarter Results
- --------------------------
Net income for the third quarter of 2003 was $58.4 million, up $1.7 million or
3.0% from second quarter 2003 net income of $56.7 million. Return on average
equity was 17.75%, up 38 bp from the second quarter of 2003, while return on
average assets increased 2 bp to 1.53%. See Tables 1 and 10. At September 30,
2003, total assets were $15.1 billion, a decrease of $105 million, or 0.7%,
since June 30, 2003. The change in assets occurred primarily in loans, which
declined $98 million between the sequential quarters, including an $82 million
decrease in commercial loans and a $20 million decline in residential real
estate. Since June 30, 2003, total deposits grew $182 million (primarily in
interest-bearing demand deposits), while wholesale funding was down $241
million.
- -------------------------------------------------------------------------------------------------------------------------
TABLE 10
Selected Quarterly Information
($ in Thousands)
- -------------------------------------------------------------------------------------------------------------------------
For the Quarter Ended
----------------------------------------------------------------------------
Sept. 30, June 30, March 31, Dec. 31, Sept. 30,
2003 2003 2003 2002 2002
- -------------------------------------------------------------------------------------------------------------------------
Summary of Operations:
Net interest income $ 128,976 $ 127,195 $ 127,454 $ 129,713 $ 128,358
Provision for loan losses 12,118 12,132 12,960 14,614 12,831
Noninterest income 63,888 70,160 65,209 64,349 58,656
Noninterest expense 97,771 103,919 98,157 102,763 98,183
Income taxes 24,589 24,635 23,553 23,244 22,528
------------------------------------------------------------------------
Net income $ 58,386 $ 56,669 $ 57,993 $ 53,441 $ 53,472
========================================================================
Taxable equivalent net interest income $ 135,141 $ 133,426 $ 133,731 $ 135,694 $ 134,349
Net interest margin 3.78% 3.79% 3.87% 3.87% 3.96%
Average Balances:
Assets $15,152,676 $15,016,497 $14,867,339 $14,901,747 $14,460,358
Earning assets 14,128,702 13,991,615 13,836,102 13,870,491 13,427,986
Interest-bearing liabilities 11,955,420 11,941,877 11,886,642 11,792,552 11,459,673
Loans 10,813,769 10,743,430 10,578,430 10,559,154 10,128,826
Deposits 9,485,000 9,121,204 8,901,441 8,934,668 8,947,047
Stockholders' equity 1,304,983 1,308,505 1,280,950 1,275,914 1,268,355
Asset Quality Data:
Allowance for loan losses to total loans 1.71% 1.66% 1.66% 1.58% 1.54%
Nonperforming loans to total loans 1.22 1.13 0.92 0.96 0.99
Nonperforming assets to total assets 0.87 0.87 0.71 0.74 0.69
Net charge offs to average loans
(annualized) 0.31 0.38 0.20 0.28 0.25
- -------------------------------------------------------------------------------------------------------------------------
Taxable equivalent net interest income for the third quarter of 2003 was $135.1
million, $1.7 million higher than second quarter 2003. Volume variances impacted
taxable equivalent net interest income favorably by $3.1 million (primarily from
loan growth), as did the day variance between the quarters ($0.8 million
favorable), while rate variances were unfavorable by $2.2 million (primarily
from unfavorable rate
variance on earning assets exceeding favorable rate variance on interest-bearing
liabilities). The net interest margin between the third and second quarters of
2003 was down 1 bp, due to a lower interest rate spread (i.e. a 15 bp drop in
the earning asset yield, net of a 14 bp decrease in the average cost of
interest-bearing liabilities). Average earning assets increased $137 million
(3.9% annualized) between the sequential quarters, attributable to a $70 million
increase in average loans (the net of a $94 million increase in commercial loans
and a $24 million combined decrease in residential real estate and consumer
loans) and a $67 million increase in average investments. The earning asset
growth was funded primarily by growth in net free funds (up $124 million, led by
increased average demand deposits which grew $138 million). While average
interest-bearing liabilities were up $14 million, there was a notable shift from
wholesale funding to interest-bearing deposits. Interest-bearing deposits were
up $226 million (primarily in interest-bearing demand deposits), while wholesale
funding was down $212 million (principally in short-term borrowings).
The provision for loan losses for the third quarter of 2003 was $12.1 million,
unchanged from $12.1 million for the second quarter 2003. See Table 10. The
allowance for loan losses to loans was 1.71% at September 30, 2003, compared to
1.66% at June 30, 2003. Net charge offs were $8.3 million for third quarter
2003, compared to $10.1 million for second quarter 2003. Annualized net charge
offs as a percent of average loans for third quarter were 0.31% versus 0.38% for
second quarter 2003. Total nonperforming loans were $125.2 million, up from
$117.2 million at June 30, 2003, primarily in accruing loans past due 90 or more
days (particularly attributable to the two large commercial credits with
specific circumstances). See discussion under sections "Allowance for Loan
Losses," and "Nonperforming Loans and Other Real Estate Owned."
Noninterest income decreased $6.3 million to $63.9 million between sequential
quarters, attributable principally to mortgage banking income. Mortgage banking
income decreased $5.2 million versus the previous quarter. While secondary
mortgage production was strong ($1.4 billion in third quarter 2003 compared to
$1.2 billion in second quarter 2003), gains on the sales of loans were down $5.1
million due to lower net margins on sales and a reduction in the fair value of
the mortgage derivatives. Other noninterest income was down $1.5 million due to
the second quarter $1.5 million gain on the sale of out-of-market credit card
accounts.
On a sequential quarter basis, noninterest expense decreased $6.1 million, led
by an $8.8 million decrease in mortgage servicing rights expense. Prepayment
speeds in the servicing portfolio slowed considerably in the third quarter of
2003; as a result, no additional valuation allowance was required in third
quarter 2003 compared to $8.5 million of additional valuation allowance provided
during second quarter 2003. Personnel expense was up $1.6 million over the
previous quarter, predominantly in production-related incentives and temporary
help. Data processing costs increased $0.7 million due to higher volume charges
and conversion-related costs.
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 October 22, 2003, the Board of Directors declared a $0.34 per share dividend
payable on November 17, 2003, to shareholders of record as of November 3, 2003.
This cash dividend has not been reflected in the accompanying consolidated
financial statements.
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.
ASSOCIATED BANC-CORP
PART II - OTHER INFORMATION
ITEM 6: Exhibits and Reports on Form 8-K
(a) Exhibits:
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 August 12, 2003, was filed under Item
12, Results of Operations and Financial Condition,
reporting Associated Banc-Corp released its earnings for the
quarter ended June 30, 2003.
A report on Form 8-K dated August 12, 2003, was filed under
Item 5, Other Events, announcing the Associated Banc-Corp
Board of Directors declared its second quarter dividend and
announced the repurchase of up to 5% of the Corporation's
outstanding shares, or approximately 3.7 million shares.
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: November 11, 2003 /s/ Paul S. Beideman
--------------------------------------
Paul S. Beideman
President and Chief Executive Officer
Date: November 11, 2003 /s/ Joseph B. Selner
--------------------------------------
Joseph B. Selner
Chief Financial Officer