- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 --------------------- FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934 For the transition period to COMMISSION FILE NUMBER: 0-5519 ASSOCIATED BANC-CORP (Exact name of registrant as specified in its charter) WISCONSIN 39-1098068 (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification no.) 112 NORTH ADAMS STREET, 54301 GREEN BAY, WISCONSIN (Zip code) (Address of principal executive offices) Registrant's telephone number, including area code: (920) 433-3166 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT COMMON STOCK, PAR VALUE--$0.01 PER SHARE (TITLE OF CLASS) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K ((S)229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of March 2, 1998, 50,685,915 shares of Common Stock were outstanding and the aggregate market value of the voting stock held by nonaffiliates of the Registrant was $2,469,894,362. Excludes $124,717,627 of market value representing the outstanding shares of the Registrant owned by all directors and officers who individually, in certain cases, or collectively, may be deemed affiliates. Includes $221,183,339 of market value representing 8.52% of the outstanding shares of the Registrant held in a fiduciary capacity by the trust departments of four wholly-owned subsidiaries of the Registrant. DOCUMENTS INCORPORATED BY REFERENCE Part of Form 10-K Into Which Document Portions of Documents are Incorporated Proxy Statement for Annual Meeting of Part III Shareholders on April 22, 1998 - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
ASSOCIATED BANC-CORP 1997 FORM 10-K TABLE OF CONTENTS <TABLE> <CAPTION> PAGE ---- <C> <S> <C> PART I Item 1. Business 3 Item 2. Properties 6 Item 3. Legal Proceedings 6 Item 4. Submission of Matters to a Vote of Security Holders 6 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 8 Item 6. Selected Financial Data 9 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 8. Financial Statements and Supplementary Data 35 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 69 PART III Item 10. Directors and Executive Officers of the Registrant 69 Item 11. Executive Compensation 69 Item 12. Security Ownership of Certain Beneficial Owners and Management 69 Item 13. Certain Relationships and Related Transactions 69 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 70 Signatures 72 </TABLE> 2
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS Forward-looking statements have been made in this document, and in documents that are incorporated by reference, that are subject to risks and uncertainties. These forward-looking statements, which are included in Management's Discussion and Analysis and in the Chairman's letter, describe future plans or strategies and include the Corporation's expectations of future results of operations. The words "believes," "expects," "anticipates" or similar expressions identify forward-looking statements. Shareholders should note that many factors, some of which are discussed elsewhere in this document and in the documents that are incorporated by reference, could affect the future financial results of the Corporation and could cause those results to differ materially from those expressed in forward-looking statements contained or incorporated by reference in this document. These factors include the following: . operating, legal and regulatory risks; . economic, political and competitive forces affecting the Corporation's banking, securities, asset management and credit services businesses; and . the risk that the Corporation's analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful. These factors should be considered in evaluating the forward-looking statements, and undue reliance should not be placed on such statements. PART I ITEM 1 BUSINESS GENERAL Associated Banc-Corp (the "Corporation") is a bank holding company registered pursuant to the Bank Holding Company Act of 1956, as amended (the "Act"). It was incorporated in Wisconsin in 1964 and was inactive until 1969 when permission was received from the Board of Governors of the Federal Reserve System to acquire three banks. The Corporation currently owns twelve commercial banks and a federally chartered thrift located in Wisconsin and Illinois (the "affiliates") serving their local communities and, measured by total assets held at December 31, 1997, was the third largest commercial bank holding company headquartered in Wisconsin. As of December 31, 1997, the Corporation owned 34 nonbanking subsidiaries located in Arizona, California, Delaware, Illinois, Missouri, Nevada, and Wisconsin. The Corporation acquired Centra Financial, Inc., and its wholly owned subsidiary, Central Bank of West Allis, and its wholly owned subsidiary, Central Investments, Inc., on February 21, 1997. Further, the Corporation, through a subsidiary, Badger Merger Corp., merged with First Financial Corporation ("FFC") and its wholly owned subsidiary, First Financial Bank ("FFB"), and its wholly owned subsidiaries, Appraisal Services, Inc., First Financial Card Services Bank, National Association, Wisconsin Insurance Management, Inc., FFS Funding Corp., UFS Capital Corp., Illini Service Corporation, Mortgage Finance Corporation, and First Financial Investments, Inc. on October 29, 1997. SERVICES The Corporation provides advice and specialized services to its affiliates in banking policy and operations, including auditing, data processing, marketing/advertising, investing, legal/compliance, personnel services, trust services, risk management, and other financial services functionally related to banking. Responsibility for the management of the affiliates remains with their respective Boards of Directors and officers. Services rendered to the affiliates by the Corporation are intended to assist the local management of these affiliates to expand the scope of services offered by them. Bank and thrift affiliates of the Corporation at December 31, 1997, provided services through 226 locations in 150 communities. The Corporation, through its affiliates, provides a complete range of banking services to individuals and businesses. These services include checking, savings, NOW, Super NOW, and money market deposit 3
accounts, business, personal, educational, residential, and commercial mortgage loans, MasterCard, VISA and other consumer-oriented financial services, including IRA and Keogh accounts, safe deposit and night depository facilities. Automated Teller Machines (ATMs), which provide 24-hour banking services to customers of the affiliates, are installed in many locations in the affiliates' service areas. The affiliates are members of an interstate shared ATM network, which allows their customers to perform banking transactions from their checking, savings or credit card accounts at ATMs in a multi-state environment. Among the services designed specifically to meet the needs of businesses are various types of specialized financing, cash management services and transfer/collection facilities. The affiliates provide lending, depository, and related financial services to commercial, industrial, financial, and governmental customers. Term loans, revolving credit arrangements, letters of credit, inventory and accounts receivable financing, real estate construction lending, and international banking services are available. Additional emphasis is given to noncredit services for commercial customers, such as advice and assistance in the placement of securities, corporate cash management, and financial planning. The affiliates make available check clearing, safekeeping, loan participations, lines of credit, portfolio analyses, data processing, and other services to approximately 150 correspondent financial institutions. Four of the affiliates and a trust company subsidiary offer a wide variety of fiduciary, investment management, advisory, and corporate agency services to individuals, corporations, charitable trusts, foundations, and institutional investors. They also administer (as trustee and in other fiduciary and representative capacities) pension, profit sharing and other employee benefit plans, and personal trusts and estates. Investment subsidiaries provide discount and full-service brokerage services, including the sale of fixed and variable annuities, mutual funds, and securities, to the affiliates' customers and the general public. Insurance brokerage subsidiaries provide commercial and individual insurance services, including various life, property, casualty, credit, and mortgage products to the affiliates' customers and the general public. Several investment subsidiaries located in Nevada hold, manage, and trade cash, stocks, and securities transferred from the affiliates and reinvest investment income. A leasing subsidiary provides lease financing for a variety of capital equipment for commerce and industry. An appraisal subsidiary provides real estate appraisals for customers, government agencies, and the general public. The mortgage banking subsidiaries are involved in the origination, servicing and warehousing of mortgage loans, and the sale of such loans to investors. The primary focus is on one- to four-family residential and multi-family properties, all of which are generally salable into the secondary mortgage market. The Corporation and affiliates are not dependent upon a single or a few customers, the loss of which would have a material adverse effect on the Corporation. No material portion of the Corporation's or the affiliates' business is seasonal. FOREIGN OPERATIONS The Corporation and its affiliates do not engage in any operations in foreign countries. EMPLOYEES At December 31, 1997, the Corporation, its affiliates, and its subsidiaries, as a group, had 3,679 full-time equivalent employees. COMPETITION Competition exists in all of the Corporation's principal markets. Competition involves efforts to obtain new deposits, the scope and type of services offered, interest rates paid on deposits and charged on loans, as well as other aspects of banking. Substantial competition exists from other financial institutions engaged in the business of making loans, accepting deposits, and issuing credit cards. All of the affiliates also face direct competition from members of bank holding company systems that have greater assets and resources than those of the Corporation. 4
SUPERVISION AND REGULATION Financial institutions are highly regulated both at the federal and state level. Numerous statutes and regulations affect the business of the Corporation and its affiliates. The activities of the Corporation are regulated by the Act. The Act requires prior approval of the Federal Reserve Board (the "Board") before acquiring direct or indirect ownership or control of more than five percent of the voting shares of any bank or bank holding company. The Riegel-Neal Interstate Banking and Branching Efficiency Act of 1994 contains provisions which amended the Act to allow an adequately-capitalized and adequately-managed bank holding company to acquire a bank located in another state as of September 29, 1995. Effective June 1, 1997, interstate branching was permitted. The Riegel-Neal Amendments Act of 1997 clarifies the applicability of host state laws to any branch in such state of an out-of-state bank. The Act also prohibits, with certain exceptions, acquisitions of more than five percent of the voting shares of any publicly traded company which is not a bank and the conduct by a holding company (directly or through its subsidiaries) of any business other than banking or performing services for its subsidiaries without prior approval of the Board. All of the affiliates are insured by the Federal Deposit Insurance Corporation and are subject to the provisions of the Federal Deposit Insurance Act. Areas subject to regulation by federal and state authorities include capital adequacy, reserves, investments, loans, mergers, issuance of securities, payments of dividends by the banking affiliates, establishment of branches, and other aspects of banking operations. The FDIC Board of Directors voted December 11, 1996 to finalize a rule lowering the rates on assessments paid to the Savings Association Insurance Fund ("SAIF"), effective as of October 1, 1996. As a result of the special assessment required by the Deposit Insurance Funds Act of 1996 ("Funds Act"), the SAIF was capitalized at the target Designated Reserve Ratio ("DRR") of 1.25% of estimated insured deposits on October 1, 1996. The Funds Act required the FDIC to set assessments in order to maintain the target DRR. The Board has, therefore, lowered the rates on assessments paid to the SAIF, while simultaneously widening the spread between the lowest and highest rates to improve the effectiveness of the FDIC's risk-based premium system. The Board has also established a process, similar to that which was applied to the Bank Insurance Fund ("BIF"), for adjusting the rate schedules for both the SAIF and the BIF within a limited range, without notice and comment to maintain each of the fund balances at the target DRR. The Funds Act also separated, effective January 1, 1997, the Financing Corporation ("FICO") assessment to service the interest on its bond obligations from the SAIF assessment. The amount assessed on individual institutions by the FICO will be in addition to the amount paid for deposit insurance according to the FDIC's risk-related assessment rate schedules. GOVERNMENT MONETARY POLICIES AND ECONOMIC CONTROLS The earnings and growth of the banking industry and the banking affiliates of the Corporation are affected by the credit policies of monetary authorities, including the Federal Reserve System. An important function of the Federal Reserve System is to regulate the national supply of bank credit in order to combat recession and curb inflationary pressures. Among the instruments of monetary policy used by the Federal Reserve to implement these objectives are open market operations in U.S. government securities, changes in reserve requirements against member bank deposits and changes in the Federal Reserve discount rate. These means are used in varying combinations to influence overall growth of bank loans, investments and deposits, and may also affect interest rates charged on loans or paid for deposits. The monetary policies of the Federal Reserve authorities have had a significant effect on the operating results of commercial banks in the past and are expected to continue to have such an effect in the future. In view of changing conditions in the national economy and in the money markets, as well as the effect of credit policies by monetary and fiscal authorities, including the Federal Reserve System, no prediction can be made as to possible future changes in interest rates, deposit levels and loan demand, or their effect on the business and earnings of the Corporation and its affiliates. 5
ITEM 2 PROPERTIES The Corporation's headquarters are located in the City of Green Bay, Wisconsin, in a leased facility with approximately 8,500 square feet of office space owned by an affiliated company. The space is currently leased on a month-to-month basis. The Corporation, as of December 31, 1997, was engaged in negotiations to lease approximately 30,000 square feet of office space in buildings yet to be constructed in the Village of Ashwaubenon to accommodate the corporate staff and support functions. The Corporation expects to occupy substantially all of the office space under construction in July 1998. The affiliates, as of December 31, 1997, occupied 226 offices in 150 different communities within Wisconsin and Illinois. All key facilities, except Associated Bank Milwaukee and Associated Bank Chicago, are owned by the affiliates. Except for the affiliate offices in downtown Milwaukee and Chicago, which are located in the lobbies of multi-story office buildings, all of the banking facilities are free-standing buildings that provide adequate customer parking facilities, including drive-in facilities of various numbers and types for customer convenience. Some banks also have offices in various supermarket locations as well as offices located within retirement community facilities. In addition, the Corporation owns other real property that, when considered in the aggregate, is not material to its financial position. ITEM 3 LEGAL PROCEEDINGS There are legal proceedings pending against certain subsidiaries of the Corporation in the ordinary course of their business. Although litigation is subject to many uncertainties and the ultimate exposure with respect to these matters cannot be ascertained, management believes, based upon discussions with counsel, that the Corporation has meritorious defenses, and any ultimate liability would not have a material adverse affect on the consolidated financial position of the Corporation. ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS During the fourth quarter of 1997, shareholders of Associated were asked to consider an amendment to Associateds Articles of Incorporation to increase the number of authorized shares of Associated common stock to 100,000,000 shares and to issue up to 28,627,148 shares of common stock of Associated pursuant to an Agreement and Plan of Merger, dated as of May 14, 1997, among Associated, Badger Merger Corp., and FFC. At a Special Meeting of Shareholders held on October 27, 1997, Associated shareholders approved the above matters. EXECUTIVE OFFICERS OF THE CORPORATION Pursuant to General Instruction G of Form 10-K, the following list is included as an unnumbered item in Part I of this report in lieu of being included in the Proxy Statement for the Annual Meeting of Stockholders to be held April 22, 1998. 6
The following is a list of names and ages of executive officers of the Corporation and affiliates indicating all positions and offices held by each such person and each such person's principal occupation(s) or employment during the past five years. The Date of Election refers to the date the person was first elected an officer of the Corporation or its affiliates. Officers are appointed annually by the Board of Directors at the meeting of directors immediately following the Annual Meeting of Shareholders. There are no family relationships among these officers nor any arrangement or understanding between any officer and any other person pursuant to which the officer was selected. No person other than those listed below has been chosen to become an Executive Officer of the Corporation. <TABLE> <CAPTION> NAME OFFICES AND POSITIONS HELD DATE OF ELECTION <C> <S> <C> Harry B. Conlon Chairman, President, Chief Executive March 1, 1975 Age: 62 Officer and Director of Associated Banc-Corp Robert C. Gallagher Vice Chairman of Associated Banc-Corp; April 28, 1982 Age: 59 Chairman and Chief Executive Officer of Associated Bank Green Bay (affiliate) Prior to April 1996, Executive Vice President and Director of Associated Banc-Corp; Chairman, President and Chief Executive Officer of Associated Bank Green Bay (affiliate) John C. Seramur Vice Chairman of Associated Banc-Corp; October 27, 1997 Age: 55 President and Chief Executive Officer of First Financial Bank (affiliate) Prior to October 1997, President and Chief Executive Officer of First Financial Corporation and President and Chief Executive Officer of First Financial Bank Brian R. Bodager Chief Administrative Officer, General July 22, 1992 Age: 42 Counsel and Corporate Secretary of Associated Banc-Corp Joseph B. Selner Senior Vice President and Chief January 25, 1978 Age: 51 Financial Officer of Associated Banc- Corp Arthur E. Olsen, III Vice President-General Auditor of July 28, 1993 Age: 46 Associated Banc-Corp Prior to July 1993, Senior manager of a national public accounting firm Mary Ann Bamber Senior Vice President-Director of January 22, 1997 Age: 47 Retail Banking of Associated Banc-Corp From January 1996 to January 1997, Independent consultant From January 1996 to January 1997, Senior Officer of an Iowa-based bank Prior to January 1996, Senior Officer of a Minnesota-based holding company Robert J. Johnson Vice President-Director of Human January 22, 1997 Age: 52 Resources of Associated Banc-Corp Prior to January 1997, Officer of a Wisconsin manufacturing company Donald E. Peters Director of Systems and Operations of October 27, 1997 Age: 48 Associated Banc-Corp; Executive Vice President of First Financial Bank (affiliate) Prior to October 1997, Executive Vice President of First Financial Bank (affiliate) John P. Evans Chief Executive Officer and Director August 16, 1993 Age: 48 of Associated Bank North (affiliate) Prior to July 1993, Officer of a Wisconsin bank David J. Handy President, Chief Executive Officer and May 31, 1991 Age: 58 Director of Associated Bank, National Association (affiliate) </TABLE> 7
<TABLE> <CAPTION> NAME OFFICES AND POSITIONS HELD DATE OF ELECTION <C> <S> <C> Michael B. Mahlik Executive Vice President, Managing January 1, 1991 Age: 45 Trust Officer, and Director of Associated Bank, National Association (affiliate); President, Chief Executive Officer, and Director of Associated Trust Company (subsidiary) George J. McCarthy President, Chief Executive Officer, November 11, 1983 Age: 47 and Director of Associated Bank Chicago (affiliate) Mark J. McMullen Executive Vice President and Director June 2, 1981 Age: 49 of Associated Bank Green Bay (affiliate) Randall J. Peterson President and Director of Associated August 2, 1982 Age: 52 Bank Green Bay (affiliate) Prior to July 1996, Executive Vice President and Director of Associated Bank Green Bay (affiliate) Gary L. Schaefer President and Director of Associated March 1, 1995 Age: 48 Bank Madison (affiliate) Prior to March 1995, Senior Officer of a Wisconsin bank Thomas R. Walsh President, Chief Executive Officer, January 1, 1994 Age: 40 and Director of Associated Bank Lakeshore (affiliate) From September 1992 to January 1994, Senior Officer of Associated Bank Lakeshore (affiliate) Gordon J. Weber President, Chief Executive Officer and December 15, 1993 Age: 50 Director of Associated Bank Milwaukee (affiliate); Director of Associated Bank Madison (affiliate) Prior to December 15, 1993, President, Chief Executive Officer and Director of Associated Bank Lakeshore (affiliate) </TABLE> PART II ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Information in response to this item is incorporated by reference to the table "Market Information" on Page 64 and the discussion of dividend restrictions in Note 11 "Stockholders' Equity" of the Notes to Consolidated Financial Statements included under Item 8 of this document. The Corporation's common stock is currently being traded on The Nasdaq Stock Market under the symbol ASBC. The approximate number of equity security holders of record of common stock, $.01 par value, as of March 1, 1998, was 10,480. Certain of the Corporation's shares are held in "nominee" or "street" name and, accordingly, the number of beneficial owners of such shares is not known nor included in the foregoing number. Payment of future dividends is within the discretion of the Corporation's Board of Directors and will depend, among other factors, on earnings, capital requirements, and the operating and financial condition of the Corporation. At the present time, the Corporation expects that dividends will continue to be paid in the future. 8
ITEM 6 SELECTED FINANCIAL DATA TABLE 1: EARNINGS SUMMARY AND SELECTED FINANCIAL DATA(1) <TABLE> <CAPTION> % CHANGE 5-YEAR 1996 COMPOUND TO GROWTH YEARS ENDED DECEMBER 31, 1997 1997 1996 1995 1994 1993 1992 RATE - -------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Interest income $ 787,244 7.7 $ 731,197 $ 696,858 $ 613,725 $ 586,567 $ 562,885 6.9% Interest expense 411,637 9.5 375,923 360,499 292,735 287,587 306,535 6.1 --------------------------------------------------------------------------------------- Net interest income 375,607 5.7 355,274 336,359 320,990 298,980 256,350 7.9 Less: Provision for possible loan losses 31,668 131.2 13,695 14,029 9,035 16,441 26,486 3.6 --------------------------------------------------------------------------------------- Net interest income after provision for possible loan losses 343,939 .7 341,579 322,330 311,955 282,539 229,864 8.4 --------------------------------------------------------------------------------------- Plus: Noninterest income 95,976 (17.9) 116,845 104,989 84,155 95,713 87,096 2.0 Less: Noninterest expense 323,647 10.4 293,235 252,927 245,310 240,318 222,453 7.8 --------------------------------------------------------------------------------------- Net noninterest expense 227,671 29.1 176,390 147,938 161,155 144,605 135,357 11.0 --------------------------------------------------------------------------------------- Income before income taxes and extraordinary item/cumulative effect of an accounting change 116,268 (29.6) 165,189 174,392 150,800 137,934 94,507 4.2 Income tax expense 63,909 11.2 57,487 62,381 54,203 49,311 32,019 14.8 Extraordinary item -- N/M (686) -- -- -- 1,006 N/M Cumulative effect of an accounting change -- N/M -- -- -- -- 6,600 N/M --------------------------------------------------------------------------------------- NET INCOME $ 52,359 (51.1) $ 107,016 $ 112,011 $ 96,597 $ 88,623 $ 70,094 (5.7) ======================================================================================= Basic earnings per share(2) Income before extraordinary item/cumulative effect of an accounting change $ 1.04 (51.1) $ 2.13 $ 2.28 $ 1.99 $ 1.88 $ 1.45 (6.4)% Net income $ 1.04 (50.8) $ 2.12 $ 2.28 $ 1.99 $ 1.88 $ 1.62 (8.5) Diluted earnings per share(2) Income before extraordinary item/cumulative effect of an accounting change $ 1.02 (51.0) $ 2.09 $ 2.24 $ 1.94 $ 1.80 $ 1.43 (6.4) Net income $ 1.02 (50.7) $ 2.08 $ 2.24 $ 1.94 $ 1.80 $ 1.60 (8.6) Cash dividends per share(2) $ 1.11 16.8 $ .95 $ .81 $ .71 $ .62 $ .51 16.8 Weighted average shares outstanding Basic 50,307 (.5) 50,564 49,109 48,598 47,204 43,173 3.1 Diluted 51,148 (.7) 51,504 49,978 49,715 49,214 43,762 3.2 SELECTED FINANCIAL DATA Year-End Balance: Loans (including loans held for sale) $7,190,577 7.3 $ 6,700,847 $6,418,683 $5,995,964 $5,380,082 $4,576,015 9.5% Allowance for possible loan losses 92,731 29.2 71,767 68,560 65,774 63,415 54,797 11.1 Investment securities 2,940,218 6.8 2,753,938 2,266,895 2,499,380 2,433,963 2,217,845 5.8 Assets 10,691,439 5.6 10,123,383 9,393,609 9,130,522 8,448,468 7,486,104 7.4 Deposits 8,364,137 5.1 7,959,298 7,570,201 7,334,240 7,063,481 6,239,654 6.0 Long-term borrowings 15,270 (54.2) 33,329 36,907 94,537 250,402 184,494 (39.2) Stockholders' equity 813,693 1.3 803,562 725,211 626,591 560,722 475,546 11.3 Stockholders' equity per share(2) 16.15 .9 16.01 14.69 12.84 11.89 10.21 9.6 --------------------------------------------------------------------------------------- Average for the Year: Loans (including loans held for sale) $ 6,962,820 5.7 $ 6,586,639 $6,157,655 $5,636,601 $5,136,319 $4,307,117 10.1% Investment securities 2,905,948 15.1 2,523,757 2,421,379 2,536,133 2,444,255 2,009,672 7.7 Assets 10,395,615 7.8 9,643,657 9,123,981 8,737,231 8,228,145 7,159,118 7.7 Deposits 8,122,011 4.4 7,778,257 7,409,409 7,191,053 6,927,867 6,173,058 5.6 Stockholders' equity 839,859 8.3 775,180 674,368 596,365 511,737 431,204 14.3 --------------------------------------------------------------------------------------- Financial Ratios: Return on average equity(3) 16.93% 16.64% 17.21% 16.20% 17.32% 16.26% Return on average assets(3) 1.37 1.34 1.27 1.11 1.08 0.98 Net interest margin (tax-equivalent) 3.85 3.95 3.95 3.93 3.91 3.91 Average equity to average assets 8.08 8.04 7.39 6.83 6.22 6.02 Dividend payout ratio(3)(4) 39.27 37.24 34.28 35.72 33.02 31.41 ======================================================================================= </TABLE> (1) All financial data adjusted retroactively for certain acquisitions accounted for using the pooling-of-interests method. (2) Per share data adjusted retroactively for stock splits and stock dividends. (3) Ratio is based upon income prior to merger integration and other one-time charges, extraordinary items or cumulative effects of an accounting change. (4) Ratio is based upon basic earnings per share. N/M = not meaningful 9
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion is management's analysis of the consolidated financial condition and results of operations of the Corporation, which may not otherwise be apparent from the consolidated financial statements included in this report. Reference should be made to the consolidated financial statements and the selected financial data presented elsewhere in this report for an understanding of the following discussion and analysis. PERFORMANCE SUMMARY The following management's discussion and analysis will focus upon "operating earnings" of the Corporation for the past three years. To arrive at operating earnings, reported results for these periods were adjusted by the following: . 1997 operating earnings exclude the merger, integration and other one- time charges recorded by the Corporation in conjunction with the merger of FFC of $103.7 million, or $89.8 million after-tax. This pre-tax charge includes a $35.3 million adjustment to securities for other than temporary impairment of value, $16.8 million of conforming provision for loan losses, and $51.6 million of merger, integration and other one-time charges. The $51.6 million of merger, integration and other one-time charges includes $12.6 million for employee and director severance and contract costs, $20.2 million for costs associated with elimination of duplicative facilities, computer systems, software and integration, and $11.2 million for investment banking, legal and accounting fees and $7.7 million for other one-time charges. These charges reduced basic earnings per share by $1.79 and diluted earnings per share by $1.76. . 1996 operating earnings exclude a one-time pre-tax charge of $28.8 million associated with the recapitalization of the Savings Association Insurance Fund and a one-time pre-tax charge of $4.2 million relating to a change in accounting for the amortization of goodwill and other intangible assets and an extraordinary after-tax charge of $686,000 resulting from the costs associated with the early redemption of subordinated notes (all recorded at FFC). These charges, $22.7 million after-tax, reduced basic earnings per share by $0.44 and diluted earnings per share by $0.42. . 1995 operating earnings exclude a one-time pre-tax charge of $6.5 million relating to acquisition-related expenses incurred relative to the acquisition of FirstRock Bancorp, Inc. by FFC. The $6.5 million of merger, integration and other one-time charges include $3.8 million for employee and director severance and contract costs, $740,000 for costs associated with duplicative facilities, computer systems, software and integration, $1.0 million for investment banking, legal and accounting fees and $870,000 for other charges. These charges, $4.0 million after- tax, reduced basic earnings per share by $0.08 and diluted earnings per share by $0.08. Performance ratios for these periods are also calculated excluding these items. The Corporation achieved record operating earnings in 1997. Operating net income grew to $142.2 million, a 9.6% increase over the $129.7 million earned in 1996. This follows an 11.7% increase over operating net income of $116.0 million in 1995. Basic operating earnings per share increased to $2.83 per share in 1997 compared to $2.56 and $2.36 per share in 1996 and 1995, respectively. The 10.5% increase over 1996 basic operating earnings per share followed an 8.5% increase in 1996 over 1995. On a diluted operating earnings per share basis, the Corporation recorded $2.78 per share in 1997, compared to $2.52 and $2.32 per share in 1996 and 1995, respectively. The presentation of basic and diluted earnings per share on the consolidated statements of income is in accordance with the Corporation's adoption of Statement of Financial Accounting Standards (SFAS) No. 128 "Earnings Per Share." Under the provisions of SFAS No. 128, primary and fully diluted earnings per share reporting were replaced with basic and diluted earnings per share. 10
The improvement in the Corporation's 1997 operating net income was led by a $20.6 million increase in fully-taxable equivalent ("FTE") net interest income. Growth in earning assets of $762 million more than offset a 10 basis point decline in the net interest margin. FTE interest income increased $56.3 million while interest expense increased $35.7 million. Provision for loan losses (excluding the merger-related charges) increased to $14.9 million compared to $13.7 million in 1996. The higher provision was in response to higher volumes of loans in 1997. Net charge-offs decreased to $11.4 million in 1997 compared to $14.0 million in 1996 as the Corporation recorded lower levels of commercial and installment loans to individuals charge-offs. Noninterest income (excluding securities gains and losses) increased to $128.8 million in 1997 over the $127.5 million recorded in 1996. 1996 noninterest income includes a $11.2 million gain on the sale of credit card loans recorded by FFC. The Corporation recorded increases in trust service fees, service charges on deposit accounts, mortgage banking income, loan fees and retail commission income. Noninterest expense (excluding merger, integration and other one-time charges) increased 4.5%, or $11.8 million to $272.0 million in 1997. Increases in salaries and employee benefits, business development and advertising, data processing, and other expenses were offset by a decrease in FDIC premiums. Return on average assets increased in 1997 to 1.37% compared to 1.34% in 1996. Return on average equity increased to 16.93% in 1997 compared to 16.64% in 1996. The Corporation's efficiency ratio remained stable, increasing to 53.33% in 1997 compared to 53.31% in 1996. Cash dividends paid in 1997 increased by 16.8% to $1.11 per share over the $.95 per share paid in 1996. This followed a 17.3% increase in 1996 dividends per share over the $.81 per share paid in 1995. All per share information has been restated to reflect the 6-for-5 stock split declared January 22, 1997, effected in the form of a 20% stock dividend, paid on March 17, 1997 to shareholders of record March 5, 1997. BUSINESS COMBINATIONS On October 29, 1997 the Corporation merged with FFC, parent company of the $6.0 billion FFB. FFB has 128 locations throughout Wisconsin and Illinois. In conjunction with this acquisition, the Corporation issued 27.8 million shares of common stock. This transaction was accounted for as a pooling of interests. All consolidated financial information was restated as if the transaction had been effected as of the beginning of the earliest reporting period. FFC's product mix is primarily retail, with a concentration of real-estate mortgage products (both traditional mortgage products and home equity loans), credit card and student loans funded primarily with retail interest-bearing deposits. Throughout the management's discussion and analysis, the impact of combining FFC's balance sheet with the more traditional commercial banking balance sheet of the Corporation is presented and discussed. On February 21, 1997, the Corporation completed its merger with Centra Financial, Inc., whose principal subsidiary is the $76 million asset Central Bank of West Allis. The number of shares issued totaled 414,365. The transaction was accounted for as a pooling of interests. However, the transaction was not material to prior years' reported operating results and, accordingly, previously reported results were not restated. The bank was subsequently renamed Associated Bank West Allis. In April 1996, the Corporation completed the acquisition of Greater Columbia Bancshares, Inc., parent company of the $211 million asset The First National Bank of Portage. This acquisition was accounted for using the pooling-of- interests method. All consolidated financial information was restated as if the transaction had been effected as of the beginning of the earliest reporting period. The bank was subsequently renamed Associated Bank Portage, National Association. The Corporation also completed two other acquisitions in 1996 that were accounted for using the pooling-of-interests method. However, neither transaction was material to prior years' reported operating results and, accordingly, previously reported prior years' results were not restated. In March 1996, the Corporation completed the acquisition of SBL Capital Bancshares, Inc., parent company of the $68 million asset The 11
State Bank of Lodi. In July 1996, the Corporation completed the acquisition of the $139 million asset F&M Bankshares of Reedsburg, Inc., parent company of Farmers & Merchants Bank. The banks were renamed Associated Bank Lodi and Associated Bank Reedsburg, respectively. In August 1995, the Corporation acquired GN Bancorp, Inc., parent company of the $130 million asset Gladstone-Norwood Trust & Savings Bank in northwest Chicago in a stock for stock merger transaction. The GN Bancorp acquisition was accounted for as a pooling of interests. All consolidated financial information was restated as if the transaction had been effected as of the beginning of the earliest reporting period. The bank was subsequently renamed Associated Bank Gladstone-Norwood. Additionally on July 31, 1996, the Corporation completed the cash acquisition of Mid-America National Bancorp Inc., parent company of the $39 million Mid-America National Bank of Chicago. Mid-America National Bank was subsequently merged into Associated Bank Chicago. This transaction was accounted for as a purchase, and accordingly, the consolidated financial statements include the results of operations since the date of acquisition. In July 1995, the Corporation completed the cash acquisition of Great Northern Mortgage Company, subsequently renamed Associated Great Northern Mortgage Company, a privately owned mortgage company in suburban Chicago. The mortgage company acquisition provided approximately $535 million in mortgage servicing as well as expanding the Corporation's mortgage loan capabilities in Chicago and northeast Illinois. The acquisition was accounted for as a purchase, and accordingly, the consolidated financial statements include the results of operations since the date of acquisition. In February 1995, FFC acquired FirstRock Bancorp, Inc. ("FirstRock") of Rockford, Illinois in a stock-for-stock merger. Upon closing, FirstRock's subsidiary, First Federal Savings Bank, FSB was merged into FFB with First Federal's six offices operating as branch banking offices of FFB. FirstRock was merged into FFC. The transaction was accounted for using the pooling-of- interests method. All consolidated financial information was restated as if the transaction had been effected as of the beginning of the earliest reporting period. PENDING COMBINATION On February 17, 1998 the Corporation announced the signing of a definitive agreement to acquire Citizens Bankshares, Inc. ("Citizens"), parent company of the $164 million Citizens Bank, N.A., with four banking locations in Northeast Wisconsin. The stock-for-stock merger transaction is contingent upon approval of regulatory authorities and the shareholders of Citizens. The transaction, expected to be completed in the second quarter of 1998, will be accounted for using the pooling-of-interests method. However, the transaction is not expected to be material to prior years' reported operating results and, accordingly, previously reported results will not be restated. NET INTEREST INCOME Net interest income continues to be the largest component of the Corporation's operating income (net interest income plus noninterest income), accounting for 74.1% of 1997 total operating income, compared to 75.3% and 76.2% in 1996 and 1995, respectively. Net interest income represents the difference between interest earned on loans, securities and other earning assets, and the interest expense associated with the deposits and borrowings that fund them. Interest rate fluctuations together with changes in volume and types of earning assets and interest-bearing liabilities combine to affect total net interest income. The remainder of this analysis discusses net interest income on an FTE basis in order to provide comparability among the types of interest earned. FTE net interest income reached $381.3 million in 1997, an increase of 5.7% over the 1996 level of $360.6 million. This increase follows a $19.9 million, or 5.8% increase in 1996 over the $340.8 million recorded in 1995. The net interest margin, or FTE net interest income as a percent of total average earning assets, decreased to 3.85% in 1997, down from 3.95% in 1996 and 1995. Strong growth in earning assets more than offset the 10 basis point decline in the net interest margin, creating the increase in net interest income in 1997. The $19.9 million increase in 1996 over 1995 was a result of earning assets increasing by $505 million while the net interest margin remained stable. 12
TABLE 2: AVERAGE BALANCES AND INTEREST RATES (INCOME AND RATES ON A TAX- EQUIVALENT BASIS) <TABLE> <CAPTION> YEARS ENDED DECEMBER 31, <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> ------------------------------------------------------------------------------------ <CAPTION> 1997 1996 1995 <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> ------------------------------------------------------------------------------------ <CAPTION> AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> ------------------------------------------------------------------------------------ <CAPTION> (IN THOUSANDS) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> ASSETS Earning assets: Loans, net of unearned income(1)(2)(3) $6,962,820 $592,984 8.52% $6,586,639 $564,576 8.57% $6,157,655 $535,168 8.69% Investment securities: Taxable 2,725,566 184,231 6.76 2,345,489 156,967 6.69 2,272,696 151,983 6.69 Tax exempt(1) 180,382 13,925 7.72 178,268 13,322 7.47 148,683 11,114 7.47 Interest-bearing deposits in other financial institutions 14,428 779 5.40 5,188 437 8.42 11,413 596 5.22 Federal funds sold and securities purchased under agreements to resell 16,237 999 6.15 21,750 1,267 5.83 41,660 2,426 5.82 ------------------------------------------------------------------------------------ Total earning assets $ 9,899,433 $792,918 8.01% $9,137,334 $736,569 8.06% $8,632,107 $701,287 8.12% ------------------------------------------------------------------------------------ Allowance for possible loan losses (73,748) (72,168) (68,180) Cash and due from banks 229,994 246,509 235,445 Other assets 339,936 331,982 324,609 ------------------------------------------------------------------------------------ Total Assets $10,395,615 $9,643,657 $9,123,981 ==================================================================================== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: Savings deposits $ 1,073,244 $ 24,396 2.27% $1,121,531 $ 27,501 2.45% $1,146,282 $ 30,723 2.68% NOW deposits 712,458 11,905 1.67 673,106 11,397 1.69 603,734 10,405 1.72 Money market deposits 902,186 34,054 3.77 799,795 28,229 3.53 697,128 24,624 3.53 Time deposits 4,692,333 267,088 5.69 4,486,355 253,788 5.66 4,296,466 237,331 5.52 Federal funds purchased and securities sold under agreements to repurchase 538,097 29,046 5.40 444,676 22,976 5.17 521,164 29,215 5.61 Other short-term borrowings 749,803 43,463 5.80 484,266 29,208 6.03 370,331 25,890 6.99 Long-term borrowings 26,929 1,685 6.26 44,799 2,824 6.30 32,445 2,311 7.12 ------------------------------------------------------------------------------------ Total interest-bearing liabilities $ 8,695,050 $411,637 4.73% $8,054,528 $375,923 4.67% $7,667,550 $360,499 4.70% ------------------------------------------------------------------------------------ Demand deposits 741,790 697,470 665,799 Accrued expenses and other liabilities 118,916 116,479 116,264 Stockholder's equity 839,859 775,180 674,368 ------------------------------------------------------------------------------------ Total liabilities and stockholder's equity $10,395,615 $9,643,657 $9,123,981 ==================================================================================== Net interest income and rate spread(1) $381,281 3.28% $360,646 3.39% $340,788 3.42% ==================================================================================== Net yield on earning assets(1) 3.85% 3.95% 3.95% ==================================================================================== </TABLE> (1) The yield on tax exempt loans and securities is computed on a tax- equivalent basis using a tax rate of 35% for all periods presented and is net of the effects of certain disallowed interest deductions. (2) Nonaccrual loans have been included in the average balances. (3) Interest income includes net loan fees. 13
Total average loans outstanding grew from $6.6 billion to $7.0 billion in 1997, an increase of 5.7%. This followed the 7.0% growth from 1995 to 1996. Investment securities increased to $2.9 billion in 1997, up from $2.5 billion in 1996 and $2.4 billion in 1995. The composition of the Corporation's earning assets has changed significantly in 1997 in conjunction with the merger with FFC. A larger portion of earning assets is now comprised of taxable investment securities. The yield on taxable investment securities in 1997 was 176 basis points lower than the yield on loans. Historically, the Corporation had approximately 21.3% of its earning assets in investment securities compared to 29.4% in 1997. The Corporation's funding mix was also significantly impacted by the merger with FFC. In prior years, the Corporation depended heavily upon net free funds (difference between earning assets and interest-bearing liabilities) as a funding source. Historically, the Corporation has funded approximately 18% of its earning asset base with interest free net free funds. FFC relied heavily upon certificates of deposit and wholesale funds to fund its earning asset base. In 1997, 12.2% of the Corporation's earning asset base was funded by interest free net free funds. The combination of a higher mix of lower yielding investment securities and lower levels of interest free net free funds has caused the Corporation's net interest margin, as reported historically, to decline by approximately 58 basis points. In 1997 the Corporation's net interest margin decreased to 3.85%, compared to 3.95% in 1996 and 1995. The interest rate spread, or difference between the yield on earning assets and the rate on interest-bearing liabilities, decreased 11 basis points in 1997. The yield on earning assets decreased by 5 basis points while the rate on interest-bearing liabilities increased by 6 basis points. The contribution from net free funds increased by 1 basis point. Combined, these factors decreased the net interest margin by 10 basis points in 1997. TABLE 3: RATE/VOLUME ANALYSIS(1) <TABLE> <CAPTION> 1997 COMPARED TO 1996 1996 COMPARED TO 1995 INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO <S> <C> <C> <C> <C> <C> <C> ---------------------------------------------------------- <CAPTION> VOLUME RATE NET VOLUME RATE NET <S> <C> <C> <C> <C> <C> <C> ---------------------------------------------------------- <CAPTION> (IN THOUSANDS) <S> <C> <C> <C> <C> <C> <C> Interest income: Loans, net of unearned income(2) $ 32,058 $ (3,650) $ 28,408 $ 36,855 $ (7,447) $ 29,408 Investment securities: Taxable 25,676 1,588 27,264 4,871 113 4,984 Tax-exempt(2) 159 444 603 2,211 (3) 2,208 Interest-bearing deposits in other financial institutions 547 (205) 342 (419) 260 (159) Federal funds sold and securities purchased under agreements to resell (337) 69 (268) (1,159) -- (1,159) ---------------------------------------------- Total earning assets(2) $ 58,103 $ (1,754) $ 56,349 $ 42,359 $ (7,077) $ 35,282 ---------------------------------------------- Interest expense: Savings deposits $ (1,152) $ (1,953) $ (3,105) $ (652) $ (2,570) $ (3,222) NOW deposits 659 (151) 508 1,178 (186) 992 Money market deposits 3,777 2,048 5,825 3,623 (18) 3,605 Time deposits 11,754 1,546 13,300 8,361 8,096 16,457 Federal funds purchased and securities sold under agreements to repurchase 5,005 1,065 6,070 (4,069) (2,170) (6,239) Other short-term borrowings 15,433 (1,178) 14,255 7,210 (3,892) 3,318 Long-term borrowings (1,118) (21) (1,139) 802 (289) 513 ---------------------------------------------- Total interest-bearing liabilities $ 34,358 $ 1,356 $ 35,714 $ 16,453 $ (1,029) $ 15,424 ---------------------------------------------- Net interest income(2) $ 23,745 $ (3,110) $ 20,635 $ 25,906 $ (6,048) $ 19,858 ---------------------------------------------- </TABLE> (1) The change in interest due to both rate and volume has been allocated in proportion to the relationship to the dollar amounts of the change in each. (2) The yield on tax-exempt loans and securities is computed on an FTE basis using a tax rate of 35% for all periods presented and is net of the effects of certain disallowed interest deductions. 14
The Corporation's reported increase in FTE net interest income in 1997 was primarily driven by larger volumes of earning assets. Net of related funding costs, this growth increased FTE net interest income by $23.7 million. This increase was tempered by a negative impact from interest rates. FTE interest income from earning assets declined $1.8 million due to the change in rates while interest expense increased $1.3 million due to the change in rates combining to decrease net interest income by $3.1 million. This negative impact from change in interest rates combined with the growth in the balance sheet caused FTE net interest income to increase by $20.6 million in 1997. The FTE net interest income reported in 1996 increased by $19.9 million over 1995. This increase was also primarily driven by larger volumes of earning assets. Higher volumes of earning assets, net of related funding costs increased FTE net interest income by $25.9 million. This increase was offset by a negative impact from the change in interest rates of $6.0 million. The Corporation's total cost of funds increased by 6 basis points in 1997, after decreasing by 3 basis points in 1996. This increase was attributable to a higher dependence upon wholesale funding in 1997. Retail interest-bearing deposits as a percent of total interest-bearing liabilities decreased to 84.9% in 1997 from 87.9% in 1996 and 1995. The rate on total retail interest-bearing deposits increased to 4.57% in 1997, up from 4.53% in 1996 and 4.49% in 1995. The cost of total wholesale funds decreased slightly in 1997 to 5.64%, down from 5.65% in 1996 and 6.21% in 1995. As funding shifted to a higher reliance on wholesale funding in 1997, costing 107 basis points more, the Corporation's total cost of funding increased by 6 basis points. TABLE 4: INTEREST RATE SPREAD AND INTEREST MARGIN (ON A TAX-EQUIVALENT BASIS) <TABLE> <CAPTION> 1997 AVERAGE 1996 AVERAGE 1995 AVERAGE <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> -------------------------------------------------------------------------- <CAPTION> % OF % OF % OF EARNING EARNING EARNING BALANCE ASSETS RATE BALANCE ASSETS RATE BALANCE ASSETS RATE <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> -------------------------------------------------------------------------- <CAPTION> (IN THOUSANDS) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> Earning assets $9,899,433 100.0% 8.01% $9,137,334 100.0% 8.06% $8,632,107 100.0% 8.12% -------------------------------------------------------------------------- Financed by: Interest-bearing funds $8,695,050 87.8% 4.73% $8,054,528 88.1% 4.67% $7,667,550 88.8% 4.70% Noninterest-bearing funds 1,204,383 12.2% 1,082,806 11.9% 964,557 11.2% -------------------------------------------------------------------------- Total funds sources $9,899,433 100.0% 4.16% $9,137,334 100.0% 4.12% $8,632,107 100.0% 4.17% -------------------------------------------------------------------------- -------------------------------------------------------------------------- Interest rate spread 3.28% 3.39% 3.42% Contribution from net free funds .57% .56% .53% Net interest margin 3.85% 3.95% 3.95% -------------------------------------------------------------------------- -------------------------------------------------------------------------- Average prime rate* 8.44% 8.27% 8.83% Average fed funds rate* 5.46% 5.30% 5.84% Average spread 298BP 297BP 299BP -------------------------------------------------------------------------- -------------------------------------------------------------------------- </TABLE> *Source: Federal Reserve Statistics The Corporation continued to experience a narrowing of loan spreads in 1997. The yield on total loans decreased by 5 basis points, after decreasing 12 basis points in 1996. Total loans represent 70.3% of total earning assets in 1997, down from 72.1% in 1996 and 71.3% in 1995. A change in the total yield on the loan portfolio will have the largest impact on total net interest income. A benchmark measurement of loan capacity is the loan to deposits (including demand) ratio. This ratio increased to 85.7% in 1997, up from 84.7% in 1996 and 83.1% in 1995. This indicates the capacity of the Corporation to accelerate loan growth and replace lower yielding investments as they mature without placing undue pressure upon retail deposit generation. The growth of net free funds (the difference between earning assets and interest-bearing liabilities, or the amount of funding that does not have a specific interest cost associated with them), and the subsequent contribution from these funds, increased in 1997. Net free funds balances grew at a rate of 11.2%, faster than the 8.3% growth of earning assets. The higher percentage of funding provided by net free funds coupled with the higher value placed on them (cost of total interest-bearing liabilities) helped offset the decline in the interest rate spread. 15
TABLE 5: SELECTED AVERAGE BALANCES <TABLE> <CAPTION> % OF TOTAL % OF TOTAL % OF $ 1997 ASSETS 1996 ASSETS CHANGE <S> <C> <C> <C> <C> <C> -------------------------------------------------- <CAPTION> (IN THOUSANDS) <S> <C> <C> <C> <C> <C> ASSETS Loans, net of unearned income $ 6,962,820 67.0% $6,586,639 68.3% 5.7% Investment securities Taxable 2,725,566 26.2 2,345,489 24.3 16.2 Tax-exempt 180,382 1.7 178,268 1.8 1.2 Interest-bearing deposits in other financial institutions 14,428 0.1 5,188 0.1 178.1 Federal funds sold and securities purchased under agreements to resell 16,237 0.2 21,750 0.2 (25.3) -------------------------------------------------- Total earning assets 9,899,433 95.2 9,137,334 94.7 8.3 Other assets 496,181 4.8 506,323 5.3 (2.0) -------------------------------------------------- Total assets $10,395,615 100.0% $9,643,657 100.0% 7.8% -------------------------------------------------- -------------------------------------------------- LIABILITIES & STOCKHOLDERS' EQUITY Interest-bearing deposits $ 7,380,221 71.0% $7,080,787 73.4% 4.2% Short-term borrowings 1,287,900 12.4 928,942 9.6 38.6 Long-term borrowings 26,929 0.2 44,799 0.5 (39.9) -------------------------------------------------- Total interest-bearing liabilities 8,695,050 83.6 8,054,528 83.5 8.0 Demand deposits 741,790 7.1 697,470 7.2 6.4 Accrued expenses and other liabilities 118,916 1.2 116,479 1.2 2.1 Stockholders' equity 839,859 8.1 775,180 8.1 8.3 -------------------------------------------------- Total liabilities and stockholders' equity $10,395,615 100.0% $9,643,657 100.0% 7.8% ================================================== </TABLE> As the largest component of operating income, improvements in the growth of net interest income are important to the Corporation's earnings performance. Growth in the Corporation's net interest income during the past three years has been a result of the growth in the level of earning asset volumes. The merger with FFC with its higher reliance on the growth of investment securities, primarily mortgage-related, has increased the importance of managing net interest income. The Corporation uses certain modeling and analysis techniques to manage net interest income and the related interest rate risk position (See Interest Rate Sensitivity and Market Risk). The Corporation seeks to meet the needs of its customers, yet provide for stability in net interest income in the event of significant interest rate changes. PROVISION FOR POSSIBLE LOAN LOSSES The provision for possible loan losses in 1997 was $14.9 million, excluding the $16.8 million additional provision to conform FFC with the policies, practices and procedures of the Corporation, compared to $13.7 million in 1996 and $14.0 million in 1995. The increase in provision reflects the loan growth recorded in 1997. Including the additional provision, the ratio of allowance for possible loan losses to total loans increased to 1.31%, up from 1.08% at December 31, 1996 and 1.12% at December 31, 1995. (See Allowance for Possible Loan Losses for additional discussion.) NONINTEREST INCOME Total operating noninterest income, excluding gains or losses from security transactions, increased $1.2 million or 1.0% compared to an increase of $24.0 million, or 23.2% in 1996 over 1995. Excluding an $11.2 million gain on sale of credit cards recorded in 1996 by FFC, the increase in operating noninterest income in 1997 would have been $12.4 million, or 10.7% compared to an increase of $12.8 million, or 12.4% in 1996 over 1995. The addition of FFC has broadened the Corporation's recurring sources of noninterest income beyond its traditional trust service fees and service fees on deposit accounts. Mortgage servicing revenue, fees on loans (primarily credit card fees) and retail commission income now represent significant sources of revenue. Historically, as the Corporation had continued to develop additional sources of noninterest income, trust service fees and service charges on deposits had represented a slowly declining portion of total noninterest income. As historically reported, these two components had represented 64.4% of total noninterest income in 1994 and 58.9% in 1996. With the addition of FFC, this percentage has now dropped to 44.0%, with mortgage banking income, loan fees and retail commission income now representing 44.7% in 1997. 16
Trust service fees increased to $28.8 million in 1997, up from $25.2 million in 1996 and $22.2 million in 1995. This represents increases of 14.2% and 13.2% in 1997 and 1996, respectively. These large increases represent the continued improvement in trust business volume and growth in assets under management. Trust assets under management totaled $4.0 billion at December 31, 1997 compared with $3.5 billion at December 31, 1996. Income from mortgage banking activity increased 7.7% in 1997, or $1.8 million. This followed an increase of $5.8 million, or 32.2% in 1996. Mortgage banking income is comprised mainly of fees related to servicing mortgage loans, residential loan origination fees, underwriting fees, escrow waiver fees and the gain or loss on sale of mortgage loans to the secondary market. Servicing revenues increased by $384,000 in 1997 over 1996 to $13.7 million from $13.4 million. The increase in servicing revenue reflects the Corporation's larger servicing portfolio, as serviced 1- to 4-family residential loans increased to $5.0 billion at the end of 1997 compared to $4.8 billion and $4.4 billion at the end of 1996 and 1995, respectively. Net gains on sales of mortgage loans accounted for the majority of the remaining increase in 1997. Loan fees increased $1.9 million, or 13.1% in 1997 after increasing $1.5 million, or 11.4% in 1996. Loan fees include late charges and service charges on real estate loans held in the Corporation's portfolio, credit card, consumer late charges, home equity line service charges, and late charges and commitment fees on commercial loans. The largest component of this category is credit card fees, accounting for $10.3 million of the total fees in 1997. Credit card fees increased $1.6 million in 1997 compared to 1996. Retail commission income increased $2.7 million, or 21.1% when compared to the full year of 1996. Retail commission income includes commissions from insurance product sales, equity brokerage product sales and the sale of annuities. TABLE 6: NONINTEREST INCOME <TABLE> <CAPTION> % CHANGE FROM PRIOR YEARS ENDED DECEMBER 31, YEAR <S> <C> <C> <C> <C> <C> ----------------------------------------- <CAPTION> 1997 1996 1995 1997 1996 -------- -------- -------- ----- ----- (IN THOUSANDS) <S> <C> <C> <C> <C> <C> Trust service fees $ 28,764 $ 25,185 $ 22,243 14.2 13.2 Service charges on deposit accounts 27,909 26,004 23,861 7.3 9.0 Mortgage banking income 25,709 23,873 18,052 7.7 32.2 Loan fees 16,407 14,505 13,023 13.1 11.4 Retail commission income 15,446 12,757 10,760 21.1 18.6 Asset sale gains, net 852 12,520 428 N/M N/M Other 13,665 12,679 15,110 7.8 (16.1) ----------------------------------------- Total, excluding securities gains 128,752 127,523 103,477 1.0 23.2 Investment securities gains (losses), net (operating) 2,514 (10,678) 1,512 N/M N/M Merger, integration and other one- time charges (35,290) -- -- N/M N/M ----------------------------------------- Total noninterest income $ 95,976 $116,845 $104,989 (17.9) 11.3 ========================================= </TABLE> N/M -- not meaningful Net asset sale gains represent the net gain or loss on the sale of assets such as fixed assets, other real estate owned, leased equipment, real estate held for investment, and loans not held for sale (credit card or student loans). Net asset sale gains decreased by $11.7 million in 1997, compared to 1996. The majority of this decrease is attributable to a gain on sale of credit card loans of $11.2 million recognized by FFC in 1996. Other miscellaneous income, from a variety of sources, increased $986,000, or 7.8% in 1997. This increase is primarily attributable to higher levels of Electronic Funds Transfer (EFT) fees. Net EFT fees increased by $967,000 in 1997. Investment securities gains of $2.5 million represent an increase of $13.2 million over 1996. This increase is primarily attributable to a $13.1 million loss recognized by FFC on the sale of mortgage-related securities in 1996. 17
The merger, integration and other one-time charges consist of writedowns taken to record other than temporary impairment of value of securities. Concurrent with the consummation of the merger with FFC, the Corporation transferred all nonagency mortgage-related securities and an agency security, with a combined amortized cost of $251.9 million from securities held to maturity to securities available for sale. These mortgage-related securities were transferred to maintain the existing interest rate risk position and credit risk policy of the Corporation. Concurrent with the transfer, the Corporation recorded a $32.5 million pre-tax charge to earnings relative to one agency security with an amortized cost of $130.6 million. Management recorded this other than temporary impairment of value in the fourth quarter of 1997. This security is highly complex, comprised of multiple cash flows predominated by an inverse floater tied to libor, for which stress tests indicate that the cash flows are volatile in higher interest rate environments. The estimated fair value of this security at the time of the other than temporary impairment charge was based on quoted prices of instruments with similar characteristics and cash flow valuation techniques. Additionally, the Corporation recorded a $2.8 million pre-tax charge, on other nonagency mortgage-related securities that were transferred to available for sale, with an amortized cost of $18.9 million to reflect an other than temporary impairment of value in the fourth quarter of 1997. These securities were subsequently sold with no additional loss in January 1998. NONINTEREST EXPENSE Total operating noninterest expense, excluding merger, integration and other one-time charges, increased $11.8 million, or 4.5% in 1997. This follows a $13.8 million, or 5.6% increase in 1996 over 1995. All categories, with the exception of FDIC insurance premiums, recorded increases in 1997. Salaries and employee benefits increased $7.5 million or 5.9% compared to 1996. This followed a $10.3 million, or 8.9% increase in 1996 compared to 1995. This category continues to be the largest component of noninterest expense, representing 49.1% of operating expenses in 1997 and 48.5% and 47.0% in 1996 and 1995, respectively. The increase in 1997 was comprised of higher salary expenses of $6.2 million and higher fringe benefit costs of $1.3 million. The increase in salary expense reflects base merit pay increases and new positions added. The fringe benefit increase is attributable to FICA taxes, 401k and profit sharing expenses. These fringe benefit increases were a result of higher levels of base compensation and changes made to benefit plans. Full-time equivalent (FTE) employees at December 31, 1997 totaled 3,679 compared to 3,666 at December 31, 1996. As the Corporation continues to expand to take advantage of business opportunities and the related revenues, management will continue to review its significant investment in salaries and employee benefit expenses. TABLE 7: NONINTEREST EXPENSE <TABLE> <CAPTION> % CHANGE FROM PRIOR YEARS ENDED DECEMBER 31, YEAR <S> <C> <C> <C> <C> <C> --------------------------------------- <CAPTION> 1997 1996 1995 1997 1996 -------- -------- -------- ----- ----- (IN THOUSANDS) <S> <C> <C> <C> <C> <C> Salaries and employee benefits $133,656 $126,154 $115,837 5.9 8.9 Net occupancy expense 20,297 19,563 19,159 3.8 2.1 Data processing expense 16,900 15,905 15,068 6.3 5.6 Business development and advertising 15,936 14,754 11,120 8.0 32.7 Equipment rentals, depreciation, and maintenance 12,600 12,033 11,433 4.7 5.2 Stationery and supplies 5,532 5,030 5,325 10.0 (5.5) FDIC expense 3,284 9,675 13,799 (66.1) (29.9) Other 63,820 57,116 54,728 11.7 4.4 --------------------------------------- Total noninterest expense (operating) 272,025 260,230 246,469 4.5 5.6 Merger, integration and other one- time charges 51,622 33,005 6,458 N/M N/M --------------------------------------- Total noninterest expense $323,647 $293,235 $252,927 10.4 15.9 ======================================= </TABLE> N/M--not meaningful 18
Net occupancy, data processing, and equipment rentals, depreciation and maintenance reflect the continued investment in the systems and operations center. Increased depreciation, maintenance and utilities directly reflect the investment made in the systems and operations center in 1996. Higher data processing fees are due to the processing volumes in excess of the base contract with the third party processor. Business development and advertising includes all business development related costs, which include public relations, travel, meals, club and association dues, and auto costs, and all advertising and marketing costs, including market research, direct mail, television, radio, newsprint and all other promotions increased $1.2 million, or 8.0% in 1997. This followed a $3.6 million, or 32.7%, increase in 1996 over 1995. FDIC expense represents the regular premiums paid to the FDIC. FFC historically has paid a higher percentage for insurance premiums. FFC's FDIC assessment was decreased to 6.4 cents per $100 of assessable deposits from the rate of 23 cents per $100 which was in effect prior to September 30, 1996. The Corporation's banking affiliates that existed prior to the FFC acquisition had their premiums virtually eliminated in 1996, with the assessment rate lowered to 1.2 cents per $100 of assessable deposits for 1997. Total FDIC premiums paid decreased to $3.3 million in 1997, down from $9.7 million and $13.8 million in 1996 and 1995, respectively. The one-time charge related to the recapitalization of the SAIF, paid by FFC in 1996, is not included in this category. This charge of $28.8 million on a pre-tax basis is included in the merger, integration and other one-time charges category. Other noninterest expense increased by $6.7 million, or 11.7%, in 1997 compared to 1996. This increase is attributable to higher levels of mortgage servicing rights amortization, increased consulting costs, higher communication and courier costs. This increase follows a $2.4 million, or 4.4%, increase in 1996 over 1995. Merger, integration and other one-time charges include the following amounts for each applicable year: . 1997 charges include $51.6 million of pre-tax charges related to the merger with FFC. These charges include $12.6 million for employee and director severance and contract costs, $20.2 million for costs associated with elimination of duplicative facilities, computer systems, software and integration, $11.2 million for investment banking, legal and accounting fees and $7.7 million for other one-time charges. . 1996 charges include a one-time charge of $28.8 million associated with the recapitalization of the SAIF and a one-time charge of $4.2 million relating to a change in accounting for the amortization of goodwill and other intangible assets recorded at FFC. . 1995 charges include a one-time charge of $6.5 million relating to acquisition-related expenses incurred relative to the acquisition of FirstRock Bancorp, Inc. by FFC. These charges include $3.8 million for employee and director severance and contract costs, $740,000 for costs associated with duplicative facilities, computer systems, software and integration, $1.0 million for investment banking, legal and accounting fees and $870,000 for other charges. INCOME TAXES Income tax expense, excluding the applicable income tax effect on merger, integration and other one-time charges, increased to $77.8 million in 1997 compared to $68.5 million and $64.9 million in 1996 and 1995, respectively. The Corporation's effective tax rate (operating income tax expense divided by operating income before taxes) was 35.4%, 34.6% and 35.9% in 1997, 1996 and 1995, respectively. BALANCE SHEET ANALYSIS LOANS Total loans, including loans held for sale, increased by $489 million, or 7.3% to $7.2 billion at the end of 1997. This follows a $282 million, or 4.4% increase in 1996 compared to 1995. In 1997 increases were experienced in commercial, financial and agricultural, real estate-construction and real estate-mortgage loans, each up $146 million, $101 million and $260 million, respectively. Included in the increase in real estate-mortgage loans is an increase of $72 million in mortgage loans held for sale. 19
TABLE 8: LOAN COMPOSITION <TABLE> <CAPTION> AS OF DECEMBER 31, ------------------------------------------------------------------------------------ 1997 1996 1995 1994 1993 ---------------- ---------------- ---------------- ---------------- ---------------- % OF % OF % OF % OF % OF AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL ---------- ----- ---------- ----- ---------- ----- ---------- ----- ---------- ----- (IN THOUSANDS) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Commercial, financial, and agricultural $ 986,839 14% $ 841,145 13% $ 801,004 13% $ 710,285 12% $ 758,925 14% Real estate-- construction 335,978 5 235,478 3 217,223 3 199,376 3 168,232 3 Real estate--mortgage 5,060,264 70 4,799,900 72 4,569,362 71 4,278,825 71 3,719,199 69 Installment loans to individuals 793,424 11 813,875 12 821,351 13 801,302 14 728,582 14 Lease financing 14,072 -- 10,449 -- 9,743 -- 6,176 -- 5,144 -- -------------------------------------------------------------------------------------------- Total loans (including loans held for sale) $7,190,577 100% $6,700,847 100% $6,418,683 100% $5,995,964 100% $5,380,082 100% -------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------- </TABLE> The acquisition of FFC had a major impact on the loan composition of the Corporation. As previously reported prior to the 1997 pooling restatements, at December 31, 1996 the Corporation's loan composition consisted of 57% real estate-mortgage, 26% commercial, financial and agricultural, 9% installment loans to individuals, 7% real estate-construction, and 1% leasing. At December 31, 1997 this mix has changed to 70% real estate-mortgage, 14% commercial, financial and agricultural, 11% installment loans to individuals and 5% real estate-construction. The mix of loans at December 31, 1997 reflects FFC's mix of loans, primarily real estate-mortgage and installment loans to individuals, as the merger brought together FFC's consumer banking franchise with the Corporation's existing business banking and asset management expertise. Real estate-mortgage loans totaled $5.1 billion at the end of 1997 and $4.8 billion at the end of 1996. Loans in this classification in 1997 include $3.8 billion of loans secured by 1- to 4-family residential properties. Residential real estate loans consist of conventional home mortgages, home equity lines, and second mortgages. Loans of this type are primarily made to borrowers in Wisconsin and Illinois. Residential real estate loans generally limit the maximum loan to 75%-80% of collateral value. Also included in the real estate- mortgage classification are loans secured by nonfarm, nonresidential real estate properties. Loans in this group totaled $966 million at December 31, 1997. Real estate loans secured by nonresidential real estate involve borrower characteristics similar to those discussed for commercial loans and real estate-construction projects. Loans of this type are mainly for business and industrial properties, multi-family properties, community purpose properties and similar properties. Loans are primarily made to borrowers in Wisconsin and Illinois. Credit risk is managed in a similar manner to commercial loans and real estate construction by employing sound underwriting guidelines, lending to borrowers in known markets and businesses, and formally reviewing the borrower's financial soundness and relationship on an ongoing basis. Commercial, financial, and agricultural loans totaled $1.0 billion at the end of 1997, comprising 14% of total loans outstanding, up from 13% at the end of 1996. The commercial, financial and agricultural loan classification primarily consists of commercial loans to middle market companies and small businesses. Loans of this type are in a broad range of industries. Borrowers are primarily concentrated in Wisconsin and Illinois. The credit risk related to commercial loans is largely influenced by general economic conditions and the resulting impact on a borrower's operations. Within commercial, financial and agricultural classification at December 31, 1997, loans to finance agricultural production total $35.4 million or 0.5% of total loans. An active credit risk management process is used for commercial loans to ensure that sound and consistent credit decisions are made. Credit risk is controlled by detailed underwriting procedures, comprehensive loan administration, and periodic review of borrower's outstanding loans and commitments. Borrower relationships are formally reviewed on an ongoing basis. Further analyses by customer, industry and geographic location are performed to monitor trends, financial performance and concentrations. 20
The loan portfolio is widely diversified by types of borrowers, industry groups and market areas. Significant loan concentrations are considered to exist for a financial institution when there are amounts loaned to multiple number of borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At December 31, 1997, no concentrations existed in the Corporation's portfolio in excess of 10% of total loans, or $708 million. Real estate construction loans totaled $336 million, or 5% of the total loan portfolio at the end of 1997 compared to $235 million, or 3% at the end of 1996. Loans in this classification are primarily short-term interim loans that provide financing for the acquisition or development of commercial real estate, such as multi-family or other commercial development projects. These interim loans are generally made with the intent that the borrower will refinance the loan with an outside third party or sell the project upon completion. Real estate construction loans are made to developers and project managers who are well known to the Corporation, have prior successful project experience and are well capitalized. Projects undertaken by these developers are carefully reviewed by the Corporation to ensure that they are economically viable. Loans of this type are primarily made in markets in Wisconsin and Illinois in which the Corporation has a thorough knowledge of the local market economy. The credit risk associated with real estate construction loans is generally confined to specific geographic areas. The Corporation controls the credit risk on these types of loans by making loans in familiar markets to developers, underwriting the loans to meet the requirements of institutional investors in the secondary market, reviewing the merits of individual projects, controlling loan structure, and monitoring project progress and construction advances. TABLE 9: LOAN MATURITY DISTRIBUTION AND INTEREST RATE SENSITIVITY(1) <TABLE> <CAPTION> DECEMBER 31, 1997 MATURITY(2) - ----------------- --------------------------------------- WITHIN 1-5 AFTER 1 YEAR YEARS 5 YEARS TOTAL -------- -------- ------- ---------- (IN THOUSANDS) <S> <C> <C> <C> <C> Commercial, financial, and agricultural $670,252 $287,163 $29,424 $ 986,839 Real estate-construction 208,415 119,941 7,622 335,978 -------------------------- Total $878,667 $407,104 $37,046 $1,322,817 -------------------------- -------------------------- Fixed rate $256,654 $359,825 $35,569 $ 652,048 Floating or adjustable rate 622,013 47,279 1,477 670,769 -------------------------- Total $878,667 $407,104 $37,046 $1,322,817 -------------------------- -------------------------- Percent 66% 31% 3% 100% </TABLE> (1) Based upon scheduled principal repayments. (2) Demand loans, past due loans, and overdrafts are reported in the "Within 1 Year" category. Installment loans to individuals totaled $793 million, down $20 million, or 2.5% compared to 1996. This followed a $7 million, or 0.9% decrease in 1996 from year-end 1995. 1996 was impacted by a sale of a $47.9 million credit card affinity group portfolio. Installment loans include short-term installment loans, direct and indirect automobile loans, recreational vehicle loans, credit card loans, student loans and other personal loans. Individual borrowers may be required to provide related collateral or a satisfactory endorsement or guaranty from another person, depending on the specific type of loan and the creditworthiness of the borrower. Loans are made to individual borrowers located primarily in Wisconsin and Illinois. Credit risk for these types of loans is generally greatly influenced by general economic conditions, the characteristics of individual borrowers and the nature of the loan collateral. Credit risk is primarily controlled by reviewing the creditworthiness of the borrowers as well as taking appropriate collateral and guaranty positions on such loans. Factors that are critical to managing overall credit quality are sound loan underwriting and administration, systematic monitoring of existing loans and commitments, effective loan review on an ongoing basis, an adequate allowance for possible loan losses, and sound nonaccrual and charge-off policies. 21
ALLOWANCE FOR POSSIBLE LOAN LOSSES As of December 31, 1997, the allowance for possible loan losses of $92.7 million represented 1.31% of total loans outstanding, compared to $71.8 million, or 1.08% at December 31, 1996. The majority of this increase is attributable to a one-time charge of $16.8 million related to the acquisition of FFC to conform its allowance for possible loan losses to the policies, practices and procedures of the Corporation. TABLE 10: LOAN LOSS EXPERIENCE <TABLE> <CAPTION> YEARS ENDED DECEMBER 31, ---------------------------------------------------------- 1997 1996 1995 1994 1993 ---------- ---------- ---------- ---------- ---------- (IN THOUSANDS) <S> <C> <C> <C> <C> <C> Average loans outstanding $6,962,820 $6,586,639 $6,157,655 $5,636,601 $5,136,319 Balance of allowance for possible loan losses at beginning of period $ 71,767 $ 68,560 $ 65,774 $ 63,415 $ 56,011 ========================================================== Loans charged-off: Commercial, financial, and agricultural 1,327 2,916 3,356 2,593 4,520 Real estate-- construction 600 193 191 89 131 Real estate--mortgage 3,222 2,813 3,099 4,224 6,070 Installment loans to individuals 9,900 11,693 9,221 9,038 7,950 Lease financing -- 1 5 18 50 ---------------------------------------------------------- Total loans charged-off 15,049 17,616 15,872 15,962 18,721 Recoveries of loans previously charged-off: Commercial, financial, and agricultural 513 1,255 1,856 3,086 2,193 Real estate-- construction -- 3 70 -- 173 Real estate--mortgage 1,312 837 931 1,151 695 Installment loans to individuals 1,792 1,514 1,764 1,676 1,718 Lease financing -- 8 8 7 20 ---------------------------------------------------------- Total recoveries 3,617 3,617 4,629 5,920 4,799 ---------------------------------------------------------- Net loans charged-off 11,432 13,999 11,243 10,042 13,922 Balance related to acquisitions 728 3,511 -- 3,366 4,885 Additions to the allowance charged to operating expense 31,668 13,695 14,029 9,035 16,441 ---------------------------------------------------------- Balance at end of period $ 92,731 $ 71,767 $ 68,560 $ 65,774 $ 63,415 ========================================================== Ratio of net charge-offs to average loans outstanding .16% .21% .18% .18% .27% Ratio of allowance for possible loan losses to total loans at end of period 1.31% 1.08% 1.12% 1.16% 1.20% ========================================================== </TABLE> The provision for possible loan losses, excluding the one-time charge of $16.8 million, increased to $14.9 million, up from $13.7 million in 1996 and $14.0 million in 1995. Total net charge-offs in 1997 were $11.4 million, compared to $14.0 million in 1996 and $11.2 million in 1995. Net charge-offs to average loans was .16% in 1997, .21% in 1996 and .18% in 1995. Reflecting the changes in the Corporation's loan portfolio mix, described earlier, the Corporation's updated five-year goals include maintaining net charge-offs to average loans below .30%. Each of the last five years' results have been within this revised future goal. Loans charged-off are subject to continuous review and specific efforts are taken to achieve maximum recovery of principal, accrued interest, and related expenses. 22
Management regularly reviews the adequacy of the allowance for possible loan losses to ensure that the allowance is sufficient to absorb potential losses arising from the credit granting process. Factors considered include the levels of nonperforming loans, other real estate, past due trends, growth in the loan portfolio, changes in the composition of the loan portfolio, historical net charge-offs, the present and potential financial condition of borrowers, general economic conditions, specific industry conditions and other regulatory or legal issues that could affect the Corporation's loss potential. The Corporation believes that the allowance for possible loan losses at December 31, 1997, is adequate to absorb potential loan losses as evidenced by its charge-off experience and allowance coverage of nonperforming loans (discussed below). Active asset quality administration ensures appropriate management of credit risk and minimization of loan losses. TABLE 11: ALLOCATION OF THE ALLOWANCE FOR POSSIBLE LOAN LOSSES <TABLE> <CAPTION> AS OF DECEMBER 31, --------------------------------------- 1997 1996 1995 1994 1993 ------- ------- ------- ------- ------- (IN THOUSANDS) <S> <C> <C> <C> <C> <C> Commercial, financial and agricultural $33,682 $27,943 $22,753 $21,279 $19,194 Real estate--construction 2,016 1,047 929 1,133 1,440 Real estate--mortgage 30,360 19,116 22,331 23,254 25,304 Installment loans to individuals 16,870 16,239 14,848 14,896 14,142 Lease financing 493 530 460 331 136 Unallocated 9,310 6,892 7,239 4,881 3,199 --------------------------------------- Total $92,731 $71,767 $68,560 $65,774 $63,415 ======================================= </TABLE> The allocation of the Corporation's allowance for possible loan losses for the last five years is shown in Table 11. Management has developed methodologies designed to assess the adequacy of the allowance for possible loan losses. The allocation methodology applied by the Corporation focuses on changes in the size and character of the loan portfolio, changes in levels of impaired and other nonperforming and past due loans, the risk inherent in specific loans, concentrations of loans to specific borrowers or industries, existing and prospective economic conditions and historical losses on each portfolio category. The indirect risk in the form of off-balance sheet unfunded commitments is also taken into consideration. Management continues to target and maintain the allowance for possible loan losses equal to the allocated requirement plus an unallocated portion, as deemed necessary. Management believes this is appropriate in light of current and expected economic conditions and trends, the geographic and industry mix of the loan portfolio and other risk related matters. NONPERFORMING LOANS, POTENTIAL PROBLEM LOANS, AND OTHER REAL ESTATE Management is committed to an aggressive nonaccrual and problem loan identification philosophy. This philosophy is embodied through the monitoring and reviewing of credit policies and procedures to ensure that all problem loans are identified quickly and the risk of loss is minimized. Nonperforming loans are considered a leading indicator of 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 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, from its definition of nonperforming loans. Loans are normally placed on nonaccrual status when contractually past due 90 days or more as to interest or principal payments. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact on the collectibility of principal or interest on loans, it is management's practice to place such loans on nonaccrual status immediately, rather than delaying such action until the loans become 90 days past due. Previously accrued and uncollected interest on such loans is reversed, amortization of related loan fees is suspended, and income is recorded only to the extent that interest payments are subsequently received in cash and a determination has been made that the principal 23
balance of the loan is collectible. If collectibility of the principal is in doubt, payments received are applied to loan principal. Loans past due 90 days or more but still accruing interest, with the exception of approximately $8 million of guaranteed student loans at December 31, 1997, are also included in nonperforming loans. Loans past due 90 days or more but still accruing are classified as such where the underlying loans are both well secured (the collateral value is sufficient to cover principal and accrued interest) and in the process of collection. Also included in nonperforming loans are "restructured" loans. Restructured loans involve the granting of some concession to the borrower involving the modification of terms of the loan, such as changes in payment schedule or interest rate. TABLE 12: NONPERFORMING LOANS AND OTHER REAL ESTATE OWNED <TABLE> <CAPTION> DECEMBER 31, ------------------------------------------- 1997 1996 1995 1994 1993 ------- ------- ------- ------- ------- (IN THOUSANDS) <S> <C> <C> <C> <C> <C> Nonaccrual loans $32,415 $32,287 $28,787 $28,025 $34,580 Accruing loans past due 90 days or more 1,324 1,801 1,320 1,484 2,469 Restructured loans 558 534 1,704 1,888 1,992 ------------------------------------------- Total nonperforming loans $34,297 $34,622 $31,811 $31,397 $39,041 =========================================== Ratio of nonperforming loans to total loans at period end .48% .52% .50% .53% .73% Ratio of the allowance for possible loans losses to nonperforming loans at period end 270.38% 207.29% 215.52% 209.49% 162.43% ------------------------------------------- Other real estate owned $ 2,067 $ 1,939 $ 4,852 $ 6,172 $10,262 =========================================== </TABLE> Nonperforming loans at December 31, 1997 were $34.3 million, a decrease of $325,000 from December 31, 1996. The ratio of nonperforming loans to total loans at the end of 1997 was .48%, an improvement from .52% at December 31, 1996 and .50% at December 31, 1995. The Corporation's allowance for possible loan losses to nonperforming loans was 270% at year-end 1997. This increased from 207% and 216% at year-end's 1996 and 1995, respectively. The increase in coverage of nonperforming loans is attributable to the $16.8 million one-time charge related to the merger with FFC to conform the level of the allowance for possible loan losses to the policies, practices and procedures of the Corporation. The following table shows, for those loans accounted for on a nonaccrual basis and restructured loans for the years ended as indicated, the gross interest that would have been recorded if the loans had been current in accordance with their original terms and the amount of interest income that was included in interest income for the period. TABLE 13: FOREGONE LOAN INTEREST <TABLE> <CAPTION> YEARS ENDED DECEMBER 31, ---------------------------- 1997 1996 1995 -------- -------- -------- (IN THOUSANDS) <S> <C> <C> <C> Interest income in accordance with original terms $ 2,332 $ 2,764 $ 2,905 Interest income recognized (1,215) (1,086) (1,110) ---------------------------- Reduction in interest income $ 1,117 $ 1,678 $ 1,795 ============================ </TABLE> Potential problem loans are loans where there are doubts as to the ability of the borrower to comply with present repayment terms. The decision of management to place loans in this category does not necessarily indicate that the Corporation expects losses to occur, but that management recognizes that a higher degree of risk is associated with these performing loans. 24
At December 31, 1997, potential problem loans totaled $74.0 million. The loans that have been reported as potential problem loans are not concentrated in a particular industry, but rather cover a diverse range of businesses, e.g. communications, wholesale trade, manufacturing, finance/insurance/real estate, and services. Management does not presently expect significant losses from credits in the potential problem loan category. Other real estate owned was $2.1 million at December 31, 1997 compared to $1.9 million at the end of 1996. Management actively seeks to ensure properties held are administered to minimize the Corporation's risk of loss. INVESTMENT SECURITIES PORTFOLIO The investment securities portfolio is intended to provide the Corporation with adequate liquidity, flexibility in asset/liability management and a source of stable income. Investment securities, at amortized cost, including those held to maturity and available for sale, totaled $2.9 billion at December 31, 1997 compared to $2.8 billion at the end of 1996. TABLE 14: INVESTMENT SECURITIES PORTFOLIO <TABLE> <CAPTION> YEARS ENDED DECEMBER 31, -------------------------------- 1997 1996 1995 ---------- ---------- ---------- (IN THOUSANDS) <S> <C> <C> <C> Investment Securities Held to Maturity: U.S. Treasury securities $ 498 $ 4,204 $ 10,036 Federal agency securities 146,259 143,927 184,158 Mortgage-related securities 361,298 673,990 791,341 Obligations of states and political subdivisions 183,286 195,860 170,971 Other securities (debt) 81,183 61,768 60,621 -------------------------------- Total Amortized Cost $ 772,524 $1,079,749 $1,217,127 ================================ Total Fair Market Value $ 782,240 $1,074,412 $1,209,820 ================================ Investment Securities Available for Sale: U.S. Treasury securities $ 109,200 $ 149,314 $ 174,360 Federal agency securities 324,708 326,049 220,801 Mortgage-related securities 1,536,134 1,057,992 585,300 Obligations of state and political subdivisions 14,312 -- -- Other securities (debt and equity) 142,081 127,787 68,679 -------------------------------- Total Amortized Cost $2,126,435 $1,661,142 $1,049,140 ================================ Total Fair Market Value $2,167,694 $1,674,189 $1,049,768 ================================ </TABLE> The merger with FFC had a major impact on the Corporation's total investment portfolio. The relationship of investments to total earning assets was altered as a result of the acquisition. As reported historically, at the end of 1996, the Corporation's average investment portfolio comprised 21.3% of total average earning assets. Subsequent to the merger with FFC, average investments to total average earning assets equaled 29.4% in 1997. The composition of the investment portfolio was altered as well. As previously reported, at the end of 1996 Treasury and Federal Agency securities totaled 55.9%, mortgage-related securities totaled 9.9%, municipal securities totaled 23.1%, and other debt and equity securities totaled 11.1% of the total investment portfolio, at amortized cost. At December 31, 1997, the mix changed to 65.5% mortgage- related securities, 20.0% treasury and federal agency securities, 6.8% municipal securities and 7.7% other debt and equity securities. Mortgage-related securities are subject to inherent risks based upon the future performance of the underlying collateral (i.e. mortgage loans) for these securities. Among these risks are prepayment risk and interest rate risk. Should general interest rate levels decline, the mortgage-related securities portfolio would be subject to 1) prepayments as borrowers typically would seek to obtain financing at lower rates, 2) a decline in interest income received on adjustable-rate issuances, and 3) an increase in the fair value of 25
fixed rate issuances. Conversely, should general interest rate levels increase, the mortgage-related securities portfolio would be subject to 1) a longer term to maturity as borrowers would be less likely to prepay their loans, 2) an increase in interest income received on adjustable rate issuances, 3) a decline in the fair value of fixed rate issuances, and 4) a decline in fair value of adjustable rate issuances to an extent dependent upon the level of interest rate increases, the time period to the next interest rate repricing date for the individual security and the applicable periodic (annual and/or lifetime) cap which could limit the degree to which the individual security could reprice within a given time period. The mortgage-related security portfolio includes both U.S. Government agency issuances and nonagency issuances. Unlike U.S. Government agency issued mortgage-related securities which include a guarantee of principal and interest payments on the underlying collateral, nonagency securities are generally structured with a senior ownership position and subordinate ownership position(s) providing credit support for the senior position. The structure of nonagency mortgage-related securities may expose the Corporation to credit risk in addition to interest rate risk and prepayment risk as discussed above. Management monitors the major factors affecting the performance of nonagency mortgage-related securities including, 1) delinquencies, foreclosures, repossessions and recoveries relative to the underlying mortgage loans collateralizing each security, 2) the level of available subordination or other credit enhancements, 3) the competence of the servicer of the underlying mortgage portfolio, and 4) the rating assigned to each security by independent national rating agencies. Concurrent with the consummation of the merger with FFC, the Corporation transferred all nonagency mortgage-related securities and an agency security, with a combined amortized cost of $251.9 million from securities held to maturity to securities available for sale. These mortgage-related securities were transferred to maintain the existing interest rate risk position and credit risk policy of the Corporation. Concurrent with the transfer, the Corporation recorded a $32.5 million pre-tax charge to earnings relative to one agency security with an amortized cost of $130.6 million. Management recorded this other than temporary impairment of value in the fourth quarter of 1997. This security is highly complex, comprised of multiple cash flows predominated by an inverse floater tied to LIBOR, for which stress tests indicate that the cash flows are volatile in higher interest rate environments. The estimated fair value of this security at the time of the other than temporary impairment charge was based on quoted prices of instruments with similar characteristics and cash flow valuation techniques. Additionally, the Corporation recorded a $2.8 million pre-tax charge on other nonagency mortgage-related securities that were transferred to available for sale, with an amortized cost of $18.9 million, to reflect an other than temporary impairment of value in the fourth quarter of 1997. These securities were subsequently sold with no additional loss in January 1998. In November 1997, the Corporation hedged certain agency issued zero-coupon bonds held by FFC, with a carrying value of $37.2 million and a market value of $41.6 million, by executing various interest rate futures contracts. These contracts had a notional value of $70.5 million and a maturity date of March 1998. Subsequently, in January 1998, the futures contracts were closed and the zero-coupon bonds were sold. A net gain of $5.1 million will be recognized, in investment securities gains, in the first quarter of 1998 from these transactions. Taxable securities were 93.2% of total securities at the end of 1997 compared to 92.9% at the end of 1996. The aggregate market value of the securities portfolio was approximately $2.95 billion compared to an amortized cost of $2.90 billion at December 31, 1997. At December 31, 1997, the Corporations securities portfolio did not contain securities, other than U.S. Treasury and federal agencies, of any single issuer that were payable from and secured by the same source of revenue or taxing authority where the aggregate book value of such securities exceeded 10% of stockholders' equity or $81.4 million. 26
TABLE 15: INVESTMENT SECURITIES PORTFOLIO MATURITY DISTRIBUTION(1) DECEMBER 31, 1997 <TABLE> <CAPTION> INVESTMENT SECURITIES HELD TO MATURITY--MATURITY DISTRIBUTION AND WEIGHTED AVERAGE YIELD ------------------------------------------------------------------------------------------------------------- AFTER ONE AFTER FIVE MORTGAGE- WITHIN BUT WITHIN BUT WITHIN AFTER RELATED ONE YEAR FIVE YEARS TEN YEARS TEN YEARS SECURITIES TOTAL TOTAL ------------------------------------------------------------------------------------------------------------- AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD FAIR VALUE ------------------------------------------------------------------------------------------------------------- ($ IN THOUSANDS) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> U.S. Treasury Securities $ 498 6.10% $ -- -- $ -- -- $ -- -- $ -- -- $ 498 6.10% $ 500 Federal agency securities 55,502 5.39% 77,258 6.25% 13,499 6.97% -- -- -- -- 146,259 5.99% 146,818 Obligations of states and political subdivisions 24,110 7.40% 92,965 7.51% 65,700 7.19% 511 7.35% -- -- 183,286 7.38% 186,300 Mortgage-related securities -- -- -- -- -- -- -- -- 361,298 7.21% 361,298 7.21% 365,952 Other securities (debt) 9,852 6.20% 56,708 6.89% 14,623 6.76% -- -- -- -- 81,183 6.78% 82,670 ------------------------------------------------------------------------------------------------------------- Total Amortized Cost $ 89,962 6.02% $226,931 6.93% $93,822 7.09% $ 511 7.35% $ 361,298 7.21% $ 772,524 6.97% $ 782,240 ------------------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------------------- Total Fair Value $ 89,990 $230,130 $95,636 $ 532 $ 365,952 $ 782,240 ------------------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------------------- <CAPTION> INVESTMENT SECURITIES AVAILABLE FOR SALE--MATURITY DISTRIBUTION AND WEIGHTED AVERAGE YIELD ------------------------------------------------------------------------------------------------------------- AFTER ONE AFTER FIVE MORTGAGE- WITHIN BUT WITHIN BUT WITHIN AFTER RELATED ONE YEAR FIVE YEARS TEN YEARS TEN YEARS SECURITIES TOTAL TOTAL ------------------------------------------------------------------------------------------------------------- AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD FAIR VALUE ------------------------------------------------------------------------------------------------------------- ($ IN THOUSANDS) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> U.S. Treasury securities $ 41,019 5.95% $ 68,181 6.14% $ -- -- $ -- -- $ -- -- $ 109,200 6.07% $ 109,841 Federal agency securities 70,197 5.85% 213,669 6.19% 8,188 6.75% 32,654 7.20% -- -- 324,708 6.23% 330,542 Obligations of states and political subdivisions 200 8.63% 2,179 8.25% 11,564 6.94% 369 9.28% -- -- 14,312 7.22% 14,136 Mortgage-related securities -- -- -- -- -- -- -- -- 1,536,134 6.55% 1,536,134 6.55% 1,557,603 Other securities (debt and equity) 137,712 5.58% 3,894 6.72% 475 6.82% -- -- -- -- 142,081 5.61% 155,572 ------------------------------------------------------------------------------------------------------------- Total Amortized Cost $249,128 6.34% $287,923 6.48% $20,227 6.97% $33,023 6.19% $1,536,134 6.55% $2,126,435 6.42% $2,167,694 ------------------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------------------- Total Fair Value $262,597 $289,219 $20,169 $38,106 $1,557,603 $2,167,694 ------------------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------------------- </TABLE> (1) Expected maturities will differ from contractual maturities, as borrowers may have the right to call or repay obligations with or without call or prepayment penalties. (2) Yields on tax-exempt securities are computed on a tax-equivalent basis using a tax rate of 35% and have not been adjusted for certain disallowed interest deductions. 27
DEPOSITS Average total deposits in 1997 were $8.1 billion, an increase of 4.4% or $344 million over 1996. Included in this growth is $59.7 million of increase in the balance of purchased brokered CDs. For the full year of 1997, the average balance of brokered CDs in total deposits was $139.7 million, which is included in time deposits in the table shown below. Adjusted for brokered CDs, internal deposit growth in 1997 was 3.7%. TABLE 16: AVERAGE DEPOSITS DISTRIBUTION <TABLE> <CAPTION> YEARS ENDED DECEMBER 31, -------------------------------- 1997 1996 1995 ---------- ---------- ---------- (IN THOUSANDS) <S> <C> <C> <C> Noninterest-bearing demand deposits $ 741,790 $ 697,470 $ 665,799 Interest-bearing demand deposits 712,458 673,106 603,734 Savings deposits 1,073,244 1,121,531 1,146,282 Money market deposits 902,186 799,795 697,128 Time deposits 4,692,333 4,486,355 4,296,466 -------------------------------- Total deposits $8,122,011 $7,778,257 $7,409,409 ================================ </TABLE> Year-end 1997 noninterest-bearing deposits were $905 million compared to $804 million at the end of 1996. These amounts are substantially above the respective yearly average balance amounts. Demand deposits normally show a sizable increase as businesses, public entities and correspondent banks adjust their cash positions at year-end. Average noninterest-bearing demand deposits as a percentage of total average deposits increased to 9.1% in 1997 compared to 9.0% for both 1996 and 1995. TABLE 17: AVERAGE RATES PAID ON DEPOSITS <TABLE> <CAPTION> YEARS ENDED DECEMBER 31, ---------------------------- 1997 1996 1995 -------- -------- -------- <S> <C> <C> <C> Interest-bearing demand deposits 1.67% 1.69% 1.72% Savings deposits 2.27 2.45 2.68 Money market deposits 3.77 3.53 3.53 Time deposits 5.69 5.66 5.52 -------- -------- -------- Total interest-bearing deposits 4.57% 4.53% 4.49% ======== ======== ======== </TABLE> The total average interest-bearing demand, savings, and money market deposits increased to $2.69 billion for 1997 from $2.59 billion in 1996. These deposits as a percentage of total average deposits have remained relatively stable over the past three years at 33.1% in 1997, 33.4% in 1996 and 33.0% in 1995. TABLE 18: MATURITY DISTRIBUTION--CERTIFICATES OF DEPOSIT AND OTHER TIME DEPOSITS OF $100,000 OR MORE <TABLE> <CAPTION> DECEMBER 31, 1997 -------------------------- CERTIFICATES OTHER OF DEPOSIT TIME DEPOSITS ------------ ------------- (IN THOUSANDS) <S> <C> <C> Three months or less $326,911 $56,858 Over three months through six months 146,204 13,695 Over six months through twelve months 133,903 -- Over twelve months 102,283 -- -------------------- Total $709,301 $70,553 ==================== </TABLE> The Corporation continues to experience strong competition for deposits in its markets. This is true for both the business and retail segments of the market. During 1997, the Corporation's affiliates offered a number of different products with specific features and competitive pricing. The deposit products are designed to retain core deposit accounts, attract new customers, and create opportunities for providing other bank services or relationships. 28
SHORT-TERM BORROWINGS Short-term borrowings consist of federal funds purchased, securities sold under repurchase agreements, Federal Home Loan Bank notes, notes payable to banks, commercial paper, treasury tax and loan notes, collateralized mortgage obligations and industrial revenue bonds. Average total short-term borrowings were $1.29 billion compared with $929 million in 1996. TABLE 19: SHORT-TERM BORROWINGS <TABLE> <CAPTION> DECEMBER 31, ---------------------------------- 1997 1996 1995 ---------- ---------- ---------- (IN THOUSANDS) <S> <C> <C> <C> Federal funds purchased and securities sold under agreements to repurchase $ 712,250 $ 666,030 $ 451,197 Federal Home Loan Bank 525,317 451,380 335,644 Notes payable to banks 87,139 68,937 66,647 Subordinated notes -- -- 54,925 Commercial paper 1,250 2,172 2,326 Current maturities of long-term borrowings -- 3,067 800 Other borrowed funds 11,052 9,807 7,852 ------------------------------- Total $1,337,008 $1,201,393 $ 919,391 ------------------------------- ------------------------------- Average amounts outstanding during year $1,287,900 $ 928,942 $ 891,495 Average interest rates on amounts outstanding during year 5.63% 5.62% 6.18% Maximum month-end amounts outstanding $1,405,233 $1,201,393 $1,071,284 Average interest rates on amounts outstanding at end of year 5.75% 5.82% 5.89% </TABLE> The change in short-term borrowings outstanding is attributable to larger amounts of overnight federal funds purchased and Federal Home Loan Bank notes with a remaining maturity less than 1 year as subsidiary banks continue to supplement the funding of asset growth with wholesale funds. The notes payable to banks and commercial paper are primarily used to fund residential, commercial, and leasing lending activities at the Corporation's residential mortgage, commercial mortgage, and leasing subsidiaries. LIQUIDITY Liquidity refers to the ability of the Corporation to generate adequate amounts of cash to meet the Corporation's needs for cash. The affiliates and the parent company of the Corporation have different liquidity considerations. Affiliates meet their cash flow requirements by having funds available to satisfy customer credit needs as well as having available funds to satisfy deposit withdrawal requests. Liquidity at banking subsidiaries is derived from deposit growth, money market investments, maturing loans, the maturity of investment securities held to maturity, the maturity or sale of investment securities available for sale, access to other funding sources and markets, and a strong capital position. Deposit growth is the primary source of liquidity at the banking subsidiaries. Total period-end deposits increased $405 million from 1996 to 1997. The Corporation's overall deposit base grew an average of $344 million, or 4.4% during 1997. Deposit growth, especially in the core deposit base, is the most stable source of liquidity of a bank. Another substantial source of liquidity is the Corporation's maturing investment securities portfolio, particularly securities maturing within one year. At December 31, 1997, excluding mortgage-related securities, the amortized cost of securities, both securities held to maturity and securities available for sale, maturing within one year amounted to $339 million. At the end of 1997, the securities portfolio contained $434 million at amortized cost of U.S. Treasury and federal agency securities available for sale. These government securities are highly marketable and had a market value of $440 million or 101.5% of amortized cost at year-end. 29
The loan portfolio is also a source of additional liquidity. The Corporation has $906 million of commercial loans and real estate-construction loans maturing within one year and a steady flow of repayments in the mortgage and installment loan portfolios. Additionally, the Corporation has $3.8 billion of loans secured 1- to 4-family residential property that could possibly be securitized. Within the classification of short-term borrowings at year-end 1997, federal funds purchased and securities sold under agreements to repurchase totaled $712 million compared to $666 million at the end of 1996. Federal funds are purchased from a sizable network of correspondent banks while securities sold under agreements to repurchase are obtained from a base of individual, business and public entity customers. The aggregate subsidiary liquidity resources were sufficient in 1997 to fund the growth in loans and the investment securities portfolio, and to meet other needs for cash when necessary. As of December 31, 1997, there were no material commitments for capital expenditures, i.e. to purchase fixed assets. Deposit growth will continue to be the primary source of bank subsidiary liquidity on a long-term basis, along with stable earnings, the resulting cash generated by operating activities and strong capital positions. Shorter-term liquidity needs will mainly be derived from growth in short-term borrowings, maturing money market investments and investment portfolio securities, loan maturities and access to other funding sources. Liquidity is also necessary at the parent company level. The parent company's primary sources of funds are dividends and service fees from subsidiaries, borrowings and proceeds from issuance of equity. The parent company manages its liquidity position to provide the funds necessary to pay dividends to stockholders, service debt, invest in subsidiaries and satisfy other operating requirements. Dividends received from subsidiaries totaled $63.4 million in 1997 and will continue to be the parent's main source of long-term liquidity. The dividends from subsidiaries, along with a $17.3 million increase in net short-term borrowed funds, were sufficient to pay cash dividends to the Corporation's common stockholders of $49.3 million in 1997 and fund increased lending activities of nonbanking subsidiaries of $16.3 million. At December 31, 1997, $131.0 million in dividends could be paid to the parent by affiliates without obtaining prior regulatory approval, subject to the capital needs of the banks. Additionally, the parent company had $120 million of established lines of credit with nonaffiliated banks, of which $87.1 million was in use. Of the amount in use, the parent company downstreamed the majority to the Corporation's residential and commercial mortgage banking subsidiaries and leasing company for their use in funding loans and leases. The parent company also has access to funds from the issuance of the Corporation's commercial paper, although such funds are also downstreamed to the nonbanking subsidiaries. Commercial paper outstanding at December 31, 1997, totaled $1.3 million. The Corporation's long-term debt-to-equity ratio at December 31, 1997 was 1.9% compared to 4.1% at December 31, 1996. The decrease is attributable to the change in current maturities of long-term borrowings between years. Management believes that, in the current economic environment, the Corporation's subsidiary and parent company liquidity positions are adequate. There are no known trends nor any known demands, commitments, events or uncertainties that will result or are reasonably likely to result in a material increase or decrease in the Corporation's liquidity. INTEREST RATE SENSITIVITY AND MARKET RISK Interest rate risk is the exposure to a bank's earnings and capital arising from changes in future interest rates. All banks assume interest rate risk as an integral part of normal banking operations. The management of interest rate risk includes four components: policy statements, risk limits, risk measurement and reporting procedures. An important responsibility of the Asset/Liability Committee (ALCO) of each subsidiary bank is the management of risks associated with changing interest rates, changing asset and liability mixes, and their impact on earnings. These ALCO's, in turn, operate under the advisory policy guidelines on interest rate sensitivity set by the Corporation's ALCO. The sensitivity of net interest income to market rate changes is evaluated regularly by the Corporation to determine the effectiveness of interest rate risk management. 30
Table 20 reflects the Corporations expected cash flows and applicable yields on earning assets and interest-bearing liabilities and the resulting current fair market value after discounting expected cash flows at existing market rates. TABLE 20: MARKET RISK ANALYSIS INTEREST RATE RISK <TABLE> <CAPTION> EXPECTED PERIOD OF MATURITY ----------------------------------------------------------------------------- WITHIN 1-2 2-3 3-4 4-5 GREATER THAN 1 YEAR YEARS YEARS YEARS YEARS 5 YEARS TOTAL <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> ---------------------------------------------------------------------------------------------------- <CAPTION> FAIR YIELD/ YIELD/ YIELD/ YIELD/ YIELD/ YIELD/ YIELD/ MARKET BAL RATE BAL RATE BAL RATE BAL RATE BAL RATE BAL RATE BAL RATE VALUE <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> ---------------------------------------------------------------------------------------------------- <CAPTION> ($ IN MILLIONS) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Short-term investments (V) $ 16 5.36% $ -- -- $ -- -- $ -- -- $ -- -- $ -- -- $ 16 5.36% $ 16 Loans held for sale (V) 114 7.44% -- -- -- -- -- -- -- -- -- -- 114 7.44% 114 Treasury, Agency, Other Securities (F) 284 5.70% 113 6.20% 80 6.36% 103 6.35% 102 6.65% 73 6.95% 755 6.18% 778 Treasury, Agency, Other Securities (V) 13 4.38% -- -- 3 5.11% 1 7.75% 31 5.51% 1 7.58% 49 5.26% 49 Mortgage-related securities (F) 2 6.16% 3 6.78% 2 6.10% 60 6.93% 42 6.77% 356 7.13% 465 7.06% 471 Mortgage-related securities (V) -- -- -- -- -- -- -- -- -- -- 1,433 6.59% 1,433 6.59% 1,452 Municipal securities (F) 23 7.21% 24 7.61% 18 7.75% 26 7.61% 26 7.20% 81 7.23% 198 7.37% 200 Residential real estate loans (F) 491 8.03% 341 8.07% 264 8.08% 156 7.95% 115 7.89% 234 7.98% 1,601 8.02% 1,614 Residential real estate loans (V) 745 8.56% 283 7.40% 240 7.55% 127 7.51% 102 7.53% 275 7.53% 1,772 7.94% 1,791 Commercial loans (F) 594 8.86% 266 8.57% 248 8.44% 90 8.31% 68 8.34% 133 8.28% 1,399 8.61% 1,399 Commercial loans (V) 883 8.82% 32 8.47% 30 8.46% 28 8.45% 27 8.45% 82 8.44% 1,082 8.75% 1,082 Consumer loans (F) 252 8.92% 157 8.82% 110 8.72% 64 8.50% 39 8.31% 69 8.08% 691 8.71% 693 Consumer loans (V) 515 10.04% 16 13.38% -- -- -- -- -- -- -- -- 531 10.14% 530 ---------------------------------------------------------------------------------------------------- Total interest earning assets $3,932 8.53% $1,235 8.01% $995 7.97% $655 7.63% $552 7.45% $2,737 7.08% $10,106 7.90% $10,189 ---------------------------------------------------------------------------------------------------- Interest-bearing deposits (F) $3,221 5.69% $1,038 5.97% $181 6.11% $ 39 5.72% $ 25 5.84% $ 2 6.34% $ 4,506 5.78% $ 4,520 Interest-bearing deposits (V) 2,949 2.82% 4 5.55% -- -- -- -- -- -- -- -- 2,953 2.83% 2,953 Short-term borrowings (V) 1,337 5.67% -- -- -- -- -- -- -- -- -- -- 1,337 5.67% 1,337 Long-term borrowings (F) -- -- 4 14.27% 1 6.42% 1 7.17% 1 6.80% 8 6.62% 15 8.94% 15 ---------------------------------------------------------------------------------------------------- Total interest- bearing liabilities $7,507 4.56% $1,046 6.01% $182 6.11% $ 40 5.75% $ 26 5.85% $ 10 6.56% $ 8,811 4.78% $ 8,825 ---------------------------------------------------------------------------------------------------- </TABLE> (V) Variable repricing terms (F) Fixed repricing terms In November 1997, the Corporation hedged certain agency issued zero-coupon bonds held by FFC, with a carrying value of $37.2 million and a market value of $41.6 million, by executing various interest rate futures contracts. These contracts had a notional value of $70.5 million and a maturity date of March 1998. Subsequently, in January 1998, the futures contracts were closed and the zero-coupon bonds were sold. A net gain of $5.1 million will be recognized, in investment securities gains, in the first quarter of 1998 from these transactions. 31
Interest rate sensitivity analysis can be performed in several different ways. The traditional method of measuring interest sensitivity is called "gap" analysis. Gap analysis is used to identify mismatches in the repricing of assets and liabilities within specified periods of time or interest sensitivity gaps. For all assets and liabilities repriced within one year, the ratio of rate sensitive assets to rate sensitive liabilities was 80.2% at December 31, 1997. As presented, this traditional gap analysis does not accurately reflect the Corporation's true rate sensitivity position. The categories of savings, NOW, and money market accounts have been included in the 0-90 days category for this gap analysis. While these accounts are contractually short-term in nature, it is management's experience that repricing occurs over a longer period of time. Gap analysis also does not reflect the modification of the receipt of cash flows from principal repayments on mortgage related products, both loan and investments, due to changes in interest rate environments. Rising rates would extend the receipt of principal repayments closer to contractual maturity, while declining rates would accelerate the receipt of principal repayments. TABLE 21: INTEREST RATE SENSITIVITY ANALYSIS <TABLE> <CAPTION> DECEMBER 31, 1997 -------------------------------------------------------------------------- INTEREST SENSITIVITY PERIOD -------------------------------------------------------------------------- TOTAL 0-90 181-365 WITHIN OVER 1 DAYS 91-180 DAYS DAYS 1 YEAR YEAR TOTAL ----------- ----------- ----------- ----------- ---------- ----------- (IN THOUSANDS) <S> <C> <C> <C> <C> <C> <C> Earning assets: Loans, held for sale $ 114,001 $ -- $ -- $ 114,001 $ -- $ 114,001 Investment securities(1) 746,661 375,446 754,847 1,876,954 1,022,004 2,898,959 Loans, net of unearned income 2,449,779 524,329 1,032,766 4,006,874 3,069,702 7,076,576 Other earning assets 15,665 -- -- 15,665 -- 15,665 -------------------------------------------------------------------------- Total $ 3,326,106 $ 899,775 $ 1,787,613 $ 6,013,494 $4,091,706 $10,105,201 ========================================================================== Interest-bearing liabilities: Interest-bearing deposits(2) $ 3,981,761 $ 894,645 $ 1,284,355 $ 6,160,761 $1,298,666 $ 7,459,427 Other interest-bearing liabilities 860,135 417,984 58,889 1,337,007 15,271 1,352,278 -------------------------------------------------------------------------- Total interest-bearing liabilities $ 4,841,896 $ 1,312,629 $ 1,343,244 $ 7,497,768 $1,313,937 $ 8,811,705 ========================================================================== Interest sensitivity gap $(1,515,790) $ (412,854) $ 444,370 $(1,484,274) $2,777,770 $ 1,293,496 -------------------------------------------------------------------------- Cumulative interest sensitivity gap $(1,515,790) $(1,928,644) $(1,484,274) Cumulative ratio of rate sensitive assets to rate sensitive liabilities at December 31, 1997 68.7% 68.7% 80.2% ========================================================================== </TABLE> (1) Securities balances exclude $41.3 million of unrealized gains relating to available for sale securities. (2) Savings, NOW, and money market account balances totaling $2.76 billion are included in the 0-90 days category. While these accounts are contractually short-term in nature, it is management's experience that repricing occurs over a longer period of time. The Corporation uses simulation modeling results that incorporate the dynamics of balance sheet and interest rate changes and reflect the related impact on net interest income over a specified time horizon. The Corporation is continually reviewing its interest rate risk position and modifying its strategies based upon simulation projections under various interest rate levels. Additionally, the Corporation may enter into interest rate swap agreements to assist in managing interest rate risk. Management's philosophy is to maintain an appropriate rate sensitive asset and liability position to provide for stability in earnings in the event of significant interest rate changes. The Corporation believes that it has an effective process for managing interest rate risk. CAPITAL Stockholders' equity at December 31, 1997, increased to $813.7 million or $16.15 per share compared with $803.6 million or $16.01 per share at the end of 1996. The growth in stockholders' equity in 1997 was diminished by the $89.8 million after-tax charge for merger, integration and other one-time charges related to the merger with FFC. Year-end capital includes a $26.1 million equity component compared to $8.3 32
million at December 31, 1996, related to unrealized gains on securities available for sale, net of tax effect. Period-end stockholders' equity to assets in 1997 was 7.61% compared to 7.94% at the end of 1996. Cash dividends paid in 1997 were $1.11 per share compared with $0.95 per share in 1996, an increase of 17.0%. Cash dividends have increased at a 16.8% compounded rate during the past five years. 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 condition in markets served and strength of management. As of December 31, 1997 and 1996, the Corporation's Tier 1 risk-based capital ratios, total risk-based capital (Tier 1 and Tier 2) ratios and Tier 1 leverage ratios were well in excess of regulatory requirements. Management of the Corporation expects to continue to exceed the minimum standards in the future. Capital ratios are included in Note 19, Regulatory Matters, of the notes to consolidated financial statements. In 1997, the Corporation's Board of Directors authorized management to repurchase up to 100,000 shares of the Corporation's common stock each calendar quarter in the market. The shares repurchased would be available in connection with the Corporation's employee incentive plans and for other corporate purposes. Shares repurchased are held as treasury stock and, accordingly, are accounted for as a reduction of stockholders' equity. The Corporation purchased 81,736 of its common shares in 1997 and 92,684 in 1996. Management believes that a strong capital position is necessary to take advantage of opportunities for profitable geographic and product expansion, and to provide depositor and investor confidence. The Corporation's capital level remains strong, but must also be maintained at an appropriate level that provides the opportunity for a superior return on capital employed. Management actively reviews capital strategies for the Corporation and each of its subsidiaries to ensure that capital levels are appropriate based on the perceived business risks, future growth opportunities, industry standards, and regulatory requirements. YEAR 2000 The Corporation has completed its initial assessment of the Year 2000 issue. The Year 2000 issue relates to systems designed to use two digits rather than four to define the applicable year. This assessment was performed by an independent third party. Management believes that all operating systems critical to its delivery of customer service will be Year 2000 compliant prior to December 31, 1998. The cost of implementing the recommendations of the initial assessment are not deemed to be material, and thus, will not have a significant impact on the Corporation's results of operations, liquidity or capital resources. ACCOUNTING DEVELOPMENTS In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 130, "Reporting Comprehensive Income". SFAS 130 is effective for both interim and annual periods beginning after December 15, 1997. SFAS 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general purpose financial statements. It does not specify when to recognize or how to measure items that make up comprehensive income. SFAS 130 requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed in equal prominence with the other financial statements and requires that an enterprise display an amount representing total comprehensive income for the period in that financial statement. SFAS 130 requires classification of "other comprehensive income" items by their nature in the financial statement and display of the balance of other comprehensive income separately in the equity section of the statement of financial position. It does not require per share amounts of comprehensive income to be disclosed. Management of the Corporation does not expect that adoption of SFAS 130 will have a material effect on the consolidated financial statements of the Corporation. 33
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information". SFAS 131 is effective for financial statements for periods beginning after December 15, 1997. SFAS 131 establishes standards for the way public business enterprises are to report information about operating segments in annual financial statements and requires those enterprises to report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. SFAS 131 replaces the "industry segment" concept of SFAS 14 with 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 and assessing performance. Consequently, the segments are evident from the structure of the enterprise's internal organization. It focuses on financial information that an enterprise's decisionmakers use to make decisions about the enterprise's operating matters. The Corporation will be adopting SFAS 131 in 1998. 34
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ASSOCIATED BANC-CORP CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION <TABLE> <CAPTION> DECEMBER 31, ------------------------ 1997 1996 ----------- ----------- (IN THOUSANDS EXCEPT SHARE DATA) <S> <C> <C> ASSETS Cash and due from banks $ 288,021 $ 369,842 Interest-bearing deposits in other financial institutions 4,154 3,183 Federal funds sold and securities purchased under agreements to resell 11,511 27,977 Investment securities: Held to maturity--at amortized cost (Fair value of approximately $782,240 and $1,074,412 at December 31, 1997 and 1996, respectively) 772,524 1,079,749 Available for sale--at fair value 2,167,694 1,674,189 Loans held for sale 114,001 42,490 Loans 7,076,576 6,658,357 Allowance for possible loan losses (92,731) (71,767) - ------------------------------------------------------------------------------- Loans, net 6,983,845 6,586,590 Premises and equipment 127,823 127,708 Other assets 221,866 211,655 - ------------------------------------------------------------------------------- Total assets $10,691,439 $10,123,383 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Noninterest-bearing deposits $ 904,710 $ 804,020 Interest-bearing deposits 7,459,427 7,155,278 - ------------------------------------------------------------------------------- Total deposits 8,364,137 7,959,298 Short-term borrowings 1,337,008 1,201,393 Long-term borrowings 15,270 33,329 Accrued expenses and other liabilities 161,331 125,801 - ------------------------------------------------------------------------------- Total liabilities 9,877,746 9,319,821 - ------------------------------------------------------------------------------- Commitments and contingent liabilities -- -- - ------------------------------------------------------------------------------- Stockholders' equity Preferred stock (Par value $1.00 per share, authorized 750,000 shares, no shares issued) -- -- Common stock (Par value $0.01 per share, authorized 100,000,000 shares, issued 50,394,647 and 50,211,171 shares at December 31, 1997 and 1996, respectively) 504 465 Surplus 218,072 230,810 Retained earnings 569,996 564,924 Net unrealized gain on securities available for sale, net of taxes 26,144 8,281 Less: Treasury stock at cost (18,894 shares in 1997 and 26,226 shares in 1996) (1,023) (918) - ------------------------------------------------------------------------------- Total stockholders' equity 813,693 803,562 - ------------------------------------------------------------------------------- Total liabilities and stockholders' equity $10,691,439 $10,123,383 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- </TABLE> See accompanying notes to Consolidated Financial Statements. 35
ASSOCIATED BANC-CORP CONSOLIDATED STATEMENTS OF INCOME <TABLE> <CAPTION> FOR THE YEARS ENDED DECEMBER 31, ---------------------------- 1997 1996 1995 -------- -------- -------- (IN THOUSANDS EXCEPT PER SHARE DATA) <S> <C> <C> <C> INTEREST INCOME Interest and fees on loans $592,071 $563,699 $534,269 Interest and dividends on investment securities: Taxable 184,231 156,967 151,575 Tax-exempt 9,164 8,827 7,584 Interest on deposits in other financial institutions 779 437 596 Interest on federal funds sold and securities purchased under agreements to resell 999 1,267 2,426 Interest on trading account securities -- -- 408 - ---------------------------------------------------------------------------- Total interest income 787,244 731,197 696,858 - ---------------------------------------------------------------------------- INTEREST EXPENSE Interest on deposits 337,443 320,915 303,083 Interest on short-term borrowings 72,509 52,184 55,105 Interest on long-term borrowings 1,685 2,824 2,311 - ---------------------------------------------------------------------------- Total interest expense 411,637 375,923 360,499 - ---------------------------------------------------------------------------- NET INTEREST INCOME 375,607 355,274 336,359 Provision for possible loan losses 31,668 13,695 14,029 - ---------------------------------------------------------------------------- Net interest income after provision for possible loan losses 343,939 341,579 322,330 - ---------------------------------------------------------------------------- NONINTEREST INCOME Trust service fees 28,764 25,185 22,243 Service charges on deposit accounts 27,909 26,004 23,861 Mortgage banking income 25,709 23,873 18,052 Loan fees 16,407 14,505 13,023 Retail commission income 15,446 12,757 10,760 Asset sale gains, net 852 12,520 428 Investment securities gains (losses), net (32,776) (10,678) 1,512 Other 13,665 12,679 15,110 - ---------------------------------------------------------------------------- Total noninterest income 95,976 116,845 104,989 - ---------------------------------------------------------------------------- NONINTEREST EXPENSE Salaries and employee benefits 133,656 126,154 115,837 Net occupancy expense 20,297 19,563 19,159 Data processing expense 16,900 15,905 15,068 Business development and advertising 15,936 14,754 11,120 Equipment rentals, depreciation and maintenance 12,600 12,033 11,433 Stationery and supplies 5,532 5,030 5,325 FDIC expense 3,284 9,675 13,799 Merger, integration and other one-time charges 51,622 33,005 6,458 Other 63,820 57,116 54,728 - ---------------------------------------------------------------------------- Total noninterest expense 323,647 293,235 252,927 - ---------------------------------------------------------------------------- Income before income taxes and extraordinary item 116,268 165,189 174,392 Income tax expense 63,909 57,487 62,381 - ---------------------------------------------------------------------------- Income before extraordinary item 52,359 107,702 112,011 Extraordinary item, net of income taxes of $370 -- (686) -- - ---------------------------------------------------------------------------- Net income $ 52,359 $107,016 $112,011 - ---------------------------------------------------------------------------- - ---------------------------------------------------------------------------- Earnings per share: Basic: Income before extraordinary item $ 1.04 $ 2.13 $ 2.28 Extraordinary item -- (.01) -- Net income $ 1.04 $ 2.12 $ 2.28 Diluted: Income before extraordinary item $ 1.02 $ 2.09 $ 2.24 Extraordinary item -- (.01) -- Net Income $ 1.02 $ 2.08 $ 2.24 - ---------------------------------------------------------------------------- - ---------------------------------------------------------------------------- </TABLE> See accompanying notes to Consolidated Financial Statements. 36
ASSOCIATED BANC-CORP CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY <TABLE> <CAPTION> NET UNREALIZED GAIN (LOSS) ON COMMON COMMON STOCK SECURITIES STOCK -------------- RETAINED AVAILABLE TREASURY PURCHASED SHARES AMOUNT SURPLUS EARNINGS FOR SALE STOCK BY ESOP TOTAL ------ ------ -------- -------- ---------- -------- --------- -------- (IN THOUSANDS) <S> <C> <C> <C> <C> <C> <C> <C> <C> Balance, December 31, 1994, as previously reported 14,531 $145 $159,086 $148,081 $(3,986) $(4,043) $ -- $299,283 Adjustment to retroactively restate 1997 business combinations accounted for as pooling of interests 27,850 278 75,214 261,949 ( 8,619) -- (1,608) 327,214 - ----------------------------------------------------------------------------------------------------- Balance December 31, 1994, as restated 42,381 423 234,300 410,030 (12,605) (4,043) (1,608) 626,497 - ----------------------------------------------------------------------------------------------------- Net income -- -- -- 112,011 -- -- -- 112,011 Cash dividends, $0.81 per share -- -- -- (16,924) -- -- -- (16,924) Cash dividends of pooled affiliates -- -- -- (14,156) -- -- -- (14,156) 5-for-4 stock split effected in the form of a stock dividend 3,153 32 -- (32) -- -- -- -- Exercise of incentive stock options 509 5 2,610 -- -- 1,863 -- 4,478 Payment on ESOP loan -- -- -- -- -- -- 790 790 Tax benefits of restricted shares and options -- -- 443 -- -- -- -- 443 Change in unrealized gain (loss) on securities available for sale, net of related income taxes -- -- -- -- 12,693 -- -- 12,693 Reissuance of treasury stock in a business combination (15) -- (478) -- -- 478 -- -- Purchase of treasury stock -- -- -- -- -- (2,085) -- (2,085) Pre-merger transactions of pooled company 44 -- 822 -- -- -- 547 1,369 - ----------------------------------------------------------------------------------------------------- Balance, December 31, 1995 46,072 460 237,697 490,929 88 (3,787) (271) 725,116 - ----------------------------------------------------------------------------------------------------- Net income -- -- -- 107,016 -- -- -- 107,016 Cash dividends, $0.95 per share -- -- -- (20,278) -- -- -- (20,278) Cash dividends of pooled affiliates -- -- -- (19,309) -- -- -- (19,309) Issuance of stock in connection with business combinations 868 9 9,800 6,566 8 -- -- 16,383 Exercise of incentive stock options 303 3 966 -- -- 2,208 -- 3,177 Tax benefits of restricted shares and options -- -- 564 -- -- -- -- 564 Retirement of stock previously issued in connection with a business combination (212) (2) (3,760) -- -- 3,762 -- -- Payment on ESOP loan -- -- -- -- -- -- 271 271 Change in unrealized gain (loss) on securities available for sale, net of related income taxes -- -- -- -- 8,185 -- -- 8,185 Purchase of treasury stock -- -- -- -- -- (3,101) (3,101) Pre-merger transactions of pooled company (496) (5) (14,457) -- -- -- -- (14,462) - ----------------------------------------------------------------------------------------------------- Balance, December 31, 1996 46,535 465 230,810 564,924 8,281 (918) -- 803,562 - ----------------------------------------------------------------------------------------------------- Net income -- -- -- 52,359 -- -- -- 52,359 Cash dividends, $1.11 per share -- -- -- (16,983) -- -- -- (16,983) Cash dividends of pooled affiliates -- -- -- (32,345) -- -- -- (32,345) 6-for-5 stock split effected in the form of a stock dividend 3,746 37 (37) -- -- -- -- -- Issuance of stock in connection with business combinations 345 4 3,778 4,218 64 -- -- 8,064 Exercise of incentive stock options 382 4 3,847 (2,177) -- 3,494 -- 5,168 Tax benefits of restricted shares and options -- -- 716 -- -- -- -- 716 Change in unrealized gain (loss) on securities available for sale, net of related income taxes -- -- -- -- 17,799 -- -- 17,799 Purchase of treasury stock -- -- -- -- -- (3,599) -- (3,599) Pre-merger transactions of pooled company (613) (6) (21,042) -- -- -- -- (21,048) - ----------------------------------------------------------------------------------------------------- Balance, December 31, 1997 50,395 $504 $218,072 $569,996 $26,144 $(1,023) -- $813,693 - ----------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------- </TABLE> See accompanying notes to Consolidated Financial Statements. 37
ASSOCIATED BANC-CORP CONSOLIDATED STATEMENTS OF CASH FLOWS <TABLE> <CAPTION> FOR THE YEARS ENDED DECEMBER 31, --------------------------------- 1997 1996 1995 --------- ---------- ---------- (IN THOUSANDS) <S> <C> <C> <C> OPERATING ACTIVITIES Net Income $ 52,359 $ 107,016 $ 112,011 Adjustments to reconcile net income to net cash provided by operating activities: Provision for possible loan losses 31,668 13,695 14,029 Provision for losses on other real estate owned -- (467) 502 Depreciation and amortization 14,418 14,415 13,075 Amortization of mortgage servicing rights 6,472 4,237 2,537 Amortization of intangibles 6,217 11,983 8,306 Deferred income taxes (20,953) (4,342) (6,174) Net amortization (accretion) of premiums and discounts (1,499) (9,116) 1,091 (Gain) loss on sales of securities, net 32,776 10,678 (1,512) Decrease (increase) in interest receivable and other assets (1,663) 8,369 (9,548) Increase in interest payable and other liabilities 33,597 7,842 16,389 Amortization (accretion) of loan fees and costs (522) 151 (224) Purchase of trading account securities -- (5) (1,294) Proceeds from sales of trading account securities -- 37 1,332 Net (increase) decrease in loans held for sale 5,810 29,586 (17,112) Gain on sales of loans held for sale, net (8,981) (6,976) (3,390) Gain on other asset sales, net (852) (12,520) (428) Other, net -- (417) 165 - ------------------------------------------------------------------------------- Net cash provided by operating activities $ 148,847 $ 174,166 $ 129,755 - ------------------------------------------------------------------------------- INVESTING ACTIVITIES Net decrease in federal funds sold and securities purchased under agreements to resell $ 20,891 $ 31,698 $ 12,535 Net decrease (increase) in interest-bearing deposits in other financial institutions (971) 32,398 (11,391) Purchases of held to maturity securities (203,759) (192,744) (205,029) Purchases of available for sale securities (316,112) (1,156,929) (132,740) Proceeds from sales of available for sale securities 71,178 434,145 20,946 Maturities of held to maturity securities 258,034 351,966 408,376 Maturities of available for sale securities 29,260 362,536 149,199 Net increase in loans (466,093) (418,676) (427,980) Proceeds from sales of other real estate owned 7,177 9,262 9,440 Purchases of premises and equipment, net of disposals (11,805) (27,528) (7,737) Mortgage servicing rights additions (9,801) (8,867) (8,341) Net cash received (paid) in acquisition of subsidiary 5,051 461 (480) Proceeds from sale of other assets 343 62,573 182 - ------------------------------------------------------------------------------- Net cash used by investing activities $(616,607) $ (519,705) $ (193,020) - ------------------------------------------------------------------------------- FINANCING ACTIVITIES Net increase in deposits $ 337,191 $ 163,736 $ 229,058 Net increase (decrease) in short-term borrowings 117,555 264,186 (40,723) Cash dividends (49,328) (39,587) (31,080) Repayment of long-term borrowings -- (2,644) (80,081) Proceeds from issuance of long-term borrowings -- 6,000 15,000 Proceeds from exercise of stock options 5,168 3,177 4,478 Proceeds from vesting of employee benefit plans -- 271 1,929 Stock purchases by pooled company (21,048) (14,447) -- Purchase of treasury stock (3,599) (3,101) (2,085) - ------------------------------------------------------------------------------- Net cash provided by financing activities $ 385,939 $ 377,591 $ 96,496 - ------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents (81,821) 32,052 33,231 Cash and due from banks at beginning of year 369,842 337,790 304,559 - ------------------------------------------------------------------------------- Cash and due from banks at end of year $ 288,021 $ 369,842 $ 337,790 - ------------------------------------------------------------------------------- Supplemental disclosures of cash flow information: Cash paid during the year for: Interest $ 409,797 $ 375,318 $ 349,899 Income taxes 79,440 59,661 67,741 Supplemental schedule of noncash investing activities: Loans transferred to other real estate 5,263 9,135 7,409 Loans made in connection with the disposition of other real estate 240 223 177 Mortgage loans securitized and transferred to securities available for sale -- 161,087 -- Securities transferred from held to maturity to available for sale 251,946 -- 412,771 Mortgage loans transferred to loans held for sale 68,340 27,068 15,467 Acquisitions: Fair value of assets acquired, including cash and cash equivalents -- 40,715 3,670 Value ascribed to intangibles -- 1,900 1,462 Liabilities assumed -- 34,772 5,132 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- </TABLE> See accompanying notes to Consolidated Financial Statements. 38
ASSOCIATED BANC-CORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997, 1996, AND 1995 NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: The accounting and reporting policies of Associated Banc-Corp and its subsidiaries (Corporation) conform to generally accepted accounting principles and to general practice within the banking and mortgage banking industries. The following is a description of the more significant of those policies. Throughout the notes to Consolidated Financial Statements, references are made to FFC (First Financial Corporation) and its wholly owned subsidiary FFB (First Financial Bank). BUSINESS The Corporation provides a full range of banking and related financial services to individual and corporate customers through its network of bank and nonbank affiliates in Wisconsin, Illinois, Nevada, Arizona, California and Missouri. The Corporation is subject to competition from other financial institutions and is regulated by federal and state banking agencies and undergoes periodic examinations by those agencies. BASIS OF FINANCIAL STATEMENT PRESENTATION The Consolidated Financial Statements include the accounts of the Corporation and subsidiaries, all of which are wholly-owned. All significant intercompany accounts and transactions have been eliminated in consolidation. Results of operations of companies purchased are included from the date of acquisition. The Consolidated Financial Statements have been restated to include companies acquired under pooling of interests when material. Certain amounts in the 1995 and 1996 consolidated financial statements have been reclassified to conform with the 1997 presentation. 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 possible loan losses and the valuation of investments and mortgage servicing rights. INVESTMENT SECURITIES Securities are classified as held to maturity, available for sale, or trading. Investment securities classified as held to maturity, which management has the intent and ability to hold to maturity, are reported at amortized cost, adjusted for amortization of premiums and accretion of discounts using a method that approximates level yield. The amortized cost of debt securities classified as held to maturity or available for sale is adjusted for amortization of premiums and accretion of discounts to earlier of call date or maturity, or in the case of mortgage-related securities, over the estimated life of the security. Such amortization and accretion is included in interest income from the related security. Available for sale and trading securities are reported at fair value with unrealized gains and losses, net of related deferred income taxes, included in stockholders' equity or income, respectively. Realized securities gains or losses and declines in value judged to be other than temporary are included in investment securities gains (losses), net in the consolidated statements of income. The cost of securities sold is based on the specific identification method. Any security for which there has been other than temporary impairment of value is written down to its estimated market value. In determining if declines in value are other than temporary, management estimates future cash flows to be generated by pools of loans underlying the mortgage-related securities. Included in this evaluation are such factors as (i) estimated loan prepayment rates, (ii) a review of delinquencies, foreclosures, repossessions and recovery rates relative to the underlying mortgage loans collateralizing each security, (iii) the level of available subordination or other credit enhancements, (iv) an assessment of the servicer of the underlying mortgage portfolio and (v) the rating assigned to each security by independent national rating agencies. 39
LOANS Loans and leases are carried at the principal amount outstanding, net of any unearned income. Unearned income, primarily from direct leases, is recognized on a basis that generally approximates a level yield on the outstanding balances receivable. Interest on all other loans is based upon the principal amount outstanding. Loans are normally placed on nonaccrual status when contractually past due 90 days or more as to interest or principal payments. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact on the collectibility of principal or interest on loans, it is management's practice to place such loans on nonaccrual status immediately, rather than delaying such action until the loans become 90 days past due. Previously accrued and uncollected interest on such loans is reversed, amortization of related loan fees is suspended, and income is recorded only to the extent that interest payments are subsequently received in cash and a determination has been made that the principal balance of the loan is collectable. If collectibility of the principal is in doubt, payments received are applied to loan principal. Loan origination fees and certain direct loan origination costs on real estate and commercial loans are deferred and recognized as an adjustment of yield using the interest method. Nonrefundable fees and direct origination costs associated with installment loans are insignificant and are not accounted for as an adjustment of yield of the related loan categories. Loan origination fees and direct origination costs on residential real estate loans held for sale are also not accounted for as an adjustment of yield. All other loan fees are included in other income. LOANS HELD FOR SALE Loans held for sale are recorded at the lower of cost or market as determined on an aggregate basis and generally consist of current production of certain fixed-rate first mortgage loans. Holding costs are treated as period costs. ALLOWANCE FOR POSSIBLE LOAN LOSSES The allowance for possible loan losses is a reserve for estimated credit losses. Credit losses arise primarily from the loan portfolio. Actual credit losses, net of recoveries, are deducted from the allowance for possible loan losses. A provision for possible loan losses, which is a charge against earnings, is added to bring the allowance to a level that, in management's judgment, is adequate to absorb losses inherent in the loan portfolio. Management performs an ongoing assessment of the loan portfolio to determine the appropriate level of the allowance. The factors considered in the evaluation include, but are not necessarily limited to, estimated losses from loans, general economic conditions, deterioration in credit concentration or pledged collateral, historical loss experience, and trends in portfolio volume, maturity, composition, delinquencies and nonaccruals. Estimated credit losses related to off balance sheet arrangements, if any, are included in accrued expenses and other liabilities. Management, considering current information and events regarding the borrower's ability to repay their obligations, considers a loan to be impaired when it is probable that the Corporation will be unable to collect all amounts due according to the contractual terms of the note agreement, including principal and interest. Management has determined that commercial loans and commercial real estate loans that have a nonaccrual status or have had their terms restructured meet this definition. Large groups of homogeneous loans, such as mortgage and installment loans and leases, are collectively evaluated for impairment. The amount of impairment is measured based on the fair value of the collateral, if the loan is collateral dependent, or alternatively, at the present value of expected future cash flows discounted at the loan's effective interest rate. Interest income on impaired loans is recorded when cash is received and only if principal is considered to be fully collectable. Management believes that the allowance for possible loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation's allowance for possible loan losses. Such 40
agencies may require the Corporation to recognize additions to the allowance based on their judgments about information available to them at the time of their examinations. REAL ESTATE ACQUIRED IN FORECLOSURE Real estate acquired in foreclosure includes properties acquired in partial or total satisfaction of loans and is included in other assets in the accompanying consolidated statements of financial condition. Properties are recorded at the lower of recorded investment in the loans at the time of acquisition or the fair value of the properties, less estimated selling costs. Any write-down in the carrying value of a property at the time of acquisition is charged to the allowance for possible loan losses. Any subsequent write- downs to reflect current fair market value, as well as gains and losses on disposition and revenues and expenses incurred in maintaining such properties, are expensed. PREMISES AND EQUIPMENT Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed on the straight-line method over the estimated useful lives of the related assets or the lease term. Maintenance and repairs are charged to expense as incurred while additions or major improvements are capitalized and depreciated over their estimated useful lives. Estimated useful lives for premises include periods up to 50 years and for equipment include periods up to 10 years. INTANGIBLES The excess of the purchase price over the fair value of net assets of subsidiaries acquired consists primarily of goodwill and core deposit intangibles that are being amortized on straight-line and accelerated methods. Goodwill is amortized to operating expense over periods of 10 to 40 years. Core deposit intangibles are amortized to expense over periods of 7 to 10 years. Other intangibles are amortized on an accelerated basis over shorter periods. The Corporation reviews long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. During 1997 and 1996, the Corporation recorded additional goodwill and deposit base intangible amortization of $1.6 million and $4.2 million, respectively. Goodwill outstanding, net of accumulated amortization, at December 31, 1997 and 1996 was $22.7 million and $26.7 million, respectively. Deposit base intangibles outstanding, net of accumulated amortization, at December 31, 1997 and 1996 was $11.7 million and $15.6 million, respectively. MORTGAGE SERVICING RIGHTS The Corporation recognizes as separate assets the rights to service mortgage loans for others, however those rights are acquired. Capitalized mortgage servicing rights are assessed for impairment based on the fair value of those rights. The fair value of mortgage servicing rights is determined based on quoted market prices for comparable transactions or a present value model of expected future cash flows. Mortgage servicing rights are amortized proportionately in relation to the associated servicing revenues over the estimated lives of the serviced loans. The Corporation evaluates and measures impairment of its servicing rights using stratifications based on the risk characteristics of the underlying loans. Management has determined those risk characteristics to include method of acquisition (bulk versus loan-by-loan). Bulk acquisitions are further stratified by loan type, while loan-by-loan acquisitions are further stratified by loan type and interest rate. Impairment is recognized through a valuation allowance. Deferred servicing rights are recorded when mortgage loans are sold with servicing retained and the actual service fee rate is in excess of the normal service fee rate. The present value of the deferred servicing rights is amortized on an accelerated basis over the estimated life of the remaining loan portfolio. The effects of prepayments are recognized based upon both historical and current prepayment conditions. 41
Effective January 1, 1997, the Corporation adopted Statement of Financial Accounting Standards (SFAS) No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." SFAS No. 125 requires that after a transfer of financial assets, the Corporation must recognize the financial and servicing assets controlled and liabilities incurred, and derecognize financial assets and liabilities in which control is surrendered or debt is extinguished. In such cases, servicing assets are determined based on estimated future revenues from contractually specified servicing fees and other ancillary revenues that are expected to compensate the Corporation for performing the servicing. The adoption of SFAS No. 125 has not had a material effect on the Corporation's consolidated financial statements. INCOME TAXES Amounts provided for income tax expense are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable under tax laws. Deferred income taxes, which arise principally from temporary differences between the period in which certain income and expenses are recognized for financial accounting purposes and the period in which they affect taxable income, are included in the amounts provided for income taxes. The Corporation files a consolidated federal income tax return and individual subsidiary state income tax returns. Accordingly, amounts equal to tax benefits of those subsidiaries having taxable federal losses or credits are reimbursed by other subsidiaries that incur federal tax liabilities. DERIVATIVE FINANCIAL INSTRUMENTS The Corporation enters into interest rate swap agreements to manage interest rate exposure in its loan portfolio from changes in market interest rates. These agreements involve the receipt of fixed or floating rate amounts in exchange for floating or fixed rate interest payments over the life of the agreement without an exchange of the underlying principal amount. The differential to be paid or received is accrued monthly and recognized as an adjustment to interest income or expense. The related amount payable to or receivable from counterparties is included in other liabilities or assets. The fair values of the swap agreements are not recognized in the consolidated financial statements. Gains or losses from terminated agreements are deferred and accreted or amortized to interest income over the remaining life of the asset related to the terminated agreement. Interest rate futures contracts are commitments to either purchase or sell a financial instrument at a specified price on an agreed-upon future date. These contracts may be settled either in cash or by delivery of the underlying financial instruments. Positions which are designated and effectively hedge specific securities are correlated based on certain duration and convexity parameters. Realized gains and losses on positions used in the management of specific asset positions are deferred and amortized over the terms of the item hedged as adjustments to interest income. Gains or losses from terminated contracts are recognized as an adjustment to the hedged asset's recognized gain or loss, included in investment security sales gains or losses in noninterest income. STOCK OPTION PLAN The Corporation accounts for its stock option and equity awards in accordance with Accounting Principles and Board Opinion No. 25 (APB Opinion No. 25) and related interpretations. The Corporation adopted SFAS No. 123, "Accounting for Stock-Based Compensation in 1996." The Corporation has included in Note 11 the impact of the fair value of employee stock-based compensation plans on net income and earnings per share on a pro forma basis for awards granted since January 1, 1995, pursuant to SFAS No. 123. CASH AND CASH EQUIVALENTS For purposes of the consolidated statements of cash flows, cash and cash equivalents are considered to include cash and due from banks. PER SHARE COMPUTATIONS The Corporation adopted SFAS No. 128, "Earnings Per Share," which became effective at year end 1997 for all periods presented. Under the provisions of SFAS No. 128, primary and fully diluted earnings per 42
share were replaced with basic and diluted earnings per share. Basic earnings per share is calculated by dividing net income available to common stockholders 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. All per share financial information except for the share information in the consolidated statements of changes in stockholders' equity, has been adjusted to reflect the 5-for-4 stock split, effected as a 25% stock dividend, paid to shareholders on June 15, 1995, and the 6-for-5 stock split, effected as a 20% stock dividend, paid to shareholders on March 17, 1997. The Corporation issued 500,995 shares of common stock to a wholly owned subsidiary as part of the 1996 acquisition of F&M Bankshares of Reedsburg, Inc. These shares are not reflected on the consolidated statements of financial condition as issued or outstanding nor were they adjusted for the 6-for-5 stock split. NOTE 2 BUSINESS COMBINATIONS: The following table summarizes completed transactions during the three years ended December 31, 1997: <TABLE> <CAPTION> CONSIDERATION PAID ------------------------ SHARES OF DATE METHOD OF CASH COMMON TOTAL ASSETS INTANGIBLES NAME OF ACQUIRED COMPANY ACQUIRED ACCOUNTING (IN MILLIONS) STOCK(A) (IN MILLIONS) (IN MILLIONS) - -------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> FirstRock Bancorp, Inc. (C)(F) 2/95 Pooling of $-- 4,175,381 $ 377 $ -- Rockford, Illinois interests Great Northern Mortgage 7/95 Purchase 1.2 -- (B) 1.5 Company Rolling Meadows, Illinois GN Bancorp, Inc. (C) Chicago, 8/95 Pooling of -- 897,151 130 -- Illinois interests SBL Capital Bank Shares, 3/96 Pooling of -- 399,548 68 -- Inc. (D) interests Lodi, Wisconsin Greater Columbia Bank Shares, 4/96 Pooling of -- 1,161,161 211 -- Inc. (C) interests Portage, Wisconsin F&M Bankshares of Reedsburg, 7/96 Pooling of -- 641,988 139 -- Inc. interests Reedsburg, Wisconsin (D)(E) Mid-America National Bancorp, 7/96 Purchase 7.8 -- 39 1.9 Inc. Chicago, Illinois Centra Financial, Inc. (D) 2/97 Pooling of -- 414,365 76 -- West Allis, Wisconsin interests First Financial 10/97 Pooling of 0.1 27,835,929 6,005 -- Corporation (C) interests Stevens Point, Wisconsin </TABLE> (A) Share amounts have been restated to reflect the 6-for-5 stock split to be effected as a 20% stock dividend payable on March 17, 1997, to shareholders of record at the close of business on March 5, 1997. (B)The Corporation acquired approximately $535 million in mortgage servicing as part of this acquisition. (C) All consolidated financial information has been restated as if the transaction had been effected as of the beginning of the earliest period presented. (D) The transaction was not material to prior years' reported operating results and, accordingly, previously reported results were not restated. (E)See "Per Share Computations" in Note 1. (F)Acquired by FFC prior to its merger with the Corporation. 43
NOTE 3 MERGER, INTEGRATION AND OTHER ONE-TIME CHARGES: The Corporation recorded merger, integration and other one-time charges of $51.6 million, $33.0 million and $6.5 million in 1997, 1996 and 1995, respectively. Merger, integration and other one-time charges of $51.6 million recorded in 1997 were associated with the acquisition of FFC. One-time charges in 1996 consist of $28.8 million associated with the recapitalization of the Savings Association Insurance Fund (SAIF) and $4.2 million relating to a change in accounting for the amortization of goodwill and other intangible assets. Merger and integration charges recorded in 1995 relate to the acquisition of FirstRock Bancorp, Inc. by FFC. The components of the charges are shown below: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ---------------------- 1997 1996 1995 ------- ------- ------ (IN THOUSANDS) <S> <C> <C> <C> Employee/director severance and contract costs $12,598 $ -- $3,813 SAIF recapitalization charge -- 28,767 -- Costs associated with duplicative facilities, computer systems, software and integration 20,181 -- 740 Investment banking, legal and accounting fees 11,151 -- 1,035 Change in accounting for the amortization of goodwill and other intangible assets -- 4,238 -- Other 7,692 -- 870 ----------------------- Total merger, integration and other one-time charges $51,622 $33,005 $6,458 ----------------------- ----------------------- </TABLE> The pretax impact of merger, integration and other one-time charges on basic earnings per share was $1.03, $0.65 and $0.13 in 1997, 1996 and 1995 respectively. The pretax effect of these charges on diluted earnings per share was $1.01 in 1997, $0.64 in 1996, and $0.13 in 1995. The 1997 merger, integration and other one-time charges of $51.6 million consisted of $22.5 million in cash expenditures made in 1997, $4.5 million in noncash asset write-downs and $24.6 million in anticipated cash expenditures which the Corporation expects will be paid in 1998. In addition, as a result of the merger with FFC, the Corporation also recorded an additional provision for possible loan losses of $16.8 million in order to conform with the policies, practices and procedures of the Corporation, and as discussed in Note 5, Investment Securities, a $35.3 million pre-tax charge for other than temporary impairment of value in the fourth quarter of 1997. NOTE 4 RESTRICTIONS ON CASH AND DUE FROM BANKS: The Corporation's bank subsidiaries are required to maintain certain vault cash and reserve balances with the Federal Reserve Bank to meet specific reserve requirements. These requirements approximated $57.4 million at December 31, 1997. 44
NOTE 5 INVESTMENT SECURITIES: The amortized cost and fair values of securities held to maturity at December 31, 1997 and 1996 were as follows: <TABLE> <CAPTION> 1997 ----------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ----------------------------------- (IN THOUSANDS) <S> <C> <C> <C> <C> U.S. Treasury securities $ 498 $ 2 $ -- $ 500 Federal agency securities 146,259 896 (337) 146,818 Mortgage-related securities 361,298 6,540 (1,886) 365,952 Obligations of state and political subdivisions 183,286 3,038 (24) 186,300 Other securities (debt) 81,183 1,491 (4) 82,670 ------------------------------------------- Total $ 772,524 $11,967 $ (2,251) $ 782,240 =========================================== <CAPTION> 1996 ----------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ----------------------------------- (IN THOUSANDS) <S> <C> <C> <C> <C> U.S. Treasury securities $ 4,204 $ 9 $ (10) $ 4,203 Federal agency securities 143,927 922 (928) 143,921 Mortgage-related securities 673,990 6,676 (12,298) 668,368 Obligations of state and political subdivisions 195,860 1,326 (1,621) 195,565 Other securities (debt) 61,768 674 (87) 62,355 ------------------------------------------- Total $1,079,749 $ 9,607 $(14,944) $1,074,412 =========================================== </TABLE> The amortized cost and fair values of securities available for sale at December 31, 1997 and 1996 were as follows: <TABLE> <CAPTION> 1997 ----------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ----------------------------------- (IN THOUSANDS) <S> <C> <C> <C> <C> U.S. Treasury securities $ 109,200 $ 737 $ (96) $ 109,841 Federal agency securities 324,708 7,558 (1,724) 330,542 Mortgage-related securities 1,536,134 21,848 (379) 1,557,603 Obligations of state and political subdivisions 14,312 229 (405) 14,136 Other securities (debt and equity) 142,081 14,178 (687) 155,572 ------------------------------------------- Total $2,126,435 $44,550 $(3,291) $2,167,694 =========================================== <CAPTION> 1996 ----------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ----------------------------------- (IN THOUSANDS) <S> <C> <C> <C> <C> U.S. Treasury securities $ 149,314 $ 655 $ (233) $ 149,736 Federal agency securities 326,049 2,156 (828) 327,377 Mortgage-related securities 1,057,992 5,667 (4,058) 1,059,601 Other securities (debt and equity) 127,787 10,446 (758) 137,475 ------------------------------------------- Total $1,661,142 $18,924 $(5,877) $1,674,189 =========================================== </TABLE> 45
The amortized cost and fair values of securities held to maturity and securities available for sale at December 31, 1997, by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or repay obligations with or without call or prepayment penalties. DECEMBER 31, 1997 INVESTMENT SECURITIES HELD TO MATURITY <TABLE> <CAPTION> AMORTIZED FAIR COST VALUE ---------- ---------- (IN THOUSANDS) <S> <C> <C> Due in one year or less $ 89,962 $ 89,990 Due after one year through five years 226,931 230,130 Due after five years through ten years 93,822 95,636 Due after ten years 511 532 ---------- ---------- Total (excluding mortgage-related securities) 411,226 416,288 ---------- ---------- Mortgage-related securities 361,298 365,952 ---------- ---------- Total Investment Securities Held to Maturity $ 772,524 $ 782,240 ========== ========== INVESTMENT SECURITIES AVAILABLE FOR SALE <CAPTION> AMORTIZED FAIR COST VALUE ---------- ---------- (IN THOUSANDS) <S> <C> <C> Due in one year or less $ 249,128 $ 262,597 Due after one year through five years 287,923 289,219 Due after five years through ten years 20,227 20,169 Due after ten years 33,023 38,106 ---------- ---------- Total (excluding mortgage-related securities) 590,301 610,091 ---------- ---------- Mortgage-related securities 1,536,134 1,557,603 ---------- ---------- Total Investment Securities Available for Sale $2,126,435 $2,167,694 ========== ========== </TABLE> Total proceeds and gross realized gains and losses from sale of securities available for sale for each of the three years ended December 31 were: <TABLE> <CAPTION> 1997 1996 1995 ------- -------- ------- (IN THOUSANDS) <S> <C> <C> <C> Proceeds $71,178 $434,145 $20,946 Gross gains 2,462 6,875 1,311 Gross losses -- 17,588 5 </TABLE> Concurrent with the consummation of the merger with FFC, the Corporation transferred all nonagency mortgage-related securities and an agency security, with a combined amortized cost of $251.9 million from securities held to maturity to securities available for sale. These mortgage-related securities were transferred to maintain the existing interest rate risk position and credit risk policy of the Corporation. Concurrent with the transfer, the Corporation recorded a $32.5 million pre-tax charge to earnings relative to one agency security with an amortized cost of $130.6 million. Management recorded this other than temporary impairment of value in the fourth quarter of 1997. This security is highly complex, comprised of multiple cash flows predominated by an inverse floater tied to libor for which stress tests indicate that the cash flows are volatile in higher interest rate environments. The estimated fair value of this security at the time of the other than temporary impairment charge was based on quoted prices of instruments with similar characteristics and cash flow valuation techniques. Additionally, the Corporation recorded a $2.8 million pre-tax charge, on other nonagency mortgage-related securities that were transferred to available for sale, with an amortized cost of $18.9 million to reflect an other than temporary impairment of value in the fourth quarter of 1997. These securities were subsequently sold with no additional loss in January 1998. 46
The net unrealized gain on the nonagency mortgage-related securities transferred to available for sale from held to maturity in 1997 that were not deemed to have an other than temporary impairment of value was $588,000, which was credited to stockholders' equity, net of income tax of $206,000. On November 25, 1996, the Corporation sold securities classified as held to maturity prior to their maturity dates. These securities were sold for $1.3 million which approximated amortized cost. These sales were made due to a significant deterioration in the issuer's creditworthiness and, therefore, were not considered to be inconsistent with their original classification. Securities with an amortized cost of approximately $836 million at December 31, 1997 and $668 million at December 31, 1996 were pledged to secure certain deposits, Federal Home Loan Bank advances, or for other purposes as required or permitted by law. NOTE 6 LOANS: Loans at December 31 are summarized below: <TABLE> <CAPTION> 1997 1996 ---------- ---------- (IN THOUSANDS) <S> <C> <C> Commercial and financial $ 951,396 $ 807,503 Agricultural 35,443 33,642 Real estate--construction 335,978 235,478 Real estate--mortgage 4,946,263 4,757,410 Installment loans to individuals 793,424 813,875 Lease financing 14,072 10,449 Total $7,076,576 $6,658,357 </TABLE> A summary of the changes in the allowance for possible loan losses for the years indicated is as follows: <TABLE> <CAPTION> 1997 1996 1995 -------- -------- -------- (IN THOUSANDS) <S> <C> <C> <C> Balance at beginning of year $ 71,767 $ 68,560 $ 65,774 Balance related to acquisitions 728 3,511 -- Charge-offs (15,049) (17,616) (15,872) Recoveries 3,617 3,617 4,629 ---------- Net charge-offs (11,432) (13,999) (11,243) Provision charged to expense 31,668 13,695 14,029 ---------- Balance at end of year $ 92,731 $ 71,767 $ 68,560 ---------- ---------- </TABLE> Nonaccrual loans totaled $32.4 million and $32.3 million at December 31, 1997 and 1996, respectively. Management has determined that commercial loans and commercial real estate loans that have a nonaccrual status or have had their terms restructured are defined as impaired loans. The following table presents data on impaired loans at December 31: <TABLE> <CAPTION> 1997 1996 ------- ------- (IN THOUSANDS) <S> <C> <C> Impaired loans for which an allowance has been provided $ 2,252 $ 1,920 Impaired loans for which no allowance has been provided 10,652 10,558 -------- Total loans determined to be impaired $12,904 $12,478 -------- -------- Required allowance $ 1,206 $ 1,001 -------- -------- </TABLE> For the years ended December 31: <TABLE> <CAPTION> 1997 1996 1995 ------- ------- ------- (IN THOUSANDS) <S> <C> <C> <C> Average recorded investment in impaired loans $13,103 $12,280 $10,668 ---------------------- ---------------------- Cash basis interest income recognized from impaired loans $ 650 $ 594 $ 695 ---------------------- ---------------------- </TABLE> 47
A summary of loans made by the Corporation's subsidiaries to or for the benefit of directors and executive officers or their affiliated companies of the Corporation or its subsidiaries during 1997 is as follows: <TABLE> <CAPTION> 1997 -------------- (IN THOUSANDS) <S> <C> Balance at beginning of year $ 73,945 New loans 31,779 Repayments (31,234) Other changes (1,629) -------- Balance at end of year $ 72,861 ======== </TABLE> The other changes primarily consisted of: loans to companies where an individual director had a related interest, but as of December 31, 1997, that individual was no longer a director; loans to directors, or their affiliated companies, newly elected in 1997; the beginning-of-year balance of loans to directors, or their affiliated companies, from an acquisition accounted for as pooling of interests, but not restated. These loans were made on substantially the same terms, including rates and collateral, if any, as those prevailing at the time for comparable transactions with other customers, and did not involve more than a normal risk of collectibility or present other unfavorable features. The Corporation serves the credit needs of its customers by offering a wide variety of loan programs to customers, primarily in Wisconsin and Illinois. The loan portfolio is widely diversified by types of borrowers, industry groups and market areas. Significant loan concentrations are considered to exist for a financial institution when there are amounts loaned to a multiple number of borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At December 31, 1997, no concentrations existed in the Corporation's loan portfolio in excess of 10% of total loans, or $708 million. Other real estate owned, which is included in other assets, totaled $2.1 million and $1.9 million at December 31, 1997 and 1996, respectively. NOTE 7 LOAN SERVICING RIGHTS: A summary of changes in the balance of mortgage servicing rights is as follows: <TABLE> <CAPTION> 1997 1996 1995 ------- ------- ------- (IN THOUSANDS) <S> <C> <C> <C> Balance at beginning of year $20,238 $15,634 $ 9,891 Additions 9,801 8,867 8,341 Amortization (6,472) (4,237) (2,598) Sales of servicing rights -- -- -- Valuation allowance (1,032) (26) -- ------- ------- ------- Balance at end of year $22,535 $20,238 $15,634 ======= ======= ======= </TABLE> At December 31, 1997, the Corporation was servicing 1- to 4-family residential mortgage loans owned by other investors with balances totaling $4.97 billion compared with $4.80 billion and $4.37 billion at December 31, 1996 and 1995, respectively. NOTE 8 PREMISES AND EQUIPMENT: A summary of premises and equipment at December 31 is as follows: <TABLE> <CAPTION> 1997 1996 --------- --------- (IN THOUSANDS) <S> <C> <C> Premises $ 120,570 $ 114,210 Land and land improvements 26,180 25,358 Furniture and equipment 102,193 99,022 Leasehold improvements 11,476 11,717 Less: Accumulated depreciation and amortization (132,596) (122,599) --------- --------- Total $ 127,823 $ 127,708 ========= ========= </TABLE> 48
Depreciation and amortization of premises and equipment totaled $14.2 million in 1997, $13.2 million in 1996, and $12.8 million in 1995. Third parties provide data processing and management information system services to the Corporation pursuant to agreements for information technology services. As of December 31, 1997, the Corporation was engaged in the renegotiations of agreements with its current primary providers. The current agreements are in effect through August 1, 2001 and February 28, 1999. The agreements provide for the delivery of certain information technology services over the life of the agreements. The agreements call for monthly fixed and variable fees covering the cost of systems operations and the migration to new systems. System migration fees are amortized over the life of agreements, while operational costs are expenses as incurred. Operational costs are subject to annual adjustment, indexed to changes in the Consumer Price Index (CPI). The facilities housing the data processing operations are owned by the Corporation, although remote processing locations are provided by vendors. Certain data processing and other related equipment is leased on a month-to- month basis. The costs associated with these contracts are included in the minimum annual rental and commitment table shown below. The Corporation and certain subsidiaries are obligated under a number of noncancelable operating leases for other facilities, equipment, and services, certain of which provide for increased rentals based upon increases in volume, cost of living adjustments, and other operating costs. The approximate minimum annual rentals and commitments under these noncancelable agreements and leases with remaining terms in excess of one year are as follows: <TABLE> <CAPTION> (IN THOUSANDS) -------------- <S> <C> 1998 $12,856 1999 9,030 2000 8,685 2001 5,826 2002 2,229 Thereafter 17,650 ------- Total $56,276 ======= </TABLE> Total rental and service expense under leases and other agreements, net of sublease income, totaled $21.6 million in 1997, $21.1 million in 1996, and $20.1 million in 1995. NOTE 9 DEPOSITS: The distribution of deposits at December 31 is as follows: <TABLE> <CAPTION> 1997 1996 ---------- ---------- (IN THOUSANDS) <S> <C> <C> Noninterest-bearing demand deposits $ 904,710 $ 804,020 Interest-bearing demand deposits 736,540 719,682 Savings deposits 1,012,050 1,046,604 Money market deposits 1,014,365 834,202 Time deposits 4,696,472 4,554,790 ---------- ---------- Total deposits $8,364,137 $7,959,298 ========== ========== </TABLE> 49
Time deposits of $100,000 or more were $779.9 million and $765.2 million at December 31, 1997 and 1996, respectively. Aggregate annual maturities of certificate accounts at December 31, 1997 are as follows: <TABLE> <CAPTION> MATURES DURING YEAR END DECEMBER 31, (IN THOUSANDS) - -------- ------------- <S> <C> 1998 $3,392,741 1999 1,050,804 2000 184,385 2001 39,921 2002 25,837 Thereafter 2,784 ---------- Total $4,696,472 ========== </TABLE> NOTE 10 SHORT-TERM BORROWINGS: Short-term borrowings at December 31 are as follows: <TABLE> <CAPTION> 1997 1996 ---------- ---------- (IN THOUSANDS) <S> <C> <C> Federal funds purchased and securities sold under agreements to repurchase $ 712,250 $ 666,030 Federal Home Loan Bank advances 525,317 451,380 Notes payable to banks 87,139 68,937 Commercial paper 1,250 2,172 Current maturities of long-term borrowings -- 3,067 Other borrowed funds 11,052 9,807 ---------- ---------- Total $1,337,008 $1,201,393 ========== ========== </TABLE> Commercial paper is issued in maturities not to exceed nine months at the prevailing market rate at date of issuance. Notes payable to banks are unsecured borrowings under existing lines of credit. At December 31, 1997, the Corporation's parent company had $120 million of established lines of credit with various nonaffiliated banks, of which $87.1 million was outstanding. Borrowings under these lines accrue interest at short-term market rates and are payable upon demand or in maturities up to 90 days. Subsidiary banks have collateral pledge agreements whereby they have agreed to keep on hand at all times, free of all other pledges, liens, and encumbrances, whole first mortgages on improved residential property with unpaid principal balances aggregating no less than 167% of all outstanding borrowings from the Federal Home Loan Bank. Loans totaling approximately $1.1 billion and $1.30 billion were maintained as collateral to secure Federal Home Loan Bank advances at December 31, 1997, and December 31, 1996, respectively. In addition, at December 31, 1997, an affiliate bank maintained as collateral to secure Federal Home Loan Bank advances, $12 million of mortgage-related securities. Included in short-term Federal Home Loan Bank advances are callable notes that have original maturities exceeding one year. However, these notes have one- year call premiums, which the Corporation expects to be called. 50
NOTE 11 LONG-TERM BORROWINGS: Long-term borrowings at December 31 are as follows: <TABLE> <CAPTION> 1997 1996 ------- ------- (IN THOUSANDS) <S> <C> <C> Parent company: 8.6% senior unsecured notes $ -- $ 400 9.35% subordinated capital note -- 2,667 ------- ------- Subsidiaries: Federal Home Loan Bank, 4.84% to 7.63% maturing in 1999 through 2004 5,882 21,698 Industrial development revenue bonds, 6.40% to 7.25% 5,900 6,015 Collateralized mortgage obligations 3,488 5,616 Less: Current maturities of long-term borrowings -- (3,067) ------- ------- Total $15,270 $33,329 ======= ======= </TABLE> The table below summarizes the maturities of the Corporation's long-term borrowings: <TABLE> <CAPTION> YEAR (IN THOUSANDS) - ---- ------------- <S> <C> 1998 $ -- 1999 4,010 2000 2,090 2001 735 2002 140 Thereafter 8,295 ------- Total 15,270 Current maturities of long-term borrowings -- ------- Total long-term borrowings $15,270 ======= </TABLE> The industrial revenue bonds are payable in seven annual installments ranging from $120,000 to $150,000 with additional payments of $1,910,000 and $3,320,000 due October 1, 2012 and 2021, respectively. Interest is payable semi-annually. The bonds were used to refinance an apartment project which was previously sold. The bonds are collateralized by mortgage-backed securities with a carrying value and fair value of $8,093,000 and $8,302,000, respectively, at December 31, 1997. FFB has a loan receivable from the buyer of $5,669,000 at December 31, 1997, which is secured by a first mortgage on the apartment project. UFS Capital Corporation and FFS Funding Corporation, wholly-owned finance subsidiaries of FFB, have issued the collateralized mortgage obligations. Principal repayments are scheduled in varying amounts through January, 2003. The obligations are collateralized by mortgage-backed securities held by UFS Capital Corporation with a carrying value of $6,847,000, and a fair value of $7,088,000 at December 31, 1997. In January 1996, FFC redeemed all of its outstanding 8% subordinated notes due November 1999, which aggregated $54,925,000 at the date of redemption. The after-tax cost of $686,000 associated with the redemption has been reported as an extraordinary charge in 1996. NOTE 12 STOCKHOLDERS' EQUITY: On March 17, 1997, the Corporation distributed 3.7 million shares of common stock in connection with a 6-for-5 stock split effected in the form of a 20% stock dividend. Additionally, on October 29, 1997, the Corporation issued 27.8 million shares in connection with the merger with FFC. The Corporation's Articles of Incorporation authorize the issuance of 750,000 shares of preferred stock at a par value of $1.00 per share. No shares have been issued. At December 31, 1997, subsidiary net assets equaled $746.1 million, of which approximately $131.0 million could be transferred to the Corporation in the form of cash dividends without prior regulatory approval, subject to the capital needs of each subsidiary. 51
The Corporation has an Incentive Stock Option Plan that provides for the granting of options to key employees to purchase common stock at a price at least equal to the fair market value of the stock on the date of grant. The options granted are for a ten-year term and may be exercised at any time during this period. As of December 31, 1997, 11,107 shares remain available for granting. No options have been granted from this plan since 1985. In January 1997, the Board of Directors, with subsequent approval of the Corporation's shareholders approved an amendment, increasing the number of shares available to be issued by an additional 720,000 shares, to the Restated Long-Term Incentive Stock Plan ("Stock Plan"). The Stock Plan was adopted by the Board of Directors and originally approved by shareholders in 1987 and amended in 1994. Options are generally exercisable up to 10 years from the date of grant and vest over two to three years. As of December 31, 1997, 865,278 shares remain available for grants. The stock incentive plans of acquired companies were terminated at each respective merger date. Option holders under such plans received the Corporation's common stock, or options to buy the Corporation's common stock, based on the conversion terms of the various merger agreements. The historical option information presented below has been restated to reflect the options originally granted under the acquired companies' plans. <TABLE> <CAPTION> WEIGHTED AVERAGE OPTIONS EXERCISE OUTSTANDING PRICE EXERCISABLE ------------------------------------- <S> <C> <C> <C> Balance, December 31, 1994 2,530,054 $ 3.24-$21.83 1,265,756 Granted 327,893 16.47- 24.17 124,675 Exercised (639,933) 4.04- 24.17 -- Forfeited (18,942) 19.28- 24.17 -- <CAPTION> ------------------------------------- <S> <C> <C> <C> Balance, December 31, 1995 2,199,072 $ 3.24-$24.17 1,390,431 <CAPTION> ------------------------------------- <S> <C> <C> <C> Granted 363,864 21.70- 30.73 66,843 Exercised (383,575) 3.24- 24.17 -- Forfeited (23,090) 10.45- 30.73 -- <CAPTION> ------------------------------------- <S> <C> <C> <C> Balance, December 31, 1996 2,156,271 $ 3.24-$30.73 1,457,274 <CAPTION> ------------------------------------- <S> <C> <C> <C> Granted 253,770 35.21- 40.72 -- Exercised (486,702) 3.39- 30.73 -- Forfeited (6,444) 15.42- 35.21 -- <CAPTION> ------------------------------------- <S> <C> <C> <C> Balance, December 31, 1997 1,916,895 $ 3.24-$40.72 1,457,274 <CAPTION> ===================================== </TABLE> Share and price information has been adjusted to reflect the March 17, 1997, 6-for-5 stock split effected as a 20% stock dividend. The following table summarizes information about the Corporation's stock option's outstanding at December 31, 1997: <TABLE> <CAPTION> WEIGHTED WEIGHTED OPTIONS AVERAGE REMAINING GRANTS AVERAGE OUTSTANDING EXERCISE PRICE LIFE (YEARS) EXERCISABLE EXERCISE PRICE ------------------------------------------------------------------ <S> <C> <C> <C> <C> <C> Range of Exercise Price: $ 3.24-$ 4.38 65,277 $ 3.51 2.51 65,277 $ 3.51 $ 5.12-$ 6.67 53,563 6.42 4.15 53,563 6.42 $ 8.37-$10.45 637,938 9.99 4.34 637,938 9.99 $14.25-$21.36 368,664 19.94 5.66 363,406 19.98 $21.70-$30.73 539,484 25.87 7.25 337,090 24.38 Greater than $35.21 251,969 35.31 9.09 -- -- <CAPTION> ------------------------------------------------------------------ <S> <C> <C> <C> <C> <C> TOTAL 1,916,895 $19.38 5.97 1,457,274 $15.39 <CAPTION> ================================================================== </TABLE> 52
The Corporation applies APB Opinion No. 25 in accounting for the Stock Plan and, accordingly, compensation cost based on fair value at grant date has not been recognized for its stock options in the consolidated financial statements during the three years ended December 31, 1997. Had the Corporation determined the compensation cost based on the fair value at grant date for its stock options under SFAS No. 123, "Accounting for Stock-Based Compensation", the Corporation's net income would have been reduced to the pro forma amounts indicated below: <TABLE> <CAPTION> FOR THE YEARS ENDED DECEMBER 31, ------------------------------------- 1997 1996 1995 ------- -------- -------- (IN THOUSANDS) <S> <C> <C> <C> <C> Net Income As Reported $52,359 $107,016 $112,011 Pro Forma $51,179 $106,293 $111,551 Basic Earnings Per Share As Reported $ 1.04 $ 2.12 $ 2.28 Pro Forma $ 1.02 $ 2.10 $ 2.27 Diluted Earnings Per Share As Reported $ 1.02 $ 2.08 $ 2.24 Pro Forma $ 1.00 $ 2.06 $ 2.23 </TABLE> Pro Forma net income reflects only options granted in 1997, 1996 and 1995. Therefore, the full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in the pro forma net income amounts presented above because compensation cost is reflected over the options' graded vesting period and compensation cost for options granted prior to January 1, 1995, is not considered. However, the annual expense allocation methodology prescribed by SFAS No. 123 attributes a higher percentage of the reported expense to earlier years than to later years, resulting in an accelerated expense recognition. The fair value of each option granted is estimated on the grant date using the Black-Scholes option-pricing model. The following assumptions were used in estimating the fair value for options granted in 1997, 1996 and 1995: <TABLE> <CAPTION> 1997 1996 1995 ------ ------ ------ <S> <C> <C> <C> Dividend yield 2.10% 3.00% 2.70% Risk free interest rate 6.47% 5.46% 7.65% Weighted average expected life 7 yrs. 7 yrs. 7 yrs. Expected volatility 19.64% 20.49% 21.54% </TABLE> The weighted average per share fair values of options granted in 1997, 1996 and 1995 were $10.01, $6.92 and $6.99, respectively. 53
NOTE 13 RETIREMENT PLAN: The Corporation has a noncontributory defined benefit retirement plan covering substantially all full-time employees. The benefits are based primarily on years of service and the employee's compensation paid while a participant in the plan. The Corporation's funding policy is consistent with the funding requirements of federal law and regulations. Plan assets are actively managed by investment professionals. The following table sets forth the plan's funded status at December 31: <TABLE> <CAPTION> 1997 1996 1995 -------- -------- -------- (IN THOUSANDS) <S> <C> <C> <C> Actuarial present value of accumulated benefit obligations: Vested $(23,940) $(20,103) $(19,471) Nonvested (1,983) (1,829) (1,888) ----------------------- Total $(25,923) $(21,932) $(21,359) ----------------------- Projected benefit obligation $(27,058) $(22,823) $(22,362) Plan assets at fair value, primarily marketable securities 30,085 24,783 21,778 ----------------------- Plan assets in excess of (less than) projected benefit obligation 3,027 1,960 (584) Unrecognized net asset (1,759) (1,955) (2,150) Unrecognized prior service cost 483 314 334 Unrecognized gain (5,700) (3,615) (1,639) ----------------------- Accrued pension liability $ (3,949) $ (3,296) $ (4,039) ----------------------- ----------------------- Net periodic pension costs include the following components: Service cost-benefits earned during the period $ 1,582 $ 1,465 $ 1,308 Interest cost on projected benefit obligation 1,729 1,593 1,622 Actual return on assets (6,131) (2,824) (4,515) Net amortization and deferral 4,144 1,048 2,856 ----------------------- Net periodic pension expense $ 1,324 $ 1,282 $ 1,271 ----------------------- ----------------------- Assumptions used in expense calculations were: Discount rates 7.50% 7.00% 8.00% Rates of increase in compensation levels 5.00% 5.00% 5.00% Expected long-term rate of return on assets 9.00% 9.00% 9.00% ----------------------- </TABLE> Assumptions used for the December 31, 1997 liability included a discount rate of 7.00% and a 5.00% increase in compensation levels. The Corporation and its subsidiaries, excluding FFC, also have a Profit Sharing/Retirement Savings Plan. Total expense related to contributions to the plan was $4.5 million, $4.4 million, and $3.7 million in 1997, 1996, and 1995, respectively. The profit sharing contribution is determined annually by the Administrative Committee of the Board of Directors. The formula is based on the return on average equity of each affiliate and the Corporation. FFC has a noncontributory defined benefit retirement plan covering substantially all Illinois-based employees. The benefits are based primarily on years of service and the employee's compensation paid while a participant in the plan. The Corporation's funding policy is consistent with the funding requirements of federal law and regulations. Plan assets are actively managed by investment professionals. This plan was merged into the Corporation's plan on January 1, 1998. 54
The following table sets forth the plan's funded status at December 31: <TABLE> <CAPTION> 1997 1996 1995 ------- ------- ------- (IN THOUSANDS) <S> <C> <C> <C> <C> Actuarial present value of accumulated benefit obligations: Vested $(3,281) $(2,936) $(2,971) Nonvested (698) (491) (155) ------------------------- Total $(3,979) $(3,427) $(3,126) ========================= Projected benefit obligation $(4,086) $(3,530) $(3,238) Plan assets at fair value, primarily marketable securities 4,145 4,080 4,143 ------------------------- Plan assets in excess of (less than) projected benefit obligation 59 550 905 Unrecognized net asset (919) (1,047) (1,175) Unrecognized prior service cost 180 190 201 Unrecognized loss 646 480 500 ------------------------- Accrued pension liability (receivable) $ (34) $ 173 $ 431 ========================= Net periodic pension costs include the following components: Service cost-benefits earned during the period $ 374 $ 363 $ 291 Interest cost on projected benefit obligation 286 256 240 Actual return on assets (554) (319) (765) Net amortization and deferral 101 (140) 357 ------------------------- Net periodic pension expense $ 207 $ 160 $ 123 ========================= Assumptions used in expense calculations were: Discount rates 7.50% 7.25% 8.25% Rates of increase in compensation levels 5.00% 5.00% 5.00% Expected long-term rate of return on assets 8.50% 8.50% 8.50% ------------------------------ </TABLE> Assumptions used for the December 31, 1997 liability included a discount rate of 7.00% and a 5.00% increase in compensation levels. FFC also has a defined-contribution profit sharing plan covering all full-time employees who have completed one year of service and are at least twenty-one years old. Corporate contributions are discretionary. Total expense related to contributions to the plan was $3.5 million, $2.1 million, and $0 in 1997, 1996, and 1995, respectively. This plan was merged into the Corporation's plan on January 1, 1998. FFC sponsored a supplemental executive retirement plan for certain executive officers, which is partially funded through life insurance and provides additional benefit at retirement, and an unfunded defined benefit retirement plan for all outside directors. FFC also entered into employment agreements with certain executive officers. As a result of the merger with the Corporation, FFC recorded a charge of $11.7 million for the year ended December 31, 1997 to terminate the plans and employment agreements. This charge is included in the Corporation's merger, integration and other one-time charges as described in Note 3. Expense for the supplemental retirement plan and defined-benefit retirement plan for outside directors was $480,000 and $341,000 for the years ended December 31, 1996 and 1995, respectively. 55
NOTE 14 INCOME TAX EXPENSE: The current and deferred amounts of income tax expense (benefit) are as follows: <TABLE> <CAPTION> YEARS ENDED DECEMBER 31, -------------------------- 1997 1996 1995 -------- ------- ------- (IN THOUSANDS) <S> <C> <C> <C> Current: Federal $ 75,238 $55,660 $59,350 State 9,624 6,169 9,205 -------------------------- Total current 84,862 61,829 68,555 -------------------------- Deferred: Federal (17,860) (2,875) (4,218) State (3,093) (1,467) (1,956) -------------------------- Total deferred (20,953) (4,342) (6,174) -------------------------- Total income tax expense 63,909 57,487 62,381 -------------------------- Extraordinary item -- (370) -- -------------------------- Total after extraordinary item $ 63,909 $57,117 $62,381 ========================== </TABLE> Temporary differences between the amounts reported in the financial statements and the tax bases of assets and liabilities resulted in deferred taxes. Deferred tax assets and liabilities at December 31 are as follows: <TABLE> <CAPTION> 1997 1996 -------- ------- (IN THOUSANDS) <S> <C> <C> Gross deferred tax assets: Allowance for possible loan losses $ 36,463 $27,891 Accrued liabilities 13,025 2,044 Accrued pension expense 1,325 1,325 Deferred compensation 6,554 4,988 Securities valuation adjustment 17,532 3,511 Deposit base intangible amortization 3,409 4,053 Benefit of tax loss carryforwards 14,420 9,225 Other 4,065 3,008 ----------------- Total gross deferred tax assets 96,793 56,045 Valuation adjustment for deferred tax assets (22,276) (4,024) ----------------- 74,517 52,021 Gross deferred tax liabilities: Premises and equipment 3,723 4,005 Deferred loan fee income and other loan yield adjustment 2,527 1,487 FHLB bank stock dividend 1,059 1,059 State income taxes 1,740 1,633 Other 2,594 1,916 ----------------- Total gross deferred tax liabilities 11,643 10,100 ----------------- Net deferred tax assets 62,874 41,921 ----------------- Tax effect of unrealized gain related to available for sale securities (14,938) (4,884) ----------------- Net deferred tax assets including unrealized gain related to available for sale securities $ 47,936 $37,037 ================= </TABLE> Components of the 1996 deferred tax assets have been adjusted to reflect the filing of corporate income tax returns. 56
For financial reporting purposes, a valuation allowance has been recognized to offset deferred tax assets related to state net operating loss carryforwards of a subsidiary and other temporary differences. When realized, the tax benefit for these items will be used to reduce current tax expense for that period. The effective income tax rate differs from the statutory federal tax rate. The major reasons for this difference are as follows: <TABLE> <CAPTION> 1997 1996 1995 ---- ---- ---- <S> <C> <C> <C> Federal income tax rate at statutory rate 35.0% 35.0% 35.0% Increases (decreases) resulting from: Tax-exempt interest and dividends (2.9) (2.0) (1.5) State income taxes (net of federal income taxes) 3.3 1.8 2.7 Merger, integration and other one-time charges 3.4 -- -- Change in valuation allowance for deferred tax assets 15.7 -- -- Other 0.5 0.1 (0.4) ------ Effective income tax rate 55.0% 34.9% 35.8% ------ ------ </TABLE> As of December 31, 1997, the Corporation had approximately $4.2 million of purchased net operating loss carryforwards available to reduce federal tax liability through the year 2009. Utilization of the net operating loss carryforwards is reflected as a charge in lieu of current tax expense and recorded in the consolidated statements of financial condition as a reduction to goodwill. In addition, the Corporation has net operating loss carryforwards for state income tax purposes of $97.0 million, which are available to offset future state taxable income, if any, through 2012. FFB qualified under provisions of the Internal Revenue Code that permitted it to deduct from taxable income an allowance for bad debts that differed from the provision for such losses charged to income for financial reporting purposes. Accordingly, no provision for income taxes has been made for $79,243,000 of retained income at December 31, 1997. If income taxes had been provided, the deferred tax liability would have been approximately $31,804,000. NOTE 15 COMMITMENTS AND CONTINGENT LIABILITIES: COMMITMENTS AND LETTERS OF CREDIT The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to interest rate risk. These financial instruments include commitments to extend credit, commercial letters of credit, standby letters of credit and financial guarantees, and interest rate swaps. The Corporation's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, commercial letters of credit, and standby letters of credit and financial guarantees written is represented by the contractual amount of those instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. The following is a summary of financial instruments with off-balance sheet risk at December 31: <TABLE> <CAPTION> 1997 1996 ---------- ---------- (IN THOUSANDS) <S> <C> <C> Financial instruments whose contract amounts represent credit risk: Commitments to extend credit $2,459,154 $2,265,225 Commercial letters of credit 3,981 3,489 Standby letters of credit and financial guarantees written 95,410 52,287 Financial instruments whose notional or contract amount exceeds the amount of credit risk: Interest rate swap agreements 3,300 3,400 Futures 70,500 -- Loans sold with recourse 12,000 27,000 </TABLE> 57
Commitments to extend credit are agreements to lend funds to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. 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. Collateral held varies but may include accounts receivable, inventory, property, plant, equipment, securities, certificates of deposit and income producing commercial properties. A letter of credit is a document issued by the Corporation on behalf of its customer (the account party) authorizing a third party (the beneficiary), or in special cases the account party, to draw drafts on the Corporation up to a stipulated amount and with specified terms and conditions. The letter of credit is a conditional commitment (except when prepaid by the account party) on the part of the Corporation to provide payment on drafts drawn in accordance with the terms of the document. A commercial letter of credit is issued specifically to facilitate trade or commerce. Under the terms of a commercial letter of credit, as a general rule, drafts will be drawn when the underlying transaction is consummated as intended. A standby letter of credit is a letter of credit or similar arrangement that represents an obligation on the part of the Corporation to a designated third party (the beneficiary) contingent upon the failure of the Corporation's customer (the account party) to perform under the terms of the underlying contract with the beneficiary, or obligates the Corporation to guarantee or stand as surety for the benefit of a third party to the extent permitted by law or regulation. The underlying contract may entail either financial or nonfinancial undertakings of the account party with the beneficiary. The underlying contract may involve such things as the customer's payment of commercial paper, delivery of merchandise, completion of a construction contract or repayment of the account party's obligations to the beneficiary. Under the terms of a standby letter, as a general rule, drafts will be drawn only when the underlying event fails to occur as intended. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Corporation enters into various interest rate swaps in managing its interest rate risk. In these swaps, the Corporation agrees to exchange, at specified intervals, the difference between fixed- and floating-interest amounts calculated on an agreed-upon notional principal amount. At December 31, 1997 and 1996, $3.3 million and $3.4 million, respectively of "pay-fixed" swaps were in effect converting a fixed rate commercial loan to a variable rate. The Corporation's current credit exposure on swaps is limited to the value of interest rate swaps that have become favorable to the Corporation. At December 31, 1997, the market value of interest rate swaps was a positive $14,000. If an interest rate swap that is used to manage interest rate risk is terminated early, any resulting gain or loss is deferred and accreted or amortized to noninterest income or expense over the remaining life of the asset related to the terminated agreement. Deferred gains totaling $107,000 at December 31, 1997, resulting from interest rate swaps terminated during 1994 with notional amounts of $19.8 million, are included in other liabilities and will be recognized as part of interest income in the following periods: $97,000 in 1998, and $10,000 in 1999. The Corporation enters into various interest rate futures contracts to hedge specific investment securities. These contracts are commitments to either purchase or sell a financial instrument at a specified price on an agreed-upon future date. In November 1997, the Corporation hedged certain agency issued zero-coupon bonds held by FFC, with a carrying value of $37.2 million and a market value of $41.6 million, by executing various interest rate futures contracts. These contracts had a notional value of $70.5 million and a maturity date of March 1998. Initial margin requirements on the futures contracts are provided by 58
investment securities provided as collateral. Unrealized losses, net of tax, of $924,000 on the futures contracts outstanding have been recorded as a component of the net unrealized gain on securities available for sale at December 31, 1997. Subsequently, in January 1998, the futures contracts were closed and the zero-coupon bonds were sold. A net gain of $5.1 million will be recognized, in investment securities gains, in the first quarter of 1998 from these transactions. All loans currently sold to others are sold on a nonrecourse basis with the servicing rights of these loans retained by the Corporation. At December 31, 1997 and 1996, $12 million and $27 million, respectively, of the serviced loans were previously sold with recourse, the majority of which is either federally-insured or federally-guaranteed. LEGAL There are legal proceedings pending against certain subsidiaries of the Corporation in the ordinary course of their business. Although litigation is subject to many uncertainties and the ultimate exposure with respect to these matters cannot be ascertained, management believes, based upon discussions with counsel, that the Corporation has meritorious defenses, and any ultimate liability would not have a material adverse affect on the consolidated financial position of the Corporation. 59
NOTE 16 PARENT COMPANY FINANCIAL INFORMATION: Presented below are condensed statements of financial condition, income and cash flows for the Parent Company: STATEMENTS OF FINANCIAL CONDITION <TABLE> <CAPTION> 1997 1996 -------- -------- (IN THOUSANDS) <S> <C> <C> ASSETS Cash and due from banks $ 5 $ 309 Notes receivable from subsidiaries 138,897 110,992 Investment in subsidiaries 746,081 752,387 Other assets 41,939 26,904 Total assets $926,922 $890,592 LIABILITY AND STOCKHOLDERS' EQUITY Short-term borrowings $ 88,389 $ 74,176 Accrued expenses and other liabilities 24,840 12,854 Total liabilities 113,229 87,030 Stockholders' equity 813,693 803,562 Total liabilities and stockholders' equity $926,922 $890,592 </TABLE> STATEMENTS OF INCOME <TABLE> <CAPTION> FOR THE YEARS ENDED DECEMBER 31, --------------------------- 1997 1996 1995 ------- -------- -------- (IN THOUSANDS) <S> <C> <C> <C> INCOME Dividends from subsidiaries $63,355 $ 51,283 $ 30,467 Management and service fees from subsidiaries 4,685 4,267 3,963 Interest income on notes receivable 7,615 6,088 4,562 Other income 514 234 267 -------------------------- Total income 76,169 61,872 39,259 -------------------------- EXPENSE Interest expense on borrowed funds 4,634 4,449 3,593 Salaries and employee benefits 3,871 3,287 3,331 Merger, integration and other one-time charges 20,837 -- -- Other expense 5,203 5,030 4,931 -------------------------- Total expense 34,545 12,766 11,855 -------------------------- Income before income tax benefit and equity in undistributed income 41,624 49,106 27,404 Income tax benefit (6,155) (547) (663) -------------------------- Income before equity in undistributed net income of subsidiaries 47,779 49,653 28,067 Equity in undistributed net income of subsidiaries 4,580 57,363 83,944 -------------------------- Net income $52,359 $107,016 $112,011 -------------------------- -------------------------- </TABLE> 60
STATEMENTS OF CASH FLOWS <TABLE> <CAPTION> FOR THE YEARS ENDED DECEMBER 31, ---------------------------- 1997 1996 1995 -------- -------- -------- (IN THOUSANDS) <S> <C> <C> <C> OPERATING INCOME Net income $ 52,359 $107,016 $112,011 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed net income of subsidiaries (4,580) (57,363) (83,944) Depreciation and other amortization 161 135 199 Amortization of intangibles 446 805 871 Loss (gain) on sales of assets, net (356) -- 2 (Increase) decrease in interest receivable and other assets (10,714) 599 (7,488) Increase (decrease) in interest payable and other liabilities 12,080 (252) 1,290 Other, net -- (154) (30) ---------------------------- Net cash provided by operating activities 49,396 50,786 22,911 ---------------------------- INVESTING ACTIVITIES Proceeds from sales of investment securities 357 -- -- Purchases of investment securities -- -- (780) Net increase in notes receivable (16,335) (12,374) (32,547) Purchase of premises and equipment, net of disposals (176) (82) (81) Capital contribution to subsidiaries -- (9,200) (500) ---------------------------- Net cash used by investing activities (16,154) (21,656) (33,908) ---------------------------- FINANCING ACTIVITIES Net increase (decrease) in short-term borrowings 14,213 (8,546) 30,165 Cash dividends (49,328) (20,278) (16,924) Proceeds from exercise of stock options 5,168 1,476 1,454 Purchase of treasury stock (3,599) (3,101) (2,085) ---------------------------- Net cash provided (used) by financing activities (33,546) (30,449) 12,610 ---------------------------- Net increase (decrease) in cash and cash equivalents (304) (1,319) 1,613 Cash and due from banks at beginning of year 309 1,628 15 ---------------------------- Cash and due from banks at end of year $ 5 $ 309 $ 1,628 ============================ </TABLE> 61
NOTE 17 FAIR VALUE OF FINANCIAL INSTRUMENTS: SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires that the Corporation disclose estimated fair values for its financial instruments. Fair value estimates, methods, and assumptions are set forth below for the Corporation's financial instruments. The estimated fair values of the Corporation's financial instruments at December 31 are as follows: <TABLE> <CAPTION> 1997 1996 - ---------------------------------------------------------------------------------------------- CONTRACT OR CONTRACT OR NOTIONAL CARRYING NOTIONAL CARRYING AMOUNT AMOUNT FAIR VALUE AMOUNT AMOUNT FAIR VALUE - ---------------------------------------------------------------------------------------------- (IN THOUSANDS) <S> <C> <C> <C> <C> <C> <C> Financial assets: Cash and due from banks $ 288,021 $ 288,021 $ 369,842 $ 369,842 Interest-bearing deposits in other financial institutions 4,154 4,154 3,183 3,183 Federal funds sold and securities purchase under agreements to resell 11,511 11,511 27,977 27,977 Investment securities: Held to maturity 772,524 782,240 1,079,749 1,074,412 Available for sale 2,167,694 2,167,694 1,674,189 1,674,189 Loans held for sale 114,001 114,001 42,490 42,490 Loans 7,076,576 7,109,315 6,658,357 6,652,466 Financial liabilities: Deposits 8,364,137 8,378,493 7,959,298 7,940,967 Short-term borrowings 1,337,008 1,337,008 1,201,393 1,201,393 Long-term borrowings 15,270 15,387 33,329 34,011 Off balance sheet: Interest swap agreements $ 3,300 2 14 $3,400 2 36 Futures contracts 70,500 (1,421) (1,421) -- -- -- --------------------------------------------------------------------- </TABLE> CASH AND DUE FROM BANKS, INTEREST-BEARING DEPOSITS IN OTHER FINANCIAL INSTITUTIONS, AND FEDERAL FUNDS SOLD AND SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL For these short-term instruments, the carrying amount is a reasonable estimate of fair value. INVESTMENT SECURITIES HELD TO MATURITY, INVESTMENT SECURITIES AVAILABLE FOR SALE, AND TRADING ACCOUNT SECURITIES The fair value of investment securities held to maturity, investment securities available for sale, and trading account securities, except certain state and municipal securities, is estimated based on bid prices published in financial newspapers or bid quotations received from securities dealers. The fair value of certain state and municipal securities is not readily available through market sources other than dealer quotations, so fair value estimates are based on quoted market prices of similar instruments, adjusted for differences between the quoted instruments and the instruments being valued. LOANS HELD FOR SALE Fair value is estimated using the prices of the Corporation's existing commitments to sell such loans and/or the quoted market prices for commitments to sell similar loans. LOANS Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, commercial real estate, residential mortgage, credit card and other consumer. 62
The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for similar maturities. Future cash flows are also adjusted for estimated reductions or delays due to delinquencies, nonaccruals or potential charge-offs. DEPOSITS Under SFAS No. 107, the fair value of deposits with no stated maturity such as noninterest-bearing demand deposits, savings, NOW accounts and money market accounts, is equal to the amount payable on demand as of December 31. The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. SHORT-TERM BORROWINGS For these short-term instruments, the carrying amount is a reasonable estimate of fair value. LONG-TERM BORROWINGS Rates currently available to the Corporation for debt with similar terms and remaining maturities are used to estimate fair value of existing borrowings. COMMITMENTS TO EXTEND CREDIT, COMMERCIAL LETTERS OF CREDIT, STANDBY LETTERS OF CREDIT AND FINANCIAL GUARANTEES WRITTEN Fair values for commitments to extend credit, commercial letters of credit, standby letters of credit and financial guarantees written are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the counterparties' credit standing and discounted cash flow analyses. The fair value of these off-balance-sheet items approximates the recorded amounts of the related fees and is not material at December 31, 1997 and 1996. INTEREST RATE SWAP AGREEMENTS AND FUTURES CONTRACTS The fair value of interest rate swap agreements and futures contracts are obtained from dealer quotes. These values represent the estimated amount the Corporation would receive or pay to terminate the contracts or agreements, taking into account current interest rates and, when appropriate, the current creditworthiness of the counter-parties. LIMITATIONS Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Corporation's entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Corporation's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. 63
NOTE 18 SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED): The following is selected financial data summarizing the results of operations for each quarter in the years ended December 31, 1997 and 1996: <TABLE> <CAPTION> 1997 QUARTER ENDED -------------------------------------------- MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 -------- -------- ------------ ----------- (IN THOUSANDS EXCEPT PER SHARE DATA) <S> <C> <C> <C> <C> Interest income $189,742 $195,056 $200,648 $201,798 Interest expense 97,943 101,419 105,857 106,418 Provision for possible loan losses 3,373 3,186 3,738 21,371 Investment securities gains (losses), net 1,195 188 852 (35,011) Income (loss) before income tax expense 52,200 54,771 56,859 (47,562) Net income (loss) 33,860 35,480 36,821 (53,802) Basic earnings (loss) per share $ 0.67 $ 0.71 $ 0.73 $ (1.07) Diluted earnings (loss) per share $ 0.66 $ 0.70 $ 0.72 $ (1.06) Basic weighted average shares 50,546 50,157 50,191 50,340 Diluted weighted average shares 51,536 50,847 51,216 50,996 <CAPTION> 1996 QUARTER ENDED -------------------------------------------- MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 -------- -------- ------------ ----------- (IN THOUSANDS EXCEPT PER SHARE DATA) <S> <C> <C> <C> <C> Interest income $179,631 $178,898 $185,842 $186,826 Interest expense 92,880 91,933 95,261 95,849 Provision for possible loan losses 3,072 3,052 3,861 3,710 Investment securities gains (losses), net (614) (321) (10,370) 627 Income before income tax expense 45,659 48,493 17,563 53,474 Net income before extraordinary item 30,727 31,710 10,962 34,303 Extraordinary item (686) -- -- -- Net income 30,041 31,710 10,962 34,303 Basic earnings per share $ 0.59 $ 0.63 $ 0.22 $ 0.68 Diluted earnings per share $ 0.59 $ 0.62 $ 0.21 $ 0.66 Basic weighted average shares 50,528 50,632 50,631 50,464 Diluted weighted average shares 51,443 51,519 51,498 51,724 </TABLE> Net income in the fourth quarter of 1997 includes $89.8 million of merger, integration and other one-time charges and the third quarter of 1996 includes $22.7 million of merger, integration and other one-time charges. NOTE 19 REGULATORY MATTERS: The Corporation and the subsidiary banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory--and possibly additional discretionary--actions by regulators that, if undertaken, could have a direct material effect on the Corporation's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation must meet specific capital guidelines that involve quantitative measures of the Corporation's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Corporation's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Corporation to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 1997, that the Corporation and the subsidiary banks meet all capital adequacy requirements to which they are subject. 64
As of December 31, 1997 and 1996, the most recent notification from the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation categorized the Corporation and its two largest subsidiary banks, FFB and Associated Bank Green Bay as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Corporation must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category. The actual capital amounts and ratios of the Corporation, FFB and Associated Bank Green Bay are also presented in the table. No deductions from capital were made for interest rate risk in 1997. <TABLE> <CAPTION> TO BE WELL CAPITALIZED UNDER PROMPT FOR CAPITAL CORRECTIVE ADEQUACY ACTION ACTUAL PURPOSES PROVISIONS: --------------- --------------- ---------------- AMOUNT RATIO* AMOUNT RATIO* AMOUNT RATIO* -------- ------ -------- ------ -------- ------- ($ IN THOUSANDS) AS OF DECEMBER 31, 1997: - -------------- ASSOCIATED BANC-CORP - ---------- <S> <C> <C> <C> <C> <C> <C> Total Capital $841,883 11.86% $567,666 ^8.00% $709,852 ^10.00% Tier I Capital $753,135 10.61% $283,833 ^4.00% $425,749 ^ 6.00% Leverage $753,135 7.10% $424,482 ^4.00% $530,603 ^ 5.00% <CAPTION> FIRST FINANCIAL BANK - -------------- <S> <C> <C> <C> <C> <C> <C> Total Capital $396,629 13.63% $232,784 ^8.00% $290,980 ^10.00% Tier I Capital $360,219 12.38% $116,387 ^4.00% $174,588 ^ 6.00% Leverage $360,219 6.11% $235,823 ^4.00% $294,591 ^ 5.00% <CAPTION> ASSOCIATED BANK GREEN BAY - -------------- <S> <C> <C> <C> <C> <C> <C> Total Capital $108,061 10.39% $ 83,227 ^8.00% $104,033 ^10.00% Tier I Capital $ 83,035 7.98% $ 41,613 ^4.00% $ 62,420 ^ 6.00% Leverage $ 83,035 6.47% $ 51,318 ^4.00% $ 64,147 ^ 5.00% <CAPTION> AS OF DECEMBER 31, 1996: - -------------- ASSOCIATED BANC-CORP - ---------- <S> <C> <C> <C> <C> <C> <C> Total Capital $786,821 13.53% $465,391 ^8.00% $581,739 ^10.00% Tier I Capital $763,230 13.12% $232,696 ^4.00% $349,043 ^ 6.00% Leverage $763,230 7.68% $397,625 ^4.00% $497,032 ^ 5.00% <CAPTION> FIRST FINANCIAL BANK - -------------- <S> <C> <C> <C> <C> <C> <C> Total Capital $346,133 13.91% $199,134 ^8.00% $248,918 ^10.00% Tier I Capital $364,146 14.63% $ 99,561 ^4.00% $149,351 ^ 6.00% Leverage $364,146 6.39% $227,947 ^4.00% $285,155 ^ 5.00% <CAPTION> ASSOCIATED BANK GREEN BAY - -------------- <S> <C> <C> <C> <C> <C> <C> Total Capital $100,777 10.52% $ 76,651 ^8.00% $ 95,814 ^10.00% Tier I Capital $ 76,782 8.01% $ 38,326 ^4.00% $ 57,488 ^ 6.00% Leverage $ 76,782 6.46% $ 47,536 ^4.00% $ 59,420 ^ 5.00% </TABLE> *Total Capital ratio is defined as Tier 1 Capital plus Tier 2 Capital divided by total risk-weighted assets. The Tier 1 Capital ratio is defined as Tier 1 capital divided by total risk-weighted assets. The leverage ratio is defined as Tier 1 capital divided by the most recent quarter's average total assets. 65
NOTE 20 EARNINGS PER SHARE: Presented below are the calculations for basic and diluted earnings per share: <TABLE> <CAPTION> FOR THE YEARS ENDED DECEMBER 31, -------------------------- 1997 1996 1995 ------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE DATA) <S> <C> <C> <C> Basic: Income before extraordinary item $52,359 $107,702 $112,011 Extraordinary item -- (686) -- -------------------------- Net income available to common stockholders $52,359 $107,016 $112,011 Weighted average shares outstanding 50,307 50,564 49,109 Basic earnings per common share before extraordinary item $ 1.04 $ 2.13 $ 2.28 Basic earnings per common share $ 1.04 $ 2.12 $ 2.28 Diluted: Income before extraordinary item $52,359 $107,702 $112,011 Extraordinary item -- (686) -- -------------------------- Net income available to common stockholders $52,359 $107,016 $112,011 Weighted average shares outstanding 50,307 50,564 49,109 Effect of dilutive stock options outstanding 840 940 869 -------------------------- Diluted weighted average shares outstanding 51,147 51,504 49,978 Diluted earnings per common share before extraordinary item $ 1.02 $ 2.09 $ 2.24 Diluted earnings per common share $ 1.02 $ 2.08 $ 2.24 </TABLE> 66
INDEPENDENT AUDITORS' REPORT ASSOCIATED BANC-CORP The Board of Directors Associated Banc-Corp: We have audited the accompanying consolidated statements of financial condition of Associated Banc-Corp and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997. These consolidated financial statements are the responsibility of Associated Banc-Corp's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We did not audit the consolidated financial statements of First Financial Corporation and subsidiaries, a wholly-owned subsidiary of Associated Banc-Corp, which statements reflect total assets constituting 55.2% and 56.3% as of December 31, 1997 and 1996, respectively and total revenues constituting 52.6%, 55.5% and 58.2% for the years ended December 31, 1997, 1996 and 1995, respectively, of the related consolidated totals. Those financial statements were audited by Ernst & Young LLP whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for First Financial Corporation and subsidiaries, is based solely on the report of Ernst & Young LLP. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of Ernst & Young LLP provide a reasonable basis for our opinion. In our opinion, based on our audits and the report of Ernst & Young LLP, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Associated Banc-Corp and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997 in conformity with generally accepted accounting principles. LOGO KPMG Peat Marwick LLP Chicago, Illinois January 22, 1998 67
INDEPENDENT AUDITORS' REPORT FIRST FINANCIAL CORPORATION The Board of Directors First Financial Corporation We have audited the accompanying consolidated statements of financial condition of First Financial Corporation and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997 (not presented separately herein). These consolidated financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Financial Corporation and subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997 in conformity with generally accepted accounting principles. LOGO ERNST & YOUNG LLP Milwaukee, Wisconsin January 22, 1998 68
MARKET INFORMATION <TABLE> <CAPTION> MARKET PRICE RANGE SALES PRICES -------------- ---------- ------------- DIVIDENDS PAID BOOK VALUE HIGH LOW -------------- ---------- ------ ------ <S> <C> <C> <C> <C> 1997 4th Quarter $.2900 $16.15 $58.75 $46.25 3rd Quarter $.2900 $17.39 $48.94 $39.00 2nd Quarter $.2900 $16.80 $39.50 $35.75 1st Quarter $.2417 $16.17 $40.50 $34.58 1996 4th Quarter $.2417 $16.01 $36.46 $32.92 3rd Quarter $.2417 $15.45 $33.65 $31.88 2nd Quarter $.2417 $15.39 $32.92 $31.25 1st Quarter $.2250 $15.04 $32.92 $29.38 </TABLE> Annual dividend rate: $1.16 Market information has been restated for the 6-for-5 stock split declared January 22, 1997, effected in the form of a 20% stock dividend, paid on March 17, 1997, to shareholders of record March 5, 1997. ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information in the Corporation's definitive Proxy Statement, prepared for the 1998 Annual Meeting of Shareholders, which contains information concerning directors of the Corporation, under the caption "Election of Directors," is incorporated herein by reference. The information concerning "Executive Officers of the Registrant," as a separate item, appears in Part I of this document. ITEM 11 EXECUTIVE COMPENSATION The information in the Corporation's definitive Proxy Statement, prepared for the 1998 Annual Meeting of Shareholders, which contains information concerning this item, under the caption "Executive Compensation," is incorporated herein by reference. ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information in the Corporation's definitive Proxy Statement, prepared for the 1998 Annual Meeting of Shareholders, which contains information concerning this item, under the captions "Principal Holders of Common Stock" and "Security Ownership of Management," is incorporated herein by reference. ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information in the Corporation's definitive Proxy Statement, prepared for the 1998 Annual Meeting of Shareholders, which contains information concerning this item under the caption "Certain Transactions," is incorporated herein by reference. 69
PART IV ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1 and 2Financial Statements and Financial Statement Schedules The following financial statements and financial statement schedules are included under a separate caption "Financial Statements and Supplementary Data" in Part II, Item 8 hereof and are incorporated herein by reference. Consolidated Statements of Financial Condition--December 31, 1997 and 1996 Consolidated Statements of Income--For the Years Ended December 31, 1997, 1996, and 1995 Consolidated Statements of Changes in Stockholders' Equity--For the Years Ended December 31, 1997, 1996, and 1995 Consolidated Statements of Cash Flows--For the Years Ended December 31, 1997, 1996, and 1995 Notes to Consolidated Financial Statements Independent Auditors' Reports (a) 3Exhibits Required by Item 601 of Regulation S-K <TABLE> <CAPTION> EXHIBIT SEQUENTIAL PAGE NUMBER OR NUMBER DESCRIPTION INCORPORATION REFERENCE TO - ------------------------------------------------------------------------------- <C> <S> <C> (3)(a) Articles of Incorporation Filed herewith (3)(b) Bylaws Filed herewith (4) Instrument Defining the Rights of Security Holders, Including Indentures The Registrant, by signing this report, agrees to furnish the Securities and Exchange Commission, upon its request, a copy of any instrument that defines the rights of holders of long- term debt of the Registrant and all of its subsidiaries for which consolidated or unconsolidated financial statements are required to be filed and that authorizes a total amount of securities not in excess of 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis *(10)(a) The 1982 Incentive Stock Exhibit (10) to Report on Form 10-K for Option Plan of the fiscal year ended December 31, 1987 Registrant *(10)(b) The Restated Long-Term Exhibits filed with Associated's Incentive registration statement (333-46467) on Stock Plan of the Form S-8 filed under the Securities Act Registrant of 1933 *(10)(c) Change of Control Plan of Exhibit (10)(d) to Report on Form 10-K the for fiscal year ended December 31, 1994 Registrant effective April 25, 1994 *(10)(d) Deferred Compensation Plan Exhibit (10)(e) to Report on Form 10-K and for fiscal year ended December 31, 1994 Deferred Compensation Trust effective as of December 16, 1993, and Deferred Compensation Agreement of the Registrant dated December 31, 1994 </TABLE> 70
<TABLE> <CAPTION> EXHIBIT SEQUENTIAL PAGE NUMBER OR NUMBER DESCRIPTION INCORPORATION BY REFERENCE TO - ------------------------------------------------------------------------------ <C> <S> <C> (11) Statement Re Computation of Per See footnote (20) in Part II Item 8 Share Earnings (21) Subsidiaries of the Corporation Filed herewith (23) Consent of Independent Auditors Filed herewith (24) Power of Attorney Filed herewith </TABLE> - --------------------- * Management contracts and arrangements. Schedules and exhibits other than those listed are omitted for the reasons that they are not required, are not applicable or that equivalent information has been included in the financial statements, and notes thereto, or elsewhere herein. (b) Reports on Form 8-K The Corporation filed a report on Form 8-K on September 15, 1997, which included a press release dated September 15, 1997, announcing the receipt of all required regulatory approvals in connection with the proposed merger of Associated Banc-Corp and First Financial Corporation. The Corporation filed a report on Form 8-K on October 30, 1997, which included a press release dated October 29, 1997, announcing the consummation of the merger between Associated Banc-Corp and First Financial Corporation. Announcements of new officers and directors were also made. 71
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. /s/ H. B. Conlon ASSOCIATED BANC-CORP H. B. Conlon Date: March 20, 1998 By: _________________________________ Chairman, President & Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. /s/ H. B. Conlon By: ________________________________ * By: ________________________________ H. B. Conlon William R. Hutchinson Chairman, President, Chief Director Executive Officer and Director /s/ Joseph B. Selner By: ________________________________ * By: ________________________________ Joseph B. Selner Robert P. Konopacky Senior Vice President-CFO Director Principal Financial Officer and Principal Accounting Officer /s/ Robert C. Gallagher By: ________________________________ * By: ________________________________ Robert C. Gallagher Dr.George R. Leach Vice Chairman and Director Director * By: ________________________________ * By: ________________________________ John C. Seramur John C. Meng Vice Chairman and Director Director * By: ________________________________ * By: ________________________________ Robert S. Gaiswinkler J. Douglas Quick Director Director /s/ * By: ________________________________ * By: ________________________________ Ronald R. Harder John H. Sproule Director Director /s/ * By: ________________________________ * By: ________________________________ John S. Holbrook, Jr. Ralph R. Staven Director Director /s/ Brian R. Bodager By: ________________________________ * By: ________________________________ Brian R. Bodager Norman L. Wanta Attorney-in-Fact Director Date: March 20, 1998 72