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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- --------- EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2002
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- --------- EXCHANGE ACT OF 1934 For the transition period from to
Commission file number: 0-5519
ASSOCIATED BANC-CORP
(Exact name of registrant as specified in its charter)
Wisconsin 39-1098068
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
1200 Hansen Road
Green Bay, Wisconsin 54304
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (920) 491-7000
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 (ss.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. [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes X No
----- -----
As of February 28, 2003, 74,185,883 shares of Common Stock were outstanding. As
of June 28, 2002, (the last business day of the Registrant's most recently
completed second fiscal quarter) the aggregate market value of the voting stock
held by nonaffiliates of the Registrant was approximately $2,748,105,000.
Excludes approximately $108,263,000 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
approximately $200,130,000 of market value representing 7.01% of the outstanding
shares of the Registrant held in a fiduciary capacity by the trust company
subsidiary 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 23, 2003
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ASSOCIATED BANC-CORP
2002 FORM 10-K TABLE OF CONTENTS
Page
PART I ----
Item 1. Business 3
Item 2. Properties 7
Item 3. Legal Proceedings 8
Item 4. Submission of Matters to a Vote of Security Holders 8
PART II
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters 10
Item 6. Selected Financial Data 11
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk 48
Item 8. Financial Statements and Supplementary Data 49
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure 87
PART III
Item 10. Directors and Executive Officers of the Registrant 87
Item 11. Executive Compensation 87
Item 12. Security Ownership of Certain Beneficial Owners and
Management 87
Item 13. Certain Relationships and Related Transactions 87
Item 14. Controls and Procedures 88
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 88
Signatures 90
Special Note Regarding Forward-Looking Statements
Statements made in this document and in documents that are incorporated by
reference which are not purely historical are forward-looking statements, as
defined in the Private Securities Litigation Reform Act of 1995, including any
statements regarding descriptions of management's plans, objectives, or goals
for future operations, products or services, and forecasts of its revenues,
earnings, or other measures of performance. Forward-looking statements are based
on current management expectations and, by their nature, are subject to risks
and uncertainties. These statements may be identified by the use of words such
as "believe," "expect," "anticipate," "plan," "estimate," "should," "will,"
"intend," or similar expressions.
Shareholders should note that many factors, some of which are discussed
elsewhere in this document and in the documents that are incorporated by
reference, could affect the future financial results of Associated Banc-Corp 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, many of which are beyond Associated Banc-Corp's
control, include the following:
- - operating, legal, and regulatory risks;
- - economic, political, and competitive forces affecting Associated
Banc-Corp's banking, securities, asset management, and credit services
businesses; and
- - the risk that Associated Banc-Corp's analyses of these risks and forces
could be incorrect and/or that the strategies developed to address them
could be unsuccessful.
These factors should be considered in evaluating the forward-looking statements,
and undue reliance should not be placed on such statements. Forward-looking
statements speak only as of the date they are made. Associated Banc-Corp
undertakes no obligation to update or revise any forward looking statements,
whether as a result of new information, future events, or otherwise.
PART I
ITEM 1 BUSINESS
General
Associated Banc-Corp (the "parent company") 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. At December 31, 2002, the parent company owned four
commercial banks located in Illinois, Minnesota, and Wisconsin serving their
local communities and, measured by total assets held at December 31, 2002, was
the second largest commercial bank holding company headquartered in Wisconsin.
The parent company also owned 22 limited purpose banking and nonbanking
subsidiaries located in Arizona, California, Illinois, Minnesota, Nevada, and
Wisconsin. The parent company, together with all its subsidiaries is hereinafter
referred to as the "Corporation."
Services
The parent company provides advice and specialized services to its subsidiaries
in banking policy and operations, including auditing, data processing,
marketing/advertising, investing, legal/compliance, personnel services, trust
services, risk management, facilities management, security, purchasing,
treasury, finance, accounting, and other financial services functionally related
to banking.
Responsibility for the management of the subsidiaries remains with their
respective Boards of Directors and officers. Services rendered to the
subsidiaries by the parent company are intended to assist the local management
of these subsidiaries to expand the scope of services offered by them. At
December 31, 2002, bank subsidiaries of the parent company provided services
through 221 locations in 153 communities.
3
The Corporation provides a complete range of banking services to individuals and
businesses. These services include checking, savings, and money market deposit
accounts, business, personal, educational, residential, and commercial mortgage
loans, other consumer-oriented financial services, including IRA and Keogh
accounts, lease financing for a variety of capital equipment for commerce and
industry, and safe deposit and night depository facilities. Automated Teller
Machines (ATMs), which provide 24-hour banking services to customers, are
installed in many locations in the Corporation's service areas. The Corporation
participates in an interstate shared ATM network, which allows 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 Corporation provides lending, depository, and related financial services to
individual, 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.
The Corporation is 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, which are generally
salable into the secondary mortgage market. The principal mortgage lending areas
are Wisconsin, Minnesota, and Illinois. Nearly all long-term, fixed-rate real
estate mortgage loans generated are sold in the secondary market and to other
financial institutions, with the servicing of those loans retained.
In addition to real estate loans, the Corporation originates and/or services
consumer loans, business credit card loans, and student loans. Consumer, home
equity, and student lending activities are principally conducted in Wisconsin,
Minnesota, and Illinois, while the credit card base and resulting loans are
principally centered in the Midwest.
Lending involves credit risk. Credit risk is controlled and monitored through
active asset quality management and the use of lending standards, thorough
review of potential borrowers, and active asset quality administration. Active
asset quality administration, including early problem loan identification and
timely resolution of problems, further ensures appropriate management of credit
risk and minimization of loan losses. The allowance for loan losses represents
management's estimate of an amount adequate to provide for probable losses
inherent in the loan portfolio. Management's evaluation of the adequacy of the
allowance for loan losses is based on management's ongoing review and grading of
the loan portfolio, consideration of past loan loss experience, trends in past
due and nonperforming loans, risk characteristics of the various classifications
of loans, current economic conditions, the fair value of underlying collateral,
and other qualitative and quantitative factors which could affect potential
credit losses. Credit risk management is discussed under sections "Critical
Accounting Policies," "Loans," "Allowance for Loan Losses," and "Nonperforming
Loans, Potential Problem Loans, and Other Real Estate Owned" in "Management's
Discussion and Analysis of Financial Condition and Results of Operations," and
under Note 1, "Summary of Significant Accounting Policies," and Note 5, "Loans,"
in the notes to consolidated financial statements.
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 bank subsidiaries make available check
clearing, safekeeping, loan participations, lines of credit, portfolio analyses,
and other services to approximately 120 correspondent financial institutions.
A trust company subsidiary and an investment management 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.
4
Investment subsidiaries provide discount and full-service brokerage services,
including the sale of fixed and variable annuities, mutual funds, and
securities, to customers and the general public. Insurance subsidiaries
headquartered in Arizona and Wisconsin provide commercial and individual
insurance services and engage in reinsurance. Various life, property, casualty,
credit, and mortgage insurance products are available to the subsidiaries'
customers and the general public. Three investment subsidiaries located in
Nevada hold, manage, and trade cash, stocks, and securities and reinvest
investment income. Three additional investment subsidiaries formed in Nevada and
headquartered and domiciled in the Cayman Islands provide investment services
for their parent bank, as well as provide management of their respective Real
Estate Investment Trust ("REIT") subsidiaries. An appraisal subsidiary provides
real estate appraisals for customers, government agencies, and the general
public. The Corporation does not engage in any material operations in foreign
countries.
The Corporation is 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 business of the Corporation is seasonal.
Employees
At December 31, 2002, the Corporation had 4,085 full-time equivalent employees.
Competition
The financial services industry is highly competitive. The Corporation competes
for loans, deposits, and financial services in all of its principal markets. The
Corporation competes directly with other bank and nonbank institutions located
within its markets, with out-of-market banks and bank holding companies that
advertise or otherwise serve the Corporation's markets, money market and other
mutual funds, brokerage houses, and various other financial institutions.
Additionally, the Corporation competes with insurance companies, leasing
companies, regulated small loan companies, credit unions, governmental agencies,
and commercial entities offering financial services products. 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. The Corporation also faces direct competition from members of bank
holding company systems that have greater assets and resources than those of the
Corporation.
Supervision and Regulation
Financial institutions are highly regulated both at the federal and state level.
Numerous statutes and regulations presently affect the business of the
Corporation.
As a registered bank holding company under the Act, the parent company and its
nonbanking subsidiaries are regulated and supervised by the Board of Governors
of the Federal Reserve System (the "Board"). The bank subsidiaries with a
national bank charter are supervised and examined by the Comptroller of the
Currency. The bank subsidiary with a state bank charter is supervised and
examined by its state banking agency and by the Federal Deposit Insurance
Corporation (the "FDIC"). All subsidiaries that accept insured deposits are
subject to examination by the FDIC.
The Gramm-Leach-Bliley Act of 1999 made major amendments to the Act. The
amendments, among other things, allow certain qualifying bank holding companies
to engage in activities that are financial in nature and that explicitly include
the underwriting and sale of insurance. The amendments also amend the Act
provisions governing the scope and manner of the Board's supervision of bank
holding companies, the manner in which activities may be found to be financial
in nature, and the extent to which state laws on insurance will apply to
insurance activities of banks and bank subsidiaries. The Board has issued
regulations implementing these provisions. The amendments allow for the
expansion of activities by banking organizations and permit consolidation among
financial organizations generally. The parent company is required to act as a
source of financial strength to each of its subsidiaries pursuant to which it
may be required to commit financial resources to support such subsidiaries in
circumstances when, absent such requirements, it might not do so. The Act also
requires the prior approval of the Board to
5
enable the parent company to acquire direct or indirect control of more
than five percent of any class of voting shares of any bank or bank holding
company. Further restrictions imposed by the Act include capital requirements,
transactions with affiliates, securities issuances, dividend payments,
inter-affiliate liabilities, extensions of credit, and expansion through merger
and acquisition.
The federal regulatory authorities have broad authority to enforce the
regulatory requirements imposed on the Corporation. In particular, the Financial
Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") and the
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), and
their implementing regulations, carry greater enforcement powers. Under FIRREA,
all commonly controlled FDIC insured depository institutions may be held liable
for any loss incurred by the FDIC resulting from a failure of, or any assistance
given by the FDIC to, any commonly controlled institutions. Pursuant to certain
provisions under FDICIA, the federal regulatory agencies have broad powers to
take prompt corrective action if a depository institution fails to maintain
certain capital levels. Prompt corrective action may include the inability of
the Corporation to pay dividends, restrictions in acquisitions or activities,
limitations on asset growth, and other restrictions.
The Riegle-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 Riegle-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 FDIC maintains the Bank Insurance Fund (BIF) and the Savings Association
Insurance Fund (SAIF) by assessing depository institutions an insurance premium
twice a year. The amount each institution is assessed is based both on the
balance of insured deposits held during the preceding two quarters, as well as
on the degree of risk the institution poses to the insurance fund. FDIC assesses
higher rates on those institutions that pose greater risks to the insurance
funds. Effective April 1, 2000, the FDIC Board of Directors (FDIC Board) adopted
revisions to the FDIC's regulation governing deposit insurance assessments which
it believes enhance the present system by allowing institutions with improving
capital positions to benefit from the improvement more quickly while requiring
those whose capital is failing to pay a higher assessment sooner. The Federal
Deposit Insurance Act governs the authority of the FDIC Board to set BIF and
SAIF assessment rates and directs the FDIC Board to establish a risk-based
assessment system for insured depository institutions and set assessments to the
extent necessary to maintain the reserve ratio at 1.25%.
The Sarbanes-Oxley Act of 2002 addresses, among other issues, corporate
governance, auditing and accounting, executive compensation, and enhanced and
timely disclosure of corporate information. The New York Stock Exchange and
Nasdaq have also proposed corporate governance rules that were presented to the
Securities and Exchange Commission for review and approval. The proposed changes
are intended to allow stockholders to more easily and efficiently monitor the
performance of companies and directors. Effective August 29, 2002, as directed
by Section 302(a) of Sarbanes-Oxley, the parent company's chief executive
officer and chief financial officer are each required to certify that the
Corporation's quarterly and annual reports do not contain any untrue statement
of a material fact. The rules have several requirements, including having these
officers certify that they are responsible for establishing, maintaining, and
regularly evaluating the effectiveness of the Corporation's internal controls;
they have made certain disclosures to the Corporation's auditors and the audit
committee of the Board of Directors about the Corporation's internal controls;
and they have included information in the Corporation's quarterly and annual
reports about their evaluation and whether there have been significant changes
in the Corporation's internal controls or in other factors that could
significantly affect internal controls subsequent to the evaluation. At its
January 22, 2003, meeting, the Corporation's Board of Directors approved a
series of actions to strengthen its corporate governance practices, including
the adoption of a Code of Ethics for Directors and Executive Officers and
revised charter for its Audit Committee. More information regarding the
Corporation's corporate governance practices is available on its web site at
www.associatedbank.com.
6
The laws and regulations to which the Corporation is subject are constantly
under review by Congress, the federal regulatory agencies, and the state
authorities. These laws and regulations could be changed drastically in the
future, which could affect the profitability of the Corporation, its ability to
compete effectively, or the composition of the financial services industry in
which the Corporation competes.
Government Monetary Policies and Economic Controls
The earnings and growth of the banking industry and 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.
Available Information
The Corporation files annual, quarterly, and current reports, proxy statements,
and other information with the Securities and Exchange Commission (the "SEC").
These filings are available to the public over the Internet at the SEC's web
site at www.sec.gov. You may also read and copy any document that the
Corporation files at the SEC's public reference room located at 450 Fifth
Street, NW, Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for
further information on the public reference room.
The Corporation's principal Internet address is www.associatedbank.com. The
Corporation makes available free of charge on www.associatedbank.com its Code of
Ethics for Directors and Executive Officers and its annual report, as soon as
reasonably practicable after the Corporation electronically files such material
with, or furnishes it to, the SEC. In addition, you may request a copy of any of
the Corporation's filings (excluding exhibits) at no cost by writing,
telephoning, faxing, or e-mailing the Corporation at the following address,
telephone number, fax number or e-mail address: Associated Banc-Corp, Attn:
Shareholder Relations, 1200 Hansen Road, Green Bay, WI 54304; phone
920-491-7006; fax 920-491-7010; or e-mail to shareholders@associatedbank.com.
ITEM 2 PROPERTIES
The parent company's headquarters are located in the Village of Ashwaubenon,
Wisconsin, in a leased facility with approximately 30,000 square feet of office
space. The space is subject to a five-year lease with two consecutive five-year
extensions.
At December 31, 2002, the bank subsidiaries occupied 221 offices in 153
different communities within Illinois, Minnesota, and Wisconsin. The main office
of Associated Bank, National Association, is owned. The bank subsidiary main
offices in downtown Chicago, Rockford, and Minneapolis are located in the
lobbies of multistory office buildings. Most subsidiary branch offices are
freestanding buildings that provide adequate customer parking, including
drive-in facilities of various numbers and types for customer convenience. Some
bank subsidiaries also have branch offices in supermarket locations or in
retirement communities. In addition, the Corporation owns other real property
that, when considered in the aggregate, is not material to its financial
position.
7
ITEM 3 LEGAL PROCEEDINGS
There are legal proceedings pending against the Corporation that arose in the
normal course of business. Although litigation is subject to many uncertainties
and the ultimate exposure with respect to these matters cannot be ascertained,
management believes, based upon discussions with counsel, that the Corporation
has meritorious defenses, and any ultimate liability would not have a material
adverse effect on the consolidated financial position or results of operations
of the Corporation.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 2002.
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 Shareholders to be held April 23,
2003.
The following is a list of names and ages of executive officers of the
Corporation 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. 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.
Name Offices and Positions Held Date of Election
Robert C. Gallagher Chairman of the Board, President, and Chief April 28, 1982
Age: 64 Executive Officer of Associated Banc-Corp;
Chairman and President of Associated Bank,
National Association (subsidiary); Director of
Associated Bank Illinois, National Association
(subsidiary); Director of Associated Trust
Company, National Association (subsidiary)
Prior to January 2003, President, Chief
Executive Officer, and Director of Associated
Banc-Corp; Chairman and President of Associated
Bank, National Association (subsidiary)
Prior to April 2000, President, Chief Operating
Officer, and Vice Chairman of Associated
Banc-Corp
From April 1996 to October 1998, Vice Chairman
of Associated Banc-Corp; Chairman and Chief
Executive Officer of Associated Bank Green Bay,
N.A. (former subsidiary)
Brian R. Bodager Chief Administrative Officer, General Counsel, July 22, 1992
Age: 47 and Corporate Secretary of Associated
Banc-Corp; Director of Associated Bank,
National Association (subsidiary); Director of
Associated Bank Illinois, National Association
(subsidiary); Executive Vice President,
Secretary, and Director of Associated Trust
Company, National Association (subsidiary)
8
Name Offices and Positions Held Date of Election
Mark J. McMullen Director, Wealth Management, of Associated June 2, 1981
Age: 53 Banc-Corp; Director of Associated Bank,
National Association (subsidiary); Chairman and
Chief Executive Officer of Associated Trust
Company, National Association (subsidiary)
Prior to July 1999, Senior Executive Vice
President and Director of Associated Bank Green
Bay, N.A. (former subsidiary)
Donald E. Peters Director, Systems and Operations, of Associated October 27, 1997
Age: 53 Banc-Corp; Director of Associated Bank,
National Association (subsidiary); Director of
Associated Trust Company, National Association
(subsidiary)
From October 1997 to November 1998, Director of
Systems and Operations of Associated Banc-Corp;
Executive Vice President of First Financial
Bank (former subsidiary)
Joseph B. Selner Chief Financial Officer of Associated January 25, 1978
Age: 56 Banc-Corp; Director of Associated Bank,
National Association (subsidiary); Director of
Associated Trust Company, National Association
(subsidiary)
Gordon J. Weber Director, Corporate Banking, of Associated January 1, 1973
Age: 54 Banc-Corp; Director of Associated Bank,
National Association (subsidiary); Director of
Associated Bank Illinois, National Association
(subsidiary); Director of Associated Bank
Minnesota, National Association (subsidiary);
Director of Associated Trust Company, National
Association (subsidiary)
Prior to April 2001, President, Chief Executive
Officer, and Director of Associated Bank
Milwaukee (former subsidiary); Director of
Associated Bank South Central (former
subsidiary)
William M. Bohn Director, Legal, Compliance, and Risk April 23, 1997
Age: 36 Management, of Associated Banc-Corp
Robert J. Johnson Director, Corporate Human Resources, of January 22, 1997
Age: 57 Associated Banc-Corp
Gordon C. King Chief Credit Officer of Associated Banc-Corp January 22, 2003
Age: 41
From October 2001 to January 2003, Chief Credit
Officer of Associated Banc-Corp
From 1996 to October 2001, Senior Vice
President and Credit Administration Manager of
Associated Bank Milwaukee (former subsidiary)
Arthur E. Olsen, III General Auditor of Associated Banc-Corp July 28, 1993
Age: 51
Teresa A. Rosengarten Treasurer of Associated Banc-Corp October 25, 2000
Age: 42
From March 1994 to August 2000, Treasurer of a
Tennessee-based bank holding company
9
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 87 and the discussion of dividend restrictions in
Note 12, "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 February 28, 2003, was 9,807. Certain of the Corporation's
shares are held in "nominee" or "street" name and the number of beneficial
owners of such shares is approximately 26,312.
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.
10
ITEM 6 SELECTED FINANCIAL DATA
TABLE 1: EARNINGS SUMMARY AND SELECTED FINANCIAL DATA
(In Thousands, except per share data)
% 5-Year
Change Compound
2001 to Growth
Years ended December 31, 2002 2002 2001 2000 1999 1998 Rate (5)
- ----------------------------------------------------------------------------------------------------------------------
Interest income $ 792,106 (10.1)% $ 880,622 $ 931,157 $ 814,520 $ 785,765 0.1%
Interest expense 290,840 (36.6) 458,637 547,590 418,775 411,028 (6.7)
-----------------------------------------------------------------------------------
Net interest income 501,266 18.8 421,985 383,567 395,745 374,737 5.9
Provision for loan losses 50,699 79.7 28,210 20,206 19,243 14,740 9.9
-----------------------------------------------------------------------------------
Net interest income after
provision for loan losses 450,567 14.4 393,775 363,361 376,502 359,997 5.5
Noninterest income 220,308 12.6 195,603 184,196 165,906 167,928 18.4
Noninterest expense 374,549 10.7 338,369 317,736 305,092 294,962 3.0
-----------------------------------------------------------------------------------
Income before income taxes 296,326 18.1 251,009 229,821 237,316 232,963 20.6
Income tax expense 85,607 19.8 71,487 61,838 72,373 75,943 6.0
-----------------------------------------------------------------------------------
NET INCOME $ 210,719 17.4% $ 179,522 $ 167,983 $ 164,943 $ 157,020 32.1%
===================================================================================
Basic earnings per share (1) $ 2.82 14.2% $ 2.47 $ 2.24 $ 2.15 $ 2.06 32.5%
Diluted earnings per share (1) 2.79 13.9 2.45 2.23 2.13 2.03 32.6
Cash dividends per share (1) 1.21 9.3 1.11 1.01 0.96 0.86 10.7
Weighted average shares
outstanding: (1)
Basic 74,685 2.9 72,587 75,005 76,844 76,382 (0.4)
Diluted 75,493 3.2 73,167 75,251 77,514 77,185 (0.5)
SELECTED FINANCIAL DATA
Year-End Balances:
Loans $10,303,225 14.2% $ 9,019,864 $ 8,913,379 $ 8,343,100 $ 7,272,697 7.8%
Allowance for loan losses 162,541 26.8 128,204 120,232 113,196 99,677 11.9
Investment securities 3,362,669 5.2 3,197,021 3,260,205 3,270,383 2,907,735 2.7
Total assets 15,043,275 10.6 13,604,374 13,128,394 12,519,902 11,250,667 7.1
Deposits 9,124,852 5.9 8,612,611 9,291,646 8,691,829 8,557,819 1.7
Long-term debt 1,906,845 72.8 1,103,395 122,420 24,283 26,004 162.6
Company-obligated mandatorily
redeemable preferred 190,111 N/M --- --- --- --- N/M
securities
Stockholders' equity 1,272,183 18.8 1,070,416 968,696 909,789 878,721 9.3
Book value per share (1) 17.13 15.0 14.89 13.32 11.90 11.55 9.9
-----------------------------------------------------------------------------------
Average Balances:
Loans $10,002,478 10.0% $ 9,092,699 $ 8,688,086 $ 7,800,791 $ 7,255,850 7.5%
Investment securities 3,262,843 3.8 3,143,786 3,317,499 3,119,923 2,737,556 2.3
Total assets 14,297,418 9.1 13,103,754 12,810,235 11,698,104 10,628,695 6.6
Deposits 8,912,534 3.9 8,581,233 9,102,940 8,631,652 8,430,701 1.9
Stockholders' equity 1,231,977 18.8 1,037,158 920,169 914,082 856,425 8.0
-----------------------------------------------------------------------------------
Financial Ratios: (2)
Return on average equity 17.10% (21) 17.31% 18.26% 18.04% 18.33%
Return on average assets 1.47 10 1.37 1.31 1.41 1.48
Net interest margin (taxable
equivalent) 3.95 33 3.62 3.36 3.74 3.79
Average equity to average assets 8.62 71 7.91 7.18 7.81 8.06
Dividend payout ratio (3) 42.97 (193) 44.90 45.09 44.65 41.75
-----------------------------------------------------------------------------------
Selected Financial Data: (4)
Net income $ 210,719 13.5% $ 185,679 $ 173,944 $ 169,376 $ 158,912
Basic earnings per share (1) 2.82 10.3 2.56 2.32 2.20 2.08
Diluted earnings per share (1) 2.79 10.0 2.54 2.31 2.19 2.06
===================================================================================
(1) Per share data adjusted retroactively for stock splits and stock dividends.
(2) Change in basis points.
(3) Ratio is based upon basic earnings per share.
(4) Selected financial data has been adjusted to exclude the amortization of
goodwill in years prior to 2002 affected by adopting Statement of Financial
Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible
Assets" and SFAS No. 147, "Acquisitions of Certain Financial Institutions,"
effective January 1, 2002. (5) Base year used in 5-year compound growth
rate is 1997 consolidated financial data.
N/M = not meaningful
11
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion is management's analysis to assist in the understanding
and evaluation of the consolidated financial condition and results of operations
of Associated Banc-Corp (the "parent company"), together with all its
subsidiaries (the "Corporation"). It should be read in conjunction with the
consolidated financial statements and footnotes and the selected financial data
presented elsewhere in this report.
During the second quarter of 2002, the parent company merged its Minnesota bank
subsidiaries (Associated Bank Minnesota; Signal Bank National Association; and
Signal Bank South National Association) into a single national banking charter
under the name Associated Bank Minnesota, National Association. During 2001, the
Corporation merged its Wisconsin bank subsidiaries (Associated Bank South
Central; Associated Bank North; Associated Bank Milwaukee; Associated Bank,
National Association; Associated Bank Lakeshore, National Association; and
Associated Bank Green Bay, National Association) into a single national banking
charter, headquartered in Green Bay, Wisconsin, under the name Associated Bank,
National Association. Certain nonbank subsidiaries (Associated Leasing, Inc.,
Associated Banc-Corp Services, Inc., and Associated Commercial Mortgage, Inc.)
also merged with and into the resultant bank, becoming operating divisions of
Associated Bank, National Association.
The financial discussion that follows may refer to the effect of the
Corporation's business combination activity, detailed under section, "Business
Combinations," and Note 2, "Business Combination," of the notes to consolidated
financial statements. The detailed financial discussion focuses on 2002 results
compared to 2001. Discussion of 2001 results compared to 2000 is predominantly
in section "2001 Compared to 2000."
Critical Accounting Policies
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the balance sheet and revenues and expenses for
the period. Actual results could differ significantly from those estimates.
Estimates that are particularly susceptible to significant change include the
determination of the allowance for loan losses, mortgage servicing rights,
derivative financial instruments and hedging activities, and income taxes.
The consolidated financial statements of the Corporation are prepared in
conformity with accounting principles generally accepted in the United States of
America and follow general practices within the industries in which it operates.
This preparation requires management to make estimates, assumptions, and
judgments that affect the amounts reported in the financial statements and
accompanying notes. These estimates, assumptions, and judgments are based on
information available as of the date of the financial statements; accordingly,
as this information changes, actual results could differ from the estimates,
assumptions, and judgments reflected in the financial statements. Certain
policies inherently have a greater reliance on the use of estimates,
assumptions, and judgments and, as such, have a greater possibility of producing
results that could be materially different than originally reported. Management
believes the following policies are both important to the portrayal of the
Corporation's financial condition and results and require subjective or complex
judgments and, therefore, management considers the following to be critical
accounting policies.
Allowance for Loan Losses: Subject to the use of estimates, assumptions, and
judgments is management's evaluation process used to determine the adequacy of
the allowance for loan losses which combines several factors: management's
ongoing review and grading of the loan portfolio, consideration of past loan
loss experience, trends in past due and nonperforming loans, risk
characteristics of the various classifications of loans, existing economic
conditions, the fair value of underlying collateral, and other qualitative and
quantitative factors which could affect probable credit losses. Because current
economic
12
conditions can change and future events are inherently difficult to
predict, the anticipated amount of estimated loan losses, and therefore the
adequacy of the allowance, could change significantly. As an integral part of
their examination process, various regulatory agencies also review the allowance
for loan losses. Such agencies may require that certain loan balances be charged
off when their credit evaluations differ from those of management, based on
their judgments about information available to them at the time of their
examination. The Corporation believes the allowance for loan losses is adequate
and properly recorded in the financial statements. See Note 1, "Summary of
Significant Accounting Policies," and Note 5, "Loans," of the notes to
consolidated financial statements and section "Allowance for Loan Losses."
Mortgage Servicing Rights Valuation: The fair value of the Corporation's
mortgage servicing rights asset is important to the presentation of the
consolidated financial statements in that mortgage servicing rights are subject
to a fair value-based impairment standard. Mortgage servicing rights do not
trade in an active open market with readily observable prices. As such, like
other participants in the mortgage banking business, the Corporation relies on
an internal discounted cash flow model to estimate the fair value of its
mortgage servicing rights. While the Corporation believes that the values
produced by its internal model are indicative of the fair value of its mortgage
servicing rights portfolio, these values can change significantly depending upon
the then current interest rate environment, estimated prepayment speeds of the
underlying mortgages serviced, and other economic conditions. The proceeds that
might be received should the Corporation actually consider a sale of the
mortgage servicing rights portfolio could differ from the amounts reported at
any point in time. The Corporation believes the mortgage servicing rights asset
is properly recorded in the financial statements. See Note 1, "Summary of
Significant Accounting Policies," and Note 6, "Goodwill and Other Intangible
Assets," of the notes to consolidated financial statements and section
"Noninterest Expense."
Derivative Financial Instruments and Hedge Accounting: In various aspects of its
business, the Corporation uses derivative financial instruments to modify
exposures to changes in interest rates and market prices for other financial
instruments. Substantially all of these derivative financial instruments are
designated as hedges for financial reporting purposes. The application of the
hedge accounting policy requires judgment in the assessment of hedge
effectiveness, identification of similar hedged item groupings, and measurement
of changes in the fair value of hedged items. However, if in the future the
derivative financial instruments used by the Corporation no longer qualify for
hedge accounting treatment and, consequently, the change in the fair value of
hedged items could be recognized in earnings, the impact on the consolidated
results of operations and reported earnings could be significant. The
Corporation believes hedge effectiveness is evaluated properly in the
consolidated financial statements. See Note 1, "Summary of Significant
Accounting Policies," and Note 16, "Derivative and Hedging Activities," of the
notes to consolidated financial statements.
Income Tax Accounting: The assessment of tax liabilities involves the use of
estimates, assumptions, interpretations, and judgments concerning certain
accounting pronouncements and federal and state tax codes. There can be no
assurance that future events, such as court decisions or positions of federal
and state taxing authorities, will not differ from management's current
assessment, the impact of which could be significant to the consolidated results
of operations and reported earnings. The Corporation believes the tax
liabilities are adequate and properly recorded in the consolidated financial
statements. See Note 1, "Summary of Significant Accounting Policies," and Note
14, "Income Taxes," and section "Income Taxes."
Segment Review
As described in Note 21, "Segment Reporting," the Corporation's primary
reportable segment is banking, conducted through its bank and lending
subsidiaries. Banking includes: a) community banking - lending and deposit
gathering to businesses (including business-related services such as cash
management and international banking services) and to consumers (including
mortgages and credit cards); and b) corporate banking - specialized lending
(such as commercial real estate), lease financing, and banking to larger
businesses and metro or niche markets; and the support to deliver banking
services.
13
The Corporation's profitability is primarily dependent on net interest income,
noninterest income, the level of the provision for loan losses, noninterest
expense, and taxes of its banking segment. The consolidated discussion is
therefore predominantly describing the banking segment results.
Performance Summary
The Corporation recorded net income of $210.7 million for the year ended
December 31, 2002, an increase of $31.2 million or 17.4% over the $179.5 million
earned in 2001. Basic earnings per share for 2002 were $2.82, a 14.2% increase
over 2001 basic earnings per share of $2.47. Earnings per diluted share were
$2.79, a 13.9% increase over 2001 diluted earnings per share of $2.45. With the
required adoption of Statement of Financial Accounting Standards ("SFAS") 142
and SFAS 147, which eliminated the amortization of goodwill effective January 1,
2002, basic earnings per share of $2.82 in 2002 represented a 10.3% increase
over 2001 and diluted earnings per share of $2.79 in 2002 were 10.0% higher than
2001 (as presented in Table 1). Return on average assets and return on average
equity for 2002 were 1.47% and 17.10%, respectively, compared to 1.37% and
17.31%, respectively, for 2001. Cash dividends of $1.21 per share paid in 2002
increased by 9.3% over 2001. Key factors behind these results were:
- - Taxable equivalent net interest income was $525.3 million for 2002, $81.1
million or 18.3% higher than 2001. Although taxable equivalent interest
income decreased $86.7 million, interest expense decreased by $167.8
million. The increase in taxable equivalent net interest income was due to
changes in interest rates (adding $45.8 million) and increased volume of
earning assets and liabilities, together with changes in product mix
(adding $35.3 million). Average earning assets increased $1.0 billion to
$13.3 billion, including the impact of the acquisition of Signal Financial
Corporation ("Signal") on February 28, 2002 (see section "Business
Combinations").
- - Net interest income and net interest margin were impacted in 2002 by the
low interest rate environment, competitive pricing pressures, higher
earning asset balances, and funding strategies to take advantage of lower
interest rates. While the Federal Reserve lowered interest rates eleven
times during 2001, producing an average Federal funds rate of 3.88% for
2001, interest rates in 2002 remained level at 1.75% until November when
the Federal Reserve reduced the rate by 50 basis points ("bp"), for an
average rate of 1.67% in 2002.
- - The net interest margin for 2002 was 3.95%, compared to 3.62% in 2001. The
33 bp increase in net interest margin is attributable to the net of a 50 bp
increase in interest rate spread (the net of a 172 bp lower cost of
interest-bearing liabilities offset by a 122 bp decrease in the yield on
earning assets), and a 17 bp lower contribution from net free funds.
- - Total loans were $10.3 billion at December 31, 2002, an increase of $1.3
billion or 14.2% over December 31, 2001, attributable in large part to the
Signal acquisition, which added $760 million in loans at consummation date.
Commercial loan balances grew $1.1 billion (20.4%) and represented 61% of
total loans at December 31, 2002, compared to 58% at year-end 2001. Total
deposits were $9.1 billion at December 31, 2002, including $785 million
acquired with the Signal acquisition. To take advantage of the lower rate
environment, the Corporation increased long-term debt by $803 million and
issued $175 million of company-obligated mandatorily redeemable preferred
securities.
- - Asset quality was affected by the impact of challenging economic conditions
on customers. The provision for loan losses increased to $50.7 million
compared to $28.2 million in 2001. Net charge offs were $28.3 million, an
increase of $8.1 million over 2001, due primarily to the charge off of
several commercial credits. Net charge offs were 0.28% of average loans
compared to 0.22% in 2001. The ratio of allowance for loan losses to loans
was 1.58% and 1.42% at December 31, 2002 and 2001, respectively.
Nonperforming loans were $99.3 million, representing 0.96% of total loans
at year-end 2002, compared to $52.1 million or 0.58% of total loans last
year.
- - Noninterest income was $220.3 million for 2002, $24.7 million or 12.6%
higher than 2001, led by strong results in mortgage banking and service
charge revenue. Mortgage banking revenue increased by $17.2 million (32.0%)
driven by strong secondary mortgage production, while service charges on
deposit accounts were up $8.2 million (21.8%) over 2001.
14
- - Noninterest expense was $374.5 million, up $36.2 million or 10.7% over
2001. Adjusting for goodwill amortization, as described above, noninterest
expense was $42.7 million or 12.9% higher in 2002, due principally to the
Corporation's larger operating base and increases in mortgage servicing
rights expense. Personnel expense rose $21.6 million or 12.6%, reflecting
the expanded employee base, as well as higher base salaries and fringe
benefit costs. Mortgage servicing rights expense increased $10.5 million, a
function of increases to both the valuation allowance and higher
amortization of the mortgage servicing rights asset.
- - Income tax expense increased to $85.6 million, up $14.1 million from 2001.
The increase was primarily attributable to higher net income before tax.
The effective tax rate in 2002 was 28.9% compared to 28.5% for 2001.
Business Combinations
On February 28, 2002, the Corporation consummated its acquisition of 100% of the
outstanding common shares of Signal, a financial holding company headquartered
in Mendota Heights, Minnesota. Signal operated banking branches in nine
locations in the Twin Cities and Eastern Minnesota. As a result of the
acquisition, the Corporation expanded its Minnesota presence, particularly in
the Twin Cities area. The Signal transaction was consummated through the
issuance of approximately 4.1 million shares of common stock and $58.4 million
in cash for a purchase price of $192.5 million. The value of the shares was
determined using the closing stock price of the Corporation's stock on September
10, 2001, the initiation date of the transaction. There were no business
combinations during 2001 or 2000. The Corporation's business combination
activity is further summarized in Note 2, "Business Combination," of the notes
to consolidated financial statements.
INCOME STATEMENT ANALYSIS
Net Interest Income
Net interest income is the primary source of the Corporation's revenue. Net
interest income is the difference between interest income on earning assets,
such as loans and securities, and the interest expense on interest-bearing
deposits and other borrowings, used to fund interest earning and other assets or
activities. The amount of net interest income is affected by changes in interest
rates and by the amount and composition of earning assets and interest-bearing
liabilities. Additionally, net interest income is impacted by the sensitivity of
the balance sheet to changes in interest rates which factors in characteristics
such as the fixed or variable nature of the financial instruments, contractual
maturities, and repricing frequencies.
Net interest income in the consolidated statements of income (which excludes the
taxable equivalent adjustment) was $501.3 million, compared to $422.0 million
last year. The taxable equivalent adjustments (the adjustments to bring
tax-exempt interest to a level that would yield the same after-tax income had
that income been subject to taxation using a 35% tax rate) of $24.0 million for
2002 and $22.2 million for 2001 resulted in fully taxable equivalent net
interest income of $525.3 million and $444.2 million, respectively.
Taxable equivalent net interest income was $525.3 million for 2002, an increase
of $81.1 million or 18.3% from 2001. The increase in taxable equivalent net
interest income was attributable to both lower interest rates, particularly on
the cost of interest-bearing liabilities, and a higher level of earning assets.
The net interest margin for 2002 was 3.95%, compared to 3.62% in 2001. The 33 bp
increase in net interest margin is attributable to the net of a 50 bp increase
in interest rate spread (the net of a 172 bp lower cost of interest-bearing
liabilities offset by a 122 bp decrease in the yield on earning assets), and a
17 bp lower contribution from net free funds. Interest rates were generally
stable and low during 2002, but were higher and steadily falling during 2001.
Comparatively, the Federal funds rate at December 31, 2002, was 50 bp lower than
at December 31, 2001, while the average Federal funds rate for 2002 was 221 bp
lower than for 2001.
15
Interest rate spread and net interest margin are utilized to measure and explain
changes in net interest income. Interest rate spread is the difference between
the yield on earning assets and the rate paid for interest-bearing liabilities
that fund those assets. The net interest margin is expressed as the percentage
of net interest income to average earning assets. The net interest margin
exceeds the interest rate spread because noninterest-bearing sources of funds
(net free funds), principally demand deposits and stockholders' equity, also
support earning assets. To compare tax-exempt asset yields to taxable yields,
the yield on tax-exempt loans and securities is computed on a taxable equivalent
basis. Net interest income, interest rate spread, and net interest margin are
discussed on a taxable equivalent basis.
Table 2 provides average balances of earning assets and interest-bearing
liabilities, the associated interest income and expense, and the corresponding
interest rates earned and paid, as well as net interest income, interest rate
spread, and net interest margin on a taxable equivalent basis for the three
years ended December 31, 2002. Tables 3 through 5 present additional information
to facilitate the review and discussion of taxable equivalent net interest
income, interest rate spread, and net interest margin.
As shown in the rate/volume analysis in Table 3, changes in the rates resulted
in a $45.8 million increase to taxable equivalent net interest income, while
increases in volume and changes in the mix of both earning assets and
interest-bearing liabilities added $35.3 million, for a combined increase of
$81.1 million. Rate changes on interest-bearing liabilities lowered interest
expense by $190.2 million, while the changes in rates on earning assets reduced
interest income by $144.4 million, for a net favorable impact of $45.8 million.
For 2002, the cost of interest-bearing liabilities decreased 172 bp to 2.55%,
aided by the low rate environment. The combined average cost of interest-bearing
deposits was 2.28%, down 175 bp, with the most significant rate decreases seen
in deposit categories with the highest balances, namely money market accounts
(down 193 bp to 1.32%) and non-brokered time deposits (down 177 bp to 3.74%).
The cost of wholesale funds (comprised of all short-term borrowings and
long-term funding) decreased 172 bp to 3.06% for 2002, with the Corporation
implementing a number of funding strategies to take advantage of the low
interest rate environment. The interest-bearing liability rate changes resulted
in $190.2 million lower interest expense, with $129.9 million attributable to
interest-bearing deposits and $60.3 million due to wholesale funding.
For 2002, the yield on earning assets fell 122 bp to 6.14%, driven primarily by
a 136 bp decline in the loan yield. The average loan yield was 6.27%. The lower
rate environment for new originations, competitive pricing pressure and
refinancing in many loan categories put downward pressure on loan yields in
2002. The yield on securities and short-term investments combined was down 85 bp
to 5.73%. The earning asset rate changes reduced interest income by $144.4
million, a combination of $118.3 million lower interest on loans and $26.1
million lower interest on securities and short-term investments combined.
From a volume perspective, the growth and composition change of earning assets
contributed an additional $57.7 million to taxable equivalent net interest
income, while the growth and composition of interest-bearing liabilities cost an
additional $22.4 million, netting a $35.3 million increase to taxable equivalent
net interest income.
Average earning assets were $13.3 billion in 2002, an increase of $1.0 billion,
or 8.3%, from 2001, including the impact of the Signal acquisition on February
28, 2002. Loans accounted for the majority of the growth in earning assets,
increasing by $910 million, or 10.0%, to $10.0 billion on average in 2002 and
representing 75.2% of average earning assets compared to 74.1% for 2001. For
2002, taxable equivalent interest income on loans increased $52.0 million from
growth, but decreased $118.3 million from the impact of the rate environment (as
noted above), for a net decrease of $66.3 million versus last year (See Table
3). Securities and short-term investments combined increased $113 million on
average. Taxable equivalent interest income on securities and short-term
investments for 2002 increased $5.7 million from volume changes, but decreased
$26.1 million from the impact of the rate environment, for a net $20.4 million
decrease to taxable equivalent interest income.
16
Average interest-bearing liabilities were $11.4 billion in 2002, an increase of
$643 million, or 6.0%, from 2001. The growth in earning assets was also
supported by a $332 million, or 28.4%, increase in average noninterest-bearing
deposits (a component of net free funds). The growth in interest-bearing
liabilities came from increases in wholesale funding sources, as average
interest-bearing deposits were level in 2002 compared to 2001. Average wholesale
funding sources increased by $644 million, representing 34.9% of average
interest-bearing liabilities for 2002, versus 31.0% last year. Furthermore, to
take advantage of the lower rate environment, the Corporation shifted funds from
short-term borrowing sources to long-term funding, increasing its long-term
funding by $1.1 billion to 14.7% of average interest-bearing liabilities
(compared to 5.3% for 2001). Therefore, for 2002, interest expense on wholesale
funding increased by $22.4 million due to volume changes (the net of a $47.3
million increase from additional average long-term funding offset by a $24.9
million decrease of short-term borrowings) and decreased by $60.3 million from
lower rates. With no volume change in total interest-bearing deposits, the
$129.9 million reduction in interest expense on those deposits was attributable
to the favorable impact of the lower rate environment.
17
TABLE 2: Average Balances and Interest Rates (interest and rates on a taxable equivalent basis)
Years Ended December 31,
-----------------------------------------------------------------------------------------------
2002 2001 2000
-----------------------------------------------------------------------------------------------
Average Average Average Average Average Average
Balance Interest Rate Balance Interest Rate Balance Interest Rate
-----------------------------------------------------------------------------------------------
($ in Thousands)
ASSETS
Earning assets:
Loans: (1)(2)(3)
Residential real estate $ 3,362,179 $223,314 6.64% $ 3,546,204 $271,039 7.64% $ 3,152,128 $243,986 7.74%
Commercial 5,929,113 348,082 5.87 4,898,895 366,495 7.48 4,313,271 376,068 8.72
Consumer 711,186 56,106 7.89 647,600 56,246 8.69 1,222,687 108,074 8.84
-----------------------------------------------------------------------------------------------
Total loans 10,002,478 627,502 6.27 9,092,699 693,780 7.63 8,688,086 728,128 8.38
Investment securities:
Taxable 2,431,713 125,299 5.15 2,306,444 146,170 6.34 2,523,492 163,768 6.49
Tax exempt(1) 831,130 62,719 7.55 837,343 61,507 7.35 794,007 58,233 7.33
Short-term investments 29,270 658 2.25 35,380 1,421 4.02 41,309 2,775 6.72
-----------------------------------------------------------------------------------------------
Securities and short-term
investments 3,292,113 188,676 5.73 3,179,167 209,098 6.58 3,358,808 224,776 6.69
-----------------------------------------------------------------------------------------------
Total earning assets $13,294,591 $816,178 6.14% $12,271,866 $902,878 7.36% $12,046,894 $952,904 7.91%
-----------------------------------------------------------------------------------------------
Allowance for loan losses (148,801) (125,790) (115,580)
Cash and due from banks 302,856 279,363 268,267
Other assets 848,772 678,315 610,654
-----------------------------------------------------------------------------------------------
Total assets $14,297,418 $13,103,754 $12,810,235
===============================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Savings deposits $ 891,105 $ 6,813 0.76% $ 839,417 $ 11,812 1.41% $ 956,177 $ 19,704 2.06%
Interest-bearing demand deposits 1,118,546 9,581 0.86 799,451 7,509 0.94 803,779 11,091 1.38
Money market deposits 1,876,988 24,717 1.32 1,722,242 55,999 3.25 1,407,502 65,702 4.67
Time deposits, excluding
Brokered CDs 3,263,766 122,181 3.74 3,648,942 201,035 5.51 4,008,382 228,191 5.69
-----------------------------------------------------------------------------------------------
Total interest-bearing
deposits, excluding
Brokered CDs 7,150,405 163,292 2.28 7,010,052 276,355 3.94 7,175,840 324,688 4.52
Brokered CDs 264,023 5,729 2.17 404,686 22,575 5.58 840,518 55,204 6.57
-----------------------------------------------------------------------------------------------
Total interest-bearing
deposits 7,414,428 169,021 2.28 7,414,738 298,930 4.03 8,016,358 379,892 4.74
Federal funds purchased and
securities Sold under
agreements to repurchase 2,058,163 42,143 2.05 1,839,336 77,011 4.19 1,724,291 107,732 6.25
Other short-term borrowings 250,919 9,229 3.68 924,420 53,535 5.79 816,553 52,698 6.45
Long-term funding 1,673,071 70,447 4.21 574,753 29,161 5.07 114,374 7,268 6.35
-----------------------------------------------------------------------------------------------
Total wholesale funding 3,982,153 121,819 3.06 3,338,509 159,707 4.78 2,655,218 167,698 6.32
-----------------------------------------------------------------------------------------------
Total interest-bearing
liabilities $11,396,581 $290,840 2.55% $10,753,247 $458,637 4.27% $10,671,576 $547,590 5.13%
-----------------------------------------------------------------------------------------------
Noninterest-bearing demand
deposits 1,498,106 1,166,495 1,086,582
Accrued expenses and other
liabilities 170,754 146,854 131,908
Stockholders' equity 1,231,977 1,037,158 920,169
-----------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity $14,297,418 $13,103,754 $12,810,235
===============================================================================================
Net interest income and rate
spread (1) $525,338 3.59% $444,241 3.09% $405,314 2.78%
===============================================================================================
Net interest margin (1) 3.95% 3.62% 3.36%
===============================================================================================
Taxable equivalent adjustment $ 24,072 $ 22,256 $ 21,747
===============================================================================================
(1) The yield on tax exempt loans and securities is computed on a taxable
equivalent basis using a tax rate of 35% for all periods presented and is
net of the effects of certain disallowed interest deductions.
(2) Nonaccrual loans and loans held for sale have been included in the average
balances.
(3) Interest income includes net loan fees.
18
TABLE 3: Rate/Volume Analysis (1)
2002 Compared to 2001 2001 Compared to 2000
Increase (Decrease) Due to Increase (Decrease) Due to
---------------------------------------------------------------------------
Volume Rate Net Volume Rate Net
---------------------------------------------------------------------------
($ in Thousands)
Interest income:
Loans: (2)
Residential real estate $ (12,535) $ (35,190) $ (47,725) $ 35,017 $ (7,964) $ 27,053
Commercial 63,495 (81,908) (18,413) 46,979 (56,552) (9,573)
Consumer 1,035 (1,175) (140) (50,910) (918) (51,828)
---------------------------------------------------------------------------
Total loans 51,995 (118,273) (66,278) 31,086 (65,434) (34,348)
Investment securities:
Taxable 6,320 (27,191) (20,871) (13,844) (3,754) (17,598)
Tax-exempt (2) (536) 1,748 1,212 3,183 91 3,274
Short-term investments (94) (669) (763) (354) (1,000) (1,354)
---------------------------------------------------------------------------
Securities and short-term investments 5,690 (26,112) (20,422) (11,015) (4,663) (15,678)
---------------------------------------------------------------------------
Total earning assets (2) $ 57,685 $(144,385) $ (86,700) $ 20,071 $ (70,097) $ (50,026)
---------------------------------------------------------------------------
Interest expense:
Savings deposits $ 395 $ (5,394) $ (4,999) $ (2,194) $ (5,698) $ (7,892)
Interest-bearing demand deposits 2,733 (661) 2,072 (59) (3,523) (3,582)
Money market deposits 2,038 (33,320) (31,282) 12,800 (22,503) (9,703)
Time deposits, excluding Brokered CDs (2,121) (76,733) (78,854) (19,977) (7,179) (27,156)
---------------------------------------------------------------------------
Total interest-bearing deposits, 3,045 (116,108) (113,063) (9,430) (38,903) (48,333)
excluding Brokered CDs
Brokered CDs (3,053) (13,793) (16,846) (25,284) (7,345) (32,629)
---------------------------------------------------------------------------
Total interest-bearing deposits (8) (129,901) (129,909) (34,714) (46,248) (80,962)
Federal funds purchased and securities
sold under Agreements to repurchase (3,482) (31,386) (34,868) 6,588 (37,309) (30,721)
Other short-term borrowings (21,456) (22,850) (44,306) 6,421 (5,584) 837
Long-term funding 47,351 (6,065) 41,286 23,479 (1,586) 21,893
---------------------------------------------------------------------------
Total wholesale funding 22,413 (60,301) (37,888) 36,488 (44,479) (7,991)
---------------------------------------------------------------------------
Total interest-bearing liabilities $ 22,405 $(190,202) $(167,797) $ 1,774 $ (90,727) $ (88,953)
---------------------------------------------------------------------------
Net interest income (2) $ 35,280 $ 45,817 $ 81,097 $ 18,297 $ 20,630 $ 38,927
===========================================================================
(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 a fully taxable
equivalent basis using a tax rate of 35% for all periods presented and is
net of the effects of certain disallowed interest deductions.
19
TABLE 4: Interest Rate Spread and Interest Margin (on a taxable equivalent basis)
2002 Average 2001 Average 2000 Average
---------------------------------------------------------------------------------------------
% of % of % of
Earning Yield Earning Yield Earning Yield
Balance Assets /Rate Balance Assets /Rate Balance Assets /Rate
---------------------------------------------------------------------------------------------
($ in Thousands)
Earning assets $13,294,591 100.0% 6.14% $12,271,866 100.0% 7.36% $12,046,894 100.0% 7.91%
---------------------------------------------------------------------------------------------
Financed by:
Interest-bearing funds $11,396,581 85.7% 2.55% $10,753,247 87.6% 4.27% $10,671,576 88.6% 5.13%
Noninterest-bearing
funds 1,898,010 14.3% 1,518,619 12.4% 1,375,318 11.4%
----------------------------------------------------------------------------------------------
Total funds sources $13,294,591 100.0% 2.19% $12,271,866 100.0% 3.74% $12,046,894 100.0% 4.55%
=============================================================================================
Interest rate spread 3.59% 3.09% 2.78%
Contribution from net
free funds .36% .53% .58%
----- ----- -----
Net interest margin 3.95% 3.62% 3.36%
=============================================================================================
Average prime rate* 4.68% 6.91% 9.23%
Average federal funds
rate* 1.67% 3.88% 6.26%
Average spread 301bp 303bp 297bp
=============================================================================================
*Source: Bloomberg
TABLE 5: Selected Average Balances
Percent 2002 as % of 2001 as % of
2002 2001 Change Total Assets Total Assets
-------------------------------------------------------------------------
($ in Thousands)
ASSETS
Loans $10,002,478 $ 9,092,699 10.0% 70.0% 69.4%
Investment securities
Taxable 2,431,713 2,306,444 5.4 17.0 17.6
Tax-exempt 831,130 837,343 (0.7) 5.8 6.4
Short-term investments 29,270 35,380 (17.3) 0.2 0.3
--------------------------------------------------------------------------
Total earning assets 13,294,591 12,271,866 8.3 93.0 93.7
Other assets 1,002,827 831,888 20.5 7.0 6.3
-------------------------------------------------------------------------
Total assets $14,297,418 $13,103,754 9.1% 100.0% 100.0%
=========================================================================
LIABILITIES & STOCKHOLDERS' EQUITY
Interest-bearing deposits $ 7,414,428 $ 7,414,738 ---% 51.8% 56.6%
Short-term borrowings 2,309,082 2,763,756 (16.5) 16.2 21.1
Long-term funding 1,673,071 574,753 191.1 11.7 4.4
-------------------------------------------------------------------------
Total interest-bearing liabilities 11,396,581 10,753,247 6.0 79.7 82.1
Noninterest-bearing demand deposits 1,498,106 1,166,495 28.4 10.5 8.9
Accrued expenses and other liabilities 170,754 146,854 16.3 1.2 1.1
Stockholders' equity 1,231,977 1,037,158 18.8 8.6 7.9
-------------------------------------------------------------------------
Total liabilities and stockholders' equity $14,297,418 $13,103,754 9.1% 100.0% 100.0%
=========================================================================
Provision for Loan Losses
The provision for loan losses in 2002 was $50.7 million. The provision for loan
losses for 2001 was $28.2 million, and $20.2 million for 2000. The provision for
loan losses is predominantly a function of the methodology and other qualitative
and quantitative factors used to determine the adequacy of the
20
allowance for loan losses which focuses on changes in the size and
character of the loan portfolio, changes in levels of impaired and other
nonperforming loans, historical losses on each portfolio category, the risk
inherent in specific loans, concentrations of loans to specific borrowers
or industries, existing economic conditions, the fair value of underlying
collateral, and other factors which could affect potential credit losses.
At December 31, 2002, the allowance for loan losses was $162.5 million, compared
to $128.2 million at December 31, 2001, and $120.2 million at December 31, 2000.
Net charge offs were $28.3 million for 2002, compared to $20.2 million for 2001
and $9.0 million for 2000. The ratio of the allowance for loan losses to total
loans was 1.58%, up from 1.42% at December 31, 2001, and up from 1.35% at
December 31, 2000. Nonperforming loans at December 31, 2002, were $99.3 million,
compared to $52.1 million at December 31, 2001, and $47.7 million at December
31, 2000. See additional discussion under sections, "Allowance for Loan Losses,"
and "Nonperforming Loans, Potential Problem Loans, and Other Real Estate Owned."
Noninterest Income
Noninterest income was $220.3 million for 2002, $24.7 million or 12.6% higher
than 2001. Primary categories that have attributed to the change between
comparable periods were mortgage banking and service charges on deposit
accounts. Fee income as a percentage of total revenues (defined as total
noninterest income less gains or losses on asset and investment sales ("fee
income") divided by taxable equivalent net interest income plus fee income) was
29.5% for 2002 compared to 30.3% last year.
TABLE 6: Noninterest Income
% Change From
Years Ended December 31, Prior Year
--------------------------------------------------------
2002 2001 2000 2002 2001
--------------------------------------------------------
($ in Thousands)
Trust service fees $ 27,875 $ 29,063 $ 37,617 (4.1)% (22.7)%
Service charges on deposit accounts 46,059 37,817 33,296 21.8 13.6
Mortgage banking 70,903 53,724 19,944 32.0 169.4
Credit card and other nondeposit fees 27,492 26,731 25,739 2.8 3.9
Retail commissions 18,264 16,872 20,187 8.3 (16.4)
Bank owned life insurance income 13,841 12,916 12,377 7.2 4.4
Asset sale gains, net 657 1,997 24,420 (67.1) (91.8)
Other 15,644 15,765 18,265 (0.8) (13.7)
--------------------------------------------------------
Subtotal $220,735 $194,885 $191,845 13.3% 1.6%
Investment securities gains (losses), net (427) 718 (7,649) N/M N/M
--------------------------------------------------------
Total noninterest income $220,308 $195,603 $184,196 12.6% 6.2%
========================================================
Subtotal, net of asset sale gains ("fee
income") $220,078 $192,888 $167,425 14.1% 15.2%
========================================================
N/M = not meaningful
21
Trust service fees for 2002 were $27.9 million, down $1.2 million (4.1%) from
last year. The change was predominantly the result of decreases in servicing
fees on personal and employee benefit plans due to the 8% lower average market
value of assets under management, reflecting market conditions, offset partly by
fee increases for other trust services. The market value of assets under
management was $3.5 billion at December 31, 2002 compared to $4.0 billion at
December 31, 2001.
Service charges on deposit accounts were $46.1 million, $8.2 million (21.8%)
higher than 2001, due in part to higher volumes associated with a larger account
base. The increase was a function of lower earnings credit rates, higher service
charges on business accounts, higher fees on overdrafts/nonsufficient funds, and
an increase in service charge fees during the first quarter of 2002.
Mortgage banking income consists of servicing fees, the gain or loss on sales of
mortgage loans to the secondary market, gains on sales of servicing, and
production-related fees (origination, underwriting, and escrow waiver fees).
Mortgage banking income was $70.9 million in 2002, an increase of $17.2 million
or 32.0% over 2001. The increase was primarily a result of increased income
associated with higher production volumes. Secondary mortgage loan production
(mortgage loan production to be sold to the secondary market) was $3.2 billion
for 2002, up 38.2% over $2.3 billion for 2001. As a result, production-related
fees were up $8.0 million. Gains on sales of loans were up $12.1 million, a
function of the volume and loan sale pricing. Servicing fees on the portfolio
serviced for others were up $1.3 million between comparable periods, in line
with the increase in the portfolio serviced for others ($5.4 billion at December
31, 2002, versus $5.2 billion at December 31, 2001). Offsetting these increases
was $4.3 million in gains on the sales of mortgage servicing rights in 2001
versus none in 2002.
Credit card and other nondeposit fees were $27.5 million for 2002, an increase
of $0.8 million or 2.8% over 2001, primarily due to increased merchant and other
credit card revenues. In February 2003, the Corporation entered into a 10-year
agreement with an outside vendor to provide merchant processing services for the
Corporation's merchant customers. The agreement will result in after tax income
of approximately $2.0 million in the first quarter of 2003 and revenue sharing
on new and existing merchant business over the life of the agreement.
Retail commission income (which includes commissions from insurance and
brokerage product sales) was $18.3 million, up $1.4 million or 8.3% compared to
last year. This increase was attributable to insurance commissions, up $2.6
million, predominantly in commissions on fixed annuities, a more attractive
product given the lower interest rate environment. Brokerage commissions,
including variable annuities, were down $1.2 million, affected largely by the
weaker financial markets. During fourth quarter 2002, legislation became
effective requiring single premium credit insurance premiums on loans with real
estate collateral to be collected based on monthly outstanding balances. This
new requirement is expected to reduce credit insurance premiums somewhat in the
early periods of adoption.
Bank owned life insurance income was $13.8 million, up $0.9 million or 7.2% over
last year due to the larger bank owned life insurance asset. Asset sale gains
for 2002 were $0.7 million, while asset sale gains for 2001 were $2.0 million.
Other noninterest income was $15.6 million for 2002, down slightly ($0.1
million) from 2001, due to the sale of stock in a regional ATM network that
resulted in a gain of $0.5 million during 2002, while a similar transaction on a
different ATM network stock resulted in a gain of $2.6 million during 2001.
The 2002 investment securities net losses of $0.4 million included an $0.8
million other than temporary write down on a security. Investment securities net
gains for 2001 were $0.7 million from various securities sold.
Noninterest Expense
Total noninterest expense for 2002 was $374.5 million, a $36.2 million or 10.7%
increase over 2001 noninterest expense, influenced by the Corporation's larger
operating base with the February 28, 2002, acquisition of Signal. Adjusting for
goodwill amortization, which ceased on January 1, 2002, as a result of adopting
SFAS 142 and SFAS 147, noninterest expense was up $42.7 million or 12.9%. Larger
22
increases were in mortgage servicing rights expense, loan expense, and in
personnel and occupancy costs, given a larger employee base and broader branch
network as the Corporation assimilated Signal's businesses and operations.
During the second quarter of 2002, the Corporation completed its integration of
Signal's banking subsidiaries with Associated Bank Minnesota, to operate under a
single national charter named Associated Bank Minnesota, National Association.
TABLE 7: Noninterest Expense
% Change
From Prior
Years Ended December 31, Year
---------------------------------------------------
2002 2001 2000 2002 2001
---------------------------------------------------
($ in Thousands)
Personnel expense $192,918 $171,362 $157,007 12.6% 9.1%
Occupancy 26,049 23,947 23,258 8.8 3.0
Equipment 14,835 14,426 15,272 2.8 (5.5)
Data processing 21,024 19,596 22,375 7.3 (12.4)
Business development and advertising 13,812 13,071 13,359 5.7 (2.2)
Stationery and supplies 7,044 6,921 7,961 1.8 (13.1)
FDIC expense 1,533 1,661 1,818 (7.7) (8.6)
Mortgage servicing rights expense 30,473 19,987 9,406 52.5 112.5
Core deposit intangible amortization 2,283 1,867 2,345 22.3 (20.4)
Loan expense 14,555 11,176 8,447 30.2 32.3
Legal and professional fees 6,075 4,394 7,595 38.3 (42.1)
Other 43,948 43,450 42,333 1.1 2.6
---------------------------------------------------
Subtotal $374,549 $331,858 $311,176 12.9% 6.6%
Goodwill amortization --- 6,511 6,560 (100.0) (0.7)
---------------------------------------------------
Total noninterest expense $374,549 $338,369 $317,736 10.7% 6.5%
===================================================
Personnel expense (including salary-related expenses and fringe benefit
expenses) increased $21.6 million or 12.6% over 2001, and represented 51.5% of
total noninterest expense in 2002 compared to 50.6% in 2001 (or 51.6% using
noninterest expense excluding goodwill amortization). Average full-time
equivalent employees were 4,072 for 2002 (with Signal adding approximately 350
at the time of acquisition or approximately 250 on average for the year),
compared to 3,849 for 2001. Total salary-related expenses increased $16.6
million or 12.5% in 2002, primarily a function of higher base salaries and
incentive compensation given the overall increase in full-time equivalent
employees, and merit increases between years. Fringe benefits increased $5.0
million or 12.9% in 2002, attributable also to the larger employee base and to
the increased cost of premium based benefits (up 11.9%), and other fringe
benefit expenses commensurate with the salary-related expense increase.
Occupancy expense increased 8.8% to support the larger branch network
attributable mostly to the Signal acquisition, while equipment expense was
minimally changed from last year, up 2.8%. Data processing costs increased to
$21.0 million, up $1.4 million or 7.3% over last year, due to Internet banking
enhancements, processing for a larger base operation, and for the conversion of
Signal to the Corporation's common operating platforms in the second quarter of
2002. Business development and advertising increased to $13.8 million for 2002,
up $0.7 million or 5.7% compared to 2001, primarily supporting the new business
production of the year and the newer markets acquired. Stationery and supplies
were relatively unchanged from last year, up 1.8%. FDIC expense was down $0.1
million, primarily a function of lower average insurance rates paid.
Mortgage servicing rights expense includes both the amortization of the mortgage
servicing rights asset and increases or decreases to the valuation allowance
associated with the mortgage servicing rights asset. Mortgage servicing rights
expense increased by $10.5 million between 2002 and 2001, including a $3.6
million increase in the amortization of the mortgage servicing rights asset and
a $6.9 million larger
23
addition to the valuation allowance between years. While the strong
mortgage refinance activity benefited mortgage banking income, it increased the
prepayment speeds of the Corporation's mortgage portfolio serviced for others, a
key factor behind the valuation of mortgage servicing rights. See Note 1,
"Summary of Significant Accounting Policies," of the notes to consolidated
financial statements for the Corporation's accounting policy for mortgage
servicing rights and section "Critical Accounting Policies." A valuation
allowance is established to the extent the carrying value of the mortgage
servicing rights exceeds the estimated fair value. Net income could be affected
if management's estimate of the prepayment speeds or other factors differ
materially from actual prepayments. Mortgage servicing rights, included in other
intangible assets on the consolidated balance sheet, were $32.3 million, net of
a $28.4 million valuation allowance at December 31, 2002 (see Note 6, "Goodwill
and Other Intangible Assets," of the notes to consolidated financial
statements).
Core deposit intangible amortization increased to $2.3 million, primarily due to
additional core deposit intangibles resulting from the Signal acquisition. Loan
expense was $14.6 million, up $3.4 million from 2001, due to increased costs
related to higher production of all loan types, primarily higher merchant
interchange costs and mortgage loan expenses. Legal and professional fees were
up $1.7 million over 2001 with most categories showing increases, including
legal costs related to loan production and loan quality, technology consulting,
and examinations. Goodwill amortization expense decreased $6.5 million due to
the adoption of SFAS 142 and SFAS 147, which ceased the amortization of goodwill
effective January 1, 2002. See Note 1, "Summary of Significant Accounting
Policies," Note 2, "Business Combination," and Note 6, "Goodwill and Other
Intangible Assets," of the notes to consolidated financial statements.
Income Taxes
Income tax expense for 2002 was $85.6 million, up $14.1 million from 2001 income
tax expense of $71.5 million. The Corporation's effective tax rate (income tax
expense divided by income before taxes) was 28.9% in 2002 compared to 28.5% in
2001. The increase was primarily attributable to the increase in net income
before tax.
See Note 1, "Summary of Significant Accounting Policies," of the notes to
consolidated financial statements for the Corporation's income tax accounting
policy and section "Critical Accounting Policies." Income tax expense recorded
in the consolidated income statement involves interpretation and application of
certain accounting pronouncements and federal and state tax codes, and is
therefore, considered a critical accounting policy. The Corporation undergoes
examination by various taxing authorities. Such taxing authorities may require
that changes in the amount of tax expense or valuation allowance be recognized
when their interpretations differ from those of management, based on their
judgments about information available to them at the time of their examinations.
See Note 14, "Income Taxes," of the notes to consolidated financial statements
for more information.
BALANCE SHEET ANALYSIS
Loans
Total loans were $10.3 billion at December 31, 2002, an increase of $1.3 billion
or 14.2% over December 31, 2001, largely attributable to the Signal acquisition,
which added $760 million in loans at consummation date. Commercial loans were
$6.3 billion, up $1.1 billion or 20.4%. Commercial loans grew to represent 61%
of total loans at the end of 2002, up from 58% at year-end 2001. Home equity and
other consumer loans combined grew $309 million or 24.3%, while residential
mortgage loans decreased 3.7%, strongly influenced by lower interest rates and
high refinance activity.
24
TABLE 8: Loan Composition
As of December 31,
-------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
-------------------------------------------------------------------------------------------------
% of % of % of % of % of
Amount Total Amount Total Amount Total Amount Total Amount Total
-------------------------------------------------------------------------------------------------
($ in Thousands)
Commercial, financial, and
agricultural $ 2,213,986 22% $1,783,300 20% $1,657,322 19% $1,412,338 17% $ 962,208 13%
Real estate construction 910,581 9 797,734 9 660,732 7 560,450 7 461,157 7
Commercial real estate 3,128,826 30 2,630,964 29 2,287,946 26 1,903,633 23 1,384,524 19
Lease financing 38,352 -- 11,629 -- 14,854 -- 23,229 -- 19,231 --
-------------------------------------------------------------------------------------------------
Commercial 6,291,745 61 5,223,627 58 4,620,854 52 3,899,650 47 2,827,120 39
Residential mortgage 2,430,746 24 2,524,199 28 3,158,721 35 3,274,767 39 3,362,885 46
Home equity 864,631 8 609,254 7 508,979 6 408,577 5 331,861 5
-------------------------------------------------------------------------------------------------
Residential real estate 3,295,377 32 3,133,453 35 3,667,700 41 3,683,344 44 3,694,746 51
Consumer 716,103 7 662,784 7 624,825 7 760,106 9 750,831 10
-------------------------------------------------------------------------------------------------
Total loans $10,303,225 100% $9,019,864 100% $8,913,379 100% $8,343,100 100% $7,272,697 100%
=================================================================================================
Commercial, financial, and agricultural loans were $2.2 billion at the end of
2002, up $431 million or 24.2% since year-end 2001, and comprised 22% of total
loans outstanding, up from 20% at the end of 2001. 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
diverse range of industries. The credit risk related to commercial loans is
largely influenced by general economic conditions and the resulting impact on a
borrower's operations. Within the commercial, financial, and agricultural
classification, loans to finance agricultural production totaled only 0.3% of
total loans at December 31, 2002, compared to 0.2% at December 31, 2001.
Real estate construction loans grew $113 million or 14.1% to $911 million,
representing 9% of the total loan portfolio at the end of 2002, compared to $798
million or 9% at the end of 2001. Loans in this classification are primarily
short-term interim loans that provide financing for the acquisition or
development of commercial real estate, such as multifamily or other commercial
development projects. 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 to customers based in
the Corporation's tri-state market 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,
but is also influenced by general economic conditions. 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.
Commercial real estate includes loans secured by farmland, multifamily
properties, and nonfarm/nonresidential real estate properties. Commercial real
estate totaled $3.1 billion at December 31, 2002, up $498 million or 18.9% over
last year and comprised 30% of total loans outstanding versus 29% at year-end
2001. Commercial real estate loans involve borrower characteristics similar to
those discussed above for commercial loans and real estate-construction
projects. Loans of this type are mainly for business and industrial properties,
multifamily properties, and community purpose properties. Loans are primarily
made to customers based in Wisconsin, Illinois, and Minnesota. Credit risk is
managed in a similar manner to commercial loans and real estate construction by
employing sound underwriting guidelines, lending to borrowers in local markets
and businesses, and formally reviewing the borrower's financial soundness and
relationship on an ongoing basis. In many cases the Corporation will take
additional real estate collateral to further secure the overall lending
relationship.
25
Residential real estate loans totaled $3.3 billion at the end of 2002, up $162
million or 5.2% from the prior year and comprised 32% of total loans outstanding
versus 35% at year-end 2001. Loans in this classification include residential
mortgage (which consists of conventional home mortgages and second mortgages)
and home equity lines. Residential mortgage loans generally limit the maximum
loan to 80% of collateral value. Residential mortgage loans were $2.4 billion at
December 31, 2002, down $93 million or 3.7% compared to last year, principally
due to high refinance activity prompted by lower interest rates and the
subsequent sale of newer, fixed-rate loan production into the secondary market.
Home equity lines grew by $255 million, or 41.9%, to $865 million in 2002, an
attractive product to consumers given the lower rate environment in 2002.
Consumer loans to individuals totaled $716 million at December 31, 2002, up $53
million or 8.0% compared to 2001, representing 7% of the year-end loan
portfolio. Consumer loans include short-term installment loans, direct and
indirect automobile loans, recreational vehicle loans, credit card loans (which
are primarily business-oriented), 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. 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, early identification of
potential problems, an adequate allowance for loan losses, and sound nonaccrual
and charge off policies.
An active credit risk management process is used for commercial loans to further
ensure that sound and consistent credit decisions are made. Credit risk is
controlled by detailed underwriting procedures, comprehensive loan
administration, and periodic review of borrowers' outstanding loans and
commitments. Borrower relationships are formally reviewed on an ongoing basis
for early identification of potential problems. Further analyses by customer,
industry, and geographic location are performed to monitor trends, financial
performance, and concentrations.
The loan portfolio is widely diversified by types of borrowers, industry groups,
and market areas within our primary three-state area. Significant loan
concentrations are considered to exist for a financial institution when there
are amounts loaned to numerous borrowers engaged in similar activities that
would cause them to be similarly impacted by economic or other conditions. At
December 31, 2002, no significant concentrations existed in the Corporation's
portfolio in excess of 10% of total loans.
TABLE 9: Loan Maturity Distribution and Interest Rate Sensitivity (1)
Maturity (2)
-----------------------------------------------------------
December 31, 2002 Within 1 Year 1-5 Years After 5 Years Total
-----------------------------------------------------------
($inThousands)
Commercial, financial, and
agricultural $1,761,903 $379,258 $72,825 $2,213,986
Real estate construction 748,742 114,368 47,471 910,581
-----------------------------------------------------------
Total $2,510,645 $493,626 $120,296 $3,124,567
===========================================================
Fixed rate $ 612,802 $439,117 $120,251 $1,172,170
Floating or adjustable rate 1,897,843 54,509 45 1,952,397
-----------------------------------------------------------
Total $2,510,645 $493,626 $120,296 $3,124,567
===========================================================
Percent 80% 16% 4% 100%
(1) Based upon scheduled principal repayments.
(2) Demand loans, past due loans, and overdrafts are reported in the "Within 1
Year" category.
26
Allowance for Loan Losses
The loan portfolio is the primary asset subject to credit risk. Credit risk is
controlled and monitored through the use of lending standards, a thorough review
of potential borrowers, and on-going review of loan payment performance. Active
asset quality administration, including early problem loan identification and
timely resolution of problems, further ensures appropriate management of credit
risk and minimization of loan losses. Credit risk management for each loan type
is discussed briefly in the section entitled "Loans."
The allowance for loan losses represents management's estimate of an amount
adequate to provide for probable credit losses in the loan portfolio at the
balance sheet date. Management's evaluation of the adequacy of the allowance for
loan losses is based on management's ongoing review and grading of the loan
portfolio, consideration of past loan loss experience, trends in past due and
nonperforming loans, risk characteristics of the various classifications of
loans, existing economic conditions, the fair value of underlying collateral,
and other factors which could affect probable credit losses. Assessing these
numerous factors involves significant judgment. Management considers the
allowance for loan losses a critical accounting policy (see section "Critical
Accounting Policies"). See management's allowance for loan losses accounting
policy in Note 1, "Summary of Significant Accounting Policies," of the notes to
consolidated financial statements and Note 5, "Loans," of the notes to
consolidated financial statements for certain additional allowance for loan
losses disclosures.
At December 31, 2002, the allowance for loan losses was $162.5 million, compared
to $128.2 million at December 31, 2001. The $34.3 million increase was the net
result of a $50.7 million provision for loan losses and $12.0 million acquired
with the Signal acquisition offset by $28.3 million of net charge offs. The
provision for loan losses in 2002 was $50.7 million. In comparison, the
provision for loan losses for 2001 was $28.2 million and $20.2 million in 2000.
The provision for loan losses is predominantly a function of the result of the
methodology and other qualitative and quantitative factors used to determine the
allowance for loan losses. As of December 31, 2002, the allowance for loan
losses to total loans was 1.58% and covered 164% of nonperforming loans,
compared to 1.42% and 246%, respectively, at December 31, 2001. Tables 10 and 11
provide additional information regarding activity in the allowance for loan
losses, and Table 12 provides additional information regarding nonperforming
loans.
Net charge offs were $28.3 million or 0.28% of average loans for 2002, compared
to $20.2 million or 0.22% of average loans for 2001, and were $9.0 million or
0.10% of average loans for 2000 (see Table 10). The $8.1 million increase in net
charge offs for 2002 compared to 2001 was primarily due to $5.0 million higher
net charge offs of commercial portfolio loans. Particularly, charge offs of
commercial, financial, and agricultural loans were $15.0 million, up $3.7
million over 2001, and charge offs of commercial real estate loans were $6.1
million, up $2.5 million, as shown in Table 10. During 2002, several commercial
credits were charged off, accountable for approximately $13.0 million of the
2002 commercial charge offs. During 2001, the charge off of a few commercial
credits accounted for approximately $10.7 million of 2001 commercial charge
offs. Loans charged off are subject to continuous review, and specific efforts
are taken to achieve maximum recovery of principal, accrued interest, and
related expenses.
27
TABLE 10: Loan Loss Experience
Years Ended December 31,
------------------------------------------------------
2002 2001 2000 1999 1998
------------------------------------------------------
($ in Thousands)
Allowance for loan losses, at beginning of year $128,204 $120,232 $113,196 $ 99,677 $92,731
Balance related to acquisitions 11,985 --- --- 8,016 3,636
Decrease from sale of credit card receivables --- --- (4,216) --- ---
Provision for loan losses 50,699 28,210 20,206 19,243 14,740
Loans charged off:
Commercial real estate 6,124 3,578 795 927 *
Residential real estate 3,292 1,262 2,923 2,545 *
------------------------------------------------------
Real estate - mortgage 9,416 4,840 3,718 3,472 3,256
Commercial, financial, and agricultural 14,994 11,268 1,679 2,222 3,533
Real estate construction 1,402 1,631 38 --- 202
Consumer 6,099 4,822 5,717 10,925 9,839
Lease financing 268 78 3 2 209
------------------------------------------------------
Total loans charged off 32,179 22,639 11,155 16,621 17,039
Recoveries of loans previously charged off:
Commercial real estate 787 242 153 364 *
Residential real estate 141 192 297 291 *
------------------------------------------------------
Real estate - mortgage 928 434 450 655 1,582
Commercial, financial, and agricultural 1,608 1,013 772 726 2,384
Real estate construction 3 --- --- 1 ---
Consumer 1,219 954 979 1,464 1,641
Lease financing 74 --- --- 35 2
------------------------------------------------------
Total recoveries 3,832 2,401 2,201 2,881 5,609
------------------------------------------------------
Net loans charged off 28,347 20,238 8,954 13,740 11,430
------------------------------------------------------
Allowance for loan losses, at end of year $162,541 $128,204 $120,232 $113,196 $99,677
======================================================
Ratio of allowance for loan losses to net
charge offs 5.7 6.3 13.4 8.2 8.7
Ratio of net charge offs to average loans 0.28% 0.22% 0.10% 0.18% 0.16%
Ratio of allowance for loan losses to total loans
at end of year 1.58% 1.42% 1.35% 1.36% 1.37%
=========== =========== ========== ========== ==========
* The additional breakdown between commercial and residential real estate was
not available.
28
TABLE 11: Allocation of the Allowance for Loan Losses
As of December 31,
------------------------------------------------------------------------------------------
% of % of % of % of % of
2002 Total 2001 Total 2000 Total 1999 Total 1998 Total
------------------------------------------------------------------------------------------
($ in Thousands)
Commercial real estate $ 57,010 35% $47,810 37% $25,925 22% * * * *
Residential real estate 17,778 11 14,084 11 25,236 21 * * * *
------------------------------------------------------------------------------------------
Real estate - mortgage 74,788 46 61,894 48 51,161 43 $50,267 45% $40,216 40%
Commercial, financial, and
agricultural 64,965 40 44,071 34 45,571 38 31,648 28 25,385 26
Real estate construction 9,106 6 7,977 6 6,531 5 5,605 5 3,369 4
Consumer 4,613 3 5,683 5 6,194 5 14,904 13 16,924 17
Lease financing 230 --- 327 --- 149 --- 184 --- 426 ---
Unallocated 8,839 5 8,252 7 10,626 9 10,588 9 13,357 13
------------------------------------------------------------------------------------------
Total allowance for loan losses $162,541 100% $128,204 100% $120,232 100% $113,196 100% $99,677 100%
==========================================================================================
* The additional breakdown between commercial and residential real estate was
not available.
The change in the allowance for loan losses is a function of a number of
factors, including but not limited to changes in the loan portfolio (see Table
8), net charge offs (see Table 10), and nonperforming loans (see Table 12).
First, total loan growth from year-end 2001 to 2002 was $1.3 billion or 14.2%.
The acquisition of Signal included $12.0 million of allowance for loan losses on
$760 million of loans. Loan growth during 2002 was strongest in the commercial
loan portfolio (defined as commercial real estate; commercial, financial, and
agricultural loans; real estate construction loans; and lease financing), which
grew to represent 61% of total loans at year-end 2002 compared to 58% last
year-end. This segment of the loan portfolio carries greater inherent credit
risk (described under section "Loans"). Net charge offs for 2002 increased to
$28.3 million, with $5.0 million of the total $8.1 million increase in
commercial loan charge offs. Finally, nonperforming loans to total loans grew to
0.96% for 2002 compared to 0.58% last year.
The allocation of the Corporation's allowance for loan losses for the last five
years is shown in Table 11. The allocation methodology applied by the
Corporation, designed to assess the adequacy of the allowance for loan losses,
focuses on changes in the size and character of the loan portfolio, changes in
levels of impaired and other nonperforming loans, the risk inherent in specific
loans, concentrations of loans to specific borrowers or industries, existing
economic conditions, and historical losses on each portfolio category. Because
each of the criteria used is subject to change, the allocation of the allowance
for loan losses is made for analytical purposes and is not necessarily
indicative of the trend of future loan losses in any particular loan category.
The total allowance is available to absorb losses from any segment of the
portfolio. Management continues to target and maintain the allowance for loan
losses equal to the allocation methodology plus an unallocated portion, as
determined by economic conditions and other qualitative and quantitative factors
affecting the Corporation's borrowers. Management allocates the allowance for
loan losses for credit losses by pools of risk. The commercial loan (commercial,
financial, and agricultural; real estate construction; commercial real estate;
and lease financing) allocations are based on a quarterly review of individual
loans, loan types, and industries. The retail loan (residential mortgage, home
equity, and consumer) allocation is based on analysis of historical delinquency
and charge off statistics and trends. Minimum loss factors used by the
Corporation for criticized loan categories are consistent with regulatory agency
factors. Loss factors for non-criticized loan categories are based primarily on
loan type, historical loan loss experience, and industry statistics. The
mechanism used to address differences between estimated and actual loan loss
experience includes review of recent nonperforming loan trends, underwriting
trends, external factors, and management's judgment relating to current
assumptions.
The allocation methods used for December 31, 2002 and 2001 were comparable.
Factors used for criticized loans (defined as specific loans warranting either
specific allocation or a criticized status of watch, special mention,
substandard, doubtful or loss), as well as for non-criticized loan categories,
were unchanged between the years. At both December 31, 2002 and 2001, current
economic conditions carried various uncertainties requiring management's
judgment as to the possible impact on the business results
29
of numerous individual borrowers and certain industries. Additionally, the
pace at which the financial results of a borrower's company can take a downturn
from challenging and varied economic conditions continued to be a factor for
both years. Thus, at year-end 2002, 55% of the allowance (compared to 48% at
year-end 2001) was allocated to criticized loans, including $10 million of
allowance identified for a $21 million commercial manufacturing credit for which
management has doubts concerning the future collectibility of the loan given
current economic conditions. While the payments for this credit have been
current during 2002, the credit was added to nonaccrual loans during second
quarter 2002. The primary shift in the allowance allocation was the amount
allocated to commercial, financial, and agricultural loans at year-end 2002
which was $65.0 million, representing 40% (compared to 34% at year-end 2001) of
the allowance for loan losses. A greater amount of these loans are in criticized
categories (22% versus 18% at year-end 2001); charge offs of this loan type have
increased (to $15.0 million for 2002, up 33%) between the years; these loans
represent 49% of nonperforming loans (compared to 24% last year-end); and
commercial, financial, and agricultural loans grew to represent 22% of total
loans at December 31, 2002 (compared to 20% at year-end 2001). As noted under
the section "Loans," the credit risk of this loan category is largely influenced
by the impact on borrowers of general economic conditions, which have been noted
to be challenging and uncertain. The allowance allocated to commercial real
estate was 35% at year-end 2002, down from 37% at year-end 2001. In 2001 for
this category, a greater amount of these loans were in criticized loan
categories, which materialized into greater charge offs during 2002 (see Table
10). While commercial real estate loans grew 18.9% since year-end 2001, they
represented 30% of total loans at December 31, 2002, relatively unchanged from
29% last year.
For December 31, 2001 and 2000, the allocation methods were also generally
comparable. However, certain economic indicators were less favorable at year-end
2001 versus 2000, such as the greater uncertainty of current economic
conditions, the terrorist attacks in September 2001, and the increased pace of
financial downturn for various businesses. Therefore, the allocations for
criticized loans in substandard and watch categories were increased at year-end
2001 compared to 2000. The amount allocated to commercial, financial, and
agricultural loans in 2001 was $44.1 million, representing 34% of the allowance
for loan losses, compared to 38% last year. In 2000 for this category, a greater
amount of these loans were in criticized loan categories and for which specific
allocations were made. Thus, as anticipated, Table 10 evidences that this
category incurred the largest amount of 2001 charge-offs. Finally, commercial,
financial, and agricultural loans represented 24% of nonperforming loans
compared to 29% last year. For 2001, the amount allocated for commercial real
estate increased to $47.8 million, representing 37% of the allowance for loan
losses compared to 22% last year. The increase was a function of changes in the
commercial real estate loan category, including increased loan balances, growing
15.0% to represent 29% of total loans versus 26% at year-end 2000, and increased
net charge off activity of $3.3 million for 2001, versus last year of $0.6
million.
Management carefully considers numerous detailed and general factors, its
assumptions, and the likelihood of materially different conditions that could
alter its assumptions. Consolidated net income could be affected if management's
estimate of the allowance for loan losses are materially different, requiring
additional provision for loan losses to be recorded. Management believes the
allowance for loan losses to be adequate at December 31, 2002. While management
uses available information to recognize losses on loans, future adjustments to
the allowance for loan losses may be necessary based on changes in economic
conditions and the impact of such change on the Corporation's borrowers. As an
integral part of their examination process, various regulatory agencies also
review the allowance for loan losses. Such agencies may require that certain
loan balances be charged off when their credit evaluations differ from those of
management, based on their judgments about information available to them at the
time of their examination. Management expects improvement in credit quality
should the economy improve in 2003.
Nonperforming Loans, Potential Problem Loans, and Other Real Estate Owned
Management is committed to an aggressive nonaccrual and problem loan
identification philosophy. This philosophy is implemented through the ongoing
monitoring and review of all pools of risk in the loan portfolio to ensure that
problem loans are identified quickly and the risk of loss is minimized.
30
Nonperforming loans are defined as nonaccrual loans, loans 90 days or more past
due but still accruing, and restructured loans. The Corporation specifically
excludes from its definition of nonperforming loans student loan balances that
are 90 days or more past due and still accruing and that have contractual
government guarantees as to collection of principal and interest. Such past due
student loans were approximately $20.2 million and $21.0 million at December 31,
2002 and 2001, respectively.
Loans are generally placed on nonaccrual status when contractually past due 90
days or more as to interest or principal payments. Additionally, whenever
management becomes aware of facts or circumstances that may adversely impact the
collectibility of principal or interest on loans, it is management's practice to
place such loans on nonaccrual status immediately, rather than delaying such
action until the loans become 90 days past due. Previously accrued and
uncollected interest on such loans is reversed, amortization of related loan
fees is suspended, and income is recorded only to the extent that interest
payments are subsequently received in cash and a determination has been made
that the principal balance of the loan is collectible. If collectibility of the
principal is in doubt, payments received are applied to loan principal.
Loans past due 90 days or more but still accruing interest are also included in
nonperforming loans. Loans past due 90 days or more but still accruing are
classified as such where the underlying loans are both well secured (the
collateral value is sufficient to cover principal and accrued interest) and are
in the process of collection. Also included in nonperforming loans are
"restructured" loans. Restructured loans involve the granting of some concession
to the borrower involving the modification of terms of the loan, such as changes
in payment schedule or interest rate.
TABLE 12: Nonperforming Loans and Other Real Estate Owned
December 31,
--------------------------------------------------------
2002 2001 2000 1999 1998
--------------------------------------------------------
($ in Thousands)
Nonaccrual loans $ 94,132 $48,238 $41,045 $32,076 $48,150
Accruing loans past due 90 days or more 3,912 3,649 6,492 4,690 5,252
Restructured loans 1,258 238 159 148 485
--------------------------------------------------------
Total nonperforming loans $ 99,302 $52,125 $47,696 $36,914 $53,887
Other real estate owned 11,448 2,717 4,032 3,740 6,025
--------------------------------------------------------
Total nonperforming assets $110,750 $54,842 $51,728 $40,654 $59,912
========================================================
Ratios at year end:
Nonperforming loans to total loans 0.96% 0.58% 0.54% 0.44% 0.74%
Nonperforming assets to total assets 0.74% 0.40% 0.39% 0.32% 0.53%
Allowance for loan losses to nonperforming loans 164% 246% 252% 307% 185%
========================================================
Nonperforming loans at December 31, 2002, were $99.3 million (with Signal adding
approximately $9 million at acquisition), compared to $52.1 million at December
31, 2001, and $47.7 million at year-end 2000. The ratio of nonperforming loans
to total loans at the end of 2002 was 0.96%, as compared to 0.58% and 0.54% at
December 31, 2001 and 2000, respectively. Nonaccrual loans accounted for the
majority of the increase in nonperforming loans since year-end 2001. Nonaccrual
loans increased $45.9 million, restructured loans increased $1.0 million, and
accruing loans past due 90 days or more increased $0.3 million. Commercial
nonaccrual loans (representing approximately 77% of nonaccrual loans at year-end
2002 versus 65% at year-end 2001) increased $41.3 million. The increase in
commercial nonaccrual loans from year-end 2001 to year-end 2002 is predominantly
attributable to the addition of one commercial manufacturing credit (totaling
$21 million) for which payments are current; however, the Corporation has doubts
concerning the future collectibility of the loan given the current economic
conditions and has set aside $10 million of the allowance for loan losses for
this credit. The remaining rise in nonaccrual loans
31
is primarily attributable to the commercial loan portfolio and is not
concentrated within the same industry. The Corporation's allowance for loan
losses to nonperforming loans was 164% at year-end 2002, down from 246% at
year-end 2001 and 252% at year-end 2000.
Other real estate owned increased to $11.4 million at December 31, 2002,
compared to $2.7 million and $4.0 million at year-end 2001 and 2000,
respectively, predominantly due to the addition of an $8.0 million commercial
real estate property during 2002. Net gains on sales of other real estate owned
were $53,000, $643,000, and $116,000 for 2002, 2001, and 2000, respectively.
Management actively seeks to ensure properties held are monitored to minimize
the Corporation's risk of loss.
The following table shows, for those loans accounted for on a nonaccrual basis
and restructured loans for the years ended as indicated, the gross interest that
would have been recorded if the loans had been current in accordance with their
original terms and the amount of interest income that was included in interest
income for the period.
TABLE 13: Foregone Loan Interest
Years Ended December 31,
-------------------------------------
2002 2001 2000
-------------------------------------
($ in Thousands)
Interest income in accordance
with original terms $ 6,866 $ 4,840 $ 3,951
Interest income recognized (4,313) (2,694) (2,609)
-------------------------------------
Reduction in interest income $ 2,553 $ 2,146 $ 1,342
=====================================
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. At December 31,
2002, potential problem loans totaled $211.9 million, compared to $177.8 million
at December 31, 2001. 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. Management does not presently expect significant losses
from credits in the potential problem loan category.
Investment Securities Portfolio
The investment securities portfolio is intended to provide the Corporation with
adequate liquidity, flexibility in asset/liability management, a source of
stable income, and is structured with minimum credit exposure to the
Corporation. Investment securities classified as available for sale are carried
at fair market value in the consolidated balance sheet while investment
securities classified as held to maturity are carried at amortized cost. At
December 31, 2002, the total carrying value of investment securities represented
22% of total assets, compared to 23% at year-end 2001. On average, the
investment portfolio represented 25% and 26% of average earning assets for 2002
and 2001, respectively.
The classification of securities as held to maturity or available for sale is
determined at the time of purchase. The Corporation classifies most investment
purchases as available for sale. This is consistent with the Corporation's
investment philosophy of maintaining flexibility to manage the investment
portfolio, particularly in light of asset/liability management strategies,
including possible securities sales in response to changes in interest rates or
prepayment risk, the need to manage regulatory capital, and other factors. SFAS
133, "Accounting for Derivative Instruments and Hedging Activities," which was
adopted by the Corporation as required on January 1, 2001, provided for the
option, upon adoption, to change the classification of investments held. Thus,
on January 1, 2001, the Corporation reclassified all its held to maturity
securities to available for sale securities. The amortized cost and fair value
of the securities transferred were $369 million and $373 million, respectively.
SFAS 133 is more fully described under Note 1, "Summary of Significant
Accounting Policies," and Note 16, "Derivative and Hedging Activities," of the
notes to consolidated financial statements.
32
TABLE 14: Investment Securities Portfolio
At December 31,
--------------------------------------
2002 2001 2000
--------------------------------------
($ in Thousands)
Investment Securities Held to Maturity:
Federal agency securities $ --- $ --- $ 25,055
Obligations of states and political
subdivisions --- --- 110,182
Mortgage-related securities --- --- 182,299
Other securities (debt) --- --- 51,022
--------------------------------------
Total amortized cost and carrying value $ --- $ --- $ 368,558
======================================
Total fair value $ --- $ --- $ 372,873
======================================
Investment Securities Available for Sale:
U.S. Treasury securities $ 44,967 $ 15,071 $ 23,847
Federal agency securities 222,787 196,175 341,929
Obligations of state and political
subdivisions 851,710 847,887 756,914
Mortgage-related securities 1,672,542 1,642,851 1,425,290
Other securities (debt and equity) 440,126 414,399 319,129
--------------------------------------
Total amortized cost $3,232,132 $3,116,383 $2,867,109
======================================
Total fair value and carrying value $3,362,669 $3,197,021 $2,891,647
======================================
Total Investment Securities:
Total amortized cost $3,232,132 $3,116,383 $3,235,667
Total fair value 3,362,669 3,197,021 3,264,520
Total carrying value 3,362,669 3,197,021 3,260,205
======================================
At December 31, 2002 and 2001, mortgage-related securities (which include
predominantly mortgage-backed securities and collateralized mortgage
obligations) represented 50.7% and 52.4%, respectively, of total investment
securities based on carrying value. The fair value of mortgage-related
securities are subject to inherent risks based upon the future performance of
the underlying collateral (i.e. mortgage loans) for these securities, such as
prepayment risk and interest rate changes.
At December 31, 2002, the Corporation's 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 carrying value of such securities exceeded 10% of
stockholders' equity or approximately $127 million (stockholders' equity was
$1.3 billion at December 31, 2002).
During 2002, a collateralized mortgage obligation (included in mortgage-related
securities) was determined to have an other than temporary impairment that
resulted in a $0.8 million write-down on the security.
33
TABLE 15: Investment Securities Portfolio Maturity Distribution (1) - At December 31, 2002
Investment Securities Available for Sale - Maturity Distribution and Weighted Average Yield
-------------------------------------------------------------------------------------------------------------------
After one but Mortgage-related Total
within five After five but After ten and equity Total Fair
Within one year years within ten years years securities Amortized Cost Value
-------------------------------------------------------------------------------------------------------------------
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield Amount
-------------------------------------------------------------------------------------------------------------------
($ in Thousands)
U. S. Treasury
securities $ 19,230 3.06% $ 25,737 3.34% $ --- --- $ --- --- $ --- --- $ 44,967 3.22% $ 45,882
Federal agency
securities 68,717 5.39% 154,020 5.41% 50 5.91% --- --- --- --- 222,787 5.40% 233,930
Obligations of
states and
political
subdivisions
(2) 29,114 6.87% 211,212 6.96% 334,796 6.98% 276,588 8.17% --- --- 851,710 7.37% 904,023
Other debt
securities 97,584 2.07% 175,624 6.23% 10,296 6.19% 10,000 3.01% --- --- 293,504 4.74% 306,615
Mortgage-related
securities --- --- --- --- --- --- --- --- 1,672,542 5.19% 1,672,542 5.19% 1,705,236
Equity securities --- --- --- --- --- --- --- --- 146,622 5.34% 146,622 5.34% 166,983
-------------------------------------------------------------------------------------------------------------------
Total amortized
cost $214,645 4.19% $566,593 6.16% $345,142 6.51% $286,588 7.99% $1,819,164 5.20% $3,232,132 5.72% $3,362,669
===================================================================================================================
Total fair value $218,272 $601,608 $363,823 $306,747 $1,872,219 $3,362,669
===================================================================================================================
(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 taxable equivalent basis
using a tax rate of 35% and have not been adjusted for certain disallowed
interest deductions.
Deposits
Deposits are the Corporation's largest source of funds. Competition is
especially strong for deposits, with the Corporation competing with other bank
and nonbank institutions, as well as with investment alternatives such as money
market or other mutual funds and brokerage houses. The Corporation's nonbrokered
deposit growth has been impacted by competitive factors, as well as other
investment opportunities available to customers. During both 2002 and 2001, the
Corporation has particularly marketed its transaction accounts (business demand
deposits, interest-bearing demand deposits, and money market accounts), which
offer competitive, market-indexed rates and greater customer flexibility.
At December 31, 2002, deposits were $9.1 billion, up $512 million or 5.9% over
last year, including $785 million added with the Signal acquisition. Certain
period-end deposit information is detailed in Note 8, "Deposits," of the notes
to consolidated financial statements, including a maturity distribution of all
time deposits at December 31, 2002. A maturity distribution of certificates of
deposits and other time deposits of $100,000 or more at December 31, 2002 is
shown in Table 17. Table 16 summarizes the distribution of average deposit
balances.
The mix of deposits changed during 2002 as customers reacted to low and
uncertain interest rates and poor stock market performance. At December 31,
2002, noninterest-bearing demand deposits were 19% of deposits, compared to 17%
at year-end 2001. Interest-bearing transaction accounts (savings,
interest-bearing demand, and money market deposits) grew to 45% of deposits
versus 41% at the end of 2001. Given the lower interest rate environment and
scheduled maturities, total time deposits declined to 36% of deposits at
year-end 2002 compared to 42% last year.
On average, deposits were $8.9 billion for 2002, up $331 million or 3.9% over
the average for 2001. Average nonbrokered deposits for 2002 were $8.6 billion,
up $472 million or 5.8% compared to last year. As discussed in sections, "Net
Interest Income," and "Other Funding Sources," average earning asset growth
outpaced deposit growth, increasing the Corporation's use of wholesale funding.
34
TABLE 16: Average Deposits Distribution
2002 2001 2000
-------------------------------------------------------------------------------
Amount % of Total Amount % of Total Amount % of Total
-------------------------------------------------------------------------------
($ in Thousands)
Noninterest-bearing demand deposits $1,498,106 17% $1,166,495 14% $1,086,582 12%
Interest-bearing demand deposits 1,118,546 12 799,451 9 803,779 9
Savings deposits 891,105 10 839,417 10 956,177 11
Money market deposits 1,876,988 21 1,722,242 20 1,407,502 15
Brokered certificates of deposit 264,023 3 404,686 5 840,518 9
Other time deposits 3,263,766 37 3,648,942 42 4,008,382 44
-------------------------------------------------------------------------------
Total deposits $8,912,534 100% $8,581,233 100% $9,102,940 100%
===============================================================================
Nonbrokered deposits $8,648,511 97% $8,176,547 95% $8,262,422 91%
===============================================================================
TABLE 17: Maturity Distribution-Certificates of Deposit
and Other Time Deposits of $100,000 or More
December 31, 2002
--------------------------------------------
Certificates of Deposit Other Time Deposits
--------------------------------------------
($ in Thousands)
Three months or less $327,591 $45,479
Over three months
through six months 115,980 3,000
Over six months through
twelve months 135,639 ---
Over twelve months 208,261 20,000
-------------------------------------------
Total $787,471 $68,479
===========================================
Other Funding Sources
Other funding sources, including short-term borrowings, long-term debt, and
company-obligated mandatorily redeemable preferred securities ("wholesale
funds"), were $4.5 billion at December 31, 2002, up $0.7 billion from $3.7
billion at December 31, 2001. Short-term borrowings decreased $254 million,
primarily in short-term Federal Home Loan Bank advances, as longer-term funding
sources were utilized. Short-term borrowings are primarily comprised of Federal
funds purchased; securities sold under agreements to repurchase; short-term
Federal Home Loan Bank advances; notes payable to banks; treasury, tax, and loan
notes; and commercial paper. The Federal Home Loan Bank advances included in
short-term borrowings are those with original maturities of less than one year.
The treasury, tax, and loan notes are demand notes representing secured
borrowings from the U.S. Treasury, collateralized by qualifying securities and
loans. The funds are placed with the subsidiary banks at the discretion of the
U.S. Treasury and may be called at any time. See Note 9, "Short-term
Borrowings," of the notes to consolidated financial statements for additional
information on short-term borrowings, and Table 18 for specific disclosure
required for major short-term borrowing categories. Long-term debt at December
31, 2002, was $1.9 billion, up from $1.1 billion at the end of last year, due to
the issuance of $300 million of bank notes, $226 million of long-term repurchase
agreements, and the use of long-term Federal Home Loan Bank advances. See Note
10, "Long-term Debt," of the notes to consolidated financial statements for
additional information on long-term debt. Additionally, during the second
quarter of 2002 the Corporation issued $175 million of company-obligated
mandatorily redeemable preferred securities. See Note 11, "Company-Obligated
Mandatorily Redeemable Preferred Securities," of the notes to consolidated
financial statements for additional information on the preferred securities.
Wholesale funds on average were $4.0 billion for 2002, up $644 million or 19.3%
over 2001. The reliance on wholesale funds increased during 2002 as mentioned
under both sections "Net Interest Income" and "Deposits." The mix of wholesale
funding shifted toward longer-term instruments, with average
35
long-term funding representing 42.0% of wholesale funds compared to 17.2%
last year, in response to certain asset/liability objectives and favorable
interest rates. Within the short-term borrowing categories, average short-term
Federal Home Loan Bank advances were down $575 million, while Federal funds
purchased and securities sold under agreements to repurchase were up $219
million.
TABLE 18: Short-Term Borrowings
December 31,
---------------------------------------
2002 2001 2000
---------------------------------------
($ in Thousands)
Federal funds purchased and securities
sold under agreements to repurchase:
Balance end of year $2,240,286 $1,691,152 $1,691,796
Average amounts outstanding during year 2,058,163 1,839,336 1,724,291
Maximum month-end amounts outstanding 2,264,557 2,298,320 2,012,529
Average interest rates on amounts outstanding
at end of year 1.49% 2.22% 6.59%
Average interest rates on amounts outstanding
during year 2.05% 4.19% 6.25%
Federal Home Loan Bank advances:
Balance end of year $ 100,000 $ 300,000 $ 750,000
Average amounts outstanding during year 147,945 722,466 541,909
Maximum month-end amounts outstanding 400,000 850,000 1,375,653
Average interest rates on amounts outstanding
at end of year 1.66% 3.15% 6.42%
Average interest rates on amounts outstanding
during year 1.91% 6.25% 6.39%
Liquidity
The objective of liquidity management is to ensure that the Corporation has the
ability to generate sufficient cash or cash equivalents in a timely and
cost-effective manner to meet its commitments as they fall due. Funds are
available from a number of sources, primarily from the core deposit base and
from loans and securities repayments and maturities. Additionally, liquidity is
provided from sales of the securities portfolio, lines of credit with major
banks, the ability to acquire large and brokered deposits, and the ability to
securitize or package loans for sale.
The Corporation's liquidity management framework includes measurement of several
key elements, such as wholesale funding as a percent of total assets and liquid
assets to short-term wholesale funding. The Corporation's liquidity framework
also incorporates contingency planning to assess the nature and volatility of
funding sources and to determine alternatives to these sources. The contingency
plan would be activated to ensure the Corporation's funding commitments could be
met in the event of general market disruption or adverse economic conditions.
Strong capital ratios, credit quality, and core earnings are essential to
retaining high credit ratings and, consequently, cost-effective access to the
wholesale funding markets. A downgrade or loss in credit ratings could have an
impact on the Corporation's ability to access wholesale funding at favorable
interest rates. As a result, capital ratios, asset quality measurements, and
profitability ratios are monitored on an ongoing basis as part of the liquidity
management process.
36
TABLE 19: Credit Ratings at December 31, 2002
Moody's S&P Fitch Ratings
------- --- -------------
Bank short-term P1 A2 F1
Bank long-term A2 A- A-
Corporation short-term P2 A2 F1
Corporation long-term A3 BBB+ A-
Subordinated debt long-term Baa1 BBB BBB+
While core deposits and loan and investment repayment are principal sources of
liquidity, funding diversification is another key element of liquidity
management. Diversity is achieved by strategically varying depositor type, term,
funding market, and instrument.
The parent company manages its liquidity position to provide the funds necessary
to pay dividends to shareholders, service debt, invest in subsidiaries,
repurchase common stock, and satisfy other operating requirements. The parent
company's primary funding sources to meet its liquidity requirements are
dividends and service fees from subsidiaries, borrowings with major banks,
commercial paper issuance, and proceeds from the issuance of equity. Dividends
received in cash from subsidiaries totaled $172.0 million in 2002 and represent
a primary funding source. At December 31, 2002, $176.4 million in dividends
could be paid to the parent by its subsidiaries without obtaining prior
regulatory approval, subject to the capital needs of the banks. As discussed in
Item 1, the subsidiary banks are subject to regulation and, among other things,
may be limited in their ability to pay dividends or transfer funds to the parent
company. Accordingly, consolidated cash flows as presented in the consolidated
statements of cash flows may not represent cash immediately available for the
payment of cash dividends to the Corporation's shareholders or for other cash
needs.
In addition to subsidiary dividends, the parent company has multiple funding
sources that could be used to increase liquidity and provide additional
financial flexibility. These sources include a revolving credit facility,
commercial paper, and two shelf registrations to issue debt and preferred
securities or a combination thereof. The parent company has available a $100
million revolving credit facility with established lines of credit from
nonaffiliated banks, of which $100 million was available at December 31, 2002.
In addition, $200 million of commercial paper was available at December 31,
2002, under the parent company's commercial paper program.
In May 2002, the parent company filed a "shelf" registration statement under
which the parent company may offer up to $300 million of trust preferred
securities. In May 2002, the parent company issued $175 million of trust
preferred securities, bearing a 7.625% fixed coupon rate. At December 31, 2002,
$125 million was available under the trust preferred shelf. In May 2001, the
parent company filed a "shelf" registration statement whereby the parent company
may offer up to $500 million of any combination of the following securities,
either separately or in units: debt securities, preferred stock, depositary
shares, common stock, and warrants. In August 2001, the parent company obtained
$200 million in a subordinated note offering, bearing a 6.75% fixed coupon rate
and 10-year maturity. At December 31, 2002, $300 million was available under the
shelf registration.
Investment securities are an important tool to the Corporation's liquidity
objective. As of December 31, 2002, all securities are classified as available
for sale. Of the $3.4 billion investment portfolio, $1.8 billion were pledged as
collateral for repurchase agreements, public deposits, treasury, tax and loan
notes, and other requirements. The remaining securities could be pledged or sold
to enhance liquidity if necessary.
The bank subsidiaries have a variety of funding sources (in addition to key
liquidity sources, such as core deposits, loan sales, loan repayments, and
investment portfolio sales) available to increase financial flexibility. A $2
billion bank note program associated with Associated Bank Illinois, National
Association, and Associated Bank, National Association, was established during
2000. Under this program, short-term and long-term debt may be issued. As of
December 31, 2002, $500 million of long-term bank notes were
37
outstanding. At December 31, 2002, $1.5 billion was available under this
program. The banks have also established federal funds lines with major banks
totaling approximately $3.0 billion and the ability to borrow approximately $1.9
billion from the Federal Home Loan Bank ($1.1 billion was outstanding at
December 31, 2002). In addition, the bank subsidiaries also accept Eurodollar
deposits, issue institutional certificates of deposit, and from time to time
offer brokered certificates of deposit.
For the year ended December 31, 2002, net cash provided from operating and
financing activities was $298.6 million and $75.8 million, respectively, while
investing activities used net cash of $534.8 million, for a net decrease in cash
and cash equivalents of $160.4 million since year-end 2001. Generally, during
2002, anticipated maturities of time deposits occurred and net asset growth
since year-end 2001 was up due to the Signal acquisition. Other funding sources
were utilized, particularly long-term debt, to finance the Signal acquisition,
replenish the net decrease in deposits, repay short-term borrowings, to provide
for common stock repurchases, and for payment of cash dividends to the
Corporation's shareholders.
For the year ended December 31, 2001, net cash provided from financing
activities was $238.1 million, while operating and investing activities used net
cash of $0.4 million and $28.8 million, respectively, for a net increase in cash
and cash equivalents of $208.9 million since year-end 2000. Generally, during
2001, time deposits matured that were not renewed (primarily in brokered
certificates of deposit), while total asset growth since year-end 2000 was
moderate. Thus, other financing sources increased, particularly long-term debt
and other short-term borrowings, to help replenish the net decrease in deposits
and to provide for common stock repurchases and payment of cash dividends to the
Corporation's shareholders.
Quantitative and Qualitative December Disclosures about Market Risk
Market risk arises from exposure to changes in interest rates, exchange rates,
commodity prices, and other relevant market rate or price risk. The Corporation
faces market risk in the form of interest rate risk through other than trading
activities. Market risk from other than trading activities in the form of
interest rate risk is measured and managed through a number of methods. The
Corporation uses financial modeling techniques that measure the sensitivity of
future earnings due to changing rate environments to measure interest rate risk.
Policies established by the Corporation's Asset/Liability Committee and approved
by the Corporation's Board of Directors limit exposure of earnings at risk.
General interest rate movements are used to develop sensitivity as the
Corporation feels it has no primary exposure to a specific point on the yield
curve. These limits are based on the Corporation's exposure to a 100 bp and 200
bp immediate and sustained parallel rate move, either upward or downward.
Interest Rate Risk
In order to measure earnings sensitivity to changing rates, the Corporation uses
three different measurement tools: static gap analysis, simulation of earnings,
and economic value of equity. The static gap analysis starts with contractual
repricing information for assets, liabilities, and off-balance sheet
instruments. These items are then combined with repricing estimations for
administered rate (interest-bearing demand deposits, savings, and money market
accounts) and non-rate related products (demand deposit accounts, other assets,
and other liabilities) to create a baseline repricing balance sheet. In addition
to the contractual information, residential mortgage whole loan products and
mortgage-backed securities are adjusted based on industry estimates of
prepayment speeds that capture the expected prepayment of principal above the
contractual amount based on how far away the contractual coupon is from market
coupon rates.
38
The following table represents the Corporation's consolidated static gap
position as of December 31, 2002.
TABLE 20: Interest Rate
Sensitivity Analysis
December 31, 2002
------------------------------------------------------------------------------------
Interest Sensitivity Period
Total
0-90 91-180 Within Over 1
Days Days 181-365 Days 1 Year Year Total
------------------------------------------------------------------------------------
($ in Thousands)
Earning assets:
Loans, held for sale $ 305,836 $ --- $ --- $ 305,836 $ --- $ 305,836
Investment securities, at fair 745,206 270,239 338,449 1,353,894 2,008,775 3,362,669
value
Loans 5,422,570 504,755 1,073,563 7,000,888 3,302,337 10,303,225
Interest rate swaps 279,487 --- --- 279,487 (279,487) ---
Other earning assets 14,322 --- --- 14,322 --- 14,322
------------------------------------------------------------------------------------
Total earning assets $6,767,421 $ 774,994 $1,412,012 $8,954,427 $ 5,031,625 $13,986,052
====================================================================================
Interest-bearing liabilities:
Interest-bearing deposits(1) (2) $1,092,628 $821,580 $1,533,816 $3,448,024 $ 5,443,178 $ 8,891,202
Other interest-bearing
liabilities (2) 2,984,060 37,000 456,853 3,477,913 1,242,300 4,720,213
Interest rate swaps (3) 175,000 --- --- 175,000 (175,000) ---
------------------------------------------------------------------------------------
Total interest-bearing liabilities $4,251,688 $ 858,580 $1,990,669 $7,100,937 $ 6,510,478 $13,611,415
====================================================================================
Interest sensitivity gap $2,515,733 $ (83,586) $ (578,657) $1,853,490 $(1,478,853) $ 374,637
Cumulative interest sensitivity gap $2,515,733 $2,432,147 $1,853,490
12 Month cumulative gap as a
percentage of earning assets at
December 31, 2002 18.0% 17.4% 13.3%
====================================================================================
(1) The interest rate sensitivity assumptions for demand deposits, savings
accounts, money market accounts, and interest-bearing demand deposit
accounts are based on current and historical experiences regarding
portfolio retention and interest rate repricing behavior. Based on these
experiences, a portion of these balances are considered to be long-term and
fairly stable and are therefore included in the "Over 1 Year" category.
(2) For analysis purposes, Brokered CDs of $234 million have been included with
other interest-bearing liabilities and excluded from interest-bearing
deposits.
(3) Interest rate swaps on funding are presented on a net basis.
The static gap analysis in Table 20 provides a representation of the
Corporation's earnings sensitivity to changes in interest rates. It is a static
indicator that does not reflect various repricing characteristics and may not
necessarily indicate the sensitivity of net interest income in a changing
interest rate environment.
At the end of 2001, the Corporation's balance sheet was relatively neutral to
interest rate movements. During 2002, a number of initiatives were executed and
the balance sheet mix changed which positioned the Corporation to be more asset
sensitive. (Asset sensitive means that assets will reprice faster than
liabilities. In a rising rate environment, an asset sensitive bank will
generally benefit.) These changes included issuing long-term funding, growth in
demand deposits, and shortening of the mortgage portfolio and investment
portfolio due to faster prepayment experience.
Interest rate risk of embedded positions (including prepayment and early
withdrawal options, lagged interest rate changes, administered interest rate
products, and cap and floor options within products) require a more dynamic
measuring tool to capture earnings risk. Earnings simulation and economic value
of equity are used to more completely assess interest rate risk.
Along with the static gap analysis, determining the sensitivity of short-term
future earnings to a hypothetical plus or minus 100 and 200 basis point parallel
rate shock can be accomplished through the use of simulation modeling. In
addition to the assumptions used to create the static gap, simulation of
earnings includes the modeling of the balance sheet as an ongoing entity. Future
business assumptions involving administered rate products, prepayments for
future rate-sensitive balances, and the reinvestment of maturing assets and
39
liabilities are included. These items are then modeled to project net interest
income based on a hypothetical change in interest rates. The resulting net
interest income for the next 12-month period is compared to the net interest
income amount calculated using flat rates. This difference represents the
Corporation's earnings sensitivity to a plus or minus 100 basis point parallel
rate shock.
The resulting simulations for December 31, 2002, projected that net interest
income would increase by approximately 3.9% of budgeted net interest income if
rates rose by a 100 basis point shock, and projected that the net interest
income would decrease by approximately 4.0% if rates fell by a 100 basis point
shock. At December 31, 2001, the 100 basis point shock up was projected to
decrease budgeted net interest income by approximately 1.2%, and the 100 basis
point shock down was projected to decrease budgeted net interest income by
approximately 0.1%.
Economic value of equity is another tool used to measure the impact of interest
rates on the present value of assets, liabilities and off-balance sheet
financial instruments. This measurement is a longer-term analysis of interest
rate risk as it evaluates every cash flow produced by the current balance sheet.
The projected changes for earnings simulation and economic value of equity for
both 2002 and 2001 were within the Corporation's interest rate risk policy. The
results of the 2002 modeling mirrored the other interest rate risk tests
discussed above, as the Corporation moved from a relatively neutral position at
December 31, 2001 to asset sensitive at December 31, 2002.
These results are based solely on immediate and sustained parallel changes in
market rates and do not reflect the earnings sensitivity that may arise from
other factors. These factors may include changes in the shape of the yield
curve, the change in spread between key market rates, or accounting recognition
of the impairment of certain intangibles. The above results are also considered
to be conservative estimates due to the fact that no management action to
mitigate potential income variances are included within the simulation process.
This action could include, but would not be limited to, delaying an increase in
deposit rates, extending liabilities, using financial derivative products to
hedge interest rate risk, changing the pricing characteristics of loans, or
changing the growth rate of certain assets and liabilities.
The Corporation uses interest rate derivative financial instruments as an
asset/liability management tool to hedge mismatches in interest rate exposure
indicated by the net interest income simulation described above. They are used
to modify the Corporation's exposures to interest rate fluctuations and provide
more stable spreads between loan yields and the rate on their funding sources.
In 2002, the Corporation entered into $341 million in notional amounts of new
interest rate swaps to reduce interest rate risk. Interest rate swaps involve
the exchange of fixed- and variable-rate payments without the exchange of the
underlying notional amount on which the interest payments are calculated.
40
Table 21: Interest Rate Swap Hedging Portfolio
Notional Balances and Yield by Maturity Date
Maturity Notional Weighted Average Weighted Average
Date Amount Rate Received Rate Paid
- ---------------------------------------------------------------------------
($ in Thousands)
2004 $ 22,920 3.56% 5.94%
2005 52,462 3.71 6.18
2006 49,159 3.65 6.97
2007 59,204 3.64 6.32
2008 34,056 3.54 6.47
2009 27,613 3.63 6.76
2010 1,382 3.77 7.85
2011 411,927 4.29 4.54
2012 13,154 3.52 6.62
2015 3,156 3.69 5.28
2017 4,454 3.83 7.89
2032 175,000 7.63 2.43
--------------------------------------------------------
$ 854,487 4.77% 4.71%
========================================================
To hedge against rising interest rates, the Corporation may use interest rate
caps. Counterparties to these interest cap agreements pay the Corporation based
on the notional amount and the difference between current rates and strike
rates. At December 31, 2002, there were $200 million of interest rate caps
outstanding, which have a six month LIBOR strike of 4.72%. To hedge against
falling interest rates, the Corporation may use interest rate floors. Like caps,
counterparties to interest rate floor agreements pay the Corporation based on
the notional amount and the difference between current rates and strike rates.
There were no floors outstanding at December 31, 2002. Derivative financial
instruments are also discussed in Note 16, "Derivative and Hedging Activities,"
of the notes to consolidated financial statements.
Contractual Obligations, Commitments, Off-Balance Sheet Risk,
and Contingent Liabilities
Through the normal course of operations, the Corporation has entered into
certain contractual obligations and other commitments. Such obligations
generally relate to funding of operations through deposits or debt issuances, as
well as leases for premises and equipment. As a financial services provider the
Corporation routinely enters into commitments to extend credit. While
contractual obligations represent future cash requirements of the Corporation, a
significant portion of commitments to extend credit may expire without being
drawn upon. Such commitments are subject to the same credit policies and
approval process accorded to loans made by the Corporation.
The following table summarizes significant contractual obligations and other
commitments at December 31, 2002. The payment amounts represent those amounts
contractually due to the recipient and do not include any unamoritized premiums
or discounts, hedge basis adjustments, or other similar carrying value
adjustments. Further discussion of the nature of each obligation is included in
the referenced note to the consolidated financial statements.
41
Table 22: Contractual Obligations and Other Commitments
Note One Year One to Three to Over
Reference or Less Three Years Five Years Five Years Total
------------------------------------------------------------------------------
($ in Thousands)
Time deposits 8 $1,818,027 $1,156,840 $ 240,632 $ 17,293 $3,232,792
Long-term funding 10 and 11 552,243 976,325 100,000 444,153 2,072,721
Operating leases 7 5,211 8,788 6,165 12,736 32,900
Commitments to extend
credit 15 3,336,646 522,763 208,180 42,022 4,109,611
------------------------------------------------------------------
Total $5,712,127 $2,664,716 $554,977 $516,204 $9,448,024
==================================================================
The Corporation also enters into derivative contracts under which the
Corporation is required to either receive cash from or pay cash to
counterparties depending on changes in interest rates. Derivative contracts are
carried at fair value on the consolidated balance sheet with the fair value
representing the net present value of expected future cash receipts or payments
based on market interest rates as of the balance sheet date. The fair value of
the contracts change daily as market interest rates change. Because the
derivative liabilities recorded on the balance sheet at December 31, 2002 do not
represent the amounts that may ultimately be paid under these contracts, these
liabilities are not included in the table of contractual obligations presented
above. Further discussion of derivative instruments is included in Note 1,
"Summary of Significant Accounting Policies," and Note 16, "Derivative and
Hedging Activities," of the notes to consolidated financial statements.
A summary of significant commitments at December 31, 2002 is as follows:
2002
----------------
($ in Thousands)
Commitments to extend credit, excluding
commitments to originate mortgage loans $3,559,497
Commitments to originate residential mortgage
loans held for sale 550,114
----------
Total commitments to extend credit 4,109,611
Commercial letters of credit 59,186
Standby letters of credit 267,858
Forward commitments to sell loans $ 538,300
==========
Further discussion of these commitments is included in Note 15, "Commitments,
Off-Balance Sheet Risk, and Contingent Liabilities," of the notes to
consolidated financial statements.
The Corporation may also have liabilities under certain contractual agreements
contingent upon the occurrence of certain events. A discussion of significant
contractual arrangements under which the Corporation may be held contingently
liable, including guarantee arrangements, is included in Note 15, "Commitments,
Off-Balance Sheet Risk, and Contingent Liabilities," of the notes to
consolidated financial statements.
Capital
Stockholders' equity at December 31, 2002, increased to $1.3 billion or $17.13
per share, compared with $1.1 billion or $14.89 per share at the end of 2001.
Stockholders' equity is also described in Note 12, "Stockholders' Equity," of
the notes to consolidated financial statements.
The increase in stockholders' equity in 2002 was primarily composed of the
retention of earnings, the issuance of common stock in connection with the
Signal acquisition, and the exercise of stock options, with offsetting decreases
to stockholders' equity from the payment of cash dividends and the repurchase of
common stock. Additionally, stockholders' equity at year-end 2002 included $60.3
million of accumulated other comprehensive income, predominantly related to
unrealized gains on securities
42
available for sale, net of the tax effect. At December 31, 2001,
stockholders' equity included $47.2 million of accumulated other comprehensive
income, predominantly related to unrealized gains on securities available for
sale, net of the tax effect. Stockholders' equity to assets at December 31, 2002
was 8.46%, compared to 7.87% at the end of 2001.
TABLE 23: Capital
At December 31,
-----------------------------------------
2002 2001 2000
-----------------------------------------
(In Thousands, except per share data)
Total stockholders' equity $1,272,183 $1,070,416 $ 968,696
Tier 1 capital 1,165,481 924,871 846,371
Total capital 1,513,424 1,253,036 966,994
Market capitalization 2,521,083 2,305,698 2,008,306
-----------------------------------------
Book value per common share $ 17.13 $ 14.89 $ 13.32
Cash dividend per common share 1.21 1.11 1.01
Stock price at end of period 33.94 32.08 27.61
Low closing price for the period 27.20 27.05 18.44
High closing price for the period 38.25 33.55 27.84
-----------------------------------------
Total equity/assets 8.46% 7.87% 7.38%
Tangible common equity/assets 7.09 7.20 6.62
Tier 1 leverage ratio 7.94 7.03 6.52
Tier 1 risk-based capital ratio 10.52 9.71 9.37
Total risk-based capital ratio 13.66 13.15 10.70
-----------------------------------------
Shares outstanding (period end) 74,281 71,869 72,728
Basic shares outstanding (average) 74,685 72,587 75,005
Diluted shares outstanding (average) 75,493 73,167 75,251
=========================================
Cash dividends paid in 2002 were $1.21 per share, compared with $1.11 per share
in 2001, an increase of 9.3%. Cash dividends per share have increased at a 10.7%
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, 2002 and 2001, 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 in excess of regulatory minimum and well capitalized requirements.
It is management's intent to exceed the minimum requisite capital levels. The
increase in the Tier 1 and total risk-based capital ratios for 2002 compared to
2001 is primarily attributable to growth in earnings and the issuance of
company-obligated mandatorily redeemable preferred securities issued in 2002
which qualify as Tier 1 capital for regulatory purposes. The increase in the
total risk-based capital ratio for 2001 compared to 2000 is primarily
attributable to the subordinated debt issued in 2001 which qualifies as Tier 2
supplementary capital for regulatory purposes. Capital ratios are included in
Note 19, "Regulatory Matters," of the notes to consolidated financial
statements.
The Board of Directors has authorized management to repurchase shares of the
Corporation's common stock each quarter in the market, to be made available for
issuance in connection with the Corporation's employee incentive plans and for
other corporate purposes. For the Corporation's employee incentive plans, the
Board of Directors authorized the repurchase of up to 1.6 million shares
(400,000 shares per quarter) in 2002 and 1.3 million shares (330,000 shares per
quarter) in 2001. Of these authorizations, approximately 1,255,000 shares were
repurchased for $43.3 million during 2002 (with approximately 955,000 shares
reissued in connection with stock options exercised), and 880,000 shares were
repurchased
43
for $26.7 million in 2001 (with approximately 271,000 shares reissued for
options exercised). Additionally, under two separate actions in 2000, the Board
of Directors authorized the repurchase and cancellation of the Corporation's
outstanding shares, not to exceed approximately 7.3 million shares on a combined
basis. Under these authorizations, approximately 1.3 million shares were
repurchased for $44.0 million during 2002 at an average cost of $32.69 per
share, while during 2001 approximately 251,000 shares were repurchased for $7.7
million at an average cost of $30.80 per share. At December 31, 2002,
approximately 2.1 million shares remain authorized to repurchase. The repurchase
of shares will be based on market opportunities, capital levels, growth
prospects, and other investment opportunities.
Shares repurchased and not retired are held as treasury stock and, accordingly,
are accounted for as a reduction of stockholders' equity.
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. Management actively reviews
capital strategies for the Corporation and each of its subsidiaries in light of
perceived business risks, future growth opportunities, industry standards, and
regulatory requirements. It is management's intent to maintain an optimal
capital and leverage mix for growth and for shareholder return.
Fourth Quarter 2002 Results
Net income for fourth quarter 2002 ("4Q02") was $53.4 million, $7.1 million
higher than the $46.3 million earned in the fourth quarter of 2001 ("4Q01").
Basic earnings per share for 4Q02 were $0.72 compared to $0.64 as reported for
4Q01 and $0.66 as adjusted for the adoption of SFAS 142 and SFAS 147. Diluted
earnings per share for 4Q02 were $0.71 compared to $0.64 as reported for 4Q01
and $0.66 as adjusted.
Taxable equivalent net interest income for 4Q02 was $135.7 million, $16.1
million higher than 4Q01. Volume was the predominant factor impacting net
interest income, with balance sheet growth increasing net interest income by
$14.2 million, while changes in interest rates added $1.9 million. Average
earning assets grew by $1.5 billion to $13.9 billion, including the impact of
Signal. Since total interest-bearing deposits were relatively unchanged, the
growth in earning assets was supported primarily by average wholesale funding
sources (up $1.1 billion). To take advantage of the lower interest rate
environment, the Corporation increased the levels of long-term funding by
replacing short-term funding balances throughout 2002. As a result, long-term
funding represented 17.6% of average interest-bearing liabilities in 4Q02
compared to 10.1% in 4Q01. The interest rate environment also impacted net
interest income and net interest margin between the comparable quarters. The
average Fed funds rate for 4Q02 of 1.45% was 69 bp lower than 4Q01. For 4Q02,
net interest margin was 3.87%, 4 bp higher than 4Q01, the result of a 15 bp
improvement in interest rate spread offset by 11 bp lower contribution from net
free funds. The rate on interest-bearing liabilities decreased 109 bp to 2.23%
due principally to repricing of deposit products and wholesale funds in the
lower interest rate environment. The yield on earning assets for 4Q02 was 5.76%
or 94 bp lower than 4Q01.
The provision for loan losses of $14.6 million in 4Q02 was $5.3 million higher
than 4Q01. Additional provision was provided in light of declines in asset
quality related to specific loans as well as the weakening economy and its
impact on borrowers, and increased risk in the portfolio.
Noninterest income in 4Q02 was $12.2 million higher than the comparable quarter
in 2001, driven by a $10.7 million increase in mortgage banking revenue. Record
high secondary mortgage production ($1.2 billion in 4Q02 versus $0.8 billion in
4Q01) led to increased gains on sales (up $6.7 million) and higher
production-related fees (up $2.5 million). Mortgage servicing fees increased
$1.5 million due to growth in the portfolio serviced for others. Service charges
on deposit accounts were up $2.3 million, impacted by an increase in
nonsufficient funds rate fees beginning in March 2002, lower earnings credit
rates on business accounts and increases in the number of deposit accounts. A
$1.4 million decrease in asset sales gains was a result of a $0.4 million loss
in 4Q02 compared to a $1.0 million gain in 4Q01. The remaining noninterest
income categories were collectively $0.6 million higher than the same period
last year.
44
Noninterest expense between the comparable quarters was up $9.2 million,
reflecting higher costs associated with mortgage servicing as well as the
Corporation's larger operating base. Personnel expense was $5.0 million higher,
with salary-related expenses up $4.8 million and fringe benefits up $0.2
million, attributable principally to the expanded employee base from Signal.
Mortgage servicing rights expense increased by $2.7 million, due to both
additional valuation reserve on the servicing portfolio based on prepayment
speeds and higher amortization given the increased size of the portfolio
serviced for others. Loan expenses were higher by $1.1 million, predominantly in
volume-driven loan costs. In conjunction with the required adoption of SFAS 142
and SFAS 147, which discontinued the amortization of goodwill effective January
1, 2002, this expense was $1.6 million in 4Q01 versus none in 4Q02. The
remaining noninterest expense categories were up $2.0 million on a comparable
quarter basis, primarily due to the larger operating base between comparable
quarters. Income tax expense was up $6.3 million between the fourth quarters due
to higher income before tax, as well as to an increase in the effective tax rate
at 30.3% for 4Q02 compared to 26.8% for 4Q01.
45
TABLE 24: Selected Quarterly Financial Data:
The following is selected financial data summarizing the results of operations
for each quarter in the years ended December 31, 2002 and 2001:
2002 Quarter Ended
------------------------------------------------
December 31 September 30 June 30 March 31
------------------------------------------------
(In Thousands, except per share data)
Interest income $ 196,178 $ 199,765 $ 201,857 $ 194,306
Interest expense 66,465 71,407 76,089 76,879
Provision for loan losses 14,614 12,831 12,003 11,251
Investment securities gains (losses),
net (801) 374 --- ---
Income before income tax expense 76,685 76,000 72,481 71,160
Net income 53,441 53,472 52,344 51,462
===============================================
Basic net income per share $ 0.72 $ 0.71 $ 0.69 $ 0.70
Diluted net income per share 0.71 0.70 0.68 0.70
Basic weighted average shares 74,497 75,158 75,922 73,142
Diluted weighted average shares 75,202 76,047 77,041 74,042
2001 Quarter Ended
------------------------------------------------
December 31 September 30 June 30 March 31
------------------------------------------------
(In Thousands, except per share data)
Interest income $ 203,861 $ 217,434 $ 225,648 $ 233,679
Interest expense 89,842 110,423 121,696 136,676
Provision for loan losses 9,297 6,966 6,365 5,582
Investment securities gains
(losses), net --- 476 (4) 246
Income before income tax expense 63,275 64,106 66,338 57,290
Net income, as reported 46,312 45,105 46,019 42,086
Net income, as adjusted (1) 47,831 46,651 47,566 43,632
===============================================
Basic net income per share, as
reported $ 0.64 $ 0.62 $ 0.63 $ 0.58
Basic net income per share, as
adjusted (1) 0.66 0.64 0.65 0.60
Diluted net income per share, as
reported 0.64 0.62 0.63 0.57
Diluted net income per share, as
adjusted (1) 0.66 0.64 0.65 0.59
Basic weighted average shares 72,137 72,692 72,760 72,765
Diluted weighted average shares 72,746 73,297 73,360 73,357
(1) Selected 2001 financial data has been adjusted to exclude the amortization
of goodwill affected by adopting SFAS 142 and SFAS 147 in 2002.
2001 Compared to 2000
The Corporation recorded net income of $179.5 million for the year ended
December 31, 2001, an increase of $11.5 million or 6.9% over the $168.0 million
earned in 2000. Basic earnings per share for 2001 were $2.47, a 10.3% increase
over 2000 basic earnings per share of $2.24. Earnings per diluted share were
$2.45, a 9.9% increase over 2000 diluted earnings per share of $2.23. Return on
average assets and return on average equity for 2001 were 1.37% and 17.31%,
respectively, compared to 1.31% and 18.26%, respectively, for 2000. Cash
dividends paid in 2001 increased to $1.11 per share over the $1.01 per share
paid in 2000. Key factors behind these results are discussed below.
Taxable equivalent net interest income was $444.2 million for 2001, $38.9
million or 9.6% higher than 2000. Interest expense decreased by $88.9 million,
while taxable equivalent interest income decreased $50.0 million. The volume of
average earning assets increased $225 million to $12.3 billion, which
46
exceeded the $81.7 million increase in interest-bearing liabilities.
Increases in the volume of earning assets and interest-bearing liabilities, as
well as changes in product mix, added $18.3 million to taxable equivalent net
interest income, while changes in interest rates resulted in a $20.6 million
increase.
Net interest income and net interest margin were also impacted in 2001 by the
declining interest rate environment, competitive pricing pressures, branch
deposit sales, and funding of stock repurchases. The Federal Reserve lowered
interest rates eleven times during 2001, producing an average Federal funds rate
for 2001 that was 238 bp lower than the average for 2000.
The net interest margin was 3.62% for 2001, a 26 bp increase from 3.36% for
2000, the net result of the 31 bp increase in interest rate spread, offset by a
5 bp decline in the net free funds contribution. Rates on interest-bearing
liabilities in 2001 were 86 bp lower than last year, while the yield on interest
earning assets decreased 55 bp, bringing the interest rate spread up by 31 bp.
Total loans were $9.0 billion at December 31, 2001, an increase of $106 million
or 1.2% over December 31, 2000. The loan mix continued to shift, with commercial
loan balances increasing $603 million (13.0%) and representing 58% of total
loans at December 31, 2001, compared to 52% at year-end 2000. Total deposits
were $8.6 billion at December 31, 2001, $679 million lower than December 31,
2000, with brokered certificates of deposit decreasing by $626 million. To take
advantage of the lower rate environment, the Corporation increased long-term
debt by $1.0 billion, including $200 million of subordinated debt, $200 million
of bank notes, and longer-term Federal Home Loan Bank advances.
Asset quality remained relatively strong. The provision for loan losses
increased to $28.2 million compared to $20.2 million in 2000. Net charge offs
were $20.2 million, an increase of $11.3 million, primarily due to the charge
off of several large commercial credits. Net charge offs were 0.22% of average
loans compared to 0.10% in 2000. The ratio of allowance for loan losses to loans
was 1.42% and 1.35% at December 31, 2001 and 2000, respectively. Nonperforming
loans were $52.1 million, representing 0.58% of total loans at year-end 2001,
compared to $47.7 million or 0.54% of total loans last year.
Noninterest income was $195.6 million for 2001, $11.4 million or 6.2% higher
than 2000. Net gains on the sales of assets and investment securities totaled
$2.7 million in 2001 compared to net gains of $16.8 million in 2000. Excluding
these asset and security sales, noninterest income was $192.9 million, or $25.5
million (15.2%) over 2000. Mortgage banking revenue more than doubled, adding
$33.8 million over the prior year, and service charges on deposit accounts were
up $4.5 million over 2000. Partially offsetting these increases were an $8.6
million reduction in trust service fees and a $3.3 million decrease in retail
commissions, with both trust and brokerage fees impacted in part by declines in
the financial markets.
Noninterest expense was $338.4 million, up $20.6 million or 6.5% over 2000.
Personnel expenses rose $14.4 million, of which $6.7 million was attributable to
salary-related expense (due primarily to increases in bonus and incentive pay,
including a long-term incentive plan introduced during 2001, and temporary help)
and $7.7 million was due to fringe benefit expense (primarily the result of a
$3.8 million increase in profit sharing expense and a $2.0 million increase in
premium based benefits). Mortgage servicing rights expense increased $10.6
million, predominantly driven by a $10.7 million increase to the valuation
reserve on mortgage servicing rights, reflecting the decline in interest rates
in 2001 and the accelerated prepayment speeds in the portfolio serviced for
others. All other expense categories were down, in total, $4.4 million, led by a
$2.8 million decrease in data processing costs, attributable to lower overall
vendor costs related to a change in service providers and a system conversion in
mid-2000.
Income tax expense increased to $71.5 million, up $9.6 million from 2000. The
effective tax rate in 2001 was 28.5% compared to 26.9% for 2000. The increase
was primarily attributable to the increase in net income before tax, an increase
in state tax expense, and a decrease in tax valuation allowance adjustments.
Subsequent Event
On January 22, 2003, the Board of Directors declared a $0.31 per share dividend
payable on February 13, 2003, to shareholders of record as of February 3, 2003.
This subsequent event has not been reflected in the accompanying consolidated
financial statements.
47
Future Accounting Pronouncements
Note 1, "Summary of Significant Accounting Policies," of the notes to
consolidated financial statements discusses new accounting policies adopted by
the Corporation during 2002 and the expected impact of accounting policies
recently issued or proposed but not yet required to be adopted. To the extent
the adoption of new accounting standards materially affects the Corporation's
financial condition, results of operations, or liquidity, the impacts are
discussed in the applicable sections of this financial review and the notes to
consolidated financial statements.
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information required by this item is set forth in Item 7 under the captions
"Quantitative and Qualitative Disclosures About Market Risk" and "Interest Rate
Risk."
48
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ASSOCIATED BANC-CORP
CONSOLIDATED BALANCE SHEETS
December 31,
--------------------------------
2002 2001
--------------- ----------------
(In Thousands,
except share data)
ASSETS
Cash and due from banks $ 430,691 $ 587,994
Interest-bearing deposits in other financial institutions 5,502 5,427
Federal funds sold and securities purchased under agreements to resell 8,820 12,015
Investment securities available for sale, at fair value 3,362,669 3,197,021
Loans held for sale 305,836 301,707
Loans 10,303,225 9,019,864
Allowance for loan losses (162,541) (128,204)
- -----------------------------------------------------------------------------------------------------------
Loans, net 10,140,684 8,891,660
Premises and equipment 132,713 119,528
Goodwill 212,112 92,397
Other intangible assets 41,565 37,991
Other assets 402,683 358,634
- -----------------------------------------------------------------------------------------------------------
Total assets $15,043,275 $13,604,374
===========================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Noninterest-bearing demand deposits $ 1,773,699 $ 1,425,109
Interest-bearing deposits, excluding Brokered certificates of deposit 7,117,503 6,897,502
Brokered certificates of deposit 233,650 290,000
- -----------------------------------------------------------------------------------------------------------
Total deposits 9,124,852 8,612,611
Short-term borrowings 2,389,607 2,643,851
Long-term debt 1,906,845 1,103,395
Company-obligated mandatorily redeemable preferred securities 190,111 ---
Accrued expenses and other liabilities 159,677 174,101
- -----------------------------------------------------------------------------------------------------------
Total liabilities 13,771,092 12,533,958
- -----------------------------------------------------------------------------------------------------------
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 75,503,410 and 72,791,792 shares at
December 31, 2002 and 2001, respectively) 755 662
Surplus 643,956 289,751
Retained earnings 607,944 760,031
Accumulated other comprehensive income 60,313 47,176
Treasury stock, at cost (1,219,997 shares in 2002 and
922,902 shares in 2001) (40,785) (27,204)
- ------------------------------------------------------------------------------------------------------------
Total stockholders' equity 1,272,183 1,070,416
- ------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $15,043,275 $13,604,374
============================================================================================================
See accompanying Notes to Consolidated Financial Statements.
49
ASSOCIATED BANC-CORP
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31,
-------------------------------------
2002 2001 2000
-------------------------------------
(In Thousands, except per share data)
INTEREST INCOME
Interest and fees on loans $ 626,378 $ 692,646 $ 726,849
Interest and dividends on investment securities and
deposits with other financial institutions:
Taxable 125,568 146,548 164,200
Tax-exempt 39,771 40,385 37,765
Interest on federal funds sold and securities purchased
under agreements to resell 389 1,043 2,343
- ---------------------------------------------------------------------------------------------------
Total interest income 792,106 880,622 931,157
- ---------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Interest on deposits 169,021 298,930 379,892
Interest on short-term borrowings 51,372 130,546 160,430
Interest on long-term debt, including preferred securities 70,447 29,161 7,268
- ---------------------------------------------------------------------------------------------------
Total interest expense 290,840 458,637 547,590
- ---------------------------------------------------------------------------------------------------
NET INTEREST INCOME 501,266 421,985 383,567
Provision for loan losses 50,699 28,210 20,206
- ---------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 450,567 393,775 363,361
- ---------------------------------------------------------------------------------------------------
NONINTEREST INCOME
Trust service fees 27,875 29,063 37,617
Service charges on deposit accounts 46,059 37,817 33,296
Mortgage banking 70,903 53,724 19,944
Credit card and other nondeposit fees 27,492 26,731 25,739
Retail commissions 18,264 16,872 20,187
Bank owned life insurance income 13,841 12,916 12,377
Asset sale gains, net 657 1,997 24,420
Investment securities gains (losses), net (427) 718 (7,649)
Other 15,644 15,765 18,265
- ---------------------------------------------------------------------------------------------------
Total noninterest income 220,308 195,603 184,196
- ---------------------------------------------------------------------------------------------------
NONINTEREST EXPENSE
Personnel expense 192,918 171,362 157,007
Occupancy 26,049 23,947 23,258
Equipment 14,835 14,426 15,272
Data processing 21,024 19,596 22,375
Business development and advertising 13,812 13,071 13,359
Stationery and supplies 7,044 6,921 7,961
FDIC expense 1,533 1,661 1,818
Mortgage servicing rights expense 30,473 19,987 9,406
Goodwill amortization -- 6,511 6,560
Core deposit intangible amortization 2,283 1,867 2,345
Loan expense 14,555 11,176 8,447
Other 50,023 47,844 49,928
- ---------------------------------------------------------------------------------------------------
Total noninterest expense 374,549 338,369 317,736
- ---------------------------------------------------------------------------------------------------
Income before income taxes 296,326 251,009 229,821
Income tax expense 85,607 71,487 61,838
- ---------------------------------------------------------------------------------------------------
Net income $ 210,719 $ 179,522 $ 167,983
===================================================================================================
Earnings per share:
Basic $ 2.82 $ 2.47 $ 2.24
Diluted $ 2.79 $ 2.45 $ 2.23
Average shares outstanding:
Basic 74,685 72,587 75,005
Diluted 75,493 73,167 75,251
===================================================================================================
See accompanying Notes to Consolidated Financial Statements.
50
ASSOCIATED BANC-CORP
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Accumulated
Other
Common Stock Retained Comprehensive Treasury
Shares Amount Surplus Earnings Income (Loss) Stock Total
------------------------------------------------------------------------------
(In Thousands, except per share data)
Balance, December 31, 1999 63,390 $634 $226,042 $728,754 $(38,782) $(6,859) $ 909,789
Comprehensive income:
Net income --- --- --- 167,983 --- --- 167,983
Net unrealized holding gains on available
for sale securities arising during year,
net of taxes of $27.2 million --- --- --- --- 49,774 --- 49,774
Less: reclassification adjustment for net
losses on available for sale securities
realized in net income, net of taxes of
$3.1 million --- --- --- --- 4,589 --- 4,589
-------
Comprehensive income 222,346
-------
Cash dividends, $1.01 per share --- --- --- (75,719) --- --- (75,719)
Common stock issued:
Incentive stock options --- --- --- (6,219) --- 10,112 3,893
10% stock dividend 6,269 63 151,170 (151,233) --- --- ---
Purchase and retirement of treasury stock in
in connection with repurchase program (3,257) (33) (81,847) --- --- 7,782 (74,098)
Purchase of treasury stock --- --- --- --- --- (18,629) (18,629)
Tax benefits of stock options --- --- 1,114 --- --- --- 1,114
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 66,402 $664 $296,479 $663,566 $15,581 $(7,594) $ 968,696
- -----------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income --- --- --- 179,522 --- --- 179,522
Cumulative effect of accounting change,
net of taxes of $843,000 --- --- --- --- (1,265) --- (1,265)
Net unrealized loss on derivative instruments
arising during the year, net of taxes of
$2.7 million --- --- --- --- (4,059) --- (4,059)
Add: reclassification adjustment to interest
expense for interest differential, net of taxes
of $2.1 million --- --- --- --- 3,215 --- 3,215
Additional pension obligation, net of taxes of
$1.5 million --- --- --- --- (2,228) --- (2,228)
Net unrealized holding gains on available for
sale securities arising during the year,
net of taxes of $20.3 million --- --- --- --- 36,363 --- 36,363
Less: reclassification adjustment for net gains
on available for sale securities realized in net
income, net of taxes of $287,000 --- --- --- --- (431) --- (431)
-------
Comprehensive income 211,117
-------
Cash dividends, $1.11 per share --- --- --- (80,553) --- --- (80,553)
Common stock issued:
Incentive stock options --- --- --- (2,504) --- 7,242 4,738
Purchase and retirement of treasury stock in
connection with repurchase program (228) (2) (7,715) --- --- --- (7,717)
Purchase of treasury stock --- --- --- --- --- (26,852) (26,852)
Tax benefits of stock options --- --- 987 --- --- --- 987
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2001 66,174 $662 $289,751 $760,031 $47,176 $(27,204) $1,070,416
- -----------------------------------------------------------------------------------------------------------------------------------
(continued on next page)
51
ASSOCIATED BANC-CORP
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Continued)
Accumulated
Other
Common Stock Retained Comprehensive Treasury
Shares Amount Surplus Earnings Income (Loss) Stock Total
-----------------------------------------------------------------------------
(In Thousands, except per share data)
Comprehensive income:
Net income --- --- --- 210,719 --- --- 210,719
Net unrealized loss on derivative instruments
arising during the year, net of taxes of
$13.3 million --- --- --- --- (19,834) --- (19,834)
Add: reclassification adjustment to interest
expense for interest differential, net of
taxes of $5.4 million --- --- --- --- 8,027 --- 8,027
Additional pension obligation, net of taxes of
$4.7 million --- --- --- --- (7,024) --- (7,024)
Net unrealized holding gains on available for
sale securities arising during the year,
net of taxes of $18.1 million --- --- --- --- 31,712 --- 31,712
Add: reclassification adjustment for net losses
on available for sale securities realized in
net income, net of taxes of $171,000 --- --- --- --- 256 --- 256
--------
Comprehensive income 223,856
--------
Cash dividends, $1.21 per share --- --- --- (90,166) --- --- (90,166)
Common stock issued:
Business combinations 3,690 37 133,892 --- --- --- 133,929
Incentive stock options --- --- --- (14,000) --- 30,564 16,564
10% stock dividend 6,975 70 258,570 (258,640) --- --- ---
Purchase and retirement of treasury stock in
connection with repurchase program (1,336) (14) (44,032) --- --- --- (44,046)
Purchase of treasury stock --- --- --- --- --- (44,145) (44,145)
Tax benefits of stock options --- --- 5,775 --- --- --- 5,775
-----------------------------------------------------------------------------
Balance, December 31, 2002 75,503 $755 $643,956 $607,944 $60,313 $(40,785) $1,272,183
=============================================================================
See accompanying Notes to Consolidated Financial Statements.
52
ASSOCIATED BANC-CORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31,
------------------------------------------
2002 2001 2000
------------------------------------------
($ in Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 210,719 $ 179,522 $ 167,983
Adjustments to reconcile net income to net cash:
Provided by operating activities:
Provision for loan losses 50,699 28,210 20,206
Depreciation and amortization 18,696 18,616 19,396
Amortization (accretion) of:
Mortgage servicing rights 30,473 19,987 9,406
Goodwill and core deposit intangibles 2,283 8,378 8,905
Investment premiums and discounts 14,150 1,078 (572)
Deferred loan fees and costs 711 2,225 2,514
Deferred income taxes (14,878) 16,648 (13,936)
(Gain) loss on sales of investment securities, net 427 (718) 7,649
Gain on sales of assets, net (657) (1,997) (24,420)
Gain on sales of loans held for sale, net (39,660) (24,372) (3,113)
Mortgage loans originated and acquired for sale (3,185,531) (2,305,059) (456,312)
Proceeds from sales of mortgage loans held for sale 3,238,167 2,052,317 446,787
Increase in interest receivable and other assets (13,351) (22,902) (3,859)
Increase (decrease) in interest payable and other
liabilities (13,664) 27,659 8,518
- ----------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 298,584 (408) 189,152
- ----------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Net increase in loans (547,159) (132,845) (715,452)
Capitalization of mortgage servicing rights (30,730) (20,920) (4,739)
Purchases of:
Securities available for sale (1,621,096) (664,329) (933,197)
Premises and equipment, net of disposals (12,864) (7,702) (11,828)
Proceeds from:
Sales of securities available for sale 27,793 135,627 648,359
Maturities of securities available for sale 1,626,013 647,626 327,385
Maturities of securities held to maturity --- --- 45,201
Sales of other assets 5,214 13,762 169,793
Net cash received in acquisition of subsidiaries 17,982 --- ---
- ----------------------------------------------------------------------------------------------------
Net cash used by investing activities (534,847) (28,781) (474,478)
- ----------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits (271,203) (667,235) 709,017
Sales of branch deposits --- (10,899) (98,034)
Net increase (decrease) in short-term borrowings (357,007) 45,648 (176,887)
Repayment of long-term debt (235,675) (907) (1,863)
Proceeds from issuance of long-term funding 1,101,518 981,882 100,000
Cash dividends (90,166) (80,553) (75,719)
Proceeds from exercise of incentive stock options 16,564 4,738 3,893
Purchase and retirement of treasury stock (44,046) (7,717) (74,098)
Purchase of treasury stock (44,145) (26,852) (18,629)
- ----------------------------------------------------------------------------------------------------
Net cash provided by financing activities 75,840 238,105 367,680
- ----------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (160,423) 208,916 82,354
Cash and cash equivalents at beginning of year 605,436 396,520 314,166
- ----------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 445,013 $ 605,436 $396,520
- ----------------------------------------------------------------------------------------------------
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 298,207 $ 478,128 $529,017
Income taxes 91,098 58,129 49,814
Supplemental schedule of noncash investing activities:
Securities held to maturity transferred to
securities available for sale --- 372,873 ---
Loans transferred to other real estate 14,158 3,897 7,255
Acquisitions:
Fair value of assets acquired, including cash and
cash equivalents $ 1,155,200 --- ---
Value ascribed to intangibles 125,300 --- ---
Liabilities assumed 962,700 --- ---
====================================================================================================
See accompanying Notes to Consolidated Financial Statements.
53
ASSOCIATED BANC-CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001, and 2000
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The accounting and reporting policies of Associated Banc-Corp (the "parent
company"), together with all its subsidiaries (the "Corporation") conform to
accounting principles generally accepted in the United States of America and to
general practice within the financial services industry. The following is a
description of the more significant of those policies.
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
subsidiaries. The Corporation is subject to competition from other financial and
non-financial institutions that offer similar or competing products and
services. The Corporation 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 parent company
and subsidiaries, all of which are wholly owned. All significant intercompany
balances and transactions have been eliminated in consolidation. Results of
operations of companies purchased and accounted for under the purchase method of
accounting are included from the date of acquisition. Certain amounts in the
2001 and 2000 consolidated financial statements have been reclassified to
conform with the 2002 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 loan losses, mortgage servicing rights,
derivative financial instruments and hedging activities, and income taxes.
Investment Securities
Securities are classified as held to maturity, available for sale, or trading at
the time of purchase. In 2002 and 2001, all securities purchased were classified
as available for sale. Investment securities classified as held to maturity,
which management has the positive 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 the 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 securities are
reported at fair value with unrealized gains and losses, net of related deferred
income taxes, included in stockholders' equity as a separate component of other
comprehensive 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 fair value
through a charge to earnings. 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.
Loans
Loans and leases are carried at the principal amount outstanding, net of any
unearned income. Unearned income from direct leases is recognized on a basis
that generally approximates a level yield on the outstanding balances
receivable. Loan origination fees and certain direct loan origination costs are
deferred, and the net amount is amortized over the contractual life of the
related loans or over the commitment period as an adjustment of yield.
54
Loans are generally 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 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 collectible. If collectibility of the
principal is in doubt, payments received are applied to loan principal. A
nonaccrual loan is returned to accrual status when the obligation has been
brought current and the ultimate collectibility of the total contractual
principal and interest is no longer in doubt.
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 Loan Losses
The allowance for loan losses is a reserve for estimated credit losses. Actual
credit losses, net of recoveries, are deducted from the allowance for loan
losses. A provision for loan losses, which is a charge against earnings, is
recorded to bring the allowance for loan losses to a level that, in management's
judgment, is adequate to absorb probable losses in the loan portfolio.
The allocation methodology applied by the Corporation, designed to assess the
adequacy of the allowance for loan losses, focuses on changes in the size and
character of the loan portfolio, changes in levels of impaired and other
nonperforming loans, historical losses on each portfolio category, the risk
inherent in specific loans, concentrations of loans to specific borrowers or
industries, existing economic conditions, the fair value of underlying
collateral, and other factors which could affect potential credit losses.
Management maintains the allowance for loan losses using an allocation
methodology plus an unallocated portion, as determined by economic conditions
and other qualitative and quantitative factors affecting the Corporation's
borrowers. Management allocates the allowance for loan losses by pools of risk.
The commercial loan (commercial, financial, and agricultural; real estate
construction; commercial real estate; and lease financing) allocation is based
on a quarterly review of individual loans, loan types, and industries. The
retail loan (residential mortgage, home equity, and consumer) allocation is
based on analysis of historical delinquency and charge-off statistics and
trends. Minimum loss factors used by the Corporation for criticized loan
categories are consistent with regulatory agency classifications and factors.
Loss factors for non-criticized loan categories are based primarily on
historical loan loss experience.
Management, considering current information and events regarding the borrowers'
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, financial, and
agricultural loans and commercial real estate loans that are on nonaccrual
status or have had their terms restructured meet this definition. Large groups
of homogeneous loans, such as mortgage and consumer loans and leases, are
collectively evaluated for impairment. The amount of impairment is measured
based upon the loan's observable market price, the estimated fair value of the
collateral for collateral-dependent loans, or alternatively, 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 collectible.
Management believes that the allowance for loan losses is adequate. While
management uses available information to recognize losses on loans, future
additions to the allowance for loan losses may be necessary based on changes in
economic conditions. In addition, various regulatory agencies, as an
55
integral part of their examination process, periodically review the
Corporation's allowance for loan losses. Such agencies may require the
Corporation to recognize additions to the allowance for loan losses or that
certain loan balances be charged off when their credit evaluations differ from
those of management based on their judgments about information available to them
at the time of their examinations.
Other Real Estate Owned
Other real estate owned is included in other assets in the consolidated balance
sheets and is comprised of property acquired through a foreclosure proceeding or
acceptance of a deed-in-lieu of foreclosure, and loans classified as
in-substance foreclosure. Other real estate owned is 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
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 treated as period costs. Other real estate
owned totaled $11.4 million and $2.7 million at December 31, 2002 and 2001,
respectively.
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 of the assets are 3 to 20 years for land
improvements, 5 to 40 years for buildings, 3 to 5 years for computers, and 3 to
20 years for furniture, fixtures, and other equipment. Leasehold improvements
are amortized on a straight-line basis over the lesser of the lease terms or the
estimated useful lives of the improvements.
Goodwill and Core Deposit Intangibles
The excess of the cost of an acquisition over the fair value of the net assets
acquired consist primarily of goodwill and core deposit intangibles. Core
deposit intangibles have finite lives and are amortized on an accelerated basis
to expense over periods of 7 to 10 years. 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, in which case an impairment charge would be recorded.
Prior to January 1, 2002, goodwill was amortized to expense over periods up to
40 years for acquisitions made before 1983 and for periods up to 25 years for
acquisitions made after 1982. The Corporation adopted Statement of Financial
Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets,"
("SFAS 142") and SFAS No. 147, "Acquisitions of Certain Financial Institutions,"
("SFAS 147") effective January 1, 2002. Under SFAS 142, goodwill and indefinite
life intangibles are no longer amortized but are subject to impairment tests on
at least an annual basis. Any impairment of goodwill or intangibles will be
recognized as an expense in the period of impairment. The Corporation was
required to complete the transitional goodwill impairment test within six months
of adoption of SFAS 142 and to record the impairment, if any, by the end of the
fiscal year. The Corporation completed the transitional goodwill impairment test
in the second quarter of 2002 as of January 1, 2002. No impairment loss was
recorded as of January 1, 2002. No impairment loss was necessary from the
January 1 and May 1, 2002, impairment tests described above under the
Corporation's adoption of SFAS 142, including the $7.4 million of goodwill
related to SFAS 147. Note 6 includes a summary of the Corporation's goodwill and
core deposit intangibles, and Note 20 provides disclosures regarding the impact
of SFAS 142 and SFAS 147 on the Corporation's consolidated financial statements.
56
SFAS 147 amends SFAS No. 72, "Accounting for Certain Acquisitions of Banking or
Thrift Institutions," ("SFAS 72") to remove the acquisition of financial
institutions from the scope of that statement and provides guidance on the
accounting for the impairment or disposal of acquired long-term
customer-relationship intangible assets. Except for transactions between two or
more mutual enterprises, SFAS 147 requires acquisitions of financial
institutions that meet the definition of a business combination to be accounted
for in accordance with SFAS No. 141, "Business Combinations," ("SFAS 141") and
SFAS 142. The provisions of SFAS 147 were effective on October 1, 2002, with
earlier application permitted. The Corporation adopted SFAS 147 effective
September 30, 2002. At January 1, 2002, the Corporation had $7.4 million of
goodwill from certain business combinations that was continuing to be amortized
in 2002 under SFAS 72, prior to the issuance of SFAS 147. With the adoption of
SFAS 147, which removed certain acquisitions from the scope of SFAS 72 and
included them under SFAS 142, the Corporation ceased such amortization. The
amount of such amortization was $0.25 million pre-tax per quarter, or
approximately 0.3 of a cent of diluted earnings per share per quarter in 2002.
The Corporation discontinued such amortization effective January 1, 2002, the
same date as the Corporation's adoption of SFAS 142, and has restated any prior
financial information as required by SFAS 147.
Mortgage Servicing Rights
Mortgage servicing rights capitalized are amortized in proportion to and over
the period of estimated servicing income. Capitalized mortgage servicing rights
are included in other intangible assets in the consolidated balance sheets. The
total cost of loans originated or purchased is allocated between loans and
servicing rights based on the relative fair values of each. The value of
mortgage servicing rights is adversely affected when mortgage interest rates
decline and mortgage loan prepayments increase. Impairment is assessed using
stratifications based on the risk characteristics of the underlying loans, such
as bulk acquisitions versus loan-by-loan, loan type, interest rate, and
estimated prepayment speeds of the underlying mortgages serviced. To the extent
the carrying value of the mortgage servicing rights exceed their fair value, a
valuation reserve is established.
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. In
assessing the realizability of deferred tax assets, management considers whether
it is more likely than not that some portion or all of the deferred tax assets
will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income,
and tax planning strategies in making this assessment. Based upon the level of
historical taxable income and projections for future taxable income over the
period which the deferred tax assets are deductible, management believes it is
more likely than not the Corporation will realize the benefits of these
deductible differences, net of the existing valuation allowances at December 31,
2002.
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 offset by
other subsidiaries that incur federal tax liabilities.
Derivative Financial Instruments and Hedging Activities
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as
amended by SFAS No. 138, "Accounting for Certain Derivative Instruments and
Certain Hedging Activities," (collectively referred to as "SFAS 133") requires
derivative instruments, including derivative instruments embedded in other
contracts, to be carried at fair value on the balance sheet with changes in the
fair value recorded
57
directly in earnings. As required, the Corporation adopted SFAS 133 on
January 1, 2001. In accordance with the transition provisions of SFAS 133, upon
adoption the Corporation recorded a cumulative effect of $1.3 million, net of
taxes of $843,000, in accumulated other comprehensive income to recognize at
fair value all derivatives that are designated as cash flow hedge instruments.
Due to immateriality, net gains on derivatives designated as fair value hedges
were recorded in earnings at adoption.
All derivatives are recognized on the consolidated balance sheet at their fair
value. On the date the derivative contract is entered into, the Corporation
designates the derivative, except for mortgage banking derivatives for which
changes in fair value of the derivative is recorded in earnings, as either a
fair value hedge (i.e., a hedge of the fair value of a recognized asset or
liability) or a cash flow hedge (i.e., a hedge of the variability of cash flows
to be received or paid related to a recognized asset or liability). The
Corporation formally documents all relationships between hedging instruments and
hedging items, as well as its risk management objective and strategy for
undertaking various hedge transactions. This process includes linking all
derivatives that are designated as fair value hedges or cash flow hedges to
specific assets or liabilities on the balance sheet. The Corporation also
formally assesses, both at the hedge's inception and on an ongoing basis,
whether the derivatives that are used in hedging transactions are highly
effective in offsetting changes in fair values or cash flows of hedged items. If
it is determined that a derivative is not highly effective as a hedge or that it
has ceased to be a highly effective hedge, the Corporation discontinues hedge
accounting prospectively.
For a derivative designated as a fair value hedge, the changes in the fair value
of the derivative and of the hedged item attributable to the hedged risk are
recognized in earnings. If the derivative is designated as a cash flow hedge,
the effective portions of changes in the fair value of the derivative are
recorded in other comprehensive income and are recognized in the income
statement when the hedged item affects earnings. Ineffective portions of changes
in the fair value of cash flow hedges are recognized in earnings.
The Corporation discontinues hedge accounting prospectively when it is
determined that the derivative is no longer effective in offsetting changes in
the fair value or cash flows of the hedged item, the derivative expires or is
sold, terminated, or exercised, the derivative is dedesignated as a hedging
instrument, or management determines that designation of the derivative as a
hedging instrument is no longer appropriate. When hedge accounting is
discontinued because it is determined that the derivative no longer qualifies as
an effective fair value hedge, the Corporation continues to carry the derivative
on the balance sheet at its fair value and no longer adjusts the hedged asset or
liability for changes in fair value. The adjustment of the carrying amount of
the hedged asset or liability is accounted for in the same manner as other
components of the carrying amount of that asset or liability.
Stock-Based Compensation
As allowed under SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123"), the Corporation accounts for stock-based compensation cost under the
intrinsic value method of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB Opinion No. 25). Compensation
expense for employee stock options is generally not recognized if the exercise
price of the option equals or exceeds the fair value of the stock on the date of
grant.
For purposes of providing the pro forma disclosures required under SFAS 123, the
fair value of stock options granted in 2002, 2001, and 2000 was estimated at the
date of grant using a Black-Scholes option pricing model which was originally
developed for use in estimating the fair value of traded options which have
different characteristics from the Corporation's employee stock options. The
model is also sensitive to changes in the subjective assumptions which can
materially affect the fair value estimate. As a result, management believes the
Black-Scholes model may not necessarily provide a reliable single measure of the
fair value of employee stock options. The following table illustrates the effect
on net income and earnings per share if the Corporation had applied the fair
value recognition provisions of SFAS 123.
58
For the Years Ended December 31,
-------------------------------------------
2002 2001 2000
-------------------------------------------
($ in Thousands, except per share amounts)
Net income, as reported $210,719 $179,522 $167,983
Adjustment: pro forma expense related to
options granted, net of tax 3,156) (3,484) (3,589)
------------------------------------------
Net income, as adjusted $207,563 $176,038 $164,394
==========================================
Basic earnings per share, as reported $ 2.82 2.47 $ 2.24
Adjustment: pro forma expense related to
options granted, net of tax (0.04) (0.04) (0.05)
------------------------------------------
Basic earnings per share, as adjusted $ 2.78 $ 2.43 $ 2.19
==========================================
Diluted earnings per share, as reported $ 2.79 $ 2.45 $ 2.23
Adjustment: pro forma expense related to
options granted, net of tax (0.04) (0.04) (0.05)
------------------------------------------
Diluted earnings per share, as adjusted $ 2.75 2.41 $ 2.18
==========================================
The following assumptions were used in estimating the fair value for options
granted in 2002, 2001 and 2000:
2002 2001 2000
---------------------------------------
Dividend yield 3.65% 3.51% 3.82%
Risk-free interest rate 4.58% 5.09% 6.63%
Weighted average expected life 7 yrs 7 yrs 7 yrs
Expected volatility 28.35% 26.07% 25.73%
The weighted average per share fair values of options granted in 2002, 2001, and
2000 were $7.73, $7.06, and $6.34, respectively. The annual expense allocation
methodology prescribed by SFAS 123 attributes a higher percentage of the
reported expense to earlier years than to later years, resulting in an
accelerated expense recognition for proforma disclosure purposes.
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, interest-bearing
deposits in other financial institutions, and federal funds sold and securities
purchased under agreements to resell.
Per Share Computations
Basic earnings per share is calculated by dividing net income by the weighted
average number of common shares outstanding. Diluted earnings per share is
calculated by dividing net income by the weighted average number of shares
adjusted for the dilutive effect of outstanding stock options. Also see Notes 12
and 20.
Recent Accounting Pronouncements
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," ("SFAS 144") which supersedes both SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and the accounting and reporting provisions of APB Opinion No.
30, "Reporting the Results of Operations - Reporting the Effects of Disposal of
a Segment of a Business, and Extraordinary, Unusual, and Infrequently Occurring
Events and Transactions," ("Opinion 30") for the disposal of a segment of a
business. SFAS 144 addresses financial accounting and reporting for the
impairment or disposal of long-lived assets and requires that long-lived assets
be reviewed for impairment whenever events or changes in circumstances
59
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 the carrying amount of an asset exceeds its estimated future cash
flows, an impairment charge is recognized for the amount by which the carrying
amount of the assets exceeds the fair value of the asset. SFAS 144 requires
companies to separately report discontinued operations and extends that
reporting to a component of an entity that either has been disposed of (by sale,
abandonment, or in a distribution to owners) or is classified as held for sale.
Assets to be disposed of are reported at the lower of the carrying amount or
fair value, less costs to sell. The Corporation adopted SFAS 144 on January 1,
2002, as required. The adoption did not have a material effect on the
Corporation's financial position or results of operations.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS 146"). The standard requires companies
to recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
The Corporation is required to adopt the provisions of SFAS 146 for exit or
disposal activities initiated after December 31, 2002. The adoption is not
expected to be material to the Corporation's financial position or results of
operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of SFAS 123" ("SFAS
148"). SFAS 148 permits two additional transition methods for entities that
adopt the fair value based method of accounting for stock-based employee
compensation. The Statement also requires new disclosures about the ramp-up
effect of stock-based employee compensation on reported results, and requires
that those effects be disclosed more prominently by specifying the form,
content, and location of those disclosures. The transition guidance and annual
disclosure provisions of SFAS 148 are effective for fiscal years ending after
December 15, 2002, with earlier application permitted in certain circumstances.
The interim disclosure provisions are effective for financial reports containing
financial statements for interim periods beginning after December 15, 2002. The
Corporation's accounting method for stock-based compensation is stated above in
Note 1. The Corporation has not decided yet if it will adopt a change to the
fair value based method of accounting.
In November 2002, the FASB issued Interpretation No. 45 ("FIN 45"), an
interpretation of FASB Statements No. 5, 57, and 107, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." This interpretation expands the disclosures to be made
by a guarantor in its interim and annual financial statements about its
obligations under certain guarantees and requires the guarantor to recognize a
liability for the fair value of an obligation assumed under a guarantee. FIN 45
clarifies the requirements of SFAS No. 5, "Accounting for Contingencies,"
relating to guarantees. In general, FIN 45 applies to contracts or
indemnification agreements that contingently require the guarantor to make
payments to the guaranteed party based on changes in an underlying instrument
that is related to an asset, liability, or equity security of the guaranteed
party. Certain guarantee contracts are excluded from both the disclosure and
recognition requirements of this interpretation, including, among others,
guarantees relating to employee compensation, residual value guarantees under
capital lease arrangements, commercial letters of credit, loan commitments,
subordinated interests in a special purpose entity, and guarantees of a
company's own future performance. Other guarantees are subject to the disclosure
requirements of FIN 45 but not to the recognition provisions and include, among
others, a guarantee accounted for as a derivative instrument under SFAS 133, a
parent's guarantee of debt owed to a third party by its subsidiary or vice
versa, and a guarantee which is based on performance not price. The disclosure
requirements of FIN 45 are effective for the Corporation as of December 31,
2002, and require disclosure of the nature of the guarantee, the maximum
potential amount of future payments that the guarantor could be required to make
under the guarantee, and the current amount of the liability, if any, for the
guarantor's obligations under the guarantee. The recognition requirements of FIN
45 are to be applied prospectively to guarantees issued or modified after
December 31, 2002. Significant guarantees that have been entered into by the
60
Corporation are disclosed in Note 11 and Note 15. The Corporation does not
expect the requirements of FIN 45 to have a material impact on the results of
operations, financial position, or liquidity.
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities." The objective of this
interpretation is to provide guidance on how to identify a variable interest
entity and determine when the assets, liabilities, noncontrolling interests, and
results of operations of a variable interest entity need to be included in a
company's consolidated financial statements. A company that holds variable
interests in an entity will need to consolidate the entity if the company's
interest in the variable interest entity is such that the company will absorb a
majority of the variable interest entity's losses and/or receive a majority of
the entity's expected residual returns, if they occur. FIN 46 also requires
additional disclosures by primary beneficiaries and other significant variable
interest holders. The provisions of this interpretation are effective upon
issuance. The Corporation is currently assessing the impact, if any, the
interpretation will have on results of operations, financial position, or
liquidity.
NOTE 2 BUSINESS COMBINATION:
There was one business combination during 2002 and none during 2001 and 2000.
The acquisition was accounted for under the purchase method of accounting; thus,
the results of operations prior to the consummation date were not included in
the accompanying consolidated financial statements. Goodwill, core deposit
intangibles, and other purchase accounting adjustments were recorded upon the
consummation of the purchase acquisition where the purchase price exceeded the
fair value of net assets acquired.
On February 28, 2002, the Corporation consummated its acquisition of 100% of the
outstanding common shares of Signal Financial Corporation ("Signal"), a
financial holding company headquartered in Mendota Heights, Minnesota. Signal
operated banking branches in nine locations in the Twin Cities and Eastern
Minnesota. As a result of the acquisition, the Corporation expanded its
Minnesota presence, particularly in the Twin Cities area.
The Signal transaction was consummated through the issuance of approximately 4.1
million shares of common stock and $58.4 million in cash for a purchase price of
$192.5 million. The value of the shares was determined using the closing stock
price of the Corporation's stock on September 10, 2001, the initiation date of
the transaction.
The following table summarizes the estimated fair value of the assets acquired
and liabilities assumed at the date of the acquisition.
$ in Millions
----------------
Investment securities available for sale $ 163.8
Loans 760.0
Allowance for loan losses (12.0)
Other assets 118.1
Intangible asset 5.6
Goodwill 119.7
---------
Total assets acquired $1,155.2
=========
Deposits $ 784.8
Borrowings 165.5
Other liabilities 12.4
---------
Total liabilities assumed $ 962.7
---------
Net assets acquired $ 192.5
=========
The intangible asset represents a core deposit intangible with a ten-year
estimated life. The $119.7 million of goodwill was assigned to the banking
segment during first quarter of 2002, as part of the adoption of SFAS 142.
61
The following represents supplemental pro forma disclosure required by SFAS No.
141, "Business Combinations," of total revenue, net income, and earnings per
share as though the business combination had been completed at the beginning of
the earliest comparable period.
Year ended December 31,
2002 2001
--------------------------
(In Thousands, except per
share data)
Total revenue $731,398 $673,363
Net income 209,829 190,444
Basic earnings per share 2.78 2.48
Diluted earnings per share 2.75 2.45
NOTE 3 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 $36.6 million at December 31,
2002. NOTE 4 INVESTMENT SECURITIES:
The amortized cost and fair values of securities available for sale at December
31, 2002 and 2001, were as follows:
2002
--------------------------------------------------------
Gross Gross
Unrealized Unrealized
Amortized Holding Holding Fair
Cost Gains Losses Value
--------------------------------------------------------
($ in Thousands)
U. S. Treasury securities $ 44,967 $ 915 $ --- $ 45,882
Federal agency securities 222,787 11,143 --- 233,930
Obligations of state and political
subdivisions 851,710 52,316 (3) 904,023
Mortgage-related securities 1,672,542 33,491 (797) 1,705,236
Other securities (debt and equity) 440,126 33,473 (1) 473,598
--------------------------------------------------------
Total securities available for sale $3,232,132 $131,338 $ (801) $3,362,669
========================================================
2001
--------------------------------------------------------
Gross Gross
Unrealized Unrealized
Amortized Holding Holding Fair
Cost Gains Losses Value
--------------------------------------------------------
($ in Thousands)
U. S. Treasury securities $ 15,071 $ 91 $ (47) $ 15,115
Federal agency securities 196,175 8,469 --- 204,644
Obligations of state and political
subdivisions 847,887 13,755 (39) 861,603
Mortgage-related securities 1,642,851 31,496 (24) 1,674,323
Other securities (debt and equity) 414,399 26,937 --- 441,336
--------------------------------------------------------
Total securities available for sale $3,116,383 $ 80,748 $ (110) $3,197,021
========================================================
Under SFAS No. 133, the Corporation was allowed a one-time opportunity to
reclassify investment securities from held to maturity to available for sale.
Thus, on January 1, 2001, the Corporation reclassified all its held to maturity
securities to available for sale. The amortized cost and fair value of the
securities transferred were $369 million and $373 million, respectively.
62
The amortized cost and fair values of investment securities available for sale
at December 31, 2002, by contractual maturity, are shown below. Expected
maturities will differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call or prepayment
penalties.
2002
--------------------------
Amortized Fair
Cost Value
--------------------------
($ in Thousands)
Due in one year or less $ 214,645 $ 218,272
Due after one year through five years 566,593 601,608
Due after five years through ten years 345,142 363,823
Due after ten years 286,588 306,747
--------------------------
Total debt securities 1,412,968 1,490,450
Mortgage-related securities 1,672,542 1,705,236
Equity securities 146,622 166,983
--------------------------
Total securities available for sale $3,232,132 $3,362,669
==========================
Total proceeds and gross realized gains and losses from sale of securities
available for sale for each of the three years ended December 31 were:
2002 2001 2000
-------------------------------------
($ in Thousands)
Proceeds $27,793 $135,627 $648,359
Gross gains 374 1,322 2,889
Gross losses (801) (604) (10,538)
Pledged securities with a carrying value of approximately $1.8 billion and $1.6
billion at December 31, 2002, and December 31, 2001, respectively, were pledged
to secure certain deposits, Federal Home Loan Bank advances, or for other
purposes as required or permitted by law.
NOTE 5 LOANS:
Loans at December 31 are summarized below.
2002 2001
--------------------------
($ in Thousands)
Commercial, financial, and agricultural $ 2,213,986 $1,783,300
Real estate construction 910,581 797,734
Commercial real estate 3,128,826 2,630,964
Lease financing 38,352 11,629
--------------------------
Commercial 6,291,745 5,223,627
Residential mortgage 2,430,746 2,524,199
Home equity 864,631 609,254
--------------------------
Residential real estate 3,295,377 3,133,453
Consumer 716,103 662,784
--------------------------
Total loans $10,303,225 $9,019,864
==========================
A summary of the changes in the allowance for loan losses for the years
indicated is as follows:
2002 2001 2000
-----------------------------------
($ in Thousands)
Balance at beginning of year $128,204 $120,232 $113,196
Balance related to acquisition 11,985 --- ---
Decrease from sale of credit card
receivables --- --- (4,216)
Provision for loan losses 50,699 28,210 20,206
Charge-offs (32,179) (22,639) (11,155)
Recoveries 3,832 2,401 2,201
-----------------------------------
Net charge-offs (28,347) (20,238) (8,954)
-----------------------------------
Balance at end of year $162,541 $128,204 $120,232
===================================
63
The following table presents nonperforming loans at December 31:
December 31,
-----------------------
2002 2001
-----------------------
($ in Thousands)
Nonaccrual loans $94,132 $48,238
Accruing loans past due 90 days or more 3,912 3,649
Restructured loans 1,258 238
-----------------------
Total nonperforming loans $99,302 $52,125
=======================
Management has determined that commercial, financial, and agricultural loans and
commercial real estate loans that have nonaccrual status or have had their terms
restructured are impaired loans. The following table presents data on impaired
loans at December 31:
2002 2001
-----------------------
($ in Thousands)
Impaired loans for which an allowance
has been provided $32,539 $10,140
Impaired loans for which no allowance
has been provided 43,638 17,720
-----------------------
Total loans determined to be impaired $76,177 $27,860
=======================
Allowance for loan losses related to
impaired loans $19,579 $ 6,445
=======================
2002 2001 2000
----------------------------------
For the years ended December 31: ($ in Thousands)
Average recorded investment in
impaired loans $60,247 $28,319 $18,650
==================================
Cash basis interest income recognized
from impaired loans $ 3,849 $ 1,795 $ 1,623
==================================
The Corporation has granted loans to their directors, executive officers, or
their related subsidiaries. These loans were made on substantially the same
terms, including rates and collateral, as those prevailing at the time for
comparable transactions with other unrelated customers, and do not involve more
than a normal risk of collection. These loans to related parties are summarized
as follows:
2002
------------------
($ in Thousands)
Balance at beginning of year $ 46,845
New loans 44,353
Repayments (58,576)
Changes due to status of executive officers and directors 432
---------
Balance at end of year $ 33,054
=========
The Corporation serves the credit needs of its customers by offering a wide
variety of loan programs to customers, primarily in Wisconsin, Illinois, and
Minnesota. 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,
2002, no significant concentrations existed in the Corporation's loan portfolio
in excess of 10% of total loans.
64
NOTE 6 GOODWILL AND OTHER INTANGIBLE ASSETS:
Upon the adoption of SFAS 142 and SFAS 147 effective January 1, 2002, the
Corporation had unamortized goodwill in the amount of $92.4 million. The change
in the carrying amount of goodwill was as follows.
Goodwill 2002 2001
- -------- ----------------------
($ in Thousands)
Balance at beginning of year $ 92,397 $98,908
Goodwill acquired 119,715 ---
Goodwill amortization --- (6,511)
----------------------
Balance at end of year $212,112 $92,397
======================
Goodwill amortization expense was zero for the year ended December 31, 2002,
$6.5 million for the year ended December 31, 2001, and $6.6 million for the year
ended December 31, 2000. See Note 20 for the disclosure of net income and per
share amounts excluding goodwill amortization, net of any income tax effects,
due to the adoption of SFAS 142 and SFAS 147 in 2002. Goodwill is assigned to
the Corporation's banking segment.
At January 1, 2002, the Corporation had other intangible assets consisting of
core deposit intangibles of $5.9 million and mortgage servicing rights of $32.1
million that continue to be amortized. The other intangible assets are assigned
to the Corporation's banking segment. The change in the carrying amount of core
deposit intangibles, gross carrying amount, accumulated amortization, and net
book value was as follows.
Core deposit intangibles 2002 2001
- ------------------------ ----------------------
($ in Thousands)
Balance at beginning of year $ 5,925 $ 7,792
Core deposit intangibles acquired 5,600 ---
Amortization (2,283) (1,867)
----------------------
Balance at end of period $ 9,242 $ 5,925
======================
Gross carrying amount $ 28,165 $22,565
Accumulated amortization (18,923) (16,640)
----------------------
Net book value $ 9,242 $ 5,925
======================
A summary of changes in the balance of mortgage servicing rights and the
mortgage servicing rights valuation allowance was as follows:
Mortgage servicing rights 2002 2001
- ------------------------- -----------------------
($ in Thousands)
Balance at beginning of year $ 32,066 $ 36,269
Additions 30,730 20,920
Sales of mortgage servicing rights --- (5,136)
Amortization (12,831) (9,267)
Change in valuation allowance (17,642) (10,720)
-----------------------
Balance at end of year $ 32,323 $ 32,066
=======================
Mortgage servicing rights valuation allowance
- ---------------------------------------------
Balance at beginning of year $(10,720) $ ---
Additions (17,642) (10,720)
-----------------------
Balance at end of year $(28,362) $(10,720)
=======================
65
At December 31, 2002, the Corporation was servicing 1- to 4- family residential
mortgage loans owned by other investors with balances totaling $5.44 billion
compared to $5.23 billion and $5.50 billion at December 31, 2001 and 2000,
respectively. The fair value of servicing was approximately $32.3 million
(representing 59 bp of loans serviced) at December 31, 2002 compared to $32.1
million (representing 61 bp of loans serviced) at December 31, 2001. During
2001, the Corporation sold $812 million of loans serviced with an unamortized
cost of $5.1 million, for a net gain of $4.3 million.
Core deposit intangible amortization was $2.3 million, $1.9 million, and $2.3
million for the years ended December 31, 2002, 2001, and 2000, respectively.
Mortgage servicing rights expense, which includes the amortization of the
mortgage servicing rights and increases or decreases to the valuation allowance
associated with the mortgage servicing rights, was $30.5 million, $20.0 million,
and $9.4 million for the years ended December 31, 2002, 2001, and 2000,
respectively. The following table shows the estimated future amortization
expense for amortizing intangible assets. The projections of amortization
expense for the next five years are based on existing asset balances and the
existing interest rate environment as of December 31, 2002. The actual
amortization expense the Corporation recognizes in any given period may be
significantly different depending upon changes in mortgage interest rates,
market conditions, regulatory requirements, and events or circumstances that
indicate the carrying amount of an asset may not be recoverable.
Estimated amortization expense
Core Deposit Intangible Mortgage Servicing Rights
--------------------------- ------------------------------
Year ending December 31, ($ in Thousands)
2003 $2,076 $13,959
2004 1,734 10,080
2005 1,264 5,420
2006 1,162 1,993
2007 1,060 752
==========================================================
NOTE 7 PREMISES AND EQUIPMENT:
A summary of premises and equipment at December 31 is as follows:
2002 2001
--------------------------------------------- ------------
Estimated Accumulated Net Book Net Book
Useful Lives Cost Depreciation Value Value
------------- ------------- ----------------- ------------- ------------
($ in Thousands)
Land --- $ 27,496 $ --- $ 27,496 $ 25,066
Land improvements 3 - 20 years 2,926 2,192 734 734
Buildings 5 - 40 years 147,093 72,705 74,388 62,384
Computers 3 - 5 years 35,957 31,753 4,204 6,882
Furniture, fixtures and other equipment 3 - 20 years 107,661 87,484 20,177 18,243
Leasehold improvements 5 - 30 years 15,903 10,189 5,714 6,219
-------------------------------------------------------
Total premises and equipment $337,036 $ 204,323 $132,713 $119,528
=======================================================
Depreciation and amortization of premises and equipment totaled $17.0 million in
2002, $16.2 million in 2001, and $17.1 million in 2000.
66
The Corporation and certain subsidiaries are obligated under a number of
noncancelable operating leases for other facilities and equipment, certain of
which provide for increased rentals based upon increases in cost of living
adjustments and other operating costs. The approximate minimum annual rentals
and commitments under these noncancelable agreements and leases with remaining
terms in excess of one year are as follows:
($ in Thousands)
2003 $ 5,211
2004 4,836
2005 3,952
2006 3,237
2007 2,928
Thereafter 12,736
------
Total $32,900
=======
Total rental expense under leases, net of sublease income, totaled $8.3 million
in 2002, $7.3 million in 2001, and $7.1 million in 2000.
NOTE 8 DEPOSITS:
The distribution of deposits at December 31 is as follows.
2002 2001
-------------------------
($ in Thousands)
Noninterest-bearing demand deposits $1,773,699 $1,425,109
Savings deposits 895,855 801,648
Interest-bearing demand deposits 1,468,193 922,164
Money market deposits 1,754,313 1,814,098
Brokered certificates of deposit 233,650 290,000
Other time deposits 2,999,142 3,359,592
-------------------------
Total deposits $9,124,852 $8,612,611
=========================
Time deposits of $100,000 or more were $856 million and $994 million at December
31, 2002 and 2001, respectively. Aggregate annual maturities of all time
deposits at December 31, 2002, are as follows:
Maturities During Year Ending December 31, ($ in Thousands)
- ------------------------------------------ ------------------
2003 $1,818,027
2004 706,276
2005 450,564
2006 74,672
2007 165,960
Thereafter 17,293
----------
Total $3,232,792
==========
67
NOTE 9 SHORT-TERM BORROWINGS:
Short-term borrowings at December 31 are as follows:
2002 2001
-------------------------
($ in Thousands)
Federal funds purchased and securities
sold under agreements to repurchase $2,240,286 $1,691,152
Federal Home Loan Bank advances 100,000 300,000
Treasury, tax, and loan notes 38,450 645,047
Other borrowed funds 10,871 7,652
-------------------------
Total short-term borrowings $2,389,607 $2,643,851
=========================
Included in short-term borrowings are Federal Home Loan Bank advances with
original maturities of less than one year. The treasury, tax, and loan notes are
demand notes representing secured borrowings from the U.S. Treasury,
collateralized by qualifying securities and loans.
At December 31, 2002, the parent company had $100 million of established lines
of credit with various nonaffiliated banks, which was not drawn on at December
31, 2002. Borrowings under these lines accrue interest at short-term market
rates. Under the terms of the credit agreement, a variety of advances and
interest periods may be selected by the parent company. During 2000, a $200
million commercial paper program was initiated, of which, no amounts were
outstanding at December 31, 2002 or 2001.
NOTE 10 LONG-TERM DEBT:
Long-term debt (debt with original contractual maturities greater than one year)
at December 31 is as follows:
2002 2001
-------------------------
($ in Thousands)
Federal Home Loan Bank advances (2.29% to
6.81%, fixed rate, maturing in 2003
through 2017 for 2002, and 3.46% to
6.81%, fixed rate, maturing in 2002
through 2014 for 2001) $ 964,931 $ 715,993
Bank notes (1) 400,000 200,000
Bank notes (3.70% fixed rate, maturing in 2007) 100,000 ---
Subordinated debt, net (2) 208,356 181,882
Repurchase agreements (1.28% to 3.65%, fixed rate,
maturing in 2004 through 2005) 226,175 ---
Other borrowed funds 7,383 5,520
------------------------
Total long-term debt $1,906,845 $1,103,395
=========================
(1) On April 4, 2001, the Corporation issued $200 million of variable rate bank
notes that mature on April 10, 2003. The April notes reprice quarterly at
LIBOR plus 22 basis points ("bp") and was 1.99% at December 31, 2002. On
May 16, 2002, the Corporation issued an additional $50 million of variable
rate bank notes that mature on November 17, 2003. The May notes reprice
quarterly at LIBOR plus 25 bp and was 1.67% at December 31, 2002. On
December 19, 2002, the Corporation issued $150 million of variable rate
bank notes that mature on December 10, 2004. The December notes reprice
quarterly at LIBOR plus 10 bp and was 1.51% at December 31, 2002.
(2) On August 6, 2001, the Corporation issued $200 million of subordinated
debt. This debt was issued at a discount, has a fixed interest rate of
6.75% and matures on August 15, 2011. During 2001, the Corporation entered
into a fair value hedge to hedge the interest rate risk on the subordinated
debt. As of December 31, 2002 and 2001, the fair value of the hedge was a
$9.6 million gain and a $16.7 million loss, respectively. The subordinated
debt qualifies under the risk-based capital guidelines as Tier 2
supplementary capital for regulatory purposes.
68
The table below summarizes the maturities of the Corporation's long-term debt at
December 31, 2002:
Year ($ in Thousands)
- ---- ----------------
2003 $ 552,243
2004 776,325
2005 200,000
2006 ---
2007 100,000
Thereafter 278,277
----------
Total long-term debt $1,906,845
===========
Under agreements with the Federal Home Loan Banks of Chicago and Des Moines,
Federal Home Loan Bank advances (short-term and long-term) are secured by the
subsidiary banks' qualifying mortgages (such as residential mortgage,
residential mortgage loans held for sale, home equity, and commercial real
estate) and by specific investment securities for certain Federal Home Loan Bank
advances.
Note 11 COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES:
On May 30, 2002, ASBC Capital I (the "ASBC Trust"), a Delaware business trust
wholly owned by the Corporation, completed the sale of $175 million of 7.625%
preferred securities (the "Preferred Securities"). The Preferred Securities are
traded on the New York Stock Exchange under the symbol ABW PRA. The ASBC Trust
used the proceeds from the offering to purchase a like amount of 7.625% Junior
Subordinated Debentures (the "Debentures") of the Corporation. The Debentures
are the sole assets of the ASBC Trust and are eliminated, along with the related
income statement effects, in the consolidated financial statements.
The Preferred Securities accrue and pay dividends quarterly at an annual rate of
7.625% of the stated liquidation amount of $25 per Preferred Security. The
Corporation has fully and unconditionally guaranteed all of the obligations of
the ASBC Trust. The guarantee covers the quarterly distributions and payments on
liquidation or redemption of the Preferred Securities, but only to the extent of
funds held by the ASBC Trust.
The Preferred Securities are mandatorily redeemable upon the maturity of the
Debentures on June 15, 2032 or upon earlier redemption as provided in the
Indenture. The Corporation has the right to redeem the Debentures on or after
May 30, 2007.
The Preferred Securities qualify under the risk-based capital guidelines as Tier
1 capital for regulatory purposes. The Corporation used the proceeds from the
sales of the Debentures for general corporate purposes. Also, during May 2002,
the Corporation entered into a fair value hedge to hedge the interest rate risk
on the Debentures. As of December 31, 2002, the fair value of the hedge was a
$15.1 million gain. Given the fair value hedge, the Preferred Securities are
carried on the balance sheet at fair value.
Signal on January 16, 1997 formed United Capital Trust I (the "UCTI Trust"), a
Delaware business trust wholly owned by the Corporation, and completed the sale
of $11 million of 9.75% preferred securities (the "9.75% Preferred Securities").
The UCTI Trust used the proceeds from the offering to purchase a like amount of
9.75% Junior Subordinated Debentures (the "9.75% Debentures") of the
Corporation. The 9.75% Preferred Securities were mandatorily redeemable upon the
maturity of the 9.75% Debentures, on January 15, 2027 or upon earlier redemption
as provided in the Indenture. The Corporation had the right to redeem the 9.75%
Debentures on or after January 15, 2002. On June 20, 2002, the Corporation
exercised this right and called the 9.75% Debentures for redemption.
Note 12 Stockholders' Equity:
On April 24, 2002, the Board of Directors declared a 10% stock dividend, payable
May 15 to shareholders of record at the close of business on April 29. All share
and per share data in the accompanying consolidated financial statements has
been adjusted to reflect the 10% stock dividend paid. As a result
69
of the stock dividend, the Corporation distributed approximately 7.0
million shares of common stock. Any fractional shares resulting from the
dividend were paid in cash. On June 15, 2000, the Corporation distributed 6.3
million shares of common stock in connection with a 10% stock dividend. Share
and price information has been adjusted to reflect all stock splits and
dividends.
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, 2002, subsidiary net assets equaled $1.4 billion, of which
approximately $176.4 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.
The Board of Directors has authorized management to repurchase shares of the
Corporation's common stock each quarter in the market, to be made available for
issuance in connection with the Corporation's employee incentive plans and for
other corporate purposes. For the Corporation's employee incentive plans, the
Board of Directors authorized the repurchase of up to 1.6 million shares
(400,000 shares per quarter) in 2002 and 1.3 million shares (330,000 shares per
quarter) in 2001. Of these authorizations, approximately 1,255,000 shares were
repurchased for $43.3 million during 2002 (with approximately 955,000 shares
reissued in connection with stock options exercised), and 880,000 shares were
repurchased for $26.7 million in 2001 (with approximately 271,000 shares
reissued for options exercised). Additionally, under two separate actions in
2000, the Board of Directors authorized the repurchase and cancellation of the
Corporation's outstanding shares, not to exceed approximately 7.3 million shares
on a combined basis. Under these authorizations, approximately 1.3 million
shares were repurchased for $44.0 million during 2002 at an average cost of
$32.69 per share, while during 2001 approximately 251,000 shares were
repurchased for $7.7 million at an average cost of $30.80 per share. At December
31, 2002, approximately 2.1 million shares remain authorized to repurchase. The
repurchase of shares will be based on market opportunities, capital levels,
growth prospects, and other investment opportunities.
The Board of Directors approved the implementation of a broad-based stock option
grant effective July 28, 1999. This stock option grant provided all qualifying
employees with an opportunity and an incentive to buy shares of the Corporation
and align their financial interest with the growth in value of the Corporation's
shares. These options have 10-year terms, fully vest in two years, and have
exercise prices equal to 100% of market value on the date of grant. As of
December 31, 2002, approximately 1.8 million shares remain available for
granting.
In January 2002, 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 3.3 million shares, to the
Amended and 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, 1997, and 1998. Options are generally
exercisable up to 10 years from the date of grant and vest over two to three
years. As of December 31, 2002, approximately 3.8 million 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.
70
2002 2001 2000
------------------------------------------------------------------------------------------------
Options Weighted Average Options Weighted Average Options Weighted Average
Outstanding Exercise Price Outstanding Exercise Price Outstanding Exercise Price
------------------------------------------------------------------------------------------------
Outstanding, January 1 4,020,017 $26.10 3,639,292 $24.85 3,527,138 $23.59
Granted 765,290 31.93 772,090 29.36 756,833 25.07
Options from acquisition 1,076,460 14.15 --- --- --- ---
Exercised (979,785) 16.90 (275,363) 17.19 (387,189) 10.04
Forfeited (133,488) 30.09 (116,002) 29.56 (257,490) 31.24
------------------------------------------------------------------------------------------------
Outstanding, December 31 4,748,494 $26.12 4,020,017 $26.10 3,639,292 $24.85
================================================================================================
Options exercisable at year-end 3,373,253 2,649,051 1,693,233
================================================================================================
The following table summarizes information about the Corporation's stock options
outstanding at December 31, 2002:
Options Weighted Average Remaining Options Weighted Average
Outstanding Exercise Price Life (Years) Exercisable Exercise Price
-----------------------------------------------------------------------------------------------
Range of Exercise Prices:
$ 8.90 - $11.42 184,187 $ 9.89 2.00 184,187 $ 9.89
$13.13 - $14.93 415,570 14.43 4.06 415,570 14.43
$15.98 - $19.80 289,264 17.67 5.24 289,264 17.67
$20.32 - $23.28 437,566 22.02 3.50 433,029 22.02
$25.05 - $29.20 1,674,672 26.72 7.16 1,077,053 26.01
$31.49 - $34.45 1,747,235 32.47 7.36 974,150 32.89
-----------------------------------------------------------------------------------------------
TOTAL 4,748,494 $26.12 6.30 3,373,253 $24.46
===============================================================================================
The pro forma disclosures required under SFAS 123, as amended by SFAS 148, are
included in Note 1.
71
NOTE 13 RETIREMENT PLANS:
The Corporation has a noncontributory defined benefit retirement plan (the
"Plan") covering substantially all full-time employees. The benefits are based
primarily on years of service and the employee's compensation paid. The
Corporation's funding policy is consistent with the funding requirements of
federal law and regulations.
The following tables set forth the Plan's funded status and net periodic benefit
cost:
2002 2001
-----------------------
($ in Thousands)
Change in Fair Value of Plan Assets
Fair value of plan assets at beginning of year $ 32,336 $ 34,681
Actual loss on plan assets (3,784) (1,907)
Employer contributions 19,489 3,138
Gross benefits paid (2,612) (3,576)
-----------------------
Fair value of plan assets at end of year $ 45,429 $ 32,336
=======================
Change in Benefit Obligation
Net benefit obligation at beginning of year $ 45,767 $ 40,908
Service cost 4,582 3,950
Interest cost 3,257 2,889
Plan amendments 206 ---
Actuarial loss 3,264 1,596
Gross benefits paid (2,612) (3,576)
-----------------------
Net benefit obligation at end of year $ 54,464 $ 45,767
=======================
Funded Status
Deficit of plan assets under benefit obligation $ (9,035) $(13,431)
Unrecognized net actuarial loss 18,046 7,034
Unrecognized prior service cost 663 532
Unrecognized net transition asset (1,060) (1,383)
-----------------------
Net prepaid asset (accrued liability) at end
of year in the balance sheet $ 8,614 $ (7,248)
=======================
Weighted average assumptions as of December 31:
Discount rate 6.75% 7.25%
Rate of increase in compensation levels 5.00 5.00
=======================
2002 2001 2000
----------------------------
($ in Thousands)
Components of Net Periodic Benefit Cost
Service cost $ 4,582 $ 3,950 $ 3,576
Interest cost 3,257 2,889 2,858
Expected return on plan assets (3,963) (3,474) (3,134)
Amortization of:
Transition asset (323) (324) (324)
Prior service cost 74 63 62
Actuarial gain --- --- (36)
----------------------------
Total net periodic benefit cost $ 3,627 $ 3,104 $ 3,002
============================
Weighted average assumptions at beginning
of year used in cost calculations:
Discount rate 7.25% 7.50% 7.75%
Rate of increase in compensation levels 5.00 5.00 5.00
Expected long-term rate of return on plan assets 9.00 9.00 9.00
===========================
72
The Corporation and its subsidiaries also have a Profit Sharing/Retirement
Savings Plan (the "plan"). The Corporation's contribution is determined annually
by the Administrative Committee of the Board of Directors, based in part on
performance-based formulas provided in the plan. Total expense related to
contributions to the plan was $11.8 million, $10.5 million, and $6.1 million in
2002, 2001, and 2000, respectively.
An additional pension obligation is required when the accumulated benefit
obligation exceeds the sum of the fair value of plan assets and the accrued
pension expense. At December 31, 2002, the Corporation's additional pension
obligation was $16.1 million, of which $9.2 million was included as a reduction
in accumulated other comprehensive income, net of tax benefit of $6.2 million,
and $0.7 million was included as an intangible asset as part of other assets in
the consolidated balance sheet. At December 31, 2001, the Corporation's
additional pension obligation was $4.2 million, of which $2.2 million was
included as a reduction in accumulated other comprehensive income, net of tax
benefit of $1.5 million, and $0.5 million was included as an intangible asset in
other assets.
NOTE 14 INCOME TAXES:
The current and deferred amounts of income tax expense (benefit) are as follows:
Years ended December 31,
-----------------------------
2002 2001 2000
-----------------------------
($ in Thousands)
Current:
Federal $ 99,730 $ 54,726 $ 73,885
State 755 113 1,889
-----------------------------
Total current 100,485 54,839 75,774
Deferred:
Federal (16,214) 14,947 (11,640)
State 1,336 1,701 (2,296)
-----------------------------
Total deferred (14,878) 16,648 (13,936)
-----------------------------
Total income tax expense $ 85,607 $71,487 $ 61,838
=============================
73
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:
2002 2001
-----------------------
($ in Thousands)
Gross deferred tax assets:
Allowance for loan losses $ 68,496 $ 53,484
Accrued liabilities 6,756 5,664
Deferred compensation 8,984 6,848
Securities valuation adjustment 9,652 9,090
Deposit base intangible 4,206 4,127
Mortgage banking activity 1,265 ---
Benefit of tax loss carryforwards 15,259 14,998
Other 6,578 7,475
-----------------------
Total gross deferred tax assets 121,196 101,686
Valuation adjustment for deferred tax assets (12,159) (12,163)
-----------------------
109,037 89,523
Gross deferred tax liabilities:
Real estate investment trust income 40,485 45,812
Mortgage banking activity --- 3,441
Deferred loan fee income and other loan
yield adjustment 6,760 5,301
State income taxes 13,167 10,126
Other 7,829 5,948
-----------------------
Total gross deferred tax liabilities 68,241 70,628
-----------------------
Net deferred tax assets 40,796 18,895
Tax effect of unrealized gain related
to available for sale securities (48,879) (29,245)
Tax effect of unrealized loss related
to derivative instruments 9,326 1,411
Tax effect of additional pension obligation 6,167 1,485
-----------------------
(33,386) (26,349)
-----------------------
Net deferred tax assets (liabilities)
including tax effected items $ 7,410 $(7,454)
=======================
Components of the 2001 deferred tax assets have been adjusted to reflect the
filing of corporate income tax returns.
For financial reporting purposes, a valuation allowance has been recognized to
offset deferred tax assets related to state net operating loss carryforwards of
certain subsidiaries and other temporary differences due to the uncertainty that
the assets will be realized. If it is subsequently determined that all or a
portion of these deferred tax assets will be realized, the tax benefit for these
items will be used to reduce current tax expense for that period.
At December 31, 2002, the Corporation had state net operating losses of $204
million and federal net operating losses of $1.7 million that will expire in the
years 2003 through 2017.
The effective income tax rate differs from the statutory federal tax rate. The
major reasons for this difference are as follows:
2002 2001 2000
---------------------------
Federal income tax rate at statutory rate 35.0% 35.0% 35.0%
Increases (decreases) resulting from:
Tax-exempt interest and dividends (4.6) (5.1) (5.0)
State income taxes (net of federal income
taxes) 0.5 0.5 (0.1)
Increase in cash surrender value of life
insurance (1.6) (1.8) (1.9)
Other (0.4) (0.1) (1.1)
---------------------------
Effective income tax rate 28.9% 28.5% 26.9%
===========================
74
A savings bank acquired by the Corporation in 1997 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 $79.2 million of retained income at December 31, 2002.
If income taxes had been provided, the deferred tax liability would have been
approximately $31.8 million.
NOTE 15 COMMITMENTS, OFF-BALANCE SHEET RISK, AND CONTINGENT LIABILITIES:
Commitments and Off-Balance Sheet Risk
The Corporation is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its customers
and to manage its own exposure to interest rate risk. These financial
instruments include lending-related commitments.
Lending-related Commitments
Off-balance sheet lending-related commitments include commitments to extend
credit, commitments to originate residential mortgage loans held for sale,
commercial letters of credit, and standby letters of credit. These financial
instruments are exercisable at the market rate prevailing at the date the
underlying transaction will be completed, and thus are deemed to have no current
fair value, or the fair value is based on fees currently charged to enter into
similar agreements and is not material at December 31, 2002 and 2001.
Commitments to extend credit are agreements to lend to customers at
predetermined interest rates as long as there is no violation of any condition
established in the contracts. Commercial and standby letters of credit are
conditional commitments issued to guarantee the performance of a customer to a
third party. Commercial letters of credit are issued specifically to facilitate
commerce and typically result in the commitment being drawn on when the
underlying transaction is consummated between the customer and the third party,
while standby letters of credit generally are contingent upon the failure of the
customer to perform according to the terms of the underlying contract with the
third party. The following is a summary of lending-related off-balance sheet
financial instruments at December 31:
2002 2001
-----------------------
($ in Thousands)
Commitments to extend credit,
excluding commitments to originate
mortgage loans $3,559,497 $2,598,170
Commitments to originate residential
mortgage loans held for sale 550,114 590,843
------------------------
Total commitments to extend credit 4,109,611 3,189,013
Commercial letters of credit 59,186 79,980
Standby letters of credit 267,858 189,996
Loans sold with recourse 1,387 1,941
Forward commitments to sell residential
mortgage loans 538,300 650,500
For commitments to extend credit, commitments to originate residential mortgage
loans held for sale, commercial letters of credit, and standby letters of
credit, the Corporation's associated credit risk is essentially the same as that
involved in extending loans to customers and is subject to normal credit
policies. The Corporation's exposure to credit loss in the event of
nonperformance by the other party to these financial instruments is represented
by the contractual amount of those instruments. The commitments generally have
fixed expiration dates or other termination clauses and may require payment of a
fee. The Corporation uses the same credit policies in making commitments and
conditional obligations as it does for on-balance-sheet instruments. The
Corporation evaluates each customer's creditworthiness on a case-by-case basis.
The amount of collateral obtained, if deemed necessary by the Corporation upon
extension of credit, is based on management's credit evaluation of the customer.
Since many of the commitments are expected to expire without being drawn upon,
the total commitment amounts do not necessarily represent future cash
requirements.
75
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,
2002 and 2001, $1.4 million and $1.9 million, respectively, of the serviced
loans were previously sold with recourse, the majority of which is either
federally-insured or federally-guaranteed.
Under SFAS 133, commitments to originate residential mortgage loans held for
sale and forward commitments to sell residential mortgage loans are defined as
derivatives and are therefore required to be recorded on the consolidated
balance sheet at fair value. The Corporation's derivative and hedging activity,
as defined by SFAS 133, is further summarized in Note 16. The commitments to
originate residential mortgage loans held for sale ("pipeline loans") of
approximately $550.1 million and $590.8 million at December 31, 2002 and 2001,
respectively, generally contain terms not exceeding 90 days. Adverse market
interest rate changes between the time a customer receives a rate-lock
commitment and the time the loan is sold to an investor can erode the value of
that mortgage. Therefore, the Corporation uses forward commitments to sell
residential mortgage loans to reduce its exposure to market risk resulting from
changes in interest rates which could alter the underlying fair value of
mortgage loans held for sale and pipeline loans. The fair value of the pipeline
loans and the forward commitments at December 31, 2002 and 2001, was a net gain
of $5.0 million and $4.1 million, respectively. Also, the Corporation had $305.8
million and $301.7 million of mortgage loans held for sale in the consolidated
balance sheets at December 31, 2002 and 2001, respectively. The mortgage loans
held for sale are carried on the consolidated balance sheet at the lower of cost
or fair value, with fair value determined based on the fixed prices of the
forward commitments or quoted market prices on uncommitted mortgage loans held
for sale.
Contingent Liabilities
There are legal proceedings pending against the Corporation in the ordinary
course of business. Although litigation is subject to many uncertainties and the
ultimate exposure with respect to these matters cannot be ascertained,
management believes, based upon discussions with legal counsel, that the
Corporation has meritorious defenses, and any ultimate liability would not have
a material adverse affect on the consolidated financial position or results of
operations of the Corporation.
NOTE 16 DERIVATIVE AND HEDGING ACTIVITIES:
Effective January 1, 2001, the Corporation adopted SFAS 133, which establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities.
All derivatives, whether designated in hedging relationships or not, are
required to be recorded on the balance sheet at fair value. If the derivative is
designated as a fair value hedge, the changes in the fair value of the
derivative and of the hedged item attributable to the hedged risk are recognized
in earnings. If the derivative is designated as a cash flow hedge, the effective
portions of changes in the fair value of the derivative are recorded in other
comprehensive income and are recognized in the income statement when the hedged
item affects earnings. Ineffective portions of changes in the fair value of cash
flow hedges are recognized in earnings.
The Corporation uses derivative instruments primarily to hedge the variability
in interest payments or protect the value of certain assets and liabilities
recorded on its consolidated balance sheet from changes in interest rates. The
contract or notional amount of a derivative is used to determine, along with the
other terms of the derivative, the amounts to be exchanged between the
counterparties. Because the contract or notional amount does not represent
amounts exchanged by the parties, it is not a measure of loss exposure related
to the use of derivatives nor of exposure to liquidity risk. The Corporation is
exposed to credit risk in the event of nonperformance by counterparties to
financial instruments. As the Corporation generally enters into transactions
only with high quality counterparties, no losses with counterparty
nonperformance on derivative financial instruments has occurred. Further, the
Corporation obtains collateral and uses master netting arrangements when
available. To mitigate counterparty risk, interest rate swap agreements
generally contain language outlining collateral pledging requirements for
76
each counterparty. Collateral must be posted when the market value exceeds
a certain threshold. The threshold limits are determined from the credit ratings
of each counterparty. Upgrades or downgrades to the credit ratings of either
counterparty would lower or raise the threshold limits. Market risk is the
adverse effect on the value of a financial instrument that results from a change
in interest rates, currency exchange rates, or commodity prices. The market risk
associated with interest rate contracts is managed by establishing and
monitoring parameters that limit the types and degree of market risk that may be
undertaken.
Interest rate swap contracts are entered into primarily as an asset/liability
management strategy to modify interest rate risk. Interest rate swap contracts
are exchanges of interest payments, such as fixed rate payments for floating
rate payments, based on a notional principal amount. Payments related to the
Corporation's swap contracts are made either monthly, quarterly, or
semi-annually by one of the parties depending on the specific terms of the
related contract. The primary risk associated with all swaps is the exposure to
movements in interest rates and the ability of the counterparties to meet the
terms of the contract. At December 31, 2002 and 2001, the Corporation had $854
million and $723 million, respectively, of interest rate swaps outstanding.
Included in this amount were $279 million and $123 million, respectively, at
December 31, 2002 and 2001, in receive variable/pay fixed interest rate swaps
used to convert fixed rate loans into floating rate assets. The remaining swap
contracts used for interest rate risk management of $575 million at December 31,
2002 and $600 million at December 31, 2001 were used to hedge interest rate risk
of various other specific liabilities. At December 31, 2002, the Corporation
pledged $24.0 million of collateral for swap agreements compared to $6.3 million
at December 31, 2001.
Weighted Average
Notional Fair Value -----------------------------------------
Amount Gain/(Loss) Receive Rate Pay Rate Maturity
------------ ---------------- --------------- ----------- -------------
December 31, 2002 ($ in Thousands)
- -----------------
Interest Rate Risk Management Hedges:
Swaps-receive variable/pay fixed (1), (3) $200,000 $(25,750) 1.77% 5.03% 101 months
Swaps-receive fixed/pay variable (2), (4) 375,000 24,757 7.21% 3.19% 223 months
Caps-written (1), (3) 200,000 2,513 Strike 4.72% --- 44 months
Swaps-receive variable/pay fixed (2), (5) 279,487 (14,806) 3.63% 6.52% 58 months
=======================================================================
December 31, 2001
- -----------------
Interest Rate Risk Management Hedges:
Swaps-receive variable/pay fixed (1), (3) $400,000 $(12,970) 2.42% 5.47% 61 months
Swaps-receive fixed/pay variable (2), (4) 200,000 (16,678) 6.85% 4.60% 117 months
Caps-written (1), (3) 200,000 9,456 Strike 4.72% --- 56 months
Swaps-receive variable / pay fixed (2), (5) 123,386 (828) 4.30% 7.06% 61 months
=======================================================================
(1) Cash flow hedges
(2) Fair value hedges
(3) Hedges variable rate long-term debt
(4) Hedges fixed rate long-term debt
(5) Hedges longer-term fixed rate commercial loans
Interest rate floors and caps are interest rate protection instruments that
involve the payment from the seller to the buyer of an interest differential.
This differential represents the difference between a short-term rate (e.g., six
month LIBOR) and an agreed upon rate (the strike rate) applied to a notional
principal amount. By buying a cap, the Corporation will be paid the differential
by a counterparty should the short-term rate rise above the strike level of the
agreement. The primary risk associated with purchased floors and caps is the
ability of the counterparties to meet the terms of the agreement. As of December
31, 2002 and 2001, the Corporation had purchased caps for asset/liability
management of $200 million.
In accordance with SFAS 133, the Corporation measures the effectiveness of its
hedges on a periodic basis. Any difference between the fair value change of the
hedge versus the fair value change of the hedged item is considered to be the
"ineffective" portion of the hedge. The ineffective portion of the
77
hedge is recorded as an increase or decrease in the related income
statement classification of the item being hedged. For the mortgage derivatives,
which are not accounted for as hedges, changes in the fair value are recorded as
an adjustment to mortgage banking income.
At December 31, 2002, the estimated fair value of the interest rate swaps and
the cap designated as cash flow hedges was a $23.2 million unrealized loss, or
$13.9 million, net of tax benefit of $9.3 million, carried as a component of
accumulated other comprehensive income. At December 31, 2001, the estimated fair
value of the interest rate swaps and the cap designated as cash flow hedges was
a $3.5 million unrealized loss, or $2.1 million, net of tax benefit of $1.4
million, carried as a component of accumulated other comprehensive income. These
instruments are used to hedge the exposure to the variability in interest
payments of variable rate liabilities. The ineffective portion of the hedges
recorded through the statements of income was immaterial. For the years ended
December 31, 2002 and 2001, the Corporation recognized interest expense of $13.4
million and $5.4 million, respectively, for interest rate swaps accounted for as
cash flow hedges. As of December 31, 2002, approximately $6.5 million of the
deferred net losses on derivative instruments that are recorded in accumulated
other comprehensive income are expected to be reclassified to interest expense
within the next twelve months. Currently, none of the existing amounts within
accumulated other comprehensive income are expected to be reclassified into
earnings for ineffectiveness during 2003.
At December 31, 2002 and 2001, the estimated fair value of the interest rate
swaps designated as fair value hedges was an unrealized gain of $10.0 million
and an unrealized loss of $17.5 million, respectively, carried as a component of
other liabilities. These swaps hedge against changes in the fair value of
certain loans and long-term debt.
The fair value of the mortgage derivatives at December 31, 2002, was a net gain
of $5.0 million, an increase of $0.9 million over the December 31, 2001, net
gain of $4.1 million, and is recorded in mortgage banking income. The $5.0
million net fair value of mortgage derivatives is comprised of the net loss on
commitments to sell approximately $538.3 million of loans to various investors
and the net gain on commitments to fund approximately $550.1 million of loans to
individual borrowers. The $4.1 million net fair value of mortgage derivatives is
composed of the net gain on commitments to sell approximately $650.5 million of
loans to various investors and commitments to fund approximately $590.8 million
of loans to individual borrowers.
The predominant activities affected by SFAS 133 include the Corporation's use of
interest rate swaps and certain mortgage banking activities. The adoption of the
statement in January 2001 included the following:
- - Under SFAS 133, the Corporation was allowed a one-time opportunity to
reclassify investment securities from held to maturity to available for
sale. Thus, upon adoption, the Corporation reclassified all its held to
maturity securities to available for sale securities. The amortized cost
and fair value of the securities transferred were $369 million and $373
million, respectively.
- - The Corporation designated its interest rate swaps existing at December 31,
2000, to qualify for hedge accounting. These swaps hedge the exposure to
variability in interest payments of variable rate liabilities. These hedges
represent cash flow hedges and were highly effective at adoption. On
adoption, the cumulative effect, net of taxes of $843,000, was recorded as
a decrease to accumulated other comprehensive income of $1.3 million.
- - The Corporation's commitments to sell groups of residential mortgage loans
that it originates or purchases as part of its mortgage banking operations,
as well as its commitments to originate residential mortgage loans, are
considered derivatives under SFAS 133. The fair value of these derivatives
at adoption, a $12,000 net gain, was recorded in mortgage banking income.
78
NOTE 17 PARENT COMPANY ONLY FINANCIAL INFORMATION:
Presented below are condensed financial statements for the parent company:
BALANCE SHEETS
2002 2001
------------------------
($ in Thousands)
ASSETS
Cash and due from banks $ 638 $ 614
Notes receivable from subsidiaries 281,258 201,759
Investment in subsidiaries 1,377,239 1,089,647
Other assets 101,304 59,005
------------------------
Total assets $1,760,439 $1,351,025
========================
LIABILITY AND STOCKHOLDERS' EQUITY
Long-term debt $ 403,880 $ 181,882
Accrued expenses and other liabilities 84,376 98,727
------------------------
Total liabilities 488,256 280,609
Stockholders' equity 1,272,183 1,070,416
------------------------
Total liabilities and stockholders' equity $1,760,439 $1,351,025
========================
STATEMENTS OF INCOME
For the Years Ended December 31,
----------------------------------
2002 2001 2000
----------------------------------
($ in Thousands)
INCOME
Dividends from subsidiaries $172,000 $ 90,000 $168,150
Management and service fees
from subsidiaries 35,346 26,482 20,617
Interest income on notes receivable 5,641 4,590 8,442
Other income 3,510 3,428 3,234
----------------------------------
Total income 216,497 124,500 200,443
----------------------------------
EXPENSE
Interest expense on borrowed funds 12,627 8,107 9,284
Provision for loan losses 500 (800) 2,000
Personnel expense 22,918 19,766 10,991
Other expense 15,191 11,379 11,565
----------------------------------
Total expense 51,236 38,452 33,840
----------------------------------
Income before income tax benefit
and equity in undistributed income 165,261 86,048 166,603
Income tax benefit (1,759) (48) (4,670)
----------------------------------
Income before equity in undistributed
net income of subsidiaries 167,020 86,096 171,273
Equity in undistributed net income
(loss) of subsidiaries 43,699 93,426 (3,290)
----------------------------------
Net income $210,719 $179,522 $167,983
==================================
79
STATEMENTS OF CASH FLOWS
For the Years Ended December 31,
----------------------------------
2002 2001 2000
----------------------------------
($ in Thousands)
OPERATING ACTIVITIES
Net income $210,719 $179,522 $167,983
Adjustments to reconcile net income
to net cash provided by operating
activities:
(Increase) decrease in equity in
undistributed net income of
subsidiaries (43,699) (93,426) 3,290
Depreciation and other amortization 335 439 476
Amortization of goodwill --- 397 420
Gain) loss on sales of assets, net 2 (8) (1,016)
Increase) decrease in interest
receivable and other assets (41,651) (6,763) 4,243
Increase (decrease) in interest
payable and other liabilities (14,351) 45,474 16,819
Capital received from (contributed
to) subsidiaries (12,997) 41,617 (24,832)
----------------------------------
Net cash provided by operating
activities 98,358 167,252 167,383
----------------------------------
INVESTING ACTIVITIES
Proceeds from sales of investment
securities --- --- 1,013
Purchase of available for sale
securities (319) --- ---
Net cash paid in acquisition of
subsidiary (78,055) --- ---
Net (increase) decrease in notes
receivable (79,551) (120,474) 36,195
Purchase of premises and equipment,
net of disposals (614) (134) (115)
----------------------------------
Net cash provided by (used in)
investing activities (158,539) (120,608) 37,093
----------------------------------
FINANCING ACTIVITIES
Net decrease in short-term borrowings --- (118,044) (38,856)
Net increase (decrease) in
long-term debt 221,998 181,882 (1,405)
Cash dividends paid (90,166) (80,553) (75,719)
Proceeds from exercise of stock
options 16,564 4,738 3,893
Purchase and retirement of treasury
stock (44,046) (7,717) (74,098)
Purchase of treasury stock (44,145) (26,852) (18,629)
-----------------------------------
Net cash provided by (used in)
financing activities 60,205 (46,546) (204,814)
-----------------------------------
Net increase (decrease) in cash
and cash equivalents 24 98 (338)
Cash and cash equivalents at
beginning of year 614 516 854
-----------------------------------
Cash and cash equivalents at
end of year $ 638 $ 614 $ 516
===================================
80
NOTE 18 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 on the
balance sheet at December 31 are as follows:
2002 2001
-----------------------------------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
-----------------------------------------------------
($ in Thousands)
Financial assets:
Cash and due from banks $ 430,691 $ 430,691 $ 587,994 $ 587,994
Interest-bearing deposits in other financial
institutions 5,502 5,502 5,427 5,427
Federal funds sold and securities purchased under
purchase under agreements to resell 8,820 8,820 12,015 12,015
Accrued interest receivable 74,077 74,077 77,289 77,289
Investment securities available for sale 3,362,669 3,362,669 3,197,021 3,197,021
Loans held for sale 305,836 317,942 301,707 302,597
Loans 10,303,225 10,650,774 9,019,864 9,277,269
Financial liabilities:
Deposits 9,124,852 9,225,812 8,612,611 8,667,356
Accrued interest payable 28,636 28,636 36,003 36,003
Short-term borrowings 2,389,607 2,389,607 2,643,851 2,643,851
Long-term debt 1,906,845 1,963,756 1,103,395 1,124,036
Company-obligated manditorily redeemable
preferred securities 190,111 206,662 --- ---
Interest rate swap and cap agreements (1) 13,286 13,286 21,020 21,020
Commitments to originate mortgage loans held for sale (7,141) (7,141) (779) (779)
Forward commitments to sell residential mortgage loans 2,095 2,095 (3,323) (3,323)
=====================================================
(1) At December 31, 2002 and 2001, the notional amount of interest rate swap
and cap agreements was $1.1 billion and $923 million, respectively. See
Notes 15 and 16 for information on the fair value of lending-related
off-balance sheet and derivative financial instruments.
Cash and due from banks, interest-bearing deposits in other financial
institutions, federal funds sold and securities purchased under agreements to
resell, and accrued interest receivable - 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. There were no investment securities held to maturity or trading
account securities at December 31, 2002 or 2001.
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. 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.
81
Deposits - The fair value of deposits with no stated maturity such as
noninterest-bearing demand deposits, savings, interest-bearing demand deposits,
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.
Accrued interest payable and short-term borrowings - For these short-term
instruments, the carrying amount is a reasonable estimate of fair value.
Long-term debt and Company-obligated mandatorily redeemable preferred securities
- - Rates currently available to the Corporation for debt with similar terms and
remaining maturities are used to estimate fair value of existing borrowings.
Interest rate swap and cap agreements - The fair value of interest rate swap and
cap agreements is obtained from dealer quotes. These values represent the
estimated amount the Corporation would receive or pay to terminate the
agreements, taking into account current interest rates and, when appropriate the
current creditworthiness of the counterparties.
Commitments to originate mortgage loans held for sale - The fair value of
commitments to originate mortgage loans held for sale is estimated by comparing
the Corporation's cost to acquire mortgages and the current price for similar
mortgage loans, taking into account the terms of the commitments and the credit
worthiness of the counterparties.
Forward commitments to sell residential mortgage loans - The fair value of
forward commitments to sell residential mortgage loans is the estimated amount
that the Corporation would receive or pay to terminate the forward delivery
contract at the reporting date based on market prices for similar financial
instruments.
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.
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, 2002, that the
Corporation meets all capital adequacy requirements to which it is subject.
82
As of December 31, 2002 and 2001, the most recent notifications from the Office
of the Comptroller of the Currency and the Federal Deposit Insurance Corporation
categorized the subsidiary banks as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well capitalized
the subsidiary banks 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
institutions' category.
The actual capital amounts and ratios of the Corporation and its significant
subsidiaries are presented below. No deductions from capital were made for
interest rate risk in 2002 or 2001. The increase in the Tier 1 and total
risk-based capital ratios for 2002 compared to 2001 is primarily attributable to
the company-obligated mandatorily redeemable preferred securities issued in 2002
which qualify as Tier 1 capital.
To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions: (2)
------------------------ --------------------------- --------------------------
Amount Ratio (1) Amount Ratio (1) Amount Ratio (1)
------------ ----------- -------------- ------------ ------------ ------------
($ In Thousands)
As of December 31, 2002:
- ------------------------
Associated Banc-Corp
- --------------------
Total Capital $1,513,424 13.66% $886,289 =>8.00%
Tier I Capital 1,165,481 10.52 443,144 =>4.00
Leverage 1,165,481 7.94 587,214 =>4.00
Associated Bank, N.A.
- ---------------------
Total Capital 790,198 10.70 591,075 =>8.00 $738,844 =>10.00%
Tier I Capital 692,207 9.37 295,538 =>4.00 443,306 => 6.00
Leverage 692,207 7.03 394,070 =>4.00 492,588 => 5.00
Associated Bank Illinois, N.A.
- ------------------------------
Total Capital 173,249 10.98 126,178 =>8.00 157,722 =>10.00
Tier I Capital 159,735 10.13 63,089 =>4.00 94,633 => 6.00
Leverage 159,735 5.99 106,731 =>4.00 133,413 => 5.00
Associated Bank Minnesota, N.A.
- -------------------------------
Total Capital 157,299 11.22 112,132 =>8.00 140,165 =>10.00
Tier I Capital 139,730 9.97 56,066 =>4.00 84,099 => 6.00
Leverage 139,730 8.46 66,086 =>4.00 82,608 => 5.00
As of December 31, 2001:
- -----------------------
Associated Banc-Corp
- --------------------
Total Capital $1,253,036 13.15% $762,217 =>8.00%
Tier I Capital 924,871 9.71 381,109 =>4.00
Leverage 924,871 7.03 526,084 =>4.00
Associated Bank, N.A.
- ---------------------
Total Capital 736,991 10.60 556,337 =>8.00 $695,421 =>10.00%
Tier I Capital 645,700 9.29 278,168 =>4.00 417,252 => 6.00
Leverage 645,700 6.88 375,540 =>4.00 469,425 => 5.00
Associated Bank Illinois, N.A.
- ------------------------------
Total Capital 177,293 12.30 115,277 =>8.00 144,096 =>10.00
Tier I Capital 163,925 11.38 57,639 =>4.00 86,458 => 6.00
Leverage 163,925 6.46 101,544 =>4.00 126,931 => 5.00
(1) Total Capital ratio is defined as Tier 1 Capital plus Tier 2 Capital
divided by total risk-weighted assets. The Tier 1 Capital ratio is defined
as Tier 1 capital divided by total risk-weighted assets. The leverage ratio
is defined as Tier 1 capital divided by the most recent quarter's average
total assets.
(2) Prompt corrective action provisions are not applicable at the bank holding
company level.
83
NOTE 20 EARNINGS PER SHARE:
Basic earnings per share is calculated by dividing net income by the weighted
average number of common shares outstanding. Diluted earnings per share is
calculated by dividing net income by the weighted average number of shares
adjusted for the dilutive effect of outstanding stock options.
On April 24, 2002, the Board of Directors declared a 10% stock dividend, payable
May 15 to shareholders of record at the close of business on April 29. All share
and per share data in the accompanying consolidated financial statements has
been adjusted to reflect the declaration of the 10% stock dividend. As a result
of the stock dividend, the Corporation distributed approximately 7.0 million
shares of common stock. Any fractional shares resulting from the dividend were
paid in cash.
Presented below are the calculations for basic and diluted earnings per share as
reported, as well as adjusted to exclude the amortization of goodwill affected
by adopting SFAS 142 and SFAS 147.
For the Years Ended December 31,
---------------------------------------
2002 2001 2000
---------------------------------------
($ in Thousands, except per share data)
Net income, as reported $210,719 $179,522 $167,983
Adjustment: Goodwill amortization,
net of tax --- 6,158 5,961
---------------------------------------
Net income, adjusted $210,719 $185,680 $173,944
=======================================
Weighted average shares outstanding 74,685 72,587 75,005
Effect of dilutive stock options
outstanding 808 580 246
---------------------------------------
Diluted weighted average shares
outstanding 75,493 73,167 75,251
=======================================
Basic earnings per share:
Basic earnings per share, as reported $ 2.82 $ 2.47 $ 2.24
Adjustment: Goodwill amortization,
net of tax --- 0.09 0.08
---------------------------------------
Basic earnings per share, adjusted $ 2.82 $ 2.56 $ 2.32
=======================================
Diluted earnings per share:
Diluted earnings per share,
as reported $ 2.79 $ 2.45 $ 2.23
Adjustment: Goodwill amortization,
net of tax --- 0.09 0.08
---------------------------------------
Diluted earnings per share, adjusted $ 2.79 $ 2.54 $ 2.31
=======================================
NOTE 21 SEGMENT REPORTING
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," requires selected financial and descriptive information about
reportable operating segments. The statement uses a "management approach"
concept as the basis for identifying reportable segments. The management
approach is based on the way that management organizes the segments within the
enterprise for making operating decisions, allocating resources, and assessing
performance. Consequently, the segments are evident from the structure of the
enterprise's internal organization, focusing on financial information that an
enterprise's chief operating decision-makers use to make decisions about the
enterprise's operating matters.
The Corporation's primary segment is banking, conducted through its bank and
lending subsidiaries. For purposes of segment disclosure under this statement,
these have been combined as one segment, as these segments have similar economic
characteristics and the nature of their products, services, processes,
customers, delivery channels, and regulatory environment are similar. Banking
includes: a) community banking - lending and deposit gathering to businesses
(including business-related services such as cash management and international
banking services) and to consumers (including mortgages and credit cards); and
b) corporate banking - specialized lending (such as commercial real estate),
lease financing, and banking to larger businesses and metro or niche markets;
and the support to deliver banking services.
84
The "Other" segment is comprised of Wealth Management (including insurance,
brokerage, and trust/asset management), as well as intersegment eliminations and
residual revenues and expenses, representing the difference between actual
amounts incurred and the amounts allocated to operating segments.
The accounting policies of the segments are the same as those described in Note
1. Selected segment information is presented below.
Consolidated
Banking Other Total
------------------------------------------
($ in Thousands)
2002
Net interest income $ 501,244 $ 22 $ 501,266
Provision for loan losses 50,699 --- 50,699
Noninterest income 190,489 29,819 220,308
Depreciation and amortization 51,230 222 51,452
Other noninterest expense 302,858 20,239 323,097
Income taxes 86,345 (738) 85,607
-----------------------------------------
Net income $ 200,601 $ 10,118 $ 210,719
=========================================
Goodwill $ 212,112 $ --- $ 212,112
Total assets $15,015,136 $ 28,139 $15,043,275
=========================================
2001
Net interest income $ 421,253 $ 732 $ 421,985
Provision for loan losses 28,210 --- 28,210
Noninterest income 164,991 30,612 195,603
Depreciation and amortization 46,616 365 46,981
Other noninterest expense 259,551 31,837 291,388
Income taxes 71,893 (406) 71,487
-----------------------------------------
Net income (loss) $ 179,974 $ (452) $ 179,522
=========================================
Goodwill $ 92,397 $ --- $ 92,397
Total assets $13,578,328 $ 26,046 $13,604,374
=========================================
2000
Net interest income $ 382,749 $ 818 $ 383,567
Provision for loan losses 20,206 --- 20,206
Noninterest income 142,307 41,889 184,196
Depreciation and amortization 37,313 394 37,707
Other noninterest expense 247,323 32,706 280,029
Income taxes 57,895 3,943 61,838
-----------------------------------------
Net income $ 162,319 $ 5,664 $ 167,983
=========================================
Goodwill $ 98,908 $ --- $ 98,908
Total assets $13,103,429 $ 24,965 $13,128,394
=========================================
85
INDEPENDENT AUDITORS' REPORT
ASSOCIATED BANC-CORP
The Board of Directors
Associated Banc-Corp:
We have audited the accompanying consolidated balance sheets of Associated
Banc-Corp and subsidiaries as of December 31, 2002 and 2001, 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, 2002.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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 Associated Banc-Corp
and subsidiaries as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2002 in conformity with accounting principles generally
accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, the Company
changed its method of accounting for goodwill in 2002.
[GRAPHIC OMITTED][GRAPHIC OMITTED]
Chicago, Illinois
January 16, 2003
86
Market Information
Market Price Range
Sales Prices
----------------------------------
Dividends Paid Book Value High Low Close
---------------- ------------- ---------- ----------- -----------
2002
4th Quarter $.31 $17.13 $34.21 $27.20 $33.94
3rd Quarter .31 17.03 36.96 30.64 31.73
2nd Quarter .31 16.84 38.25 33.63 37.71
1st Quarter .28 16.23 35.29 30.37 34.57
- ---------------------------------------------------------------------------------------------
2001
4th Quarter $.28 $14.89 $32.71 $28.89 $32.08
3rd Quarter .28 14.90 33.55 27.12 30.81
2nd Quarter .28 14.45 32.72 28.75 32.72
1st Quarter .26 14.08 32.90 27.05 30.23
- ---------------------------------------------------------------------------------------------
Annual dividend rate: $1.24
Market information has been restated for the 10% stock dividend declared April
24, 2002, paid on May 15, 2002, to shareholders of record at the close of
business on April 29, 2002.
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 2003 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 2003 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 2003 Annual Meeting of Shareholders, which contains information concerning
this item, under the captions "Stock Ownership," and "Equity Compensation Plan
Information," is incorporated herein by reference.
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information in the Corporation's definitive Proxy Statement, prepared for
the 2003 Annual Meeting of Shareholders, which contains information concerning
this item under the caption "Interest of Management in Certain Transactions," is
incorporated herein by reference.
87
ITEM 14 CONTROLS AND PROCEDURES
We maintain a system of internal controls and procedures designed to provide
reasonable assurance as to the reliability of our published financial statements
and other disclosures included in this report. Within the 90-day period prior to
the date of this report, we evaluated the effectiveness of the design and
operation of our disclosure controls and procedures pursuant to Rule 13a-14 of
the Securities Exchange Act of 1934. Based upon that evaluation, our Chief
Executive Officer and our Chief Financial Officer concluded that our disclosure
controls and procedures are effective in timely alerting them to material
information relating to the Corporation required to be included in this annual
report on Form 10-K.
There have been no significant changes in our internal controls or in other
factors which could significantly affect internal controls subsequent to the
date that we carried out our evaluation.
PART IV
ITEM 15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1 and 2 Financial 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 Balance Sheets - December 31, 2002 and 2001
Consolidated Statements of Income - For the Years Ended December 31, 2002,
2001, and 2000
Consolidated Statements of Changes in Stockholders' Equity - For the Years
Ended December 31, 2002, 2001, and 2000
Consolidated Statements of Cash Flows - For the Years Ended December 31,
2002, 2001, and 2000
Notes to Consolidated Financial Statements
Independent Auditors' Report
(a) 3 Exhibits Required by Item 601 of Regulation S-K
Sequential Page Number or
Exhibit Number Description Incorporate by Reference to
- --------------------------- -------------------------------------------------- ---------------------------------------------
(3)(a) Articles of Incorporation Exhibit (3)(a) to Report on Form 10-K for
fiscal year ended December 31, 1999
(3)(b) Bylaws Exhibit (3)(b) to Report on Form 10-K for
fiscal year ended December 31, 1999
(4) Instruments 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
88
Sequential Page Number or
Exhibit Number Description Incorporate by Reference to
- --------------------------- -------------------------------------------------- ---------------------------------------------
*(10)(a) The 1982 Incentive Stock Option Plan of the Exhibit (10) to Report on Form 10-K for
Registrant fiscal year ended December 31, 1987
*(10)(b) The Restated Long-Term Incentive Stock Plan Exhibits filed with Associated's
of the Registrant registration statement (333-46467) on Form
S-8 filed under the Securities Act of 1933
*(10)(c) Change of Control Plan of the Registrant Exhibit (10)(d) to Report on Form 10-K for
effective April 25, 1994 fiscal year ended December 31, 1994
*(10)(d) Deferred Compensation Plan and Deferred Exhibit (10)(e) to Report on Form 10-K for
Compensation Trust effective as of December fiscal year ended December 31, 1994
16, 1993, and Deferred Compensation Agreement
of the Registrant dated December 31, 1994
*(10)(e) Incentive Compensation Agreement (form) and Exhibit (10)(e) to Report on Form 10-K for
schedules dated as of October 1, 2001 fiscal year ended December 31, 2001
*(10)(f) Retirement Agreement between Associated Exhibit (10)(f) to Report on Form 10-K for
Banc-Corp and Harry B. Conlon effective April fiscal year ended December 31, 2001
26, 2000
(11) Statement Re Computation of Per Share Earnings See Note 20 in Part II Item 8
(21) Subsidiaries of the Corporation Filed herewith
(23) Consent of Independent Auditors Filed herewith
(24) Power of Attorney Filed herewith
(99)(a) Certification by the Chief Executive Officer Filed herewith
and Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(99)(b) Certification Under Section 302 of the Filed herewith
Sarbanes-Oxley Act of 2002 by Robert C.
Gallagher, Chief Executive Officer
(99)(c) Certification Under Section 302 of the Filed herewith
Sarbanes-Oxley Act of 2002 by Joseph B.
Selner, Chief Financial Officer
* 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
None.
89
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.
ASSOCIATED BANC-CORP
Date: March 20, 2003 By: /s/ ROBERT C. GALLAGHER
---------------------------------
Robert C. Gallagher
Chairman of the Board, President, and
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/ ROBERT C. GALLAGHER /s/ William R. Hutchinson *
------------------------------ -------------------------------
Robert C. Gallagher William R. Hutchinson
Chairman of the Board, President, and Director
Chief Executive Officer
/s/ JOSEPH B. SELNER /s/ Dr. George R. Leach *
------------------------------ -------------------------------
Joseph B. Selner Dr. George R. Leach
Chief Financial Officer Director
Principal Financial Officer and
Principal Accounting Officer
/s/ H.B. Conlon * /s/ John C. Meng *
------------------------------ -------------------------------
H. B. Conlon John C. Meng
Director Director
/s/ Robert S. Gaiswinkler * /s/ J. Douglas Quick *
------------------------------ -------------------------------
Robert S. Gaiswinkler J. Douglas Quick
Director Director
/s/ Ronald R. Harder * /s/ John C. Seramur *
------------------------------ -------------------------------
Ronald R. Harder John C. Seramur
Director Vice Chairman
* /s/ BRIAN R. BODAGER /s/ John H. Sproule *
------------------------------ -------------------------------
Brian R. Bodager John H. Sproule
Attorney-in-Fact Director
Date: March 20, 2003