UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 -------------------------- FORM 10-Q (Mark one) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1998 [ ] 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 - 9676 FIRST COMMERCIAL CORPORATION (Exact name of registrant as specified in its charter) ARKANSAS 71-0540166 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 400 WEST CAPITOL AVENUE, LITTLE ROCK, ARKANSAS 72201 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (501)371-7000 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 the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practical date. Class Outstanding at March 31, 1998 --------------------------------------- -------------------------------- Common Stock, $3.00 par value per share 37,603,692 TABLE OF CONTENTS Item Page ---- ---- PART I - FINANCIAL INFORMATION 1. Financial Statements (Unaudited)............................. 1 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................... 10 3. Quantitative and Qualitative Disclosures about Market Risk... 20 PART II - OTHER INFORMATION 1. Legal Proceedings............................................ 20 6. Exhibits and Reports on Form 8-K............................. 20 Signatures............................................................. 21 1 PART I - FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS FIRST COMMERCIAL CORPORATION Unaudited CONSOLIDATED BALANCE SHEETS March 31, December 31, (Dollars in thousands, except par value) -------------- -------------- 1998 1997 -------------- -------------- ASSETS Cash and due from banks................................................... $ 447,245 $ 397,361 Federal funds sold........................................................ 237,220 173,794 -------------- -------------- Total cash and cash equivalents.......................................... 684,465 571,155 Investment securities held-to-maturity, estimated market value $341,105 and $410,620 respectively................................. 338,877 408,683 Investment securities available-for-sale.................................. 1,413,171 1,309,955 Trading account securities................................................ 516 149 Loans and leases, net of unearned income.................................. 4,643,100 4,317,631 Allowance for possible loan and lease losses.............................. (86,879) (79,970) -------------- -------------- Net loans and leases..................................................... 4,556,221 4,237,661 Bank premises and equipment, net.......................................... 136,015 124,872 Other real estate owned, net of allow for possible losses of $1 and $2, respectively............................................................. 6,917 5,658 Other assets.............................................................. 245,907 229,119 -------------- -------------- Total assets........................................................... $ 7,382,089 $ 6,887,252 ============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY Non-interest bearing transaction accounts................................. $ 1,110,616 $ 1,222,660 Interest bearing transaction and savings accounts......................... 2,256,228 1,983,803 Certificates of deposit $100,000 and over................................. 665,239 727,000 Other time deposits....................................................... 2,297,488 2,014,227 -------------- -------------- Total deposits........................................................... 6,329,571 5,947,690 Short-term borrowings..................................................... 314,329 203,185 Other liabilities and deferred income taxes............................... 78,866 80,161 Long-term debt............................................................ 23,394 5,103 -------------- -------------- Total liabilities........................................................ 6,746,160 6,236,139 Stockholders' equity Preferred stock, $1 par value, 400,000 shares authorized, none issued.... -- -- Common stock, $3 par value, 50,000,000 shares authorized, 37,612,842 and 37,578,681 shares issued, respectively................... 112,839 112,736 Capital surplus.......................................................... 330,135 359,629 Retained earnings........................................................ 191,359 174,423 Accumulated other comprehensive income, net of taxes Unrealized net gains on available-for-sale securities................... 2,222 4,325 Less treasury stock at cost, 9,150 and -0- shares, respectively.......... (626) -- -------------- -------------- Total stockholders' equity.............................................. 635,929 651,113 -------------- -------------- Total liabilities and stockholders' equity............................. $ 7,382,089 $ 6,887,252 ============== ============== See accompanying notes. 2 FIRST COMMERCIAL CORPORATION CONSOLIDATED INCOME STATEMENTS (Dollars in thousands, except per share data) Unaudited Three Months Ended March 31, ---------------------- 1998 1997 ---------- ---------- Interest income Loans and leases, including fees................... $ 95,962 $ 95,226 Short-term investments............................. 2,238 2,249 Investment securities-taxable...................... 21,890 22,406 -nontaxable................... 2,925 3,037 Trading account securities......................... (1) 12 ---------- ---------- Total interest income............................ 123,014 122,930 Interest expense Interest on deposits............................... 49,777 51,236 Short-term borrowings.............................. 2,741 2,502 Long-term debt..................................... 99 420 ---------- ---------- Total interest expense........................... 52,617 54,158 Net interest income................................... 70,397 68,772 Provision for possible loan and lease losses.......... 2,051 2,842 ---------- ---------- Net interest income after provision for possible loan and lease losses................. 68,346 65,930 Other income Trust department income............................ 4,161 3,238 Mortgage servicing fee income...................... 8,849 9,774 Broker-dealer operations income.................... 1,696 1,243 Service charges on deposit accounts................ 8,003 8,112 Other service charges and fees..................... 4,078 3,932 Investment securities gains (losses), net.......... 154 10 Other real estate gains (losses), net.............. (76) (354) Other.............................................. 2,687 1,970 ---------- ---------- Total other income............................... 29,552 27,925 Other expenses Salaries, wages and employee benefits.............. 28,922 28,880 Net occupancy...................................... 3,735 3,931 Equipment.......................................... 3,907 3,925 FDIC insurance..................................... 267 (48) Amortization of mortgage servicing rights.......... 2,193 4,243 Other.............................................. 17,910 18,215 ---------- ---------- Total other expenses............................. 56,934 59,146 Income before income taxes......................... 40,964 34,709 Income tax provision............................... 13,656 12,148 ---------- ---------- Net income....................................... $ 27,308 $ 22,561 ========== ========== 3 FIRST COMMERCIAL CORPORATION CONSOLIDATED INCOME STATEMENTS (Continued) (Dollars in thousands, except per share data) Unaudited Three Months Ended March 31, ---------------------- 1998 1997 ---------- ---------- Weighted average number of common shares outstanding - Basic................... 37,318,092 37,432,824 Dilutive potential common shares...................... 525,543 430,330 ---------- ---------- Weighted average number of common shares - assuming dilution................................... 37,843,635 37,863,154 ========== ========== Basic earnings per common share....................... $ 0.73 $ 0.60 ========== ========== Diluted earnings per common share..................... $ 0.72 $ 0.60 ========== ========== See accompanying notes. 4 FIRST COMMERCIAL CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Dollars in thousands, except per share data) Accumulated Other Common Retained Comprehensive Treasury Stock Surplus Earnings Income (Loss) Stock Total --------- --------- --------- ------------- --------- --------- Balance - December 31, 1996............ $ 101,618 $ 263,090 $ 191,813 $ 1,079 $ -- $ 557,600 Comprehensive income Net income............................ 22,561 22,561 Other comprehensive income, net of taxes Unrealized gain (loss) on available- for-sale (AFS) securities........... (5,256) (5,256) --------- Total comprehensive income....... 17,305 --------- Cash dividends-$.23 per common share... (9,691) (9,691) Stock options exercised................ 85 111 196 Purchase of treasury stock, 91 shares.. (2) (2) Purchase of minority shares of Springhill Bank & Trust Company, 253 shares........................... 1 10 2 13 Acquisition of W.B.T. Holding Company, Inc., 1,430,050 shares..................... 4,087 14,524 214 18,825 Acquisition of City National Bank, 152,752 shares..................... 436 1,289 14 1,739 Acquisition of First Charter Bancshares, Inc., 277,439 shares..................... 792 (487) 5,109 5,414 ---------- ---------- --------- ------------- --------- --------- Balance - March 31, 1997...............$ 107,019 $ 264,013 $ 224,330 $ (3,963) -- $ 591,399 ========== ========== ========= ============= ========= ========= Balance - December 31, 1997............$ 112,736 $ 359,629 $ 174,423 $ 4,325 $ -- $ 651,113 Comprehensive income Net income............................ 27,308 27,308 Other comprehensive income, net of taxes Unrealized gain (loss) on AFS securities ($2,145), net of reclassification adjustment for income(loss) included in net income of ($42) (2,103) (2,103) --------- Total comprehensive income....... 25,205 --------- Cash dividends-$.28 per common share... (10,372) (10,372) Stock options exercised................ 103 412 515 Purchase of treasury stock for use in Kemmons Wilson, Inc. acquisition, 1,125,000 shares...................... (74,270) (74,270) Acquisition of Kemmons Wilson, Inc. 1,115,850 shares...................... (29,906) 73,644 43,738 ---------- ---------- --------- ------------- --------- --------- Balance - March 31, 1998................$ 112,839 $ 330,135 $ 191,359 $ 2,222 $ (626)$ 635,929 ========== ========== ========= ============= ========= ========= See accompanying notes. 5 FIRST COMMERCIAL CORPORATION Unaudited CONSOLIDATED STATEMENTS OF CASH FLOW Three Months Ended (Dollars in thousands) March 31, ----------------------- 1998 1997 ---------- ---------- OPERATING ACTIVITIES Net income......................................................................... $ 27,308 $ 22,561 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization..................................................... 6,360 8,429 Provision for possible loan and lease losses...................................... 2,051 2,842 Gain on sale of available-for-sale investment securities.......................... (154) (10) Gain on sale of equipment......................................................... (26) (6) Loss (gain) on sale of other real estate.......................................... (531) 26 Write downs of other real estate.................................................. 111 11 Equity in undistributed earnings of unconsolidated subsidiary..................... (510) (146) Decrease (increase) in trading securities......................................... (374) 171 Realized loss on trading securities............................................... 7 -- Decrease (increase) in mortgage loans held for resale............................. (22,929) 2,939 Increase in income taxes payable.................................................. 7,484 11,879 Decrease (increase) in interest and other receivables............................. 3,536 (240) Decrease in interest payable...................................................... (335) (1,685) Increase (decrease) in accrued expenses........................................... (19,869) 1,100 Increase in prepaid expenses...................................................... (182) (438) ---------- ---------- Net cash provided by operating activities........................................ 1,947 47,433 INVESTING ACTIVITIES Proceeds from sales of investment securities available-for-sale.................... 152,991 80 Proceeds from maturing investment securities available-for-sale.................... 605,879 211,179 Proceeds from maturing investment securities held-to-maturity...................... 133,683 91,535 Purchases of investment securities available-for-sale.............................. (853,037) (184,849) Purchases of investment securities held-to-maturity................................ (59,968) (94,607) Purchase of institutions, net of funds acquired.................................... 42,935 32,362 Net (increase) decrease in loans and leases........................................ 21,261 (48,769) Capital expenditures............................................................... (4,432) (3,561) Proceeds from sale of bank premises and equipment.................................. 742 263 Purchased mortgage servicing rights and changes in other assets, net............... 7,916 1,961 Proceeds from sales of other real estate........................................... 1,901 675 ---------- ---------- Net cash provided by investing activities......................................... 49,871 6,269 6 FIRST COMMERCIAL CORPORATION Unaudited CONSOLIDATED STATEMENTS OF CASH FLOW (continued) Three Months Ended (Dollars in thousands) March 31, ----------------------- 1998 1997 ---------- ---------- FINANCING ACTIVITIES Net increase (decrease) in demand deposits, NOW accounts, and savings accounts..... 47,130 (179,777) Net increase (decrease) in time deposits........................................... (647) 17,785 Net increase in short-term borrowings.............................................. 99,144 4,967 Proceeds from long-term borrowings................................................. 3 -- Repayment of long-term debt........................................................ (11) (6,062) Purchase of treasury stock......................................................... (74,270) (2) Sale of treasury stock............................................................. -- 2 Stock options exercised............................................................ 515 196 Cash dividends paid on common stock................................................ (10,372) (9,691) ---------- ---------- Net cash provided by (used in) financing activities............................... 61,492 (172,582) Net increase (decrease) in cash and cash equivalents............................... 113,310 (118,880) Cash and cash equivalents at the beginning of year................................. 571,155 654,830 ---------- ---------- Cash and cash equivalents at end of period......................................... $ 684,465 $ 535,950 ========== ========== See accompanying notes. 7 FIRST COMMERCIAL CORPORATION NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998 1.	There have been no significant changes in the accounting policies of the Company since December 31, 1997, the date of the most recent annual report on Form 10-K, except as disclosed in Note 7, nor have there occurred events, except as disclosed in Notes 4, 5 and 6, which have had a material impact on the disclosures contained therein. 2.	In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly the financial position as of March 31, 1998, and the results of operations and changes in cash flows for the three months then ended. Any adjustments consist only of normal recurring accruals. 3.	Cash payments for interest were approximately $50.9 million and $55.8 million for the first quarter of 1998 and 1997, respectively. Cash payments for income taxes during the first quarter of 1998 and 1997 were approximately $700 thousand and $970 thousand, respectively. 4.	Aearth Development, Inc. v. First Commercial Bank, N.A. 	------------------------------------------------------- 	First Commercial Bank, N.A., a wholly owned subsidiary of Registrant, is the defendant in litigation initiated in 1989 seeking approximately $200 million in compensatory damages plus punitive damages. Plaintiffs in the litigation allege fraudulent conspiracy, fraudulent misrepresentation, tortious interference with a business expectancy, breach of contract, willful breach of fiduciary duty, interference with performance of contract, securities law violations, conversion, prima facie tort and violations of the Federal Racketeer Influenced and Corrupt Organizations Act as a basis for trebled damages. In June of 1991, the matter was tried before a chancery judge in Chancery Court in Pulaski County, Arkansas, and on June 5, 1992, the complaint was dismissed and no damages were assessed against First Commercial Bank, N.A. Plaintiffs appealed this decision to the Supreme Court of Arkansas in July of 1992, alleging error for failure to try the case before a jury in Circuit Court. On July 18, 1994, the Supreme Court of Arkansas remanded the case to Circuit Court in Pulaski County, Arkansas, for jury trial. A jury trial was held, which concluded March 13, 1996, with the jury awarding plaintiffs a total of $12.5 million compensatory damages and $10.0 million punitive damages. After a setoff pertaining to monies owed by Aearth Development, Inc., and related interests, to First Commercial Bank, N.A., and a Remittitur reducing the punitive damages awarded in the judgment by $7.0 million, the final award was $8.2 million. On June 27, 1996, First Commercial Bank, N.A., filed a Notice of Appeal to the Supreme Court of Arkansas. On April 30, 1998, the Arkansas Supreme Court reversed the judgment and dismissed the case. First Commercial Bank, N.A. is uncertain if any additional appeals or motions might be attempted, but believes the impact of this matter will not have a materially adverse effect on the Company's financial position. However, if any substantial loss were to occur as a result of this litigation it could have a material adverse impact upon results of operations in the fiscal quarter and/or year in which it were to be incurred, but the Company cannot estimate the range of any reasonably possible loss. 8 FIRST COMMERCIAL CORPORATION NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998 5. On February 8, 1998, the Company and Regions Financial Corporation ("Regions") entered into a definitive agreement that provides for the merger of the Company into Regions. Following the merger, Regions will have assets of $32.8 billion and 667 banking locations in nine southern states. Under the terms of the agreement, Regions will exchange 1.7 shares of its common stock for each share of the Company's common stock. Based on Regions' closing stock price on February 6, 1998, the transaction would be valued at approximately $2.7 billion. The merger, which is expected to be a tax-free reorganization for federal income tax purposes and accounted for as a pooling of interests, is expected to be consummated during the third quarter of 1998, pending Regions and Company shareholder approval, regulatory approval and other customary conditions of closing. Approximately 65.9 million shares of Regions' common stock are expected to be issued in the transaction. In connection with the execution of the definitive agreement, the Company granted Regions an option to purchase, under certain circumstances, up to 19.9% of the Company's outstanding shares of common stock. 6. On March 25, 1998, the Company acquired all of the outstanding shares of Kemmons Wilson, Inc., in exchange for 1,115,850 shares of the Company's common stock. The Company used treasury shares it had acquired during the first quarter of 1998 for the expressed intent of this acquisition. Kmmons Wilson, Inc., which name the Company changed to KWB Holdings, Inc., was the parent company of KW Bancshares, Inc., which owned Federal Savings Bank headquartered in Rogers, Arkansas. Federal Savings Bank had assets of $393 million and serviced approximately $1 billion in residential mortgage loans. This transaction was accounted for as a purchase. The Company recorded costs in excess of fair value of the net assets acquired of $41.9 million, which will be amortized over 25 years using the straight-line method. 7. In June 1997, the Financial Accounting Standards Board issued Statement 130, "Reporting Comprehensive Income." This Statement establishes new rules for the reporting and display of comprehensive income and its components. As of January 1, 1998, the Company adopted Statement 130 and the adoption of this Statement had no impact on the Company's net income or stockholders' equity. Statement 130 requires unrealized gains or losses on the Company's available-for-sale securities, which prior to adoption were reported separately in stockholders' equity, to be included in other comprehensive income. Prior year financial statements have been reclassified to conform to the requirements of Statement 130. 8. Long-term debt Long-term debt increased during the first quarter of 1998 primarily due to the addition of an $18.3 million note through the acquisition of Kemmons Wilson, Inc. This note is payable to Mercantile Bank with interest rates floating at 30-day London InterBank Offered Rate plus 1.25%. The terms include quarterly principal and interest payments with the remaining balance due at maturity of December 31, 2000. 9 9. Earnings per share The following table sets forth the computation of basic and diluted earnings per share ("EPS"): Three Months Ended March 31, (Dollars in Thousands, Except Per Share) 1998 1997 ---------- ---------- Numerator: Net income $ 27,308 $ 22,561 Preferred stock dividends................ - - Effect of dilutive securities............ - - ---------- ---------- Numerator for basic and diluted EPS...... $ 27,308 $ 22,561 ========== ========== Denominator: Denominator for basic EPS-weighted shares outstanding...................... 37,318,092 37,432,824 Effect of dilutive securities: Employee stock options.................. 525,543 430,330 ---------- ---------- Denominator for diluted EPS-adjusted weighted average shares and assumed conversion.............................. 37,843,635 37,863,154 ========== ========== Basic earnings per common share........... $ 0.73 $ 0.60 ========== ========== Diluted earnings per common share......... $ 0.72 $ 0.60 ========== ========== 10 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS --------------------- 	First Commercial Corporation ("Registrant" or the "Company") is a multi- bank holding company headquartered in Little Rock, Arkansas. The Company operates 17 institutions in the state of Arkansas, seven institutions in the state of Texas, one institution in the state of Tennessee, and one institution in the state of Louisiana. In a joint venture with Arvest Bank Group, Inc., of Bentonville, Arkansas, the Company owns 50% of two institutions in the state of Oklahoma. The Company's consolidated assets at March 31, 1998, totaled $7.4 billion. On February 8, 1998, the Company and Regions Financial Corporation ("Regions") entered into an Agreement and Plan of Merger (the "Agreement"), pursuant to which the Company will be merged with and into Regions, with Regions as the surviving entity (the "Merger"). The Boards of Directors of the Company and Regions approved the Agreement and the transactions contemplated thereby at separate meetings held on February 8, 1998. A joint press release was issued by the Company and Regions on February 9, 1998 regarding the proposed transactions. Under the terms of the Agreement, Regions will exchange 1.7 shares of its common stock for each share of the Company's common stock. The Merger is expected to be a tax-free reorganization for federal income tax purposes and accounted for as a pooling of interests. It is expected that the Merger will be consummated during the third quarter of 1998, pending approval by the shareholders of the Company and Regions, regulatory approval and other customary conditions of closing. The Agreement contains provisions granting the Company the right to terminate the Agreement which are intended, in general, to protect the Company's shareholders against an excessive decline in the value of Regions' common stock. The termination right is dependent upon the average closing price of Regions' common stock being less than 80% of a reference price and less than 85% of a weighted index of the stock prices of a group of seventeen bank holding companies, all as described more specifically in the Agreement. In the event the Company gives notice of its intention to terminate the Agreement based on such provisions, Regions has the right to elect to adjust the exchange ratio in accordance with the terms of the Agreement and thereby would extinguish the Company's right to terminate. In connection with the Agreement, the Company entered into a Stock Option Agreement pursuant to which it granted to Regions an option to purchase up to 7,480,450 shares of the Company's common stock, representing 19.9% of the outstanding shares of the Company's common stock without giving effect to the exercise of the option. The option is exercisable at a purchase price of $59.00 per share, upon certain terms and in accordance with certain conditions. Under the terms of the Agreement, the Total Profit and the Notional Total Profit, as each term is defined in the Agreement, that Regions or any other holder may realize as a result of exercising the option may not exceed $130,000,000. 11 On March 25, 1998, the Company acquired all of the outstanding shares of Kemmons Wilson, Inc., in exchange for 1,115,850 shares of the Company's common stock. Kemmons Wilson, Inc., which name the Company changed to KWB Holdings, Inc., was the parent company of KW Bancshares, Inc., which owned Federal Savings Bank headquartered in Rogers, Arkansas. Federal Savings Bank had assets of $393 million and serviced approximately $1 billion in residential mortgage loans. This transaction was accounted for as a purchase. The Company recorded costs in excess of fair value of the net assets acquired of $41.9 million, which will be amortized over 25 years using the straight- line method. Financial Review - ---------------- 	The following financial review provides management's analysis of the consolidated financial condition and results of operations of the Company. As such, the presentation focuses on those factors that have had the most significant impact on the Company's financial condition during the periods discussed. Consolidated Earnings Summary 	Basic earnings of $0.73 per share in first quarter 1998 represented an increase of 21% from $0.60 per share during the same period in 1997. Diluted earnings per share also increased 21% to $0.72 from $0.60. Net income for the first quarter of 1998 increased 21% to $27.3 million from $22.6 million in 1997. The increase in net income reflects strong growth in net interest margin combined with tight controls over non-interest expense. 	When evaluating the earnings performance of a banking organization, two profitability ratios are important standards of measurement: return on average assets and return on average common stockholders' equity. Return on average assets measures net income in relation to total average assets and portrays the organization's ability to profitably employ its resources. Annualized returns on average assets for the first quarter of 1998 and 1997 were 1.62% and 1.34%, respectively. 	The second profitability ratio, return on average common stockholders' equity, indicates how effectively a company has been able to generate earnings on the capital invested by its stockholders. In the first quarter of 1998, the Company earned 17.04% on average common stockholders' equity compared with 15.49% for the first quarter of 1997. The Company's continued improvement in the return on average common stockholders' equity ratio is indicative of the Company's successful deployment of its capital, combined with strong earnings growth. Net Interest Income 	Net interest income, the greatest component of a bank's earnings, is the difference between income generated by earning assets and the interest cost of funding those assets. For the purpose of this analysis and discussion, net interest income and net interest margin reflect income from tax-exempt loans and tax-exempt investments on a fully tax-equivalent basis. This permits comparability of income data through recognition of the tax savings realized on tax-exempt earnings. On a tax-equivalent basis, net interest income was $71.7 million in the first quarter of 1998 compared to $70.2 million for the same period in 1997. Net interest margin is the ratio of net interest income 12 to average earning assets. This ratio indicates the Company's ability to manage its earning assets and to control the spread between yields earned on assets and rates paid on liabilities. Fully tax-equivalent net interest margin was 4.67% for the first quarter of 1998, compared to 4.60% for the same period in 1997. The increase in net interest income and net interest margin resulted from stable yields on earning assets combined with a decrease in liability costs. 	Management of net interest income and net interest margin is actively pursued through a continuing emphasis on pricing both loans and deposits with focus on profitability, rather than a narrow emphasis on local market conditions. Presented in the following table is an analysis of the components of fully tax-equivalent net interest income for the first quarter of 1998 and 1997. Analysis of Net Interest Income (FTE = Fully Tax-Equivalent) For the Three Months Ended March 31, (Dollars in thousands) ----------------------- 1998 1997 ---------- ---------- Interest income...................................$ 123,014 $ 122,930 Fully tax-equivalent adjustment................... 1,263 1,404 ---------- ---------- Interest income - FTE............................. 124,277 124,334 Interest expense.................................. 52,617 54,158 ---------- ---------- Net interest income - FTE $ 71,660 $ 70,176 ========== ========== Yield on earning assets - FTE..................... 8.10% 8.14% Cost of interest bearing liabilities ............ 4.16% 4.35% Net interest spread - FTE......................... 3.94% 3.79% Net interest margin - FTE......................... 4.67% 4.60% Management has and will continue to monitor the interest rate sensitivity position of the Company, so as to balance assets and liabilities to minimize the effects associated with changes in the interest rate environment on the net interest margin and the net interest spread. One process for achieving this balance is to manage the adjusted interest rate sensitivity gap of the Company. Due to the large amount of loans subject to Arkansas usury statutes and the effect those statutes have on loan terms and structures, the Company has traditionally focused on its six month adjusted gap ratio with the target range being .90 to 1.10. The Company may move within this range to optimize the trade-off between the competitive market level of loan rates and the statutory caps which would be applicable to both fixed and variable rate loans. The Company has traditionally used net interest revenue simulation modeling with a variety of interest rate scenarios for the entire Company as well as for certain large affiliate banks. The Company also monitors economic valuation risk by measuring the sensitivity of the economic value of the Company's equity. 13 Current financial reporting standards require that the interest rate sensitivity analysis be based on contractual maturities rather than repricing terms. Certain non-interest bearing accounts such as checking accounts are included while others are not. The Company has chosen to spread non-maturity deposits over the same maturity spectrum as it uses in its economic value of equity modeling. The average rates are as of December 31, 1997. Based on these reporting criteria, the table indicates the Company is asset sensitive on a cumulative basis at both the six month and one year time periods. However, changes in net interest income are determined by the volumes of assets being repriced as well as the rates at which the assets and liabilities are repriced. For example, the rates paid on savings, NOW, and money market accounts tend to have a relatively low sensitivity to market interest rates. Adjusting these and all other balance sheet categories for their repricing terms and estimated sensitivity results in the Company having a ratio of cumulative assets to cumulative liabilities of .96 at the six month time period and 1.00 at the one year time period. The Company also reviews the gap position for periods in excess of one year, comparing certain longer term fixed rate assets to certain liabilities and equity. 14 Interest Rate Sensitivity Principal Amount Maturing in: March 31, 1998 ------------------------------------------------------------------------------------- (Dollars in thousands) 0 - 6 7 - 12 1- 2 2 - 3 3 - 4 4 - 5 There- Months Months Years Years Years Years after Total ---------- --------- --------- --------- -------- -------- --------- --------- Rate sensitive assets: Fixed interest rate loans.... $1,064,256 $ 647,341 $ 615,513 $ 409,060 $ 223,739 $ 262,524 $ 419,556 $3,641,989 Average interest rate....... 8.75% 9.02% 9.17% 9.15% 9.03% 8.82% 8.19% 8.87% Variable interest rate loans. 354,671 237,040 133,227 75,348 45,126 46,308 81,255 972,975 Average interest rate....... 8.41% 8.47% 9.12% 9.21% 8.70% 8.29% 8.94% 8.63% Fixed interest rate securities 518,980 168,605 258,966 180,629 83,196 86,654 343,064 1,640,094 Average interest rate....... 5.55% 5.86% 6.06% 6.00% 5.97% 5.88% 6.06% 5.86% Variable interest rate securities.................. 2,775 29,218 18,680 5,939 9,491 8,746 37,105 111,954 Average interest rate....... 5.31% 4.87% 5.51% 7.40% 6.05% 6.64% 6.18% 5.98% Other interest-bearing assets 237,736 - - - - - - 237,736 Average interest rate....... 4.91% - - - - - - 4.91% ---------- --------- --------- --------- -------- -------- --------- --------- Total rate sensitive assets.. 2,178,418 1,082,204 1,026,386 670,976 361,552 404,232 880,980 6,604,748 Rate sensitive liabilities: Non interest-bearing checking $ 341,186 $ - $ 196,710 $ 264,948 $ 111,062 $ 111,062 $ 85,648 $1,110,616 Average interest rate....... - - - - - - - - Savings & interest-bearing deposits.................... - 96,641 709,079 644,652 322,272 161,195 322,389 2,256,228 Average interest rate....... - 2.47% 2.47% 2.47% 2.47% 2.47% 2.47% 2.47% Time deposits................ 1,601,500 783,078 413,018 94,053 27,480 34,070 9,528 2,962,727 Average interest rate....... 5.19% 5.58% 5.79% 5.94% 5.64% 5.84% 5.48% 5.41% Fixed interest rate borrowings 268,154 18 18,429 36 36 36 349 287,058 Average interest rate....... 4.87% 6.30% 7.34% 6.30% 6.30% 6.30% 6.30% 5.03% Variable interest rate borrowings.................. 45,665 - 5,000 - - - - 50,665 Average interest rate....... 5.74% - 5.82% - - - - 5.75% ---------- --------- --------- --------- -------- -------- --------- --------- Total rate sensitive liabilities................. 2,256,505 879,737 1,342,236 1,003,689 460,850 306,363 417,914 6,667,294 Rate sensitive assets minus liabilities................. (78,087) 202,467 (315,850) (332,713) (99,298) 97,869 463,066 (62,546) Cumulative interest rate sensitivity gap............. (78,087) 124,380 (191,470) (524,183) (623,481) (525,612) (62,546) Cumulative rate sensitive assets to rate sensitive liabilities 96.5% 104.0% 95.7% 90.4% 89.5% 91.6% 99.1% Cumulative gap as a % of earning assets...................... (1.2%) 1.9% (2.9%) (7.9%) (9.4%) (8.0%) (0.9%) 15 Non-Interest Income 	In addition to net interest income increases, the Company has continued to develop its sources of non-interest income. The primary sources of sustainable non-interest income are mortgage servicing, trust services, service charges on deposit accounts, and other service charges and fees. For the first quarter of 1998, non-interest income increased to $29.6 million, a 5.83% increase from the same period in 1997. The primary contributors to this increase were trust income, bank dealer operations income and other fee income. The following table summarizes non-interest income for the first quarter of 1998 and 1997. For the Three Months Ended March 31, (Dollars in thousands) ----------------------------------- 1998 1997 % Change ---------- ---------- ---------- Trust department income.......... $ 4,161 $ 3,238 28.51% Mortgage servicing fee income.... 8,849 9,774 (9.46) Broker-dealer operations income.. 1,696 1,243 36.44 Service charges on deposits...... 8,003 8,112 (1.34) Other service charges and fees... 4,078 3,932 3.71 Investment securities gains (losses), net.................. 154 10 1,440.00 Other real estate gains (losses), net.................. (76) (354) (78.53) Other income..................... 2,687 1,970 36.40 ---------- ---------- Total non-interest income........ $ 29,552 $ 27,925 5.83% ========== ========== Non-Interest Expense 	Non-interest expenses consist of salaries and benefits, occupancy, equipment and other expenses necessary for the operation of the Company. Management is committed to controlling the level of non-interest expenses through improved efficiency and consolidation of certain activities to achieve economies of scale. Non-interest expenses were $56.9 million for the first quarter of 1998 compared to $59.1 million for the same period in 1997. The primary contributor to this decrease was lower amortization expense due to a change in the estimated life of mortgage servicing rights in the second quarter of 1997. The following table summarizes non-interest expenses for the first quarter of 1997 and 1996. 16 For the Three Months Ended March 31, (Dollars in thousands) ----------------------------------- 1998 1997 % Change ---------- ---------- ---------- Salaries, wages and employee benefits.............. $ 28,922 $ 28,880 0.15% Net occupancy.................... 3,735 3,931 (4.99) Equipment........................ 3,907 3,925 (0.46) FDIC Insurance................... 267 (48) 656.25 Amortization of mortgage servicing rights......................... 2,193 4,243 (48.31) Other expenses................... 17,910 18,215 (1.67) ---------- ---------- Total non-interest expenses...... $ 56,934 $ 59,146 (3.74%) ========== ========== 	An important tool in determining a bank's effectiveness in managing non- interest expenses is the efficiency ratio, which is calculated by dividing non-interest expense by the sum of net interest income on a tax-equivalent basis and non-interest income, excluding securities gains and losses. The Company's ratio decreased from 53.83% in the first quarter of 1997 to 53.18% in the first quarter of 1998. The Company, in calculating its efficiency ratio has excluded the effect of non-recurring expenses, as well as the amortization of intangible assets. The decrease in the efficiency ratio shows the Company's commitment to controlling non-interest expenses while increasing revenues. Income Taxes 	The effective income tax rate differs from the statutory rate primarily because of tax-exempt income from loans, leases and municipal securities. The effective tax rate was 33.3% for the first quarter of 1998 and 35.0% for the same period of 1997. Loan and Lease Portfolio 	At March 31, 1998, the Company's loan and lease portfolio, net of unearned income, increased to $4.6 billion, as compared to $4.3 billion at December 31, 1997. The growth was primarily due to the acquisition of Federal Savings Bank. The Company has continued its policy of conservative lending thereby avoiding significant risk areas, such as out-of-territory lending and highly leveraged transactions. In keeping with this philosophy, the Company has no foreign loans, no loans outstanding to borrowers engaged in highly leveraged transactions, and no concentrations of credit to borrowers in any one industry. A concentration generally exists when more than 10% of total loans are outstanding to borrowers in the same industry. Provision and Allowance for Possible Loan and Lease Losses 	The allowance for possible loan and lease losses is the amount deemed by management to be adequate to provide for possible losses on loans and leases that may become uncollectible. Reviews of general loss experience and the performance of specific credits are conducted in determining reserve adequacy and required provision expense. The allowance is adjusted by the provision 17 for possible loan and lease losses, increased by loan recoveries and decreased by loan losses. As of March 31, 1998, the allowance for possible loan and lease losses equaled $86.9 million or 1.87% of total loans and leases. Comparatively, the allowance for possible loan and lease losses amounted to $80.0 million or 1.85% of total loans and leases at December 31, 1997. The provision for possible loan and lease losses amounted to $2.1 million in the first quarter of 1998 as compared to $2.8 million in the same period of 1997. 	A key indicator of the adequacy of the allowance for possible loan and lease losses is the ratio of the allowance to non-performing loans. The Company's ratio has been at or above 100% for the past eight years. At March 31, 1998, the Company's ratio was 186%. This means that for every dollar of non-performing loans (impaired loans, other non-accrual loans, loans 90 days or more past due, and renegotiated loans), $1.86 has been set aside in the Company's reserves to cover possible losses. The ratio at December 31, 1997, was 185%. Another reserve adequacy indicator is the ratio of allowance for possible loan and lease losses and other real estate losses to non-performing assets (defined as impaired loans, other non-accrual loans, renegotiated debt, repossessed assets and other real estate owned). The ratio was 191% at March 31, 1998, compared to 197% at December 31, 1997. Annualized Three Months Ended March 31, For the Years Ended December 31, -------------- --------------------------------- 1998 1997 1996 1995 1994 1993 -------------- ------ ------ ------ ------ ----- Net loan and lease losses to average loans and leases 0.23% 0.33% 0.18% 0.07% 0.04% 0.14% Allowance for possible loan and lease losses to total loans and leases 1.87% 1.85% 1.55% 1.46% 1.62% 2.01% Non-performing loans to total loans and leases 1.01% 1.00% 0.68% 0.47% 0.47% 0.63% 	The principal areas of risk for the Company are in the commercial and industrial, and commercial real estate loan portions of the portfolio. Accordingly, these areas have been allocated the largest portion of the reserve. Management attempts to control the loan loss risks by maintaining a diverse portfolio with no significant concentrations and through an aggressive real estate write down policy. The Company has only 58 loan relationships with aggregate outstanding balances of $5 million or greater, which further mitigates the loan loss risks. Liquidity 	Long-term liquidity is a function of a large core deposit base and a strong capital position. Core deposits, which consist of total deposits less certificates of deposit of $100,000 and over, represent the Company's largest and most important funding source. The capital position of the Company is a result of internal generation of capital and earnings retention. The Company manages dividends to retain sufficient capital for long-term liquidity and growth. 18 Two key measures of the Company's long-term liquidity are the ratios of loans and leases to total deposits and loans and leases to core deposits. Lower ratios in these two measures correlate to higher liquidity. As can be seen in the accompanying table, liquidity ratios have generally increased, indicating lower liquidity. The Company's liquidity has decreased because the funding of loans has outpaced the growth in the Company's deposits. The Company's relatively sound deposit base, along with its low debt level and common and preferred stock availability, provide the company with several alternatives for future financing and long-term liquidity needs. Three Months Ended March 31, For the Years Ended December 31, ------------------ -------------------------------- 1998 1997 1996 1995 ------------------ ---------- ---------- -------- Average loans and leases to average deposits 73.52% 72.98% 71.95% 70.38% Average loans and leases to average core deposits 82.29% 83.90% 83.20% 75.43% 	Short-term liquidity is the ability of the Company to meet the borrowing needs and deposit withdrawal requirements of its customers due to growth in the customer base and, to a lesser extent, seasonal and cyclical customer demands. Short-term liquidity needs can be met by short-term borrowings in state and national money markets. Short-term borrowings include federal funds purchased, securities sold under agreement to repurchase, treasury tax and loan accounts, and other borrowings. Average short-term borrowings exceeded average short-term investments by $14.5 million in the first quarter of 1998. Average short-term investments exceeded average borrowings by $21.2 million in the fourth quarter of 1997. During the first quarter of 1998, the Company used $74.3 million of liquidity to repurchase its own common shares, which were used to acquire Kemmons Wilson, Inc. The Company has continued to use short-term borrowings to fund overall loan growth throughout the Company. Future short-term liquidity needs for daily operations are not expected to vary significantly and management believes that the Company's level of liquidity is sufficient to meet current funding requirements. Capitalization 	The Company maintains its goal of providing a strong capital position while earning an acceptable return for its shareholders. Management will use the additional financial leverage provided by internal generation of capital in pursuit of above average return opportunities. A position of strength is important to the Company's customers, investors and regulators. 	At March 31, 1998, the Company's equity to asset ratio was 8.61% compared to 9.45% at December 31, 1997. The decrease was caused by the repurchase of Company's common shares, which were used to acquire Kemmons Wilson, Inc. At March 31, 1998, the Company's leverage and tier 1 and total risk-based capital ratios substantially exceeded the required 3%, 4% and 8% levels established by the Board of Governors of the Federal Reserve System, as can be seen from the accompanying table. 19 						Regulatory March 31, Dec. 31, Sep. 30, June 30, March 31, Minimum 1998 1997 1997 1997 1997 ----------- ------------ ------------ ------------ ------------ ---------- Leverage ratio................... 3.00% 8.13% 9.01% 8.90% 8.39% 8.13% Tier 1 risk-based capital ratio.. 4.00% 11.58% 12.74% 12.97% 12.17% 11.91% Total risk-based capital ratio... 8.00% 12.58% 13.60% 13.83% 13.04% 12.79% 	While management plans to maintain the Company's strong capital base, it recognizes the need to effectively manage capital levels as they relate to asset growth. In order to avoid declining return on equity ratios caused by a more rapid rate of growth in capital than in assets, management will continue to evaluate options to utilize excess capital thereby improving return on equity. 	The Company is not aware of any current recommendations by any regulatory authorities which, if they were implemented, are reasonably likely to have a material effect on the Company's liquidity, capital resources or operations. Dividend Policy The Company's long-term dividend policy is to pay between 35% and 40% of earnings in cash dividends to its stockholders while maintaining adequate capital to support growth. The dividend payout ratios for the past three years were 37.20% in 1997, 33.59% in 1996, and 34.29% in 1995. In October 1997, the Company increased its dividend rate for the eleventh consecutive year, bringing the annual dividend rate to $1.12 per share. SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 ("PSLRA") Certain forward-looking information contained in this report is being provided in reliance upon the "safe harbor" provisions of the PSLRA as set forth in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such information includes, without limitation, discussions as to estimates, expectations, beliefs, plans, strategies and objectives concerning the Company's future financial and operating performance. Such forward-looking information is subject to assumptions and beliefs based on current information known to the Company and factors that could yield actual results differing materially from those anticipated. Such factors include, without limitation, changes in general economic conditions, capital deployment opportunities, ability to control non-interest expense, and availability of liquidity sources to support asset growth. 20 Item 3. Quantitative and Qualitative Disclosures about Market Risk ---------------------------------------------------------- The information required by this Item is contained in this Form 10-Q in the "Interest Rate Sensitivity" table, and is incorporated herein by reference. PART II. OTHER INFORMATION Item 1. LEGAL PROCEEDINGS ----------------- Discussions of legal proceedings is included in this Form 10-Q in Note 4 to unaudited consolidated financial statements, and is incorporated herein by reference. Item 6. EXHIBITS AND REPORTS ON FORM 8-K -------------------------------- (a) Exhibits 27 Financial Data Schedule. (b) Reports on Form 8-K On February 13, 1998, the Company filed a report on Form 8-K relating to the proposed merger of Regions Financial Corporation and the Company. 21 Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FIRST COMMERCIAL CORPORATION /s/ J. Lynn Wright By: ------------------------------- J. Lynn Wright Chief Financial Officer Date: May 14, 1998 22 Index to Exhibits Exhibit Number Exhibit ---------------- -------------------------------------------- 27 Financial Data Schedule