EXHIBIT 99.3
OLD KENT FINANCIAL CORPORATION
FINANCIAL REVIEW
This financial review presents management's discussion and analysis of
financial condition and results of operations. It should be read in conjunction
with the Consolidated Financial Statements in Exhibit 99.1 and the five year
summary of selected financial data in Exhibit 99.2. As discussed in Note 2 to
the Consolidated Financial Statements, Old Kent Financial Corporation
("Old Kent" or the "Corporation") completed the mergers of CFSB Bancorp,
Inc., on July 9, 1999, Pinnacle Banc Group, Inc., on September 3, 1999,
Merchants Bancorp, Inc., on February 11, 2000 and Grand Premier Financial,
Inc., on April 1, 2000. These mergers were accounted for as poolings-of-
interests and all financial statements have been adjusted to reflect these
business combinations.
OVERVIEW
Net income was $279.1 million for 1999, the forty-first consecutive year of
increased per share earnings and dividends in Old Kent's history. This
represented an $18.0 million increase over net income of $261.1 million for
1998. Diluted net income per common share was $1.98 for 1999, up by 10.6% over
the $1.79 of diluted net income per share for 1998. Diluted net income per
common share has increased at an annual compound rate of 9.8% over the past
five years.
During the third quarter of 1999, Old Kent recognized $17.6 million of after-
tax, merger-related charges which had the effect of reducing diluted earnings
per share by $.13. In addition, during the fourth quarter of 1998, Old Kent
recognized $19.7 million of after-tax, merger-related charges which had the
effect of reducing diluted earnings per share by $.13. Excluding these merger
charges for both years, diluted earnings per share was $2.11 for 1999, or 9.9%
better than the $1.92 of diluted per share earnings for 1998. For the year
ended December 31, 1999, operating net income was $296.7 million, 5.7% more
than operating net income of $280.8 million for 1998. Excluding a large one-
time gain on the sale of the Corporation's credit card portfolio included in
the 1997 results, the 1998 diluted earnings per share of $1.92 represents a
26.3% increase.
Effective with the fourth quarter of 1999, the quarterly cash dividend rate on
common stock was increased to $.21 per share. The new annualized rate of $.84
per share is 15.8% greater than the rate paid in the fourth quarter of 1998
and includes the effect of a five percent stock dividend paid on July 19, 1999
and a five percent stock dividend paid on July 14, 2000. Old Kent has paid
increased cash dividends each year since its formation as a holding company in
1972. The compound annual growth rate for the Corporation's per share dividend
payment for the last five years is 11.7%. The dividend payout ratio has
averaged 37.1% over that same period.
Old Kent's corporate culture is geared toward maximizing shareholder value. The
information appearing below compares the performance of Old Kent Common Stock
with the S&P 500 and the KBW 50 indexes. The total return, as shown, is
measured using both stock price appreciation and the effect of reinvestment of
cash dividends paid. The S&P 500 index includes the performance of five hundred
individual stocks selected by Standard & Poor's Corporation to be a
representative indicator of a broad base of industries whose stocks are traded
and available to the investing public. The KBW 50 index is based upon the
stock performance of 50 large financial services companies selected by Keefe,
Bruyette, and Woods, Inc., specialists in the financial services industry. The
total return of the KBW 50 index is calculated in the same manner as the S&P
500 index. Old Kent is included in both the S&P 500 and KBW 50 indexes. The
table displays the December 31, 1999 value of an initial $100 investment in
Old Kent Common Stock made one, five and ten years prior to the year-end 1999
date (with dividends reinvested). The table indicates that the total return on
an investment in Old Kent Common Stock surpassed that of the S & P 500 and
KBW 50 for the ten year period, was approximately the same as both indexes
for the five year period, and was below both indexes for the year 1999.
DECEMBER 31, 1999 VALUE OF A EQUIVALENT COMPOUND
$100 INVESTMENT MADE ANNUAL RATE OF RETURN
----------------------------- -----------------------
1 YR AGO 5 YRS AGO 10 YRS AGO 1 YEAR 5 YEAR 10 YEAR
-------- --------- ---------- ------ ------ -------
Old Kent Common Stock $ 81.4 $339.7 $664.8 (18.6%) 27.7% 20.9%
S&P 500 Index $121.1 $351.1 $532.8 21.1% 28.6% 18.2%
KBW 50 Index $ 96.5 $346.2 $502.2 (3.5%) 28.2% 17.5%
The Corporation's return on average total equity in 1999 was 18.5%, compared to
an equity return of 16.6% for 1998. Old Kent's return on equity has averaged
15.7% over the past five years. Old Kent's return on average assets was 1.36%
for 1999 compared to 1.29% for 1998, and has averaged 1.3% over the last five
years.
Steady annual earnings increases have been attributable to balance sheet growth
and to increases in non-interest income. Total average interest-earning assets
increased by $273 million, or 1.5%, in 1999 and by $573 million, or 3.2%, in
1998. Over the last five years, total average interest-earning assets have
increased at a compound annual growth rate of 4.6%. Interest-earning assets
primarily consist of securities (including those classified as available-for-
sale and those classified as held-to-maturity) and loans. Average securities
decreased by $533 million, or 11%, in 1999. This decrease was primarily the
result of Old Kent's liquidation of securities to fund growth in loans, which
averaged $12.7 billion in 1999 compared to $11.7 billion in 1998. This
represented an increase of $960 million, or 8.2% more than the average for
1998. During 1998, the Corporation took measures to reduce credit risk by
exiting certain marginal commercial relationships as well as by reducing
certain consumer loan portfolio components having higher credit risk, which
management believed would have negatively impacted the Corporation's future
profitability. These actions combined with continued stringent credit
underwriting policies, and a generally favorable economy had a positive impact
on 1999 performance.
BUSINESS OF THE CORPORATION
Old Kent is a financial services organization which operates as a bank holding
company. The services offered by Old Kent's subsidiaries cover a wide range of
banking, fiduciary and other financial services. These include commercial,
mortgage, and retail loans, business and personal checking accounts, savings
and retirement accounts, time deposit instruments, ATMs, debit cards and other
electronically accessed banking services, money transfer services, safe deposit
facilities, cash management, real estate and lease financing, international
banking services, investment management and trust services, personal investment
and related advisory services, brokerage and investment advisory services, and
access to insurance products.
The principal sources of revenues for Old Kent are interest and fees on loans,
principally originated by the Corporate Banking, Retail Banking, Community
Banking and Mortgage Banking lines of business. Interest and fees on loans
accounted for 56% of total revenues in 1999, 55% in 1998 and 59% in 1997.
Approximately 61% of deposits and 71% of total loans at December 31, 1999, were
associated with these business lines serving the lower peninsula of the State
of Michigan, excluding the Mortgage Banking line of business which operates
147 offices in 32 states.
Interest on securities, attributable to the Treasury line of business, is also
a significant source of revenue, accounting for 14% of total revenues in 1999,
17% in 1998, and 19% in 1997.
2
Investment and Insurance Services generates revenues primarily from fees and
commissions on various investment products within investment management and
trust, brokerage and insurance activities. These accounted for 5.8%, 5.2%, and
4.5% of total revenues in 1999, 1998, and 1997 respectively. This business line
primarily services customers in the lower peninsula of the State of Michigan.
Old Kent has had no foreign loans or hedge fund investments at any time during
the last five years. The foreign activities of the Corporation primarily
involve time deposits with banks, and placements and exchange transactions for
domestic customers of the banks. These activities were not material to the
Corporation's financial condition or results of operations.
LINE OF BUSINESS MANAGEMENT APPROACH
Old Kent's primary business activities are administered under a "line of
business" management approach. Under this approach, key executives of the
Corporation are individually responsible for optimizing operating results in
each of their respective "lines." For the years 1999 and 1998, Old Kent has
identified these lines as follows:
LINE OLD KENT EXECUTIVE PRIMARY BUSINESS ACTIVITIES
- -------------------------------------------------------------------------------------------
Corporate Banking Daniel W. Terpsma Credit, cash management, and international
services for corporate customers
Retail Banking David C. Schneider Retail deposits, retail delivery, consumer
lending, leasing and small business banking
Community Banking Michelle L. Van Dyke Loans, deposits and other services for all
customers and small businesses in smaller
communities
Investment and Insurance Kenneth C. Krei Asset management, employee benefit programs,
Services mutual funds, trust services, private
banking, brokerage services and insurance to
consumers, business owners, and corporations
Mortgage Banking Donald R. Britton Origination and acquisition, sale and
servicing of residential mortgages on a
nationwide basis
Treasury Ronald C. Mishler Investment portfolio, funds management, and
interest rate risk management
The following represents the percentage of net income provided by each line of
business in 1999, excluding the $17.6 million of after-tax, merger-related
charges associated with Old Kent's acquisition of CFSB Bancorp, Inc. and
Pinnacle Banc Group, Inc. on July 9, 1999, and September 3, 1999, respectively,
in pooling-of-interests transactions. Excluding these charges, Old Kent's
operating net income was $296.7 million for 1999.
Corporate Banking 28%
Retail Banking 28
Community Banking 21
Investment and Insurance Services 11
Mortgage Banking 8
Treasury 4
---
Total 100%
===
Disclosure about Old Kent's business segments required by Statement of
Financial Accounting Standard No. 131, "Disclosures about Segments of an
Enterprise and Related Information", are included in Note 17 to the
Consolidated Financial Statements included in Exhibit 99.1 to this Form 8-K.
As of January 2000, Old Kent combined its Community Banking line of
business with the Retail Banking line of business.
3
MERGERS AND ACQUISITIONS
Old Kent's primary method of expansion into new markets has been through
acquisitions of other financial institutions. The following is a summary
of Old Kent's significant merger and acquisition activity.
On October 13, 2000, Old Kent completed the acquisition of Home Bancorp. The
merger was accounted for as a purchase transaction. Old Kent exchanged
approximately 1.4 million shares of Old Kent Common Stock for all of the
outstanding shares of Home Bancorp Common Stock. The approximate purchase
price for this transaction is $39.1 million. Home Bancorp was a bank holding
company headquartered in Fort Wayne, Indiana, with consolidated assets of
approximately $390 million and consolidated deposits of approximately $327
million at September 30, 2000. Home Bancorp operated 10 banking locations;
seven in Fort Wayne, two in Decatur and one branch in New Haven.
On April 1, 2000, Old Kent completed the acquisition of Grand Premier
Financial, Inc. ("Grand Premier"). The merger was accounted for as a pooling-
of-interests. Old Kent exchanged approximately 9.4 million shares of Old
Kent Common Stock for all the outstanding shares of Grand Premier Common
Stock. Grand Premier was a bank holding company headquartered in Wauconda,
Illinois, with consolidated assets of approximately $1.7 billion and
consolidated deposits of approximately $1.3 billion at March 31, 2000.
Grand Premier operated 23 banking offices in the Chicago area and Northern
Illinois.
On February 11, 2000, Old Kent completed the acquisition of Merchants
Bancorp, Inc. ("Merchants"). The merger was accounted for as a pooling-of-
interests. Old Kent exchanged approximately 4.4 million shares of Old Kent
Common Stock for all outstanding shares of Merchants Common Stock. Merchants
was a bank holding company headquartered in Aurora, Illinois. When acquired,
Merchants had consolidated assets of approximately $1 billion and consolidated
deposits of approximately $0.7 billion. Merchants operated 12 suburban
Chicago area banking sites as well as two banking sites in DeKalb and Kendall
Counties.
During the first six months of 2000, Old Kent recognized $43.6 million of
after-tax merger-related charges associated with Grand Premier Financial, Inc.
and Merchants Bancorp, Inc. which had the effect of reducing earnings per
share by $.31. On a pre-tax basis, the charges consisted of transaction costs
of $5.9 million; employment charges of $19.8 million primarily related to
redundant staffing; $16.3 million mainly associated with contract
cancellation costs and asset obsolescence for duplicate operations; $12.0
million special loan loss provision to conform Grand Premier and Merchants
asset quality measurements with Old Kent's practices; and $6.1 million of
securities losses resulting from the sale of $266 million of securities and
$5.3 million resulting from the securitization and sale of $270 million of
residential mortgages to realign the balance sheet composition of the newly
combined companies to Old Kent's profile.
On September 3, 1999, Old Kent completed the acquisition of Pinnacle Banc
Group, Inc. ("Pinnacle"). The merger was accounted for as a pooling-of-
interests. Old Kent exchanged approximately 5.6 million shares of Old Kent
Common Stock for all of the outstanding shares of Pinnacle Common Stock.
Pinnacle was a bank holding company headquartered in the Chicago suburb of Oak
Brook, Illinois. When acquired, Pinnacle had assets of approximately $1.0
billion and consolidated deposits of approximately $861 million. Pinnacle was
the parent of Pinnacle Bank, which operated thirteen branches in the Chicago
metropolitan area and Pinnacle Bank of the Quad-Cities, which operated three
branches in western Illinois.
On July 9, 1999, Old Kent completed the acquisition of CFSB Bancorp, Inc.
("CFSB"). The merger was accounted for as a pooling-of-interests. Old Kent
exchanged approximately 5.5 million shares of Old Kent Common Stock for all of
the outstanding shares of CFSB Common Stock. CFSB was a holding company
headquartered in Lansing, Michigan. When acquired, CFSB had consolidated assets
of approximately $878 million and consolidated deposits of approximately $567
million. CFSB was the parent of Community First Bank. CFSB provided banking
services through sixteen offices in Ingham, Clinton, Eaton and Ionia Counties.
During the third quarter of 1999, Old Kent recognized $17.6 million of after-
tax, merger-related charges associated with CFSB and Pinnacle, which had the
effect of reducing earnings per share by $.13. On a pre-tax basis, the charges
consisted of transaction costs of $2.0 million; employment charges of $11.8
million, primarily related to redundant staffing; and $12.2 million mainly
associated with contract cancellation costs and asset obsolescence for
4
duplicate operations. Old Kent's unexpended reserves for these charges were
$7.7 million at December 31, 1999. These reserves were substantially utilized
during 2000.
On October 1, 1998, Old Kent completed the acquisition of First Evergreen
Corporation ("First Evergreen"). When acquired, First Evergreen had assets of
approximately $1.9 billion and deposits of approximately $1.7 billion. The
merger was accounted for as a pooling-of-interests and all financial
statements in this report have been adjusted to reflect this business
combination. Old Kent exchanged approximately 12.8 million shares of Old Kent
Common Stock for all of the outstanding shares of First Evergreen Common Stock.
During the fourth quarter of 1998, Old Kent recognized $19.7 million of after-
tax, merger-related charges, which had the effect of reducing earnings per
share by $.13. First Evergreen was a bank holding company headquartered in
Evergreen Park, Illinois. First Evergreen provided banking services through
eight offices in Cook County, Illinois.
On September 1, 1997, Old Kent Insurance Group, Inc. (a subsidiary of Old Kent
Bank), acquired Grand Rapids Holland Insurance Agency, Inc. ("GRH"), a provider
of commercial and personal insurance products through offices in western
Michigan. Old Kent issued approximately 86,000 shares of its common stock to
acquire all the outstanding common stock of GRH. When acquired, GRH had assets
of approximately $6.2 million.
On January 1, 1997, Old Kent acquired Seaway Financial Corporation ("Seaway"),
a bank holding company headquartered in St. Clair, Michigan. Seaway was the
parent of The Commercial and Savings Bank of St. Clair County (St. Clair,
Michigan) and The Algonac Savings Bank (Algonac, Michigan). When acquired,
Seaway had total assets and total deposits of approximately $345 million and
$302 million, respectively. Old Kent issued approximately 1.9 million shares of
Old Kent Common Stock in exchange for all of the outstanding common stock of
Seaway. These banks were merged into and with Old Kent Bank in 1997.
PENDING MERGER
Old Kent signed a definitive agreement on November 20, 2000, providing for the
merger of the Corporation into a wholly-owned subsidiary of Fifth Third
Bancorp ("Fifth Third"). The merger is intended to be structured as a pooling-
of-interests for accounting purposes. Under the terms of the agreement, each
share of Old Kent common stock will be converted into .74 shares of Fifth
Third common stock, and each share of Old Kent preferred stock will be
converted into one share of Fifth Third preferred stock with substantially
identical terms. Management anticipates that this merger will be completed
during the second quarter of 2001.
SUMMARY OF OPERATING RESULTS
The following is a summary of the major components of the Corporation's
operating results for the last five years:
Proforma Proforma
1999 1998
Excluding Excluding
Year ended December 31 Merger Merger
(in thousands) Charges* 1999 Charges** 1998 1997 1996 1995
- ---------------------------------------------------------------------------------------------------
Net interest income $773,118 $773,118 $740,203 $740,203 $733,774 $686,067 $661,074
Add: taxable-equivalent
adjustment 23,999 23,999 20,758 20,758 19,396 14,118 15,808
--------- --------- --------- --------- --------- --------- --------
Taxable-equivalent net
interest income 797,117 797,117 760,961 760,961 753,170 700,185 676,882
Provision for credit
losses (35,388) (35,388) (49,430) (52,930) (59,673) (40,765) (25,124)
Non-interest income 456,730 456,730 413,620 413,620 314,342 254,792 209,733
Non-interest expense (739,879) (765,879) (678,610) (703,603) (613,732) (585,419) (547,020)
Income taxes, including
taxable-equivalent
adjustment (181,862) (173,462) (165,725) (156,910) (146,276) (116,981) (109,906)
--------- --------- --------- --------- --------- --------- --------
Net income $296,718 $279,118 $280,816 $261,138 $247,831 $211,812 $204,565
========= ========= ========= ========= ========= ========= ========
- --------
* Proforma results for 1999 "excluding merger charges" have been adjusted to
exclude the effects of $17.6 million of one-time, after-tax merger charges
related to the July 9, 1999, and September 3, 1999, acquisitions of CFSB
Bancorp, Inc. and Pinnacle Banc Group, Inc. accounted for as poolings-of-
interests.
** Proforma results for 1998 "excluding merger charges" have been adjusted to
exclude the effects of $19.7 million of one-time, after-tax merger charges
related to the October 1, 1998, acquisition of First Evergreen Corporation,
accounted for as a pooling-of-interests.
5
NET INTEREST INCOME
In the summaries above, the taxable-equivalent adjustment increases tax-exempt
income to an amount equivalent to interest income subject to income taxes at
statutory rates. The federal income tax rate was 35% for all years presented.
During 1999, total average interest-earning assets increased by $272.7 million,
or 1.5%. In that same period, total average interest-bearing liabilities
increased by $371.7 million, or 2.3%.
The following table sets forth the changes in interest income and interest
expense as they relate to changes in volumes and changes in rates:
1999 Compared to 1998 1998 Compared to 1997
Increase (Decrease)* Increase (Decrease)*
-------------------------------- --------------------------------
(Fully taxable-equivalent Change in Due to Due to Change in Due to Due to
in thousands) Income/Expense Volume Rate Income/Expense Volume Rate
- --------------------------------------------------------------------------------------------
Interest-Earning Assets:
Loans (including
mortgages held-for-
sale) $35,282 $67,987 $(32,705) $31,709 $66,746 $(35,037)
Taxable securities (46,033) (42,573) (3,460) (19,747) (12,954) (6,793)
Tax-exempt securities 8,923 12,249 (3,326) 3,289 4,929 (1,640)
Interest-earning
deposits (246) (136) (110) (547) (127) (420)
Federal funds sold and
resale agreements (566) (399) (167) (2,338) (2,381) 43
Trading account
securities 1,014 856 158 (604) (384) (220)
---------------------------------------------------------------
Change in Interest
Income (1,626) 37,984 (39,610) 11,762 55,829 (44,067)
---------------------------------------------------------------
Interest-Bearing
Liabilities:
Savings deposits 17,329 18,433 (1,104) 35,264 26,483 8,781
Time deposits:
Negotiable (52) 6,656 (6,708) (13,755) (22,149) 8,394
Foreign 1,835 1,937 (102) (106) (75) (31)
Consumer (49,332) (24,876) (24,456) (40,758) (25,925) (14,833)
Federal funds purchased
and repurchase
agreements (6,107) (1,602) (4,505) 9,988 10,832 (844)
Other borrowed funds (1,126) 5,455 (6,581) 12,884 16,564 (3,680)
Long-term debt (329) -- (329) 454 548 (94)
---------------------------------------------------------------
Change in Interest
Expense (37,782) 6,003 (43,785) 3,971 6,278 (2,307)
---------------------------------------------------------------
Change in Net Interest
Income $36,156 $31,981 $4,175 $7,791 $49,551 $(41,760)
===============================================================
- --------
* THE CHANGE IN INTEREST DUE TO BOTH VOLUME AND RATE HAS BEEN ALLOCATED BETWEEN
THE FACTORS IN PROPORTION TO THE RELATIONSHIP OF THE ABSOLUTE AMOUNTS OF THE
CHANGE IN EACH. YIELDS ARE CALCULATED ON A FULLY TAXABLE BASIS, USING A
FEDERAL TAX RATE OF 35% FOR ALL YEARS PRESENTED.
Net interest margin is calculated by dividing taxable-equivalent net interest
income by average interest-earning assets. Interest spread is the difference
between the average yield on earning assets and the average cost of interest-
bearing liabilities. The net interest margin was 4.22% in 1999 compared to
4.09% for 1998. The interest spread was 3.66% for 1999 and 3.46% for 1998. The
primary factors underlying the increases in net interest margin and interest
spread were an increase in loan balances and a decrease in cost of total
interest-bearing liabilities from 4.53% in 1998 to 4.20% in 1999.
The net interest margin was 4.09% in 1998 compared to 4.17% for 1997. The
interest spread was 3.46% for 1998 and 3.51% for 1997. The average yield on
interest-earning assets also decreased to 7.99% in 1998 from 8.18% in 1997. The
primary factor underlying the decreases in net interest margin, interest
spread, and yield on total interest-earning assets was a decline in yield on
mortgages held-for-sale to 6.91% in 1998 from 7.40% in 1997. This decrease in
yield, combined with the overall increase in the mortgages held-for-sale
average balance of $849 million from 1997 to 1998 compressed the margin. The
average cost of interest-bearing liabilities decreased to 4.53% in 1998 from
4.67% 1997, but was not enough to offset the impact of the decrease in yield on
total interest-earning assets.
6
Three Month U.S.
Prime Interest Treasury Bill
Rate Rate
Percentage 1999 1998 1997 1999 1998 1997
- ---------------------------------------------------------------
Simple average during year 8.00% 8.35% 8.44% 4.78% 4.89% 5.19%
At December 31 8.50% 7.75% 8.50% 5.33% 4.45% 5.35%
As indicated above, interest rates over the past three years have fallen each
year, but increased in the second half of 1999. As shown in the preceding
"rate/volume" table, both increases in volume and increases in rate contributed
to the increase in interest income. In 1998, the increase in average total
earning assets, particularly mortgages held-for-sale, was the primary factor
for the increase in net interest income, more than offsetting decreases in
rate.
The interest rate environment is significantly impacted by the health of the
national economy and the monetary policies of the Federal Reserve. There are a
number of factors which affect net interest income, including the mix of
interest-earning assets, the mix of interest-bearing liabilities, and the
interest rate sensitivity of the various categories. As of December 31, 1999,
Old Kent's management believes that the Corporation's net interest income would
not be materially impacted by upward or downward movements in prevailing
interest rates within anticipated ranges, as discussed later in this report.
ANALYSIS OF NET INTEREST INCOME
The following table allocates net interest income and interest-earning assets
to show how much was attributable to each major funding source. The interest
spread on earning assets funded by interest-bearing liabilities is the
difference between the average yield on earning assets and the average cost of
interest-bearing liabilities. The interest spread on earning assets funded by
non-interest bearing liabilities and equity is the average yield on earning
assets.
1999 1998 1997
-----------------------------------------------------------------------------------
(Fully taxable- Average Net Average Net Average Net
equivalent, Earning Interest Interest Earning Interest Interest Earning Interest Interest
dollars in millions) Assets Spread Income Assets Spread Income Assets Spread Income
- ------------------------------------------------------------------------------------------------------------
Source of Funding:
Interest-bearing
liabilities $16,392.2 3.66% $600.0 $16,020.5 3.46% $554.3 $15,476.3 3.51% $543.2
Non-interest-bearing
liabilities and equity 2,494.2 7.86% 197.1 2,593.2 7.99% 206.7 2,564.1 8.18% 210.0
--------- ------ --------- ------ --------- ------
Total $18,886.4 $797.1 $18,613.7 $761.0 $18,040.4 $753.2
========= ====== ========= ====== ========= ======
The following table shows the relative importance of changes in interest
spread, earning asset volumes and changes in funding sources:
1999 Over 1998 Over 1997 Over
(Under) (Under) (Under)
1998 1997 1996
-------------------------------------------------------------------------------
(Fully taxable- Average Net Average Net Average Net
equivalent, Earning Interest Interest Earning Interest Interest Earning Interest Interest
dollars in millions) Assets Spread Income Assets Spread Income Assets Spread Income
- --------------------------------------------------------------------------------------------------------
Source of Funding:
Interest-bearing
liabilities $371.7 0.20% $45.7 $544.2 (0.05)% $11.1 $1,156.1 0.03% $44.9
Non-interest-bearing
liabilities and equity (99.0) (0.13)% (9.6) 29.1 (0.19)% (3.3) 74.3 0.07% 8.1
------ ----- ------ ----- -------- -----
Total $272.7 $36.1 $573.3 $7.8 $1,230.4 $53.0
====== ===== ====== ===== ======== =====
7
AVERAGE CONSOLIDATED BALANCE SHEET
(Income and rates 1999 1998 1997
on fully taxable- ------------------------------ ------------------------------ ------------------------------
equivalent basis, Average Average Average Average Average Average
dollars in thousands) Balance Interest Rate Balance Interest Rate Balance Interest Rate
- -------------------------------------------------------------------------------------------------------------------
AVERAGE ASSETS:
Loans(1)(2) $12,702,217 $1,071,935 8.44% $11,741,746 $1,030,765 8.78% $11,817,598 $1,053,264 8.91%
Taxable
investment
securities 3,714,605 232,339 6.25 4,398,684 278,372 6.33 4,601,809 298,119 6.48
Tax-exempt
investment
securities(2) 737,901 59,121 8.01 587,310 50,198 8.55 529,803 46,909 8.85
Mortgages held-
for-sale 1,595,749 115,135 7.22 1,752,175 121,023 6.91 903,144 66,815 7.40
Interest-earning
deposits:
Domestic 12,988 214 1.65 20,004 460 2.30 23,301 1,007 4.32
Foreign -- -- -- -- -- -- -- -- --
Federal funds
sold and resale
agreements 92,843 5,009 5.39 100,179 5,575 5.56 143,165 7,913 5.53
Trading account
securities(2) 30,103 1,609 5.35 13,609 595 4.37 21,546 1,199 5.56
---------------------- ---------------------- ----------------------
Total earning
assets 18,886,406 1,485,362 7.86 18,613,707 1,486,988 7.99 18,040,366 1,475,226 8.18
---------------------- ---------------------- ----------------------
Unrealized
gain/(losses) on
securities
available-for-
sale (16,986) 36,780 2,101
Allowance for
loan losses (204,290) (202,246) (195,880)
Cash and due from
banks 674,788 681,497 638,656
Other assets 1,249,358 1,072,962 999,718
----------- ------------ ------------
Total Assets $20,589,276 $20,202,700 $19,484,961
=========== ============ ============
AVERAGE
LIABILITIES AND
SHAREHOLDERS'
EQUITY:
Savings deposits $6,210,846 $179,168 2.88% $5,582,425 $161,839 2.90% $4,653,588 $126,575 2.72%
Time deposits:
Negotiable 1,314,921 65,402 4.97 1,188,380 65,454 5.51 1,602,994 79,209 4.94
Foreign 75,232 3,842 5.11 37,384 2,007 5.37 38,792 2,113 5.45
Other time 6,018,630 298,110 4.95 6,501,608 347,442 5.34 6,984,644 388,200 5.56
---------------------- ---------------------- ----------------------
Total interest-
bearing deposits 13,619,629 546,522 4.01 13,309,797 576,742 4.33 13,280,018 596,097 4.49
Federal funds
purchased and
repurchase
agreements 1,017,867 44,719 4.39 1,051,951 50,826 4.83 827,973 40,838 4.93
Other borrowed
funds 1,554,750 83,852 5.39 1,458,756 84,978 5.83 1,176,551 72,094 6.13
Subordinated debt 100,000 6,745 6.75 100,000 6,745 6.75 100,000 6,745 6.75
Capital
securities 100,000 6,407 6.41 100,000 6,736 6.74 91,781 6,282 6.84
---------------------- ---------------------- ----------------------
Total interest-
bearing funds 16,392,246 688,245 4.20 16,020,504 726,027 4.53 15,476,323 722,056 4.67
---------------------- ---------------------- ----------------------
Demand deposits 2,362,813 2,318,006 2,098,872
Other liabilities 320,195 282,704 302,775
Shareholders'
equity:
Common stock,
capital surplus
and retained
earnings 1,524,843 1,557,237 1,618,482
Unrealized
gain/(losses) on
securities
available-for-
sale (10,821) 24,249 (11,491)
----------- ------------ ------------
Total Liabilities
and Shareholders'
Equity $20,589,276 $20,202,700 $19,484,961
=========== ============ ============
Fully Taxable-
Equivalent Net
Interest Income $797,117 3.66% $760,961 3.46% $753,170 3.51%
========= ========= =========
Net Interest
Income as a
Percentage of
Average Earning
Assets 4.22% 4.09% 4.17%
Percentage of
Total Assets:
Foreign Assets -- -- --
Foreign
Liabilities 0.37% 0.19% 0.20%
(Income and rates 1996 1995
on fully taxable- ------------------------------ ------------------------------
equivalent basis, Average Average Average Average
dollars in thousands) Balance Interest Rate Balance Interest Rate
- --------------------------------------------------------------------------------------
Average Assets:
Loans(1)(2) $10,745,609 $963,763 8.97% $9,710,283 $881,651 9.08%
Taxable
investment
securities 4,960,887 316,597 6.38 5,050,611 332,128 6.58
Tax-exempt
investment
securities(2) 526,518 42,964 8.16 556,427 47,076 8.46
Mortgages held-
for-sale 363,891 28,619 7.86 246,600 19,301 7.83
Interest-earning
deposits:
Domestic 41,759 1,860 4.45 51,649 2,723 5.27
Foreign 6,885 390 5.66 42,599 2,515 5.90
Federal funds
sold and resale
agreements 154,166 8,338 5.41 299,998 18,053 6.02
Trading account
securities(2) 10,280 527 5.13 20,643 1,197 5.80
---------------------- ----------------------
Total earning
assets 16,809,995 1,363,058 8.11 15,978,810 1,304,644 8.16
---------------------- ----------------------
Unrealized
gain/(losses) on
securities
available-for-
sale (8,383) (16,701)
Allowance for
loan losses (203,788) (202,812)
Cash and due from
banks 656,786 597,386
Other assets 831,412 765,680
------------ ------------
Total Assets $18,086,022 $17,122,363
============ ============
Average
Liabilities and
Shareholders'
Equity:
Savings deposits $4,493,383 $123,166 2.74% $4,682,767 $130,709 2.79%
Time deposits:
Negotiable 1,777,434 91,681 5.16 2,034,875 111,288 5.47
Foreign 46,841 2,685 5.73 225,964 14,137 6.26
Other time 6,394,648 354,634 5.55 5,157,115 281,870 5.47
---------------------- ----------------------
Total interest-
bearing deposits 12,712,306 572,166 4.50 12,100,721 538,004 4.45
Federal funds
purchased and
repurchase
agreements 631,095 30,125 4.77 553,235 29,193 5.28
Other borrowed
funds 876,785 53,822 6.14 942,641 59,688 6.33
Subordinated debt 100,000 6,760 6.76 12,603 877 6.96
Capital
securities -- -- -- -- -- --
---------------------- ----------------------
Total interest-
bearing funds 14,320,186 662,873 4.63 13,609,200 627,762 4.61
---------------------- ----------------------
Demand deposits 1,952,929 1,826,600
Other liabilities 284,768 244,678
Shareholders'
equity:
Common stock,
capital surplus
and retained
earnings 1,541,904 1,454,680
Unrealized
gain/(losses) on
securities
available-for-
sale (13,765) (12,795)
------------ ------------
Total Liabilities
and Shareholders'
Equity $18,086,022 $17,122,363
============ ============
Fully Taxable-
Equivalent Net
Interest Income $700,185 3.48% $676,882 3.55%
========= =========
Net Interest
Income as a
Percentage of
Average Earning
Assets 4.17% 4.24%
Percentage of
Total Assets:
Foreign Assets 0.04% 0.25%
Foreign
Liabilities 0.26% 1.32%
- -----
(1) LOAN FEES ARE INCLUDED IN INTEREST INCOME AND ARE USED TO CALCULATE AVERAGE
RATES EARNED. NON-ACCRUAL LOANS ARE INCLUDED IN THE AVERAGE LOAN BALANCES.
(2) YIELDS ARE COMPUTED ON A FULLY TAXABLE-EQUIVALENT BASIS USING A FEDERAL TAX
RATE OF 35% IN ALL YEARS PRESENTED.
8
LOAN PORTFOLIO
As a financial intermediary, the acceptance and management of credit risk is an
integral part of Old Kent's business activities. The Corporation has
established strict credit underwriting standards. Except for certain loans,
these standards include a policy of granting loans only within Old Kent's
defined target market areas (primarily midwestern states) and prohibition of
foreign loans. Lending standards are codified in a comprehensive lending policy
which is uniform throughout the organization. Old Kent's lending staff is
highly skilled and experienced. The Corporation's conservative lending
philosophy is implemented through strong administrative and reporting
requirements. Old Kent maintains a centralized, independent loan review
function which monitors asset quality at its subsidiary banks. The Corporation
also employs a centralized group of specialists which assists the subsidiaries
in resolving troubled loans.
Percent
of
Composition of total loans at December 31, 1999: total
------------------------------------------------ -------
Commercial, financial, agricultural loans and leases 29%
Real estate loans--commercial and construction 30
---
Total commercial loans 59
Real estate loans--residential mortgages 14
Consumer home equity loans 16
Consumer loans (primarily automobile loans) 11
---
Total Loans 100%
===
One of Old Kent's strengths is its diversified loan portfolio. Approximately
41% of Old Kent's loan assets are comprised of credits granted to consumers in
the form of residential mortgages and a variety of other consumer credit
products, such as automobile loans, home equity loans, educational loans and
other consumer financings.
Beginning in late 1998, as a means of better leveraging its balance sheet to
enhance profitability, Old Kent began developing relationships to acquire
consumer loans originated primarily through flow arrangements with third party
originators. These loans, which largely consisted of home equity loans secured
by residential real estate, aggregated approximately $822 million in 1999 and
$39 million in 1998. The Corporation's underwriting criteria for these loan
originations closely parallel those for loans originated under Old Kent's
internal underwriting standards, and include a reasonable expectation of
appropriate returns based upon prudent assessments of risk, giving
consideration to collateral values and expected duration in relation to the
proposed transaction terms, and also included satisfactory completion of "due
diligence" by qualified Old Kent staff. The due diligence procedures followed
by the Corporation included an examination of the proposed loans; a review of
the historical performance of similar loans originated by the counterparty; and
consideration of the counterparty's reputation, history and its financial
viability. In those instances where the loans are serviced by the counterparty,
Old Kent also conducts on-site inspections of the servicer on a periodic,
ongoing basis.
At December 31, 1999, these purchased loans had a carrying value of $790
million, with an associated delinquency ratio of 1.2%. These purchases also
served to further geographically diversify the Corporation's credit risk, as
they generally consist of loans originated outside of Old Kent's primary
banking markets of Michigan, Illinois and Indiana. The credit risk of these
purchased consumer loan portfolios as a group is geographically diversified. As
of December 31, 1999, each of these purchased loan portfolios had performed in
accordance with, or better than, Old Kent's initial expectation at the time of
purchase. The Corporation continued this strategy during 2000, by acquiring
similar loan packages from time to time based on "flow" arrangements with
select counterparties, provided that such portfolios, and the originators,
continue to meet Old Kent's standards.
Old Kent has no foreign loans. Old Kent's policy is to be highly restrictive in
granting credit to borrowers in businesses which are highly cyclical, such as
agriculture and petroleum production. The Corporation is extremely selective in
participating in loan syndications.
9
The following table summarizes the components of the Corporation's total loans
at December 31 for each of the last two years:
December 31 (dollars in millions) 1999 1998
- -------------------------------------------------------
Commercial, financial and
agricultural loans $3,742.3 $3,353.0
Real estate loans--commercial 2,988.6 2,536.6
Real estate loans--
construction 1,204.3 835.7
Real estate loans--residential
mortgages 1,881.5 2,095.8
Consumer home equity loans 2,240.7 1,251.7
Consumer loans--other 1,582.0 1,548.7
Lease financing 262.3 166.4
--------- ---------
Total loans $13,901.7 $11,787.9
========= =========
PROVISION FOR CREDIT LOSSES
The provision for credit losses is the amount added to the allowance for credit
losses to absorb probable credit losses. The amount of the credit loss
provision is determined by management, in its judgment, after reviewing the
risk characteristics of the loan portfolio, historical credit loss experience
and economic conditions. These determinations are reviewed by Old Kent's
centralized, independent loan review function which monitors the credit quality
of the Corporation's loan portfolio through its uniform procedures, credit
grading and reporting systems.
The following table summarizes the credit loss provisions, net credit losses
and the allowance for credit losses for the last three years:
Year ended December 31
(dollars in thousands) 1999 1998 1997
- -------------------------------------------------------------
Provision for credit losses $35,388 $52,930 $59,673
Net credit losses 29,784 48,868 56,602
Allowance for credit losses at
year-end 206,279 200,555 196,968
Allowance as a percentage of:
Year-end loans 1.48% 1.70% 1.64%
Year-end loans, excluding loans
secured by residential first
and second mortgages 2.11% 2.38% 2.40%
Impaired loans 301% 260% 262%
Ratio of net charge-offs to
average loans outstanding during
the year 0.23% 0.42% 0.48%
Credit loss recoveries as a
percentage of prior year
charge-offs 36% 29% 29%
The provision for credit losses was $35.4 million in 1999, down from a
provision of $49.4 million in 1998, excluding a special merger-related credit
loss provision of $3.5 million to conform First Evergreen's credit review
process and reserves with those of Old Kent. Favorable credit quality combined
with the reduction in net credit losses justified a reduction of the provision
from that of 1998. Impaired loans at December 31, 1999, totaled $68.6 million,
a decrease of $8.7 million from $77.3 million at year-end 1998. At December 31,
1999, the ratio of the allowance to impaired loans was 301%. Over the past five
years, the Corporation's actual loss experience on residential real estate
loans has been negligible. At December 31, 1999, the ratio of the allowance to
total loans exclusive of residential mortgages was 2.11%.
10
The following table summarizes loan balances at the end of each period and the
daily averages; changes in the allowance for credit losses arising from loans
charged-off and recoveries on loans previously charged-off, by loan
classification; and additions to the allowance which have been charged to
expense:
Year ended December 31
(dollars in thousands) 1999 1998 1997
- --------------------------------------------------------------
Loans outstanding at end
of year $13,901,663 $11,787,940 $12,007,193
=========== =========== ===========
Daily average of loans
outstanding for year $12,702,217 $11,741,746 $11,817,598
=========== =========== ===========
Balance of allowance for
credit losses at
beginning of year $200,555 $196,968 $199,288
Net change in allowance
due to loans (sold) and
purchased 120 (475) (5,391)
Provision for credit
losses 35,388 52,930 59,673
Loans charged-off:
Commercial, financial
and agricultural loans 18,817 25,696 14,794
Real estate loans--
commercial 2,517 3,634 1,613
Real estate loans--
construction 549 179 922
Real estate loans--
residential mortgages 2,106 857 1,405
Consumer loans
(including home equity
loans) 28,001 35,739 37,114
Credit card loans -- 2 13,968
Lease financing 3,016 4,703 5,021
----------- ----------- -----------
Total charged-off 55,006 70,810 74,837
----------- ----------- -----------
Recoveries of loans
previously charged-off:
Commercial, financial
and agricultural loans 7,282 4,338 5,142
Real estate loans--
commercial 1,833 1,166 3,281
Real estate loans--
construction 31 58 73
Real estate loans--
residential mortgages 10 270 514
Consumer loans
(including home equity
loans) 14,298 14,552 7,106
Credit card loans -- 1 626
Lease financing 1,768 1,557 1,493
----------- ----------- -----------
Total recovered 25,222 21,942 18,235
----------- ----------- -----------
Balance of allowance for
credit losses at end of
year $206,279 $200,555 $196,968
=========== =========== ===========
The following tables summarize net credit losses (total loans charged-off less
total loans recovered), allocation of allowance for credit losses, and net
credit losses and their relationship to the daily average balances for
each loan type listed for the last three years:
Net credit losses (recoveries) for the year ended December 31
(in thousands) 1999 1998 1997
- ----------------------------------------------------------------------------------------
Commercial, financial and
agricultural loans $11,535 $21,358 $9,652
Real estate loans--commercial 684 2,468 (1,668)
Real estate loans--construction 518 121 849
Real estate loans--residential
mortgages 2,096 587 891
Consumer loans (including home
equity loans) 13,703 21,187 30,008
Credit card loans -- 1 13,342
Lease financing 1,248 3,146 3,528
------- ------- -------
Total net credit losses $29,784 $48,868 $56,602
======= ======= =======
Net credit losses as a percentage
of daily average
total loans .23% .42% .48%
======= ======= =======
11
Old Kent's reserve for credit losses ("reserve") is general in nature and
available to absorb credit losses of any loan segment. For analytical purposes
in the table below, Old Kent has allocated its reserve among all loan segments
at December 31, 1999. For the dates preceding 1999, the Corporation did not
allocate the reserve in its entirety.
Allocation of allowance for credit losses at December 31
(dollars in thousands) 1999 1998 1997
- -------------------------------------------------------------------------------
Percent Percent Percent
of of of
loans loans loans
to to to
total total total
Allowance loans Allowance loans Allowance loans
--------- ------- --------- ------- --------- -------
Commercial, financial
and agricultural $89,415 26.9% $80,000 28.4% $75,800 26.1%
Real estate--commercial 40,243 21.5 36,500 21.5 28,400 18.1
Real estate--
construction 13,138 8.7 12,200 7.1 4,700 6.2
Real estate--residential 14,038 13.5 9,600 17.8 10,700 23.2
Consumer loans
(including home equity
loans) 43,294 27.5 36,000 23.8 50,600 24.9
Leases 6,151 1.9 6,000 1.4 8,000 1.5
Not allocated -- -- 20,255 -- 18,768 --
-------- ----- -------- ----- -------- -----
Total allowance for
credit losses $206,279 100.0% $200,555 100.0% $196,968 100.0%
======== ===== ======== ===== ======== =====
Net credit losses as a percent of
daily average balance for the year 1999 1998 1997
- ------------------------------------------------------------
Commercial, financial and
agricultural loans 0.09% 0.18% 0.08%
Real estate loans--commercial -- 0.02 (0.01)
Real estate loans--construction -- -- 0.01
Real estate loans--residential
mortgages 0.02 0.01 0.01
Consumer loans (including home
equity loans) 0.11 0.18 0.25
Credit card loans -- -- 0.11
Leases 0.01 0.03 0.03
------- ------- -------
Total 0.23% 0.42% 0.48%
======= ======= =======
The decrease of 19 basis points in 1999 from 1998 is primarily the result of
continued conservative underwriting standards as well as a generally favorable
economy. As a result of the sale of the Corporation's credit card portfolio in
1997, net credit losses in this category were significantly reduced in 1998.
Net credit losses for 1998 included approximately $3 million, or .03% of
average total loans, attributable to Old Kent's application of its credit
evaluation policies and practices to First Evergreen's loan portfolio at the
time of the merger.
NONPERFORMING ASSETS
The following is a summary of nonperforming assets for the last two years:
December 31 (dollars in thousands) 1999 1998
- ---------------------------------------------------
Impaired loans:
Nonaccrual loans $66,395 $73,295
Restructured loans 2,210 3,964
------- -------
Total impaired loans 68,605 77,259
Other real estate owned 8,538 8,795
------- -------
Total nonperforming assets $77,143 $86,054
======= =======
Impaired loans as a percentage of
total loans 0.49% 0.66%
Loans past due 90 days or more, but for which interest income continues to be
recognized, are not included in the Corporation's nonperforming assets. The
following table summarizes such loans for the last two years:
December 31, (Dollars in thousands) 1999 1998
- ---------------------------------------------------
Loans past due ninety days or
more $14,854 $17,028
Loans past due ninety days or
more, as a percentage of total
loans 0.11% 0.14%
The loan portfolio has been reviewed and analyzed for the purpose of
estimating probable credit losses. The management of Old Kent believes that
the allowance for credit losses at December 31, 1999, is adequate to absorb
12
probable credit losses inherent in the loan portfolio. The Corporation's
policy dictates that specifically identified credit losses be recognized
immediately by a charge to the allowance for credit losses. This determination
is made for each loan at the time of transfer into impaired status after
giving consideration to collateral value and the borrowers' ability to repay
loan principal. Since Old Kent immediately recognizes losses on its impaired
loans, it has not become necessary to separately record a valuation allowance
on these assets. Because the ultimate collection of interest on impaired loans
is in doubt, any interest income recognized on these assets is generally
limited to cash collections of interest.
OTHER INCOME
Total non-interest income (excluding security transactions) increased 19.2%, or
$72.4 million, in 1999 compared to 26.5%, or $79.0 million, in 1998. Non-
interest income has become a proportionally greater component of Old Kent's
total revenues. In 1999, non-interest income was 36.0% of total revenues
compared to 33.1% for 1998, and 27.6% for 1997. This favorable change in
revenue mix is a direct result of Old Kent's goal to diversify its revenue
streams. A discussion of non-interest income components follows.
The following table summarizes the major categories of other income for the
last three years:
Year ended December 31 (in thousands) 1999 1998 1997
- --------------------------------------------------------------------
Mortgage banking revenues--net $192,296 $152,378 $98,144
Investment management and trust revenues 80,642 72,366 62,323
Deposit account revenue 78,153 74,401 66,544
Transaction processing revenue 22,891 20,832 16,082
Insurance sales commissions 24,139 21,216 15,066
Securities transactions 7,863 37,192 16,832
Other 50,746 35,235 39,351
-------- -------- --------
Total other income $456,730 $413,620 $314,342
======== ======== ========
MORTGAGE BANKING REVENUES
The Corporation's mortgage banking activities are conducted through its wholly-
owned subsidiary, Old Kent Mortgage Company ("OKMC"). OKMC is a full service
mortgage company, originating loans on a nationwide basis. OKMC is primarily
engaged in the origination, sale and servicing of single family mortgage
loans. OKMC also purchases and sells mortgage servicing portfolios. Revenues
for the mortgage banking line of business represented 15.3%, 13.0% and 9.2% of
the Corporation's fully taxable-equivalent net interest income plus
non-interest income for the years 1999, 1998, and 1997, respectively.
OKMC's profitability is impacted by the absolute level of interest rates as
well as their volatility. For example, loan origination volumes, including the
level of loan originations associated with loan refinancings, are highly
dependent upon interest rates for mortgage loans. Also, loan origination
commitments, loans held-for-sale and mortgage servicing rights are valued based
on Treasury and mortgage interest rates. Volatility in the Treasury and
mortgage interest rates can impact the recorded values of these assets.
Furthermore, policy setting decisions of government sponsored enterprises, such
as FNMA, FHLMC and GNMA, can also impact OKMC's business activities.
As discussed below, increases in interest rates during the latter part of 1999
had the effect of reducing demand for residential mortgages, especially
refinancings.
13
The following summarizes the mortgage banking activity and revenue for the past
three years:
Year ended December 31 (in thousands) 1999 1998 1997
- -------------------------------------------------------------------------------
Originations and acquisitions of mortgages
held-for-sale $12,228,588 $13,693,103 $6,926,939
=========== =========== ==========
Proceeds from sales and prepayments of
mortgages held-for-sale $13,540,066 $12,673,555 $6,313,959
=========== =========== ==========
Mortgage banking revenue (net), consisted
of:
Mortgage banking gains $164,073 $165,502 $71,381
Mortgage origination fees (net of direct
costs) 14,228 (848) 15,407
Mortgage loan servicing revenues (net of
direct costs) 13,995 (12,276) 11,356
----------- ----------- ----------
Total mortgage banking revenue (net) $192,296 $152,378 $98,144
=========== =========== ==========
December 31 (in millions) 1999 1998 1997
- -------------------------------------------------------------------------------
Mortgages serviced for third parties $14,726 $14,568 $12,261
Mortgages held-for-sale 901 2,272 1,280
Mortgage loans serviced by Old Kent for
its own portfolio 1,593 1,555 1,735
----------- ----------- ----------
Total mortgages serviced $17,220 $18,395 $15,276
=========== =========== ==========
The following table summarizes location and origination volume for the past
three years:
December 31 1999 1998 1997
- -------------------------------------------------------------------------------
States/Offices 32/147 32/143 25/104
Originations (in billions) $12.2 $13.7 $6.9
Loan origination volumes declined slightly from 1998 to 1999. Higher interest
rates during the latter part of 1999 reduced the level of loan origination
volumes, particularly refinancings. In contrast, refinancing activity during
1998 contributed to the high level of loan origination volume during that year.
Gain on sale of loans and mortgage origination fees remained high despite the
slowdown in mortgage production volume in 1999 compared to 1998. The
origination of government and specialty loans and an increase in the loan
volume generated from the retail production franchise contributed to the strong
level of fee income and gains on sales of loans.
OKMC is an active seller of mortgage servicing portfolios. The Corporation views
these sales as an opportunity to maximize the value of the mortgage servicing
rights retained on the balance sheet while simultaneously limiting the exposure
of the Corporation to changes in the value of mortgage servicing rights. At
December 31, 1999, OKMC had commitments to sell mortgage servicing rights
associated with between $2.5 and $5.0 billion of newly originated conventional
mortgage loans.
Mortgage servicing revenue increased significantly during 1999. Higher mortgage
interest rates contributed to slowing prepayment speeds and increased the value
of existing servicing rights. As a result, the rate of servicing rights
amortization was reduced and the servicing valuation reserve decreased by $9.1
million. In contrast, mortgage servicing revenues in 1998 were adversely
impacted by lower mortgage interest rates and higher mortgage refinancing
activity and prepayments. Therefore, the rate of servicing rights amortization
increased and the servicing valuation reserve rose by $4.5 million.
For the past three years, net mortgage servicing revenue was comprised of:
Year ended December 31 (in thousands) 1999 1998 1997
- ------------------------------------------------------------------------------
Mortgage servicing revenues $68,374 $53,727 $42,933
Amortization of servicing rights and other
direct servicing costs (63,508) (61,503) (31,430)
Change in servicing valuation reserve 9,129 (4,500) (147)
--------- -------- --------
Mortgage loan servicing revenues (net of direct
costs) $13,995 $(12,276) $11,356
========= ======== ========
14
The following reflects changes in the carrying value of mortgage servicing
rights:
Year ended December 31 (in thousands) 1999 1998 1997
- ------------------------------------------------------------------------------
Balance at beginning of period $221,983 $148,435 $97,735
Additions 257,925 204,224 112,172
Sales (155,839) (73,740) (30,457)
Amortization (55,654) (52,436) (30,868)
Change in servicing valuation reserve 9,129 (4,500) (147)
--------- -------- --------
Balance at end of period $277,544 $221,983 $148,435
========= ======== ========
Estimated fair value of mortgage servicing
rights $323,000 $255,000 $168,043
========= ======== ========
INVESTMENT MANAGEMENT AND TRUST REVENUES
Investment management and trust activities also generate a significant amount
of revenue for Old Kent. Trust revenues increased to $80.6 million in 1999, up
$8.3 million, or 11.4%, over 1998. This compares to a $10.0 million increase, or
16.1%, in 1998. These increases reflect the Corporation's commitment to growth
and optimization of its fee-based businesses, and resulted from successful,
aggressive sales and new business development efforts.
DEPOSIT ACCOUNT REVENUES
Service charges on deposit accounts increased to $78.2 million in 1999, an
increase of $3.8 million, or 5.0%. This compares to an increase of $7.9
million, or 11.8%, in 1998. These increases were due both to an increase in the
customer base and to Old Kent's continuing focus on improving non-interest
revenues.
TRANSACTION PROCESSING FEES
Transaction processing fees include items such as fees and commissions on money
orders and travelers checks, foreign exchange fees, debit card interchange
income, check cashing and collection charges. These revenues totaled $22.9
million in 1999 and $20.8 million in 1998.
INSURANCE SALES COMMISSIONS
The increase in insurance sales commissions to $24.1 million in 1999, $21.2
million in 1998 and $15.1 million in 1997 is due to the Corporation's emphasis
on fee-based revenues and new business development efforts. At December 31,
1999, Old Kent Insurance Group was the largest bank-owned insurance agency in
the State of Michigan.
OTHER EXPENSES
The following table summarizes the major categories of other expenses for the
last three years:
Year ended December 31 (in thousands) 1999 1998 1997
- ---------------------------------------------------------------------
Salaries $326,731 $302,224 $274,902
Employee benefits 54,493 59,327 58,863
Occupancy 58,064 53,505 50,229
Equipment 49,281 45,948 41,173
Professional services 48,941 32,560 29,369
Telephone and telecommunications 25,426 20,863 16,362
Postage and courier charges 19,063 18,559 16,357
Amortization of goodwill and core deposit
intangibles 19,928 19,900 19,152
Merger related charges 26,000 24,993 --
Other 137,952 125,724 107,325
-------- -------- --------
Total other expenses $765,879 $703,603 $613,732
======== ======== ========
15
SALARIES AND EMPLOYEE BENEFITS
Salaries and employee benefits represent the largest category of non-interest
expense. These personnel costs increased by $19.7 million in 1999 and $27.8
million in 1998 primarily due to growth and expansion of OKMC, and increased
staffing of the Investment and Insurance Services line of business. In
addition, during 1999, Old Kent shifted a greater portion of its compensation
to a "pay for performance" sales incentive based structure. This shift had a
favorable influence on total revenues as discussed above. Old Kent measures its
staff size in terms of full-time equivalent ("FTE") employees. Full-time
equivalency expresses staff size by translating the efforts of part-time
employees and over-time hours into the equivalent efforts of full-time
employees.
OCCUPANCY AND EQUIPMENT EXPENSE
Occupancy expense increased by $4.6 million, or 8.5%, in 1999 due primarily to
the geographic expansion of OKMC. Occupancy expense increased by $3.3 million,
or 6.5%, in 1998 due to the effect of OKMC business acquisitions. The table
below summarizes occupancy expense for the years indicated:
Occupancy expense for the year 1999 over
(dollars in thousands) 1998 1999 1998 1997
- -------------------------------------------------------------------
Banking $662 $44,191 $43,529 $43,222
Mortgage banking 4,046 12,574 8,528 6,076
Insurance, leasing and brokerage (149) 1,299 1,448 931
------ ------- ------- -------
Total occupancy expense $4,559 $58,064 $53,505 $50,229
====== ======= ======= =======
Equipment expense increased by approximately $3.3 million in 1999 as compared
to the prior year. This increase includes the effects of expansion by OKMC. It
also reflects the effects of changes in Old Kent's retail delivery system. Old
Kent increased its use of ATMs and other technology based delivery mechanisms
(such as telecommunications based services) as a means of improving and
expanding retail service access.
PROFESSIONAL SERVICES
Expenses related to professional services increased to $48.9 million, or 50.3%,
from 1998 to 1999. The increase was primarily related to outside support in the
origination and servicing of mortgage loans, a decision to outsource
maintenance and processing of the Corporation's trust system and technology
support related to the Corporation's year 2000 remediation.
MERGER-RELATED CHARGES
During the third quarter of 1999, Old Kent recognized $17.6 million of after-
tax, merger-related charges which had the effect of reducing diluted earnings
per share by $.13. On a pre-tax basis, the charges consisted of: transaction
costs of $2.0 million; employment charges of $11.8 million, primarily related
to reduction of redundant staffing; and $12.2 million mainly associated with
contract cancellation costs and asset obsolescence for duplicate operations.
During 2000, Old Kent recognized additional merger related charges
associated with the acquisitions of Merchants Bancorp, Inc. and Grand Premier
Financial, Inc.
During the fourth quarter of 1998, Old Kent recognized $19.7 million of after-
tax, merger related charges which had the effect of reducing diluted earnings
per share by $.13. On a pre-tax basis, the charges consisted of: transaction
costs of $6.0 million; employment charges of $9.4 million, primarily related to
reduction of redundant staffing; $9.6 million mainly associated with contract
cancellation costs and asset obsolescence for duplicate operations; and a $3.5
million special loan loss provision to conform First Evergreen's credit review
process and reserves to Old Kent's.
YEAR 2000 READINESS DISCLOSURE
The Old Kent corporate compliance program was developed in 1995 and was a three
phased project plan managed through a central Year 2000 project office. All
three phases of the project have been successfully completed as
16
scheduled. Old Kent has been operating successfully in the 2000 environment
since December 31, 1999, with no material issues encountered.
Diagnosis, reprogramming, and other remedies were projected to result in
expenditures of approximately $16 million over the four years ended December
31, 1999. Cumulative expenditures totaled $15.9 million for the four year
period ended December 31, 1999.
INCOME TAXES
The income tax provision was $149.5 million in 1999, $136.2 million in 1998,
and $126.9 million in 1997. Income tax expense as a percentage of pre-tax
income was 34.9% in 1999, 34.3% in 1998, and 33.9% in 1997.
OLD KENT COMMON STOCK
Old Kent Common Stock is traded on The New York Stock Exchange under the symbol
OK. The following table sets forth the range of prices for Old Kent Common
Stock for the periods indicated. Prices for periods prior to December 2, 1998,
represent bid quotations on The NASDAQ Stock Market. Prices have been adjusted
to reflect 5% stock dividends distributed in both 1999 and 1998.
1999 1998
------------- -------------
Quarter Low High Low High
------- ------ ------ ------ ------
1st $37.64 $42.86 $31.10 $35.42
2nd 38.10 44.62 32.33 35.79
3rd 34.89 42.62 26.19 36.06
4th 31.96 40.24 26.42 42.18
CASH DIVIDENDS
The Corporation has paid regular cash dividends every quarter since it was
organized as a bank holding company in 1972. Including the history of Old Kent
Bank and Trust Company prior to organization of its holding company, Old Kent
has increased its cash dividends per share in each of the last 41 years. The
following table summarizes the quarterly cash dividends paid to common
shareholders over the past three years, adjusted for five percent stock
dividends paid during the third quarter in 2000, and each of the past three
years, and for a two-for-one stock split paid in December, 1997.
Quarter 1999 1998 1997
------- ------ ------ ------
1st $0.181 $0.155 $0.140
2nd 0.181 0.155 0.140
3rd 0.190 0.164 0.146
4th 0.210 0.181 0.155
------ ------ ------
Total $0.762 $0.655 $0.581
====== ====== ======
The earnings of Old Kent's subsidiary banks are the principal source of funds
to pay cash dividends. Consequently, cash dividends are dependent upon the
earnings, capital needs, regulatory constraints and other factors affecting
each individual bank. The Corporation continued to declare and pay regular
quarterly cash dividends on its common shares in 2000.
CAPITAL
At December 31, 1999, the Corporation's total equity was $1.5 billion, or 5.7%,
less than the preceding year-end total. As shown in the accompanying
onsolidated financial statements and described in Note 13 to the Consolidated
Financial Statements, Old Kent repurchased stock in each of the last three
years under authorizations which included reacquiring shares to reissue in
connection with future stock dividends, employee stock plans, and certain other
corporate purposes. These repurchases have favorably influenced earnings per
share and return on average equity. The Corporation continued to repurchase
its common stock in 2000, under the June, 1999, authorization cited in Note
13 to the Consolidated Financial Statements included in Exhibit 99.1 to this
Form 8-K.
17
Statement of Financial Accounting Standard ("SFAS") No. 115, "Accounting for
Certain Investments in Debt and Equity Securities" ("SFAS 115"), requires that
the "after-tax" unrealized gain or loss on securities available-for-sale be
carried as a separate component of comprehensive income. At December 31, 1999
this after-tax loss was $118.4 million compared to a gain of $7.0 million on
December 31, 1998. Market values of securities, particularly those that are of
longer terms, and which have fixed rates of interest, are subject to price
volatility depending upon changes in interest rates. Under SFAS 115, total
shareholders' equity will be subject to favorable or unfavorable influences of
the financial markets on the fair values of securities available-for-sale.
Under the risk-based capital regulations presently in effect for banks and bank
holding companies, minimum capital levels are based on the perceived risk of
various asset categories, and certain off-balance sheet instruments, such as
loan commitments and letters of credit. Banks and bank holding companies are
required to maintain certain minimum ratios. As shown in Note 23 to the
Consolidated Financial Statements, at December 31, 1999, ratios of Old Kent and
its subsidiary banks exceeded the regulatory guidelines to be considered "well
capitalized" for regulatory purposes. At December 31, 1999, the ratio of total
shareholders' equity to total assets was 7.2% compared to 7.5% one year
earlier.
The Corporation has generally financed its growth through the retention of
earnings and the issuance of long-term debt. It is expected that future growth
can be financed through internal earnings retention, additional long-term debt
offerings, or the issuance of additional common or preferred stock or other
capital instruments.
LIQUIDITY AND MARKET RISK MANAGEMENT
LIQUIDITY
Old Kent manages its liquidity to ensure that funds are available to each of
its banks to satisfy the cash flow requirements of depositors and borrowers and
to ensure that the Corporation's own cash requirements are met. Old Kent
maintains liquidity by obtaining funds from several sources.
Old Kent's most readily available source of liquidity is its investment
portfolio. Old Kent's securities available-for-sale, which totaled $3.2 billion
at December 31, 1999, represent a highly accessible source of liquidity. The
Corporation's portfolio of securities held-to-maturity, which totaled $609
million at December 31, 1999, provides liquidity from maturities and
amortization payments. The Corporation's mortgages held-for-sale provide
additional liquidity. These loans represent recently funded home mortgage loans
that are being prepared for delivery to investors, which generally occurs
within thirty to ninety days after the loan has been funded.
Depositors within Old Kent's defined markets are another source of liquidity.
Core deposits (demand, savings, money market, and consumer time deposits)
totaled $14.4 billion at December 31, 1999. These same markets offer additional
liquidity in the form of large deposit instruments and other equivalent non-
deposit products. Additionally, Old Kent Bank may access the federal funds
markets or utilize collateralized borrowings.
The national capital markets represent a further source of liquidity to Old
Kent. Old Kent filed three shelf registrations, which are intended to permit
Old Kent to raise capital through sales of additional securities with a
relatively short lead time. A $250 million shelf registration registers common
stock, preferred stock, depository shares, debt securities, and warrants for
future sale. A second shelf registration registers an additional $200 million
of trust preferred securities for future sale. The proceeds of any issuance
will be for general corporate purposes, which may include reducing debt and
repurchasing common stock. The third shelf registration was filed to register
2.5 million shares of common stock to use in future small, stock-based
acquisitions.
Old Kent Bank has implemented a bank note program which permits it to issue up
to $2.0 billion of short-term and medium-term notes. This program is intended
to enhance liquidity by enabling Old Kent Bank to sell its debt instruments in
the public markets in the future without the delays which would otherwise be
incurred. As shown in Note 10 to the Consolidated Financial Statements
included in Exhibit 99.1 to this Form 8-K, there were $500 million of bank
notes outstanding at December 31, 1999.
18
CREDIT RATINGS AT DECEMBER 31, THOMSON STANDARD
1999 BANKWATCH MOODY'S & POOR'S
------------------------------ --------- ------- --------
OLD KENT FINANCIAL CORPORATION:
Issuer A/B -- --
Short-term TBW-1 -- --
Long-term senior debt -- A2 --
Long-term subordinated debt A+ A3 A-
OLD KENT BANK:
Short-term TBW-1 P-1 A-1
Long-term senior debt AA- A1 A
OLD KENT CAPITAL TRUST I: -- "a2" BBB+
Federal and state banking laws place certain restrictions on the amount of
dividends and loans which a bank may make to its parent company. Such
restrictions have not had, and are not expected to have, any material effect on
the Corporation's ability to meet its cash obligations.
MARKET RISK MANAGEMENT
Old Kent faces market risk to the extent that the fair values of its financial
instruments are affected by changes in interest rates, foreign currency
exchange rates, commodity prices, equity prices, or other market factors. The
Corporation's market risk exposure is mainly comprised of its sensitivity to
interest rate risk. The Corporation is sensitive, in various categories of
assets, liabilities and off-balance sheet positions, to changes in prevailing
rates in the U.S. for the prime rate, mortgage rates, U.S. Treasury rates and
various money market indices. The asset/liability management discipline as
applied at Old Kent seeks to limit the volatility of both earnings and the
value of capital that can result from changes in market interest rates. This is
accomplished by matching asset and liability principal balances that re-price
and mature, estimating how administered rates adjust, simulating business
results under varying interest rate scenarios, and estimating the change in the
net present value of the Corporation's assets, liabilities, and off-balance
sheet instruments due to interest rate changes. Principal maturities and
re-pricing profiles are monitored through static gap analysis, business results
are simulated, and the net present value of the Corporation's financial
instruments is estimated through computer modeling. These different measurement
techniques offer complementary information to assist management to better
understand and mitigate the possible negative impact that interest rate changes
can have on the Corporation.
Virtually all of the Corporation's financial instruments have been entered into
for non-trading purposes. The Corporation held no securities in its trading
account as of December 31, 1999 and only occasionally warehouses securities in
this account for re-sale to customers or for liquidation. Accordingly, the
Corporation does not consider the market risk of its trading portfolio to be
material. The Corporation's foreign exchange activities are primarily limited
to fixing forward currency settlements for customers and then offsetting those
positions with approved counterparties. Since the customer forward settlements
are fully offset with counterparty contracts, the Corporation does not consider
the market risk of its foreign exchange activities to be material.
19
STATIC GAP ANALYSIS: The management of interest rate sensitivity includes
monitoring the maturities and re-pricing opportunities of interest-earning
assets and interest-bearing liabilities. The following table summarizes the
interest rate re-pricing gaps for selected maturity periods as of December 31,
1999:
0-30 31-90 91-180 181-365 1-5 Over 5
(IN MILLIONS) Days Days Days Days Years Years Total
- -------------------------------------------------------------------------------------
Non-loan interest-
earning assets $89 $118 $187 $297 $1,779 $1,507 $3,977
Loans 4,808 1,049 591 1,184 5,444 1,727 14,803
------ ------- ------- ------- ------ ------ ------
Total interest-earning
assets 4,897 1,167 778 1,481 7,223 3,234 18,780
------ ------- ------- ------- ------ ------ ------
Savings & money market
accounts* 1,173 1,280 36 71 438 3,149 6,147
Domestic time deposits 983 1,464 1,671 1,823 1,178 66 7,185
Foreign time deposits 105 -- -- 5 -- -- 110
Purchased funds and
long-term debt 2,028 246 87 41 305 317 3,024
------ ------- ------- ------- ------ ------ ------
Total interest-bearing
liabilities 4,289 2,990 1,794 1,940 1,921 3,532 16,466
------ ------- ------- ------- ------ ------ ------
Interest-earning assets
less interest-bearing
liabilities 608 (1,823) (1,016) (459) 5,302 (298) 2,314
Impact of interest rate
swaps (425) (195) 200 200 220 -- --
------ ------- ------- ------- ------ ------ ------
Asset (liability) gap $183 $(2,018) $(816) $(259) $5,522 $(298) $2,314
Cumulative asset gap $183 $(1,835) $(2,651) $(2,910) $2,612 $2,314
Cumulative gap as a
percentage of
cumulative earning
assets 3.7% (30.3)% (38.7)% (35.0)% 16.8% 12.3%
- --------
* (THE PLACEMENT OF INDETERMINATE MATURITY DEPOSITS ON THE GAP ANALYSIS
REPRESENTS AN ALLOCATION OF 19% OF THE BALANCES TO THE 0-30 DAYS PERIOD, 21%
TO THE 31-90 DAYS PERIOD, 1% TO THE 91-180 DAYS PERIOD, 1% TO THE 181-365
DAYS PERIOD, 7% TO THE 1-5 YEARS PERIOD, AND 51% TO THE OVER 5 YEARS PERIOD
EVEN THOUGH THESE DEPOSITS ARE PAYABLE ON DEMAND.
THIS DISTRIBUTION IS BASED ON HISTORICAL ANALYSES OF THE AMOUNT BY WHICH THE
RATES PAID ON THESE DEPOSITS CHANGED AS ALTERNATIVE MARKET RATES CHANGED,
AND ON THE ESTIMATED SENSITIVITY OF BALANCES TO CHANGES IN SUCH ALTERNATIVE
MARKET RATES.)
Total interest-earning assets exceeded interest-bearing liabilities by $2.3
billion at December 31, 1999. This difference was funded through non-interest-
bearing liabilities and shareholders' equity. The above table shows that total
liabilities maturing or re-pricing within one year exceed assets maturing or
re-pricing within one year by $2.9 billion. However, the re-pricing and cash-
flows of certain categories of assets and liabilities are subject to
competitive and other influences that are beyond the control of Old Kent. As
a result, certain assets and liabilities indicated as maturing or re-pricing
within a stated period may, in fact, mature or re-price in other periods or at
different volumes.
SIMULATION: Old Kent recognizes the limitations of static gap analysis as a
tool for managing its interest rate risk. Old Kent also uses a computer-based
earnings simulation model to estimate the effects of various interest rate
environments on the balance sheet structure and net interest income. These
simulation techniques involve changes in interest rate relationships, asset and
liability mixes, and prepayment options inherent in financial instruments, as
well as interest rate levels in order to quantify risk. The Corporation's
sensitivity is estimated by first forecasting the next twelve months of net
interest income under an assumed environment of constant market interest rates.
Next, immediate parallel interest rate shocks are constructed in the model.
These rate shocks reflect changes of equal magnitude to all market interest
rates. The Corporation's next twelve months of net interest income are then
forecast under each of the rate shock scenarios. The resulting change in net
interest income is an indication of the sensitivity of the Corporation's
earnings to directional changes in market interest rates. This model is based
solely on parallel changes in market rates and does not reflect the levels of
interest rate risk that may arise from other factors such as changes in the
spreads between key market rates or in the shape of the Treasury yield curve.
The net interest income simulation model includes both on-balance sheet loan,
investment, deposit, and debt instruments as well as off-balance sheet interest
rate swaps.
The Corporation's forecasted net interest income sensitivity is monitored by
the corporate Asset/Liability Committee which has established limits in the
interest rate risk limit policy. Throughout 1999, the forecasted exposure was
within the Corporation's established policy limits.
20
Net Interest Income Sensitivity: Change vs. Projected Results under Constant
Rates
YEAR-END 1999 12 MONTH PROJECTION
ALCO
RATE SHOCK AMOUNT: (2.00)% (1.00)% 0.00% 1.00% 2.00% POLICY
- ------------------ ------- ------- ----- ------ ------ --------
Percent change in net interest 1.3% 1.0% -- (1.5)% (2.8)% (10.00)%
income vs. constant rates
YEAR-END 1998 12 MONTH PROJECTION
ALCO
RATE SHOCK AMOUNT: (2.00)% (1.00)% 0.00% 1.00% 2.00% POLICY
- ------------------ ------- ------- ----- ------ ------ --------
Percent change in net interest (.5)% .1% -- (.7)% (1.6)% (10.00)%
income vs. constant rates
Note: The Year-End 1998 Net Interest Income Sensitivity Profile has not been
restated to include Grand Premier. The required data was not available
and it was impracticable to re-create the analysis for that entity.
An important component of Old Kent's management of interest rate risk is the
Corporation's use of interest rate swaps. At December 31, 1999 the total
notional amount (the amount used to calculate interest) of outstanding interest
rate swap agreements used to manage interest rate risk was $1.4 billion. For
1999 and 1998, Old Kent's interest rate swaps increased net interest income by
approximately $6.8 million and $5.1 million respectively. This improved the
Corporation's net interest margin by .04% in 1999 and by .03% in 1998. The
following table presents information regarding swap activity during 1999:
SWAP ACTIVITY
12/31/98 Matured or New Swap 12/31/99
(In millions) Notional Called Cancelled Notional Notional
- --------------------------------------------------------------------------
Receive fixed/pay floating $819.9 $(100.0) $(200.0) $510.0 $1,029.9
Receive floating/pay fixed 60.0 0.0 (50.0) 400.0 410.0
------ ------- ------- ------ --------
$879.9 $(100.0) $(250.0) $910.0 $1,439.9
====== ======= ======= ====== ========
SWAP MATURITY PROFILE
Notional amounts of swaps are scheduled to mature as follows:
(in millions) 2000 2001 2002 2003 2004+ Total
- ----------------------------------------------------------------------
Receive fixed/pay floating $400.0 $194.9 $425.0 $ -- $10.0 $1,029.9
Receive floating/pay fixed -- 210.0 100.0 100.0 -- 410.0
--------
$1,439.9
========
The weighted average interest rates for the above swap portfolio are summarized
as follows:
At December At December
31, 1999 31, 1998
------------- -------------
Receive Pay Receive Pay
Rate Rate Rate Rate
------- ----- ------- -----
Receive fixed/pay floating 6.71% 6.68% 6.34% 5.30%
Receive floating/pay fixed 5.48% 5.99% 5.30% 5.54%
ECONOMIC VALUE OF EQUITY: As part of the Corporation's asset/liability
management process, quarterly estimations are conducted that measure the net
present value of Old Kent's current financial instruments--also referred to
as the economic value of equity. The process involves estimating the principal
and interest cash flows for all financial instruments and then discounting
those cash flows back to their present value using discount rates for products
of similar duration and credit quality. The economic value of equity is
defined as the Corporation's book equity plus the net present value of the
asset, liability, and off-balance sheet instruments. The measurement is first
21
conducted under an assumed environment of unchanged market interest rates.
Next, net present value measurements are conducted under various levels of
parallel market interest rate shocks. The resulting change in economic value
of equity under rate shocks is an indication of the fair value variability
of the Corporation's financial instruments as of the reporting date.
The economic value of equity model includes both on-balance sheet loan,
investment, mortgage servicing rights, deposit, and debt instruments as well as
off-balance-sheet interest rate swaps, Treasury futures and options, mortgage
forward sales contracts, and mortgage options. The cash flows for instruments
containing options are adjusted to reflect expected results under each rate
shock scenario. Those adjustments are made by considering both the specific
terms of certain instruments (e.g. callable bonds) and market consensus
forecasts about specific asset classes (e.g. mortgage-backed securities). This
measure does not reflect the impact of new financial instruments or of changes
in loan production volume that would be expected to occur as interest rates
change. For example, management believes that lower market interest rates would
significantly increase mortgage production volume and income, more than
offsetting any decrease in the value of mortgage servicing rights that is
reflected in the economic value of equity measure below.
The magnitude of the change in the economic value of equity is monitored by the
corporate Asset/Liability Committee which has established limits in the
interest rate risk limit policy. Throughout 1999, the estimated variability of
the economic value of equity was within the Corporation's established policy
limits.
Economic Value of Equity
Sensitivity Change vs. Results under Constant Rates
YEAR-END 1999 ECONOMIC VALUE OF EQUITY PROFILE
ALCO
Rate Shock Amount: (2.00)% 0.00% 2.00% Policy
- ------------------ ------- ----- ------ -------
Static Economic Value of Equity Change (.8)% -- (9.1)% (16.0)%
YEAR-END 1998 ECONOMIC VALUE OF EQUITY PROFILE
ALCO
Rate Shock Amount: (2.00)% 0.00% 2.00% Policy
- ------------------ ------- ----- ------ -------
Static Economic Value of Equity Change (9.4)% -- (1.9)% (16.0)%
Note: The Year-End 1999 Economic Value of Equity Profile has not been restated
to include Merchants Bancorp and Grand Premier Financial. The required data
was not available and it was impracticable to re-create the analysis for those
entities. The Year-End 1998 Economic Value of Equity Profile has not been
restated to include Merchants, Grand Premier, CFSB and Pinnacle. The required
data was not available and it was impracticable to re-create the analysis for
those entities.
The Corporation's projected net interest income sensitivity and economic value
of equity sensitivity both indicate a slightly greater exposure to an upward
2.00% rate shock at December 31, 1999 than at December 31, 1998. This is
primarily due to three factors that developed throughout 1999. First, most of
the Corporation's loan growth occurred in fixed rate products. Second,
customers shifted a larger portion of their deposit dollars into accounts that
are more sensitive to changes in interest rates. Third, the forecasted
prepayment speeds for the corporation's mortgage-related assets were lowered as
market rates rose and re-finance activity slowed. These three factors combined
to lengthen the maturity and re-pricing sensitivity of assets and to shorten the
re-pricing sensitivity of liabilities. Management partially offset this trend by
cancelling existing pay floating swaps, entering new pay fixed swaps, and
increasing its medium-term fixed rate borrowings from the Federal Home Loan
Bank.
Despite the above change in the Corporation's interest rate risk profile, the
estimated sensitivity as of December 31, 1999 is well within approved policy
limits and is not believed to represent a material exposure to interest rate
risk.
SECURITIES HELD-TO-MATURITY
Securities held-to-maturity are purchased with the intent and ability to hold
for long-term investment for the purpose of generating interest income over the
lives of the investments. Thus, they are carried on the books at cost, adjusted
for amortization of premium and accretion of discount.
22
SECURITIES AVAILABLE-FOR-SALE
Securities available-for-sale include those securities which might be sold as
part of Old Kent's management of interest risk, in response to changes in
interest rates, prepayment or credit risk, or due to a desire to increase
capital measures or liquidity. These assets are carried on the balance sheet at
their estimated fair values, with corresponding (after-tax) valuation
adjustments included as a component of shareholders' equity. Premiums and
discounts are amortized over the estimated lives of the related securities.
In 1999, net gains on the sale of securities were $7.9 million. This compares
to net gains of $37.2 million in 1998 and $16.8 million in 1997. The primary
sources of these gains were the activities of merged affiliates. As previously
noted, the mergers were accounted for as poolings-of-interests transactions and
all periods have been restated to reflect these business combinations.
SOURCES AND USES OF FUNDS TRENDS
As shown on the Consolidated Balance Sheets set forth in Exhibit 99.1, total
assets at December 31, 1999, were $20.6 billion, down by $548.4 million, or
2.6%, from the preceding year-end. In general, Old Kent's management relies
more on the use of daily average balances, than on balances at a period end,
to analyze trends. Old Kent's Average Consolidated Balance Sheet for the last
five years appears earlier in this Exhibit 99.3. Information contained in that
statement was the basis for the summarized trends in sources and uses of funds
appearing below.
1999 1998
------------------------- --------------------------
Increases Increases
(Decreases) (Decreases)
Average --------------- Average ----------------
(dollars in millions) Balance Amount Percent Balance Amount Percent
- ------------------------- --------- ------ ------- --------- ------- -------
Funding Uses:
Loans $12,702.2 $960.5 8.2% $11,741.7 $ (75.9) (6.4)%
Mortgages held-for-sale 1,595.8 (156.4) (8.9) 1,752,2 849.0 94.0
Taxable securities 3,714.6 (684.1) (15.6) 4,398.7 (203.1) (4.4)
Tax-exempt securities 737.9 150.6 25.6 587.3 57.5 10.9
Interest-earning
deposits 13.0 (7.0) (35.0) 20.0 (3.3) (14.2)
Federal funds sold and
resale agreements 92.8 (7.4) (7.4) 100.2 (43.0) (30.0)
Trading account
securities 30.1 16.5 121.3 13.6 (7.9) (36.7)
--------- ------ --------- -------
Total Uses $18,886.4 $272.7 1.5% $18,613.7 $573.3 3.2%
========= ====== ========= =======
Funding Sources:
Demand deposits $2,362.8 $44.8 1.9% $2,318.0 $219.1 10.4%
Savings deposits 6,210.8 628.4 11.3 5,582.4 928.8 20.0
Time deposits:
Negotiable 1,314.9 126.5 10.6 1,188.4 (414.6) (25.9)
Foreign 75.2 37.8 101.1 37.4 (1.4) (3.6)
Consumer 6,018.6 (483.0) (7.4) 6,501.6 (483.0) (6.9)
Federal funds purchased
and repurchase
agreements 1,017.9 (34.1) (3.2) 1,052.0 224.0 27.1
Other borrowed funds 1,554.8 96.0 6.6 1,458.8 282.2 24.0
Long-term debt 200.0 -- -- 200.0 8.2 4.3
Other 131.4 (143.7) (52.2) 275.1 (190.0) (40.8)
--------- ------ --------- -------
Total Sources $18,886.4 $272.7 1.5% $18,613.7 $573.3 3.2%
========= ====== ========= =======
During 1999, loans averaged $12.7 billion, an increase of 8.2% over 1998. The
primary funding source to accommodate this growth was a reduction of securities
balances as well as higher demand and savings deposit balances.
Lower interest rates over the years preceding 1995 had an effect on the
relative mix in Old Kent's core deposits. During these periods of lower rates,
consumer time deposits grew to become a proportionally greater component of
average core deposits as shown in the table below. However, since 1997, higher
yielding rates were paid on our savings products as rates on consumer time
deposits fell. This had the effect of increasing the percentage of savings
deposits while the proportion of consumer time products fell.
23
QUARTERLY FINANCIAL DATA
The following is a summary of selected quarterly results of operations for the
years ended December 31, 1999 and 1998:
Three Months Ended
-----------------------------------
1999 March 31 June 30 Sept. 30 Dec. 31
- ---- -------- -------- -------- --------
(dollars in thousands, except per
share data)
Interest income $357,987 $360,580 $369,941 $372,855
Net interest income 186,820 192,595 198,968 194,735
Provision for credit losses 8,196 5,964 8,358 12,870
Income before income taxes 113,917 112,267 91,068 111,328
Net income 74,479 72,416 58,985 73,238
Basic earnings per share $.53 $.52 $.42 $.53
Diluted earnings per share $.52 $.51 $.42 $.53
Three Months Ended
-----------------------------------
1998 March 31 June 30 Sept. 30 Dec. 31
- ---- -------- -------- -------- --------
(dollars in thousands, except per
share data)
Interest income $371,395 $367,286 $360,113 $367,436
Net interest income 185,776 182,908 183,618 187,902
Provision for credit losses 17,261 13,248 10,007 12,414
Income before income taxes 98,305 104,730 119,769 74,486
Net income 64,619 68,388 78,544 49,586
Basic earnings per share $.44 $.47 $.56 $.35
Diluted earnings per share $.43 $.46 $.56 $.35
As discussed in Note 2 to the Financial Statements, Old Kent completed the
mergers of Merchants on February 11, 2000, Grand Premier on April 1, 2000,
Pinnacle on September 3, 1999, CFSB on July 9, 1999, and First Evergreen on
October 1, 1998. These mergers were accounted for as poolings-of-interests
transactions, and the applicable data in the tables above has been restated
to reflect these business combinations. During the third quarter of 1999,
Old Kent recognized $17.6 million of after-tax charges related to the
mergers with CFSB and Pinnacle. Excluding these charges, net income for the
quarter would have been $70.4 million, and diluted earnings per share would
have been $.13 higher. During the fourth quarter of 1998, Old Kent
recognized $19.7 million of after-tax charges related to the merger with
First Evergreen. Excluding these charges, net income for the quarter would
have been $63.6 million, and diluted earnings per share would have been
$.13 higher. Also discussed in Note 2 to the Financial Statements set forth
in Exhibit 99.1 to this Form 8-K, Old Kent recognized $43.6 million in
charges related to the mergers with Merchants and Grand Premier during the
first and second quarters of 2000.
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