1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1996
OR
[ ] 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 0-6198
FIRST AMERICAN CORPORATION
(Exact name of Registrant as specified in its charter)
TENNESSEE 62-0799975
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
FIRST AMERICAN CENTER, NASHVILLE, TENNESSEE 37237
(address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 615/748-2000
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 issuer's classes
of common stock, as of the latest practicable date.
Common shares outstanding: 29,579,410 as of July 31, 1996.
2
FIRST AMERICAN CORPORATION
AND SUBSIDIARIES
INDEX
Part I. Financial Information Page
--------------------------------
Item 1 Financial Statements (unaudited)
Consolidated Income Statements for the Three and Six
Months Ended June 30, 1996 and 1995 3
Consolidated Balance Sheets as of June 30, 1996,
June 30, 1995 and December 31, 1995 4
Consolidated Statements of Changes in Shareholders' Equity
for the Six Months Ended June 30, 1996 and June 30, 1995 5
Consolidated Statements of Cash Flows for the Six
Months Ended June 30, 1996 and June 30, 1995 6
Notes to Consolidated Financial Statements 7
Item 2 Management's Discussion and Analysis of Results of
Operations and Financial Condition 11
Part II. Other Information
----------------------------
Item 1 Legal Proceedings 20
Item 4 Submission of Matters to a Vote of Security Holders 20
Item 6 Exhibits and Reports on Form 8-K 20
2
3
FIRST AMERICAN CORPORATION
AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENTS
QUARTER ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
------------------ ------------------
1996 1995 1996 1995
-------- -------- -------- --------
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
INTEREST INCOME
Interest and fees on loans $135,259 $116,271 $268,251 $224,765
Interest and dividends on securities 37,740 35,319 71,819 70,579
Interest on Federal funds sold and securities
purchased under agreements to resell 961 932 4,719 1,774
Interest on time deposits with other banks and other interest 663 456 1,164 844
- -------------------------------------------------------------------------------------------------------
Total interest income 174,623 152,978 345,953 297,962
- -------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Interest on deposits:
NOW accounts 3,956 4,094 7,836 8,298
Money market accounts 27,331 20,101 52,646 38,352
Regular savings 1,997 2,461 4,199 5,103
Certificates of deposit under $100,000 21,864 18,131 43,593 33,989
Certificates of deposit $100,000 and over 8,894 8,783 18,043 14,463
Other time and foreign 6,677 5,365 13,257 10,053
- -------------------------------------------------------------------------------------------------------
Total interest on deposits 70,719 58,935 139,574 110,258
- -------------------------------------------------------------------------------------------------------
Interest on short-term borrowings 12,108 11,960 24,319 23,272
Interest on long-term debt 6,569 4,658 13,015 9,344
- -------------------------------------------------------------------------------------------------------
Total interest expense 89,396 75,553 176,908 142,874
- -------------------------------------------------------------------------------------------------------
Net interest income 85,227 77,425 169,045 155,088
Provision for loan losses - 28 - 59
- -------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 85,227 77,397 169,045 155,029
- -------------------------------------------------------------------------------------------------------
Non-interest income
Service charges on deposit accounts 14,640 12,032 28,229 23,123
Commissions and fees on fiduciary activities 4,329 4,211 8,756 8,148
Investment services income 3,667 2,545 6,867 4,732
Trading account revenue 11 (245) 284 418
Merchant discount fees 856 742 1,625 1,435
Net realized gain (loss) on sales and write-downs of securities 106 337 1,507 354
Other income 7,847 5,940 16,197 11,752
- -------------------------------------------------------------------------------------------------------
Total non-interest income 31,456 25,562 63,465 49,962
- -------------------------------------------------------------------------------------------------------
Non-interest expense
Salaries and employee benefits 39,057 35,860 77,924 71,574
Net occupancy expense 5,665 5,364 11,690 10,740
Equipment expense 4,155 4,019 8,235 7,575
Systems and processing expense 3,537 3,069 6,633 5,859
FDIC insurance expense 722 3,438 1,376 6,886
Marketing expense 3,449 2,507 6,980 4,625
Communication expense 2,968 2,418 5,761 4,915
Supplies expense 1,109 921 2,375 2,064
Foreclosed properties expense (income), net (2,466) (2,660) (2,652) (3,276)
Other expenses 8,225 6,793 15,787 13,122
- -------------------------------------------------------------------------------------------------------
Total non-interest expense 66,421 61,729 134,109 124,084
- -------------------------------------------------------------------------------------------------------
Income before income tax expense 50,262 41,230 98,401 80,907
Income tax expense 19,373 15,462 37,712 29,876
- -------------------------------------------------------------------------------------------------------
Net income $ 30,889 $ 25,768 $60,689 $ 51,031
=======================================================================================================
Per common share:
Net income $ 1.04 $ .91 $ 2.05 $ 1.79
Cash dividends .31 .25 .59 .50
=======================================================================================================
Weighted average common shares outstanding 29,699 28,315 29,608 28,493
=======================================================================================================
See notes to consolidated financial statements.
3
4
FIRST AMERICAN CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30 DECEMBER 31
----------------------------- -----------
1996 1995 1995
---------- ---------- -----------
(DOLLARS IN THOUSANDS)
ASSETS
Cash and due from banks $ 452,360 $ 417,191 $ 494,496
Time deposits with other banks 7,692 36,883 26,733
Securities:
Held to maturity (market value $885,446, $1,631,375 and
$933,911, respectively) 890,051 1,632,582 931,084
Available for sale (amortized cost $1,532,856, $583,130
and $1,196,414, respectively) 1,513,420 582,941 1,202,493
- ------------------------------------------------------------------------------------------------------------------------------
Total securities 2,403,471 2,215,523 2,133,577
- ------------------------------------------------------------------------------------------------------------------------------
Federal funds sold and securities purchased under
agreements to resell 62,201 90,805 291,042
Trading account securities 44,375 29,224 22,419
Loans:
Commercial 2,923,322 2,554,860 2,823,827
Consumer--amortizing mortgages 1,840,511 1,456,934 1,784,836
Consumer--other 1,301,216 1,096,144 1,281,921
Real estate--construction 168,520 167,143 186,655
Real estate--commercial mortgages and other 372,302 311,396 354,918
- ------------------------------------------------------------------------------------------------------------------------------
Total loans 6,605,871 5,586,477 6,432,157
Unearned discount and net deferred loan fees 6,389 6,336 6,181
- ------------------------------------------------------------------------------------------------------------------------------
Loans, net of unearned discount and net deferred
loan fees 6,599,482 5,580,141 6,425,976
Allowance for possible loan losses 133,562 128,903 132,415
- ------------------------------------------------------------------------------------------------------------------------------
Total net loans 6,465,920 5,451,238 6,293,561
- ------------------------------------------------------------------------------------------------------------------------------
Premises and equipment, net 143,357 116,972 129,419
Foreclosed properties 8,778 9,256 10,683
Other assets 285,691 232,243 279,699
- ------------------------------------------------------------------------------------------------------------------------------
Total assets $9,873,845 $ 8,599,335 $9,681,629
==============================================================================================================================
Liabilities
Deposits:
Demand (non-interest-bearing) $1,240,038 $ 1,135,942 $1,266,285
NOW accounts 792,221 794,938 811,862
Money market accounts 2,195,793 1,794,999 2,031,796
Regular savings 339,207 400,745 376,725
Certificates of deposit under $100,000 1,699,914 1,401,419 1,679,792
Certificates of deposit $100,000 and over 696,276 680,318 750,491
Other time 363,369 297,502 320,382
Foreign 93,173 106,047 144,961
- ------------------------------------------------------------------------------------------------------------------------------
Total deposits 7,419,991 6,611,910 7,382,294
- ------------------------------------------------------------------------------------------------------------------------------
Short-term borrowings 1,154,541 819,993 938,287
Long-term debt 349,766 269,878 421,791
Other liabilities 130,479 205,720 143,725
- ------------------------------------------------------------------------------------------------------------------------------
Total liabilities 9,054,777 7,907,501 8,886,097
- ------------------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Common stock, $5 par value; authorized 50,000,000
shares; issued: 29,567,951 shares at June 30, 1996;
28,012,240 shares at June 30, 1995; and 29,539,819
shares at December 31, 1995 147,840 140,061 147,699
Capital surplus 159,226 107,842 162,254
Retained earnings 527,296 447,119 483,973
Deferred compensation on restricted stock (2,693) (2,051) (1,263)
Employee stock ownership plan obligation (599) (721) (661)
- ------------------------------------------------------------------------------------------------------------------------------
Realized shareholders' equity 831,070 692,250 792,002
Net unrealized gains (losses) on securities available for
sale, net of tax (12,002) (416) 3,530
- ------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 819,068 691,834 795,532
- ------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $9,873,845 $ 8,599,335 $9,681,629
==============================================================================================================================
See notes to consolidated financial statements.
4
5
FIRST AMERICAN CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
NET
UNREALIZED
DEFERRED EMPLOYEE GAINS
COMPENSATION STOCK (LOSSES)
ON OWNERSHIP ON SECURITIES
SIX MONTHS ENDED JUNE 30, 1995, AND COMMON CAPITAL RETAINED RESTRICTED PLAN AVAILABLE
JUNE 30, 1996 STOCK SURPLUS EARNINGS STOCK OBLIGATION FOR SALE TOTAL
------ ------- -------- ---------- ---------- ------------ -----
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
Balance, January 1, 1995 $143,625 $130,933 $409,638 $ (2,161) $ (781) $(13,581) $667,673
Issuance of 191,094 common shares in
connection with Employee Benefit
Plan, net of discount on Dividend
Reinvestment Plan 955 3,061 - - - - 4,016
Issuance of 15,077 shares of restricted
common stock 76 414 - (490) - - -
Repurchase of 919,000 shares of common
stock (4,595) (26,789) - - - - (31,384)
Amortization of deferred compensation
on restricted stock - - - 600 - - 600
Reduction in employee stock ownership
plan obligation - - - - 60 - 60
Net income - - 51,031 - - - 51,031
Cash dividends declared ($.50 per
common share) - - (12,994) - - - (12,994)
Cash dividends declared by pooled
company - - (605) - - - (605)
Change in net unrealized gains and
losses on securities available for
sale, net of tax - - - - - 13,165 13,165
Tax benefit from stock option and award
plans - 223 - - - - 223
Other - - 49 - - - 49
- -------------------------------------------------------------------------------------------------------------------------
Balance June 30, 1995 $140,061 $107,842 $447,119 $ (2,051) $ (721) $ (416) $691,834
=========================================================================================================================
Balance, January 1, 1996 $147,699 $162,254 $483,973 $(1,263) $ (661) $ 3,530 $795,532
Issuance of 225,813 common shares in
connection with Employee Benefit
Plan, net of discount on Dividend
Reinvestment Plan 1,129 7,067 - - - - 8,196
Issuance of 44,488 shares of restricted
common stock 223 1,868 - (2,091) - - -
Repurchase of 1,315,331 shares of common
stock (6,577) (52,884) - - - - (59,461)
Issuance of 1,073,759 common shares for
purchase of First City Bancorp, Inc. 5,369 40,937 - - - - 46,306
Amortization of deferred compensation
on restricted stock - - - 661 - - 661
Reduction in employee stock ownership
plan obligation - - - - 62 - 62
Net income - - 60,689 - - - 60,689
Cash dividends declared ($.59 per
common share) - - (17,366) - - - (17,366)
Change in net unrealized gains and
losses on securities available
for sale, net of tax - - - - - (15,532) (15,532)
Other (3) (16) - - - - (19)
- -------------------------------------------------------------------------------------------------------------------------
Balance, June 30, 1996 $147,840 $159,226 $527,296 $(2,693) $ (599) $(12,002) $819,068
=========================================================================================================================
See notes to consolidated financial statements.
5
6
FIRST AMERICAN CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED
JUNE 30
-----------------------
1996 1995
-------- --------
(IN THOUSANDS)
OPERATING ACTIVITIES
Net income $ 60,689 $ 51,031
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses - 59
Depreciation of premises and equipment 7,239 6,797
Amortization of intangible assets 4,356 1,960
Other amortization (accretion), net 250 (3,974)
Deferred income tax expense 6,844 5,602
Net realized gain on sales of securities (1,507) (354)
Net gain on sales of premises and equipment (15) (12)
Change in assets and liabilities, net of effects from acquisition:
(Increase) decrease in accrued interest receivable 5,215 (4,889)
Increase (decrease) in accrued interest payable (14,215) 5,015
Increase in trading account securities (21,956) (20,607)
(Increase) decrease in other assets 38,226 (14,042)
Increase (decrease) in other liabilities (1,895) 97,001
- -------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 83,231 123,587
- -------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Net (increase) decrease in time deposits with other banks 19,579 (33,028)
Proceeds from sales of securities available for sale 240,255 489,921
Proceeds from maturities of securities available for sale 191,338 9,859
Purchases of securities available for sale (635,710) (368,509)
Proceeds from maturities of securities held to maturity 109,564 146,894
Purchases of securities held to maturity (65,792) (134,400)
Net (increase) decrease in Federal funds sold and securities
purchased under agreements to resell 264,030 (62,671)
Net increase in loans (6,612) (409,548)
Acquisitions, net of cash acquired 4,525 -
Proceeds from sales of premises and equipment 11,809 137
Purchases of premises and equipment (28,457) (12,819)
- --------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 104,529 (374,164)
- --------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Net increase (decrease) in deposits (289,539) 304,131
Net increase (decrease) in short-term borrowings 201,811 (109,847)
Net repayment of Federal Home Loan Bank advances (73,187) (383)
Net repayment of other long-term debt (393) (446)
Net proceeds from issuance of common stock 8,196 4,016
Cash dividends paid (17,366) (13,599)
Repurchase of common stock (59,461) (31,384)
Other 43 1,364
- --------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities (229,896) 153,852
- --------------------------------------------------------------------------------------------------------------
Decrease in cash and due from banks (42,136) (96,725)
Cash and due from banks, January 1 494,496 513,916
- --------------------------------------------------------------------------------------------------------------
Cash and due from banks, June 30 $452,360 $417,191
==============================================================================================================
Cash paid during the period for:
Interest expense $189,684 $137,865
Income taxes 26,308 14,392
Noncash investing activities:
Foreclosures 216 727
Stock issued for acquisition 46,306 -
- --------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements.
6
7
FIRST AMERICAN CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
The consolidated financial statements have been prepared in conformity
with generally accepted accounting principles and general practices within the
banking industry.
The interim consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
presented in the Corporation's 1995 Annual Report to Shareholders. The
quarterly consolidated financial statements reflect all adjustments which are,
in the opinion of management, necessary for a fair presentation of the results
for interim periods. All such adjustments are of a normal recurring nature.
Certain prior year amounts have been reclassified to conform with the current
year presentation. The results for interim periods are not necessarily
indicative of results to be expected for the complete fiscal year.
(2) NONPERFORMING ASSETS
Nonperforming assets were as follows:
JUNE 30 December 31
- ---------------------------------------------------------------------------------------
(in thousands) 1996 1995 1995
- ---------------------------------------------------------------------------------------
Non-accrual loans $17,567 $15,270 $18,670
Foreclosed properties 8,778 9,256 10,683
- ---------------------------------------------------------------------------------------
Total nonperforming assets $26,345 $24,526 $29,353
=======================================================================================
90 days or more past due on accrual $13,797 $ 6,567 $ 6,123
=======================================================================================
Nonperforming assets as a percent of loans
and foreclosed properties (excluding
90 days or more past due on accrual) .40 % .44 % .46 %
=======================================================================================
(3) ALLOWANCE FOR POSSIBLE LOAN LOSSES
Transactions in the allowance for possible loan losses were as follows:
SIX MONTHS ENDED
JUNE 30
- ---------------------------------------------------------------------------------------
(in thousands) 1996 1995
Balance, January 1 $132,415 $129,436
Provision (credited) charged to operating expenses - 59
Allowance of subsidiary purchased 2,126 -
- ---------------------------------------------------------------------------------------
134,541 129,495
- ---------------------------------------------------------------------------------------
Loans charged off 12,295 7,536
Recoveries of loans previously charged off 11,316 6,944
- ---------------------------------------------------------------------------------------
Net charge-offs 979 592
- ---------------------------------------------------------------------------------------
Balance, June 30 $133,562 $128,903
=======================================================================================
Allowance ratios were as follows:
SIX MONTHS ENDED
JUNE 30
- ---------------------------------------------------------------------------------------
1996 1995
- ---------------------------------------------------------------------------------------
Allowance end of period to net loans outstanding 2.02% 2.31%
Net charge-offs to average loans (annualized) .03 .02
=======================================================================================
7
8
(4) ACQUISITIONS
Effective July 1, 1996, First American National Bank ("FANB"), a
wholly-owned subsidiary of the Corporation, purchased 96.2% of the stock of
INVEST Financial Corporation ("INVEST") for $26.0 million in cash.
Simultaneously, INVEST completed its acquisition of Investment Center Group,
Inc., the parent of Investment Centers of America, in a transaction valued at
approximately $5 million. Both transactions will be accounted for as
purchases.
Effective April 1, 1996, FANB purchased 49% of the stock of The SSI Group,
Inc., a healthcare payments processing company, for $8.6 million. The
transaction is being accounted for under the equity method of accounting.
Effective March 11, 1996, the Corporation acquired First City Bancorp,
Inc. ("First City") by exchanging approximately 1.1 million shares of First
American Corporation common stock for all of the outstanding shares of First
City. First City was a bank holding company headquartered in Murfreesboro,
Tennessee, and operated two Tennessee state chartered banks and a consumer
finance company. First City had $366 million in assets, 11 banking offices,
and nine consumer finance locations in the middle Tennessee area. The
transaction was accounted for as a purchase.
Effective December 1, 1995, First American Corporation acquired Charter
Federal Savings Bank ("Charter") by exchanging approximately 1.8 million shares
of First American Corporation common stock for all of the outstanding shares of
Charter, a federal savings bank headquartered in Bristol, Virginia, with $725
million of assets and 27 branches (eight in Knoxville, Tennessee, five in
Bristol, Tennessee and Bristol, Virginia; and 14 in other locations in
southwestern Virginia). The transaction was accounted for as a purchase.
Simultaneously with the acquisition, the name of Charter was changed to First
American Federal Savings Bank ("FAFSB"). The Virginia branches of the
Corporation are operated under this legal entity.
Effective November 1, 1995, First American Corporation acquired Heritage
Federal Bancshares, Inc. ("Heritage") by exchanging approximately 2.9 million
shares of First American Corporation common stock for all of the outstanding
shares of Heritage. Heritage was merged with and into the Corporation.
Heritage was the holding company for Heritage Federal Bank for Savings, a
federal savings bank which was merged into FANB and which had $526 million of
assets and 13 offices primarily in the east Tennessee areas of Tri-Cities,
Anderson County, and Roane County. The transaction was accounted for as a
pooling of interests, and accordingly, prior period information has been
restated reflecting the combination.
(5) ACCOUNTING MATTERS
During 1995, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 122, "Accounting for
Mortgage Servicing Rights--An Amendment of FASB Statement No. 65." SFAS No.
122 amends SFAS 65, "Accounting for Certain Mortgage Banking Activities," to
require that rights to service mortgage loans for others be recognized as
separate assets, however those servicing rights are acquired. An enterprise
that acquires mortgage servicing rights through either the purchase or
origination of mortgage loans and sells or securitizes those loans with
servicing rights retained should allocate the total cost of the mortgage loans
to the mortgage servicing rights and the loans (without the mortgage servicing
rights) based on their relative fair value. SFAS No. 122 also requires that
capitalized mortgage servicing rights be assessed for impairment based on the
fair value of those rights. SFAS No. 122 was adopted by the Corporation on
January 1, 1996, and applied prospectively to any transactions in which the
Corporation sells or securitizes mortgage loans with servicing rights retained
and to impairment evaluations of all amounts capitalized as mortgage servicing
rights, including those purchased before the adoption of SFAS No. 122.
Adoption of SFAS No. 122 did not have a material effect on the Corporation's
consolidated financial statements.
During 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation." SFAS No. 123 establishes a new optional method of accounting
for stock-based compensation based on calculations of fair value at grant date.
Under this method, the fair value of a stock option is recognized as
compensation expense over the service period (generally the vesting period).
SFAS No. 123 requires that if a company continues to account for stock options
under APB Opinion No. 25, "Accounting for Stock Issued to Employees" ("Opinion
25"), it must provide proforma net income and earnings per share information
"as if" the new fair value approach had been adopted. The recognition
provisions of SFAS No. 123 may be adopted upon issuance. The disclosure
provisions are effective for years beginning after
8
9
December 15, 1995; however, the proforma disclosures shall include the effects
of all awards granted in fiscal years beginning after December 15, 1994. The
SFAS No. 123 disclosure provisions need not be applied to an interim report
unless a complete set of financial statements is presented for that period. The
Corporation will continue to account for stock-based compensation under Opinion
25.
(6) EARNINGS PER COMMON SHARE
Earnings per common share amounts are computed by dividing net income by
the weighted average number of common shares outstanding during each respective
period.
(7) COMMON STOCK
The Corporation purchased 1.3 million shares of First American Corporation
common stock in the open market during the first six months of 1996 at a total
cost of $59.5 million. Under Tennessee law, such shares are considered
authorized but unissued. Accordingly, the Corporation reduced common stock and
reflected the excess of the purchase price over par of such repurchased shares
as a reduction from capital surplus. As of June 30, 1996, all repurchased
shares had been used to fund the acquisitions of Charter and First City.
(8) LEGAL AND REGULATORY MATTERS
The Savings Association Insurance Fund ("SAIF"), which insures deposits of
thrift institutions, is undercapitalized as a result of losses sustained by the
S&L industry during the late 1980's and early 1990's. To adequately capitalize
the SAIF fund, Congress has considered a series of proposed legislation to levy
a one-time assessment on SAIF deposits. While no proposed legislation has been
enacted into law, most proposals generally would require a one-time payment of
up to 85 basis points on SAIF deposits. Under what is believed to be the most
costly proposal, banks that obtained SAIF deposits through acquisitions (where
the FDIC premium is computed under the "Oakar Amendment" to the Federal Deposit
Insurance Act) would receive a 20% discount to allow for deposit runoff that
occurs subsequent to acquisitions. The discount would apply to the SAIF
deposits acquired by FANB. Should passage of such legislation occur, the
Corporation is expected to record a one-time charge estimated to be
approximately $5.5 million, net of tax. In addition, such proposal would
impose up to a 2.4 basis point annual charge through 2019 on all insured
deposits of depository institutions in order to pay interest on the debt
incurred by the Financing Corporation, a corporation established by the Federal
Housing Finance Board to issue stock and debt principally to assist in funding
the Federal Savings and Loan Insurance Corporation ("FSLIC") Resolution Fund.
Should this annual charge become effective, it will increase the Corporation's
total Bank Insurance Fund and SAIF premiums over the next 12 months over
currently anticipated amounts by $1.1 million, net of tax, based on deposits at
June 30, 1996. Other Congressional proposals or their combinations produce
less costs to the Corporation to assist the SAIF fund issues.
The Corporation and seven other financial institutions are defendants in a
class action lawsuit brought in the Circuit Court of Shelby County, Tennessee.
The lawsuit alleges antitrust, unconscionability, usury, and contract claims
arising out of the defendant's returned check charges. The asserted plaintiff
class consists of depositors who have been charged returned check or overdraft
fees. The plaintiffs are requesting compensatory and punitive damages of $25.0
million against each defendant. The antitrust, unconscionability, and usury
claims were previously dismissed, and in December 1993, the Circuit Court
granted the defendants' motion for summary judgment, dismissing the remaining
claims. The plaintiffs appealed to the Tennessee Court of Appeals, which
affirmed the Circuit Court's dismissal of the action. The plaintiffs then
appealed to the Tennessee Supreme Court. Oral argument was heard before the
Tennessee Supreme Court on April 2, 1996, and the Corporation is awaiting the
Court's decision. Management believes the above suit is without merit and,
based upon information currently known and on advice of counsel, that it will
not have a material adverse effect on the Corporation's consolidated financial
statements.
Following the adoption of the Financial Institutions Reform, Recovery and
Enforcement Act of 1989 ("FIRREA"), Charter (now FAFSB), brought an action
against the OTS and FDIC seeking injunctive and other relief, contending that
Congress' elimination of supervisory goodwill required rescission of certain
supervisory transactions. The Federal District Court found in Charter's favor,
but in 1992 the Fourth Circuit Court of Appeals reversed, and the U.S. Supreme
Court denied Charter's petition for certiorari. In 1995, the Federal Circuit
Court found in favor of another thrift institution in a similar case (Winstar
9
10
Corp. v. United States) in which the association sought damages for breach of
contract. Charter also filed suit against the United States Government
("Government") in the Court of Federal Claims based on breach of contract. The
Government sought Supreme Court review of the Winstar decision and the Supreme
Court granted the Government's petition. The Government agreed to stay FAFSB's
action pending the Supreme Court's decision in the Winstar case. On July 1,
1996, the Supreme Court affirmed the lower court's decision in Winstar. The
stay was automatically lifted, and FAFSB's suit is now proceeding.
The value of FAFSB's claims against the Government, as well as their
ultimate outcome, are contingent upon a number of factors, some of which are
outside of FAFSB's control, and are highly uncertain as to substance, timing
and the dollar amount of any damages which might be awarded should FAFSB
finally prevail. Under the Agreement and Plan of Reorganization as amended by
and between FAFSB and the Corporation, in the event that FAFSB is successful in
this litigation, the FAFSB shareholders as of December 1, 1995 will be entitled
to receive additional consideration equal in value to 50% of any recovery, net
of all taxes and certain other expenses, including the costs and expenses of
such litigation, received on or before December 1, 2000 subject to certain
limitations in the case of certain business combinations. Such additional
consideration, if any, is payable in the common stock of the Corporation, based
on the average per share closing price on the date of receipt by FAFSB of the
last payment constituting a recovery from the Government.
Also, there are from time to time other legal proceedings pending against
the Corporation and its subsidiaries. In the opinion of management and
counsel, liabilities, if any, arising from such proceedings presently pending
would not have a material adverse effect on the consolidated financial
statements of the Corporation.
10
11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
The following discussion should be read in conjunction with the
consolidated financial statements appearing within this report. Reference
should also be made to First American Corporation's 1995 Annual Report for a
complete discussion of factors that impact results of operations, liquidity,
and capital.
OVERVIEW
Net income for the second quarter of 1996 was $30.9 million, or $1.04 per
share compared with $25.8 million, or $.91 per share, for the second quarter of
1995. The $5.1 million increase in second quarter 1996 earnings compared to
the same time last year included a $7.8 million increase in net interest
income, a $5.9 million increase in non-interest income, and a $4.7 million
increase in non-interest expense. Return on average assets ("ROA") and return
on average equity ("ROE") were 1.28% and 15.05%, respectively, for the second
quarter of 1996. ROA and ROE were 1.24% and 14.88%, respectively, in the
second quarter of 1995.
Net income for the six months ended June 30, 1996, was $60.7 million, or
$2.05 per share compared with $51.0 million, or $1.79 per share, for the same
time last year. The $9.7 million increase in earnings for the first half
of 1996 compared to the same time last year included a $14.0 million increase
in net interest income, a $13.5 million increase in non-interest income, and a
$10.0 million increase in non-interest expense. ROA and ROE were 1.27% and
15.07%, respectively, for the six months ended June 30, 1996. ROA and ROE were
1.25% and 14.87%, respectively, in the first half of 1995.
Effective July 1, 1996, First American National Bank ("FANB"), a
wholly-owned subsidiary of First American, purchased 96.2% of the stock of
INVEST Financial Corporation ("INVEST") for $26.0 million in cash.
Simultaneously, INVEST completed its acquisition of Investment Center Group,
Inc., the parent of Investment Centers of America, in a transaction valued at
$5.0 million, which makes INVEST the nation's largest marketer of mutual funds,
annuities, and other investment products sold through financial institutions.
Both transactions will be accounted for as purchases.
Effective April 1, 1996, FANB purchased 49% of the stock of The SSI Group,
Inc., a health care payments processing company, for $8.6 million. The
transaction is being accounted for under the equity method of accounting.
Effective March 11, 1996, First American acquired First City Bancorp, Inc.
("First City") by exchanging approximately 1.1 million shares of First American
Corporation common stock for all of the outstanding shares of First City.
First City was a bank holding company headquartered in Murfreesboro, Tennessee,
and operated two Tennessee state chartered banks and a consumer finance
company. First City had $366 million in assets, 11 banking offices, and nine
consumer finance locations in the middle Tennessee area. The transaction was
accounted for as a purchase.
Effective December 1, 1995, First American acquired Charter Federal
Savings Bank ("Charter") by exchanging approximately 1.8 million shares of
First American Corporation common stock for all of the outstanding shares of
Charter, a federal savings bank headquartered in Bristol, Virginia, with $725
million of assets and 27 branches (eight in Knoxville, Tennessee, five in
Bristol, Tennessee and Bristol, Virginia; and 14 in other locations in
southwestern Virginia). The transaction was accounted for as a purchase.
Simultaneously with the acquisition, the name of Charter was changed to First
American Federal Savings Bank ("FAFSB"). The Virginia branches of First
American are operated under this legal entity.
Effective November 1, 1995, First American acquired Heritage Federal
Bancshares, Inc. ("Heritage") by exchanging approximately 2.9 million shares of
First American Corporation common stock for all of the outstanding shares of
Heritage. Heritage was merged with and into First American. Heritage was the
holding company for Heritage Federal Bank for Savings, a federal savings bank
which was merged into FANB and which had $526 million of assets and 13 offices
primarily in the east Tennessee areas of Tri-Cities, Anderson County, and Roane
County. The transaction was accounted for as a pooling of interests, and
accordingly, prior period information has been restated to reflect the
combination.
11
12
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income on a taxable equivalent basis represented 73% of total
revenues in the second quarter of 1996 and 75% in the second quarter of 1995.
For purposes of this discussion, total revenues consist of the sum of net
interest income and non-interest income. Net interest income on a taxable
equivalent basis in the second quarter of 1996 was $86.1 million, up $7.8
million, or 10%, from $78.3 million in the second quarter of 1995. Net
interest income is the difference between total interest income earned on
earning assets such as loans and securities and total interest expense incurred
on interest-bearing liabilities such as deposits. Net interest income is
affected by the volume and mix of earning assets and interest-bearing
liabilities and the corresponding interest yields and costs.
Total interest income on a taxable equivalent basis amounted to $175.5
million for the second quarter of 1996, compared to $153.8 million for the
second quarter of 1995, an increase of $21.7 million, or 14%. Of the $21.7
million increase in total interest income, $24.8 million resulted from an
increase in the volume of earning assets (primarily loans) which was partially
offset by a $3.1 million decrease which resulted from a decrease in average
yields. Average earning assets rose $1.25 billion, or 16%, to $8.95 billion.
Average loans increased $1.08 billion, or 20%, to $6.52 billion, average
securities increased $148.6 million, or 7%, to $2.31 billion, and average money
market investments increased $21.1 million to $118.2 million. Excluding the
Charter and First City acquisitions, average loans for the quarter ended June
30, 1996, increased 9% over the same period last year. The average yield on
earning assets decreased 13 basis points to 7.88% from 8.01%, reflecting a
generally lower short-term interest rate environment in the second quarter of
1996 compared to the second quarter of 1995. For example, the national prime
lending rate and 1-year treasury security yields averaged 8.25% and 5.66%,
respectively, in the second quarter of 1996 compared to 9.00% and 5.97%,
respectively, in the second quarter of 1995. Longer-term external interest
rates were generally equal to or slightly higher than the second quarter of
1995.
Total interest income on a taxable equivalent basis amounted to $347.7
million for the six months ended June 30, 1996, compared to $299.7 million for
the same time last year, an increase of $48.0 million, or 16%. Of the $48.0
million increase in total interest income, $52.1 million resulted from an
increase in the volume of earning assets (primarily loans) which was partially
offset by a $4.1 million decrease which resulted from a decrease in average
yields. Average earning assets rose $1.31 billion, or 17%, to $8.90 billion.
Average loans increased $1.14 billion, or 21%, to $6.47 billion, average
securities increased $39.9 million, or 2%, to $2.21 billion, and average money
market investments increased $124.9 million to $217.7 million. Excluding the
Charter and First City acquisitions, average loans for the six months ended
June 30, 1996, increased 12% over the same period last year. The average yield
on earning assets decreased 10 basis points to 7.86% from 7.96%, reflecting a
generally lower interest rate environment in the first half of 1996 compared to
the same time last year. For example, the national prime lending rate and
5-year treasury security yields averaged 8.29% and 6.02%, respectively, in the
first six months of 1996 compared to 8.92% and 6.90%, respectively, in the
first six months of 1995.
Total interest expense in the second quarter of 1996 increased $13.8
million, or 18%, to $89.4 million from the second quarter of 1995. Of the
increase, $12.7 million resulted from an increase in the volume of
interest-bearing liabilities and $1.1 million was due to higher average
interest rates paid on interest-bearing funds. In the second quarter of 1996,
average interest-bearing liabilities grew $1.09 billion, or 17%, to $7.54
billion from $6.45 billion in the second quarter of 1995. Average
interest-bearing deposits increased $845.6 million, or 16%, to $6.18 billion,
average short-term borrowings rose $148.5 million, or 17%, to $1.00 billion,
and average long-term debt increased $91.5 million, or 34%, to $361.6 million.
Excluding the Charter and First City acquisitions, total interest-bearing
deposits increased 1%.
The average rate paid on interest-bearing liabilities increased 8 basis
points to 4.77% from 4.69%. The increase in rates paid on interest-bearing
liabilities during a period in which short-term external interest rates
declined on average (e.g., the Federal funds rate averaged 5.24% in the second
quarter of 1996 compared to 6.02% in the second quarter of 1995) reflected the
use of derivatives, the fact that First American's fixed rate liabilities do
not reprice immediately due to varying maturities, and the change in the mix of
deposits and other interest-bearing liabilities away from demand deposits, NOW
accounts, and regular savings toward funding sources with higher interest
rates. Excluding the impact of derivatives, the average rates on
interest-bearing liabilities decreased 22 basis points to 4.51% from 4.73%.
Average non-interest bearing demand deposits represented 13.3% of average
earning assets during the second quarter of 1996 compared to 14.1% during the
quarter of 1995. NOW accounts averaged 9.1% of average
12
13
earning assets during the three months ended June 30, 1996, versus 10.6% during
the same time last year and had average interest rates of 1.96% and 2.02%,
respectively, during the second quarters of 1996 and 1995. Regular savings
averaged 3.9% of earning assets during the second quarter of 1996 down from 5.4%
during the previous year's second quarter and had average interest rates of
2.29% and 2.38%, respectively, during the second quarters of 1996 and 1995. All
other interest-bearing liabilities averaged 71.3% of average earning assets
during the second quarter of 1996 compared to 67.8% during the same time last
year and had average interest rates of 5.26% during the three months ended June
30, 1996, and 5.29% during the same time in the previous year.
Total interest expense in the six months ended June 30, 1996, increased
$34.0 million, or 24%, to $176.9 million from the same time last year. Of the
increase, $26.4 million resulted from an increase in the volume of
interest-bearing liabilities and $7.6 million was due to higher average
interest rates paid on interest-bearing funds. In the first six months of
1996, average interest-bearing liabilities grew $1.16 billion, or 18%, to
$7.49 billion from $6.33 billion in the first half of 1995. Average
interest-bearing deposits increased $910.2 million, or 17%, to $6.12 billion,
average short-term borrowings rose $146.1 million, or 17%, to $997.8 million,
and average long-term debt increased $102.4 million, or 38%, to $372.7
million. Excluding the Charter and First City acquisitions, total
interest-bearing deposits increased 4%. The average rate paid on
interest-bearing liabilities increased 20 basis points to 4.75% from 4.55%.
The increase in rates paid on interest-bearing liabilities during a period in
which short-term external interest rates declined on average (e.g., the Federal
funds rate averaged 5.30% in the first six months of 1996 compared to 5.92% in
the first half of 1995) reflected the use of derivatives, the fact that First
American's fixed rate liabilities do not reprice immediately due to varying
maturities, and the change in the mix of deposits and other interest-bearing
liabilities away from demand deposits, NOW accounts, and regular savings toward
funding sources with higher interest rates. Excluding the impact of
derivatives, the average rates on interest-bearing liabilities decreased 6
basis points to 4.53% from 4.59%. Average non-interest bearing demand deposits
represented 13.3% of average earning assets during the first six months of 1996
compared to 14.4% during the first half of 1995. NOW accounts averaged 9.1% of
average earning assets during the six months ended June 30, 1996, versus 10.9%
during the same time last year and had average interest rates of 1.95% and
2.02%, respectively, during the first six months of 1996 and 1995. Regular
savings averaged 4.0% of earning assets during the first six months of 1996
down from 5.7% during the previous year and had average interest rates of 2.35%
and 2.38%, respectively, during the first six months of 1996 and 1995. All
other interest-bearing liabilities averaged 71.1% of average earning assets
during the first half of 1996 compared to 66.8% during the same time last year
and had average interest rates of 5.24% during the six months ended June 30,
1996, and 5.15% during the same time in the previous year.
Net interest income in the second quarter of 1996 increased primarily as a
result of the increase in the volume of earning assets partially offset by a
lower net interest spread. Net interest spread is the difference between the
yield on earning assets and the rate paid on interest-bearing liabilities.
First American's net interest spread declined 21 basis points to 3.11% during
the second quarter of 1996 from 3.32% for the second quarter of 1995. This
decline was due to an eight basis point increase in the rates paid on
interest-bearing liabilities and a 13 basis point decrease in yields on earning
assets.
As the net interest spread declined, the net interest margin, which is net
interest income expressed as a percentage of average earning assets, decreased
to 3.87% for the second quarter of 1996 as compared with 4.07% for the same
quarter a year earlier. The primary factor leading to the decline in net
interest margin was the change in the mix of deposits and other
interest-bearing liabilities away from demand deposits, NOW accounts, and
regular savings toward funding sources with higher interest rates. In addition
to the other factors previously discussed, the competitive environment also put
downward pressure on the net interest margin.
Net interest income in the six months ended June 30, 1996, increased
primarily as a result of the increase in the volume of earning assets partially
offset by a lower net interest spread. First American's net interest spread
declined 30 basis points to 3.11% during the first six months of 1996 from
3.41% for the same time last year. This decline was due to a 20 basis point
increase in the rates paid on interest-bearing liabilities and a 10 basis point
decrease in yields on earning assets.
As the net interest spread declined, the net interest margin decreased to
3.86% for the six months ended June 30, 1996, as compared with 4.16% for the
same period a year earlier. The primary factor leading to the decline in net
interest margin was the change in the mix of deposits and other
interest-bearing liabilities away from demand deposits, NOW accounts, and
regular savings toward funding sources
13
14
with higher interest rates. In addition to the other factors previously
discussed, the competitive environment also put downward pressure on the net
interest margin.
PROVISION FOR LOAN LOSSES
This topic is addressed under the caption "Allowance and Provision for
Possible Loan Losses."
NON-INTEREST INCOME
Total non-interest income was $31.5 million for the second quarter of 1996
compared with $25.6 million for the second quarter of 1995, an increase of $5.9
million, or 23%. Non-interest income represented 27% of total revenues in the
second quarter of 1996 and 25% during the same time last year. Non-interest
income, excluding net securities gains, totalled $31.4 million, an increase of
$6.2 million, or 24%, from $25.2 million in the second quarter of 1995. The
increase from the second quarter of 1995 included a $2.6 million, or 22%,
increase in service charges on deposit accounts, a $1.1 million, or 44%,
increase in investment services income, and a $1.9 million, or 32%, increase in
other income. The increase in service charges on deposit accounts resulted
primarily from a greater number of deposit accounts and related activities for
commercial and retail deposits. The average number of retail deposit accounts
increased 16% and the average number of commercial deposit accounts increased
12% from second quarter 1995 to the current quarter. The improvement in
investment services income over the second quarter of 1995 resulted principally
from growth in retail brokerage commissions related to mutual funds and
annuities sales and institutional brokerage commissions on various types of
securities transactions. Other income in the second quarter of 1996 included a
$.7 million increase in income and fees related to selling residential mortgage
loans, a $.4 million increase in interchange fees from the Check Card, and an
$.8 million net increase in the various other classifications within other
income. Excluding the Charter and First City acquisitions, non-interest income
increased 18% from the second quarter of 1995 to the current quarter.
Total non-interest income was $63.5 million for the first six months of
1996 compared with $50.0 million for the same time last year, an increase of
$13.5 million, or 27% and included a $1.2 million increase in net realized
gains on sales of securities. Non-interest income represented 27% of total
revenues in the first half of 1996 and 24% during the same time last year.
Non-interest income, excluding net securities gains, totalled $62.0 million, an
increase of $12.4 million, or 25%, from $49.6 million in the six months ended
June 30, 1995. The increase from the first six months of 1995 included a $5.1
million, or 22%, increase in service charges on deposit accounts, a $2.1
million, or 45%, increase in investment services income, and a $4.4 million, or
38%, increase in other income. The increase in service charges on deposit
accounts resulted primarily from a greater number of deposit accounts and
related activities for commercial and retail deposits. The average number of
retail deposit accounts increased 16% and the average number of commercial
deposit accounts increased 11% from six months ended June 30, 1995 to the
current period. The improvement in investment services income over the first
half of 1995 resulted principally from growth in retail brokerage commissions
related to mutual funds and annuities sales and institutional brokerage
commissions on various types of securities transactions. Other income in the
first six months of 1996 included a $1.3 million increase in income and fees
related to selling residential mortgage loans, an $.8 million increase in
interchange fees from the Check Card, a $.5 million increase in gains from
sales of student loans, and a $1.8 million net increase in the various other
classifications within other income. Excluding the Charter and First City
acquisitions, non-interest income increased 23% from the six months ended June
30, 1995.
NON-INTEREST EXPENSE
Total non-interest expense increased $4.7 million, or 8%, to $66.4 million
for the second quarter of 1996 compared with $61.7 million for the same period
in 1995. Salaries and employee benefits increased $3.2 million, or 9%, from
the same period in 1995 principally due to merit increases and additional
employees resulting primarily from acquisitions. From June 30, 1995, to June
30, 1996, the number of full-time equivalent employees increased 8% related
primarily to the Charter and First City acquisitions. Marketing expenses
increased $.9 million, or 38%, from the second quarter of 1995 due primarily to
media and direct mail advertising in new and existing markets related
principally to consumer and small business deposit and loan products.
Communication expenses increased $.6 million, or 23%, primarily related to
higher telecommunications expenditures and postage. Other expenses increased
$1.4 million, or 21%, from
14
15
the previous year's second quarter primarily due to a $1.4 million increase in
amortization of intangibles related to the Charter and First City acquisitions.
The above increases in non-interest expense were partially offset by a $2.7
million decrease in FDIC insurance expense, which declined due to a reduction
in the annual assessment rate on the majority of the Company's deposits from
$.23 per $100 of deposits during the second quarter of 1995 to a rate of $.00
per $100 of deposits during the second quarter of 1996. The Company's deposit
liabilities, however, included approximately $1.21 billion of deposits which
were obtained through acquisitions of various thrift institutions on which the
annual assessment rate remained approximately $.23 per $100 of deposits. First
American's operating efficiency ratio (non-interest expense as a percentage of
the sum of net interest income, on a fully taxable basis, and non-interest
income) improved to 56.49% in the second quarter of 1996, compared to 59.45%
the second quarter of 1995. Non-interest expense excluding the Charter and
First City acquisitions decreased 3%.
Total non-interest expense increased $10.0 million, or 8%, to $134.1
million for the six months ended June 30, 1996, compared with $124.1 million
for the same period in 1995. Salaries and employee benefits increased $6.4
million, or 9%, from the same period in 1995 principally due to merit increases
and additional employees resulting primarily from acquisitions. Marketing
expenses increased $2.4 million, or 51%, from the first six months of 1995 due
primarily to media and direct mail advertising in new and existing markets
related principally to consumer and small business deposit and loan products.
Net occupancy expense grew $1.0 million, or 9%, primarily due to higher rent
and other occupancy-related expenses due to the Charter and First City
acquisitions. Communication expenses increased $.9 million, or 17%, primarily
related to higher telecommunications expenditures and postage. Other expenses
increased $2.7 million, or 20%, from the previous year's first six months
primarily due to a $2.4 million increase in amortization of intangibles related
to the Charter and First City acquisitions. The above increases in
non-interest expense were partially offset by a $5.5 million decrease in FDIC
insurance expense, which declined due to a reduction in the annual assessment
rate on the majority of the Company's deposits. First American's operating
efficiency ratio improved to 57.24% in the first half of 1996, compared to
60.02% in the first half of 1995. Non-interest expense excluding the Charter
and First City acquisitions decreased .4%.
INCOME TAXES
During the second quarters of 1996 and 1995, First American's income tax
expense was $19.4 million and $15.5 million, respectively. During the six
months ended June 30, 1996 and 1995, income tax expense was $37.7 million and
$29.9 million, respectively. The major factor for the increases in income tax
expense for the quarter and six-month periods was the higher income before
income taxes.
ASSET/LIABILITY MANAGEMENT
First American has utilized off-balance-sheet derivative products for a
number of years in managing its interest rate sensitivity. The use of
non-complex, non-leveraged derivative products has reduced the Company's
exposure to changes in the interest rate environment. By using derivative
products such as interest rate swaps and futures contracts to alter the nature
of (hedge) specific assets or liabilities on the balance sheet (for example to
change a variable to a fixed rate obligation), the derivative product offsets
fluctuations in net interest income from the otherwise unhedged position. In
other words, if net interest income from the otherwise unhedged position
changes (increases or decreases) by a given amount, the derivative product
should produce close to the opposite result, making the combined amount
(otherwise unhedged position impact plus the derivative product position
impact) essentially unchanged. Derivative products have enabled First American
to improve its balance between interest-sensitive assets and interest-sensitive
liabilities by managing interest rate sensitivity, while continuing to meet the
lending and deposit needs of its customers.
In conjunction with managing interest rate sensitivity, at June 30, 1996,
First American had derivatives with notional values totaling $1.25 billion.
These derivatives had a net positive fair value (unrealized net pre-tax gain)
of $6.1 million. Notional amounts are key elements of derivative financial
instrument agreements. However, notional amounts do not represent the amounts
exchanged by the parties to derivatives and do not measure First American's
exposure to credit or market risks. The amounts exchanged are based on the
notional amounts and the other terms of the underlying derivative agreements.
At June 30, 1995, First American had derivatives with notional values totaling
$1.84 billion. These
15
16
derivatives had a net negative fair value of $3.9 million at June 30, 1995. The
instruments utilized are noted in the following table along with their notional
amounts and fair values at June 30, 1996 and 1995.
Weighted
Average
Weighted Average Rate Maturity
Related Variable Rate Notional -------------------------- -------- Fair
(in thousands) Asset/Liability Amount Paid Received Years Value
- ---------------------------------------------------------------------------------------------------------------
June 30, 1996
Interest rate swaps Money market deposits $ 700,000 5.86% (1) 5.50% (2) 1.5 $ 5,286
Interest rate swaps Long-term debt 100,000 6.32 (1) 5.49 (3) .2 (173)
Interest rate swaps Loans 250,000 5.51 (3) 6.75 (1) 3.0 1,632
Forward interest rate Available for sale
swaps securities 100,000 7.02 (4) N/A (4) 3.9 (661)
Forward interest rate
swaps Money market deposits 100,000 6.50 (5) N/A (5) 1.9 (9)
---------- -------
$1,250,000 $ 6,075
===============================================================================================================
June 30, 1995
Interest rate swaps Money market deposits $ 650,000 5.91% (1) 6.19% (2) 1.4 $ 494
Interest rate swaps Long-term debt 200,000 7.11 (1) 6.11 (3) 1.3 (3,222)
Interest rate swaps Loans 200,000 6.22 (3) 7.39 (1) 3.9 9,133
Forward interest rate
swaps Money market deposits 650,000 7.81 (6) N/A (6) 1.4 (9,549)
Futures contracts (7) Money market deposits 140,000 N/A N/A 1.4 (727)
---------- -------
$1,840,000 $(3,871)
========== =======
(1) Fixed rate.
(2) Variable rate which reprices quarterly based on 3-month LIBOR except for
$25 million which reprices every 6 months based on 6-month LIBOR.
(3) Variable rate which reprices quarterly based on 3-month LIBOR.
(4) Forward swap periods to begin in May 1997 for $50 million and June 1997
for $50 million. The rates to be paid are fixed and were set at the
inception of the contracts. Variable rates to be received are based on
3-month LIBOR but were unknown at June 30, 1996, since the forward swap
periods had not yet begun.
(5) Forward swap periods to begin in May 1997. The rates to be paid are
fixed and were set at the inception of the contracts. Variable rates to
be received are based on 3-month LIBOR but were unknown at June 30, 1996,
since the forward swap period had not yet begun.
(6) Forward swap periods began in June 1995 for $200 million and December
1995 for $450 million. The rates to be paid were fixed and were set at
the inception of the contracts. Variable rates received were based on
3-month LIBOR and were 5.95% for the contracts which began in June 1995
but were unknown at June 30, 1995 for the December 1995 contracts since
the forward swap periods on those contracts had not yet begun.
(7) Represents $140 million short position of Eurodollar futures contracts
which in aggregate simulates a $35 million 2-year interest rate swap.
As First American's individual derivative contracts approach maturity,
they may be terminated and replaced with derivatives with longer maturities
which offer more interest rate risk protection. At June 30, 1996, there were
$1.4 million of deferred net losses related to terminated derivatives
contracts, and there were $3.5 million of deferred net gains at June 30, 1995.
Deferred gains and losses on off-balance-sheet derivative activities are
recognized as interest income or interest expense over the original covered
periods.
Net interest income for the quarter ended June 30, 1996, was decreased by
derivative products expense of $4.1 million. Net interest income for the
quarter ended June 30, 1995, was increased by $1.3 million derivative products
income. Net interest income for the six months ended June 30, 1996, was
decreased by derivative products expense of $6.8 million. Net interest income
for the six months ended June 30, 1995, was increased by $2.5 million
derivative products income.
Credit risk exposure due to off-balance-sheet hedging is closely
monitored, and counterparts to these contracts are selected on the basis of
their credit worthiness, as well as their market-making ability. As of June
30, 1996, all outstanding derivative transactions were with counterparts with
credit ratings of A-2 or better. Enforceable bilateral netting contracts
between First American and its counterparts allow for the netting of gains and
losses in determining net credit exposure. First American's net credit
exposure on outstanding derivatives was $6.7 million on June 30, 1996. Given
the credit standing of the counterparts to the derivative contracts, Management
believes that this credit exposure is reasonable in light of its objectives.
16
17
FINANCIAL CONDITION
ASSETS
Total assets of First American rose $1.27 billion, or 15%, to $9.87
billion at June 30, 1996, compared to $8.60 billion one year earlier. The
growth in total assets was primarily due to the $1.02 billion, or 18%, increase
in loans, net of unearned discount and net deferred loan fees, to $6.60
billion at June 30, 1996, from $5.58 billion at June 30, 1995. Leading the
growth in loans were consumer amortizing mortgages, which increased $383.6
million, or 26%, commercial loans, which increased $368.5 million, or 14%,
over a broad range of industry categories, and other consumer loans, which
increased $205.1 million, or 19%. The increase in loans reflects the Charter
and First City acquisitions, positive economic conditions in Tennessee and
selected markets in adjacent states, and the success of First American's sales
efforts and marketing programs. Excluding the Charter and First City
acquisitions, loans grew $441.1 million, or 8%, from June 30, 1995, to June 30,
1996. Additionally, total assets increased due to a $187.9 million, or 8%,
increase in securities. Excluding the Charter and First City acquisitions,
total assets grew $100.4 million, or 1%, from June 30, 1995, to June 30, 1996.
Total assets increased $192.2 million from $9.68 billion at December 31,
1995, to $9.87 billion at June 30, 1996. The growth in total assets from
December 31, 1995, to June 30, 1996, was primarily due to the $173.5 million
increase in loans, net of unearned discount and net deferred loan fees, and the
$269.9 million increase in securities partially offset by the $228.8 million
decrease in Federal funds sold and securities purchased under agreements to
resell. Leading the growth in loans were commercial loans, which increased
$99.5 million, consumer amortizing loans, which increased $55.7 million, and
other consumer loans, which increased $19.3 million. Excluding the First City
acquisition, total loans increased $6.4 million and total assets decreased
$205.9 million from December 31, 1995, to June 30, 1996.
During June 1996, approximately $92 million of mortgage loans were
transferred to the mortgage warehouse and held for sale pending the July 1996
closing of a transaction to securitize and sell those mortgage loans. The
mortgage servicing will be retained by First American. The transaction will
result in a gain in the amount of approximately $1.0 million.
ALLOWANCE AND PROVISION FOR POSSIBLE LOAN LOSSES
Management's policy is to maintain the allowance for possible loan losses
at a level which is adequate to absorb estimated loan losses inherent in the
loan portfolio. The provision for loan losses is a charge (credit) to earnings
necessary, after loan charge-offs and recoveries, to maintain the allowance at
an appropriate level. Determining the appropriate level of the allowance and
the amount of the provision for loan losses involves uncertainties and matters
of judgment and therefore cannot be determined with precision.
In order to maintain the allowance at an appropriate level, First
American's loan loss methodology produced no provision for loan losses during
the second quarter of 1996 nor during the first six months of 1996. The
provisions for loan losses of $28 thousand in the second quarter of 1995 and
$59 thousand in the first six months of 1995 were recorded by Heritage prior to
its merger with First American. The primary factors leading to no provision
for loan losses in the six months ended June 30, 1996, were the continued
favorable levels of asset quality as discussed under the caption "Asset
Quality" and relatively low net loan charge-off experience. In the second
quarter of 1996 there was net recoveries of $1.1 million which compared to net
charge-offs of $.5 million in the second quarter of 1995. Net (recoveries)
charge-offs as a percentage of average loans on an annualized basis amounted to
(.07)% and .04%, respectively, in the second quarters of 1996 and 1995. For
the six months ended June 30, 1996, net charge-offs were $1.0 million and $.6
million, respectively, and net charge-offs as a percentage of average loans on
an annualized basis amounted to .03% and .02%, respectively.
The allowance for possible loan losses was $133.6 million at June 30,
1996, $128.9 million at June 30, 1995, and $132.4 million at December 31, 1995.
The allowance for possible loan losses represented 2.02% and 2.31% of net
loans at June 30, 1996 and 1995, respectively, and 2.06% at December 31, 1995.
ASSET QUALITY
First American's nonperforming assets (excluding loans 90 days past due on
accrual status) were $26.3 million at June 30, 1996, $24.5 million at June 30,
1995, and $29.4 million at December
17
18
31, 1995. Nonperforming assets (excluding loans 90 days past due on accrual
status) at June 30, 1996, represented .40% of total loans and foreclosed
properties, compared to .44% at June 30, 1995, and .46% at December 31, 1995.
At June 30, 1996, nonperforming assets were comprised of $17.5 million of
non-accrual loans and $8.8 million of foreclosed properties.
Other potential problem loans consist of loans that are currently not
considered nonperforming but on which information about possible credit
problems has caused Management to doubt the ability of the borrowers to comply
fully with present repayment terms. At June 30, 1996, loans totalling
approximately $88 million, while not considered nonperforming loans, were
classified in First American's internal loan grading system as substandard or
worse, compared with approximately $63 million of such loans at June 30, 1995,
and $67 million at December 31, 1995. Depending on the economy and other
factors, these loans and others, which may not be presently identified, could
become nonperforming assets in the future.
LIABILITIES
Total deposits were $7.42 billion at June 30, 1996, an increase of $808.1
million, or 12%, from $6.61 billion a year earlier. Excluding the Charter and
First City acquisitions, total deposits decreased $33.0 million, or 1%, from
June 30, 1995, to June 30, 1996. Core deposits, which are defined as total
deposits excluding certificates of deposit $100,000 and over and foreign
deposits, totalled $6.63 billion at June 30, 1996, and $5.83 billion at June
30, 1995. Short-term borrowings increased $334.6 million, or 41%, to $1.15
billion at June 30, 1996, from $820.0 million at June 30, 1995. Long-term debt
increased $79.9 million from June 30, 1995, to $349.8 million at June 30, 1996,
primarily due to the $144.2 million increase in long-term debt in the fourth
quarter of 1995 partially offset by the repayment of $55.5 million of variable
rate and $16.8 million of fixed rate borrowings from the Federal Home Loan
Bank ("FHLB") in the first six months of 1996.
Total deposits increased $37.7 million from December 31, 1995, to June 30,
1996. Excluding the First City acquisition, total deposits decreased $289.5
million during the same time frame. Core deposits increased $143.7 million,
short-term borrowings increased $216.3 million, and long-term debt decreased
$72.0 million from December 31, 1995, to June 30, 1996. The decrease in
long-term debt resulted principally from the repayment of $55.5 million of
variable rate and $16.8 million of fixed rate borrowings from the FHLB.
CAPITAL POSITION
Total shareholders' equity was $819.1 million, or 8.30% of total assets at
June 30, 1996, $691.8 million, or 8.05% of total assets, at June 30, 1995, and
$795.5 million, or 8.22% of total assets at December 31, 1995. Book value per
share was $27.70 on June 30, 1996, $24.70 per share on June 30, 1995, and
$26.93 per share on December 31, 1995.
Total shareholders' equity increased $23.5 million from December 31, 1995,
principally from $43.3 million of earnings retention ($60.7 million of net
income less $17.4 million of dividends) and the issuance of $8.2 million of
common stock in connection with employee benefit and dividend reinvestment
plans. Partially offsetting the above increase in shareholders' equity was
the $15.5 million change in net unrealized gains and losses on securities
available for sale, net of tax, and the net repurchase of $13.2 million of
common stock, which consisted of $59.5 million of common stock repurchased for
the acquisitions of Charter and First City, net of $46.3 million of common
stock issued in the acquisition of First City.
In the second quarter of 1996, First American declared cash dividends on
its common stock of $.31 per share compared to $.25 per share in the second
quarter of 1995, a 24% increase. The dividend payout ratio was 30% in the
second quarter of 1996 compared to 27% in the second quarter of 1995. Cash
dividends for the first six months of 1996 were $.59 versus $.50 in the first
six months of 1995, an 18% increase. The dividend payout ratios for the six
months ended June 30, 1996 and 1995, were 29% and 28%, respectively. The
Federal Reserve Board and Office of the Comptroller of the Currency (OCC)
regulations require that bank holding companies and national banks maintain
minimum capital ratios. As of June 30, 1996, the Company and its principal
bank subsidiary, First American National Bank (FANB), had ratios which exceeded
the regulatory requirements to be classified as "well capitalized," the highest
regulatory capital rating. At June 30, 1996, the Company and FANB,
respectively, had total risk-based capital ratios of 12.32% and 11.61%, Tier I
risk-based capital ratios of 9.75% and 10.35%, and Tier I leverage capital
ratios of 7.67% and 8.31%. In order to be considered well capitalized, the
total risk-based capital ratio must be a minimum of 10%, the Tier I risk-based
capital ratio must equal or exceed 6%, and the Tier I leverage capital ratio
must be 5% or greater.
18
19
FAFSB is subject to capital requirements adopted by the OTS, which are
similar to those issued by the Federal Reserve Board and the OCC. As of June
30, 1996, FAFSB had ratios which exceeded the regulatory requirements to be
classified as "well capitalized".
On July 18, 1996, the Board of Directors authorized a stock repurchase
program for up to 1.5 million shares of the Corporation's common stock to fund
its various employee benefit plans, dividend reinvestment plans and potential
future acquisitions.
LIQUIDITY
Liquidity management consists of maintaining sufficient cash levels to
fund operations and to meet the requirements of borrowers, depositors, and
creditors. Liquid assets, which include cash and cash equivalents (less
Federal Reserve Bank reserve requirements), money market instruments, and
securities that will mature within one year, amounted to $801.6 million and
$786.2 million at June 30, 1996 and 1995, respectively. The estimated average
maturity of securities was 4.7 years and 4.0 years at June 30, 1996 and 1995,
respectively. The average repricing life of the total securities portfolio was
2.3 years and 1.9 years at June 30, 1996 and 1995, respectively. The overall
liquidity position of First American is further enhanced by a high proportion
of core deposits, which provide a stable funding base. Core deposits comprised
89% of total deposits at June 30, 1996, versus 88% at June 30, 1995.
There were no revolving credit borrowings outstanding during the six
months ended June 30, 1996, on First American's $70.0 million revolving credit
agreement.
19
20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The information called for by this item is incorporated by
reference to Item 3 of the Registrant's annual report on Form 10-K
for the year ended December 31, 1995, and Note 8 to the Corporation's
Consolidated Financial Statements for the quarter ended June 30, 1996
included herein.
Item 4. Submission of Matters to a Vote of Security Holders
(a) An annual meeting of shareholders was held on April 18, 1996.
(b) At the annual meeting, the shareholders voted on the election of
directors. The name of each director elected, including a tabulation
of votes, is as follows:
For Against Abstain
---------- ------- -------
Sam H. Anderson, Jr. 23,262,810 19,792 62,611
Earnest W. Deavenport, Jr. 23,269,179 13,630 62,415
Martha R. Ingram 23,268,425 14,627 62,162
James R. Martin 23,263,800 19,009 62,405
Roscoe R. Robinson 23,250,437 34,409 62,368
David K. Wilson 23,249,617 32,985 62,611
William S. Wire II 23,255,610 27,235 62,359
The name of each other director whose term of office as a director
continued after the annual meeting is as follows: (until 1997
meeting) Dennis C. Bottorff, T. Scott Fillebrown, Jr., James A.
Haslam II, Walter G. Knestrick, Robert A. McCabe, Jr., William O.
McCoy, and Toby S. Wilt; (until 1998 meeting) Reginald D. Dickson,
Gene C. Koonce, Dale W. Polley, James F. Smith, Jr., Cal Turner, Jr.,
and Ted H. Welch.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Number Description
11 Statement regarding computation of per share earnings
is included in Note 6 to the Consolidated Financial Statements
for the quarter ended June 30, 1996. See Part 1, Item 1.
15 Letter regarding unaudited interim financial
information from KPMG Peat Marwick LLP, dated July 18, 1996.
27 Financial Data Schedule for interim year-to-date
period ended June 30, 1996. (For SEC use only)
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended June 30,
1996.
20
21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FIRST AMERICAN CORPORATION
(Registrant)
/s/ Martin E. Simmons
-------------------------------
Martin E. Simmons
Executive Vice President, General Counsel,
Secretary and Principal Financial Officer
Date: August 9, 1996
-------------------------
21