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 September 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: 29,604,942 as of October 31, 1996.
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FIRST AMERICAN CORPORATION
AND SUBSIDIARIES
INDEX
Part I. Financial Information Page
----
Item 1 Financial Statements (unaudited)
Consolidated Income Statements for the Three and Nine
Months Ended September 30, 1996 and 1995 3
Consolidated Balance Sheets as of September 30, 1996
and 1995 and December 31, 1995 4
Consolidated Statements of Changes in Shareholders'
Equity for the Nine Months Ended September 30, 1996
and 1995 5
Consolidated Statements of Cash Flows for the Nine
Months Ended September 30, 1996 and 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 21
Item 6 Exhibits and Reports on Form 8-K 21
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FIRST AMERICAN CORPORATION
AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENTS
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------- --------------------
1996 1995 1996 1995
-------- -------- -------- --------
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
INTEREST INCOME
Interest and fees on loans $138,286 $119,355 $406,537 $344,120
Interest and dividends on securities 39,384 36,607 111,203 107,186
Interest on federal funds sold and securities
purchased under agreements to resell 845 859 5,564 2,633
Interest on time deposits with other banks and other interest 1,487 884 2,651 1,728
- ---------------------------------------------------------------------------------------------------------------------
Total interest income 180,002 157,705 525,955 455,667
- ---------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Interest on deposits:
NOW accounts 3,962 3,960 11,798 12,258
Money market accounts 26,970 21,444 79,616 59,796
Regular savings 1,878 2,322 6,077 7,425
Certificates of deposit under $100,000 21,976 19,039 65,569 53,028
Certificates of deposit $100,000 and over 9,736 10,340 27,779 24,803
Other time and foreign 6,518 5,669 19,775 15,722
- ---------------------------------------------------------------------------------------------------------------------
Total interest on deposits 71,040 62,774 210,614 173,032
- ---------------------------------------------------------------------------------------------------------------------
Interest on short-term borrowings 13,510 12,831 37,829 36,103
Interest on long-term debt 6,161 4,690 19,176 14,034
- ---------------------------------------------------------------------------------------------------------------------
Total interest expense 90,711 80,295 267,619 223,169
- ---------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 89,291 77,410 258,336 232,498
PROVISION FOR LOAN LOSSES - 24 - 83
- ---------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 89,291 77,386 258,336 232,415
- ---------------------------------------------------------------------------------------------------------------------
NON-INTEREST INCOME
Service charges on deposit accounts 14,436 11,760 42,665 34,883
Commissions and fees on fiduciary activities 4,644 4,256 13,400 12,404
Investment services income 26,685 2,755 33,552 7,487
Trading account revenue 686 31 970 449
Merchant discount fees 1,021 911 2,646 2,346
Net realized gain on sales and write-downs of securities 15 214 1,522 568
Other income 10,232 6,679 26,429 18,431
- ---------------------------------------------------------------------------------------------------------------------
Total non-interest income 57,719 26,606 121,184 76,568
- ---------------------------------------------------------------------------------------------------------------------
NON-INTEREST EXPENSE
Salaries and employee benefits 44,022 35,362 121,946 106,936
Net occupancy expense 7,008 5,400 18,698 16,140
Equipment expense 4,322 3,784 12,557 11,359
Systems and processing expense 3,885 2,591 10,518 8,450
FDIC insurance expense 8,910 27 10,286 6,913
Marketing expense 3,805 2,167 10,785 6,792
Communication expense 3,155 2,401 8,916 7,316
Supplies expense 1,370 1,253 3,745 3,317
Foreclosed properties expense (income), net (1,098) (17) (3,750) (3,293)
Subscribers' commissions 17,449 - 17,449 -
Other expenses 10,349 7,206 26,136 20,328
- ---------------------------------------------------------------------------------------------------------------------
Total non-interest expense 103,177 60,174 237,286 184,258
- ---------------------------------------------------------------------------------------------------------------------
Income before income tax expense 43,833 43,818 142,234 124,725
Income tax expense 16,414 16,105 54,126 45,981
- ---------------------------------------------------------------------------------------------------------------------
NET INCOME $ 27,419 $ 27,713 $ 88,108 $ 78,744
=====================================================================================================================
PER COMMON SHARE:
Net income $ .93 $ .99 $ 2.98 $ 2.78
Cash dividends .31 .28 .90 .78
=====================================================================================================================
Weighted average common shares outstanding 29,551 27,854 29,589 28,278
=====================================================================================================================
See notes to consolidated financial statements.
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FIRST AMERICAN CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30 DECEMBER 31
--------------------------- -----------
1996 1995 1995
----------- ---------- -----------
(DOLLARS IN THOUSANDS)
ASSETS
Cash and due from banks $ 521,296 $ 440,058 $ 494,496
Time deposits with other banks 8,592 10,718 26,733
Securities:
Held to maturity (market value $887,798, $1,642,218 and
$933,911, respectively) 888,462 1,626,604 931,084
Available for sale (amortized cost $1,513,172, $670,638
and $1,196,414, respectively) 1,495,760 670,075 1,202,493
- --------------------------------------------------------------------------------------------------------------------
Total securities 2,384,222 2,296,679 2,133,577
- --------------------------------------------------------------------------------------------------------------------
Federal funds sold and securities purchased under
agreements to resell 110,781 103,321 291,042
Trading account securities 95,647 33,628 22,419
Loans:
Commercial 2,952,130 2,712,487 2,823,827
Consumer--amortizing mortgages 1,771,531 1,522,488 1,784,836
Consumer--other 1,325,130 1,157,493 1,281,921
Real estate--construction 182,993 179,643 186,655
Real estate--commercial mortgages and other 354,490 307,299 354,918
- --------------------------------------------------------------------------------------------------------------------
Total loans 6,586,274 5,879,410 6,432,157
Unearned discount and net deferred loan fees 5,505 5,935 6,181
- --------------------------------------------------------------------------------------------------------------------
Loans, net of unearned discount and net deferred
loan fees 6,580,769 5,873,475 6,425,976
Allowance for possible loan losses 128,225 128,835 132,415
- --------------------------------------------------------------------------------------------------------------------
Total net loans 6,452,544 5,744,640 6,293,561
- --------------------------------------------------------------------------------------------------------------------
Premises and equipment, net 149,833 120,047 129,419
Foreclosed properties 7,944 8,897 10,683
Other assets 297,506 212,400 279,699
- --------------------------------------------------------------------------------------------------------------------
Total assets $10,028,365 $8,970,388 $9,681,629
====================================================================================================================
LIABILITIES
Deposits:
Demand (non-interest-bearing) $ 1,319,074 $1,169,806 $1,266,285
NOW accounts 786,077 765,542 811,862
Money market accounts 2,242,885 1,933,052 2,031,796
Regular savings 318,248 373,913 376,725
Certificates of deposit under $100,000 1,673,629 1,396,420 1,679,792
Certificates of deposit $100,000 and over 714,741 691,801 750,491
Other time 396,299 295,627 320,382
Foreign 100,712 102,495 144,961
- --------------------------------------------------------------------------------------------------------------------
Total deposits 7,551,665 6,728,656 7,382,294
- --------------------------------------------------------------------------------------------------------------------
Short-term borrowings 1,153,294 1,073,082 938,287
Long-term debt 340,497 278,190 421,791
Other liabilities 144,918 196,332 143,725
- --------------------------------------------------------------------------------------------------------------------
Total liabilities 9,190,374 8,276,260 8,886,097
- --------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Common stock, $5 par value; authorized 50,000,000
shares; issued: 29,556,609 shares at September 30, 1996;
27,630,197 shares at September 30, 1995; and 29,539,819
shares at December 31, 1995 147,783 138,151 147,699
Capital surplus 158,229 91,394 162,254
Retained earnings 545,564 467,451 483,973
Deferred compensation on restricted stock (2,333) (1,599) (1,263)
Employee stock ownership plan obligation (567) (691) (661)
- --------------------------------------------------------------------------------------------------------------------
Realized shareholders' equity 848,676 694,706 792,002
Net unrealized gains (losses) on securities available for
sale, net of tax (10,685) (578) 3,530
- --------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 837,991 694,128 795,532
- --------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $10,028,365 $8,970,388 $9,681,629
====================================================================================================================
See notes to consolidated financial statements.
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FIRST AMERICAN CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
NET
UNREALIZED
DEFERRED EMPLOYEE GAINS
COMPENSATION STOCK (LOSSES)
ON OWNERSHIP ON SECURITIES
NINE MONTHS ENDED SEPTEMBER 30, 1995, AND COMMON CAPITAL RETAINED RESTRICTED PLAN AVAILABLE
SEPTEMBER 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 341,185 common shares in
connection with Employee Benefit
Plan, net of discount on Dividend
Reinvestment Plan 1,705 5,231 - - - - 6,936
Issuance of 12,095 shares of restricted
common stock 61 347 - (321) - - 87
Repurchase of 1,448,152 shares of common
stock (7,240) (45,748) - - - - (52,988)
Amortization of deferred compensation
on restricted stock - - - 883 - - 883
Reduction in employee stock ownership
plan obligation - - - - 90 - 90
Net income - - 78,744 - - - 78,744
Cash dividends declared ($.78 per
common share) - - (20,067) - - - (20,067)
Cash dividends declared by pooled
company - - (908) - - - (908)
Change in net unrealized gains and
losses on securities available for
sale, net of tax - - - - - 13,003 13,003
Tax benefit from stock option and award
plans - 631 - - - - 631
Other - - 44 - - - 44
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 1995 $138,151 $ 91,394 $467,451 $ (1,599) $ (691) $ (578) $694,128
===================================================================================================================================
Balance, January 1, 1996 $147,699 $162,254 $483,973 $ (1,263) $ (661) $ 3,530 $795,532
Issuance of 289,471 common shares in
connection with Employee Benefit
Plan, net of discount on Dividend
Reinvestment Plan 1,447 8,966 - - - - 10,413
Issuance of 44,488 shares of restricted
common stock 223 1,868 - (2,091) - - -
Repurchase of 1,390,331 shares of common
stock (6,952) (55,780) - - - - (62,732)
Issuance of 1,073,759 common shares for
purchase of First City Bancorp, Inc. 5,369 40,937 - - - - 46,306
Amortization of deferred compensation
on restricted stock - - - 1,021 - - 1,021
Reduction in employee stock ownership
plan obligation - - - - 94 - 94
Net income - - 88,108 - - - 88,108
Cash dividends declared ($.90 per
common share) - - (26,517) - - - (26,517)
Change in net unrealized gains and
losses on securities available
for sale, net of tax - - - - - (14,215) (14,215)
Other (3) (16) - - - - (19)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 1996 $147,783 $158,229 $545,564 $ (2,333) $ (567) $ (10,685) $837,991
===================================================================================================================================
See notes to consolidated financial statements.
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FIRST AMERICAN CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED
SEPTEMBER 30
-------------------------
1996 1995
--------- --------
(IN THOUSANDS)
OPERATING ACTIVITIES
Net income $ 88,108 $ 78,744
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses - 83
Depreciation of premises and equipment 11,432 10,378
Amortization of intangible assets 6,952 2,918
Other amortization (accretion), net 103 (5,263)
Deferred income tax expense 11,149 8,903
Net realized gain on sales of securities (1,522) (568)
Net gain on sales of premises and equipment (57) (31)
Change in assets and liabilities, net of effects from acquisition:
(Increase) decrease in accrued interest receivable 8,476 (4,254)
Increase (decrease) in accrued interest payable (10,730) 18,109
Increase in trading account securities (65,238) (25,011)
Decrease in other assets 42,311 649
Increase (decrease) in other liabilities (5,551) 75,791
- ---------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 85,433 160,448
- ---------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Net (increase) decrease in time deposits with other banks 19,905 (6,863)
Proceeds from sales of securities available for sale 437,770 651,280
Proceeds from maturities of securities available for sale 287,925 118,088
Purchases of securities available for sale (909,413) (723,898)
Proceeds from maturities of securities held to maturity 161,271 214,632
Purchases of securities held to maturity (115,961) (196,323)
Net (increase) decrease in federal funds sold and securities
purchased under agreements to resell 215,450 (75,187)
Increase in loans, net of repayments and sales (85,630) (702,193)
Sales of loans 92,394 -
Acquisitions, net of cash acquired (19,216) -
Proceeds from sales of premises and equipment 5,737 201
Purchases of premises and equipment (29,746) (19,520)
- ---------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 60,486 (739,783)
- ---------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Net increase (decrease) in deposits (157,877) 420,877
Net increase in short-term borrowings 200,564 143,242
Net increase (decrease) in Federal Home Loan Bank advances (82,106) 7,922
Net repayment of other long-term debt (939) (1,205)
Net proceeds from issuance of common stock 10,413 7,023
Cash dividends paid (26,517) (20,975)
Repurchase of common stock (62,732) (52,988)
Other 75 1,581
- ---------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities (119,119) 505,477
- ---------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and due from banks 26,800 (73,858)
Cash and due from banks, January 1 494,496 513,916
- ---------------------------------------------------------------------------------------------------------------------
Cash and due from banks, September 30 $ 521,296 $ 440,058
=====================================================================================================================
Cash paid during the period for:
Interest expense $ 276,910 $ 205,067
Income taxes 43,964 28,711
Noncash investing activities:
Foreclosures 1,051 1,012
Stock issued for acquisitions 46,306 -
- ---------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements.
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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:
SEPTEMBER 30 December 31
- ---------------------------------------------------------------------------------------------------------------
(in thousands) 1996 1995 1995
- ---------------------------------------------------------------------------------------------------------------
Non-accrual loans $ 14,064 $ 16,472 $ 18,670
Foreclosed properties 7,944 8,897 10,683
- ---------------------------------------------------------------------------------------------------------------
Total nonperforming assets $ 22,008 $ 25,369 $ 29,353
===============================================================================================================
90 days or more past due on accrual $ 8,335 $ 4,245 $ 6,123
===============================================================================================================
Nonperforming assets as a percent of loans
and foreclosed properties (excluding
90 days or more past due on accrual) .33% .43% .46%
===============================================================================================================
(3) ALLOWANCE FOR POSSIBLE LOAN LOSSES
Transactions in the allowance for possible loan losses were as follows:
NINE MONTHS ENDED
SEPTEMBER 30
- ---------------------------------------------------------------------------------------------------------------
(in thousands) 1996 1995
- ---------------------------------------------------------------------------------------------------------------
Balance, January 1 $132,415 $129,436
Provision charged to operating expenses - 83
Allowance of subsidiary purchased 2,126 -
- ---------------------------------------------------------------------------------------------------------------
134,541 129,519
- ---------------------------------------------------------------------------------------------------------------
Loans charged off 21,784 12,054
Recoveries of loans previously charged off 15,468 11,370
- ---------------------------------------------------------------------------------------------------------------
Net charge-offs 6,316 684
- ---------------------------------------------------------------------------------------------------------------
Balance, September 30 $128,225 $128,835
===============================================================================================================
Allowance ratios were as follows:
NINE MONTHS ENDED
SEPTEMBER 30
- ---------------------------------------------------------------------------------------------------------------
1996 1995
- ---------------------------------------------------------------------------------------------------------------
Allowance end of period to net loans outstanding 1.95% 2.19%
Net charge-offs to average loans (annualized) .13 .02
===============================================================================================================
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(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 were accounted for as purchases.
The purchase price in excess of the fair value of net assets (goodwill)
acquired was $16.4 million. Preacquisition results of INVEST was immaterial.
During the third quarter of 1996, FANB purchased an additional 2.1% of the
stock of INVEST.
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. The purchase price in excess of
the fair value of net assets (goodwill) acquired was $32.2 million.
Preacquisition results of First City was immaterial.
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.
During the nine months ended September 30, 1996, $752 thousand of
mortgage servicing rights were capitalized and $33 thousand of amortization of
mortgage servicing rights was recorded. As of September 30, 1996, the
estimated fair value of capitalized mortgage servicing rights was $1 million.
Upon adoption of SFAS No. 122, all transactions involving transfers of mortgage
loans in which servicing rights have been retained have had cost allocated to
mortgage servicing rights based on the requirements of SFAS No. 122.
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The Corporation utilizes the positive cash flow method to estimate
fair value of mortgage servicing rights, which is a method consistent with
those of models used to calculate market quotes. Industry consensus
prepayment, default, discount, and market delivery rates are utilized in the
Corporation's fair value calculations. The Corporation amortizes the cost
allocated to mortgage servicing rights in proportion to and over the period of
estimated net servicing income.
The risk characteristics of the underlying loans used to stratify
capitalized mortgage servicing rights for purposes of measuring impairment are:
type of loan (i.e., fixed rate, adjustable rate, loan guarantee, if any, etc.),
loan-to-value ratio, and interest rate. During the nine months ended September
30, 1996, approximately $1 thousand was initially recorded as a valuation
allowance for capitalized mortgage servicing rights.
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 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.
During 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishment of Liabilities." SFAS No. 125
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities based on consistent
application of a financial-components approach that focuses on control. It
distinguishes transfers of financial assets that are sales from transfers that
are secured borrowings. SFAS No. 125 is effective for transfers and servicing
of financial assets and extinguishments of liabilities occurring after December
31, 1996, and is to be applied prospectively. The adoption of SFAS No. 125 is
not expected to have a material impact on the Corporation's consolidated
financial statements.
(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 1.4 million shares of First American Corporation
common stock in the open market during the first nine months of 1996 at a total
cost of $62.7 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 September 30, 1996, substantially
all repurchased shares had been used to fund the acquisitions of Charter and
First City and to fund employee benefit and dividend reinvestment plans.
(8) LEGAL AND REGULATORY MATTERS
The Savings Association Insurance Fund ("SAIF"), which insures deposits
of thrift institutions, has been undercapitalized as a result of losses
sustained by the S&L industry during the late 1980's and early 1990's. On
September 30, 1996, legislation was enacted into law which requires a special
one-time assessment at the rate of approximately 66 basis points per $100 of
deposits on SAIF deposits held as of March 31, 1995, to capitalize the thrift
fund up to the statutorily prescribed 1.25%. Consequently, effective January 1,
1997, the SAIF deposit insurance rate for well-capitalized institutions will
drop to 0 basis points per $100 of deposits. The Corporation accrued a one-time
charge of approximately $8.1 million ($5.0 million, net of tax) in the third
quarter of 1996 for this special assessment. In addition, beginning January 1,
1997, the new law imposes a 1.3 basis point annual charge through 1999 on Bank
Insurance Fund
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("BIF") deposits and a 6.4 basis point annual charge on SAIF deposits 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. For 1997, this annual charge is
expected to be approximately $1.0 million, net of tax, based on deposits at
September 30, 1996. Starting in the year 2000, until FSLIC Resolution funding
is retired, banks and thrifts will pay such assessment on a pro rata basis
(estimated to run approximately 2.5 basis points for BIF deposits and slightly
higher for SAIF deposits).
The Corporation and seven other financial institutions have been
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. On November 4,
1996, the Tennessee Supreme Court affirmed the lower courts dismissal of the
action. The plaintiffs have through November 14, 1996 to file a petition to
rehear. 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
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.
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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 third quarter of 1996 was $27.4 million, or $.93
per share. During the quarter, First American accrued a one-time charge of
approximately $8.1 million in non-interest expense ($5.0 million, net of tax,
or $.17 per share) for a special FDIC assessment enacted into law on September
30, 1996, which required a one-time assessment at the rate of approximately 66
basis points per $100 of deposits on Savings Association Insurance Fund
("SAIF") deposits held by financial institutions as of March 31, 1995, to
capitalize the thrift fund up to the statutorily prescribed 1.25%. In the third
quarter of 1996, excluding this assessment, net income per share was $1.10, up
11% from the previous year, and return on average assets ("ROA") was 1.31%
versus 1.27% in the previous year's third quarter and return on average equity
("ROE") was 15.30% compared to 15.79% in third quarter 1995.
Net income for the nine months ended September 30, 1996, was $88.1
million, or $2.98 per share. Excluding the special FDIC assessment, net income
per share for the first nine months was $3.15, up 13% from the previous year.
In the nine months ended September 30, 1996, excluding the special FDIC
assessment, ROA was 1.28% versus 1.26% in the previous year's first nine months
and ROE was 15.15% compared to 15.18% in the same period in 1995.
In October 1996, First American signed a definitive merger agreement for
Hartsville Bancshares, Inc. ("Hartsville") to merge with First American in a
transaction valued at approximately $13 million. Of the total First American
shares to be exchanged in the transaction, 100% are expected to be repurchased
in the open market. Hartsville has $100 million in assets and five branches in
the Nashville area operating under the name CommunityFirst.
The merger is expected to be completed late in the fourth quarter of 1996 or
early 1997, subject to regulatory approval and a vote by Hartsville
shareholders. The transaction will be accounted for as a purchase.
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 were accounted for as purchases. During the third quarter of
1996, FANB purchased an additional 2.1% of the stock of INVEST. The impact of
the INVEST acquisition increased non-interest income and non-interest expense
by approximately $24 million each in the 1996 third quarter.
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.
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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.
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income on a taxable equivalent basis represented 61% of total
revenues in the third quarter of 1996 and 75% in the third 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 third quarter of 1996 was $90.2 million, up $11.9 million, or 15%,
from $78.3 million in the third 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.
Net interest income on a taxable equivalent basis represented 68% of total
revenues in the first nine months of 1996 and 75% during the same period last
year. Net interest income on a taxable equivalent basis in the nine months
ended September 30, 1996 was $261.0 million, up $26.0 million, or 11%, from
$235.0 million during the same period last year.
Total interest income on a taxable equivalent basis amounted to $180.9
million for the third quarter of 1996, compared to $158.6 million for the third
quarter of 1995, an increase of $22.3 million, or 14%. Of the $22.3 million
increase in total interest income, $20.8 million resulted from an increase in
the volume of earning assets (primarily loans and securities) and $1.5 million
resulted from an increase in average yields. Average earning assets rose $1.05
billion, or 13%, to $9.07 billion. Average loans increased $844.7 million, or
15%, to $6.51 billion, average securities increased $167.4 million, or 7%, to
$2.40 billion, and average money market investments increased $39.6 million to
$152.7 million. Excluding the Charter and First City acquisitions, average
loans for the quarter ended September 30, 1996, increased 5% over the same
period last year. The average yield on earning assets increased 9 basis points
to 7.94% from 7.85%, reflecting a generally higher interest rate environment in
the third quarter of 1996 compared to the third quarter of 1995 for financial
instruments with maturities of one year or longer. For example, the 1-year and
5-year treasury security yields averaged 5.78% and 6.54%, respectively, in the
third quarter of 1996 compared to 5.65% and 6.08%, respectively, in the third
quarter of 1995. Shorter-term external interest rates were generally lower than
the third quarter of 1995. Because some of First American's earning assets (and
interest-bearing liabilities) do not reprice immediately upon a change in
external rates and because of other factors, such as competitive pressures, a
change in external rates will not result in a change in the Company's average
yields on earning assets (and rates paid on interest-bearing liabilities) of the
same magnitude or timing as the change in external rates.
Total interest income on a taxable equivalent basis amounted to $528.7
million for the nine months ended September 30, 1996, compared to $458.3 million
for the same time last year, an increase of $70.4 million, or 15%. Of the $70.4
million increase in total interest income, $72.4 million resulted from an
increase in the volume of earning assets (primarily loans) which was partially
offset by a $2.0 million decrease which resulted from a decrease in average
yields. Average earning assets rose $1.22 billion, or 16%, to $8.95 billion.
Average loans increased $1.04 billion, or 19%, to $6.49 billion, average
securities increased $82.7 million, or 4%, to $2.27 billion, and average money
market investments increased $96.2 million to $195.9 million. Excluding the
Charter and First City acquisitions, average loans for the nine months ended
September 30, 1996, increased 9% over the same period last year. The average
yield on earning assets decreased 3 basis points to 7.89% from 7.92%, reflecting
a generally lower interest rate environment in the first nine months of 1996
compared to the same time last year. For example, the national prime lending
rate and 5-year treasury security yields averaged 8.28% and 6.19%, respectively,
in the first nine months of 1996 compared to 8.87% and 6.63%, respectively, in
the first nine months of 1995.
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Total interest expense in the third quarter of 1996 increased $10.4
million, or 13%, to $90.7 million from the third quarter of 1995. Of the
increase, $11.1 million resulted from an increase in the volume of
interest-bearing liabilities which was partially offset by a $.7 million
decrease which was due to lower average interest rates paid on interest-bearing
funds. In the third quarter of 1996, average interest-bearing liabilities grew
$931.5 million, or 14%, to $7.65 billion from $6.72 billion in the third
quarter of 1995. Average interest-bearing deposits increased $696.3 million,
or 13%, to $6.22 billion, average short-term borrowings rose $158.7 million, or
17%, to $1.09 billion, and average long-term debt increased $76.5 million, or
28%, to $346.5 million. Excluding the Charter and First City acquisitions,
total interest-bearing deposits decreased 2%.
The average rate paid on interest-bearing liabilities decreased three
basis points to 4.71% from 4.74%. The three-basis point decrease in rates paid
on interest-bearing liabilities during a period in which short-term external
interest rates generally declined by larger amounts on average (e.g., the
federal funds rate averaged 5.31% in the third quarter of 1996 compared to 5.80%
in the third 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 24 basis points to 4.52% from 4.76%. Average non-interest bearing
demand deposits represented 13.1% of average earning assets during the third
quarter of 1996 compared to 13.9% during the third quarter of 1995. NOW
accounts averaged 8.9% of average earning assets during the three months ended
September 30, 1996, versus 9.8% during the same time last year and had average
interest rates of 1.96% and 2.00%, respectively, during the third quarters of
1996 and 1995. Regular savings averaged 3.6% of earning assets during the third
quarter of 1996 down from 4.8% during the previous year's third quarter and had
average interest rates of 2.28% and 2.38%, respectively during the third
quarters of 1996 and 1995. All other interest-bearing liabilities averaged
71.9% of average earning assets during the third quarter of 1996 compared to
69.3% during the same time last year and had average interest rates of 5.18%
during the three months ended September 30, 1996, and 5.29% during the same time
in the previous year.
Total interest expense in the nine months ended September 30, 1996,
increased $44.4 million, or 20%, to $267.6 million from the same time last
year. Of the increase, $37.4 million resulted from an increase in the volume of
interest-bearing liabilities and $7.0 million was due to higher average interest
rates paid on interest-bearing funds. In the first nine months of 1996, average
interest-bearing liabilities grew $1.08 billion, or 17%, to $7.55 billion from
$6.46 billion in the first half of 1995. Average interest-bearing deposits
increased $838.0 million, or 16%, to $6.15 billion, average short-term
borrowings rose $150.2 million, or 17%, to $1.03 billion, and average long-term
debt increased $93.7 million, or 35%, to $363.9 million. Excluding the Charter
and First City acquisitions, total interest-bearing deposits increased 2%.
The average rate paid on interest-bearing liabilities increased 12 basis
points to 4.74% from 4.62%. The increase in rates paid on interest-bearing
liabilities during a period in which external interest rates declined on
average (e.g., the federal funds rate averaged 5.30% in the first nine months
of 1996 compared to 5.88% in the first nine months 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 12 basis points to 4.53% from 4.65%.
Average non-interest bearing demand deposits represented 13.2% of average
earning assets during the first nine months of 1996 compared to 14.2% during
the same period last year. NOW accounts averaged 9.0% of average earning
assets during the nine months ended September 30, 1996, versus 10.5% during the
same time last year and had average interest rates of 1.96% and 2.01%,
respectively, during the first nine months of 1996 and 1995. Regular savings
averaged 3.9% of earning assets during the first nine months of 1996 down from
5.4% during the previous year and had average interest rates of 2.33% and
2.38%, respectively, during the first nine months of 1996 and 1995. All other
interest-bearing liabilities averaged 71.4% of average earning assets during
the first nine months of 1996 compared to 67.6% during the same time last year
and had average interest rates of 5.22% during the nine months ended September
30, 1996, and 5.20% during the same time in the previous year.
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Net interest income in the third quarter of 1996 increased primarily as a
result of the increase in the volume of earning assets and an improved 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 improved 12 basis points to 3.23% during the
third quarter of 1996 from 3.11% for the third quarter of 1995. This increase
was due to a nine basis point increase in yields on earning assets and a three
basis point decrease in the rates paid on interest-bearing liabilities.
As the net interest spread improved, the net interest margin, which is net
interest income expressed as a percentage of average earning assets, increased
to 3.96% for the third quarter of 1996 as compared with 3.87% for the same
quarter a year earlier. The primary factors leading to the improvement in the
net interest margin were the increase in the volume of earning assets and the
improvement in net interest spread.
Net interest income in the nine months ended September 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 16 basis points to 3.15% during the first nine months of 1996 from
3.31% for the same time last year. This decline was due to a 12 basis point
increase in the rates paid on interest-bearing liabilities and a three basis
point decrease in yields on earning assets.
As the net interest spread declined, the net interest margin decreased to
3.89% for the nine months ended September 30, 1996, as compared with 4.06% 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 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 $57.7 million for the third quarter of 1996
compared with $26.6 million for the third quarter of 1995, an increase of $31.1
million, or 117%. Non-interest income represented 39% of total revenues in the
third quarter of 1996 and 25% during the same time last year. The increase in
non-interest income from the third quarter of 1995 included a $23.9 million
increase in investment services income, a $2.7 million, or 23%, increase in
service charges on deposit accounts, a $3.6 million, or 53%, increase in other
income, and a $.7 million increase in trading account revenue. Of the total
$23.9 million improvement in investment services income over the third quarter
of 1995, $23.4 million resulted from the acquisition of INVEST and the remainder
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. 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 12% and the average number of commercial
deposit accounts increased 10% from third quarter 1995 to the current quarter.
Other income in the third quarter of 1996 included a $1.4 million increase in
income and fees related to selling and servicing residential mortgage loans, a
$.9 million increase in ATM surcharge and network transaction fees, a $.4
million increase in interchange fees from the Check Card, and a $.9 million net
increase in the various other classifications within other income. Excluding
INVEST, non-interest income increased $7.2 million, or 27%. Excluding INVEST
and the Charter and First City acquisitions, non-interest income increased 22%
from the third quarter of 1995 to the current quarter.
Total non-interest income was $121.2 million for the first nine months of
1996 compared with $76.6 million for the same time last year, an increase of
$44.6 million, or 58%. Non-interest income represented 32% of total revenues
in the first nine months of 1996 and 25% during the same time last year. The
increase from the first nine months of 1995 included a $26.1 million increase in
investment services income, a $7.8 million, or 22%, increase in service charges
on deposit accounts, and an $8.0 million, or 43%, increase in other income. Of
the total $26.1 million improvement in investment services income over the first
nine months of 1995, $23.4 million resulted from the acquisition of INVEST and
the remainder resulted principally from growth in retail brokerage commissions
related to mutual funds and annuities
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sales and institutional brokerage commissions on various types of securities
transactions. 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 15% and the average number of commercial deposit accounts increased
10% from the nine months ended September 30, 1995 to the current period.
Other income in the first nine months of 1996 included a $2.7 million increase
in income and fees related to selling and servicing residential mortgage loans,
a $1.2 million increase in interchange fees from the Check Card, a $1.2 million
increase in ATM surcharge and network transaction fees, and a $2.9 million net
increase in the various other classifications within other income. Excluding
INVEST, non-interest income increased $20.7 million, or 27%. Excluding INVEST
and the Charter and First City acquisitions, non-interest income increased 23%
from the nine months ended September 30, 1995.
NON-INTEREST EXPENSE
Total non-interest expense increased $43.0 million, or 71%, to $103.2
million for the third quarter of 1996 compared with $60.2 million for the same
period in 1995. The increase in non-interest expense included a $17.4 million
increase in subscribers' commissions related to INVEST's brokerage activities,
an $8.9 million increase in FDIC insurance, an $8.7 million, or 25% increase in
salaries and employee benefits, a $3.1 million, or 44%, increase in other
expenses, a $1.6 million, or 76%, increase in marketing expense, a $1.6 million,
or 30%, increase in net occupancy expense, and a $1.3 million, or 50%, increase
in systems and processing expense.
Of the $8.9 million increase in FDIC insurance, $8.1 million related to
legislation which was enacted into law on September 30, 1996, which requires a
special one-time assessment at the rate of approximately 66 basis points per
$100 of deposits on SAIF deposits held as of March 31, 1995, to capitalize the
thrift fund up to the statutorily prescribed 1.25%. Consequently, effective
January 1, 1997, the normal SAIF deposit insurance rate for well-capitalized
institutions will drop to 0 basis points per $100 of deposits. The legislation
also requires that beginning January 1, 1997, a separate 1.3 basis point annual
charge will be assessed through 1999 on Bank Insurance Fund ("BIF") deposits and
a 6.4 basis point annual charge will be assessed on SAIF deposits 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. For 1997, this annual charge for First
American is expected to be approximately $1.0 million, net of tax, based on
deposits at September 30, 1996. Starting in the year 2000, until FSLIC
Resolution funding is retired, banks and thrifts will pay such assessment on a
pro rata basis (estimated to run approximately 2.5 basis points for BIF and
slightly higher for SAIF deposits).
Salaries and employee benefits increased $8.7 million, or 25%, from the
same period in 1995 principally due to merit increases and additional employees
resulting primarily from acquisitions. From September 30, 1995, to September
30, 1996, the number of full-time equivalent employees increased 18% related
primarily to the Charter, First City, and INVEST acquisitions. Other expenses
increased $3.1 million from the previous year's third quarter primarily due to a
$1.6 million increase in amortization of intangibles related to the Charter,
First City, and INVEST acquisitions. Marketing expenses increased $1.6 million
from the third 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. Net occupancy expense grew $1.6
million primarily due to higher rent and other occupancy-related expenses due to
the Charter, First City, and INVEST acquisitions. Systems and processing
expense increased $1.3 million over last year's third quarter primarily due to
higher processing volumes related to the recent acquisitions and various
projects to enhance systems. Of the total $43.0 million increase in
non-interest expense, $24.0 million was associated with INVEST. Excluding
INVEST, non-interest expense increased $19.0 million, or 32%. 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)
excluding INVEST and the special FDIC assessment, improved to 57.28% in the
third quarter of 1996, compared to 57.48% the third quarter of 1995.
Non-interest expense excluding INVEST, the special FDIC assessment, and the
Charter and First City acquisitions increased 8%.
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Total non-interest expense increased $53.0 million, or 29%, to $237.3
million for the nine months ended September 30, 1996, compared with $184.3
million for the same period in 1995. The increase in non-interest expense
included a $17.4 million increase in subscribers' commissions, a $15.0 million,
or 14%, increase in salaries and employee benefits, a $5.8 million, or 29%,
increase in other expenses, a $4.0 million, or 59%, increase in marketing
expense, a $3.4 million increase in FDIC insurance, $2.6 million, or 16%
increase in net occupancy expense, and a $2.1 million, or 24%, increase in
systems and processing expense.
Salaries and employee benefits increased $15.0 million from the same
period in 1995 principally due to additional employees resulting primarily from
acquisitions and due to merit increases. Other expenses increased $5.8 million
from the previous year's first nine months primarily due to a $4.0 million
increase in amortization of intangibles related to the Charter, First City, and
INVEST acquisitions. Marketing expenses increased $4.0 million from the first
nine months of 1995 primarily due to media and direct mail advertising in new
and existing markets related principally to consumer and small business deposit
and loan products. FDIC insurance expense for the nine months ended September
30, 1996, was $3.4 million higher than the same time last year because
year-to-date 1996 included an $8.1 million special assessment while the annual
assessment rate on the majority of the Company's deposits during the first five
months of 1995 was significantly higher than in 1996. Net occupancy expense grew
$2.6 million primarily due to higher rent and other occupancy-related expenses
due to the Charter, First City, and INVEST acquisitions. Systems and processing
expense increased $2.1 million over last year's first nine months primarily due
to higher processing volumes related to recent acquisitions and various projects
to enhance systems. Of the total $53.0 million increase in non-interest
expense, $24.0 million was associated with INVEST. Excluding INVEST,
non-interest expense increased $29.1 million, or 16% First American's operating
efficiency ratio, excluding INVEST and the special FDIC assessment, improved to
57.26% in the first nine months of 1996, compared to 59.13% in the first nine
months of 1995. Non-interest expense, excluding INVEST, the special FDIC
assessment, and the Charter and First City acquisitions, increased 2%.
INCOME TAXES
During the third quarters of 1996 and 1995, income tax expense was $16.4
million and $16.1 million, respectively. During the nine months ended September
30, 1996 and 1995, income tax expense was $54.1 million and $46.0 million,
respectively. The major factor for the increases in income tax expense 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 September 30,
1996, First American had derivatives with notional values totaling $1.3
billion. These derivatives had a net positive fair value (unrealized net
pre-tax gain) of $5.6 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 September 30, 1995, First American had derivatives with
notional values totaling $1.49 billion. These derivatives had a net negative
fair value (unrealized pre-tax loss) of $12.0 million at
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September 30, 1995. The instruments utilized are noted in the following table
along with their notional amounts and fair values at September 30, 1996 and
1995.
Weighted
Average
Weighted Average Rate Maturity
Related Variable Rate Notional --------------------- -------- Fair
(in thousands) Asset/Liability Amount Paid Received Years Value
- -------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 1996
Interest rate swaps Money market deposits $ 600,000 5.77% (1) 5.58% (2) 1.5 $ 4,013
Interest rate swaps Loans 300,000 5.59 (3) 6.80 (1) 4.8 3,644
Forward interest rate Available for sale
swaps securities 200,000 7.11 (4) N/A (4) 3.8 (2,025)
Forward interest rate
swaps Money market deposits 200,000 6.54 (5) N/A (5) 1.8 (63)
---------- --------
$1,300,000 $ 5,569
=========================================================================================================================
September 30, 1995
Interest rate swaps Money market deposits $ 500,000 5.99% (1) 5.92% (2) 1.7 $314
Interest rate swaps Long-term debt 200,000 7.11 (1) 5.86 (3) 1.0 (2,699)
Forward interest rate
swaps Money market deposits 650,000 7.81 (6) N/A (6) 1.1 (8,857)
Futures contracts (7) Money market deposits 140,000 N/A N/A 1.1 (729)
---------- --------
$1,490,000 $(11,971)
=========================================================================================================================
(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, June 1997 for
$50 million and July 1997 for $100 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 September 30,
1996, since the forward swap periods had not yet begun.
(5) Forward swap periods to begin in May 1997 for $100 million and September
1997 for $100 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 September 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 5.87% for the contracts which began in June 1995 but were
unknown at September 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 September 30, 1996, there
were $1.4 million of deferred net gains related to terminated derivatives
contracts, and there were $10.1 million of deferred net gains at September 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 September 30, 1996, was
decreased by derivative products expense of $2.5 million. Net interest income
for the quarter ended September 30, 1995, was increased by $.8 million
derivative products income. Net interest income for the nine months ended
September 30, 1996, was decreased by derivative products expense of $9.3
million. Net interest income for the nine months ended September 30, 1995, was
increased by $3.3 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
September 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 $5.9 million on
September 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.
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FINANCIAL CONDITION
ASSETS
Total assets of First American rose $1.06 billion, or 12%, to $10.0 billion
at September 30, 1996, compared to $8.97 billion one year earlier. The growth
in total assets was primarily due to the $707.3 million, or 12%, increase in
loans, net of unearned discount and net deferred loan fees, to $6.58 billion at
September 30, 1996, from $5.87 billion at September 30, 1995. Leading the
growth in loans were consumer amortizing mortgages, which increased $249.0
million, or 16%, commercial loans, which increased $239.6 million, or 9%, over
a broad range of industry categories, and other consumer loans, which increased
$167.6 million, or 14%. 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 $129.0 million, or 2%, from September 30, 1995, to September 30,
1996. Also contributing to total asset growth were increases in investment
securities ($87.5 million), cash ($81.2 million), and trading securities ($62.0
million). Excluding the Charter and First City acquisitions, total assets
decreased $116.1 million, or 1%, from September 30, 1995, to September 30,
1996.
Total assets increased $346.7 million from $9.68 billion at December 31,
1995, to $10.0 billion at September 30, 1996. The growth in total assets from
December 31, 1995, to September 30, 1996, was primarily due to the $154.8
million increase in loans, net of unearned discount and net deferred loan fees,
and the $250.6 million increase in securities partially offset by the $180.3
million decrease in federal funds sold and securities purchased under
agreements to resell. Leading the growth in loans were commercial loans, which
increased $128.3 million and other consumer loans, which increased $43.2
million, while other categories of loans had modest decreases. Excluding the
First City acquisition, total loans decreased $18.7 million and total assets
decreased $51.3 million from December 31, 1995, to September 30, 1996.
During July 1996, approximately $92 million of mortgage loans were
securitized and sold with the mortgage servicing rights retained by First
American. The transaction resulted 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 third quarter of 1996 nor during the first nine months of 1996. The
provisions for loan losses of $24 thousand in the third quarter of 1995 and $83
thousand in the first nine 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 nine months ended September 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 third quarter of 1996
there were net charge-offs of $5.3 million which compared to net charge-offs
of $.1 million in the third quarter of 1995. Net charge-offs as a percentage of
average loans on an annualized basis amounted to .33% and .01%, respectively, in
the third quarters of 1996 and 1995. For the nine months ended September 30,
1996 and 1995, net charge-offs were $6.3 million and $.7 million, respectively,
and net charge-offs as a percentage of average loans on an annualized basis
amounted to .13% and .02%, respectively.
The allowance for possible loan losses was $128.2 million at September 30,
1996, $128.8 million at September 30, 1995, and $132.4 million at December 31,
1995. The allowance for possible loan losses represented 1.95% and 2.19% of
net loans at September 30, 1996 and 1995, respectively, and 2.06% at December
31, 1995.
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ASSET QUALITY
First American's nonperforming assets (excluding loans 90 days past due on
accrual status) were $22.0 million at September 30, 1996, $25.4 million at
September 30, 1995, and $29.4 million at December 31, 1995. Nonperforming
assets (excluding loans 90 days past due on accrual status) at September 30,
1996, represented .33% of total loans and foreclosed properties, compared to
.43% at September 30, 1995, and .46% at December 31, 1995. At September 30,
1996, nonperforming assets were comprised of $14.1 million of non-accrual loans
and $7.9 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 September 30, 1996, such loans totaled
approximately $76 million compared with approximately $48 million of such loans
at September 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 $7.55 billion at September 30, 1996, an increase of
$823.0 million, or 12%, from $6.73 billion a year earlier. Excluding the
Charter and First City acquisitions, total deposits decreased $18.1 million, or
.3%, from September 30, 1995, to September 30, 1996. Core deposits, which are
defined as total deposits excluding certificates of deposit $100,000 and over
and foreign deposits, totaled $6.74 billion at September 30, 1996, and $5.93
billion at September 30, 1995. Short-term borrowings increased $80.2 million,
or 7%, to $1.15 billion at September 30, 1996, from $1.07 billion at September
30, 1995. Long-term debt increased $62.3 million from September 30, 1995, to
$340.5 million at September 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 $25.9 million of fixed rate
borrowings from the Federal Home Loan Bank ("FHLB") in the first nine months of
1996.
Total deposits increased $169.4 million from December 31, 1995, to
September 30, 1996. Excluding the First City acquisition, total deposits
decreased $157.8 million during the same time frame. Core deposits increased
$249.4 million, short-term borrowings increased $215.0 million, and long-term
debt decreased $81.3 million from December 31, 1995, to September 30, 1996. The
decrease in long-term debt resulted principally from the repayment of $55.5
million of variable rate and $25.9 million of fixed rate borrowings from the
FHLB.
CAPITAL POSITION
Total shareholders' equity was $838.0 million, or 8.36% of total assets at
September 30, 1996, $694.1 million, or 7.74% of total assets, at September 30,
1995, and $795.5 million, or 8.22% of total assets at December 31, 1995. Book
value per share was $28.35 on September 30, 1996, $25.12 per share on September
30, 1995, and $26.93 per share on December 31, 1995.
Total shareholders' equity increased $42.5 million from December 31, 1995,
principally from $61.6 million of earnings retention ($88.1 million of net
income less $26.5 million of dividends). Partially offsetting the above
increase in shareholders' equity was the $14.2 million change in net unrealized
gains and losses on securities available for sale, net of tax, and the net
repurchase of $6.0 million of common stock.
In the third quarter of 1996, First American declared cash dividends on its
common stock of $.31 per share compared to $.28 per share in the third quarter
of 1995, an 11% increase. The dividend payout ratio was 33% in the third
quarter of 1996 compared to 28% in the third quarter of 1995. Cash dividends
for the first nine months of 1996 were $.90 versus $.78 in the first nine
months of 1995, a 15% increase. The dividend payout ratios for the nine month
ended September 30, 1996 and 1995, were 30% 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 September 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 September 30, 1996,
the Company and FANB, respectively, had total risk-based capital ratios of
12.21% and 11.54%, Tier I risk-based capital ratios of 9.66% and 10.29%, and
Tier I leverage
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capital ratios of 7.61% and 8.28%. 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.
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
September 30, 1996, FAFSB had ratios which exceeded the regulatory requirements
to be classified as "well capitalized".
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 $943.0 million and
$745.3 million at September 30, 1996 and 1995, respectively. The estimated
average maturity of securities was 5.3 years and 4.3 years at September 30,
1996 and 1995, respectively. The average repricing life of the total
securities portfolio was 2.2 years and 2.0 years at September 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 September 30,
1996, versus 88% at September 30, 1995.
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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 September 30, 1996 included
herein.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Number Description
3.1 Restated Charter (previously filed as
Exhibit 1 to the Registrant's Quarterly Report
on Form 10-Q for the quarter ended September
30, 1991, and incorporated herein by
reference).
3.2 By-Laws of the Registrant currently in effect
as amended January 18, 1996, is incorporated
by reference to Item 14 of the Registrant's
annual report on Form 10-K for the year ended
December 31, 1995.
11 Statement regarding computation of per share
earnings is included in Note 6 to the
Consolidated Financial Statements for the
quarter ended September 30, 1996. See Part
1, Item 1.
15 Letter regarding unaudited interim financial
information from KPMG Peat Marwick LLP, dated
October 17, 1996.
27 Financial Data Schedule for interim
year-to-date period ended September 30, 1996.
(For SEC use only)
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended
September 30, 1996.
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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: November 12, 1996
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