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 March 31, 1999
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: 116,749,805 as of April 30, 1999.
2
FIRST AMERICAN CORPORATION
AND SUBSIDIARIES
INDEX
Part I. Financial Information Page
- -------------------------------- ----
Item 1 Financial Statements (unaudited)
Consolidated Income Statements for the Three
Months Ended March 31, 1999 and 1998 3
Consolidated Balance Sheets as of March 31, 1999 and
1998 and December 31, 1998 4
Consolidated Statements of Changes in Shareholders'
Equity for the Three Months Ended March 31, 1999
and March 31, 1998 5
Consolidated Statements of Cash Flows for the Three
Months Ended March 31, 1999 and March 31, 1998 6
Notes to Consolidated Financial Statements 7
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 3 Quantitative and Qualitative Disclosures about Market Risk 28
Part II. Other Information
- ----------------------------
Item 1 Legal Proceedings 28
Item 6 Exhibits and Reports on Form 8-K 28
2
3
FIRST AMERICAN CORPORATION
AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENTS
THREE MONTHS ENDED
MARCH 31
-----------------------
(in thousands except per share amounts) 1999 1998
- -------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans $232,409 $255,217
Securities
Taxable 92,800 69,451
Tax-exempt 5,220 3,682
Federal funds sold and securities purchased under
agreements to resell 1,688 1,726
Time deposits with other banks and other interest 4,873 4,008
- -------------------------------------------------------------------------------------------------
Total interest income 336,990 334,084
- -------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Deposits 108,797 118,381
Short-term borrowings 25,836 25,743
Long-term debt 16,557 9,481
- -------------------------------------------------------------------------------------------------
Total interest expense 151,190 153,605
- -------------------------------------------------------------------------------------------------
NET INTEREST INCOME 185,800 180,479
PROVISION FOR LOAN LOSSES 9,234 6,938
- -------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 176,566 173,541
- -------------------------------------------------------------------------------------------------
NONINTEREST INCOME
Investment services income 41,416 35,420
Service charges on deposit accounts 31,384 29,463
Commissions and fees on fiduciary activities 9,825 10,804
Mortgage banking 11,472 10,742
Merchant discount fees 911 800
Net realized gain on sales of securities 2,339 1,685
Trading account revenue 1,140 1,957
Other 18,214 18,528
- -------------------------------------------------------------------------------------------------
Total noninterest income 116,701 109,399
- -------------------------------------------------------------------------------------------------
NONINTEREST EXPENSE
Salaries and employee benefits 88,233 90,336
Subscribers' commissions 24,295 20,190
Net occupancy 13,184 12,722
Equipment 13,310 11,961
Systems and processing 3,916 3,664
Communication 8,881 7,306
Marketing 5,926 5,155
Supplies 2,811 3,364
Goodwill amortization 4,504 4,405
Merger and integration costs 3,274 --
Other 21,549 22,848
- -------------------------------------------------------------------------------------------------
Total noninterest expense 189,883 181,951
- -------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAX EXPENSE 103,384 100,989
Income tax expense 36,920 36,643
- -------------------------------------------------------------------------------------------------
NET INCOME $ 66,464 $ 64,346
=================================================================================================
PER COMMON SHARE:
Net income:
Basic $ .58 $ .58
Diluted .57 .57
Dividends declared .25 .20
=================================================================================================
AVERAGE COMMON SHARES OUTSTANDING:
Basic 115,409 111,060
Diluted 117,226 113,545
=================================================================================================
See accompanying notes to consolidated financial statements.
3
4
FIRST AMERICAN CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31 December 31
------------------------------- ------------
(dollars in thousands) 1999 1998 1998
- -----------------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks $ 881,638 $ 1,031,901 $ 1,203,358
Time deposits with other banks 18,740 67,272 297,374
Federal funds sold and securities purchased under agreements to resell 102,620 69,564 351,989
- -----------------------------------------------------------------------------------------------------------------------------------
Total cash and cash equivalents 1,002,998 1,168,737 1,852,721
- -----------------------------------------------------------------------------------------------------------------------------------
Securities held to maturity (fair value $2,355,805, $844,227, and
$1,739,852, respectively) 2,356,351 836,384 1,730,460
Securities available for sale (amortized cost $4,457,519, $4,069,184,
and $4,505,730, respectively) 4,437,875 4,074,972 4,495,160
- -----------------------------------------------------------------------------------------------------------------------------------
Total securities 6,794,226 4,911,356 6,225,620
- -----------------------------------------------------------------------------------------------------------------------------------
Trading account securities 65,166 73,120 43,987
Mortgage loans held for sale 80,121 240,701 214,745
Loans:
Commercial 5,567,682 4,634,177 5,558,099
Consumer--amortizing mortgages 1,811,815 2,582,459 1,784,035
Consumer--other 2,638,941 2,656,764 2,690,227
Real estate--construction 457,459 492,417 452,191
Real estate--commercial mortgages and other 1,003,053 1,517,892 1,053,147
- -----------------------------------------------------------------------------------------------------------------------------------
Total loans 11,478,950 11,883,709 11,537,699
Unearned discount (10,078) (13,552) (12,756)
- -----------------------------------------------------------------------------------------------------------------------------------
Loans, net of unearned discount 11,468,872 11,870,157 11,524,943
Allowance for loan losses (189,648) (188,872) (197,681)
- -----------------------------------------------------------------------------------------------------------------------------------
Total net loans 11,279,224 11,681,285 11,327,262
- -----------------------------------------------------------------------------------------------------------------------------------
Premises and equipment, net 393,585 359,320 383,865
Other assets 711,147 794,202 683,570
- -----------------------------------------------------------------------------------------------------------------------------------
Total assets $ 20,326,467 $ 19,228,721 $ 20,731,770
===================================================================================================================================
LIABILITIES
Deposits:
Noninterest-bearing $ 2,756,312 $ 2,881,626 $ 3,046,651
Interest-bearing 11,678,952 11,585,891 12,224,105
- -----------------------------------------------------------------------------------------------------------------------------------
Total deposits 14,435,264 14,467,517 15,270,756
- -----------------------------------------------------------------------------------------------------------------------------------
Short-term borrowings 2,532,200 2,064,074 2,213,637
Long-term debt 1,227,744 605,867 1,152,939
Other liabilities 313,390 450,349 314,643
- -----------------------------------------------------------------------------------------------------------------------------------
Total liabilities 18,508,598 17,587,807 18,951,975
- -----------------------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Common stock, $2.50 par value; authorized 200,000,000 shares; issued:
116,691,785 shares at March 31, 1999; 112,607,285 shares at March 31,
1998; and 116,318,734
shares at December 31, 1998 291,729 281,518 290,797
Additional paid-in capital 250,381 181,907 241,333
Retained earnings 1,323,809 1,204,370 1,286,512
Deferred compensation on restricted stock (35,343) (30,985) (31,781)
- -----------------------------------------------------------------------------------------------------------------------------------
Realized shareholders' equity 1,830,576 1,636,810 1,786,861
Accumulated other comprehensive (loss) income, net of tax (12,707) 4,104 (7,066)
- -----------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 1,817,869 1,640,914 1,779,795
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 20,326,467 $ 19,228,721 $ 20,731,770
===================================================================================================================================
See accompanying notes to consolidated financial statements.
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FIRST AMERICAN CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
THREE MONTHS ENDED MARCH 31, COMMON DEFERRED EMPLOYEE
1998 AND MARCH 31, 1999 SHARES COMPENSATION STOCK
ISSUED ADDITIONAL ON OWNERSHIP
(dollars in thousands except per AND COMMON PAID-IN RETAINED RESTRICTED PLAN
share amounts) OUTSTANDING STOCK CAPITAL EARNINGS STOCK OBLIGATION
- ----------------------------------------------------------------------------------------------------------------------------
Balance, January 1, 1998 112,187,226 $ 280,468 $ 212,311 $ 1,161,877 $(13,341) $(163)
Comprehensive income:
Net income -- -- -- 64,346 -- --
Other comprehensive
income, net of tax -- -- -- -- -- --
Comprehensive income
Cash dividends ($.20 per --
common share) -- -- -- (11,530) -- --
Cash dividends of pooled --
companies -- -- -- (10,323) -- --
Repurchase of common stock (1,205,263) (3,013) (60,480) -- -- --
Issuance of common stock:
Acquisitions 870,694 2,177 4,474 -- -- --
Employee Benefit Plans, net
of discount on Dividend
Reinvestment Plan 338,122 845 5,185 -- -- --
Restricted common stock,
net of forfeitures 416,506 1,041 18,107 -- (19,148) --
Amortization of deferred
compensation on restricted
stock -- -- -- -- 1,504 --
Reduction in employee stock
ownership plan obligation -- -- -- -- -- 163
Tax benefit from stock option
and award plans -- -- 2,310 -- -- --
- ----------------------------------------------------------------------------------------------------------------------------
Balance, March 31, 1998 112,607,285 $ 281,518 $ 181,907 $ 1,204,370 $(30,985) $ --
============================================================================================================================
BALANCE, JANUARY 1, 1999 116,318,734 $ 290,797 $ 241,333 $ 1,286,512 $(31,781) $ --
COMPREHENSIVE INCOME:
NET INCOME -- -- -- 66,464 -- --
OTHER COMPREHENSIVE
LOSS, NET OF TAX -- -- -- -- -- --
COMPREHENSIVE INCOME
CASH DIVIDENDS ($.25 PER --
COMMON SHARE) -- -- -- (29,142) -- --
REPURCHASE OF COMMON STOCK (43,897) (110) (1,684) -- -- --
ISSUANCE OF COMMON STOCK:
EMPLOYEE BENEFIT PLANS, NET
OF DISCOUNT ON DIVIDEND
REINVESTMENT PLAN 289,905 725 4,838 -- -- --
RESTRICTED COMMON STOCK,
NET OF FORFEITURES 127,043 317 4,933 -- (5,250) --
AMORTIZATION OF DEFERRED
COMPENSATION ON RESTRICTED
STOCK -- -- -- -- 1,688 --
TAX BENEFIT FROM STOCK OPTION
AND AWARD PLANS -- -- 961 -- -- --
OTHER -- -- (25) -- --
- ----------------------------------------------------------------------------------------------------------------------------
BALANCE, MARCH 31, 1999 116,691,785 $ 291,729 $ 250,381 $ 1,323,809 $(35,343) $ --
============================================================================================================================
ACCUMULATED
OTHER
COMPREHENSIVE
INCOME (LOSS),
NET OF TAX TOTAL
- -------------------------------------------------------------
Balance, January 1, 1998 $ 2,741 $ 1,643,893
Comprehensive income:
Net income -- 64,346
Other comprehensive
income, net of tax 1,345 1,345
-----------
Comprehensive income 65,691
Cash dividends ($.20 per
common share) -- (11,530)
Cash dividends of pooled
companies -- (10,323)
Repurchase of common stock -- (63,493)
Issuance of common stock: --
Acquisitions 18 6,669
Employee Benefit Plans, net
of discount on Dividend
Reinvestment Plan -- 6,030
Restricted common stock,
net of forfeitures -- --
Amortization of deferred
compensation on restricted
stock -- 1,504
Reduction in employee stock
ownership plan obligation -- 163
Tax benefit from stock option
and award plans -- 2,310
- -------------------------------------------------------------
Balance, March 31, 1998 $ 4,104 $ 1,640,914
=============================================================
BALANCE, JANUARY 1, 1999 $ (7,066) $ 1,779,795
COMPREHENSIVE INCOME:
NET INCOME -- 66,464
OTHER COMPREHENSIVE
LOSS, NET OF TAX (5,641) (5,641)
-----------
COMPREHENSIVE INCOME 60,823
CASH DIVIDENDS ($.25 PER
COMMON SHARE) -- (29,142)
REPURCHASE OF COMMON STOCK -- (1,794)
ISSUANCE OF COMMON STOCK: --
EMPLOYEE BENEFIT PLANS, NET
OF DISCOUNT ON DIVIDEND
REINVESTMENT PLAN -- 5,563
RESTRICTED COMMON STOCK,
NET OF FORFEITURES -- --
AMORTIZATION OF DEFERRED
COMPENSATION ON RESTRICTED
STOCK -- 1,688
TAX BENEFIT FROM STOCK OPTION
AND AWARD PLANS -- 961
OTHER -- (25)
- -------------------------------------------------------------
BALANCE, MARCH 31, 1999 $(12,707) $ 1,817,869
=============================================================
See accompanying notes to consolidated financial statements.
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FIRST AMERICAN CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended
March 31
-----------------------------
(in thousands) 1999 1998
- ----------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 66,464 $ 64,346
Adjustments to reconcile net income to net cash provided by (used in) operating
activities:
Provision for loan losses 9,234 6,938
Depreciation and amortization of premises and equipment 10,803 10,132
Amortization of intangible assets 6,091 8,219
Other amortization, net 3,722 1,422
Noncash portion of merger and integration costs 1,328 --
Deferred income tax expense 19,915 2,797
Net gain on sales and writedowns of other real estate owned (829) (112)
Net realized gains on sales and writedowns of securities (2,339) (1,677)
Net gain on sales and writedowns of premises and equipment (840) --
Other, net 174 --
Change in assets and liabilities, net of effects from acquisitions and dispositions:
Decrease (increase) in mortgage loans held for sale 134,624 (125,888)
Decrease in accrued interest receivable 829 1,201
Increase in accrued interest payable 3,892 1,139
Increase in trading account securities (21,179) (8,651)
Increase in other assets (66,610) (108,790)
(Decrease) increase in other liabilities (40,791) 115,868
- ----------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 124,488 (33,056)
- ----------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Proceeds from sales of securities available for sale 541,729 234,452
Proceeds from maturities of securities available for sale 552,867 446,318
Purchases of securities available for sale (1,033,524) (1,160,078)
Proceeds from maturities of securities held to maturity 241,342 137,618
Purchases of securities held to maturity (880,301) (6,237)
Proceeds from sales of other real estate owned 2,865 1,674
Acquisitions and divestitures, net of cash and cash equivalents 4,659 11,262
Net decrease in loans, net of repayments and sales 27,953 172,212
Proceeds from sales of premises and equipment 1,874 595
Purchases of premises and equipment (22,652) (14,982)
- ----------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (563,188) (177,166)
- ----------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Net (decrease) increase in deposits (780,005) 199,257
Net increase in short-term borrowings 206,473 9,436
Net repayments of long-term debt (38) (33)
Advances from (repayments to) Federal Home Loan Bank 186,959 (8,923)
Issuance of common shares under Employee Benefit and Dividend
Reinvestment Plans 5,563 6,030
Repurchase of common stock (1,794) (63,493)
Tax benefit related to stock options and award plans 961 2,310
Cash dividends paid (29,142) (21,853)
- ----------------------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities (411,023) 122,731
- ----------------------------------------------------------------------------------------------------------------------------
Decrease in cash and cash equivalents (849,723) (87,491)
Cash and cash equivalents, January 1 1,852,721 1,256,228
- ----------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, March 31 $ 1,002,998 $ 1,168,737
============================================================================================================================
Cash paid during the year for:
Interest expense $ 147,249 $ 151,550
Income taxes 37,321 3,678
Non-cash investing activities:
Foreclosures 1,669 920
Change in unrealized (loss) gain on available for sale securities, net of tax (5,641) 1,363
Stock issued for acquisitions -- 6,669
Mortgage loans securitized and retained -- 229,471
============================================================================================================================
See accompanying notes to consolidated financial statements.
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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 First American Corporation's ("First American") 1998 Annual Report
to Shareholders. The interim consolidated financial statements reflect all
adjustments which are, in the opinion of management, necessary for a fair
presentation of the results for interim periods. 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) ACQUISITIONS AND DIVESTITURES
Effective May 1, 1998, First American consummated the acquisition of
Deposit Guaranty Corp. ("Deposit Guaranty") by exchanging approximately 48.7
million shares of First American common stock for all of the outstanding shares
of Deposit Guaranty (based on an exchange ratio of 1.17 shares of First American
common stock for each share of Deposit Guaranty common stock). Deposit Guaranty
was a $7.2 billion asset financial services holding company headquartered in
Jackson, Mississippi, with banking offices in Mississippi, Louisiana, Arkansas,
and Tennessee. The transaction was accounted for as a pooling of interests, and
accordingly, the consolidated financial statements have been restated to include
the results of Deposit Guaranty for all periods presented.
In April 1998, and in conjunction with the Deposit Guaranty business
combination, the Board of Directors increased the number of authorized shares
from 100 million to 200 million.
Effective November 20, 1998, First American completed the acquisition
of Pioneer Bancshares, Inc. ("Pioneer") by exchanging approximately 6.2 million
shares of First American common stock for all of the outstanding shares of
Pioneer (based on an exchange ratio of 1.65 shares of First American common
stock for each share of Pioneer common stock). Pioneer was a $990 million asset
financial services holding company headquartered in Chattanooga, Tennessee. The
transaction was accounted for as a pooling of interests, and accordingly, the
consolidated financial statements have been restated to include the results of
Pioneer for all periods presented.
Other business combinations completed by First American during 1998,
are presented in the following table (in millions):
Common
Shares Accounting
Acquiree Location Date Assets Issued Treatment
- ------------------------------------------------------------------------------------------------------------------------
Victory Bancshares, Inc. TN Mar. 1998 $131 0.9 Pooling
- ------------------------------------------------------------------------------------------------------------------------
Peoples Bank TN Oct. 1998 142 0.9 Pooling
- ------------------------------------------------------------------------------------------------------------------------
The Middle Tennessee Bank TN Oct. 1998 225 1.2 Pooling
- ------------------------------------------------------------------------------------------------------------------------
CSB Financial Corporation TN Oct. 1998 148 0.9 Pooling
========================================================================================================================
For the acquisitions in the above table, the results of operations have
been included in the consolidated financial statements from the date of the
acquisition as preacquisition amounts were not material.
7
8
Net interest income and net income as originally reported by First
American, Deposit Guaranty, and Pioneer for the three months ended March 31,
1998, are presented in the table below:
First Deposit
(in thousands) American Guaranty Pioneer Combined
- ------------------------------------------------------------------------
Net interest income $102,383 $68,289 $9,807 $180,479
Noninterest income 70,139 36,302 2,958 109,399
Net income 37,646 24,340 2,360 64,346
========================================================================
On March 19, 1999, Center Finance Company, a subsidiary of First
American National Bank ("FANB") sold substantially all of its assets ($5.2
million) to New South Financial for $5 million, recording a pretax loss of
approximately $.2 million.
On March 19, 1999, First American Federal Savings Bank ("FAFSB"), a
subsidiary of First American, divested five branches in Virginia, with deposits
of approximately $56 million, to National Bank of Commerce ("NBC"), recording a
pretax loss of $1.3 million. On April 23, 1999, FANB acquired nine Tennessee
branches from NBC, located primarily in Wal-Mart stores.
(3) MERGER AND INTEGRATION COSTS
First American recorded merger and integration costs of $3.3 million
during the three months ended March 31, 1999. These costs were associated with
the acquisitions of Pioneer, The Middle Tennessee Bank ("MTB"), Peoples Bank
("Peoples"), and CSB Financial Corporation ("CSB"), as well as the divestiture
of five branches in Virginia to NBC. The merger and integration costs included
$1.5 million of systems and operations conversion costs, a $1.3 million loss on
the branch divestitures, and $.5 million of other costs, consisting primarily of
termination and personnel-related costs, compliance costs, occupancy and
equipment costs.
Systems and operations conversion costs result from the conversions and
integration of the acquired banks' branches and operations; such costs were
primarily for contract labor, outside consultants, internal staff and customer
communications, training, and travel.
Of the $18.8 million accrued liability at December 31, 1998 for merger
and integration costs, approximately $10.7 million was disbursed in the first
quarter of 1999. These payments consisted mainly of severance, retention,
outplacement costs, and other employment-related costs ($6.5 million), equipment
maintenance and rental ($.8 million), and settlement of a lease buy-out ($.6
million). The liability balance at March 31, 1999 of $8.1 million will be paid
in 1999 and represents costs that have been incurred primarily for severance and
personnel-related benefits, compliance-related issues and system conversions.
(4) NONPERFORMING ASSETS
Nonperforming assets were as follows:
March 31 December 31
-------------------------------------
(dollars in thousands) 1999 1998 1998
- -------------------------------------------------------------------------------------
Nonaccrual loans $45,748 $41,535 $47,913
Foreclosed properties 7,968 7,813 7,085
- -------------------------------------------------------------------------------------
Total nonperforming assets $53,716 $49,348 $54,998
=====================================================================================
90 days or more past due on accrual $39,660 $30,190 $38,696
=====================================================================================
Nonperforming assets as a percent of loans
and other real estate owned (excluding
90 days or more past due on accrual) .47% .42% .48%
=====================================================================================
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(5) ALLOWANCE FOR LOAN LOSSES
Transactions in the allowance for loan losses were as follows:
Three Months Ended March 31
---------------------------
(dollars in thousands) 1999 1998
- ----------------------------------------------------------------------------------
Balance, January 1 $197,681 $187,880
- ----------------------------------------------------------------------------------
Provision charged to operating expenses 9,234 6,938
Allowance of subsidiary purchased -- 1,313
- ----------------------------------------------------------------------------------
Subtotal 206,915 196,131
- ----------------------------------------------------------------------------------
Loans charged off 24,903 12,748
Recoveries of loans previously charged off 7,636 5,489
- ----------------------------------------------------------------------------------
Net charge-offs 17,267 7,259
- ----------------------------------------------------------------------------------
Balance, March 31 $189,648 $188,872
==================================================================================
Allowance end of period to net loans outstanding 1.65% 1.59%
Net charge-offs to average loans (annualized) .61 .24
==================================================================================
(6) RECENT ACCOUNTING PRONOUNCEMENT
Statement of Financial Accounting Standards ("SFAS") No. 133,
"Accounting for Derivative Instruments and for Hedging Activities," establishes
accounting and reporting standards for derivative instruments and hedging
activities. SFAS No. 133 requires that an entity recognize the value of
derivatives as assets or liabilities on the balance sheet. Gains or losses
resulting from changes in the values of derivatives will be accounted for
depending on the use of the derivative and whether it qualifies for hedge
accounting. The key criterion for hedge accounting is that the hedging
relationship must be highly effective in achieving offsetting changes in fair
value or cash flows attributable to the hedged risk during the period that the
hedge is designated. SFAS No. 133 is effective for fiscal years beginning after
June 15, 1999, and shall not be applied retroactively to financial statements of
prior periods. At this time, management has not fully evaluated the impact of
SFAS No. 133. First American will adopt SFAS No. 133 prospectively on January 1,
2000.
(7) COMPUTATION OF EARNINGS PER COMMON SHARE
Three Months Ended March 31
---------------------------
(in thousands, except per share amounts) 1999 1998
- ---------------------------------------------------------------------------------------
Basic
Average common shares outstanding 115,409 111,060
=======================================================================================
Net income $ 66,464 $ 64,346
=======================================================================================
Per share amount $ .58 $ .58
=======================================================================================
Diluted
Average common shares outstanding 115,409 111,060
Dilutive common stock options at average market price 1,817 2,485
=======================================================================================
Average diluted shares outstanding 117,226 113,545
=======================================================================================
Net income $ 66,464 $ 64,346
=======================================================================================
Per share amount $ .57 $ .57
=======================================================================================
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(8) LEGAL AND REGULATORY MATTERS
FAFSB has a lawsuit pending against the United States Government
seeking damages for breach of contract. The suit arose from the elimination of
approximately $47 million in supervisory goodwill upon the adoption of the
Financial Institutions Reform, Recovery and Enforcement Act of 1989. The value
and ultimate outcome of the suit are contingent upon a number of factors, and
highly uncertain. Pursuant to the agreement under which First American acquired
FAFSB in 1995, the former shareholders of FAFSB as of December 1, 1995 will be
entitled to receive additional consideration equal in value to 50 percent of any
recovery in the litigation, net of all taxes and other expenses, including the
cost of litigation, which is received by FAFSB on or before December 1, 2000,
subject to certain limitations. Such additional consideration, if any, is
payable in the common stock of First American, 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.
Deposit Guaranty National Bank ("DGNB"), now a division of FANB, is a
defendant in an action brought in Pike County, Mississippi by a land owner and a
gaming corporation, alleging that DGNB and the two defendant casinos entered
into an agreement, expressed or implied, to oppose an application to operate a
casino on the Big Black River in Mississippi. The plaintiffs contend that DGNB
used its influence to cause the Mississippi Gaming Commission to deny the
casinos' application. The plaintiffs seek actual damages for injury to property
and business in the total amount of $38 million and punitive damages in the
amount of $200 million. DGNB denies all liability and has filed a Motion for
Summary Judgment. It is the opinion of management and counsel that ultimate
disposition of the case should not have a material effect on First American's
consolidated financial statements.
There are from time to time other legal proceedings pending against
First American 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 First
American.
(9) SEGMENT INFORMATION
First American operates in two business segments, Banking Services and
Enterprises, based upon management responsibility. First American's reportable
segments are strategic business operations that offer different products and
services. They are managed separately based on the fundamental differences in
their operations.
The Banking Services segment consists of the traditional banking
components of First American's wholly-owned banking subsidiaries. This segment
makes commercial, consumer, and real estate loans and provides various banking
and mortgage-related services to its customers located within First American's
market, which consists primarily of the Mid-South region of the United States.
The Enterprises segment includes:
- IFC Holdings, Inc. ("IFC"), which distributes securities,
investment, and insurance products to customers of subscribing
financial institutions located throughout the United States;
- ISG, the investment services group of FANB;
- First American Network, Inc., a subsidiary of FANB; and
- The SSI Group Inc., a healthcare payments processing company
in which FANB holds a 49 percent interest.
10
11
The Enterprises segment provides a variety of nondeposit financial services not
available through traditional banking channels.
Banking
(in thousands) Services Enterprises Other Total
- ------------------------------------------------------------------------------------------------------------
QUARTER ENDED MARCH 31, 1999
Net interest income $ 184,859 $ 941 $ -- $ 185,800
Provision for loan losses 9,234 -- -- 9,234
Noninterest income, external customers 62,003 54,698 -- 116,701
Noninterest expense 140,368 46,241 3,274(a) 189,883
Net pretax contribution 97,260 9,398 (3,274)(a) 103,384
Average total assets 20,191,055 125,152 (48,626)(b) 20,267,581
Return on average assets 1.27% 18.16%
Return on average equity 14.73 37.46
Productivity 55.62 83.11
QUARTER ENDED MARCH 31, 1998
Net interest income $ 179,270 $ 1,209 -- 180,479
Provision for loan losses 6,938 -- -- 6,938
Noninterest income, external customers 59,784 49,615 -- 109,399
Noninterest expense 140,170 41,781 -- 181,951
Net pretax contribution 91,946 9,043 -- 100,989
Average total assets 18,508,155 102,538 (38,663)(b) 18,572,030
Return on average assets 1.29% 21.37%
Return on average equity 15.20 43.00
Productivity 57.69 82.21
============================================================================================================
(a) Merger and integration costs
(b) Effect of intersegment loan, due from bank, and investment in
subsidiary
11
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
INTRODUCTION
The following discussion should be read in conjunction with the
consolidated financial statements and accompanying notes of First American
appearing within this report and by reference to First American's 1998 Annual
Report.
To the extent that statements in this discussion relate to the plans,
objectives, or future performance of First American, these statements may be
deemed to be forward looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. Such statements are based on
management's current expectations and the current economic environment. Actual
strategies and results in future periods may differ materially from those
currently expected due to various assumptions, risks, and uncertainties.
In 1998, First American nearly doubled in size as a result of business
combinations. As a result of the Deposit Guaranty merger, First American focused
significant sales, service, and management resources on the successful
integration of Deposit Guaranty and the achievement of targeted synergies.
During this time period in 1998, the historically strong retention and sales
performance was impacted by service quality issues, which resulted in
unanticipated client attrition. Lower than anticipated earnings for the first
quarter of 1999 and declining loan and deposit balances have resulted. In the
first quarter of 1999, First American initiated programs to (a) improve client
retention and new business acquisition, (b) improve service quality, and (c)
reduce expense levels.
On April 15, 1999, First American's Board of Directors increased the
quarterly cash dividend on its common stock by 12 percent to $.28 per share from
$.25 per share. The dividend will be payable on May 28, 1999, to shareholders of
record on May 14, 1999.
FIRST QUARTER PERFORMANCE OVERVIEW (comparison of first quarter 1999 to first
quarter 1998)
Unless otherwise indicated, all earnings per share data included in
this discussion are presented on a diluted basis.
- Net income was $66.5 million in 1999, up 3 percent from $64.3
million in 1998. Operating earnings, which exclude the effect
of $3.3 million merger and integration costs in 1999, were up
7 percent to $69 million.
- Earnings per share amounted to $.57 for both quarters. On an
operating basis, 1999 earnings per share was up 4 percent to
$.59 per share.
- Return on assets ("ROA") was 1.33 percent compared to 1.41
percent a year ago. ROA on an operating basis was 1.38 percent
in 1999.
- Return on equity ("ROE") was 14.94 percent compared to 16.08
in 1998. ROE on an operating basis was 15.50 percent in 1999.
- The productivity ratio in the banking segment improved to
55.62 percent in 1999 from 57.69 percent.
- Asset quality remained strong. Nonperforming assets were $53.7
million, or .47 percent of total loans and foreclosed
properties, at March 31, 1999, compared to $49.3 million, or
.42 percent, at the end of March 31, 1998.
- Net interest income (TEB) was $191.3 million, an increase of 4
percent over the first quarter of 1998.
- Noninterest income grew 7 percent. Investment services income
increased 17 percent and made up 82 percent of the overall
growth in noninterest income. This growth reflects First
American's progress in transforming from a bank to a financial
services company.
12
13
- Noninterest expense, excluding the merger and integration
costs, increased only 3 percent compared to the first quarter
of 1998.
- Average earning assets increased 9 percent.
- Average loans decreased 5 percent. Average loan volume,
adjusted for loans securitized and retained, was 5 percent
higher than in 1998.
- Average deposits increased 4 percent.
- Capital adequacy remained strong and exceeded the regulatory
requirements to be classified as "well capitalized." The
risk-based capital ratio was 12.58 percent at March 31, 1999,
compared to 11.33 percent a year ago.
The selected financial data set forth in Table 1 presents certain
information highlighting the results of operations and financial condition for
First American for each of the last five quarters.
13
14
TABLE 1: SELECTED QUARTERLY FINANCIAL DATA
=================================================================================================================================
1999 1998
----------- -----------------------------------------------------
FIRST Fourth Third Second First
QUARTER Quarter Quarter Quarter Quarter
- ---------------------------------------------------------------------------------------------------------------------------------
CONDENSED INCOME STATEMENTS (in thousands):
Net interest income, taxable equivalent basis (1) $ 191,299 $ 194,041 $ 187,360 $ 187,343 $ 184,416
Less taxable equivalent adjustment 5,499 5,415 5,270 4,926 3,937
- ---------------------------------------------------------------------------------------------------------------------------------
Net interest income 185,800 188,626 182,090 182,417 180,479
Provision for loan losses (2) 9,234 19,054 8,604 6,337 6,938
Noninterest income 116,701 115,632 128,140 124,441 109,399
Noninterest expense 186,609 168,307 175,270 189,585 181,951
Merger and integration costs 3,274 12,523 37,159 72,043 --
- ---------------------------------------------------------------------------------------------------------------------------------
Income before income tax expense 103,384 104,374 89,197 38,893 100,989
Income tax expense 36,920 36,543 31,700 17,205 36,643
- ---------------------------------------------------------------------------------------------------------------------------------
Net income $ 66,464 $ 67,831 $ 57,497 $ 21,688 $ 64,346
=================================================================================================================================
Operating earnings (3) $ 68,952 $ 83,118 $ 75,890 $ 71,452 $ 64,346
=================================================================================================================================
SELECTED PER SHARE DATA:
Net income:
Basic $ .58 $ .59 $ .51 $ .19 $ .58
Diluted .57 .58 .50 .19 .57
Operating earnings (3):
Diluted .59 .71 .67 .63 .57
Cash dividends declared .25 .25 .25 .25 .20
Book value (end of period) 15.58 15.30 15.04 14.71 14.57
Market price (end of period) 36.875 44.375 38.375 48.125 49.00
Market/book (end of period) 2.37 X 2.90x 2.55x 3.27x 3.36x
=================================================================================================================================
AVERAGES (in thousands):
Assets $20,267,581 $20,333,130 $19,336,177 $18,879,074 $18,572,030
Loans, net of unearned discount 11,415,835 11,385,949 11,142,042 11,631,714 12,067,547
Earning assets 18,344,240 18,423,046 17,636,487 17,149,566 16,809,933
Deposits 14,602,033 14,720,534 14,086,042 14,201,774 14,014,948
Long-term debt 1,195,529 1,209,973 871,991 538,197 612,028
Shareholders' equity 1,804,618 1,746,481 1,671,239 1,653,162 1,623,245
=================================================================================================================================
END OF PERIOD (in thousands):
Assets $20,326,467 $20,731,770 $19,854,123 $20,064,152 $19,228,661
Loans, net of unearned discount 11,468,872 11,524,943 11,092,918 11,587,327 11,870,157
Earning assets 18,529,745 18,658,658 17,964,882 18,117,659 17,232,170
Deposits 14,435,264 15,270,756 14,001,390 14,445,748 14,467,517
Long-term debt 1,227,744 1,152,939 1,262,068 610,125 605,867
Shareholders' equity 1,817,869 1,779,795 1,701,275 1,660,167 1,640,914
=================================================================================================================================
SIGNIFICANT RATIOS:
Return on average assets 1.33% 1.32% 1.18% .46% 1.41%
Return on average assets - operating (3) 1.38 1.62 1.56 1.52 1.41
Return on average equity 14.94 15.41 13.65 5.26 16.08
Return on average equity - operating (3) 15.50 18.88 18.02 17.34 16.08
Dividends declared per share to basic net income per share
(dividend payout ratio) 43.10 42.37 49.02 131.58 34.48
Productivity - banking segment (4) 55.62 49.36 51.73 55.26 57.69
Average equity to average assets 8.90 8.59 8.64 8.76 8.74
Average loans to average deposits 78.18 77.35 79.10 81.90 86.10
Average core deposits to average total deposits 86.77 86.82 87.84 88.59 89.18
Allowance to net loans (end of period) 1.65 1.72 1.72 1.63 1.54
Nonperforming assets to loans and foreclosed properties
(end of period) (5) .47 .48 .38 .38 .42
Net interest margin 4.23 4.18 4.21 4.38 4.45
=================================================================================================================================
OTHER STATISTICS:
Average common shares outstanding (in thousands):
Basic 115,409 115,170 112,003 111,794 111,060
Diluted 117,226 117,117 113,973 114,065 113,545
End of period common shares (in thousands) 116,692 116,319 113,102 112,896 112,607
Number of full-time equivalent employees (end of period) 7,219 7,195 6,803 7,320 7,577
=================================================================================================================================
(1) Adjusted to a taxable equivalent basis based on the statutory federal
income tax rates, adjusted for applicable state income taxes net of the
related federal tax benefit.
(2) Fourth quarter 1998 includes an additional loan loss provision for
Pioneer of $9.5 million.
(3) Excludes merger-related charges and the third quarter 1998 gain on the
sale of a corporate trust business.
(4) Ratio of operating expenses to taxable equivalent net interest income
plus noninterest income excluding operations related to Enterprises,
merger and integration costs, and certain nonrecurring transactions
such as asset sales.
(5) Excludes loans 90 days or more past due on accrual.
14
15
INCOME STATEMENT ANALYSIS
NET INTEREST INCOME (TEB)
For purposes of this discussion, total revenues consist of the sum of
net interest income and noninterest income. Net interest income represented 62
percent of total revenues in the first quarter of 1999 and 63 percent in the
first quarter of 1998. Net interest income in the first quarter of 1999 was up
$6.9 million, or 4 percent, from the first quarter of 1998.
Various components of the balance sheet and their respective yields and
rates, which affect net interest income, are presented in Table 2. The
information presented in Table 3 provides a summary of the effect on net
interest income of changes in average balances and changes in yields/rates. As
shown in Table 3, the increase in net interest income resulted primarily from an
increase in the volume of earning assets partially offset by rate-related
decreases.
The net interest spread declined 14 basis points to 3.58 percent in the
first quarter of 1999 from 3.72 percent in the same period last year as yields
on earning assets decreased more than rates paid on interest-bearing
liabilities.
The yield on earning assets decreased 59 basis points from 8.16 percent
in the first quarter of 1998 to 7.57 percent in the first quarter of 1999. The
decrease in the yield on earning assets was essentially reflective of the
overall lower interest rate environment in the first quarter of 1999 compared to
the same period in 1998. For example, the prime rate averaged 7.75 percent in
the first quarter of 1999 versus 8.50 percent in the first quarter of 1998; the
5-year U.S. Treasury bill yield averaged 4.88 percent in the first quarter of
1999 compared to 5.51 percent in the first quarter of 1998. Also contributing to
the decreased yield on earning assets was an increase in investment securities
(which generally have lower yields than loans). Reference is made to the
"Balance Sheet Analysis" section in this discussion for additional information
on earning assets and on the increase in the investment securities portfolio.
The lower rate paid on deposits contributed to the 45 basis point
decrease in the average rate paid on interest-bearing liabilities. Average rates
paid on interest-bearing deposits declined 49 basis points primarily due to the
general decline in market rates. Although average deposits increased, additional
borrowings were needed to fund the increased volume of earning assets,
contributing to the 22 basis point decrease in the net interest margin.
Reference is made to the captions "Core Deposits" and "Borrowed Funds" for
additional information, including First American's funding strategy.
15
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TABLE 2: CONSOLIDATED AVERAGE BALANCE SHEETS AND TAXABLE EQUIVALENT
INCOME/EXPENSE AND YIELDS/RATES
========================================================================================================================
Three Months Ended March 31
----------------------------------------------------------------------
1999 1998
---------------------------------- --------------------------------
AVERAGE Average
AVERAGE INCOME/ YIELD/ Average Income/ Yield/
(dollars in thousands) BALANCE EXPENSE RATE Balance Expense Rate
- ------------------------------------------------------------------------------------------------------------------------
Interest-earning assets:(1)
Taxable securities:
Held to maturity $ 1,973,963 $ 32,301 6.64% $ 659,969 $ 10,744 6.60%
Available for sale 3,969,233 62,883 6.43 3,443,367 59,616 7.02
Tax-exempt securities
Held to maturity 43,861 893 8.26 38,742 715 7.48
Available for sale 370,914 6,545 7.16 253,671 4,904 7.84
- ------------------------------------------------------------------------------------------------------------------------
Total securities 6,357,971 102,622 6.55 4,395,749 75,979 7.01
Federal funds sold and repurchase agreements 215,101 1,688 3.18 124,682 1,726 5.61
Mortgage loans held for sale 178,365 2,647 6.02 147,173 2,792 7.69
Loans, net of unearned discount
Commercial 5,473,730 108,168 8.01 4,618,049 95,553 8.39
Consumer-amortizing mortgages 1,765,626 36,810 8.46 2,852,131 57,765 8.21
Consumer-other 2,697,980 57,088 8.58 2,630,338 60,444 9.32
Real estate-construction 453,481 9,085 8.12 481,836 9,868 8.31
Real estate-commercial mortgages
and other 1,025,018 22,109 8.75 1,485,193 32,660 8.92
- ------------------------------------------------------------------------------------------------------------------------
Loans, net of unearned discount 11,415,835 233,260 8.29 12,067,547 256,290 8.61
Other 176,968 2,272 5.21 74,782 1,234 6.69
- ------------------------------------------------------------------------------------------------------------------------
Total earning assets(1) 18,344,240 $ 342,489 7.57% 16,809,933 $338,021 8.16%
Allowance for loan losses (197,229) (188,149)
Cash and due from banks 1,006,053 927,155
Other assets 1,114,517 1,023,091
- ------------------------------------------------------------------------------------------------------------------------
Total assets $ 20,267,581 $ 18,572,030
========================================================================================================================
Deposits and borrowed funds:
Demand deposits $ 2,819,720 $ 2,656,073
Interest-bearing deposits:
NOW accounts 2,542,397 $ 13,308 2.12% 2,124,046 $ 10,103 1.93%
Money market accounts 2,568,801 19,198 3.03 2,895,824 31,030 4.35
Regular savings 1,046,288 6,059 2.35 958,650 5,831 2.47
Certificates of deposit under $100,000 2,885,184 35,633 5.01 3,112,135 40,700 5.30
Certificates of deposit $100,000 and over 1,669,749 22,145 5.38 1,394,775 18,833 5.48
Other time 807,846 9,646 4.84 752,450 10,343 5.57
Foreign 262,048 2,808 4.35 120,995 1,541 5.17
- ------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 11,782,313 108,797 3.74 11,358,875 118,381 4.23
- ------------------------------------------------------------------------------------------------------------------------
Total deposits 14,602,033 14,014,948
Federal funds purchased and repurchase
agreements 2,153,443 23,286 4.39 1,713,821 21,066 4.99
Other short-term borrowings 210,209 2,550 4.92 330,962 4,677 5.73
Long-term debt 1,195,529 16,557 5.62 612,028 9,481 6.28
- ------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits and
borrowed funds 15,341,494 $ 151,190 3.99% 14,015,686 $153,605 4.44%
- ------------------------------------------------------------------------------------------------------------------------
Total deposits and borrowed funds 18,161,214 16,671,759
Other liabilities 301,749 277,026
Shareholders' equity 1,804,618 1,623,245
- ------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 20,267,581 $ 18,572,030
========================================================================================================================
Net interest income(1) $ 191,299 $184,416
Provision for loan losses 9,234 6,938
Noninterest income 116,701 109,399
Noninterest expense 189,883 181,951
- ------------------------------------------------------------------------------------------------------------------------
Income before income tax expense 108,883 104,926
Income tax expense 42,419 40,580
- ------------------------------------------------------------------------------------------------------------------------
Net income $ 66,464 $ 64,346
========================================================================================================================
Net interest spread 3.58% 3.72%
Benefit of interest-free funding .65 .73
- ------------------------------------------------------------------------------------------------------------------------
Net interest margin 4.23% 4.45%
========================================================================================================================
(1) Yields/rates and income/expense amounts are presented on a fully
taxable equivalent basis based on the statutory federal income tax
rates, adjusted for applicable state income taxes net of the related
federal tax benefit; related interest income includes taxable
equivalent adjustments of $5.5 million in first quarter of 1999 and
$3.9 million in first quarter of 1998. Nonaccrual loans are included in
average loans and average earning assets. Consequently, yields on those
items are lower than they would have been if these loans had earned at
their contractual rates of interest. Yields on all securities are
computed based on carrying value. Loan fees considered an integral part
of the lending function are included in rates and related interest
categories.
16
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TABLE 3: RATE-VOLUME RECAP
============================================================================================
THREE MONTHS ENDED MARCH 31, 1998 VS.
THREE MONTHS ENDED MARCH 31, 1999
--------------------------------------
INCREASE (DECREASE)(1)
TOTAL DUE TO
INCREASE ------------------------
(in millions) (DECREASE) VOLUME RATE
- --------------------------------------------------------------------------------------------
CHANGE IN INTEREST INCOME:
Securities:
Taxable
Held to maturity $ 21,557 $ 21,384 $ 173
Available for sale 3,267 9,103 (5,836)
Tax-exempt
Held to maturity 178 94 84
Available for sale 1,641 2,266 (625)
--------
Total securities 26,643 33,917 (7,274)
--------
Loans, net of unearned discount (23,030) (13,836) (9,194)
Mortgage loans held for sale (145) 591 (736)
Federal funds sold and securities purchased
under agreements to resell (38) 1,251 (1,289)
Other 1,038 1,686 (648)
--------
Total change in interest income 4,468 30,871 (26,403)
--------
CHANGE IN INTEREST EXPENSE:
NOW 3,205 1,991 1,214
Money market accounts (11,832) (3,508) (8,324)
Certificates of deposit under $100,000 (5,067) (2,966) (2,101)
Certificates of deposit $100,000 and greater 3,312 3,716 (404)
Other interest-bearing deposits 798 2,746 (1,948)
Short-term borrowings 93 4,018 (3,925)
Long-term debt 7,076 9,035 (1,959)
--------
Total change in interest expense (2,415) 14,515 (16,930)
--------
CHANGE IN NET INTEREST INCOME $ 6,883 16,356 (9,473)
============================================================================================
(1) Amounts are adjusted to a fully taxable basis, based on the statutory
federal income tax rates, adjusted for applicable state income taxes
net of the related federal tax benefit. The effect of volume change is
computed by multiplying the change in volume by the prior year rate.
The effect of rate change is computed by multiplying the change in rate
by the prior year volume. Rate/volume change is computed by multiplying
the change in volume by the change in rate and included in the rate
change.
PROVISION FOR LOAN LOSSES
This topic is addressed under the caption, "Allowance and Provision for
Loan Losses."
NONINTEREST INCOME
Noninterest income is a growing component of First American's total
revenues as evidenced by the increase in the ratio of noninterest income to
total revenues from 37 percent during the first quarter of 1998 to 38 percent in
the first quarter of 1999. Noninterest income totaled $116.7 million in the
first quarter of 1999, up $7.3 million, or 7 percent, from the same period last
year.
As shown in Table 4, the largest contribution to the increase in First
American's noninterest income came from investment services income. Investment
services income increased $6 million, or 17 percent, in the first quarter of
1999 compared to the first quarter of 1998. The increase in investment services
income was primarily attributable to retail brokerage commissions of the
Enterprises segment. Growth in investment services income is an indicator of how
First American is succeeding in implementing its strategy of transforming from a
bank to a financial services company.
17
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TABLE 4: NONINTEREST INCOME
=======================================================================================================
THREE MONTHS ENDED MARCH 31
----------------------------------------------
1999 vs. 1998
------------------
(dollars in thousands) 1999 1998 $ Change %
- -------------------------------------------------------------------------------------------------------
Noninterest income:
Investment services income $ 41,416 $ 35,420 $ 5,996 17%
Service charges on deposit accounts 31,384 29,463 1,921 7
Commissions and fees on fiduciary activities 9,825 10,804 (979) (9)
Mortgage banking 11,472 10,742 730 7
Merchant discount fees 911 800 111 14
Net realized gain on sale of securities 2,339 1,685 654 39
Trading account revenue 1,140 1,957 (817) (42)
Other:
Open-end credit fees 3,025 2,750 275 10
Other service fees 3,149 2,755 394 14
Collection, exchange and related bank fees 1,889 3,195 (1,306) (41)
Insurance and acceptance commissions 1,157 1,496 (339) (23)
Fees and service charges on letters of credit 1,146 1,445 (299) (21)
Miscellaneous 7,848 6,887 961 14
- ---------------------------------------------------------------------------------------------
Total other income 18,214 18,528 (314) (2)
- ---------------------------------------------------------------------------------------------
Total noninterest income $116,701 $109,399 $ 7,302 7
=======================================================================================================
Explanations for significant changes from 1998 to 1999 in other
categories of noninterest income are as follows:
- Service charges on deposit accounts. Increases in NSF charges
on individual demand deposit accounts accounted for most of
the increase.
- Commissions and fees on fiduciary activities. The decrease is
partially due to the sale of the corporate trust business.
- Mortgage banking. The increase was primarily attributable to
an increase in net gains on mortgage loans held for sale.
NONINTEREST EXPENSE
Noninterest expense, as shown in Table 5, was up $7.9 million, or 4
percent, in the first quarter of 1999 from the same period last year. The 1999
amount included nonrecurring merger and integration costs of $3.3 million, which
consisted of $1.6 million of systems and operations conversions costs, $1.3
million related to the branch divestiture, and $.4 million of other costs.
Excluding the merger and integration costs, noninterest expense increased $4.6
million, or 3 percent.
18
19
TABLE 5: NONINTEREST EXPENSE
===================================================================================================
THREE MONTHS ENDED MARCH 31
------------------------------------------------
1999 vs. 1998
------------------
(dollars in thousands) 1999 1998 $ Change %
- ---------------------------------------------------------------------------------------------------
Noninterest expense:
Salaries and employee benefits $ 88,233 $ 90,336 $(2,103) (2)%
Subscribers' commissions 24,295 20,190 4,105 20
Net occupancy 13,184 12,722 462 4
Equipment 13,310 11,961 1,349 11
Systems and processing 3,916 3,664 252 7
Communication 8,881 7,306 1,575 22
Marketing 5,926 5,155 771 15
Supplies 2,811 3,364 (553) (16)
Goodwill amortization 4,504 4,405 99 2
Other:
Software 2,926 3,416 (490) (14)
Loan/credit 2,678 1,992 686 34
Amortization of mortgage servicing rights 3,057 1,940 1,117 58
Noninterest deposit 2,623 1,737 886 51
Other real estate (income) expense (830) 149 (979) (657)
Professional fees 3,347 3,520 (173) (5)
Miscellaneous taxes 2,315 2,875 (560) (19)
Miscellaneous 5,433 7,219 (1,786) (25)
- ---------------------------------------------------------------------------------------------------
Total other expense 21,549 22,848 (1,299) (6)
- ---------------------------------------------------------------------------------------------------
Subtotal noninterest expense 186,609 181,951 4,658 3
Merger and integration costs 3,274 -- 3,274 100
- ---------------------------------------------------------------------------------------------------
Total noninterest expense $ 189,883 $181,951 $ 7,932 4
===================================================================================================
The largest increase in noninterest expense came from IFC's
subscribers' commissions. Subscribers' commissions were up $4.1 million, or 20
percent, in the first quarter of 1999 over the same period last year. The
increase in subscribers' commissions is directly related to the increase in
brokerage activity income of the Enterprises segment.
Explanations for significant changes from 1998 to 1999 in other
categories of noninterest expense are as follows:
- Salaries and employee benefits. The $2.1 decrease reflected a
number of factors, including decreases in salaries and benefit
expense related to synergies achieved in connection with the
1998 mergers (the number of employees was down 5 percent at
March 31, 1999 from a year ago). Additional decreases resulted
from performance-based accruals for incentives, commissions,
and benefits. The decreases were partially offset by pay rate
increases and increases in variable costs related to temporary
and contract labor.
- Equipment. The $1.3 million increase was primarily
attributable to increases in rental expense.
- Communications. The 22 percent increase resulted from higher
expenditures for network telecommunications and courier
services.
- Other. The decrease in other expenses was primarily
attributable to net gains realized on sales of other real
estate and fixed assets. Offsetting these gains was an
increase in the amortization of mortgage servicing rights, due
to an increase in the portfolio of servicing rights.
INCOME TAXES
Income tax expense in the first quarter of 1999 was $36.9 million,
which resulted in an effective tax rate of 35.7 percent of pretax income versus
$36.6 million, or 36.3 percent of pretax income, for the same period in 1998.
The decrease in the effective tax rate for 1999 compared to 1998 was primarily
attributable to a more favorable effective state income tax rate.
19
20
BALANCE SHEET ANALYSIS
LOAN PORTFOLIO
Loans comprised the largest component of earning assets. During 1998,
First American securitized approximately $1.2 billion of mortgage loans, which
were contributed to a Real Estate Investment Trust established by First
American. Approximately $977.2 million was securitized between March 31, 1998,
and March 31, 1999. Securitizations and retention result in a change in
classification from loans to securities on the balance sheet and affect the
growth rates of reported loans and investment securities. Excluding the effect
of securitizations, divestitures, and business combinations except Deposit
Guaranty and Pioneer, average loans increased $216.9 million, or 2 percent, in
the first quarter of 1999 compared to the same period in 1998.
In addition to the effect of divestitures and securitizations, loan
balances were also affected by unanticipated client attrition associated with
operational and customer issues, which resulted from the integration of Deposit
Guaranty. First American is focused on retaining clients, returning historical
levels of customer service, and generating new business.
INVESTMENT SECURITIES PORTFOLIO
The securities portfolio is the second largest component of earning
assets, representing 35 percent of average earning assets during the first
quarter of 1999 compared to 26 percent during the first quarter of 1998. The
increase in the investment securities portfolio between the first quarter of
1998 and the first quarter of 1999 was primarily attributable to two factors:
(1) the securitization and retention of mortgage loans and (2) the strategic
increase in the portfolio. Excluding the effects of the securitizations, average
investment securities increased 17 percent, in the first quarter of 1999 over
the first quarter of 1998.
CORE DEPOSITS
Core deposits are First American's primary source of funding and
consist of total deposits less certificates of deposit $100,000 and over and
foreign deposits. Average core deposits for the first quarter of 1999 compared
to the first quarter of 1998 increased $171.1 million, or 1 percent. Excluding
the effect of business combinations except Deposit Guaranty and Pioneer and
divestitures, average deposits decreased $252.9 million, or 2 percent, in the
first quarter of 1999 compared to the first quarter of 1998.
As shown in Table 6, decreases in money market accounts and
certificates of deposit less than $100,000 were the primary types of core
deposits that decreased in the first three months of 1999 compared to the first
three months of 1998. Changes in balances of core deposits reflect some service
quality issues associated with the Deposit Guaranty integration and an overall
industry trend of funds moving out of traditional deposits into alternative
investment products. Programs currently in place to increase core funding
include the offering of updated products, such as the First American Platinum
Account, High Yield Savings Account, and the Select Rewards Program. First
American is responding to the service quality issues by: (1) offering a
"5-Minute Guarantee" to clients (i.e., clients receive $5 if not served within
five minutes while in a teller line), (2) specialized service training, (3)
balancing retention with new sales in the retail incentive plans, and (4) adding
a senior service executive to the retail bank organization. First American is
responding to the overall industry trend to invest in alternative products with
its ISG Funds, which is made up of 16 individual mutual funds and 5 additional
tailored "fund-of-funds." First American believes that continued flexibility and
innovation will be required of financial services companies to attract future
funding.
First American's core deposits are expected to increase at a slower
pace than loans during the remainder of 1999.
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TABLE 6: AVERAGE CORE DEPOSITS AND BORROWED FUNDS
===============================================================================================================================
QUARTER ENDED Quarter Ended Quarter Ended MARCH 31, 1999 VS. March 31, 1999 vs.
MARCH 31, 1999 March 31, 1998 December 31, 1998 MARCH 31, 1998 December 31, 1998
-------------- -------------- ----------------- ------------------ -----------------
(dollars in millions) AMOUNT % Amount % Amount % $ CHANGE % $ Change %
- -------------------------------------------------------------------------------------------------------------------------------
Demand deposits (noninterest bearing) $ 2,819.7 16% $ 2,656.1 16% $ 2,921.1 16% $ 163.6 6% $(101.4) (3)%
NOW accounts 2,542.4 14 2,124.1 13 2,414.9 13 418.3 20 127.5 5
Money market accounts 2,568.8 14 2,895.8 17 2,704.2 15 (327.0) (11) (135.4) (5)
Regular savings 1,046.3 6 958.6 6 979.4 6 87.7 9 66.9 7
Certificates of deposit under $100,000 2,885.2 16 3,112.1 19 2,984.1 16 (226.9) (7) (98.9) (3)
Other time deposits 807.8 4 752.4 4 776.4 4 55.4 7 31.4 4
- -------------------------------------------------------------------------------------------------------------------------------
Total core deposits 12,670.2 70 12,499.1 75 12,780.1 70 171.1 1 (109.9) (1)
- -------------------------------------------------------------------------------------------------------------------------------
Certificates of deposit $100,000
and over 1,669.8 9 1,394.8 8 1,725.9 9 275.0 20 (56.1) (3)
Foreign 262.0 1 121.0 1 214.5 1 141.0 117 47.5 22
- -------------------------------------------------------------------------------------------------------------------------------
Total deposits 14,602.0 80 14,014.9 84 14,720.5 80 587.1 4 (118.5) (1)
- -------------------------------------------------------------------------------------------------------------------------------
Short-term borrowings:
Federal funds purchased and
repurchase agreements 2,153.4 12 1,713.8 10 2,134.9 12 439.6 26 18.5 1
FHLB advances 145.4 1 244.6 1 108.1 1 (99.2) (41) 37.3 35
Other 64.8 -- 86.4 1 83.4 -- (21.6) (25) (18.6) (22)
- -------------------------------------------------------------------------------------------------------------------------------
Total short-term borrowings 2,363.6 13 2,044.8 12 2,326.4 13 318.8 16 37.2 2
- -------------------------------------------------------------------------------------------------------------------------------
Long-term debt:
Subordinated and senior notes 200.7 1 200.8 1 200.7 1 (.1) -- -- --
FHLB advances 993.4 6 409.9 3 1,007.4 6 583.5 142 (14.0) (1)
Other 1.4 -- 1.3 -- 1.9 -- .1 8 (.5) (26)
- -------------------------------------------------------------------------------------------------------------------------------
Total long-term debt 1,195.5 7 612.0 4 1,210.0 7 583.5 95 (14.5) (1)
- -------------------------------------------------------------------------------------------------------------------------------
Total $18,161.1 100% $16,671.7 100% $18,256.9 100% $1,489.4 9% $(95.8) (1)%
===============================================================================================================================
BORROWED FUNDS
Between March 31, 1998, and March 31, 1999, First American placed more
reliance on borrowed funds, including certificates of deposit $100,000 and over,
and short- and long-term debt.
CAPITAL
First American's capital position remained strong during the first
quarter of 1999. The ratio of average equity to average assets was 8.90 percent
during the first quarter of 1999, which compared to 8.74 percent during the
first quarter of 1998. The increases in shareholders' equity between March 31,
1998, and March 31, 1999, and between December 31, 1998, and March 31, 1999,
were primarily attributable to increases in comprehensive income and issuance of
shares for employee benefit plans reduced by dividends paid to shareholders. The
"Consolidated Statements of Changes in Shareholders' Equity" provide additional
detail on the changes in shareholders' equity during the first quarter of 1999.
On April 15, 1999, First American's Board of Directors increased the
quarterly cash dividend on its common stock by 12 percent to $.28 per share.
This dividend will be payable on May 28, 1999, to shareholders of record on May
14, 1999.
Federal regulators prescribe capital guidelines applicable to First
American and its bank and thrift subsidiaries, which as of March 31, 1999, are
classified as "well capitalized," the highest regulatory capital rating. Table 7
summarizes the risk-based and related ratios for First American and its
principal subsidiary, FANB.
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TABLE 7: CAPITAL RATIOS (1)
======================================================================================================================
CORPORATION FIRST AMERICAN NATIONAL BANK
------------------------------------- -------------------------------------
MARCH 31 DECEMBER 31 MARCH 31 December 31
------------------- ----------- ------------------- -----------
1999 1998 1998 1999 1998 1998
----- ----- ----- ----- ----- -----
Total risk-based capital ratio 12.58% 11.33% 12.16% 12.64% 11.50% 12.40%
Tier I risk-based capital ratio 10.67 9.41 10.25 11.41 10.25 11.15
Tier I leverage ratio 7.99 7.60 7.72 8.65 8.32 8.88
======================================================================================================================
(1) Risk-based capital ratios were computed using realized equity (total
shareholders' equity exclusive of net unrealized gains (losses) on
securities available for sale, net of tax).
CREDIT RISK MANAGEMENT
NONPERFORMING ASSETS
First American's asset quality remains strong as evidenced by its ratio
of nonperforming assets (excluding loans 90 days or more past due on accrual
status) to total loans and foreclosed properties of .47 percent at March 31,
1999, which is down slightly from year end of .48 percent and up from .42
percent at March 31, 1998. Nonperforming assets (excluding loans 90 days or more
past due on accrual status) totaled $53.7 million at March 31, 1999, down $1.3
million, or 2 percent, from December 31, 1998, and up $4.4 million, or 9
percent, from a year ago.
Note 4 to the consolidated financial statements presents the
composition of nonperforming assets and balances of loans contractually past due
90 days or more as to interest or principal payments at March 31, 1999, December
31, 1998, and March 31, 1998.
ALLOWANCE AND PROVISION FOR LOAN LOSSES
As a financial services company which assumes lending and credit risks
as a principal element of its business, First American recognizes that credit
losses will be experienced in the normal course of business. Accordingly, First
American consistently applies a comprehensive methodology and procedural
discipline, which is updated on a quarterly basis at the subsidiary level to
determine the adequacy of the allowance for loan losses. The allowance for loan
losses is based on assessments of the probable estimated losses inherent in the
loan portfolio.
Table 8 provides an analysis of the changes in the allowance for the
first quarter of 1999 and the first quarter of 1998. The $8.1 million decrease
in the allowance during the first quarter of 1999 from year end 1998 was
primarily attributable to a $7.9 million charge-off in connection with a
commercial loan to a company doing business as a sub-prime lender that filed for
protection under federal bankruptcy laws.
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TABLE 8: ALLOWANCE FOR LOAN LOSSES
=================================================================================================================================
Three Months Ended March 31
---------------------------
(dollars in thousands) 1999 1998
- ---------------------------------------------------------------------------------------------------------------------------------
Balance at beginning of period $197,681 $187,880
Loans charged off:
Commercial 11,970(1) 2,512
Consumer--amortizing mortgages 399 833
Consumer--other 12,232 9,260
Real estate--construction 51 7
Real estate--commercial mortgages and other 251 136
- ---------------------------------------------------------------------------------------------------------------------------------
Total charge-offs 24,903 12,748
- ---------------------------------------------------------------------------------------------------------------------------------
Recoveries of loans previously charged off:
Commercial 3,088 1,007
Consumer--amortizing mortgages 123 253
Consumer--other 4,124 3,863
Real estate--construction 33 20
Real estate--commercial mortgages and other 268 346
- ---------------------------------------------------------------------------------------------------------------------------------
Total recoveries 7,636 5,489
- ---------------------------------------------------------------------------------------------------------------------------------
Net charge-offs 17,267 7,259
- ---------------------------------------------------------------------------------------------------------------------------------
Provision charged to operating expenses 9,234 6,938
Net change due to business combination -- 1,313
- ---------------------------------------------------------------------------------------------------------------------------------
Balance at end of period $189,648 $188,872
=================================================================================================================================
Allowance to net loans, end of period 1.65% 1.59%
Allowance to nonperforming loans 414.55 454.73
Allowance to nonperforming assets 353.06 382.73%
Net charge-offs to average loans (annualized) .61 .24
Net charge-offs to average loans (annualized) excluding charge-off of loan to sub-prime lender .33 .24
=================================================================================================================================
(1) Includes charge-off of $7,949 thousand of a loan to a sub-prime lender.
Excluding the effect of the first quarter charge-off to the sub-prime
lender, net charge-offs increased $2.1 million in the first quarter of 1999 over
the same period last year. The increase reflected the national trend of
increasing consumer loan losses.
MARKET RISK MANAGEMENT
INTEREST RATE SENSITIVITY
In the normal course of business, First American is exposed to market
risk arising from fluctuations in interest rates. First American's
asset/liability management team determines the appropriate amounts of
on-balance-sheet (e.g., loans, investment securities, deposits) and off-balance
sheet items (e.g., interest rate swaps) to maintain consistent growth of net
interest income with acceptable levels of interest rate risk. Measurement tools
used to facilitate the management of interest rate risk include an earnings
simulation model, an economic value of equity model, and gap analysis
computations.
First American believes that interest rate risk is best measured by
earnings simulation modeling. Forecasted levels of earning assets,
interest-bearing liabilities, and off-balance-sheet financial instruments are
combined with the Asset/Liability Committee's ("ALCO's") forecast of interest
rates for the next 12 to 24 months and other factors in order to produce various
earnings simulations. To limit interest rate risk, First American has guidelines
for earnings at risk which state that net income should not vary by more than 5
percent for a 150 basis point change in rates from ALCO's most likely interest
rate forecast over the next twelve months. First American operated within these
parameters during the first three months of 1999 and in 1998.
First American's economic value of equity model measures the extent
that estimated economic values of assets, liabilities, and off-balance-sheet
items will change as a result of changes in interest rates. To help limit
interest rate risk, First American has a guideline stating that for an
instantaneous 150 basis point change in interest rates, the economic value of
equity will not change by more than 20 percent from the base case. During the
first three months of 1999, First American operated within these limits.
First American's interest rate sensitivity gap model measures the
difference between assets and liabilities repricing or maturing within specified
time periods. The net interest sensitivity
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position at March 31, 1999, was a negative 18 percent (a net liability
sensitivity position) at a one-year repricing horizon. A cumulative net
liability sensitivity (negative amount) indicates that net interest income has a
tendency to increase if interest rates decline. Although the gap model is a tool
used to manage interest rate risk, the model is limited in its usefulness
because the gap position is a snapshot of interest sensitivity for one point in
time whereas interest rate gap sensitivity can change on a daily basis.
DERIVATIVE INSTRUMENTS
Derivative financial instruments are used by First American to improve
the balance between interest-sensitive assets and interest-sensitive
liabilities. First American uses derivatives as one means to manage its interest
rate sensitivity while continuing to meet the credit and deposit needs of
customers.
At March 31, 1999, First American held interest rate contracts with
notional values totaling $2.99 billion and a net positive fair value (unrealized
net pre-tax gain) of $2.7 million. At March 31, 1998, First American held
interest rate contracts with notional values totaling $2.83 billion and a net
positive fair value (unrealized net pre-tax gain) of $15 million. All of these
were hedges of interest-bearing assets or liabilities, in conjunction with First
American's management of its exposure to changes in the interest rate
environment. The instruments utilized are noted in the following table, along
with their notional amounts and fair values at March 31, 1999 and 1998.
TABLE 9: DERIVATIVE INSTRUMENTS
Weighted
Average
Weighted Average Rate Maturity
Related Variable Rate Notional ----------------------- -------- Fair
(dollars in thousands) Asset/Liability Amount Paid Received Years Value
- ----------------------------------------------------------------------------------------------------------------------------------
MARCH 31, 1999
Interest rate swaps Money market deposits $ 150,000 5.43%(1) 5.02% (2) 2.7 $ 640
Interest rate swaps Commercial loans 625,000 4.99 (2) 6.57 (1) 3.1 17,020
Interest rate swaps Mortgage loans 19,310 6.65 (1) 4.94 (3) 8.3 (732)
Interest rate swaps FHLB advances 85,000 6.33 (1) 5.00 (2) 5.5 (2,729)
Interest rate swaps Available for sale securities 210,150 5.04 (1) 5.08 (2) 2.7 885
Forward interest rate swaps Money market deposits 350,000 5.78 (1) N/A (2,4) 2.2 (1,702)
Forward interest rate swaps Available for sale securities 1,550,000 5.86 (1) 5.02 (2,5) 2.1 (10,706)
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest rate contracts $2,989,460 $ 2,676
==================================================================================================================================
March 31, 1998
Interest rate swaps Money market deposits $ 150,000 5.97%(1) 5.68% (2) 1.9 $ (78)
Interest rate swaps Commercial loans 775,000 5.64 (2) 6.61 (1) 4.0 20,497
Interest rate swaps Mortgage loans 20,857 6.65 (1) 5.68 (3) 9.3 (593)
Interest rate swaps FHLB advances 85,000 6.33 (1) 5.64 (2) 6.4 (1,795)
Interest rate swaps Available for sale securities 100,000 5.54 (1) 5.72 (2) 4.8 1,952
Interest rate swaps Available for sale securities 50,000 5.69 (2) 5.44 (6) 4.5 (692)
Forward interest rate swaps Money market deposits 600,000 6.46 (1) 5.65 (2,7) 1.0 (2,074)
Forward interest rate swaps Available for sale securities 750,000 6.24 (1) N/A (2,8) 2.3 (3,516)
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest rate swaps 2,530,857 13,701
Interest rate floors Commercial loans 300,000 N/A 5.37 (9) 2.6 1,336
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest rate contracts $2,830,857 $ 15,037
==================================================================================================================================
(1) Fixed rate.
(2) Variable rate which reprices quarterly based on 3-month LIBOR.
(3) Variable rate which reprices monthly based on 1-month LIBOR.
(4) Forward swap periods will begin at various dates during 1999. Variable
rates were unknown at March 31, 1999.
(5) Forward swap periods have become effective for $500 million and will
begin at various dates during 1999 and 2000 for $1,050 million.
Variable rates were unknown at March 31, 1999, for forward swaps which
were not yet effective. Variable rates are based on LIBOR and will
reprice quarterly except $400 million which will reprice semi-annually.
(6) Variable rate which reprices quarterly based on the constant maturity
treasury index.
(7) Forward swap periods have become effective for $150 million and will
begin at various dates during 1998 for $450 million. Variable rates
were unknown at March 31, 1998, for forward swaps which were not yet
effective.
(8) Forward swap periods began at various dates during 1998. Variable rates
were unknown at March 31, 1998, for forward swaps which were not yet
effective.
(9) Fixed rate strike price, based on 3-month LIBOR.
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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 March 31, 1999, there were
$12.7 million of deferred net gains related to terminated derivatives contracts,
and there were $5.1 million of deferred net gains at March 31, 1998. Deferred
gains and losses on off-balance-sheet derivative activities are recognized as
interest income or interest expense over the original periods covered by the
related derivative hedge.
Net interest income for first quarter 1999 included derivative products
pretax net income of $.1 million, compared with $1.3 million for first quarter
1998. Although the stand-alone effect of First American's derivative products on
net interest income can vary, hedges are intended to improve First American's
overall exposure to changes in the interest rate environment and therefore
should not be evaluated on a stand-alone basis.
Credit risk exposure due to off-balance-sheet derivative activities is
closely monitored, and counterparties to these contracts are selected based on
their creditworthiness as well as their market-making ability. As of March 31,
1999, all outstanding derivative transactions were with counterparties with
credit ratings of A-2 or better. Enforceable bilateral netting contracts between
First American and its counterparties allow for the netting of gains and losses
in determining net credit exposure to the counterparty. First American's net
credit exposure on outstanding interest rate swaps was $15 million at March 31,
1999.
In June 1998 the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instrument and Hedging Activities," effective
for fiscal years beginning after June 15, 1999. SFAS No. 133 establishes
accounting and reporting standards for derivative instruments and for hedging
activities. It requires an entity to recognize all derivatives as either assets
or liabilities in the statement of financial position and to measure those
instruments at fair value. Under certain conditions, a derivative may be
specifically designated as a fair value hedge or a cash flow hedge. The
accounting for changes in the fair value of a derivative will depend on the
intended use of the derivative and the resulting designation. At this time,
management has not fully evaluated the impact of SFAS No. 133. First American
will adopt SFAS No. 133 prospectively on January 1, 2000.
LIQUIDITY MANAGEMENT
The ALCO is responsible for ensuring that sufficient funds are
available to meet the demands of depositors, borrowers, and creditors. Liquid
assets, which include cash and cash equivalents (less Federal Reserve
requirements), time deposits with other banks, federal funds sold and securities
purchased under agreements to resell, mortgage loans held for sale, trading
account securities, and securities that are estimated to mature within one year,
amounted to:
- $1.3 billion, or 7 percent of earning assets, at March 31,
1999,versus
- $1.7 billion, or 10 percent of earning assets, at March 31,
1998.
The decrease in the ratio is primarily attributable to a decrease in the
balances of cash and due from banks, mortgage loans held for sale, and held to
maturity securities maturing within a year, and a higher level of earning
assets. In addition to assets included in liquid assets, available-for-sale
securities maturing after one year, which can be sold to meet liquidity needs,
had a balance of $4 billion at March 31, 1999, compared to $3.7 billion at March
31, 1998.
First American's liquidity is enhanced by a sizeable base of core
deposits. Additional funds can be raised from regional, national, and
international money markets as certificates of deposit $100,000 and over,
federal funds purchased, and securities sold under agreements to repurchase. As
shown in Table 10 and discussed under the captions, "Core Deposits" and
"Borrowed Funds," First American has increased its reliance on noncore
interest-bearing liabilities to fund earning assets.
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TABLE 10: LIQUIDITY RATIOS
===================================================================================================
Three Months Ended March 31
--------------------------- Year Ended
1999 1998 December 31, 1998
- ---------------------------------------------------------------------------------------------------
Average core deposits to average total deposits 86.77% 89.18% 88.08%
Average core deposits to average earning assets 69.07 74.36 71.70
Long-term debt to total assets (end of period) 6.04 3.15 5.56
===================================================================================================
An additional source of liquidity is First American's three-year $100
million revolving credit agreement. The credit facility agreement expires in
July 2001. First American had no borrowings under the credit agreement facility
in 1999.
YEAR 2000 READINESS DISCLOSURE
The term "Year 2000 issue" refers to the necessity of converting
computer/microprocessor-controlled information systems so that such systems
recognize four digits to identify a year in any given date field and are able to
differentiate between years in the twentieth and twenty-first centuries (e.g.,
1900 and 2000). First American continued to make progress towards Year 2000
readiness during the first quarter of 1999.
To address the Year 2000 issue, in 1997, First American adopted a
broad-based approach designed to encompass its total environment. A project
manager and a project team comprised of managers from various areas were
appointed. Overseeing the project is the Year 2000 Steering Committee made up of
senior management. The project team is responsible for evaluating Year 2000
impact on products and systems, developing a plan for bringing those products
and systems to Year 2000 ready levels, and testing or verifying that readiness.
First American's project team is using a 5-phase approach comprised of
awareness, assessment, remediation, validation, and implementation phases. Areas
of risk being addressed by the project team include:
- Business Systems Applications. This involves Year 2000
remediation of application software that is used to perform
specific business functions such as deposits or loan systems.
- Technical Infrastructure. This involves Year 2000 remediation
of the hardware and software environment used to run
application software and includes PC networks,
telecommunications, mainframe computers, operating systems,
and productivity software.
- Credit Administration. In this area, the project team is
reviewing and addressing the risk associated with Year 2000
status of First American's clients and depositors.
- Facilities Systems. This involves Year 2000 remediation of
microprocessor-controlled systems such as elevators, HVAC
systems, security systems, lighting systems, and utilities.
- Vendor and Third Party Assessment. In this area, the project
team has conducted an inventory of the systems and products
provided by third parties and has contacted the providers
regarding the status of their Year 2000 compliance. In certain
instances, First American has conducted or participated in
testing to validate vendors' certifications. This has been a
broad-based effort including IT vendors, non-IT vendors, and
public utilities.
During the first quarter of 1999, testing validation of mission
critical business systems and applications identified during the assessment
process was a key focus area. As of March 31, 1999, remediation of mission
critical applications was 100 percent complete. By April 16, 1999,
recertification of internal testing processes for mission critical systems was
also complete. Testing with non-mission critical systems vendors, third party
service providers, and customers will continue throughout 1999.
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Other areas of emphasis during the first quarter included updated risk
assessments of corporate borrowers, facilities' remediation and testing, and the
development of a plan to maintain the Year 2000 readiness of systems previously
remediated. With respect to credit issues, First American continues to monitor
large borrower relationships, focusing on those considered "high risk" (defined
as corporate borrowers with loans of $10 million or greater). An update of the
original Year 2000 evaluation of all "high risk" borrowers, which was conducted
in 1998, is substantially complete. This effort includes relationships for all
depository institutions acquired by First American in 1998. For the remainder of
1999, First American intends to update the evaluations of these borrowers on a
periodic basis. Significant progress has also been made in the area of
facilities management, and all of First American's multi-tenant facilities have
now been remediated and tested for Year 2000 readiness. Also, the development of
a plan to control changes to First American's systems environment began in the
first quarter. As a result of this, it is anticipated that a general moratorium
on changes made to systems will be implemented in the fourth quarter to preserve
the Year 2000 ready environment.
During the first quarter of 1999, the Steering Committee formed
cross-functional teams to address customer and internal communications, cash and
liquidity issues, and event and contingency planning. With the formation of the
communications team, several initiatives were accomplished. Key messages were
drafted to ensure that uniform points of communication are promulgated
throughout the corporation and used in employee training. A "Year 2000 Readiness
Disclosure" brochure was printed and mailed to all branches and deposit account
holders in both the First American and Deposit Guaranty markets. City and
Regional Presidents were trained and prepared to address key aspects of the Year
2000 project in their respective communities. A communications team
representative attended both regulatory and regional bank Year 2000 meetings to
ensure First American's communication strategy was coordinated with regulatory
agencies' communication plans. Updates on the Year 2000 project are made
available to employees through internal newsletters and briefings.
The cash and liquidity planning team's primary focus is to estimate the
amount of additional cash which will be needed to respond to potential customer
requests. The plan developed by this team will also address the facilitation of
cash distribution throughout the First American system. A detailed project plan
has been finalized identifying tasks with completion target dates.
The event/contingency team's primary objective is to develop plans
addressing actions to be taken before, during and after the event period.
According to the Federal Financial Institutions Examination Council, "event
planning" is a proactive and detailed planning process that covers monitoring
specific operations prior to, during, and after January 1, 2000, detecting
problems and resolving issues related to whether and how to implement business
resumption contingency plans, and communicating with appropriate bank officials
and customers. It also involves personnel issues (e.g., vacation/leave policies,
the availability of subject matter experts) and communications issues
(e.g.,command centers, internal and external notification procedures, call
center scripts). First American's event/contingency planning team is in the
process of developing detailed plans for each of these areas. This team is also
responsible for evaluating the existing contingency plans in place for the First
American's core processes and to modify them where necessary to satisfy
potential Year 2000 risks. The planning for this aspect of the Year 2000 project
is scheduled to be accomplished by June 30, 1999.
First American does not expect Year 2000 costs to exceed $5 million in
the aggregate, exclusive of any costs that might be associated with contingency
planning or implementation of contingency planning. External expenses are
estimated at $2.2 million. Internal allocation of existing staff is estimated to
total approximately $2.5 million.
First American's management believes its approach to the Year 2000
issue to be comprehensive and does not expect the Year 2000 issue to have a
material impact on its results of operations, liquidity, or financial condition.
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PART I. FINANCIAL INFORMATION
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The information called for by this item is incorporated
herein by reference to the "Market Risk Management"
caption of the Management's Discussion and Analysis
included as Item 2 of Part 1 of this report and to the
"Interest Rate Sensitivity" and "Derivatives"
subsections of Items 7 and 7A contained in the
Registrant's Annual Report on Form 10-K for the year
ended December 31, 1998.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Legal proceedings are included in Note 8 to First American's
Consolidated Financial Statements for the three months ended
March 31, 1999 included herein. See Part I, Item 1.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Number Description
------ ----------------------------------------------------
3.1 Restated Charter of the Registrant currently in
effect as amended and corrected is incorporated
herein by reference to Exhibit 3.1 of the
Registrant's Form 10-Q for the three months ended
March 31, 1998.
3.2 By-laws of the Registrant currently in effect as
amended September 17, 1998, are incorporated herein
by reference to Exhibit 3.2 of the Registrant's Form
10-Q for the nine months ended September 30, 1998.
11 "Computation of Earnings per Common Share" is
included in Note 7 to the Consolidated Financial
Statements for the three months ended March 31, 1999,
and March 31, 1998. See Part 1, Item 1.
15 Letter regarding unaudited interim financial
information from KPMG LLP, dated April 15, 1999,
included herein.
27.1 Financial Data Schedule for interim year-to-date
period ended March 31, 1999, included herein. (For
SEC use only)
27.2 Restated Financial Data Schedule for interim
year-to-date period ended March 31, 1998, included
herein. (For SEC use only)
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the three months
ended March 31, 1999.
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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/ Allan R. Landon
-------------------------------------
Allan R. Landon
Executive Vice President, CFO and
Principal Financial Officer
Date: May 14, 1999
--------------------------------
/s/ Marvin J. Vannatta, Jr.
-------------------------------------
Marvin J. Vannatta, Jr.
Executive Vice President and
Principal Accounting Officer
Date: May 14, 1999
--------------------------------
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