UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended June 30, 2001
Commission File Number 0-8076
FIFTH THIRD BANCORP
(Exact name of Registrant as specified in its charter)
Ohio 31-0854434
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
Fifth Third Center
Cincinnati, Ohio 45263
(Address of principal executive offices)
Registrant's telephone number, including area code: (513) 579-5300
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_______
-----
There were 577,285,634 shares of the Registrant's Common Stock, without par
value, outstanding as of July 31, 2001.
FIFTH THIRD BANCORP
INDEX
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets -
June 30, 2001 and 2000 and December 31, 2000 3
Condensed Consolidated Statements of Income -
Three and Six Months Ended June 30, 2001 and 2000 4
Condensed Consolidated Statements of Cash Flows -
Six Months Ended June 30, 2001 and 2000 5
Condensed Consolidated Statements of Changes in Shareholders' Equity -
Six Months Ended June 30, 2001 and 2000 6
Notes to Condensed Consolidated Financial Statements 7 - 15
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 16 - 19
Item 3. Quantitative and Qualitative Disclosures About Market Risk 20
Part II. Other Information 21 - 22
2
Fifth Third Bancorp and Subsidiaries
Condensed Consolidated Balance Sheets (unaudited)
- --------------------------------------------------------------------------------------------------------------
June 30, December 31, June 30,
($000's) 2001 2000 2000
- --------------------------------------------------------------------------------------------------------------
Assets
- --------------------------------------------------------------------------------------------------------------
Cash and Due from Banks $ 1,585,300 1,706,538 1,425,500
Securities Available for Sale (a) 18,719,861 19,028,803 18,302,233
Securities Held to Maturity (b) 19,395 552,563 617,312
Other Short-Term Investments 700,074 232,524 131,231
Loans Held for Sale 2,932,347 1,654,996 1,578,543
Loans and Leases
Commercial Loans 10,690,126 10,674,980 10,595,844
Construction Loans 3,495,358 3,222,553 2,644,306
Commercial Mortgage Loans 6,596,721 6,226,839 6,008,736
Commercial Lease Financing 2,934,245 3,158,436 2,748,035
Residential Mortgage Loans 4,439,013 5,635,286 6,206,877
Consumer Loans 11,886,770 11,551,102 10,256,379
Consumer Lease Financing 2,503,772 3,006,942 3,810,119
Unearned Income (970,914) (945,748) (976,921)
Reserve for Credit Losses (617,270) (609,340) (602,204)
- --------------------------------------------------------------------------------------------------------------
Total Loans and Leases 40,957,821 41,921,050 40,691,171
Bank Premises and Equipment 819,061 803,793 809,663
Accrued Income Receivable 545,633 558,695 508,953
Other Assets 3,554,148 3,199,377 2,830,549
- --------------------------------------------------------------------------------------------------------------
Total Assets $ 69,833,640 69,658,339 66,895,155
==============================================================================================================
Liabilities
- --------------------------------------------------------------------------------------------------------------
Deposits
Demand $ 7,621,352 7,152,381 6,364,057
Interest Checking 11,567,613 10,319,753 9,265,895
Savings and Money Market 7,162,973 6,914,353 6,821,492
Time Deposits 18,751,747 23,972,954 21,814,192
- --------------------------------------------------------------------------------------------------------------
Total Deposits 45,103,685 48,359,441 44,265,636
Federal Funds Borrowed 4,356,098 2,178,703 3,896,454
Short-Term Bank Notes - - 2,740,000
Other Short-Term Borrowings 5,160,677 5,920,594 5,676,656
Accrued Taxes, Interest and Expenses 1,964,855 1,694,965 1,246,171
Other Liabilities 555,465 358,414 461,398
Long-Term Debt 5,452,136 4,311,310 2,587,003
Guaranteed Preferred Beneficial Interests in
Convertible Subordinated Debentures 172,500 172,500 172,500
- --------------------------------------------------------------------------------------------------------------
Total Liabilities 62,765,416 62,995,927 61,045,818
- --------------------------------------------------------------------------------------------------------------
Shareholders' Equity
- --------------------------------------------------------------------------------------------------------------
Common Stock (c) 1,280,024 1,263,418 1,260,177
Preferred Stock (d) 9,250 9,250 9,250
Capital Surplus 1,271,182 1,144,079 1,073,044
Retained Earnings 4,422,847 4,226,047 3,940,792
Unrealized Gains (Losses) on Securities
Available for Sale 84,921 28,012 (329,443)
Deferred Compensation - (2,727) -
Treasury Stock - (5,667) (104,483)
- --------------------------------------------------------------------------------------------------------------
Total Shareholders' Equity 7,068,224 6,662,412 5,849,337
- --------------------------------------------------------------------------------------------------------------
Total Liabilities and Shareholders' Equity $ 69,833,640 69,658,339 66,895,155
==============================================================================================================
(a) Amortized cost: June 30, 2001 - $18,587,032, December 31, 2000 - $18,986,346
and June 30, 2000 -$18,790,934.
(b) Market values: June 30, 2001 - $19,395, December 31, 2000 - $557,275 and
June 30, 2000 - $601,551.
(c) Common Shares: Stated value $2.22 per share; authorized at June 30, 2001 -
1,300,000,000, December 31, 2000 and June 30, 2000 - 650,000,000;
outstanding at June 30, 2001 - 576,587,585, December 31, 2000 - 569,056,843
(excludes 104,455 treasury shares) and June 30, 2000 - 566,309,657 (excludes
2,197,666 treasury shares).
(d) 490,750 shares of no par value preferred stock are authorized of which none
had been issued as of June 30, 2001; 7,250 shares of 8.00% Series D
convertible perpetual preferred stock with a stated value of $1,000 were
authorized, issued and outstanding at June 30, 2001; 2,000 shares of 8.00%
Series E perpetual preferred stock with a stated value of $1,000 were
authorized, issued and outstanding at June 30, 2001
See Notes to Consolidated Financial Statements
3
Fifth Third Bancorp and Subsidiaries
Condensed Consolidated Statements of Income (unaudited)
- ------------------------------------------------------------------------------------------- ------------------------
Three Months Six Months
Ended Ended
June 30, June 30,
------------------------ ------------------------
($000's) 2001 2000 2001 2000
=========================================================================================== ========================
Interest Income
Interest and Fees on Loans and Leases $ 919,792 882,124 $ 1,858,970 1,712,614
Interest on Securities
Taxable 287,161 326,936 587,271 622,709
Exempt from Income Taxes 17,666 18,708 34,763 37,435
- ------------------------------------------------------------------------------------------- ------------------------
Total Interest on Securities 304,827 345,644 622,034 660,144
Interest on Other Short-Term Investments 3,797 3,290 6,602 6,977
- ------------------------------------------------------------------------------------------- ------------------------
Total Interest Income 1,228,416 1,231,058 2,487,606 2,379,735
- ------------------------------------------------------------------------------------------- ------------------------
Interest Expense
Interest on Deposits
Interest Checking 84,128 82,441 170,919 147,371
Savings and Money Market 53,798 49,091 115,941 109,612
Time Deposits 274,763 330,941 591,687 595,676
- ------------------------------------------------------------------------------------------- ------------------------
Total Interest on Deposits 412,689 462,473 878,547 852,659
Interest on Federal Funds Borrowed 61,503 81,541 110,031 158,260
Interest on Short-Term Bank Notes - 22,503 - 44,914
Interest on Other Short-Term Borrowings 61,111 69,534 138,707 136,706
Interest on Long-Term Debt and Notes 85,396 34,358 164,200 71,487
- ------------------------------------------------------------------------------------------- ------------------------
Total Interest Expense 620,699 670,409 1,291,485 1,264,026
- ------------------------------------------------------------------------------------------- ------------------------
Net Interest Income 607,717 560,649 1,196,121 1,115,709
Provision for Credit Losses 25,618 35,309 91,557 67,293
Merger-Related Provision for Credit Losses 35,437 8,000 35,437 12,000
- ------------------------------------------------------------------------------------------- ------------------------
Net Interest Income After Provision for Credit Losses 546,662 517,340 1,069,127 1,036,416
Other Operating Income
Data Processing Income 78,371 59,155 147,936 112,205
Service Charges on Deposits 91,871 75,894 169,700 143,366
Mortgage Banking Revenue 53,157 63,548 113,622 128,917
Investment Advisory Income 80,409 70,283 157,524 141,769
Other Service Charges and Fees 118,226 96,667 242,113 195,051
Securities Gains (Losses) 2,788 (150) 7,107 (60)
- ------------------------------------------------------------------------------------------- ------------------------
Total Other Operating Income 424,822 365,397 838,002 721,248
- ------------------------------------------------------------------------------------------- ------------------------
Operating Expenses
Salaries, Wages and Incentives 216,225 193,167 419,429 388,389
Employee Benefits 38,933 38,252 76,817 81,453
Equipment Expenses 21,567 25,221 43,631 49,852
Net Occupancy Expenses 37,049 33,486 73,647 67,390
Other Operating Expenses 199,319 162,798 384,948 325,511
Merger-Related Charges 219,229 64,848 219,229 86,973
- ------------------------------------------------------------------------------------------- ------------------------
Total Operating Expenses 732,322 517,772 1,217,701 999,568
- ------------------------------------------------------------------------------------------- ------------------------
Income Before Income Taxes 239,162 364,965 689,428 758,096
Applicable Income Taxes 110,274 117,192 254,140 245,852
- ------------------------------------------------------------------------------------------- ------------------------
Net Income 128,888 247,773 435,288 512,244
Cumulative Effect of Change in Accounting
Principle, Net of Tax - - 6,781 -
Dividend on Preferred Stock 185 185 370 370
- ------------------------------------------------------------------------------------------- ------------------------
Net Income Available to Common Shareholders $ 128,703 247,588 $ 428,137 511,874
=========================================================================================== ========================
Per Share:
Earnings $ 0.22 0.44 $ 0.75 0.91
Diluted Earnings $ 0.22 0.43 $ 0.73 0.89
Cash Dividends $ 0.20 0.18 $ 0.40 0.34
=========================================================================================== ========================
Average Shares (000's):
Outstanding 574,545 566,272 572,873 566,025
Diluted 590,234 578,856 588,416 578,118
=========================================================================================== ========================
See Notes to Consolidated Financial Statements
4
Fifth Third Bancorp and Subsidiaries
Condensed Consolidated Statements of Cash Flows (unaudited)
- ---------------------------------------------------------------------------------------------------------------------------
Six Months Ended
June 30,
------------------------------
($000's) 2001 2000
- ---------------------------------------------------------------------------------------------------------------------------
Operating Activities
Net Income $ 428,507 512,244
Adjustments to Reconcile Net Income to Net Cash Provided by
(Used in) Operating Activities:
Provision for Credit Losses 91,557 67,293
Depreciation, Amortization and Accretion 97,344 92,183
Provision for Deferred Income Taxes 37,551 103,237
Realized Securities Gains (10,160) (1,876)
Realized Securities Losses 3,053 1,936
Proceeds from Sales of Residential Mortgage Loans Held for Sale 4,217,714 5,447,807
Net Gain (Loss) on Sales of Loans (109,110) (69,134)
Increase in Residential Mortgage Loans Held for Sale (5,404,905) (5,835,235)
(Increase) Decrease in Accrued Income Receivable 18,758 (41,399)
Increase in Other Assets (235,669) (310,137)
Increase in Accrued Taxes, Interest and Expenses 191,757 113,701
Increase in Other Liabilities 164,129 138,096
- ---------------------------------------------------------------------------------------------------------------------------
Net Cash Provided by (Used in) Operating Activities (509,474) 218,716
===========================================================================================================================
Investing Activities
Proceeds from Sales of Securities Available for Sale 4,097,814 3,320,894
Proceeds from Calls, Paydowns and Maturities of Securities Available for Sale 5,390,413 951,213
Purchases of Securities Available for Sale (7,239,510) (5,792,803)
Proceeds from Calls, Paydowns and Maturities of Securities Held to Maturity 14,294 45,788
Purchases of Securities Held to Maturity - (10,786)
(Increase) Decrease in Other Short-Term Investments (467,550) 256,645
(Increase) Decrease in Loans and Leases 577,100 (3,309,244)
Purchases of Bank Premises and Equipment (93,027) (61,898)
Proceeds from Disposal of Bank Premises and Equipment 33,260 6,714
Net Cash Paid in Acquisitions (146,807) -
- ---------------------------------------------------------------------------------------------------------------------------
Net Cash Provided by (Used in) Investing Activities 2,165,987 (4,593,477)
===========================================================================================================================
Financing Activities
Increase in Transaction Account Deposits 1,628,309 55,034
Decrease in Consumer Time Deposits (581,660) (48,322)
Increase (Decrease) in CDs - $100,000 and Over, including Foreign (5,131,436) 2,403,118
Increase in Federal Funds Borrowed 2,126,580 653,113
Increase in Short-Term Bank Notes - 922,600
Decrease in Other Short-Term Borrowings (777,398) (461,090)
Proceeds from Issuance of Long-Term Debt and Notes 2,373,328 1,851,741
Proceeds from Issuance of Subordinated Bank Notes - 100,000
Repayment of Long-Term Debt (1,248,752) (1,368,683)
Payment of Cash Dividends (228,979) (213,051)
Exercise of Stock Options 62,908 26,753
Proceeds from Sale of Common Stock - 10,881
Purchases of Stock - (45,773)
Other (651) 21,697
- ---------------------------------------------------------------------------------------------------------------------------
Net Cash Provided by (Used In) Financing Activities (1,777,751) 3,908,018
===========================================================================================================================
Decrease in Cash and Due from Banks (121,238) (466,743)
Cash and Due from Banks at Beginning of Period 1,706,538 1,892,244
- ---------------------------------------------------------------------------------------------------------------------------
Cash and Due from Banks at End of Period $ 1,585,300 1,425,501
===========================================================================================================================
See Notes to Consolidated Financial Statements
5
Fifth Third Bancorp and Subsidiaries
Condensed Consolidated Statements of Changes in Shareholders' Equity (unaudited)
- --------------------------------------------------------------------------------------------------------------------------
Six Months Ended
June 30,
---------------------------------
($000's) 2001 2000
- --------------------------------------------------------------------------------------------------------------------------
Balance at December 31 $ 6,662,412 5,562,795
Net Income 428,507 512,244
Nonowner Changes in Equity, Net of Tax:
Change in Unrealized Gains (Losses) on Securities Available for Sale 56,909 (27,582)
- --------------------------------------------------------------------------------------------------------------------------
Net Income and Nonowner Changes in Equity 485,416 484,662
Cash Dividends Declared:
Fifth Third Bancorp:
Common Stock (2001 - $.40 per share and 2000 - $.34 per share) (209,691) (158,027)
Preferred Stock (185) -
Pooled Companies Prior to Acquisition:
Common Stock (50,872) (56,221)
Preferred Stock (185) (370)
Stock Options Exercised including Treasury Shares Issued 62,908 26,753
Shares Purchased - (45,773)
Stock Issued in Acquisitions and Other 118,421 35,518
- --------------------------------------------------------------------------------------------------------------------------
Balance at June 30 $ 7,068,224 $ 5,849,337
==========================================================================================================================
See Notes to Consolidated Financial Statements
6
FINANCIAL INFORMATION
---------------------
Item 1. Notes to Condensed Consolidated Financial Statements
- -------------------------------------------------------------
1. In the opinion of management, the unaudited Condensed Consolidated
Financial Statements include all adjustments (which consist of normal
recurring accruals) necessary, to present fairly the consolidated
financial position as of June 30, 2001 and 2000, the results of
operations for the three and six months ended June 30, 2001 and 2000,
the statements of cash flows for the six months ended June 30, 2001 and
2000 and the statements of changes in shareholders' equity for the six
months ended June 30, 2001 and 2000. In accordance with accounting
principles generally accepted in the United States of America for
interim financial information, these statements do not include certain
information and footnote disclosures required for complete annual
financial statements. Financial information as of December 31, 2000 has
been derived from the Consolidated Financial Statements of Fifth Third
Bancorp (the "Registrant" or "Fifth Third"). The results of operations
for the three and six months ended June 30, 2001 and 2000 and the
statements of cash flows for the six months ended June 30, 2001 and
2000 are not necessarily indicative of the results to be expected for
the full year. For further information, refer to the Consolidated
Financial Statements and footnotes thereto for the year ended December
31, 2000, included in the Registrant's Annual Report on Form 10-K.
Certain reclassifications have been made to prior periods' consolidated
financial statements and related notes to conform with the current
period presentation. As described in note 2, the accompanying prior
period Condensed Consolidated Financial Statements of the Registrant,
have been restated to include the financial results of Old Kent.
2. Business Combinations:
---------------------
On January 2, 2001, the Registrant completed the acquisition of
Resource Management, Inc., d.b.a. Maxus Investment Group ("Maxus"), an
Ohio corporation. Maxus was a privately-held diversified financial
services company that provides investment management and brokerage
services, headquartered in Cleveland, Ohio. In connection with this
acquisition, the Registrant issued 470,162 shares of Fifth Third common
stock and paid $18,090,000 in cash for the outstanding capital stock of
Maxus. This transaction was accounted for as a purchase transaction.
The results of operations of Maxus have been included in the Condensed
Consolidated Financial Statements of the Registrant since January 2,
2001. The pro forma prior period results are not material.
On March 9, 2001, the Registrant completed the acquisition of Capital
Holdings, Inc. ("Capital Holdings") and its subsidiary, Capital Bank
N.A., headquartered in Sylvania, Ohio. At December 31, 2000, Capital
Holdings had total assets of $1.1 billion and total deposits of $874
million. In connection with this acquisition, the Registrant issued
4,505,385 shares of Fifth Third common stock for the outstanding common
shares of Capital Holdings. This transaction was tax-free and was
accounted for as a pooling of interest. The accompanying prior period
Condensed Consolidated Financial Statements of the Registrant have not
been restated for Capital Holdings due to immateriality.
On April 2, 2001, the Registrant completed the acquisition of Old Kent
Financial Corporation ("Old Kent"), a publicly-traded financial holding
company headquartered in Grand Rapids, Michigan. At December 31, 2000,
Old Kent had total assets of $23.8 billion and total deposits of $17.4
billion. In connection with this acquisition, the Registrant issued
7
Item 1. Notes to Condensed Consolidated Financial Statements (continued)
-------------------------------------------------------------------------
103,716,638 shares of Fifth Third common stock, 7,250 shares of Fifth Third
series D convertible perpetual preferred stock and 2,000 shares of Fifth
Third series E perpetual preferred stock to the shareholders of Old Kent.
This transaction was tax-free and was accounted for as a pooling of
interest. The accompanying prior period Condensed Consolidated Financial
Statements of the Registrant, have been restated to include the financial
results of Old Kent. Certain reclassifications were made to Old Kent's
financial statements to conform presentation. The summarized operating
results for the separate companies and the combined amounts presented in
the condensed consolidated financial statements follow:
Three Months Ended March 31, 2001
- ----------------------------------------------------------------------------------------------------------------------------
($000's) Fifth Third Old Kent Combined
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
Net Interest Income $ 392,935 $195,469 $ 588,404
Other Operating Income 292,492 120,688 413,180
Net Income 244,304 55,315 299,619
Three Months Ended June 30, 2000
- ----------------------------------------------------------------------------------------------------------------------------
($000's) Fifth Third Old Kent Combined
- ----------------------------------------------------------------------------------------------------------------------------
Net Interest Income $ 364,720 $195,929 $ 560,649
Other Operating Income 248,061 117,336 365,397
Net Income 192,088 55,685 247,773
Six Months Ended June 30, 2000
- ----------------------------------------------------------------------------------------------------------------------------
($000's) Fifth Third Old Kent Combined
- ----------------------------------------------------------------------------------------------------------------------------
Net Interest Income $ 728,164 $387,545 $1,115,709
Other Operating Income 488,224 233,024 721,248
Net Income 398,457 113,787 512,244
The combined results are not necessarily indicative of the results that
would have occurred had the acquisition been consummated in the past or
which might be attained in the future.
During the second quarter of 2001, the Registrant incurred merger-related
costs totaling $254,666,000 ($209,530,000 after tax, or $.36 per diluted
share) in connection with the Old Kent merger transaction. The significant
components of the second quarter merger charge include employee-related
costs of $72 million, professional fees of $45 million, credit quality
charges of $35 million, duplicate facilities and equipment of $38 million,
conversion costs of $32 million and $33 million of other merger-related
costs (including losses incurred on the sales of Old Kent's subprime
mortgage lending portfolio and small-ticket leasing portfolio in order to
align Old Kent with the Registrant's asset liability management policies).
As previously announced, additional merger-related charges will be incurred
in the second half of fiscal 2001 as the Registrant completes the remaining
conversions of Old Kent's Michigan operations, including headquarters and
back-office functions in Grand Rapids and the remaining rationalization of
Old Kent's mortgage banking business.
8
Item 1. Notes to Condensed Consolidated Financial Statements (continued)
- ------------------------------------------------------------------------
Employee-related costs include the severance packages negotiated with
approximately 1,400 people (including all levels of the previous Old Kent
organization from the executive management level to back office support
staff) and the change-in-control payments made pursuant to pre-existing
employment agreements. Employee-related payments made through June 30, 2001
totaled approximately $41 million, including payment to the approximate 400
people that have been terminated through June 30, 2001.
Credit quality charges relate to conforming Old Kent commercial and
consumer loans to the Registrant's credit policies. Specifically, these
loans were conformed to the Registrant's credit rating and review systems
as documented in the Registrant's credit policies. Commercial credit
quality charges largely relate to Old Kent concentrations in real estate
investment property lending and sub prime lending and their related
collateral quality valuations as well as Old Kent's overall higher
commercial lending authorities, as compared to the Registrant's standards.
Consumer credit quality charges largely relate to the application of the
Registrant's more conservative grading of high LTV loans and purchased home
equity loan portfolios. Based on the conforming ratings, reserves were
established based on the present value of expected future cash flows
discounted at the loan's effective interest rate or fair value of the
underlying collateral. The Registrant evaluated the collectibility of both
principal and interest in assessing the need for a loss accrual. During the
second quarter of 2001, the Registrant charged-off $35 million in loans
related to these factors.
Duplicate facilities and equipment charges of $38 million largely include
negotiated terminations of several office leases and writedowns of
duplicative software.
Conversion costs of $32 million include vendor contract termination costs
related to certain application systems and the conversion of affiliates and
banking centers in certain locations (including signage and all customer
relationships).
3. For the first six months of 2001, the Registrant paid $1,328,890,000 in
interest and paid $7,500,000 in Federal income taxes. For the same period
in 2000, the Registrant paid $1,282,428,000 in interest and paid
$96,444,000 in Federal income taxes. During the first six months of 2001
and 2000, the Registrant had noncash investing activities consisting of the
securitization of $1,782,911,000 and $1,120,261,000 of residential mortgage
loans, respectively.
4. Effective January 1, 2001, the Registrant adopted Statement of Financial
Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended, which establishes
accounting and reporting standards for derivative instruments and hedging
activities and requires recognition of all derivatives as either assets or
liabilities in the statement of financial condition and measurement of
those instruments at fair value. On the date the Registrant enters into a
derivative contract, the Registrant designates the derivative instrument as
either a fair value hedge, cash flow hedge or as a free-standing derivative
instrument. For a fair value hedge, changes in the fair value of the
derivative
9
Item 1. Notes to Condensed Consolidated Financial Statements (continued)
- ------------------------------------------------------------------------
instrument and changes in the fair value of the hedged asset or liability
or of an unrecognized firm commitment attributable to the hedged risk are
recorded in current period net income. For a cash flow hedge, changes in
the fair value of the derivative instrument to the extent that it is
effective are recorded in other comprehensive income within shareholders'
equity and subsequently reclassified to net income in the same period(s)
that the hedged transaction impacts net income.
For free-standing derivative instruments, changes in the fair values are
reported in current period net income. Prior to entering a hedge
transaction, the Registrant formally documents the relationship between
hedging instruments and hedged items, as well as the risk management
objective and strategy for undertaking various hedge transactions. This
process includes linking all derivative instruments that are designated as
fair value or cash flow hedges to specific assets and liabilities on the
balance sheet or to specific forecasted transactions along with a formal
assessment at both inception of the hedge and on an ongoing basis as to the
effectiveness of the derivative instrument in offsetting changes in fair
values or cash flows of the hedged item. If it is determined that the
derivative instrument is not highly effective as a hedge, hedge accounting
is discontinued and the fair value of the derivative instrument is recorded
in net income.
The Registrant maintains an overall interest rate risk management strategy
that incorporates the use of derivative instruments to minimize significant
unplanned fluctuations in earnings and cash flows caused by interest rate
volatility. The Registrant's interest rate risk management strategy
involves modifying the repricing characteristics of certain assets and
liabilities so that changes in interest rates do not adversely affect the
net interest margin and cash flows. Derivative instruments that the
Registrant uses as part of its interest rate risk management strategy
include interest rate and principal only swaps, interest rate floors,
forward contracts and both futures contracts and options on futures
contracts. Interest rate swap contracts are exchanges of interest payments,
such as fixed-rate payments for floating-rate payments, based on a common
notional amount and maturity date. Forward contracts are contracts in
which the buyer agrees to purchase and the seller agrees to make delivery
of a specific financial instrument at a predetermined price or yield.
Principal only ("PO") swaps are total return swaps based on the underlying
PO true value. Futures contracts are contracts that represent the
obligation to buy or sell a predetermined amount of debt subject to the
contracts specific delivery requirements at a predetermined date and a
predetermined price. Options on futures contracts represent the right but
not the obligation to buy or sell. The Registrant also enters into foreign
exchange contracts for the benefit of customers. By policy, the Registrant
hedges the exposure of these free-standing derivatives entered into for the
benefit of customers by entering into offsetting third-party forward
contracts with approved reputable counterparties with matching terms and
currencies that are generally settled daily. Risks arise from the possible
inability of counterparties to meet the terms of their contracts and from
any resultant exposure to movement in foreign currency exchange rates,
limiting the Registrant's exposure to the replacement value of the
contracts rather than the notional principal or contract amounts. Free-
standing derivatives also include derivative transactions entered into for
risk management purposes that do not otherwise qualify for hedge
accounting. The registrant will enter into interest rate swap agreements
with commercial clients and an unconsolidated qualifying special purpose
entity. The Registrant will hedge its interest rate exposure on these
transactions by executing offsetting swap agreements with primary dealers.
FAIR VALUE HEDGES - The Registrant enters into interest rate swaps to
convert its nonprepayable, fixed-rate long-term debt to floating-rate debt.
The Registrant's practice is to convert fixed-rate debt to floating-rate
debt. Decisions to convert fixed-rate debt to floating are made primarily
by consideration of the asset/liability mix of the Registrant, the
10
Item 1. Notes to Condensed Consolidated Financial Statements (continued)
-------------------------------------------------------------------------
desired asset/liability sensitivity and by interest rate levels. For the
quarter ended June 30, 2001, the Registrant met certain criteria required
to qualify for shortcut method accounting on its fair value hedges of this
type. Based on this shortcut method accounting treatment, no
ineffectiveness is assumed and fair value changes in the interest rate swap
are recorded as changes in the value of both swap and long term debt in the
Condensed Consolidated Balance Sheet. Additionally, the Registrant enters
into a combination of derivative instruments (PO swaps, floors, forward
contracts and interest rate swaps) to hedge changes in fair value of its
fixed rate mortgage servicing rights as it relates to changes in the
benchmark rate.
For the three and six months ended June 30, 2001, the Registrant recognized
a gain of $2.3 million and a loss of $5.5 million, respectively, in
noninterest income, which represents the ineffective portion of all fair
value hedges on mortgage servicing rights. As of June 30, 2001, there were
no instances of designated hedges no longer qualifying as fair value
hedges. The Registrant has approximately $329.8 million of fair value
hedges included in other assets in the June 30, 2001 Condensed Consolidated
Balance Sheet.
CASH FLOW HEDGES - The Registrant enters into interest rate swaps to
convert floating-rate liabilities to fixed rates. The liabilities are
typically grouped and share the same risk exposure for which they are being
hedged. As of June 30, 2001, $1.6 million in deferred losses related to
existing hedges were recorded in other comprehensive income. Gains and
losses on derivative contracts that are reclassified from cumulative other
comprehensive income to current period earnings are included in the line
item in which the hedged item's effect in earnings is recorded. As of June
30, 2001, $1.6 million in deferred losses on derivative instruments
included in other comprehensive income are expected to be reclassified into
earnings during the next twelve months. All components of each derivative
instrument's gain or loss are included in the assessment of hedge
effectiveness. Additionally, the Registrant enters into forward contracts
to hedge the forecasted sale of its mortgage loans. For the three months
ended June 30, 2001, the Registrant met certain criteria to qualify for
matched terms accounting on the hedged loans for sale. Based on this
treatment, fair value changes in the forward contracts are recorded as
changes in the value of both the forward contract and loans held for sale
in the Condensed Consolidated Balance Sheet. For the three months ended
June 30, 2001, there were no cash flow hedges that were discontinued
related to forecasted transactions deemed not probable of occurring. The
maximum term over which the Registrant is hedging its exposure to the
variability of future cash flows for all forecasted transactions, excluding
those forecasted transactions related to the payments of variable interest
in existing financial instruments, is five years for hedges converting
floating-rate loans to fixed and one year for hedges of forecasted sales of
mortgage loans. The Registrant has approximately $1.6 million of cash flow
hedges related to floating-rate liabilities included in other short-term
borrowings and $6.5 million of cash flow hedges related to loans held for
sale included in other assets in the June 30, 2001 Condensed Consolidated
Balance Sheet.
FREE-STANDING DERIVATIVE INSTRUMENTS - The Registrant enters into various
derivative contracts which primarily focus on providing derivative products
to customers. These derivative contracts are not linked to specific assets
and liabilities on the balance sheet or to forecasted transactions and,
therefore, do not qualify for hedge accounting. Additionally, interest rate
lock commitments issued on residential mortgage loans intended
11
Item 1. Notes to Condensed Consolidated Financial Statements (continued)
-------------------------------------------------------------------------
to be held for resale are considered free-standing derivative instruments.
The interest rate exposure on these commitments is economically hedged
primarily with forward contracts. The commitments and free-standing
derivative instruments are marked to market and recorded as a component of
mortgage banking noninterest income in the Condensed Consolidated Statement
of Income. For the three and six months ended June 30, 2001, the Registrant
recorded a gain of $4.9 million and $11 million, respectively, on foreign
exchange contracts for customers and a gain of $2.9 million and $2.7
million, respectively on the net change in interest rate locks and forward
contracts. The Registrant has approximately $2.6 million of free-standing
derivatives related to customer transactions included in accrued income
receivable and $3.8 million of free-standing derivatives related to
interest rate locks included in other assets in the June 30, 2001 Condensed
Consolidated Balance Sheet.
5. In September 2000, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities." The statement is effective for
transfers and servicing of financial assets occurring after March 31, 2001,
with certain disclosure and reclassification requirements effective for
financial statements for fiscal years ending after December 15, 2000.
Included in SFAS No. 140, which replaced SFAS No. 125 of the same name, are
the accounting and reporting standards related to securitizations and
Qualifying Special Purpose Entities ("QSPE"). The adoption of SFAS No. 140
did not have a material effect on the Registrant.
6. On July 20, 2001, the FASB issued SFAS No. 141, "Business Combinations",
and SFAS No. 142, "Goodwill and Other Intangible Assets." These Statements
make significant changes to the accounting for business combinations,
goodwill, and intangible assets. SFAS No. 141 eliminates the pooling of
interests method of accounting for business combinations with limited
exceptions for combinations initiated prior to July 1, 2001. In addition,
it further clarifies the criteria for recognition of intangible assets
separately from goodwill. This statement is effective for business
combinations completed after June 30, 2001. The Registrant has not yet
determined the impact of adopting this standard.
SFAS No. 142 discontinues the practice of amortizing goodwill and
indefinite lived intangible assets and initiates an annual review for
impairment. Impairment would be examined more frequently if certain
indicators are encountered. Intangible assets with a determinable useful
life will continue to be amortized over that period. The amortization
provisions apply to goodwill and intangible assets acquired after June 30,
2001. Goodwill and intangible asset balances at June 30, 2001 will be
affected when the Registrant adopts the Statement. The Registrant has not
yet determined the impact of adopting this standard.
In July 2001, the SEC issued Staff Accounting Bulletin ("SAB") No. 102
"Selected Loan Loss Allowance Methodology and Documentation Issues." This
bulletin further clarifies the staff's view on the development,
documentation and application of a systematic methodology for determining
allowances for loan and lease losses in accordance with generally accepted
accounting principles. The Registrant does not anticipate any material
changes to its existing methodology as a result of adoption of this
standard.
12
Item 1. Notes to Condensed Consolidated Financial Statements (continued)
-------------------------------------------------------------------------
7. In accordance with SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," the Registrant has determined its
principal segments to be retail banking, commercial banking, investment
advisory services and data processing. Retail banking provides a full range
of deposit products and consumer loans and leases. Commercial banking
offers services to business, government and professional customers.
Investment advisory services provides a full range of investment
alternatives for individuals, companies and not-for-profit organizations.
Data processing, through Midwest Payment Systems ("MPS"), provides
electronic funds transfer ("EFT") services, merchant transaction
processing, operates the Registrant's Jeanie ATM network and provides other
data processing services to affiliated and unaffiliated customers. General
corporate and other includes the investment portfolio, certain non-deposit
funding, unassigned equity, the net effect of funds transfer pricing and
other items not allocated to operating segments.
Total revenues exclude securities gains and losses. The Registrant did not
allocate resources or assess the ongoing operating performance of acquired
entities prior to acquisition. Therefore, financial information prior to
acquisition is shown separately as acquired entities. Following
acquisition, results of operations are included in the Registrant's segment
information for the acquired entities.
Results of operations and selected financial information by operating
segment for the three and six months ended June 30, 2001 and 2000 are as
follows:
Three Months Ended Investment General
June 30, Commercial Retail Advisory Data Acquired Corporate
($000's) Banking Banking Services Processing (a) Entities And Other Eliminations (a) Total
- ------------------------------------------------------------------------------------------------------------------------------------
2001
Total Revenues $280,074 $466,051 $103,137 $86,535 $ - $ 99,787 $ (5,833) $1,029,751
- ------------------------------------------------------------------------------------------------------------------------------------
Net Income $ 94,656 $114,386 $ 24,357 $23,859 $ - $(128,370) $ - $ 128,888
- ------------------------------------------------------------------------------------------------------------------------------------
2000
Total Revenues $157,281 $315,601 $ 63,267 $60,672 $313,255 $ 20,809 $ (4,689) $ 926,196
- ------------------------------------------------------------------------------------------------------------------------------------
Net Income $ 60,649 $102,865 $ 21,025 $18,921 $ 55,685 $ (11,372) $ - $ 247,773
- ------------------------------------------------------------------------------------------------------------------------------------
Six Months Ended Investment General
June 30, Commercial Retail Advisory Data Acquired Corporate
($000's) Banking Banking Services Processing (a) Entities And Other Eliminations (a) Total
- ------------------------------------------------------------------------------------------------------------------------------------
2001
Total Revenues $465,611 $785,182 $170,024 $158,971 $316,074 $142,679 $(11,525) $2,027,016
- ------------------------------------------------------------------------------------------------------------------------------------
Net Income $165,256 $216,619 $ 43,286 $ 46,780 $ 55,315 $(98,749) $ - $ 428,507
- ------------------------------------------------------------------------------------------------------------------------------------
Identifiable Assets
(in millions) $ 20,099 $ 26,240 $ 1,082 $ 307 $ - $ 22,106 $ - $ 69,834
- ------------------------------------------------------------------------------------------------------------------------------------
2000
Total Revenues $310,247 $613,891 $125,633 $115,020 $620,991 $ 60,089 $ (8,854) $1,837,017
- ------------------------------------------------------------------------------------------------------------------------------------
Net Income $122,013 $194,800 $ 39,878 $ 35,814 $113,787 $ 5,952 $ - $ 512,244
- ------------------------------------------------------------------------------------------------------------------------------------
Identifiable Assets
(in millions) $ 10,961 $ 15,415 $ 479 $ 92 $ 22,171 $ 17,777 $ - $ 66,895
- ------------------------------------------------------------------------------------------------------------------------------------
(a) Data Processing services revenues provided to the banking segments by MPS
are eliminated in the Consolidated Statements of Income.
13
Item 1. Notes to Condensed Consolidated Financial Statements (continued)
- ------------------------------------------------------------------------
8. The Registrant has elected to present the disclosures required by SFAS No.
130, "Reporting Comprehensive Income," in the Condensed Consolidated
Statement of Changes in Shareholders' Equity on page 6. The caption "Net
Income and Nonowner Changes in Equity" represents total comprehensive income
as defined in the statement. Disclosure of the reclassification adjustments
and related tax effects allocated to nonowner changes in equity and
accumulated nonowner changes in equity for the six months are as follows:
Six Months Ended
June 30,
($000's) 2001 2000
- -----------------------------------------------------------------------------------------------------------------------------
Reclassification Adjustments, Before Tax
- -----------------------------------------------------------------------------------------------------------------------------
Change in Unrealized Gains (Losses) Arising During Period $97,577 (43,612)
Reclassification Adjustment for (Gains) Losses Included in Net Income (7,107) 60
- -----------------------------------------------------------------------------------------------------------------------------
Net Unrealized Gains (Losses) on Securities Available for Sale $90,470 (43,552)
=============================================================================================================================
Related Tax Effects
- -----------------------------------------------------------------------------------------------------------------------------
Change in Unrealized Gains (Losses) Arising During Period $35,698 (15,985)
Reclassification Adjustment for (Gains) Losses Included in Net Income (2,137) 15
- -----------------------------------------------------------------------------------------------------------------------------
Net Unrealized Gains (Losses) on Securities Available for Sale $33,561 (15,970)
=============================================================================================================================
Reclassification Adjustments, Net of Tax
- -----------------------------------------------------------------------------------------------------------------------------
Change in Unrealized Gains (Losses) Arising During Period $61,879 (27,627)
Reclassification Adjustment for (Gains) Losses Included in Net Income (4,970) 45
- -----------------------------------------------------------------------------------------------------------------------------
Net Unrealized Gains (Losses) on Securities Available for Sale $56,909 (27,582)
=============================================================================================================================
Accumulated Nonowner Changes in Equity
- -----------------------------------------------------------------------------------------------------------------------------
Beginning Balance-Unrealized Holding Gains (Losses) on
Securities Available for Sale $28,012 (301,861)
Current Period Change 56,909 (27,582)
- -----------------------------------------------------------------------------------------------------------------------------
Ending Balance-Unrealized Holding Gains (Losses) on Securities
Available for Sale $84,921 (329,443)
=============================================================================================================================
14
Item 1. Notes to Condensed Consolidated Financial Statements (continued)
-------------------------------------------------------------------------
9. The reconciliation of earnings per share to earnings per diluted share
follows:
Three Months Ended June 30, 2001 2000
- -------------------------------------------------------------------------------------------------------------------------------
Net Average Per-Share Net Average Per-Share
($000's) Income Shares Amount Income Shares Amount
- -------------------------------------------------------------------------------------------------------------------------------
EPS
Net Income $128,888 $247,773
Less: Dividend on Preferred Stock 185 185
- -------------------------------------------------------------------------------------------------------------------------------
Income Available to Common Shareholders $128,703 574,545 $0.22 $247,588 566,272 $0.44
Effect of Dilutive Securities
Stock Options 10,965 7,860
Convertible Preferred Stock 145 308 145 308
Interest on 6% Convertible
Subordinated Debentures due 2028,
Net of Applicable Income Taxes 1,640 4,416 1,640 4,416
- -------------------------------------------------------------------------------------------------------------------------------
Earnings Per Diluted Share
Income Available to Common Shareholders
Plus Assumed Conversions $130,488 590,234 $0.22 $249,373 578,856 $0.43
===============================================================================================================================
Six Months Ended June 30, 2001 2000
- -------------------------------------------------------------------------------------------------------------------------------
Net Average Per-Share Net Average Per-Share
($000's) Income Shares Amount Income Shares Amount
- -------------------------------------------------------------------------------------------------------------------------------
EPS
Net Income $428,507 $512,244
Less: Dividend on Preferred Stock 370 370
- -------------------------------------------------------------------------------------------------------------------------------
Income Available to Common Shareholders $428,137 572,873 $0.75 $511,874 566,025 $0.91
Effect of Dilutive Securities
Stock Options 10,819 7,369
Convertible Preferred Stock 290 308 290 308
Interest on 6% Convertible
Subordinated Debentures due 2028,
Net of Applicable Income Taxes 3,280 4,416 3,280 4,416
- --------------------------------------------------------------------------------------------------------------------------------
Earnings Per Diluted Share
Income Available to Common Shareholders
Plus Assumed Conversions $431,707 588,416 $0.73 $515,444 578,118 $0.89
===============================================================================================================================
15
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- -------------------------------------------------------------------------------
of Operations
- -------------
The following is management's discussion and analysis of certain significant
factors which have affected the Registrant's financial condition and results of
operations during the periods included in the Condensed Consolidated Financial
Statements which are a part of this filing.
This report includes forward-looking statements within the meaning of Section
27A of the Securities Act of 1933, as amended, that involve inherent risks and
uncertainties. A number of important factors could cause actual results to
differ materially from those in the forward-looking statements. Those factors
include the economic environment, competition, products and pricing in
geographic and business areas in which the Registrant operates, prevailing
interest rates, changes in government regulations and policies affecting
financial services companies, credit quality and credit risk management, changes
in the banking industry including the effects of consolidation resulting from
possible mergers of financial institutions, acquisitions and integration of
acquired businesses. The Registrant undertakes no obligation to release
revisions to these forward-looking statements or reflect events or circumstances
after the date of this report.
Results of Operations
- ---------------------
The Registrant's operating earnings were $338.2 million for the second quarter
of 2001 and $644.4 million for the first six months of 2001, up 14 percent and
11 percent, respectively, compared to $296.7 million and $578.5 million for the
same periods last year. Operating earnings per diluted share were $.58 for the
second quarter, up 12 percent over last year's $.52, and $1.10 for the first six
months of 2001, up 9 percent from $1.01 for the same period last year.
Net interest income on a fully taxable equivalent basis for the second quarter
of 2001 was $619.4 million, an 8 percent increase over $572.8 million for the
same period last year, resulting principally from a 7.5 percent growth in
average interest-earning assets and a 2 basis points ("bp") increase in net
interest margin, from 3.74 percent during the second quarter of 2000 to 3.76
percent in the second quarter of 2001. For the six-month period, net interest
income on a fully taxable equivalent basis increased to $1.2 billion, or 7
percent, from the $1.1 billion reported in the same period last year, resulting
principally from a 7.5 percent growth in average interest-earning assets while
net interest margin remained constant at 3.78 percent. The negative effect of a
decline in the yield on average interest-earning assets of 60bp over second
quarter 2000 and 20bp over the first six months of 2000, was offset by a
decrease in funding costs of 55bp over second quarter 2000 and 10bp over the
first six months of 2000. The decline in funding costs was primarily due to the
repricing of borrowed funds and lower year-over-year deposit rates on existing
accounts.
The provision for credit losses was $25.6 million in the 2001 second quarter
compared to $35.3 million in the same period last year. Net charge-offs for the
quarter were $42.1 million compared to $26 million in the 2000 second quarter
and $48.4 million last quarter. Net charge-offs as a percent of average loans
and leases outstanding increased 13bp to .39 percent from .26 percent in the
same period last year. Nonperforming assets as a percentage of total loans,
leases and other real estate owned was .44 percent at June 30, 2001 compared to
.39 percent at June 30, 2000 and .52 percent last quarter. Underperforming
assets were $316.3 million at June 30, 2001, or .76 percent of total loans,
leases and other real estate owned, up 10bp compared to the
16
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- -------------------------------------------------------------------------------
of Operations (continued)
- -------------------------
$271.6 million, or .66 percent, at June 30, 2000 and the $332.1 million or .77
percent last quarter.
The Registrant maintains a reserve to absorb probable loan and lease losses
inherent in the portfolio. The reserve for credit losses is maintained at a
level the Registrant considers to be adequate to absorb probable loan and lease
losses inherent in the portfolio, based on evaluations of the collectibility and
historical loss experience of loans and leases. Credit losses are charged and
recoveries are credited to the reserve. Provisions for credit losses are based
on the Registrant's review of the historical credit loss experience and such
factors which, in management's judgement, deserve consideration under existing
economic conditions in estimating probable credit losses. The reserve is based
on ongoing quarterly assessments of the probable estimated losses inherent in
the loan and lease portfolio. In determining the appropriate level of reserves,
the Registrant estimates losses using a range derived from "base" and
"conservative" estimates. The Registrant's methodology for assessing the
appropriate reserve level consists of several key elements.
Larger commercial loans that exhibit potential or observed credit weaknesses are
subject to individual review. Where appropriate, reserves are allocated to
individual loans based on management's estimate of the borrower's ability to
repay the loan given the availability of collateral, other sources of cash flow
and legal options available to the Registrant. Included in the review of
individual loans are those that are impaired as provided in Statement of
Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment
of a Loan." Any reserves for impaired loans are measured based on the present
value of expected future cash flows discounted at the loan's effective interest
rate or fair value of the underlying collateral. The Registrant evaluates the
collectibility of both principal and interest when assessing the need for a loss
accrual. Historical loss rates are applied to other commercial loans not subject
to specific reserve allocations. The loss rates are derived from a migration
analysis, which computes the net charge-off experience sustained on loans
according to their internal risk grade. These grades encompass ten categories
that define a borrower's ability to repay their loan obligations.
Homogenous loans, such as consumer installment, residential mortgage loans, and
automobile leases are not individually risk graded. Reserves are established for
each pool of loans based on the expected net charge-offs for one year. Loss
rates are based on the average net charge-off history by loan category.
Historical loss rates for commercial and consumer loans may be adjusted for
significant factors that, in management's judgement, reflect the impact of any
current conditions on loss recognition. Factors which management considers in
the analysis include the effects of the national and local economies, trends in
the nature and volume of loans (delinquencies, charge-offs, nonaccrual and
problem loans), changes in the internal lending policies and credit standards,
collection practices, and examination results from bank regulatory agencies and
the Registrant's internal credit examiners.
An unallocated reserve is maintained to recognize the imprecision in estimating
and measuring loss when evaluating reserves for individual loans or pools of
loans. Reserves on individual loans and historical loss rates are reviewed
17
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- -------------------------------------------------------------------------------
of Operations (continued)
- -------------------------
quarterly and adjusted as necessary based on changing borrower and/or collateral
conditions and actual collection and charge-off experience.
The Registrant has not substantively changed any aspect to its overall approach
in the determination of the allowance for loan losses. There have been no
material changes in assumptions or estimation techniques as compared to prior
periods that impacted the determination of the current period allowance. The
overall decrease between periods in total non-performing and under-performing
assets was somewhat offset as a result of the consideration of historical loss
rates and did not materially affect the current period allowance. The overall
decrease in loan and lease balances outstanding as of June 30, 2001, combined
with the effect of securitizations, did, however, have a favorable impact on the
current period allowance.
Total other operating income, excluding securities gains, increased 15 percent
to $422 million compared to $365.5 million in the second quarter 2000, and
increased to $830.9 million for the first six months of 2001, or 15 percent over
the same period last year. Compared to the same periods in 2000, data processing
income increased 32 percent, to $78.4 million in the 2001 second quarter and 32
percent, to $147.9 million, in the six-month period. Increases in electronic
funds transfers ("EFT") and higher transaction volume from increased debit and
ATM card usage, coupled with expansion of business-to-business e-commerce,
contributed to the increase in data processing income.
Compared to the same periods in 2000, investment advisory income increased 14
percent to $80.4 million in the second quarter and 11 percent to $157.5 million
in the six month period. These increases reflect strong growth in personal trust
revenue and brokerage revenue on the strength of a more productive sales force
and increased market activity. Service charges on deposits increased 21 percent
over the same period last year and 18 percent for the six-month period primarily
due to continued sales success in treasury management services and Retail and
Commercial deposit campaigns. Other service charges and fees increased 22
percent over the same period last year, and 24 percent for the six-month period,
primarily due to increases in loan origination fees across nearly all categories
from continued strong loan demand. Compared to the same periods in 2000, for the
second quarter and six months ended June 30, 2001, commercial banking fees
increased 36 percent and 31 percent, credit card fees increased 22 percent and
18 percent, and loan and lease fees increased 31 percent and 23 percent,
respectively.
Operating earnings include a nonrecurring pretax merger-related charge of $254.7
million and $72.8 million in the second quarter of 2001 and 2000, respectively,
and $254.7 million and $99 million for the six months ended June 30, 2001 and
2000, respectively. These merger-related charges were incurred in connection
with Fifth Thirds's integration of Old Kent in 2001 and Old Kent's integration
of Grand Premier Financial, Inc. and Merchant Bancorp, Inc. in 2000. The merger-
related charges incurred in 2001 consist of employee-related costs of $72
million, professional fees of $45 million, credit quality charges of $35
million, duplicate facilities and equipment of $38 million, conversion costs of
$32 million and $33 million of other merger related costs. Excluding these
merger related charges, the efficiency ratio (operating expenses divided by the
sum of taxable equivalent net interest income and other operating income) was
49.3 percent for the second quarter of 2001 and 48.7 percent for the 2001 six-
month period. These ratios represent a slight decline from the 48.3 percent
achieved in the second quarter of 2000 and an improvement over the 49.1 percent
for the six months ended 2000. The slight decline in the second quarter
efficiency ratio was primarily due to increased operating expenses partially
offset by increased revenues, while the six month improvement was due to revenue
growth outpacing expense increases. Total operating expenses, excluding the
merger-related charges, increased to $513.1 million or 13 percent as compared to
the second quarter of 2000 and increased 9 percent to $998.5 million as compared
to the 2000 six-month period. Salaries, incentives and benefits increased 10
percent in the second quarter of 2001 and 6 percent during the six-month period
as compared to 2000. Net occupancy expense increased 11 percent during the
second quarter and 9 percent during the six-month period primarily due to rent
expense incurred, while total other operating expenses increased 22 percent in
the second quarter and 18 percent for the six-month period.
18
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- -------------------------------------------------------------------------------
of Operations (continued)
- ------------------------
Financial Condition
- -------------------
The Registrant's balance sheet remains strong with high-quality assets and solid
capital levels. Total assets were $69.8 billion at June 30, 2001 compared to
$69.7 billion at December 31, 2000 and $66.9 billion at June 30, 2000, an
increase of .3 percent and 4 percent, respectively. On an operating basis,
return on average equity was 18.9 percent and return on average assets was 1.89
percent for the second quarter of 2001 compared to 21.1 percent and 1.80
percent, respectively, for the same quarter of last year.
Net interest income growth continues to be fueled by interest-earning asset mix
and growth and an increase in net interest margin. Average interest-earning
assets increased to $66.2 billion for the second quarter of 2001, an increase of
$4.6 billion, or 7 percent, over the same period last year and 2000 year-end.
Average interest-earning assets increased primarily due to growth in commercial
loans and leases and consumer loans and leases.
Transaction account deposits grew 17 percent, or $3.9 billion, over the same
period last year and $2 billion, or 8 percent, over 2000 year-end. Deposits
growth during the period is primarily attributable to the success of promotional
campaigns emphasizing customer deposit accounts.
Liquidity and Capital Resources
- -------------------------------
The maintenance of an adequate level of liquidity is necessary to ensure
sufficient funds are available to meet customer loan demand and deposit
withdrawals. The banking subsidiaries' liquidity sources consist of short-term
marketable securities, maturing loans and federal funds loaned and selected
securitizable loan assets. Liquidity has also been obtained through liabilities
such as customer-related core deposits, funds borrowed, certificates of deposit
and public funds deposits.
At June 30, 2001, shareholders' equity was $7.1 billion compared to $5.8 billion
at June 30, 2000, an increase of $1.2 billion, or 21 percent. Shareholders'
equity as a percentage of total assets as of June 30, 2001 was 10.12 percent.
The Federal Reserve Board has adopted risk-based capital guidelines which assign
risk weightings to assets and off-balance sheet items and also define and set
minimum capital requirements (risk-based capital ratios). The guidelines also
define "well-capitalized" ratios of Tier 1, total capital and leverage as 6
percent, 10 percent and 5 percent, respectively. The Registrant exceeded these
"well-capitalized" ratios at June 30, 2001 and 2000. Estimated at June 30, 2001,
the Registrant had a Tier 1 risk-based capital ratio of 11.69 percent, a total
risk-based capital ratio of 13.77 percent and a leverage ratio of 9.28 percent.
At June 30, 2000, the Registrant had a Tier 1 risk-based capital ratio of 11.22
percent, a total risk-based capital ratio of 13.21 percent and a leverage ratio
of 9.08 percent.
Foreign Currency Exposure
- -------------------------
At June 30, 2001 and 2000, the Registrant maintained foreign office deposits of
$1.5 billion and $3.8 billion, respectively. These foreign deposits represent
U.S. dollar denominated deposits in our foreign branch located in the Cayman
Islands. In addition, the Registrant enters into foreign exchange derivative
contracts for the benefit of customers involved in international trade to hedge
their exposure to foreign currency fluctuations. By policy, the Registrant
enters into offsetting third-party forward contracts with approved reputable
counterparties with matching terms and currencies that are generally settled
daily.
19
Item 3. Quantitative and Qualitative Disclosures about Market Risk
- ------------------------------------------------------------------
Interest rate risk management focuses on maintaining consistent growth in net
interest income within Board-approved policy limits. The Registrant uses an
earnings simulation model to analyze net interest income sensitivity to
movements in interest rates. Given an immediate, sustained 200 basis point
upward shock to the yield curve used in the simulation model, it is estimated
net interest income for the Registrant would decrease by 2.22 percent over one
year and decrease by .86 percent over two years. A 200 basis point immediate,
sustained downward shock in the yield curve would decrease net interest income
by an estimated 6.95 percent over one year and decrease net interest income by
an estimated 4.49 percent over two years. For further discussion of the
Registrants' market risk see the Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and Market Risk,
included in the Annual Report on Form 10-K for the year ended December 31, 2000.
20
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
- -----------------------------------------
(a) List of Exhibits
(3)(i) Amended Articles of Incorporation, as amended, incorporated by
reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended March 31, 2001
(3)(ii) Code of Regulations, as amended, incorporated by reference to
the Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 2001
(b) Reports on Form 8-K
The Registrant filed a report on Form 8-K dated April 4, 2001 related
to 1) the consummation of the merger of Old Kent Financial Corporation
with and into Fifth Third Financial Corporation, a wholly-owned
subsidiary of Fifth Third Bancorp and 2) to include Old Kent's audited
financial information for each of the three years in the period ended
December 31, 2000.
The Registrant filed a report on Form 8-K/A dated April 17, 2001
related to the consummation of the merger of Old Kent Financial
Corporation with and into Fifth Third Financial Corporation, a wholly-
owned subsidiary of Fifth Third Bancorp. This report stated that
unaudited pro forma financial information for this transaction through
March 31, 2001 would be filed by an amendment.
21
Item 6. Exhibits and Reports on Form 8-K (continued)
- -----------------------------------------------------
The Registrant filed a report on Form 8-K dated June 1, 2001 related
to 1) quarterly and annual unaudited condensed financial statements
and supplemental financial data that include the effect of the
Registrant's acquisition of Old Kent Financial Corporation; and 2)
Regulation FD Disclosures to assist investors, financial analysts and
other interested parties in their analysis of the Registrant.
The Registrant filed a report on Form 8-K/A dated June 15, 2001
related to 1) the consummation of the merger of Old Kent Financial
Corporation with and into Fifth Third Financial Corporation, a wholly-
owned subsidiary of Fifth Third Bancorp, previously reported in Fifth
Third Bancorp's Current Report on Form 8-K filed with the SEC on April
4, 2001 and amended on April 17, 2001 and 2) to include unaudited pro
forma financial information for this transaction through March 31,
2001.
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.
Fifth Third Bancorp
-------------------
Registrant
Date: August 14, 2001 /s/ Neal E. Arnold
------------------
Neal E. Arnold
Executive Vice President and
Chief Financial Officer
22