ITEM 1. BUSINESS
General
Marshall & Ilsley Corporation (“M&I” or the “Corporation”), a Wisconsin corporation, is a registered bank holding company under the Bank Holding Company Act of 1956 (the “BHCA”) and is certified as a financial holding company under the Gramm-Leach-Bliley Act. As of December 31, 2010, M&I had consolidated total assets of approximately $50.8 billion and consolidated total deposits of approximately $38.3 billion, making M&I the largest bank holding company headquartered in Wisconsin. The executive offices of M&I are located at 770 North Water Street, Milwaukee, Wisconsin 53202 (telephone number (414) 765-7700). M&I’s principal assets are the stock of its bank and nonbank subsidiaries, which, as of February 15, 2011, consisted of four bank and trust subsidiaries and a number of companies engaged in businesses that the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) has determined to be closely-related or incidental to the business of banking. M&I provides its subsidiaries with financial and managerial assistance in such areas as budgeting, tax planning, auditing, compliance, asset and liability management, investment administration and portfolio planning, business development, advertising and human resources management.
M&I provides diversified financial services to a wide variety of corporate, institutional, government and individual customers. M&I’s largest affiliates and principal operations are in Wisconsin; however, it has activities in other markets, particularly in certain neighboring Midwestern states, and in Arizona, Nevada and Florida. The Corporation’s principal activities consist of banking and wealth management services.
M&I provides banking services, which include lending to and accepting deposits from commercial and community banking customers, through its lead bank, M&I Marshall & Ilsley Bank (“M&I Bank”), and M&I Bank FSB, a federal savings bank subsidiary of M&I located in Las Vegas, Nevada. M&I provides these services through branch offices of M&I’s subsidiary banks located throughout Wisconsin and Arizona, in western and central Florida, central Indiana, the metropolitan areas of Minneapolis, Minnesota, Kansas City, Missouri and St. Louis, Missouri, and Duluth, Minnesota, Belleville, Illinois, and Las Vegas, Nevada, and through the Internet.
Wealth Management includes Marshall & Ilsley Trust Company National Association (“M&I Trust Company”), M&I Financial Advisors, Inc. (“M&I Financial Advisors”), the private banking divisions of M&I’s bank subsidiaries and other subsidiaries related to the wealth management business. Wealth Management services include trust services, brokerage and insurance services, and investment management and advisory services, which are provided to residents of Wisconsin, Arizona, Minnesota, Missouri, Kansas, Florida, Nevada and Indiana.
Other financial services provided by M&I include personal property lease financing, wholesale lending, investment services to institutional clients and venture capital.
Based on the way M&I organizes its business, M&I has four reportable segments: Commercial Banking, Community Banking, Wealth Management and Treasury. Each of these segments is described in detail below. More information on M&I’s business segments is contained in Note 23 of the Notes to Consolidated Financial Statements contained in Item 8, Consolidated Financial Statements and Supplementary Data.
Commercial Banking
The Commercial Banking segment provides products and services to middle market businesses, large corporate businesses and public sector entities primarily within M&I’s footprint states. These products and services include: secured and unsecured loans and lines of credit, letters of credit, asset-based lending, equipment financing, mezzanine financing, global trade services, treasury management, demand deposit accounts, interest bearing accounts and time deposits. Commercial Banking also supports the commercial real estate market with products and services including secured and unsecured lines of credit, letters of credit, construction loans for commercial and residential development and land acquisition and development loans.
Community Banking
M&I’s Community Banking segment provides consumer and business banking products and services to customers primarily within the states in which M&I offers banking services. Community Banking services are provided through branches located throughout Wisconsin and Arizona, in western and central Florida, central Indiana, the metropolitan areas of Minneapolis, Minnesota, Kansas City, Missouri and St. Louis, Missouri, and Duluth,
Minnesota, Belleville, Illinois, and Las Vegas, Nevada, and through the Internet. Consumer products include loan and deposit products such as mortgages, home equity loans and lines, credit cards, student loans, personal lines of credit and term loans, demand deposit accounts, interest bearing transaction accounts and time deposits. Business banking products include secured and unsecured lines and term loans for working capital, inventory and general corporate use, commercial real estate construction loans, agricultural loans, demand deposit accounts, interest bearing transaction accounts and time deposits.
Wealth Management
The Wealth Management segment, which includes M&I’s trust, brokerage and private banking business, provides integrated asset management, trust and banking services through three business lines: Investment Management, Personal Services and Institutional Services. Investment Management is a multi-dimensional asset management service with a broad range of strategies, styles and product delivery options such as separately managed equity and fixed income strategies, managed asset allocation strategies, alternative investments and The Marshall Funds, M&I’s family of mutual funds. Personal Services includes Cedar Street Advisors, Personal Wealth Management and M&I Financial Advisors. Cedar Street Advisors manages the complex financial affairs of ultra-high net worth individuals and their families. Personal Wealth Management services assemble and implement an all-inclusive financial roadmap for high net worth individuals and families, providing for their private banking (credit and deposits), investment, estate and tax planning needs. M&I Financial Advisors uses a formulized financial planning process based on an individual’s resources, goals, and risk tolerance to develop a personalized financial plan, and then offers a full array of brokerage and insurance solutions to meet that plan. The Institutional Services business includes Retirement Plan Services, Taft-Hartley Services, Not-for-Profit Services, North Star Deferred Exchange and Trust Operations Outsourcing.
Treasury
Treasury provides management of interest rate risk, capital, liquidity, funding and investments to the Corporation and to all of its subsidiary banks.
Others
The Others segment includes a Capital Markets Division and a National Consumer Banking Division. The Capital Markets Division provides a variety of products and services designed to address its customers’ risk management and investment needs. These services include derivative solutions and investment services, currency conversion and foreign exchange services and risk management. These services are provided primarily to corporate, business banking and financial institution clients. The National Consumer Banking Division provides mortgage and home equity consumer lending, indirect automobile financing, and affinity banking services.
Risk Management
Managing risk is an essential component of successfully operating a financial services company. M&I has an enterprise-wide approach to risk governance, measurement, management and reporting risks inherent in its businesses. Risk management practices include key elements such as independent checks and balances, formal authority limits, policies and procedures and portfolio management. M&I’s internal audit department also evaluates risk management activities. These evaluations include performing internal audits and reporting the results to management and the Audit and Risk Management Committees, as appropriate.
M&I has established a number of management committees responsible for assessing and evaluating risks associated with the Corporation’s businesses including the Credit Policy Committee, Asset Liability Committee and the Enterprise Risk Committee. M&I has in place a Risk Management Committee of the Board of Directors for oversight and governance of its risk management function. The Risk Management Committee consists of four non-management directors and has the responsibility of overseeing management’s actions with respect to credit, market, liquidity, fiduciary, operational, compliance, legal and reputational risks as well as M&I’s overall risk profile. M&I’s Chief Risk Officer is responsible for reporting to the Risk Management Committee of the Board of Directors.
Operational Risk Management
Operational risk is the risk of loss from human errors, failed or inadequate processes or systems and external events. This risk is inherent in all businesses. Resulting losses could take the form of explicit charges, increased operational costs, harm to M&I’s reputation or lost opportunities.
M&I seeks to mitigate operational risk through a system of internal controls to manage this risk at appropriate levels. Primary responsibility for managing internal controls lies with the managers of M&I’s various business lines. M&I monitors and assesses the overall effectiveness of its system of internal controls on an ongoing basis. The Enterprise Risk Committee oversees M&I’s monitoring, management and measurement of operational risk. In addition, M&I has established several other executive management committees to monitor, measure and report on specific operational risks to the Corporation, including business continuity planning, customer information security and compliance. These committees report to the Risk Management Committee of the Board of Directors on a regular basis.
Corporate Governance Matters
M&I has adopted a Code of Business Conduct and Ethics that applies to all of M&I’s employees, officers and directors, including M&I’s Chief Executive Officer, Chief Financial Officer and Controller. The Code of Business Conduct and Ethics is incorporated as an exhibit to this report and is also available on M&I’s website at www.micorp.com. M&I intends to disclose any amendment to or waiver of the Code of Business Conduct and Ethics that applies to M&I’s Chief Executive Officer, Chief Financial Officer or Controller on its website within five business days following the date of the amendment or waiver.
M&I makes available free of charge through its website its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and its insiders’ Section 16 reports, and any amendments to these reports, as soon as reasonably practicable after these materials are filed with or furnished to the Securities and Exchange Commission (the “SEC”). In addition, certain documents relating to corporate governance matters are available on M&I’s website described above. These documents include, among others, the following:
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Charter for the Audit Committee of the Board of Directors;
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Charter for the Compensation and Human Resources Committee of the Board of Directors;
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Charter for the Nominating and Corporate Governance Committee of the Board of Directors;
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Categorical Standards for Lending, Banking and Other Business Relationships Involving M&I’s Directors;
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Corporate Governance Guidelines; and
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Code of Business Conduct and Ethics.
Shareholders also may obtain a copy of any of these documents free of charge by calling the M&I Shareholder Information Line at 1 (800) 642-2657. Information contained on any of M&I’s websites is not deemed to be a part of this Annual Report.
Pending Merger with BMO Financial Group
On December 17, 2010, the Corporation entered into a definitive merger agreement under which BMO Financial Group (“BMO” or “Bank of Montreal”) will acquire all outstanding shares of common stock of the Corporation in a stock-for-stock transaction. Under the terms of the agreement, each outstanding share of the Corporation’s common stock will be exchanged for 0.1257 shares of BMO common stock upon closing. The transaction is expected to close prior to July 31, 2011. The transaction is subject to customary closing conditions, including regulatory approvals and approval of the shareholders of M&I.
Acquisitions by M&I
M&I did not complete any acquisitions in 2010. Information on M&I’s acquisitions in previous years can be found in Note 6 of the Notes to Consolidated Financial Statements contained in Item 8, Consolidated Financial Statements and Supplementary Data.
Principal Sources of Revenue
The table below shows the amount and percentages of M&I’s total consolidated revenues resulting from interest and fees on loans and leases, interest on investment securities, and Wealth Management revenues, for each of the last three years ($ in thousands):
M&I business segment information is contained in Note 23 of the Notes to Consolidated Financial Statements contained in Item 8, Consolidated Financial Statements and Supplementary Data.
Competition
M&I and its subsidiaries face substantial competition from hundreds of competitors in the markets they serve, some of which are larger and have greater resources than M&I. M&I’s bank subsidiaries compete for deposits and other sources of funds and for credit relationships with other banks, savings associations, credit unions, finance companies, mutual funds, life insurance companies (and other long-term lenders) and other financial and non-financial companies located both within and outside M&I’s primary market areas, many of which offer products functionally equivalent to bank products. M&I’s nonbank operations compete with numerous banks, finance companies, leasing companies, mortgage bankers, brokerage firms, financial advisors, trust companies, mutual funds and investment bankers in Wisconsin and throughout the United States.
Employees
As of December 31, 2010, M&I and its subsidiaries employed, in the aggregate, 9,137 employees. M&I considers employee relations to be excellent. None of the employees of M&I or its subsidiaries are represented by a collective bargaining group.
Supervision and Regulation
As a registered bank holding company, M&I is subject to regulation and examination by the Federal Reserve Board under the BHCA. As of February 15, 2011, M&I owned a total of four bank and trust subsidiaries, including two Wisconsin state banks, a federal savings bank and a national banking association. M&I’s two Wisconsin state bank subsidiaries are subject to regulation and examination by the Wisconsin Department of Financial Institutions (the “DFI”), as well as by the Federal Reserve Board. M&I’s federal savings bank subsidiary is subject to regulation and examination by the Office of Thrift Supervision (“OTS”). M&I’s national bank, through which trust operations are conducted, is subject to regulation and examination by the Office of the Comptroller of the Currency. In addition, three of M&I’s four bank subsidiaries are subject to examination by the Federal Deposit Insurance Corporation (“FDIC”).
Under Federal Reserve Board policy, M&I is expected to act as a source of financial strength to each of its bank subsidiaries and to commit resources to support each bank subsidiary in circumstances when it might not do so absent such requirements. In addition, there are numerous federal and state laws and regulations which regulate the activities of M&I and its bank subsidiaries, including requirements and limitations relating to capital and reserve requirements, permissible investments and lines of business, transactions with officers, directors and affiliates, loan limits, consumer protection laws, privacy of financial information, predatory lending, mergers and acquisitions, issuances of securities, dividend payments, inter-affiliate liabilities, extensions of credit and branch banking. Information regarding capital requirements for bank holding companies and tables reflecting M&I’s regulatory capital position at December 31, 2010 can be found in Note 17 of the Notes to Consolidated Financial Statements contained in Item 8, Consolidated Financial Statements and Supplementary Data.
The federal regulatory agencies have broad power to take prompt corrective action if a depository institution fails to maintain certain capital levels. In addition, a bank holding company’s controlled insured depository institutions
are liable for any loss incurred by the FDIC in connection with the default of, or any FDIC-assisted transaction involving, an affiliated insured bank or savings association. Current federal law provides that adequately capitalized and managed bank holding companies from any state may acquire banks and bank holding companies located in any other state, subject to certain conditions. Banks are permitted to create interstate branching networks in all states. M&I Bank currently maintains interstate branches in Arizona, Florida, Indiana, Kansas, Minnesota and Missouri and an interstate branch in Illinois.
The laws and regulations to which M&I is subject are constantly under review by Congress, regulatory agencies and state legislatures.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law on July 21, 2010. Since the Dodd-Frank Act calls for federal regulatory agencies to adopt almost 250 new rules and conduct more than 60 studies over the next several years in order to implement its provisions, the ultimate impact of the legislation on M&I will not be known for many months or years. However, since many of the provisions apply to “systemically important” companies, including M&I, M&I will be subject to substantial new requirements and enhanced regulatory oversight. Management expects the impact of the new requirements on M&I to be significant.
While the Dodd-Frank Act contains numerous provisions that will in some way affect M&I, key provisions of the Dodd-Frank Act that M&I believes will have the most significant potential impact on M&I, M&I Bank and its other subsidiaries in the near- and long-term include:
Changes in FDIC insurance. The Dodd-Frank Act increases the FDIC’s minimum ratio of reserves to insured deposits and changes how deposit insurance premium assessments from the FDIC are calculated through provisions specifically designed to capture more deposit insurance premium income from the larger U.S. banks. These provisions will likely lead to higher FDIC insurance premiums for M&I Bank for the foreseeable future. The legislation also permanently increases federal deposit insurance coverage to $250,000.
Debit card transaction interchange fees. The Dodd-Frank Act directs the Federal Reserve Board to issue rules to ensure that small businesses and other merchants are charged only an amount “reasonable and proportional” to the cost incurred by payment processors and issuers of debit cards. These rules are likely to have a negative impact on M&I Bank’s debit card interchange fee income, though the extent of any such impact will not be known until the final rules are issued.
Restrictions on proprietary trading investments in private equity and hedge funds. With certain exceptions, the Dodd-Frank Act prohibits insured depositary institutions and their parent holding companies (including M&I and its banking subsidiaries) from engaging in proprietary trading, except for limited purposes, and from sponsoring or owning equity interests in private equity and hedge funds, subject to several exemptions, including a de minimis exemption that permits a banking entity to make investments in funds that are sponsored by the banking entity in an aggregate amount not exceeding 3% of the bank’s Tier 1 capital. M&I, M&I Bank and its other subsidiaries engage in only a de minimis amount of proprietary trading. M&I is currently evaluating the effect that these new restrictions will have on its investments in private equity and hedge funds, but this portfolio is relatively small. Furthermore, final regulations adopted by the Federal Reserve Board include a two-year conformance period following the effective date of the final regulations to wind down, sell or otherwise comply with these restrictions. Banking entities may also apply for three one-year extensions and, subject to certain requirements, may petition the Federal Reserve Board for an additional extended period with respect to any “illiquid fund.”
Regulation of derivatives. The Dodd-Frank Act imposes significant restrictions on the trading of derivatives, and provides for increased regulation by the SEC and the Commodities Futures Trading Commission of the over-the-counter derivative market. The Dodd-Frank Act will require bank holding companies to spin off certain riskier derivative trading activities to separately capitalized affiliates, while continuing to authorize perceived lower-risk derivative activities by banks to the extent these activities qualify as risk mitigating activities directly related to the bank’s activities. M&I does not currently expect these provisions to have a significant impact on its operations, though they may limit potential areas of expansion by M&I’s banking subsidiaries of their derivative activities, products and services.
Bank capital. The Collins Amendment in the Dodd-Frank Act affects the capital requirements for commercial banks, and includes a phased-in exclusion of trust preferred securities as an element of Tier 1 capital for certain bank holding companies. Bank holding companies, such as M&I, with total assets of $15 billion or more have three years to phase-out trust preferred securities from their Tier 1 capital, beginning January 1, 2013. At December 31, 2010, M&I
had $99.0 million in trust preferred securities outstanding. Preferred stock issued to the United States Department of the Treasury (the “UST”) under the Capital Purchase Program is exempt from the Collins Amendment and is includible in Tier 1 capital for all bank holding companies during its entire term.
Minimum Leverage and Risk-Based Capital Requirements. The Dodd-Frank Act mandates federal banking agencies to establish new minimum leverage and risk-based capital requirements for banks, bank holding companies, and “systemically important” non-banking companies. These new requirements must be established within 18 months of the Dodd-Frank Act’s effective date. While the Dodd-Frank Act does not provide any specific guidance on what the new capital levels should be, the law does provide that the capital levels currently in place should serve as a floor for any new capital requirements. Further, “systemically important companies,” including M&I, will be stress-tested at least annually by the Federal Reserve Board. Accordingly, M&I expects that these new “prudential standards” and stress-testing exercises will lead to higher capital requirements in the future. The new law further mandates regulators to adapt capital requirements as banks grow in size or engage in riskier activities, and codifies for the first time the requirement imposed by bank regulators that a bank holding company must serve as a “source of strength” or provider of funds to its subsidiary depository institutions, if deemed necessary by such regulators.
Consumer Financial Protection Bureau. The Dodd-Frank Act establishes the Consumer Financial Protection Bureau (“CFPB”) as a new independent executive agency within the Federal Reserve Board, empowered with broad authority to regulate the offering and provision of consumer financial products and services. The CFPB will have primary examination and enforcement authority over all insured banks with more than $10 billion in assets, including their affiliates, and will become the one central federal regulator with consolidated consumer protection authority for such banks. The CFPB will have authority to require reports and conduct examinations of the largest depository institutions to assess compliance with federal consumer financial laws, to obtain information about activities and compliance systems, and to detect and assess risks to consumers and markets for consumer financial products and services.
The Dodd-Frank Act also directs the CFPB to prevent persons from engaging in or committing an unfair, deceptive or abusive act or practice in connection with a transaction with a consumer for a consumer financial product or service, or the offering thereof, to ensure that “fair disclosures” are provided to consumers, and that information relevant to the purchase of consumer products or services is disclosed to the consumer in plain language in a manner that permits consumers to understand the costs, benefits, and risks associated with the product or service.
Generally, M&I believes that its compliance costs and burdens will increase substantially as a result of the creation of the CFPB and the new rules it is expected to implement for consumer financial products and services.
Insurance for noninterest-bearing transaction accounts. Under the Dodd-Frank Act, beginning December 31, 2010 (the termination date for the Transaction Account Guarantee Program (the “TAGP”), a component of the FDIC’s Temporary Liquidity Guarantee Program in which M&I was formerly a participant) and continuing through December 31, 2012, all funds held in noninterest-bearing transaction accounts will be fully guaranteed by the FDIC for the full amount of the account. This unlimited insurance coverage was eliminated for Interest on Lawyer Trust Accounts and minimal interest-bearing NOW accounts, which were originally covered under TAGP. However, subsequent to the enactment of the Dodd-Frank Act, Congress amended the Federal Deposit Insurance Act to include Interest on Lawyer Trust Accounts within the definition of “noninterest-bearing transaction accounts,” thereby granting such accounts unlimited insurance coverage by the FDIC from December 31, 2010 through December 31, 2012.
Corporate governance and executive compensation. The Dodd-Frank Act contains a number of provisions relating to corporate governance and executive compensation practices and disclosure. These include, among others, “say on pay,” which is a nonbinding shareholder vote on executive compensation; disclosure of so-called golden parachute arrangements; clawback provisions to recover erroneously awarded executive compensation; provisions relating to the independence and composition of compensation committees; and provisions requiring disclosure of the relationship between executive compensation and company performance, and the ratio of mean employee compensation to CEO compensation. Pursuant to authority granted it under the Dodd-Frank Act, the SEC recently issued rules relating primarily to executive compensation matters. A number of additional rules are to be adopted later in 2011. M&I will take any necessary actions to comply with the applicable requirements as they take effect.
In 1999, Congress enacted the Gramm-Leach-Bliley Act (the “GLB Act”). Among other things, the GLB Act repealed certain restrictions on affiliations between banks and securities firms. The GLB Act also amended the BHCA to permit bank holding companies that qualify as “financial holding companies” to engage in a broad list of “financial
activities,” and any non-financial activity that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines is “complementary” to a financial activity and poses no substantial risk to the safety and soundness of depository institutions or the financial system. The GLB Act treats various lending, insurance underwriting, insurance company, portfolio investment, financial advisory, securities underwriting, dealing and market-making, and merchant banking activities as financial in nature for this purpose.
Under the GLB Act, a bank holding company may become certified as a financial holding company by filing a notice with the Federal Reserve Board, together with a certification that the bank holding company meets certain criteria, including capital, management, and Community Reinvestment Act requirements. M&I has registered as a financial holding company.
The Federal Reserve Board has authority to prohibit bank holding companies from paying dividends if it deems such payment to be an unsafe or unsound practice. The Federal Reserve Board has indicated generally that it may be an unsafe or unsound practice for a bank holding company to pay dividends unless the company’s net income is sufficient to fund the dividends and the company’s expected rate of earnings retention is consistent with its capital needs, asset quality and overall financial condition. M&I depends, in part, upon dividends received from its subsidiary banks to fund its activities, including the payment of dividends. These subsidiary banks are subject to regulatory limitations on the amount of dividends they may pay.
In October 2008, Congress enacted the Emergency Economic Stabilization Act of 2008 (the “EESA”). Among other things, the EESA enabled the federal government to insure troubled assets, including mortgage-backed securities, and collect premiums from participating financial institutions. Under the EESA, the UST authorized a voluntary capital purchase program (“CPP”) to purchase up to $250 billion of senior preferred shares of qualifying financial institutions that elected to participate.
On November 14, 2008, as part of the Corporation’s participation in the CPP, the Corporation entered into a Letter Agreement with the UST. Pursuant to the Securities Purchase Agreement - Standard Terms (the “Securities Purchase Agreement”) attached to the Letter Agreement, the Corporation sold 1,715,000 shares of the Corporation’s Senior Preferred Stock, Series B (the “Senior Preferred Stock”), having a liquidation preference of $1,000 per share, for a total purchase price of $1,715 million. The Senior Preferred Stock qualifies as Tier 1 capital and pays cumulative compounding dividends at a rate of 5% per year for the first five years and 9% per year thereafter.
Under the terms of the Securities Purchase Agreement, as long as any Senior Preferred Stock is outstanding, the Corporation may pay quarterly common stock cash dividends of up to $0.32 per share, and may redeem or repurchase its common stock, provided that all accrued and unpaid dividends for all past dividend periods on the Senior Preferred Stock are fully paid. Prior to the third anniversary of the UST’s purchase of the Senior Preferred Stock, unless Senior Preferred Stock has been redeemed or the UST has transferred all of the Senior Preferred Stock to third parties, the consent of the UST will be required for the Corporation to increase its common stock dividend to more than $0.32 per share per quarter or repurchase its common stock or other equity or capital securities, other than in connection with benefit plans consistent with past practice and certain other circumstances specified in the Securities Purchase Agreement. The Senior Preferred Stock is non-voting except for class voting rights on matters that would adversely affect the rights of the holders of the Senior Preferred Stock.
As a condition to participating in the CPP, the Corporation issued and sold to the UST a warrant (the “Warrant”) to purchase 13,815,789 shares (the “Warrant Shares”) of the Corporation’s common stock, at an initial per share exercise price of $18.62, for an aggregate purchase price of approximately $257.25 million. The term of the Warrant is ten years. The Warrant is no longer subject to any contractual restrictions on transfer. The Warrant provides for the adjustment of the exercise price and the number of Warrant Shares issuable upon exercise pursuant to customary anti-dilution provisions, such as upon stock splits or distributions of securities or other assets to holders of the Corporation’s common stock, and upon certain issuances of the Corporation’s common stock at or below a specified price range relative to the initial exercise price. Pursuant to the Securities Purchase Agreement, the UST has agreed not to exercise voting power with respect to any shares of common stock issued upon exercise of the Warrant.
Pursuant to the Securities Purchase Agreement, until the UST no longer owns any shares of the Senior Preferred Stock, the Warrant or Warrant Shares, the Corporation’s employee benefit plans and other executive compensation arrangements for its Senior Executive Officers must continue to comply in all respects with Section 111(b) of the Emergency Economic Stabilization Act and the rules and regulations of the UST promulgated thereunder.
The Securities Purchase Agreement permits the UST to unilaterally amend any provision of the Letter Agreement and the Securities Purchase Agreement to the extent required to comply with any changes in the applicable Federal statutes.
In addition to federal and state banking laws and regulations, M&I and certain of its subsidiaries and affiliates, including those that engage in securities brokerage, dealing and investment advisory activities, are subject to other federal and state laws and regulations, and to supervision and examination by other regulatory authorities, including the SEC, the Financial Institution Regulatory Authority (FINRA), the New York Stock Exchange and others.
In 2001, Congress enacted the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”). The USA PATRIOT Act was designed to deny terrorists and criminals the ability to obtain access to the United States financial system, and has significant implications for depository institutions, brokers, dealers and other businesses involved in the transfer of money. The USA PATRIOT Act mandates financial services companies to implement additional policies and procedures with respect to, or additional measures designed to address, any or all of the following matters, among others: money laundering, terrorist financing, identifying and reporting suspicious activities and currency transactions, and currency crimes.
M&I’s banking subsidiaries are also subject to a variety of other regulations with respect to the operation of their businesses, including, but not limited to, the Truth in Lending Act, the Truth in Savings Act, the Equal Credit Opportunity Act, the Electronic Funds Transfer Act, the Fair Housing Act, the Home Mortgage Disclosure Act, the Fair Debt Collections Practices Act and the Fair Credit Reporting Act. Changes in these or similar regulations could affect the operations of the banking subsidiaries.
The earnings and business of M&I and its banking subsidiaries also are affected by the general economic and political conditions in the United States and abroad and by the monetary and fiscal policies of various federal agencies. The Federal Reserve Board impacts the competitive conditions under which M&I operates by determining the cost of funds obtained from money market sources for lending and investing and by exerting influence on interest rates and credit conditions. In addition, legislative and economic factors can be expected to have an ongoing impact on the competitive environment within the financial services industry. The impact of fluctuating economic conditions and federal regulatory policies on the future profitability of M&I and its subsidiaries cannot be predicted with certainty.
Selected Statistical Information
Statistical information relating to M&I and its subsidiaries on a consolidated basis is set forth as follows:
(1)
Average Balance Sheets and Analysis of Net Interest Income for each of the last three years is included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
(2)
Analysis of Changes in Interest Income and Interest Expense for each of the last two years is included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
(3)
The amortized cost of the consolidated investment securities for each of the last three years is included in Item 6, Selected Financial Data.
(4)
The maturities of consolidated investment securities, at amortized cost, and the weighted average yields for each range of maturities as of the end of the latest reporting period are included in Item 6, Selected Financial Data.
(5)
The end of period loans and leases by type for each of the last five years is included in Item 6, Selected Financial Data.
(6)
The maturities of selected categories of the loan portfolio, including those loans due after one year which have predetermined interest rates or have floating or adjustable rates are included in Item 6, Selected Financial Data.
(7)
Information regarding the Corporation’s short-term borrowings, including amounts outstanding and weighted average interest rate for certain categories, can be found in Liquidity and Capital Resources which is included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
(8)
Nonaccrual, Past Due and Restructured Loans and Leases for each of the last five years is included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
(9)
Potential Problem Loans and Leases for the last two years can be found in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
(10)
Summary of Loan and Lease Loss Experience for each of the last five years (including the allocation of the allowance for loans and leases) is included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
(11)
Average Deposits for selected categories and the average rate paid for each category for each of the last three years is included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
(12)
Return on Average Shareholders’ Equity, Return on Average Assets and other statistical ratios for each of the last five years can be found in Item 6, Selected Financial Data.
ITEM 1A.
ITEM 1A. RISK FACTORS
The Corporation is subject to a number of risks that may adversely affect its financial condition and results of operations. Many of these risks are outside of the Corporation's direct control. In addition to the other information included or incorporated by reference into this report, readers should carefully consider the following important factors which, among others, could materially impact the Corporation's business, financial condition and results of operations.
Risks Related to the Corporation’s Pending Merger with BMO
On December 17, 2010, the Corporation entered into a definitive merger agreement under which BMO will acquire all outstanding shares of the Corporation’s common stock in a stock-for-stock transaction. There can be no assurance that the merger with BMO will be completed. In connection with the pending merger, certain additional risks and uncertainties should also be considered, including, without limitation:
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attrition of deposits and customers, operating costs and business disruption before and following the completion of the pending merger, including potential difficulties in maintaining relationships with employees, may be greater than expected;
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the inability to obtain governmental approvals of the pending merger on the proposed terms and schedule; and
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the failure of the Corporation’s shareholders to approve the pending merger and/or the failure of the parties to complete the merger on the proposed terms and schedule.
Federal and state agency regulation and enforcement actions could limit the Corporation’s activities, increase the Corporation’s cost structures or have other negative effects on the Corporation.
The Corporation, its subsidiary banks and many of its non-bank subsidiaries are heavily regulated at the federal and state levels. This regulation is designed primarily to protect consumers, depositors and the banking system as a whole, not shareholders. Congress and state legislatures and federal and state regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in their interpretation or implementation, could affect the Corporation in substantial and unpredictable ways, including limiting the types of financial services and products the Corporation may offer, increasing the ability of non-banks to offer competing financial services and products and/or increasing the Corporation’s cost structures.
The Federal Reserve Board and the Office of the Comptroller of the Currency have issued policy statements generally requiring insured banks and bank holding companies only to pay dividends out of current operating earnings. On February 24, 2009, the Federal Reserve Board released supervisory letter SR 09-4 (the “SR 09-4”) to provide direction to bank holding companies on, among other things, the declaration and payment of dividends. SR 09-4 states that, as a general matter, a bank holding company should inform the Federal Reserve and should eliminate, defer or significantly reduce its dividends if (i) the bank holding company’s net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends, (ii) the bank holding company’s prospective rate of earnings is not consistent with the bank holding company’s capital needs
and overall current and prospective financial condition, or (iii) the bank holding company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. It is possible that the Corporation will determine or will be required under SR 09-4 to eliminate, defer or significantly reduce the dividends on its common stock, the Senior Preferred Stock, or both. In addition, the Corporation is currently required to obtain the prior approvals of the Federal Reserve and the DFI to pay a cash dividend on its common stock. There can be no assurance that the Corporation will be able to obtain such approvals in future quarters. The inability of the Corporation to continue to pay dividends on its common stock or on the Senior Preferred Stock could have a material adverse effect on the trading price of the Corporation’s common stock and could have consequences under the Letter Agreement relating to the Corporation’s participation in the UST’s Capital Purchase Program.
Federal and state regulators also have the ability to impose substantial restrictions and requirements on the Corporation’s bank and non-bank subsidiaries to the extent they determine that the Corporation or its subsidiaries have violated laws to which they are subject or have weaknesses or failures with respect to general standards of safety or soundness. Enforcement of these restrictions may be formal or informal, and can include directors’ resolutions, memoranda of understanding, written agreements, cease and desist orders, civil money penalties or termination of deposit insurance and bank closures. Certain enforcement actions are not publicly disclosed by federal and state regulators. While enforcement actions may be taken without regard to the capital level of an institution, institutions that are not sufficiently capitalized in accordance with regulatory standards may also face capital directives or prompt corrective action. Enforcement actions may require corrective steps, impose limits on activities such as acquisitions, branching, lending or deposit taking, prescribe lending parameters or require additional capital to be raised, any of which could adversely affect the Corporation’s financial condition and results of operations, damage the Corporation’s reputation, cause it to incur significant expenses or restrict it from engaging in potentially profitable activities.
The Corporation’s earnings are significantly affected by general business and economic conditions, including credit risk and interest rate risk.
The Corporation’s business and earnings are sensitive to general business and economic conditions in the United States and, in particular, the states where it has significant operations, including Wisconsin, Arizona, Indiana, Minnesota, Missouri, Kansas and Florida. M&I Bank FSB, a subsidiary of the Corporation, is headquartered in Nevada, but its activities are primarily outside of Nevada and it has no significant exposure to economic conditions in that state. The general business and economic conditions described above include short-term and long-term interest rates, inflation, monetary supply, fluctuations in both debt and equity capital markets, the strength of the U.S. and local economies, real estate values, consumer spending, borrowing and saving habits, all of which are beyond the Corporation’s control. For example, an economic downturn, increase in unemployment or higher interest rates could decrease the demand for loans and other products and services and/or result in a deterioration in credit quality and/or loan performance and collectability. Nonpayment of loans could have an adverse effect on the Corporation’s financial condition and results of operations and cash flows. Higher interest rates also could increase the Corporation’s cost to borrow funds and increase the rate the Corporation pays on deposits.
The Corporation’s real estate loans expose the Corporation to increased credit risks.
A substantial portion of the Corporation’s loan and lease portfolio consists of real estate-related loans, including construction and development, commercial and residential mortgage loans, as well as home equity loans and lines of credit. As a result, the deterioration in the U.S. real estate markets, along with the deterioration in the U.S. economy as a whole, has led to an increase in nonperforming loans and charge-offs, and the Corporation has had to increase its allowance for loan and lease losses. In addition, lower property values have resulted in lower values for collateral securing some of these loans. Further deterioration in the commercial or residential real estate markets and in the U.S. economy would increase the Corporation’s exposure to real estate-related credit risk and cause the Corporation to further increase its allowance for loan and lease losses, all of which would have a material adverse effect on the Corporation’s financial condition and results of operations.
Various factors may cause the Corporation’s allowance for loan and lease losses to increase.
The Corporation’s allowance for loan and lease losses represents management’s estimate of probable losses inherent in the Corporation’s loan and lease portfolio. Management evaluates the allowance each quarter to determine that it is adequate to absorb these inherent losses. This evaluation is supported by a methodology that identifies estimated losses based on assessments of individual problem loans and historical loss patterns of homogeneous loan pools. In addition, environmental factors unique to each measurement date are also considered, including economic conditions in certain geographic or industry segments of the loan portfolio, economic trends, risk profile and portfolio
composition. The determination of the appropriate level of the allowance for loan and lease losses is highly subjective and requires management to make significant estimates of current credit risks and future trends, all of which may undergo material changes. If actual losses exceed the estimate, the excess losses could adversely affect the Corporation’s net income and capital. Such excess losses may require an increase in the allowance for loan and lease losses. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, many of which are outside of the Corporation’s control, may also require an increase in the allowance for loan and lease losses. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the adequacy of the Corporation’s allowance for loan and lease losses. These agencies may require the Corporation to establish additional allowances for loan and lease losses based on their judgment of the information available at the time of their examinations. Any increase in the allowance for loan and lease losses will result in a decrease in net income and capital, and would have a material adverse effect on the Corporation’s financial condition and results of operations. The Corporation cannot provide any assurance that it will not sustain losses in excess of its allowance for loan and lease losses or that the Corporation will not be required to increase such allowance.
A failure by the Corporation to maintain required levels of capital could have a material adverse effect on the Corporation.
Banking regulations require the Corporation to maintain adequate levels of capital, in order to support its operations and fund outstanding liabilities. Furthermore, given current economic conditions, bank regulators expect banks to maintain capital levels well above statutory requirements. Each of the Corporation’s subsidiary banks is required, or expected, to maintain specific capital levels. If any of the subsidiary banks fails to maintain the required, or expected, capital levels, the subsidiary banks could be subject to various sanctions by federal regulators that could adversely impact the Corporation. Such sanctions could potentially include, without limitation, the termination of deposit insurance by the FDIC, limitations on the subsidiary banks’ ability to pay dividends to the Corporation and the issuance of a capital directive by a federal regulatory authority requiring an increase in capital.
The Corporation’s ability and the ability of its subsidiary banks to raise additional capital, if needed, may be impaired by changes and trends in the capital markets that are outside the Corporation’s control. Accordingly, there can be no assurance that the Corporation or its subsidiary banks will be able to raise additional capital, if needed, on terms acceptable to the Corporation or its subsidiary banks.
The Dodd-Frank Act will have a significant impact on the business and operations of the Corporation and its banking subsidiaries and will substantially increase their cost of doing business, which could, in turn, have a material adverse effect on the Corporation’s results of operations and financial condition.
It is anticipated that the Corporation, including some or all of its banking subsidiaries, will become subject to the following provisions of the Dodd-Frank Act, any or all of which may directly or indirectly increase their costs of doing business, in some cases materially:
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increased federal deposit insurance premiums to fund shortfalls in the FDIC’s deposit insurance fund;
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provisions designed to address perceived industry-wide deficiencies in the residential mortgage loan underwriting process, in part by creating new documentation requirements and underwriting criteria, and increasing the Corporation’s and its banking subsidiaries’ potential liability to their customers if they fail to take steps to ensure and document that each borrower has the capacity and ability to repay their loans;
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increased regulatory oversight of our consumer lending functions through the establishment of the Consumer Financial Protection Bureau; and
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increasingly strict rules for capital, leverage, liquidity, risk management and other requirements applicable to large bank holding companies.
In addition, certain provisions of the Dodd-Frank Act will restrict and/or prohibit the Corporation and/or M&I Bank from engaging in certain business activities, such as proprietary trading, private equity investments and certain hedging activities. There can be no assurance that such restrictions and prohibitions will not have a material adverse effect on the Corporation’s business, financial condition and results of operations.
A significant proportion of the Dodd-Frank Act’s provisions will not become effective until the various federal bank and other regulatory agencies propose and issue regulations to give effect to those provisions. The
Corporation will continue to conduct its banking and other operations and make strategic decisions about its business during this period of legal and regulatory uncertainty consistent with existing federal and state law and the Dodd-Frank Act. There can be no assurance that the Corporation’s or its banking subsidiaries business decisions and strategic initiatives made in response to the applicable provisions of the Dodd-Frank Act, or in anticipation of the scope, content and application of the regulations under the Dodd-Frank Act, will be the correct decisions that will enable them to conduct business in a competitive manner, or that their competitors will not implement strategic initiatives to address or minimize the cost of complying with the Dodd-Frank Act or the regulations that will be more successful than those employed by the Corporation or its banking subsidiaries.
The Corporation expects that compliance with the Dodd-Frank Act and the rules and regulations that will be adopted thereunder may create significant additional costs to its operations and those of M&I Bank and may negatively impact their competitive position, which could have a material adverse effect on the Corporation’s business, financial condition and results of operations.
There can be no assurance that legislation enacted to help stabilize the U.S. financial system will be effective in doing so.
The Emergency Economic Stabilization Act of 2008 (the “EESA”) was signed into law in 2008 in response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions. Pursuant to the EESA, the UST was granted the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. The UST announced a Capital Purchase Program (the “CPP”) under the EESA pursuant to which has purchased and will continue to purchase senior preferred stock in participating financial institutions. On November 14, 2008, the Corporation entered into a Letter Agreement, and the related Securities Purchase Agreement - Standard Terms attached thereto, with the UST providing for the issuance to the UST of the Corporation’s Senior Preferred Stock, Series B and a warrant to purchase shares of the Corporation’s common stock at a specified price.
On February 17, 2009, the American Recovery and Reinvestment Act (the “ARRA”) was signed into law. The purpose of the ARRA is to make supplemental appropriations for job preservation and creation, infrastructure investment, energy efficiency and science, assistance to the unemployed, and state and local fiscal stabilization.
On July 21, 2010, the Dodd-Frank Act was signed into law. The purpose of the Dodd-Frank Act is to promote the financial stability of the United States by improving accountability and transparency in the financial system, to protect consumers from abusive financial services practices, and for other purposes. The provisions of the Dodd-Frank Act that are most likely to affect the Corporation are described elsewhere in this report.
There can be no assurance as to the actual impact that these legislative initiatives will have on the financial markets or on the Corporation. The failure of these programs to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect the Corporation’s business, financial condition, results of operations, access to credit or the trading price of the Corporation’s common stock.
The failure of other financial institutions could adversely affect the Corporation.
The Corporation’s ability to engage in funding transactions could be adversely affected by the actions and failure of other financial institutions. Financial institutions are interrelated as a result of trading, clearing, counterparty or other relationships. The Corporation has exposure to many different industries and counterparties, and routinely executes transactions with counterparties in the financial industry, including brokers and dealers, commercial banks, investment banks, insurers, mutual and hedge funds, and other institutional clients. As a result, defaults by, or even questions or rumors about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by the Corporation or other institutions. Many of these transactions expose the Corporation to credit risk in the event of default of its counterparty or client. In addition, the Corporation’s credit risk may be exacerbated when collateral it holds cannot be relied upon or is liquidated at prices not sufficient to recover the full amount of exposure of the Corporation. Any such losses could materially and adversely affect the Corporation’s results of operations.
Current levels of market volatility are unprecedented.
The capital and credit markets have been experiencing volatility and disruption since 2008. Recently, this volatility and disruption has reached unprecedented levels, and in many cases has produced downward pressure on stock prices and credit availability for certain issuers without regard to the underlying financial strength of those
issuers. If current levels of market disruption and volatility continue or worsen, there can be no assurance that such conditions will not have a material adverse effect on the Corporation’s business, financial condition and results of operations.
The Corporation’s stock price can be volatile.
The Corporation’s stock price can fluctuate widely in response to a variety of factors, including the factors described elsewhere in these Risk Factors and the following additional factors:
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actual or anticipated variations in the Corporation’s quarterly results;
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changes or contemplated changes in government regulations;
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unanticipated losses or gains due to unexpected events, including losses or gains on securities held for investment purposes;
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credit quality ratings;
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new technology or services offered by the Corporation’s competitors;
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significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving the Corporation or its competitors;
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changes in accounting policies or practices;
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failure to successfully integrate the Corporation’s acquisitions or realize anticipated benefits from the Corporation’s acquisitions; or
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announcements or events that affect the price of shares of BMO common stock.
Changes in the Corporation’s credit ratings could adversely affect the Corporation’s liquidity and financial condition.
The credit ratings of the Corporation and its subsidiaries are important factors in the Corporation’s ability to access certain types of liquidity. A downgrade in the credit ratings of the Corporation or any of its subsidiaries could potentially increase the cost of debt, limit the Corporation’s access to capital markets, require the Corporation to post collateral, or negatively impact the Corporation’s profitability. Furthermore, a downgrade of the credit rating of securities issued by the Corporation or its subsidiaries could adversely affect the ability of the holders to sell those securities.
Sales or other dilution of the Corporation’s equity may adversely affect the market price of the Corporation’s common stock.
During 2009, the Corporation issued a significant number of shares of its common stock. The issuance of these additional shares of common stock resulted in a material increase of outstanding shares of common stock at December 31, 2009, compared with December 31, 2008, and those additional shares were significantly dilutive to existing common shareholders. The Corporation continually evaluates opportunities to access capital markets, taking into account its regulatory capital ratios, financial condition, and other relevant conditions. Subject to market conditions, it is possible that the Corporation may take further capital actions.
Terrorism, acts of war, international conflicts and natural disasters could negatively affect the Corporation’s business and financial condition.
Acts or threats of war or terrorism, international conflicts (including conflict in the Middle East), natural disasters, and the actions taken by the U.S. and other governments in response to such events, could disrupt business operations and negatively impact general business and economic conditions in the U.S. If terrorist activity, acts of war, other international hostilities or natural disasters disrupt business operations, trigger technology delays or failures, or damage physical facilities of the Corporation, its customers or service providers, or cause an overall economic decline, the financial condition and operating results of the Corporation could be materially adversely affected. The potential for future occurrences of these events has created many economic and political uncertainties that could seriously harm the Corporation’s business and results of operations in ways that cannot presently be predicted.
The Corporation’s earnings also are significantly affected by the fiscal and monetary policies of the federal government and its agencies, which could affect repayment of loans and thereby materially adversely affect the Corporation.
The policies of the Federal Reserve Board impact the Corporation significantly. The Federal Reserve Board regulates the supply of money and credit in the United States. Its policies directly and indirectly influence the rate of interest earned on loans and paid on borrowings and interest-bearing deposits and can also affect the value of financial instruments the Corporation holds. Those policies determine to a significant extent the Corporation’s cost of funds for lending and investing. Changes in those policies are beyond the Corporation’s control and are difficult to predict. Federal Reserve Board policies can affect the Corporation’s borrowers, potentially increasing the risk that they may fail to repay their loans. For example, a tightening of the money supply by the Federal Reserve Board could reduce the demand for a borrower’s products and services. This could adversely affect the borrower’s earnings and ability to repay its loan, which could materially adversely affect the Corporation.
The banking and financial services industry is highly competitive, which could adversely affect the Corporation’s financial condition and results of operations.
The Corporation operates in a highly competitive environment in the products and services the Corporation offers and the markets in which the Corporation serves. The competition among financial services providers to attract and retain customers is intense. Customer loyalty can be easily influenced by a competitor’s new products, especially offerings that provide cost savings to the customer. Some of the Corporation’s competitors may be better able to provide a wider range of products and services over a greater geographic area.
The Corporation believes the banking and financial services industry will become even more competitive as a result of legislative, regulatory and technological changes and the continued consolidation of the industry. Technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic funds transfer and automatic payment systems. Also, investment banks and insurance companies are competing in more banking businesses such as syndicated lending and consumer banking. Many of the Corporation’s competitors are subject to fewer regulatory constraints and have lower cost structures. The Corporation expects the consolidation of the banking and financial services industry to result in larger, better-capitalized companies offering a wide array of financial services and products.
The Corporation is subject to examinations and challenges by tax authorities, which, if not resolved in the Corporation’s favor, could adversely affect the Corporation’s financial condition and results of operations and cash flows.
In the normal course of business, the Corporation and its affiliates are routinely subject to examinations and challenges from federal and state tax authorities regarding the amount of taxes due in connection with investments it has made and the businesses in which it is engaged. Recently, federal and state taxing authorities have become increasingly aggressive in challenging tax positions taken by financial institutions. These tax positions may relate to tax compliance, sales and use, franchise, gross receipts, payroll, property and income tax issues, including tax base, apportionment and tax credit planning. The challenges made by tax authorities may result in adjustments to the timing or amount of taxable income or deductions or the allocation of income among tax jurisdictions. If any such challenges are made and are not resolved in the Corporation’s favor, they could have an adverse effect on the Corporation’s financial condition and results of operations and cash flows.
Consumers may decide not to use banks to complete their financial transactions, which could result in a loss of income to the Corporation.
Technology and other changes are allowing parties to complete financial transactions that historically have involved banks at one or both ends of the transaction. For example, consumers can now pay bills and transfer funds directly without banks. The process of eliminating banks as intermediaries, known as disintermediation, could result in the loss of fee income, as well as the loss of customer deposits and income generated from those deposits.
Maintaining or increasing the Corporation’s market share depends on market acceptance and regulatory approval of new products and services and other factors, and the Corporation’s failure to achieve such acceptance and approval could harm its market share.
The Corporation’s success depends, in part, on its ability to adapt its products and services to evolving industry standards and to control expenses. There is increasing pressure on financial services companies to provide products and services at lower prices. This can reduce the Corporation’s net interest margin and revenues from its fee-
based products and services. In addition, the Corporation’s success depends in part on its ability to generate significant levels of new business in its existing markets and in identifying and penetrating new markets. Growth rates for card-based payment transactions and other product markets may not continue at recent levels. Further, the widespread adoption of new technologies, including Internet-based services, could require the Corporation to make substantial expenditures to modify or adapt its existing products and services or render the Corporation’s existing products obsolete. The Corporation may not successfully introduce new products and services, achieve market acceptance of its products and services, develop and maintain loyal customers and/or break into targeted markets.
The Corporation relies on dividends from its subsidiaries for most of its revenue, and the Corporation’s banking subsidiaries hold a significant portion of their assets indirectly.
The Corporation is a separate and distinct legal entity from its subsidiaries, and receives substantially all of its revenue from dividends from its subsidiaries. These dividends are the principal source of funds to pay dividends on the Corporation’s common stock and interest on its debt. The payment of dividends by a banking subsidiary is subject to federal law restrictions and to the laws of the subsidiary’s state of incorporation, and payment of dividends by M&I Bank is subject to prior approval of the Federal Reserve and the DFI, and with respect to M&I Bank FSB, the OTS. In addition, a parent company’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors. Furthermore, the Company’s banking and federal savings bank subsidiaries hold a significant portion of their mortgage loan and investment portfolios indirectly through their ownership interests in direct and indirect subsidiaries.
The inability of the Corporation’s banking subsidiaries to pay dividends to the Corporation for any of the reasons described above could have a material adverse effect on the Corporation’s financial condition and results of operations.
The Corporation depends on the accuracy and completeness of information about customers and counterparties, and inaccurate or incomplete information could negatively impact the Corporation’s financial condition and results of operations.
In deciding whether to extend credit or enter into other transactions with customers and counterparties, the Corporation may rely on information provided to it by customers and counterparties, including financial statements and other financial information. The Corporation may also rely on representations of customers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit to a business, the Corporation may assume that the customer’s audited financial statements conform to generally accepted accounting principles ("GAAP") and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. The Corporation may also rely on the audit report covering those financial statements. The Corporation’s financial condition and results of operations could be negatively impacted to the extent it relies on financial statements that do not comply with GAAP or that are materially misleading.
An interruption or breach in security of the Corporation’s or the Corporation’s third party service providers’ communications and information technologies could have a material adverse effect on the Corporation’s business.
The Corporation relies heavily on communications and information technology to conduct its business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in the Corporation’s customer relationship management, general ledger, deposit, loan and other systems. Despite the Corporation’s policies and procedures designed to prevent or limit the effect of such a failure, interruption or security breach of its information systems, there can be no assurance that any such events will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of the Corporation’s information systems could damage the Corporation’s reputation, result in a loss of customers or customer business, subject the Corporation to additional regulatory scrutiny, or expose the Corporation to civil litigation and possible financial liability, any of which could have a material adverse effect on the Corporation’s financial condition and results of operations.
In addition, the Corporation relies on third-party service providers for a substantial portion of its communications, information, operating and financial control systems technology. If any of these third-party service providers experiences financial, operational or technological difficulties or if there is any other disruption in the Corporation’s relationships with them, the Corporation may be required to locate alternative sources for these services. There can be no assurance that the Corporation could negotiate terms as favorable to the Corporation or obtain services with similar functionality as it currently has without the expenditure of substantial resources, if at all. Any of these circumstances could have a material adverse effect the Corporation’s business.
The Corporation’s accounting policies and methods are the basis of how the Corporation reports its financial condition and results of operations, and they may require management to make estimates about matters that are inherently uncertain.
The Corporation’s accounting policies and methods are fundamental to how the Corporation records and reports its financial condition and results of operations. The Corporation’s management must exercise judgment in selecting and applying many of these accounting policies and methods in order to ensure that they comply with GAAP and reflect management’s judgment as to the most appropriate manner in which to record and report the Corporation’s financial condition and results of operations. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which might be reasonable under the circumstances yet might result in the Corporation’s reporting materially different amounts than would have been reported under a different alternative.
The Corporation has identified three accounting policies as being “critical” to the presentation of its financial condition and results of operations because they require management to make particularly subjective and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These critical accounting policies relate to: (1) the allowance for loan and lease losses, (2) income taxes, and (3) fair value measurements. Because of the inherent uncertainty of estimates about these matters, no assurance can be given that the application of alternative policies or methods might not result in the Corporation’s reporting materially different amounts.
Changes in accounting standards could adversely affect the Corporation’s reported financial results.
The bodies that set accounting standards for public companies, including the Financial Accounting Standards Board (“FASB”), the SEC and others, periodically change or revise existing interpretations of the accounting and reporting standards that govern the way that the Corporation reports its financial condition and results of operations. These changes can be difficult to predict and can materially impact the Corporation’s reported financial results. In some cases, the Corporation could be required to apply a new or revised accounting standard, or a new or revised interpretation of an accounting standard, retroactively, which could have a negative impact on reported results or result in the restatement of the Corporation’s financial statements for prior periods.
The Corporation is dependent on senior management, and the loss of the services of any of the Corporation’s senior executive officers could cause the Corporation’s business to suffer.
The Corporation’s continued success depends to a significant extent upon the continued services of its senior management. The loss of services of any of the Corporation’s senior executive officers could cause the Corporation’s business to suffer. In addition, the Corporation’s success depends in part upon senior management’s ability to implement the Corporation’s business strategy.
The Corporation may be a defendant in a variety of litigation and other actions, which may have a material adverse effect on its business, operating results and financial condition.
The Corporation and its subsidiaries may be involved from time to time in a variety of litigation arising out of the Corporation’s business. The Corporation’s insurance may not cover all claims that may be asserted against it, and any claims asserted against the Corporation, regardless of merit or eventual outcome, may harm the Corporation’s reputation. Should the ultimate judgments or settlements in any litigation exceed the Corporation’s insurance coverage, they could have a material adverse effect on the Corporation’s business, operating results and financial condition and cash flows. In addition, the Corporation may not be able to obtain appropriate types or levels of insurance in the future, nor may the Corporation be able to obtain adequate replacement policies with acceptable terms, if at all.
If the Corporation’s share distribution and transactions related to the separation of the Corporation and its data processing subsidiary formerly known as Metavante Corporation in November 2007 do not qualify as tax-free distributions or reorganizations under the Internal Revenue Code, then the Corporation and the Corporation’s shareholders may be responsible for payment of significant U.S. federal income taxes.
In transactions related to the separation of the Corporation and its data processing subsidiary formerly known as Metavante Corporation in November 2007, old M&I distributed shares of its common stock to effect the separation. If the share distribution does not qualify as a tax-free distribution under Section 355 of the Internal Revenue Code, Metavante Corporation’s successor entity would recognize a taxable gain that would result in significant U.S. federal income tax liabilities to Metavante Corporation’s successor entity. Metavante Corporation’s successor entity would be primarily liable for these taxes and the Corporation would be secondarily liable. Under the terms of a tax allocation agreement related to the separation, the Corporation will generally be required to
indemnify against any such taxes unless such taxes would not have been imposed but for an act of Metavante Corporation’s successor entity, subject to specified exceptions.
Even if the Corporation’s share distribution otherwise qualifies as a tax-free distribution under Section 355 of the Internal Revenue Code, the distribution would result in significant U.S. federal income tax liabilities to Metavante Corporation’s successor entity if there is an acquisition of the Corporation’s common stock or the stock of Metavante Corporation’s successor entity as part of a plan or series of related transactions that includes the Corporation’s share distribution and that results in an acquisition of 50% or more of such stock. In this situation, the Corporation may be required to indemnify Metavante Corporation’s successor entity under the terms of a tax allocation agreement related to the separation unless such taxes would not have been imposed but for specified acts of Metavante Corporation’s successor entity. In addition, mutual indemnity obligations in the tax allocation agreement could discourage or prevent a third party from making a proposal to acquire the Corporation.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES
M&I and M&I Bank occupy offices on all or portions of 15 floors of a 21-story building located at 770 North Water Street, Milwaukee, Wisconsin. M&I Bank owns the building and its adjacent 10-story parking lot and leases the remaining floors to a professional tenant. In addition, various subsidiaries of M&I lease commercial office space in downtown Milwaukee office buildings near the 770 North Water Street facility. M&I Bank also owns or leases various branch offices throughout Wisconsin, as well as 182 branch offices among the Phoenix and Tucson, Arizona metropolitan areas, the St. Louis metropolitan area, Kansas City and nearby communities, Florida’s west coast and Orlando, Florida, Minneapolis/St. Paul and Duluth, Minnesota, and central Indiana. M&I Bank of Mayville, a special limited purpose subsidiary of M&I located in Mayville, Wisconsin, and M&I Bank FSB, a federal savings bank subsidiary of M&I located in Las Vegas, Nevada with one office in Milwaukee, Wisconsin, occupy modern facilities which are leased.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
On December 17, 2010, the Corporation and BMO announced that they had entered into a definitive merger agreement under which BMO will acquire all outstanding shares of common stock of the Corporation in a stock-for-stock transaction which is referred to as the “pending merger”.
Eight putative class action complaints have been filed in the Circuit Court of Milwaukee County, Wisconsin against the Corporation, its directors, and BMO relating to the Corporation’s pending merger with BMO: Berens v. Marshall & Ilsley Corp., et al., Case No. 10CV021273; Ohlgart v. Marshall & Ilsley Corp., et al., Case No. 10CV021485; Sayeg v. Marshall & Ilsley Corp., et al., Case No. 10CV021622; Schindler v. Marshall & Ilsley Corp., et al., Case No. 10CV021528; Stadler v. Marshall & Ilsley Corp., et al., Case No. 10CV021676; Onwudebe v. Marshall & Ilsley Corp., et al., Case No. 10CV021742; Anthony v. Marshall & Ilsley Corp., et al., Case No. 11CV000338; and Drummond v. Marshall & Ilsley Corp., et al., Case No. 11CV000380. Each of these complaints names the Corporation and the members of the Corporation’s board of directors as defendants and alleges that the Corporation’s directors breached their fiduciary duties to its shareholders. Each of the complaints except the Onwudebe action also names BMO as a defendant and alleges that BMO aided and abetted the alleged breach of fiduciary duty. In addition, the Anthony action names Gregory A. Smith, the Corporation’s Senior Vice President and Chief Financial Officer, as a defendant and alleges that Mr. Smith breached fiduciary duties to the Corporation’s shareholders.
Two putative class actions have been filed in the United States Court for the Eastern District of Wisconsin relating to the merger: Fruchter v. Marshall & Ilsley Corp., et al., No. 10-cv-01157, and Folisi v. Marshall & Ilsley Corp., et al., No. 11-cv-00025. These complaints allege that the Corporation and its directors breached fiduciary duties to the Corporation’s shareholders and that BMO aided and abetted such breaches.
All ten lawsuits seek, among other things, to enjoin completion of the merger and an award of costs and attorneys’ fees. Certain of the actions also seek the imposition of a constructive trust for benefits allegedly improperly received by the defendants and/or an accounting of damages sustained as a result of the alleged breaches of fiduciary duty. The state court actions were consolidated on February 11, 2011 by stipulation of the parties to these actions. The stipulation and proposed order of consolidation is pending approval by the Wisconsin state court.
At this early stage of the state court lawsuits, it is not possible for management of the Corporation to assess the probability of a material adverse outcome or reasonably estimate the amount of any potential loss at this time. The Corporation intends to vigorously defend the state court lawsuits.
In April 2010, two substantially identical putative class action lawsuits were filed in the United States District Court for the Eastern District of Wisconsin against the Corporation, the M&I Retirement Plan Investment Committee, and certain of the Corporation’s officers and directors. The lawsuits were purportedly filed on behalf of M&I Retirement Program, three other retirement savings plans and a class of former and current participants in those plans, relating to the holdings of Corporation common stock during the period from November 10, 2006 to December 17, 2009. The complaints, which were consolidated into a single complaint in July 2010, allege breaches of fiduciary duties in violation of the Employee Retirement Income Security Act (ERISA) relating to Corporation common stock being offered as an investment alternative for participants in the retirement plans and seek monetary damages. At this early stage of the lawsuit, it is not possible for management of the Corporation to assess the probability of a material adverse outcome or reasonably estimate the amount of any potential loss at this time. The Corporation intends to vigorously defend this lawsuit.
In June 2010, M&I Bank was named as a defendant in a putative class action alleging that M&I Bank’s posting of debit card transactions is a breach of the implied obligation of good faith and fair dealing, is a breach of the Wisconsin Consumer Act, is unconscionable, constitutes conversion, and unjustly enriches the Corporation. The plaintiffs allege that the daily high to low postings of debit card entries, rather than chronological postings, results in excessive overdraft fees. The plaintiffs seek to represent a nationwide class for all of the claims except that involving the Wisconsin Consumer Act, for which it seeks to represent a class of Wisconsin customers of M&I Bank. The lawsuit, while initially filed in the United States District Court for the Middle District of Florida, has been transferred for pretrial purposes in a multi-district litigation (“MDL”) proceeding in the Southern District of Florida, in which numerous other putative class actions against financial institutions asserting similar claims are pending. The consolidation in the MDL is for pre-trial discovery and motion proceedings. The Corporation has filed a motion to compel the plaintiffs to arbitrate the dispute. This motion is pending. At this early stage of the lawsuit, it is not possible for management of the Corporation to assess the probability of a material adverse outcome or reasonably estimate the amount of any potential loss at this time. M&I Bank intends to vigorously defend this lawsuit.
ITEM 4.
ITEM 4. RESERVED
Executive Officers of the Marshall & Ilsley Corporation
(Ages as of March 1, 2011)
Name of Officer
Office
Richard C. Becker
Age 59
Senior Vice President since October 2010 of Marshall & Ilsley Corporation; Executive Vice President since October 2010, and Senior Vice President from January 2008 to October 2010 of M&I Marshall & Ilsley Bank.
Ann M. Benschoter
Age 53
Senior Vice President since December 2008 of Marshall & Ilsley Corporation; Executive Vice President since December 2008, Senior Vice President since December 2001, and Vice President since August 1998 of M&I Marshall & Ilsley Bank; Director and Vice President of SWB Holdings, Inc.; Director, Marshall & Ilsley Trust Company National Association, M&I Bank of Mayville, M&I Equipment Finance Company, M&I Business Credit, LLC, M&I Private Equity Group II, LLC, and Water Street Land, LLC.
Walt A. Buckhanan
Age 49
Vice President and Director of Corporate Diversity since December 2007 of Marshall & Ilsley Corporation; Senior Vice President from April 2008, Vice President of Diversity and Inclusion Management from 2004 to 2007, Vice President and Strategic Sales Manager from February 2003 to 2004 of M&I Marshall & Ilsley Bank.
Patricia M. Cadorin
Age 57
Vice President since June 2001 and Director of Corporate Communications since July 2002 of Marshall & Ilsley Corporation; Senior Vice President of M&I Marshall & Ilsley Bank since June 2005; and Vice President of M&I Foundation.
Bradley D. Chapin
Age 50
Senior Vice President since October 2010 of Marshall & Ilsley Corporation; Executive Vice President since October 2010, Senior Vice President from April 2010 to October 2010 and Vice President/Regional President from January 2005 to April 2010 of M&I Marshall & Ilsley Bank.
Ryan R. Deneen
Age 46
Senior Vice President, Director of Corporate Tax of Marshall & Ilsley Corporation since December 2003; Director and President of M&I Business Credit Holdings, Inc., Manager of M&I MEDC Fund, LLC, Director, Vice President and Treasurer of Milease, LLC, President and Secretary of M&I Marshall & Ilsley Holdings II, Inc.
Thomas R. Ellis
Age 53
Executive Vice President since October 2010, Senior Vice President from February 2005 to October 2010 of Marshall & Ilsley Corporation; President since October 2010, Executive Vice President from February 2005 to October 2010, Senior Vice President from 1998 to February 2005 of M&I Marshall & Ilsley Bank; Director of Marshall & Ilsley Trust Company National Association, M&I Equipment Finance Company, M&I Financial Advisors, Inc. and M&I Insurance Services, Inc.
Randall J. Erickson
Age 51
Senior Vice President, General Counsel since June 2002, Chief Administrative Officer since April 2007, and Corporate Secretary from June 2002 to April 2007 of Marshall & Ilsley Corporation; General Counsel since June 2002, and Corporate Secretary from June 2002 to April 2007 of M&I Marshall & Ilsley Bank; Director, Vice President and Treasurer of M&I Private Equity Group LLC; Director, Vice President and Secretary of M&I Ventures, L.L.C. and TCH MI Holding Company, Inc.; Director of M&I Bank FSB, M&I Community Development Corporation, M&I Investment Partners Management, LLC; Director and Secretary of M&I Private Equity Group II, LLC; Director and Vice President of SWB Holdings, Inc.; Successor Administrator of Gold Banc Trust III, Gold Banc Trust IV, Gold Banc Trust V, Trustcorp Statutory Trust I, EBC Statutory Trust I, EBC Statutory Trust II and First Indiana Capital Statutory Trust II. Also a director of Renaissance Learning Inc. (Nasdaq: RLRN), a provider of computer-based assessment technology for K-12 schools.
Name of Officer
Office
Mark F. Furlong
Age 53
Chairman of the Board since October 2010; Chief Executive Officer since April 2007, President since April 2005, Executive Vice President from January 2002 to April 2005, Senior Vice President from April 2001 to January 2002, and Chief Financial Officer from February 2007 to June 2007 and April 2001 to October 2004 of the Company; Chairman of the Board since December 2009, Director since July 2004, Chief Executive Officer since April 2007, and President from July 2004 to October 2010 of M&I Marshall & Ilsley Bank; Director and Vice President of M&I Private Equity Group LLC; Director, Vice President and Treasurer of M&I Ventures L.L.C.; Director of Marshall & Ilsley Trust Company National Association and Milease, LLC. Also a director of Kforce Inc., a professional staffing firm, Wisconsin Manufacturers & Commerce, Greater Milwaukee Committee, Metropolitan Milwaukee Association of Commerce, United Performing Arts Fund and Junior Achievement of Wisconsin. A Director since April 2006.
Patricia R. Justiliano
Age 60
Senior Vice President since 1994 and Corporate Controller since April 1989, Vice President from 1986 to 1994 of Marshall & Ilsley Corporation; Senior Vice President since April 2006, Vice President from January 1999 to April 2006, Controller since September 1998 of M&I Marshall & Ilsley Bank; Director, President and Treasurer of M&I Marshall & Ilsley Holdings, Inc., M&I Marshall & Ilsley Investment II Corporation, M&I Zion Investment II Corporation, M&I Zion Holdings. Inc. and SWB of St. Louis Holdings, Inc.; Director and President of M&I Marshall & Ilsley Regional Holdings, Inc.; Director and Treasurer of M&I Mortgage Reinsurance Corporation; Director of M&I Bank FSB, M&I Bank of Mayville, M&I Marshall & Ilsley Investment Corporation, M&I Servicing Corp., M&I Zion Investment Corporation, M&I Custody of Nevada, Inc. and Louisville Realty Corporation; Vice President and Treasurer of TCH MI Holding Company, Inc.; Manager of SWB of St. Louis Holdings I, LLC and SWB of St. Louis Holdings II, LLC; and Trustee of SWB Investment II Corporation.
Beth D. Knickerbocker
Age 44
Senior Vice President, Chief Risk Officer since January 2005, Vice President, Senior Compliance Counsel from May 2004 to January 2005 of Marshall & Ilsley Corporation.
Kenneth C. Krei
Age 61
Senior Vice President of Marshall & Ilsley Corporation since July 2003; Chairman of the Board since January 2005, President and Chief Executive Officer of Marshall & Ilsley Trust Company National Association since July 2003; Chairman of the Board since January 2005, and Chief Executive Officer of M&I Investment Management Corp. since July 2003; Director and President of M&I Investment Partners Management, LLC and M&I Investment Partners TALF Fund, L.P.; Chairman and Director of M&I Financial Advisors, Inc., M&I Insurance Services, Inc., M&I Distributors LLC, and Marshall Funds; Director and Vice President of M&I Realty Advisors, Inc., and Management Committee Member of Taplin, Canida & Habacht, LLC.
Thomas J. O’Neill
Age 50
Senior Vice President since April 1997 of Marshall & Ilsley Corporation; Executive Vice President since 2000, Senior Vice President from 1997 to 2000, Vice President from 1991 to 1997 of M&I Marshall & Ilsley Bank; Chairman, Director and Chief Executive Officer of M&I Bank FSB; Director and President of M&I Mortgage Reinsurance Corporation; Director and Vice President of M&I Community Development Corporation and M&I Realty Advisors, Inc.; Director of M&I Bank of Mayville, M&I Dealer Finance, Inc., Regional Holding Company, Inc. and Louisville Realty Corporation; and Manager of M&I MEDC Fund, LLC.
Paul J. Renard
Age 50
Senior Vice President, Director of Human Resources since 2000, Vice President and Manager since 1994 of Marshall & Ilsley Corporation; Senior Vice President of M&I Marshall & Ilsley Bank; and Vice President and Assistant Secretary of TCH MI Holding Company, Inc.
Name of Officer
Office
John L. Roberts
Age 58
Senior Vice President of Marshall & Ilsley Corporation since 1994; Executive Vice President since 2009; Senior Vice President since 1994, Vice President and Controller from 1986 to 1995 of M&I Marshall & Ilsley Bank; Director of M&I Bank FSB; Director and President of M&I Bank of Mayville, Chairman, Director and President of Northern-NVSL, LLC, Speedway-HVSL, LLC and Water Street Land, LLC.
Thomas A. Root
Age 54
Senior Vice President since 1998, Audit Director since May 1996, Vice President from 1991 to 1998 of Marshall & Ilsley Corporation; Senior Vice President since April 2006, Vice President since 1993 and Audit Director since 1999 of M&I Marshall & Ilsley Bank.
Gregory A. Smith
Age 47
Senior Vice President and Chief Financial Officer of Marshall & Ilsley Corporation since June 2006; Chief Financial Officer of M&I Marshall & Ilsley Bank since June 2006; Director and President of TCH MI Holding Company, Inc.; Director of M&I Insurance Services, Inc., Marshall & Ilsley Trust Company National Association, M&I Financial Advisors, Inc., and Milease, LLC; Chief Financial Officer of M&I Bank of Mayville and M&I Bank FSB; Managing Director, Investment Banking, Credit Suisse from October 2004 to June 2006.
Michael C. Smith
Age 52
Senior Vice President and Corporate Treasurer of Marshall & Ilsley Corporation, since March 2006; Senior Vice President since April 2006 of M&I Marshall & Ilsley Bank; Director of M&I Community Development Corporation, M&I Bank FSB, M&I Custody of Nevada, Inc., M&I Servicing Corp, M&I Marshall & Ilsley Investment Corporation, M&I Marshall & Ilsley Investment II Corporation, M&I Marshall & Ilsley Holdings, Inc., M&I Zion Holdings, Inc., M&I Zion Investment Corporation, M&I Zion Investment II Corporation, SWB of St. Louis Holdings, Inc., and M&I Marshall & Ilsley Regional Holdings, Inc.; Manager of SWB of St. Louis Holdings I, LLC and SWB of St. Louis Holdings II, LLC; Trustee of SWB Investment II Corporation; Successor Administrator of Gold Banc Trust III, Gold Bank IV, Gold Banc V, Trustcorp Statutory Trust I, EBC Statutory Trust I, EBC Statutory Trust II, and First Indiana Capital Statutory Trust II; Treasurer, AIG Consumer Finance Group from May 2001 to February 2006.
Ronald E. Smith
Age 64
Senior Vice President since March 2005 of Marshall & Ilsley Corporation; Executive Vice President since March 2005, Senior Vice President from 2001 to March 2005 of M&I Marshall & Ilsley Bank; Director Northern-NVSL, LLC and Speedway-HVSL, LLC.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Stock Listing
The Corporation’s common stock is traded under the symbol “MI” on the New York Stock Exchange. Common dividends declared and the price range for the Corporation’s common stock for each of the last five years can be found in Item 8, Consolidated Financial Statements and Supplementary Data, Quarterly Financial Information.
A discussion of the regulatory restrictions on the payment of dividends can be found under Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and in Note 17 in Item 8, Consolidated Financial Statements and Supplementary Data.
Holders of Common Equity
There were approximately 13,564 record holders of the Corporation’s common stock as of December 31, 2010.
Shares Purchased
The following table reflects M&I’s purchases of its common stock for the specified period:
______________
(1)
Includes shares purchased by rabbi trusts pursuant to nonqualified deferred compensation plans. In connection with the Corporation’s participation in the CPP, the consent of the UST will be required for the Corporation to repurchase its common stock other than in connection with benefit plans consistent with past practice and certain other specified circumstances. See Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources for additional information regarding the CPP.
Equity Compensation Plan Information
_______________
(1)
The table does not include information regarding the following plans: the Company’s Dividend Reinvestment and Cash Investment Plan; and the M&I Retirement Program (an employee benefit plan intended to meet the qualification requirements of Section 401(a) of the Internal Revenue Code of 1986, as amended).
(2)
Includes 30,365,007 shares to be issued upon exercise of outstanding options under all of the Company’s stock option plans. This includes 94,102 shares to be issued upon exercise of outstanding options under plans assumed by the Company in mergers. The weighted-average exercise price of outstanding options granted under plans assumed in mergers as of December 31, 2010 was $18.94. There will be no further grants under these assumed plans. Also includes 1,100,135 shares held in the Directors Deferred Compensation Plan. These shares were not included in computing the weighted average exercise price. Under the Directors Deferred Compensation Plan, directors may elect to defer all or a portion of their directors’ fees into one of two accounts: (i) a cash account, earning interest at a rate equal to that earned on U.S. Treasury Bills with maturities of 13 weeks, or (ii) a Common Stock account in which shares are purchased on the open market and held in trust until the director’s retirement.
(3)
Does not include 1,638,903 units available for issuance under the LTIP (not including additional units credited to the accounts of participants in lieu of the payment of cash dividends). See the description of the LTIP in the narrative under “Executive Compensation-Compensation Discussion and Analysis-Elements of Executive Compensation” in this Proxy Statement. Any payout obligations under the LTIP must be satisfied in cash, in an amount equal to the fair market value of the number of shares represented by the units. Also does not include 740,725 shares held in the Executive Deferred Compensation Plan. Under the Executive Deferred Compensation Plan, participants had the ability to elect to defer the receipt of restricted shares.
(4)
Includes 407,845 shares available for issuance under the 2003 Executive Stock Option and Restricted Stock Plan; 5,925,157 shares available for issuance under the 2006 Equity Incentive Plan; 12,273 shares available under the 2009 Equity Incentive Plan; and 13,454,972 shares available under the 2010 Equity Compensation Plan.
(5)
All of the Company’s existing equity compensation plans have been approved by shareholders.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Consolidated Summary of Earnings
($000’s except share data)
______________
* Includes preferred equity and noncontrolling interest in subsidiaries.
** See Exhibit 12 for detailed computation of these ratios.
Consolidated Average Balance Sheets
($000’s except share data)
______________
* Excludes nonaccrual loans held for sale.
Types of Loans and Leases
M&I’s consolidated loans and leases, including loans held for sale, classified by type, at December 31 of each year are ($ in thousands):
Loan Balances and Maturities
The analysis of selected loan maturities at December 31, 2010 and the rate structure for the categories indicated are ($ in thousands):
Notes:
(1)
Scheduled repayments are reported in the maturity category in which the payments are due based on the terms of the loan agreements. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less.
(2)
The estimated effect arising from the use of interest rate swaps as shown in the rate structure of loans and leases is immaterial.
Investment Securities
The amortized cost of M&I’s consolidated available for sale and held to maturity investment securities at December 31 of each year are ($ in thousands):
The maturities, at amortized cost, and weighted average yields (for tax-exempt obligations on a fully taxable basis assuming a 35% tax rate) of investment securities at December 31, 2010 are ($ in thousands):
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
The following discussion should be read in conjunction with the Corporation’s consolidated financial statements and accompanying notes included elsewhere in this annual report.
On December 17, 2010, the Corporation and BMO Financial Group (“BMO” or “Bank of Montreal”) announced that they had entered into a definitive merger agreement (the “agreement”) under which BMO will acquire all outstanding shares of common stock of the Corporation in a stock-for-stock transaction. The transaction, which has been approved by the Corporation’s Board of Directors and the Board of Directors of BMO, is expected to close prior to July 31, 2011 subject to customary closing conditions, including regulatory approvals and approval by the Corporation’s shareholders.
Under the terms of the agreement, each outstanding share of the Corporation’s common stock will be exchanged for 0.1257 shares of common stock of Bank of Montreal upon closing. Based on the closing share price of Bank of Montreal on the Toronto Stock Exchange of C$62.05 on December 16, 2010, the transaction values each share of the Corporation at US$7.75, or an aggregate amount of approximately US$4.1 billion in Bank of Montreal common shares.
As part of the agreement, BMO will purchase the Corporation’s Senior Preferred Stock, Series B (the “Senior Preferred Stock”) issued to the United States Department of Treasury (the “UST”) in the fourth quarter of 2008 under the UST’s Capital Purchase Program (the “CPP”) at par plus accrued interest , with full repayment to the UST immediately prior to closing. The Corporation’s existing stock purchase warrant held by the UST will also be purchased by BMO.
In connection with the agreement, the Corporation issued to BMO an option, exercisable under certain circumstances, to purchase up to 19.7% of the Corporation’s common stock.
The Corporation’s financial results for the years ended December 31, 2010, 2009 and 2008 were significantly impacted by the condition of the U.S. economy and weakened real estate markets. The recessionary economy beginning in 2008, high unemployment levels and a decline in commercial and residential real estate values lead to an increase in loan delinquencies, charge-offs, and higher levels of nonperforming loans and leases in the Corporation’s loan portfolio. The Corporation’s strong capital and liquidity base has provided a solid foundation during these economic downturns. The Corporation’s loan and lease portfolio credit quality trends continued to improve in 2010 even though the pace and growth of the economic recovery was slow and unemployment levels remained elevated.
2010 compared to 2009
For the year ended December 31, 2010, the net loss attributable to the Corporation’s common shareholders (“net loss”) amounted to $616.9 million or $1.18 per diluted common share compared to a net loss of $858.8 million or $2.46 per diluted common share for the year ended December 31, 2009.
The net loss for the years ended December 31, 2010 and December 31, 2009 included $101.1 million and $100.2 million, or $0.20 and $0.28 per diluted common share, respectively, for dividends on the Senior Preferred Stock.
Financial performance in 2010 compared to 2009 based on diluted earnings per share is affected by the number of average common shares used to determine earnings per share. Average common shares increased 176.1 million or 50.5% in 2010 compared to 2009. The increase in the number of average common shares used to determine diluted earnings per share was primarily due to the effect of sales of newly-issued shares of common stock during June and October of 2009.
Growth in transaction deposits, a favorable shift in deposit types, lower term funding costs and higher yields on loans and leases enabled the Corporation to maintain a relatively stable level of net interest income in 2010 compared to 2009, despite continued loan contraction, maintenance of excess liquidity in cash and lower yielding short-term investments and reduced interest income due to the sales of investment securities during 2010. The ratio of net interest income on a fully taxable equivalent basis divided by average earning assets (“net interest margin”) improved by 30 basis points in 2010 compared to 2009.
Credit quality-related charges continued to be the primary driver of the Corporation’s financial performance in each of the years ended December 31, 2010 and 2009. For the year ended December 31, 2010, the provision for loan
and lease losses amounted to $1,758.9 million, which on an after-tax basis was approximately $1,108.1 million or $2.12 per diluted common share. By comparison, the provision for loan and lease losses for the year ended December 31, 2009 amounted to $2,314.6 million, which on an after-tax basis was approximately $1,458.2 million or $4.18 per diluted common share.
Write-downs associated with loans held for sale (other than mortgage loans originated for sale) are reported as a reduction of other income in the Consolidated Statements of Income and amounted to $16.1 million, which, on an after-tax basis, was approximately $10.2 million or $0.02 per diluted common share for the year ended December 31, 2010. By comparison, write-downs associated with loans held for sale amounted to $40.9 million, which on an after-tax basis, was approximately $25.7 million, or $0.07 per diluted common share for the year ended December 31, 2009.
Nonaccrual loans and leases, which the Corporation refers to as nonperforming loans, decreased $477.1 million or 23.3% from December 31, 2009 to December 31, 2010. The Corporation has reported a decrease in nonperforming loans in each of the past six consecutive quarters. The highest reported point of nonperforming loans at any quarter-end in the prior two years was $2,416.1 million at June 30, 2009. Since June 30, 2009, nonperforming loans declined approximately $848.4 million or 35.1% and amounted to $1,567.7 million at December 31, 2010. The elevated levels of nonperforming loans reflect the anemic economy, elevated levels of unemployment, and the weak national real estate markets. In addition, the amount of impairment, which affects charge-offs and the level of the allowance for loans and leases, remained elevated due to the depressed state of underlying real estate collateral values. The decrease in nonperforming loans at December 31, 2010 reflects the decline in new nonperforming loans, charge-offs and the effects of the Corporation’s actions taken to reduce the levels of nonperforming loans.
The amount of loans and leases that were placed on nonperforming status in 2010 amounted to $2,631.0 million compared to $4,208.2 million in 2009, a decrease of $1,577.2 million or 37.5%. The amount of loans and leases that went into nonperforming status in the fourth quarter of 2010 amounted to $637.6 million which was relatively consistent with the amount of loans and leases that were placed on nonperforming status in the first and second quarters of 2010. In the third quarter of 2010, three larger commercial real estate loan relationships that were classified as troubled debt restructurings, which the Corporation refers to as “renegotiated loans,” were transferred from previously accruing renegotiated loans to nonperforming loans.
Loans past due 30-89 days, excluding credit card loans, student loans and loans in nonperforming status, which the Corporation refers to as “early stage delinquencies”, decreased $107.7 million or 20.0% at December 31, 2010 compared to December 31, 2009, and decreased $75.7 million or 14.9% compared to September 30, 2010. At both December 31, 2010 and 2009 early stage delinquencies were 1.2% of total loans and leases.
Management believes these credit quality metrics are evidence of continuing credit quality improvement but recognizes that the economic recovery remains fragile, unemployment remains elevated and real estate markets remain relatively weak.
The Corporation continued to employ a variety of strategies to mitigate and reduce its loan loss exposures such as loan sales and restructuring loan terms to lessen the financial stress and the probability of foreclosure for qualifying customers that have demonstrated the capacity and ability to repay their debt obligations in a manner that serves the best interests of both the customer and the Corporation.
Accruing renegotiated loans amounted to $548.4 million at December 31, 2010 compared to $793.5 million at December 31, 2009, a decrease of $245.1 million or 30.9%.
The allowance for loan and lease losses amounted to $1,387.6 million or 3.75% of total loans and leases outstanding at December 31, 2010 compared to $1,480.5 million or 3.35% at December 31, 2009. Net charge-offs amounted to $1,851.8 million or 4.49% of average loans and leases for the year ended December 31, 2010 compared to $2,036.3 million or 4.26% of average loans and leases for the year ended December 31, 2009.
Included in net charge-offs and the provision for loan and lease losses in 2010 was the impact of bringing one hospitality/lodging industry credit relationship toward a final resolution. That credit relationship consisted of multiple geographically dispersed commercial real estate loans. Two commercial real estate loans aggregating $83.2 million were transferred from accruing renegotiated loans to nonperforming loans and $209.4 million was charged-off across all ten of the related commercial real estate loans. An additional provision for loan and lease losses of $94.6 million was recorded for the shortfall over the amounts reserved in prior periods that resulted from a valuation based on the sale disposition strategy. On an after-tax basis, that incremental provision for loan and lease losses amounted to $59.6 million or $0.12 per share for the year ended December 31, 2010.
Sales growth in both personal and institutional trust business lines resulted in higher wealth management revenue for the year ended December 31, 2010 compared to the year ended December 31, 2009.
Fewer mortgage loan closings resulted in lower mortgage banking revenue for the year ended December 31, 2010 compared to the year ended December 31, 2009.
During 2010, the Corporation sold United States government agency investment securities, resulting in a gain and also realized gains on private equity investments that are included in Net Investment Securities Gains for the year ended December 31, 2010. During 2009, the Corporation sold United States government agency investment securities and sold its shares of Visa, Inc. (“Visa”), Class B common stock. The gain resulting from these transactions is included in Net Investment Securities Gains for the year ended December 31, 2009.
The results of operations for the years ended December 31, 2010 and 2009 reflect the deployment of excess liquidity to acquire and extinguish existing borrowings at a gain. This gain is reported in Gain on Termination of Debt in the Corporation’s Consolidated Statements of Income.
During 2010, the Corporation sold its merchant portfolio processing at a gain. The gain from this transaction is reported as Sale of Merchant Portfolio Processing in the Corporation’s Consolidated Statements of Income for the year ended December 31, 2010.
Noninterest expense for the years ended December 31, 2010 and 2009 included elevated expenses associated with Federal Deposit Insurance Corporation (“FDIC”) deposit insurance. FDIC insurance expense for the year ended December 31, 2009 included a special assessment by the FDIC that was levied on all banks.
Noninterest expense for the years ended December 31, 2010 and 2009 remained at elevated levels due to the increased costs associated with collection efforts and carrying nonperforming assets. The estimated expense associated with collection efforts and carrying nonperforming assets, net of related gains, amounted to $160.7 million for the year ended December 31, 2010 compared to $215.8 million for the year ended December 31, 2009, a decrease of $55.1 million. On an after-tax basis, that net expense amounted to $101.2 million or $0.20 per diluted common share in 2010 compared to $135.9 million or $0.39 per diluted common share in 2009. The decrease in net expense associated with collection efforts and carrying nonperforming assets in the comparative periods was primarily due to improved results from the sale of other real estate owned (“OREO”) and lower post-transfer write-downs on OREO.
In conjunction with its activities to re-align the Corporation’s funding profile, the Corporation has selectively exercised its call option associated with brokered certificates of deposit (“CDs”) to redeem those CDs at par. In conjunction with these activities, the Corporation incurred a non-cash charge to write-off the unamortized issuance costs attributable to those brokered CDs that have been redeemed. The loss is reported in Other expense in the Consolidated Statements of Income as Loss on Brokered CDs.
During 2010, the Corporation recognized additional net tax benefits that in total amounted to $10.9 million and reduced net loss by approximately $0.02 per diluted common share. During 2009, the Corporation recognized additional tax benefits that in total amounted to $69.0 million and reduced net loss by approximately $0.20 per diluted common share.
At December 31, 2010, the Corporation’s Tier 1 regulatory capital ratio was 11.14% or $2,044.4 million in excess of well capitalized under the Federal Reserve Board’s regulatory framework. To be well capitalized under the regulatory framework, the Tier 1 capital ratio must meet or exceed 6%. The Corporation’s Tier 1 regulatory capital ratio at December 31, 2010 includes the impact of the closing of two underwritten public offerings of its common stock during 2009. In addition, the Corporation issued shares of its common stock on an at-the-market basis prior to the underwritten public offerings in 2009. The Corporation issued a total of 257.1 million shares of its common stock as a result of these transactions in 2009. The proceeds, net of underwriting discounts and commissions and offering expenses, from these issuances amounted to $1,419.4 million.
2009 Compared to 2008
For the year ended December 31, 2009, the net loss attributable to the Corporation’s common shareholders amounted to $858.8 million or $2.46 per diluted common share compared to a net loss of $2,056.2 million or $7.92 per diluted common share for the year ended December 31, 2008. The net loss for the year ended December 31, 2008 included a non-cash charge for goodwill impairment in the amount of $1,535.1 million. On an after-tax basis, the charge for goodwill impairment amounted to $1,487.9 million or $5.73 per diluted common share.
The net loss for the years ended December 31, 2009 and December 31, 2008 included $100.2 million and $12.7 million, or $0.29 and $0.05 per diluted common share, respectively, for dividends on the Senior Preferred Stock issued to the UST in the fourth quarter of 2008.
Comparative performance in 2009 compared to 2008 based on diluted earnings per share was also affected by the number of common shares used to determine earnings per share. Shares of common stock outstanding at December 31, 2009 increased by 260.0 million shares or 98.0% compared to common stock outstanding at December 31, 2008. Average common stock used to determine diluted earnings per share increased by 88.9 million shares or 34.2% in 2009 compared to 2008. The increase in common stock outstanding and average common stock used to determine diluted earnings per share was primarily due to the sales of newly-issued shares of common stock during 2009.
Credit quality-related charges were the primary driver of the Corporation’s 2009 financial performance. For the year ended December 31, 2009, the provision for loan and lease losses amounted to $2,314.6 million, which on an after-tax basis was approximately $1,458.2 million or $4.18 per diluted common share. For the year ended December 31, 2008, the provision for loan and lease losses amounted to $2,037.7 million, which on an after-tax basis was approximately $1,303.3 million or $5.02 per diluted common share.
Write-downs associated with loans held for sale (other than mortgage loans originated for sale) amounted to $40.9 million, which on an after-tax basis was approximately $25.7 million or $0.07 per diluted common share in 2009. There were no write-downs associated with loans held for sale in 2008.
Nonperforming loans and leases at December 31, 2009 increased $517.8 million or 33.9% since December 31, 2008. Nonperforming loans and leases continued to increase during the first and second quarters of 2009. At June 30, 2009, nonperforming loans and leases amounted to $2,416.1 million. Since June 30, 2009, nonperforming loans declined $166.0 million in the third quarter of 2009 and $205.3 million in the fourth quarter of 2009 and amounted to $2,044.8 million at December 31, 2009. In addition, the amount of impairment, which affects charge-offs and the level of the allowance for loans and leases, remained elevated due to the depressed state of underlying real estate collateral values, particularly construction and development loans. The decrease in nonperforming loans in the second half of 2009 reflects the effects of the Corporation’s actions taken to reduce the levels of nonperforming loans and the decline in new nonperforming loans. The amount of new loans and leases that went into nonperforming status during the second half of 2009 decreased by approximately $636.8 million or 26.3% compared to the first half of 2009. In addition, early stage delinquencies decreased by $352.1 million or 39.5%, from December 31, 2008 to December 31, 2009.
Accruing renegotiated loans increased $523.1 million since December 31, 2008 and amounted to $793.5 million at December 31, 2009. At December 31, 2009, renegotiated residential real estate, residential construction by individuals, residential land and other consumer-related renegotiated loans amounted to $651.5 million or 82.1% of total accruing renegotiated loans.
The allowance for loans and leases amounted to $1,480.5 million or 3.35% of total loans and leases outstanding at December 31, 2009 compared to $1,202.2 million or 2.41% at December 31, 2008. Net charge-offs amounted to $2,036.3 million or 4.26% of average loans and leases for the year ended December 31, 2009 compared to $1,363.8 million or 2.74% of average loans and leases for the year ended December 31, 2008.
Throughout 2009, the Corporation continued to experience elevated levels of expenses due to the increase in operating costs associated with collection efforts and carrying nonperforming assets. The estimated expense associated with collection efforts and carrying nonperforming assets, net of related gains, amounted to $215.8 million for the year ended December 31, 2009 compared to $104.5 million for the year ended December 31, 2008, an increase of $111.3 million. On an after-tax basis, that net expense amounted to $135.9 million or $0.39 per diluted common share in 2009 compared to $65.9 million or $0.25 per diluted common share in 2008. The increase in net expense associated with collection efforts and carrying nonperforming assets in the comparative periods was primarily due to higher expenses and losses associated with OREO.
Declining asset yields, competitive deposit pricing in the low interest rate environment, elevated levels of nonperforming loans and management’s decision to maintain liquidity in cash and cash equivalents resulted in lower net interest income in the year ended December 31, 2009 compared to the year ended December 31, 2008. Equity market volatility along with downward pressure in the equity markets resulted in lower wealth management revenue in the twelve months ended December 31, 2009 compared to the twelve months ended December 31, 2008. Mortgage loan closings, primarily due to re-financings, and increased sales of those loans to the secondary market resulted in mortgage banking revenue growth for the year ended December 31, 2009 compared to the year ended December 31, 2008.
As a result of market conditions, the Corporation re-acquired and extinguished both bank holding company and banking affiliate long-term borrowings at a discount to its carrying value during 2009. In addition, during 2009 the Corporation sold its shares of Class B common stock of Visa and certain United States government agency investment securities. The gains associated with the termination of debt and sale of certain investment securities were partially offset by the special insurance assessment by the FDIC. These items in total reduced the loss before income taxes by $190.4 million. On an after-tax basis, these items together with incremental income tax benefits recognized due to a change in state of Wisconsin tax law and a favorable Federal income tax settlement reduced the net loss for the year ended December 31, 2009 by $188.9 million or $0.54 per diluted common share.
Deterioration in the national real estate markets, economic recession and disruption in the capital markets adversely impacted the Corporation’s financial condition and results of operations throughout 2008.
As a result of the unprecedented weakness in the financial markets and the decline in the Corporation’s common stock price, numerous tests for goodwill impairment were performed throughout 2008. The results of goodwill impairment testing at the end of the fourth quarter of 2008 indicated that the fair value of certain of the Corporation’s banking-related reporting units were less than their book values, resulting in a non-cash after-tax charge to earnings for goodwill impairment in the amount of $1,487.9 million or $5.73 per diluted common share. The Tier 1 and Total regulatory capital ratios were unaffected by this adjustment.
The continued deterioration in the national real estate markets and the economic recession had a negative impact on the Corporation’s loan and lease portfolio in 2008. In addition to a significant increase in nonperforming assets, the amount of loan impairment increased in 2008 due to the depressed state of underlying real estate collateral values. The Corporation’s construction and development real estate loans, particularly in Arizona, the west coast of Florida and certain correspondent banking business channels, exhibited the most dramatic increase in stress and impairment. The increase in stress and impairment and the accelerated disposition of problem assets resulted in net charge-offs and provision for loan and lease losses that were significantly higher in 2008 when compared to the Corporation’s historical experience with net charge-offs and provision for loan and lease losses.
The economic recession and disruption in the capital markets also resulted in an other than temporary investment security loss, write-down of a bank-owned life insurance policy, unexpected losses in the Corporation’s Wealth Management segment and other credit and market related losses. Those write-downs and losses were partially offset by gains from the extinguishment of certain debt obligations, securities gains and reversals of litigation accruals associated with the Corporation’s membership interests in Visa and an additional income tax benefit related to prior years. During the fourth quarter of 2008, the Corporation recorded severance expense associated with a corporate-wide reduction in force. For the year ended December 31, 2008, these items resulted in a net pre-tax loss of $29.3 million which on an after-tax basis amounted to approximately $0.05 per diluted common share.
During the fourth quarter of 2008, the Corporation sold to the UST Senior Preferred Stock for $1.7 billion and issued a warrant to purchase the Corporation’s common stock. At December 31, 2008, the Corporation’s Tier 1 regulatory capital ratio was 9.49%.
In order to preserve its strong capital base, the Corporation undertook a series of significant expense reduction initiatives in 2008, reduced the quarterly common stock cash dividend to $0.01 per share and implemented several risk-management strategies to reduce its exposure to construction and development loans.
In the fourth quarter of 2008, the Corporation announced an expense reduction initiative that included a freeze on filling open positions, attrition and staff reductions. In addition, de novo branch expansion was curtailed. The Corporation reduced its workforce by approximately 830 positions or approximately 8% of its total workforce. Approximately 80% of the workforce reductions were completed in 2008. The remaining 20% were related to operational efficiencies and were achieved by the end of 2009. Executive officer and other senior level salaries were frozen in 2009 and awards and benefits under a variety of other programs for employees were reduced. The Board of Directors also reduced the annual cash retainer for directors by 25%, and the Corporation reduced a number of other expenses.
Other Noteworthy Transactions and Events
Some of the more noteworthy transactions and events in 2010, 2009 and 2008 consisted of the following:
As previously discussed, on December 17, 2010, the Corporation and BMO announced that they had entered into a definitive merger agreement under which BMO will acquire all outstanding shares of common stock of the
Corporation in a stock-for-stock transaction. Under the terms of the agreement, each outstanding share of the Corporation’s common stock will be exchanged for 0.1257 shares of common stock of Bank of Montreal upon closing. The transaction, which has been approved by the Corporation’s Board of Directors and the Board of Directors of BMO, is expected to close prior to July 31, 2011 subject to customary closing conditions, including regulatory approvals and approval by the Corporation’s shareholders.
During 2010, the Corporation realized gains of $82.8 million from the sale of approximately $2.2 billion in aggregate principal amount of United States government agency investment securities. In addition, the Corporation realized net gains of $18.0 million on private equity investments. Approximately $8.6 million of the gains on private equity investments was related to the sale of one investment. In total, net investment securities gains reported in the Consolidated Statements of Income in 2010 amounted to $99.8 million. On an after-tax basis, the reported net gain amounted to $62.9 million or $0.12 per diluted common share for the year ended December 31, 2010.
The Corporation continued to re-acquire and extinguish banking affiliate long-term borrowings. During 2010, the Corporation re-acquired and extinguished long-term borrowings with a par value of $223.3 million. The gain on termination of debt amounted to $19.7 million. On an after-tax basis, the gain on termination of debt amounted to $12.4 million or $0.02 per diluted common share for the year ended December 31, 2010.
During 2010, the Corporation sold its merchant portfolio processing. Like other bank holding companies, the Corporation determined that processing, clearing, settlement and related services with respect to credit card and debit card transactions with merchants was not a material source of revenue or part of the Corporation’s core operating activities. The gain, which is reported as Sale of Merchant Portfolio Processing in the Consolidated Statements of Income, amounted to $48.3 million which, on an after-tax basis, amounted to $30.4 million or $0.05 per diluted common share for the year ended December 31, 2010.
In conjunction with its activities to re-align the Corporation’s funding profile, the Corporation has selectively exercised its call option associated with brokered CDs to redeem those CDs at par. During 2010, the Corporation redeemed $3,998.6 million of brokered CDs. The Corporation incurred a non-cash charge to write-off the unamortized issuance costs attributable to those brokered CDs. That charge amounted to $47.1 million which is reported in Other Expense in the Consolidated Statements of Income as Loss on Brokered CDs. On an after-tax basis, the reported charge amounted to $29.7 million or $0.05 per diluted common share for the year ended December 31, 2010.
During 2010, the Corporation recognized additional net tax benefits that in total amounted to $10.9 million and reduced net loss by approximately $0.02 per diluted common share. Additional tax benefits related to the final resolution of a tax matter and adjustments for income tax audit settlements were offset by additional income tax expense that was recorded to write-off deferred tax assets to reflect the change in the tax treatment of the Medicare Part D federal subsidy as a result of health care reform legislation.
On October 27, 2009, the Corporation announced the closing of its public offering of 156.4 million shares of its $1.00 par value common stock at $5.75 per share. The 156.4 million shares included 20.4 million shares issued pursuant to an option granted to the underwriters by the Corporation, which was exercised in full. The proceeds, net of underwriting discounts and commissions and offering expenses, from the offering amounted to $863.1 million.
On June 17, 2009, the Corporation announced the closing of its public offering of 100.0 million shares of its $1.00 par value common stock at $5.75 per share. The 100.0 million shares included 13.0 million shares issued pursuant to an option granted to the underwriters by the Corporation, which was exercised in full. The proceeds, net of underwriting discounts and commissions and offering expenses, from the offering amounted to $551.8 million.
The Corporation also sold on an at-the-market basis 670,300 shares of its common stock resulting in proceeds of $4.5 million, net of fees and commissions and offering expenses, during the second quarter of 2009.
During 2009, the Corporation recognized a gain of $35.4 million in conjunction with the sale of its Visa Class B common stock. Also during the year, the Corporation’s banking affiliates realized gains of $85.6 million from the sale of approximately $1.9 billion in aggregate principal amount of United States government agency investment securities. These gains are included in Net Investment Securities Gains in the Consolidated Statements of Income. On an after-tax basis, these total gains amounted to $76.2 million and reduced net loss by approximately $0.22 per diluted common share.
The Corporation continued to re-acquire and extinguish both bank holding company and banking affiliate long-term borrowings through open market purchases and a public tender offer. During 2009, the Corporation re-
acquired and extinguished $1,285.7 million of debt. The gain amounted to $99.4 million and is reported as Gain on Termination of Debt in the Consolidated Statements of Income. On an after-tax basis, this gain amounted to $62.6 million and reduced net loss by approximately $0.18 per diluted common share.
During 2009, the Corporation recorded a special FDIC insurance assessment charge of $29.3 million. On an after-tax basis, the assessment amounted to $18.5 million and increased net loss by approximately $0.05 per diluted common share. The insurance assessment charge is included in FDIC Insurance in the Consolidated Statements of Income.
During 2009, the Corporation recognized additional tax benefits that in total amounted to $69.0 million and reduced net loss by approximately $0.20 per diluted common share. During the first quarter of 2009, the State of Wisconsin enacted legislation that requires combined reporting for state income tax purposes. As a result, the Corporation recorded an additional income tax benefit of $51.0 million to recognize certain state deferred tax assets, which included the reduction of a valuation allowance for Wisconsin net operating losses. Also during 2009, the Corporation recognized an additional tax benefit of $18.0 million that was primarily related to the favorable resolution of a tax matter associated with a 2002 stock issuance.
On January 2, 2008, the Corporation completed its acquisition of First Indiana Corporation (“First Indiana”) based in Indianapolis, Indiana. First Indiana, with $2.1 billion in consolidated assets as of December 31, 2007, had 32 branches in central Indiana which became branches of M&I Marshall & Ilsley Bank on February 2, 2008. Stockholders of First Indiana received $32.00 in cash for each share of First Indiana common stock outstanding, or approximately $530.2 million.
On November 14, 2008, as part of the CPP, the Corporation agreed to sell 1,715,000 shares of the Corporation’s Senior Preferred Stock having a liquidation preference of $1,000 per share, for a total price of $1.715 billion. The Senior Preferred Stock qualifies as Tier 1 capital and pays cumulative compounding dividends at a rate of 5% per year for the first five years and 9% per year thereafter. As a condition to participating in the CPP, the Corporation issued and sold to the UST a warrant to purchase 13,815,789 shares of the Corporation’s common stock, at an initial per share exercise price of $18.62, for an aggregate purchase price of approximately $257.25 million. The term of the Warrant is ten years. Pursuant to the Securities Purchase Agreement entered into in connection with the transaction, until the UST no longer owns any shares of the Senior Preferred Stock, the Warrant or Warrant Shares, the Corporation’s employee benefit plans and other executive compensation arrangements for its senior executive officers must continue to comply in all respects with Section 111(b) of EESA and the rules and regulations promulgated by the UST.
The results of goodwill impairment testing at the end of the fourth quarter of 2008 indicated that the fair value of certain of the Corporation’s banking-related reporting units were less than their book values, resulting in an after-tax total non-cash charge to earnings for goodwill impairment in the amount of $1,487.9 million or $5.73 per diluted common share.
During 2008, the Corporation recognized income of $39.1 million due to the completion of the initial public offering (“IPO”) by Visa. As a result of the IPO, Visa redeemed 38.7% of the Class B Visa common stock owned by the Corporation. The gain from the redemption amounted to $26.9 million and is reported in Net Investment Securities Gains in the Consolidated Statements of Income. In addition, Visa established an escrow for certain litigation matters from the proceeds of the IPO. As a result of the funded escrow, the Corporation reversed $12.2 million of the litigation accruals that were originally recorded in 2007 due to the Corporation’s membership interests in Visa. The reversed accrual is reported in the Other line of Other Expense in the Consolidated Statements of Income. On an after-tax basis, these two Visa-related items reduced net loss by approximately $0.10 per diluted common share.
During 2008, the Corporation recognized an other than temporary loss on an investment in a small-business lending venture. The loss amounted to $10.0 million and is reported in Net Investment Securities Gains in the Consolidated Statements of Income. On an after-tax basis, this loss increased net loss by approximately $0.02 per diluted common share.
During 2008, the Corporation recognized a loss related to one of its bank-owned life insurance (“BOLI”) policies. The BOLI policy contains a stable value agreement that provides limited cash surrender value protection from declines in the value of the policy’s underlying investments. During the fourth quarter of 2008, the value of the policy’s underlying investments declined due to disruptions in the credit markets. As a result, the decline in cash surrender value of the policy exceeded the protection provided by the stable value agreement. The loss amounted to
$11.8 million or $0.05 per diluted common share and is reported as a reduction of Bank-Owned Life Insurance Revenue in the Consolidated Statements of Income.
During 2008, the Corporation re-acquired and extinguished $169.2 million of debt. The gain amounted to $14.7 million and is reported as Gain on Termination of Debt in the Consolidated Statements of Income. On an after-tax basis, this gain reduced net loss by approximately $0.04 per diluted common share.
Market disruptions in the equity and fixed income markets resulted in unexpected losses in the Corporation’s Wealth Management segment. Losses attributable to the Lehman Brothers bankruptcy, costs of providing credit support agreements and other market related losses amounted to $45.7 million in 2008. The losses are reported in the Other line of Other Expense in the Consolidated Statements of Income. On an after-tax basis, these losses increased net loss by approximately $0.11 per diluted common share.
The deterioration in the national real estate markets resulted in a significant increase in the provision for losses for unfunded commitments and other credit related charges. In addition, rising fuel costs earlier in 2008 resulted in write-downs of residual values associated with consumer vehicle leases. In total, these provisions and write-downs amounted to $26.9 million and are reported in the Other line of Other Expense in the Consolidated Statements of Income. On an after-tax basis, these items increased net loss by approximately $0.07 per diluted common share.
During 2008, the Corporation recognized an additional income tax benefit of $20.0 million, or $0.08 per diluted common share, related to how the TEFRA (interest expense) disallowance should be calculated within a consolidated group.
Net Interest Income
Net interest income is the difference between interest income on earning assets and interest expense on interest bearing liabilities.
2010 Compared to 2009
Net interest income for the year ended December 31, 2010 amounted to $1,557.3 million compared to $1,582.6 million reported for the year ended December 31, 2009, a decrease of $25.3 million or 1.6%. Growth in transaction deposits, a favorable shift in deposit types, lower term funding costs and higher yields on loans enabled the Corporation to maintain a relatively stable level of net interest income in 2010 compared to 2009, despite continued loan contraction, maintenance of excess liquidity in cash and lower yielding short-term investments and reduced interest income due to the sales of investment securities during 2010.
For the year ended December 31, 2010, average interest earning assets amounted to $50.2 billion compared to $56.5 billion for the year ended December 31, 2009, a decrease of $6.3 billion or 11.1%. Average loans and leases decreased $6.5 billion or 13.7% in the year ended December 31, 2010 compared to the year ended December 31, 2009. Average investment and trading securities decreased $0.2 billion or 3.2% in 2010 compared to 2009. Average other short-term investments averaged $1.8 billion in 2010 compared to $1.3 billion in 2009, an increase of $0.5 billion which reflects the impact of excess liquidity.
Average interest bearing liabilities decreased $6.5 billion or 14.3% in 2010 compared to 2009. Average interest bearing deposits decreased $0.9 billion or 2.7% in the twelve months ended December 31, 2010 compared to the twelve months ended December 31, 2009. Average wholesale deposits and average bank-issued time deposits in total decreased $4.0 billion or 19.4% in 2010 compared to 2009. That decrease was offset by the growth in average bank-issued interest-bearing transaction deposits which increased $3.1 billion or 24.4% in 2010 compared to 2009. Average short-term borrowings declined $2.6 billion or 77.3% and average long-term borrowings decreased $3.0 billion or 34.7% in 2010 compared to 2009. As previously discussed, the decline in average long-term borrowings reflects the effect of the acquisition and extinguishment of long-term borrowings throughout 2009 and 2010, at a net gain, in addition to maturities. Over the 24 months ended December 31, 2010, the Corporation re-acquired and extinguished $1.5 billion in par value of long-term borrowings.
For the year ended December 31, 2010 compared to the year ended December 31, 2009, average noninterest bearing deposits increased $0.4 billion or 5.8%.
2009 Compared to 2008
Net interest income in 2009 amounted to $1,582.6 million compared with net interest income of $1,780.7 million in 2008, a decrease of $198.1 million or 11.1%. Net interest income in 2009 was pressured as interest rates on earning assets declined more rapidly than the rates paid for interest bearing liabilities. The Corporation’s inability
to continue to lower deposit pricing in the low interest rate environment due to competition for deposits contributed to lower net interest income. In addition, net interest income was compressed as a result of higher levels of nonperforming loans and leases, charge-offs, interest rate concessions associated with renegotiated loans and management’s decision to maintain higher levels of low-yield liquid assets. Positive contributors to net interest income in 2009 compared to 2008 included the impact of a full year of benefit from the proceeds from the sale of the Senior Preferred Stock to the UST, improved asset spreads, increase in interest rate floors on loans, the increase in noninterest bearing deposits, cash received from the issuance of the Corporation’s common stock and the modification and early extinguishment of higher-cost long-term borrowings.
Average earning assets in 2009 amounted to $56.5 billion compared to $57.9 billion in 2008, a decrease of $1.4 billion or 2.6%. Average trading and short-term investments, including federal funds sold and security resale agreements, increased $1.1 billion or 180.0% in 2009 compared to 2008. Average loans and leases decreased $1.9 billion or 3.9% and average investment securities decreased $0.7 billion or 8.8%.
Average interest bearing liabilities decreased $4.2 billion or 8.4% in 2009 compared to 2008. Average interest bearing deposits decreased $0.2 billion or 0.7% in 2009 compared to 2008. Average short-term borrowings decreased $2.8 billion or 46.2% in 2009 compared to 2008. Average long-term borrowings decreased $1.1 billion or 11.0% in 2009 compared to 2008.
Average noninterest bearing deposits increased $1.6 billion or 26.8% in 2009 compared to the prior year.
Loans and Leases
The growth and composition of the Corporation’s average loan and lease portfolio for the current year and prior two years are reflected in the following table ($ in millions):
2010 Compared to 2009
Total consolidated average loans and leases decreased approximately $6.5 billion or 13.7% for the year ended December 31, 2010 compared to the year ended December 31, 2009.
Total average commercial loans and leases declined $2.2 billion or 15.1% for the year ended December 31, 2010 compared to the year ended December 31, 2009. Commercial and industrial loans continued to contract in the fourth quarter of 2010 compared to the third quarter of 2010. Commercial customers appear to still be focused on expense management and debt reduction by delaying capital expenditures and reducing working capital demand. Commercial loan commitments and credit line utilization have declined. Commercial loan and lease balances and the demand for new credit will depend on the pace and strength of economic improvement.
Total average commercial real estate loans decreased $0.3 billion or 2.0% in the twelve months ended December 31, 2010 compared to the twelve months ended December 31, 2009. The relative stability of the reported year to date average balance in commercial real estate loans reflects the migration of construction loans to commercial real estate loans once construction was completed. All performing past due loans transferred from the construction portfolio to the commercial portfolio retain their past due status upon transfer. In normal market conditions, the Corporation generally limited the amount of post construction financing (permanent financing) it provided to those loans with interest rates and terms that conform to the Corporation’s interest rate risk profile or loans where a significant long-term customer relationship existed. In many cases, the interest rate and term that customers wanted for permanent financing was readily available and provided by institutional investors in normal market conditions. The current lack of market liquidity has resulted in customers not being able to secure financing elsewhere irrespective of their ability to service the debt. As a result, the Corporation has provided interim loans that are intended to provide temporary financing until such time as the liquidity in the commercial real estate lending markets returns to normal conditions. The interim loans may be interest only or structured to ensure a significant amount of the income generated from the commercial real estate project is used to pay interest at market rates and reduce outstanding principal. The Corporation continues to experience declines in new commercial real estate development originations and expects this trend to continue. As a result of that reduced demand and normal payment activity, commercial real estate loans are expected to continue to contract. Commercial real estate loans held for sale amounted to $4.5 million at December 31, 2010.
Total average residential real estate loans declined $0.8 billion or 14.2% for the year ended December 31, 2010 compared to the year ended December 31, 2009. Throughout 2009 and 2010, the Corporation sold over 93% of its residential real estate production to the secondary market. For the years ended December 31, 2010 and 2009, residential real estate loans sold to investors amounted to $2.1 billion and $3.1 billion, respectively. At December 31, 2010, the Corporation had approximately $80.7 million of residential mortgage loans held for sale. Gains from the sale of residential mortgage loans amounted to $34.9 million in 2010 compared to $44.3 million in 2009. As a result of selling the majority of new production and normal payment activity, residential real estate loans are expected to continue to contract.
Total average construction and development loans declined $2.8 billion or 38.1% in the year ended December 31, 2010 compared to the year ended December 31, 2009. The decrease in construction and development loans has been due to payments, transfers to other loan types when projects are completed, loan sales and charge-offs. At December 31, 2010, the Corporation had approximately $27.4 million of construction and development loans held for sale. Given market conditions and the lack of new originations, construction and development loans are expected to continue to contract. Construction and development loans amounted to $3.2 billion at December 31, 2010, which were 8.7% of total loans and leases outstanding at that date and was $0.3 billion less than average construction and development loans for the quarter ended December 31, 2010.
Total average consumer loans and leases declined $0.6 billion or 7.7% in 2010 compared to 2009. Average home equity loans and lines of credit declined $0.4 billion or 8.9% in the year ended December 31, 2010 compared to the year ended December 31, 2009. Average consumer auto loans increased $0.2 billion or 18.3% in the twelve months ended December 31, 2010 compared to the twelve months ended December 31, 2009. However, during the fourth quarter of 2010, the Corporation sold $0.9 billion of consumer auto loans at a gain of $8.5 million. That gain is reported in the Other line of Other Income in the Consolidated Statements of Income. Average auto leases, student loans and other consumer loans decreased $0.3 billion in 2010 compared to 2009. Credit card loans averaged $0.3 billion for the year ended December 31, 2010 and were relatively unchanged compared to average credit card loans in 2009. Credit card loans represented less than 1.0% of the Corporation’s total average loan and leases in 2010 and 2009 and are not a significant component of the Corporation’s loan and lease portfolio.
2009 Compared to 2008
For the year ended December 31, 2009, total consolidated average loans and leases declined $1.9 billion or 3.9% compared to total consolidated average loans and leases for the year ended December 31, 2008.
For the year ended December 31, 2009, total average commercial loans and leases amounted to $14.4 billion compared to $15.4 billion for the year ended December 31, 2008, a decrease of $1.0 billion or 6.3%. The weak economy resulted in lower demand for new loans and lower utilization of existing lines of credit.
For the year ended December 31, 2009, total average commercial real estate loans amounted to $13.5 billion compared to $11.8 billion for the year ended December 31, 2008, an increase of $1.7 billion or 14.2%. The majority of this growth represents the migration of construction loans to commercial real estate loans once construction was completed. As previously discussed, the Corporation has provided more interim financing for post-construction loans than it has historically due to the commercial real estate lending environment.
For the year ended December 31, 2009, total average residential real estate loans amounted to $5.5 billion and was relatively unchanged compared to average residential real estate loans for the year ended December 31, 2008. In 2009, the Corporation sold substantially all of its residential real estate production in the secondary market. For the years ended December 31, 2009 and 2008, real estate loans sold to investors amounted to $3.1 billion and $1.4 billion, respectively. At December 31, 2009, the Corporation had approximately $76.5 million of residential mortgage loans and home equity loans which were originated for sale and were held for sale. For the year ended December 31, 2009, gains from the sale of mortgage loans amounted to $44.3 million compared to $22.4 million for the year ended December 31, 2008.
For the year ended December 31, 2009, total average construction and development loans amounted to $7.2 billion compared to $10.2 billion for the year ended December 31, 2008, a decrease of $3.0 billion or 28.8%. The decrease in construction and development loans has been due to payments, transfers to other loan types when projects are completed and permanent financing is obtained, loan sales and charge-offs. Construction and development loans held for sale amounted to $57.3 million at December 31, 2009. Construction and development loans amounted to $5.5 billion at December 31, 2009 which was 12.5% of total loans and leases outstanding at that date.
Total average personal loan and lease growth was $0.3 billion or 5.0% in 2009 compared to 2008. Average home equity loans and lines of credit were relatively unchanged in 2009 compared to 2008. Approximately $0.4 billion of the growth was attributable to consumer auto loans. Average auto leases, student loans and other consumer loans decreased $0.1 billion in 2009 compared to 2008. Credit card loans averaged $0.3 billion in each of 2009 and 2008.
Deposits
The growth and composition of the Corporation’s consolidated average deposits for 2010 and prior two years are reflected below ($ in millions):
2010 Compared to 2009
For the year ended December 31, 2010 compared to the year ended December 31, 2009, total consolidated average deposits decreased $0.5 billion or 1.1%.
Total average deposits that were originated directly with customers, which the Corporation refers to as bank-issued deposits, increased $1.2 billion or 4.0% in 2010 compared to 2009. The Corporation has placed emphasis on originating transaction deposits (noninterest bearing, savings and NOW, foreign activity and money market) and de-emphasized the origination of time deposits. Average bank-issued transaction deposits increased $3.5 billion or 17.5% in 2010 compared to 2009. Average bank-issued time deposits decreased $2.3 billion or 24.6% compared to 2009.
The growth in transaction deposits, especially money market accounts and savings and NOW accounts, compared with the prior year reflects the reconfiguration of many of the Corporation’s deposit product offerings. In addition, some existing customers have transferred their balances from other deposit types as those deposit instruments matured. The growth in transaction deposits and shift in the mix of average deposit types was beneficial to net interest income and the net interest margin in 2010.
The Corporation has historically used wholesale deposits (brokered NOW, brokered money market, brokered CDs and foreign time) to supplement deposits generated through the Corporation’s banking branch network due to pricing advantages. In addition, the Corporation used wholesale deposits due to the cost advantage over the cost of issuing debt, especially new long-term borrowings, during unstable market conditions in the capital markets. As assets have contracted, the Corporation has been able to reduce the use of wholesale deposits as a funding source. Average wholesale deposits decreased $1.6 billion or 14.8% in 2010 compared to 2009. In conjunction with its activities to re-align the Corporation’s funding profile, the Corporation has selectively exercised its call option associated with brokered CDs to redeem those CDs at par. During 2010, the Corporation redeemed $4.0 billion of brokered CDs. In conjunction with these redemptions, the Corporation incurred a non-cash charge to write-off the unamortized issuance costs attributable to those brokered CDs that were redeemed. This charge is reported in Other expense in the Consolidated Statements of Income as Loss on brokered CDs.
Historically, noninterest bearing deposit balances tended to exhibit some seasonality with a trend of balances declining somewhat in the early part of the year followed by growth in balances throughout the remainder of the year. A portion of the noninterest balances, especially commercial balances, is sensitive to the interest rate environment. Larger balances tend to be maintained when overall interest rates are low and smaller balances tend to be maintained as overall interest rates increase.
The Corporation elected to opt out of the FDIC’s Temporary Liquidity Guarantee Program (the “TAGP”) effective as of June 30, 2010. Under the TAGP, all noninterest-bearing transaction accounts held at the Corporation’s affiliate banks were fully guaranteed by the FDIC for the entire amount in the account, in addition to and separate from the coverage available under the FDIC’s general deposit rules. Due to the stressed economic conditions that existed in 2008 and 2009, the Corporation believes that its participation in the TAGP was warranted and that such participation had a positive affect on its deposit growth in 2009. As anticipated, certain NOW deposits and certain noninterest bearing deposits, migrated to other deposit accounts, investment products or into products offered by other entities.
Under the Dodd-Frank Act, beginning December 31, 2010 and continuing through December 31, 2012, all funds held in noninterest-bearing transaction accounts will be fully guaranteed by the FDIC for the full amount of the account. This unlimited insurance coverage was eliminated for Interest on Lawyer Trust Accounts and minimal interest-bearing NOW accounts, which were originally covered under TAGP. However, subsequent to the enactment of the Dodd-Frank Act, Congress amended the Federal Deposit Insurance Act to include Interest on Lawyer Trust Accounts within the definition of “noninterest-bearing transaction accounts,” thereby granting such accounts unlimited insurance coverage by the FDIC from December 31, 2010 through December 31, 2012.
In addition to the continuation of insurance coverage for noninterest-bearing transaction accounts, the Dodd-Frank Act permanently increased the standard maximum FDIC deposit insurance amount to $250,000.
2009 Compared to 2008
Total consolidated average deposits increased $1.3 billion or 3.4% for the year ended December 31, 2009 compared to the year ended December 31, 2008. Average noninterest bearing deposits increased $1.6 billion or 26.8% for the year ended December 31, 2009 compared to the year ended December 31, 2008. Average interest bearing deposits decreased approximately $0.3 billion or 0.7% for the year ended December 31, 2009 compared to the year ended December 31, 2008. Of the $0.3 billion decrease in average interest bearing deposits over the prior year, average total money market deposits decreased $0.6 billion and total foreign deposits decreased approximately $2.2 billion for the year ended 2009 compared to the year ended 2008. The decline in average money market and foreign deposits reflects the competitive pricing environment. The declines in average money market deposits and foreign deposits were offset by growth in average savings and NOW deposits and average time deposits. Average savings and NOW increased $1.7 billion for the year ended December 31, 2009 compared to the same period in the prior year. The
growth in average savings and NOW balances reflected the Corporation’s use of competitive pricing and more effective bundling of product and services to retain customers and attract new deposits. In addition, existing customers have transferred their balances from other deposit types as those deposit instruments matured. Average total time deposits increased $0.8 billion for the year ended December 31, 2009 compared to the year ended December 31, 2008. The shift in the mix of average deposit types was beneficial to net interest income and the net interest margin in 2009.
Average Balance Sheets and Analysis of Net Interest Income
The Corporation’s consolidated average balance sheets, interest earned and interest paid, and the average interest rates earned and paid for each of the last three years are presented in the following table ($ in thousands):
Notes:
(1)
Fully taxable equivalent (“FTE”) basis, assuming a Federal income tax rate of 35% for all years presented, and excluding disallowed interest expense.
(2)
Loans and leases on nonaccrual status have been included in the computation of average balances.
(3)
Based on average balances excluding fair value adjustments for available for sale securities.
2010 Compared to 2009
The net interest margin FTE as a percent of average earning assets was 3.15% in 2010 compared to 2.85% in 2009, an increase of 30 basis points. The favorable shift in deposit types, redemption of brokered CDs, lower term
funding costs due in part to the reduction in higher cost long-term borrowings through re-acquisition and maturities and lower nonperforming loans resulted in relatively stable net interest income in the twelve months ended December 31, 2010 compared to the twelve months ended December 31, 2009. At December 31, 2010, the Corporation’s ratio of loans to deposits was 96.7% compared to 106.2% at December 31, 2009. The yield on earning assets decreased by 5 basis points and the cost for interest bearing liabilities declined by 38 basis points for the year ended December 31, 2010 compared to the year ended December 31, 2009. Net interest income in 2010 continued to be compressed as a result of the elevated levels of nonperforming loans and leases, interest rate concessions associated with accruing renegotiated loans and management’s decision to maintain higher levels of liquid assets. The net interest margin FTE in the fourth quarter of 2010 increased by one basis point compared to the reported net interest margin FTE of 3.14% for the third quarter of 2010.
Net interest income and the net interest margin percentage can vary and will continue to be influenced by loan and deposit growth, product spreads, pricing competition in the Corporation’s markets, prepayment activity, future interest rate changes, levels of nonperforming loans and various other factors.
Total long-term borrowings amounted to $5.0 billion at December 31, 2010 compared to $6.4 billion at December 31, 2009, a decrease of $1.4 billion or 21.7%. During 2010, the Corporation re-acquired and extinguished $223.3 million of long-term borrowings at a gain of $19.7 million. Those gains are reported as Gain on Termination of Debt in the Consolidated Statements of Income. During 2009, the Corporation re-acquired and extinguished $1,285.7 million of debt, which resulted in a gain of $99.4 million for the year ended December 31, 2009. In addition, late in 2009 the Corporation modified approximately $580.0 million of Federal Home Loan Bank (“FHLB”) advances by extending the term and lowering the interest rate.
2009 Compared to 2008
The net interest margin on a fully taxable equivalent basis (“FTE”) as a percent of average earning assets was 2.85% in 2009 compared to 3.12% in 2008. The yield on average earning assets was 4.42% in 2009 compared to 5.70% in 2008. The cost of interest bearing liabilities was 1.96% in 2009 compared to 3.03% in 2008. Net interest income was adversely affected by the decline in interest rates, higher levels of nonperforming loans and leases, interest rate concessions associated with renegotiated loans and management’s decision to maintain higher levels of liquid assets which caused the yield on earning assets to decline by 128 basis points. The cost of interest bearing liabilities declined 107 basis points for the twelve months ended December 31, 2009 compared to the twelve months ended December 31, 2008. The Corporation’s inability to continue to lower deposit pricing in the low interest rate environment due to competition for deposits contributed to lower net interest income and reduced net interest margin. The adverse impact of deposit pricing competition was somewhat mitigated by the improved loan to deposit ratio resulting from growth in noninterest bearing deposits. In addition, the net interest margin benefited from reduced use of wholesale funding, a favorable shift in the interest-bearing deposit mix and reduction in higher cost long-term borrowings through modification, early extinguishments and maturities throughout 2009.
Analysis of Changes in Interest Income and Interest Expense
The effects on interest income and interest expense due to volume and rate changes are outlined in the following table. Changes not due solely to either volume or rate are allocated to rate ($ in thousands):
Notes:
(1)
Fully taxable equivalent basis (“FTE”), assuming a Federal income tax rate of 35% for all years presented, and excluding disallowed interest expense.
(2)
Based on average balances excluding fair value adjustments for available for sale securities.
Summary of Loan and Lease Loss Experience and Credit Quality
The following table presents credit quality information as of and for the year ended December 31, 2010, as well as selected comparative years:
Consolidated Credit Quality Information
December 31, ($000’s)
Credit Quality Trends
The Corporation’s credit quality statistics as of and for the year ended December 31, 2010 reinforced recent trends with additional positive evidence that the Corporation has experienced credit improvement. Those trends included the following:
Nonaccrual loans and leases, which the Corporation refers to as nonperforming loans and leases, are considered to be those loans and leases with the greatest risk of loss. Nonperforming loans and leases reached their highest reported quarter-end balance of $2,416.1 million or 5.01% of consolidated loans and leases at June 30, 2009, which was the tenth consecutive quarterly increase in nonperforming loans and leases since December 31, 2006. Since June 30, 2009, nonperforming loans and leases have declined each consecutive quarter-end and amounted to $1,567.7 million or 4.24% of consolidated loans and leases at December 31, 2010, a decrease of $477.1 million or 23.3% since December 31, 2009 and a decrease of $848.4 million or 35.1% since June 30, 2009.
The amount of loans and leases that were placed on nonperforming status in 2010 amounted to $2,631.0 million compared to $4,208.2 million in 2009, a decrease of $1,577.2 million or 37.5%. The amount of loans and leases that were placed on nonperforming status in the fourth quarter of 2010 amounted to $637.6 million compared to $707.1 million in the third quarter of 2010, a decrease of $69.5 million or 9.8%.
Loans past due 30-89 days, excluding credit card loans, student loans and loans in nonperforming status, which the Corporation refers to as early stage delinquencies, decreased $107.7 million or 20.0% at December 31, 2010 compared to December 31, 2009 and decreased $75.8 million or 14.9% at December 31, 2010 compared to September 30, 2010. At December 31, 2010, early stage delinquencies were $431.4 million or 1.2% of total loans and leases compared to $539.1 million or 1.2% at December 31, 2009 and $507.2 million or 1.3% at September 30, 2010. Early stage delinquencies amounted to $1,477.0 million or 3.0% of outstanding loans and leases at March 31, 2009. Since March 31, 2009, early stage delinquencies have decreased $1,045.6 million or 70.8%.
Included in net charge-offs and the provision for loan and lease losses for the year ended December 31, 2010 was the impact of bringing one credit relationship toward a final resolution. That credit relationship consisted of multiple geographically dispersed commercial real estate loans related to the hospitality/lodging industry (“the hospitality/lodging loans”). In conjunction with the actions taken towards that resolution, two commercial real estate loans aggregating $83.2 million were transferred from accruing renegotiated loans to nonperforming loans and $209.4 million was charged off across all of the related commercial real estate loans based on a sale disposition strategy. An additional provision for loan and lease losses of $94.6 million was recorded in 2010 for the shortfall over the amounts reserved in prior periods that resulted from the valuation based on a sale disposition strategy. Management does not believe this credit event is indicative of a trend because the Corporation has no other outstanding credit exposure with the size and characteristics that resemble this one credit relationship. The actions taken by the Corporation in connection with the hospitality/lodging loans adversely affected the reported amounts of net charge-offs, provision for loan and lease losses and the amount of loans and leases that went into nonperforming status for the year ended December 31, 2010, but significantly contributed to the decrease in nonperforming loans and accruing renegotiated loans at December 31, 2010.
Nonperforming Loans and Leases
At December 31, 2010, total nonperforming loans and leases amounted to $1,567.7 million or 4.24% of consolidated loans and leases compared to $2,044.8 million or 4.62% of consolidated loans and leases at December 31, 2009, a decrease of $477.1 million or 23.3%. Included in nonperforming loans and leases at December 31, 2010 and 2009 were $238.1 million and $272.1 million, respectively, of nonperforming renegotiated loans.
The Corporation’s policy for determining when a loan is impaired and placed on nonaccrual status is described in Note 2 in Notes to Consolidated Financial Statements in Consolidated Financial Statements and Supplementary Data for years ended December 31, 2010, 2009 and 2008.
At December 31, 2010, approximately $504.9 million or 32.2% of the Corporation’s total nonperforming loans and leases were less than 30 days past due. In addition, approximately $108.4 million or 6.9% of the Corporation’s total nonperforming loans and leases were greater than 30 days past due but less than 90 days past due at December 31, 2010. In total, approximately $613.3 million or 39.1% of the Corporation’s total nonperforming loans and leases were less than 90 days past due at December 31, 2010. By comparison, at December 31, 2009, approximately $517.8 million or 25.3% of the Corporation’s total nonperforming loans and leases were less than 30 days past due. In addition, approximately $169.4 million or 8.3% of the Corporation’s total nonperforming loans and leases were greater than 30 days past due but less than 90 days past due at December 31, 2009. In total, approximately $687.2 million or 33.6% of the Corporation’s total nonperforming loans and leases were less than 90 days past due at December 31, 2009.
Due to the stress in the real estate markets, which includes elevated levels of delinquencies and volatile real estate values, the adequacy of collateral securing the loan becomes a much more important factor in determining expected loan performance. These factors resulted in the Corporation’s loan and lease portfolio experiencing significantly higher incidences of default and a significant increase in loss severity especially in 2009 and 2008.
For commercial real estate loans, the Corporation obtains updated appraisals at the time a borrower begins to show financial stress. This typically coincides with management’s reassessment of the borrower’s creditworthiness. For consumer type loans, market valuation information is obtained each quarter and appraisals are obtained when a loan is transferred to nonperforming status in anticipation of foreclosure.
An “as is” value estimates the market value of a property in its current physical condition, use, and zoning as of the appraisal date. Depending upon the market and the product type, there is an assumed marketing time of between 6 and 12 months and an assumption that the seller is not compelled to consummate a transaction. Both buyer and seller are typically assumed to be motivated to transact, are well informed, and are acting in what they consider to be in their own best interests.
An “as developed” value estimates the market value of a property value as of the time the development is expected to be completed. Unlike an as is value, an as developed value incorporates assumptions that are projected to occur between the current date and completion date.
A “liquidation value” is the most probable price that a specified interest in real property is likely to bring under the following conditions: (a) consummation of a sale will occur within a severely limited marketing period, (b)
the actual marketing conditions are those currently prevailing for similar properties, (c) the seller is under extreme compulsion to sell, and (d) the buyer is knowledgeable and is acting in what it considers to be its own best interests.
For construction and development loans, specifically for loans where land is the primary collateral for either commercial construction or residential property construction loans, both “as is” and “liquidation value” valuations are obtained in updated appraisals. If these loans are on nonaccrual status, greater emphasis is placed on the liquidation value as the basis for identifying potential impairment.
For construction and development loans, specifically where construction has commenced, “as is,” “as developed,” and/or “liquidation value” valuations may be obtained. Greater weight is placed on the valuation alternative based on the percentage of completion of the project. If substantial construction has been completed, the “as is” or “as developed” valuations would be used to identify potential impairment if the loan is in nonperforming status. Determining the percentage of completed construction requires significant management judgment. The quality of existing tenants, lease commitments for future construction, and lease rates are all considered when selecting the appropriate valuation method for loans where the primary collateral is income producing properties.
In calculating the fair value of collateral for collateral dependent loans, which is used in determining the adequacy of the allowance for loan and lease losses, the Corporation applies 5% to 10% discounts for selling expenses in measuring impairment. In addition, the appropriateness of discounts for “as is” or “liquidation value” appraisals that are more than nine months old are considered in evaluating impairment for collateral dependent loans. The Corporation continuously re-assesses the timeliness and propriety of appraisals for collateral dependent loans, especially in volatile real estate markets such as Arizona. The Corporation uses a variety of sources, such as recent sales of loans and sales of OREO, to validate the collateral values used to determine the amount of loss exposure at the measurement date.
The Corporation continues to work aggressively to isolate, identify and assess its underlying loan and lease portfolio credit quality and has developed and continues to develop strategies to reduce and mitigate its loss exposure. During 2010, the Corporation sold $268.0 million of nonperforming and $23.0 million of potential problem loans. At December 31, 2010, the Corporation held for sale $23.4 million of nonperforming loans and $8.6 million of potential problem loans. Those loans were charged down to their net realizable value when they were classified as held for sale.
The following table shows the Corporation’s nonperforming loans and leases by type of loan or lease, including nonaccrual loans held for sale, at December 31, 2010 and 2009:
Major Categories of Nonperforming Loans and Leases ($ in millions)
Every major category of loans and leases experienced a decline in the amount of nonperforming loans and leases at December 31, 2010 compared to December 31, 2009 except for residential real estate loans and home equity loans and lines of credit.
Consistent with recent quarters, nonperforming real estate loans were the primary source of the Corporation’s nonperforming loans and leases and represented approximately 81.8% of total nonperforming loans and leases at December 31, 2010 compared to approximately 78.2% of total nonperforming loans and leases at December 31, 2009. Nonperforming real estate loans amounted to $1,282.5 million at December 31, 2010 compared to $1,598.4 million at December 31, 2009, a decrease of $315.9 million or 19.8%. Nonperforming real estate loans consisted of the following categories:
Nonperforming commercial real estate loans amounted to $572.8 million at December 31, 2010 compared to $584.9 million at December 31, 2009, a decrease of $12.1 million or 2.1%. Included in the category of nonperforming commercial real estate loans are nonperforming business real estate, multifamily and farmland loans. Nonperforming business real estate loans decreased $64.8 million or 15.8% at December 31, 2010 compared to December 31, 2009. The decrease in the nonperforming hospitality/lodging loans previously discussed was approximately $159.1 million at December 31, 2010 compared to December 31, 2009. Nonperforming multifamily loans increased $48.0 million or 30.1% at December 31, 2010 compared to December 31, 2009. Business and multifamily real estate loans outside the Corporation’s primary markets continued to exhibit stress. Nonperforming farmland loans increased $4.7 million at December 31, 2010 compared to December 31, 2009.
Nonperforming residential real estate (1-4 family) loans increased $67.7 million or 32.9% at December 31, 2010 compared to December 31, 2009 and amounted to $273.8 million or 6.31% of total residential real estate loans at December 31, 2010, compared to $206.1 million or 4.15% of total residential real estate loans at December 31, 2009. Elevated levels of unemployment have continued to be a source of economic stress for this portfolio. Nonperforming residential real estate loans in Arizona were $169.4 million or
61.9% of total nonperforming residential real estate loans at December 31, 2010 and accounted for the majority of the increase in nonperforming residential real estate loans from December 31, 2009 to December 31, 2010.
Since December 31, 2009, nonperforming construction and development loans have declined at each consecutive quarter-end and amounted to $435.9 million at December 31, 2010 compared to $807.4 million at December 31, 2009, a decrease of $371.5 million or 46.0%. The decrease in nonperforming construction and development loans was primarily due to reduced levels of new nonperforming loans, loan sales and charge-offs. The reduced levels of new nonperforming construction and development loans reflect the decline in volume of new larger construction loans transferring to nonperforming status, especially in Florida and Arizona. Nonperforming construction and development loans represented 34.0% of the Corporation’s nonperforming real estate loans and 27.8% of the Corporation’s total nonperforming loans and leases at December 31, 2010. By comparison, nonperforming construction and development loans represented 50.5% of the Corporation’s nonperforming real estate loans and 39.5% of the Corporation’s total nonperforming loans and leases at December 31, 2009. Nonperforming construction and development loans in Florida and Arizona accounted for $173.4 million or 39.8% of total nonperforming construction and development loans at December 31, 2010.
Nonperforming consumer loans and leases amounted to $94.9 million at December 31, 2010 compared to $95.9 million at December 31, 2009, a decrease of $1.0 million or 1.0%. Nonperforming consumer loans and leases as a percent of total consumer loans and leases were 1.75% at December 31, 2010 and 1.35% at December 31, 2009. The modest increase reflects the effect of lingering elevated levels of unemployment that have continued to be a source of economic stress for consumers.
The following table presents a geographical summary of nonperforming loans and leases, including nonaccrual loans held for sale, at December 31, 2010 and 2009:
Geographical Summary of Nonperforming Loans & Leases ($ in millions)
At December 31, 2010, nonperforming loans in Arizona amounted to $314.7 million or 7.62% of loans outstanding in Arizona compared to $431.4 million or 8.08% of loans outstanding in Arizona at December 31, 2009, a decrease in nonperforming loans of $116.7 million or 27.1%. Nonperforming loans in Arizona represented 20.1% of total consolidated nonperforming loans and leases at December 31, 2010 and continue to be one of the largest concentrations of nonperforming loans in the Corporation’s loan and lease portfolio. Nonperforming residential real estate loans in Arizona increased $48.3 million or 39.9% during 2010 and amounted to $169.4 million or 53.8% of nonperforming loans in Arizona at December 31, 2010 compared to $121.1 million or 28.1% of nonperforming loans in Arizona at December 31, 2009. Nonperforming construction and development loans in Arizona decreased $155.2 million or 65.9% during 2010 and amounted to $80.2 million or 25.5% of nonperforming loans in Arizona at December 31, 2010 compared to $235.4 million or 54.6% of nonperforming loans in Arizona at December 31, 2009.
The largest geographic concentration of loans and leases in the Corporation’s loan and lease portfolio is in Wisconsin. The Wisconsin loan and lease portfolio has consistently maintained the lowest percent of nonperforming loans and leases to total loans and leases compared to the Corporation’s other markets. Consistent with the Corporation’s total loan and lease portfolio, loans and leases in Wisconsin have experienced some elevated levels of stress across the portfolio but generally have performed better than the Corporation’s other markets. Nonperforming loans in Wisconsin represented 19.7% of total consolidated nonperforming loans at December 31, 2010.
Nonperforming loans and leases in Wisconsin amounted to $401.7 million or 2.43% of total loans and leases outstanding in Wisconsin at December 31, 2009. Nonperforming loans and leases in Wisconsin decreased $92.3 million or 23.0% from December 31, 2009 to December 31, 2010. Approximately $50.0 million of that decrease was associated with a loan to a bank holding company that was charged-off during the first quarter of 2010.
Loans and leases in Minnesota and Indiana have experienced some elevated levels of stress. The increase in nonperforming loans in Minnesota at December 31, 2010 compared to December 31, 2009 was primarily attributable to commercial real estate and residential real estate loans placed on nonperforming status during 2010. The increase in nonperforming loans in Indiana at December 31, 2010 compared to December 31, 2009 was generally across all loan types except commercial loans. Nonperforming loans and leases in Kansas and Missouri decreased across most loan types in 2010 compared to 2009 except for nonperforming residential real estate loans.
Nonperforming loans in Florida amounted to $213.3 million at December 31, 2010 compared to $307.5 million at December 31, 2009, a decrease of $94.2 million or 30.6%. Nonperforming loans in Florida represented 13.6% of total consolidated nonperforming loans at December 31, 2010. Nonperforming commercial real estate loans in Florida decreased $17.9 million or 19.5% during 2010 and amounted to $74.0 million or 34.7% of nonperforming loans in Florida at December 31, 2010 compared to $91.9 million or 29.9% of nonperforming loans in Florida at December 31, 2009. Nonperforming construction and development loans in Florida decreased $77.6 million or 45.4% during 2010 and amounted to $93.2 million or 43.7% of nonperforming loans in Florida at December 31, 2010 compared to $170.8 million or 55.5% of nonperforming loans in Florida at December 31, 2009. Consistent with the trends exhibited in the Corporation’s other markets, nonperforming residential real estate loans increased in 2010 compared to 2009.
Nonperforming loans outside of the Corporation’s primary markets amounted to $402.9 million at December 31, 2010 compared to $513.6 million at December 31, 2009, a decrease in nonperforming loans of $110.7 million or 21.5%. The decrease in the nonperforming hospitality/lodging loans previously discussed was approximately $121.9 million at December 31, 2010 compared to December 31, 2009. In addition, nonperforming construction and development loans outside of the Corporation’s primary markets decreased $77.4 million or 38.4% at December 31, 2010 compared to December 31, 2009. Business and multifamily real estate loans outside the Corporation’s primary markets continued to exhibit stress in 2010.
Other Real Estate Owned (OREO)
OREO is principally comprised of commercial and residential properties acquired in partial or total satisfaction of problem loans. Activity relating to OREO for the three years ended December 31, 2010 consisted of the following:
Write-downs at initial transfer from loans to OREO are recorded as charge-offs. Valuation adjustments after the initial transfer, which are included as a component of Net OREO Expenses in the Consolidated Statements of Income, reflect the decline in real estate values due to the economy and elevated levels of unemployment and other real estate market conditions at the measurement date.
At December 31, 2010, properties acquired in partial or total satisfaction of problem loans, based on loan type, consisted of construction and development of $202.3 million, 1-4 family residential real estate of $54.3 million and commercial real estate of $82.9 million. At December 31, 2009, properties acquired in partial or total satisfaction of problem loans, based on loan type, consisted of construction and development of $336.9 million, 1-4 family residential
real estate of $31.6 million and commercial real estate of $62.3 million. OREO in Arizona represented approximately 17.8%, 43.1% and 50.8% of total OREO at December 31, 2010, 2009 and 2008, respectively. As a result of the soft real estate market and the increased possibility of foreclosures due to the elevated levels of nonperforming loans, management expects that OREO will remain at elevated levels in future quarters.
Troubled Debt Restructurings (Renegotiated Loans)
The Corporation does not characterize all modified loans as troubled debt restructurings (“TDR”). In the ordinary course of business, the Corporation modifies loan terms across loan types, including both consumer and commercial loans, for a variety of reasons. For example, modifications to consumer loans are generally limited to short-term deferrals to accommodate specific, temporary circumstances. The Corporation frequently grants extensions to help consumers who have demonstrated a willingness and ability to repay their loan in the event of a specific unforeseen temporary hardship event. An extension defers monthly payments and requires a balloon payment at the original contractual maturity. Extensions are predominantly granted to defer one monthly payment. On an exception basis, an extension may occasionally be granted to defer up to three monthly payments. The Corporation does not consider these extensions to be troubled debt restructurings. The Corporation believes that these short-term extensions represent the type of modification any bank would otherwise consider especially in situations where the temporary event is not expected to impact a borrower’s ability to repay the debt, and where the Corporation expects to collect all amounts due including interest accrued at the contractual interest rate for the period of delay at contractual maturity.
Modifications to commercial loans may include, but not be limited to, changes in interest rate, maturity, amortization and financial covenants. In the original underwriting, loan terms are established that represent the then current and projected financial condition of the borrower. Over any period of time, modifications to these loan terms may be required due to changes in the original underwriting assumptions. These assumptions may include the changing financial requirements of the borrower as well as changes in underwriting standards of the Corporation. If the modified terms are consistent with competitive market conditions and representative of terms the borrower could otherwise obtain in the open market, the modified loan is not categorized as a TDR.
For a loan modification to be a TDR, which the Corporation also refers to as “renegotiated loans,” the following three conditions must all be present: (1) the borrower is experiencing financial difficulty, (2) the Corporation makes a concession to the original contractual loan terms, and (3) the concessions are for economic or legal reasons related to the borrower’s financial difficulty that the Corporation would not otherwise consider.
Modifications of loan terms to borrowers experiencing financial difficulty are made in an attempt to protect as much of the Corporation’s investment in the loan as possible. These modifications are generally made to either prevent a loan from becoming nonaccrual or to return a nonaccrual loan to performing status based on the expectation that the borrower can adequately perform in accordance with the modified terms.
The determination of whether a modification should be accounted for as a TDR requires significant judgment after taking into consideration all facts and circumstances surrounding the transaction. No single characteristic or factor, taken alone, is determinative of whether a modification should be classified as a TDR. The fact that a single characteristic is present in a transaction is not considered sufficient to overcome the preponderance of contrary evidence.
Assuming all the other TDR criteria are met, the Corporation considers one or a combination of the following concessions to the loan terms to be a TDR: (1) a reduction of the stated interest rate, (2) an extension of the contractual maturity at a stated interest rate lower than the current market rate for a new loan with a similar term, or (3) forgiveness of principal or accrued interest.
Overview
The Corporation recognizes that the current economy, elevated levels of unemployment and depressed real estate values have resulted in many customers being far more leveraged than prudent and in a very difficult financial position. Through various forms of communications, the Corporation encourages all customers to contact the Corporation if they are experiencing financial difficulties so that their individual situations can be assessed and to discuss alternatives before formal collection actions are required. In addition, the Corporation monitors borrowers that are not currently delinquent. For those borrowers with an original credit bureau score at or below an established level, the Corporation determines if there has been a specified decline in their current credit bureau score. Customers meeting
those criteria are solicited directly and encouraged to contact the Corporation if they are experiencing financial difficulties.
In many cases, the Corporation has restructured loan terms for certain qualified financially distressed borrowers that have agreed to work in good faith to reach a successful repayment agreement and, as previously discussed, have demonstrated the ability to make the restructured payments in order to avoid a pending foreclosure or a foreclosure in the future. The Corporation has predominantly used reduced interest rates and extended terms to lower contractual payments.
Accruing troubled debt restructured loans, which the Corporation refers to as “accruing renegotiated loans,” amounted to $548.4 million at December 31, 2010 compared to $793.5 million at December 31, 2009. At December 31, 2010, approximately 26.1% of accruing renegotiated loans were restructured at market interest rates and could be eligible to be transferred out of renegotiated status at the beginning of next year if their payments remain current according to the restructured terms and were current at the end of the year. Irrespective of their classification, these loans are specifically assessed for impairment for purposes of determining the allowance for loan and lease losses.
After restructuring, renegotiated loans result in lower payments than originally required and therefore have a lower risk of loss due to nonperformance than loans classified as nonperforming. The Corporation’s instances of default and re-default on consumer-related renegotiated loans have been relatively favorable compared with data published by national bank and thrift regulators.
At December 31, 2010, the re-default rates for those consumer-related renegotiated loans that were restructured between June 2008 and December 2009 by loan type were as follows:
Re-default Rates on Consumer-Related Renegotiated Loans
The Corporation attributes this experience to its processes used to determine a reasonable repayment program for qualified borrowers and its policy of requiring such borrowers to demonstrate the ability to make the restructured payments for a specified period of time before the loan is transferred to accruing renegotiated status. The Corporation’s experience with renegotiated loan performance does not encompass an extended period of time. The Corporation generally has not observed a consistent pattern on the frequency of re-defaults based on the passage of time. Based on the Corporation’s limited experience, the timing of re-defaults on consumer-related renegotiated loans appear to be more attributable to some event such as loss of employment. Irrespective of the Corporation’s procedures and policies, payment performance will continue to be adversely affected by unexpected increases and prolonged levels of elevated unemployment.
At December 31, 2010 and 2009, the delinquency status of the Corporation’s accruing renegotiated loans was as follows:
Accruing Renegotiated Loans Delinquency Status
($000’s)
The Corporation considers accruing renegotiated loans that are less than 30 days past due to be current because of the numerous factors other than credit quality that may cause payments to be temporarily past due. Renegotiated loans past due 90 days or more are classified as nonaccrual and reported as nonperforming loans.
The Corporation expects nonaccrual loans will initially increase until the loan terms are restructured. Upon restructuring, nonaccrual loans will decline and the balance of accruing renegotiated loans will increase. The Corporation expects the balance of accruing renegotiated loans will continue to be elevated in future quarters.
Commercial Loans
Underwriting for all commercial loan modifications follows established credit risk management policies and includes an assessment of the credit risk profile and analysis of the borrower’s current financial position. Included in this analysis is a detailed review of the borrower’s ability to continue to service its loans under the existing contractual agreement. Each decision to modify a loan is required to be supported by a written underwriting summary appropriate for the size and type of credit that establishes the sufficiency of the primary and secondary sources of repayment based on the modified terms.
This analysis includes, but is not limited to, a detailed analysis of the borrower’s ability to adequately maintain a current payment history under the restructured agreement. For collateral-dependent loans, this analysis also includes current appraisals or valuations of the collateral so that updated loan-to-values are within the Corporation’s loan policy guidelines. The analysis may also include an assessment of the borrower’s management team and the industry in which it competes. These factors, along with any other factors that management of the Corporation may deem appropriate given the risk profile of the borrower, are analyzed to ensure a high probability that the borrower will be able to perform under the terms and conditions of the modified loan.
Commercial loans are returned to an accrual status when receipt of principal and interest payments as they become contractually due is not in doubt based on the preponderance of evidence in the credit analysis, the borrower’s successful past performance, or performance under the modified terms exceeds nine months. Otherwise, interest income is recognized using a cost recovery method.
In connection with the extension, renewal or restructuring of a loan with an interest reserve, additional interest reserves may be funded by the borrower, partially funded by the borrower and the Corporation or fully provided by the Corporation. Typically, interest reserves provided by the Corporation are secured by additional collateral and are limited to more conservative advance rates on the pledged collateral. These loans must also be supported by an analysis of the borrower’s willingness and capacity to service the debt.
Consumer Loans
Prior to approval of a consumer loan modification, the Corporation performs a comprehensive financial review of the borrower, which entails an evaluation of the borrower’s total income and total expenses. The Corporation’s evaluation of a borrower’s total expenses is more comprehensive than the evaluation typically undertaken by the credit bureaus. The Corporation’s review is substantiated by an analysis of the borrower’s bank account activity and updated credit bureau reports. Modifications seek to offer the customer an affordable housing payment, maintain total debt service within a prescribed range of net income and provide a monthly cash flow cushion for unexpected events.
For all modified loans, the Corporation maintains the assessment of the borrower’s hardship, debt service capacity, financial condition and prospects for repayment under the revised terms, along with a hardship letter, personal
financial worksheet, credit bureau report, proof of income, bank statements and status of homeowner’s insurance and taxes.
In addition to the comprehensive financial review, the Corporation generally requires a successful completion of a performance period prior to a formal modification for consumer loans. For borrowers whose pre-modified loan was less than 90 days past due at the time of modification, three payments at the proposed restructured payment amount (a three-month performance period) are required before the formal restructuring. Since repayment performance had been maintained under the original terms and the Corporation has modified the repayment terms to be consistent with the borrower’s re-underwritten debt service capacity, the Corporation is able to determine that it can be reasonably assured that the loan will perform according to the modified terms after the customer successfully completed the three-month performance period prior to the formal restructuring.
If the customer’s pre-modified loan was past due 90 days or more or if the customer’s Total Debt to Total Income ratio exceeds 100%, nine payments based on the proposed restructured terms are required (a nine-month performance period) before a formal modification is made. Because the borrower was greater than 90 days past due, a longer performance period is required prior to the formal modification. Since the customer will have successfully completed the performance period prior to the formal restructuring based on repayment terms modified to be consistent with the re-underwritten debt service capacity, the Corporation is able to determine that it can be reasonably assured that the loan will perform according to the modified terms.
Successful performance results in a formal restructuring agreement, at which time the restructured loan will return to an accrual status.
The following table shows the Corporation’s accruing renegotiated loans by type of loan at December 31, 2010 and 2009.
Major Categories of Accruing Renegotiated Loans ($ in millions)
At December 31, 2010, consumer-related accruing renegotiated loans (residential real estate, residential land, construction by individuals, home equity loans and lines of credit and other consumer loans) represented 72.5% of total accruing renegotiated loans. By comparison, at December 31, 2009, consumer-related accruing renegotiated loans represented 82.1% of total accruing renegotiated loans.
Total accruing renegotiated loans amounted to $548.4 million at December 31, 2010 compared to $793.5 million at December 31, 2009, a decrease of $245.1 million or 30.9%. In addition to normal activity, that decline
reflects the effect of approximately $189.0 million of renegotiated loans that were transferred out of renegotiated status to performing loans during the first quarter of 2010.
The amount of accruing renegotiated loans that were placed in nonperforming status for the year ended December 31, 2010 amounted to $275.6 million compared to $334.2 million for the year ended December 31, 2009, a decrease of $58.6 million or 17.6%. Included in the amount of accruing renegotiated loans that were placed in nonperforming status in 2010 were two commercial real estate loans aggregating $83.2 million that were transferred in conjunction with the actions taken toward a final resolution of the previously discussed single credit relationship that consisted of multiple geographically dispersed commercial real estate loans related to the hospitality/lodging industry.
The Corporation has determined that it will be less likely to restructure significant amounts of commercial, commercial real estate and construction and development loans in the future as economic conditions have demonstrated that once a degree of stress becomes evident in a project, the likelihood of a successful outcome is greatly diminished. Unlike commercial and commercial real estate loans, the Corporation believes the restructuring process has been successful with respect to residential real estate and consumer home mortgage loans.
The following table shows the geographical summary of the Corporation’s accruing renegotiated loans at December 31, 2010 and 2009.
Geographical Summary of Accruing Renegotiated Loans ($ in millions)
The majority of the accruing renegotiated loans have been originated in the Arizona market. At December 31, 2010, approximately $285.7 million or 92.4% of Arizona accruing renegotiated loans related to consumer-related loans.
Accruing renegotiated loans located outside of the Corporation’s primary markets amounted to $78.0 million at December 31, 2010 compared to $206.7 million at December 31, 2009, a decrease of $128.7 million or 62.2%. That decline reflects payments and the transfer of $83.2 million of accruing renegotiated commercial real estate loans to nonperforming status as previously discussed.
Past Due Loans and Leases
Loans 90 days past due and still accruing interest amounted to $6.1 million at December 31, 2010 compared to $8.8 million at December 31, 2009.
Delinquency can be an indicator of potential problem loans and leases. At December 31, 2010, early stage delinquencies amounted to $431.4 million or 1.2% of total loans and leases outstanding compared to $539.1 million or 1.2% of total loans and leases outstanding at December 31, 2009, a decrease of $107.7 million or 20.0%. Early stage delinquencies peaked at March 31, 2009 and amounted to $1,477.0 million or 3.0% of total loans and leases outstanding. Management expects that a stabilized level for early stage delinquencies will be in the range of 1.5% of total loans and leases outstanding.
The following table presents the reconciliation of the consolidated allowance for loan and lease losses for the year ended December 31, 2010, as well as selected comparative years:
Reconciliation of Consolidated Allowance for Loan and Lease Losses ($000’s)
Summary of Net Charge-Offs on Loans and Leases
Year Ended December 31, ($000’s)
Net charge-offs amounted to $1,851.8 million or 4.49% of average loans and leases in 2010 compared to $2,036.3 million or 4.26% of average loans and leases in 2009 and $1,363.8 million or 2.74% of average loans and leases in 2008. The net charge-offs for the periods presented in the table above include the net charge-offs related to the loans that were sold during 2010 and 2009.
Included in commercial real estate net charge-offs for the year ended December 31, 2010 was the impact of bringing one credit relationship toward a final resolution. That credit relationship consisted of multiple geographically dispersed commercial real estate loans related to the hospitality/lodging industry. In conjunction with the actions taken towards that resolution, $209.4 million was charged-off across all of the related commercial real estate loans based on a sale disposition strategy.
Included in net charge-offs for commercial loans and leases for the year ended December 31, 2010 was approximately $76.6 million in charge-offs related to loans to certain bank holding companies, of which $50.0 million was related to one bank holding company loan. Included in net charge-offs for the year ended December 31, 2009 were charge-offs related to loans to certain bank holding companies that amounted to $159.8 million.
Included in total net charge-offs for the year ended December 31, 2009 were $185.4 million in net charge-offs related to the bulk sale of a pool of consumer loans, of which $184.5 million were residential real estate loans net charge-offs.
Excluding the charge-offs for the commercial real estate loans related to the hospitality/lodging industry, the loans to bank holding companies and net charge-offs related to the bulk sale of a pool of consumer loans, net charge-offs amounted to $1,565.8 million or 3.80% of average loans and leases in 2010 compared to $1,691.1 million or 3.54% of average loans and leases in 2009, a decrease of $125.3 million or 7.4%. That decrease in net charge-offs was experienced across all loan types except net charge-offs for commercial real estate loans and home equity loans. Net charge-offs on construction and development loans experienced the largest decrease in 2010 compared to 2009.
Net charge-offs for construction and development loans amounted to $623.5 million for the year ended December 31, 2010 compared to $853.5 million for the year ended December 31, 2009, a decrease of $230.0 million or 26.9%. Net charge-offs for construction and development loans represented 33.7% of total net charge-offs in 2010 and, consistent with the prior two years, continued to be the largest concentration of net charge-offs across the various loan types.
Net charge-offs for commercial real estate loans represented 31.2% of total net charge-offs in 2010. Excluding the hospitality/lodging loan charge-offs, net charge-offs for commercial real estate loans amounted to $368.8 million for the year ended December 31, 2010 compared to $237.2 million for the year ended December 31, 2009, an increase of $131.6 million or 55.4%. Approximately $85.5 million of that increase related to loans for commercial and industrial developments and $52.1 million of that increase related to loans for residential real estate developments such as multi-family and residential condominium developments. Within loans for commercial and industrial developments, net charge-offs associated with loans for retail trade, offices and recreation exhibited the largest increase in net charge-offs in 2010 compared to 2009. Like other bank holding companies, this portfolio experienced increased stress across all of the Corporation’s markets in 2010.
The majority of the Corporation’s net charge-offs in 2010 and 2009 were attributable to loans in Arizona, Florida and loans outside the Corporation’s primary markets. Net charge-offs related to loans in Arizona, Florida and loans outside the Corporation’s primary markets amounted to $1,082.9 million or 69.2% of total net charge-offs of $1,565.8 million in 2010, excluding the charge-offs for the commercial real estate loans related to the hospitality/lodging industry and loans to bank holding companies. By comparison, net charge-offs related to loans in Arizona, Florida and loans outside the Corporation’s primary markets amounted to $1,319.8 million or 78.0% of total net charge-offs of $1,691.1 million in 2009, excluding the charge-offs for the loans to bank holding companies and net charge-offs related to the bulk sale of a pool of consumer loans. Although net charge-offs in Arizona, Florida and net charge-offs outside the Corporation’s primary markets continued to be the largest geographical proportion of the Corporation’s net charge-offs, the amount of net charge-offs in Arizona and net charge-offs outside the Corporation’s primary markets decreased in 2010. Net charge-offs in Arizona and net charge-offs outside the Corporation’s primary markets in 2010 decreased $288.7 million or 26.2% compared to 2009. Net charge-offs in the Corporation’s primary markets, other than Arizona, increased in 2010 compared to 2009 due to the increased stress in commercial real estate loans.
While there were signs of improvement, real estate related loans continued to be the primary source of the elevated levels in nonperforming loans and leases and net charge-offs in 2010. Real estate related loans represented the majority of the Corporation’s nonperforming loans and leases at December 31, 2010. In a stressed real estate market, the value of the collateral securing the loans has become one of the most important factors in determining the amount of loss incurred and the appropriate amount of allowance for loan and lease losses to record at the measurement date. The likelihood of losses that are equal to the entire recorded investment for a real estate loan is remote. However, in many cases, rapidly declining real estate values have resulted in the determination that the estimated value of the collateral was insufficient to cover all of the recorded investment in the loan which has required additional charge-offs. Declining or reduced collateral values have significantly contributed to the elevated levels of net charge-offs and the elevated levels in the provision for loan and lease losses that the Corporation experienced over the past three years.
Partial Charge-Offs
The Corporation’s accounting policies for charge-offs are described in Note 2 in Notes to Consolidated Financial Statements. Consistent with regulatory guidance and the Corporation’s loan policy, charge-offs are taken when specific loans, or portions thereof, are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. The Corporation’s policy is to promptly charge these loans off in the period the uncollectible loss amount is reasonably determined. The charge-off does not mean that the asset has no recovery or salvage value, but rather that it is not practical to defer writing down this loan when available information confirms that the loan or a portion thereof, is uncollectible.
The amount of cumulative net charge-offs recorded on the Corporation’s nonperforming loans outstanding at December 31, 2010 was approximately $876.2 million or 52.3% of the unpaid principal balance of the affected nonperforming loans.
The Corporation’s nonperforming loans and leases at December 31, 2010 and 2009 consisted of the following ($000’s):
The result of recording partial charge-offs on nonperforming loans and leases had the following impact on certain credit quality statistics at December 31, 2010 and 2009:
As shown in the above table, the ratio of the allowance for loan and lease losses to nonperforming loans and leases (excluding nonperforming loans held for sale) is affected by the amount of partial charge-offs recorded on nonperforming loans because the partial charge-offs reduce the allowance for loan and lease losses required at the measurement date. The partial charge-offs have significantly contributed to the reported decline in the ratio of the allowance for loan and lease losses to nonperforming loans and leases (excluding nonperforming loans held for sale) in recent years.
Allocation of the Allowance for Loan and Lease Losses ($000’s)
The following table presents the allocation of the consolidated allowance for loan and lease losses at December 31, 2010, as well as selected comparative years:
See Note 9 in Notes to Consolidated Financial Statements for additional information on the allocation of the consolidated allowance for loan and lease losses at December 31, 2010.
Provision for Loan and Lease Losses
Consistent with the credit quality trends noted above, the provision for loan and lease losses amounted to $1,758.9 million for the year ended December 31, 2010. By comparison, the provision for loan and lease losses amounted to $2,314.6 million in 2009 and $2,037.7 million in 2008. The provision for loan and lease losses is the amount required to establish the allowance for loan and lease losses at the required level after considering charge-offs and recoveries. The ratio of the allowance for loan and lease losses to total loans and leases was 3.75% at December 31, 2010 compared to 3.35% at December 31, 2009 and 2.41% at December 31, 2008.
Included in net charge-offs and the provision for loan and lease losses for the year ended December 31, 2010 was the impact of bringing one credit relationship toward a final resolution. That credit relationship consisted of multiple geographically dispersed commercial real estate loans related to the hospitality/lodging industry. In conjunction with the actions taken towards that resolution, two commercial real estate loans aggregating $83.2 million were transferred from accruing renegotiated loans to nonperforming loans and $209.4 million was charged-off across all of the related commercial real estate loans based on a sale disposition strategy. An additional provision for loan and
lease losses of $94.6 million was recorded in 2010 for the shortfall over prior period reserved amounts that resulted from the valuation based on the sale disposition strategy.
At December 31, 2010, the allowance for loan and lease losses amounted to $1,387.6 million or 3.75% of total loans and leases compared to $1,480.5 million or 3.35% of total loans and leases at December 31, 2009. The decrease in the allowance for loan and lease losses in 2010 of $92.9 million compared to 2009 reflects the lower amount of loans and leases and lower amount of nonperforming loans and leases outstanding at December 31, 2010, the other improving credit quality trends previously discussed and the utilization of prior period reserved amounts established for the hospitality/lodging loans charged off during 2010.
The Corporation’s credit quality statistics as of and for the year ended December 31, 2010 reinforced recent trends with additional positive evidence that the Corporation has experienced credit improvement. Consistent with prior quarters in 2010, during the fourth quarter of 2010, the Corporation experienced a decline in nonperforming loans for the sixth consecutive quarter, continued reduced levels of delinquencies and new loans going into nonperforming status and lower levels of net charge-offs. The reported amount of the Corporation’s nonperforming loans and leases and new loans and leases placed on nonperforming status in 2010 continue to be elevated especially in the commercial loan portfolios. The improving economy remains fragile, unemployment levels continue to be elevated and underlying collateral values continue to reflect a somewhat illiquid market. The Corporation’s allowance for loan and lease losses at December 31, 2010 has taken these factors into consideration.
Management expects that these trends will continue. Management also expects that continuing credit improvement along with continued improvement in the economy and a reduction or stabilization in unemployment would result in lower provisions for loan and lease losses and a reduced allowance for loan and lease losses in future quarters. There are numerous unknown factors at this time that will ultimately affect the timing and amount of nonperforming loans and leases, net charge-offs and the provision for loan and lease losses that will be recognized in 2011. The timing and amount of charge-offs will continue to be influenced by loan sales and the Corporation’s other strategies for managing its nonperforming loans and leases.
Consolidated Loan and Lease Risk Profile
In determining the adequacy of the allowance for loan and lease losses, management considers a number of factors to assess the risk and determine the amount of inherent loss in the portfolio at the measurement date. The tables below present certain statistics that are indicators of credit risk by loan type and provides supplemental information that, together with the previous discussion, is intended to assist in obtaining an understanding of the current credit risks that are in each loan type.
Commercial Loans and Leases
Commercial loans and leases are extended across many industry types that at December 31, 2010 included: manufacturing (24%), wholesale trade (15%), finance and insurance (10%), retail trade (8%), real estate (7%), construction (5%), professional (5%), agriculture (5%), transportation and warehousing (4%), management companies (3%) and health care (3%).
Commercial loans and leases are evaluated for the adequacy of repayment sources at the time of approval and are regularly reviewed for any possible deterioration in the ability of the borrower to repay the loan. Collateral varies by individual customer and may include accounts receivable, inventory, equipment, deposits, securities, personal guarantees, general business security agreements and real estate.
Commercial loans and leases are associated with customers located in Wisconsin (43%), Minnesota (14%), Missouri (10%), Illinois (5%), Arizona (4%), Indiana (4%), Florida (3%) and Kansas (3%).
Commercial and industrial loans continued to contract in 2010 compared to 2009. Commercial customers appear to still be focused on expense management and debt reduction by delaying capital expenditures and reducing working capital demand. Commercial loan commitments and credit line utilization have declined. Commercial loan and lease balances and the demand for new credit will depend on the pace and strength of economic improvement.
Nonperforming commercial loans and leases amounted to $190.3 million at December 31, 2010 compared to $350.5 million at December 31, 2009, a net decrease of $160.2 million.
Accruing renegotiated commercial loans decreased $22.0 million or 47.4% at December 31, 2010 compared to December 31, 2009. That decrease was primarily the result of the payout of the largest loan that was classified as an accruing renegotiated commercial loan as of December 31, 2009. At December 31, 2010, the remaining accruing renegotiated commercial loans consisted of numerous smaller balance loans.
Charge-offs related to loans to bank holding companies amounted to $76.6 million in 2010. Included in net charge-offs for the year ended December 31, 2010, was a charge-off of approximately $50.0 million related to a loan to one bank holding company. That loan had been fully reserved since being placed in nonperforming status earlier in 2009. Included in net charge-offs for the year ended December 31, 2009 were charge-offs related to loans to certain bank holding companies that amounted to $159.8 million.
The charge-offs in 2009 related to four bank holding companies and were taken due to a series of events that included: (1) a significant deterioration in the loan portfolios of certain of these bank holding companies, (2) unanticipated difficulties or delays in capital raising transactions by certain of these bank holding companies, and (3) regulatory actions against certain of these bank holding companies. At December 31, 2010 and 2009, loans outstanding to bank holding companies were approximately $392.9 million and $535.0 million, respectively. At December 31, 2010, the loans outstanding to bank holding companies included $12.2 million of loans in nonperforming status and $224.4 million identified as potential problem loans.
The ratio of nonaccrual commercial loans and leases to total commercial loans and leases at December 31, 2010 was 1.64% compared to 2.71% at December 31, 2009. The average annualized net charge-offs for commercial loans and leases over the past nine quarters based on end of period loans were 2.8%. Excluding the charge-offs relating to loans to bank holding companies, the average annualized net charge-offs for commercial loans and leases over the past nine quarters based on end of period loans was 2.0%.
At December 31, 2010, the allowance for consolidated commercial loan and lease losses amounted to $384.9 million or 3.31% of consolidated commercial loans and leases compared to an allowance of $289.9 million or 2.24% of consolidated commercial loans and leases at December 31, 2009. The increase in the allowance for consolidated commercial loan and lease losses was primarily due to the exposure to loans to bank holding companies.
Commercial Real Estate Loans
Commercial real estate loans include multi-family properties and business purpose loans secured by 1-4 family residences (28%), industrial (16%), office (15%), retail (15%), farmland (6%), hospitality/lodging (5%), and medical facilities (4%). Commercial real estate loans as presented do not include commercial construction and land development loans.
The Corporation has established policies that set standards for maximum commercial mortgage amounts by type of property, loan terms, pricing structures, loan-to-value limits by property type, minimum requirements for initial investment and maintenance of equity by the borrower, borrower net worth, property cash flow and debt service coverage as well as policies and procedures for granting exceptions to established underwriting standards. Commercial mortgages are evaluated for adequacy of repayment sources at the time of approval and regularly reviewed for any possible deterioration in the ability of the borrower to repay the loan.
Commercial real estate loans are located primarily in the Midwest: Wisconsin (45%), Minnesota (12%), Missouri (8%), Illinois (5%), Indiana (4%) and Kansas (2%). Commercial real estate loans in higher risk markets include Arizona (7%) and Florida (7%).
As a result of the economy, the Corporation has experienced minimal new development loan activity. For the year ended December 31, 2010, average commercial real estate loans amounted to $13,255.1 million compared to average commercial real estate loans of $13,522.8 million for the year ended December 31, 2009.
A portion of the reported year end average amount represents the migration of construction loans to commercial real estate loans once construction is completed. In normal market conditions, the Corporation generally limited the amount of post construction financing (permanent financing) it provided to those loans with interest rates and terms that conform to the Corporation’s interest rate risk profile or loans where a significant long-term customer relationship existed. In many cases, the interest rate and term that customers wanted for permanent financing was readily available and provided by institutional investors in normal market conditions. The current lack of market liquidity has resulted in customers not being able to secure financing elsewhere irrespective of their ability to service the debt. As a result, the Corporation has provided interim loans that are intended to provide temporary financing until such time as the liquidity in the commercial real estate lending markets returns to normal conditions. The interim loans may be interest only or structured to ensure a significant amount of the income generated from the commercial real estate project is used to pay interest at market rates and reduce outstanding principal. At the present time, management does not believe that these interim loans have resulted in increased incremental credit risk compared to other commercial real estate loans or have resulted in a significant increase in concentration risk that requires special consideration in determining the adequacy of the allowance for loan and lease losses.
At December 31, 2010, commercial real estate loans consisted of business real estate loans of $8,337.0 million, multi-family properties and business purpose loans secured by 1-4 family residences of $3,326.3 million and farmland loans of $738.0 million. At December 31, 2010, nonperforming business real estate loans amounted to $345.4 million or 4.14% of total business real estate loans, nonperforming multi-family properties and business purpose loans secured by 1-4 family residences amounted to $207.5 million or 6.24% of total multi-family properties and business purpose loans secured by 1-4 family residences and nonperforming farmland loans amounted to $19.9 million or 2.71% of total farmland loans.
At December 31, 2010, approximately 40% of the business real estate loans were owner-occupied. Owner-occupied real estate loans are generally expected to have lower levels of default risk.
Nonperforming commercial real estate loans amounted to $572.8 million at December 31, 2010 compared to $584.9 million at December 31, 2009, a decrease of $12.1 million or 2.1%. Included in the category of nonperforming commercial real estate loans are nonperforming business real estate, multifamily and farmland loans. Nonperforming business real estate loans decreased $64.8 million or 15.8% at December 31, 2010 compared to December 31, 2009. The decrease in the nonperforming hospitality/lodging loans discussed below was approximately $159.1 million at December 31, 2010 compared to December 31, 2009. Nonperforming multifamily loans increased $48.0 million or 30.1% at December 31, 2010 compared to December 31, 2009. Business and multifamily real estate loans outside the Corporation’s primary markets continued to exhibit stress. Nonperforming farmland loans increased $4.7 million at December 31, 2010 compared to December 31, 2009.
Included in commercial real estate net charge-offs for the year ended December 31, 2010 was the impact of bringing one credit relationship toward a final resolution. That credit relationship consisted of multiple geographically dispersed commercial real estate loans related to the hospitality/lodging industry. In conjunction with the actions taken towards that resolution, two commercial real estate loans aggregating $83.2 million were transferred from accruing renegotiated loans to nonperforming loans and $209.4 million was charged-off across all of the related commercial real estate loans based on a sale disposition strategy. Management does not believe this credit event is indicative of a trend because the Corporation has no other outstanding credit exposure of a size and characteristic that resembles this one credit relationship.
Net charge-offs for commercial real estate loans represented 31.2% of total net charge-offs in 2010. Excluding the hospitality/lodging loan charge-offs, net charge-offs for commercial real estate loans amounted to $368.8 million for the year ended December 31, 2010 compared to $237.2 million for the year ended December 31, 2009, an increase of $131.6 million or 55.4%. Approximately $85.5 million of that increase related to loans for commercial and industrial developments and $52.1 million of that increase related to loans for residential real estate developments such as multi-family and residential condominium developments. Within loans for commercial and industrial developments, net charge-offs associated with loans for retail trade, offices and recreation exhibited the largest increase in net charge-offs in 2010 compared to 2009. Like other bank holding companies, this portfolio experienced increased stress across all of the Corporation’s markets in 2010.
The ratio of nonaccrual commercial real estate loans to total commercial real estate loans at December 31, 2010 was 4.62%, compared to 4.29% at December 31, 2009. The ratio of nonaccrual commercial real estate loans to total commercial real estate loans in Arizona and Florida at December 31, 2010 was 4.93% and 8.30%, respectively. Nonaccrual commercial real estate loans in Arizona and Florida amounted to $117.1 million or 20.4% of total nonaccrual commercial real estate loans at December 31, 2010. Nonaccrual commercial real estate loans in Wisconsin amounted to $137.1 million or 23.9% of total nonaccrual commercial real estate loans at December 31, 2010. The ratio of nonaccrual commercial real estate loans to total commercial real estate loans in Wisconsin at December 31, 2010 was 2.45%.
The average annualized net charge-offs for commercial real estate loans over the past nine quarters based on end of period loans were 3.0%. Excluding the hospitality/lodging loan charge-offs, the average annualized net charge-offs for commercial real estate loans over the past nine quarters based on end of period loans was 2.3%. Excluding the hospitality/lodging loan charge-offs, the average annualized net charge-offs for commercial real estate loans based on end of period loans was 2.8% in 2010 compared to 1.7% in 2009.
Residential Real Estate Loans
Consistent with long standing practices, the Corporation does not originate sub-prime mortgages, variable interest-only payment plans, or mortgage loans that permit negative amortization. The Corporation does not originate loans with below market or so-called teaser interest rates at closing and then increase after some contractual period of time.
Residential real estate loans are concentrated in Arizona (37%) and Wisconsin (35%).
Throughout 2009 and 2010, the Corporation sold over 93% of its residential real estate production to the secondary market without servicing responsibilities. At December 31, 2010, the residential real estate portfolio consisted of approximately 17% of residential real estate loans that were originated in 2004 or before, 33% that were originated in 2008 or later and 50% that were originated in 2005 through 2007. Loans originated in 2005 through 2007 have higher potential loss severity in the event of default because the collateral values underlying these loans experienced the greatest depreciation in value.
The Corporation processes a relatively low volume of residential mortgage foreclosures and many of the relevant processes are manual in nature and, as a result, the Corporation believes it does not have any significant issues relating to "robo signing" or documents not being reviewed prior to legal action. At December 31, 2010, residential real estate loans held for investment and in the process of foreclosure amounted to $167.8 million. The portfolio of residential mortgage loans serviced for others was $351.4 million, of which $3.4 million was in the process of foreclosure at December 31, 2010.
Residential real estate loans in Arizona have elevated levels of risk. At December 31, 2010, Arizona residential real estate loans amounted to $1,594.2 million. At December 31, 2010, nonperforming residential real estate loans in Arizona amounted to $169.4 million or 10.63% of total Arizona residential real estate loans. Nonperforming residential real estate loans in Arizona represented 61.9% of total nonperforming residential real estate loans at December 31, 2010.
The ratio of nonaccrual residential real estate loans to total residential real estate loans was 6.31% at December 31, 2010 compared to 4.15% at December 31, 2009. In Wisconsin, the ratio of nonaccrual residential real estate loans to total residential real estate loans at December 31, 2010 was 2.73%.
At December 31, 2010, approximately $206.3 million or 78.2% of accruing renegotiated residential real estate loans were in Arizona. The total estimated cumulative default and re-default rate as of December 31, 2010 for renegotiated residential real estate loans that were restructured between June 2008 and December 2009 was approximately 28.5%.
The average annualized net charge-offs for residential real estate loans over the past nine quarters based on end of period loans was 4.7%. Excluding the net charge-offs for the bulk loan sales completed in 2009, the average annualized net charge-offs for residential real estate loans over the past nine quarters based on end of period loans was 3.2% and the average annualized net charge-offs for residential real estate loans based on end of period loans was 3.7% in 2010 compared to 3.2% in 2009.
Construction and Development Loans
Construction and development loans consist of commercial construction, commercial land, construction by developers, residential land and construction by individuals.
The cumulative net charge-offs for construction and development loans was 42.4% of total loan and lease cumulative net charge-offs for the nine quarters ended December 31, 2010. The average annualized net charge-offs for construction and development loans over the past nine quarters based on end of period loans was 14.9%. Those losses were predominantly associated with construction and development loans located in Florida and Arizona.
The Corporation has significantly reduced the construction and development loan portfolio, which at its peak in 2007, was approximately 23% of total loans and leases outstanding. The Corporation continues to reduce the construction and development portfolio. Given market conditions, construction and development loans are expected to continue to contract. Construction and development loans were 8.7% of total consolidated loans and leases at December 31, 2010.
The Corporation has also significantly reduced the amount of nonperforming construction and development loans. Since June 30, 2009, nonperforming construction and development loans have decreased at each consecutive quarter-end through December 31, 2010. At June 30, 2009, nonperforming construction and development loans amounted to $1,043.4 million or 15.28% of outstanding construction and development loans compared to nonperforming construction and development loans of $435.9 million or 13.61% of outstanding construction and development loans at December 31, 2010, a decrease of $607.5 million or 58.2%. The decrease in nonperforming construction and development loans was primarily due to reduced levels of new nonperforming loans, restructurings, loan sales and charge-offs. The reduced levels of new nonperforming loans reflect the decline in volume of new larger construction loans transferring to nonperforming status, especially in Florida and Arizona.
Construction and development loans in Florida and Arizona amounted to $1,182.7 million or 36.9% of total construction and development loans at December 31, 2010 compared to $2,019.5 million or 36.5% of total construction
and development loans at December 31, 2009, a decrease of $836.8 million or 41.4%. At December 31, 2010, nonperforming construction and development loans in Florida and Arizona amounted to $173.4 million or 14.66% of total construction and development loans in Florida and Arizona compared to nonperforming construction and development loans of $406.2 million or 20.12% of total construction and development loans in Florida and Arizona at December 31, 2009, a decrease of $232.8 million or 57.3%. Nonperforming construction and development loans in Florida and Arizona represented 39.8% of total nonperforming construction and development loans at December 31, 2010 and 50.3% of total nonperforming construction and development loans at December 31, 2009. Accruing renegotiated construction and development loans in Florida and Arizona amounted to $80.2 million or 75.0% of total accruing renegotiated construction and development loans at December 31, 2010 compared to $139.4 million or 94.2% of total accruing renegotiated construction and development loans at December 31, 2009, a decrease of $59.2 million or 42.5%.
Residential land loans have higher potential loss severity in the event of default because the collateral values underlying these loans have experienced the largest relative decline in value, especially in Arizona. At December 31, 2010, residential land loans amounted to $1,073.4 million or 33.5% of total construction and development loans compared to $1,574.3 million or 28.4% of total construction and development loans at December 31, 2009, a decrease of $500.9 million or 31.8%. Residential land loans in Arizona were 52.9% of total residential land loans at December 31, 2010 and 55.3% of total residential land loans at December 31, 2009. At December 31, 2010, nonperforming residential land loans amounted to $127.7 million or 11.90% of total residential land loans compared to nonperforming residential land loans of $273.4 million or 17.37% of total residential land loans at December 31, 2009, a decrease of $145.7 million or 53.3%. Nonperforming residential land loans in Arizona were 37.2% of total nonperforming residential land loans at December 31, 2010 and 44.0% of total nonperforming residential land loans at December 31, 2009. Nonperforming residential land loans were 29.3% of total nonperforming construction and development loans at December 31, 2010 and 33.9% of total nonperforming construction and development loans at December 31, 2009.
Consumer Loans and Leases
The majority of consumer loans and leases are home equity loans and lines of credit which amounted to $4,212.8 million at December 31, 2010. At December 31, 2010, home equity lines of credit represented 59% and home equity loans represented 41% of total home equity loans and lines of credit. Approximately 45% of home equity loans and lines of credit are secured by first mortgages. At December 31, 2010, home equity lines of credit outstanding (amount drawn) represented approximately 61% of the total lines of credit outstanding. During 2005 and 2006, when real estate market values were at a peak, the majority of the Corporation’s wholesale home equity originations were sold.
The largest geographic concentration of home equity loans and lines of credit is in Wisconsin (36%) with the remainder geographically dispersed.
The average annualized net charge-offs for home equity loans and lines of credit over the past nine quarters based on end of period loans were 2.5%. The average annualized net charge-offs for home equity loans and lines of credit for the years ended December 31, 2010 and 2009, based on end of period loans were 2.9% and 2.4%, respectively.
Credit card loans amounted to $289.6 million or 0.8% of total loans and leases at December 31, 2010. Credit cards are not a significant component of the Corporation’s loan and lease portfolio.
Other Income
2010 Compared to 2009
Total other income amounted to $875.0 million in 2010 compared to $903.0 million in 2009, a decrease of $28.0 million or 3.1%.
Total other income for the year ended December 31, 2010 includes net investment securities gains, gain on debt terminations, gain on sale of merchant portfolio processing and write-downs associated with loans held for sale (other than mortgage loans originated for sale). For the year ended December 31, 2010, these items amounted to $151.6 million. Total other income in 2009 included gains of $99.4 million from the termination of debt and net investment securities gains of $121.8 million. Those gains were offset by losses of $40.9 million from write-downs associated with loans held for sale (other than mortgage loans originated for sale). Excluding these items, total other income was $723.4 million and $722.7 million for the years ended December 31, 2010 and 2009, respectively.
Wealth management revenue was $280.4 million in 2010 compared to $265.1 million in 2009, an increase of $15.3 million or 5.7%. Wealth management revenue is affected by market volatility and direction. Assets under management (“AUM”) were $33.6 billion at December 31, 2010 compared to $32.9 billion at December 31, 2009, an increase of $0.7 billion or 2.1%, which reflects the effect of market volatility despite continued expansion of the customer base. Assets under administration (“AUA”) increased by $11.9 billion or 9.7% and amounted to $134.2 billion at December 31, 2010 compared to $122.3 billion at December 31, 2009. Favorable asset management performance resulted in new customer relationships and increased sales and has positively impacted opportunities for new customers. Revenue growth was experienced in both personal and institutional trust services.
Service charges on deposits amounted to $127.5 million in 2010 compared to $136.6 million in 2009, a decrease of $9.1 million or 6.6%. A portion of this source of fee income is sensitive to interest rates. Competitive pricing in the form of earnings credits was used to encourage customers to maintain higher deposit balances resulting in lower fee income. In addition and as expected, a portion of the decline in service charge revenue for the year ended December 31, 2010 compared to the year ended December 31, 2009 is attributable to the decline in overdraft fee revenue due to recent changes in banking regulations. Overdraft revenue is not a significant source of revenue to the Corporation. However, the Corporation has introduced new products targeted to those customers that have historically generated overdrafts and has had success in recovering a portion of this expected lost revenue.
Total mortgage banking revenue was $37.6 million in 2010 compared with $48.3 million in 2009, a decrease of $10.7 million or 22.2%. Reduced sales volume resulted in lower fee income from mortgage banking. Throughout 2010 and 2009, the Corporation sold substantially all of its residential real estate production to the secondary market. Residential mortgage loans sold in the secondary market amounted to $2.1 billion and $3.1 billion in 2010 and 2009, respectively. The retained interests in the form of mortgage servicing rights in 2010 and 2009 were not material and at December 31, 2010, the carrying value of mortgage servicing rights was insignificant.
Net investment securities gains amounted to $99.8 million in 2010 compared to $121.8 million in 2009. During 2010, the Corporation realized a gain of $82.8 million from the sale of approximately $2.2 billion in aggregate principal amount of United States government agency investment securities. In addition, the Corporation realized gains of $18.0 million on private equity investments. Approximately $8.6 million of gains on private equity investments was related to the sale of one investment. During 2009, the Corporation recorded a gain of $35.4 million from the sale of Visa Class B Stock. Also during 2009, the Corporation sold U.S. government agency securities with a principal amount of approximately $1.9 billion, resulting in a gain of $85.6 million.
BOLI revenue amounted to $46.6 million in 2010 compared to $39.0 million in 2009, an increase of $7.6 million or 19.4%. The recovery in the value of the underlying invested assets throughout 2009 and 2010 resulted in improved crediting rates in the year ended December 31, 2010 compared to the year ended December 31, 2009.
Certain BOLI policies have a stable value agreement through either a large, well-rated bank or multi-national insurance carrier that provides limited cash surrender value protection from declines in the value of each policy’s underlying investments. At December 31, 2010, the cash surrender value protection had not been exceeded for any BOLI policies.
Throughout 2010 and 2009, the Corporation re-acquired and extinguished debt that had been reported as Long-term Borrowings in the Consolidated Balance Sheets. The debt consisted of various senior and subordinated bank notes issued by the Corporation and its wholly-owned subsidiary, M&I Marshall & Ilsley Bank (“M&I Bank”). Small blocks of various bank notes were acquired in individual privately negotiated transactions in 2010 and 2009. In addition, a $400 million public tender offer for M&I Bank’s senior and subordinated bank notes was completed in 2009. During
2010, the Corporation re-acquired and extinguished $223.3 million of debt at a gain of $19.7 million. During 2009, the Corporation re-acquired and extinguished $1,285.7 million of debt at a gain of $99.4 million.
During 2010, the Corporation sold its merchant portfolio processing at a gain of $48.3 million. Like other bank holding companies, the Corporation determined that processing, clearing, settlement and related services with respect to credit card and debit card transactions with merchants was not a significant source of revenue or part of the Corporation’s core operating activities.
Other noninterest income amounted to $215.1 million in 2010 compared to $192.8 million in 2009, an increase of $22.3 million or 11.6%. Write-downs associated with loans held for sale (other than mortgage loans originated for sale) are reported as a reduction in Other Income in the Consolidated Statements of Income and amounted to $16.8 million for the year ended December 31, 2010 and $40.9 million for the year ended December 31, 2009. Excluding the write-downs, other income in 2010 amounted to $231.9 million compared to $233.7 million in 2009, a decrease of $1.8 million. The decline in other income over the comparative twelve month periods, excluding the write-downs, was primarily due to lower earnings on the Corporation’s deferred compensation trust accounts that primarily consist of fixed income investments which were partially offset by the gain from the sale of auto loans in 2010.
2009 Compared to 2008
Total other income amounted to $903.0 million in 2009 compared to $740.4 million in 2008, an increase of $162.6 million or 22.0%. Total other income in 2009 included gains of $99.4 million from the termination of debt and net investment securities gains of $121.8 million. Those gains were offset by losses of $40.9 million from write-downs associated with loans held for sale (other than mortgage loans originated for sale).
Wealth management revenue was $265.1 million in 2009 compared to $282.2 million in 2008, a decrease of $17.1 million or 6.0%. Equity market volatility along with downward pressure in the equity markets resulted in lower wealth management revenue in 2009 compared to 2008. However, expanding sales, enhanced investment products and investment performance resulted in linked quarter revenue growth in each quarter throughout 2009. A full year of revenue attributable to the acquisitions amounted to approximately $11.2 million in 2009. AUM was $32.9 billion at December 31, 2009 compared to $30.4 billion at December 31, 2008, an increase of $2.5 billion or 8.4%. AUA increased by $17.9 billion or 17.2% and amounted to $122.3 billion at December 31, 2009 compared to $104.4 billion at December 31, 2008.
Service charges on deposits amounted to $136.6 million in 2009 compared to $146.2 million in 2008, a decrease of $9.6 million or 6.6%. A portion of this source of fee income is sensitive to changes in interest rates. During 2009, the Corporation used competitive pricing in the form of earnings credits to encourage customers to maintain higher deposit balances which resulted in lower fee income.
Total mortgage banking revenue was $48.3 million in 2009 compared with $26.0 million in 2008, an increase of $22.3 million or 85.6%. The Corporation has been utilizing the secondary market for the increase in demand for fixed rate mortgages primarily associated with refinancing activities. During 2009, the Corporation sold $3.1 billion of residential mortgage and home equity loans to the secondary market. During 2008, the Corporation sold $1.4 billion of residential mortgage and home equity loans to the secondary market. The retained interests in the form of mortgage servicing rights in 2009 and 2008 were not material and at December 31, 2009, the carrying value of mortgage servicing rights was insignificant.
Net investment securities gains amounted to $121.8 million in 2009 compared to $17.2 million in 2008. During 2009, the Corporation recorded a gain of $35.4 million from the sale of Visa Class B Stock. Also during 2009, the Corporation sold U.S. government agency securities with a principal amount of approximately $1.9 billion, resulting in a gain of $85.6 million. During 2008, in conjunction with the Visa IPO, 38.7% of the Class B Visa common stock owned by the Corporation was redeemed. The gain from the redemption amounted to $26.9 million. During 2008, the Corporation recognized an other than temporary loss on an investment in a small-business lending venture. That loss amounted to $10.0 million.
BOLI revenue amounted to $39.0 million in 2009 compared to $35.9 million in 2008, an increase of $3.1 million or 8.6%. Despite lower crediting rates due to the interest rate environment in 2009, higher death benefit gains and no stable value adjustment resulted in the revenue growth in 2009 compared to 2008.
During the fourth quarter of 2008, the value of the investments underlying one of the Corporation’s BOLI policies declined significantly due to disruptions in the credit markets, widening of credit spreads and illiquidity in the securities market. These factors caused the decline in the cash surrender value to exceed the protection provided by the stable value agreement. As a result of exceeding the cash surrender value protection, the Corporation recorded a loss of
$11.8 million in 2008 to reflect the change in cash surrender value related to the affected BOLI policy. The cash surrender value of this BOLI policy was $238.3 million at December 31, 2008. The cash surrender value of this policy increased throughout 2009 as a result of the improvement in market conditions related to the policy’s underlying investments. At December 31, 2009, the cash surrender value protection had not been exceeded for any BOLI policies.
Beginning in the fourth quarter of 2008 and throughout 2009, the Corporation re-acquired and extinguished debt that had been reported as Long-term Borrowings in the Consolidated Balance Sheets. The debt consisted of various senior and subordinated bank notes issued by the Corporation and its wholly-owned subsidiary, M&I Bank. Small blocks of various bank notes were acquired in individual transactions in 2008 and 2009. In addition, a $400 million public tender offer for M&I Bank’s senior and subordinated bank notes was completed in 2009. During 2009, the Corporation re-acquired and extinguished $1,285.7 million of debt at a gain of $99.4 million. During 2008, the Corporation re-acquired and extinguished $169.2 million of debt at a gain of $14.7 million.
Other noninterest income amounted to $192.8 million in 2009 compared to $218.2 million in 2008, a decrease of $25.4 million or 11.6%. Write-downs associated with loans held for sale (other than mortgage loans originated for sale) are reported as a reduction in the Other line of Other Income in the Consolidated Statements of Income and amounted to $40.9 million for the year ended December 31, 2009. There were no write-downs associated with loans held for sale in 2008.
Other Expense
Total other expense in 2010, 2009 and 2008 amounted to $1,572.8 million, $1,565.2 million and $2,985.6 million, respectively.
Total other expense included elevated levels of credit and collection-related expenses and elevated levels of expenses associated with the acquisition, valuation and holding of OREO properties, which are referred to collectively as “credit and collection expense”.
Total other expense included FDIC insurance premiums for insurance on deposits including the cost of participating in the TAGP. Total other expense in 2009 included the FDIC special assessment related to insurance on deposits in addition to increased expense related to regular insurance premiums for insurance on deposits.
Total other expense included non-cash charges to write-off the unamortized issuance costs attributable to redeemed brokered CDs.
Total other expense included legal and advisor fees incurred in 2010 associated with the definitive merger agreement between the Corporation and BMO entered into on December 17, 2010.
The results of goodwill impairment testing at the end of the fourth quarter of 2008 resulted in a non-cash charge to pre-tax earnings for goodwill impairment. Tier 1 and Total regulatory capital ratios were unaffected by this adjustment.
The following table summarizes these components of Other Expense ($ in millions):
The efficiency ratio is a non-GAAP statistical measure that is used to evaluate comparative expense control across the financial services industry. The efficiency ratio is calculated by dividing total other expense by the sum of total other income (excluding investment securities gains and losses) and net interest income FTE. The Corporation’s efficiency ratios for the years ended December 31, 2010, 2009 and 2008 were:
Efficiency Ratio ($ in millions)
The Corporation estimates that the operating expenses associated with collection efforts and carrying nonperforming assets, net of OREO income, increased the Corporation’s 2010 efficiency ratio statistic by approximately 7.0%. By comparison, the operating expenses associated with collection efforts and carrying nonperforming assets, net of OREO income, increased the Corporation’s 2009 efficiency ratio statistic by approximately 9.2% and increased the Corporation’s 2008 efficiency ratio statistic by approximately 4.1%.
The Corporation’s 2010 efficiency ratio was also adversely affected by the write-downs associated with loans held for sale (other than mortgage loans originated for sale), the loss on brokered CDs, severance and the BMO transaction fees. Conversely, the Corporation’s 2010 efficiency ratio statistic was positively impacted by the gain on debt terminations and sale of merchant portfolio processing. The estimated adverse net impact of these items on the Corporation’s efficiency ratio in 2010 was approximately 1.0%.
The Corporation’s 2009 efficiency ratio statistic was also adversely impacted by elevated levels of provisions for loss exposures associated with unfunded loan commitments, write-downs associated with loans held for sale (other than mortgage loans originated for sale), the FDIC special assessment and severance. Conversely, the Corporation’s 2009 efficiency ratio statistic was positively impacted by the previously discussed gains on termination of debt. The net effect of these items was an increase in the Corporation’s 2009 efficiency ratio statistic by approximately 0.6%.
The Corporation’s 2008 efficiency ratio statistic was also adversely impacted by the goodwill impairment, unexpected losses and charges in the Corporation’s Wealth Management segment, increased provisions for loss exposures associated with unfunded loan commitments and other credit-related liabilities, the residual write-downs, severance expense and the previously discussed BOLI loss. Conversely, the Corporation’s 2008 efficiency ratio statistic was positively impacted by the previously discussed gains on termination of debt and reversal of part of the Corporation’s Visa litigation accruals. The net effect of these items was to increase the Corporation’s 2008 efficiency ratio statistic by approximately 63.3%.
2010 Compared to 2009
Total other expense in 2010 amounted to $1,572.8 million compared to $1,565.2 million in 2009, an increase of $7.6 million or 0.5%.
For the year ended December 31, 2010, credit and collection expenses associated with the acquisition, valuation and holding of OREO properties amounted to $160.7 million compared to $215.8 million for the year ended December 31, 2009, a decrease of $55.1 million or 25.5%. At December 31, 2010, the carrying value of OREO properties amounted to $339.5 million compared to $430.8 million at December 31, 2009.
FDIC insurance premiums for insurance on deposits including the cost of participating in the TAGP amounted to $99.4 million in 2010 compared to $107.9 million in 2009, a decrease of $8.5 million or 7.9%. Total FDIC
insurance expense in 2009 included the FDIC special assessment of $29.3 million related to insurance on deposits in addition to increased expense related to regular insurance premiums for insurance on deposits.
Non-cash charges to write-off the unamortized issuance costs attributable to redeemed brokered CDs, which is reported as Loss on Brokered CDs in the Consolidated Statements of Income, amounted to $47.1 million in 2010 compared to $9.2 million in 2009, an increase of $37.9 million. In conjunction with its activities to re-align the Corporation’s funding profile, the Corporation has selectively exercised its call option associated with brokered CDs to redeem those CDs at par. During 2010, the Corporation redeemed $3,998.6 million of brokered CDs.
Total other expense in 2010 included $5.8 million in legal and advisor fees associated with the definitive merger agreement between the Corporation and BMO entered into on December 17, 2010.
The Corporation’s expense in 2010 compared to 2009, excluding the items discussed above, increased $27.5 million or 2.2%.
Salaries and employee benefits expense amounted to $713.7 million in 2010 compared to $690.8 million in 2009, an increase of $22.9 million or 3.3%. Salaries and employee benefits expense associated with credit and collection efforts increased $3.2 million.
Net occupancy and equipment expense amounted to $133.6 million in 2010 compared to $135.7 million in 2009, a decrease of $2.1 million or 1.6%. The decrease reflects the effect of curtailing de novo branch expansion activity in 2010.
Software, processing, supplies, printing, postage and delivery expenses amounted to $192.5 million in 2010 compared to $196.2 million in 2009, a decrease of $3.7 million or 1.9%.
Professional services fees amounted to $116.4 million in 2010 compared to $91.4 million in 2009, an increase of $25.0 million or 27.4%. Legal fees and other professional fees associated with problem loans amounted to $23.5 million in 2010 compared to $29.5 million in 2009, a decrease of $6.0 million. The decline in legal fees and other professional fees associated with problem loans in 2010 compared to 2009 was offset by increased consulting fees associated with numerous items, including updating certain internal systems and processes, strategic consulting and the legal and advisor fees associated with the BMO transaction incurred in 2010.
Amortization of intangibles amounted to $20.2 million in 2010 compared to $23.4 million in 2009. Amortization of intangibles decreased $3.2 million in 2010 compared to 2009. Goodwill is tested for impairment using a two-step process that begins with an estimation of the fair value of a reporting unit. The first step is a screen for potential impairment and the second step measures the amount of impairment, if any. The Corporation has elected to perform its annual test for impairment as of June 30th. Based on the results of the 2010 test, the Corporation determined that the recorded goodwill was not impaired as of June 30, 2010. See Note 13 in Notes to Consolidated Financial Statements and the fair value discussion in Critical Accounting Policies included in Management’s Discussion and Analysis of Financial Condition and Results of Operations for more information regarding the goodwill impairment test.
Net OREO expenses amounted to $116.7 million in 2010 compared to $169.0 million in 2009, a decrease of $52.3 million. The costs of acquiring and holding the elevated levels of foreclosed properties increased $6.9 million or 14.6% in 2010 compared to 2009. The increased costs of acquiring and holding the elevated levels of foreclosed properties were more than offset by lower valuation write-downs and the impact of realizing net gains on the disposition of OREO in 2010 compared to incurring net losses on the disposition of OREO in 2009. Valuation write-downs decreased $26.6 million in 2010 compared to 2009. For the year ended December 31, 2010, net gains from the sale of OREO amounted to $19.9 million. For the year ended December 31, 2009, net losses from the sale of OREO amounted to $12.7 million. The Corporation expects that elevated levels of expenses associated with acquiring and holding foreclosed properties will continue. Valuation write-downs and net gains or losses on the disposition of OREO will depend on real estate market conditions.
Other noninterest expense amounted to $133.3 million in 2010 compared to $141.6 million in 2009, a decrease of $8.3 million or 5.9%. The decline in other noninterest expense in 2010 compared to 2009 was primarily due to reduced provision for losses for unfunded commitments and other off-balance sheet exposures such as letters of credit. The reduced provision for losses for unfunded commitments and other off-balance sheet exposures primarily reflects the lower amount of unfunded commitments outstanding.
2009 Compared to 2008
Total other expense in 2009 amounted to $1,565.2 million compared to $2,985.6 million in 2008, a decrease of $1,420.4 million or 47.6%.
For the year ended December 31, 2009, credit and collection expenses associated with the acquisition, valuation and holding of OREO properties amounted to $215.8 million compared to $104.5 million for the year ended December 31, 2008, an increase of $111.3 million. At December 31, 2009, the carrying value of OREO properties amounted to $430.8 million compared to $320.9 million at December 31, 2008.
FDIC insurance premiums for the year ended December 31, 2009 amounted to $107.9 million compared to $17.3 million in 2008, an increase of $90.6 million. Total FDIC insurance expense in 2009 included the FDIC special assessment of $29.3 million related to insurance on deposits in addition to increased expense related to regular insurance premiums for insurance on deposits.
Non-cash charges to write-off the unamortized issuance costs attributable to redeemed brokered CDs amounted to $9.2 million in 2009 compared to $1.8 million in 2008, an increase of $7.4 million.
As previously discussed, during 2008 the Corporation recorded a non-cash charge to pre-tax earnings for goodwill impairment in the amount of $1,535.1 million. Tier 1 and Total regulatory capital ratios were unaffected by this adjustment.
The Corporation’s expense in 2009 compared to 2008, excluding the items discussed above, decreased $94.6 million or 7.1%.
Salaries and employee benefits expense amounted to $690.8 million in 2009 compared to $723.2 million in 2008, a decrease of $32.4 million or 4.5%. Salaries and employee benefits expense associated with credit and collection efforts increased $4.7 million in 2009 compared to 2008. Included in salaries and employee benefit expense for the years ended December 31, 2009 and 2008 was severance expense of $5.8 million and $8.7 million, respectively. The number of full-time equivalent employees decreased approximately 6.8% at December 31, 2009 compared to December 31, 2008. Salaries and employee benefits expense for incentive commissions and incentive compensation decreased $20.3 million in 2009 compared to 2008.
Net occupancy and equipment expense amounted to $135.7 million in 2009 compared to $126.9 million in 2008, an increase of $8.8 million or 7.0%. The increase reflects the effect of a full year of expense for the de novo branch expansion activity completed in 2008 and six new de novo branches completed in 2009.
Software, processing, supplies, printing, postage and delivery expenses amounted to $196.2 million in 2009 compared to $198.8 million in 2008, a decrease of $2.6 million or 1.3%.
Professional services fees amounted to $91.4 million in 2009 compared to $72.0 million in 2008, an increase of $19.4 million or 26.8%. Increased legal fees and other professional fees associated with problem loans contributed approximately $13.1 million to the expense growth in 2009 compared to 2008. Consulting fees associated with updating certain internal systems also contributed to the increase in professional services fees in 2009 compared to 2008.
Amortization of intangibles amounted to $23.4 million in 2009 compared to $24.3 million in 2008. Amortization of intangibles decreased $0.9 million in 2009 compared to 2008.
The results of goodwill impairment testing at the end of the fourth quarter of 2008 indicated that the fair value of certain of the Corporation’s reporting units were less than their book values, resulting in a non-cash charge to pre-tax earnings for goodwill impairment in the amount of $1,535.1 million. Tier 1 and Total regulatory capital ratios were unaffected by this adjustment. The Commercial Banking segment recorded goodwill impairment of $925.6 million and the Community Banking segment recorded goodwill impairment of $609.5 million.
Net OREO expenses amounted to $169.0 million in 2009 compared to $75.5 million in 2008, an increase of $93.5 million. Approximately $70.1 million of the increase from 2008 to 2009 was due to valuation write-downs and net losses on dispositions, which reflects both the increased levels of foreclosed properties and the rapid decline in real estate values. Approximately $23.4 million of the increase for the year ended December 31, 2009 compared to the year ended December 31, 2008 reflects the cost of acquiring and holding the increased levels of foreclosed properties.
Other noninterest expense amounted to $141.6 million in 2009 compared to $210.6 million in 2008, a decrease of $69.0 million or 32.8%. The market disruption resulted in unexpected losses and charges in the Corporation’s Wealth Management segment that increased other expense by $45.7 million in 2008. Provisions for loss exposures associated with unfunded commitments, other credit-related charges and residual write-downs associated with direct financing leases incurred in 2008 reduced other noninterest expense by $13.0 million in 2009 compared to 2008. Other noninterest expense in 2008 includes the reversal of $12.2 million related to the Visa litigation.
Income Tax Provision
The benefit for income taxes amounted to $385.1 million or 42.8% of the pre-tax loss for the year ended December 31, 2010. The benefit for income taxes amounted to $637.2 million or 45.7% of the pre-tax loss for the year ended December 31, 2009. For the year ended December 31, 2008, the benefit for income taxes amounted to $459.5 million or 18.4% of the pre-tax loss.
The Health Care Acts signed in to law during March 2010 effectively changed the income tax treatment of federal subsidies paid to sponsors of retiree health benefit plans that provide qualifying prescription drug benefits. Under the Health Care Acts, beginning in 2013 the Corporation’s income tax deduction for the costs of providing Medicare Part D-equivalent prescription drug benefits to retirees will be reduced by the amount of the subsidy. As a result, the Corporation recognized a non-cash charge of $4.1 million in 2010 for the write-off of deferred tax assets to reflect the change in tax treatment of the federal subsidy. That tax expense was offset by additional tax benefits of $15.0 million which included the closing of audits for certain open years by the Internal Revenue Service (“IRS”).
During 2009, the State of Wisconsin passed legislation that requires combined reporting for state income tax purposes effective January 1, 2009. As a result, the Corporation recorded an additional income tax benefit of $51.0 million to recognize certain state deferred tax assets, which included the reduction of a valuation allowance for Wisconsin net operating losses. Also during 2009, the Corporation recorded an additional tax benefit of $18.0 million that was primarily due to the favorable resolution of a tax matter associated with the issuance of stock in 2002.
The effective tax rate in 2008 reflected, in part, the effect of the goodwill impairment charge. Approximately $1,402.1 million of the goodwill impairment charge was not deductible for income tax purposes.
As a result of the IRS’s decision not to appeal a November 2007 US Tax Court ruling related to how the TEFRA (interest expense) disallowance should be calculated within a consolidated group and the position the IRS has taken in another related case, the Corporation recognized an additional income tax benefit related to years 1996-2007 of $20.0 million for its similar issue during 2008.
Liquidity and Capital Resources
Total consolidated equity was $6.3 billion or 12.5% of total consolidated assets at December 31, 2010, compared to $7.0 billion or 12.2% of total consolidated assets at December 31, 2009.
Total equity at December 31, 2010 and December 31, 2009 was affected by the following transactions:
On October 27, 2009, the Corporation announced the closing of its public offering of 156.4 million shares of its common stock at $5.75 per share. The 156.4 million shares included 20.4 million shares issued pursuant to an option granted to the underwriters by the Corporation, which was exercised in full. The proceeds, net of underwriting discounts and commissions and offering expenses, from the issuance of shares in this public offering amounted to $863.1 million.
On June 17, 2009, the Corporation announced the closing of its public offering of 100.0 million shares of its common stock at $5.75 per share. The 100.0 million shares included 13.0 million shares issued pursuant to an option granted to the underwriters by the Corporation, which was exercised in full. The proceeds, net of underwriting discounts and commissions and offering expenses, from the issuance of shares in this public offering amounted to $551.8 million.
The Corporation also sold on an at-the-market basis 670,300 shares of its common stock during the second quarter of 2009 resulting in proceeds of $4.5 million, net of fees and commissions and offering expenses.
During 2010, the Corporation paid cash dividends of $21.0 million or $0.04 per share of on its common stock. Currently, the Corporation is required to obtain the prior approval of the Federal Reserve Bank of Chicago (the
“Federal Reserve”) and the Wisconsin Department of Financial Institutions (the “DFI”) to pay a cash dividend on its common stock.
During 2010, the Corporation issued 950,237 shares of its common stock for $5.9 million to fund its obligation under its employee stock purchase plan (the “ESPP”). For the year ended December 31, 2009, the Corporation issued 1,409,358 shares of its common stock for $6.9 million to fund its obligation under the ESPP.
On November 14, 2008, as part of the Corporation’s participation in the CPP, the Corporation entered into a Letter Agreement with the UST. Pursuant to the Securities Purchase Agreement - Standard Terms (the “Securities Purchase Agreement”) attached to the Letter Agreement, the Corporation sold 1,715,000 shares of the Corporation’s Senior Preferred Stock, having a liquidation preference of $1,000 per share, for a total price of $1,715 million. The Senior Preferred Stock qualifies as Tier 1 capital and pay cumulative compounding dividends at a rate of 5% per year for the first five years and 9% per year thereafter.
Under the terms of the Securities Purchase Agreement, except as described below, the Corporation may not redeem the Senior Preferred Stock during the first three years that it is outstanding. After the first three years, the Corporation may redeem shares of the Senior Preferred Stock for the per share liquidation preference of $1,000 plus any accrued and unpaid dividends. The Corporation is permitted, subject to regulatory approval, to redeem in whole or in part the Senior Preferred Stock during the first three years only if (a) it has received aggregate gross proceeds of not less than $428.75 million from one or more “Qualified Equity Offerings” (as defined in the Securities Purchase Agreement), and (b) the aggregate redemption price of the Senior Preferred Stock redeemed does not exceed the aggregate net proceeds received by the Corporation from any such Qualified Equity Offerings.
The Corporation received a total of $1,419.4 million in aggregate net proceeds from the common stock offerings in 2009, which met the requirements for Qualified Equity Offerings. Any repurchase of the Senior Preferred Stock would be contingent upon the determination of the Board of Directors that such repurchase is in the best interests of the Corporation and its shareholders. Furthermore, any repurchase of the Senior Preferred Stock would be subject to consultation with and approval by the Corporation’s banking regulators. To the extent the Corporation seeks such approval, there can be no assurance that such approval will be granted.
Pursuant to the American Recovery and Reinvestment Act, which was signed into law in February 2009, CPP participants are permitted to redeem the preferred stock issued under the CPP at any time, subject to consultation with the appropriate federal banking agency. However, the Corporation’s Restated Articles of Incorporation contain the redemption restrictions described above. The Corporation may seek Board of Directors and shareholder approval in the future to amend the Restated Articles of Incorporation to allow the Corporation to redeem the Senior Preferred Stock at any time after consultation with the Federal Reserve Board.
Under the terms of the Securities Purchase Agreement, as long as any Senior Preferred Stock is outstanding, the Corporation may pay quarterly common stock cash dividends of up to $0.32 per share, and may redeem or repurchase its common stock, provided that all accrued and unpaid dividends for all past dividend periods on the Senior Preferred Stock are fully paid. Prior to the third anniversary of the UST’s purchase of the Senior Preferred Stock, unless Senior Preferred Stock has been redeemed or the UST has transferred all of the Senior Preferred Stock to third parties, the consent of the UST will be required for the Corporation to increase its common stock dividend to more than $0.32 per share per quarter or repurchase its common stock or other equity or capital securities, other than in connection with benefit plans consistent with past practice and certain other circumstances specified in the Securities Purchase Agreement. The Senior Preferred Stock is non-voting, except for class voting rights on matters that would adversely affect the rights of the holders of the Senior Preferred Stock.
As a condition to participating in the CPP, the Corporation issued and sold to the UST a warrant (the “Warrant”) to purchase 13,815,789 shares (the “Warrant Shares”) of the Corporation’s common stock, at an initial per share exercise price of $18.62, for an aggregate purchase price of approximately $257.25 million. The term of the Warrant is ten years. The Warrant is no longer subject to any contractual restrictions on transfer. The Warrant provides for the adjustment of the exercise price and the number of Warrant Shares issuable upon exercise pursuant to customary anti-dilution provisions, such as upon stock splits or distributions of securities or other assets to holders of the Corporation’s common stock, and upon certain issuances of the Corporation’s common stock at or below a specified price range relative to the initial exercise price. Pursuant to the Securities Purchase Agreement, the UST has agreed not to exercise voting power with respect to any shares of common stock issued upon exercise of the Warrant.
Pursuant to the Securities Purchase Agreement, until the UST no longer owns any shares of the Senior Preferred Stock, the Warrant or Warrant Shares, the Corporation’s employee benefit plans and other executive
compensation arrangements for its Senior Executive Officers must continue to comply in all respects with Section 111(b) of the Emergency Economic Stabilization Act and the rules and regulations of the UST promulgated thereunder.
The Securities Purchase Agreement permits the UST to unilaterally amend any provision of the Letter Agreement and the Securities Purchase Agreement to the extent required to comply with any changes in the applicable Federal statutes.
For accounting purposes, the proceeds of $1,715 million were allocated between the preferred stock and the warrant based on their relative fair values. The initial value of the Warrant, which is classified as equity, was $81.12 million. The entire discount on the Senior Preferred Stock, created from the initial value assigned to the Warrant, will be accreted over a five year period in a manner that produces a level preferred stock dividend yield which is 6.10%. At the end of the fifth year, the carrying amount of the Senior Preferred Stock will equal its liquidation value.
Preferred dividends accrued and discount accretion on the Senior Preferred Stock amounted to $101.1 million for the year ended December 31, 2010. On November 15, 2010, the Corporation paid the quarterly preferred dividend covering the period from August 15, 2010 through November 15, 2010 in the amount of $21.4 million. Preferred dividends paid on the Senior Preferred Stock amounted to $85.8 million for the year ended December 31, 2010.
On December 17, 2010, the Corporation and BMO announced that they have entered into a definitive merger agreement under which BMO will acquire all outstanding shares of common stock of the Corporation in a stock-for-stock transaction. As part of the agreement, BMO has agreed to purchase the Senior Preferred Stock at par plus accrued interest - with full repayment to the UST immediately prior to closing. The Corporation’s existing warrants held by the UST will also be purchased by BMO.
At December 31, 2010, the net loss in accumulated other comprehensive income amounted to $106.8 million which represents a negative change in accumulated other comprehensive income of $55.5 million since December 31, 2009. Net accumulated other comprehensive income associated with available for sale investment securities was a net loss of $66.2 million at December 31, 2010, compared to a net loss of $13.0 million at December 31, 2009, resulting in a net loss of $53.2 million over the twelve month period. The net unrealized loss associated with the change in fair value of the Corporation’s derivative financial instruments designated as cash flow hedges decreased $2.4 million since December 31, 2009, and amounted to $41.7 million at December 31, 2010, compared to a net loss of $44.1 million at December 31, 2009. The accumulated other comprehensive income which represents the amount required to adjust the Corporation’s postretirement health benefit liability to its funded status amounted to an unrealized gain of $1.0 million as of December 31, 2010.
At December 31, 2010, the Corporation’s Tier 1 regulatory capital ratio was 11.14% or $2.0 billion in excess of well capitalized under the Federal Reserve Board’s regulatory framework. To be well capitalized under the regulatory framework, the Tier 1 capital ratio must meet or exceed 6%. The Corporation’s Tier 1 regulatory capital ratio at December 31, 2010 includes the impact of the two underwritten public offerings of its common stock completed in 2009, plus the at-the-market offering previously discussed.
The Corporation manages its liquidity to ensure that funds are available to each of its banks to satisfy the cash flow requirements of depositors and borrowers and to ensure the Corporation’s own cash requirements are met. The Corporation maintains liquidity by obtaining funds from several sources.
Cash and short-term investments held at the Federal Reserve amounted to $2.3 billion at December 31, 2010. At the present time, these balances represent the Corporation’s most readily available source of liquidity. This source of liquidity reflects management’s decision to maintain higher levels of liquid assets.
Another readily available source of liquidity to the Corporation is its investment portfolio. Investment securities available for sale, which totaled $6.5 billion at December 31, 2010, represent a highly accessible source of liquidity. The Corporation’s portfolio of held-to-maturity investment securities provides liquidity from maturities.
Depositors within the Corporation’s defined markets are another source of liquidity. Core deposits (demand, savings, NOW, money market and consumer time deposits) averaged $28.6 billion in 2010. These core deposits represented 71.2% of total consolidated average deposits for the year ended December 31, 2010. As previously discussed, the Corporation elected to opt out of the TAGP program extension effective as of July 1, 2010. As anticipated, certain NOW deposits and certain noninterest bearing deposits migrated to other deposit accounts, investment products or into products offered by other entities.
The Corporation has historically used brokered deposits to supplement deposit funding generated through the Corporation’s banking branch network due to pricing advantages. As a result of unstable market conditions in the capital markets during 2008 and 2009, the Corporation increased its use of brokered deposits primarily because the cost of brokered deposits was below the cost of issuing debt, especially new long-term borrowings. Brokered and institutional certificates of deposit represented 52.4% of total average wholesale deposit balances in 2010. The weighted average remaining term of outstanding brokered and institutional certificates of deposit at December 31, 2010 was 9.8 years. These long-term deposits have improved the Corporation’s structural liquidity.
In conjunction with its activities to re-align the Corporation’s funding profile, the Corporation has selectively exercised its call option associated with brokered certificates of deposit and redeemed those brokered certificates of deposit at par. During 2010, the Corporation redeemed $4.0 billion of brokered CDs.
The Corporation's banking affiliates may also access the federal funds markets or utilize collateralized borrowings such as treasury demand notes, FHLB advances or other forms of collateralized borrowings.
As a result of asset contraction, core deposit growth and management’s decision to maintain higher levels of liquid assets, the Corporation has also reduced its use of short-term borrowings. In addition to a source of funding, short-term borrowings may be used to accommodate correspondent bank customers’ needs and to manage its interest rate risk. The Corporation does not net short-term positions for reporting purposes or account for any security repurchase agreements as sales.
During 2010, short-term borrowings have mainly consisted of federal funds purchased and security repurchase agreements except for a $510.0 million of short-term FHLB advances that matured in February 2010. At December 31, 2010, total short-term borrowings amounted to $227.8 million. The largest amount of total short-term borrowings outstanding at any month-end during 2010 was $1,034.2 million at January 31, 2010, which included the $510.0 million of short-term FHLB advances previously discussed. Total average short-term borrowings were $751.6 million for the year ended December 31, 2010.
Information related to Federal funds purchased and security repurchase agreements for the last three years is as follows:
(a) Excludes impact of interest rate swaps.
The national capital markets represent a further source of liquidity to the Corporation.
The Corporation and/or M&I Bank may repurchase or redeem its outstanding debt securities from time to time, including, without limitation, senior and subordinated global bank notes, medium-term corporate notes, MiNotes or junior subordinated deferrable interest debentures and the related trust preferred securities. Such repurchases or redemptions may be made in open market purchases, in privately negotiated transactions or otherwise for cash or other consideration. Any such repurchases or redemptions will be made on an opportunistic basis as market conditions permit and are dependent on the Corporation’s liquidity needs, compliance with any contractual or indenture restrictions, regulatory requirements and other factors the Corporation deems relevant.
For the year ended December 31, 2010, the Corporation re-acquired and extinguished $223.3 million of debt at a gain. The debt consisted of small blocks of various senior and subordinated bank notes issued by M&I Bank. For the year ended December 31, 2009, the Corporation re-acquired and extinguished $1,285.7 million of debt at a gain. The debt consisted of small blocks of various bank notes issued by the Corporation and M&I Bank and included the $400 million debt tender offer.
Federal and state banking laws place certain restrictions on the amount of dividends and loans which a bank may make to its parent company. Such restrictions have not had, and are not expected to have, any material effect on the Corporation’s ability to meet its cash obligations. The market impact of the recession and deterioration in the national real estate markets have resulted in a strain on liquidity in the financial services sector. However, the common stock issued in financing transactions in 2009 and participation in the CPP in 2008 provided the Corporation with $3.1 billion in cash and significantly increased its regulatory and tangible capital levels. Notwithstanding the current
national capital market impact on the cost and availability of liquidity, management believes that it has adequate liquidity to ensure that funds are available to the Corporation and each of its banks to satisfy their cash flow requirements.
M&I Bank has implemented a global bank note program that permits it to issue up and sell up to a maximum of US$13.0 billion aggregate principal amount (or the equivalent thereof in other currencies) at any one time outstanding of its senior global bank notes with maturities of seven days or more from their respective date of issue and subordinated global bank notes with maturities more than five years from their respective date of issue. The notes may be fixed rate or floating rate and the exact terms will be specified in the applicable Pricing Supplement or the applicable Program Supplement. This program is intended to enhance liquidity by enabling M&I Bank to sell its debt instruments in global markets in the future without the delays that would otherwise be incurred. At December 31, 2010, approximately $11.4 billion of new debt could be issued under M&I Bank’s global bank note program.
Total bank notes outstanding at December 31, 2010 amounted to $2.1 billion, of which $1.4 billion is subordinated. A portion of the subordinated bank notes qualifies as supplementary capital for regulatory capital purposes.
During the second quarter of 2008, the Corporation filed a shelf registration statement with the Securities and Exchange Commission enabling the Corporation to issue up to 6.0 million shares of its common stock, which may be offered and issued from time to time in connection with acquisitions by the Corporation and/or other consolidated subsidiaries of the Corporation. At December 31, 2010, approximately 1.14 million shares of the Corporation’s common stock could be issued under the shelf registration statement for future acquisitions.
On October 13, 2010, the Corporation filed a shelf registration statement for the sale of an unspecified number of the Corporation’s securities by the Corporation or by selling security holders from time to time. The registration statement covers the sale of senior and subordinated debt securities, common and preferred stock, depositary shares, stock purchase contracts, units, and warrants. The registration statement was filed to replace the Corporation’s existing shelf registration statement, which expired on November 6, 2010.
Contractual Obligations
The following table summarizes the Corporation’s more significant contractual obligations at December 31, 2010. Excluded from the following table are a number of obligations to be settled in cash. These items are reflected in the Corporation’s consolidated balance sheet and include deposits with no stated maturity, trade payables, accrued interest payable and derivative payables that do not require physical delivery of the underlying instrument.
Notes:
In the banking industry, interest-bearing obligations are principally utilized to fund interest-bearing assets. As such, interest charges on certificate of deposit and other time deposit obligations and short-term debt obligations were excluded from amounts reported, as the potential cash outflows would have corresponding cash inflows from interest-earning assets. The same, although to a lesser extent, is the case with respect to interest charges on long-term debt obligations. As long-term debt obligations may be used for purposes other than to fund interest-earning assets, an estimate of interest charges is included in the amounts reported.
As of December 31, 2010, the Corporation has unrecognized tax benefits that if recognized, would impact the annual effective tax rate in future periods. Due to the uncertainty of the amounts to be ultimately paid as well as the timing of such payments, all uncertain tax liabilities that have not been paid have been excluded from the Contractual Obligations table. See Note 18 in Notes to Consolidated Financial Statements for further information regarding the Corporation’s income taxes.
(1)
Certain retail certificates of deposit and other time deposits give customers rights to early withdrawal. Early withdrawals may be subject to penalties. The penalty amount depends on the remaining time to maturity at the time of early withdrawal. Brokered certificates of deposits may be redeemed early upon the death or adjudication of incompetence of the holder.
(2)
Many short-term borrowings such as Federal funds purchased and security repurchase agreements and commercial paper are expected to be reissued and, therefore, do not necessarily represent an immediate need for cash. See Note 15 in Notes to Consolidated Financial Statements for a description of the Corporation’s short-term borrowings.
(3)
See Note 16 in Notes to Consolidated Financial Statements for a description of the Corporation’s various long-term borrowings. The amounts shown in the table include interest on both fixed and variable rate obligations. The interest associated with variable rate obligations is based upon rates in effect at December 31, 2010. The contractual amounts to be paid on variable rate obligations are affected by changes in market interest rates. Future changes in market interest rates could materially affect the contractual amounts to be paid.
(4)
See Note 22 in Notes to Consolidated Financial Statements for a description of the Corporation’s foreign exchange activities. The Corporation generally matches commitments to deliver foreign currencies with obligations to purchase foreign currencies, which minimizes the immediate need for cash.
(5)
The Corporation also has unfunded obligations for certain investments in investment funds. Under the obligations for certain investments in investment funds the Corporation could be required to invest an additional $52.3 million if the investment funds identify and commit to invest in additional qualifying investments. The investment funds have limited lives and defined periods for investing in new qualifying investments or providing additional funds to existing investments. As a result, the timing and amount of the funding requirements for these obligations are uncertain and could expire with no additional funding requirements.
(6)
See Note 20 in Notes to Consolidated Financial Statements for a description of the Corporation’s defined contribution program. The amount shown represents the unfunded contribution for the year ended December 31, 2010.
(7)
The health and welfare benefit plans are periodically funded throughout each plan year with participant contributions and the Corporation’s portion of benefits expected to be paid.
OFF-BALANCE SHEET ARRANGEMENTS
The term off-balance sheet arrangement describes the means through which companies typically structure off-balance sheet transactions or otherwise incur risks of loss that are not fully transparent to investors or other users of financial information. For example, in many cases, in order to facilitate the transfer of assets or otherwise finance the activities of an unconsolidated entity, a company may be required to provide financial support designed to reduce the risks to the entity or other third parties. That financial support may take many different forms such as financial guarantees, subordinated retained interests, derivative instruments or other contingent arrangements that expose the company to continuing risks or contingent liabilities regardless of whether or not they are recorded on the balance sheet.
Certain guarantees may be a source of potential risk to future liquidity, capital resources and results of operations. Guarantees may be in the form of contracts that contingently require the guarantor to make payments to the guaranteed party based on: (1) changes in an underlying instrument or variable such as a financial standby letter of credit or credit support agreement; (2) failure to perform under an obligating agreement such as a performance standby letter of credit; and (3) indemnification agreements that require the indemnifying party to make payments to the indemnified party based on changes in an underlying instrument or variable that is related to an asset, a liability or an equity security of the indemnified party, such as an adverse judgment in a lawsuit. The Corporation, for a fee, regularly enters into standby letters of credit transactions and provides certain indemnifications against loss in conjunction with securities lending activities, which are described in detail in Note 4 - Fair Value Measurements and Note 24 - Guarantees in Notes to Consolidated Financial Statements.
Companies may structure and facilitate off-balance sheet arrangements by retaining an interest in assets transferred to an unconsolidated entity. Such interests may be in the form of a subordinated retained interest in a pool of receivables transferred to an unconsolidated entity, cash collateral accounts, recourse obligations or other forms of credit, liquidity, or market risk support. These subordinated interests protect the senior interests in the unconsolidated entity in the event a portion of the underlying transferred assets becomes uncollectible or there are insufficient funds to repay senior interest obligations. In the past the Corporation has used such arrangements primarily in conjunction with its indirect automobile lending activities. The Corporation discontinued the sale and securitization of automobile loans into the secondary market. As a result of clean-up calls and other events, the Corporation acquired the remaining loans from the auto securitization trusts during 2009 and at December 31, 2009 the Corporation was not involved in any such arrangements.
As described in Note 16 - Long-term Borrowings in Notes to Consolidated Financial Statements, the Corporation holds all of the common interests in certain trusts that issued cumulative preferred capital securities which are supported by junior subordinated deferrable interest debentures and a full guarantee issued by the Corporation.
In conjunction with the banking acquisitions of Gold Banc, Trustcorp Financial, Inc. and Excel Bank Corporation, the Corporation acquired all of the common interests in trusts that issued cumulative preferred capital securities which are supported by junior subordinated deferrable interest debentures. M&I has fully and
unconditionally guaranteed the securities that these trusts have issued. At December 31, 2010, the principal amounts outstanding associated with the remaining trusts amounted to $16.0 million, $30.0 million, $38.0 million and $15.0 million. The Corporation does not consolidate any of these trusts in accordance with United States generally accepted accounting principles.
On January 1, 2010, the Corporation adopted the new accounting standards for accounting for transfers of financial assets and consolidation of variable interest entities which were known as SFAS 166 and SFAS 167 prior to becoming part of the Codification. SFAS 166 and SFAS 167 made fundamental changes to the accounting for transfers of financial interests and consolidation of variable interest entities. The impact of adopting these new accounting standards was not material.
At December 31, 2010, the Corporation did not hold any material variable interests in entities that provide it liquidity, market risk or credit risk support, or engage in leasing, hedging or research and development services with the Corporation. Based on the off-balance sheet arrangements with which it is presently involved, the Corporation does not believe that such off-balance sheet arrangements either have, or are reasonably likely to have, a material impact to its current or future financial condition, results of operations, liquidity or capital.
CRITICAL ACCOUNTING POLICIES
The Corporation has established various accounting policies that govern the application of accounting principles generally accepted in the United States in the preparation of the Corporation’s consolidated financial statements. The significant accounting policies of the Corporation are described in the footnotes to the consolidated financial statements contained herein and updated as necessary in its Quarterly Reports on Form 10-Q. Certain accounting policies involve significant judgments and assumptions by management that may have a material impact on the carrying value of certain assets and liabilities. Management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of judgments and assumptions made by management, actual results could differ from these judgments and estimates which could have a material impact on the carrying values of assets and liabilities and the results of the operations of the Corporation. Management continues to consider the following to be those accounting policies that require significant judgments and assumptions:
Allowance for Loan and Lease Losses
The allowance for loan and lease losses represents management’s estimate of probable losses inherent in the Corporation’s loan and lease portfolio. Management’s evaluation of the adequacy of the allowance for credit losses is a subjective process impacted by many factors. Some factors considered in determining the adequacy of the allowance for credit losses are quantifiable while other factors require qualitative judgment. Management evaluates the allowance each quarter to determine that it is adequate to absorb these inherent losses. This evaluation is supported by a methodology that identifies estimated losses based on assessments of individual problem loans, historical loss patterns of homogeneous loan pools and adjustments to reflect current economic conditions. The lagging of credit quality measurements relative to the performance of the loan portfolio and numerous other factors create degrees of imprecision in these measurements. Management considers the effect of imprecision and many other factors in determining the allowance for credit losses. In addition, environmental factors, including economic conditions and regulatory guidance, unique to each measurement date are also considered.
The Corporation’s reserving methodology is described in Note 9 - Allowance for Loan and Lease Losses in Notes to Consolidated Financial Statements. Credit quality trends that affected the allowance for loan and lease losses are discussed in Summary of Loan and Lease Loss Experience and Credit Quality.
Income Taxes
Income taxes are accounted for using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on tax assets and liabilities of a change in tax rates is recognized in the income statement in the period that includes the enactment date.
The determination of current and deferred income taxes is based on complex analyses of many factors, including interpretation of Federal and state income tax laws, the difference between tax and financial reporting basis of assets and liabilities (temporary differences), estimates of amounts currently due or owed, such as the timing of reversals of temporary differences and current accounting standards.
The Federal and state taxing authorities periodically review the Corporation’s interpretation of Federal and state income tax laws and make assessments based on their determination of tax laws. Tax liabilities could differ significantly from the estimates and interpretations used in determining the current and deferred income tax liabilities based on the completion of taxing authority examinations. The Corporation establishes tax liabilities or reduces tax assets for uncertain tax positions when, despite its belief that its tax return positions are appropriate and supportable under local tax law, the Corporation believes it may not succeed in realizing the tax benefit of certain positions if challenged. In evaluating a tax position, the Corporation determines whether it is more likely than not that the position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The Corporation’s estimate of the ultimate tax liability contains assumptions based on past experiences, and judgments about potential actions by taxing jurisdictions as well as judgments about the likely outcome of issues that have been raised by taxing jurisdictions. The tax position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. The Corporation evaluates these uncertain tax positions each quarter and adjusts the related tax liabilities or assets in light of changing facts and circumstances, such as the progress of a tax audit or the expiration of a statute of limitations. The Corporation believes the estimates and assumptions used to support its evaluation of uncertain tax positions are reasonable. At December 31, 2010, the Corporation does not expect its unrecognized tax benefits will significantly increase or decreased within the next 12 months.
At December 31, 2010, the Corporation reported a net deferred tax asset of approximately $1.5 billion. On an ongoing basis, management evaluates the deferred tax asset to determine if a valuation allowance is required. The determination of whether a valuation allowance is required is based on available positive and negative evidence. Based on its analysis of the evidence, the Corporation determined that no valuation allowance was required to be recorded against the Federal deferred tax asset at December 31, 2010. The Corporation is in a 3-year cumulative loss position as of December 31, 2010. The cumulative losses were attributable to the significantly higher amount of credit losses associated with real estate loans and the goodwill impairment charge recorded in 2008. This was considered as a significant piece of negative evidence.
The positive evidence the Corporation considered consisted of the following: Despite the credit related losses, the Corporation’s pre-tax, pre-provision income has remained stable and provides the base of income that will allow the Corporation to utilize its net operating losses as the economy improves.
Pre-tax, pre-provision income is non-GAAP measure that the Corporation believes is useful in analyzing underlying performance trends. This is the level of earnings adjusted to exclude the impact of the provision for loan and lease losses, which is excluded because its absolute level is elevated and volatile. This financial measure is considered to be an important metric with which to supplement the analysis and evaluation of the Corporation’s results of operations and financial strength.
The following table reflects pre-tax, pre-provision, pre-goodwill impairment income for each of the past three years ended December 31, 2010:
Net operating losses have a 20 year carryforward life. The Corporation forecasted sufficient taxable income during the carryforward period, exclusive of tax planning strategies, to utilize the net operating losses prior to expiration. Projected taxable income was based on objectively verifiable evidence. Under this method, certain losses which were considered “nonrecurring” were added back to the 2010 loss before income taxes. Nonrecurring losses were determined to be primarily credit losses and related expenses associated with the Corporation’s construction and development loan portfolio, which the Corporation deemed to be appropriate given its strategy of minimizing this type
of lending. This loan type experienced the greatest amount of stress over the past two years. The Corporation has significantly reduced its exposure to these types of loans through loan sales and charge-offs and minimized this type of lending. Based on this analysis, the deferred tax asset and the net operating losses would be fully recovered well before expiration. The Corporation considered this method to be conservative because the credit losses and related expenses for the Corporation’s other loan types were projected to continue in future periods at the 2010 levels which were considered to be elevated compared to historical experience. The Corporation’s capital base was considered more than adequate to withstand the expected timeframe required to utilize the net operating losses.
The realization of the deferred tax asset can be subjective and could be significantly reduced in the near term if estimates of future taxable income are significantly lower than currently forecasted.
Fair Value Measurements
The Corporation measures fair value in accordance with the Fair Value Measurements and Disclosures Topic of the Codification, which provides a framework for measuring fair value under accounting principles generally accepted in the United States of America. The topic defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The topic also addresses the valuation techniques used to measure fair value. These valuation techniques include the market approach, income approach and cost approach. The market approach uses prices or relevant information generated by market transactions that are identical to or comparable with assets or liabilities being valued. The income approach involves converting future amounts based on current market expectations about those future amounts to a single present amount. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset.
The Fair Value Measurements and Disclosures Topic of the Codification, establishes a fair value hierarchy, which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The reported fair value of a financial instrument is categorized within the fair value hierarchy based upon the lowest level of input that is significant to the instrument’s fair value measurement. The three levels within the fair value hierarchy consist of the following:
Level 1 - Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 - Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Fair values for these instruments are estimated using pricing models, quoted prices of financial assets or liabilities with similar characteristics or discounted cash flows.
Level 3 - Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Fair values are initially valued based upon a transaction price and are adjusted to reflect exit values as evidenced by financing and sale transactions with third parties.
A description of the valuation methodologies used for financial instruments measured at fair value on a recurring basis, as well as the general classification of such instruments pursuant to the valuation hierarchy is disclosed in Note 4 - Fair Value Measurements in Notes to Consolidated Financial Statements.
In addition to financial instruments that are measured at fair value on a recurring basis, fair values are used in purchase price allocations and goodwill impairment testing. See Note 13 in the Notes to Consolidated Financial Statements for the discussion regarding the Corporation’s annual test for goodwill impairment.
Measurements other than Level 1 involve various valuation techniques and models, which seek to maximize inputs that are observable, when available. Selecting the relevant inputs, appropriate valuation techniques and the appropriate category to report the fair value of a financial instrument requires varying levels of judgment depending on the facts and circumstances. The determination of some fair values can be a complex analysis of many factors. Judgment is required when determining the fair value of an asset or liability when either relevant observable inputs do not exist or available observable inputs are in a market that is not active. When relevant observable inputs are not available, the Corporation must use its own assumptions about future cash flows and appropriately risk-adjusted discount rates. Conversely, in some cases observable inputs may require significant adjustments. For example, in cases where the volume and level of trading activity in an asset or liability have declined significantly, the available prices vary significantly over time or among market participants, or the prices are not current, the observable inputs might not be relevant and could require significant adjustment.
Valuation techniques and models used to measure the fair value of financial assets on a recurring basis are reviewed and validated by the Corporation at least quarterly and in some cases monthly. In addition, the Corporation monitors the fair values of significant assets and liabilities using a variety of methods including the evaluation of pricing service information, using exception reports based on analytical criteria, comparisons to previous trades or broker quotes and overall reviews and assessments for reasonableness.
Goodwill Impairment Tests
Goodwill is tested for impairment using a two-step process that begins with an estimation of the fair value of a reporting unit. A reporting unit is an operating segment or one level below an operating segment as defined by the Segment Reporting Topic of the Codification. This first step is a screen for potential impairment. The second step, if necessary, measures the amount of impairment, if any. Goodwill is reviewed for impairment annually as of June 30th or more frequently if indicators of impairment exist. Goodwill has been assigned to six reporting units for purposes of impairment testing.
Significant judgment is applied when goodwill is assessed for impairment. The judgment includes developing cash flow projections, selecting appropriate discount rates, identifying relevant market comparables, incorporating general economic and market conditions and selecting an appropriate control premium. The assumptions used in the goodwill impairment assessment and the application of these estimates and assumptions are discussed below.
The estimated fair values for the Commercial Banking, Private Banking and Trust reporting units at June 30, 2010 were determined by equally weighting an income approach (50%) and market approach (50%) to assess if potential goodwill impairment existed. For the Capital Markets, National Consumer Banking and the Brokerage reporting units the estimated fair value at June 30, 2010 was determined by weighting 100% to an income approach. The Corporation determined that there was not sufficient comparable metrics associated with guideline companies and those reporting units to place any reliance on the market approach.
The income approach is based on discounted cash flows (“DCF”). The key assumptions used to determine fair value under the income approach included the cash flows, terminal values based on a terminal growth rate and the discount rate. Under the DCF method, forecasted cash flows were developed for each reporting unit by considering several key business drivers such as new business initiatives, client retention standards, market share changes, anticipated loan and deposit growth, historical performance, and industry and economic trends, among other considerations. The long-term growth rate used in determining the terminal value of each reporting unit was estimated at 10% for the Trust reporting unit and 3% for all other reporting units based on the Corporation’s assessment of the minimum expected terminal growth rate of each reporting unit, as well as broader economic considerations such as gross domestic product and inflation. Due to the current state of the economy, unemployment levels and the lending environment, significant judgment was required to estimate the duration of the economic recession and the period and strength of recovery, especially for the Commercial Banking, Private Banking and National Consumer Banking reporting units. Discount rates were estimated based on a Capital Asset Pricing Model, which considers the risk-free interest rate, market risk premium, beta, and in some cases, unsystematic risk and size premium adjustments specific to a particular reporting unit. The risk-free rate was 3.9% at June 30, 2010 and was based on 20-year Treasury Bonds. The discount rates used in the income approach for the six reporting units evaluated at June 30, 2010 ranged from 11.5% to 17%. Higher discount rates were used for banking-related segments and reporting units to account for the risk in the cash flow projections associated with the estimate of the duration of the economic recession and the period and strength of recovery. An increase to the discount rate of 1% would have lowered the preliminary fair value determined under the income approach for the nine reporting units evaluated at June 30, 2010 by a range of $10.0 million to $160.0 million. Each reporting unit with excess shown in the table below would continue to have excess under the increased discount rate.
The market approach is a technique that provides indications of value based upon comparisons of the reporting unit to market values and pricing evidence of public companies in the same or similar lines of businesses. Market ratios (pricing multiples) and performance fundamentals relating to the public companies’ stock prices (equity) were applied to each reporting unit as previously discussed to determine indications of its fair value.
The aggregate fair values were compared to the Corporation’s market capitalization as an assessment of the appropriateness of the fair value measurements. The Corporation used the average stock price for the month of June 2010. The comparison between the aggregate fair values and market capitalization indicated an implied premium. A control premium analysis indicated that the implied premium was within a range of the overall premiums observed in the market place.
The following table presents the goodwill allocated to each segment or reporting unit and the results of the step one analysis, which depicts the extent to which fair value exceeded carrying value (Excess) and the extent to which carrying value exceeded fair value (Deficiency) at June 30, 2010 ($ in millions):
Results of Step One Goodwill Analysis
As a result of applying the first step of goodwill impairment testing to determine if potential goodwill impairment existed at June 30, 2010, Trust, Private Banking, and Brokerage, the three reporting units that comprise the Wealth Management segment, the Commercial Banking segment and the Capital Markets reporting unit “passed” (fair value exceeded the carrying amount) the first step of the goodwill impairment test on a preliminary basis. The National Consumer Banking reporting unit “failed” (the carrying amount exceeded the fair value) the first step of the goodwill impairment test at June 30, 2010 and was subjected to the second step of the goodwill impairment test.
The second step of the goodwill impairment test compares the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. The fair value of a reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the price paid to acquire the reporting unit. The fair value allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets) also requires significant judgment, especially for those assets and liabilities that are not measured on a recurring basis such as certain types of loans. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. The Corporation believes the implied fair value of goodwill is significantly affected by unobservable inputs and would be categorized as Level 3 within the fair value hierarchy.
The Corporation completed an evaluation of the second step of the process in order to determine if there was any goodwill impairment for the National Consumer Banking reporting unit.
The implied fair value of a reporting unit’s goodwill will generally increase if the fair value of its loans and leases are less than the carrying value of the reporting unit’s loans and leases. The fair value of loans and leases was derived from the same discounted cash flow analysis as described in Note 4 - Fair Value Measurements in Notes to Consolidated Financial Statements.
The stress in the national real estate markets, liquidity stress and current economic conditions have depressed prices buyers and sellers are paying and receiving for bank-related assets, especially loans and leases. The Corporation’s allocation of the fair values to the assets and liabilities assigned to the National Consumer Banking reporting unit was less than its reported carrying values. As a result, the Corporation concluded that it was not required to recognize any goodwill impairment.
There have been no events since the annual test at June 30, 2010 to indicate that it is more likely than not that the recorded goodwill had become impaired. That determination was made after considering numerous qualitative and quantitative factors. Qualitative factors included the following: (1) the Corporation has not observed any trends that would indicate a material loss of customers, deposits or unanticipated loss in loans; (2) credit quality trends have improved since June 30, 2010, when the annual test was performed; and (3) pre-tax, pre-provision income, a non-GAAP measure currently being tracked closely in banking, was relatively stable in the second half of 2010 compared to the first half of 2010, and the Corporation has not observed any trends that would indicate a material loss in pre-tax, pre-provision income. Quantitatively, the Corporation updated the estimates of the fair value of the reporting units based on the total value, which includes a control premium, that was established when the Corporation and BMO
announced that they had entered into a definitive merger agreement under which BMO will acquire all of the outstanding shares of common stock of the Corporation in a stock-for-stock transaction.
The results were that the Trust, Brokerage and Capital Markets reporting units continued to have significant excess fair value over book value. The National Consumer reporting unit continued to show a deficiency, which was consistent with the conclusions reached in the annual test. The Commercial Banking segment and the Private Banking reporting unit indicated a small deficiency. Updated estimated fair values of assets and liabilities and an updated estimate of the amount assigned to an unrecognized core deposit intangible were determined for each of the Commercial Banking segment and the Private Banking and the National Consumer reporting units. Based on those updated amounts the implied fair value of goodwill continued to be in excess over the allocated book value of goodwill.
Management expects the prevailing economic and difficult real estate market conditions will last through 2011 in many of the Corporation’s markets. The Corporation’s pre-tax, pre-provision income was assumed to remain stable. Credit related charges were assumed to gradually improve and be normalized by 2013. Due to the current economic environment and the uncertainties regarding the impact on the Corporation’s reporting units, there can be no assurances that the Corporation’s estimates and assumptions regarding the duration of the economic recession, or the period or strength of recovery, made for purposes of the Corporation’s annual goodwill impairment test will prove to be accurate predictions of the future. If the Corporation’s assumptions regarding credit quality trends, forecasted revenues or margin growth rates for certain reporting units are not achieved, the Corporation may be required to record additional goodwill impairment losses in future periods. It is not possible at this time to determine if any such future impairment loss would result or, if it does, whether such charge would be material.
New Accounting Pronouncements
A discussion of new accounting pronouncements that are applicable to the Corporation and have been or will be adopted by the Corporation is included in Note 3 - New Accounting Pronouncements in Notes to Consolidated Financial Statements contained in Item 8, Consolidated Financial Statements and Supplementary Data.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk arises from exposure to changes in interest rates, exchange rates, commodity prices, and other relevant market rate or price risk. The Corporation faces market risk through trading and other than trading activities. While market risk that arises from trading activities, in the form of foreign exchange and interest rate risk, is immaterial to the Corporation, market risk from other than trading activities, in the form of interest rate risk, is measured and managed through a number of methods.
Interest Rate Risk
The Corporation uses financial modeling techniques to identify potential changes in income and market value under a variety of possible interest rate scenarios. Financial institutions, by their nature, bear interest rate and liquidity risk as a necessary part of the business of managing financial assets and liabilities. The Corporation has designed strategies to limit these risks within prudent parameters and identify appropriate risk/reward tradeoffs in the financial structure of the balance sheet.
The financial models identify the specific cash flows, repricing timing and embedded option characteristics of the assets and liabilities held by the Corporation. The net change in net interest income in different market rate environments is the amount of earnings at risk. The net change in the present value of the asset and liability cash flows in different market rate environments is the amount of market value at risk. Policies are in place to assure that neither earnings nor market value at risk exceed appropriate limits. The use of a limited array of derivative financial instruments has allowed the Corporation to achieve the desired balance sheet repricing structure while simultaneously meeting the desired objectives of both its borrowing and depositing customers.
The models used include measures of the expected repricing characteristics of administered rate (NOW, savings and money market accounts) and non-rate related products (demand deposit accounts, other assets and other liabilities). These measures recognize the relative insensitivity of these accounts to changes in market interest rates, as demonstrated through current and historical experiences. In addition to contractual payment information for most other assets and liabilities, the models also include estimates of expected prepayment characteristics for those items that are likely to materially change their cash flows in different rate environments, including residential mortgage products, certain commercial and commercial real estate loans and certain mortgage-related securities. Estimates for these
sensitivities are based on industry assessments and are substantially driven by the differential between the contractual coupon of the item and current market rates for similar products.
This information is incorporated into a model that projects future net interest income levels in several different interest rate environments. Earnings at risk are calculated by modeling net interest income in an environment where rates remain constant, and comparing this result to net interest income in a different rate environment, and then expressing this difference as a percentage of net interest income for the succeeding 12 months. Since future interest rate moves are difficult to predict, the following table presents two potential scenarios-a gradual increase of 100bp across the entire yield curve over the course of the year (+25bp per quarter), and a gradual decrease of 100bp across the entire yield curve over the course of the year (-25bp per quarter) for the balance sheet as of December 31, 2010:
These results are based solely on the modeled parallel changes in market rates, and do not reflect the earnings sensitivity that may arise from other factors such as changes in the shape of the yield curve and changes in spread between key market rates. These results also do not include any management action to mitigate potential income variances within the simulation process. Such action could potentially include, but would not be limited to, adjustments to the repricing characteristics of any on- or off-balance sheet item with regard to short-term rate projections and current market value assessments.
Actual results will differ from simulated results due to the timing, magnitude, and frequency of interest rate changes as well as changes in market conditions and management strategies.
Equity Risk
In addition to interest rate risk, the Corporation incurs market risk in the form of equity risk. The Corporation invests directly and indirectly through investment funds, in private medium-sized companies to help establish new businesses or recapitalize existing ones. These investments expose the Corporation to the change in equity values of the portfolio companies. However, fair values are difficult to determine until an actual sale or liquidation transaction actually occurs. At December 31, 2010, the carrying value of total active private equity investments amounted to approximately $78.7 million.
At December 31, 2010, Wealth Management administered $134.2 billion in assets and directly managed $33.6 billion in assets. Exposure exists to changes in equity values due to the fact that fee income is partially based on equity balances. Quantification of this exposure is difficult due to the number of other variables affecting fee income. Interest rate changes can also have an effect on fee income for the above-stated reasons.
ITEM 8.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA FOR YEARS ENDED DECEMBER 31, 2010, 2009 AND 2008
Consolidated Balance Sheets
December 31 ($000’s except share data)
The accompanying notes are an integral part of the Consolidated Financial Statements.
Consolidated Statements of Income
Years ended December 31 ($000’s except share data)
The accompanying notes are an integral part of the Consolidated Financial Statements.
Consolidated Statements of Cash Flows
Years ended December 31 ($000’s)
The accompanying notes are an integral part of the Consolidated Financial Statements.
Consolidated Statements of Equity
($000’s except share data)
The accompanying notes are an integral part of the Consolidated Financial Statements.
Consolidated Statements of Equity
($000’s except share data)
The accompanying notes are an integral part of the Consolidated Financial Statements
Consolidated Statements of Equity
($000’s except share data)
The accompanying notes are an integral part of the Consolidated Financial Statements
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008 ($000’s except share data)
Marshall & Ilsley Corporation (“M&I” or the “Corporation”) is a financial holding company that provides diversified financial services to a wide variety of corporate, institutional, government and individual customers. M&I’s largest affiliates and principal operations are in Wisconsin; however, it has activities in other markets, particularly in certain neighboring Midwestern states, and in Arizona, Nevada and Florida. The Corporation’s principal activities consist of banking and wealth management services. Banking services, lending and accepting deposits from commercial banking and community banking customers are provided through its lead bank, M&I Marshall & Ilsley Bank (“M&I Bank”), which is headquartered in Wisconsin and one federally chartered thrift headquartered in Nevada. In addition to branches located throughout Wisconsin, banking services are provided in branches located throughout Arizona, the Minneapolis, Minnesota, Kansas City, Missouri and St. Louis, Missouri metropolitan areas, Duluth, Minnesota, Belleville, Illinois, Las Vegas, Nevada, Florida and central Indiana, as well as on the Internet. Wealth Management, which includes Marshall & Ilsley Trust Company National Association (“M&I Trust”), M&I Financial Advisors, Inc., the private banking divisions of the Corporation’s bank subsidiaries and other subsidiaries related to the wealth management business, provides trust services, brokerage and insurance services, and investment management and advisory services to residents of Wisconsin, Arizona, Minnesota, Missouri, Florida, Nevada and Indiana. Other financial services provided by M&I include personal property lease financing, wholesale lending, investment services to institutional clients and venture capital.
1. Basis of Presentation
Estimates-The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. Actual results could differ from those estimates.
Consolidation principles-The Consolidated Financial Statements include the accounts of the Corporation, its subsidiaries that are wholly or majority owned and/or over which it exercises substantive control and significant variable interest entities for which the Corporation has determined that, based on the variable interests it holds, it is the primary beneficiary. The primary beneficiary of a variable interest entity is the party that has both the power to direct the activities of the entity that most significantly impact the entity’s economic performance and the obligation to absorb losses of the entity that could potentially be significant to the entity or the right to receive benefits from the entity that could potentially be significant to the entity. Variable interests are the ownership, contractual or other pecuniary interests in an entity. Investments in unconsolidated affiliates, in which the Corporation has 20% or more ownership interest and has the ability to exercise significant influence, but not substantive control, over the affiliates’ operating and financial policies, are accounted for using the equity method of accounting, unless the investment has been determined to be temporary. All intercompany balances and transactions are eliminated in consolidation.
2. Significant Accounting Policies
Cash and Cash Equivalents-For purposes of the Consolidated Financial Statements, the Corporation defines cash and cash equivalents as cash and due from banks and short-term investments, which have an original maturity of three months or less and are readily convertible into cash. At December 31, 2010 and 2009, $199,999 and $152,076, respectively, of cash and due from banks was restricted, primarily due to requirements of the Federal Reserve System to maintain certain reserve balances.
Trading Assets-Trading assets include trading securities and other free-standing derivative contracts. Securities are designated as trading securities when purchased and are held principally for sale in the near term. Trading and other free-standing derivative contracts are not linked to specific assets and liabilities on the balance sheet or to forecasted transactions in an accounting hedge relationship and, therefore, do not qualify for hedge accounting under the Derivatives and Hedging Topic of the Codification. Trading and other free-standing derivative contracts are carried at fair value with changes in fair value recorded in the Consolidated Statements of Income.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Investment Securities-Securities, when purchased, are designated as Investment Securities Available for Sale or Investment Securities Held to Maturity, and remain in that category until they are sold or mature. The specific identification method is used in determining the cost of securities sold. Investment Securities Held to Maturity are carried at cost, adjusted for amortization of premiums and accretion of discounts. The Corporation designates investment securities as held to maturity only when it has the positive intent and ability to hold them to maturity. All other securities are classified as Investment Securities Available for Sale and are carried at fair value with fair value adjustments, net of the related income tax effects, reported as a component of Accumulated Other Comprehensive Income in the Consolidated Balance Sheets. Investment securities are reviewed on a quarterly basis for possible other than temporary impairment (“OTTI”). Impairment occurs when the fair value of a security is less than its historical cost. These declines are recorded as either temporary impairment or other-than-temporary-impairment. Impairment is considered to be other than temporary if the present value of cash flows expected to be collected on the investment security discounted at the security’s implicit interest rate at acquisition is less than the investment security’s amortized cost. In addition, impairment is considered to be other than temporary if the Corporation intends to sell an impaired investment security or it is more likely than not that the Corporation will be required to sell the impaired investment security before the recovery of its amortized cost basis. All other impairments are considered temporary.
Prior to 2010, the Corporation presented investments in Federal Reserve Bank stock and FHLB stock within Investment Securities Available for Sale on the Consolidated Balance Sheets. During 2010, the Corporation determined that investments in Federal Reserve Bank stock and FHLB stock should be separately presented on the consolidated balance sheet. As a result, the accompanying 2009 consolidated balance sheet and the 2009 and 2008 consolidated statements of cash flows have been restated to present investments in Federal Reserve Bank stock and FHLB stock separately from Investment Securities Available for Sale. Federal Reserve Bank stock and FHLB stock are carried at cost.
Loans-The Corporation’s accounting methods for loans depends on whether the loans are originated or purchased or acquired and whether the loans are classified as held for sale or held for investment.
Originated Loans Held for Sale-Loans that the Corporation originates and intends to sell or securitize are reported as loans held for sale. Loans held for sale may be carried at fair value or at the lower of cost or fair value (“LOCOM”). The Corporation has elected fair value to account for certain residential mortgage loans originated for sale into the secondary market. Where an election is made to carry the loans held for sale at fair value, all subsequent changes in fair value are recognized in noninterest income and are reported as a component of Gain on Sale of Mortgage Loans in the Consolidated Statements of Income. All other loans that the Corporation originates and intends to sell or securitize are carried at LOCOM. For loans carried at LOCOM, any excess of the cost of a loan held for sale over its fair value is recognized as a valuation allowance. Changes in the valuation allowance are recognized in noninterest income in the Consolidated Statements of Income. Premiums, discounts and/or other loan basis adjustments on loans held for sale carried at LOCOM are deferred upon acquisition, included in the cost basis of the loan, and are not amortized. In the event that loans held for sale carried at LOCOM are reclassified to loans held for investment, the loans are transferred at LOCOM on the date of transfer, forming the new cost basis of such loans. Any LOCOM adjustment recognized upon transfer is recognized as a basis adjustment to the portfolio loan.
The Corporation determines any LOCOM adjustment on originated loans held for sale on a pool basis by aggregating those loans based on similar risks and other characteristics, such as product types and interest rates. The fair value of loans held for sale is generally based on whole loan sale prices, if formally committed, or observable market prices of securities that have loan collateral or interests in loans that are similar to the loans held for sale. If market prices are not readily available, the fair value is based on a discounted cash flow model, which takes into account the degree of credit risk associated with the loans and the estimated effects of changes in market interest rates relative to the loans’ interest rates.
Originated Loans Held for Investment-Loans the Corporation originates for investment are reported at the principal amount outstanding, net of unearned income, net deferred loan fees or costs, and any direct principal charge-offs. This amount is the Corporation’s recorded investment in the loan. Net deferred loan fees include loan fees collected net of certain incremental direct costs, primarily salary and employee benefit expenses. Net deferred loan fees are amortized over the contractual term of the loan or lease as an adjustment to the yield over the life of the loan and/or commitment period. Interest on loans, other than direct financing leases, is recognized as income based on the
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
loan principal outstanding during the period. Unearned income on financing leases is recognized over the lease term on a basis that results in an approximate level rate of return on the lease investment.
Loans Held for Investment Transferred to Held for Sale-When a determination is made at the time of commitment to originate a loan as held for investment, it is the Corporation’s intent to hold the loan to maturity, payoff or for the foreseeable future, subject to periodic review. In determining the foreseeable future for these loans, management considers (1) the current economic environment and market conditions, (2) its business strategy and current business plans, (3) collection strategies and (4) the nature and type of the loan receivable. If a decision has been made to sell loans not previously classified as held for sale, such loans are reclassified to loans held for sale. Upon reclassification, the loan is transferred at LOCOM. If the change in fair value on these loans is due to credit concerns on such loans, the loans are reclassified net of the portion of the allowance for loan losses that is attributable to the transferred loans, with a corresponding reduction in the allowance for loan losses. The LOCOM adjustment for commercial loans held for investment transferred to loans held for sale is generally determined on a loan-by-loan basis. The LOCOM adjustment for consumer loans held for investment transferred to loans held for sale is generally determined on a pool basis. The cash proceeds from the sale of loans that were reclassified from loans held in portfolio to loans held for sale are classified as investing activities in the Consolidated Statement of Cash Flows.
Purchased or Acquired Loans-Loans that are purchased or acquired are initially measured at fair value as of the acquisition date in accordance with applicable authoritative accounting guidance. An allowance for credit losses is not recorded at the acquisition date because credit discounts are included in the determination of fair value. For loans that are impaired at the time they are purchased or acquired, which are insignificant for the Corporation, expected cash flows in excess of the fair value of loans at the purchase date are recorded as interest income over the life of the loans. Subsequent to the purchase date, increases in cash flows over those expected at the purchase date are recognized as additional interest income prospectively. The present value of decreases in expected cash flows after the purchase date are recognized in the allowance for loan and lease losses. For purchased loans that are not deemed impaired at acquisition, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value. Subsequent to the purchase date, the methods utilized to estimate the required allowance for credit losses for these loans is similar to those used for originated loans. However, the Corporation records a provision for loan losses only when the required allowance exceeds any remaining credit discounts. The remaining differences between the purchase price and the unpaid principal balance at the date of acquisition are recorded in interest income over the life of the loans.
Commitments to Extend Credit-Unfunded loan commitments on residential mortgage loans that the Corporation intends to sell or securitize in connection with its mortgage banking activities (“rate locks”) are derivatives and recorded on the Consolidated Balance Sheets at fair value. Changes in fair value are recorded in noninterest income and reported as a component of Gain on Sale of Mortgage Loans in the Consolidated Statements of Income. All other unfunded loan commitments are not considered derivatives. An allowance for probable credit losses associated with off-balance sheet credit exposures on unfunded loan commitments other than rate locks is recorded on the Consolidated Balance Sheets in Accrued Expenses and Other Liabilities. The provision for these probable credit losses is recorded in noninterest expense and is reported in Other Expense in the Consolidated Statements of Income. The Corporation utilizes similar processes to estimate the allowance for probable credit losses associated with unfunded loan commitments other than rate locks as the allowance for loan and lease losses because business processes and credit risks associated with those loan commitments are essentially the same as for loans. However, since many of those loan commitments are expected to expire without being drawn upon, the allowance for probable credit losses associated with those unfunded loan commitments incorporates an estimate of the probability of those loan commitments being funded.
Renegotiated Loans-Certain loans are classified as troubled debt restructurings (“TDR”), which the Corporation refers to as “renegotiated loans,” when the borrower has experienced financial difficulties, the Corporation has made certain concessionary modifications to the contractual terms of the loan and the concessions are for economic or legal reasons related to the borrower’s financial difficulty that the Corporation would not otherwise consider. Once the other criteria are met, the Corporation considers one or a combination of the following concessions to the loan terms to be a TDR: (1) a reduction of the stated interest rate, (2) an extension of the maturity date or dates at a stated interest rate lower than the current market rate for a new loan with a similar term, or (3) forgiveness of principal or accrued interest. Renegotiated loans are permitted to remain on accrual status or are returned to accrual status when receipt of principal and interest payments as they become contractually due is not in doubt based on the preponderance
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
of evidence from a current credit assessment, the borrower’s successful past performance, or successful performance under the modified terms for periods ranging from three months to over nine months depending on the borrower and type of loan restructured. Loans restructured at a rate equal to or greater than that of a new loan with comparable risk at the time the contract is modified are excluded from renegotiated loans in the calendar years subsequent to the restructuring if the loan is in compliance with the modified terms.
Impaired Loans-The Corporation considers a loan to be impaired when, based on current information and events, it determines that it is probable it will be unable to collect all amounts due, including scheduled interest, according to the loan’s original loan contract, regardless of payment status. Nonaccrual loans, which the Corporation refers to as nonperforming loans and troubled debt restructurings, which the Corporation refers to as renegotiated loans, meet the definition of an impaired loan.
Loans are generally considered impaired and placed on nonaccrual status when the collection of interest or principal has become 90 days past due. However, loans with payments that are less than 90 days past due may be placed on nonaccrual based on a judgmental assessment of the borrower’s ability to continue to pay under the terms of the loan contract. The entire balance of a loan is considered delinquent if the minimum payment contractually required to be made is not received by the specified date on the billing statement.
When a loan is placed on nonaccrual status, previously accrued and uncollected interest is charged to interest and fee income on loans. A nonaccrual loan may be restored to an accrual basis when interest and principal payments are brought current and collectibility of future payments is not in doubt. Interest payments received on nonaccrual loans are recorded as interest income unless collection of the remaining recorded investment is doubtful, at which time payments received are recorded as reductions of principal. Interest on renegotiated loans is recognized on an accrual basis at the renegotiated rate if the loan is in compliance with the modified terms. Certain consumer loans are generally not placed on nonaccrual status and are charged off when such loans have been past due for a specified period of time. Impaired loans that have been purchased or acquired are initially accruing loans unless the timing and amount of future cash flows is not reasonably estimable. In that case, those loans are classified as nonaccrual loans and interest income is not recognized until the timing and amount of the future cash flows can be reasonably estimated.
Charge-Off Policy-Consistent with regulatory guidance, charge-offs are taken when specific loans, or portions thereof, are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. The Corporation’s policy is to promptly charge these loans off in the period the uncollectible loss amount is reasonably determined.
The Corporation promptly charges-off commercial loans, or portions thereof, when available information confirms that specific loans are uncollectible based on information that includes, but is not limited to, (1) the deteriorating financial condition of the borrower, (2) declining collateral values, and/or (3) legal action, including bankruptcy, that impairs the borrower’s ability to adequately meet its obligations. For impaired loans that are considered to be solely collateral dependent, a partial charge-off is recorded when a loss has been confirmed by an updated appraisal or other appropriate valuation of the collateral.
If a loan with interest reserves is in default and/or deemed uncollectible, interest is no longer funded through the interest reserve. Interest income previously recognized from interest reserves generally is not reversed against current income when a loan with interest reserves is placed on nonperforming status. However, the loan is evaluated for impairment.
The Corporation promptly charges-off consumer-related loans, or portions thereof, when the Corporation reasonably determines the amount of the loss. However, in no case does the charge-off exceed the applicable regulatory timeframes. Such regulatory timeframes provide for the charge-down of 1-4 family first and junior lien mortgages to the net realizable value less costs to sell when the loan is 180 days past due, charge-off of unsecured open-end loans when the loan is 180 days past due, and charge down to the net realizable value when other secured loans are loan 120 days past due.
The Corporation periodically reviews the residual values associated with its leasing portfolios. Declines in residual values that are judged to be other than temporary are recognized as a loss resulting in a reduction in the net investment in the lease.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Allowance for loan and lease losses-The allowance for loan and lease losses is maintained at a level believed adequate by management to absorb estimated losses inherent in the loan and lease portfolio including loans that have been determined to be impaired. For nonaccrual loans greater than an established threshold and all renegotiated loans, impairment is measured using one of three alternatives: (1) the present value of expected future cash flows discounted at the loan’s effective interest rate; (2) the loan’s observable market price, if available; or (3) the fair value of the collateral for collateral dependent loans and loans for which foreclosure is deemed to be probable. Loans below the established thresholds are evaluated as homogenous pools. Management’s determination of the adequacy of the allowance is based on a continual review of the loan and lease portfolio, loan and lease loss experience, economic conditions, growth and composition of the portfolio, and other relevant factors. As a result of management’s continual review, the allowance is adjusted through provisions for loan and lease losses charged against income. See Note 9 - Allowance for Loan and Lease Losses in Notes to Consolidated Financial Statements for additional information.
Premises and equipment-Land is recorded at cost. Premises and equipment are recorded at cost and depreciated principally on the straight-line method with annual rates varying from 10 to 50 years for buildings and 3 to 10 years for equipment. Long-lived assets which are impaired are written down to fair value and long-lived assets to be disposed of are carried at the lower of the carrying amount or fair value less cost to sell. Maintenance and repairs are charged to expense and betterments are capitalized.
Goodwill and Other Intangible Assets - Goodwill is not amortized, but is tested for impairment using a two-step process that begins with an estimation of the fair value of a reporting unit. A reporting unit is an operating segment as defined by the Segment Reporting Topic of the Codification, or one level below an operating segment. The first step is a screen for potential impairment and the second step measures the amount of impairment, if any. The Corporation tests goodwill for impairment annually or more frequently when indicators of impairment are present. See Note 13 - Goodwill and Other Intangibles in Notes to Consolidated Financial Statements for additional information.
Identifiable intangibles arising from purchase acquisitions with a finite useful life are amortized over their useful lives and consist of core deposit intangibles, customer lists, tradename and other intangibles.
Identifiable intangibles that have been determined to have an indefinite useful life are not amortized but are subject to periodic tests for impairment. At December 31, 2010 and 2009, the Corporation did not have any identifiable intangibles that have been determined to have an indefinite useful life.
Bank-Owned Life Insurance (“BOLI”)-The Corporation purchases life insurance policies on the lives of certain officers and employees and is the owner and beneficiary of the policies. The Corporation’s investments in these policies are intended to provide funding for future employee benefit costs. The Corporation records these BOLI policies at each policy’s respective cash surrender value, with changes recorded in Bank-Owned Life Insurance Revenue in the Consolidated Statements of Income. Certain BOLI policies have a stable value agreement through either a large, well-rated bank or multi-national insurance carrier that provides limited cash surrender value protection from declines in the value of each policy’s underlying investments. Losses are recognized when the decline in the cash surrender value exceeds the protection provided by the stable value agreement. At December 31, 2010, the cash surrender value protection had not been exceeded for any BOLI policies.
Other real estate owned (“OREO”)-Other real estate owned consists primarily of assets that have been acquired in satisfaction of debts. Other real estate owned is recorded at fair value, less estimated selling costs, at the date of transfer, which becomes the new cost basis. Valuation adjustments required at the date of transfer for assets acquired in satisfaction of debts are charged to the allowance for loan and lease losses. Subsequent to transfer, other real estate owned is carried at the lower of cost or fair value, less estimated selling costs, based upon periodic evaluations. Property expenses, which include carrying costs, required valuation adjustments and gains and losses on sales, are reported in Net OREO Expenses in the Consolidated Statements of Income.
Prior to 2010, the Corporation had presented gains on sale of OREO within Other Income in the Consolidated Statements of Income as OREO Income. During 2010, the Corporation determined that gains on sale of OREO should be presented net along with OREO expenses in the Consolidated Statements of Income. As a result, the accompanying 2009 and 2008 Consolidated Statements of Income and related disclosures have been restated to present gains on sale of OREO along with OREO expenses in Net OREO Expenses in the Consolidated Statements of Income.
Income Tax-Income taxes are accounted for using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
temporary differences are expected to be recovered or settled. The effect on tax assets and liabilities of a change in tax rates is recognized in the income statement in the period that includes the enactment date. Positive and negative evidence is evaluated on an ongoing basis to determine if a valuation allowance is required to reduce the deferred tax assets to the amounts that are more likely than not to be realized.
Derivative financial instruments-Derivative financial instruments, including certain derivative instruments embedded in other contracts, are carried in the Consolidated Balance Sheets as either an asset or liability measured at its fair value. The fair value of the Corporation’s derivative financial instruments is determined based on market prices for comparable transactions, if available, or a valuation model that calculates the present value of expected future cash flows.
Changes in the fair value of derivative financial instruments are recognized currently in earnings unless specific hedge accounting criteria are met. For derivative financial instruments designated as hedging the exposure to changes in the fair value of a recognized asset or liability (fair value hedge), the gain or loss is recognized in earnings in the period of change together with the offsetting loss or gain on the hedged item attributable to the risk being hedged. For derivative financial instruments designated as hedging the exposure to variable cash flows of a forecasted transaction (cash flow hedge), the effective portion of the derivative financial instrument’s gain or loss is initially reported as a component of accumulated other comprehensive income and is subsequently reclassified into earnings when the forecasted transaction affects earnings. The ineffective portion of the gain or loss is reported in earnings immediately.
At inception of a hedge, the Corporation formally documents the hedging relationship as well as the Corporation’s risk management objective and strategy for undertaking the hedge, including identification of the hedging instrument, the hedged transaction, the nature of the risk being hedged, and how the hedging instrument’s effectiveness in hedging the exposure will be assessed.
The adjustment of the carrying amount of an interest bearing hedged asset or liability in a fair value hedge is amortized into earnings when the hedged item ceases to be adjusted for changes in its fair value attributable to the risk being hedged.
If a cash flow hedge is discontinued because it is probable that the original forecasted transaction will not occur, the net gain or loss in accumulated other comprehensive income is immediately reclassified into earnings. If the cash flow hedge is sold, terminated, expires or the designation of the cash flow hedge is removed, the net gain or loss in accumulated other comprehensive income is reclassified into earnings in the same period or periods during which the hedged forecasted transaction affects earnings.
In accordance with the Corporation’s accounting policy, derivative fair values are presented on a gross basis. Cash flows from derivative financial instruments are reported in the Consolidated Statements of Cash Flows as operating activities.
Foreign exchange contracts-Foreign exchange contracts include such commitments as foreign currency spot, forward, future and option contracts. Foreign exchange contracts and the premiums on options written or sold are carried at market value with changes in market value included in other income.
Treasury stock-Treasury stock acquired is recorded at cost and is carried as a reduction of shareholders’ equity in the Consolidated Balance Sheets. Treasury stock issued is valued based on average cost. The difference between the consideration received upon issuance and the average cost is charged or credited to additional paid-in capital.
3. New Accounting Pronouncements
In July 2010, the Financial Accounting Standards Board (“FASB”) issued new accounting guidance that will require additional disclosures in the notes to the financial statements regarding the nature of credit risk inherent in the loan and lease portfolio, how that credit risk is analyzed and assessed in arriving at the allowance for credit losses, information regarding loan modifications that meet the definition of a TDR and changes in the loan portfolio and the allowance for credit losses. For the Corporation, period end disclosures are required as of December 31, 2010 and disclosures about activity that occurs during the period will be initially required for the three months ended March 31, 2011. In January 2011, the FASB elected to temporarily defer the effective date of the updated disclosures about TDRs until the FASB clarifies guidance for determining what constitutes a TDR. See Note 2 -
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Significant Accounting Policies and Note 9 - Allowance for Loan and Lease Losses for additional credit risk disclosures required in the Notes to Consolidated Financial Statements at December 31, 2010.
Effective January 1, 2010, the Corporation adopted updated accounting guidance to the Transfers and Servicing Topic and the Consolidations Topic of the FASB Accounting Standards Codification. Changes to the Transfers and Servicing Topic eliminated the concept of a qualifying special-purpose entity (“QSPE”), changed the requirements for derecognizing financial assets, and required additional disclosures regarding an entity’s continuing involvement in and exposure to risks related to transferred financial assets. The changes to the Consolidations Topic replace the quantitative approach previously required for determining which enterprise should consolidate a variable interest entity with a consolidation approach focused on which enterprise has both the power to direct the activities of the entity that most significantly impact the entity’s economic performance and the obligation to absorb losses of the entity that could potentially be significant to the entity or the right to receive benefits from the entity that could potentially be significant to the entity. The updated Consolidations Topic also requires ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity, and eliminated the scope exception that a troubled debt restructuring, as defined by the Debt Topic, is not an event that required reconsideration of whether an entity is a variable interest entity and whether an enterprise is the primary beneficiary of a variable interest entity. The adoption of this updated accounting guidance did not have a material impact on the Corporation’s financial statements and related disclosures.
In January 2010, the FASB updated the disclosure guidance in the Fair Value Measurements and Disclosures Topic. This update clarifies certain existing disclosure requirements and requires separate disclosures of significant transfers in and out of Level 1 and Level 2 of the fair value hierarchy along with descriptions of the reasons for the transfers. In addition, information about purchases, sales, issuances, and settlements will be presented separately for Level 3 disclosures. The updated guidance was effective beginning on January 1, 2010, except for the disclosures about purchases, sales, issuances, and settlements of Level 3 fair value measurements. Those disclosures are effective beginning on January 1, 2011. The impact of the updated disclosure guidance is reflected in Note 4 - Fair Value Measurements.
4. Fair Value Measurements
The Fair Value Measurements and Disclosures Topic of the Codification generally applies whenever other topics require or permit assets or liabilities to be measured at fair value. Under the topic, fair value refers to the price at the measurement date that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in which the reporting entity is engaged. The Topic does not expand the use of fair value in any new circumstances.
Fair-Value Hierarchy
The Fair Value Measurements and Disclosure Topic of the Codification establishes a three-tier hierarchy for fair value measurements based upon the transparency of the inputs to the valuation of an asset or liability and expands the disclosures about instruments measured at fair value. A financial instrument is categorized in its entirety and its categorization within the hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels are described below.
Level 1 - Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 - Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Fair values for these instruments are estimated using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows.
Level 3 - Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Fair values are initially valued based upon transaction price and are adjusted to reflect exit values as evidenced by financing and sale transactions with third parties.
Determination of Fair Value
The following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis, as well as the general classification of such instruments pursuant to the valuation hierarchy.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Trading Assets and Investment Securities
When available, the Corporation uses quoted market prices to determine the fair value of trading assets and investment securities; such items are classified in Level 1 of the fair value hierarchy.
For the Corporation’s investments in government agencies, mortgage-backed securities and obligations of states and political subdivisions where quoted prices are not available for identical securities in an active market, the Corporation determines fair value utilizing vendors who apply matrix pricing for similar bonds where no price is observable or may compile prices from various sources. These models are primarily industry-standard models that consider various assumptions, including time value, yield curve, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace. Fair values from these models are verified, where possible, to quoted prices for recent trading activity of assets with similar characteristics to the security being valued. Such methods are generally classified as Level 2. However, when prices from independent sources vary, cannot be obtained or cannot be corroborated, a security is generally classified as Level 3.
The Corporation’s private equity investments generally take the form of investments in private equity funds. The private equity investments are valued using the Corporation’s ownership interest in partners’ capital to which a proportionate share of net assets is attributed via the valuations provided by the general partners on a quarterly basis. These nonpublic investments are included in Level 3 of the fair value hierarchy because the fair value is not readily determinable and the redemption of the investments will occur via distribution though sale of the underlying investments of the private equity fund. The length of investment in private equity funds is generally ten years and the majority of the private equity distributions are expected to occur in the next five to ten years. At December 31, 2010, unfunded private equity commitments were $52.3 million.
Derivative Financial Instruments
Fair values for exchange-traded contracts are based on quoted prices and are classified as Level 1. The fair value of over-the-counter interest rate contracts are measured using discounted cash flow analysis that incorporates significant inputs, including LIBOR curve, derivative counterparty spreads and measurements of volatility. Interest rate contracts that are valued using discounted cash flow analysis through use of models, and other observable inputs are considered Level 2.
Certain derivative transactions are executed with counterparties who are large financial institutions (“dealers”). These derivative transactions primarily consist of interest rate swaps that were used for fair value hedges, cash flow hedges and economic hedges of interest rate swaps executed with the Corporation’s customers. The Corporation and its subsidiaries maintain risk management policies and procedures to monitor and limit exposure to credit risk. Approved dealers for these transactions must have and maintain an investment grade rating on long-term senior debt from at least two nationally recognized statistical rating organizations or have a guarantor with an acceptable rating from such organizations. International Swaps and Derivative Association Master Agreements (“ISDA”) and Credit Support Annexes (“CSA”) are employed for all contracts with dealers. These agreements contain bilateral collateral arrangements. Notwithstanding its policies and procedures, the Corporation recognizes that unprecedented events could result in counterparty failure. The Corporation also recognizes that there could be additional credit exposure due to certain industry conventions established for operational efficiencies.
On a quarterly basis, the Corporation performs an analysis using historical and market implied default and recovery rates that also consider certain industry conventions established for operational efficiencies to estimate the potential impact on the reported fair values of these derivative financial assets and liabilities due to counterparty credit risk and the Corporation’s own credit risk. Based on this analysis, the Corporation determined that the impact of these factors was insignificant and did not make any additional credit risk adjustments for purposes of determining the reported fair values of these derivative assets and liabilities with dealers at December 31, 2010.
Certain derivative transactions are executed with customers whose counterparty credit risk is similar in nature to the credit risk associated with the Corporation’s lending activities. As is the case with a loan, the Corporation evaluates the credit risk of each of these customers on an individual basis and, where deemed appropriate collateral is obtained. The type of collateral varies and is often the same collateral as the collateral obtained to secure a customer’s loan. To assess the potential impact of counterparty credit risk on the fair values of derivative assets with customers, the Corporation incorporates probability analysis to estimate the amount of expected loss exposure of customer
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
derivative contracts outstanding at December 31, 2010. While not significant, the Corporation did factor in the estimated amount of expected loss due to customer default into the reported fair value of its customer derivative assets at December 31, 2010.
Loans Held for Sale
During 2010, the Corporation elected to account for certain residential mortgage loans held for sale into the secondary market at fair value. The fair value of those mortgage loans held for sale was determined using current secondary market prices for loans with similar interest rates, maturities and credit quality and are classified as Level 2.
Assets and liabilities measured at fair value on a recurring basis are categorized in the tables below based upon the lowest level of significant input to the valuations as of December 31, 2010:
(1)
The amounts presented above exclude certain over-the-counter interest rate swaps that are the designated hedging instruments in fair value and cash flow hedges that are used by the Corporation to manage interest rate risk. These interest rate swaps are measured at fair value on a recurring basis based on significant other observable inputs and are categorized as Level 2. See Note 22 - Derivative Financial Instruments and Hedging Activities in Notes to Consolidated Financial Statements for further information. Level 3 derivative liabilities represent the fair value of the derivative financial instrument entered into in conjunction with the sale of the Corporation’s shares of Visa, Inc. (“Visa”) Class B common stock.
(2)
The amounts presented above are exclusive of $61,840 in affordable housing partnerships, which are generally carried on the equity method.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Assets and liabilities measured at fair value on a recurring basis are categorized in the tables below based upon the lowest level of significant input to the valuations as of December 31, 2009:
(1)
The amounts presented above exclude certain over-the-counter interest rate swaps that are the designated hedging instruments in fair value and cash flow hedges that are used by the Corporation to manage interest rate risk. These interest rate swaps are measured at fair value on a recurring basis based on significant other observable inputs and are categorized as Level 2. See Note 22 - Derivative Financial Instruments and Hedging Activities in Notes to Consolidated Financial Statements for further information. Level 3 derivative liabilities represent the fair value of the derivative financial instrument entered into in conjunction with the sale of the Corporation’s shares of Visa Class B common stock.
(2)
The amounts presented above are exclusive of $56,538 in affordable housing partnerships, which are generally carried on the equity method.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Level 3 Gains and Losses
The table presented below summarizes the change in balance sheet carrying values associated with financial instruments measured using significant unobservable inputs (Level 3) during the twelve months ended December 31, 2010:
(1)
Unrealized changes in fair value for available-for-sale investments (debt securities) are recorded in other comprehensive income, while gains and losses from sales are recorded in Net Investment Securities Gains in the Consolidated Statements of Income.
(2)
Private equity investments are generally recorded at fair value. Accordingly, both unrealized changes in fair value and gains or losses from sales are included in Net Investment Securities Gains in the Consolidated Statements of Income.
During 2010, securities were transferred from Level 2 in to Level 3 as the Corporation determined that it could not obtain a sufficient number of observable inputs in the form of market or broker quotes to substantiate a Level 2 classification.
Also during 2010, the Corporation transferred securities, which primarily consisted of $62,140 of senior tranche asset backed securities and $66,692 of Government National Mortgage Association (“GNMA”) securities, from Level 3 to Level 2 as significant inputs to the pricing model used to value these securities became observable in the marketplace, could be derived from observable data or the value could be supported by observable levels at which transactions were executed in the marketplace.
Transfers to and from level 3 were recognized at the end of each interim reporting period.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
The table presented below summarizes the change in balance sheet carrying values associated with financial instruments measured using significant unobservable inputs (Level 3) during the twelve months ended December 31, 2009:
(1)
Unrealized changes in fair value for available-for-sale investments (debt securities) are recorded in other comprehensive income, while gains and losses from sales are recorded in Net Investment Securities Gains in the Consolidated Statements of Income.
(2)
Private equity investments are generally recorded at fair value. Accordingly, both unrealized changes in fair value and gains or losses from sales are included in Net Investment Securities Gains in the Consolidated Statements of Income.
The increase in Level 3 investment securities at December 31, 2009 was primarily due to the purchase of certain GNMA securities and the transfer of certain municipal auction rate securities from Level 2. At December 31, 2009, the Corporation determined that it could not obtain a sufficient number of observable inputs in the form of market or broker quotes to substantiate a level 2 classification.
Transfers to and from level 3 were recognized at the end of each interim reporting period.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
The table presented below summarizes the change in balance sheet carrying values associated with financial instruments measured using significant unobservable inputs (Level 3) during the twelve months ended December 31, 2008:
(1)
Unrealized changes in fair value for available-for-sale investments (debt securities) are recorded in other comprehensive income, while gains and losses from sales are recorded in Net Investment Securities Gains in the Consolidated Statements of Income.
(2)
Private equity investments are generally recorded at fair value. Accordingly, both unrealized changes in fair value and gains or losses from sales are included in Net Investment Securities Gains in the Consolidated Statements of Income.
The increase in Level 3 investment securities at December 31, 2008 was primarily due to the transfer of certain highly-rated asset backed securities. At December 31, 2008, the Corporation determined that it could not obtain a sufficient number of observable inputs in the form of market or broker quotes to substantiate a Level 2 classification.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
Certain assets are measured at fair value on a nonrecurring basis. These assets are not measured at fair value on an ongoing basis; however, they are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment or a change in the amount of a previously recognized impairment.
The tables presented below summarize the adjusted carrying values and level of fair value hierarchy for assets measured at fair value on a nonrecurring basis:
Net losses related to nonrecurring fair value measurements of certain assets consisted of the following:
Net losses on loans held for sale represent net write downs during the period presented to record the loans at the lower of cost or fair value subsequent to their initial classification as loans held for sale. Such fair values are generally based on bids and are considered Level 2 fair values.
When impairment was measured based on the fair value of the collateral less estimated selling costs or the fair value of the loan, the loan is considered to be measured at fair value on a nonrecurring basis. The Corporation generally obtains appraisals to support the fair value of collateral underlying loans. Appraisals incorporate measures such as recent sales prices for comparable properties and costs of construction. The Corporation considers these fair values Level 3.
Losses on impaired loans represent net write-downs during the periods presented on impaired loans that were individually evaluated for impairment based on the estimated fair value of the collateral less estimated selling costs or the fair value of the loan, excluding impaired loans fully charged off.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
OREO is recorded at fair value based on property appraisals, less selling costs, at the date of transfer. Subsequent to transfer, OREO is carried at the lower of cost or fair value, less estimated selling costs. The carrying value of OREO is subject to fair value adjustments when the carrying value exceeds the fair value, less estimated selling costs.
Losses on OREO represent the net write-downs during the periods presented where the carrying value of the foreclosed real estate exceeded the current fair value less estimated selling costs of the foreclosed real estate subsequent to their initial classification as foreclosed assets.
Fair Value of Financial Instruments
Book values and estimated fair values for on and off-balance sheet financial instruments as of December 31, 2010 and 2009 are presented in the following table. Derivative financial instruments designated as hedging instruments are included in the book values and fair values presented for the related hedged items. Derivative financial instruments designated as trading and other free standing derivatives are included in Trading assets.
Balance Sheet Financial Instruments ($ in millions)
Quoted market prices are utilized by the Corporation for determining fair value, where readily available. If quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The calculated fair value estimates, therefore, cannot be substantiated by comparison to independent markets and, in many cases, could not be realized upon immediate settlement of the instrument. The current reporting requirements exclude certain financial instruments and all nonfinancial assets and liabilities from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the entire Corporation.
The following methods and assumptions are used in estimating the fair value for financial instruments.
Cash and short-term investments
The carrying amounts reported for cash and short-term investments approximate the fair values for those assets.
Trading assets and investment securities
Fair value is based on market prices where available. The fair value of trading assets and investment securities are categorized as Level 1, Level 2 and Level 3, based on the inputs to the valuations.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Net loans and leases
The fair value of loans and leases was derived from discounted cash flow analyses. Loans and leases as of December 31, 2010 were grouped into 1,788 pools based on similar characteristics such as maturity, payment type and payment frequency, rate type and underlying index, recent loan-to-value (LTV) measures and various types of credit indicators such as recent FICO scores and the Corporation’s internal loan rating system. Credit spreads were derived from observable information wherever possible. In cases where observable information was not available because of inactive markets or the change in the loan characteristics such as declining collateral values, certain adjustments were judgmentally made to estimate credit spreads consistent with the manner the Corporation believes market participants would assess the fair value of the loan pool. The Corporation has estimated that increasing or decreasing the credit spreads by the equivalent of a one credit rating adjustment could affect the aggregate fair value of the loans and leases by approximately $0.6 billion or 1.6% of the net carrying value of total loans and leases at December 31, 2010. The fair value of loans held for sale is based on the expected sales price. At December 31, 2010, the fair value of net loans and leases is considered Level 2 and Level 3 in the fair value hierarchy.
Deposits
The fair value for demand deposits or any interest bearing deposits with no fixed maturity date is considered to approximate carrying value. Time deposits with defined maturity dates are considered to have a fair value which approximates the book value if the maturity date was within three months of the measurement date. The remaining time deposits are assigned fair values based on a discounted cash flow analysis using discount rates that approximate interest rates currently being offered on time deposits with comparable maturities. At December 31, 2010, the fair value of deposits is considered Level 2 in the Fair Value Hierarchy.
Borrowings
Short-term borrowings are generally carried at cost that approximates fair value. Long-term debt is valued using discounted cash flow analysis with discount curves developed using several methods. Wherever possible, the Corporation uses pricing from industry accepted services or recently observed transactions in the Corporation’s long-term debt to develop the discounting curves. The observed transactions are between unaffiliated parties where there has been sufficient transaction volume to conclude that the observed pricing is representative of the fair value of the long-term debt obligation. In the absence of representative observed transactions, the Corporation develops discount curves based on current incremental borrowing rates for similar types of arrangements. At December 31, 2010, the fair value of borrowings is considered Level 2 in the Fair Value Hierarchy.
Off-Balance Sheet Financial Instruments ($ in millions)
Fair values of off-balance sheet financial instruments have been estimated based on the equivalent fees, net of expenses, which would be charged for similar contracts and customers at December 31:
See Note 21 - Financial Instruments with Off-Balance Sheet Risk in Notes to Consolidated Financial Statements for additional information.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
5. Earnings Per Common Share
The following presents a reconciliation of the numerators and denominators of the basic and diluted per common share computations (dollars and shares in thousands, except per share data):
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
The table below presents the options to purchase shares of common stock not included in the computation of diluted earnings per common share because the stock options’ exercise price was greater than the average market price of the common shares for the years ended December 31, 2010, 2009 and 2008 (anti-dilutive options). As a result of the Corporation’s reported net loss for the years ended December 31, 2010, 2009 and 2008, all stock options outstanding were excluded from the computation of diluted earnings per common share (shares in thousands):
An outstanding warrant to purchase 13,815,789 shares of the Corporation’s common stock issued in connection with the Corporation’s participation in the U.S. Treasury Department’s Capital Purchase Program was not included in the computation of diluted earnings per common share for the years ended December 31, 2010, 2009 and 2008 because of the reported net loss in the respective years. In addition, the $18.62 per share exercise price of the Warrant was greater than the average market price of the Corporation’s common stock for the years ended December 31, 2010 and 2009.
Effective January 1, 2009, the Corporation adopted updated guidance in the Earnings Per Share Topic of the Codification. Unvested share-based payment awards that provide nonforfeitable rights to dividends (such as restricted stock units granted by the Corporation) are considered participating securities to be included in the computation of earnings per share pursuant to the “two-class method” described in the Earnings Per Share Topic of the Codification. There was no impact to the Corporation’s current or prior periods presented as a result of the adoption of this accounting topic.
6. Business Combinations
The following acquisition, which is not considered to be a material business combination, was completed during 2009:
On May 29, 2009, the Corporation acquired the investment team and managed accounts of Delta Asset Management (“Delta”), an institutional large-cap core equity money manager based in Los Angeles, California. Delta, which was an operating division of Berkeley Capital Management LLC, had approximately $1.2 billion in assets under management as of April 30, 2009. Total consideration in this transaction amounted to $5.1 million, consisting of 775,166 shares of the Corporation’s common stock valued at $6.52 per common share. This is considered a non-cash transaction for the purposes of the Consolidated Statement of Cash Flows. Goodwill amounted to $3.8 million. The
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
estimated identifiable intangible assets to be amortized (customer relationships and non-compete agreement) amounted to $1.2 million. The goodwill and intangibles resulting from this acquisition are deductible for tax purposes.
The following acquisitions, which are not considered to be material business combinations individually or in the aggregate, were completed during 2008:
On December 3, 2008, the Corporation completed its acquisition of an 80% equity interest in Taplin, Canida & Habacht, Inc. (“TCH”). TCH, based in Miami, Florida, is an institutional fixed income money manager with approximately $7.3 billion of assets under management as of December 31, 2008. Total consideration in this transaction amounted to $64.0 million, consisting of 4,863,221 shares of the Corporation’s common stock valued at $13.16 per common share. This is considered a non-cash transaction for the purposes of the Consolidated Statement of Cash Flows. TCH was integrated with the Corporation’s Wealth Management segment. Goodwill amounted to $42.1 million. The estimated identifiable intangible assets to be amortized (customer relationships, tradename and non-compete agreement) amounted to $22.3 million. The goodwill and intangibles resulting from this acquisition are deductible for tax purposes. The Corporation will acquire the remaining 20% interest in TCH over a five year period beginning in December 2008, through subsequent payments based on certain criteria, which include the future earnings of TCH, as defined in the TCH Purchase Agreement, and therefore the total consideration cannot be determined at the present time. During 2010, the Corporation made a $2.0 million payment based on criteria in the Purchase Agreement.
On January 2, 2008, the Corporation completed its acquisition of First Indiana Corporation (“First Indiana”) based in Indianapolis, Indiana. First Indiana, with $2.1 billion in consolidated assets as of December 31, 2007, had 32 branches in central Indiana which became branches of M&I Bank on February 2, 2008. Stockholders of First Indiana received $32.00 in cash for each share of First Indiana common stock outstanding, or approximately $530.2 million. Goodwill amounted to $412.7 million. The estimated identifiable intangible asset to be amortized (core deposits) with a weighted average life of 5.7 years amounted to $33.6 million. The goodwill and intangibles resulting from this acquisition are not deductible for tax purposes.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
7. Investment Securities
The amortized cost, fair value and unrealized gains and losses of selected investment securities, by major security type, held by the Corporation were as follows:
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
The following tables provide the gross unrealized losses and fair value, aggregated by investment category and length of time the individual securities have been in a continuous realized loss position:
Other-Than-Temporary-Impairment (OTTI)
The investment securities reported in the December 31, 2010 table above were temporarily impaired. This temporary impairment represents the amount of loss that would have been realized if the investment securities had been sold on December 31, 2010. The Corporation determined that the temporary impairment in the investment securities at December 31, 2010 was not from a decline in value due to a credit event that would result in OTTI. At December 31, 2010, the Corporation does not intend to sell these temporarily impaired investment securities until a recovery of recorded investment, which may be at maturity. In addition, the Corporation concluded that it is more likely than not, that it will not have to sell the investment securities prior to recovery of the recorded investment.
The most severe impairment was recognized in the Corporation’s investments in asset backed securities, which consist primarily of senior tranche collateralized debt obligations (“CDOs”) that are secured by pools of trust preferred securities issued by financial institutions or insurance companies. To assess the CDOs for potential OTTI, the Corporation estimated the expected cash flows for each security in this portfolio. The analysis was completed by evaluating the credit quality of the underlying collateral and the cash flow structure. At December 31, 2010, the estimated cash flow analysis for each security indicated that contractual principal and interest was fully collectible by maturity.
The credit quality analysis included analyses of profitability, credit quality, operating efficiency, leverage, and liquidity using the most recently available financial and regulatory information for each underlying collateral issuer. The credit review also incorporated historical industry default data and current/near term operating conditions. Using the results of this analysis, the Corporation estimated appropriate default and recovery probabilities for each piece of collateral. No recoveries were assumed on issuers who were deferring interest or currently in default.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
There are various tranches or investment classes issued within each CDO. The most senior tranches generally have the lowest yield but the most protection from credit losses compared to other tranches that are subordinate to the most senior tranches. The Corporation holds only the two most senior tranches of the CDO issuances. Because of that seniority, the Corporation’s investments receive credit support from the subordinated tranches. At December 31, 2010, the Corporation estimated that the percentage of the currently performing collateral that would be required to default to cause the Corporation’s tranches to not receive all of its contractual cash flows (principal and interest) ranged from 18% to 46%. Based on that analysis, the Corporation concluded that there was excess protection to absorb the expected credit losses from both current and projected defaults and there was no OTTI. In addition, the Corporation concluded that the lengthening of the expected time for principal repayment combined with the illiquid market for trust preferred securities resulted in market expectations of higher yields for similar instruments which explained the entire decline in the fair value of the securities compared with their book values.
Other classes of investments with impairment at December 31, 2010 included U.S. Government agency securities and obligations of states and political subdivisions. U.S. Government agency securities consist of mortgage-backed securities issued by Federal Home Loan Mortgage Corporation (“FHLMC”), Federal National Mortgage Association (“FNMA”), and GNMA. This portfolio consists of securities with both fixed and floating rate interest rates, average lives of 3-5 years and contractual cash flows guaranteed by the U.S. government or agencies of the U.S. government.
Obligations of states and political subdivisions are bank qualified fixed rate securities with original maturities of ten to twenty years. The securities primarily consist of general obligation bonds with some essential service revenue bonds. The majority of these securities has a credit ratings of investment grade or better. Management performs ongoing credit quality reviews on these securities and at December 31, 2010, determined there were no credit losses.
The amortized cost and fair value of investment securities by contractual maturity at December 31, 2010 were:
Federal Reserve Bank stock and FHLB stock have no contractual maturities.
The gross investment securities gains and losses, including Wealth Management transactions, amounted to $104,903 and $5,087 in 2010, $132,074 and $9,721 in 2009, and $32,023 and $14,697 in 2008, respectively. See the Consolidated Statements of Cash Flows for the proceeds from the sale of investment securities.
Income tax expense related to net securities transactions amounted to $37,171, $45,565, and $6,164 in 2010, 2009 and 2008, respectively.
At December 31, 2010 and 2009, securities with a value of approximately $1,020,202 and $1,530,764, respectively, were pledged to secure public deposits, short-term borrowings, interest rate swaps and for other purposes required by law.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
8. Loans and Leases
The Corporation’s loan and lease portfolio at December 31 were as follows:
Loans and leases are presented net of unearned income and unamortized deferred fees, which amounted to $83,768 and $111,924 at December 31, 2010 and 2009, respectively.
Included in loans held for sale are nonaccrual loans which amounted to $23,448 and $57,670 at December 31, 2010 and 2009, respectively. Also included in loans held for sale are troubled debt restructured loans, which the Corporation refers to accruing renegotiated loans, which amounted to $15 at December 31, 2009.
For the years ended December 31, 2010, 2009 and 2008, loans transferred to OREO, net of initial write-downs, amounted to $446,456, $534,258 and $343,541, respectively. These amounts are considered non-cash transactions for purposes of the Consolidated Statements of Cash Flows.
The Corporation evaluates the credit risk of each customer and, where deemed appropriate, collateral is obtained. Collateral varies by loan type and individual loan customer and may include accounts receivable, inventory, real estate, equipment, deposits, personal and government guarantees, and general security agreements. The Corporation’s access to collateral is dependent upon the type of collateral obtained.
Policies have been established that set standards for collateral by creditworthiness, type of collateral, loan terms, pricing structures, loan-to-value limits by property type, minimum requirements for initial investment and maintenance of equity by the borrower, borrower net worth, cash flow and debt service coverage as well as policies and procedures for granting exceptions to established underwriting standards.
The Corporation’s lending activities are concentrated primarily in the Midwest. The Corporation’s loan portfolio consists of business loans extending across many industry types, as well as loans to individuals. As of December 31, 2010, total loans to any group of customers engaged in similar activities and having similar economic characteristics, as defined by the North American Industry Classification System, did not exceed 10% of total loans.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
The following table presents a geographical summary of loans and leases as a percent of total consolidated loans and leases at December 31:
The Corporation offers a variety of loan products with payment terms and rate structures that have been designed to meet the needs of its customers within an established framework of acceptable credit risk. Payment terms range from fully amortizing loans that require periodic principal and interest payments to terms that require periodic payments of interest-only with principal due at maturity. Interest only loans are typical in commercial and business line of credit or revolving line of credit loans, home equity lines of credit and construction loans (residential and commercial). At December 31, 2010, the Corporation did not have loans with below market or so-called teaser interest rates. At December 31, 2010, the Corporation did not offer, hold or service option adjustable rate mortgages that may expose the borrowers to future increase in repayments in excess of changes resulting solely from increases in the market rate of interest (loans subject to negative amortization).
The Corporation reported no loss related to residual impairment for the years ended December 31, 2010 and 2009.
Loans outstanding to directors and officers, including their related interests, by the Corporation and its significant subsidiaries did not exceed the reporting threshold at any time during 2010 or 2009.
At December 31, 2010 and 2009, loans and leases with a value of approximately $15,551,726 and $21,984,259, respectively, were pledged to secure deposits, borrowings and for other purposes required by law.
9. Allowance for Loan and Lease Losses
The allowance for loan and lease losses represents management’s estimate of probable losses inherent in the Corporation’s loan and lease portfolio. Some factors considered in determining the adequacy of the allowance for credit losses include an assessments of individual problem loans, historical loss patterns of homogeneous loan pools and adjustments to reflect current economic conditions. In addition, environmental factors, including economic conditions and regulatory guidance, unique to each measurement date are also considered. The determination of the allowance for loan and lease losses is inherently subjective as it requires estimates, including amounts of future cash collections expected on nonaccrual loans, which may be susceptible to significant change.
The Corporation’s reserving methodology considers the following portfolio segments, which are collectively reported as the allowance for loan and lease losses. The entire allowance for loan and lease losses is available to absorb losses from loans and leases in any of the segments.
Specific Reserve: The Corporation individually evaluates certain loans for impairment. Nonaccrual loans, which the Corporation refers to as nonperforming loans and troubled debt restructurings, which the Corporation refers to as renegotiated loans, meet the definition of an impaired loan. In general, these loans have been internally identified via the Corporation’s loan grading system as credits requiring management’s attention due to underlying problems in the borrower’s business or collateral concerns. This evaluation considers expected future cash flows, the value of collateral and also other factors that may impact the borrower’s ability to make payments when due. For nonaccrual loans greater than $1.0 million and renegotiated commercial loans greater than $250,000 impairment is individually measured each quarter using one of three alternatives: (1) the present value of expected future cash flows discounted at the loan’s effective interest rate; (2) the loan’s observable market price, if available; or (3) the fair value of the
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
collateral less costs to sell for collateral dependent loans and loans for which foreclosure is deemed to be probable. The specific reserve or valuation allowance for impaired loans is determined as the excess, if any, of the carrying value of the loan over the amount determined using the measurement alternative employed at the measurement date. The required valuation allowance is included in the allowance for loan and lease losses in the Consolidated Balance Sheets. The carrying value of the loan reflects reductions from prior charge-offs. Nonaccrual loans below the threshold are collectively evaluated for impairment.
Impairment for consumer-related renegotiated loans is measured on a pool level at the present value of expected future cash flows discounted at the loan pool’s effective interest rate. Contractual cash flows are adjusted for probability of default, expected prepayments, the expected collateral value for loans that will not be fully amortized at maturity and other factors that may impact the timing and amount of expected cash flows. Factors used to adjust contractual cash flows are based on historical experience and market performance statistics where available.
The Corporation utilizes a dual credit risk rating system (“DRR”) to measure the credit quality of individual commercial loans. The DRR measures the probability of default (“PD”) of an obligor and the loss given default (“LGD”) of credit facilities. The DRR system has 14 grades of PD (numeric) and 8 grades of LGD (alpha). The Company uses the DRR for regulatory reporting purposes, determining the frequency of review of credit exposures, and the evaluation and determination of the allowance for commercial credit losses. The PD for all business purpose credit relationships are reviewed at least annually, while loans on criticized status are reviewed as frequently as quarterly depending on the relationship size. The DRR system is designed to provide a consistent method and means to assess the credit risk of the Corporation’s loan customers across all commercial products. The PD attempts to measure the likelihood of an obligor going into default over a one-year time horizon. The probabilities are intended to represent a long-term average covering periods of high and low defaults. The LGD attempts to measure the economic loss the Corporation would incur subsequent to an event of default. Each credit facility of an obligor must have an independent LGD rating.
Collective Loan Impairment: This segment of the allowance for loan and lease losses is comprised of two elements. First, the Corporation makes a significant number of loans and leases, which due to their underlying similar characteristics, are assessed for loss as homogeneous pools. Included in the homogeneous pools are commercial and retail loans and leases that were excluded from the specific reserve allocation.
For purposes of determining collective loan impairment, commercial loans not evaluated individually are further disaggregated by the following loan types: commercial and industrial loans, commercial real estate loans, commercial construction and development loans and commercial leases. Using the Corporation’s internal risk ratings, commercial loans and leases are further stratified into three stratums. One stratum consists of loans and leases with risk ratings that are indicators of a nonperforming loan or lease or potential problem loan or lease (PD ratings 11-14), which the Corporation refers to as criticized loans and leases. Two stratums, (PD ratings 1-8 for “pass” credits) and (PD ratings 9-10 for “rated” credits), are developed for loans and leases that indicate no particular weakness. Using historical loss information, an estimate of loss is determined for each stratum. All nonaccrual loans and leases are classified as criticized.
For criticized loans and leases, more recent historical loss information forms the basis to determine the estimates of losses inherent in the pools at the measurement date. For the other stratums of loans and leases, longer-term historical loss information is used to form the basis to determine the estimates of losses inherent in the pools at the measurement date. Longer-term historical loss information is expected to be representative of inherent losses over an entire business cycle. Historical loss information is updated quarterly to reflect current experience. Historical loss information may be adjusted for portfolio trends, the effect of loan sales and factors that may be unique to a particular loan or lease type to ensure the loss rates ultimately used are appropriate at the measurement date. Selecting the appropriate loss rates that are used to determine the estimates of losses inherent in the pools at the measurement date requires significant judgment.
Retail loans and leases consist of residential real estate loans, residential construction and development loans, home equity loans and lines of credit, personal loans and personal leases. Other than retail nonaccrual loans greater than $1.0 million and renegotiated loans, retail loan types are stratified based on origination channels, underwriting guidelines, collateral type and product features such as a loan or line of credit and delinquency status. The loans are further stratified by selected markets (Arizona, Wisconsin, Florida and others), updated credit scores and the loan’s year of origination. Credit scores are updated quarterly. In the event an updated credit score cannot be obtained, the original credit scores are used. Loss factors are derived from historical loss experience by delinquency status for each
Notes to Consolidated Financial Statements - (Continued) December 31, 2010, 2009 and 2008 ($000’s except share data)
stratum and applied to the outstanding loan and lease balance by delinquency status to determine a reserve. Based on current market conditions, the Corporation estimates additional probable loss by evaluating probability of default and loss severity, the factors that collectively impact the amount of loss inherent in the retail sector loans and leases. Current factors impacting the probability of default such as lingering levels of elevated unemployment may not be fully reflected in updated credit scores or in existing levels of delinquency, causing historical default experience to be understated at the measurement date. Rapidly changing real estate collateral values arising from illiquid markets, excess inventories in certain markets and high current loan-to value ratios resulting from property value depreciation since the date the loans were originated impact historical loss severity. This additional probable loss is added to the amounts determined based on historical experience.
The second element reflects management’s recognition of the uncertainty and imprecision underlying the process of estimating losses. From time to time, the Corporation has identified certain loans within certain industry segments that based on financial, payment or collateral performance, warrant closer ongoing monitoring by management. The specific loans mentioned earlier are excluded from this analysis. Based on management’s judgment, reserve ranges may be allocated to industry segments due to environmental conditions unique to the measurement period. Consideration is given to both internal and external environmental factors such as economic conditions in certain geographic or industry segments of the portfolio, economic trends, risk profile, and portfolio composition. Reserve ranges are then allocated using estimates of loss exposure that management has identified based on these economic trends or conditions.
The Corporation has not materially changed any aspect of its overall approach in the determination of the allowance for loan and lease losses. However, on an on-going basis the Corporation continues to refine the methods used in determining management’s best estimate of the allowance for loan and lease losses.
Notes to Consolidated Financial Statements - (Continued) December 31, 2010, 2009 and 2008 ($000’s except share data)
An analysis of the allowance for loan and lease losses by major class of the Corporation’s loan and lease portfolio was as follows:
Notes to Consolidated Financial Statements - (Continued) December 31, 2010, 2009 and 2008 ($000’s except share data)
The analysis of the allowance for loan and lease losses for the year ended December 31, 2008 was:
The Corporation’s recorded investment in impaired loans and leases are as follows:
Notes to Consolidated Financial Statements - (Continued) December 31, 2010, 2009 and 2008 ($000’s except share data)
The Corporation’s recorded investment in impaired loans and leases individually evaluated for impairment and the related unpaid principal balances, valuation allowances, average recorded investment and interest income recognized were as follows:
Notes to Consolidated Financial Statements - (Continued) December 31, 2010, 2009 and 2008 ($000’s except share data)
The table presented below reflects the Corporation’s credit exposure by credit quality indicator for the loan and lease portfolio:
Notes to Consolidated Financial Statements - (Continued) December 31, 2010, 2009 and 2008 ($000’s except share data)
Commercial loans and commercial leases, commercial real estate loans and commercial construction and development loans in the Corporation’s loan portfolio without a credit quality rating are primarily loans with relationship balances less than $100,000 that are not required by internal policy to be assigned a DRR. In addition to these smaller commercial relationships, business purpose credit card loans, and commercial overdrafts do not have a DRR.
Residential real estate loans, residential construction and development loans, home equity loans and lines of credit, personal loans and personal leases without a credit quality rating are primarily consumer relationships serviced by third-party service providers where the provider was unable to provide a current or original credit score.
Nonaccrual loans and leases at December 31, 2010 and December 31, 2009:
The current and past due status of the Corporation’s loans and leases at December 31, 2010 were:
10. Financial Asset Sales
During 2009 the Corporation discontinued, on a recurring basis, the sale and securitization of automobile loans into the secondary market.
As a result of clean-up calls and other events, the Corporation acquired the remaining loans from the auto securitization trusts in the third quarter of 2009 and recognized net gains of $5,163. The loans were returned as portfolio loans at fair value. The Corporation no longer participates in the securitizations, and therefore no longer has any retained interests or any future obligations.
For the year ended December 31, 2009, net gains associated with the securitization of automobile loans amounted to $5,501. During 2008, the Corporation recognized net losses of $354 on the sale and securitization of
Notes to Consolidated Financial Statements - (Continued) December 31, 2010, 2009 and 2008 ($000’s except share data)
automobile loans. Net trading gains associated with related interest swaps amounted to $845 and $2,627 in 2009 and 2008, respectively.
Net gains (losses) associated with the retained interests, held in the form of interest-only strips amounted to $300 in 2009 and ($1,743) in 2008 and are included in Net Investment Securities Gains in the Consolidated Statements of Income. The gains realized in 2009 and 2008 resulted from excess cash received over the carrying amount of certain interest-only strips. The gains in 2008 were offset by impairment losses of $1,972. The impairment losses in 2008 were the result of the differences between the actual credit losses experienced compared to the expected credit losses used in measuring certain interest-only strips. Those impairments were deemed to be other than temporary.
11. Variable Interest Entities
The Corporation is committed to community reinvestment and is required under federal law to take affirmative steps to help meet the credit needs of the local communities it serves. For this purpose, the Corporation holds variable interests in variable interest entities. The Corporation regularly invests in or lends to entities that: own residential facilities that provide housing for low-to-moderate income families (affordable housing projects); own commercial properties that are involved in historical preservations (rehabilitation projects); or provide funds for qualified low income community investments. These projects are generally located within the geographic markets served by the Corporation’s banking segment. The Corporation’s involvement in these entities is limited to providing funding in the form of subordinated debt or equity interests. The Corporation does not have the power to direct the activities of the entities that significantly affects their economic performance. At December 31, 2010, the aggregate carrying value of investments in the form of subordinated debt amounted to $6,419 and represented an involvement in fourteen unrelated entities.
Generally, the economic benefit from the equity investments consists of the income tax benefits obtained from the Corporation’s allocated operating losses from the partnership that are tax deductible, allocated income tax credits for projects that qualify under the Internal Revenue Code and in some cases, participation in the proceeds from the eventual disposition of the property. The Corporation uses the equity method of accounting to account for these investments. To the extent a project qualifies for income tax credits, the project must continue to qualify as an affordable housing project for fifteen years, a rehabilitation project for five years, or a qualified low income community investment for seven years in order to avoid recapture of the income tax credit. These requirements generally define the time the Corporation will be involved in a project.
The Corporation’s maximum exposure to loss as a result of its involvement with these entities is generally limited to the carrying value of these investments plus any unfunded commitments on projects that are not completed. At December 31, 2010, the aggregate carrying value of the subordinated debt and equity investments was $60,300 and the amount of unfunded commitments outstanding was $22,019.
12. Premises and Equipment
The composition of premises and equipment at December 31 was:
Depreciation expense was $48,618 in 2010, $48,707 in 2009 and $44,160 in 2008.
The Corporation leases certain of its facilities and equipment. Rent expense under such operating leases was $39,734 in 2010, $39,328 in 2009 and $37,270 in 2008.
The future minimum lease payments under operating leases that have initial or remaining noncancellable lease terms in excess of one year for 2011 through 2015 are $29,071, $27,044, $23,958, $21,975 and $19,266, respectively.
Notes to Consolidated Financial Statements - (Continued) December 31, 2010, 2009 and 2008 ($000’s except share data)
13. Goodwill and Other Intangibles
The changes in carrying amount of goodwill for the twelve months ended December 31, 2010 were as follows:
The changes in carrying amount of goodwill for the twelve months ended December 31, 2009 were as follows:
Goodwill acquired during 2009 includes initial goodwill of $3,788 for the acquisition of Delta. See Note 6 - Business Combinations in Notes to Consolidated Financial Statements for additional information regarding this acquisition. Purchase accounting adjustments for the Commercial Banking segment relates to an income tax adjustment for a prior acquisition. Purchase accounting adjustments for Wealth Management represent adjustments made to the initial estimates of fair value associated with the December 2008 acquisition of TCH.
The Corporation’s other intangible assets consisted of the following at December 31, 2010:
Notes to Consolidated Financial Statements - (Continued) December 31, 2010, 2009 and 2008 ($000’s except share data)
The Corporation’s other intangible assets consisted of the following at December 31, 2009:
Amortization expense of other intangible assets amounted to $19,416, $22,324 and $22,982 in 2010, 2009 and 2008, respectively. Amortization of mortgage loan servicing rights was $793, $1,099 and $1,300 in 2010, 2009 and 2008, respectively.
The estimated amortization expense of other intangible assets and mortgage loan servicing rights for the next five years are:
Mortgage loan servicing rights are subject to the prepayment risk inherent in the underlying loans that are being serviced. The actual remaining life could be significantly different due to actual prepayment experience in future periods.
Goodwill Impairment Tests
The Intangibles - Goodwill and Other Topic of the Codification provides guidance for impairment testing of goodwill and intangible assets that are not amortized. Goodwill is tested for impairment using a two-step process that begins with an estimation of the fair value of a reporting unit. The first step is a screen for potential impairment and the second step measures the amount of impairment, if any. The Corporation has elected to perform the annual test for goodwill impairment as of June 30th of each year. Other than goodwill, the Corporation did not have any other intangible assets with indefinite lives at December 31, 2010.
As a result of applying the first step of goodwill impairment testing to determine if potential goodwill impairment existed at June 30, 2010, the Commercial Banking segment, Trust, Private Banking, and Brokerage, the three reporting units that comprise the Wealth Management segment, and the Capital Markets reporting unit “passed” (fair value exceeded the carrying amount) the first step of the goodwill impairment test. The National Consumer Banking reporting unit “failed” (the carrying amount exceeded the fair value) the first step of the goodwill impairment test at June 30, 2010 and was subjected to the second step of the goodwill impairment test.
The second step of the goodwill impairment test compares the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination is determined. The fair value of a reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the price paid to acquire the reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. The allocation process is performed solely for purposes of testing
Notes to Consolidated Financial Statements - (Continued) December 31, 2010, 2009 and 2008 ($000’s except share data)
goodwill for impairment. Recognized assets and liabilities and previously unrecognized intangible assets are not adjusted or recognized as a result of the allocation process.
The Corporation completed an evaluation of the second step of the process in order to determine if there is any goodwill impairment for the National Consumer Banking reporting unit.
The implied fair value of a reporting unit’s goodwill will generally increase if the fair value of its loans and leases are less than the carrying value of the reporting unit’s loans and leases. The fair value of loans and leases was derived from discounted cash flow analysis as described in Note 4 - Fair Value Measurements in Notes to Consolidated Financial Statements.
The Corporation’s allocation of the fair values to the assets and liabilities assigned to the National Consumer Banking reporting unit was less than its reported carrying values. As a result, the Corporation concluded that it was not required to recognize any goodwill impairment.
14. Deposits
The composition of deposits at December 31 was:
At December 31, 2010, the scheduled maturities for CDs $100,000 and over, other time deposits, and foreign deposits were:
The maturity distribution of time deposits issued in amounts of $100,000 and over outstanding at December 31, 2010 was:
At December 31, 2010, time deposits issued by foreign offices totaled $163,527. The majority of foreign deposits were in denominations of $100,000 or more.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
FDIC’s Temporary Liquidity Guarantee Program
On December 5, 2008, the Corporation announced that it and its eligible affiliates would be participating in a component of the FDIC’s Temporary Liquidity Guarantee Program - the Transaction Account Guarantee Program (the “TAGP”).
Under the TAGP, all noninterest-bearing transaction accounts held at the Corporation’s affiliate banks were fully guaranteed by the FDIC for the entire amount in the account, in addition to and separate from the coverage available under the FDIC’s general deposit rules.
Due to the stressed economic conditions that existed in 2008 and 2009, the Corporation believed that its participation in the TAGP was warranted and that such participation had a positive affect on its deposit growth in 2009. The Corporation subsequently determined that its participation in the TAGP program and the additional cost of participating in the program were no longer warranted, and elected to opt out of the program effective as of June 30, 2010. As anticipated, certain NOW deposits and certain noninterest bearing demand deposits migrated to other deposit accounts, investment products or into products offered by other entities during 2010.
Under the Dodd-Frank Act, beginning December 31, 2010 and continuing through December 31, 2012, all funds held in noninterest-bearing transaction accounts will be fully guaranteed by the FDIC for the full amount of the account. This unlimited insurance coverage was eliminated for Interest on Lawyer Trust Accounts and minimal interest-bearing NOW accounts, which were originally covered under TAGP. However, subsequent to the enactment of the Dodd-Frank Act, Congress amended the Federal Deposit Insurance Act to include Interest on Lawyer Trust Accounts within the definition of “noninterest-bearing transaction accounts,” thereby granting such accounts unlimited insurance coverage by the FDIC from December 31, 2010 through December 31, 2012.
In addition to the continuation of insurance coverage for noninterest-bearing transaction accounts, the Dodd-Frank Act permanently increased the standard maximum FDIC deposit insurance amount to $250,000.
FDIC’s Prepaid Assessments
On November 12, 2009, the FDIC adopted the final rule amending the assessment regulations to require insured depository institutions to prepay their quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011 and 2012 on December 30, 2009, along with each institution’s risk-based deposit insurance assessment for the third quarter of 2009. As a result, the Corporation recorded a $333,565 prepaid FDIC premium assessment at December 31, 2009. The balance as of December 31, 2010 was $221,640 and is included in Accrued Interest and Other Assets in the Consolidated Balance Sheets.
15. Short-term Borrowings
Short-term borrowings at December 31 were:
At December 31, 2009, there were two FHLB advances, which included $260,000 with a fixed interest rate of 0.46% that matured on February 8, 2010 and $250,000 with a fixed interest rate of 0.46% that matured on February 10, 2010. The Corporation was required to pledge mortgage related assets as collateral to the FHLB to secure the borrowing.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
16. Long-term Borrowings
Long-term borrowings at December 31 were:
At December 31, 2010, Series E notes outstanding amounted to $79,900 with fixed rates of 5.02% to 6.00%. Series E notes outstanding mature at various times and amounts through 2023. At December 31, 2010, the Series F note outstanding amounted to $250,000 with a fixed rate of 5.35%. The Series F note matures in 2011. The MiNotes, issued in minimum denominations of one thousand dollars or integral multiples of one thousand dollars, may have maturities ranging from nine months to 30 years and may be at fixed or floating rates. At December 31, 2010, MiNotes outstanding amounted to $106,152 with fixed rates ranging from 4.00% to 6.30%. MiNotes outstanding mature at various times through 2038.
The Corporation’s floating rate subordinated-debt securities mature November 2011 and pay interest semiannually at a variable rate, based upon six-month LIBOR plus 3.75%. At December 31, 2010, the subordinated notes were disallowed as “Tier 2” or supplementary capital for regulatory capital purposes.
In conjunction with the acquisition of First Indiana, the Corporation assumed $22,500 of subordinated notes maturing in November 2013. These subordinated notes carry a fixed interest rate of 7.50% with interest payable semiannually. At December 31, 2010, 40% of the subordinated notes qualified as “Tier 2” or supplementary capital for regulatory capital purposes.
In conjunction with the acquisitions of Gold Banc, Trustcorp, Excel and First Indiana, M&I acquired all of the common interests in trusts that issued cumulative preferred capital securities that are supported by junior subordinated deferrable interest debentures. These trusts are 100% owned unconsolidated finance subsidiaries of the Corporation. M&I has fully and unconditionally guaranteed the securities that the trusts have issued. At December 31, 2010, the junior subordinated deferrable interest debentures qualify as “Tier 1” capital for regulatory capital purposes.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Gold Banc Trust III was formed in March 2004, and issued $16,000 of trust-preferred securities to institutional investors. Gold Banc Trust III used the proceeds from the issuance of the trust-preferred securities, as well as Gold Banc’s $495 capital investment in the trust, to purchase $16,495 of junior subordinated debt securities issued by Gold Banc. The debentures mature on April 23, 2034, and may be redeemed, at the option of the Corporation after April 23, 2009. The interest rate of the debentures was fixed at 5.80% for a five-year period through April 23, 2009. Thereafter, interest is at a floating rate equal to the three-month London Inter-Bank Offered Rate (“LIBOR”) plus 2.75%, adjustable quarterly. Interest is payable quarterly. The dividend rate on the trust-preferred securities is identical to the interest rate of the related junior subordinated deferrable interest debentures.
Gold Banc Trust IV was formed in March 2004, and issued $30,000 of trust-preferred securities to institutional investors. Gold Banc Trust IV used the proceeds from the issuance of the trust-preferred securities, as well as Gold Banc’s $928 capital investment in the trust, to purchase $30,928 of floating rate junior subordinated debt securities issued by Gold Banc. The debentures mature on April 7, 2034 and may be redeemed, at the option of the Corporation after April 7, 2009. The interest rate of the debentures is a floating rate equal to three-month LIBOR plus 2.75%, adjustable quarterly. Interest is payable quarterly. The dividend rate on the trust-preferred securities is identical to the interest rate of the related junior subordinated deferrable interest debentures.
Gold Banc Capital Trust V was formed in November 2004, and issued $38,000 of trust-preferred securities to institutional investors. Gold Banc Capital Trust V used the proceeds from the issuance of the trust-preferred securities, as well as Gold Banc’s $1,176 capital investment in the trust, to purchase $39,176 of junior subordinated deferrable interest debentures issued by Gold Banc. The debentures mature on December 15, 2034, and may be redeemed, at the option of the Corporation after December 15, 2009. The interest rate of the debentures was fixed at 6.00% for a five-year period through December 15, 2009. Thereafter, interest is at a floating rate equal to three-month LIBOR plus 2.10%, adjustable quarterly. Interest is payable quarterly. The dividend rate on the trust-preferred securities is identical to the interest rate of the related junior subordinated deferrable interest debentures.
Trustcorp Statutory Trust I was formed in August 2000, and issued $15,000 of 10.60% Cumulative Preferred Trust Securities. Trustcorp Statutory Trust I used the proceeds from the issuance of the cumulative preferred trust securities, as well as Trustcorp’s $464 capital investment in the trust, to purchase $15,464 of junior subordinated deferrable interest debentures issued by Trustcorp. The debentures mature on September 7, 2030. Interest is payable semi-annually. The dividend rate on the cumulative preferred trust securities is identical to the interest rate of the related junior subordinated deferrable interest debentures.
At December 31, 2010, floating rate FHLB advances outstanding mature at various times between 2013 and 2018. The interest rate is reset monthly based on one-month LIBOR. Fixed rate FHLB advances have interest rates, which range from 2.18% to 7.27% and mature at various times in 2011 through 2026.
The Corporation is required to maintain unencumbered first mortgage loans and mortgage-related securities such that the outstanding balance of FHLB advances does not exceed 80% (67% for multi-family and 40% for home equity loans) of the book value of this collateral. In addition, a portion of these advances are collateralized by FHLB stock.
During 2009, the Corporation modified $580 million of fixed rate FHLB advances. The weighted-average interest rate on the debt was modified from 4.83% to 2.20% and the terms were extended. A payment of $29 million was made and is recorded as a discount to be amortized over the remaining life of the modified debt.
The floating rate senior bank notes have interest rates based on one-month or three-month LIBOR with a spread that ranges from a plus 0.11% to a plus 0.13%. Interest payments are either monthly or quarterly. The floating rate senior bank notes outstanding mature in 2011.
The fixed rate senior bank notes have interest rates, which range from 5.15% to 5.30% and pay interest semi-annually. The fixed rate senior bank notes outstanding mature at various times and amounts from 2011 through 2012.
The floating rate subordinated bank notes, issued by M&I Bank mature in 2012 and have an interest rate based on the three-month LIBOR plus 0.27%, adjustable quarterly. Interest is payable quarterly. At December 31, 2010, 20% of the floating rate subordinated bank notes qualified as “Tier 2” or supplementary capital for regulatory capital purposes.
The fixed rate subordinated bank notes have interest rates that range from 4.85% to 7.50% and mature at various times in 2011 through 2020. Interest is paid semi-annually. A portion of these notes qualify as “Tier 2” or supplementary capital for regulatory capital purposes.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
The $475 million of agricultural mortgage backed notes are due August 19, 2011. These notes carry an unconditional guarantee of principal and interest and are secured by Federal Agricultural Mortgage Corporation (“Farmer Mac”). The interest rate is fixed at 3.875% and is payable semi-annually.
The Corporation re-acquired and extinguished both bank holding company and banking affiliate long-term borrowings through open market purchases in 2010 and 2009. The borrowings consisted of various senior and subordinated notes. Small blocks of various bank holding company and bank notes were acquired in individual transactions in 2010 and 2009. In addition, a $400 million public tender offer of M&I Bank senior and subordinated notes was completed in 2009. During 2010, the Corporation re-acquired and extinguished $223.3 million of debt. The gain amounted to $19.7 million and is reported as Gain on Termination of Debt in the Consolidated Statements of Income. During 2009, the Corporation re-acquired and extinguished $1,285.7 million of debt at gain of $99.4 million.
Scheduled maturities of long-term borrowings are $1,265,580, $824,972, $1,152,485, $81,145 and $350,702 for 2011 through 2015, respectively.
FDIC’s Temporary Liquidity Guarantee Program
On December 5, 2008, the Corporation announced that it and its eligible affiliates will be participating in a component of the FDIC’s Temporary Liquidity Guarantee Program - the Debt Guarantee Program (the “DGP”).
During 2010 and 2009, the Corporation did not issue any debt guaranteed by the FDIC.
17. Shareholders’ Equity
The Corporation has 5,000,000 shares of preferred stock authorized, with a par value of $1.00 per share. There were 1,715,000 shares of Senior Preferred Stock, Series B issued and outstanding, with a liquidation preference of $1,000 per share, for each of the years ended December 31, 2010 and 2009.
On November 14, 2008, as part of the Corporation’s participation in the CPP, the Corporation entered into a Letter Agreement with the UST. Pursuant to the Securities Purchase Agreement - Standard Terms (the “Securities Purchase Agreement”) attached to the Letter Agreement; the Corporation sold 1,715,000 shares of the Corporation’s Senior Preferred Stock, having a liquidation preference of $1,000 per share, for a total price of $1,715 million. The Senior Preferred Stock qualifies as Tier 1 capital and pay cumulative compounding dividends at a rate of 5% per year for the first five years and 9% per year thereafter.
Under the terms of the Securities Purchase Agreement, except as described below, the Corporation may not redeem the Senior Preferred Stock during the first three years that it is outstanding. After the first three years, the Corporation may redeem shares of the Senior Preferred Stock for the per share liquidation preference of $1,000 plus any accrued and unpaid dividends. The Corporation is permitted, subject to regulatory approval, to redeem in whole or in part the Senior Preferred Stock during the first three years only if (a) it has received aggregate gross proceeds of not less than $428.75 million from one or more “Qualified Equity Offerings” (as defined in the Securities Purchase Agreement), and (b) the aggregate redemption price of the Senior Preferred Stock redeemed does not exceed the aggregate net proceeds received by the Corporation from any such Qualified Equity Offerings.
The Corporation received a total of $1,419.4 million in aggregate net proceeds from the common stock offerings in 2009, which met the requirements for Qualified Equity Offerings. Any repurchase of the Senior Preferred Stock would be contingent upon the determination of the Board of Directors that such repurchase is in the best interests of the Corporation and its shareholders. Furthermore, any repurchase of the Senior Preferred Stock would be subject to consultation with and approval by the Corporation’s banking regulators. To the extent the Corporation seeks such approval, there can be no assurance that such approval will be granted.
Pursuant to the American Recovery and Reinvestment Act, which was signed into law in February 2009, CPP participants are permitted to redeem the preferred stock issued under the CPP at any time, subject to consultation with the appropriate federal banking agency. However, the Corporation’s Restated Articles of Incorporation contain the redemption restrictions described above. The Corporation may seek Board of Directors and shareholder approval in the future to amend the Restated Articles of Incorporation to allow the Corporation to redeem the Senior Preferred Stock at any time after consultation with the Federal Reserve Board.
Under the terms of the Securities Purchase Agreement, as long as any Senior Preferred Stock is outstanding, the Corporation may pay quarterly common stock cash dividends of up to $0.32 per share, and may redeem or
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
repurchase its common stock, provided that all accrued and unpaid dividends for all past dividend periods on the Senior Preferred Stock are fully paid. Prior to the third anniversary of the UST’s purchase of the Senior Preferred Stock, unless Senior Preferred Stock has been redeemed or the UST has transferred all of the Senior Preferred Stock to third parties, the consent of the UST will be required for the Corporation to increase its common stock dividend to more than $0.32 per share per quarter or repurchase its common stock or other equity or capital securities, other than in connection with benefit plans consistent with past practice and certain other circumstances specified in the Securities Purchase Agreement. The Senior Preferred Stock will be non-voting except for class voting rights on matters that would adversely affect the rights of the holders of the Senior Preferred Stock.
As a condition to participating in the CPP, the Corporation issued and sold to the UST a warrant (the “Warrant”) to purchase 13,815,789 shares (the “Warrant Shares”) of the Corporation’s common stock, at an initial per share exercise price of $18.62, for an aggregate purchase price of approximately $257.25 million. The term of the Warrant is ten years. The Warrant is no longer subject to any contractual restrictions on transfer. The Warrant provides for the adjustment of the exercise price and the number of Warrant Shares issuable upon exercise pursuant to customary anti-dilution provisions, such as upon stock splits or distributions of securities or other assets to holders of the Corporation’s common stock, and upon certain issuances of the Corporation’s common stock at or below a specified price range relative to the initial exercise price. Pursuant to the Securities Purchase Agreement, the UST has agreed not to exercise voting power with respect to any shares of common stock issued upon exercise of the Warrant.
Pursuant to the Securities Purchase Agreement, until the UST no longer owns any shares of the Senior Preferred Stock, the Warrant or Warrant Shares, the Corporation’s employee benefit plans and other executive compensation arrangements for its Senior Executive Officers must continue to comply in all respects with Section 111(b) of the Emergency Economic Stabilization Act and the rules and regulations of the UST promulgated thereunder.
The Securities Purchase Agreement permits the UST to unilaterally amend any provision of the Letter Agreement and the Securities Purchase Agreement to the extent required to comply with any changes in the applicable Federal statutes.
For accounting purposes, the proceeds of $1,715 million were allocated between the preferred stock and the warrant based on their relative fair values. The initial value of the Warrant, which is classified as equity, was $81.12 million. The entire discount on the Senior Preferred Stock, created from the initial value assigned to the Warrant, will be accreted over a five year period in a manner that produces a level preferred stock dividend yield which is 6.10%. At the end of the fifth year, the carrying amount of the Senior Preferred Stock will equal its liquidation value.
Preferred dividends accrued and discount accretion on the Senior Preferred Stock amounted to $101.1 million for the year ended December 31, 2010. On November 15, 2010, the Corporation paid the quarterly preferred dividend covering the period from August 15, 2010 through November 15, 2010 in the amount of $21.4 million. Preferred dividends paid on the Senior Preferred Stock amounted to $85.8 million for the year ended December 31, 2010.
On October 27, 2009, the Corporation announced the closing of its public offering of 156.4 million shares of its $1.00 par value common stock at $5.75 per share. The 156.4 million shares included 20.4 million shares issued pursuant to an option granted to the underwriters by the Corporation, which was exercised in full. The proceeds, net of underwriting discounts and commissions and offering expenses, from the offering amounted to $863.1 million.
On June 17, 2009, the Corporation announced the closing of its public offering of 100.0 million shares of its $1.00 par value common stock at $5.75 per share. The 100.0 million shares include 13.0 million shares issued pursuant to an option granted to the underwriters by the Corporation, which was exercised in full. The proceeds, net of underwriting discounts and commissions and offering expenses, from the offering amounted to $551.8 million.
The Corporation also sold on an at-the-market basis 670,300 shares of its common stock resulting in proceeds of $4.5 million, net of fees and commissions and offering expenses, during the second quarter of 2009.
The Corporation issues treasury common stock in conjunction with exercises of stock options and restricted stock, acquisitions, and from time-to-time issues treasury stock to fund a portion of its retirement plan obligations. Treasury shares are acquired from restricted stock forfeitures, shares tendered to cover tax withholding associated with stock option exercises and vesting of key restricted stock and mature shares tendered for stock option exercises in lieu of cash. The Corporation had a Stock Repurchase Program under which up to 12 million shares of the Corporation’s common stock could be repurchased annually. As a result of the restrictions contained in the Securities Purchase Agreement, the Corporation allowed the Stock Repurchase Program to expire and did not reconfirm the Stock Repurchase Program for 2009. During 2008, the Corporation acquired 4,782,400 shares of its common stock in open market share repurchase transactions under the Stock Repurchase Program. Total cash consideration amounted to $124.9 million.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
The Corporation sponsors a deferred compensation plan for its non-employee directors and the non-employee directors and advisory board members of its affiliates. Participants may elect to have their deferred fees used to purchase M&I common stock with dividend reinvestment. Such shares will be distributed to plan participants in accordance with the plan provisions. At December 31, 2010 and 2009, 1,242,957 and 1,069,044 shares, respectively, of M&I and Fidelity National Information Services Inc. common stock were held in a grantor trust. The aggregate cost of such shares is included in Deferred Compensation as a reduction of Shareholders’ Equity in the Consolidated Balance Sheets and amounted to $17,952 at December 31, 2010 and $17,075 at December 31, 2009.
The Corporation amended its deferred compensation plan for its non-employee directors and selected key employees to permit participants to defer the gain from the exercise of nonqualified stock options. In addition, the gain upon vesting of restricted common stock to participating executive officers may be deferred. Shares of M&I common stock, which represent the aggregate value of the gains deferred are maintained in a grantor trust with dividend reinvestment. Such shares will be distributed to plan participants in accordance with the plan provisions. At December 31, 2010 and 2009, 936,909 and 820,709 shares, respectively, of M&I and Fidelity National Information Services Inc. common stock were held in the grantor trust. The aggregate cost of such shares is included in Deferred Compensation as a reduction of Shareholders’ Equity in the Consolidated Balance Sheets and amounted to $20,677 at December 31, 2010 and $20,463 at December 31, 2009.
The following tables present the Corporation’s comprehensive income:
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Regulatory Capital
Federal banking regulatory agencies established capital adequacy rules which take into account risk attributable to balance sheet assets and off-balance sheet activities. All banks and bank holding companies must meet a minimum total risk-based capital ratio of 8%. Of the 8% required, at least half must be comprised of core capital elements defined as “Tier 1” capital. The Federal banking agencies also have adopted leverage capital guidelines which banking organizations must meet. Under these guidelines, the most highly rated banking organizations must meet a minimum leverage ratio of at least 3% “Tier 1” capital to total assets, while lower rated banking organizations must maintain a ratio of at least 4% to 5%. Failure to meet minimum capital requirements can result in certain mandatory-and possibly additional discretionary-actions by regulators that, if undertaken, could have a direct material effect on the consolidated financial statements.
At December 31, 2010 and 2009, the most recent notification from the Federal Reserve Board categorized the Corporation as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Corporation’s category.
To be well capitalized under the regulatory framework, the “Tier 1” capital ratio must meet or exceed 6%, the total capital ratio must meet or exceed 10% and the leverage ratio must meet or exceed 5%.
The Corporation’s risk-based capital and leverage ratios are as follows ($ in millions):
At December 31, 2010 and 2009, the estimated deferred tax liabilities that reduced the carrying value of acquired intangibles used in determining Tier 1 capital amounted to $42,519 and $49,394, respectively.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
The Corporation’s banking subsidiaries’ risk-based capital and leverage ratios meet or exceed the defined minimum requirements, and were well capitalized as of December 31, 2010 and 2009. The following table presents the risk-based capital ratios for the Corporation’s significant banking subsidiaries:
(1) Southwest Bank, an M&I Bank was merged into M&I Marshall & Ilsley Bank during 2010.
The payment of dividends by banking subsidiaries is subject to regulatory restrictions by various federal and/or state regulatory authorities. Dividends paid by bank subsidiaries are further limited if the effect would result in a bank’s subsidiary capital being reduced below applicable minimum capital amounts. At December 31, 2010, the Corporation’s subsidiary banks, identified above, did not have any retained earnings available for the payment of dividends to the Corporation without first obtaining the consent of its federal and state regulatory authorities.
Currently, the Corporation is required to obtain the prior approval of the Federal Reserve Bank of Chicago and the Wisconsin Department of Financial Institutions to pay a cash dividend on its common stock.
18. Income Taxes
The Corporation adopted the provisions of the Income Taxes Topic of the Codification related to accounting for Uncertainty in Income Taxes which prescribes a recognition threshold and measurement process for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
The Corporation, along with its subsidiaries, files income tax returns in the U.S. and various state jurisdictions. With limited exceptions, the Corporation is no longer subject to examinations by federal taxing authorities for taxable years prior to 2009 and state taxing authorities for taxable years prior to 2005.
As of December 31, 2010, the total amount of gross unrecognized tax benefits was $37,907, of which $36,051 relates to benefits that, if recognized, would impact the annual effective tax rate. A reconciliation of the beginning and ending amounts of unrecognized tax benefits is as follows:
The Corporation anticipates that its unrecognized tax benefits will not significantly increase or decrease within the next twelve months.
The Corporation’s policy is to include interest and penalties related to income tax liabilities in income tax expense. The total amount of net interest (income) expense included in the income statement as it pertains to the unrecognized tax benefits for 2010, 2009 and 2008 is $(880), $(4,551) and $2,334, respectively. These amounts include interest income received from settlements, reversal of interest expense on lapsing of the statute of limitations, and decreases of prior year’s positions. Interest included in the total liability for unrecognized tax benefits as of
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
December 31, 2010 and 2009 is $6,674 and $7,553, respectively. The Corporation has not accrued any penalties for any unrecognized tax benefits.
Total income tax expense (benefit) for the years ended December 31, 2010, 2009 and 2008 was allocated as follows:
The current and deferred portions of the benefit for income taxes were:
The following reconciliation is between the amount of the benefit for income taxes of continuing operations and the amount of tax computed by applying the statutory Federal income tax rate (35%):
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
The tax effects of temporary differences that give rise to significant elements of the deferred tax assets and deferred tax liabilities at December 31 are as follows:
The net deferred tax asset is included in Accrued Interest and Other Assets on the Consolidated Balance Sheets.
The Corporation’s federal net operating losses of approximately $1,600,000 will begin to expire in 2027. The Corporation’s tax credit carryforwards will begin to expire in 2027. Its state net operating losses and tax credits will expire at various times through 2025.
The Corporation continues to carry a valuation allowance to reduce certain state deferred tax assets which include, in part, certain state net operating loss carryforwards which expire at various times through 2025. At December 31, 2010, the Corporation believes it is more likely than not that these items will not be realized. However, as time passes the Corporation will be able to better assess the amount of tax benefit it will realize from using these items.
In 2006, the Corporation was awarded an allocation of $75,000 under the New Markets Tax Credit Program administered by the Community Development Financial Institutions Fund. Under the program, the Corporation invested $75,000 in a wholly-owned subsidiary, which will make qualifying loans and investments. In return, the Corporation will receive federal income tax credits that will be recognized over seven years, including the year in which the funds were invested in the subsidiary. The Corporation recognizes these tax credits for financial reporting purposes in the same year the tax benefit is recognized in the Corporation’s tax return. The investment resulted in a tax credit that reduced income tax expense by $4,500 in 2010 and $4,500 in 2009 and $3,750 in 2008. The Corporation was awarded an additional $40,000 under the New Markets Tax Credit Program in 2009. None of the $40,000 has been invested as of December 31, 2010.
19. Stock Options, Restricted Stock, Employee Stock Purchase Plan and Stock Salary
The Corporation has equity incentive plans (collectively, the “Equity Incentive Plans”) which provide for the grant of nonqualified and incentive stock options, stock appreciation rights, rights to purchase shares of restricted stock and the award of restricted stock units to key employees and directors of the Corporation at prices ranging from zero to the market value of the shares at the date of grant. The Equity Incentive Plans generally provide for the grant of options to purchase shares of the Corporation’s common stock for a period of ten years from the date of grant. Stock options granted generally become exercisable over a period of three years from the date of grant. However, stock options granted to directors of the Corporation vest immediately and stock options granted after 1996 provide
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
immediate vesting for grants to individuals who meet certain age and years of service criteria at the date of grant. Restrictions on stock or units issued pursuant to the Equity Incentive Plans generally lapse within a three to seven year period.
The Corporation also has a long-term incentive plan. Under this plan, performance units may be awarded from time to time. Once awarded, additional performance units will be credited to each participant based on dividends paid by the Corporation on its common stock. At the end of a designated vesting period, participants will receive a cash award based on the Corporation’s common stock price, the performance units and the performance criteria established for each award. The vesting period is three years from the date the performance units were awarded.
The Corporation also had a qualified employee stock purchase plan (the “ESPP”) which gave employees (excluding executive officers) who elected to participate in the plan the right to acquire shares of the Corporation’s common stock at a purchase price which was 85% of the fair market value of the Corporation’s common stock on the last day of each three month period within the one-year offering period. Employee contributions under the ESPP were made ratably during the plan period. Employees could have withdrawn from the plan prior to the end of the one year offering period. The ESPP was terminated on the last day of the three month period within the one-year offering period ending December 31, 2010. No further purchases of the Corporation’s common stock will be made under this plan.
Beginning in 2010, modifications were made to the executive compensation program to match the means available to compensate these individuals with requirements of the Interim Final Rule on TARP Standards for Compensation and Corporate Governance (“Interim Final Rule”) issued by the U.S. Department of the Treasury. As a result, the means available to the Corporation for compensating individuals covered by the Interim Final Rule are cash salary, stock salary and, on a limited basis, restricted stock.
Consistent with the provisions of the Interim Final Rule, the stock salary is fully vested at the time of grant. However, the shares awarded as salary are subject to restrictions on transfer. One third of the stock salary shares will be released from the transfer restrictions after each of the first three years following the date on which the stock salary shares were paid, at the end of the quarter during which the corresponding payment was made. All common shares received through stock salary that are still under the transfer restriction when a change in control occurs will be released from their transfer restrictions at that time.
The number of shares of common stock paid through stock salary is determined by dividing the amount of salary to be paid in common stock for each pay period by the reported closing price per share of the Corporation’s common stock on the New York Stock Exchange on the pay date for the corresponding pay period. These individuals may satisfy their income and employment tax withholding obligations in connection with the stock salary payments by surrendering shares of common stock to the Corporation.
Under the fair value method of accounting, compensation cost is measured at the grant date based on the fair value of the award. The fair value for stock option awards is determined using an option-pricing model that takes into account the stock price at the grant date, the exercise price, the expected life of the option, the volatility of the underlying stock, expected dividends and the risk-free interest rate over the expected life of the option. The resulting compensation cost for stock options that vest is recognized over the service period, which is usually the vesting period.
Activity relating to nonqualified and incentive stock options was:
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
The ranges of options outstanding at December 31, 2010 were:
Options exercisable at December 31, 2009 and 2008 were 27,080,649 and 25,792,664, respectively. The weighted-average exercise price for options exercisable was $26.99 at December 31, 2009 and $27.05 at December 31, 2008.
The fair value of each option grant was estimated as of the date of grant using the Black-Scholes closed form option-pricing model for options granted prior to September 30, 2004. A form of a lattice option-pricing model was used for options granted after September 30, 2004.
The grant date fair values and assumptions used to determine such value are as follows:
The total intrinsic value of nonqualified and incentive stock options exercised was immaterial for the year ended December 31, 2010. There were no nonqualified and incentive stock options exercised during 2009. The total intrinsic value of nonqualified and incentive stock options exercised was $6.6 million for the year ended December 31, 2008. The total fair value of shares vested during the years ended December 31, 2010, 2009 and 2008 amounted to $15.5 million, $22.3 million and $25.5 million, respectively.
There was approximately $10.0 million and $26.6 million of total unrecognized compensation expense related to unvested nonqualified and incentive stock options at December 31, 2010 and 2009, respectively. The total unrecognized compensation expense will be recognized over a weighted average period of 1.2 years. For awards with graded vesting, compensation expense was recognized using an accelerated method prior to the adoption of Stock Compensation Topic of the Codification and is recognized on a straight line basis for awards granted after the effective date.
For the years ended December 31, 2010, 2009 and 2008, the expense for nonqualified and incentive stock options that is included in Salaries and Employee Benefits expense in the Consolidated Statements of Income amounted to $15.1 million, $22.5 million and $23.1 million, respectively. These amounts are considered non-cash expenses for the Consolidated Statements of Cash Flow purposes.
For the years ended December 31, 2010, 2009 and 2008, the expense for directors’ nonqualified and incentive stock options that is included in the Other line of Other Expense in the Consolidated Statements of Income amounted to $0.1 million, $0.1 million and $0.1 million, respectively.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Activity relating to the Corporation’s restricted stock purchase rights was:
Restrictions on stock issued pursuant to the exercise of restricted stock purchase rights generally lapse within a three to seven year period. Accordingly, the compensation related to issuance of the rights is amortized over the vesting period. At December 31, 2010, the unamortized compensation expense will be recognized over a weighted average period of 1.5 years. These amounts are considered non-cash expenses for the Consolidated Statements of Cash Flow purposes.
For the year ended December 31, 2010, the expense for stock salary compensation amounted to $8.8 million. During 2010, common shares issued for stock salary amounted to 1,269,107. The weighted average grant date market value for common shares used for stock salary was $6.95 for the year ended December 31, 2010.
Compensation under the long-term incentive plan is paid in cash at the end of the designated vesting period. This plan meets the definition of a liability award. Unlike equity awards, liability awards are remeasured at fair value at each balance sheet date until settlement. For the years ended December 31, 2010, 2009 and 2008, the net expense or net expense reversal for the Long-Term Incentive Plan that is included in Salaries and Employee Benefits expense in the Consolidated Statements of Income amounted to $1.6 million, $(1.3) million and $(4.3) million, respectively.
The compensation cost per share for the ESPP was $1.17, $0.99 and $2.88 for the plan years ended December 31, 2010, 2009 and 2008, respectively. Employee contributions under the ESPP are made ratably during the plan period. Employees may withdraw from the plan prior to the end of the one year offering period. The total shares to be purchased are estimated at the beginning of the plan period based on total expected contributions for the plan period and 85% of the market price at that date. During 2010 and 2009, common shares purchased by employees under the ESPP amounted to 950,237 and 1,409,358, respectively. For the years ended December 31, 2010, 2009 and 2008 the total expense for the ESPP that is included in Salaries and Employee Benefits expense in the Consolidated Statements of Income amounted to $1.1 million, $1.4 million and $1.7 million, respectively. These amounts are considered non-cash expenses for the Consolidated Statements of Cash Flow purposes.
Shares reserved for the granting of options and stock purchase rights at December 31, 2010 were 19,800,247, of which, 6,500,742 are available for future grants of restricted stock.
20. Employee Retirement and Health Plans
The Corporation has a defined contribution program that consists of a 401(k) component, including employer matching contributions, and an employer contribution component that is allocated based on compensation. Employee 401(k) contributions into the retirement program of up to 6% of eligible compensation are matched at 50% by the Corporation. The employer contribution component provides for a guaranteed contribution to eligible participants equal to 2% of compensation. At the Corporation’s option, an additional amount may also be contributed and may vary from year to year up to a maximum of an additional 6% of eligible compensation. For the years ended December 31, 2010, 2009 and 2008, the additional amount contributed was 4%, 2%, and 4%, respectively. Total expense relating to these plans was $32,282, $30,289 and $47,440 in 2010, 2009 and 2008, respectively. Effective for the plan year beginning on January 1, 2011, the defined contribution program was amended to eliminate the program’s guarantees of the 2% employer contribution and the 50% employer match for the 401(k) components of the defined contribution program. In lieu of the guarantees, the Corporation is permitted to determine and provide future contributions at levels it deems appropriate. The Corporation also has supplemental retirement plans which provide retirement benefits to key executives. Total expense relating to these plans amounted to $2,564 in 2010, $3,260 in 2009 and $3,933 in 2008.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
The Corporation sponsors a defined benefit health plan that provides health care benefits to eligible current and retired employees. Eligibility for retiree benefits is dependent upon age, years of service, and participation in the health plan during active service. The plan is contributory and in 1997 and 2002 the plan was amended. Employees hired after September 1, 1997, including employees retained from mergers, will be granted access to the Corporation’s plan upon becoming an eligible retiree; however, such retirees must pay 100% of the cost of health care benefits. The plan continues to contain other cost-sharing features such as deductibles and coinsurance. During 2010, the Corporation did not make any discretionary contributions to the postretirement medical plan.
On November 1, 2007, the Corporation completed a corporate reorganization in connection with the separation of its data services subsidiary Metavante Corporation. As part of this reorganization, the old Marshall & Ilsley Corporation was separated into two publicly traded companies, new Marshall & Ilsley Corporation (which is referred to as “M&I” or the “Corporation” ) and Metavante Technologies, Inc. The Corporation refers to this transaction as the “Separation.” In the Separation, the Corporation assumed Metavante’s obligation to provide postretirement medical benefits to all of Metavante’s existing retirees eligible for such coverage and those retirement-eligible employees that were also eligible for postretirement medical benefits but had not yet retired as of November 1, 2007. The assets held in a trust that is used to fund such obligations, which included Metavante’s contributions made through November 1, 2007, were retained by the Corporation.
The Corporation uses a measurement date of December 31 for its retirement plans. The following table summarizes the accumulated postretirement benefit obligation (“APBO”) reflecting Medicare Part D subsidy, and plan asset activity for the retirement plans:
The weighted average discount rate used in determining the APBO was based on matching the Corporation’s estimated plan duration to a yield curve derived from a portfolio of high-quality corporate bonds with yields within the 10th to 90th percentiles. The portfolio consisted of over 500 actual Aa quality bonds at various maturity points across the full maturity spectrum that were all United States issues.
The long-term rate used in determining the expected return on retirement plan assets was based on a historical return experience for a diversified asset allocation of equities and fixed income securities, along with equity and bond indices used for forward looking return projections.
The assumed health care cost trend rate for 2011 is 7.50% for pre-age 65 and post-age 65 retirees. The rate was assumed to decrease gradually to 5.00% for pre-age 65 and post-age 65 retirees in 2016 and remain at that level thereafter.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
The funded status at December 31:
At December 31, 2010 and 2009, $24,512 and $28,020, respectively, are included in Accrued Expenses and Other Liabilities in the Consolidated Balance Sheets.
The amounts recognized in accumulated other comprehensive income (pre-tax) for the years ended December 31, 2010 and 2009 consists of:
The estimated amounts that will be amortized from accumulated other comprehensive income into net periodic benefit cost in 2011 are as follows:
Net periodic postretirement benefit cost for the years ended December 31, 2010, 2009 and 2008 includes the following components:
Other changes in plan assets and benefit obligations recognized in other comprehensive income for the years ended December 31, 2010, 2009 and 2008 include the following components:
The weighted average annual discount rate used to determine net periodic benefit cost was 5.44% for the year ended 2010 and 6.0% for the years ended 2009 and 2008. The expected long-term rate of return on plan assets used to determine net periodic benefit cost was 5.25% for the years 2010, 2009 and 2008.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
The assumed health care cost trend used to determine net periodic benefit cost for 2011 is 7.50%. The rate is assumed to decrease gradually to 5.00% in 2016 and remain at that level thereafter.
The assumed health care cost trend rate has a significant effect on the amounts reported for the health care plans. A one-percentage point change in assumed health care cost trend rates would have the following effects:
The fair value of the postretirement medical plan assets at December 31, by asset category are as follows:
The Corporation’s primary investment objective is to achieve a combination of income and growth of capital through the investment in a diversified portfolio of equity and fixed income securities. The portfolio seeks to maximize potential total return consistent with minimizing overall volatility. The long-term target asset mix is 50% equities and 50% fixed income securities. At December 31, 2010, the equity mutual fund consisted of a pooled large cap equity fund. This equity mutual fund is valued with quoted prices in active markets for identical assets, and as such, considered Level 1. The fixed income securities are comprised of a short-term municipal (tax-exempt) fund and a corporate and government bond market index fund. These fixed income securities are also valued with quoted prices in active markets for identical assets, and is considered Level 1.
Management has established acceptable guidelines for the types of investments held in the portfolio. The acceptable ranges for the long-term allocation of funds among asset classes within the portfolio are: 40% to 60% equities, 40% to 60% fixed income securities, and 0% to 10% cash reserves. Individual fixed income securities will have maturities of thirty years or less. The average maturity of the portfolio will not exceed ten years. In order to maintain diversification, management has set limits with regards to holdings of individual investments as a percentage of the total portfolio. Based on the Corporation’s investment objective, the allocation of the plan assets is aligned with meeting the funding objectives of the benefit obligation of the postretirement plan.
On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”) was signed into law. The Act introduced a prescription drug benefit program under Medicare (Medicare Part D) as well as a 28% Federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D.
The following expected benefit payments to be paid, which reflect future service, as appropriate, are as follows:
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
On March 23, 2010, the Patient Protection and Affordable Care Act (the “PPACA”) was signed into law, and, on March 30, 2010, the Health Care and Reconciliation Act of 2010 (the “HCERA” and, together with PPACA, the “Acts”), which makes various amendments to certain aspects of the PPACA, was signed into law. The Acts effectively change the income tax treatment of federal subsidies paid to sponsors of retiree health benefit plans that provide prescription drug benefits that are at least actuarially equivalent to the corresponding benefits provided under Medicare Part D. The federal subsidy paid to employers was introduced as part of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “MPDIMA”). The Corporation has been receiving the federal subsidy related to its eligible retiree prescription plan. Under the MPDIMA, the federal subsidy does not reduce the Corporation’s income tax deduction for the costs of providing such prescription drug plans nor is it subject to income tax individually. Under the Acts, beginning in 2013 the Corporation’s income tax deduction for the costs of providing Medicare Part D-equivalent prescription drug benefits to retirees will be reduced by the amount of the subsidy. Under U.S. generally accepted accounting principles, any impact from a change in tax law must be recognized in earnings in the period enacted regardless of the effective date. As a result, during the first quarter of 2010, the Corporation recognized a non-cash charge of $4.1 million for the write-off of deferred tax assets to reflect the change in tax treatment of the federal subsidy.
21. Financial Instruments with Off-balance Sheet Risk
Financial instruments with off-balance sheet risk at December 31 were:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates and may require payment of a fee. The majority of the Corporation’s commitments to extend credit generally provide for the interest rate to be determined at the time the commitment is utilized. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
The Corporation evaluates each customer’s credit worthiness on an individual basis. Collateral obtained, if any, upon extension of credit, is based upon management’s credit evaluation of the customer. Collateral requirements and the ability to access collateral is generally similar to that required on loans outstanding as described in Note 8 - Loans and Leases in Notes to Consolidated Financial Statements.
Commercial letters of credit are contingent commitments issued by the Corporation to support the financial obligations of a customer to a third party. Commercial letters of credit are issued to support payment obligations of a customer as buyer in a commercial contract for the purchase of goods. Letters of credit have maturities which generally reflect the maturities of the underlying obligations. The credit risk involved in issuing letters of credit is the same as that involved in extending loans to customers. If deemed necessary, the Corporation holds various forms of collateral to support letters of credit.
Certain mortgage loans sold have limited recourse provisions. The losses arising from limited recourse provisions are not material.
The credit support agreement the Corporation entered into, represents the maximum aggregate contribution, contingent upon certain specified and defined circumstances as described in Note 24 - Guarantees in Notes to Consolidated Financial Statements.
Standby letters of credit are contingent commitments issued by the Corporation to support customer obligations to a third party and to support public and private financing, and other financial or performance obligations of customers. Standby letters of credit have maturities that generally reflect the maturities of the underlying obligations. The credit risk involved in issuing standby letters of credit is the same as that involved in extending loans to customers. If deemed necessary, the Corporation holds various forms of collateral to support standby letters of
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
credit. Of the amount outstanding at December 31, 2010, standby letters of credit conveyed to others in the form of participations amounted to $24.7 million. Since many of the standby letters of credit are expected to expire without being drawn upon, the amounts outstanding do not necessarily represent future cash requirements. At December 31, 2010, the estimated fair value associated with letters of credit amounted to $6.2 million.
At December 31, 2010 and 2009, the Corporation had an allowance for probable credit losses associated with off-balance sheet credit exposures in the amount of $32,790 and $32,646, respectively. The amounts are included in Accrued Expenses and Other Liabilities in the Consolidated Balance Sheets.
22. Derivative Financial Instruments and Hedging Activities
Interest rate risk, the exposure of the Corporation’s net interest income and net fair value of its assets and liabilities to adverse movements in interest rates, is a significant market risk exposure that can have a material effect on the Corporation’s financial condition, results of operations and cash flows. The Corporation has established policies that neither earnings nor fair value at risk should exceed established guidelines and assesses these risks by modeling the impact of changes in interest rates that may adversely impact expected future earnings and fair values.
The Corporation has strategies designed to confine these risks within the established limits and identify appropriate risk/reward trade-offs in the financial structure of its balance sheet. These strategies include the use of derivative financial instruments to help achieve the desired balance sheet repricing structure while meeting the desired objectives of its customers.
The Corporation employs certain over-the-counter interest rate swaps that are the designated hedging instruments in fair value and cash flow hedges that are used by the Corporation to manage its interest rate risk. These interest rate swaps are measured at fair value on a recurring basis based on significant other observable inputs and are categorized as Level 2. See Note 4 - Fair Value Measurements in Notes to Consolidated Financial Statements for additional information.
During 2010, the Corporation began originating residential mortgage loans for sale to the secondary market on a mandatory basis. In conjunction with these activities, the Corporation elected to account for the loans held for sale on a mandatory basis at fair value and economically hedge the change in fair value of both the loan commitments and funded loans held for sale on a mandatory basis with To Be Announced (“TBA”) forward contracts on agency securities. The economic hedges are not intended to qualify for the special hedge accounting prescribed by the Derivative and Hedging Topic of the Codification.
The Dodd-Frank Act contains a number of significant requirements and restrictions relating to derivative financial instruments and hedging activities by financial institutions and other companies. While many of the details of these requirements and restrictions are uncertain pending rules required to be promulgated under the Dodd-Frank Act, the Corporation believes its derivative and hedging activities are in compliance with the provisions of the Dodd-Frank Act as they currently appear.
Trading Instruments and Other Free Standing Derivatives
The Corporation enters into various derivative contracts which are designated as trading and other free standing derivative contracts. These derivative contracts are not linked to specific assets and liabilities on the balance sheet or to forecasted transactions in an accounting hedge relationship and, therefore, do not qualify for hedge accounting under the Derivatives and Hedging Topic of the Codification. They are carried at fair value with changes in fair value recorded as a component of other noninterest income.
Trading and other free standing derivatives are used primarily to focus on providing derivative products to customers that enables them to manage interest rate risk exposure. The Corporation’s market risk from unfavorable movements in interest rates is generally economically hedged by concurrently entering into offsetting derivative contracts. The offsetting derivative contracts generally have nearly identical notional values, terms and indices. The Corporation used interest rate futures to economically hedge the exposure to interest rate risk arising from the interest rate swap (designated as trading) entered into in conjunction with its auto securitization activities. There were no auto securitization activities during the year ended December 31, 2010. See Note 10 - Financial Asset Sales in Notes to Consolidated Financial Statements.
The Corporation originates certain residential real estate loans that are intended to be sold to the secondary market. In conjunction with these activities, the Corporation enters into commitments to originate residential real estate loans whereby the interest rate of the loan is determined prior to funding (“interest rate lock”) which are
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
considered freestanding derivatives. Interest rate locks and funded held for sale residential mortgage loans are subject to interest rate risk between the date of the interest rate lock and the date loans are sold to the secondary market. To economically hedge interest rate risk, the Corporation enters into TBA forward contracts on agency securities. The interest rate locks, funded mortgage loans held for sale and TBA forward contracts are carried at fair value with changes in fair value included in gain on sale of mortgage loans which is reported in Other Income in the Consolidated Statements of Income. The fair value of interest rate locks, funded mortgage loans held for sale and TBA forward contracts are based on current secondary market prices for underlying loans with similar interest rates, maturities and credit quality. The fair value of interest rate locks, are subject to the anticipated probability that the loans will fund within the terms of the loan commitments.
Foreign exchange contracts are commitments to purchase or deliver foreign currency at a specified exchange rate. The Corporation enters into foreign exchange contracts primarily in connection with trading activities to enable customers involved in international trade to hedge exposure to foreign currency fluctuations and to minimize the Corporation’s own exposure to foreign currency fluctuations resulting from the above. Foreign exchange contracts include such commitments as foreign currency spot, forward, future and, to a much lesser extent, option contracts. The risks in these transactions arise from the ability of counterparties to perform under the terms of the contracts and the risk of trading in a volatile commodity. The Corporation actively monitors all transactions and positions against predetermined limits established on trades and types of currency to ensure reasonable risk taking.
Matching commitments to deliver foreign currencies with commitments to purchase foreign currencies minimizes the Corporation’s market risk from unfavorable movements in currency exchange rates.
Visa
As permitted under the by-laws of Visa, during the second quarter of 2009, the Corporation sold its 998,826 shares of Visa Class B common stock, for which there was no carrying value recorded, for $35.4 million to a qualified purchaser. At the time of the sale, the conversion ratio of Visa Class B common stock to Visa Class A common stock was 0.6296. That exchange ratio can change based on the outcome of certain litigation matters. Concurrently with the sale, the Corporation and the purchaser entered into a derivative transaction whereby the Corporation will make cash payments to the purchaser whenever the conversion ratio of Visa Class B common stock to Visa Class A common stock was reset to an amount less than 0.6296. The purchaser will make cash payments to the Corporation when the litigation is settled and the ultimate settlement results in a return of cash or additional shares of Visa common stock to the purchaser. The Corporation determined that the initial fair value of the derivative was equal to the Corporation’s Visa U.S.A. membership proportion of the unfunded estimated fair value of the litigation settlement amount, which was determined to be a liability of $14.7 million.
The Corporation’s estimate of the fair value of the litigation settlement amount was based in part on the announced settled litigation and based in part on an estimate of the amount required to settle the unresolved matters. Estimating the amount required to settle the unresolved matters involved a significant amount of judgment that cannot be verified other than by information provided by Visa. As a result, the Corporation has determined that the estimated fair value should be classified in Level 3 of the fair value hierarchy.
On June 30, 2009, Visa announced that it had decided to deposit $700 million into the litigation escrow account previously established under its retrospective responsibility plan. Despite the funding, Visa did not disclose any updates about the litigation matters that would change the Corporation’s estimate of the fair value of the litigation settlement amount. As a result of the deposit, the conversion ratio of Visa Class B common stock to Visa Class A common stock was revised to 0.5824 and the Corporation made a $3.1 million payment to the purchaser in 2009.
On June 1, 2010, Visa announced that it had deposited an additional $500 million into the litigation escrow account previously established under its retrospective responsibility plan. Despite the funding, Visa did not provide any updates about the litigation matters that would change the Corporation’s estimate of the fair value of the litigation settlement amount. As a result of the deposit, the conversion ratio of Visa Class B common stock to Visa Class A common stock was revised to 0.5550 and the Corporation made a $2.0 million payment to the purchaser in the second quarter of 2010.
On September 21, 2010, Visa announced that it had deposited an additional $800 million in the litigation escrow account. Despite the additional funding, Visa did not provide any updates about the litigation matters that would change the Corporation’s estimate of the fair value of the litigation settlement amount. As a result of the deposit, the conversion ratio of Visa Class B common stock to Visa Class A common stock decreased from 0.5550 to 0.5102 and on October 22, 2010, the Corporation made a $3.5 million payment to the purchaser.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Financial Guarantees
The Corporation is both a purchaser and seller of credit protection in the financial guarantees market. The Corporation primarily uses financial guarantees to mitigate credit risk associated with the derivative receivables associated with loan participations (bought and sold).
Financial guarantees are financial instruments whose value is derived from credit risk associated with debt of a third-party issuer (the reference entity) and which allow one party (the protection purchaser) to transfer that risk to another party (the protection seller). Financial guarantees expose the protection purchaser to the creditworthiness of the protection seller, as the protection seller is required to make payments under the contract when the reference entity experiences a credit event, such as a bankruptcy, a failure to pay its obligation or a restructuring. The seller of credit protection receives a premium for providing protection but has the risk that the underlying instrument referenced in the contract will be subject to a credit event.
Upon a credit event, the seller of protection would typically pay out only a percentage of the full notional amount of net protection sold, as the amount actually required to be paid on the contracts takes into account the recovery value of the reference obligation at the time of settlement. The Corporation does not use notional as the primary measure of risk management for credit derivatives because notional does not take into account the probability of occurrence of a credit event, recovery value of the reference obligation, or related cash instruments and economic hedges.
At December 31, 2010, the maximum potential amount of future payments (undiscounted) that the Corporation, as a seller of protection, could be required to make under the credit derivative amounted to $5.6 million, of which $0.7 million matures within one year and $4.9 million matures in one to five years. The fair value of the credit derivative amounted to a negative $0.7 million at December 31, 2010 and is included in the Accrued Expenses and Other Liabilities category of the Corporation’s Consolidated Balance Sheets.
At December 31, 2010, the maximum potential amount of future receivables that the Corporation, as a purchaser of protection, may be eligible to receive under the credit derivative amounted to $3.5 million, of which $2.1 million matures in one to five years and $1.4 million matures in five to ten years. At December 31, 2010, the fair value of the credit derivative was immaterial and is included in the Accrued Interest and Other Assets category of the Corporation’s Consolidated Balance Sheets.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
The following tables summarize the balance sheet category and fair values of trading instruments and other free standing derivatives:
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
The following table summarizes the income statement categories of the gain or (loss) recognized in income on trading instruments and other free standing derivatives for the years ended December 31, 2010, 2009 and 2008:
At December 31, 2010, the Corporation’s foreign currency position resulting from foreign exchange contracts by major currency was as follows (U.S. dollars):
The Corporation uses various derivative instruments that qualify as hedging relationships under the Derivatives and Hedging Topic of the Codification. These instruments are designated as either fair value hedges or cash flow hedges. The Corporation recognizes derivative instruments as either assets or liabilities at fair value in the statement of financial position. The following provides further explanation of the hedging relationships.
Fair Value Hedges
The Corporation has fixed rate liabilities that expose the Corporation to variability in fair values due to changes in market interest rates. To limit that variability, the Corporation has entered into received-fixed/pay floating interest rate swaps.
The Corporation structures the interest rate swaps so that all of the critical terms of the fixed rate CDs and fixed rate borrowings match the receive fixed leg of the interest rate swaps at inception of the hedging relationship. As a result, the Corporation expects the hedging relationship to be highly effective in achieving offsetting changes in fair value due to changes in market interest rates both at inception and on an ongoing basis.
At December 31, 2010, no component of the derivative instruments’ gain or loss was excluded from the assessment of hedge effectiveness for derivative financial instruments designated as fair value hedges.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Cash Flow Hedges
The Corporation has variable rate assets and liabilities that expose the Corporation to variability in interest payments due to changes in interest rates. The Corporation believes it is prudent to limit the variability of a portion of its interest receipts and payments. To meet this objective, the Corporation enters into various types of derivative financial instruments to manage fluctuations in cash flows resulting from interest rate risk. At December 31, 2010, these instruments consisted of interest rate swaps.
The Corporation invests in floating rate investment securities indexed to three-month LIBOR. As a result, the Corporation’s interest receipts are exposed to variability in cash flows due to changes in three-month LIBOR.
To hedge interest rate risk associated with the floating rate investment securities indexed to three-month LIBOR, the Corporation entered into receive fixed/pay LIBOR-based floating interest rate swaps designated as cash flow hedges against the LIBOR-based interest payments received. During 2009, the cash flow hedge matured.
The Corporation issued floating rate institutional CDs indexed to three-month LIBOR. As a result, the Corporation’s interest payments are exposed to variability in cash flows due to changes in three-month LIBOR.
To hedge interest rate risk associated with floating rate institutional CDs, the Corporation entered into pay fixed/receive LIBOR-based floating interest rate swaps designated as cash flow hedges against interest payments on the forecasted issuance of floating rate institutional CDs.
For certain institutional CDs, hedge effectiveness is assessed at inception and each quarter on an on-going basis using regression analysis that regresses daily observations of three-month LIBOR to itself with a five day mismatch on either side for potential reset date differences between the interest rate swaps and the floating rate institutional CDs. Regression analysis is based on a rolling five years of daily observations. Ineffectiveness is measured using the hypothetical derivative method and is recorded as a component of interest expense on deposits.
The Corporation structures interest rate swaps so all of critical terms of LIBOR-based floating rate deposits and borrowings match the floating leg of the interest rate swaps at inception of the hedging relationship. As a result, the Corporation expects those hedging relationships to be highly effective in achieving offsetting changes in cash flows due to changes in market interest rates both at inception and on an ongoing basis.
At December 31, 2010, no component of the derivative instruments’ gain or loss was excluded from the assessment of hedge effectiveness for derivative financial instruments designated as cash flow hedges.
Changes in fair value of interest rate swaps designated as cash flow hedges are reported in accumulated other comprehensive income. These amounts are subsequently reclassified to interest income or interest expense as a yield adjustment in the same period in which the related interest on the variable rate loans and short-term borrowings affects earnings. Ineffectiveness arising from differences between the critical terms of the hedging instrument and hedged item is recorded in interest income or expense.
The impact to total net interest income from cash flow hedges, including amortization of terminated cash flow hedges, for the year ended December 31, 2010 was a negative $53.8 million.
The impact due to ineffectiveness was immaterial. The estimated net loss to be reclassified from accumulated other comprehensive income related to cash flow hedges in the next twelve months is approximately $33.0 million.
The impact to total net interest income from cash flow hedges, including amortization of terminated cash flow hedges, for the year ended December 31, 2009 was a negative $82.5 million. The impact due to ineffectiveness was immaterial.
The impact to total net interest income from cash flow hedges, including amortization of terminated cash flow hedges, for the year ended December 31, 2008 was a negative $38.6 million. The impact due to ineffectiveness was immaterial.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
The following tables summarize the balance sheet category and fair values of derivatives designated as hedging instruments:
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
The effect of Fair Value Hedges on the Consolidated Statements of Income for the Year Ended December 31, 2010 ($ in millions):
(a)
Included in the amount of gain or (loss) recognized in income on derivative is net derivative interest income, which totaled $202.7 million.
(b)
Included in the amount of gain or (loss) recognized in income on hedged item was income related to the amortization of terminated swaps which totaled $3.3 million for the year ended December 31, 2010.
The effect of Fair Value Hedges on the Consolidated Statements of Income for the Year Ended December 31, 2009 ($ in millions):
(a)
Included in the amount of gain or (loss) recognized in income on derivative is net derivative interest income, which totaled $281.1 million.
(b)
Amortization income included in the gain or (loss) recognized in income on hedged item was immaterial for the year ended December 31, 2009.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
The effect of Fair Value Hedges on the Consolidated Statements of Income for the Year Ended December 31, 2008 ($ in millions):
(a)
Included in the amount of gain or (loss) recognized in income on derivative is net derivative interest income, which totaled $109.9 million.
(b)
Amortization income included in the gain or (loss) recognized in income on hedged item was immaterial for the year ended December 31, 2008.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
The effect of Cash Flow Hedges for the Year Ended December 31, 2010 ($ in millions):
(1)
Includes $2.1 million related to termination of swaps which is included in Gain on Termination of Debt in the Consolidated Statements of Income.
(2)
Represents amortization related to the termination of swaps.
The gain recognized in income representing the ineffective portion of hedging relationships and amounts excluded from assessment of hedge effectiveness was not material for the year ended December 31, 2010.
The effect of Cash Flow Hedges for the Year Ended December 31, 2009 ($ in millions):
(1)
Represents amortization related to the termination of swaps.
The gain recognized in income representing the ineffective portion of hedging relationships and amounts excluded from assessment of hedge effectiveness was not material for the year ended December 31, 2009.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
The effect of Cash Flow Hedges for the Year Ended December 31, 2008 ($ in millions):
(1)
Represents amortization related to the termination of swaps.
The gain recognized in income representing the ineffective portion of hedging relationships and amounts excluded from assessment of hedge effectiveness was not material for the year ended December 31, 2008.
23. Business Segments
The Corporation’s operating segments are presented based on its management structure and management accounting practices. The structure and practices are specific to the Corporation; therefore, the financial results of the Corporation’s business segments are not necessarily comparable with similar information for other financial institutions.
The Corporation manages interest rate risk centrally at the corporate level by employing a funds transfer pricing (“FTP”) methodology. This methodology insulates the business segments from interest rate volatility, enabling them to focus on servicing customers. The FTP system assigns charge rates and credit rates to classes of assets and liabilities, respectively, based on expected duration. The net impact of the FTP methodology is included in Treasury. Net interest income is presented on a fully taxable equivalent basis.
The financial results of the business segments include allocations for shared services and corporate expenses. Even with these allocations, the financial results are not necessarily indicative of the business segments’ financial condition and results of operations as if they were to exist as independent entities. Additionally, the business segments form synergies by taking advantage of cross-sell opportunities and when funding their operations by accessing the capital markets as a collective unit. The financial information for each segment is reported on the basis used internally by the Corporation’s management to evaluate performance and allocate resources. The allocation has been consistently applied for all periods presented. Revenues from affiliated transactions are typically charged at rates available to and transacted with unaffiliated customers. The accounting policies of the Corporation’s segments are generally the same as those described in Note 1 - Basis of Presentation and Note 2 - Significant Accounting Policies in Notes to Consolidated Financial Statements.
Based on the way the Corporation organizes its segments, the Corporation has determined that it has four reportable segments, which include Commercial Banking, Community Banking, Wealth Management and Treasury.
Commercial Banking
The Commercial Banking segment provides products and services to middle market businesses, large corporate businesses and public sector entities primarily within M&I’s footprint states. These products and services
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
include: secured and unsecured loans and lines of credit, letters of credit, asset-based lending, equipment financing, mezzanine financing, global trade services, treasury management, demand deposit accounts, interest bearing accounts and time deposits. Commercial Banking also supports the commercial real estate market with products and services including secured and unsecured lines of credit, letters of credit, construction loans for commercial and residential development and land acquisition and development loans.
Community Banking
Community Banking provides consumer and business banking products and services to customers primarily within M&I’s footprint states. Banking services are provided through branches located throughout Wisconsin, Arizona, the Minneapolis, Minnesota, Kansas City, Missouri and St. Louis, Missouri metropolitan areas, and Orlando, Florida metropolitan areas, Duluth, Minnesota, Belleville, Illinois, Las Vegas, Nevada and Florida’s west coast. Consumer products include loan and deposit products: mortgage, home equity loans and lines, credit cards, student loans, personal lines and term loans, demand deposit accounts, interest bearing transaction accounts and time deposits. Business banking products include secured and unsecured lines and term loans for working capital, inventory and general corporate use, commercial real estate construction loans, agricultural loans, demand deposit accounts, interest bearing transaction accounts and time deposits.
Wealth Management
The Wealth Management segment, which includes M&I’s trust, brokerage and private banking business, provides integrated asset management, trust and banking services through three business lines: Investment Management, Personal Services and Institutional Services. Investment Management is a multi-dimensional asset management service with a broad range of strategies, styles and product delivery options such as separately managed equity and fixed income strategies, managed asset allocation strategies, alternative investments and The Marshall Funds, M&I’s family of mutual funds. Personal Services includes Cedar Street Advisors, Personal Wealth Management and M&I Financial Advisors. Cedar Street Advisors manages the complex financial affairs of ultra-high net worth individuals and their families. Personal Wealth Management services assemble and implement an all-inclusive financial roadmap for high net worth individuals and families, providing for their private banking (credit and deposits), investment, estate and tax planning needs. M&I Financial Advisors uses a formulized financial planning process based on an individual’s resources, goals, and risk tolerance to develop a personalized financial plan, and then offers a full array of brokerage and insurance solutions to meet that plan. The Institutional Services business includes Retirement Plan Services, Taft-Hartley Services, Not-for-Profit Services, North Star Deferred Exchange and Trust Operations Outsourcing.
Treasury
Treasury provides management of interest rate risk, capital, liquidity, funding and investments to the Corporation and all of its subsidiary banks.
Others
The Others segment includes a Capital Markets and a National Consumer Banking Division. The Capital Markets Division provides a variety of products and services designed to address its customers’ risk management and investment needs. These services include derivative solutions and investment services, currency conversion and foreign exchange services and risk management. These services are provided primarily to corporate, business banking and financial institution clients. The National Consumer Banking Division provides mortgage and home equity consumer lending, indirect automobile financing, and affinity banking services.
Total Revenues by type in Others consist of the following ($ in millions):
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Results of operations and identifiable assets by segment for each of the three years ended December 31 are:
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
24. Guarantees
Trust Preferred Securities
In conjunction with the acquisitions of Gold Banc, Trustcorp, Excel and First Indiana, the Corporation acquired all of the common interests in the trusts that issued cumulative preferred capital securities which are supported by junior subordinated deferrable interest debentures. At December 31, 2010, the principal amounts outstanding associated with the remaining trusts were $16.0 million, $30.0 million, $38.0 million and $15.0 million. The full guarantees were assumed by M&I. See Note 16 - Long-term Borrowings in Notes to Consolidated Financial Statements for further information.
Securities Lending
As part of securities custody activities and at the direction of its clients, the Corporation’s Wealth Management segment lends securities owned by its clients to borrowers who have been evaluated for credit risk in a manner similar to that employed in making lending decisions. In connection with these activities, M&I Trust has issued an indemnification against loss resulting from the default by a borrower under the master securities loan agreement due to the failure of the borrower to return loaned securities when due. The borrowing party is required to fully collateralize securities received with cash or marketable securities. As securities are loaned, collateral is maintained at a minimum of 100% of the fair value of the securities plus accrued interest and the collateral is revalued on a daily basis. The amount of securities loaned subject to indemnification was $5.4 billion at December 31, 2010 and $7.5 billion at December 31, 2009. Because of the requirement to fully collateralize securities borrowed, management believes that exposure to credit loss from this activity is remote and there are no liabilities reflected on the Consolidated Balance Sheets at December 31, 2010 and December 31, 2009, related to these indemnifications.
During 2008, Lehman Brothers declared bankruptcy and failed to return loaned securities when due. As a result of the indemnification against loss resulting from the default by Lehman Brothers under the master securities loan agreement, M&I Trust recognized a loss for the difference between the amount paid to acquire the replacement securities and the collateral available to purchase the replacement securities. The collateral shortfall was due to an unexpected volatile market condition that existed when the replacement securities were acquired. The loss amounted to $8.4 million and is reported in the line Other within Other Expense in the Consolidated Statements of Income.
Credit Support Agreement
The Corporation was a party to a capital support agreement (“CSA”) with M&I Employee Benefit Stable Principal Fund ( the “Stable Principal Fund”). Under the CSA in effect as of December 31, 2009, the Corporation would be required to contribute up to $35 million in capital to the Stable Principal Fund if the retention or disposition of certain assets of the Stable Principal Fund caused a loss that would otherwise prevent the Stable Principal Fund from maintaining a stable net asset value of $1.00 per unit.
During 2010, Marshall & Ilsley Trust Company N.A. as Trustee of the Stable Principal Fund, terminated the Stable Principal Fund’s participation in securities lending resulting in a loss to the Stable Principal Fund that was covered under the CSA. The Corporation made a net payment of $12.0 million for that loss, after which the CSA was terminated.
25. Other Contingent Liabilities
In the normal course of business, the Corporation and its subsidiaries are routinely defendants in or parties to a number of pending and threatened legal actions, including, but not limited to, actions brought on behalf of various classes of claimants, employment matters, and challenges from tax authorities regarding the amount of taxes due. In certain of these actions and proceedings, claims for monetary damages or adjustments to recorded tax liabilities are asserted. In view of the inherent difficulty of predicting the outcome of such matters, particularly matters that will be decided by a jury and actions that seek large damages based on novel and complex damage and liability legal theories or that involve a large number of parties, the Corporation cannot state with confidence the eventual outcome of these matters or the timing of their ultimate resolution, or estimate the possible loss or range of loss associated with them; however, based on current knowledge and after consultation with legal counsel, management does not believe that judgments or settlements in excess of amounts already reserved, if any, arising from pending or threatened legal actions, employment matters, or challenges from tax authorities, either individually or in the aggregate, would have a material adverse effect on the consolidated financial position or liquidity of the Corporation, although they could have a material effect on operating results for a particular period.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
As explained in Note 26, Subsequent Events, in Notes to Consolidated Financial Statements, the Corporation and BMO announced that they had entered into a definitive merger agreement under which BMO will acquire all outstanding shares of common stock of the Corporation in a stock-for-stock transaction which is referred to as the “pending merger”.
Eight putative class action complaints have been filed in the Circuit Court of Milwaukee County, Wisconsin against the Corporation, its directors, and BMO relating to the Corporation’s pending merger with BMO: Berens v. Marshall & Ilsley Corp., et al., Case No. 10CV021273; Ohlgart v. Marshall & Ilsley Corp., et al., Case No. 10CV021485; Sayeg v. Marshall & Ilsley Corp., et al., Case No. 10CV021622; Schindler v. Marshall & Ilsley Corp., et al., Case No. 10CV021528; Stadler v. Marshall & Ilsley Corp., et al., Case No. 10CV021676; Onwudebe v. Marshall & Ilsley Corp., et al., Case No. 10CV021742; Anthony v. Marshall & Ilsley Corp., et al., Case No. 11CV000338; and Drummond v. Marshall & Ilsley Corp., et al., Case No. 11CV000380. Each of these complaints names the Corporation and the members of the Corporation’s board of directors as defendants and alleges that the Corporation’s directors breached their fiduciary duties to its shareholders. Each of the complaints except the Onwudebe action also names BMO as a defendant and alleges that BMO aided and abetted the alleged breach of fiduciary duty. In addition, the Anthony action names Gregory A. Smith, the Corporation’s Senior Vice President and Chief Financial Officer, as a defendant and alleges that Mr. Smith breached fiduciary duties to the Corporation’s shareholders.
Two putative class actions have been filed in the United States Court for the Eastern District of Wisconsin relating to the merger: Fruchter v. Marshall & Ilsley Corp., et al., No. 10-cv-01157, and Folisi v. Marshall & Ilsley Corp., et al., No. 11-cv-00025. These complaints allege that the Corporation and its directors breached fiduciary duties to the Corporation’s shareholders and that BMO aided and abetted such breaches.
All ten lawsuits seek, among other things, to enjoin completion of the merger and an award of costs and attorneys’ fees. Certain of the actions also seek the imposition of a constructive trust for benefits allegedly improperly received by the defendants and/or an accounting of damages sustained as a result of the alleged breaches of fiduciary duty. The state court actions were consolidated on February 11, 2011 by stipulation of the partes to these actions. The stipulation and proposed order of consolidation is pending approval by the Wisconsin state court.
At this early stage of the state court lawsuits, it is not possible for management of the Corporation to assess the probability of a material adverse outcome or reasonably estimate the amount of any potential loss at this time. The Corporation intends to vigorously defend the state court lawsuits.
In April 2010, two substantially identical putative class action lawsuits were filed in the United States District Court for the Eastern District of Wisconsin against the Corporation, the M&I Retirement Plan Investment Committee, and certain of the Corporation’s officers and directors. The lawsuits were purportedly filed on behalf of M&I Retirement Program, three other retirement savings plans and a class of former and current participants in those plans, relating to the holdings of Corporation common stock during the period from November 10, 2006 to December 17, 2009. The complaints, which were consolidated into a single complaint in July 2010, allege breaches of fiduciary duties in violation of the Employee Retirement Income Security Act (ERISA) relating to Corporation common stock being offered as an investment alternative for participants in the retirement plans and seek monetary damages. At this early stage of the lawsuit, it is not possible for management of the Corporation to assess the probability of a material adverse outcome or reasonably estimate the amount of any potential loss at this time. The Corporation intends to vigorously defend this lawsuit.
In June 2010, M&I Bank was named as a defendant in a putative class action alleging that M&I Bank’s posting of debit card transactions is a breach of the implied obligation of good faith and fair dealing, is a breach of the Wisconsin Consumer Act, is unconscionable, constitutes conversion, and unjustly enriches the Corporation. The plaintiffs allege that the daily high to low postings of debit card entries, rather than chronological postings, results in excessive overdraft fees. The plaintiffs seek to represent a nationwide class for all of the claims except that involving the Wisconsin Consumer Act, for which it seeks to represent a class of Wisconsin customers of M&I Bank. The lawsuit, while initially filed in the United States District Court for the Middle District of Florida, has been transferred for pretrial purposes in a multi-district litigation (“MDL”) proceeding in the Southern District of Florida, in which numerous other putative class actions against financial institutions asserting similar claims are pending. The consolidation in the MDL is for pre-trial discovery and motion proceedings. The Corporation has filed a motion to compel the two plaintiffs to arbitrate the dispute. This motion is pending. At this early stage of the lawsuit, it is not possible for management of the Corporation to assess the probability of a material adverse outcome
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
or reasonably estimate the amount of any potential loss at this time. M&I Bank intends to vigorously defend this lawsuit.
26. Subsequent Events
On December 17, 2010, the Corporation and BMO announced that they had entered into a definitive merger agreement (the “agreement”) under which BMO will acquire all outstanding shares of common stock of the Corporation in a stock-for-stock transaction.
Under the terms of the agreement, each outstanding share of the Corporation will be exchanged for 0.1257 shares of Bank of Montreal upon closing.
As part of the agreement, BMO will purchase the Corporation’s Senior Preferred Stock, Series B issued to the UST in the fourth quarter of 2008 under the UST’s Capital Purchase Program at par plus accrued interest - with full repayment to the U.S. Treasury immediately prior to closing. The Corporation’s existing warrants held by the U.S. Treasury will also be purchased by BMO.
In connection with the agreement, the Corporation issued to BMO an option, exercisable under certain circumstances, to purchase up to 19.7% of the Corporation’s common stock.
Under the agreement, the Corporation is required to redeem all of its outstanding junior preferred debt securities (trust preferred securities) prior to the closing of the merger with BMO. These trust preferred securities have an aggregate outstanding principal amount of $99,000,000 at March 1, 2011.
The transaction, which has been approved by the Corporation’s Board of Directors and the Board of Directors of BMO, is expected to close prior to July 31, 2011 subject to customary closing conditions, including regulatory approvals and approval by the Corporation’s shareholders.
On February 2, 2011, BMO filed with the Securities and Exchange Commission a Registration Statement on Form that included a Proxy Statement of the Corporation and a Prospectus of BMO, as well as other relevant documents concerning the proposed transaction.
On January 20, 2011, the Corporation announced that its Board of Directors declared a first quarter cash dividend of $0.01 per share on its common stock. The dividend is payable on March 11, 2011 to common stock shareholders of record as of the close of business on March 1, 2011.
In addition, the Board of Directors declared a regular quarterly cash dividend of $21.4 million in the aggregate on its Senior Preferred Stock, Series B. The Senior Preferred Stock, Series B was purchased from the Corporation by the U.S. Treasury as part of the U.S. Treasury’s Capital Purchase Program. The Preferred Stock dividend is payable on February 15, 2011 to the shareholder of record at the close of business on February 1, 2011.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
27. Condensed Financial Information-Parent Corporation Only
In conjunction with the Separation on November 1, 2007, Marshall & Ilsley Corporation (Accounting Predecessor to New Marshall & Ilsley Corporation) became M&I LLC, a wholly-owned subsidiary of New Marshall & Ilsley, which became Marshall & Ilsley Corporation. The Condensed Statements of Income and Condensed Statements of Cash Flows for the years ended December 31, 2009, and 2008 present the Parent Corporation Only on a consolidated basis, which is more reflective of the financial position, results of operations and cash flows of the Parent Corporation and its activities. On December 31, 2009, M&I LLC was merged with and into Marshall & Ilsley Corporation, with Marshall & Ilsley Corporation surviving as the single parent company.
Condensed Balance Sheets
December 31
Scheduled maturities of long-term borrowings are $282,045 in 2011, $14,176 in 2012, $22,592 in 2013, $858 in 2014 and $95 in 2015. See Note 16 in Notes to Consolidated Financial Statements for a description of the long-term borrowings.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Condensed Statements of Income
Years Ended December 31
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Consolidating Statements of Income
Year Ended December 31, 2009
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Consolidating Statements of Income
Year Ended December 31, 2008
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Condensed Statements of Cash Flows
Years Ended December 31
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Consolidating Statements of Cash Flows
Year Ended December 31, 2009
Notes to Consolidated Financial Statements - (Continued)
December 31, 2010, 2009 and 2008 ($000’s except share data)
Consolidating Statements of Cash Flows
Year Ended December 31, 2008
Quarterly Financial Information (Unaudited)
Following is unaudited financial information for each of the calendar quarters during the years ended December 31, 2010 and 2009. ($000’s except per share data):
Quarterly Financial Information (Unaudited) - (Continued)
Price Range of Stock*
(Low and High Close)
*The results for 2007 have been separated to show the prices prior to and after the Separation on November 1, 2007. As a result, the fourth quarter pre-Separation prices are through October 31, 2007 only. The post-Separation prices are from November 1, 2007 through December 31, 2007.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors of Marshall & Ilsley Corporation
We have audited the accompanying consolidated balance sheets of Marshall & Ilsley Corporation and subsidiaries (the “Corporation”) as of December 31, 2010 and 2009, and the related consolidated statements of income, equity, and cash flows for each of the three years in the period ended December 31, 2010. These financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Marshall & Ilsley Corporation and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 26 to the consolidated financial statements, on December 17, 2010, the Corporation and Bank of Montreal announced that they had entered into a definitive agreement under which Bank of Montreal will acquire all outstanding shares of common stock of the Corporation in a stock-for-stock transaction.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Corporation’s internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 1, 2011 expressed an unqualified opinion on the Corporation’s internal control over financial reporting.
/s/ Deloitte & Touche LLP
Milwaukee, Wisconsin
March 1, 2011
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The Corporation maintains a set of disclosure controls and procedures that are designed to ensure that information required to be disclosed by the Corporation in the reports filed by it under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and to ensure that information required to be disclosed by the Corporation in such reports is accumulated and communicated to the Corporation’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. The Corporation carried out an evaluation, under the supervision and with the participation of its management, including the Chief Executive Officer and President and the Senior Vice President and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures pursuant to Rule 13a-15(e) of the Exchange Act. Based on that evaluation, the Chief Executive Officer and President and the Senior Vice President and Chief Financial Officer concluded that the Corporation’s disclosure controls and procedures are effective, as of the end of the period covered by this report, for the purposes for which they are designed.
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting. As such term is defined in Exchange Act Rule 13a-15(f), internal control over financial reporting is a process designed by, or under the supervision of, the principal executive and principal financial officers, or persons performing similar functions, and effected by the board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. Internal control over financial reporting includes those policies and procedures that:
(1)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets of the Corporation;
(2)
provide reasonable assurance that transactions are recorded as necessary to permit preparation of the financial statements in accordance with accounting principles generally accepted in the United States, and that receipts and expenditures of the Corporation are being made only in accordance with authorizations of management and the directors of the Corporation; and
(3)
provide reasonable assurance regarding prevention of unauthorized acquisition, use, or disposition of the Corporation’s assets that could have a material effect on the financial statements.
Management conducted an evaluation of the effectiveness of the Corporation’s internal control over financial reporting based on the criteria in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation under the criteria in Internal Control - Integrated Framework, management concluded that internal control over financial reporting was effective as of December 31, 2010.
The effectiveness of internal control over financial reporting as of December 31, 2010 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report dated March 1, 2011, which is included herein.
Changes in Internal Controls
There have been no changes in the Corporation’s internal control over financial reporting identified in connection with the evaluation discussed above that occurred during the Corporation’s fourth fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors of Marshall & Ilsley Corporation
We have audited the internal control over financial reporting of Marshall & Ilsley Corporation and subsidiaries (the “Corporation”) as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Corporation’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2010, of the Corporation and our report dated March 1, 2011 expressed an unqualified opinion on those financial statements and included an explanatory paragraph relating to the announcement by the Corporation and Bank of Montreal that they had entered into a definitive agreement under which Bank of Montreal will acquire all outstanding shares of common stock of the Corporation in a stock-for-stock transaction.
/s/ Deloitte & Touche LLP
Milwaukee, Wisconsin
March 1, 2011
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Not applicable
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required under this Item is incorporated herein by reference to the information that will be provided in the Proxy Statement for the Corporation’s 2011 Annual Meeting of Shareholders or by amendment to this annual report on Form 10-K not later than 120 days after the end of the Corporation’s fiscal year ended December 31, 2010, except for information relating to executive officers and the Corporation’s Code of Business Conduct and Ethics, which is set forth in Part 1 of this report.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required under this Item is incorporated herein by reference to the information that will be provided in the Proxy Statement for the Corporation’s 2011 Annual Meeting of Shareholders or by amendment to this annual report on Form 10-K not later than 120 days after the end of the Corporation’s fiscal year ended December 31, 2010.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required under this Item is incorporated herein by reference to the information that will be provided in the Proxy Statement for the Corporation’s 2011 Annual Meeting of Shareholders or by amendment to this annual report on Form 10-K not later than 120 days after the end of the Corporation’s fiscal year ended December 31, 2010.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information required under this Item is incorporated herein by reference to the information that will be provided in the Proxy Statement for the Corporation’s 2011 Annual Meeting of Shareholders or by amendment to this annual report on Form 10-K not later than 120 days after the end of the Corporation’s fiscal year ended December 31, 2010.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required under this Item is incorporated herein by reference to the information that will be provided in the Proxy Statement for the Corporation’s 2011 Annual Meeting of Shareholders or by amendment to this annual report on Form 10-K not later than 120 days after the end of the Corporation’s fiscal year ended December 31, 2010.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) 1. Financial Statements
Consolidated Financial Statements:
Balance Sheets - December 31, 2010 and December 31, 2009
Statements of Income - years ended December 31, 2010, 2009 and 2008
Statements of Cash Flows - years ended December 31, 2010, 2009 and 2008
Statements of Equity - years ended December 31, 2010, 2009 and 2008
Notes to Consolidated Financial Statements
Quarterly Financial Information (Unaudited)
Report of Independent Registered Public Accounting Firm
2. Financial Statement Schedules
All schedules are omitted because they are not required, not applicable or the required information is contained elsewhere.
3. Exhibits
See Index to Exhibits of this Form 10-K, which is incorporated herein by reference. Shareholders may obtain a copy of any Exhibit free of charge by calling M&I’s Shareholder Information Line at 1 (800) 642-2657.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:
/s/ Gregory A. Smith
Gregory A. Smith
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)
Date: March 1, 2011
/s/ Patricia R. Justiliano
Patricia R. Justiliano
Senior Vice President and Corporate Controller
(Principal Accounting Officer)
Date: March 1, 2011
Directors:
Jon F. Chait, John W. Daniels, Jr., Mark F. Furlong, Ted D. Kellner, Dennis J. Kuester, David J. Lubar, Katharine C. Lyall, John A. Mellowes, Robert J. O’Toole, San W. Orr, Jr., Peter M. Platten, III, John S. Shiely, George E. Wardeberg and James B. Wigdale.
By: /s/ Randall J. Erickson
Date: March 1, 2011
Randall J. Erickson
As Attorney-In-Fact*
____________
* Pursuant to authority granted by powers of attorney, copies of which are filed herewith.
MARSHALL & ILSLEY CORPORATION
INDEX TO EXHIBITS
(Item 15(a)3)
ITEM
(2)
(a)
Agreement and Plan of Merger dated as of December 17, 2010 by and between Bank of Montreal and Marshall & Ilsley Corporation, incorporated by reference to M&I’s Current Report on Form 8-K filed December 23, 2010, SEC File No. 001-33488
(b)
Stock Option Agreement dated as of December 17, 2010 between Marshall & Ilsley Corporation and Bank of Montreal, incorporated by reference to M&I’s Current Report on Form 8-K filed December 23, 2010, SEC File No. 001-33488.
(3)
(a)
Restated Articles of Incorporation, incorporated by reference to M&I’s Registration Statement on Form S-3 filed on November 6, 2007, SEC File No. 333-147162
(b)
Articles of Amendment to the Corporation’s Restated Articles of Incorporation, incorporated by reference to M&I’s Current Report on Form 8-K filed November 14, 2008, SEC File No. 1-33488
(c)
Amended and Restated By-Laws, incorporated by reference to M&I’s Registration Statement on Form S-3 filed on November 6, 2007, SEC File No. 333-147162
(4)†
(a)
Warrant for Purchase of Shares of Common Stock, incorporated by reference to M&I’s Current Report on Form 8-K filed November 14, 2008, SEC File No. 1-33488
(b)
Form of Certificate for the Senior Preferred Stock, incorporated by reference to M&I’s Current Report on Form 8-K filed November 14, 2008, SEC File No. 1-33488
(10)
(a)
Deferred Compensation Trust between Marshall & Ilsley Corporation and Bessemer Trust Company dated April 28, 1987, as amended, incorporated by reference to Old M&I’s Annual Report on Form 10-K for the fiscal year ended December 31, 1988, SEC File No. 1-15403*
(b)
Marshall & Ilsley Corporation Amended and Restated Supplementary Retirement Benefits Plan, incorporated by reference to Old M&I’s Annual Report on Form 10-K for the fiscal year ended December 31, 1996, SEC File No. 1-15403*
(c)
Amended and Restated Directors Deferred Compensation Plan of Marshall & Ilsley Corporation, incorporated by reference to M&I’s Registration Statement on Form S-8 dated September 22, 2010, SEC File No. 333-169530*
(d)
Marshall & Ilsley Corporation Amended and Restated Deferred Compensation Trust II between M&I and Marshall & Ilsley Trust Company National Association, incorporated by reference to Old M&I’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2003, SEC File No. 1-15403*
(e)
Marshall & Ilsley Corporation Amended and Restated Deferred Compensation Trust III between M&I and Marshall & Ilsley Trust Company National Association, incorporated by reference to Old M&I’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2003, SEC File No. 1-15403*
(f)
Marshall & Ilsley Corporation 2003 Death Benefit Plan, incorporated by reference to Old M&I’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003, SEC File No. 1-15403*
(g)
Death Benefit Award Agreement, dated December 30, 2003, between M&I and Mr. Kuester, incorporated by reference to Old M&I’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003, SEC File No. 1-15403*
(h)
Death Benefit Award Agreement, dated December 30, 2003, between M&I and Mr. Wigdale, incorporated by reference to Old M&I’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003*
(i)
Marshall & Ilsley Corporation Amended and Restated Annual Executive Incentive Compensation Plan, incorporated by reference to Old M&I’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003*
(j)
Marshall & Ilsley Corporation Amended and Restated Executive Deferred Compensation Plan, incorporated by reference to M&I’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008, SEC File No. 1-33488*
(k)
Consulting Agreement dated December 15, 2004, between M&I and Mr. Wigdale, incorporated by reference to Old M&I’s Current Report on Form 8-K filed December 17, 2004, SEC File No. 1-15403*
(l)
2005 Directors Deferred Compensation Plan of Marshall & Ilsley Corporation, incorporated by reference to M&I’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008, SEC File No. 1-33488*
(m)
Marshall & Ilsley Corporation 2005 Executive Deferred Compensation Plan, incorporated by reference to M&I’s Registration Statement on Form S-8 dated September 22, 2010, SEC File No. 333-169530*
(n)
Amended and Restated Marshall & Ilsley Corporation Nonqualified Retirement Benefit Plan, incorporated by reference to Old M&I’s Annual Report on Form 10-K for the year ended December 31, 2005, SEC File No. 1-15403*
(o)
Marshall & Ilsley Corporation Amended and Restated 1994 Long-Term Incentive Plan for Executives, incorporated by reference to M&I’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008, SEC File No. 1-33488*
(p)
Transition and Consulting Agreement between the M&I and Dennis J. Kuester dated December 21, 2006, incorporated by reference to Old M&I’s Current Report on Form 8-K dated December 21, 2006, SEC File No. 1-15403*
(q)
Letter Agreement from M&I to Mark F. Furlong dated December 21, 2006 containing the terms of the Supplemental Executive Retirement Benefit, incorporated by reference to Old M&I’s Current Report on Form 8-K dated December 21, 2006, SEC File No. 1-15403*
(r)
Letter of Amendment between M&I and Mr. Furlong dated February 17, 2009 regarding the Supplemental Executive Retirement Benefit*
(s)
Marshall & Ilsley Corporation 2006 Equity Incentive Plan, as amended October 19, 2006, incorporated by reference to Old M&I’s Annual Report on Form 10-K for the year ended December 31, 2006, SEC File No. 1-15403*
(t)
Marshall & Ilsley Corporation 2003 Executive Stock Option and Restricted Stock Plan, effective January 1, 2006, retroactive to January 1, 2005, as further amended on February 16, 2006 and October 19, 2006, incorporated by reference to Old M&I’s Annual Report on Form 10-K for the year ended December 31, 2006, SEC File No. 1-15403*
(u)
Marshall & Ilsley Corporation 2000 Executive Stock Option and Restricted Stock Plan, effective January 1, 2006, retroactive to January 1, 2005, as further amended on October 19, 2006, incorporated by reference to Old M&I’s Annual Report on Form 10-K for the year ended December 31, 2006, SEC File No. 1-15403*
(v)
Marshall & Ilsley Corporation Amended and Restated 1997 Executive Stock Option and Restricted Stock Plan, effective January 1, 2006, retroactive to January 1, 2005, as further amended on October 19, 2006, incorporated by reference to Old M&I’s Annual Report on Form 10-K for the year ended December 31, 2006, SEC File No. 1-15403*
(w)
Marshall & Ilsley Corporation 1995 Directors Stock Option Plan, as amended on August 15, 2002, as further amended on October 19, 2002, incorporated by reference to Old M&I’s Annual Report on Form 10-K for the year ended December 31, 2006, SEC File No. 1-15403*
(x)
Gold Banc Corporation, Inc. 1996 Equity Compensation Plan, as amended February 2, 2001, as further amended on October 19, 2006, incorporated by reference to Old M&I’s Annual Report on Form 10-K for the year ended December 31, 2006, SEC File No. 1-15403*
(y)
Trustcorp Financial, Inc. 1997 Non-Qualified Stock Option Plan, as amended, incorporated by reference to Old M&I’s Registration Statement on Form S-8 filed April 4, 2006, SEC File No. 333-132977*
(z)
United Community Bankshares of Florida, Inc. Director Stock Option Plan, incorporated by reference to the United Community Bankshares of Florida, Inc. (n/k/a United Heritage Bankshares of Florida, Inc.) Quarterly Report on Form 10-QSB for the quarter ended March 31, 2003, SEC File No. 000-50287*
(aa)
United Community Bankshares of Florida, Inc. Officers’ and Employees’ Stock Option Plan, incorporated by reference to the United Community Bankshares of Florida, Inc. (n/k/a United Heritage Bankshares of Florida, Inc.) Quarterly Report on Form 10-QSB for the quarter ended March 31, 2003, SEC File No. 000-50287*
(bb)
Tax Allocation Agreement, dated as of April 3, 2007, among Marshall & Ilsley Corporation, Metavante Holding Company, Metavante Corporation and New Marshall & Ilsley Corporation, incorporated by reference to Old M&I’s Current Report on Form 8-K filed April 9, 2007, SEC File No. 1-15403
(cc)
Employee Matters Agreement, dated as of April 3, 2007, among Marshall & Ilsley Corporation, Metavante Holding Company, Metavante Corporation and New Marshall & Ilsley Corporation, incorporated by reference to Old M&I’s Current Report on Form 8-K filed April 9, 2007, SEC File No. 1-15403
(dd)
Form of Shareholders Agreement, incorporated by reference to Old M&I’s Current Report on Form 8-K filed April 9, 2007, SEC File No. 1-15403
(ee)
Form of Stock Purchase Right Agreement, incorporated by reference to Old M&I’s Current Report on Form 8-K filed April 9, 2007, SEC File No. 1-15403
(ff)
Excel Bank Corporation 2005 Equity Incentive Plan, incorporated by reference to Old M&I’s Registration Statement on Form S-3 filed July 5, 2007, SEC File No. 333-144360*
(gg)
Amendment No. 1 to the Employee Matters Agreement, dated as of August 21, 2007, among M&I, Metavante Corporation, Metavante Holding Company and New M&I, incorporated by reference to Old M&I’s Current Report on Form 8-K filed September 5, 2007, SEC File No. 1-15403
(hh)
Assignment and Assumption Agreement dated January 1, 2007 relating to Mr. Furlong’s Supplemental Executive Retirement Benefit, by and between M&I LLC, M&I and Mr. Furlong, incorporated by reference to M&I’s Annual Report on Form 10-K for the year ended December 31, 2007, SEC File No. 1-33488*
(ii)
Form of Change of Control Agreements dated January 1, 2008 between M&I and Messrs. Furlong, O’Neill and Gregory A. Smith, incorporated by reference to M&I’s Annual Report on Form 10-K for the year ended December 31, 2007, SEC File No. 1-33488*
(jj)
Form of Change of Control Agreements dated January 1, 2008 between M&I and Messrs. Becker, Chapin, Deneen, Ellis, Renard, Roberts, Root, Michael C. Smith and Ronald E. Smith and Ms. Benschoter , Ms. Justiliano and Ms. Knickerbocker, incorporated by reference to M&I’s Annual Report on Form 10-K for the year ended December 31, 2007, SEC File No. 1-33488*
(kk)
Form of Change of Control Agreements dated December 18, 2008 between M&I and Messrs. Erickson and Krei, incorporated by reference to M&I’s Current Report on Form 8-K filed December 23, 2008, SEC File No. 1-33488*
(ll)
Letter Agreement, dated November 14, 2008, between M&I and the U.S. Treasury, including the Securities Purchase Agreement attached thereto, incorporated by reference to M&I’s Current Report on Form 8-K filed November 14, 2008, SEC File No. 1-33488
(mm)
Marshall & Ilsley Corporation 2009 Equity Incentive Plan, incorporated by reference to Appendix B to the definitive Proxy Statement on Schedule 14A for M&I’s 2009 Annual Meeting of Shareholders filed on March 13, 2009*
(nn)
Marshall & Ilsley Corporation 2010 Equity Incentive Plan, incorporated by reference to Appendix A to the definitive Proxy Statement on Schedule 14A for M&I’s 2010 Annual Meeting of Shareholders filed on March 12, 2010*
(oo)
Form of Restricted Stock Agreement (Stock Base Salary Award), incorporated by reference to M&I’s Current Report on Form 8-K filed December 29, 2009, SEC File No. 1-33488*
(pp)
Form of Restricted Stock Agreement, incorporated by reference to M&I’s Annual Report on Form 10-K for the year ended December 31, 2009, SEC File No. 1-15403*
(qq)
Form of Omnibus Amendment Agreements between M&I, Messrs. Furlong, Smith, Krei, Ellis and O’Neill, incorporated by reference to M&I’s Annual Report on Form 10-K for the year ended December 31, 2009, SEC File No. 1-15403*
(rr)
Form of Amendment to Change of Control Agreements in connection with Section 409A of the Internal Revenue Code of 1986, as amended.*
(11)
Computation of Earnings Per Common Share, incorporated by reference to Note 5 of Notes to Consolidated Financial Statements included in Item 8, Consolidated Financial Statements and Supplementary Data
(12)
Computation of Ratio of Earnings to Fixed Charges
(14)
Code of Business Conduct and Ethics, incorporated by reference to Old M&I’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004, SEC File No. 1-15403
(21)
Subsidiaries
(23)
Consent of Deloitte & Touche LLP
(24)
Powers of Attorney
(31)
(I)
Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
(II)
Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
(32)
(I)
Section 1350 Certification of Chief Executive Officer
(II)
Section 1350 Certification of Chief Financial Officer
(99)
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 111(b)(4) of the EESA
(101)
INS
XBRL Instance Document**
SCH
XBRL Taxonomy Extension Schema Document**
CAL
XBRL Taxonomy Extension Calculation Linkbase Document**
DEF
XBRL Taxonomy Extension Definition Linkbase Document**
LAB
XBRL Taxonomy Extension Label Linkbase Document**
PRE
XBRL Taxonomy Extension Presentation Linkbase Document**
† The total amount of securities authorized pursuant to any instrument defining the rights of holders of long-term debt of M&I does not exceed 10% of the total assets of M&I and its subsidiaries on a consolidated basis. M&I agrees to furnish to the Commission upon request a copy of any such instrument.
*
Management contract or compensatory plan or arrangement.
**
As provided in Rule 406T of Regulation S-T, this information shall not be deemed “filed” for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Exchange Act or otherwise subject to liability under these sections.