ITEM 1 -- BUSINESS
Compass Bancshares, Inc. (the "Company") is a bank holding company with its principal place of business in Birmingham, Alabama. The Company was organized in 1970 and commenced business in late 1971 upon the acquisition of Central Bank & Trust Co. and State National Bank. The Company subsequently acquired substantially all of the outstanding stock of additional banks located in Alabama, 11 of which were merged in late 1981 to create Central Bank of the South, Alabama's first statewide bank. In February, 1987, the Company acquired First National Bank of Crosby near Houston, Texas, and became the first out- of-state bank holding company to acquire a bank in Texas. The Company first expanded into Florida in July, 1991, when it acquired Citizens & Builders Federal Savings, F.S.B., in Pensacola, Florida. In November, 1993, the Company changed its name from Central Bancshares of the South, Inc. to Compass Bancshares, Inc. and Central Bank of the South, the Company's lead bank subsidiary, changed its name to Compass Bank ("Compass Bank").
In addition to Compass Bank, the Company also owns Central Bank of the South, an Alabama banking corporation headquartered in Anniston, Alabama, and Compass Banks of Texas, Inc., a Delaware bank holding company ("Compass of Texas"), which owns Compass Bank, a Texas state bank headquartered in Houston, Texas ("Compass Bank-Texas"). The bank subsidiaries of the Company and Compass of Texas are referred to collectively herein as the "Subsidiary Banks".
The principal role of the Company is to supervise and coordinate the activities of its subsidiaries and to provide them with capital and services of various kinds. The Company derives substantially all of its income from dividends from its subsidiaries. Such dividends are determined on an individual basis, generally in relation to each subsidiary's earnings and capital position.
SUBSIDIARY BANKS
Compass Bank conducts a general commercial banking and trust business at 88 locations in 45 communities in Alabama and in 34 locations in 14 communities in Florida. Compass Bank-Texas conducts a general commercial banking business from 41 banking offices in Houston, 25 banking offices in the Dallas-Ft. Worth area, 17 banking offices in San Antonio, 8 banking offices in Austin and 10 banking offices in Central and East Texas.
The Subsidiary Banks perform banking services customary for full service banks of similar size and character. Such services include receiving demand and time deposit accounts, making personal and commercial loans and furnishing personal and commercial checking accounts. The Asset Management Division of Compass Bank offers its customers a variety of fiduciary services, including portfolio management the administration and investment of funds of estates, trusts and employee benefit plans. Through Compass Bancshares Insurance, Inc., a wholly-owned subsidiary of Compass Bank, the Subsidiary Banks make available to their customers and others, as agent for a variety of insurance companies, term life insurance, fixed-rate annuities and other insurance products.
The Subsidiary Banks provide correspondent banking services including audit services, educational seminars and operational and investment services to approximately 1,000 financial institutions located throughout the United States. Through the Correspondent and Investment Services Division of Compass Bank, the Subsidiary Banks distribute or make available a variety of investment services and products to institutional and individual investors including institutional sales, bond accounting, safekeeping and interest rate risk analysis services. Through Compass Brokerage, Inc., a wholly-owned subsidiary of Compass Bank, the Subsidiary Banks also provide discount brokerage services, mutual funds and variable annuities to individuals and businesses. Through Compass Bank's wholly-owned subsidiary, Compass Financial Corporation, the Subsidiary Banks provide lease financing services to individuals and businesses.
NONBANKING SUBSIDIARIES
Through wholly-owned subsidiaries, the Company is engaged in providing insurance products to customers of the Subsidiary Banks and owning real estate for bank premises. Revenues from operation of these subsidiaries do not presently constitute a significant portion of the Company's total operating revenues. The Company may subsequently engage in other activities permissible for registered bank holding companies when suitable opportunities develop. Any proposal for such further activities is subject to approval by appropriate regulatory authorities. (See "Supervision and Regulation".)
ACQUISITIONS
The Company may seek to acquire other banks and banking offices when suitable opportunities develop. Discussions are held from time to time with institutions primarily in Texas and Florida about their possible affiliation with the Company. It is impossible to predict accurately whether any discussions will lead to agreement. Any bid or proposal for the acquisition of additional banks is subject to approval by appropriate regulatory authorities. (See "Supervision and Regulation".)
Since the Company first expanded to Texas in 1987 and to Florida in 1991, the Company has acquired 40 financial institutions and numerous branch offices in Texas and Florida. The following is a list of the acquisitions completed during the past three years with their asset size (in thousands) and closing dates.
ACQUISITIONS COMPLETED AFTER DECEMBER 31, 1997
On January 13, 1998, the Company completed the acquisition of G.S.B. Investments, Inc. ("GSB") and its subsidiary, Gainesville State Bank, of Gainesville, Florida, with the issuance of 1,649,807 shares of the Company's common stock. At the date of closing, GSB had assets of $213 million and equity of $22 million. The transaction was accounted for under the pooling-of- interests method of accounting and, accordingly, all prior period information will be restated in the first quarter of 1998.
The Company completed the acquisition of First University Corporation ("First University") and its subsidiary, West University Bank, N.A., of Houston, Texas, on January 29, 1998, with the issuance of approximately 350,000 shares of the Company's common stock. At the date of closing, First University had assets of $68 million and equity of $4 million. The transaction was accounted for under the pooling-of-interests method of accounting and, accordingly, all prior period information will be restated in the first quarter of 1998.
On February 9, 1998, the Company completed the acquisition of Fidelity Resources Company ("Fidelity") and its subsidiary, Fidelity Bank, N.A., of Dallas, Texas, with the issuance of approximately 1,800,000 shares of the Company's common stock. At the date of closing, Fidelity had assets of $335 million and equity of $20 million. The transaction was accounted for under the pooling-of-interests method of accounting and, accordingly, all prior period information will be restated in the first quarter of 1998.
COMPETITION
The Subsidiary Banks encounter intense competition in their businesses, generally from other banks located in Alabama, Texas, Florida and adjoining states, and compete for interest bearing funds with other banks, mutual funds and with many issuers of commercial paper and other securities which are not banks. Competition also exists for the correspondent banking and securities sales business from commercial and investment banks and brokerage firms. In the case of larger customers, competition exists with financial institutions in Texas and other major metropolitan areas in the United States, many of which are larger in terms of capital, resources and personnel. Increasingly, in the conduct of certain aspects of their businesses, the Subsidiary Banks compete with finance companies, savings and loan associations, credit unions, mutual funds, factors, insurance companies and similar financial institutions.
There is significant competition among bank holding companies in most of the markets served by the Subsidiary Banks. The Company believes that intense competition for banking business among bank holding companies in Alabama, Texas and Florida will continue and that during 1998 the competition may further intensify if additional regional bank holding companies enter such states through the acquisition of local bank holding companies or savings and loan institutions and with continued consolidation of savings and loan institutions with and into bank holding companies. Competition among bank holding companies is also significant in Texas where Compass Bank-Texas is located in the major metropolitan markets of Dallas/Ft. Worth, Houston, San Antonio and Austin having populations of approximately 4.6 million, 4.3 million, 1.5 million and 1.0 million people, respectively. Compass Bank-Texas is small in terms of assets and deposits in comparison with the super-regional banks it competes with. Likewise, in Jacksonville, Pensacola and Fort Walton Beach, Florida, Compass Bank encounters intense competition from other financial institutions that are substantially larger in terms of assets and deposits.
EMPLOYEES
At December 31, 1997, the Company and its subsidiaries employed approximately 5,500 persons. The Company and its subsidiaries provide a variety of benefit programs including group life, health, accident, and other insurance, retirement and stock ownership plans. The Company also maintains training, educational and affirmative action programs designed to prepare employees for positions of increasing responsibility.
GOVERNMENT MONETARY POLICY
The Company and the Subsidiary Banks are affected by the credit policies of monetary authorities, including the Board of Governors of the Federal Reserve System ("Federal Reserve"). An important function of the Federal Reserve is to regulate the national supply of bank credit. Among the instruments of monetary policy used by the Federal Reserve to implement these objectives are: open market operations in U.S. Government securities, changes in the discount rate, reserve requirements on member bank deposits and funds availability regulations. These instruments are used in varying combinations to influence the overall growth of bank loans, investments and deposits and may also affect interest rates charged on loans or paid on deposits.
The monetary policies of the Federal Reserve authorities have had a significant effect on the operating results of financial institutions in the past and will continue to do so in the future. In view of changing conditions in the national economy and money markets, as well as the effect of actions by monetary and fiscal authorities, no prediction can be made as to the future impact that changes in interest rates, deposit levels or loan demand may have on the business and income of the Company and the Subsidiary Banks.
SUPERVISION AND REGULATION
THE COMPANY
The Company and Compass of Texas are multi-bank holding companies within the meaning of the Bank Holding Company Act ("BHC Act") and are registered as such with the Federal Reserve. As bank holding companies, the Company and Compass of Texas are required to file with the Federal Reserve an annual report and such additional information as the Federal Reserve may require pursuant to the BHC Act. The Federal Reserve may also make examinations of the Company and each of its subsidiaries. Under the BHC Act, bank holding companies are prohibited, with certain exceptions, from acquiring direct or indirect ownership or control of more than five percent of the voting shares of any company engaging in activities other than banking or managing or controlling banks or furnishing services to or performing services for their banking subsidiaries. However, the BHC Act authorizes the Federal Reserve to permit bank holding companies to engage in, and to acquire or retain shares of companies that engage in, activities which the Federal Reserve determines to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.
The BHC Act requires a bank holding company to obtain the prior approval of the Federal Reserve before it may acquire substantially all the assets of any bank or ownership or control of any voting shares of any bank if, after such acquisition, it would own or control, directly or indirectly, more than five percent of the voting shares of any such bank. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 ("Interstate Act"), facilitates branching and the establishment of agency relationships across state lines and permits, commencing one year after enactment, bank holding companies to acquire banks located in any state without regard to whether the transaction is prohibited under any state law, subject to certain state provisions, including the establishment by states of a minimum age of their local banks subject to interstate acquisition of out-of-state bank holding companies. The minimum age of local banks subject to interstate acquisition is limited to a maximum of five years.
The States of Alabama, Florida and Texas, where the Company currently operates banking subsidiaries, each have laws relating specifically to acquisitions of banks, bank holding companies and other types of financial institutions in those states by financial institutions that are based in, and not based in, those states. In 1995, the State of Alabama enacted an interstate banking act. In general, the Alabama statute implements the Interstate Act, specifying five years as the minimum age of banks which may be acquired and participating in interstate branching beginning May 31, 1997. Texas and Florida law currently permits out-of-state bank holding companies to acquire banks in Texas and Florida regardless of where the acquiror is based, subject to the satisfaction of various provisions of state law, including the requirement that the bank to be acquired has been in existence at least five years in Texas and two years in Florida.
The Federal Reserve Act generally imposes certain limitations on extensions of credit and other transactions by and between banks which are members of the Federal Reserve and other affiliates (which includes any holding company of which such bank is a subsidiary and any other non-bank subsidiary of such holding company). Banks which are not members of the Federal Reserve are also subject to these limitations. Further, federal law prohibits a bank holding company and its subsidiaries from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or the furnishing of services.
In December, 1991, the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") was enacted. This act recapitalized the Bank Insurance Fund ("BIF"), of which the Subsidiary Banks are members, and the Savings Association Insurance Fund ("SAIF"), which insures certain of the Subsidiary Banks' deposits, substantially revised statutory provisions, including capital standards, restricted certain powers of state banks, gave regulators the authority to limit officer and director compensation and required holding companies to guarantee the capital compliance of their banks in certain instances. Among other things, FDICIA requires the federal banking agencies to take "prompt corrective action" with respect to banks that do not meet minimum capital requirements. FDICIA established five capital tiers: "well capitalized", "adequately capitalized", "undercapitalized", "significantly undercapitalized" and "critically undercapitalized", as defined by regulations adopted by the Federal Reserve, the FDIC and the other federal depository institution regulatory agencies. A depository institution is well capitalized if it significantly exceeds the minimum level required by regulation for each relevant capital measure, adequately capitalized if it meets such measure, undercapitalized if it fails to meet any such measure, significantly undercapitalized if it is significantly below such measure and critically undercapitalized if it fails to meet any critical capital level set forth in the regulations. The critical capital level must be a level of tangible equity capital equal to the greater of 2 percent of total tangible assets or 65 percent of the minimum leverage ratio to be prescribed by regulation. An institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it receives an unsatisfactory examination rating.
If a depository institution fails to meet regulatory capital requirements, the regulatory agencies can require submission and funding of a capital restoration plan by the institution, place limits on its activities, require the raising of additional capital and, ultimately, require the appointment of a conservator or receiver for the institution. The obligation of a controlling bank holding company under FDICIA to fund a capital restoration plan is limited to the lesser of five percent of an undercapitalized subsidiary's assets or the amount required to meet regulatory capital requirements. If the controlling bank holding company fails to fulfill its obligations under FDICIA and files (or has filed against it) a petition under the Federal Bankruptcy Code, the FDIC's claim may be entitled to a priority in such bankruptcy proceeding over third party creditors of the bank holding company.
An insured depository institution may not pay management fees to any person having control of the institution nor may an institution, except under certain circumstances and with prior regulatory approval, make any capital distribution (including the payment of dividends) if, after making such payment or distribution, the institution would be undercapitalized. FDICIA also restricts the acceptance of brokered deposits by insured depository institutions and contains a number of consumer banking provisions, including disclosure requirements and substantive contractual limitations with respect to deposit accounts.
At December 31, 1997, the Subsidiary Banks were "well capitalized" and were not subject to any of the foregoing restrictions, including, without limitation, those relating to brokered deposits. The Subsidiary Banks do not rely upon brokered deposits as a primary source of deposit funding; although, such deposits are sold through the Correspondent and Investment Services Division of Compass Bank.
FDICIA contains numerous other provisions, including new reporting requirements, termination of the "too big to fail" doctrine except in special cases, limitations on the FDIC's payment of deposits at foreign branches and revised regulatory standards for, among other things, real estate lending and capital adequacy. In addition, FDICIA requires the FDIC to establish a system of risk-based assessments for federal deposit insurance, by which banks that pose a greater risk of loss to the FDIC (based on their capital levels and the FDIC's level of supervisory concern) will pay a higher insurance assessment.
THE SUBSIDIARY BANKS
In general, federal and state banking laws and regulations govern all areas of the operations of the Subsidiary Banks, including reserves, loans, mortgages, capital, issuances of securities, payment of dividends and establishment of branches. Federal and state banking regulatory agencies also have the general authority to limit the dividends paid by insured banks and bank holding companies if such payments may be deemed to constitute an unsafe and unsound practice. Federal and state banking agencies also have authority to impose penalties, initiate civil and administrative actions and take other steps intended to prevent banks from engaging in unsafe or unsound practices.
Compass Bank, organized under the laws of the State of Alabama, is a member of the Federal Reserve. As such, it is supervised, regulated and regularly examined by the Alabama State Banking Department and the Federal Reserve. Compass Bank-Texas is supervised, regulated and regularly examined by the Department of Banking of the State of Texas and the Federal Reserve. The Subsidiary Banks are subject to the provisions of the Federal Deposit Insurance Act and to examination by and regulations of the FDIC.
Compass Bank is governed by Alabama laws restricting the declaration and payment of dividends to 90 percent of annual net income until its surplus funds equal at least 20 percent of capital stock. Compass Bank has surplus in excess of this amount. Compass Bank-Texas, governed by the laws of the State of Texas, is, under certain circumstances, restricted in the declaration and payment of dividends to the extent that before declaring any dividends, it must transfer to its "certified surplus" accounts an amount not less than 10 percent of the net profits earned since the last dividend was declared, except that there is no requirement for a transfer to certified surplus of a sum which would increase the certified surplus to more than the capital stock of the bank. As members of the Federal Reserve, Compass Bank and Compass Bank- Texas are subject to dividend limitations imposed by the Federal Reserve that are similar to those applicable to national banks.
Federal law further provides that no insured depository institution may make any capital distribution, including a cash dividend, if, after making the distribution, the institution would not satisfy one or more of its minimum capital requirements. Moreover, the federal bank regulatory agencies also have the general authority to limit the dividends paid by insured banks if such payments may be deemed to constitute an unsafe and unsound practice. Insured banks are prohibited from paying dividends on their capital stock while in default in the payment of any assessment due to the FDIC except in those cases where the amount of the assessment is in dispute and the insured bank has deposited satisfactory security for the payment thereof.
The Community Reinvestment Act of 1977 ("CRA") and the regulations of the Federal Reserve and the FDIC implementing that act are intended to encourage regulated financial institutions to help meet the credit needs of their local community or communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of such financial institutions. The CRA and such regulations provide that the appropriate regulatory authority will assess the records of regulated financial institutions in satisfying their continuing and affirmative obligations to help meet the credit needs of their local communities as part of their regulatory examination of the institution. The results of such examinations are made public and are taken into account upon the filing of any application to establish a domestic branch or to merge or to acquire the assets or assume the liabilities of a bank. In the case of a bank holding company, the CRA performance record of the banks involved in the transaction are reviewed in connection with the filing of an application to acquire ownership or control of shares or assets of a bank or to merge with any other bank holding company. An unsatisfactory record can substantially delay or block the transaction.
OTHER
Other legislative and regulatory proposals regarding changes in banking and the regulation of banks, thrifts and other financial institutions are being considered by the executive branch of the federal government, Congress and various state governments, including Alabama, Texas and Florida. Certain of these proposals, if adopted, could significantly change the regulation of banks and the financial services industry. It cannot be predicted accurately whether any of these proposals will be adopted or, if adopted, how these proposals will affect the Company or the Subsidiary Banks.
The Investment Services Division of Compass Bank is treated as a municipal securities dealer and a government securities dealer for purposes of the federal securities laws and, therefore, is subject to certain reporting requirements and/or regulatory controls by the Securities and Exchange Commission (the "Commission"), the United States Department of the Treasury and the Federal Reserve. Compass Brokerage, Inc. is a discount brokerage service registered with the Commission and the National Association of Securities Dealers, Inc. and is subject to certain reporting requirements and regulatory control by these agencies. Compass Bancshares Insurance, Inc. is a licensed insurance agent or broker for various insurance companies and is subject to reporting and licensing regulations of the Alabama Insurance Commission.
References to applicable statutes under the heading "Supervision and Regulation" are brief summaries of portions thereof, do not purport to be complete and are qualified in their entirety by reference to such statutes.
ITEM 1 -- STATISTICAL DISCLOSURE
ITEM 2
ITEM 2 -- PROPERTIES
The Company, through its subsidiaries, owns or leases buildings that are used in the normal course of business. The principal executive offices of the Company are located at 15 South 20th Street, Birmingham, Alabama, in a 289,000 square-foot office building. The Subsidiary Banks own or lease various other offices and facilities in Alabama, Florida and Texas with remaining lease terms of 1 to 20 years exclusive of renewal options. In addition, the Company owns a 306,000 square-foot administrative headquarters facility located in Birmingham, Alabama. The Company also owns the River Oaks Bank Building in Houston, Texas, a 14-story, 168,000 square-foot office building, and the Post Oak Building in Houston, Texas, an 8-story, 124,000 square-foot office building. Compass Bank-Texas currently occupies approximately 35 percent of the River Oaks Bank Building and approximately 30 percent of the Post Oak Building. The remaining space in both buildings is leased to multiple tenants. See "Summary of Significant Accounting Policies" and "Notes to Consolidated Financial Statements" for information with respect to the amounts at which bank premises, equipment and other real estate are carried and information relating to commitments under long-term leases.
ITEM 3
ITEM 3 -- LEGAL PROCEEDINGS
The Subsidiary Banks are defendants in legal proceedings arising in the ordinary course of business. Some of these proceedings which relate to lending, collections, servicing, investment, trust and other activities by such subsidiaries seek substantial sums as damages.
Among the actions which are pending against the Subsidiary Banks are actions filed as class actions in the State of Alabama. The actions are similar to others that have been brought in recent years in Alabama against financial institutions in that they seek substantial compensatory and punitive damages in connection with transactions involving relatively small amounts of actual damages. In recent years, juries in certain Alabama state courts have rendered large punitive damage awards in such cases.
It may take a number of years to finally resolve some of these pending legal proceedings due to their complexity and other reasons. It is difficult to determine with any certainty at this time the potential exposure from the proceedings. However, based upon the advice of legal counsel, management is of the opinion that the ultimate resolution of these legal proceedings will not have a material adverse effect on the Company's financial condition or results of operations.
ITEM 4
ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders by solicitation of proxies or otherwise during the fourth quarter of 1997.
PART II
ITEM 5
ITEM 5 -- MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
The following table sets forth the high and low closing prices of the common stock of the Company as reported through the National Association of Securities Dealers, Inc. Automated Quotation National Market System and the dividends paid thereon during the periods indicated. All per share information for periods prior to April, 1997, has been restated to reflect the 3-for-2 stock split with respect to the Company's common stock, which was effected by a stock dividend paid on April 2, 1997. The prices shown do not reflect retail mark-ups, mark-downs, or commissions. All share prices have been rounded to the nearest 1/8 of one dollar.
As of January 31, 1998, there were approximately 7,000 shareholders of record of common stock of which approximately 5,800 were residents of either Alabama, Texas or Florida.
ITEM 6
ITEM 6 -- SELECTED FINANCIAL DATA
The following table sets forth selected financial data for the last five years. All per share information for periods prior to April, 1997, has been restated to reflect the 3-for-2 stock split with respect to the Company's common stock, which was effected by a stock dividend paid on April 2, 1997. All prior year information has been restated to reflect acquisitions consummated during 1997 accounted for under the pooling-of-interests method of accounting.
ITEM 7
ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The purpose of this discussion is to focus on significant changes in the financial condition and results of operations of the Company and its subsidiaries during the past three years. The discussion and analysis is intended to supplement and highlight information contained in the accompanying consolidated financial statements and the selected financial data presented elsewhere in this report. Prior year information has been restated to reflect 1997 acquisitions accounted for using the pooling-of-interests accounting method. Financial institutions acquired by the Company during the past three years and accounted for as purchases are reflected in the financial position and results of operations of the Company since the date of their acquisition.
This report may contain forward-looking statements which are subject to numerous assumptions, risks and uncertainties. Statements pertaining to future periods are subject to uncertainty because of the possibility of changes in underlying factors and assumptions. Actual results could differ materially from those contained in or implied by such forward-looking statements for a variety of factors including: sharp and/or rapid changes in interest rates; significant changes in the economic scenario from the current anticipated scenario which could materially change anticipated credit quality trends and the ability to generate loans; significant delay in or inability to execute strategic initiatives designed to grow revenues and/or control expenses; and significant changes in accounting, tax or regulatory practices or requirements.
SUMMARY
In 1997, the Company reported record net income of $155.6 million, a 17 percent increase over the Company's previous high of $132.4 million in 1996. Net income for 1996 increased 11 percent over 1995 net income. Basic earnings per share for 1997 was $2.37, also a record, compared with $2.04 in 1996 and $1.84 in 1995, representing a 16 percent increase in 1997 and an 11 percent increase in 1996. Diluted earnings per share increased to $2.34 in 1997, a 15 percent increase, from $2.03 in 1996. Diluted earnings per share in 1996 increased 11 percent over 1995. Pretax income for 1997 was up $30.4 million, or 15 percent, over 1996 while income tax expense increased 10 percent over the same period reflecting a decrease in the Company's effective tax rate from 36.3 percent in 1996 to 34.8 percent in 1997.
One significant factor in the growth of the Company has been the Company's acquisitions in Texas since early 1987, specifically the Houston, Dallas, San Antonio and Austin areas. The Texas expansion continued in 1997 and is expected to continue in 1998. With the acquisition of three financial institutions in 1997, the assets of the Company's Texas operations has grown to $5.5 billion at December 31, 1997. In addition, the Company expanded its Florida operations with the acquisition of Enterprise National Bank of Jacksonville, Florida and has continued to increase its presence in Florida in 1998. For additional information, see "Acquisitions" and "Acquisitions Completed After December 31, 1997" in Part I of this report and the accompanying "Notes to the Consolidated Financial Statements," Note 11, Business Combinations.
EARNING ASSETS
Average earning assets in 1997 increased 9 percent over 1996 due principally to a 13 percent increase in average total loans. The average earning asset mix shifted moderately in 1997 with loans at 71 percent, investment securities and investment securities available for sale at 27 percent and other earning assets at 2 percent. In 1996, loans were 69 percent, investment securities and investment securities available for sale were 29 percent and other earning assets were 2 percent, unchanged from 1995 levels. The mix of earning assets is monitored on a continuous basis in order to place the Company in a position to react to interest rate movements and to maximize the return on earning assets.
LOANS
Average loans increased 13 percent in 1997 with much of the increase concentrated in commercial, financial and agricultural loans, real estate construction loans and consumer installment loans. Total loans outstanding at
year end increased 10 percent over previous year-end levels. Commercial, financial and agricultural loans, which were 25 percent of total loans, increased 20 percent in 1997 compared to the previous year. Real estate construction loans increased 20 percent while consumer installment loans increased 16 percent from year-end 1996 to year-end 1997. Residential mortgage and commercial mortgage loans each increased one percent compared to 1996 levels. The 13 percent increase in the Company's loan portfolio from 1995 to 1996 was primarily the result of an increase of 26 percent in commercial, financial and agricultural loans and a 12 percent increase in residential mortgage loans.
The Company's loan portfolio continues to reflect the diversity of the markets served by the Subsidiary Banks. The condition of the economy in states in which the Subsidiary Banks lend money is further reflected in the loan portfolio mix. The volume of commercial, financial and agricultural loans, as a percentage of total loans outstanding, increased significantly during 1997 continuing the trend of prior years. Residential real estate loans represented 34 percent of the total portfolio at December 31, 1997, down from the 37 percent reported in the prior year.
The Company has not invested in loans that would be considered highly leveraged transactions as defined by the Federal Reserve and other regulatory agencies. The Company had no foreign loans or loans to lesser developed countries as of December 31, 1997.
The Loan Portfolio table shows the classifications of loans by major category at December 31, 1997, and for each of the preceding four years. The second table shows maturities of certain loan classifications at December 31, 1997, and an analysis of the rate structure for such loans due in over one year.
LOAN PORTFOLIO
SELECTED LOAN MATURITY AND INTEREST RATE SENSITIVITY
INVESTMENT SECURITIES
The Company's investment securities are classified into one of three categories based on management's intent to hold the securities: (i) trading account securities, (ii) held-to-maturity securities or (iii) securities available for sale. Securities held in a trading account are required to be reported at fair value, with unrealized gains and losses included in earnings. Securities designated to be held to maturity are reported at amortized cost. Securities classified as available for sale are required to be reported at fair value with unrealized gains and losses, net of taxes, excluded from earnings and shown separately as a component of shareholders' equity. On December 31, 1995, the Company adopted the Financial Accounting Standards Board's Special Report, A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities ("Special Report"). The Special Report allowed a company the one-time opportunity to reassess the appropriateness of its investment securities classifications and to transfer securities from the held-to-maturity portfolio to the available- for-sale portfolio without calling into question the company's intent to hold other debt securities to maturity. Upon adoption, the Company transferred held-to-maturity investment securities totaling $828 million to its available- for-sale portfolio and $33 million of available-for-sale securities to its held-to-maturity portfolio. Generally, individual holdings with greater than $10 million par value were transferred to the available-for-sale portfolio in order to increase liquidity and portfolio management capabilities, with smaller positions transferred to the held-to-maturity portfolio.
The composition of the Company's total investment securities portfolio reflects the Company's investment strategy of maximizing portfolio yields commensurate with risk and liquidity considerations. The primary objectives of the Company's investment strategy are to maintain an appropriate level of liquidity and provide a tool to assist in controlling the Company's interest rate position while at the same time producing adequate levels of interest income. For securities classified as held to maturity, the Company has the ability, and it is management's intention, to hold such securities to maturity. Management of the maturity of the portfolio is necessary to provide liquidity and control interest rate risk. Certain securities that may be sold prior to maturity are reflected as investment securities available for sale on the Company's balance sheet.
Maturities of held-to-maturity securities in 1997, 1996 and 1995 were $371 million, $233 million and $466 million, respectively. During 1995, gross gains of $1.2 million were realized on $32 million of mortgage-backed securities ("MBS") in the held-to-maturity portfolio, which were classified as maturities in accordance with generally accepted accounting principles. Sales and maturities of securities available for sale totaled $966 million and $552 million, respectively, in 1997 while sales and maturities in the portfolio in 1996 were $812 million and $497 million. Net gains realized during the year accounted for four percent, six percent and two percent of noninterest income in 1997, 1996 and 1995, respectively. Gross unrealized gains in the Company's held-to-maturity portfolio at year-end 1997 totaled $19.2 million and gross unrealized losses totaled $1.3 million.
In recent years, the trend of the Company has been to invest in taxable securities due to the lack of preferential treatment afforded tax-exempt securities under the tax laws. Because of their liquidity, credit quality and yield characteristics, the majority of the purchases of taxable securities have been in collateralized mortgage obligations ("CMOs"). Total average investment securities, including those available for sale, was relatively unchanged during 1997 after increasing 10 percent in 1996.
The following table contains the carrying amount of the investment securities portfolio at the end of each of the last three years.
INVESTMENT SECURITIES AND INVESTMENT SECURITIES AVAILABLE FOR SALE
The maturities and weighted average yields of the investment securities and investment securities available for sale portfolios at the end of 1997 are presented in the following table using primarily the average expected lives including the effects of prepayments. The amounts and yields disclosed for investment securities available for sale reflect the amortized cost rather than the net carrying value, i.e., fair value, of these securities. Taxable equivalent adjustments, using a 35 percent tax rate, have been made in calculating yields on tax-exempt obligations.
INVESTMENT SECURITIES AND INVESTMENT SECURITIES AVAILABLE FOR SALE MATURITY SCHEDULE
While the weighted average stated maturities of total MBS and CMOs are 15.3 years and 23.0 years, respectively, the corresponding weighted average expected lives assumed in the above table are 4.5 years and 3.0 years. During a period of rising rates, prepayment speeds generally slow on MBS and CMOs with a resulting extension in average life, and vice versa. Given a 100 basis point immediate and permanent parallel increase in rates, the expected average lives for MBS and CMOs would be 5.2 and 4.3 years, respectively. Similarly, given a 100 basis point immediate and permanent parallel decrease in rates, the expected average lives for MBS and CMOs would be 3.2 and 1.4 years, respectively.
The weighted average market prices as a percentage of par value for MBS and CMOs at December 31, 1997, were 101.9 percent and 99.9 percent, respectively. The market prices for MBS and CMOs generally decline in a rising rate environment due to the resulting increase in average life as well as the decreased market yield on fixed rate securities and impact of annual and life rate caps on adjustable-rate securities. The opposite is generally true during a period of falling rates. At December 31, 1997, fixed-rate MBS and CMOs totaled $184 million and $2.3 billion, respectively, with corresponding weighted average expected lives of 2.5 and 2.7 years. Adjustable-rate MBS and CMOs totaled $180 million and $126 million, respectively, with corresponding weighted average expected lives of 6.6 and 8.8 years. Substantially all adjustable-rate MBS and CMOs are subject to life rate caps, and MBS are also generally subject to a two percent annual cap. The weighted average life caps at year end were 11.22 percent and 9.20 percent for MBS and CMOs, respectively, and the corresponding weighted average coupon rates at year end were 7.04 percent and 6.73 percent. Given a 100 basis point immediate and permanent parallel increase in rates, the estimated market prices for MBS and CMOs would be 100.8 and 97.1, respectively.
Given a 100 basis point immediate and permanent parallel decrease in rates, the estimated market prices for MBS and CMOs would be 102.4 and 101.0, respectively.
TRADING ACCOUNT SECURITIES AND OTHER EARNING ASSETS
Securities carried in the trading account, while interest bearing, are primarily held for sale. The volume of activity is directly related to general market conditions and reactions to the changing interest rate environment. The average balance in the trading account securities portfolio for 1997 increased by 17 percent following a 38 percent increase in 1996, as a result of increased retail sales demand and a larger, more experienced sales force. The following table details the composition of the Company's trading account at December 31, 1997, 1996 and 1995.
TRADING ACCOUNT COMPOSITION
Average federal funds sold and securities purchased under agreements to resell decreased 28 percent in 1997 compared to a 36 percent increase in 1996. The average balance of interest bearing deposits in other banks decreased 61 percent during 1997 from 1996 levels after decreasing 70 percent from 1995 to 1996.
DEPOSITS AND BORROWED FUNDS
Changes in the Company's markets and the economy in general were also reflected in the liability mix during 1997. Average interest bearing deposits, the primary source of funding for the Company, made up 79 percent of total average interest bearing liabilities in 1997, down from 83 percent in 1996 and 81 percent in 1995. Contributing to the overall decrease in average interest bearing deposits relative to the prior year was the impact of investment alternatives pursued by customers in response to the continued strength of the stock and bond markets. In addition, the mix of average interest bearing deposits in 1997 shifted from demand deposits to savings due primarily to a program initiated by the Company during 1996. Under this program, deposit balances in certain NOW accounts above a certain threshold are transferred to savings accounts, thereby reducing the level of deposit reserves required to be maintained with the Federal Reserve. See Note 1, Cash and Due From Banks, in the "Notes to Consolidated Financial Statements" for a further discussion of reserve requirements maintained with the Federal Reserve. As a result of this program, during 1997 and 1996 NOW account balances averaging $626.4 million and $44.9 million, respectively, were transferred to the savings category. Contributing to the change in the mix of interest bearing liabilities in 1997 was a three percent decrease in average certificates of deposit less than $100,000 and other time deposits, offset in part by a one percent increase in average certificates of deposit of $100,000 or more.
During 1996, the increase in average interest bearing deposits as a percentage of total interest bearing liabilities from the prior year was the result of increases in all interest bearing deposit categories. Savings deposits and certificates of deposit of $100,000 or more increased 33 percent and 10 percent, respectively, while
demand deposits and certificates of deposit less than $100,000 and other time deposits showed more modest increases of 5 percent and 4 percent, respectively. The increases during 1996 were due primarily to internally generated growth with a portion of the increase due to merger and acquisition related activity.
The following table summarizes the maturities of certificates of deposit of $100,000 or more and other time deposits of $100,000 or more outstanding at December 31, 1997.
MATURITIES OF TIME DEPOSITS
In order to support earning asset growth of nine percent in 1997 and as a result of consumers choosing alternative investments other than deposits, the Company relied more heavily on borrowed funds in 1997. Borrowed funds consist of Federal Home Loan Bank ("FHLB") advances and other short-term borrowings, primarily in the form of federal funds purchased, securities sold under agreements to repurchase and other short-term borrowings. Included in other short-term borrowings are trading account short sales and the parent company's commercial paper. Average federal funds purchased increased $205 million, or 45 percent, and other short-term borrowings increased $30 million, or 17 percent, while average securities sold under agreements to repurchase showed a slight decrease of 3 percent during 1997. During 1997, the average balance of FHLB and other borrowings increased $372 million, or 59 percent, primarily as a result of additional FHLB advances of $1.2 billion, partially offset by repayments of $573 million. For a discussion of interest rates and maturities of FHLB and other borrowings, refer to Note 5, FHLB and Other Borrowings, in the "Notes to Consolidated Financial Statements."
During the first quarter of 1997, the Company supplemented its funding sources through the formation of a statutory business trust ("Compass Trust I") which issued capital securities ("Capital Securities") to institutional investors in the amount of $100 million. The proceeds from the issuance of the Capital Securities and the issuance of $3.1 million of common securities were concurrently used by Compass Trust I to purchase $103.1 million of guaranteed preferred beneficial interests in Company's junior subordinated deferrable interest debentures. The average balance of the Capital Securities is included in FHLB and other borrowings in the tables on pages 28 and 29. For a further discussion of Capital Securities, refer to Note 6, Capital Securities, in the "Notes to Consolidated Financial Statements."
The Short-Term Borrowings table below shows the distribution of the Company's short-term borrowed funds and the weighted average interest rates thereon at the end of each of the last three years. Also provided are the maximum outstanding amounts of borrowings, the average amounts of borrowings and the average interest rates at year end for the last three years.
SHORT-TERM BORROWINGS
LIQUIDITY MANAGEMENT
Liquidity is the ability of the Company to convert assets into cash or cash equivalents without significant loss and to raise additional funds by increasing liabilities. Liquidity management involves maintaining the Company's ability to meet the day-to-day cash flow requirements of the Subsidiary Banks' customers, whether they are depositors wishing to withdraw funds or borrowers requiring funds to meet their credit needs. Without proper liquidity management, the Subsidiary Banks would not be able to perform the primary function of a financial intermediary and would, therefore, not be able to meet the needs of the communities they serve. Additionally, the parent holding company requires cash for various operating needs including dividends to shareholders, business combinations, capital injections to the Subsidiary Banks, the servicing of debt and the payment of general corporate expenses. The primary source of liquidity for the parent holding company is dividends from the Subsidiary Banks. At December 31, 1997, the Company's Subsidiary Banks could have paid additional dividends to the parent holding company in the amount of $139.3 million while continuing to meet the capital requirements for "well-capitalized" banks. Also, the parent holding company has access to various capital markets as evidenced by the issuance of the Capital Securities during the first quarter of 1997 and the
issuance of subordinated debentures in 1994 and 1993. The parent holding company does not anticipate any liquidity requirements in the near future that it will not be able to meet.
Asset and liability management functions not only to assure adequate liquidity in order for the Subsidiary Banks to meet the needs of their customers, but also to maintain an appropriate balance between interest- sensitive assets and interest-sensitive liabilities so that the Company can earn a return that meets the investment requirements of its shareholders. Daily monitoring of the sources and uses of funds is necessary to maintain an acceptable cash position that meets both requirements. In a banking environment, both assets and liabilities are considered sources of liquidity funding and are monitored on a daily basis.
The asset portion of the balance sheet provides liquidity primarily through loan principal repayments, maturities of investment securities and, to a lesser extent, sales of investment securities available for sale and trading account securities. Other short-term investments such as federal funds sold, securities purchased under agreements to resell and maturing interest bearing deposits with other banks are additional sources of liquidity funding.
The liability portion of the balance sheet provides liquidity through various customers' interest bearing and noninterest bearing deposit accounts. Federal funds purchased, securities sold under agreements to repurchase and other short-term borrowings are additional sources of liquidity and, basically, represent the Company's incremental borrowing capacity. These sources of liquidity are short-term in nature and are used as necessary to fund asset growth and meet short-term liquidity needs.
As disclosed in the Company's "Consolidated Statements of Cash Flows," net cash provided by operating activities decreased to $45 million primarily due to the increase in other assets offset by an increase in net income and trading account securities. Net cash used in investing activities of $859 million consisted primarily of net loans originated of $812 million and available-for-sale securities purchased of $1.8 billion, largely funded by maturities of investment securities held to maturity of $371 million, as well as sales and maturities of investment securities available for sale of $966 million and $552 million, respectively. Net cash provided by financing activities provided the remainder of funding sources for 1997. The $794 million of net cash provided by financing activities consisted primarily of a net increase of $584 million in FHLB advances and other borrowings, a $321 million increase in federal funds purchased, an increase of $36 million in securities sold under agreements to repurchase and the issuance of $100 million in Capital Securities offset partially by a reduction of $177 million in deposits and the payment of $62 million in dividends.
INTEREST RATE SENSITIVITY MANAGEMENT
The Company's net interest income, and the fair value of its financial instruments, are influenced by changes in the level of interest rates. The Company manages its exposure to fluctuations in interest rates through policies established by its Asset/Liability Management Committee ("ALCO"). The ALCO meets at least monthly and has responsibility for approving asset/liability management policies, formulating and implementing strategies to improve balance sheet positioning and/or earnings and reviewing the interest rate sensitivity of the Company and the Subsidiary Banks.
Management utilizes an interest rate simulation model to estimate the sensitivity of the Company's net interest income to changes in interest rates. Such estimates are based upon a number of assumptions for each scenario, including the level of balance sheet growth, deposit repricing characteristics and the rate of prepayments.
The estimated impact on the Company's net interest income sensitivity over a one-year time horizon is shown below. Such analysis assumes an immediate and sustained parallel shift in interest rates, no balance sheet growth and the Company's estimate of how interest-bearing transaction accounts will reprice in each scenario.
The ALCO policy, with which the Company complies, is based on the same assumptions as the above table and provides that a 100 basis point increase or decrease in interest rates should not reduce net interest income by more than five percent. Certain financial instruments have been excluded from the above analysis because of the no-growth assumption, including letters of credit and commitments to extend credit. Trading account interest rate contracts and options and non-trading caps purchased have also been excluded because they have no material impact on net interest income.
The Company enters into various interest rate contracts not held in the trading account ("interest rate protection products") to help manage the Company's interest sensitivity. Such contracts generally have a fixed notional principal amount and include interest rate swaps where the Company typically receives or pays a fixed rate and a counterparty pays or receives a floating rate based on a specified index, generally prime rate or the London Interbank Offered Rate ("LIBOR") and interest rate caps and floors purchased or written where the Company receives or pays, respectively, interest if the specified index falls below the floor rate or rises above the cap rate. The interest rate risk factor in these contracts is considered in the overall interest management strategy and the Company's interest risk management program. The income or expense associated with interest rate swaps, caps and floors and gains or losses in futures contracts classified as hedges are ultimately reflected as adjustments to interest income or expense. Changes in the estimated fair value of interest rate protection contracts are not reflected in the financial statements until realized. A discussion of interest rate risks, credit risks and concentrations in off-balance sheet financial instruments is included in Note 7, Derivative Financial Instruments, of the "Notes to Consolidated Financial Statements." The following table details various information regarding interest rate protection contracts as of December 31, 1997.
INTEREST RATE PROTECTION CONTRACTS
- -------- + On $128.3 million of a total notional amount of $178.3 million, the Company receives interest based on three-month LIBOR plus 84 basis points and pays interest based on the one-year Constant Maturity Treasury plus 150 basis points. On the remaining $50 million notional, the Company receives interest based on Prime minus 273.5 basis points and pays interest based on the three-month LIBOR. * Weighted average rates received/paid are shown only for swaps, caps and floors for which net interest amounts were receivable or payable at December 31, 1997.
The net interest amount received or paid on an interest rate protection contract represents an adjustment of the yield or rate on the respective asset or liability with which such contract is associated. The gain or loss on a terminated interest rate protection contract is deferred and amortized over the remaining term of the original contract as an adjustment of yield or rate on the asset or liability with which the original contract was associated. At year-end 1997, there were no deferred gains and $84,000 of deferred losses on terminated interest rate protection contracts, which will be recorded as net interest expense through 1999. The following table indicates the asset or liability category with which the non-trading interest rate protection contracts were associated at December 31, 1997.
ASSETS/LIABILITIES ASSOCIATED WITH INTEREST RATE PROTECTION CONTRACTS
In addition to interest rate protection contracts used to manage overall interest sensitivity, the Company also enters into interest rate contracts for the trading account. The primary purposes for using interest rate protection contracts in the trading account are to facilitate customer transactions and to protect cash market positions in the trading account against interest rate movement. Changes in the estimated fair value of contracts in the trading account are recorded in other noninterest income as trading account profits and commissions. Net interest
amounts received or paid on interest rate contracts in the trading account are recorded as an adjustment of interest on trading account securities. The following table summarizes interest rate contracts held in the trading account at December 31, 1997.
TRADING ACCOUNT INTEREST RATE CONTRACTS
- -------- * Weighted average rates received/paid are shown only for swaps, caps and floors for which net interest amounts were receivable or payable at December 31, 1997. For caps and floors, the rate shown represents the weighted average net interest differential between the index rate and the cap or floor rate. ++Positive carrying values represent assets of the Company while negative amounts represent liabilities.
In addition to the interest rate contracts shown above, the Company uses other options and futures in the trading account. At December 31, 1997, the trading account contained other options purchased and written having weighted average expiration dates shorter than three months, with a notional balance of $10.5 million for purchased options and a notional balance of $5.0 million for written options and estimated fair values of $65,000 and $(31,000), respectively. Changes in the estimated fair value of these instruments are recorded in other noninterest income as trading account profits and commissions. The position of purchased options was taken in order to protect the market value of the trading account against rising short-term interest rates while maintaining limited risk to declining rates. At December 31, 1997, futures contracts having a notional principal of $69 million were also used to reduce the price sensitivity of the trading account.
CAPITAL RESOURCES
Shareholders' equity increased 13 percent in 1997 after increasing 9 percent in 1996. Exclusive of the net change in unrealized holding gains (losses) on securities available for sale in both 1997 and 1996, net income after dividends accounted for substantially all of the increase in shareholders' equity.
Dividends of $61.6 million were declared on the Company's common stock in 1997, representing a 22 percent increase over 1996. The 1997 annual dividend rate per common share, after adjusting for a three-for-two stock split effected in the form of a 50 percent stock dividend paid in April, 1997, was $0.947, an 11 percent increase over 1996. The dividend payout ratio for 1997 was 40 percent compared to 38 percent for 1996 and 36
percent for 1995. The Company intends to continue a dividend payout ratio that is competitive in the banking industry while maintaining an adequate level of retained earnings to support continued growth. On February 16, 1998, the Company's Board of Directors approved an 11 percent increase in the annual dividend rate, raising it to $1.05 per common share for 1998. This marked the seventeenth consecutive year the Company has increased its dividend.
A strong capital position, which is vital to the continued profitability of the Company, also promotes depositor and investor confidence and provides a solid foundation for the future growth of the organization. The Company has satisfied its capital requirements principally through the retention of earnings. The Company's five-year compound growth rate in shareholders' equity of 11 percent was achieved primarily through reinvested earnings.
Average shareholders' equity as a percentage of total average assets is one measure used to determine capital strength. Overall, the Company's capital position remains strong as the ratio of average shareholders' equity to average assets for 1997 was 7.13 percent compared to 6.94 percent in 1996 and 6.93 percent in 1995. As noted above, exclusive of the net change in unrealized holding gains (losses) on securities available for sale, the increase in shareholders' equity in 1997 and 1996 is due almost exclusively to the retention of earnings. In order to maintain this ratio at appropriate levels with continued growth in total average assets, a corresponding level of capital growth must be achieved. The table below summarizes these and other key ratios for the Company for each of the last three years.
RETURN ON EQUITY AND ASSETS
In addition to the capital ratios mentioned above, banking industry regulators have defined minimum regulatory capital ratios that the Company and the Subsidiary Banks are required to maintain. These risk-based capital guidelines take into consideration risk factors, as defined by the regulators, associated with various categories of assets, both on and off of the balance sheet. Under the guidelines, capital strength is measured in two tiers which are used in conjunction with risk-adjusted assets to determine the risk-based capital ratios. Tier I Capital is defined as common shareholders' equity, excluding the net unrealized holding gain (loss) on available-for-sale securities (except for net unrealized losses on marketable equity securities), plus the Capital Securities, minus goodwill and other disallowed intangible assets. Other disallowed intangibles represent intangible assets, other than goodwill, recorded after February 19, 1992. Total Qualifying Capital is defined as Tier I Capital plus Tier II capital components, which include such items as qualifying allowance for loan losses and qualifying subordinated debt.
At December 31, 1997, the Company's Tier I Capital and Total Qualifying Capital totaled $961 million and $1.2 billion, respectively. The percentage ratios, as calculated under the guidelines, were 9.84 percent and 12.36 percent for Tier I and Total Qualifying Capital, respectively, at year-end 1997, up from 8.70 percent and 11.41 percent at year-end 1996. These ratios are well within the minimum requirements of four percent for Tier I Capital and eight percent for Total Qualifying Capital. Tier I Capital increased in 1997 primarily as a result of the issuance of the Capital Securities in January, 1997, and the $94 million in earnings retained by the Company, net of dividends. While shareholders' equity increased 9 percent from December 31, 1995, to December 31, 1996, the increases in Tier I and Total Qualifying Capital were significantly less due to the addition of $70 million in intangibles resulting from the Company's purchase business combinations in 1996.
Two other important indicators of capital adequacy in the banking industry are the leverage ratio and the tangible leverage ratio. The leverage ratio is defined as Tier I Capital divided by total adjusted quarterly average assets. Average quarterly assets are adjusted by subtracting the average unrealized gain (loss) on available-for-sale securities (except for net unrealized losses on marketable equity securities), period-end goodwill and other disallowed intangibles. The tangible leverage ratio is defined similarly, except, by definition, all other intangible assets not previously excluded are removed from both the numerator and denominator. Even though core deposit intangibles and goodwill increased due to purchase business combinations completed during 1996 and 1994, the leverage ratio remained well within regulatory guidelines: 7.45 percent at year-end 1997; 6.19 percent at year-end 1996 and 6.78 percent at year-end 1995. The tangible leverage ratio was 7.33 percent at year-end 1997; 6.05 percent at year-end 1996 and 6.61 percent at year-end 1995. The increase in both the leverage ratio and the tangible leverage ratio in 1997 was due primarily to the issuance of the Capital Securities in January, 1997, while the decrease in 1996 of these ratios was due primarily to the substantial increase in intangibles resulting from the purchase business combinations completed by the Company in 1996.
The following table shows the calculation of capital ratios for the Company for the last three years.
CAPITAL RATIOS
The regulatory capital ratios of the Company's Subsidiary Banks currently exceed the minimum ratios of 5 percent leverage capital, 6 percent Tier I Capital and 10 percent Total Qualifying Capital required in 1997 for "well- capitalized" banks as defined by federal regulators. The Company continually monitors these ratios to assure that the Subsidiary Banks exceed the guidelines. For further information regarding the regulatory capital ratios of the Company and the Subsidiary Banks, see Note 10, Regulatory Matters and Dividends from Subsidiaries, in the "Notes to Consolidated Financial Statements".
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income is the principal component of a financial institution's income stream and represents the difference or spread between interest and fee income generated from earning assets and the interest expense paid on deposits and borrowed funds. Fluctuations in interest rates as well as volume and mix changes in earning assets and interest bearing liabilities can materially impact net interest income. The following discussion of net interest income is presented on a taxable equivalent basis, unless otherwise noted, to facilitate performance comparisons among various taxable and tax-exempt assets.
Net interest income for 1997 increased 10 percent over 1996 while increasing 9 percent in 1996 over 1995. A nine percent increase in the volume of average earning assets, primarily total loans, coupled with a three basis
point increase in the net yield were responsible for the increase in 1997. In 1996, an 11 percent increase in the volume of earning assets, primarily as a result of a 10 percent increase in both total investment securities and total loans, more than offset a 6 basis point decline in the net yield. The schedule on pages 30 and 31 provides the detail of changes in interest income, interest expense and net interest income due to changes in volumes and rates.
Interest income increased 10 percent in 1997 and 9 percent in 1996 after increasing 24 percent in 1995. Interest income in 1997 grew as a result of a nine percent increase in the volume of average earning assets coupled with a three basis point increase in the average interest rate earned. A 13 percent increase in the volume of average loans and a 6 basis point decrease in yield accounted for the 12 percent increase in interest income on loans. Interest income on investment securities, including securities available for sale, increased two percent from 1996 to 1997. This increase resulted from a one percent increase in the average balance of total investment securities and a seven basis point increase in yield. Interest income on trading account securities increased 10 percent as a result of a 17 percent increase in the average balance.
Total interest expense increased by nine percent in 1997 due to a nine percent increase in the average volume of interest bearing liabilities offset partially by a one basis point decrease in the rate paid on interest bearing liabilities. Interest expense on interest bearing deposits increased by one percent as the result of a three percent increase in the average volume and a nine basis point decrease in rate. The 40 percent increase in average borrowed funds, which includes interest bearing liabilities that are not classified as deposits, combined with a 4 basis point increase in rate resulted in a 40 percent increase in interest expense for this category. A 59 percent increase in the average balance of FHLB advances and other borrowings, which includes $100 million of Capital Securities, and a 45 percent increase in federal funds purchased were primarily responsible for the increase in averaged borrowed funds in comparison with the prior year.
From 1995 to 1996, interest income increased 9 percent as a result of an 11 percent increase in the volume of average earning assets and a 15 basis point decrease in the yield on average earning assets. Interest income on loans rose 9 percent as a result of a 10 percent increase in average volume and a 13 basis point decrease in yield. Interest income on investment securities, including securities available for sale, increased 8 percent from 1995 to 1996 as a result of a 10 percent increase in average volume and an 11 basis point decrease in the yield on investment securities. A 38 percent increase in the average balance offset by a 70 basis point decrease in yield increased interest income on trading account securities by 26 percent in 1996.
A 12 basis point decrease in the rate paid on interest bearing liabilities combined with an 11 percent increase in average volume resulted in an 8 percent increase in interest expense on interest bearing liabilities in 1996. A substantial portion of the increase in total interest expense was due to a 13 percent increase in interest expense on interest bearing deposits, resulting from a 14 percent increase in the average volume offset, in part, by a 5 basis point decrease in rate. A 25 basis point decrease in the rate paid on average borrowed funds, along with a 4 percent increase in average volume, resulted in a 7 percent decrease in interest expense for this category.
Net interest income is commonly evaluated in terms of average rates using the net yield and the interest rate spread. The net yield on earning assets is computed by dividing fully taxable equivalent net interest income by average total earning assets. This ratio represents the difference between the average yield returned on average earning assets and the average rate paid for all funds used to support those earning assets, including both interest bearing and noninterest bearing sources of funds. The net yield increased three basis points to 4.11 percent in 1997 after decreasing three basis points to 4.08 percent in 1996. The moderate increase in net yield in 1997 was a function of the downward repricing of interest bearing deposits and FHLB and other borrowings which outpaced the downward repricing of loans and total investment securities. This is evidenced by the fact the yield on interest earning assets increased three basis points while the rate paid on interest bearing liabilities decreased by one basis point. At the same time, the portion of interest earning assets funded by interest bearing liabilities in 1997 was 85 percent, unchanged from 1996.
During 1997, the net yield on interest earning assets was minimally impacted by the Company's use of interest rate contracts, primarily interest rate swaps and interest rate floors, increasing the taxable equivalent net yield on interest earning assets by three basis points. The greatest impact from the use of interest rate contracts was on the yield and interest income on loans where the net yield was increased by five basis points and interest income was increased by $4.3 million. At the same time, the impact of interest rate contracts on interest bearing liabilities was less significant, decreasing interest expense by less than $1 million. The impact of the use of interest rate contracts in 1997 was greater than in 1996 when the positive impact on the net yield on interest earning assets was one basis point. It is the Company's intention to continue to use interest rate contracts to manage its exposure to the changing interest rate environment in the future, although there can be no assurance that the impact of interest rate contracts on the earnings of future periods will be positive.
The interest rate spread measures the difference between the average yield on earning assets and the average rate paid on interest bearing liabilities. The interest rate spread eliminates the impact of noninterest bearing funds and gives a direct perspective on the effect of market interest rate movements. During 1997, the net interest rate spread increased four basis points to 3.37 percent from the 1996 spread of 3.33 percent as the cost of interest bearing liabilities declined slightly while the yields earned on earning assets increased by three basis points. The decrease in 1996 was three basis points from 3.36 percent in 1995. See the accompanying tables entitled "Consolidated Average Balances, Interest Income/Expense and Yields/Rates" and "Rate/Volume Variance Analysis" for more information.
The following table presents certain interest rates without modification for tax equivalency. The table on pages 28 and 29 contains these same percentages on a taxable equivalent basis. Tax-exempt earning assets continue to make up a smaller percentage of total earning assets. As a result, the difference between these interest rates with and without modification for tax equivalency continues to narrow.
Interest income, as reported in the "Consolidated Statements of Income", on a nominal yield basis increased in 1997 by $83.6 million while net interest income increased by $44.0 million. The two basis point increase in the net yield in 1997 was a result of an increase in the yields in the Company's interest earning assets and a slight decrease in the cost of interest bearing liabilities, as discussed earlier.
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CONSOLIDATED AVERAGE BALANCES, INTEREST INCOME/EXPENSE AND YIELDS/RATES
Taxable Equivalent Basis
- -------- * Loans on nonaccrual status have been included in the computation of average balances.
RATE/VOLUME VARIANCE ANALYSIS
Taxable Equivalent Basis
PROVISION FOR LOAN LOSSES, NET CHARGE-OFFS AND ALLOWANCE FOR LOAN LOSSES
The provision for loan losses is the annual cost of providing an allowance or reserve for anticipated future losses on loans. The amount for each year is dependent upon many factors including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, management's assessment of loan portfolio quality, the value of collateral and general economic factors.
The economic outlook for the states in which the Company does business is optimistic in the midst of an improvement of the economy overall. On a regional basis, however, any economic slowdown in the Subsidiary Banks' markets could have an effect on most regional bank holding companies and could impact overall asset growth. Such an economic slowdown would probably also have a negative impact on real estate lending as well as the level of net charge-offs and delinquencies.
Since an economic slowdown could have an adverse effect on property values and, for commercial development projects, cause an increase in vacancy rates, the possibility exists for write-downs, charge-offs and the transfer of currently performing loans to a nonaccrual status in the real estate and commercial loan categories. The mix of loans in the construction and development portfolios are diversified in areas such as office buildings, retail stores and malls, apartment buildings, health care facilities and industrial warehouses. In addition, the Subsidiary Banks' specialized real estate lending areas review, approve and monitor large real estate credits on a continuing basis.
Loan review procedures, including such techniques as loan grading and on- site reviews, are constantly utilized by the Company's loan review department in order to ensure that potential problem loans are identified early in order to lessen any potentially negative impact such problem loans may have on the Company's earnings. Automated loan reports are prepared and used in conjunction with the identification and monitoring of such loans on a monthly basis. Management's involvement continues throughout the process and includes participation in the work-out process and recovery activity. These formalized procedures are monitored internally by the loan review department whose work is supplemented by regulatory agencies that provide an additional level of review on an annual basis. Such internal review procedures are quantified in monthly and quarterly reports to senior management and are used in determining whether such loans represent potential loss to the Company. Special reports are prepared for consumer installment loans to identify trends unique to that portfolio. A determination of a potential loss will result in a charge to the provision for loan losses, thereby increasing the allowance for loan losses available for potential risk. Management monitors the entire loan portfolio, including loans acquired in business combinations, in an attempt to identify problem loans so that risks in the portfolio can be timely identified and an appropriate allowance maintained.
As shown in the following table, net loan charge-offs in 1997 were $22.5 million, or 0.27 percent of average loans, compared with $19.1 million, or 0.26 percent of average loans, in 1996 and $11.2 million, or 0.17 percent of average loans, in 1995. The increase in the level of net charge-offs in 1997 was concentrated in the consumer installment, commercial real estate mortgages and commercial, financial and agricultural portfolios. The increase in net charge-offs in 1996 was attributable to increases in the consumer installment and commercial, financial and agricultural portfolios, while the increase in 1995 was the result of increased net charge-offs in all loan categories with the exception of residential real estate mortgages. During 1997, net charge- offs of commercial real estate mortgages and commercial, financial and agricultural loans increased by $636,000 and $400,000, respectively, and net charge-offs of consumer installment loans increased by $2.3 million. The Company's consumer installment portfolio was impacted by the continuing nationwide deterioration in consumer credit quality, as indicated by the increasingly high number of bankruptcies. Net charge-offs for the credit card portfolio, which represented only three percent of the Company's loan portfolio, increased as a percentage of average volume from 3.92 percent in 1996 to 4.21 percent in 1997. Net charge-offs as a percentage of loans in the Company's indirect consumer installment portfolio, consisting primarily of new and used automobile loans, was relatively unchanged from 0.28 percent in 1996 to 0.27 percent in 1997.
The following table sets forth information with respect to the Company's loans and the allowance for loan losses for the last five years.
SUMMARY OF LOAN LOSS EXPERIENCE
When determining the adequacy of the allowance for loan losses, management considers changes in the size and character of the loan portfolio, changes in nonperforming and past due loans, historical loan loss experience, the existing risk of individual loans, concentrations of loans to specific borrowers or industries and existing and prospective economic conditions. The allowance for loan losses at December 31, 1997, was $122.0 million, or 1.41 percent of loans, compared with $122.1 million, or 1.55 percent of loans, at December 31, 1996, and $113.8 million, or 1.64 percent of loans, at December 31, 1995. As shown in the table below, management determined that at December 31, 1997, approximately 20 percent of the allowance for loan losses was related to commercial, financial and agricultural loans, 22 percent was associated with real estate loans and 27 percent was related to consumer installment loans. Approximately 31 percent of the allowance remained unallocated to any specific category due to uncertainties related to loan portfolios acquired in connection with business combinations with regard to underwriting standards and other factors. While additional provision is provided with respect to these loans when identified as nonperforming, the corresponding portion of the allowance remains a component of the total allowance upon a loan's return to performing status. The amount of the allowance allocated to impaired loans by loan category is presented in the table on page 35.
ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
NONPERFORMING ASSETS
Nonperforming assets include loans classified as nonaccrual or renegotiated and foreclosed real estate. It is the general policy of the Subsidiary Banks to stop accruing interest income and place the recognition of interest on a cash basis when any commercial, industrial or real estate loan is 90 days or more past due as to principal or interest and the ultimate collection of either is in doubt, unless collection of both principal and interest is assured by way of collateralization, guarantees or other security. Accrual of interest income on consumer loans is suspended when any payment of principal or interest, or both, is more than 120 days delinquent. When a loan is placed on nonaccrual status, any interest previously accrued but not collected is reversed against current income unless the collateral for the loan is sufficient to cover the accrued interest or a guarantor assures payment of interest.
Nonperforming assets at December 31, 1997, were $35.4 million, an increase of $5.0 million from year-end 1996. Nonperforming loans increased $6.4 million from year-end 1996 to $28.9 million. The increase in nonperforming assets in 1997 was due, in part, to nonperforming assets acquired in connection with business combinations completed during 1997. During 1997, $7.8 million of loans were transferred to other real estate owned ("ORE") offset by total sales of other real estate owned of $9.4 million. Of these sales, $8.4 million were cash sales while $1.0 million represented loans originated by the Subsidiary Banks to facilitate the sale of other real estate. During 1996, loans transferred to other real estate owned totaled $7.6 million, cash sales were $4.1 million and loans to facilitate the sale of other real estate owned were $1.8 million.
Even though the stabilization in the commercial real estate market in the Southeastern part of the country continued during 1997, management will continue to monitor the Company's real estate and commercial loan portfolio during 1998. Particular attention will be focused on those credits identified by the loan monitoring and review process. Management continues to emphasize the need to maintain a low level of nonperforming assets and to return current nonperforming assets to a performing status.
Renegotiated loans decreased $257,000 from year-end 1996 while foreclosed real estate declined $1.4 million for the year. Loans past due 90 days or more increased $3.9 million compared to the 1996 year-end level. Other foreclosed or repossessed assets at year-end 1997 totaled approximately $420,000.
At December 31, 1997, nonperforming assets were 0.41 percent of loans outstanding and foreclosed real estate held for sale compared to 0.39 percent at year-end 1996. Nonaccrual loans and renegotiated loans as a percentage of loans outstanding at year-end 1997 were 0.30 percent and 0.03 percent, respectively.
The following table summarizes the Company's nonperforming assets for each of the last five years. Also provided are tables which detail nonaccrual loans and loans with terms modified in troubled debt restructurings at December 31, 1997 and 1996.
NONPERFORMING ASSETS
Details of nonaccrual loans at December 31, 1997 and 1996 appear below:
Details of loans with terms modified in troubled debt restructurings at December 31, 1997 and 1996 appear below:
Detailed in the table below are loans designated by the Company as impaired, as defined by Financial Accounting Statement No. 114, Accounting by Creditors for Impairment of a Loan, as amended by Financial Accounting Statement No. 118, Accounting by Creditors for Impairment of a Loan -- Income Recognition and Disclosures, ("FAS114"), at December 31, 1997, by loan category:
At December 31, 1997, impaired loans totaled $23.8 million with a total related allowance of $3.7 million. Of these amounts, nonaccrual impaired loans totaled $9.8 million with a related allowance of $1.5 million. Of the $14.0 million in accruing impaired loans, there were loans totaling approximately $400,000 for which there was no related allowance.
Impaired loans totaled $25.7 million at December 31, 1996, with a total related allowance of $4.8 million, with nonaccrual impaired loans totaling $8.1 million with a related allowance of approximately $1.5 million. Included in the $17.6 million of accruing impaired loans were loans totaling approximately $200,000 for which there was no related allowance.
As indicated in the table, $9.8 million of the $26.6 million of total nonaccrual loans at December 31, 1997, were considered impaired. The balance of nonaccrual loans consisted of residential mortgages, credit card receivables and consumer installment loans, primarily direct and indirect automobile loans, that meet the definition of smaller balance, homogeneous loans which are excluded from the scope of FAS114.
NONINTEREST INCOME
Noninterest income consists of revenues generated from a broad range of financial services and activities, including fee-based services, profits and commissions earned through securities and insurance sales, and trading activities. In addition, gains and losses realized from the sale of investment portfolio securities are included in noninterest income. Noninterest income totaled $181.5 million in 1997, an increase of 12 percent from the prior year, and $161.4 million in 1996, an increase of 20 percent from that reported in 1995.
NONINTEREST INCOME
Included in the results above are nonrecurring items of $8.8 million in 1997, $13.7 million in 1996 and $4.6 million in 1995. Nonrecurring items of noninterest income include gains on sales of investment securities, gains on the sale of premises and equipment and other real estate owned, gains on the sales of branches and gains on loan settlements. Nonrecurring items represented four percent of total noninterest income in 1997, eight percent in 1996 and three percent in 1995. The net gains on sales of investment securities totaled $7.4 million in 1997, $9.6 million in 1996 and $2.6 million in 1995, while gains on sales of branches totaled $2.5 million in 1996. After adjusting for the nonrecurring items, noninterest income for 1997 totaled $172.7 million, an increase of $25.0 million or 17 percent, over the adjusted total of $147.7 million in 1996. After similarly adjusting for nonrecurring items, 1996 noninterest income increased $18.1 million, or 14 percent, relative to 1995.
Fee income from service charges on deposit accounts increased 11 percent in 1997 following a 9 percent increase in 1996. Continued emphasis on low cost checking account services, appropriate pricing for transaction deposit accounts and fee collection practices for other deposit services contributed to the increased levels of income for both years. Increases during 1997 and 1996 were further influenced by the increase in both the number of accounts and balances outstanding in transaction deposit accounts.
Trading account profits and commissions increased by $525,000 and $1.6 million in 1997 and 1996, respectively. For 1997, trading account profits related specifically to derivative securities were approximately $1.0 million, consisting of $800,000 of profits related to collateralized mortgage obligations held in the trading account and $200,000 of profits on non-CMO derivative securities, specifically options and interest rate swaps, caps and floors. It should be noted that changes in the trading account profits and commissions in future years cannot be predicted accurately because of the uncertainty of changes in market conditions. There can be no assurance that such amounts will continue at their current levels. For a discussion of interest rate contracts held in the trading account and the composition of the trading account at December 31, 1997, see page 16.
Retail investment sales income, comprised primarily of mutual fund and annuity sales income, increased 29 percent in 1997 and 42 percent in 1996 reflecting management's continued efforts to increase sales in this area. Credit card service charge and fee income increased 16 percent in 1997 after increasing 22 percent in 1996. An increase in merchants' discounts accounted for the increase in 1997 while the increase in 1996 also included an increase in annual credit card fees.
Other noninterest income increased 33 percent in 1997 and 27 percent in 1996. Included in other noninterest income are ATM surcharge fees, insurance fees and commissions, income from mortgage banking operations and correspondent services fees.
NONINTEREST EXPENSE
Noninterest expense totaled $395.7 million in 1997, an increase of 9 percent from the prior year, and $364.3 million in 1996, an increase of 10 percent from that reported in 1995. Total salaries, benefits and commissions, as reflected in the "Consolidated Statements of Income", increased 12 percent in 1997 and 1996. Salaries increased 15 percent during 1997 and 11 percent in 1996 due to normal increases relating to additions to staff, merit increases and the completion of five business combination accounted for as purchases during 1996, while the increase in 1997 also reflected an increase in incentive bonuses of $5.9 million, or 70 percent. During 1997, other personnel expense, consisting primarily of employee benefits, decreased 6 percent after increasing 20 percent in 1996. The increase in other personnel expense during 1996 was due to increased pension plan and ESOP expense.
NONINTEREST EXPENSE
Net occupancy expense increased by 12 percent in 1997 following a 6 percent increase in 1996. These increases were due principally to the aforementioned purchase business combinations completed during 1996, opening of new branches and normal renovation of existing properties. Equipment expense increased 20 percent
in 1997 and 4 percent in 1996. The increase in equipment expense during 1997 reflected the Company's completion of a program started in 1996 to replace a majority of its core application systems with new technology necessary to support increased business growth and increased expenses associated with purchase business combinations.
Federal Deposit Insurance Corporation ("FDIC") insurance expense totaled $1.5 million compared with $10.8 million in 1996 and $10.3 million in 1995. The decrease in FDIC insurance expense in 1997 was due to a substantial decrease in the statutory premium rates in 1995. Offsetting the decrease in the statutory premium rates in 1996 was a special one-time charge of $7.2 million incurred in the third quarter to provide for an assessment mandated by the Deposit Insurance Funds Act of 1996 to recapitalize the Savings Association Insurance Fund. The amount of FDIC insurance premiums paid by the Subsidiary Banks is a function of both the Subsidiary Banks' deposit base and the rate at which insurance premiums are assessed by the FDIC, which is based, in part, on the capital adequacy of each bank. Because each of the Subsidiary Banks meets the regulatory definition of "well capitalized", this expense reflects the lowest possible assessment rate charged by the FDIC.
Professional services expense increased 22 percent and supplies expense increased 14 percent due to the previously mentioned systems conversions. Amortization of intangibles increased 24 percent in 1997 after increasing 48 percent in 1996 as a result of purchase business combinations completed throughout 1996.
INCOME TAXES
Income tax expense increased $7.3 million, or 10 percent, to $82.9 million for the year ended December 31, 1997. The effective tax rate as a percentage of pretax income was 34.8 percent in 1997, 36.3 percent in 1996 and 35.6 percent in 1995. The statutory federal rate was 35 percent during 1997, 1996 and 1995. The decrease in the effective tax rate for 1997 was primarily attributable to increased investment in tax-advantaged assets. For further information concerning the provision for income taxes, refer to Note 14, Income Taxes, of the "Notes to Consolidated Financial Statements".
YEAR 2000 ISSUES
As with other companies, the Company has initiated a program to study the impact on its computer systems in order to be Year 2000 compliant. This study not only involves identifying any modifications or replacements of certain hardware and software maintained by the Company, but also receiving assurance from qualified, independent parties that the appropriate actions have or are being taken by third parties to remedy their Year 2000 issues for computer systems that the third party is responsible for maintaining and that are relied upon by the Company. In addition, the Company is also taking appropriate actions to receive assurance that its customers, principally commercial lending customers, are taking necessary steps to remedy their Year 2000 issues due to the fact that noncompliance could adversely effect their ability to repay borrowings to the Company.
Under this program, the Company has identified the computer systems which will require either modification, upgrade or replacement. The Company anticipates that in-house personnel will be primarily responsible for completing these tasks and although outside contractors may be used, the costs will not be significant. As such, the Company believes that the planned modifications, upgrades and replacement of existing systems, along with third party confirmation, will be completed in a timely fashion to assure Year 2000 compliance, and any related costs will not have a material impact on the Company's results of operations, cash flows or financial condition in future periods.
OTHER ACCOUNTING ISSUES
In 1996, the Financial Accounting Standards Board ("FASB") issued Financial Accounting Statement No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, ("FAS125"). FAS125 requires an entity to recognize the financial and servicing assets it controls and the
liabilities it has incurred and to cease to recognize them as financial assets when control has been surrendered in accordance with the criteria provided in FAS125. Subsequently, the FASB issued Financial Accounting Statement No. 127, Deferral of the Effective Date of Certain Provisions of SFAS No. 125, which deferred until January 1, 1998, the implementation of certain aspects of the original statement. The adoption of FAS125 is not expected to have a material impact on the financial condition or operating results of the Company. The Company will apply the new rules prospectively to transactions when required.
Additionally in 1997, the FASB issued Financial Accounting Statement No. 130, Reporting Comprehensive Income, ("FAS130") and Financial Accounting Statement No. 131, Disclosures about Segments of an Enterprise and Related Information, ("FAS131"). FAS130 establishes reporting and presentation standards for comprehensive income and its components in a full set of general-purpose financial statements. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances arising from nonowner sources. FAS130 is effective for both interim and annual financial statements issued for periods beginning after December 15, 1997, and also applies to financial statements presented for prior periods. FAS131 requires that financial and descriptive information be disclosed for each reportable operating segment based on the management approach. The management approach focuses on financial information that an enterprise's decision makers use to assess performance and make decisions about resource allocation. The statement also prescribes the enterprise-wide disclosures to be made about products, services, geographic areas and major customers. FAS131 is effective for annual financial statements issued for periods beginning after December 15, 1997, and for interim financial statements in the second year of application. The Company adopted FAS130 and FAS131 on January 1, 1998, which did not result in a material impact on the financial condition or results of operations of the Company.
PENDING ACQUISITIONS
For information on pending acquisitions, see the accompanying "Notes to Consolidated Financial Statements", Note 11, Business Combinations.
IMPACT OF INFLATION AND CHANGING PRICES
A bank's asset and liability structure is substantially different from that of an industrial company in that virtually all assets and liabilities of a bank are monetary in nature. Management believes the impact of inflation on financial results depends upon the Company's ability to react to changes in interest rates and, by such reaction, reduce the inflationary impact on performance. Interest rates do not necessarily move in the same direction, or at the same magnitude, as the prices of other goods and services. As discussed previously, management seeks to manage the relationship between interest- sensitive assets and liabilities in order to protect against wide interest rate fluctuations, including those resulting from inflation.
Various information shown elsewhere in this Annual Report will assist in the understanding of how well the Company is positioned to react to changing interest rates and inflationary trends. In particular, the summary of net interest income, the maturity distributions, the compositions of the loan and securities portfolios, the data on the interest sensitivity of loans and deposits and the information related to off-balance sheet hedging activities discussed in Note 7, Derivative Financial Instruments, of the "Notes to Consolidated Financial Statements" should be considered.
ITEM 8
ITEM 8 -- FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required by Regulation S-X and by Item 302 of Regulation S-K are set forth in the pages listed below.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES FINANCIAL STATEMENTS
INDEPENDENT AUDITORS' REPORT
The Shareholders and Board of Directors Compass Bancshares, Inc.
We have audited the accompanying consolidated balance sheets of Compass Bancshares, Inc. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. 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, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Compass Bancshares, Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Birmingham, Alabama January 14, 1998
COMPASS BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
See accompanying summary of significant accounting policies and notes to consolidated financial statements.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
See accompanying summary of significant accounting policies and notes to consolidated financial statements.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
See accompanying summary of significant accounting policies and notes to consolidated financial statements.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying summary of significant accounting policies and notes to consolidated financial statements.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DECEMBER 31, 1997, 1996 AND 1995
The accounting principles followed by Compass Bancshares, Inc. (the "Company") and its subsidiaries and the methods of applying these principles conform with generally accepted accounting principles and with general practices within the banking industry. Certain principles which significantly affect the determination of financial position, results of operations and cash flows are summarized below.
Prior years' financial statements have been restated to reflect acquisitions consummated during 1997 accounted for using the pooling-of-interests method of accounting. Financial institutions acquired by the Company during the past three years and accounted for as purchases are reflected in the financial position and results of operations of the Company since the date of their acquisition. Certain items in prior years' financial statements have been reclassified to conform with the current financial statement presentations.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company and its subsidiaries, Compass Bank, the Company's lead bank subsidiary headquartered in Birmingham, Alabama, ("Compass Bank"), Compass Banks of Texas, which owns Compass Bank, headquartered in Houston, Texas, ("Compass Bank- Texas"), Central Bank of the South, (collectively, the "Subsidiary Banks"), Compass Land Holding Corporation and Compass Underwriters, Inc. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to prior year amounts to conform with the current year presentation.
NATURE OF OPERATIONS
The Company operates 223 branches in 101 cities in Alabama, Texas and Florida. The Company's branches in Alabama are located throughout the state while its Florida branches are concentrated in the Jacksonville area and in the Florida panhandle. In Texas, the Company's branches are primarily located in the state's four largest metropolitan areas of Houston, Dallas, San Antonio and Austin. The Company's primary source of income is interest income on loans made to individuals, small businesses and large corporations.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally accepted accounting principles 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 reporting period, the most significant of which relates to the allowance for loan losses. Actual results could differ from those estimates.
CONTINGENCIES
The Subsidiary Banks are defendants in legal proceedings arising in the ordinary course of business. Some of these proceedings which relate to lending, collections, servicing, investment, trust and other activities by such subsidiaries seek substantial sums as damages. Among the actions which are pending against the Subsidiary Banks are actions filed as class actions in the State of Alabama. The actions are similar to others that have been brought in recent years in Alabama against financial institutions in that they seek substantial compensatory and punitive damages in connection with transactions involving relatively small amounts of actual damages. In recent years, juries in certain Alabama state courts have rendered large punitive damage awards in such cases.
It may take a number of years to finally resolve some of these pending legal proceedings due to their complexity and other reasons. It is difficult to determine with any certainty at this time the potential exposure from the proceedings. However, based upon the advice of legal counsel, management is of the opinion that the
COMPASS BANCSHARES, INC. AND SUBSIDIARIES SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
ultimate resolution of these legal proceedings will not have a material adverse effect on the Company's financial condition or results of operations.
SECURITIES
Securities are held in three portfolios: (i) trading account securities, (ii) held-to-maturity securities and (iii) securities available for sale. Trading account securities are stated at fair value. Investment securities held to maturity are stated at cost adjusted for amortization of premiums and accretion of discounts. With regard to investment securities held to maturity, management has the intent and ability to hold such securities until maturity. Investment securities available for sale are classified as such due to the fact that management may decide to sell certain securities prior to maturity for liquidity, tax planning or other valid business purposes. Increases and decreases in the net unrealized gain (loss) on the portfolio of securities available for sale are reflected as adjustments to the carrying value of the portfolio and, for the tax-effected amounts, as adjustments to the separate component of shareholders' equity.
Interest earned on investment securities held to maturity, investment securities available for sale and trading account securities is included in interest income. Net gains and losses on the sale of investment securities available for sale, computed principally on the specific identification method, are shown separately in noninterest income in the "Consolidated Statements of Income".
As part of the Company's overall interest rate risk management, the Company uses interest rate futures, swaps, caps and floors. Interest rate futures contracts are accounted for as hedges provided the criteria in Financial Accounting Statement No. 80 ("FAS80"), Accounting for Futures Contracts, are met. For interest rate swaps, caps and floors that are designated as synthetic alterations of existing assets or liabilities and that meet the Company's criteria for interest rate risk, changes in the fair value are not reflected in the financial statements until realized. Interest rate futures contracts that do not meet the hedge criteria of FAS80 and interest rate swaps, caps and floors that do not reduce the Company's overall interest rate risk are accounted for as trading contracts and marked to market through net income. Gains and losses on futures contracts are deferred and amortized over the lives of the hedged assets or liabilities as an adjustment to interest income or expense. Gains or losses on terminated swaps, caps and floors are deferred and amortized as an adjustment of net interest income over the remaining life of the original contract.
Interest income or expense related to interest rate swaps, caps and floors is recorded over the life of the agreement as an adjustment to net interest income. Changes in fair value of futures contracts and options used in the securities trading portfolio, as well as changes in fair value of short-sale transactions, are recognized currently by the mark-to-market method of accounting and are recorded in the noninterest income section of the "Consolidated Statements of Income" as trading account profits and commissions. Income received as an intermediary for customers under interest rate contracts is amortized over the life of the respective contract and recorded in trading account profits and commissions.
LOANS
All loans are stated at principal outstanding. Interest income on installment loans is recognized primarily on the level yield method. Interest income on other loans is credited to income based primarily on the principal outstanding at appropriate rates of interest. Loan fees, net of direct costs, are reflected as an adjustment to the yield of the related loan over the term of the loan.
It is the general policy of the Subsidiary Banks to stop accruing interest income and place the recognition of interest on a cash basis when any commercial, industrial or real estate loan is 90 days or more past due as to
COMPASS BANCSHARES, INC. AND SUBSIDIARIES SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
principal or interest and/or the ultimate collection of either is in doubt, unless collection of both principal and interest is assured by way of collateralization, guarantees or other security. Accrual of interest income on consumer installment loans is suspended when any payment of principal or interest, or both, is more than 120 days delinquent. Credit cards and the related accrued interest is charged off when the receivable is more than 150 days past due. When a loan is placed on a nonaccrual basis, any interest previously accrued but not collected is reversed against current income unless the collateral for the loan is sufficient to cover the accrued interest or a guarantor assures payment of interest.
Effective January 1, 1995, the Company adopted Financial Accounting Statement No. 114, Accounting by Creditors for Impairment of a Loan, as amended by Financial Accounting Statement No. 118, Accounting by Creditors for Impairment of a Loan -- Income Recognition and Disclosures, ("FAS114"). FAS114 requires loans to be measured for impairment using one of three methods when it is probable that all amounts, including principal and interest, will not be collected in accordance with the contractual terms of the loan agreement. The amount of impairment and any subsequent changes are recorded through the provision for credit losses as an adjustment to the allowance for credit losses. FAS114 does not apply to debt securities, leases, loans that are measured at fair value or at the lower of cost or fair value or to smaller balance, homogeneous loans that are collectively evaluated for impairment. In addition, it applies to all loans that are restructured in a troubled debt restructuring involving a modification of terms. However, such loans restructured prior to the effective date of FAS114 that are performing in accordance with their restructured terms are accounted for in accordance with Financial Accounting Statement No. 15, Accounting by Debtors and Creditors for Troubled Debt Restructurings. In evaluating impairment, the Company has identified residential mortgages, credit card receivables, and consumer installment loans, primarily direct and indirect automobile loans, as smaller balance homogeneous loans that are excluded from the scope of FAS114.
Generally, the Company evaluates a loan for impairment in accordance with FAS114 when a portion of the loan is internally risk rated as substandard or doubtful. All nonaccrual loans not meeting the definition of smaller balance homogeneous loans are considered impaired. As required by FAS114, the Company generally measures impairment based upon the present value of the loan's expected future cash flows, except where foreclosure or liquidation is probable or when the primary source of repayment is provided by real estate collateral. In these circumstances, impairment is measured based upon the fair value of the collateral. In addition, in certain rare circumstances, impairment may be based on the loan's observable fair value. Impairment with regard to substantially all of the Company's impaired loans has been measured based on the fair value of the underlying collateral.
The Company's policy for recognizing interest income on impaired loans is the same as the policy applied to nonaccrual loans prior to the adoption of FAS114. Adopting FAS114 did not affect the Company's charge-off policy. It is generally the Company's policy to charge off a portion of a loan if the recoverability of principal is in doubt. The adoption of FAS114 did not have a material effect on the Company's financial position or results of operations.
ALLOWANCE FOR LOAN LOSSES
The amount of the provision for loan losses charged to income is determined on the basis of several factors including actual loss experience, current and expected economic conditions and periodic examinations and appraisals of the loan portfolio. Such provisions, less net loan charge-offs, comprise the allowance for loan losses which is deducted from loans and is available for future loan charge-offs.
The Subsidiary Banks generally follow the policy of charging off loans determined to be uncollectible by management, the Company's loan examination division or Federal and state supervisory authorities. Subsequent recoveries are credited to the allowance for loan losses.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using primarily the straight-line method over the estimated useful lives of assets.
INTANGIBLES
Intangibles are included in other assets in the "Consolidated Balance Sheets". The amortization periods for these assets are dependent upon the type of intangible. Goodwill is amortized over a period not greater than 20 years; core deposit and other identifiable intangibles are amortized over a period based on the life of the intangible which generally varies from 10 to 25 years. Goodwill is amortized using the straight-line method and other identifiable intangibles are amortized using accelerated methods as appropriate. The Company periodically reviews its intangible assets for impairment. Intangible assets totaled $116.0 million and $125.1 million at December 31, 1997 and 1996, respectively.
OTHER REAL ESTATE
For real estate acquired through foreclosure and in-substance foreclosed assets, a new cost basis is established at fair value at the time of foreclosure. Subsequent to foreclosure, foreclosed assets are carried at the lower of fair value less estimated costs to sell or cost, with the difference recorded as a valuation allowance, on an individual asset basis. Subsequent decreases in fair value and increases in fair value, up to the value established at foreclosure, are recognized as charges or credits to expense. Other real estate, net of allowance for losses, is reported in other assets in the "Consolidated Balance Sheets".
TREASURY STOCK
Stock repurchases are accounted for using the cost method.
STOCK BASED COMPENSATION
During 1995, the Financial Accounting Standards Board ("FASB") issued Financial Accounting Statement No. 123, Accounting for Stock-Based Compensation, ("FAS123"). FAS123 encourages, but does not require, companies to account for stock compensation awards based on their fair value at the date of grant, with the resulting compensation cost reflected as expense in the statement of operations. FAS123 requires companies that choose not to reflect the compensation cost in the statement of operations to provide footnote disclosure of the pro forma effect of stock compensation awards on net income and earnings per share. The Company adopted FAS123 in the first quarter of 1996 and has elected to provide pro forma disclosures related to the compensation cost of stock compensation awards.
EMPLOYEE BENEFIT PLANS
The Company and its subsidiaries have various employee benefit plans which cover substantially all employees. Pension expense is determined based on an actuarial valuation. The Company contributes amounts to the pension fund sufficient to satisfy funding requirements of the Employee Retirement Income Security Act. Contributions to the various other plans are determined by the Board of Directors.
MARKETING EXPENSE
The Company expenses all marketing related costs, including advertising costs, as incurred.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
INCOME TAXES
The Company and its subsidiaries provide for income taxes using the asset and liability method in accordance with Financial Accounting Statement No. 109, Accounting for Income Taxes. The Company files a consolidated tax return.
NET INCOME PER COMMON SHARE
During 1996, the FASB issued Financial Accounting Statement No. 128, Earnings per Share, ("FAS128"). FAS128 specifies the computation, presentation and disclosure requirements for earnings per share, replacing the presentation of primary earnings per share with the presentation of basic earnings per share. For entities with complex capital structures, the presentation of fully diluted earnings per share is replaced with diluted earnings per share. FAS128 is effective for both interim and annual financial statements issued for periods ending after December 15, 1997, with earlier adoption prohibited. The Company adopted FAS128 on December 31, 1997, and, as required, all periods presented in the consolidated financial statements have been restated to reflect the adoption of the statement.
Presented below is a summary of the components used to calculate basic and diluted earnings per share for the year ended December 31, 1997, 1996 and 1995:
In January, 1998, the Company completed the acquisitions of G.S.B. Investments, Inc. and First University Corporation. In addition, during February, 1998, the Company completed the acquisition of Fidelity Resources Company. Each of these acquisitions were accounted for under the pooling-of- interests method of accounting and, accordingly, all prior period information will be restated in the first quarter of 1998. The Company issued 3.8 million of its common shares as a result of these acquisitions. These transactions are more fully discussed in Note 11, Business Combinations.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June, 1996, the FASB issued Financial Accounting Statement No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, ("FAS125"). FAS125 requires an entity to
COMPASS BANCSHARES, INC. AND SUBSIDIARIES SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
recognize the financial and servicing assets it controls and the liabilities it has incurred and to cease to recognize them as financial assets when control has been surrendered in accordance with the criteria provided in FAS125. Subsequently, the FASB issued Financial Accounting Statement No. 127, Deferral of the Effective Date of Certain Provisions of SFAS No. 125, which deferred until January 1, 1998, the implementation of certain aspects of the original statement. The adoption of FAS125 is not expected to have a material impact on the financial condition or operating results of the Company. The Company will apply the new rules prospectively to transactions when required.
In June, 1997, the FASB issued Financial Accounting Statement No. 130, Reporting Comprehensive Income, ("FAS130") and Financial Accounting Statement No. 131, Disclosures about Segments of an Enterprise and Related Information, ("FAS131"). FAS130 establishes reporting and presentation standards for comprehensive income and its components in a full set of general-purpose financial statements. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances arising from nonowner sources. FAS130 is effective for both interim and annual financial statements issued for periods beginning after December 15, 1997, and also applies to financial statements presented for prior periods. FAS131 requires that financial and descriptive information be disclosed for each reportable operating segment based on the management approach. The management approach focuses on financial information that an enterprise's decision makers use to assess performance and make decisions about resource allocation. The statement also prescribes the enterprise-wide disclosures to be made about products, services, geographic areas and major customers. FAS131 is effective for annual financial statements issued for periods beginning after December 15, 1997, and for interim financial statements in the second year of application. The Company adopted FAS130 and FAS131 on January 1, 1998.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997, 1996 AND 1995
(1) CASH AND DUE FROM BANKS
The Subsidiary Banks are required to maintain cash balances with the Federal Reserve. The average amounts of those balances for the years ended December 31, 1997 and 1996 were approximately $64.6 million and $87.9 million, respectively.
(2) CASH FLOWS
The Company paid approximately $469.1 million, $434.9 million and $383.0 million in interest on deposits and other liabilities during 1997, 1996 and 1995, respectively. A following table presents the Company's noncash investing and financing activities for the years ended December 31, 1997, 1996 and 1995.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
(3) INVESTMENT SECURITIES AND INVESTMENT SECURITIES AVAILABLE FOR SALE
The following table presents the adjusted cost and approximate fair value of investment securities and investment securities available for sale at December 31, 1997 and 1996.
Securities with principal amounts of approximately $1.1 billion and $1.2 billion at December 31, 1997 and 1996, respectively, were pledged to secure public deposits and for other purposes as required by law. The following table details unrealized gains and unrealized losses on investment securities and investment securities available for sale related to the various categories as of December 31, 1997 and 1996.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
The maturity of the securities portfolio is presented in the tables below.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
During 1995, gross gains of $1.2 million were realized on $32.2 million of mortgage-backed pass-through securities in the held-to-maturity portfolio, which were classified as maturities in accordance with generally accepted accounting principles. Proceeds from sales of available-for-sale investment securities were $966.1 million in 1997, $812.2 million in 1996 and $704.2 million in 1995. Gross gains of $8.2 million in 1997, $9.8 million in 1996 and $2.6 million in 1995 and gross losses of $729,000 in 1997, $198,000 in 1996 and $1.2 million in 1995 were realized on such sales.
On December 31, 1995, the Company adopted the Financial Accounting Standards Board's Special Report, A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities ("Special Report"). The Special Report allowed a company the one-time opportunity to reassess the appropriateness of its investment securities classifications and to transfer securities from the held-to-maturity portfolio to the available- for-sale portfolio without calling into question the company's intent to hold other debt securities to maturity. Upon adoption, the Company transferred held-to-maturity investment securities totaling $827.5 million to its available-for-sale portfolio and $33.3 million of available-for-sale securities to its held-to-maturity portfolio. Generally, individual holdings with greater than $10 million par were transferred to the available-for-sale portfolio in order to increase liquidity and portfolio management capabilities, with smaller positions transferred to the held-to-maturity portfolio. During 1997, investment securities available for sale totaling $118.9 million were transferred to the held-to-maturity portfolio at a fair value of $119.4 million. No securities were transferred to the trading portfolio during either 1997 or 1996.
(4) LOANS AND ALLOWANCES FOR LOAN LOSSES
The following presents the composition of the loan portfolio at December 31, 1997 and 1996.
During 1997 and 1996, certain executive officers and directors of the Company and its principal subsidiary, Compass Bank, including their immediate families and companies with which they are associated, were loan customers of the Subsidiary Banks. Total loans outstanding to these persons at December 31, 1997 and 1996, amounted to $55.6 million and $48.4 million, respectively. The change from December 31, 1996, to
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
December 31, 1997, reflects payments amounting to $16.4 million, advances of $22.0 million, and other changes of $1.6 million. Other changes in loans to certain executive officers and directors during the year represent changes in the composition of the Company's board of directors. Such loans are made in the ordinary course of business at normal credit terms, including interest rate and collateral requirements, and do not represent more than normal credit risk.
The Company does not have a concentration of loans to any one industry.
A summary of the activity in the allowance for loan losses for the years ended December 31, 1997, 1996 and 1995 follows:
At December 31, 1997 and 1996, the Company's recorded investment in loans considered to be impaired under FAS114 was $23.8 million and $25.7 million, respectively, of which $9.8 million and $8.1 million, respectively, were on nonaccrual status. Included in the $23.8 million of impaired loans at December 31, 1997 is $23.4 million of impaired loans for which the related allowance is $3.7 million and $400,000 of loans for which there is no related allowance. At December 31, 1996, $25.5 million of impaired loans had a related allowance of $4.8 million and $200,000 of loans with no related allowance. Average impaired loans during the years ended December 31, 1997 and 1996, were approximately $24.5 million and $31.4 million, respectively.
Nonperforming assets at December 31, 1997, 1996 and 1995 are detailed in the following table.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
(5) FHLB AND OTHER BORROWINGS
At December 31, 1997, the Company had 7 percent subordinated debentures of $75 million maturing in 2003 and 8.375 percent subordinated debentures of $50 million maturing in 2004, with interest paid semi- annually on both debentures. At December 31, 1997, the net carrying amount of these debentures was $124.4 million.
The Company had a mortgage amounting to $4.2 million as of December 31, 1997, secured by the River Oaks Bank Building in Houston, Texas. The 8.875 percent mortgage has monthly principal and interest payments of approximately $50,000 and matures December 31, 2008.
At December 31, 1997, the Company also had $1.2 billion in outstanding advances from the Federal Home Loan Bank of which $200 million matures in 1998, $272.5 million matures in 1999 and $200 million matures in 2000. The Company had an additional $486 million that is callable quarterly and carries a weighted average interest rate of 4.87 percent. The interest rate on the remaining advances resets quarterly based on the three- month LIBOR rate and interest payments are due quarterly. The advances are secured by first mortgages of $1.6 billion carried on the books of Compass Bank and Compass Bank-Texas.
(6) CAPITAL SECURITIES
In January, 1997, the Company formed a wholly owned Delaware statutory business trust, Compass Trust I, which issued $100 million of guaranteed preferred beneficial interests in the Company's junior subordinated deferrable interest debentures ("Capital Securities") that qualify as Tier I capital under Federal Reserve Board guidelines. All of the common securities of Compass Trust I are owned by the Company. The proceeds from the issuance of the Capital Securities ($100 million) and common securities ($3.1 million) were used by Compass Trust I to purchase $103.1 million of junior subordinated deferrable interests debentures of the Company which carries an interest rate of 8.23 percent. The debentures represent the sole asset of Compass Trust I. The debentures and related income statement effects are eliminated in the Company's financial statements.
The Capital Securities accrue and pay distributions semiannually at a rate of 8.23 percent per annum of the stated liquidation value of $1,000 per capital security. The Company has entered into contractual arrangements which, taken collectively, fully and unconditionally guarantee payment of: (i) accrued and unpaid distributions required to be paid on the Capital Securities; (ii) the redemption price with respect to any capital securities called for redemption by Compass Trust I and (iii) payments due upon a voluntary or involuntary liquidation, winding-up or termination of Compass Trust I.
The Capital Securities are mandatorily redeemable upon the maturity of the debentures on January 15, 2027, or upon earlier redemption as provided in the indenture. The Company has the right to redeem the debentures purchased by Compass Trust I: (i) in whole or in part, on or after January 15, 2007, and (ii) in whole (but not in part) at any time within 90 days following the occurrence and during the continuation of a tax event or capital treatment event (as defined in the offering circular). As specified in the indenture, if the debentures are redeemed prior to maturity, the redemption price will be the principal amount, any accrued but unpaid interest, plus a premium ranging from 4.12 percent in 2007 to 0.41 percent in 2016.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
(7) DERIVATIVE FINANCIAL INSTRUMENTS
The Company is a party to derivative financial instruments in the normal course of business for trading purposes and for other than trading purposes to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. The following table summarizes the contract or notional amount of all derivative financial instruments as of December 31, 1997 and 1996.
Commitments to extend credit are agreements to lend to customers as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
Standby letters of credit are commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions, and expire in decreasing amounts. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds various assets as collateral supporting those commitments for which collateral is deemed necessary.
Forward and futures contracts are contracts for delayed delivery of securities or money market instruments in which the seller agrees to make delivery of a specified instrument, at a designated future date and at a specific price or yield. Risks arise from the possible inability of counterparties to meet the terms of their contracts and from movements in securities' values and interest rates.
The Company enters into a variety of interest rate contracts, including interest rate caps and floors, interest rate options and interest rate swap agreements, in its trading activities. Interest rate swap transactions generally involve the exchange of fixed and floating rate interest payment obligations without the exchange of the underlying principal amounts. Interest rate options are contracts that allow the holder of the option to purchase or sell a financial instrument at a specified price and within a specified period of time from or to the seller, or writer, of the option. As a writer of options, the Company receives a premium at the outset and then bears the risk of the unfavorable change in the price of the financial instrument underlying the option.
Entering into interest rate swap agreements involves not only the risk of dealing with counterparties and their ability to meet the terms of the contracts but also the interest rate risk associated with unmatched positions. Notional principal amounts often are used to express the volume of these transactions; however, the amounts potentially subject to credit risk are much smaller.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
The primary purposes for using interest rate contracts in the trading account are to facilitate customer transactions and to help protect cash market positions in the trading account against interest rate movement. Changes in the estimated fair value of contracts in the trading account are recorded in other noninterest income as trading profits and commissions. Net interest amounts received or paid on interest rate contracts in the trading account are recorded as an adjustment of interest on trading account securities.
The following table summarizes interest rate contracts held in the trading account at December 31, 1997:
- -------- * Weighted average rates received/paid are shown only for swaps, caps and floors for which net interest amounts were receivable or payable at December 31, 1997. For caps and floors, the rate shown represents the weighted average net interest differential between the index rate and the cap or floor rate. ++Positive carrying values represent assets of the Company while negative amounts represent liabilities.
In addition to the interest rate contracts shown above, the Company uses other options and futures in the trading account. At December 31, 1997, the trading account contained other options purchased and written having weighted average expiration dates shorter than three months, with a notional balance of $10.5 million for purchased options and a notional balance of $5.0 million for written options and estimated fair values of $65,000 and $(31,000), respectively. The net purchased position in other options was taken in order to assist in protecting the market value of the trading account against rising short-term interest rates while maintaining limited risk to declining rates. At December 31, 1997, futures contracts having a notional principal of $69 million were also used to assist in reducing the price sensitivity of the trading account.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
For derivative financial instruments held or issued for trading purposes, the fair values as of December 31, 1997 and 1996, and the average fair value during those years, are presented in the following table.
The net trading profits (losses) for derivative financial instruments during 1997 were $(48,000) for forwards and futures; $56,000 for swaps; $79,000 for floors and caps; and $(273,000) for other options. Such amounts represent only a portion of total trading account profits and commissions. The total trading account profit for 1997 was $14.4 million, an increase of $500,000 from 1996.
Derivative financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated financial statements. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on- balance sheet instruments. For interest rate contracts, including caps, floors and swap transactions, forward and futures contracts and other options, the contract or notional amounts significantly exceed the ultimate exposure to credit loss. The Company has credit risk on uncollateralized interest rate swaps and purchased floors and caps for the amount required to replace such contracts in the event of counterparty default. At December 31, 1997, the Company estimates its credit risk in the event of total counterparty default to be $6.5 million for interest rate swaps and $304,000 for purchased floors and caps. The Company controls the credit risk of its interest rate contracts through credit approvals, limits and monitoring procedures.
The Company also has recorded as liabilities certain short-sale transactions amounting to $52.1 million at December 31, 1997, which could result in losses to the extent the ultimate obligation exceeds the amount of the recorded liability. The amount of the ultimate obligation under such transactions will be affected by movements in the financial markets, which are not determinable, and the point at which securities are purchased to cover the short sales. The short-sale transactions relate principally to U.S. Government securities for which there is an active, liquid market. The Company does not expect the amount of losses, if any, on such transactions to be material. In addition to the ongoing monitoring of interest-sensitive assets and liabilities, the Company enters into various interest rate contracts not held in the trading account to assist in managing the Company's interest sensitivity. The interest rate risk factor in these contracts is considered in the overall interest management strategy and the Company's interest risk management program. The income or expense associated with interest rate swaps, caps and floors and gains or losses in futures contracts classified as hedges are ultimately reflected as adjustments to interest income or expense. Changes in the estimated fair value of interest rate protection contracts are not reflected in the financial statements until realized.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
The following table details various information regarding swaps, caps and floors used for other than trading purposes as of December 31, 1997.
- -------- + On $128.3 million of a total notional amount of $178.3 million, the Company receives interest based on three-month LIBOR plus 84 basis points and pays interest based on the one-year Constant Maturity Treasury plus 150 basis points. On the remaining $50 million notional, the Company receives interest based on Prime minus 273.5 basis points and pays interest based on the three-month LIBOR. * Weighted average rates received/paid are shown only for swaps, caps and floors for which net interest amounts were receivable or payable at December 31, 1997.
At December 31, 1997, swaps, caps and floors acquired for other than trading purposes were associated with the following asset or liability categories:
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
(8) COMMITMENTS
The Company and its subsidiaries lease certain facilities and equipment for use in their businesses. The leases for facilities generally run for periods of 10 to 20 years with various renewal options, while leases for equipment generally have terms not in excess of 5 years. The majority of the leases for facilities contain rental escalation clauses with fixed rental increases or increases tied to changes in market lease rates. Certain real property leases contain purchase options. Management expects that most leases will be renewed or replaced with new leases in the normal course of business.
The following is a schedule of future minimum rentals required under operating leases that have initial or remaining noncancellable lease terms in excess of one year as of December 31, 1997, for leased facilities (in thousands):
Minimum rentals for all operating leases charged to earnings totaled $14.2 million, $12.5 million and $11.9 million for years ended December 31, 1997, 1996 and 1995, respectively.
(9) STOCK OPTION AND STOCK APPRECIATION RIGHT PLANS
The Company has three long-term incentive stock option plans for key senior officers of the Company and its subsidiaries. The stock option plans provide for these key employees to purchase shares of the Company's $2.00 par value common stock at the fair market value at the date of the grant. Pursuant to the 1982 Long Term Incentive Plan, the 1989 Long Term Incentive Plan and the 1996 Long Term Incentive Plan, 3,712,500, 2,250,000 and 2,850,000 shares, respectively, of the Company's common stock have been reserved for issuance. The options granted under the plans may be exercised within 5 years and 10 years from the date of grant. The incentive stock option agreements state that incentive options may be exercised in whole or in part until expiration date, but for options issued before 1987 no incentive stock option may be exercised if an incentive stock option is outstanding that was granted before the granting of such option. The plans also provide for the granting of stock appreciation rights to certain holders of nonqualified stock options. A stock appreciation right allows the holder to surrender an exercisable stock option in exchange for common stock (at fair market value on the date of exercise), cash, or in a combination thereof, in an amount equal to the excess of the fair market value of covered shares over the option price of such shares.
The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB25") and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under Financial Accounting Statement No. 123, Accounting for Stock-Based Compensation ("FAS123"), requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
Pro forma information regarding net income and earnings per share is required by FAS123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for 1997, 1996 and 1995, respectively: risk-free interest rates of 6.12 percent, 5.19 percent and 7.54 percent; dividend yields of 3.33 percent, 3.89 percent and 4.31 percent; volatility factors of the expected market price of the Company's common stock of 0.213, 0.224 and 0.226; and a weighted- average expected life of the options of 4.00, 3.67 and 3.78 years.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
The Company's options granted in 1997 vest ratably over a period of three years, therefore for purposes of pro forma disclosures, the compensation expense related to these options has been allocated over the vesting period. Because the vast majority of the Company's options granted in 1996 and all of the Company's options granted in 1995 vested immediately, the estimated fair value of the options for those years has been expensed in the year of grant for purposes of pro forma disclosures. The Company's actual and pro forma information follows (in thousands except for earnings per share information):
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
The following summary sets forth activity under the plan for the years ended December 31:
Of the 2,049,340 outstanding options at December 31, 1997, 1,461,610 were exercisable with the remaining 587,730 having a vesting period of three years. Exercise prices for options outstanding as of December 31, 1997, ranged from $6.22 to $37.44. Unexercised options with exercise prices of less than $20.00 for 837,758 shares had a weighted average contractual life of 5.1 years and a weighted average exercise price of $15.02 while unexercised options with exercise prices greater than $20.00 for 1,211,582 shares had a weighted average contractual life of 8.4 years and a weighted average exercise price of $26.32.
At December 31, 1997, the shares under option included nonqualified options issued to certain executives to acquire 45,000 shares of common stock which provide for tandem stock appreciation rights that are exercisable only upon the occurrence of certain contingent events. Because of the restrictions upon exercise of the stock appreciation rights, no compensation expense has been recorded with respect to these rights.
The shares under option also included nonqualified options without stock appreciation rights issued to certain executives to acquire shares of common stock as follows: 102,282 shares at year-end 1997, 104,586 shares at year-end 1996 and 29,460 shares at year-end 1995.
During 1997 and 1996, the Company issued 94,800 and 59,025 shares, respectively, of restricted common stock to certain executive officers with a fair value at issuance of $2,706,224 and $1,296,189, respectively. The shares issued in 1997 vest ratably over a three year period while the shares issued in 1996 vest ratably over five years. Because the restricted stock is legally issued and outstanding, the fair value of the restricted stock at issuance is reflected in common stock and surplus with a corresponding offset for the amount of unearned compensation expense. During 1997 and 1996, compensation expense of $1,010,967 and $216,030, respectively, was recognized in connection with the restricted stock.
(10) REGULATORY MATTERS AND DIVIDENDS FROM SUBSIDIARIES
The Company and the Subsidiary Banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory --and possibly additional discretionary -- actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Subsidiary Banks must meet specific capital guidelines that involve quantitative measures of each bank's assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification of the Company and the Subsidiary Banks are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
Quantitative measures established by the regulators to ensure capital adequacy require the Company and the Subsidiary Banks to maintain minimum core capital ("Tier I Capital") of at least four percent of risk-weighted assets, minimum total capital ("Total Qualifying Capital") of at least eight percent of risk-weighted assets and a minimum leverage ratio of four percent of adjusted quarterly assets. Management believes, as of December 31, 1997, that the Company and the Subsidiary Banks meet all capital adequacy requirements to which they are subject.
As of December 31, 1997, the most recent notification from the appropriate regulatory agencies categorized the Subsidiary Banks as "well-capitalized" under the regulatory framework for prompt corrective action. To be categorized as "well-capitalized", the Subsidiary Banks must maintain minimum Total Qualifying Capital, Tier I Capital and leverage ratios of at least 10 percent, 6 percent and 5 percent, respectively. There are no conditions or events since that notification that management believes have changed the Subsidiary Banks' category.
The following table presents the actual capital amounts and ratios of the Company and its significant subsidiary banks at December 31, 1997 and 1996.
Capital amounts and ratios at December 31, 1996, have been restated to reflect acquisitions in 1997 accounted for under the pooling-of-interests method of accounting as well as the merger in September, 1997, of the Company's Florida subsidiary bank into Compass Bank.
Dividends paid by the Subsidiary Banks are the primary source of funds available to the Company for payment of dividends to its shareholders and other needs. Applicable federal and state statutes and regulations impose restrictions on the amounts of dividends that may be declared by the Subsidiary Banks. In addition to the formal statutes and regulations, regulatory authorities also consider the adequacy of each bank's total capital in relation to its assets, deposits and other such items. Capital adequacy considerations could further limit the availability of dividends from the Subsidiary Banks.
At December 31, 1997, approximately $230.8 million of the Subsidiary Banks' net assets were available for payment of dividends without prior regulatory approval. Additionally, the Company's Subsidiary Banks could have paid additional dividends to the parent holding company in the amount of $139.3 million while continuing to meet the capital requirements for "well- capitalized" banks at December 31, 1997.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
(11) BUSINESS COMBINATIONS
Completed Acquisitions
Summarized below are the acquisitions completed by the Company during the years ended December 31, 1997 and 1996, along with the related accounting treatment. All of the acquisitions completed by the Company during 1997 were accounted for under the pooling-of-interests method of accounting and, accordingly, all prior period information has been restated.
- -------- * For business combinations accounted for under the pooling-of-interests method of accounting, acquired equity is presented. For business combinations accounted for under the purchase method of accounting, acquired deposits is presented.
Presented below is summary operating information for the Company showing the effect of the business combinations completed during 1997.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
The entities acquired in 1997 that were accounted for under the pooling-of- interests method of accounting had net interest income of $6.4 million and net income of $1.1 million prior to their respective acquisition dates in 1997.
Acquisitions Completed after December 31, 1997
On January 13, 1998, the Company completed the acquisition of G.S.B. Investments, Inc. ("GSB") of Gainesville, Florida, and its bank subsidiary, Gainesville State Bank, with the issuance of 1,649,807 shares of the Company's common stock. At the date of closing, GSB had assets of $213 million and equity of $22 million. The transaction was accounted for under the pooling-of- interests method of accounting and, accordingly, all prior period information will be restated in the first quarter of 1998.
On January 29, 1998, the Company completed the acquisition of First University Corporation ("First University"), and its subsidiary, West University Bank, N.A., of Houston, Texas with the issuance of approximately 350,000 shares of the Company's common stock. At the date of closing, First University had assets of $68 million and equity of $4 million. The transaction was accounted for under the pooling-of-interests method of accounting and, accordingly, all prior period information will be restated in the first quarter of 1998.
On February 9, 1998, the Company completed the acquisition of Fidelity Resources Company ("Fidelity"), and its subsidiary, Fidelity Bank, N.A., of Dallas, Texas with the issuance of approximately 1,800,000 shares of the Company's common stock. At the date of closing, Fidelity had assets of $335 million and equity of $20 million. The transaction was accounted for under the pooling-of-interests method of accounting and, accordingly, all prior period information will be restated in the first quarter of 1998.
(12) BENEFIT PLANS
The Company sponsors a defined benefit pension plan pursuant to which participants are entitled to an annual benefit upon retirement equal to a percentage of the average base compensation (generally defined as direct cash compensation exclusive of bonuses and commissions) earned in the five consecutive years of benefit service which produces the highest average. The percentage amount of the benefit is determined by multiplying the number of years, up to 30, of a participant's service with the Company by 1.8 percent. Benefits are reduced by Social Security payments at the rate of 1.8 percent of primary Social Security benefits times years of service up to 30 years. All employees of the Company who are over the age of 21 and have worked 1,000 hours or more in their first 12 months of employment or 1,000 hours or more in any calendar year thereafter are eligible to participate. Since 1989, under most circumstances, employees are vested after five years of service. Prior to 1989, the vesting period was 10 years. Benefits are payable monthly commencing on the later of age 65 or the participant's date of retirement. Eligible participants may retire at reduced benefit levels after reaching age 55, if they have at least 10 years of service. The Company contributes amounts to the pension fund sufficient to satisfy funding requirements of the Employee Retirement Income Security Act.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
The following table sets forth the plan's funded status and amounts recognized in the Company's consolidated balance sheets at December 31:
Net pension cost for 1997, 1996 and 1995 included the following components:
The weighted average discount rate was 8.0 percent for 1997, 7.50 percent for 1996 and 8.50 percent for 1995. The rate of increase in future compensation levels was six percent for 1997, 1996 and 1995. Both rates are used in determining the actuarial present value of the projected benefit obligation. The assumed long-term rate of return on plan assets was 9.50 percent in 1997 and 1996 and 10.50 percent in 1995.
The Company maintains an employee stock purchase plan to which contributions are made in amounts determined by the Board of Directors of the Company. Such contributions are invested in stock of the Company and are ordinarily distributed to employees upon their retirement or other termination of employment. Contributions to the plan are allocated to the accounts of the participants based upon their compensation, with right to such accounts vested after five years of employment. The Company contributed $3.1 million during 1997, $4.8 million during 1996, and $1.1 million during 1995.
The Company has a qualified employee benefit plan under section 401(k) of the Internal Revenue Code. Employees can contribute up to 10 percent of their salaries to the plan on a pretax basis subject to regulatory limits and the Company at its discretion can match up to 100 percent of 6 percent of the participants' compensation. The Company's contributions are based on predetermined income levels and totaled $2.4 million in 1997, $2.1 million in 1996 and $1.4 million in 1995. The administrative costs incurred by the plan are paid by the Company at no cost to the participants.
The Company also has a monthly investment plan. Under the plan, employees may contribute monthly up to 10 percent of their salary and the Company contributes 30 cents for each dollar of the employees' contributions toward the purchase of common stock of the Company. The stock is purchased in the open market and brokerage fees and other incidental expenses are absorbed by the Company.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
In 1995, the Company established a deferred compensation plan for executive officers which enables certain executive officers of the Company to defer a portion of their annual salary. In 1997, the Company established benefit plans for certain key executives that provide additional retirement benefits not otherwise provided in the Company's basic benefit plans.
(13) OTHER NONINTEREST EXPENSE
The major components of other noninterest expense are as follows:
(14) INCOME TAXES
For the years ended December 31, 1997, 1996 and 1995, income tax expense attributable to income from operations consists of:
During 1997, the Company made income tax payments of approximately $69.8 million and received cash income tax refunds amounting to approximately $2.0 million. For 1996 and 1995, income tax payments were approximately $72.2 million and $64.3 million, respectively. Cash income tax refunds amounted to approximately $1.4 million for 1996 and $700,000 for 1995. Applicable income tax expense of $2.8 million, $3.6 million and $1.0 million for 1997, 1996 and 1995, respectively, on net securities gains is included in the provision for income taxes.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
Income tax expense attributable to income from operations differed from the amount computed by applying the federal statutory income tax rate to pretax earnings for the following reasons:
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1997, 1996 and 1995, are presented below:
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
(15) PARENT COMPANY
The condensed financial information for Compass Bancshares, Inc. (Parent Company Only) is presented as follows:
Balance Sheets
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
(15) PARENT COMPANY, Continued
Statements of Income
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
(15) PARENT COMPANY, Continued
Statements of Cash Flows
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
(16) FAIR VALUE OF FINANCIAL INSTRUMENTS
Financial Accounting Statement No. 107, Disclosures about Fair Value of Financial Instruments ("FAS107") requires disclosure of fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate that value. The assumptions used in the estimation of the fair value of the Company's financial instruments are detailed below. Where quoted prices are not available, fair values are based on estimates using discounted cash flows and other valuation techniques. The use of discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following disclosures should not be considered a surrogate of the liquidation value of the Company or its Subsidiary Banks, but rather represent a good-faith estimate of the increase or decrease in value of financial instruments held by the Company since purchase, origination or issuance. The Company has not undertaken any steps to value any intangibles, which is permitted by the provisions of FAS107.
The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:
Cash and due from banks and interest bearing deposits with other banks: Fair value equals the carrying value of such assets.
Investment securities and investment securities available for sale: Fair values for investment securities are based on quoted market prices.
Trading account securities: Fair value and book value of the Company's trading account securities (including off-balance sheet instruments) are based on quoted market prices where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments except in the case of certain options and swaps where pricing models are used.
Federal funds sold and securities purchased under agreements to resell: Due to the short-term nature of these assets, the carrying values of these assets approximate their fair value.
Loans: Loans were valued using discounted cash flows. The discount rate used to determine the present value of these loans was based on interest rates currently being charged by the Subsidiary Banks on comparable loans as to credit risk and term.
Off-balance sheet instruments: Fair value of the Company's off-balance sheet instruments (futures, forwards, swaps, caps, floors and options written) are based on quoted market prices. The Company's loan commitments are negotiated at current market rates and are relatively short-term in nature and, as a matter of policy, the Company generally makes commitments for fixed rate loans for relatively short periods of time, therefore, the estimated value of the Company's loan commitments approximates carrying amount.
Deposit liabilities: The fair values of demand deposits are, as required by FAS107, equal to the carrying value of such deposits. Demand deposits include noninterest bearing demand deposits, savings accounts, NOW accounts and money market demand accounts. The fair value of variable rate term deposits, those repricing within six months or less, approximates the carrying value of these deposits. Discounted cash flows have been used to value fixed rate term deposits and variable rate term deposits having an interest rate floor that has been reached. The discount rate used is based on interest rates currently being offered by the Subsidiary Banks on comparable deposits as to amount and term.
Short-term borrowings: The carrying value of federal funds purchased, securities sold under agreements to repurchase and other short-term borrowings approximates their carrying values.
FHLB and other borrowings: The fair value of the Company's fixed rate borrowings are estimated using discounted cash flows, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements. The carrying amount of the Company's variable rate borrowings approximates their fair values. FHLB and other borrowings includes the Capital Securities.
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
COMPASS BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
(17) QUARTERLY RESULTS (UNAUDITED)
A summary of the unaudited results of operations for each quarter of 1997 and 1996 follows:
ITEM 9
ITEM 9 -- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
ITEM 10
ITEM 10 -- DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this item is incorporated by reference from the sections entitled "Election of Directors" and "Executive Compensation and Other Information" in the Proxy Statement for the Annual Meeting of Shareholders which is to be filed with the Securities and Exchange Commission.
ITEM 11
ITEM 11 -- EXECUTIVE COMPENSATION
Information required by this item is incorporated by reference from the section entitled "Executive Compensation and Other Information" in the Proxy Statement for the Annual Meeting of Shareholders which is to be filed with the Securities and Exchange Commission; provided, however, that such incorporation by reference shall not be deemed to specifically incorporate by reference the information referred to in Item 402(a)(8) of Securities and Exchange Commission Regulation S-K.
ITEM 12
ITEM 12 -- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this item is incorporated by reference from the sections entitled "Holdings of Voting Securities" and "Election of Directors" in the Proxy Statement for the Annual Meeting of Shareholders which is to be filed with the Securities and Exchange Commission.
ITEM 13
ITEM 13 -- CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item is incorporated by reference from the section entitled "Certain Transactions" in the Proxy Statement for the Annual Meeting of Shareholders which is to be filed with the Securities and Exchange Commission.
PART IV
ITEM 14
ITEM 14 -- EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) INDEX OF DOCUMENTS FILED AS PART OF THIS REPORT:
Compass Bancshares, Inc. and Subsidiaries Financial Statements
(b) REPORTS ON FORM 8-K
None
(c) EXHIBITS
(c) EXHIBITS (CONTINUED)
Certain financial statement schedules and exhibits have been omitted because they are not applicable.
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.
COMPASS BANCSHARES, INC.
Date: February 16, 1998 By /s/ D. Paul Jones, Jr. ___________________________________ D. PAUL JONES, JR. CHAIRMAN AND CHIEF EXECUTIVE OFFICER
Date: February 16, 1998 By /s/ Garrett R. Hegel ___________________________________ GARRETT R. HEGEL CHIEF FINANCIAL OFFICER
Date: February 16, 1998 By /s/ Michael A. Bean ___________________________________ MICHAEL A. BEAN CHIEF ACCOUNTING OFFICER
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, THAT EACH PERSON WHOSE SIGNATURE APPEARS BELOW CONSTITUTES AND APPOINTS D. PAUL JONES, JR., JERRY W. POWELL AND DANIEL B. GRAVES, AND EACH OF THEM, HIS TRUE AND LAWFUL ATTORNEY-IN-FACT AS AGENT WITH FULL POWER OF SUBSTITUTION AND RESUBSTITUTION FOR HIM AND IN HIS NAME, PLACE AND STEAD, IN ANY AND ALL CAPACITIES, TO SIGN ANY OR ALL AMENDMENTS TO THIS FORM 10-K AND TO FILE THE SAME, WITH ALL EXHIBITS THERETO, AND OTHER DOCUMENTS IN CONNECTION THEREWITH, WITH THE SECURITIES AND EXCHANGE COMMISSION, GRANTING UNTO SAID ATTORNEYS-IN-FACT AND AGENTS WITH FULL POWER AND AUTHORITY TO DO AND PERFORM EACH AND EVERY ACT AND THING REQUISITE AND NECESSARY TO BE DONE IN AND ABOUT THE PREMISES, AS FULLY AND TO ALL INTENTS AND PURPOSES AS THEY MIGHT OR COULD DO IN PERSON, HEREBY RATIFYING AND CONFIRMING ALL THAT SAID ATTORNEYS-IN-FACT AND AGENTS, AND THEIR SUBSTITUTE OR SUBSTITUTES, MAY LAWFULLY DO OR CAUSE TO BE DONE BY VIRTUE HEREOF.
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.
DIRECTORS DATE
/s/ W. Eugene Davenport February 16, 1998 - ------------------------------------- W. EUGENE DAVENPORT
- ------------------------------------- CHARLES W. DANIEL
- ------------------------------------- JACK C. DEMETREE
SIGNATURES, CONTINUED
DIRECTORS DATE
/s/ Marshall Durbin, Jr. February 16, 1998 - ------------------------------------- MARSHALL DURBIN, JR.
/s/ Tranum Fitzpatrick February 16, 1998 - ------------------------------------- TRANUM FITZPATRICK
/s/ George W. Hansberry February 16, 1998 - ------------------------------------- GEORGE W. HANSBERRY
/s/ D. Paul Jones, Jr. February 16, 1998 - ------------------------------------- D. PAUL JONES, JR.
/s/ John S. Stein February 16, 1998 - ------------------------------------- JOHN S. STEIN
/s/ Robert J. Wright February 16, 1998 - ------------------------------------- ROBERT J. WRIGHT