ITEM 1. BUSINESS
(a) The Registrant, Regions Financial Corporation (the "Registrant" or "Regions"), is a regional bank holding company headquartered in Birmingham, Alabama, which operated 713 full-service banking offices in Alabama, Arkansas, Florida, Georgia, Louisiana, South Carolina, Tennessee and Texas as of December 31, 1998. At that date, Regions had total consolidated assets of approximately $36.8 billion, total consolidated deposits of approximately $28.4 billion, and total consolidated stockholders' equity of approximately $3.0 billion.
Regions was organized under the laws of the state of Delaware and commenced operations in 1971 under the name First Alabama Bancshares, Inc. On May 2, 1994, the name of First Alabama Bancshares, Inc. was changed to Regions Financial Corporation. Regions' principal executive offices are located at 417 North 20th Street, Birmingham, Alabama 35203, and its telephone number at such address is (205) 326-7100.
At December 31, 1998, Regions operated seven state-chartered commercial bank subsidiaries and two nationally-chartered bank subsidiaries (collectively, the "Subsidiary Banks") in Alabama, Arkansas, Florida, Georgia, Louisiana, South Carolina, Tennessee and Texas and various banking-related subsidiaries engaged in mortgage banking, credit life insurance, leasing, commercial accounts receivable factoring, specialty mortgage financing and securities brokerage activities with offices in various southeastern states. Through its subsidiaries, Regions offers a broad range of banking and banking-related services.
In Alabama, Regions operates through (i) Regions Bank and (ii) Jacobs Bank which combined operate 199 banking offices throughout the state. At December 31, 1998, these offices had 36% of total consolidated assets and 32% of total consolidated deposits.
In Arkansas, Regions operates through Regions Bank with 116 banking offices throughout the state. At December 31, 1998, these offices had 19% of total consolidated assets and 18% of total consolidated deposits.
In Florida, Regions operates through (i) Regions Bank, (ii) Regions Bank, NA, and (iii) The Village Bank of Florida. These institutions operate through 65 banking offices in the northwest and central regions of the state. At December 31, 1998, these offices had 6% of total consolidated assets and 8% of total consolidated deposits.
In Georgia, Regions operates through (i) Regions Bank, (ii) Fayette County Bank, and (iii) Etowah Bank, which at December 31, 1998, had 20% of total consolidated assets and 21% of total consolidated deposits. These institutions operate 143 banking offices in Georgia.
In Louisiana, (i) Regions Bank, (ii) St. Mary Bank and Trust, and (iii) St. James Bank and Trust operate 86 banking offices throughout the state. At December 31, 1998, these offices had 8% of total consolidated assets and 10% of total consolidated deposits.
In South Carolina, (i) Regions Bank and (ii) Greenville National Bank operate 33 banking offices throughout the state. At December 31, 1998, these offices had 4% of total consolidated assets and total consolidated deposits.
In Tennessee, Regions Bank operates 42 banking offices. At December 31, 1998, these offices had 4% of total consolidated assets and total consolidated deposits.
In Texas, Regions Bank operates 29 banking offices throughout the eastern portion of the state. At December 31, 1998, these offices had 3% of total consolidated assets and total consolidated deposits.
In addition to the Subsidiary Banks, Regions provides additional banking services through various banking-related subsidiaries, the most significant of which provide mortgage banking, credit life insurance, securities brokerage activities, commercial accounts receivable factoring, and specialty financing.
Regions Mortgage Inc. (RMI), a subsidiary of Regions Bank, is engaged in mortgage banking with its primary business and source of income being the origination and servicing of mortgage loans for long-term
investors. RMI serviced approximately $22.3 billion in real estate mortgages at December 31, 1998, and operates loan production offices in Alabama, Arkansas, Florida, Georgia, Louisiana, South Carolina, and Tennessee.
Regions Agency, Inc., a subsidiary of Regions, acts as an insurance agent or broker with respect to credit life and accident and health insurance and other types of insurance relating to extensions of credit by the Subsidiary Banks or banking-related subsidiaries.
Regions Life Insurance Company, a subsidiary of Regions, acts as a re-insurer of credit life and accident and health insurance in connection with the activities of certain affiliates of Regions.
Regions Investment Company, Inc., a subsidiary of Regions Bank, engages in securities underwriting and brokerage activities and operates offices in Alabama, Arkansas, Florida, Georgia, Louisiana, South Carolina, Tennessee and Texas.
Regions Interstate Billing Service, Inc. (RIBS), a subsidiary of Regions, factors commercial accounts receivable and performs billing and collection services. RIBS primarily serves clients related to the automotive service industry.
EquiFirst, a subsidiary of EFC Holdings Corporation (a wholly owned subsidiary of Regions Bank), provides specialty mortgage financing to consumers.
A substantial portion of the growth of Regions since commencing operations in 1971 has been through the acquisition of other financial institutions, including commercial banks and thrift institutions, and the assets and deposits thereof. Since it began operations as a bank holding company, Regions has completed 85 acquisitions of other financial institutions representing in aggregate (at the time the acquisitions were completed) approximately $23.5 billion in assets. As part of its ongoing strategic plan, Regions continually evaluates business combination opportunities and frequently conducts due diligence activities in connection with possible business combinations. As a result, business combination discussions and, in some cases, negotiations frequently take place, and future business combinations involving cash, debt, or equity securities can be expected. Any future business combination or series of business combinations that Regions might undertake may be material, in terms of assets acquired or liabilities assumed, to Regions' financial condition. Recent business combinations in the banking industry have typically involved the payment of a premium over book and market values. This practice could result in dilution of book value and net income per share for the acquirer.
Reference is made to Items 6 and 7 of this Annual Report on Form 10-K for certain statistical (Guide 3) and other information.
This Annual Report on Form 10-K, other periodic reports filed by Regions under the Securities Exchange Act of 1934, as amended, and any other written or oral statements made by or on behalf of Regions may include forward looking statements which reflect Regions' current views with respect to future events and financial performance. Such forward looking statements are based on general assumptions and are subject to various risks, uncertainties, and other factors that may cause actual results to differ materially from the views, beliefs, and projections expressed in such statements. These risks, uncertainties and other factors include, but are not limited to:
(1) Possible changes in economic and business conditions that may affect the prevailing interest rates, the prevailing rates of inflation, or the amount of growth, stagnation, or recession in the global, U.S., and southeastern U.S. economies, the value of investments, collectibility of loans, and the profitability of business entities;
(2) Possible changes in monetary and fiscal policies, laws, and regulations, and other activities of governments, agencies, and similar organizations;
(3) The effects of easing of restrictions on participants in the financial services industry, such as banks, securities brokers and dealers, investment companies, and finance companies, and attendant changes in patterns and effects of competition in the financial services industry;
(4) The cost and other effects of legal and administrative cases and proceedings, claims, settlements, and judgments;
(5) The ability of Regions to achieve the earnings expectations related to the acquired operations of recently-completed and pending acquisitions, which depends on a variety of factors, including (i) the ability of Regions to achieve the anticipated cost savings and revenue enhancements with respect to the acquired operations, (ii) the assimilation of the acquired operations to Regions' corporate culture, including the ability to instill Regions' credit practices and efficient approach to the acquired operations, (iii) the continued growth of the markets in which Regions operates consistent with recent historical experience, (iv) the absence of material contingencies related to the acquired operations, including asset quality and litigation contingencies, and (v) Regions' ability to expand into new markets and to maintain profit margins in the face of pricing pressures.
(6) Possible changes in the credit worthiness of customers and the possible impairment of collectibility of loans to certain customers resulting from the impact of Year 2000 issues on customers' operations and cashflows needed to service indebtedness.
The words "believe", "expect", "anticipate", "project", and similar expressions signify forward looking statements. Readers are cautioned not to place undue reliance on any forward looking statements made by or on behalf of Regions. Any such statement speaks only as of the date the statement was made. Regions undertakes no obligation to update or revise any forward looking statements.
(b) The primary business conducted by Registrant's banking affiliates, in each geographic region, is banking, which includes provision of commercial and retail banking services and, in some cases, trust services. Registrant's bank-related subsidiaries perform services incidental to the business of banking.
Reference is made to Note W. "Business Segment Information" to the consolidated financial statements included under Item 8 of this Annual Report on Form 10-K for information required by this item.
(c)(1) General. The Registrant is a bank holding company, registered with the Board of Governors of the Federal Reserve System ("Federal Reserve") under the Bank Holding Company Act of 1956, as amended ("BHC Act"). As such, the Registrant and its subsidiaries are subject to the supervision, examination, and reporting requirements of the BHC Act and the regulations of the Federal Reserve. In addition, as a national chartered bank holding company, the Registrant is also registered with the Office of the Comptroller of the Currency (OCC) and is subject to the regulation, supervision, examination, and reporting requirements of the OCC.
The BHC Act requires every bank holding company to obtain the prior approval of the Federal Reserve before: (i) it may acquire direct or indirect ownership or control of any voting shares of any bank if, after such acquisition, the bank holding company will directly or indirectly own or control more than 5.0% of the voting shares of the bank; (ii) it or any of its subsidiaries, other than a bank, may acquire all or substantially all of the assets of any bank; or (iii) it may merge or consolidate with any other bank holding company.
The BHC Act further provides that the Federal Reserve may not approve any transaction that would result in a monopoly or would be in furtherance of any combination or conspiracy to monopolize or attempt to monopolize the business of banking in any section of the United States, or the effect of which may be substantially to lessen competition or to tend to create a monopoly in any section of the country, or that in any other manner would be in restraint of trade, unless the anticompetitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served. Consideration of financial resources generally focuses on capital adequacy, and consideration of convenience and needs issues includes the parties' performance under the Community Reinvestment Act of 1977 (the "CRA"), both of which are discussed below.
The BHC Act, as amended by the interstate banking provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Banking Act"), which became effective on
September 29, 1995, repealed the prior statutory restrictions on interstate acquisitions of banks by bank holding companies, such that the Registrant, and any other bank holding company located in Alabama may now acquire a bank located in any other state, and any bank holding company located outside Alabama may lawfully acquire any Alabama-based bank, regardless of state law to the contrary, in either case subject to certain deposit-percentage, aging requirements, and other restrictions. The Interstate Banking Act also generally provided that, after June 1, 1997, national and state-chartered banks may branch interstate through acquisitions of banks in other states.
The BHC Act generally prohibits the Registrant from engaging in activities other than banking or managing or controlling banks or other permissible subsidiaries and from acquiring or retaining direct or indirect control of any company engaged in any activities other than those activities determined by the Federal Reserve to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In determining whether a particular activity is permissible, the Federal Reserve must consider whether the performance of such an activity reasonably can be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest, or unsound banking practices. For example, factoring accounts receivable, acquiring or servicing loans, leasing personal property, conducting discount securities brokerage activities, performing certain data processing services, acting as agent or broker in selling credit life insurance and certain other types of insurance in connection with credit transactions, and performing certain insurance underwriting activities all have been determined by the Federal Reserve to be permissible activities of bank holding companies. The BHC Act does not place territorial limitations on permissible nonbanking activities of bank holding companies. Despite prior approval, the Federal Reserve has the power to order a bank holding company or its subsidiaries to terminate any activity or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that continuation of such activity or such ownership or control constitutes a serious risk to the financial safety, soundness, or stability of any bank subsidiary of that bank holding company.
Each of the Subsidiary Banks of the Registrant is a member of the Federal Deposit Insurance Corporation ("FDIC"), and as such, its deposits are insured by the FDIC to the extent provided by law. Each Subsidiary Bank is also subject to numerous state and federal statutes and regulations that affect its business, activities, and operations, and each is supervised and examined by one or more state or federal bank regulatory agencies.
All of the Subsidiary Banks that are state-chartered banks and are not members of the Federal Reserve System are subject to supervision and examination by the FDIC and the state banking authorities of the states in which they are located. The Subsidiary Banks that are nationally chartered are subject to regulation, supervision, and examination by the OCC and the FDIC. The federal banking regulator for each of the Subsidiary Banks, as well as the appropriate state banking authority for each of the Subsidiary Banks that is a state chartered bank, regularly examines the operations of the Subsidiary Banks and is given authority to approve or disapprove mergers, consolidations, the establishment of branches, and similar corporate actions. The federal and state banking regulators also have the power to prevent the continuance or development of unsafe or unsound banking practices or other violations of law.
The Subsidiary Banks are subject to the provisions of the CRA. Under the terms of the CRA, the Subsidiary Banks have a continuing and affirmative obligation consistent with their safe and sound operation to help meet the credit needs of their entire communities, including low- and moderate-income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires each appropriate federal bank regulatory agency, in connection with its examination of a subsidiary depository institution, to assess such institution's record in assessing and meeting the credit needs of the community served by that institution, including low- and moderate-income neighborhoods. The regulatory agency's assessment of the institution's record is made available to the public. Further, such assessment is required of any institution which has applied to: (i) charter a national bank; (ii) obtain deposit insurance coverage for a newly chartered institution; (iii) establish a new branch office that will accept deposits; (iv) relocate an office; or (v) merge or consolidate
with, or acquire the assets or assume the liabilities of, a federally regulated financial institution. In the case of a bank holding company applying for approval to acquire a bank or other bank holding company, the Federal Reserve will assess the records of each subsidiary depository institution of the applicant bank holding company, and such records may be the basis for denying the application. All of the Subsidiary Banks received at least a "satisfactory" CRA rating in their most recent examinations.
In April 1995, the federal banking agencies adopted amendments revising their CRA regulations, with a phase-in schedule applicable to various provisions. Among other things, the amended CRA regulations, implemented on July 1, 1997, substitute for the prior process-based assessment factors a new evaluation system that rates an institution based on its actual performance in meeting community needs. In particular, the system focuses on three tests; (i) a lending test, to evaluate the institution's record of making loans in its service areas; (ii) an investment test, to evaluate the institution's record of investing in community development projects; and (iii) a service test, to evaluate the institution's delivery of services through its branches, ATM's and other offices. The amended CRA regulations also clarify how an institution's CRA performance will be considered in the application process.
Payment of Dividends. The Registrant is a legal entity separate and distinct from its banking and other subsidiaries. The principal source of cash flow of the Registrant, including cash flow to pay dividends to its stockholders, is dividends from the Subsidiary Banks. There are statutory and regulatory limitations on the payment of dividends by the Subsidiary Banks to the Registrant as well as the Registrant to its stockholders.
As to the payment of dividends, all of the Subsidiary Banks that are state nonmember banks are subject to the respective laws and regulations of the states of Alabama, Florida, Georgia, and Louisiana and to the regulations of the FDIC.
If, in the opinion of a federal regulatory agency, an institution under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the institution, could include the payment of dividends), such agency may require, after notice and hearing, that such institution cease and desist from such practice. The federal banking agencies have indicated that paying dividends that deplete an institution's capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), an insured institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. See "Prompt Corrective Action." Moreover, the Federal Reserve and the FDIC have issued policy statements which provide that bank holding companies and insured banks should generally pay dividends only out of current operating earnings.
At December 31, 1998, under dividend restrictions imposed under federal and state laws, the Subsidiary Banks, without obtaining governmental approvals, could declare aggregate dividends to the Registrant of approximately $266 million.
The payment of dividends by the Registrant and the Subsidiary Banks may also be affected or limited by other factors, such as the requirement to maintain adequate capital above regulatory guidelines.
Capital Adequacy. The Registrant and the Subsidiary Banks are required to comply with the capital adequacy standards established by the Federal Reserve in the case of the Registrant and the FDIC and the OCC in the case of the Subsidiary Banks. There are two basic measures of capital adequacy for bank holding companies that have been promulgated by the Federal Reserve: a risk-based measure and a leverage measure. All applicable capital standards must be satisfied for a bank holding company to be considered in compliance.
The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profile among banks and bank holding companies, to account for off-balance-sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.
The minimum guideline for the ratio of total capital ("Total Capital") to risk-weighted assets (including certain off-balance-sheet items, such as standby letters of credit) is 8.0%. At least half of the Total Capital
must be composed of common equity, undivided profits, minority interests in the equity accounts of consolidated subsidiaries, noncumulative perpetual preferred stock, and a limited amount of cumulative perpetual preferred stock, less goodwill and certain other intangible assets ("Tier 1 Capital"). The remainder may consist of subordinated debt, other preferred stock, and a limited amount of loan loss reserves. The minimum guideline for Tier 1 Capital is 4.0%. At December 31, 1998, the Registrant's consolidated Tier 1 Capital and Total Capital ratios were 10.26% and 12.17%, respectively.
In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum ratio of Tier 1 Capital to average assets, less goodwill and certain other intangible assets (the "Leverage Ratio"), of 3.0% for bank holding companies that meet certain specified criteria, including having the highest regulatory rating. All other bank holding companies generally are required to maintain a Leverage Ratio of at least 3.0%, plus an additional cushion of 100 to 200 basis points. The Registrant's Leverage Ratio at December 31, 1998, was 7.40%. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the Federal Reserve has indicated that it will consider a "tangible Tier 1 Capital leverage ratio" (deducting all intangibles) and other indicators of capital strength in evaluating proposals for expansion or new activities.
Each of the Registrant's Subsidiary Banks is subject to risk-based and leverage capital requirements adopted by the FDIC or the OCC, which are substantially similar to those adopted by the Federal Reserve. Each of the Registrant's Subsidiary Banks was in compliance with applicable minimum capital requirements as of December 31, 1998. Neither the Registrant nor any of the Subsidiary Banks has been advised by any federal banking agency of any specific minimum capital ratio requirement applicable to it.
Failure to meet capital guidelines could subject a bank to a variety of enforcement remedies, including the termination of deposit insurance by the FDIC, and to certain restrictions on its business. See "Prompt Corrective Action."
Support of Subsidiary Banks. Under Federal Reserve policy, the Registrant is expected to act as a source of financial strength to, and to commit resources to support, each of the Subsidiary Banks. This support may be required at times when, absent such Federal Reserve policy, the Registrant may not be inclined to provide it. In addition, any capital loans by a bank holding company to any of the Subsidiary Banks are subordinate in right of payment to deposits and to certain other indebtedness of such Subsidiary Bank. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a Subsidiary Bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.
Under the Federal Deposit Insurance Act (FDIA), a depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC after August 9, 1989, in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to any commonly controlled FDIC-insured depository institution "in danger of default." "Default" is defined generally as the appointment of a conservator or receiver, and "in danger of default" is defined generally as the existence of certain conditions indicating that a default is likely to occur in the absence of regulatory assistance. The FDIC's claim for damages is superior to claims of stockholders of the insured depository institution or its holding company, but is subordinate to claims of depositors, secured creditors, and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institution. The Subsidiary Banks are subject to these cross-guarantee provisions. As a result, any loss suffered by the FDIC in respect of any of the Subsidiary Banks would likely result in assertion of the cross-guarantee provisions, the assessment of such estimated losses against the Registrant's other Subsidiary Banks, and a potential loss of the Registrant's investment in such other Subsidiary Banks.
Prompt Corrective Action. FDICIA establishes a system of prompt corrective action to resolve the problems of undercapitalized institutions. Under this system, which became effective in December 1992, the federal banking regulators are required to establish five capital categories ("well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized") and to
take certain mandatory supervisory actions, and are authorized to take other discretionary actions, with respect to institutions in the three undercapitalized categories, the severity of which will depend upon the capital category in which the institution is placed. Generally, subject to a narrow exception, FDICIA requires the banking regulator to appoint a receiver or conservator for an institution that is critically undercapitalized. The federal banking agencies have specified by regulation the relevant capital level for each category.
Under the final agency rule implementing the prompt corrective action provisions, an institution that (i) has a Total Capital ratio of 10% or greater, a Tier 1 Capital ratio of 6.0% or greater, and a Leverage Ratio of 5.0% or greater and (ii) is not subject to any written agreement, order, capital directive, or prompt corrective action directive issued by the appropriate federal banking agency is deemed to be "well capitalized." An institution with a Total Capital ratio of 8.0% or greater, a Tier 1 Capital ratio of 4.0% or greater, and a Leverage Ratio of 4.0% or greater is considered to be "adequately capitalized." A depository institution that has a Total Capital ratio of less than 8.0%, a Tier 1 Capital ratio of less than 4.0%, or a Leverage Ratio of less than 4.0% is considered to be "undercapitalized." A depository institution that has a Total Capital ratio of less than 6.0%, a Tier 1 Capital ratio of less than 3.0%, or a Leverage Ratio of less than 3.0% is considered to be "significantly undercapitalized," and an institution that has a tangible equity capital to assets ratio equal to or less than 2.0% is deemed to be "critically undercapitalized." For purposes of the regulation, the term "tangible equity" includes core capital elements counted as Tier 1 Capital for purposes of the risk-based capital standards plus the amount of outstanding cumulative perpetual preferred stock (including related surplus), minus all intangible assets with certain exceptions. A depository 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.
An institution that is categorized as undercapitalized, significantly undercapitalized, or critically undercapitalized is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. Under FDICIA, a bank holding company must guarantee that a subsidiary depository institution meet its capital restoration plan, subject to certain limitations. The obligation of a controlling bank holding company under FDICIA to fund a capital restoration plan is limited to the lesser of 5.0% of an undercapitalized subsidiary's assets and the amount required to meet regulatory capital requirements. An undercapitalized institution is also generally prohibited from increasing its average total assets, making acquisitions, establishing any branches, or engaging in any new line of business, except in accordance with an accepted capital restoration plan or with the approval of the FDIC. In addition, the appropriate federal banking agency is given authority with respect to any undercapitalized depository institution to take any of the actions it is required to or may take with respect to a significantly undercapitalized institution as described below if it determines "that those actions are necessary to carry out the purpose" of FDICIA.
For those institutions that are significantly undercapitalized or undercapitalized and either fail to submit an acceptable capital restoration plan or fail to implement an approved capital restoration plan, the appropriate federal banking agency must require the institution to take one or more of the following actions: (i) sell enough shares, including voting shares, to become adequately capitalized; (ii) merge with (or be sold to) another institution (or holding company), but only if grounds exist for appointing a conservator or receiver; (iii) restrict certain transactions with banking affiliates as if the "sister bank" exception to the requirements of Section 23A of the Federal Reserve Act did not exist; (iv) otherwise restrict transactions with bank or nonbank affiliates; (v) restrict interest rates that the institution pays on deposits to "prevailing rates" in the institution's "region"; (vi) restrict asset growth or reduce total assets; (vii) alter, reduce, or terminate activities; (viii) hold a new election of directors; (ix) dismiss any director or senior executive officer who held office for more than 180 days immediately before the institution became undercapitalized, provided that in requiring dismissal of a director or senior officer, the agency must comply with certain procedural requirements, including the opportunity for an appeal in which the director or officer will have the burden of proving his or her value to the institution; (x) employ "qualified" senior executive officers; (xi) cease accepting deposits from correspondent depository institutions; (xii) divest certain nondepository affiliates which pose a danger to the institution; or (xiii) be divested by a parent holding company. In addition, without the prior approval of the appropriate federal banking agency, a significantly undercapitalized institution may not pay
any bonus to any senior executive officer or increase the rate of compensation for such an officer without regulatory approval.
At December 31, 1998, all of the Registrant's Subsidiary Banks had the requisite capital levels to qualify as well capitalized.
FDIC Insurance Assessments. Pursuant to FDICIA, the FDIC adopted a risk-based assessment system for insured depository institutions that takes into account the risks attributable to different categories and concentrations of assets and liabilities. The risk-based system, which went into effect on January 1, 1994, assigns an institution to one of three capital categories: (i) well capitalized; (ii) adequately capitalized; and (iii) undercapitalized. These three categories are substantially similar to the prompt corrective action categories described above, with the "undercapitalized" category including institutions that are undercapitalized, significantly undercapitalized, and critically undercapitalized for prompt corrective action purposes. An institution is also assigned by the FDIC to one of three supervisory subgroups within each capital group. The supervisory subgroup to which an institution is assigned is based on a supervisory evaluation provided to the FDIC by the institution's primary federal regulator and information which the FDIC determines to be relevant to the institution's financial condition and the risk posed to the deposit insurance funds (which may include, if applicable, information provided by the institution's state supervisor). An institution's insurance assessment rate is then determined based on the capital category and supervisory category to which it is assigned. Under the final risk-based assessment system, there are nine assessment risk classifications (i.e., combinations of capital groups and supervisory subgroups) to which different assessment rates are applied.
Pursuant to the Deposit Insurance Funds Act of 1996, the FDIC implemented a special one-time assessment of approximately 65.7 basis points (0.657%) on a depository institution's deposits insured by the Savings Association Insurance Fund ("SAIF") held as of March 31, 1995 (or approximately 52.6 basis points on SAIF deposits acquired by banks in certain qualifying transactions), and adopted revisions to the assessment rate schedules that would generally eliminate the disparity between assessment rates applicable to the deposits insured by the Bank Insurance Fund ("BIF") and the SAIF. The revisions in the assessment rate schedules reduced assessment rates on SAIF-insured deposits and would generally equalize BIF and SAIF assessment rates by January, 2000. Regions anticipates that the net effect of the decrease in the premium assessment rate on SAIF deposits will result in a reduction in its total deposit insurance premium assessments through 1999 as compared to years prior to 1997, assuming no further changes in announced premium assessment rates. Regions recorded a charge against earnings for the special assessment in the quarter ended September 30, 1996 in the pre-tax amount of approximately $25.0 million.
Under the FDIA, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC.
Safety and Soundness Standards. The FDIA, as amended by FDICIA and the Riegle Community Development and Regulatory Improvement Act of 1994, requires the federal bank regulatory agencies to prescribe standards, by regulations or guidelines, relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings, stock valuation and compensation, fees and benefits and such other operational and managerial standards as the agencies deem appropriate. The federal bank regulatory agencies have adopted, effective August 9, 1995, a set of guidelines prescribing safety and soundness standards pursuant to FDICIA, as amended. The guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director, or principal stockholder. In addition, the agencies adopted regulations that authorize, but do not require, an agency to order an institution that has been given notice by an agency that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If, after being so notified, an
institution fails to submit an acceptable compliance plan or fails in any material respect to implement an acceptable compliance plan, the agency must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized institution is subject under the "prompt corrective action" provisions of FDICIA. See "Prompt Corrective Action." If an institution fails to comply with such an order, the agency may seek to enforce such order in judicial proceedings and to impose civil money penalties. The federal bank regulatory agencies also proposed guidelines for asset quality and earnings standards.
Depositor Preference. The Omnibus Budget Reconciliation Act of 1993 provides that deposits and certain claims for administrative expenses and employee compensation against an insured depository institution would be afforded a priority over other general unsecured claims against such an institution in the "liquidation or other resolution" of such an institution by any receiver.
Other. Because of concerns relating to the competitiveness and the safety and soundness of the industry, the United States Congress continues to consider a number of wide-ranging proposals for altering the structure, regulation, and competitive relationships of the nation's financial institutions. Among such bills are proposals to prohibit depository institutions and bank holding companies from conducting certain types of activities, to subject depository institutions to increased disclosure and reporting requirements, to alter the statutory separation of commercial and investment banking, to require federal savings banks to convert to commercial bank charters and to further expand the powers of depository institutions, bank holding companies, and competitors of depository institutions. It cannot be predicted whether or in what form any of these proposals will be adopted or the extent to which the business of the Registrant may be affected thereby.
Registrant's broker/dealer subsidiary, Regions Investment Company, Inc., is subject to regulation by the Securities and Exchange Commission, the National Association of Securities Dealers, and certain state securities commissions.
(i) The following chart shows for the last three years the percentage of total operating income contributed by each of the major categories of income.
(ii) There has been no public announcement, and no information otherwise has become public, about a material new product or line of business.
(iii) The monetary policies of the Federal Reserve affect the operations of Registrant's Subsidiary Banks. Through changes in the reserve requirements against bank and thrift deposits, open market operations in U.S. Government securities and changes in the discount rate on borrowings, the Federal Reserve influences the cost and availability of funds obtained for lending and investing.
The monetary policies of the Federal Reserve have had a significant effect on the operating results of financial institutions in the past and are expected to do so in the future. The impact of such policies on the future business and earnings of the Registrant cannot be predicted.
(iv) The Registrant does not have any material patents, trademarks, licenses, franchises, or concessions.
(v) No material portion of the Registrant's business is of a seasonal nature.
(vi) The primary sources of funds for the Subsidiary Banks are deposits and borrowed funds. The Registrant's primary sources of operating funds are service fees, dividends, and interest which it receives from bank and bank-related subsidiaries.
(vii) No material part of the business of the Registrant is dependent upon a single customer or a few customers. No single customer or affiliated group of customers accounts for 10% or more of Registrant's consolidated revenues.
(viii) Information concerning backlog orders is not relevant to an understanding of the business of the Registrant.
(ix) No material portion of the business of the Registrant is subject to renegotiation of profits or termination of contracts or subcontracts by governmental authorities.
(x) All aspects of the Registrant's business are highly competitive. The Registrant's subsidiaries compete with other financial institutions located in Alabama, Arkansas, northwest and central Florida, Georgia, Louisiana, South Carolina, Tennessee, east Texas and other adjoining states, as well as large banks in major financial centers and other financial intermediaries, such as savings and loan associations, credit unions, consumer finance companies, brokerage firms, insurance companies, investment companies, mutual funds, other mortgage companies and financial service operations of major commercial and retail corporations.
As of December 31, 1998, the Registrant was the second largest bank holding company headquartered in Alabama based on assets. For information with respect to the Registrant's markets and the size of the Subsidiary Banks operating in such markets, see the information provided under subsection (a) of this Item 1.
Customers for banking services are generally influenced by convenience, quality of service, personal contacts, price of services, and availability of products. Although the ranking of Registrant's position varies in different markets, Registrant believes that its affiliates effectively compete with other banks and thrifts in their relevant market areas.
Under the provisions of the Interstate Banking Act, the existing restrictions on interstate acquisitions of banks by bank holding companies, including the regional interstate banking legislation adopted in 1987 by the state of Alabama permitting interstate acquisitions of banks and bank holding companies generally in certain southeastern states, were repealed effective September 29, 1995, such that the Registrant and any other bank holding company located in Alabama are now able to acquire a bank located in any other state, and a bank holding company located outside Alabama could acquire any Alabama-based bank, in either case subject to certain deposit percentage and other restrictions. The Interstate Banking Act also generally provided that, after June 1, 1997, national and state-chartered banks may branch interstate through acquisitions of banks in other states. To the extent that large bank holding companies that previously were not permitted to make acquisitions in the markets in which Regions operates do effect acquisitions pursuant to the Interstate Banking Act, competition in the Registrant's markets could further intensify.
(xi) There were no material expenditures during the last three fiscal years on research and development activities by the Registrant.
(xii) Regulations of any governmental authority concerning the discharge of materials into the environment are expected to have no material effect on the Registrant or any of its subsidiaries.
(xiii) As of December 31, 1998, Registrant, its affiliate banks and other subsidiaries had a total of 14,632 full-time-equivalent employees.
(d) Registrant neither engages in foreign operations nor derives a significant portion of its business from customers in foreign countries.
ITEM 2.
ITEM 2. PROPERTIES
The corporate headquarters of the Registrant occupy several floors of the main Birmingham banking facility of Regions Bank (Alabama), located at 417 North 20th Street, Birmingham, Alabama 35203.
The Registrant and its subsidiaries, including the Subsidiary Banks, operate through 853 office facilities, of which 633 are owned by the Registrant or one of its subsidiaries and 220 are subject to building or ground leases. Of the 713 branch office facilities operated by the Subsidiary Banks at December 31, 1998, 188 are subject to building or ground leases and 525 are wholly owned by the Subsidiary Banks.
For offices in premises leased by the Registrant and its subsidiaries, annual rentals totaled approximately $17,245,000 as of December 31, 1998. During 1998, the Registrant and its subsidiaries received approximately $9,334,000 in rentals for space leased to others. At December 31, 1998, encumbrances on the offices, equipment and other operational facilities owned by the Registrant and its subsidiaries totaled approximately $3,208,000 with a weighted average interest rate of 5.5%.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Reference is made to Note L. to the consolidated financial statements included under Item 8 of this Annual Report on Form 10-K.
The Registrant continues to be concerned about the general trend in litigation in Alabama state courts involving large damage awards against financial service company defendants. Registrant directly or through its subsidiaries is party to approximately 84 cases in Alabama in the ordinary course of business, some of which seek class action treatment or punitive damages. The damage exposure in Alabama in any case and in the aggregate is difficult to estimate because the jury has broad discretion as to the amount of damages awarded.
Several appellate court rulings since 1996 provide a basis for the courts to exercise some control over excessive punitive damage awards. In 1996 the U.S. Supreme Court overturned an Alabama case involving a large jury award, holding that the punitive damage award was so grossly excessive as to violate due process. Subsequently, the U.S. Supreme Court has returned several cases to the Alabama courts for reconsideration in light of its ruling. In addition, the Alabama Supreme Court has reduced several large damage awards against defendants that were awarded by lower court juries. In March of 1997, the Alabama Supreme Court reversed a precedent set in 1989 regarding reliance by plaintiffs on verbal representations which are not in agreement with written contracts. The 1989 ruling had been the source of significant litigation losses in the state. Regions views these appellate court rulings as having a positive influence on the litigation climate in Alabama.
Registrant believes, based on consultation with legal counsel, that the outcome of pending litigation will not have a material effect on Registrant's consolidated financial position.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to security holders for a vote during the fourth quarter of 1998.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS
On November 30, 1998, 849,590 shares of common stock of the Registrant were issued in connection with a business combination with EFC Holdings Corporation. Such shares were not registered under the Securities Act of 1933, in reliance upon the exemption from registration provided by section 4(2) of such act. Such shares were issued to six recipients, each of which was an accredited investor within the meaning of Regulation D and each of which had background and experience such that the recipient was capable of evaluating the merits and risks of an investment in the Registrant's common stock. The Registrant took appropriate precautions to prevent the unregistered distribution of such securities, consisting of securing the agreement of the recipients not to resell the securities in the absence of registration or the availability of an exemption. The shares have been registered for resale under the Securities Act (Registration No. 333-70421.)
Common Stock Market Prices and Dividend information for the year ended December 31, 1998, is included under Item 8 of this Annual Report filed on Form 10-K in Note Y. to the Consolidated Financial Statements.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
REGIONAL FINANCIAL CORPORATION & SUBSIDIARIES
HISTORICAL FINANCIAL SUMMARY
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* Ratios for 1996 excluding $20.2 million in after-tax charges for SAIF assessment and merger expenses are as follows: Return on average stockholders' equity 15.64%, Return on average total assets 1.33%, and Efficiency 60.93%. ** Ratios for 1998 excluding $80.7 million in after-tax charges for merger and consolidation expenses are as follows: Return on average stockholders' equity 17.42%, Return on average total assets 1.48%, and Efficiency 54.13%.
REGIONS FINANCIAL CORPORATION & SUBSIDIARIES
HISTORICAL FINANCIAL SUMMARY -- CONTINUED
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Notes to Historical Financial Summary:
(1) Amounts in all periods have been restated to reflect significant business combinations accounted for as poolings of interests. (2) All per share amounts give retroactive recognition to the effect of stock dividends and stock splits. (3) Non-accruing loans, of an immaterial amount, are included in earning assets. No adjustment has been made for these loans in the calculation of yields. (4) Yields are computed on a taxable equivalent basis, net of interest disallowance, using marginal federal income tax rates of 35% for 1998-1993. (5) This summary should be read in conjunction with the related consolidated financial statements and notes thereto under item 8 on pages 50 to 87 of this Annual Report on Form 10-K.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
The following discussion and financial information is presented to aid in understanding Regions Financial Corporation's (Regions or the Company) financial position and results of operations. The emphasis of this discussion will be on the years 1996, 1997 and 1998; however, financial information for prior years will also be presented when appropriate.
On July 31, 1998, First Commercial Corporation of Little Rock, Arkansas, (First Commercial) with approximately $7.3 billion in assets, merged with and into Regions. On March 31, 1998, First State Corporation of Albany, Georgia, with approximately $536 million in assets, merged with and into Regions. On March 14, 1998, First United Bancorporation of Anderson, South Carolina, with approximately $305 million in assets, merged with and into Regions. On February 13, 1998, PALFED, Inc., of Aiken, South Carolina, with approximately $665 million in assets, merged with and into Regions. On March 1, 1996, First National Bancorp of Gainesville, Georgia, with approximately $3.2 billion in assets, merged with and into Regions. These transactions were accounted for as poolings of interests and accordingly, financial information for all prior periods has been restated to present the combined financial condition and results of operations of all companies as if these transactions had been in effect for all periods presented.
Regions' primary business is banking. In 1998, Regions' banking affiliates contributed approximately $451 million to consolidated income. During 1997 and 1998, Regions' individual banking affiliates in each state (except for recently acquired banks) were merged into one state-chartered (Alabama) bank. A distribution of selected information as of December 31, 1998, on Regions' banking operations, by state, is as follows:
Supplementing the Company's banking operations are a mortgage banking company, credit life insurance related companies, a registered broker/dealer firm and a commercial accounts receivable financing, billing and collection company. Regions has no foreign operations, although it maintains an International Department to assist customers with their foreign transactions. The mortgage banking company services approximately $22.3 billion in mortgage loans and in 1998 contributed approximately $22.0 million to income.
The Company's principal market areas are all of Alabama and Arkansas, north and southwest Georgia, east Texas, parts of Louisiana, northwest and central Florida, middle and west Tennessee and parts of South Carolina. In addition, real estate mortgage loan origination offices are located in other market areas in Tennessee, Mississippi and South Carolina.
The acquisitions of other banks and related institutions have contributed significantly to Regions' growth during the last three years. Regions has expanded into new markets and strengthened its presence in existing markets.
Acquisition activity in 1996 was centered primarily in Georgia and Louisiana. In early 1996, Regions acquired two suburban, Atlanta-area banks, Metro Financial Corporation and The Enterprise National Bank of Atlanta, which combined added $265 million in assets. Prior to its merger with Regions in March 1996, First National acquired The Bank of Heard County, which added another $42 million in assets. Further
expansion in the northern half of Georgia continued in 1996 through the acquisitions of First Federal Bank of Northwest Georgia, First Gwinnett Bancshares, Inc. and Rockdale Community Bank. All of these banks, including First National's 18 separate Georgia banks and Regions' banks in Rome and Dalton, were merged into Regions Bank in Georgia in 1996. All operating systems of these banks were converted to Regions' standard processing systems, which enabled Regions to reduce the level of operating expenses in the Georgia franchise.
Expansion activity in Louisiana in 1996 occurred in the southern part of the state. Delta Bank & Trust Company, with $191 million in assets, was acquired in August and American Bancshares of Houma, Inc., added another $89 million in assets in September. Both banks acquired in these transactions were merged into Regions Bank in Louisiana.
In 1996 First Commercial acquired Security National Bank in Nacogdoches, Texas. This transaction added $35 million in assets.
Also in 1996, First State Corporation purchased two branches and $82 million in deposits from First Union National Bank in Albany, Georgia.
During 1997, Regions continued to strengthen its presence in Florida, Georgia and Louisiana, through nine acquisitions, which combined added $1.9 billion in assets, $1.0 billion in loans and $1.6 billion in deposits.
Regions expanded its Florida presence in Panama City and Longwood through the acquisition of Florida First Bancorp, Inc. and First Mercantile National Bank with $287 million and $157 million in assets, respectively.
In Georgia, Regions continued to expand its market presence through the acquisition of four institutions: Allied Bancshares, Inc. of Thomson with assets of $560 million; First Bankshares, Inc. of Hapeville with $127 million in assets; SB&T Corporation of Smyrna with $148 million in assets; and GF Bancshares, Inc. of Griffin with $99 million in assets.
Regions expansion in Louisiana consisted of three institutions; West Carroll Bancshares, Inc. of Oak Grove with assets of $127 million in the northern part of the state, Gulf South Bancshares, Inc. of Gretna with assets of $55 million and The New Iberia Bancorp, Inc. of New Iberia with assets of $313 million in the southern part of Louisiana.
In Arkansas, First Commercial acquired First Charter Bancshares, Inc. located in Searcy, Arkansas, First Central Corporation located in Searcy, Arkansas, and Southwest Bancshares, Inc. located in Jonesboro, Arkansas. These transactions added $1.2 billion in assets.
First Commercial also acquired City National Bank of Whitehouse, Texas, adding assets of $39 million.
In Tennessee, First Commercial expanded into Memphis through the acquisition of W.B.T. Holding Company with assets of $267 million.
Regions' 1998 acquisition activity expanded its presence in Alabama, Georgia, Florida, Louisiana, South Carolina, and Tennessee through ten acquisitions with combined assets of $2.1 billion, combined loans of $1.3 billion and combined deposits of $1.8 billion.
In Alabama, Regions acquired Jacobs Bank, located in Scottsboro. The Jacobs transaction added $186 million in assets.
Regions' expansion in Georgia included the acquisition of Etowah Bank located in Canton, First Community Banking Services, Inc. located in Peachtree City and branches purchased from First Union National Bank in Valdosta, adding assets of $409 million, $125 million and $109 million, respectively.
Regions' acquisition activity in Florida added $416 million in combined assets from transactions with two institutions; Key Florida Bancorp, Inc. and Village Bankshares, Inc. These institutions added to Regions' existing central Florida presence.
In Louisiana, Regions acquired two institutions: St. Mary Holding Corporation in Franklin with assets of $111 million and St. James Bancorporation, Inc. in Lutcher with assets of $172 million.
Also in 1998, Regions expanded its South Carolina market with the acquisition of Greenville Financial Corporation. This transaction added $141 million in assets.
In Tennessee, First Commercial acquired Federal Savings Bank, a subsidiary of Kemmons Wilson, Inc. This transaction added $396 million in assets.
Additionally, Regions expanded its line of businesses and market area by acquiring EFC Holdings Corporation ("EFC"), a Charlotte, North Carolina, specialty financing institution. EFC, with $63 million in assets, originates and sells consumer mortgage loans.
Regions' and the pooled companies' business combinations over the last three years are summarized in the following chart.
As of December 31, 1998, Regions had four pending acquisitions, one in each of the states of Arkansas and Tennessee and two in the state of Georgia. These institutions have combined assets of approximately $629 million. See Note Q to the consolidated financial statements for additional information regarding pending acquisitions.
FINANCIAL CONDITION
Regions' financial condition depends primarily on the quality and nature of its assets, liabilities and capital structure, the market and economic conditions, and the quality of its personnel.
LOANS AND ALLOWANCE FOR LOAN LOSSES
As a financial institution, Regions' primary investment is loans. At December 31, 1998, loans represented 72% of Regions' earning assets.
Lending at Regions is generally organized along three functional lines: commercial loans (including industrial and agricultural), real estate loans and consumer loans. The composition of the portfolio by these major categories is presented below (with real estate loans further broken down between construction and mortgage loans):
The amounts of total gross loans (excluding residential mortgages on 1-4 family residences and consumer loans) outstanding at December 31, 1998, based on remaining scheduled repayments of principal, due in (1) one year or less, (2) more than one year but less than five years and (3) more than five years, are shown in the following table. The amounts due after one year are classified according to sensitivity to changes in interest rates.
Over the last four years loans increased a total of $9.6 billion, a compound growth rate of 13%. Loans acquired in connection with acquisitions over the last four years contributed $3.5 billion of this growth. The most significant growth in the loan portfolio occurred in 1996, 1997 and 1998, with loans increasing $2.2 billion, $3.5 billion and $2.5 billion, respectively. The acquisition of nine banks in 1996 added $492 million in loans. In 1997 and 1998, respectively, acquisitions added $1.3 billion in loans.
During 1998, Regions securitized $534 million in single-family residential mortgage loans. These assets were transferred from the loan portfolio to the available for sale securities portfolio. The securitization of these loans gives Regions additional flexibility for funding purposes and results in a lower risk-weighted capital allocation for these assets. After adjusting for the effect of the securitizations, loans would have increased $3.0 billion or 14% in 1998.
All major categories of loans have shared in the growth in the loan portfolio over the last four years, with the strongest growth occurring in commercial and consumer loans. Over the last four years, commercial, financial and agricultural loans increased $3.9 billion or 124%. Real estate construction loans increased $1.2 billion or 176% over the same period. Real estate mortgage loans increased $2.2 billion or 30%, and consumer loans increased $2.3 billion or 65% over the last four years. The increase in real estate mortgage loans is net of the $534 million securitization previously discussed.
Regions' real estate mortgage portfolio includes $3.6 billion of mortgage loans secured by single-family residences that were originated by Regions' mortgage subsidiary. The majority of these loans are secured by homes in Alabama, Georgia and Florida. These loans increased approximately $424 million in 1996, $655 million in 1997, and $815 million in 1998, accounting for approximately 19%, 19%, and 33% respectively, of the growth in total loans in 1996, 1997, and 1998. The increase in 1998 is net of the securitization of the $534 million in single-family residential mortgages. Eighty-three percent of the overall balance consists of adjustable-rate mortgages (ARM's) that have rates approximately 275 basis points above one of several money market indices when fully priced.
Regions' real estate portfolio also includes $2.0 billion of single-family mortgage loans obtained in various acquisitions, which are being serviced by Regions' mortgage subsidiary. Fixed-rate single-family mortgages with a weighted average interest rate of 8.01% and a weighted average remaining term of 14.8 years comprise 51% of this portfolio. Single-family ARM's, which have rates approximately 250 to 275 basis points above one
of several money market indices when fully priced, comprise the remaining 49% of the overall balance of these loans.
A sound credit policy and careful, consistent credit review are vital to a successful lending program. All affiliates of Regions operate under written loan policies which attempt to maintain a consistent lending philosophy, provide sound traditional credit decisions, provide an adequate return and render service to the communities in which the banks are located. Regions' lending policy generally confines loans to local customers or to national firms doing business locally. Credit reviews and loan examinations help confirm that affiliates are adhering to these loan policies.
Every loan carries some degree of credit risk. This risk is reflected in the consolidated financial statements by the allowance for loan losses, the amount of loans charged off and the provision for loan losses charged to operating expense. It is Regions' policy that when a loss is identified, it is charged against the allowance for loan losses in the current period. The policy regarding recognition of losses requires immediate recognition of a loss if significant doubt exists as to principal repayment.
Regions' provision for loan losses is a reflection of actual losses experienced during the year and management's judgment as to the adequacy of the allowance for loan losses to absorb future losses. Some of the factors considered by management in determining the amount of the provision and resulting allowance include: (1) credit reviews of individual loans; (2) gross and net loan charge-offs in the current year; (3) growth in the loan portfolio; (4) the current level of the allowance in relation to total loans and to historical loss levels; (5) past due and non-accruing loans; (6) collateral values of properties securing loans; (7) the composition of the loan portfolio (types of loans); and (8) management's estimate of future economic conditions and the resulting impact on Regions.
Regions uses a systematic approach to determine the adequacy of allowance for loan losses. Regions' systematic approach includes assigning loss factors, based on historical data as adjusted for current business and economic conditions, to portfolios of loans with similar characteristics for which estimates of inherent probable losses can be made. The loss factors are applied to the respective portfolios in order to determine the overall allowance adequacy.
A coordinated effort is undertaken to identify credit risks in the loan portfolio for management purposes and to establish the loan loss provision and resulting allowance for accounting purposes. A regular, formal and ongoing loan review is conducted to identify loans with unusual risks or possible losses. The primary responsibility for this review rests with the management of the individual banking offices. Their work is supplemented with reviews by Regions' internal audit staff and corporate loan examiners. Bank regulatory agencies and the Company's independent auditors provide additional levels of review. This process provides information which helps in assessing the quality of the portfolio, assists in the prompt identification of problems and potential problems and aids in deciding if a loan represents a probable loss which should be recognized or a risk for which an allowance should be maintained.
If, as a result of Regions' loan review and evaluation procedures, it is determined that payment of interest on a loan is questionable, it is Regions' policy to reverse interest previously accrued on the loan against interest income. Interest on such loans is thereafter recorded on a "cash basis" and is included in earnings only when actually received in cash and when full payment of principal is no longer doubtful.
Although it is Regions' policy to immediately charge off as a loss all loan amounts judged to be uncollectible, historical experience indicates that certain losses exist in the loan portfolio which have not been specifically identified. To anticipate and provide for these unidentifiable losses, the allowance for loan losses is established by charging the provision for loan losses expense against current earnings. No portion of the resulting allowance is in any way allocated or restricted to any individual loan or group of loans. The entire allowance is available to absorb losses from any and all loans.
Over the last five years, the year-end allowance for loan losses as a percentage of loans ranged from a low of 1.29% in 1998 to a high of 1.43% in 1995. Although this ratio is important, it is only one of the factors considered by management in determining the adequacy of the allowance for loan losses. Management does
not attempt to maintain the allowance for loan losses at a certain percentage of loans. As previously discussed, the adequacy of the allowance for loan losses is based on management's evaluation of various factors.
The ratio of non-performing assets (including loans past due 90 days or more and other real estate) to loans and other real estate declined from 0.98% at December 31, 1994 to 0.81% at December 31, 1995. Generally improving economic conditions in Regions' markets during this period, partially offset by the effect of non-performing assets added by certain acquisitions, resulted in the declining trend in this ratio. The ratio of non-performing assets (including loans past due 90 days or more and other real estate) to loans and other real estate increased to 0.83% at December 31, 1996, 0.91% in 1997, and 1.15% in 1998, due primarily to increases in consumer loan delinquencies.
The allowance for loan losses as a percentage of non-performing loans (including loans past due 90 days or more) was 120% at December 31, 1998, compared to 169% at December 31, 1997, and to 193% at December 31, 1996. Management considers the current level of the allowance for loan losses adequate to absorb possible losses from loans in the portfolio. Management's determination of the adequacy of the allowance for loan losses, which is based on the factors and risk identification procedures previously discussed, requires the use of judgments and estimations that may change in the future. Unfavorable changes in the factors used by management to determine the adequacy of the reserve, including increased consumer loan delinquencies and subsequent charge-offs, or the availability of new information, could cause the allowance for loan losses to be increased or decreased in future periods. In addition, bank regulatory agencies, as part of their examination process, may require that additions be made to the allowance for loan losses based on their judgments and estimates.
The analysis of loan loss experience (see chart following) shows that net loan losses, over the last five years, ranged from a high of $66.4 million in 1998 to a low of $23.2 million in 1995. Net loan losses were $56.1 million in 1997, $30.4 million in 1996, and $23.7 million in 1994. Over the last five years, net loan losses averaged 0.22% of average loans and were 0.28% of average loans in 1998. Regions' relatively low level of net loan losses is due to favorable economic conditions, quality control efforts in the underwriting and monitoring of loans and a substantial amount of recoveries of previously charged-off loans.
In order to assess the risk characteristics of the loan portfolio at December 31, 1998, it is appropriate to consider the three major categories of loans -- commercial, real estate and consumer.
Regions' commercial loan portfolio is highly diversified within the markets served by the Company. Geographically, the largest concentration is the 33% of the portfolio held by banking offices in the state of Alabama. Banking offices in Georgia and Arkansas each hold 21% of the commercial loan portfolio, followed by Louisiana with 11%, Tennessee with 5%, and Florida, South Carolina and Texas with 3% each. A small portion of these loans is secured by properties outside Regions' banking market areas.
The Alabama economy has experienced relatively stable growth over the last several years. Industries important in the Alabama economy include vehicle and vehicle parts manufacturing and assembly, lumber and wood products, and steel production. High technology industries are important in the northern part of the state. Service and health care industries have increased in importance and are predicted to continue growing. Agriculture, particularly poultry, beef cattle and cotton, are important to the state's economy.
The economy of the northern two-thirds of Georgia is diversified with a strong presence in poultry production, carpet manufacturing, automotive manufacturing related industries, tourism, and various service sector industries. A well developed transportation system has contributed to the growth in north Georgia. This area has experienced rapid population growth and has very favorable household income characteristics, relative to many of Regions' other markets. Prospects are good for continued strong growth in this area.
In the southwestern area of Georgia, while agriculture is important, other industries play an important role in the economy. Albany and Valdosta, Regions primary market areas, are hubs for retail trade and health care for the entire south Georgia market. These markets are also home to numerous Fortune 500 Company manufacturing and production facilities.
The Arkansas economy is supported in part by the forest products industry due to the abundance of corporate owned forests and public lands. In recent years, steel production has become increasingly important to the state's economy. A national retailing chain and large food processing company are headquartered in Arkansas, which adds to the state's diversified economy.
Natural resources are very important to the Louisiana economy. Energy and petrochemical industries play a significant role in the economy. Shipping, shipbuilding, and other transportation equipment industries are strong in the state's durable goods industries. Tourism, amusement and recreation, service, and health care industries are becoming increasingly important to the Louisiana economy. Cotton, rice and sugarcane are among Louisiana's most important agricultural commodities.
The economy along the I-85 corridor in South Carolina is among the fastest growing in the country. This area is home to numerous multinational manufacturers, resulting in one of the highest per capita foreign investment areas in the nation. South Carolina has the third highest growth rate in personal income in the nation.
Tennessee's economy is heavily influenced by automobile manufacturing, tourism, entertainment and recreation, health care and other service industries. With one out of four Tennesseeans employed in service industries, the state's economy is very dependent on this sector for continued good economic performance.
The economy of the eastern portion of Texas remains healthy. A major distribution center and a new telemarketing service center bode well for the Tyler market while the Longview area benefits from manufacturing expansion and a medical claims service center.
The northwestern part of Florida and the central Florida area have also experienced excellent economic growth during the last several years. Tourism is very important to the Florida economy, and military payrolls are significant in the panhandle area. Florida has experienced strong in-migration, contributing to strong construction activity and a growing retirement-age population. Citrus fruit production is also important in the state.
From 1994 to 1998, net losses on commercial loans ranged from a low of 0.03% in 1997 to a high of 0.25% in 1994. Commercial loan losses in 1998 were 0.19% due, in part, to losses on a small number of larger commercial credits. Future losses are a function of many variables, of which general economic conditions are the most important. A continuation of moderate economic growth during 1999 in Regions' market areas could result in 1999 net commercial loan losses at or above the 1998 level.
Regions' real estate loan portfolio consists of construction and land development loans, loans to businesses for long-term financing of land and buildings, loans on one-to-four family residential properties, loans to mortgage banking companies (which are secured primarily by loans on one-to-four family residential properties and are known as warehoused mortgage loans) and various other loans secured by real estate.
Real estate construction loans increased $283 million in 1998 to $1.9 billion. At December 31, 1998, these loans represented 7.7% of Regions' total loan portfolio, compared to 4.6% at the end of 1994. Strong economic growth and new development in Regions' market areas have enabled Regions to steadily increase construction loans. Most of the construction loans relate to shopping centers, apartment complexes, commercial buildings and residential property development. These loans are normally secured by land and buildings and are generally backed by commitments for long-term financing from other financial institutions. Real estate construction loans are closely monitored by management, since these loans are generally considered riskier than other types of loans and are particularly vulnerable in economic downturns and in periods of high interest rates. Regions has not been an active lender to speculative real estate developers or to developers outside its market areas.
The loans to businesses for long-term financing of land and buildings are primarily to commercial customers within Regions' markets. Total loans secured by non-farm, non-residential properties totaled $3.8 billion at December 31, 1998. Although some risk is inherent in this type of lending, the Company attempts to minimize this risk by generally making such loans only on owner-occupied properties, and by requiring
collateral values which exceed the loan amount, adequate cash flow to service the debt, and in most cases, the personal guaranties of principals of the borrowers.
Generally, Regions' most significant market areas have not experienced rapid increases in real estate property values or significant overbuilding. Therefore, in management's opinion, real estate loan collateral values in Regions' market areas should not be as vulnerable to significant deterioration, as would other market areas which have experienced rapidly increasing property values and significant overbuilding. However, collateral values are difficult to estimate and are subject to change depending on economic conditions, the supply of and demand for properties and other factors. Regions attempts to mitigate the risks of real estate lending by adhering to strict loan underwriting policies and by diversifying the portfolio both geographically within its market area and within industry groups.
Loans on one-to-four family residential properties, which total approximately 70% of Regions' real estate mortgage portfolio, are principally on single-family residences. These loans are geographically dispersed throughout the southeastern states and some are guaranteed by government agencies or private mortgage insurers. Historically, this category of loans has not produced sizable loan losses; however, it is subject to some of the same risks as other real estate lending. Warehoused mortgage loans, since they are secured primarily by loans on one-to-four family residential properties, are similar to these loans in terms of risk.
From 1994 to 1998, net losses on real estate loans ranged from a high of 0.12% of real estate loans in 1994, to a low of 0.01% of real estate loans in 1996. The 1998 real estate loan losses were 0.11% as a result of higher commercial real estate charge offs. These losses depend, to a large degree, on the level of interest rates, economic conditions and collateral values, and thus, are very difficult to predict. Management expects 1999 net real estate loan losses to be at or above the 1998 level.
Regions' consumer loan portfolio consists of $4.8 billion in consumer loans, $627 million in personal lines of credit (including home equity loans) and $301 million in credit card loans. Consumer loans are primarily borrowings of individuals for home improvements, automobiles and other personal and household purposes. Regions' consumer loan portfolio includes $1.3 billion in indirect installment loans at December 31, 1998, compared to $1.9 billion as of December 31, 1997. Periods of economic recession tend to increase consumer loan losses. During the past five years, the ratio of net consumer loan losses to consumer loans ranged from a low of 0.28% in 1994 to a high of 0.99% in 1997. Higher levels of personal bankruptcies in Regions' market areas contributed to the higher net consumer loan losses in 1997 and 1998. Net consumer loan losses were 0.70% in 1998. Management expects net consumer loan losses in 1999 to be near the 1998 level.
The following table presents information on non-performing loans and real estate acquired in settlement of loans:
The following analysis presents a five year history of the allowance for loan losses and loan loss data:
At December 31, 1998, non-accrual loans totaled $124.7 million or 0.51% of loans, compared to $138.1 million or 0.63% of loans at December 31, 1997. The decrease in the dollar amount of non-accrual loans at December 31, 1998, was primarily due to a change in policy that conformed Regions' non-accrual consumer loan policy with that of the industry, partially offset by certain commercial credits included in the impaired loan amount as a part of Note D to the consolidated financial statements. Commercial loans comprised $51.6 million of the 1998 total, with real estate loans accounting for $73.0 million and consumer loans $0.1 million.
Loans contractually past due 90 days or more were 0.55% of total loans at December 31, 1998, compared to 0.13% of total loans at December 31, 1997. Increased levels of past due consumer loans, due primarily to the change in policy mentioned above (to no longer transfer consumer loans past due ninety or more days to non-accrual status as a matter of course), accounted for the increase in total loans past due 90 days or more since December 31, 1997. Loans past due 90 days or more at December 31, 1998, consisted of $61.8 million in commercial and real estate loans and $72.6 million in consumer loans.
Renegotiated loans were 0.02% and 0.06% of loans at December 31, 1998 and 1997, respectively. Renegotiated loans have remained at low levels over the last five years, as a result of paydowns and payoffs on renegotiated loans, which were added by acquisitions.
Other real estate has declined during the last four years and totaled $17.3 million at December 31, 1998, compared to $20.5 million at December 31, 1997. Other real estate added by acquisitions in 1998, were offset by sales of other real estate. From 1994 through 1996, other real estate declined due to increased sales of parcels of other real estate, combined with fewer additions. Other real estate is recorded at the lower of (1) the recorded investment in the loan or (2) the estimated net realizable value of the collateral. Although Regions does not anticipate material loss upon disposition of other real estate, sustained periods of adverse economic conditions, substantial declines in real estate values in Regions' markets, actions by bank regulatory agencies, or other factors, could result in additional loss from other real estate.
The amount of interest income earned in 1998 on the $124.7 million of non-accruing loans outstanding at year end was approximately $4.4 million. If these loans had been current in accordance with their original terms, approximately $12.0 million would have been earned on these loans in 1998. Approximately $456,000 in interest income would have been earned in 1998 under the original terms of the $4.5 million in renegotiated loans outstanding at December 31, 1998. Approximately $239,000 in interest income was actually earned in 1998 on these loans.
In the normal course of business, Regions makes commitments under various terms to lend funds to its customers. These commitments include (among others) revolving credit agreements, term loan agreements and short-term borrowing arrangements, which are usually for working capital needs. Letters of credit are also issued, which under certain conditions could result in loans. See Note L. to the consolidated financial statements for additional information on commitments.
The commercial, real estate and consumer loan portfolios are highly diversified in terms of industry concentrations. The following table shows the largest concentrations in terms of the customer's Standard Industrial Classification (SIC) Code at December 31, 1998:
INTEREST-BEARING DEPOSITS IN OTHER BANKS
Interest-bearing deposits in other banks are used primarily as temporary investments. These assets generally have short-term maturities. This category of earning assets increased from $43.0 million at December 31, 1996 to $48.2 million at December 31, 1997 due to favorable rates. This category of earning assets increased to $144.0 million at December 31, 1998, due to balances added in connection with acquisition activity in 1998.
SECURITIES
The following table shows the carrying values of securities as follows:
In 1998, total securities increased $1.7 billion or 26%. U. S. Treasury and Federal agency securities decreased $291 million. Mortgage-backed securities increased $2.0 billion due to acquisition activity and the $534 million securitization of mortgage loans previously discussed. Obligations of states and political subdivisions decreased $57.8 million in 1998.
Total securities increased $574 million in 1997. U. S. Treasury and Federal agency securities increased $716 million or 25% due primarily to acquisitions. Obligations of states and political subdivisions increased $75 million or 11%. Mortgage-backed securities decreased $219 million or 11% in 1997.
Regions' investment portfolio policy stresses quality and liquidity. At December 31, 1998, the average maturity of U.S. Treasury and Federal agency securities was 4.9 years and that of obligations of states and political subdivisions was 8.0 years. The average expected maturity of mortgage-backed securities was 3.8 years and other securities had an average contractual maturity of 4.0 years. Overall, the average maturity of the portfolio was 14.1 years using contractual maturities and 4.5 years using expected maturities. Expected maturities differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
The estimated fair market value of Regions' investment securities portfolio at December 31, 1998, was 1.3% ($41.3 million) above the amount carried on Regions' books. Regions' securities available for sale portfolio at December 31, 1998, included net unrealized gains of $37.8 million. Regions' investment securities and securities available for sale portfolios included gross unrealized gains of $80 million and gross unrealized losses of $1 million at December 31, 1998. Market values of these portfolios vary significantly as interest rates change; however, management expects normal maturities from the securities portfolios to meet liquidity needs.
Of Regions' tax-free securities rated by Moody's Investors Service, Inc., 96% are rated "A" or better. The portfolio is carefully monitored to assure no unreasonable concentration of securities in the obligations of a single debtor, and current credit reviews are conducted on each security holding.
The following table shows the maturities of securities (excluding equity securities) at December 31, 1998, the weighted average yields and the taxable equivalent adjustment used in calculating the yields:
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Note: The weighted average yields are calculated on the basis of the yield to maturity based on the book value of each security. Weighted average yields on tax-exempt obligations have been computed on a fully taxable equivalent basis using a tax rate of 35%. Yields on tax-exempt obligations have not been adjusted for the non-deductible portion of interest expense used to finance the purchase of tax-exempt obligations.
LIQUIDITY
Liquidity is an important factor in the financial condition of Regions and affects Regions' ability to meet the borrowing needs and deposit withdrawal requirements of its customers. Assets, consisting principally of loans and securities, are funded by customer deposits, purchased funds, borrowed funds and stockholders' equity.
The securities portfolio is one of Regions' primary sources of liquidity. Maturities of securities provide a constant flow of funds which are available for cash needs (see previous table on Securities Maturing). Maturities in the loan portfolio also provide a steady flow of funds (see previous table on Loans Maturing). At December 31, 1998, commercial loans, real estate construction loans and commercial mortgage loans with an aggregate balance of $5.3 billion, as well as securities of $672 million, were due to mature in one year or less. Additional funds are provided from payments on consumer loans and one-to-four family residential mortgage loans. Historically, the Company's high levels of net operating earnings have also contributed to cash flow. In addition, liquidity needs can be met by the purchase of funds in state and national money markets. Regions' liquidity also continues to be enhanced by a relatively stable deposit base.
The loan to deposit ratio increased from 83.54% at December 31, 1996, to 87.49% at December 31, 1997 but decreased to 85.95% at December 31, 1998, due to the securitization and reclassification of mortgage loans to the securities available for sale classification discussed previously.
As shown in the Consolidated Statement of Cash Flows, operating activities provided significant levels of funds in 1996 and 1997, due primarily to high levels of net income. Operating activities were a net user of funds in 1998 as net income, mortgage loans held for sale and other assets increased and other liabilities decreased. Investing activities, primarily in loans and securities, were a net user of funds in all three years. Strong loan growth over the last three years has required a significant amount of funds for investing activities. Funds needed for investing activities were provided primarily by deposits, purchased funds, and borrowings. Financing activities provided more funds in 1998 due to more reliance on short-term borrowings and to increases in deposits. Cash dividends and the open-market purchase of the Company's common stock, which was reissued in connection with specific purchase acquisitions, also required funds in 1996, 1997 and 1998. Funds needed for the pending acquisitions as of December 31, 1998, are expected to be provided by working capital or short-term borrowings.
Standard & Poor's Corporation has assigned high quality ratings to Regions Bank's certificates of deposit. Regions Bank's short-term certificates of deposit are rated "A-1" by Standard & Poor's Corporation and long-term certificates of deposit are rated "A+".
Moody's Investors Service has also given similar quality ratings to Regions Bank's short- and long-term debt and certificates of deposit. Short-term debt and certificates of deposit are rated "P-1" and long-term debt and certificates of deposit are rated "Aa2".
In addition, Regions Financial Corporation (the parent company) received the highest issuer rating available ("A") from the internationally recognized bank rating organization, Thomson BankWatch. This organization also assigned its highest short-term rating of "TBW-1" to Regions Financial Corporation and to Regions Bank (Alabama).
The $200 million in subordinated debt issued by Regions is rated "A-" by Standard & Poor's Corporation, "A2" by Moody's Investors Service, and "AA-" by Thomson BankWatch.
Regions' and its banking subsidiary's high quality ratings from nationally recognized rating agencies enhance the Company's ability to raise funds in national money markets. The high ratings also help to attract both loan and deposit customers in local markets.
Historically, Regions has found short- and intermediate-term credit readily available on reasonable terms from money center or regional banks. Regions' management places constant emphasis on the maintenance of adequate liquidity to meet conditions which might reasonably be expected to occur.
DEPOSITS
Deposits are Regions' primary source of funds -- providing funding for 85% of average earning assets in 1998 and 88% in 1997. During the last four years, average total deposits grew at a compound annual rate of 12%. Average deposits grew $2.0 billion or 10% in 1996, $3.2 billion or 15% in 1997 and $2.7 billion or 11% in 1998. Acquisitions contributed average deposit growth of $667 million in 1996, $948 million in 1997 and $1.5 billion in 1998.
Regions faces stiff competition from other banking and financial services companies for a share of the deposit market. Regions' ability to compete in the deposit market depends heavily on how effectively the company meets customers' needs. Regions employs both traditional and non-traditional means to meet customers' needs and enhance competitiveness. The traditional means include: providing well-designed products, providing a high level of customer service, providing attractive pricing and expanding the traditional branch network to provide convenient branch locations for customers throughout the Southeastern United States. Recently, Regions has also begun to employ non-traditional approaches to enhance its competitiveness. These include: providing centralized, high quality telephone banking services and providing alternative product delivery channels like PC banking. Regions' success at competing for deposits is discussed below.
Average non-interest bearing deposits have grown at a steady pace, increasing at a compound growth rate of 11% since 1995. This category of deposits grew 7% in 1996, 20% in 1997 and 7% in 1998. Non-interest
bearing deposits are a significant funding source for Regions, accounting for 14%, 15% and 14% of average total deposits in 1996, 1997 and 1998 respectively.
During 1996, 1997 and 1998, the rate paid on savings accounts was less attractive to customers, relative to other investment alternatives. As a result, savings accounts have increased at only a 3% compound growth rate since 1995. Savings increased 2% in 1996, 6% in 1997 and 3% in 1998. Management expects savings accounts to continue to be a stable funding source, but does not expect any significant growth in the current interest rate environment. In 1998, savings accounts accounted for 6% of average total deposits.
During 1998, interest-bearing transaction accounts decreased 3%. In 1997, the average balance of these types of deposits accounts increased 21%. During 1996, Regions reclassified a portion of interest-bearing transaction accounts to money market savings accounts, resulting in a 58% decline in 1996. During 1998 and 1997, interest-bearing transaction accounts accounted for 3% and 4%, respectively, of average total deposits.
Money market savings products continue to be Regions' fastest growing deposits, increasing at a compound annual rate of 28% since 1995. Customers have responded to Regions' innovative, competitive money market savings products by continuing to invest in these accounts. The results are increases in average balances of 43% in 1996, 16% in 1997 and 28% in 1998. As mentioned above, a reclassification from interest-bearing transaction accounts to money market savings increased the 1996 money market savings growth rate. Money market savings products are one of Regions' most significant funding sources, accounting for 24% of average total deposits in 1996, 25% of average total deposits in 1997 and 28% of average total deposits in 1998.
Certificates of deposit of $100,000 or more increased 22% in 1996, and 1997, due to their increased use as a funding source but increased only 2% in 1998 as customers turned to other investments due to rates. Since 1995, certificates of deposit of $100,000 or more have increased at a compound annual rate of 15%, and in 1998 accounted for 13% of average total deposits.
Other interest-bearing deposits (certificates of deposit of less than $100,000 and time open accounts) increased 11% in 1997 and 8% in 1998. This category of deposits continues to be Regions' primary funding source; it accounted for 35% of average total deposits in 1998, down from 36% of average total deposits in 1997. Wider pricing spreads over the last two years have made this category of deposits attractive relative to other investment alternatives. Innovative deposit products in this category have helped Regions continue to increase deposits and maintain market share in the Company's major markets.
The sensitivity of Regions' deposit rates to changes in market interest rates is reflected in the Company's average interest rate paid on interest-bearing deposits (see table following on Average Rates Paid). Beginning in early 1995 and continuing throughout the year, market interest rates began to decline. During 1996 and 1997, market interest rates were relatively stable. During 1998, market interest rates generally declined. While Regions' average interest rate paid on interest-bearing deposits follows these trends, a lag period exists between the change in market rates and the repricing of the deposits. The rate paid on interest-bearing deposits increased from 4.58% in 1996, to 4.63% in 1997 but decreased to 4.61% in 1998.
A detail of interest-bearing deposit balances at December 31, 1998 and 1997, and the interest expense on these deposits for the three years ended December 31, 1998, is presented in Note H to the consolidated financial statements.
The following table presents the detail of interest-bearing deposits and maturities of the larger time deposits:
The following table presents the average amounts of deposits outstanding by category for the three years ended December 31, 1998:
The following table presents the average rates paid on deposits by category for the three years ended December 31, 1998:
BORROWED FUNDS
Regions' short-term borrowings consist of federal funds purchased and security repurchase agreements, commercial paper, Federal Home Loan Bank structured notes and other short-term borrowings.
Federal funds purchased and security repurchase agreements are used to satisfy daily funding needs and, when advantageous, for rate arbitrage. Federal funds purchased and security repurchase agreements totaled $2.1 billion at December 31, 1997 and 1998. Balances in these accounts can fluctuate significantly on a day-to-day basis. The average daily balance of federal funds purchased and security repurchase agreements, net of federal funds sold and security reverse repurchase agreements, increased $366 million in 1997 but decreased $276 million in 1998. The 1997 increase resulted from increased reliance on purchased funds to support earning asset growth. The 1998 decrease resulted from increased utilization of alternative short term funding due to favorable rates.
In December 1997 and throughout 1998, Regions utilized Federal Home Loan Bank structured notes as a short-term funding source, primarily due to their favorable interest rate. These structured notes have a stated ten year maturity but are callable, at the option of the Federal Home Loan Bank, every three months. Because of the call feature, the structured notes are considered short term. As of December 31, 1998, $2.4 billion of structured notes were outstanding compared to $500 million as of December 31, 1997.
At December 31, 1998, $56.8 million in commercial paper was outstanding, compared to $52.8 million at December 31, 1997. The Company issues commercial paper through its private placement commercial paper program. Company policy limits total commercial paper outstanding, at any time, to $75 million. The level of commercial paper outstanding depends on the funding requirements of the Company and the cost of commercial paper compared to alternative borrowing sources.
Other short-term borrowings decreased $3.1 million from December 31, 1997 to December 31, 1998, primarily due to a decline in short-term Federal Home Loan Bank advances. The remaining balance in other short-term borrowings consists of a Treasury tax and loan note and a short sale liability, which is frequently used by Regions' broker/dealer subsidiary to offset other market risks which are undertaken in the normal course of business.
Regions' long-term borrowings consist primarily of subordinated notes, Federal Home Loan Bank borrowings and other long-term notes payable.
The amount outstanding on subordinated notes decreased $900,000 between December 31, 1997 and 1998 due to a prepayment of subordinated notes acquired in connection with a pooled company.
Federal Home Loan Bank borrowings increased $102.7 million in 1998 due to notes assumed through acquisitions. Membership in the Federal Home Loan Bank system provides access to an additional source of lower-cost funds. These borrowings can be used to partially hedge against the effect future interest rate changes may have on the Company's real estate mortgage portfolio.
Other long-term notes payable consist of mortgage notes payable on certain of the Company's buildings and low-income housing partnership investments, notes issued to former stockholders of acquired banks, notes for equipment financing, notes payable to unaffiliated banks and miscellaneous notes payable. Other long-term borrowings increased $26.3 million in 1998, due to loans to unaffiliated banks assumed in connection with acquisitions in 1998.
STOCKHOLDERS' EQUITY
Over the past three years, stockholders' equity has increased at a compound annual growth rate of 13.6%. Stockholders' equity has grown from $2.0 billion at the beginning of 1996 to $3.0 billion at year-end 1998. Internally generated retained earnings contributed $680 million of this growth, equity issued in connection with acquisitions accounted for $200 million, $62 million was attributable to the exercise of stock options and to the issuance of stock for dividend reinvestment plans and employee incentive plans, and $11 million was attributable to increases in other components of equity. The internal capital generation rate (net income less dividends as a percentage of average stockholders' equity) was 8.0% in 1998, compared to 9.6% in 1997 and 9.3% in 1996.
Regions' ratio of stockholders' equity to total assets was 8.15% at December 31, 1998, compared to 8.53% at December 31, 1997, and 8.43% at December 31, 1996. Regions' capital level is a source of strength and provides flexibility for future growth.
Regions and its subsidiaries are required to comply with capital adequacy standards established by banking regulatory agencies. Currently, there are two basic measures of capital adequacy: a risk-based measure and a leverage measure.
The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposure and interest rate risk, and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with specified risk-weighting factors. The resulting
capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items. Banking organizations that are considered to have excessive interest rate risk exposure are required to hold additional capital.
The minimum standard for the ratio of total capital to risk-weighted assets is 8%. At least 50% of that capital level must consist of common equity, undivided profits and non-cumulative perpetual preferred stock, less goodwill and certain other intangibles ("Tier 1 capital"). The remainder ("Tier 2 capital") may consist of a limited amount of other preferred stock, mandatory convertible securities, subordinated debt and a limited amount of the allowance for loan losses. The sum of Tier 1 capital and Tier 2 capital is "total risk-based capital."
The banking regulatory agencies also have adopted regulations which supplement the risk-based guidelines to include a minimum ratio of 3% of Tier 1 capital to average assets less goodwill (the "leverage ratio"). Depending upon the risk profile of the institution and other factors, the regulatory agencies may require a leverage ratio of 1% to 2% above the minimum 3% level.
The following chart summarizes the applicable bank regulatory capital requirements. Regions' capital ratios at December 31, 1998, substantially exceeded all regulatory requirements.
BANK REGULATORY CAPITAL REQUIREMENTS
At December 31, 1998, Tier 1 capital totaled $2.6 billion, total risk-based capital totaled $3.1 billion, and risk-adjusted assets totaled $25.6 billion.
Total capital at the banking affiliates also has an important effect on the amount of FDIC insurance premiums paid. Institutions not considered well capitalized can be subject to higher rates for FDIC insurance. As of December 31, 1998, all of Regions' banking affiliates had the requisite capital levels to qualify as well capitalized.
Regions attempts to balance the return to stockholders through the payment of dividends, with the need to maintain strong capital levels for future growth opportunities. In 1998, Regions returned 45% of earnings to its stockholders in the form of dividends. Total dividends declared by Regions in 1998 were $191.6 million or $.92 per share, an increase of 15% from the $0.80 per share in 1997. Also in 1997, Regions effected a two-for-one stock split.
In January 1999, the Board of Directors declared a 9% increase in the quarterly cash dividend from $.23 to $.25 per share. This is the twenty-eighth consecutive year that Regions has increased cash dividends.
The following table shows the percentage distribution of Regions' consolidated average balances of assets, liabilities and stockholders' equity for the five years ended December 31, 1998:
OPERATING RESULTS
Net income increased 6% in 1998 and 25% in 1997. Excluding the SAIF assessment in 1996 and the merger and consolidation expenses incurred in 1996 and 1998 (see Note U to the consolidated financial statements) income increased 17% in 1997 and 26% in 1998. The accompanying table presents the dollar amount and percentage change in the important components of income that occurred in 1998 and 1997.
SUMMARY OF CHANGES IN OPERATING RESULTS
NET INTEREST INCOME
Net interest income (interest income less interest expense) is Regions' principal source of income. Net interest income increased 12% in 1998 and 17% in 1997. On a taxable equivalent basis, net interest income also increased 12% in 1998 and 17% in 1997. The table on page 41 provides additional information to analyze the changes in net interest income.
In 1998 and 1997, growth in interest-earning assets and interest-bearing liabilities contributed to the increase in net interest income. During 1998, average interest-earning assets grew 16% and average interest-bearing liabilities grew 17%. Growth in earning assets typically increases net interest income due to the positive spread between earning asset yields and interest-bearing liability rates. However, unfavorable changes in interest-bearing liability rates partially offset the increase in net interest income attributable to growth.
Regions measures its ability to produce net interest income with a ratio called the interest margin. The interest margin is net interest income (on a taxable equivalent basis) as a percentage of average earning assets. The interest margin increased from 4.36% in 1996, to 4.41% in 1997 but declined to 4.25% in 1998. Changes in
the interest margin occur primarily due to two factors: (1) the interest rate spread (the difference between the taxable equivalent yield on earning assets and the rate on interest-bearing liabilities) and (2) the percentage of earning assets funded by interest-bearing liabilities.
The first factor affecting Regions' interest margin is the interest rate spread. Regions' average interest rate spread was 3.65% in 1996, 3.66% in 1997, and 3.54% in 1998. Market interest rates, both the level of rates and the slope of the yield curve (the spread between short-term rates and longer-term rates), affect the interest rate spread by influencing the pricing on most categories of Regions' interest-earning assets and interest-bearing liabilities.
In January 1996, the Federal Reserve (Fed) lowered the Federal Funds rate to 5.25%. The Fed maintained the 5.25% Fed Funds rate throughout 1996. In March 1997 the Fed raised the Federal Funds rate to 5.50% where it remained for the rest of 1997. In 1998, the Fed reduced the Federal Funds rate to 4.75% in a series of rate reductions in the second half of the year.
As the Federal Funds rate declined during 1998, yields on intermediate to long-term government securities dropped considerably. This drop in government interest rates created a relatively flat yield curve. Regions' interest-earning asset yields and interest-bearing liability rates were both lower in 1998 compared to 1997 -- reflecting the declining market interest rates experienced in 1998. However, as market interest rates declined and as the yield curve flattened, Regions' interest-earning asset yields decreased faster than did interest-bearing liability rates. The interest rate spread contracted in 1998 because interest-earning asset yields decreased 12 basis points more than did interest-bearing liability rates.
The mix of earning assets can also affect the interest rate spread. During 1998, loans, which are typically Regions' highest yielding earning asset, decreased as a percentage of earning assets -- adding to the effects of changing earning asset yields and interest-bearing liability rates. Average loans as a percentage of earning assets were 75% in 1997 and 74% in 1998.
The second factor affecting the interest margin is the percentage of earning assets funded by interest-bearing liabilities. Funding for Regions' earning assets comes from interest-bearing liabilities, non-interest-bearing liabilities and stockholders' equity. The net spread on earning assets funded by non-interest-bearing liabilities and stockholders' equity is higher than the net spread on earning assets funded by interest-bearing liabilities. The percentage of earning assets funded by interest-bearing liabilities was 85% in 1996, 84% in 1997 and 85% in 1998. The changes in the percentage of earning assets funded by interest-bearing liabilities had a positive effect on net interest income in 1997 but a negative effect in 1998. The trend has been for a greater percentage of new funding for earning assets to come from interest-bearing sources. Management expects this trend to continue.
MARKET RISK -- INTEREST RATE SENSITIVITY
Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to a change in interest rates, exchange rates and equity prices. Regions' primary risk is interest rate risk.
The primary objective of Asset/Liability Management at Regions is to manage interest rate risk and achieve reasonable stability in net interest income throughout interest rate cycles. This is achieved by maintaining the proper balance of rate sensitive earning assets, rate sensitive liabilities and off-balance sheet interest rate hedges. The relationship of rate sensitive earning assets to rate sensitive liabilities, adjusted for the effect of off-balance sheet hedges (interest rate sensitivity), is the principal factor in projecting the effect that fluctuating interest rates will have on future net interest income. Rate sensitive earning assets and interest-bearing liabilities are those that can be repriced to current market rates within a relatively short time period. Management monitors the rate sensitivity of earning assets and interest-bearing liabilities over the entire life of these instruments, but places particular emphasis on the first year. At December 31, 1998, approximately 47% of earning assets and 66% of the funding for these earning assets were scheduled to be repriced to current market rates at least once during 1999.
The accompanying table shows Regions' rate sensitive position at December 31, 1998, as measured by gap analysis (the difference between the earning asset and interest-bearing liability amounts scheduled to be
repriced to current market rates in subsequent periods). Over the next 12 months approximately $6.3 billion more interest-bearing liabilities than earning assets can be repriced to current market rates at least once. As a result, the one-year cumulative gap (the ratio of rate sensitive assets to rate sensitive liabilities) at December 31, 1998, was 0.72, indicating a "liability sensitive" position. However, this ratio is only one of the tools that management uses to measure rate sensitivity.
Historically, Regions has not experienced the level of net interest income volatility indicated by gap analysis. The primary reason for the lack of volatility is that Regions has a relatively large base of core deposits that do not reprice on a contractual basis. These deposit products include regular savings, interest-bearing transaction accounts and a portion of money market savings accounts. Balances for these accounts are reported in the one to three month repricing category. However, the rates paid are typically not directly related to market interest rates, since management exercises some discretion in adjusting these rates as market rates change.
Another reason for the lack of volatility in net interest income is that Regions' loan and security portfolios contain fixed-rate mortgage-related products, including whole loans, mortgage-backed securities and collateralized mortgage obligations having amortization and cash flow characteristics that vary with the level of market interest rates. These earning assets are generally reported in the non-sensitive category. In fact, a significant portion of these earning assets may pay-off within one year or less because their cash flow characteristics are materially impacted by mortgage refinancing activity. If deposit accounts that are not sensitive to market interest rate changes were redistributed based on expected cash flows and probable repricing intervals, Regions' one-year cumulative gap ratio would be 0.99 -- indicating a slight "liability sensitive" position.
Regions uses additional tools to monitor and manage interest rate sensitivity. One of the primary tools used is simulation analysis. Simulation analysis is the primary method of estimating earnings at risk and capital at risk under varying interest rate conditions. Simulation analysis is used to test the sensitivity of Regions' net interest income and stockholders' equity to both the level of interest rates and the slope of the yield curve. Simulation analysis uses a more detailed version of the information shown in the accompanying table and adds adjustments for the expected timing and magnitude of asset and liability cash flows, as well as the expected timing and magnitude of repricings of deposits that do not reprice on a contractual basis. In addition, simulation analysis includes adjustments for the lag between movements in market interest rates and the movement of administered rates on prime rate loans, interest-bearing transaction accounts, regular savings and money market savings accounts. These adjustments are made to reflect more accurately possible future cash flows, repricing behavior and ultimately net interest income. Simulation analysis indicates that Regions is slightly "liability sensitive."
FORWARD-LOOKING STATEMENTS
The section that follows, "Exposure to Interest Rate Shifts", contains certain forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995). These forward-looking statements may involve significant risk and uncertainties. Although Regions believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from the results discussed in these forward-looking statements.
Exposure to Interest Rate Shifts. Based on the aforementioned discussion, management can estimate the effect shifts in interest rates may have upon the Company's net interest income, Regions' principal source of income.
The following table demonstrates the expected effect a given interest rate shift would have on Regions net interest income.
In the event of a shift in interest rates, management would attempt to take certain actions to mitigate the negative impact to net interest income. These actions include but are not limited to, restructuring of interest-earning assets, seeking alternative funding sources and entering into interest rate swap agreements.
INTEREST RATE SENSITIVITY ANALYSIS
ANALYSIS OF CHANGES IN NET INTEREST INCOME
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Note: The change in interest due to both rate and volume has been allocated to change due to volume and change due to rate in proportion to the absolute dollar amounts of the change in each.
PROVISION FOR LOAN LOSSES
This expense is used to fund the allowance for loan losses. Actual loan losses, net of recoveries, are charged directly to the allowance. The expense recorded each year is a reflection of actual losses experienced during the year and management's judgment as to the adequacy of the allowance to absorb future losses. For an analysis and discussion of the allowance for loan losses, refer to the section entitled "Loans and Allowance for Loan Losses." In 1996, the provision for loan losses was increased to $46.0 million due to growth in the loan portfolio and higher levels of consumer loan losses. In 1997, the provision for loan losses was increased to $89.7 million due to internal growth in the loan portfolio, growth in loans from acquisitions, higher levels of consumer loan losses and provisions for loan losses made by a pooled company for several specific problem commercial loans. Acquisitions added $17.4 million to the allowance for loan losses in 1997. In 1998, the provision for loan losses totaled $60.5 million and acquisition activity added $17.1 million to the allowance for loan losses. The provision for loan losses declined $29.2 million in 1998, even with higher net charge-offs,
because a significant portion of the 1998 charge-offs had been identified and provided for in the prior years. The resulting year end allowance for loan losses increased $11.2 million to $315.4 million. Unfavorable changes in the previously discussed factors considered by management in determining the amount of the provision for loan losses and the resulting allowance could require significantly higher provisions for loan losses in the future.
TRUST INCOME
Trust income increased 9% in 1996, 6% in 1997 and 25% in 1998. Regions has in place an aggressive sales program as a means of increasing trust revenue. Trust sales efforts are promoted throughout the company by strong sales goals and cash incentives. In addition to increased sales efforts, trust income is also affected by the securities markets, because most trust fees are calculated as a percentage of trust asset values. The strength of the securities markets during the last three years has had a favorable impact on trust income.
SERVICE CHARGES ON DEPOSIT ACCOUNTS
Service charge income increased 19% in 1996, 21% in 1997, and 13% in 1998, due to increases in the number of deposit accounts, primarily because of acquisitions, and changes in the pricing of certain deposit accounts and related services.
MORTGAGE SERVICING AND ORIGINATION FEES
The primary source of this income is Regions' mortgage banking affiliate -- Regions Mortgage, Inc. (RMI). RMI's primary business and source of income is the origination and servicing of mortgage loans for long-term investors.
In 1998, mortgage servicing and origination fees increased 20%, from $93.3 million in 1997 to $111.6 million in 1998. Origination fees were significantly higher due to an increase in the number of loans closed and the dollar amount of loans closed. Servicing fees were also higher in 1998 than in 1997. At December 31, 1998, Regions' servicing portfolio totaled $22.3 billion and included approximately 349,000 loans. At December 31, 1997, the servicing portfolio totaled $20.4 billion, compared to $19.7 billion at December 31, 1996. Growth in the servicing portfolio resulted from retention of servicing on most mortgages originated in-house and the purchase of servicing rights to mortgages originated by other companies.
In 1997, mortgage servicing and origination fees increased 1%, from $92.8 million in 1996 to $93.3 million in 1997. Origination fees were higher due to an increase in the number of loans closed and the dollar amount of loans closed. Servicing fees increased slightly in 1997.
In 1996, mortgage servicing and origination fees increased 41%, from $65.9 million in 1995 to $92.8 million in 1996. Origination fees were up significantly due to an increase in the number of loans closed and the dollar amount of loans closed. Servicing fees also increased in 1996.
RMI, through its retail and correspondent operations, produced mortgage loans totaling $5.0 billion, $2.9 billion, and $2.2 billion in 1998, 1997 and 1996, respectively. RMI produces loans from 87 offices in Alabama, Arkansas, Florida, Georgia, Louisiana, South Carolina, and Tennessee, and from other correspondent offices located primarily in the Southeast.
An analysis of mortgage servicing rights, which are included in other assets in the consolidated statement of condition, is presented as follows. The balances shown represent the original amounts capitalized, less accumulated amortization and valuation adjustments, for the right to service mortgage loans that are owned by other investors. The carrying values of mortgage servicing rights are affected by various factors, including
prepayments of the underlying mortgages. A significant increase in prepayments of mortgages in the servicing portfolio in the future could result in significant increases in the valuation adjustments.
SECURITIES GAINS (LOSSES)
In 1996, net gains from the sale of available for sale securities were $3,311,000, resulting primarily from the sale of Freddie Mac stock that was acquired in an acquisition.
In 1997, net gains of $498,000 were reported from sale of available for sale securities. These gains resulted primarily from the sale of U.S. agency securities.
The $7.0 million in net gains recognized in 1998 from the sale of available for sale securities were the result, primarily, of the sale of odd-lot high coupon mortgage backed securities and odd-lot municipal securities obtained through various acquisitions. These securities had characteristics which were not consistent with Regions overall securities portfolio management strategy.
OTHER INCOME
Refer to Note O to the consolidated financial statements for an analysis of the significant components of other income. Increases in fee and commission income over the last three years resulted primarily from revisions in charges for certain services, an increased emphasis on charging customers for services performed and an increased customer base due to internal growth and acquisitions. Increases in safe deposit fees, international department income, automated teller machine fees, credit card fees and other customer charges contributed to growth in fees and commissions over the last three years.
Insurance premium and commission income increased in 1998, 1997, and 1996. This income originates primarily from the sale of credit life and accident and health insurance to consumer loan customers. Increased consumer loan volumes resulted in increased income in 1998, 1997 and 1996.
Trading account income increased in 1998, 1997 and 1996 due to expanded trading activities, increased underwriting fees, and larger profits from trading in the portfolio.
In 1997, a pooled company recognized a gain related to the divestiture of two banks. The divestiture was required by regulatory authorities in connection with a business combination.
SALARIES AND EMPLOYEE BENEFITS
Total salaries and benefits increased 11% in 1996, 16% in 1997 and 10% in 1998. These increases resulted from normal merit and promotional adjustments, increased incentive payments tied to performance, the effects of inflation, higher benefit costs and increases in the number of employees due to increased business activity and acquisitions.
At December 31, 1998, Regions had 14,632 full-time equivalent employees, compared to 13,294 at December 31, 1997 and 12,272 at December 31, 1996. Employees added as a result of acquisitions accounted for most of these increases.
Salaries, excluding benefits, totaled $295.1 million in 1996, compared to $335.1 million in 1997 and $382.4 million in 1998. These increases resulted from increased employment levels, due to acquisitions and increased business activity, and normal merit and promotional adjustments.
Regions provides employees who meet established employment requirements with a benefits package which includes pension, profit sharing, stock purchase, and medical, life and disability insurance plans. The total cost to Regions for fringe benefits, including payroll taxes, equals approximately 26% of salaries.
The contribution to the profit sharing plan was equal to approximately 7% of after-tax income in 1996 and 1997 and 6% in 1998.
The contribution to the employee stock ownership plan (ESOP) equaled approximately 1% of after-tax income in each of the last three years.
Commissions and incentives expense decreased to $47.0 million in 1998, compared to $54.4 million in 1997 and $37.6 million in 1996. Incentives are being used increasingly to reward employees for selling products and services, for productivity improvements and for achievement of other corporate goals. Regions' long-term incentive plan provides for the granting of stock options, stock appreciation rights, restricted stock and performance shares (see Note R to the consolidated financial statements). The long-term incentive plan is intended to assist the Company in attracting, retaining, motivating and rewarding employees who make a significant contribution to the Company's long-term success, and to encourage employees to acquire and maintain an equity interest in the Company. The decline in Regions stock price in 1998 contributed to the lower commissions and incentives expense in 1998 because expense recognition for a portion of Regions' equity incentive awards is related to Regions stock price performance. Regions also uses cash incentive plans to reward employees for achievement of various goals.
Payroll taxes increased 10% in 1996, 17% in 1997 and 18% in 1998. Increases in the Social Security tax base, combined with increased salary levels and additional employees due to growth and acquisitions, were the primary reasons for increased payroll taxes.
Group insurance expense increased 8% and 17% in 1996 and 1998, respectively, due to increased employment levels associated with increased business activity and acquisitions and higher claims cost. In 1997, as a result of reduced claims costs, group insurance expense decreased 1%.
NET OCCUPANCY EXPENSE
Net occupancy expense includes rents, depreciation and amortization, utilities, maintenance, insurance, taxes and other expenses of premises occupied by Regions and its affiliates. Regions' affiliates operate offices throughout Alabama, Arkansas and parts of Texas, Louisiana, Florida, Georgia, Tennessee and South Carolina.
Net occupancy expense increased 13% in 1996, 12% in 1997, and 2% in 1998 due to new and acquired branch offices, rising price levels, and increased business activity.
FURNITURE AND EQUIPMENT EXPENSE
Furniture and equipment expense increased 20% in 1996, 13% in 1997, and 22% in 1998. These increases resulted from acquisitions, rising price levels, expenses related to equipment for new branch offices, and increased depreciation and service contract expenses associated with other new back office and branch equipment.
FDIC INSURANCE EXPENSE
FDIC insurance expense decreased 67% in 1996, and 46% in 1997. In 1996, the FDIC significantly reduced insurance premium rates on Bank Insurance Fund (BIF) deposits, which resulted in lower FDIC insurance expense in 1996. Deposit insurance premium rates for Savings Association Insurance Fund (SAIF) deposits, which were approximately 25% of Regions' assessable deposits, remained at $0.23 per $100 of insured deposits during 1996. In 1997, deposit insurance premium rates for BIF and SAIF deposits were further reduced; however, these reductions were partially offset by the Financing Corporation (FICO) assessments, which are approximately $.065 per $100 of SAIF-assessable deposits and $.013 per
$100 of BIF-assessable deposits. FDIC insurance expense increased 13% in 1998 as a result of increased deposits from acquisitions and growth.
MERGER AND CONSOLIDATION EXPENSES AND SAIF ASSESSMENT
In 1998, Regions incurred a pre-tax, non-recurring merger and consolidation charge of $121.4 million related primarily to the merger of First Commercial and four other institutions with Regions. The charge, recognized in the third ($114.7 million) and fourth ($6.7 million) quarters, consisted primarily of employee-related obligations ($33.6 million), elimination of duplicate facilities, obsolete equipment and other assets ($47.6 million), contract terminations ($6.0 million), cost to exit certain lines of business ($5.1 million), and professional fees and contractual payments associated with the mergers ($29.1 million). During 1998, merger-and consolidation-related costs incurred or charged against the accrual totaled $117.0 million, resulting in a balance in the merger and consolidation accrual of $4.4 million at December 31, 1998, which is primarily associated with certain employee related obligations. These employee related obligations were paid out in early 1999, resulting in the merger and consolidation accrual being reduced to zero.
On September 30, 1996, legislation to recapitalize the SAIF became effective. This legislation required Regions, and all other depository institutions having SAIF-insured deposits, to pay a one-time, special assessment. This resulted in a pre-tax expense of $25.0 million for Regions, which was recognized primarily in the third quarter of 1996.
In the first quarter of 1996, Regions incurred a pre-tax, non-recurring merger charge of $8.8 million related to the merger of First National Bancorp with Regions. This charge consisted primarily of investment banking and other professional fees, severance costs, data processing contract buyouts and obsolete equipment write-downs.
OTHER EXPENSES
Refer to Note O to the consolidated financial statements for an analysis of the significant components of other expense. Increases in this category of expense generally resulted from acquisitions, expanded programs, increased business activity and rising price levels.
Other non-credit losses increased in 1998 as well as in 1997 and 1996. Other non-credit losses primarily include charges for items unrelated to the extension of credit such as fraud losses, litigation losses, write-downs of other real estate and insurance claims.
Amortization of mortgage servicing rights increased in 1998 and 1996, but declined in 1997. Statement 122, which was adopted beginning in 1996, results in the capitalization, and subsequent amortization thereof, of more mortgage servicing rights than under previous standards. This resulted in additional amortization expense in 1996 and 1998. However, mortgage servicing rights amortization expense declined in 1997 due to slower prepayment activity on the underlying mortgages than in other years.
Gains or losses on sales of mortgages result from changes in the fair market value of mortgages held in inventory while awaiting sale to long-term investors. Purchased commitments covering the sale of mortgages held in inventory are used to mitigate market losses. (See Note M to the consolidated financial statements for additional information.)
The decrease in other miscellaneous expenses in 1998 resulted primarily from decreases in sales and use taxes, equity asset line fees paid to third parties and fewer losses on disposals and sales of fixed assets.
YEAR 2000
The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs or hardware that have date-sensitive software or embedded chips may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities.
Based on past assessments, the Company determined that it would be required to upgrade significant portions of its software and selected hardware so that those systems would properly utilize dates beyond December 31, 1999. The Company presently believes that with these upgrades of existing software and selected hardware, the Year 2000 Issue can be mitigated.
The Company's plan to resolve the Year 2000 Issue involves the following five steps: awareness of the potential problems Year 2000 can present, inventory and assessment of where potential problems are within the company, renovation and repair of noncompliant systems, testing and validation of solutions, and implementation. Regions began planning its Year 2000 strategy in 1996 and has since formed a project office composed of five people who manage the project on a full-time basis. Additionally, a task force composed of individuals representing all business units within the corporation, and a leadership committee representing all areas of the company have been formed to support the project office. The task force and leadership team provide reports to the Audit Committee of the Board of Directors and to the Board of Directors on a regular basis. Regions is utilizing both internal and external resources to reprogram, replace, and test software and other components of its systems for Year 2000 modifications. Systems have been scheduled for modification based on a risk-adjusted priority to ensure that mission-critical systems are completed in time to allow for extended testing.
To date, Regions has completed its awareness, assessment, renovation and testing steps. The Company has completed the installation of the Year 2000 releases provided by vendors on its core-business systems and has completed the century date testing and validation of its core business systems. Regions will continue to communicate with its vendors and install any additional code releases through 1999.
Approximately ninety percent of Regions' software is supplied by outside suppliers affecting most significant systems of the Company. Regions has initiated formal communications with all of its significant suppliers and large customers to determine the extent to which Regions is vulnerable to those third parties' failure to remediate their own Year 2000 Issue. Regions is spending the majority of its Year 2000 resource allocation installing and testing vendor releases, and has hired consultants to ensure that communications are proceeding properly with vendors. To date, Regions is not aware of any external agent with a Year 2000 Issue that would materially impact Regions' results of operations, liquidity or capital resources.
The projected total cost of the Year 2000 project is currently estimated at approximately $20 million and is being funded through operating cash flows. The projected total costs includes personnel costs and other operating expenses related to the modification of systems and applications, as well as the cost to purchase or lease certain hardware and software. Personnel costs and other operating expenses associated with the Year 2000 project are being expensed in the period incurred. The costs of hardware and software associated with the Year 2000 project are capitalized in accordance with normal policy. The costs of the project and the date on which Regions plans to complete Year 2000 modifications are based on management's best estimates, which were derived utilizing numerous assumptions of future events including the continued availability of certain resources, third party modification plans and other factors. However, there can be no assurance that these estimates will be achieved and actual results could differ materially from those plans. From initiation of the project through December 31, 1998, a cumulative total of approximately $10.2 million had been spent on the assessment of and efforts in connection with the Year 2000 project, including the renovation and repair of noncompliant systems. This includes approximately $1.7 million expended in 1997 (including $1 million for hardware and software) and $8.5 million expended in 1998 (including $1 million for hardware and software). The majority of the remaining cost will be spent on personnel costs and consultant fees.
Management of Regions believes it has an effective program in place to resolve the Year 2000 issue in a timely manner. As noted above, the Company has completed the necessary phases of the Year 2000 program. The mission-critical systems have been upgraded. However, disruptions in the economy that are beyond the Company's control resulting from Year 2000 issues could materially adversely affect the Company. Furthermore, the Company has no means of ensuring that external agents will be Year 2000 ready. The inability of external agents to complete their Year 2000 resolution process in a timely fashion could materially impact the
Company's operations, the estimated costs of the Year 2000 project, and the target dates for completion. The effect of non-compliance by external agents is not determinable. The Company could be subject to litigation for computer systems product failure, for example, equipment shutdown or failure to properly date business records. The amount of potential liability and lost revenue cannot be reasonably estimated at this time.
Management is continuing to develop contingency plans in the event that efforts to renovate Regions' systems are not fully successful or are not completed in accordance with current expectations. The contingency plans represent an enhancement of Regions' existing business resumption plans to safeguard Regions under various Year 2000 scenarios. The contingency plans are being designed to address failures of systems outside Regions. The contingency plans include the use of third party service providers, alternative commercial vendors, alternative data security and other contingency service suppliers.
APPLICABLE INCOME TAX
Regions' provision for income taxes increased 8% in 1998. This increase was caused primarily by a 7% increase in income before taxes. The Company's effective income tax rates for 1998, 1997 and 1996 were 33.6%, 33.2%, and 32.9%, respectively. Note P to the consolidated financial statements provides additional information about the provision for income taxes.
Examinations of Regions' consolidated federal income tax returns have been completed for years through 1995. The Company believes adequate provisions for income tax have been recorded for all years open for review.
Management's determination of the realization of the deferred tax asset is based upon management's judgment of various future events and uncertainties, including the timing and amount of future income earned by certain subsidiaries and the implementation of various tax planning strategies to maximize realization of the deferred tax asset. Management believes that the subsidiaries may be able to generate sufficient operating earnings to realize the deferred tax benefits. However, a portion of the amount of the deferred tax asset that can be realized in any year is subject to certain statutory federal income tax limitations. Because of these uncertainties, a valuation allowance has been established. Management periodically evaluates the realizability of the deferred tax asset and, if necessary, adjusts the valuation allowance accordingly.
EFFECTS OF INFLATION
The majority of assets and liabilities of a financial institution are monetary in nature; therefore, a financial institution differs greatly from most commercial and industrial companies, which have significant investments in fixed assets or inventories. However, inflation does have an important impact on the growth of total assets in the banking industry and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity to assets ratio. Inflation also affects other expenses which tend to rise during periods of general inflation.
Management believes the most significant impact of inflation on financial results is the Company's ability to react to changes in interest rates. As discussed previously, management is attempting to maintain an essentially balanced position between rate sensitive assets and liabilities in order to protect net interest income from being affected by wide interest rate fluctuations.
ITEM 7A.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
Reference is made to page 38 through 39 "Market Risk -- Interest Rate Sensitivity" and pages 39 through 40 "Forward Looking Statements" included in Management's Discussion and Analysis under Item 7 of this Annual Report on Form 10-K.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements and report of independent auditors of Regions Financial Corporation and subsidiaries are set forth in the pages listed below.
Schedules to the consolidated financial statements required by Article 9 of Regulation S-X are not required under the related instructions or are inapplicable, and therefore have been omitted.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors Regions Financial Corporation
We have audited the accompanying consolidated statements of condition of Regions Financial Corporation and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Regions Financial Corporation and subsidiaries at December 31, 1998 and 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Birmingham, Alabama March 11, 1999
REGIONS FINANCIAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION
- ---------------
( ) Indicates deduction.
See notes to consolidated financial statements.
REGIONS FINANCIAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
See notes to consolidated financial statements.
REGIONS FINANCIAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
See notes to consolidated financial statements.
REGIONS FINANCIAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
REGIONS FINANCIAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY -- (CONTINUED)
REGIONS FINANCIAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY -- (CONTINUED)
- ---------------
( ) Indicates deduction See notes to consolidated financial statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of Regions Financial Corporation (Regions or the Company), conform with generally accepted accounting principles and with general financial service industry practices. Regions provides a full range of banking and bank-related services to individual and corporate customers through its subsidiaries and branch offices located primarily in Alabama, Arkansas, Florida, Georgia, Louisiana, South Carolina, Tennessee and Texas. The Company is subject to intense competition from other financial institutions and is also subject to the regulations of certain government agencies and undergoes periodic examinations by those regulatory authorities.
On July 31, 1998, First Commercial Corporation (First Commercial), merged with and into Regions. Additionally, during the first quarter of 1998, PALFED, Inc., First United Bancorporation, and First State Corporation merged with and into Regions. All of these transactions were accounted for as poolings of interests and, accordingly, financial information for all prior periods has been restated to present the combined financial condition and results of operations of all companies as if the transactions had been in effect for all periods presented. Further details of these transactions are presented in Note Q Business Combinations.
FASB No. 130, "Reporting Comprehensive Income," was adopted for 1998. The statement requires additional reporting of items that are recorded directly to shareholders' equity, but not reported in net income, such as unrealized gains and losses on available-for-sale securities. Regions elected to present the required disclosures in the Consolidated Statements of Changes in Stockholders' Equity. The adoption of this standard did not affect Regions' financial results, as it relates to disclosure requirements only.
BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Regions and its subsidiaries. Significant intercompany balances and transactions have been eliminated. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the statement of condition dates and revenues and expenses for the periods shown. Actual results could differ from the estimates and assumptions used in the consolidated financial statements.
Certain amounts in prior year financial statements have been reclassified to conform to the current year presentation.
SECURITIES
The Company's policies for investments in debt and equity securities are as follows. Management determines the appropriate classification of debt and equity securities at the time of purchase and reevaluates such designations as of the date of each statement of condition.
Debt securities are classified as investment securities when the Company has the positive intent and ability to hold the securities to maturity. Investment securities are stated at amortized cost.
Debt securities not classified as investment securities or trading account assets, and marketable equity securities not classified as trading account assets, are classified as securities available for sale. Securities available for sale are stated at estimated fair value, with unrealized gains and losses, net of taxes, reported as a separate component of stockholders' equity.
The amortized cost of debt securities classified as investment securities or securities available for sale is adjusted for amortization of premiums and accretion of discounts to maturity, or in the case of mortgage-backed securities, over the estimated life of the security, using the effective yield method. Such amortization or accretion is included in interest on securities. Realized gains and losses are included in securities gains (losses). The cost of the securities sold is based on the specific identification method.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Trading account assets, which are held for the purpose of selling at a profit, consist of debt and marketable equity securities and are carried at estimated market value. Gains and losses, both realized and unrealized, are included in other income.
MORTGAGE LOANS HELD FOR SALE
Mortgage loans held for sale are carried at the lower of aggregate cost or estimated market value. Gains and losses on mortgages held for sale are included in other expense.
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL AND SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities purchased under agreements to resell and securities sold under agreements to repurchase are generally treated as collaterized financing transactions and are recorded at market value plus accrued interest. It is Regions' policy to take possession of securities purchased under resell agreements.
LOANS
Interest on loans is generally accrued based upon the principal amount outstanding.
Through provisions charged directly to operating expense, Regions has established an allowance for loan losses. This allowance is reduced by actual loan losses and increased by subsequent recoveries, if any.
The allowance for loan losses is maintained at a level believed adequate by management to absorb potential losses in the loan portfolio. Management's determination of the adequacy of the allowance is based on an evaluation of the portfolio, historical loan loss experience, current economic conditions, collateral values of properties securing loans, volume, growth, quality and composition of the loan portfolio and other relevant factors. Unfavorable changes in any of these, or other factors, or the availability of new information, could require that the allowance for loan losses be increased in future periods. The method used to determine the amount of loss inherent in the loan portfolio and thereby assess the adequacy of the recorded balance of the allowance for loan losses involves identifying portfolios of loans with similar characteristics for which estimates of inherent future probable losses can be made. The estimates are based on historical loss factors as adjusted for current business and economic conditions. The loss factors are applied to the respective portfolios in order to determine the overall allowance adequacy.
On loans which are considered impaired, it is Regions' policy to reverse interest previously accrued on the loan against interest income. Interest on such loans is thereafter recorded on a "cash basis" and is included in earnings only when actually received in cash and when full payment of principal is no longer doubtful.
PREMISES AND EQUIPMENT
Premises and equipment and leasehold improvements are stated at cost, less accumulated depreciation and amortization. The provision for depreciation is computed using the straight-line and declining-balance methods over the estimated useful lives of the assets. Leasehold improvements are amortized using the straight-line method over the estimated useful lives of the improvements (or the terms of the leases if shorter).
Estimated useful lives generally are as follows:
INTANGIBLE ASSETS
Intangible assets, consisting of (1) the excess of cost over the fair value of net assets of acquired businesses and (2) amounts capitalized for the right to service mortgage loans, are included in other assets. The excess of cost over the fair value of net assets of acquired businesses, which totaled $354,501,000 at
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
December 31, 1998, and $250,167,000 at December 31, 1997, is being amortized over periods of 12 to 25 years, principally using the straight-line method of amortization. Amounts capitalized for the right to service mortgage loans, which totaled $141,926,000 at December 31, 1998 and $124,087,000 at December 31, 1997, are being amortized over the estimated remaining servicing life of the loans, considering appropriate prepayment assumptions. The estimated fair values of capitalized mortgage servicing rights were $169 million and $198 million at December 31, 1998 and 1997, respectively. The fair value of mortgage servicing rights is calculated by discounting estimated future cash flows from the servicing assets, using market discount rates, and using expected future prepayment rates. In 1998, 1997 and 1996, Regions capitalized $49.7 million, $31.9 million and $30.1 million in mortgage servicing rights, respectively. In 1998, 1997 and 1996, Regions' amortization of mortgage servicing rights was $31.8 million, $25.9 million and $33.7 million, respectively. Intangible assets are evaluated periodically for impairment. For purposes of evaluating impairment, the Company stratifies its mortgage servicing portfolio on the basis of certain risk characteristics including loan type and note rate.
On January 1, 1997, Regions adopted Statement of Financial Accounting Standards No. 125 "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities" (Statement 125), which superseded Statement 122. Statement 125 retained most of the provisions of Statement 122, and it modified existing provisions affecting servicing right impairment evaluation, and income from servicing in excess of contractually-stated amounts. The impact of Statement 125 was not material to Regions' financial condition or results of operations.
PENSION, PROFIT-SHARING AND EMPLOYEE STOCK OWNERSHIP PLANS
Regions has pension, profit-sharing and employee stock ownership plans covering substantially all employees. Annual contributions to the profit-sharing and employee stock ownership plans are determined at the discretion of the Board of Directors. Pension expense is computed using the projected unit credit (service prorate) actuarial cost method and the pension plan is funded using the aggregate actuarial cost method. Annual contributions to all the plans do not exceed the maximum amounts allowable for federal income tax purposes.
INCOME TAXES
Regions and its subsidiaries file a consolidated federal income tax return. The consolidated financial statements (including the provision for income taxes) are prepared on the accrual basis. Regions accounts for income taxes using the liability method pursuant to Financial Accounting Standards Board Statement 109, "Accounting for Income Taxes." Under this method, the Company's deferred tax assets and liabilities were determined by applying federal and state tax rates currently in effect to its cumulative temporary book/tax differences. Temporary differences occur when income and expenses are recognized in different periods for financial reporting purposes and for purposes of computing income taxes currently payable. Deferred taxes are provided as a result of such temporary differences.
PER SHARE AMOUNTS
Earnings per share computations are based upon the weighted average number of shares outstanding during the periods. Diluted earnings per share computations are based upon the weighted average number of shares outstanding during the period plus the dilutive effect of outstanding stock options and stock performance awards.
TREASURY STOCK
The purchase of the Company's common stock is recorded at cost. At the date of retirement or subsequent reissue, the treasury stock account is reduced by the cost of such stock.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
INSURANCE SUBSIDIARIES
Insurance premium and commission income and acquisition costs are recognized over the terms of the related policies. Losses are recognized as incurred.
STATEMENT OF CASH FLOWS
Cash equivalents include cash and due from banks and federal funds sold and securities purchased under agreements to resell. Regions paid $1.3 billion in 1998, $1.1 billion in 1997, and $934 million in 1996 for interest on deposits and borrowings. Income tax payments totaled $187 million for 1998, $147 million for 1997, and $166 million for 1996. Loans transferred to other real estate totaled $19 million in 1998, $26 million in 1997, and $22 million in 1996. The securitization of loans during 1998 resulted in the transfer of $533.7 million from loans to securities available for sale. In 1997, a pooled subsidiary securitized $47.5 million of mortgage loans, which were transferred to trading account assets.
NOTE B. RESTRICTIONS ON CASH AND DUE FROM BANKS
Regions' subsidiary banks are required to maintain reserve balances with the Federal Reserve Bank. The average amount of the reserve balances maintained for the year ended December 31, 1998 and 1997 was approximately $110,884,000 and $96,109,000, respectively.
NOTE C. SECURITIES
The amortized cost and estimated fair value of investment securities and securities available for sale at December 31, 1998, are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The cost and estimated fair value of investment securities and securities available for sale at December 31, 1998 by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Proceeds from sales of securities available for sale in 1998, were $628.2 million. Gross realized gains and losses were $9.5 million and $2.5 million, respectively. Proceeds from sales of securities available for sale in 1997 were $71.1 million, with gross realized gains and losses of $604,000 and $106,000, respectively. Proceeds from sales of securities available for sale in 1996 were $337.4 million with gross realized gains and losses of $4.9 million and $1.6 million, respectively.
The amortized cost and estimated fair value of investment securities and securities available for sale at December 31, 1997, are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Securities with carrying values of $3,606,804,000 and $3,334,555,000 at December 31, 1998, and 1997, respectively, were pledged to secure public funds, trust deposits and certain borrowing arrangements.
NOTE D. LOANS
The loan portfolio at December 31, 1998 and 1997, consisted of the following:
Directors and executive officers of Regions and its principal subsidiaries, including the directors' and officers' families and affiliated companies, are loan and deposit customers and have other transactions with Regions in the ordinary course of business. Total loans to these persons (excluding loans which in the aggregate do not exceed $60,000 to any such person) at December 31, 1998, and 1997, were approximately $113 million and $294 million respectively. During 1998, $518 million of new loans were made, repayments totaled $521 million and decreases for changes in the composition of related parties totaled $178 million. These loans were made in the ordinary course of business and on substantially the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other persons and involve no unusual risk of collectibility.
Loans sold with recourse totaled $506.5 million and $641.0 million at December 31, 1998, and 1997, respectively.
The loan portfolio is diversified geographically, primarily within Alabama, Arkansas, Louisiana, Georgia, South Carolina, northwest and central Florida, eastern Texas, and western and middle Tennessee.
The recorded investment in impaired loans was $175 million at December 31, 1998, and $57 million at December 31, 1997. The increase is due primarily to certain commercial credits, added in 1998, which have been written down to estimated fair value of the underlying collateral. The average amount of impaired loans during 1998 was $167 million.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE E. ALLOWANCE FOR LOAN LOSSES
An analysis of the allowance for loan losses follows:
NOTE F. PREMISES AND EQUIPMENT
A summary of premises and equipment follows:
Net occupancy expense is summarized as follows:
NOTE G. OTHER REAL ESTATE
Other real estate acquired in satisfaction of indebtedness ("foreclosure") is carried in other assets at the lower of the recorded investment in the loan or the estimated net realizable value of the collateral. Other real estate totaled $17,273,000 at December 31, 1998, and $20,511,000 at December 31, 1997. Gain or loss on the sale of other real estate is included in other expense.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE H. DEPOSITS
The following schedule presents the detail of interest-bearing deposits:
The following schedule details interest expense on deposits:
The aggregate amount of maturities of all time deposits in each of the next five years is as follows: 1999 -- $8.8 billion; 2000 -- $2.9 billion; 2001 -- $444 million; 2002 -- $410 million; and 2003 -- $170 million.
NOTE I. BORROWED FUNDS
Following is a summary of short-term borrowings:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Federal funds purchased and securities sold under agreements to repurchase had weighted average maturities of six, seven and ten days at December 31, 1998, 1997 and 1996, respectively. Weighted average rates on these dates were 5.4%, 4.8%, and 6.0%, respectively.
Federal Home Loan Bank structured notes have a stated ten year maturity, but are callable within three months. The structured notes had weighted average rates of 4.8% and 4.9% at December 31, 1998 and 1997, respectively.
Commercial paper maturities ranged from 53 to 1,054 days at December 31, 1998, from 257 to 581 days at December 31, 1997 and from 3 to 715 days at December 31, 1996. Weighted average maturities were 811, 329 and 372 days at December 31, 1998, 1997 and 1996, respectively. The weighted average interest rates on these dates were 5.8%, 6.3% and 5.8%, respectively.
Regions has an unsecured short-term credit agreement with an unaffiliated bank that provides for maximum borrowings of $100 million. No borrowings were outstanding under this agreement at December 31, 1998 or 1997. No compensating balances or commitment fees are required by this agreement. In addition to this short-term credit agreement, a subsidiary of Regions has, as of December 31, 1998, a $50 million revolving credit line with an unaffiliated bank that requires a $10,000 compensating balance. As of December 31, 1998 and 1997, no borrowings were outstanding under this agreement. On December 31, 1996, $53.4 million was outstanding.
The short-sale liability represents Regions' trading obligation to deliver certain government securities at a predetermined date and price. These securities had weighted average interest rates of 5.0%, 6.3% and 6.5% at December 31, 1998, 1997 and 1996, respectively.
The Federal Home Loan Bank advances represent borrowings with original stated maturities of less than one year. These notes had weighted average interest rates on December 31, 1998, 1997, and 1996, of 6.1%, 5.8%, and 5.5%, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Long-term borrowings consist of the following:
In July 1994, Regions issued $25 million of 7.65% subordinated notes, due August 15, 2001, and in September 1994, Regions issued $100 million of 7.75% subordinated notes, due September 15, 2024. The $100 million of 7.75% subordinated notes may be redeemed in whole or in part at the option of the holders thereof on September 15, 2004, at 100% of the principal amount to be redeemed, together with accrued interest. In December 1992, Regions issued $75 million of 7.80% subordinated notes, due December 1, 2002. All issues of these notes are subordinated and subject in right of payment of principal and interest to the prior payment in full of all senior indebtedness of the Company, generally defined as all indebtedness and other obligations of the Company to its creditors, except subordinated indebtedness. Payment of the principal of the notes may be accelerated only in the case of certain events involving bankruptcy, insolvency proceedings or reorganization of the Company. The subordinated notes described above, qualify as "Tier 2 capital" under Federal Reserve guidelines. Regions prepaid $900,000 of subordinated notes originally issued by pooled companies during 1998.
Federal Home Loan Bank notes represent borrowings from Federal Home Loan Banks. Interest on these borrowings is at fixed rates ranging from 5.0% to 8.1%, with maturities of one to nineteen years. These borrowings, as well as the short-term borrowings from the Federal Home Loan Bank, are secured by Federal Home Loan Bank stock (carried at cost of $139.3 million) and by first mortgage loans on one-to-four family dwellings held by certain banking subsidiaries (approximately $4.4 billion at December 31, 1998). The maximum amount that could be borrowed from Federal Home Loan Banks under the current borrowing agreements and without further investment in Federal Home Loan Bank stock is approximately $3.3 billion.
The mortgage notes payable at December 31, 1998, had a weighted average interest rate of 8.23% and were collateralized by premises and equipment carried at $7,659,000.
The industrial development revenue bonds mature on July 1, 2008, with principal of $200,000 payable annually and interest at a tax effected prime rate payable monthly.
Notes payable to unaffiliated banks represents revolving credit agreements with unaffiliated banks. These agreements have interest rates that range from 5.3% to 9.2% and mature in 1999.
Other notes payable at December 31, 1998, had a weighted average interest rate of 5.8% and a weighted average maturity of 5.4 years.
The aggregate amount of maturities of all long-term debt in each of the next five years is as follows: 1999 -- $44,118,506; 2000 -- $218,188,571; 2001 -- $61,895,177; 2002 -- $91,312,476; 2003 -- $1,653,574.
Substantially all of the consolidated net assets are owned by the subsidiaries and dividends paid by Regions are substantially provided by dividends from the subsidiaries. Statutory limits are placed on the amount of dividends the subsidiary banks can pay without prior regulatory approval. In addition, regulatory
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
authorities require the maintenance of minimum capital to asset ratios at banking subsidiaries. At December 31, 1998, the banking subsidiaries could pay approximately $266 million in dividends without prior approval.
Management believes that none of these dividend restrictions will materially affect Regions' dividend policy. In addition to dividend restrictions, federal statutes also prohibit unsecured loans from banking subsidiaries to the parent company. Because of these limitations, substantially all of the net assets of Regions' subsidiaries are restricted, except for the amount which can be paid to the parent in the form of dividends.
NOTE J. EMPLOYEE BENEFIT PLANS
In 1998, Regions adopted FASB 132 "Employers Disclosures about Pensions and Other Postretirement Benefits," (Statement 132) and accordingly the 1997 disclosures have been restated to reflect the requirements of Statement 132.
Regions has a defined benefit pension plan covering substantially all employees. The benefits are based on years of service and the employee's highest five years of compensation during the last ten years of employment. Regions' funding policy is to contribute annually at least the amount required by IRS minimum funding standards. Contributions are intended to provide not only for benefits attributed to service to date, but also for those expected to be earned in the future.
The Company also sponsors a supplemental executive retirement program, which is a non-qualified plan that provides certain senior executive officers defined pension benefits in relation to their compensation.
The following table sets forth the plans' funded status and amounts recognized in the consolidated statement of condition:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Net pension cost included the following components:
The weighted average discount rate and the rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 7.00% and 4.50%, respectively, at December 31, 1998; 7.50% and 4.50%, respectively, at December 31, 1997; and 7.75% and 4.50%, respectively, at December 31, 1996. The expected long-term rate of return on plan assets was 9% in all years.
Contributions to employee profit sharing plans totaled $23,764,000, $21,016,000 and $16,202,000 for 1998, 1997 and 1996, respectively.
The 1998 contribution to the employee stock ownership plan totaled $2,650,000, compared to $2,950,000 in 1997, and $1,863,000 in 1996. Contributions are used to purchase Regions common stock for the benefit of participating employees.
Contributions to the employee stock purchase plan in 1998, 1997 and 1996 were $1,838,000, $1,516,000 and $1,479,000, respectively.
Regions sponsors a defined benefit postretirement health care plan that covers certain retired employees. Currently the Company pays a portion of the costs of certain health care benefits for all eligible employees that retired before January 1, 1989. No health care benefits are provided for employees retiring at normal retirement age after December 31, 1988. For employees retiring before normal retirement age, the Company currently pays a portion (based upon length of active service at the time of retirement) of the costs of certain health care benefits until the retired employee becomes eligible for Medicare. The plan is contributory and contains other cost-sharing features such as deductibles and co-payments. Retiree health care benefits, as well as similar benefits for active employees, are provided through a group insurance program in which premiums are based on the amount of benefits paid. The Company's policy is to fund the Company's share of the cost of health care benefits in amounts determined at the discretion of management.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table sets forth the plan's funded status and amounts recognized in the consolidated statement of condition:
Net periodic postretirement benefit cost included the following components:
The assumed health care cost trend rate was 9.1% for 1999 and is assumed to decrease gradually to 5.1% by 2007 and remain at that level thereafter. Increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation at December 31, 1998, by $1,774,327 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1998 by $241,127. Decreasing the assumed health care cost trend rates by one percentage in each year would decrease the accumulated postretirement benefit obligation at December 31, 1998, by $1,555,949 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1998 by $207,472. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.00% at December 31, 1998, and 7.50% at December 31, 1997.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE K. LEASES
Rental expense for all leases amounted to approximately $19,537,000, $14,828,000 and $12,718,000 for 1998, 1997 and 1996, respectively. The approximate future minimum rental commitments as of December 31, 1998, for all noncancelable leases with initial or remaining terms of one year or more are shown in the following table. Included in these amounts are all renewal options reasonably assured of being exercised.
NOTE L. COMMITMENTS AND CONTINGENCIES
To accommodate the financial needs of its customers, Regions makes commitments under various terms to lend funds to consumers, businesses and other entities. These commitments include (among others) revolving credit agreements, term loan commitments and short-term borrowing agreements. Many of these loan commitments have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of these commitments are expected to expire without being funded, the total commitment amounts do not necessarily represent future liquidity requirements. Standby letters of credit are also issued, which commit Regions to make payments on behalf of customers if certain specified future events occur. Historically, a large percentage of standby letters of credit also expire without being funded.
Both loan commitments and standby letters of credit have credit risk essentially the same as that involved in extending loans to customers and are subject to normal credit approval procedures and policies. Collateral is obtained based on management's assessment of the customer's credit.
Loan commitments totaled $5.9 billion at December 31, 1998, and $4.9 billion at December 31, 1997. Standby letters of credit were $492.3 million at December 31, 1998, and $498.3 million at December 31, 1997. Commitments under commercial letters of credit used to facilitate customers' trade transactions were $21.0 million at December 31, 1998, and $24.0 million at December 31, 1997.
The Company and its affiliates are defendants in litigation and claims arising from the normal course of business. Based on consultation with legal counsel, management is of the opinion that the outcome of pending and threatened litigation will not have a material effect on Regions' consolidated financial statements.
NOTE M. OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
In the normal course of business, Regions enters into financial instrument transactions with off-balance sheet risk. These financial instrument agreements help the Company manage its exposure to interest rate fluctuations and help customers manage exposure to foreign currency fluctuations.
Forward contracts represent commitments to sell money market instruments at a future date at a specified price or yield. These contracts are utilized by the Company to hedge interest rate risk positions associated with the origination of mortgage loans held for sale. The amount of hedging gains and losses deferred, which is reflected in gains and losses on mortgage loans held for sale as realized, was not material to
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the results of operations for the years ended December 31, 1998, 1997 or 1996. The Company is subject to the market risk associated with changes in the value of the underlying financial instrument as well as the risk that the other party will fail to perform. The gross contract amount of forward contracts, which totaled $265 million and $126 million at December 31, 1998, and 1997, respectively, represents the extent of Regions' involvement. However, those amounts significantly exceed the future cash requirements, as the Company intends to close out open positions prior to settlement, and thus is subject only to the change in the value of the instruments. The gross amount of contracts represents the Company's maximum exposure to credit risk.
The Company utilizes put and call option contracts to hedge mortgage loan originations in process. Option contracts represent rights to purchase or sell securities or other money market instruments at a specified price and within a specified period of time at the option of the holder. There were no option contracts outstanding as of December 31, 1998 or December 31, 1997. The commitment fees paid for option contracts reflect the maximum exposure to the Company.
Foreign currency exchange contracts involve the trading of one currency for another on a specified date and at a specified rate. These contracts are executed on behalf of the Company's customers and are used to facilitate the management of fluctuations in foreign exchange rates. The notional amount of forward foreign exchange contracts totaled $75 million and $31 million at December 31, 1998 and 1997, respectively. The Company is subject to the risk that another party will fail to perform and the gross amount of the contracts represents the Company's maximum exposure to credit risk.
Regions operates a broker-dealer subsidiary, which in the normal course of trading inventory and clearing customers' securities transactions, is a party to certain financial instruments with off-balance-sheet risk. The aggregate off-balance-sheet risk from these financial instruments is not material to the consolidated financial statements.
NOTE N. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments.
Cash and cash equivalents: The carrying amount reported in the consolidated statements of condition and cash flows approximates the estimated fair value.
Interest-bearing deposits in other banks: The carrying amount reported in the consolidated statement of condition approximates the estimated fair value.
Investment securities: Estimated fair values are based on quoted market prices, where available. If quoted market prices are not available, estimated fair values are based on quoted market prices of comparable instruments.
Securities available for sale: Estimated fair values, which are the amounts recognized in the consolidated statements of condition, are based on quoted market prices, where available. If quoted market prices are not available, estimated fair values are based on quoted market prices of comparable instruments.
Trading account assets: Estimated fair values, which are the amounts recognized in the consolidated statements of conditions, are based on quoted market prices, where available. If quoted market prices are not available, estimated fair values are based on quoted market prices of comparable instruments.
Mortgage loans held for sale: Estimated fair values, which are the amounts recognized in the consolidated statements of condition, are based on quoted market prices of comparable instruments.
Loans: Estimated fair values for variable rate loans, which reprice frequently and have no significant credit risk, are based on carrying value. Estimated fair values for all other loans are estimated using discounted cash flow analyses, based on interest rates currently offered on loans with similar terms to borrowers of similar
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
credit quality. The carrying amount of accrued interest reported in the consolidated statements of condition approximates the fair value.
Deposit liabilities: The fair value of non-interest bearing demand accounts, interest-bearing transaction accounts, savings accounts, money market accounts and certain other time open accounts is the amount payable on demand at the reporting date (i.e., the carrying amount). Fair values for certificates of deposit are estimated by using discounted cash flow analyses, using the interest rates currently offered for deposits of similar maturities.
Short-term borrowings: The carrying amount reported in the consolidated statements of condition approximates the estimated fair value.
Long-term borrowings: Fair values are estimated using discounted cash flow analyses, based on the current rates offered for similar borrowing arrangements.
Loan commitments, standby and commercial letters of credit: Estimated fair values for these off-balance-sheet instruments are based on standard fees currently charged to enter into similar agreements.
The carrying amounts and estimated fair values of the Company's financial instruments are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE O. OTHER INCOME AND EXPENSE
Other income consists of the following:
Other expense consists of the following:
NOTE P. INCOME TAXES
At December 31, 1998, Regions has net operating loss carryforwards for federal tax purposes of $23.1 million that expire in years 2003 through 2011. These carryforwards resulted from various acquired financial institutions. For financial reporting purposes, a valuation allowance of approximately $2.8 million has been recognized to offset a portion of the deferred tax assets related to those carryforwards and certain temporary differences.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Significant components of Regions' deferred tax assets and liabilities as of December 31, 1998 and 1997 are listed below.
The valuation allowance for net deferred tax assets decreased by $8.4 million in 1998. The decrease was due to a reassessment of the Company's ability to realize the benefit of certain net operating loss carryforwards.
Applicable income taxes for financial reporting purposes differs from the amount computed by applying the statutory federal income tax rate of 35% for the reasons below:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The provisions for income taxes in the consolidated statements of income are summarized below. Included in these amounts are income taxes of $2,644,000, $187,000, and $1,159,000 in 1998, 1997 and 1996, respectively, related to securities transactions.
NOTE Q. BUSINESS COMBINATIONS
On July 31, 1998, First Commercial Corporation of Little Rock, Arkansas, with approximately $7.3 billion in assets merged with and into Regions. Under the terms of the transaction, Regions issued 64,120,031 shares of its common stock for all of First Commercial's outstanding common stock (based on an exchange ratio of 1.7 shares of Regions common stock for each share of First Commercial common stock).
On March 31, 1998, First State Corporation of Albany, Georgia, (First State) with approximately $536 million in assets merged with and into Regions. Under the terms of the transaction, Regions issued 3,853,298 shares of its common stock for all of First State's outstanding common stock (based on an exchange ratio of .56 of a share of Regions common stock for each share of First State common stock).
On March 14, 1998, First United Bancorporation of Anderson, South Carolina, (First United) with approximately $305 million in assets merged with and into Regions. Under the terms of the transaction, Regions issued 2,148,950 shares of its common stock for all of First United's outstanding common stock (based on an exchange ratio of .5173 of a share of Regions common stock for each share of First United common stock).
On February 13, 1998, PALFED, Inc., of Aiken, South Carolina, (PALFED) with approximately $665 million in assets merged with and into Regions. Under the terms of the transaction, Regions issued 3,790,747 shares of its common stock for all of PALFED's outstanding common stock (based on an exchange ratio of .7 of a share of Regions common stock for each share of PALFED common stock).
On March 1, 1996, First National Bancorp of Gainesville, Georgia, with approximately $3.2 billion in assets merged with and into Regions. Under the terms of the transaction, Regions issued 31,840,216 shares of its common stock for all of First National's outstanding common stock (based on an exchange ratio of .76 of a share of Regions common stock for each share of First National common stock).
These transactions were accounted for as poolings of interests and accordingly, all prior period financial statements were restated to include the effect of these transactions.
The following table presents financial information as reported by Regions, First Commercial, First National, and the other pooled companies (First State, First United, and PALFED) and on a combined basis.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In 1998, prior to consummation of First Commercial and the other pooled companies, First Commercial contributed $171.8 in net interest income and $72.3 million to net income and the other pooled companies contributed $11.9 million in net interest income and $3.8 million to net income.
The following table presents recent acquisitions of the pooled companies:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During 1998 Regions completed the following additional business combinations:
The total consideration paid for these business combinations was approximately $14.6 million in cash and 13.2 million shares of Regions' common stock (including treasury stock reissued) valued at $493 million. Total intangible assets recorded in connection with the purchase transactions totaled approximately $114 million.
During 1997 Regions completed the following business combinations:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Because certain of the 1998 and 1997 business combinations were accounted for as purchases, Regions' consolidated financial statements include the results of operations of those companies only from their respective dates of acquisition. The following unaudited summary information presents the consolidated results of operations of Regions on a pro forma basis, as if all the above companies had been acquired on January 1, 1997. The pro forma summary information does not necessarily reflect the results of operations that would have occurred, if the acquisitions had occurred at the beginning of the periods presented, or of results which may occur in the future.
The following chart summarizes the assets acquired and liabilities assumed in connection with business combinations, excluding the First Commercial and other pooled companies business combinations, in 1998 and 1997.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Regions' business combinations pending as of December 31, 1998, are as follows:
- ---------------
(1) Computed as of the date of announcement of each transaction.
In early 1999, the Company consummated the VB&T, Meigs County, and Bullsboro transactions, with the issuance of approximately 1.7 million shares of common stock.
NOTE R. STOCK OPTION AND LONG-TERM INCENTIVE PLANS
Regions has stock option plans for certain key employees that provide for the granting of options to purchase up to 5,720,000 (excluding options assumed in connection with acquisitions) shares of Regions' common stock. The terms of options granted are determined by the personnel committee of the Board of Directors; however, no options may be granted after ten years from the plans' adoption and no options may be exercised beyond ten years from the date granted. The option price per share of incentive stock options can not be less than the fair market value of the common stock on the date of the grant; however, the option price of non-qualified options may be less than the fair market value of the common stock on the date of the grant. The plans also permit the granting of stock appreciation rights to holders of stock options. Stock appreciation rights were attached to 116,713; 134,956 and 180,228 of the shares under option at December 31, 1998, 1997 and 1996, respectively.
Regions' long-term incentive plan provides for the granting of up to 10,000,000 shares of common stock in the form of stock options, stock appreciation rights, performance awards or restricted stock awards. The terms of stock options granted under the long-term incentive plan are generally subject to the same terms as options granted under Regions' stock option plans. A maximum of 3,000,000 shares of restricted stock and 5,000,000 shares of performance awards may be granted. During 1998 and 1997, Regions granted 199,506 and 236,469 shares, respectively, as restricted stock and during 1998, 1997, and 1996, granted 311,393; 211,350 and 277,600 shares, respectively, as performance awards. Grantees of restricted stock must remain employed with Regions for certain periods from the date of the grant at the same or a higher level in order for the shares to be released. However, during this period the grantee is eligible to receive dividends and exercise voting privileges on such restricted shares. In 1998, 1997, and 1996, 99,013; 179,314 and 11,552 restricted shares, respectively, were released. Issuance of performance shares is dependent upon achievement of certain performance criteria and is, therefore, deferred until the end of the performance period. In 1998, 1997 and 1996, 264,540, 629,150 and 491,280 performance shares, respectively, were issued. Total expense for restricted stock was $2,693,000 in 1998, $2,969,000 in 1997, and $1,507,000 in 1996. Total expense for performance shares was $18,424,000 in 1998, $20,927,000 in 1997, and $9,264,000 in 1996.
In connection with the business combinations with First Community Banking Services, Inc. and Greenville Financial Corporation in 1998, Regions assumed stock options, which were previously granted by those companies and converted those options, based on the appropriate exchange ratio, into options to acquire Regions' common stock. The common stock for such options has been registered under the Securities Act of
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1933 by Regions and is not included in the maximum number of shares that may be granted by Regions under its existing stock option plans.
Stock option activity (including assumed options) over the last three years is summarized as follows:
In October 1995, the FASB issued Statement of Financial Accounting Standards No. 123, "Accounting and Disclosure of Stock-Based Compensation" (Statement 123). Statement 123 is effective for fiscal years beginning after December 15, 1995, and allows for the option of continuing to follow Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees", and the related Interpretations, or selecting the fair value method of expense recognition as described in Statement 123. The Company has elected to follow APB 25 in accounting for its employee stock options. Pro forma net income and net income per share data as if the fair-value method had been applied in measuring compensation costs is presented below for the years ended December 31:
Regions' options outstanding have a weighted average contractual life of 6.6 years. The weighted average fair value of options granted was $8.77 in 1998, $7.82 in 1997 and $4.78 in 1996. The fair value of each grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for grants in 1998: expected dividend yield of 2.3%; expected option life of 5 years; expected volatility of 19.3%; and a risk free interest rate of 4.5%. The 1997 assumptions used in the model included: expected dividend yield of 2.2%; expected option life of 5 years; expected volatility of 19.7%; and a risk free interest rate of 5.7%. The 1996 assumptions were: expected dividend yield of 2.7%; expected option life of 5 years; expected volatility of 19.2%; and a risk free interest rate of 6.0%.
Since the exercise price of the Company's employee incentive stock options equals the market price of underlying stock on the date of grant, no compensation expense is recognized.
The effects of applying Statement 123 for providing pro forma disclosures are not likely to be representative of the effects on reported net income for future years. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE S. PARENT COMPANY ONLY FINANCIAL STATEMENTS
Presented below are condensed financial statements of Regions Financial Corporation:
STATEMENTS OF CONDITION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
STATEMENTS OF INCOME
Aggregate maturities of long-term borrowings in each of the next five years for the parent company only are as follows: $770,000 in 1999; $730,000 in 2000; $25,760,000 in 2001; $75,790,000 in 2002; and $810,000 in 2003. Standby letters of credit issued by the parent company totaled $8.1 million at December 31, 1998. This amount is included in total standby letters of credit disclosed in Note L.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
STATEMENTS OF CASH FLOWS
NOTE T. REGULATORY CAPITAL REQUIREMENTS
Regions and its banking subsidiaries are subject to regulatory capital requirements administered by federal banking agencies. These regulatory capital requirements involve quantitative measures of the Company's assets, liabilities and certain off-balance sheet items, and also qualitative judgments by the regulators. Failure to meet minimum capital requirements can subject the Company to a series of increasingly restrictive regulatory actions. As of December 31, 1998, the most recent notification from federal banking agencies categorized Regions and its significant subsidiaries as "well capitalized" under the regulatory framework.
Minimum capital requirements for all banks are Tier 1 Capital of at least 4% of risk-weighted assets, Total Capital of at least 8% of risk-weighted assets and a Leverage Ratio of 3%, plus an additional 100 to 200
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
basis point cushion in certain circumstances, of adjusted quarterly average assets. Tier 1 Capital consists principally of stockholders' equity, excluding unrealized gains and losses on securities available for sale, less excess purchase price and certain other intangibles. Total Capital consists of Tier 1 Capital plus certain debt instruments and the allowance for loan losses, subject to limitation.
Regions' and its most significant subsidiaries' capital levels at December 31, 1998 and 1997, exceeded the "well capitalized" levels, as shown below:
NOTE U. MERGER AND CONSOLIDATION EXPENSES AND SAIF ASSESSMENT
In 1998, Regions incurred a pre-tax, non-recurring merger and consolidation charge of $121.4 million related primarily to the merger of First Commercial and four other institutions with Regions. The charge, recognized in the third ($114.7 million) and fourth ($6.7 million) quarters, consisted primarily of employee-related obligations ($33.6 million), elimination of duplicate facilities, obsolete equipment and other assets ($47.6 million), contract terminations ($6.0 million), costs to exit certain lines of business ($5.1 million), and professional fees and contractual payments associated with the mergers ($29.1 million). During 1998, merger-and consolidation-related costs incurred or charged against the accrual totaled $117.0 million, resulting in a balance in merger and consolidation accrual of $4.4 million at December 31, 1998, which is primarily associated with certain employee related obligations. These employee related obligations were paid out in early 1999, resulting in the merger and consolidation accrual being reduced to zero.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The employee-related obligations primarily relates to termination payments and payments under change of control provisions. The termination payments related to the elimination of back office and administrative personnel. Excess personnel were terminated during 1998 and all employee obligations were paid during 1998, with the exception of the $4.4 million referred to above.
Regions recorded $47.6 million of write-downs related to facilities, equipment and other assets that were impaired as a result of Regions' consolidation of bank charters, consolidations of back office and certain branch operations, and instituting efficiencies through alteration and elimination of activities of the combining enterprises.
On September 30, 1996, legislation to recapitalize the SAIF became effective. This legislation required Regions, and all other depository institutions having SAIF-insured deposits, to pay a one-time, special assessment. This resulted in a pre-tax expense of $25.0, which was recognized primarily in the third quarter of 1996.
In the first quarter of 1996, Regions incurred a pre-tax, non-recurring merger charge of $8.8 million related to the merger of First National Bancorp with Regions. This charge consisted primarily of investment banking and other professional fees, severance costs, data processing contract buyouts and obsolete equipment write-downs.
NOTE V. EARNINGS PER SHARE
The following table sets forth the computation of basic net income per share and diluted net income per share.
NOTE W. BUSINESS SEGMENT INFORMATION
In 1998, Regions adopted FASB No. 131, "Disclosures About Segments of an Enterprise and Related Information." This statement requires additional financial disclosure of segment information in the manner in which management organizes the segments within the enterprise for making operating decisions and assessing performance. The new disclosures are as follows.
Regions segment information is presented geographically, based on Regions six operating regions in the Southeastern United States. Each region is a strategic business unit that serves a particular group of customers in a specified area. The company's six reportable regions are Central, North, Northeast, South, Southwest, and West. These regions have separate managements that are responsible for the operation of each business
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
unit. The Central region mainly consists of central Alabama and all of South Carolina. The Northern region is made up of north Alabama and middle Tennessee. Regions' Georgia franchise comprises the Northeast region. The South region consists primarily of south Alabama and the Florida panhandle. The Southwest region is made up of west Alabama, all of Louisiana and central Florida. The West region consists of Arkansas, east Texas and west Tennessee. The other reportable segments include activity of Regions' mortgage banking, broker dealer and insurance subsidiaries, the indirect lending division, and the parent company (including the merger and consolidation charge).
The accounting policies used by each reportable segment are the same as those discussed in Note A (summary of significant accounting policies). The following table presents financial information for each reportable segment.
NOTE X. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," (Statement 133). Statement 133 requires all derivatives to be recorded on the balance sheet at fair value and establishes "special accounting" for the following three different types of hedges: hedges of changes in the fair value of assets, liabilities or firm commitments (referred to as fair value hedges); hedges of the variable cash flows of forecasted transactions (cash flow hedges); and hedges of foreign currency exposures of net investments in foreign operations. Statement 133 is effective for fiscal years beginning after June 15, 1999. Regions is currently evaluating the impact of Statement 133 on its financial position and results of operations.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In October 1998, the FASB issued Statement of Financial Accounting Standards No. 134, "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Entity," (Statement 134). Statement 134 amends Financial Accounting Standards No. 65, "Accounting for Certain Mortgage Banking Activities," and requires an entity engaged in mortgage banking activities to classify securitized mortgage loans held for sale based on its ability and intent to sell or hold those investments. Statement 134 is effective for fiscal quarters beginning after December 15, 1998. Regions is currently evaluating the impact of Statement 134 on its financial position and results of operations.
NOTE Y. SUMMARY OF QUARTERLY RESULTS OF OPERATIONS, COMMON STOCK MARKET PRICES AND DIVIDENDS (UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Regions Common Stock trades on the Nasdaq National Market tier of The Nasdaq Stock Market under the symbol RGBK. Market prices shown represent sales prices as reported in the Nasdaq Monthly Summary of Activity Report. At December 31, 1998, there were 54,434 shareholders of record of Regions Financial Corporation Common Stock.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There have been no disagreements on accounting and financial disclosure between Registrant and Ernst & Young LLP.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
"Information On Directors" from pages 4 to 6 and "Section 16 Transaction" on page 7 of the Registrant's proxy statement dated April 7, 1999, are incorporated by reference
Executive officers of the Registrant as of December 31, 1998, are as follows:
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* The years indicated are those in which the individual was first deemed to be an executive officer of Registrant, although in every case the individual had been an executive officer of a subsidiary of Registrant for a number of years.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
"Executive Compensation and Other Transaction" on pages 7 through 11, excluding the information on page 11 under the subheading "Compensation Committee Executive Compensation Report" of the Registrant's proxy statement dated April 7, 1999, are incorporated herein by reference. "Executive Compensation Report" on pages 11 through 13, of the Registrant's proxy statement dated April 7, 1999, are specifically not incorporated by reference herein.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
"Voting Securities and Principal Holders Thereof" on pages 3 through 4 and "Information on Directors" on pages 4 through 6 of the Registrant's proxy statement dated April 7, 1999, are incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
"Other Transactions", on page 14 of the Registrant's proxy statement dated April 7, 1999, are incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
14(a)(1) and (2) Financial Statement Schedules.
The following consolidated financial statements and report of independent auditors of Regions Financial Corporation and subsidiaries are included in Item 8 of this Annual Report on Form 10-K:
Report of Independent Auditors
Consolidated Statements of Condition -- December 31, 1998 and 1997
Consolidated Statements of Income -- Years ended December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows -- Years ended December 31, 1998, 1997 and 1996
Consolidated Statements of Changes in Stockholders' Equity -- Years ended December 31, 1998, 1997 and 1996
Notes to Consolidated Financial Statements -- December 31, 1998
Schedules to the consolidated financial statements required by Article 9 of Regulation S-X are not required under the related instructions or are inapplicable, and therefore have been omitted.
14(a)(3) Listing of Exhibits:
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* Represents a compensatory plan agreement that is required to be filed under this item.
14(b) Reports on Form 8-K filed in the fourth quarter of 1998:
No reports on Form 8-K were filed in the fourth quarter of 1998.
14(c) The Exhibits not incorporated herein by reference are submitted as a separate part of this report.
Note: Copies of the aforementioned exhibits are available to stockholders upon request to: Stockholder Assistance 417 North 20th Street P. O. Box 10247 Birmingham, Alabama 35202-10247
14(d) Financial statement schedules:
None.
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. Date March 17, 1999.
REGIONS FINANCIAL CORPORATION
By: /s/ Samuel E. Upchurch, Jr. ------------------------------------ Samuel E. Upchurch, Jr. Executive Vice President, General Counsel and Corporate Secretary
By: /s/ Robert P. Houston ------------------------------------ Robert P. Houston Executive Vice President and Comptroller
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.
as attorney-in-fact pursuant to a power of attorney
ANNUAL REPORT ON FORM 10-K
ITEM 14(C)
EXHIBITS
EXHIBITS INDEX