ITEM 3: LEGAL PROCEEDINGS
Note 16 to First American's Consolidated Financial Statements, included in this Report under Item 8 at pages 99-102, is hereby incorporated in this Item 3 by reference.
ITEM 4:
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the quarter ended December 31, 1998.
PART II
ITEM 5:
ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
On July 1, 1998, First American began trading its Common Stock on the New York Stock Exchange under the symbol "FAM." Prior to July 1, 1998, First American's Common Stock was traded on the National Association of Securities Dealers Automated Quotation National Market System (the "Nasdaq National Market System") under the symbol "FATN."
At the close of business on February 5, 1999, there were approximately 16,790 holders of record of First American's Common Stock. The following table sets out the quarterly high and low sales prices of First American's Common Stock. The dividends declared during each quarter for the last two years are also shown.
STOCK PRICES*
(* STOCK PRICES AND DIVIDEND AMOUNTS HAVE BEEN RESTATED TO GIVE RETROACTIVE EFFECT TO THE 2-FOR-1 SPLIT OF FIRST AMERICAN'S COMMON STOCK EFFECTIVE MAY 9, 1997.)
See SUPERVISION AND REGULATION, PAYMENT OF DIVIDENDS. See also, Notes 10 and 16 to First American's Consolidated Financial Statements, included in this Report under Item 8, which are incorporated herein by reference.
ITEM 6:
ITEM 6: SELECTED FINANCIAL DATA
The table "Selected Financial Data: 1994-1998" on page 23 hereof is incorporated in this Item 6 by reference.
ITEMS 7 AND 7A:
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS; QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
TABLE 1: SELECTED FINANCIAL DATA: 1994-1998
(1) Adjusted to a taxable equivalent basis based on the statutory federal income tax rates, adjusted for applicable state income taxes net of the related federal tax benefit.
(2) Includes an additional loan loss provision for Pioneer of $9.5 million.
(3) Ratio of operating expenses to taxable equivalent net interest income plus noninterest income excluding operations related to Enterprises, merger and integration costs, and certain nonrecurring transactions such as asset sales and regulatory assessments.
(4) Excludes loans 90 days or more past due on accrual.
- -------------------------------------------------------------------------------- MANAGEMENT'S DISCUSSION AND ANALYSIS - --------------------------------------------------------------------------------
The following pages contain the First American Corporation's ("First American") management's discussion and analysis of financial condition and results of operations for 1998, including comparisons with prior years' results and identification of possible risks and trends. This section should be read in conjunction with First American's consolidated financial statements and accompanying notes which begin on page 68.
- ---------- OVERVIEW - ----------
The selected financial data set forth in Table 1 presents certain information highlighting the results of operations and financial condition for First American for each of the last five years. Unless otherwise indicated, all earnings per share data included in this section and throughout the remainder of this discussion are presented on a diluted basis.
Net income was $211.4 million, or $1.84 per share, in 1998 compared to net income of $247.5 million in 1997, or $2.15 per share. The decrease was primarily due to merger-related charges associated with 1998 acquisitions offset by increases in noninterest income.
Net income was $214.2 million, or $1.91 per share, in 1996. The 16 percent increase in net income from 1996 to 1997 was primarily attributable to increases in noninterest income and net interest income offset by increases in noninterest expense. On a per share basis, net income increased 13 percent in 1997 from the prior year.
During 1998, First American essentially doubled in size as a result of several strategic mergers. On May 1, 1998, First American consummated its merger with Deposit Guaranty Corp. ("Deposit Guaranty") by exchanging approximately 48.7 million shares of First American common stock for all of the outstanding shares of Deposit Guaranty. Deposit Guaranty was a $7.2 billion asset financial services holding company headquartered in Jackson, Mississippi, with banking offices in Mississippi, Louisiana, Arkansas, and Tennessee. The transaction was accounted for as a pooling of interests, and accordingly, prior period financial data has been restated to include the results of Deposit Guaranty. The strategic decision to acquire Deposit Guaranty was based on the expectation that leveraging the combined strengths of the two companies would enable First American to reach its financial goals more quickly.
During the fourth quarter of 1998, First American completed the acquisitions of The Middle Tennessee Bank ("MTB"), Peoples Bank ("Peoples"), CSB Financial Corporation ("CSB"), and Pioneer Bancshares, Inc. ("Pioneer"), which added approximately $1.5 billion in assets. All four transactions were accounted for using the pooling-of-interests method of accounting. Prior period financial statements have been restated to include the results of Pioneer for all periods presented. Operations of MTB, Peoples, and CSB have been included in the consolidated financial statements from the date of acquisition (October 1, 1998, in all the cases), as preacquisition amounts were not material to the consolidated financial statements. These four
in-market business combinations gave First American the leading deposit market share in Tennessee.
In 1998, First American recognized merger and integration costs of $121.7 million ($81.2 million after tax) associated with 1998 acquisitions. First American currently anticipates recording additional merger and integration costs of approximately $20 million in 1999 relating primarily to systems and operations conversion costs associated with 1998 acquisitions and 1999 branch swaps. Refer to Note 3 to the consolidated financial statements for a discussion of the merger and integration costs.
Acquisitions of nontraditional financial services businesses are an integral part of First American's strategy of transforming from a bank to a financial services company. On December 16, 1998, First American, through its subsidiary IFC Holdings, Inc. ("IFC"), purchased the assets of the Specialized Investment Division ("SID") of Financial Service Corporation, a subsidiary of SunAmerica Inc. SID provides investment products to customers of community banks and credit unions that do not have their own broker/dealer capabilities. This acquisition added increased distribution capability to IFC along with an established position in the credit union market, thus allowing First American to increase its investment in this high-growth industry. The transaction was accounted for as a purchase business combination.
On October 19, 1998, First American and National Commerce Bancorporation ("NCBC") announced the signing of agreements to exchange a total of 14 existing bank branches in Tennessee and Virginia. The branch swaps and related systems conversions are planned to be completed by mid-1999 and should enable First American to increase its presence in markets where there is already a strong client base with above average growth prospects. First American will have 178 branches in Tennessee upon completion of the swap.
On August 31, 1998, First American completed the sale of Deposit Guaranty's corporate trust business to The Bank of New York. The transaction resulted in a gain of $7 million ($4.4 million after tax) and involved the transfer of approximately 900 bond trustee and agency relationships representing $8 billion in outstanding securities for municipalities and corporations located primarily in Mississippi and Louisiana. This transaction followed the sale of First American's corporate trust business to The Bank of New York on December 22, 1997, which resulted in an initial gain of $2.4 million and consisted of the transfer of approximately 250 bond trustee and agency relationships representing $4 billion of outstanding securities.
Additional information is provided in Note 2 to the consolidated financial statements regarding acquisitions and divestitures.
- ------------------------- BUSINESS SEGMENT RESULTS - -------------------------
First American is a financial services company that operates in two business segments, Banking Services and Enterprises, based upon management responsibility. First American's reportable segments are strategic business operations that offer different products and services. They are managed separately based on the fundamental differences in their operations. Note 20 to the consolidated financial statements provides additional information about First American's
business segments and financial data by segment, including reconciling items to consolidated totals.
BANKING SERVICES
The Banking Services segment includes the traditional banking components of First American's wholly-owned banking subsidiaries, operating 391 offices and 699 ATMs. The Banking Services segment makes commercial, consumer, and real estate loans and provides various banking and mortgage-related services to its customers located within First American's market, which consists primarily of the Mid-South region of the United States.
During 1998 the Banking Services segment experienced significant growth as a result of several banking acquisitions. Following these acquisitions, First American's Banking Services segment ranked first in deposit market share in Tennessee and second in deposit market share in Mississippi in 1998. See the "Overview" section for more information about acquisitions.
First American seeks to distinguish this segment from its competition by offering tailored solutions to clients at a competitive cost using efficient and effective distribution methods. First American has set high goals and is steadily striving to maximize the profitability and contribution from its traditional banking business, while progressing with the transformation from a bank to a financial services company.
TABLE 2: BANKING SERVICES SEGMENT
Net interest income increased in each year, though at a lesser rate during 1998 due to the interest rate environment and the mix and volume of earning assets. See "Net Interest Income" for additional discussion. The level of First American's provision for loan losses, which is completely in the Banking Services segment, is discussed under the caption, "Allowance and Provision for Loan Losses." Noninterest income for the Banking Services segment grew 15 percent during 1998, and 11 percent during 1997, with the largest contributing factors being service charges on deposit accounts and mortgage banking income. Noninterest expense was essentially level during 1998 and increased 10 percent during 1997, with the favorable change related to synergies in connection with the merger with Deposit Guaranty. See the "Noninterest Income" and "Noninterest Expense" sections for more discussion of these topics. Overall, the net pretax contribution for Banking Services increased 15 percent in 1998 and 13 percent in
1997, and the Banking Services segment average total assets rose a steady 8 percent during both 1998 and 1997.
ENTERPRISES
The Enterprises segment provides a variety of financial services. Its main businesses are offered through:
- IFC Holdings, Inc., the largest third-party marketer of investment and insurance products in the United States,
- ISG, the investment services group of First American National Bank ("FANB"), which offers clients a wide selection of mutual funds, fiduciary, and investment products, and
- The SSI Group Inc. ("SSI"), a healthcare payments processing company in which FANB holds a 49 percent interest.
A key element of First American's strategy to transform from a bank to a financial services company is the focus on increasing fee-for-service capabilities in the traditional bank. To this end, over 300 employees were licensed to sell annuities in First American's markets, which have expanded through acquisitions. Following the merger with Deposit Guaranty in 1998, First American merged the AmeriStar mutual funds and the DG Investor Series to form 14 individual ISG Funds, with total assets under management of nearly $3 billion. Just as the Enterprises segment has developed strong investment products through ISG with proven track records, First American plans to benefit from the sale of those products in IFC's distribution network of over 400 financial institution clients in 50 states, the District of Columbia, and Puerto Rico. Beginning in 1999, the ISG Funds family will be added to the product line of IFC and will be available to all of IFC's clients.
During 1998 IFC Holdings, Inc. also experienced growth. IFC acquired the assets of the SID of SunAmerica, expanding its distribution capabilities and gaining an entrance to a new market. In addition, The SSI Group, Inc., acquired Health Management Technologies, which is a developer and marketer of healthcare information management software for workers compensation, occupational health, and managed care organization insurance carriers.
TABLE 3: ENTERPRISES SEGMENT
During mid-1996, First American purchased INVEST Financial Corporation, which is now IFC. The substantial increases in income statement categories in 1997 over 1996 are due to the full-year benefit of IFC in 1997 compared with the partial-year benefit of IFC in 1996. During 1998 net interest income showed a small decline, but noninterest income experienced strong growth, reflecting both First American's strategy of increased fee-for-service capabilities and also its expanded markets. Noninterest expense showed similar growth due to subscribers' commissions expense, which is related to the growth in investment services income. The net pretax contribution from Enterprises increased steadily in 1998, 1997, and 1996 as this segment's value grew and its contribution to First American's consolidated results increased, due to successful strategies to increase fee income through nontraditional sources. The Enterprises segment average total assets decreased 14 percent during 1998 from 1997 and decreased 7 percent during 1997 from 1996, primarily due to exited businesses.
TABLE 4: CONSOLIDATED AVERAGE BALANCE SHEETS AND TAXABLE EQUIVALENT INCOME/EXPENSE AND YIELDS/RATES
(1) Loan fees and amortization of net deferred loan fees (costs), which are considered an integral part of the lending function and are included in yields and related interest categories, amounted to $7.7 million in 1998, $8.3 million in 1997, $9.9 million in 1996, $7.0 million in 1995, and $5.0 million in 1994. Yields/rates and income/expense amounts are presented on a fully taxable equivalent basis based on the statutory federal income tax rates, adjusted for applicable state income taxes net of the related federal tax benefit; related interest income includes taxable equivalent adjustments of $19.5 million in 1998, $13.0 million in 1997, $13.3 million in
1996, $11.5 million in 1995, and $11.0 million in 1994. Nonaccrual and restructured loans are included in average loans and average earning assets. Consequently, yields on these items are lower than they would have been if these loans had earned at their contractual rates of interest. Yields on all securities are computed based on carrying value.
- --------------------------- INCOME STATEMENT ANALYSIS - ---------------------------
NET INTEREST INCOME (TEB)
Net interest income represented 61 percent of total revenues in 1998 versus 64 percent in 1997 and 67 percent in 1996. The decline in the ratio of net interest income to total revenues is consistent with management's focus on increasing fee income in order to diversify revenue production and is in line with First American's continuing transformation to a financial services company. Net interest income increased $40.9 million, or 6 percent, to $753.1 million in 1998. As shown in Table 5, the increase resulted primarily from an increase in the volume of earning assets offset by rate-related decreases. Average earning assets increased 8 percent in 1998 over 1997.
TABLE 5: RATE-VOLUME RECAP
(1) Amounts are adjusted to a fully taxable basis, based on the statutory federal income tax rates, adjusted for applicable state income taxes net of the related federal tax benefit. The effect of volume change is computed by multiplying the change in volume by the prior year rate. The effect of rate change is computed by multiplying the change in rate by the prior year volume. Rate/volume change is computed by multiplying the change in volume by the change in rate and included in the rate change.
The net interest spread declined 6 basis points to 3.58 percent in 1998 as yields on earning assets decreased more than rates paid on interest-bearing liabilities. Table 4 shows yields and rates on earning assets and interest-bearing liabilities.
The 17 point decrease in the yield on earning assets was essentially due to decreases in yields on investment securities and to the relative size of the investment securities portfolio as a percentage of total average earning assets in 1998 as compared to 1997 as shown in Table 6.
TABLE 6: MIX OF AVERAGE EARNING ASSETS
A contributing factor to the increased relative size of the securities portfolio was the securitization of $1.21 billion of mortgage loans and subsequent contribution to a real estate investment trust established by First American. The average yield on investment securities was 15 basis points lower in 1998 compared to 1997. The interest rate environment impacts the rates that First American earns on investment securities, charges for loans, and pays on interest-bearing liabilities. For example, the prime rate averaged 8.35 percent during 1998 versus 8.44 percent during 1997 and the 5-year U.S. Treasury bill yield averaged 5.15 percent in 1998 compared to 6.22 percent in 1997. As general market interest rates declined in 1998, mortgage prepayments increased since mortgage borrowers could refinance at lower rates. This resulted in a decrease in the average yield on the investment securities portfolio as lower yielding securities replaced higher yielding mortgage-backed securities. Also contributing to the lower yield on the investment securities portfolio was the increase in the average volume of investment securities during the lower interest rate environment in 1998. The yield on loans was relatively unchanged in 1998 compared to 1997.
Deposit pricing actions, which were primarily related to the decline in general market rates, resulted in an 18 basis point decrease in the average rate paid on interest-bearing deposits. Such actions contributed to the 11 basis point decrease in the average rate paid on interest-bearing liabilities. A partial offset to deposit pricing actions was an increase in the average rate paid on noncore sources of funds and a funding mix change to include more noncore funds as reflected in Table 11.
The 9 basis point decrease in the net interest margin to 4.30 percent in 1998 was due primarily to the decline in the net interest spread and a slightly lower contribution from the benefit of noninterest-bearing deposits. The decline in general market rates during 1998, which resulted in accelerated loan prepayments and refinancings at lower rates and lower reinvestment rates for investment securities, contributed to the decline in the net interest spread and the corresponding decrease in the net interest margin. First American responded to this trend by lowering rates on deposits and strategically increasing the investment securities portfolio.
Net interest income increased $74.9 million, or 12 percent, in 1997 from $637.3 million in 1996. The increase in net interest income during 1997 resulted primarily from an increase in the volume of earning assets (mainly loans) over interest-bearing liabilities and an improvement in the net interest spread. Changes attributable to volume and rate are shown in Table 5. The net interest spread improved 20 basis points during 1997 as average yields on earning assets increased while the average rates paid on interest-bearing liabilities decreased. The 18 basis point increase in the net interest margin between 1997 and 1996 was primarily due to a better earning asset mix, pricing actions on loans and deposits, and a decrease in hedging expense.
PROVISION FOR LOAN LOSSES
This topic is addressed under the caption, "Allowance and Provision for Loan Losses."
NONINTEREST INCOME
Noninterest income is a growing component of First American's total revenues. Noninterest income represented 39 percent of total revenues during 1998 compared with 36 percent in 1997 and 33 percent in 1996. Noninterest income totaled $477.6 million in 1998, up $72 million, or 18 percent, from the prior year. Noninterest income, excluding the 1998 gain on the sale of a corporate trust business of $7 million, was up 16 percent in 1998 from the prior year.
All major categories of noninterest income experienced growth in 1998 over 1997. As shown in Table 7, increases from the prior year came principally from investment services income, service charges on deposit accounts, and mortgage banking. These increases resulted from First American's continued emphasis on increasing and diversifying sources of noninterest income, improving the pricing of fee-based services, and the growing impact of mortgage banking activities.
TABLE 7: NONINTEREST INCOME
In 1998, the largest contribution to the increase in First American's noninterest income came from Enterprises. Investment services income increased $27 million, or 22 percent, in 1998 over the prior year and comprised 38 percent of the increase in noninterest income between 1998 and 1997. The increase in investment services income was primarily attributable to retail brokerage commissions of IFC. Growth in investment services income is an indicator of how
First American is succeeding in implementing its strategy of transforming from a bank to a financial services company.
Other increases from 1997 to 1998 in other categories of noninterest income were:
- Service charges on deposit accounts. The increase reflected fee increases and product changes in conjunction with the utilization of a customer information system called VISION. Overdraft charges and commercial analysis fees made up most of the increase.
- Mortgage banking income. The substantial increase in mortgage banking income was due to a larger volume of mortgage loans processed and to an increase in net gains on the sale of mortgage warehouse loans in the secondary market.
- Other. As First American took steps to target profitable customer segments and take advantage of business opportunities, decisions were made to sell:
- corporate trust businesses
- three branches with assets of $16 million in Virginia
- $3.5 million of assets of First Mortgage Corp. headquartered in Nebraska
- McAfee Mortgage, a $22.8 million asset mortgage banking subsidiary in Texas
- a consumer finance subsidiary with $11.9 million of assets acquired with the purchase of First City Bancorp, Inc.
- a $.1 million equity ownership in a bank-card network company called HONORS Technologies, Inc.
Details of the gains or losses associated with these divestitures are presented in Table 7. Also contributing to increases in other income were interchange fees generated by the "Check Card" product, which pushed up open-end credit fees. Other service fees were up due to ATM surcharge fees.
Noninterest income increased $93.7 million, or 30 percent, in 1997 over 1996. Noninterest income for 1997 included a full year of IFC's noninterest income, whereas 1996 included IFC's income from its date of acquisition of July 1, 1996. Growth in investment services income comprised 59 percent of the increase in noninterest income between 1997 and 1996 and was primarily due to the activities of IFC. In addition to growth in investment services income, service charges on deposit accounts and mortgage banking income were primary contributors to the increase in noninterest income in 1997 over 1996.
NONINTEREST EXPENSE
Noninterest expense, as shown in Table 8, totaled $836.8 million in 1998 compared with $699.1 million for 1997. The 1998 amount included nonrecurring charges of $121.7 million recorded in connection with the integration of the 1998 acquisitions into First American. Excluding merger and integration costs, noninterest expense increased $16 million, or 2 percent. The modest increase in noninterest expense demonstrates First American's success in lowering the costs of distribution and the effect of cost savings related to the merger with Deposit Guaranty.
TABLE 8: NONINTEREST EXPENSE
In 1998 the largest increase in noninterest expense, exclusive of the merger and integration costs, came from IFC's subscribers' commissions. Subscribers' commissions were up $19.1 million in 1998, or 27 percent, over the prior year. The increase in subscribers' commissions is directly related to the increase in IFC's brokerage activities which resulted in the $27 million increase in investment services income during 1998.
Other significant changes in noninterest expense from 1998 to 1997 were:
- Salaries and employee benefits. The $3.1 million decrease in salaries and employee benefits was attributable to synergies achieved in connection with the merger with Deposit Guaranty. The number of employees was down 9 percent at December 31, 1998 from one year ago.
- Equipment. Equipment expense was up $3.3 million, or 7 percent, due to increased rental of personal computers and to the expansion of branch teller automation equipment.
- Communication. The 12 percent increase resulted from higher expenditures for network telecommunications and courier services.
- Supplies. The 20 percent decrease in supplies expense reflected (a) the effect of higher expenditures in 1997 related to purchase acquisitions and (b) a reduction in 1998 expenditures associated with operations after the merger with Deposit Guaranty.
- Other. Other expense includes software expense, loan/credit expense, amortization of mortgage servicing rights, noninterest deposit expense, other real estate income,
and many smaller categories, such as legal fees, directors' fees, contributions, and travel and entertainment expenses. The $5.4 million, or 6 percent, decrease in other expenses was primarily due to the effect of synergies achieved in connection with the Deposit Guaranty merger and $6.2 million net gains realized on sales of foreclosed properties. Amortization of mortgage servicing rights was up $2.5 million, or 35 percent, due to an increase in the portfolio of servicing rights.
A key measure of operating efficiency is the productivity ratio, which is the ratio of noninterest expenses to taxable equivalent net interest income plus noninterest income. As shown in Table 1, First American's productivity ratio has been improving over the past few years. The productivity ratio was 58.98 percent in 1996. The productivity ratio improved from 57.93 percent in 1997 to 53.44 percent in 1998. The improvement in the productivity ratio was the result of improved expense control and the effect of cost savings achieved in connection with the Deposit Guaranty merger.
During 1997 noninterest expense increased $101.7 million, or 17 percent, from 1996. A primary reason for the increase was that in 1997 a full year of IFC's expenses were included, whereas in 1996, IFC's expenses for only six months from its date of acquisition of July 1, 1996, were included. Of the $101.7 million increase, $52.4 million was attributable to IFC. Most of the increase from IFC was due to increases in subscribers' commissions ($35.7 million), salaries and employee benefits ($7.6 million), and general and administrative expenses ($7.4 million). Excluding IFC, noninterest expense increased 8 percent in 1997 over 1996. The 1996 results include a $8.1 million one-time SAIF assessment. Excluding IFC and the one-time SAIF assessment, noninterest expense increased $57.6 million, or 10 percent. This increase was primarily attributable to the effects of bank acquisitions in 1997 and 1996. In addition to increases resulting from acquisitions, salaries and employee benefits, equipment, and net occupancy expenses were up in 1997 from 1996. Salaries and employee benefits expense increased due to merit adjustments, incentive programs, related payroll taxes, and the increased cost of medical benefits. Equipment expense and net occupancy expense were up due to steps taken by First American to improve operations and banking facilities.
INCOME TAXES
Income tax expense in 1998 was $122.1 million, which resulted in an effective tax rate of 36.6 percent of pretax income versus $142.1 million, or 36.5 percent of pretax income, for 1997. The increase in the effective tax rate for 1998 was attributable to nondeductible acquisition expenses offset by a lower overall effective state income tax rate due to the realignment of certain corporate entities. Income tax expense for 1996 was $117.9 million, or 35.5 percent, of pretax income. The increase in the tax rate for 1997 versus 1996 was attributable to an increase in nondeductible goodwill. For additional information on income taxes of First American, see Note 12 to the consolidated financial statements.
- ------------------------ BALANCE SHEET ANALYSIS - ------------------------
LOAN PORTFOLIO
Loans comprise the largest component of First American's earning assets. Average loans were $11.73 billion in 1998 compared to $11.80 billion in 1997, a decrease of .6 percent. During 1998 First American securitized approximately $1.21 billion of mortgage loans and contributed them to a real estate investment trust established by First American. Excluding the effect of securitizations, loan sales, loan purchases, divestitures, and business combinations except Deposit Guaranty and Pioneer, average loans increased $390.2 million, or 3 percent, in 1998 from 1997. Total average loans exclusive of consumer-amortizing mortgages increased $469.4 million, or 5 percent, in 1998 over 1997.
Loan growth in 1998 was primarily due to growth in commercial loans. Commercial loans are loans that are made for business purposes and consist primarily of single payment loans and loans secured by real estate. As shown in Table 9, commercial loans are the largest category of loans and have been growing as a percentage of the total loan portfolio. Commercial loans were 41 percent of the portfolio in 1998 compared to 38 percent in 1997. Average commercial loans increased $314.6 million, or 7 percent, in 1998 from 1997. The increase in commercial loans occurred throughout the major industry groups and markets served by First American.
TABLE 9: AVERAGE LOANS
During 1998, First American continued to maintain a leadership position in the state of Tennessee in small business (revenues under $10 million) and middle market lending (revenues of $10 million to $100 million). First American increased its market effectiveness in middle market lending in Tennessee in 1998, as evidenced by increases in First American's percentage of lead relationships in middle market lending; in addition, First American had the largest percentage of lead relationships in Tennessee in middle market lending in 1998.
Average consumer-amortizing mortgages decreased $534.9 million, or 18 percent, in 1998 compared to 1997, which was essentially due to the securitization of $1.21 billion of 1-4 family mortgage loans. The decline in average consumer-amortizing mortgages, due to securitizations, was consistent with First American's plan to manage the balance sheet. Excluding the 1998 securitizations, average consumer-amortizing mortgages increased 5 percent.
The increase in average consumer-other loans of $152.9 million, or 6 percent, was primarily attributable to the purchase of $200 million of loans on June 30, 1997, with recourse, from a wholly-owned corporate agency and instrumentality of the United States Government.
First American did not experience any problems in 1998 related to foreign markets due to limited foreign exposure. First American is monitoring the turbulence in foreign markets (particularly Asia, Latin America, and Russia), limiting direct exposure, and continually evaluating indirect exposure. Substantially all exposure to Asian-related companies is in the form of credit facilities extended to United States-based affiliates of Asian companies. All of these affiliates generate a majority of their revenues from the United States marketplace. At December 31, 1998, total committed exposure to Asian affiliates was $77 million, which was primarily comprised of short-term working capital lines of credit. Under these committed credit facilities, First American had total outstandings of $17.4 million. First American's total Asian exposure, which includes committed credit facilities, uncommitted credit facilities, foreign exchange internal credit limits, and automated clearing house internal credit limits, was $105.2 million at December 31, 1998. First American had no direct exposure related to Latin American or Russian companies.
To facilitate the foreign trade needs of our customers, First American maintains relationships with a number of foreign banks. As of December 31, 1998, approved exposure limits to Asian banks amounted to $4.9 million. As of December 31, 1998, $.3 million was funded and committed under the internally set limits. The total approved exposure limit to Latin American banks, which was $.4 million during 1998, expired on December 31, 1998. As of December 31, 1998, First American had no commitments to Latin American or Russian banks.
Table 22 presents end of period loan balances by category for the past five years.
INVESTMENT SECURITIES PORTFOLIO
At December 31, 1998, First American's investment securities portfolio totaled $6.2 billion, consisting of $4.5 billion of securities available for sale and $1.7 billion of securities classified as held to maturity. This compares with a total portfolio at year-end 1997 of $4.3 billion, comprised of $3.5 billion of available for sale securities and $.8 billion of held to maturity securities. The composition of the two securities portfolios by type of security, as of each of these dates, is presented in Note 5 to the consolidated financial statements. In addition, Table 10 presents certain information pertaining to the composition, yields, and maturities of the available for sale and held to maturity portfolios at December 31, 1998.
First American's securities portfolio is the second largest component of First American's earning assets, representing 32 percent of average earning assets in 1998. As an integral component of asset/liability strategy, First American manages the investment securities portfolio to maintain liquidity, balance interest rate risk, and augment interest income. The portfolio is also used to meet pledging requirements for deposits and borrowings.
TABLE 10: SECURITY PORTFOLIO ANALYSIS
(1) Yields on all securities were computed based on carrying value. (2) Yields presented on a taxable equivalent basis, based on the statutory federal income tax rate, adjusted for applicable state income taxes net of the related federal tax benefit. (3) Securities held to maturity were reported on the consolidated balance sheet at amortized cost and securities available for sale were reported on the consolidated balance sheet at fair value for a combined carrying value of $6,226 million.
At year-end 1998, First American had $3.63 billion invested in mortgage-backed securities within the available for sale portfolio, representing 81 percent of the total. First American's held to maturity portfolio held $1.52 billion of mortgage-backed securities, or 88 percent of its total. First American also held a high percentage of mortgage-backed securities within its total security portfolio one year earlier. Substantially all of the mortgage-backed securities held at December 31, 1998 and 1997, were issued or guaranteed by federal agencies, and as such, management considers these investments to be sound and well-suited to First American's objectives. Mortgage-backed security holdings at December 31, 1998, included $113.3 million floating rate mortgage-backed securities, of which $14.2 million were classified as available for sale and $99.1 million were classified as held to maturity.
At December 31, 1998, over 99.9 percent of First American's debt securities were investment grade, with the remaining unrated. Of the securities which are rated, none are below investment grade (BBB).
DEPOSITS AND OTHER SOURCES OF FUNDS
Table 11 provides information on deposits and other sources of funds. Core deposits are First American's primary source of funding and consist of total deposits less certificates of deposit $100,000 and over and foreign deposits. Core deposits increased 1 percent in 1998 from the prior year and averaged $12.6 billion in 1998 compared to $12.4 billion in 1997. The increase in average core deposits reflected increases in NOW accounts and demand deposit accounts offset by decreases in certificates of deposit under $100,000 and money market accounts. The 1998 acquisitions contributed to the increase in core deposits.
TABLE 11: AVERAGE DEPOSITS AND OTHER SOURCES OF FUNDS
The mix of average core deposits shifted slightly in 1998 compared to 1997 as shown in Table 12.
TABLE 12: MIX OF AVERAGE CORE DEPOSITS
The change in the mix of average core deposits was attributable to a proactive deposit strategy aimed at providing more competitive flexible products for customers and improving profitability. During 1998 First American introduced the "Tailored Money Sweep" account, an interest-bearing checking account that provides for unlimited checking privileges while allowing for money market returns. Increases in NOW accounts and decreases in money market accounts were partially attributable to this new product. The decrease in certificates of deposit $100,000 and under reflected an overall industry trend of funds moving out of certificates of deposit into alternative investment products in the stock and bond market. First American responded to this industry trend by introducing a new mutual fund family or product array, ISG Funds. ISG Funds is made up of 14 individual funds in a wide selection of asset classes, including equity, taxable fixed income, tax-exempt fixed income, and money market funds.
In addition to the introduction of the Tailored Money Sweep account and the ISG Funds, steps being taken by First American to strengthen customer relationships in order to maintain its core deposit funding base include:
- offering updated deposit products, including the First American Platinum Account and High Yield Savings;
- continuation of the Select Rewards program, a relationship oriented program which is similar to the airline industry's frequent flyer programs. This program rewards customers for banking with First American with redeemable points based on the number, size, and longevity of accounts; and
- utilization of the Distribution Management System ("DMS") and VISION, a customer information system, to consider client preference in providing the best mix of distribution channels--branches, mini branches, ATMs, telephone, and PC banking--as well as the best mix of products and pricing.
Average core deposits as a percentage of average earning assets was 71.7 percent in 1998 compared to 76.36 percent in 1997. The decrease was due to the strategic increase in the investment securities portfolio using sources of funding other than core deposits. Further discussion of the balance sheet realignment in 1998 is found in the "Net Interest Income" and "Investment Securities Portfolio" sections of this management's discussion and analysis.
In order to fund an increased level of earning assets in the most economically desirable manner in 1998, First American placed more reliance on sources of funds other than core deposits, including certificates of deposit $100,000 and over, federal funds purchased and repurchase agreements, and advances from the Federal Home Loan Bank ("FHLB"). Average certificates of deposit $100,000 and over increased $286.1 million, or 23 percent, in 1998 over 1997. The $421.3 million increase in average short-term borrowings was attributable to increases in federal funds purchased and repurchase agreements. Average long-term debt was up 83 percent, reflecting the addition of borrowings from the FHLB.
Table 13 presents maturities of certificates of deposit $100,000 and over.
TABLE 13: MATURITIES OF CERTIFICATES OF DEPOSIT $100,000 AND OVER
CAPITAL
Capital adequacy is important to the continued soundness, profitability, and growth of First American. The principal objectives of First American's strategy in managing capital are to (1) protect shareholders and depositors, (2) comply with all regulatory requirements, (3) improve profitability, and (4) effectively utilize excess capital. Plans to effectively utilize excess capital include investing in financial service businesses that yield returns in excess of 20 percent, focusing on bank acquisitions to further enhance the branch network and lower distribution costs, and, when appropriate, returning excess capital to shareholders in the form of increased dividends and repurchases of First American's common stock.
First American's capital position remained strong during 1998. The ratio of average equity to average assets was 8.68 percent in 1998 compared to 8.88 percent in 1997 and 8.86 percent in 1996.
TABLE 14: CAPITAL ANALYSIS DATA
(1) Dividends declared per share to basic earnings per share.
On April 16, 1998, the Board of Directors increased the quarterly cash dividend by 25 percent to $.25 per share. In 1998, First American paid dividends at the rate of $.95 per common share, up 26 percent from $.755 per share during 1997. The rate of dividends paid
per common share in 1997 was up 25 percent over 1996. The increase in the dividend payout ratio to 50.53 percent in 1998 over 1997, as shown in Table 14, reflected the decrease in net income for 1998 due to the merger-related charges. Excluding merger-related charges, the payout ratio for 1998 was 35.71 percent.
Total shareholders' equity at December 31, 1998, increased $135.9 million, or 8 percent, from December 31, 1997. This followed a 1997 increase of 6 percent from the balance at the end of 1996. During both 1998 and 1997 the overall increase was primarily due to increases in comprehensive income and issuance of shares for employee benefit plans, reduced by dividends paid to shareholders and common stock repurchases. Common stock repurchases were $65.4 million in 1998 compared to $197.7 million in 1997. The "Consolidated Statements of Changes in Shareholders' Equity" detail the changes in shareholders' equity during 1998, 1997, and 1996. Notes 1 and 5 to the consolidated financial statements provide further information on unrealized gains and losses on securities available for sale included in comprehensive income.
Risk-based capital rules and definitions for bank holding companies and national banks are established by the Federal Reserve Board ("FRB") and the Office of the Comptroller of the Currency ("OCC"). These rules require minimum levels of capital and capital ratios. The required minimum levels of capital are based on calculations that apply various risk ratings to defined categories of assets and off-balance-sheet items. As prescribed by the FRB and the OCC, total capital consists of Tier I capital (essentially realized common equity reduced by disallowed intangible assets) plus Tier II capital (essentially Tier I capital plus qualifying long-term debt and a portion of the allowance for loan losses). Note 16 to the consolidated financial statements summarizes the risk-based capital and related ratios for First American and its principal subsidiary, FANB. As of December 31, 1998, First American and its banking subsidiaries had ratios which exceeded the regulatory requirements to be classified as "well capitalized," the highest regulatory capital rating.
First American Federal Savings Bank ("FAFSB") and Pioneer f.s.b. are subject to capital requirements adopted by the Office of Thrift Supervision ("OTS"). These requirements are similar but not identical to those issued by the FRB and the OCC. As of December 31, 1998, both FAFSB and Pioneer f.s.b. had capital ratios that exceeded the regulatory requirements to be classified as "well capitalized."
- -------------- RISK ELEMENTS - --------------
CREDIT RISK MANAGEMENT
First American exercises prudent credit risk management in lending, including diversification of the loan portfolio by loan category and by industry segment, as well as by identification of credit risks. Accordingly, First American places particular importance on industry specialization and relationship management so that relationship managers (loan officers) are better able to understand the complexities of an industry's characteristics. Specialization by relationship managers permits First American to provide expertise in structuring the original credit facility and enables continuous risk evaluation.
First American's loans are predominantly to borrowers from its primary market territory, an area in which First American's relationship managers are knowledgeable. First American's primary market territory includes Arkansas, Georgia, Kentucky, Louisiana, Mississippi, Tennessee, and Virginia. Based on Standard Industrial Classification codes, there were no concentrations within the commercial loan category in excess of 10 percent of total loans at December 31, 1998, or at December 31, 1997. First American's ten largest outstanding loan relationships at December 31, 1998, amounted to $300.4 million, or 2.6 percent of total loans, compared to $265.3 million, or 2.2 percent of total loans, at year end 1997. At December 31, 1998, the largest loan relationship had $36.2 million outstanding. Under the regulatory legal lending limit as calculated at December 31, 1998, FANB could make loans to a single customer relationship up to $240.2 million.
NONPERFORMING ASSETS
Table 15 summarizes changes in nonperforming assets for each of the past five years and presents the composition of the nonperforming assets balance at the end of each year. The ratio of nonperforming assets to total loans and foreclosed properties was .47 percent at December 31, 1998, compared to .37 percent at December 31, 1997. Nonperforming assets totaled $55 million at December 31, 1998, up $9.2 million from $45.8 million at December 31, 1997. The $9.2 million increase in nonperforming assets since year end 1997 was from the commercial and real estate nonaccrual loan portfolios.
Loans contractually past due 90 days or more as to interest or principal payments that have not been put on nonaccrual status amounted to $38.7 million at year end 1998 compared to $29 million at year end 1997. The ratio of these past due loans to total loans was .33 percent at December 31, 1998, and .24 percent at December 31, 1997.
TABLE 15: NONPERFORMING ASSET ACTIVITY
ALLOWANCE AND PROVISION FOR LOAN LOSSES
As a financial institution which assumes lending and credit risks as a principal element of its business, First American recognizes that credit losses will be experienced in the normal course of business. Accordingly, First American consistently applies a comprehensive methodology and procedural discipline which is updated on a quarterly basis at the subsidiary bank and thrift level to determine both the adequacy of the allowance for loan losses and the necessity for charging provisions against earnings. The allowance for loan losses is based on assessments of the probable estimated losses inherent in the loan portfolio. The allowance for loan losses includes an allocated and unallocated portion. Both portions of the allowance are available to absorb losses. The allocated allowance is determined for each classification of performing and nonperforming loans within the portfolio. This methodology includes:
- The allocations for commercial loans are calculated by using a trailing twelve-quarter migration analysis of the average actual net loan losses incurred within the entire commercial loan portfolio by loan quality grade. First American has established minimum loss factors for certain loan grade categories.
- The allocations for consumer loans are based upon a migration analysis of First American's historical average of actual net loan losses experienced for the last twelve quarters in each consumer loan category. First American has established minimum loss factors for certain loan categories.
- A detailed review of criticized and impaired loans is performed to determine if specific allocations are required for individual loans where management has identified significant conditions or circumstances exist that indicate the probability that a loss has been incurred in excess of the amount determined by the application of the migration loss methodology.
The unallocated allowance is established for loss exposure that may exist in the remainder of the loan portfolio but has yet to be specifically identified and to compensate for uncertainty in estimating loan losses, including the possibility of changes in risk ratings of loans. The unallocated allowance is based upon management's evaluation of various conditions, the effects of which are not directly measured in determining the allocated allowance. The evaluation of the inherent loss related to these conditions involves a higher degree of uncertainty because they are not associated with specific problem loans or portfolio segments. The conditions evaluated in connection with establishing the unallocated allowance include the following:
- Credit concentrations - Recent levels of, and trends in, delinquencies and nonaccruals - Trends in loan volumes and terms of loans and the portfolio - New credit products and/or geographic distribution of those products - Changes in lending policies and procedures - Loan review evaluation of the credit process - Changes in experience of personnel - National and local economic conditions - Ratios of recoveries to prior year's charge-offs - Accrued income receivable on loans
Management reviews these conditions quarterly in discussion with its senior credit officers. Management believes that in most instances, the impact of these conditions may not yet be reflected in the level of nonperforming loans or in the internal risk grading process regarding these loans. Accordingly, the evaluation of the probability of additional losses related to these factors is reflected in the unallocated allowance. The unallocated allowance is not weighted among segments of the portfolio. The following specific factors were reflected in management's estimate of the unallocated allowance:
- An increase in loans 90 days or more past due from $29 million at December 31, 1997 to $38.7 million at December 31, 1998 - Uncertainty in loan portfolio performance within markets experiencing potentially weakening economies - Perceived risks in new markets entered into through recent mergers - Declining performance in certain industries such as healthcare
While the rate of charge-offs has been low, management is aware that First American has been operating in a favorable economic environment. Management, along with a number of economists, perceives increasing instability in the national and mid-south economies and a worldwide economic slowdown that could contribute to job losses and otherwise adversely affect a broad variety of business sectors in our markets. In addition, as First American has grown through acquisitions, its aggregate risk profile of loans has increased. Also, by virtue of its increased capital levels, First American is able to make larger loans, thereby increasing the possibility of a loan having a larger adverse impact than before. Accordingly, management believes that the maintenance of an unallocated allowance in the current amount is prudent and consistent with regulatory requirements.
First American believes that the allocation of its allowance for credit losses is reasonable. Table 16 provides an analysis of the changes in the allowance for the past five years, including the provision and the charge-offs and recoveries by loan category.
At December 31, 1998, the allowance for loan losses was $197.7 million, or 1.68 percent of net loans, versus $187.9 million, or 1.53 percent of net loans, at December 31, 1997. The $9.8 million change in the allowance during 1998 from year-end 1997 was due to (1) a $40.9 million provision for loan losses which exceeded $37.3 million of net loan charge-offs by $3.6 million and (2) a $6.2 million net increase due to the business combinations with MTB, Peoples and CSB, and the sale of McAfee. Included in the provision for loan losses and the net loan charge-offs for 1998 was an additional loan loss provision of $9.5 million to restore the allowance to appropriate levels following $7.5 million of loan charge-offs to align the loss recognition and loan loss reserve standards of Pioneer with those of First American. The allowance as a percentage of nonperforming loans decreased to 413 percent at December 31, 1998 from 493 percent at December 31, 1997.
Net loan charge-offs were $37.3 million, or .32 percent of average loans in 1998 and $27.5 million or .23 percent of average loans in 1997. Net loan charge-offs, excluding the $7.5 million of Pioneer charge-offs, were .25 percent of average loans in 1998. On a gross basis, total recoveries of $27.7 million in 1998 did not change significantly from total recoveries of $28.9 million in 1997, while the change in gross charge-offs from 1997 to 1998, of $8.6
million, is attributable to the $7.5 million charge-offs associated with the Pioneer business combination discussed above.
Of the major loan categories, consumer-other loans had the highest level of net charge-offs in 1998, 1997, and 1996 and experienced the largest increase, or $5 million, from December 31, 1997 to December 31, 1998. Consumer-other loan charge-offs were .79 percent and .64 percent of average consumer-other loans in 1998 and 1997, respectively. This increase was due to higher consumer losses following national trends. The largest increase in net charge-offs, or $15.3 million, between December 31, 1996 and December 31, 1997 was related to commercial loans. The predominant factor contributing to this increase was large recoveries in 1996.
TABLE 16: ALLOWANCE FOR LOAN LOSSES
MARKET RISK MANAGEMENT
Interest Rate Sensitivity
In the normal course of business, First American is exposed to market risk arising from fluctuations in interest rates. The Asset/Liability Committee ("ALCO") measures and evaluates interest rate risk so that First American can meet customer demands for various types of loans
and deposits. Asset/Liability management determines the most appropriate amounts of on-balance-sheet and off-balance-sheet items. Measurements used to help First American manage interest rate risk include an earnings simulation model, an economic value of equity model, and gap analysis computations. These measurement tools are used in conjunction with the competitive pricing analysis.
Earnings Simulation Modeling: First American believes that interest rate risk is best measured by its earnings simulation modeling. Forecasted levels of earning assets, interest-bearing liabilities, and off-balance-sheet financial instruments are combined with ALCO's forecasts of interest rates for the next twelve to twenty-four months and are combined with other factors in order to produce various earnings simulations. To limit interest rate risk, First American has guidelines for its earnings at risk which state that net income will not vary by more than 5 percent for a 150 basis point change in rates from management's most likely interest rate forecast over the next twelve months. During 1998, First American operated within these guidelines.
Economic Value of Equity: First American's economic value of equity model measures the extent that estimated economic values of First American's assets, liabilities, and off-balance-sheet-items will change as a result of a change in interest rates. Economic values are determined by discounting the expected future cash flows from assets, liabilities, and off-balance-sheet items, which establishes a base case economic value of equity. To help limit interest risk, First American has a guideline stating that for an instantaneous 150 basis point change in interest rates, the economic value of equity will not change by more than 20 percent from the base case. During 1998, First American operated within these limits.
Gap Analysis: First American's interest rate sensitivity gap model measures the difference between assets and liabilities repricing or maturing within specified time periods. Table 17 shows that First American has a net liability sensitive position for a cumulative one-year period of negative 15.6 percent at December 31, 1998. First American's guideline for its one-year cumulative interest rate sensitivity ratio is negative 4 percent (net liability sensitive) to negative 24 percent. First American classifies all NOW and regular savings and money market deposit accounts as immediately rate sensitive. If NOW and savings accounts are reflected as sensitive beyond one year, the interest sensitive position for a cumulative one-year period would be a positive 3.8 percent. A cumulative net liability sensitivity (negative amount) indicates that First American's net interest income has a tendency to increase if interest rates decline. An interest rate gap sensitivity analysis is limited in its usefulness since the interest rate gap position presents a snapshot of interest sensitivity for one point in time (interest gap sensitivity can change on a daily basis).
TABLE 17: INTEREST RATE SENSITIVITY ANALYSIS
Each column includes earning assets and interest-bearing liabilities that are estimated to mature or reprice within the respective time frame. All floating rate balance sheet items are included as "within three months" regardless of maturity. Nonearning assets (cash and due from banks, premises and equipment, foreclosed properties, and other assets), noninterest-bearing liabilities (demand deposits and other liabilities), and shareholders' equity are considered to be noninterest-sensitive for purposes of this presentation and thus are not included in the above table.
In the table, all NOW, money market, and savings accounts are reflected as interest-sensitive within three months. NOW accounts, savings, and certain money market accounts are not totally interest-sensitive in all interest rate environments. If NOW and regular savings accounts were not considered interest-sensitive, the one year cumulative positive interest-sensitive gap position and percent of earning assets would be $713.5 million and 3.8 percent, respectively, for 1998, as compared to a positive interest-sensitive gap position and percent of earning assets of $31.7 and .2 percent, respectively, for 1997.
Derivatives
Derivative financial instruments are used by First American to improve the balance between interest-sensitive assets and interest-sensitive liabilities. First American uses derivatives as one means to manage its interest rate sensitivity while continuing to meet the credit and deposit needs of customers.
At December 31, 1998, First American held interest rate swaps with notional values totaling $3.18 billion. One year earlier, First American held $2.43 billion of interest rate swaps and $300 million of interest rate floors. All of these were hedges of interest-bearing assets or liabilities, in conjunction with First American's management of its exposure to changes in the interest rate environment. Note 15 to the consolidated financial statements presents more detail about the derivative financial instruments outstanding at December 31, 1998 and 1997.
For a number of years, First American has used interest rate swap contracts primarily to convert certain deposits and long-term debt to fixed interest rates and to convert certain groups of customer loans to fixed interest rates. During 1997 and 1998, First American continued this use of derivative instruments and also increased its use of pay-fixed interest rate swaps to hedge market value fluctuations of available for sale securities. These strategies help First American's interest-sensitivity gap position and also protect market values in a rising rate environment. The table below summarizes, by notional amounts, the activity for each major category of derivative financial instruments.
TABLE 18: DERIVATIVE FINANCIAL INSTRUMENT ACTIVITY
Net interest income for 1998 included derivative products pretax net income of $3.8 million, compared with $.8 million in 1997. In 1996 net interest income included derivative products pretax net expense of $13.6 million. Although the stand-alone effect of First American's derivative products on net interest income can vary, hedges are intended to improve First American's overall exposure to changes in the interest rate environment and therefore should not be evaluated on a stand-alone basis.
As First American's individual derivative contracts approach maturity, they may be terminated and replaced with derivatives with longer maturities, which offer more interest rate risk protection. Note 15 to the consolidated financial statements presents the net deferred gain related to terminated derivative contracts. The net deferred gain at December 31, 1998, totaled
$14.7 million and at year-end 1997 was $5.4 million. The higher net deferred gain at year-end 1998 over 1997 reflects $9.8 million deferred gains on two swaps closed in 1998 related to loans. Deferred gains and losses on terminated off-balance-sheet derivative contracts are recognized as interest income or interest expense over the original covered periods. Of the $14.7 million of net deferred gain at year-end 1998, $2.5 million will increase net interest income during 1999 and $12.2 million will be recognized in the years from 2000 to 2006.
First American's derivatives had net negative fair values (unrealized net pretax losses) of $9.7 million at year-end 1998 and net positive fair values (unrealized net pretax gains) of $12.0 million at year-end 1997. The change in net fair values is largely related to interest rate swaps hedging available for sale securities. For estimated fair value information related to all financial instruments, see Note 17 to the consolidated financial statements.
All derivatives activity is conducted under ALCO and Board of Directors' supervision and according to detailed policies and procedures governing these activities. Policy prohibits the use of leveraged and complex derivatives. The Board of Directors also sets interim limitations on the total notional amount of derivatives contracts that may be outstanding at any time.
Credit risk exposure due to off-balance-sheet derivative activities is closely monitored, and counterparties to these contracts are selected based on their creditworthiness as well as their market-making ability. As of December 31, 1998, all outstanding derivative transactions were with counterparties with credit ratings of A-2 or better. Enforceable bilateral netting contracts between First American and its counterparties allow for the netting of gains and losses in determining net credit exposure to the counterparty. First American's net credit exposure on outstanding interest rate swaps was $14.8 million at December 31, 1998.
In June 1998 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities, effective for fiscal years beginning after June 15, 1999. SFAS No. 133 establishes accounting and reporting standards for derivative instruments and for hedging activities. It requires an entity to recognize all derivatives as either assets or liabilities in the statement of financial position and to measure those instruments at fair value. Under certain conditions, a derivative may be specifically designated as a fair value hedge or a cash flow hedge. The accounting for changes in the fair value of a derivative will depend on the intended use of the derivative and the resulting designation. At this time, management has not fully evaluated the impact of SFAS No. 133. First American plans to adopt SFAS No. 133 prospectively on January 1, 2000.
LIQUIDITY RISK MANAGEMENT
First American's goal in liquidity management is to ensure that sufficient funds are available to meet the demands of depositors, borrowers, and creditors. ALCO is responsible for structuring the balance sheet to meet those demands and regularly reviews current and forecasted funding needs. Liquid assets, which include cash and cash equivalents (less Federal Reserve Bank reserve requirements), money market instruments, and securities that are estimated to mature within one year, amounted to:
- $2.3 billion, or 13 percent of earning assets, at December 31, 1998, versus - $1.48 billion, or 9 percent of earning assets, at December 31, 1997.
The increase in the ratio of liquid assets to earning assets between year-end 1998 and 1997 was primarily attributable to increases in securities that are estimated to mature in one year and time deposits with other banks. In addition to assets included in liquid assets, available-for-sale securities maturing after one year, which can be sold to meet liquidity needs, had a balance of $3.90 billion at December 31, 1998, compared to $3.41 billion at December 31, 1997. As presented in Table 19, loans (exclusive of consumer loans) that mature within one year amounted to $2.77 billion at December 31, 1998. The maturity of securities is also discussed under the caption "Investment Securities" and provided in Table 10.
TABLE 19: MATURITIES OF LOANS, EXCLUSIVE OF CONSUMER LOANS
First American's primary sources of liquidity are core deposits, short- and long-term borrowings, and cash flows from operations. First American's strategy is to fund assets to the maximum extent possible with core deposits. Additional funds can be raised from regional, national, and international money markets as certificates of deposit $100,000 and over, federal funds purchased, and securities sold under agreements to repurchase. First American can also borrow from the Federal Home Loan Bank to meet both short-term and long-term funding needs. As shown in Table 20, First American increased its reliance on noncore interest-bearing liabilities to fund earning assets during 1998. An additional source of liquidity is First American's three year $100 million revolving credit agreement, which was put in place in July 1998 following the expiration of a $70 million revolving credit agreement. The credit facility agreement expires in July 2001. First American had no borrowings under either credit facility in 1998.
TABLE 20: LIQUIDITY RATIOS
The "Consolidated Statements of Cash Flows" show net cash provided or used by operating, investing, and financing activities and the net effect of those activities on cash and cash equivalents. As such, it is a tool that management uses in analyzing liquidity. During 1998 cash provided by operating activities was $155.4 million compared to $263.4 million in 1997 and $351.3 million in 1996. The largest component of cash provided by operating
activities in both years was net income. The decrease in cash provided by operating activities between 1998 and 1997 was primarily attributable to increases in mortgage loans held for sale. Investing activities utilized $705.5 million of cash in 1998, $509.9 million in 1997, and $965.3 million in 1996. The largest component of cash used in investing activities was purchases of securities available for sale, which used $4.8 billion of cash in 1998 and $3.31 billion in 1997. Financing activities provided $1,146.6 million in net cash in 1998, $182 million in 1997, and $249.5 million in 1996. During 1998 financing activities included an increase in deposits of $590.3 million, an increase in FHLB advances of $461.5 million, and an increase in short-term borrowings of $230.9 million.
First American had no material capital expenditure commitments at year-end.
First American's cash requirements consist primarily of debt service, dividends to shareholders, operating expenses, income taxes and share repurchases, if any. These cash needs are routinely met through dividends from subsidiaries, proportionate shares of current income taxes, management and other fees, unaffiliated bank lines, and debt issuance.
Management believes that First American has adequate liquidity to meet all known commitments including loan commitments, dividend payments, debt service, and reasonable borrower, depositor, and creditor requirements over the next twelve months.
YEAR 2000 ISSUE
The term "Year 2000 issue" refers to the necessity of converting computer information systems so that such systems recognize four digits to identify a year in any given date field and are able to differentiate between years in the twentieth and twenty-first centuries (e.g. 1900 and 2000). To address the Year 2000 issue, First American has adopted a broad-based approach designed to encompass First American's total environment.
First American has appointed a project manager from its information technology ("IT") group and a project team comprised of managers from various areas of the organization to address the Year 2000 issue. Overseeing the project is a steering committee made up of senior management. The project team is responsible for evaluating Year 2000 impact to each area's products and systems, developing a plan for bringing those products and systems to compliant levels, and testing or verifying that compliance. First American's project team is using a 5-phase approach comprised of awareness, assessment, remediation, validation, and implementation phases. Areas of risk being addressed by the project team include:
- Business Systems Applications--This involves Year 2000 remediation of application software that is used to perform specific business functions such as deposits or loan systems.
- Technical Infrastructure--This involves Year 2000 remediation of the hardware and software environment used to run application software and includes PC networks, telecommunications, mainframe computers, operating systems, and productivity software.
- Credit Administration--In this area, the project team is reviewing and addressing the risk associated with Year 2000 status of First American's clients and depositors.
- Facilities Systems--This involves Year 2000 remediation of microprocessor-controlled systems such as elevators, HVAC systems, security systems, lighting systems, and utilities.
- Vendor and Third Party Assessment--In this area, the project team has conducted an inventory of the systems and products provided by third parties and has contacted the providers regarding the status of their Year 2000 compliance. This has been a broad-based effort including IT vendors, non-IT vendors, and public utilities.
In the areas of business systems applications and technical infrastructure, First American has made substantial progress in the remediation and testing of mission critical applications, which were substantially complete by the end of 1998. As of December 31, 1998, 90 percent of First American's mission critical applications were completed and 100 percent were anticipated to be completed by March 31, 1999. In the first quarter of 1999, First American plans to conduct an end-to-end re-certification test to re-verify the results from individual application tests. By June 1999 other mission critical applications are expected to be remediated and tested.
First American has an extensive program focused on facilities systems. All buildings and equipment were inventoried and assessed for critical Year 2000 remediation. A small number of systems were identified that required upgrades or replacements. These projects are underway, with facilities remediation projects scheduled to be completed by March 31, 1999.
First American completed its initial credit risk review of significant borrowers in September 1998. Clients have been evaluated for Year 2000 risk and preparedness through a survey and interview process. First American continues to monitor large borrowers throughout 1999 with more emphasis being placed on borrowers in the higher risk category.
First American continues to focus on three areas of Year 2000 contingency planning. Remediation contingency plans have been developed for mission critical applications that remain to be completed at December 31, 1998. Very few systems fall into this category and there are currently no expectations to need to execute these plans. A Year 2000 element for the existing corporate business continuity plan is a second layer of contingency planning that is underway. The project team is evaluating a number of possible Year 2000 contingencies against core banking processes to determine any additional elements or process changes to the existing plan that would be required. The third element of contingency is Event Planning. This is focused on operational issues just before and during the rollover to the Year 2000, including the creation of a central "command center," to monitor systems and track issues. Contingency plans are scheduled to be complete by June 30, 1999.
First American does not expect Year 2000 costs to exceed $5 million in the aggregate. External expenses are expected to total $2.2 million. Internal allocation of existing staff to work on the Year 2000 Project is estimated to total $2.5 million, bringing the total estimated Year 2000 expenditures to approximately $4.7 million dollars.
First American management believes its approach to the Year 2000 issue to be comprehensive and does not expect the Year 2000 issue to have a material impact on its results of operations, liquidity or financial condition.
- --------- OUTLOOK - ---------
To the extent that statements in this discussion relate to the plans, objectives, or future performance of First American, these statements may be deemed to be forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are based on management's current expectations and the current economic environment. Actual strategies and results in future periods may differ materially from those currently expected due to various assumptions, risks, and uncertainties.
Although future performance cannot be predicted, we believe opportunities exist for sustained, profitable growth with continued emphasis on fee-based financial services. Acquisition of banking businesses during 1998 expanded First American's geographical presence primarily in Mississippi, Louisiana, Arkansas, and Georgia and provides the distribution network to deliver fee-based financial products and services emanating from First American's nontraditional financial services businesses.
Management anticipates net interest income will increase in 1999 primarily due to continuing growth in loans. Loans are expected to increase in the 5 percent to 10 percent range. Although management is not expecting a recession, a slow down in some sectors of the economy is anticipated. First American's most likely interest rate scenario at December 31, 1998, assumes that short-term interest rates will remain relatively stable and that there will be a slight steepening of the yield curve throughout 1999.
Management anticipates a provision for loan losses during 1999, although a specific amount cannot be determined at this time. Management expects net charge-offs for loans will be slightly higher in 1999. The appropriate level of the allowance for loan losses and the provision for loan losses will be determined quarterly in accordance with the established allowance assessment methodology.
Noninterest income is expected to increase in excess of 10 percent during 1999. This growth is anticipated due to continued emphasis on fee-based products and from the integration of products and services through the companies acquired and merged during 1998.
Cost synergies, efficiencies, and controls continue to be an emphasis of management. Total integration of the 1998 acquisitions will be a driver in improving the productivity ratio in 1999. First American is striving for a ratio of 50 percent or less by the end of the year 2000.
First American's capital ratios during 1998 exceeded the bank holding companies and national banks regulatory requirements to be classified as "well capitalized," and management anticipates the ratios will continue to meet the regulatory requirements to be "well capitalized" in 1999.
- ------- OTHER - -------
Additional financial information is presented in Tables 21 and 22. Table 21 presents selected quarterly financial data for 1998 and 1997. Table 22 presents consolidated year-end balance sheets for each of the past five years.
TABLE 21: QUARTERLY FINANCIAL DATA
(1) Adjusted to a taxable equivalent basis based on the statutory federal income tax rates, adjusted for applicable state income taxes net of the related federal tax benefit.
TABLE 22: CONSOLIDATED YEAR-END BALANCE SHEETS
ITEM 8:
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements listed in Item 14(a)(1) and (2) are included in this Report beginning on page 68 and are incorporated in this Item 8 by reference. The table "Quarterly Financial Data" on page 56 hereof, "Consolidated Year-End Balance Sheets" on page 57 hereof, and "Consolidated Average Balance Sheets and Taxable Equivalent Income/Expense and Yields/Rates" on pages 29-30 hereof are incorporated in this Item 8 by reference.
ITEM 9:
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10:
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Executive Officers of the Registrant
The following is a list of First American's executive officers, their ages and their positions and offices during the last five years (listed alphabetically).
The additional information required by Item 401 and Item 405 of Regulation S-K is contained in First American's Notice of 1999 Annual Meeting of Shareholders and Proxy Statement (the "1999 Proxy Statement") filed with the Securities and Exchange Commission within 120 days of First American's year-end pursuant to Regulation 14A. Such information appears in the sections entitled "Election of Directors" and "Reports of Beneficial Ownership" in the 1999 Proxy Statement and is incorporated herein by reference.
ITEM 11:
ITEM 11: EXECUTIVE COMPENSATION
This information appears in the sections entitled "Executive Compensation", "Human Resources Committee Interlocks and Insider Participation", "Compensation of Directors" and "Retirement Plans" in the 1999 Proxy Statement, and is incorporated herein by reference.
ITEM 12:
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This information appears in the section entitled "Security Ownership of Management" in the 1999 Proxy Statement, and is incorporated herein by reference.
ITEM 13:
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This information appears in the sections entitled "Certain Transactions" and "Human Resources Committee Interlocks and Insider Participation" in the 1999 Proxy Statement, and is incorporated herein by reference.
PART IV
ITEM 14:
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report:
1. Financial Statements
The Report of KPMG LLP, Independent Auditors
Consolidated Income Statements of First American Corporation and Subsidiaries for each of the years in the three year period ended December 31, 1998
Consolidated Balance Sheets of First American Corporation and Subsidiaries at December 31, 1998 and 1997
Consolidated Statements of Changes in Shareholders' Equity of First American Corporation and Subsidiaries for each of the years in the three year period ended December 31, 1998
Consolidated Statements of Cash Flows of First American Corporation and Subsidiaries for each of the years in the three year period ended December 31, 1998
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
All schedules are omitted because they are not applicable.
The following reports and consents are submitted herewith:
Accountants' Consent by KPMG LLP -- Exhibit 23
3. Exhibits
Upon written or oral request, a copy of the above exhibits will be furnished at cost.
(b) No reports on Form 8-K were filed in the last quarter of 1998.
FIRST AMERICAN CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders First American Corporation:
We have audited the accompanying consolidated balance sheets of First American Corporation and subsidiaries as of December 31, 1998 and 1997, and the related consolidated income statements, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1998. These consolidated financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First American Corporation and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles.
/s/ KPMG LLP -------------------------------------- KPMG LLP
Nashville, Tennessee January 21, 1999
- -------------------------------------------------------------------------------- CONSOLIDATED INCOME STATEMENTS First American Corporation and Subsidiaries - --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
- -------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEETS First American Corporation and Subsidiaries - --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
- -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY First American Corporation and Subsidiaries - --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
- -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS First American Corporation and Subsidiaries - --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
- -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 1: DESCRIPTION OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF OPERATIONS
First American Corporation ("First American"), a bank holding company headquartered in Nashville, Tennessee, is a financial services company. Its major subsidiaries, First American National Bank ("FANB") and First American Enterprises, Inc. ("Enterprises"), provide a wide range of financial services to corporate, individual, and institutional customers. Banking services are provided primarily across the Mid-South region of the United States. Other financial services are provided throughout the United States through its Enterprises segment.
See Note 20 for more information about First American's business segments.
CONSOLIDATION AND BASIS OF PRESENTATION
The consolidated financial statements of First American have been prepared in conformity with generally accepted accounting principles, including general practices of the banking industry. In preparing the financial statements, management makes estimates and assumptions that affect the reported amounts of certain assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of related revenues and expenses during the reporting period. Actual results could differ from those estimates.
The consolidated financial statements include the accounts of First American and its subsidiaries more than 50 percent owned. Subsidiaries not more than 50 percent owned are recorded under the equity method and included in other assets. All significant intercompany accounts and transactions have been eliminated in consolidation. The consolidated financial statements for prior periods also reflect certain reclassifications to conform to the 1998 presentation.
CASH AND CASH EQUIVALENTS
Cash and highly liquid investments with maturities of three months or less when purchased are considered cash and cash equivalents. Cash and cash equivalents consist primarily of cash and due from banks, time deposits with other banks, and federal funds sold.
SECURITIES
First American classifies investments in equity securities that have a readily determinable fair value and investments in debt securities into three categories: held to maturity debt securities, securities available for sale, and trading account securities.
Classification of a debt security as held to maturity is based on First American's intent and ability to hold such security to maturity. Securities held to maturity are stated at cost adjusted for amortization of premiums and accretion of discounts, unless there is a decline in value which is considered to be other than temporary, in which case the cost basis of such security is written down to fair value and the amount of the write-down is included in earnings.
Securities classified as available for sale are reported at fair value with unrealized gains and losses excluded from earnings and reported, net of tax, in a separate component of shareholders' equity in other comprehensive income. All securities not classified as trading account securities or securities held to maturity are classified as available for sale. These include securities used as part of First American's asset/liability strategy which may be sold in response to changes in interest rates, prepayment risk, liquidity needs, and other similar factors. Gains or losses on the sale of securities available for sale are recognized at the time of sale (trade date), based upon the specific identification of the security sold, and are included in noninterest income in the consolidated income statements. Declines in value that are considered other than temporary are recorded in noninterest income as a loss on investment securities.
Securities that are bought and held principally for the purpose of selling them in the near term are classified as trading account securities, which are valued at fair value with unrealized gains and losses included in earnings as trading account revenue. Gains or losses on sales and adjustments to the fair value of trading account securities are included in noninterest income as trading account revenue in the consolidated income statements.
Purchased premiums and discounts are amortized and accreted into interest income on a constant yield basis over the lives of the securities, taking into consideration current prepayment projections.
DERIVATIVE FINANCIAL INSTRUMENTS
First American enters into interest rate swap and forward interest rate swap transactions (swaps), as well as interest rate caps, floors, and futures contracts, in connection with its asset/liability management program in managing interest rate exposure arising out of nontrading assets and liabilities. Interest rate impacts of derivative instruments are correlated with interest rate movements of underlying assets or liabilities. The earnings impact of a derivative is accrued over the life of the agreement based on expected settlement payments and is recorded as an adjustment to interest income or expense in the period in which it accrues and in the category appropriate to the related asset or liability. The related amount receivable from or payable to the derivative counterpart is included in other assets or liabilities in the consolidated balance sheets. Realized and unrealized gains and losses on futures contracts which are designated as hedges of interest rate exposure arising out of nontrading assets and liabilities are deferred and recognized as interest income or interest expense, in the category appropriate to the related asset or liability, over the covered periods or lives of the hedged assets or liabilities. Gains or losses on early terminations of derivative financial instruments that relate to specific assets or liabilities are deferred and amortized as an adjustment to the yield or rate of the related assets or liabilities over the remaining covered period. At such time that there is no longer correlation of interest rate movements between the derivative instrument and the underlying asset or liability, or if the underlying assets or liabilities specifically related to a derivative instrument
matures, are sold or terminated, then the related derivative instrument would be closed out or marked to market as an element of noninterest income on an ongoing basis.
Interest rate derivatives used in connection with the securities available for sale portfolio are carried at fair value with gains and losses, net of applicable deferred income taxes, reported in stockholders' equity in other comprehensive income, consistent with the reporting of unrealized gains and losses on such securities. Premiums paid for interest rate floors qualifying for hedge accounting are deferred and classified with the assets and liabilities hedged and are amortized into interest income or expense over the life of the instrument.
On a limited basis, First American also enters into interest rate swap agreements, as well as interest rate cap and floor agreements, with customers desiring protection from possible adverse future fluctuations in interest rates. As an intermediary, First American generally maintains a portfolio of matched offsetting interest rate contract agreements. At the inception of such agreements, the portion of the compensation related to credit risk and ongoing servicing, if any, is deferred and taken into income over the term of the agreements.
LOANS
Loans are carried at the principal amount outstanding, including net deferred loan fees and costs. Unearned discount and the allowance for loan losses are shown as reductions of loans. Loan origination and commitment fees and certain loan-related costs are being deferred and the net amount amortized as an adjustment of the related loan's yield over the contractual life of the loan. Unearned discount represents the unamortized amount of finance charges, principally related to certain installment loans. Interest income on loans is primarily accrued based on the principal amount outstanding.
First American identifies a loan as impaired when it is probable that First American will be unable to collect the scheduled payments of principal and interest due under the contractual terms of the loan agreement. The value of impaired loans is measured at the present value of expected future cash flows discounted at the loan's effective interest rate, at the loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. If the value of the impaired loan is less than the recorded investment in the loan, First American recognizes this impairment by creating a valuation allowance with a corresponding charge to the provision for loan losses or by adjusting an existing valuation allowance for the impaired loan with a corresponding charge or credit to the provision for loan losses. First American's consumer loans are divided into various groups that are collectively evaluated for impairment.
First American considers all loans on nonaccrual status to be impaired. Commercial loans are placed on nonaccrual status when doubt as to timely collection of principal or interest exists, or when principal or interest is past due 90 days or more, unless such loans are well-secured and in the process of collection. Delays or shortfalls in loan payments are evaluated along with other factors to determine if a loan should be placed on nonaccrual status. Generally, loans with delinquencies under 90 days are placed on nonaccrual status only if specific conditions indicate impairment is probable. The decision to place a loan on nonaccrual status is also based on an evaluation of the borrower's financial condition, collateral, liquidation value, and other factors that affect the borrower's ability to pay.
Generally, at the time a loan is placed on nonaccrual status, interest accrued and uncollected on the loan in the current fiscal year is reversed from income, and interest accrued and uncollected from the prior year is charged off against the allowance for loan losses. Thereafter, interest on nonaccrual loans is recognized as interest income only to the extent that cash is received and future collection of principal is not in doubt. If the collectibility of outstanding principal is doubtful, such interest received is applied as a reduction of principal. A nonaccrual loan may be restored to an accruing status when principal and interest are no longer past due and unpaid and future collection of principal and interest on a timely basis is not in doubt.
Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. Net unrealized losses are recognized through a valuation allowance through charges to earnings.
ALLOWANCE FOR LOAN LOSSES
The provision for loan losses represents a charge to earnings necessary, after loan charge-offs and recoveries, to maintain the allowance for loan losses at an appropriate level which is adequate to absorb potential losses in the portfolio. Such estimated losses arise primarily from the loan portfolio but may also be derived from other sources, including commitments to extend credit and standby letters of credit. The level of the allowance for loan losses is determined on a quarterly basis using procedures which include: (1) categorizing commercial and commercial real estate loans into risk categories to estimate loss probabilities based primarily on the historical loss experience of those risk categories; (2) analyzing significant commercial and commercial real estate credits and calculating specific reserves as necessary; (3) assessing various homogeneous consumer loan categories to estimate loss probabilities based primarily on historical loss experience; (4) reviewing unfunded commitments; and (5) considering various other factors, such as changes in credit concentrations, loan mix, and economic conditions.
OTHER REAL ESTATE OWNED
Other real estate owned is reported in other assets and consists primarily of foreclosed properties. Foreclosed properties include property acquired in situations in which First American has physical possession of a debtor's assets (collateral), regardless of whether formal foreclosure proceedings have taken place. Other real estate owned also includes premises no longer used for business operations.
Other real estate is valued at the lower of cost or fair value of the assets minus estimated costs to sell. The fair value of the assets is the amount that First American could reasonably expect to receive for them in a current sale between a willing buyer and a willing seller, that is, other than in a forced or liquidation sale. Cost includes loan principal, foreclosure expense, and expenditures for subsequent improvements. The excess of cost over fair value minus estimated costs to sell at the time of foreclosure is charged to the allowance for loan losses. Subsequent write-downs to fair value minus estimated costs to sell are included in other real estate owned expense.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation and amortization, which is computed principally on the straight-line method based on the estimated useful lives of the assets or the lease terms, whichever is shorter.
Premises and equipment used by First American are reviewed for impairment when events or changes in circumstances indicate the carrying amount may not be recoverable. In performing a review for recoverability, First American estimates the future cash flows expected to result from the use of an asset and its eventual disposition. If the sum of the expected future cash flows, undiscounted and without interest charges, is less than the carrying amount of the asset, an impairment loss is recognized. Measurement of an impairment loss for assets that First American expects to hold and use is based on the fair market value of the asset. Assets to be disposed of are reported at the lower of carrying amount or fair value less cost to sell. Impairment losses are included as a component of noninterest expense.
OTHER ASSETS
For business combinations accounted for as purchases, the net assets have been adjusted to their estimated fair values as of the respective acquisition dates. The value of core deposit rights and the excess of the purchase price over net assets acquired (goodwill) are recorded in other assets and are being amortized on a straight-line basis over periods ranging from ten to fifteen years.
The carrying value of the excess of the purchase price over net assets acquired is periodically reviewed for impairment. If this review indicates that the goodwill will not be recoverable, as determined based on the undiscounted cash flows of the entity acquired over the remaining amortization period, First American's carrying value of the goodwill will be reduced by the estimated shortfall of discounted cash flows with a corresponding charge to earnings.
Separate assets are recognized for the rights to service mortgage loans. The value of mortgage servicing rights is determined by calculating the net present value of estimated future net cash flows. The mortgage servicing rights are amortized in proportion to and over the estimated period of the net servicing revenues. The carrying values of mortgage servicing rights are periodically evaluated in relation to the fair value of estimated future net servicing revenues. For purposes of impairment evaluation and measurement, the risk characteristics used to stratify the mortgage servicing rights are loan type, payment type, and interest rate stratum, which results in groups of loans that have similar credit and prepayment risk characteristics. Impairment of mortgage servicing rights is recorded through a valuation allowance with changes reflected in earnings.
COMPUTER SOFTWARE COSTS
External direct costs of materials, services utilized in developing or obtaining internal-use computer software, and payroll-related costs for employees directly associated with an internal-use computer software project are capitalized in other assets. Computer software costs that represent research and development and training costs included in the price of purchased
computer software are expensed as incurred. Maintenance fees included in the purchase price are recognized in expense over the maintenance period. Capitalized computer software costs are amortized over the estimated useful life of the software on a straight-line basis.
EMPLOYEE BENEFIT PLANS
First American provides a variety of benefit plans to eligible employees. Retirement plan expense is accrued each year and plan funding represents at least the minimum amount required by the Employee Retirement Income Security Act of 1974, as amended. Differences between expense and funded amounts are carried in other assets or other liabilities. First American recognizes postretirement benefits other than pensions on an accrual basis and other postemployment benefits are also recognized on an accrual basis. First American also makes contributions to an employee thrift and profit-sharing plans based on employee contributions and performance levels of First American.
INCOME TAXES
First American files a consolidated federal income tax return, with the exception of its life insurance subsidiaries, which file separate returns. The provision for income tax expense is determined under the asset and liability method. Under this method, deferred tax assets and liabilities are determined based on the differences between financial reporting and tax bases of assets and liabilities, and are measured using enacted tax rates and laws expected to apply to taxable income in the years in which these temporary differences are expected to be recovered or settled. The effect of changes in tax rates is recognized when the rate is enacted.
EARNINGS PER COMMON SHARE
Basic earnings per share ("EPS") is computed by dividing net income by the weighted average common shares outstanding. Diluted EPS reflects the dilution that could occur if securities or other contracts to issue common stock were exercised or converted.
TREASURY STOCK
Under Tennessee law, when a corporation purchases its common stock in the open market, such repurchased shares become authorized but unissued. Accordingly, First American reduces the par value and reflects the excess of the purchase price over par of any such repurchased shares as a reduction of additional paid-in capital.
REVENUE RECOGNITION
Commission revenues (included in investment services income) and subscribers' commissions for IFC are recorded as of trade date. Certain revenues and subscribers' commissions, such as trailer fee commissions earned from mutual funds, are estimated based upon historical experience.
Subscribers' commissions are commissions on sales of investment products marketed by IFC and are paid to subscribing institutions. These commissions are accrued monthly based
upon a percentage of gross commissions after deduction of certain contractual charges, and paid to subscribing institutions in the month following settlement of the transactions.
STOCK-BASED COMPENSATION
First American accounts for stock-based compensation plans under Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees." Compensation cost for fixed and variable stock-based awards is measured by the excess, if any, of the fair market price of the underlying stock over the amount the individual is required to pay. Compensation cost for fixed awards is measured at the grant date, while compensation cost for variable awards is estimated until both the number of shares an individual is entitled to receive and the exercise or purchase price are known (measurement date).
ACCOUNTING CHANGE
Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments of an Enterprise and Related Information," was adopted at December 31, 1998. SFAS No. 131 requires disclosure of information about operating segments in financial statements. Operating segments are business components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Financial information is required to be reported on the basis that it is used internally for evaluating segment performance and deciding how to allocate resources. Adoption of SFAS No. 131 expands disclosures included in the consolidated financial statements.
RECENT ACCOUNTING PRONOUNCEMENTS
SFAS No. 133, "Accounting for Derivative Instruments and for Hedging Activities," establishes accounting and reporting standards for derivative instruments and hedging activities. SFAS No. 133 requires that an entity recognize the value of derivatives as assets or liabilities on the balance sheet. Gains or losses resulting from changes in the values of derivatives will be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. The key criterion for hedge accounting is that the hedging relationship must be highly effective in achieving offsetting changes in fair value or cash flows. SFAS No. 133 is effective for fiscal years beginning after June 15, 1999, and shall not be applied retroactively to financial statements of prior periods. At this time, management has not fully evaluated the impact of SFAS No. 133. First American plans to adopt SFAS No. 133 prospectively on January 1, 2000.
NOTE 2: ACQUISITIONS AND DIVESTITURES
Acquisitions
Effective May 1, 1998, First American consummated the acquisition of Deposit Guaranty by exchanging approximately 48.7 million shares of First American common stock for all of the outstanding shares of Deposit Guaranty (based on an exchange ratio of 1.17 shares of First American common stock for each share of Deposit Guaranty common stock). Deposit Guaranty
was a $7.2 billion asset financial services holding company headquartered in Jackson, Mississippi, with banking offices in Mississippi, Louisiana, Arkansas, and Tennessee. The transaction was accounted for as a pooling of interests, and accordingly, the consolidated financial statements have been restated to include the results of Deposit Guaranty for all periods presented.
In April 1998, and in conjunction with the Deposit Guaranty business combination, the Board of Directors increased the number of authorized shares from 100 million to 200 million.
Effective November 20, 1998, First American completed the acquisition of Pioneer by exchanging approximately 6.2 million shares of First American common stock for all of the outstanding shares of Pioneer (based on an exchange ratio of 1.65 shares of First American common stock for each share of Pioneer common stock). Pioneer was a $990 million asset financial services holding company headquartered in Chattanooga, Tennessee. The transaction was accounted for as a pooling of interests, and accordingly, the consolidated financial statements have been restated to include the results of Pioneer for all periods presented.
Other business combinations completed by First American during the three years ended December 31, 1998, are presented in the following table (in millions):
For the acquisitions accounted for as poolings of interests in the above table, the results of operations have been included in the consolidated financial statements from the date of the acquisition as preacquisition amounts were not material. Accordingly, prior period financial statements have not been restated since the changes to prior years would have been immaterial. For acquisitions accounted for as purchases, the results of operations have been included in the consolidated financial statements from the respective dates of acquisition. The purchase price in excess of the net assets acquired has been recorded as goodwill and is being amortized on a straight-line basis over 15 years. The proforma effect on prior financial statements of these acquisitions is not significant.
Net interest income and net income as originally reported by First American, Deposit Guaranty, and Pioneer for the years ended December 31, 1997 and 1996, are presented in the table below:
In 1998, Deposit Guaranty had net interest income of $91.4 million, noninterest income of $49 million, and net income of $32.5 million prior to its acquisition date. In 1998, Pioneer had net interest income of $38.1 million, noninterest income of $9.8 million, and net income of $3.1 million prior to its acquisition date.
On December 16, 1998, First American through its subsidiary IFC purchased the assets of the Specialized Investment Division (SID) of Financial Service Corporation. A subsidiary of SunAmerica Inc., SID provides investment products to customers of community banks and credit unions that do not have their own broker/dealer capabilities. The $9 million purchase price was primarily for goodwill and other intangible assets. The goodwill is being amortized on a straight-line basis over 10 years.
Effective April 1, 1996, FANB purchased 49 percent of the stock of The SSI Group ("SSI"), a healthcare payments processing company, for $8.6 million. This investment is being accounted for under the equity method of accounting.
Divestitures
Divestitures by First American during the past three years are presented below:
- On August 17, 1998, First American completed the sale of Deposit Guaranty's corporate trust business to The Bank of New York. The transaction resulted in an initial gain of $7 million ($4.4 million net of tax) and involved the transfer of approximately 900 bond trustee and agency relationships representing $8 billion in outstanding securities for municipalities and corporations located primarily in Mississippi and Louisiana.
- On August 16, 1998, First American completed the sale of McAfee Mortgage, a mortgage subsidiary in Texas, and recognized a pretax gain of $73 thousand.
- Effective July 11, 1998, First American sold certain assets of First Mortgage Corp., a mortgage subsidiary operating in Nebraska, Iowa, and Oklahoma, and recognized a pretax loss of approximately $2.4 million.
- On April 3, 1998, First American completed the sale of three branches in Virginia with total deposits of approximately $37 million for a pretax gain of $2.7 million.
- On December 22, 1997, First American completed the sale of its corporate trust business to The Bank of New York for an initial gain of $2.4 million in 1997. The sale consisted of the transfer of approximately 250 bond trustee and agency relationships representing $4 billion of outstanding securities.
- On July 17, 1997, First American completed the sale of Tennessee Credit Corporation and First City Life Insurance with total assets of $13.6 million to Norwest Financial Tennessee, Inc. The transaction resulted in a net gain of $2.1 million.
NOTE 3: MERGER AND INTEGRATION COSTS
First American recorded merger and integration costs of $121.7 million in 1998. These charges were associated with the acquisitions of Deposit Guaranty, Pioneer, MTB, CSB, and Peoples. The merger and integration costs included: $45.8 million of systems and operations conversion costs; $29.1 million of investment banking and other transaction costs; $32.9 million in termination and personnel-related costs reduced by a $7 million pension curtailment gain resulting from a reduction in active plan participants in Deposit Guaranty's Master Retirement Plan; $15 million to fund a charitable foundation for the Deposit Guaranty market; $3.3 million of compliance costs; and $2.7 million of occupancy and equipment writedowns.
Termination and personnel-related costs include payments for severance, retention, change-of-control, outplacement, and other benefits associated with the termination of employees primarily in corporate support and data processing functions. Occupancy and equipment writedowns reflect write-offs for duplicate or abandoned equipment, branches, and office space. Systems and operations conversion costs result from the conversions and integration of the acquired branches and operations; such costs are primarily for contract labor, outside consultants, direct and indirect customer communications, training, and associated travel.
In connection with the Deposit Guaranty merger and the resulting plan to consolidate operations, business line locations, and administrative functions, management approved and communicated employee termination benefits including severance and retention bonuses of $18.2 million to approximately 900 employees to be involuntarily terminated. Pursuant to the plan, 760 employees have been terminated and paid $20.5 million in the form of severance, retention bonuses, outplacement, and change in control payments. With regards to Pioneer, approximately 140 employees have been notified of employee termination benefits of $2.9 million. No terminations were made as of December 31, 1998 and such terminations are anticipated in 1999.
The $18.8 million liability at December 31, 1998, will be paid in 1999 and represents costs that have been incurred primarily for severance and personnel-related benefits, compliance- related issues, and system conversions. The following table presents a summary of activity with respect to the merger and integration costs:
NOTE 4: CASH AND DUE FROM BANKS
First American's bank and thrift subsidiaries are required to maintain reserves, in the form of cash and balances with the Federal Reserve Bank. Approximately $263.0 and $228.6 million of the cash and due from banks balance at December 31, 1998 and 1997, respectively, represented reserves maintained in order to meet Federal Reserve requirements.
NOTE 5: SECURITIES
SECURITIES HELD TO MATURITY
The amortized cost, gross unrealized gains, gross unrealized losses, and approximate fair values of securities held to maturity at December 31, 1998 and 1997, are presented in the following table:
The amortized cost and approximate fair values of held to maturity mortgage-backed securities at December 31, 1998 and 1997, included in U.S. Treasury and U.S. Government agencies and corporations, and in other debt securities, are presented in the following table:
SECURITIES AVAILABLE FOR SALE
The amortized cost, gross unrealized gains, gross unrealized losses, and approximate fair values of securities available for sale at December 31, 1998 and 1997, are presented in the following table:
The amortized cost and approximate fair values of available for sale mortgage-backed securities at December 31, 1998 and 1997, included in U.S. Treasury and U.S. Government agencies and corporations, and in other debt securities, are presented in the following table:
The sale of securities available for sale resulted in gross realized gains and losses as follows:
TOTAL SECURITIES
The amortized cost and approximate fair values of debt securities at December 31, 1998, by average estimated maturity are shown below. The expected maturity for governmental and corporate securities is the stated maturity, and the expected maturity for mortgage-backed securities and other asset-backed securities is based on current estimates of average maturities, which include prepayment assumptions.
At December 31, 1998 and 1997, First American held securities with amortized cost amounting to $1,273.5 million and $1,443.7 million, respectively, which were issued or guaranteed by the Federal National Mortgage Association and $1,651.0 million and $1,120.5 million, respectively, which were issued or guaranteed by the Federal Home Loan Mortgage Corporation.
Securities carried in the consolidated balance sheets at approximately $4,635.6 million and $3,197.4 million at December 31, 1998 and 1997, respectively, were pledged to secure public and trust deposits, repurchase transactions, and for other purposes as required or permitted by law.
NOTE 6: LOANS AND ALLOWANCE FOR LOAN LOSSES
First American's bank and thrift subsidiaries have a diversified loan portfolio consisting of commercial, consumer, and real estate loans primarily with customers located within First American's market, which is the Mid-South region of the United States. Mortgage loans held for sale at December 31, 1998 and 1997, were $214.2 million and $116.6 million, respectively, and related net gains amounted to $13.5 million in 1998 and $11 million in 1997. Total mortgage loans serviced, including mortgage loans serviced on behalf of First American's banking subsidiaries, approximated $5.9 billion and $6.4 billion at December 31, 1998 and 1997, respectively.
Loans are either secured or unsecured based on the type of loan and the financial condition of the borrower. The loans are generally expected to be repaid from cash flow or proceeds from the sale of selected assets of the borrower; however, First American is exposed to risk of loss on loans due to the borrower's difficulties, which may arise from any number of factors including problems within the respective industry or economic conditions, including those within First American's market.
Transactions in the allowance for loan losses were as follows:
Net charge-offs (recoveries) by major loan categories were as follows:
At December 31, 1998 and 1997, loans on a nonaccrual status amounted to $47.9 million and $38.1 million, respectively. Interest income not recognized on nonaccrual loans was approximately $2.7 million in 1998, $2.5 million in 1997, and $2.1 million in 1996.
Certain First American directors and executive officers (and their associates), were engaged in loan transactions with First American during 1998 and 1997. Such loans are at normal credit terms, including interest rates and collateral, and do not represent more than a normal risk of collection. Outstanding balances and activity are presented below:
Impaired loans and related allocated allowance amounts at December 31, 1998, 1997 and 1996 were as follows:
The average recorded investment in impaired loans and related interest income for the years ended December 31, 1998, 1997, and 1996, were as follows:
NOTE 7: PREMISES AND EQUIPMENT AND LEASE COMMITMENTS
Premises and equipment are summarized as follows:
Depreciation and amortization expense of premises and equipment for 1998, 1997, and 1996 was $41.5 million, $40.8 million, and $37.0 million, respectively.
Rent expense, net of rental income, on bank premises for 1998, 1997, and 1996 was $5.7 million, $4.5 million, and $3.7 million, respectively. Rental income on bank premises for 1998, 1997, and 1996 was $12.3 million, $11.3 million, and $10.8 million, respectively. First American is obligated under a number of noncancelable operating leases for premises and equipment with varying terms which may include the payment of taxes, insurance, and maintenance costs.
At December 31, 1998, the future minimum lease payments under operating and capital leases were as follows:
First American has a data processing outsourcing agreement expiring in 2001 with an average annual base expense of $11.3 million for future years. Total annual fees vary with cost of living adjustments and changes in services provided by the vendor, which depend upon First American's volume of business and system needs. The related expense is included in system and processing expense in the consolidated income statements.
NOTE 8: OTHER ASSETS
Goodwill and Other Intangible Assets
Following is a summary of changes in goodwill and other intangible assets, net of accumulated amortization, included in other assets on the consolidated balance sheets.
Mortgage Servicing Rights
Following is a summary of changes in capitalized mortgage servicing rights, net of accumulated amortization, included in other assets on the consolidated balance sheets.
Changes in the valuation allowance for capitalized mortgage servicing rights were as follows:
The estimated aggregate fair value of the capitalized mortgage servicing rights at December 31, 1998 and 1997, was $57.9 million and $46.2 million, respectively.
NOTE 9: SHORT-TERM BORROWINGS
Short-term borrowings are issued on normal banking terms and consisted of the following:
Other short-term borrowings included U.S. Treasury tax and loan accounts of $42.7 million and $112.7 million at December 31, 1998 and 1997, respectively, and advances from the Federal Home Loan Bank ("FHLB") of $148.2 million and $244.4 million at December 31, 1998, and 1997, respectively.
The balance of short-term FHLB advances, weighted-average interest rates, and maturities at December 31, 1998, are listed below:
First American's FHLB advances are collateralized by a blanket pledge on $707 million of 1-4 family mortgage loans and $819 million of investment securities.
The following table presents information regarding federal funds purchased and securities sold under agreements to repurchase:
NOTE 10: LONG-TERM DEBT
Long-term debt consisted of the following:
The balance of long-term FHLB advances, weighted-average interest rates, and maturities at December 31, 1998, are listed below:
First American's FHLB advances are collateralized by a blanket pledge on $707 million of 1-4 family mortgage loans and $819 million of investment securities.
First American entered into a $100 million unsecured revolving credit agreement in 1998 which replaced the 1994 $70 million revolving credit agreement. Under the terms of the agreement, which expires in July 2001, First American pays a facility fee for the availability of these funds computed at a rate ranging from 1/10 to 1/4 of 1 percent per annum on the commitment with the rate depending on First American's Moody's and S&P ratings of its senior unsecured long-term debt securities. The agreement also provides for First American to pay a utilization fee computed at 1/20 to 3/20 percent per annum on the average daily principal amount of borrowings exceeding 50 percent of the aggregate commitment with the rate depending on First American's credit ratings of its unsecured long-term debt securities. Interest to be paid on the outstanding balances will be computed based on the corporate base rate of the lending bank, federal funds effective rates or Eurodollar rates. First American had no revolving credit borrowings outstanding at December 31, 1998, or 1997.
The terms of the credit agreements provide for, among other things, restrictions on payment of cash dividends and purchases, redemptions, and retirement of capital shares. Under First American's most restrictive debt covenant, approximately $215.7 million of retained earnings was available to pay dividends as of December 31, 1998.
NOTE 11: EMPLOYEE BENEFIT PLANS
RETIREMENT PLAN AND OTHER POSTRETIREMENT BENEFITS
First American and its subsidiaries participate in noncontributory retirement plans with death and disability benefits covering substantially all employees (except the employees of IFC) with one or more years of service. The benefits are based on years of service and average monthly earnings of a participant for the 60 consecutive months which produce the highest average earnings.
In addition to pension benefits, First American and its subsidiaries have postretirement benefit plans that provide medical insurance and death benefits for substantially all retirees (except the retirees of IFC) and eligible dependents. Because the death benefit plan, which was terminated during 1998, is not significant, it is combined with the medical insurance plans for disclosure purposes.
The following table presents a reconciliation of (a) the benefit obligation between the beginning and the end of the year, (b) the fair value of plan assets between the beginning and the end of the year, and (c) the funded status of the plan with amounts recognized in First American's consolidated balance sheets for 1998 and 1997 for the retirement plans and the other postretirement benefit plans. The table includes the retirement and other postretirement plans of the 1998 business combinations. No additional minimum pension liability was required to be recognized in either 1998 or 1997.
Of the year-end benefit obligation for postretirement benefits, amounts attributable to life insurance benefits were $.8 million and $1.1 million at December 31, 1998 and 1997, respectively.
Components of the net periodic benefit cost were as follows:
During 1998 the Corporation experienced a $7.4 million curtailment gain in its retirement plan due to the estimated effect of significant employee terminations associated with the Deposit Guaranty merger. The curtailment gain was recorded as a reduction of merger and integration costs. Also during 1998, the Corporation terminated and settled its postretirement death benefits plan, resulting in a curtailment gain of $1.2 million.
Weighted-average assumptions at December 31 used in accounting for the plans were as follows:
For measurement purposes, an 8 percent annual rate of increase in the per capita cost of covered health care benefits was assumed for 1999. The rate was assumed to decrease gradually to 5.5 percent for 2010 and remain at that level thereafter.
Assumed healthcare cost trend rates have a significant effect on the amounts reported for the medical insurance plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects:
First American continues to fund medical benefit costs principally on a pay-as-you-go basis.
SUPPLEMENTAL RETIREMENT PLAN
First American has a retirement plan which provides supplemental retirement benefits to certain executives. The expense was $.4 million in 1998, $.3 million in 1997, and $.3 million in 1996. Benefit payments from the plan are made from general assets of First American. The weighted average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation at December 31, 1998 were 6.75 percent and 5.4 percent, respectively, and at December 31, 1997 were 7.25 percent and 5.3 percent, respectively.
OTHER EMPLOYEE BENEFITS
- - First American has a combination savings thrift and profit-sharing plan ("FIRST Plan") available to all employees (except the employees of IFC and hourly paid and special exempt-salaried employees). The plan is funded by employee and employer contributions. First American's annual contribution to the plan is based upon the amount of basic contributions of participants, participants' compensation, and the achievement of certain corporate performance standards and may be made in the form of cash or First American's common stock with a market value equal to the cash contribution amount. Total plan expense was $8.8 million in 1998, $8.4 million in 1997 and $7.2 million in 1996. During 1998, 1997 and 1996 First American matched employees' qualifying contributions at 100 percent.
- - In 1983, IFC formed the Salary Savings Retirement Plan. IFC has also established a profit sharing plan covering certain employees. Contributions to both plans totaled $.4 million in 1998 and $.5 million in 1997.
- - Certain of the companies which First American acquired during 1998 sponsored various employee benefit plans. Such plans, including the 401(k) plans, ESOPs, and deferred compensation plans, are in the process of being terminated or frozen and their employees are participating or will be participating in First American's retirement and other benefit plans. The liabilities, if any, for such terminations have been recorded as of December 31, 1998.
NOTE 12: INCOME TAXES
The components of income tax expense are presented below:
The following table presents a reconciliation of income tax expense as shown in the consolidated income statements with that which would be computed by applying the statutory federal income tax rate of 35 percent to income before income tax expense.
The 1998 and 1997 net deferred tax liability is included in other liabilities on the consolidated balance sheets. Management believes that it is more likely than not that the deferred tax asset will be realized. Significant components of the deferred tax asset and liability are as follows:
NOTE 13: CAPITAL STOCK
On July 16, 1998, the Board of Directors authorized a new Rights Agreement between First American and First Chicago Trust Company of New York, as Rights Agent (the "1998 Rights Plan"). The 1998 Rights Plan replaced First American's Rights Agreement, dated December 14, 1988, which expired on December 27, 1998 (the "1988 Rights Plan"). The primary purpose of the 1998 Rights Plan, like that of the 1988 Rights Plan, is to enhance the ability of First American's Board of Directors to protect the interests of all shareholders in connection with any effort to acquire control of First American.
First American has stock-based compensation plans for certain officers and other key employees. The plans provide for restricted stock incentives based on the attainment of annual and long-term performance goals. Stock-based compensation plans also include stock option programs, which provide for the granting of statutory incentive stock options and nonstatutory options to key employees. Additionally, First American has a stock option plan for nonemployee directors. As of December 31, 1998, First American had 20.8 million shares of common stock reserved for issuance under these plans.
Since 1991, First American has issued restricted common stock to certain executive officers. The restrictions lapse within primarily 10 years of issuance; however, if certain performance criteria are met, restrictions will lapse earlier. The amount recorded for the restricted stock issued is based on the market value of First American's common stock on the award dates and is shown as deferred compensation in shareholders' equity. Such compensation expense is recognized over periods ranging from three to ten years. The amount of compensation expense recognized from awards of restricted stock in First American's consolidated financial statements for 1998, 1997, and 1996 was $7.2 million, $3.4 million, and $1.4 million, respectively.
The following table summarizes First American's restricted stock grants and the weighted-average fair values at grant date:
As discussed under Note 1, First American has chosen to follow APB Opinion No. 25 and related interpretations in accounting for employee stock options, and accordingly, no compensation expense has been recognized for options granted during 1998, 1997, and 1996. Had First American used the provisions under SFAS No. 123, the fair value of each option granted would be estimated on the date of grant using the Black-Scholes option-pricing model. Based on this fair value calculation of compensation expense, net income and earnings per share on a proforma basis have been computed and are compared with reported amounts in the table below:
The effects of applying SFAS No. 123, for either recognizing or disclosing compensation cost under such pronouncement, may not be representative of the effects on reported net income in future years. The following weighted-average assumptions were used in the Black-Scholes option-pricing model:
A summary of First American's stock option plans as of December 31, 1998, 1997, and 1996, and changes during the years ended on those dates is presented below:
The following table summarizes information about stock options outstanding at December 31, 1998:
NOTE 14: COMPUTATION OF EARNINGS PER COMMON SHARE
The effect from assumed exercise of .5 million and .6 million of stock options was not included in the computation of diluted earnings per share for 1998 and 1996, respectively, because such shares would have had an antidilutive effect on earnings.
NOTE 15: OFF-BALANCE-SHEET AND DERIVATIVE FINANCIAL INSTRUMENTS
In the normal course of business, First American is a party to financial transactions which have off-balance-sheet risk. Such transactions arise in meeting customers' financing needs and from First American's activities in reducing its own exposure to fluctuations in interest rates. Off-balance-sheet items involving customers consist primarily of commitments to extend credit and letters of credit, which generally have fixed expiration dates. These instruments may involve, to varying degrees, elements of credit and interest rate risk. To evaluate credit risk, First American uses the same credit policies in making commitments and conditional obligations on these instruments as it does for instruments reflected on the balance sheet. Collateral obtained, if any, varies but may include deposits held in financial institutions; U.S. Treasury securities or other marketable securities; income-producing commercial properties; accounts receivable; property, plant, and equipment; and inventory. First American's exposure to credit risk under commitments to extend credit and letters of credit is the contractual (notional) amount of the instruments. Interest rate contract transactions may have credit and interest rate risk significantly less than the contractual amount.
COMMITMENTS
Commitments to extend secured or unsecured credit are contractual agreements to lend money provided there is no violation of any condition. Commitments may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. At December 31, 1998 and 1997, respectively, First American had $4.8 billion and $5.2 billion of unfunded commitments to extend credit. Of these amounts, unfunded commitments for borrowers with loans on nonaccrual status were $1.8 million at December 31, 1998, and $.1 million at December 31, 1997.
Standby letters of credit are commitments issued by First American to guarantee the performance of a customer to a third party. As of December 31, 1998 and 1997, First American had standby letters of credit issued amounting to approximately $406.9 million and $406 million, respectively. First American also had commercial letters of credit of $51 million and $40.9 million at December 31, 1998 and 1997, respectively. Commercial letters of credit are conditional commitments issued by First American to facilitate trade for corporate customers. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
Forward commitments are contracts for the delayed delivery of securities in which the seller agrees to make delivery of a specified instrument at a specified future date and at a specified price or yield. Credit risk may arise from the possibility that counterparties may not have the ability to fulfill their commitments, while market risk may arise from movements in interest rates and security values. As of December 31, 1998, the contract amounts for forward commitments totaled $99 million compared to $139 million at December 31, 1997.
First American contracts to buy and sell foreign exchange primarily to meet the currency needs of its customers and to hedge any resulting exposure against market risk. At December 31, 1998 and 1997, First American had $15.3 million and $30.6 million, respectively, of foreign exchange forward contracts, which is the sum of customers' contracts and First American's offsetting contracts to minimize its exposure.
DERIVATIVES
First American's principal objective in holding or issuing derivative financial instruments is the management of interest rate exposure arising out of nontrading assets and liabilities. First American's earnings are subject to risk of interest rate fluctuations to the extent that interest-earning assets and interest-bearing liabilities mature or reprice at different times or in differing amounts. First American's objective is to manage the interest sensitivity position so that net income will not be impacted more than 5 percent for interest rates varying up to 150 basis points from the most likely interest rate forecast over the next 12 months.
To achieve its risk management objective, First American uses a combination of derivative financial instruments, particularly interest rate swaps. The instruments utilized are noted in the following table along with their notional amounts and fair values at year-end 1998 and 1997:
(1) Fixed rate. (2) Variable rate which reprices quarterly based on 3-month LIBOR. (3) Variable rate which reprices monthly based on 1-month LIBOR. (4) Forward swap periods will begin at various dates during 1999. Variable rates were unknown at December 31, 1998. (5) Forward swap periods have become effective for $750 million and will begin at various dates during 1999 for $950 million. Variable rates were unknown at December 31, 1998, for forward swaps which were not yet effective. Variable rates are based on LIBOR and will reprice quarterly except $400 million which will reprice semi-annually. (6) Variable rate which reprices quarterly based on the constant maturity treasury index. (7) Forward swap periods have become effective for $150 million and will begin at various dates during 1998 for $450 million. Variable rates were unknown at December 31, 1997, for forward swaps which were not yet effective. (8) Forward swap periods began at various dates during 1998. Variable rates were unknown at December 31, 1997, for forward swaps which were not yet effective. (9) Fixed rate strike price, based on the 3-month LIBOR rate.
Notional amounts are key elements of derivative financial instrument agreements. However, notional amounts do not represent the amounts exchanged by the parties to derivatives and do not measure First American's exposure to credit or market risks. The amounts exchanged are based on the notional amounts and the other terms of the underlying derivative agreements. First American's credit exposure at the reporting date from derivative financial instruments is represented by the fair value of instruments with a positive fair value at that date offset by the effect of master netting agreements and by any collateral held. Credit risk disclosures, however, relate to losses that would be recognized if counterparties failed completely to perform their obligations.
The risk that counterparties to derivative financial instruments might default on their obligations is monitored on an ongoing basis. To manage the level of credit risk, First American reviews the credit standing of its counterparties and enters into master netting agreements whenever possible, and when appropriate, obtains collateral. Master netting agreements incorporate rights of setoff that provide for the net settlement of subject contracts with the same counterparties in the event of default.
Interest rate swap contracts are used to convert certain deposits and long-term debt to fixed interest rates, to convert certain groups of customer loans to fixed rates, and to hedge market value fluctuations of available for sale securities. First American's net credit exposure with interest rate contract counterparties, considering master netting agreements and collateral held, totaled $14.8 million at December 31, 1998, and $14.1 million at December 31, 1997.
At December 31, 1998, First American did not have any outstanding interest rate floors. However, during 1995, interest rate floors were purchased in anticipation of decreases in interest rates. These floors limited First American's exposure to unfavorable interest rate fluctuations below a particular rate for commercial loans. A premium was paid for this protection. The risk assumed by First American was limited to the amount of the premium and not the notional amount of the interest rate floor. At December 31, 1997, the unamortized portion of the interest rate floor was $1.9 million.
The table below presents the net deferred gains related to terminated derivative financial instruments at December 31, 1998 and 1997, and their locations within the consolidated balance sheets. All of the net deferred gains are related to interest rate swaps.
(1) $2.5 million of net deferred gains to be recognized during 1999 and $12.2 million of net deferred gains to be recognized during 2000 through 2006. (2) $1.1 million of net deferred gains recognized during 1998 and $4.3 million of net deferred gains to be recognized during 1999 through 2006.
NOTE 16: LEGAL AND REGULATORY MATTERS
First American is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on First American's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, First American must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require First American to maintain minimum ratios of Tier I and total capital to risk-weighted assets, and of Tier I capital to average assets of 4 percent, 8 percent, and 4 percent, respectively. Management believes as of December 31, 1998, that First American met all capital adequacy requirements to which it was subject.
As of December 31, 1998, the most recent notification from the OCC categorized FANB as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, FANB must maintain minimum Tier I risk-based capital, total risk-based capital, and Tier I leverage ratios of 6 percent, 10 percent, and 5 percent, respectively. There are no conditions or events since that notification that management believes would change FANB's well capitalized status. The actual capital amounts and ratios for First American and FANB are presented in the table below:
(1) Risk-based capital ratios were computed using realized equity (total shareholders' equity exclusive of net unrealized gains (losses) on securities available for sale, net of tax).
The extent to which dividends may be paid to First American from its subsidiaries is governed by applicable laws and regulations. For First American's national bank subsidiary, the approval of the OCC is required if dividends declared in any year exceed net profits for that year (as defined under the National Bank Act) combined with the retained net profits of the two preceding years. In addition, a national bank may not pay a dividend, make any other capital distribution, or pay management fees if such payment would cause it to fail to satisfy certain minimum capital requirements. Under the regulations of the OTS, a savings association that exceeds its fully phased-in capital requirements both immediately prior to and on a proforma basis after giving effect to a proposed capital distribution is generally permitted without prior approval of the OTS to make a capital distribution during a calendar year equal to the greater of (i) 100 percent of net earnings to date during the calendar year, plus the amount that would reduce by one-half its "surplus capital ratio" (i.e., the excess capital over its fully phased-in capital requirements) at the beginning of the calendar year; or (ii) 75 percent of its net income for the previous four quarters. In accordance with the most restrictive regulations, at December 31,
1998, the above subsidiaries had $257.6 million available for distribution as dividends to First American.
On September 30, 1996, special legislation was enacted which required many financial institutions to pay a one-time assessment on deposits insured by the Savings Association Insurance Fund ("SAIF") at the rate of $.657 per $100 of deposits held as of March 31, 1995. First American's assessment was $8.1 million or $5 million, net of tax ($.05 per share). The purpose of the legislation was to recapitalize the thrift fund up to the statutorily prescribed 1.25 percent. Effective January 1, 1997, the normal SAIF deposit insurance rate for well-capitalized institutions dropped to 0 basis points per $100 of deposits. Beginning January 1, 1997, a separate 1.3 basis point annual charge will be assessed through 1999 on Bank Insurance Fund deposits and a 6.4 basis point annual charge will be assessed on SAIF deposits in order to service debt incurred by the Financing Corporation, a corporation established by the Federal Housing Finance Board to issue stock and debt principally to assist in funding the Federal Savings and Loan Insurance Corporation Resolution Fund. Starting in the year 2000 until the Financial Corporation debt is retired, banks and thrifts will pay such assessment on a pro rata basis, which is estimated to run approximately 2.5 basis points.
Following the adoption of the Financial Institutions Reform, Recovery and Enforcement Act of 1989, Charter Federal Savings Bank ("Charter" or now "FAFSB" which was subsequently acquired by First American), brought an action against the Office of Thrift Supervision and the Federal Deposit Insurance Corporation seeking injunctive and other relief, contending that Congress' elimination of supervisory goodwill required rescission of certain supervisory transactions. The Federal District Court found in Charter's favor, but in 1992 the Fourth Circuit Court of Appeals reversed, and the U.S. Supreme Court denied Charter's petition for certiorari. In 1995, the Federal Circuit Court found in favor of another thrift institution in a similar case (Winstar Corp. v. United States) in which the association sought damages for breach of contract. Charter also filed suit against the United States Government ("Government") in the Court of Federal Claims based on breach of contract. Pending the Supreme Court's review of the Winstar decision, FAFSB's action was stayed. In July 1996, the Supreme Court affirmed the lower court's decision in Winstar. The stay was automatically lifted and FAFSB's suit is now proceeding. The Government filed a motion to dismiss the suit based on the prior Fourth Circuit decision, and FAFSB filed a Motion for Partial Summary Judgment. These motions have not yet been decided by the Federal Claims Court.
The value of FAFSB's claims against the Government, as well as their ultimate outcome, are contingent upon a number of factors, some of which are outside of FAFSB's control, and are highly uncertain as to substance, timing and the dollar amount of any damages which might be awarded should FAFSB finally prevail. Under the Agreement and Plan of Reorganization as amended by and between FAFSB and First American, in the event that FAFSB is successful in this litigation, the Charter shareholders as of December 1, 1995, will be entitled to receive additional consideration equal in value to 50 percent of any recovery, net of all taxes and certain other expenses, including the costs and expenses of such litigation, received on or before December 1, 2000, subject to certain limitations in the case of certain business combinations. Such additional consideration, if any, is payable in the common stock of First American, based on the average per share closing price on the date of receipt by FAFSB of the last payment constituting a recovery from the Government.
Deposit Guaranty National Bank ("DGNB"), now a division of FANB, is a defendant in an action brought in Pike County, Mississippi by a land owner and a gaming corporation, alleging that DGNB and the two defendant casinos entered into an agreement, expressed or implied, to oppose an application to operate a casino on the Big Black River in Mississippi. The plaintiffs contend that DGNB used its influence to cause the Mississippi Gaming Commission to deny the casino's application. The plaintiffs seek actual damages for injury to property and business in the total amount of $38 million and punitive damages in the amount of $200 million. DGNB denies all liability. It is the opinion of management and counsel that ultimate disposition of the case should not have a material effect on First American's consolidated financial statements.
There are from time to time other legal proceedings pending against First American and its subsidiaries. In the opinion of management and counsel, liabilities, if any, arising from such proceedings presently pending would not have a material adverse effect on the consolidated financial statements of First American.
NOTE 17: FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires disclosure of fair value information about financial instruments for both on- and off-balance-sheet assets and liabilities for which it is practicable to estimate fair value. The techniques used for this valuation are significantly affected by the assumptions used, including the amount and timing of future cash flows and the discount rate. Such estimates involve uncertainties and matters of judgment and therefore cannot be determined with precision. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets. Accordingly, the aggregate fair value amounts presented are not meant to represent the underlying value of First American.
The estimated fair values for First American's off-balance-sheet financial instruments are summarized as follows:
The following methods and assumptions were used in estimating the fair value disclosures for financial instruments:
Short-term financial instruments -- The carrying amounts of short-term financial instruments, including cash, federal funds sold and purchased and resell and repurchase agreements approximate fair value. These instruments expose First American to limited credit risk and have no stated maturity or mature within one year or less and carry interest rates which approximate market.
Securities held to maturity, securities available for sale, and trading account securities -- Fair values are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
Loans -- For variable-rate loans that reprice frequently, fair values are based on carrying values. The fair values for certain homogeneous categories of loans, such as residential mortgages, are estimated using quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair values for other performing loans are estimated by discounting estimated future cash flows using the current rates at which similar loans would be made to borrowers with similar credit risk and for similar maturities. Included within financial assets are certain nonperforming assets, consisting primarily of nonperforming loans, the fair values of which are based principally on the lower of the amount due from customers or the fair value of the loans' collateral, which is the amount First American could reasonably expect to receive in a current sale between a willing buyer and seller other than in a forced or liquidation sale.
Deposits -- The fair value of deposits with no stated maturity, such as demand deposits, NOW accounts, money market accounts, and regular savings accounts, is equal to the amount payable on demand at the reporting date. The fair value of certificates of deposit and other fixed maturity time deposits is estimated using the rates currently offered for deposits of similar remaining maturities. Any foreign deposits are valued at the carrying value due to the frequency with which rates for such deposits are adjusted to a market rate.
Short-term borrowings -- Fair value is estimated to equal the carrying amount since these instruments have a relatively short maturity.
Long-term debt -- Rates for long-term debt with similar terms and remaining maturities are used to estimate fair value of existing debt.
Off-balance-sheet instruments -- The fair value of commitments to extend credit is based on unamortized deferred loan fees and costs. For letters of credit, fair value is estimated using fees currently charged to enter into similar agreements with similar maturities. The fair value of First American's outstanding interest rate floors is based on quoted market prices, and the estimated fair value of interest rate swaps and forward interest rate swaps is based on estimated costs to settle the obligations with the counterparties at the reporting date.
NOTE 18: COMPREHENSIVE INCOME
SFAS No. 130, "Reporting Comprehensive Income," was adopted by First American on January 1, 1998. SFAS No. 130 establishes standards for reporting comprehensive income. Comprehensive income includes net income and other comprehensive income, which is defined as nonowner related transactions in equity. Prior periods have been reclassified to reflect the application of the provisions of SFAS No. 130. The statement requires First American's unrealized gains or losses (net of tax) on securities available for sale to be included in other
comprehensive income. The amounts of other comprehensive income included in equity along with the related tax effect are set forth in the table below:
NOTE 19: PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information for First American (Parent Company only) was as follows:
CONDENSED INCOME STATEMENTS
CONDENSED BALANCE SHEETS
CONDENSED STATEMENTS OF CASH FLOWS
NOTE 20: SEGMENT INFORMATION
First American is a diversified financial services company that operates in two business segments, Banking Services and Enterprises, based upon management responsibility. First American's reportable segments are strategic business operations that offer different products and services. They are managed separately based on the fundamental differences in their operations.
The Banking Services segment consists of the traditional banking components of First American's wholly-owned banking subsidiaries. The Banking Services segment operates 391 offices and has 699 ATM's. This segment makes commercial, consumer, and real estate loans and provides various banking and mortgage-related services to its customers located within First American's market, which consists primarily of the Mid-South region of the United States.
The Enterprises segment includes:
- IFC, which distributes securities, investment, and insurance products to customers of subscribing financial institutions located throughout the United States; - ISG, the investment services group of FANB; - First American Network, Inc., a subsidiary of FANB; and - SSI, a healthcare payments processing company in which FANB holds a 49 percent interest.
The Enterprises segment provides a variety of financial services not available through traditional banking channels.
First American evaluates the performance of its business segments based on net pre-tax contribution. First American accounts for intersegment sales and transfers, if any, as if the sales or transfers were to third parties, that is, at current market prices. The accounting policies of the segments are the same as those described in the summary of significant accounting policies.
No single customer provides more than 10 percent of First American's revenue. First American derives essentially all of its revenues from markets within the United States. First American has no long-lived assets outside of the United States. The following table presents certain financial data by business segment, including reconciling items to consolidated totals.
(a) Pioneer merger-related provision (b) Gain on sale of corporate trust services (c) Merger and integration costs (d) One-time SAIF assessment (e) Effect of intersegment loan, due from bank, and investment in subsidiary
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.
FIRST AMERICAN CORPORATION (Registrant)
BY: /s/ Dennis C. Bottorff -------------------------------- DENNIS C. BOTTORFF, CHAIRMAN, CHIEF EXECUTIVE OFFICER, AND DIRECTOR
Date: March 25, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
/s/ Dennis C. Bottorff /s/ Dale W. Polley - ---------------------------------------- ------------------------------ Dennis C. Bottorff Dale W. Polley Chairman, Chief Executive Officer and President and Director Director Dated: March 25, 1999 Dated: March 23, 1999
/s/ Allan R. Landon /s/ Marvin J. Vannatta, Jr. - ----------------------------------------- ----------------------------- Allan R. Landon Marvin J. Vannatta, Jr. Executive Vice President, Chief Financial Executive Vice President and Officer and Principal Financial Officer Principal Accounting Officer Dated: March 19, 1999 Dated: March 19, 1999
/s/ Dennis C. Bottorff /s/ James R. Martin - -------------------------------- ---------------------------------- DENNIS C. BOTTORFF JAMES R. MARTIN Director Director Dated: March 18, 1999 Dated: March 18, 1999
/s/ George M. Clark, III /s/ Robert A. McCabe, Jr. - -------------------------------- ---------------------------------- GEORGE M. CLARK, III ROBERT A. MCCABE, JR. Director Director Dated: March 18, 1999 Dated: March 18, 1999
/s/ Earnest W. Deavenport, Jr. /s/ John N. Palmer - -------------------------------- ---------------------------------- EARNEST W. DEAVENPORT, JR. JOHN N. PALMER Director Director Dated: March 18, 1999 Dated: March 18, 1999
/s/ Reginald D. Dickson /s/ Dale W. Polley - -------------------------------- ---------------------------------- REGINALD D. DICKSON DALE W. POLLEY Director Director Dated: March 18, 1999 Dated: March 18, 1999
/s/ James A. Haslam, II /s/ E.B. Robinson, Jr. - -------------------------------- ---------------------------------- JAMES A. HASLAM, II E.B. ROBINSON, JR. Director Director Dated: March 18, 1999 Dated: March 18, 1999
/s/ Warren A. Hood, Jr. /s/ Roscoe R. Robinson - -------------------------------- ---------------------------------- WARREN A. HOOD, JR. ROSCOE R. ROBINSON Director Director Dated: March 18, 1999 Dated: March 18, 1999
/s/ Martha R. Ingram /s/ James F. Smith, Jr. - -------------------------------- ---------------------------------- MARTHA R. INGRAM JAMES F. SMITH, JR. Director Director Dated: March 18, 1999 Dated: March 18, 1999
/s/ Walter G. Knestrick /s/ Cal Turner, Jr. - -------------------------------- ---------------------------------- WALTER G. KNESTRICK CAL TURNER, JR. Director Director Dated: March 18, 1999 Dated: March 18, 1999
/s/ Gene C. Koonce /s/ Celia A. Wallace - --------------------------------- ---------------------------------- GENE C. KOONCE CELIA A. WALLACE Director Director Dated: March 18, 1999 Dated: March 18, 1999
/s/ Ted H. Welch - ------------------------------------- TED H. WELCH Director Dated: March 18, 1999
/s/ J. Kelley Williams, Sr. - ------------------------------------- J. KELLEY WILLIAMS, SR. Director Dated: March 18, 1999
/s/ David K. Wilson - ------------------------------------- DAVID K. WILSON Director Dated: March 18, 1999
/s/ Toby S. Wilt - ------------------------------------ TOBY S. WILT Director Dated: March 18, 1999
/s/ William S. Wire, II - ------------------------------------ WILLIAM S. WIRE, II Director Dated: March 18, 1999
EXHIBIT INDEX