Nonperforming
loans and leases consist of nonaccrual, troubled-debt restructured loans which
the Corporation refers to as renegotiated, and loans and leases that are
delinquent 90 days or more and still accruing interest. Nonperforming assets
consist of nonperforming loans and leases and other real estate owned (“OREO”).
In addition to the negative impact on net interest income and credit losses,
nonperforming assets also increase operating costs due to the expense associated
with collection efforts and the expenses of holding OREO. Nonperforming assets
increased $748.2 million or 35.1% at March 31, 2009 compared to December 31,
2008.
Every
major category of loans and leases experienced an increase in nonperforming
loans and leases except other consumer loans and leases during the first quarter
of 2009. Those increases reflect the varying degrees of economic stress
throughout the Corporation’s markets. Nonperforming loans and leases
continue to be concentrated in construction and development loans which
represented 48.4% of total nonperforming loans and leases at March 31, 2009. In
aggregate, nonperforming loans and leases in the Arizona, Florida and the
correspondent business channels represented 52.7% of total nonperforming loans
and leases at March 31, 2009.
During
the first quarter of 2009, the Corporation worked closely with Huntington
Bancshares Incorporated to re-assess the value of the underlying collateral that
supports the loans with Franklin Credit Management Corp. (“Franklin”). Based on
that assessment, the loans to Franklin were restructured. As a result, a
charge-off of $33.8 million was taken on Franklin and the remaining $69.1
million was placed in nonperforming status. At March 31, 2009,
nonperforming loans associated with Franklin consisted of $17.3 million reported
as nonaccrual and $51.8 million reported as renegotiated. Nonperforming loans
associated with Franklin are reported in commercial loans and leases in the
Major Categories of Nonperforming Loans & Leases and are included in Others
in the Geographical Summary of Nonperforming Loans & Leases
tables presented below.
The
Corporation has worked aggressively to isolate, identify and assess its
underlying loan and lease portfolio credit quality and has developed and
continues to develop strategies to reduce and mitigate its loss
exposure. During the first quarter of 2009, the Corporation sold $104
million of nonperforming loans and $24 million of potential problem loans. At
March 31, 2009, the Corporation held $113.7 million of nonaccrual loans and
$16.6 million of potential problem loans that are intended to be sold and have
been charged down to their net realizable value. Since the first quarter of
2008, the unpaid principal balance of nonperforming loans and potential problem
loans sold was approximately $991.4 million.
Generally,
loans that are 90 days or more past due as to interest or principal are placed
on nonaccrual. Exceptions to these rules are generally only for loans
fully collateralized by readily marketable securities or other relatively risk
free collateral and certain personal loans. In addition, a loan may
be placed on nonaccrual when management makes a determination that the facts and
circumstances warrant such classification irrespective of the current payment
status. At March 31, 2009, approximately $672.4 million or 26.5% of
the Corporation’s total nonperforming loans and leases were less than 30 days
past due. In addition, approximately $273.7 million or 10.8% of the
Corporation’s total nonperforming loans and leases were greater than 30 days
past due but less than 90 days past due at March 31, 2009. In total,
approximately $946.1 million or 37.3% of the Corporation’s total nonperforming
loans and leases were less than 90 days past due at March 31, 2009.
At March
31, 2009, nonperforming loans and leases amounted to $2,536.6 million or 5.15%
of consolidated loans and leases compared to $1,811.8 million or 3.62% of
consolidated loans and leases at December 31, 2008 and $787.0 million or 1.60%
of consolidated loans and leases at March 31, 2008.
Nonaccrual
loans, the largest component of nonperforming loans, are considered to be those
loans with the greatest risk of loss due to nonperformance and amounted to
$2,074.6 million or 4.21% of total loans and leases outstanding at March 31,
2009 compared to $1,527.0 million or 3.05% of total loans and leases outstanding
at December 31, 2008 and $774.1 million or 1.6% of total loans and leases
outstanding at March 31, 2008. The amount of cumulative charge-offs recorded on
the Corporation’s nonaccrual loans outstanding at March 31, 2009 was
approximately $665.1 million or 48.3% of the unpaid principal balance of the
affected nonaccrual loans and 24.3% of the unpaid principal balance of its total
nonaccrual loans outstanding at March 31, 2009. These
charge-offs have reduced the carrying value of these nonaccrual loans and leases
which reduced the allowance for loan and lease losses required at the
measurement date.
Renegotiated
loans and leases amounted to $446.0 million at March 31, 2009 compared to $270.4
million at December 31, 2008 and $0.1 million at March 31, 2008. After
restructuring, renegotiated loans generally result in lower payments than
originally required and therefore, have a lower risk of loss due to
nonperformance than loans classified as nonaccrual. The Corporation’s instances
of default and re-default on renegotiated loans has been relatively low.
However, the Corporation’s experience with renegotiated loan performance is
relatively new and does not encompass an extended period of time. In order to
avoid foreclosure in the future, the Corporation has restructured loan terms for
certain qualified borrowers that have demonstrated the ability to make the
restructured payments for a specified period of time. The Corporation’s
foreclosure abatement program includes several options. The
Corporation has primarily used reduced interest rates and extended terms to
lower contractual payments. In addition, the Corporation recently
announced that it extended its foreclosure moratorium on all owner-occupied
residential loans for customers who agreed to work in good faith to reach a
successful repayment agreement through June 30, 2009. At March 31, 2009,
restructured construction and development loans amounted to $156.2 million or
35.0% of total renegotiated loans and leases and residential real estate, home
equity and other consumer loans amounted to $217.1 million or 48.7% of total
renegotiated loans and leases. As previously discussed, $51.8 million
or 11.6% of renegotiated loans and leases at March 31, 2009 was attributable to
Franklin. Approximately $232.4 million or 52.1% of total renegotiated loans and
leases at March 31, 2009 were related to renegotiated loans and leases in
Arizona.
Loans 90
days past due and still accruing amounted to $16.1 million at March 31, 2009
compared to $14.5 million at December 31, 2008 and $12.8 million at March 31,
2008.
In
addition to its nonperforming loans and leases, the Corporation has loans and
leases for which payments are presently current, but which management believes
could possibly be classified as nonperforming in the near
future. These loans are subject to constant management attention and
their classification is reviewed on an ongoing basis. At March 31,
2009, such loans amounted to $1,176.1 million or 2.39% of total loans and leases
outstanding compared to $880.6 million or 1.76% of total loans and leases
outstanding at December 31, 2008.
The
following table shows the Corporation’s nonperforming loans and leases by type
of loan or lease at March 31, 2009 and December 31, 2008.
Major Categories of
Nonperforming Loans & Leases
($ in
millions)
|
|
March
31, 2009
|
|
|
December
31, 2008
|
|
|
|
|
|
|
Percent
|
|
|
Non-
|
|
|
%
Non-
|
|
|
|
|
|
Percent
|
|
|
Non-
|
|
|
%
Non-
|
|
|
|
Total
|
|
|
of
Total
|
|
|
Perform-
|
|
|
Perform-
|
|
|
Total
|
|
|
of
Total
|
|
|
Perform-
|
|
|
Perform-
|
|
|
|
Loans
|
|
|
Loans
|
|
|
ing
Loans
|
|
|
ing
to
|
|
|
Loans
|
|
|
Loans
|
|
|
ing
Loans
|
|
|
ing
to
|
|
|
|
&
|
|
|
&
|
|
|
&
|
|
|
Loan
&
|
|
|
&
|
|
|
&
|
|
|
&
|
|
|
Loan
&
|
|
|
|
Leases
|
|
|
Leases
|
|
|
Leases
|
|
|
Lease
Type
|
|
|
Leases
|
|
|
Leases
|
|
|
Leases
|
|
|
Lease
Type
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial
loans & leases
|
|
$
|
15,108
|
|
|
|
30.7
|
%
|
|
$
|
401.9
|
|
|
|
2.66
|
%
|
|
$
|
15,442
|
|
|
|
30.9
|
%
|
|
$
|
180.5
|
|
|
|
1.17
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial
real estate
|
|
|
12,999
|
|
|
|
26.4
|
|
|
|
294.9
|
|
|
|
2.27
|
|
|
|
12,542
|
|
|
|
25.1
|
|
|
|
188.2
|
|
|
|
1.50
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
real estate
|
|
|
5,711
|
|
|
|
11.6
|
|
|
|
476.7
|
|
|
|
8.35
|
|
|
|
5,734
|
|
|
|
11.5
|
|
|
|
324.3
|
|
|
|
5.66
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Construction
and Development:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial
land and
construction
|
|
|
4,643
|
|
|
|
9.5
|
|
|
|
378.3
|
|
|
|
8.15
|
|
|
|
5,063
|
|
|
|
10.1
|
|
|
|
314.7
|
|
|
|
6.22
|
|
Residential
construction
by individuals
|
|
|
752
|
|
|
|
1.5
|
|
|
|
125.0
|
|
|
|
16.63
|
|
|
|
881
|
|
|
|
1.7
|
|
|
|
99.2
|
|
|
|
11.26
|
|
Residential
land and
construction by developers
|
|
|
2,856
|
|
|
|
5.8
|
|
|
|
723.4
|
|
|
|
25.33
|
|
|
|
3,099
|
|
|
|
6.2
|
|
|
|
603.4
|
|
|
|
19.47
|
|
Total
construction and development
|
|
|
8,251
|
|
|
|
16.8
|
|
|
|
1,226.7
|
|
|
|
14.87
|
|
|
|
9,043
|
|
|
|
18.0
|
|
|
|
1,017.3
|
|
|
|
11.25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer
loans & leases
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Home
equity loans and
lines of
credit
|
|
|
5,025
|
|
|
|
10.2
|
|
|
|
123.2
|
|
|
|
2.45
|
|
|
|
5,082
|
|
|
|
10.2
|
|
|
|
86.5
|
|
|
|
1.70
|
|
Other
consumer
loans and leases
|
|
|
2,151
|
|
|
|
4.3
|
|
|
|
13.2
|
|
|
|
0.61
|
|
|
|
2,142
|
|
|
|
4.3
|
|
|
|
15.0
|
|
|
|
0.70
|
|
Total
consumer loans & leases
|
|
|
7,176
|
|
|
|
14.5
|
|
|
|
136.4
|
|
|
|
1.90
|
|
|
|
7,224
|
|
|
|
14.5
|
|
|
|
101.5
|
|
|
|
1.41
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
loans & leases
|
|
$
|
49,245
|
|
|
|
100.0
|
%
|
|
$
|
2,536.6
|
|
|
|
5.15
|
%
|
|
$
|
49,985
|
|
|
|
100.0
|
%
|
|
$
|
1,811.8
|
|
|
|
3.62
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
charge-offs amounted to $328.0 million or 2.67% of average loans and leases in
the first quarter of 2009 compared to $679.8 million or 5.38% of average loans
and leases in the fourth quarter of 2008 and $131.1 million or 1.08% of average
loans and leases in the first quarter of 2008.
Consistent
with the year ended December 31, 2008, net charge-offs in the first quarter of
2009 were concentrated in three areas which the Corporation refers to as
business channels. Net charge-offs for the Arizona business channel
amounted to $120.8 million, net charge-offs for the Florida business channel
amounted to $24.9 million and net charge-offs for the correspondent banking
business channel amounted to $51.2 million which includes the $33.8 million
charge-off related to Franklin as previously discussed. Included in net
charge-offs were the net charge-offs related to the loans that were sold during
the three months ended March 31, 2009. The aggregate net charge-offs for these
three business channels amounted to $196.9 million or 60.0% of total net
charge-offs for the three months ended March 31, 2009. By comparison, the
aggregate net charge-offs for these three business channels amounted to 68.9% of
total net charge-offs for the year ended December 31, 2008.
Net
charge-offs for the Florida business channel amounted to $205.9 million for the
year ended December 31, 2008, or on average, approximately $51.5 million per
quarter. Despite the increase in nonperforming loans, net charge-offs
for the Florida business channel amounted to $24.9 million in the first quarter
of 2009. Management believes the lower loss levels are an indication that the
high level of credit losses in this business channel are
stabilizing.
Net
charge-offs of real estate loans amounted to $257.6 million or 78.5% of total
net charge-offs in the first quarter of 2009. For the three months
ended March 31, 2009, approximately $176.4 million of the real estate loan net
charge-offs were construction and development loan net charge-offs.
As
previously discussed, real estate related loans, especially construction and
development real estate loans, were the primary contributors to the increase in
nonperforming loans and leases and net charge-offs in the first quarter of
2009. Real estate related loans made up the majority of the
Corporation’s nonperforming loans and leases at March 31,
2009. Historically, the Corporation’s loss experience with real
estate loans has been relatively low due to the sufficiency of the underlying
real estate collateral. In a stressed real estate market such as
currently exists, the value of the collateral securing the loans has become one
of the most important factors in determining the amount of loss incurred and the
appropriate amount of allowance for loan and lease losses to record at the
measurement date. The likelihood of losses that are equal to the
entire recorded investment for a real estate loan is remote. However,
in many cases, rapidly declining real estate values have resulted in the
determination that the estimated value of the collateral was insufficient to
cover all of the recorded investment in the loan which has required significant
additional charge-offs. Declining collateral values have
significantly contributed to the elevated levels of net charge-offs and the
increase in the provision for loan and lease losses that the Corporation
experienced in recent quarters.
As
previously stated, the amount of cumulative charge-offs recorded on the
Corporation’s nonaccrual loans outstanding at March 31, 2009 was approximately
$665.1 million or 48.3% of the unpaid principal balance of the affected
nonaccrual loans and 24.3% of the unpaid principal balance of its total
nonaccrual loans outstanding at March 31, 2009. These
charge-offs have reduced the carrying value of these nonaccrual loans and leases
which reduced the allowance for loan and lease losses required at the
measurement date.
Consistent
with the credit quality trends noted above, the provision for loan and lease
losses amounted to $477.9 million in the first quarter of 2009. By comparison,
the provision for loan and lease losses amounted to $850.4 million in the fourth
quarter of 2008 and $146.3 million in the first quarter of 2008. The provision
for loan and lease losses is the amount required to establish the allowance for
loan and lease losses at the required level after considering charge-offs and
recoveries. The ratio of the allowance for loan and lease losses to
total loans and leases was 2.75% at March 31, 2009 compared to 2.41% at December
31, 2008 and 1.10% at March 31, 2008.
Management
expects nonperforming loans and leases and OREO balances to remain elevated for
the remainder of 2009. Nonperforming loans and leases are expected to
continue increasing over the next few quarters in response to broader economic
stresses. It is expected that the rate at which larger
construction-related loans go to nonperforming status will likely decrease while
the rate at which consumer-related loans go to nonperforming status will likely
increase. Management expects the provision for loan and lease losses will
continue to be at elevated levels due to the recessionary economy and weak
national real estate markets. The credit environment and underlying collateral
values continue to be rapidly changing and as a result, there are numerous
unknown factors at this time that will ultimately affect the timing and amount
of nonperforming assets, net charge-offs and the provision for loan and lease
losses that will be recognized in the remainder of 2009. In addition,
the timing and amount of charge-offs will continue to be influenced by the
Corporation’s strategies for managing its nonperforming loans and
leases.
The
Corporation will continue to proactively manage its problem loans and
nonperforming assets and be aggressive to isolate, identify and assess its
underlying loan and lease portfolio credit quality. The Corporation
has developed and continues to develop strategies, such as selective sales of
nonperforming loans and restructuring loans to qualified borrowers, to mitigate
its loss exposure. Construction and development loans tend to be more
complex and may take more time to attain a satisfactory
resolution. Depending on the facts and circumstances, acquiring real
estate collateral in partial or total satisfaction of problem loans may continue
to be the best course of action to take in order to mitigate the Corporation’s
exposure to loss.
Total
other income in the first quarter of 2009 amounted to $176.7 million compared to
$211.2 million in the same period last year, a decrease of $34.5 million or
16.3%. Total other income in the first quarter of 2008 included gains
resulting from Visa’s redemption of 38.7% of the Class B Visa common stock owned
by the Corporation. The gain from the redemption amounted to $26.9
million and is reported in Net investment securities gains in the Consolidated
Statements of Income for the three months ended March 31,
2008. Excluding net investment securities gains from the VISA
redemption in the first quarter of 2008, total other income in the first quarter
of 2009 decreased $7.6 million or 4.1% compared to the first quarter of
2008.
Equity
market volatility persisted during the first quarter of 2009. That
volatility along with downward pressure in the equity markets resulted in lower
wealth management revenue in the first quarter of 2009 compared to the first
quarter of 2008. Wealth management revenue amounted to $62.7 million in the
first quarter of 2009 compared to $71.9 million in the first quarter of 2008, a
decrease of $9.2 million or 12.8%. Assets under management were $29.7 billion at
March 31, 2009 compared to $30.4 billion at December 31, 2008 and $25.8 billion
at March 31, 2008. Assets under administration were $101.5 billion at March 31,
2009 compared to $104.4 billion at December 31, 2008 and $105.4 billion at March
31, 2008. Sales pipelines have remained stable since the fourth quarter of 2008.
However, customer conversions are taking longer due to protracted investor
decision-making processes. Revenue from operations outsourcing
services continued to grow during the first quarter of 2009. Wealth management
revenue will continue to be affected by market volatility and direction through
the remainder of 2009.
Service
charges on deposits amounted to $35.3 million in the first quarter of 2009 and
was relatively unchanged compared to the first quarter of 2008.
Total
mortgage banking revenue was $10.8 million in the first quarter of 2009 compared
to $9.4 million in the first quarter of 2008, an increase of $1.4 million or
15.4%. Residential mortgage and home equity loans sold in the secondary market
amounted to $0.7 billion in the first quarter of 2009 compared to $0.5 billion
in the first quarter of 2008.
Net
investment securities gains amounted to $0.1 million in the first quarter of
2009 compared to $25.7 million in the first quarter of 2008. During
the first quarter of 2008, in conjunction with its IPO, Visa redeemed 38.7% of
the Class B Visa common stock owned by the Corporation. The gain from
the redemption amounted to $26.9 million.
Bank-owned
life insurance revenue amounted to $9.3 million for the three months ended March
31, 2009 compared to $12.4 million for the three months ended March 31, 2008, a
decrease of $3.1 million or 24.8%. The decline in revenue reflects
the lower crediting rates due to the interest rate environment and lower death
benefit gains in the first quarter of 2009 compared to the first quarter of
2008.
Gain on
the termination of debt amounted to $3.1 million in the first quarter of
2009. During the first quarter of 2009, the Corporation re-acquired
and extinguished $42.1 million of debt. The debt consisted of small
blocks of various bank notes issued by the Corporation and M&I Marshall
& Ilsley Bank (“M&I Bank”). The size of the blocks ranged
from $4.1 million to $11.8 million with a weighted average buyback price of
approximately 92.7% of par.
OREO
income primarily consists of gains from the sale of OREO and amounted to $2.6
million in the first quarter of 2009 compared to $1.0 million in the first
quarter of 2008. The carrying value of OREO properties sold amounted
to $52.7 million in the first quarter of 2009 compared to $13.5 million in the
first quarter of 2008.
Other
income in the first quarter of 2009 amounted to $52.9 million compared to $55.2
million in the first quarter of 2008, a decrease of $2.3 million or 4.1%. During
the first quarter of 2008, a final settlement for three branches in Tulsa,
Oklahoma that were sold in the fourth quarter of 2007 resulted in additional
gain of $2.4 million.
Total
other expense for the three months ended March 31, 2009 amounted to $345.2
million compared to $315.6 million for the three months ended March 31, 2008, an
increase of $29.6 million or 9.4%.
Total
other expense for the three months ended March 31, 2009 compared to the three
months ended March 31, 2008 included increased credit and collection-related
expenses and increased expenses associated with the acquisition, valuation and
holding of OREO properties. Approximately $22.2 million of the operating expense
growth in the first quarter of 2009 compared to the first quarter of 2008 were
attributable to these items.
During
the first quarter of 2008, Visa established an escrow for certain litigation
matters from the proceeds of its IPO. As a result, the Corporation
reversed part of its litigation accruals that were originally recorded due to
the Corporation’s membership interests in Visa in an amount equal to its pro
rata share of the funded escrow. Included in total other expense for
the three months ended March 31, 2008 is the reversal of $12.2 million related
to the Visa litigation matters.
The
Corporation’s expense in the three months ended March 31, 2009 compared to the
three months ended March 31, 2008, excluding the items discussed above, declined
$4.8 million or 1.6% despite the increase in FDIC insurance premiums on
deposits. This expense decline reflects in part lower incentive
compensation and the impact of the expense reduction initiatives announced in
the fourth quarter of 2008.
Expense
control is sometimes measured in the financial services industry by the
efficiency ratio statistic. The efficiency ratio is calculated by
taking total other expense divided by the sum of total other income (including
Private Equity revenue but excluding other investment securities gains or
losses) and net interest income on a fully taxable equivalent
basis. The Corporation’s efficiency ratios for the three months ended
March 31, 2009 and 2008 were:
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
|
March
31,
|
|
|
|
2009
|
|
|
2008
|
|
Consolidated
Corporation
|
|
|
59.0
|
%
|
|
|
50.6
|
%
|
The
efficiency ratio for the first quarter of 2009 was adversely affected by the
increase in credit and collection-related expenses and net expenses associated
with OREO properties. The estimated adverse net impact to the
Corporation’s efficiency ratio for the three months ended March 31, 2009 from
these items was approximately 6.9%.
The
efficiency ratio for the first quarter of 2008 was adversely affected by the
increase in credit and collection-related expenses and net expenses associated
with OREO properties. However, the efficiency ratio for the first quarter of
2008 was positively impacted by the reversal of the liability related to the
Visa litigation matters. The estimated net positive impact to the
Corporation’s efficiency ratio for the three months ended March 31, 2008 from
these items was approximately 1.1%.
Salaries
and employee benefits expense amounted to $155.2 million in the first quarter of
2009 compared to $174.7 million in the first quarter of 2008, a decrease of
$19.5 million or 11.2%. Salaries and employee benefits related to
credit and collection increased approximately $1.8 million in the three months
ended March 31, 2009 compared to the three months ended March 31, 2008.
Incentive compensation decreased $14.2 million in the first quarter of 2009
compared to the first quarter of 2008.
Net
occupancy and equipment expense for three months ended March 31, 2009 amounted
to $33.8 million, compared to $31.2 million for the three months ended March 31,
2008, an increase of $2.6 million or 8.3%. The increase reflects the effect of
de novo branch expansion activities.
Professional
services expense amounted to $19.2 million in the first quarter of 2009 compared
to $13.5 million in the first quarter of 2008, an increase of $5.7 million or
42.3%. Increased legal fees and other professional fees associated
with problem loans contributed approximately $2.7 million to the increase in
professional services expense in the first quarter of 2009 compared to the first
quarter of 2008. Consulting fees associated with updating certain
internal systems also contributed to the increase in professional services
expense for the three months ended March 31, 2009 compared to the three months
ended March 31, 2008.
OREO
expenses amounted to $32.6 million in the first quarter of 2009 compared to
approximately $14.9 million in the first quarter of 2008, an increase of $17.7
million. Approximately $13.8 million of the increase for the three
months ended March 31, 2009 compared to the three months ended March 31, 2008
was due to valuation write-downs and losses on disposition which reflects both
the increased levels of foreclosed properties and the rapid decline in real
estate values during the first three months of 2009. Approximately
$3.9 million of the increase for the three months ended March 31, 2009 compared
to the three months ended March 31, 2008 reflects the costs of acquiring and
holding the increased levels of foreclosed properties. The
Corporation expects that higher levels of expenses associated with acquiring and
holding foreclosed properties will continue. Valuation write-downs and losses on
disposition will depend on real estate market conditions.
Other
expense amounted to $49.2 million in the first quarter of 2009 compared to $25.2
million in the first quarter of 2008, an increase of $24.0 million or
94.8%. Deposit insurance premiums increased $13.2 million in the
first quarter of 2009 compared to the first quarter of 2008. As
previously discussed, other expense for the three months ended March 31, 2008
included the reversal of $12.2 million related to the Visa
litigation.
For the
three months ended March 31, 2009, the benefit for income taxes amounted to
$153.0 million or 62.5% of the pre-tax loss. In February 2009, the State of
Wisconsin passed legislation that requires combined reporting for state income
tax purposes effective January 1, 2009. As a result, the Corporation recorded an
additional income tax benefit of $51.0 million, or $0.19 per diluted common
share to recognize certain state deferred tax assets, which included
the reduction of a valuation allowance for Wisconsin net operating losses. The
Corporation expects that income tax expense will increase in future periods due
to the enacted legislation.
For the
three months ended March 31, 2008, the provision for income taxes amounted to
$33.3 million or 18.5% of pre-tax income. As a result of the Internal
Revenue Service’s (“IRS”) decision not to appeal a November 2007 US Tax Court
ruling related to how the TEFRA (interest expense) disallowance should be
calculated within a consolidated group and the position the IRS had taken in
another related case, the Corporation recognized an additional income tax
benefit related to years 1996-2007 of $20.0 million for its similar issue in the
first quarter of 2008.
Total
equity was $6.25 billion or 10.12% of total consolidated assets at March 31,
2009, compared to $6.27 billion or 10.06% of total consolidated assets at
December 31, 2008 and $6.98 billion or 11.02% of total consolidated assets at
March 31, 2008.
On
February 19, 2009, the Corporation’s Board of Directors declared a $0.01 per
share dividend on its common stock for the first quarter of 2009.
During
the first quarter of 2009, the Corporation issued 383,890 shares of its common
stock for $1.8 million to fund its obligation under its employee stock purchase
plan (the “ESPP”). During the first quarter of 2008, the Corporation
issued 110,172 shares of its common stock for $2.2 million to fund its
obligation under the ESPP.
On
November 14, 2008, as part of the Corporation’s participation in the
Capital Purchase Program (the “CPP”), the Corporation entered into a Letter
Agreement with the United States Department of the Treasury (the
“UST”). Pursuant to the Securities Purchase Agreement – Standard
Terms (the “Securities Purchase Agreement”) attached to the Letter Agreement,
the Corporation sold 1,715,000 shares of the Corporation’s Senior Preferred
Stock, Series B (the “Senior Preferred Stock”), having a liquidation preference
of $1,000 per share, for a total price of $1,715 million. The Senior
Preferred Stock qualifies as Tier 1 capital and pays cumulative compounding
dividends at a rate of 5% per year for the first five years and 9% per
year thereafter.
The
Securities Purchase Agreement provided that the Corporation may not redeem the
Senior Preferred Stock during the first three years except with the proceeds
from one or more “Qualified Equity Offerings” (as defined in the Securities
Purchase Agreement), and that after three years, the Corporation may redeem
shares of the Senior Preferred Stock for the per share liquidation preference of
$1,000 plus any accrued and unpaid dividends. Pursuant to the
American Recovery and Reinvestment Act (the “ARRA”), which was signed into law
in February 2009, CPP participants are permitted to redeem the preferred stock
issued under the CPP at any time, subject to consultation with the appropriate
federal banking agency. However, the Corporation’s Restated Articles
of Incorporation contain the redemption restrictions described above. The
Corporation may seek Board of Directors and shareholder approval in the future
to amend the Restated Articles of Incorporation to allow the Corporation to
redeem the Senior Preferred Stock at any time after consultation with the
Federal Reserve Board.
As long
as any Senior Preferred Stock is outstanding, the Corporation may pay quarterly
common stock cash dividends of up to $0.32 per share, and may redeem or
repurchase its common stock, provided that all accrued and unpaid dividends for
all past dividend periods on the Senior Preferred Stock are fully
paid. Prior to the third anniversary of the UST’s purchase of the
Senior Preferred Stock, unless Senior Preferred Stock has been redeemed or the
UST has transferred all of the Senior Preferred Stock to third parties, the
consent of the UST will be required for the Corporation to increase its common
stock dividend to more than $0.32 per share per quarter or repurchase its common
stock or other equity or capital securities, other than in connection with
benefit plans consistent with past practice and certain other circumstances
specified in the Securities Purchase Agreement. As previously
described, the Corporation recently reduced its quarterly common stock cash
dividend to $0.01 per share. The Senior Preferred Stock will be
non-voting except for class voting rights on matters that would adversely affect
the rights of the holders of the Senior Preferred Stock.
As a
condition to participating in the CPP, the Corporation issued and sold to the
UST a warrant (the “Warrant”) to purchase 13,815,789 shares (the “Warrant
Shares”) of the Corporation’s common stock, at an initial per share exercise
price of $18.62, for an aggregate purchase price of approximately $257.25
million. The term of the Warrant is ten years. The Warrant
will not be subject to any contractual restrictions on transfer, provided that
the UST may only transfer a portion or portions of the Warrant with respect to,
or exercise the Warrant for, more than one-half of the initial Warrant Shares
prior to the earlier of (a) the date on which the Corporation has received
aggregate gross proceeds of at least $1,715 million from one or more Qualified
Equity Offerings, and (b) December 31, 2009. If the
Corporation completes one or more Qualified Equity Offerings on or prior to
December 31, 2009 that result in the Corporation receiving aggregate gross
proceeds equal to at least $1,715 million, then the number of Warrant Shares
will be reduced to 50% of the original number of Warrant Shares. The
Warrant provides for the adjustment of the exercise price and the number of
Warrant Shares issuable upon exercise pursuant to customary anti-dilution
provisions, such as upon stock splits or distributions of securities or other
assets to holders of the Corporation’s common stock, and upon certain issuances
of the Corporation’s common stock at or below a specified price range relative
to the initial exercise price. Pursuant to the Securities Purchase
Agreement, the UST has agreed not to exercise voting power with respect to any
shares of common stock issued upon exercise of the Warrant.
Pursuant
to the Securities Purchase Agreement, until the UST no longer owns any shares of
the Senior Preferred Stock, the Warrant or Warrant Shares, the Corporation’s
employee benefit plans and other executive compensation arrangements for its
Senior Executive Officers must continue to comply in all respects with
Section 111(b) the Emergency Economic Stabilization Act of 2008 and the
rules and regulations of the UST promulgated thereunder.
The
Securities Purchase Agreement permits the UST to unilaterally amend any
provision of the Letter Agreement and the Securities Purchase Agreement to the
extent required to comply with any changes in applicable federal
statutes.
For
accounting purposes, the proceeds of $1,715 million were allocated between the
preferred stock and the warrant based on their relative fair
values. The initial value of the Warrant, which is classified as
equity, was $81.12 million. The entire discount on the Senior
Preferred Stock, created from the initial value assigned to the Warrant, is
being accreted over a five-year period in a manner that produces a level
preferred stock dividend yield which is 6.10%. At the end of the
fifth year, the carrying amount of the Senior Preferred Stock will equal its
liquidation value.
Preferred
dividends accrued on the Senior Preferred Stock amounted to $25.0 million during
the first quarter of 2009. On February 17, 2009, the Corporation paid
the quarterly dividend covering the period from November 14, 2008 through
February 15, 2009 in the amount of $21.7 million.
The
Corporation had a Stock Repurchase Program under which up to 12 million shares
of the Corporation’s common stock could be repurchased
annually. During the first quarter of 2008, the Corporation acquired
4,782,400 shares of its common stock in open market share repurchase
transactions under the Stock Repurchase Program. Total cash
consideration amounted to $124.9 million. As a result of the restrictions
contained in the Securities Purchase Agreement, the Corporation allowed the
Stock Repurchase Program to expire and did not reconfirm the Stock Repurchase
Program for 2009.
At March
31, 2009, the net loss in accumulated other comprehensive income amounted to
$75.6 million, which represented a positive change in accumulated other
comprehensive income of $82.3 million since December 31, 2008
.
Net accumulated
other comprehensive income associated with available for sale investment
securities was a net gain of $15.6 million at March 31, 2009, compared to a net
loss of $57.1 million at December 31, 2008, resulting in a net gain of $72.7
million over the three month period. The net unrealized loss
associated with the change in fair value of the Corporation’s derivative
financial instruments designated as cash flow hedges decreased $9.9 million
since December 31, 2008, and amounted to $92.8 million at March 31, 2009,
compared to a net loss of $102.7 million at December 31, 2008. The
amount required to adjust the Corporation’s postretirement health benefit
liability to its funded status included in accumulated other comprehensive
income amounted to an unrealized gain of $1.6 million as of March 31,
2009.
The
Corporation continues to have a strong capital base and its regulatory capital
ratios are significantly above the minimum requirements as shown in the
following tables.
RISK-BASED CAPITAL
RATIOS
($ in
millions)
|
|
March
31, 2009
|
|
|
December
31, 2008
|
|
|
|
Amount
|
|
|
Ratio
|
|
|
Amount
|
|
|
Ratio
|
|
Tier
1 Capital
|
|
$
|
5,107
|
|
|
|
9.17
|
%
|
|
$
|
5,357
|
|
|
|
9.49
|
%
|
Tier
1 Capital Minimum Requirement
|
|
|
2,229
|
|
|
|
4.00
|
|
|
|
2,257
|
|
|
|
4.00
|
|
Excess
|
|
$
|
2,878
|
|
|
|
5.17
|
%
|
|
$
|
3,100
|
|
|
|
5.49
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Capital
|
|
$
|
7,159
|
|
|
|
12.85
|
%
|
|
$
|
7,445
|
|
|
|
13.19
|
%
|
Total
Capital Minimum Requirement
|
|
|
4,458
|
|
|
|
8.00
|
|
|
|
4,514
|
|
|
|
8.00
|
|
Excess
|
|
$
|
2,701
|
|
|
|
4.85
|
%
|
|
$
|
2,931
|
|
|
|
5.19
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Risk-Adjusted
Assets
|
|
$
|
55,725
|
|
|
|
|
|
|
$
|
56,428
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
Corporation manages its liquidity to ensure that funds are available to each of
its banks to satisfy the cash flow requirements of depositors and borrowers and
to ensure the Corporation’s own cash requirements are met. The
Corporation maintains liquidity by obtaining funds from several
sources.
The
Corporation’s most readily available source of liquidity is its investment
portfolio. Investment securities available for sale, which totaled
$7.5 billion at March 31, 2009, represent a highly accessible source of
liquidity. The Corporation’s portfolio of held-to-maturity investment
securities, which totaled $0.2 billion at March 31, 2009, provides liquidity
from maturities and amortization payments. The Corporation’s loans
held for sale provide additional liquidity. These loans represent
recently funded loans that are prepared for delivery to investors, which are
generally sold shortly after the loan has been funded.
Depositors
within the Corporation’s defined markets are another source of
liquidity. Core deposits (demand, savings, money market and consumer
time deposits) averaged $23.5 billion in the first quarter of
2009. The Corporation's banking affiliates may also access the
federal funds markets, the Federal Reserve’s Term Auction Facility or utilize
collateralized borrowings such as treasury demand notes, FHLB advances or other
forms of collateralized borrowings.
The
Corporation’s banking affiliates may use wholesale deposits, which include
foreign (Eurodollar) deposits. Wholesale deposits, which averaged
$11.2 billion in the first quarter of 2009, are deposits generated through
distribution channels other than the Corporation’s own banking
branches. The weighted average remaining term of outstanding brokered
and institutional certificates of deposit at March 31, 2009 was 10.4
years. These deposits allow the Corporation’s banking subsidiaries to
gather funds across a national geographic base and at pricing levels considered
attractive, where the underlying depositor may be retail or
institutional. Access to wholesale deposits also provides the
Corporation with the flexibility not to pursue single service time deposit
relationships in markets that have experienced some unprofitable pricing
levels.
The
Corporation may use certain financing arrangements to meet its balance sheet
management, funding, liquidity, and market or credit risk management
needs. The majority of these activities are basic term or revolving
securitization vehicles. These vehicles are generally funded through
term-amortizing debt structures or with short-term commercial paper designed to
be paid off based on the underlying cash flows of the assets
securitized. These facilities provide access to funding sources
substantially separate from the general credit risk of the Corporation and its
subsidiaries.
M&I
Bank has implemented a global bank note program that permits it to issue and
sell up to a maximum of US$13.0 billion aggregate principal amount (or the
equivalent thereof in other currencies) at any one time outstanding of its
senior global bank notes with maturities of seven days or more from their
respective date of issue and subordinated global bank notes with maturities more
than five years from their respective date of issue. The notes may be
fixed rate or floating rate and the exact terms will be specified in the
applicable Pricing Supplement or the applicable Program
Supplement. This program is intended to enhance liquidity by enabling
M&I Bank to sell its debt instruments in global markets in the future
without the delays that would otherwise be incurred. At March 31,
2009, approximately $8.9 billion of new debt could be issued under M&I
Bank’s global bank note program.
Bank
notes outstanding at March 31, 2009 amounted to $4.1 billion of which $1.9
billion is subordinated. A portion of the subordinated bank notes
qualifies as supplementary capital for regulatory capital purposes.
The
national capital markets represent a further source of liquidity to the
Corporation.
During
the second quarter of 2008, the Corporation filed a shelf registration statement
with the Securities and Exchange Commission enabling the Corporation to issue up
to 6.0 million shares of its common stock, which may be offered and issued from
time to time in connection with acquisitions by the Corporation and/or other
consolidated subsidiaries of the Corporation. At March 31, 2009,
approximately 1.14 million shares of the Corporation’s common stock could be
issued under the shelf registration statement for future
acquisitions.
On
November 6, 2007, the Corporation filed a shelf registration statement pursuant
to which the Corporation was initially authorized to raise up to $1.9 billion
through sales of corporate debt and/or equity securities with a relatively short
lead time.
The
Corporation and/or M&I Bank may repurchase or redeem its outstanding debt
securities from time to time, including, without limitation, senior and
subordinated global bank notes, medium-term corporate notes, MiNotes or junior
subordinated deferrable interest debentures and the related trust preferred
securities. Such repurchases or redemptions may be made in open
market purchases, in privately negotiated transactions or otherwise for cash or
other consideration. Any such repurchases or redemptions will be made
on an opportunistic basis as market conditions permit and are dependent on the
Corporation’s liquidity needs, compliance with any contractual or indenture
restrictions and regulatory requirements and other factors the Corporation deems
relevant. During the first quarter of 2009, the Corporation re-acquired and
extinguished $42.1 million of debt. The debt consisted of small
blocks of various bank notes issued by the Corporation and M&I
Bank. The size of the blocks ranged from $4.1 million to $11.8
million with a weighted average buyback price of approximately 92.7% of
par.
The
market impact of the recession and deterioration in the national real estate
markets has resulted in a decline in market confidence and a subsequent strain
on liquidity in the financial services sector. However, participation
in the CPP in 2008 provided the Corporation with $1.7 billion in cash and
significantly increased its regulatory and tangible capital
levels. Management expects that it will continue to make use of a
wide variety of funding sources, including those that have not shown the levels
of stress demonstrated in some of the national capital
markets. Notwithstanding the current national capital market impact
on the cost and availability of liquidity, management believes that it has
adequate liquidity to ensure that funds are available to the Corporation and
each of its banks to satisfy their cash flow requirements. However,
if capital markets deteriorate more than management currently expects, the
Corporation could experience stress on its liquidity position.
OFF-BALANCE
SHEET ARRANGEMENTS
At March
31, 2009, there have been no substantive changes with respect to the
Corporation’s off-balance sheet activities disclosed in the Corporation’s Annual
Report on Form 10-K for the year ended December 31, 2008. The
Corporation continues to believe that based on the off-balance sheet
arrangements with which it is presently involved, such off-balance sheet
arrangements neither have, nor are reasonably likely to have, a material impact
to its current or future financial condition, results of operations, liquidity
or capital.
CRITICAL
ACCOUNTING POLICIES
The
Corporation has established various accounting policies which govern the
application of accounting principles generally accepted in the United States in
the preparation of the Corporation’s consolidated financial
statements. The significant accounting policies of the Corporation
are described in the footnotes to the consolidated financial statements
contained in the Corporation’s Annual Report on Form 10-K for the year ended
December 31, 2008, and updated as necessary in its Quarterly Reports on Form
10-Q. Certain accounting policies involve significant judgments and
assumptions by management that may have a material impact on the carrying value
of certain assets and liabilities. Management considers such
accounting policies to be critical accounting policies. The judgments
and assumptions used by management are based on historical experience and other
factors, which are believed to be reasonable under the
circumstances. Because of the nature of judgments and assumptions
made by management, actual results could differ from these judgments and
estimates which could have a material impact on the carrying values of assets
and liabilities and the results of operations of the
Corporation. Management continues to consider the following to be
those accounting policies that require significant judgments and
assumptions:
Allowance
for Loan and Lease Losses
The
allowance for loan and lease losses represents management’s estimate of probable
losses inherent in the Corporation’s loan and lease
portfolio. Management evaluates the allowance each quarter to
determine that it is adequate to absorb these inherent losses. This
evaluation is supported by a methodology that identifies estimated losses based
on assessments of individual problem loans and historical loss patterns of
homogeneous loan pools. In addition, environmental factors, including
economic conditions and regulatory guidance, unique to each measurement date are
also considered. This reserving methodology has the following
components:
Specific
Reserve.
The Corporation’s nonaccrual loans and renegotiated
loans form the basis to identify loans and leases that meet the criteria as
being “impaired” under the definition in SFAS 114. A loan is impaired
when, based on current information and events, it is probable that a creditor
will be unable to collect all amounts due according to the contractual terms of
the loan agreement. For impaired loans, impairment is measured using
one of three alternatives: (1) the present value of expected future cash flows
discounted at the loan’s effective interest rate; (2) the loan’s observable
market price, if available; or (3) the fair value of the collateral for
collateral dependent loans and loans for which foreclosure is deemed to be
probable. In general, these loans have been internally identified as
credits requiring management’s attention due to underlying problems in the
borrower’s business or collateral concerns. A quarterly review of
nonaccrual loans, subject to minimum size, and all renegotiated loans is
performed to identify the specific reserve necessary to be allocated to each of
these loans. This analysis considers expected future cash flows, the
value of collateral and also other factors that may impact the borrower’s
ability to make payments when due.
Collective Loan
Impairment.
This component of the allowance for loan and lease
losses is comprised of two elements. First, the Corporation makes a
significant number of loans and leases, which due to their underlying similar
characteristics, are assessed for loss as homogeneous pools. Included
in the homogeneous pools are loans and leases from the retail sector and
commercial loans under a certain size that have been excluded from the specific
reserve allocation previously discussed. The Corporation segments the
pools by type of loan or lease and the business channel that originated the loan
or lease. Using historical loss information, loss is estimated for each
pool.
The
second element reflects management’s recognition of the uncertainty and
imprecision underlying the process of estimating losses. The
Corporation has identified certain loans within certain industry segments that
based on financial, payment or collateral performance, warrant closer ongoing
monitoring by management. The specific loans mentioned earlier are
excluded from this analysis. Based on management’s judgment, reserve
ranges are allocated to industry segments due to environmental conditions unique
to the measurement period. Consideration is given to both internal
and external environmental factors such as economic conditions in certain
geographic or industry segments of the portfolio, economic trends, risk profile,
and portfolio composition. Reserve ranges are then allocated using
estimates of loss exposure that management has identified based on these
economic trends or conditions.
The
Corporation has not materially changed any aspect of its overall approach in the
determination of the allowance for loan and lease losses. However, on
an on-going basis the Corporation continues to refine the methods used in
determining management’s best estimate of the allowance for loan and lease
losses.
The
following factors were taken into consideration in determining the adequacy of
the allowance for loan and lease losses at March 31, 2009:
The
Corporation’s problem loans continue to be primarily real estate related loans
in areas that were previously experiencing substantial population growth and
increased demand for housing such as Arizona and Florida, and in the
correspondent banking business. The Corporation’s higher growth
markets have been disproportionately affected by the excess real estate
inventory and deterioration in the national real estate markets as the economy
deteriorated into recession. Rising unemployment, the recession and illiquid
real estate markets have resulted in an increasing number of borrowers that are
unable to either refinance or sell their properties and consequently have
defaulted or are very close to defaulting on their loans. In this
stressed housing market that is experiencing increasing delinquencies and
rapidly declining real estate values, the adequacy of collateral securing the
loan becomes a much more important factor in determining expected loan
performance. In many cases, rapidly declining real estate values
resulted in the determination that the collateral was insufficient to cover the
recorded investment in the loan. These factors resulted in the
Corporation’s loan and lease portfolio experiencing significantly higher
incidences of default and a significant increase in loss severity in recent
quarters. The Corporation has taken these factors into consideration in
determining the adequacy of its allowance for loan and leases.
At March
31, 2009, allowances for loan and lease losses were established for a
Midwest-based correspondent bank holding company. Allowances for loan and lease
losses continue to be carried for exposures to accommodation (hotels/motels) and
motor vehicle and parts dealers. While most loans in these categories
are still performing, the Corporation continues to believe these sectors present
a higher than normal risk due to their financial and external
characteristics.
The
Corporation’s primary lending areas are Wisconsin, Arizona, Minnesota, Missouri,
Florida and Indiana. Recent acquisitions are in relatively new
markets for the Corporation. Included in these new markets is the
Kansas City metropolitan area and Tampa, Sarasota, Bradenton and Orlando,
Florida and the Indianapolis and central Indiana market. Each of
these regions and markets has cultural and environmental factors that are unique
to it. Segmenting loan pools by type of loan or lease and the business channel
that originated the loan or lease is used to measure the impact of these factors
on both new and existing business channels.
Almost
every major geographical area experienced an increase in nonperforming loans and
leases in the first quarter of 2009. Those increases reflect varying degrees of
economic stress throughout the Corporation’s markets.
At March 31, 2009,
nonperforming loans in Arizona amounted to $1,068.3 million compared to $857.5
million at December 31, 2008, an increase of $210.8 million or 24.6%.
Nonperforming loans in Arizona represented 42.1% of total consolidated
nonperforming loans and leases at March 31, 2009 and continue to be the largest
concentration of nonperforming loans in the Corporation’s loan and lease
portfolio. Nonperforming construction and development loans made up
approximately $642.8 million or 60.2% and nonperforming residential real estate
loans made up approximately $336.2 million or 31.5% of nonperforming loans in
Arizona at March 31, 2009. Nonperforming loans in Florida amounted to $244.3
million at March 31, 2009 compared to $172.8 million at December 31, 2008 an
increase of $71.5 million or 41.4%. Approximately $144.2 million or
59.0% of nonperforming loans in Florida at March 31, 2009 were construction and
development loans. Construction and development real estate loans that are
concentrated in the west coast of Florida and Arizona have been the primary
contributor to the increase in nonperforming loans and leases and net
charge-offs in recent quarters.
At March
31, 2009, nonperforming loans and leases amounted to $2,536.6 million or 5.15%
of consolidated loans and leases compared to $1,811.8 million or 3.62% of
consolidated loans and leases at December 31, 2008, an increase of $724.8
million or 40.0%. Consistent with recent quarters, nonperforming real estate
loans were the primary source of the Corporation’s nonperforming loans and
leases and represented 78.8% of total nonperforming loans and leases at March
31, 2009. Nonperforming construction and development loans, a subset of
nonperforming real estate loans, represented 48.4% of total nonperforming loans
and leases at March 31, 2009. Nonperforming real estate loans
amounted to $1,998.3 million at March 31, 2009 compared to $1,529.8 million at
December 31, 2008, an increase of $468.5 million or 30.6%. Nonperforming
commercial loans and leases amounted to $401.9 million at March 31, 2009
compared to $180.5 million at December 31, 2008, an increase of $221.4 million.
While this portfolio has generally shown increased stress, the increase is
attributable to a small number of larger loans that are not concentrated in any
particular industry. Nonperforming consumer loans and leases amounted to $136.4
million at March 31, 2009 compared to $101.5 million at December 31, 2008, an
increase of $34.9 million or 34.4%. All of the increase was attributable to home
equity loans and lines of credit. Renegotiated consumer loans and leases,
predominantly home equity loans and lines of credit, accounted for $20.2 million
or 57.8% of the increase in nonperforming consumer loans and leases amounted at
March 31, 2009 compared to December 31, 2008.
Nonaccrual
loans, the largest component of nonperforming loans, are considered to be those
loans with the greatest risk of loss due to nonperformance and amounted to
$2,074.6 million or 4.21% of total loans and leases outstanding at March 31,
2009 compared to $1,527.0 million or 3.05% of total loans and leases outstanding
at December 31, 2008, an increase of $547.6 million or 35.9%. The amount of
cumulative charge-offs recorded on the Corporation’s nonaccrual loans
outstanding at March 31, 2009 was approximately $665.1 million or 48.3% of the
unpaid principal balance of the affected nonaccrual loans and 24.3% of the
unpaid principal balance of its total nonaccrual loans outstanding at
March 31, 2009. These charge-offs have reduced the carrying
value of these nonaccrual loans and leases which reduced the allowance for loan
and lease losses required at the measurement date.
Renegotiated
loans and leases amounted to $446.0 million at March 31, 2009 compared to $270.4
million at December 31, 2008, an increase of $175.6 million or 65.0%. After
restructuring, renegotiated loans generally result in lower payments than
originally required and therefore, should have a lower risk of loss due to
nonperformance than loans classified as nonaccrual. The Corporation’s instances
of default and re-default on renegotiated loans has been relatively low.
However, the Corporation’s experience with renegotiated loan performance is
relatively new and does not encompass an extended period of time. In order to
avoid foreclosure in the future, the Corporation has restructured loan terms for
certain qualified borrowers that have demonstrated the ability to make the
restructured payments for a specified period of time. The Corporation has
primarily used reduced interest rates and extended terms to lower contractual
payments. At March 31, 2009, restructured construction and development loans
amounted to $156.2 million or 35.0% of total renegotiated loans and leases and
residential real estate, home equity and other consumer loans amounted to $217.1
million or 48.7% of total renegotiated loans and leases. Approximately $232.4
million or 52.1% of total renegotiated loans and leases at March 31, 2009 were
related to renegotiated loans and leases in Arizona. The present value of
expected future cash flows discounted at the loan’s effective interest rate was
the primary method used to measure impairment and determine the amount of
allowance for loan and lease losses required for renegotiated loans and leases
at March 31, 2009. Significant judgment is required to estimate
expected future cash flows.
Net charge-offs amounted to $328.0
million or 2.67% of average loans and leases in the first quarter of 2009. Net
charge-offs of real estate loans amounted to $257.6 million or 78.5% of total
net charge-offs in the first quarter of 2009. For the three months
ended March 31, 2009, approximately $176.4 million of the real estate loan net
charge-offs were construction and development loan net charge-offs.
The Corporation’s construction and development real estate loans continued to
exhibit the most increase in impairment. In addition, commercial
loans whose performance is dependent on the housing market also continued to be
adversely affected.
Net
charge-offs in the first quarter of 2009 were concentrated in three areas which
the Corporation refers to as business channels. Net charge-offs for
the Arizona business channel amounted to $120.8 million, net charge-offs for the
Florida business channel amounted to $24.9 million and net charge-offs for the
correspondent banking business channel amounted to $51.2 million. The aggregate
net charge-offs for these three business channels amounted to $196.9 million or
60.0% of total net charge-offs for the three months ended March 31, 2009. That
concentration of net charge-offs in the first quarter was consistent with the
Corporation’s experience in 2008. The aggregate net charge-offs for these three
business channels amounted to 68.9% of total net charge-offs for the year ended
December 31, 2008.
Based on
the loss estimates discussed, management determined its best estimate of the
required allowance for loans and leases. Management’s evaluation of
the factors previously described resulted in an allowance for loan and lease
losses of $1,352.1 million or 2.75% of loans and leases outstanding at March 31,
2009. The allowance for loan and lease losses was $1,202.2 million or
2.41% of loans and leases outstanding at December 31,
2008. Consistent with the credit quality trends noted above, the
provision for loan and lease losses amounted to $477.9 million in the first
quarter of 2009. The resulting provision for loan and lease losses are the
amounts required to establish the allowance for loan and lease losses at the
required level after considering charge-offs and
recoveries. Management recognizes there are significant estimates in
the process and the ultimate losses could be significantly different from those
currently estimated.
Income
Taxes
Income
taxes are accounted for using the asset and liability method. Under
this method, deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
basis. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The
effect on tax assets and liabilities of a change in tax rates is recognized in
the income statement in the period that includes the enactment
date.
The
determination of current and deferred income taxes is based on complex analyses
of many factors, including interpretation of Federal and state income tax laws,
the difference between tax and financial reporting basis of assets and
liabilities (temporary differences), estimates of amounts currently due or owed,
such as the timing of reversals of temporary differences and current accounting
standards. The Federal and state taxing authorities who make
assessments based on their determination of tax laws periodically review the
Corporation’s interpretation of Federal and state income tax
laws. Tax liabilities could differ significantly from the estimates
and interpretations used in determining the current and deferred income tax
liabilities based on the completion of taxing authority
examinations.
The
Corporation accounts for the uncertainty in income taxes recognized in financial
statements in accordance with the recognition threshold and measurement process
for a tax position taken or expected to be taken in a tax return in accordance
with Financial Accounting Standards Board (“FASB”) Interpretation No. 48 (“FIN
48”),
Accounting for
Uncertainty in Income Taxes- an Interpretation of FASB Statement No. 109
.
FIN 48 also provides guidance on derecognition, classification, interest and
penalties, accounting in interim periods and disclosures.
In
February 2009, the State of Wisconsin passed legislation that requires combined
reporting for state income tax purposes effective January 1, 2009. As a result,
the Corporation recorded an additional income tax benefit of $51.0 million, or
$0.19 per diluted common share to recognize certain state deferred tax
assets, which included the reduction of a valuation allowance for Wisconsin net
operating losses. The Corporation expects that income tax expense will increase
in future periods due to the enacted legislation.
As a
result of the Internal Revenue Service’s decision not to appeal a November 2007
US Tax Court ruling related to how the TEFRA (interest expense) disallowance
should be calculated within a consolidated group and the position the IRS has
taken in another related case, the Corporation recognized an additional income
tax benefit related to years 1996-2007 of $20.0 million for its similar issue
during the first quarter of 2008.
The
Corporation anticipates it is reasonably possible that unrecognized tax benefits
up to approximately $20 million could be realized within 12 months of March 31,
2009. The realization would principally result from settlement with
taxing authorities as it relates to the tax benefits associated with a 2002
stock issuance.
Fair
Value Measurement
The
Corporation measures fair value in accordance with Statement of Financial
Accounting Standards No. 157,
Fair Value
Measurements
and the additional guidance provided by Financial
Accounting Standards Board Staff Position FSP FAS 157-4,
Determining Fair
Value When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That Are Not
Orderly
, collectively “SFAS 157”. SFAS 157 provides a
framework for measuring fair value under accounting principles generally
accepted in the United States of America. SFAS 157 defines fair value
as the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date. SFAS 157 addresses the valuation techniques used to
measure fair value. These valuation techniques include the market
approach, income approach and cost approach. The market approach uses
prices or relevant information generated by market transactions that are
identical to or comparable with assets or liabilities. The income
approach involves converting future amounts to a single present
amount. The measurement is valued based on current market
expectations about those future amounts. The cost approach is based
on the amount that currently would be required to replace the service capacity
of an asset.
SFAS 157
establishes a fair value hierarchy, which prioritizes the inputs to valuation
techniques used to measure fair value into three broad levels. The
fair value hierarchy gives the highest priority to quoted prices in active
markets for identical assets or liabilities (Level 1) and the lowest priority to
unobservable inputs (Level 3). The reported fair value of a financial
instrument is categorized within the fair value hierarchy based upon the lowest
level of input that is significant to the instrument’s fair value
measurement. The three levels within the fair value hierarchy consist
of the following:
Level 1 -
Inputs to the valuation methodology are quoted prices (unadjusted) for identical
assets or liabilities in active markets.
Level 2 -
Inputs to the valuation methodology include quoted prices for similar assets and
liabilities in active markets and inputs that are observable for the asset or
liability, either directly or indirectly, for substantially the full term of the
financial instrument. Fair values for these instruments are estimated
using pricing models, quoted prices of financial assets or liabilities with
similar characteristics or discounted cash flows.
Level 3-
Inputs to the valuation methodology are unobservable and significant to the fair
value measurement. Fair values are initially valued based upon a
transaction price and are adjusted to reflect exit values as evidenced by
financing and sale transactions with third parties.
These
measurements involve various valuation techniques and models, which involve
inputs that are observable, when available. A description of the
valuation methodologies used for financial instruments measured at fair value on
a recurring basis, as well as the general classification of such instruments
pursuant to the valuation hierarchy is disclosed in Note 3 – Fair Value
Measurements in Notes to Consolidated Financial Statements.
In
addition to financial instruments that are measured at fair value on a recurring
basis, fair values are used in purchase price allocations and goodwill
impairment testing.
Other
than Level 1 inputs, selecting the relevant inputs, appropriate valuation
techniques and determining the appropriate category to report the fair value of
a financial instrument requires varying levels of judgment depending on the
facts and circumstances. The determination of some fair values can be
a complex analysis of many factors. Judgment is required when
determining the fair value of an asset or liability when either relevant
observable inputs do not exist or available observable inputs are in a market
that is not active. When relevant observable inputs are not
available, the Corporation must use its own assumptions about future cash flows
and appropriately risk-adjusted discount rates. Conversely, in some
cases observable inputs may require significant adjustments. For
example, in cases where the volume and level of trading activity in an asset or
liability have declined significantly, the available prices vary significantly
over time or among market participants, or the prices are not current, the
observable inputs might not be relevant and could require significant
adjustment.
Valuation
techniques and models used to measure the fair value of financial assets on a
recurring basis are reviewed and validated by the Corporation at least quarterly
and in some cases monthly. In addition, the Corporation monitors the
fair values of significant assets and liabilities using a variety of methods
including the evaluation of pricing service information, using exception reports
based on analytical criteria, comparisons to previous trades or broker quotes
and overall reviews and assessments for reasonableness.
New
Accounting Pronouncements
A
discussion of new accounting pronouncements that are applicable to the
Corporation and have been or will be adopted by the Corporation is included in
Note 2 in Notes to Financial Statements contained in Item 1 herein.
Items 2
and 3 of this Form 10-Q, “Management’s Discussion and Analysis of Financial
Condition and Results of Operations” and “Quantitative and Qualitative
Disclosures about Market Risk,” respectively, contain forward-looking statements
within the meaning of the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements
include, without limitation, statements regarding expected financial and
operating activities and results which are preceded by words such as “expects”,
“anticipates” or “believes”. Such statements are subject to important
factors that could cause the Corporation’s actual results to differ materially
from those anticipated by the forward-looking statements. These
factors include those referenced in Item 1A. Risk Factors, in the Corporation’s
Annual Report on Form 10-K for the year ended December 31, 2008 and as may be
described from time to time in the Corporation’s subsequent SEC
filings.
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ITEM 3.
QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
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The
following updated information should be read in conjunction with the
Corporation’s Annual Report on Form 10-K for the year ended December 31,
2008. Updated information regarding the Corporation’s use of
derivative financial instruments is contained in Note 12 – Derivative Financial
Instruments and Hedging Activities in Notes to Financial Statements contained in
Item 1 herein.
Market
risk arises from exposure to changes in interest rates, exchange rates,
commodity prices, and other relevant market rate or price risk. The
Corporation faces market risk through trading and other than trading
activities. While market risk that arises from trading activities, in
the form of foreign exchange and interest rate risk, is immaterial to the
Corporation, market risk from other than trading activities, in the form of
interest rate risk, is measured and managed through a number of
methods.
Interest
Rate Risk
The
Corporation uses financial modeling techniques to identify potential changes in
income and market value under a variety of possible interest rate
scenarios. Financial institutions, by their nature, bear interest
rate and liquidity risk as a necessary part of the business of managing
financial assets and liabilities. The Corporation has designed
strategies to limit these risks within prudent parameters and identify
appropriate risk/reward tradeoffs in the financial structure of the balance
sheet.
The
financial models identify the specific cash flows, repricing timing and embedded
option characteristics of the assets and liabilities held by the
Corporation. The net change in net interest income in different
market rate environments is the amount of earnings at risk. The net
change in the present value of the asset and liability cash flows in different
market rate environments is the amount of market value at
risk. Policies are in place to assure that neither earnings nor
market value at risk exceed appropriate limits. The use of a limited
array of derivative financial instruments has allowed the Corporation to achieve
the desired balance sheet repricing structure while simultaneously meeting the
desired objectives of both its borrowing and depositing customers.
The
models used include measures of the expected repricing characteristics of
administered rate (NOW, savings and money market accounts) and non-rate related
products (demand deposit accounts, other assets and other
liabilities). These measures recognize the relative insensitivity of
these accounts to changes in market interest rates, as demonstrated through
current and historical experiences. In addition to contractual
payment information for most other assets and liabilities, the models also
include estimates of expected prepayment characteristics for those items that
are likely to materially change their cash flows in different rate environments,
including residential mortgage products, certain commercial and commercial real
estate loans and certain mortgage-related securities. Estimates for
these sensitivities are based on industry assessments and are substantially
driven by the differential between the contractual coupon of the item and
current market rates for similar products.
This
information is incorporated into a model that projects future net interest
income levels in several different interest rate
environments. Earnings at risk are calculated by modeling net
interest income in an environment where rates remain constant, and comparing
this result to net interest income in a different rate environment, and then
expressing this difference as a percentage of net interest income for the
succeeding 12 months. Since future interest rate moves are difficult
to predict, the following table presents two potential scenarios—a gradual
increase of 100bp across the entire yield curve over the course of the year
(+25bp per quarter), and a gradual decrease of 100bp across the entire yield
curve over the course of the year (-25bp per quarter) for the balance sheet
as of March 31, 2009:
Hypothetical Change in Interest
Rates
|
|
Impact to 2009
|
|
100
basis point gradual rise
in rates
|
|
|
1.4
|
%
|
100
basis point gradual decline in rates
|
|
|
(5.1
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)
%
|