-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, B+UxP+kyshKu/q1H2dpkD4hJgUOfIJ0wVS6OHn8fXK/iqR2ZwVRQAstzVnu5kGzg V/8jvfz/oaxXoUxao7bhTw== 0000950144-99-003429.txt : 19990331 0000950144-99-003429.hdr.sgml : 19990331 ACCESSION NUMBER: 0000950144-99-003429 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST AMERICAN CORP /TN/ CENTRAL INDEX KEY: 0000036068 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 620799975 STATE OF INCORPORATION: TN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-14249 FILM NUMBER: 99576884 BUSINESS ADDRESS: STREET 1: FIRST AMERICAN CTR CITY: NASHVILLE STATE: TN ZIP: 37237 BUSINESS PHONE: 6157482000 MAIL ADDRESS: STREET 1: FIRST AMERICAN CENTER CITY: NASHVILLE STATE: TN ZIP: 37237 FORMER COMPANY: FORMER CONFORMED NAME: FIRST AMTENN CORP DATE OF NAME CHANGE: 19810122 FORMER COMPANY: FORMER CONFORMED NAME: FIRST AMERICAN NATIONAL CORP DATE OF NAME CHANGE: 19731128 10-K 1 FIRST AMERICAN CORPORATION 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------- FORM 10-K ------------- ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998. COMMISSION FILE NUMBER 0-6198. FIRST AMERICAN CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) TENNESSEE 62-0799975 (STATE OR OTHER JURISDICTION OF (IRS EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) FIRST AMERICAN CENTER, NASHVILLE, TENNESSEE 37237-0700 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 615/748-2000 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, PAR VALUE $2.50 PER SHARE AND ASSOCIATED SERIES A JUNIOR PREFERRED STOCK (Title of Class) ------------------ Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for at least the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value (computed on the basis of the reported last sale price on February 5, 1999) of shares of Common Stock, par value $2.50 per share, held by non-affiliates of the Registrant was $4,444,718,851.80. The aggregate market value calculation assumes (i) that all shares beneficially held by members of the Board of Directors of the Registrant are shares owned by "affiliates," a status which each of the directors individually disclaims, and (ii) that shares beneficially owned by the Registrant's subsidiaries are owned by "affiliates." Indicate the number of shares outstanding of each of the Registrant's classes of common stock, as of the latest practicable date.
Outstanding at Class February 5, 1999 ----- ---------------- Common Stock, $2.50 par value: 116,486,187 DOCUMENTS INCORPORATED BY REFERENCE: DOCUMENT FROM WHICH PORTIONS ARE PART OF FORM 10-K INCORPORATED BY REFERENCE TO WHICH INCORPORATED - ------------------------- --------------------- 1. PROXY STATEMENT DATED MARCH 15, 1999 PART III
2 TABLE OF CONTENTS
Page ---- PART I Items 1-2 Business and Properties............................................1 General.................................................... 1 Statistical Information.................................... 7 Supervision and Regulation................................ 8 Competition............................................... 19 Employees..................................................20 Item 3 Legal Proceedings................................................ 20 Item 4 Submission of Matters to a Vote of Security Holders.......................................... 20 PART II Item 5 Market for Registrant's Common Equity and Related Stockholder Matters........................... 21 Item 6 Selected Financial Data.......................................... 21 Items 7; 7A Management's Discussion and Analysis of Financial Condition and Results of Operations; Quantitative and Qualitative Disclosures About Market Risk.................................... 22 Item 8 Financial Statements and Supplementary Data...................... 58 Item 9 Changes In and Disagreements with Accountants on Accounting and Financial Disclosure....................... 58 PART III Item 10 Directors and Executive Officers of the Registrant............... 58 Item 11 Executive Compensation........................................... 61 Item 12 Security Ownership of Certain Beneficial Owners and Management............................................ 61 Item 13 Certain Relationships and Related Transactions................... 61 PART IV Item 14 Exhibits, Financial Statement Schedules, and Reports on Form 8-K....................................... 62
i 3 PART I ITEMS 1-2: BUSINESS AND PROPERTIES GENERAL First American Corporation ("First American"), a Tennessee corporation, was incorporated in 1968. First American is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended ("BHCA"), and as a savings and loan holding company under the Home Owner's Loan Act, as amended ("HOLA"). Through its banking and thrift subsidiaries, First American operates in Tennessee, Mississippi, Louisiana, Kentucky, Virginia, Arkansas and Georgia. First American owns all of the capital stock of First American National Bank ("FANB"), a national bank headquartered in Nashville, Tennessee (which operates as Deposit Guaranty National Bank in Mississippi, Louisiana and Arkansas); Peoples Bank, a Tennessee state chartered bank headquartered in Dickson, Tennessee; First American Federal Savings Bank ("FAFSB"), a federal savings bank headquartered in Roanoke, Virginia; Pioneer Bank, f.s.b., a federal savings bank headquartered in East Ridge, Tennessee; and First American Enterprises, Inc. ("FAE"), a Tennessee corporation headquartered in Nashville, Tennessee. FANB owns 98.75% of the issued and outstanding capital stock of IFC Holdings, Inc. ("IFC"), a Delaware corporation headquartered in Tampa, Florida, which is engaged in the distribution of securities, other investment products and insurance. Through its subsidiaries, IFC is licensed to sell investment products in all 50 states, the District of Columbia and Puerto Rico. IFC offers these products under two brand names, INVEST Financial Corporation ("INVEST") and Investment Centers of America, Inc. ("ICA"). Under the INVEST brand, IFC markets investment products to financial institutions of various asset sizes while under the ICA brand, IFC markets investment products primarily to community banks. FANB also owns 49% of the capital stock of The SSI Group, Inc. ("SSI"), a Florida corporation headquartered in Mobile, Alabama, which is engaged in health care claims processing. First American coordinates the financial resources of the consolidated enterprise and maintains systems of financial, operational and administrative controls that allow coordination of policies and activities. First American derives its income from interest, dividends and management fees received from its subsidiaries. The mailing address of the principal executive offices of First American is First American Center, Nashville, Tennessee 37237-0700, and the telephone number is (615) 748-2000. As of December 31, 1998, First American had total assets of approximately $20.7 billion, total deposits of approximately $15.3 billion, shareholders' equity of approximately $1.8 billion, and net income of approximately $211 million. As of December 31, 1998, FANB had total assets of approximately $20 billion, total deposits of approximately $15 billion, shareholders' equity of approximately $1.9 billion, and net income of approximately $250 million for 1998. As of June 30, 1998, on the basis of assets, First American estimates that it ranked as the 36th largest bank holding 1 4 company in the United States and the ninth largest bank holding company headquartered in the Southeast. First American operates in two business segments, Banking Services and Enterprises, based upon management responsibilities. For a discussion of these segments, see the following section of Management's Discussion and Analysis of Financial Condition and Results of Operations, included in this Report as Item 7: Business Segment Results, pages 25-28. First American's subsidiary banks engage in consumer and commercial lending. The risk involved to First American and its subsidiary banks in making these loans varies based on, among other things, the amount of the loan, the length of amortization of the principal, the type of collateral, if any, used to secure the loan and the characteristics of the borrower. For a further discussion of lending activities, see the following sections of Management's Discussion and Analysis of Financial Condition and Results of Operations, included in this Report as Item 7: Loan Portfolio, pages 37-38; Allowance and Provision for Loan Losses, pages 45-47; Credit Risk Management, pages 43-44; and Nonperforming Assets, page 44. First American's investment securities portfolio is the second largest component of First American's earning assets. For a discussion of investment activities, see the following section of Management's Discussion and Analysis of Financial Condition and Results of Operations, included in this Report as Item 7: Investment Securities Portfolio, pages 38-40. In addition, First American and its subsidiary banks derive funds from core deposits, certificates of deposit, foreign deposits, short-term borrowings and long-term debt. For a further discussion of these activities, see the following sections of Management's Discussion and Analysis of Financial Condition and Results of Operations, included in this Report as Item 7: Deposits and Other Sources of Funds, pages 40-42; and Liquidity Risk Management, pages 51-53. ACQUISITIONS AND DIVESTITURES In 1998, First American experienced significant growth through mergers and acquisitions. Effective May 1, 1998, Deposit Guaranty Corp. ("Deposit Guaranty"), a bank holding company headquartered in Jackson, Mississippi, was merged with and into First American. Deposit Guaranty, the parent company of Deposit Guaranty National Bank ("DGNB"), had total assets of $7.0 billion and total shareholders' equity of $635.2 million at December 31, 1997. This transaction was accounted for as a pooling-of-interests. First American released audited supplemental consolidated financial statements giving retroactive effect to this merger on July 14, 1998. Prior to the Deposit Guaranty merger, Deposit Guaranty announced plans to acquire Victory Bancshares, Inc., a bank holding company headquartered in Memphis, Tennessee, with total assets of $131 million as of December 31, 1997. Deposit Guaranty's acquisition of Victory Bancshares, Inc. closed on March 23, 1998 and was accounted for as a pooling-of-interests. 2 5 Effective September 1, 1998, DGNB was merged with and into FANB. FANB continues to operate under the Deposit Guaranty brand name in Mississippi, Louisiana and Arkansas. For a further discussion of FANB, see Commercial Banking - First American National Bank, included in this Report at pages 4-5. On October 1, 1998, First American completed its acquisitions of Peoples Bank, headquartered in Dickson, Tennessee, The Middle Tennessee Bank, headquartered in Columbia, Tennessee ("MTB") and CSB Financial Corporation, headquartered in Kingston Springs, Tennessee ("CSB"). Peoples Bank operated six branches in Dickson and Houston Counties, Tennessee and had approximately $136 million in assets, $118 million in deposit liabilities and $16.8 million in shareholders' equity as of June 30, 1998. As of the same date, MTB operated seven branches in Maury County, Tennessee, and had approximately $225 million in assets, $190 million in deposit liabilities and $30 million in shareholders' equity. CSB, through its subsidiary Cheatham State Bank, a Tennessee state chartered bank, operated four branches in Cheatham County, Tennessee, and had approximately $145 million in assets, $132 million in deposit liabilities and $11 million in shareholders' equity as of June 30, 1998. MTB and CSB were merged into FANB effective October 1, 1998 and Peoples Bank is expected to be merged into FANB by the end of the third quarter of 1999. These transactions were accounted for as poolings-of-interests. On October 19, 1998, First American and National Commerce Bancorporation ("NCBC") announced definitive agreements to exchange a total of 14 existing bank branches in Tennessee and Virginia. Under the terms of the agreements, NCBC will acquire five existing FAFSB branches in Virginia and FAFSB will acquire nine existing NCBC branches throughout Tennessee. The branch swaps and conversions are expected to be complete by the end of the second quarter of 1999. Effective November 20, 1998, First American acquired Pioneer Bancshares, Inc. ("Pioneer"), a $990 million bank holding company headquartered in Chattanooga, Tennessee. Pioneer was the parent company of Pioneer Bank of Chattanooga, Tennessee, Valley Bank of Sweetwater, Tennessee and Pioneer Bank, f.s.b. of East Ridge, Tennessee. Pioneer Bank and Valley Bank were merged into FANB on November 20, 1998. Pioneer Bank, f.s.b. is expected to be merged into FAFSB in the second quarter of 1999. This transaction was accounted for as a pooling-of-interests. The restated financial results giving retroactive effect to this merger are incorporated herein by reference to First American's Consolidated Financial Statements, included in this Report under Item 8. First American also divested a number of non-core businesses in 1998. Effective July 11, 1998, First American sold certain assets of First Mortgage Corp., a mortgage subsidiary acquired from Deposit Guaranty. First Mortgage Corp., headquartered in Nebraska, operated throughout Nebraska, Iowa and Oklahoma. On August 16, 1998, First American completed the sale of McAfee Mortgage ("McAfee"), a mortgage subsidiary headquartered in Texas. The sale of McAfee, along with the sale of certain assets of First Mortgage Corp., finalized the strategic process of focusing First American's mortgage operations on primarily in-market mortgage businesses. 3 6 In August 1998, DGNB consummated the sale of its corporate trust business to The Bank of New York. In the transaction, DGNB transferred approximately 900 bond trustee and agency relationships representing $8 billion in outstanding securities for municipalities and corporations located primarily in Mississippi and Louisiana to The Bank of New York and its trust company affiliates. For further discussion of these activities, see Note 2 to First American's Consolidated Financial Statements, included in this Report under Item 8, at pages 78-81. BANKING SERVICES FIRST AMERICAN NATIONAL BANK ("FANB") Founded in 1883, at December 31, 1998, FANB operated in six states throughout the southeastern United States. At year's end, FANB's banking offices were located: (1) in 34 Tennessee counties containing approximately 73.9% of Tennessee's population; (2) in 26 Mississippi counties containing approximately 55.9% of Mississippi's population; (3) in 13 Louisiana parishes containing approximately 52.9% of Louisiana's population; (4) in two Kentucky counties containing approximately 2.6% of Kentucky's population; (5) in two Virginia counties (or cities) containing approximately 1.0% of Virginia's population; and (6) in one Arkansas county containing approximately 4.2% of Arkansas' population. On a pro forma basis as of June 30, 1998, FANB estimates that it maintained the following market shares in the markets that it serves: (1) Tennessee. FANB was the largest bank in Tennessee. FANB had the largest deposit base in the Middle Tennessee Region, the largest deposit base in the Southeast Tennessee Region and the largest deposit base in the Tri-Cities Metropolitan Statistical Area. In the Knoxville Metropolitan Statistical Area and the West Tennessee Region, FANB held the second and fourth largest deposit bases, respectively. The Middle Tennessee Region includes Bedford, Cannon, Cheatham, Davidson, DeKalb, Dickson, Giles, Houston, Maury, Montgomery, Putnam, Rutherford, Stewart, Sumner, Trousdale, Warren, Williamson and Wilson Counties. The Southeast Tennessee Region includes Bradley, Cumberland, Hamilton, Marion, McMinn, Meigs, Rhea, Roane and Sequatchie Counties in addition to Whitfield County, Georgia. The West Tennessee Region includes Gibson, Henry, Madison and Shelby Counties; (2) Mississippi. FANB, operating as DGNB, was the second largest bank in Mississippi. FANB had the largest deposit base in the South Mississippi Region, excluding Harrison County in which FANB had the eighth largest deposit base. In the Middle and North Mississippi Regions, FANB had the second largest deposit base. The South Mississippi Region includes Adams, Forrest, Jones, Lamar, Lawrence, Pike and Wilkinson Counties. The Middle Mississippi Region includes Hinds, Lauderdale, Madison, Rankin, Warren and Yazoo Counties. The 4 7 North Mississippi Region includes Alcorn, Coahoma, Itawamba, Lee, Leflore, Lowndes, Oktibbeha, Prentiss, Tishomingo, Webster and Washington Counties; and (3) Louisiana. FANB, operating as DGNB, was the fifth largest bank in Louisiana. FANB had the third largest deposit base in the North Louisiana Region and the fifth largest deposit base in the South Louisiana Region. The North Louisiana Region includes Bossier, Caddo, Madison, Morehouse, Ouachita and Richland Parishes. The South Louisiana Region includes Ascension, East Baton Rouge, Jefferson, Livingston, Orleans, St. Tammany and Tangipahoa Parishes. At December 31, 1998, FANB had a total of 391 banking offices. In Tennessee, FANB had banking offices in the ten largest Tennessee counties (measured by aggregate bank deposits of banks in the county at June 30, 1998) and in the ten most populous Tennessee cities. In Mississippi, FANB had banking offices in nine of the ten largest Mississippi counties (measured by aggregate bank deposits of banks in the county at June 30, 1998) and in nine of the ten most populous Mississippi cities. In Louisiana, FANB had banking offices in six of the ten largest Louisiana parishes (measured by aggregate bank deposits of banks in the parish at June 30, 1998) and in six of the ten most populous Louisiana cities. FANB offers the services generally performed by commercial banks of like size and character. FANB also provides individual trust services and investment management services for customers of First American's subsidiary banks. For a discussion of the securities brokerage services provided by FANB, please see "Investment Product Distribution; Broker/Dealer Services" on page 6 of this Report. In addition, FANB owns First AmTenn Life Insurance Company, which underwrites credit life and accident and health insurance on extensions of credit made by FANB. On July 1, 1998, First AmTenn Life Insurance Company was merged into G&W Life Insurance Company, a wholly owned subsidiary of FANB acquired in conjunction with the Deposit Guaranty merger. Immediately following the merger, the entity's name was changed to First AmTenn Life Insurance Company. FANB offers 24-hour banking service through a variety of means, including PC banking, telephone banking and automated teller machines located at a majority of its banking offices and at other locations. At December 31, 1998, FANB operated a total of 699 automated teller machines. FEDERAL SAVINGS BANK SUBSIDIARIES FAFSB offers the services generally performed by savings banks of like size and character. At December 31, 1998, FAFSB had ten branches in the southwestern region of Virginia and offered 24-hour banking service through 12 automated teller machines. On the basis of deposits at June 30, 1998, First American estimates that FAFSB had the fifth largest deposit base in the Pulaski County, Virginia market, the fifth largest deposit base in the Smyth County, Virginia market and the fifth largest deposit base in the Wythe County, Virginia market. 5 8 In April, 1998, three FAFSB branches in Virginia, with total deposits of approximately $37 million, were sold for a pretax gain of $2.7 million. The sale of these branches was a part of the implementation of First American's Distribution Management System, which is designed to reconfigure First American's distribution system to determine the best mix of distribution alternatives for clients and to maximize return on capital investment. Pioneer Bank, f.s.b. also offers services generally performed by savings banks of like size and character. At December 31, 1998, Pioneer Bank, f.s.b. had one branch in Tennessee, two branches in Georgia and offered 24-hour banking service through three automated teller machines. ENTERPRISES FAE was formed in 1995 for the purpose of developing sources of non-traditional financial services income. FAE has concentrated its efforts in exploring potential fee income generation in the areas of health care payment processing, insurance company relational database services, and third-party marketing and securities distribution. A division of FANB manages First American's investments in these areas, including investments in IFC and SSI. INVESTMENT PRODUCT DISTRIBUTION; BROKER/DEALER SERVICES IFC (formerly INVEST Financial Corporation) is a securities broker/dealer registered with the National Association of Securities Dealers, Inc. ("NASD"). IFC, through the INVEST and ICA brands, is licensed to sell investment products in all 50 states, the District of Columbia and Puerto Rico. Headquartered in Tampa, Florida, IFC is a third party marketer of investment products for financial institutions. Through its Investment Services Group ("ISG"), IFC also serves as the third party marketer of investment products for First American's subsidiary banks. ICA, a North Dakota corporation headquartered in Bismarck, North Dakota, is a wholly owned subsidiary of IFC. ICA is also a broker/dealer registered with the NASD and a third-party marketer of its own brand of investment products through financial institutions. ICA primarily services community banks with assets of $500 million or less. On December 16, 1998, IFC completed the purchase of the assets of the Specialized Investment Division of Financial Service Corporation, a subsidiary of SunAmerica, Inc. This acquisition gave IFC an entry into the credit union market and brought additional management and sales experience to IFC. The purchase added new clients, new representatives, new locations and approximately $300 million in product sales to IFC's operations. As of December 31, 1998, IFC serviced more than 330 banks through approximately 2500 licensed representatives in more than 1334 investment centers located throughout the United States, making IFC the nation's leading provider of investment services for banks and financial institutions. 6 9 HEALTH CARE CLAIMS PROCESSING SSI is a health care claims processing company headquartered in Mobile, Alabama. SSI uses automated data processing to assist hospitals and physicians in relaying billing and payment-related information to medical benefits third-party payors such as government agencies, health maintenance organizations and insurance carriers. SSI's claims processing services include transmission of bill payments by both patients and third-party payors to hospitals or physicians. SSI provides these electronic financial data processing services to more than 910 hospitals, clinics and physicians in 43 states. On November 6, 1998, SSI completed the purchase of the assets of Health Management Technologies, Inc. ("HMT"), a corporation headquartered in Lafayette, California. HMT developed and marketed healthcare information management software for workers compensation, occupational health and managed care organization insurance carriers. HMT's shareholders received 9.16% of SSI's common stock in the transaction. Simultaneously, FANB exercised a portion of its option to purchase additional shares from Southern Medical Health Systems, Inc., which is wholly owned by Celia A. Wallace, at a cost of approximately $900,000. FANB currently owns 49% of SSI and has the option to purchase up to a total of 58.5% of the company. The balance of SSI is owned, either directly or indirectly, by Ms. Wallace, a member of First American's Board of Directors since 1996, Health Care Insight, L.C., Karen Wolfe and A. Allan Machesney. STATISTICAL INFORMATION Management's Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Year-End Balance Sheets, which discuss First American and its subsidiaries from a financial perspective, are contained in Items 7, 7A, and 8 of this Report and incorporated herein by reference. 7 10 SUPERVISION AND REGULATION GENERAL First American is a bank holding company subject to regulation, supervision and examination by the Federal Reserve Board under the BHCA. The activities of First American are limited to banking, managing or controlling banks, furnishing services to or performing services for their subsidiaries or any other activity which the Federal Reserve Board determines to be an appropriate activity for a bank holding company because such activity is closely related to banking or managing or controlling banks. In making such determinations, the Federal Reserve Board is required to consider whether the performance of such activities by a bank holding company can reasonably be expected to produce benefits to the public such as greater convenience, increased competition or gains in efficiency that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. Generally, bank holding companies such as First American are required to obtain prior approval of the Federal Reserve Board to engage in any new activity or to acquire more than 5% of any class of voting stock of any company. First American is also a savings and loan holding company subject to the supervision of the Office of Thrift Supervision ("OTS") under HOLA. FANB, a national bank, is subject to regulation, supervision and examination by the Office of the Comptroller of the Currency ("OCC"). FAFSB and Pioneer Bank, f.s.b. are federal savings banks and, as such, are subject to regulation, supervision and examination by the OTS. Peoples Bank, a Tennessee state-chartered bank, is subject to regulation by the Tennessee Department of Financial Institutions ("TDFI"). Each of First American's depository institution subsidiaries is also subject to regulation by the Federal Reserve Board and insured by, and subject to the regulations of, the Federal Deposit Insurance Corporation ("FDIC"). In addition, First American's banking subsidiaries are significantly affected by the actions of the Federal Reserve Board by virtue of its role in regulating money supply and credit availability, as well as by the U.S. economy in general. Areas subject to regulation by federal authorities include loan loss reserves, investments, loans, mergers, issuance of securities, capital, payment of dividends, establishment and closing of branches, product offerings and other aspects of operations. In addition to banking laws, regulations and regulatory agencies, First American and its subsidiaries and affiliates are subject to various other laws, regulations, supervision and examination by other regulatory agencies, all of which, directly or indirectly, affect the operations and management of First American and its ability to make distributions. First American's (Enterprises), First American's non-banking subsidiaries ("Enterprises") are non-banking subsidiaries, are subject to the supervision of the Federal Reserve Board, and may be subject to the supervision of other regulatory agencies including the Securities and Exchange Commission ("SEC"), the NASD and state securities and insurance regulators. Subsidiaries and permitted investments of FANB, such as IFC and SSI, are also subject to regulation and conditions of acquisition by the OCC. The following discussion summarizes certain aspects of those laws and regulations that affect First American. To the extent statutory or regulatory provisions or proposals are described, the description is qualified in its entirety by reference to the particular statutory or regulatory provision or proposal. 8 11 Supervision and regulation of bank holding companies and their subsidiaries are intended primarily for the protection of depositors, the deposit insurance funds of the FDIC, and the banking system as a whole, not for the protection of bank holding company shareholders or creditors. For example, according to Federal Reserve Board policy, First American is expected to serve as a source of financial and managerial strength to each of its subsidiary banks and to commit resources to support each of them. This support may be required at times when First American would not otherwise be inclined to provide it. Under the "cross-guarantee" provisions of the Federal Deposit Insurance Act ("FDIA"), any FDIC-insured subsidiary of First American can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with (i) the default of a commonly controlled FDIC-insured subsidiary or (ii) any assistance provided by the FDIC to any commonly controlled FDIC-insured subsidiary "in danger of default." "Default" is defined generally as the appointment of a conservator or receiver and "in danger of default" is defined generally as the existence of certain conditions indicating that a default is likely to occur in the absence of regulatory assistance. The FDIC may decline to enforce the cross-guarantee provisions if it determines that a waiver is in the best interest of the Bank Insurance Fund ("BIF") or the Savings Association Insurance Fund ("SAIF"), or both. The FDIC's claim for damages is superior to claims of shareholders of the insured depository institution or its holding company but is subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institutions. The FDIA also provides that amounts received from the liquidation or other resolution of any insured depository institution by any receiver must be distributed (after payment of secured claims) to pay the deposit liabilities of the institution prior to payment of any other general or unsecured senior liability, subordinated liability, general creditor or shareholder. This provision would give depositors a preference over general and subordinated creditors and shareholders in the event a receiver is appointed to distribute the assets of any of the bank subsidiaries of First American. Proposals to change the laws and regulations governing the banking industry are frequently introduced in Congress, in the state legislatures and by the various bank regulatory agencies. The likelihood and timing of any such proposals or bills being enacted and the impact they might have on First American and its subsidiaries cannot be determined at this time. CAPITAL AND OPERATIONAL REQUIREMENTS The Federal Reserve Board, the OCC, the OTS and the FDIC have adopted substantially similar risk-based and leverage capital guidelines applicable to U.S. banking organizations. In addition, those regulatory agencies may from time to time require that a banking organization maintain capital above the minimum levels, whether because of its financial condition or actual or anticipated growth. The Federal Reserve Board risk-based guidelines applicable to bank holding companies define a two-tier capital framework. Tier 1 capital generally consists of common and qualifying preferred shareholders' equity, less goodwill, certain intangibles and other adjustments. Tier 2 capital consists of subordinated and other qualifying debt, and the allowance for credit losses 9 12 up to 1.24% of risk-weighted assets. The sum of Tier 1 and Tier 2 capital less investments in unconsolidated subsidiaries represents qualifying total capital, at least 50% of which must consist of Tier 1 capital. Risk-based capital ratios are calculated by dividing Tier 1 and total capital by risk-weighted assets. For purposes of calculating risk-weighted assets, assets and off-balance sheet exposures are assigned to one of four categories of risk weights, based primarily on relative credit risk. The minimum Tier 1 risk-based capital ratio is 4% and the minimum total risk-based capital ratio is 8%. For a discussion of First American's Tier 1 and total risk-based capital ratios, please see Note 16 ("Legal and Regulatory Matters") to First American's Consolidated Financial Statements on pages 99-102 herein. In addition, each of the federal bank regulatory agencies has established minimum leverage capital ratio guidelines. The leverage ratio is determined by dividing Tier 1 capital by adjusted average total assets. Although the stated minimum ratio is 3%, most banking organizations are required to maintain ratios of at least 100 to 200 basis points above 3%. For information on First American's leverage ratio, see Note 16 ("Legal and Regulatory Matters") to First American's Consolidated Financial Statements on pages 99-102 herein. FAFSB and Pioneer Bank, f.s.b. are subject to similar capital requirements adopted by the OTS. Under OTS capital guidelines, a federal savings bank is required to maintain tangible capital of at least 1.5% of tangible assets, core (leverage) capital of at least 3% of the association's adjusted total assets and risk-based capital of at least 8% of risk-weighted assets. For more information on these capital ratios, please see Note 16 ("Legal and Regulatory Matters") to First American's Consolidated Financial Statements on pages 99-102 herein. In 1991, each federal banking agency was required to revise its risk-based capital standards to ensure that those standards take adequate account of interest rate risk, concentration of credit risk and the risks of nontraditional activities. Each of the federal banking agencies subsequently revised the risk-based capital guidelines to take account of concentration of credit risk, risk of nontraditional activities, and a bank's exposure to declines in the economic value of its capital due to changes in interest rates. In 1996, these agencies adopted a joint policy statement requiring that banks adopt comprehensive policies and procedures for managing interest rate risk, and this statement sets forth the general standards that such policies and procedures must meet. Unlike an earlier proposal, however, the statement does not contain a standardized measure or explicit capital charge for interest rate risk. The OTS regulatory capital requirements, which are applicable to FAFSB and Pioneer Bank, f.s.b., also incorporate an interest rate risk component. Under the OTS regulation, a federal savings bank's interest rate risk is measured by the decline in the net portfolio value of its assets that would result from a hypothetical 200 basis point increase or decrease in interest rates, divided by the estimated economic value of the federal savings bank's assets. A federal savings bank whose interest rate risk exposure exceeds 2% would be required to deduct an amount equal to one half of the difference between the federal savings bank's interest rate risk and 2% multiplied by the estimated economic value of its assets. At December 31, 1998, each of First American's insured depository institution subsidiaries 10 13 were in compliance with applicable federal capital adequacy guidelines. The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), among other things, identifies five capital categories for insured depository institutions (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) and requires the respective U.S. federal regulatory agencies to implement systems for "prompt corrective action" for insured depository institutions that do not meet minimum capital requirements within such categories. FDICIA imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which an institution is classified. Failure to meet the capital guidelines could also subject a banking institution to capital raising requirements. An "undercapitalized" bank must develop a capital restoration plan and its parent holding company must guarantee that bank's compliance with the plan in order for the capitalization plan to be accepted by the appropriate bank regulator. The liability of the parent holding company under any such guarantee is limited to the lesser of 5% of the bank's assets at the time it became "undercapitalized" or the amount needed to comply with the plan. Furthermore, in the event of the bankruptcy of the parent holding company, such guarantee would take priority over the parent's general unsecured creditors. FDICIA also requires the various regulatory agencies to prescribe certain non-capital standards for safety and soundness related generally to operations and management, asset quality and executive compensation and permits regulatory action against a financial institution that does not meet such standards. The federal banking agencies have adopted substantially similar regulations that define the five capital categories identified by FDICIA, using the total risk-based capital, Tier 1 risk-based capital and leverage capital ratios as the relevant capital measures. Such regulations establish successive degrees of corrective action to be taken when an institution is considered undercapitalized, including, in the most severe cases, placing an institution into conservatorship or receivership. Under the regulations, a "well capitalized" institution must have a Tier 1 capital ratio of at least 6%, a total capital ratio of at least 10% and a leverage ratio of at least 5% and not be subject to a capital directive order. An "adequately capitalized" institution must have a Tier 1 capital ratio of at least 4%, a total capital ratio of at least 8% and a leverage ratio of at least 4%, or 3% in some cases. For a discussion of First American's capital ratios, please see Note 16 ("Legal and Regulatory Matters") to First American's Consolidated Financial Statements on pages 99-102 herein. The federal banking agencies have also adopted final regulations that mandate that regulators take into consideration concentrations of credit risk and risks from non-traditional activities, as well as an institution's ability to manage those risks, when determining the adequacy of an institution's capital. That evaluation is a part of the institution's regular safety and soundness examination. In addition, the banking agencies have adopted final regulations requiring regulators to consider interest rate risk (when the interest rate sensitivity of an institution's assets does not match the sensitivity of its liabilities or its off-balance sheet position) in the determination of a bank's capital adequacy. On June 4, 1998, the OTS released a proposed comprehensive guidance bulletin regarding risk management of interest rates, investment securities and use of financial derivatives. For a discussion of the accounting and reporting standards applicable to derivative instruments, please see "Derivatives" on pages 50-51 of this Report. 11 14 ACQUISITION AND EXPANSION The BHCA requires any bank holding company to obtain the prior approval of the Federal Reserve Board before acquiring more than 5% of any class of voting stock of any bank that is not already majority-owned by the bank holding company. The BHCA, as amended by the interstate banking provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Banking and Branching Act"), permits bank holding companies from any state to acquire banks and bank holding companies located in any other state, except that applicable agency and aggregate market share limitations may apply. Under these market share limitations, a bank holding company which controls more than 10% of the total amount of deposits of insured depository institutions in the United States is prohibited from making further acquisitions. The BHCA also prohibits an acquisition if, upon consummation of the transaction, a bank holding company would control 30% or more of the total amount of deposits of insured depository institutions in the state which is the home state of the bank or bank holding company being acquired. First American estimates that, as of December 31, 1998, it held the following percentages of all such deposits in each of the following states: less than 14% in Tennessee; less than 14% in Mississippi; less than 4% in Louisiana; less than 1% in Arkansas; less than .5% in Kentucky; less than .5% in Virginia; and less than .5% in Georgia. Tennessee has adopted conforming legislation incorporating the deposit caps enacted by Congress. Under the Tennessee Bank Structure Act, a bank or bank holding company will be prohibited from acquiring any bank in Tennessee if that bank or bank holding company, on consummation of the acquisition, would control 30% or more of the total deposits in all insured financial institutions in Tennessee. In addition, a bank holding company, whether incorporated in Tennessee or elsewhere, may not acquire any bank in Tennessee that has been in operation less than five years or organize a new bank in Tennessee except in the case of certain interim bank mergers and acquisitions of banks in financial difficulty. Under Tennessee laws pertaining to bank mergers, banks in separate counties in Tennessee which have been in operation at least five years may merge. Banks with principal offices in the same county may merge without regard to the five-year aging requirement. The effect of these provisions is that First American may acquire banks in Tennessee which have been in operation for five years but may not form or acquire a new bank in any Tennessee county other than Davidson County, in which the main office of FANB is located. The Interstate Banking and Branching Act also authorizes banks with different home states to merge across state lines, unless the home state of a participating institution has passed legislation prior to June 1, 1997 explicitly prohibiting interstate branching with that state. No states in which First American's banking subsidiaries are located passed such legislation. Furthermore, pursuant to the Interstate Banking and Branching Act, a bank is now able to open new branches in a state in which it does not already have banking operations if such state has enacted a law permitting such de novo branching. Tennessee state law currently allows interstate branching by acquisition or merger, of either a bank or a bank branch, but does not expressly permit the de novo establishment of a bank branch. 12 15 ENFORCEMENT POWERS OF THE BANKING AGENCIES Federal and state banking agencies have broad enforcement powers over bank holding companies and their subsidiaries, including, in the case of federal agencies, the power to terminate deposit insurance, impose substantial fines and other civil penalties and, in the most severe cases, to appoint a conservator or receiver for a depository institution. Failure to maintain adequate capital or to comply with applicable laws, regulations and supervisory agreements could subject First American or its subsidiaries to these enforcement provisions. BANK REGULATION Payment of Dividends. First American is a legal entity separate and distinct from its subsidiary banks and its Enterprises. First American's revenues (on a parent company only basis) result, in part, from dividends paid to First American by its subsidiaries. The right of First American, and consequently the right of its creditors and shareholders, to participate in any distribution of the assets or earnings of any subsidiary through the payment of dividends is subject to the prior claims of creditors of the subsidiary (including depositors, in the case of banking subsidiaries), except to the extent that claims of First American in its capacity as a creditor may be recognized. In addition, under applicable law, FANB may not pay a dividend without prior approval of the OCC if the total of all dividends declared in any calendar year exceeds the total of its net profits of the preceding two calendar years, less any required transfers to surplus or to a fund for the retirement of any preferred stock. FAFSB and Pioneer Bank, f.s.b. must provide the OTS with at least 30 days notice prior to declaring a dividend and are subject to other OTS regulations governing capital distributions. The ability of Peoples Bank to pay dividends is subject to the rules and regulations of the TDFI governing the amount of dividends which may be paid to shareholders, the manner in which dividends are paid, and the methods, if any, by which capital stock and surplus may be retired and reduced. Each of the banking subsidiaries is prohibited from paying a dividend if such payment would cause the subsidiary to fail to maintain capital within regulatory minimums. Similarly, the appropriate federal regulatory authority is authorized to determine, under certain circumstances relating to the financial condition of the bank or bank holding company, that the payment of dividends would be an unsafe or unsound practice and to prohibit payment thereof. Federal Reserve Board policy provides that, as a matter of prudent banking, a bank holding company generally should not maintain a level of cash dividends unless its net income available to common shareholders has been sufficient to fully fund the dividends, and the prospective rate of earnings retention appears to be consistent with the holding company's capital needs, asset quality and overall financial condition. In addition to the foregoing, the ability of First American and its banking subsidiaries to pay dividends may be affected by the various minimum capital requirements and the capital and non-capital standards established under FDICIA, as previously described. The right of First American, its shareholders and its creditors to participate in any distribution of the assets or earnings of its subsidiaries is further subject to the prior claims of creditors of the respective subsidiaries. For more information on "Payment of Dividends," please see Note 16 ("Legal and Regulatory Matters") to First American's Consolidated Financial Statements on pages 99-102 herein. For a discussion on the 13 16 impact of First American's long-term debt on its ability to pay dividends to shareholders, please see Note 10 ("Long-term Debt") to First American's Consolidated Financial Statements on page 89 herein. Furthermore, under the FDIA, insured depository institutions are prohibited from making capital distributions, including the payment of dividends, if, after making such distribution, the institutions would become "undercapitalized" (as such term is used in the statute). Based on the current financial condition of these institutions, First American does not expect that this provision will have any impact on its ability to obtain dividends from its bank subsidiaries. FDIC Insurance. First American's subsidiary depository institutions are subject to FDIC deposit insurance assessments. The FDIC has promulgated risk-based deposit insurance assessment regulations which became effective in 1993. Under these regulations, insured institutions (whether members of BIF or SAIF) are assigned assessment risk classifications based upon capital levels and supervisory evaluations. With the exception of deposits attributable to thrift acquisitions, FANB and Peoples Bank pay their premiums at the BIF rate. Premiums on deposits attributable to thrift acquisitions held by non-thrifts are paid at the SAIF rate based on a percentage of total deposits determined at the time of acquisition. As federal savings banks, FAFSB and Pioneer Bank, f.s.b. pay their premiums at the SAIF rate. Thus, First American's overall deposit insurance premium expenses are affected by changes in both the BIF and the SAIF assessment rates. For a discussion of First American's assessment rates, please see Note 16 ("Legal and Regulatory Matters") to First American's Consolidated Financial Statements on pages 99-102 herein. The Deposit Insurance Funds Act of 1996 ("DIFA") requires BIF members to pay one-fifth of the assessment rate imposed upon thrifts to cover the annual Financing Corporation ("FICO") bond payments from January 1, 1997 until December 31, 1999 or until the insurance funds are merged, whichever occurs first. DIFA provides that the insurance funds may only be merged following the merger of the thrift and banking charters (when the last savings and loan association ceases to exist). Thereafter, banks and thrifts will pay the assessment on a pro rata basis. For more information regarding FDIC assessment rates, please see Note 16 ("Legal and Regulatory Matters") of First American's Consolidated Financial Statements on pages 99-102 herein. Community Reinvestment Act. First American's subsidiary depository institutions are also subject to the requirements of the Community Reinvestment Act of 1976 ("CRA"). The CRA imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of their local communities, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of those institutions. Each financial institution's efforts in meeting community credit needs currently are evaluated as part of the examination process, as well as when an institution applies to undertake a merger, acquisition or to open a branch facility. CRA regulations incorporate an evaluation system that rates institutions based on their performance in meeting community credit needs. Under these regulations, each institution is evaluated based on the degree to which it is providing loans (the lending test), branches and other services (the service test), and investments (the investment test) to low and moderate income areas in the communities it serves, based on the 14 17 communities' demographics, characteristics and needs, the institution's capacity, product offerings and business strategy. Under this evaluation system, institutions receive one of four composite ratings: Outstanding, Satisfactory, Needs to Improve or Substantial Noncompliance. As of December 31, 1998, each of First American's subsidiary depository institutions had a satisfactory rating. Certain Transactions with Affiliates. Provisions of the Federal Reserve Act impose restrictions on the type, quantity and quality of transactions between affiliates of an insured bank (including First American and its non-bank subsidiaries) and the insured bank (or federal savings bank) itself. Under these restrictions, an insured bank (or federal savings bank) and its subsidiaries are, among other things, limited in engaging in "covered transactions" with any one affiliate to no more than 10% of the capital stock and surplus of the insured bank (or federal savings bank); and with all affiliates in the aggregate, to no more than 20% of the capital stock and surplus of the bank (or federal savings bank). "Covered transactions" are defined by statute to include a loan or extension of credit, as well as a purchase of securities issued by an affiliate, a purchase of assets (unless otherwise exempted by the Federal Reserve Board), the acceptance of securities issued by the affiliate as collateral for a loan and the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate. In addition, any transaction with an affiliate, including loans, contractual arrangements and purchases, must be on terms and conditions that are substantially the same or at least as favorable to the bank (or federal savings bank) as those prevailing at the time for comparable transactions with non-affiliated companies. The purpose of these restrictions is to prevent the misuse of resources of the bank by its uninsured affiliates. An exception to the quantitative restrictions is provided for transactions between two insured banks or federal savings banks that are within the same holding company structure where the holding company owns 80% or more of each bank. If a rule proposed by the Federal Reserve Board on July 15, 1997, becomes final, it will affect "covered transactions" between banks, such as FANB and FAFSB, and their operating subsidiaries. The proposed rule, among other things, limits credit transactions between banks and their subsidiaries. Transactions with Insiders. Any loans made by First American's depository institution subsidiaries to their respective executive officers, directors or shareholders who own 10% or more of First American's common stock, as well as entities such persons control, are required to be made on terms substantially the same as those offered to unaffiliated individuals and to involve not more than the normal risk of repayment. These loans are subject to individual and aggregate limits depending on the person involved. Further, provisions of the BHCA prohibit a bank holding company and its subsidiaries from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. Other Safety and Soundness Regulations. The federal banking agencies have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institutions in question are categorized as "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" or "critically undercapitalized," as such terms are defined under uniform regulations issued by each of the federal banking agencies. In addition, FDIC regulations require that management report on its institution's responsibility for (a) preparing financial statements, (b) establishing and maintaining an internal control structure 15 18 and procedures for financial reporting, and (c) compliance with designated laws and regulations concerning safety and soundness. Under these rules, independent auditors must attest to and report separately on assertions in management's report concerning the effectiveness of the internal control structure over financial reporting, using FDIC-approved audit procedures. FDICIA requires each of the federal banking agencies to develop regulations addressing certain safety and soundness standards for insured depository institutions, including operational and managerial standards, asset quality, earnings and stock valuation standards, as well as compensation standards (but not dollar levels of compensation). Each of the federal banking agencies has issued regulations and interagency guidelines implementing these standards. The regulations and guidelines set forth general operational and managerial standards in the areas of internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees, benefits, asset quality and earnings standards. These rules require each federal agency to determine compliance with safety and soundness standards through the examination process and, if necessary to correct weaknesses, require an institution to file a written compliance plan. In September 1995, the OCC implemented the Supervision by Risk program to ensure OCC regulatory examinations address activities that are most likely to have a material impact on a bank's safety and soundness. The OCC identified nine areas of risk to be examined under this program: credit, interest rate, liquidity, price, foreign currency translation, transaction, compliance, strategic and reputation. On February 4, 1998, the OCC released guidelines bringing technology within the Supervision by Risk program. These guidelines emphasized the importance of technology as an integral part of the financial services business, focusing on identification, measurement, monitoring and control of risks associated with the use of technology. On July 22, 1998, the OCC revised its supervision manual applicable to national banks with total assets of $1 billion or more, expanding the application of Supervision by Risk to all aspects of the supervisory process. The revised manual bases its supervisory framework on three key elements, core knowledge, core assessment and optional procedures, and is intended to facilitate consistent risk assessments across geographic lines and products regardless of the diversity or complexity of the financial institution. INTEREST RATE LIMITATIONS The maximum permissible rates of interest on most commercial and consumer loans made by First American's insured depository institution subsidiaries are governed by state usury laws in the states where these subsidiaries operate and by applicable federal statutes and regulations that in each case set limits on interest rates and impose penalties in the event such limits are exceeded. In certain circumstances, these federal statutes and regulations preempt state usury laws that otherwise would apply. The interest rates in Tennessee are governed by Tennessee's general usury law and the Tennessee Industrial Loan and Thrift Companies Act ("Industrial Loan Act"). Tennessee's general usury law authorizes a floating rate of 4% per annum over the average prime or base commercial loan rate, as published by the Federal Reserve Board from time to time, subject to an absolute 24% per annum limit. The Industrial Loan Act, which is also generally applicable to most loans made by 16 19 FANB in Tennessee, authorizes an interest rate of 24% per annum and allows certain loan charges, typically on a more liberal basis than does the general usury law. Under Mississippi law, the legal rate of interest on all notes, accounts and contracts is 8% per annum. However, until July 1, 2001, the parties may agree to pay a higher interest rate. Louisiana's general usury law provides that the amount of conventional interest may not exceed 12% per annum. In Kentucky, the legal rate of interest is 8% or less per annum; however, by written agreement, parties may agree for the payment of interest at any rate under any written contract or other written obligation where the original principal amount is in excess of $15,000. For loans where the original principal amount is $15,000 or less, any rate allowed national banking associations under federal law is permissible. In Arkansas, the maximum legal rate for consumer loans and credit sales is 5% over the federal discount rate. Under Virginia law, usury limits do not generally apply to the type of loans most commonly made by FANB or federal savings banks such as FAFSB. In Georgia, the legal rate of interest is 7% per annum unless the rate is established by written contract. Certain other usury laws affect limited classes of loans, but the laws referenced above are by far the most significant. Under the Interstate Banking and Branching Act, the usury or interest laws of a bank's home state may be applied to that bank's operations in other states under certain circumstances. However, FANB generally applies the interest rate of the state in which the transaction occurs to that transaction. ENVIRONMENTAL REGULATION As real estate lenders and as owners of real property, financial institutions such as First American and its subsidiary insured depository institutions may become subject to liability under various statutes and regulations applicable to property owners, specifically including those which impose liability with respect to the environmental condition of real property. First American's primary exposure under these statutes and regulations stems from the lending activities of its subsidiary commercial banks, which have adopted policies and procedures to identify and monitor their exposure to avoid any material loss or liability related to the environmental condition of mortgaged property. Environmental liability can also result from mergers and acquisitions, and First American has implemented procedures to identify and avoid any material loss or liability related to the acquisition of real property through mergers and acquisitions. YEAR 2000 On May 5, 1997, the Federal Financial Institutions Examination Council ("FFIEC"), which consists of the Federal Reserve Board, the OCC, the FDIC, the OTS, and the National Credit Union Administration, issued a statement (the "May 1997 Interagency Statement") encouraging financial institutions, such as First American and its subsidiaries, to undertake initiatives to address and resolve the Year 2000 issue by December 31, 1998. During 1997 and throughout 1998, the FFIEC expanded on its May 1997 Interagency Statement to provide further guidance to management of financial institutions in addressing the Year 2000 issue (collectively, the "FFIEC Interagency Statements"). For example, on May 13, 1998, the FFIEC released a statement requiring each financial institution to establish a Year 2000 customer awareness program to inform its customers of steps taken to minimize the risk that its customers may be affected by Year 2000-related computer problems. Also on May 17 20 13, 1998, the FFIEC issued guidance on the Year 2000 business resumption contingency planning process that should be undertaken by each financial institution. This process includes four phases: (1) organizational planning guidelines; (2) assessment of the potential impact of mission-critical system failures; (3) a contingency plan establishing a timeline for implementation; and (4) testing. In addition, the FFIEC released a statement in August 1998 regarding the potential risks associated with fiduciary services and the Year 2000 date change. On October 15, 1998, the Interagency Guidelines establishing Year 2000 Standards for Safety and Soundness were issued, establishing minimum standards for safety and soundness. The Guidelines address the review of mission-critical systems for Year 2000 readiness, renovation of internal and external mission-critical systems, testing of mission-critical systems by specific deadlines, business-resumption contingency planning, customer risk and involvement of the board of directors and management. The FDIC provides that by June 30, 1999, testing of mission-critical systems should be complete and implementation of the contingency planning process should be substantially complete. A financial institution's failure to appropriately address Year 2000 readiness issues may result in supervisory action, including formal and informal enforcement actions, denials of applications filed pursuant to the FDIA, civil money penalties, reductions in the institution's composite ratings and increased risk-related premiums. For a discussion of First American's initiative undertaken in response to the FFIEC Interagency Statements, as updated, please see pages 53-55 of Management's Discussion and Analysis of Financial Condition and Results of Operations, included in this Report as Item 7. RIEGLE COMMUNITY DEVELOPMENT AND REGULATORY IMPROVEMENT ACT The Riegle Community Development and Regulatory Improvement Act ("RCDRIA") is an effort to alleviate certain regulatory burdens imposed on the banking industry by amending sections of FDICIA and other statutes pertaining to the regulation of financial institutions and financial institution holding companies. For example, as amended by the RCDRIA, FDICIA empowers each agency to adopt its own standards for safety and soundness relating to quality, earnings and stock valuation as the agency deems appropriate. The RCDRIA also contains various community development initiatives; measures to promote the securitization of small business loans; changes to the National Flood Insurance Program and changes to the Bank Secrecy Act in terms of money laundering; protection against bank insolvency of the security interests of public entities in bank assets pledged to secure the entities' deposits; restrictions on certain high-rate, high-fee mortgages; and disclosure requirements for reverse mortgages. BROKER/DEALER REGULATION The United States securities industry generally is subject to extensive regulation under federal and state laws. The SEC is the federal agency charged with administration of the federal securities laws. Much of the regulation of broker/dealers, however, has been delegated to self-regulatory organizations, principally the NASD and the national securities exchanges. These self-regulatory 18 21 organizations adopt rules (subject to approval by the SEC) which govern the industry and conduct periodic examinations of member broker/dealers. Securities firms are also subject to regulation by state securities commissions in the states in which they are registered. IFC and ICA are registered broker/dealers in securities under the Securities Exchange Act of 1934, as amended, and are members of the NASD. IFC and ICA are also investment advisers pursuant to the Investment Advisers Act of 1940, as amended, and members of the Securities Investor Protection Corporation. IFC is registered as a broker/dealer in 50 states, the District of Columbia and Puerto Rico. As a third-party marketer of investment products, IFC may, in certain instances, be subject to regulation by those agencies having supervisory authority over IFC's financial institution clients, including, for example, the Federal Reserve Board, the OCC, the OTS, the FDIC and various state banking agencies. The regulations to which broker/dealers are subject cover all aspects of the securities business, including sales methods, trade practices among broker/dealers, capital structure of securities firms, uses and safekeeping of customers' funds and securities, recordkeeping, and the conduct of directors, officers and employees. Additional legislation, changes in rules promulgated by the SEC and by self-regulatory organizations, or changes in interpretation or enforcement of existing laws and rules, often directly affect the method of operation and profitability of broker/dealers. The SEC and the self-regulatory organizations may conduct administrative proceedings which can result in censure, fines, suspension or expulsion of a broker/dealer, its directors, officers or employees. The principal purpose of regulation and discipline of broker/dealers is the protection of the customer and the securities market rather than the protection of creditors and stockholders of broker/dealers. COMPETITION The activities in which First American engages are very competitive. Generally, the lines of activity and markets served by First American involve competition with money market mutual funds, national and state banks, mutual savings banks, savings and loan associations, finance companies, brokerage firms, credit unions and other financial institutions located primarily in the southeastern region of the United States. The principal methods of competition center around such aspects as interest rates on loans and deposits, lending limits, customer services, location of offices, provision of financial services and other service delivery systems. Some of First American's competitors are major corporations with substantially more assets and personnel than First American and its subsidiaries. Additionally, First American's competitive environment is subject to future changes in federal and state legislation. First American's subsidiary banks actively compete for loans and deposits with other commercial banks, savings and loan associations, and credit unions. Consumer finance companies, department stores, factors, mortgage brokers and insurance companies are also significant competitors for various types of loans. FANB competes for various types of fiduciary and trust business from other banks, trust and investment companies, investment advisory firms and others. Through IFC, FANB competes with other third-party marketers of investment products and other entities offering securities brokerage services. 19 22 EMPLOYEES As of December 31, 1998, First American and its subsidiaries employed 7,195 full-time equivalent officers and employees, compared with 7,869 at December 31, 1997. 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: 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. 20 23 PART II 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*
DIVIDENDS HIGH LOW DECLARED ---- --- -------- 1997 ---- First Quarter $34.63 $28.00 $.155 Second Quarter 40.00 29.63 .20 Third Quarter 50.13 38.00 .20 Fourth Quarter 55.38 43.75 .20 ===== ===== === 1998 ---- First Quarter $49.69 $43.13 $ .20 Second Quarter 54.88 43.13 .25 Third Quarter 51.00 34.75 .25 Fourth Quarter 44.69 33.44 .25 ===== ===== ===
(* 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: SELECTED FINANCIAL DATA The table "Selected Financial Data: 1994-1998" on page 23 hereof is incorporated in this Item 6 by reference. 21 24 ITEMS 7 AND 7A: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS; QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 22 25 TABLE 1: SELECTED FINANCIAL DATA: 1994-1998
================================================================================================================================== YEAR ENDED DECEMBER 31 - ---------------------------------------------------------------------------------------------------------------------------------- 1998 1997 1996 1995 1994 - ---------------------------------------------------------------------------------------------------------------------------------- CONDENSED INCOME STATEMENTS (in thousands): Net interest income, taxable equivalent basis(1) $ 753,160 $ 712,153 $ 637,283 $ 576,510 $ 513,914 Less taxable equivalent adjustment 19,548 12,993 13,312 11,467 10,996 - ---------------------------------------------------------------------------------------------------------------------------------- Net interest income 733,612 699,160 623,971 565,043 502,918 Provision for loan losses(2) 40,933 16,109 6,437 2,861 (13,212) Noninterest income 477,612 405,633 311,927 209,987 187,996 Noninterest expense 715,113 699,104 597,403 479,479 438,789 Merger and integration charges 121,725 -- -- 7,269 -- - ---------------------------------------------------------------------------------------------------------------------------------- Income before income tax expense 333,453 389,580 332,058 285,421 265,337 Income tax expense 122,091 142,066 117,879 102,639 92,946 - ---------------------------------------------------------------------------------------------------------------------------------- Net income $ 211,362 $ 247,514 $ 214,179 $ 182,782 $ 172,391 ================================================================================================================================== SELECTED PER SHARE DATA: Net income: Basic $ 1.88 $ 2.19 $ 1.93 $ 1.70 $ 1.64 Diluted 1.84 2.15 1.91 1.67 1.62 Cash dividends declared and paid .95 .755 .605 .53 .44 Book value (end of year) 15.30 14.65 13.87 12.86 11.35 Market price (end of year) 44.375 49.75 28.81 23.69 13.44 Market/book (end of year) 2.90 x 3.40 x 2.08 x 1.84 x 1.18 x ================================================================================================================================== AVERAGES (in thousands): Assets $19,308,928 $17,910,943 $16,596,260 $14,877,319 $13,398,717 Loans, net of unearned discount 11,729,519 11,794,989 10,746,138 9,228,568 7,746,575 Earning assets 17,513,530 16,225,962 15,120,673 13,531,551 12,147,118 Deposits 14,255,892 13,751,103 12,835,783 11,603,925 10,756,831 Long-term debt 826,795 451,118 434,086 292,455 109,031 Shareholders' equity 1,676,118 1,590,246 1,470,889 1,286,123 1,152,531 ================================================================================================================================== END OF PERIOD (in thousands): Assets $20,731,770 $18,791,326 $17,673,250 $16,527,158 $14,112,231 Loans, net of unearned discount 11,739,688 12,291,490 11,155,918 10,421,140 8,363,052 Earning assets 18,658,658 16,893,930 15,857,117 14,970,874 12,714,565 Deposits 15,270,756 14,153,878 13,540,935 12,842,282 10,929,688 Long-term debt 1,152,939 614,218 440,562 421,791 271,473 Shareholders' equity 1,779,795 1,643,893 1,543,896 1,422,210 1,189,127 ================================================================================================================================== SIGNIFICANT RATIOS: Return on average assets 1.09% 1.38% 1.29% 1.23% 1.29% Return on average equity 12.61 15.56 14.56 14.21 14.96 Dividends declared per share to basic net income per share (dividend payout ratio) 50.53 34.47 31.35 31.18 26.83 Productivity - banking segment(3) 53.44 57.93 58.98 60.87 62.41 Average equity to average assets 8.68 8.88 8.86 8.64 8.60 Average loans to average deposits 82.28 85.77 83.72 79.53 72.02 Average core deposits to average total deposits 88.08 90.10 90.68 90.56 92.71 Allowance to net loans (end of year) 1.68 1.53 1.71 1.89 2.28 Nonperforming assets to loans and foreclosed properties (end of year)(4) .47 .37 .43 .57 .66 Net interest margin 4.30 4.39 4.21 4.26 4.23 ================================================================================================================================== OTHER STATISTICS: Average common shares outstanding (in thousands): Basic 112,517 112,907 110,727 107,781 104,882 Diluted 114,682 115,249 112,286 109,488 106,379 End of period common shares (in thousands) 116,319 112,187 111,289 110,601 104,782 Number of full-time equivalent employees (end of year) 7,195 7,869 7,713 6,985 6,422 Number of banking offices (end of year) 391 371 349 329 301 Number of automatic teller machines (end of year) 699 671 466 375 313 ==================================================================================================================================
(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. 23 26 - -------------------------------------------------------------------------------- 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 24 27 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 25 28 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
================================================================================================================================= 1998 VS. 1997 1997 vs. 1996 ----------------- ------------------ (dollars in thousands) 1998 1997 1996 $ CHANGE % $ Change % - --------------------------------------------------------------------------------------------------------------------------------- Net interest income $ 729,584 $ 694,719 $ 619,445 $ 34,865 5% $ 75,274 12% Provision for loan losses (31,387) (16,109) (6,437) 15,278 95 9,672 150 Noninterest income, external customers 262,442 227,804 204,347 34,638 15 23,457 11 Noninterest expense (540,569) (541,921) (493,690) (1,352) -- 48,231 10 Net pretax contribution 420,070 364,493 323,665 55,577 15 40,828 13 Income tax expense (147,744) (131,823) (114,394) 15,921 12 17,429 15 Net income 272,326 232,670 209,271 39,656 17 23,399 11 Average total assets 19,233,992 17,814,152 16,464,518 1,419,840 8 1,349,634 8 Average shareholders' equity 1,622,849 1,517,712 1,420,618 105,137 7 97,094 7 Return on average assets 1.42% 1.31% 1.27% Return on average equity 16.78 15.33 14.73 Productivity 53.44 57.93 58.98 ================================================================================================================================
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 26 29 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
============================================================================================================================ 1998 VS. 1997 1997 vs. 1996 ----------------- ------------------ (dollars in thousands) 1998 1997 1996 $ CHANGE % $ Change % - ---------------------------------------------------------------------------------------------------------------------------- Net interest income $ 4,028 $ 4,441 $ 4,526 $ (413) (9)% $ (85) (2)% Noninterest income, external customers 208,145 177,829 107,580 30,316 17 70,249 65 Noninterest expense (174,544) (157,183) (95,613) 17,361 11 61,570 64 Net pretax contribution 37,629 25,087 16,493 12,542 50 8,594 52 Income tax expense (15,148) (10,243) (6,636) 4,905 48 3,607 54 Net income 22,481 14,844 9,857 7,637 51 4,987 51 Average total assets 115,633 134,000 144,311 (18,367) (14) (10,311) (7) Average shareholders' equity 53,269 72,534 50,271 (19,265) (27) 22,263 44 Return on average assets 19.44% 11.08% 6.83% Return on average equity 42.20 20.46 19.61 Productivity 82.26 86.24 85.29 =============================================================================================================================
27 30 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. 28 31 TABLE 4: CONSOLIDATED AVERAGE BALANCE SHEETS AND TAXABLE EQUIVALENT INCOME/EXPENSE AND YIELDS/RATES
==================================================================================================================================== 1998 1997 1996 ------------------------------ ----------------------------- ------------------------- AVERAGE Average Average AVERAGE INCOME/ YIELD/ Average Income/ Yield/ Average Income/ Yield/ (dollars in millions) BALANCE EXPENSE RATE Balance Expense Rate Balance Expense Rate - ------------------------------------------------------------------------------------------------------------------------------------ Interest-earning assets:(1) Taxable securities: Held to maturity $ 1,198.3 $ 77.9 6.50% $ 889.1 $ 60.1 6.76% $ 1,052.3 $ 70.7 6.72 Available for sale 4,043.8 274.3 6.78 3,060.6 208.9 6.82 2,619.6 171.6 6.55 Tax-exempt securities Held to maturity 41.9 3.3 7.81 36.4 2.7 7.47 32.2 2.4 7.45 Available for sale 292.6 22.0 7.52 241.9 20.9 8.64 267.8 22.4 8.36 - ------------------------------------------------------------------------------------------------------------------------------------ Total securities 5,576.6 377.5 6.77 4,228.0 292.6 6.92 3,971.9 267.1 6.72 - ------------------------------------------------------------------------------------------------------------------------------------ Federal funds sold and repurchase 127.4 6.6 5.14 117.9 6.6 5.57 333.4 18.0 5.40 agreements Loans, net of unearned discount Commercial 4,807.2 402.1 8.37 4,492.6 369.7 8.23 4,015.8 335.1 8.34 Consumer-amortizing mortgages 2,371.1 194.4 8.20 2,906.0 237.1 8.16 2,784.4 220.3 7.91 Consumer-other 2,654.2 238.2 8.98 2,501.3 232.7 9.30 2,247.2 204.2 9.09 Real estate-construction 503.6 41.9 8.32 439.9 36.6 8.31 381.6 31.4 8.23 Real estate-commercial mortgages and other 1,393.4 121.5 8.72 1,455.2 131.7 9.05 1,317.1 123.2 9.35 - ------------------------------------------------------------------------------------------------------------------------------------ Loans, net of unearned discount 11,729.5 998.1 8.51 11,795.0 1,007.8 8.54 10,746.1 914.2 8.51 - ---------------------------------------------------------------------------------------------------------------------------------- Other 80.0 5.0 6.33 85.1 5.4 6.30 69.3 4.3 6.20 - ------------------------------------------------------------------------------------------------------------------------------------ Total earning assets(1) 17,513.5 $1,387.2 7.92% 16,226.0 $1,312.4 8.09% 15,120.7 $1,203.6 7.96% - ------------------------------------------------------------------------------------------------------------------------------------ Allowance for loan losses (191.9) (194.5) (197.1) Cash and due from banks 937.6 888.2 796.1 Other assets 1,049.7 991.2 876.6 - ------------------------------------------------------------------------------------------------------------------------------------ Total assets $19,308.9 $17,910.9 $16,596.3 ==================================================================================================================================== Deposits and borrowed funds: Demand deposits $ 2,750.4 $ 2,577.9 $ 2,338.1 Interest-bearing deposits: NOW accounts 2,288.2 $ 45.8 2.00% 1,968.0 $ 44.3 2.25% 1,771.7 $ 37.6 2.12% Money market accounts 2,779.3 110.8 3.99 2,869.5 121.9 4.25 2,670.5 123.0 4.61 Regular savings 955.3 23.0 2.40 989.1 25.2 2.55 998.6 25.3 2.53 Certificates of deposit under $100,000 3,017.2 157.9 5.23 3,220.0 170.3 5.29 3,102.7 162.8 5.25 Certificates of deposit $100,000 and over 1,542.4 84.8 5.50 1,256.3 68.5 5.45 1,090.4 60.1 5.51 Other time 766.8 41.3 5.39 765.1 42.8 5.59 758.0 43.3 5.71 Foreign 156.3 7.6 4.85 105.2 5.4 5.17 105.8 5.7 5.39 - ------------------------------------------------------------------------------------------------------------------------------------ Total interest-bearing deposits 11,505.5 471.2 4.10 11,173.2 478.4 4.28 10,497.7 457.8 4.36 - ------------------------------------------------------------------------------------------------------------------------------------ Total deposits 14,255.9 13,751.1 12,835.8 - ------------------------------------------------------------------------------------------------------------------------------------ Federal funds purchased and repurchase agreements 2,007.5 98.6 4.91 1,529.7 75.3 4.92 1,441.6 69.9 4.85 Other short-term borrowings 270.1 15.7 5.81 326.6 18.3 5.61 166.9 9.0 5.39 Long-term debt 826.8 48.6 5.87 451.1 28.2 6.26 434.1 29.6 6.82 - ------------------------------------------------------------------------------------------------------------------------------------ Total interest-bearing deposits and borrowed funds 14,609.9 $ 634.1 4.34% 13,480.6 $ 600.2 4.45% 12,540.3 $ 566.3 4.52% - ------------------------------------------------------------------------------------------------------------------------------------ Total deposits and borrowed funds 17,360.3 16,058.5 14,878.4 - ------------------------------------------------------------------------------------------------------------------------------------ Other liabilities 272.5 262.2 247.0 Shareholders' equity 1,676.1 1,590.2 1,470.9 - ------------------------------------------------------------------------------------------------------------------------------------ Total liabilities and shareholders' equity $19,308.9 $17,910.9 $16,596.3 ==================================================================================================================================== Net interest income(1) $ 753.1 $ 712.2 $ 637.3 Provision for loan losses 40.9 16.1 6.4 Noninterest income 477.6 405.6 311.9 Noninterest expense 836.8 699.1 597.4 - ------------------------------------------------------------------------------------------------------------------------------------ Income before income tax expense 353.0 402.6 345.4 Income tax expense 141.6 155.1 131.2 - ------------------------------------------------------------------------------------------------------------------------------------ Net income $ 211.4 $ 247.5 $ 214.2 ==================================================================================================================================== Net interest spread 3.58% 3.64% 3.44% Benefit of interest-free funding .72 .75 .77 - ------------------------------------------------------------------------------------------------------------------------------------ Net interest margin 4.30% 4.39% 4.21% ====================================================================================================================================
(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 29 32
==================================================================================================================== 1995 1994 AVERAGE BALANCE INCOME/EXPENSE - ------------------------------ ---------------------------- ------------------------ ----------------------- Average Average COMPOUND COMPOUND Average Income/ Yield/ Average Income/ Yield/ % CHANGE GROWTH RATE % CHANGE GROWTH RATE Balance Expense Rate Balance Expense Rate 1998/1997 1998/1993 1998/1997 1998/1993 - -------------------------------------------------------------------------------------------------------------------- $ 2,837.7 $ 191.0 6.73% $ 2,061.6 $ 127.2 6.17% 34.78% (5.90)% 29.62% (6.29)% 954.3 61.4 6.43 1,598.1 89.7 5.61 32.12 10.82 31.31 13.01 129.2 13.2 10.22 210.1 19.1 9.09 15.11 (25.74) 22.22 (28.69) 101.8 7.3 7.17 3.4 .2 5.56 20.96 161.34 5.26 136.08 - -------------------------------------------------------------------------------------------------------------------- 4,023.0 272.9 6.78 3,873.2 236.2 6.10 31.90 5.68 29.02 6.56 - -------------------------------------------------------------------------------------------------------------------- 211.8 12.5 5.90 364.2 14.8 4.06 8.06 (22.59) -- (14.45) 3,517.7 297.4 8.45 2,929.1 216.4 7.39 7.00 13.89 8.76 18.50 2,327.6 187.2 8.04 1,894.5 147.8 7.80 (18.41) 7.83 (18.01) 7.82 1,920.7 172.3 8.97 1,694.3 141.5 8.35 6.11 11.64 2.36 12.53 292.4 26.2 8.96 210.9 16.2 7.68 14.48 21.60 14.48 23.64 1,170.2 107.9 9.22 1,017.8 83.7 8.22 (4.25) 8.80 (7.74) 10.52 - -------------------------------------------------------------------------------------------------------------------- 9,228.6 791.0 8.57 7,746.6 605.6 7.82 (.56) 11.62 (.96) 13.68 - -------------------------------------------------------------------------------------------------------------------- 68.2 3.9 5.72 163.1 6.8 4.17 (5.99) (6.62) (7.41) 5.64 - -------------------------------------------------------------------------------------------------------------------- 13,531.6 $1,080.3 7.98% 12,147.1 $ 863.4 7.11% 7.93 8.64 5.70% 11.12% - -------------------------------------------------------------------------------------------------------------------- (194.3) (206.6) (1.34) (5.27) 823.5 829.2 5.56 2.12 716.5 629.1 5.90 11.31 - -------------------------------------------------------------------------------------------------------------------- $14,877.3 $13,398.8 7.81% 8.61% ==================================================================================================================== $ 2,193.8 $ 2,160.3 6.69% 6.22% 1,693.8 $ 37.9 2.24% 1,685.1 $ 33.9 2.01% 16.27 8.40 3.39% 7.30% 2,219.7 96.9 4.37 1,894.9 68.6 3.62 (3.14) 8.87 (9.11) 14.14 1,047.6 28.3 2.70 1,145.5 27.8 2.43 (3.42) (2.63) (8.73) (3.58) 2,667.7 141.3 5.30 2,415.3 99.7 4.13 (6.30) 4.45 (7.28) 8.98 1,004.2 54.5 5.43 743.7 30.4 4.09 22.77 15.25 23.80 23.77 685.7 39.4 5.75 671.0 34.6 5.16 .22 1.90 (3.50) 1.00 91.4 5.3 5.80 41.0 1.7 4.15 48.57 43.37 40.74 61.12 - -------------------------------------------------------------------------------------------------------------------- 9,410.1 403.6 4.29 8,596.5 296.7 3.45 2.97 6.63 (1.51) 10.28 - -------------------------------------------------------------------------------------------------------------------- 11,603.9 10,756.8 3.67 6.55 - -------------------------------------------------------------------------------------------------------------------- 1,367.6 73.2 5.35 1,121.9 41.6 3.71 31.23 12.33 30.94 26.70 115.8 7.0 6.04 87.7 4.1 4.68 (17.30) 37.73 (14.21) 55.99 292.5 20.0 6.81 109.0 7.1 6.51 83.29 68.93 72.34 62.42 - -------------------------------------------------------------------------------------------------------------------- 11,186.0 $ 503.8 4.50% 9,915.1 $ 349.5 3.52% 8.38 8.80 5.65% 14.30% - -------------------------------------------------------------------------------------------------------------------- 13,379.8 12,075.4 8.11 8.36 - -------------------------------------------------------------------------------------------------------------------- 211.4 170.9 3.93 10.37 1,286.1 1,152.5 5.40 11.00 - -------------------------------------------------------------------------------------------------------------------- $14,877.3 $13,398.8 7.81% 8.61% ==================================================================================================================== $ 576.5 $ 513.9 5.74% 8.82% 2.9 (13.2) 154.04 N/A 210.0 188.0 17.75 22.53 486.7 438.8 19.70 13.79 - -------------------------------------------------------------------------------------------------------------------- 296.9 276.3 (12.32) 4.42 114.1 103.9 (8.70) 6.66 - -------------------------------------------------------------------------------------------------------------------- $ 182.8 $ 172.4 (14.59)% 2.93% ==================================================================================================================== 3.48% 3.59% .78 .64 - -------------------------------------------------------------------------------------------------------------------- 4.26% 4.23% ====================================================================================================================
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. 30 33 - --------------------------- 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
================================================================================================================== 1998 FROM 1997 1997 from 1996 ----------------------------- ------------------------------- TOTAL INCREASE (DECREASE)(1) Total Increase (Decrease)(1) INCREASE DUE TO Increase Due to --------------------- ---------------------- (in millions) (DECREASE) VOLUME RATE (Decrease) Volume Rate - ----------------------------------------------------------------------------------------------------------------------- CHANGE IN INTEREST INCOME: Securities: Taxable Held to maturity $ 17.8 $ 20.9 $ (3.1) $ (10.6) $ (11.0) $ .4 Available for sale 65.4 67.1 (1.7) 37.3 28.9 8.4 Tax-exempt Held to maturity .6 .4 .2 .3 .3 -- Available for sale 1.1 4.4 (3.3) (1.5) (2.2) .7 ------- -------- Total securities 84.9 93.3 (8.4) 25.5 17.2 8.3 ------- -------- Loans (9.7) (5.6) (4.1) 93.6 89.2 4.4 Federal funds sold and securities purchased under agreements to resell -- .5 (.5) (11.4) (11.6) .2 Other (.4) (.3) (.1) 1.1 1.0 .1 ------- -------- Total change in interest income 74.8 104.1 (29.3) 108.8 88.0 20.8 ------- -------- CHANGE IN INTEREST EXPENSE: NOW, money market, and savings accounts (11.8) 6.4 (18.2) 5.5 13.2 (7.7) Certificates of deposit 3.9 4.4 (.5) 15.9 15.1 .8 Other interest-bearing deposits .7 2.9 (2.2) (.8) .4 (1.2) Short-term borrowings 20.7 21.2 (.5) 14.7 12.2 2.5 Long-term debt 20.4 23.5 (3.1) (1.4) 1.2 (2.6) ------- -------- Total change in interest expense 33.9 50.3 (16.4) 33.9 42.5 (8.6) ------- -------- CHANGE IN NET INTEREST INCOME $ 40.9 53.8 (12.9) $ 74.9 45.5 29.4 ==================================================================================================================
(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. 31 34 TABLE 6: MIX OF AVERAGE EARNING ASSETS
================================================================================ 1998 1997 1996 - -------------------------------------------------------------------------------- Investment securities 32% 26% 26% Loans 67 73 71 Other short-term investments 1 1 3 - -------------------------------------------------------------------------------- Total average earning assets 100% 100% 100% ================================================================================
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. 32 35 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
======================================================================================================================== 1998 VS. 1997 1997 vs. 1996 ----------------------------- ---------------- ----------------- (dollars in thousands) 1998 1997 1996 $ CHANGE % $ Change % - ------------------------------------------------------------------------------------------------------------------------ Noninterest income: Investment services income $151,027 $124,003 $ 68,820 $27,024 22% $55,183 80% Service charges on deposit accounts 131,926 118,113 97,189 13,813 12 20,924 22 Commissions and fees on fiduciary activities 42,979 40,412 35,875 2,567 6 4,537 13 Mortgage banking 48,265 36,787 29,488 11,478 31 7,299 25 Merchant discount fees 4,027 3,766 4,602 261 7 (836) (18) Net realized gain on sale of securities 7,999 4,528 2,882 3,471 77 1,646 57 Trading account revenue 7,250 4,414 6,939 2,836 64 (2,525) 36 Other: Open-end credit fees 12,228 9,716 7,950 2,512 26 1,766 22 Other service fees 12,243 10,600 6,576 1,643 16 4,024 61 Collection, exchange and related bank fees 11,117 10,767 9,148 350 3 1,619 18 Insurance and acceptance commissions 5,707 6,265 6,614 (558) (9) (349) (5) Fees and service charges on letters of credit 5,183 5,734 4,834 (551) (10) 900 19 Gain on sale of corporate trust business 7,025 2,387 -- 4,638 194 2,387 100 Gain on sale of HONORS Technologies, Inc. stock -- 1,960 -- (1,960) (100) 1,960 100 Gain on sale of branches 2,681 -- -- 2,681 100 -- -- Gain on sale of subsidiaries 73 2,105 -- (2,032) (97) 2,105 100 Loss on sale of First Mortgage Corp.'s assets (2,385) -- -- (2,385) (100) -- -- Miscellaneous 30,267 24,076 31,010 6,191 26 (6,934) (22) - ------------------------------------------------------------------------------------------------------------------------ Total other income 84,139 73,610 66,132 10,529 14 7,478 11 - ------------------------------------------------------------------------------------------------------------------------ Total noninterest income $477,612 $405,633 $311,927 $71,979 18% $93,706 30% ========================================================================================================================
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 33 36 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. 34 37 TABLE 8: NONINTEREST EXPENSE
================================================================================================================== 1998 VS. 1997 1997 vs. 1996 ---------------------------- ----------------- --------------- (dollars in thousands) 1998 1997 1996 $ CHANGE % $ Change % - ------------------------------------------------------------------------------------------------------------------ Noninterest expense: Salaries and employee benefits $342,927 $346,024 $310,985 $ (3,097) (1)% $ 35,039 11% Subscribers' commissions 89,918 70,785 35,075 19,133 27 35,710 102 Net occupancy 52,769 50,276 44,135 2,493 5 6,141 14 Equipment 48,896 45,563 38,333 3,333 7 7,230 19 Systems and processing 15,461 15,662 14,755 (201) (1) 907 6 Communication 30,450 27,194 21,804 3,256 12 5,390 25 Marketing 20,742 22,129 21,334 (1,387) (6) 795 4 Supplies 12,411 15,523 13,073 (3,112) (20) 2,450 19 Goodwill amortization 17,410 16,815 12,429 595 4 4,386 35 FDIC insurance 2,188 1,798 10,488 390 22 (8,690) (83) Other: Software 12,419 11,120 9,169 1,299 12 1,951 21 Loan/credit 10,682 10,499 10,173 183 2 326 3 Amortization of mortgage servicing rights 9,569 7,079 3,753 2,490 35 3,326 89 Noninterest deposit 9,446 8,620 8,260 826 10 360 4 Other real estate income (6,175) (3,598) (5,015) (2,577) (72) 1,417 28 Miscellaneous 46,000 53,615 48,652 (7,615) (14) 4,963 10 - ------------------------------------------------------------------------------------------------------------------ Total other expense 81,941 87,335 74,992 (5,394) (6) 12,343 16 - ------------------------------------------------------------------------------------------------------------------ Subtotal noninterest expense 715,113 699,104 597,403 16,009 2 101,701 17 Merger and integration costs 121,725 -- -- 121,725 100 -- -- - ------------------------------------------------------------------------------------------------------------------ Total noninterest expense $836,838 $699,104 $597,403 $137,734 20% $101,701 17% ==================================================================================================================
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, 35 38 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. 36 39 - ------------------------ 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
========================================================================================================================== 1998 1997 1996 1998 VS. 1997 1997 vs. 1996 --------------- -------------- -------------- ------------- --------------- (dollars in millions) AMOUNT % Amount % Amount % AMOUNT % Amount % - -------------------------------------------------------------------------------------------------------------------------- Commercial $ 4,807.2 41% $ 4,492.6 38% $ 4,015.8 37% $ 314.6 7% $ 476.8 12% Consumer - amortizing mortgages 2,371.1 20 2,906.0 25 2,784.4 26 (534.9) (18) 121.6 4 Consumer - other 2,654.2 23 2,501.3 21 2,247.2 21 152.9 6 254.1 11 Real estate - construction 503.6 4 439.9 4 381.6 4 63.7 14 58.3 15 Real estate - commercial mortgages and other 1,393.4 12 1,455.2 12 1,317.1 12 (61.8) (4) 138.1 10 - -------------------------------------------------------------------------------------------------------------------------- Total $11,729.5 100% $11,795.0 100% $10,746.1 100% $ (65.5) (1)% $1,048.9 10% ==========================================================================================================================
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. 37 40 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. 38 41 TABLE 10: SECURITY PORTFOLIO ANALYSIS
==================================================================================================================================== ESTIMATED MATURITY AT DECEMBER 31, 1998 ----------------------------------------------------------------------------------------------------- TOTAL FAIR AVERAGE WITHIN 1 YEAR 1-5 YEARS 5-10 YEARS AFTER 10 YEARS AMORTIZED COST VALUE MATURITY ----------------------------------------------------------------------------------------------------- (dollars in millions) AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YEARS - ------------------------------------------------------------------------------------------------------------------------------------ SECURITIES HELD TO MATURITY:(1) U.S. Treasury $ 5.9 5.30% $ 4.6 6.04% $ .9 5.81% $ -- -- % $ 11.4 5.64% $ 11.4 1.5 U.S. Gov. agencies and corporations: Mortgage-backed 65.3 6.58 443.9 6.30 65.9 6.13 1.2 6.45 576.3 6.31 579.6 3.5 Other 44.7 5.35 -- -- -- -- .7 6.88 45.4 5.38 45.6 .3 Obligations of states and political subdivisions(2) 2.2 7.17 50.7 5.40 12.5 7.86 25.7 7.77 91.1 6.45 95.5 7.6 Other debt securities: Mortgage-backed 4.6 5.02 363.2 6.98 577.3 6.75 -- -- 945.1 6.83 944.3 5.0 Other .2 10.37 .3 7.17 60.7 5.01 -- -- 61.2 5.04 63.5 5.4 - ---------------------------------------------------------------------------------------------------------------------------------- Total debt securities held to maturity $122.9 6.03% $ 862.7 6.53% $ 717.3 6.56% $ 27.6 7.69% $1,730.5(3) 6.53% $1,739.9 4.5 ================================================================================================================================== SECURITIES AVAILABLE FOR SALE:(1) U.S. Treasury $ 17.5 6.22% $ 45.9 4.55% $ -- -- % $ -- -- % $ 63.4 5.01% $ 63.1 2.6 U.S. Gov. agencies and corporations: Mortgage-backed 254.3 6.63 2,425.1 6.60 210.2 6.99 23.2 6.16 2,912.8 6.63 2,904.8 3.2 Other 38.5 5.87 59.8 6.02 114.8 6.31 76.2 7.21 289.3 6.43 287.9 9.4 Obligations of states and political subdivisions(2) 12.0 8.27 35.9 7.46 68.4 8.04 258.8 6.98 375.1 7.26 379.3 11.9 Other debt securities: Mortgage-backed 270.0 6.36 307.6 6.53 56.4 6.41 99.0 6.64 733.0 6.47 728.6 4.5 Other .5 6.68 5.8 6.14 -- -- 12.8 5.32 19.1 5.60 18.7 13.6 - ---------------------------------------------------------------------------------------------------------------------------------- Total debt securities available for sale $592.8 6.48% $2,880.1 6.55% $ 449.8 6.90% $470.0 6.86% 4,392.7 6.61% 4,382.4 4.6 ================================================================================================ ======= ==== Total equity securities 113.0 112.8 -------- --------- Total securities available for sale $4,505.7 $4,495.2(3) ======== ======== TOTAL SECURITIES: Total debt securities $715.7 6.56% $3,742.8 6.55% $1,167.1 6.69% $497.6 6.91% $6,123.2 6.59% $6,122.3 4.6 ================================================================================================ ====== ==== Total equity securities 113.0 112.8 -------- -------- Total securities $6,236.2 $6,235.1 =================================================================================================================================
(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. 39 42 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
================================================================================================================================== 1998 1997 1996 1998 VS. 1997 1997 vs. 1996 --------------- ---------------- ---------------- ---------------- ---------------- (dollars in millions) AMOUNT % Amount % Amount % $ CHANGE % $ Change % - ---------------------------------------------------------------------------------------------------------------------------------- Demand deposits (noninterest bearing) $ 2,750.4 16% $ 2,577.9 16% $ 2,338.1 16% $ 172.5 7% $ 239.8 10% NOW accounts 2,288.2 13 1,968.0 12 1,771.7 12 320.2 16 196.3 11 Money market accounts 2,779.3 16 2,869.5 18 2,670.5 18 (90.2) (3) 199.0 7 Regular savings 955.3 6 989.1 6 998.6 7 (33.8) (3) (9.5) (1) Certificates of deposit under $100,000 3,017.2 17 3,220.0 20 3,102.7 20 (202.8) (6) 117.3 4 Other time deposits 766.8 4 765.1 5 758.0 5 1.7 -- 7.1 1 - ---------------------------------------------------------------------------------------------------------------------------------- Total core deposits 12,557.2 72 12,389.6 77 11,639.6 78 167.6 1 750.0 6 - ---------------------------------------------------------------------------------------------------------------------------------- Certificates of deposit $100,000 and over 1,542.4 9 1,256.3 8 1,090.4 7 286.1 23 165.9 15 Foreign 156.3 1 105.2 1 105.8 1 51.1 49 (.6) (1) - ---------------------------------------------------------------------------------------------------------------------------------- Total deposits 14,255.9 82 13,751.1 86 12,835.8 86 504.8 4 915.3 7 - ---------------------------------------------------------------------------------------------------------------------------------- Short-term borrowings: Federal funds purchased and repurchase agreements 2,007.5 12 1,529.7 9 1,441.6 10 477.8 31 88.1 6 FHLB advances 179.9 1 206.7 1 68.1 -- (26.8) (13) 138.6 204 Other 90.2 -- 119.9 1 98.8 1 (29.7) (25) 21.1 21 - ---------------------------------------------------------------------------------------------------------------------------------- Total short-term borrowings 2,277.6 13 1,856.3 11 1,608.5 11 421.3 23 247.8 15 - ---------------------------------------------------------------------------------------------------------------------------------- Long-term debt: Subordinated and senior notes 200.8 1 199.8 1 167.2 1 1.0 1 32.6 19 FHLB advances 625.3 4 250.0 2 264.7 2 375.3 150 (14.7) (6) Other .7 -- 1.3 -- 2.2 -- (.6) (46) (.9) (41) - ---------------------------------------------------------------------------------------------------------------------------------- Total long-term debt 826.8 5 451.1 3 434.1 3 375.7 83 17.0 4 - ---------------------------------------------------------------------------------------------------------------------------------- Total $17,360.3 100% $16,058.5 100% $14,878.4 100% $1,301.8 8% $1,180.1 8% ================================================================================================================================== Core deposits as a percent of earning assets 71.70% 76.36% 76.98% =================================================================================================================================
40 43 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
================================================================================== 1998 1997 1996 - ---------------------------------------------------------------------------------- Demand deposits (noninterest-bearing) 22% 21% 20% NOW accounts 18 16 15 Money market accounts 22 23 23 Regular savings 8 8 9 Certificates of deposit under $100,000 24 26 27 Other time deposits 6 6 6 - ---------------------------------------------------------------------------------- Total average core deposits 100% 100% 100% ==================================================================================
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. 41 44 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
================================================================================== MATURITIES AT DECEMBER 31 ------------------------------ (IN THOUSANDS) 1998 1997 - ---------------------------------------------------------------------------------- 3 months or less $ 991,335 $ 737,285 Over 3 through 6 months 405,005 335,705 Over 6 through 12 months 332,463 256,635 Over 12 months 112,781 126,622 - ---------------------------------------------------------------------------------- Total $1,841,584 $1,456,247 ==================================================================================
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
================================================================================= YEAR ENDED DECEMBER 31 ---------------------------------- 1998 1997 1996 - --------------------------------------------------------------------------------- Average equity to average assets 8.68% 8.88% 8.86% Dividend payout ratio (1) 50.53 34.47 31.35 Dividends per common share $ .95 $ .755 $ .605 =================================================================================
(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 42 45 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. 43 46 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
===================================================================================================================== YEAR ENDED DECEMBER 31 ------------------------------------------------------------ (in thousands) 1998 1997 1996 1995 1994 - --------------------------------------------------------------------------------------------------------------------- Balance, January 1 $ 45,840 $ 47,554 $ 59,279 $ 55,545 $ 89,169 Transfers in and new foreclosed properties 57,823 49,986 25,905 35,741 26,441 Change in nonperforming assets due to subsidiaries purchased 2,305 1,279 2,348 6,393 2,045 Payments received (23,812) (20,018) (23,803) (29,495) (21,821) Proceeds from sales of foreclosed properties (14,579) (13,184) (10,874) (11,917) (26,467) Net gains on sales 6,252 5,194 5,113 5,963 7,561 Charge-offs and writedowns (14,399) (13,655) (8,433) (2,202) (11,835) Return to earning status (3,819) (11,316) (1,981) (749) (8,400) Other (613) -- -- -- (969) Adjustment for change in fiscal year for pooled company -- -- -- -- (179) - --------------------------------------------------------------------------------------------------------------------- Balance, December 31 $ 54,998 $ 45,840 $ 47,554 $ 59,279 $ 55,545 ===================================================================================================================== DECEMBER 31 ---------------------------------------------------------- (dollars in thousands) 1998 1997 1996 1995 1994 - --------------------------------------------------------------------------------------------------------------------- Nonaccrual loans $ 47,913 $ 38,130 $ 34,461 $ 42,275 $ 38,151 Restructured loans -- -- 694 -- -- - --------------------------------------------------------------------------------------------------------------------- Total nonperforming loans 47,913 38,130 35,155 42,275 38,151 Foreclosed properties 7,085 7,710 12,399 17,004 17,394 - --------------------------------------------------------------------------------------------------------------------- Total nonperforming assets $ 54,998 $ 45,840 $ 47,554 $ 59,279 $ 55,545 ===================================================================================================================== Nonperforming assets to total loans plus other real estate owned .47% .37% .43% .57% .66% ===================================================================================================================== 90 days or more past due on accrual $ 38,696 $ 28,995 $ 22,561 $ 11,273 $ 8,559 =====================================================================================================================
44 47 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 45 48 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 46 49 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
================================================================================================================== YEAR ENDED DECEMBER 31 ------------------------------------------------------------- (dollars in thousands) 1998 1997 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------ Allowance for loan losses, January 1 $187,880 $191,228 $197,006 $190,664 $203,915 Loans charged off: Commercial 21,113 19,852 11,110 4,794 13,656 Consumer--amortizing mortgages 2,939 2,432 2,604 1,690 1,993 Consumer--other 35,925 32,758 32,899 24,005 16,264 Real estate--construction 280 625 119 732 132 Real estate--commercial mortgages and other 4,716 725 1,616 380 1,684 - ------------------------------------------------------------------------------------------------------------------ Total charge-offs 64,973 56,392 48,348 31,601 33,729 - ------------------------------------------------------------------------------------------------------------------ Recoveries of loans previously charged off: Commercial 7,433 6,793 13,315 7,767 13,837 Consumer--amortizing mortgages 920 1,421 1,907 1,639 1,918 Consumer--other 15,022 16,826 14,622 12,703 12,935 Real estate--construction 30 133 76 652 764 Real estate--commercial mortgages and other 4,272 3,762 2,025 1,096 2,278 - ------------------------------------------------------------------------------------------------------------------ Total recoveries 27,677 28,935 31,945 23,857 31,732 - ------------------------------------------------------------------------------------------------------------------ Net charge-offs 37,296 27,457 16,403 7,744 1,997 - ------------------------------------------------------------------------------------------------------------------ Net change in allowance due to subsidiaries purchased/sold 6,164 8,000 4,188 11,225 1,547 Provision charged (credited) to operating expenses 40,933 16,109 6,437 2,861 (13,212) Adjustment for change in fiscal year of pooled company -- -- -- -- 411 - ------------------------------------------------------------------------------------------------------------------ Balance, December 31 $197,681 $187,880 $191,228 $197,006 $190,664 ================================================================================================================== Allocation of allowance for loan losses, end of year: Commercial $ 81,770 $ 61,824 $ 59,867 $ 56,729 $ 53,684 Consumer loans 40,291 43,997 44,604 38,982 38,289 Real estate 15,334 18,427 17,188 19,073 21,114 Unallocated/general 60,286 63,632 69,569 82,222 77,577 - ------------------------------------------------------------------------------------------------------------------ Balance, December 31 $197,681 $187,880 $191,228 $197,006 $190,664 ================================================================================================================== Net charge-offs as a percent of average loans, net .32% .23% .15% .08% .03% Allowance to net loans (end of year) 1.68 1.53 1.71 1.89 2.28 ================================================================================================================== Percent of total year-end loans: Commercial 47.3% 38.5% 37.8% 37.5% 39.1% Consumer--amortizing mortgages 17.0 24.0 25.6 26.0 24.0 Consumer--other 22.9 21.4 20.8 20.8 21.4 Real estate--construction 3.8 3.7 3.6 3.2 2.9 Real estate--commercial mortgages and other 9.0 12.4 12.2 12.5 12.6 - ------------------------------------------------------------------------------------------------------------------ Total percent of year-end loans 100.0% 100.0% 100.0% 100.0% 100.0% ==================================================================================================================
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 47 50 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). 48 51 TABLE 17: INTEREST RATE SENSITIVITY ANALYSIS
==================================================================================================================================== INTEREST-SENSITIVE PERIODS -------------------------------------------------------------------------------- MONTHS -------------------------------- OVER OVER THREE SIX TOTAL WITHIN THROUGH THROUGH ONE 1-5 OVER 5 (dollars in millions) THREE SIX TWELVE YEAR YEARS YEARS TOTAL - ------------------------------------------------------------------------------------------------------------------------------------ DECEMBER 31, 1998 EARNING ASSETS: Securities held to maturity $ 298.3 $ 71.2 $ 120.3 $ 489.8 $ 1,087.0 $ 153.7 $ 1,730.5 Securities available for sale 331.9 204.4 378.9 915.2 3,143.3 436.7 4,495.2 - ------------------------------------------------------------------------------------------------------------------------------------ Total securities 630.2 275.6 499.2 1,405.0 4,230.3 590.4 6,225.7 Loans 5,661.6 634.3 964.0 7,259.9 3,707.2 772.6 11,739.7 Other earning assets 693.3 -- -- 693.3 -- -- 693.3 - ------------------------------------------------------------------------------------------------------------------------------------ Total earning assets $ 6,985.1 $ 909.9 $ 1,463.2 $ 9,358.2 $ 7,937.5 $ 1,363.0 $18,658.7 ==================================================================================================================================== INTEREST-BEARING LIABILITIES: Interest-bearing deposits: NOW, money market, and savings accounts $ 6,277.9 $ -- $ -- $ 6,277.9 $ -- $ -- $ 6,277.9 Certificates of deposit 1,761.4 1,084.9 1,178.3 4,024.6 741.8 5.7 4,772.1 Other interest-bearing deposits 581.2 103.4 138.6 823.2 313.3 37.6 1,174.1 - ------------------------------------------------------------------------------------------------------------------------------------ Total interest-bearing deposits 8,620.5 1,188.3 1,316.9 11,125.7 1,055.1 43.3 12,224.1 Other borrowed funds 2,675.4 81.6 6.7 2,763.7 400.7 202.2 3,366.6 - ------------------------------------------------------------------------------------------------------------------------------------ Total interest-bearing liabilities 11,295.9 1,269.9 1,323.6 13,889.4 1,455.8 245.5 15,590.7 Net effect of swaps (629.7) (550.0) (450.0) (1,629.7) 1,525.0 104.7 - - ------------------------------------------------------------------------------------------------------------------------------------ Adjusted interest-bearing liabilities $10,666.2 $ 719.9 $ 873.6 $12,259.7 $ 2,980.8 $ 350.2 $15,590.7 ==================================================================================================================================== INTEREST-SENSITIVITY GAP: For the indicated period $(3,681.1) $ 190.0 $ 589.6 $(2,901.5) $ 4,956.7 $ 1,012.8 $ 3,068.0 Cumulative (3,681.1) (3,491.1) (2,901.5) (2,901.5) 2,055.2 3,068.0 3,068.0 Cumulative, as a percent of total earning assets (19.7)% (18.7)% (15.6)% (15.6)% 11.0% 16.4% 16.4% ==================================================================================================================================== DECEMBER 31, 1997 EARNING ASSETS: Securities held to maturity $ 82.7 $ 40.7 $ 79.4 $ 202.8 $ 380.2 $ 180.4 $ 763.4 Securities available for sale 330.0 137.9 256.3 724.2 2,005.9 822.1 3,552.2 - ------------------------------------------------------------------------------------------------------------------------------------ Total securities 412.7 178.6 335.7 927.0 2,386.1 1,002.5 4,315.6 Loans 5,055.3 932.1 1,338.7 7,326.1 4,299.1 666.3 12,291.5 Other earning assets 286.8 -- -- 286.8 -- -- 286.8 - ------------------------------------------------------------------------------------------------------------------------------------ Total earning assets $ 5,754.8 $ 1,110.7 $ 1,674.4 $ 8,539.9 $ 6,685.2 $ 1,668.8 $16,893.9 ==================================================================================================================================== INTEREST-BEARING LIABILITIES: Interest-bearing deposits: NOW, money market, and savings accounts $ 5,908.9 $ -- $ -- $ 5,908.9 $ -- $ -- $ 5,908.9 Certificates of deposit 1,512.5 1,070.3 1,150.5 3,733.3 871.4 3.1 4,607.8 Other interest-bearing deposits 232.1 90.7 113.1 435.9 416.5 10.3 862.7 - ------------------------------------------------------------------------------------------------------------------------------------ Total interest-bearing deposits 7,653.5 1,161.0 1,263.6 10,078.1 1,287.9 13.4 11,379.4 Other borrowed funds 2,316.8 11.4 4.9 2,333.1 44.1 287.1 2,664.3 - ------------------------------------------------------------------------------------------------------------------------------------ Total interest-bearing liabilities 9,970.3 1,172.4 1,268.5 12,411.2 1,332.0 300.5 14,043.7 Net effect of swaps 78.8 125.6 (1,124.3) (919.9) 834.0 85.9 -- - ------------------------------------------------------------------------------------------------------------------------------------ Adjusted interest-bearing liabilities $10,049.1 $ 1,298.0 $ 144.2 $11,491.3 $ 2,166.0 $ 386.4 $14,043.7 ==================================================================================================================================== INTEREST-SENSITIVITY GAP: For the indicated period $(4,294.3) $ (187.3) $ 1,530.2 $(2,951.4) $ 4,519.2 $ 1,282.4 $ 2,850.2 Cumulative (4,294.3) (4,481.6) (2,951.4) (2,951.4) 1,567.8 2,850.2 2,850.2 Cumulative, as a percent of total earning assets (25.4)% (26.5)% (17.5)% (17.5)% 9.3% 16.9% 16.9% ====================================================================================================================================
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. 49 52 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
- ------------------------------------------------------------------------------------------------------------------- FORWARD INTEREST RATE SWAPS SWAPS ---------------------- --------- INTEREST INTERESTS BASIS PAY RECEIVE PAY FUTURES (in thousands) RATE CAPS RATE FLOORS SWAP FIXED FIXED FIXED CONTRACTS - ------------------------------------------------------------------------------------------------------------------ Balance, December 31, 1995 $100,000 $115,000 $ -- $1,213,910 $ 40,000 $ 300,000 $ 140,000 Additions -- 185,000 -- -- 400,000 700,000 -- Maturities/terminations -- -- -- (891,288) (140,000) (500,000) (140,000) - ------------------------------------------------------------------------------------------------------------------ Balance, December 31, 1996 100,000 300,000 -- 322,622 300,000 500,000 -- Additions -- -- 50,000 135,000 775,000 1,300,000 -- Maturities/terminations (100,000) -- -- (201,397) (300,000) (450,000) -- - ------------------------------------------------------------------------------------------------------------------ Balance, December 31, 1997 -- 300,000 50,000 256,225 775,000 1,350,000 -- Additions -- -- -- 300,000 50,000 1,300,000 -- Maturities/terminations -- (300,000) (50,000) (51,525) (200,000) (600,000) -- - ------------------------------------------------------------------------------------------------------------------ BALANCE, DECEMBER 31, 1998 $ -- $ -- $ -- $ 504,700 $ 625,000 $2,050,000 $ -- ==================================================================================================================
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 50 53 $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. 51 54 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
==================================================================================== MATURITIES AT DECEMBER 31, 1998 ----------------------------------------------- WITHIN 1-5 AFTER (in millions) 1 YEAR YEARS 5 YEARS TOTAL - ------------------------------------------------------------------------------------ Commercial loans $2,250.7 $2,764.8 $ 542.6 $5,558.1 Real estate--construction loans 231.1 171.8 49.3 452.2 Real estate--commercial mortgages and other 289.2 611.7 152.2 1,053.1 - ------------------------------------------------------------------------------------ Total $2,771.0 $3,548.3 $ 744.1 $7,063.4 ==================================================================================== For maturities over one year: Loans with fixed interest rates $1,824.7 $ 433.2 $2,257.9 Loans with floating interest rates 1,723.6 310.9 2,034.5 - ------------------------------------------------------------------------------------ Total $3,548.3 $ 744.1 $4,292.4 ====================================================================================
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
=================================================================================== YEAR ENDED DECEMBER 31 ---------------------------------- 1998 1997 1996 - ----------------------------------------------------------------------------------- Average core deposits to average total deposits 88.08% 90.10% 90.68% Average core deposits to average earning assets 71.70 76.36 76.98 Long-term debt to total assets (end of period) 5.56 3.27 2.49 ===================================================================================
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 52 55 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. 53 56 - 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. 54 57 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. 55 58 - ------- 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
================================================================================================================== Three Months Ended --------------------------------------------------------- (dollars in thousands except per share amounts) DECEMBER 31 SEPTEMBER 30 JUNE 30 MARCH 31 - ------------------------------------------------------------------------------------------------------------------ 1998 Net interest income $188,626 $182,090 $182,417 $180,479 Net interest income, taxable equivalent basis(1) 194,041 187,360 187,343 184,416 Provision for loan losses 19,054 8,604 6,337 6,938 Noninterest income 115,632 128,140 124,441 109,399 Noninterest expense, excluding merger and integration costs 168,307 175,270 189,585 181,951 Merger and integration costs 12,523 37,159 72,043 -- Net income 67,831 57,497 21,688 64,346 - ------------------------------------------------------------------------------------------------------------------ SELECTED PER SHARE DATA: Net income: Basic $ .59 $ .51 $ .19 $ .58 Diluted .58 .50 .19 .57 Cash dividends paid .25 .25 .25 .20 Common stock price High 44.69 51.00 54.88 49.69 Low 33.44 34.75 43.13 43.13 Last trade 44.38 38.38 48.13 49.00 - ------------------------------------------------------------------------------------------------------------------ SELECTED RATIOS: Return on average assets (annualized) 1.32% 1.18% .46% 1.41% Return on average equity (annualized) 15.41 13.65 5.26 16.08 Net interest margin 4.18 4.21 4.38 4.45 ================================================================================================================== 1997 Net interest income $180,782 $175,730 $171,316 $171,332 Net interest income, taxable equivalent basis(1) 184,161 178,913 174,491 174,588 Provision for loan losses 7,741 2,997 3,030 2,341 Noninterest income 109,998 102,838 97,795 95,002 Noninterest expense 179,624 175,448 172,339 171,693 Net income 65,539 63,606 59,330 59,039 - ------------------------------------------------------------------------------------------------------------------ SELECTED PER SHARE DATA: Net income: Basic $ .58 $ .57 $ .52 $ .52 Diluted .57 .56 .52 .51 Cash dividends paid .20 .20 .20 .16 Common stock price High 55.38 50.13 40.00 34.63 Low 43.75 38.00 29.63 28.00 Last trade 49.75 48.88 38.38 31.81 - ------------------------------------------------------------------------------------------------------------------ SELECTED RATIOS: Return on average assets (annualized) 1.42% 1.41% 1.35% 1.35% Return on average equity (annualized) 16.00 15.87 15.42 14.98 Net interest margin 4.41 4.37 4.66 4.41 ==================================================================================================================
(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. 56 59 TABLE 22: CONSOLIDATED YEAR-END BALANCE SHEETS
=================================================================================================================== December 31 --------------------------------------------------------------- (in thousands) 1998 1997 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------- ASSETS Cash and due from banks $ 1,203,358 $ 1,033,865 $ 1,053,737 $ 920,288 $ 910,307 Securities: U.S. Treasury and other U.S. Government agencies and corporations 3,888,823 3,371,920 3,638,371 3,132,356 3,493,027 Obligations of states and political subdivisions 470,447 287,600 301,096 261,001 211,093 Other 1,866,350 656,088 432,036 365,652 235,008 - --------------------------------------------------------------------------------------------------------------------- Total securities 6,225,620 4,315,608 4,371,503 3,759,009 3,939,128 - --------------------------------------------------------------------------------------------------------------------- Federal funds sold and securities purchased under agreements to resell 351,989 208,372 210,952 737,992 259,883 Loans: Commercial 5,558,099 4,738,596 4,224,121 3,912,956 3,278,749 Consumer-amortizing mortgages 1,998,780 2,955,221 2,856,088 2,717,222 2,009,870 Consumer-other 2,690,227 2,626,060 2,324,915 2,170,638 1,794,021 Real estate-construction 452,191 455,181 398,775 327,935 241,859 Real estate-commercial mortgages and other 1,053,147 1,530,009 1,368,081 1,306,149 1,059,845 - --------------------------------------------------------------------------------------------------------------------- Total loans 11,752,444 12,305,067 11,171,980 10,434,900 8,384,344 Unearned discount (12,756) (13,577) (16,062) (13,760) (21,292) - --------------------------------------------------------------------------------------------------------------------- Loans, net of unearned discount 11,739,688 12,291,490 11,155,918 10,421,140 8,363,052 Allowance for loan losses (197,681) (187,880) (191,228) (197,006) (190,664) - --------------------------------------------------------------------------------------------------------------------- Total net loans 11,542,007 12,103,610 10,964,690 10,224,134 8,172,388 - --------------------------------------------------------------------------------------------------------------------- Premises and equipment, net 383,865 384,787 330,826 290,169 256,869 Other assets 1,024,931 745,084 741,542 595,566 573,656 - --------------------------------------------------------------------------------------------------------------------- TOTAL ASSETS $20,731,770 $18,791,326 $17,673,250 $16,527,158 $14,112,231 ===================================================================================================================== LIABILITIES Deposits: Demand (noninterest-bearing) $ 3,046,651 $ 2,774,449 $ 2,690,613 $ 2,505,922 $ 2,333,508 Interest-bearing 12,224,105 11,379,429 10,850,322 10,336,360 8,596,180 - --------------------------------------------------------------------------------------------------------------------- Total deposits 15,270,756 14,153,878 13,540,935 12,842,282 10,929,688 - --------------------------------------------------------------------------------------------------------------------- Federal funds purchased and securities sold under agreements to repurchase 1,988,161 1,675,370 1,535,616 1,397,346 1,453,867 Other short-term borrowings 225,476 374,708 225,124 182,338 79,232 Long-term debt 1,152,939 614,218 440,562 421,791 271,473 Other liabilities 314,643 329,259 387,117 261,191 188,844 - --------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES 18,951,975 17,147,433 16,129,354 15,104,948 12,923,104 - --------------------------------------------------------------------------------------------------------------------- SHAREHOLDERS' EQUITY Common stock 290,797 280,468 278,221 276,502 261,955 Additional paid-in capital 241,333 212,311 288,560 290,048 249,354 Retained earnings 1,286,512 1,161,877 981,833 834,652 697,959 Deferred compensation on restricted stock (31,781) (13,341) (2,066) (1,263) (2,161) Employee Stock Ownership Plan -- (163) (443) (661) (781) Accumulated other comprehensive income (loss), net of tax (7,066) 2,741 (2,209) 22,932 (17,199) - --------------------------------------------------------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY 1,779,795 1,643,893 1,543,896 1,422,210 1,189,127 - --------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $20,731,770 $18,791,326 $17,673,250 $16,527,158 $14,112,231 =====================================================================================================================
57 60 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: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III 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).
Officer Age Business Experience - Past 5 years - ------- --- ---------------------------------- Dennis C. Bottorff 54 Mr. Bottorff serves as Chairman and Chief Executive Officer of First American and FANB. He has served as Chief Executive Officer since 1991 and as Chairman since 1994. He also served as First American's President from 1991 until August 1997. Throughout 1994, Mr. Bottorff served as President and Chief Executive Officer of First American and Chief Executive Officer of FANB. Mr. Bottorff also serves as a director of First American's affiliates SSI and IFC. Melissa J. Buffington 41 Since August 1996, Ms. Buffington has served as Executive Vice President and Director of Human Resources of First American and FANB. From June 1993 through August 1996, she served as First American's Director of Quality Management. R. Booth Chapman 58 Since September 1991, Mr. Chapman has served as Executive Vice President - Independent Loan Review of FANB. Brian L. Cooper 40 Mr. Cooper is President of Retail Banking for FANB. From November 1997 to May 1998, he served as President of AmeriStar Investments. Mr. Cooper served as Executive Vice
58 61 President - Marketing of FANB from September 1995 until November 1998. From March 1992 through August 1995, he served as Senior Vice President - Marketing & Electronic Banking of Banc One Corporation. Emery F. Hill 55 Mr. Hill is Executive Vice President and Director of Operations and Technology of First American and FANB and has served in this position since 1992. Rufus B. King 53 Mr. King is Executive Vice President and Chief Credit Officer of FANB and has served in such position since July 1989. Allan R. Landon 50 Mr. Landon is Executive Vice President, Chief Financial Officer and Principal Financial Officer of First American and FANB and has served in this capacity since September 1998. From 1970 until September 1998, Mr. Landon was associated with Ernst & Young LLP, serving as a partner in the firm since 1984. Robert A. McCabe, Jr. 48 Mr. McCabe is President - FAE and Vice Chairman of First American and FANB and has served in such positions since January 1994. He also serves as Director of First American and FANB. From January 1992 until January 1994, he served as President, General Bank of FANB. Mr. McCabe has also served as a director of First American's affiliates SSI and IFC since April 1, 1996, and July 1, 1996, respectively. Dale W. Polley 49 Mr. Polley has served as President of First American since July 1997 and as Vice Chairman of FANB since May 1998. He also serves as Director of First American and FANB. From 1994 through July 1997, Mr. Polley served as Vice Chairman of First American. He also served as President of FANB from 1994 until May 1998. From November 1992 through 1994 and from August 1997 through August 1998, he served as Principal Financial Officer of First American and FANB. Joe J. Powell, III 45 Mr. Powell is Executive Vice President, Bank Investments and Investor Relations for First American and FANB and has served in such capacity since May 1998. From 1977 until its merger into First American in May 1998, Mr. Powell served in various capacities at Deposit Guaranty and DGNB, including Senior Vice President and Treasurer from 1993 until May 1998. Mary Neil Price 38 Ms. Price is Executive Vice President, General Counsel, and Corporate Secretary of First American and FANB and has
59 62 served in such capacity since August 1997. From July 1996 until July 1997, she served as Deputy General Counsel, Executive Vice President and Assistant Corporate Secretary. Ms. Price served as Senior Counsel, Senior Vice President and Assistant Corporate Secretary from February 1995 until July 1996. From October 1993 to February 1995, she served as Associate General Counsel, Senior Vice President and Assistant Corporate Secretary. She is also the corporate secretary and a director of IFC. E.B. Robinson, Jr. 57 Mr. Robinson has served as Vice Chairman and Chief Operating Officer of First American and President of FANB since May 1998. From 1984 until its merger into First American in May 1998, Mr. Robinson served as Chairman and CEO of Deposit Guaranty and DGNB. Terry S. Spencer 42 Mr. Spencer serves as Executive Vice President and Treasurer of First American and as Executive Vice President of FANB. From September 1993 until March 1995, he served as Executive Vice President - Development of FANB. Claire W. Tucker 45 Ms. Tucker is President - Corporate Bank of FANB and has served in such capacity since January 1997. From January 1995 through January 1997, she served as the Manager of FANB's Specialized Lending Group and Commercial Real Estate Group. She was appointed Executive Vice President in April 1995. From August 1991 through January 1995, Ms. Tucker served as Senior Vice President - Manager of FANB's HealthCare and Manufacturers Divisions. M. Terry Turner 43 Mr. Turner serves as President - Investment Services Group and has served in such capacity since November 1998. From January 1994 until November 1998, he served as President of the Retail Bank of FANB. Mr. Turner served as Executive Vice President - Business and Professional Banking of FANB from January 1991 until January 1994. Marvin J. Vannatta, Jr. 55 Mr. Vannatta serves as Executive Vice President, Controller and Principal Accounting Officer of First American and FANB and as Cashier of FANB and has served in such positions since March 1995. From October 1982 until March 1995, he served as Senior Vice President and Controller of First American and FANB.
60 63 Steven C. Walker 49 Since May 1998, Mr. Walker has served as President of FANB's Commercial and Private Banking Group. Until its merger into First American in May 1998, Mr. Walker served in various capacities with Deposit Guaranty and DGNB, including Executive Vice President of Corporate Banking from 1996 to May 1998 and President & CEO of Commercial National Bank, a wholly owned subsidiary based in Shreveport, LA, from 1989 to 1996. James W. Weakley 36 Mr. Weakley serves as Executive Vice President and Director of Marketing of FANB and has served in such position since November 1998. Prior to November 1998, he served in various capacities at General Electric Company, including Senior Vice President of Marketing and Vice President of Product Development and Ventures in the Vendor Financial Services Division ("VFS") of GE Capital, Director General of VFS in Mexico City and General Manager of VFS in Toronto.
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: 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: 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: 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. 61 64 PART IV 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
Exhibit Number Description ------ ----------- 3.1 Amended and Restated Charter of First American effective April 21, 1998, and corrections thereto (previously filed as Exhibit 3.1 to First American's Form 10-Q for the quarter ending March 31, 1998 and incorporated herein by reference).
62 65 3.2 By-Laws of First American currently in effect as amended September 17, 1998 (previously filed as Exhibit 3.2 to First American's Form 10-Q for the quarter ending September 30, 1998 and incorporated herein by reference). 4.1 First American agrees to provide the Securities and Exchange Commission, upon request, copies of instruments defining the rights of holders of long-term debt of First American, and all of its subsidiaries for which consolidated or unconsolidated financial statements are required to be filed with the Securities and Exchange Commission. 4.2 Rights Agreement dated as of July 16, 1998 between First American Corporation and First Chicago Trust Company of New York, as Rights Agent (previously filed as Exhibit 1 under Item 2 on First American's Form 8-A filed November 10, 1998 and incorporated herein by reference). 4.3(a) Indenture, dated as of April 22, 1993, between First American Corporation and Chemical Bank, as Trustee (previously filed as Exhibit 4.1 to First American's Form S-3, Registration Statement No. 33-59844, and incorporated herein by reference). 4.3(b) Supplemental Indenture, dated as of April 22, 1993, between First American Corporation and Chemical Bank, as Trustee (previously filed as Exhibit 4.2 to First American's Form S-3, Registration Statement No. 33-59844, and incorporated herein by reference). 4.3(c) Indenture, dated as of April 26, 1996, between Deposit Guaranty Corp. and SunTrust Bank, Atlanta, as Trustee (previously filed as Exhibit 4.2 to Deposit Guaranty's Form 8-K, Registration Statement No. 000-04518, and incorporated herein by reference). 4.3(d) Credit Agreement among First American Corporation, Lenders named in the Agreement and the First National Bank of Chicago dated July 17, 1998 (previously filed as Exhibit 10 to First American's Form 10-Q for the quarter ending June 30, 1998 and incorporated herein by reference). 10.1(a) First American STAR Award Plan (previously filed as Exhibit 10.03(b) to First American's Annual Report on Form 10-K for the year ended December 31, 1986 and incorporated herein by reference). 10.1(b) First American Corporation 1991 Employee Stock Incentive Plan (previously filed as part of First American's Notice of Annual Meeting
63 66 and Proxy Statement dated March 18, 1991 for the annual meeting of shareholders held April 18, 1991, amended as of April 21, 1994 and April 17, 1997, and incorporated herein by reference). 10.1(c) 1993 Non-Employee Director Stock Option Plan (previously filed as part of First American's Notice of Annual Meeting and Proxy Statement dated March 18, 1993 for the annual meeting of shareholders held April 15, 1993 and incorporated herein by reference). 10.1(d) First American Corporation 1992 Executive Early Retirement Program (previously filed as Exhibit 10.4(a) to First American's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference). 10.1(e) First American Corporation Directors' Deferred Compensation Plan as amended on October 18, 1996 (previously filed as Exhibit 10.3(e) to First American's Annual Report on Form 10-K for the year ended December 31, 1996 and incorporated herein by reference). 10.1(f) First American Corporation Supplemental Executive Retirement Program dated as of January 1, 1989 (previously filed as Exhibit 19.2 to First American's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference). 10.1(g) Form of Deferred Compensation Agreement approved by the Human Resources Committee of the Board of Directors of First American on December 19, 1996, entered into by First American and Brian L. Cooper effective December 31, 1998 (previously filed as Exhibit 10.3(g) to First American's Annual Report on Form 10-K for the year ended December 31, 1996 and incorporated herein by reference). 10.1(h) Amended and Restated First American Corporation First Incentive Reward Savings Thrift Plan (previously filed as Exhibit 4 to First American's Form S-8, Registration Statement No. 33-57385, filed January 20, 1995 and incorporated herein by reference). 10.1(i) Form of Key Employee Change in Control Agreement by and between First American and certain of its Executive Officers (previously filed as Exhibit 10.3(j) to First American's Annual Report on Form 10-K for the year ended December 31, 1995 and incorporated herein by reference). 10.1(j) Agreement effective August 1, 1997 by and between First American and Martin E. Simmons (previously filed as Exhibit 10 to First
64 67 American's Form 10-Q for the quarter ending September 30, 1997 and incorporated herein by reference). 10.1(k) Deposit Guaranty Corp. Stock-Based, Long-Term Incentive Plan, dated April 15, 1986, and Stock-Based, Long-Term Incentive Plan II, dated April 20, 1993 (previously filed as Exhibit 4 to First American's Form S-8 filed on May 8, 1998 and incorporated herein by reference). 10.1(l) Pioneer Bancshares, Inc. 1994 Long-Term Incentive Plan (previously filed as Exhibit 4 to First American's Post-Effective Amendment No. 1 on Form S-8 to Registration Statement on Form S-4 filed November 30, 1998 and incorporated herein by reference). 10.1(m) Employment Agreement dated December 7, 1997 by and between First American Corporation and E.B. Robinson, Jr., effective May 1, 1998, as amended July 1, 1998, included herein. 10.1(n) Consulting Agreement by and between First American National Bank and George M. Clark, III, effective March 1, 1999, included herein. 11 Calculation of basic and diluted earnings per share is included in Note 14 to the consolidated financial statements contained herein on page 96, included in this Report. 13 First American Corporation's Annual Report to Shareholders for the fiscal year ended December 31, 1998. Such report, except for the portions included herein, is furnished for the information of the Securities and Exchange Commission and is not "filed" as part of this Report. 21 List of Subsidiaries, included herein. 23 Consent of KPMG LLP, independent auditors, included herein. 27 Financial Data Schedule, included herein.
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. 65 68 FIRST AMERICAN CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
Page ---- Independent Auditors' Report 67 Financial Statements: Consolidated Income Statements of First American Corporation and Subsidiaries for each of the years in the three year period ended December 31, 1998 68 Consolidated Balance Sheets of First American Corporation and Subsidiaries at December 31, 1998 and 1997 69 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 70 Consolidated Statements of Cash Flows of First American Corporation and Subsidiaries for each of the years in the three year period ended December 1998 71 Notes to Consolidated Financial Statements 72 Supplemental Data: Consolidated Average Balance Sheets and Taxable Equivalent Income/Expense and Yields/Rates for each of the years ended December 31, 1998, 1997, 1996, 1995, and 1994 29 Consolidated Year-End Balance Sheets of First American Corporation and Subsidiaries at December 31, 1998, 1997, 1996, 1995, and 1994 57
66 69 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 67 70 - -------------------------------------------------------------------------------- CONSOLIDATED INCOME STATEMENTS First American Corporation and Subsidiaries - --------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31 -------------------------------------------------- (in thousands except per share amounts) 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------------- INTEREST INCOME Loans $ 994,353 $1,002,783 $ 908,967 Securities Taxable 344,643 269,004 242,008 Tax-exempt 17,175 15,762 17,233 Federal funds sold and securities purchased under agreements to resell 6,552 6,560 18,011 Time deposits with other banks and other interest 4,943 5,258 4,045 - --------------------------------------------------------------------------------------------------------------------------- Total interest income 1,367,666 1,299,367 1,190,264 - --------------------------------------------------------------------------------------------------------------------------- INTEREST EXPENSE Deposits 471,230 478,357 457,784 Short-term borrowings 114,294 93,599 78,934 Long-term debt 48,530 28,251 29,575 - --------------------------------------------------------------------------------------------------------------------------- Total interest expense 634,054 600,207 566,293 - --------------------------------------------------------------------------------------------------------------------------- NET INTEREST INCOME 733,612 699,160 623,971 PROVISION FOR LOAN LOSSES 40,933 16,109 6,437 - --------------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 692,679 683,051 617,534 - --------------------------------------------------------------------------------------------------------------------------- NONINTEREST INCOME Investment services income 151,027 124,003 68,820 Service charges on deposit accounts 131,926 118,113 97,189 Commissions and fees on fiduciary activities 42,979 40,412 35,875 Mortgage banking 48,265 36,787 29,488 Merchant discount fees 4,027 3,766 4,602 Net realized gain on sales of securities 7,999 4,528 2,882 Trading account revenue 7,250 4,414 6,939 Other 84,139 73,610 66,132 - --------------------------------------------------------------------------------------------------------------------------- Total noninterest income 477,612 405,633 311,927 - --------------------------------------------------------------------------------------------------------------------------- NONINTEREST EXPENSE Salaries and employee benefits 342,927 346,024 310,985 Subscribers' commissions 89,918 70,785 35,075 Net occupancy 52,769 50,276 44,135 Equipment 48,896 45,563 38,333 Systems and processing 15,461 15,662 14,755 Communication 30,450 27,194 21,804 Marketing 20,742 22,129 21,334 Supplies 12,411 15,523 13,073 Goodwill amortization 17,410 16,815 12,429 FDIC insurance 2,188 1,798 10,488 Merger and integration costs 121,725 -- -- Other 81,941 87,335 74,992 - --------------------------------------------------------------------------------------------------------------------------- Total noninterest expense 836,838 699,104 597,403 - --------------------------------------------------------------------------------------------------------------------------- INCOME BEFORE INCOME TAX EXPENSE 333,453 389,580 332,058 Income tax expense 122,091 142,066 117,879 - --------------------------------------------------------------------------------------------------------------------------- NET INCOME $ 211,362 $ 247,514 $ 214,179 =========================================================================================================================== PER COMMON SHARE: Net income: Basic $ 1.88 $ 2.19 $ 1.93 Diluted 1.84 2.15 1.91 Dividends declared .95 .755 .605 =========================================================================================================================== AVERAGE COMMON SHARES OUTSTANDING: Basic 112,517 112,907 110,727 Diluted 114,682 115,249 112,286 ===========================================================================================================================
See accompanying notes to consolidated financial statements. 68 71 - -------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEETS First American Corporation and Subsidiaries - --------------------------------------------------------------------------------
DECEMBER 31 ------------------------------------ (dollars in thousands except per share amounts) 1998 1997 - --------------------------------------------------------------------------------------------------------------------------- ASSETS Cash and due from banks $ 1,203,358 $ 1,033,865 Time deposits with other banks 297,374 13,991 Federal funds sold and securities purchased under agreements to resell 351,989 208,372 - --------------------------------------------------------------------------------------------------------------------------- Total cash and cash equivalents 1,852,721 1,256,228 - --------------------------------------------------------------------------------------------------------------------------- Securities held to maturity (fair value $1,739,852 and $771,815, respectively) 1,730,460 763,423 Securities available for sale (amortized cost $4,505,730 and $3,547,537, respectively) 4,495,160 3,552,185 - --------------------------------------------------------------------------------------------------------------------------- Total securities 6,225,620 4,315,608 - --------------------------------------------------------------------------------------------------------------------------- Trading account securities 43,987 64,469 Loans: Commercial 5,558,099 4,738,596 Consumer--amortizing mortgages 1,998,780 2,955,221 Consumer--other 2,690,227 2,626,060 Real estate--construction 452,191 455,181 Real estate--commercial mortgages and other 1,053,147 1,530,009 - --------------------------------------------------------------------------------------------------------------------------- Total loans 11,752,444 12,305,067 Unearned discount (12,756) (13,577) - --------------------------------------------------------------------------------------------------------------------------- Loans, net of unearned discount 11,739,688 12,291,490 Allowance for loan losses (197,681) (187,880) - --------------------------------------------------------------------------------------------------------------------------- Total net loans 11,542,007 12,103,610 - --------------------------------------------------------------------------------------------------------------------------- Premises and equipment, net 383,865 384,787 Other assets 683,570 666,624 - --------------------------------------------------------------------------------------------------------------------------- TOTAL ASSETS $20,731,770 $18,791,326 =========================================================================================================================== LIABILITIES Deposits: Noninterest-bearing $ 3,046,651 $ 2,774,449 Interest-bearing 12,224,105 11,379,429 - --------------------------------------------------------------------------------------------------------------------------- Total deposits 15,270,756 14,153,878 - --------------------------------------------------------------------------------------------------------------------------- Short-term borrowings 2,213,637 2,050,078 Long-term debt 1,152,939 614,218 Other liabilities 314,643 329,259 - --------------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES 18,951,975 17,147,433 - --------------------------------------------------------------------------------------------------------------------------- Commitments and contingencies SHAREHOLDERS' EQUITY Preferred stock, without par value; authorized 2,500,000 shares -- -- Common stock, $2.50 par value; authorized 200,000,000 shares; issued and outstanding: 116,318,734 shares at December 31, 1998; 112,187,227 shares at December 31, 1997 290,797 280,468 Additional paid-in capital 241,333 212,311 Retained earnings 1,286,512 1,161,877 Deferred compensation on restricted stock (31,781) (13,341) Employee stock ownership plan obligation -- (163) - --------------------------------------------------------------------------------------------------------------------------- Realized shareholders' equity 1,786,861 1,641,152 Accumulated other comprehensive (loss) income, net of tax (7,066) 2,741 - --------------------------------------------------------------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY 1,779,795 1,643,893 - --------------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $20,731,770 $18,791,326 ===========================================================================================================================
See accompanying notes to consolidated financial statements. 69 72 - -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY First American Corporation and Subsidiaries - --------------------------------------------------------------------------------
Common Deferred Employee Accumulated Shares Compensation Stock Other Issued Additional on Ownership Comprehensive and Common Paid-in Retained Restricted Plan Income (Loss), (in thousands except per share amounts) Outstanding Stock Capital Earnings Stock Obligation Net of Tax Total - ----------------------------------------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1995 110,601 $276,502 $290,048 $ 834,652 $ (1,263) (661) $ 22,932 $1,422,210 Comprehensive income: Net income -- -- -- 214,179 -- -- -- 214,179 Other comprehensive loss, net of tax -- -- -- -- -- -- (25,141) (25,141) --------- Comprehensive income 189,038 Cash dividends declared ($.605 per common share) -- -- -- (35,694) -- -- -- (35,694) Cash dividends declared by pooled companies -- -- -- (31,272) -- -- -- (31,272) Repurchase of common stock (4,976) (12,439) (96,980) -- -- -- -- (109,419) Issuance of common stock: Acquisitions 4,122 10,306 73,449 (32) -- -- -- 83,723 Employee Benefit Plans, net of discount on Dividend Reinvestment Plan 1,449 3,623 15,572 -- -- -- -- 19,195 Restricted common stock, net of forfeitures 93 232 1,958 -- (2,190) -- -- -- Amortization of deferred compensation on restricted stock -- -- -- -- 1,387 -- -- 1,387 Reduction in employee stock ownership plan obligation -- -- -- -- -- 218 -- 218 Tax benefit from stock option and award plans -- -- 4,530 -- -- -- -- 4,530 Other (1) (3) (17) -- -- -- -- (20) - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE, DECEMBER 31, 1996 111,288 278,221 288,560 981,833 (2,066) (443) (2,209) 1,543,896 - ------------------------------------------------------------------------------------------------------------------------------------ Net income -- -- -- 247,514 -- -- -- 247,514 Other comprehensive income, net of tax -- -- -- -- -- -- 4,950 4,950 --------- Comprehensive income 252,464 Cash dividends declared ($.755 per common share) -- -- -- (44,393) -- -- -- (44,393) Cash dividends declared by pooled company -- -- -- (37,017) -- -- -- (37,017) Repurchase of common stock (6,321) (15,802) (181,891) -- -- -- -- (197,693) Issuance of common stock: Acquisitions 5,511 13,776 66,921 13,940 -- -- -- 94,637 Employee Benefit Plans, net of discount on Dividend Reinvestment Plan 1,263 3,158 19,552 -- -- -- -- 22,710 Restricted common stock, net of forfeitures 446 1,114 13,564 -- (14,678) -- -- -- Amortization of deferred compensation on restricted stock -- -- -- -- 3,403 -- -- 3,403 Reduction in employee stock ownership plan obligation -- -- -- -- -- 280 -- 280 Tax benefit from stock option and award plans -- -- 5,603 -- -- -- -- 5,603 Other -- 1 2 -- -- -- -- 3 - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE, DECEMBER 31, 1997 112,187 280,468 212,311 1,161,877 (13,341) (163) 2,741 1,643,893 - ------------------------------------------------------------------------------------------------------------------------------------ Comprehensive income: Net income -- -- -- 211,362 -- -- -- 211,362 Other comprehensive loss, net of tax -- -- -- -- -- -- (9,825) (9,825) --------- Comprehensive income 201,537 Cash dividends declared ($.95 per common share) -- -- -- (81,794) -- -- -- (81,794) Cash dividends declared by pooled companies -- -- -- (12,203) -- -- -- (12,203) Repurchase of common stock (1,211) (3,028) (62,347) (9) -- -- -- (65,384) Issuance of common stock: Acquisitions 3,889 9,723 45,926 7,280 -- -- 18 62,947 Employee Benefit Plans, net of discount on Dividend Reinvestment Plan 896 2,238 15,993 -- -- -- -- 18,231 Restricted common stock, net of forfeitures 558 1,396 24,269 -- (25,665) -- -- -- Amortization of deferred compensation on restricted stock -- -- -- -- 7,225 -- -- 7,225 Reduction in employee stock ownership plan obligation -- -- -- -- -- 163 -- 163 Tax benefit from stock option and award plans -- -- 5,183 -- -- -- -- 5,183 Other -- -- (2) (1) -- -- -- (3) - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE, DECEMBER 31, 1998 116,319 $290,797 $241,333 $1,286,512 $(31,781) $ -- $ (7,066) $1,779,795 - -----------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. 70 73 - -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS First American Corporation and Subsidiaries - --------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31 ------------------------------------------- (in thousands) 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES Net income $ 211,362 $ 247,514 $ 214,179 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 40,933 16,109 6,437 Depreciation and amortization of premises and equipment 41,493 40,774 36,986 Amortization of intangible assets 23,816 23,351 17,287 Other amortization (accretion), net 19,094 9,534 2,922 Noncash portion of merger and integration costs 5,900 -- -- Deferred income tax expense 24,738 17,911 24,231 Net loss (gain) on sales and write-downs of other real estate owned 7,240 (4,226) (4,833) Net realized gains on sales and write-downs of securities (7,999) (4,528) (2,882) Net gain on sales and write-downs of premises and equipment (972) (796) (370) Net gain on disposition of branches, business operations, subsidiaries and other assets (9,528) (7,088) (162) Change in assets and liabilities, net of effects from acquisitions and dispositions: (Increase) decrease in mortgage loans held for sale (97,629) 337 9,088 (Increase) decrease in accrued interest receivable (2,737) (10,953) 3,834 Increase (decrease) in accrued interest payable 384 11,326 (11,258) Decrease (increase) in trading account securities 20,482 (7,077) (22,619) Increase in other assets (93,165) (46,910) (5,569) (Decrease) increase in other liabilities (28,020) (21,834) 84,009 - --------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 155,392 263,444 351,280 - --------------------------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES Proceeds from sales of securities available for sale 2,094,870 2,708,554 2,177,300 Proceeds from maturities of securities available for sale 1,961,886 565,799 954,494 Purchases of securities available for sale (4,795,290) (3,306,227) (3,683,418) Proceeds from maturities of securities held to maturity 648,271 463,500 278,945 Purchases of securities held to maturity (443,604) (212,131) (168,211) Proceeds from sales of other real estate owned 18,491 16,373 16,009 Acquisitions, net of cash and cash equivalents acquired 96,418 76,697 25,156 Sales of branches, business operations, subsidiaries and other assets, net of cash and cash equivalents disposed of 13,927 8,187 573 Net increase in loans, net of repayments and sales (274,155) (754,305) (499,080) Proceeds from sales of premises and equipment 17,999 7,092 6,230 Purchases of premises and equipment (44,286) (83,484) (73,272) - --------------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (705,473) (509,945) (965,274) - --------------------------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES Net increase (decrease) in deposits 590,259 (34,766) 227,533 Net increase in short-term borrowings 230,937 135,894 128,042 Net (repayment of)/proceeds from long-term debt (139) 1,688 99,255 Advances from (repayments to) Federal Home Loan Bank 461,484 328,753 (54,166) Issuance of common stock under Employee Benefit and Dividend Reinvestment Plans 18,231 22,710 19,195 Repurchase of common stock (65,384) (197,693) (109,419) Tax benefit related to stock option and award plans 5,183 5,603 4,530 Cash dividends paid (93,997) (80,177) (65,472) - --------------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 1,146,574 182,012 249,498 - --------------------------------------------------------------------------------------------------------------------------- Increase (decrease)in cash and cash equivalents 596,493 (64,489) (364,496) Cash and cash equivalents, beginning of year 1,256,228 1,320,717 1,685,213 - --------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of year $ 1,852,721 $ 1,256,228 $ 1,320,717 =========================================================================================================================== Cash paid during the year for: Interest expense $ 633,670 $ 588,881 $ 577,551 Income taxes 52,587 103,543 93,845 Non-cash investing activities: Mortgage loans securitized and retained 1,206,958 -- -- Foreclosures 7,029 5,812 4,247 Change in unrealized gain (loss) on available for sale securities, net of tax (9,807) 4,950 (25,141) Stock issued for acquisitions 62,947 94,637 83,723 ===========================================================================================================================
See accompanying notes to consolidated financial statements. 71 74 - -------------------------------------------------------------------------------- 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. 72 75 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 73 76 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. 74 77 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. 75 78 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 76 79 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 77 80 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 78 81 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):
Common Shares Cash Accounting Acquiree Location Date Assets Issued Paid Treatment - --------------------------------------------------------------------------------------------------------------------- First City Bancorp, Inc. TN Mar. 1996 $ 366 2.1 $ -- Purchase - --------------------------------------------------------------------------------------------------------------------- Bank of Gonzolas Holding Company LA June 1996 126 1.5 -- Purchase - --------------------------------------------------------------------------------------------------------------------- IFC Holdings, Inc. (formerly INVEST) FL July 1996 29 -- 26 Purchase - --------------------------------------------------------------------------------------------------------------------- Tuscaloosa Bancshares, Inc. LA Nov. 1996 41 0.5 -- Purchase - --------------------------------------------------------------------------------------------------------------------- Jefferson Guaranty Bancorp, Inc. LA Jan. 1997 299 2.1 10 Purchase - --------------------------------------------------------------------------------------------------------------------- Hartsville Bancshares, Inc. TN Jan. 1997 90 0.4 -- Purchase - --------------------------------------------------------------------------------------------------------------------- First Capital Bancorp, Inc. LA Mar. 1997 186 1.8 -- Pooling - --------------------------------------------------------------------------------------------------------------------- NBC Financial Corporation LA July 1997 69 0.5 -- Purchase - --------------------------------------------------------------------------------------------------------------------- Citisave Financial Corporation LA Aug. 1997 75 -- 19 Purchase - --------------------------------------------------------------------------------------------------------------------- Victory Bancshares, Inc. TN Mar. 1998 131 0.9 -- Pooling - --------------------------------------------------------------------------------------------------------------------- Peoples Bank TN Oct. 1998 142 0.9 -- Pooling - --------------------------------------------------------------------------------------------------------------------- The Middle Tennessee Bank TN Oct. 1998 225 1.2 -- Pooling - --------------------------------------------------------------------------------------------------------------------- CSB Financial Corporation TN Oct. 1998 148 0.9 -- Pooling =====================================================================================================================
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. 79 82 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:
----------------------------------------------------------------------------------- Year Ended December 31, 1997 Year Ended December 31, 1996 -------------------------------------- ---------------------------------------- First Deposit First Deposit (in thousands) American Guaranty Pioneer Combined American Guaranty Pioneer Combined - ----------------------------------------------------------------------------------------------------------------------- Net interest income $383,410 $278,713 $37,037 $699,160 $349,698 $243,563 $ 30,710 $623,971 Noninterest income 259,594 136,167 9,872 405,633 180,533 123,216 8,178 311,927 Net income 145,472 92,280 9,762 247,514 121,572 83,610 8,997 214,179 =======================================================================================================================
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. 80 83 - 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:
YEAR ENDED (in millions) DECEMBER 31, 1998 - ----------------------------------------------------------------------------- Charged against income $121.7 Cash outlays (97.0) Noncash charges, net (5.9) - ----------------------------------------------------------------------------- Balance at December 31, 1998 $ 18.8 =============================================================================
81 84 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:
UNREALIZED AMORTIZED --------------------------- FAIR (in thousands) COST GROSS GAINS GROSS LOSSES VALUE - ------------------------------------------------------------------------------------------------------------------------ DECEMBER 31, 1998 U.S. Treasury and U.S. Government agencies and corporation $ 633,056 $ 5,284 $ 1,737 $ 636,603 Obligations of states and political subdivisions 91,100 4,398 4 95,494 Other debt securities (primarily mortgage-backed securities 1,006,304 2,621 1,170 1,007,755 - ------------------------------------------------------------------------------------------------------------------------ Total securities held to maturity $1,730,460 $ 12,303 $ 2,911 $1,739,852 ======================================================================================================================== December 31, 1997 U.S. Treasury and U.S. Government agencies and corporation $ 498,029 $ 3,487 $ 1,228 $ 500,288 Obligations of states and political subdivisions 42,723 1,588 48 44,263 Other debt securities (primarily mortgage-backed securities) 222,671 5,088 495 227,264 - ------------------------------------------------------------------------------------------------------------------------ Total securities held to maturity $ 763,423 $ 10,163 $ 1,771 $ 771,815 ========================================================================================================================
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:
AMORTIZED FAIR (in thousands) COST VALUE - ----------------------------------------------------------------------------------------------------------- DECEMBER 31, 1998 U.S. Treasury and U.S. Government agencies and corporations $ 576,351 $ 579,593 Other debt securities 945,162 944,298 - ----------------------------------------------------------------------------------------------------------- Total mortgage-backed securities held to maturity $1,521,513 $1,523,891 =========================================================================================================== December 31, 1997 U.S. Treasury and U.S. Government agencies and corporations $ 438,463 $ 440,499 Other debt securities 104,927 104,603 - ----------------------------------------------------------------------------------------------------------- Total mortgage-backed securities held to maturity $ 543,390 $ 545,102 ===========================================================================================================
82 85 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:
UNREALIZED AMORTIZED --------------------------- FAIR (in thousands) COST GROSS GAINS GROSS LOSSES VALUE - -------------------------------------------------------------------------------------------------------------------------- DECEMBER 31, 1998 U.S. Treasury and U.S. Government agencies and corporations $3,265,370 $ 19,241 $ 28,844 $3,255,767 Obligations of states and political subdivisions 375,100 7,577 3,330 379,347 Other debt securities 752,284 3,224 8,236 747,272 - -------------------------------------------------------------------------------------------------------------------------- Total debt securities 4,392,754 30,042 40,410 4,382,386 Equity securities (primarily Federal Reserve Bank and Federal Home Loan Bank stock) 112,976 -- 202 112,774 - -------------------------------------------------------------------------------------------------------------------------- Total securities available for sale $4,505,730 $ 30,042 $ 40,612 $4,495,160 ========================================================================================================================== December 31, 1997 U.S. Treasury and U.S. Government agencies and corporations $2,873,330 $ 13,215 $ 12,653 $2,873,892 Obligations of states and political subdivisions 239,738 5,335 196 244,877 Other debt securities 349,184 1,356 2,409 348,131 - -------------------------------------------------------------------------------------------------------------------------- Total debt securities 3,462,252 19,906 15,258 3,466,900 Equity securities (primarily Federal Reserve Bank and Federal Home Loan Bank stock) 85,285 -- -- 85,285 - -------------------------------------------------------------------------------------------------------------------------- Total securities available for sale $3,547,537 $ 19,906 $ 15,258 $3,552,185 ==========================================================================================================================
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:
AMORTIZED FAIR (in thousands) COST VALUE - ---------------------------------------------------------------------------------------------------------------- DECEMBER 31, 1998 U.S. Treasury and U.S. Government agencies and corporations $2,912,703 $2,904,795 Other debt securities 733,139 728,617 - ---------------------------------------------------------------------------------------------------------------- Total mortgage-backed securities available for sale $3,645,842 $3,633,412 ================================================================================================================ December 31, 1997 U.S. Treasury and U.S. Government agencies and corporations $2,249,097 $2,250,005 Other debt securities 338,772 337,694 - ---------------------------------------------------------------------------------------------------------------- Total mortgage-backed securities available for sale $2,587,869 $2,587,699 ================================================================================================================
The sale of securities available for sale resulted in gross realized gains and losses as follows:
YEAR ENDED DECEMBER 31 --------------------------------------- (in thousands) 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------- Gross realized gains $12,123 $14,782 $14,861 Gross realized losses (4,124) (10,254) (11,979) - ----------------------------------------------------------------------------------------------------------- Net realized gains on sales of securities available for sale $ 7,999 $ 4,528 $ 2,882 ===========================================================================================================
83 86 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.
SECURITIES HELD TO MATURITY SECURITIES AVAILABLE FOR SALE ------------------------------- ----------------------------------- AMORTIZED FAIR AMORTIZED FAIR (in thousands) COST VALUE COST VALUE - ----------------------------------------------------------------------------------------------------------------- Due in one year or less $ 122,860 $ 123,223 $ 592,820 $ 595,717 Due after one year through five years 862,677 867,757 2,880,094 2,863,078 Due after five years through ten years 717,280 720,294 449,772 454,233 Due after ten years 27,643 28,578 470,068 469,359 - ----------------------------------------------------------------------------------------------------------------- Total debt securities 1,730,460 1,739,852 4,392,754 4,382,387 Equity securities -- -- 112,976 112,773 - ----------------------------------------------------------------------------------------------------------------- Total securities $1,730,460 $1,739,852 $4,505,730 $4,495,160 =================================================================================================================
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. 84 87 Transactions in the allowance for loan losses were as follows:
YEAR ENDED DECEMBER 31 --------------------------------------------- (in thousands) 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------- Balance, January 1 $187,880 $191,228 $197,006 Provision for loan losses 31,387 16,109 6,437 Additional Pioneer loan loss provision 9,546 -- -- Allowance of subsidiary sold -- (252) -- Additions due to business combinations 6,164 8,252 4,188 - ---------------------------------------------------------------------------------------------------------- Subtotal 234,977 215,337 207,631 - ---------------------------------------------------------------------------------------------------------- Loans charged off 64,973 56,392 48,348 Recoveries of loans previously charged off (27,677) (28,935) (31,945) - ---------------------------------------------------------------------------------------------------------- Net charge-offs 37,296 27,457 16,403 - ---------------------------------------------------------------------------------------------------------- Balance, December 31 $197,681 $187,880 $191,228 ==========================================================================================================
Net charge-offs (recoveries) by major loan categories were as follows:
YEAR ENDED DECEMBER 31 --------------------------------------------- (in thousands) 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------- Commercial $ 13,680 $ 13,059 $ (2,205) Consumer--amortizing mortgages 2,019 1,011 697 Consumer--other 20,903 15,932 18,277 Real estate--construction 250 492 43 Real estate--commercial mortgages and other 444 (3,037) (409) - ----------------------------------------------------------------------------------------------------------- Total net charge-offs $ 37,296 $ 27,457 $ 16,403 ===========================================================================================================
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:
(in millions) 1998 1997 - ------------------------------------------------------------------------------------- Balance, January 1 $ 98.3 $ 113.6 Additions 4,417.1 3,138.4 Repayments (4,329.1) (3,116.6) No longer related (20.9) (37.1) - ------------------------------------------------------------------------------------- Balance, December 31 $ 165.4 $ 98.3 =====================================================================================
Impaired loans and related allocated allowance amounts at December 31, 1998, 1997 and 1996 were as follows:
DECEMBER 31 ------------------------------------------------------------------------ 1998 1997 1996 ----------------------- --------------------- ---------------------- RECORDED ALLOCATED Recorded Allocated Recorded Allocated (in thousands) INVESTMENT ALLOWANCE Investment Allowance Investment Allowance - ------------------------------------------------------------------------------------------------------------------- Impaired loans with allocated allowance $21,338 $ 9,581 $23,779 $ 7,333 $12,998 $ 3,187 Impaired loans with no allocated allowance 28,343 -- 18,319 -- 25,511 -- - ------------------------------------------------------------------------------------------------------------------- Total $49,681 $ 9,581 $42,098 $ 7,333 $38,509 $ 3,187 ===================================================================================================================
85 88 The average recorded investment in impaired loans and related interest income for the years ended December 31, 1998, 1997, and 1996, were as follows:
(in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------ Average impaired loans - recorded investment $41,146 $36,159 $45,029 - ------------------------------------------------------------------------------------ Interest income recognized on an accrual basis during period loans were impaired 375 382 798 ====================================================================================
NOTE 7: PREMISES AND EQUIPMENT AND LEASE COMMITMENTS Premises and equipment are summarized as follows:
DECEMBER 31 --------------------------- (in thousands) 1998 1997 - ------------------------------------------------------------------------------------ Land $ 58,419 $ 60,864 Buildings 318,345 311,324 Furniture and equipment 284,004 305,089 Leasehold improvements 67,020 54,430 Premises leased under capital leases 3,008 3,008 - ------------------------------------------------------------------------------------ Subtotal 730,796 734,715 Accumulated depreciation and amortization (346,931) (349,928) - ------------------------------------------------------------------------------------ Net book value $383,865 $384,787 ====================================================================================
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:
Operating Capital (in thousands) Total Leases Leases - ------------------------------------------------------------------------------------ 1999 $ 33,527 $ 33,247 $ 280 2000 30,467 30,197 270 2001 22,450 22,180 270 2002 13,763 13,493 270 2003 10,578 10,307 271 Thereafter 65,442 63,913 1,529 - ------------------------------------------------------------------------------------ Total $176,227 $173,337 2,890 - ------------------------------------------------------------------------------------ Purchase option 110 Amounts representing interest at 6.75% (1,720) - ------------------------------------------------------------------------------------ Total capitalized lease obligations 1,280 Amounts included in short-term borrowings (127) - ------------------------------------------------------------------------------------ Capitalized lease obligations included in long-term debt $ 1,153 ====================================================================================
86 89 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.
TOTAL TOTAL OTHER INTANGIBLE (in thousands) GOODWILL INTANGIBLES ASSETS - --------------------------------------------------------------------------------------- Balance, December 31, 1995 $111,279 $ 34,516 $145,795 Additions 71,973 7,042 79,015 Dispositions -- -- -- Amortization (12,429) (4,858) (17,287) - --------------------------------------------------------------------------------------- Balance, December 31, 1996 170,823 36,700 207,523 Additions 51,717 15,036 66,753 Dispositions (319) -- (319) Amortization (16,815) (6,536) (23,351) - --------------------------------------------------------------------------------------- Balance, December 31, 1997 205,406 45,200 250,606 Additions 9,694 -- 9,694 Dispositions (6,195) (834) (7,029) Amortization (17,410) (6,406) (23,816) - --------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1998 $191,495 $ 37,960 $229,455 =======================================================================================
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.
(in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------------- Balance, January 1 $41,729 $36,616 $27,920 Additions 29,567 14,938 13,461 Dispositions -- (2,746) (1,012) Amortization (9,569) (7,079) (3,753) - -------------------------------------------------------------------------------------- BALANCE, DECEMBER 31 $61,727 $41,729 $36,616 ======================================================================================
Changes in the valuation allowance for capitalized mortgage servicing rights were as follows:
(in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------------- Balance, January 1 $ (310) $ (259) $ -- Additions (3,543) (51) (259) - -------------------------------------------------------------------------------------- BALANCE, DECEMBER 31 $ (3,853) $ (310) $ (259) ======================================================================================
87 90 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:
DECEMBER 31 ---------------------------------- (in thousands) 1998 1997 - ------------------------------------------------------------------------------------------------------------------- Federal funds purchased and securities sold under agreements to repurchase $1,988,161 $1,675,370 Other short-term borrowings 225,476 374,708 - ------------------------------------------------------------------------------------------------------------------- Total short-term borrowings $2,213,637 $2,050,078 ===================================================================================================================
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:
AMOUNT MATURING IN: WEIGHTED- ------------------------------------- AVERAGE (dollars in millions) INTEREST RATE BALANCE 3 MONTHS 6 MONTHS 12 MONTHS - ------------------------------------------------------------------------------------------------------------------- Interest rate: Tied to 3-month LIBOR 5.27% $110.0 $ 10.0 $ -- $100.0 Fixed rate 5.46 38.2 25.0 .2 13.0 ----------------------------------------------------- Total $148.2 $ 35.0 $ .2 $113.0 ===================================================================================================================
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:
DECEMBER 31 --------------------------------------------------- (dollars in thousands) 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------- Federal funds purchased and securities sold under agreements to repurchase: Amount outstanding at December 31 $1,988,161 $1,675,370 $1,535,616 Average rate at December 31 4.49% 4.69% 4.68% Average amount outstanding during the year $2,007,509 $1,529,640 $1,441,554 Average rate paid for the year 4.91% 4.92% 4.85% Maximum amount outstanding at any month-end $2,471,737 $1,795,793 $1,558,096 =================================================================================================================
88 91 NOTE 10: LONG-TERM DEBT Long-term debt consisted of the following:
DECEMBER 31 ---------------------------------- (in thousands) 1998 1997 - ------------------------------------------------------------------------------------------------------------------- FHLB advances $ 950,748 $412,090 6 7/8% noncallable subordinated notes (effective rate of 6.965%) due 2003, interest payable semiannually (less unamortized discount of $137 in 1998 and $169 in 1997) 49,863 49,831 6 5/8% noncallable subordinated notes (effective rate of 6.761%) due 2005, interest payable semiannually (less unamortized discount of $340 in 1998 and $389 in 1997) 49,660 49,611 7 1/4% noncallable senior notes (effective rate of 7.375%) due 2006, interest payable semiannually (less unamortized discount of $501 in 1998 and $550 in 1997) 101,212 101,397 8% mortgage note, due 2012, monthly payments of principal and interest 303 -- Capitalized lease obligations 1,153 1,289 - ------------------------------------------------------------------------------------------------------------------- Total long-term debt $1,152,939 $614,218 ===================================================================================================================
The balance of long-term FHLB advances, weighted-average interest rates, and maturities at December 31, 1998, are listed below:
WEIGHTED- AVERAGE AMOUNT MATURING IN: INTEREST -------------------------------------------------------- (dollars in millions) RATE BALANCE 2000 2001 2002 2003 2004 THEREAFTER - --------------------------------------------------------------------------------------------------------------- Interest rate: Tied to 1-month LIBOR 5.56% $270.0 $200.0 $ 70.0 $ -- $ -- $ -- $ -- Tied to 3-month LIBOR 5.53 560.0 145.0 -- -- 330.0 85.0 -- Fixed rate 5.42 120.7 .3 .8 7.1 3.0 1.1 108.4 -------------------------------------------------------------------- Total $950.7 $345.3 $ 70.8 $7.1 $333.0 $ 86.1 $108.4 ===============================================================================================================
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. 89 92 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.
RETIREMENT PLAN OTHER POSTRETIREMENT BENEFITS ------------------------------- ------------------------------ (in thousands) 1998 1997 1998 1997 - ---------------------------------------------------------------------------------------------------------------- CHANGE IN BENEFIT OBLIGATION Benefit obligation at beginning of year $238,058 $216,863 $ 20,354 $ 18,703 Service cost 8,642 7,946 449 434 Interest cost 16,973 15,918 1,442 1,423 Plan participants' contributions -- -- 978 849 Amendments 1,445 59 (7,505) -- Actuarial loss 21,398 6,413 1,034 1,123 Acquisitions -- 944 -- -- Curtailment (7,924) -- (1,445) -- Benefits paid (11,824) (10,085) (2,619) (2,178) - ----------------------------------------------------------------------------------------------------------------- Benefit obligation at end of year $266,768 $238,058 $ 12,688 $ 20,354 ================================================================================================================= CHANGE IN PLAN ASSETS Fair value of plan assets at beginning of year $307,734 $255,343 $ -- $ -- Actual return on plan assets 63,474 60,048 -- -- Acquisitions -- 2,429 -- -- Employer contribution -- -- 1,641 1,329 Plan participants' contributions -- -- 978 849 Benefits paid (11,824) (10,085) (2,619) (2,178) - ----------------------------------------------------------------------------------------------------------------- Fair value of plan assets at end of year $359,384 $307,735 $ -- $ -- ================================================================================================================= Funded status at end of year $ 92,616 $ 69,676 $(12,688) $(20,354) Unrecognized net actuarial loss (gain) (57,234) (46,046) 119 (717) Unrecognized prior service cost 2,597 2,055 (6,085) -- Unrecognized net transition asset (obligation) (1,853) (2,754) 172 229 - ----------------------------------------------------------------------------------------------------------------- Prepaid (accrued) benefit cost $ 36,126 $ 22,931 $(18,482) $(20,842) =================================================================================================================
90 93 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:
RETIREMENT PLAN OTHER POSTRETIREMENT BENEFITS -------------------------------- ---------------------------------- 1998 1997 1996 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------- COMPONENTS OF NET PERIODIC BENEFIT COST (BENEFIT) Service cost $ 8,642 $ 7,946 $ 7,250 $ 449 $ 434 $ 330 Interest cost 16,973 15,918 14,659 1,441 1,423 1,339 Expected return on plan assets (28,095) (23,071) (20,603) -- -- -- Amortization of prior service cost 381 421 412 -- -- -- Amortization of net gain (2,793) (275) -- (9) (14) (1,449) Amortization of transition (asset) obligation (901) (901) (849) 57 57 57 Amortization of plan amendment -- -- -- (1,420) -- -- Change due to acquisition -- -- 43 -- -- -- Curtailment gain (7,402) -- -- (1,237) -- -- - ------------------------------------------------------------------------------------------------------------------- Net periodic benefit cost (benefit) $(13,195) $ 38 $ 912 $ (719) $ 1,900 $ 277 ===================================================================================================================
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:
1998 1997 1996 - -------------------------------------------------------------------------------------- Discount rate 6.75% 7.25% 7.25 - 7.75% Expected return on plan assets 9.30 9.00 - 9.30 9.00 - 9.30 Rate of compensation increase 5.40 5.00 - 5.30 5.00 - 5.15 ======================================================================================
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:
1-Percentage- 1-Percentage- (in thousands) Point Increase Point Decrease - ------------------------------------------------------------------------------------------------ Effect on total of service and interest cost components $ 1,856 $ 1,712 Effect on postretirement benefit obligation 13,179 12,255 ================================================================================================
First American continues to fund medical benefit costs principally on a pay-as-you-go basis. 91 94 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:
YEAR ENDED DECEMBER 31 ------------------------------------- (in thousands) 1998 1997 1996 - ---------------------------------------------------------------------------------------------- Income tax expense from continuing operations: Current federal income taxes $ 95,709 $110,423 $ 83,766 Current state income taxes 1,644 13,732 9,882 Deferred federal income tax expense 22,297 15,639 20,533 Deferred state income tax expense 2,441 2,272 3,698 - ---------------------------------------------------------------------------------------------- Total income tax expense from continuing operations 122,091 142,066 117,879 - ---------------------------------------------------------------------------------------------- Income tax expense (benefit) reported in shareholders' equity related to: Securities available for sale (7,806) 2,857 (15,818) Employee stock option and award plans (5,043) (5,603) (4,530) - ---------------------------------------------------------------------------------------------- Total income tax expense (benefit) reported in shareholders' equity (12,849) (2,746) (20,348) - ---------------------------------------------------------------------------------------------- Total income taxes $109,242 $139,320 $ 97,531 ==============================================================================================
92 95 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.
YEAR ENDED DECEMBER 31 ------------------------------------------- (in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------- Tax expense at statutory rates $116,709 $136,213 $116,100 Increase (decrease) in taxes resulting from: Tax-exempt interest income (8,631) (7,667) (8,576) Cash surrender value of life insurance (1,779) (1,680) (1,461) Amortization of intangibles 5,863 5,618 4,096 Acquisition expenses 6,301 (12) (352) State income taxes, net of federal income tax benefit 2,656 10,469 8,880 Other, net 972 (875) (808) - ------------------------------------------------------------------------------------------------------------------- Total income tax expense from continuing operations $122,091 $142,066 $117,879 ===================================================================================================================
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:
YEAR ENDED DECEMBER 31 ------------------------ (in thousands) 1998 1997 - ------------------------------------------------------------------------------------------------------- Deferred tax asset Allowance for loan losses $ 69,842 $ 68,733 Deferred compensation 14,535 14,829 Postretirement benefit obligation 7,901 9,124 Unrealized loss on securities available for sale 4,907 -- Other 17,934 19,120 - ------------------------------------------------------------------------------------------------------- Total deferred tax asset 115,119 111,806 - ------------------------------------------------------------------------------------------------------- Deferred tax liability Property, plant, and equipment 20,242 12,610 Direct lease financing 64,510 54,000 Unrealized gain on securities available for sale -- 1,584 Purchase accounting 13,363 15,284 Intercompany dividend 7,350 -- Mortgage servicing rights 12,675 10,031 Retirement plan 7,159 8,568 Other 14,314 10,958 - ------------------------------------------------------------------------------------------------------- Total deferred tax liability 139,613 113,035 - ------------------------------------------------------------------------------------------------------- Net deferred tax liability $(24,494) $ (1,229) =======================================================================================================
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. 93 96 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:
YEAR ENDED DECEMBER 31 ------------------------------------------ 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------ Restricted stock granted during the year 632,248 470,594 97,776 Weighted-average fair value of restricted stock granted during the year $45.47 $34.65 $23.14 ==================================================================================================================
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:
YEAR ENDED DECEMBER 31 ---------------------------------- (dollars in millions, except per share amounts) 1998 1997 1996 - ------------------------------------------------------------------------------------------------- Net income, as reported $211.4 $247.5 $214.2 Net income, proforma 208.2 245.5 213.1 - ------------------------------------------------------------------------------------------------- Basic earnings per share, as reported 1.88 2.19 1.93 Basic earnings per share, proforma 1.85 2.17 1.92 - ------------------------------------------------------------------------------------------------- Diluted earnings per share, as reported 1.84 2.15 1.91 Diluted earnings per share, proforma 1.82 2.14 1.90 =================================================================================================
94 97 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:
YEAR ENDED DECEMBER 31 ---------------------------------- 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------ Risk-free interest rate during the life of the option 5.50% 6.49% 5.69% Expected life of the option (in years) 6.1 6.1 6.1 Expected dividend yield over the expected life of the option 2.12% 2.56% 2.75% Expected volatility of the stock over the option's life 23.75 22.50 22.45 ============================================================================================================
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:
1998 1997 1996 ----------------------- ----------------------- ----------------------- TOTAL WEIGHTED- Total Weighted- Total Weighted- OPTION AVERAGE Option Average Option Average SHARES EXERCISE Shares Exercise Shares Exercise OUTSTANDING PRICE Outstanding Price Outstanding Price - ------------------------------------------------------------------------------------------------------------------- Options outstanding at beginning of year 4,534,363 $18.66 4,576,823 $15.55 4,434,667 $12.24 Options granted 775,163 47.19 926,726 29.20 1,202,840 22.68 Options exercised (697,155) 46.85 (829,966) 12.47 (997,654) 9.24 Options cancelled (192,739) 30.47 (139,220) 23.80 (63,030) 17.39 Options expired -- -- -- -- -- -- - ------------------------------------------------------------------------------------------------------------------- Options outstanding at end of year 4,419,632 $23.68 4,534,363 $18.66 4,576,823 $15.55 - ------------------------------------------------------------------------------------------------------------------- Options exercisable at end of year 2,387,399 $16.64 2,382,978 $14.60 2,434,238 $12.41 Weighted-average fair value of options granted during year $13.07 $10.20 $6.02 ===================================================================================================================
The following table summarizes information about stock options outstanding at December 31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE -------------------------------------------- ---------------------------- OPTIONS WEIGHTED- OPTIONS OUTSTANDING AVERAGE WEIGHTED- EXERCISABLE WEIGHTED- Range of AT REMAINING AVERAGE AT AVERAGE Exercise DECEMBER 31, CONTRACTUAL LIFE EXERCISE DECEMBER 31, EXERCISE Prices 1998 (YEARS) PRICE 1998 PRICE - ----------------------------------------------------------------------------------------------------------------- $ 4.625 - $10.940 394,926 2.47 $ 7.88 394,926 $ 7.88 $10.950 - $14.750 829,187 4.43 13.01 695,307 12.72 $14.760 - $20.000 758,314 5.05 17.15 615,693 17.12 $20.001 - $24.625 957,865 6.90 22.55 431,125 22.06 $24.626 - $29.563 701,113 8.02 28.75 208,412 27.86 $29.564 - $44.999 71,670 8.65 34.17 8,730 32.81 $45.000 - $55.000 706,557 9.03 47.49 33,206 49.32 - ----------------------------------------------------------------------------------------------------------------- $ 4.625 - $55.000 4,419,632 6.27 $23.68 2,387,399 $16.64 =================================================================================================================
95 98 NOTE 14: COMPUTATION OF EARNINGS PER COMMON SHARE
YEAR ENDED DECEMBER 31 ----------------------------------------------- (in thousands, except per share amounts) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------ Basic Average common shares outstanding 112,517 112,907 110,727 ================================================================================================================== Net income $211,362 $247,514 $214,179 ================================================================================================================== Per share amount $1.88 $2.19 $1.93 ================================================================================================================== Diluted Average common shares outstanding 112,517 112,907 110,727 Forward purchase commitment -- 21 -- Dilutive common stock options at average market price 2,165 2,321 1,559 - ------------------------------------------------------------------------------------------------------------------ Average diluted shares outstanding 114,682 115,249 112,286 ================================================================================================================== Net income $211,362 $247,514 $214,179 ================================================================================================================== Per share amount $1.84 $2.15 $1.91 ==================================================================================================================
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. 96 99 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. 97 100 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:
WEIGHTED- AVERAGE WEIGHTED-AVERAGE RATE MATURITY RELATED VARIABLE RATE NOTIONAL --------------------- -------- FAIR (dollars in thousands) ASSET/LIABILITY AMOUNT PAID RECEIVED YEARS VALUE - ---------------------------------------------------------------------------------------------------------------------------------- DECEMBER 31, 1998 Interest rate swaps Money market deposits $ 200,000 5.49%(1) 5.27% (2) 2.5 $ (1,052) Interest rate swaps Commercial loans 625,000 5.30 (2) 6.57 (1) 3.4 24,933 Interest rate swaps Mortgage loans 19,700 6.65 (1) 5.59 (3) 8.6 (1,132) Interest rate swaps FHLB advances 85,000 6.33 (1) 5.25 (2) 5.7 (4,811) Interest rate swaps Available for sale securities 200,000 5.30 (1) 5.36 (2) 3.0 (1,999) Forward interest rate swaps Money market deposits 350,000 5.78 (1) N/A (2,4) 2.4 (4,101) Forward interest rate swaps Available for sale securities 1,700,000 5.88 (1) 5.31 (2,5) 2.0 (21,541) ---------- ---------- Total interest rate contracts $3,179,700 $ (9,703) ================================================================================================================================== December 31, 1997 Interest rate swaps Money market deposits $ 150,000 5.97%(1) 5.91% (2) 2.1 $ 164 Interest rate swaps Commercial loans 775,000 5.82 (2) 6.61 (1) 4.3 17,507 Interest rate swaps Mortgage loans 21,225 6.65 (1) 6.00 (3) 9.5 (545) Interest rate swaps FHLB advances 85,000 6.33 (1) 5.88 (2) 6.7 (1,439) Interest rate swaps Available for sale securities 50,000 5.75 (2) 5.77 (6) 4.8 (693) Forward interest rate swaps Money market deposits 600,000 6.46 (1) 5.89 (2,7) 1.3 (1,821) Forward interest rate swaps Available for sale securities 750,000 6.24 (1) N/A (2,8) 2.5 (2,755) ---------- ---------- Total interest rate swaps 2,431,225 10,418 Interest rate floors Commercial loans 300,000 5.37 (9) N/A 2.9 1,604 ---------- ---------- Total interest rate contracts $2,731,225 $ 12,022 ==================================================================================================================================
(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. 98 101 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.
DECEMBER 31 ------------------------------ (in thousands) 1998 1997 - ------------------------------------------------------------------------------------- Related to interest rate swaps Deferred gains included in other liabilities $20,828 $11,189 Deferred losses included in other assets (6,163) (5,787) - ------------------------------------------------------------------------------------- Total net deferred gains $14,665 (1) $ 5,402 (2) =====================================================================================
(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. 99 102 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:
CORPORATION FIRST AMERICAN NATIONAL BANK --------------------------- ----------------------------- DECEMBER 31 DECEMBER 31 ------------------------------------------------------------- (dollars in thousands) 1998 1997 1998 1997 - ----------------------------------------------------------------------------------------------------------------- CAPITAL COMPONENTS Tier I capital: Realized shareholders' common equity $ 1,786,861 $ 1,641,152 $ 1,894,448 $ 1,726,527 Less disallowed intangibles (234,933) (247,983) (216,404) (229,188 - ----------------------------------------------------------------------------------------------------------------- Total Tier I capital 1,551,928 1,393,169 1,678,044 1,497,339 - ----------------------------------------------------------------------------------------------------------------- Tier II capital: Allowable allowance for loan losses 189,394 187,880 188,199 184,553 Unsecured holding company debt 99,523 99,442 -- -- - ----------------------------------------------------------------------------------------------------------------- Total Tier II capital 288,917 287,322 188,199 184,553 - ----------------------------------------------------------------------------------------------------------------- Total capital $ 1,840,845 $ 1,680,491 $ 1,866,243 $ 1,681,892 ================================================================================================================= Risk-adjusted assets $15,143,202 $14,960,708 $15,050,807 $14,948,812 Quarterly average assets 20,102,703 18,063,561 18,889,642 17,692,611 ================================================================================================================= CAPITAL RATIOS(1) Total risk-based capital ratio 12.16% 11.23% 12.40% 11.25% Tier I risk-based capital ratio 10.25 9.31 11.15 10.02 Tier I leverage ratio 7.72 7.71 8.88 8.46 =================================================================================================================
(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, 100 103 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. 101 104 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.
DECEMBER 31 ------------------------------------------------------------- 1998 1997 --------------------------- ------------------------------ ESTIMATED Estimated CARRYING FAIR Carrying Fair (in thousands) AMOUNT VALUE Amount Value - ------------------------------------------------------------------------------------------------------------------- Financial instruments (assets): Cash and short-term investments $ 1,500,732 $ 1,500,732 $ 1,047,856 $ 1,047,856 Securities held to maturity 1,730,460 1,739,852 763,423 771,815 Securities available for sale 4,495,160 4,495,160 3,552,185 3,552,185 Federal funds sold and securities purchased under agreements to resell 351,989 351,989 208,372 208,372 Trading account securities 43,987 43,987 64,469 64,469 Loans, net of unearned discount and allowance for loan losses 11,542,007 11,530,395 12,103,610 12,217,964 Financial instruments (liabilities): Noninterest-bearing deposits 3,046,651 3,046,651 2,774,449 2,774,449 Interest-bearing deposits 12,224,105 12,267,146 11,379,429 11,382,988 Short-term borrowings 2,213,637 2,213,637 2,050,078 2,050,078 Long-term debt 1,152,939 1,162,053 614,218 618,622 ===================================================================================================================
102 105 The estimated fair values for First American's off-balance-sheet financial instruments are summarized as follows:
DECEMBER 31 ------------------------------------------------------------- 1998 1997 --------------------------- ------------------------------ CONTRACTUAL ESTIMATED Contractual Estimated OR NOTIONAL FAIR or Notional Fair (in thousands) AMOUNT VALUE Amount Value - ----------------------------------------------------------------------------------------------------------- Commitments to extend credit $4,849,770 $ 889 $5,262,018 $ 9,021 Standby letters of credit 406,947 1,023 406,049 1,282 Commercial letters of credit 51,005 128 40,930 95 Interest rate swaps 1,129,700 15,939 1,081,225 14,994 Forward interest rate swaps 2,050,000 (25,642) 1,350,000 (4,576) Interest rate floors -- -- 300,000 1,604 ===========================================================================================================
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 103 106 comprehensive income. The amounts of other comprehensive income included in equity along with the related tax effect are set forth in the table below:
GAIN (LOSS) TAX BEFORE (EXPENSE) (in thousands) TAX BENEFIT NET OF TAX - ------------------------------------------------------------------------------------------------------------------ YEAR ENDED DECEMBER 31, 1998 - ------------------------------------------------------------------------------------------------------------------ Net unrealized loss on securities available for sale arising during 1998 $(15,298) $ 10,402 $ (4,896) Less: Reclassification adjustment for net gains included in net income 7,999 (3,070) 4,929 - ------------------------------------------------------------------------------------------------------------------ Other comprehensive loss $(23,297) $ 13,472 $ (9,825) ================================================================================================================== Year ended December 31, 1997 - ------------------------------------------------------------------------------------------------------------------ Net unrealized gain on securities available for sale arising during 1997 $ 12,554 $ (4,728) $ 7,826 Less: Reclassification adjustment for net gains included in net income 4,528 (1,652) 2,876 - ------------------------------------------------------------------------------------------------------------------ Other comprehensive income $ 8,026 $ (3,076) $ 4,950 ================================================================================================================== Year ended December 31, 1996 - ------------------------------------------------------------------------------------------------------------------ Net unrealized loss on securities available for sale arising during 1996 $(37,812) $ 14,435 $(23,377) Less: Reclassification adjustment for net gains included in net income 2,882 (1,118) 1,764 - ------------------------------------------------------------------------------------------------------------------ Other comprehensive loss $(40,694) $ 15,553 $(25,141) ==================================================================================================================
NOTE 19: PARENT COMPANY FINANCIAL INFORMATION Condensed financial information for First American (Parent Company only) was as follows: CONDENSED INCOME STATEMENTS
YEAR ENDED DECEMBER 31 ------------------------------------------------ (in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------- Income Dividends from subsidiaries: Banks $158,856 $267,018 $ 79,795 Fees from subsidiaries 7,324 42,821 41,465 Interest from subsidiaries 1,419 1,407 3,734 Interest on time deposits with other banks and other income 1,281 4,461 257 - ------------------------------------------------------------------------------------------------------------------- Total income 168,880 315,707 125,251 - ------------------------------------------------------------------------------------------------------------------- Expenses Interest expense 14,054 14,701 11,627 Salaries and employee benefits 12,159 27,627 28,234 Other expenses 45,668 24,939 23,903 - ------------------------------------------------------------------------------------------------------------------- Total expenses 71,881 67,267 63,764 - ------------------------------------------------------------------------------------------------------------------- Income before income taxes 96,999 248,440 61,487 Reduction to consolidated income taxes arising from parent company loss 20,208 9,099 8,129 - ------------------------------------------------------------------------------------------------------------------- Income before equity in undistributed earnings of subsidiaries 117,207 257,539 69,616 - ------------------------------------------------------------------------------------------------------------------- Equity in undistributed earnings (dividends in excess of earnings) of subsidiaries: Banks 94,089 (10,373) 144,037 Nonbanks 66 348 526 - ------------------------------------------------------------------------------------------------------------------- Net income $211,362 $247,514 $214,179 ===================================================================================================================
104 107 CONDENSED BALANCE SHEETS
DECEMBER 31 ---------------------------------- (in thousands) 1998 1997 - ------------------------------------------------------------------------------------------------------------------- Assets Cash $ 443 $ 5,003 Interest-bearing deposit with unaffiliated bank -- 7,600 Short-term investments with subsidiary 38,162 24,356 - ------------------------------------------------------------------------------------------------------------------- Total cash and cash equivalents 38,605 36,959 - ------------------------------------------------------------------------------------------------------------------- Securities available for sale 72 -- Note receivable from nonbank subsidiary 390 -- Employee stock ownership plan loan -- 163 Investment in subsidiaries, at cost adjusted for equity in earnings and net unrealized gains (losses) on securities available for sale: Bank 1,953,174 1,797,639 Nonbank 1,965 8,091 Other assets 25,186 53,764 - ------------------------------------------------------------------------------------------------------------------- Total assets $ 2,019,392 $ 1,896,616 =================================================================================================================== Liabilities and shareholders' equity Long-term debt $ 200,735 $ 200,839 Other liabilities 38,862 51,884 - ------------------------------------------------------------------------------------------------------------------- Total liabilities 239,597 252,723 - ------------------------------------------------------------------------------------------------------------------- Preferred stock, without par value -- -- Common stock, $2.50 par value 290,797 280,468 Additional paid-in capital 241,333 212,311 Retained earnings 1,286,512 1,161,877 Deferred compensation on restricted stock (31,781) (13,341) Employee stock ownership plan obligation -- (163) - ------------------------------------------------------------------------------------------------------------------- Realized shareholders' equity 1,786,861 1,641,152 Accumulated other comprehensive income (loss), net of tax (7,066) 2,741 - ------------------------------------------------------------------------------------------------------------------- Total shareholders' equity 1,779,795 1,643,893 - ------------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 2,019,392 $ 1,896,616 ===================================================================================================================
105 108 CONDENSED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31 ----------------------------------------------------- (in thousands) 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES Net income $ 211,362 $ 247,514 $ 214,179 Adjustments to reconcile net income to net cash provided by operating activities: (Undistributed income) dividends in excess of income of subsidiaries (94,155) 9,675 (144,563) Depreciation and amortization 541 2,296 3,470 Deferred income tax expense 2,277 113 1,614 Net gain on sale of other assets -- (2,258) -- Change in assets and liabilities Decrease (increase) in interest receivable and other assets 17,617 (8,241) (13,528) (Decrease) increase in interest payable and other liabilities (8,071) 1,156 7,543 - ---------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 129,571 250,255 68,715 - ---------------------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES Net decrease in employee stock ownership plan loan 163 280 218 Acquisitions, net of cash and cash equivalents acquired 979 (29,587) (1,477) Sale of other assets -- 2,830 -- Purchases of premises and equipment -- (4,255) (2,071) Net (increase) decrease in notes receivable from nonbank subsidiary (390) -- 2,990 Net decrease (increase) in investment in subsidiaries 7,290 (8,000) -- - ----------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) investing activities 8,042 (38,732) (340) - ----------------------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES Net decrease in short-term borrowings -- -- (27,600) Net proceeds from long-term debt -- 2,038 96,647 Issuance of common shares for Employee Benefit and Dividend Reinvestment Plans 18,231 22,710 19,195 Repurchase of common stock (65,384) (197,693) (109,419) Tax benefit related to stock options and award plans 5,183 5,603 4,530 Cash dividends paid (93,997) (80,177) (65,472) - ----------------------------------------------------------------------------------------------------------------------- Net cash used in financing activities (135,967) (247,519) (82,119) - ----------------------------------------------------------------------------------------------------------------------- Increase (decrease) in cash and cash equivalents 1,646 (35,996) (13,744) Cash and cash equivalents, beginning of year 36,959 72,955 86,699 - ----------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of year $ 38,605 $ 36,959 $ 72,955 ======================================================================================================================= Cash paid during the year for: Interest expense $ 14,000 $ 14,715 $ 10,419 Income taxes 49,392 103,581 96,370 Noncash investing activities: Stock issued for acquisitions (note 2) 62,947 94,637 83,723 =======================================================================================================================
106 109 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. 107 110
BANKING (in thousands) SERVICES ENTERPRISES OTHER TOTAL - ---------------------------------------------------------------------------------------------------------------------- Net interest income 1998 $ 729,584 $ 4,028 $ -- $ 733,612 1997 694,719 4,441 -- 699,160 1996 619,445 4,526 -- 623,971 Provision for loan losses 1998 (31,387) -- (9,546(a) (40,933) 1997 (16,109) -- -- (16,109) 1996 (6,437) -- -- (6,437) Noninterest income, external customers 1998 262,442 208,145 7,025(b) 477,612 1997 227,804 177,829 -- 405,633 1996 204,347 107,580 -- 311,927 Noninterest expense 1998 (540,569) (174,544) (121,725(c) (836,838) 1997 (541,921) (157,183) -- (699,104) 1996 (493,690) (95,613) (8,100(d) (597,403) Net pretax contribution 1998 420,070 37,629 (124,246(a)(b)(c) 333,453 1997 364,493 25,087 -- 389,580 1996 323,665 16,493 (8,100(d) 332,058 Equity in net income of equity method investees 1998 423 740 -- 1,163 1997 996 119 -- 1,115 1996 1,156 304 -- 1,460 Depreciation and amortization 1998 80,634 3,769 -- 84,403 1997 69,994 3,665 -- 73,659 1996 54,645 2,550 -- 57,195 Purchases of premises and equipment 1998 40,475 3,811 -- 44,286 1997 81,957 1,527 -- 83,484 1996 67,310 5,962 -- 73,272 Investment in equity method investees 1998 942 -- -- 942 1997 667 -- -- 667 1996 8,575 -- -- 8,575 Average total assets 1998 19,233,992 115,633 (40,697(E) 19,308,928 1997 17,814,152 134,000 (37,209(e) 17,910,943 1996 16,464,518 144,311 (12,569(e) 16,596,260 =======================================================================================================================
(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 108 111 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 109 112 /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 110 113 /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 111 114 EXHIBIT INDEX
NUMBER NAME - ------ ---- Exhibit 10.1(m) Employment Agreement dated December 7, 1997 by and between First American Corporation and E.B. Robinson, Jr., effective May 1, 1998, as amended July 1, 1998. Exhibit 10.1(n) Consulting Agreement by and between First American National Bank and George M. Clark, III, effective March 1, 1999. Exhibit 21 List of Subsidiaries. Exhibit 23 Accountants' Consent. Exhibit 27 Financial Data Schedule (for SEC use only).
112 EX-10.1.M 2 EMPLOYMENT AGREEMENT 1 EXHIBIT 10.1(m) Employment Agreement dated December 7, 1997 by and between First American Corporation and E.B. Robinson, Jr., effective May 1, 1998, as amended July 1, 1998. 2 EMPLOYMENT AGREEMENT AGREEMENT by and between First American Corporation, a Tennessee corporation (the "Company") and E. B. Robinson, Jr. (the "Executive") dated as of the 7th day of December, 1997. The Company has determined that it is in the best interests of the Company and its shareholders to assure that Deposit Guaranty Corp., a Mississippi corporation ("DGC") will have the continued dedication of the Executive pending the merger of the Company and DGC (the "Merger") pursuant to the Agreement and Plan of Merger dated as of December 7, 1997 and to provide the surviving corporation after the Merger with continuity of management. Therefore, in order to accomplish these objectives, the Board of Directors of the Company (the "Board") has caused the Company to enter into this Agreement. NOW, THEREFORE, IT IS HEREBY AGREED AS FOLLOWS: 1. Effective Date. The "Effective Date" shall mean the effective date of the Merger. 2. Employment Period. The Company hereby agrees to employ the Executive, and the Executive hereby agrees to enter into the employ of the Company subject to the terms and conditions of this Agreement, for the period commencing on the Effective Date and ending on the last day of the calendar month in which the Executive's 62nd birthday occurs (the "Employment Period"). 3. Terms of Employment. (a) Position and Duties. (i) (A) During the Employment Period, the Executive shall serve as Vice Chairman and Chief Operating Officer of the Company, President of First American National Bank and a member of the Company's Policy Team with such authority, duties and responsibilities as are commensurate with such position and as may be consistent with such position and (B) the Executive's services shall be performed in Nashville, Tennessee and Jackson, Mississippi. During the Employment Period, the Executive shall report directly to the Chief Executive Officer of the Company. The Executive shall serve on the Board and on the Executive Committee thereof during the Employment Period. (ii) During the Employment Period, and excluding any periods of vacation and sick leave to which the Executive is entitled, the Executive agrees to devote substantially all of his attention and time during normal business hours to the business and affairs of the Company and, to the extent necessary to discharge the responsibilities assigned to the Executive hereunder, to use the Executive's reasonable best efforts to perform faithfully and efficiently such responsibilities. During the Employment Period it shall not be a violation of this Agreement for the Executive to (A) serve on corporate, civic or charitable boards or committees, (B) deliver lectures, fulfill speaking engagements or teach at educational institutions and (C) manage personal 3 investments, so long as such activities do not significantly interfere with the performance of the Executive's responsibilities as an employee of the Company in accordance with this Agreement. It is expressly understood and agreed that to the extent that any such activities have been conducted by the Executive prior to the Effective Date, the continued conduct of such activities (or the conduct of activities similar in nature and scope thereto) subsequent to the Effective Date shall not thereafter be deemed to interfere with the performance of the Executive's responsibilities to the Company. (b) Compensation. (i) Base Salary. During the Employment Period, the Executive shall receive an annual base salary ("Annual Base Salary") of no less than $600,000 or if greater, 80% of the annual base salary paid to the Chief Executive Officer of the Company. During the Employment Period, the Annual Base Salary shall be reviewed no more than 12 months after the last salary increase awarded to the Executive prior to the Effective Date and thereafter at least annually. Any increase in Annual Base Salary shall not serve to limit or reduce any other obligation to the Executive under this Agreement. Annual Base Salary shall not be reduced after any such increase and the term Annual Base Salary as utilized in this Agreement shall refer to Annual Base Salary as so increased. As used in this Agreement, the term "affiliated companies" shall include any company controlled by, controlling or under common control with the Company. (ii) Annual Bonus. During the Employment Period, the Executive shall be eligible to receive an annual cash bonus ("Annual Bonus") at a target of 50% of his Annual Base Salary up to a maximum of 100% of Annual Base Salary, provided the Annual Bonus shall be in a minimum amount such that the sum of the Executive's Annual Base Salary and Annual Bonus shall be no less than 80% of the sum of the annual base salary and annual bonus paid to the Chief Executive Officer of the Company with respect to the year in question. (iii) Incentive Awards. On the Effective Date, the Company shall grant the Executive 45,000 shares of restricted stock (the "Restricted Stock") and an option to acquire 90,000 shares of the Company's stock (the "Option") pursuant to the terms of the Company's stock incentive plan. The Option will have an exercise price equal to the fair market value of the stock subject thereto on the date of grant. Except as otherwise provided herein, the Option and the Restricted Stock shall vest in three equal installments, on the first, second and third anniversaries of the date of grant or, if earlier, upon a change of control of the Company (as defined in the Company's stock incentive plan). The Option will remain exercisable until the tenth anniversary of the date of grant, unless forfeited prior thereto upon the Executive's termination for Cause (as defined herein) or without Good Reason (as defined herein). At such time as the Company makes its annual stock incentive grants, the Executive shall be made grants with a value equal to 166% of his Annual Base Salary on the same basis as peer executives, pursuant to the terms of the Company's stock incentive plan. (iv) Retirement. The Executive shall be paid an annual retirement benefit of 60% of his Final Average Pay (as defined below) commencing at 4 age 62 for his life less any benefit payable pursuant to the Company's and DGC's qualified retirement plan and in lieu of any benefit to which he might be entitled under DGC's Supplemental Retirement Plan or any nonqualified retirement plan of the Company or any of its affiliated companies (not including DGC's Executive and Directors Deferred Income Plan) (the "Retirement Benefit"). Upon the Executive's death, his current spouse, should she survive the Executive, shall be paid an annual benefit of 50% of the Retirement Benefit for her life. "Final Average Pay" means the average of the sum of the Executive's annual base salary and annual bonus for the five calendar years prior to his date of retirement. (v) Other Employee Benefit Plans. During the Employment Period, except as otherwise expressly provided herein, the Executive shall be entitled to participate in all employee benefit, welfare and other plans, practices, policies and programs applicable to peer executives of the Company on a basis no less favorable than that provided to peer executives of the Company, including, without limitation, change of control severance arrangements which shall be entered into on or prior to the Effective Date. (vi) Expenses. During the Employment Period, the Executive shall be entitled to receive prompt reimbursement for all reasonable expenses incurred by the Executive in accordance with the Company's policies. (vii) Fringe Benefits. During the Employment Period, the Executive shall be entitled to fringe benefits, including, without limitation, payment of club dues, to the extent applicable to peer executives of the Company. During the Employment Period, the Executive shall be entitled to the use of an automobile and payment of related expenses, pursuant to the terms of DGC's policy until the first anniversary of the Effective Date, and thereafter, in accordance with the terms of the Company's policy as it applies to peer executives of the Company. (viii) Office and Support Staff. During the Employment Period, the Executive shall be entitled to an office or offices of a size and with furnishings and other appointments as provided generally at any time thereafter with respect to other peer executives of the Company and its affiliated companies. (ix) Vacation. During the Employment Period, the Executive shall be entitled to paid vacation in accordance with the plans, policies, programs and practices of the Company and its affiliated companies as in effect with respect to the peer executives of the Company. 4. Termination of Employment. (a) Death or Disability. The Executive's employment shall terminate automatically upon the Executive's death during the Employment Period. If the Company determines in good faith that the Disability of the Executive has occurred during the Employment Period (pursuant to the definition of Disability set forth below), it may give to the Executive written notice in accordance with Section 11(b) of this Agreement of its intention to terminate the 5 Executive's employment. In such event, the Executive's employment with the Company shall terminate effective on the 30th day after receipt of such notice by the Executive (the "Disability Effective Date"), provided that, within the 30 days after such receipt, the Executive shall not have returned to full-time performance of the Executive's duties. For purposes of this Agreement, "Disability" shall mean the absence of the Executive from the Executive's duties with the Company on a full-time basis for 180 consecutive business days as a result of incapacity due to mental or physical illness which is determined to be total and permanent by a physician selected by the Company or its insurers and acceptable to the Executive or the Executive's legal representative. (b) Cause. The Company may terminate the Executive's employment during the Employment Period for Cause. For purposes of this Agreement, "Cause" shall mean: (i) the continued failure of the Executive to perform substantially the Executive's duties with the Company or one of its affiliates (other than any such failure resulting from incapacity due to physical or mental illness), after a written demand for substantial performance is delivered to the Executive by the Board or the Chief Executive Officer of the Company which specifically identifies the manner in which the Board or Chief Executive Officer believes that the Executive has not substantially performed the Executive's duties, or (ii) the willful engaging by the Executive in illegal conduct or gross misconduct, which is materially and demonstrably injurious to the Company, or (iii) conviction of a felony or guilty or nolo contendere plea by the Executive with respect thereto, which is materially and demonstrably injurious to the Company. For purposes of this provision, no act or failure to act, on the part of the Executive, shall be considered "willful" unless it is done, or omitted to be done, by the Executive in bad faith or without reasonable belief that the Executive's action or omission was in the best interests of the Company. Any act, or failure to act, based upon authority given pursuant to a resolution duly adopted by the Board or upon the instructions of the Chief Executive Officer or a senior officer of the Company or based upon the advice of counsel for the Company shall be conclusively presumed to be done, or omitted to be done, by the Executive in good faith and in the best interests of the Company. The cessation of employment of the Executive shall not be deemed to be for Cause unless and until there shall have been delivered to the Executive a copy of a resolution duly adopted by the affirmative vote of not less than two-thirds of the entire membership of the Board at a meeting of the Board called and held for such purpose (after reasonable notice is provided to the Executive and the Executive is given an opportunity, together with counsel, to be heard before the Board), finding that, in the good faith opinion of the Board, the Executive is guilty of the conduct described in subparagraph (i), (ii) or (iii) above, and specifying the particulars thereof in detail. 6 (c) Good Reason. The Executive's employment may be terminated by the Executive for Good Reason. For purposes of this Agreement, "Good Reason" shall mean in the absence of a written consent of the Executive: (i) the assignment to the Executive of any duties inconsistent in any respect with the Executive's position (including status, offices, titles and reporting requirements), authority, duties or responsibilities as contemplated by Section 3(a) of this Agreement, or any other action by the Company which, in the Executive's reasonable judgment, results in a diminution in such position, authority, duties or responsibilities, excluding for this purpose an isolated, insubstantial and inadvertent action not taken in bad faith and which is remedied by the Company promptly after receipt of notice thereof given by the Executive; (ii) any failure by the Company to comply with any of the provisions of Section 3(b) of this Agreement, other than an isolated, insubstantial and inadvertent failure not occurring in bad faith and which is remedied by the Company promptly after receipt of notice thereof given by the Executive; (iii) the Company's requiring the Executive to be based at any office or location more than 35 miles from that provided in Section 3(a)(i)(B) hereof; (iv) any purported termination by the Company of the Executive's employment otherwise than as expressly permitted by this Agreement; or (v) any failure by the Company to comply with and satisfy Section 10(c) of this Agreement. For purposes of this Section 4(c), any good faith determination of "Good Reason" made by the Executive shall be conclusive. (d) Notice of Termination. Any termination by the Company for Cause, or by the Executive for Good Reason, shall be communicated by Notice of Termination to the other party hereto given in accordance with Section 11(b) of this Agreement. For purposes of this Agreement, a "Notice of Termination" means a written notice which (i) indicates the specific termination provision in this Agreement relied upon, (ii) to the extent applicable, sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated and (iii) if the Date of Termination (as defined below) is other than the date of receipt of such notice, specifies the termination date (which date shall be not more than thirty days after the giving of such notice). The failure by the Executive or the Company to set forth in the Notice of Termination any fact or circumstance which contributes to a showing of Good Reason or Cause shall not waive any right of the Executive or the Company, respectively, hereunder or preclude the Executive or the Company, respectively, from asserting such fact or circumstance in enforcing the Executive's or the Company's rights hereunder. 7 (e) Date of Termination. "Date of Termination" means (i) if the Executive's employment is terminated by the Company for Cause, or by the Executive for Good Reason, the date of receipt of the Notice of Termination or any later date specified therein within 30 days of such notice, as the case may be, (ii) if the Executive's employment is terminated by the Company other than for Cause or Disability, the Date of Termination shall be the date on which the Company notifies the Executive of such termination and (iii) if the Executive's employment is terminated by reason of death or Disability, the Date of Termination shall be the date of death of the Executive or the Disability Effective Date, as the case may be. 5. Obligations of the Company upon Termination. (a) Good Reason; Other Than for Cause, Death or Disability. If, during the Employment Period, the Company shall terminate the Executive's employment other than for Cause or Disability or the Executive shall terminate employment for Good Reason: (i) the Company shall pay to the Executive in a lump sum in cash within 30 days after the Date of Termination the aggregate of the following amounts: A. the sum of (1) the Executive's Annual Base Salary through the Date of Termination to the extent not theretofore paid, and (2) the product of (x) the highest annual bonus earned by the Executive under DGC's Variable Pay Plan for any of the three years prior to the Effective Date (the "Recent Annual Bonus") and (y) a fraction, the numerator of which is the number of days in the fiscal year in which the Date of Termination occurs through the Date of Termination, and the denominator of which is 365, in each case to the extent not theretofore paid (the sum of the amounts described in clauses (1) and (2), shall be hereinafter referred to as the "Accrued Obligations"); and B. the amount equal to the product of (1) the number of months and portions thereof from the Date of Termination until the end of the calendar month in which the Executive's 62nd birthday occurs (the "Continuation Period") divided by twelve and (2) the sum of (x) the Executive's Annual Base Salary and (y) the Recent Annual Bonus; and (ii) for the Continuation Period, the Company shall continue to provide medical and dental benefits (collectively "Medical Benefits") and other welfare benefits to the Executive and his spouse on a basis such benefits were provided to the Executive immediately prior to the Date of Termination; (iii) the Option and the Restricted Stock shall vest immediately; (iv) for purposes of the Executive's Retirement Benefit, the Executive shall be deemed to have terminated employment at the end of the Continuation Period and have received compensation during such period equal to the sum of his 8 Annual Base Salary and Recent Annual Bonus in respect of the calendar year immediately prior to the Date of Termination, and such benefit shall commence at the end of the Continuation Period; and (v) to the extent not theretofore paid or provided, the Company shall timely pay or provide to the Executive any other amounts or benefits required to be paid or provided or which the Executive is eligible to receive under any plan, program, policy or practice or contract or agreement of the Company and its affiliated companies through the Date of Termination (such other amounts and benefits shall be hereinafter referred to as the "Other Benefits"). (b) Death. If the Executive's employment is terminated by reason of the Executive's death during the Employment Period, this Agreement shall terminate without further obligations to the Executive's legal representatives under this Agreement, other than the continued payment for one year following the Date of Termination of the Executive's Annual Base Salary and Annual Bonus in the amounts earned in respect of the calendar year immediately prior to the Date of Termination, the payment of Accrued Obligations and the timely payment or provision of Other Benefits. In addition, the Option and the Restricted Stock shall vest immediately. Accrued Obligations shall be paid to the Executive's estate or beneficiary, as applicable, in a lump sum in cash within 30 days of the Date of Termination. With respect to the provision of Other Benefits, the term Other Benefits as utilized in this Section 5(b) shall include death benefits as in effect on the date of the Executive's death with respect to the Chief Executive Officer of the Company and his beneficiaries, the continued provision of Medical Benefits to the Executive's current spouse and the payment of the Retirement Benefit to the Executive's current spouse commencing upon the date the Executive would have attained age 62. (c) Disability. If the Executive's employment is terminated by reason of the Executive's Disability during the Employment Period, this Agreement shall terminate without further obligations to the Executive, other than for payment of Accrued Obligations and the timely payment or provision of Other Benefits. In addition, the Option and the Restricted Stock shall vest immediately. Accrued Obligations shall be paid to the Executive in a lump sum in cash within 30 days of the Date of Termination. With respect to the provision of Other Benefits, the term Other Benefits as utilized in this Section 5(c) shall include, and the Executive shall be entitled after the Disability Effective Date to receive, disability and other benefits as in effect at any time thereafter generally with respect to the Chief Executive Officer of the Company, the continued provision of Medical Benefits to the Executive and his current spouse and the payment of the Retirement Benefit commencing upon the date the Executive attains age 62. (d) Cause; Other than for Good Reason. If the Executive's employment shall be terminated for Cause or the Executive terminates his employment without Good Reason during the Employment Period, this Agreement shall terminate without further obligations to the Executive other than the obligation to pay to the Executive (x) his Annual Base Salary through the Date of Termination, and (y) Other Benefits, in each case to the extent theretofore unpaid. With respect to the provision of 9 Other Benefits, the term Other Benefits as utilized in this Section 5(d) shall include the payment of the Retirement Benefit commencing upon the date the Executive attains age 62. 6. Non-exclusivity of Rights. Except as specifically provided, nothing in this Agreement shall prevent or limit the Executive's continuing or future participation in any plan, program, policy or practice provided by the Company or any of its affiliated companies and for which the Executive may qualify, nor, subject to Section 11(f), shall anything herein limit or otherwise affect such rights as the Executive may have under any contract or agreement with the Company or any of its affiliated companies. Amounts which are vested benefits or which the Executive is otherwise entitled to receive under any plan, policy, practice or program of or any contract or agreement with the Company or any of its affiliated companies at or subsequent to the Date of Termination shall be payable in accordance with such plan, policy, practice or program or contract or agreement except as explicitly modified by this Agreement. 7. Full Settlement. The Company's obligation to make the payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any set-off, counterclaim, recoupment, defense or other claim, right or action which the Company may have against the Executive or others. In no event shall the Executive be obligated to seek other employment or take any other action by way of mitigation of the amounts payable to the Executive under any of the provisions of this Agreement and, such amounts shall not be reduced whether or not the Executive obtains other employment. The Company agrees to pay as incurred, to the full extent permitted by law, all legal fees and expenses which the Executive may reasonably incur as a result of any contest (regardless of the outcome thereof) by the Company, the Executive or others of the validity or enforceability of, or liability under, any provision of this Agreement or any guarantee of performance thereof (including as a result of any contest by the Executive about the amount of any payment pursuant to this Agreement), plus in each case interest on any delayed payment at the applicable Federal rate provided for in Section 7872(f)(2)(A) of the Internal Revenue Code of 1986, as amended (the "Code"). 8. Certain Additional Payments by the Company. (a) Anything in this Agreement to the contrary notwithstanding and except as set forth below, in the event it shall be determined that any payment or distribution by the Company or DGC to or for the benefit of the Executive (whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise, but determined without regard to any additional payments required under this Section 8) (a "Payment") would be subject to the excise tax imposed by Section 4999 of the Code or any interest or penalties are incurred by the Executive with respect to such excise tax (such excise tax, together with any such interest and penalties, are hereinafter collectively referred to as the "Excise Tax"), then the Executive shall be entitled to receive an additional payment (a "Gross-Up Payment") in an amount such that after payment by the Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including, without limitation, any income taxes (and any interest 10 and penalties imposed with respect thereto) and Excise Tax imposed upon the Gross-Up Payment, the Executive retains an amount of the Gross-Up Payment equal to the Excise Tax imposed upon the Payments. Notwithstanding the foregoing provisions of this Section 8(a), if it shall be determined that the Executive is entitled to a Gross-Up Payment, but that the Payments do not exceed 110% of the greatest amount (the "Reduced Amount") that could be paid to the Executive such that the receipt of Payments would not give rise to any Excise Tax, then no Gross-Up Payment shall be made to the Executive and the Payments, in the aggregate, shall be reduced to the Reduced Amount. (b) Subject to the provisions of Section 8(c), all determinations required to be made under this Section 8, including whether and when a Gross-Up Payment is required and the amount of such Gross-Up Payment and the assumptions to be utilized in arriving at such determination, shall be made by KPMG Peat Marwick LLP or such other certified public accounting firm reasonably acceptable to the Company as may be designated by the Executive (the "Accounting Firm") which shall provide detailed supporting calculations both to the Company and the Executive within 15 business days of the receipt of notice from the Executive that there has been a Payment, or such earlier time as is requested by the Company. All fees and expenses of the Accounting Firm shall be borne solely by the Company. Any Gross-Up Payment, as determined pursuant to this Section 8, shall be paid by the Company to the Executive within five days of the later of (i) the due date for the payment of any Excise Tax, and (ii) the receipt of the Accounting Firm's determination. Any determination by the Accounting Firm shall be binding upon the Company and the Executive. As a result of the uncertainty in the application of Section 4999 of the Code at the time of the initial determination by the Accounting Firm hereunder, it is possible that Gross-Up Payments which will not have been made by the Company should have been made ("Underpayment"), consistent with the calculations required to be made hereunder. In the event that the Company exhausts its remedies pursuant to Section 8(c) and the Executive thereafter is required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be promptly paid by the Company to or for the benefit of the Executive. (c) The Executive shall notify the Company in writing of any claim by the Internal Revenue Service that, if successful, would require the payment by the Company of the Gross-Up Payment. Such notification shall be given as soon as practicable but no later than ten business days after the Executive is informed in writing of such claim and shall apprise the Company of the nature of such claim and the date on which such claim is requested to be paid. The Executive shall not pay such claim prior to the expiration of the 30-day period following the date on which it gives such notice to the Company (or such shorter period ending on the date that any payment of taxes with respect to such claim is due). If the Company notifies the Executive in writing prior to the expiration of such period that it desires to contest such claim, the Executive shall: (i) give the Company any information reasonably requested by the Company relating to such claim, 11 (ii) take such action in connection with contesting such claim as the Company shall reasonably request in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by the Company, (iii) cooperate with the Company in good faith in order effectively to contest such claim, and (iv) permit the Company to participate in any proceedings relating to such claim; provided, however, that the Company shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and shall indemnify and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income tax (including interest and penalties with respect thereto) imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this Section 8(c), the Company shall control all proceedings taken in connection with such contest and, at its sole option, may pursue or forgo any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, at its sole option, either direct the Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company shall determine; provided, however, that if the Company directs the Executive to pay such claim and sue for a refund, the Company shall advance the amount of such payment to the Executive, on an interest-free basis and shall indemnify and hold the Executive harmless, on an after-tax basis, from any Excise Tax or income tax (including interest or penalties with respect thereto) imposed with respect to such advance or with respect to any imputed income with respect to such advance; and further provided that any extension of the statute of limitations relating to payment of taxes for the taxable year of the Executive with respect to which such contested amount is claimed to be due is limited solely to such contested amount. Furthermore, the Company's control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable hereunder and the Executive shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority. (d) If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 8(c), the Executive becomes entitled to receive any refund with respect to such claim, the Executive shall (subject to the Company's complying with the requirements of Section 8(c)) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after taxes applicable thereto). If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 8(c), a determination is made that the Executive shall not be entitled to any refund with respect to such claim and the Company does not notify the Executive in 12 writing of its intent to contest such denial of refund prior to the expiration of 30 days after such determination, then such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of Gross-Up Payment required to be paid. 9. Confidential Information. (a) The Executive shall hold in a fiduciary capacity for the benefit of the Company all secret or confidential information, knowledge or data relating to the Company or any of its affiliated companies, and their respective businesses, which shall have been obtained by the Executive during the Executive's employment by the Company or any of its affiliated companies and which shall not be or become public knowledge (other than by acts by the Executive or representatives of the Executive in violation of this Agreement). After termination of the Executive's employment with the Company, the Executive shall not, without the prior written consent of the Company or as may otherwise be required by law or legal process, communicate or divulge any such information, knowledge or data to anyone other than the Company and those designated by it. In no event shall an asserted violation of the provisions of this Section 9 constitute a basis for deferring or withholding any amounts otherwise payable to the Executive under this Agreement. (b) In the event of a breach or threatened breach of this Section 9, the Executive agrees that the Company shall be entitled to injunctive relief in a court of appropriate jurisdiction to remedy any such breach or threatened breach, the Executive acknowledges that damages would be inadequate and insufficient. (c) Any termination of the Executive's employment or of this Agreement shall have no effect on the continuing operation of this Section 9. 10. Successors. (a) This Agreement is personal to the Executive and without the prior written consent of the Company shall not be assignable by the Executive otherwise than by will or the laws of descent and distribution. This Agreement shall inure to the benefit of and be enforceable by the Executive's legal representatives. (b) This Agreement shall inure to the benefit of and be binding upon the Company and its successors and assigns. (c) The Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company to assume expressly and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place. As used in this Agreement, "Company" shall mean the Company as hereinbefore defined and any successor to its business and/or assets as aforesaid which assumes and agrees to perform this Agreement by operation of law, or otherwise. 11. Miscellaneous. (a) This Agreement shall be governed by and construed in accordance with the laws of the State of Tennessee, without 13 reference to principles of conflict of laws. The captions of this Agreement are not part of the provisions hereof and shall have no force or effect. This Agreement may not be amended or modified otherwise than by a written agreement executed by the parties hereto or their respective successors and legal representatives. (b) All notices and other communications hereunder shall be in writing and shall be given by hand delivery to the other party or by registered or certified mail, return receipt requested, postage prepaid, addressed as follows: If to the Executive: If to the Company: Attention: General Counsel or to such other address as either party shall have furnished to the other in writing in accordance herewith. Notice and communications shall be effective when actually received by the addressee. (c) The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement. (d) The Company may withhold from any amounts payable under this Agreement such Federal, state, local or foreign taxes as shall be required to be withheld pursuant to any applicable law or regulation. (e) The Executive's or the Company's failure to insist upon strict compliance with any provision of this Agreement or the failure to assert any right the Executive or the Company may have hereunder, including, without limitation, the right of the Executive to terminate employment for Good Reason pursuant to Section 4(c)(i) - (v) of this Agreement, shall not be deemed to be a waiver of such provision or right or any other provision or right of this Agreement. (f) From and after the Effective Date, this Agreement shall supersede any other employment, severance or change of control agreement between the parties hereto or the Executive and DGC with respect to the subject matter hereof. 14 IN WITNESS WHEREOF, the Executive has hereunto set the Executive's hand and, pursuant to the authorization from its Board of Directors, the Company has caused these presents to be executed in its name on its behalf, all as of the day and year first above written. /s/ E.B. Robinson, Jr. ------------------------------------------ E.B. ROBINSON, JR. FIRST AMERICAN CORPORATION By: /s/ Dennis C. Bottorff -------------------------------------- 15 FIRST AMENDMENT TO EMPLOYMENT AGREEMENT THIS FIRST AMENDMENT TO EMPLOYMENT AGREEMENT ("First Amendment"), dated as of the 1st day of July, 1998, is made and entered into by and between First American Corporation, a Tennessee corporation (the "Company"), and E. B. Robinson, Jr. (the "Executive") and amends certain provisions of the Employment Agreement by and between the Company and the Executive, dated as of December 7, 1997 (the "Agreement"). WHEREAS, the Company and the Executive have determined that it is in the best interests of the parties to the Agreement to amend the Agreement to modify certain provisions. NOW, THEREFORE, the parties hereto agree as follows: 1. Section 3(b)(v) of the Agreement is hereby amended to read in its entirety as follows: (v) Other Employee Benefit Plans. During the Employment Period, except as otherwise expressly provided herein, the Executive shall be entitled to participate in all employee benefit, welfare and other plans, practices, policies and programs applicable to peer executives of the Company (excluding any change of control severance plan, policy or program of the Company or its affiliated companies), on a basis no less favorable than that provided to peer executives of the Company. 2. Section 5 of the Agreement is hereby amended by adding the following paragraph (e) at the end thereof: (e) Change of Control Protection. If within two years following a "Change in Control" or "Potential Change in Control" (each as defined in the First American Corporation 1991 Employee Stock Incentive Plan), the Company shall terminate the Executive's employment other than for Cause, Disability or death or the Executive shall terminate for Good Reason, the Executive shall be entitled to receive the payments and benefits set forth in Section 5(a)(i) through (v) of this Agreement, provided that, if the Change of Control or Potential Change of Control occurs on or after the date that is three years prior to the Executive's 62nd birthday, the Executive shall be entitled to the payments and benefits set forth in Section 5(a), modified as follows: (i) for purposes of the calculation in Section 5(a)(i)(B), clause (1) thereof shall be replaced with the following: "(1) three"; (ii) for purposes of Section 5(a)(ii), the words "for the Continuation Period" shall be replaced with the following: "for the three year period following the Date of Termination"; and 16 (iii) for purposes of Section 5(a)(iv), the words "at the end of the Continuation Period", shall be globally replaced with the following: "on the last day of the calendar month in which the Executive's 62nd birthday occurs". Notwithstanding anything to the contrary contained in this Agreement, the payments and benefits provided under this Section 5(e) shall be in lieu of, and not in addition to, any other payments or benefits that the Executive may be entitled to receive under the Agreement as amended or under any other severance plan or policy maintained by the Company; provided, however, that nothing contained herein shall effect the Executive's right to receive benefits under Section 3(b)(iv) and Section 8 of this Agreement in accordance with the terms of such Sections. 3. Except as expressly modified hereby, the terms and provisions of the Employment Agreement remain in full force and effect. IN WITNESS WHEREOF, the parties hereto have caused this First Amendment to be duly executed and delivered as of the date first above written. FIRST AMERICAN CORPORATION By: /s/ Dennis C. Bottorff /s/ E.B. Robinson, Jr. ------------------------- --------------------------------- E.B. Robinson, Jr. EX-10.1.N 3 CONSULTING AGREEMENT 1 EXHIBIT 10.1(n) Consulting Agreement by and between First American National Bank and George M. Clark, III, effective March 1, 1999. 2 CONSULTING AGREEMENT This AGREEMENT, made as of February 25, 1999, between First American National Bank, a national banking association ("FANB"), and George M. Clark, III ("Consultant"). W I T N E S S E T H: WHEREAS, FANB is regularly engaged in the business of banking and the providing of financial services; and WHEREAS, pursuant to the Merger Agreement (as that term is defined in Paragraph 1 hereof), it is contemplated that First American Corporation ("FAC"), the sole shareholder of FANB, acquired Pioneer Bancshares, Inc. ("PBI") and consummated the transactions related thereto (the "Merger") on November 20, 1998; and WHEREAS, Consultant served as Executive Vice President - Private Banking and as a director of PBI and has significant experience and expertise in the business of banking and the providing of financial services; and WHEREAS, FANB wishes to engage Consultant to provide his assistance and services to FANB for their mutual benefit and profit; and WHEREAS, Consultant is willing to provide assistance and services to FANB on the terms set out herein. NOW, THEREFORE, premises considered, in consideration of the mutual covenants set out below, and for other good and valuable consideration, the receipt and sufficiency of which are acknowledged, the parties hereto intending to be legally bound agree as follows: 1. ENGAGEMENT. FANB retains Consultant for a term beginning on March 1, 1999 and ending as provided in paragraph 4 hereof (the "Term"). The date on which Consultant ceases to be retained by FANB and/or its subsidiaries (as defined below) or its successors or assigns is referred to herein as the "Termination Date". 2. SERVICES. Throughout the Term and in a manner commensurate with his previous position with PBI, Consultant undertakes to provide his personal advice and counsel to FANB and/or its affiliates, including without limitation, First American Corporation ("FAC"), in connection with the business of banking and financial services. Specifically, Consultant agrees to provide his advice and counsel to FANB in connection with the ongoing operations of PBI as one or more branches of FANB serve as an Advisory Director on FANB's Chattanooga Advisory Board of Directors, and shall also render such administrative, sales, marketing and other services to FANB, its affiliates and its 3 subsidiaries as FANB and Consultant may mutually agree under the general direction of the President of FAC, or his designee. FANB shall also provide to Consultant, at FANB's expense, use of office space, which is to be selected by FANB, during the term of this Agreement. (a) The duties and obligations of Consultant under this Agreement are neither exclusive nor full-time. Subject to the provisions of Section 6 hereof, Consultant shall be free to pursue and conduct all other business activities. (b) For purposes of this Agreement, "subsidiaries" shall mean any corporation of which the securities having at least 50% of the voting power in electing directors are, at the time of determination, owned by FANB or FAC, directly or through one or more subsidiaries. The term "affiliate" shall mean a direct or indirect subsidiary of either FANB or FAC. 3. REMUNERATION. In consideration of the services to be rendered by Consultant pursuant to this Agreement, FANB shall pay Consultant annual fees of Eighty Three Thousand and Fifty-One Dollars ($83,051.00). FANB shall pay one twelfth (1/12) of such annual fees to Consultant monthly, on or before the last day of each calendar month, throughout the Term. On March 1, 1999, FANB shall also pay Consultant an additional one-time payment of $2000 as additional consideration for Consultant's entering into the Agreement. Further, each of Consultant's options for PBI common stock (to the extent that such options are exercisable) awarded to him while an Employee of PBI that would have vested in 1998 and 1999 notwithstanding the Merger shall be vested as of January 1, 1999. FANB shall also reimburse Consultant for his reasonable and appropriate out-of-pocket travel and business expenses incurred in rendering services hereunder in accordance with FANB's policies and procedures relating to the reimbursement of such expenses. 4. TERMINATION. This Agreement, the Term hereof, and FANB's duty to pay Consultant the remuneration set out herein may be terminated either (i) on December 31, 2000 or (ii) at any time, upon the occurrence of one or more of the following: (a) Upon the written mutual agreement of Consultant and FANB; (b) For Cause, as that term is defined herein, but only at the election of FANB. For these purposes, "Cause" shall mean a good faith determination by the Board of Directors of FAC and FANB that (i) Consultant has been convicted of a crime involving fraud, theft, embezzlement, or other felony, (ii) Consultant knowingly or intentionally has breached any of the material terms of this Agreement, or (iii) Consultant has willfully committed a violation of any laws and/or regulations applicable to FANB and/or its affiliates; or (c) By FANB upon the death or total disability of Consultant. 4 5. CONFIDENTIAL INFORMATION. Consultant acknowledges that in the course of his engagement by FANB he will have access to confidential proprietary information and data concerning the business of FANB and its affiliates, collectively, the "Information", which FANB desires to protect. Consultant understands that the Information, to the extent not otherwise published or known generally, is confidential and proprietary, and agrees not to reveal such Information to persons outside FANB; provided, however, that Consultant may reveal, utilize, and otherwise employ the Information in any manner required by law or as may be necessary in carrying out his duties hereunder. If this Agreement is terminated for any reason, the obligations contained in this Section 5 shall survive forever such termination. 6. RESTRICTIONS. During the Term of this Agreement and for a period of one (1) year thereafter, Consultant shall not, directly or indirectly, participate or be actively involved in, own, manage, operate, control or participate in the ownership, management, operation or control of, or be connected as an officer, employee, partner, director or otherwise with, or have any financial interest in, or aid or assist anyone else in the conduct of, any business which is in competition with the commercial banking business or operations of FANB, FAC, or any subsidiary of either FAC or FANB, in any geographic area where such business is now or hereafter conducted; provided, however, that passive ownership of one percent (1%) or less of the outstanding voting stock of any corporation which is publicly traded shall not constitute a violation hereof. 7. ENFORCEMENT. If, at the time of enforcement of paragraph 4, 5 or 6 of this Agreement, a court holds that the restrictions stated herein are unreasonable under circumstances then existing, the parties hereto agree that the maximum period, scope or geographical area reasonable under such circumstances shall be substituted for the stated period, scope or area. Because Consultant's services are unique and because Consultant has access to Confidential Information and Work Product, the parties hereto agree that money damages would be an inadequate remedy for any breach of this Agreement. Therefore, in the event of a breach or threatened breach of this Agreement, FANB or its successors or assigns may, in addition to other rights and remedies existing in their favor, apply to any court of competent jurisdiction for specific performance and/or injunctive or other relief in order to enforce, or prevent any violations of, the provisions hereof (without posting a bond or other security). 8. CONSULTANT'S REPRESENTATIONS. Consultant hereby represents and warrants to FANB that (i) the execution, delivery and performance of this Agreement by Consultant does not and will not conflict with, breach, violate or cause a default under any contract, agreement, instrument, order, judgment or decree to which Consultant is a party or by which he is bound, (ii) Consultant is not a party to or bound by an employment agreement, noncompete agreement or confidentiality agreement with any other person or entity and (iii) upon the execution and delivery of this Agreement by FANB, this Agreement shall be the valid and binding obligation of Consultant, enforceable in accordance with its terms. 5 9. ENTIRE AGREEMENT. This Agreement sets forth the entire understanding between Consultant and FANB with respect to the subject matter hereof. There are no covenants, agreements, understandings, representations or warranties, oral or written, between Consultant and FANB relating to the subject matter of this Agreement other than those set forth herein. 10. WAIVER. No waiver of any right or remedy under any term of this Agreement shall in any event be deemed to apply to any subsequent default under the same or any other term contained herein. 11. SEVERABILITY. If any term or provision of this Agreement shall be held invalid or unenforceable, the remainder of this Agreement, shall be construed in all respects as if such invalid or unenforceable term or provision were omitted. If it is determined that any term of this Agreement is unenforceable because of the duration or the geographic scope of this term, the duration or geographic scope of such term shall be reduced to the maximum time and geographic scope permitted by applicable law, and as so reduced, such term shall then be enforced. 12. NOTICES. Any notice or other communication required or permitted to be given under this Agreement shall be in writing and deemed to be properly given when delivered in person or three days after being sent by certified or registered United States mail, return receipt required, postage prepaid, addressed: If to Consultant: George M. Clark, III. If to FANB: First American National Bank First American Center Nashville, Tennessee 37237 Attn: Dale W. Polley with a copy to: First American National Bank First American Center Nashville, Tennessee 37237 Attn: Mary Neil Price, Esq. Either party may change his or its address for notices hereunder from time to time in the manner set forth above. 6 13. JOINT PREPARATION. This Agreement is to have been prepared jointly by Consultant and FANB, and any uncertainty or ambiguity existing herein shall not be interpreted against either party, but shall be interpreted according to the rules of interpretation for arms-length agreements. 14. RULES OF CONSTRUCTION. Unless the context otherwise requires, words in the singular number include the plural, and in the plural include the singular, words of the masculine gender include the feminine and the neuter, and when the sense so indicates, words of the neuter gender may refer to any gender. The names of the parties, the date, and the recitals set out above written are all a part of this Agreement. The captions and section numbers appearing in this Agreement are inserted only as a matter of convenience; they do not define, limit, construe, or describe the scope or intent of the provisions of this Agreement. 15. COUNTERPARTS. This Agreement may be executed in any number of counterparts, all of which shall constitute one and the same instrument, and either party hereto may execute this Agreement by signing one or more counterparts. 16. ACTIONS CONTRARY TO LAW. Nothing contained in this Agreement shall require Consultant or FANB to engage in any conduct or perform any act contrary to law. 17. COSTS. In the event of a dispute between Consultant and FANB involving the terms of this Agreement which results in the filing of suit, the prevailing party shall be paid and reimbursed by the other for all costs and expenses, including all defense costs, investigation costs, and reasonable attorneys' fees, paid or incurred by such prevailing party in connection with such dispute. 18. CHOICE OF LAW, JURISDICTION, VENUE. This Agreement is entered into and is intended to be performed in the State of Tennessee and shall be governed by the laws of this State. Any action, claim, or dispute relating to the terms of this Agreement shall be brought in the appropriate state or federal court physically located in Nashville, Davidson County, Tennessee. 19. AMENDMENT. This Agreement may be modified or amended only upon the written agreement of Consultant and FANB. 20. INDEPENDENT CONTRACTOR. The parties hereto acknowledge that Consultant will be an independent contractor of FANB retained to perform the services described herein, and that, as such, FANB shall not be responsible for the withholding of income taxes, FICA or other taxes. The parties hereto further acknowledge that Consultant will not be deemed an employee of FANB for any reason and that Consultant will not be entitled to participate in or receive benefits under any employee benefit plans available to employees of FANB. 7 21. ASSIGNMENT. This Agreement shall be binding upon, inure to the benefit of and be enforceable by each of FANB and its successors and assigns. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first mentioned above. FIRST AMERICAN NATIONAL BANK BY: /s/ Dale W. Polley ---------------------------------- TITLE: President and Director ------------------------------- ATTEST: /s/ Frances Spencer ------------------------ CONSULTANT /s/ George M. Clark, III -------------------------------------- GEORGE M. CLARK, III ATTEST: /s/ Sherry Skiles ------------------------- EX-21 4 LIST OF SUBSIDIARIES 1 EXHIBIT 21 LIST OF SUBSIDIARIES OF REGISTRANT AT DECEMBER 31, 1998
NAME STATE OR JURISDICTION OF INCORPORATION First American National Bank U.S.A. Guaranty Title Company Tennessee MCC Holdings, Inc. Virginia Meriwether Capital Corporation Virginia First AmTenn Life Insurance Company Mississippi (f/k/a G&W Life Insurance Company) First American Network, Inc. Tennessee IFC Holdings, Inc. Delaware (f/k/a INVEST Financial Corporation) INVEST Financial Corporation Delaware Insurance Agency Inc. of Delaware INVEST Financial Corporation Alabama Insurance Agency Inc. of Alabama INVEST Financial Corporation Connecticut Insurance Agency Inc. of Connecticut INVEST Financial Corporation Georgia Insurance Agency Inc. of Georgia INVEST Financial Corporation Illinois Insurance Agency Inc. of Illinois INVEST Financial Corporation Maryland Insurance Agency Inc. of Maryland INVEST Financial Corporation Massachusetts Insurance Agency Inc. of Massachusetts INVEST Financial Corporation Mississippi Insurance Agency PA of Mississippi
2 INVEST Financial Corporation Montana Insurance Agency Inc. of Montana INVEST Financial Corporation Nevada Insurance Agency Inc. of Nevada INVEST Financial Corporation New Mexico Insurance Agency Inc. of New Mexico INVEST Financial Corporation Ohio Insurance Agency Inc. of Ohio INVEST Financial Corporation Oklahoma Insurance Agency Inc. of Oklahoma* INVEST Financial Corporation South Carolina Insurance Agency Inc. of South Carolina INVEST Financial Corporation Texas Insurance Agency Inc. of Texas* INVEST Financial Corporation Wyoming Insurance Agency Inc. of Wyoming Investment Centers of America, Inc. North Dakota Trust Center of America North Dakota First Dakota, Inc. North Dakota Lewis & Clark Securities, Inc. North Dakota (f/k/a Farwest Securities, Inc.) First Dakota of Montana, Inc. Montana First Dakota of Texas, Inc.* Texas First Dakota of New Mexico, Inc. New Mexico First Dakota of Wyoming, Inc. Wyoming Parksouth Corporation Mississippi 665 Florida Street Corporation Louisiana
3 Commercial National Investment Services, Inc. Louisiana Deposit Guaranty Leasing Company Mississippi CSB Insurance Services, Inc. Tennessee CSB Acceptance Corporation Tennessee Community Finance Company Tennessee Center Finance Co., Inc. Tennessee Pioneer Securities, Inc. Tennessee First American Enterprises, Inc. Tennessee First American Federal Savings Bank U.S.A. Charter Financial Services Corporation Virginia CentralSouth Financial Services LLC Mississippi Peoples Bank Tennessee Highland Rim Title Company Tennessee Pioneer Bank, f.s.b. U.S.A.
NON-PROFIT CORPORATIONS NAME STATE OR JURISDICTION OF INCORPORATION First American Community Development Corporation Tennessee First American Foundation Tennessee Deposit Guaranty/First American Foundation Mississippi
"*" indicates that corporation is held by nominee for the benefit of IFC Holdings, Inc. EX-23 5 ACCOUNTANTS CONSENT 1 EXHIBIT 23 ACCOUNTANTS' CONSENT The Board of Directors First American Corporation: We consent to incorporation by reference in the Registration Statements No. 33-49768, No. 33-57387 and No. 33-59844 each on Form S-3 and No. 33-53269, No. 33-57385, No. 33-44286, No. 2-81920, No. 2-81685, No. 33-44775, No. 33-63188, No. 33-64161, No. 333-19577, No. 333-25491, and No. 333-52127, each on Form S-8 of First American Corporation of our report dated January 21, 1999, relating to the 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, which report appears in the December 31, 1998 Annual Report to stockholders on Form 10-k of First American Corporation. KPMG LLP Nashville, Tennessee March 23, 1999 EX-27.1 6 FINANCIAL DATA SCHEDULE
9 1,000 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 1,203,358 297,374 351,989 43,987 4,495,160 1,730,460 1,739,852 11,739,688 197,681 20,731,770 15,270,756 2,213,637 314,643 1,152,939 0 0 290,797 1,488,998 20,731,770 994,353 361,818 11,495 1,367,666 471,230 634,054 733,612 40,933 7,999 836,838 333,453 333,453 0 0 211,362 1.88 1.84 4.19 47,913 38,696 0 49,681 187,880 64,973 27,677 197,681 137,395 0 60,286
EX-27.2 7 FINANCIAL DATA SCHEDULE
9 1,000 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 1,033,865 13,991 208,372 64,469 3,552,185 763,423 771,815 12,291,490 187,880 18,791,326 14,153,878 2,050,078 329,259 614,218 0 0 280,468 1,363,425 18,791,326 1,002,783 284,766 11,818 1,299,367 478,357 600,207 699,160 16,109 4,528 699,104 389,580 389,580 0 0 247,514 2.19 2.15 4.31 38,130 28,995 0 42,098 191,228 56,392 28,935 187,880 124,248 0 63,632
EX-27.3 8 FINANCIAL DATA SCHEDULE
9 1,000 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 1,053,737 56,028 210,952 62,715 3,342,297 1,029,206 1,037,086 11,155,918 191,228 17,673,250 13,540,935 1,760,740 387,117 440,562 0 0 278,221 1,265,675 17,673,250 908,967 259,241 22,056 1,190,264 457,784 566,293 623,971 6,437 2,882 597,403 332,058 332,058 0 0 214,179 1.93 1.91 4.13 34,461 22,561 694 38,509 197,006 48,348 31,945 191,228 121,659 0 69,569
-----END PRIVACY-ENHANCED MESSAGE-----