-----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, B2ZwE3oGBWPJqpAXFWFre31PTQknfY+npvM8m/UOhYOqZZuZNvNa4rsJa1YUhz+y tF+Dub+4TJQCe2sQ28Ci2g== 0000950144-99-002784.txt : 19990318 0000950144-99-002784.hdr.sgml : 19990318 ACCESSION NUMBER: 0000950144-99-002784 CONFORMED SUBMISSION TYPE: DEF 14A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19990420 FILED AS OF DATE: 19990317 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST TENNESSEE NATIONAL CORP CENTRAL INDEX KEY: 0000036966 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 620803242 STATE OF INCORPORATION: TN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: DEF 14A SEC ACT: SEC FILE NUMBER: 000-04491 FILM NUMBER: 99566970 BUSINESS ADDRESS: STREET 1: 165 MADISON AVE CITY: MEMPHIS STATE: TN ZIP: 38103 BUSINESS PHONE: 9015234444 MAIL ADDRESS: STREET 1: P O BOX 84 CITY: MEMPHIS STATE: TN ZIP: 38101-0084 FORMER COMPANY: FORMER CONFORMED NAME: FIRST TENNESSEE BANKS INC DATE OF NAME CHANGE: 19600201 DEF 14A 1 FIRST TENNESSEE NATIONAL CORPORATION 1 SCHEDULE 14A INFORMATION Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 Filed by the registrant [X] Filed by a party other than the registrant [ ] Check the appropriate box: [ ] Preliminary Proxy Statement [ ] Confidential, for Use of the Commission Only (as permitted by Rule 14a-6(e)(2)) [X] Definitive Proxy Statement [ ] Definitive Additional Materials [ ] Soliciting Material Pursuant to ss.240.14a-11(c) or ss.240.14a-12 FIRST TENNESSEE NATIONAL CORPORATION - -------------------------------------------------------------------------------- (Name of Registrant as Specified in Its Charter) - -------------------------------------------------------------------------------- (Name of Person(s) Filing Proxy Statement if other than the Registrant) Payment of filing fee (Check the appropriate box): [X] No fee required. [ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11. (1) Title of each class of securities to which transaction applies: -------------------------------------------------------------------- (2) Aggregate number of securities to which transactions applies: -------------------------------------------------------------------- (3) Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11 (Set forth the amount on which the filing fee is calculated and state how it was determined): -------------------------------------------------------------------- (4) Proposed maximum aggregate value of transaction: -------------------------------------------------------------------- (5) Total fee paid: -------------------------------------------------------------------- [ ] Fee paid previously with preliminary materials. [ ] Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the Form or Schedule and the date of its filing. (1) Amount previously paid: -------------------------------------------- (2) Form, Schedule or Registration Statement No.: ----------------------- (3) Filing party: ------------------------------------------------------- (4) Dated filed: -------------------------------------------------------- 2 [LOGO](sm) FIRST TENNESSEE All Things Financial(sm) FIRST TENNESSEE NATIONAL CORPORATION 1999 PROXY STATEMENT & 1998 FINANCIAL INFORMATION 3 March 17, 1999 Dear Shareholders: You are cordially invited to attend First Tennessee National Corporation's 1999 annual meeting of shareholders. We will hold the meeting on April 20, 1999, in the Auditorium, First Tennessee Building, 165 Madison Avenue, Memphis, Tennessee, at 10:00 a.m. We have enclosed the formal notice of the annual meeting, our 1999 proxy statement, and a form of proxy. At the meeting, we will ask you to elect four Class III directors and ratify the appointment of Arthur Andersen LLP as our independent auditors for 1999. The attached proxy statement contains information about these matters. An appendix to this proxy statement contains detailed financial information relating to our activities and operating performance during 1998. We have also enclosed a Summary Annual Report for those of you that did not receive this document previously. Your vote is important. You may vote by telephone, over the Internet or by mail. A postage-paid envelope has been provided if you choose to vote by mail. If you want to vote your shares at the meeting, then prior to the balloting you should request that your form of proxy be withheld from voting. We request that you vote as soon as possible. Sincerely yours, /s/ Ralph Horn ------------------------------------- Ralph Horn Chairman of the Board, President and Chief Executive Officer 4 FIRST TENNESSEE NATIONAL CORPORATION 165 Madison Avenue Memphis, Tennessee 38103 NOTICE OF ANNUAL SHAREHOLDERS' MEETING April 20, 1999 The annual meeting of shareholders of First Tennessee National Corporation will be held on April 20, 1999, at 10:00 a.m., CDT, in the Auditorium, First Tennessee Building, 165 Madison Avenue, Memphis, Tennessee. The items of business are: 1. Election of four Class III directors to serve until the 2002 annual meeting of shareholders, or until their successors are duly elected and qualified. 2. Ratification of appointment of auditors. These items are described more fully in the following pages, which are made a part of this notice. The close of business February 26, 1999, is the record date for the meeting. All shareholders of record at that time are entitled to vote at the meeting. Management requests that you vote by telephone or over the Internet (following the instructions on the enclosed form of proxy) or that you sign and return the form of proxy promptly, so that if you are unable to attend the meeting your shares can nevertheless be voted. You may revoke a proxy at any time before it is exercised at the annual meeting in the manner described on page 1 of the proxy statement. /s/ Lenore S. Creson -------------------- Lenore S. Creson Corporate Secretary Memphis, Tennessee March 17, 1999 - -------------------------------------------------------------------------------- IMPORTANT NOTICE PLEASE (1) VOTE BY TELEPHONE OR (2) OVER THE INTERNET OR (3) MARK, DATE, SIGN AND PROMPTLY MAIL THE ENCLOSED FORM OF PROXY IN THE ENCLOSED ENVELOPE SO THAT YOUR SHARES WILL BE REPRESENTED AT THE MEETING. - -------------------------------------------------------------------------------- 1 5 PROXY STATEMENT FIRST TENNESSEE NATIONAL CORPORATION TABLE OF CONTENTS
Page ---- GENERAL MATTERS...................................................................3 STOCK OWNERSHIP INFORMATION AND TABLE.............................................4 VOTE ITEM NO. 1 - ELECTION OF DIRECTORS...........................................5 Nominees For Director.......................................................5 Continuing Directors........................................................6 The Board Of Directors And Its Committees...................................7 VOTE ITEM NO. 2 - RATIFICATION OF APPOINTMENT OF AUDITORS.........................7 OTHER MATTERS.....................................................................8 SHAREHOLDER PROPOSAL DEADLINES....................................................8 EXECUTIVE COMPENSATION............................................................8 Summary Compensation Table..................................................9 Option/SAR Grants in 1998..................................................11 Aggregated Option/SAR Exercises in 1998 and Year End Values................12 Pension Plan Table.........................................................13 Employment Contracts and Termination of Employment and Change-in-Control Arrangements............................................................14 Compensation Committee Interlocks and Insider Participation................15 Certain Relationships and Related Transactions.............................15 Board Compensation Committee Report on Executive Compensation..............16 Total Shareholder Return Performance Graph.................................20 Compensation of Directors..................................................21 Section 16(a) Beneficial Ownership Reporting Compliance....................22 AVAILABILITY OF ANNUAL REPORT ON FORM 10-K.......................................22 APPENDIX - FINANCIAL INFORMATION AND DISCUSSION..................................
2 6 PROXY STATEMENT FIRST TENNESSEE NATIONAL CORPORATION 165 Madison Avenue Memphis, Tennessee 38103 GENERAL MATTERS The following proxy statement is being mailed to shareholders beginning on or about March 17, 1999. The Board of Directors is soliciting proxies to be used at our annual meeting of the shareholders to be held on April 20, 1999, at 10:00 a.m., CDT, in the Auditorium, First Tennessee Building, 165 Madison Avenue, Memphis, Tennessee, and at any adjournment or adjournments thereof. The accompanying form of proxy is for use at the meeting if you will be unable to attend in person. You may revoke your proxy at any time before it is exercised by writing to the Corporate Secretary, by timely delivery of a properly executed, later-dated proxy (including a telephone or Internet vote) or by voting by ballot at the meeting. All shares represented by valid proxies received pursuant to this solicitation, and not revoked before they are exercised, will be voted in the manner specified therein. If no specification is made, the proxies will be voted in favor of: 1. Election of four Class III directors to serve until the 2002 annual meeting of shareholders or until their successors are duly elected and qualified. 2. Ratification of appointment of auditors. We will bear the entire cost of soliciting the proxies. In following up the original solicitation of the proxies by mail, we may request brokers and others to send proxies and proxy material to the beneficial owners of the shares and may reimburse them for their expenses in so doing. If necessary, we may also use several of our regular employees to solicit proxies from the shareholders, either personally or by telephone or by special letter, for which they will receive no compensation in addition to their normal compensation. Our common stock is the only class of voting securities. There were 129,809,484 shares of common stock outstanding and entitled to vote as of February 26, 1999, the record date for the annual shareholders' meeting. Each share is entitled to one vote. A quorum of the shares must be represented at the meeting to take action on any matter at the meeting. A majority of the votes entitled to be cast constitutes a quorum for purposes of the annual meeting. A plurality of the votes cast is required to elect the nominees as directors. To approve the ratification of the appointment of auditors, the votes cast in favor of the item must exceed the votes cast in opposition to it. Both "abstentions" and broker "non-votes" will be considered present for quorum purposes, but will not otherwise have any effect on either of the vote items. 3 7 STOCK OWNERSHIP INFORMATION AND TABLE We know of no person who owned beneficially, as that term is defined by Rule 13d-3 of the Securities Exchange Act of 1934, more than five percent of our common stock on December 31, 1998. The following table sets forth certain information as of December 31, 1998, concerning beneficial ownership of our common stock by each director and nominee, each executive officer named in the Summary Compensation Table, and directors and executive officers as a group:
Name of Shares Beneficially Stock Units in Total and Percent Beneficial Owner Owned (1) Deferral Accounts (2) of Class (3) - ----------------------------------------------------------------------------------------------------- Robert C. Blattberg 50,084(4) -- 50,084 Carlos H. Cantu 27,645(4) -- 27,645 George E. Cates 37,701(4) -- 37,701 J. Kenneth Glass 315,591(5) 45,340 360,931 James A. Haslam, III 36,031(4) -- 36,031 Ralph Horn 1,043,880(5) 44,229 1,088,109 John C. Kelley, Jr. 288,348(5) 77,501 365,849 George P. Lewis 424,792(5) -- 424,792 R. Brad Martin 44,582(4) -- 44,582 Joseph Orgill, III 237,281(4) -- 237,281 Vicki R. Palmer 49,916(4) -- 49,916 Michael D. Rose 49,109(4) -- 49,109 William B. Sansom 62,665(4) -- 62,665 Elbert L. Thomas, Jr. 201,402(5) 7,226 208,628 Directors and Executive Officers as a Group (19 persons) 3,679,822(5) 222,934 3,902,756 3.0% - -----------------------------------------------------------------------------------------------------
(1) All share amounts have been adjusted to reflect the two-for-one stock split that was paid February 20, 1998. The respective directors and officers have sole voting and investment powers with respect to all of such shares except as specified in note (4) and note (5). Amounts in the second column do not include stock units in the next column. (2) The Board of Directors and Human Resources Committee approved amendments to our stock option program in 1997 that permit participants to defer receipt of shares upon the exercise of options and amendments to our restricted stock incentive plan in 1998 that permit participants to defer receipt of shares prior to the lapsing of restrictions imposed on restricted stock awards. Amounts in the third column reflect the number of shares deferred that a participant has the vested right to receive on a future date. These shares are not currently issued and are not considered to be beneficially owned for purposes of Rule 13d-3, but are reflected in a deferral account on our books as phantom stock units or restricted stock units. (3) No individual director or executive officer beneficially owns 1% or more of our common stock that is outstanding. The percentage of class owned by the director and executive officer group (3.0%) includes stock units. The percentage would be 2.8% with stock units excluded. (4) Includes 2,400 shares of restricted stock (as to each of Messrs. Blattberg, Orgill, Rose and Sansom), 4,800 shares (as to each of Messrs. Cantu, Cates and Haslam), 3,600 shares (as to Mr. Martin), and 3,000 shares (as to Mrs. Palmer) with respect to which the nonemployee director possesses sole voting power, but no investment power. Includes the following shares as to which the named nonemployee directors have the right to acquire beneficial ownership through the exercise of stock options granted under our director plan, all of which are 100% vested: 4 8 Dr. Blattberg - 43,724; Mr. Cantu - 21,583; Mr. Cates - 25,639; Mr. Haslam - 20,489; Mr. Martin - 17,139; Mr. Orgill - 47,351; Mrs. Palmer - 43,808; Mr. Rose - 39,949; and Mr. Sansom - 54,744. (5) Includes the following shares of restricted stock with respect to which the named person or group has sole voting power but no investment power: Mr. Glass - 24,237; Mr. Horn - 60,000; Mr. Kelley - 24,237; Mr. Lewis - 21,676; Mr. Thomas - 14,450; and the director and executive officer group - 220,594. Includes the following shares as to which the named person or group has the right to acquire beneficial ownership within 60 days through the exercise of stock options granted under our stock option plans: Mr. Glass - 130,316; Mr. Horn - 494,319; Mr. Kelley - 130,658; Mr. Lewis - 49,768; Mr. Thomas - 144,818; and the director and executive officer group - 1,536,415. Also includes shares held at December 31, 1998, for 401(k) Savings Plan accounts. VOTE ITEM NO. 1 - ELECTION OF DIRECTORS The Board of Directors is divided into three Classes. The term of office of each Class expires in successive years. The term of Class III directors expires at this annual meeting. The terms of Class I and Class II directors expire at the 2000 and 2001 annual meetings, respectively. The Board of Directors proposes the election of four Class III directors. Each director elected at the meeting will hold office until the specified annual meeting of shareholders and until his or her successor is elected and qualified. If any nominee proposed by the Board of Directors is unable to accept election, which the Board of Directors has no reason to anticipate, the persons named in the enclosed form of proxy will vote for the election of such other persons as management may recommend, unless the Board decides to reduce the number of directors pursuant to the Bylaws. We have provided below certain information about the nominees and directors (including age, current principal occupation which has continued for at least five years unless otherwise indicated, name and principal business of the organization in which his or her occupation is carried on, directorships in other reporting companies, and year first elected to our Board). All of our directors are also directors of First Tennessee Bank National Association (the "Bank" or "FTB"). The Bank is our principal operating subsidiary. NOMINEES FOR DIRECTOR Class III For a Three-Year Term Expiring at 2002 Annual Meeting CARLOS H. CANTU (65) is President and Chief Executive Officer of The ServiceMaster Company, Downers Grove, Illinois, a company that provides consumer services and supportive management services. Mr. Cantu is a director of two other public companies, The ServiceMaster Company and Unicom Corporation. Mr. Cantu has been a director since 1996 and is a member of the Human Resources Committee. GEORGE E. CATES (61) is Chairman of the Board and Chief Executive Officer of Mid-America Apartment Communities, Inc., ("Mid-America") Memphis, Tennessee, a real estate investment trust. Mr. Cates is a director of one other public company, Mid-America Apartment Communities, Inc. Mr. Cates has been a director of the Corporation since 1996. JAMES A. HASLAM, III (44) is Chief Executive Officer and Chief Operating Officer of Pilot Corporation, Knoxville, Tennessee, a national retail operator of convenience stores and travel centers. Mr. Haslam is a director of one other public company, Plasti-Line, Inc. Mr. Haslam has been a director since 1996 and is a member of the Audit Committee. 5 9 RALPH HORN (57) is Chairman of the Board, President, and Chief Executive Officer of First Tennessee and the Bank. Mr. Horn has served as President of First Tennessee since 1991, Chief Executive Officer since 1994, and Chairman of the Board since 1996. Mr. Horn is a director of two other public companies, Harrah's Entertainment, Inc. and Mid-America Apartment Communities, Inc. Mr. Horn has been a director since 1991. CONTINUING DIRECTORS Class I Term Expiring at 2000 Annual Meeting R. BRAD MARTIN (47) is Chairman of the Board and Chief Executive Officer of Saks Incorporated (formerly, Proffitt's, Inc.), Birmingham, Alabama, a retail merchandising company. Mr. Martin is a director of two other public companies, Saks Incorporated and Harrah's Entertainment, Inc. He has been a director since 1994 and is Chairman of the Human Resources Committee. JOSEPH ORGILL, III (61) is Chairman of the Board of Orgill, Inc., Memphis, Tennessee, wholesale hardware distributors. Prior to January 1996, Orgill, Inc., was a subsidiary of West Union Corporation, Memphis, Tennessee, of which Mr. Orgill remains Chairman of the Board. Mr. Orgill has been a director since 1969. VICKI R. PALMER (45) is Corporate Vice President and Treasurer of Coca-Cola Enterprises Inc., Atlanta, Georgia, a bottler of soft drink products. Mrs. Palmer has been a director since 1993 and is Chairperson of the Audit Committee. WILLIAM B. SANSOM (57) is Chairman of the Board and Chief Executive Officer of The H. T. Hackney Co., Knoxville, Tennessee, a diversified wholesale distribution firm serving the food, gas, oil and industrial markets in the Southeast. He is a director of two other public companies, Martin Marietta Materials, Inc. and Astec Industries, Inc. Mr. Sansom has been a director since 1984 and is a member of the Human Resources Committee. Class II Term Expiring at 2001 Annual Meeting ROBERT C. BLATTBERG (56) is the Polk Brothers Distinguished Professor of Retailing, J. L. Kellogg Graduate School of Management, Northwestern University, Evanston, Illinois. Dr. Blattberg is a director of one other public company, Factory Card Outlet Corp. Dr. Blattberg has been a director since 1984 and is a member of the Audit Committee. J. KENNETH GLASS (52) is President-Tennessee Banking Group of the Bank and Executive Vice President of First Tennessee. Mr. Glass has been President of the Tennessee Banking Group since 1993 and Executive Vice President of First Tennessee since 1995. Mr. Glass has been a director since 1996. JOHN C. KELLEY, JR. (55) is President-Memphis Banking Group of the Bank and Executive Vice President of First Tennessee. Mr. Kelley has been President of the Memphis Banking Group since 1993 and Executive Vice President of First Tennessee since 1995. Mr. Kelley has been a director since 1996. MICHAEL D. ROSE (57) is a private investor. Prior to December 19, 1997, he was Chairman of the Board of Promus Hotel Corporation, Memphis, Tennessee, a franchiser and operator of hotel brands. Prior to January 1997, Mr. Rose was also Chairman of the Board of Harrah's Entertainment, Inc. Prior to June 30, 1995, Mr. Rose was Chairman of The Promus Companies Incorporated, and prior to April 1994, its Chief Executive Officer. Mr. Rose is a director of six other public companies, Ashland, Inc., Darden Restaurants, Inc., FelCor Lodging Trust, 6 10 Inc., General Mills, Inc., ResortQuest International, Inc., and Stein Mart, Inc. Mr. Rose has been a director since 1984 and is a member of the Human Resources Committee. THE BOARD OF DIRECTORS AND ITS COMMITTEES ----------------------------------------- During 1998 the Board of Directors held five meetings. The average attendance at Board and committee meetings exceeded 90 percent. No director attended fewer than 75 percent of the meetings of the Board and the committees of the Board on which he or she served, except for Mr. Cantu and Mr. Haslam. The Board has several standing committees, including the Audit Committee and the Human Resources Committee. The Human Resources Committee serves as both a nominating committee and a compensation committee. The Audit Committee and the Human Resources Committee are each composed of directors who are not First Tennessee employees. Currently, Messrs. Blattberg and Haslam and Mrs. Palmer serve on the Audit Committee and Messrs. Cantu, Martin, Rose and Sansom serve on the Human Resources Committee. The Audit Committee is responsible for causing corporate audits and examinations to be made by independent auditors and supervising our internal audit program. The Committee approves, subject to shareholder ratification, the engagement of our independent auditors and reviews the scope and results of their examination. Other committee functions include review of our internal controls and our annual report to the SEC and proxy materials. During 1998 the Audit Committee held four meetings. As a nominating committee, the Human Resources Committee primarily considers recommendations for nominees to the Board of Directors, reviews the performance of incumbent directors and senior officers in determining whether to recommend them to the Board of Directors for reappointment, reviews succession plans, and between annual meetings appoints persons to offices except the offices of Chairman, CEO, President, Auditor and any office in which the incumbent has been designated by the Board as an Executive Officer. As a compensation committee, the Human Resources Committee's primary functions include recommending to the Board major policies concerning compensation, periodically reviewing corporate compensation and management of human resources, fixing the compensation of executive officers, reviewing remuneration structures for non-executive officers, and making recommendations to the Board concerning compensation arrangements for directors and adoption or amendment of employee benefit and management compensation plans. During 1998 the Human Resources Committee held six meetings. It is our practice to encourage communication between management and shareholders. Management in turn communicates appropriate information to the Board. The Human Resources Committee, as a committee of the Board, follows this procedure in considering nominations for directorships and does not receive nominations directly from shareholders. VOTE ITEM NO. 2 - RATIFICATION OF APPOINTMENT OF AUDITORS The Board of Directors has appointed, subject to ratification by the shareholders at the annual meeting, the firm of Arthur Andersen LLP, independent accountants, to be our auditors for the year 1999. Representatives of Arthur Andersen LLP are expected to be present at the annual meeting of shareholders with the opportunity to make a statement and to respond to appropriate questions. 7 11 OTHER MATTERS The Board of Directors, at the time of the preparation and printing of this proxy statement, knew of no other business to be brought before the meeting other than the matters described in this proxy statement. If any other business properly comes before the meeting, the persons named in the enclosed proxy will have discretionary authority to vote all proxies in accordance with their best judgment. SHAREHOLDER PROPOSAL DEADLINES If you intend to present a shareholder proposal at the 2000 annual meeting, it must be received by the Corporate Secretary, First Tennessee National Corporation, P. O. Box 84, Memphis, Tennessee, 38101, not later than November 18, 1999, for inclusion in the proxy statement and form of proxy relating to that meeting. In addition, Sections 2.8 and 3.6 of our Bylaws provide that a shareholder who wishes to nominate a person for election to the Board or submit a proposal at a shareholder meeting must comply with certain procedures whether or not the matter is included in our proxy statement. These procedures require written notification to us, generally not less than 90 days nor more than 120 days prior to the date of the shareholder meeting. If, however, we give fewer than 100 days notice or public disclosure of the shareholder meeting date to shareholders, then we must receive the shareholder notification not later than 10 days after the earlier of the date notice of the shareholder meeting was mailed or publicly disclosed. The shareholder must disclose certain information about the nominee or item proposed, the shareholder and any other shareholders known to support the nominee or proposal. Section 2.4 of our Bylaws provides that the date and time of the annual meeting will be the third Tuesday in April (or if that day is a legal holiday, on the next succeeding business day that is not a legal holiday) at 10:00 a.m. Memphis time or such other date and/or such other time as our Board may fix by resolution. The meeting date for 2000, determined according to the Bylaws, is April 18, 2000. Thus, shareholder proposals submitted outside the process that permits them to be included in our proxy statement must be submitted to the Corporate Secretary between December 20, 1999, and January 19, 2000, or the proposals will be considered untimely. Untimely proposals may be excluded by the Chairman or our proxies may exercise their discretion and vote on these matters in a manner they determine to be appropriate. EXECUTIVE COMPENSATION The Summary Compensation Table provides information for the last three years about the Chief Executive Officer (CEO) and our other four most highly compensated executive officers. The amounts include all compensation earned during each year, including amounts deferred, by the named officers for all services rendered in all capacities to us and our subsidiaries. Information is provided for each entire year in which an individual served during any portion of the year as an executive officer. Additional information is provided in tabular form below about option grants and exercises in 1998, year-end option values, and pension benefits, along with a report of the Board's Human Resources Committee on executive compensation and certain other information concerning compensation of executive officers and directors. 8 12 SUMMARY COMPENSATION TABLE --------------------------
Long-Term Compensation ------------------------------------ Annual Compensation Awards (3) Payouts -------------------------------------------------------------------------------------- (a) (b) (c) (d) (e) (f) (g) (h) (i) Number of Other Securities Annual Underlying All Other Compen- Restricted Options/ LTIP Compen- Name and Salary Bonus sation (6) Stock (1) SARs (2) Payouts sation (7) Principal Position Year ($) ($) ($) ($) (#) ($) ($) - ------------------------------------------------------------------------------------------------------------------------------ Ralph Horn 1998 $ 683,654 $ 512,741(5) $ 10,806 $ - 65,536(5) $ - $ 149,231 Chairman, President 1997 523,077(4) 313,846 10,806 - 113,872(4) - 138,930 & CEO 1996 497,866(4) 224,040 10,850 - 108,026(4) - 146,322 FTNC and FTB J. Kenneth Glass 1998 387,634(4) 232,580 6,720 - 21,911(4) - 106,042 President-Tennessee 1997 343,577(4) 186,549 6,720 - 55,632(4) - 96,426 Banking Grp.-FTB 1996 316,461 123,040 6,720 536,796 31,076 - 88,310 John C. Kelley, Jr. 1998 381,923 226,862 6,720 - 16,169 - 129,012 President-Memphis 1997 338,077 181,294 6,720 - 48,608 - 116,175 Banking Grp.-FTB 1996 310,961 120,902 6,720 536,796 30,542 - 105,483 George P. Lewis 1998 239,066 119,533 - - 6,681 - 27,951 Exec. Vice Pres., 1997 215,795 104,661 - - 10,310 - 27,117 Manager Money 1996 205,519 74,912 - 320,046 13,408 - 26,735 Mgmt. Grp.-FTB Elbert L. Thomas, Jr. 1998 226,983(4) 113,492(5) - - 41,206(4)(5) - 18,064 Exec. Vice Pres. & CFO 1997 202,277(4) 101,139(5) - - 45,764(4)(5) - 17,621 FTNC and FTB 1996 190,000(4) 76,950(5) - 320,046 69,720(4)(5) - 10,716 - ------------------------------------------------------------------------------------------------------------------------------
(1) Restricted stock awards are valued on the basis of the fair market value of a share of stock on the date of the award: $14.77 (1-16-96), adjusted for stock splits. On December 31, 1998, the named officers held the following shares of restricted stock with market values as indicated: Mr. Horn - 90,000 shares ($3,425,400); Mr. Glass - 36,356 shares ($1,383,709); Mr. Kelley - 36,356 shares ($1,383,709); Mr. Lewis - 21,676 shares ($824,989); Mr. Thomas - 21,676 shares ($824,989). The number of shares disclosed includes restricted stock units (RSU's), described in note (2) to the Stock Ownership Table, with respect to which restrictions had not lapsed at December 31, 1998, as follows: Mr. Horn - 30,000 RSU's; Mr. Glass - 12,119 RSU's; Mr. Kelley - 12,119 RSU's; Mr. Lewis - 0 RSU's; and Mr. Thomas - 7,226 RSU's. Dividends are paid on restricted stock (and dividend equivalents are paid on RSU's) at the same rate as all other shares of our common stock. Dividend equivalents on RSU's accrue interest at a 10-year Treasury rate and are settled only in cash. (2) All amounts represent shares subject to option. No stock appreciation rights (SAR's) were awarded. (3) All share amounts and share values have been revised to reflect the two-for-one stock splits, distributed 2-20-98 and 2-16-96. (4) In both 1996 and 1995 Mr. Horn elected to receive a deferred compensation stock option in lieu of $100,000 of salary earned for the following year. The amounts in column (c) include this amount, in lieu of which options for 27,700 shares and 43,384 shares (included in the amounts in column (g)) were granted on 7-1-97 and 7-1-96. In 1997 and 1996 Mr. Glass elected to receive a deferred compensation stock option in lieu of $30,000 of salary earned for the following year. The amounts in column (c) include this amount, in lieu of which options for 2,758 shares, 2,984 shares, 9 13 3,018 shares and 4,156 shares (included in the amounts in column (g)) were granted on 1-4-99, 7-1-98, 1-2-98 and 7-1-97, respectively. In 1997, 1996 and 1995 Mr. Thomas elected to receive a deferred compensation stock option in lieu of $80,000 of 1998 salary, $60,000 of 1997 salary and $90,000 of 1996 salary. The amount in column (c) include these amounts, in lieu of which options for 7,355 shares, 7,958 shares, 6,036 shares, 8,310 shares, 16,804 shares and 18,742 shares (included in the amounts in column (g)) were granted on 1-4-99, 7-1-98,1-2-98, 7-1-97, 1-2-97 and 7-1-96. (5) In 1997 Mr. Horn elected to receive a deferred compensation stock option in lieu of $100,000 of his annual bonus for the following year. The amount in column (d) for 1998 includes this amount, in lieu of which an option for 17,153 shares (included in the amounts in column (g)) was granted on 2-23-99. In 1997, 1996 and 1995 Mr. Thomas elected to receive a deferred compensation stock option in lieu of his annual bonus for the following year. The amount in column (d) for 1998 includes a bonus of $113,492, for 1997 includes a bonus of $101,139, and for 1996 includes a bonus of $76,950, in lieu of which options for 19,467 shares, 21,704 shares and 21,892 shares (included in the amounts in column (g)) were granted on 2-23-99, 2-19-98, and 2-24-97, respectively. (6) The amounts in column (e) for all years represent automobile allowance tax gross-up payments. (7) Elements of "All Other Compensation" for 1998 consist of the following:
Mr. Horn Mr. Glass Mr. Kelley Mr. Lewis Mr. Thomas - ------------------------------------------------------------------------------------- Above Market Rate $ 68,764 $ 68,475 $ 76,820 $ 2,907 $ - Survivor Benefits/SERP 55,297 17,397 32,022 14,524 7,935 Flex $ 5,720 5,720 5,720 5,720 5,720 401(k) Match 4,800 4,800 4,800 4,800 4,409 Auto Allowance 14,650 9,650 9,650 - - - ------------------------------------------------------------------------------------- Total $ 149,231 $ 106,042 $ 129,012 $ 27,951 $ 18,064 =====================================================================================
"Above Market Rate" represents above-market interest accrued on deferred compensation. "Survivor Benefits/SERP" represents insurance premiums with respect to our supplemental life insurance and excess pension plans. Under our Survivor Benefits Plan a benefit of 2 1/2 times final annual base salary is paid upon the participant's death prior to retirement (or 2 times final salary upon death after retirement). "Flex $" represents First Tennessee's contribution to the Flexible Benefits Plan, based on salary, service and corporate performance. "401(k) Match" represents First Tennessee's 50% matching contribution to the 401(k) Savings Plan, which is based on the amount contributed by the participant, up to 6% of compensation. 10 14 The following table provides information about stock options granted to the officers named in the Summary Compensation Table during 1998. No stock appreciation rights (SAR's) were granted during 1998. Option/SAR Grants in 1998 -------------------------
Individual Grants ----------------------------------------------------------------- (a) (b) (c) (d) (e) (h) Number of Percentage Securities of Total Alternatives to Underlying Options/SARs (f) and (g): Grant Options/SARs Granted to Exercise Date Value. Grant Granted (1) Employees Price (1) Expiration Date Present Value (4) Name (#) in 1998 ($ Per Share) Date ($) - ------------------------------------------------------------------------------------------------------------- Mr. Horn 48,383 1.21% $ 34.88 4-21-08 $ 387,473 Mr. Glass 3,018 (2) .08 28.16 1-2-18 32,405 16,169 .41 34.88 4-21-08 129,489 2,984 (3) .07 27.41 7-1-18 31,007 Mr. Kelley 16,169 .41 34.88 4-21-08 129,489 Mr. Lewis 6,681 .17 34.88 4-21-08 53,504 Mr. Thomas 6,036 (2) .15 28.16 1-2-18 64,811 21,704 (2) .54 26.41 2-19-18 215,180 6,426 .16 34.88 4-21-08 51,462 7,958 (3) .20 27.41 7-1-18 82,693 - -------------------------------------------------------------------------------------------------------------
(1) The amount of shares and the stock prices reflect the two-for-one stock split, distributed 2-20-98. All options except those marked with footnote (2) or (3) were granted 4-21-98 and vest 50% after four years from the date of grant and 100% after five years, with accelerated vesting if certain performance criteria (our stock price equals or exceeds $47.70 on 4-20-01 or on 5 consecutive days before 4-22-01) are met. No SAR's were granted. The exercise price per share equals the fair market value of one share of our common stock on the date of grant. Under the terms of all options, including those marked with footnote (2) and (3), participants are permitted to pay the exercise price of the options with our stock; participants are permitted to defer receipt of shares upon an exercise and thereby defer gain; options exercised more than one year prior to the end of their term are eligible for a reload option grant when the exercise price is paid with our stock, with the reload option grant for the number of shares surrendered and having an exercise price equal to fair market value at the time of the first exercise and a term equal to the remainder of the first option's term; the option plan provides for tax withholding rights upon approval of the plan committee; and upon a Change in Control (as defined in the subsection entitled "Employment Contracts and Termination of Employment and Change-in-Control Arrangements"), all options vest. (2) Options indicated by footnote (2) that were granted during 1998 were granted in lieu of compensation earned during 1997. Mr. Glass's and Mr. Thomas's options were granted on 1-2-98 in lieu of $15,000 of Mr. Glass's 1997 salary and $30,000 of Mr. Thomas's 1997 salary and vest 100% at the time of grant. No SAR's were granted. The exercise price per share equals 85% of the fair market value of $33.16 of one share of Corporation common stock on the grant date. Mr. Thomas's other option was granted 2-19-98 in lieu of his bonus of $101,139 for 1997 and contains the same terms as described for his option granted in lieu of salary. Fair market value on the grant date was $31.06. 11 15 (3) Options indicated by footnote (3) were granted in lieu of compensation earned during 1998 and contain the same terms as described generally in footnote (2). Mr. Glass's and Mr. Thomas's options were granted on 7-1-98 in lieu of $14,444 of Mr. Glass's 1998 salary and $38,518 of Mr. Thomas's 1998 salary. Fair market value on the grant date was $32.25. (4) A variation of the Black-Scholes option pricing model has been used. The following assumptions were made for purposes of calculating the Grant Date Value of the options granted 1-2-98, 2-19-98, 4-21-98, and 7-1-98, respectively: an exercise price of $28.16, $26.41, $34.88 and $27.41; an option term of 20 years, 20 years, 10 years, and 20 years; an interest rate of 5.54%, 5.57%, 5.64%, and 5.46%; volatility of 26.49%, 26.68%, 25.07%, and 26.89%; a dividend yield of 1.99%, 2.12%, 1.89%, and 2.05%; a reduction of 0%, 0%, 24.18%, and 0% to reflect the probability of forfeiture due to termination prior to vesting; and reduction of 16.07%, 14.84%, 13.15% and 15.26% to reflect the probability of a shortened option term due to termination prior to the option expiration date. The actual value, if any, realized by a participant upon the exercise of an option may differ and will depend on the future market value of our common stock. The following table provides information about stock options and SAR's held at December 31, 1998, and exercises during 1998 by the officers named in the Summary Compensation Table. The values in column (e) reflect the spread between the market value at December 31, 1998, of the shares underlying the option and the exercise price of the option. Aggregated Option/SAR Exercises in 1998 --------------------------------------- And Year End Option Values --------------------------
(a) (b) (c) (d) (e) Number of Securities Underlying Value of Unexercised Unexercised Options/ In-the-Money Number of SARs at 12/31/98 (1)(2) Options/SARs at 12/31/98 (1) Shares Acquired Value ------------------------- ---------------------------- On Exercise (2) Realized Exercisable Unexercisable Exercisable Unexercisable Name (#) ($) (#) (#) ($) ($) - ----------------------------------------------------------------------------------------------------------- Mr. Horn 16,276 (3) $ 469,563 494,319 56,990 $ 12,786,806 $ 361,075 Mr. Glass 74,788 (3) 2,123,145 130,316 18,217 2,857,161 97,971 Mr. Kelley 74,788 (3) 2,157,634 130,658 18,217 3,078,768 97,971 Mr. Lewis 15,276 403,590 49,768 8,319 1,251,065 62,175 Mr. Thomas - - 144,818 7,654 2,809,518 50,281 - -----------------------------------------------------------------------------------------------------------
(1) No SAR's are attached to any of the options in the table. Option values are based on $37.47 per share, the average of the high and low sales price on December 31, 1998. (2) All share amounts reflect the two-for-one stock split distributed 2-20-98. (3) Exercises identified with footnote (3) include the following shares whose receipt was deferred by the officer to a future date subsequent to the exercise date: Mr. Horn - 14,229 shares, Mr. Glass - 33,221 shares, and Mr. Kelley - 65,382 shares. The value realized is the difference between the fair market value of the shares on the exercise date and the exercise price of the option. The actual value ultimately realized will depend on the future market value of the shares at the termination of the deferral period. 12 16 The following table provides information about estimated combined benefits under both our Pension Plan and our Pension Restoration Plan. Pension Plan Table ------------------
Years of Service(*) Covered ------------------------------------------------------------------------- Compensation 15 Yrs 20 Yrs 25 Yrs 30 Yrs 35 Yrs 40 Yrs - ------------------------------------------------------------------------------------------ $100,000 $ 42,728 $ 51,607 $ 60,482 $ 64,419 $ 68,360 $ 72,300 150,000 57,530 71,345 85,155 91,556 97,964 104,371 200,000 72,332 91,083 109,827 118,693 127,568 136,442 250,000 87,134 110,821 134,500 145,830 157,172 168,513 300,000 101,936 130,559 159,172 172,967 186,776 200,584 350,000 116,738 150,297 183,845 200,104 216,380 232,655 400,000 131,540 170,035 208,517 227,241 245,984 264,726 450,000 146,342 189,773 233,190 254,378 275,588 296,797 500,000 161,144 209,511 257,862 281,515 305,192 328,868 550,000 175,946 229,249 282,535 308,652 334,796 360,939 600,000 190,748 248,987 307,207 335,789 364,400 393,010 650,000 205,550 268,725 331,880 362,926 394,004 425,081 - ------------------------------------------------------------------------------------------
*Benefit shown is subject to limitations fixed by the Secretary of the Treasury pursuant to Section 415 of the Internal Revenue Code of 1986, as amended. The limitation is $130,000 for 1998 or 100% of the employee's average income in his three highest paid years, whichever is less. However, a benefit as high as $136,425 could be accrued prior to 1983 and such higher benefit may be paid to the employee who attained that level prior to 1983. Our Pension Plan is integrated with social security under an "offset" formula, applicable to all participants. Retirement benefits are based upon a participant's average base salary for the highest 60 consecutive months of the last 120 months of service ("Covered Compensation"), service, and social security benefits. Benefits are normally payable in monthly installments after age 65. The normal form of benefit payment for a married participant is a qualified joint and survivor annuity with the surviving spouse receiving for life 50 percent of the monthly amount the participant received. The normal form of benefit payment for an unmarried participant is an annuity payable for life and 10 years certain. For purposes of the plan "compensation" is defined as the total cash remuneration reportable on the employee's IRS form W-2, plus pre-tax contributions under the Savings Plan and employee contributions under the Flexible Benefits Plan, excluding bonuses, commissions, and incentive and contingent compensation. Our Pension Restoration Plan is an unfunded plan covering employees in the highest salary grades, including Messrs. Horn, Glass, and Kelley, whose benefits under the Pension Plan have been limited under Tax Code Section 415, as described in the note to the Pension Table, and Tax Code Section 401(a)(17), which limits compensation to $160,000 for purposes of certain benefit calculations. "Compensation" is defined in the same manner as it is for purposes of the Pension Plan. Under the Pension Restoration Plan participants receive the difference between the monthly pension payable if tax code limitations did not apply and the actual pension payable. The estimated credited years of service and the compensation covered by the plans for each of the individuals named in the Summary Compensation Table are as follows: Mr. Horn, 35 ($496,738); Mr. Glass, 25 ($290,984); Mr. Kelley, 29 ($297,461); Mr. Lewis, 38 ($208,440); and Mr. Thomas, 9 ($134,992). 13 17 Employment Contracts and Termination of Employment and Change-in-Control ------------------------------------------------------------------------ Arrangements ------------ We have entered into contracts with 64 officers, including each of the named executive officers, which may be terminated upon three years prior notice. These contracts provide generally for a payment (which, for the named executive officers is equal to three times annual base salary plus annual target bonus) in the event of a termination of the officer's employment by us other than "for cause" or by the employee for "good reason" (as such terms are defined in the contracts) within 36 months after a Change-in-Control (as defined below) or the officer's termination of employment for any reason (other than "cause") during the 30-day period commencing one year after a Change-in-Control. The contracts provide generally for an excise tax gross-up with respect to any taxes incurred under Internal Revenue Code Section 4999 following a Change-in-Control and for three years continued welfare benefits. The term Change-in-Control is defined to include: - a merger or other business combination, unless (i) more than 50 percent of the voting power of the corporation resulting from the business combination is represented by our voting securities outstanding immediately prior thereto, (ii) no person or other entity beneficially owns 20 percent or more of the resulting corporation, and (iii) at least a majority of the members of the board of directors of the resulting corporation were our directors at the time of board approval of the business combination (solely for purposes of the severance contracts, but not for purposes of their 30-day termination period, the "50%" test in clause (i) is changed to "60%" and the "majority of the board" test in clause (iii) is changed to "two-thirds of the board"), - the acquisition by a person or other entity of 20 percent or more of our outstanding voting stock, - a change in a majority of the Board of Directors, or - shareholder approval of a plan of complete liquidation or a sale of substantially all of our assets. A Change-in-Control has the following effect on certain benefit plans in which the named executive officers participate: - Target annual bonuses are prorated through the date of the Change-in-Control and paid. - Restricted stock, restricted stock units, phantom stock units and unvested stock options vest. - Under our Pension Restoration Plan, a lump sum payout is made to participants of the present value, using a discount rate of 4.2 percent, of the participant's scheduled projected benefits, assuming periodic distributions of the participant's accrued benefit in the normal form under the plan, actuarially adjusted according to a formula for the participant's age at the time of the Change-in-Control. - Excess funding in the pension plan is allocated, according to a formula, to participants and retirees. - Deferred compensation under individual deferral agreements which accrue interest based on the 10-year Treasury rate and certain other benefits are paid over to previously established rabbi trusts. Funds in such trusts will remain available for the benefit of our general creditors prior to distribution. - Our Survivor Benefits Plan generally cannot be amended to reduce benefits. 14 18 - Under the Directors and Executives Deferred Compensation Plan, a lump sum payout is made to participating employees and certain terminated employees of the present value, using a discount rate of 4.2 percent, of the participant's scheduled projected distributions, assuming employment through normal retirement date and continued interest accruals at above-market rates, described in the "Compensation of Directors" section below. Compensation Committee Interlocks and Insider Participation ----------------------------------------------------------- Messrs. Cantu, Martin, Rose, and Sansom, all of whom are nonemployee directors, served as members of the Board of Director's Human Resources Committee (Committee), which is our compensation committee, during all or a portion of 1998. No interlocking relationships existed with respect to any of the members of the Committee. Mr. Horn, Chairman, President and CEO of First Tennessee, was, however, during 1998 Chairman of the compensation committee of Mid-America Apartment Communities, Inc., of which Mr. Cates, a director of First Tennessee, is Chairman and CEO. Certain Relationships and Related Transactions ---------------------------------------------- Our banking subsidiaries have had banking transactions in the ordinary course of business with our executive officers, directors, nominees, and their associates which are reported in a note to our financial statements, and they expect to have such transactions in the future. Such transactions, which at December 31, 1998, amounted to 6.4 percent of our shareholders' equity, have been on substantially the same terms, including interest rates, except for one individual as described below, and collateral on loans, as those prevailing at the same time for comparable transactions with others and have not involved more than normal risk of collectibility or presented other unfavorable features. Two loans were made to a person not named in the Summary Compensation Table, who has now retired, aggregating an amount less than $40,000 under an employee program which provided a below market interest rate at a time prior to that person becoming an executive officer. -------------------------------------- 15 19 Notwithstanding anything to the contrary set forth in any of our previous filings under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, that might incorporate future filings by reference, including this proxy statement, in whole or in part, the following Board Compensation Committee Report on Executive Compensation and the Total Shareholder Return Performance Graph shall not be incorporated by reference into any such filings. Board Compensation Committee Report on Executive Compensation ------------------------------------------------------------- Our Bylaws require the Board of Directors or a Board committee to determine the compensation of executive officers. The Board has designated the Human Resources Committee (Committee) to perform this function. The Committee is composed entirely of independent, nonemployee directors who have no interlocking relationships with us. The Committee has set forth below its report on the compensation policies applicable to executive officers and the basis for the compensation of the Chief Executive Officer (CEO) during 1998. Our executive compensation programs are designed to align the interests of the executive officers with our performance and the interests of our shareholders. Approximately 70 percent of the executive officers' annual compensation potential is at risk based on corporate performance and total shareholder return (defined below). Compensation programs have been designed to reward executive officers in both cash and our stock based on performance that also rewards shareholders. When corporate performance does not meet criteria established by the Committee, incentive compensation is reduced accordingly. In addition, the executive compensation program has been designed to attract and retain qualified executive officers. Executive compensation consists generally of the following components: - base salary - annual incentive bonus - long-term incentive awards - deferral of compensation at above-market rates or through stock option grants - customary employee and other benefits typically offered to similarly situated executives Base salary and annual bonus are based on an evaluation of the individual's position and responsibilities based on independent criteria and external market data and personal and corporate performance. The Committee does not assign a specific weight to any of the factors but places greater emphasis on corporate and personal performance in the overall mix. Long-term incentive awards consist of restricted stock awards containing provisions for acceleration of vesting upon achievement of corporate performance criteria and stock options. It is not our practice to "reprice" stock options or to price them at less than fair market value on the date of grant. Although deferred compensation options have an exercise price of 85 percent of fair market value on the grant date, to receive the option the participant must forego the right to receive cash compensation. Under our option plans the amount of the foregone cash compensation plus the option exercise price must equal or exceed 100 percent of fair market value. We have offered deferred compensation at above-market rates and deferrals through the use of stock options with deferrals since 1995 limited to stock options or a 10-year Treasury rate of interest. As a result of plan amendments adopted by the Committee and the Board during 1997 and 1998, executive officers may also defer the receipt of shares upon the exercise of stock options and defer the receipt of restricted stock prior to the lapse of restrictions. Except for our stock fund within our 401(k) plan, other benefits provided to the executive officers are not tied to corporate performance. The Committee reviewed external market data provided by an independent consulting firm from thirteen highest-performing companies in the American Banker Top 50, a peer group of banking organizations against which we measure our strategic performance. We selected the highest-performing companies 16 20 based generally on the following one and five-year return measures: return on assets, return on equity, earnings per share growth, and total shareholder return. The purpose of the review was to determine compensation practices of these companies. The Committee also reviewed available compensation data on the other banking organizations in the American Banker Top 50. The compensation peer group used by the independent consulting firm did not include all of the banking organizations listed in the Total Shareholder Return Performance Graph (TSR graph) for the 1998 peer group because compensation data on every organization included in the TSR graph was not available. The median asset size of the compensation highest-performing peer group was $30.0 billion. The median asset size of the American Banker Top 50 was $54.7 billion. In actual practice the compensation of executive officers approximates the median of the compensation highest-performing peer group. We do not, however, have a specific policy that mandates how our compensation practices will compare to the peer group. All compensation paid to executive officers during 1998 is fully deductible on our corporate federal income tax return. Section 162(m) of the Tax Code generally disallows a tax deduction to public companies, including us, for compensation exceeding $1 million paid during the year to the CEO and the four other highest paid executive officers at year end. Certain performance-based compensation is not, however, subject to the deduction limit. Under Tax Code regulations the salary and TARSAP (defined below) portions of compensation do not meet the performance-based compensation criteria of Section 162(m). The Committee and Board approved amendments to the restricted stock plan permitting deferral by participants of the receipt of restricted stock prior to the lapse of restrictions. Any such deferral does not represent compensation paid during the year, and thus, is not currently subject to the Section 162(m) limitation. The Committee's practice is to continue to consider ways to maximize the deductibility of executive compensation while retaining the discretion deemed necessary to compensate executive officers in a manner commensurate with performance and the competitive market of executive talent. (i) The CEO's Compensation -------------------------- Base Salary: The Committee establishes the CEO's base salary annually based on corporate performance, achievement of objectives in his individualized written personal plan and competitive practices within the industry. The CEO develops his personal plan and submits it to the Committee for review and recommendation. The Board of Directors approves the plan, which generally contains strategic, quality and financial goals. A salary increase of 28.6 percent for Mr. Horn was approved in February of 1998 based on achievement of 1997 corporate return on common equity (ROE) objectives, Bank return on assets (ROA) objectives, personal plan objectives, and competitive practices. Although no specific weight is assigned to these factors, the Committee places greater emphasis on corporate and personal performance than on competitive practices within the industry. Base salary is intended to represent approximately 25 percent of the CEO's total compensation potential. Annual Bonus: The CEO's annual bonus is based entirely on our corporate performance against financial objectives established by the Committee at the beginning of each year. The financial objectives for 1998 were based on ROE and earnings per share (EPS). The CEO may be awarded an annual bonus of a maximum of 75 percent of his salary dollars earned during the year. This percentage was increased from 60 percent in 1997, based on an analysis of competitive practices within the industry. The degree of our success in reaching the corporate targets determines a payout of zero percent to 100 percent of the CEO's annual bonus potential. During 1998, our corporate performance resulted in a payout of 100 percent of the maximum. 17 21 Long-term Awards: The CEO's long-term incentive compensation consists of restricted stock and stock options. Our restricted stock program has since 1990 included performance criteria as a condition to early vesting of awards to executive officers. The objective of this time accelerated restricted stock award plan (TARSAP) feature is to associate more closely the long-term compensation of executive officers with shareholder interests. Under the TARSAP feature, restricted stock is granted with accelerated vesting if performance criteria established by the Committee are met with respect to specified performance periods. Performance periods are for three years and overlap: e.g., 1996-1998, 1997-1999, 1998-2000. Performance criteria since inception have been based, for all participants, including the CEO, on total shareholder return (appreciation in the market value of our stock with dividends reinvested-"TSR") targets established at the beginning of each performance period. Targets are based on our percentile ranking in a peer group (the "100-bank peer group") of approximately the 100 largest banking organizations by asset size traded on U.S. exchanges, including the Nasdaq Stock Market's National Market System, with the condition that TSR must be a positive number. The 100-bank peer group is different from the peer group used to compare shareholder returns. The 100-bank peer group was originally selected in 1990, prior to the adoption of SEC rules requiring disclosure of a shareholder return performance graph, because the Committee believed that it was an appropriate index with which to associate more closely long-term compensation of executives with shareholder interests. The restricted stock program which contains the 100-bank peer group has produced the desired results, and thus, the Committee has continued to use it for the restricted stock program. In January of 1999, the Committee approved vesting the TARSAP shares for the 1996-1998 performance period. The Committee's decision was based on a TSR for the period January 1, 1996 through December 31, 1998 of 169 percent, which exceeded the target and ranked us in the top 23 percent of the peer group. The restrictions on these shares will lapse on April 21, 1999. In addition to the TSR targets, the Committee adopted alternative criteria for the accelerated vesting of TARSAP awards made in 1996 and future years based upon our percentile ranking within the 100-bank peer group with respect to operating EPS growth rate (or exceeding a minimum operating EPS growth rate) and average operating ROE, with the condition that TSR must be a positive number. In addition to performance-based restricted stock awards, the Committee generally awards stock options to executive officers, including the CEO, as a part of a broad-based stock option program under which awards are made to all of our employees, both full-time and part-time. The CEO's option award (which is disclosed in the "Option/SAR Grants in 1998" table) was based on an estimated value of the option which in combination with the restricted stock award provides the basis for a competitive long-term incentive package. Because the value of the option to the CEO is a function of the price growth of our stock, the amount realized by the CEO is tied directly to increases in shareholder value. In addition, the option grant contained a performance-based, accelerated vesting feature, which is described in part (ii) of this report. Other Benefits: The CEO's compensation reported in the Summary Compensation Table also includes accrual of above-market rates of interest on compensation deferred prior to 1996 and the cost of insurance to fund a supplemental retirement plan and life insurance benefit, which are not directly based on corporate performance. Above-market rates are accrued for deferred compensation of the CEO and other named executive officers to retain key officers. Generally, the plan under which this benefit is offered requires that the amount deferred be automatically recalculated at market rates if termination occurs prior to retirement. (ii) Other Executive Officer Compensation ----------------------------------------- Base Salary: The CEO recommends and the Committee approves the base salary for executive officers other than the CEO. Recommendations are generally based on corporate performance (as measured by financial, quality and strategic 18 22 objectives), individual overall performance during the prior year, and competitiveness in the market place. Corporate performance objectives for 1997, which were achieved, were the same for executive officers as the CEO: corporate ROE and Bank ROA objectives. It is our policy to maintain a competitive salary commensurate with the duties and responsibilities of the executive officers. Salary is intended to represent approximately 40 percent of an executive officer's potential annual compensation. Annual Bonus: Executive officers' annual bonus is based on achievement of corporate financial objectives and performance against personal objectives for the year, which are recorded in individualized written personal plans. Individual objectives must include financial, quality and strategic goals. The degree of completion of goals determines the award. Financial objectives for 1998 were based on ROE and EPS. Although Mr. Horn has an individualized personal plan, his annual bonus is based entirely on corporate financial performance as described above for the CEO, and the Chief Credit Officer's annual bonus is based solely on his individualized personal plan. The maximum annual bonus of executive officers other than the CEO is between 45 percent and 60 percent of salary dollars during the year, based on salary grade. Long-term Awards: The executive officers named in the Summary Compensation Table and all but one of the other executive officers participate in the TARSAP program described above with respect to the CEO. The performance criteria are identical. The number of shares awarded for a three-year performance period is generally 50 percent of the participant's salary grade mid-point, based on market value of the shares at the time of the award. We do not provide a federal income tax gross-up to executive officers at the vesting of restricted stock. In addition to performance-based restricted stock awards, the Committee generally awards stock options annually on our stock to executive officers, including the CEO, as a part of the option program discussed in part (i) of this report. The number of shares awarded to executive officers is equal to a percentage of salary (ranging from 100 percent to 200 percent depending on salary grade, with 200 percent used for the CEO) divided by the market value of one share of our stock at the time of grant. Executive officers may also be awarded shares in addition to those calculated as a percent of salary if in the opinion of the Committee additional shares are required to ensure a competitive compensation opportunity. The exercise price is the market value at the time of grant. Options are awarded based on personal performance and to encourage future performance as well as for retention purposes (with a ten-year term and vesting at 50 percent after four years and 100 percent after five years). The April 1998 grant's exercise price is $34.88. This grant contains a provision for accelerated vesting if the closing market price per share equals at least $47.70 for five consecutive days in the three years following the grant or at the end of the three-year period. Options are not granted based on prior corporate performance. Other Benefits: We have adopted certain broad-based employee benefit plans in which executive officers participate and certain other retirement, life and health insurance plans and we provide customary personal benefits. Except for our stock fund within our 401(k) plan, the benefits under these plans are not tied to corporate performance. The executive officers named in the Summary Compensation Table participate in the other benefits described above with respect to the CEO. Human Resources Committee ------------------------- R. Brad Martin, Chairman Carlos H. Cantu Michael D. Rose William B. Sansom ----------------- 19 23 The following graph compares the yearly percentage change in our cumulative total shareholder return with returns based on the Standard and Poor's 500 index and a peer group index, which is described below and in a footnote to the graph. It should be noted that the "total shareholder return" reflected in the graph is not comparable to the "total shareholder return" described in the Compensation Committee Report because the former has a different measurement period and it has been adjusted and weighted for the market capitalization of the companies in the peer group, as required by SEC regulations. Our peer group consists of the American Banker Top 50 banking organizations (excluding First Tennessee) as measured by market capitalization as of the end of the most recent fiscal year. Total Shareholder Return Performance Graph ------------------------------------------
1993 1994 1995 1996 1997 1998 - --------------------------------------------------------------------------- First Tennessee $ 100 $ 110 $ 170 $ 218 $ 397 $ 463 S & P 500 100 101 139 171 228 293 1998 Peer Group 100 92 144 198 303 327 - ---------------------------------------------------------------------------
The graph assumes $100 is invested on December 31, 1993, and dividends are reinvested. Returns are market-capitalization weighted. The 1998 peer group consists of the following: AmSouth Bancorporation, Banc One Corporation, BankAmerica Corporation, BankBoston Corporation, Bankers Trust New York Corporation, Bank of New York, Branch Banking and Trust Company, CCB Financial Corporation, The Chase Manhattan Corporation, Citigroup Inc., Comerica Incorporated, Commerce Bancshares, Inc., Compass Bancshares, Crestar Financial Corporation, Fifth Third Bancorp, First American Corporation [TN], First Virginia Banks, Inc., Firstar Corporation, First Security Corporation [DE], First Union Corporation, Fleet Financial Group, Hibernia Corporation, Huntington Bancshares Incorporated, J.P. Morgan, KeyCorp, M & T Bank Corporation, Marshall & Ilsley Corporation, Mellon Bank Corporation, Mercantile Bankshares Corporation, Mercantile Bancorporation, Inc., National City Corporation, North Fork Bancorporation, Northern Trust Corporation, Old Kent Financial Corporation, PNC Bank Corp, Popular Inc., Regions Financial Corporation, Republic New York Corporation, SouthTrust Corporation, State Street Corporation, Summit Bancorp, SunTrust Banks, Inc., Synovus Financial Corporation, UnionBanCal Corporation, Union Planters Corporation, U.S. Bancorp [DE], Wachovia Corporation, Wells Fargo and Co., and Zions Bancorporation. 20 24 Compensation of Directors ------------------------- During 1998, each nonemployee director was paid a retainer quarterly at an annual rate of $22,000 plus a fee of $1,000 for each Board and each committee meeting attended. The chairpersons of the Audit and Human Resources Committees were paid monthly an additional retainer at an annual rate of $3,000 each. Our practice is to hold Board and committee meetings jointly with the Bank's Board and committees. All of our directors are also directors of the Bank. Directors are not separately compensated for Bank Board or committee meetings except for those infrequent meetings that do not occur jointly. Directors who are officers are not separately compensated for their services as directors. Under the terms of our 1992 Restricted Stock Incentive Plan, which was approved by the shareholders, all nonemployee directors received an automatic, nondiscretionary award of 6,000 shares (adjusted for stock splits) of restricted stock on May 1, 1992, and all new nonemployee directors will receive such award upon election to the Board. Restrictions lapse at the rate of 10 percent annually. Such shares are forfeited if the director terminates for any reason other than death, disability, retirement, or the acquisition by a person of 20 percent of the voting power of our stock. Upon termination for any of the four listed reasons, all shares vest. Directors may elect to defer their retainers and fees. Under the Nonemployee Directors' Deferred Compensation Stock Option Plan, all nonemployee directors have elected, and new nonemployee directors are permitted to elect, to receive stock options in lieu of fees through 1999. The exercise price per share is 85 percent of fair market value of one share of our common stock on the date of grant, and the number of shares subject to option granted equals the amount of fees deferred divided by 15 percent of the fair market value of one share on the date of grant. Under the Directors and Executives Deferred Compensation Plan, not offered with respect to compensation earned since 1995, under which up to six annual deferrals may be elected, amounts deferred accrue interest at rates ranging from 17 to 22 percent annually, based on age at the time of deferral, with a reduction to a guaranteed rate based on 10-year Treasury obligations if a participant terminates prior to a change-in-control for a reason other than death, disability or retirement. Interim distributions in an amount between 85 percent and 100 percent of the amount originally deferred are made in the eighth through the eleventh years following the year of deferral, with the amount remaining in a participant's account and accrued interest generally paid monthly over the 15 years following retirement at age 65. Certain restrictions and limitations apply on payments and distributions. Under other deferral agreements, nonemployee directors have deferred and may defer amounts which generally accrue interest at a rate tied to 10-year Treasury obligations. 21 25 Section 16(a) Beneficial Ownership Reporting Compliance ------------------------------------------------------- Section 16(a) of the Securities Exchange Act of 1934, as amended (Exchange Act) requires our directors and officers to file with the SEC initial reports of ownership and reports of changes in ownership of our common stock and to furnish us with copies of all forms filed. To our knowledge, based solely on a review of the copies of such reports furnished to us and written representations that no other reports were required, during the past fiscal year all Section 16(a) filing requirements applicable to our officers and directors were complied with, except that one report covering two transactions, involving two employee stock option exercises, payment of the exercise price with our stock, and deferral of receipt of the option shares, was filed late by G. Robert Vezina, a retired executive officer, and one report covering one transaction, an employee option exercise for cash, was filed late by James F. Keen, an executive officer. In each case the officer's transaction was exempt from short-swing profitability. AVAILABILITY OF ANNUAL REPORT ON FORM 10-K A COPY OF OUR ANNUAL REPORT ON FORM 10-K, INCLUDING THE FINANCIAL STATEMENTS AND SCHEDULES THERETO, WHICH IS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION, IS AVAILABLE FREE OF CHARGE TO EACH SHAREHOLDER OF RECORD UPON WRITTEN REQUEST TO THE TREASURER, FIRST TENNESSEE NATIONAL CORPORATION, P. O. BOX 84, MEMPHIS, TENNESSEE, 38101. Each such written request must set forth a good faith representation that as of the record date specified in the notice of annual shareholders' meeting the person making the request was a beneficial owner of a security entitled to vote at the annual meeting of shareholders. The exhibits to the Annual Report on Form 10-K will also be supplied upon written request to the Treasurer and payment to us of the cost of furnishing the requested exhibit or exhibits. A document containing a list of each exhibit to Form 10-K, as well as a brief description and the cost of furnishing each such exhibit, will accompany the Annual Report on Form 10-K. BY ORDER OF THE BOARD OF DIRECTORS /s/ Lenore S. Creson - ------------------------- Corporate Secretary March 17, 1999 22 26 FINANCIAL INFORMATION & DISCUSSION (APPENDIX TO PROXY STATEMENT) 27 FINANCIAL INFORMATION AND DISCUSSION TABLE OF CONTENTS SELECTED FINANCIAL AND OPERATING DATA MANAGEMENT'S DISCUSSION AND ANALYSIS FINANCIAL HIGHLIGHTS OF 1998 INCOME STATEMENT ANALYSIS (1998 COMPARED TO 1997) INCOME STATEMENT ANALYSIS (1997 COMPARED TO 1996) BALANCE SHEET REVIEW RISK MANAGEMENT OTHER GLOSSARY CONSOLIDATED STATEMENTS OF CONDITION CONSOLIDATED STATEMENTS OF INCOME CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY CONSOLIDATED STATEMENTS OF CASH FLOWS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS CONSOLIDATED HISTORICAL STATEMENTS OF INCOME CONSOLIDATED AVERAGE BALANCE SHEETS AND RELATED YIELDS AND RATES CORPORATE OFFICERS AND BOARDS OF DIRECTORS 28 FIRST TENNESSEE NATIONAL CORPORATION ANNUAL FINANCIAL STATEMENTS AND REVIEW OF OPERATIONS SELECTED FINANCIAL AND OPERATING DATA
(Dollars in millions except per share data) 1998 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------ SUMMARY Interest income $ 1,133.8 $ 941.3 $ 896.5 $ 822.5 INCOME Less interest expense 593.3 458.2 445.3 431.8 STATEMENTS --------------------------------------------------------------------------------------------------------- Net interest income 540.5 483.1 451.2 390.7 Provision for loan losses 51.3 51.1 35.7 20.6 --------------------------------------------------------------------------------------------------------- Net interest income after provision 489.2 432.0 415.5 370.1 Noninterest income 985.5 668.1 571.2 492.6 --------------------------------------------------------------------------------------------------------- Adjusted gross income after provision 1,474.7 1,100.1 986.7 862.7 Noninterest expense 1,121.8 785.0 704.5 609.7 --------------------------------------------------------------------------------------------------------- Income before income taxes 352.9 315.1 282.2 253.0 Applicable income taxes 126.5 117.6 102.3 88.1 --------------------------------------------------------------------------------------------------------- Net income $ 226.4 $ 197.5 $ 179.9 $ 164.9 ======================================================================================================================== COMMON Basic earnings per share $ 1.77 $ 1.54 $ 1.34 $ 1.21 STOCK Diluted earnings per share 1.72 1.50 1.32 1.20 DATA Cash dividends declared per share .685 .615 .5475 .485 Year-end book value per share 8.50 7.44 7.14 6.50 Closing price of common stock per share: High 38 1/16 33 3/4 19 5/16 15 7/16 Low 23 13/16 18 3/8 14 7/16 9 13/16 Year-end 38 1/16 33 3/8 18 3/4 15 1/8 Dividends per share/year-end closing price 1.8% 1.8% 2.9% 3.2% Dividends/earnings (payout ratio) 38.8 40.2 40.9 39.8 Closing price/diluted earnings per share 22.1x 22.3x 14.2x 12.6x Market capitalization $ 4,920.8 $ 4,279.0 $ 2,507.2 $ 2,032.1 Average shares outstanding (thousands) 128,235 128,365 134,393 136,050 Period-end shares outstanding (thousands) 128,974 128,209 133,715 134,356 Volume of shares traded (thousands) 107,837 135,205 109,038 131,296 - ------------------------------------------------------------------------------------------------------------------------ SELECTED Total assets $ 16,720.7 $ 13,280.6 $ 12,588.3 $ 11,359.5 AVERAGE Total loans* 8,242.1 7,945.1 7,472.1 6,887.2 BALANCES Investment securities 2,425.8 2,139.4 2,203.2 2,161.0 Earning assets 14,320.5 11,512.1 11,062.0 10,094.7 Deposits 10,996.4 9,207.1 8,945.5 8,132.4 Term borrowings 252.7 185.5 253.7 208.9 Shareholders' equity 996.0 878.8 897.5 822.8 - ------------------------------------------------------------------------------------------------------------------------ SELECTED Total assets $ 18,734.0 $ 14,387.9 $ 13,058.9 $ 12,076.9 PERIOD-END Total loans* 8,557.1 8,311.4 7,728.2 7,333.3 BALANCES Investment securities 2,426.3 2,186.5 2,239.5 2,111.4 Earning assets 15,694.6 12,220.2 11,045.8 10,483.6 Deposits 11,723.0 9,671.8 9,033.1 8,582.2 Term borrowings 414.5 168.9 234.6 260.0 Shareholders' equity 1,099.5 954.1 954.5 873.2 - ------------------------------------------------------------------------------------------------------------------------ SELECTED Return on average shareholders' equity 22.73% 22.47% 20.05% 20.04% RATIOS Return on average assets 1.35 1.49 1.43 1.45 Net interest margin 3.80 4.23 4.13 3.92 Allowance for loan losses to loans* 1.59 1.51 1.52 1.54 Net charge-offs to average loans* .46 .54 .41 .30 Average total capital to average assets** 6.55 7.36 7.13 7.24 Average shareholders' equity to average assets 5.96 6.62 7.13 7.24 Average tangible equity to average tangible assets 5.23 5.81 6.20 6.36 Average shareholders' equity to average net loans 12.28 11.24 12.20 12.15 - ------------------------------------------------------------------------------------------------------------------------ RETURN TO Stock appreciation 14.0% 78.0% 24.0% 48.5% SHAREHOLDERS Dividend yield 2.1 3.3 3.6 4.8 Annual return 16.1 81.3 27.6 53.3 - ------------------------------------------------------------------------------------------------------------------------ * Net of unearned income. ** Total capital includes shareholders' equity and guaranteed preferred beneficial interests in First Tennessee's junior subordinated debentures. See accompanying notes to consolidated financial statements. Common stock data reflects the 1998 and 1996 two-for-one stock splits.
29 FIRST TENNESSEE NATIONAL CORPORATION ANNUAL FINANCIAL STATEMENTS AND REVIEW OF OPERATIONS SELECTED FINANCIAL AND OPERATING DATA
(Dollars in millions except per share data) 1994 1993 - ---------------------------------------------------------------------------------------------- SUMMARY Interest income $ 701.1 $ 652.2 INCOME Less interest expense 306.6 276.1 STATEMENTS ------------------------------------------------------------------------------- Net interest income 394.5 376.1 Provision for loan losses 17.2 36.5 ------------------------------------------------------------------------------- Net interest income after provision 377.3 339.6 Noninterest income 456.2 388.1 ------------------------------------------------------------------------------- Adjusted gross income after provision 833.5 727.7 Noninterest expense 625.7 552.6 ------------------------------------------------------------------------------- Income before income taxes 207.8 175.1 Applicable income taxes 60.7 65.4 ------------------------------------------------------------------------------- Net income $ 147.1 $ 109.7 ============================================================================================== COMMON Basic earnings per share $ 1.07 $ .81 STOCK Diluted earnings per share 1.07 .80 DATA Cash dividends declared per share .435 .375 Year-end book value per share 5.69 5.26 Closing price of common stock per share: High 11 15/16 11 3/4 Low 9 5/16 9 Year-end 10 3/16 9 5/8 Dividends per share/year-end closing price 4.3% 3.9% Dividends/earnings (payout ratio) 38.0 39.7 Closing price/diluted earnings per share 9.5x 12.0x Market capitalization $ 1,388.5 $ 1,319.8 Average shares outstanding (thousands) 136,884 136,292 Period-end shares outstanding (thousands) 136,296 137,120 Volume of shares traded (thousands) 93,384 101,944 - ---------------------------------------------------------------------------------------------- SELECTED Total assets $ 10,579.8 $ 9,982.4 AVERAGE Total loans* 5,984.4 4,996.4 BALANCES Investment securities 2,248.7 3,015.3 Earning assets 9,406.2 8,953.6 Deposits 7,714.4 7,186.0 Term borrowings 101.8 102.8 Shareholders' equity 759.5 684.1 - ---------------------------------------------------------------------------------------------- SELECTED Total assets $ 10,932.9 $ 10,800.7 PERIOD-END Total loans* 6,498.0 5,560.3 BALANCES Investment securities 2,170.9 2,364.3 Earning assets 9,610.1 9,511.8 Deposits 7,880.3 7,602.7 Term borrowings 113.8 92.0 Shareholders' equity 774.9 721.1 - ---------------------------------------------------------------------------------------------- SELECTED Return on average shareholders' equity 19.36% 16.04% RATIOS Return on average assets 1.39 1.10 Net interest margin 4.25 4.27 Allowance for loan losses to loans* 1.69 1.99 Net charge-offs to average loans* .30 .60 Average total capital to average assets** 7.18 6.85 Average shareholders' equity to average assets 7.18 6.85 Average tangible equity to average tangible assets 6.38 6.28 Average shareholders' equity to average net loans 12.94 14.00 - ---------------------------------------------------------------------------------------------- RETURN TO Stock appreciation 5.8% 4.8% SHAREHOLDERS Dividend yield 4.5 4.1 Annual return 10.3 8.9 - ---------------------------------------------------------------------------------------------- * Net of unearned income. ** Total capital includes shareholders' equity and guaranteed preferred beneficial interests in First Tennessee's junior subordinated debentures. See accompanying notes to consolidated financial statements. Common stock data reflects the 1998 and 1996 two-for-one stock splits.
30 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION First Tennessee National Corporation (First Tennessee) is headquartered in Memphis, Tennessee, and is a nationwide, diversified financial services institution which provides banking and other financial services to its customers through various regional and national business lines. The REGIONAL BANKING GROUP includes the retail/commercial bank, the credit card division and the trust division. The NATIONAL LINES OF BUSINESS include FT Mortgage Companies and affiliates (also referred to as mortgage banking), First Tennessee Capital Markets (also referred to as capital markets), and transaction processing (credit card merchant processing, automated teller machine network and check clearing operations). Certain revenues and expenses are allocated and equity is assigned to the various business lines to reflect the inherent risk in each business line, based on management's best estimates. These allocations are periodically reviewed and may be revised from time to time to more accurately reflect current business conditions and risks. In addition, certain reclassifications of accounts may occur to reflect current reporting standards within the industry. In each case, the previous history is restated to ensure comparability. For the purpose of this management discussion and analysis (MD&A), noninterest income (also called fee income) and total revenues exclude securities gains and losses. Net interest income has been adjusted to a fully taxable-equivalent (FTE) basis for certain tax-exempt loans and investments included in earning assets. Earning assets, including loans, have been expressed as averages, net of unearned income. The following financial discussion should be read with the accompanying consolidated financial statements and notes. A glossary is included at the end of this section to assist with terminology. Management's discussion and analysis may contain forward-looking statements with respect to First Tennessee's beliefs, plans, goals, expectations, and estimates. These statements are contained in certain sections that follow such as Net Interest Income, Interest Rate Risk Management, Credit Risk Management/Asset Quality, and Year 2000. Forward-looking statements are statements that are not based on historical information but rather are related to future operations, strategies, financial results or other developments. Forward-looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies many of which are beyond a company's control, and many of which, with respect to future business decisions, are subject to change. Examples of uncertainties and contingencies include, among other important factors, general and local economic and business conditions; interest rate, market and monetary fluctuations; inflation; competition within and without the financial services industry; and new products and services in the industries in which First Tennessee operates. Other factors are those inherent in originating loans, including prepayment risks and fluctuating collateral values and changes in customer profiles. Uncertainties regarding changes in technology, within First Tennessee and by third-party vendors of First Tennessee and future acquisitions, can also affect results. Additionally, the policies of the Office of the Comptroller of the Currency and the Board of Governors of the Federal Reserve System, unanticipated regulatory and judicial proceedings, and changes in laws and regulations applicable to First Tennessee and First Tennessee's success in managing the risks involved in the foregoing, could cause actual results to differ. First Tennessee assumes no obligation to update any forward-looking statements that are made from time to time. SECURITIZATION ACTIVITY During 1998, First Tennessee Bank National Association (FTBNA) securitized approximately $73 million of direct automobile loan receivables. Also during 1998, FTBNA securitized $711 million of its consumer real estate loans from the consumer loan and permanent mortgage portfolios through the use of a Real Estate Mortgage Investment Conduit (REMIC). All of the interests in the REMIC are owned by subsidiaries of First Tennessee, including FTBNA. This transaction affects categorization of individual line items on the balance sheet. Consequently, loans have been reduced and investment securities have been increased. 31 For a more complete understanding, where significant, these transactions are discussed and identified as "Managed" information, which adds data on these securitized loans to "Reported" data for loans. "Reported" information has been prepared in conformity with generally accepted accounting principles. "Managed" information treats loans securitized and sold with servicing retained and loans securitized through the REMIC as if they had not been securitized and/or sold. "Managed" information does not include the mortgage banking servicing portfolio. FINANCIAL HIGHLIGHTS OF 1998 A detailed discussion follows these highlights. * Earnings for 1998 reflect the eighth consecutive year of RECORD EARNINGS for First Tennessee. * Net income for the year INCREASED 15 PERCENT to $226.4 million from $197.5 million earned in 1997. * Diluted earnings per share (adjusted for the 1998 two-for-one stock split) were $1.72 in 1998, UP 15 PERCENT over the $1.50 earned in 1997. Basic earnings per share were $1.77 in 1998, up 15 percent over the $1.54 earned in 1997. * RETURN ON AVERAGE SHAREHOLDERS' EQUITY was 22.7 percent in 1998 ranking First Tennessee fifth in this ratio among the top 50 bank holding companies. In 1997, the return on average shareholders' equity was 22.5 percent. RETURN ON AVERAGE ASSETS was 1.35 percent in 1998 compared with 1.49 percent in 1997. The decline in the return on average assets was attributable to the 26 percent growth in average assets of which 55 percent was caused by growth in the mortgage warehouse, a lower earning asset, from a record year of originations. * Total revenues for 1998 GREW 32 PERCENT with growth in fee income of 47 percent and growth in net interest income of 12 percent. Mortgage banking and capital markets led the increase in fee income with growth of 69 percent and 50 percent, respectively. * The consolidated net interest margin was 3.80 percent in 1998 compared with 4.23 percent in 1997. The lower margin was primarily related to the growth in the mortgage warehouse which has a lower spread than the regional banking group. The consolidated net interest margin compression was partially offset by the 16 basis points improvement in the regional banking group's margin. * Asset quality remained stable with a lower level of charge-offs and a lower percentage of nonperforming assets for the year. * At December 31, 1998, First Tennessee RANKED in the ninth 50 bank holding companies nationally in market capitalization ($4.9 billion) and assets ($18.7 billion). FT Mortgage Companies RANKED ninth nationally in retail mortgage originations and ranked in the top 20 in servicing, and First Tennessee Capital Markets was again ONE OF THE TOP FIVE UNDERWRITERS of U.S. agency debt. INCOME STATEMENT ANALYSIS - 1998 COMPARED TO 1997 NONINTEREST INCOME - ------------------ Noninterest income, also called fee income, provides the majority of First Tennessee's revenue. During 1998, fee income increased 47 percent, to a record $981.5 million from $668.8 million, and contributed 64 percent to total revenue in 1998 compared with 58 percent in 1997. This high contribution level ranks First Tennessee sixth among the largest 50 bank holding companies in the nation for this ratio. Table 1 - Analysis of Noninterest Income provides six years of detail by category with growth rates. 32 TABLE 1 - ANALYSIS OF NONINTEREST INCOME
Compound Annual Growth Rates (%) ---------------- (Dollars in thousands) 1998 1997 1996 1995 1994 1993 98/97 98/93 - ---------------------------------------------------------------------------------------------------------------------------------- NONINTEREST INCOME: Mortgage banking $ 558,366 $ 330,131 $ 275,406 $ 213,563 $ 188,270 $ 139,542 69.1 + 32.0 + Capital markets 147,353 98,310 85,871 82,814 77,478 91,525 49.9 + 10.0 + Deposit transactions and cash management 90,444 86,047 78,228 74,124 65,797 59,580 5.1 + 8.7 + Trust services and investment management 51,198 40,941 34,704 34,435 27,895 25,556 25.1 + 14.9 + Merchant processing 37,462 32,111 24,185 19,164 14,699 12,021 16.7 + 25.5 + Cardholder 21,046 19,833 17,155 14,885 15,572 15,769 6.1 + 5.9 + Equity securities gains/(losses) 3,940 (854) (2,495) 3,195 24,251 (479) N/A N/A Debt securities gains/(losses) 36 141 (186) (751) (4,298) 1,371 74.5 - 51.7 - All other income and commissions: Other service charges 14,863 10,474 9,891 7,709 7,334 9,296 41.9 + 9.8 + Check clearing fees 9,199 13,043 16,873 17,585 16,124 14,569 29.5 - 8.8 - Insurance premiums and commissions 8,725 6,457 5,644 6,606 5,797 4,077 35.1 + 16.4 + Other 42,871 31,496 25,873 19,282 17,247 15,275 36.1 + 22.9 + - ---------------------------------------------------------------------------------------------------------------- Total other income 75,658 61,470 58,281 51,182 46,502 43,217 23.1 + 11.9 + - ---------------------------------------------------------------------------------------------------------------- Total noninterest income $ 985,503 $ 668,130 $ 571,149 $ 492,611 $ 456,166 $ 388,102 47.5 + 20.5 + ================================================================================================================ Certain previously reported amounts have been reclassified to agree with current presentation.
MORTGAGE BANKING FT Mortgage Companies, an affiliate of FTBNA, originates and services residential mortgage loans. Following origination, the first-lien mortgage loans are sold to investors in the secondary market while the rights to service such loans are usually retained. Various hedging strategies are used to mitigate changes in the market value of the loan during the time period beginning with a price commitment to the customer and ending with the delivery of the loan to the investor. Gains or losses from these hedging activities are reflected as secondary marketing gains or losses (secondary marketing activities). Secondary marketing activities also include pricing concessions as well as the capitalized value of the mortgage servicing rights. Servicing rights permit the collection of fees for gathering and processing monthly mortgage payments for the owner of the mortgage loans. FT Mortgage employs hedging strategies to mitigate the risk of prepayment and loss of value of its servicing portfolio due to interest rate changes. Any gains or losses due to the early termination of mortgage servicing hedges are reported in miscellaneous income. As shown in Table 2 - Mortgage Banking, total mortgage banking fee income increased 69 percent in 1998, due primarily to growth in the mortgage origination function (loan origination fees and secondary marketing activities). TABLE 2 - MORTGAGE BANKING
Compound Annual Growth Rates (%) ----------------- (Dollars and volume in millions) 1998 1997 1996 98/97 98/96 - -------------------------------------------------------------------------------------------------------------------------------- NONINTEREST INCOME: Secondary marketing activities $ 223.4 $ 128.8 $ 104.4 73.3 + 46.3 + Loan origination fees 159.7 83.5 85.6 91.3 + 36.6 + Servicing fees 117.9 94.4 69.2 24.9 + 30.5 + Sale of mortgage servicing rights (.5) 9.1 15.1 NM NM Miscellaneous 57.9 14.3 1.1 304.1 + 618.1 + - ------------------------------------------------------------------------------------------------------------ Total noninterest income $ 558.4 $ 330.1 $ 275.4 69.1 + 42.4 + ============================================================================================================ Mortgage loan originations $ 23,251 $ 10,624 $ 10,396 118.9 + 49.6 + Servicing portfolio 39,738 26,929 22,288 47.6 + 33.5 + - ------------------------------------------------------------------------------------------------------------ Certain previously reported amounts have been adjusted to agree with current presentation. NM = not meaningful
33 Income derived from the mortgage origination function increased 80 percent in 1998, from $212.3 million to $383.1 million, as FT Mortgage Companies originated a record $23.3 billion of mortgage loans in 1998, and ranked as the ninth largest retail mortgage loan originator in the nation. Origination volume, consisting of refinances and home purchases, increased 119 percent during 1998. Refinance activity increased 317 percent and accounted for 56 percent of the origination volume during 1998 as borrowers seized the opportunity to lower the interest rates on their mortgages. In 1997, refinance activity accounted for 29 percent of the origination volume. Lower interest rates, a strong real estate market and the effect of increased market share by FT Mortgage Companies also contributed to the 37 percent increase in home purchase-related mortgages. The higher volume of originations, coupled with more profitable execution of loan sales stemming from more favorable interest rates, accounted for most of the increase in income from secondary marketing activities. Mortgage servicing fee income increased 25 percent in 1998, from $94.4 million to $117.9 million. The mortgage servicing portfolio (which includes servicing for ourselves and others) totaled $39.7 billion at December 31, 1998, as compared with $26.9 billion at December 31, 1997. This growth was generated through FT Mortgage's origination network and no servicing was purchased. The favorable relationship between the origination capacity and the size of the servicing portfolio contributed to the 48 percent growth in the servicing portfolio. The change in the portfolio during 1998 resulted from originations of $23.3 billion less $1.2 billion in sales of servicing released originations and principal reductions of $9.3 billion from payments and payoffs received in the normal course of business. Sales of servicing rights of $25 million were transacted during 1998 compared with sales of $475 million in 1997. The growth in miscellaneous income relates primarily to recognized gains from the termination of hedge positions on the servicing portfolio. Recognized gains from hedge activities will vary from period to period depending on the interest rate environment and market conditions. Servicing hedges are used to counterbalance the loss in value of the servicing portfolio that occurs when declining interest rates accelerate expected prepayments. During 1998 and 1997, $38.1 million and $6.4 million, respectively, of miscellaneous income came from gains on the termination of certain mortgage servicing hedges. In addition, income of $12.5 million was received related to a program where First Tennessee buys delinquent loans to reduce future foreclosure costs. CAPITAL MARKETS First Tennessee Capital Markets generates fee income primarily from the purchase and sale of securities as both principal and agent. Inventory positions are limited to the procurement of securities solely for distribution to customers by the sales staff. Inventory is hedged to protect against movements in interest rates. During 1998, noninterest income increased 50 percent from $98.3 million in 1997 to $147.4 million. Total securities bought and sold by the capital markets division increased 88 percent in 1998, from $226.6 billion to $427.0 billion. The increased core volume growth, paralleling the growth in revenue, came from continued expansion of the customer base, additional product penetration, and strong performance in all of the offices including the recently opened New York office, and an entire year of operations for the Chicago office. The majority of the remaining volume growth was due to additional emphasis on short-term U.S. agency notes. Total underwritings during 1998 were $52.6 billion, an increase of 81 percent from $29.0 billion underwritten in 1997. For 1998, First Tennessee Capital Markets ranked as the top underwriter of U.S. government agency debt greater than one year. DEPOSIT TRANSACTIONS AND CASH MANAGEMENT Deposit transaction fees are received for services related to retail deposit products (such as service charges on checking accounts) and cash management 34 fees are generated by products and services such as electronic transaction processing (automated clearing house (ACH) and Electronic Data Interchange (EDI)), account reconciliation services, cash vault services, lockbox processing and information reporting (Prime Connection). Noninterest income from deposit transactions and cash management increased 5 percent in 1998, from $86.1 million to $90.4 million. The increase in 1998 was led by growth in cash management fees from ACH processing and retail and wholesale lockbox processing. TRUST SERVICES AND INVESTMENT MANAGEMENT Trust services generates fees from the asset management product lines of investment management accounts, personal trusts, employee benefits, and custodial and corporate trust services. During 1998, noninterest income from trust services grew 25 percent, from $40.9 million to $51.2 million. The growth was principally due to acquisition activity, increased assets under management and strong market performance. The acquisition of Martin & Company, Inc. (Martin) during 1998, accounted for 45 percent, or $4.7 million, of the growth in noninterest income. Assets under management grew from $6.6 billion at December 31, 1997, to $8.9 billion at December 31, 1998, with the acquisition of Martin accounting for 50 percent, or $1.2 billion, of this growth. The growth in fee income was led by the asset management business lines with fee growth of 77 percent in investment management, 7 percent in employee benefits and 6 percent in personal trust. Noninterest income from corporate trust services, an indenture trustee business that acts as trustee on public bond issues, increased 9 percent. Highland Capital Management Corp. (Highland Capital) and Martin, both wholly owned subsidiaries, provide investment advisory services to the managed asset segments. Highland Capital manages the First Funds Growth and Income Portfolio and the First Funds Bond Portfolio. Martin manages the First Funds Tennessee Tax-Free Portfolio and the First Funds Intermediate Bond Portfolio. First Funds is a family of mutual funds managed by FTBNA. The Growth and Income Portfolio gained national recognition during 1998 by achieving the five-star Morningstar rating in the Equity (Large Blend) category for both the retail and institutional classes for the three-year period ending December 31, 1998. MERCHANT PROCESSING Credit card merchant processing involves converting transactions from plastic media such as check cards, debit cards, credit cards, purchase cards, and private label credit cards into cash for merchants selling goods and services to consumers and businesses. Fee income from merchant processing grew 17 percent in 1998, from $32.1 million to $37.5 million. Merchant transaction volume grew 25 percent, from 125 million transactions processed in 1997 to a record 157 million transactions processed in 1998, due to the addition of new merchants and higher activity levels. The increase in revenues was partially negated by the effect of a new outsourcing agreement for equipment sales and leases. Fees and expenses related to the outsourcing had previously been recorded separately, but upon execution of the new agreement in the fourth quarter of 1997, began to be recorded as net revenue. Revenues were also positively impacted by a special assessment received from a large customer during the fourth quarter of 1998. CARDHOLDER Cardholder fees result from issuing and servicing credit cards and include the collection of late charges and annual fees, as well as interchange fees received for accepting a credit card payment. Cardholder noninterest income increased 6 percent in 1998, from $19.8 million to $21.0 million. The credit card portfolio grew moderately during 1998, consistent with the industry, with growth of 3 percent (from $544.7 million to $563.5 million). This moderate growth, coupled with strong purchasing volume led to higher interchange collections the effect of which was diminished by the collection of fewer late fees due to lower delinquencies. 35 SECURITIES GAINS/(LOSSES) In 1998, there were $3.9 million of net equity securities gains compared with $.8 million of net equity securities losses for 1997. The gains in 1998 were from the investment subsidiary, Hickory Venture Capital Corporation. ALL OTHER NONINTEREST INCOME All other noninterest income grew 23 percent in 1998, from $61.5 million to $75.7 million. Other service charges are generated from banking services performed, but are not directly related to deposit transactions, such as fees for money orders, travelers' checks, savings bonds, safe deposit box rentals, mutual fund services and safekeeping. Other service charges also include servicing fees collected from securitized transactions. During 1998, other service charges grew 42 percent, from $10.5 million to $14.9 million, primarily from growth in investment/mutual fund sales and the securitization transactions completed during the year. Check clearing fees declined 29 percent (from $13.0 million to $9.2 million) from the previous year primarily due to the continuing impact of industry consolidations. Insurance premiums and commissions increased 35 percent (from $6.5 million to $8.7 million) from 1997 due to increased sales efforts throughout the year. The other category increased 36 percent, from $31.5 million to $42.9 million. This growth was spread over several areas including fees received from flood zone certifications, earnings from First Tennessee's investment in bank owned life insurance, and gains related to foreclosures. NET INTEREST INCOME - ------------------- During 1998, net interest income increased 12 percent, from $487.4 million to $544.3 million, principally from the growth in earning assets. Earning assets increased 24 percent, from $11.5 billion to $14.3 billion. The major factor for this growth in earning assets was the mortgage warehouse which produced 68 percent of the increase in earning assets. The increase in earning assets, combined with the narrower spread earned on the mortgage warehouse, led to the decline in the consolidated net interest margin (margin) from 4.23 percent in 1997 to 3.80 percent in 1998. The margin's compression was partially compensated for by the improvement in the regional banking group's margin from 4.71 percent in 1997 to 4.87 percent in 1998. This improvement was primarily due to lower cost funding. The margin is affected by the activity levels and related funding for First Tennessee's national lines of business in addition to mortgage banking, as these nonbank business lines typically produce different margins than traditional banking activities. In mortgage banking, because the spread between the rates on mortgage loans temporarily in the warehouse and the related short-term funding rates is less than the comparable spread earned in the regional banking group, the overall margin is compressed. Consequently, as the warehouse volume increases, the margin also compresses. Capital markets tends to compress the margin because of its strategy to reduce market risk by hedging its inventory in the cash markets which effectively eliminates net interest income on these positions. As a result, First Tennessee's consolidated margin cannot be readily compared to that of other bank holding companies. Table 3 - Net Interest Margin Composition details the computation of the net interest margin for the regional banking group and the impact that the other business lines had on the consolidated margin for the years 1996 through 1998. 36 TABLE 3 - NET INTEREST MARGIN COMPOSITION
1998 1997 1996 - -------------------------------------------------------------------------------------------------------- REGIONAL BANKING GROUP: Yields on earning assets 8.20% 8.25% 8.15% Rates paid on interest-bearing liabilities 4.36 4.54 4.67 - -------------------------------------------------------------------------------------------------------- Net interest spread 3.84 3.71 3.48 - -------------------------------------------------------------------------------------------------------- Effect of interest-free sources .89 .89 .88 Loan fees .14 .11 .11 - -------------------------------------------------------------------------------------------------------- Net interest margin-Regional Banking Group 4.87% 4.71% 4.47% - -------------------------------------------------------------------------------------------------------- MORTGAGE BANKING (.92) (.37) (.22) CAPITAL MARKETS (.17) (.12) (.09) TRANSACTION PROCESSING .02 .01 .03 BASIS SWAP IMPACT -- -- (.06) - -------------------------------------------------------------------------------------------------------- Consolidated net interest margin 3.80% 4.23% 4.13% ========================================================================================================
Interest rate sensitivity is primarily a function of the repricing structure of First Tennessee's balance sheet (Statement of Condition). Table 4 - Rate Sensitivity Analysis at December 31, 1998, shows the assets and liabilities as of year-end, subject to repricing in specified time intervals with each maturity interval referring to the earliest repricing opportunity (i.e., the earlier of scheduled contractual maturity or repricing date) for each asset and liability category. The resulting gap is one tool, though not a predominant management tool, used to measure the sensitivity of earnings to changes in interest rates. It should be noted that the required gap analysis does not take into account future management actions that could be undertaken to alter the simulated results, the effect of interest-free sources, or a change in the slope of the yield curve. (For additional information see Risk Management-Interest Rate Risk Management.) In order to reflect more appropriately the repricing structure of First Tennessee's balance sheet, management has made certain adjustments to the balances shown in the table. Based on historical and industry data, an estimate of the expected prepayments on consumer loans and investment securities is reflected in the balances in the table. Changes in the economic and interest rate environments may also affect these expected prepayments. Similarly, an adjustment to deposits is made to reflect the behavioral characteristics of certain core deposits that do not have specified contractual maturities (i.e., interest checking, savings and money market deposit accounts). Historically, balances on these deposit accounts have remained relatively stable despite changes in market interest rates. Management has classified certain of these accounts as non-interest sensitive based on management's historical pricing practices and runoff experience. Approximately 86 percent of interest checking and 91 percent of savings balances were classified as over one year at December 31, 1998. At December 31, 1998, the balance sheet was asset sensitive to interest rate movements and within internal guideline limits, with $629 million more assets than liabilities scheduled to reprice within one year (4 percent of earning assets). The requirements of Table 4 do not take into account the effect of interest-free sources which can be significant to First Tennessee. When the interest-free sources are added to the rate sensitivity analysis, the balance sheet is relatively neutral with $54 million of assets repricing faster than liabilities within one year (.3 percent of earning assets). 37 The primary tool used by First Tennessee to manage the exposure of net interest income and margin to volatile interest rates, changing market spreads, forecasted changes in balance sheet mix, and rate sensitivity is simulation analysis. This type of analysis computes the amount of earnings at risk from dynamic changes in the market place and related rate, pricing and balance sheet movements. The simulation models create various earnings at risk scenarios looking at increases and/or decreases in interest rates from an instantaneous movement, or a staggered movement over a certain time period. Management reviews these different scenarios to determine probable actions. The models are then updated to incorporate management action. A level of acceptable earnings at risk based on a staggered increase or decrease in interest rates of 300 basis points is a component of internal guidelines. Using these models and based on First Tennessee's rate sensitivity position, there were no earnings at risk in 1998 from a decrease in rates and the earnings at risk from a staggered increase averaged less than 2.4 percent of projected 1998 net interest income. Based on the rate sensitivity position at December 31, 1998, earnings exposure over the next 12 months to an increase in interest rates is estimated to be less than 2.0 percent of projected 1999 net interest income. There is projected to be no earnings exposure to a decline in interest rates. A 300 basis point staggered increase or decrease in interest rates is a hypothetical rate scenario. This scenario is used as one estimate of risk, and does not necessarily represent management's current view of future interest rates or market developments and may well vary from actual results for a number of reasons, including those presented at the beginning of this MD&A discussion. With First Tennessee's existing balance sheet mix and the current interest rate environment, the regional banking group's margin is expected to be relatively stable. Going forward, the consolidated margin will continue to be influenced by the activity levels in the nonbanking lines of business, especially from mortgage banking as this business line experiences fluctuations in origination volume strongly tied to refinance activity. The following statements are forward looking. Actual results could differ because of several factors, including those presented at the beginning of this MD&A discussion. Table 5 - Analysis of Changes in Net Interest Income provides rate and volume changes in interest income and interest expense for earning assets and interest-bearing liabilities for the past three years. TABLE 4 - RATE SENSITIVITY ANALYSIS AT DECEMBER 31, 1998
---------------------------------------------------------------------------------- Within 3 After 3 Months After 6 Months After 1 Year After (Dollars in millions) Months Within 6 Months Within 12 Months Within 5 Years 5 Years Total - -------------------------------------------------------------------------------------------------------------------------------- EARNING ASSETS: Loans $4,616 $ 348 $535 $2,350 $ 708 $ 8,557 Investment securities 292 267 425 1,200 242 2,426 Mortgage loans held for sale 4,228 -- -- -- -- 4,228 Federal funds sold and securities purchased under agreements to resell 124 -- -- -- -- 124 Other earning assets 360 -- -- -- -- 360 - -------------------------------------------------------------------------------------------------------------------------------- Total earning assets $9,620 $ 615 $960 $3,550 $ 950 $15,695 ================================================================================================================================ EARNING ASSET FUNDING: Savings $ 32 $ -- $ -- $ 258 $ 50 $ 340 Checking interest 185 -- -- 715 459 1,359 Money market 2,032 -- -- -- 263 2,295 CD's under $100,000 and other time 532 582 668 659 40 2,481 CD's $100,000 and more 1,793 200 113 74 11 2,191 Short-term borrowed funds 4,147 126 66 -- -- 4,339 Term borrowings 15 75 -- 1 323 414 - -------------------------------------------------------------------------------------------------------------------------------- Total earning asset funding $8,736 $ 983 $847 $1,707 $1,146 $13,419 ================================================================================================================================ RATE SENSITIVITY GAP: Period $ 884 $(368) $113 $1,843 $ (196) Cumulative 884 516 629 2,472 2,276 - ------------------------------------------------------------------------------------------------------------------- RATE SENSITIVITY GAP ADJUSTED FOR INTEREST RATE FUTURES AND INTEREST RATE SWAPS: Period $ 592 $(142) $179 $1,843 $ (196) Cumulative 592 450 629 2,472 2,276 - ------------------------------------------------------------------------------------------------------------------- ADJUSTED GAP AS A PERCENTAGE OF TOTAL EARNING ASSETS: Period 3.8% (.9)% 1.1% 11.7% (1.2)% Cumulative 3.8 2.9 4.0 15.7 14.5 - ------------------------------------------------------------------------------------------------------------------- Interest-sensitive categories represent ranges in which assets and liabilities can be repriced, not necessarily their actual maturities. The 'After 5 Years' column includes assets and liabilities with interest sensitivity of more than five years or with indefinite repricing schedules. Noninterest earning/bearing balances have been excluded from this analysis.
38 TABLE 5 - ANALYSIS OF CHANGES IN NET INTEREST INCOME
1998 Compared to 1997 1997 Compared to 1996 Increase / (Decrease) Due to* Increase / (Decrease) Due to* (Fully taxable equivalent) ------------------------------------------------------------- (Dollars in thousands) Rate** Volume** Total Rate** Volume** Total - ----------------------------------------------------------------------------------------------------------------------------------- INTEREST INCOME - FTE: Loans: Commercial $(4,538) $ 27,874 $ 23,336 $ 2,349 $19,268 $21,617 Consumer 6,184 3,128 9,312 5,596 13,203 18,799 Permanent mortgage 237 (12,580) (12,343) 1,128 (1,792) (664) Credit card receivables (2,479) 2,304 (175) (1,359) 1,712 353 Real estate construction (626) 6,535 5,909 (29) 6,021 5,992 Nonaccrual 294 (218) 76 (1,775) 1,118 (657) - -------------------------------------------------------- -------- ------- Total loans (97) 26,212 26,115 5,307 40,133 45,440 - -------------------------------------------------------- -------- ------- Investment securities: U.S. Treasury and other U.S. government agencies (482) (11,037) (11,519) 2,940 (4,639) (1,699) States and municipalities (213) (1,094) (1,307) 66 (1,180) (1,114) Other 174 32,025 32,199 120 1,218 1,338 - -------------------------------------------------------- -------- ------- Total investment securities 298 19,075 19,373 2,950 (4,425) (1,475) - -------------------------------------------------------- -------- ------- Other earning assets: Mortgage loans held for sale (6,199) 135,013 128,814 (925) (4,281) (5,206) Investment in bank time deposits (25) 1,493 1,468 3 (244) (241) Federal funds sold and securities purchased under agreements to resell (297) (724) (1,021) 77 6,047 6,124 Capital markets securities inventory (1,266) 18,468 17,202 16 (949) (933) - -------------------------------------------------------- -------- ------- Total other earning assets (5,162) 151,625 146,463 (3,079) 2,823 (256) - -------------------------------------------------------- -------- ------- Total earning assets (32,040) 223,991 191,951 8,778 34,931 43,709 - ----------------------------------------------------------------------------------------------------------------------------------- Total interest income - FTE $191,951 $43,709 - ----------------------------------------------------------------------------------------------------------------------------------- INTEREST EXPENSE: Interest-bearing deposits: Savings $ (466) $ (609) $ (1,075) $ (193) $(1,066) $(1,259) Checking interest and money market 3,517 14,531 18,048 (5,502) 7,977 2,475 Certificates of deposit under $100,000 and other time (3,860) (11,783) (15,643) (595) (5,417) (6,012) Certificates of deposit $100,000 and more (575) 64,317 63,742 1,078 369 1,447 - -------------------------------------------------------- -------- ------- Total interest-bearing deposits 4,039 61,033 65,072 (8,423) 5,074 (3,349) - -------------------------------------------------------- -------- ------- Federal funds purchased and securities sold under agreements to repurchase (450) 33,248 32,798 1,879 9,914 11,793 Commercial paper and other short-term borrowings (2,902) 36,050 33,148 642 8,737 9,379 Term borrowings (1,378) 5,401 4,023 933 (5,868) (4,935) - -------------------------------------------------------- -------- ------- Total interest-bearing liabilities 4,795 130,246 135,041 (5,078) 17,966 12,888 - ----------------------------------------------------------------------------------------------------------------------------------- Total interest expense $135,041 $12,888 - ----------------------------------------------------------------------------------------------------------------------------------- Net interest income - FTE $ 56,910 $30,821 =================================================================================================================================== * The changes in interest due to both rate and volume have been allocated to change due to rate and change due to volume in proportion to the absolute amounts of the changes in each. ** Variances are computed on a line-by-line basis and are non-additive.
PROVISION FOR LOAN LOSSES - ------------------------- The provision for loan losses is the charge to operating earnings that management determines to be necessary to maintain the allowance for loan losses at an adequate level reflecting management's estimate of the risk of loss inherent in the loan portfolio. The provision for loan losses was $51.3 million in 1998 compared with $51.1 million in 1997. The provision for loan losses remained relatively stable in 1998 due to improvements in mortgage banking and credit card asset quality, which was principally negated by the increased inherent risk in the loan portfolio from loan growth and a change in loan mix partially due to securitizations. A more detailed discussion follows in the Risk Management-Credit Risk Management/Asset Quality section. NONINTEREST EXPENSE - ------------------- Noninterest expense, also called operating expense, increased 43 percent in 1998, from $785.0 million to $1,121.8 million, primarily because of growth in the commission-based business lines. Table 6 - Analysis of Noninterest Expense provides detail by category for the past six years with growth rates. Table 7 - Operating Expense Composition gives a breakdown of total expenses by business line for the prior three years. 39 TABLE 6 - ANALYSIS OF NONINTEREST EXPENSE
Compound Annual Growth Rates (%) ---------------- (Dollars in thousands) 1998 1997 1996 1995 1994 1993 98/97 98/93 - ----------------------------------------------------------------------------------------------------------------------- NONINTEREST EXPENSE: Employee compensation, incentives and benefits $ 563,576 $409,783 $385,380 $340,508 $349,769 $308,601 37.5 + 12.8 + Amortization of mortgage servicing rights 95,507 37,452 26,041 14,980 14,936 25,478 155.0 + 30.2 + Operations services 58,505 49,879 44,109 38,798 33,679 28,705 17.3 + 15.3 + Occupancy 51,421 42,848 39,815 37,867 34,102 27,673 20.0 + 13.2 + Equipment rentals, depreciation and maintenance 45,771 40,093 34,121 31,845 29,202 22,246 14.2 + 15.5 + Communications and courier 41,468 34,899 32,981 29,880 30,653 24,775 18.8 + 10.9 + Advertising and public relations 25,184 18,722 17,629 12,972 10,678 7,987 34.5 + 25.8 + Amortization of intangible assets 11,114 9,631 9,491 8,100 6,406 5,871 15.4 + 13.6 + All other expense: Contract employment 35,937 17,420 11,288 5,744 5,323 5,631 106.3 + 44.9 + Foreclosed real estate 31,019 10,827 7,533 4,962 3,862 1,542 186.5 + 82.3 + Legal and professional fees 24,551 13,999 12,050 13,403 13,747 11,274 75.4 + 16.8 + Supplies 20,195 15,267 14,383 11,866 11,472 10,312 32.3 + 14.4 + Travel and entertainment 19,485 13,802 10,394 8,211 10,144 8,868 41.2 + 17.1 + Amortization of hedge instruments 13,345 4,867 -- -- -- -- 174.2 + N/A Computer software 11,629 6,731 4,076 3,004 2,619 2,334 72.8 + 37.9 + Distribution on guaranteed preferred securities 8,070 8,070 -- -- -- -- -- N/A Fed service fees 5,307 5,799 7,814 9,489 8,544 7,778 8.5 - 7.4 - Deposit insurance premium 1,578 1,485 5,129 9,957 16,923 16,585 6.3 + 37.5 - Contribution to charitable foundation -- -- -- -- 9,379 -- N/A N/A Other 58,107 43,470 42,252 28,129 34,245 36,899 33.7 + 9.5 + - ------------------------------------------------------------------------------------------------------ Total other expense 229,223 141,737 114,919 94,765 116,258 101,223 61.7 + 17.8 + - ------------------------------------------------------------------------------------------------------ Total noninterest expense $1,121,769 $785,044 $704,486 $609,715 $625,683 $552,559 42.9 + 15.2 + ====================================================================================================== Certain previously reported amounts have been reclassified to agree with current presentation.
TABLE 7 - OPERATING EXPENSE COMPOSITION
(Dollars in millions) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------ Regional banking group $ 403.5 $352.3 $322.9 Mortgage banking 536.9 292.7 256.0 Capital markets 111.0 74.2 66.7 Transaction processing 62.3 57.7 55.1 Corporate 8.1 8.1 3.8 - ------------------------------------------------------------------------------------------------------ Total operating expense $1,121.8 $785.0 $704.5 ======================================================================================================
Operating expense in the mortgage banking division increased 83 percent, from $292.7 million to $536.9 million, and accounted for 73 percent of the overall expense growth. Mortgage banking expense growth was driven by increased mortgage origination volume and a larger servicing portfolio. Higher volumes also led to the 50 percent increase in operating expense in capital markets which accounted for 11 percent of the overall expense growth. Excluding mortgage banking and capital markets, overall operating expenses increased 13 percent during 1998. Investments to expand consumer lending beyond our traditional markets, growth in the insurance business, consolidation expenses of the merchant processing operation, and investments in marketing and technology contributed to this growth rate. Employee compensation, incentives and benefits (personnel expense), the largest component of noninterest expense, increased 38 percent in 1998, from $409.8 million to $563.6 million. Personnel expense includes commissions paid in several lines of business, such as capital markets and mortgage banking. As the revenues increase or decrease and/or as the product mix changes in these business lines, the amount of commissions changes accordingly. Excluding these two business lines, personnel expense increased 13 percent due in part to market expansion in our other business lines. 40 Amortization of capitalized mortgage servicing rights increased 155 percent, from $37.4 million to $95.5 million. This increase came as a result of a larger servicing portfolio and additional prepayments. All other expense consists of other expense categories such as contract employment, foreclosed real estate expenses, legal and professional fees, supplies, travel and entertainment, and other. During 1998, all other expense increased 62 percent, from $141.8 million to $229.2 million. Mortgage banking accounted for approximately 84 percent of the growth in these expense categories. Contract employment increased $18.5 million, or 106 percent, over 1997. Foreclosed real estate increased $20.2 million in 1998, or 187 percent over last year. Excluding mortgage banking, all other expense increased 18 percent from 1997 with the growth being spread out over a number of categories. INCOME STATEMENT ANALYSIS - 1997 COMPARED TO 1996 Earnings in 1997 were $197.5 million, the seventh consecutive year of record earnings, and an increase of 10 percent from $179.9 million earned in 1996. Basic earnings per share increased 15 percent from $1.34 in 1996 to $1.54 in 1997. Diluted earnings per share increased 14 percent from $1.32 in 1996 to $1.50 in 1997. The difference between the net income growth and the earnings per share growth reflects the positive effect of share repurchase programs on the computation of earnings per share. Return on average shareholder's equity was 22.5 percent in 1997 compared with 20.0 percent in 1996. Return on average assets was 1.49 percent in 1997 and 1.43 percent in 1996. Noninterest income increased 17 percent during 1997, from $573.9 million to $668.8 million and contributed 56 percent to total revenue. During 1997, mortgage banking fees increased 20 percent, from $275.4 million to $330.1 million, from growth in the servicing portfolio and improved profitability in the loan origination process. During 1997, originations were a record $10.6 billion compared with $10.4 billion in 1996, and the servicing portfolio was $26.9 billion at December 31, 1997, compared with $22.3 billion at December 31, 1996. See Table 2 for a breakout of noninterest income. Capital markets' fee income increased 14 percent in 1997, from $85.9 million to $98.3 million and securities bought and sold increased 4 percent, from $217.8 billion to $226.6 billion. This growth was due to market expansion with the opening of a new office in Chicago and other customer base expansion initiatives. During 1997, deposit transactions and cash management fees grew 10 percent, from $78.2 million to $86.1 million; trust services and investment management fees increased 18 percent, from $34.7 million to $40.9 million; merchant processing fees grew 33 percent, from $24.2 million to $32.1 million; and cardholder fees grew 16 percent, from $17.2 million to $19.8 million. All other noninterest income grew 5 percent in 1997, from $58.3 million to $61.5 million. In 1997, there were $.8 million of equity securities losses and $.1 million of debt securities gains compared with $2.5 million of equity securities losses and $.2 million of debt securities losses in 1996. During 1997, net interest income increased 7 percent, from $456.6 million to $487.4 million. The consolidated net interest margin improved from 4.13 percent to 4.23 percent. See Table 3 for the detailed computation of the net interest margin for the regional banking group and the impact that the other business lines had on the consolidated margin. The provision for loan losses was $51.1 million in 1997 compared with $35.7 million in 1996. The increase was primarily related to a higher estimate of inherent losses in the credit card portfolio reflecting the national trend in credit card asset quality; commercial loans associated with a more normal credit cycle; and mortgages repurchased by mortgage banking during 1997. During 1997, noninterest expense increased 11 percent, from $704.5 million to $785.0 million, primarily because of growth in mortgage banking. Table 7 gives a breakdown of expenses by business line. Mortgage banking accounted for 46 percent of the overall expense growth in 1997 and was driven by a larger servicing portfolio, increased production costs and additional expenses incurred to correct loan document deficiencies. Personnel expense, the largest component, increased 6 percent overall, from $385.4 million in 1996 to $409.8 million in 1997, and increased 2 percent in mortgage banking and 12 percent in capital markets, two commission-based businesses. Amortization of mortgage servicing rights increased 44 percent, from $26.0 million in 1996 to $37.4 million in 1997 as a result of a larger capitalized servicing portfolio and the implementation of a new accounting standard which led to reclassification of certain amortization-related accounts. All other expense increased 23 percent, from $115.0 million in 1996 to $141.8 million in 1997, with the growth in mortgage banking accounting for 62 percent of this increase. Deposit insurance premiums decreased 71 percent, from $5.1 million in 1996 to $1.5 million in 1997, as a result of the reduction in the FDIC premium to zero on Bank Insurance Fund (BIF)-insured deposits at the beginning of 1996, partially offset in that year by the one-time Savings Association Insurance Fund (SAIF) assessment. 41 BALANCE SHEET REVIEW At December 31, 1998, First Tennessee reported total assets of $18.7 billion compared with $14.4 billion at the end of 1997 and $13.1 billion at the end of 1996. Average assets were $16.7 billion in 1998 compared with $13.3 billion in 1997 and $12.6 billion in 1996. The large increase in period-end and average balances from 1997 to 1998 was principally driven by the growth in the mortgage warehouse. (The mortgage warehouse accounted for 69 percent of the growth in period-end assets and 55 percent of the growth in average assets.) EARNING ASSETS - -------------- Loans, investment securities and mortgage loans held for sale are the primary earning assets. For 1998, earning assets averaged $14.3 billion compared with $11.5 billion for 1997 and $11.1 billion for 1996. Average earning assets were 86 percent of total average assets in 1998, 87 percent in 1997 and 88 percent in 1996. LOANS As previously discussed, First Tennessee securitized certain loans in 1998. For a more complete understanding of loan growth trends it is helpful to analyze information on a "reported" as well as a "managed" basis. "Reported" information is derived from consolidated financial statements that have been prepared in conformity with generally accepted accounting principles. "Managed" information treats consumer loans securitized and sold with servicing retained and loans securitized through the REMIC and held by First Tennessee as if they had not been securitized and/or sold. "Managed" information does not include the mortgage banking servicing portfolio. Table 8 - Selected Loans includes information for reported and managed loans. For 1998, total loans were $8.2 billion but on a managed basis averaged $8.6 billion. This compares with total loans of $7.9 billion for 1997 and $7.5 billion for 1996. Loans grew 4 percent, or $297.0 million, during 1998 and 6 percent, or $473.0 million during 1997. However, on a managed basis, loans grew 10 percent during 1998. Loans represented 58 percent of earning assets in 1998; 69 percent of earning assets in 1997 and 68 percent in 1996. This ratio was lower in 1998 due to the securitization activity. Additional loan information is provided in Note 4 - Loans. TABLE 8 - SELECTED LOANS
1998 1998 1998 AS Growth 1998 Growth (Dollars in millions) REPORTED 1997 Rate (%) MANAGED* Rate (%) - -------------------------------------------------------------------------------------------------------------- DECEMBER 31 PERIOD-END Consumer loans $ 3,018.8 $ 2,855.2 5.7 $ 3,342.5 17.1 Permanent mortgages 423.2 663.5 (36.2) 683.6 3.0 Total loans 8,557.1 8,311.4 3.0 9,141.2 10.0 - -------------------------------------------------------------------------------------------------------------- YEAR-TO-DATE AVERAGES Consumer loans $ 2,794.4 $ 2,760.0 1.2 $ 3,055.0 10.7 Permanent mortgages 481.6 638.4 (24.6) 679.8 6.5 Total loans 8,242.1 7,945.1 3.7 8,700.9 9.5 - -------------------------------------------------------------------------------------------------------------- * Excludes managed loans in the mortgage banking servicing portfolio.
Commercial loans continued as the single largest loan category and represented 48 percent of total loans for 1998. These loans represented approximately 46 percent of total managed loans between 1996 and 1998 (46 percent in both 1998 and 1997 and 45 percent in 1996). For 1998, commercial loans averaged $4.0 billion compared with $3.6 billion for 1997 and $3.4 billion for 1996. During 1998, commercial loans grew 9 percent, or $341.4 million, compared with 7 percent growth, or $241.3 million, in 1997. The increase in commercial loans, influenced by strong economic growth in Tennessee, came from acquisitions of new relationships in our targeted markets as a result of new sales support systems and training programs implemented in 1997 and 1998. Additional commercial loan information is provided in Table 9 - Contractual Maturities of Commercial Loans at December 31, 1998. 42 TABLE 9 - CONTRACTUAL MATURITIES OF COMMERCIAL LOANS AT DECEMBER 31, 1998
After 1 Year (Dollars in thousands) Within 1 Year Within 5 Years After 5 Years Total - ---------------------------------------------------------------------------------------------------------- Commercial $2,262,296 $1,478,304 $376,318 $4,116,918 Real estate construction 264,322 83,587 27,981 375,890 Commercial nonaccrual 9,970 1,416 42 11,428 - ---------------------------------------------------------------------------------------------------------- Total commercial loans, net of unearned income $2,536,588 $1,563,307 $404,341 $4,504,236 ========================================================================================================== For maturities over one year: Interest rates - floating $1,074,604 $269,577 $1,344,181 Interest rates - fixed 488,703 134,764 623,467 - ---------------------------------------------------------------------------------------------------------- Total $1,563,307 $404,341 $1,967,648 ==========================================================================================================
The consumer loan portfolio consists of real estate, automobile, student and other consumer installment loans that require periodic payments of principal and interest. Consumer loans represented 34 percent of total loans for 1998 and managed consumer loans represented 35 percent of total managed loans for 1998, 1997 and 1996. For 1998 and 1997, consumer loans averaged $2.8 billion compared with $2.6 billion for 1996. However, on a managed basis, consumer loans averaged $3.1 billion for 1998. During 1998, managed consumer loans grew 11 percent, or $295.0 million, compared with 6 percent growth, or $152.5 million in 1997. Lower interest rates and a favorable economy contributed to this increase. Real estate loans, principally secured by first and/or second liens on residential property, led the increase in consumer loans and accounted for 68 percent of the consumer loan portfolio in 1998. Gulf Pacific Mortgage, a division of FTBNA, is active in originating second mortgages and originated $131.2 million to the managed consumer loan portfolio in 1998. Unsecured consumer loans increased approximately $50 million in 1998 due to targeted promotional campaigns. The permanent mortgage portfolio includes certain mortgage loans that First Tennessee periodically decides to retain. The permanent mortgage portfolio represented 6 percent of total loans for 1998 and managed permanent mortgages represented approximately 8 percent of total managed loans for the three-year period (8 percent in both 1998 and 1997 and 9 percent in 1996). For 1998, permanent mortgage loans averaged $481.6 million but on a managed basis, averaged $679.8 million. This compares with $638.4 million for 1997 and $660.0 million for 1996. Managed permanent mortgage loans increased 6 percent, or $41.4 million in 1998 compared to a decline of 3 percent or $21.6 million in 1997. The majority of the growth in 1998 was from second mortgage loans originated by mortgage banking. From 1996 to 1998, credit card receivables (i.e., outstanding balances on credit card accounts) represented approximately 7 percent of total loans. For 1998, credit card receivables averaged $563.5 million compared with $544.7 million for 1997 and $530.2 million for 1996. Credit card receivables increased 3 percent, or $18.8 million, in 1998 and increased 3 percent, or $14.5 million, during 1997. Visa/Mastercard balances grew 5 percent due to the acquisition of a credit card portfolio (approximately $11 million), increased use of debt by consumers, as well as targeted promotional campaigns to regional banking customers. The overall growth rate was impacted by the planned decline in private label receivable balances. The real estate construction loan portfolio represented approximately 4 percent of total loans from 1996 through 1998 (5 percent in 1998 and 4 percent in both 1997 and 1996). For 1998, real estate construction loans averaged $405.3 million compared with $337.4 million for 1997 and $275.1 million for 1996. During 1998, this portfolio grew 20 percent, or $67.9 million, compared with 23 percent growth, or $62.3 million, in 1997. The increase is reflective of economic growth in Tennessee, favorable market conditions, and growth in residential construction loans primarily originated by mortgage banking. Going forward First Tennessee expects moderate loan growth due to the anticipated slower growth in the national and regional economies. In the consumer-related loan portfolios, the opening of new finance company offices and targeted promotional programs are expected to help sustain and generate growth. As loan growth continues to outpace deposit growth, First Tennessee will continue to evaluate alternative sources of funding which may include loan sales, securitizations, syndications, and debt offerings. 43 INVESTMENT SECURITIES The investment portfolio of First Tennessee consists principally of debt securities used as a source of income, liquidity and collateral for repurchase agreements or public fund deposits. Additionally, the investment portfolio is used as a tool to manage risk from movements in interest rates. Table 10 - Investment Securities includes reported information and information excluding the securitizations. Table 11 - Contractual Maturities of Investment Securities at December 31, 1998, shows information pertaining to the composition, yields and maturities of the investment securities portfolio. TABLE 10 - INVESTMENT SECURITIES
1998 1998 1998 EXCLUDING 1998 AS Growth SECURITIZATION Growth (Dollars in millions) REPORTED 1997 Rate (%) ACTIVITY Rate (%) - -------------------------------------------------------------------------------------------------------------------------- December 31 period-end $2,426.3 $2,186.5 11.0 $1,857.0 (15.1) Year-to-date averages 2,425.8 2,139.4 13.4 1,985.7 (7.2) - --------------------------------------------------------------------------------------------------------------------------
TABLE 11 - CONTRACTUAL MATURITIES OF INVESTMENT SECURITIES AT DECEMBER 31, 1998 (AMORTIZED COST)
After 1 Year After 5 Years Within 1 Year Within 5 Years Within 10 Years After 10 Years ------------------- ------------------ ------------------ --------------------- (Dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield - ------------------------------------------------------------------------------------------------------------------------ SECURITIES HELD TO MATURITY: States and municipalities* $11,759 5.11% $ 14,990 6.29% $ 8,851 6.86% $ 5,232 8.02% Private issued CMOs -- -- -- -- 371,930 7.00 197,042 7.73 - ------------------------------------------------------------------------------------------------------------------------ Total $11,759 5.11% $ 14,990 6.29% $ 380,781 7.00% $ 202,274 7.74% ======================================================================================================================== SECURITIES AVAILABLE FOR SALE: Mortgage-backed securities and collateralized mortgage obligations** $26,993 6.81% $ 58,087 7.00% $ 101,166 6.84% $ 1,304,989 6.49% U.S. Treasury and other U.S. government agencies 25,121 4.94 106,221 6.45 16,824 6.01 1,346 6.47 States and municipalities* 1,986 5.37 6,826 5.89 10,012 6.05 300 9.66 Other 1,192 7.15 4,863 7.03 5,346 6.50 124,294 *** 6.23 - ------------------------------------------------------------------------------------------------------------------------ Total $55,292 5.92% $175,997 6.63% $ 133,348 6.66% $ 1,430,929 6.46% ======================================================================================================================== * Weighted average yields on tax-exempt obligations have been computed by adjusting allowable tax-exempt income to a fully taxable equivalent basis using a tax rate of 35 percent. ** Includes $1,490.2 million of government agency issued mortgage-backed securities and collateralized mortgage obligations which, when adjusted for early paydowns, have an estimated average life of 2.7 years. *** Represents equity securities with no stated maturity.
Average investment securities increased 13 percent, or $286.3 million, in 1998, and Table 10 shows the impact the securitization activity had on this growth rate. During 1997, average investment securities decreased 3 percent, or $63.8 million. Investment securities represented 17 percent of earning assets in 1998 compared with 19 percent in 1997 and 20 percent in 1996. The investment portfolio is classified into two categories: securities available for sale (AFS) and securities held to maturity (HTM). The securities portfolio totaled $2.4 billion at December 31, 1998. The majority of these securities were classified as AFS with an average life of 2.4 years. These securities consisted primarily of mortgage-backed securities, collateralized mortgage obligations (CMOs), U.S. Treasuries, U.S. government agencies and equities. At December 31, 1998, these securities had approximately $20.9 million of net unrealized gains that resulted in an increase in book equity of approximately $12.9 million, net of $8.0 million of deferred income taxes. At December 31, 1997, the AFS securities portfolio totaled $2.1 billion and had approximately $25.3 million of net unrealized gains that resulted in an increase in book equity of approximately $15.6 million, net of $9.7 million of deferred income taxes. At December 31, 1996, the AFS securities portfolio totaled $2.2 billion and had approximately $5.9 million of net unrealized gains that resulted in an increase in book equity of approximately $3.7 million, net of $2.2 million of deferred income taxes. 44 At December 31, 1998, the HTM securities totaled $609.8 million and had an average life of 5.2 years. The REMIC securities accounted for 93 percent ($569.0 million) of this category and had an average life of 5.0 years. Municipal bonds made up the remainder of this classification and had an average life of 7.3 years. The HTM securities portfolio had a net unrealized gain at December 31, 1998, of $.6 million. At December 31, 1997, the HTM securities totaled $53.2 million and had a net unrealized gain of $1.1 million, and at December 31, 1996, the HTM securities portfolio totaled $65.9 million and had a net unrealized gain of $.8 million. Internal corporate guidelines require all securities purchased for the investment portfolio to be rated investment grade by Moody's Investors Service or Standard & Poor's. Because of the structure of the REMIC transaction, a rating was not obtained for the REMIC securities. Excluding the REMIC securities, First Tennessee was in compliance with its internal guidelines at December 31, 1998. Securities backed by the U.S. government or its agencies, both on a direct and indirect basis, represented 89 percent of the investment portfolio at December 31, 1998, excluding the REMIC securities. MORTGAGE LOANS HELD FOR SALE Mortgage loans held for sale (mortgage warehouse) are loans that have been originated and are awaiting securitization and/or delivery. In 1998 these mortgages represented approximately 20 percent of total earning assets up from the 1997 and 1996 ratios of 10 percent and 9 percent, respectively, due to record originations during 1998. During 1998, the mortgage warehouse averaged $2.9 billion and increased 189 percent, or $1.9 billion, from 1997. During 1997, the mortgage warehouse averaged $1.0 billion and decreased 5 percent, or $53.5 million, from 1996. Since the mortgage warehouse loans are generally held in inventory for a short period of time (30 to 60 days), there may be significant differences between average and period-end balances. At year-end 1998, the mortgage warehouse totaled $4.2 billion compared with $1.2 billion and $787.4 million at year-end 1997 and 1996, respectively. The higher balance at year-end 1998 was comparable to the average balance for the fourth quarter, which was $4.3 billion. DEPOSITS, OTHER SOURCES OF FUNDS, AND LIQUIDITY MANAGEMENT - ---------------------------------------------------------- DEPOSITS During 1998, core deposits grew 8 percent, or $639.8 million, and averaged $9.0 billion with the majority of the growth in noninterest-bearing accounts which included growth in mortgage escrow balances. Excluding the growth in mortgage escrow accounts, core deposit accounts would have grown 5 percent during 1998. This compares with growth of 3 percent, or $254.4 million, and an average balance of $8.4 billion in 1997. In 1996, these deposits averaged $8.1 billion. Growth in 1998 was comparable to regional market growth and came primarily from expansion of First Tennessee's targeted customer base. Interest-bearing core deposits grew 3 percent, or $201.7 million, during 1998 and averaged $6.3 billion compared with 2 percent growth, or $112.8 million, and an average balance of $6.1 billion in 1997. Interest-bearing core deposits averaged $6.0 billion in 1996. Noninterest-bearing deposits grew 20 percent, or $438.1 million, during 1998 from growth in mortgage escrow accounts, a cash management investment product and demand deposits, and averaged $2.7 billion. In comparison, noninterest-bearing deposits grew 7 percent, or $141.6 million, and averaged $2.2 billion in 1997. Noninterest-bearing deposits averaged $2.1 billion in 1996. OTHER SOURCES OF FUNDS Purchased funds averaged $5.7 billion for 1998, up 74 percent, or $2.4 billion, from the previous year. This increase was primarily used to fund the growth in the mortgage warehouse. Purchased funds increased 12 percent, or $352.1 million in 1997, and averaged $3.3 billion and $2.9 billion during 1997 and 1996, respectively. Purchased funds accounted for 38 percent of First Tennessee's funding (core deposits plus purchased funds and term borrowings) in 1998, 28 percent in 1997, and 26 percent in 1996. See Note 9 - Short-Term Borrowings for additional information. Term borrowings include senior and subordinated borrowings and advances with maturities greater than one year. Term borrowings increased $67.2 million during 1998 and averaged $252.7 million compared with a decrease of 27 percent, or $68.2 million, and an average balance of $185.5 million in 1997. The increase in 1998 was primarily due to $100 million of subordinated debt issued in March and $150 million of subordinated debt issued in December. Term borrowings averaged $253.7 million in 1996. See Note 10 - Term Borrowings for additional information. LIQUIDITY MANAGEMENT The objective of liquidity management is to ensure the continuous availability of funds to meet the demands of depositors and borrowers. The Asset/Liability Committee, a committee consisting of senior management that meets regularly, is responsible for managing these needs by taking into account the marketability of assets; the sources, stability and availability of funding; and the level of unfunded commitments. Core deposits are First Tennessee's primary source of funding and one of the most stable sources of liquidity for a bank. In 1998, core deposits funded 63 percent of earning assets compared with 73 percent in both 1997 and 1996. This ratio fell in 1998 due to the build-up in the mortgage 45 warehouse which was primarily funded with purchased funds. FTBNA has a $3 billion bank note program available for additional liquidity. Under this program, the bank may borrow funds from time to time, at maturities of 30 days to 30 years. At December 31, 1998, approximately $2.2 billion was available under the bank note program as a long-term (greater than one year) funding source. Parent company liquidity is maintained by cash flows stemming from dividends and interest payments collected from subsidiaries, which represent the primary source of funds to pay dividends to shareholders and interest to debtholders. The amount of dividends from bank subsidiaries is subject to certain regulatory restrictions which are described in Note 17 - Restrictions, Contingencies and Other Disclosures. The parent company statements are presented in Note 24 - Parent Company Financial Information. The parent company also has the ability to enhance its liquidity position by raising equity or incurring debt. Under an effective shelf registration statement on file with the Securities and Exchange Commission (SEC), First Tennessee, as of December 31, 1998, may offer from time to time at its discretion, debt securities, and common and preferred stock aggregating up to $225 million. In addition, First Tennessee also has an effective capital securities shelf registration statement on file with the SEC under which up to $200 million of capital securities is available for issuance. Maintaining adequate credit ratings on debt issues is critical to liquidity because it affects the ability of First Tennessee to attract funds from various sources on a cost-competitive basis. The various credit ratings are detailed in Table 12 - Credit Ratings at December 31, 1998. TABLE 12 - CREDIT RATINGS AT DECEMBER 31, 1998
Thomson Fitch Standard & Poor's Moody's BankWatch IBCA - ------------------------------------------------------------------------------------------------------------- FIRST TENNESSEE NATIONAL CORPORATION Overall rating B Subordinated capital notes due 1999 BBB+ Baa1 Subordinated capital notes due 2005 BBB+ Baa1 Capital securities due 2027* BBB A3 A- Commercial paper TBW-1 - ------------------------------------------------------------------------------------------------------------- FIRST TENNESSEE BANK NATIONAL ASSOCIATION Short-term/long-term deposits A-1/A P-1/A1 TBW-1 F1/A+ Other short-term/long-term funding** A-1/A P-1/A1 Subordinated bank notes A- A3 Counterparty credit rating A A1 - ------------------------------------------------------------------------------------------------------------- * Guaranteed preferred beneficial interests in First Tennessee's subordinated debentures. ** Other funding includes certificates of deposit and senior bank notes.
CAPITAL - ------- Total capital (shareholders' equity plus qualifying capital securities) at December 31, 1998, was $1.2 billion, up 14 percent, or $145.4 million, from December 31, 1997. Shareholders' equity (excluding the qualifying capital securities) was $1.1 billion at year-end 1998, up 15 percent from year-end 1997 which remained relatively flat with year-end 1996. The increase in total capital in 1998 came from retention of net income after dividends, equity issued for acquisitions and stock option exercises, reduced by shares repurchased. The increase in total capital in 1997 was primarily due to the issuance of qualifying capital securities and the retention of net income after dividends, reduced by share repurchase programs during the year. The Consolidated Statements of Shareholders' Equity highlights the changes in equity since December 31, 1995. Capital adequacy is an important indicator of financial stability and performance. Management's objectives are to maintain a level of capitalization that is sufficient to sustain asset growth, take advantage of profitable growth opportunities and promote depositor and investor confidence. Overall, First Tennessee's capital position remained strong as shown in Table 13 - Capital Ratios. However, despite the increase in shareholders' equity, the capital ratios declined as a result of the 26 percent increase in average assets driven by the 189 percent growth in the mortgage warehouse. Unrealized market valuations had no material effect on the ratios during the three year period. However, in 1998, excluding the effects of unrealized market valuations would have lowered the period-end equity to assets ratio to 5.81 percent. 46 TABLE 13 - CAPITAL RATIOS
1998 1997 1996 - ------------------------------------------------------------------------------------------------------------- Average total capital to average assets* 6.55% 7.36% 7.13% Average shareholders' equity to average assets 5.96 6.62 7.13 Period-end shareholders' equity to assets 5.87 6.63 7.31 Period-end double leverage 112.5 113.2 107.6 - ------------------------------------------------------------------------------------------------------------- * Total capital includes shareholders' equity and guaranteed preferred beneficial interests in First Tennessee's junior subordinated debentures.
Banking regulators define minimum capital ratios for bank holding companies and their subsidiaries. Based on the risk-based capital rules and definitions prescribed by the banking regulators, should an institution's capital ratios decline below predetermined levels, it would become subject to a series of increasingly restrictive regulatory actions. The system categorizes a financial institution's capital position into one of five categories ranging from well-capitalized to critically under-capitalized. For an institution to qualify as well-capitalized, Tier 1 Capital, Total Capital and Leverage capital ratios must be at least 6 percent, 10 percent and 5 percent, respectively. As of December 31, 1998, First Tennessee and all of its banking affiliates had sufficient capital to qualify as well-capitalized institutions as shown in Note 12 - Regulatory Capital. At the January 1998 meeting of the board of directors, a two-for-one stock split was approved. The stock split was effective February 20, 1998, and changed the par value of First Tennessee's common stock from $1.25 to $.625 per share and the shares of authorized common stock increased from 200 million to 400 million. All share-related information has been restated in this document to reflect the stock split. At December 31 book value per common share was $8.50 in 1998 compared with $7.44 in 1997 and $7.14 in 1996. Average shares outstanding for the three year period were: 128.2 million in 1998, 128.4 million in 1997 and 134.4 million in 1996. Period-end shares outstanding for this same three year period were: 129.0 million, 128.2 million and 133.7 million, respectively. First Tennessee's shares are traded on The Nasdaq Stock Market national market system under the symbol FTEN, and are listed in the financial section of most newspapers as FstTN Ntl. The sales price ranges, net income per share and dividends by quarter for each of the last two years are presented in Table 20 - Summary of Quarterly Financial Information. At December 31, 1998, the closing sales price of First Tennessee's common stock was $38.0625 per share. This price was 448 percent of year-end book value per share, and the annual dividend yield was 2.1 percent for 1998 based on dividends declared in 1998 and the closing market price of $33.375 on December 31, 1997. The quarterly dividend was last increased at the October 15, 1998, board of directors' meeting to $.19 per share, payable January 1, 1999, up 15 percent from $.165 per share. The board of directors has authorized management to repurchase common stock from time to time, for various purposes. At December 31, 1997, management had remaining authority to purchase up to $46.7 million of stock prior to December 31, 1998. During 1998, no shares were purchased pursuant to this authority, and as a result the authority expired December 31, 1998. Had shares been purchased under this authority, these shares would have been considered tainted for purposes of pooling-of-interests accounting rules. Management also has authority to repurchase common stock from time to time, for the various benefit programs. During 1998, 1.9 million shares were repurchased while 2.1 million were issued for benefit plans and .5 million were issued for acquisitions. During 1997, First Tennessee repurchased 7.5 million shares of its common stock (of which 3.8 million shares, at a cost of $83.3 million, were purchased under an accelerated purchase program) and issued 1.9 million shares for benefit plans. During 1996, 1.7 million shares were repurchased with 1.0 million shares being issued for benefit plans. Pursuant to board authority, First Tennessee plans to continue to purchase shares from time to time for its stock option plans, and will evaluate the level of capital and take action designed to generate or use capital as appropriate for the interest of the shareholders. 47 RISK MANAGEMENT INTEREST RATE RISK MANAGEMENT - ----------------------------- The primary purpose of managing interest rate risk is to effectively invest First Tennessee's capital to manage and preserve the value created by its banking and nonbanking businesses. This is done by managing the structure of the balance sheet to maximize overall profitability, increasing revenues, and achieving the desired level of net interest income while managing interest sensitivity risk and liquidity. Derivative financial instruments are used to aid in managing the exposure of the balance sheet, net interest income, fee income and expenses, to changes in interest rates. Interest sensitivity risk is defined as the risk that future changes in interest rates will reduce income. Interest rate risk occurs when assets and liabilities reprice at different times as interest rates change. First Tennessee uses a variety of measurement tools to monitor and control the overall interest rate risk exposure of both its on- and off-balance sheet positions. One way to gauge the impact that future changes in interest rates may have on earnings is through an interest rate sensitivity analysis. This analysis examines the net position of assets, liabilities and derivative instruments subject to repricing within specified time periods. Table 14 - Risk Sensitivity Analysis details First Tennessee's interest rate sensitivity profile at December 31, 1998. As required, Table 14 is based on projected cashflows using contractual maturity for loans and expected repayment dates for securities. This methodology does not necessarily reflect management's evaluation of interest rate risk as these instruments may reprice more frequently than at contractual maturity. First Tennessee's net interest income and its financial condition are affected by changes in the level of market interest rates as the repricing characteristics of its loans and other assets do not necessarily match those of its deposits, other borrowings and capital. For example, a portion of fixed-rate assets that reprice within one year are funded with floating-rate debt. This position will benefit net interest income in a declining interest rate environment and will negatively impact net interest income in a rising interest rate environment. In the case of floating-rate assets and liabilities, First Tennessee may also be exposed to basis risk, which results from changing spreads between loans and deposit rates. Because the interest rate sensitivity analysis does not fully capture the impact of changes in the balance sheet mix, administered rates (such as the prime lending rate), embedded options, or lagged interest rate changes, it cannot be used in isolation to determine the level of interest rate risk exposure. Accordingly, First Tennessee uses simulation analysis as its primary tool to manage interest rate risk exposure. This type of analysis computes earnings at risk under a variety of market interest rate scenarios to identify more dynamic interest rate risk exposures. This simulation, which considers forecasted balance sheet changes, prepayment speeds, deposit mix, pricing impacts and other changes in the net interest spread, provides an estimate of the annual earnings at risk for given changes in interest rates. (See Net Interest Income discussion for additional assumptions and information.) The information provided in the simulation analysis is forward looking. Actual results could differ because of several factors, including those presented at the beginning of this MD&A discussion. The derivative financial instruments listed in Table 14 are shown at the notional and fair values. Note 23 - Financial Instruments with Off-Balance Sheet Risk should be referred to for additional information. The notional amount of derivative financial instruments used by the mortgage company grew significantly during 1998. This growth was due to the record pipeline volume, a larger servicing portfolio and a change in hedging strategy to greater use of corridors (where purchase and written options are used, thereby doubling the notional amount). The increased activity in capital markets also led to greater use of derivative financial instruments in 1998. 48 TABLE 14 - RISK SENSITIVITY ANALYSIS
CAPITAL MARKETS Fair (Dollars in millions) 1999 2000 2001 2002 2003 2004+ Total Value - ------------------------------------------------------------------------------------------------------------------------ ASSETS: Capital markets securities inventory: Floating $ 358 $ -- $ -- $ -- $ -- $ -- $ 358 $ 358 Average interest rate 5.47% -- -- -- -- -- 5.47% - ------------------------------------------------------------------------------------------------------------------------ INTEREST RATE DERIVATIVES: Interest rate forward contracts: Commitments to buy $ 2,495 $ -- $ -- $ -- $ -- $ -- $ 2,495 $ (2) Weighted average settlement price 99.97% -- -- -- -- -- 99.97% Commitments to sell $ 2,487 $ -- $ -- $ -- $ -- $ -- $ 2,487 * Weighted average settlement price 100.05% -- -- -- -- -- 100.05% - ------------------------------------------------------------------------------------------------------------------------ * Amount is less than $500,000. HELD FOR PURPOSES OTHER THAN TRADING Fair (Dollars in millions) 1999 2000 2001 2002 2003 2004+ Total Value - ------------------------------------------------------------------------------------------------------------------------ ASSETS: Loans, net of unearned income*: Floating $ 3,402 $ 198 $ 98 $ 118 $ 101 $ 165 $ 4,082 $ 4,082 Average interest rate 8.22% 8.70% 6.99% 7.22% 7.51% 8.19% 8.16% Fixed $ 2,083 $ 566 $ 444 $ 283 $ 531 $ 540 $ 4,447 $ 4,432 Average interest rate 8.58% 9.07% 8.79% 8.80% 7.81% 8.12% 8.53% Mortgage loans held for sale Floating $ 4,228 $ -- $ -- $ -- $ -- $ -- $ 4,228 $ 4,220 Average interest rate 7.03% -- -- -- -- -- 7.03% Investment securities: Fixed $ 984 $ 493 $ 231 $ 154 $ 322 $ 242 $ 2,426 $ 2,427 Average interest rate 6.92% 6.65% 6.76% 6.92% 6.62% 7.06% 6.82% Liquid assets**: Floating $ 126 $ -- $ -- $ -- $ -- $ -- $ 126 $ 126 Average interest rate 3.57% -- -- -- -- -- 3.57% - ------------------------------------------------------------------------------------------------------------------------ LIABILITIES: Interest-bearing deposits: Fixed $ 6,137 $ 649 $ 365 $ 373 $ 319 $ 823 $ 8,666 $ 8,674 Average interest rate 4.70% 4.01% 2.72% 2.75% 2.16% 2.59% 4.18% Short-term borrowings: Floating $ 4,316 $ -- $ -- $ -- $ -- $ -- $ 4,316 $ 4,317 Average interest rate 4.98% -- -- -- -- -- 4.98% Fixed $ 23 $ -- $ -- $ -- $ -- $ -- $ 23 $ 23 Average interest rate 4.12% -- -- -- -- -- 4.12% Term borrowings: Fixed $ 90 $ 1 $ -- $ -- $ -- $ 323 $ 414 $ 420 Average interest rate 9.33% 6.45% -- -- -- 6.48% 7.10% - ------------------------------------------------------------------------------------------------------------------------ * Excludes nonaccrual loans. ** Consists of federal funds sold, securities purchased under agreements to resell and investments in time deposits.
49 TABLE 14 - RISK SENSITIVITY ANALYSIS (CONTINUED)
Fair (Dollars in millions) 1999 2000 2001 2002 2003 2004+ Total Value - ---------------------------------------------------------------------------------------------------------------------------------- INTEREST RATE DERIVATIVES - (notional value) Mortgage banking: Forward contracts: Commitments to sell $ 3,926 $-- $ -- $ -- $ -- $ -- $ 3,926 $ (3) Weighted average settlement price 99.98% -- -- -- -- -- 99.98% Option contracts**: Call options purchased $ 150 $-- $ -- $ -- $ -- $ -- $ 150 $ 1 Weighted average strike price 132.00% -- -- -- -- -- 132.00% Call options written $ 150 $-- $ -- $ -- $ -- $ -- $ 150 $ (1) Weighted average strike price 98.61% -- -- -- -- -- 98.61% Floors purchased $ -- $-- $4,350 $ 400 $11,400 $ 600 $16,750 $264 Weighted average strike price -- -- 4.81% 5.97% 4.66% 4.88% 4.74% Floors written $ -- $-- $ -- $ -- $ 4,800 $ 600 $ 5,400 $(80) Weighted average strike price -- -- -- -- 4.43% 4.13% 4.39% Caps purchased $ 1,000 $-- $ -- $ -- $ 250 $ -- $ 1,250 $ 4 Weighted average strike price 6.50% -- -- -- 6.38% -- 6.48% Caps written $ 1,000 $-- $ -- $ -- $ 250 $ -- $ 1,250 $ (9) Weighted average strike price 6.00% -- -- -- 5.75% -- 5.95% Interest rate risk management: Swaps $ 432 $-- $ -- $ -- $ -- $ -- $ 432 $ 1 Average pay rate (floating) 5.27% -- -- -- -- -- 5.27% Average receive rate (fixed) 5.84% -- -- -- -- -- 5.84% Swaps $ 150 $-- $ -- $ -- $ -- $ -- $ 150 * Average pay rate (floating) 5.30% -- -- -- -- -- 5.30% Average receive rate (floating) 4.94% -- -- -- -- -- 4.94% Caps: Purchased $ -- $-- $ -- $ 20 $ -- $ -- $ 20 * Weighted average strike price -- -- -- 8.00% -- -- 8.00% Written $ -- $-- $ -- $ 20 $ -- $ -- $ 20 * Weighted average strike price -- -- -- 8.00% -- -- 8.00% - ---------------------------------------------------------------------------------------------------------------------------------- * Amount is less than $500,000. ** Option contracts in total had a book value of $174 million at December 31, 1998.
CREDIT RISK MANAGEMENT / ASSET QUALITY - -------------------------------------- First Tennessee manages credit risk and asset quality through diversification in the loan portfolio and adherence to its credit policy process. First Tennessee's goal is not to avoid risk but to manage it and include it in the pricing decision. To assess the quality of individual commercial loans, all commercial loans are internally assigned a credit rating, ranging from grades A to F, to assist in the credit risk management of these loans. In addition, management strives to identify loans experiencing difficulty early enough to correct the deficiencies. Nonperforming loans are recognized in a timely manner, and charge-offs are recorded promptly, based on realistic assessments of current collateral values and the borrower's ability to repay. The adequacy of reserves is assessed for the purpose of maintaining coverage of estimated losses inherent in the loan portfolio. At December 31, 1998, First Tennessee did not have any concentrations of 10 percent or more of total loans in any single industry. ALLOWANCE FOR LOAN LOSSES AND CHARGE-OFFS Management's policy is to maintain the allowance for loan losses at a level sufficient to absorb the estimated losses inherent in the loan portfolio. The allowance for loan losses is increased by the provision for loan losses and recoveries and is decreased by charged-off loans. The evaluation process used to determine the adequacy of the allowance for loan losses combines three factors: historical loss experience derived from analytical models, current trends, and reasonably foreseeable events. This methodology determines an estimated loss percentage (reserve rate) which is applied against the balance of loans in each segment of the loan portfolio at the evaluation date. 50 COMMERCIAL AND COMMERCIAL REAL ESTATE LOANS For the commercial loan portfolio, the reserve rate is based on a three-year, moving average of actual charge-offs for each loan grade. The reserve rate is then adjusted for current trends, both internal and external, that may affect the loan portfolio. Some of the factors considered in making these adjustments include: levels of, and trends in delinquencies, classified loans and nonaccrual loans; trends in volume and maturity; effects of changes in lending policies and underwriting guidelines; introduction of new loan products; experience, ability and depth of lending management and staff; migration of loans from watchlist loans to classified assets; and recent charge-off trends that may skew the three-year moving average. Finally, the reserve rates for each loan grade are reviewed quarterly to reflect local, regional and national economic trends, concentration of cyclical industries, and the economic prospects for industry concentrations. To supplement management's process in setting these additional adjustments, an economic model is used that measures the correlation between historical charge-offs and a number of state and national economic indicators. All classified loans over $1 million are evaluated separately, and a specific reserve is set based on the exposure (the difference between the outstanding loan amount and the estimated net realizable value of the collateral) and the probability of loss. Table 15 - Reserve Rates shows the percentage of allowance for loan losses to outstanding balances by loan category. Table 16 - Loans and Foreclosed Real Estate at December 31 gives a breakdown of the allowance allocation by major loan types and commercial loan grades at December 31, 1998, compared with the same period in 1997. This table also shows the amount of the general reserve. A general reserve is maintained on the commercial loan portfolio based on management's judgment regarding the risk of error in the specific allowances for individual loans or pools of loans. Table 17 - Analysis of Allowance for Loan Losses summarizes by category, loans charged off and recoveries of loans previously charged off. This table also shows the additions to the reserve which have been charged against operating earnings. Table 18 - Net Charge-off Ratios provides charge-off information by loan type. TABLE 15 - RESERVE RATES
1998 1997 1996 - -------------------------------------------------------------------------------- Commercial and commercial real estate* 1.01% 1.02% 1.14% Impaired** 50.00 33.33 36.36 Consumer 1.13 .91 .89 Credit card receivables 3.87 4.65 4.25 - -------------------------------------------------------------------------------- * Excludes impaired and nonaccrual loans. ** Includes nonaccrual loans.
The reserve rate (see Table 15) and the charge-off ratio (see Table 18) for commercial loans in 1998 was relatively flat to 1997. The decline in the reserve rate from 1.14 percent in 1996 to 1.01 percent in 1998 reflected the improvement in charge-offs. Commercial loan recoveries were approximately 60 percent of gross charge-offs and contributed to the low charge-off ratio of .05 percent in 1998. In 1996, commercial loan recoveries exceeded charge-offs. The reserve rate for impaired loans increased from 33.33 percent in 1997 to 50.00 percent in 1998 following a decline from 36.36 percent in 1996. The adjustment to the reserve rates for economic conditions increased during 1998 reflecting the slower growth in the economy. CONSUMER LOANS Reserve rates are also established for each segment of the consumer portfolio based on historical loss trends and are adjusted to reflect current trends. Some of the factors for making these adjustments include: changes in underwriting guidelines or credit scoring models; trends in consumer payment patterns, delinquencies and personal bankruptcy; staffing levels in the collection area; change in the mix of loan products outstanding; value of underlying collateral; and recent charge-off trends. The reserve rates are also adjusted for changing economic conditions and the adequacy of the reserves to cover inherent loss in case of error. 51 The reserve rate for consumer loans increased from .91 percent in 1997 to 1.13 percent in 1998, following an increase from .89 percent in 1996. During this period, the reserve rates declined for residential real estate and direct and indirect auto lending due to the improvement in charge-off trends for these pools of loans as demonstrated in Table 17 and Table 18. The overall increase in the consumer loan portfolio reserve rate was driven by two pools of loans with higher reserve rates - unsecured consumer debt and revolving home equity lines of credit. This unsecured consumer debt primarily relates to an installment loan product that receives a higher reward (wider spread) commensurate with the higher risk, and consequently higher reserve rate. The majority of these loans were originated in the latter part of 1998. The revolving home equity line of credit has a higher reserve rate due to the charge-off experience of higher-yielding/higher loan-to-value loan products. CREDIT CARD The establishment of the reserve rate for the credit card portfolio follows a process similar to the consumer loan portfolio. As shown in Table 15, the reserve rate declined in 1998 to 3.87 percent following an increase to 4.65 percent in 1997, and paralleled the charge-off trend for this same period (see Table 18). The credit card receivables net charge-off ratio decreased 80 basis points between 1998 and 1997 and reached its lowest level since 1995. The credit card charge-off ratio was again favorable to the industry average in 1998. A significant part of the increase in charge-offs in 1997 was due to continuing losses from a private label program discontinued the previous year. TOTAL LOANS The total allowance for loan losses increased 8 percent, or $10.2 million, in 1998 and 7 percent, or $8.1 million, in 1997. Period-end loans grew 3 percent in 1998 and 8 percent in 1997. The ratio of allowance for loan losses to loans, net of unearned income, was 1.59 percent at December 31, 1998, compared with 1.51 percent at December 31, 1997, and 1.52 percent at December 31, 1996. The increase in this coverage ratio in 1998 was primarily due to higher inherent risk in the loan portfolio due to the increase in the reserve rate in the consumer loan portfolio and the effect of securitizations. The securitizations completed during 1998 removed loans with a lower reserve rate from the loan portfolio, thus changing the risk mix. Net charge-offs decreased to $37.8 million for the year ended December 31, 1998. Net charge-offs were $43.0 million for 1997 and $30.5 million for 1996. The decrease in the level of net charge-offs was due to improved asset quality in credit card receivables where net charge-offs decreased $3.6 million from $25.7 million for 1997 to $22.1 million for 1998. Consumer loan net charge-offs also decreased in 1998 from $11.7 million for 1997 to $10.0 million, while commercial loan and permanent mortgage net charge-offs remained relatively flat to 1997 levels. The ratio of net charge-offs to average loans decreased to .46 percent for 1998 from .54 percent for 1997 and .41 percent for 1996. Excluding the repurchased mortgages (described in the Repurchased Mortgage Loans section), the ratio of net charge-offs to average loans would have decreased to .42 percent in 1998. The permanent mortgage net charge-off ratio decreased 6 basis points in 1998 to a net recovery position. Going forward, in light of current economic conditions, anticipated trends and First Tennessee's loan portfolio mix, management believes overall asset quality will remain stable and net charge-offs as a percentage of average loans should remain relatively consistent with the levels experienced in 1998. Commercial loan charge-offs will continue to rise and will approach a more normal charge-off level as the amount of potential recoveries declines. As securitizations, loan sales or other balance sheet management tools are employed which could result in a change in the mix of consumer loans, consumer loan charge-offs will potentially be at a higher level commensurate with the inherent risk of the portfolio. This is forward-looking information. Actual results could differ because of several factors, including those presented at the beginning of this MD&A discussion. 52 TABLE 16 - LOANS AND FORECLOSED REAL ESTATE AT DECEMBER 31
1998 1997 ------------------------------------------------------------ ---------------------- Construction Allowance Allowance and Commercial for Loan for Loan (Dollars in millions) Commercial Development Real Estate TOTAL Loss Total Loss - -------------------------------------------------------------------------------------------------------------------------- Internal grades*: A $ 251 $ -- $ 1 $ 252 $ -- $ 251 $ 1 B 644 -- 89 733 1 656 2 C 2,097 227 448 2,772 24 2,518 22 C- 412 40 128 580 7 574 6 D 68 5 8 81 4 90 4 E 20 -- 6 26 3 15 1 F 15 1 4 20 6 20 6 - -------------------------------------------------------------------------------------------------------------------------- 3,507 273 684 4,464 45 4,124 42 Impaired loans: Contractually past due 4 -- 1 5 2 7 3 Contractually current 6 -- 1 7 4 1 -- Nonaccrual loans: Contractually past due -- -- -- -- -- 1 -- Contractually current -- -- -- -- -- -- -- - -------------------------------------------------------------------------------------------------------------------------- Total commercial and commercial real estate loans $3,517 $273 $686 $4,476 $ 51 $4,133 $ 45 - -------------------------------------------------------------------------------------------------------------------------- Retail: Consumer 3,019 34 2,855 26 Credit card 594 23 581 27 Permanent mortgages 423 2 664 3 Mortgage banking nonaccrual 16 3 29 3 - -------------------------------------------------------------------------------------------------------------------------- Total retail loans 4,052 62 4,129 59 - -------------------------------------------------------------------------------------------------------------------------- Other/Unfunded commitments 29 2 49 3 General reserve -- 21 -- 19 - -------------------------------------------------------------------------------------------------------------------------- Total loans $8,557 $136 $8,311 $126 ========================================================================================================================== Foreclosed real estate: Foreclosed property $ 2 $ 1 $ 2 $ 5 $ 4 Foreclosed property - mortgage banking 11 8 - -------------------------------------------------------------------------------------------------------------------------- Total foreclosed real estate $ 16 $ 12 ========================================================================================================================== Loans are expressed net of unearned income. All amounts in the Allowance for Loan Loss columns have been rounded to the nearest million dollars. Grade A loans have reserve amounts of less than $500,000. *Based on internal loan classifications. Definitions of each credit grade are provided below: GRADE A: Established, stable companies with excellent earnings, liquidity, and capital. Possess many of the same characteristics as Standard & Poor's (S&P) AA rated companies. GRADE B: Established, stable companies with good earnings, liquidity, rated companies. GRADE C: Established, stable companies with satisfactory earnings, liquidity, and capital and with consistent, positive trends relative to industry norms. GRADE C-: Established, stable companies with either inconsistent and/or marginal earnings, or liquidity, or capital. Overall acceptable credits with minor weaknesses which warrant additional servicing. GRADE D: Financial condition adversely affected by temporary lack of earnings or liquidity or changes in the operating environment. An action plan is required to rehabilitate the credit or have it refinanced elsewhere. GRADE E: Significant developing weaknesses or adverse trends in earnings, liquidity, capital, or operating environment. No discernible market for refinancing is available. GRADE F: Significantly higher than normal probability that: (1) legal action or liquidation of collateral is required; (2) there will be a loss; or (3) both will occur. This grade is believed to be substantially equivalent to the regulators' classifications of substandard or doubtful. IMPAIRED: A loan for which it is probable that all amounts due, according to the contractual terms of the loan agreement, will not be collected. NONACCRUAL: A loan that is placed on nonaccrual status is not included in any of these six grades, but is placed in a separate nonaccrual category. Commercial and real estate loans are placed on nonaccrual status automatically once they become 90 days or more past due.
53 TABLE 17 - ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
(Dollars in thousands) 1998 1997 1996 1995 1994 1993 - ------------------------------------------------------------------------------------------------------------------------------ ALLOWANCE FOR LOAN LOSSES: Beginning balance $ 125,859 $ 117,748 $ 112,567 $ 109,859 $ 110,720 $ 103,223 Provision for loan losses 51,351 51,115 35,677 20,592 17,182 36,461 Allowance from acquisitions 140 -- -- 2,632 -- 971 Securitization adjustment (3,575) -- -- -- -- -- Charge-offs: Commercial 5,379 6,388 3,355 5,614 6,458 16,905 Consumer 14,976 16,574 15,531 12,373 9,180 8,909 Credit card receivables 24,242 27,420 22,964 16,874 12,674 13,357 Real estate construction 442 245 10 44 -- 2,320 Permanent mortgage* 3,483 3,648 522 326 884 1,170 - ------------------------------------------------------------------------------------------------------------------------------ Total charge-offs 48,522 54,275 42,382 35,231 29,196 42,661 - ------------------------------------------------------------------------------------------------------------------------------ Recoveries: Commercial 3,372 4,340 3,712 6,728 4,001 6,266 Consumer 4,938 4,919 5,720 5,732 4,415 3,590 Credit card receivables 2,179 1,689 2,112 2,022 1,890 2,262 Real estate construction 148 171 171 59 373 159 Permanent mortgage 123 152 171 174 474 449 - ------------------------------------------------------------------------------------------------------------------------------ Total recoveries 10,760 11,271 11,886 14,715 11,153 12,726 - ------------------------------------------------------------------------------------------------------------------------------ Net charge-offs 37,762 43,004 30,496 20,516 18,043 29,935 - ------------------------------------------------------------------------------------------------------------------------------ Ending balance $ 136,013 $ 125,859 $ 117,748 $ 112,567 $ 109,859 $ 110,720 ============================================================================================================================== LOANS, OUTSTANDING AT DECEMBER 31** $8,557,064 $8,311,350 $7,728,203 $7,333,283 $6,498,042 $5,560,348 - ------------------------------------------------------------------------------------------------------------------------------ Average loans, outstanding during the year** $8,242,135 $7,945,143 $7,472,095 $6,887,218 $5,984,424 $4,996,339 - ------------------------------------------------------------------------------------------------------------------------------ RATIOS**: Allowance to loans 1.59% 1.51% 1.52% 1.54% 1.69% 1.99% Net charge-offs to average loans .46 .54 .41 .30 .30 .60 Net charge-offs to allowance 27.8 34.2 25.9 18.2 16.4 27.0 - ------------------------------------------------------------------------------------------------------------------------------ * Permanent mortgage charge-offs include $3,421,000 and $3,170,000 of charge-offs for 1998 and 1997, respectively, related to the mortgage loans repurchased since the beginning of 1997 (for further information on repurchased mortgages see discussion in Repurchased Mortgage Loans section). ** Net of unearned income.
TABLE 18 - NET CHARGE-OFF RATIOS
1998 1997 1996 - ----------------------------------------------------------------------------------------------------------- BREAKDOWN BY LOAN CATEGORY: Commercial and commercial real estate .05% .05% (.01)% Consumer .36 .42 .38 Credit card receivables 3.92 4.72 3.93 Permanent mortgage* (.01) .05 .05 =========================================================================================================== Total net charge-offs excluding repurchased mortgages .42% .50% .41% Impact of repurchased mortgages .04 .04 -- - ----------------------------------------------------------------------------------------------------------- Total net charge-offs .46% .54% .41% =========================================================================================================== * Excludes mortgage loans repurchased beginning 1997 to correct file documentation in order to certify loan pools. This occurred principally from the consolidation of six separate mortgage operations during 1996. A negative ratio indicates that recoveries exceeded charge-offs. Loans are averages expressed net of unearned income.
54 NONPERFORMING ASSETS Nonperforming loans consist of impaired, other nonaccrual and restructured loans. These, along with foreclosed real estate and other assets, represent nonperforming assets. Impaired loans are those loans for which it is probable that all amounts due, according to the contractual terms of the loan agreement, will not be collected and for which recognition of interest income has been discontinued. Nonaccrual loans are those loans on which recognition of interest income has been discontinued. Restructured loans generally take the form of an extension of the original repayment period and/or a reduction or deferral of interest or principal because of a deterioration in the financial position of the borrower. Nonperforming assets decreased 13 percent, or $6.6 million, in 1998 following an increase of 89 percent, or $23.9 million, in 1997. Total nonperforming loans decreased 28 percent, or $10.6 million, in 1998 compared to an increase of 103 percent, or $19.5 million, in 1997. Mortgage loans, repurchased for documentation problems, are considered nonperforming loans (see discussion in Repurchased Mortgage Loans section). With the inception of this repurchase program in 1997, nonperforming assets and nonperforming loans increased. As these documentation deficiencies were cured these nonperforming balances declined in 1998. At December 31, 1998, foreclosed properties amounted to $16.2 million, an increase of 33 percent from the $12.2 million of foreclosed properties reported in 1997. Of the $4.0 million increase, $3.4 million came from mortgage banking due to the repurchased mortgage loans. Information regarding nonperforming assets and loans is presented in Table 19 - Nonperforming Assets at December 31. As shown in the table, the ratio of nonperforming assets to total loans was .52 percent at December 31, 1998. In the regional banking group, the ratio of nonperforming assets to total loans was .20 percent. Table 20 - Changes in Nonperforming Assets gives additional information related to nonperforming assets for 1996 through 1998. TABLE 19 - NONPERFORMING ASSETS AT DECEMBER 31
(Dollars in thousands) 1998 1997 1996 1995 1994 1993 - ------------------------------------------------------------------------------------------------------------------------- AMOUNTS: Impaired loans* $ 12,111 $ 8,712 $ 10,322 $ 11,865 Other nonaccrual loans 15,696 29,703 8,604 7,175 - ------------------------------------------------------------------------------------------------------------------------- Total nonaccrual loans 27,807 38,415 18,926 19,040 $ 16,853 $ 27,599 Restructured loans - - - - 158 1,195 - ------------------------------------------------------------------------------------------------------------------------- Total nonperforming loans 27,807 38,415 18,926 19,040 17,011 28,794 Foreclosed real estate 16,242 12,202 7,823 11,794 19,215 35,048 Other assets 199 235 196 1,022 2,055 1,292 - ------------------------------------------------------------------------------------------------------------------------- Total nonperforming assets $ 44,248 $ 50,852 $ 26,945 $ 31,856 $ 38,281 $ 65,134 ========================================================================================================================= Non-government guaranteed past due loans** $ 21,745 $ 21,015 $ 20,011 $ 19,796 $ 11,213 $ 13,634 Government guaranteed past due loans** 9,858 11,059 10,736 10,820 10,030 11,024 - ------------------------------------------------------------------------------------------------------------------------- RATIOS***: Nonperforming loans to total loans .32% .46% .24% .26% .26% .52% Nonperforming assets to total loans plus foreclosed real estate and other assets .52 .61 .35 .43 .59 1.16 Nonperforming assets and non-government guaranteed past due loans to total loans plus foreclosed real estate and other assets .77 .86 .61 .70 .76 1.41 - ------------------------------------------------------------------------------------------------------------------------- * For the years 1997, 1996 and 1995 impaired loans included $196,000, $279,000 and $303,000 of restructured loans, respectively. ** Loans that are 90 days or more past due as to principal and/or interest and not yet impaired or on nonaccrual status. *** Total loans are net of unearned income. Certain previously reported amounts have been adjusted to agree with current presentation.
55 TABLE 20 - CHANGES IN NONPERFORMING ASSETS
(Dollars in millions) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------- Beginning balance $ 50.9 $ 26.9 $ 31.9 Additional nonperforming assets 124.5 104.2 22.6 Payments (123.0) (71.5) (24.9) Charge-offs (8.2) (8.7) (2.7) - ------------------------------------------------------------------------------------------------------------- Ending balance $ 44.2 $ 50.9 $ 26.9 =============================================================================================================
PAST DUE LOANS AND POTENTIAL PROBLEM ASSETS Past due loans are loans contractually past due 90 days or more as to interest or principal payments, but which have not yet been put on nonaccrual status. The ratio of past due loans to total loans was .37 percent at year-end 1998, essentially unchanged from 1997. Past due loans were $31.6 million at December 31, 1998, compared with $32.1 million for 1997. Additional historical past due loan information can be found in Table 19. Potential problem assets, which are not included in nonperforming assets, decreased to $63.3 million at December 31, 1998, from $70.3 million at December 31, 1997, and were 1 percent of total loans in 1998 and 1997. Potential problem assets represent those assets where information about possible credit problems of borrowers has caused management to have serious doubts about the borrower's ability to comply with present repayment terms. This definition is believed to be substantially consistent with the standards established by the Office of the Comptroller of the Currency for loans classified substandard or doubtful. REPURCHASED MORTGAGE LOANS Within the course of normal mortgage banking activities, a small percentage of nonperforming assets is created when FHA/VA borrowers are delinquent in their monthly payments prior to the completion of the insuring process. Additionally, loans that have been sold may be found not to meet an investors' origination criteria and could be required to be repurchased. In the first quarter of 1997, these nonperforming assets increased $28.3 million to $39.9 million as several events led to a backlog in the documentation and insuring operations. The consolidation of the six independent mortgage companies into Dallas, combined with the 1996 production volume surge during which refinancing activity was more than double expected origination levels, created a document flow problem. As a result, some loans became delinquent prior to being insured. The insuring process is unique to government (FHA/VA) loans which are pooled (packaged) and sold as mortgage-backed securities called GNMA securities. When a loan becomes more than 90 days past due, the originator has the option of repurchasing the loan out of the GNMA pool then, or waiting until the loan has been foreclosed. When a repurchase does occur, the loan is classified as a nonperforming asset if it has not been previously insured. Management of the nonperforming assets, through curing the delinquencies or sale of foreclosed properties, has resulted in a reduction in these assets, bringing the balance to $27.5 million at year-end 1998 compared with a balance of $36.7 million at year-end 1997. Additionally, First Tennessee participates in FNMA's REO management and liquidation program. Through this relationship, which includes the use of FNMA's nationwide network of residential real estate service providers, First Tennessee is able to efficiently liquidate certain foreclosed properties. OTHER YEAR 2000 - --------- Many computer programs were originally designed to store and process data using two digits rather than four to define a calendar year. This could cause programs that have date sensitive software to recognize a date using "00" as the year 56 1900 rather than the year 2000. The "Year 2000 computer issue" can create risk for a company from unforeseen problems in its own computer systems and from the company's vendors and customers. First Tennessee began planning its Year 2000 remediation strategy to fix this computer issue in 1995. Among other things, the process included the formation of a company-wide project team that meets regularly to coordinate and review the status of conversion initiatives. The main phases involved in the Year 2000 project are assessment, renovation, validation, and implementation. A comprehensive review to assess the systems affected by this issue has been completed, estimated cost projections have been determined and an implementation plan has been compiled. As a result of the assessment review, First Tennessee is in the process of modifying or replacing certain existing systems. New systems being acquired will provide new functionality to meet the expanding needs of customers and will be Year 2000 compliant. Modifications to systems are made in the renovation phase. These modifications are then subjected to current and future date testing during the next phase, the validation phase. Finally, after systems are thoroughly tested, the implementation phase begins. Training and product integration occur during this final phase to aid in assuring a smooth transition to the normal day-to-day operations. The completion of these phases is expected to occur by the second quarter of 1999. As of December 31, 1998, First Tennessee had completed approximately 92 percent of renovation, 76 percent of validation and 65 percent of implementation for mission critical systems. For all systems, the completion status was approximately 94 percent renovated, 86 percent validated and 84 percent implemented. Management believes the efforts described above will provide reasonable assurance that its systems will be adequately prepared for the Year 2000. Costs of new systems will be capitalized and amortized, and spending for maintenance and modification associated with Year 2000 will be expensed as incurred. The total gross cost of Year 2000 compliance is estimated to range from $40 million to $45 million, of which approximately $25 million had been incurred as of December 31, 1998, with approximately 60 percent of this being capitalized. Consistent with current corporate accounting policy, the capitalized costs will be amortized on a straight-line basis over a maximum period of five years once the systems project is substantially complete and ready for its intended use. As part of our Year 2000 preparedness, First Tennessee is also assessing business risks that potentially could arise from customers, business partners, vendors, and government agencies who may fail to successfully complete renovation of their systems before January 1, 2000. The processes include periodic assessments of Year 2000 readiness of material credit customers, funds providers, financial market counterparties, and mission critical vendors. During 1998, First Tennessee initiated a review with its large commercial customers to identify, assess and mitigate potential risks, including credit risk, associated with customers' failure to adequately address their Year 2000 issues. This process is expected to be completed by the second quarter of 1999. While First Tennessee continues, when it deems appropriate, to discuss these matters with, obtain written certification from, and test the systems of other companies as to their Year 2000 compliance, there can be no assurance that any potential impact associated with incompatible systems after December 31, 1999, would not have a material adverse effect on First Tennessee's business, financial condition or results of operations. However, our regular contingency planning processes will be adapted to aid us in preparing for the most significant potential risks from these external sources. The Office of the Comptroller of the Currency, which is our primary bank regulator, includes a review of the risk assessments and contingency plans in its quarterly examination of Year 2000 preparedness. Our contingency plans will be adapted to include such items as outsourcing options, business resumption plans for all of the business units, identification of alternative sources of liquidity, and evaluation of alternative manual processes. The adaptation and testing of these contingency plans should be finalized by the second quarter of 1999. The foregoing statements are forward looking. Actual results could differ because of several factors, including those presented at the beginning of this MD&A discussion. 57 QUARTERLY FINANCIAL INFORMATION - ------------------------------- TABLE 21 - SUMMARY OF QUARTERLY FINANCIAL INFORMATION
1998 1997 --------------------------------------------- -------------------------------------- (Dollars in millions except Fourth Third Second First Fourth Third Second First per share data) Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter - ------------------------------------------------------------------------------------------------------------------------------ SUMMARY INCOME INFORMATION: Interest income $ 312.4 $ 288.3 $ 276.1 $ 257.0 $ 246.3 $ 241.8 $ 230.9 $ 222.3 Interest expense 165.9 153.6 143.9 129.9 121.3 118.2 111.9 106.8 Provision for loan losses 11.9 13.1 12.8 13.5 13.3 12.8 12.5 12.5 Noninterest income before securities transactions 303.8 267.9 219.9 190.0 195.4 180.4 154.0 139.0 Securities gains /(losses) 3.9 -- -- -- .1 -- (.8) -- Noninterest expense 339.8 292.7 258.4 230.9 214.6 204.1 186.0 180.3 Net income 65.5 61.8 52.7 46.4 57.8 54.7 46.4 38.6 - ----------------------------------------------------------------------------------- -------------------------------------- NET INCOME PER COMMON SHARE $ .51 $ .48 $ .41 $ .36 $ .45 $ .43 $ .36 $ .30 DILUTED NET INCOME PER COMMON SHARE .50 .47 .40 .35 .44 .42 .35 .29 - ----------------------------------------------------------------------------------- -------------------------------------- COMMON STOCK INFORMATION: Closing price per share: High $38 1/16 $33 3/4 $35 3/4 $33 1/8 $33 3/4 $29 1/8 $24 7/8 $24 1/2 Low 25 1/2 23 13/16 29 29 15/64 28 24 1/16 21 18 3/8 Period-end 38 1/16 27 5/16 31 9/16 32 1/8 33 3/8 28 1/2 24 21 1/8 Dividends declared per share .19 .165 .165 .165 .165 .15 .15 .15 - ------------------------------------------------------------------------------------------------------------------------------ Per share data reflects the 1998 two-for-one stock split.
58 GLOSSARY ALLOWANCE FOR LOAN LOSSES - Valuation reserve representing the amount considered by management to be adequate to cover estimated losses inherent in the loan portfolio. BASIS POINT - The equivalent of one-hundredth of one percent (0.01). One hundred basis points equals one percent. This unit is generally used to measure movements in interest yields and rates. BASIS RISK - Refers to changes in the relationship between various interest rate segments (e.g., the difference between the Prime and the Fed Funds Rates). BASIS SWAP - A notional principle swap that was intended to hedge the basis risk of the loan portfolio. First Tennessee's basis swap was terminated in 1995 in order to restructure the rate sensitive position and limit the loss going forward in a rising rate scenario. BOOK VALUE PER SHARE - A ratio determined by dividing shareholders' equity at the end of a period by the number of common shares outstanding at the end of that period. CHARGE-OFFS - The amount charged against the allowance for loan losses to reduce specific loans to their collectible amount. CLASSIFIED LOAN - A loan that has caused management to have serious doubts about the borrower's ability to comply with present repayment terms. Included in this category are grade F performing and nonperforming loans. In compliance with the standards established by the Office of the Comptroller of the Currency (OCC), these loans are classified as substandard, doubtful and loss depending on the severity of the loan's deterioration. COMMERCIAL PAPER - A short-term unsecured debt obligation of the parent company with maturities typically of 30 days to 270 days. COMMERCIAL AND STANDBY LETTERS OF CREDIT - Commercial letters of credit are issued or confirmed by an entity to ensure the payment of its customers' payables and receivables. Standby letters of credit are issued by an entity to ensure its customers' performance in dealing with others. COMMITMENT TO EXTEND CREDIT - Agreements to make or acquire a loan or lease as long as agreed-upon terms (e.g., expiry, covenants or notice) are met. Generally these commitments have fixed expiration dates or other termination clauses and may require payment of a fee. CORE DEPOSITS - Core deposits consist of all interest-bearing and noninterest- bearing deposits, except certificates of deposit over $100,000. They include checking interest deposits, money market deposit accounts, time and other savings, plus demand deposits. DERIVATIVE FINANCIAL INSTRUMENT - Futures, forwards, swaps, option contracts, or other financial instruments with similar characteristics, such as interest rate caps or floors, or fixed-rate loan commitments. DILUTED EARNINGS PER SHARE - Net income, divided by average shares outstanding plus the number of shares that would be outstanding if all dilutive common shares had been issued. Dilutive common shares, for example, would be outstanding options where the average stock price exceeds the price at which the option was granted. DOUBLE LEVERAGE RATIO - A ratio that measures the degree to which parent company debt supports investments in subsidiaries. It is calculated by dividing the parent company's investment in subsidiaries by total consolidated equity. EARNING ASSETS - Assets that generate interest or dividend income or yield- related fee income, such as loans and investment securities. EARNINGS PER SHARE (ALSO CALLED BASIC EARNINGS OR BASIC NET INCOME PER SHARE) - Net income, divided by the average number of common shares outstanding in the period (see also diluted earnings per share). FEDERAL FUNDS SOLD/PURCHASED - Excess balances of depository institutions which are loaned to each other, generally on an overnight basis. FULLY TAXABLE-EQUIVALENT INCOME (FTE) - Income that has been adjusted by increasing tax-exempt income to a level that would yield the same after-tax income had that income been subject to taxation. HEDGE - An instrument used to reduce risk by entering into a transaction which offsets existing or anticipated exposures to changes in interest rates. INTEREST-FREE SOURCES - Noninterest-bearing liabilities (such as demand deposits, other liabilities and shareholders' equity) net of nonearning assets (such as cash, fixed assets and other assets). 59 INTEREST RATE CAPS AND FLOORS - Contracts with notional principal amounts that require the seller, in exchange for a fee, to make payments to the purchaser if a specified market interest rate exceeds a fixed upper "capped" level or falls below a fixed lower "floor" level on specified future dates. INTEREST RATE FORWARD AND FUTURES CONTRACTS - Contracts representing commitments either to purchase or sell at a specified future date a specified security or financial instrument at a specified price, and may be settled in cash or through delivery. These obligations are generally short term in nature. INTEREST RATE OPTION (OPTIONS) - A contract that grants the holder (purchaser), for a fee, the right to either purchase or sell a financial instrument at a specified price within a specified period of time or on a specified date from the writer (seller) of the option. INTEREST RATE SENSITIVITY - The relationship of changes in interest income and interest expense to fluctuations in interest rates over a defined period of time. INTEREST RATE SWAP (SWAP) - An agreement in which two entities agree to exchange, at specified intervals, interest payment streams calculated on an agreed upon notional principal amount with at least one stream based on a floating rate index. INTEREST SENSITIVITY GAP - The difference between interest-rate sensitive assets and interest-rate sensitive liabilities over a designated time period. A net asset exists when interest-rate sensitive assets exceed interest-rate sensitive liabilities. A net liability position exists when liabilities exceed assets. LEVERAGE RATIO - Tier 1 capital divided by quarterly average assets excluding any adjustments for available for sale securities unrealized gains/(losses), goodwill, and certain other intangible assets. LIQUIDITY - The ability of a corporation to generate adequate funds to meet its cash flow requirements. It is measured by the ability to quickly convert assets into cash with minimal exposure to interest rate risk, by the size and stability of the core deposit base, and by additional borrowing capacity within the money markets. MARKET CAPITALIZATION - Market value of a firm computed by multiplying the amount of shares outstanding by the current stock price. MORTGAGE SERVICING RIGHTS - The right to service mortgage loans, generally owned by someone else, for a fee. Loan servicing includes collecting payments; remitting funds to investors, insurance companies and taxing authorities; collecting delinquent payments; and foreclosing on properties when necessary. NET INTEREST INCOME (NII) - Interest income less interest expense. NET INTEREST MARGIN - A measurement of how effectively the bank utilizes its earning assets in relationship to the interest cost of funding them. It is computed by dividing fully taxable-equivalent net interest income by average interest earning assets. NET INTEREST SPREAD - The difference between the average yield earned on earning assets on a fully taxable-equivalent basis and the average rate paid for interest-bearing liabilities. NONACCRUAL LOANS - Loans on which interest accruals have been discontinued due to the borrower's financial difficulties. Interest income on these loans is reported on a cash basis as it is collected after recovery of principal. NONPERFORMING ASSETS - Interest earning assets on which interest income is not being accrued, restructured loans on which interest rates or terms of repayment have been materially revised, real estate properties acquired through foreclosure, and repossessed assets. NOTIONAL PRINCIPAL AMOUNT - An amount on which payments for interest rate swaps and interest rate options, caps and floors are based. The "notional amount" is not paid or received. OPERATING MARGIN (ALSO CALLED RETURN ON REVENUE - ROR) - A measure of profitability that indicates operation efficiency and productivity. It is calculated by dividing the fully taxable-equivalent pre-tax profit before loan loss provision by the fully taxable-equivalent net interest income plus noninterest income. PRICE/EARNINGS RATIO - The relationship of the market price of a share of common stock to the earnings per share of the stock, expressed as a multiple. PROVISION FOR LOAN LOSSES - The periodic charge to earnings for potential losses in the loan portfolio. PURCHASED FUNDS - The combination of certificates of deposit greater than $100,000, federal funds purchased, securities sold under agreement to repurchase, bank notes, commercial paper, and other short-term borrowings. 60 RECOVERIES - The amount added to the allowance for loan losses when funds are received on a loan that was previously charged off. REPURCHASE AGREEMENT - A method of short-term financing in which one party agrees to buy back, at a future date (generally overnight) and an agreed-upon price, a security it sells to another party. RESTRUCTURED LOANS - Loans where the institution, for economic or legal reasons related to the debtor's financial difficulties, grants a concession to the debtor that it would not otherwise consider. RETURN ON AVERAGE ASSETS (ROA) - A measure of profitability that indicates how effectively an institution utilized its assets. It is calculated by dividing annualized net income by total average assets. RETURN ON AVERAGE EQUITY (ROE) - A measure of profitability that indicates what an institution earned on its shareholders' investment. ROE is calculated by dividing net income by total average shareholders' equity. REVENUE - The sum of net interest income and noninterest income. For some comparisons, securities gains/losses are excluded. RISK-ADJUSTED ASSETS - A regulatory risk-based calculation that takes into account the broad differences in risks among a banking organization's assets and off-balance sheet instruments. SECURITIZED ASSETS OR SECURITIZATION - The process by which financial assets are packaged, underwritten and sold as securities. SHAREHOLDER RETURN (ALSO CALLED TOTAL RETURN) - The sum of dividend income and price appreciation of an equity security for a given period of time divided by the price of the security at the beginning of the period. TIER 1 CAPITAL RATIO - Ratio consisting of shareholders' equity before any adjustments for available for sale securities unrealized gains/(losses) reduced by goodwill, certain other intangible assets and the disallowable portion of mortgage servicing rights divided by risk-adjusted assets. TOTAL CAPITAL RATIO - Tier 1 capital plus the allowable portion of the allowance for loan losses and qualifying subordinated debt divided by risk-adjusted assets. 61 FIRST TENNESSEE NATIONAL CORPORATION CONSOLIDATED STATEMENTS OF CONDITION
December 31 --------------------------------- (Dollars in thousands) 1998 1997 - --------------------------------------------------------------------------------------------------------------------------- ASSETS: Cash and due from banks (Note 17) $ 811,881 $ 775,760 Federal funds sold and securities purchased under agreements to resell 124,239 225,861 - --------------------------------------------------------------------------------------------------------------------------- Total cash and cash equivalents 936,120 1,001,621 - --------------------------------------------------------------------------------------------------------------------------- Investment in bank time deposits 1,211 2,522 Capital markets securities inventory 358,304 253,240 Mortgage loans held for sale 4,227,443 1,240,648 Securities available for sale (Note 3) 1,816,485 2,133,303 Securities held to maturity (market value of $610,364 at December 31, 1998, and $54,323 at December 31, 1997) (Note 3) 609,804 53,230 Loans, net of unearned income (Note 4) 8,557,064 8,311,350 Less: Allowance for loan losses 136,013 125,859 - --------------------------------------------------------------------------------------------------------------------------- Total net loans 8,421,051 8,185,491 - --------------------------------------------------------------------------------------------------------------------------- Premises and equipment, net (Note 5) 254,292 206,895 Real estate acquired by foreclosure 16,242 12,202 Mortgage servicing rights, net (Note 6) 664,438 408,921 Intangible assets, net (Note 7) 132,845 112,411 Capital markets receivables and other assets 1,295,726 777,413 - --------------------------------------------------------------------------------------------------------------------------- TOTAL ASSETS $ 18,733,961 $ 14,387,897 =========================================================================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY: Deposits: Interest-bearing (Note 8) $ 8,665,175 $ 7,135,733 Noninterest-bearing 3,057,864 2,536,046 - --------------------------------------------------------------------------------------------------------------------------- Total deposits 11,723,039 9,671,779 - --------------------------------------------------------------------------------------------------------------------------- Federal funds purchased and securities sold under agreements to repurchase (Note 9) 2,912,018 2,085,679 Commercial paper and other short-term borrowings (Note 9) 1,427,274 702,388 Capital markets payables and other liabilities 1,057,646 705,062 Term borrowings (Note 10) 414,450 168,893 - --------------------------------------------------------------------------------------------------------------------------- Total liabilities 17,534,427 13,333,801 - --------------------------------------------------------------------------------------------------------------------------- Guaranteed preferred beneficial interests in First Tennessee's junior subordinated debentures (Note 11) 100,000 100,000 - --------------------------------------------------------------------------------------------------------------------------- SHAREHOLDERS' EQUITY: Preferred stock - no par value (5,000,000 shares authorized, but unissued) -- -- Common stock - $.625 par value (shares authorized - 400,000,000; shares issued - 128,974,362 at December 31, 1998 and 128,209,142 at December 31, 1997) 80,609 80,131 Capital surplus 96,778 49,536 Undivided profits 908,977 811,396 Accumulated other comprehensive income (Note 13) 12,872 15,333 Deferred compensation on restricted stock incentive plans (1,209) (2,300) Deferred compensation obligation 1,507 -- - --------------------------------------------------------------------------------------------------------------------------- Total shareholders' equity 1,099,534 954,096 - --------------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 18,733,961 $ 14,387,897 =========================================================================================================================== See accompanying notes to consolidated financial statements.
62 FIRST TENNESSEE NATIONAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31 ----------------------------------------------------- (Dollars in thousands except per share data) 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------- INTEREST INCOME: Interest and fees on loans $ 725,907 $ 699,617 $ 653,466 Interest on investment securities: Taxable 155,956 135,321 135,969 Tax-exempt 3,658 4,502 5,146 Interest on mortgage loans held for sale 205,654 76,840 82,046 Interest on capital markets securities inventory 30,541 13,399 14,139 Interest on other earning assets 12,061 11,614 5,731 - -------------------------------------------------------------------------------------------------------------------- Total interest income 1,133,777 941,293 896,497 - -------------------------------------------------------------------------------------------------------------------- INTEREST EXPENSE: Interest on deposits: Savings 7,113 8,188 9,447 Checking interest and money market 113,171 95,123 92,648 Certificates of deposit under $100,000 and other time 144,879 160,522 166,534 Certificates of deposit $100,000 and more 111,472 47,730 46,283 Interest on short-term borrowings 196,665 130,719 109,547 Interest on term borrowings 19,938 15,915 20,850 - -------------------------------------------------------------------------------------------------------------------- Total interest expense 593,238 458,197 445,309 - -------------------------------------------------------------------------------------------------------------------- NET INTEREST INCOME 540,539 483,096 451,188 Provision for loan losses 51,351 51,115 35,677 - -------------------------------------------------------------------------------------------------------------------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 489,188 431,981 415,511 - -------------------------------------------------------------------------------------------------------------------- NONINTEREST INCOME: Mortgage banking 558,366 330,131 275,406 Capital markets 147,353 98,310 85,871 Deposit transactions and cash management 90,444 86,047 78,228 Trust services and investment management 51,198 40,941 34,704 Merchant processing 37,462 32,111 24,185 Cardholder fees 21,046 19,833 17,155 Equity securities gains/(losses) 3,940 (854) (2,495) Debt securities gains/(losses) 36 141 (186) All other income and commissions (Note 14) 75,658 61,470 58,281 - -------------------------------------------------------------------------------------------------------------------- Total noninterest income 985,503 668,130 571,149 - -------------------------------------------------------------------------------------------------------------------- ADJUSTED GROSS INCOME AFTER PROVISION FOR LOAN LOSSES 1,474,691 1,100,111 986,660 - -------------------------------------------------------------------------------------------------------------------- NONINTEREST EXPENSE: Employee compensation, incentives and benefits 563,576 409,783 385,380 Amortization of mortgage servicing rights 95,507 37,452 26,041 Operations services 58,505 49,879 44,109 Occupancy 51,421 42,848 39,815 Equipment rentals, depreciation and maintenance 45,771 40,093 34,121 Communications and courier 41,468 34,899 32,981 Advertising and public relations 25,184 18,722 17,629 Amortization of intangible assets 11,114 9,631 9,491 All other expense (Note 14) 229,223 141,737 114,919 - -------------------------------------------------------------------------------------------------------------------- Total noninterest expense 1,121,769 785,044 704,486 - -------------------------------------------------------------------------------------------------------------------- INCOME BEFORE INCOME TAXES 352,922 315,067 282,174 Applicable income taxes (Note 15) 126,542 117,595 102,267 - -------------------------------------------------------------------------------------------------------------------- NET INCOME $ 226,380 $ 197,472 $ 179,907 ==================================================================================================================== EARNINGS PER SHARE (Note 16) $ 1.77 $ 1.54 $ 1.34 - -------------------------------------------------------------------------------------------------------------------- DILUTED EARNINGS PER SHARE (Note 16) $ 1.72 $ 1.50 $ 1.32 - -------------------------------------------------------------------------------------------------------------------- WEIGHTED AVERAGE SHARES OUTSTANDING 128,235,006 128,365,434 134,393,172 - -------------------------------------------------------------------------------------------------------------------- See accompanying notes to consolidated financial statements.
63 FIRST TENNESSEE NATIONAL CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Accumulated Deferred Deferred Other Compen- Compen- Common Common Capital Undivided Comprehensive sation sation (Amounts in thousands) Shares Total Stock Surplus Profits Income Asset Liability - --------------------------------------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1995 134,356 $ 873,224 $ 83,973 $ 63,610 $ 716,861 $ 10,582 $(1,802) $ -- Net income -- 179,907 -- -- 179,907 -- -- -- Other comprehensive income: Unrealized market adjustments, net of tax and reclassification adjustment -- (7,885) -- -- -- (7,885) -- -- -------------------------------------------------------------------------------------------- Comprehensive income -- 172,022 -- -- 179,907 (7,885) -- -- -------------------------------------------------------------------------------------------- Cash dividends declared -- (73,593) -- -- (73,593) -- -- -- Common stock issued: For exercise of stock options 789 5,569 493 5,076 -- -- -- -- Restricted: Employee benefit plan 205 -- 128 2,890 -- -- (3,018) -- Incentive to non-employee directors 18 -- 11 285 -- -- (296) -- Common stock repurchased (1,653) (28,356) (1,033) (27,323) -- -- -- -- Amortization on restricted stock incentive plans -- 1,541 -- -- -- -- 1,541 -- Other -- 4,119 -- 4,119 -- -- -- -- - --------------------------------------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1996 133,715 954,526 83,572 48,657 823,175 2,697 (3,575) -- Net income -- 197,472 -- -- 197,472 -- -- -- Other comprehensive income: Unrealized market adjustments, net of tax and reclassification adjustment -- 12,636 -- -- -- 12,636 -- -- -------------------------------------------------------------------------------------------- Comprehensive income -- 210,108 -- -- 197,472 12,636 -- -- -------------------------------------------------------------------------------------------- Cash dividends declared -- (79,362) -- -- (79,362) -- -- -- Common stock issued: Federal Flood Certification Corporation acquisition 74 1,362 47 1,315 -- -- -- -- For exercise of stock options 1,900 24,174 1,187 22,987 -- -- -- -- Tax benefit from non-qualified stock options -- 4,962 -- 4,962 -- -- -- -- Common stock repurchased (7,480) (169,492) (4,675) (34,928) (129,889) -- -- -- Amortization on restricted stock incentive plans -- 1,275 -- -- -- -- 1,275 -- Other -- 6,543 -- 6,543 -- -- -- -- - --------------------------------------------------------------------------------------------------------- ----------------------- BALANCE, DECEMBER 31, 1997 128,209 954,096 80,131 49,536 811,396 15,333 (2,300) -- Net income -- 226,380 -- -- 226,380 -- -- -- Other comprehensive income: Unrealized market adjustments, net of tax and reclassification adjustment -- (2,461) -- -- -- (2,461) -- -- -------------------------------------------------------------------------------------------- Comprehensive income -- 223,919 -- -- 226,380 (2,461) -- -- -------------------------------------------------------------------------------------------- Cash dividends declared -- (87,768) -- -- (87,768) -- -- -- Common stock issued: McGuire Mortgage Company acquisition 351 8,951 219 8,732 -- -- -- -- Keystone Mortgage, Inc. acquisition 190 5,164 119 5,045 -- -- -- -- For exercise of stock options 2,087 26,546 1,305 23,734 -- -- -- 1,507 Restricted employee benefit plan 4 -- 2 119 -- -- (121) -- Tax benefit from non-qualified stock options -- 17,135 -- 17,135 -- -- -- -- Common stock repurchased (1,867) (61,836) (1,167) (19,638) (41,031) -- -- -- Amortization on restricted stock incentive plans -- 1,212 -- -- -- -- 1,212 -- Other -- 12,115 -- 12,115 -- -- -- -- - --------------------------------------------------------------------------------------------------------- ----------------------- BALANCE, DECEMBER 31, 1998 128,974 $ 1,099,534 $ 80,609 $ 96,778 $ 908,977 $ 12,872 $(1,209) $ 1,507 ================================================================================================================================= See accompanying notes to consolidated financial statements.
64 FIRST TENNESSEE NATIONAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31 -------------------------------------------- (Dollars in thousands) 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------------- OPERATING Net income $ 226,380 $ 197,472 $ 179,907 ACTIVITIES Adjustments to reconcile net income to net cash provided/(used) by operating activities: Provision for loan losses 51,351 51,115 35,677 Provision for deferred income tax 83,454 45,521 39,274 Depreciation and amortization of premises and equipment 40,431 32,784 28,806 Amortization of mortgage servicing rights 95,507 37,452 26,041 Amortization of intangible assets 11,114 9,631 9,491 Net other amortization and accretion 15,283 5,916 14,453 Market value adjustment on foreclosed property 16,820 9,145 6,479 Gain on sale of securitized loans (643) -- -- Equity securities (gains)/losses (3,940) 854 2,495 Debt securities (gains)/losses (36) (141) 186 Net (gains)/losses on disposals of fixed assets (703) (698) 270 Gain on sale of bank branches (567) -- -- Net (increase)/decrease in: Capital markets securities inventory (105,064) (102,838) 32,253 Mortgage loans held for sale (2,968,356) (453,286) 1,821 Capital markets receivables (143,893) (24,433) 29,174 Interest receivable (25,013) (7,609) (865) Other assets (722,144) (343,697) (250,156) Net increase/(decrease) in: Capital markets payables 112,110 33,152 (39,643) Interest payable (8,919) 2,977 (626) Other liabilities 181,366 46,655 (16,211) - --------------------------------------------------------------------------------------------------------------------------- Total adjustments (3,371,842) (657,500) (81,081) - --------------------------------------------------------------------------------------------------------------------------- Net cash provided/(used) by operating activities (3,145,462) (460,028) 98,826 - --------------------------------------------------------------------------------------------------------------------------- INVESTING Held to maturity securities: ACTIVITIES Maturities 160,471 12,656 10,184 Purchases -- -- (1,462) Available for sale securities: Sales 53,643 104,067 391,795 Maturities 944,145 767,625 476,770 Purchases (675,358) (808,952) (1,016,553) Premises and equipment: Sales 2,733 4,212 1,856 Purchases (80,414) (56,099) (37,549) Net increase in loans (1,102,674) (637,790) (424,844) Proceeds from loan securitizations 72,756 -- -- Net (increase)/decrease in investment in bank time deposits 1,076 (600) 197 Sale of bank branches, net of cash and cash equivalents (7,654) -- -- Acquisitions, net of cash and cash equivalents acquired (9,243) (185) 400 - --------------------------------------------------------------------------------------------------------------------------- Net cash used by investing activities (640,519) (615,066) (599,206) - --------------------------------------------------------------------------------------------------------------------------- FINANCING Common stock: ACTIVITIES Exercise of stock options 24,943 24,309 5,779 Cash dividends (84,521) (78,348) (71,310) Repurchase of shares (61,854) (169,520) (28,356) Term borrowings: Issuance 247,613 -- -- Payments (2,301) (65,923) (25,544) Issuance of guaranteed preferred beneficial interests in First Tennessee's junior subordinated debentures -- 100,000 -- Net increase in: Deposits 2,063,738 638,717 444,121 Short-term borrowings 1,532,862 529,511 497,811 - --------------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 3,720,480 978,746 822,501 - --------------------------------------------------------------------------------------------------------------------------- Net increase/(decrease) in cash and cash equivalents (65,501) (96,348) 322,121 - --------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at beginning of period 1,001,621 1,097,969 775,848 - --------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of period $ 936,120 $1,001,621 $ 1,097,969 =========================================================================================================================== Total interest paid $ 601,749 $ 454,881 $ 438,830 Total income taxes paid 28,348 61,007 48,345 - --------------------------------------------------------------------------------------------------------------------------- See accompanying notes to consolidated financial statements.
65 FIRST TENNESSEE NATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF ACCOUNTING. The consolidated financial statements of First Tennessee National Corporation (First Tennessee), including its subsidiaries, are prepared in conformity with generally accepted accounting principles and follow general practices within the industries in which it operates. This preparation requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. These estimates and assumptions are based on information available as of the date of the financial statements and could differ from actual results. PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION. The consolidated financial statements include the accounts of First Tennessee and its majority-owned subsidiaries. Affiliates that are not majority owned are accounted for by the equity method. All significant intercompany transactions and balances have been eliminated. For purposes of comparability, certain prior period amounts have been reclassified to conform with current year presentation. None of these reclassifications had any effect on net income or earnings per share for any of the periods presented. Prior year financial statements are restated to include the accounts of companies that are acquired and accounted for as poolings of interests. Business combinations accounted for as purchases are included in the financial statements from the respective dates of acquisition. STATEMENTS OF CASH FLOWS. For purposes of these statements, cash and due from banks, federal funds sold, and securities purchased under agreements to resell are considered cash and cash equivalents. Federal funds are usually sold for one-day periods, and securities purchased under agreements to resell are short-term, highly liquid investments. The following significant non-cash stock transactions have been adjusted for a two-for-one stock split that First Tennessee effected February 20, 1998, and for a two-for-one stock split effected February 16, 1996. In 1997, First Tennessee issued approximately 75,000 shares of its common stock related to the acquisition of Federal Flood Certification Corporation. In 1998, approximately 190,000 shares of First Tennessee stock were issued related to the acquisition of Keystone Mortgage, Inc. and approximately 351,000 shares were issued related to the acquisition of McGuire Mortgage Company. CAPITAL MARKETS SECURITIES INVENTORY. Inventories purchased in connection with underwriting or dealer activities are carried at market value. Gains and losses, both realized and unrealized, on these inventories are reflected in noninterest income as capital markets income. INVESTMENT SECURITIES. Securities that First Tennessee has the ability and positive intent to hold to maturity are classified as securities held to maturity and are carried at amortized cost. Securities that may be sold prior to maturity for asset/liability management purposes and equity securities are classified as securities available for sale and are carried at fair value. The unrealized gains and losses on securities available for sale are excluded from earnings and are reported, net of tax, as a component of other comprehensive income within shareholders' equity. The amortized cost of all securities is adjusted for amortization of premium and accretion of discount to maturity, or earlier call date if appropriate, using the level yield method. Such amortization and accretion is included in interest income from securities. Realized gains and losses and declines in value judged to be other than temporary are computed by the specific identification method and reported in noninterest income. SECURITIES PURCHASED UNDER RESALE AGREEMENTS AND SECURITIES SOLD UNDER REPURCHASE AGREEMENTS. First Tennessee Capital Markets enters into short-term purchases of securities under agreements to resell as a means of converting proceeds from securities sold short into interest earning assets. Securities delivered under these transactions are delivered to either the dealer custody account at the Federal Reserve Bank or to the applicable counterparty. 66 Securities sold under agreements to repurchase (securities sold) are offered to cash management customers as an automated, collateralized investment account. Securities sold are also used by the regional banking group to obtain favorable borrowing rates on its purchased funds. Under these transactions, securities are delivered to the counterparty's custody account. In the normal course of business, First Tennessee does not use this as a primary funding source. MORTGAGE BANKING. First Tennessee's mortgage lenders originate first-lien mortgage loans for the purpose of selling them in the secondary market. Mortgage loans held for sale are recorded at the lower of aggregate cost or market value. Gains and losses realized from the sale of these assets and adjustments to market value are included in noninterest income. Servicing rights related to the mortgages sold are ordinarily retained. Accounting standards require the recognition of mortgage servicing rights (MSRs) as separate assets by allocating the total cost between the loan and the servicing right based on their relative fair values. First Tennessee uses an industry standard cash flow valuation model to determine the fair value of the servicing rights created. These valuations are tested for reasonableness against prices obtained from flow and bulk sales of servicing and are validated through an independent market valuation. Model assumptions are periodically reviewed and may be revised from time to time to more accurately reflect current assumptions such as prepayment speeds. For purposes of impairment evaluation and measurement, the MSRs are stratified based on the predominant risk characteristics of the underlying loans. For First Tennessee, these strata include adjustable rate conventional and government; fixed rate conventional and government by interest rate band. The MSRs are amortized as noninterest expense over the period of and in proportion to the estimated net servicing revenues. A quarterly value impairment analysis is performed using a discounted cash flow methodology that is disaggregated by predominant risk characteristics. Impairment, if any, is recognized through a valuation allowance for individual strata. See further detail about mortgage banking policies in the derivative financial instruments disclosure below. LOANS. Loans are stated at principal amounts outstanding, net of unearned income. Interest on loans is recognized at the applicable interest rate on the principal amount outstanding. Impaired loans are generally carried on a nonaccrual status. Loans are ordinarily placed on nonaccrual status when, in management's opinion, the collection of principal or interest is unlikely, or when the collection of principal or interest is 90 days or more past due. Consumer installment loans and credit card receivables are not placed on nonaccrual status, but are charged off when past due 120 days and 180 days, respectively. Accrued but uncollected interest is reversed and charged against interest income when the loan is placed on nonaccrual status. On consumer loans, accrued but uncollected interest is reversed when the loan is charged off. Management may elect to continue the accrual of interest when the estimated net realizable value of collateral is sufficient to recover the principal balance and accrued interest. Interest payments received on nonaccrual and impaired loans are normally applied to principal. Once all principal has been received, additional interest payments are recognized on a cash basis as interest income. ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is maintained at a level that management determines is adequate to absorb estimated losses inherent in the loan portfolio. Management's evaluation process used to determine the adequacy of the allowance combines three factors: historical loss experience derived from analytical models, current trends and reasonably foreseeable events. The actual amounts realized could differ in the near term from the amounts assumed in arriving at the allowance for possible loan losses reported in the financial statements. 67 All losses of principal are charged to the account when the loss actually occurs or when a determination is made that a loss is probable. Additions are made to the allowance through periodic provisions charged to current operations and recovery of principal on loans previously charged off. PREMISES AND EQUIPMENT. Premises and equipment are carried at cost less accumulated depreciation and amortization and include additions that materially extend the useful lives of existing premises and equipment. All other maintenance and repair expenditures are expensed as incurred. Gains and losses on dispositions are reflected in noninterest income and expense. Depreciation and amortization are computed principally on the straight-line method over the estimated useful lives of the assets and are expensed to noninterest expense. Leasehold improvements are amortized over the lesser of the lease periods or the estimated useful lives using the straight-line method. REAL ESTATE ACQUIRED BY FORECLOSURE. Real estate acquired by foreclosure consists of properties that have been acquired in satisfaction of debt. These properties are carried at the lower of the outstanding loan amount or the estimated fair market value minus the estimated cost to sell the real estate. Losses arising at foreclosure are charged to the allowance for loan losses. Required developmental costs associated with foreclosed property under construction are capitalized and included in determining the estimated net realizable value of the property which is reviewed periodically, and any write-downs are charged against current earnings as market adjustments. INTANGIBLE ASSETS. Intangible assets consist of "Premium on purchased deposits and assets" and "Goodwill." The "Premium on purchased deposits and assets" represents identified intangible assets, which are amortized over their estimated useful lives, except for those assets related to deposit bases that are primarily amortized over 10 years. "Goodwill" represents the excess of cost over net assets of acquired subsidiaries less identifiable intangible assets and is amortized to noninterest expense using the straight-line method over periods ranging from 15 to 40 years. Management evaluates whether events or circumstances have occurred that indicate the remaining useful life or carrying value of goodwill should be revised. DERIVATIVE FINANCIAL INSTRUMENTS. First Tennessee utilizes derivative financial instruments in order to manage exposure to fluctuations in interest rates and to meet the financial needs of customers. For interest rate risk management purposes, First Tennessee primarily utilizes interest rate swaps. Mortgage banking operations mainly use mandatory forward delivery commitments and purchased and written options to hedge against risks associated with the warehouse, the pipeline, or the servicing portfolio. Capital markets uses various derivatives, including interest rate swaps, futures, forward and option contracts and securities underwriting commitments in order to meet the needs of its customers with forwards being the most commonly used instrument. To qualify as a hedge used to manage interest rate risk, the following criteria must be met: (1) the asset or liability to be hedged exposes First Tennessee to interest rate risk; (2) the instrument alters or reduces sensitivity to interest rate changes; and (3) the instrument is designated and effective as a hedge. For interest rate contracts used to hedge interest rate risk, income and expense are deferred and amortized over the lives of the hedged assets or liabilities. The amortization of this income and expense is an adjustment to interest income or expense of the hedged item. Fees are deferred and amortized over the lives of the contracts. Any related assets or liabilities are recorded on the balance sheet in other assets or other liabilities. For those derivatives used to manage interest rate risk that are terminated prior to maturity, realized gains and losses are deferred and amortized straight-line over the remaining original life of the agreement as an adjustment to the hedged asset or liability. If the underlying hedged asset or liability is sold or prepaid, the related portion of any unrecognized gain or loss on the derivative is recognized in current earnings as part of the gain or loss on the sale or prepayment. 68 Forward and option contracts used by mortgage banking operations to hedge against interest rate risk in the warehouse and the pipeline are designated to a specific pool of assets and are reviewed periodically for correlation with expected changes in value. Option contracts used to hedge against interest rate risk in the servicing portfolio are designated to specific risk tranches of servicing rights and reduce the risk of market value fluctuations. Forward and option contracts used to hedge the warehouse are considered in the lower of cost or market valuation of the warehouse with any related gains or losses being recognized in mortgage banking noninterest income. Premiums paid for purchased options are deferred and reported in other assets and are amortized over the lives of the contracts to mortgage banking noninterest income. Options used to hedge the servicing portfolio are adjusted for changes in intrinsic value with gains and losses recognized as a basis adjustment of the related mortgage servicing rights risk tranche. Cash flows received from option contracts are also recognized as an adjustment to mortgage servicing rights. Premiums are deferred and amortized on a straight-line basis over the contract life to other noninterest expense. Any unamortized premiums related to the options are reported in other assets. For derivatives hedging the warehouse and pipeline that are terminated prior to maturity, gains and losses are recognized in current earnings as mortgage banking noninterest income and are deferred and recognized at the time the loan is sold if the sale is deferred to a future date. For derivatives hedging the servicing portfolio that are terminated prior to maturity, gains and losses are split between the return of time value premium and the intrinsic value. Gains or losses from the change in the intrinsic value are deferred as a basis adjustment to the related mortgage servicing rights risk tranche, and the gains or losses resulting from the return of time value premium are recognized in current earnings in mortgage banking noninterest income. Any contracts that fail to qualify for hedge accounting are measured at fair value with any gains or losses included in current earnings in noninterest income. Derivative contracts utilized in trading activities by capital markets are measured at fair value, and gains or losses are recognized in capital markets noninterest income as they occur. Related assets are recorded on the balance sheet as capital markets securities inventory or receivables and any liabilities are recognized as capital markets payables. Cash flows from derivative contracts are reported as operating activities on the Consolidated Statements of Cash Flows. INCOME TAXES. The provision for income taxes is based on income reported for consolidated financial statement purposes and includes deferred taxes resulting from the recognition of certain revenues and expenses in different periods for tax reporting purposes. First Tennessee files a consolidated federal income tax return except for a credit life insurance company which files a separate return. EARNINGS PER SHARE. Earnings per share is computed by dividing net income by the weighted average number of common shares outstanding for each period. Diluted earnings per share is computed by dividing net income by the weighted average number of common shares outstanding adjusted to include the number of additional common shares that would have been outstanding if the dilutive potential common shares resulting from options granted under First Tennessee's stock option plans had been issued. First Tennessee utilizes the treasury stock method in this calculation. Previously reported per share amounts have been restated for the effect of both the February 20, 1998, and February 16, 1996, two-for-one stock splits. 69 ACCOUNTING CHANGES. On January 1, 1998, First Tennessee adopted Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income," which establishes standards for reporting comprehensive income and its components in the financial statements. Comprehensive income is the total of net income and all other nonowner changes in equity. The only component of other comprehensive income for First Tennessee is unrealized holding gains/(losses) on available for sale securities. On January 1, 1998, First Tennessee adopted Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," which allows for the capitalization of internal and external personnel costs for the development or modification of qualified internal use software. During 1998, approximately $14.2 million of internal and external costs, excluding the software license fees, were capitalized and will be amortized over the next five years. For the year ending December 31, 1998, First Tennessee adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." This standard requires a business to report financial and descriptive information about its reportable operating segments. Operating segments are 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. For the year ending December 31, 1998, First Tennessee adopted SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." The new standard revises the required disclosures for employee benefit plans but does not change the measurement or recognition of such plans. On January 1, 1997, First Tennessee adopted SFAS No. 125, "Accounting for the Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." The Statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings based on a control-oriented "financial components" approach. Under this approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and liabilities it has incurred, derecognizes financial assets when control has been surrendered and derecognizes liabilities when extinguished. The adoption of this standard required a change in the method used to recognize mortgage servicing rights, increasing both the amortization expense as well as the servicing income. SFAS No. 128, "Earnings per Share," was adopted as of January 1, 1997. This standard specifies the computation, presentation and disclosure requirements for earnings per share (EPS). The objective of SFAS No. 128 is to simplify the computation and to make the United States' standard more compatible with EPS standards of other countries and with that of the International Accounting Standards Committee. First Tennessee now presents on the income statement both earnings per share and diluted earnings per share for all periods presented. On January 1, 1996, First Tennessee adopted SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." This standard requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the expected undiscounted future cash flows from the use of the asset and its eventual disposition are less than the carrying amount of the asset, an impairment loss is recognized. The impairment loss is measured based upon the present value of the expected future cash flows. SFAS No. 123, "Accounting for Stock-Based Compensation," was adopted January 1, 1996. SFAS No. 123 defines a fair value-based method of accounting for stock-based compensation plans. Under the fair value-based method, compensation cost is measured at the grant date based upon the value of the award and is recognized over the service period. The standard encourages all entities to adopt this method of accounting; however, it allows an entity to continue to measure compensation costs for its plans as prescribed in Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees." 70 Under this election, First Tennessee continues to account for stock-based compensation in accordance with APB Opinion No. 25 and provides additional disclosure on the pro forma impact of the fair value-based method under SFAS No. 123. See Note 20 - Stock Option, Restrictive Stock Incentive, and Dividend Reinvestment Plans for further disclosure. In October 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 134, "Accounting for Mortgage-Backed Securities Retained after Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise." This Statement amends SFAS No. 65, which required that retained securities be classified as trading securities. SFAS No. 134 allows these securities to be classified as trading, held to maturity or available for sale based on the intent and ability of the enterprise. This Statement is effective January 1, 1999, and is not expected to materially impact First Tennessee's financial position or results of operations. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." The new Statement requires that an entity recognize all derivatives as either assets or liabilities in the statement of condition and measure those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. This Statement is effective for all quarters of fiscal years beginning after June 15, 1999; which for First Tennessee will mean the first quarter of 2000. Because of the complexity of this standard and uncertainties associated with predicting future derivative usage and related fair values, it is not practicable at this time to predict what the impact of adopting this Statement will be to First Tennessee's financial position or results of operations. In April 1998, the American Institute of Certified Public Accountants issued SOP 98-5, "Reporting on the Costs of Start-up Activities." This Statement requires that the costs of start-up activities, including organization costs, be expensed as incurred. When adopted, previously capitalized start-up and organization costs should be written off and reported as the cumulative effect of a change in accounting principle. The Statement is effective for fiscal years beginning after December 15, 1998, and is not expected to materially impact First Tennessee's financial position or results of operations. NOTE 2 - ACQUISITIONS On December 31, 1998, First Tennessee acquired McGuire Mortgage Company (McGuire) of Prairie Village, Kansas, for approximately 351,000 shares of its common stock pending final settlement during 1999. McGuire was merged into FT Mortgage Companies, an indirect, wholly owned subsidiary of First Tennessee. This acquisition was accounted for as a purchase and was immaterial to First Tennessee. On July 1, 1998, First Tennessee acquired Keystone Mortgage, Inc. (Keystone) of Kirkland, Washington, and merged Keystone into FT Mortgage Companies. First Tennessee issued approximately 190,000 shares of its common stock for this acquisition which was accounted for as a purchase and was immaterial to First Tennessee. On January 2, 1998, First Tennessee acquired Martin & Company, LLP (Martin) of Knoxville, Tennessee, for approximately $19.5 million. This acquisition was accounted for as a purchase and was immaterial to First Tennessee. The following table provides information concerning acquisitions completed during the three years ended December 31, 1998. Acquisitions accounted for as purchases are included in the financial statements from the date of the acquisition. All share information reflects the 1998 two-for-one stock split. 71
Common Shares Date of Issued Method of Acquisition Location Acquisition (thousands) Accounting - ----------------------------------------------------------------------------------------------------------------------------- McGuire Mortgage Company Prairie Village, Kansas 12/31/98 351 Purchase Keystone Mortgage, Inc. Kirkland, Washington 7/1/98 190 Purchase Martin & Company, LLP Knoxville, Tennessee 1/2/98 $19.5 million cash Purchase Federal Flood Certification Corporation Dallas, Texas 7/14/97 75 Purchase - -----------------------------------------------------------------------------------------------------------------------------
The following presents on a proforma basis certain financial data pertaining to the McGuire, Keystone, and Martin transactions as if they had been acquired at the beginning of the years presented. The proforma results presented are not necessarily indicative of the future results of operations that would have actually occurred had the merger been in effect for the periods presented.
(Dollars in thousands, except per share data) 1998 1997 - ----------------------------------------------------------------------------------------------------------------- TOTAL REVENUE:* First Tennessee, as originally reported $1,526,042 $1,151,226 First Tennessee proforma 1,559,879 1,181,540 NET INCOME: First Tennessee, as originally reported $ 226,380 $ 197,472 First Tennessee proforma 227,840 200,411 NET INCOME PER SHARE: First Tennessee, as originally reported $ 1.77 $ 1.54 First Tennessee proforma 1.77 1.55 DILUTED NET INCOME PER SHARE: First Tennessee, as originally reported $ 1.72 $ 1.50 First Tennessee proforma 1.72 1.51 - ----------------------------------------------------------------------------------------------------------------- * Total revenue is net interest income and noninterest income.
NOTE 3 - INVESTMENT SECURITIES The following tables summarize First Tennessee's securities held to maturity and available for sale at December 31, 1998 and 1997:
AT DECEMBER 31, 1998* ------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair (Dollars in thousands) Cost Gains Losses Value - ------------------------------------------------------------------------------------------------------------- SECURITIES HELD TO MATURITY: States and municipalities $ 40,832 $ 1,267 $ (141) $ 41,958 Private issue CMOs** 568,972 5,752 (6,318) 568,406 - ------------------------------------------------------------------------------------------------------------- Total securities held to maturity $ 609,804 $ 7,019 $(6,459) $ 610,364 ============================================================================================================= SECURITIES AVAILABLE FOR SALE: U.S. Treasury and other U.S. government agencies $ 149,512 $ 1,790 $ (87) $ 151,215 Government agency issued MBSs 193,082 2,636 (281) 195,437 Government agency issued CMOs 1,297,152 7,061 (1,112) 1,303,101 States and municipalities 19,124 851 -- 19,975 Private issue CMOs 1,001 18 -- 1,019 Other 11,401 239 (6) 11,634 Equity*** 124,294 9,829 (19) 134,104 - ------------------------------------------------------------------------------------------------------------- Total securities available for sale $1,795,566 $22,424 $(1,505) $1,816,485 ============================================================================================================= * Includes $1,655,182,000 of securities pledged to secure public deposits, securities sold under agreements to repurchase and for other purposes. ** Represents First Tennessee's Real Estate Mortgage Investment Conduit. *** Equity securities include venture capital investment securities.
72
At December 31, 1997* ------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair (Dollars in thousands) Cost Gains Losses Value - ------------------------------------------------------------------------------------------------------------- SECURITIES HELD TO MATURITY: States and municipalities $ 53,230 $ 1,270 $ (177) $ 54,323 - ------------------------------------------------------------------------------------------------------------- SECURITIES AVAILABLE FOR SALE: U.S. Treasury and other U.S. government agencies $ 364,157 $ 2,242 $ (387) $ 366,012 Government agency issued MBSs 248,876 4,305 (943) 252,238 Government agency issued CMOs 1,380,289 9,040 (884) 1,388,445 States and municipalities 22,539 851 -- 23,390 Private issue CMOs 1,212 23 -- 1,235 Other 10,290 117 (608) 9,799 Equity** 80,608 13,040 (1,464) 92,184 - ------------------------------------------------------------------------------------------------------------- Total securities available for sale $2,107,971 $29,618 $(4,286) $2,133,303 ============================================================================================================= * Includes $1,816,347,000 of securities pledged to secure public deposits, securities sold under agreements to repurchase and for other purposes. ** Equity securities include venture capital investment securities.
Provided below are the amortized cost and estimated fair value by contractual maturity for the securities portfolios at December 31, 1998:
Held to Maturity Available for Sale --------------------- --------------------------- Estimated Estimated By Contractual Maturity Amortized Fair Amortized Fair (Dollars in thousands) Cost Value Cost Value - ------------------------------------------------------------------------------------------------------------- Within 1 year $ 11,759 $ 11,886 $ 28,299 $ 28,410 After 1 year; within 5 years 14,990 15,318 117,910 119,830 After 5 years; within 10 years 8,851 9,178 32,182 32,909 After 10 years 5,232 5,576 1,646 1,675 - ------------------------------------------------------------------------------------------------------------- Subtotal 40,832 41,958 180,037 182,824 - ------------------------------------------------------------------------------------------------------------- Mortgage-backed securities and CMOs 568,972 568,406 1,491,235 1,499,557 Equity securities -- -- 124,294 134,104 - ------------------------------------------------------------------------------------------------------------- Total $609,804 $610,364 $1,795,566 $1,816,485 ============================================================================================================= Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The table below provides information on realized gross gains and realized gross losses on sales from the available for sale portfolio for the years ended December 31:
Available Available for Sale - for Sale - (Dollars in thousands) Debt Equity Total - ------------------------------------------------------------------------------------------------------------- 1998 Gross gains on sales $ 323 $6,804 $ 7,127 Gross losses on sales (292) -- (292) - ------------------------------------------------------------------------------------------------------------- 1997 Gross gains on sales $ 373 $ 214 $ 587 Gross losses on sales (441) -- (441) - ------------------------------------------------------------------------------------------------------------- 1996 Gross gains on sales $ 1,164 $ 540 $ 1,704 Gross losses on sales (1,385) -- (1,385) - -------------------------------------------------------------------------------------------------------------
73 Losses totaling $2,947,000, $1,147,000, and $3,035,000 for the years 1998, 1997 and 1996, respectively, were recognized for securities that, in the opinion of management, have been permanently impaired. NOTE 4 - LOANS A summary of the major categories of loans outstanding at December 31 is shown below:
(Dollars in thousands) 1998 1997 - ------------------------------------------------------------------------------------------------------------- Commercial $ 4,116,918 $ 3,768,554 Consumer: Real estate* 2,041,579 1,954,590 Auto 443,674 505,536 Student 274,763 257,518 Other 258,766 137,596 - ------------------------------------------------------------------------------------------------------------- Total consumer 3,018,782 2,855,240 Permanent mortgage 423,200 663,494 Credit card receivables 594,467 581,451 Real estate construction 375,890 404,196 Nonaccrual 27,807 38,415 - ------------------------------------------------------------------------------------------------------------- Loans, net of unearned income** 8,557,064 8,311,350 Allowance for loan losses 136,013 125,859 - ------------------------------------------------------------------------------------------------------------- Total net loans $ 8,421,051 $ 8,185,491 ============================================================================================================= * Consumer real estate loans included $1,950,739,000 and $1,910,323,000 of first and second liens and home equity loans at December 31, 1998 and 1997, respectively. ** Loans are presented net of $4,661,000 and $5,244,000 of unearned income at December 31, 1998 and 1997, respectively.
Nonperforming loans consist of loans which management has identified as impaired, other nonaccrual loans and loans which have been restructured. At December 31, 1998 and 1997, there were no outstanding commitments to advance additional funds to customers whose loans had been restructured. The following table presents nonperforming loans at December 31:
(Dollars in thousands) 1998 1997 - ---------------------------------------------------------------------------------------------------------- Impaired loans $ 12,111 $ 8,712 Other nonaccrual loans 15,696 29,703 - ---------------------------------------------------------------------------------------------------------- Total nonperforming loans $ 27,807 $ 38,415 ========================================================================================================== Restructured impaired loans at December 31, 1997, were $196,000.
Interest income received during 1998 for impaired loans was $1,195,000 and for other nonaccrual loans was $860,000. Under their original terms, interest income would have been approximately $1,432,000 for the impaired loans and $1,224,000 for the other nonaccrual loans outstanding at December 31, 1998. The average balance of impaired loans was approximately $9,093,000 for 1998 and $11,187,000 for 1997. Activity in the allowance for loan losses related to non-impaired and impaired loans for years ended December 31 is summarized as follows:
(Dollars in thousands) Non-impaired Impaired Total - ------------------------------------------------------------------------------------------------------------ Balance at December 31, 1995 $ 109,051 $ 3,516 $ 112,567 Provision for loan losses 33,179 2,498 35,677 Charge-offs (39,555) (2,827) (42,382) Loan recoveries 11,542 344 11,886 - ------------------------------------------------------------------------------------------------------------ Net charge-offs (28,013) (2,483) (30,496) - ------------------------------------------------------------------------------------------------------------ Balance at December 31, 1996 114,217 3,531 117,748 Provision for loan losses 46,007 5,108 51,115 Charge-offs (48,974) (5,301) (54,275) Loan recoveries 10,857 414 11,271 - ------------------------------------------------------------------------------------------------------------ Net charge-offs (38,117) (4,887) (43,004) - ------------------------------------------------------------------------------------------------------------ Balance at December 31, 1997 122,107 3,752 125,859 Transfer of allowance due to securitizations (3,575) - (3,575) Allowance from acquisitions 140 - 140 Provision for loan losses 48,474 2,877 51,351 Charge-offs (43,384) (5,138) (48,522) Loan recoveries 9,810 950 10,760 - ------------------------------------------------------------------------------------------------------------ Net charge-offs (33,574) (4,188) (37,762) - ------------------------------------------------------------------------------------------------------------ BALANCE AT DECEMBER 31, 1998 $ 133,572 $ 2,441 $ 136,013 ============================================================================================================
74 Certain executive officers and directors (and their associates) of First Tennessee were loan customers 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. The following is a summary of related party loans outstanding and the activity for the years ended December 31:
(Dollars in thousands) 1998 1997 - ----------------------------------------------------------------------------- Balance at beginning of year $ 85,867 $ 101,573 Additions 165,049 307,895 Deletions: Repayments (141,738) (307,383) No longer related (38,447) (16,218) - ----------------------------------------------------------------------------- Total deletions (180,185) (323,601) - ----------------------------------------------------------------------------- BALANCE AT END OF YEAR $ 70,731 $ 85,867 =============================================================================
Included in "Other assets" and "Other liabilities" on the Consolidated Statements of Condition are amounts due from customers on acceptances and bank acceptances outstanding of $6,869,000 and $2,487,000 at December 31, 1998 and 1997, respectively. NOTE 5 - PREMISES, EQUIPMENT AND LEASES Premises and equipment at December 31 are summarized below:
(Dollars in thousands) 1998 1997 - ----------------------------------------------------------------------------------- Land $ 32,026 $ 31,373 Buildings 154,758 137,373 Leasehold improvements 41,009 27,833 Furniture, fixtures and equipment 229,062 183,826 - ----------------------------------------------------------------------------------- Premises and equipment, at cost 456,855 380,405 Less accumulated depreciation and amortization 202,563 173,510 - ----------------------------------------------------------------------------------- Premises and equipment, net $ 254,292 $ 206,895 ===================================================================================
First Tennessee is obligated under a number of noncancelable operating leases for premises and equipment with terms up to 20 years, which may include the payment of taxes, insurance and maintenance costs. Minimum future lease payments for operating leases on premises and equipment at December 31, 1998, are shown below:
(Dollars in thousands) - ----------------------------------------------------------------------------------- 1999 $ 32,923 2000 26,750 2001 22,366 2002 17,210 2003 10,933 2004 and after 19,679 - ----------------------------------------------------------------------------------- Total minimum lease payments $ 129,861 =================================================================================== Payments required under capital leases are not material.
Aggregate minimum income under sublease agreements for these periods is $2,129,000. Rent expense incurred under all operating lease obligations was as follows for the years ended December 31:
(Dollars in thousands) 1998 1997 1996 - ---------------------------------------------------------------------------------- Rent expense, gross $ 35,857 $ 29,820 $ 27,746 Rent income (1,901) (1,670) (1,517) - ---------------------------------------------------------------------------------- Rent expense, net $ 33,956 $ 28,150 $ 26,229 ==================================================================================
NOTE 6 - CAPITALIZED MORTGAGE SERVICING RIGHTS Following is a summary of changes in capitalized mortgage servicing rights, net of accumulated amortization, included in the Consolidated Statements of Condition:
(Dollars in thousands) - ----------------------------------------------------------------------------------- December 31, 1995 $ 149,220 Addition of mortgage servicing rights 144,988 Amortization (26,041) Sales of mortgage servicing rights (2,140) - ----------------------------------------------------------------------------------- December 31, 1996 266,027 Addition of mortgage servicing rights 182,959 Amortization (37,452) Sales of mortgage servicing rights (2,613) - ----------------------------------------------------------------------------------- December 31, 1997 408,921 Addition of mortgage servicing rights 435,893 Amortization (95,507) Hedge gains applied (84,557) Sales of mortgage servicing rights (312) - ----------------------------------------------------------------------------------- DECEMBER 31, 1998 $ 664,438 ===================================================================================
The mortgage servicing rights at December 31, 1998 and 1997, had estimated market values of approximately $685.1 million and $437.7 million, respectively. These balances represent the rights to service approximately $34.0 billion and $23.8 billion of mortgage loans at December 31, 1998 and 1997. In addition, First Tennessee had approximately $1.6 billion and $2.3 billion in unpaid principal balance of mortgage loans for which the servicing rights were not capitalized at December 31, 1998 and 1997. These mortgage servicing rights had estimated market values of $10.2 million and $15.8 million, respectively. No valuation allowance due to impairment was required as of December 31, 1998 or 1997. 75 NOTE 7 - INTANGIBLE ASSETS Following is a summary of intangible assets, net of accumulated amortization, included in the Consolidated Statements of Condition:
Premium on Purchased Deposits (Dollars in thousands) Goodwill and Assets - ------------------------------------------------------------------------- December 31, 1995 $ 91,792 $ 37,193 Amortization expense (4,386) (5,105) Acquisitions/Divestitures 237 (266) - ------------------------------------------------------------------------- December 31, 1996 87,643 31,822 Amortization expense (4,343) (5,288) Acquisitions 377 2,200 - ------------------------------------------------------------------------- December 31, 1997 83,677 28,734 Amortization expense (5,463) (5,651) Acquisitions 29,256 2,292 - ------------------------------------------------------------------------- DECEMBER 31, 1998 $ 107,470 $ 25,375 =========================================================================
NOTE 8 - TIME DEPOSIT MATURITIES Following is a table of maturities for time deposits outstanding at December 31, 1998, which include "Certificates of deposit under $100,000 and other time" and "Certificates of deposit $100,000 and more". "Certificates of deposit $100,000 and more" totaled $2,190,803,000 at December 31, 1998. Time deposits are included in "Interest-bearing" deposits on the Consolidated Statements of Condition.
(Dollars in thousands) - ------------------------------------------------------------------------------- 1999 $ 3,876,004 2000 409,112 2001 116,554 2002 142,748 2003 and after 126,788 - ------------------------------------------------------------------------------- Total $ 4,671,206 ===============================================================================
NOTE 9 - SHORT-TERM BORROWINGS Short-term borrowings include federal funds purchased and securities sold under agreements to repurchase, commercial paper, and other borrowed funds which include term federal funds purchased, short-term bank notes, and advances from the Federal Home Loan Bank. The advances from the Federal Home Loan Bank, which totaled $535,000,000 at December 31, 1998, are collateralized 150 percent with first-lien permanent mortgage loans of First Tennessee Bank National Association (FTBNA). 76 Federal funds purchased and securities sold under agreements to repurchase and commercial paper generally have maturities of less than 90 days. Other short-term borrowings have original maturities of one year or less. The detail of these borrowings for the years 1998, 1997 and 1996 is presented in the following table:
Federal Funds Purchased and Securities Sold Other Under Agreements Commercial Short-term (Dollars in thousands) to Repurchase Paper Borrowings - ---------------------------------------------------------------------------------------------------------- 1998 Average balance $ 2,456,449 $ 22,337 $ 1,263,121 Year-end balance 2,912,018 23,203 1,404,071 Maximum month-end outstanding 3,733,294 26,958 1,511,624 Average rate for the year 4.99% 4.59% 5.79% Average rate at year-end 4.79 4.12 5.19 - ---------------------------------------------------------------------------------------------------------- 1997 Average balance $ 1,790,130 $ 20,792 $ 642,235 Year-end balance 2,085,679 23,176 679,212 Maximum month-end outstanding 2,085,679 24,170 873,739 Average rate for the year 5.01% 4.64% 6.23% Average rate at year-end 5.56 4.70 6.07 - ---------------------------------------------------------------------------------------------------------- 1996 Average balance $ 1,588,101 $ 22,207 $ 497,870 Year-end balance 1,881,187 22,648 354,721 Maximum month-end outstanding 1,881,187 33,790 699,113 Average rate for the year 4.91% 4.39% 6.15% Average rate at year-end 5.65 4.43 5.92 - ----------------------------------------------------------------------------------------------------------
At December 31, 1998, $50,000,000 of borrowings under unsecured lines of credit from non-affiliated banks were available to the parent company to provide for general liquidity needs at an annual facility fee of .10 percent. NOTE 10 - TERM BORROWINGS The following table presents information pertaining to term borrowings (debt with original maturities greater than one year) for First Tennessee and its subsidiaries at December 31:
(Dollars in thousands) 1998 1997 - ----------------------------------------------------------------------------------------------------------------------- FIRST TENNESSEE NATIONAL CORPORATION: Subordinated capital notes: Matures on June 1, 1999 -- 10 3/8% $ 74,962 $ 74,873 Matures on November 15, 2005 -- 6 3/4% 74,438 74,356 FIRST TENNESSEE BANK NATIONAL ASSOCIATION: Notes payable to Federal Home Loan Bank*: Matures on January 29, 1999 -- 7.95% 15,000 15,000 Matures through 2009 -- 8.10% 2,183 2,383 Matures through January 1, 2028 -- 4.00% 41 -- Matures through May 1, 2028 -- 4.00% 40 -- Matured through 1998 -- 7.50% -- 1,383 Subordinated bank notes: Matures on April 1, 2008 -- 6.40% 99,277 -- Matures on December 1, 2008 -- 5.75% 148,409 -- Industrial development bond payable to City of Alcoa, Tennessee; matures 1999 -- 6.50% 100 200 CLEVELAND BANK AND TRUST COMPANY: Industrial development bond payable to City of Cleveland, Tennessee; -- 65% of prime (5.525% at December 31, 1997) -- 698 - ----------------------------------------------------------------------------------------------------------------------- Total $ 414,450 $ 168,893 ======================================================================================================================= * The Federal Home Loan Bank borrowings are collateralized 150 percent with first-lien permanent mortgage loans of FTBNA.
77 Annual principal repayment requirements as of December 31, 1998, are as follows:
(Dollars in thousands) - ----------------------------------------------------------------------------------------------------------------------- 1999 $90,302 2000 202 2001 202 2002 202 2003 202 2004 and after 326,254 - -----------------------------------------------------------------------------------------------------------------------
At maturity, the 10 3/8 percent subordinated notes will be redeemed, at First Tennessee's option, in cash from the proceeds of the sale of capital securities, or exchanged for qualifying capital securities having a market value equal to the principal amount of the notes. All subordinated capital and bank notes are unsecured and are subordinate to other present and future senior indebtedness. These notes qualify as Tier 2 risk-based capital under the Federal Reserve Board and Office of the Comptroller of the Currency guidelines for assessing capital adequacy. The subordinated capital and bank notes may not be redeemed or prepaid prior to maturity. NOTE 11 - GUARANTEED PREFERRED BENEFICIAL INTERESTS IN FIRST TENNESSEE'S JUNIOR SUBORDINATED DEBENTURES On December 30, 1996, First Tennessee, through its underwriters, sold to institutional investors $100 million of capital securities. First Tennessee Capital I (Capital I), a Delaware business trust wholly owned by First Tennessee, issued $100 million of Capital Securities, Series A at 8.07%. The proceeds were upstreamed to First Tennessee as junior subordinated debt under the same terms and conditions. First Tennessee has, through various contractual arrangements, fully and unconditionally guaranteed all of Capital I's obligations with respect to the capital securities. These capital securities qualify as Tier 1 capital and are presented in the Consolidated Statements of Condition as "Guaranteed Preferred Beneficial Interests in First Tennessee's Junior Subordinated Debentures." The sole asset of Capital I is $103 million of junior subordinated debentures issued by First Tennessee. These junior subordinated debentures also carry an interest rate of 8.07 percent. Both the capital securities of Capital I and the junior subordinated debentures of First Tennessee will mature on January 6, 2027; however, under certain circumstances, the maturity of both may be shortened to a date not earlier than January 6, 2017. During 1997, under an accelerated purchase program, a portion of the proceeds from this issuance were used to repurchase 3.8 million shares at a cost of $83.3 million. NOTE 12 - REGULATORY CAPITAL First Tennessee 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 Tennessee's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices must be met. Capital amounts and classification are also subject to qualitative judgment by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require First Tennessee to maintain minimum amounts and ratios of total and Tier 1 capital to risk-weighted assets, and of Tier 1 capital to average assets (leverage). Management believes, as of December 31, 1998, that First Tennessee met all capital adequacy requirements to which it was subject. The most recent notification from the Office of the Comptroller of the Currency at January 20, 1999, categorized First Tennessee as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized First Tennessee must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. In the opinion of management, no conditions or events have occurred since that notification that would change First Tennessee's category. 78 The actual capital amounts and ratios of First Tennessee and FTBNA (the primary banking subsidiary of First Tennessee) are presented in the table below:
First Tennessee National First Tennessee Bank Corporation National Association --------------------------- -------------------------- (Dollars in thousands) Amount Ratio Amount Ratio - ---------------------------------------------------------------------------------------------------------- AS OF DECEMBER 31, 1998 Actual: Total Capital $1,576,009 11.91% $1,424,980 11.24% Tier 1 Capital 1,038,484 7.85 968,458 7.64 Leverage 1,038,484 5.54 968,458 5.43 For Capital Adequacy Purposes: Total Capital 1,058,613 >or= 8.00 1,013,884 >or= 8.00 Tier 1 Capital 529,307 >or= 4.00 506,942 >or= 4.00 Leverage 749,176 >or= 4.00 713,870 >or= 4.00 To Be Well Capitalized Under Prompt Corrective Action Provisions: Total Capital 1,323,267 >or= 10.00 1,267,355 >or= 10.00 Tier 1 Capital 793,960 >or= 6.00 760,413 >or= 6.00 Leverage 936,470 >or= 5.00 892,338 >or= 5.00 - --------------------------------------------------------------------------------------------------------- As of December 31, 1997: Actual: Total Capital $1,213,578 11.65% $1,041,057 10.61% Tier 1 Capital 938,456 9.01 848,817 8.65 Leverage 938,456 6.83 848,817 6.62 For Capital Adequacy Purposes: Total Capital 833,448 >or= 8.00 785,138 >or= 8.00 Tier 1 Capital 416,724 >or= 4.00 392,569 >or= 4.00 Leverage 549,791 >or= 4.00 513,165 >or= 4.00 To Be Well Capitalized Under Prompt Corrective Action Provisions: Total Capital 1,041,810 >or= 10.00 981,422 >or= 10.00 Tier 1 Capital 625,086 >or= 6.00 588,853 >or= 6.00 Leverage 687,239 >or= 5.00 641,456 >or= 5.00 - ----------------------------------------------------------------------------------------------------------
The following table details the actual regulatory capital ratios for other bank subsidiaries at December 31, 1998:
FNB Peoples and CBT(1) Springdale(2) Peoples(3) Union(4) Planters(5) - ------------------------------------------------------------------------------------------------------------------------- AS OF DECEMBER 31, 1998: Total Capital 13.40% 17.34% 17.28% 14.10% 18.67% Tier 1 Capital 12.14 16.27 16.03 12.85 17.40 Leverage 7.35 9.40 9.60 7.37 10.66 - ------------------------------------------------------------------------------------------------------------------------- (1)Cleveland Bank and Trust Company (2)First National Bank of Springdale (3)Peoples Bank of Senatobia (4)Peoples and Union Bank (5)Planters Bank
79 NOTE 13 - COMPONENTS OF OTHER COMPREHENSIVE INCOME Following is detail of "Accumulated other comprehensive income" as presented in the Consolidated Statements of Condition:
Accumulated Gain/(Loss) Tax Other Before-Tax (Expense)/ Comprehensive (Dollars in thousands) Amount Benefit Income - ------------------------------------------------------------------------------------------------------------------ December 31, 1995 $ 10,582 Other comprehensive income: Unrealized market adjustments for the period $ (16,443) $ 6,920 (9,523) Less: adjustment for net losses included in net income (2,681) 1,043 (1,638) - ------------------------------------------------------------------------------------------------ -------- December 31, 1996 $ (13,762) $ 5,877 2,697 ================================================================================================ -------- Other comprehensive income: Unrealized market adjustments for the period $ 19,842 $ (7,642) 12,200 Less: adjustment for net losses included in net income (713) 277 (436) - ------------------------------------------------------------------------------------------------ -------- December 31, 1997 $ 20,555 $ (7,919) 15,333 ================================================================================================ -------- Other comprehensive income: Unrealized market adjustments for the period $ (51) $ 19 (32) Less: adjustment for net gains included in net income 3,976 (1,547) 2,429 - ------------------------------------------------------------------------------------------------ -------- DECEMBER 31, 1998 $ (4,027) $ 1,566 $ 12,872 ================================================================================================ ========
NOTE 14 - OTHER INCOME AND OTHER EXPENSE Following is detail concerning "All other income and commissions" and "All other expense" as presented in the Consolidated Statements of Income:
(Dollars in thousands) 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------- ALL OTHER INCOME AND COMMISSIONS: Other service charges $ 14,863 $ 10,474 $ 9,891 Check clearing fees 9,199 13,043 16,873 Insurance premiums and commissions 8,725 6,457 5,644 Other 42,871 31,496 25,873 - --------------------------------------------------------------------------------------------------------------------- Total $ 75,658 $ 61,470 $ 58,281 ===================================================================================================================== ALL OTHER EXPENSE: Contract employment $ 35,937 $ 17,420 $ 11,288 Foreclosed real estate 31,019 10,827 7,533 Legal and professional fees 24,551 13,999 12,050 Supplies 20,195 15,267 14,383 Travel and entertainment 19,485 13,802 10,394 Amortization of hedge instruments 13,345 4,867 - Computer software 11,629 6,731 4,076 Distributions on guaranteed preferred securities 8,070 8,070 - Fed service fees 5,307 5,799 7,814 Deposit insurance premium 1,578 1,485 5,129 Other 58,107 43,470 42,252 - --------------------------------------------------------------------------------------------------------------------- Total $ 229,223 $ 141,737 $ 114,919 =====================================================================================================================
80 NOTE 15 - INCOME TAXES The components of income tax expense are as follows:
(Dollars in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------- Current: Federal $ 45,374 $ 68,665 $ 52,090 State (2,286) 3,409 10,903 Deferred: Federal 68,528 34,674 40,266 State 14,926 10,847 (992) - -------------------------------------------------------------------------------------------------------------- Total $ 126,542 $ 117,595 $ 102,267 ==============================================================================================================
The effective tax rates for 1998, 1997 and 1996 were 35.86 percent, 37.32 percent and 36.24 percent, respectively. Income tax expense was different than the amounts computed by applying the statutory federal income tax rate to income before income taxes because of the following:
(Dollars in thousands) 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------- Federal income tax rate 35% 35% 35% - -------------------------------------------------------------------------------------------------------------- Tax computed at statutory rate $ 123,523 $ 110,274 $ 98,761 Increase/(decrease) resulting from: Tax-exempt interest (2,145) (2,494) (3,269) State income taxes 8,222 9,073 6,472 Other (3,058) 742 303 - -------------------------------------------------------------------------------------------------------------- Total $ 126,542 $ 117,595 $ 102,267 ==============================================================================================================
A deferred tax asset or liability is recognized for the tax consequences of temporary differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The tax consequence is calculated by applying enacted statutory tax rates, applicable to future years, to these temporary differences. Temporary differences which gave rise to deferred tax (assets)/liabilities at December 31, 1998 and 1997, were as follows:
(Dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------------------------------------- DEFERRED TAX ASSETS: Loss reserves $ (66,332) $ (52,101) Net operating loss carryforwards (4,381) (4,381) Other (10,665) (8,896) - -------------------------------------------------------------------------------------------------------------- Gross deferred tax assets (81,378) (65,378) - -------------------------------------------------------------------------------------------------------------- DEFERRED TAX LIABILITIES: Capitalized mortgage servicing rights 216,413 115,704 Depreciation 9,754 6,553 Investments in loans and securities 8,044 9,424 Employee benefits 2,852 5,866 Purchase accounting adjustments 4,454 4,268 Intangible assets 5,245 6,187 Federal Home Loan Bank stock 6,120 4,683 Operations services 2,728 3,417 Other 13,695 14,448 - -------------------------------------------------------------------------------------------------------------- Gross deferred tax liabilities 269,305 170,550 - -------------------------------------------------------------------------------------------------------------- Net deferred tax liabilities $ 187,927 $ 105,172 ==============================================================================================================
81 NOTE 16 - EARNINGS PER SHARE The following table shows a reconciliation of earnings per share to diluted earnings per share. All share and per share data have been adjusted to reflect the 1998 and 1996 two-for-one stock splits.
(Dollars in thousands, except per share data) 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------- EARNINGS PER SHARE COMPUTATION: Net income $ 226,380 $ 197,472 $ 179,907 Weighted average shares outstanding 128,056,450 128,365,434 134,393,172 Shares attributable to deferred compensation 178,556 -- -- - -------------------------------------------------------------------------------------------------------------- Total weighted average shares outstanding 128,235,006 128,365,434 134,393,172 Earnings per share $ 1.77 $ 1.54 $ 1.34 ============================================================================================================== DILUTED EARNINGS PER SHARE COMPUTATION: Net income $ 226,380 $ 197,472 $ 179,907 Weighted average shares outstanding 128,235,006 128,365,434 134,393,172 Dilutive effect due to stock options 3,627,484 3,621,498 1,986,370 - -------------------------------------------------------------------------------------------------------------- Weighted average shares outstanding, as adjusted 131,862,490 131,986,932 136,379,542 Diluted earnings per share $ 1.72 $ 1.50 $ 1.32 ==============================================================================================================
NOTE 17 - RESTRICTIONS, CONTINGENCIES AND OTHER DISCLOSURES RESTRICTIONS ON CASH AND DUE FROM BANKS. The commercial banking subsidiaries of First Tennessee are required to maintain average reserve and clearing balances with the Federal Reserve Bank under the Federal Reserve Act and Regulation D. The balances required at December 31, 1998 and 1997, were $213,446,000 and $181,446,000, respectively. These reserves are included in "Cash and due from banks" on the Consolidated Statements of Condition. RESTRICTIONS ON DIVIDENDS. Dividends are paid by First Tennessee from its assets which are mainly provided by dividends from its subsidiaries. Certain regulatory restrictions exist regarding the ability of the banking subsidiaries to transfer funds to First Tennessee in the form of cash, dividends, loans or advances. As of December 31, 1998, the banking subsidiaries had undivided profits of $859,913,000 of which $246,104,000 was available for distribution to First Tennessee as dividends without prior regulatory approval. RESTRICTIONS ON INTERCOMPANY TRANSACTIONS. Under Federal banking law, banking subsidiaries may not extend credit to the parent company in excess of 10 percent of the banks' capital stock and surplus, as defined, or $155,283,000 at December 31, 1998. The parent company had borrowings of $56,950,000 from FTBNA at December 31, 1998. Certain loan agreements also define other restricted transactions related to additional borrowings. CONTINGENCIES. In June 1998, a judgment entered in the circuit court of Houston County, Alabama became final, approving a settlement of a class action filed against FTBNA on behalf of persons in Alabama who had financed with FTBNA their purchases of satellite dish television systems. All individual lawsuits previously filed in state court in Alabama relating to the financing of satellite systems by FTBNA were finally settled in 1997. In May 1996, FTBNA was also named as a defendant in a purported nationwide class action lawsuit filed in federal court in Alabama in which plaintiffs assert that FTBNA and another defendant engaged in unfair and deceptive practices in connection with the financing of satellite systems. The complaint alleges violations of the Truth in Lending Act and the federal RICO statute, and fraud by suppression with respect to Alabama residents. In addition to these theories, plaintiffs proceed against FTBNA on an agency theory. The complaint seeks unquantified compensatory, triple, and punitive damages. FTBNA has filed a motion requesting the dismissal of plaintiffs' RICO and fraudulent suppression claims, but the court has not ruled on the motion. In addition to the Alabama lawsuits, in September 1997, a nationwide class action was filed in state court in Tennessee relating to the same satellite systems financing program. The 82 complaint asserts that material facts were withheld from the purchasers in connection with the financing, that FTBNA and First Tennessee were unjustly enriched from the sale of such systems, and that FTBNA and First Tennessee violated the Tennessee Consumer Protection Act. The trial court entered an order of conditional class certification and FTBNA and First Tennessee have requested a review of that certification order for the purpose of having the conditional order set aside. FTBNA and First Tennessee deny liability, deny that any co-defendant is their agent, and intend to defend these actions vigorously. In July 1998, a judgment was rendered in the Chancery Court of Shelby County, Tennessee against FTBNA as the successor by merger to Community Bank of Germantown for $9 million in punitive damages. The court had previously entered a judgment against FTBNA in the amount of $209,000 compensatory damages in August 1997, and a judgment in favor of the Bank against the plaintiff in the amount of $60,000. The plaintiff had claimed that Community Bank of Germantown had obtained additional collateral on a loan by promising to make a new loan to the plaintiff, which was never made. The litigation was pending at the time of First Tennessee's acquisition of Community Bank of Germantown in February 1995. FTBNA believes that the court erred in its award of damages and has appealed. In June 1997, First Tennessee, FTBNA, FT Mortgage Companies, an affiliate of FTBNA, and Sunbelt National Mortgage Corporation (Sunbelt), a company acquired by First Tennessee and merged into FT Mortgage Companies, were sued in California state court. Plaintiffs allege that Sunbelt charged excessive document preparation fees in connection with funding mortgage loans in California. They also assert that Sunbelt disclosed the fee in a way that led borrowers to think the entire fee was paid to a third party provider, when, in fact, a portion of the fee was retained by Sunbelt. Plaintiffs allege claims for violation of California's unfair practices act, breach of contract, fraud, and unjust enrichment. Nationwide class certification was denied but a class of Sunbelt's California borrowers has been certified. First Tennessee, FTBNA and FT Mortgage Companies, for itself and as successor to Sunbelt, deny liability and intend to defend this action vigorously. In addition to these cases, various other claims and lawsuits are pending against First Tennessee and its subsidiaries. Although First Tennessee cannot predict the outcome of the foregoing actions, after consulting with counsel, it is management's opinion that when resolved, the amount, if any, will not have a material adverse effect on the consolidated financial statements of First Tennessee and its subsidiaries. OTHER DISCLOSURES - BANK OWNED LIFE INSURANCE. First Tennessee has purchased life insurance on certain of its employees and is the beneficiary on these policies. At December 31, 1998, the cash surrender value of these policies, which is included in "Capital markets receivables and other assets" on the Consolidated Statements of Condition, was $115,520,000. There are no restrictions on the proceeds from these benefits, and First Tennessee has not borrowed against the cash surrender value of these policies. NOTE 18 - SHAREHOLDER PROTECTION RIGHTS AGREEMENT On October 20, 1998, First Tennessee adopted a Shareholder Protection Rights Agreement (the "1998 Agreement") and declared a dividend of one right on each outstanding share of common stock held on November 2, 1998, or issued thereafter and prior to the time the rights separate. This plan is substantially identical to First Tennessee's existing Agreement (defined below) and will not become operative until the expiration on September 18, 1999, (or an earlier redemption) of the existing rights. Under the 1998 Agreement, the exercise price is $150.00 per right, the redemption price is a fixed $0.001 per right, and the expiration date of the plan is December 31, 2009. In September 1989, First Tennessee adopted a Shareholder Protection Rights Agreement (the Agreement) and distributed a dividend of one right on each outstanding share of common stock held on September 18, 1989, or issued thereafter and prior to the time the rights separate. On January 21, 1997, First Tennessee amended and restated the Agreement. As so amended, the Agreement provides that until the 10th business day (subject to certain adjustments 83 by the board of directors) after a person or group commences a tender or exchange offer that will result in such person or group owning 10 percent or more of First Tennessee's common stock, or the public announcement by First Tennessee that a person or group owns 10 percent or more of First Tennessee's common stock, the rights will be evidenced by the common stock certificates, will automatically trade with the common stock, and will not be exercisable. Thereafter, separate rights certificates will be distributed, and each right will entitle its holder to purchase one one-hundredth of a share of participating preferred stock having economic and voting terms similar to those of one share of common stock for an exercise price of $75. If any person or group acquires 10 percent or more of First Tennessee's common stock, then each right (other than rights beneficially owned by holders of 10 percent or more of the common stock or affiliates, associates or transferees thereof, which rights become void) will entitle its holder to purchase, for the exercise price, a number of shares of First Tennessee common stock or participating preferred stock having a market value of twice the exercise price. Also, if there is a 10 percent shareholder and First Tennessee is involved in certain significant transactions, each right will entitle its holder to purchase, for the exercise price, a number of shares of common stock of the other party having a market value of twice the exercise price. If any person or group acquires 10 percent or more of First Tennessee's common stock, First Tennessee's board of directors may, at its option, exchange one share of First Tennessee common stock or one one-hundredth of a share of participating preferred stock for each right (other than rights which have become void). The board of directors may amend the agreement in any respect other than to change the redemption price or expiration date (and may amend the 1998 Agreement in any respect) prior to the tenth business day after announcement by First Tennessee that a person or group had acquired 10 percent or more of First Tennessee's common stock. The rights will expire on the earliest of one of the following three times: the time of the exchange described in the preceding sentence; September 18, 1999; or the date the rights are redeemed as described in the following sentence. The rights may be redeemed by the board of directors for $0.0017 per right until 10 business days after First Tennessee announces that any person or group owns 10 percent or more of First Tennessee's common stock. NOTE 19 - SAVINGS, PENSION AND OTHER EMPLOYEE BENEFITS SAVINGS PLAN. Substantially all employees of First Tennessee are covered by a contributory savings plan in conjunction with a flexible benefits plan. During the year, First Tennessee makes contributions to each employee's flexible benefits plan account. These contributions are based on length of service and a percentage of the employee's salary. The employees have the option to direct a portion or all of the contribution into their savings plan accounts. Employees may also make pre-tax and after-tax personal contributions to the savings plan. First Tennessee matches the majority of employee pre-tax contributions invested in First Tennessee's common stock at a rate of $.50 for each $1.00 invested up to 6 percent of the employee's qualifying salary. Contributions made by First Tennessee to the flexible benefits plan were $15,660,000 for 1998, $13,716,000 for 1997 and $13,202,000 for 1996. PENSION PLAN. Substantially all employees of First Tennessee are covered by a noncontributory, defined benefit pension plan. Pension benefits are based on years of service, average compensation near retirement and estimated social security benefits at age 65. The annual funding is based on an actuarially determined amount using the entry age cost method. OTHER EMPLOYEE BENEFITS. First Tennessee provides postretirement medical insurance to full-time employees retiring under the provisions of the First Tennessee Pension Plan. The postretirement medical plan is contributory with retiree contributions adjusted annually. The plan is based on criteria that are a combination of the employee's age and years of service and utilizes a two-step approach. For any employee retiring on or after January 1, 1995, First Tennessee will contribute a fixed amount based on years of service and age at time of retirement. 84 ACTUARIAL ASSUMPTIONS. The actuarial assumptions used in the defined benefit pension plan and the other employee benefit plans were as follows:
Pension Benefits Postretirement Benefits ------------------------------- ---------------------------- 1998 1997 1996 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------- WEIGHTED-AVERAGE ASSUMPTIONS AS OF SEPTEMBER 30 MEASUREMENT DATE Discount rate 6.75% 7.25% 7.75% 6.75% 7.25% 7.75% Expected return on plan assets 10.00 10.00 10.00 10.00 10.00 10.00 Expected return on plan assets dedicated to employees who retired prior to January 1, 1993 N/A N/A N/A 6.50 6.50 6.50 Rate of compensation increase 4.00 4.00 4.00 N/A N/A N/A - -------------------------------------------------------------------------------------------------------------------------
The components of net periodic benefit cost for the plan years 1998, 1997 and 1996 were as follows:
Pension Benefits Postretirement Benefits ------------------------------- ---------------------------- (Dollars in thousands) 1998 1997 1996 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------------- COMPONENTS OF NET PERIODIC BENEFIT COST Service cost $ 7,258 $ 5,737 $ 6,083 $ 712 $ 584 $ 608 Interest cost 9,971 8,187 7,895 1,637 1,781 1,689 Expected return on plan assets (18,773) (16,071) (14,558) (1,374) (906) (886) Amortization of prior service cost 322 290 290 3 3 3 Recognized gains & losses -- -- -- (107) -- -- Amortization of transition obligation or asset (460) (460) (460) 989 989 989 - ----------------------------------------------------------------------------------------------------------------------- Net periodic benefit cost/(benefit) $ (1,682) $ (2,317) $ (750) $ 1,860 $2,451 $2,403 =======================================================================================================================
The following table sets forth the plans' funded status reconciled to the amounts shown in the Consolidated Statements of Condition:
Pension Benefits Postretirement Benefits ------------------------ ------------------------ (Dollars in thousands) 1998 1997 1998 1997 - --------------------------------------------------------------------------------------------------------------------- CHANGE IN BENEFIT OBLIGATION Benefit obligation at beginning of plan year $ 139,467 $ 107,403 $ 23,241 $ 23,862 Service cost 7,258 5,737 712 584 Interest cost 9,971 8,187 1,637 1,781 Amendments -- 446 -- -- Actuarial (gain)/loss 19,939 22,261 1,981 (1,520) Benefits paid (4,570) (4,567) (1,507) (1,466) - --------------------------------------------------------------------------------------------------------------------- Benefit obligation at end of plan year $ 172,065 $ 139,467 $ 26,064 $ 23,241 ===================================================================================================================== CHANGE IN PLAN ASSETS Fair value of plan assets at beginning of plan year $ 218,342 $ 169,488 $ 12,210 $ 11,198 Actual return on plan assets 13,288 45,198 1,181 2,478 Employer contribution 1,541 8,223 4,976 -- Benefits paid (4,570) (4,567) (1,507) (1,466) - --------------------------------------------------------------------------------------------------------------------- Fair value of plan assets at end of plan year $ 228,601 $ 218,342 $ 16,860 $ 12,210 ===================================================================================================================== NET FUNDED STATUS AT SEPTEMBER 30 $ 56,536 $ 78,875 $ (9,204) $(11,031) Unrecognized net actuarial gain 8,595 (16,829) (2,080) (4,362) Unrecognized net transitional (asset)/obligation (1,860) (2,320) 13,840 14,829 Unrecognized prior service cost 2,682 3,004 35 38 - --------------------------------------------------------------------------------------------------------------------- Prepaid (accrued) benefit cost at September 30 65,953 62,730 2,591 (526) Contributions paid from October 1 to December 31 -- 82 1,037 4,976 - --------------------------------------------------------------------------------------------------------------------- Prepaid (accrued) benefit cost at December 31 $ 65,953 $ 62,812 $ 3,628 $ 4,450 =====================================================================================================================
85 The following table sets forth the amounts and types of securities of First Tennessee that are included in the plan assets. First Funds is a family of mutual funds managed by FTBNA.
Pension Benefits Postretirement Benefits ------------------------ ----------------------- (Dollars in thousands) 1998 1997 1998 1997 - --------------------------------------------------------------------------------------------------------------------- First Funds Capital Appreciation Portfolio Class I $ 26,033 $ 21,186 $ 1,165 $ 1,362 First Funds Growth & Income Portfolio Class I 98,346 120,374 4,358 3,733 First Funds Bond Portfolio Class I 102,920 75,775 4,147 3,216 - ---------------------------------------------------------------------------------------------------------------------
The cost of health care benefits was projected to increase at an annual per capita rate of 7.75 percent in 1998 and decrease evenly to a rate of 5.75 percent by the year 2000 and remain at an even level thereafter. In 1997, the annual rate of increase was assumed to be 8.75 percent decreasing evenly to a rate of 5.75 percent by the year 2000 and remaining at an even level thereafter. In 1996, the annual rate of increase was assumed to be 9.75 percent decreasing evenly to a rate of 5.75 percent by the year 2000 and remaining at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. A one-percentage-point change in assumed health care cost trend rates would have the following effects:
(Dollars in thousands) 1% Increase 1% Decrease - --------------------------------------------------------------------------------------------------------------------- Adjusted total service and interest cost components $ 2,427 $ 2,283 Adjusted postretirement benefit obligation at end of plan year 27,339 25,037 - ---------------------------------------------------------------------------------------------------------------------
First Tennessee provides benefits to former and inactive employees after employment but before retirement. The obligation/(benefit) recognized in accordance with accounting standards was $(.2) million in 1998, $.6 million in 1997 and $(.3) million in 1996. Medical and group life insurance expenses incurred for active employees are shown in the following table:
(Dollars in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------------------------------- Medical plan expense based on claims incurred $ 12,322 $ 10,802 $ 10,762 Participants 6,689 5,652 5,267 - -------------------------------------------------------------------------------------------------------- Group life insurance expense based on benefits incurred $ 1,120 $ 949 $ 865 Participants 10,097 8,457 8,022 - --------------------------------------------------------------------------------------------------------
86 NOTE 20 - STOCK OPTION, RESTRICTIVE STOCK INCENTIVE, AND DIVIDEND REINVESTMENT PLANS At its January 1998 meeting, the board of directors authorized a two-for-one split of First Tennessee's common stock. The shares were distributed February 20, 1998, to shareholders of record on February 6, 1998. Share and per share amounts in the accompanying text and tables have been adjusted for this stock split and the 1996 two-for-one stock split. STOCK OPTION PLANS. First Tennessee issues non-qualified stock options under various plans to employees, non-employee directors, and bank advisory board members. The plans provide for the issuance of First Tennessee common stock at a price equal to its fair market value at the date of grant; however, the exercise price may be less than the fair market value if the grantee has agreed to receive the options in lieu of compensation. The foregone compensation plus the exercise price must equal the fair market value of the stock on the date of grant. All options expire 10 years from the date of grant, except for those options that were part of compensation deferral, which expire 20 years from the date of grant. There were 1,999,344 shares available for option plan grants at December 31, 1998. As a result of plan amendments adopted by the board of directors during 1997, employees may defer the receipt of shares upon the exercise of stock options. The summary of stock option activity is shown below:
Weighted Options Average Outstanding Exercise Price - ----------------------------------------------------------------------------------------------------------------------- January 1, 1996 7,368,468 $ 8.25 Options granted 4,157,596 14.53 Stock options exercised (795,642) 7.16 Stock options canceled (693,786) 12.83 ------------ December 31, 1996 10,036,636 10.62 ============ Options exercisable 4,571,800 8.40 - ----------------------------------------------------------------------------------------------------------------------- January 1, 1997 10,036,636 $ 10.62 Options granted 4,791,158 20.53 Stock options exercised (1,904,284) 12.76 Stock options canceled (770,280) 15.99 ------------ December 31, 1997 12,153,230 13.85 ============ Options exercisable 8,554,866 13.67 - ----------------------------------------------------------------------------------------------------------------------- January 1, 1998 12,153,230 $ 13.85 Options granted 4,069,623 30.16 Stock options exercised* (2,468,821) 11.73 Stock options canceled (499,430) 21.20 ------------ December 31, 1998 13,254,602 18.96 ============ Options exercisable 10,185,877 16.97 - ----------------------------------------------------------------------------------------------------------------------- * Stock options exercised includes 307,867 shares converted to stock option equivalents as part of the deferred compensation program.
87 The following table summarizes information about stock options outstanding at December 31, 1998:
Weighted Weighted Weighted Average Average Average Exercise Exercise Remaining Price - Price - Options Contractual Options Options Options Exercise Price Range Outstanding Life Outstanding Exercisable Exercisable - ------------------------------------------------------------------------------------------------------------------- $ 4.00 - $10.00 1,721,367 4.59 years $ 6.58 1,721,367 $ 6.58 $10.01 - $15.00 2,955,063 9.50 years 11.53 2,357,192 11.37 $15.01 - $25.00 4,839,828 11.11 years 19.21 3,799,228 18.84 $25.01 - $35.00 3,738,344 15.45 years 30.22 2,308,090 27.35 - ------------------------------------------------------------------------------------------------------------------
First Tennessee accounts for these plans under APB Opinion No. 25 pursuant to which no compensation cost has been recognized. Had compensation cost for these plans been determined consistent with SFAS No. 123, First Tennessee's net income and earnings per share would have been reduced to the following pro forma amounts:
December 31 --------------------------------------- (Dollars in thousands except per share data) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------- Net income, as reported $ 226,380 $ 197,472 $ 179,907 Pro forma net income 221,252 189,366 178,068 Earnings per share, as reported 1.77 1.54 1.34 Pro forma earnings per share 1.73 1.48 1.32 - -------------------------------------------------------------------------------------------------------------------
Total compensation costs that would have been recognized in income under SFAS No. 123 for all stock-based compensation awards was $8,392,000 for 1998, $13,267,000 for 1997 and $3,010,000 for 1996. Because the SFAS No. 123 method of accounting has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years. First Tennessee used the Black-Scholes Option Pricing Model to estimate the fair value of stock options granted in 1998, 1997 and 1996, with the following assumptions:
1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------- Expected dividend yield 3.06% 3.31% 3.76% Expected option lives of options issued at market 6.28 years 6.01 years 5.72 years Expected option lives of options issued below market 2.20 years 2.36 years 2.65 years Expected volatility 18.94% 17.29% 16.75% Risk-free interest rates 5.54% 6.51% 6.16% - -------------------------------------------------------------------------------------------------------------------
Weighted Average Fair Number Value per Option Issued at Grant Date - ---------------------------------------------------------------------------------------------------------------------- 1998: Options issued at market on the date of grant 1,559,580 $ 8.42 Options issued below market on the date of grant 2,510,043 6.66 - ---------------------------------------------------------------------------------------------------------------------- 1997: Options issued at market on the date of grant 2,989,752 $ 4.87 Options issued below market on the date of grant 1,801,406 4.81 - ---------------------------------------------------------------------------------------------------------------------- 1996: Options issued at market on the date of grant 2,811,422 $ 2.66 Options issued below market on the date of grant 1,346,174 3.48 - ----------------------------------------------------------------------------------------------------------------------
RESTRICTED STOCK INCENTIVE PLANS. First Tennessee has authorized the issuance of its common stock for awards to executive employees who have a significant impact on the profitability of First Tennessee under restricted stock incentive plans. Additionally, one of the plans provide for 6,000 shares of restricted stock to be granted to each new non-employee director upon election to the board of directors with restrictions lapsing as defined in the plans. In 1998, First Tennessee granted 3,849 restricted shares under the plans. No restricted shares were granted in 1997, and in 1996, First Tennessee granted 222,392 restricted shares. Compensation expense related to these plans was $1,212,000, $1,275,000 and $1,541,000 for the years 1998, 1997 and 1996, respectively. There were 88 749,487 shares available for restricted stock incentive grants at December 31, 1998. The board of directors approved amendments to the restricted stock plan during 1998 permitting deferral by participants of the receipt of restricted stock prior to the lapse of restrictions. DIVIDEND REINVESTMENT PLAN. The Dividend Reinvestment and Stock Purchase Plan, as amended in 1995, authorizes the sale of First Tennessee's common stock from authorized, but unissued common stock or from shares acquired on the open market to shareholders who choose to invest all or a portion of their cash dividends and make optional cash payments of $25 to $10,000 per quarter without paying commissions. Since 1988, shares for this plan have been purchased on the open market. The price of the shares purchased directly from First Tennessee is the mean between the high and low sales price on the investment date. The price of shares purchased on the open market is the average price paid. NOTE 21 - BUSINESS SEGMENT INFORMATION First Tennessee provides traditional retail/commercial banking and other financial services to its customers. These products and services are categorized into two broad groups: a regional banking group and national lines of business. The regional banking group provides a comprehensive package of financial services including traditional banking, trust services, investments, asset management, insurance and credit card services to its customers. Banking subsidiaries offer general banking products in 19 Tennessee counties, in northern Mississippi and in northwest Arkansas. The national lines of business include mortgage banking, capital markets and transaction processing. Mortgage banking offers first and second mortgages through origination offices in 32 states and also services a multi-billion dollar portfolio. Capital markets offers investment securities and advisory services such as portfolio analysis, tax planning and loan securitization to institutional clients nationwide through offices in Chicago, Dallas, Kansas City, Knoxville, Memphis, Mobile, and New York. Transaction processing includes credit card merchant processing, an automated teller machine network, nationwide check clearing and transaction-oriented cash management products. The Other segment is used to isolate corporate items such as expense related to guaranteed preferred beneficial interests in First Tennessee's junior subordinated debentures and nonrecurring items such as securities gains or losses which include any venture capital gains or losses and related expenses. First Tennessee's reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different technology and marketing strategies. The measurements used in reporting these segments are the same as those reviewed monthly by the chief operating decision-maker. Total revenue, expense and asset levels reflect those which are specifically identifiable or which are allocated based on an internal allocation method. Net interest income is allocated to the segments using a combination of matched funding and multiple pool transfer pricing methods. In addition to expenses paid directly by the segments, allocated expenses may be charged to the lines of business based on the utilization of resources. Equity is allocated to the segments through risk analysis that incorporates the appropriate level of credit, operating, market and franchise risk factors. Because the allocations are based on internally developed assignments and allocations, they are to an extent subjective. This assignment and allocation has been consistently applied for all periods presented. The following table reflects the approximate amounts of consolidated revenue, expense, tax, and assets for the three years ended December 31, for each segment: 89
Regional Banking Mortgage Capital Transaction (Dollars in thousands) Group Banking Markets Processing Other Consolidated - ------------------------------------------------------------------------------------------------------------------ 1998 Interest income $ 850,002 $ 228,113 $ 37,555 $ 18,107 $ -- $ 1,133,777 Interest expense 382,003 175,363 33,101 2,771 -- 593,238 - ------------------------------------------------------------------------------------------------------------------ Net interest income 467,999 52,750 4,454 15,336 -- 540,539 Other revenues 207,186 562,601 147,360 64,380 3,976 985,503 Depreciation and amortization 30,647 127,062 1,748 2,878 -- 162,335 Other expenses* 419,272 414,120 109,283 59,372 8,738 1,010,785 - ------------------------------------------------------------------------------------------------------------------ Pre-tax income 225,266 74,169 40,783 17,466 (4,762) 352,922 Income taxes 79,435 26,951 15,329 6,637 (1,810) 126,542 - ------------------------------------------------------------------------------------------------------------------ Net income $ 145,831 $ 47,218 $ 25,454 $ 10,829 $(2,952) $ 226,380 ================================================================================================================== Average assets $11,200,707 $4,304,449 $729,081 $486,494 $ -- $16,720,731 - ------------------------------------------------------------------------------------------------------------------ Expenditures for long-lived assets $ 56,988 $ 33,861 $ 1,782 $ 5,633 $ -- $ 98,264 - ------------------------------------------------------------------------------------------------------------------ 1997 Interest income $ 817,327 $ 86,151 $ 19,632 $ 17,434 $ 749 $ 941,293 Interest expense 377,953 59,561 17,007 3,676 -- 458,197 - ------------------------------------------------------------------------------------------------------------------ Net interest income 439,374 26,590 2,625 13,758 749 483,096 Other revenues 179,021 330,467 98,311 61,257 (926) 668,130 Depreciation and amortization 26,550 54,587 1,197 3,449 -- 85,783 Other expenses* 370,158 244,813 73,049 54,235 8,121 750,376 - ------------------------------------------------------------------------------------------------------------------ Pre-tax income 221,687 57,657 26,690 17,331 (8,298) 315,067 Income taxes 81,739 22,427 10,002 6,580 (3,153) 117,595 - ------------------------------------------------------------------------------------------------------------------ Net income $ 139,948 $ 35,230 $ 16,688 $ 10,751 $(5,145) $ 197,472 ================================================================================================================== Average assets $10,662,569 $1,767,923 $366,416 $483,665 $ -- $13,280,573 - ------------------------------------------------------------------------------------------------------------------ Expenditures for long-lived assets $ 32,280 $ 19,981 $ 1,408 $ 2,430 $ -- $ 56,099 - ------------------------------------------------------------------------------------------------------------------ 1996 Interest income $ 779,224 $ 85,965 $ 16,461 $ 14,847 $ -- $ 896,497 Interest expense 380,348 48,493 13,652 2,816 -- 445,309 - ------------------------------------------------------------------------------------------------------------------ Net interest income 398,876 37,472 2,809 12,031 -- 451,188 Other revenues 157,831 274,728 85,871 55,400 (2,681) 571,149 Depreciation and amortization 32,544 41,689 987 3,571 -- 78,791 Other expenses* 325,719 214,620 65,716 51,494 3,823 661,372 - ------------------------------------------------------------------------------------------------------------------ Pre-tax income 198,444 55,891 21,977 12,366 (6,504) 282,174 Income taxes 71,102 20,845 8,094 4,695 (2,469) 102,267 - ------------------------------------------------------------------------------------------------------------------ Net income $ 127,342 $ 35,046 $ 13,883 $ 7,671 $(4,035) $ 179,907 ================================================================================================================== Average assets $10,316,939 $1,506,098 $307,388 $457,839 $ -- $12,588,264 - ------------------------------------------------------------------------------------------------------------------ Expenditures for long-lived assets $ 25,154 $ 8,676 $ 1,191 $ 2,528 $ -- $ 37,549 - ------------------------------------------------------------------------------------------------------------------ * Includes loan loss provision.
90 NOTE 22 - FAIR VALUE OF FINANCIAL INSTRUMENTS Accounting standards require the disclosure of estimated fair values of all asset, liability and off-balance sheet financial instruments. The following fair value estimates are determined as of a specific point in time utilizing various assumptions and estimates. The use of assumptions and various valuation techniques, as well as the absence of secondary markets for certain financial instruments, will likely reduce the comparability of fair value disclosures between financial institutions. In some cases, book value is a reasonable estimate of fair value due to the relatively short period of time between origination of the instrument and its expected realization. The following table summarizes the book value and estimated fair value of financial instruments recorded in the Consolidated Statements of Condition as of December 31, 1998 and 1997:
AT DECEMBER 31, 1998 At December 31, 1997 -------------------------------- -------------------------------- Book Fair Book Fair (Dollars in thousands) Value Value Value Value - --------------------------------------------------------------------------------------------------------------------------------- ASSETS: Loans, net of unearned income: Floating $ 4,081,673 $ 4,081,677 $ 4,150,569 $ 4,151,045 Fixed 4,447,584 4,432,309 4,122,366 4,137,707 Nonaccrual 27,807 27,807 38,415 38,415 Allowance for loan losses (136,013) (136,013) (125,859) (125,859) - --------------------------------------------------------------------------------------------------------------------------------- Total net loans 8,421,051 8,405,780 8,185,491 8,201,308 Liquid assets 483,754 483,754 481,623 481,623 Mortgage loans held for sale* 4,227,443 4,220,385 1,240,648 1,248,114 Securities available for sale 1,816,485 1,816,485 2,133,303 2,133,303 Securities held to maturity 609,804 610,364 53,230 54,323 Nonearning assets 1,170,477 1,170,477 966,201 966,201 - --------------------------------------------------------------------------------------------------------------------------------- LIABILITIES: Deposits: Defined maturity $ 4,671,206 $ 4,679,626 $ 3,430,870 $ 3,470,409 Undefined maturity 7,051,833 7,051,833 6,240,909 6,240,909 - --------------------------------------------------------------------------------------------------------------------------------- Total deposits 11,723,039 11,731,459 9,671,779 9,711,318 Short-term borrowings 4,339,292 4,339,673 2,788,067 2,788,067 Term borrowings 414,450 420,147 168,893 174,854 Other noninterest-bearing liabilities 315,805 314,735 212,565 210,919 Guaranteed preferred beneficial interests in First Tennessee's junior subordinated debentures 100,000 111,857 100,000 106,453 - --------------------------------------------------------------------------------------------------------------------------------- *Mortgage loans held for sale had an additional fair value related to mortgage servicing rights of approximately $46,485,000 and $9,344,000 at December 31, 1998 and 1997, respectively. Information on the fair value of off-balance sheet financial instruments can be found in Note 23 - Financial Instruments with Off-Balance Sheet Risk.
The following describes the assumptions and methodologies used to estimate the fair value for financial instruments: FLOATING RATE LOANS. With the exception of floating rate 1-4 family residential mortgage loans, the fair value is approximated by the book value. Floating rate 1-4 family residential mortgage loans reprice annually and will lag movements in market rates; whereas, commercial and consumer loans typically reprice monthly. The fair value for floating rate 1-4 family mortgage loans is calculated by discounting future cash flows to their present value. Future cash flows are discounted to their present value by using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same time period. Prepayment assumptions based on historical prepayment speeds have been applied to the floating rate 1-4 family residential mortgage portfolio. FIXED RATE LOANS. The fair value is estimated by discounting future cash flows to their present value. Future cash flows are discounted to their present value by using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same time period. Prepayment assumptions based on historical prepayment speeds have been applied to the fixed rate mortgage and installment loan portfolios. 91 NONACCRUAL LOANS. The fair value is approximated by the book value. ALLOWANCE FOR LOAN LOSSES. The fair value is approximated by the book value. Additionally, the credit exposure known to exist in the loan portfolio is embodied in the allowance for loan losses. LIQUID ASSETS. The fair value is approximated by the book value. For the purpose of this disclosure, liquid assets consist of federal funds sold, securities purchased under agreements to resell, capital markets securities inventory and investment in bank time deposits. MORTGAGE LOANS HELD FOR SALE. Fair values are based primarily on quoted market prices. SECURITIES AVAILABLE FOR SALE. Fair values are based primarily on quoted market prices. SECURITIES HELD TO MATURITY. Fair values are based primarily on quoted market prices. NONEARNING ASSETS. The fair value is approximated by the book value. For the purpose of this disclosure, nonearning assets include cash and due from banks, accrued interest receivable and capital markets receivables. DEFINED MATURITY DEPOSITS. The fair value is estimated by discounting future cash flows to their present value. Future cash flows are discounted by using the current market rates of similar instruments applicable to the remaining maturity. For the purpose of this disclosure, defined maturity deposits include all certificates of deposit and other time deposits. UNDEFINED MATURITY DEPOSITS. The fair value is considered to be equal to the book value. For the purpose of this disclosure, undefined maturity deposits include demand deposits, checking interest accounts, savings accounts, and money market accounts. SHORT-TERM BORROWINGS. The fair value of federal funds purchased, securities sold under agreements to repurchase, commercial paper, bank notes and other short-term borrowings is approximated by the book value. The fair value for Federal Home Loan Bank borrowings is determined using discounted future cash flows. TERM BORROWINGS. The fair value is approximated by the present value of the contractual cash flows discounted by the investor's yield which considers First Tennessee's and FTBNA's debt ratings. OTHER NONINTEREST-BEARING LIABILITIES. For the purpose of this disclosure, other noninterest-bearing liabilities include accrued interest payable and capital markets payables. Accrued interest, which is not payable until maturity, has been discounted to its present value given current market rates and the maturity structure of the financial instrument. The fair value of capital markets payables approximates the book value. GUARANTEED PREFERRED BENEFICIAL INTERESTS. The fair value is approximated by the present value of the contractual cash flows discounted by the investor's yield which considers First Tennessee's debt rating. 92 NOTE 23 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK First Tennessee utilizes various financial instruments as part of its risk management strategy and as a means to meet customers' needs. These instruments are subject to credit and market risks that are not reflected on the balance sheet. The activities that currently employ financial instruments with off- balance sheet risk are mortgage banking, interest rate risk management and capital markets operations. First Tennessee also enters into commitments for lending related purposes to meet customers' financial needs. Controls and monitoring procedures for these instruments have been established and are routinely revised. The Asset/Liability Committee (ALCO) monitors the usage and effectiveness of financial instruments. ALCO, in conjunction with senior credit officers, also periodically reviews and revises counterparty credit limits. Credit Risk represents the maximum potential loss due to possible non-performance by obligors and counterparties under the terms of contracts. First Tennessee manages credit risk by entering into financial instrument transactions through national exchanges, primary dealers or approved counterparties, and using mutual margining agreements whenever possible to limit potential exposure. With exchange-traded contracts, the credit risk is limited to the clearinghouse used. For non-exchange traded instruments, credit risk may occur when there is a gain in the fair value of the financial instrument and the counterparty fails to perform according to the terms of the contract and/or when the collateral proves to be of insufficient value. Market Risk represents the potential loss due to the decrease in the value of a financial instrument caused primarily by changes in interest rates, prepayment speeds or the prices of debt instruments. The measurement of market risk associated with financial instruments is meaningful only when all related and offsetting on- and off-balance sheet hedges are aggregated, and the resulting net positions are identified. LENDING RELATED First Tennessee enters into fixed and variable loan commitments with customers. When these commitments have contract rate adjustments that lag changes in market rates, the financial instruments have characteristics similar to option contracts. First Tennessee follows the same credit policies and underwriting practices in making commitments as it does for on-balance sheet instruments. Each counterparty's creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if any, is based on management's credit evaluation of the counterparty. Commitments to Extend Credit are contractual obligations to lend to a customer as long as all established contractual conditions are met. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The majority of First Tennessee's loan commitments have maturities less than one year and reflect the prevailing market rates at the time of the commitment. Since commitments may expire without being fully drawn upon, the total contract amount does not necessarily represent future cash requirements. Commercial and Standby Letters of Credit are conditional commitments issued by First Tennessee to guarantee the performance and/or payment of a customer to a third party in connection with specified transactions. The credit risk involved in issuing commercial and standby letters of credit is essentially the same as that involved in extending loan facilities to customers. 93 The following is a summary of the maximum credit exposure of each class of lending related off-balance sheet financial instruments outstanding at December 31:
(Dollars in millions) 1998 1997 - ------------------------------------------------------------------------------------------------------------------------------------ Commitments to extend credit: Consumer credit card lines $ 2,246.3 $ 1,866.7 Consumer home equity 534.0 413.4 Commercial real estate and construction and land development 363.6 371.4 Mortgage banking 1,783.8 761.6 Commercial and other 1,835.9 1,876.8 - ------------------------------------------------------------------------------------------------------------------------------------ Total loan commitments 6,763.6 5,289.9 Other commitments: Standby letters of credit 480.1 513.0 Commercial letters of credit 7.5 5.5 - ------------------------------------------------------------------------------------------------------------------------------------ Total loan and other commitments $ 7,251.2 $ 5,808.4 ==================================================================================================================================== The following table shows the notional or contractual amounts and related fair values for the off-balance sheet financial instruments at December 31:
1998 1997 ----------------------------- ---------------------------- Notional Fair Notional Fair (Dollars in millions) Value Value Value Value - ------------------------------------------------------------------------------------------------------------------------------------ Loan commitments $ 6,763.6 $ 2.9 $ 5,289.9 $ 5.4 Commercial and standby letters of credit 487.6 6.0 518.5 6.4 - ------------------------------------------------------------------------------------------------------------------------------------ Foreign exchange contracts: Contracts to buy $ (.5) * $ (2.5) * Contracts to sell .5 * 2.7 * - ------------------------------------------------------------------------------------------------------------------------------------ Net position $ -- $ .2 ==================================================================================================================================== * Amount is less than $100,000. Mortgage banking loan commitments had an additional fair value related to mortgage servicing rights of approximately $13.2 million at December 31, 1998, and $3.8 million at December 31, 1997.
MORTGAGE BANKING First Tennessee uses both forward sales commitments and option contracts to protect the value of residential mortgage loans originated for sale in the secondary market. Adverse market interest rate changes, between the time a customer receives a rate-lock commitment and the time the loan is sold to an investor, can erode the value of that mortgage. Therefore, First Tennessee enters into forward sales commitments and option contracts to mitigate the interest rate risk associated with the origination and sale of mortgage loans. First Tennessee enters into interest rate contracts to counterbalance the loss in value of its mortgage servicing rights from the effects of increased prepayment activity that generally results from declining interest rates. With respect to the purchased interest rate contracts, First Tennessee is not exposed to loss beyond its initial outlay to acquire the hedge instruments and therefore, there is no off-balance sheet risk. These financial instruments are included in the discussion to fully disclose the servicing hedging position. The credit risk inherent in these transactions relates to the possibility of counterparties not performing according to the terms of the contract. This credit risk is controlled through credit approvals, risk control limits and on-going monitoring procedures through ALCO. The credit risk is represented by the aggregate fair value of only those interest rate contracts that currently have a positive fair value. Interest Rate Forward Contracts are over-the-counter contracts where two parties agree to purchase and sell a specific quantity of a financial instrument at a specified price, with delivery or settlement at a specified date. Interest Rate Option Contracts give the purchaser the right, but not the obligation, to buy or sell a specified quantity of a financial instrument, at a specified price, during a specified period of time. Caps and Floors are options that are linked to a notional principal amount and an underlying indexed interest rate. Exposure to loss on all interest rate contracts will increase or decrease as interest rates fluctuate. The following disclosures of the fair value of interest rate contracts are made using available market information and appropriate valuation methodologies. Fair value is defined as the amount First Tennessee would receive or pay to replace the contracts as of the valuation date. 94
1998 1997 ------------------------- ---------------------- Notional Fair Notional Fair (Dollars in millions) Value Value Value Value - ---------------------------------------------------------------------------------------------------------- Interest rate contracts: Mortgage pipeline and warehouse hedging: Forward contracts - commitments to sell $ 3,925.9 $ (3.1) $1,644.8 $(4.3) Option contracts - put options purchased** -- -- 26.0 * Option contracts - call options written** (150.0) (1.3) -- -- Servicing portfolio hedging**: Option contracts - call options purchased 150.0 1.1 640.0 2.5 Floors: Purchased 16,750.0 264.2 3,750.0 27.5 Written (5,400.0) (79.7) -- -- Caps: Purchased 1,250.0 4.4 -- -- Written (1,250.0) (9.2) -- -- - ---------------------------------------------------------------------------------------------------------- * Amount is less than $100,000. ** Option contracts in total had a book value at December 31, 1998, of $173.7 million, and $17.8 million at December 31, 1997.
Residential first-lien mortgage loans are originated by First Tennessee to be sold in the secondary market. Some of these loans are sold with provisions of recourse. As of December 31, 1998 and 1997, the outstanding principal amount of these loans and the amount of credit risk was $154.7 million and $111.6 million, respectively. A reserve has been established to cover any inherent losses. These loans are reviewed on a regular basis to ensure that reserves are adequate to provide for foreclosure losses. In addition, First Tennessee originates, sells and services loans guaranteed by the Veterans Administration (VA). A VA guaranty typically covers only the lesser of $46,000 or 25 percent to 50 percent of the unpaid loan balance. In the event of foreclosure, First Tennessee, as a servicer of VA loans, has credit risk to the extent that the outstanding loan balance exceeds the VA guaranty and the value of the underlying real estate. As of December 31, 1998 and 1997, the outstanding principal balance of VA loans serviced was $4.5 billion and $3.2 billion, respectively. These loans are reviewed on a regular basis, and a reserve has been established to cover any inherent losses. INTEREST RATE RISK MANAGEMENT First Tennessee's ALCO focuses on managing market risk by controlling and limiting earnings volatility attributable to changes in interest rates. Interest rate risk exists to the extent that interest-earning assets and liabilities have different maturity or repricing characteristics. First Tennessee uses off-balance sheet financial instruments that are designed to moderate the impact on earnings as interest rates change. Interest Rate Swaps involve the exchange of interest payments at specified intervals between two parties without the exchange of any underlying principal. Notional amounts are used in such contracts to calculate interest payments due to counterparties and do not represent credit exposure. The primary risks associated with swaps are the exposure to movements in interest rates and the ability of counterparties to meet the terms of the contracts.
Weighted Final Notional Fair Average Maturity (Dollars in millions) Value Value Receive Rate In - --------------------------------------------------------------------------------------------------------------- 1998 Interest rate contracts: Swaps - receive fixed/pay floating* $ 432.0 $ .7 5.837% 1999 Swaps - receive floating/pay floating* 150.0 (.2) 4.937% 1999 Caps: Purchased 20.0 .1 Strike 8% 2002 Written (20.0) (.1) Strike 8% 2002 Equity contracts: Purchased options 1.9 .7 2003 - --------------------------------------------------------------------------------------------------------------- 1997 Interest rate contracts: Swaps - receive fixed/pay floating* $ 210.0 $ .1 6.200% 1998 Caps: Purchased 20.0 .1 Strike 8% 2002 Written (20.0) (.1) Strike 8% 2002 - --------------------------------------------------------------------------------------------------------------- * The weighted average rate paid on interest rate swaps at December 31, 1998, was 5.280 percent and 5.899 percent at December 31, 1997.
95 CAPITAL MARKETS Capital markets buys and sells mortgage securities, municipal bonds and other securities for trading purposes. When these securities settle on a delayed basis, they are considered forward contracts. These transactions are measured at fair value, and gains or losses are recognized in earnings as they occur. Capital markets utilize futures contracts, from time to time, to manage exposure arising from the inventory position. Credit risk related to these transactions is controlled through credit approvals, risk control limits and on-going monitoring procedures through ALCO.
AT FOR THE YEAR ENDED DECEMBER 31, 1998 DECEMBER 31, 1998 --------------------- --------------------- Net Average Notional Fair Gain/ Fair (Dollars in millions) Value Value (Loss) Value - ------------------------------------------------------------------------------------------------------------------ Forward contracts: Commitments to buy: Gain position $ (855.7) $ 2.3 Loss position (1,639.6) (3.9) Commitments to sell: Gain position 1,707.6 2.5 Loss position 779.5 (2.8) - ------------------------------------------------------------------------------------------------------------------ Net position $ (8.2) $ (1.9) $ 136.5 $ (2.1) ================================================================================================================== At For the Year Ended December 31, 1997 December 31, 1997 --------------------- --------------------- Net Average Notional Fair Gain/ Fair (Dollars in millions) Value Value (Loss) Value - ------------------------------------------------------------------------------------------------------------------ Forward contracts: Commitments to buy: Gain position $ (424.1) $ 1.4 Loss position (1,174.4) (4.2) Commitments to sell: Gain position 1,062.5 2.6 Loss position 608.0 (1.9) - ------------------------------------------------------------------------------------------------------------------ Net position $ 72.0 $ (2.1) $ 61.2 $ (1.5) ================================================================================================================== Option contracts: Purchased $ 11.0 $ * $ -- $ * Written (11.0) * -- * - ------------------------------------------------------------------------------------------------------------------ Net position $ -- $ -- $ -- $ -- ================================================================================================================== * Amount is less than $100,000.
96 NOTE 24 - PARENT COMPANY FINANCIAL INFORMATION Following are condensed statements of the parent company:
STATEMENT OF CONDITION December 31 - ------------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) 1998 1997 - ------------------------------------------------------------------------------------------------------------------------- ASSETS: Cash $ 1 $ 2 Securities purchased from subsidiary bank under agreements to resell 36,279 85,891 - ------------------------------------------------------------------------------------------------------------------------- Total cash and cash equivalents 36,280 85,893 Investment in bank time deposits 53,171 5,094 Securities available for sale 59,160 23,760 Notes receivable--long-term 75,000 75,000 Investments in subsidiaries at equity: Bank 1,202,910 1,063,646 Non-bank 33,944 16,636 Other assets 45,052 36,051 - ------------------------------------------------------------------------------------------------------------------------- TOTAL ASSETS $ 1,505,517 $ 1,306,080 ========================================================================================================================= LIABILITIES AND SHAREHOLDERS' EQUITY: Commercial paper and other short-term borrowings $ 23,204 $ 23,176 Accrued employee benefits and other liabilities 73,325 54,501 Term borrowings 309,454 274,307 - ------------------------------------------------------------------------------------------------------------------------- Total liabilities 405,983 351,984 Shareholders' equity 1,099,534 954,096 - ------------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,505,517 $ 1,306,080 =========================================================================================================================
STATEMENTS OF INCOME Year Ended December 31 - ------------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------- Dividend income: Bank $ 122,484 $ 175,965 $ 87,130 Non-bank 6,059 3,557 2,850 - ------------------------------------------------------------------------------------------------------------------------- Total dividend income 128,543 179,522 89,980 Interest income 12,117 11,287 9,626 Other income 432 460 38 - ------------------------------------------------------------------------------------------------------------------------- Total income 141,092 191,269 99,644 - ------------------------------------------------------------------------------------------------------------------------- Interest expense: Short-term debt 1,112 1,132 1,725 Term borrowings 23,594 22,729 13,150 - ------------------------------------------------------------------------------------------------------------------------- Total interest expense 24,706 23,861 14,875 Compensation, employee benefits and other expense 12,085 10,903 10,203 - ------------------------------------------------------------------------------------------------------------------------- Total expense 36,791 34,764 25,078 - ------------------------------------------------------------------------------------------------------------------------- Income before income taxes and equity in undistributed net income of subsidiaries 104,301 156,505 74,566 Applicable income taxes (10,522) (10,458) (6,099) - ------------------------------------------------------------------------------------------------------------------------- Income before equity in undistributed net income of subsidiaries 114,823 166,963 80,665 Equity in undistributed net income of subsidiaries: Bank 110,566 29,439 98,148 Non-bank 991 1,070 1,094 - ------------------------------------------------------------------------------------------------------------------------- NET INCOME $ 226,380 $ 197,472 $ 179,907 =========================================================================================================================
97
STATEMENTS OF CASH FLOWS Year Ended December 31 - ------------------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES: Net income $ 226,380 $ 197,472 $ 179,907 Less undistributed net income of subsidiaries 111,557 30,509 99,242 - ------------------------------------------------------------------------------------------------------------------------------- Income before undistributed net income of subsidiaries 114,823 166,963 80,665 Adjustments to reconcile income to net cash provided by operating activities: Provision/(benefit) for deferred income taxes (1,207) 1,797 (2,763) Depreciation and amortization 2,101 2,176 2,087 Loss/(gain) on disposal of fixed assets -- 3 56 Net change in interest receivable and other assets (5,100) (4,740) (1,541) Net change in interest payable and other liabilities 19,415 5,678 9,879 - ------------------------------------------------------------------------------------------------------------------------------- Total adjustments 15,209 4,914 7,718 - ------------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 130,032 171,877 88,383 - ------------------------------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES: Securities: Maturities -- 40 270 Purchases (35,400) (3,900) (18,660) Premises and equipment: Sales -- -- 21 Purchases (45) (72) (166) Investment in subsidiaries -- (3,093) -- Increase in investment in bank time deposits (48,077) (854) (4,140) Acquisitions, cash received/(paid) (9,719) (185) 400 - ------------------------------------------------------------------------------------------------------------------------------- Net cash provided/(used) by investing activities (93,241) (8,064) (22,275) - ------------------------------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES: Common stock: Exercise of stock options 24,943 24,309 5,779 Cash dividends (84,521) (78,348) (71,310) Repurchase of shares (61,854) (169,520) (28,356) Term borrowings: Issuance 35,000 106,793 18,250 Decrease in short-term borrowings 28 (9,472) (16,753) - ------------------------------------------------------------------------------------------------------------------------------- Net cash used by financing activities (86,404) (126,238) (92,390) - ------------------------------------------------------------------------------------------------------------------------------- Net increase/(decrease) in cash and cash equivalents (49,613) 37,575 (26,282) - ------------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at beginning of year 85,893 48,318 74,600 - ------------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 36,280 $ 85,893 $ 48,318 =============================================================================================================================== Total interest paid $ 24,035 $ 19,167 $ 14,706 Total income taxes paid 25,631 60,050 47,812 - -------------------------------------------------------------------------------------------------------------------------------
98 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders and Board of Directors of First Tennessee National Corporation: We have audited the accompanying consolidated statements of condition of First Tennessee National Corporation (a Tennessee corporation) and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of First Tennessee National Corporation and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. /s/Arthur Andersen LLP Memphis, Tennessee, January 19, 1999. 99
CONSOLIDATED HISTORICAL STATEMENTS OF INCOME (UNAUDITED) FIRST TENNESSEE NATIONAL CORPORATION - ---------------------------------------------------------------------------------------------------------------------------- Growth Rates (%) ----------------- (Dollars in millions except per share data) 1998 1997 1996 1995 1994 1993 98/97 98/93* - ---------------------------------------------------------------------------------------------------------------------------- INTEREST INCOME: Interest and fees on loans: Commercial $ 322.5 $ 298.9 $277.2 $264.4 $211.6 $178.7 7.9 + 12.5 + Consumer 258.0 248.7 229.9 206.0 166.8 128.1 3.7 + 15.0 + Permanent mortgage 38.7 51.0 51.7 52.1 44.0 45.9 24.1 - 3.4 - Credit card receivables 67.7 67.9 67.6 65.5 56.6 51.1 .3 - 5.8 + Real estate construction 39.0 33.1 27.1 23.0 11.4 7.3 17.8 + 39.8 + Investment securities: Taxable 155.9 135.3 136.0 130.9 128.9 175.8 15.2 + 2.4 - Tax-exempt 3.7 4.5 5.1 4.6 5.2 7.2 17.8 - 12.5 - Other earning assets: Mortgage loans held for sale 205.7 76.9 82.1 54.7 56.0 44.9 167.5 + 35.6 + Investments in bank time deposits 2.0 .5 .7 .2 .2 .2 300.0 + 58.5 + Federal funds sold and securities purchased under agreements to resell 10.1 11.1 5.0 8.5 7.6 3.7 9.0 - 22.2 + Capital markets securities inventory 30.5 13.4 14.1 12.6 12.8 9.3 127.6 + 26.8 + - -------------------------------------------------------------------------------------------------------- Total interest income 1,133.8 941.3 896.5 822.5 701.1 652.2 20.5 + 11.7 + - -------------------------------------------------------------------------------------------------------- INTEREST EXPENSE: Deposits: Savings 7.1 8.2 9.4 10.8 13.4 15.4 13.4 - 14.3 - Checking interest and money market 113.2 95.1 92.7 95.8 65.7 54.3 19.0 + 15.8 + Certificates of deposit under $100,000 and other time 144.9 160.5 166.5 167.8 122.0 117.3 9.7 - 4.3 + Certificates of deposit $100,000 and more 111.5 47.7 46.3 30.6 18.7 16.2 133.8 + 47.1 + Federal funds purchased and securities sold under agreements to repurchase 122.6 89.8 78.0 80.9 40.5 29.2 36.5 + 33.2 + Commercial paper and other short-term borrowings 72.6 39.2 29.3 25.7 35.6 33.6 85.2 + 16.7 + Federal Reserve Bank penalties 1.5 1.8 2.3 2.2 1.1 .5 16.7 - 24.6 + Term borrowings 19.9 15.9 20.8 18.0 9.6 9.6 25.2 + 15.7 + - -------------------------------------------------------------------------------------------------------- Total interest expense 593.3 458.2 445.3 431.8 306.6 276.1 29.5 + 16.5 + - -------------------------------------------------------------------------------------------------------- NET INTEREST INCOME 540.5 483.1 451.2 390.7 394.5 376.1 11.9 + 7.5 + Provision for loan losses 51.3 51.1 35.7 20.6 17.2 36.5 .4 + 7.0 + - -------------------------------------------------------------------------------------------------------- NET INTEREST INCOME AFTER PROVISION 489.2 432.0 415.5 370.1 377.3 339.6 13.2 + 7.6 + - -------------------------------------------------------------------------------------------------------- NONINTEREST INCOME: Mortgage banking 558.4 330.1 275.4 213.6 188.2 139.6 69.1 + 32.0 + Capital markets 147.4 98.3 85.9 82.8 77.5 91.5 49.9 + 10.0 + Deposit transactions and cash management 90.4 86.1 78.2 74.1 65.8 59.6 5.1 + 8.7 + Trust services and investment management 51.2 40.9 34.7 34.4 27.9 25.5 25.1 + 14.9 + Merchant processing 37.5 32.1 24.2 19.2 14.7 12.0 16.7 + 25.5 + Cardholder fees 21.0 19.8 17.2 14.9 15.6 15.8 6.1 + 5.9 + Equity securities gains/(losses) 3.9 (.8) (2.5) 3.2 24.3 (.5) N/A N/A Debt securities gains/(losses) -- .1 (.2) (.8) (4.3) 1.4 N/A N/A All other income and commissions 75.7 61.5 58.3 51.2 46.5 43.2 23.1 + 11.9 + - -------------------------------------------------------------------------------------------------------- Total noninterest income 985.5 668.1 571.2 492.6 456.2 388.1 47.5 + 20.5 + - -------------------------------------------------------------------------------------------------------- ADJUSTED GROSS INCOME AFTER PROVISION 1,474.7 1,100.1 986.7 862.7 833.5 727.7 34.1 + 15.2 + - -------------------------------------------------------------------------------------------------------- NONINTEREST EXPENSE: Employee compensation, incentives and benefits 563.6 409.8 385.4 340.5 349.8 308.6 37.5 + 12.8 + Amortization of mortgage servicing rights 95.5 37.4 26.0 15.0 14.9 25.5 155.0 + 30.2 + Operations services 58.5 49.9 44.1 38.8 33.7 28.7 17.3 + 15.3 + Occupancy 51.4 42.8 39.8 37.9 34.1 27.7 20.0 + 13.2 + Equipment rentals, depreciation and maintenance 45.8 40.1 34.1 31.8 29.2 22.2 14.2 + 15.5 + Communications and courier 41.5 34.9 33.0 29.9 30.7 24.8 18.8 + 10.9 + Advertising and public relations 25.2 18.7 17.6 13.0 10.7 8.0 34.5 + 25.8 + Amortization of intangible assets 11.1 9.6 9.5 8.1 6.4 5.8 15.4 + 13.6 + All other expense 229.2 141.8 115.0 94.7 116.2 101.3 61.7 + 17.8 + - -------------------------------------------------------------------------------------------------------- Total noninterest expense 1,121.8 785.0 704.5 609.7 625.7 552.6 42.9 + 15.2 + - -------------------------------------------------------------------------------------------------------- INCOME BEFORE INCOME TAXES 352.9 315.1 282.2 253.0 207.8 175.1 12.0 + 15.0 + Applicable income taxes 126.5 117.6 102.3 88.1 60.7 65.4 7.6 + 14.1 + - -------------------------------------------------------------------------------------------------------- NET INCOME $ 226.4 $ 197.5 $179.9 $164.9 $147.1 $109.7 14.6 + 15.6 + ======================================================================================================== FULLY TAXABLE EQUIVALENT ADJUSTMENT $ 3.8 $ 4.3 $ 5.4 $ 5.0 $ 4.8 $ 6.3 11.6 - 9.6 - - -------------------------------------------------------------------------------------------------------- EARNINGS PER SHARE $ 1.77 $ 1.54 $ 1.34 $ 1.21 $ 1.07 $ .81 14.9 + 16.9 + - -------------------------------------------------------------------------------------------------------- DILUTED EARNINGS PER SHARE $ 1.72 $ 1.50 $ 1.32 $ 1.20 $ 1.07 $ .80 14.7 + 16.5 + - -------------------------------------------------------------------------------------------------------- * Compound annual growth rate. Certain previously reported amounts have been reclassified to agree with current presentation. Per share data reflect the 1998 and 1996 two-for-one stock splits.
100
CONSOLIDATED AVERAGE BALANCE SHEETS AND RELATED YIELDS AND RATES (UNAUDITED) FIRST TENNESSEE NATIONAL CORPORATION - ------------------------------------------------------------------------------------------------------------------------------------ 1998 1997 Average ----------------------------- ----------------------------- Balance Interest Average Interest Average Growth(%) (Fully taxable equivalent) Average Income/ Yields/ Average Income/ Yields/ --------- (Dollars in millions) Balance Expense Rates Balance Expense Rates 98/97 - ------------------------------------------------------------------------------------------------------------------------------------ ASSETS: Earning assets: Loans, net of unearned income: Commercial $ 3,966.3 $ 323.1 8.15% $ 3,624.8 $299.8 8.27% 9.4 + Consumer 2,794.4 258.1 9.23 2,760.0 248.7 9.01 1.2 + Permanent mortgage 481.6 38.7 8.03 638.4 51.0 7.99 24.6 - Credit card receivables 563.5 67.7 12.02 544.7 67.9 12.47 3.5 + Real estate construction 405.4 38.9 9.60 337.4 33.0 9.79 20.2 + Nonaccrual loans 30.9 .9 3.03 39.8 .9 2.16 22.4 - - ------------------------------------------------------------------------------------------------------------------------ Total loans, net of unearned income 8,242.1 727.4 8.83 7,945.1 701.3 8.83 3.7 + - ------------------------------------------------------------------------------------------------------------------------ Investment securities: U.S. Treasury and other U.S. government agencies 1,795.2 117.8 6.56 1,963.3 129.3 6.59 8.6 - States and municipalities 69.8 5.4 7.80 83.7 6.8 8.06 16.6 - Other 560.8 38.4 6.84 92.4 6.1 6.65 506.9 + - ------------------------------------------------------------------------------------------------------------------------ Total investment securities 2,425.8 161.6 6.66 2,139.4 142.2 6.65 13.4 + - ------------------------------------------------------------------------------------------------------------------------ Other earning assets: Mortgage loans held for sale 2,911.2 205.7 7.06 1,005.9 76.9 7.64 189.4 + Investment in bank time deposits 40.8 2.0 4.81 9.8 .5 5.05 316.3 + Federal funds sold and securities purchased under agreements to resell 193.4 10.1 5.22 207.1 11.1 5.37 6.6 - Capital markets securities inventory 507.2 30.8 6.07 204.8 13.6 6.65 147.7 + - ------------------------------------------------------------------------------------------------------------------------ Total other earning assets 3,652.6 248.6 6.80 1,427.6 102.1 7.15 155.9 + - ------------------------------------------------------------------------------------------------------------------------ Total earning assets 14,320.5 1,137.6 7.94 11,512.1 945.6 8.21 24.4 + Allowance for loan losses (133.1) (123.6) 7.7 + Cash and due from banks 697.6 658.6 5.9 + Premises and equipment, net 222.4 195.1 14.0 + Capital markets receivables and other assets 1,613.3 1,038.4 55.4 + - ------------------------------------------------------------------------------------------------------------------------ Total assets/Interest income $16,720.7 $1,137.6 $13,280.6 $945.6 25.9 + ======================================================================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY: Interest-bearing liabilities: Interest-bearing deposits: Savings $ 347.5 $ 7.1 2.05% $ 376.5 $ 8.2 2.17% 7.7 - Checking interest and money market 3,403.7 113.2 3.32 2,963.7 95.1 3.21 14.8 + Certificates of deposit under $100,000 and other time 2,588.7 144.9 5.60 2,798.0 160.5 5.74 7.5 - - ------------------------------------------------------------------------------------------------------------------------- Total interest-bearing core deposits 6,339.9 265.2 4.18 6,138.2 263.8 4.30 3.3 + Certificates of deposit $100,000 and more 1,992.5 111.5 5.59 843.0 47.7 5.66 136.4 + Federal funds purchased and securities sold under agreements to repurchase 2,456.4 122.6 4.99 1,790.1 89.8 5.01 37.2 + Commercial paper and other short-term borrowings 1,285.5 74.1 5.76 663.0 41.0 6.18 93.9 + Term borrowings 252.7 19.9 7.91 185.5 15.9 8.60 36.2 + - ------------------------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 12,327.0 593.3 4.81 9,619.8 458.2 4.76 28.1 + Demand deposits 1,749.0 1,695.8 3.1 + Other noninterest-bearing deposits 915.0 530.1 72.6 + Capital markets payables and other liabilities 633.7 457.5 38.5 + Guaranteed preferred beneficial interests in First Tennessee's junior subordinated debentures 100.0 98.6 1.4 + Shareholders' equity 996.0 878.8 13.3 + - ------------------------------------------------------------------------------------------------------------------------ Total liabilities and shareholders' equity/Interest expense $16,720.7 $ 593.3 $13,280.6 $458.2 25.9 + ======================================================================================================================== Net interest income-tax equivalent basis/Yield $ 544.3 3.80% $487.4 4.23% Fully taxable equivalent adjustment (3.8) (4.3) - ------------------------------------------------------------------------------------------------------------------------ Net interest income $ 540.5 $483.1 ======================================================================================================================== Net interest spread 3.13% 3.45% Effect of interest-free sources used to fund earning assets .67 .78 - ------------------------------------------------------------------------------------------------------------------------ Net interest margin 3.80% 4.23% ======================================================================================================================== Certain previously reported amounts have been reclassified to agree with current presentation. Yields and corresponding income amounts are adjusted to a fully taxable equivalent. Earning assets yields are expressed net of unearned income. Rates are expressed net of unamortized debenture cost for long-term debt. Net interest margin is computed using total net interest income.
101
CONSOLIDATED AVERAGE BALANCE SHEETS AND RELATED YIELDS AND RATES (UNAUDITED) FIRST TENNESSEE NATIONAL CORPORATION - --------------------------------------------------------------------------------------------------------------------------------- 1996 1995 ---------------------------- ---------------------------- Interest Average Interest Average (Fully taxable equivalent) Average Income/ Yields/ Average Income/ Yields/ (Dollars in millions) Balance Expense Rates Balance Expense Rates - -------------------------------------------------------------------------------------------------------------------------------- ASSETS: Earning assets: Loans, net of unearned income: Commercial $ 3,383.5 $278.2 8.22% $ 3,148.4 $265.3 8.43% Consumer 2,607.5 229.9 8.82 2,367.1 206.0 8.70 Permanent mortgage 660.0 51.7 7.83 658.4 52.1 7.91 Credit card receivables 530.2 67.6 12.74 480.4 65.5 13.63 Real estate construction 275.1 27.0 9.82 216.4 23.0 10.65 Nonaccrual loans 15.8 1.5 9.62 16.5 1.4 8.48 - -------------------------------------------------------------------------------------------------------------------------------- Total loans, net of unearned income 7,472.1 655.9 8.78 6,887.2 613.3 8.90 - -------------------------------------------------------------------------------------------------------------------------------- Investment securities: U.S. Treasury and other U.S. government agencies 2,031.2 131.0 6.45 2,004.3 125.9 6.28 States and municipalities 98.1 7.9 8.02 81.4 7.0 8.63 Other 73.9 4.8 6.51 75.3 4.9 6.53 - -------------------------------------------------------------------------------------------------------------------------------- Total investment securities 2,203.2 143.7 6.52 2,161.0 137.8 6.38 - -------------------------------------------------------------------------------------------------------------------------------- Other earning assets: Mortgage loans held for sale 1,059.4 82.1 7.74 706.1 54.7 7.75 Investment in bank time deposits 14.6 .7 5.05 3.1 .2 5.79 Federal funds sold and securities purchased under agreements to resell 94.2 5.0 5.30 157.5 8.5 5.42 Capital markets securities inventory 218.5 14.5 6.66 179.8 13.0 7.22 - -------------------------------------------------------------------------------------------------------------------------------- Total other earning assets 1,386.7 102.3 7.38 1,046.5 76.4 7.30 - -------------------------------------------------------------------------------------------------------------------------------- Total earning assets 11,062.0 901.9 8.15 10,094.7 827.5 8.20 Allowance for loan losses (117.1) (113.0) Cash and due from banks 662.8 659.0 Premises and equipment, net 181.4 166.0 Capital markets receivables and other assets 799.2 552.8 - -------------------------------------------------------------------------------------------------------------------------------- Total assets/Interest income $12,588.3 $901.9 $11,359.5 $827.5 ================================================================================================================================ LIABILITIES AND SHAREHOLDERS' EQUITY: Interest-bearing liabilities: Interest-bearing deposits: Savings $ 424.3 $ 9.4 2.23% $ 459.5 $ 10.8 2.35% Checking interest and money market 2,715.9 92.7 3.41 2,378.9 95.8 4.03 Certificates of deposit under $100,000 and other time 2,885.2 166.5 5.77 2,872.6 167.8 5.84 - -------------------------------------------------------------------------------------------------------------------------------- Total interest-bearing core deposits 6,025.4 268.6 4.46 5,711.0 274.4 4.81 Certificates of deposit $100,000 and more 835.8 46.3 5.54 531.9 30.6 5.75 Federal funds purchased and securities sold under agreements to repurchase 1,588.1 78.0 4.91 1,491.1 80.9 5.43 Commercial paper and other short-term borrowings 520.1 31.6 6.07 404.2 27.9 6.90 Term borrowings 253.7 20.8 8.24 208.9 18.0 8.63 - -------------------------------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 9,223.1 445.3 4.83 8,347.1 431.8 5.17 Demand deposits 1,816.1 1,746.8 Other noninterest-bearing deposits 268.2 142.7 Capital markets payables and other liabilities 383.4 300.1 Guaranteed preferred beneficial interests in First Tennessee's junior subordinated debentures -- -- Shareholders' equity 897.5 822.8 - -------------------------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity/Interest expense $12,588.3 $445.3 $11,359.5 $431.8 ================================================================================================================================ Net interest income-tax equivalent basis/Yield $456.6 4.13% $395.7 3.92% Fully taxable equivalent adjustment (5.4) (5.0) - -------------------------------------------------------------------------------------------------------------------------------- Net interest income $451.2 $390.7 ================================================================================================================================ Net interest spread 3.32% 3.03% Effect of interest-free sources used to fund earning assets .81 .89 - -------------------------------------------------------------------------------------------------------------------------------- Net interest margin 4.13% 3.92% ================================================================================================================================ Certain previously reported amounts have been reclassified to agree with current presentation. Yields and corresponding income amounts are adjusted to a fully taxable equivalent. Earning assets yields are expressed net of unearned income. Rates are expressed net of unamortized debenture cost for long-term debt. Net interest margin is computed using total net interest income.
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CONSOLIDATED AVERAGE BALANCE SHEETS AND RELATED YIELDS AND RATES (UNAUDITED) FIRST TENNESSEE NATIONAL CORPORATION - ------------------------------------------------------------------------------------------------------------------------------------ 1994 1993 Average ---------------------------- ---------------------------- Balance Interest Average Interest Average Growth(%) (Fully taxable equivalent) Average Income/ Yields/ Average Income/ Yields/ --------- (Dollars in millions) Balance Expense Rates Balance Expense Rates 98/93* - ------------------------------------------------------------------------------------------------------------------------------------ ASSETS: Earning assets: Loans, net of unearned income: Commercial $ 2,775.7 $212.4 7.65% $2,435.3 $179.4 7.37% 10.2 + Consumer 2,082.6 166.8 8.01 1,524.9 128.1 8.40 12.9 + Permanent mortgage 557.5 44.0 7.90 527.4 45.9 8.70 1.8 - Credit card receivables 432.7 56.6 13.08 396.5 51.1 12.90 7.3 + Real estate construction 117.3 11.4 9.71 82.0 7.3 8.92 37.7 + Nonaccrual loans 18.6 1.3 7.25 30.3 1.8 5.86 .4 + - ------------------------------------------------------------------------------------------------------------------------- Total loans, net of unearned income 5,984.4 492.5 8.23 4,996.4 413.6 8.28 10.5 + - ------------------------------------------------------------------------------------------------------------------------- Investment securities: U.S. Treasury and other U.S. government agencies 2,063.4 122.8 5.95 2,679.9 160.8 6.00 7.7 - States and municipalities 84.3 7.8 9.26 109.2 10.8 9.92 8.6 - Other 101.0 5.9 5.91 226.2 14.9 6.60 19.9 + - ------------------------------------------------------------------------------------------------------------------------- Total investment securities 2,248.7 136.5 6.07 3,015.3 186.5 6.19 4.3 - - ------------------------------------------------------------------------------------------------------------------------- Other earning assets: Mortgage loans held for sale 767.9 56.0 7.29 615.3 44.9 7.29 36.5 + Investment in bank time deposits 5.3 .2 3.88 4.2 .2 3.84 57.6 + Federal funds sold and securities purchased under agreements to resell 191.9 7.6 3.97 142.0 3.7 2.63 6.4 + Capital markets securities inventory 208.0 13.1 6.28 180.4 9.6 5.34 23.0 + - ------------------------------------------------------------------------------------------------------------------------- Total other earning assets 1,173.1 76.9 6.55 941.9 58.4 6.20 31.1 + - ------------------------------------------------------------------------------------------------------------------------- Total earning assets 9,406.2 705.9 7.50 8,953.6 658.5 7.35 9.8 + Allowance for loan losses (113.1) (109.6) 4.0 + Cash and due from banks 659.7 582.5 3.7 + Premises and equipment, net 149.1 126.3 12.0 + Capital markets receivables and other assets 477.9 429.6 30.3 + - ------------------------------------------------------------------------------------------------------------------------- Total assets/Interest income $10,579.8 $705.9 $9,982.4 $658.5 10.9 + ========================================================================================================================= LIABILITIES AND SHAREHOLDERS' EQUITY: Interest-bearing liabilities: Interest-bearing deposits: Savings $ 544.3 $ 13.4 2.47% $ 567.9 $ 15.4 2.72% 9.4 - Checking interest and money market 2,295.6 65.7 2.86 2,221.9 54.3 2.44 8.9 + Certificates of deposit under $100,000 and other time 2,529.4 122.0 4.82 2,439.4 117.3 4.81 1.2 + - ------------------------------------------------------------------------------------------------------------------------- Total interest-bearing core deposits 5,369.3 201.1 3.75 5,229.2 187.0 3.58 3.9 + Certificates of deposit $100,000 and more 460.2 18.7 4.06 414.0 16.2 3.91 36.9 + Federal funds purchased and securities sold under agreements to repurchase 1,045.6 40.5 3.87 1,029.0 29.2 2.84 19.0 + Commercial paper and other short-term borrowings 683.2 36.7 5.37 724.5 34.1 4.70 12.2 + Term borrowings 101.8 9.6 9.41 102.8 9.6 9.39 19.7 + - ------------------------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 7,660.1 306.6 4.00 7,499.5 276.1 3.68 10.4 + Demand deposits 1,742.7 1,542.8 2.5 + Other noninterest-bearing deposits 142.2 -- N/A Capital markets payables and other liabilities 275.3 256.0 19.9 + Guaranteed preferred beneficial interests in First Tennessee's junior subordinated debentures -- -- N/A Shareholders' equity 759.5 684.1 7.8 + - ------------------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity/Interest expense $10,579.8 $306.6 $9,982.4 $276.1 10.9 + ========================================================================================================================= Net interest income-tax equivalent basis/Yield $399.3 4.25% $382.4 4.27% Fully taxable equivalent adjustment (4.8) (6.3) - ------------------------------------------------------------------------------------------------------------------------- Net interest income $394.5 $376.1 ========================================================================================================================= Net interest spread 3.50% 3.67% Effect of interest-free sources used to fund earning assets .75 .60 - ------------------------------------------------------------------------------------------------------------------------- Net interest margin 4.25% 4.27% ========================================================================================================================= *Compound annual growth rate Certain previously reported amounts have been reclassified to agree with current presentation. Yields and corresponding income amounts are adjusted to a fully taxable equivalent. Earning assets yields are expressed net of unearned income. Rates are expressed net of unamortized debenture cost for long-term debt. Net interest margin is computed using total net interest income.
103
CORPORATE AND FIRST TENNESSEE BANK NATIONAL ASSOCIATION BOARDS OF CORPORATE OFFICERS DIRECTORS - ------------------------------------------------------------------------------------------------------------- RALPH HORN ROBERT C. BLATTBERG Chairman of the Board Polk Brothers Distinguished Professor of Retailing President and Chief Executive Officer J.L. Kellogg Graduate School of Management Northwestern University J. KENNETH GLASS CARLOS H. CANTU President President and Chief Executive Officer Tennessee Banking Group The ServiceMaster Company First Tennessee Bank National Association JOHN C. KELLEY, JR. GEORGE E. CATES President Chairman of the Board and Chief Executive Officer Memphis Banking Group Mid-America Apartment Communities, Inc. First Tennessee Bank National Association GEORGE P. LEWIS J. KENNETH GLASS Executive Vice President President - Tennessee Banking Group Money Management Group First Tennessee Bank National Association First Tennessee Bank National Association SUSAN SCHMIDT BIES JAMES A. HASLAM, III Executive Vice President Chief Executive Officer and Chief Operating Officer Risk Management Pilot Corporation HARRY A. JOHNSON, III RALPH HORN Executive Vice President Chairman of the Board, President and Chief Executive General Counsel Officer - First Tennessee National Corporation First Tennessee Bank National Association SARAH L. MEYERROSE JOHN C. KELLEY, JR. Executive Vice President President - Memphis Banking Group Personnel Division Manager First Tennessee Bank National Association JOHN P. O'CONNOR, JR. R. BRAD MARTIN Executive Vice President Chairman of the Board and Chief Executive Officer Chief Credit Officer Saks Incorporated ELBERT L. THOMAS, JR. JOSEPH ORGILL, III Executive Vice President Chairman of the Board Chief Financial Officer Orgill, Inc. JAMES F. KEEN VICKI R. PALMER Senior Vice President Corporate Vice President and Treasurer Corporate Controller Coca-Cola Enterprises, Inc. TERESA A. ROSENGARTEN MICHAEL D. ROSE Vice President Private Investor Treasurer LENORE S. CRESON WILLIAM B. SANSOM Corporate Secretary Chairman of the Board and Chief Executive Officer The H.T. Hackney Co.
104 APPENDIX PROXY [FIRST TENNESSEE LOGO] FIRST TENNESSEE NATIONAL CORPORATION ANNUAL MEETING April 20, 1999 10:00 a.m. Central Daylight Time First Tennessee Building M-Level Auditorium 165 Madison Avenue Memphis, Tennessee 38103 - -------------------------------------------------------------------------------- FIRST TENNESSEE NATIONAL CORPORATION PROXY SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS The undersigned appoints James L. Boren, Jr., Lewis R. Donelson, and George P. Lewis, or any one or more of them with full power of substitution, as Proxy or Proxies, to represent and vote all shares of stock standing in my name on the books of the Corporation at the close of business on February 26, 1999, which I would be entitled to vote if personally present at the Annual Meeting of Shareholders of First Tennessee National Corporation to be held in the Auditorium, First Tennessee Building, 165 Madison Avenue, Memphis, Tennessee, April 20, 1999, at 10 a.m. CDT or any adjournments thereof, upon the matters set forth in the notice of said meeting as stated on the reverse side. The Proxies are further authorized to vote in their discretion as to any other matters which may come before the meeting. The Board of Directors, at the time of preparation of the Proxy Statement, knows of no business to come before the meeting other than that referred to in the Proxy Statement. THE SHARES COVERED BY THIS PROXY WILL BE VOTED IN ACCORDANCE WITH THE INSTRUCTIONS GIVEN ON THE REVERSE SIDE AND WHEN NO INSTRUCTIONS ARE GIVEN WILL BE VOTED FOR THE PROPOSALS DESCRIBED IN THE ACCOMPANYING NOTICE OF ANNUAL MEETING AND PROXY STATEMENT AND ON THE REVERSE SIDE OF THIS PROXY. (Continued on reverse side) YOU CAN VOTE YOUR PROXY BY TELEPHONE, OVER THE INTERNET, OR BY SIGNING AND RETURNING THIS CARD ON THE REVERSE SIDE. (See voting instructions on reverse.) 105 ----------------- COMPANY # CONTROL # ----------------- THERE ARE THREE WAYS TO VOTE YOUR PROXY. Your telephone or Internet vote authorizes the named proxies to vote your shares in the same manner as if you marked, signed and returned your proxy card. VOTE BY PHONE - TOLL FREE - 1-800-240-6326 - QUICK *** EASY *** IMMEDIATE - - Use any touch-tone telephone to vote your proxy 24 hours a day, 7 days a week. - - You will be prompted to enter your 3-digit Company Number and your 7-digit Control Number which is located above. - - Follow the simple voice mail instructions. VOTE BY INTERNET - http://www.eproxy.com/ften/ - QUICK *** EASY *** IMMEDIATE - - Use the Internet to vote your proxy 24 hours a day, 7 days a week. - - You will be prompted to enter your 3-digit Company Number and your 7-digit Control Number which is located above to obtain your records and create an electronic ballot. VOTE BY MAIL Mark, sign and date your proxy card and return it in the postage-paid envelope we've provided or return it to First Tennessee National Corporation, c/o Shareowner Services(TM) P.O. Box 64873, St. Paul, MN 55164-9397. IF YOU VOTE BY PHONE OR INTERNET, PLEASE DO NOT MAIL YOUR PROXY CARD. -- Please detach here -- - --- --- THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE FOR ALL ITEMS. 1. Election of four Class III directors to serve until the 2002 Annual Meeting of Shareholders. Nominees: (01) Carlos H. Cantu (03) James A. Haslam, III / / FOR / / WITHHELD (02) George E. Cates (04) Ralph Horn all nominees from all nominees ----------------------------------------------- INSTRUCTIONS: TO WITHHOLD AUTHORITY TO VOTE FOR ANY NOMINEE(S), WRITE THE NUMBER(S) OF THE NOMINEE(S) IN THE BOX TO THE RIGHT. ----------------------------------------------- 2. Ratification of appointment of Arthur Andersen LLP as auditors. / / For / / Against / / Abstain
The undersigned hereby acknowledges receipt of notice of said meeting and the related proxy statement. Address Change? Mark Box / / Indicate changes below: Date 1999 ------------------------------- ----------------------------------------- ----------------------------------------- Signature(s) in Box Shareholder sign here exactly as shown on the imprint on this card. When signing as Attorney, Executor, Administrator, Trustee or Guardian, please give full name. If more than one Trustee, all should sign. All Joint Owners should sign. - --- --- -----END PRIVACY-ENHANCED MESSAGE-----