-----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, Ou7JovX7HDeTWZ7LBU5WZ3tsgw/jIs0DraXafxbiWld3JLKTrrg7+9xhaJLQFi4p WMndm4hAqukK0r0hSWUXsQ== 0000062741-06-000113.txt : 20060809 0000062741-06-000113.hdr.sgml : 20060809 20060809153033 ACCESSION NUMBER: 0000062741-06-000113 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20060630 FILED AS OF DATE: 20060809 DATE AS OF CHANGE: 20060809 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MARSHALL & ILSLEY CORP/WI/ CENTRAL INDEX KEY: 0000062741 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 390968604 STATE OF INCORPORATION: WI FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-15403 FILM NUMBER: 061017233 BUSINESS ADDRESS: STREET 1: ATTN: OFFICE OF THE GENERAL COUNSEL STREET 2: 770 NORTH WATER STREET CITY: MILWAUKEE STATE: WI ZIP: 53202 BUSINESS PHONE: 4147657801 MAIL ADDRESS: STREET 1: 770 NORTH WATER ST CITY: MILWAUKEE STATE: WI ZIP: 53202 10-Q 1 fm10q606.txt FORM 10-Q DATED 03630/2006 1 ========================================================================== UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2006 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission file number 1-15403 MARSHALL & ILSLEY CORPORATION (Exact name of registrant as specified in its charter) Wisconsin 39-0968604 (State or other jurisdiction of (I.R.S. Employer Incorporation or organization) Identification No.) 770 North Water Street Milwaukee, Wisconsin 53202 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (414) 765-7801 None (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b- 2 of the Exchange Act. (Check one): Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ] Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes [ ] No [X] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Outstanding at Class July 31, 2006 ----- ---------------- Common Stock, $1.00 Par Value 254,295,652 ========================================================================== 2 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS
MARSHALL & ILSLEY CORPORATION CONSOLIDATED BALANCE SHEETS (Unaudited) ($000's except share data) As Adjusted Note 11 --------------------------- June 30, December 31, June 30, 2006 2005 2005 -------------- ------------- -------------- Assets - ------ Cash and cash equivalents: Cash and due from banks $ 1,280,941 $ 1,155,263 $ 976,073 Federal funds sold and security resale agreements 221,497 209,869 217,139 Money market funds 40,831 49,219 51,410 ------------- ------------- ------------- Total cash and cash equivalents 1,543,269 1,414,351 1,244,622 Investment securities: Trading securities, at market value 54,928 29,779 22,539 Interest bearing deposits at other banks 18,252 40,659 14,362 Available for sale, at market value 6,627,287 5,701,703 5,572,628 Held to maturity, market value $559,869 ($638,135 December 31, 2005 and $698,534 June 30, 2005) 547,686 618,554 668,107 ------------- ------------- ------------- Total investment securities 7,248,153 6,390,695 6,277,636 Loans held for sale 157,041 277,847 193,092 Loans and leases: Loans and leases, net of unearned income 40,230,299 33,889,066 31,952,759 Less: Allowance for loan and lease losses 415,201 363,769 360,138 ------------- ------------- ------------- Net loans and leases 39,815,098 33,525,297 31,592,621 Premises and equipment, net 569,240 490,687 448,730 Goodwill and other intangibles 3,154,828 2,461,461 2,159,624 Accrued interest and other assets 1,931,237 1,652,379 1,567,395 ------------- ------------- ------------- Total Assets $ 54,418,866 $ 46,212,717 $ 43,483,720 ============= ============= ============= Liabilities and Shareholders' Equity - ------------------------------------ Deposits: Noninterest bearing $ 5,773,090 $ 5,525,019 $ 5,088,947 Interest bearing 27,184,702 22,149,202 20,972,493 ------------- ------------- ------------- Total deposits 32,957,792 27,674,221 26,061,440 Federal funds purchased and security repurchase agreements 2,378,380 2,327,258 1,705,817 Other short-term borrowings 4,399,478 3,299,476 3,456,383 Accrued expenses and other liabilities 1,449,603 1,507,621 1,510,461 Long-term borrowings 7,476,087 6,668,670 6,470,684 ------------- ------------- ------------- Total liabilities 48,661,340 41,477,246 39,204,785 Shareholders' equity: - --------------------- Series A convertible preferred stock, $1.00 par value; 2,000,000 shares authorized -- -- -- Common stock, $1.00 par value; 261,972,933 shares issued (244,587,222 shares at December 31, 2005 and 244,432,222 shares at June 30, 2005) 261,973 244,587 244,432 Additional paid-in capital 1,747,576 970,739 870,380 Retained earnings 4,137,607 3,871,614 3,626,707 Accumulated other comprehensive income, net of related taxes (101,251) (37,291) 15,508 Less: Treasury stock, at cost: 8,000,318 shares (9,148,493 December 31, 2005 and 14,782,208 June 30, 2005) 253,201 277,423 448,212 Deferred compensation 35,178 36,755 29,880 ------------- ------------- ------------- Total shareholders' equity 5,757,526 4,735,471 4,278,935 ------------- ------------- ------------- Total Liabilities and Shareholders' Equity $ 54,418,866 $ 46,212,717 $ 43,483,720 ============= ============= ============= See notes to financial statements.
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MARSHALL & ILSLEY CORPORATION CONSOLIDATED STATEMENTS OF INCOME (Unaudited) ($000's except per share data) As Adjusted Note 11 --------------- Three Months Three Months Ended June 30, Ended June 30, 2006 2005 --------------- --------------- Interest and fee income - ----------------------- Loans and leases $ 714,243 $ 469,774 Investment securities: Taxable 70,908 53,265 Exempt from federal income taxes 15,749 16,103 Trading securities 198 47 Short-term investments 5,011 2,294 ------------- ------------ Total interest and fee income 806,109 541,483 Interest expense - ---------------- Deposits 271,592 122,803 Short-term borrowings 43,124 28,391 Long-term borrowings 117,336 77,284 ------------- ------------ Total interest expense 432,052 228,478 ------------- ------------ Net interest income 374,057 313,005 Provision for loan and lease losses 11,053 13,725 ------------- ------------ Net interest income after provision for loan and lease losses 363,004 299,280 Other income - ------------ Data processing services 344,976 282,363 Wealth management 56,309 48,129 Service charges on deposits 25,005 23,711 Gains on sale of mortgage loans 10,219 9,489 Other mortgage banking revenue 2,062 1,702 Net investment securities gains 960 29,422 Life insurance revenue 7,408 8,055 Other 37,434 31,453 ------------- ------------ Total other income 484,373 434,324 Other expense - ------------- Salaries and employee benefits 307,060 268,975 Net occupancy 25,698 20,789 Equipment 38,113 30,076 Software expenses 17,348 14,143 Processing charges 29,586 13,517 Supplies and printing 6,473 5,791 Professional services 14,036 12,802 Shipping and handling 21,669 16,751 Amortization of intangibles 12,004 8,106 Other 72,269 68,903 ------------- ------------ Total other expense 544,256 459,853 ------------- ------------ Income before income taxes 303,121 273,751 Provision for income taxes 99,372 90,006 ------------- ------------ Net income $ 203,749 $ 183,745 ============= ============ Net income per common share Basic $ 0.81 $ 0.80 Diluted 0.79 0.79 Dividends paid per common share $ 0.270 $ 0.240 Weighted average common shares outstanding (000's): Basic 252,764 228,630 Diluted 258,298 233,904 See notes to financial statements.
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MARSHALL & ILSLEY CORPORATION CONSOLIDATED STATEMENTS OF INCOME (Unaudited) ($000's except per share data) As Adjusted Note 11 --------------- Six Months Six Months Ended June 30, Ended June 30, 2006 2005 --------------- --------------- Interest and fee income - ----------------------- Loans and leases $ 1,303,126 $ 893,695 Investment securities: Taxable 128,776 105,208 Exempt from federal income taxes 31,748 31,510 Trading securities 268 116 Short-term investments 8,576 3,638 ------------- ------------- Total interest and fee income 1,472,494 1,034,167 Interest expense - ---------------- Deposits 469,718 226,293 Short-term borrowings 82,459 50,353 Long-term borrowings 221,680 145,658 ------------- ------------- Total interest expense 773,857 422,304 ------------- ------------- Net interest income 698,637 611,863 Provision for loan and lease losses 22,048 21,851 ------------- ------------- Net interest income after provision for loan and lease losses 676,589 590,012 Other income - ------------ Data processing services 687,956 565,297 Wealth management 109,108 95,197 Service charges on deposits 47,555 47,056 Gains on sale of mortgage loans 20,960 16,426 Other mortgage banking revenue 3,776 2,945 Net investment securities gains 2,090 35,276 Life insurance revenue 14,374 14,264 Other 71,324 60,320 ------------- ------------- Total other income 957,143 836,781 Other expense - ------------- Salaries and employee benefits 584,463 514,051 Net occupancy 50,579 43,153 Equipment 71,052 61,086 Software expenses 34,786 27,495 Processing charges 56,599 28,442 Supplies and printing 12,595 12,287 Professional services 25,485 23,688 Shipping and handling 45,571 36,386 Amortization of intangibles 20,879 16,198 Other 147,380 140,058 ------------- ------------- Total other expense 1,049,389 902,844 ------------- ------------- Income before income taxes 584,343 523,949 Provision for income taxes 193,826 174,888 ------------- ------------- Net income $ 390,517 $ 349,061 ============= ============= Net income per common share Basic $ 1.60 $ 1.53 Diluted 1.57 1.50 Dividends paid per common share $ 0.510 $ 0.450 Weighted average common shares outstanding (000's) : Basic 244,088 228,097 Diluted 249,379 233,310 See notes to financial statements.
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MARSHALL & ILSLEY CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) ($000's) Six Months Six Months Ended June 30, Ended June 30, 2006 2005 --------------- --------------- Net Cash Provided by Operating Activities $ 436,972 $ 349,951 Cash Flows From Investing Activities: - ------------------------------------- Proceeds from sales of securities available for sale 558,720 82,409 Proceeds from maturities of securities available for sale 587,188 575,259 Proceeds from maturities of securities held to maturity 71,539 58,468 Purchases of securities available for sale (1,366,562) (857,602) Net increase in loans (2,609,407) (2,526,610) Purchases of assets to be leased (101,711) (142,589) Principal payments on lease receivables 105,735 100,071 Purchases of premises and equipment, net (56,977) (18,022) Acquisitions, net of cash and cash equivalents acquired (66,911) (15,910) Other (1,684) 3,270 ------------- ------------- Net cash used in investing activities (2,880,070) (2,741,256) Cash Flows From Financing Activities: - ------------------------------------- Net increase (decrease) in deposits 1,596,693 (369,087) Proceeds from issuance of commercial paper 2,019,445 2,566,764 Principal payments on commercial paper (1,972,059) (2,582,429) Net increase in other short-term borrowings 521,658 1,197,465 Proceeds from issuance of long-term borrowings 1,199,051 2,030,041 Payments of long-term borrowings (670,666) (123,569) Dividends paid (124,524) (102,567) Purchases of common stock (41,790) -- Proceeds from exercise of stock options 49,408 36,372 Other (5,200) (5,201) ------------- ------------- Net cash provided by financing activities 2,572,016 2,647,789 ------------- ------------- Net increase in cash and cash equivalents 128,918 256,484 Cash and cash equivalents, beginning of year 1,414,351 988,138 ------------- ------------- Cash and cash equivalents, end of period $ 1,543,269 $ 1,244,622 ============= ============= Supplemental cash flow information: - ----------------------------------- Cash paid during the period for: Interest $ 688,262 $ 355,298 Income taxes 174,028 169,032 See notes to financial statements.
6 MARSHALL & ILSLEY CORPORATION Notes to Financial Statements June 30, 2006 & 2005 (Unaudited) 1. The accompanying unaudited consolidated financial statements should be read in conjunction with Marshall & Ilsley Corporation's ("M&I" or "Corporation") Annual Report on Form 10-K for the year ended December 31, 2005. The unaudited financial information included in this report reflects all adjustments consisting of normal recurring accruals and the adjustments as discussed in Note 11 which are necessary for a fair statement of the financial position and results of operations as of and for the three and six months ended June 30, 2006 and 2005. The results of operations for the three and six months ended June 30, 2006 and 2005 are not necessarily indicative of results to be expected for the entire year. Certain amounts in the 2005 consolidated financial statements and analyses have been reclassified to conform with the 2006 presentation. 2. New Accounting Pronouncements In June 2006, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 48 ("FIN 48") Accounting for Uncertainty in Income Taxes an interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The provisions of FIN 48 are effective beginning January 1, 2007, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The Corporation is currently evaluating the financial statement impact, if any, of adopting FIN 48. On June 28, 2006, the FASB ratified EITF Issue No. 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation). Certain taxes such as sales taxes and other excise taxes are levied by various taxing authorities based on sales activity. Although generally levied on the purchaser of the goods or services, the selling party usually collects and remits the sales tax to the government. However, in certain jurisdictions sales taxes are levied on sellers of the goods and services as opposed to the purchasers. Under this consensus these taxes may be presented gross as revenue and an offsetting expense or may be presented net and excluded from revenue. The guidance in this consensus is effective January 1, 2007 with early application permitted. This consensus will not impact the Corporation's results of operations or financial position and the Corporation will continue to report these taxes on a net basis. Taxes subject to this consensus primarily relate to the Corporation's data processing subsidiary, Metavante. 7 MARSHALL & ILSLEY CORPORATION Notes to Financial Statements - Continued June 30, 2006 & 2005 (Unaudited) 3. Comprehensive Income The following tables present the Corporation's comprehensive income ($000's):
Three Months Ended June 30, 2006 ------------------------------------------ Before-Tax Tax (Expense) Net-of-Tax Amount Benefit Amount -------------- ------------ ------------- Net income $ 203,749 Other comprehensive income: Unrealized gains (losses) on securities: Arising during the period $ (86,639) $ 30,269 (56,370) Reclassification for securities transactions included in net income (1,493) 522 (971) ------------- ------------ ------------ Unrealized gains (losses) (88,132) 30,791 (57,341) Net gains (losses) on derivatives hedging variability of cash flows: Arising during the period 3,536 (1,238) 2,298 Reclassification adjustments for hedging activities included in net income (3,794) 1,328 (2,466) ------------- ------------ ------------ Net gains (losses) $ (258) $ 90 (168) ------------- ------------ ------------ Other comprehensive income (loss) (57,509) ------------ Total comprehensive income $ 146,240 ============
Three Months Ended June 30, 2005 As Adjusted ------------------------------------------ Before-Tax Tax (Expense) Net-of-Tax Amount Benefit Amount -------------- ------------ ------------- Net income $ 183,745 Other comprehensive income: Unrealized gains (losses) on securities: Arising during the period $ 49,028 $ (17,313) 31,715 Reclassification for securities transactions included in net income (144) 50 (94) ------------- ------------ ------------ Unrealized gains (losses) 48,884 (17,263) 31,621 Net gains (losses) on derivatives hedging variability of cash flows: Arising during the period 403 (141) 262 Reclassification adjustments for hedging activities included in net income (34) 12 (22) ------------- ------------ ------------ Net gains (losses) $ 369 $ (129) 240 ------------- ------------ ------------ Other comprehensive income (loss) 31,861 ------------ Total comprehensive income $ 215,606 ============
8 MARSHALL & ILSLEY CORPORATION Notes to Financial Statements - Continued June 30, 2006 & 2005 (Unaudited)
Six Months Ended June 30, 2006 ------------------------------------------ Before-Tax Tax (Expense) Net-of-Tax Amount Benefit Amount -------------- ------------ ------------- Net income $ 390,517 Other comprehensive income: Unrealized gains (losses) on securities: Arising during the period $ (102,563) $ 35,865 (66,698) Reclassification for securities transactions included in net income (1,941) 679 (1,262) ------------- ------------ ------------ Unrealized gains (losses) (104,504) 36,544 (67,960) Net gains (losses) on derivatives hedging variability of cash flows: Arising during the period 11,873 (4,156) 7,717 Reclassification adjustments for hedging activities included in net income (5,719) 2,002 (3,717) ------------- ------------ ------------ Net gains (losses) $ 6,154 $ (2,154) 4,000 ------------- ------------ ------------ Other comprehensive income (loss) (63,960) ------------ Total comprehensive income $ 326,557 ============
Six Months Ended June 30, 2005 As Adjusted ------------------------------------------ Before-Tax Tax (Expense) Net-of-Tax Amount Benefit Amount -------------- ------------ ------------- Net income $ 349,061 Other comprehensive income: Unrealized gains (losses) on securities: Arising during the period $ (26,691) $ 9,426 (17,265) Reclassification for securities transactions included in net income (118) 41 (77) ------------- ------------ ------------ Unrealized gains (losses) (26,809) 9,467 (17,342) Net gains (losses) on derivatives hedging variability of cash flows: Arising during the period 11,594 (4,058) 7,536 Reclassification adjustments for hedging activities included in net income 3,040 (1,064) 1,976 ------------- ------------ ------------ Net gains (losses) $ 14,634 $ (5,122) 9,512 ------------- ------------ ------------ Other comprehensive income (loss) (7,830) ------------ Total comprehensive income $ 341,231 ============
9 MARSHALL & ILSLEY CORPORATION Notes to Financial Statements - Continued June 30, 2006 & 2005 (Unaudited) 4. A reconciliation of the numerators and denominators of the basic and diluted per share computations are as follows (dollars and shares in thousands, except per share data):
Three Months Ended June 30, 2006 --------------------------------------- Income Average Shares Per Share (Numerator) (Denominator) Amount ------------ --------------- ---------- Basic Earnings Per Share Income Available to Common Shareholders $ 203,749 252,764 $ 0.81 ========= Effect of Dilutive Securities Stock Options, Restricted Stock and Other Plans -- 5,534 ---------- -------------- Diluted Earnings Per Share Income Available to Common Shareholders $ 203,749 258,298 $ 0.79 =========
Three Months Ended June 30, 2005 As Adjusted --------------------------------------- Income Average Shares Per Share (Numerator) (Denominator) Amount ------------ --------------- ---------- Basic Earnings Per Share Income Available to Common Shareholders $ 183,745 228,630 $ 0.80 ========= Effect of Dilutive Securities Stock Options, Restricted Stock and Other Plans -- 5,274 ---------- -------------- Diluted Earnings Per Share Income Available to Common Shareholders $ 183,745 233,904 $ 0.79 =========
Six Months Ended June 30, 2006 --------------------------------------- Income Average Shares Per Share (Numerator) (Denominator) Amount ------------ --------------- ---------- Basic Earnings Per Share Income Available to Common Shareholders $ 390,517 244,088 $ 1.60 ========= Effect of Dilutive Securities Stock Options, Restricted Stock and Other Plans -- 5,291 ---------- -------------- Diluted Earnings Per Share Income Available to Common Shareholders $ 390,517 249,379 $ 1.57 =========
Six Months Ended June 30, 2005 As Adjusted --------------------------------------- Income Average Shares Per Share (Numerator) (Denominator) Amount ------------ --------------- ---------- Basic Earnings Per Share Income Available to Common Shareholders $ 349,061 228,097 $ 1.53 ========= Effect of Dilutive Securities Stock Options, Restricted Stock and Other Plans -- 5,213 ---------- -------------- Diluted Earnings Per Share Income Available to Common Shareholders $ 349,061 233,310 $ 1.50 =========
10 MARSHALL & ILSLEY CORPORATION Notes to Financial Statements - Continued June 30, 2006 & 2005 (Unaudited) Options to purchase shares of common stock not included in the computation of diluted net income per share because the stock options were antidilutive are as follows (shares in thousands):
Three Months Ended June 30, Six Months Ended June 30, ------------------------------------ ------------------------------------ 2006 2005 2006 2005 ----------------- ----------------- ----------------- ----------------- Shares 47 8 131 34 Price Range $45.110 - $47.020 $43.310 - $44.200 $44.200 - $47.020 $42.710 - $44.200
5. Business Combinations The following acquisitions, which are not considered to be material business combinations individually or in the aggregate, were completed during the second quarter of 2006: On April 1, 2006, Marshall & Ilsley Corporation completed the acquisition of Gold Banc Corporation, Inc. ("Gold Banc"), a bank holding company headquartered in Leawood, Kansas, which offers commercial banking, retail banking, trust and asset management products and services through various subsidiaries. Gold Banc had consolidated assets of $4.2 billion at the time of the merger. Total consideration in this transaction, including the effect of terminating Gold Banc's employee stock ownership plan, amounted to $716.2 million, consisting of 13,673,072 shares of M&I common stock valued at $601.0 million, the exchange of 119,816 vested options valued at $2.9 million and total cash consideration of $112.3 million. Gold Banc's largest subsidiary, Gold Bank, a Kansas state-chartered bank, was merged with and into M&I Marshall & Ilsley Bank on April 1, 2006, at which time the 32 Gold Bank branch offices in Florida, Kansas, Missouri and Oklahoma became interstate branch offices of M&I Marshall & Ilsley Bank. Initial goodwill, subject to the completion of appraisals and valuation of the assets acquired and liabilities assumed, amounted to $493.3 million. Approximately $485.4 million of the goodwill was assigned to the Banking segment and the remainder was assigned to the Corporation's Trust reporting unit. The estimated identifiable intangible asset to be amortized (core deposits) with an estimated weighted average life of 5.0 years amounted to $44.1 million. The goodwill and intangibles resulting from this transaction are not deductible for tax purposes. On April 1, 2006, Marshall & Ilsley Corporation completed the acquisition of St. Louis-based Trustcorp Financial, Inc. ("Trustcorp"). With the acquisition of Trustcorp, which had consolidated assets of $735.7 million at the time of the merger, the Corporation acquired Missouri State Bank and Trust Company, which provides commercial banking services in Missouri through seven bank locations. In July 2006, Missouri State Bank and all of its branches were merged with and into Southwest Bank, the Corporation's St. Louis-based banking affiliate. Total consideration in this transaction amounted to $182.0 million, consisting of 3,069,430 shares of M&I common stock valued at $134.9 million, the exchange of 412,317 vested options valued at $13.4 million and cash consideration of $33.7 million. Initial goodwill, subject to the completion of appraisals and valuation of the assets acquired and liabilities assumed, amounted to $129.4 million. The estimated identifiable intangible asset to be amortized (core deposits) with an estimated weighted average life of 7.5 years amounted to $10.9 million. The goodwill and intangibles resulting from this transaction are partially deductible for tax purposes. The common stock issued and vested options exchanged in the acquistion of Gold Banc and Trustcorp are non-cash transactions for purposes of the Consolidated Statements of Cash Flows. Recent acquisition activities ----------------------------- On June 29, 2006, Metavante announced the signing of a definitive agreement to acquire VICOR, Inc. ("VICOR") of Richmond, California. VICOR is a provider of software and solutions that simplify and automate the processing of complex payments for businesses and financial institutions. The acquisition is expected to close in the third quarter of 2006, pending regulatory approval and other customary closing conditions. The purchase is not expected to have a material impact on the financial results of Metavante or the Corporation. 11 MARSHALL & ILSLEY CORPORATION Notes to Financial Statements - Continued June 30, 2006 & 2005 (Unaudited) 6. Selected investment securities, by type, held by the Corporation were as follows ($000's):
June 30, December 31, June 30, 2006 2005 2005 -------------- -------------- -------------- Investment securities available for sale: U.S. treasury and government agencies $ 5,219,287 $ 4,379,148 $ 4,254,711 State and political subdivisions 748,967 703,892 671,782 Mortgage backed securities 101,945 116,464 144,070 Other 557,088 502,199 502,065 ------------- ------------- ------------- Total $ 6,627,287 $ 5,701,703 $ 5,572,628 ============= ============= ============= Investment securities held to maturity: State and political subdivisions $ 546,186 $ 616,554 $ 665,807 Other 1,500 2,000 2,300 ------------- ------------- ------------- Total $ 547,686 $ 618,554 $ 668,107 ============= ============= =============
The following table provides the gross unrealized losses and fair value, aggregated by investment category and the length of time the individual securities have been in a continuous unrealized loss position, at June 30, 2006 ($000's):
Less than 12 Months 12 Months or More Total ------------------------- ------------------------- -------------------------- Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses ------------ ----------- ------------ ----------- ------------ ------------ U.S. treasury and government agencies $ 3,090,843 $ 78,238 $ 1,936,556 $ 86,669 $ 5,027,399 $ 164,907 State and political subdivisions 328,100 7,300 82,492 4,070 410,592 11,370 Mortgage backed securities 36,796 910 65,149 2,912 101,945 3,822 Other 1,822 62 -- -- 1,822 62 ----------- ---------- ----------- ---------- ----------- ----------- Total $ 3,457,561 $ 86,510 $ 2,084,197 $ 93,651 $ 5,541,758 $ 180,161 =========== ========== =========== ========== =========== ===========
The investment securities in the above table were temporarily impaired at June 30, 2006. This temporary impairment represents the amount of loss that would have been realized if the investment securities had been sold on June 30, 2006. The temporary impairment in the investment securities portfolio is predominantly the result of increases in market interest rates since the investment securities were acquired and not from deterioration in the creditworthiness of the issuer. 12 MARSHALL & ILSLEY CORPORATION Notes to Financial Statements - Continued June 30, 2006 & 2005 (Unaudited) 7. The Corporation's loan and lease portfolio, including loans held for sale, consisted of the following ($000's):
June 30, December 31, June 30, 2006 2005 2005 -------------- -------------- -------------- Commercial, financial and agricultural $ 11,763,501 $ 9,599,361 $ 9,147,994 Cash flow hedging instruments at fair value (55,541) (33,886) (4,549) ------------- ------------- ------------- Commercial, financial and agricultural 11,707,960 9,565,475 9,143,445 Real estate: Construction 5,402,120 3,641,942 2,984,601 Residential mortgage 5,816,886 5,050,803 4,335,593 Home equity loans and lines of credit 4,537,014 4,833,480 4,977,525 Commercial mortgage 10,860,893 8,825,104 8,585,700 ------------- ------------- ------------- Total real estate 26,616,913 22,351,329 20,883,419 Personal 1,408,973 1,617,761 1,526,442 Lease financing 653,494 632,348 592,545 ------------- ------------- ------------- Total loans and leases $ 40,387,340 $ 34,166,913 $ 32,145,851 ============= ============= =============
8. Financial Asset Sales During the second quarter of 2006, automobile loans with principal balances of $177.7 million were sold in securitization transactions. The net gains and losses from the sale and securitization of auto loans for the three and six months ended June 30, 2006 and 2005, respectively, were not significant. Other income associated with auto securitizations, primarily servicing income, amounted to $3.0 million in the current quarter. Key economic assumptions used in measuring the retained interests at the date of securitization resulting from securitizations completed during the quarter were as follows (rate per annum):
Prepayment speed (CPR) 17-42 % Weighted average life (in months) 20.8 Expected credit losses (based on original balance) 0.36-1.03 % Residual cash flow discount rate 12.0 % Variable returns to transferees Forward one-month LIBOR yield curve
At June 30, 2006, securitized automobile loans and other automobile loans managed together with them, along with delinquency and credit loss information consisted of the following ($000's):
Total Securitized Portfolio Managed ------------- ------------- ------------- Loan balances $ 1,028,361 $ 152,716 $ 1,181,077 Principal amounts of loans 60 days or more past due 2,075 390 2,465 Net credit losses year to date 1,230 807 2,037
9. Goodwill and Other Intangibles The changes in the carrying amount of goodwill for the six months ended June 30, 2006 were as follows ($000's):
Banking Metavante Others Total ------------- ------------- ------------- ------------- Goodwill balance as of January 1, 2006 $ 809,376 $ 1,272,039 $ 7,804 $ 2,089,219 Goodwill acquired during the period 614,801 21,767 21,251 657,819 Purchase accounting adjustments (121) (22,224) -- (22,345) ------------ ------------ ------------ ------------ Goodwill balance as of June 30, 2006 $ 1,424,056 $ 1,271,582 $ 29,055 $ 2,724,693 ============ ============ ============ ============
13 MARSHALL & ILSLEY CORPORATION Notes to Financial Statements - Continued June 30, 2006 & 2005 (Unaudited) Goodwill acquired during the second quarter of 2006 for the Banking segment includes initial goodwill of $485.4 million for the acquisition of Gold Banc and $129.4 million in initial goodwill relating to the acquisition of Trustcorp. Goodwill acquired for the Metavante segment includes initial goodwill relating to the acquisition of AdminiSource in the first quarter of 2006. Goodwill for the Others segment includes initial goodwill relating to the acquisition of FirstTrust Indiana of $13.4 million in the first quarter of 2006, and initial goodwill allocated to the Trust reporting unit of $7.9 million from the acquisition of Gold Banc in the second quarter of 2006. Purchase accounting adjustments for Metavante for the six months ended June 30, 2006 represent adjustments made to the initial estimates of fair value associated with the acquisitions of Everlink Payment Services, Inc., GHR Systems, Inc., Brasfield, AdminiSource, Med-i-Bank, Inc., LINK2GOV Corp. and NYCE Corporation ("NYCE") and its affiliate companies. During the first quarter, Metavante received $29.9 million as a return of the purchase price associated with the NYCE acquisition. Purchase accounting adjustments for the Banking segment were attributable to the reduction of goodwill allocated to a branch divestiture. At June 30, 2006, the Corporation's other intangible assets consisted of the following ($000's):
June 30, 2006 ----------------------------------------- Accum- Gross ulated Net Carrying Amort- Carrying Amount ization Value ------------- ------------- ------------- Other intangible assets Core deposit intangible $ 207,805 $ 86,516 $ 121,289 Data processing contract rights/customer lists 338,608 45,367 293,241 Trust customers 6,750 1,580 5,170 Tradename 8,275 996 7,279 Other Intangibles 1,250 552 698 ------------ ------------ ------------ $ 562,688 $ 135,011 $ 427,677 ============ ============ ============ Mortgage loan servicing rights $ 2,458 ============
Amortization expense of other intangible assets for the three and six months ended June 30, 2006 amounted to $12.0 million and $20.9 million, respectively. Amortization expense of other intangible assets for the three and six months ended June 30, 2005 was $8.1 million and $16.2 million, respectively. The estimated amortization expense of other intangible assets and mortgage loan servicing rights for the next five annual fiscal years are ($000's): 2007 $ 44,441 2008 40,863 2009 37,775 2010 35,455 2011 33,688 14 MARSHALL & ILSLEY CORPORATION Notes to Financial Statements - Continued June 30, 2006 & 2005 (Unaudited) 10. The Corporation's deposit liabilities consisted of the following ($000's):
June 30, December 31, June 30, 2006 2005 2005 -------------- -------------- -------------- Noninterest bearing demand $ 5,773,090 $ 5,525,019 $ 5,088,947 Savings and NOW 11,549,045 10,462,831 9,999,393 Cash flow hedge-Brokered MMDA (5,633) (5,326) (2,998) ------------- ------------- ------------- Total Savings and NOW 11,543,412 10,457,505 9,996,395 CD's $100,000 and over 8,107,033 5,652,359 5,980,536 Cash flow hedge-Institutional CDs (17,419) (13,767) (13,944) ------------- ------------- ------------- Total CD's $100,000 and over 8,089,614 5,638,592 5,966,592 Other time deposits 4,801,124 3,434,476 3,006,936 Foreign deposits 2,750,552 2,618,629 2,002,570 ------------- ------------- ------------- Total deposits $ 32,957,792 $ 27,674,221 $ 26,061,440 ============= ============= =============
11. Share-Based Compensation Plans The Corporation has Equity Incentive Plans which provide for the grant of nonqualified and incentive stock options, stock appreciation rights, rights to purchase shares of restricted stock and the award of restricted stock units to key employees and directors of the Corporation at prices ranging from zero to the market value of the shares at the date of grant. The Equity Incentive Plans generally provide for the grant of options to purchase shares of the Corporation's common stock for a period of ten years from the date of grant. Stock options granted generally become exercisable over a period of three years from the date of grant. However, stock options granted to directors of the Corporation vest immediately and stock options granted after 1996 provide accelerated or immediate vesting for grants to individuals who meet certain age and years of service criteria at the date of grant. Restrictions on stock or units issued pursuant to the Equity Incentive Plans generally lapse within a three to seven year period. The Corporation also has a Long-Term Incentive Plan. Under the plan, performance units may be awarded from time to time. Once awarded, additional performance units will be credited to each participant based on dividends paid by the Corporation on its common stock. At the end of a designated vesting period, participants will receive a cash award equal to the Corporation's average common stock price over the last five days of the vesting period multiplied by some percent (0%-275%) of the initial performance units credited plus those additional units credited as dividends based on the established performance criteria. The vesting period is three years from the date the performance units were awarded. The Corporation also has a qualified employee stock purchase plan (the "ESPP") which gives employees who elect to participate in the plan the right to acquire shares of the Corporation's common stock at the purchase price which is 85 percent of the lesser of the fair market value of the Corporation's common stock on the first or last day of the one-year offering period ("look-back feature") which has historically been from July 1 to June 30. Effective July 1, 2006, the ESPP plan was amended to eliminate the look-back feature and to provide employees who elect to participate in the plan the right to acquire shares of the Corporation's common stock at the purchase price which is 85 percent of the fair market value of the Corporation's common stock on the last day of each three month period within the one-year offering period. Effective January 1, 2006, the Corporation adopted Statement of Financial Accounting Standard No. 123 (revised 2004), Share-Based Payment ("SFAS 123(R)"). SFAS 123(R) replaces FASB Statement No. 123 Accounting for Stock-Based Compensation ("SFAS 123"), and supercedes Accounting Principles Board Opinion No. 25 ("APBO 25") Accounting for Stock Issued to Employees. Statement 123(R) requires that compensation cost relating to share-based payment transactions be recognized in financial statements. That cost is measured based on the fair value of the equity or liability instruments issued. Statement 123(R) covers a wide range of share-based compensation arrangements including stock options, restricted stock plans, performance-based awards, stock appreciation rights, and employee stock purchase plans. Statement 123(R) also provides guidance on measuring the fair value of share-based payments awards. 15 MARSHALL & ILSLEY CORPORATION Notes to Financial Statements - Continued June 30, 2006 & 2005 (Unaudited) The Corporation elected the Modified Retrospective Application method to implement this new accounting standard. Under that method, compensation cost is recognized beginning on the effective date based upon (a) the requirements of SFAS 123(R) for all share-based payments granted after the effective date and (b) the fair value method of accounting provisions of SFAS 123 for all awards granted to employees prior to the effective date of SFAS 123(R) that remain unvested on the effective date. As permitted under SFAS 123, the Corporation previously recognized compensation cost using the intrinsic value method of accounting prescribed in APBO 25. Under the intrinsic value method, compensation cost is the excess, if any, of the quoted market price of the stock at grant date or other measurement date over the amount paid to acquire the stock. Under APBO 25, no compensation cost was recognized for the nonqualified and incentive stock options because the exercise price was equal to the quoted market price of the Corporation's common stock at the date of grant and therefore, those options had no intrinsic value on the date of grant. Under APBO 25, no compensation cost was recognized for the Corporation's ESPP because the discount (15%) and the plan met the definition of a qualified plan of the Internal Revenue Code and met the requirements of APBO 25. Under the fair value method of accounting, compensation cost is measured at the grant date based on the fair value of the award using an option- pricing model that takes into account the stock price at the grant date, the exercise price, the expected life of the option, the volatility of the underlying stock, expected dividends and the risk-free interest rate over the expected life of the option. The resulting compensation cost for stock options that vest is recognized over the service period, which is usually the vesting period. The fair value method of accounting provided under SFAS 123 is generally similar to the fair value method of accounting under SFAS 123(R). Under the Modified Retrospective Application method, in addition to recognizing compensation cost beginning on the effective date, financial statements prior to the effective date have been adjusted based on pro forma amounts previously disclosed under SFAS 123 for all periods for which SFAS 123 was effective. The impact to Shareholders' equity as a result of applying the Modified Retrospective Application method to adopt SFAS 123(R) is as follows ($000's):
December 31, June 30, 2005 2005 ------------ ------------ Decrease to Retained Earnings $ (149,544) $ (137,271) Increase to Additional Paid-in Capital 217,205 203,021 ----------- ----------- Net Increase to Shareholders' equity $ 67,661 $ 65,750 =========== ===========
The net increase to Shareholders' equity represents the deferred income tax benefit outstanding associated with the cumulative effect on net income from January 1, 1995 to December 31, 2005 and June 30, 2005, respectively, from recognizing share-based compensation previously not reported. 16 MARSHALL & ILSLEY CORPORATION Notes to Financial Statements - Continued June 30, 2006 & 2005 (Unaudited) The Corporation's net income and earnings per share as adjusted for the ESPP and stock options is as follows for the three and six months ended June 30, 2005 ($000's except per share data):
Three Months Six Months Ended June 30, Ended June 30, 2005 2005 ------------- ------------- Net Income, as originally reported $ 188,487 $ 358,067 Less: Stock-based employee compensation expense previously not included in net income under the intrinsic method of accounting, net of tax (4,742) (9,006) ------------ ------------ Restated net income $ 183,745 $349,061 ============ ============ Basic earnings per share: As originally reported $0.82 $1.57 Restated 0.80 1.53 Diluted earnings per share: As originally reported $0.81 $1.54 Restated 0.79 1.50
The Consolidated Statements of Cash Flows was not materially impacted. Activity relating to nonqualified and incentive stock options for the three months ended June 30, 2006 and 2005 was:
Weighted- Average Number Option Price Exercise of Shares Per Share Price ------------ --------------- ------------ Shares under option at March 31, 2005 22,380,226 $10.13 - 44.20 $30.86 Options granted 102,750 41.72 - 44.96 42.24 Options lapsed or surrendered (77,815) 22.80 - 41.95 34.72 Options exercised (594,584) 10.13 - 38.25 24.50 ------------ --------------- ------------ Shares under option at June 30, 2005 21,810,577 $13.09 - 44.96 $31.07 ============ =============== ============ Shares under option at March 31, 2006 23,806,283 $15.94 - 47.02 $33.30 Options granted 398,500 43.36 - 45.72 43.99 Vested options exchanged in acquisitions 532,133 5.71 - 43.67 12.99 Options lapsed or surrendered (64,918) 31.72 - 44.96 42.60 Options exercised (779,491) 5.71 - 42.82 23.22 ------------ --------------- ------------ Shares under option at June 30, 2006 23,892,507 $ 5.71 - 47.02 $33.32 ============ =============== ============
17 MARSHALL & ILSLEY CORPORATION Notes to Financial Statements - Continued June 30, 2006 & 2005 (Unaudited) Activity relating to nonqualified and incentive stock options for the six months ended June 30, 2006 and 2005 was:
Weighted- Average Number Option Price Exercise of Shares Per Share Price ------------ --------------- ------------ Shares under option at December 31, 2004 22,878,097 $10.13 - 44.20 $30.70 Options granted 153,250 40.49 - 44.96 42.20 Options lapsed or surrendered (149,339) 22.80 - 41.95 36.03 Options exercised (1,071,431) 10.13 - 41.95 23.99 ------------ --------------- ------------ Shares under option at June 30, 2005 21,810,577 $13.09 - 44.96 $31.07 ============ =============== ============ Shares under option at December 31, 2005 24,655,317 $15.94 - 47.02 $33.09 Options granted 470,400 41.30 - 45.72 43.92 Vested options exchanged in acquisitions 532,133 5.71 - 43.67 12.99 Options lapsed or surrendered (238,172) 31.72 - 44.96 41.73 Options exercised (1,527,171) 5.71 - 42.82 24.46 ------------ --------------- ------------ Shares under option at June 30, 2006 23,892,507 $ 5.71 - 47.02 $33.32 ============ =============== ============
Stock option awards to directors of the Corporation generally occur during the second quarter and stock option awards to employees primarily occur in the fourth quarter. Generally, the Corporation uses shares of treasury stock to satisfy stock options exercised. The ranges of nonqualified and incentive stock options outstanding at June 30, 2006 were:
Weighted-Average Weighted-Average Remaining Weighted-Average Aggregate Contractual Number of Shares Exercise Price Intrinsic Value Life (In Years) ----------------------- ------------------- ------------------- ------------------- Out- Exer- Out- Exer- Out- Exer- Out- Exer- Price Range standing cisable standing cisable standing cisable standing cisable - -------------- ----------- ----------- --------- --------- --------- --------- --------- --------- $ 5.50 - 24.99 2,579,983 2,579,983 $20.32 $20.32 $25.42 $25.42 4.0 4.0 $25.00 - 28.49 1,724,245 1,724,245 25.93 25.93 19.81 19.81 3.1 3.1 $28.50 - 30.49 4,025,390 4,022,990 28.59 28.59 17.15 17.15 5.2 5.2 $30.50 - 32.49 4,708,106 4,700,704 31.43 31.43 14.31 14.31 4.7 4.7 $32.50 - 35.49 3,092,706 2,281,898 34.77 34.76 10.97 10.98 7.3 7.2 $35.50 - 42.49 3,632,670 1,696,229 41.59 41.41 4.15 4.33 8.3 8.3 Over $42.50 4,129,407 617,943 42.97 42.96 2.77 2.78 9.4 9.4 ----------- ----------- --------- --------- --------- --------- --------- --------- 23,892,507 17,623,992 $33.32 $30.41 $12.42 $15.33 6.3 5.4 =========== =========== ========= ========= ========= ========= ========= =========
The fair value of each stock option grant was estimated as of the date of grant using the Black-Scholes closed form option-pricing model for stock options granted prior to September 30, 2004. A form of a lattice option-pricing model was used for stock options granted after September 30, 2004. The grant date fair values and assumptions used to determine such value are as follows:
Three Months Ended June 30, Six Months Ended June 30, ------------------------------ -------------------------------- 2006 2005 2006 2005 -------------- -------------- -------------- ---------------- Weighted-average grant date fair value $7.93 $8.38 $7.92 $8.02 Assumptions: Risk-free interest rates 4.87 - 5.66 % 3.33 - 4.45 % 4.22 - 5.66 % 3.33 - 4.45 % Expected volatility 18.20 % 18.50 % 18.20 - 18.50 % 13.12 - 18.50 % Expected term (in years) 6.3 - 6.9 5.1 - 7.8 6.3 - 6.9 5.1 - 7.8 Expected dividend yield 2.20 % 2.19 % 2.20 % 1.92 - 2.19 %
18 MARSHALL & ILSLEY CORPORATION Notes to Financial Statements - Continued June 30, 2006 & 2005 (Unaudited) The total intrinsic value of nonqualified and incentive stock options exercised during the three months ended June 30, 2006 and 2005 was $17.2 million and $11.2 million, respectively. For the six months ended June 30, 2006 and 2005, the total intrinsic value of nonqualified and incentive stock options exercised was $30.7 million and $19.9 million, respectively. The total fair value of shares vested during the three months ended June 30, 2006 and 2005 amounted to $1.1 million and $1.2 million, respectively. For the six months ended June 30, 2006 and 2005, the total fair value of shares vested amounted to $1.6 million and $1.5 million, respectively. There was approximately $24.7 million of total unrecognized compensation expense related to unvested nonqualified and incentive stock options at June 30, 2006. The total unrecognized compensation expense will be recognized over a weighted average period of 2.0 years. For awards with graded vesting, compensation expense was recognized using an accelerated method prior to the adoption of SFAS 123(R) and is recognized on a straight line basis for awards granted after the effective date. For the three months ended June 30, 2006 and 2005 the expense for nonqualified and incentive stock options that is included in Salaries and employee benefits expense in the Consolidated Statements of Income amounted to $6.7 million and $5.9 million, respectively. For the six months ended June 30, 2006 and 2005 the expense for nonqualified and incentive stock options that is included in Salaries and employee benefits expense in the Consolidated Statements of Income amounted to $13.3 million and $11.7 million, respectively. These amounts are considered non-cash expenses for the Statements of Cash Flow purposes. For the three and six months ended June 30, 2006 and 2005 the expense for Director's nonqualified and incentive stock options that is included in Other expense in the Consolidated Statements of Income amounted to $0.6 million and $0.7 million, respectively. Activity relating to the Corporation's Restricted Stock Purchase Rights was:
Three Months Ended Six Months Ended June 30, June 30, --------------------- --------------------- 2006 2005 2006 2005 ---------- --------- ---------- --------- Restricted stock purchase rights outstanding - Beginning of Year -- -- -- -- Restricted stock purchase rights granted 44,000 7,000 51,000 14,500 Restricted stock purchase rights exercised (44,000) (7,000) (51,000) (14,500) ---------- --------- ---------- --------- Restricted stock purchase rights outstanding - End of Period -- -- -- -- ========== ========= ========== ========= Weighted-average grant date market value $44.67 $42.61 $44.54 $41.95 Aggregate compensation expense ($000's) $1,377 $977 $2,647 $2,027 Unamortized compensation expense ($000's) $12,298 $9,027 $12,298 $9,027
Restrictions on stock issued pursuant to the exercise of stock purchase rights generally lapse within a three to seven year period. Accordingly, the compensation related to issuance of the rights is amortized over the vesting period. At June 30, 2006, the unamortized compensation expense will be recognized over a weighted average period of 1.8 years. Aggregate compensation expense for the three and six months ended June 30, 2006 amounted to $1.4 million and $2.6 million, respectively. For the three and six months ended June 30, 2005, the aggregate compensation expense amounted to $1.0 million and $2.0 million, respectively. These amounts are considered non-cash expenses for the Statements of Cash Flow purposes. As participants in the Long-Term Incentive Plan will receive a cash award at the end of the designated vesting period, this plan meets the definition of a liability award. Unlike equity awards, liability awards are remeasured at fair value at each balance sheet date until settlement. For the three months ended June 30, 2006 and 2005 the expense for the Long-Term Incentive Plan that is included in Salaries and employee benefits expense in the Consolidated Statements of Income amounted to $5.4 million and $6.0 million, respectively. For the six months ended June 30, 2006 and 2005 the expense for the Long-Term Incentive Plan that is included in Salaries and employee benefits expense in the Consolidated Statements of Income amounted to $3.5 million and $6.6 million, respectively. 19 MARSHALL & ILSLEY CORPORATION Notes to Financial Statements - Continued June 30, 2006 & 2005 (Unaudited) Under SFAS 123(R), compensation expense is recognized for the ESPP. The compensation cost per share is approximately equal to the sum of: the initial discount (15% of beginning of plan period price per share), plus the value of a one year call option on 85% of a share of common stock and the value of a one year put option on 15% of a share of common stock for each share purchased. The compensation cost per share for the ESPP was $9.96 and $8.04 for the three and six months ended June 30, 2006 and 2005, respectively. Employee contributions under the ESPP are made ratably during the plan period. Employees may withdraw from the plan prior to the end of the one year offering period. The total estimated shares to be purchased are estimated at the beginning of the plan period based on total expected contributions for the plan period and 85% of the market price at that date. The Corporation estimated that 346,342 shares would be purchased on July 1, 2006 for the purpose of determining compensation expense. For the three months ended June 30, 2006 and 2005 the total expense for the ESPP that is included in Salaries and employee benefits expense in the Consolidated Statements of Income amounted to $0.9 million and $0.7 million, respectively. For the six months ended June 30, 2006 and 2005 the total expense for the ESPP that is included in Salaries and employee benefits expense in the Consolidated Statements of Income amounted to $1.8 million and $1.4 million, respectively. These amounts are considered non-cash expenses for the Statements of Cash Flow purposes. As previously discussed, effective July 1, 2006 the ESPP plan was amended to eliminate the look-back feature and to provide employees, who elect to participate in the plan, the right to acquire shares of the Corporation's common stock at the purchase price, which is 85 percent of the fair market value of the Corporation's common stock on the last day of each three month period within the one-year offering period. The effect of the amendment will be to lower the amount of expense in future quarters. The Corporation estimates that the quarterly savings in expense will be approximately $0.3 million. 12. Derivative Financial Instruments and Hedging Activities The following is an update of the Corporation's use of derivative financial instruments and its hedging activities as described in its Annual Report on Form 10-K for the year ended December 31, 2005. Generally there were no substantive changes in the types of derivative financial instruments the Corporation employs or its hedging activities in the six months ended June 30, 2006. Trading Instruments and Other Free Standing Derivatives Loan commitments accounted for as derivatives are not material to the Corporation and the Corporation does not employ any formal hedging strategies for these commitments. Trading and free-standing derivative contracts are not linked to specific assets and liabilities on the balance sheet or to forecasted transactions in an accounting hedge relationship and, therefore, do not qualify for hedge accounting under SFAS 133. They are carried at fair value with changes in fair value recorded as a component of other noninterest income. At June 30, 2006, free standing interest rate swaps consisted of $2.1 billion in notional amount of receive fixed / pay floating with an aggregate negative fair value of $46.3 million and $1.4 billion in notional amount of pay fixed / receive floating with an aggregate positive fair value of $44.8 million. At June 30, 2006, interest rate caps purchased amounted to $20.5 million in notional amount with a positive fair value of $0.1 million and interest rate caps sold amounted to $20.5 million in notional amount with a negative fair value of $0.1 million. At June 30, 2006, the notional value of interest rate futures designated as trading was $3.4 billion with a negative fair value of $0.3 million. 20 MARSHALL & ILSLEY CORPORATION Notes to Financial Statements - Continued June 30, 2006 & 2005 (Unaudited) Fair Value Hedges The Corporation has fixed rate CDs and fixed rate long-term debt which expose the Corporation to variability in fair values due to changes in market interest rates. To limit the Corporation's exposure to changes in interest rates, the Corporation has entered into received-fixed / pay floating interest rate swaps. The Corporation structures the interest rate swaps so that all of the critical terms of the fixed rate CDs and fixed rate borrowings match the receive fixed leg of the interest rate swaps at inception of the hedging relationship. As a result, the Corporation expects the hedging relationship to be highly effective in achieving offsetting changes in fair value due to changes in market interest rates both at inception and on an on-going basis. At June 30, 2006, certain interest rate swaps designated as fair value hedges met the criteria required to qualify for the shortcut method of accounting. Based on the shortcut method of accounting treatment, no ineffectiveness is assumed. At June 30, 2006, no component of the derivative instruments' gain or loss was excluded from the assessment of hedge effectiveness for derivative financial instruments designated as fair value hedges. The following table presents additional information with respect to selected fair value hedges.
Fair Value Hedges June 30, 2006 Weighted Notional Fair Average Hedged Hedging Amount Value Remaining Item Instrument ($ in mil)($ in mil) Term (Yrs) ---------------------- ------------------- --------- --------- ---------- Fair Value Hedges that Qualify for Shortcut Accounting Fixed Rate Bank Notes Receive Fixed Swap $ 427.3 $ (27.7) 8.3 Other Fair Value Hedges Fixed Rate CDs Receive Fixed Swap $1,045.1 $ (40.9) 7.8 Medium Term Notes Receive Fixed Swap 359.3 (13.1) 6.9 Fixed Rate Bank Notes Receive Fixed Swap 625.0 (24.6) 4.4 Institutional CDs Receive Fixed Swap 65.0 (1.5) 24.8 Brokered Bullet CDs Receive Fixed Swap 627.9 (2.5) 0.6
The impact from fair value hedges to total net interest income for the three and six months ended June 30, 2006 was a negative $1.1 million and a positive $0.6 million, respectively. The impact to net interest income due to ineffectiveness was not material. Cash Flow Hedges The Corporation has variable rate loans, deposits and borrowings that expose the Corporation to variability in interest rate payments due to changes in interest rates. The Corporation believes it is prudent to limit the variability of a portion of its interest receipts and payments. To meet this objective, the Corporation enters into various types of derivative financial instruments to manage fluctuations in cash flows resulting from interest rate risk. At June 30, 2006, these instruments consisted of interest rate swaps. The Corporation regularly originates and holds floating rate commercial loans that reprice monthly on the first business day to one-month LIBOR. As a result, the Corporation's interest receipts are exposed to variability in cash flows due to changes in one-month LIBOR. 21 MARSHALL & ILSLEY CORPORATION Notes to Financial Statements - Continued June 30, 2006 & 2005 (Unaudited) In order to hedge the interest rate risk associated with the floating rate commercial loans indexed to one-month LIBOR, the Corporation has entered into receive fixed / pay LIBOR-based floating interest rate swaps designated as cash flow hedges against the first LIBOR-based interest payments received that, in the aggregate for each period, are interest payments on such principal amount of its then existing LIBOR- indexed floating-rate commercial loans equal to the notional amount of the interest rate swaps outstanding. Hedge effectiveness is assessed at inception and each quarter on an on- going basis using regression analysis that takes into account reset date differences for certain designated interest rate swaps that reset quarterly. Each month the Corporation makes a determination that it is probable that the Corporation will continue to receive interest payments on at least that amount of principal of its existing LIBOR-indexed floating-rate commercial loans that reprice monthly on the first business day to one-month LIBOR equal to the notional amount of the interest rate swaps outstanding. Ineffectiveness is measured using the hypothetical derivative method and is recorded as a component of interest income on loans. The Corporation regularly issues floating rate institutional CDs indexed to three-month LIBOR. As a result, the Corporation's interest payments are exposed to variability in cash flows due to changes in three-month LIBOR. In order to hedge the interest rate risk associated with floating rate institutional CDs, the Corporation has entered into pay fixed / receive LIBOR-based floating interest rate swaps designated as cash flow hedges against the interest payments on the forecasted issuance of floating rate institutional CDs. For certain institutional CDs, hedge effectiveness is assessed at inception and each quarter on an on-going basis using regression analysis that regresses daily observations of three-month LIBOR to itself with a five day mismatch on either side for potential reset date differences between the interest rate swaps and the floating rate institutional CDs. The regression analysis is based on a rolling five years of daily observations. Ineffectiveness is measured using the hypothetical derivative method and is recorded as a component of interest expense on deposits. The Corporation regularly purchases overnight borrowings indexed to the Federal funds rate. As a result, the Corporation's interest payments are exposed to variability in cash flows due to changes in the Federal funds effective rate. In order to hedge the interest rate risk associated with overnight borrowings, the Corporation has entered into pay fixed / receive floating interest rate swaps designated as cash flow hedges against interest payments on the forecasted issuance of floating rate overnight borrowings. The floating leg of the interest rate swap resets monthly to the H15 Federal Effective index. The H15 Federal Effective index is not a benchmark rate, therefore hedge effectiveness is assessed at inception and each quarter on an on-going basis using regression analysis. Each month the Corporation makes a determination that it is probable that the Corporation will continue to make interest payments on at least that amount of outstanding overnight floating-rate borrowings equal to the notional amount of the interest rate swaps outstanding. Ineffectiveness is measured using the hypothetical derivative method and is recorded as a component of interest expense on short-term borrowings. The Corporation structures the remaining interest rate swaps so that all of the critical terms of the LIBOR-based floating rate deposits and borrowings match the floating leg of the interest rate swaps at inception of the hedging relationship. As a result, the Corporation expects those hedging relationships to be highly effective in achieving offsetting changes in cash flows due to changes in market interest rates both at inception and on an on-going basis. At June 30, 2006, one interest rate swap designated as a cash flow hedge met the criteria required to qualify for the shortcut method of accounting. Based on the shortcut method of accounting treatment, no ineffectiveness is assumed. At June 30, 2006, no component of the derivative instruments' gain or loss was excluded from the assessment of hedge effectiveness for derivative financial instruments designated as cash flow hedges. 22 MARSHALL & ILSLEY CORPORATION Notes to Financial Statements - Continued June 30, 2006 & 2005 (Unaudited) The following table summarizes the Corporation's cash flow hedges.
Cash Flow Hedges June 30, 2006 Weighted Notional Fair Average Hedged Hedging Amount Value Remaining Item Instrument ($ in mil)($ in mil) Term (Yrs) ---------------------- ------------------- --------- --------- ---------- Cash Flow Hedges that Qualify for Shortcut Accounting Floating Rate Bank Notes Pay Fixed Swap $ 125.0 $ 1.5 0.8 Other Cash Flow Hedges Variable Rate Loans Receive Fixed Swap $ 1,150.0 $ (55.5) 3.4 Institutional CDs Pay Fixed Swap 1,980.0 17.4 2.0 Federal Funds Purchased Pay Fixed Swap 250.0 0.7 1.1 FHLB Advances Pay Fixed Swap 1,220.0 35.7 2.5 Floating Rate Bank Notes Pay Fixed Swap 300.0 4.2 2.2 Money Market Accounts Pay Fixed Swap 250.0 5.6 1.0
The impact to total net interest income from cash flow hedges, including amortization of terminated cash flow hedges for the three and six months ended June 30, 2006 was a positive $3.8 million and a positive $5.7 million, respectively. The impact due to ineffectiveness was not material. For the three and six months ended June 30, 2005, the total effect on net interest income resulting from derivative financial instruments was a positive $9.1 million and a positive $16.1 million, respectively, including the amortization of terminated derivative financial instruments. 13. Postretirement Health Plan The Corporation sponsors a defined benefit health plan that provides health care benefits to eligible current and retired employees. Eligibility for retiree benefits is dependent upon age, years of service, and participation in the health plan during active service. The plan is contributory and in 1997 and 2002 the plan was amended. Employees hired or retained from mergers after September 1, 1997 will be granted access to the Corporation's plan upon becoming an eligible retiree; however, such retirees must pay 100% of the cost of health care benefits. The plan continues to contain other cost-sharing features such as deductibles and coinsurance. Net periodic postretirement benefit costs for the three and six month periods ended June 30, 2006 and 2005 included the following components ($000's):
Three Months Ended Six Months Ended June 30, June 30, ------------------------ ------------------------- 2006 2005 2006 2005 ----------- ----------- ----------- ----------- Service cost $ 570 $ 552 $ 1,140 $ 1,105 Interest on APBO 1,022 1,159 2,044 2,318 Expected return on assets (232) (150) (464) (299) Prior service amortization (680) (680) (1,360) (1,361) Actuarial loss amortization 378 264 757 528 ---------- ---------- ---------- ---------- Total postretirement benefit costs $ 1,058 $ 1,145 $ 2,117 $ 2,291 ========== ========== ========== ==========
Benefit payments and expenses, net of participant contributions, for the three and six months ended June 30, 2006 amounted to $1.1 million and $2.1 million, respectively. 23 MARSHALL & ILSLEY CORPORATION Notes to Financial Statements - Continued June 30, 2006 & 2005 (Unaudited) 14. Segments The following represents the Corporation's operating segments as of and for the three and six months ended June 30, 2006 and 2005. Effective January 1, 2006, the Corporation transferred a portion of its Item Processing business from the Banking segment to Metavante. Prior period segment information has been adjusted for the transfer. There have not been any other changes to the way the Corporation organizes its segments. Beginning with the third quarter of 2005, total other income for Metavante includes float income which represents interest income on balances invested in an affiliate bank which arises from Electronic Bill Payment activities. This income was formerly reported as a component of Net Interest Income for Metavante. Segment information for all periods has been adjusted for this reclassification. Fees - intercompany represent intercompany revenue charged to other segments for providing certain services. Expenses - intercompany represent fees charged by other segments for certain services received. For each segment, Expenses - intercompany are not the costs of that segment's reported intercompany revenues. Intrasegment revenues, expenses and assets have been eliminated ($ in millions):
Three Months Ended June 30, 2006 --------------------------------------------------------------------------------- Reclass- ifications Consol- Corporate & Elimi- idated Banking Metavante Others Overhead nations Income ------------ ------------ ------------ ------------ ----------- ------------ Net interest income $ 381.3 $ (7.5) $ 5.9 $ (8.3) $ 2.7 $ 374.1 Other income Fees - external 82.0 345.0 56.0 1.4 -- 484.4 Fees - internal Fees - intercompany 16.8 25.8 5.7 25.0 (73.3) -- Float income - intercompany -- 2.7 -- -- (2.7) -- ----------- ----------- ----------- ----------- ---------- ----------- Total other income 98.8 373.5 61.7 26.4 (76.0) 484.4 Other expense Expenses - other 179.3 294.6 41.6 28.4 0.4 544.3 Expenses - intercompany 46.9 13.0 12.7 1.1 (73.7) -- ----------- ----------- ----------- ----------- ---------- ----------- Total other expense 226.2 307.6 54.3 29.5 (73.3) 544.3 Provision for loan and lease losses 10.6 -- 0.5 -- -- 11.1 ----------- ----------- ----------- ----------- ---------- ----------- Income before taxes 243.3 58.4 12.8 (11.4) -- 303.1 Income tax expense 80.8 18.0 4.7 (4.1) -- 99.4 ----------- ----------- ----------- ----------- ---------- ----------- Segment income (loss) $ 162.5 $ 40.4 $ 8.1 $ (7.3) $ -- $ 203.7 =========== =========== =========== =========== ========== =========== Identifiable assets $ 51,578.5 $ 2,790.6 $ 821.4 $ 684.9 $ (1,456.5) $ 54,418.9 =========== =========== =========== =========== ========== =========== Return on average equity 13.3% 14.5% 11.2% 14.4% =========== =========== =========== ===========
Three Months Ended June 30, 2005 --------------------------------------------------------------------------------- Reclass- ifications Consol- Corporate & Elimi- idated Banking Metavante Others Overhead nations Income ------------ ------------ ------------ ------------ ----------- ------------ Net interest income $ 314.9 $ (9.6) $ 6.8 $ (2.1) $ 3.0 $ 313.0 Other income Fees - external 73.5 282.3 70.1 8.4 -- 434.3 Fees - internal Fees - intercompany 15.5 21.9 5.6 21.6 (64.6) -- Float income - intercompany -- 3.0 -- -- (3.0) -- ----------- ----------- ----------- ----------- ---------- ----------- Total other income 89.0 307.2 75.7 30.0 (67.6) 434.3 Other expense Expenses - other 153.6 237.6 33.7 36.4 (1.4) 459.9 Expenses - intercompany 40.7 10.1 12.0 0.4 (63.2) -- ----------- ----------- ----------- ----------- ---------- ----------- Total other expense 194.3 247.7 45.7 36.8 (64.6) 459.9 Provision for loan and lease losses 13.4 -- 0.3 -- -- 13.7 ----------- ----------- ----------- ----------- ---------- ----------- Income (loss) before taxes 196.2 49.9 36.5 (8.9) -- 273.7 Income tax expense (benefit) 59.1 19.9 14.3 (3.3) -- 90.0 ----------- ----------- ----------- ----------- ---------- ----------- Segment income (loss) As Adjusted $ 137.1 $ 30.0 $ 22.2 $ (5.6) $ -- $ 183.7 =========== =========== =========== =========== ========== =========== Identifiable assets $ 41,149.6 $ 2,469.0 $ 759.5 $ 733.1 $ (1,627.5) $ 43,483.7 =========== =========== =========== =========== ========== =========== Return on average equity 16.0% 18.6% 33.0% 17.5% =========== =========== =========== ===========
24 MARSHALL & ILSLEY CORPORATION Notes to Financial Statements - Continued June 30, 2006 & 2005 (Unaudited)
Six Months Ended June 30, 2006 --------------------------------------------------------------------------------- Reclass- ifications Consol- Corporate & Elimi- idated Banking Metavante Others Overhead nations Income ------------ ------------ ------------ ------------ ----------- ------------ Net interest income $ 708.9 $ (15.8) $ 11.6 $ (12.0) $ 5.9 $ 698.6 Other income Fees - external 155.5 688.0 110.4 3.2 -- 957.1 Fees - internal Fees - intercompany 33.7 50.6 10.5 49.9 (144.7) -- Float income - intercompany -- 5.9 -- -- (5.9) -- ----------- ----------- ----------- ----------- ---------- ----------- Total other income 189.2 744.5 120.9 53.1 (150.6) 957.1 Other expense Expenses - other 337.7 590.7 81.1 40.5 (0.6) 1,049.4 Expenses - intercompany 90.1 25.6 25.1 3.3 (144.1) -- ----------- ----------- ----------- ----------- ---------- ----------- Total other expense 427.8 616.3 106.2 43.8 (144.7) 1,049.4 Provision for loan and lease losses 21.0 -- 1.0 -- -- 22.0 ----------- ----------- ----------- ----------- ---------- ----------- Income before taxes 449.3 112.4 25.3 (2.7) -- 584.3 Income tax expense 148.6 37.5 9.3 (1.6) -- 193.8 ----------- ----------- ----------- ----------- ---------- ----------- Segment income (loss) $ 300.7 $ 74.9 $ 16.0 $ (1.1) $ -- $ 390.5 =========== =========== =========== =========== ========== =========== Identifiable assets $ 51,578.5 2,790.6 821.4 684.9 (1,456.5) $ 54,418.9 =========== =========== =========== =========== ========== =========== Return on average equity 13.9% 13.8% 11.5% 15.0% =========== =========== =========== ===========
Six Months Ended June 30, 2005 --------------------------------------------------------------------------------- Reclass- ifications Consol- Corporate & Elimi- idated Banking Metavante Others Overhead nations Income ------------ ------------ ------------ ------------ ----------- ------------ Net interest income $ 618.1 $ (20.0) $ 12.4 $ (3.9) $ 5.3 $ 611.9 Other income Fees - external 143.6 565.3 117.7 10.2 -- 836.8 Fees - internal Fees - intercompany 31.4 42.8 10.3 43.2 (127.7) -- Float income - intercompany -- 5.3 -- -- (5.3) -- ----------- ----------- ----------- ----------- ---------- ----------- Total other income 175.0 613.4 128.0 53.4 (133.0) 836.8 Other expense Expenses - other 300.5 478.6 65.6 59.0 (0.8) 902.9 Expenses - intercompany 79.5 21.1 24.5 1.8 (126.9) -- ----------- ----------- ----------- ----------- ---------- ----------- Total other expense 380.0 499.7 90.1 60.8 (127.7) 902.9 Provision for loan and lease losses 21.2 -- 0.6 -- -- 21.8 ----------- ----------- ----------- ----------- ---------- ----------- Income before taxes 391.9 93.7 49.7 (11.3) -- 524.0 Income tax expense 122.9 37.4 19.4 (4.8) -- 174.9 ----------- ----------- ----------- ----------- ---------- ----------- Segment income (loss) As Adjusted $ 269.0 $ 56.3 $ 30.3 $ (6.5) $ -- $ 349.1 =========== =========== =========== =========== ========== =========== Identifiable assets $ 41,149.6 $ 2,469.0 $ 759.5 $ 733.1 $ (1,627.5) $ 43,483.7 =========== =========== =========== =========== ========== =========== Return on average equity 16.0% 18.1% 23.4% 17.1% =========== =========== =========== ===========
Total revenue, which consists of net interest income plus total other income, by type in Others consisted of the following ($ in millions):
Three Months Six Months Ended June 30, Ended June 30, ------------------------ ------------------------ 2006 2005 2006 2005 ----------- ----------- ----------- ----------- Trust Services $ 49.2 $ 40.6 $ 95.2 $ 80.2 Residential Mortgage Banking 5.8 6.1 10.9 11.1 Capital Markets (0.3) 21.6 0.3 22.3 Brokerage and Insurance 7.4 7.2 14.6 14.3 Commercial Leasing 2.9 4.1 5.8 7.6 Commercial Mortgage Banking 1.6 1.6 3.3 2.8 Others 1.0 1.3 2.4 2.2 ---------- ---------- ---------- ---------- Total revenue $ 67.6 $ 82.5 $ 132.5 $ 140.5 ========== ========== ========== ==========
25 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
MARSHALL & ILSLEY CORPORATION CONSOLIDATED AVERAGE BALANCE SHEETS (Unaudited) ($000's) Three Months Ended June 30, ------------------------------ 2006 2005 -------------- -------------- Assets - ------ Cash and due from banks $ 1,030,657 $ 938,451 Investment securities: Trading securities 50,268 25,582 Short-term investments 374,212 271,731 Other investment securities: Taxable 5,818,278 4,828,606 Tax-exempt 1,316,122 1,333,700 ------------- ------------- Total investment securities 7,558,880 6,459,619 Loans and leases: Loans and leases, net of unearned income 39,649,733 31,294,058 Less: Allowance for loan and lease losses 416,328 361,488 ------------- ------------- Net loans and leases 39,233,405 30,932,570 Premises and equipment, net 565,369 445,382 Accrued interest and other assets 5,199,418 3,877,271 ------------- ------------- Total Assets $ 53,587,729 $ 42,653,293 ============= ============= Liabilities and Shareholders' Equity Deposits: Noninterest bearing $ 5,404,147 $ 4,826,304 Interest bearing 27,331,590 20,643,276 ------------- ------------- Total deposits 32,735,737 25,469,580 Federal funds purchased and security repurchase agreements 2,332,734 2,393,989 Other short-term borrowings 1,085,859 998,363 Long-term borrowings 10,050,166 7,920,117 Accrued expenses and other liabilities 1,691,978 1,664,868 ------------- ------------- Total liabilities 47,896,474 38,446,917 Shareholders' equity 5,691,255 4,206,376 ------------- ------------- Total Liabilities and Shareholders' Equity $ 53,587,729 $ 42,653,293 ============= =============
26
MARSHALL & ILSLEY CORPORATION CONSOLIDATED AVERAGE BALANCE SHEETS (Unaudited) ($000's) Six Months Ended June 30, ------------------------------ 2006 2005 -------------- -------------- Assets - ------ Cash and due from banks $ 1,005,507 $ 928,733 Investment securities: Trading securities 42,267 24,355 Short-term investments 345,127 229,595 Other investment securities: Taxable 5,401,133 4,825,732 Tax-exempt 1,328,293 1,306,082 ------------- ------------- Total investment securities 7,116,820 6,385,764 Loans and leases: Loans and leases, net of unearned income 37,159,330 30,592,745 Less: Allowance for loan and lease losses 392,442 361,220 ------------- ------------- Net loans and leases 36,766,888 30,231,525 Premises and equipment, net 530,820 448,079 Accrued interest and other assets 4,769,638 3,857,632 ------------- ------------- Total Assets $ 50,189,673 $ 41,851,733 ============= ============= Liabilities and Shareholders' Equity - ------------------------------------ Deposits: Noninterest bearing $ 5,174,349 $ 4,760,154 Interest bearing 24,944,683 20,592,326 ------------- ------------- Total deposits 30,119,032 25,352,480 Federal funds purchased and security repurchase agreements 2,386,379 2,170,661 Other short-term borrowings 1,008,475 973,360 Long-term borrowings 9,728,869 7,564,611 Accrued expenses and other liabilities 1,682,305 1,666,152 ------------- ------------- Total liabilities 44,925,060 37,727,264 Shareholders' equity 5,264,613 4,124,469 ------------- ------------- Total Liabilities and Shareholders' Equity $ 50,189,673 $ 41,851,733 ============= =============
27 OVERVIEW -------- The Corporation's overall strategy is to drive earnings per share growth by: (1) expanding banking operations not only in Wisconsin but also into faster growing regions beyond Wisconsin; (2) increasing the number of financial institutions to which the Corporation provides correspondent banking services and products; (3) expanding trust services and other wealth management product and service offerings; and (4) growing Metavante's business through organic growth, cross sales of technology products and acquisitions. The Corporation continues to focus on its key metrics of growing revenues through balance sheet growth, fee-based income growth and strong credit quality. Management believes that the Corporation has demonstrated solid fundamental performance in each of these key areas and as a result, the second quarter and first half of 2006 produced strong financial results. Net income for the second quarter of 2006 amounted to $203.7 million compared to $183.7 million for the same period in the prior year, an increase of $20.0 million, or 10.9%. Diluted earnings per share were $0.79 for the three months ended June 30, 2006 and 2005, respectively. The return on average assets and average equity was 1.53% and 14.36%, respectively, for the quarter ended June 30, 2006, and 1.73% and 17.52%, respectively, for the quarter ended June 30, 2005. Net income for the first half of 2006 amounted to $390.5 million compared to $349.1 million for the same period in the prior year, an increase of $41.4 million, or 11.9%. Diluted earnings per share were $1.57 for the six months ended June 30, 2006, compared with $1.50 for the six months ended June 30, 2005, an increase of 4.7%. The return on average assets and average equity was 1.57% and 14.96%, respectively, for the six months ended June 30, 2006, and 1.68% and 17.07%, respectively, for the six months ended June 30, 2005. Earnings growth for the three and six months ended June 30, 2006 compared to the three and six months ended June 30, 2005 was attributable to a number of factors. The increase in net interest income was due to strong organic loan and bank-issued deposit growth and the contribution from the two banking acquisitions that were completed on April 1, 2006. Strong credit quality has resulted in net charge-offs that continue to be below the Corporation's five-year historical average. Metavante continued to exhibit growth in both revenue and earnings which was attributable, in part, to the impact of its acquisition activities as well as success in retaining and cross-selling products and services to its core customer base. Metavante's acquisition activities included one acquisition completed in the first quarter of 2006, two acquisitions completed in the fourth quarter of 2005, three acquisitions completed in the third quarter of 2005 and one acquisition completed in the first quarter of 2005. Net investment securities gains were not significant in the three or six months ended June 30, 2006. During the second quarter of 2005, the Corporation realized a gain due to the sale of an entity associated with the Corporation's investment in an independent private equity and venture capital partnership. The gross gain amounted to $29.0 million and is reported in Net investment securities gains in the Consolidated Statements of Income. On an after-tax basis, and net of related compensation expense, the gain amounted to $16.2 million or $0.07 per diluted share. The increase in expenses for the three and six months ended June 30, 2006 compared to the three and six months ended June 30, 2005 were primarily due to the banking and Metavante acquisitions. These factors along with continued organic expense management resulted in the reported earnings growth in the three and six months ended 2006 compared to the three and six months ended June 30, 2005. Management continues to believe that the 2006 outlook provided in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2005 is generally still representative of its expectations for the year ended December 31, 2006. Management expects Metavante revenue will be at the high end of the previously forecasted revenue projection of $1.4 billion to $1.5 billion including all closed acquisitions and the transfer of external item processing which is discussed in the next section. The Corporation's actual results for the year ended December 31, 2006 could differ materially from those expected by management. See "Forward-Looking Statements" in this Form 10-Q and "Risk Factors" in Item 1A of the Corporation's Annual Report on Form 10-K for the year ended December 31, 2005, for a discussion of the various risk factors that could cause actual results to differ materially from expected results. 28 NOTEWORTHY TRANSACTIONS AND EVENTS ---------------------------------- Some of the more noteworthy transactions and events that occurred in the three and six months ended June 30, 2006 and 2005 consisted of the following: Second quarter 2006 The results of operations and financial position as of and for the three and six months ended June 30, 2006 include the effect of the previously announced acquisitions of Gold Banc Corporation, Inc. and Trustcorp Financial, Inc. which were both completed on April 1, 2006. As of April 1, 2006, the combined assets of Gold Banc Corporation, Inc. and Trustcorp Financial, Inc. amounted to approximately $4.9 billion. The acquired companies had combined loans of $3.9 billion and combined bank issued deposits of $3.1 billion. The combined purchase price for these companies, which included approximately $146.0 million of cash, amounted to $898.2 million. In the aggregate, 16.74 million shares of the Corporation's common stock were issued and fully vested stock options to purchase 0.5 million of its common stock were exchanged in these transactions. For the three months ended June 30, 2006, Salaries and employee benefits expense includes $7.6 million and Other expense includes $0.6 million of expense for stock options and the Corporation's employee stock purchase plan ("ESPP"), which reduced net income by $5.3 million or $0.02 per diluted share. The Corporation expects that the additional compensation expense associated with stock options and the ESPP will be dilutive to the Corporation's operating results by $0.02 per diluted share in the third quarter of 2006 and $0.04 per diluted share in the fourth quarter of 2006. The Corporation's largest stock option awards have historically been granted during the fourth quarter and expense for stock options is larger in the fourth quarter compared to the other quarters in any given year. Under the existing plans, awards to individuals who meet certain age and years of service criteria at the date of grant immediately vest and therefore the full fair value of those awards are immediately expensed. For the year ended December 31, 2006, the Corporation expects that the additional compensation expense associated with stock options and the ESPP will be dilutive to the Corporation's operating results by approximately $0.10 per diluted share compared to $0.11 per diluted share for the year ended December 31, 2005 as adjusted. See Note 11 in Notes to Financial Statements for further information. Beginning with the second quarter of 2006, trust services revenue, brokerage and investment advisor revenue and noninterest revenue from the private banking business have been combined and reported in the line item Wealth management in the Consolidated Statements of Income in response to requests by users of the Corporation's financial information. All prior periods have been adjusted for this reclassification. First quarter 2006 On January 1, 2006 the Corporation adopted the accounting standard that requires share-based compensation to be expensed. The Corporation elected the Modified Retrospective Application method to implement this new accounting standard. Under that method all prior period consolidated and segment financial information was adjusted to reflect the effect of expensing share-based compensation plans which were not previously expensed. Prior to the adoption of the new standard, the Corporation used the intrinsic method of accounting for stock options. Under that method generally, no compensation expense was recognized for stock option awards or the Corporation's ESPP. Shareholders' equity as of January 1, 2006 increased $67.7 million due to the deferred income tax benefit recognized from applying the Modified Retrospective Application method of adoption. For the three months ended March 31, 2006, Salaries and employee benefits expense includes $7.5 million of expense for stock options and the ESPP, which reduced net income by $4.9 million or $0.02 per diluted share. Beginning with the first quarter of 2006, the Corporation included certain loan and lease fees, primarily prepayment fees, in reported interest income on loans and leases. Previously, these fees were reported in Other income. Such fees are in addition to loan origination fees that are capitalized and amortized over the life of a loan or lease on a basis that produces a level yield in accordance with existing accounting standards. Including these fees in interest income may result in more volatility in net interest income and the net interest margin. However, management believes this reclassification will improve comparability of the net interest margin between the Corporation and its peer banking group. All prior periods have been adjusted for this reclassification. 29 On January 1, 2006 the Banking segment transferred its external item processing business, including all check-processing client relationships, to Metavante. This transfer, together with recent investments in electronic check image technology, enables Metavante to provide its clients with an end-to-end image solution that includes check truncation at the point of first presentment, image exchange through the Endpoint Exchange Network and final settlement. As a result of the transfer, the previously reported Other income line, Item processing, was reclassified to Data processing services in the Consolidated Statements of Income and prior period segment financial information for both the Banking segment and Metavante has been adjusted for the transfer. See Note 14 in Notes to Financial Statements for segment information. Second quarter 2005 As a result of adopting the accounting standard that requires share-based compensation to be expensed, as previously discussed, adjusted Salaries and employee benefits expense includes $6.6 million and adjusted Other expense includes $0.7 million of expense for stock options and the Corporation's ESPP, which reduced previously reported net income by $4.7 million or $0.02 per diluted share for the three months ended June 30, 2005. During the second quarter of 2005, the Corporation realized a gain due to the sale of an entity associated with the Corporation's investment in an independent private equity and venture capital partnership. The gross gain amounted to $29.0 million and is reported in Net investment securities gains in the Consolidated Statements of Income. On an after- tax basis, and net of related compensation expense, the gain amounted to $16.2 million or $0.07 per diluted share. First quarter 2005 As a result of adopting the accounting standard that requires share-based compensation to be expensed, as previously discussed, adjusted Salaries and employee benefits expense for the three months ended March 31, 2005 includes $6.5 million of expense for stock options and the ESPP which reduced previously reported net income by $4.3 million or $0.02 per diluted share. NET INTEREST INCOME ------------------- Net interest income is the difference between interest earned on earning assets and interest owed on interest bearing liabilities. Net interest income represented approximately 43.6% of the Corporation's source of revenues for the three months ended June 30, 2006 compared to 41.9% for the three months ended June 30, 2005. For the six months ended June 30, 2006 net interest income represented approximately 42.2% of the Corporation's source of revenues compared to 42.2% for the six months ended June 30, 2005. Net interest income for the second quarter of 2006 amounted to $374.1 million compared to $313.0 million reported for the second quarter of 2005, an increase of $61.1 million or 19.5%. For the six months ended June 30, 2006, net interest income amounted to $698.6 million compared to $611.9 million reported for the six months ended June 30, 2005, an increase of $86.7 million or 14.2%. Both acquisition related and organic loan growth, as well as the growth in noninterest bearing and other bank- issued deposits, were the primary contributors to the increase in net interest income. Factors negatively affecting net interest income compared to the prior year included the impact of the financing costs associated with the 2006 banking acquisitions and Metavante's acquisitions, common stock buybacks and a general shift in the bank-issued deposit mix from lower cost to higher cost deposit products in response to increasing interest rates. Average earning assets in the second quarter of 2006 amounted to $47.2 billion compared to $37.8 billion in the second quarter of 2005, an increase of $9.4 billion or 25.0%. Average loans and leases accounted for $8.4 billion of the growth in average earning assets in the second quarter of 2006 compared to the second quarter of 2005. Average investment securities increased $1.0 billion over the prior year quarter. The growth in average investment securities was primarily due to the banking acquisitions. Average interest bearing liabilities increased $8.8 billion or 27.7% in the second quarter of 2006 compared to the second quarter of 2005. Average interest bearing deposits increased $6.7 billion or 32.4% in the second quarter of 2006 compared to the second quarter of last year. Average total borrowings, primarily long-term borrowings, increased $2.2 billion or 19.1% in the second quarter of 2006 compared to the same period in 2005. 30 For the six months ended June 30, 2006, average earning assets amounted to $44.3 billion compared to $37.0 billion in the six months ended June 30, 2005, an increase of $7.3 billion or 19.7%. Average loans and leases accounted for $6.6 billion of the growth in average earning assets in the six months ended June 30, 2006 compared to the six months ended June 30, 2005. Average investment securities increased $0.6 billion over the comparative six month periods. The growth in average investment securities was primarily due to the banking acquisitions. Average interest bearing liabilities increased $6.8 billion or 21.6% in the six months ended June 30, 2006 compared to the six months ended June 30, 2005. Average interest bearing deposits increased $4.4 billion or 21.1% in the six months ended June 30, 2006 compared to the six months ended June 30, 2005. Average total borrowings, primarily long-term borrowings, increased $2.4 billion or 22.6% over the comparative six month periods. Average noninterest bearing deposits increased $0.6 billion or 12.0% in the three months ended June 30, 2006 compared to the three months ended June 30, 2005. For the six months ended June 30, 2006 compared to the six months ended June 30, 2005, average noninterest bearing deposits increased $0.4 billion or 8.7% The growth and composition of the Corporation's quarterly average loan and lease portfolio for the current quarter and previous four quarters are reflected in the following table ($ in millions): Consolidated Average Loans and Leases -------------------------------------
2006 2005 Growth Pct. ------------------- ------------------------------ ----------------- Second First Fourth Third Second Prior Quarter Quarter Quarter Quarter Quarter Annual Quarter --------- --------- --------- --------- --------- -------- --------- Commercial Loans and Leases - --------------------------- Commercial $ 11,393 $ 9,839 $ 9,290 $ 9,126 $ 8,932 27.5 % 15.8 % Commercial real estate Commercial mortgages 10,746 8,839 8,850 8,661 8,509 26.3 21.6 Construction 2,834 1,742 1,564 1,484 1,358 108.7 62.7 -------- -------- -------- -------- -------- ------- ------- Total commercial real estate 13,580 10,581 10,414 10,145 9,867 37.6 28.4 Commercial lease financing 504 493 471 462 425 18.6 2.2 -------- -------- -------- -------- -------- ------- ------- Total Commercial Loans and Leases 25,477 20,913 20,175 19,733 19,224 32.5 21.8 Personal Loans and Leases - ------------------------- Residential real estate Residential mortgages 5,621 5,190 4,855 4,537 3,986 41.0 8.3 Construction 2,365 2,085 1,862 1,633 1,382 71.2 13.4 -------- -------- -------- -------- -------- ------- ------- Total residential real estate 7,986 7,275 6,717 6,170 5,368 48.8 9.8 Personal loans Student 51 99 78 74 78 (33.7) (48.0) Credit card 237 227 233 228 217 9.5 (4.4) Home equity loans and lines 4,596 4,706 4,822 4,905 5,098 (9.9) (2.3) Other 1,167 1,289 1,245 1,241 1,186 (1.6) (9.4) -------- -------- -------- -------- -------- ------- ------- Total personal loans 6,051 6,321 6,378 6,448 6,579 (8.0) (4.3) Personal lease financing 136 132 132 128 123 10.3 2.8 -------- -------- -------- -------- -------- ------- ------- Total Personal Loans and Leases 14,173 13,728 13,227 12,746 12,070 17.4 3.2 -------- -------- -------- -------- -------- ------- ------- Total Consolidated Average Loans and Leases $ 39,650 $ 34,641 $ 33,402 $ 32,479 $ 31,294 26.7 % 14.5 % ======== ======== ======== ======== ======== ======= =======
Total consolidated average loans and leases increased $8.4 billion or 26.7% in the second quarter of 2006 compared to the second quarter of 2005. Excluding the effect of the banking acquisitions, total consolidated average loan and lease organic growth was 12.6% in the second quarter of 2006 compared to the second quarter of 2005. Approximately $3.9 billion of the growth in total consolidated average loans and leases was attributable to the banking acquisitions and $4.5 billion of the growth was organic. Of the $3.9 billion of average growth attributable to the banking acquisitions, $2.8 billion was attributable to average commercial real estate loans, $0.8 billion was attributable to average commercial loans and leases and $0.3 billion was attributable to average residential real estate loans. Of the $4.5 billion of average loan and lease organic growth, $1.7 billion was attributable to average commercial loans and leases, $0.9 billion was attributable to average commercial real estate loans, and $2.4 billion was attributable to residential real estate loans. From a production standpoint, residential real estate loan closings in the second quarter of 2006 were $1.4 billion compared to $1.2 billion in the first quarter of 2006 and $1.6 billion in the second quarter of 2005. Average home equity loans and lines declined $0.5 billion in the second quarter of 2006 compared to the second quarter of 2005. 31 For the six months ended June 30, 2006, total consolidated average loans and leases increased $6.6 billion or 21.5% compared to the six months ended June 30, 2005. Excluding the effect of the banking acquisitions, total consolidated average loan and lease organic growth was 14.1% for the six months ended June 30, 2006 compared to the six months ended June 30, 2005. Approximately $2.0 billion of the growth in total consolidated average loans and leases was attributable to the banking acquisitions and $4.6 billion of the growth was organic. Of the $2.0 billion of average growth attributable to the banking acquisitions, $1.4 billion was attributable to average commercial real estate loans, $0.4 billion was attributable to average commercial loans and leases and the remainder was primarily attributable to average residential real estate loans. Of the $4.6 billion of average loan and lease organic growth, $1.6 billion was attributable to average commercial loans and leases, $1.0 billion was attributable to average commercial real estate loans, and $2.5 billion was attributable to residential real estate loans. From a production standpoint, residential real estate loan closings in the first half of 2006 and the first half of 2005 amounted to $2.6 billion and $2.7 billion, respectively. Average home equity loans and lines declined $0.5 billion in the six months ended June 30, 2006 compared to the six months ended June 30, 2005. Total average commercial loan and lease organic growth continued to be strong in the second quarter and first half of 2006. Management attributes the loan growth to the strength of the local economies in the markets the Corporation serves, new business and continued customer satisfaction. Management continues to expect that year over year organic commercial loan growth (as a percentage) will reach low double digits in 2006. The basis for this expectation includes continued success in attracting new customers in all of the Corporation's markets and continued modest economic growth in the primary markets that the Corporation serves. Recently the Corporation has experienced some slowing in the construction market for both commercial and residential developers, and to some extent throughout the commercial real estate business. As a result, management expects that year over year organic commercial real estate loan growth (as a percentage) will reach mid single digits in 2006. Home equity loans and lines, which includes M&I's wholesale activity, continue to be one of the primary consumer loan products. Average home equity loans and lines declined in the second quarter and first half of 2006 compared to the second quarter and first half of 2005. This is consistent with what is occurring in many parts of the country. The softer home equity market, combined with the Corporation's continued sales of certain loans at origination, which is partly in response to the demand for home equity products with higher loan-to-value characteristics, will impact balance sheet organic loan growth. Management does not expect this trend to change in the near term. The Corporation sells some of its residential real estate production (residential real estate and home equity loans) in the secondary market. Selected residential real estate loans with rate and term characteristics that are considered desirable are periodically retained in the portfolio. For the three months ended June 30, 2006 and 2005 real estate loans sold to investors amounted to $0.6 billion and $0.5 billion, respectively. For the six months ended June 30, 2006, real estate loans sold to investors amounted to $1.2 billion compared to $0.9 billion for the six months ended June 30, 2005. At June 30, 2006 and 2005, the Corporation had approximately $123.4 million and $153.8 million of mortgage loans held for sale, respectively. Gains from the sale of mortgage loans amounted to $10.2 million in the second quarter of 2006 compared to $9.5 million in the second quarter of 2005. For the six months ended June 30, 2006, gains from the sale of mortgage loans amounted to $21.0 million compared to $16.4 million in the six months ended June 30, 2005. Auto loans securitized and sold in the second quarters of 2006 and 2005 amounted to $0.2 billion and $0.1 billion, respectively. For the six months ended June 30, 2006, auto loans securitized and sold amounted to $0.3 billion compared to $0.2 billion in the six months ended June 30, 2005. The net gains and losses from the sale and securitization of auto loans for the three and six months ended June 30, 2006 and 2005, respectively, were not significant. The Corporation anticipates that it will continue to divest itself of selected assets through sale or securitization in future periods. 32 The growth and composition of the Corporation's quarterly average deposits for the current and previous four quarters are as follows ($ in millions): Consolidated Average Deposits -----------------------------
2006 2005 Growth Pct. ------------------- ------------------------------ ----------------- Second First Fourth Third Second Prior Quarter Quarter Quarter Quarter Quarter Annual Quarter --------- --------- --------- --------- --------- -------- --------- Bank issued deposits - -------------------- Noninterest bearing deposits Commercial $ 3,873 $ 3,473 $ 3,687 $ 3,589 $ 3,377 14.7 % 11.5 % Personal 998 943 942 932 958 4.2 5.9 Other 533 526 566 528 491 8.5 1.2 -------- -------- -------- -------- -------- ------- ------- Total noninterest bearing deposits 5,404 4,942 5,195 5,049 4,826 12.0 9.4 Interest bearing deposits Savings and NOW 3,251 2,831 2,911 3,049 3,149 3.2 14.8 Money market 7,389 6,599 6,354 6,047 5,819 27.0 12.0 Foreign activity 1,000 1,034 1,084 932 882 13.4 (3.2) -------- -------- -------- -------- -------- ------- ------- Total interest bearing deposits 11,640 10,464 10,349 10,028 9,850 18.2 11.2 Time deposits Other CDs and time deposits 4,769 3,509 3,354 3,095 2,951 61.7 35.9 CDs greater than $100,000 2,878 2,035 1,703 1,421 1,243 131.5 41.4 -------- -------- -------- -------- -------- ------- ------- Total time deposits 7,647 5,544 5,057 4,516 4,194 82.4 37.9 -------- -------- -------- -------- -------- ------- ------- Total bank issued deposits 24,691 20,950 20,601 19,593 18,870 30.8 17.9 Wholesale deposits - ------------------ Money market 732 887 1,074 1,068 1,077 (32.1) (17.5) Brokered CDs 5,382 3,874 4,752 4,615 4,437 21.3 38.9 Foreign time 1,931 1,762 897 1,076 1,086 77.8 9.6 -------- -------- -------- -------- -------- ------- ------- Total wholesale deposits 8,045 6,523 6,723 6,759 6,600 21.9 23.3 -------- -------- -------- -------- -------- ------- ------- Total consolidated average deposits $ 32,736 $ 27,473 $ 27,324 $ 26,352 $ 25,470 28.5 % 19.2 % ======== ======== ======== ======== ======== ======= =======
Average total bank issued deposits increased $5.8 billion or 30.8% in the second quarter of 2006 compared to the second quarter of 2005. Excluding the effect of the banking acquisitions, total average bank issued deposits organic growth was 12.6% in the second quarter of 2006 compared to the second quarter of 2005. Approximately $3.0 billion of the growth in average total bank issued deposits was attributable to the banking acquisitions and $2.8 billion of the growth was organic. Of the $3.0 billion of average growth attributable to the banking acquisitions, $0.4 billion was attributable to average noninterest bearing deposits, $0.9 billion was attributable to average interest bearing deposits and $1.7 billion was attributable to average time deposits. Of the $2.8 billion of average bank issued deposit organic growth, $0.2 billion was attributable to average noninterest bearing deposits, $0.8 billion was attributable to average interest bearing deposits and $1.8 billion was attributable to average time deposits. For the six months ended June 30, 2006, average total bank issued deposits increased $4.2 billion or 22.4% compared to the six month ended June 30, 2005. Excluding the effect of the banking acquisitions, total average bank issued deposits organic growth was 13.1% in the six months ended June 30, 2006 compared to the six months ended June 30, 2005. Approximately $1.5 billion of the growth in average total bank issued deposits was attributable to the banking acquisitions and $2.7 billion of the growth was organic. Of the $1.5 billion of average growth attributable to the banking acquisitions, $0.2 billion was attributable to average noninterest bearing deposits, $0.5 billion was attributable to average interest bearing deposits and $0.8 billion was attributable to average time deposits. Of the $2.7 billion of average bank issued deposit organic growth, $0.2 billion was attributable to average noninterest bearing deposits, $0.8 billion was attributable to average interest bearing deposits and $1.7 billion was attributable to average time deposits. Noninterest bearing deposit balances tend to exhibit some seasonality with a trend of balances declining somewhat in the early part of the year followed by growth in balances throughout the remainder of the year. A portion of the noninterest balances, especially commercial balances, is sensitive to the interest rate environment. Larger balances tend to be maintained when overall interest rates are low and smaller balances tend to be maintained as overall interest rates increase. 33 As interest rates have risen, the Corporation has increasingly been able to competitively price deposit products which has contributed to the growth in average bank-issued interest bearing deposits and average bank issued time deposits. In addition, rising interest rates have resulted in a shift in the bank issued deposit mix. In their search for higher yields, both new and existing customers have been migrating their deposit balances to higher cost money market and time deposit products. In commercial banking, the focus remains on developing deeper relationships by capitalizing on cross-sale opportunities. Incentive plans based on the sale of treasury management products and services are focused on growing deposits. The retail banking strategy continues to focus on aggressively selling the right products to meet the needs of customers and enhance the Corporation's profitability. Wholesale deposits are funds in the form of deposits generated through distribution channels other than M&I's own banking branches. The Corporation continues to make use of wholesale funding alternatives, especially brokered and institutional certificates of deposit. These deposits allow the Corporation's bank subsidiaries to gather funds across a wider geographic base and at pricing levels considered attractive, where the underlying depositor may be retail or institutional. For the three months ended June 30, 2006, average wholesale deposits increased $1.4 billion, or 21.9% compared to the three months ended June 30, 2005. For the six months ended June 30, 2006 average wholesale deposits increased $0.6 billion, or 8.8% compared to the six months ended June 30, 2005. Average wholesale deposits for the three and six months ended June 30, 2006 include $0.6 billion and $0.3 billion, respectively, of wholesale deposits that were assumed in the acquisitions. During the first quarter of 2006, a significant portion of longer-term institutional certificates of deposits matured and were re-financed at a higher cost. At June 30, 2006, long-term borrowings from the banking acquisitions amounted to $229.0 million. Approximately $30.0 million is subordinated, $100.0 million of advances from the Federal Home Loan Bank ("FHLB") and $99.0 million is subordinated debt associated with four separate issuances of trust preferred securities. During the second quarter of 2006, $400.0 million of floating rate global senior bank notes were issued. These floating rate senior bank notes mature in 2011 and have a coupon rate that is indexed to the three-month London Inter-Bank Offered Rate ("LIBOR"). During the first quarter of 2006, the Corporation issued $250.0 million of fixed rate senior notes. The fixed rate senior notes mature in 2011 and have a coupon rate of 5.35%. Also during the first quarter of 2006, $500.0 million of floating rate senior bank notes were issued. These floating rate senior bank notes mature in 2008 and have a coupon rate that is indexed to the three-month LIBOR. During the first quarter of 2006, $250.0 million of senior bank notes - Extendible Liquidity Securities matured. During the second quarter of 2005, $350.0 million of subordinated bank notes were issued. The subordinated bank notes mature in 2015 and have a coupon rate of 4.85%. Senior bank notes in an aggregate amount of $525.0 million were also issued during the second quarter of 2005. The senior bank notes are floating rate and mature at various times in 2007 and 2010. During the first quarter of 2005 the Corporation obtained a new floating rate advance from the FHLB aggregating $250.0 million. The FHLB advance matures in 2011. During the first quarter of 2005, $900.0 million of senior bank notes with an annual weighted average coupon interest rate of 4.13% were issued. The notes mature at various times beginning in 2008 through 2017. 34 The Corporation's consolidated average interest earning assets and interest bearing liabilities, interest earned and interest paid for the three and six months ended June 30, 2006 and 2005, are presented in the following tables ($ in millions): Consolidated Yield and Cost Analysis ------------------------------------
Three Months Ended Three Months Ended June 30, 2006 June 30, 2005 --------------------------- --------------------------- Average Average Average Yield or Average Yield or Balance Interest Cost (b) Balance Interest Cost (b) --------------------------- --------------------------- Loans and leases: (a) Commercial loans and leases $ 11,896.4 $ 215.4 7.26 % $ 9,357.0 $ 136.3 5.84 % Commercial real estate loans 13,580.4 248.6 7.34 9,867.4 151.4 6.15 Residential real estate loans 7,985.7 139.7 7.01 5,367.6 79.9 5.97 Home equity loans and lines 4,595.7 82.6 7.21 5,098.3 79.2 6.23 Personal loans and leases 1,591.5 28.5 7.20 1,603.8 23.6 5.91 ---------- ------- ------- ---------- ------- ------- Total loans and leases 39,649.7 714.8 7.23 31,294.1 470.4 6.03 Investment securities (b): Taxable 5,818.3 70.9 4.79 4,828.6 53.3 4.41 Tax Exempt (a) 1,316.1 22.9 7.04 1,333.7 23.9 7.34 ---------- ------- ------- ---------- ------- ------- Total investment securities 7,134.4 93.8 5.19 6,162.3 77.2 5.03 Trading securities (a) 50.3 0.2 1.70 25.6 0.1 0.78 Other short-term investments 374.2 5.0 5.37 271.7 2.2 3.39 ---------- ------- ------- ---------- ------- ------- Total interest earning assets $ 47,208.6 $ 813.8 6.90 % $ 37,753.7 $ 549.9 5.84 % ========== ======= ======= ========== ======= ======= Interest bearing deposits: Bank issued deposits: Bank issued interest bearing activity deposits $ 11,639.6 $ 94.6 3.26 % $ 9,850.0 $ 41.8 1.70 % Bank issued time deposits 7,646.9 80.9 4.24 4,193.2 31.6 3.02 ---------- ------- ------- ---------- ------- ------- Total bank issued deposits 19,286.5 175.5 3.65 14,043.2 73.4 2.10 Wholesale deposits 8,045.1 96.1 4.79 6,600.1 49.4 3.00 ---------- ------- ------- ---------- ------- ------- Total interest bearing deposits 27,331.6 271.6 3.99 20,643.3 122.8 2.39 Short-term borrowings 3,418.6 43.1 5.06 3,392.3 28.4 3.36 Long-term borrowings 10,050.1 117.3 4.68 7,920.1 77.3 3.91 ---------- ------- ------- ---------- ------- ------- Total interest bearing liabilities $ 40,800.3 $ 432.0 4.25 % $ 31,955.7 $ 228.5 2.87 % ========== ======= ======= ========== ======= ======= Net interest margin (FTE) $ 381.8 3.24 % $ 321.4 3.42 % ======= ======= ======= ======= Net interest spread (FTE) 2.65 % 2.97 % ======= =======
(a) Fully taxable equivalent ("FTE") basis, assuming a Federal income tax rate of 35%, and excluding disallowed interest expense. (b) Based on average balances excluding fair value adjustments for available for sale securities. 35 Consolidated Yield and Cost Analysis ------------------------------------
Six Months Ended Six Months Ended June 30, 2006 June 30, 2005 --------------------------- --------------------------- Average Average Average Yield or Average Yield or Balance Interest Cost (b) Balance Interest Cost (b) --------------------------- --------------------------- Loans and leases: (a) Commercial loans and leases $ 11,118.8 $ 390.6 7.09 % $ 9,108.7 $ 257.1 5.69 % Commercial real estate loans 12,088.7 429.7 7.17 9,692.9 290.0 6.03 Residential real estate loans 7,632.5 262.5 6.94 5,050.1 147.2 5.88 Home equity loans and lines 4,650.5 163.6 7.09 5,114.4 154.3 6.08 Personal loans and leases 1,668.8 57.7 6.97 1,626.6 46.4 5.75 ---------- -------- ------- ---------- -------- ------- Total loans and leases 37,159.3 1,304.1 7.08 30,592.7 895.0 5.90 Investment securities (b): Taxable 5,401.1 128.8 4.72 4,825.7 105.2 4.39 Tax Exempt (a) 1,328.3 46.3 7.12 1,306.1 46.9 7.41 ---------- -------- ------- ---------- -------- ------- Total investment securities 6,729.4 175.1 5.18 6,131.8 152.1 5.02 Trading securities (a) 42.3 0.3 1.37 24.4 0.1 0.99 Other short-term investments 345.1 8.6 5.01 229.6 3.6 3.20 ---------- -------- ------- ---------- -------- ------- Total interest earning assets $44,276.1 $1,488.1 6.77 % $ 36,978.5 $1,050.8 5.73 % ========== ======== ======= ========== ======== ======= Interest bearing deposits: Bank issued deposits: Bank issued interest bearing activity deposits $11,055.2 $ 169.2 3.09 % $ 9,863.4 $ 75.5 1.54 % Bank issued time deposits 6,601.4 134.2 4.10 4,028.1 57.6 2.89 ---------- -------- ------- ---------- -------- ------- Total bank issued deposits 17,656.6 303.4 3.47 13,891.5 133.1 1.93 Wholesale deposits 7,288.0 166.2 4.60 6,700.8 93.2 2.80 ---------- -------- ------- ---------- -------- ------- Total interest bearing deposits 24,944.6 469.6 3.80 20,592.3 226.3 2.22 Short-term borrowings 3,394.9 82.5 4.90 3,144.0 50.3 3.23 Long-term borrowings 9,728.9 221.7 4.59 7,564.6 145.7 3.88 ---------- -------- ------- ---------- -------- ------- Total interest bearing liabilities $38,068.4 $ 773.8 4.10 % $ 31,300.9 $ 422.3 2.72 % ========== ======== ======= ========== ======== ======= Net interest margin (FTE) $ 714.3 3.25 % $ 628.5 3.43 % ======= ======== ======= ======= Net interest spread (FTE) 2.67 % 3.01 % ======== =======
(a) Fully taxable equivalent ("FTE") basis, assuming a Federal income tax rate of 35%, and excluding disallowed interest expense. (b) Based on average balances excluding fair value adjustments for available for sale securities. The net interest margin FTE decreased 18 basis points from 3.42% in the second quarter of 2005 to 3.24% in the second quarter of 2006. For the six months ended June 30, 2006, the net interest margin FTE was 3.25% compared to 3.43% for the six months ended June 30, 2005, a decrease of 18 basis points. Beginning with the first quarter of 2006, the Corporation included certain loan and lease fees in interest income on loans and leases. All prior periods have been adjusted for this reclassification. For the three and six months ended June 30, 2005, the net interest margin FTE increased by approximately 9 basis points and 8 basis points, respectively from the previously reported amounts due to this reclassification. Compared to the first quarter of 2006, the net interest margin FTE decreased 2 basis points from 3.26% in the first quarter of 2006 to 3.24% in the second quarter of 2006. Similar to the general trends being experienced throughout the industry, the Corporation continues to be challenged by narrowing loan spreads in a solid economy with a flat yield curve, loan growth that may exceed the Corporation's ability to generate appropriately priced deposits and the shift in the bank issued deposit mix by new and existing depositors into higher yielding products. Management expects these trends to continue and expects that there will be modest downward pressure on the net interest margin FTE for the remainder of 2006. Net interest income and the net interest margin percentage can vary and continue to be influenced by loan and deposit growth, product spreads, pricing competition in the Corporation's markets, prepayment activity, future interest rate changes and various other factors. 36 PROVISION FOR LOAN AND LEASE LOSSES AND CREDIT QUALITY ------------------------------------------------------ The following tables present comparative consolidated credit quality information as of June 30, 2006, and the prior four quarters: Nonperforming Assets -------------------- ($000's)
2006 2005 ----------------------- ----------------------------------- Second First Fourth Third Second Quarter Quarter Quarter Quarter Quarter ----------- ----------- ----------- ----------- ----------- Nonaccrual $ 193,028 $ 144,484 $ 134,718 $ 141,408 $ 126,920 Renegotiated 133 138 143 148 176 Past due 90 days or more 4,855 4,523 5,725 5,743 4,514 ---------- ---------- ---------- ---------- ---------- Total nonperforming loans and leases 198,016 149,145 140,586 147,299 131,610 Other real estate owned 11,701 8,207 8,869 8,774 9,124 ---------- ---------- ---------- ---------- ---------- Total nonperforming assets $ 209,717 $ 157,352 $ 149,455 $ 156,073 $ 140,734 ========== ========== ========== ========== ========== Allowance for loan and lease losses $ 415,201 $ 368,760 $ 363,769 $ 362,257 $ 360,138 ========== ========== ========== ========== ==========
Consolidated Statistics -----------------------
2006 2005 ----------------------- ----------------------------------- Second First Fourth Third Second Quarter Quarter Quarter Quarter Quarter ----------- ----------- ----------- ----------- ----------- Net charge-offs to average loans and leases annualized 0.10 % 0.07 % 0.14 % 0.10 % 0.15 % Total nonperforming loans and leases to total loans and leases 0.49 0.42 0.41 0.44 0.41 Total nonperforming assets to total loans and leases and other real estate owned 0.52 0.45 0.44 0.47 0.44 Allowance for loan and lease losses to total loans and leases 1.03 1.05 1.06 1.09 1.12 Allowance for loan and lease losses to total nonperforming loans and leases 210 247 259 246 274
Nonaccrual Loans and Leases By Type ----------------------------------- ($000's)
2006 2005 ----------------------- ----------------------------------- Second First Fourth Third Second Quarter Quarter Quarter Quarter Quarter ----------- ----------- ----------- ----------- ----------- Commercial Commercial, financial and agricultural $ 59,558 $ 50,103 $ 43,730 $ 47,644 $ 35,777 Lease financing receivables 454 1,399 1,539 3,012 3,990 ---------- ---------- ---------- ---------- ---------- Total commercial 60,012 51,502 45,269 50,656 39,767 Real estate Construction and land development 33,115 3,276 913 3,057 1,500 Commercial mortgage 34,260 30,633 28,644 30,351 37,107 Residential mortgage 64,151 57,425 57,982 56,488 47,797 ---------- ---------- ---------- ---------- ---------- Total real estate 131,526 91,334 87,539 89,896 86,404 Personal 1,490 1,648 1,910 856 749 ---------- ---------- ---------- ---------- ---------- Total nonaccrual loans and leases $ 193,028 $ 144,484 $ 134,718 $ 141,408 $ 126,920 ========== ========== ========== ========== ==========
37 Reconciliation of Allowance for Loan and Lease Losses ----------------------------------------------------- ($000's)
2006 2005 ----------------------- ----------------------------------- Second First Fourth Third Second Quarter Quarter Quarter Quarter Quarter ----------- ----------- ----------- ----------- ----------- Beginning balance $ 368,760 $ 363,769 $ 362,257 $ 360,138 $ 358,280 Provision for loan and lease losses 11,053 10,995 12,995 9,949 13,725 Allowance of banks and loans acquired 45,258 -- -- -- -- Loans and leases charged-off Commercial 6,125 3,869 9,481 2,256 3,767 Real estate 3,385 2,901 3,110 6,576 8,190 Personal 3,088 3,727 5,213 3,186 3,765 Leases 1,253 189 226 337 380 ---------- ---------- ---------- ---------- ---------- Total charge-offs 13,851 10,686 18,030 12,355 16,102 Recoveries on loans and leases Commercial 847 2,715 4,256 2,634 2,264 Real estate 1,224 263 374 575 413 Personal 1,149 971 781 787 782 Leases 761 733 1,136 529 776 ---------- ---------- ---------- ---------- ---------- Total recoveries 3,981 4,682 6,547 4,525 4,235 ---------- ---------- ---------- ---------- ---------- Net loans and leases charge-offs 9,870 6,004 11,483 7,830 11,867 ---------- ---------- ---------- ---------- ---------- Ending balance $ 415,201 $ 368,760 $ 363,769 $ 362,257 $ 360,138 ========== ========== ========== ========== ==========
Nonperforming assets consist of nonperforming loans and leases and other real estate owned ("OREO"). OREO is principally comprised of commercial and residential properties acquired in partial or total satisfaction of problem loans and amounted to $11.7 million at June 30, 2006, compared to $8.2 million at March 31, 2006 and $9.1 million at June 30, 2005. The increase in OREO of $3.5 million from March 31, 2006 to June 30, 2006 is predominantly due to the OREO acquired in the banking acquisitions. Nonperforming loans and leases consist of nonaccrual, renegotiated or restructured loans, and loans and leases that are delinquent 90 days or more and still accruing interest. The balance of nonperforming loans and leases can fluctuate widely based on the timing of cash collections, renegotiations and renewals. Maintaining nonperforming assets at an acceptable level is important to the ongoing success of a financial services institution. The Corporation's comprehensive credit review and approval process are critical to ensuring that the amount of nonperforming assets on a long- term basis is minimized within the overall framework of acceptable levels of credit risk. In addition to the negative impact on net interest income and credit losses, nonperforming assets also increase operating costs due to the expense associated with collection efforts. At June 30, 2006, nonperforming loans and leases amounted to $198.0 million or 0.49% of consolidated loans and leases compared to $149.1 million or 0.42% of consolidated loans and leases at March 31, 2006, and $131.6 million or 0.41% of consolidated loans and leases at June 30, 2005. Approximately $42.7 million or 87% of the $48.9 million increase in nonperforming loans from March 31, 2006 to June 30, 2006 was attributable to the banking acquisitions. Excluding the effect of the acquisitions, nonperforming loans and leases would have amounted to $155.3 million or 0.43% of consolidated loans and leases at June 30, 2006. Excluding the acquisitions, the pro forma ratio of nonperforming loans and leases to consolidated loans and leases at June 30, 2006 and the actual ratio at each quarter end throughout 2005 has remained in a fairly narrow range and continues to be below management's expectations. Nonaccrual loans and leases continue to be the primary source of nonperforming loans and leases. 38 Net charge-offs amounted to $9.9 million or 0.10% of average loans and leases in the second quarter of 2006 compared to $6.0 million or 0.07% of average loans and leases in the first quarter of 2006 and $11.9 million or 0.15% of average loans and leases in the second quarter of 2005. The lower level of net charge-offs experienced throughout 2005 and the first six months of 2006 has to some extent been the result of higher than normal recoveries. Based on the status of some of the larger charge-offs recognized in recent quarters, management expects recoveries will likely return to lower levels in future periods. The ratio of recoveries to charge-offs was 28.7% for the three months ended June 30, 2006 which was closer to average historical experience. The ratio of recoveries to charge-offs was 35.3% for the six months ended June 30, 2006 which continues to be above the Corporation's five year historical average ratio of recoveries to charge-offs of 27.9%. Management continues to expect the longer term level of nonperforming loans and leases to be in the range of 50-60 basis points of total loans and leases and expects net charge-offs to trend to historical levels. With respect to the banking acquisitions, management expects the level of nonperforming loans to decline slowly over the next couple of years and expects net charge-off levels to increase modestly. The provisions for loan and lease losses amounted to $11.0 million for the three months ended June 30, 2006 compared to $11.0 million for the three months ended March 31, 2006 and $13.7 million for the three months ended June 30, 2005. For the six months ended June 30, 2006, the provisions for loan and lease losses amounted to $22.0 million compared to $21.9 million for the six months ended June 30, 2005. The allowance for loan and lease losses as a percent of consolidated loans and leases outstanding was 1.03% at June 30, 2006, 1.05% at March 31, 2006 and 1.12% at June 30, 2005. OTHER INCOME ------------ Other income or noninterest sources of revenue represented approximately 56.4% and 58.1% of the Corporation's total sources of revenues for the three months ended June 30, 2006 and 2005, respectively. Total other income in the second quarter of 2006 amounted to $484.4 million compared to $434.3 million in the same period last year, an increase of $50.1 million or 11.5%. For the six months ended June 30, 2006 and 2005, noninterest sources of revenue represented approximately 57.8% of the Corporation's total sources of revenues, respectively. Total other income for the six months ended June 30, 2006 amounted to $957.1 million compared to $836.8 million for the six months ended June 30, 2005, an increase of $120.3 million or 14.4%. The increase in other income was primarily due to growth in data processing services and wealth management services revenue. Other income for the three and six months ended June 30, 2005 includes significant investment securities gains as previously discussed. Data processing services revenue (Metavante) amounted to $345.0 million in the second quarter of 2006 compared to $282.4 million in the second quarter of 2005, an increase of $62.6 million or 22.2%. For the six months ended June 30, 2006, Data processing services revenue amounted to $688.0 million compared to $565.3 million for the six months ended June 30, 2005, an increase of $122.7 million or 21.7%. Revenue growth continued throughout the segment due to revenue associated with acquisitions, higher transaction volumes in core processing activity, payment processing and electronic banking and an increase in healthcare eligibility and payment card production. Revenue associated with Metavante's acquisitions completed in 2006 and 2005 contributed a significant portion of the revenue growth in the three and six months ended June 30, 2006, compared to the three and six months ended June 30, 2005. The acquisition related revenue growth includes cross sales of acquired products to clients across the entire segment. Metavante estimates that total revenue growth (internal and external) for the six months ended June 30, 2006 compared to the six months ended June 30, 2005 excluding the acquisitions ("organic revenue growth"), was approximately 8.2%. To determine the estimated organic revenue growth rate, Metavante adjusts its prior year revenue for the acquisitions as if they had been consummated on January 1 of the prior year. The linked-quarter data processing services revenue growth will tend to be somewhat more cyclical and seasonal in nature. Total buyout revenue, which varies from period to period, increased $3.0 million and $1.8 million in the three and six months ended June 30, 2006 compared to the three and six months ended June 30, 2005, respectively. As previously reported, on January 1, 2006 the Banking segment transferred its external item processing business, including all check-processing client relationships, to Metavante. As a result of the transfer, the previously reported Other income line, Item processing, was reclassified to Data processing services in the Consolidated Statements of Income and prior period segment financial information for both the Banking segment and Metavante has been adjusted for the transfer. Management continues to expect that Metavante revenue (internal and external) for the year ended December 31, 2006 will be at the high end of the previously forecasted revenue projection of $1.4 billion to $1.5 billion. Organic revenue growth rates are expected to exceed prior year levels and segment income is expected to continue to improve. These expectations include the impact of all closed acquisitions and the transfer of external item processing. 39 As previously discussed, beginning with the second quarter of 2006, trust services revenue, brokerage and investment advisor revenue and noninterest revenue from the private banking business have been combined and reported in the line item Wealth management in the Consolidated Statements of Income in response to requests by users of the Corporation's financial information. All prior periods have been adjusted for this reclassification. Wealth management revenue amounted to $56.3 million in the second quarter of 2006 compared to $48.1 million in the second quarter of 2005, an increase of $8.2 million or 17.0%. For the six months ended June 30, 2006, Wealth management revenue amounted to $109.1 million compared to $95.2 million for the six months ended June 30, 2005, an increase of $13.9 million or 14.6%. For the three and six months ended June 30, 2006, wealth management revenue attributable to the previously reported January 3, 2006 acquisition of certain assets of First Trust Indiana and the April 1, 2006 acquisition of Gold Banc Corporation, Inc. amounted to $2.3 million and $3.4 million, respectively. Continued success in the cross- selling and integrated delivery initiatives, improved investment performance and improving results in institutional sales efforts and outsourcing activities were the primary contributors to the remaining revenue growth over the respective periods. Assets under management were approximately $20.4 billion at June 30, 2006 compared to $19.8 billion at March 31, 2006, and $18.5 billion at June 30, 2005. Service charges on deposits amounted to $25.0 million in the second quarter of 2006 compared to $23.7 million in the second quarter of 2005. For the six months ended June 30, 2006, service charges on deposits amounted to $47.6 million compared to $47.1 million for the six months ended June 30, 2005. The banking acquisitions contributed $2.1 million of service charges on deposits for the three and six months ended June 30, 2006. A portion of this source of fee income is sensitive to changes in interest rates. In a rising interest rate environment, customers that pay for services by maintaining eligible deposit balances receive a higher earnings credit which results in lower fee income. Excluding the effect of the banking acquisitions, lower service charges on deposits associated with commercial demand deposits accounted for the majority of the decline in this revenue in the three and six months ended June 30, 2006 compared to the three and six months ended June 30, 2005, respectively. Total mortgage banking revenue was $12.3 million in the second quarter of 2006 compared with $11.2 million in the second quarter of 2005, an increase of $1.1 million or 9.7%. For the six months ended June 30, 2006, total mortgage banking revenue amounted to $24.7 million compared to $19.4 million for the six months ended June 30, 2005, an increase of $5.3 million or 27.7%. For the three months ended June 30, 2006 and 2005, the Corporation sold $0.6 billion and $0.5 billion of residential mortgage and home equity loans to the secondary market, respectively. For the six months ended June 30, 2006 and 2005, the Corporation sold $1.2 billion and $0.9 billion of residential mortgage and home equity loans to the secondary market, respectively. As previously discussed, the Corporation continues to sell home equity loans at origination which is partly in response to the demand for home equity products with higher loan-to-value characteristics. Retained interests in the form of mortgage servicing rights on residential mortgage loans sold amounted to $0.4 million for the six months ended June 30, 2006 and $0.5 million for the six months ended June 30, 2005. At June 30, 2006 mortgage servicing rights amounted to $2.5 million. Net investment securities gains for the three and six months ended June 30, 2006 were not significant. Net investment securities gains for the three and six months ended June 30, 2005 amounted to $29.4 million and $35.3 million, respectively. As previously discussed, during the second quarter of 2005, the Corporation realized a gain due to the sale of an entity associated with its investment in an independent private equity and venture partnership. The gross gain amounted to $29.0 million. During the first quarter of 2005, the Corporation's banking segment's investment in certain membership interests of PULSE was liquidated by PULSE. The cash received resulted in a pre-tax gain of $5.3 million. An additional $0.3 million was received in the second quarter of 2005. Other income in the second quarter of 2006 amounted to $37.4 million compared to $31.5 million in the second quarter of 2005, an increase of $5.9 million or 19.0%. For the six months ended June 30, 2006, other income amounted to $71.3 million compared to $60.3 million for the six months ended June 30, 2005, an increase of $11.0 million or 18.2%. Other income for the three and six months ended June 30, 2006 includes $2.8 million of income attributable to the banking acquisitions. The remaining increase in other income for the three and six months ended June 30, 2006 compared to the three and six months ended June 30, 2005 was primarily due to increases in card related fees and trading and investment fees. OTHER EXPENSE ------------- Total other expense for the three months ended June 30, 2006 amounted to $544.3 million compared to $459.9 million for the three months ended June 30, 2005, an increase of $84.4 million or 18.4%. For the six months ended June 30, 2006, total other expense amounted to $1,049.4 million compared to $902.8 million for the six months ended June 30, 2005, an increase of $146.6 million or 16.2%. 40 Total other expense for the three and six months ended June 30, 2006 included the operating expenses associated with Metavante's 2005 and 2006 acquisitions, the 2006 banking acquisitions and the 2006 acquisition of certain assets of First Trust Indiana. The operating expenses of the acquired entities have been included in the Corporation's consolidated operating expenses from the dates the transactions were completed, which had a significant impact on the period to period comparability of operating expenses in 2006 compared to 2005. Approximately $65.6 million of the operating expense growth in the second quarter of 2006 compared to the second quarter of 2005 and $109.6 million of the operating expense growth in the six months ended June 30, 2006 compared to the six months ended June 30, 2005 was attributable to the acquisitions. In addition, expenses for the three and six months ended June 30, 2006 include conversion and integration expenses related to the banking acquisitions. The Corporation estimates that its expense growth in the three and six months ended June 30, 2006 compared to the three and six months ended June 30, 2005, excluding the effects of the acquisitions, was approximately $18.8 million and $36.9 million, respectively, and the estimated growth rate was approximately 4.1% over the respective comparative periods. Expense control is sometimes measured in the financial services industry by the efficiency ratio statistic. The efficiency ratio is calculated by taking total other expense divided by the sum of total other income (including Capital Markets revenue but excluding investment securities gains or losses) and net interest income on a fully taxable equivalent basis. The Corporation's efficiency ratios for the three months ended June 30, 2006, and prior four quarters were: Efficiency Ratios -----------------
Three Months Ended -------------------------------------------------------------------------- June 30, March 31, December 31, September 30, June 30, 2006 2006 2005 2005 2005 -------------- -------------- -------------- -------------- -------------- Consolidated Corporation 62.9 % 62.8 % 64.1 % 62.5 % 60.9 % Consolidated Corporation Excluding Metavante 51.2 % 48.8 % 51.5 % 50.8 % 49.9 %
The Consolidated Corporation Excluding Metavante efficiency ratio for the remainder of 2006 is expected to decline somewhat from the second quarter 2006 and is expected to continue to decline slightly until the banking acquisitions are fully integrated. Salaries and employee benefits expense amounted to $307.1 million in the second quarter of 2006 compared to $269.0 million in the second quarter of 2005, an increase of $38.1 million or 14.2%. For the six months ended June 30, 2006, Salaries and employee benefits expense amounted to $584.5 million compared to $514.1 million for the six months ended June 30, 2005, an increase of $70.4 million or 13.7%. Salaries and benefits associated with the acquisitions previously discussed accounted for approximately $27.5 million and $45.1 million of the increase in Salaries and employee benefits expense in the three and six months ended June 30, 2006 compared to the three and six months ended June 30, 2005, respectively. For the second quarter of 2006, occupancy and equipment expense amounted to $63.8 million compared to $50.9 million in the second quarter of 2005, an increase of $12.9 million or 25.5%. The acquisitions accounted for approximately $9.7 million of the increase in occupancy and equipment expense in the three months ended June 30, 2006 compared to the three months ended June 30, 2005. For the six months ended June 30, 2006, occupancy and equipment expense amounted to $121.6 million compared to $104.2 million for the six months ended June 30, 2005, an increase of $17.4 million or 16.7%. The acquisitions accounted for approximately $12.7 million of the increase in occupancy and equipment expense in the six months ended June 30, 2006 compared to the six months ended June 30, 2005. The remaining increase in occupancy and equipment expense for the three and six months ended June 30, 2006 compared to the three and six months ended June 30, 2005 was primarily attributable to the banking segment and wealth management. 41 Software expenses, processing charges, supplies and printing, professional services and shipping and handling expenses totaled $89.1 million in the second quarter of 2006 compared to $63.0 million in the second quarter of 2005, an increase of $26.1 million or 41.4%. For the six months ended June 30, 2006, software expenses, processing charges, supplies and printing, professional services and shipping and handling expenses totaled $175.0 million compared to $128.3 million for the six months ended June 30, 2005, an increase of $46.7 million or 36.4%. The acquisitions accounted for $19.6 million and $35.5 million of the expense growth for the three and six months ended June 30, 2006 compared to the three and six months ended June 30, 2005, respectively. Metavante's expense growth accounted for the majority of the remaining increase in expense for these items in the three and six months ended June 30, 2006 compared to the three and six months ended June 30, 2005, respectively. Amortization of intangibles amounted to $12.0 million in the second quarter of 2006 compared to $8.1 million in the second quarter of 2005, an increase of $3.9 million. For the six months ended June 30, 2006, amortization of intangibles amounted to $20.9 million compared to $16.2 million for the six months ended June 30, 2005, an increase of $4.7 million. The increase in amortization associated with the acquisitions amounted to $5.1 million and $7.1 million for the three and six months ended June 30, 2006 compared to the three and six months ended June 30, 2005, respectively. Those increases were offset by lower amortization of core deposit intangibles, which is based on a declining balance method and lower amortization of Metavante's contract intangibles from previous acquisitions. Other expense amounted to $72.3 million in the second quarter of 2006 compared to $68.9 million in the second quarter of 2005, an increase of $3.4 million or 4.9%. For the six months ended June 30, 2006, other expense amounted to $147.4 million compared to $140.1 million for the six months ended June 30, 2005, an increase of $7.3 million or 5.2%. Other expense is affected by the capitalization of costs, net of amortization associated with software development and customer data processing conversions. Net software and conversion capitalization was $0.6 million in the second quarter of 2006 compared to net software and conversion amortization of $5.7 million in the second quarter of 2005, resulting in a decrease to other expense over the comparative quarters of $6.3 million. For the six months ended June 30, 2006, net software and conversion amortization was $2.1 million compared to net software and conversion amortization of $11.4 million for the six months ended June 30, 2005, resulting in a decrease to other expense over the comparative six months of $9.3 million. The acquisitions accounted for $3.8 million and $9.3 million of the growth in other expense for the three and six months ended June 30, 2006 compared to the three and six months ended June 30, 2005, respectively. The cost of card plastic and cost of equipment associated with Metavante's revenues and travel and other costs associated with the conversion and integration of the banking acquisitions accounted for the remainder of the increase in other expense for the three and six months ended June 30, 2006 compared to the three and six months ended June 30, 2005, respectively. INCOME TAXES ------------ The provision for income taxes for the three months ended June 30, 2006 amounted to $99.4 million or 32.8% of pre-tax income compared to $90.0 million or 32.9% of pre-tax income for the three months ended June 30, 2005. For the six months ended June 30, 2006, the provision for income taxes amounted to $193.8 million or 33.2% of pre-tax income compared to $174.9 million or 33.4% of pre-tax income for the six months ended June 30, 2005. During the second quarter of 2006, an income tax benefit was recognized for the integration and realignment of Metavante subsidiaries that resulted in a lower provision for income taxes in the consolidated statements of income for the three and six months ended June 30, 2006. During the second quarter of 2005, an income tax issue was resolved which primarily affected the banking segment and resulted in a lower provision for income taxes in the consolidated statements of income for the three and six months ended June 30, 2005. LIQUIDITY AND CAPITAL RESOURCES ------------------------------- Shareholders' equity was $5.8 billion or 10.6% of total consolidated assets at June 30, 2006, compared to $4.7 billion or 10.2% of total consolidated assets at December 31, 2005, and $4.3 billion or 9.8% of total consolidated assets at June 30, 2005. During the second quarter of 2006, the Corporation issued 13,673,072 shares of its common stock and exchanged fully vested stock options to purchase 119,816 of its common stock with a total value of $603.9 million in conjunction with the Corporation's acquisition of Gold Banc Corporation, Inc. Also during the second quarter of 2006, the Corporation issued 3,069,430 shares of its common stock and exchanged fully vested stock options to purchase 412,317 of its common stock with a total value of $148.3 million in conjunction with the Corporation's acquisition of Trustcorp Financial, Inc. During the first quarter of 2006, the Corporation issued 527,864 shares of its common stock valued at $23.2 million in conjunction with Metavante's acquisition of AdminiSource Inc. Also during the first quarter of 2006, the Corporation issued 385,192 shares of its common stock valued at $16.9 million to fund its 2005 obligations under its retirement and employee stock ownership plans. 42 On April 25, 2006, the Corporation announced that its Board of Directors increased the quarterly cash dividend on its common stock 12.5%, from $0.24 per share to $0.27 per share. The Corporation has a Stock Repurchase Program under which it may repurchase up to 12 million shares of its common stock annually. During the first quarter of 2006, the Corporation repurchased 1.0 million shares at an aggregate cost of $41.8 million or an average price of $41.79 per common share. There were no purchases under the program in the second quarter of 2006. In 2005, the Corporation entered into an equity distribution agreement whereby the Corporation may offer and sell up to 3.5 million shares of its common stock from time to time through certain designated sales agents. However, the Corporation will not sell more than the number of shares of its common stock necessary for the aggregate gross proceeds from such sales to reach $150.0 million. No sales occurred in the three or six months ended June 30, 2006. The aggregate gross proceeds available for future sales was approximately $143.3 million at June 30, 2006. At June 30, 2006, the net loss in accumulated other comprehensive income amounted to $101.3 million, which represented a negative change in accumulated other comprehensive income of $64.0 million since December 31, 2005. Net accumulated other comprehensive income associated with available for sale investment securities was a net loss of $104.3 million at June 30, 2006, compared to a net loss of $36.3 million at December 31, 2005, resulting in a net loss of $68.0 million over the six month period. Net accumulated other comprehensive income associated with the change in fair value of the Corporation's derivative financial instruments designated as cash flow hedges was a net gain of $4.0 million over the six month period. The Corporation continues to have a strong capital base and its regulatory capital ratios are significantly above the minimum requirements as shown in the following tables. The risk-based capital and leverage ratios at December 31, 2005 have not been adjusted for the adoption of SFAS 123(R). RISK-BASED CAPITAL RATIOS ------------------------- ($ in millions)
June 30, 2006 December 31, 2005 --------------------------------- --------------------------------- Amount Ratio Amount Ratio --------------------------------- --------------------------------- Tier 1 Capital $ 3,623 7.65 % $ 3,046 7.67 % Tier 1 Capital Minimum Requirement 1,894 4.00 1,588 4.00 ----------------- ------------- ----------------- ------------- Excess $ 1,729 3.65 % $ 1,458 3.67 % ================= ============= ================= ============= Total Capital $ 5,283 11.15 % $ 4,659 11.74 % Total Capital Minimum Requirement 3,789 8.00 3,176 8.00 ----------------- ------------- ----------------- ------------- Excess $ 1,494 3.15 % $ 1,483 3.74 % ================= ============= ================= ============= Risk-Adjusted Assets $ 47,361 $ 39,698 ================= =================
LEVERAGE RATIOS --------------- ($ in millions)
June 30, 2006 December 31, 2005 --------------------------------- --------------------------------- Amount Ratio Amount Ratio --------------------------------- --------------------------------- Tier 1 Capital $ 3,623 7.13 % $ 3,046 7.08 % Minimum Leverage Requirement 1,524 - 2,540 3.00 - 5.00 1,291 - 2,152 3.00 - 5.00 ----------------- ------------- ----------------- ------------- Excess $ 2,099 - 1,083 4.13 - 2.13 % $ 1,755 - 894 4.08 - 2.08 % ================= ============= ================= ============= Adjusted Average Total Assets $ 50,807 $ 43,039 ================= =================
M&I manages its liquidity to ensure that funds are available to each of its banks to satisfy the cash flow requirements of depositors and borrowers and to ensure the Corporation's own cash requirements are met. M&I maintains liquidity by obtaining funds from several sources. 43 The Corporation's most readily available source of liquidity is its investment portfolio. Investment securities available for sale, which totaled $6.6 billion at June 30, 2006, represent a highly accessible source of liquidity. The Corporation's portfolio of held-to-maturity investment securities, which totaled $0.5 billion at June 30, 2006, provides liquidity from maturities and amortization payments. The Corporation's loans held for sale provide additional liquidity. These loans represent recently funded loans that are prepared for delivery to investors, which generally occurs within thirty to ninety days after the loan has been funded. Depositors within M&I's defined markets are another source of liquidity. Core deposits (demand, savings, money market and consumer time deposits) averaged $20.8 billion in the second quarter of 2006. The Corporation's banking affiliates may also access the federal funds markets or utilize collateralized borrowings such as treasury demand notes or FHLB advances. The banking affiliates may use wholesale deposits, which include foreign (Eurodollar) deposits. Wholesale deposits are funds in the form of deposits generated through distribution channels other than the Corporation's own banking branches. These deposits allow the Corporation's banking subsidiaries to gather funds across a national geographic base and at pricing levels considered attractive, where the underlying depositor may be retail or institutional. Access to wholesale deposits also provides the Corporation with the flexibility to not pursue single service time deposit relationships in markets that have experienced some unprofitable pricing levels. Wholesale deposits averaged $8.0 billion in the second quarter of 2006. The Corporation utilizes certain financing arrangements to meet its balance sheet management, funding, liquidity, and market or credit risk management needs. The majority of these activities are basic term or revolving securitization vehicles. These vehicles are generally funded through term-amortizing debt structures or with short-term commercial paper designed to be paid off based on the underlying cash flows of the assets securitized. These vehicles provide access to funding sources substantially separate from the general credit risk of the Corporation and its subsidiaries. See Note 8 to the Consolidated Financial Statements for an update of the Corporation's securitization activities in the second quarter of 2006. The Corporation's lead bank, M&I Marshall & Ilsley Bank (the "Bank"), has implemented a bank note program. During the second quarter of 2006, the Bank amended the bank note program into a global bank note program which permits it to issue and sell up to a maximum of US$13.0 billion aggregate principal amount (or the equivalent thereof in other currencies) at any one time outstanding of its senior global bank notes with maturities of seven days or more from their respective date of issue and subordinated global bank notes with maturities more than five years from their respective date of issue. The notes may be fixed rate or floating rate and the exact terms will be specified in the applicable Pricing Supplement or the applicable Program Supplement. This program is intended to enhance liquidity by enabling the Bank to sell its debt instruments in global markets in the future without the delays which would otherwise be incurred. Senior global bank notes outstanding at June 30, 2006 amounted to $0.4 billion. Other bank notes outstanding at June 30, 2006 amounted to $6.0 billion of which $1.3 billion is subordinated and qualifies as supplementary capital for regulatory capital purposes. Bank notes issued during the first quarter of 2006 amounted to $500.0 million. The national capital markets represent a further source of liquidity to M&I. M&I has filed a number of shelf registration statements that are intended to permit M&I to raise funds through sales of corporate debt and/or equity securities with a relatively short lead time. During the third quarter of 2005, the Corporation amended the shelf registration statement originally filed with the Securities and Exchange Commission during the second quarter of 2004 to include the equity distribution agreement. The amended shelf registration statement enables the Corporation to issue various securities, including debt securities, common stock, preferred stock, depositary shares, purchase contracts, units, warrants, and trust preferred securities, up to an aggregate amount of $3.0 billion. Approximately $1.3 billion is available for future securities issuances. During the fourth quarter of 2004, the Corporation filed a shelf registration statement with the Securities and Exchange Commission enabling the Corporation to issue up to 6.0 million shares of its common stock, which may be offered and issued from time to time in connection with acquisitions by M&I, Metavante and/or other consolidated subsidiaries of the Corporation. At June 30, 2006, there were 3.1 million shares of common stock available for future issuances. 44 Under another shelf registration statement, the Corporation may issue up to $0.6 billion of medium-term Series F notes with maturities ranging from 9 months to 30 years and at fixed or floating rates. At June 30, 2006, Series F notes issued amounted to $250.0 million. The Corporation may issue up to $0.5 billion of medium-term MiNotes with maturities ranging from 9 months to 30 years and at fixed or floating rates. The MiNotes are issued in smaller denominations to attract retail investors. At June 30, 2006, MiNotes issued amounted to $0.2 billion. Additionally, the Corporation has a commercial paper program. At June 30, 2006, commercial paper outstanding amounted to $0.3 billion. Short-term borrowings represent contractual debt obligations with maturities of one year or less and amounted to $4.1 billion at June 30, 2006. Long-term borrowings amounted to $10.1 billion at June 30, 2006. The scheduled maturities of long-term borrowings including estimated interest payments at June 30, 2006 are as follows: $3.1 billion is due in less than one year; $2.9 billion is due in one to three years; $3.0 billion is due in three to five years; and $4.0 billion is due in more than five years. During the first quarter of 2006, the Corporation issued shares of its common stock valued at $16.9 million to fund a portion of its 2005 obligations under its retirement and employee stock ownership plans. There have been no other substantive changes to the Corporation's contractual obligations as reported in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2005. OFF-BALANCE SHEET ARRANGEMENTS ------------------------------ In conjunction with the acquisitions of Gold Banc Corporation, Inc. and Trustcorp Financial, Inc., the Corporation acquired all of the common interests in four Trusts that issued cumulative preferred capital securities which are supported by junior subordinated deferrable interest debentures in the amounts of $16.0 million, $30.0 million, $38.0 million and $15.0 million, respectively and full guarantees assumed by the Corporation. The Corporation does not consolidate these Trusts in accordance with United States generally accepted accounting principles. At June 30, 2006, there have been no other substantive changes with respect to the Corporation's off-balance sheet activities as disclosed in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2005. See Note 8 to the Consolidated Financial Statements for an update of the Corporation's securitization activities in the second quarter of 2006. The Corporation continues to believe that based on the off-balance sheet arrangements with which it is presently involved, such off-balance sheet arrangements neither have, nor are reasonably likely to have, a material impact to its current or future financial condition, results of operations, liquidity or capital. CRITICAL ACCOUNTING POLICIES ---------------------------- The Corporation has established various accounting policies which govern the application of accounting principles generally accepted in the United States in the preparation of the Corporation's consolidated financial statements. The significant accounting policies of the Corporation are described in the footnotes to the consolidated financial statements contained in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2005, and updated as necessary in its Quarterly Reports on Form 10-Q. Certain accounting policies involve significant judgments and assumptions by management that may have a material impact on the carrying value of certain assets and liabilities. Management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of judgments and assumptions made by management, actual results could differ from these judgments and estimates which could have a material impact on the carrying values of assets and liabilities and the results of the operations of the Corporation. Management continues to consider the following to be those accounting policies that require significant judgments and assumptions: Allowance for Loan and Lease Losses ----------------------------------- The allowance for loan and lease losses represents management's estimate of probable losses inherent in the Corporation's loan and lease portfolio. Management evaluates the allowance each quarter to determine that it is adequate to absorb these inherent losses. This evaluation is supported by a methodology that identifies estimated losses based on assessments of individual problem loans and historical loss patterns of homogeneous loan pools. In addition, environmental factors, including economic conditions and regulatory guidance, unique to each measurement date are also considered. This reserving methodology has the following components: 45 Specific Reserve. The Corporation's internal risk rating system is used to identify loans and leases that meet the criteria as being "impaired" under the definition in SFAS 114. A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. For impaired loans, impairment is measured using one of three alternatives: (1) the present value of expected future cash flows discounted at the loan's effective interest rate; (2) the loan's observable market price, if available; or (3) the fair value of the collateral for collateral dependent loans and loans for which foreclosure is deemed to be probable. In general, these loans have been internally identified as credits requiring management's attention due to underlying problems in the borrower's business or collateral concerns. Subject to a minimum size, a quarterly review of these loans is performed to identify the specific reserve necessary to be allocated to each of these loans. This analysis considers expected future cash flows, the value of collateral and also other factors that may impact the borrower's ability to make payments when due. Collective Loan Impairment. This component of the allowance for loan and lease losses is comprised of two elements. First, the Corporation makes a significant number of loans and leases, which due to their underlying similar characteristics, are assessed for loss as homogeneous pools. Included in the homogeneous pools are loans and leases from the retail sector and commercial loans under a certain size that have been excluded from the specific reserve allocation previously discussed. The Corporation segments the pools by type of loan or lease and, using historical loss information, estimates a loss reserve for each pool. The second element reflects management's recognition of the uncertainty and imprecision underlying the process of estimating losses. The internal risk rating system is used to identify those loans within certain industry segments that based on financial, payment or collateral performance, warrant closer ongoing monitoring by management. The specific loans mentioned earlier are excluded from this analysis. Based on management's judgment, reserve ranges are allocated to industry segments due to environmental conditions unique to the measurement period. Consideration is given to both internal and external environmental factors such as economic conditions in certain geographic or industry segments of the portfolio, economic trends, risk profile, and portfolio composition. Reserve ranges are then allocated using estimates of loss exposure that management has identified based on these economic trends or conditions. The following factors were taken into consideration in determining the adequacy of the allowance for loan and lease losses at June 30, 2006: In general, the Corporation's customer base is still showing signs of increased business activity as evidenced by the continued loan growth in this quarter. At June 30, 2006, allowances for loan and lease losses continue to be carried for exposures to manufacturing, healthcare, production agriculture (including dairy and cropping operations), truck transportation, accommodation, general contracting, motor vehicle and parts dealers and the airline industries. The majority of the commercial charge-offs incurred during the past three years were in these industry segments. While most loans in these categories are still performing, the Corporation continues to believe these sectors present a higher than normal risk due to their financial and external characteristics. Reduced revenues causing a declining utilization of the industry's capacity levels can affect collateral values and the amounts realized through the sale or liquidation. During the second quarter of 2006, the Corporation's commitments to Shared National Credits were approximately $3.6 billion with usage averaging around 47%. Over time, many of the Corporation's largest charge-offs have come from the Shared National Credit portfolio. Although these factors result in an increased risk profile, as of June 30, 2006, there were no Shared National Credit nonperforming loans. The Corporation's exposure to Shared National Credits is monitored closely given this lending group's loss experience. The Corporation's primary lending areas are Wisconsin, Arizona, Minnesota and Missouri. The vast majority of the assets acquired from Gold Banc Corporation, Inc. are in entirely new markets for the Corporation. Included in these new markets are the Kansas City metropolitan area, Tulsa, Oklahoma, and Tampa, Sarasota and Bradenton, Florida. Each of these regions and markets has cultural and environmental factors that are unique to them. 46 At June 30, 2006, nonperforming loans and leases amounted to $198.0 million or 0.49% of consolidated loans and leases compared to $149.1 million or 0.42% of consolidated loans and leases at March 31, 2006, and $131.6 million or 0.41% of consolidated loans and leases at June 30, 2005. Approximately $42.7 million or 87% of the $48.9 million increase in nonperforming loans from March 31, 2006 to June 30, 2006 was attributable to the banking acquisitions. Excluding the effect of the acquisitions, nonperforming loans and leases would have amounted to $155.3 million or 0.43% of consolidated loans and leases at June 30, 2006. Excluding the acquisitions, the pro forma ratio of nonperforming loans and leases to consolidated loans and leases at June 30, 2006 and the actual ratio at each quarter end throughout 2005 has remained in a fairly narrow range and continues to be below management's expectations. Nonaccrual loans and leases continue to be the primary source of nonperforming loans and leases. Net charge-offs amounted to $9.9 million or 0.10% of average loans and leases in the second quarter of 2006 compared to $6.0 million or 0.07% of average loans and leases in the first quarter of 2006 and $11.9 million or 0.15% of average loans and leases in the second quarter of 2005. The lower level of net charge-offs experienced throughout 2005 and the first six months of 2006 has to some extent been the result of higher than normal recoveries. Based on the status of some of the larger charge-offs recognized in recent quarters, management expects recoveries will likely return to lower levels in future periods. The ratio of recoveries to charge-offs was 28.7% for the three months ended June 30, 2006 which was closer to average historical experience. The ratio of recoveries to charge-offs was 35.3% for the six months ended June 30, 2006 which continues to be above the Corporation's five year historical average ratio of recoveries to charge-offs of 27.9%. Based on the above loss estimates, management determined its best estimate of the required allowance for loans and leases. Management's evaluation of the factors described above resulted in an allowance for loan and lease losses of $415.2 million or 1.03% of loans and leases outstanding at June 30, 2006. The allowance for loan and lease losses was $363.8 million or 1.06% of loans and leases outstanding at December 31, 2005 and $360.1 million or 1.12% of loans and leases outstanding at June 30, 2005. Consistent with the credit quality trends noted above, the provision for loan and lease losses amounted to $11.1 million for the three months ended June 30, 2006 and $22.0 million for the six months ended June 30, 2006. By comparison, the provision for loan and lease losses amounted to $13.7 million for the three months ended June 30, 2005 and $21.9 million for the six months ended June 30, 2005. The resulting provisions for loan and lease losses are the amounts required to establish the allowance for loan and lease losses at the required level after considering charge-offs and recoveries. Management recognizes there are significant estimates in the process and the ultimate losses could be significantly different from those currently estimated. The Corporation has not materially changed any aspect of its overall approach in the determination of the allowance for loan and lease losses. There have been no material changes in assumptions or estimation techniques as compared to prior periods that impacted the determination of the current period allowance. However, on an on-going basis the Corporation continues to refine the methods used in determining management's best estimate of the allowance for loan and lease losses. Capitalized Software and Conversion Costs ----------------------------------------- Direct costs associated with the production of computer software that will be licensed externally or used in a service bureau environment are capitalized. Capitalization of such costs is subject to strict accounting policy criteria, although the appropriate time to initiate capitalization requires management judgment. Once the specific capitalized project is put into production, the software cost is amortized over its estimated useful life, generally four years. Each quarter, the Corporation performs net realizable value tests to ensure the assets are recoverable. Such tests require management judgment as to the future sales and profitability of a particular product which involves, in some cases, multi-year projections. Technology changes and changes in customer requirements can have a significant impact on the recoverability of these assets and can be difficult to predict. Should significant adverse changes occur, estimates of useful life may have to be revised or write-offs would be required to recognize impairment. For the three months ended June 30, 2006 and 2005, the amount of software costs capitalized amounted to $13.7 million and $9.9 million, respectively. Amortization expense of software costs amounted to $13.4 million for the three months ended June 30, 2006 compared to $15.4 million for the three months ended June 30, 2005. For the six months ended June 30, 2006 and 2005, the amount of software costs capitalized amounted to $25.0 million and $18.9 million, respectively. Amortization expense of software costs amounted to $27.6 million for the six months ended June 30, 2006 compared to $30.3 million for the six months ended June 30, 2005. Direct costs associated with customer system conversions to the data processing operations are capitalized and amortized on a straight-line basis over the terms, generally five to seven years, of the related servicing contracts. 47 Capitalization only occurs when management is satisfied that such costs are recoverable through future operations or penalties (buyout fees) in case of early termination. For the three months ended June 30, 2006 and 2005, the amount of conversion costs capitalized amounted to $3.1 million and $2.7 million, respectively. Amortization expense of conversion costs amounted to $2.8 million and $2.9 million for the three months ended June 30, 2006 and 2005, respectively. For the six months ended June 30, 2006 and 2005, the amount of conversion costs capitalized amounted to $5.5 million and $5.6 million, respectively. Amortization expense of conversion costs amounted to $5.0 million and $5.6 million for the six months ended June 30, 2006 and 2005, respectively. Net unamortized costs were ($ in millions):
June 30, -------------------------- 2006 2005 ------------ ------------ Software $ 152.5 $ 151.6 Conversions 27.7 26.5 ----------- ----------- Total $ 180.2 $ 178.1 =========== ===========
The Corporation has not substantively changed any aspect of its overall approach in the determination of the amount of costs that are capitalized for software development or conversion activities. There have been no material changes in assumptions or estimation techniques as compared to prior periods that impacted the determination of the periodic amortization of such costs. Financial Asset Sales and Securitizations ----------------------------------------- The Corporation utilizes certain financing arrangements to meet its balance sheet management, funding, liquidity, and market or credit risk management needs. The majority of these activities are basic term or revolving securitization vehicles. These vehicles are generally funded through term-amortizing debt structures or with short term commercial paper designed to be paid off based on the underlying cash flows of the assets securitized. These financing entities are contractually limited to a narrow range of activities that facilitate the transfer of or access to various types of assets or financial instruments. In certain situations, the Corporation provides liquidity and/or loss protection agreements. In determining whether the financing entity should be consolidated, the Corporation considers whether the entity is a qualifying special-purpose entity ("QSPE") as defined in Statement of Financial Accounting Standards ("SFAS") No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. For non-consolidation, a QSPE must be demonstrably distinct, have significantly limited permitted activities, hold assets that are restricted to transferred financial assets and related assets, and can sell or dispose of non-cash financial assets only in response to specified conditions. In December 2003, the Corporation adopted Financial Accounting Standards Board Interpretation No. 46 ("FIN 46R"), Consolidation of Variable Interest Entities (revised December 2003). This interpretation addresses consolidation by business enterprises of variable interest entities. Transferors to QSPEs and "grandfathered" QSPEs subject to the reporting requirements of SFAS 140 are outside the scope of FIN 46R and do not consolidate those entities. With respect to the Corporation's securitization activities, the adoption of FIN 46R did not have an impact on its consolidated financial statements because its transfers are generally to QSPEs. The Corporation sells financial assets in a two-step process that results in a surrender of control over the assets as evidenced by true-sale opinions from legal counsel, to unconsolidated entities that securitize the assets. The Corporation retains interests in the securitized assets in the form of interest-only strips and a cash reserve account. Gain or loss on sale of the assets depends in part on the carrying amount assigned to the assets sold allocated between the asset sold and retained interests based on their relative fair values at the date of transfer. The value of the retained interests is based on the present value of expected cash flows estimated using management's best estimates of the key assumptions - credit losses, prepayment speeds, forward yield curves and discount rates commensurate with the risks involved. Actual results can differ from expected results. The Corporation reviews the carrying values of the retained interests monthly to determine if there is a decline in value that is other than temporary and periodically reviews the propriety of the assumptions used based on current historical experience as well as the sensitivities of the carrying value of the retained interests to adverse changes in the key assumptions. The Corporation believes that its estimates result in a reasonable carrying value of the retained interests. 48 The Corporation regularly sells automobile loans to an unconsolidated multi-seller special purpose entity commercial paper conduit in securitization transactions in which servicing responsibilities and subordinated interests are retained. The outstanding balances of automobile loans sold in these securitization transactions were $1,028.4 million at June 30, 2006. At June 30, 2006 the carrying amount of retained interests amounted to $35.4 million. The Corporation also sells, from time to time, debt securities classified as available for sale that are highly rated to an unconsolidated bankruptcy remote QSPE whose activities are limited to issuing highly rated asset-backed commercial paper with maturities up to 180 days which is used to finance the purchase of the investment securities. The Corporation provides liquidity back-up in the form of Liquidity Purchase Agreements. In addition, the Corporation acts as counterparty to interest rate swaps that enable the QSPE to hedge its interest rate risk. Such swaps are designated as free-standing derivative financial instruments in the Corporation's Consolidated Balance Sheet. At June 30, 2006, highly rated investment securities in the amount of $301.7 million were outstanding in the QSPE to support the outstanding commercial paper. Income Taxes ------------ Income taxes are accounted for using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on tax assets and liabilities of a change in tax rates is recognized in the income statement in the period that includes the enactment date. The determination of current and deferred income taxes is based on complex analyses of many factors, including interpretation of Federal and state income tax laws, the difference between tax and financial reporting basis of assets and liabilities (temporary differences), estimates of amounts currently due or owed, such as the timing of reversals of temporary differences and current accounting standards. The Federal and state taxing authorities who make assessments based on their determination of tax laws periodically review the Corporation's interpretation of Federal and state income tax laws. Tax liabilities could differ significantly from the estimates and interpretations used in determining the current and deferred income tax liabilities based on the completion of taxing authority examinations. In June 2006, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 48, ("FIN 48"), Accounting for Uncertainty in Income Taxes an interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The provisions of FIN 48 are effective beginning January 1, 2007, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The Corporation is currently evaluating the financial statement impact, if any, of adopting FIN 48. FORWARD-LOOKING STATEMENTS -------------------------- Items 2 and 3 of this Form 10-Q, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Quantitative and Qualitative Disclosures about Market Risk," respectively, contain forward- looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements include, without limitation, statements regarding expected financial and operating activities and results which are preceded by words such as "expects", "anticipates" or "believes". Such statements are subject to important factors that could cause the Corporation's actual results to differ materially from those anticipated by the forward-looking statements. These factors include those referenced in Item 1A, Risk Factors, of the Corporation's Annual Report on Form 10-K for the year ended December 31, 2005 and under the heading "Forward-Looking Statements," and as may be described from time to time in the Corporation's subsequent SEC filings, and such factors are incorporated herein by reference. 49 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The following updated information should be read in conjunction with the Corporation's Annual Report on Form 10-K for the year ended December 31, 2005. Updated information regarding the Corporation's use of derivative financial instruments is contained in Note 12, Notes to Financial Statements contained in Item 1 herein. Market risk arises from exposure to changes in interest rates, exchange rates, commodity prices, and other relevant market rate or price risk. The Corporation faces market risk through trading and other than trading activities. While market risk that arises from trading activities in the form of foreign exchange and interest rate risk is immaterial to the Corporation, market risk from other than trading activities in the form of interest rate risk is measured and managed through a number of methods. Interest Rate Risk ------------------ The Corporation uses financial modeling techniques to identify potential changes in income under a variety of possible interest rate scenarios. Financial institutions, by their nature, bear interest rate and liquidity risk as a necessary part of the business of managing financial assets and liabilities. The Corporation has designed strategies to limit these risks within prudent parameters and identify appropriate risk/reward tradeoffs in the financial structure of the balance sheet. The financial models identify the specific cash flows, repricing timing and embedded option characteristics of the assets and liabilities held by the Corporation. Policies are in place to assure that neither earnings nor fair value at risk exceed appropriate limits. The use of a limited array of derivative financial instruments has allowed the Corporation to achieve the desired balance sheet repricing structure while simultaneously meeting the desired objectives of both its borrowing and depositing customers. The models used include measures of the expected repricing characteristics of administered rate (NOW, savings and money market accounts) and non-rate related products (demand deposit accounts, other assets and other liabilities). These measures recognize the relative insensitivity of these accounts to changes in market interest rates, as demonstrated through current and historical experiences. In addition to contractual payment information for most other assets and liabilities, the models also include estimates of expected prepayment characteristics for those items that are likely to materially change their payment structures in different rate environments, including residential mortgage products, certain commercial and commercial real estate loans and certain mortgage-related securities. Estimates for these sensitivities are based on industry assessments and are substantially driven by the differential between the contractual coupon of the item and current market rates for similar products. This information is incorporated into a model that allows the projection of future income levels in several different interest rate environments. Earnings at risk are calculated by modeling income in an environment where rates remain constant, and comparing this result to income in a different rate environment, and then dividing this difference by the Corporation's budgeted operating income before taxes for the calendar year. Since future interest rate moves are difficult to predict, the following table presents two potential scenarios - a gradual increase of 100bp across the entire yield curve over the course of the year (+25bp per quarter), and a gradual decrease of 100bp across the entire yield curve over the course of the year (-25bp per quarter) for the balance sheet as of the indicated dates:
Impact to Annual Pretax Income as of -------------------------------------------------------------------------- June 30, March 31, December 31, September 30, June 30, 2006 2006 2005 2005 2005 -------------- -------------- -------------- -------------- -------------- Hypothetical Change in Interest Rate - ------------------------------------ 100 basis point gradual: Rise in rates (0.3)% (0.2)% (0.2)% (0.1)% 0.3 % Decline in rates 0.3 % 0.1 % 0.0 % 0.0 % (0.6)%
These results are based solely on the modeled parallel changes in market rates, and do not reflect the earnings sensitivity that may arise from other factors such as changes in the shape of the yield curve and changes in spread between key market rates. These results also do not include any management action to mitigate potential income variances within the simulation process. Such action could potentially include, but would not be limited to, adjustments to the repricing characteristics of any on- or off-balance sheet item with regard to short-term rate projections and current market value assessments. 50 Actual results will differ from simulated results due to the timing, magnitude, and frequency of interest rate changes as well as changes in market conditions and management strategies. Another component of interest rate risk is measuring the fair value at risk for a given change in market interest rates. The Corporation also uses computer modeling techniques to determine the present value of all asset and liability cash flows (both on- and off-balance sheet), adjusted for prepayment expectations, using a market discount rate. The net change in the present value of the asset and liability cash flows in different market rate environments is the amount of fair value at risk from those rate movements. As of June 30, 2006, the fair value of equity at risk for a gradual 100bp shift in rates was no more than 2.0% of the market value of the Corporation. Equity Risk ----------- In addition to interest rate risk, the Corporation incurs market risk in the form of equity risk. The Corporation invests directly and indirectly through investment funds, in private medium-sized companies to help establish new businesses or recapitalize existing ones. These investments expose the Corporation to the change in equity values for the portfolio companies. However, fair values are difficult to determine until an actual sale or liquidation transaction actually occurs. At June 30, 2006, the carrying value of total active capital markets investments amounted to approximately $39.1 million. As of June 30, 2006, M&I Trust Services administered $89.1 billion in assets and directly managed a portfolio of $20.4 billion. The Corporation is exposed to changes in equity values due to the fact that fee income is partially based on equity balances. Quantification of this exposure is difficult due to the number of other variables affecting fee income. Interest rate changes can also have an effect on fee income for the above stated reasons. ITEM 4. CONTROLS AND PROCEDURES We maintain a set of disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in the reports filed by us under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective as of the end of the period covered by this report. There have been no changes in our internal control over financial reporting identified in connection with the evaluation discussed above that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 51 PART II - OTHER INFORMATION ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS The following table reflects the purchases of Marshall & Ilsley Corporation stock for the specified period:
Total Number of Maximum Number Shares Purchased of Shares that as Part of May Yet Be Total Number Average of Publicly Purchased Under of Shares Price Paid Announced Plans the Plans Period Purchased(1) per Share or Programs or Programs ----------------- ------------- ----------- ------------------ ----------------- January 1 to January 31, 2006 443,919 $ 41.92 437,700 11,562,300 February 1 to February 28, 2006 565,972 41.70 562,300 11,000,000 March 1 to March 31, 2006 2,434 41.84 -- 11,000,000 April 1 to April 30, 2006 123,064 44.22 -- 11,000,000 May 1 to May 31, 2006 3,129 45.08 -- 11,000,000 June 1 to June 30, 2006 2,635 45.04 -- 11,000,000 ------------ ---------- ---------------- Total 1,141,153 $ 42.07 1,000,000 ============ ========== ================
(1) Includes shares purchased by rabbi trusts pursuant to nonqualified deferred compensation plans. The Corporation's Share Repurchase Program was publicly reconfirmed in April 2005 and again in April 2006. The Share Repurchase Program authorizes the purchase of up to 12 million shares annually and renews each year at that level unless changed or terminated by subsequent Board action. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) The Corporation held its Annual Meeting of Shareholders on April 25, 2006. (b) Votes cast for the election of five directors to serve as Class I directors until the 2009 Annual Meeting of Shareholders are as follows: Director For Withheld --------------------- ----------- ----------- Mark F. Furlong 190,663,322 4,510,194 Ted D. Kellner 188,042,220 7,131,296 Katharine C. Lyall 191,780,574 3,392,942 Peter M. Platten, III 185,630,211 9,543,305 James B. Wigdale 190,741,495 4,432,021 52 The continuing directors of the Corporation are as follows: Jon F. Chait Malcolm M. Aslin Bruce E. Jacobs Andrew N. Baur Dennis J. Kuester John W. Daniels, Jr. Edward L. Meyer, Jr. John A. Mellowes San W. Orr, Jr. Robert J. O'Toole Debra S. Waller John S. Shiely George E. Wardeberg (c) Votes cast for the ratification of the appointment of Deloitte & Touche LLP to audit the statements of the Company for the fiscal year ending December 31, 2006 are as follows: For Against Abstentions ----------- ---------- ----------- Ratification of Auditors 192,281,360 1,415,784 1,476,372 Votes cast to approve the Company's 2006 Equity Incentive Plan are as follows: For Against Abstentions Non-Vote ----------- ---------- ----------- ---------- Ratification of Plan 119,283,686 38,900,515 3,647,656 33,341,659 Votes cast for the shareholder proposal to request the Board of Directors of the Company to declassify the board are as follows: For Against Abstentions Non-Vote ----------- ---------- ----------- ---------- Request to declassify the Board of Directors 79,363,430 78,488,983 3,979,444 33,341,659 ITEM 6. EXHIBITS Exhibit 10 - Change of Control Agreement, dated June 19, 2006, between the Corporation and Gregory A. Smith, incorporated by reference to Item 1.01 of the Corporation's amended Current Report on Form 8-K/A filed June 19, 2006, SEC File No. 1-15403. * Exhibit 11 - Statement Regarding Computation of Earnings Per Share, Incorporated by Reference to NOTE 4 of Notes to Financial Statements contained in Item 1 - Financial Statements (unaudited) of Part I - Financial Information herein. Exhibit 12 - Statement Regarding Computation of Ratio of Earnings to Fixed Charges Exhibit 31(a) - Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended. Exhibit 31(b) - Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended. Exhibit 32(a) - Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350. Exhibit 32(b) - Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350. ____________________________________________ * Management contract or compensatory plan or arrangement. 53 SIGNATURES ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. MARSHALL & ILSLEY CORPORATION (Registrant) /s/ Patricia R. Justiliano __________________________________ Patricia R. Justiliano Senior Vice President and Corporate Controller (Chief Accounting Officer) /s/ James E. Sandy __________________________________ James E. Sandy Vice President August 9, 2006 54 EXHIBIT INDEX ------------- Exhibit Number Description of Exhibit ______________ ____________________________________________ (10) Change of Control Agreement, dated June 19, 2006, between the Corporation and Gregory A. Smith, incorporated by reference to Item 1.01 of the Corporation's amended Current Report on Form 8-K/A filed June 19, 2006, SEC File No. 1-15403. * (11) Statement Regarding Computation of Earnings Per Share, Incorporated by Reference to NOTE 4 of Notes to Financial Statements contained in Item 1 - Financial Statements (unaudited) of Part I - Financial Information herein. (12) Statement Regarding Computation of Ratio of Earnings to Fixed Charges. (31)(a) Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended. (31)(b) Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended. (32)(a) Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350. (32)(b) Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350. ____________________________________________ * Management contract or compensatory plan or arrangement. EX-12 2 ex12_606.txt EXHIBIT 12 TO FORM 10-Q DATED 06/30/2006 Exhibit 12 MARSHALL & ILSLEY CORPORATION COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES ($000's)
As Adjusted Note 11 Six Months ---------------------------------------------------------------- Ended Years Ended December 31, June 30, ---------------------------------------------------------------- 2006 2005 2004 2003 2002 2001 ------------- ------------ ------------ ------------ ------------ ------------ Earnings: Earnings before income taxes, extraordinary items and cumulative effect of changes in accounting principles $ 584,343 $ 1,057,654 $ 911,840 $ 724,508 $ 683,364 $ 475,128 Fixed charges, excluding interest on deposits 317,505 463,209 281,244 267,379 301,518 321,059 ------------ ----------- ----------- ----------- ----------- ----------- Earnings including fixed charges but excluding interest on deposits 901,848 1,520,863 1,193,084 991,887 984,882 796,187 Interest on deposits 469,718 544,920 276,102 228,216 283,385 566,899 ------------ ----------- ----------- ----------- ----------- ----------- Earnings including fixed charges and interest on deposits $ 1,371,566 $ 2,065,783 $ 1,469,186 $ 1,220,103 $ 1,268,267 $ 1,363,086 ============ =========== =========== =========== =========== =========== Fixed Charges: Interest Expense: Short-term borrowings $ 82,459 $ 106,333 $ 61,256 $ 81,070 $ 150,310 $ 188,587 Long-term borrowings 221,680 330,144 196,440 163,348 127,343 110,842 One-third of rental expense for all operating leases (the amount deemed representative of the interest factor) 13,366 26,732 23,548 22,961 23,865 21,630 ------------ ----------- ----------- ----------- ----------- ----------- Fixed charges excluding interest on deposits 317,505 463,209 281,244 267,379 301,518 321,059 Interest on deposits 469,718 544,920 276,102 228,216 283,385 566,899 ------------ ----------- ----------- ----------- ----------- ----------- Fixed charges including interest on deposits $ 787,223 $ 1,008,129 $ 557,346 $ 495,595 $ 584,903 $ 887,958 ============ =========== =========== =========== =========== =========== Ratio of Earnings to Fixed Charges: Excluding interest on deposits 2.84 x 3.28 x 4.24 x 3.71 x 3.27 x 2.48 x Including interest on deposits 1.74 x 2.05 x 2.64 x 2.46 x 2.17 x 1.54 x
EX-31 3 ex31a606.txt EXHIBIT 31(A) TO FORM 10-Q DATED 06/30/2006 Exhibit 31(a) CERTIFICATION _____________ I, Dennis J. Kuester, Chairman of the Board and Chief Executive Officer of Marshall & Ilsley Corporation, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Marshall & Ilsley Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 9, 2006 /s/ Dennis J. Kuester _________________________________________________ Dennis J. Kuester Chairman of the Board and Chief Executive Officer MW1136680_1.doc EX-31 4 ex31b606.txt EXHIBIT 31(B) TO FORM 10-Q DATED 06/30/2006 Exhibit 31(b) CERTIFICATION _____________ I, Gregory A. Smith, Senior Vice President and Chief Financial Officer of Marshall & Ilsley Corporation, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Marshall & Ilsley Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 9, 2006 /s/ Gregory A. Smith _________________________________________________ Gregory A. Smith Senior Vice President and Chief Financial Officer MW1136739_1.doc EX-32 5 ex32a606.txt EXHIBIT 32(A) TO FORM 10-Q DATED 06/30/2006 Exhibit 32(a) CERTIFICATION OF PERIODIC REPORT ________________________________ I, Dennis J. Kuester, Chief Executive Officer of Marshall & Ilsley Corporation (the "Company"), certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that to my knowledge: (1) the Quarterly Report on Form 10-Q of the Company for the quarter ended June 30, 2006 (the "Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (14 U.S.C. 78m or 78o(d)); and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: August 9, 2006. /s/ Dennis J. Kuester ______________________________ Dennis J. Kuester Chief Executive Officer Marshall & Ilsley Corporation This certification accompanies this Quarterly Report on Form 10-Q pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed filed by Marshall & Ilsley Corporation for purposes of the Securities Exchange Act of 1934. MW1136678_1.doc EX-32 6 ex32b606.txt EXHIBIT 32(B) TO FORM 10-Q DATED 06/30/2006 Exhibit 32(b) CERTIFICATION OF PERIODIC REPORT ________________________________ I, Gregory A. Smith, Chief Financial Officer of Marshall & Ilsley Corporation (the "Company"), certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that to my knowledge: (1) the Quarterly Report on Form 10-Q of the Company for the quarter ended June 30, 2006 (the "Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (14 U.S.C. 78m or 78o(d)); and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: August 9, 2006. /s/ Gregory A. Smith ______________________________ Gregory A. Smith Chief Financial Officer Marshall & Ilsley Corporation This certification accompanies this Quarterly Report on Form 10-Q pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed filed by Marshall & Ilsley Corporation for purposes of the Securities Exchange Act of 1934. MW1136742_1.doc -----END PRIVACY-ENHANCED MESSAGE-----