-----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, Q/PA+mMgMx/qniSQIGSGRroNu09tyTbQAzqTucjE2vuj4VFJFjwdsBtZk0UDEwHQ uBL0R/6sQkURotTlSS0voQ== 0000950131-99-001907.txt : 19990630 0000950131-99-001907.hdr.sgml : 19990630 ACCESSION NUMBER: 0000950131-99-001907 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MERCANTILE BANCORPORATION INC CENTRAL INDEX KEY: 0000064907 STANDARD INDUSTRIAL CLASSIFICATION: 6021 IRS NUMBER: 430951744 STATE OF INCORPORATION: MO FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-11792 FILM NUMBER: 99578256 BUSINESS ADDRESS: STREET 1: 7TH & WASHINGTON TRAM 19 1 STREET 2: ONE MERCANTILE CENTER STREET CITY: ST LOUIS STATE: MO ZIP: 63101-1643 BUSINESS PHONE: 3144252525 MAIL ADDRESS: STREET 1: P O BOX 524 CITY: ST LOUIS STATE: MO ZIP: 63166 FORMER COMPANY: FORMER CONFORMED NAME: MERCANTILE TRUST CO DATE OF NAME CHANGE: 19720229 10-K 1 FORM 10-K - - ------------------------------------------------------------------------------- - - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------- FORM 10-K ---------------- ANNUAL REPORT PURSUANT TO SECTION 13 OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, Commission File No. 1-11792 1998 ---------------- Mercantile Bancorporation Inc. (Exact name of Registrant as specified in its charter) Missouri 43-0951744 (State of Incorporation) (IRS Employer Identification No.) P.O. Box 524 63166-0524 St. Louis, Missouri (Zip code) (Address of principal executive offices) Registrant's telephone number, including area code: 314-418-2525 Securities registered pursuant to Section Name of exchange on which registered: 12(b) of the Act: (1) Common Stock ($0.01 Par Value) (1) New York Stock Exchange (2) Preferred Stock Purchase Rights (2) New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K. [X] State the aggregate market value of the voting stock held by non-affiliates of the Registrant as of February 26, 1999: Common Stock, $0.01 par value, $6,099,118,381 Indicate the number of shares outstanding of each of the Registrant's classes of common stock, as of February 26, 1999: Common Stock $0.01 par value, 157,625,883 shares outstanding DOCUMENTS INCORPORATED BY REFERENCE As provided herein, portions of the documents below are incorporated by reference:
Document Part--Form 10-K -------- --------------- Annual Report of the Registrant to its Shareholders for the Year Ended December 31, 1998.................................. Parts I, II, IV Registrant's Proxy Statement for the 1999 Annual Meeting of Shareholders.................................................. Part III
- - ------------------------------------------------------------------------------- - - ------------------------------------------------------------------------------- PART I Item 1. Business THE COMPANY Mercantile Bancorporation Inc. ("Mercantile" or "Corporation") is a bank holding company which, as of February 26, 1999, owned, directly or indirectly, all of the stock of Mercantile Bank National Association ("Mercantile Bank"), six other commercial banks, one trust company, and other non-banking subsidiaries located in Missouri, Illinois, Iowa, eastern Kansas, northern and central Arkansas, and western Kentucky. At December 31, 1998, Mercantile reported consolidated assets of $35,800,177,000, consolidated loans of $22,311,258,000, consolidated deposits of $25,461,397,000 and consolidated shareholders' equity of $3,073,755,000. At December 31, 1998, Mercantile Bank and its consolidated subsidiaries reported assets of $22,653,777,000, loans of $13,070,938,000, deposits of $15,023,894,000, and shareholder's equity of $1,762,076,000. Mercantile has its principal offices at One Mercantile Center, St. Louis, Missouri 63101 (telephone number 314-418-2525). BUSINESS General Mercantile was organized on March 10, 1970, as a Missouri corporation for the purpose of becoming a multi-bank holding company. Mercantile commenced operations as a bank holding company in March 1971. Since then Mercantile has acquired and organized additional financial institutions and bank holding companies located throughout Missouri, Illinois, Iowa, eastern Kansas, northern and central Arkansas, and western Kentucky. Financial Summary of Mercantile A financial summary of Mercantile and its consolidated subsidiaries is detailed below:
December 31 ----------------------------------------------------------- 1998 1997 1996 1995 1994 ----------- ----------- ----------- ----------- ----------- (Thousands) Total assets............ $35,800,177 $33,332,190 $24,995,735 $23,651,434 $22,089,195 Loans and leases........ 22,311,258 21,361,955 16,937,254 15,584,285 14,558,820 Investments in debt and equity securities...... 9,470,937 8,464,881 5,429,759 5,626,084 5,573,913 Deposits................ 25,461,397 24,809,455 19,784,845 18,463,655 17,341,514 Shareholders' equity.... 3,073,755 2,762,302 2,263,243 2,210,845 1,897,387
Subsidiaries The table setting forth the names and locations of Mercantile's subsidiary financial institutions is included as Exhibit 21 hereto. Services and Transactions with Subsidiaries Mercantile provides its subsidiaries with advice and specialized services in the areas of accounting and taxation, budgeting and strategic planning, employee benefits and human resources, insurance, operations, marketing, credit analysis and administration, loan support and participations, investments, auditing, trust, data processing, bank security and banking and corporate law. A fee is charged by Mercantile for these services. The responsibility for the management of each subsidiary remains with its Board of Directors and with the officers elected by each Board. Intercompany transactions between Mercantile and its subsidiaries are subject to restrictions of existing laws and accepted principles of fair dealing. Mercantile uses the premises of Mercantile Bank for its offices and pays Mercantile Bank a fee for services and facilities furnished to it. 1 Employees At December 31, 1998, Mercantile had 306 full-time equivalent employees, while Mercantile and its subsidiaries had a combined total of 10,475 full-time equivalent employees. Mercantile provides a variety of employment benefits and believes it enjoys a good relationship with its employees. Operations Financial Services. Through its subsidiaries, Mercantile offers complete banking and trust services to the consumer, institutional, commercial, corporate, affluent and agricultural segments of the market areas which it serves. Services include commercial, real estate, installment and credit card loans, checking, savings and time deposits, trust and other fiduciary services, and various other customer services such as brokerage services, direct equipment lease financing, international banking and safe deposit services. Most of Mercantile's subsidiary financial institutions serve only the general area in which they are located, predominantly in the 7th, 8th and 10th Federal Reserve Districts. Membership in Mercantile's subsidiary group provides each subsidiary institution with a means of satisfying the credit needs of its customers beyond its own legal lending limit. Trust and Investment Advisory Services. Mercantile, through its subsidiaries, offers clients all types of fiduciary services, ranging from the management of funds for individuals, corporate retirement plans and charitable foundations to the administration of estates and trusts. To investors it offers portfolio management, advisory and custodian services. Mercantile Trust Company National Association ("Mercantile Trust") is a federally-chartered bank which provides personal trust services. Mississippi Valley Advisors Inc., a registered investment advisor, among other things, provides investment advisory services for employee benefit funds, including pension and profit- sharing plans, endowment funds and registered mutual funds. At December 31, 1998, Mercantile subsidiaries managed investments with a market value of approximately $25.9 billion and administered $16.2 billion additional in non- managed assets. Investment Services. Mercantile Bank offers a wide range of investment services to individuals, corporations, correspondent banks and others. Included in those services are foreign exchange, derivative products, money market and bond trading operations which serve banks and corporations in the purchase and sale of various investments and/or hedging instruments. In addition, Mercantile Bank is registered as a municipal securities dealer. Brokerage Services. Mercantile Investment Services, Inc. ("MISI"), a subsidiary of Mercantile Bank, is a registered broker/dealer and a member of both the National Association of Securities Dealers, Inc. ("NASD") and the Securities Investors Protection Corporation ("SIPC"). MISI currently offers both retail and discount brokerage services, including execution of transactions involving stocks, bonds, options, mutual funds and other securities. International. Mercantile Bank maintains accounts at 92 foreign banks, and 31 foreign banks maintain accounts at Mercantile Bank. In addition, Mercantile Bank is engaged in providing its customers with international banking services. Mercantile Bank and Mercantile Bank--Kansas/Kansas City offer a wide range of services to their customers involved in international business including currency exchange and letters of credit. Mercantile Bank maintains a Hong Kong subsidiary, Mercantile Trade Services Ltd., which enables the bank to issue, amend and negotiate letters of credit in Hong Kong on behalf of the bank's importing customers. Customers of other subsidiary banks with a need for international services are referred to these banks. Mercantile Bank also maintains a branch in the City of Georgetown in the Grand Cayman Islands. This branch enables Mercantile Bank to participate in the Eurodollar market for deposits and loans. At December 31, 1998, total deposits of the foreign branch amounted to $554,547,000. Correspondent Banking. In addition to Mercantile's services for individuals and corporations, its largest subsidiary bank, Mercantile Bank National Association (St. Louis), is a correspondent bank for approximately 250 commercial banks located primarily in the lower Midwest. Correspondent banking services to banks in 2 Kansas and the Kansas City metropolitan area are provided through Mercantile Bank--Kansas/Kansas City. Correspondent banking services include the processing of checks and collection items, financing for acquisitions and capital augmentation, and assistance with training and operations. Competition Mercantile's subsidiary financial institutions are subject to intense competition from other banks and financial institutions in their service areas, predominantly the 7th, 8th and 10th Federal Reserve Districts. In making loans, substantial competition is encountered from banks and other lending institutions such as savings and loan associations, insurance companies, finance companies, credit unions, factors, small loan companies and pension trusts. In addition, Mercantile subsidiaries compete for retail deposits with savings and loan associations, credit unions, insurance companies and money market mutual funds. The competition provided by other financial institutions is not limited to those institutions with offices located in the area served by the particular subsidiary. Many other institutions also offer some or all of the trust and fiduciary services performed by Mercantile's subsidiaries. Mercantile Bank competes with all local institutions and, in the field of corporate pension trust services, competition is nationwide. Supervision and Regulation General. As a bank holding company, Mercantile is subject to regulation under the Bank Holding Company Act of 1956, as amended ("BHCA"), and its examination and reporting requirements. Under the BHCA, a bank holding company may not directly or indirectly acquire the ownership or control of more than 5% of the voting shares or substantially all of the assets of any company, including a bank or savings and loan association, without the prior approval of the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). In addition, bank holding companies are generally prohibited under the BHCA from engaging in nonbanking activities, subject to certain exceptions. Mercantile and its subsidiaries are subject to supervision and examination by applicable federal and state banking agencies. The earnings of Mercantile's subsidiaries, and therefore the earnings of Mercantile, are affected by general economic conditions, management policies and the legislative and governmental actions of various regulatory authorities, including the Federal Reserve Board, the Federal Deposit Insurance Corporation ("FDIC"), the Office of the Comptroller of the Currency (the "Comptroller") and various state financial institution regulatory agencies. In addition, there are numerous governmental requirements and regulations that affect the activities of Mercantile and its subsidiaries. Certain Transactions with Affiliates. There are various legal restrictions on the extent to which a bank holding company and certain of its nonbank subsidiaries can borrow or otherwise obtain credit from its bank subsidiaries. In general, these restrictions require that any such extensions of credit must be on non-preferential terms and secured by designated amounts of specified collateral and be limited, as to the holding company or any one of such nonbank subsidiaries, to 10% of the lending institution's capital stock and surplus, and as to the holding company and all such nonbank subsidiaries in the aggregate, to 20% of such capital stock and surplus. Payment of Dividends. Mercantile is a legal entity separate and distinct from its financial institutions and other subsidiaries. The principal source of Mercantile's revenues is dividends from its financial institution subsidiaries. Various federal and state statutory provisions limit the amount of dividends an affiliate financial institution can pay to Mercantile without regulatory approval. Generally, approval of federal and state bank regulatory agencies, as appropriate, is required for any dividend if the total of all dividends declared in any calendar year would exceed the total of the institution's net profits, as defined by regulatory agencies, for such year combined with its retained net profits for the preceding two years. In addition, a national bank or a state member bank may not pay a dividend in an amount greater than its net profits then on hand. The payment of dividends by any financial institution subsidiary also may be affected by other factors, such as the maintenance of adequate capital. 3 Capital Adequacy. The Federal Reserve Board has issued standards for measuring capital adequacy for bank holding companies. These standards are designed to provide risk-responsive capital guidelines and to incorporate a consistent framework for use by financial institutions operating in major international financial markets. The banking regulators have issued standards for banks that are similar to, but not identical with, the standards for bank holding companies. In general, the risk-related standards require financial institutions and financial institution holding companies to maintain certain capital levels based on "risk-adjusted" assets, so that categories of assets with potentially higher credit risk will require more capital backing than categories with lower credit risk. In addition, banks and bank holding companies are required to maintain capital to support off-balance-sheet activities such as loan commitments. Mercantile and each of its subsidiary financial institutions exceed all applicable capital adequacy standards. Support of Subsidiary Banks. Under Federal Reserve Board policy, Mercantile is expected to act as a source of financial strength to each subsidiary bank and to commit resources to support each of the subsidiaries in circumstances where it might not choose to do so absent such a policy. This may be required at times when Mercantile may not find itself able to provide such support. In addition, any capital loans by Mercantile to any of its subsidiaries also would be subordinate in right of payment to deposits and certain other indebtedness of such subsidiary. Consistent with this policy regarding bank holding companies serving as a source of financial strength for their subsidiary banks, the Federal Reserve Board has stated that, as a matter of prudent banking, a bank holding company generally should not maintain a rate of cash dividends unless its net income available to common shareholders has been sufficient to fully fund the dividends, and the prospective rate of earnings retention appears consistent with the bank holding company's capital needs, asset quality and overall financial condition. FIRREA and FDICIA. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") contains a cross-guarantee provision that could result in insured depository institutions owned by Mercantile being assessed for losses incurred by the FDIC in connection with assistance provided to, or the failure of, any other insured depository institution owned by Mercantile. Under FIRREA, failure to meet the capital guidelines could subject a banking institution to a variety of enforcement remedies available to federal regulatory authorities, including the termination of deposit insurance by the FDIC. The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") made extensive changes to the federal banking laws. FDICIA instituted certain changes to the supervisory process, including provisions that mandate certain regulatory agency actions against undercapitalized institutions within specified time limits. FDICIA contains various other provisions that may affect the operations of banks and savings institutions. The prompt corrective action provision of FDICIA requires the federal banking regulators to assign each insured institution to one of five capital categories ("well capitalized," "adequately capitalized" or one of three "undercapitalized" categories) and to take progressively more restrictive actions based on the capital categorization, as specified below. Under FDICIA, capital requirements include a leverage limit, a risk-based capital requirement and any other measure of capital deemed appropriate by the federal banking regulators for measuring the capital adequacy of an insured depository institution. All institutions, regardless of their capital levels, are restricted from making any capital distribution or paying any management fees that would cause the institution to fail to satisfy the minimum levels for any relevant capital measure. The FDIC, the OCC and the Federal Reserve Board adopted capital-related regulations under FDICIA. Under those regulations, a bank will be well capitalized if it: (i) had a total risk-based capital ratio of 10% or greater; (ii) had a ratio of Tier I capital to risk-weighted assets of 6% or greater; (iii) had a ratio of Tier I capital to adjusted total assets of 5% or greater; and (iv) was not subject to an order, written agreement, capital directive or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. An association will be adequately capitalized if it was not "well capitalized" and: (i) had a total risk-based capital 4 ratio of 8% or greater; (ii) had a ratio of Tier I capital to risk-weighted assets of 4% or greater; and (iii) had a ratio of Tier I capital to adjusted total assets of 4% or greater (except that certain associations rated "Composite 1" under the federal banking agencies' CAMEL rating system in their most recent examination may be adequately capitalized if their ratios of Tier I capital to adjusted total assets were 3% or greater). All Mercantile subsidiary financial institutions as of December 31, 1998 were categorized as "well capitalized." Banking agencies also have adopted regulations that mandate that regulators take into consideration concentrations of credit risk and risks from non- traditional activities, as well as an institution's ability to manage those risks, when determining the adequacy of an institution's capital. This evaluation is made as part of the institution's regular safety and soundness examination. Banking agencies also have adopted regulations requiring regulators to consider interest rate risk (when the interest rate sensitivity of an institution's assets does not match the sensitivity of its liabilities or its off-balance-sheet position) in the evaluation of a bank's capital adequacy and have established an explicit risk-based capital charge for interest rate risk. Depositor Preference Statute. Legislation enacted in August 1993 provides a preference for deposits and certain claims for administrative expenses and employee compensation against an insured depository institution in the liquidation or other resolution of such an institution by any receiver. Such obligations would be afforded priority over other general unsecured claims against such an institution, including federal funds and letters of credit, as well as any obligation to shareholders of such an institution in their capacity as such. FDIC Insurance Assessments. The subsidiary depository institutions of Mercantile are subject to FDIC deposit insurance assessments. The FDIC has adopted a risk-based premium schedule. Each financial institution is assigned to one of three capital groups--well capitalized, adequately capitalized or undercapitalized--and further assigned to one of three subgroups within a capital group, on the basis of supervisory evaluations by the institution's primary federal and, if applicable, state supervisors, and on the basis of other information relevant to the institution's financial condition and the risk posed to the applicable insurance fund. The actual assessment rate applicable to a particular institution will, therefore, depend in part upon the risk assessment classification so assigned to the institution by the FDIC. See "--FIRREA and FDICIA." Interstate Banking and Other Recent Legislation. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 ("Riegle-Neal"), enacted in 1994, facilitates the interstate expansion and consolidation of banking organizations by permitting (i) bank holding companies that are adequately capitalized and managed to acquire banks located in states outside their home states regardless of whether such acquisitions are authorized under the law of the host state, (ii) interstate merger of banks, except for banks located in Montana and Texas, which states enacted legislation to "opt out" of this authority, (iii) banks to establish new branches on an interstate basis provided that such action is specifically authorized by the law of the host state, (iv) foreign banks to establish, with approval of the regulators in the United States, branches outside their home states to the same extent that national or state banks located in the home state would be authorized to do so, and (v) banks to receive deposits, renew time deposits, close loans, service loans and receive payments on loans and other obligations as agent for any bank or thrift affiliate, whether the affiliate is located in the same state or a different state. One effect of Riegle-Neal is to permit Mercantile to acquire banks located in any state and to permit bank holding companies located in any state to acquire banks and bank holding companies in Missouri. There also have been a number of recent legislative and regulatory proposals designed to improve the overall financial stability of the United States banking system, and to provide for other changes in the bank regulatory structure, including proposals to reduce regulatory burdens on banking organizations and to expand the nature of products and services banks and bank holding companies may offer. It is not possible to predict whether or in what form these proposals may be adopted in the future, and, if adopted, what their effect will be on Mercantile. 5 Statistical Disclosures The following statistical disclosures, except as noted, are included in the Annual Report of the Registrant to its Shareholders for the year ended December 31, 1998, and incorporated herein by reference.
Annual Report Schedule Reference - - -------- ------------------- I. Distribution of Assets, Liabilities and Shareholders' Equity; Interest Rates and Interest Differential A. Average Balance Sheets Page 82 B. Analysis of Net Interest Earnings (included herein at page 7) N/A C. Taxable-Equivalent Rate-Volume Analysis (included herein at page 7) N/A II. Investment Portfolio A. Book Value by Type of Security Note F, Page 64 B. Maturity Distribution (included herein at page 8) N/A III. Loan Portfolio A. Types of Loans Exhibit 13, Page 39 B. Maturities and Sensitivities to Changes in Interest Rates Exhibit 13, Page 39 C. Risk Elements 1. Non-Accrual, Past Due and Restructured Loans Exhibit 16, Page 43 Exhibit 17, Page 43 Note A, Page 59 2. Potential Problem Loans Commentary, Page 44 3. Foreign Outstandings * IV. Summary of Loan Loss Experience A. Reserve for Possible Loan Losses Exhibit 14, Page 40 Commentary, Page 40 Note A, Page 59 B. Allocation of the Reserve for Possible Loan Exhibit 15, Page 41 Losses V. Deposits A. Average Balances and Rates Paid by Deposit Category Page 82 B. Maturity Distribution of Certain CDs and Time Deposits Exhibit 7, Page 33 VI. Return on Equity and Assets Exhibit 4, Page 28 VII. Short-term Borrowings (included herein at page 9) N/A
*There were no significant interest bearing deposits with foreign banks at December 31, 1998, 1997 or 1996. 6 - - ------------------------------------------------------------------------------- TAXABLE-EQUIVALENT RATE-VOLUME ANALYSIS (Dollars in Millions)
Average Average Volume Rate(/1/) Interest - - ------------------------ ------------------ -------------------- 1998 1997 1996 1998 1997 1996 1998 1997 1996 - - ------- ------- ------- ---- ----- ----- ------ ------ ------ Interest Income Loans and leases(/3/) $ 5,539 $ 4,824 $ 4,365 8.20% 8.59% 8.57% Commercial $ 454 $ 415 $ 374 3,711 3,490 3,208 8.50 8.66 8.66 Real estate--commercial 315 302 278 769 661 593 8.66 8.87 9.10 Real estate--construction 67 59 54 8,386 6,777 4,340 7.57 7.84 8.10 Real estate--residential mortgage 635 532 352 552 510 417 9.48 9.69 9.67 Real estate--home equity credit loans 52 49 40 2,694 2,404 2,217 9.06 9.12 9.18 Consumer 244 219 203 129 636 850 6.63 12.83 12.87 Credit card 9 82 110 - - ------- ------- ------- ------ ------ ------ 21,780 19,302 15,990 8.16 8.59 8.82 Total Loans and Leases 1,776 1,658 1,411 Investments in debt and equity securities 135 105 57 6.56 6.80 6.49 Trading 9 7 4 8,630 6,334 5,189 6.47 6.42 6.08 Taxable 559 407 315 425 470 511 8.13 8.13 8.01 Tax-exempt 35 38 41 - - ------- ------- ------- ------ ------ ------ 9,190 6,909 5,757 6.55 6.54 6.25 Total 603 452 360 Short-term investments 232 189 71 5.72 5.50 5.83 Due from banks--interest bearing 13 10 4 Federal funds sold and repurchase 311 265 267 5.44 6.41 5.67 agreements 17 17 15 - - ------- ------- ------- ------ ------ ------ 543 454 338 5.56 6.03 5.71 Total Short-term Investments 30 27 19 - - ------- ------- ------- ------ ------ ------ $31,513 $26,665 $22,085 7.64 8.01 8.10 Total Interest Income(/1/) $2,409 $2,137 $1,790 ======= ======= ======= ====== ====== ====== Interest Expense Interest Bearing Deposits $ 3,088 $ 2,935 $ 2,683 1.84 2.01 2.27 Interest bearing demand $ 57 $ 59 $ 61 3,991 3,463 3,029 4.04 4.02 3.64 Money market accounts 161 139 110 1,739 1,471 1,351 2.58 2.39 2.34 Savings 45 35 32 Consumer time certificates 9,574 8,644 7,055 5.54 5.55 5.58 under $100,000 530 479 393 185 205 192 5.31 4.62 4.22 Other time 10 10 8 - - ------- ------- ------- ------ ------ ------ 18,577 16,718 14,310 4.32 4.32 4.22 Total Interest Bearing Core Deposits 803 722 604 1,893 1,675 1,440 5.58 5.64 5.35 Time certificates $100,000 and over 106 95 77 411 458 184 5.65 5.72 5.70 Foreign 23 26 11 - - ------- ------- ------- ------ ------ ------ 2,304 2,133 1,624 5.59 5.66 5.39 Total Purchased Deposits 129 121 88 - - ------- ------- ------- ------ ------ ------ 20,881 18,851 15,934 4.46 4.47 4.34 Total Interest Bearing Deposits 932 843 692 3,294 2,930 1,671 5.29 5.43 5.37 Short-term borrowings 174 159 90 56 175 261 6.09 6.02 5.88 Bank notes 4 11 15 3,050 869 343 5.85 6.72 7.29 Long-term debt(/4/) 178 58 25 - - ------- ------- ------- ------ ------ ------ $27,281 $22,825 $18,209 4.72 4.69 4.52 Total Interest Expense $1,288 $1,071 $ 822 ======= ======= ======= ====== ====== ====== 2.92 3.32 3.58 Net Interest Rate Spread Net Interest Rate Margin 3.56 4.00 4.38 and Net Interest Income(/1/) $1,121 $1,066 $ 968 ====== ====== ====== Increase (Decrease) --------------------------------------------- 1997 to 1998 1996 to 1997 ---------------------- ---------------------- Rate(/2/) Vol. Total Rate(/2/) Vol. Total --------- ----- ------ --------- ----- ------ Interest Income Loans and leases(/3/) Commercial $(21) $ 60 $ 39 $ 1 $ 40 $ 41 Real estate--commercial (6) 19 13 -- 24 24 Real estate--construction (2) 10 8 (1) 6 5 Real estate--residential mortgage (23) 126 103 (17) 197 180 Real estate--home equity credit loans (1) 4 3 -- 9 9 Consumer (1) 26 25 (1) 17 16 Credit card (8) (65) (73) -- (28) (28) ------- ----- ------ --------- ----- ------ Total Loans and Leases (62) 180 118 (18) 265 247 Investments in debt and equity securities Trading -- 2 2 -- 3 3 Taxable 4 148 152 22 70 92 Tax-exempt -- (3) (3) 1 (4) (3) ------- ----- ------ --------- ----- ------ Total 4 147 151 23 69 92 Short-term investments Due from banks--interest bearing 1 2 3 (1) 7 6 Federal funds sold and repurchase agreements (3) 3 -- 2 -- 2 ------- ----- ------ --------- ----- ------ Total Short-term Investments (2) 5 3 1 7 8 ------- ----- ------ --------- ----- ------ Total Interest Income(/1/) $(60) $332 $272 $ 6 $341 $347 ======= ===== ====== ========= ===== ====== Interest Expense Interest Bearing Deposits Interest bearing demand $ (5) $ 3 $ (2) $(8) $ 6 $ (2) Money market accounts 1 21 22 13 16 29 Savings 3 7 10 -- 3 3 Consumer time certificates under $100,000 (1) 52 51 (3) 89 86 Other time 1 (1) -- 1 1 2 ------- ----- ------ --------- ----- ------ Total Interest Bearing Core Deposits (1) 82 81 3 115 118 Time certificates $100,000 and over (1) 12 11 5 13 18 Foreign -- (3) (3) -- 15 15 ------- ----- ------ --------- ----- ------ Total Purchased Deposits (1) 9 8 5 28 33 ------- ----- ------ --------- ----- ------ Total Interest Bearing Deposits (2) 91 89 8 143 151 Short-term borrowings (5) 20 15 2 67 69 Bank notes -- (7) (7) 1 (5) (4) Long-term debt(/4/) (27) 147 120 (5) 38 33 ------- ----- ------ --------- ----- ------ Total Interest Expense $(34) $251 $217 $ 6 $243 $249 ======= ===== ====== ========= ===== ====== Net Interest Rate Spread Net Interest Rate Margin and Net Interest Income(/1/)
(/1/)Taxable-equivalent basis includes tax-equivalent adjustments of $16,664,000, $18,084,000 and $18,593,000 for 1998, 1997 and 1996, respectively, based on a Federal income tax rate of 35%. (/2/)The rate-volume variance is allocated entirely to rate. (/3/)Income from loans on non-accrual status is included on a cash basis, while non-accrual loan balances are included in average volume. (/4/)Includes company-obligated mandatorily redeemable preferred securities of Mercantile Capital Trust I. - - ------------------------------------------------------------------------------- 7 - - ------------------------------------------------------------------------------- INVESTMENTS IN DEBT AND EQUITY SECURITIES(/1/) (Dollars in Thousands)
December 31, 1998 ------------------------------------------------------------------- Available-for-sale Held-to-maturity -------------------------------- ------------------------------ Estimated Amortized Estimated Amortized Fair Cost Fair Value Yield(/2/) Cost Value Yield(/2/) ---------- ---------- ---------- --------- --------- ---------- U.S. Treasury Within one year $ 217,801 $ 218,971 6.53% $ 6,513 $ 6,560 6.87% One to five years 59,619 60,655 6.01 -- -- -- Five to 10 years -- -- -- -- -- -- After 10 years -- -- -- -- -- -- ---------- ---------- ------- ------- Total 277,420 279,626 6.41 6,513 6,560 6.87 Average Maturity 9 mos. 5 mos. U.S. Government Agencies(/3/) Within one year 469,387 471,286 6.36 24,886 24,980 6.25 One to five years 4,105,446 4,137,876 6.27 64,355 65,984 8.32 Five to 10 years 1,400,245 1,408,487 6.21 -- -- -- After 10 years 19,318 19,746 6.71 -- -- -- ---------- ---------- ------- ------- Total 5,994,396 6,037,395 6.27 89,241 90,964 7.74 Average Maturity 4 yrs. 1 mo. 2 yrs. 1 mo. Obligations of State and Political Subdivisions Within one year 90,652 91,461 7.53 -- -- -- One to five years 157,653 162,456 7.89 -- -- -- Five to 10 years 100,725 105,162 8.09 -- -- -- After 10 years 80,790 83,922 8.02 -- -- -- ---------- ---------- ------- ------- Total 429,820 443,001 7.89 -- -- -- Average Maturity 5 yrs. 3 mos. Other(/3/) Within one year 240,659 240,890 6.58 1,704 1,664 9.61 One to five years 1,280,833 1,289,507 6.85 -- -- -- Five to 10 years 217,948 220,458 5.48 149 148 6.41 After 10 years 258,591 249,232 7.11 -- -- -- ---------- ---------- ------- ------- Total 1,998,031 2,000,087 6.70 1,853 1,812 9.35 Average Maturity 6 yrs. 3 mos. 3 yrs. 2 mos. Total Interest Earning Investments(/3/) Within one year 1,018,499 1,022,608 6.55 33,103 33,204 6.54 One to five years 5,603,551 5,650,494 6.45 64,355 65,984 8.32 Five to 10 years 1,718,918 1,734,107 6.23 149 148 6.41 After 10 years 358,699 352,900 7.29 -- -- -- ---------- ---------- ------- ------- Total 8,699,667 8,760,109 6.45 97,607 99,336 7.72 Average Maturity 4 yrs. 6 mos. 2 yrs. 0 mos. Federal Reserve Bank Stock, Federal Home Loan Bank Stock and Other Equity Investments 486,103 486,681 7.68 -- -- -- ---------- ---------- ------- ------- Total Portfolio $9,185,770 $9,246,790 6.52 $97,607 $99,336 7.72 ========== ========== ======= =======
(1) This exhibit excludes trading securities, which are reported at estimated fair value on the Consolidated Balance Sheet. Trading securities totaled $126,540,000, $70,536,000 and $31,361,000 at December 31, 1998, 1997, and 1996, respectively. (2) Taxable-equivalent basis. (3) Maturities of asset-backed obligations are based on the remaining weighted average maturities. - - ------------------------------------------------------------------------------- 8 - - -------------------------------------------------------------------------------- SHORT-TERM BORROWINGS (Dollars in Thousands)
1998 1997 1996 ------------------------- ------------------------- ------------------------- Average Average Average Amount Rate Maturity Amount Rate Maturity Amount Rate Maturity ---------- ---- -------- ---------- ---- -------- ---------- ---- -------- At Year End Federal funds purchased and repurchase agreements $2,087,373 4.60% 8 days $2,127,443 5.49% 14 days $1,861,994 5.77% 8 days Short-term FHLB advances 667,672 5.13 38 days 1,412,701 5.86 164 days 123,094 5.75 157 days Treasury tax and loan notes 222,044 4.69 4 days 104,535 5.42 2 days 118,886 5.16 2 days Commercial paper 3,025 5.23 29 days 1,510 5.25 15 days 19,405 5.45 17 days Other short-term borrowings 22,546 5.84 4 days 32,351 6.32 2 days 9,295 6.52 4 days ---------- ---------- ---------- Total Short-term Borrowings $3,002,660 4.73 14 days $3,678,540 5.64 71 days $2,132,674 5.74 16 days ========== ========== ========== Average for the Year Federal funds purchased and repurchase agreements $2,051,219 5.13% $2,085,927 5.32% $1,446,828 5.29% Short-term FHLB advances 1,052,433 5.61 718,697 5.73 117,705 6.36 Treasury tax and loan notes 157,074 5.20 87,513 5.25 78,909 5.20 Commercial paper 1,712 5.49 17,097 5.56 18,222 5.42 Other short-term borrowings 31,640 5.74 20,592 6.43 9,688 6.48 ---------- ---------- ---------- Total Short-term Borrowings $3,294,078 5.29 $2,929,826 5.43 $1,671,352 5.37 ========== ========== ========== Maximum Month-End Balance Federal funds purchased and repurchase agreements $2,370,228 $2,579,789 $1,886,127 Short-term FHLB advances 1,472,114 1,412,701 130,239 Treasury tax and loan notes 402,733 260,822 439,181 Commercial paper 5,010 24,800 21,660 Other short-term borrowings 79,366 102,833 45,142
- - -------------------------------------------------------------------------------- 9 Item 2. Properties Mercantile and Mercantile Bank occupy 22 stories of the Mercantile Tower, a 35-story building owned by Mercantile Bank and located at Seventh and Washington Streets in St. Louis, Missouri. Among the other properties owned by Mercantile Bank are a four-story, 223,262 square foot data processing center located at 1005 Convention Plaza, St. Louis, Missouri, and a four-story, 110,503 square foot banking facility located at 721 Locust Street, St. Louis, Missouri. In addition, Mercantile Bank leases a two-story, 34,773 square foot banking facility located at 10 North Hanley Road, Clayton, Missouri. Mercantile's subsidiaries own and lease other facilities in Missouri, Illinois, Kansas, Iowa, Arkansas and Kentucky. See Note H to the Consolidated Financial Statements included on page 66 in the Annual Report of the Registrant to its Shareholders for the year ended December 31, 1998, which is incorporated herein by reference. Item 3. Legal Proceedings Mercantile and its subsidiaries are subject to various legal actions and proceedings in the normal course of business, some of which involve substantial claims for compensatory or punitive damages. Although litigation is subject to many uncertainties and the ultimate exposure with respect to these matters cannot be ascertained, management does not believe that the final outcome of any known or threatened litigation will have a material adverse effect on the financial condition of Mercantile. Item 4. Submission of Matters to a Vote of Security Holders None. Item 4a. Executive Officers of the Registrant See Part III, Item 10. 10 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters Information concerning the Common Stock of the Registrant, included on page 85 in the Annual Report of the Registrant to its Shareholders for the year ended December 31, 1998, is incorporated herein by reference. Item 6. Selected Financial Data Selected Financial Data, included as Exhibit 3 on page 27 in the Annual Report of the Registrant to its Shareholders for the year ended December 31, 1998, is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Management's Discussion and Analysis of Financial Condition and Results of Operations, included on pages 25 through 52 of the Annual Report of the Registrant to its Shareholders for the year ended December 31, 1998, is incorporated herein by reference. Item 7a. Quantitative and Qualitative Disclosures About Market Risk Quantitative and Qualitative Disclosures About Market Risk, included as Exhibit 6 on page 32 and under the Section entitled "Interest Rate Sensitivity" on page 31 of the Annual Report of the Registrant to its Shareholders for the year ended December 31, 1998, is incorporated herein by reference. Item 8. Financial Statements and Supplementary Data The following consolidated financial statements, included in the Annual Report of the Registrant to its Shareholders for the year ended December 31, 1998, are incorporated herein by reference.
Annual Report Statement Reference - - --------- ------------- Independent Auditors' Report. Page 53 Consolidated Statement of Income--Years ended December 31, 1998, 1997 and 1996. Page 54 Consolidated Balance Sheet--December 31, 1998, 1997 and 1996. Page 55 Consolidated Statement of Changes in Shareholders' Equity--Years ended December 31, 1998, 1997 and 1996. Page 56 Consolidated Statement of Cash Flows--Years ended December 31, 1998, 1997 and 1996. Page 57 Consolidated Statement of Comprehensive Income Page 58 Notes to Consolidated Financial Statements. Pages 59-79
Selected Quarterly Financial Data, included as Exhibit 20 on page 52 in the Annual Report of the Registrant to its Shareholders for the year ended December 31, 1998, is incorporated herein by reference. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable. PART III Item 10. Directors and Executive Officers of the Registrant Information regarding directors is contained in "Election of Directors" and "Beneficial Ownership of Stock by Management," included in the Registrant's Proxy Statement for the 1999 Annual Meeting of Shareholders, which information is incorporated herein by reference. 11 The following is a list, as of February 26, 1999, of the names and ages of the executive officers of Mercantile and all positions and offices with Mercantile presently held by the person named. There is no family relationship between any of the named persons.
Name Age All Positions and Offices Held with Mercantile ---- --- ---------------------------------------------- W.Randolph Adams 54 Senior Executive Vice President and Chief Administrative Officer John Q. Arnold 54 Vice Chairman, Private Banking and Investments Jon W. Bilstrom 52 General Counsel and Secretary John P. Dubinsky 55 Chairman, President and Chief Executive Officer, Mercantile Bank National Association John R. Elmore 42 President and Chief Executive Officer, Mercantile Credit Corp., Inc. Arthur G. Heise 50 Senior Vice President and Auditor Thomas H. Jacobsen 59 Chairman of the Board, President and Chief Executive Officer Stephen F. Milstid 48 Vice Chairman--Operations, Mercantile Bank National Association John W. McClure 53 Vice Chairman and Chief Financial Officer Michael T. Normile 49 Senior Vice President, Finance and Control
The executive officers were appointed by and serve at the pleasure of the Board of Directors of Mercantile. Messrs. Adams, Arnold, Bilstrom, Heise, Jacobsen, Milstid, McClure and Normile have served as executive or senior officers of either Mercantile or Mercantile Bank for at least the last five years. Mr. Dubinsky served as President and Chief Executive Officer at Mark Twain Bancshares, Inc. prior to joining Mercantile in April of 1997. Mr. Elmore served as President of Mercantile Bank of Lawrence from 1990 until starting in his new position in 1998. Information regarding compliance with Section 16 of the Securities and Exchange Act of 1934, as amended, is contained in "Compliance with Section 16(a) of the Exchange Act," included in the Registrant's Proxy Statement for the 1999 Annual Meeting of Shareholders, which information is incorporated herein by reference. Item 11. Executive Compensation Information regarding executive compensation is contained in "Compensation of Executive Officers," included in the Registrant's Proxy Statement for the 1999 Annual Meeting of Shareholders, which is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management Information regarding security ownership of certain beneficial owners and management is contained in "Voting Securities and Principal Holders Thereof" and "Beneficial Ownership of Stock by Management," included in the Registrant's Proxy Statement for the 1999 Annual Meeting of Shareholders, which is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions Information regarding certain relationships and related transactions is contained in "Interest of Management and Others in Certain Transactions," included in the Registrant's Proxy Statement for the 1999 Annual Meeting of Shareholders, which is incorporated herein by reference. 12 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) (1) Financial Statements: Incorporated herein by reference, are listed in Item 8 hereof. (2) Financial Statement Schedules: None. (3) Exhibits: See Exhibit Index at page 17 hereof. (b) Reports on Form 8-K Registrant filed a Current Report on Form 8-K on October 7, 1998, as previously disclosed in the Quarterly Report on Form 10-Q for the quarter ended September 30, 1998. That 8-K, under Item 5, contained supplemental consolidated financial statements for the years ended December 31, 1997, 1996 and 1995. Said statements restated Registrant's historical consolidated financial statements for those years to reflect the acquisitions of Firstbank of Illinois Co. ("Firstbank") and CBT Corporation ("CBT") on July 1, 1998. The Firstbank and CBT acquisitions were accounted for under the pooling-of-interests method of accounting. Registrant also filed Unaudited Interim Consolidated Financial Statements restating the Registrant's historical consolidated financial statements for the Firstbank and CBT transactions: 1) as of and for the three month periods ended March 31, 1998 and 1997; and 2) as of June 30, 1998 and 1997, and for the three and six month periods ended June 30, 1998 and 1997. Under Item 7, Registrant filed the consent of KPMG Peat Marwick LLP to incorporation by reference of its report on the Supplemental Financial Statements into pending registration statements of the Registrant. The October 7, 1998 Form 8-K included the financial statements, notes and auditor's report listed below: Independent Auditor's Report of KPMG Peat Marwick LLP dated October 7, 1998. Supplemental Consolidated Statement of Income for the years ended December 31, 1997, 1996 and 1995. Supplemental Consolidated Balance Sheet as of December 31, 1997, 1996 and 1995. Supplemental Consolidated Statement of Changes in Shareholders' Equity for the years ended December 31, 1997, 1996 and 1995. Supplemental Consolidated Statement of Cash Flows for the years ended December 31, 1997, 1996 and 1995. Notes to Supplemental Consolidated Statements. Supplemental Interim Consolidated Statement of Income (Unaudited) for the three months ended March 31, 1998 and 1997. Supplemental Interim Consolidated Balance Sheets (Unaudited) as of March 31, 1998 and 1997. Supplemental Interim Consolidated Statement of Changes in Shareholders' Equity (Unaudited) for the three months ended March 31, 1998 and 1997. Supplemental Interim Consolidated Statement of Cash Flows (Unaudited) for the three months ended March 31, 1998 and 1997. 13 Supplemental Interim Consolidated Statement of Comprehensive Income (Unaudited) for the three months ended March 31, 1998 and 1997. Supplemental Interim Consolidated Statement of Income (Unaudited) for the three months and six months ended June 30, 1998 and 1997. Supplemental Interim Consolidated Balance Sheets (Unaudited) as of June 30, 1998 and 1997. Supplemental Interim Consolidated Statement of Changes in Shareholders' Equity (Unaudited) for the six months ended June 30, 1998 and 1997. Supplemental Interim Consolidated Statement of Cash Flows (Unaudited) for the six months ended June 30, 1998 and 1997. Supplemental Interim Consolidated Statement of Comprehensive Income (Unaudited) for the three months and six months ended June 30, 1998 and 1997. 14 SIGNATURES Pursuant to the requirements of Section 13 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. MERCANTILE BANCORPORATION INC. (Registrant) /s/ Thomas H. Jacobsen Date: March 26, 1999 By: _________________________________ Thomas H. Jacobsen Chairman of the Board, President, Chief Executive Officer and Director POWER OF ATTORNEY We, the undersigned officers and directors of Mercantile Bancorporation Inc., hereby severally and individually constitute and appoint Thomas H. Jacobsen and John W. McClure, and each of them, the true and lawful attorneys and agents of each of us to execute in the name, place and stead of each of us (individually and in any capacity stated below) any and all amendments to this Annual Report on Form 10-K and all instruments necessary or advisable in connection therewith and to file the same with the Securities and Exchange Commission, each of said attorneys and agents to have the power to act with or without the others and to have full power and authority to do and perform in the name and on behalf of each of the undersigned every act whatsoever necessary or advisable to be done in the premises as fully and to all intents and purposes as any of the undersigned might or could do in person, and we hereby ratify and confirm our signatures as they may be signed by our said attorneys and agents or each of them to any and all such amendments and instruments. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date --------- ----- ---- /s/ Thomas H. Jacobsen Chairman of the Board, March 26, 1999 ____________________________________ President and Chief (Thomas H. Jacobsen) Executive Officer Principal Executive Officer /s/ John W. McClure Vice Chairman, Chief March 18, 1999 ____________________________________ Financial Officer (John W. McClure) Principal Financial Officer /s/ Michael T. Normile Senior Vice President, March 19, 1999 ____________________________________ Finance and Control (Michael T. Normile) Principal Accounting Officer /s/ Richard E. Beumer Director March 16, 1999 ____________________________________ (Richard E. Beumer) /s/ Harry M. Cornell Director March 15, 1999 ____________________________________ (Harry M. Cornell, Jr.)
15
Signature Title Date --------- ----- ---- /s/ Dr. Henry Givens Director March 15, 1999 ____________________________________ (Dr. Henry Givens, Jr.) /s/ William A. Hall Director March 16, 1999 ____________________________________ (William A. Hall) /s/ Cinda A. Hallman Director March 15, 1999 ____________________________________ (Cinda A. Hallman) /s/ Frank Lyon, Jr. Director March 15, 1999 ____________________________________ (Frank Lyon, Jr.) /s/ Robert W. Murray Director March 23, 1999 ____________________________________ (Robert W. Murray) /s/ Harvey Saligman Director March 16, 1999 ____________________________________ (Harvey Saligman) /s/ Craig D. Schnuck Director March 26, 1999 ____________________________________ (Craig D. Schnuck) /s/ Alvin J. Siteman Director March 16, 1999 ____________________________________ (Alvin J. Siteman) /s/ Patrick T. Stokes Director March 22, 1999 ____________________________________ (Patrick T. Stokes) /s/ John A. Wright Director March 14, 1999 ____________________________________ (John A. Wright)
16 EXHIBIT INDEX
Exhibit No. Description ----------- ----------- No. 3-1(a) Restated Articles of Incorporation of the Registrant, as amended and currently in effect, filed as Exhibit 3-1(a) to Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998 (Commission File No. 1-11792), are incorporated herein by reference. No. 3-1(b) Certificate of Designation, Preferences and Rights of Series B Junior Participating Preferred Stock of the Registrant filed as Exhibit 3-1(b) to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998 (Commission File No. 1-11792), is incorporated herein by reference. No. 3-2 By-Laws of the Registrant, as amended and currently in effect, filed as Exhibit 3.2 to Amendment No. 2 to Registrant's Registration Statement on Form S-4 (No. 333- 17757), are incorporated herein by reference. No. 4-1 Form of Indenture Regarding Subordinated Securities between the Registrant and The First National Bank of Chicago as Trustee, filed on March 31, 1992 as Exhibit 4.1 to Registrant's Report on Form 8-K dated September 24, 1992 (Commission File No. 1-11792), is incorporated herein by reference. No. 4-2 Rights Agreement dated as of May 20, 1998, between Registrant and Harris Trust and Savings Bank, as Rights Agent (including as an exhibit thereto the form of Rights Certificate) filed as Exhibit 4-2 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998 (Commission File No. 1-11792), is incorporated herein by reference. No. 4-3 Form of Indenture Regarding Senior Debt Securities, filed as Exhibit 4.1 to Registrant's Registration Statement on Form S-3 (No. 333-25775), is incorporated herein by reference. No. 4-4 Form of Indenture Regarding Subordinated Debt Securities, filed as Exhibit 4.2 to Registrant's Registration Statement on Form S-3 (No. 333-25775), is incorporated herein by reference. No. 4-5 Indenture, dated February 4, 1997; First Supplemental Indenture, dated February 4, 1997, and Supplemental Indenture of First Supplemental Indenture, dated May 22, 1997, between the Company, as issuer, and The Chase Manhattan Bank, as Indenture Trustee, filed as Exhibits 4.5, 4.6 and 4.12, respectively, to the Company's Registration Statement on Form S-4 (No. 333-25131), are incorporated herein by reference. No. 10-1 The Mercantile Bancorporation Inc. 1987 Stock Option Plan, as amended, filed as Exhibit 10-3 to Registrant's Report on Form 10-K for the year ended December 31, 1989 (Commission File No. 1-11792), is incorporated herein by reference.* No. 10-2 The Mercantile Bancorporation Inc. Amended and Restated Executive Incentive Compensation Plan, filed as Annex H to Registrant's definitive Proxy Statement for the 1997 Annual Meeting of Shareholders (Commission File No. 1-11792), is incorporated herein by reference.* No. 10-3 The Mercantile Bancorporation Inc. Employee Stock Purchase Plan, filed as Exhibit 10-7 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 (Commission File No. 1-11792), is incorporated herein by reference.* No. 10-4 The Mercantile Bancorporation Inc. 1991 Employee Incentive Plan, filed as Exhibit 10-7 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1990 (Commission File No. 1-11792), is incorporated herein by reference.* No. 10-5 Amendment Number One to the Mercantile Bancorporation Inc. 1991 Employee Incentive Plan, filed as Exhibit 10-6 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 (Commission File No. 1-11792), is incorporated herein by reference.* No. 10-6 The Mercantile Bancorporation Inc. Amended and Restated Stock Incentive Plan, filed as Annex G to Registrant's definitive Proxy Statement for the 1997 Annual Meeting of Shareholders (Commission File No. 1-11792), is incorporated herein by reference.* No. 10-7 The Mercantile Bancorporation Inc. 1994 Stock Incentive Plan for Non-Employee Directors, filed as Appendix E to Registrant's definitive Proxy Statement for the 1994 Annual Meeting of Shareholders (Commission File No. 1-11792), is incorporated herein by reference.*
17
Exhibit No. Description ----------- ----------- No. 10-8 The Mercantile Bancorporation Inc. Amended and Restated Voluntary Deferred Compensation Plan, filed as Exhibit 10.1 to Registrant's Registration Statement on Form S-8 (No. 333- 47713), is incorporated herein by reference.* No. 10-9 Mercantile Bancorporation Inc. Supplemental Retirement Plan, filed as Exhibit 10-12 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 (Commission File No. 1-11792), is incorporated herein by reference.* No. 10-10 Mercantile Bancorporation Inc. Voluntary Deferred Compensation Plan for Non-Employee Affiliate Directors and Advisory Directors, filed as Exhibit 10.3 to Registrant's Registration Statement on Form S-8 (No. 333-47713), is incorporated herein by reference.* No. 10-11 Mercantile Bancorporation Inc. Amended and Restated Stock Incentive Plan for Non-Employee Directors, filed as Exhibit 10.2 to Registrant's Registration Statement on Form S-8 (No. 333-47713), is incorporated herein by reference.* No. 10-12 Employment Agreement for Thomas H. Jacobsen, as amended and restated, filed as Exhibit 10.9 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1997 (Commission File No. 1-11792), is incorporated by reference herein.* No. 10-13 Form of Change of Control Employment Agreement for John W. McClure, W. Randolph Adams, John Q. Arnold and Certain Other Executive Officers, filed as Exhibit 10-10 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 (Commission File No. 1-11792), is incorporated herein by reference.* No. 10-14 Employment Agreement for Alvin J. Siteman, dated November 18, 1996, filed as Exhibit 10.3 to Registrant's Report on Form 10-Q for the quarter ended March 31, 1997 (Commission File No. 1-11792), is incorporated herein by reference.* No. 10-15 Employment Agreement for John P. Dubinsky, dated October 27, 1996, filed as Exhibit 10.4 to Registrant's Report on Form 10-Q for the quarter ended March 31, 1997 (Commission File No. 1-11792), is incorporated herein by reference.* No. 13 Excerpts from Annual Report of the Registrant to its Shareholders for the year ended December 31, 1998. No. 21 Subsidiaries of the Registrant as of February 26, 1999. No. 23 Consent of KPMG LLP. No. 24 Power of Attorney (on signature page). No. 27 Financial Data Schedule (December 31, 1998).
- - -------- *Management contract or compensatory plan or arrangement 18 EX-13 2 EXCERPTS FROM ANNUAL REPORT EXHIBIT NO. 13 Mercantile Bancorporation Inc. and Subsidiaries FINANCIAL CONTENTS Financial Commentary 25 Performance Summary 29 Net Interest Income 29 Liquidity 31 Interest Rate Sensitivity 33 Deposits 34 Non-Core Funding 35 Capital Resources 37 Investments in Debt and Equity Securities 38 Loans 40 Risk Management and the Reserve for Possible Loan Losses 42 Non-Performing Assets 44 Off-Balance-Sheet Risk 45 Other Income 47 Other Expense 49 Year 2000 50 Income Taxes 51 Fourth Quarter Results 53 Management Report on Consolidated Financial Statements Audited Financial Statements 53 Independent Auditors' Report 54 Mercantile Bancorporation Inc. and Subsidiaries Consolidated Financial Statements 59 Notes to Consolidated Financial Statements 80 Six Year Consolidated Financial Statements Special Note Certain statements in this report that relate to the plans, objectives or future performance of Mercantile Bancorporation Inc. may be deemed to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are based on Management's current expectation. Actual strategies and results in future periods may differ materially from those currently expected because of various risks and uncertainties. ---- 24 Mercantile Bancorporation Inc. and Subsidiaries FINANCIAL COMMENTARY PERFORMANCE SUMMARY The most meaningful comparison of the fundamental financial performance of Mercantile Bancorporation Inc. ("Mercantile" or "Corporation") excludes certain charges from the results of operations for the years 1998, 1997 and 1996. In all three years, Mercantile recorded anticipated costs relating to the 17 acquisitions that were made in those years. These charges include accruals to substantially conform the accounting and credit policies of the acquired institutions to those of Mercantile as well as to account for the infrequent expenses associated with those transactions. After the appropriate tax benefit, acquisition charges in 1998 totaled $76,783,000, and they were partially offset by $29,421,000 after-tax gains recorded on the divestitures of two Missouri banks formerly owned by Firstbank of Illinois Co. ("Firstbank"). The corresponding gain on this sale offset nearly 40% of the 1998 acquisition charges. The sale of these banks, which had combined assets of approximately $300 million, was required by the State of Missouri. Additionally, in the fourth quarter of 1998, the Corporation recorded an after-tax restructuring charge of $29,330,000 relating to staff rightsizing, centralization, branch closings and consolidation of back office functions. Details of this charge are described in Note V to the Consolidated Financial Statements. The years 1997 and 1996 also included one-time after-tax charges of $32,500,000 and $8,050,000, respectively, to recognize the sale of the $405,000,000 non-strategic private label credit card business in 1997 at a discount and a special assessment paid to the Savings Association Insurance Fund ("SAIF") reserve fund in 1996. Acquisition charges were also recorded in both years. Exhibit 1 summarizes actual results and "adjusted" results, which exclude these infrequent expenses discussed above. It is the adjusted results that allow for the best financial comparison for the years 1998 to 1997 and 1996. Exhibit 3 provides a six-year summary of actual results with appropriate growth rates. After eliminating the infrequent expense previously detailed, adjusted net income for 1998 was $451,995,000, a 19.2% increase over the adjusted $379,199,000 earned a year ago, which in turn was up 11.2% from 1996. Diluted earnings per share on an adjusted basis was $2.90 in 1998, 9.0% higher than the $2.66 reported in 1997. Adjusted diluted earnings per share in 1997 was 6.0% higher than in 1996. Adjusted return on assets was 1.31% in 1998 compared with 1.30% in 1997, while adjusted return on average equity for the year was 15.29% versus 15.32% last year. Including the infrequent charges, reported net income for Mercantile in 1998 was $375,303,000 as compared with $246,822,000 earned a year ago and $284,453,000 in 1996. The corresponding basic earnings per share in 1998 was $2.45 compared with $1.76 and $2.12 in the prior years, respectively. Diluted earnings per share was $2.41 in 1998 versus $1.73 in 1997 and $2.09 in 1996. Exhibit 1
- - --------------------------------------------------------------------------------------- ADJUSTED RESULTS Year Ended December 31, 1998 -------------------------------------- Diluted Earnings per Return (Dollars in thousands except per share data) Net Income Share on Assets - - --------------------------------------------------------------------------------------- Reported $375,303 $2.41 1.09% Acquisition expenses 76,783 .49 .22 Gain on sale of subsidiaries (29,421) (.19) (.08) Restructuring charge 29,330 .19 .08 - - --------------------------------------------------------------------------------------- Adjusted $451,995 $2.90 1.31% - - --------------------------------------------------------------------------------------- Year Ended December 31, 1997 -------------------------------------- Reported $246,822 $1.73 .85% Acquisition expenses 99,877 .70 .34 Loss on sale of credit card loans 32,500 .23 .11 - - --------------------------------------------------------------------------------------- Adjusted $379,199 $2.66 1.30% - - --------------------------------------------------------------------------------------- Year Ended December 31, 1996 -------------------------------------- Reported $284,453 $2.09 1.19% Acquisition expenses 48,489 .36 .20 Special SAIF assessment 8,050 .06 .04 - - --------------------------------------------------------------------------------------- Adjusted $340,992 $2.51 1.43% - - ---------------------------------------------------------------------------------------
As noted above, the past three years included significant acquisition activity. In 1998, seven transactions were completed adding $5.2 billion in assets. In 1997, three acquisitions were closed adding $10.7 billion in assets, while in 1996 there were seven transactions that added $3.0 billion in assets. Note C to the Consolidated Financial Statements details acquisition activity for the past three years. There are no pending transactions as of December 31, 1998, and at year-end 1998 Mercantile operated from 11 bank charters and 474 banking offices in six states. As recently as December 31, 1995, Mercantile had 75 bank charters and one thrift charter. The reduction in charters has increased operating efficiency and expanded customer service. By March 1, 1999, Mercantile further reduced its bank charters to seven and all banks were operating on common Mercantile systems. Mercantile's acquisition of St. Louis-based Roosevelt Financial Group, Inc. ("Roosevelt") was consummated on July 1, 1997 and accounted for as a purchase. Thus, historical financial statements were not restated, and its results of operations are included with Mercantile's from July 1, 1997 forward. ------ 25 Mercantile Bancorporation Inc. and Subsidiaries All figures have been restated to include the pre-acquisition accounts and results of operations of Firstbank and CBT Corporation ("CBT"), which were merged with Mercantile on July 1, 1998 in transactions accounted for as poolings-of-interests. The earnings per share dilution from these transactions was $.03 in the first half of 1998. There were four other poolings-of-interests in 1998, but they were immaterial to the financial position and results of operations of Mercantile, and thus the historical financial statements were not restated for these acquisitions. It is important to recognize cash based earnings, which excludes intangible asset amortization, because it is more indicative of cash flows and thus the Corporation's ability to support growth and pay dividends. Goodwill of $608,076,000 was added to the Corporation's balance sheet in conjunction with the July 1, 1997 purchase transaction. Incremental goodwill amortization in 1998 versus 1997 was $20,394,000, and the earnings per share impact was $.13. In 1998, cash based adjusted diluted earnings per share was $3.26, up 11.3% from the $2.93 earned in 1997. See Exhibit 2 for other cash based performance ratios and the related comparisons to 1997. Net interest income increased 5.4% to $1.1 billion during 1998. The acquisition of Roosevelt caused a significant shift in the mix of earning assets and funding sources, which in a changed interest rate environment had a dampening effect on net interest income growth. These shifts, combined with the cost of debt issued in conjunction with the acquisition and the sale of the former co-branded credit card portfolio, resulted in an estimated 60-basis-point decline in the net interest rate margin during the second half of 1997. The net interest rate margin dropped further during the first three quarters of 1998, before stabilizing, due to competitive pressures on both deposit and loan pricing, accelerated mortgage asset prepayments and refinancings, the flat yield curve, and the divestiture of selected portions of the Corporation's remaining credit card portfolio. The year-to-date margin was 3.56% in 1998 compared with 4.00% in 1997 and 4.38% in 1996. Average earning assets for 1998 of $31.5 billion were 18.2% higher than last year following growth of 20.7% in 1997. The mortgage asset attrition significantly impacted average earning asset growth in 1997 and 1998. For the year ended December 31, 1998, other income was $541,918,000, an improvement of $127,725,000 or 30.8% from last year following growth of 12.5% in 1997. Excluding 1998's $48,051,000 gain on the required divestiture of the two Missouri Firstbank units and securities losses incurred on the realignment of acquired portfolios, 1998 other income was up 19.6%. Other income grew due to fee growth in core businesses, increased service charge revenue, higher retail brokerage and mortgage banking income, and gains recorded on the sales of both selected businesses and investment securities. Gains on the sale of selected non-strategic businesses occurred in all three years and are discussed in the other income section on page 45 of this report. Exhibit 2
- - ----------------------------------------------------------------------------- CASH BASED EARNINGS ----------------------------- (Dollars in thousands except per share data) 1998 1997 Change - - ----------------------------------------------------------------------------- Adjusted net income $451,995 $379,199 19.2% Add back: Goodwill amortization 55,257 34,863 58.5 Other intangible asset amortization 2,537 5,307 (52.2) - - ----------------------------------------------------------------------------- Total Intangible Asset Amortization 57,794 40,170 43.9 Less tax effect (917) (1,720) (46.7) - - ----------------------------------------------------------------------------- Cash Based Adjusted Net Income $508,872 $417,649 21.8 - - ----------------------------------------------------------------------------- CASH BASED ADJUSTED DILUTED EARNINGS PER SHARE $ 3.26 $ 2.93 11.3% - - ----------------------------------------------------------------------------- CASH BASED ADJUSTED PERFORMANCE RATIOS Return on tangible assets 1.51% 1.46% Return on tangible equity 23.72 21.57 Efficiency ratio 51.63 52.35 Other expense to average tangible assets 2.47 2.71 - - -----------------------------------------------------------------------------
Non-interest expenses were up $40,379,000 or 4.1% from a year ago and totaled $1,026,757,000 compared with $986,378,000 last year and $805,187,000 in 1996. Other expense in 1998, 1997 and 1996 included $89,192,000, $121,393,000 and $51,071,000, respectively, in infrequent merger-related costs. As discussed earlier, 1998 also included the $45,130,000 restructuring charge, 1997 included a $50,000,000 discount on the sale of former co-branded credit card loans, and 1996 included the one-time SAIF assessment of $12,385,000. Excluding these infrequent costs, 1998 operating expenses grew by $77,450,000 or 9.5%; however, increased goodwill amortization accounted for $20,394,000 of this increase. On an adjusted basis, the year-to-date efficiency ratio was 55.21% compared with 55.07% last year, and the other expense to average assets ratio improved to 2.58% in 1998 from 2.80% in 1997. The cash based ------ 26 Mercantile Bancorporation Inc. and Subsidiaries efficiency ratio improved to 51.63% from 52.35% last year, and the expense to asset ratio contracted to 2.47% from 2.71% in 1997. Exhibit 3
- - ----------------------------------------------------------------------------------------------------------------------------------- SELECTED FINANCIAL DATA Growth Rates ------------------------------------------------------------------------------------------------------ 1998 1997 1996 1995 1994 1993 One Year Five Years - - ----------------------------------------------------------------------------------------------------------------------------------- OPERATING RESULTS EXCLUDING INFREQUENT ITEMS Adjusted net income (Thousands) $ 451,995 $ 379,199 $ 340,992 $ 318,155 $285,276 $246,605 19.2% 12.9% Adjusted basic earnings per share 2.95 2.71 2.54 2.37 2.18 1.92 8.9 9.0 Adjusted diluted earnings per share 2.90 2.66 2.51 2.33 2.14 1.88 9.0 9.1 PER SHARE DATA Basic earnings per share $ 2.45 $ 1.76 $ 2.12 $ 2.37 $ 2.05 $ 1.79 39.2% 6.5% Diluted earnings per share 2.41 1.73 2.09 2.33 2.02 1.75 39.3 6.6 Dividends declared 1.24 1.148 1.092 .88 .748 .66 8.0 13.4 Book value at year-end 19.53 18.57 16.87 16.31 14.43 13.46 5.2 7.7 Market price at year-end 46 1/8 61 1/2 34 1/4 30 11/16 20 13/16 20 1/16 (25.0) 18.1 OPERATING RESULTS (Thousands)/1/ Taxable-equivalent net interest income $1,120,924 $1,065,822 $ 967,556 $ 938,004 $ 929,199 $ 895,808 5.2% 4.6% Tax-equivalent adjustment 16,664 18,084 18,593 20,225 20,920 22,395 (7.9) (5.7) - - ----------------------------------------------------------------------------------------------------------------------------------- Net interest income 1,104,260 1,047,738 948,963 917,779 908,279 873,413 5.4 4.8 Provision for possible loan losses 51,154 86,355 78,766 44,952 53,094 77,485 (40.8) (8.0) Other income 541,918 414,193 368,010 339,989 297,783 316,025 30.8 11.4 Other expense 1,026,757 986,378 805,187 725,915 732,566 754,130 4.1 6.4 Income taxes 192,964 142,376 148,567 168,746 151,826 127,718 35.5 8.6 - - ----------------------------------------------------------------------------------------------------------------------------------- Net Income $ 375,303 $ 246,822 $ 284,453 $ 318,155 $ 268,576 $ 230,105 52.1 10.3 - - ----------------------------------------------------------------------------------------------------------------------------------- ENDING BALANCE SHEET (Millions) Total assets $ 35,800 $ 33,332 $ 24,996 $ 23,651 $ 22,089 $ 21,443 7.4% 10.8% Earning assets 32,376 30,383 22,775 21,555 20,394 19,765 6.6 10.4 Loans and leases 22,311 21,362 16,937 15,584 14,559 13,292 4.4 10.9 Investments in debt and equity securities 9,471 8,465 5,430 5,626 5,574 5,904 11.9 9.9 Deposits 25,461 24,809 19,785 18,464 17,342 17,607 2.6 7.7 Long-term debt/2/ 3,723 1,518 328 371 382 384 57.5 Shareholders' equity 3,074 2,762 2,263 2,211 1,897 1,757 11.3 11.8 Reserve for possible loan losses 309 284 258 261 275 262 8.7 3.3 Average Balance Sheet (Millions) Total assets $ 34,571 $ 29,097 $ 23,899 $ 22,915 $ 21,677 $ 21,081 18.8% 10.4% Earning assets 31,513 26,665 22,085 21,207 20,007 19,366 18.2 10.2 Loans and leases 21,780 19,302 15,990 15,265 13,687 12,918 12.8 11.0 Investments in debt and equity securities 9,190 6,909 5,757 5,547 5,914 5,874 33.0 9.4 Deposits 24,781 22,262 19,112 18,143 17,656 17,648 11.3 7.0 Long-term debt/2/ 3,050 869 343 381 395 378 51.8 Shareholders' equity 2,955 2,475 2,199 2,072 1,843 1,661 19.4 12.2 - - ----------------------------------------------------------------------------------------------------------------------------------- /1/ Infrequent items included herein. /2/ Includes company-obligated mandatorily redeemable securities of Mercantile Capital Trust I.
The provision for possible loan losses in 1998 was $51,154,000 compared with $86,355,000 the prior year and $78,766,000 in 1996. Included are infrequent merger-related provisions of $19,600,000 in 1998, $20,340,000 in 1997 and $13,666,000 in 1996. Net charge-offs for the year were $42,084,000 and represented .19% of average loans in 1998, compared with $81,070,000 and .42% the prior year and $92,193,000 or .58% in 1996. The declining loss rate reflects favorable asset quality trends and diminished credit card losses. At December 31, 1998, the reserve for possible loan losses was $308,890,000 and provided coverage of 222.76% of non-performing loans (i.e., non-accrual and renegotiated loans) compared with 241.91% last year. ------ 27 Mercantile Bancorporation Inc. and Subsidiaries Exhibit 4
SELECTED RATIOS --------------------------------------------------------------- 1998 1997 1996 1995 1994 1993 - - --------------------------------------------------------------------------------------------------------------------------- ADJUSTED RATIOS Return on assets 1.31% 1.30% 1.43% 1.39% 1.32% 1.17% Return on equity 15.29 15.32 15.50 15.36 15.48 14.85 Efficiency ratio 55.21 55.07 55.41 56.80 58.67 61.18 Other expense to average assets 2.58 2.80 3.10 3.17 3.32 3.52 Dividend payout 42.76 43.16 43.51 37.77 34.95 35.11 AS REPORTED RATIOS Return on assets 1.09 .85 1.19 1.39 1.24 1.09 Return on equity 12.70 9.97 12.93 15.36 14.58 13.85 Efficiency ratio 61.75 66.65 60.29 56.80 59.70 62.23 Other expense to average assets 2.97 3.39 3.37 3.17 3.38 3.58 Dividend yield 2.69 1.87 3.19 2.87 3.59 3.29 Dividend payout* 51.45 66.36 52.25 37.77 37.03 37.71 Tangible equity to tangible assets 6.55 5.92 8.31 8.83 8.08 7.61 Equity to assets 8.59 8.29 9.05 9.35 8.59 8.19 Tier I capital to risk-adjusted assets 9.84 9.40 11.50 12.37 12.03 10.97 Total capital to risk-adjusted assets 12.55 12.42 14.02 15.02 14.83 13.81 Leverage 7.16 6.52 8.52 8.87 8.37 7.73 Loans to deposits (Average) 87.89 86.71 83.66 84.14 77.52 73.20 Reserve for possible loan losses to outstanding loans 1.38 1.33 1.52 1.68 1.89 1.97 Reserve for possible loan losses to non-performing loans 222.76 241.91 298.11 240.34 536.18 290.58 Non-performing loans to outstanding loans .62 .55 .51 .70 .35 .68 Non-performing assets to total assets .60 .67 .42 .55 .36 .68 Net interest rate margin 3.56 4.00 4.38 4.42 4.64 4.63 - - --------------------------------------------------------------------------------------------------------------------------- *Based upon diluted earnings per share.
Non-performing loans and foreclosed assets as of December 31, 1998 were $152,163,000 or .68% of total loans and foreclosed assets, compared with $138,567,000 or .65% last year. The increase was largely in residential mortgage loans, which historically have low loan loss rates. Additional non-performing assets include investment securities acquired July 1, 1997, which had incurred a change in value that is considered an "other than temporary" impairment. These securities totaled $85,887,000 at December 31, 1997 and are discussed in detail on page 44 of this report. With paydowns, they had declined to $63,296,000 at December 31, 1998. Foreclosed assets declined to $13,500,000 from $21,098,000 at December 31, 1997. Consolidated assets of $35.8 billion at December 31, 1998 were up 7.4% from last December 31. Core deposits increased by 2.6% to $23.0 billion, loans were $22.3 billion, up 4.4% from last year, and shareholders' equity of $3.1 billion was 11.3% higher than at December 31, 1997. All measures of capital adequacy remained adequate and were significantly strengthened from December 31, 1997 levels. Tier I capital to risk-adjusted assets was 9.84%, while total capital to risk-adjusted assets at December 31, 1998 was 12.55%. The ratio of tangible equity to tangible assets was 6.55% at December 31, 1998, up significantly from the 5.92% at year-end 1997. At the Board of Directors meeting on February 17, 1999, the quarterly dividend was increased by 9.7% to $.34 from $.31 per share. At December 31, 1998, Mercantile's assets are distributed as follows: St. Louis metropolitan area $18.4 billion, outstate Missouri $4.4 billion, metropolitan Kansas City $4.2 billion, Iowa and northwestern Illinois $3.8 billion, Arkansas $1.8 billion, outstate Illinois $2.4 billion and western Kentucky $1.0 billion. Financial Accounting Standard ("FAS") 131, "Disclosures about Segments of an Enterprise and Related Information," requires for the first time in 1998 results of operations for the various business activities in the manner that the Corporation internally manages. Those results are portrayed in Note U to the Consolidated Financial Statements. The following financial commentary presents a more thorough discussion and analysis of the results of operations and financial condition of the Corporation for the years ------ 28 Mercantile Bancorporation Inc. and Subsidiaries ended December 31, 1998, 1997 and 1996. It should be read in conjunction with the accompanying audited Consolidated Financial Statements and related notes. Financial highlights for the past six years are presented in Exhibits 3 and 4. NET INTEREST INCOME Net interest income, the difference between total interest income on earning assets and total interest expense, the cost of funds supporting those assets, is Mercantile's primary source of earnings. Representing the Corporation's gross profit from lending, investing, deposit gathering and borrowing activities, net interest income is affected by many variables including the volume, yield and mix of earning assets and interest bearing liabilities, the level of non- performing assets, the level of non-interest bearing liabilities, the general level of interest rates and the slope of the yield curve. The net interest rate margin is net interest income on a fully taxable-equivalent basis as a percentage of average earning assets. In 1998, net interest income was $1.1 billion, an increase of $56,522,000 or 5.4% from the $1.0 billion earned in 1997, which was up 10.4% over 1996 results. The volume of average earning assets grew by 18.2% in 1998, and the net interest rate margin was 3.56% compared with 4.00% in 1997 and 4.38% in 1996. The July 1, 1997 acquisition caused a significant shift in the mix of earning assets and funding sources. This shift and the cost of the debt issued in the transaction caused an estimated 60-basis-point decline in the net interest rate margin during the second half of 1997. Competitive pressures on both loan and deposit pricing, accelerated mortgage asset prepayments and refinancings, the flat yield curve and the divestiture of selected portions of the Corporation's remaining credit card portfolio caused further contraction in the net interest rate margin in the first three quarters of 1998. Average earning assets in 1998 grew by $4.8 billion or 18.2% when compared with 1997, and average loans grew by 12.8%. This growth was funded by an increase of $2.3 billion or 11.7% in average core deposits, a $170,745,000 increase in purchased deposits, a $364,252,000 increase in short-term borrowed funds and a $1.9 billion increase in Federal Home Loan Bank ("FHLB") term borrowings. The shift in funding was necessitated by the lower overall interest rate environment and management's efforts to bring down the average cost of funds. On average, lower-yielding residential real estate mortgage loans as a percentage of earning assets increased from 25.42% in 1997 to 26.61% in 1998, even though from year-end 1997 to year-end 1998 residential mortgage loans were down $549,055,000 or 6.3%. Additionally, the ratio of higher costing consumer time certificates under $100,000 to total average core deposits remained above 40% even though from year-end 1997 these deposits declined by $663,906,000 or 6.7%. It has been management's strategy to reduce the Corporation's reliance on both to levels more typical for Mercantile in periods prior to 1997. The decline in the net interest rate margin in 1998 from 1997 and 1996 levels also was attributable to continued competitive pricing for both loans and deposits, the sales of investment securities at gains, the interest expense incurred on recent debt issues, the continued movement of retail deposits from savings and transaction accounts to mutual funds, a greater dependence on wholesale funding and the absence of high-yielding credit card loans as a significant earning asset. Partially offsetting these negative factors in 1998 were increases in net demand deposits (non-interest bearing demand deposits less cash and due from banks) of $317,291,000 or 14.1%. Subsequent discussions on liquidity and interest rate sensitivity, deposits, securities and loans further detail the changes in net interest income and the net interest rate margin for the years 1998, 1997 and 1996. LIQUIDITY The Corporation's Asset/Liability Management Committee ("ALCO") meets monthly to formulate guidelines for and to monitor the composition of assets and liabilities. The objectives are to meet earnings goals by producing the optimal yield and maturity mix consistent with pre-established guidelines for interest rate and liquidity plus capital constraints. Key to these goals is liquidity management, which ensures Mercantile has ready access to sufficient funds at reasonable rates to meet both existing commitments and future financial obligations. Liquidity management also is necessary to withstand fluctuations in deposit levels and to provide for customers' credit needs in a timely and cost- effective manner. Liquidity management is viewed from a long-term and short-term perspective, as well as from a liability and asset perspective. Management monitors liquidity through a periodic review of maturity profiles, yield and rate behaviors, and loan and deposit forecasts to minimize funding risks. ------ 29 Mercantile Bancorporation Inc. and Subsidiaries Long-term liquidity is a function of a strong capital position and a large core deposit base. Growth and stability of both of these components form the foundation for Mercantile's long-term liquidity strength. Short-term liquidity needs arise from the continuous fluctuations in the flow of funds on both sides of the balance sheet, and to a lesser extent from seasonal and cyclical customer demands. The six bank acquisitions made in 1998, as well as the acquisition of Mark Twain Bancshares, Inc. ("Mark Twain") in the second quarter of 1997, did not have a significant impact on the liquidity profile and funding needs of the Corporation, as their balance sheet profiles were those of a typical bank. The July 1, 1997 acquisition of Roosevelt significantly modified the liquidity profile as: 1) $650,000,000 of term debt was obtained in capital markets largely to fund the transaction; 2) significant FHLB borrowings were assumed; 3) a liquid and largely unpledged investment portfolio was acquired; 4) significant mortgage assets were acquired that generated large cash flows over time and provided opportunities to secure additional FHLB borrowings; and 5) substantial core deposits and customer relationships came with the transaction. The most important source of liquidity for Mercantile continues to be liability liquidity, which is the ability to raise new funds and renew maturing liabilities in a variety of markets. The most critical factor in assuring liability liquidity is the maintenance of confidence in Mercantile by suppliers of funds. The Corporation has its current liability position in line with established strategic objectives. Some of these objectives emphasize significant core deposit funding of subsidiary banks and capital positions that exceed regulatory guidelines. Mercantile's extensive retail network continues to provide the necessary core deposits to meet desired liquidity levels. Examples of the Corporation's liability liquidity include: 1) FHLB borrowing availability of $6.0 billion, of which only $3.5 billion was utilized at December 31, 1998; 2) an expanded, but as yet unused, $3.0 billion bank note program developed in 1998 supported by strong and improved credit ratings, which allows all of the major subsidiary banks to issue senior and subordinated notes over a broad range of maturities; 3) the $35.8 billion-asset size of Mercantile, which allows for greater diversification of funding sources where higher limits of funds can be obtained from large providers; and 4) $100,000,000 in lines of credit available to the Parent Company. These programs provide the Corporation with significant access to funds at a wide range of maturities. Asset liquidity is typically provided through the maturities of various assets, the net cash flow of fee-based businesses, the ability to convert loans and investments into cash, securitizations and the utilization of securities as collateral in repurchase agreements. Unpledged investment securities were $3.7 billion at December 31, 1998 compared with $4.5 billion last year-end. The reputation of Mercantile Bank N.A., as well as its financial strength and numerous long-term customer relationships, enables it to raise funds as needed in various markets. Historically, these funds have been purchased locally, nationally and internationally in the federal funds market and via large certificates of deposit and eurodollar transactions, capitalizing on relationships maintained with investment banks, money center banks and money market funds. At December 31, 1998, the Parent Company held $283,174,000 in cash, liquid money market investments and available-for-sale securities. The Parent Company's routine cash requirements consist primarily of operating expenses, dividends to shareholders, principal and interest payments on debt, and funds used in acquisitions, which are expected to be insignificant in 1999. Operating expenses are funded by subsidiary bank management fees, while shareholder dividends and debt service are satisfied by quarterly subsidiary bank dividends. The Parent Company has the ability to borrow funds in the commercial paper market, and has access to long-term capital markets. Maintaining favorable debt ratings is critical to liquidity as these ratings affect the availability and cost of funds to the Corporation. These public ratings are indicated in Exhibit 9 on page 35. Net cash provided by operating activities for the Corporation in 1998 was $356,739,000. Net income of $375,303,000, adjusted for non-cash charges, largely accounted for the net cash provided by operating activities. Net cash used by investing activities was $249,189,000 in 1998. The largest component of cash used by investing activities was the purchase of investment securities, which totaled $6.9 billion. Net cash provided by financing activities in 1998 was $360,840,000. The increase in the Corporation's long-term FHLB advances was a major source of net cash from financing activities. ------ 30 Mercantile Bancorporation Inc. and Subsidiaries INTEREST RATE SENSITIVITY Interest sensitivity is related to liquidity, as each is affected by maturing assets and sources of funds. Interest sensitivity, however, also takes into consideration those assets and liabilities with interest rates that are subject to change prior to maturity. The objective and primary focus of interest sensitivity management is to optimize earnings results, while managing, within internal policy constraints, interest rate risk. Mercantile's policy on rate sensitivity is to manage exposure to potential risks associated with changing interest rates by maintaining a balance sheet posture in which annual net interest income and the market value of portfolio equity are not significantly impacted by unexpected changes in interest rates. The total absence of risk, as well as excessive risk, will result in less than acceptable returns; therefore, Mercantile manages its interest sensitivity risk between those two extremes. Interest rate risk at a given point in time can be represented by an interest rate sensitivity position ("gap"). Exhibit 5 presents a summary balance sheet at December 31, 1998 with an interest rate gap analysis that shows the difference between the amount of assets and liabilities maturing or subject to repricing in given time periods. The cumulative gap represents the net position of assets and liabilities subject to repricing over specified time periods. A static gap report is one measure of the risk inherent in the existing balance sheet structure as it relates to potential changes in net interest income; it indicates that the Corporation was modestly negatively gapped, i.e., slightly liability sensitive, at December 31, 1998 within the one-year timeframe. Exhibit 5
- - ------------------------------------------------------------------------------------------------------------------------------------ INTEREST RATE SENSITIVITY December 31, 1998 ------------------------------------------------------------------------ Total Variable 1-3 4-6 7-12 1 Year Over (Dollars in millions) Rate Months Months Months or Less 1 Year Total - - ------------------------------------------------------------------------------------------------------------------------------------ EARNING ASSETS Loans and leases/1/ $ 2,934 $ 4,432 $ 1,822 $ 2,741 $11,929 $10,382 $22,311 Investments in debt and equity securities 127 2,004 1,162 787 4,080 5,391 9,471 Short-term investments 228 360 1 5 594 -- 594 - - ------------------------------------------------------------------------------------------------------------------------------------ Total Earning Assets $ 3,289 $ 6,796 $ 2,985 $ 3,533 $16,603 $15,773 $32,376 - - ------------------------------------------------------------------------------------------------------------------------------------ ACQUIRED FUNDS Interest bearing core deposits2 $ 5,436 $ 2,112 $ 1,926 $ 2,329 $11,803 $ 6,772 $18,575 Purchased deposits 391 790 514 349 2,044 389 2,433 Short-term borrowings 1,848 1,120 32 3 3,003 -- 3,003 Bank notes -- 25 -- -- 25 -- 25 Long-term debt3 -- 1,653 1 106 1,760 1,963 3,723 Net effect of credit card securitization -- 176 -- -- 176 (176) -- Interest rate swaps -- 590 -- -- 590 (590) -- - - ------------------------------------------------------------------------------------------------------------------------------------ Total Interest Bearing Acquired Funds 7,675 6,466 2,473 2,787 19,401 8,358 27,759 Non-interest bearing deposits/2/ 1,408 -- -- -- 1,408 3,045 4,453 - - ------------------------------------------------------------------------------------------------------------------------------------ Total Acquired Funds $ 9,083 $ 6,466 $ 2,473 $ 2,787 $20,809 $11,403 $32,212 - - ------------------------------------------------------------------------------------------------------------------------------------ GAP ANALYSIS Interest sensitivity gap $(5,794) $ 330 $ 512 $ 746 $(4,206) - - ------------------------------------------------------------------------------------------------------------------------------------ Cumulative interest sensitivity gap $(5,794) $(5,464) $(4,952) $(4,206) - - ------------------------------------------------------------------------------------------------------------------------------------ Cumulative ratio of interest-sensitive assets to interest-sensitive liabilities .36 .65 .73 .80 - - ------------------------------------------------------------------------------------------------------------------------------------ /1/ Non-accrual loans are reported in the "Over 1 Year" category. /2/ Mercantile's experience with interest bearing demand, money market accounts, savings and non-interest bearing deposits has been that, although these deposits are subject to immediate withdrawal or repricing, a portion of the balances has remained relatively constant in periods of both rising and falling rates. Therefore, a portion of these deposits is included in the "Over 1 Year" category. If these deposits were all included in the "Total 1 Year or Less" category, the cumulative ratio of interest-sensitive assets to interest- sensitive liabilities would be .60. /3/ Includes company-obligated mandatorily redeemable securities of Mercantile Capital Trust I.
------ 31 Mercantile Bancorporation Inc. and Subsidiaries Exhibit 6
- - ------------------------------------------------------------------------------------------------------------------------------------ MARKET RISK DISCLOSURE December 31, 1998 -------------------------------------------------------------------------------------------- Book or Notional Value Fair Value -------------------------------------------------------------------------------------------- More than More than More than More than Within 1 Year to 2 Years to 3 Years to 4 Years to Over (Dollars in millions) 1 Year 2 Years 3 Years 4 Years 5 Years 5 Years Total - - ------------------------------------------------------------------------------------------------------------------------------------ EARNING ASSETS Loans and leases:* Fixed interest rate $ 168 $ 2,052 $ 1,249 $ 1,657 $ 1,476 $ 5,922 $12,524 $10,470 Average interest rate 8.36% 7.89% 8.47% 8.41% 8.48% 8.78% 8.51% Variable/adjustable interest rate $ 161 $ 1,750 $ 488 $ 458 $ 317 $ 6,613 $ 9,787 $12,401 Average interest rate 8.79% 8.19% 7.93% 8.02% 8.04% 6.67% 7.15% Investments in debt and equity securities: Fixed interest rate $ 593 $ 365 $ 582 $ 241 $ 1,578 $ 4,534 $ 7,893 $ 7,909 Average interest rate 6.04% 6.56% 6.27% 6.55% 6.06% 5.93% 6.04% Variable/adjustable interest rate $ 6 $ 2 $ 2 $ -- $ 1 $ 1,567 $ 1,578 $ 1,563 Average interest rate 4.57% 5.61% 7.93% 6.78% 7.10% 7.09% Short-term investments $ 594 $ -- $ -- $ -- $ -- $ -- $ 594 $ 594 Average interest rate 5.56% 5.56% - - ------------------------------------------------------------------------------------------------------------------------------------ Total Earning Assets $ 1,522 $ 4,169 $ 2,321 $ 2,356 $ 3,372 $18,636 $32,376 $32,937 - - ------------------------------------------------------------------------------------------------------------------------------------ ACQUIRED FUNDS Deposits: Transaction deposits $ 7,846 $ 2,357 $ 1,201 $ 1,490 $ -- $ -- $12,894 $12,894 Average interest rate 1.77% 1.77% 1.47% 1.34% 1.70% Time deposits $ 9,170 $ 2,022 $ 621 $ 350 $ 303 $ 101 $12,567 $12,984 Average interest rate 4.73% 5.48% 5.68% 5.93% 5.80% 6.44% 4.97% Borrowed funds: Fixed interest rate $ 2,883 $ 20 $ 4 $ 164 $ 55 $ 1,369 $ 4,495 $ 4,565 Average interest rate 4.78% 5.13% 6.29% 7.46% 5.14% 5.90% 5.23% Variable interest rate $ 1,220 $ 465 $ 10 $ 10 $ -- $ 551 $ 2,256 $ 2,342 Average interest rate 5.43% 5.48% 5.07% 5.52% 5.58% 5.47% - - ------------------------------------------------------------------------------------------------------------------------------------ Total Acquired Funds $21,119 $ 4,864 $ 1,836 $ 2,014 $ 358 $ 2,021 $32,212 $32,785 - - ------------------------------------------------------------------------------------------------------------------------------------ RATE-SENSITIVE DERIVATIVE FINANCIAL INSTRUMENTS Pay variable/receive fixed interest rate exchange agreements: $ 65 $ 5 $ 70 $ 71 Average rate paid 8.48% 5.50% 8.19% Average rate received 8.16% 6.90% 8.07% - - ------------------------------------------------------------------------------------------------------------------------------------ *The book value of loans represents loans before deducting the reserve for possible loan losses. The fair value of loans was estimated by utilizing cash flow analysis discounted at rates that include a credit risk premium.
Because the static gap portrayal does not capture many of the factors that determine interest rate risk, Mercantile places more emphasis on the use of sophisticated simulation models to estimate changes in net interest income and market value. These models encompass the entire range of assets, liabilities and off-balance-sheet investments, and they capture multiple aspects of interest rate risk, including rate-driven customer behavior such as the prepayment of mortgages. The Corporation uses this information to adjust its strategies to protect the net interest margin and market value against significant interest rate fluctuations. Uniform sensitivity reports and guidelines are used by all subsidiary banks. Current model projections indicate that in 1999 net interest income would increase by 1% should rates rise gradually by 200 basis points from their current level over the next 12 months. Similarly, if rates were to gradually decline by 150 basis points, 1999 net interest income would be negatively impacted by less than 1%. As the year-end 1998 gap report shows a negative interest sensitivity gap position, i.e., liability sensitive for all periods less than one year, it would be expected that net interest income would generally be enhanced in a declining rate environment, and if rates rose net interest income would be somewhat negatively impacted. The Corporation's simulation models are contrary to that expectation and ------ 32 Mercantile Bancorporation Inc. and Subsidiaries additionally point to a concern that if the yield curve remains flat or inverted in 1999, net interest income will continue to be negatively impacted. Likewise, if the prime rate were to drop immediately and funding costs did not adjust as quickly, the net interest income decline would be greater. The Corporation believes it is appropriately positioned for subsequent rate movements in the current economic environment; however, since the Corporation still holds significant mortgage assets, as in 1998, the potential for large paydowns of mortgage-backed securities and the refinancing of mortgage loans held in the loan portfolio do present risk to the current level of net interest income. If the yield curve remains flat, profitable reinvestment opportunities of the cash flows generated by these paydowns will not exist and balance sheet leverage may be lessened. Exhibit 6 provides additional information about the Corporation's financial instruments and derivatives used for purposes other than trading that are sensitive to changes in interest rates. For loans and leases, investment securities and liabilities with contractual maturities, the table presents principal cash flows and weighted average interest rates by contractual maturities as well as the Corporation's historical experience of the impact of interest rate fluctuations on the prepayment of loans and mortgage-backed securities. For interest bearing transaction deposits, while such amounts are subject to immediate withdrawal or repricing, a portion of the balances has remained constant during periods of rising and falling interest rates. Therefore, a portion of these amounts has been allocated to periods outside of one year based on management's assessment of the most likely withdrawal behavior. For interest rate swaps and cap and floor agreements, the table presents notional amounts and applicable weighted average interest rates by contractual maturity dates. Forward rates are based on the implied forward rates on the reporting dates. Deposits Deposits are the Corporation's primary source for the funding of its earning assets and are acquired from a broad base of local markets, including both individual and corporate customers. Total deposits at December 31, 1998 were $25.5 billion, a 2.6% increase from the $24.8 billion of a year ago, which was up $5.0 billion or 25.4% from December 31, 1996. On average, total deposits grew by $2.5 billion or 11.3%; average balances were affected by the inclusion of the July 1, 1997 purchase transaction for 12 months of 1998 versus six months in 1997. Exhibit 8 details the components of the Corporation's deposit mix for the past five years. Core deposits remain Mercantile's largest, most reliable and most important funding source. Core deposits include both interest bearing and non-interest bearing demand deposits, money market and savings deposits, consumer certificates of deposit under $100,000 and other time deposits. Average core deposits grew by 11.7% in 1998 and represented 71.33% of earning assets compared with 75.49% last year. Exhibit 7
- - --------------------------------------------------------------------- MATURITY OF DOMESTIC TIME DEPOSITS $100,000 December 31, 1998 AND OVER ------------------------------------ (Thousands) Certificates Other Time of Deposit Deposits Total - - --------------------------------------------------------------------- Three months or less $ 699,094 $ 173,454 $ 872,548 Over three through six months 514,011 4,741 518,752 Over six through 12 months 348,940 9,241 358,181 Over 12 months 388,632 135 388,767 - - --------------------------------------------------------------------- Total $1,950,677 $ 187,571 $2,138,248 - - ---------------------------------------------------------------------
Deposit run-off has been monitored closely by the Corporation since the transaction was announced in December 1996. Tracking from July 1, 1997 (the effective date of the merger) through November 14, 1997 (the date that Roosevelt was split into nine Mercantile banks), indicates that only $158,000,000 or a 3.0% deposit run-off occurred in that four and one-half month period. Deposit run-off since November 1997 has been higher than 3%. Excluding the mandated divestitures of Firstbank deposits noted earlier, Mercantile disposed of $59,500,000 additional deposits in 1998 as five non- strategic branches were sold. An additional $235,622,000 of deposits were sold in 1997 with specific branch sales. Average non-interest bearing deposits increased by $489,368,000 or 14.3% from 1997. Part of the growth came from the U.S. Government, which is a significant cash management customer of Mercantile Bank N.A. and pays for services rendered via compensating balances. These average balances have increased from $637,386,000 in 1996 to $675,793,000 in 1997 and finally $765,653,000 in 1998, and are expected to continue to grow in 1999. Cash and due from banks volume is directly related to non-interest bearing deposit volume and increased on average by $172,077,000 or 14.9%. Successful efforts in managing float and minimizing reserve requirements coupled with deposit volume growth resulted in an increase in average net non-interest bearing funds of $317,291,000 for 1998. ------ 33 Mercantile Bancorporation Inc. and Subsidiaries Exhibit 8
- - ------------------------------------------------------------------------------------------------------------ DEPOSITS December 31 --------------------------------------------------------------- (Thousands) 1998 1997 1996 1995 1994 - - ------------------------------------------------------------------------------------------------------------ Non-interest bearing $ 4,453,048 $ 3,956,138 $ 3,389,776 $ 2,925,272 $ 2,775,055 Interest bearing demand 3,281,788 3,086,259 2,800,964 2,769,944 2,806,657 Money market accounts 4,151,540 3,811,081 3,152,825 2,712,227 2,614,531 Savings 1,766,918 1,559,441 1,323,775 1,353,335 1,455,381 Consumer time certificates under $100,000 9,186,531 9,850,437 7,136,532 6,468,366 6,344,298 Other time 189,122 191,199 233,997 656,532 38,717 - - ------------------------------------------------------------------------------------------------------------ Total Core Deposits 23,028,947 22,454,555 18,037,869 16,885,676 16,034,639 Time certificates $100,000 and over 1,950,677 1,769,461 1,495,089 1,368,809 1,087,740 Foreign 481,773 585,439 251,887 209,170 219,135 - - ------------------------------------------------------------------------------------------------------------ Total Purchased Deposits 2,432,450 2,354,900 1,746,976 1,577,979 1,306,875 - - ------------------------------------------------------------------------------------------------------------ Total Deposits $25,461,397 $24,809,455 $19,784,845 $18,463,655 $17,341,514 - - ------------------------------------------------------------------------------------------------------------
Average interest bearing demand, savings, money market accounts and retail certificates of deposit increased by 5.2%, 18.2%, 15.3% and 10.8%, respectively. Mercantile's average of consumer time certificates to total core deposits was 42.60% in 1998 and 42.94% in 1997 compared with 40.34% in 1996. Certificates of deposit greater than $100,000 and foreign branch deposits increased on average by 8.0% to $2.3 billion as this source of funding became more important to replace core deposit run-off and to fund earning asset growth. Most of the large domestic deposits were gathered from the local retail, commercial and institutional customer base, which provides a natural access to purchased funds and, accordingly, tends to be less volatile than other categories of purchased funds. Exhibit 7 portrays the maturities of domestic time deposits $100,000 and over. Non-Core Funding Other than core deposits, long-term debt (excluding FHLB borrowings) and shareholders' equity, Mercantile has alternative funding sources including bank notes, certificates of deposit greater than $100,000, eurodollar deposits and short-term borrowings, which are defined as federal funds purchased, treasury tax and loan note option accounts, securities sold under agreements to repurchase, short-term FHLB advances and commercial paper. All these sources of funding are utilized primarily by Mercantile Bank N.A., and volumes are monitored by ALCO. As a major bank in the Midwest with a significant correspondent bank network and corporate account base, Mercantile Bank N.A. purchases excess funds from correspondent banks and borrows on a short-term basis from commercial customers. Accordingly, some of Mercantile's non-core funding can be considered a stable source of funds, similar to core deposits. Depending on funding requirements and liquidity strategies employed by ALCO, these funds are either used internally or redeployed as short-term investments. Average short-term borrowings increased by $364,252,000 or 12.4% in 1998, due largely to the addition of Roosevelt's short-term FHLB advances for a full year and an increase in treasury tax and loan note option accounts to fund the earning asset growth that was in excess of core deposit growth. The FHLB advances funded a significant part of its investment portfolio. Bank note borrowings declined on average from $175,000,000 in 1997 to $56,233,000 in 1998 as the Corporation utilized less costly sources of funding. Long-term FHLB advances became a significant funding source for Mercantile in 1998, averaging $2.1 billion compared with only $170,774,000 in 1997. These borrowings are secured by residential mortgage loans, and in 1998 the pricing was attractive relative to bank notes and purchased deposits. Short-term investments include due from banks interest bearing, federal funds sold and securities purchased under agreements to resell. Short-term investments averaged $542,670,000 in 1998, an increase of $89,627,000 or 19.8% from 1997. ------ 34 Mercantile Bancorporation Inc. and Subsidiaries CAPITAL RESOURCES Mercantile maintains a capital base that provides a foundation for anticipated future asset growth and promotes depositor and investor confidence. Capital management is a continuous process at Mercantile and is focused on ensuring that adequate capital is available for both current needs and anticipated growth. This strategy has enabled the Corporation to profitably expand its balance sheet while maintaining capital ratios that exceed minimum capital requirements. At December 31, 1998, shareholders' equity was $3.1 billion, an increase of 11.3% from a year ago. The increase from last year was from retained earnings, the four 1998 bank acquisitions accounted for as poolings without restatement and a favorable FAS 115 adjustment, partially offset by share repurchases. The tangible equity to tangible assets ratio increased to 6.55% at December 31, 1998 from 5.92% a year ago, exceeding the 6.00% goal the Corporation established during the third quarter of 1997. Additionally, all regulatory capital ratios have improved since year-end 1997 and significantly exceed regulatory minimums. Exhibits 11 and 12 detail significant capital information for the past five years. As long-term interest rates continued to decline during 1998, the Corporation recorded a favorable adjustment to equity of $13,703,000 on available-for-sale investment securities. As of December 31, 1998, the balance of the valuation on available-for-sale securities totaled $41,160,000. In 1997, the net fair value adjustment increased equity by $8,805,000, likewise due to the lower level of interest rates. In 1998, the Corporation repurchased 1,834,375 shares of its common stock via designated broker-dealers at an average cost of $55.06. Most of the 1998 share repurchases occurred when Mercantile's stock price was at higher levels. Of these shares, 1,750,000 were subsequently reissued in acquisitions that closed by July 1, 1998. The remaining shares were repurchased under Mercantile's systematic reacquisition plan. During 1997, the Corporation repurchased 6,778,324 shares of its common stock via designated broker-dealers at an average cost of $42.38 per share. As in 1998, these repurchases occurred largely through accelerated stock repurchase programs. A small portion of that stock was held for reissuance in conjunction with the 1994 Stock Incentive Plan, while the remainder was reissued in the July 1, 1997 transaction. The Corporation has no current authorization to repurchase shares in the open market, other than those Exhibit 9
- - ------------------------------------------------------------------------------------------------------------------------------ DEBT RATINGS December 31, 1998 ---------------------------------------------------------------- Thomson Standard Moody's Fitch BankWatch & Poor's - - ------------------------------------------------------------------------------------------------------------------------------ MERCANTILE BANCORPORATION INC. Issuer rating B Commercial paper F1 TBW-1 6.800% senior notes, due 2001 A2 A- BBB+ 7.050% senior notes, due 2004 A2 A- BBB+ 7.625% subordinated notes, due 2002 A3 BBB+ BBB 7.300% subordinated notes, due 2007 A3 BBB+ BBB Floating rate capital trust pass-through securities/SM/ a2 BBB- MERCANTILE BANK N.A. Bank notes (long-term/short-term) A1/P-1 A/TBW-1 A-/A-2 6.375% subordinated notes, due 2004 A2 A A- BBB+ 9.000% mortgage-backed notes, due 1999 Aaa Certificates of deposit (long-term/short-term) A1/P-1 A-/A-2 - - ------------------------------------------------------------------------------------------------------------------------------
Exhibit 10
- - ------------------------------------------------------------------------------------------------------------------------------ INTANGIBLE ASSETS December 31 ------------------------------------------------------------------- (Thousands) 1998 1997 1996 1995 1994 - - ------------------------------------------------------------------------------------------------------------------------------ Goodwill $ 723,186 $ 777,693 $ 171,539 $ 110,537 $ 98,832 Mortgage servicing rights 49,413 51,955 6,712 5,372 -- Core deposit premium 6,531 7,440 11,104 14,954 16,765 Other 2,058 2,197 12,716 2,982 6,834 - - ------------------------------------------------------------------------------------------------------------------------------ Total $ 781,188 $ 839,285 $ 202,071 $ 133,845 $ 122,431 - - ------------------------------------------------------------------------------------------------------------------------------
------ 35 Mercantile Bancorporation Inc. and Subsidiaries Exhibit 11
- - ----------------------------------------------------------------------------------------------------------------------------- REGULATORY CAPITAL December 31 ------------------------------------------------------------------- (Thousands) 1998 1997 1996 1995 1994 - - ----------------------------------------------------------------------------------------------------------------------------- Tier I capital $ 2,451,449 $ 2,104,078 $ 2,049,795 $ 2,051,263 $ 1,832,180 Tier II capital 674,039 674,716 450,359 439,862 425,123 - - ----------------------------------------------------------------------------------------------------------------------------- Total Risk-based Capital $ 3,125,488 $ 2,778,794 $ 2,500,154 $ 2,491,125 $ 2,257,303 - - ----------------------------------------------------------------------------------------------------------------------------- Risk-adjusted assets $24,907,551 $22,372,830 $17,831,456 $16,582,726 $15,224,325 - - ----------------------------------------------------------------------------------------------------------------------------- Quarterly average tangible assets $34,220,797 $32,276,375 $24,056,623 $23,130,977 $21,893,661 - - -----------------------------------------------------------------------------------------------------------------------------
Exhibit 12
- - ----------------------------------------------------------------------------------------------------------------------------- CAPITAL RATIOS December 31 ------------------------------------------------------------------- 1998 1997 1996 1995 1994 - - ----------------------------------------------------------------------------------------------------------------------------- Tier I capital to risk-adjusted assets 9.84% 9.40% 11.50% 12.37% 12.03% Total capital to risk-adjusted assets 12.55 12.42 14.02 15.02 14.83 Leverage 7.16 6.52 8.52 8.87 8.37 Equity to assets Consolidated 8.59 8.29 9.05 9.35 8.59 Combined bank subsidiaries 7.99 7.80 8.15 8.91 8.41 Tangible equity to tangible assets 6.55 5.92 8.31 8.83 8.08 Double leverage 120.75 125.38 104.53 106.81 107.11 Long-term debt to total capitalization* 23.29 25.38 11.38 12.20 15.60 - - ----------------------------------------------------------------------------------------------------------------------------- *Excluding long-term FHLB advances.
systematically repurchased pursuant to the Corporation's benefit plans and/or for the Mercantile Bancorporation Inc. Shareholder Investment Plan. At December 31, 1998, Mercantile had only 82,691 treasury shares, and none were tainted for pooling-of-interests accounting purposes. In order to finance a part of the Roosevelt acquisition, the Corporation formed Mercantile Capital Trust I on January 29, 1997. Through this trust, Mercantile obtained $150,000,000 of floating-rate debt that, for regulatory purposes, is considered part of Tier I capital. Senior and subordinated debt securities in the amount of $500,000,000 were issued in June 1997, for the same purpose. By December 31, 1997, the ratio of long-term debt to total capitalization increased to 25.38% from 11.38% at year-end 1996, reflecting the impact of the debt issued earlier in the year. At year-end 1998, the ratio had declined to 23.29%. FHLB advances are excluded from long-term debt in this ratio. The Corporation has $53,450,000 of 9.00% mortgage-backed notes that mature in 1999. Additionally, Mercantile's $400,000,000 credit card securitization is scheduled to begin a 12-month amortization period in November 1999. Excluding FHLB advances, the maturities of the remaining long-term debt are laddered between 2001 and 2007. The Parent Company's double leverage ratio, which measures the extent to which the equity capital of its subsidiaries is supported by Parent Company debt rather than equity, improved to 120.75% at December 31, 1998 from 125.38% last year. Intangible assets, which consisted largely of goodwill, totaled $781,188,000 at December 31, 1998 compared with $839,285,000 a year ago and $202,071,000 at December 31, 1996. The 1997 Roosevelt acquisition, accounted for as a purchase, initially increased goodwill by $608,076,000; however, subsequent amortization has lowered the balance to $547,317,000 at December 31, 1998. Due to the strength of the capital base at the 11 individual bank subsidiaries, approximately $82,939,000 was available at December 31, 1998 for distribution through dividends to the Parent Company without prior regulatory approval and without reducing the capital of the respective subsidiary banks below present minimum standards. An additional $311,578,000 would be available in the form of loans to the Parent Company under current regulations. Cash dividends totaling $1.24 per share were declared and paid during 1998, an 8.0% increase from last year's total of $1.148. In addition, on February 17, 1999, the quarterly dividend payable April 1, 1999 was increased by 9.7% to $.34 per share. This was the eighth consecutive ------ 36 Mercantile Bancorporation Inc. and Subsidiaries year of dividend increases and the five-year compound growth rate for dividends per share from 1994 to 1999 is 12.7%. Book value per share at December 31, 1998 was $19.53 compared with $18.57 at the prior year-end, an increase of 5.2%. Additional data relating to Mercantile's common stock and dividends are included on the Investor Information summary on page 85. Debt ratings for the Corporation and Mercantile Bank N.A. are included in Exhibit 9. Management has established financial objectives designed to monitor future capital needs. Mercantile's dividend policy is influenced by the belief that most shareholders are interested in long-term performance as well as current yield. The current dividend payout level is considered reasonable given the Corporation's present cash flow position, level of earnings and the strength of its subsidiary banks' capital. Future dividends will be determined based on Mercantile's results of operations, growth expectations, financial condition, regulatory constraints and other factors deemed relevant by the Board of Directors. INVESTMENTS IN DEBT AND EQUITY SECURITIES The Corporation's investment portfolio serves five important functions. First, it is a vehicle for adjusting balance sheet rate sensitivity and protecting against the impact of changes in interest rate movements by managing the purchases and maturities of securities; second, it is a means for the investment of excess funds depending on loan demand; third, the available-for-sale securities provide potential immediate liquidity; fourth, it serves as collateral for public deposits; and fifth, it is a natural balance sheet hedge for mortgage servicing rights with gains available to offset possible accelerated amortization of those rights. The investment portfolio is structured to maximize the return on invested funds within acceptable interest rate risk guidelines and to meet pledging requirements while giving consideration to loan demand, credit risk, future liquidity needs, balance sheet strategies and the outlook for trends in interest rates. In 1998, the Corporation completely centralized investment portfolio management. Such centralization allows the Corporation's Treasury area to manage the portfolio more efficiently through a decrease in the number of specific securities, larger positions and better control of collateral for pledging purposes. Securities are the largest category of earning assets after loans. During 1998, average securities represented 29.16% of earning assets compared with 25.91% in 1997 and 26.07% for 1996. Investment securities totaled $9.5 billion at December 31, 1998 compared with $8.5 billion at December 31, 1997, an increase of 11.9%. The increased portfolio absorbed the cash flows associated with the higher rate of prepayment of mortgage loans. Current accounting guidance proscribes that investment securities be classified into three categories: trading, available-for-sale and held-to- maturity. At December 31, 1998, trading securities totaled $126,540,000, the available-for-sale portfolio was $9.2 billion and held-to-maturity securities were $97,607,000. The held-to-maturity and available-for-sale portfolios as of December 31, 1998 consisted of 68.63% in U.S. and other government agency securities (including 35.55% in mortgage-related issues), 4.74% in state and municipal securities and 26.63% of other miscellaneous securities. The comparable distribution at December 31, 1997 was 62.81%, 27.46%, 6.12% and 31.07%, respectively. The change in the mix of the investment portfolio from the prior year was attributable primarily to continued evaluation and repositioning of the portfolios acquired in 1997, which had a high concentration of privately issued mortgage-backed securities and collateralized mortgage obligations. The privately issued collateralized mortgage obligations are included in miscellaneous securities. In 1998, these holdings dropped significantly due to paydowns and sales. The bulk of the proceeds were reinvested in more liquid U.S. agency mortgage-backed securities and collateralized mortgage obligations. Second, Mercantile increased its holdings of other asset-backed securities and corporate bonds to optimize yield. Finally, the Corporation transferred $80,000,000 from the credit card loan portfolio to miscellaneous securities in accordance with the terms of the securitization agreement and FAS 125. Concentration guidelines for all types of securities are in place and are monitored by ALCO. Note F to the Consolidated Financial Statements details the components of the investment portfolio for the past three years. At acquisition date, Roosevelt owned $84,706,000 of private-label collateralized mortgage-backed securities that were considered impaired on December 31, 1997. These have subsequently paid down to $62,056,000 on December 31, 1998. The section on non-performing assets addresses the credit risk issues associated with these securities. ------ 37 Mercantile Bancorporation Inc. and Subsidiaries The average maturity of the overall portfolio increased to four years and six months at the end of 1998 from four years and one month at year-end 1997. Likewise, duration increased slightly from 1.65 years to 1.96 years. The overall tax-equivalent yield of the portfolio was stable during 1998 at 6.55% compared with 6.54% in 1997. Mercantile established real estate investment trusts and investment subsidiaries in 1996 and 1997 and has placed participation interests in certain real estate mortgage loans and investment securities in those entities. Such entities aid in the management of those assets. Several of these entities were liquidated or merged in 1998 as Mercantile continued to reduce the number of bank charters and subsidiaries. These entities held $238,271,000 in investment securities and $6.6 billion in loans at December 31, 1998. Mercantile's commitment to its expanding region continued to be reflected by the holdings of securities of Missouri, Arkansas, Illinois, Kansas, Kentucky and Iowa and their local governmental units, although securities of many other states were also held in the portfolio. At December 31, 1998, investments in securities of those six states and their political subdivisions amounted to approximately 68.49% of total tax-exempt securities. However, securities of any one single political subdivision in any of these states did not exceed .12% of shareholders' equity at December 31, 1998. Outside of those six states, securities of no single issuer exceeded .17% of shareholders' equity. Approximately 57% of the state and municipal securities held at December 31, 1998 were rated A or higher by Moody's Investors Service. Of the remaining securities, most were non-rated bonds due to the smaller size of the issues. These bonds generally represented local issues that are evaluated internally for creditworthiness on an ongoing basis, similar to loans. Approximately 79% of the non-U.S. Government guaranteed collateralized mortgage obligations held at December 31, 1998 were rated A or higher by Moody's Investors Service. Those not rated A are primarily the "impaired securities" discussed later in the non-performing assets section of this commentary. LOANS Loans are the primary earning asset of the Corporation and were $22.3 billion at December 31, 1998, up $949,303,000 or 4.4% from year-end 1997. This growth follows a 26.1% increase in 1997 over 1996 year-end, reflecting the impact of the July 1, 1997 acquisition. Negatively affecting loan growth in 1998 was the sale of $112,000,000 in Roosevelt out-of-market credit card loans in the first quarter and the reclassification of $80,000,000 credit card loans to investment securities in compliance with FAS 125 and the securitization agreement. Excluding these two transactions, the internal loan growth rate for 1998 was approximately $1.1 billion or 5.3%. Furthermore, if the $549,055,000 decline in residential mortgage loans is excluded, internal loan growth on the remaining base would be approximately $1.7 billion. The vast majority of the Corporation's loans are extended in its natural six-state trade area. At December 31, 1998, the loan portfolio was 48.50% commercial and 51.50% consumer-related, compared with 43.51% and 56.49%, respectively, at December 31, 1997. The accelerated paydown of residential mortgage loans, the two credit card reductions described above, as well as good growth in commercial loans, brought the commercial/consumer balance back to the portfolio. The portfolio remains diversified as to both industry and geographic concentrations. Note Q to the Consolidated Financial Statements provides more details on concentrations of credit and the overall loan portfolio. The 1998 average loan-to-deposit ratio for the Corporation continued to increase and was 87.89% compared with 86.71% and 83.66% in 1997 and 1996, respectively. Loan growth and the replacement of deposits with FHLB borrowings likewise accounted for the increase in this ratio. Exhibit 13 portrays the composition of the loan portfolio for the past five years. During 1998, commercial loans averaged $5.5 billion, which represented a growth rate of 14.8% following growth of 10.5% in 1997. Commercial loan growth occurred on a system-wide basis and was greater in the first half of the year. Expertise in certain specialized industries, as well as experienced lenders coupled with a strong regional economy, accounted for the growth. Agriculture is a segment of the regional economy that did not contribute to commercial loan growth. At year-end 1998, Mercantile held $134,000,000 of loan participations purchased in the national markets and held for investment. Other than these ------ 38 Mercantile Bancorporation Inc. and Subsidiaries loans, commercial lending has a heavy relationship focus. The Corporation does not engage in commercial lending to emerging markets including those in Latin America, Eastern Europe and in the Asia Pacific Region. Exhibit 13
- - ------------------------------------------------------------------------------------------------------------------------------------ LOAN AND LEASE PORTFOLIO MATURITIES* ------------------------------------------------------------------------------------- 1 to 5 Years Over 5 Years December 31 ---------------------------------------------------------------------------------------------- Under Fixed Floating Fixed Floating (Millions) 1 Year Rate Rate Rate Rate 1998 1997 1996 1995 1994 - - ------------------------------------------------------------------------------------------------------------------------------------ Commercial $ 2,158 $ 2,011 $ 959 $ 743 $ 228 $ 6,099 $ 4,990 $ 4,591 $ 4,148 $ 3,918 Real estate -- commercial 915 1,753 507 313 310 3,798 3,570 3,256 3,175 2,725 Real estate -- construction 492 244 120 38 29 923 735 643 564 602 Real estate -- residential mortgage 455 588 107 1,875 5,129 8,154 8,703 4,787 4,240 3,984 Real estate -- home equity credit loans 73 1 23 4 425 526 588 440 417 426 Consumer 422 1,891 43 355 55 2,766 2,492 2,306 2,178 2,035 Credit card -- 45 -- -- -- 45 284 914 862 869 - - ------------------------------------------------------------------------------------------------------------------------------------ Total Loans and Leases $ 4,515 $ 6,533 $ 1,759 $ 3,328 $ 6,176 $22,311 $21,362 $16,937 $15,584 $14,559 - - ------------------------------------------------------------------------------------------------------------------------------------ * Non-accrual loans are reported at contractual maturities and rates.
Average commercial real estate mortgage and construction loans were $4.5 billion in 1998 and increased by 7.9% following a 9.2% growth rate in 1997. These loans are generally secured by the underlying property in the six-state corporate footprint at a 75% to 80% loan-to-appraisal value, and are typically supported by guarantees from the project developers. Additional collateral may be taken as deemed necessary. The strong regional economy once again accounted for this growth. For 1998, average residential real estate mortgage loan volume grew by $1.6 billion or 23.7% following 56.2% growth in 1997. Purchase accounting caused most of the increase in these average balances. The trend from year-end 1997 to year- end 1998 is more indicative of residential mortgage loan patterns, and it shows a decline of $549,055,000 or 6.3%. The 1998 interest rate environment encouraged borrowers to prepay or refinance into conforming fixed-rate loans that Mercantile generally sells in the market. The year-end 1998 mortgage pipeline, which consists primarily of fixed-rate loans to be sold, was $194,718,000. The average balance for 1998 was $179,550,000, and it is generally 70% to 75% hedged to mitigate interest rate risk. Home equity credit loans increased on average but from December 31, 1997 to December 31, 1998 declined by $62,131,000 or 10.6%. The decline in this product likewise is due to refinancing in 1998 when many borrowers added their home equity loan balances to a refinanced fixed-rate loan. Average credit card loans were down $506,300,000 or 79.7% in 1998. Highly successful targeted marketing efforts, aimed at expanding relationships with the current Mercantile customer base, were offset by the previously mentioned card sale, the required reclassification of $80,000,000 in loans to investment securities and the third quarter 1997 sale of $405,000,000 in co-branded cards. On a managed portfolio basis, credit card loans averaged $663,000,000 in 1998, and prospects for growth in 1999 from cross-selling initiatives are excellent. Average direct consumer loans grew by $62,933,000 or 5.6%, while indirect consumer loans were up by $226,976,000 or 17.7%. The large growth in indirect lending was partially attributable to the centralization of that function and the use of risk-based pricing across the Mercantile system. Mercantile does not engage in any significant subprime consumer lending in its own portfolio. The overall tax-equivalent yield of the loan portfolio decreased by 43 basis points to 8.16% in 1998 compared with 8.59% in 1997. Very competitive pricing for loans as well as the managed decline in credit card loans, the highest yielding loan type, and a slightly lower interest rate environment in 1998 that drove mortgage and home equity credit loan prepayments accounted for the decrease in yield. As shown in Exhibit 13, which portrays the maturity and interest sensitivity of the portfolio, 55.80% of loans were priced at floating rates or maturing within one year. ------ 39 Mercantile Bancorporation Inc. and Subsidiaries RISK MANAGEMENT AND THE RESERVE FOR POSSIBLE LOAN LOSSES The underlying objectives of Mercantile's credit management are to identify and manage credit exposure and to support the growth of a profitable and high- quality loan portfolio. At Mercantile, these functions are performed centrally by corporate Credit Administration, which provides management with extensive information on risk levels, trends, delinquencies, portfolio concentrations and internal ratings. Credit Administration includes corporate Credit Policy, approval of large credits and corporate Credit Review. Credit Administration also provides special asset teams that promptly concentrate on identified problem loans and workout situations when necessary, as well as the management of foreclosed property. Mercantile utilizes a lender-initiated system of rating credits that is subsequently tested by Credit Review, external auditors and bank regulators. Adversely rated credits are included on a watch list and are reviewed at the bank level and centrally at least on a quarterly basis. The reserve for possible loan losses represents the aggregate reserves of the Corporation's banking subsidiaries and at December 31, 1998 was $308,890,000 compared with $284,165,000 at the end of 1997. The year-end 1998 ratio of the reserve to outstanding loans was 1.38% compared with 1.33% at December 31, 1997. The reserve as a percentage of non-performing loans was 222.76% compared with 241.91% last year. The 1998 level remains reasonable considering that the risk profile has been further lessened due to a substantial decline in higher risk commercial non-accrual loans. Additionally, residential real estate mortgage loans, for which historical Exhibit 14
- - ----------------------------------------------------------------------------------------------------------------------- RESERVE FOR POSSIBLE LOAN LOSSES Year Ended December 31 -------------------------------------------------------------------- (Dollars in thousands) 1998 1997 1996 1995 1994 - - ----------------------------------------------------------------------------------------------------------------------- BEGINNING BALANCE $ 284,165 $ 257,718 $ 261,339 $ 274,636 $ 262,208 PROVISION 51,154 86,355 78,766 44,952 53,094 CHARGE-OFFS Commercial 21,477 20,784 23,454 10,965 11,728 Real estate -- commercial 4,055 4,784 5,123 8,368 8,697 Real estate -- construction 304 306 598 275 2,203 Real estate -- residential mortgage 4,042 2,103 2,306 2,918 5,619 Real estate -- home equity credit loans 220 194 141 386 385 Consumer 24,601 20,446 16,394 13,982 8,195 Credit card 10,167 60,642 66,111 42,650 41,363 - - ----------------------------------------------------------------------------------------------------------------------- Total Charge-offs 64,866 109,259 114,127 79,544 78,190 - - ----------------------------------------------------------------------------------------------------------------------- RECOVERIES Commercial 6,270 9,502 5,074 4,613 11,303 Real estate -- commercial 2,478 3,118 4,737 4,217 16,503 Real estate -- construction 68 84 501 154 257 Real estate -- residential mortgage 1,694 794 845 1,245 994 Real estate -- home equity credit loans 30 1 24 83 67 Consumer 6,095 5,803 4,801 3,757 3,455 Credit card 6,147 8,887 5,952 5,390 4,498 - - ----------------------------------------------------------------------------------------------------------------------- Total Recoveries 22,782 28,189 21,934 19,459 37,077 - - ----------------------------------------------------------------------------------------------------------------------- NET CHARGE-OFFS 42,084 81,070 92,193 60,085 41,113 Acquired reserves 15,655 21,162 9,806 13,836 447 Transfer to Mercantile Credit Card Master Trust -- -- -- (12,000) -- - - ----------------------------------------------------------------------------------------------------------------------- ENDING BALANCE $ 308,890 $ 284,165 $ 257,718 $ 261,339 $ 274,636 - - ----------------------------------------------------------------------------------------------------------------------- LOANS AND LEASES December 31 balance $22,311,258 $21,361,955 $16,937,254 $15,584,285 $14,558,820 - - ----------------------------------------------------------------------------------------------------------------------- Average balance $21,780,088 $19,302,451 $15,989,784 $15,264,606 $13,687,183 - - ----------------------------------------------------------------------------------------------------------------------- RATIOS Reserve balance to outstanding loans 1.38% 1.33% 1.52% 1.68% 1.89% Reserve balance to non-performing loans 222.76 241.91 298.11 240.34 536.18 Net charge-offs to average loans .19 .42 .58 .39 .30 - - -----------------------------------------------------------------------------------------------------------------------
------ 40 Mercantile Bancorporation Inc. and Subsidiaries loss rates are only .03%, comprised 36.55% of the Corporation's loan portfolio at December 31, 1998. If residential mortgages are excluded from total loans and the reserve is adjusted down for the related loss exposure, the reserve represents 2.05% of outstanding loans at December 31, 1998. The provision for loan losses is the annual cost of providing a reserve for anticipated future loan losses. In any accounting period, the amount of provision is dependent upon many factors, including loan growth, net charge- offs, changes in the composition of the loan portfolio, delinquencies, management's assessment of loan quality, general economic factors and collateral values. The 1998 total provision was $51,154,000 compared with $86,355,000 last year. In 1998 and 1997, infrequent merger-related provisions of $19,600,000 and $20,340,000, respectively, were recorded largely to conform the credit policies of recently acquired entities to those of Mercantile. The ratio of net charge-offs to average loans for 1998 improved to .19% compared with .42% in 1997. The corresponding net charge-off figures for 1998 and 1997 were $42,084,000 and $81,070,000, respectively. The two credit card portfolio sales significantly reduced the Corporation's charge-offs in 1998. Exhibit 14 provides charge-offs and recoveries by loan type for the past five years. For the total managed portfolio of credit card loans (including securitized loans), the ratio of net charge-offs to average loans improved to 6.88% in 1998 from 7.59% in 1997. By credit policy, losses are taken on credit card loans after six cycles of nonpayment, or within 15 days of receipt of personal bankruptcy notice, if earlier. Due to the 1995 securitization and FAS 125 accounting, very few credit card outstandings are accounted for as loans at December 31, 1998. The Corporation evaluates the loan portfolios and reserves of all banks on a quarterly basis to ensure the timely charge-off of loans and the adequacy of those reserves. This review is performed and validated by each bank preliminarily with a second review by both corporate Credit Review and the Chief Credit Officer. Factors considered in determining reserve adequacy include: volumes and trends in delinquencies and non-performing loans; specific loan ratings and outstandings; historical and projected loss experience based on volumes and types of loans; the results of independent internal loan ratings or external credit reviews; industrial or geographical concentrations; national, regional and/or specific industry economic conditions; off-balance-sheet risk; and other subjective factors. Every significant problem credit is reviewed initially by the respective bank, and a secondary review is performed quarterly to confirm the risk rating, proper accounting and adequacy of both strategy and the loan loss reserve. In addition to specific allocations, reserve allocations are made based on percentage guidelines for all individually rated loans, whether criticized by examiners or not. Allocations are made for unrated loans, such as residential mortgage, credit card and other consumer loans, based on historical loss experience adjusted for portfolio activity and current economic trends. These allocated reserves are further supplemented by unallocated reserves based on judgments regarding risk of error, local economic con-ditions and any other relevant factors. Exhibit 15
- - ----------------------------------------------------------------------------------------------------------------------------------- ALLOCATION OF THE RESERVE FOR POSSIBLE LOAN LOSSES ------------------------------------------------------------------------------------------------------------ 1998 1997 1996 1995 1994 ------------------------------------------------------------------------------------------------------------ Percent of Percent of Percent of Percent of Percent of Loans to Loans to Loans to Loans to Loans to Allocated Total Allocated Total Allocated Total Allocated Total Allocated Total (Dollars in thousands) Reserves Loans Reserves Loans Reserves Loans Reserves Loans Reserves Loans - - ----------------------------------------------------------------------------------------------------------------------------------- Commercial $ 90,812 27.34 $ 78,516 23.36 $ 35,810 27.11 $ 65,713 26.62 $ 53,760 26.91 Real estate - commercial 42,366 17.02 33,652 16.71 52,002 19.22 59,113 20.37 48,669 18.72 Real estate - construction 11,274 4.14 7,909 3.44 8,715 3.80 7,473 3.62 6,738 4.13 Real estate - residential mortgage 13,157 36.55 24,500 40.74 17,817 28.26 16,818 27.20 14,045 27.36 Real estate - home equity credit loans 1,520 2.36 1,778 2.75 3,880 2.60 2,238 2.68 2,324 2.93 Consumer 42,512 12.39 20,438 11.67 16,690 13.62 16,431 13.98 18,066 13.98 Credit card 34,122 .20 18,665 1.33 57,666 5.39 27,333 5.53 36,827 5.97 Unallocated 73,127 N/A 98,707 N/A 65,138 N/A 66,220 N/A 94,207 N/A - - ----------------------------------------------------------------------------------------------------------------------------------- Total $308,890 100.00 $284,165 100.00 $257,718 100.00 $261,339 100.00 $274,636 100.00 - - -----------------------------------------------------------------------------------------------------------------------------------
------ 41 Mercantile Bancorporation Inc. and Subsidiaries In Exhibit 15, the Corporation has estimated an allocation of the reserve for possible loan losses to the various loan categories. Consideration for making such allocations is consistent with the factors discussed above, and all of those factors are subject to change; thus, the allocation is not necessarily indicative of the loan categories in which future losses will occur. The total reserve is available to absorb losses from any portion of the loan portfolio. Management believes the December 31, 1998 consolidated reserve of 1.38% of total loans outstanding and 222.76% of non-performing loans was adequate based on the risks identified at such date in the loan portfolio. The large increase in the allocated reserve to credit card loans shown in Exhibit 15 is necessitated by the scheduled amortization of the securitized credit card loans beginning in 1999. Over a 12-month period, approximately $600,000,000 of loans in the trust will return to the Corporation's balance sheet as loans, and thus the loan loss reserve must be available to absorb charge-offs. Currently, $400,000,000 of credit card loans are off the balance sheet and in the trust as collateral for the debt of the trust. The other $200,000,000 in loans are also in the trust but are classified as investor certificates and held on Mercantile's balance sheet in the investment portfolio. The Asia Pacific Region, Russia and Latin America have been areas of concern to the banking industry throughout 1997 and 1998. The Corporation has no direct credit exposure in these regions and has an insignificant exposure via its letters of credit business. No bonds from these areas are held in the trading or the investment portfolios, and all foreign exchange transactions are done through a correspondent bank headquartered in the United States. There are no derivative transactions with any counterparty banks in these parts of the world. In addition, the Corporation does not engage in lending to any emerging markets or invest in hedge funds. High-risk speculative consumer lending programs commonly known as subprime or 100+% loan to value are insignificant. Pork production is currently a portfolio sector of special attention due to falling prices. Total direct exposures to 279 hog producers is less than $150,000,000 at year-end 1998. None of these loans are currently classified as non-performing. NON-PERFORMING ASSETS Non-performing assets consist of non-accrual loans, renegotiated loans, foreclosed property and investment securities with an impairment in value which is considered other than temporary. A summary of these assets for the past five years is presented in Exhibit 16. At year-end 1998, non-performing loans (i.e., non-accrual and renegotiated) were $138,663,000 and represented .62% of total loans compared with .55% at year-end 1997. Foreclosed assets at December 31, 1998 were $13,500,000; the ratio of non-performing loans and foreclosed assets to total loans plus foreclosed assets was .68% at December 31, 1998 versus .65% in the prior year. As noted in Exhibit 16, non-accrual loans increased by $19,579,000 from last year-end. On their respective dates of acquisition, $7,942,000 of non-accrual loans were added from the four companies Mercantile acquired in 1998 for which prior periods' results were not restated. Lower risk residential mortgage and home equity credit non-accrual loans totaled $73,934,000 and represented 55.71% of non-accrual loans at year-end 1998. They increased by $30,836,000 from year- end 1997 while generally higher risk commercial non-accrual loans declined by $20,803,000. Note A to the Consolidated Financial Statements details the Corporation's policy on accounting for non-accrual loans. At December 31, 1998, the Corporation had one non-accrual loan with a balance exceeding $2,000,000; it totals $5,300,000 and is expected to return to performing status in 1999. As shown in Exhibit 17, interest lost on non-performing loans cost Mercantile an immaterial $.02 per share in 1998. Renegotiated loans are those for which the terms have been restructured beyond those available in the market, in order to aid the borrower by providing a reduction or deferral of interest and/or principal. Renegotiations usually result from a deterioration in the financial condition of the borrower. Renegotiated loans were $5,950,000 compared with $4,335,000 at year-end 1997. All loans classified as renegotiated were paying in accordance with their modified terms at December 31, 1998. Loans past due 90 days or more and still accruing interest amounted to $28,998,000 compared with $22,332,000 at December 31, 1997. These past due loans at year-end 1998 were one-half commercial-related and one-half consumer-related. ------ 42 Mercantile Bancorporation Inc. and Subsidiaries Exhibit 16
- - ------------------------------------------------------------------------------------------------------------ NON-PERFORMING ASSETS December 31 ------------------------------------------------------- (Dollars in thousands) 1998 1997 1996 1995 1994 - - ------------------------------------------------------------------------------------------------------------ Non-Accrual Loans Commercial $ 21,799 $ 42,602 $ 27,540 $ 49,261 $ 10,917 Real estate -- commercial 20,935 18,362 20,884 25,810 16,447 Real estate -- construction 3,411 1,948 1,666 4,900 691 Real estate -- residential mortgage 73,383 42,870 25,108 19,759 11,978 Real estate -- home equity credit loans 551 228 172 68 650 Consumer 12,634 7,124 5,667 5,390 3,361 - - ------------------------------------------------------------------------------------------------------------ Total Non-accrual Loans 132,713 113,134 81,037 105,188 44,044 Renegotiated loans 5,950 4,335 5,413 3,549 7,177 - - ------------------------------------------------------------------------------------------------------------ Total Non-performing Loans 138,663 117,469 86,450 108,737 51,221 FORECLOSED ASSETS Foreclosed real estate 8,983 16,869 14,052 16,190 23,917 Other foreclosed assets 4,517 4,229 4,176 3,727 3,762 - - ------------------------------------------------------------------------------------------------------------ Total Foreclosed Assets 13,500 21,098 18,228 19,917 27,679 - - ------------------------------------------------------------------------------------------------------------ Total Non-performing Loans and Foreclosed Assets 152,163 138,567 104,678 128,654 78,900 Impaired investment securities 63,296 85,887 1,240 1,240 1,240 - - ------------------------------------------------------------------------------------------------------------ Total Non-performing Assets/1/ $215,459 $224,454 $105,918 $129,894 $ 80,140 - - ------------------------------------------------------------------------------------------------------------ PAST DUE LOANS (90 DAYS OR MORE)/2/ Commercial $ 12,263 $ 5,656 $ 3,558 $ 1,728 $ 1,377 Real estate -- commercial 1,621 467 759 1,438 2,757 Real estate -- construction -- -- 147 414 5 Real estate -- residential mortgage 6,543 3,587 4,573 6,002 6,695 Real estate -- home equity credit loans 504 1,856 553 331 554 Consumer 7,395 5,355 6,700 3,651 1,809 Credit card 672 5,411 21,608 17,383 13,209 - - ------------------------------------------------------------------------------------------------------------ Total Past-due Loans/1/ $ 28,998 $ 22,332 $ 37,898 $ 30,947 $ 26,406 - - ------------------------------------------------------------------------------------------------------------ RATIOS/2/ Non-performing loans to outstanding loans .62% .55% .51% .70% .35% Non-performing loans and foreclosed assets to outstanding loans and foreclosed assets .68 .65 .62 .82 .54 Non-performing assets to total assets .60 .67 .42 .55 .36 - - ------------------------------------------------------------------------------------------------------------ /1/ Excludes insured FHA and government-guaranteed VA loans that were acquired primarily in the Roosevelt transaction and are contractually past due more than 90 days. Since these loans are fully insured or guaranteed for the payment of both principal and interest by the U.S. Government, the Corporation does not consider these loans to be non-performing assets, consistent with Roosevelt's past disclosure for these loans. The total of such insured or guaranteed loans was $26,977,000 at December 31, 1998 and $37,677,000 at December 31, 1997. /2/ Past-due loans 90 days or more are not included in non-performing asset totals or ratios.
Exhibit 17
- - ----------------------------------------------------------------------------------------------------------------------------------- INTEREST NOT RECORDED ON NON-PERFORMING LOANS Year Ended December 31 --------------------------------------------------- (Thousands except per share data) 1998 1997 1996 1995 1994 - - ----------------------------------------------------------------------------------------------------------------------------------- Interest not accrued $5,263 $4,795 $ 6,088 $5,982 $4,541 Less cash-basis income (342) (526) (1,017) (658) (854) - - ----------------------------------------------------------------------------------------------------------------------------------- Effect on Income Before Income Taxes $4,921 $4,269 $ 5,071 $5,324 $3,687 - - ----------------------------------------------------------------------------------------------------------------------------------- Effect on Net Income $3,199 $2,775 $ 3,296 $3,461 $2,397 - - ----------------------------------------------------------------------------------------------------------------------------------- Effect on Diluted Earnings per Share $ .02 $ .02 $ .02 $ .03 $ .02 - - ----------------------------------------------------------------------------------------------------------------------------------- Interest Collected Applied to Principal $ 643 $ 619 $ 930 $1,242 $ 851 - - -----------------------------------------------------------------------------------------------------------------------------------
------ 43 Mercantile Bancorporation Inc. and Subsidiaries Foreclosed assets declined to $13,500,000 at December 31, 1998 compared with the prior year-end level of $21,098,000. These assets are at their lowest level in five years. Foreclosed assets consisted primarily of real estate and were recorded at the lower of cost or fair value less estimated costs to sell. At year-end 1998, the carrying value of all properties was less than appraised value, and the Corporation had no foreclosed assets with a book value exceeding $1,000,000. With the July 1, 1997 acquisition, Mercantile acquired investment securities with a relatively high level of credit risk. The acquiree owned pools of privately issued adjustable-rate mortgage-backed securities where the majority of the underlying collateral was California residential real estate. The loan pools backing these investment securities have high delinquency and foreclosure rates and relatively high losses on foreclosed property sales. As a result, the securities are rated below investment grade. Roosevelt recorded an "other than temporary" write-down of $27,100,000 on these securities during 1995. The current net book value of $23,326,000 is net of that 1995 write-down; the securities are paying down faster than expected and no further loss is anticipated. A second group of Roosevelt privately issued mortgage-backed securities was added to impaired investment securities in the fourth quarter of 1997, as the Corporation had received less than full principal and interest payments on these securities. The net book value of these securities was $54,351,000 after the write-down. That value has been paid down to $38,730,000 at year-end 1998, and no further loss is expected. The current yield on the net book value of all impaired securities is 8.97%. Paydowns in 1998 were $22,591,000, leaving a year- end 1998 balance of $63,296,000. "Potential problem loans" at December 31, 1998 amounted to $90,834,000. These are defined as loans and commitments not included in any of the two basic non- performing loan categories discussed above or 90 days past due and still accruing interest, but which management, through normal internal credit review procedures, has developed information regarding possible credit problems that could cause the borrowers future difficulties in complying with present loan repayment terms. There were no loans greater than $250,000 classified for regulatory purposes as loss, doubtful or substandard that were not included above or that caused management to have serious doubts as to the ability of such borrowers to comply with repayment terms. In addition, there were no material commitments to lend additional funds to borrowers whose loans were classified as non-performing. OFF-BALANCE-SHEET RISK In the normal course of business, there are various commitments and contingent liabilities outstanding that are properly not recorded on the balance sheet, such as letters of credit, commitments under operating leases, commitments to extend credit and interest rate swaps, caps and floors. Many of these arrangements are complementary to the loans, investments and deposits that are accounted for on the balance sheet. The Corporation's activities in foreign exchange, interest rate swaps, futures contracts and forward commitments continue to be minimal for a corporation the size of Mercantile. Mercantile offers these products as a financial intermediary, and at present it makes very limited use of financial derivatives to manage its own interest rate exposure. There are $265,691,000 in forward delivery contracts outstanding as hedges to the fixed-rate production in the residential loan pipeline. Standby letters of credit and similar arrangements issued primarily to support corporate obligations commit Mercantile to make payments on behalf of customers contingent upon the occurrence of future specified events. Standbys outstanding were related primarily to customer obligations, such as industrial revenue financings, as well as other financial and performance-related obligations. At December 31, 1998, the Corporation's commitments under standbys aggregated $514,300,000, with $237,114,000 expiring within one year, $128,063,000 expiring within one to five years and $149,123,000 expiring after five years. At year-end 1998, Mercantile subsidiary banks had outstanding unused loan commitments of $9.2 billion, including $194,407,000 in credit card lines and $728,541,000 in home equity credit lines. The remaining commitments were largely to commercial customers in Mercantile's primary service area. Management does not anticipate any losses that would materially affect the financial position or results of operations of the Corporation as a result of such commitments and contingent liabilities. Note R to the Consolidated ------ 44 Mercantile Bancorporation Inc. and Subsidiaries Financial Statements provides further discussion pertaining to these off- balance-sheet activities and provides information as to the estimated fair values of all financial instruments, including off-balance-sheet instruments. FAS 133, "Accounting for Derivative Instruments and Hedging Activities," which was issued in June 1998, establishes accounting and reporting standards for derivative instruments and hedging activities. Under FAS 133, derivatives are recognized on the balance sheet at fair value as an asset or liability. Changes in the fair value of derivatives are reported as a component of other comprehensive income or recognized as earnings through the income statement depending on the nature of the instrument. FAS 133 is effective for all quarters of fiscal years beginning after June 15, 1999 with earlier adoption permitted. The Corporation is currently evaluating FAS 133's effect on its financial position and results of operations, but it is not expected to have a material impact. OTHER INCOME Non-interest income increased 30.8% during 1998 to $541,918,000. This follows growth of 12.5% in 1997. In September 1998, Mercantile divested Firstbank's two Missouri banks due to state bank regulatory restrictions on deposit concentrations. These banks had total assets of approximately $300 million, and a pre-tax gain of $48,051,000 was recorded on the sale. Excluding that gain and merger-related securities losses, adjusted non-interest income grew by 19.6% in 1998. Additionally, in 1996, 1997 and 1998, Mercantile sold, in eight distinct transactions, certain non-strategic and/or underperforming businesses that resulted in gains. Excluding those gains, non-interest income grew by 14.5% in 1998 and 20.6% in 1997. Furthermore, if securities gains are also excluded, non- interest revenue growth is 12.4% in 1998 and 19.5% in 1997. Exhibit 18 portrays such transactions and a summary of all categories of fee income for the past three years. Deposit service charges were the largest source of non-interest income in all three years and increased by 9.4% in 1998 and 10.3% in 1997. The Roosevelt transaction, partially offset by customer attrition in 1998, favorably impacted service charges in 1997 and 1998. In 1998, trust fees were $112,999,000 compared with $103,928,000 during 1997, an increase of 8.7% following growth of 10.9% in 1997. Personal trust fees earned by Mercantile Trust Company N.A. were the largest source of trust revenue and increased slightly from last year. Income from Mississippi Valley Advisors Inc., the investment management subsidiary of Mercantile, rose by 15.9%. Mississippi Valley Advisors Inc. manages 17 proprietary mutual funds -- the ARCH funds, which had assets of $4.3 billion at December 31, 1998, an increase of 11.4% over last year-end. Increases in the value of assets managed and successful new business development efforts largely accounted for the growth in trust fees in both years. Effective March 31, 1999, the ARCH funds will adopt the name Mercantile Mutual Funds. At December 31, 1998, the Corporation held $25.9 billion in assets under investment management and $16.2 billion additional assets under custodial relationships, increases of 18.1% and 4.0%, respectively, from year-end 1997. Mortgage banking income in 1998 was more than double what was earned in 1997, which in turn was double the 1996 level. In January 1998, the Corporation sold $1.9 billion in loan servicing, which reduced originated mortgage servicing rights by approximately $3.2 million. A pre-tax gain of $23,155,000 was recognized. This sale was consistent with the Corporation's goals to "right size" the servicing portfolio as all Mercantile servicing operations were consolidated in Nevada, Missouri. The sale also lowered the prepayment risk associated with the servicing portfolio and helped to fund the Corporation's systems cost to become Year 2000 compliant. All other mortgage banking income was $31,300,000 in 1998, up 34.1% from 1997. The growth was attributable largely to increased servicing volume and the higher than expected level of refinancing activity in 1998. Mortgages serviced totaled $11.6 billion at December 31, 1998 compared with $12.5 billion at December 31, 1997. Total originated and purchased mortgage servicing rights on the balance sheet at December 31, 1998 totaled $49,413,000. The current low interest rate environment could further accelerate refinancing activity and cause quicker amortization, and thus cause possible future impairment in value of those assets. Retail brokerage revenue for 1998 was $20,086,000, an increase of 49.2% over 1997, which in turn was up 36.5% over 1996. The inclusion of Roosevelt for 12 months as well as generally favorable market conditions in 1998 have had a positive impact on this source of revenue. The Bruno Stolze & Company, Inc. discount brokerage acquisition in late 1998 should favorably impact 1999 revenues. ----- 45 Mercantile Bancorporation Inc. and Subsidiaries Exhibit 18
- - ------------------------------------------------------------------------------------------------------------------------ OTHER INCOME ------------------------------------------------------------- 1997 to 1998 1996 to 1997 (Dollars in thousands) 1998 1997 Change 1996 Change - - ------------------------------------------------------------------------------------------------------------------------ Trust $112,999 $103,928 8.7% $ 93,704 10.9% Service charges 119,277 109,058 9.4 98,908 10.3 Retail brokerage revenue 20,086 13,459 49.2 9,857 36.5 Other investment banking 21,051 24,722 (14.8) 25,494 (3.0) Mortgage banking 54,455 26,625 -- 13,518 97.0 Credit card fees 12,556 21,169 (40.7) 28,415 (25.5) Securitization revenue 20,011 18,404 8.7 16,008 15.0 Securities gains (losses) 15,435 7,649 -- 292 -- Electronic Funds Transfer Payment System (EFTPS) fees 12,812 14,039 (8.7) 4,873 -- ATM fees 15,556 13,271 17.2 8,450 57.1 Income from operating leases 9,537 3,740 -- 917 -- Loan commitment fees* 8,238 7,942 3.7 6,476 22.6 Loan late charges* 5,780 5,127 12.7 4,490 14.2 Letters of credit fees 7,518 6,810 10.4 9,432 (27.8) Official check fees 8,339 5,041 65.4 4,648 8.5 Safe deposit box rental 5,597 5,073 10.3 4,732 7.2 Insurance commissions 7,737 4,310 79.5 3,852 11.9 Miscellaneous 84,934 23,826 -- 33,944 (29.8) - - ------------------------------------------------------------------------------------------------------------------------ Total Other Income 541,918 414,193 30.8 368,010 12.5 Add: Merger-related securities losses 1,649 -- -- 3,114 -- Less: Gain on sale of subsidiaries (48,051) -- -- -- -- - - ------------------------------------------------------------------------------------------------------------------------ Adjusted Other Income 495,516 414,193 19.6 371,124 11.6 Less gains from: Sale of available-for-sale securities (17,084) (7,649) -- (3,406) -- Sale of mortgage servicing rights (23,155) (3,277) -- -- -- Sale of merchant credit card business (2,658) (2,300) 15.6 (10,000) -- Sale of corporate trust (2,002) -- -- (6,750) -- Reimbursement on co-branded credit card start-up costs -- -- -- (12,000) -- Sale of leveraged lease residual values -- -- -- (3,542) -- - - ------------------------------------------------------------------------------------------------------------------------ Adjusted Other Income After Gains $450,617 $400,967 12.4 $335,426 19.5 - - ------------------------------------------------------------------------------------------------------------------------ *Excludes such fees from the Corporation's mortgage banking and credit card operations, which are included in mortgage banking and credit card revenue.
Other investment banking revenue declined for the second consecutive year. Growth in foreign exchange revenue was more than offset by declines in commission income earned on fixed income securities, caused by the lack of demand for such product, due largely to the low level of interest rates in 1997 and 1998 and the flat yield curve. Credit card income declined from 1996 to 1997 and then again in 1998. Credit card income now represents primarily interchange fees received on transactions of Mercantile cardholders and other cardholder miscellaneous fees. The three sales of merchant processing businesses and the two portfolio sales largely accounted for the decline in credit card income. In the fourth quarter of 1998, Mercantile credit cards were reissued under Missouri law, which allows the Corporation greater flexibility in pricing and the opportunity to increase fee revenue in 1999. Securitization revenue in 1998 was $20,011,000 compared with $18,404,000 last year and $16,008,000 in 1996, and represents amounts accruing to Mercantile on the $400,000,000 in credit card loans securitized in the 1995 Mercantile Credit Card Master Trust, as well as amounts recognized under FAS 125 for investor certificate loans that were sold and reclassified to the investment portfolio. For securitized loans, amounts that would otherwise have been reported as interest income, interest expense, credit card fees and provision for loan losses are instead netted in non-interest income as securitization revenue. Because credit losses are absorbed against credit card servicing income over the life of these transactions, such income may vary depending upon the credit performance of the securitized loans. Lower levels of net charge-offs positively impacted securitization revenue in 1998. Mercantile acts ------ 46 Mercantile Bancorporation Inc. and Subsidiaries as servicing agent and receives loan servicing fees equal to 2% per annum of the securitized receivables. As servicing agent, Mercantile continues to provide customer service to collect past due accounts and to provide other services typically performed for its customers. Accordingly, Mercantile's relationship with its credit card customers is not affected by the securitization. The securitized loans will start amortizing in November 1999, and credit card loans will be purchased by Mercantile from the trust for 12 consecutive months. Letters of credit fees grew by 10.4% in 1998 following a 27.8% decline in 1997. In 1998, there was growth in standby and export letters of credit fees. The 1997 decline was due to the loss of a large customer as well as more selective servicing of the retail industry. Significant other revenue growth categories in both years included credit life and other insurance product sales, operating lease income, both ATM surcharge and cardholder fees and official check fees. Excluding the gain on sale of subsidiaries shown in Exhibit 18, year-to-date miscellaneous income increased by 54.8% over 1997. Miscellaneous income includes the gain on sales of merchant credit card, corporate trust and leveraged leases; this category grew as a result of a focus to increase ancillary fees. Net securities gains on investment securities totaled $17,084,000, $7,649,000 and $3,406,000 in 1998, 1997 and 1996, respectively. These amounts exclude securities losses incurred by newly acquired banks in portfolio restructurings of $1,649,000 in 1998 and $3,114,000 in 1996. Repositioning of the acquired portfolios and more active portfolio management in the lower 1998 interest rate environment account for the increase in gains. OTHER EXPENSE Expenses other than interest expense and the provision for possible loan losses for 1998 were $1,026,757,000, an increase of 4.1% from 1997, which was up 22.5% from 1996. Exhibit 19 portrays the growth in operating expenses after excluding from 1996, 1997 and 1998 the following infrequent expenses: 1) the merger- related charges in all years; 2) the 1998 restructuring charge; 3) the 1997 loss on the sale of a credit card portfolio; and 4) the 1996 nonrecurring SAIF assessment. Adjusted other expense grew by 9.5% from 1997 to 1998 and by 9.9% from 1996 to 1997. Acquisition expenses of $89,192,000, $121,393,000 and $51,071,000 for the respective years 1998, 1997 and 1996 represent costs incurred for the 17 acquisitions Mercantile made in the past three years. The fourth quarter 1998 restructuring charge of $45,130,000 relates to 26 branch closings and severance for 1,400 staff separations due to staff rightsizing, centralization and further consolidation of back office functions. Approximately 650 staff were served notices of separation in late 1998, and approximately 750 more will be severed in 1999. The severance, outplacement, vacation pay and related benefits costs for those staff are estimated to be $40,000,000. The remaining $5,130,000 charge is the estimated cost to shut down and exit the 26 branches that are to be closed. It is expected that these branches will be closed and sold during 1999. The 1,400 separated staff cross all levels of employment, and many of the recent 750 include management positions as Mercantile's management will broaden its span of control as it restructures the company. The continued consolidation of bank charters and efforts to centralize back office functions account for the remaining severed staff. On September 25, 1997, the Corporation announced the sale of its former co- branded credit card loans. The terms of the sale contract resulted in a pre-tax charge of $50,000,000, which represented the discount on the loan balances, a write-off of an intangible asset associated with the cards, investment banking fees and accruals for severance and other expenses. Excluding the above infrequent items, adjusted other expense was $892,435,000 for 1998 compared with $814,985,000 in 1997, an increase of $77,450,000 or 9.5%. However, increased goodwill amortization was $20,394,000 of the growth in the 1998 expense level. Roosevelt's results of operations were included for 12 months in 1998 versus only six in 1997 and accounted for over one-half of the increase in expenses. Adjusted other expense as a percentage of average assets, however, improved to 2.58% versus 2.80% in 1997 and 3.10% in 1996. The efficiency ratio, defined as adjusted operating expenses as a percentage of taxable-equivalent net interest income and other income, was 55.21% compared with 55.07% last year and 55.41% in 1996. ------ 47 Mercantile Bancorporation Inc. and Subsidiaries Exhibit 19
- - ------------------------------------------------------------------------------------------------------------------------------ OTHER EXPENSE -------------------------------------------------------------- 1997 to 1998 1996 to 1997 (Dollars in thousands) 1998 1997 Change 1996 Change - - ------------------------------------------------------------------------------------------------------------------------------ Salaries $ 418,351 $381,942 9.5% $335,803 13.7% Employee benefits 77,608 85,048 (8.7) 77,437 9.8 - - ------------------------------------------------------------------------------------------------------------------------------ Total Personnel Expense 495,959 466,990 6.2 413,240 13.0 Net occupancy 67,003 61,697 8.6 55,489 11.2 Equipment 85,426 70,272 21.6 60,605 16.0 Postage and freight 28,028 27,061 3.6 26,427 2.4 Marketing/business development 17,696 18,856 (6.2) 15,183 24.2 Office supplies 17,141 16,178 6.0 15,037 7.6 Communications 20,309 16,719 21.5 13,886 20.4 Legal and professional 16,792 14,541 15.5 15,523 (6.3) Credit card 5,707 11,322 (49.6) 15,891 (28.8) FDIC insurance 5,456 3,652 49.4 4,757 (23.2) Foreclosed property expense (recoveries) 682 (4,997) -- (788) -- Miscellaneous 74,442 72,524 2.6 93,244 (22.2) - - ------------------------------------------------------------------------------------------------------------------------------ Adjusted Other Expense Before Intangible Asset Amortization 834,641 774,815 7.7 728,494 6.4 Intangible asset amortization 57,794 40,170 43.9 13,237 -- - - ------------------------------------------------------------------------------------------------------------------------------ Adjusted Other Expense 892,435 814,985 9.5 741,731 9.9 Acquisition expenses 89,192 121,393 (26.5) 51,071 -- Restructuring charge 45,130 -- -- -- -- Loss on sale of credit card loans -- 50,000 -- -- -- Special SAIF assessment -- -- -- 12,385 -- - - ------------------------------------------------------------------------------------------------------------------------------ Total Other Expense $1,026,757 $986,378 4.1 $805,187 22.5 - - ------------------------------------------------------------------------------------------------------------------------------
Personnel expense increased by $28,969,000 or 6.2% during 1998 as salaries rose by $36,409,000 or 9.5%, while employee benefit costs declined by $7,440,000 or 8.7%. The impact of significant acquisitions on salaries was estimated to be $6,000,000. Additionally, external temporary help salaries rose by $9,672,000, and were utilized primarily in operations, mortgage banking and in the Year 2000 effort. Incentive compensation increased by $9,059,000 from last year as Mercantile continued to move toward more performance-based compensation. The remaining increase was due to merit increases and the 1998 salaries of other acquirees. Personnel expense increased by $53,750,000 from 1996 to 1997 as salary and benefit costs grew by 13.7% and 9.8%, respectively. The impact of the July 1, 1997 acquisition was estimated to be $12,500,000. Employee benefit costs grew at a lower rate than salaries in 1997 and were indicative of the Corporation's efforts in controlling benefit costs. In 1998, employee benefit costs actually declined due to the continued effect of 1997 efforts, the implementation of a cash balance plan that lowered pension costs by approximately $3,800,000, a reconfiguration of the 401(k) plan that saved $2,500,000 and, finally, employees paid a larger portion of total health and welfare costs in 1998. Occupancy and equipment costs grew by 15.5% during 1998 following an increase of 13.7% in 1997. These growth rates reflect the addition of Roosevelt expenses, the costs of maintaining additional offices, and a consistent program of investing in new technology to improve customer service and enhance employee efficiency. A new deposit system installed throughout most of the Corporation also contributed to the increased equipment expense in 1998 over 1997. The benefits of this system are included in lower staff costs. Additionally, with the growth of the Mercantile leasing business, depreciation of equipment Mercantile leases to customers has increased by $4,601,000 in 1998 over 1997. The rent received on this equipment is included in miscellaneous income. Total capital expenditures were $93,008,000, $122,785,000 and $76,386,000 in 1998, 1997 and 1996, respectively. The major components of all other operating expenses for the past three years are shown in Exhibit 19. Commu-nications expense grew by 21.5% in 1998, following an increase of 20.4% in 1997, reflecting the costs of technology to expand both voice and data networking. Credit card expense declined in 1997 and again in 1998, due primarily to the absence of the costs associated with the merchant processing businesses and the two credit card portfolios that were sold. The reduced rate of growth in ------ 48 Mercantile Bancorporation Inc. and Subsidiaries office supplies was also due to the absence of those business lines and expense control initiatives. Marketing and business development expense declined in 1998 as a corporate-wide image advertising campaign that began in 1997 wound down in 1998. During 1998, there was a reduction of miscellaneous expense of $3,601,000 realized by gains on the sales of selected non-strategic Mercantile branch offices. The comparable gains in 1997 and 1996 were $18,263,000 and $3,003,000, respectively. Intangible asset amortization was $57,794,000 in 1998 versus $40,170,000 in 1997 and $13,237,000 in 1996. The increase was caused by amortization of goodwill recorded in 1996 and 1997 purchase acquisitions, which is being amortized using the straight-line method over 15 years. The Roosevelt acquisition increased goodwill by $608,076,000 and added $40,500,000 to annual amortization expense. During 1997, Mercantile recorded acquisition adjustments totaling $121,393,000 that were originally recorded as an accrued liability. Of that original liability, $117,491,000 has been utilized at December 31, 1998 and $3,902,000 remains to absorb future cash payments. Of the comparable $89,192,000 liability recorded in the third quarter of 1998 for this year's seven acquisitions, $48,960,000 has been utilized at December 31, 1998 and $40,232,000 remains to absorb future payments. Substantially all the merger-related provisions made for acquisitions prior to 1997 have been exhausted. YEAR 2000 Financial institutions are particularly vulnerable to Year 2000 issues because of industry reliance on electronic data processing and funds transfer systems. In 1996, the Corporation initiated a formal and centralized Year 2000 Program ("Program") with the objective of addressing all aspects of the Year 2000 issue. All business units of the organization were brought into the Program through the creation of a Year 2000 Operational Task Force. A Program Manager, who provides monthly Year 2000 status reports to executive management and quarterly reports to the Board of Directors, was appointed. The Corporation has completed the assessment, analysis and planning phases of its Year 2000 Program and is well into the execution phase. As part of the Program, a comprehensive Year 2000 Program Plan ("Plan") was developed and implemented in the third quarter of 1997. The Plan addresses both Information Technology ("IT") projects, such as insuring that data processing and data network applications are Year 2000 compliant, and non-IT projects, such as insuring that all building facilities and security systems having "embedded technology" will be operational when Year 2000 arrives. Of the plan projects identified, approximately 87% have been completed. Most remaining projects are dependent upon external testing for completion, which is scheduled to be completed by the end of the second quarter of 1999. As part of its Plan, Mercantile identified those systems and business applications that are "mission critical," that is, systems and business applications which, if they failed, would render Mercantile incapable of performing core business processes. As of December 31, 1998, renovation and testing of such identified mission-critical applications was 100% complete. Achievement of this milestone fulfilled the Program goal to have all mission- critical applications renovated and substantially tested "2000 compliant" by no later than December 31, 1998. As a financial institution, Mercantile's Year 2000 efforts are subject to regulation and monitoring by bank and bank holding company regulatory agencies. These agencies, under the auspices of the Federal Financial Institutions Examination Council ("FFIEC"), have established specific guidelines and interim deadlines for achieving Year 2000 compliance. Mercantile's Program has met all of the deadlines and complied with all guidelines to date, and fully intends and expects to continue to do so. In addition to Year 2000 compatibility of all Mercantile applications, Mercantile's Year 2000 Program addresses third-party Year 2000 issues. Mercantile has numerous customers, vendors, service providers, counterparties and other business relationships with third parties. Failure of any of these parties to address Year 2000 issues could result in significant and in some cases material disruptions of business and costs to Mercantile. Mercantile has undertaken an assessment of all third-party relationships and thus far has completed its evaluation of such relationships which are considered to be material. Follow-up plans have been put in place to deal with relationships that have been identified as "high risk." In addition, all customers with whom Mercantile exchanges electronic data have received notification of Year 2000- related date format impacts. Now, plans are being finalized to perform Year 2000 date testing with a representative sample of third-party customers and others in 1999. Review of third-party relationships will be an ongoing process throughout 1999. ------ 49 Mercantile Bancorporation Inc. and Subsidiaries Mercantile estimates that its total costs related to Year 2000 remediation will be approximately $31,000,000. Expenses of the Program in 1998 were $14,597,000, and total expenses through December 31, 1998 were $24,012,000. Personnel costs for Mercantile employees and outside consultants working on the Program, and the cost of setting up testing environments are the largest components of the total Program cost. Other costs include costs for communication and training, and for required hardware and software replacement, upgrade or renovation. Year 2000 expenditures are expensed as incurred. It is not expected that Year 2000 costs or activities will have a material adverse impact on operations of the Corporation. The principal risks associated with the Year 2000 problem can be grouped into two categories. The first is the risk that Mercantile does not successfully ready its operations for the next century. The second is the risk of disruption of Mercantile operations due to operational failures of third parties. The first category includes those risks that are largely under Mercantile's control. As set forth above, the Corporation believes it has made the necessary corrections to its mission-critical internal systems and therefore, there is little risk of any critical internal system or asset not being Year 2000 ready by the end of 1999. In the unlikely event that Mercantile has not successfully completed its remediation, it could be materially adversely affected as a result of disruption of core business processes. The second risk category is largely outside of Mercantile's control. Computer failure of third parties may jeopardize Mercantile operations. The most serious impact on Mercantile operations from Year 2000 failures of others would result if basic services such as telecommunications, electric power and services provided by other financial institutions and governmental agencies were disrupted. Similarly, operational failures affecting Mercantile's sources of major funding, larger borrowers and capital market counterparties could affect the ability of such parties to continue to provide funding or meet obligations when due. Significant public disclosure of the state of readiness among basic infrastructure and other suppliers, funding sources and counterparties has not generally been available. Although inquiries are under way to assess this potential risk, Mercantile does not yet have the necessary information to estimate the likelihood of such significant disruptions. An initial plan to address funding issues is expected to be completed by June 1999. Review of this plan will be an ongoing process throughout 1999. There can be no assurance that Year 2000 failures of third parties will not have a material adverse impact on Mercantile. Mercantile is developing remediation contingency plans and business resumption contingency plans specific to Year 2000 issues. Remediation contingency plans address the actions to be taken if the current approach to remediating a system is falling behind schedule, or otherwise appears in jeopardy of failing to deliver a Year 2000 ready system when needed. Business resumption contingency plans address the actions that would be taken if core business processes and critical business functions cannot be carried out in the normal manner upon entering the next century due to system or supplier failure. Remediation contingency plans with trigger dates for review and implementation have been developed for mission-critical applications. The effort to develop business resumption contingency plans is in progress. The first two phases of this effort, Organizational Planning Guidelines and Business Impact Analysis, are complete. The third and fourth phases, Plan Development and Method for Validation of Plans, are approximately 65% and 75% complete, respectively. These phases are due to be completed in the first six months of 1999, as required by FFIEC guidelines. The review of these plans will be an ongoing process throughout 1999. INCOME TAXES Mercantile records a provision for income taxes currently payable and for income taxes payable in the future that arise due to timing differences in the recognition of certain items for financial statement and income tax purposes. For the year ended December 31, 1998, the Corporation recorded income tax expense of $192,964,000 compared with $142,376,000 in 1997 and $148,567,000 in 1996. The effective tax rate for 1998 was 33.96% compared with 36.58% last year and 34.31% in 1996. Income tax benefits relating to infrequent charges totaled $30,828,000 in 1998, $59,356,000 in the prior year and $23,697,000 in 1996, resulting in year-to-date adjusted income tax expense for 1998 of $223,792,000 compared with $201,732,000 in 1997 and $172,264,000 in 1996. Excluding the tax benefits recorded in conjunction with ------ 50 Mercantile Bancorporation Inc. and Subsidiaries acquisitions and other infrequent charges previously discussed, the Corporation's year-to-date adjusted effective tax rate was 33.56% in 1996 compared with 34.73% and 33.12% in 1997 and 1998, respectively. The effective tax rates in 1998 and 1997 were influenced by nondeductible goodwill amortization and lower levels of tax-exempt income. These were partially offset by reductions in state and local taxes resulting from the benefits of captive real estate investment trusts, investment subsidiaries and mergers, the realignment of corporate entities consistent with its plan of reducing bank charters, the realization of state and federal tax credits, and benefits recorded due to the resolution of certain tax uncertainties. A three-year summary of significant income tax data is presented in Note M to the Consolidated Financial Statements, which provides an analysis of deferred income taxes as well as a reconciliation between the amount of taxes computed using the statutory rate and the amount actually recorded. As disclosed, Mercantile had a net deferred tax asset of $103,833,000 at December 31, 1998. Due to the significant amount of taxes paid for the past three years and the forecasted taxes payable for 1999, no valuation reserve for the deferred tax asset is deemed necessary. The Corporation currently has only insignificant operating loss carryforwards from acquired entities and federal returns have been examined through 1994 by the Internal Revenue Service. FOURTH QUARTER RESULTS Mercantile earned $90,153,000 or $.57 per diluted share in the fourth quarter of 1998. Excluding a $29,330,000 or $.18 per share restructuring charge, Mercantile earned $119,483,000 in the fourth quarter of 1998, a 13.4% increase from the $105,399,000 earned in the same period last year, while corresponding adjusted diluted earnings per share improved to $.75 from $.70, an increase of 7.1%. Mercantile remains committed to reducing its cost base and took a pre-tax charge of $45,130,000 in the current quarter to account for the costs related to 26 branch closings and severance for approximately 1,400 staff. The staff rightsizing results from further centralization, consolidation of back office functions, a widened span of control and branch closures. These initiatives are expected to enable Mercantile to hold its 1999 expense base flat with 1998 and slightly improve top line revenue. Net interest income improved by 2.9% to $283,158,000 as the volume of average earning assets increased by 6.1%. This growth was partially offset by a decline in the net interest rate margin to 3.56% from 3.67% last year. Average loan volume was up 3.4% with growth in commercial, commercial real estate and consumer loans partially offset by decline in residential real estate. The commentary on net interest income on page 29 provides more details on the dynamics of net interest income and the net interest rate margin. The provision for possible loan losses for the fourth quarter was $11,402,000 compared with $7,627,000 the prior year. Net charge-offs were $11,381,000 or .21% of average loans for the quarter compared with the year-earlier $10,486,000 or .20%, which included a $3,600,000 recovery on a commercial real estate loan. Other income grew by $19,307,000 or 17.7% from the fourth quarter of 1997. Strong results in service charge income, all miscellaneous fee businesses and in both the trust and retail brokerage businesses were partially offset by declines in credit card fees and mortgage banking. Mortgage banking revenue last year included a $3,277,000 gain on the sale of mortgage servicing rights, while the current quarter increased by a $2,700,000 revaluation of purchased mortgage servicing rights. Fourth quarter 1998 included $5,851,000 in securities gains compared with $2,401,000 last year. A detailed explanation of the year-over-year increase in non-interest income is included on page 45. Other operating expenses of $270,341,000 were up $52,220,000 from a year ago. The 1998 results included the $45,130,000 restructuring charge. Excluding this charge, operating expenses grew by only 3.3% even though last year included a $6,041,000 gain on the sale of an office building. Excluding that gain, 1998 operating expenses were flat with the fourth quarter of 1997. The adjusted effective tax rate this quarter was 31.69% compared with 33.51% last year. This quarter included $10,000,000 in federal tax benefits realized from the realignment of corporate entities. Exhibit 20 presents condensed quarterly financial data for the last two years. ------ 51 Mercantile Bancorporation Inc. and Subsidiaries Exhibit 20
- - ---------------------------------------------------------------------------------------------------------------------------------- QUARTERLY FINANCIAL SUMMARY ------------------------------------------------------------------------------------- 1997 1998 ------------------------------------------------------------------------------------- 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr. 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr. - - ---------------------------------------------------------------------------------------------------------------------------------- OPERATING RESULTS AND SELECTED RATIOS EXCLUDING INFREQUENT EXPENSE Adjusted net income (Thousands) $ 85,313 $ 85,180 $103,307 $105,399 $114,859 $107,147 $110,506 $119,483 Adjusted basic earnings per share .64 .66 .70 .71 .76 .71 .72 .76 Adjusted diluted earnings per share .63 .64 .68 .70 .75 .69 .71 .75 Return on assets 1.38% 1.34% 1.25% 1.27% 1.35% 1.23% 1.29% 1.36% Return on equity 15.25 15.87 14.94 15.39 16.03 14.88 14.84 15.46 Efficiency ratio 54.44 54.76 54.83 56.13 53.28 57.00 56.56 54.15 Other expense to average assets 3.02 3.00 2.66 2.64 2.59 2.57 2.59 2.57 PER SHARE DATA Basic earnings per share $ .64 $ .33 $ .09 $ .71 $ .76 $ .71 $ .41 $ .57 Diluted earnings per share .63 .32 .09 .70 .75 .69 .41 .57 Dividends declared .287 .287 .287 .287 .31 .31 .31 .31 Book value at period-end 16.69 16.23 18.18 18.57 18.77 19.16 19.45 19.53 Market price at period-end 35 5/16 40 1/2 50 3/4 61 1/2 54 13/16 50 3/8 48 3/8 46 1/8 OPERATING RESULTS* (Thousands) Taxable-equivalent net interest income $246,616 $251,475 $288,199 $279,532 $276,956 $279,493 $276,985 $287,490 Tax-equivalent adjustment 4,575 4,708 4,477 4,324 4,235 4,191 3,906 4,332 - - ---------------------------------------------------------------------------------------------------------------------------------- Net interest income 242,041 246,767 283,722 275,208 272,721 275,302 273,079 283,158 Provision for possible loan losses 20,090 29,429 29,209 7,627 8,537 7,344 23,871 11,402 Other income 96,358 96,421 112,344 109,070 136,951 114,751 161,839 128,377 Other expense 186,726 242,364 339,167 218,121 220,538 224,726 311,152 270,341 Income taxes 46,270 28,641 14,334 53,131 65,738 50,836 36,751 39,639 - - ---------------------------------------------------------------------------------------------------------------------------------- Net Income $ 85,313 $ 42,754 $ 13,356 $105,399 $114,859 $107,147 $ 63,144 $ 90,153 - - ---------------------------------------------------------------------------------------------------------------------------------- AVERAGE BALANCE SHEET (Millions) Total assets $ 24,724 $ 25,402 $ 33,030 $ 33,097 $ 34,039 $ 34,941 $ 34,260 $ 35,037 Earning assets 22,841 23,304 30,208 30,187 31,027 31,727 31,276 32,014 Loans and leases 16,959 17,268 21,587 21,322 21,585 21,813 21,673 22,045 Deposits 19,576 19,936 24,788 24,663 24,886 25,130 24,372 24,743 Shareholders' equity 2,238 2,147 2,767 2,739 2,866 2,881 2,979 3,092 SELECTED RATIOS Return on assets 1.38% .67% .16% 1.27% 1.35% 1.23% .74% 1.03% Return on equity 15.25 7.97 1.93 15.39 16.03 14.88 8.48 11.66 Efficiency ratio 54.44 69.67 84.68 56.13 53.28 57.00 70.91 65.01 Other expense to average assets 3.02 3.82 4.11 2.64 2.59 2.57 3.63 3.09 Tangible equity to tangible assets 7.97 7.37 5.72 5.92 5.88 6.19 6.70 6.55 Equity to assets 8.78 8.18 8.15 8.29 8.09 8.38 8.84 8.59 Tier I capital to risk-adjusted assets 11.76 10.96 9.35 9.40 9.20 9.55 9.87 9.84 Total capital to risk-adjusted assets 14.25 14.49 12.56 12.42 12.11 12.46 12.75 12.55 Leverage 8.81 8.08 6.30 6.52 6.60 6.65 7.12 7.16 Loans to deposits (Average) 86.63 86.62 87.09 86.45 86.73 86.80 88.93 89.10 Reserve for possible loan losses to outstanding loans 1.51 1.51 1.35 1.33 1.35 1.34 1.40 1.38 Reserve for possible loan losses to non-performing loans 261.69 268.69 217.65 241.91 227.48 242.45 231.98 222.76 Non-performing loans to outstanding loans .58 .56 .62 .55 .59 .55 .61 .62 Net interest rate margin 4.38 4.33 3.79 3.67 3.62 3.53 3.51 3.56 - - ---------------------------------------------------------------------------------------------------------------------------------- *Infrequent income statement amounts included herein.
------ 52 Mercantile Bancorporation Inc. and Subsidiaries MANAGEMENT REPORT ON CONSOLIDATED FINANCIAL STATEMENTS The management of Mercantile Bancorporation Inc. is responsible for the preparation and the integrity and objectivity of the accompanying financial statements. The financial statements necessarily include amounts that are based on management's best estimates and judgments. Future economic conditions and events, and the economic prospects of the Corporation's borrowers, create the possibility that such estimates and judgments may be subject to review and revision. The Corporation maintains an accounting system and related internal controls that have been deemed sufficient to provide reasonable assurance that the financial records are reliable for preparing the financial statements and maintaining accountability for assets. The concept of reasonable assurance is based upon the recognition that the cost of a system of internal controls must be related to the benefits derived, and that the balancing of those factors requires estimates and judgments. The system of internal controls includes written policies and procedures, proper delegation of authority, and segregation of duties. In addition, written Standards of Conduct adopted by the Corporation help to ensure the highest standards of ethical conduct by all employees. Management continually monitors compliance with the system of internal controls, primarily through an extensive program of internal audits. The system of internal controls and compliance therewith are considered by independent auditors, in accordance with generally accepted auditing standards, to the extent necessary to render an opinion on the financial statements, and by regulatory examiners. The financial statements were audited by KPMG LLP, independent auditors, in accordance with generally accepted auditing standards. Their independent professional opinion on the Corporation's financial statements is presented herein. /s/ Thomas H. Jacobsen /s/ John W. McClure Thomas H. Jacobsen John W. McClure Chairman of the Board, Vice Chairman and President and Chief Executive Officer Chief Financial Officer INDEPENDENT AUDITORS' REPORT SHAREHOLDERS AND BOARD OF DIRECTORS MERCANTILE BANCORPORATION INC.: We have audited the accompanying consolidated balance sheets of Mercantile Bancorporation Inc. and subsidiaries as of December 31, 1998, 1997 and 1996, and the related consolidated statements of income, changes in shareholders' equity, cash flows, and comprehensive income for each of the years in the three-year period ended December 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Mercantile Bancorporation Inc. and subsidiaries as of December 31, 1998, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles. /s/ KPMG LLP St. Louis, Missouri January 20, 1999 ------ 53 Mercantile Bancorporation Inc. and Subsidiaries
- - ----------------------------------------------------------------------------------------------------------------------------------- CONSOLIDATED STATEMENT OF INCOME Year Ended December 31 --------------------------------------------- (Thousands except per share data) 1998 1997 1996 - - ----------------------------------------------------------------------------------------------------------------------------------- INTEREST INCOME Interest and fees on loans and leases $ 1,771,235 $ 1,651,816 $ 1,404,809 Investments in debt and equity securities Trading 8,821 7,077 3,630 Taxable 558,635 406,663 315,120 Tax-exempt 23,230 25,797 28,255 - - ----------------------------------------------------------------------------------------------------------------------------------- Total Investments in Debt and Equity Securities 590,686 439,537 347,005 Due from banks - interest bearing 13,293 10,379 4,128 Federal funds sold and repurchase agreements 16,904 16,946 15,178 - - ----------------------------------------------------------------------------------------------------------------------------------- Total Interest Income 2,392,118 2,118,678 1,771,120 INTEREST EXPENSE Interest bearing deposits 908,534 816,771 681,637 Foreign deposits 23,182 26,178 10,501 Short-term borrowings 174,335 159,013 89,676 Bank notes 3,423 10,537 15,333 Long-term debt and mandatorily redeemable preferred securities 178,384 58,441 25,010 - - ----------------------------------------------------------------------------------------------------------------------------------- Total Interest Expense 1,287,858 1,070,940 822,157 - - ----------------------------------------------------------------------------------------------------------------------------------- Net Interest Income 1,104,260 1,047,738 948,963 PROVISION FOR POSSIBLE LOAN LOSSES* 51,154 86,355 78,766 - - ----------------------------------------------------------------------------------------------------------------------------------- Net Interest Income After Provision for Possible Loan Losses 1,053,106 961,383 870,197 OTHER INCOME Trust 112,999 103,928 93,704 Service charges 119,277 109,058 98,908 Investment banking and brokerage 41,137 38,181 35,351 Securitization revenue 20,011 18,404 16,008 Mortgage banking 31,300 23,348 13,518 Gain on sale of mortgage servicing rights 23,155 3,277 -- Securities gains (losses)* 15,435 7,649 292 Gain on sale of subsidiaries* 48,051 -- -- Miscellaneous 130,553 110,348 110,229 - - ----------------------------------------------------------------------------------------------------------------------------------- Total Other Income 541,918 414,193 368,010 OTHER EXPENSE Salaries 418,351 381,942 335,803 Employee benefits 77,608 85,048 77,437 Net occupancy 67,003 61,697 55,489 Equipment 85,426 70,272 60,605 Intangible asset amortization 57,794 40,170 13,237 Restructuring and merger-related costs* 134,322 121,393 51,071 Loss on sale of credit card loans* -- 50,000 -- Miscellaneous* 186,253 175,856 211,545 - - ----------------------------------------------------------------------------------------------------------------------------------- Total Other Expense 1,026,757 986,378 805,187 - - ----------------------------------------------------------------------------------------------------------------------------------- Income Before Income Taxes 568,267 389,198 433,020 INCOME TAXES* 192,964 142,376 148,567 - - ----------------------------------------------------------------------------------------------------------------------------------- Net Income* $ 375,303 $ 246,822 $ 284,453 - - ----------------------------------------------------------------------------------------------------------------------------------- PER SHARE DATA Basic earnings per share $ 2.45 $ 1.76 $ 2.12 Diluted earnings per share 2.41 1.73 2.09 Dividends declared 1.24 1.148 1.092 - - ----------------------------------------------------------------------------------------------------------------------------------- *Includes the following infrequent amounts: Provision for possible loan losses $ 19,600 $ 20,340 $ 13,666 Securities losses 1,649 -- 3,114 Gain on sale of subsidiaries (48,051) -- -- Loss on sale of credit card loans -- 50,000 -- Restructuring and merger-related costs 134,322 121,393 51,071 Miscellaneous expense -- -- 12,385 Income tax benefit (30,828) (59,356) (23,697) - - ----------------------------------------------------------------------------------------------------------------------------------- Reduction of Net Income $ 76,692 $ 132,377 $ 56,539 - - -----------------------------------------------------------------------------------------------------------------------------------
The accompanying notes to consolidated financial statements are an integral part of these statements. ------ 54 Mercantile Bancorporation Inc. and Subsidiaries
- - ------------------------------------------------------------------------------------------------------------------------------------ CONSOLIDATED BALANCE SHEET December 31 ---------------------------------------------- (Thousands) 1998 1997 1996 - - ------------------------------------------------------------------------------------------------------------------------------------ ASSETS Cash and due from banks $ 1,760,636 $ 1,330,512 $ 1,448,637 Due from banks - interest bearing 367,304 251,909 96,714 Federal funds sold and repurchase agreements 226,730 303,859 310,963 Investments in debt and equity securities Trading 126,540 70,536 31,361 Available-for-sale (Amortized cost of $9,185,770, $8,023,157 and $4,731,005, respectively) 9,246,790 8,059,066 4,741,677 Held-to-maturity (Estimated fair value of $99,336, $341,954 and $661,632, respectively) 97,607 335,279 656,721 - - ------------------------------------------------------------------------------------------------------------------------------------ Total Investments in Debt and Equity Securities 9,470,937 8,464,881 5,429,759 Loans held-for-sale 217,941 96,955 75,377 Loans and leases, net of unearned income 22,093,317 21,265,000 16,861,877 - - ------------------------------------------------------------------------------------------------------------------------------------ Total Loans and Leases 22,311,258 21,361,955 16,937,254 Reserve for possible loan losses (308,890) (284,165) (257,718) - - ------------------------------------------------------------------------------------------------------------------------------------ Net Loans and Leases 22,002,368 21,077,790 16,679,536 Bank premises and equipment 545,559 531,650 428,972 Intangible assets 781,188 839,285 202,071 Other assets 645,455 532,304 399,083 - - ------------------------------------------------------------------------------------------------------------------------------------ Total Assets $35,800,177 $33,332,190 $24,995,735 - - ------------------------------------------------------------------------------------------------------------------------------------ LIABILITIES Deposits Non-interest bearing $ 4,453,048 $ 3,956,138 $ 3,389,776 Interest bearing 20,526,576 20,267,878 16,143,182 Foreign 481,773 585,439 251,887 - - ------------------------------------------------------------------------------------------------------------------------------------ Total Deposits 25,461,397 24,809,455 19,784,845 Federal funds purchased and repurchase agreements 2,087,373 2,127,443 1,861,994 Other short-term borrowings 915,287 1,551,097 270,680 Bank notes 25,000 175,000 175,000 Long-term Federal Home Loan Bank advances 2,790,336 578,484 37,085 Other long-term debt 782,998 789,687 290,590 Company-obligated mandatorily redeemable preferred securities of Mercantile Capital Trust I 150,000 150,000 -- Other liabilities 514,031 388,722 312,298 - - ------------------------------------------------------------------------------------------------------------------------------------ Total Liabilities 32,726,422 30,569,888 22,732,492 Commitments and contingent liabilities -- -- -- ----------------------------- SHAREHOLDERS' EQUITY 1998 1997 1996 ----------------------------- Preferred stock - no par value Shares authorized 5,000 5,000 5,000 Shares issued and outstanding -- -- -- -- -- -- Common stock - $.01 par value at December 31, 1998 and 1997, and $5.00 par value at December 31, 1996 Shares authorized 400,000 200,000 200,000 Shares issued 157,487 148,874 136,766 1,574 1,489 683,832 Capital surplus 999,595 1,016,844 16,091 Retained earnings 2,035,157 1,724,752 1,638,610 Accumulated other comprehensive income 41,160 25,222 8,911 Treasury stock, at cost 83 162 2,591 (3,731) (6,005) (84,201) - - ------------------------------------------------------------------------------------------------------------------------------------ Total Shareholders' Equity 3,073,755 2,762,302 2,263,243 - - ------------------------------------------------------------------------------------------------------------------------------------ Total Liabilities and Shareholders' Equity $35,800,177 $33,332,190 $24,995,735 - - ------------------------------------------------------------------------------------------------------------------------------------
The accompanying notes to consolidated financial statements are an integral part of these statements. ------ 55 Mercantile Bancorporation Inc. and Subsidiaries CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
Common Stock ----------------------- Total Outstanding Preferred Capital Retained Treasury Shareholders' (Dollars in thousands) Shares Dollars Stock Surplus Earnings* Stock Equity - - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE AT DECEMBER 31, 1995 134,845,809 $ 684,581 $ 12,153 $ 72,528 $1,502,140 $ (60,557) $ 2,210,845 Net income 284,453 284,453 Common dividends declared: Mercantile Bancorporation Inc., $1.092 per share (101,499) (101,499) Pooled companies prior to acquisition (33,938) (33,938) Preferred dividends declared (408) (408) Redemption of preferred stock (12,153) (531) (12,684) Issuance of common stock in acquisitions of: Today's Bancorp, Inc. 1,690,587 (2,195) 52,321 50,126 First Financial Corporation of America 388,113 (1,226) 12,954 11,728 Peoples State Bank 488,756 849 14,791 15,640 Metro Savings Bank, F.S.B. 296,853 57 14 8,983 9,054 Security Bank of Conway, F.S.B. 482,946 75 14,614 14,689 First Sterling Bancorp, Inc. 782,126 3,911 572 13,772 18,255 Issuance of common stock for: Employee incentive plans 411,775 1,638 (4,318) 2,397 (283) Convertible notes 438,002 2,190 2,681 4,871 Other comprehensive income (16,841) (16,841) Purchase of treasury stock (5,890,426) (186,811) (186,811) Reissuance and retirement of treasury stock (9,688) (47,478) 57,166 -- Pre-merger transactions of pooled companies and other 240,056 1,200 (5,454) 359 (59) (3,954) - - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE AT DECEMBER 31, 1996 134,174,597 683,832 -- 16,091 1,647,521 (84,201) 2,263,243 Net income 246,822 246,822 Common dividends declared: Mercantile Bancorporation Inc., $1.148 per share (132,535) (132,535) Pooled companies prior to acquisition (28,134) (28,134) Issuance of common stock in acquisitions of: Roosevelt Financial Group, Inc. 18,948,884 123 353,128 6,872 280,981 641,104 Regional Bancshares, Inc. 900,625 (474) 361 28,813 28,700 Change in par value of common stock from $5.00 per share to $.01 per share (676,575) 676,575 -- Issuance of common stock for: Employee incentive plans 899,716 322 5,846 5,512 11,680 Convertible notes 79,335 80 802 882 Other comprehensive income 8,805 8,805 Purchase of treasury stock (6,778,324) (287,288) (287,288) Reissuance and retirement of treasury stock (7,396) (42,950) 50,346 -- Pre-merger transactions of pooled companies and other 487,474 1,103 7,826 262 (168) 9,023 - - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE AT DECEMBER 31, 1997 148,712,307 1,489 -- 1,016,844 1,749,974 (6,005) 2,762,302 Net income 375,303 375,303 Common dividends declared: Mercantile Bancorporation Inc., $1.24 per share (179,642) (179,642) Pooled companies prior to acquisition (10,466) (10,466) Issuance of common stock in acquisitions of: First Financial Bancorporation 3,138,823 31 8,522 50,343 58,896 Financial Services Corporation of the Midwest 2,071,448 21 5,093 27,730 32,844 HomeCorp, Inc. 854,760 9 6,727 13,792 20,528 Horizon Bancorp, Inc. 2,549,970 25 10,755 35,615 357 46,752 Issuance of common stock for: Employee incentive plans 1,613,060 14 41,800 8,446 50,260 Convertible notes 26,407 1 293 294 Other comprehensive income 13,703 13,703 Purchase of treasury stock (1,834,375) (101,000) (101,000) Reissuance and retirement of treasury stock (94,471) 94,471 -- Pre-merger transactions of pooled companies and other 271,638 (16) 4,032 (35) 3,981 - - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE AT DECEMBER 31, 1998 157,404,038 $ 1,574 $ -- $ 999,595 $2,076,317 $ (3,731) $ 3,073,755 - - ------------------------------------------------------------------------------------------------------------------------------------ *Includes accumulated other comprehensive income.
The accompanying notes to consolidated financial statements are an integral part of these statements. ------ 56
CONSOLIDATED STATEMENT OF CASH FLOWS Year Ended December 31 ---------------------------------------------- (Thousands) 1998 1997 1996 - - ------------------------------------------------------------------------------------------------------------------------------------ OPERATING ACTIVITIES Net income $ 375,303 $ 246,822 $ 284,453 Adjustments to reconcile net income to net cash provided by operating activities Provision for possible loan losses 51,154 86,355 78,766 Depreciation and amortization 74,028 62,637 52,566 Provision for deferred income tax credits (11,724) (9,995) (23,318) Net change in loans held-for-sale (114,912) (21,578) 30,516 Net change in trading securities (43,298) (53,020) 32,745 Net change in accrued interest receivable 8,120 (2,780) 11,366 Net change in accrued interest payable (8,176) 36,254 (12,348) Other, net 26,244 55,194 85,651 - - ------------------------------------------------------------------------------------------------------------------------------------ Net Cash Provided by Operating Activities 356,739 399,889 540,397 INVESTING ACTIVITIES Investments in debt and equity securities, other than trading securities Purchases (6,928,474) (4,509,883) (2,455,696) Proceeds from maturities 4,358,854 3,608,721 2,366,128 Proceeds from sales of available-for-sale securities 2,040,541 802,007 506,636 Net change in loans and leases (148,977) (642,617) (898,355) Purchases of loans and leases (626,655) (442,154) (141,600) Proceeds from sale of mortgage servicing rights 26,330 4,958 -- Proceeds from sales of loans and leases 880,656 696,454 255,043 Purchases of premises and equipment (93,008) (122,785) (76,386) Proceeds from sales of premises and equipment 21,081 19,679 4,997 Proceeds from sales of foreclosed property 55,925 45,905 32,353 Net cash and cash equivalents received from (paid for) acquisitions 124,071 (231,537) 57,152 Net cash and cash equivalents received from (paid for) sale of banking offices 16,300 (193,058) (12,154) Other, net 24,167 14,160 18,391 - - ------------------------------------------------------------------------------------------------------------------------------------ Net Cash Used by Investing Activities (249,189) (950,150) (343,491) FINANCING ACTIVITIES Net change in consumer certificates under $100,000 (1,255,266) (726,907) (406,202) Net change in time certificates $100,000 and over 33,637 (68,418) 74,010 Net change in other time deposits (9,623) (42,798) 190,437 Net change in foreign deposits (103,666) 333,552 42,717 Net change in other deposits 685,658 156,414 460,853 Net change in short-term borrowings (738,915) 259,830 23,670 Issuance of bank notes -- -- 25,000 Principal payments on bank notes (150,000) -- (100,000) Issuance of long-term debt, including FHLB advances 2,336,500 980,175 2,607 Issuance of company-obligated mandatorily redeemable preferred securities -- 150,000 -- Principal payments on long-term debt, including FHLB advances (176,162) (16,195) (41,081) Cash dividends paid (182,286) (160,347) (135,578) Net proceeds from issuance of common stock from employee incentive plans and pre-merger transactions of pooled companies 22,096 13,220 (22,089) Purchase of treasury stock (101,000) (299,063) (175,036) Redemption of preferred stock -- -- (12,684) Other, net (133) 764 2,176 - - ------------------------------------------------------------------------------------------------------------------------------------ Net Cash Provided (Used) by Financing Activities 360,840 580,227 (71,200) - - ------------------------------------------------------------------------------------------------------------------------------------ Increase in Cash and Cash Equivalents 468,390 29,966 125,706 Cash and Cash Equivalents at Beginning of Year 1,886,280 1,856,314 1,730,608 - - ------------------------------------------------------------------------------------------------------------------------------------ Cash and Cash Equivalents at End of Year $ 2,354,670 $ 1,886,280 $ 1,856,314 - - ------------------------------------------------------------------------------------------------------------------------------------
The accompanying notes to consolidated financial statements are an integral part of these statements. ------ 57
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME Year Ended December 31 ---------------------------------------------- (Thousands) 1998 1997 1996 - - ------------------------------------------------------------------------------------------------------------------------------------ Net income $ 375,303 $ 246,822 $ 284,453 Other comprehensive income, before tax: Holding gains (losses) on available-for-sale securities 36,517 21,186 (25,635) Less: Reclassification adjustment on available-for-sale securities gains included in net income above 15,435 7,640 274 - - ------------------------------------------------------------------------------------------------------------------------------------ Other Comprehensive Income (Loss) Before Tax 21,082 13,546 (25,909) Income taxes related to other comprehensive income (loss) 7,379 4,741 (9,068) - - ------------------------------------------------------------------------------------------------------------------------------------ Other Comprehensive Income (Loss), Net of Tax 13,703 8,805 (16,841) - - ------------------------------------------------------------------------------------------------------------------------------------ Comprehensive Income $ 389,006 $ 255,627 $ 267,612 - - ------------------------------------------------------------------------------------------------------------------------------------
The accompanying notes to consolidated financial statements are an integral part of these statements. ------ 58 Mercantile Bancorporation Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A--ACCOUNTING POLICIES Mercantile Bancorporation Inc. ("Corporation" or "Mercantile") and its subsidiaries follow generally accepted accounting principles and reporting practices applicable to the banking industry. The significant accounting policies are summarized below. Basis of Presentation Consolidation: The Consolidated Financial Statements include the accounts of Mercantile Bancorporation Inc. and its subsidiaries. Material intercompany transactions are eliminated. Reclassification: Certain reclassifications have been made to the 1997 and 1996 historical financial statements to conform with the 1998 presentation. New Accounting Standards Financial Accounting Standard ("FAS") 130, "Reporting Comprehensive Income," was issued in June 1997. Comprehensive income is defined as net income plus certain items that are recorded directly to shareholders' equity, such as unrealized gains and losses on available-for-sale securities. The Corporation's Consolidated Statement of Comprehensive Income is presented on page 58. FAS 131, "Disclosures about Segments of an Enterprise and Related Information," is effective for financial statements for periods beginning after December 15, 1997. An operating segment is defined under FAS 131 as a component of an enterprise that engages in business activities that generate revenue and expense for which operating results are reviewed by the chief operating decision maker in the determination of resource allocation and performance. The new disclosures are included in Note U to the Consolidated Financial Statements. FAS 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," addresses disclosure of such benefit plans and is effective for fiscal years beginning after December 15, 1997. The new disclosures are included in Note N to the Consolidated Financial Statements. FAS 133, "Accounting for Derivative Instruments and Hedging Activities," which was issued in June 1998, establishes accounting and reporting standards for derivative instruments and hedging activities. Under FAS 133, derivatives are recognized on the balance sheet at fair value as an asset or liability. Changes in the fair value of derivatives are reported as a component of other comprehensive income or recognized as earnings through the income statement depending on the nature of the instrument. FAS 133 is effective for all quarters of fiscal years beginning after June 15, 1999 with earlier adoption permitted. The Corporation has not adopted FAS 133 yet and is currently evaluating FAS 133's effect on its financial position and results of operations, but it is not expected to have a material impact. Use of Estimates Management of the Corporation has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare the Consolidated Financial Statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. Investments in Debt and Equity Securities Trading securities, which include any security held primarily for near-term sale, are valued at fair value. Gains and losses on trading securities, both realized and unrealized, are recorded in investment banking and brokerage income. Available-for-sale securities, which include any security for which the Corporation has no immediate plan to sell but which may be sold in the future, are valued at fair value. Realized gains and losses, based on the amortized cost of the specific security, are included in other income as securities gains (losses). Unrealized gains and losses are recorded, net of related income tax effects, in retained earnings. Held-to-maturity securities, which include any security for which the Corporation has the positive intent and ability to hold until maturity, are valued at historical cost adjusted for amortization of premiums and accretion of discounts computed by the level-yield method. Unrealized losses on held-to- maturity and available-for-sale securities are recognized in the Consolidated Statement of Income only if market valuation differences are deemed to be other than temporary impairments in value. Loans Held-for-Sale In its lending activities, the Corporation originates residential mortgage loans and student loans intended for sale in the secondary market. Loans held-for-sale are carried at the lower of cost or fair value, which is determined on an aggregate basis. Gains or losses on the sale of loans held-for-sale are determined on a specific identification method. ------ 59 Mercantile Bancorporation Inc. and Subsidiaries Loans and Leases Interest income on loans is generally accrued on a simple interest basis. Loan fees and direct costs of loan originations are deferred and amortized over the estimated life of the loans under methods approximating the interest method. The finance method is used to account for direct and leveraged equipment lease contracts. Income is recorded over the lease periods in proportion to the unrecovered investment in the leases after consideration of investment tax credits and other related income tax effects. When, in management's opinion, the collection of interest on a loan (exclusive of certain consumer and credit card loans) is unlikely, or when either principal or interest is past due over 90 days, that loan is generally placed on non- accrual status. When a loan is placed on non-accrual status, accrued interest for the current year is reversed and charged against current earnings, and accrued interest from prior years is charged against the reserve for possible loan losses. Interest payments received on non-accrual loans are applied to principal if there is doubt as to the collectibility of such principal; otherwise, these receipts are recorded as interest income. A loan remains on non-accrual status until the loan is current as to payment of both principal and interest, and/or the borrower demonstrates the ability to pay and remain current. All non-accrual and renegotiated commercial-related loans are considered impaired. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, or at the loan's observable market price, or the fair value of the collateral, if the loan is collateral dependent. Reserve for Possible Loan Losses The reserve for possible loan losses is increased by provisions charged to expense and reduced by loans charged off, net of recoveries. The reserve is maintained at a level considered adequate to provide for potential loan losses based on management's evaluation of current economic conditions, changes in the character and size of the portfolio, past experience, expected future losses and other pertinent factors. Mercantile charges off credit card loans after six cycles of nonpayment, or within 15 days of receipt of personal bankruptcy notice, if earlier. Foreclosed Assets Foreclosed assets include real estate and other assets acquired through foreclosure or other proceedings and are included in other assets in the Consolidated Balance Sheet. Foreclosed assets are valued at the lower of cost or fair value less estimated costs to sell. Losses arising at the time of transfer from loans are charged to the reserve for possible loan losses. Subsequent reductions in valuation based upon periodic appraisals are charged against current earnings. Bank Premises and Equipment Bank premises and equipment are stated at cost less accumulated depreciation. Provisions for depreciation are computed principally by the straight-line method and are based on estimated useful lives of the assets. The carrying values of assets sold or retired and the related accumulated depreciation are eliminated from the accounts, and the resulting gains or losses are reflected in net income. Expenditures for maintenance and repairs are expensed, while expenditures for major renewals are capitalized. Intangible Assets Intangible assets consist primarily of goodwill and mortgage servicing rights. Goodwill, the excess of cost over the net assets acquired in business combinations accounted for as purchases, is amortized using the straight-line method over the estimated period to be benefited, most recently 15 years, but not exceeding 40 years. Mortgage servicing rights represent recorded value associated with the contractual right to service loans in return for a fee. These assets may be purchased and recorded at fair value or result from the sale of loans, where servicing is retained and recorded at an allocated carrying amount based on the relative fair value of the assets sold. This intangible is amortized using the level-yield method over the estimated lives of the related loans. The carrying value of mortgage servicing rights is subject to periodic adjustment based upon changing market conditions. Income Taxes Deferred income taxes, computed using the liability method, are provided on temporary differences between the financial reporting basis and the tax basis of the assets and liabilities of the Corporation. Treasury Stock The purchase of the Corporation's common stock is recorded at cost. Upon subsequent reissuance, the treasury stock account is reduced by the average cost basis of such stock. Cash Equivalents Cash and due from banks, due from banks--interest bearing, and federal funds sold and repurchase agreements are considered cash equivalents for purposes of the Consolidated Statement of Cash Flows. ------ 60 Mercantile Bancorporation Inc. and Subsidiaries Financial Instruments Financial instruments include cash, evidence of an ownership interest in an entity or a contract that both a) imposes on the Corporation a contractual obligation, 1) to deliver a financial instrument to another party or 2) to exchange other financial instruments on potentially unfavorable terms with another party; and b) conveys to another party a contractual right, 1) to receive a financial instrument from the Corporation or 2) to exchange other financial instruments on potentially favorable terms with the Corporation. Derivative Financial Instruments The Corporation is a party to certain financial instruments, primarily to stabilize interest rate margins and to hedge against interest rate movements. An instrument designated as a hedge of an asset or liability carried at cost is accounted for on an accrual basis, in which the interest income or interest expense of the related asset or liability is adjusted for the net amount of any interest receivable or payable generated by the hedging instrument. There is no market valuation on these interest rate contracts. If the underlying assets or liabilities hedged are no longer recorded on the Consolidated Balance Sheet (e.g., due to sale), the remaining gain or loss related to the interest rate contract is recognized through earnings immediately. In the normal course of business, the Corporation does not maintain trading positions in interest rate derivative financial instruments. The Corporation's non-hedging transactions are entered into on behalf of customers and are simultaneously hedged by the Corporation. As a consequence, these transactions do not represent exposure to market risk. The Corporation manages the potential credit exposure through established credit approvals, risk control limits and other monitoring procedures. These contracts are recorded at their fair value with gains or losses included in the Consolidated Statement of Income. Mercantile has entered into foreign exchange forward contracts, primarily to facilitate customers' foreign exchange requirements. The Corporation maintains a generally matched position; therefore, exchange rate and market risks are minimal. Credit risk to the Corporation could result from non-performance by a counterparty to a contract. Credit risk is managed as indicated in the previous paragraph. Unrealized gains and losses on these foreign exchange forward contracts are reflected in the Consolidated Statement of Income. NOTE B--EARNINGS PER SHARE Basic earnings per share data is calculated by dividing net income, after deducting dividends on preferred stock, by the weighted average number of common shares outstanding during the period. Diluted earnings per share gives effect to both the increase in the average shares outstanding that would have resulted from both the exercise of dilutive stock options and the conversion of the entire balance of outstanding convertible notes. Net income attributable to common shareholders' equity in the diluted earnings per share computation is increased by interest expense that would not be incurred on notes if they converted, net of taxes. The components of basic and diluted earnings per share are as follows:
Year Ended December 31 ----------------------------------------- (Thousands except per share data) 1998 1997 1996 - - ---------------------------------------------------------------------- BASIC Net income $ 375,303 $ 246,822 $ 284,453 Preferred stock dividends -- -- (408) - - ---------------------------------------------------------------------- Net Income Attributable to Common Shareholders' Equity $ 375,303 $ 246,822 $ 284,045 - - ---------------------------------------------------------------------- Weighted average common shares outstanding 153,462,295 140,009,105 133,925,697 - - ---------------------------------------------------------------------- Basic Earnings per Share $ 2.45 $ 1.76 $ 2.12 - - ---------------------------------------------------------------------- DILUTED Net income attributable to common shareholders' equity $ 375,303 $ 246,822 $ 284,045 Interest on convertible notes, net of taxes 43 83 120 - - ---------------------------------------------------------------------- Diluted Net Income $ 375,346 $ 246,905 $ 284,165 - - ---------------------------------------------------------------------- Weighted average common shares outstanding 153,462,295 140,009,105 133,925,697 Employee incentive plans 2,370,290 2,493,277 1,775,913 Convertible notes 88,613 136,605 294,419 - - ---------------------------------------------------------------------- Diluted Weighted Average Common Shares Outstanding 155,921,198 142,638,987 135,996,029 - - ---------------------------------------------------------------------- Diluted Earnings per Share $ 2.41 $ 1.73 $ 2.09 - - ----------------------------------------------------------------------
------ 61 Mercantile Bancorporation Inc. and Subsidiaries NOTE C--ACQUISITIONS Listed below are the acquisitions completed by Mercantile during the years ended December 31, 1998, 1997 and 1996:
Original Consideration Intangible -------------------------- Accounting (Dollars in thousands) Date Assets Asset Cash Gross Shares Method - - ------------------------------------------------------------------------------------------------------------------------------------ ACQUISITIONS COMPLETED Bruno Stolze & Company, Inc. Sept. 30, 1998 /1/ $ -- /1/ /1/ Purchase First Financial Bancorporation Sept. 28, 1998 $ 558,483 -- $ 12 3,138,823 Pooling/2/ Financial Services Corporation of the Midwest Aug. 3, 1998 514,051 -- 4 2,071,448 Pooling/2/ CBT Corporation ("CBT") July 1, 1988 1,006,384 -- 34 5,123,214 Pooling Firstbank of Illinois Co. ("Firstbank") July 1, 1998 2,285,146 -- 64 13,352,641 Pooling HomeCorp, Inc. Mar. 2, 1998 335,137 -- 14 854,760 Pooling/2/ Horizon Bancorp, Inc. Feb. 2, 1998 536,507 -- 2 2,549,970 Pooling/2/ Roosevelt Financial Group, Inc. ("Roosevelt") July 1, 1997 7,251,985 608,076 374,477 18,948,884 Purchase Mark Twain Bancshares, Inc. ("Mark Twain") April 25, 1997 3,227,972 -- 73 24,088,713 Pooling Regional Bancshares, Inc. March 5, 1997 171,979 16,217 12,300 900,625 Purchase Today's Bancorp, Inc. Nov. 7, 1996 501,418 46,854 34,912 1,690,587 Purchase First Financial Corporation of America Nov. 1, 1996 87,649 5,137 3,253 388,113 Purchase Peoples State Bank Aug. 22, 1996 95,657 7,552 -- 488,756 Purchase Metro Savings Bank, F.S.B. March 7, 1996 80,857 3,016 5 296,853 Purchase Security Bank of Conway, F.S.B. Feb. 9, 1996 102,502 6,000 1 482,946 Purchase Hawkeye Bancorporation Jan. 2, 1996 1,978,540 -- 80 11,838,294 Pooling First Sterling Bancorp, Inc. Jan. 2, 1996 167,610 -- 1 782,126 Pooling/2/ - - ------------------------------------------------------------------------------------------------------------------------------------ /1/ Terms of the transaction not disclosed. /2/ The historical financial statements of the Corporation were not restated for the acquisition due to the immateriality of the acquiree's financial condition and results of operations to those of Mercantile.
The Firstbank and CBT acquisitions were accounted for as poolings-of- interests. Net income, net interest income and basic earnings per share in 1998 for the Corporation, CBT and Firstbank prior to this restatement were as follows:
Six Months Ended June 30 ------------- (Thousands except per share data) 1998 - - -------------------------------------------------- Corporation Net income $198,902 Net interest income 482,912 Basic earnings per share 1.50 CBT Net income 7,151 Net interest income 21,038 Basic earnings per share 1.40 Firstbank Net income 15,953 Net interest income 44,073 Basic earnings per share 1.21 - - --------------------------------------------------
During 1998, the Corporation recorded adjustments related to the acquisitions of Bruno Stolze & Company, Inc., First Financial Bancorporation, Financial Services Corporation of the Midwest, CBT, Firstbank, HomeCorp, Inc. and Horizon Bancorp, Inc. These adjustments consisted of $19,600,000 in provision for loan losses, $1,649,000 in realized losses on securities sold in portfolio restructurings, $89,192,000 of other expense and a related tax benefit of $15,028,000. Of the $89,192,000 merger-related liability established, $48,960,000 had been used by December 31, 1998 and $40,232,000 remains to absorb future payments. As a result of the acquisition by Mercantile, Firstbank's two Missouri banks were sold in September 1998 due to state restrictions on deposit concentration. An after-tax gain of $29,421,000 was recorded in connection with these divestitures. Firstbank acquired BankCentral Corporation and its wholly-owned subsidiary, Central National Bank of Mattoon on June 10, 1997. The acquisition involved an exchange of cash and Firstbank common stock totaling approximately $13,000,000, and was recorded using the purchase method of accounting. ------ 62 Mercantile Bancorporation Inc. and Subsidiaries The Roosevelt acquisition was accounted for as a purchase. The following unaudited pro forma combined consolidated financial data gives effect to the July 1, 1997 acquisition of Roosevelt as if it had been consummated on January 1, 1996. The unaudited pro forma combined consolidated financial data provided includes the impact of goodwill amortization and the reduction in net interest income due to: 1) interest lost on cash paid for share repurchases or paid directly to Roosevelt shareholders as consideration; and 2) interest on $650,000,000 of senior debt, subordinated debt and redeemable preferred securities issued in 1997 largely to finance the Roosevelt acquisition, offset by interest earned on funds not utilized in the acquisition. There is no estimate of potential cost savings included in the following table:
As of or for the Year Ended December 31 ----------------------- (Thousands except per share data) 1997 1996 - - ------------------------------------------------------------ Total assets N/A $33,025,746 Net interest income $1,125,021 1,080,885 Other income 401,619 332,043 Net income 216,564 224,351 Basic earnings per share 1.48 1.53 - - ------------------------------------------------------------
The Mark Twain acquisition was accounted for as a pooling-of-interests. Net income, net interest income and basic earnings per share for the Corporation and Mark Twain in 1997 prior to this restatement were as follows:
Three Months Ended March 31 -------------- (Thousands except per share data) 1997 - - ------------------------------------------------- Corporation Net income $ 60,336 Net interest income 179,515 Basic earnings per share .67 Mark Twain Net income 14,659 Net interest income 32,446 Basic earnings per share .85 - - -------------------------------------------------
During 1997, Mercantile recorded adjustments related to the acquisitions of Roosevelt, Mark Twain and Regional Bancshares, Inc. The adjustments consisted of $20,340,000 in provision for loan losses, $121,393,000 other expense, reduced by a related tax benefit of $41,856,000, for a net income reduction of $99,877,000. Of the $121,393,000 merger-related liability established, $117,491,000 had been utilized at December 31, 1998. During 1996, adjustments were recorded by the Corporation related to companies acquired that year. These adjustments consisted of a $13,666,000 increase in provision for loan losses, $3,114,000 in losses on securities sold in portfolio restructurings, a $51,071,000 charge to other expense and a related tax benefit of $19,362,000, resulting in an after-tax reduction to net income of $48,489,000. These accruals have been substantially exhausted. For all acquisitions accounted for as purchases, the unamortized excess of cost over the fair value of assets acquired was $723,186,000, $777,693,000 and $171,539,000 at December 31, 1998, 1997 and 1996, respectively. NOTE D--CASH FLOWS The Corporation paid interest on deposits, short-term borrowings, bank notes and long-term debt of $1,320,709,000, $1,033,434,000 and $834,516,000 in 1998, 1997 and 1996, respectively. The Corporation paid Federal income taxes of $114,926,000, $159,797,000 and $162,068,000 in 1998, 1997 and 1996, respectively. The following details cash and cash equivalents from acquisitions accounted for as purchases or poolings without restatement, net of cash paid:
Year Ended December 31 ------------------------------------------ (Thousands) 1998 1997 1996 - - ------------------------------------------------------------------------ Fair value of assets purchased $(1,943,257) $(8,065,744) $(1,260,315) Fair value of liabilities assumed 1,780,406 7,044,026 1,090,663 Issuance of common stock 159,319 676,433 136,124 - - ------------------------------------------------------------------------ Net Cash Paid for Acquisitions (3,532) (345,285) (33,528) Cash and cash equivalents acquired 127,603 113,748 90,680 - - ------------------------------------------------------------------------ Net Cash and Cash Equivalents Received from (Paid for) Acquisitions $ 124,071 $ (231,537) $ 57,152 - - ------------------------------------------------------------------------
NOTE E--CASH AND DUE FROM BANKS RESTRICTIONS The Corporation's subsidiary banks are required to maintain average reserve balances that place withdrawal and/or usage restrictions on cash and due from banks balances. The average amount of these restricted balances for the year ended December 31, 1998 was $205,533,000. ------ 63 Mercantile Bancorporation Inc. and Subsidiaries NOTE F--INVESTMENTS IN DEBT AND EQUITY SECURITIES Available-for-Sale The amortized cost, estimated fair values, and unrealized gains and losses of available-for-sale securities were as follows:
Amortized Unrealized Unrealized Estimated (Thousands) Cost Gains Losses Fair Value - - ------------------------------------------------------------------------------------------------------ DECEMBER 31, 1998 U.S. Government $6,271,816 $50,590 $ 5,385 $6,317,021 State and political subdivisions: Tax-exempt 405,109 12,991 21 418,079 Taxable 24,711 211 -- 24,922 - - ------------------------------------------------------------------------------------------------------ Total State and Political Subdivisions 429,820 13,202 21 443,001 Privately issued collateralized mortgage obligations 864,584 5,949 4,030 866,503 Other 1,619,550 10,345 9,630 1,620,265 - - ------------------------------------------------------------------------------------------------------ Total $9,185,770 $80,086 $19,066 $9,246,790 - - ------------------------------------------------------------------------------------------------------ DECEMBER 31, 1997 U.S. Government $4,998,860 $33,373 $ 7,697 $5,024,536 State and political subdivisions: Tax-exempt 359,834 8,214 243 367,805 Taxable 61,817 279 82 62,014 - - ------------------------------------------------------------------------------------------------------ Total State and Political Subdivisions 421,651 8,493 325 429,819 Privately issued collateralized mortgage obligations 1,727,572 8,698 8,182 1,728,088 Other 875,074 3,372 1,823 876,623 - - ------------------------------------------------------------------------------------------------------ Total $8,023,157 $53,936 $18,027 $8,059,066 - - ------------------------------------------------------------------------------------------------------ DECEMBER 31, 1996 U.S. Government $4,042,304 $21,839 $17,432 $4,046,711 State and political subdivisions: Tax-exempt 403,803 8,555 936 411,422 Taxable 112,158 490 469 112,179 - - ------------------------------------------------------------------------------------------------------ Total State and Political Subdivisions 515,961 9,045 1,405 523,601 Privately issued collateralized mortgage obligations 20,316 316 172 20,460 Other 152,424 144 1,663 150,905 - - ------------------------------------------------------------------------------------------------------ Total $4,731,005 $31,344 $20,672 $4,741,677 - - ------------------------------------------------------------------------------------------------------
------ 64 Mercantile Bancorporation Inc. and Subsidiaries Held-to-Maturity The amortized cost, estimated fair values, and unrealized gains and losses of held-to-maturity securities were as follows:
Amortized Unrealized Unrealized Estimated (Thousands) Cost Gains Losses Fair Value - - ----------------------------------------------------------------------------------------- DECEMBER 31, 1998 U.S. Government $ 95,754 $ 3,477 $1,707 $ 97,524 Other 1,853 -- 41 1,812 - - ----------------------------------------------------------------------------------------- Total $ 97,607 $ 3,477 $1,748 $ 99,336 - - ----------------------------------------------------------------------------------------- DECEMBER 31, 1997 U.S. Government $247,705 $ 6,625 $3,938 $250,392 State and political subdivisions: Tax-exempt 80,330 3,825 8 84,147 Taxable 3,822 132 -- 3,954 - - ----------------------------------------------------------------------------------------- Total State and Political Subdivisions 84,152 3,957 8 88,101 Other 3,422 158 119 3,461 - - ----------------------------------------------------------------------------------------- Total $335,279 $10,740 $4,065 $341,954 - - ----------------------------------------------------------------------------------------- DECEMBER 31, 1996 U.S. Government $558,911 $ 9,784 $7,750 $560,945 State and political subdivisions: Tax-exempt 88,287 3,294 525 91,056 Taxable 4,304 66 3 4,367 - - ----------------------------------------------------------------------------------------- Total State and Political Subdivisions 92,591 3,360 528 95,423 Other 5,219 220 175 5,264 - - ----------------------------------------------------------------------------------------- Total $656,721 $13,364 $8,453 $661,632 - - -----------------------------------------------------------------------------------------
In conjunction with the acquisition of Roosevelt, the Corporation acquired privately issued adjustable-rate mortgage-backed securities that have incurred an impairment in value which is considered other than temporary. The loan pools backing these securities have been affected by high delinquency and foreclosure rates, and higher than anticipated losses on foreclosed property sales. The net book value of these mortgage-backed securities was $62,056,000 as of December 31, 1998. During the third quarter of 1996, the Corporation transferred securities from the available-for-sale classification to the held-to-maturity classification. The securities transferred had an amortized cost basis of $370,014,000 and an estimated fair value of $373,557,000 on the transfer date. The unrealized gain on the date of the transfer remained in shareholders' equity and is being amortized over the remaining life of the transferred securities. The unamortized balance as of December 31, 1998 was $1,007,000. Securities with a carrying value of $5,656,506,000 at December 31, 1998, $3,918,545,000 at December 31, 1997 and $3,348,145,000 at December 31, 1996 were pledged to secure public and trust deposits, securities sold under agreements to repurchase and for other purposes required by law. The following table presents proceeds from sales of securities and the components of net securities gains. There were no transfers of securities from the held-to-maturity category to available-for-sale during 1996, 1997 and 1998. Held-to-maturity securities gains and losses resulted from portfolio restructurings in connection with subsidiary bank acquisitions or calls by the security issuer prior to maturity.
Year Ended December 31 ------------------------------------ (Thousands) 1998 1997 1996 - - ---------------------------------------------------------------------- Proceeds from sales of available-for-sale securities $2,040,541 $802,007 $506,636 - - ---------------------------------------------------------------------- Securities gains on: Available-for-sale securities $ 19,390 $ 8,225 $ 4,295 Held-to-maturity securities -- 9 18 - - ---------------------------------------------------------------------- Total Securities Gains 19,390 8,234 4,313 Securities losses on: Available-for-sale securities 3,955 585 4,021 Held-to-maturity securities -- -- -- - - ---------------------------------------------------------------------- Total Securities Losses 3,955 585 4,021 - - ---------------------------------------------------------------------- Net Securities Gains Before Income Taxes 15,435 7,649 292 Applicable income taxes (5,402) (2,677) (102) - - ---------------------------------------------------------------------- Net Securities Gains $ 10,033 $ 4,972 $ 190 - - ----------------------------------------------------------------------
------ 65 Mercantile Bancorporation Inc. and Subsidiaries NOTE G--LOANS AND LEASES Loans and leases consisted of the following:
December 31 --------------------------------------- (Thousands) 1998 1997 1996 - - ------------------------------------------------------------------------------------------------------------- Commercial $ 6,099,692 $ 4,990,505 $ 4,591,604 Real estate--commercial 3,798,032 3,569,922 3,255,590 Real estate--construction 922,915 734,722 643,345 Real estate--residential mortgage 8,153,824 8,702,879 4,787,012 Real estate--home equity credit loans 526,097 588,228 439,806 Consumer 2,765,556 2,492,150 2,306,184 Credit card 45,142 283,549 913,713 - - ------------------------------------------------------------------------------------------------------------- Total Loans and Leases $22,311,258 $21,361,955 $16,937,254 - - -------------------------------------------------------------------------------------------------------------
Changes in the reserve for possible loan losses were as follows:
Year Ended December 31 ---------------------------------------- (Thousands) 1998 1997 1996 - - ------------------------------------------------------------------------------------------------------------- Beginning balance $ 284,165 $ 257,718 $ 261,339 Provision 51,154 86,355 78,766 Charge-offs (64,866) (109,259) (114,127) Recoveries 22,782 28,189 21,934 - - ------------------------------------------------------------------------------------------------------------- Net Charge-offs (42,084) (81,070) (92,193) Acquired reserves 15,655 21,162 9,806 - - ------------------------------------------------------------------------------------------------------------- Ending Balance $ 308,890 $ 284,165 $ 257,718 - - -------------------------------------------------------------------------------------------------------------
Non-performing loans consisted of the following:
December 31 ---------------------------------------- (Thousands) 1998 1997 1996 - - ------------------------------------------------------------------------------------------------------------- Non-accrual $ 132,713 $ 113,134 $ 81,037 Renegotiated 5,950 4,335 5,413 - - ------------------------------------------------------------------------------------------------------------- Non-performing Loans $ 138,663 $ 117,469 $ 86,450 - - -------------------------------------------------------------------------------------------------------------
By the Corporation's definition, all non-accrual and renegotiated commercial- related loans are considered impaired. The following table presents information on impaired loans:
As of or for the Year Ended December 31 ----------------------------------------- (Thousands) 1998 1997 1996 - - ----------------------------------------------------------------------------- Ending impaired loans $47,598 $65,188 $53,294 Related reserve for possible loan losses 6,487 13,890 11,284 Average impaired loans 61,622 66,785 59,532 Interest income recognized on impaired loans 332 374 748 - - -----------------------------------------------------------------------------
Certain directors and executive officers of the Corporation were loan customers of the Corporation's banks during 1998, 1997 and 1996. Such loans were made in the ordinary course of business at normal terms, including interest rate and collateralization, and did not represent more than a normal risk. Loans to those persons, their immediate families and companies in which they were principal owners were $55,539,000, $15,255,000 and $26,570,000, at December 31, 1998, 1997 and 1996, respectively. During 1998, $56,641,000 of new loans were made to these persons, and repayments totaled $16,357,000. NOTE H--BANK PREMISES AND EQUIPMENT Bank premises and equipment were as follows:
December 31 ---------------------------------- (Thousands) 1998 1997 1996 - - --------------------------------------------------------------- Land $ 81,830 $ 82,154 $ 70,021 Bank premises 466,540 460,408 392,250 Leasehold improvements 48,864 45,343 50,519 Furniture and equipment 504,748 462,179 366,444 - - --------------------------------------------------------------- Total Cost 1,101,982 1,050,084 879,234 Accumulated depreciation (556,423) (518,434) (450,262) - - --------------------------------------------------------------- Net Carrying Value $ 545,559 $ 531,650 $ 428,972 - - ---------------------------------------------------------------
At December 31, 1998, the Corporation had certain long-term leases, none of which were considered to be capital leases, which were principally related to the use of land, buildings and equipment. The following table summarizes the future minimum rental commitments for noncancelable operating leases which had initial or remaining noncancelable lease terms in excess of one year:
Minimum Rental Period (Thousands) - - ----------------------------- 1999 $18,374 2000 15,884 2001 11,928 2002 8,840 2003 6,403 2004 and later 19,160 - - ----------------------------- Total $80,589 - - -----------------------------
Net rental expense for all operating leases was $19,031,000 in 1998, $19,706,000 in 1997 and $15,232,000 in 1996. ------ 66 Mercantile Bancorporation Inc. and Subsidiaries NOTE I--DEPOSITS Deposits consisted of the following:
December 31 -------------------------------------- (Thousands) 1998 1997 1996 - - -------------------------------------------------------------------- Non-interest bearing $ 4,453,048 $ 3,956,138 $ 3,389,776 Interest bearing demand 3,281,788 3,086,259 2,800,964 Money market accounts 4,151,540 3,811,081 3,152,825 Savings 1,766,918 1,559,441 1,323,775 Consumer time certificates under $100,000 9,186,531 9,850,437 7,136,532 Other time 189,122 191,199 233,997 - - -------------------------------------------------------------------- Total Core Deposits 23,028,947 22,454,555 18,037,869 Time certificates $100,000 and over 1,950,677 1,769,461 1,495,089 Foreign 481,773 585,439 251,887 - - -------------------------------------------------------------------- Total Purchased Deposits 2,432,450 2,354,900 1,746,976 - - -------------------------------------------------------------------- Total Deposits $25,461,397 $24,809,455 $19,784,845 - - --------------------------------------------------------------------
The scheduled maturities of Mercantile's consumer time certificates under $100,000, time certificates $100,000 and over and other time deposits were as follows:
Scheduled Maturity Amount Period (Thousands) - - ------------------------------ 1999 $ 7,929,081 2000 2,021,757 2001 621,143 2002 350,619 2003 302,714 2004 and later 101,016 - - ------------------------------ Total $11,326,330 - - ------------------------------
NOTE J--SHORT-TERM BORROWINGS Short-term borrowings were as follows:
December 31 --------------------------------- (Thousands) 1998 1997 1996 - - ----------------------------------------------------------------- Federal funds purchased and repurchase agreements $2,087,373 $2,127,443 $1,861,994 Short-term Federal Home Loan Bank ("FHLB") advances 667,672 1,412,701 123,094 Treasury tax and loan notes 222,044 104,535 118,886 Commercial paper 3,025 1,510 19,405 Other short-term borrowings 22,546 32,351 9,295 - - ----------------------------------------------------------------- Total Short-term Borrowings $3,002,660 $3,678,540 $2,132,674 - - -----------------------------------------------------------------
The average balance of total short-term borrowings was $3,294,078,000, $2,929,826,000 and $1,671,352,000 during 1998, 1997 and 1996, respectively. The average rate on total short-term borrowings was 5.29% in 1998, 5.43% in 1997 and 5.37% in 1996. The maximum balances at month-end are listed below:
Year Ended December 31 ---------------------------------- (Thousands) 1998 1997 1996 - - ----------------------------------------------------------------- Federal funds purchased and repurchase agreements $2,370,228 $2,579,789 $1,886,127 Short-term FHLB advances 1,472,114 1,412,701 130,239 Treasury tax and loan notes 402,733 260,822 439,181 Commercial paper 5,010 24,800 21,660 Other short-term borrowings 79,366 102,833 45,142 - - -----------------------------------------------------------------
The Corporation had unused lines of credit arrangements with unaffiliated banks for support of commercial paper and for other uses totaling $100,000,000 at December 31, 1998. NOTE K--LONG-TERM DEBT AND BANK NOTES Long-term Debt Long-term debt consisted of the following:
December 31 --------------------------------- (Thousands) 1998 1997 1996 - - --------------------------------------------------------------- MERCANTILE BANCORPORATION INC. (PARENT COMPANY ONLY) 7.300% subordinated notes, due 2007 $ 200,000 $ 200,000 $ -- 6.800% senior notes, due 2001 150,000 150,000 -- 7.050% senior notes, due 2004 150,000 150,000 -- 7.625% subordinated notes, due 2002 150,000 150,000 150,000 7.000% convertible subordinated notes, due 1999 859 1,153 -- - - --------------------------------------------------------------- Subtotal 650,859 651,153 150,000 SECOND-TIER HOLDING COMPANIES 3,641 -- 2,036 BANKS AND OTHER SUBSIDIARIES 6.375% subordinated notes, due 2004 75,000 75,000 75,000 9.000% mortgage-backed notes, due 1999 53,450 53,450 53,450 Other 48 10,084 10,104 - - --------------------------------------------------------------- Subtotal 128,498 138,534 138,554 - - --------------------------------------------------------------- Total Long-term Debt Before FHLB Advances 782,998 789,687 290,590 FHLB advances 2,790,336 578,484 37,085 - - --------------------------------------------------------------- Total Long-term Debt $3,573,334 $1,368,171 $327,675 - - ---------------------------------------------------------------
------ 67 Mercantile Bancorporation Inc. and Subsidiaries In June 1997, the Corporation issued $200,000,000 of subordinated notes with a 10-year maturity and a coupon rate of 7.300%, $150,000,000 of senior notes with a four-year maturity and a coupon rate of 6.800%, and $150,000,000 of senior notes with a seven-year maturity and a coupon rate of 7.050%. The subordinated and senior debt was primarily issued to assist in the financing of the Roosevelt acquisition. For regulatory purposes the subordinated notes qualify as Tier II capital. In June 1987, Mark Twain issued 7.000% convertible subordinated capital notes which are due in 1999. These convertible notes were transferred to Mercantile Bancorporation Inc. (Parent Company Only) during 1997. The balance of the convertible notes was $2,036,000 at December 31, 1996. The notes are convertible into common stock at a conversion price equivalent to $11.127 per Mercantile share. Included in other long-term debt in 1997 and 1996 was a $10,000,000 term note to Fidelity Credit Corporation, a subsidiary of CBT. This term note was paid off and refinanced with loans from Mercantile subsidiary banks in the third quarter of 1998. FHLB advances at December 31, 1998 consisted of various debt instruments with rates varying from 4.850% to 6.850%. This debt was collateralized by certain loans and securities. During 1996, Roosevelt defeased mortgage-backed bonds totaling $19,700,000 by delivering treasury securities to the bond trustee for the periodic payment of interest and the ultimate payment of the bonds to the bondholders on the maturity date of April 15, 2018. Mercantile exercised the bonds' call provision during the second quarter of 1998. A summary of annual principal reductions of long-term debt is presented below:
(Thousands) Period FHLB Advances Other Total - - ----------------------------------------------------- 1999 $1,410,716 $ 55,068 $1,465,784 2000 98,120 653 98,773 2001 12,075 152,277 164,352 2002 124,604 150,000 274,604 2003 355,650 -- 355,650 2004 and later 789,171 425,000 1,214,171 - - ----------------------------------------------------- Total $2,790,336 $782,998 $3,573,334 - - -----------------------------------------------------
Bank Notes Beginning in 1994, certain subsidiary banks could offer unsecured bank notes. In 1998, the bank note program was restructured. Note maturities can range from seven days to 30 years from the date of issue and may be issued with fixed or floating interest rates. Each bank note issued will be an obligation solely of that issuing bank and will not be an obligation of, or otherwise guaranteed by, the other issuing banks or the Corporation. The bank notes issued under this program may be senior bank notes or subordinated bank notes. The bank notes are being offered and sold only to institutional investors, and are not insured by the Federal Deposit Insurance Corporation or any other governmental agency. Bank notes as presented below were issued under the 1994 program:
December 31 --------------------------- (Thousands) 1998 1997 1996 - - -------------------------------------------------------- MERCANTILE BANK N.A. 5.462% floating-rate bank notes, due 1999 $25,000 $ 25,000 $ 25,000 6.056% floating-rate bank notes, due 1998 -- 150,000 150,000 - - -------------------------------------------------------- Total Bank Notes $25,000 $175,000 $175,000 - - --------------------------------------------------------
NOTE L -- COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF MERCANTILE CAPITAL TRUST I In January 1997, the Corporation formed Mercantile Capital Trust I. Through this trust, the Corporation obtained $150,000,000 of floating-rate debt maturing in 2027 that, for regulatory purposes, is part of Tier I capital. Mercantile Capital Trust I is a subsidiary of which the Corporation owns all the outstanding common securities; its sole assets are the $150,000,000 in mandatorily redeemable preferred securities, and considered together, the back- up undertakings constitute a full and unconditional guarantee by Mercantile Bancorporation Inc. of the trust's obligations under the preferred securities. ------ 68 Mercantile Bancorporation Inc. and Subsidiaries NOTE M -- INCOME TAXES The Corporation's results include income tax expense as follows:
(Thousands) Current Deferred Total - - --------------------------------------------------- YEAR ENDED DECEMBER 31, 1998 U.S. Federal $179,319 $ (11,342) $167,977 State and local 25,369 (382) 24,987 - - --------------------------------------------------- Total $204,688 $ (11,724) $192,964 - - --------------------------------------------------- YEAR ENDED DECEMBER 31, 1997 U.S. Federal $141,435 $ (9,593) $131,842 State and local 10,936 (402) 10,534 - - --------------------------------------------------- Total $152,371 $ (9,995) $142,376 - - --------------------------------------------------- YEAR ENDED DECEMBER 31, 1996 U.S. Federal $155,218 $ 22,306) $132,912 State and local 16,667 (1,012) 15,655 - - --------------------------------------------------- Total $171,885 $(23,318) $148,567 - - ---------------------------------------------------
The tax effects of temporary differences that gave rise to the deferred tax assets and deferred tax liabilities are presented below:
December 31 --------------------------------- (Thousands) 1998 1997 1996 - - ----------------------------------------------------------------- DEFERRED TAX ASSETS Reserve for possible loan losses $ 99,130 $ 91,027 $ 82,964 Foreclosed property 140 839 1,448 Deferred compensation 9,451 5,290 5,869 Expenses not currently allowable for tax purposes 58,353 20,977 23,386 State tax liabilities -- -- 1,595 Retirement expenses in excess of tax deduction 12,478 9,324 5,130 Other 5,215 13,775 7,780 - - ----------------------------------------------------------------- Total Gross Deferred Tax Assets 184,767 141,232 128,172 DEFERRED TAX LIABILITIES Leasing (20,915) (26,938) (29,956) Intangible assets -- -- (5,637) Depreciation (7,769) (6,000) (6,698) Investments in debt and equity securities -- FAS 115 (19,595) (13,583) (3,413) FHLB stock dividends (11,073) (9,672) -- Other (21,582) (10,330) (12,132) - - ----------------------------------------------------------------- Total Gross Deferred Tax Liabilities (80,934) (66,523) (57,836) - - ----------------------------------------------------------------- Net Deferred Tax Assets $103,833 $ 74,709 $ 70,336 - - -----------------------------------------------------------------
Certain events covered by IRC Section 593(e), which was not repealed, will trigger a recapture of the base year reserve of acquired thrift institutions. The base year reserve of acquired thrift institutions would be recaptured if an entity ceases to qualify as a bank for federal income tax purposes. The base year reserves of thrift institutions also remain subject to income tax penalty provisions that, in general, require recapture upon certain stock redemptions of, and excess distributions to, stockholders. At December 31, 1998, retained earnings included approximately $101.8 million of base year reserves for which no deferred federal income tax liability has been recognized. Income tax expense as reported differs from the amounts computed by applying the statutory U.S. Federal income tax rate to pre-tax income as follows:
Year Ended December 31 ------------------------------ (Thousands) 1998 1997 1996 - - ------------------------------------------------------------ Computed "expected" tax expense $198,893 $136,219 $151,557 Increase (reduction) in income taxes resulting from: Tax-exempt income (10,078) (10,839) (11,833) State and local income taxes, net of federal income tax benefit 16,242 6,847 10,176 Amortization of goodwill 19,311 12,216 403 Liquidation of affiliate (25,000) -- -- Other, net (6,404) (2,067) (1,736) - - ------------------------------------------------------------ Total Tax Expense $192,964 $142,376 $148,567 - - ------------------------------------------------------------
NOTE N -- RETIREMENT PLANS Pension Plans The Corporation maintains both qualified and nonqualified noncontributory pension plans that cover all employees meeting certain age and service requirements. For the qualified plan, the Corporation's funding policy is to contribute annually at least the minimum amount required by government funding standards but not more than is tax deductible. No contribution was required during 1998, 1997 or 1996. The nonqualified plans provide pension benefits that would have been provided under the qualified plan in the absence of limits placed on qualified plan benefits by the Internal Revenue Service. The Corporation's funding policy is to fund benefits as they are paid. ------ 69 Mercantile Bancorporation Inc. and Subsidiaries Effective in 1998, Mercantile changed the type of formula used to determine pension benefits for its qualified and nonqualified plans. Pension benefits under this formula are calculated based upon compensation and age.This change is first reflected in 1998 net periodic benefit cost. In 1997 and 1996, the qualified and nonqualified plans provided pension benefits based on the employee's length of service and the five highest consecutive years of compensation. The Corporation generally begins covering employees of acquired corporations in its pension and life insurance plans within a year following the acquisition date. The effect of acquisitions that are accounted for as purchases or poolings-of-interests without restatement is first reflected in net periodic cost reported below for the year the employees first become covered in the plans. Changes in benefit obligations and plan assets attributable to these acquisitions are illustrated below. The net periodic pension expense related to the qualified and nonqualified plans included in the Consolidated Statement of Income is summarized as follows:
Year Ended December 31 --------------------------------- (Thousands) 1998 1997 1996 - - ------------------------------------------------------------------------------------------------------------ Service cost $ 9,216 $ 12,169 $ 11,361 Interest cost 15,937 15,770 14,219 Expected return on assets (18,834) (16,817) (15,138) Amortization of: Transition obligation (asset) (159) (679) (584) Prior service cost (1,180) (126) 22 Actuarial loss 268 100 379 - - ------------------------------------------------------------------------------------------------------------ FAS 87 cost 5,248 10,417 10,259 Curtailment charge -- 94 -- - - ------------------------------------------------------------------------------------------------------------ Total Net Periodic Pension Cost $ 5,248 $ 10,511 $ 10,259 - - ------------------------------------------------------------------------------------------------------------
Weighted average assumptions used as of December 31 were as follows:
1998 1997 1996 - - ------------------------------------------------------------------------------------------------------------- Discount rate in determining benefit obligations 6.75% 7.25% 7.50% Expected long-term rate on plan assets 9.50 9.50 9.50 Rate of increase in compensation levels 5.00 5.00 5.00 - - -------------------------------------------------------------------------------------------------------------
The table below sets forth the change in benefit obligation:
Year Ended December 31 ---------------------------------- (Thousands) 1998 1997 1996 - - ------------------------------------------------------------------------------------------------------------ Net benefit obligation at beginning of year $232,266 $199,676 $178,677 Service cost 9,216 12,169 11,361 Interest cost 15,937 15,770 14,219 Plan amendments (11,213) (5,042) -- Actuarial loss 4,257 19,409 4,847 Acquisitions/divestitures 8,981 -- -- Gross benefits paid (10,455) (8,913) (9,428) Curtailments -- (803) -- - - ------------------------------------------------------------------------------------------------------------ Net Benefit Obligation at End of Year $248,989 $232,266 $199,676 - - ------------------------------------------------------------------------------------------------------------
The change in plan assets is as follows:
Year Ended December 31 --------------------------------- (Thousands) 1998 1997 1996 - - ------------------------------------------------------------------------------------------------------------ Fair value of plan assets at beginning of year $218,155 $183,137 $170,446 Actual return on plan assets 25,526 35,100 17,476 Employer contributions 2,517 2,296 4,643 Acquisitions/divestitures 13,512 6,535 -- Gross benefits paid (10,455) (8,913) (9,428) - - ------------------------------------------------------------------------------------------------------------ Fair Value of Plan Assets at End of Year $249,255 $218,155 $183,137 - - ------------------------------------------------------------------------------------------------------------
The reconciliation of funded status is as follows:
Year Ended December 31 ---------------------------------- (Thousands) 1998 1997 1996 - - ------------------------------------------------------------------------------------------------------------ Funded status at end of year $ 266 $(14,111) $(16,539) Unrecognized net actuarial loss 1,426 7,389 13,484 Unamortized prior service cost (14,136) (4,226) 53 Unrecognized net transition obligation (asset) (1,230) (881) (703) - - ------------------------------------------------------------------------------------------------------------ Net Amount Recognized at End of Year $(13,674) $(11,829) $ (3,705) - - ------------------------------------------------------------------------------------------------------------
The prepaid benefit cost on the Consolidated Balance Sheet was $7,235,000, $4,906,000 and $11,528,000 at December 31, 1998, 1997 and 1996, respectively. The accrued benefit cost on the Consolidated Balance Sheet was $20,909,000, $16,735,000 and $11,528,000 at December 31, 1998, 1997 and 1996, respectively. ------ 70 Mercantile Bancorporation Inc. and Subsidiaries The projected benefit obligation and accumulated benefit obligation for pension plans with accumulated benefit obligations in excess of plan assets were $29,662,000 and $27,941,000, respectively, as of December 31, 1998 and $22,239,000 and $20,761,000, respectively, as of December 31, 1997. The plans referred to in this paragraph have no assets. Other Postretirement Benefits: The Corporation provides other postretirement benefits, largely medical benefits and life insurance, to its retirees. Medical benefit contributions are adjusted annually; the life insurance is noncontributory. The net periodic postretirement expense included in the Consolidated Statement of Income is summarized as follows:
Year Ended December 31 --------------------------------------- (Thousands) 1998 1997 1996 - - ---------------------------------------------------------------------------------- Service cost $ 832 $ 793 $ 820 Interest cost 2,719 2,790 2,748 Amortization of: Transition obligation (asset) 1,581 1,581 1,581 Prior service cost 8 8 8 Actuarial loss 38 19 124 - - ---------------------------------------------------------------------------------- Total Net Periodic Postretirement Cost $ 5,178 $ 5,191 $ 5,281 - - ----------------------------------------------------------------------------------
Weighted average assumptions used as of December 31 were as follows:
1998 1997 1996 - - ------------------------------------------------------------------------------------------------------------------- Discount rate in determining 6.75% 7.25% 7.50% benefit obligations Health care cost trend: First year 7.50 8.50 9.50 Ultimate (2001 and after) 5.50 5.50 5.50 - - -------------------------------------------------------------------------------------------------------------------
The following table sets forth the change in benefit obligation:
Year Ended December 31 --------------------------------------- (Thousands) 1998 1997 1996 - - -------------------------------------------------------------------------------------------------------------------- Net benefit obligation at beginning of year $39,614 $38,210 $36,204 Service cost 832 793 820 Interest cost 2,719 2,790 2,748 Plan participants' contributions 992 -- -- Actuarial loss 638 329 872 Gross benefits paid (3,515) (2,508) (2,434) - - -------------------------------------------------------------------------------------------------------------------- Net Benefit Obligation at End of Year $41,280 $39,614 $38,210 - - --------------------------------------------------------------------------------------------------------------------
The reconciliation of funded status is as follows:
Year Ended December 31 -------------------------------------- (Thousands) 1998 1997 1996 - - -------------------------------------------------------------------------------------------------------------------- Funded status at end of year $(41,280) $(39,614) $(38,210) Unrecognized net actuarial loss 2,897 2,298 1,988 Unamortized prior service cost 124 132 140 Unrecognized transition obligation 22,146 23,727 25,308 - - -------------------------------------------------------------------------------------------------------------------- Net Amount Recognized at End of Year $(16,113) $(13,457) $(10,774) - - --------------------------------------------------------------------------------------------------------------------
The sensitivity of reported figures for postretirement welfare benefits to changes in the assumed health care cost trend are set forth below:
1 Percentage Point Change in Health Care Cost --------------------------- (Thousands) Increase Decrease - - ----------------------------------------------------------------- Effect on service and interest cost components of net periodic cost $ 112 $ (99) Effect on accumulated postretirement benefit obligation 1,542 (1,365) - - -----------------------------------------------------------------
NOTE O--SHAREHOLDERS' EQUITY Common Stock At Mercantile's Annual Meeting on April 24, 1997, the Corporation's shareholders approved an amendment to its Restated Articles of Incorporation that reduced the par value of the Corporation's common stock from $5.00 per share to $.01 per share. The authorized common stock of the Corporation consisted of 400,000,000 shares in 1998 and 200,000,000 shares in 1997 and 1996, of which 157,404,038, 148,712,307 and 134,174,597 shares were outstanding at December 31, 1998, 1997 and 1996, respectively. The Corporation's Shareholder Investment Plan ("Plan") allows new shareholders a means to make an initial investment in Mercantile common stock or for shareholders of record to purchase additional shares. Under the Plan, participants have the option of reinvesting dividends. ------ 71 Mercantile Bancorporation Inc. and Subsidiaries Preferred Stock The authorized preferred stock of the Corporation consists of 5,000,000 shares, no par value, of which none were issued or outstanding at December 31, 1998, 1997 and 1996, although 2,000,000 shares were reserved for issuance pursuant to the Preferred Share Purchase Rights Plan. The preferred stock, which is issuable in series, shall have specific terms, preferences and other rights as determined by the Board of Directors for each series. Preferred Share Purchase Rights Plan One preferred share purchase right ("MBI Right") is attached to each share of common stock. The MBI Rights trade automatically with shares of common stock and become exercisable and will trade separately from the common stock on the tenth day after public announcement that a person or group has acquired, or has the right to acquire, beneficial ownership of 20% or more of the outstanding shares of common stock, or upon commencement or announcement of intent to make a tender offer for 20% or more of the outstanding shares of common stock, in either case without prior written consent of the Board. When exercisable, each MBI Right will entitle the holder to buy 1/100 of a share of MBI Series B Junior Participating Preferred Stock at an exercise price of $212 per MBI Right. In the event a person or group acquires beneficial ownership of 20% or more of common stock, holders of MBI Rights (other than the acquiring person or group) may purchase common stock having a market value of twice the then current exercise price of each MBI Right.If the Corporation is acquired by any person or group after the rights become exercisable, each MBI Right will entitle its holder to purchase stock of the acquiring company having a market value of twice the current exercise price of each MBI Right. The MBI Rights are designed to protect the interests of MBI and its shareholders against coercive takeover tactics. The purpose of the MBI Rights is to encourage potential acquirors to negotiate with Mercantile's Board of Directors prior to attempting a takeover and and to give the Board leverage in negotiating on behalf of all shareholders the terms of any proposed takeover. The MBI Rights may deter certain takeover proposals. The MBI Rights, which can be redeemed by MBI's Board of Directors in certain circumstances, expire by their terms on June 3, 2008. Stock Options The Corporation had stock options outstanding under various plans at December 31, 1998, including plans assumed in acquisitions. The original Mercantile plans provide for the granting to employees of the Corporation and its subsidiaries of options to purchase shares of common stock of the Corporation over periods of up to 10 years at a price not less than the market value of the shares at the date the options are granted. The plans provide for the granting of options that either qualify or do not qualify as Incentive Stock Options as defined by Section 422 of the Internal Revenue Code of 1986, as amended. As of December 31, 1998, there were 4,235,102 options available for grant. The per share price range for options exercisable was $3.61 to $58.31 as of December 31, 1998. The following table summarizes stock options outstanding as of December 31, 1998:
Options Outstanding ------------------------------------------------- Weighted Average Range of Remaining Weighted Average Exercise Price Outstanding Contractual Life Exercise Price - - ---------------------------------------------------------------------------------------------------------------------- $ 3.61 - 21.18 1,471,023 2.36 yrs. $13.66 21.44 - 21.67 1,245,550 4.62 21.67 21.77 - 33.13 1,478,453 5.21 28.02 34.08 - 52.69 1,579,142 7.83 36.57 53.06 - 58.31 1,365,837 9.28 54.45 - - ---------------------------------------------------------------------------------------------------------------------- 3.61 - 58.31 7,140,005 5.88 30.90 ----------------------------------------------------------------------------------------------------------------------
Changes in options outstanding were as follows:
Weighted Average Exercise Shares Price - - --------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1995 6,295,043 $17.36 Granted 1,066,576 28.90 Exercised (826,963) 10.74 Canceled (156,318) 24.79 Assumed 76,488 15.27 - - --------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1996 6,454,826 19.91 Granted 1,889,201 34.72 Exercised (1,407,609) 17.20 Canceled (108,121) 27.19 Assumed 610,536 17.72 - - --------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1997 7,438,833 23.90 Granted 1,580,662 53.64 Exercised (1,720,684) 19.57 Canceled (296,262) 37.18 Assumed 137,456 20.81 - - --------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1998 7,140,005 30.90 - - ---------------------------------------------------------------------------------------------------------------------
------ 72 Mercantile Bancorporation Inc. and Subsidiaries The numbers of shares exercisable under stock options as of December 31, 1998, 1997 and 1996 were 4,271,291, 4,936,522 and 3,436,204, respectively, with a weighted average exercise price of $22.84, $19.47 and $15.71, respectively. The fair value of the option grants was estimated on the date of grant using an option-pricing model based upon the following assumptions:
1998 1997 1996 - - --------------------------------------------------------------- Dividend yield 2.69% 2.85% 3.30% Expected volatility 29.52 29.80 31.70 Average risk-free interest rate 5.36 6.13 5.15 Expected option life from vesting date 1.55 yrs. 1.40 yrs. 1.26 yrs. Weighted per share average fair value of stock options granted $16.01 $ 8.26 $ 7.15 - - ---------------------------------------------------------------
The Corporation applies Accounting Principles Board Opinion 25 in accounting for its stock option plans. The compensation cost that has been charged against income for stock-based compensation plans was $6,866,000, $5,984,000 and $4,081,000 for 1998, 1997 and 1996, respectively. Had the Corporation adopted FAS 123's optional accounting method, the Corporation's net income and earnings per share would have been reduced to the pro forma amounts noted below:
(Thousands except per share data) As Reported Pro Forma - - ------------------------------------------------------------ YEAR ENDED DECEMBER 31, 1998 Net income $375,303 $370,840 Basic earnings per share 2.45 2.42 Diluted earnings per share 2.41 2.37 YEAR ENDED DECEMBER 31, 1997 Net income 246,822 240,132 Basic earnings per share 1.76 1.72 Diluted earnings per share 1.73 1.68 YEAR ENDED DECEMBER 31, 1996 Net income 284,453 280,514 Basic earnings per share 2.12 2.09 Diluted earnings per share 2.09 2.06 - - ------------------------------------------------------------
The effect of applying FAS 123 as presented above is not representative of the effects on pro forma net income for future years. Debt and Dividend Restrictions Consolidated retained earnings at December 31, 1998 were not restricted under any agreement as to payment of dividends or reacquisition of common stock. The primary source of funds for dividends paid by the Corporation to its shareholders is dividends received from bank subsidiaries. At December 31, 1998, approximately $82,939,000 of the equity of bank subsidiaries was available for distribution as dividends to the Parent Company without prior regulatory approval or without reducing the capital of the respective subsidiary banks below present minimum standards. An additional $311,578,000 would be available for loans to the Parent Company under Federal Reserve regulations. The remaining equity of bank subsidiaries approximating $2,495,319,000 was restricted as to transfers to the Parent Company. NOTE P--REGULATORY MATTERS The Corporation and its subsidiary banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Corporation's Consolidated Financial Statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Mercantile and its subsidiary banks must meet specific capital guidelines that involve quantitative measures of the Corporation and its subsidiary banks' assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Mercantile and subsidiary banks' capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulations to ensure capital adequacy require the Corporation and its subsidiary banks to maintain minimum amounts and ratios, as set forth in the table on the next page, of Tier I and total capital to risk-weighted assets, and of Tier I capital to average assets, the leverage ratio. Management believes, as of December 31, 1998, the Corporation and its subsidiary banks met all their capital adequacy requirements. ------ 73 Mercantile Bancorporation Inc. and Subsidiaries The actual and required capital amounts and ratios as of December 31, 1998, 1997 and 1996 for the Corporation and Mercantile Bank N.A. are listed in the following table:
December 31, 1998 December 31, 1997 December 31, 1996 ------------------------------------------------------------------------------------------------------- Minimum Capital Minimum Capital Minimum Capital Actual Requirements Actual Requirements Actual Requirements ------------------------------------------------------------------------------------------------------- (Dollars in thousands) Amount Ratio Amount Amount Ratio Amount Amount Ratio Amount - - ------------------------------------------------------------------------------------------------------------------------------------ TIER I CAPITAL (TO RISK-WEIGHTED ASSETS) Corporation $2,451,449 9.84% $ 996,302 $2,104,078 9.40% $ 894,913 $2,049,795 11.50% $ 713,258 Mercantile Bank N.A. 1,731,390 10.82 639,898 1,210,872 10.86 446,178 499,602 9.51 210,225 TOTAL CAPITAL (TO RISK-WEIGHTED ASSETS) Corporation 3,125,488 12.55 1,992,604 2,778,794 12.42 1,789,826 2,500,154 14.02 1,426,516 Mercantile Bank N.A. 1,974,542 12.34 1,279,795 1,406,983 12.61 892,356 620,308 11.80 420,450 LEVERAGE (TO AVERAGE ASSETS) Corporation 2,451,449 7.16 1,368,832 2,104,078 6.52 1,291,055 2,049,795 8.52 962,265 Mercantile Bank N.A. 1,731,390 7.99 866,856 1,210,872 7.33 660,542 499,602 6.97 286,873 - - ------------------------------------------------------------------------------------------------------------------------------------
Minimum capital ratios are 4.00% for Tier I capital and leverage, and 8.00% for total capital. As of November 30, 1998, the date of the most recent notification from regulatory agencies, the subsidiary banks were categorized as well capitalized under the regulatory framework. There are no conditions or events since that notification that management believes have changed the subsidiary banks' category. NOTE Q--CONCENTRATIONS OF CREDIT The Corporation's primary market area is the state of Missouri and the lower Midwest. At December 31, 1998, approximately 87% of the total loan portfolio, and 86% of the commercial and commercial real estate loan portfolio, were to borrowers within this region. The diversity of the region's economic base tends to provide a stable lending environment. Real estate constituted the only other area of significant concentration of credit risk. Real estate-related financial instruments (loans, commitments and standby letters of credit) composed 47% of all such instruments of the Corporation. However, of this total, approximately 64% was consumer-related in the form of residential real estate mortgages and home equity lines of credit. The Corporation is, in general, a secured lender. At December 31, 1998, approximately 93% of the loan portfolio was secured. Collateral is required in accordance with the normal credit evaluation process based upon the creditworthiness of the customer and the credit risk associated with the particular transaction. NOTE R--FINANCIAL INSTRUMENTS Fair Values Fair values for financial instruments are management's estimates of the values at which the instruments could be exchanged in a transaction between willing parties. These estimates are subjective and may vary significantly from amounts that would be realized in actual transactions. In addition, certain financial instruments and all non-financial instruments are excluded from the fair value disclosure requirements of FAS 107, "Disclosures about Fair Value of Financial Instruments." Therefore, the fair values presented below should not be construed as the underlying value of the Corporation. The following methods and assumptions were used in estimating fair values for financial instruments. Cash and Due from Banks, Short-term Investments and Short-term Borrowings: The carrying values reported in the Consolidated Balance Sheet approximated fair values. Investments in Debt and Equity Securities: Fair values for held-to-maturity securities were based upon quoted market prices where available. Fair values for trading and available-for-sale securities, which also were the amounts reported in the Consolidated Balance Sheet, were based on quoted market prices where available. If quoted market prices were not available, fair values were based upon quoted market prices of comparable instruments. Loans and Leases: The fair values for most fixed-rate loans were estimated by utilizing discounted cash flow analysis, applying interest rates currently being offered ------ 74 Mercantile Bancorporation Inc. and Subsidiaries for similar loans to borrowers with similar risk profiles. The discount rates used, therefore, include a credit risk premium. The fair values of variable-rate loans and all residential mortgages were estimated by utilizing the same type of discounted cash flows, but over a range of interest rate scenarios, in order to incorporate the value of the options imbedded in these assets. Loans with similar characteristics were aggregated for purposes of these calculations. Deposits: The fair values disclosed for deposits generally payable on demand (i.e., interest bearing and non-interest bearing demand, savings and money market accounts) were considered equal to their respective carrying amounts as reported in the Consolidated Balance Sheet. Fair values for certificates of deposit and foreign deposits were estimated using a discounted cash flow calculation that applied interest rates generally offered on similar certificates to a schedule of aggregated expected monthly maturities of time deposits. The fair value estimate of the deposit portfolio has not been adjusted for any value derived from the retention of those deposits for an expected future period of time, and was neither considered in the fair value amounts below nor recorded as an intangible asset on the Consolidated Balance Sheet. Bank Notes and Long-term Debt: The fair value of publicly traded debt was based upon quoted market prices, where available, or upon quoted market prices of comparable instruments. The fair values of bank notes and long-term debt were estimated using discounted cash flow analysis, based on the Corporation's current incremental borrowing rates for similar types of borrowing arrangements. Off-Balance-Sheet Instruments: Fair values of foreign exchange contracts, interest rate contracts and when-issued securities were determined from quoted market prices. Fair values of commitments to extend credit, standby letters of credit and commercial letters of credit were based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standings. The estimated fair values of the Corporation's financial instruments were as follows:
December 31 -------------------------------------------------------------------------------- 1998 1997 1996 -------------------------------------------------------------------------------- Carrying Fair Carrying Fair Carrying Fair (Thousands) Value Value Value Value Value Value - - ------------------------------------------------------------------------------------------------------------------------ FINANCIAL ASSETS Cash and due from banks, and short-term investments $ 2,354,670 $ 2,354,670 $ 1,886,280 $ 1,886,280 $ 1,856,314 $ 1,856,314 Trading securities 126,540 126,540 70,536 70,536 31,361 31,361 Held-to-maturity securities 97,607 99,336 335,279 341,954 656,721 661,632 Available-for-sale securities 9,246,790 9,246,790 8,059,066 8,059,066 4,741,677 4,741,677 Net loans and leases 22,002,368 22,871,157 21,077,790 21,525,593 16,679,536 17,129,917 FINANCIAL LIABILITIES Deposits 25,461,397 25,877,849 24,809,455 25,112,466 19,784,845 19,999,832 Short-term borrowings 3,002,660 3,002,660 3,678,540 3,678,540 2,132,674 2,132,674 Bank notes and long-term debt 3,748,334 3,904,190 1,693,171 1,709,813 502,675 506,954 OFF-BALANCE-SHEET Foreign exchange contracts purchased 322 (5,880) (428) Foreign exchange contracts sold 1,425 4,367 39 Interest rate contracts 34,164 17,244 (143) When-issued securities purchased 647 (2,578) -- When-issued securities sold (6,702) 2,509 -- Commitments to extend credit (33,738) (37,790) (17,779) Standby letters of credit (4,477) (3,862) (2,879) Commercial letters of credit (2,100) (1,998) (5,406) - - --------------------------------------------------------------------------------------------------------------------------
OFF-BALANCE-SHEET RISK The Corporation is, in the normal course of business, a party to certain off- balance-sheet financial instruments. These instruments, which include commitments to extend credit, standby letters of credit, interest rate options written, interest rate swaps and foreign exchange contracts, are used by the Corporation to meet the financing needs of its customers and to reduce its own exposure to interest rate fluctuations. They involve varying degrees of credit, interest rate and liquidity risk, but do not represent unusual risks for the Corporation. Management does not anticipate any significant losses as a result of these transactions. ------ 75 Mercantile Bancorporation Inc. and Subsidiaries The notional or contract amounts of financial instruments with off-balance- sheet credit risk were as follows:
December 31 ---------------------------------------- (Thousands) 1998 1997 1996 - - --------------------------------------------------------------------- Commitments to extend credit Commercial $5,152,065 $4,175,423 $3,325,464 Consumer 4,056,684 2,270,781 6,176,412 - - --------------------------------------------------------------------- Total $9,208,749 $6,446,204 $9,501,876 - - --------------------------------------------------------------------- Standby letters of credit $ 514,300 $ 442,245 $ 462,082 - - --------------------------------------------------------------------- Interest rate contracts $ 978,666 $1,021,563 $ 391,000 - - --------------------------------------------------------------------- When-issued securities: Commitments to purchase $ 213,895 $ 178,475 $ -- Commitments to sell 291,700 230,981 -- - - ---------------------------------------------------------------------
The Corporation's maximum exposure to credit loss under commitments to extend credit and standby letters of credit is the equivalent of the contractual amount of those instruments. The same credit policies are used by the Corporation in granting commitments and conditional obligations as are used in the extension of credit. Commitments to extend credit are legally binding agreements to lend to a borrower as long as the borrower performs in accordance with the terms of the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. As many of the commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. Included in consumer commitments are the unused portions of lines of credit for credit card and home equity credit loans. Standby letters of credit are commitments issued by the Corporation to guarantee specific performance of a customer to a third party. Collateral is required for both commitments and standby letters of credit in accordance with the normal credit evaluation process based upon the creditworthiness of the customer and the credit risk associated with the particular transaction. Collateral held varies but may include commercial real estate, accounts receivable, inventory or equipment. Included in interest rate contracts are interest rate swaps and floors. Derivative Financial Instruments Held or Issued for Trading Purposes: In the normal course of business, the Corporation maintains minimal trading positions in a variety of derivative financial instruments. Most of the Corporation's trading activities are customer oriented, with trading positions established to meet the financing and foreign exchange transaction needs of customers. This activity complements the Corporation's traditional money and capital markets trading business, which also exists to meet customers' demands. Net revenue recognized on interest rate contracts and foreign exchange contracts totaled $4,699,000, $4,615,000 and $3,916,000 in 1998, 1997 and 1996, respectively. The notional amounts of interest rate options written, foreign exchange contracts purchased and foreign exchange contracts sold were as follows:
December 31 ------------------------------ (Thousands) 1998 1997 1996 - - --------------------------------------------------------------- Interest rate options written $ 5,475 $ 13,533 $ 16,456 Foreign exchange contracts purchased 431,246 328,127 243,800 Foreign exchange contracts sold 383,637 291,995 193,179 - - ---------------------------------------------------------------
These transactions are generally entered into on behalf of customers and are simultaneously hedged by the Corporation. As a consequence, these matched transactions do not represent exposure to market risk. The Corporation manages the potential credit exposure through established credit approvals, risk control limits and other monitoring procedures. Credit risk to the Corporation could result from non-performance by a counterparty to a contract; however, currently that credit risk is minimal. Held or Issued for Purposes Other Than Trading: The Corporation uses off- balance-sheet derivative financial instruments such as interest rate swaps and floors to manage interest rate risk. The Corporation's exposure to interest rate risk stems from the mismatch between the sensitivity to movements in interest rates of the Corporation's assets and liabilities. The use of derivatives to manage interest rate risk is primarily for interest sensitivity adjustments. Interest rate swaps are generally used to lengthen the interest rate sensitivity of short-term assets and to shorten the repricing characteristics of longer term liabilities. Gains or losses are used to adjust the basis of the related asset or liability, and interest differentials are adjustments of the related interest income or expense. ------ 76 Mercantile Bancorporation Inc. and Subsidiaries Of the commitments to extend credit discussed in the preceding paragraphs, $587,796,000, $554,396,000 and $346,850,000 were entered into with fixed rates for commercial loan customers at December 31, 1998, 1997 and 1996, respectively. Fixed-rate commitments for consumer (residential mortgage) loan customers totaled $233,256,000 at December 31, 1998, $231,204,000 at December 31, 1997 and $77,727,000 at December 31, 1996. Fixed-rate commitments to extend credit are defined as fixed-rate commercial loan commitments with remaining maturities greater than one year, fixed-rate residential mortgage loan commitments, and adjustable-rate residential mortgage loan commitments for loans with adjustment periods greater than one year. Fixed-rate mortgage loans held for resale are partially hedged with contracts for forward delivery in the secondary mortgage market. This hedging activity is designed to protect the Corporation from changes in interest rates. Gains and losses from the hedging transactions on mortgage loans held for resale are deferred and included in the cost of the loans for determining the gain or loss when the loans are sold. Forward delivery contracts outstanding totaled $265,691,000 as of December 31, 1998, $85,585,000 as of December 31, 1997 and $62,823,000 as of December 31, 1996. NOTE S--CONTINGENT LIABILITIES In the ordinary course of business, there are various legal proceedings pending against the Corporation and its subsidiaries. Management, after consultation with legal counsel, is of the opinion that the ultimate resolution of these proceedings will have no material adverse effect on the consolidated financial condition or results of operations of the Corporation. NOTE T--PARENT COMPANY FINANCIAL INFORMATION Following are the condensed financial statements of Mercantile Bancorporation Inc. (Parent Company Only) for the periods indicated. For the Statement of Cash Flows (Parent Company Only), cash and short-term investments were considered cash equivalents. Interest paid on commercial paper and long-term debt was $52,568,000, $35,494,000 and $12,420,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
STATEMENT OF INCOME December 31 ---------------------------------------------- (Thousands) 1998 1997 1996 - - ----------------------------------------------------------------------------------------------------------------------------------- INCOME Dividends from subsidiaries $ 402,026 $ 324,884 $ 444,136 Other interest and dividends 8,678 11,386 4,359 Management fees 29,681 21,404 16,987 Other 6,225 6,602 5,159 - - ----------------------------------------------------------------------------------------------------------------------------------- Total Income 446,610 364,276 470,641 - - ----------------------------------------------------------------------------------------------------------------------------------- EXPENSE Interest on commercial paper 94 951 987 Interest on long-term debt and mandatorily redeem- able preferred securities 52,929 38,243 11,681 Personnel expense 29,902 32,889 18,503 Intangible asset amortization 51,187 30,615 6,046 Other operating expenses 132,880 115,534 40,326 - - ----------------------------------------------------------------------------------------------------------------------------------- Total Expense 266,992 218,232 77,543 - - ----------------------------------------------------------------------------------------------------------------------------------- INCOME BEFORE INCOME TAX BENEFIT AND EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARIES 179,618 146,044 393,098 Income tax benefit 68,283 48,458 16,514 - - ----------------------------------------------------------------------------------------------------------------------------------- INCOME BEFORE EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARIES 247,901 194,502 409,612 Equity in undistributed income of subsidiaries 127,402 52,320 (125,159) - - ----------------------------------------------------------------------------------------------------------------------------------- Net Income $ 375,303 $ 246,822 $ 284,453 - - -----------------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET December 31 ---------------------------------------------- (Thousands) 1998 1997 1996 - - ----------------------------------------------------------------------------------------------------------------------------------- ASSETS Cash $ 193 $ 15 $ 33 Short-term investments 264,145 224,230 128,480 Available-for-sale securities 18,836 28,578 30,167 Investment in subsidiaries 2,988,236 2,685,587 2,194,274 Intangible assets 672,742 723,785 126,239 Loans and advances to subsidiaries 3,025 1,510 19,405 Other assets 80,288 36,929 9,316 - - ----------------------------------------------------------------------------------------------------------------------------------- Total Assets $4,027,465 $3,700,634 $2,507,914 - - ----------------------------------------------------------------------------------------------------------------------------------- LIABILITIES Commercial paper $ 3,025 $ 1,510 $ 19,405 Long-term debt 650,859 651,153 150,000 Company-obligated mandatorily redeemable preferred securities 150,000 150,000 -- Other liabilities 149,826 135,669 75,266 - - ----------------------------------------------------------------------------------------------------------------------------------- Total Liabilities 953,710 938,332 244,671 - - ----------------------------------------------------------------------------------------------------------------------------------- SHAREHOLDERS' EQUITY 3,073,755 2,762,302 2,263,243 - - ----------------------------------------------------------------------------------------------------------------------------------- Total Liabilities and Shareholders' Equity $4,027,465 $3,700,634 $2,507,914 - - -----------------------------------------------------------------------------------------------------------------------------------
------ 77 Mercantile Bancorporation Inc. and Subsidiaries
STATEMENT OF CASH FLOWS Year Ended December 31 ---------------------------------------------- (Thousands) 1998 1997 1996 - - ----------------------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES Net income $ 375,303 $ 246,822 $ 284,453 Adjustments to reconcile net income to net cash provided by operating activities Net income of subsidiaries (529,428) (377,204) (318,977) Dividends from subsidiaries 402,026 312,072 421,299 Other, net 35,383 79,097 33,386 - - ----------------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 283,284 260,787 420,161 INVESTING ACTIVITIES Investments in debt and equity securities Purchases (10,626) (4,554) (8,339) Proceeds from maturities 11,555 4,100 -- Acquisitions (130) (386,850) (33,082) Other, net (2,456) 8,846 (2,943) - - ----------------------------------------------------------------------------------------------------------------------------------- Net Cash Used by Investing Activities (1,657) (378,458) (44,364) FINANCING ACTIVITIES Cash dividends paid (171,813) (132,535) (101,907) Net issuance of common stock for employee incentive plans 29,764 11,762 (327) Purchase of treasury stock (101,000) (299,063) (175,036) Redemption of preferred stock -- -- (12,684) Issuance of long-term debt -- 501,859 -- Issuance of mandatorily redeemable preferred securities -- 150,000 -- Net change in commercial paper 1,515 (17,895) 2,455 Other, net -- (725) (164) - - ----------------------------------------------------------------------------------------------------------------------------------- Net Cash Provided (Used) by Financing Activities (241,534) 213,403 (287,663) - - ----------------------------------------------------------------------------------------------------------------------------------- INCREASE IN CASH AND CASH EQUIVALENTS 40,093 95,732 88,134 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 224,245 128,513 40,379 - - ----------------------------------------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 264,338 $ 224,245 $ 128,513 - - -----------------------------------------------------------------------------------------------------------------------------------
NOTE U--LINE OF BUSINESS RESULTS The financial performance of Mercantile is monitored by an internal profitability measurement system that produces line of business results and key performance measures on a pre-tax basis. Mercantile's three major business units in 1998 included general commercial and retail banking ("Banking"), private banking and investments, and specialty retail banking. The reported results reflect the underlying economics of the businesses which are match-funded for interest rate risk. Expenses for centrally provided services are allocated based on usage of those services, and loan loss provision is allocated based on credit quality. The contribution of Mercantile's major business units to consolidated results for 1998 is summarized in the table on page 79. Comparable financial information for 1997 is not available due to the significant amount of acquisition activity that occurred in that year and thus the lack of comparable management accounting information. Banking includes the Corporation's branch network and deposit gathering, commercial lending, non-specialty retail lending, the investment portfolio and the treasury function. It is by far the largest business unit, and it houses most staff department functions. Private Banking & Investments was structured to serve the investment management needs of high net worth individuals. It includes private banking offices, personal and institutional trust activities, institutional money management and retail brokerage. Specialty retail banking (Mercantile Credit Corp.) includes residential mortgage origination and servicing, credit card, indirect lending, insurance activities and consumer product management. Parent Company and Other includes interest expense on Parent Company debt, goodwill amortization, consolidation eliminations, provision for loan losses not allocated to the business units and some general corporate expenses not allocated to the business units. ------ 78 Mercantile Bancorporation Inc. and Subsidiaries The "Adjusted Results" below exclude the financial impact of the conforming adjustments that relate to the seven 1998 acquisitions and the fourth quarter 1998 restructuring charge. These adjustments would be allocated largely to the Banking segment, but to show meaningful financial results, they are displayed separately. The management accounting system of Mercantile allows for double counting of the results of certain product lines and business units because of the level of cooperation necessary to generate favorable results. In the table below, this double counting is eliminated.
Year Ended December 31, 1998 --------------------------------------------------------------------------------------------- Conforming Private Parent Adjustments & Mercantile Banking & Company Adjusted Restructuring (Dollars in millions) Banking Credit Corp. Investments & Other Results Charges Consolidated - - ----------------------------------------------------------------------------------------------------------------------------------- OPERATING RESULTS Taxable-equivalent net interest income $ 1,087 $ 51 $ 13 $ (30) $ 1,121 $ -- $ 1,121 Provision for possible loan losses 13 13 -- 5 31 20 51 Other income 294 96 138 (32) 496 46 542 Other expense 704 73 94 22 893 134 1,027 - - ----------------------------------------------------------------------------------------------------------------------------------- Taxable-equivalent Income Before Income Taxes $ 664 $ 61 $ 57 $ (89) $ 693 $ (108) $ 585 - - ----------------------------------------------------------------------------------------------------------------------------------- Percent of Adjusted Taxable-equivalent Income Before Income Taxes 95.82% 8.80% 8.22% (12.84)% 100.00% - - ----------------------------------------------------------------------------------------------------------------------------------- AVERAGE BALANCES Loans and leases $20,683 $ 1,005 $ 103 $ (11) $21,780 $ -- $21,780 Total assets 33,008 1,298 165 100 34,571 -- 34,571 Deposits 24,568 393 329 (509) 24,781 -- 24,781 - - ----------------------------------------------------------------------------------------------------------------------------------- PERFORMANCE RATIOS Efficiency ratio 50.94% 49.52% 62.21% -- 55.21% 61.75% Net interest rate margin 3.55 4.44 8.84 -- 3.56 3.56 Net charge-offs to average loans .14 1.26 (.01) -- .19 .19 - - -----------------------------------------------------------------------------------------------------------------------------------
NOTE V--RESTRUCTURING CHARGE During the fourth quarter of 1998, Mercantile recorded a $45,130,000 charge relating to cost management programs and customer service initiatives. The charge will fund the costs related to 26 branch closings and severance for approximately 1,400 staff reductions that will result from further centralization, consolidation of back office functions, branch closures and a wider span of control. These programs are to be substantially completed by the first quarter of 1999. Any additional costs that do not qualify for recognition in the charge will be expensed as incurred, but are not expected to be material. Total payments through December 31, 1998 were $2,287,000 and the remaining balance of $42,843,000 represents the liability for the future cash outflows associated with these specific actions. ------ 79 Mercantile Bancorporation Inc. and Subsidiaries SIX YEAR CONSOLIDATED STATEMENT OF INCOME
Growth Rates (Thousands except per ----------------- share data) 1998 1997 1996 1995 1994 1993 1 Year 5 Years - - ---------------------------------------------------------------------------------------------------------------------------------- INTEREST INCOME Interest and fees on loans and leases $1,771,235 $ 1,651,816 $ 1,404,809 $ 1,371,083 $ 1,146,450 $1,076,675 7.2% 10.5% Investments in debt and equity securities Trading 8,821 7,077 3,630 3,457 4,746 3,687 24.6 19.1 Taxable 558,635 406,663 315,120 296,425 299,328 318,454 37.4 11.9 Tax-exempt 23,230 25,797 28,255 31,202 33,554 34,265 (10.0) (7.5) - - ---------------------------------------------------------------------------------------------------------------------------------- Total Investments in Debt and Equity Securities 590,686 439,537 347,005 331,084 337,628 356,406 34.4 10.6 Due from banks--interest bearing 13,293 10,379 4,128 2,508 2,878 3,521 28.1 30.4 Federal funds sold and repurchase agreements 16,904 16,946 15,178 21,644 15,083 15,646 (.2) 1.6 - - ---------------------------------------------------------------------------------------------------------------------------------- Total Interest Income 2,392,118 2,118,678 1,771,120 1,726,319 1,502,039 1,452,248 12.9 10.5 Tax-equivalent adjustment* 16,664 18,084 18,593 20,225 20,920 22,395 (7.9) (5.7) - - ---------------------------------------------------------------------------------------------------------------------------------- Taxable-equivalent Interest Income 2,408,782 2,136,762 1,789,713 1,746,544 1,522,959 1,474,643 12.7 10.3 INTEREST EXPENSE Deposits 931,716 842,949 692,138 664,974 500,184 516,979 10.5 12.5 Borrowed funds 356,142 227,991 130,019 143,566 93,576 61,856 56.2 41.9 - - ---------------------------------------------------------------------------------------------------------------------------------- Total Interest Expense 1,287,858 1,070,940 822,157 808,540 593,760 578,835 20.3 17.3 - - ---------------------------------------------------------------------------------------------------------------------------------- Taxable-equivalent Net Interest Income 1,120,924 1,065,822 967,556 938,004 929,199 895,808 5.2 4.6 PROVISION FOR POSSIBLE LOAN LOSSES 51,154 86,355 78,766 44,952 53,094 77,485 (40.8) (8.0) OTHER INCOME Trust 112,999 103,928 93,704 84,066 78,455 77,969 8.7 7.7 Service charges 119,277 109,058 98,908 91,951 89,033 88,020 9.4 6.3 Investment banking and brokerage 41,137 38,181 35,351 30,543 30,831 31,764 7.7 5.3 Credit card fees 12,556 21,169 28,415 20,634 27,487 26,289 (40.7) (13.7) Securitization revenue 20,011 18,404 16,008 23,005 8.7 Securities gains (losses) 15,435 7,649 292 4,634 2,889 6,310 19.6 Other 220,503 115,804 95,332 85,156 69,088 85,673 90.4 20.8 - - ---------------------------------------------------------------------------------------------------------------------------------- Total Other Income 541,918 414,193 368,010 339,989 297,783 316,025 30.8 11.4 OTHER EXPENSE Salaries 418,351 381,942 335,803 320,687 311,754 301,188 9.5 6.8 Employee benefits 77,608 85,048 77,437 72,149 70,676 68,876 (8.7) 2.4 Net occupancy 67,003 61,697 55,489 53,044 51,548 52,327 8.6 5.1 Equipment 85,426 70,272 60,605 54,745 52,348 51,559 21.6 10.6 Other 378,369 387,419 275,853 225,290 246,240 280,180 (2.3) 6.2 - - ---------------------------------------------------------------------------------------------------------------------------------- Total Other Expense 1,026,757 986,378 805,187 725,915 732,566 754,130 4.1 6.4 - - ---------------------------------------------------------------------------------------------------------------------------------- Taxable-equivalent Income Before Income Taxes 584,931 407,282 451,613 507,126 441,322 380,218 43.6 9.0 INCOME TAXES Income taxes 192,964 142,376 148,567 168,746 151,826 127,718 35.5 8.6 Tax-equivalent adjustment* 16,664 18,084 18,593 20,225 20,920 22,395 (7.9) (5.7) - - ---------------------------------------------------------------------------------------------------------------------------------- Adjusted Income Taxes 209,628 160,460 167,160 188,971 172,746 150,113 30.6 6.9 - - ---------------------------------------------------------------------------------------------------------------------------------- Net Income $ 375,303 $ 246,822 $ 284,453 $ 318,155 $ 268,576 $ 230,105 52.1 10.3 - - ---------------------------------------------------------------------------------------------------------------------------------- PER SHARE DATA Basic earnings per share $ 2.45 1.76 $ 2.12 $ 2.37 $ 2.05 $ 1.79 39.2 6.5 Diluted earnings per share 2.41 1.73 2.09 2.33 2.02 1.75 39.3 6.6 Dividends declared 1.24 1.148 1.092 .88 .748 .66 8.0 13.4 - - ---------------------------------------------------------------------------------------------------------------------------------- TAX-EQUIVALENT ADJUSTMENT* Loans $ 5,214 5,409 $ 5,630 $ 5,776 $ 5,517 $ 6,187 (3.6) (3.4) Investments in debt and equity securities 11,450 12,675 12,963 14,449 15,403 16,208 (9.7) (6.7) - - ---------------------------------------------------------------------------------------------------------------------------------- Total Tax-equivalent Adjustment $ 16,664 18,084 $ 18,593 $ 20,225 $ 20,920 $ 22,395 (7.9) (5.7) - - ---------------------------------------------------------------------------------------------------------------------------------- *Taxable-equivalent basis.
------ 80 Mercantile Bancorporation Inc. and Subsidiaries SIX YEAR CONSOLIDATED AVERAGE BALANCE SHEET
1998 1997 (Dollars in thousands) Volume Rate/1/ Volume Rate/1/ - - ----------------------------------------------------------------------- ASSETS Earning assets Loans and leases Commercial $ 5,538,558 8.20% $ 4,823,799 8.59% Real estate--commercial 3,710,849 8.50 3,490,043 8.66 Real estate--construction 768,804 8.66 661,455 8.87 Real estate-- residential mortgage 8,386,390 7.57 6,777,396 7.84 Real estate--home equity credit loans 552,381 9.48 510,261 9.69 Consumer 2,693,839 9.06 2,403,930 9.12 Credit card 129,267 6.63 635,567 12.83 - - ----------------------------------------------------------------------- Total Loans and Leases 21,780,088 8.16 19,302,451 8.59 Investments in debt and equity securities Trading 135,285 6.56 104,897 6.80 Taxable 8,630,333 6.47 6,334,401 6.42 Tax-exempt 424,648 8.13 470,187 8.13 - - ----------------------------------------------------------------------- Total Investments in Debt and Equity Securities 9,190,266 6.55 6,909,485 6.54 Short-term investments Due from banks interest bearing 232,220 5.72 188,756 5.50 Federal funds sold and repurchase agreements 310,450 5.44 264,287 6.41 - - ----------------------------------------------------------------------- Total Short-term Investments 542,670 5.56 453,043 6.03 - - ----------------------------------------------------------------------- Total Earning Asset 31,513,024 7.64 26,664,979 8.01 Non-earning assets Cash and due from banks 1,329,870 1,157,793 Bank premises and equipment 540,545 478,561 Other assets 1,481,834 1,063,661 Reserve for possible loan losses (294,058) (267,809) - - ----------------------------------------------------------------------- Total Assets $34,571,215 $29,097,185 - - ----------------------------------------------------------------------- LIABILITIES Acquired funds Deposits Non-interest bearing $ 3,899,766 $ 3,410,398 Interest bearing demand 3,088,268 1.84 2,934,822 2.01 Money market accounts 3,991,348 4.04 3,462,844 4.02 Savings 1,739,005 2.58 1,471,442 2.39 Consumer time certificates under $100,000 9,574,189 5.54 8,643,840 5.55 Other time 184,433 5.31 205,437 4.62 - - ----------------------------------------------------------------------- Total Core Deposits 22,477,009 4.32 20,128,783 4.32 Time certificates $100,000 and over 1,893,255 5.58 1,675,343 5.64 Foreign 410,644 5.65 457,811 5.72 - - ----------------------------------------------------------------------- Total Purchased Deposits 2,303,899 5.59 2,133,154 5.66 - - ----------------------------------------------------------------------- Total Deposits 24,780,908 4.46 22,261,937 4.47 Short-term borrowings 3,294,078 5.29 2,929,826 5.43 Bank notes 56,233 6.09 175,000 6.02 Long-term debt/2/ 3,049,791 5.85 869,495 6.72 - - ----------------------------------------------------------------------- Total Acquired Funds 31,181,010 4.72 26,236,258 4.69 Other liabilities 434,858 386,090 - - ----------------------------------------------------------------------- Total Liabilities 31,615,868 26,622,348 SHAREHOLDERS' EQUITY 2,955,347 2,474,837 - - ----------------------------------------------------------------------- Total Liabilities and Shareholders' Equity $34,571,215 $29,097,185 - - ----------------------------------------------------------------------- /1/Taxable-equivalent basis. /2/Includes company-obligated mandatorily redeemable preferred securities of Mercantile Capital Trust I.
------ 81 Mercantile Bancorporation Inc. and Subsidiaries SIX YEAR CONSOLIDATED AVERAGE BALANCE SHEET (CONTINUED)
1996 1995 1994 1993 Growth Rates - - ---------------------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) Volume Rate/1/ Volume Rate/1/ Volume Rate/1/ Volume Rate/1/ 1 Year 5 Years - - ---------------------------------------------------------------------------------------------------------------------------------- ASSETS Earning assets Loans and leases Commercial $ 4,365,041 8.57% $ 4,114,286 9.10% $ 3,847,614 7.82% $ 3,587,630 7.41% 14.8% 9.1% Real estate--commercial 3,208,049 8.66 3,012,825 8.88 2,722,408 8.07 2,542,309 7.99 6.3 7.9 Real estate--construction 592,976 9.10 614,810 9.97 575,419 8.16 542,765 8.53 16.2 7.2 Real estate-- residential mortgage 4,339,596 8.10 4,194,013 7.80 3,489,239 7.65 3,543,574 7.81 23.7 18.8 Real estate--home equity credit loans 417,426 9.67 414,148 10.04 418,561 8.38 418,561 7.43 8.3 5.7 Consumer 2,216,771 9.18 2,134,742 9.06 1,868,318 8.55 1,601,863 9.33 12.1 11.0 Credit card 849,925 12.87 779,782 14.29 765,624 15.99 681,283 16.24 (79.7) (28.3) - - ---------------------------------------------------------------------------------------------------------------------------------- Total Loans and Leases 15,989,784 8.82 15,264,606 9.02 13,687,183 8.42 12,917,985 8.38 12.8 11.0 Investments in debt and equity securities Trading 56,616 6.49 55,441 6.24 75,706 6.31 60,335 6.22 29.0 17.5 Taxable 5,188,833 6.08 4,942,262 6.00 5,245,252 5.71 5,225,937 6.10 36.2 10.6 Tax-exempt 511,453 8.01 548,872 8.29 593,130 8.21 587,402 8.53 (9.7) (6.3) - - ---------------------------------------------------------------------------------------------------------------------------------- Total Investments in Debt and Equity Securities 5,756,902 6.25 5,546,575 6.23 5,914,088 5.97 5,873,674 6.34 33.0 9.4 Short-term investments Due from banks interest bearing 70,850 5.83 42,148 5.95 66,834 4.31 102,145 3.45 23.0 17.9 Federal funds sold and repurchase agreements 267,469 5.67 353,358 6.13 338,693 4.45 471,824 3.32 17.5 (8.0) - - ---------------------------------------------------------------------------------------------------------------------------------- Total Short-term Investments 338,319 5.71 395,506 6.11 405,527 4.43 573,969 3.34 19.8 (1.1) - - ---------------------------------------------------------------------------------------------------------------------------------- Total Earning Asset 22,085,005 8.10 21,206,687 8.24 20,006,798 7.61 19,365,628 7.61 18.2 10.2 Non-earning assets Cash and due from banks 1,139,143 1,084,943 1,078,590 1,060,685 14.9 4.6 Bank premises and equipment 404,835 384,438 369,036 358,521 13.0 8.6 Other assets 529,681 508,252 492,398 546,087 39.3 22.1 Reserve for possible loan losses (259,871) (269,752) (269,363) (249,971) 9.8 3.3 - - ---------------------------------------------------------------------------------------------------------------------------------- Total Assets $23,898,793 $22,914,568 $21,677,459 $21,080,950 18.8 10.4 - - ---------------------------------------------------------------------------------------------------------------------------------- LIABILITIES Acquired funds Deposits Non-interest bearing $ 3,178,244 $ 2,907,648 $ 2,951,411 $ 2,953,436 14.3 5.7 Interest bearing demand 2,682,839 2.27 2,711,739 2.23 2,829,843 1.96 2,629,263 2.18 5.2 3.3 Money market accounts 3,028,825 3.64 2,624,200 3.87 2,864,065 2.94 2,902,100 2.75 15.3 6.6 Savings 1,351,226 2.34 1,415,048 2.43 1,532,175 2.35 1,491,199 2.56 18.2 3.1 Consumer time certificates under $100,000 7,054,537 5.58 6,827,210 5.46 6,277,759 4.35 6,561,572 4.55 10.8 7.8 Other time 191,952 4.22 126,120 6.30 43,733 2.97 86,978 2.62 (10.2) 16.2 - - ---------------------------------------------------------------------------------------------------------------------------------- Total Core Deposits 17,487,623 4.22 16,611,965 4.21 16,498,986 3.33 16,624,548 3.48 11.7 6.2 Time certificates $100,000 and over 1,440,025 5.35 1,319,811 5.66 1,047,777 4.22 992,312 4.01 13.0 13.8 Foreign 184,182 5.70 210,873 6.21 108,986 4.95 31,093 4.38 (10.3) 67.6 - - ---------------------------------------------------------------------------------------------------------------------------------- Total Purchased Deposits 1,624,207 5.39 1,530,684 5.74 1,156,763 4.29 1,023,405 4.02 8.0 17.6 - - ---------------------------------------------------------------------------------------------------------------------------------- Total Deposits 19,111,830 4.34 18,142,649 4.36 17,655,749 3.40 17,647,953 3.52 11.3 7.0 Short-term borrowings 1,671,352 5.37 1,829,383 5.57 1,517,324 4.20 1,113,995 2.97 12.4 24.2 Bank notes 260,587 5.88 214,658 6.37 12,603 6.19 -- -- (67.9) -- Long-term debt/2/ 342,968 7.29 380,636 7.34 394,874 7.37 377,762 7.63 -- 51.8 - - ---------------------------------------------------------------------------------------------------------------------------------- Total Acquired Funds 21,386,737 4.52 20,567,326 4.58 19,580,550 3.57 19,139,710 3.58 18.9 10.3 Other liabilities 312,758 275,692 254,209 280,423 12.6 9.2 - - ---------------------------------------------------------------------------------------------------------------------------------- Total Liabilities 21,699,495 20,843,018 19,834,759 19,420,133 18.8 10.2 SHAREHOLDERS' EQUITY 2,199,298 2,071,550 1,842,700 1,660,817 19.4 12.2 - - ---------------------------------------------------------------------------------------------------------------------------------- Total Liabilities and Shareholders' Equity $23,898,793 $22,914,568 $21,677,459 $21,080,950 18.8 10.4 - - ---------------------------------------------------------------------------------------------------------------------------------- /1/ Taxable - equivalent basis. /2/ Includes company - obligated mandatorily redeemable preferred securities of Mercantile Capital Trust I.
------ 82 EX-21 3 SUBSIDIARIES OF THE REGISTRANT EXHIBIT NO. 21 MERCANTILE BANCORPORATION INC. SUBSIDIARIES AS OF FEBRUARY 26, 1999
Subsidiary Jurisdiction ---------- ------------ Ameribanc, Inc. Missouri Mercantile Bank of Trenton Missouri Mercantile Trust Company National Association United States Mercantile Bank of Kentucky Kentucky Mercantile Bank Missouri Eastern Missouri Investments, LLC Illinois Mark Twain Real Estate Development Corp. I Kansas Mark Twain Kansas City Bank Community Development Corporation Kansas Mercantile Bank of Illinois Illinois Home Federal Service Corporation Illinois FFG Investments, Inc. Illinois Mercantile Bank of Arkansas National Association United States Mercantile Financial of Little Rock LLC Arkansas Landau I, Inc. Arkansas Mercantile Bank Midwest Iowa Mercantile Leasing Corporation Iowa Mercantile Guaranteed Loans Iowa Midwest Realty Company, Inc. Iowa Mercantile Bank National Association United States Mercantile Business Credit, Inc. Missouri Mississippi Valley Advisors Inc. Missouri Mercantile Properties, Inc. Missouri Mark Twain Brokerage Services Inc. Missouri Sangamon Investment Company Missouri Mercantile Insurance Services, Inc. Missouri Mark Twain St. Louis Investment Company Missouri Mercantile Investment Services Inc. Missouri Bruno Stolze LLC Missouri Metropolitan Savings Service Corporation Missouri Lending Express, L.P. Missouri Mercantile Center Associates Missouri Mercantile Redevelopment Corp. Missouri Mercantile Bank International Missouri Mercantile Trade Services Limited Hong Kong Manley Investment Services, Inc. Missouri United Financial Services Illinois
Subsidiary Jurisdiction ---------- ------------ SoMo Investment Company, Inc. Missouri Roosevelt Texas Holdings, Inc. Missouri Mercantile Community Development Corporation Missouri Mercantile Mortgage Financial Company Missouri Mercantile Mortgage Realty L.L.C. Illinois Caltrop Corporation Illinois Lakewood Oaks Golf Club, Ltd. Missouri Fortune Homes, Inc. Missouri F&H Realty Corp. Missouri Mississippi Valley Life Insurance Company Missouri D.D. Development of Sterling Limited Partnership Illinois Mercantile Service Corp. Missouri Roosevelt Financial Services, Inc. Missouri Tarquad Corporation Missouri Mark Twain Properties, Inc. Missouri Mark Twain Investment Advisory Company Missouri Horizon Financial Services, Inc. Arkansas FFG Trust, Inc. Illinois GCT Realty Company Illinois Mercantile Consumer Loan Company Inc. Illinois Franklin Finance Company Delaware Supplemental Monetary Transfer System Missouri Mercantile Capital Trust I Missouri
EX-23 4 CONSENT OF KPMG LLP EXHIBIT NO. 23 Independent Auditors' Consent The Board of Directors Mercantile Bancorporation Inc.: We consent to the incorporation by reference in the Registration Statements No. 2-78395, No. 33-15265, No. 33-33870, No. 33-35139, No. 33-43694, No. 33-48952, No. 33-57543, No. 333-47713, and No. 333-55905, each on Form S-8; and No. 33- 45863, No. 33-52986, No. 33-50981, No. 33-55439, No. 33-58467, No. 33-63609, No. 333-09803, No. 333-23607, No. 333-27431, No. 333-42557, No. 333-50203, No. 333-51329, No. 333-56639, and No. 333-57345, each on Form S-4; and No. 333- 37547 on Form S-3, of Mercantile Bancorporation Inc. of our report dated January 20, 1999, relating to the consolidated balance sheets of Mercantile Bancorporation Inc. and subsidiaries as of December 31, 1998, 1997, and 1996, and the related consolidated statements of income, changes in shareholders' equity, cash flows, and comprehensive income for each of the years in the three-year period ended December 31, 1998, which report appears in the Annual Report on Form 10-K of Mercantile Bancorporation Inc. for the fiscal year ended December 31, 1998. /s/ KPMG LLP St. Louis, Missouri March 26, 1999 EX-27 5 FINANCIAL DATA SCHEDULE
9 1,000 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 1,760,636 367,304 226,730 126,540 9,246,790 97,607 99,336 22,311,258 308,890 35,800,177 25,461,397 3,002,660 514,031 3,723,334 1,574 0 0 3,072,181 35,800,177 1,771,235 590,686 30,197 2,392,118 931,716 1,287,858 1,104,260 51,154 15,435 1,026,757 568,267 375,303 0 0 375,303 2.45 2.41 3.56 132,713 28,998 5,950 90,834 284,165 64,866 22,782 308,890 308,890 0 73,127
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