-----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, VHf9CMmjLWnIGKD6SMOR/JxkSAkQ39Ra1GNrgXUCiKXwCQzdVEwOjYtskUvLhmo/ 1N3dv0lbxaZc3t1jK0tZ6Q== 0001068800-99-000354.txt : 19990816 0001068800-99-000354.hdr.sgml : 19990816 ACCESSION NUMBER: 0001068800-99-000354 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990813 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MERCANTILE BANCORPORATION INC CENTRAL INDEX KEY: 0000064907 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 430951744 STATE OF INCORPORATION: MO FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-11792 FILM NUMBER: 99689129 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-Q 1 MERCANTILE BANCORPORATION INC. FORM 10-Q ==================================================================== FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR QUARTER ENDED JUNE 30, 1999 COMMISSION FILE NUMBER 1-11792 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 ST. LOUIS, MISSOURI 63166-0524 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (314) 418-2525 INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. X --------- --------- YES NO INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE. COMMON STOCK, $.01 PAR VALUE, 158,365,949 SHARES OUTSTANDING AS OF THE CLOSE OF BUSINESS ON JULY 30, 1999. ==================================================================== INDEX PART I--FINANCIAL INFORMATION
PAGE NO. -------- Item 1--Financial Statements Consolidated Statement of Income (Unaudited) Three months and six months ended June 30, 1999 and 1998 3 Consolidated Balance Sheet June 30, 1999 and 1998 (Unaudited), and December 31, 1998 4 Consolidated Statement of Changes in Shareholders' Equity (Unaudited) Six months ended June 30, 1999 and 1998 5 Consolidated Statement of Cash Flows (Unaudited) Six months ended June 30, 1999 and 1998 6 Notes to Consolidated Financial Statements 7 Item 2--Management's Discussion and Analysis of Financial Condition and Results of Operations 9 Item 3--Quantitative and Qualitative Disclosures Regarding Market Risk There have been no material changes from the information provided in the December 31, 1998 Form 10-K. PART II--OTHER INFORMATION Item 4--Submission of Matters to a Vote of Security Holders 28 Item 6--Exhibits and Reports on Form 8-K 28 Signature 29 Exhibit Index 30
2 PART I. FINANCIAL INFORMATION Item 1. Financial Statements. MERCANTILE BANCORPORATION INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME (UNAUDITED) (THOUSANDS EXCEPT PER SHARE DATA)
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30 JUNE 30 1999 1998 1999 1998 ---- ---- ---- ---- INTEREST INCOME Interest and fees on loans and leases $432,831 $445,880 $ 864,734 $ 888,212 Investments in debt and equity securities Trading 2,818 2,846 5,397 4,911 Taxable 140,768 141,066 281,061 277,007 Tax-exempt 4,824 5,944 10,287 12,055 -------- -------- ---------- ---------- Total Investments in Debt and Equity Securities 148,410 149,856 296,745 293,973 Due from banks--interest bearing 3,558 3,483 7,249 6,576 Federal funds sold and repurchase agreements 3,677 4,868 6,686 8,506 -------- -------- ---------- ---------- Total Interest Income 588,476 604,087 1,175,414 1,197,267 INTEREST EXPENSE Interest bearing deposits 202,631 231,026 413,388 460,829 Foreign deposits 7,657 6,241 13,538 13,858 Short-term borrowings 35,552 47,924 66,409 100,253 Bank notes -- 368 133 2,691 Long-term debt and mandatorily redeemable preferred securities 57,303 43,226 112,384 71,613 -------- -------- ---------- ---------- Total Interest Expense 303,143 328,785 605,852 649,244 -------- -------- ---------- ---------- NET INTEREST INCOME 285,333 275,302 569,562 548,023 PROVISION FOR POSSIBLE LOAN LOSSES 9,479 7,344 16,958 15,881 -------- -------- ---------- ---------- NET INTEREST INCOME AFTER PROVISION FOR POSSIBLE LOAN LOSSES 275,854 267,958 552,604 532,142 OTHER INCOME Trust 31,745 28,816 60,887 56,944 Service charges 31,047 29,073 60,687 57,317 Investment banking and brokerage 11,524 9,826 22,606 20,892 Mortgage banking 4,503 8,959 10,702 14,902 Gain on sale of mortgage servicing rights -- -- -- 23,155 Securitization revenue 7,555 4,520 13,006 9,043 Securities gains 3,283 2,834 16,246 7,287 Miscellaneous 36,350 30,723 68,317 62,162 -------- -------- ---------- ---------- Total Other Income 126,007 114,751 252,451 251,702 OTHER EXPENSE Salaries 103,600 103,747 205,287 206,378 Employee benefits 20,449 18,032 42,101 40,579 Net occupancy 16,704 16,015 33,895 32,199 Equipment 23,888 21,255 47,577 42,113 Intangible asset amortization 14,268 14,462 28,591 29,058 Postage and freight 7,050 6,575 14,654 13,880 Miscellaneous 34,030 44,640 73,238 81,057 -------- -------- ---------- ---------- Total Other Expense 219,989 224,726 445,343 445,264 -------- -------- ---------- ---------- INCOME BEFORE INCOME TAXES 181,872 157,983 359,712 338,580 INCOME TAXES 61,344 50,836 121,147 116,574 -------- -------- ---------- ---------- NET INCOME $120,528 $107,147 $ 238,565 $ 222,006 ======== ======== ========== ========== PER SHARE DATA Basic earnings per share $.76 $.71 $1.51 $1.47 Diluted earnings per share .75 .69 1.49 1.44 Dividends declared .34 .31 .68 .62 The accompanying notes to consolidated financial statements are an integral part of these statements.
3 MERCANTILE BANCORPORATION INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (THOUSANDS)
JUNE 30 JUNE 30 1999 DEC. 31 1998 (UNAUDITED) 1998 (UNAUDITED) ----------- ------- ----------- ASSETS Cash and due from banks $ 1,234,011 $ 1,760,636 $ 1,446,296 Due from banks--interest bearing 263,788 367,304 233,686 Federal funds sold and repurchase agreements 251,609 226,730 261,442 Investments in debt and equity securities Trading 120,800 126,540 124,839 Available-for-sale (Amortized cost of $9,395,996, $9,185,770 and $8,915,489, respectively) 9,199,571 9,246,790 8,959,632 Held-to-maturity (Estimated fair value of $63,672, $99,336 and $256,849, respectively) 62,503 97,607 251,040 ----------- ----------- ----------- Total Investments in Debt and Equity Securities 9,382,874 9,470,937 9,335,511 Loans held-for-sale 139,035 217,941 205,236 Loans and leases, net of unearned income 22,580,420 22,093,317 21,569,778 ----------- ----------- ----------- Total Loans and Leases 22,719,455 22,311,258 21,775,014 Reserve for possible loan losses (309,271) (308,890) (292,795) ----------- ----------- ----------- Net Loans and Leases 22,410,184 22,002,368 21,482,219 Bank premises and equipment 528,973 545,559 538,287 Intangible assets 750,527 781,188 811,070 Other assets 698,127 645,455 636,399 ----------- ----------- ----------- Total Assets $35,520,093 $35,800,177 $34,744,910 =========== =========== =========== LIABILITIES Deposits Non-interest bearing $ 3,814,497 $ 4,453,048 $ 3,900,600 Interest bearing 19,581,897 20,526,576 20,316,577 Foreign 937,233 481,773 328,641 ----------- ----------- ----------- Total Deposits 24,333,627 25,461,397 24,545,818 Federal funds purchased and repurchase agreements 2,253,290 2,087,373 1,849,787 Other short-term borrowings 1,293,367 915,287 1,561,572 Bank notes -- 25,000 25,000 Long-term Federal Home Loan Bank advances 3,169,555 2,790,336 2,510,845 Other long-term debt 780,299 782,998 789,525 Company-obligated mandatorily redeemable preferred securities of Mercantile Capital Trust I 150,000 150,000 150,000 Other liabilities 487,049 514,031 402,219 ----------- ----------- ----------- Total Liabilities 32,467,187 32,726,422 31,834,766 Commitments and contingent liabilities -- -- -- JUNE 30 DEC. 31 JUNE 30 1999 1998 1998 ------- ------- ------- SHAREHOLDERS' EQUITY Preferred stock--no par value Shares authorized 5,000 5,000 5,000 Shares issued and outstanding -- -- -- -- -- -- Common stock--$.01 par value Shares authorized 400,000 400,000 400,000 Shares issued 158,217 157,487 153,699 1,581 1,574 1,537 Capital surplus 1,015,017 999,595 1,074,394 Retained earnings 2,166,302 2,035,157 1,901,396 Accumulated other comprehensive income (126,911) 41,160 31,171 Treasury stock, at cost 53 83 1,791 (3,083) (3,731) (98,354) ----------- ----------- ----------- Total Shareholders' Equity 3,052,906 3,073,755 2,910,144 ----------- ----------- ----------- Total Liabilities and Shareholders' Equity $35,520,093 $35,800,177 $34,744,910 =========== =========== =========== The accompanying notes to consolidated financial statements are an integral part of these statements.
4 MERCANTILE BANCORPORATION INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED) (THOUSANDS EXCEPT PER SHARE DATA)
ACCUMULATED OTHER TOTAL COMMON CAPITAL RETAINED COMPREHENSIVE TREASURY SHAREHOLDERS' STOCK SURPLUS EARNINGS INCOME STOCK EQUITY ------ ------- -------- ------------- -------- ------------- BALANCE AT DECEMBER 31, 1997 $1,489 $1,016,844 $1,724,752 $ 25,222 $ (6,005) $2,762,302 Net income 222,006 222,006 Other comprehensive income: Holding gains on available-for-sale securities, net of tax of $5,104 9,478 9,478 Less: Reclassification adjustment for securities gains included in net income above, net of tax of $2,550 (4,737) (4,737) --------- ---------- Other Comprehensive Income Net of Tax 4,741 4,741 ---------- Total Comprehensive Income 226,747 Common dividends declared: Mercantile Bancorporation Inc.--$.62 per share (83,094) (83,094) Pooled companies prior to acquisition (10,467) (10,467) Issuance of common stock in acquisitions of: HomeCorp, Inc. 9 6,727 13,765 27 20,528 Horizon Bancorp, Inc. 25 10,755 34,434 1,181 357 46,752 Issuance of common stock for: Employee incentive plans 10 35,808 5,746 41,564 Convertible notes 1 148 149 Purchase of treasury stock (98,452) (98,452) Pre-merger transactions of pooled companies and other 3 4,112 4,115 ------ ---------- ---------- --------- -------- ---------- BALANCE AT JUNE 30, 1998 $1,537 $1,074,394 $1,901,396 $ 31,171 $(98,354) $2,910,144 ====== ========== ========== ========= ======== ========== BALANCE AT DECEMBER 31, 1998 $1,574 $ 999,595 $2,035,157 $ 41,160 $ (3,731) $3,073,755 Net income 238,565 238,565 Other comprehensive income (loss): Holding losses on available-for-sale securities, net of tax benefit of $84,814 (157,511) (157,511) Less: Reclassification adjustment for securities gains included in net income above, net of tax of $5,686 (10,560) (10,560) --------- ---------- Other Comprehensive Loss Net of Tax Benefit (168,071) (168,071) ---------- Total Comprehensive Income 70,494 Common dividends declared--$.68 per share (107,420) (107,420) Issuance of common stock for: Employee incentive plans 6 14,842 5,173 20,021 Convertible notes 1 580 581 Purchase of treasury stock (4,525) (4,525) ------ ---------- ---------- --------- -------- ---------- BALANCE AT JUNE 30, 1999 $1,581 $1,015,017 $2,166,302 $(126,911) $ (3,083) $3,052,906 ====== ========== ========== ========= ======== ========== The accompanying notes to consolidated financial statements are an integral part of these statements.
5 MERCANTILE BANCORPORATION INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) (THOUSANDS)
SIX MONTHS ENDED JUNE 30 1999 1998 ---- ---- OPERATING ACTIVITIES Net income $ 238,565 $ 222,006 Adjustments to reconcile net income to net cash provided by operating activities Provision for possible loan losses 16,958 15,881 Depreciation and amortization 39,402 36,629 Provision for deferred income taxes (credits) 4,728 (4,295) Net change in loans held-for-sale 78,906 (102,207) Net change in trading securities 36,382 4,326 Net change in accrued interest receivable 1,094 2,786 Net change in accrued interest payable 6,771 (85) Other, net 5,841 (76,174) ----------- ----------- Net Cash Provided by Operating Activities 428,647 98,867 INVESTING ACTIVITIES Investments in debt and equity securities, other than trading securities Purchases (3,292,033) (4,319,287) Proceeds from maturities 1,763,991 2,582,417 Proceeds from sales of available-for-sale securities 1,351,007 1,122,789 Net change in loans and leases (532,434) 13,408 Purchases of loans and leases (310,416) (175,230) Proceeds from sale of mortgage servicing rights -- 26,330 Proceeds from sales of loans and leases 315,078 405,896 Purchases of premises and equipment (39,373) (45,330) Proceeds from sales of premises and equipment 15,065 13,668 Proceeds from sales of foreclosed property 27,408 21,710 Cash and cash equivalents from acquisitions, net of cash paid -- 34,448 Sale of banking offices, net of cash paid (110,401) (3,524) Other, net 10,851 11,799 ----------- ----------- Net Cash Used by Investing Activities (801,257) (310,906) FINANCING ACTIVITIES Net change in non-interest bearing, savings, interest bearing demand and money market deposit accounts (892,232) (111,883) Net change in time certificates of deposit under $100,000 (595,277) (587,014) Net change in time certificates of deposit $100,000 and over 47,549 (52,152) Net change in other time deposits (22,786) (4,472) Net change in foreign deposits 455,460 (256,798) Net change in short-term borrowings 518,612 (308,528) Principal payments on bank notes (25,000) (150,000) Issuance of long-term FHLB advances and other long-term debt 1,110,000 1,916,500 Principal payments on long-term debt (732,738) (6,779) Cash dividends paid (102,729) (91,212) Proceeds from issuance of common stock from employee incentive plans 11,014 17,973 Purchase of treasury stock (4,525) (98,452) ----------- ----------- Net Cash Provided (Used) by Financing Activities (232,652) 267,183 ----------- ----------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (605,262) 55,144 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 2,354,670 1,886,280 ----------- ----------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,749,408 $ 1,941,424 =========== =========== The accompanying notes to consolidated financial statements are an integral part of these statements.
6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A ACCOUNTING POLICIES The consolidated financial statements include all adjustments which are, in the opinion of management, necessary for the fair statement of the results of these periods and are of a normal recurring nature. Certain reclassifications have been made to the 1998 historical financial statements to conform to the 1999 presentation. NOTE B NEW ACCOUNTING STANDARDS Financial Accounting Standard ("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 will be reported as a component of other comprehensive income or recognized as earnings through the income statement depending on the nature of the instrument. FAS 137 was issued in June 1999, and deferred the effectiveness of FAS 133 to all quarters of fiscal years beginning after June 15, 2000, 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. NOTE C EARNINGS PER SHARE Basic earnings per share is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share gives effect to the increase in the average shares outstanding that would have resulted from the exercise of dilutive stock options, the issuance of share equivalents under other employee incentive plans and the conversion of the entire balance of outstanding convertible notes. Net income is increased in the diluted earnings per share computation 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:
(THOUSANDS EXCEPT PER SHARE DATA) SECOND QUARTER SIX MONTHS 1999 1998 1999 1998 ---- ---- ---- ---- BASIC Net income $120,528 $107,147 $238,565 $222,006 Weighted average common shares outstanding 158,018,753 151,685,553 157,826,865 151,372,927 BASIC EARNINGS PER SHARE $.76 $.71 $1.51 $1.47 DILUTED Net income $120,528 $107,147 $238,565 $222,006 Interest on convertible notes, net of taxes (5) 11 3 23 -------- -------- -------- -------- Diluted Net Income $120,523 $107,158 $238,568 $222,029 ======== ======== ======== ======== Weighted average common shares outstanding 158,018,753 151,685,553 157,826,865 151,372,927 Employee incentive plans 2,126,942 2,491,505 2,013,601 2,635,970 Convertible notes 39,004 93,715 55,361 95,893 ----------- ----------- ----------- ----------- Diluted Average Shares Outstanding 160,184,699 154,270,773 159,895,827 154,104,790 =========== =========== =========== =========== DILUTED EARNINGS PER SHARE $.75 $.69 $1.49 $1.44
7 NOTE D ACQUISITIONS On July 1, 1998, the Corporation acquired CBT Corporation ("CBT") of Paducah, Kentucky, and Firstbank of Illinois Co. ("Firstbank"), headquartered in Springfield, Illinois. The CBT and Firstbank acquisitions were accounted for under the pooling-of-interests method. 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: (THOUSANDS EXCEPT PER SHARE DATA) SIX MONTHS ENDED JUNE 30, 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 NOTE E COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF MERCANTILE CAPITAL TRUST I 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. NOTE F PENDING MERGER On April 30, 1999, a definitive Agreement and Plan of Merger by and between Mercantile and Firstar Corporation ("Firstar") was signed. Pursuant to the terms of the Merger Agreement, Mercantile will merge with and into Firstar in a transaction structured as and intended to be a "tax-free" reorganization, with Mercantile shareholders to receive 2.091 shares of Firstar common stock for each share of Mercantile common stock owned. Firstar is a $38.4 billion-asset bank holding company headquartered in Milwaukee. The transaction will be accounted for as a pooling-of-interests, and is expected to close late in the third or early in the fourth quarter of 1999. Shareholder approvals for the transaction were received on July 28, 1999. Regulatory approval was received from the Comptroller of the Currency in July 1999, and was pending from the Federal Reserve Board and the United States Department of Justice as of August 11, 1999. 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. - -------------------------------------------------------------------------------------------------------------------------------- EXHIBIT 1 HIGHLIGHTS
SECOND QUARTER SIX MONTHS ($ IN THOUSANDS EXCEPT PER SHARE DATA) 1999 1998 CHANGE 1999 1998 CHANGE - -------------------------------------------------------------------------------------------------------------------------------- PER SHARE DATA Diluted earnings per share $.75 $.69 8.7% $1.49 $1.44 3.5% Basic earnings per share .76 .71 7.0 1.51 1.47 2.7 Dividends declared .34 .31 9.7 .68 .62 9.7 Book value at June 30 19.30 19.16 .7 19.30 19.16 .7 Market price at June 30 57.13 50.38 13.4 57.13 50.38 13.4 - -------------------------------------------------------------------------------------------------------------------------------- OPERATING RESULTS Taxable-equivalent net interest income $288,974 $279,493 3.4% $577,143 $556,449 3.7% Tax-equivalent adjustment 3,641 4,191 (13.1) 7,581 8,426 (10.0) Net interest income 285,333 275,302 3.6 569,562 548,023 3.9 Provision for possible loan losses 9,479 7,344 29.1 16,958 15,881 6.8 Other income 126,007 114,751 9.8 252,451 251,702 .3 Other expense 219,989 224,726 (2.1) 445,343 445,264 -- Income taxes 61,344 50,836 20.7 121,147 116,574 3.9 Net income 120,528 107,147 12.5 238,565 222,006 7.5 - -------------------------------------------------------------------------------------------------------------------------------- SELECTED RATIOS AND DATA Return on assets 1.34% 1.23% 1.34% 1.29% Return on equity 15.40 14.88 15.30 15.45 Efficiency ratio 53.01 57.00 53.68 55.10 Other expense to average assets 2.45 2.57 2.49 2.58 Net interest rate margin 3.55 3.53 3.58 3.58 Tangible equity to tangible assets 6.62 6.19 Equity to assets 8.59 8.38 Tier I capital to risk-adjusted assets 9.93 9.55 Total capital to risk-adjusted assets 12.42 12.46 Leverage 7.48 6.65 Reserve for possible loan losses to outstanding loans 1.36 1.34 Reserve for possible loan losses to non-performing loans 296.45 319.73 Non-performing loans to outstanding loans .46 .42 Banks 7 30 Banking offices 461 514 Full-time equivalent employees 10,353 10,991 - -------------------------------------------------------------------------------------------------------------------------------- AVERAGE BALANCES Total assets $35,846,384 $34,941,329 2.6% $35,701,619 $34,492,416 3.5% Earning assets 32,675,970 31,727,147 3.0 32,528,287 31,379,005 3.7 Loans and leases 22,600,598 21,813,425 3.6 22,466,211 21,699,554 3.5 Deposits 24,845,958 25,130,037 (1.1) 24,946,284 25,008,523 (.2) Shareholders' equity 3,131,020 2,881,078 8.7 3,118,828 2,873,617 8.5 - --------------------------------------------------------------------------------------------------------------------------------
9 PERFORMANCE SUMMARY Net income for Mercantile Bancorporation Inc. ("Mercantile" or "Corporation") was $120,528,000 in the second quarter of 1999 versus $107,147,000 in the same period of 1998, an increase of 12.5%. Basic earnings per share was $.76 compared with $.71 in the second quarter of 1998 and diluted earnings per share increased by 8.7% to $.75. Net income for the six months ended June 30, 1999 was $238,565,000 compared with $222,006,000 last year and diluted earnings per share was $1.49, up 3.5% from 1998. Other financial highlights and performance ratios for the three and six month periods ending June 30, 1999 and 1998 are presented on Exhibit 1. There were significant transactions in both years and their impact on the results of operations are discussed below. ----------------------------------------------------------------------------------------------------------------------------- EXHIBIT 2 ACQUISITIONS ($ IN THOUSANDS)
CONSIDERATION -------------------- GROSS ACCOUNTING DATE ASSETS DEPOSITS CASH SHARES METHOD ---- ------ -------- ---- ------ ---------- BANK ACQUISITIONS COMPLETED First Financial Bancorporation Sept. 28, 1998 $ 558,483 $ 477,573 $12 3,138,823 Pooling Financial Services Corporation of the Midwest Aug. 3, 1998 514,051 414,350 4 2,071,448 Pooling CBT Corporation July 1, 1998 1,006,384 695,923 34 5,123,214 Pooling Firstbank of Illinois Co. July 1, 1998 2,285,146 1,969,600 64 13,352,641 Pooling HomeCorp, Inc. Mar. 2, 1998 335,137 309,157 14 854,760 Pooling Horizon Bancorp, Inc. Feb. 2, 1998 536,507 454,230 2 2,549,970 Pooling NONBANK ACQUISITION COMPLETED Bruno Stolze & Company, Inc. Sept. 30, 1998 Purchase The Corporation's historical financial statements were not restated for the acquisition due to the immateriality of the acquiree's financial condition and results of operations to those of Mercantile. Terms of the transaction not disclosed. - --------------------------------------------------------------------------------------------------------------------------------
The Corporation believes it is significant to also disclose cash based earnings, which excludes intangible asset amortization. Second quarter 1999 cash based diluted earnings per share was $.84, up 6.3% from the $.79 earned in 1998. See Exhibit 3 for other cash based performance ratios. On April 30, 1999, a definitive Agreement and Plan of Merger by and between Mercantile and Firstar Corporation ("Firstar") was signed. The transaction was approved by shareholders of Mercantile and Firstar in special shareholder meetings held on July 28, 1999. Firstar received regulatory approval from the Comptroller of the Currency in July 1999. After the necessary approvals from the Federal Reserve Board and the United States Department of Justice are obtained, Mercantile will merge with and into Firstar in a transaction intended to be a tax-free reorganization, with Mercantile shareholders to receive 2.091 shares of Firstar common stock for each share of Mercantile common stock owned. Firstar, headquartered in Milwaukee, is a $38.4 billion-asset bank holding company with approximately 715 full-service banking offices in Ohio, Wisconsin, Kentucky, Illinois, Indiana, Iowa, Minnesota, Tennessee and Arizona. The transaction is expected to close in the late third or early fourth quarter of 1999, and will be accounted for as a pooling-of-interests. Net interest income increased 3.6% to $285,333,000 for the second quarter of 1999 and was up 3.9% to $569,562,000 for the first six months of 1999. The net interest rate margin was 3.55% this quarter compared with 3.61% in the first quarter of this year and 3.53% for the second quarter of 1998, while the year-to-date margin was 3.58%, the same level as in 1998. Average earning assets for the first half of 1999 of $32.5 billion were 3.7% higher than the $31.4 billion reported last year, as average loan volume increased by 3.5%. The growth was primarily in commercial loans and in securities, partially offset by the paydown of residential mortgage loans. For the first six months of 1999, other income was $252,451,000, an increase of $749,000 or .3% from last year. The first quarter of 1998 was favorably influenced by the $23,155,000 pre-tax gain on the sale of mortgage servicing rights and gains of $2,002,000 10 on the sale of an acquired corporate trust business and $2,658,000 on the sale of an out-of-market credit card portfolio. Excluding those gains from 1998 results and securities gains from both years, non-interest income was up by $19,605,000 or 9.1% from 1998. Fee growth in core businesses largely accounted for the increase. The Corporation introduced a program titled "Profit 2000" late in 1998 to proceed with initiatives to grow fee-based businesses and streamline the organization. That program is consistent with the Firstar banking model. ------------------------------------------------------------------------------------------------------------------------------ EXHIBIT 3 CASH BASED EARNINGS ($ IN THOUSANDS EXCEPT PER SHARE DATA)
SECOND QUARTER SIX MONTHS 1999 1998 CHANGE 1999 1998 CHANGE ---- ---- ------ ---- ---- ------ Net Income $120,528 $107,147 12.5% $238,565 $222,006 7.5% Add Back: Goodwill amortization 13,792 13,847 (.4) 27,582 27,801 (.8) Other intangible asset amortization 476 615 (22.6) 1,009 1,257 (19.7) -------- -------- -------- -------- Total Intangible Asset Amortization 14,268 14,462 (1.3) 28,591 29,058 (1.6) Less: Tax effect (181) (223) (18.8) (378) (452) (16.4) -------- -------- -------- -------- CASH BASED NET INCOME $134,615 $121,386 10.9 $266,778 $250,612 6.5 ======== ======== ======== ======== CASH BASED DILUTED EARNINGS PER SHARE $.84 $.79 6.3 $1.67 $1.63 2.5 CASH BASED PERFORMANCE RATIOS Return on tangible assets 1.53% 1.42% 1.53% 1.49% Return on tangible equity 22.69 23.55 22.68 24.48 Efficiency ratio 49.57 53.33 50.24 51.50 Other expense to average tangible assets 2.35 2.46 2.39 2.47 ------------------------------------------------------------------------------------------------------------------------------
Second quarter non-interest expenses were $219,989,000 compared with $224,726,000 last year, a decrease of 2.1%. Year-to-date operating expenses in the current year were at the same level as in 1998. The year-to-date efficiency ratio was 53.68% compared with 55.10% last year, and the expense to average assets ratio improved to 2.49% compared with 2.58% in the prior year. The year-to-date cash based efficiency ratio was 50.24% compared with 51.50% last year, and the expense to tangible assets ratio was 2.39% versus 2.47% in 1998. Gains on the sales of selected branches reduced non-interest expense by $5,906,000 in 1999 compared with $1,200,000 last year. The provision for possible loan losses for the second quarter of 1999 was $9,479,000 compared with $7,344,000 the prior year, and was $16,958,000 for the first six months of 1999 compared with $15,881,000 in 1998. Net charge-offs for the first six months of 1999 and 1998 were $16,577,000 and $15,007,000, respectively, and on an annualized basis were at historical lows at .15% of average loans in 1999 and .14% last year. At June 30, 1999, the reserve for possible loan losses was $309,271,000 and provided coverage of 296.45% of non-performing loans compared with 335.25% at year-end and 319.73% last June 30. Non-performing loans (i.e., non-accrual and renegotiated loans) as of June 30, 1999 were $104,326,000 or .46% of total loans compared with $108,515,000 or .48% at March 31, 1999 and $91,575,000 or .42% at June 30, 1998. Impaired securities declined to $45,451,000 at June 30, 1999 from $73,909,000 last June 30 due to paydowns and first quarter 1999 selective sales. Foreclosed assets declined by $3,981,000 from March 31, 1999. No single foreclosed property exceeded $1,000,000 in book value at June 30, 1999. Consolidated assets of $35.5 billion were up 2.2% from a year ago. Core deposits decreased by 4.5% to $21.4 billion, loans were up 4.3% to $22.7 billion, and shareholders' equity of $3.0 billion was 4.9% higher than at June 30, 1998. All measures of capital adequacy remained adequate. As of June 30, 1999, tier I capital to risk-adjusted assets was 9.93% and total capital to risk-adjusted assets was 12.42%. The ratio of tangible equity to tangible assets was 6.62% at June 30, 1999. At June 30, 1999, Mercantile's assets were distributed as follows: St. Louis metropolitan areas $18.5 billion, outstate Missouri $4.4 billion, metropolitan Kansas City $4.1 billion, Iowa and northwestern Illinois $3.5 billion, Arkansas $1.9 billion, outstate Illinois $2.2 billion and western Kentucky $.9 billion. 11 The following financial commentary presents a more thorough discussion and analysis of the results of operations and financial position of the Corporation for the first half and second quarter of 1999. 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 1999 include general commercial and retail banking ("Banking"), Private Banking & Investments, and specialty retail banking ("Mercantile Credit Corp."). Asset/Liability Management ("ALM") includes the investment portfolio and the treasury function, and is also a reportable business line under Financial Accounting Standard ("FAS") 131, "Disclosures about Segments of an Enterprise and Related Information". In 1998, the Corporation presented line of business results with ALM as a part of Banking. The management of ALM was separated from Banking in January 1999, and 1998 results have been restated for this change. 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 the second quarter and first six months of 1999 with comparable amounts for 1998 is summarized in Exhibit 4. Banking includes the Corporation's branch network and deposit gathering outside the St. Louis and Kansas City metropolitan areas, commercial lending and non-specialty retail lending. It is the largest business unit, and it houses most staff department functions. Pre-tax income improved by $29,000,000 or 21.3% from the first six months of 1998. Loan growth, increases in net demand deposits and an expanded net interest rate margin accounted for a $16,000,000 increase in net interest income. The provision for loan losses increased by $11,000,000 from 1998, yet net charge-offs represented only 12 basis points of average loans, portraying continued exceptional credit quality. The Banking segment had higher net recoveries during the first six months of last year. Fee income improved by $18,000,000 due to growth in cash management fees, leasing income, service charges and miscellaneous ancillary sources. Operating expenses declined by $6,000,000, resulting primarily from expense control efforts and gains on branch sales in 1999. Mercantile Credit Corp. includes the retail branch network in the St. Louis and Kansas City metropolitan areas, residential mortgage origination and servicing, credit card, indirect lending, insurance activities and consumer product management. The management of St. Louis and Kansas City retail moved to Mercantile Credit Corp. from Banking in early 1999, and 1998 results were restated for this transfer. Pre-tax income declined by $29,000,000 from 1998, due primarily to the $25,813,000 in one-time gains on sales of mortgage servicing rights and an out-of-market credit card loan portfolio recorded in the first quarter of 1998. Increased pre-tax profits in 1999 in the indirect lending and credit card businesses were more than offset by declines in mortgage banking and insurance income this year. Private Banking & Investments was structured to serve the investment management needs of high net worth individuals. This line of business includes private banking offices, personal and institutional trust activities, institutional money management and retail brokerage. Pre-tax income improved by $3,000,000 or 10.0% due to expanded deposit and loan bases as well as growth in trust fees and brokerage revenue. Parent Company & 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. The ALM unit pre-tax profit improved by $7,000,000, due primarily to a higher level of securities gains in 1999. 12 ----------------------------------------------------------------------------------------------------------------------------- EXHIBIT 4 LINE OF BUSINESS RESULTS ($ IN MILLIONS)
PRIVATE ASSET/ PARENT MERCANTILE BANKING & LIABILITY COMPANY BANKING CREDIT CORP. INVESTMENTS MANAGEMENT & OTHER CONSOLIDATED ------- ------------ ----------- ---------- ------- ------------ SECOND QUARTER 1999 ------------------- OPERATING RESULTS Taxable-equivalent net interest income $ 170 $ 68 $ 4 $ 51 $ (4) $ 289 Provision for possible loan losses 10 8 -- -- (8) 10 Non-interest income 47 35 41 3 -- 126 Non-interest expense 121 53 27 -- 19 220 ------- ------ ----- ------ ------ ------- Taxable-equivalent Income before Income Taxes $ 86 $ 42 $ 18 $ 54 $ (15) $ 185 ======= ====== ===== ====== ====== ======= Percent of Taxable-equivalent Income before Income Taxes 46.5% 22.7% 9.7% 29.2% (8.1)% 100.0% AVERAGE BALANCES Loans and leases $15,971 $6,717 $ 178 -- $ (265) $22,601 Deposits 14,116 8,422 437 $1,220 651 24,846 PERFORMANCE RATIOS Efficiency ratio 56.13% 51.29% 60.41% N/A N/A 53.01% Net interest rate margin 4.18 4.04 8.42 N/A N/A 3.55 Net charge-offs to average loans .13 .27 -- N/A N/A .16 ----------------------------------------------------------------------------------------------------------------------------- SECOND QUARTER 1998 ------------------- OPERATING RESULTS Taxable-equivalent net interest income $ 162 $ 71 $ 3 $ 51 $ (8) $ 279 Provision for possible loan losses 2 3 -- -- 2 7 Non-interest income 39 37 37 3 (1) 115 Non-interest expense 128 59 23 -- 15 225 ------- ------ ----- ------ ------ ------- Taxable-equivalent Income before Income Taxes $ 71 $ 46 $ 17 $ 54 $ (26) $ 162 ======= ====== ===== ====== ====== ======= Percent of Taxable-equivalent Income before Income Taxes 43.8% 28.4% 10.5% 33.3% (16.0)% 100.0% AVERAGE BALANCES Loans and Leases $14,911 $7,004 $ 99 -- $ (201) $21,813 Deposits 14,072 9,176 317 $ 762 803 25,130 PERFORMANCE RATIOS Efficiency ratio 64.00% 53.05% 59.60% N/A N/A 57.00% Net interest rate margin 4.04 4.03 7.76 N/A N/A 3.53 Net charge-offs to average loans .08 .22 -- N/A N/A .15 ----------------------------------------------------------------------------------------------------------------------------- SIX MONTHS 1999 --------------- OPERATING RESULTS Taxable-equivalent net interest income $ 335 $ 143 $ 8 $ 102 $ (11) $ 577 Provision for possible loan losses 15 10 -- -- (8) 17 Non-interest income 92 67 78 15 -- 252 Non-interest expense 247 110 53 -- 35 445 ------- ------ ----- ------ ------ ------- Taxable-equivalent Income before Income Taxes $ 165 $ 90 $ 33 $ 117 $ (38) $ 367 ======= ====== ===== ====== ====== ======= Percent of Taxable-equivalent Income before Income Taxes 44.9% 24.5% 9.0% 31.9% (10.3)% 100.0% AVERAGE BALANCES Loans and leases $15,711 $6,821 $ 173 -- $ (239) $22,466 Deposits 14,045 8,665 426 $1,142 668 24,946 PERFORMANCE RATIOS Efficiency ratio 58.21% 52.60% 61.42% N/A N/A 53.68% Net interest rate margin 4.16 4.19 8.42 N/A N/A 3.58 Net charge-offs to average loans .12 .22 -- N/A N/A .15 ----------------------------------------------------------------------------------------------------------------------------- SIX MONTHS 1998 --------------- OPERATING RESULTS Taxable-equivalent net interest income $ 319 $ 147 $ 5 $ 102 $ (17) $ 556 Provision for possible loan losses 4 8 -- -- 4 16 Non-interest income 74 99 71 8 -- 252 Non-interest expense 253 119 46 -- 27 445 ------- ------ ----- ------ ------ ------- Taxable-equivalent Income before Income Taxes $ 136 $ 119 $ 30 $ 110 $ (48) $ 347 ======= ====== ===== ====== ====== ======= Percent of Taxable-equivalent Income before Income Taxes 39.2% 34.3% 8.6% 31.7% (13.8)% 100.0% AVERAGE BALANCES Loans and Leases $14,658 $7,143 $ 99 -- $ (201) $21,699 Deposits 13,837 9,069 303 $1,000 800 25,009 PERFORMANCE RATIOS Efficiency ratio 64.55% 48.26% 61.74% N/A N/A 55.10% Net interest rate margin 4.07 4.10 7.88 N/A N/A 3.58 Net charge-offs to average loans .08 .24 -- N/A N/A .14 -----------------------------------------------------------------------------------------------------------------------------
13 NET INTEREST INCOME Net interest income for the second quarter of 1999 was $285,333,000, a 3.6% increase from the $275,302,000 earned last year, and for the first six months of 1999 was $569,562,000 or 3.9% higher than last year. For the quarter, the net interest rate margin was 3.55% compared with 3.53% last year, and the year-to-date margin was 3.58%, unchanged from last year. Average earning assets for the first six months of 1999 grew by $1.1 billion or 3.7% when compared with 1998, as average loans grew by $766,657,000 or 3.5%. This growth was funded by a $256,713,000 increase in average purchased deposits, a $245,211,000 increase in shareholders' equity and a $1.9 billion increase in long-term Federal Home Loan Bank ("FHLB") advances, partially offset by a $318,952,000 decline in core deposits and a $845,927,000 or 22.7% decrease in short-term borrowings. Securities are the largest category of earning assets after loans, and averaged $9.5 billion in the first six months of 1999, an increase of 3.8% from 1998. The held-to-maturity and available-for-sale portfolios as of June 30, 1999 consisted of 67.16% in U.S. and other government agency securities, (including 35.54% in mortgage-related issues), 3.93% in state and municipal securities, and 28.91% of other miscellaneous securities. The comparable distribution at June 30, 1998 was 68.20%, 30.74%, 5.07% and 26.73%, respectively. The largest dollar volume of loan growth occurred in the commercial loan category. When compared with the first six months of 1998, average commercial loans grew by $1.1 billion or 19.7%. The expertise of experienced lenders in certain specialized industries, coupled with a strong regional economy, largely accounted for the growth. Agriculture is a segment of the regional economy that did not contribute to commercial loan growth, and agriculture-related commercial loans declined by 4.1%. An additional factor adding to the commercial loan growth was Mercantile's portfolio of $220,000,000 in loan participations purchased in the national markets and held for investment, compared with $70,000,000 last year. Other than these 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. Average commercial real estate mortgage and construction loans increased by $374,312,000 or 8.6%, also reflecting the strength of the regional economy. --------------------------------------------------------------------- EXHIBIT 5 LOANS AND LEASES ($ IN THOUSANDS)
JUNE 30 1999 1998 CHANGE ---- ---- ------ Commercial $ 6,736,331 $ 5,565,996 21.0% Real estate--commercial 3,702,152 3,728,619 (.7) Real estate--construction 977,794 737,452 32.6 Real estate--residential mortgage 7,805,515 8,363,823 (6.7) Real estate--home equity credit loans 559,788 557,220 .5 Consumer 2,895,591 2,701,295 7.2 Credit card loans managed 442,284 520,609 (15.0) Securitized credit card loans (400,000) (400,000) -- ----------- ----------- Total Loans and Leases $22,719,455 $21,775,014 4.3 =========== =========== ---------------------------------------------------------------------
Average residential real estate mortgage loans decreased by $697,102,000 or 8.1%. The low interest rate environment encouraged borrowers to prepay or refinance into conforming fixed-rate loans that Mercantile generally sold in the market. The recent increase in interest rates has since modified that behavior and the rate of reduction in loans has diminished. Average residential mortgage loans as a percentage of earning assets decreased from 27.48% in the first six months of 1998 to 24.36% in 1999. Home equity credit loans also declined on average by 7.5%, due to customer refinancing of those debts, although the volume did grow from the first quarter of 1999. Average consumer loans grew by $215,499,000 or 8.3%, with the growth occurring in indirect consumer loans. Such growth in indirect lending was largely attributable to the centralization of that function and the use of risk-based pricing across the Mercantile system. Mercantile does not engage in significant subprime consumer lending in its own portfolio. Due to the securitization of credit card loans in the 1995 Mercantile Credit Card Master Trust, credit card outstandings classified as loans averaged only $41,191,000 in the first six months of 1999. Average credit card loans declined in 1999 as successful targeted marketing efforts, aimed at expanding relationships with the current Mercantile customer base, were offset by the sale of $112,000,000 in out-of-market credit card loans in the first quarter of 1998 and the third quarter 1998 reclassification of $80,000,000 in loans to investment securities in compliance with FAS 125 and terms of the credit card securitization agreement. 14 On a managed portfolio basis, credit card loans averaged $623,910,000 in 1999 versus $703,047,000 in 1998. This decline was due to the sale noted above. For the first six months of 1999, average non-interest and interest bearing demand deposits, and money market accounts increased while savings deposits, certificates of deposit under $100,000 and other time deposits declined. Core deposits remain Mercantile's largest, most reliable and most important funding source and include the deposits listed above. In total, average core deposits declined by $318,952,000 or 1.4%. Partially contributing to the decline was the sale of $120,000,000 of deposits as five non-strategic branches were sold in 1999. For the first six months of 1999, Mercantile remained substantially core funded at 89.32% of average deposits and 68.50% of earning assets. Mercantile's average of consumer certificates to total core deposits declined to 39.69% from 43.19% in 1998. Changes in average core deposits for the past six quarters are shown in the Consolidated Quarterly Average Balance Sheet on pages 25 and 26 of this report. Average non-interest bearing deposits increased by $224,706,000 or 5.8% from 1998. Cash and due from banks volume is related to non-interest bearing deposit volume and increased on average by $76,509,000 or 5.5%, thus net non-interest bearing deposits grew by $148,197,000 or 6.0%. Successful efforts in managing float and minimizing reserve requirements coupled with deposit volume growth resulted in the increase in average net non-interest bearing funds. Much of the growth came from the U.S. government, a significant cash management customer of Mercantile Bank N.A., which pays for services rendered via compensating balances. These average non-interest bearing deposits increased from $692,171,000 in the first six months of 1998 to $869,122,000 in 1999. Average interest bearing demand and money market accounts increased by 2.1% and 8.7%, respectively, as customers preferred these types of more liquid deposits to retail certificates. Year-to-date average short-term borrowings declined by $845,927,000, to $2.9 billion in 1999 as short-term FHLB advances were refunded with comparable longer term borrowings, which averaged $3.3 billion in the first six months of 1999 compared with $1.4 billion in the prior year. Throughout 1998, these borrowings became a significant funding source for Mercantile due to their attractive pricing. As of June 30, 1999, there were no borrowings outstanding under the current $3.0 billion bank note program initiated in 1998. The remainder of bank notes issued under the prior program matured during the first quarter of 1999. The factors discussed previously are consistent with Mercantile's overall corporate policy relative to rate sensitivity and liquidity, which is to produce the optimal yield and maturity mix consistent with interest rate expectations and projected liquidity needs. The Consolidated Quarterly Average Balance Sheet, with rates earned and paid, is summarized by quarter on pages 25 and 26. OTHER INCOME Non-interest income increased by 9.8% during the second quarter of 1999 to $126,007,000, and for the six months was $252,451,000 compared with $251,702,000 a year ago, an increase of .3%. In the first quarter of 1998, the Corporation recorded gains on the sales of: 1) mortgage servicing rights of $23,155,000; 2) an acquired corporate trust business of $2,002,000 and; 3) an acquired out-of-market credit card portfolio for $2,658,000. If these 1998 items as well as securities gains in both years are excluded, non-interest income grew by 9.1% in the six months ended June 30, 1999. Exhibit 6 portrays such transactions and a summary of all categories of fee income in the second quarter and first six months of 1999 and 1998. In 1999, trust fees were $60,887,000 compared with $56,944,000 during 1998, an increase of 6.9%. There was an increase in personal trust fees earned by Mercantile Trust Company N.A. Mississippi Valley Advisors Inc., the investment management subsidiary of Mercantile, experienced a reduced rate of revenue growth. In addition, there were some reclassifications from trust income in 1998 to miscellaneous fees in 1999 resulting from the integration of Firstbank of Illinois Co. in late 1998, thereby making the annual comparisons difficult. Increases in the value of assets managed and successful new business development efforts largely accounted for the increase in trust fees. Mississippi Valley Advisors Inc. manages the 19 Mercantile Mutual Funds. These funds had assets of $4.3 billion at June 30, 1999 compared with $4.2 billion on June 30, 1998. 15 ------------------------------------------------------------------------------------------------------------------------------ EXHIBIT 6 OTHER INCOME ($ IN THOUSANDS)
SECOND QUARTER SIX MONTHS 1999 1998 CHANGE 1999 1998 CHANGE ---- ---- ------ ---- ---- ------ Trust $ 31,745 $ 28,816 10.2% $ 60,887 $ 56,944 6.9% Service charges 31,047 29,073 6.8 60,687 57,317 5.9 Retail brokerage revenue 7,553 5,312 42.2 13,814 10,194 35.5 Other investment banking 3,971 4,514 (12.0) 8,792 10,698 (17.8) Mortgage banking 4,503 8,959 (49.7) 10,702 38,057 (71.9) Credit card fees 3,835 2,558 49.9 7,338 6,083 20.6 Securitization revenue 7,555 4,520 67.1 13,006 9,043 43.8 Securities gains 3,283 2,834 15.8 16,246 7,287 -- Electronic Federal Tax Payment System (EFTPS) fees 2,091 3,060 (31.7) 4,824 5,378 (10.3) ATM fees 4,210 3,877 8.6 7,982 7,437 7.3 Income on operating leases 3,835 2,325 64.9 7,355 4,245 73.3 Loan commitment fees 2,243 1,904 17.8 4,075 3,903 4.4 Loan late charges 2,182 2,220 (1.7) 4,488 4,443 1.0 Letters of credit fees 2,291 1,831 25.1 4,085 3,366 21.4 Official check fees 2,851 2,112 35.0 5,774 3,726 55.0 Safe deposit box rental 1,428 1,442 (1.0) 3,079 3,033 1.5 Insurance commissions 2,219 2,535 (12.5) 3,992 4,354 (8.3) Debit card income 2,165 1,353 60.0 3,720 2,387 55.8 Miscellaneous 7,000 5,506 27.1 11,605 13,807 (15.9) -------- -------- -------- -------- Total Other Income 126,007 114,751 9.8 252,451 251,702 .3 Less gains from: Sale of available-for-sale securities (3,283) (2,834) 15.8 (16,246) (7,287) -- Sale of mortgage servicing rights -- -- -- -- (23,155) -- Sale of out-of-market credit card portfolio -- -- -- -- (2,658) -- Sale of corporate trust -- -- -- -- (2,002) -- -------- -------- -------- -------- Total Other Income After Gains $122,724 $111,917 9.7 $236,205 $216,600 9.1 ======== ======== ======== ======== Excludes such fees from the Corporation's mortgage banking and credit card operations, which are included in mortgage banking and credit card revenue. ------------------------------------------------------------------------------------------------------------------------------
Deposit service charges totaled $60,687,000 in the first six months of 1999, which represented an increase of $3,370,000 or 5.9% over 1998. Growth occurred in both commercial and retail lines of business. In January 1998, the Corporation sold $1.9 billion in residential mortgage loan servicing that reduced originated mortgage servicing assets by approximately $3,200,000. 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 funded the Corporation's 1998 systems cost to become Year 2000 compliant. Excluding the gain on sale, mortgage banking income was $10,702,000 in the first six months of 1999 versus $14,902,000 the prior year. Amortization of mortgage servicing rights, which reduces mortgage banking income, was $2,308,000 higher than in the first six months of 1998. The increased amortization was primarily caused by two factors. In the second quarter of 1999, the Corporation began computing mortgage servicing amortization using the level yield method. In addition, loan specific amortization was initiated for the entire portfolio in 1999 versus the prior method of pooling certain loans for servicing right purposes. Mortgages serviced totaled $11.3 billion at June 30, 1999 compared with $10.6 billion at June 30, 1998. Total originated and purchased mortgage servicing assets on the balance sheet at June 30, 1999 totaled $47,510,000. The associated risk for impairment was not considered to be material even before the recent increase in interest rates. Year-to-date retail brokerage and other investment banking revenue was $22,606,000 compared with $20,892,000 last year; second quarter fees totaled $11,524,000 versus $9,826,000 last year. The Bruno Stolze & Company, Inc. discount brokerage acquisition in late 1998 favorably impacted 1999 revenues and foreign exchange revenue growth remained strong. 16 For the first six months of 1999, credit card income was $7,338,000 compared with $6,083,000 last year. Credit card income primarily represents interchange fees received on transactions of Mercantile cardholders and cardholders' miscellaneous fees. In the fourth quarter of 1998, Mercantile credit cards were reissued under Missouri law, allowing the Corporation greater flexibility in pricing and the opportunity to increase fee revenue in 1999. Securitization revenue for the first six months of 1999 was $13,006,000 compared with $9,043,000 last year, and represents amounts accruing to Mercantile on the $400,000,000 in credit card loans securitized in the Mercantile Credit Card Master Trust during May 1995, as well as amounts recognized under FAS 125 for investor certificate loans that were sold and reclassified to the investment portfolio. In 1999, the Corporation increased pricing on credit card loans, including the securitized portion. For securitized loans, amounts that would previously 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. Mercantile acts 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. Significant other revenue growth categories in both years included operating lease income, both ATM and debit card fees, official check fees and letters of credit fees. All these businesses are key focuses of the Corporation. Net securities gains on investment securities totaled $3,283,000 and $2,834,000 in the second quarter of 1999 and 1998, respectively. Year-to-date securities gains were $16,246,000 in 1999 and $7,287,000 in 1998. Repositioning of 1998 acquired investment portfolios and more active portfolio management in the current interest rate environment accounted for the increased gains in early 1999. Additionally, the Corporation disposed of $8,036,000 of impaired investment securities in the first quarter of 1999 at gains of $1,275,000. The corresponding impaired balance declined to $45,451,000 from $63,296,000 at year-end 1998. OTHER EXPENSE For the first half of 1999, expenses other than interest expense and the provision for possible loan losses were $445,343,000, which approximates the 1998 level. Year-to-date salary expenses decreased by $1,091,000 or .5% from last year. The impact of merit increases was more than offset by lower staff levels resulting from 1998 acquisition synergies, Profit 2000 initiatives, branch closings and better use of technology. The announcement of the Firstar transaction also resulted in higher staff turnover during the second quarter of 1999 and thus lower salary levels. Employee benefit costs increased in the first six months of 1999 by 3.8% to $42,101,000, primarily due to increased 401(k) plan expense. Occupancy and equipment costs through June 30, 1999 increased by 9.6% from the prior year, reflecting a consistent program of investing in new technology to improve customer service and enhance employee efficiency. Additionally, with the growth of Mercantile's leasing business, depreciation of equipment the Corporation leases to customers increased by $2,807,000 over the first six months of 1998. The rent received on this equipment is a component of non-interest income. Exhibit 7 details the composition of all other operating expenses. Communications expense totaled $11,122,000 in the first six months of 1999 compared with $9,268,000 last year, reflecting the costs of technology to expand both voice and data networking. Marketing and business development expense declined in 1999 as a corporate-wide image advertising campaign that began in 1997 wound down last year. Additionally, marketing of the Mercantile name has been reduced in 1999 because of the pending Firstar transaction. In 1999, there were reductions in miscellaneous expense of $5,906,000 from gains realized on the sales of non-strategic Mercantile branch offices. During the first six months of 1998, a comparable expense reduction totaling $1,200,000 17 was recorded on the sale of one branch office. Intangible asset amortization was $28,591,000 in the first six months of 1999 compared with $29,058,000 in 1998. During 1998, Mercantile recorded acquisition-related accruals of $89,192,000. Of that original liability, $65,951,000 has been utilized at June 30, 1999 and $23,241,000 remains to absorb future cash payments. Payment streams may change from what was originally anticipated due to Mercantile's pending sale to Firstar. Substantially all the merger-related liabilities made for acquisitions prior to 1998 have been exhausted. During the fourth quarter of 1998, Mercantile recorded a $45,130,000 charge relating to cost management programs and customer service initiatives. The charge was expected to fund the costs related to 26 branch closings and severance for approximately 1,400 staff reductions that would result from further centralization, consolidation of back office functions, branch closures and a wider span of control. These initiatives are continuing throughout 1999. Any additional costs that do not qualify for recognition in the charge are being expensed as incurred, but are not expected to be material. Total payments through June 30, 1999 were $14,724,000, and the remaining balance of $30,406,000 represents the estimated liability for the future cash outflows associated with these specific actions. These scheduled Profit 2000 projects are being reevaluated jointly by Firstar and Mercantile as to viability and/or timing. ------------------------------------------------------------------------------------------------------------------------------ EXHIBIT 7 OTHER EXPENSE ($ IN THOUSANDS)
SECOND QUARTER SIX MONTHS 1999 1998 CHANGE 1999 1998 CHANGE ---- ---- ------ ---- ---- ------ Salaries $103,600 $103,747 (.1)% $205,287 $206,378 (.5)% Employee benefits 20,449 18,032 13.4 42,101 40,579 3.8 -------- -------- -------- -------- Total Personnel Expense 124,049 121,779 1.9 247,388 246,957 .2 Net occupancy 16,704 16,015 4.3 33,895 32,199 5.3 Equipment 23,888 21,255 12.4 47,577 42,113 13.0 Postage and freight 7,050 6,575 7.2 14,654 13,880 5.6 Marketing/business development 4,411 4,590 (3.9) 7,717 8,623 (10.5) Office supplies 3,926 4,336 (9.5) 8,472 8,689 (2.5) Communications 5,488 4,840 13.4 11,122 9,268 20.0 Legal and professional 3,576 4,500 (20.5) 7,702 7,935 (2.9) Credit card 1,167 1,788 (34.7) 2,394 3,077 (22.2) FDIC insurance 1,384 1,455 (4.9) 2,658 2,822 (5.8) Foreclosed property expense (recoveries) 451 (260) -- 1,204 (88) -- Miscellaneous 13,627 23,391 (41.7) 31,969 40,731 (21.5) -------- -------- -------- -------- Other Expense Before Intangible Asset Amortization 205,721 210,264 (2.2) 416,752 416,206 .1 Intangible asset amortization 14,268 14,462 (1.3) 28,591 29,058 (1.6) -------- -------- -------- -------- Total Other Expense $219,989 $224,726 (2.1) $445,343 $445,264 -- ======== ======== ======== ======== ------------------------------------------------------------------------------------------------------------------------------
INCOME TAXES For the six months ended June 30, 1999, the Corporation recorded income tax expense of $121,147,000 compared with 1998 expense of $116,574,000. The effective tax rate was relatively stable at 33.68% compared with 34.43% in 1998. The implementation of various business strategies and receipt of certain state tax refunds from prior years resulted in the lower effective tax rate in 1999. This 1999 lower effective tax rate is anticipated in the third and fourth quarters. RESERVE FOR POSSIBLE LOAN LOSSES The reserve for possible loan losses was $309,271,000 or 1.36% of loans outstanding at June 30, 1999 compared with $308,890,000 or 1.38% at year's end and $292,795,000 or 1.34% at June 30, 1998. Approximately one-third of the Corporation's total loan portfolio is invested in residential real estate loans for which the loan loss experience averaged only .03% for the past 18 three years. If residential mortgages and its allocated reserve are excluded, the remaining reserve for possible loan losses represents 1.99% of outstanding loans at June 30, 1999. The year-to-date 1999 provision for possible loan losses was $16,958,000, which exceeded net charge-offs of $16,577,000 by $381,000 or 2.3%. The annualized ratio of net charge-offs to average loans for the first six months of 1999 was .15%, comparable to the .14% ratio in 1998. For the total managed portfolio of credit card loans (including securitized loans), the ratio of net charge-offs to average loans was 5.39% in 1999 versus 7.21% last year. 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 as of June 30, 1999. Over a 12-month period commencing in November 1999, $600,000,000 of loans in the Mercantile Credit Card Master Trust will return to the Corporation's balance sheet. 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 $200,000,000 in loans are also in the trust but are classified as investor certificates and held on Mercantile's balance sheet in the investment portfolio. Mercantile evaluates the reserve for loan losses on a quarterly basis to ensure the timely charge-off of loans and to determine the adequacy of the reserve. Management believes the consolidated reserve of 1.36% of loans and 296.45% of non-performing loans as of June 30, 1999 was adequate based on the risks identified at such date in the portfolio. ------------------------------------------------------------------------------------------------------------------------------ EXHIBIT 8 RESERVE FOR POSSIBLE LOAN LOSSES ($ IN THOUSANDS)
SECOND QUARTER SIX MONTHS 1999 1998 1999 1998 ---- ---- ---- ---- BEGINNING BALANCE $309,048 $293,565 $308,890 $284,165 PROVISION 9,479 7,344 16,958 15,881 Charge-offs (14,470) (14,667) (27,212) (27,439) Recoveries 5,214 6,617 10,635 12,432 -------- -------- -------- -------- NET CHARGE-OFFS (9,256) (8,050) (16,577) (15,007) Acquired Reserves -- (64) -- 7,756 -------- -------- -------- -------- ENDING BALANCE $309,271 $292,795 $309,271 $292,795 ======== ======== ======== ======== LOANS AND LEASES June 30 balance $22,719,455 $21,775,014 $22,719,455 $21,775,014 =========== =========== =========== =========== Average balance $22,600,598 $21,813,425 $22,466,211 $21,699,554 =========== =========== =========== =========== RATIOS Reserve balance to outstanding loans 1.36% 1.34% 1.36% 1.34% Reserve balance to non-performing loans 296.45 319.73 296.45 319.73 Net charge-offs to average loans .16 .15 .15 .14 ------------------------------------------------------------------------------------------------------------------------------
NON-PERFORMING ASSETS Non-performing assets consist of non-accrual loans, renegotiated loans, foreclosed property and investment securities with an impairment in value that is considered other than temporary. A summary of these assets is presented in Exhibit 9. Non-performing loans (non-accrual and renegotiated loans) were $104,326,000 or .46% of total loans at June 30, 1999, compared with $92,137,000 or .41% at December 31, 1998 and $91,575,000 or .42% at June 30, 1998. By the Corporation's definition, all non-accrual and renegotiated commercial-related loans are considered impaired. Impaired loans totaled $57,273,000 at June 30, 1999 and averaged $60,631,000 for the first six months of 1999. Foreclosed assets at June 30, 1999 were $12,142,000 compared with $13,500,000 at year's end and $23,293,000 last year. 19 - -------------------------------------------------------------------------------- EXHIBIT 9 NON-PERFORMING ASSETS ($ IN THOUSANDS)
JUNE 30 DEC. 31 JUNE 30 1999 1998 1998 ------- ------- ------- NON-ACCRUAL LOANS Commercial $ 31,048 $ 21,799 $ 33,469 Real estate--commercial 24,502 20,935 24,289 Real estate--construction 1,674 3,411 1,404 Real estate--residential mortgage 35,791 31,355 21,723 Real estate--home equity credit loans 522 551 421 Consumer 10,740 12,633 8,697 -------- -------- -------- Total Non-accrual Loans 104,277 90,684 90,003 RENEGOTIATED LOANS 49 1,453 1,572 -------- -------- -------- TOTAL NON-PERFORMING LOANS 104,326 92,137 91,575 FORECLOSED ASSETS Foreclosed real estate 8,383 8,983 18,936 Other foreclosed assets 3,759 4,517 4,357 -------- -------- -------- TOTAL FORECLOSED ASSETS 12,142 13,500 23,293 -------- -------- -------- TOTAL NON-PERFORMING LOANS AND FORECLOSED ASSETS 116,468 105,637 114,868 Impaired investment securities 45,451 63,296 73,909 -------- -------- -------- TOTAL NON-PERFORMING ASSETS $161,919 $168,933 $188,777 ======== ======== ======== PAST-DUE LOANS (90 DAYS OR MORE) Commercial $ 8,893 $ 12,263 $ 7,049 Real estate--commercial 1,766 1,621 1,590 Real estate--construction 97 -- 300 Real estate--residential mortgage 43,002 48,572 33,337 Real estate--home equity credit loans 509 503 524 Consumer 6,107 7,396 5,220 Credit card 278 672 1,322 -------- -------- -------- Total Past-due Loans $ 60,652 $ 71,027 $ 49,342 ======== ======== ======== RATIOS Non-performing loans to outstanding loans .46% .41% .42% Non-performing loans and foreclosed assets to outstanding loans and foreclosed assets .51 .47 .53 Non-performing assets to total assets .46 .47 .54 Excludes insured FHA and government-guaranteed VA loans that are contractually past due more than 90 days. Since these loans are fully insured or guaranteed for the payment of both principal and interest, the Corporation does not consider these loans to be non-performing assets. The total of such insured or guaranteed loans was $12,503,000 at June 30, 1999, $7,855,000 at December 31, 1998, and $9,556,000 at June 30, 1998. Past-due loans 90 days or more are not included in non-performing asset totals or ratios. - --------------------------------------------------------------------------------
Non-accrual loans declined by $2,795,000 from the March 31, 1999 level and foreclosed property decreased by 24.7% from the prior quarter-end. As of June 30, 1999, Mercantile had only two non-accrual loans with balances in excess of $2,000,000, the largest of which amounted to $3,500,000. As significant, the Corporation held no foreclosed assets with a book value exceeding $1,000,000. All loans classified as renegotiated were paying in accordance with their modified terms at June 30, 1999. Loans past due 90 days or more and still accruing interest consisted largely of credit card loans, consumer loans and residential real estate mortgage loans. Exhibit 9 details the composition of loans past due 90 days and over. The Corporation's impaired investment securities represent selected pools of privately issued mortgage-backed securities and have declined by $17,845,000 from December 31, 1998, to $45,451,000, due to paydowns and sales. In the first quarter of 1999, $8,036,000 in impaired securities were sold at gains of $1,275,000 which is part of securities gains reported in the Consolidated Statement of Income. The current yield on the net book value of these impaired securities was 9.43% at June 30, 1999. CAPITAL RESOURCES Mercantile maintains a capital base that provides a foundation that promotes both depositor and investor confidence. Capital management is a continuous process at Mercantile, and is focused on ensuring that adequate capital is provided for both current needs and anticipated growth. This strategy has enabled Mercantile to profitably expand its balance sheet, while maintaining capital ratios that exceed minimum regulatory capital requirements. At June 30, 1999, shareholders' equity was $3.1 billion, an increase of 4.9% from June 30, 1998. Retained earnings were partially offset by an unfavorable FAS 115 adjustment of $168,071,000 in the first six months of 1999, which was caused by the rise in interest rates. As of June 30, 1999, the balance of the valuation on available-for-sale securities reduced shareholders' equity by $126,911,000. The tangible equity to tangible assets ratio increased to 6.62% at June 30, 1999 from 6.19% a year ago. Additionally, the tier I and leverage ratios have improved since last year and all regulatory capital ratios significantly exceed regulatory requirements. Exhibit 10 details significant capital information for June 30, 1999, December 31, 1998 and June 30, 1998. 20 In the first six months of 1998, the Corporation repurchased 1,778,125 shares of its common stock via designated broker-dealers at an average cost of $53.60 per share. These repurchases in the first quarter of 1998 occurred through an accelerated stock repurchase program, and were reissued for the 1994 Stock Incentive Plan and the July 1, 1998 acquisitions of CBT Corporation and Firstbank of Illinois Co. This year's repurchases of 56,250 shares through June 30 followed Mercantile's systematic reacquisition plan for the 1994 Stock Incentive Plan. As of June 30, 1999, Mercantile had only 52,781 treasury shares outstanding, and none were tainted for pooling-of-interests accounting purposes. The Corporation's 9.00% mortgage-backed notes that totaled $53,450,000 matured on July 26, 1999. Additionally, Mercantile's $400,000,000 credit card securitization is scheduled to begin a 12-month amortization period in November 1999. Excluding FHLB advances, the maturities of remaining long-term debt are laddered between 2001 and 2007. ------------------------------------------------------------------------ EXHIBIT 10 RISK-BASED CAPITAL ($ IN THOUSANDS)
JUNE 30 DEC. 31 JUNE 30 1999 1998 1998 ------- ------- ------- Capital Tier I $ 2,631,844 $ 2,451,449 $ 2,270,127 Total 3,291,164 3,125,488 2,962,242 Risk-adjusted assets 26,496,612 24,907,551 23,773,542 Tier I capital to risk-adjusted assets 9.93% 9.84% 9.55% Total capital to risk-adjusted assets 12.42 12.55 12.46 Leverage 7.48 7.16 6.65 Tangible equity to tangible assets 6.62 6.55 6.19 Double leverage 117.75 120.75 123.79 ------------------------------------------------------------------------
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 117.75% at June 30, 1999 compared with 123.79% last year. Intangible assets, which consisted largely of goodwill, totaled $750,527,000 at June 30, 1999 compared with $811,070,000 a year ago. The Corporation paid a quarterly cash dividend of $.34 on July 1, 1999. On July 21, 1999, the Board of Directors declared a cash dividend of $.34 per share, payable October 1, 1999 to shareholders of record at the end of business September 1, 1999. Book value per share was $19.30 at June 30, 1999 compared with $19.16 a year earlier. Public debt ratings of the Corporation and Mercantile Bank N.A. are shown in Exhibit 11. --------------------------------------------------------------------------------------------------------------------------- EXHIBIT 11 DEBT RATINGS
JUNE 30, 1999 --------------------------------------------------------------- FITCH THOMSON STANDARD MOODY'S IBCA 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 July 1999 Aaa Certificates of deposit (long-term/short-term) A1/P-1 A/A-2 Mortgage-backed notes matured on July 26, 1999. ---------------------------------------------------------------------------------------------------------------------------
21 YEAR 2000 Financial institutions are 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 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 substantially completed the assessment, analysis, remediation and validation 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 96% have been completed. 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 June 30, 1999, renovation and testing of such identified mission-critical applications were 100% complete. 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 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 credit 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 such 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. Year 2000 date testing has been completed with approximately 95% of material third-party relationships. Review of third-party customers and supplies will be an ongoing process throughout 1999. Mercantile estimates that its total costs related to Year 2000 remediation will be approximately $31,000,000. Expenses of the Program in the first six months of 1999 declined to $3,377,000 from $7,804,000 in the same period of 1998. 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 systems, and therefore believes there is little risk of any critical system or asset not being able to process date-related functions. In the event that Mercantile has not successfully completed the remediation of its mission-critical systems, 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 22 such as telecommunications, electric power and service 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. Public disclosure of the state of readiness among basic infrastructure and other suppliers, funding sources and counterparties indicates significant progress in their Year 2000 preparedness. At this time, the Corporation believes the likelihood of such significant disruptions is minimal. A Year 2000 Liquidity Plan has been completed and approved, with implementation occurring later in 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 has developed business resumption contingency plans specific to Year 2000 issues. 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. The effort to develop and validate business resumption contingency plans was complete as of June 30, 1999, as required by FFIEC guidelines. The review of these plans will be an ongoing process throughout the remainder of 1999. As stated before, Mercantile is expected to merge with and into Firstar late in the third quarter or early in the fourth quarter of 1999. However, conversions to Firstar's systems are not scheduled until the first quarter of 2000, and therefore, will not impact Mercantile's Year 2000 preparedness. 23 MERCANTILE BANCORPORATION INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED QUARTERLY STATEMENT OF INCOME ($ IN THOUSANDS EXCEPT PER SHARE DATA)
1998 1999 1ST QTR. 2ND QTR. 3RD QTR. 4TH QTR. 1ST QTR. 2ND QTR. -------- -------- -------- -------- -------- -------- INTEREST INCOME Interest and fees on loans and leases $442,332 $445,880 $443,631 $439,392 $431,903 $432,831 Investments in debt and equity securities 144,117 149,856 146,296 150,417 148,335 148,410 Short-term investments 6,731 8,351 7,334 7,781 6,700 7,235 -------- -------- -------- -------- -------- -------- Total Interest Income 593,180 604,087 597,261 597,590 586,938 588,476 Tax-equivalent adjustment 4,235 4,191 3,906 4,332 3,940 3,641 -------- -------- -------- -------- -------- -------- TAXABLE-EQUIVALENT INTEREST INCOME 597,415 608,278 601,167 601,922 590,878 592,117 INTEREST EXPENSE Deposits 237,420 237,267 231,983 225,046 216,638 210,288 Borrowed funds 83,039 91,518 92,199 89,386 86,071 92,855 -------- -------- -------- -------- -------- -------- Total Interest Expense 320,459 328,785 324,182 314,432 302,709 303,143 -------- -------- -------- -------- -------- -------- TAXABLE-EQUIVALENT NET INTEREST INCOME 276,956 279,493 276,985 287,490 288,169 288,974 PROVISION FOR POSSIBLE LOAN LOSSES 8,537 7,344 23,871 11,402 7,479 9,479 OTHER INCOME Trust 28,128 28,816 27,442 28,613 29,142 31,745 Service charges 28,244 29,073 30,498 31,462 29,640 31,047 Investment banking and brokerage 11,066 9,826 9,760 10,485 11,082 11,524 Mortgage banking 29,098 8,959 6,149 10,249 6,199 4,503 Securities gains 4,453 2,834 2,297 5,851 12,963 3,283 Other 35,962 35,243 85,693 41,717 37,418 43,905 -------- -------- -------- -------- -------- -------- Total Other Income 136,951 114,751 161,839 128,377 126,444 126,007 OTHER EXPENSE Personnel expense 125,178 121,779 124,155 124,847 123,339 124,049 Net occupancy and equipment 37,042 37,270 38,608 39,509 40,880 40,592 Other 58,318 65,677 148,389 105,985 61,135 55,348 -------- -------- -------- -------- -------- -------- Total Other Expense 220,538 224,726 311,152 270,341 225,354 219,989 -------- -------- -------- -------- -------- -------- TAXABLE-EQUIVALENT INCOME BEFORE INCOME TAXES 184,832 162,174 103,801 134,124 181,780 185,513 INCOME TAXES Income taxes 65,738 50,836 36,751 39,639 59,803 61,344 Tax-equivalent adjustment 4,235 4,191 3,906 4,332 3,940 3,641 -------- -------- -------- -------- -------- -------- Adjusted Income Taxes 69,973 55,027 40,657 43,971 63,743 64,985 -------- -------- -------- -------- -------- -------- NET INCOME $114,859 $107,147 $ 63,144 $ 90,153 $118,037 $120,528 ======== ======== ======== ======== ======== ======== PER SHARE DATA Basic earnings per share $.76 $.71 $.41 $.57 $.75 $.76 Diluted earnings per share .75 .69 .41 .57 .74 .75 SIGNIFICANT RATIOS Return on assets 1.35% 1.23% .74% 1.03% 1.33% 1.34% Return on equity 16.03 14.88 8.48 11.66 15.20 15.40
24 MERCANTILE BANCORPORATION INC. AND SUBSIDIARIES CONSOLIDATED QUARTERLY AVERAGE BALANCE SHEET ($ IN MILLIONS)
1998 1ST QTR. 2ND QTR. 3RD QTR. 4TH QTR. ------------------- ------------------- ------------------- ------------------- VOLUME RATE VOLUME RATE VOLUME RATE VOLUME RATE ------ -------- ------ -------- ------ -------- ------ -------- ASSETS Earning Assets Loans and leases, net of unearned income Commercial $ 5,152 8.48% $ 5,608 8.38% $ 5,566 8.19% $ 5,820 7.81% Real estate--commercial 3,585 8.53 3,631 8.47 3,750 8.58 3,874 8.42 Real estate--construction 729 8.86 726 8.78 742 8.69 877 8.37 Real estate--residential mortgage 8,742 7.66 8,505 7.60 8,203 7.60 8,105 7.41 Real estate--home equity credit loans 579 9.64 562 9.65 536 9.63 534 9.00 Consumer 2,550 9.15 2,655 9.08 2,763 9.04 2,803 8.97 Credit card 248 9.30 126 6.76 113 2.51 32 -- ------- ------- ------- ------- Total Loans and Leases 21,585 8.22 21,813 8.20 21,673 8.21 22,045 8.00 Investments in debt and equity securities Trading 125 6.67 169 6.69 115 6.24 132 6.21 Taxable 8,404 6.47 8,728 6.47 8,560 6.49 8,825 6.47 Tax-exempt 434 8.38 417 8.47 411 7.94 437 7.73 ------- ------- ------- ------- Total Investments in Debt and Equity Securities 8,963 6.57 9,314 6.56 9,086 6.56 9,394 6.52 Short-term investments 479 5.62 600 5.51 517 5.55 575 5.30 ------- ------- ------- ------- Total Earning Assets 31,027 7.81 31,727 7.69 31,276 7.63 32,014 7.46 Non-earning assets 3,012 3,214 2,984 3,023 ------- ------- ------- ------- Total Assets $34,039 $34,941 $34,260 $35,037 ======= ======= ======= ======= LIABILITIES Acquired Funds Deposits Non-interest bearing $ 3,746 $ 4,003 $ 3,801 $ 4,047 Interest bearing demand 3,128 1.98 3,136 1.90 3,009 1.82 3,081 1.66 Money market accounts 3,884 4.11 3,979 4.08 3,960 4.06 4,141 3.89 Savings 1,647 2.50 1,762 2.62 1,774 2.72 1,770 2.49 Consumer time certificates under $100,000 9,836 5.60 9,685 5.57 9,420 5.53 9,363 5.46 Other time 196 5.93 196 5.50 174 5.20 173 4.51 ------- ------- ------- ------- Total Core Deposits 22,437 4.41 22,761 4.36 22,138 4.33 22,575 4.18 Time certificates $100,000 and over 1,908 5.62 1,928 5.62 1,837 5.65 1,901 5.43 Foreign 541 5.63 441 5.60 397 5.61 267 5.32 ------- ------- ------- ------- Total Purchased Deposits 2,449 5.64 2,369 5.63 2,234 5.65 2,168 5.42 ------- ------- ------- ------- Total Deposits 24,886 4.55 25,130 4.50 24,372 4.47 24,743 4.31 Short-term borrowings 3,876 5.40 3,570 5.31 2,860 5.32 2,886 4.78 Bank notes 152 6.13 25 5.82 25 5.85 25 5.60 Long-term debt 1,823 6.23 2,911 5.87 3,641 5.69 3,796 5.55 ------- ------- ------- ------- Total Acquired Funds 30,737 4.82 31,636 4.77 30,898 4.75 31,450 4.55 Other liabilities 436 424 383 495 SHAREHOLDERS' EQUITY 2,866 2,881 2,979 3,092 ------- ------- ------- ------- Total Liabilities and Shareholders' Equity $34,039 $34,941 $34,260 $35,037 ======= ======= ======= ======= SIGNIFICANT RATIOS Net interest rate spread 2.99% 2.92% 2.88% 2.91% Net interest rate margin 3.62 3.53 3.51 3.56 Taxable-equivalent basis. Includes company-obligated mandatorily redeemable preferred securities of Mercantile Capital Trust I.
25 MERCANTILE BANCORPORATION INC. AND SUBSIDIARIES CONSOLIDATED QUARTERLY AVERAGE BALANCE SHEET ($ IN MILLIONS)
1999 1998 1999 1ST QTR. 2ND QTR. SIX MONTHS SIX MONTHS ------------------ ------------------ ------------------ ------------------ VOLUME RATE VOLUME RATE VOLUME RATE VOLUME RATE ------ -------- ------ -------- ------ -------- ------ -------- ASSETS Earning Assets Loans and leases, net of unearned income Commercial $ 6,263 7.57% $ 6,622 7.62% $ 5,381 8.43% $ 6,442 7.60% Real estate--commercial 3,767 8.21 3,738 8.11 3,607 8.50 3,752 8.16 Real estate--construction 948 8.11 967 7.93 728 8.82 958 8.02 Real estate--residential mortgage 8,008 7.40 7,844 7.32 8,623 7.63 7,926 7.37 Real estate--home equity credit loans 518 8.72 537 8.41 570 9.65 528 8.56 Consumer 2,785 8.79 2,852 8.62 2,603 9.12 2,819 8.71 Credit card 41 12.77 41 -- 187 8.46 41 -- ------- ------- ------- ------- Total Loans and Leases 22,330 7.76 22,601 7.68 21,699 8.21 22,466 7.72 Investments in debt and equity securities Trading 161 6.45 173 6.49 147 6.68 167 6.47 Taxable 8,926 6.29 8,945 6.30 8,567 6.47 8,936 6.29 Tax-exempt 399 8.12 368 7.81 426 8.43 383 7.97 ------- ------- ------- ------- Total Investments in Debt and Equity Securities 9,486 6.37 9,486 6.36 9,140 6.56 9,486 6.36 Short-term investments 563 4.76 589 4.86 540 5.56 576 4.81 ------- ------- ------- ------- Total Earning Assets 32,379 7.40 32,676 7.27 31,379 7.75 32,528 7.33 Non-earning assets 3,176 3,170 3,113 3,174 ------- ------- ------- ------- Total Assets $35,555 $35,846 $34,492 $35,702 ======= ======= ======= ======= LIABILITIES Acquired Funds Deposits Non-interest bearing $ 4,050 $ 4,149 $ 3,875 $ 4,100 Interest bearing demand 3,153 1.60 3,239 1.66 3,132 1.94 3,196 1.63 Money market accounts 4,244 3.82 4,300 3.77 3,932 4.09 4,272 3.79 Savings 1,754 2.49 1,620 2.28 1,705 2.56 1,687 2.39 Consumer time certificates under $100,000 9,012 5.29 8,676 5.15 9,760 5.58 8,843 5.22 Other time 194 3.91 172 4.07 196 5.71 183 3.99 ------- ------- ------- ------- Total Core Deposits 22,407 4.03 22,156 3.92 22,600 4.39 22,281 3.98 Time certificates $100,000 and over 2,164 5.27 2,075 5.12 1,918 5.62 2,119 5.20 Foreign 477 4.93 615 4.93 491 5.62 546 4.93 ------- ------- ------- ------- Total Purchased Deposits 2,641 5.22 2,690 5.09 2,409 5.64 2,665 5.16 ------- ------- ------- ------- Total Deposits 25,048 4.18 24,846 4.08 25,009 4.53 24,946 4.13 Short-term borrowings 2,701 4.57 3,050 4.61 3,722 5.36 2,876 4.59 Bank notes 10 5.47 -- -- 88 6.08 5 5.47 Long-term debt 4,134 5.33 4,321 5.25 2,370 6.01 4,228 5.29 ------- ------- ------- ------- Total Acquired Funds 31,893 4.41 32,217 4.33 31,189 4.79 32,055 4.37 Other liabilities 556 498 429 528 SHAREHOLDERS' EQUITY 3,106 3,131 2,874 3,119 ------- ------- ------- ------- Total Liabilities and Shareholders' Equity $35,555 $35,846 $34,492 $35,702 ======= ======= ======= ======= SIGNIFICANT RATIOS Net interest rate spread 2.99% 2.94% 2.96% 2.96% Net interest rate margin 3.61 3.55 3.58 3.58 Taxable-equivalent basis. Includes company-obligated mandatorily redeemable preferred securities of Mercantile Capital Trust I.
26 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. These forward-looking statements involve certain risks and uncertainties. For example, by accepting deposits at fixed rates, at different times and for different terms, and lending funds at fixed rates for fixed periods, a bank accepts the risk that the cost of funds may rise and the use of the funds may be at a fixed rate. Similarly, the cost of funds may fall, but a bank may have committed by virtue of the term of a deposit to pay what becomes an above-market rate. Investments may decline in value in a rising interest rate environment. Because the business of banking is highly regulated, decisions of governmental authorities, such as the rate of deposit insurance, can have a major effect on operating results. Unanticipated events associated with Year 2000 compliance, relating to work on developments or modifications to the Corporation's computer systems and software, including work performed by suppliers or vendors or relating to the failure of third parties upon whom the Corporation relies, including customers, suppliers, governmental entities and others, to address their own Year 2000 issues, could affect Mercantile's future financial condition and operating results. Actual charges associated with completed acquisitions may prove to be greater than current estimates. In addition, management's objectives with respect to the Corporation's capital base and equity levels may not reach the targeted objectives within the targeted periods due to numerous factors, including those previously mentioned. All of these uncertainties, as well as others, are present in a banking operation and shareholders are cautioned that management's view of the future on which it prices its products, evaluates collateral, sets loan reserves and estimates costs of operation and regulation may prove to be other than as anticipated. Actual strategies and results in future periods may differ materially from those currently expected. 27 PART II--OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders. A Special Meeting of Shareholders of the Registrant was held on July 28, 1999 to consider and vote upon a proposal to approve an Agreement and Plan of Merger, dated as of April 30, 1999, as amended as of June 17, 1999, by and between the Registrant and Firstar Corporation ("Firstar"), a Wisconsin corporation, and the transactions contemplated thereby, including the merger of the Registrant with and into Firstar. Of 158,156,398 shares outstanding and eligible to be voted at the meeting, 122,436,284 shares, constituting a quorum, were represented in person or by proxy at the meeting. The voting results were as follows: FOR AGAINST ABSTENTIONS BROKER 119,362,897 1,815,638 697,852 559,897 Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits 27 Financial Data Schedule (b) Reports on Form 8-K: The Registrant filed a Current Report on Form 8-K on May 4, 1999. Under Item 5 of the Form 8-K, the Registrant disclosed that on April 30, 1999 it had entered into an Agreement and Plan of Merger with Firstar. Pursuant to the Agreement and Plan of Merger, as described in the Form 8-K, the Registrant is to be merged with and into Firstar, with the shareholders of the Registrant to receive 2.091 shares of the common stock of Firstar for each share of common stock of the Registrant. The Form 8-K also briefly described the terms of two Option Agreements between the Registrant and Firstar, pursuant to which the Registrant received an option to purchase approximately 9.9% of Firstar's outstanding common stock and Firstar received an option to purchase approximately 19.9% of the Registrant's outstanding common stock. The options are exercisable only upon the occurrence of certain triggering events. Finally, the Form 8-K also disclosed that the Registrant had entered into an amendment to its Rights Agreement in connection with and immediately prior to entering into an Agreement and Plan of Merger and Option Agreements. Under Item 7 of the Form 8-K, the following documents were filed as Exhibits thereto: 4.1 Amendment to Rights Agreement, dated as of May 20, 1998, by and between Mercantile Bancorporation Inc. and Harris Trust and Savings Bank as Rights Agent. 99.1 Press Release issued April 30, 1999. 28 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. MERCANTILE BANCORPORATION INC. (Registrant) Date August 13, 1999 /s/ JOHN W. MCCLURE - -------------------------- -------------------------------- John W. McClure Chief Financial Officer 29 EXHIBIT INDEX EXHIBIT NO. DESCRIPTION LOCATION - ----------- ----------- -------- 27 Financial Data Schedule Included herein 30 EX-27.1 2 FINANCIAL DATA SCHEDULE
9 1,000 6-MOS DEC-31-1999 JAN-01-1999 JUN-30-1999 1,234,011 263,788 251,609 120,800 9,199,571 62,503 63,672 22,719,455 309,271 35,520,093 24,333,627 3,546,657 487,049 4,099,854 0 0 1,581 3,051,325 35,520,093 864,734 296,745 13,935 1,175,414 426,926 605,852 569,562 16,958 16,246 445,343 359,712 238,565 0 0 238,565 1.51 1.49 3.58 104,277 60,652 49 0 308,890 27,212 10,635 309,271 309,271 0 0 Reported only at fiscal year-end date.
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