-----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, Accy+3zxRnZuywtkmIZ4roXy/5LUTcZWdyCnmFD1VkfUVrP3OaWYt7Yb6TYjm3dU PyqxqXQhyrGMYDGl0wL9tg== 0001036050-98-000435.txt : 19980324 0001036050-98-000435.hdr.sgml : 19980324 ACCESSION NUMBER: 0001036050-98-000435 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19980318 ITEM INFORMATION: ITEM INFORMATION: FILED AS OF DATE: 19980323 SROS: NYSE SROS: PHLX FILER: COMPANY DATA: COMPANY CONFORMED NAME: CORESTATES FINANCIAL CORP CENTRAL INDEX KEY: 0000069952 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 231899716 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 8-K SEC ACT: SEC FILE NUMBER: 001-11285 FILM NUMBER: 98570888 BUSINESS ADDRESS: STREET 1: CENTRE SQ W STREET 2: 1500 MARKET ST CITY: PHILADELPHIA STATE: PA ZIP: 19101 BUSINESS PHONE: 2159733806 MAIL ADDRESS: STREET 1: 1500 MARKET ST CITY: PHILADELPHIA STATE: PA ZIP: 19101 FORMER COMPANY: FORMER CONFORMED NAME: NATIONAL CENTRAL FINANCIAL CORP DATE OF NAME CHANGE: 19830517 8-K 1 FORM 8-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 8-K CURRENT REPORT PURSUANT TO SECTION 13 OR 15 (d) of THE SECURITIES EXCHANGE ACT OF 1934 DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED): MARCH 23, 1998 CoreStates Financial Corp - -------------------------------------------------------------------------------- (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) Pennsylvania 0-6879 23-1899716 - -------------------------------------------------------------------------------- (STATE OR OTHER (COMMISSION (IRS EMPLOYEE JURISDICTION OF FILE NUMBER) IDENTIFICATION NO.) INCORPORATION) Centre Square West, 1500 Market Street Philadelphia, Pennsylvania 19101 - -------------------------------------------------------------------------------- (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE, INCLUDING AREA CODE: (215) 973-7488 -------------- ________________________________________________________________________________ (FORMER NAME AND FORMER ADDRESS, IF CHANGED SINCE LAST REPORT) A-1 Item 5. OTHER EVENTS As reported in a Current Report on Form 8-K dated November 18, 1997, CoreStates Financial Corp ("CoreStates") entered into an Agreement and Plan of Mergers ("the Merger Agreement") with First Union Corporation ("First Union"), pursuant to which CoreStates will merge with and into First Union ("the Merger"). The Merger is expected to be accounted for as a pooling of interests, and pending receipt of regulatory approvals and other customary conditions of closing, is expected to close in the second quarter of 1998. CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION This Current Report on Form 8-K (including information included or incorporated by reference herein) contains certain forward-looking statements with respect to the financial condition, results of operations, plans, objectives, future performance and business of each of CoreStates and First Union on a stand-alone basis and of First Union on a pro forma combined basis, as well as certain additional information relating to the Merger, including (i) statements relating to the cost savings estimated to result from the Merger, (ii) statements relating to revenues estimated to result from the Merger, (iii) statements relating to the restructuring charges estimated to be incurred in connection with the Merger, and (iv) statements preceded by, followed by or that include the words "believes", "expects", "anticipates", "estimates" or similar expressions. These forward-looking statements involve certain risks and uncertainties. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following possibilities: (a) expected cost savings from the Merger may not be fully realized or realized within the expected time frame; (b) revenues following the Merger may be lower than expected, or deposit attrition, operating costs or customer loss and business disruption following the Merger may be greater than expected; (c) competitive pressures among depository and other financial institutions may increase significantly; (d) costs or difficulties related to the integration of the business of CoreStates and First Union may be greater than expected; (e) changes in the interest rate environment may reduce margins; (f) general economic or business conditions, either nationally or in the states in which CoreStates and First Union are doing business, may be less favorable than expected resulting in, among other things, a deterioration in credit quality or a reduced demand for credit; (g) legislative or regulatory changes may adversely affect the business in which CoreStates and First Union are engaged; and (h) changes may occur in the securities markets. A-2 Item 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS (c) Exhibits
23(a) Consent of Ernst & Young LLP. 23(b) Consent of KPMG Peat Marwick LLP. 23(c) Consent of KPMG Peat Marwick LLP. Page ---- 99(a) Pro forma Financial Information - First Union Corporation, CoreStates Financial Corp. (Unaudited): (i) Pro Forma Financial Information (Unaudited) for five years ended December 31, 1997, 1996, 1995, 1994 and 1993 2 (ii) Pro Forma Combined Condensed Balance Sheet (Unaudited) as of December 31, 1997 3 (iii) Pro Forma Combined Condensed Statements of Income (Unaudited) for five years ended December 31, 1997, 1996, 1995, 1994 and 1993 4 (iv) Notes to Pro Forma Financial Information 5-6 99(b) Consolidated Financial Statements of CoreStates Financial Corp and Subsidiaries: (i) Management's Discussion and Analysis of Financial Condition and Results of Operations 3-42 (ii) Management's Report Regarding the Effectiveness of Internal Control Over Financial Reporting 43 (iii) Report of Independent Auditors 44 (iv) Consolidated Statements of Income for the three years ended December 31, 1997 45 (v) Consolidated Balance Sheets as of December 31, 1997 and 1996 46 (vi) Consolidated Statements of Changes in Shareholders' Equity for the three years ended December 31, 1997 47-48 (vii) Consolidated Statements of Cash Flows for the three years ended December 31, 1997 49-50 (viii) Notes to the December 31, 1997 Consolidated Financial Statements 51-84 SUPPLEMENTAL FINANCIAL DATA (xi) Five Year Average Balance Sheet, Statement of Income and Balance Sheet 85-90 (x) Rate/Volume Analysis Taxable Equivalent Basis 91 (xi) Loan Portfolio, Risk Elements and Allowance for Loan Losses Data 92-95 (xii) Selected Maturity and Interest Sensitivity Data 95-97 99(c) Consolidated Financial Statements of First Union Corporation and Subsidiaries: (i) Management's Statement of Responsibility 2 (ii) Independent Auditors' Report 3 (iii) Consolidated Balance Sheets as of December 31, 1997 and 1996 4 (iv) Consolidated Statements of Income for the three years ended December 31, 1997 5 (v) Consolidated Statements of Changes in Stockholders' Equity for the three years ended December 31, 1997 6-7 (vi) Consolidated Statements of Cash Flow for the three years ended December 31, 1997 8 (vii) Notes to the December 31, 1997 Consolidated Financial Statements 9-45 (viii) Financial Tables 46-53 99(d) Independent Auditors' Report of KPMG Peat Marwick LLP 99(e) Independent Auditors' Report of KPMG Peat Marwick LLP
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. CoreStates Financial Corp (Registrant) By: /s/ Albert W. Mandia ------------------------ Albert W. Mandia Chief Financial Officer Date: March 18, 1998 --------------------- A-3 EX-23.A 2 CONSENT OF ERNST & YOUNG LLP Exhibit 23(a) Consent of Independent Auditors We consent to the inclusion in the Current Report on Form 8-K dated on or about March 20, 1998 and to the incorporation by reference in the following registration statements of our report dated January 20, 1998 with respect to the consolidated financial statements of CoreStates Financial Corp for the year ended December 31, 1997 included in the Current Report on Form 8-K: (a) The Registration Statement (Form S-8, No. 33-5874), in Post-Effective Amendment No. 1 to the Registration Statement (Form S-8, No. 2-91176), the Registration Statement (Form S-8, 33-28808) and in the related prospectuses, each pertaining to the CoreStates Financial Corp Long-Term Incentive Plan, (b) The Registration Statement (Form S-8, No. 33-32934) and prospectus relating to shares of the Corporation's Common Stock issuable under the CoreStates Employee Stock Ownership and Savings Plan, (c) The Registration Statement (Form S-3, No. 33-50324) pertaining to the CoreStates Financial Corp. 1992 Long-Term Incentive Plan, (d) The Registration Statement (Form S-3, No. 33-57034) and prospectus and prospectus supplement pertaining to $1,000,000,000 in aggregate amount of Debt Securities issuable by CoreStates Capital Corp and the related guarantees of the Corporation, and Preferred Stock, Depository Shares, Common Stock and Capital Securities, issuable by the Corporation, (e) The Registration Statement (Form S-3, No. 33-54049) and prospectus and prospectus supplement pertaining to $1,000,000,000 in aggregate amount of Debt Securities and warrants issuable by CoreStates Capital Corp and the related guarantees of the Corporation and Preferred Stock, Depository Shares and Common Stock issuable by the Corporation, (f) The Registration Statement (Form S-4, as amended by Form S-8, No. 33-48422) and prospectus relating to shares of the Corporation's Common Stock issuable upon the exercise of stock options, the obligations in respect to which were assumed by the Corporation in connection with the acquisition of First Peoples Corporation, 1 (g) The Registration Statement (Form S-4, as amended by Form S-8, No. 33-51429) and prospectus relating to shares of the Corporation's Common Stock issuable upon the exercise of stock options, the obligations in respect to which were assumed by the Corporation in connection with the acquisition of Constellation Bancorp, (h) The Registration Statement (Form S-4, as amended by Form S-8, No. 33-53539) and prospectus relating to shares of the Corporation's Common Stock issuable upon the exercise of stock options, the obligations in respect to which were assumed by the Corporation in connection with the acquisition of Independence Bancorp, Inc., (i) The Registration Statement (Form S-4, as amended by Form S-8, No. 33-55505) and prospectus relating to shares of the Corporation's Common Stock issuable upon the exercise of stock options, the obligations in respect to which were assumed by the Corporation in connection with the acquisition of Germantown Savings Bank, (j) The Registration Statement (Form S-4, as amended by Form S-8, No. 33-300067) and prospectus relating to shares of the Corporation's Common Stock issuable upon the exercise of stock options, the obligations in respect to which were assumed by the Corporation in connection with the acquisition of Meridian Bancorp, Inc., (k) The Registration Statements (Form S-3, Nos. 33-54049 and 333-2297) and prospectus and prospectus supplement pertaining to $1,750,000,000 in aggregate amount of Debt Securities issuable by CoreStates Capital Corp and the related guarantees of the Corporation and Preferred Stock, Depository Shares and Common Stock issuable by the Corporation, (l) The Registration Statement (Form S-3, No. 033-40717) and prospectus relating to shares of the Corporation's Common Stock issuable under the Dividend Reinvestment Plan, (m) The Registration Statement (Form S-8, No. 333-16569) and prospectus relating to shares of the Corporation's Common Stock issuable under the QuestPoint Savings Plan, (n) The Registration Statement (Form S-8, No. 333-41083) and prospectus relating to shares of the Corporation's Amended and Restated Long-Term Incentive Plan (1997), (o) The Registration Statement (Form S-8, No. 33-27725) and prospectus relating to shares of the Corporation's Amended and Restated Stock Compensation Plan for Non-Employee Directors (1997). /s/ Ernst & Young LLP Philadelphia, Pennsylvania March 17, 1998 2 EX-23.B 3 CONSENT OF KPMG PEAT MARWICK LLP Exhibit 23(b) Consent of Certified Public Accountants Board of Directors CoreStates Financial Corp We consent to the incorporation by reference of those reports described below under the caption Reports, in the Current Report on Form 8-K in the following registration statements of CoreStates Financial Corp: (a) The Registration Statement (Form S-8, No. 33-5874), in Post-Effective Amendment No. 1 to the Registration Statement (Form S-8, No. 2-91176), the Registration Statement (Form S-8, No. 33-28808) and in the related prospectuses, each pertaining to the CoreStates Financial Corp Long-Term Incentive Plan, (b) The Registration Statement (Form S-8, No. 33-32934) and prospectus relating to shares of the Corporation's Common Stock issuable under the CoreStates Employee Stock Ownership and Savings Plan, (c) The Registration Statement (Form S-3, No. 33-50324) pertaining to the CoreStates Financial Corp 1992 Long-Term Incentive Plan, (d) The Registration Statement (Form S-3, No. 33-57034) and prospectus and prospectus supplement pertaining to $1,000,000,000 in aggregate amount of Debt Securities issuable by CoreStates Capital Corp. and the related guarantees of the Corporation, and Preferred Stock, Depository Shares, Common Stock, and Capital Securities, issuable by the Corporation, (e) The Registration Statement (Form S-3, No. 33-54049) and prospectus and prospectus supplement pertaining to $1,000,000,000 in aggregate amount of Debt Securities and warrants issuable by CoreStates Capital Corp. and the related guarantees of the Corporation and Preferred Stock, Depository Shares and Common Stock issuable by the Corporation, (f) The Registration Statement (Form S-4, as amended by Form S-8, No. 33-48422) and prospectus relating to shares of the Corporation's Common Stock issuable upon the exercise of stock options, the obligations in respect to which were assumed by the Corporation in connection with the acquisition of First Peoples Corporation, (g) The Registration Statement (Form S-4, as amended by Form S-8, No. 33-51429) and prospectus relating to shares of the Corporation's Common Stock issuable upon the exercise of stock options, the obligations in respect to which were assumed by the Corporation in connection with the acquisition of Constellation Bancorp, (h) The Registration Statement (Form S-4, as amended by Form S-8, No. 33- 53539) and prospectus relating to shares of the Corporation's Common Stock issuable upon the exercise of stock options, the obligations in respect to which were assumed by the Corporation in connection with the acquisition of Independence Bancorp, Inc., 1 (i) The Registration Statement (Form S-4, as amended by Form S-8, No. 33-55505) and prospectus relating to shares of the Corporation's Common Stock issuable upon the exercise of stock options, the obligations in respect to which were assumed by the Corporation in connection with the acquisition of Germantown Savings Bank, (j) The Registration Statement (Form S-4, as amended by Form S-8, No. 33- 300067) and prospectus relating to shares of the Corporation's Common Stock issuable upon the exercise of stock options, the obligations in respect to which were assumed by the Corporation in connection with the acquisition of Meridian Bancorp, Inc., (k) The Registration Statements (Form S-3, Nos. 33-54049 and 333-2297) and prospectus and prospectus supplement pertaining to $1,750,000,000 in aggregate amount of Debt Securities issuable by CoreStates Capital Corp. and the related guarantees of the Corporation and Preferred Stock, Depository Shares and Common Stock issuable by the Corporation, (l) The Registration Statement (Form S-3, No. 033-40717) and prospectus relating to shares of the Corporation's Common Stock issuable under the Dividend Reinvestment Plan, (m) The Registration Statement (Form S-8, No. 333-16569) and prospectus relating to shares of the Corporation's Common Stock issuable under the QuestPoint Savings Plan, (n) The Registration Statement (Form S-8, No. 333-41083) and prospectus relating to shares of the Corporation's Amended and Restated Long-Term Incentive Plan (1997), (o) The Registration Statement (Form S-8, No. 33-27725) and prospectus relating to shares of the Corporation's Amended and Restated Stock Compensation Plan for Non-Employee Directors (1997). Reports ------- Our report dated January 17, 1996, except as to Note 2, which is as of February 23, 1996, with respect to the consolidated balance sheet of Meridian Bancorp, Inc. and subsidiaries as of December 31, 1995, and the related consolidated statements of income, changes in shareholders' equity and cash flows for the year ended December 31, 1995. Our report dated January 16, 1996, except as to Note 20, which is as of February 23, 1996, with respect to the consolidated balance sheet of United Counties Bancorporation and subsidiaries as of December 31, 1995, and the related consolidated statements of income, changes in stockholders' equity and cash flows, for the year ended December 31, 1995. KPMG Peat Marwick LLP Philadelphia, Pennsylvania March 17, 1998 2 EX-23.C 4 CONSENT OF KPMG PEAT MARWICK LLP Exhibit 23(c) The Board of Directors First Union Corporation: We consent to the incorporation by reference in the registration statements listed below of CoreStates Financial Corp of our report dated January 21, 1998, relating to the consolidated balance sheets of First Union Corporation and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1997, which report appears in the 1997 Annual Report to Stockholders which is incorporated by reference in First Union Corporation's 1997 Form 10-K, which in turn is incorporated by reference in the Form 8-K of CoreStates Financial Corp dated March 23, 1998. (a) The Registration Statement (Form S-8, No. 33-5874), in Post-Effective Amendment No. 1 to the Registration Statement (Form S-8, No. 2-91176), the Registration Statement (Form S-8, No. 33-28808) and in the related prospectuses, each pertaining to the CoreStates Financial Corp Long-Term Incentive Plan, (b) The Registration Statement (Form S-8, No. 33-32934) and prospectus relating to shares of the Corporation's Common Stock issuable under the CoreStates Employee Stock Ownership and Savings Plan, (c) The Registration Statement (Form S-3, No. 33-50324) pertaining to the CoreStates Financial Corp 1992 Long-Term Incentive Plan, (d) The Registration Statement (Form S-3, No. 33-57034) and prospectus and prospectus supplement pertaining to $1,000,000,000 in aggregate amount of Debt Securities issuable by CoreStates Capital Corp. and the related guarantees of the Corporation, and Preferred Stock, Depository Shares, Common Stock, and Capital Securities, issuable by the Corporation, (e) The Registration Statement (Form S-3, No. 33-54049) and prospectus and prospectus supplement pertaining to $1,000,000,000 in aggregate amount of Debt Securities and warrants issuable by CoreStates Capital Corp. and the related guarantees of the Corporation and Preferred Stock, Depository Shares and Common Stock issuable by the Corporation, (f) The Registration Statement (Form S-4, as amended by Form S-8, No. 33-48422) and prospectus relating to shares of the Corporation's Common Stock issuable upon the exercise of stock options, the obligations in respect to which were assumed by the Corporation in connection with the acquisition of First Peoples Corporation, (g) The Registration Statement (Form S-4, as amended by Form S-8, No. 33-51429) and prospectus relating to shares of the Corporation's Common Stock issuable upon the exercise of stock options, the obligations in respect to which were assumed by the Corporation in connection with the acquisition of Constellation Bancorp, 1 (h) The Registration Statement (Form S-4, as amended by Form S-8, No. 33-53539) and prospectus relating to shares of the Corporation's Common Stock issuable upon the exercise of stock options, the obligations in respect to which were assumed by the Corporation in connection with the acquisition of Independence Bancorp, Inc., (i) The Registration Statement (Form S-4, as amended by Form S-8, No. 33-55505) and prospectus relating to shares of the Corporation's Common Stock issuable upon the exercise of stock options, the obligations in respect to which were assumed by the Corporation in connection with the acquisition of Germantown Savings Bank, (j) The Registration Statement (Form S-4, as amended by Form S-8, No. 33- 300067) and prospectus relating to shares of the Corporation's Common Stock issuable upon the exercise of stock options, the obligations in respect to which were assumed by the Corporation in connection with the acquisition of Meridian Bancorp, Inc., (k) The Registration Statements (Form S-3, Nos. 33-54049 and 333-2297) and prospectus and prospectus supplement pertaining to $1,750,000,000 in aggregate amount of Debt Securities issuable by CoreStates Capital Corp. and the related guarantees of the Corporation and Preferred Stock, Depository Shares and Common Stock issuable by the Corporation, (l) The Registration Statement (Form S-3, No. 033-40717) and prospectus relating to shares of the Corporation's Common Stock issuable under the Dividend Reinvestment Plan, (m) The Registration Statement (Form S-8, No. 333-16569) and prospectus relating to shares of the Corporation's Common Stock issuable under the QuestPoint Savings Plan, (n) The Registration Statement (Form S-8, No. 333-41083) and prospectus relating to shares of the Corporation's Amended and Restated Long-Term Incentive Plan (1997), (o) The Registration Statement (Form S-8, No. 33-27725) and prospectus relating to shares of the Corporation's Amended and Restated Stock Compensation Plan for Non-Employee Directors (1997). KPMG Peat Marwick LLP Charlotte, North Carolina March 17, 1998 2 EX-99.A 5 FIRST UNION, CORESTATES PRO FORMA FINANCIAL INFO Exhibit 99(a) Pro Forma Financial Information -- First Union Corporation, CoreStates Financial Corp (Unaudited) 1 PRO FORMA FINANCIAL INFORMATION FIRST UNION CORPORATION CORESTATES FINANCIAL CORP PRO FORMA FINANCIAL INFORMATION (Unaudited) - -------------------------------------------------------------------------------- The following unaudited pro forma combined selected statistical data, balance sheet and condensed statements of income present combined financial information for First Union Corporation ("First Union") and CoreStates Financial Corp ("CoreStates") assuming First Union and CoreStates had been combined for each period presented on a pooling of interests accounting basis (the "Merger").
December 31, -------------------------------------------------------------- (In millions) 1997 1996 1995 1994 1993 - ----------------------------------------------------------------------------------------------------------------------- COMBINED BALANCE SHEET DATA Securities available for sale $ 23,524 19,199 23,100 12,498 14,402 Investment securities 3,526 4,190 6,200 14,215 15,703 Loans, net of unearned income 131,687 134,647 127,905 107,965 97,375 Earning assets 176,303 173,712 167,036 141,543 132,061 Total assets 205,735 197,341 188,855 159,577 148,759 Noninterest-bearing deposits 31,005 29,713 27,706 24,542 24,976 Interest-bearing deposits 106,072 106,716 106,406 98,097 90,773 Long-term debt 11,746 10,809 9,586 6,405 5,686 Guaranteed preferred beneficial interests 1,741 795 - - - Common stockholders' equity 15,269 14,628 13,600 11,775 11,137 Total stockholders' equity $ 15,269 14,628 13,783 12,005 11,651 - ----------------------------------------------------------------------------------------------------------------------- COMBINED AVERAGE BALANCE SHEET DATA Securities available for sale $ 20,801 21,869 14,905 14,708 8,327 Investment securities 3,607 4,867 12,304 13,915 20,900 Loans, net of unearned income 134,517 129,120 121,245 100,836 92,159 Earning assets 174,502 170,069 156,419 135,328 127,423 Total assets 196,093 189,285 173,981 150,244 143,046 Noninterest-bearing deposits 27,489 24,514 23,240 21,395 20,582 Interest-bearing deposits 105,358 104,925 102,922 90,393 87,715 Long-term debt 10,915 10,386 8,334 6,049 5,492 Guaranteed preferred beneficial interests 1,681 57 - - - Common stockholders' equity 14,367 13,801 12,978 11,452 10,228 Total stockholders' equity $ 14,367 13,909 13,189 11,954 10,748 - ----------------------------------------------------------------------------------------------------------------------- COMBINED PERCENTAGE DATA Allowance for loan losses to Loans, net 1.40% 1.64 1.80 2.09 2.32 Nonperforming assets 186 211 201 170 111 Net charge-offs to average loans, net 0.65 0.64 0.45 0.53 0.72 Net charge-offs to average loans, net, excluding Bankcard 0.31 0.35 0.27 0.46 0.69 Nonperforming assets to loans, net and foreclosed properties 0.75% 0.78 0.90 1.23 2.08 - ----------------------------------------------------------------------------------------------------------------------- See accompanying Notes to Pro Forma Financial Information.
2 PRO FORMA FINANCIAL INFORMATION FIRST UNION CORPORATION CORESTATES FINANCIAL CORP PRO FORMA COMBINED CONDENSED BALANCE SHEET (Unaudited)
- ------------------------------------------------------------------------------------------------------------------------------ December 31, 1997 ---------------------------------------------------------------------- Pro Forma Pro Forma (In millions) First Union CoreStates Adjustments Combined - ------------------------------------------------------------------------------------------------------------------------------ ASSETS Cash and due from banks $ 6,445 3,830 - 10,275 Interest-bearing bank balances 710 3,122 - 3,832 Federal funds sold and securities purchased under resale agreements 7,740 41 - 7,781 - ------------------------------------------------------------------------------------------------------------------------------ Total cash and cash equivalents 14,895 6,993 - 21,888 - ------------------------------------------------------------------------------------------------------------------------------ Trading account assets 5,457 496 - 5,953 Securities available for sale 21,415 2,109 - 23,524 Investment securities 2,175 1,351 - 3,526 Loans, net of unearned income 96,873 34,814 - 131,687 Allowance for loan losses (1,212) (634) - (1,846) - ------------------------------------------------------------------------------------------------------------------------------ Loans, net 95,661 34,180 - 129,841 - ------------------------------------------------------------------------------------------------------------------------------ Premises and equipment 4,233 630 - 4,863 Due from customers on acceptances 854 642 - 1,496 Other intangible assets 2,674 280 - 2,954 Other assets 9,910 1,780 - 11,690 - ------------------------------------------------------------------------------------------------------------------------------ Total assets $ 157,274 48,461 - 205,735 - ------------------------------------------------------------------------------------------------------------------------------ LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Noninterest-bearing deposits 21,753 9,252 - 31,005 Interest-bearing deposits 81,136 24,936 - 106,072 - ------------------------------------------------------------------------------------------------------------------------------ Total deposits 102,889 34,188 - 137,077 Short-term borrowings 27,357 4,323 - 31,680 Bank acceptances outstanding 855 642 - 1,497 Other liabilities 5,108 1,617 - 6,725 Long-term debt 8,042 3,704 - 11,746 - ------------------------------------------------------------------------------------------------------------------------------ Total liabilities 144,251 44,474 - 188,725 - ------------------------------------------------------------------------------------------------------------------------------ Guaranteed preferred beneficial interests in junior subordinated deferrable interest debentures 991 750 - 1,741 - ------------------------------------------------------------------------------------------------------------------------------ STOCKHOLDERS' EQUITY Preferred stock - - - - Common stock 2,121 224 858 3,203 Paid-in capital 1,384 1,262 (1,065) 1,581 Retained earnings 8,273 3,053 (1,127) 10,199 Unrealized gain on debt and equity securities, net 254 32 - 286 Treasury stock - (1,282) 1,282 - Unallocated shares held by ESOP - (52) 52 - - ------------------------------------------------------------------------------------------------------------------------------ Total stockholders' equity 12,032 3,237 - 15,269 - ------------------------------------------------------------------------------------------------------------------------------ Total liabilities and stockholders' equity $ 157,274 48,461 - 205,735 - ------------------------------------------------------------------------------------------------------------------------------ See accompanying Notes to Pro Forma Financial Information.
3 PRO FORMA FINANCIAL INFORMATION FIRST UNION CORPORATION CORESTATES FINANCIAL CORP PRO FORMA COMBINED CONDENSED STATEMENTS OF INCOME (Unaudited)
- --------------------------------------------------------------------------------------------------------------------------------- Years Ended December 31, ----------------------------------------------------------------------- (In millions, except per share data) 1997 1996 1995 1994 1993 - --------------------------------------------------------------------------------------------------------------------------------- Interest income $ 14,362 13,758 13,028 10,245 9,507 Interest expense 6,452 6,151 5,732 3,739 3,376 - --------------------------------------------------------------------------------------------------------------------------------- Net interest income 7,910 7,607 7,296 6,506 6,131 Provision for loan losses 1,103 678 403 458 559 - --------------------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 6,807 6,929 6,893 6,048 5,572 Securities available for sale transactions 52 96 76 24 76 Investment security transactions 3 4 6 4 7 Noninterest income 4,267 3,435 2,976 2,336 2,332 Merger-related and restructuring charges 284 421 233 107 - SAIF special assessment - 149 - - - Noninterest expense 7,052 6,360 6,309 5,558 5,430 - --------------------------------------------------------------------------------------------------------------------------------- Income before income taxes 3,793 3,534 3,409 2,747 2,557 Income taxes 1,084 1,261 1,213 938 818 - --------------------------------------------------------------------------------------------------------------------------------- Net income 2,709 2,273 2,196 1,809 1,739 Dividends on preferred stock - 9 26 46 46 - --------------------------------------------------------------------------------------------------------------------------------- Net income applicable to common stockholders before redemption premium 2,709 2,264 2,170 1,763 1,693 Redemption premium on preferred stock - - - 41 - - --------------------------------------------------------------------------------------------------------------------------------- Net income applicable to common stockholders after redemption premium $ 2,709 2,264 2,170 1,722 1,693 - --------------------------------------------------------------------------------------------------------------------------------- PER COMMON SHARE DATA Basic earnings $ 2.84 2.33 2.21 1.86 1.85 Diluted earnings $ 2.80 2.30 2.17 1.83 1.81 AVERAGE COMMON SHARES (In thousands) Basic 955,241 973,712 979,852 927,941 913,621 Diluted 966,792 982,755 1,001,145 946,969 940,167 - --------------------------------------------------------------------------------------------------------------------------------- FIRST UNION HISTORICAL PER COMMON SHARE DATA Basic earnings $ 3.03 2.61 2.44 2.30 2.15 Diluted earnings $ 2.99 2.58 2.38 2.25 2.09 AVERAGE COMMON SHARES (In thousands) Basic 625,649 619,237 619,777 561,442 543,321 Diluted 633,772 625,224 637,186 577,709 565,239 - --------------------------------------------------------------------------------------------------------------------------------- See accompanying Notes to Pro Forma Financial Information.
4 PRO FORMA FINANCIAL INFORMATION FIRST UNION CORPORATION CORESTATES FINANCIAL CORP NOTES TO PRO FORMA FINANCIAL INFORMATION (Unaudited) - -------------------------------------------------------------------------------- (1) The unaudited pro forma information presented herein is not necessarily indicative of the results of operations or the combined financial position that would have resulted had the Merger been consummated at the beginning of the applicable periods indicated, nor is it necessarily indicative of the results of operations in future periods or the future financial position of the combined entities. Pro forma financial information with respect to the Merger assumes the Merger was consummated as of the beginning of each period presented. Average common and total stockholders' equity excludes net unrealized gains or losses on debt and equity securities. (2) It is assumed that the Merger will be accounted for on a pooling of interests accounting basis, and accordingly, the related pro forma adjustments herein reflect, where applicable, an exchange ratio of 1.62 shares of First Union's common stock for each of the 198,216,000 shares of CoreStates common stock which were outstanding at December 31, 1997 (excluding 2.1 million unallocated CoreStates ESOP shares). The 1.62 exchange ratio is subject to possible adjustment under certain circumstances. As a result, information was adjusted for the Merger by the (i) addition of 321,110,000 shares of First Union's common stock amounting to $1.1 billion (excluding the shares of First Union's common stock to be issued in exchange for an estimated 3.5 million shares of CoreStates common stock that CoreStates expects to issue in order to qualify the Merger as a pooling of interests and 2.1 million unallocated CoreStates ESOP shares); (ii) elimination of 198,216,000 shares of outstanding CoreStates common stock amounting to $224 million; (iii) elimination of the cost of CoreStates treasury stock of $1.3 billion; (iv) reclassification of the cost of unallocated shares held by the CoreStates ESOP of $52 million; and (v) recordation of the remaining amount of $1.1 billion as a reduction of paid-in capital at December 31, 1997. As of December 31, 1997, First Union and CoreStates had 51,580,000 and 16,490,000 shares of common stock reserved for issuance primarily for stock option plans, respectively, (excluding, as to First Union, shares reserved for issuance in connection with the Merger, or upon exercise of the rights attached to First Union's common stock), which are not included in the unaudited pro forma financial information presented herein. For the year ended December 31, 1997, CoreStates had net income applicable to common stockholders of $813 million. In 1993, CoreStates changed its method of accounting for postemployment benefits, and in 1993 CoreStates reported additional expense as a cumulative effect of a change in accounting principle, net of tax of $16 million in 1993. Such amount has been reclassified to noninterest expense and income taxes in 1993, in the pro forma financial information presented herein. (3) On November 28, 1997, First Union acquired Signet Banking Corporation ("Signet"), which was accounted for as a pooling of interests. The financial information presented herein includes Signet as of and for the three years ended December 31, 1997. (4) The pro forma financial information presented herein does not include financial information related to First Union's (i) January 15, 1998, purchase accounting acquisition of Covenant Bancorp, Inc. ("Covenant"), which had assets of $415 million, net loans of $254 million, deposits of $294 million and stockholders' equity of $31 million at December 31, 1997; and (ii) January 31, 1998, pooling of interests acquisition of Wheat First Butcher Singer, Inc. ("Wheat First"), which had assets of $1.1 billion and stockholders' equity of $171 million at December 31, 1997. 5 PRO FORMA FINANCIAL INFORMATION - -------------------------------------------------------------------------------- First Union issued 1.6 million shares of its common stock to stockholders of Covenant, substantially all of which were repurchased in the open market at a cost of $79 million, and 10.3 million shares of its common stock to stockholders of Wheat First. On March 4, 1998, First Union entered into an Agreement and Plan of Merger with The Money Store Inc. ("TMSI") under which First Union will issue approximatelty 41 million shares. First Union expects to repurchase approximately 41 million of its outstanding shares in the open market prior to the close of the TMSI transaction. Financial information related to Wheat First and TMSI is not considered material to the historical results of First Union, and accordingly, such financial information will not be combined with the historical results of First Union. (5) Earnings per share data has been computed based on the combined historical net income applicable to common stockholders of First Union and CoreStates using the combined (i) historical weighted average shares outstanding with respect to basic earnings per share, and (ii) sum of the historical weighted average shares outstanding and common stock equivalents related to employee stock options including restricted stock awards with respect to diluted earnings per share, adjusted to equivalent shares of First Union's common stock with respect to CoreStates, as of the earliest applicable period presented, as appropriate. (6) Certain insignificant reclassifications have been included herein to conform to financial statement presentations. Transactions conducted in the ordinary course of business between First Union and CoreStates are immaterial, and accordingly, they have not been eliminated. (7) The unaudited pro forma financial information does not include any material merger-related expenses or any material expenses related to the Merger. First Union currently estimates after-tax merger-related and restructuring charges of approximately $795 million related to the Merger, or $0.81 per share of First Union's common stock, expected to be recorded in the second quarter of 1998. In addition, First Union expects to incur an estimated $75 million in pre-tax merger-related and restructuring charges in the 12-month period following the Merger. (8) First Union expects to realize significant revenue enhancements and cost savings from the Merger. The pro forma financial information, which does not reflect any revenue enhancements, direct costs or potential savings from the consolidation of operations of First Union and CoreStates, is not indicative of the results of future operations. No assurance can be given with respect to the ultimate level of such revenue enhancements or cost savings. As indicated by the foregoing unaudited pro forma financial information and based solely on the foregoing assumptions, consummation of the Merger would have diluted each of First Union's historical basic and diluted earnings per common share amounts for the year ended December 31, 1997, by 6 percent. 6 EX-99.B 6 CORESTATES FINANCIAL CORP FINANCIAL STATEMENTS Exhibit 99(b) Consolidated Financial Statements of CORESTATES FINANCIAL CORP AND SUBSIDIARIES December 31, 1997 1 CoreStates Financial Corp and Subsidiaries
CONTENTS OF FINANCIAL SECTION PAGE ----- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS........................................................ 3-42 FINANCIAL STATEMENTS Management's Report Regarding the Effectiveness of Internal Control Over Financial Reporting........ 43 Report of Independent Auditors....................................................................... 44 Consolidated Statements of Income for the years ended December 31, 1997, 1996 and 1995............... 45 Consolidated Balance Sheets as of December 31, 1997 and 1996......................................... 46 Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1997, 1996 and 1995................................................................ 47-48 Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995........... 49-50 Notes to the Consolidated Financial Statements....................................................... 51-84 SUPPLEMENTAL FINANCIAL DATA Five Year Average Balance Sheet, Statement of Income and Balance Sheet............................... 85-90 Rate/Volume Analysis Taxable Equivalent Basis........................................................ 91 Loan Portfolio, Risk Elements and Allowance for Loan Losses Data..................................... 92-95 Selected Maturity and Interest Sensitivity Data...................................................... 95-97
2 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations Cautionary Statement Certain statements contained herein are not based on historical fact and are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements which are based on various assumptions (some of which are beyond CoreStates' control), may be identified by reference to a future period, or periods, or by the use of forward-looking terminology such as "may", "will", "believe", "expect", "estimate", "anticipate", "continue", or similar terms or variations on those terms, or the negative of those terms. Actual results could differ materially from those set forth in forward-looking statements. Factors that could cause actual results to differ materially from those in the forward-looking statements include, but are not limited to: the global, national and regional economies where CoreStates conducts operations; economic growth; governmental monetary policy including interest rate policies of the Federal Reserve Board; sources and costs of funds; levels of interest rates; inflation rates; market capital spending; technological change; the state of the securities and capital markets; acquisitions; consumer spending and savings; expense levels; and tax, securities, and banking laws and prospective legislation. OVERVIEW (Unless otherwise noted, all "per share" amounts are on a diluted basis.) CoreStates Financial Corp ("CoreStates") reported record financial performance in 1997 driven by broad based increases in fee revenues, loan growth, and the favorable impact of the common stock repurchase program on earnings per share. CoreStates recorded net income of $813.3 million, or $4.00 per average common share, in 1997 compared to $649.2 million, or $2.97 per average common share, in 1996. Diluted net income per share was $3.96 in 1997 compared to $2.94 in 1996. Key performance measures such as returns on average equity and assets and the net interest margin were among the highest in the banking industry. Pending Merger with First Union Corporation - On November 18, 1997, ------------------------------------------- CoreStates entered into an Agreement and Plan of Mergers (the "Merger Agreement"), which provides for the merger (the "Merger") of CoreStates into First Union Corporation ("First Union"). Pursuant to the Merger Agreement, each outstanding share of CoreStates common stock would be converted into 1.62 shares of First Union's common stock, subject to possible adjustment under certain circumstances. Based on the December 31, 1997 closing price of First Union's common stock, the transaction would have a value of approximately $16.5 billion. The Merger is expected to be accounted for as a pooling of interests, and pending receipt of regulatory approval and other customary conditions of closing, is expected to close in the second quarter of 1998. The Merger will create a $205 billion financial services company having a leading banking presence on the eastern seaboard. The combined company will be the sixth largest banking company in the United States. First Union reported net income of $1.9 billion, or $2.99 per share, for 1997 compared to net income of $1.6 billion, or $2.58 per share, in 1996. Earnings - Basic "operating earnings" per share increased 9.5% for 1997. -------- Operating earnings, which has been defined for purposes of this discussion as net income excluding a special tax benefit, a special provision for losses on loans, and other significant charges in 1997 (all as discussed on pages 5 and 6) were $795.3 million, or $3.91 per average common share. Operating earnings for 1996 were $780.8 million, or $3.57 per average common share. Diluted operating earnings per share were $3.87 in 1997 compared to $3.54 in 1996. The increase in operating earnings per share primarily resulted from strong growth in non- interest income before certain net investment gains in 1996 and from the decline in shares outstanding due to the common stock repurchase program. The common stock repurchase program added $0.14 to 1997 earnings per share after considering the unfavorable impact of $58.8 million of 1997 funding costs incurred associated with the repurchase program. Returns on average equity and assets based on operating earnings were 23.64% and 1.74%, respectively, in 1997, compared to 20.07% and 1.78%, respectively, in 1996. The 1997 Keefe, Bruyette & Woods (KBW) Peer Group 1 composite for returns on average equity and assets were 17.55% and 1.26%, respectively. The KBW Peer Group 1 composite includes CoreStates and is comprised of 32 U.S. banking companies having assets in excess of $25 billion. 3 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued OVERVIEW - continued Operating earnings, key performance ratios and per share information are summarized in the following table (in millions, except per share):
Percentage increase (decrease) ----------------------- 1997 1996 1995 `97/'96 `96/'95 -------- -------- -------- ------- ------- Net interest income (taxable equivalent basis). $2,139.5 $2,167.7 $2,200.2 (1.3)% (1.5)% ======== ======== ======== Net income..................................... $ 813.3 $ 649.2 $ 655.2 25.3 (0.9) Exclude after-tax effects of: Special tax benefit........................ (109.0) - - Special provision for losses on loans...... 44.9 - - Net restructuring and merger-related charges 9.6 150.8 92.2 Certain net investment gains............... - (28.1) (8.6) Other...................................... 36.5 8.9 - Gain on affiliate joint venture............ - - (11.8) -------- ------- ------- Operating earnings............................. $ 795.3 $ 780.8 $ 727.0 1.9 7.4 ======== ======= ======= Operating earnings per share: Basic...................................... $ 3.91 $ 3.57 $ 3.28 9.5 8.8 ======== ======= ======= Diluted.................................... $ 3.87 $ 3.54 $ 3.24 9.3 9.3 ======== ======= ======= Return on average assets (a)................... 1.74% 1.78% 1.63% Return on average equity (a)................... 23.64 20.07 19.43 Net interest margin............................ 5.22 5.53 5.47 Expense/revenue ratio (a)...................... 52.98 53.71 57.07 Average common shares outstanding: Basic...................................... 203.452 218.812 222.268 Diluted.................................... 205.568 220.698 224.666
- -------------- (a) Calculated based on "Operating earnings." The $14.5 million improvement in operating earnings for 1997 was primarily due to a $70.0 million, or 8.2%, increase in non-interest income before certain 1996 net investment gains. The increase in non-interest income was mainly due to growth in revenues from fee-based services particularly trust income, third party processing fees, international service fees, income from trading activities, and investment banking fees. This improvement was partially offset by a $25.6 million, or 1.2%, decline in net interest income and a $34.2 million, or 21.6%, increase in the provision for losses on loans, excluding the special provision described on page 5. The decline in net interest income was solely due to $58.8 million of funding costs associated with the common stock repurchase program. The increase in the provision for losses on loans was due to higher charge-offs in the credit card, installment loan and commercial loan portfolios. For detailed discussions of non-interest income, net interest income and the provision for losses on loans, see pages 38, 37 and 20, respectively. 1997 Business Line Highlights - Three business line segments contributed ----------------------------- strong growth to net income in 1997. The Global and Specialized Banking segment contributed net income growth of $28.1 million, or 11.7%, primarily due to increases in net interest income and non-interest income. The growth in net interest income was principally due to an increase in loans; the growth in non-interest income was principally due to increases in international service fees, service charges on deposits and income from trading activities. Regional Banking's net income increased $29.7 million, or 8.7%, as a result of a decline in non-financial expenses due to branch consolidations and merger efficiencies and an increase in non-interest income primarily due to increases in delivery channel income. Trust and Asset Management contributed net income growth of $21.8 million, or 52.4%, reflecting increases in net interest income due to loan growth and trust fees primarily due to increased asset values, and reduced non-financial expenses due to merger-related efficiencies. For a more detailed analysis of the performance of CoreStates' business lines, refer to the "Business Line Results" section beginning on page 8. 4 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued OVERVIEW - continued Common Stock Repurchase Program - On October 15, 1996, the Board of ------------------------------- Directors authorized the management of CoreStates to repurchase up to 22 million shares of common stock, or approximately 10% of outstanding shares, and on July 15, 1997, the Board of Directors authorized an extension of the common stock repurchase program permitting management to repurchase up to an additional 6 million shares, or approximately 3% of outstanding shares. Acting under these authorizations, CoreStates repurchased 15.3 million and 8.8 million shares of common stock in 1997 and 1996, respectively. Management was also authorized to repurchase additional shares to fulfill requirements of employee benefit and dividend reinvestment plans. As of March 15, 1998, it is anticipated that CoreStates will issue approximately 1.0 million shares of common stock prior to the consummation of the Merger in order for the Merger to qualify for pooling of interests accounting treatment. Special Tax Benefit - CoreStates liquidated an affiliate in the fourth ------------------- quarter of 1997 that resulted in a tax benefit of $109.0 million, or $0.54 per share. The transaction will have no significant effect on ongoing operations or earnings. Special Provision for Losses on Loans - In the fourth quarter of 1997, ------------------------------------- CoreStates recorded a $70.0 million ($44.9 million after-tax, or $0.22 per share) special provision for losses on loans primarily related to management's decision to sell approximately $450 million of credit card outstandings. As a result, CoreStates wrote down the credit card balance by $102 million, and reclassified the net $348 million of loans were reclassified to loans held for sale. Restructuring and Merger-Related Charges - In 1997, CoreStates recorded ---------------------------------------- pre-tax restructuring and merger-related charges of $15.0 million, $9.6 million or $0.05 per share after-tax, primarily related to costs incurred in the pending First Union Merger and costs incurred in the creation of a strategic technology alliance with Andersen Consulting (see "Technology Initiatives" on page 6). In 1996, CoreStates recorded pre-tax net restructuring and merger-related charges of $209.7 million, $150.8 million or $0.68 per share after-tax, primarily in connection with the April 1996 acquisition of Meridian Bancorp, Inc. ("Meridian"). Included in that amount were: a $161.6 million merger-related restructuring charge, a $70.0 million provision for loan losses recorded in connection with a change in strategic direction related to Meridian's problem assets and to conform Meridian's consumer lending charge-off policies to those of CoreStates (See "Provision for Losses on Loans" on page 20), $29.0 million of implementation costs that were incurred in the process of consolidating Meridian businesses and operations, and $50.9 million of credits for gains on the curtailment of pension benefits and sales of branches resulting from the merger and completion of previous process redesigns. The credits on the sales of branches resulted primarily from the sale of eleven former Meridian Bank PA branches in Berks and Lebanon counties in Southeastern Pennsylvania. The sale was necessary to satisfy a condition of regulatory approval of the Acquisition contained in an agreement between CoreStates, the U.S. Department of Justice and the Attorney General for the Commonwealth of Pennsylvania. Approximately $380 million of deposits and $120 million of loans were included in the sale, which generated a pre-tax gain of $40.1 million. Additional gains of $3.0 million were recorded as restructuring credits in 1996 on the sale of branches which were sold as a result of the 1995 process redesigns. In 1995, CoreStates and Meridian completed intensive reviews of their operations and businesses and announced corporate-wide process redesign plans. As a result of these process redesigns, CoreStates recorded net pre-tax restructuring charges of $128.6 million, $82.2 million after-tax or $0.37 per share in 1995. In the fourth quarter of 1995, Meridian paid $10.0 million, or $0.04 per share, of non-deductible costs associated with the CoreStates' acquisition of Meridian. 5 CORESTATES FINANCIAL CORP AN D SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued OVERVIEW - continued A summary of 1997, 1996 and 1995 pre-tax restructuring and merger-related charges (credits), excluding the $70.0 million provision for loan losses in 1996, was as follows (in millions):
1997 1996 1995 ------ ------ ------ Merger-related restructuring charges......................... $6.2 $161.6 $10.0 Strategic technology alliance charges........................ 8.8 - - Process redesign restructuring charges....................... - - 142.0 Meridian merger-related implementation costs................. - 29.0 - Gains on sales of branches................................... - (43.1) (4.0) Pension curtailment gains.................................... - (7.8) (9.4) ------ ------ ------ Total.................................................... $15.0 $139.7 $138.6 ====== ====== ======
Other Significant and Unusual Charges - In the fourth quarter of 1997, ------------------------------------- CoreStates recorded other significant and unusual charges including a $25.0 million pre-tax charitable contribution, $20.0 million pre-tax for certain legal matters and a special $12.0 million employee bonus (in total, $36.5 million after-tax or $0.18 per share). On September 30, 1996, the Deposits Insurance Fund Act of 1996 ("Funds Act") became law. A key element of the Funds Act was to fully capitalize the Savings Association Insurance Fund ("SAIF") by mandating a special one-time assessment on institutions carrying SAIF insured deposits. In the third quarter of 1996, CoreStates expensed $14.2 million pre-tax, $8.9 million after-tax or $0.04 per share, for the special assessment on its SAIF insured deposits. Certain Net Investment Gains - Excluded from operating earnings in 1996 are ---------------------------- net pre-tax gains of $43.3 million, $28.1 million after-tax or $0.12 per share, which consist of a $28.7 million pre-tax gain on the exchange of domestic equity securities and a net $14.6 million pre-tax gain on the sale of foreign equity securities. In 1995, CoreStates recorded pre-tax gains which are also excluded from operating earnings of $13.6 million, $8.6 million after-tax or $0.04 per share, on the exchange of domestic equity securities. Gain on Affiliate Joint Venture - In March 1995, Electronic Payment ------------------------------- Services, Inc. ("EPS"), an affiliate joint venture formed in 1992 to combine the consumer electronic transaction processing businesses of CoreStates and three other partners, admitted a fifth partner and increased the ownership interest of an existing partner. As a result of the change in its ownership interest, CoreStates recognized a pre-tax gain of $19.0 million, $11.8 million after-tax or $0.05 per share, in the first quarter of 1995. Technology Initiatives - Prior to the announcement of the Merger, ---------------------- CoreStates announced the creation of a 10-year strategic technology alliance with Andersen Consulting designed to help CoreStates expand its access to improved technology skills and capabilities, strengthen CoreStates' competitive position by improving responsiveness and flexibility of the technologies that underlie CoreStates products and services, and increase the return on CoreStates' investments in those technologies. The alliance is comprised of three major components: a program to develop new strategic technology applications; a business process management contract for applications development and maintenance; and a Year 2000 Initiative, already under way at CoreStates, as more fully described below. CoreStates and Andersen Consulting will terminate their alliance upon consummation of the Merger. Andersen Consulting will continue to make certain project staff available to CoreStates through the systems conversion period. The cost of terminating the alliance will be paid by First Union. 6 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued OVERVIEW - continued Year 2000 Initiative - It is anticipated that the majority of -------------------- CoreStates' computer systems and applications (collectively the "systems") will be converted to those of First Union and that costs to convert those systems to be Year 2000 compliant will not be directly incurred by CoreStates. Prior to the announcement of the Merger, CoreStates had undertaken a corporate-wide program to prepare and convert its systems to enable them to function properly with respect to dates in the year 2000 and thereafter ("the Year 2000 Initiative"). CoreStates also initiated formal communications with all of its third party service providers to determine the extent to which CoreStates' interface systems are vulnerable to those third parties' failure to remediate their own Year 2000 issues. CoreStates is currently focusing its efforts on converting only the systems that will be retained by First Union subsequent to the Merger. Although there is no guarantee that other companies will be successful in addressing their Year 2000 issues, CoreStates believes that modifications to systems that are going to be retained can be made such that the Year 2000 issue will not pose significant operational problems. In the event that the Merger is not consummated, CoreStates will need to make all remaining CoreStates systems Year 2000 compliant. If such modifications are not made, or are not completed timely, the Year 2000 issue could have a material impact on the operations of CoreStates. CoreStates is utilizing both Andersen Consulting personnel and internal resources to make its systems compliant. CoreStates anticipates completing the Year 2000 Initiative by September 30, 1998 for those systems to be retained after the merger. Should the Merger not be consummated, CoreStates anticipates that it would need twelve months to make all remaining systems Year 2000 compliant. The total cost of the Year 2000 Initiative is estimated to be between $40 and $60 million. The cost to convert both the systems that will be retained by First Union, and to the extent necessary the remaining CoreStates systems, will be funded through operating cash flows and is not expected to have a material effect on the results of operations. Should the Merger not be consummated by April 30, 1998, First Union has agreed to indemnify CoreStates for any costs incurred to complete the Year 2000 Initiative in excess of $60 million and to use its best efforts to secure qualified resources to complete the Year 2000 Initiative in a timely manner. The costs of the project and the date on which CoreStates believes it will complete the Year 2000 Initiative are based on management's best estimates, which were derived utilizing numerous assumptions of future events, including the anticipated merger consumation date, the continued availability of certain resources, representations received from third party service providers and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those anticipated. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes, and similar uncertainties. Comparison of Operating Earnings: 1996 to 1995 - "Operating earnings" for ---------------------------------------------- 1996 were $780.8 million, or $3.57 per average common share, an increase of 8.8% on a per share basis over 1995. Operating earnings for 1995 were $727.0 million, or $3.28 per average common share. The growth in operating earnings for 1996 was primarily driven by expense reductions resulting from process redesigns and Meridian merger-related efficiencies ("merger-related efficiencies"). Diluted operating earnings per share were $3.54 in 1996, compared to $3.24 in 1995. Non-financial expenses declined $124.0 million, or 7.1% in 1996 (see the detailed discussion of "Non-Financial Expenses" on page 40). CoreStates' expense/revenue ratio (total operating expenses, excluding other real estate owned expenses, as a percentage of total operating revenues) was 53.7% in 1996 compared to an expense/revenue ratio of 57.1% in 1995. Merger-related efficiencies achieved in 1996 were approximately $47 million pre-tax, $30 million after-tax, or $0.14 per share. Merger efficiencies were impacted by approximately $9 million in revenue losses. A slight decline in net interest income, an increase in the provision for losses on loans, and modest growth in non-interest income tempered the impact of reduced non-financial expenses in 1996. For detailed discussions of net interest income, the provision for losses on loans and non-interest income, see pages 37, 20 and 38, respectively. 7 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued BUSINESS LINE RESULTS CoreStates utilizes a value-based reporting methodology to facilitate management's analysis of performance by defined business lines. This process supports CoreStates' strategic objective of creating superior growth in shareholder value by focusing on the performance and value creation potential of CoreStates' component businesses. This section of management's discussion and analysis presents the performance results of CoreStates' five core businesses: Global and Specialized Banking; Regional Banking; Retail Credit Services; Trust and Asset Management; and Third Party Processing. Each core business is comprised of well-defined business lines with market or product specific missions. Corporate overhead, processing and support costs, and the loan loss provision are allocated along with the impact of balance sheet management and hedging activities of CoreStates. A matched maturity transfer pricing system is used to allocate interest income and interest expense. All business lines in the five core businesses are allocated equity utilizing regulatory risk-based capital guidelines as well as each business line's fixed assets and other capital investment requirements. The development of these allocation methodologies is a continuous process at CoreStates, and as a result, certain amounts in prior years have been reclassified for comparative purposes. The Corporate Center category includes the income and expense impact of unallocated equity, unusual or non-recurring items not attributable to the operating activities of the major business areas, emerging business activities not directly related to the five major business areas, eliminations of intercompany business transactions, and miscellaneous items. 8 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued BUSINESS LINE RESULTS - continued The earnings contribution of these core businesses is reflected in the table below (in millions):
Retail Trust and (taxable equivalent basis) Global and Regional Credit Asset Specialized Banking Banking Services Management ---------------------- ------------------ ----------------- ------------------- 1997 1996 1997 1996 1997 1996 1997 1996 ------- ------- -------- -------- ------ ------ ------ -------- Net interest income.................. $ 603.7 $ 561.7 $1,116.9 $1,118.2 $306.1 $295.0 $ 55.8 $ 50.9 Provision for losses on loans........ 40.1 31.5 21.4 28.4 197.8(a) 98.5 2.2 2.2 Non-interest income.................. 278.5 232.3 253.7 244.9 87.8 85.9 188.1 167.6 Non-financial expenses............... 405.5 366.0 759.5 795.6 170.1 192.1 142.4 151.4 ------- ------- ------- ------- ------ ------ ------ ----- Income before income taxes........... 436.6 396.5 589.7 539.1 26.0 90.3 99.3 64.9 Income tax expense................... 167.7 155.7 216.7 195.8 9.2 33.6 35.9 23.3 ------- ------- ------- ------- ------ ------ ------ ----- Net income........................... $ 268.9 $ 240.8 $ 373.0 $343.3 $16.8 $56.7 $ 63.4 $ 41.6 ======= ======= ======= ======= ====== ====== ====== ===== Return on average assets............. 1.47% 1.67% 2.89% 2.42% 0.22% 0.72% 4.97% 3.03% Return on average equity ............ 23.55% 25.98% 55.92% 47.81% 4.84% 15.45% 89.30% 60.29% Average assets....................... $18,308 $14,460 $12,900 $14,159 $7,501 $7,884 $1,275 $1,372 Average equity ...................... $1,142 $927 $667 $718 $347 $367 $71 $69
Third Party Processing Corporate Center Total ----------------- -------------------- ----------------- 1997 1996 1997 1996 1997 1996 ------ ------ ------- ------ ------- ------- Net interest income.................. $20.7 $ 18.0 $ 36.3 $123.9 $2,139.5 $2,167.7 Provision for losses on loans........ 0.1 0.2 1.4 68.0 (e) 263.0 228.8 Non-interest income.................. 225.4 209.3 (107.7)(b) (40.9)(b,f) 925.8 899.1 Non-financial expenses............... 225.4 198.4 (7.1)(b,d) 73.3 (b,e) 1,695.8 1,776.8 ------ ------ ------- ------ ------- ------- Income (loss) before income taxes.... 20.6 28.7 (65.7) (58.3) 1,106.5 1,061.2 Income tax expense................... 7.3 10.1 (143.6)(c) (6.5) 293.2 412.0 ------ ------ ------- ------ ------- ------- Net income (loss).................... $13.3 $ 18.6 $ 77.9 $(51.8) $ 813.3 $ 649.2 ====== ====== ======= ====== ======= ======= Return on average assets............. 4.62% 6.84% 1.43% (0.92)% 1.78% 1.48% Return on average equity ............ 44.33% 58.13% 7.04% (2.92)% 24.18% 16.69% Average assets....................... $288 $272 $5,446 $5,647 $45,718 $43,794 Average equity ...................... $30 $32 $1,107 $1,777 $3,364 $3,890
- ------------- (a) Includes a special provision of $70.0 million primarily related to management's decision to sell approximately $450 million of credit card outstandings. (b) Includes eliminations for intercompany processing fees of $108.4 million and $105.9 million in 1997 and 1996, respectively. (c) Includes a $109.0 million tax benefit related to the liquidation of an affiliate. (d) Includes restructuring and merger-related charges and other significant and unusual charges of $72.0 million. (e) Includes net restructuring and merger-related charges of $70.0 million in the provision for losses on loans and $139.7 million in non-financial expenses, and a SAIF special assessment of $14.2 million. (f) Includes certain net investment gains of $43.3 million. 9 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued BUSINESS LINE RESULTS - continued Global and Specialized Banking includes the following business lines: ------------------------------ Specialized Banking, Secured Lending, Real Estate, Large Corporate Banking, Congress Financial Corporation ("Congress Financial"), International Banking, Investment Banking and Cash Management. Net income for 1997 increased $28.1 million, or 11.7%, above 1996. The favorable variance was due to increases in net interest income and non-interest income, partially offset by increases in non-financial expenses and the provision for losses on loans. Net interest income for 1997 increased $42.0 million, or 7.5%, above 1996 due to increases in average loans, average demand deposits, and fees on loans. Average loan volume increased $2.7 billion, or 22.8%, above 1996, due largely to growth in Specialized Banking, International Banking, and the Large Corporate and Healthcare Groups within Large Corporate Banking. Average demand balances increased $98 million, or 5.4%, over 1996 primarily due to higher balances maintained by customers to pay for services particularly within the Financial Services Group of Large Corporate Banking. Amortized fees on loans increased $6.4 million, or 18.6%, due to fees collected on new loans and several significant termination fees. Non-interest income for 1997 increased $46.2 million, or 19.9%, primarily due to increases in international service fees, service charges on deposits and income from trading activities. International service fees increased $11.4 million, or 11.4%, in 1997 principally due to increased trade payment activity in the offshore branches. Service charges on deposits increased $8.2 million, or 12.5%, for 1997 primarily reflecting increases in cash management activities. Non-financial expenses for 1997 increased $39.5 million, or 10.8%, over 1996 due to increases in personnel expenses, Congress Financial expenses and processing costs. Regional Banking includes Retail Banking and Delivery, Small Business ---------------- Lending, Commercial Business Lending and Middle Market Lending. Net income was $373.0 million, up $29.7 million, or 8.7%, from 1996. The increase for 1997 was principally due to declines in non-financial expenses resulting from merger synergies and branch closings/sales, an increase in non-interest income related to delivery channel income pricing and volume (delivery channel income includes ATM, PC and telephone banking fees), and price increases in service charges on deposits. Net interest income for 1997 declined $1.3 million, or 0.1%, below 1996. The decrease was mainly attributable to a $1.3 billion, or 5.3%, decline in average deposit volumes. Also contributing to the decrease was a decline in average loan outstandings of $358 million, or 3.1%. The deposit decline resulted from a combination of runoff resulting from the Meridian acquisition and competitive pressures in the market. The decline in loans mainly resulted from the securitization of $382 million in home equity loans and runoff in revolving credit loans. Partially offsetting the impact of volume declines was an increase in deposit interest rate spreads driven by pricing strategies implemented in the second quarter of 1997. Non-interest income increased $8.8 million, or 3.6%, over 1996. Delivery channel income rose $7.7 million influenced by ATM surcharges levied on all non-CoreStates Bank customer ATM transactions, a policy initiated in the fourth quarter of 1996. In addition, service charges on deposits increased $3.8 million, or 2.5%, mainly due to 1997 price increases implemented on deposit accounts. Non-financial expenses for 1997 declined $36.1 million, or 4.5%, from 1996. Personnel expenses declined $16.1 million, or 5.4%, while non-personnel expenses declined $20.0 million, or 4.0%. These savings were achieved through branch closings/sales, operational efficiencies related to the Meridian merger and new contracts with many of the suppliers of goods and services to CoreStates. 10 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued BUSINESS LINE RESULTS - continued Retail Credit Services includes the following major business lines: Credit ---------------------- Card, Dealer Services, Educational Lending, Mortgage Services, Card Linx (CoreStates' merchant credit card processing business) and SynapQuest (CoreStates' consumer and commercial card processing company). Net income for Retail Credit Services was $16.8 million for 1997, which was $39.9 million, or 70.4%, below 1996. The decrease in net income for 1997 was primarily attributable to a higher provision for losses on loans. Prior year results have been restated for the reclassification of SynapQuest into Retail Credit Services. Net interest income for 1997 increased $11.1 million, or 3.8%, above 1996. This increase was attributable to the impact of a change in mix of Dealer Services loan products which contributed $1.9 million to net interest income, and to higher average credit card outstandings of $119 million which contributed $8.6 million to net interest income. The provision for loan losses for 1997 increased by $99.3 million, or 100.8% over 1996. This increase includes a $70 million special provision for losses on loans primarily related to management's decision to sell approximately $450 million of credit card outstandings. The remainder of the increase over 1996 was attributable to higher credit card charge-offs. Higher credit card charge-offs are an industry-wide trend also being experienced by CoreStates. Non-interest income for 1997 was $1.9 million, or 2.2%, above 1996. This increase was primarily due to higher credit card fees of $3.2 million, and higher mortgage fee income of $3.4 million, partially offset by a $2.4 million decrease in merchant fee income and lower credit life insurance fee income of $2.3 million. Non-financial expenses for 1997 decreased by $22.0 million, or 11.5%, from 1996. The decline in expenses was primarily due to merger-related efficiencies that impacted personnel, occupancy and outside services hired expenses. A reduction in marketing expense also contributed to the decline. The expense savings were partially offset by volume related expense growth. Trust and Asset Management is organized into four business lines: Personal -------------------------- Trust (including Private Banking), Institutional Trust, Retirement Plan Services, and Investment Management. CoreStates' remaining Corporate Trust Business, previously included in Institutional Trust, was sold in the fourth quarter of 1996. Full year net income for 1997 of $63.4 million increased $21.8 million, or 52.4%, over 1996. Increases in net interest income and trust fee income as well as reduced non-financial expenses all contributed to the improvement in net income. Net interest income for 1997 increased $4.9 million, or 9.6%, over 1996. This increase is primarily due to higher investment income, commercial loan growth in Private Banking, increased money market account deposits related to additional customer sweep balances, and higher demand deposit balances. These favorable variances were partially offset by funding costs for increased overdraft balances. Non-interest income for 1997 increased $20.5 million, or 12.2%, over 1996. Excluding 1996 Corporate Trust fees, non-interest income increased $22.2 million, or 13.4%, in 1997. This improvement resulted primarily from increases in Personal and Institutional fee income primarily due to increases in the market value of assets under management. Non-financial expenses for 1997 decreased $9.0 million, or 5.9%, from 1996. Excluding Corporate Trust expenses in 1996, non-financial expenses would have decreased $8.0 million, or 5.3%, in 1997, primarily due to merger-related efficiencies. 11 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued BUSINESS LINE RESULTS - continued Third Party Processing consists of the QuestPoint specialty transaction ---------------------- processing units, earnings from CoreStates' investment in Electronic Payment Services, Inc. ("EPS"), and earnings from CoreStates Bank's Financial Institutions Division ("FID"). The QuestPoint processing units include: QuestPoint Check Services ("Check Services"), a provider of check processing and payment services to CoreStates and other financial institutions; and QuestPoint Remittance Services ("Remittance Services"), a leading supplier of remittance processing services nationwide with processing sites in key markets within the United States and Canada. EPS is a leading provider of ATM and POS processing services. FID is a provider of correspondent bank services to financial institutions in the United States. FID cash letter volumes are processed by contract with Check Services. Third Party Processing ("TPP") 1997 net income of $13.3 million decreased $5.3 million, or 28.5%, from 1996. Prior year results have been restated for the reclassification of SynapQuest into Retail Credit Services and for the inclusion of FID in TPP. The decline in 1997 net income is primarily due to a price reduction on CoreStates intercompany processing activity, costs associated with investments in technology and lower earnings on the Remittance Services processing business in Canada. TPP net interest income for 1997 increased $2.7 million, or 15%, over 1996. The increase over 1996 is due primarily to higher average demand balances within FID. TPP non-interest income for 1997 totaled $225.4, million including $108.4 million for the CoreStates intercompany business, $29.5 million for EPS, and $87.5 million of other external QuestPoint/FID revenue. This compares to 1996 non-interest income of $209.3 million, including $105.9 million for the CoreStates intercompany business, $29.9 million for EPS, and $73.5 million of other QuestPoint/FID revenue. Total revenue growth for 1997 was $16.1 million, or 7.7%, above 1996. The CoreStates intercompany business, which contributes 48% of the TPP revenue base, increased $2.5 million, or 2.4%. External QuestPoint/FID, which accounts for 39% of the TPP revenue base increased $14.0 million, or 19.0%. Revenues for EPS decreased modestly. The increase in revenue from the CoreStates intercompany business was primarily the result of the addition of Meridian processing, offset slightly by a decline in fees due to the repricing of services on January 1, 1997. The acquisition of five check processing centers in October 1996 contributed $10.2 million to the external revenue growth. The remaining increase is primarily the result of new business within Check Services and Remittance Services. Income from the investment in EPS reflects CoreStates' share in EPS net income, interest income on a 6.45% note and income from the amortization of a deferred gain. Year-to-year, the lower interest income on the note, which is being paid down at a rate of $6.25 million per quarter by EPS, is offset by higher EPS equity related income. TPP non-financial expenses for 1997 were $225.4 million, an increase of $27.0 million, or 13.6%, over 1996. Most of the increase supports the addition of new business, including the acquisition of five check processing centers in October 1996 and overall Remittance Services volume growth. Higher staff costs within Remittance Services also contributed to the increase. 12 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued CAPITAL STRENGTH Capital strength must be evaluated in the context of business risk exposures, including asset quality, interest sensitivity, liquidity and earnings diversification. CoreStates places a significant emphasis on the maintenance of strong capital which promotes investor confidence, helps provide access to the credit markets under favorable terms and enhances the flexibility to capitalize on business growth and acquisition opportunities. Capital is managed for each CoreStates subsidiary based on its respective risks and growth opportunities, as well as regulatory requirements. CoreStates is positioned to take advantage of market opportunities to strengthen capital. A shelf registration provides for the issuance of a wide-range of securities including: senior and subordinated debt, straight and convertible preferred securities and equity. At December 31, 1997, CoreStates had $579 million of registered but unissued securities under the shelf. In addition, CoreStates Bank, N.A. (CoreStates' principal bank subsidiary) has the ability to issue subordinated debt under its Senior and Subordinated Bank Note program (See the "Liquidity" discussion on page 33 for further detail). Through the implementation of its capital policies, CoreStates has achieved a strong capital position. The relative strength of CoreStates' capital is reflected in the chart "Average Common Equity/Assets."
Average Common Equity/Assets Average Common Five Year Comparison Equity/Assets ---------------------------- ------------------------------------------- (in percent) KBW Peer Group 1 CoreStates Composite * ---------- ---------------- 1997 7.36% 7.77% 1996 8.88 8.06 1995 8.37 7.48 1994 8.27 7.47 1993 7.93 7.52
* The KBW Peer Group 1 Composite includes CoreStates and is comprised of U.S. banking companies having assets in excess of $25 billion. At December 31, 1997, common shareholders' equity totaled $3,237 million or 6.7% of total assets, compared with $3,696 million or 8.1% at year-end 1996. The primary reasons for the declines in common shareholders' equity and the equity to assets ratio were the common stock repurchase program and asset growth of 6.5%. CoreStates has achieved steady internal capital generation throughout the past five years. Excluding the cost of the common stock repurchase program in 1997, common shareholders' equity increased over the five years ended December 31, 1997 at a compound annual growth rate of 5.3%, while dividends paid increased at a compound annual growth rate of 13.5%. During 1997, CoreStates increased its quarterly dividend amount by 6.4% to $0.50 per share beginning with the fourth quarter declaration. This follows increases of 11.9% in 1996 and 23.5% in 1995. CoreStates declared dividends on its common stock of $1.91 per share in 1997, $1.73 per share in 1996 and $1.44 per share in 1995. The common dividend payout ratio based on operating earnings per average common share was 48.8% for 1997, compared to 48.5% for 1996, and 43.9% for 1995. 13 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued CAPITAL STRENGTH - continued Common Stock Repurchase Program - On October 15, 1996, the Board of ------------------------------- Directors authorized the management of CoreStates to repurchase up to 22 million shares of common stock, or approximately 10% of outstanding shares, and on July 15, 1997, the Board of Directors authorized an extension of the common stock repurchase program permitting management to repurchase up to an additional 6 million shares, or approximately 3% of outstanding shares. Acting under these authorizations, CoreStates repurchased 15.3 million shares and 8.8 million shares in 1997 and 1996, respectively. Management is also authorized to repurchase additional shares to fulfill requirements of employee benefit and dividend reinvestment plans. As of March 15, 1998, it is anticipated that CoreStates will issue approximately 1.0 million shares of common stock prior to the consummation of the Merger in order for the Merger to qualify for pooling of interests accounting treatment. Capital Ratios - CoreStates and its bank subsidiaries are subject to -------------- minimum risk-based and leverage capital guidelines issued by the Federal Reserve Board and Comptroller of the Currency. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on CoreStates. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, CoreStates must meet specific capital guidelines that involve quantitative measures of CoreStates' assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. CoreStates' capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. In 1996, the Federal Reserve Board approved the limited use of certain cumulative preferred instruments ("Trust Capital Securities") as Tier 1 capital. While these Trust Capital Securities are classified as long-term debt on the Consolidated Balance Sheet (see Note 12 to the Financial Statements for further description of these securities), CoreStates utilizes these Trust Capital Securities in managing its total capital mix. CoreStates' principal bank subsidiary issued $300 million of these securities in 1996 and $450 million in 1997. This type of security issuance provides CoreStates more flexibility in managing its capital. At December 31, 1997, management believes that CoreStates exceeds all capital adequacy requirements to which it is subject. The following table illustrates CoreStates' risk-based and leverage capital ratios compared to regulatory guidelines at December 31, 1997 and 1996: Risk-based and Leverage Capital Ratios - -------------------------------------- At December 31, - --------------
Regulatory Guidelines ------------------------ Well- 1997 1996 Minimum Capitalized ---- ---- ------- ----------- Tier 1 capital ratio....... 8.5% 9.4% 4.0% 6.0% Total capital ratio........ 12.0 13.2 8.0 10.0 Tier 1 leverage ratio...... 8.0 8.5 3.0 5.0
14 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued RISK MANAGEMENT Risk management at CoreStates encompasses the oversight of a broad range of risks undertaken by CoreStates including credit, market (including interest rate, trading and liquidity risks), product, human capital, compliance, operations, systems, technology and general business risk. CoreStates' ongoing refinement of its risk management practices takes place within the framework of a corporate risk management program. The objective of the program is a continued strengthening of CoreStates' risk management culture and its policies, processes and controls for managing risk on an integrated basis throughout the company. The following sections, "CREDIT QUALITY" and "MARKET RISK", discuss two components of risk management. CREDIT QUALITY Credit Risk Management The management of credit risk at CoreStates relies on maintaining a diversified loan portfolio, limiting exposures to any given borrower, industry or market segment, and on upholding a well-established credit culture. Early identification and communication of deterioration/problems in the portfolio, early recognition of non-performing assets and charge-offs, maintaining reserves that are strong, and a credit advisory team process that provides all lenders in both wholesale and consumer businesses access to the most senior and experienced credit officers in the organization, are key components of this credit culture. In addition, CoreStates has established a wide range of specialized lending areas staffed with industry experts and experienced lending resources. Underlying this credit culture is a tradition of extensive and ongoing credit training and comprehensive and well-communicated policies and procedures. Further, while CoreStates maintains a successful process of managing individual credits, it continues to place a greater emphasis on portfolio management issues. The maintenance of CoreStates' credit quality standards is supported by a comprehensive and independent assessment of credit quality and portfolio management by a Credit Review department, which reports to the Audit Committee of the Board of Directors. Loan Portfolio CoreStates' loan portfolio totaled $34.8 billion at December 31, 1997, a 7.7% increase from $32.3 billion at December 31, 1996. At year-end 1997, the portfolio is comprised of $26.1 billion or 75% wholesale loans and $8.7 billion or 25% consumer loans, compared to $23.0 billion or 71% wholesale loans and $9.3 billion or 29% consumer loans at December 31, 1996. The $34.8 billion in total loans at December 31, 1997 was subsequent to loan sales of approximately $890 million in 1997 and $450 million of credit card outstandings transferred to loans held for sale. These loan sales included $550 million of residential mortgages, $190 million of home equity loan securitizations and $150 million of student loans. The loan sales are discussed in the Consumer Lending Portfolio sections which follow. Wholesale Loan Portfolio CoreStates has traditionally maintained limits on industry, country and borrower concentrations as a way to diversify and manage credit risk. CoreStates manages industry concentrations by applying limits to a family of industries that have common risk characteristics. CoreStates' top industry concentrations are reflected in the following chart, "Wholesale Loans by Industry". The chart reflects favorable performance as measured by the percentage of outstandings which are non-performing, with the exception of Healthcare which was impacted by the addition of one significant loan to non-performing status. 15 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued CREDIT QUALITY - continued Wholesale Loans by Industry At December 31, 1997 (in millions)
% of Loans Outstandings Outstanding non-performing ----------- -------------- Completed Real Estate Projects (a)............. $1,779.7 1.3% Depository Institutions........................ 1,568.3 - Communications................................. 1,459.0 0.1 Non-bank Finance (b)........................... 1,311.2 0.6 Retail Trade................................... 1,176.1 0.5 Healthcare..................................... 1,005.5 7.5 Automobile Dealers............................. 875.3 0.1 Agri-Finance................................... 681.2 1.2 Real Estate Construction....................... 651.1 0.5 Chemicals and Allied Products.................. 636.0 0.2 Trucking and Auto Leasing...................... 620.4 - Apparel Manufacturing.......................... 418.8 0.2 Paper Manufacturing............................ 364.6 -
- ------------ (a) Consists of loans on commercial real estate to investors on completed properties. (b) Includes insurance, mortgage, mutual funds and finance companies. The following highlights two portfolios: the Congress Financial Corporation ("Congress Financial") portfolio, due to its growth opportunities and significant contribution to CoreStates' performance; and the international financial institutions portfolio, as this is a significantly expanded business. Congress Financial - Congress Financial's loan portfolio is comprised of ------------------ factoring and asset-based lending relationships generated through its offices in major cities in the United States and its growth in business in Canada. Despite considerable competitive pressure with regard to pricing and structure, the asset-based loan portfolio at December 31, 1997 grew 5% over 1996. With a look toward globalizing the asset-based lending function, Congress launched an asset-based operation in the United Kingdom with the purchase of Burdale Financial LTD in February 1997. Congress Financial's expertise with the syndication of large, multifaceted transactions also contributed significantly to loan growth. In spite of extreme competition, the volume in the factoring portfolio at December 31, 1997 grew 11% over 1996. Credit quality for both the factoring and asset-based lending portfolios, as reflected in the strong historical trends noted in the following table, continued to be consistent with Congress Financial's lending philosophy. Congress Financial Portfolio - ---------------------------- At December 31, - -------------- (in millions)
1997 1996 -------- -------- Asset-based lending portfolio: Loans............................. $2,373.1 $2,269.8 Non-performing.................... 3.8 12.2 % of loans ...................... 0.2% 0.5% Net charge-offs $ 9.8 $ 5.5 % of average loans 0.3% 0.2% Factoring receivables (a)............ $ 454.9 $ 411.3
- ------------ (a) There were no non-performing factoring receivables at December 31, 1997 and 1996. 16 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued CREDIT QUALITY - continued International Financial Institutions - CoreStates' International Financial ------------------------------------ Institutions business serves a portfolio of over 1,300 international relationships in 78 countries. In the correspondent banking business, CoreStates continues to focus on global multi-currency payment flows and on global trade collections and disbursements. In addition to facilitating the short term, trade related businesses of correspondents, CoreStates also provides treasury support, foreign exchange and, in selected cases, medium-term financing. CoreStates is one of the most active banks in the United States in working with correspondents to facilitate their access to Eximbank financing, particularly for small and medium-sized transactions. The portfolio's growth in 1997 in various geographic areas, as well as in certain product categories, is primarily attributable to generally improved political and economic conditions worldwide, which have encouraged international financial institutions to expand their activities and portfolios. However, following the start of the Asian turmoil, CoreStates has prudently shortened maturities, changed its product mix from non-trade to trade, and reduced outstandings where appropriate. Apart from limits on exposures to individual banks and countries, which are extended after thorough analysis and on-site visits, CoreStates manages its international portfolio through concentration limits for certain industries, tenors, and risk-rated assets which are determined through a stringent credit approval and monitoring process. International Financial Institutions' exposure consists of deposit placements, bankers' acceptances, letters of credit and loans outstanding. Total exposure at December 31, 1997 of $5.7 billion represented a $1.1 billion or 21% increase above $4.6 billion at year-end 1996. For both 1997 and 1996, approximately 50% of the total exposures were deposit placements. Non-trade exposures in 1997 approximated 13% of total exposure. Exposure in the International Financial Institutions portfolio at December 31, 1997 and 1996 was distributed geographically as follows: International Financial Institutions Portfolio - ---------------------------------------------- At December 31, - -------------- (in millions)
1997 1996 -------------------- ------------------- Total % of Total % of Exposure Total Exposure Total -------- ----- -------- ----- Europe/Africa........... $ 2,165 38% $ 1,751 38% Asia.................... 1,923 34 1,801 39 Americas................ 1,610 28 1,030 23 ----- -- ----- -- Total exposure...... $5,698 100% $ 4,582 100% ====== === ======= ===
17 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued CREDIT QUALITY - continued Real Estate Loans - Real estate loans of $8,851.0 at December 31, 1997 ----------------- includes both wholesale and consumer loans. An analysis of CoreStates' real estate portfolios is provided below. The regional market in which CoreStates operates has remained stable for both the residential and commercial segments, with active competition in all markets. Total real estate loans outstanding of $8,851.0 million at December 31, 1997, compared to $9,169.9 million at December 31, 1996. The decline from year-end 1996 was the result of loan repayments and the impact of $740 million in residential mortgage loan sales and home equity loan securitizations. The construction and development loan portfolio was $651.1 million or 1.9% of total loans at December 31, 1997. At December 31, 1997, 0.5% of CoreStates' construction and development loan portfolio was non-performing, compared to 1.0% at December 31, 1996. Within real estate loans are residential mortgages, which include home equity loans of $1,772.4 million, one-to-four family mortgages of $1,842.5 million, and multi-family residential mortgages of $300.8 million. Total residential mortgages were $3,915.7 million or 11.2% of total loans at December 31, 1997. Residential mortgage loan quality remained consistent as measured against 1996's performance. CoreStates' commercial real estate portfolio includes both completed property investor loans and loans collateralized by owner-occupied real estate. The commercial real estate portfolio totaled $4,284.2 million or 12.3% of total loans at December 31, 1997. The percentage of non-performing commercial real estate loans to year-end commercial real estate loans declined from 1.7% at December 31, 1996 to 1.3% at December 31, 1997. Net charge-offs for the commercial real estate portfolio totaled only $3.3 million for 1997. CoreStates continues to place an emphasis on loan quality in the commercial real estate portfolio. The non-performing loans and net charge-offs did not include any significant individual borrower exposure. The commercial real estate portfolio continues to exhibit diversity by product type. Real Estate Loans - ----------------- At December 31, - -------------- (in millions)
Construction/ Development Residential Commercial (a) Total ------------ ----------- ------------- ----------- 1997 - --- Year-end outstandings................ $651.1 $3,915.7 $4,284.2 $8,851.0 Average loans outstanding............ 600.2 4,325.5 4,362.7 9,288.4 Non-performing loans................. 3.2 47.2 55.8 106.2 % of year-end loans................ 0.5% 1.2% 1.3% 1.2% Net charge-offs...................... $ 1.3 $ 8.9 $ 3.3 $ 13.5 % of average loans................. 0.2% 0.2% 0.1% 0.1% 1996 - ---- Year-end outstandings................ $554.9 $4,073.3 $4,541.7 $ 9,169.9 Average loans outstanding............ 589.0 5,203.8 4,300.9 10,093.7 Non-performing loans................. 5.6 41.2 77.3 124.1 % of year-end loans................ 1.0% 1.0% 1.7% 1.4% Net charge-offs...................... $ (0.1) $ 21.1 $ 15.6 $ 36.6 % of average loans................. - 0.4% 0.4% 0.4%
- ------------ (a) Includes loans on completed properties to investors and commercial loans secured by owner-occupied real estate. 18 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued CREDIT QUALITY - continued Consumer Lending Portfolio Consumer Lending Portfolio (excluding credit card) - This portfolio ------------------------------------------------- declined $202 million or 2.6% from year-end 1996. Excluding sales of $890 million of consumer loans, principally residential mortgages, home equity loans and student loans, this portfolio experienced modest growth in 1997. Residential mortgages and home equity loans are sold on a recurring basis primarily for asset and liability management purposes. Net loan charge-offs as a percentage of the average portfolio outstandings increased from 63 basis points in 1996 to 76 basis points in 1997. While loan charge-offs in this portfolio have increased, CoreStates continues to operate within a framework of strong credit policies and maintains the ability to identify and mitigate risk factors in these retail loan products. Consumer Lending Portfolio (Excluding Credit Card) - ------------------------------------------------- At December 31, - --------------- (in millions)
1997 1996 -------- --------- Year-end outstandings: Home equity (a).............................. $1,772.4 $1,760.0 Indirect installment......................... 1,994.0 2,088.4 Residential first mortgages (a)............ 1,842.5 1,994.8 Direct installment........................... 979.7 939.5 Auto leasing................................. 880.3 888.4 -------- -------- Total....................................... $7,468.9 $7,671.1 ======== ======== Average loans outstanding........................ $7,958.1 $8,773.7 Net charge-offs.................................. $60.2 $55.1 % of average loans........................... 0.76% 0.63%
(a) These loans have also been included in the "Real Estate Loans" discussion. Credit Card Portfolio - Credit card outstandings decreased $469 million, or --------------------- 28% from $1,674.9 million at 1996 year end to $1,205.9 million at 1997 year end. In the fourth quarter of 1997, management decided to sell approximately $450 million of credit card outstandings. As a result, a $102 million writedown to net realizable value was recorded, and the loans were reclassified to loans held for sale. The credit card portfolio was also impacted in 1997 and 1996 by the significant amount of personal bankruptcies experienced nationwide and industry-wide. Net charge-offs have increased, which is consistent with industry averages, to 6.4% of average loans. In the second quarter of 1996, $5.8 million of credit card loans were charged off as the result of a change in policy to charge off delinquent credit card loans at 150 days past due, instead of at 180 days past due. Credit card outstandings past due 90 days or more as to payment of principal or interest were $13 million and $22 million at December 31, 1997 and 1996, respectively. Credit Card Portfolio - --------------------- At December 31, - -------------- (in millions)
1997 1996 -------- -------- Year-end outstandings................... $1,205.9 $1,674.9 Average loans outstanding............... 1,675.0 1,556.0 Net charge-offs......................... 107.7(a) 82.9 % of average loans.................. 6.4% 5.3%
(a) Excludes the $102 million writedown on credit cards held for sale. 19 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued CREDIT QUALITY - continued Allowance for Loan Losses In CoreStates' methodology for determining appropriate levels of allowance for loan losses ("the Allowance"), each subsidiary which extends credit maintains an allowance sufficient to absorb the anticipated loss inherent in its credit portfolio. Factors included in management's determination of an adequate level of Allowance are a statistical analysis of historical loss levels throughout an economic cycle and one year of projected charge-offs, establishing a minimum level below which the Allowance is considered inadequate and a maximum level above which is considered inappropriate. A quarterly evaluation of loss potential on specific credits, products, industries, and portfolios, as well as indicators for loan growth, the economic environment and concentrations, assist in validating the position of the Allowance within those boundaries. Management's evaluation of the adequacy of the Allowance is independently tested by Credit Review. Prompt recognition of problem situations and prompt write-downs of these assets to net realizable value is an important source of protection against problems in the portfolio. At year-end 1997 the Allowance totaled $634.4 million and represented 1.82% of loans. This compares with an Allowance at year-end 1996 of $710.3 million, or 2.20% of loans. The Allowance at year-end 1997 was 249.9% of non-performing loans, a decline from the year-end 1996 coverage ratio of 321.7% and a reflection of the lower balance in the Allowance at December 31, 1997 resulting from loan charge-offs, the $102 million writedown of credit card loans held for sale and the increase in non-performing loans at December 31, 1997. Provision for Losses on Loans - CoreStates' provision for loan losses in ----------------------------- 1997 was $263.0 million, an increase of $34.2 million over 1996. The increase in the 1997 provision for losses on loans was made in response to loan growth and higher charge-offs on credit card outstandings, installment loans and commercial loans. Net charge-offs on credit cards increased to $107.7 million, excluding the $102 million writedown of credit card loans held for sale, or 6.43% of average outstandings in 1997, from $82.9 million or 5.33% of average outstandings in 1996. Net charge-offs on installment loans increased to $49.1 million, or 1.54% of average outstandings in 1997, from $33.8 million, or 1.13% in 1996. Net charge-offs on commercial loans increased to $56.0 million, or 0.36% of average outstandings in 1997, from $27.4 million or 0.20% in 1996. Total net loan charge-offs in 1997 were $236.9 million or 0.69% of average loans. Net charge-offs in 1996 were $188.7 million or 0.59% of average loans. In the fourth quarter of 1997, CoreStates recorded a $70.0 million ($44.9 million after-tax, or $0.22 per share) special provision for losses on loans primarily related to management's decision to sell approximately $450 million of credit card outstandings. As a result, CoreStates wrote down the credit card balance by $102 million, and reclassified the net $348 million of loans to loans held for sale. As a result of the acquisition of Meridian in 1996, CoreStates recorded a $70.0 million provision for losses on loans in connection with a change in strategy related to Meridian's problem assets, and to conform Meridian's consumer lending charge-off policies to those of CoreStates. Historically for CoreStates, a strategy that involves the accelerated resolution of problem assets has been more economical than a long-term work out approach. It has been CoreStates' general experience that the costs of working out assets as well as other carrying costs typically outweigh any improvement in those assets' realized value. It is CoreStates' judgment that such a change in strategy maximizes the total value of an acquisition and allows CoreStates to concentrate upon new franchise initiatives and revenue generation. Furthermore, the process of working out problem assets diverts resources and management time and attention from building the business and creating long-term franchise value. 20 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued CREDIT QUALITY - continued The following table reflects the distribution of 1997 and 1996 net charge-offs by loan type: Distribution of Net Charge-Offs - ------------------------------- For the Years Ended December 31, - ------------------------------- (in millions)
1997 1996 ------------------------------------ ---------------------------------- % of % of Total Total Net % of net Net % of net charge- Average charge- charge- Average charge- Loan type offs loan type offs offs loan type offs - --------- ---------- --------- --------- -------- --------- -------- Domestic: Commercial and industrial.................... $ 57.3 0.38% 24.2% $27.4 0.20% 14.5% Real estate: Construction...................... 1.3 0.22 0.5 (0.1) - - Other............................. 12.3 0.14 5.2 36.7 0.39 19.4 Consumer: Credit card....................... 107.7(b) 6.43 45.5 82.9 5.33 43.9 Installment....................... 49.1 1.54 20.7 33.8 1.13 17.9 Other (a)........................... 9.2 0.43 3.9 10.1 0.50 5.4 ------ ----- ----- ----- Total domestic.................. 236.9 0.74 100.0 190.8 0.62 101.1 Foreign.............................. - - - (2.1) (0.15) (1.1) ------ ----- ----- ----- Total net charge-offs............ $236.9 0.69 100.0% $188.7 0.59 100.0% ====== ===== ===== =====
- ----------- (a) Includes loans to financial institutions and lease financing. (b) Excludes the $102 million writedown of credit card loans held for sale. Non-Performing Assets Non-performing assets at year-end 1997 were $268.3 million, or 0.77% of total loans plus other real estate owned ("OREO") and 0.55% of total assets. These levels compared to total non-performing assets at year-end 1996 of $245.0 million, or 0.76% of total loans plus OREO and 0.54% of total assets. The $23.3 million, or 9.5%, increase in total non-performing assets as compared to year-end 1996 was principally due to an increase of $37.3 million, or 40.3%, in non-performing commercial loans. The increase in commercial non-performing loans was primarily due to the addition of a single large credit to non-accrual status during 1997. Non-performing real estate assets at December 31, 1997 decreased $27.8 million, or 18.7% from the prior year end. At year-end 1997, total non-performing assets were comprised of $254.0 million of non-accrual loans and $14.3 million of OREO. Non-performing assets at year-end 1996 declined $23.3 million, or 8.7%, as compared to year-end 1995. The 1996 decline reflected decreases of $41.7 million, or 21.9%, in the real estate portfolio. Most of the decline in non-performing assets was attributable to collections, and bulk sales of non-performing residential mortgages. Non-performing loans in the commercial loan portfolio at year-end 1996 increased $19.9 million, or 27.4%, from year-end 1995, primarily due to the addition of two large credits to non-accrual loans during 1996. 21 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued CREDIT QUALITY - continued The following table illustrates the components of the changes in non-performing assets during 1997, 1996 and 1995: Changes in Non-Performing Assets - -------------------------------- For the Years Ended December 31, - -------------------------------- (in millions)
1997 1996 1995 ------ ------- ------ Balance at January 1,.......... $245 $268 $441 Additions...................... 335 287 274 Return to accrual.............. (8) (18) (30) Payments....................... (194) (184) (299) Charge-offs.................... (110) (108) (118) ---- ---- ---- Net change..................... 23 (23) (173) ---- ---- ---- Balance at December 31,........ $268 $245 $268 ==== ==== ====
The following table reflects the distribution of non-performing assets by loan type at December 31, 1997 and 1996: Distribution of Non-Performing Assets - ------------------------------------- At December 31, - --------------- (in millions)
1997 1996 ---------------------------------- ----------------------------------- % of % Total % of % Total Non- Loan non- Non- Loan non- Loan type performing type performing performing type performing - --------- ---------- ------- ---------- ---------- ------- ---------- Domestic: Commercial and industrial.............. $129.9 0.79% 48.4% $92.6 0.65% 37.8% Real estate: Construction.......................... 3.2 0.50 1.2 5.6 1.00 2.3 Other loans........................... 103.0 1.26 38.4 118.5 1.29 48.4 OREO.................................. 14.3 - 5.3 24.2 - 9.9 Other domestic loans (a)................ 17.8 0.61 6.7 4.1 0.17 1.6 ------ ----- ------ ----- Total domestic........................ 268.2 0.83 100.0 245.0 0.79 100.0 Foreign loans............................ 0.1 - - - - - ------ ----- ------ ----- Total non-performing assets (b) (c)... $268.3 0.77 100.0% $245.0 0.76 100.0% ====== ===== ====== ===== % of total assets..................... 0.55% 0.54% ==== ====
- ---------- (a) Includes loans to financial institutions and lease financing. (b) The table does not include assets of $94 million and $113 million at December 31, 1997 and 1996, respectively, that are past due 90 days or more as to principal or interest. (c) At December 31, 1997 and 1996, there were no non-performing consumer loans. Non-performing residential mortgage loans are included in other real estate loans in the above table. 22 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued MARKET RISK Market risk is a potential loss of earnings and/or equity due to a change in interest rates, prices or foreign exchange rates. It includes traditional asset/liability management issues of interest rate risk and liquidity as well as trading activities. CoreStates' policy is to manage its businesses in a manner that constrains market risk to modest levels and stresses appropriate returns for risks taken. Interest rate sensitivity management of the balance sheet focuses on stable spreads throughout rate cycles while trading businesses emphasize product origination and distribution over proprietary trading positions. Market risk is measured in terms of its impact on earnings over the short term as well as its long term effects. For non-trading positions, near term market risk includes potential income changes within the next twelve months while longer term measures include the change in present value for a given change in rates. Trading risks are included in both measures and represent the potential change in market value over a 7 day holding period based on historical rate and price changes for similar instruments. Near and long term consolidated market risk limits are 4% and 10%, respectively, of Tier I Capital. Those limits include both trading and non-trading activities. Within those consolidated policy limits, additional sublimits are used to control specific types of risk such as market sectors or optionality. The specifics of the risk measures applied to non-trading interest rate risks are described in the interest rate risk section below. At CoreStates, trading activities are customer driven and position taking is not material. Market risk from trading activities was $8 million on December 31, 1997. Asset and Liability Management Asset and liability management is the process of directing and coordinating activities that effectively control liquidity and interest rate risk. CoreStates' philosophy includes a disciplined approach to asset and liability management which calls for minimizing interest rate risk, maintaining a strong balance sheet and a focus on achieving appropriate product spreads. This disciplined approach contributes to the stability and strength of CoreStates' net interest margin. CoreStates' asset and liability management is centralized and individual subsidiaries are managed within the context of overall corporate policies. CoreStates' management emphasizes stable net interest income throughout rate cycles, with the result that intermediate and longer term considerations take precedence over short-term profitability. This commitment is evidenced by the consistency of CoreStates' net interest margin over time. During the past five years, a period of significant changes in economic conditions, competition and interest rates, CoreStates' net interest margin has remained consistently above industry averages as illustrated in the chart "Net Interest Margin". Net Interest Margin - ------------------- Five Year Comparison - -------------------- (in percent)
Net Interest Margin ---------------------------------- KBW Peer Group 1 CoreStates Composite * ---------- ---------------- 1997 5.22% 4.25% 1996 5.53 4.37 1995 5.47 4.42 1994 5.33 4.42 1993 5.27 4.61
* The KBW Peer Group 1 Composite is comprised of 32 U. S. banking companies having assets in excess of $25 billion. 23 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued MARKET RISK - continued CoreStates' net interest margin reflects relationship business activities rather than interest rate risk taking. The strength of CoreStates' net interest margin comes from the combination of healthy spreads on both loans and deposits and a balance sheet which has a relatively high portion of loans and a large base of non-interest bearing funds. Areas of business such as credit card, middle market lending, specialized lending and commercial finance at Congress Financial produce attractive lending spreads. CoreStates' cash management business provides a significant source of non-interest bearing funds, while the retail franchise includes a substantial base of low cost funding. Emphasis on profitable relationship business is supported by CoreStates' management practices. CoreStates uses a matched maturity funds transfer pricing system which focuses business managers on profitability, appropriate compensation for embedded risks and overall pricing discipline. In addition to providing a pricing tool, transfer pricing supports performance measurement and analysis of net interest margin components. Interest Rate Risk Management Non-trading interest rate risk refers to potential changes in current and future net interest income resulting from changes in interest rates, product spreads and mismatches in the repricing between interest rate sensitive assets and liabilities. At CoreStates, measurement of near term interest rate risk focuses on potential changes in net interest income identified through computer simulations against both rising and falling interest rates. Longer term repricing risks are measured using potential changes in the present value of future income streams inherent in current positions. While present value sensitivity is used to measure risk in longer time periods, gap analysis is used to manage strategy execution. All measurements of interest rate risk include the impact of off-balance sheet activities. Under CoreStates' policy, rate changes of at least 200 basis points in either direction over a six-month period are simulated with rate related negative net interest income volatility over a twelve-month horizon subject to the consolidated near term market risk limit of 4% of Tier 1 Capital. Changes are measured relative to a base forecast in which rates remain constant at current levels. Based on historical data, 95% of the time rates have moved less than 200 basis points over a six-month period. Included in these simulations are all contractual repricing risks, the impact of prepayments in the loan and securities portfolios, potential spread and volume changes on consumer deposits and fluctuations in the value of non-interest bearing funding sources. Potential changes in the spread between the prime rate and financial market rates are monitored, and when changes are believed to be interest rate related, are subject to the interest rate risk policy guidelines. CoreStates believes that the prime spread is more a function of credit conditions than interest rate changes. Estimated changes in the present value of future income streams are based on a 200 basis point parallel shift of the yield curve and negative changes are measured against the aggregate market risk limit of 10% of Tier 1 Capital. As a matter of practice, positions are generally managed to produce significantly lower volatility than policy guidelines would permit. Current net interest income simulations using a 200 basis point change in short-term interest rates show that CoreStates' net interest income over the next twelve months would decline $35 million versus what income would have been had rates remained stable. That level is representative of simulations performed throughout the last twelve months. Recognizing that the simulation process is based on a variety of assumptions, management reviews results by category of risk as well as by product and tests the sensitivity of the results to key assumptions. Present value changes are also managed well within policy guidelines and represented $132 million, which is less than 5% of Tier 1 Capital, at year-end. There are two main elements to CoreStates' exposure to interest rate risk. The first is the broad mismatch between the rate sensitivity of the assets and liabilities in its core businesses, and the second is the spread risk between the rates on those products and financial market rates. Option risk, such as prepayment risk on consumer lending products, has increased in recent years. CoreStates' core wholesale and retail businesses generate a large portfolio of prime and other short-term rate related assets. Characteristic of a regional banking company, CoreStates also has a significant funding base of consumer deposits with indefinite maturities and non-contractual rates such as savings, NOW and money market accounts. The repricing characteristics of those deposits tend to be longer term; traditionally, pricing has been relatively stable for long periods and pricing changes lag changes in financial market rates. While this mix of relationship assets and liabilities provides excellent liquidity, it results in considerable interest rate risk. This inherent mismatch (the "relationship gap") of longer term fixed-rate liabilities funding short-term rate sensitive assets generates significant exposure to declining interest rates if not managed. 24 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued MARKET RISK - continued CoreStates manages this relationship gap through the use of both on and off-balance sheet discretionary assets and liabilities. The typical offsetting position is created by purchasing fixed-rate investment securities funded by short-term liabilities, or by entering into interest rate swaps in which CoreStates receives a fixed-rate and pays a variable rate. The following excerpts from the Interest Sensitivity Analysis shown on page 96 demonstrates the basic mismatch of the relationship portfolios and the offsetting discretionary position. In keeping with CoreStates' interest rate risk discipline, the combined position is relatively balanced so that there is minimal impact on earnings from an interest rate move in either direction. Selected Interest Sensitivity Balances - -------------------------------------- At December 31, 1997 - -------------------- (in millions)
Months Years ------------------------------ ------------------------------ 0-3 4-6 7-12 1-2 2-5 over 5 Total -------- -------- ------- -------- -------- ------ ------- Relationship Portfolios: Total loans.................... $23,481 $1,819 $ 2,037 $ 2,685 $ 3,807 $ 985 $34,814 Total consumer deposits, net non-interest funding........ 9,919 2,471 2,655 3,501 4,797 5,825 29,168 Adjustments.................... 652 (967) (693) (1,015) (2,951) 4,974 - -------- ------ ------- -------- -------- ------ ------- Relationship gap............. 14,214 (1,619) (1,311) (1,831) (3,941) 134 5,646 -------- ------ ------- -------- -------- ------ ------- Discretionary Portfolios: Assets......................... 5,341 1,825 1,638 2,291 4,612 1,102 16,809 Liabilities.................... 20,021 107 188 420 597 1,122 22,455 -------- ------ ------- -------- -------- ------ ------- Discretionary gap............ (14,680) 1,718 1,450 1,871 4,015 (20) (5,646) ------- ------ ------- -------- -------- ------ ------- Combined gap................. $ (466) $ 99 $ 139 $ 40 $ 74 $ 114 $ - ======= ====== ======= ======== ======== ====== ======= Cumulative gap............... $ (466) $ (367) $ (228) $ (188) $ (114) $ - $ - ======= ====== ======= ======== ======== ====== =======
The second major element of CoreStates' interest rate risk is the spread risk between product rates and financial market rates. These spreads are a function of competitive and other factors as well as interest rate levels. CoreStates simulates the behavior of individual products under various rate scenarios to determine an appropriate investment or funding strategy to provide a stable spread. Consumer deposit spreads are a key element of net interest income. There was significant shifting across bank deposit products in 1997 as well as deposit runoff. As consumer investment alternatives continue to grow in number and customers demonstrate greater willingness to use alternative products, it is increasingly difficult to model future balances and spreads. Simulations incorporate pricing and volume assumptions including runoff and shifting across products for various rate changes. Those assumptions are developed in conjunction with the business managers, and while management believes its simulation assumptions are realistic, it recognizes this as an area of potential volatility. It should be noted that these products are also influenced by the changing nature of the consumer product line and the positioning of these products within that line. The spread between the prime rate and short-term market rates, such as LIBOR, is also an important component of net interest income. CoreStates uses a blend of short-term maturities to fund prime related assets which should help preserve a stable spread provided that spread relationships in the financial market, such as Prime/LIBOR, remain stable. While the risk of a narrowing of the prime spread is not unique to CoreStates, a contraction in that spread would reduce net interest income. At December 31, 1997, CoreStates has approximately $9.1 billion in loans subject to changes in the prime rate. While it is not a significant exposure, option risk has increased in the last few years. The primary source of option risk in CoreStates' balance sheet is prepayment risk in residential mortgages, home equity and other consumer lending products and, to a lesser extent, loans to commercial customers and investment securities. CoreStates mitigates most of this risk through sales and securitizations. Risks that are retained are managed with a combination of caps, floors and other derivative instruments. The second type of option risk is from caps and floors embedded in loan and deposit products. CoreStates offsets those risks with purchases of similar caps and floors. 25 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued MARKET RISK - continued Off-balance Sheet Instruments and Derivative Activities - CoreStates uses off-balance sheet derivative instruments primarily to manage CoreStates' interest rate risk. CoreStates believes that interest rate risk management must be coordinated with the management of liquidity and capital. Therefore, CoreStates uses off-balance sheet instruments to modify its rate sensitivity and consequently, avoids the unnecessary leverage and liquidity impairment which would result from on-balance sheet alternatives. CoreStates also uses interest rate contracts to provide risk management services for its customers and to hedge the interest rate risk in its trading positions. Credit risk exists in a derivative transaction to the extent that there is a favorable move in interest rates and the counterparty fails to perform. The current credit exposure in a derivative transaction is the estimated cost to replace the transaction at current market rates, while potential exposure is the estimated cost to replace the transaction at future interest rates. CoreStates monitors both the current and potential risk. CoreStates evaluates the credit worthiness of all off-balance sheet counterparties using the same standards applied in any other loan or credit transaction. In addition, CoreStates uses collateral agreements to manage credit risk in its derivatives portfolio. Under those agreements, collateral is transferred between counterparties when exposure exceeds an agreed upon threshold. Collateral agreements and thresholds are determined based on the quality of individual counterparties. As of December 31, 1997, the current cost to replace CoreStates' derivatives portfolio was $253 million. This assumes that only counterparties for whom it would be favorable to default would do so. Interest Rate Risk Related Derivative Activities - CoreStates' use of derivatives for interest rate risk management falls into three categories: interest sensitivity adjustments, spread protection and the hedging of anticipated asset sales. The following schedule reflects by interest rate risk management category, the outstanding derivative positions as of December 31, 1997, the major balance sheet category to which they relate, and the associated unrealized gains/losses: 26 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued MARKET RISK - continued Outstanding Interest Rate Risk Related Derivatives - -------------------------------------------------- At December 31, 1997 - -------------------- (in millions)
Interest Interest Interest rate rate rate caps Other swaps futures and floors derivatives Total ------- ------- ---------- ----------- ------- Interest Sensitivity Adjustment: Assets (primarily loans): Notional amount............... $ 4,668 $1,089 $ 7 $ 5,764 Unrealized gains.............. 80 - - 80 Unrealized losses............. (6) - - (6) Deposits and other borrowings: Notional amount............... 2,829 824 $ 50 3,703 Unrealized gains.............. 24 6 - 30 Unrealized losses............. (6) - - (6) Long-term debt: Notional amount............... 1,381 150 1,531 Unrealized gains.............. 33 1 34 Unrealized losses............. (7) - (7) Spread Protection: Assets (primarily loans): Notional amount............... 76 492 568 Unrealized gains.............. 1 2 3 Unrealized losses............. - - - Deposits and other borrowings: Notional amount............... 86 86 Unrealized gains.............. - - Unrealized losses............. - - Anticipated Asset Sales: Notional amount............... 51 51 Unrealized gains.............. - - Unrealized losses............. - - Total: Notional amount............ $ 8,954 $ 1,089 $ 1,409 $ 251 $ 11,703 ======= ======= ====== ====== ======== Unrealized gains........... $ 138 $ - $ 8 $ 1 $ 147 ======= ======= ======= ====== ======== Unrealized losses.......... $ (19) $ - $ - $ - $ (19) ======= ======= ======= ====== ======== Net unrealized gains....... $ 119 $ - $ 8 $ 1 $ $128 ======= ======= ======= ====== ========
Although the value of the various derivative instruments will change with interest rates, CoreStates does not consider changes in individual portfolio values to be significant given that the portfolios are used to offset specific risks. As of December 31, 1997, CoreStates' use of off-balance sheet derivative instruments which carry a leveraged exposure to either rising or falling rates or have other complex features is not material. 27 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued MARKET RISK - continued Interest sensitivity adjustments account for the majority of CoreStates' derivative activities. CoreStates has a naturally asset sensitive balance sheet as a result of its basic loan and deposit businesses. Commercial and consumer loan activities tend to have short-term repricing characteristics versus the longer term repricing nature of CoreStates' funding sources. These relationship portfolios have a positive effect on earnings in a rising rate environment and a negative effect in a falling rate environment. Therefore, CoreStates uses fixed-rate assets or off-balance sheet instruments with characteristics similar to fixed rate assets to offset this risk. When off-balance sheet instruments are used, cash balances are invested in shorter time periods and interest rate swaps or other derivatives are used to "fix" the rate for longer terms similar to those of CoreStates' liabilities. The risks in certain products, particularly non-contractual deposits, are sometimes greater in one direction of rate change than the other. To the extent that marginal amounts of deposits need protection from falling rates but are likely to shift to higher rate instruments as interest rates rise, caps and/or floors are a more appropriate hedge. CoreStates has used interest rate floors in this manner to augment the risk protection provided by the swaps and futures portfolios. By using swaps, futures and options in this manner, leverage is reduced and liquidity is enhanced. If derivative instruments were not used, CoreStates would invest in longer term assets based on its disciplined interest rate risk management practice of strict matching of asset and liability terms. Therefore, the impact of derivatives on pre-tax income is confined to the spread between the derivative instrument and other instruments of similar terms. Management estimates that this spread is not material relative to pre-tax income. CoreStates also uses derivative instruments to protect spreads on certain balance sheet products. CoreStates' loan and securities portfolios include adjustable rate mortgages which carry interest rate caps limiting the amount of rate increase per year as well as over the life of the mortgage. As interest rates rise and funding costs increase, the spread on that portfolio will compress. At December 31, 1997, CoreStates holds $406 million of interest rate caps which offset that risk by limiting the potential increase in funding costs. CoreStates has issued retail certificates of deposits with floating rates which carry a guaranteed minimum rate. CoreStates has used caps and floors to offset that risk. For accounting purposes, the income effects of futures or swaps used to adjust interest sensitivity or to protect a product spread are associated with either the asset or the liability being managed. The amount recorded in net interest income related to derivative financial instruments was $63.2 million in 1997 and $75.5 million in 1996. The following table shows the impact of derivatives income on average interest rates: Impact of Derivatives Income on Yields and Costs - ------------------------------------------------ For the Year Ended - ------------------ December 31, - ------------ (in millions)
1997 1996 -------------------------------------------- ----------------------------------------- Reported Impact Reported Impact Average Yield/ Product of Average Yield/ Product of Balance Cost Rate Derivatives Balance Cost Rate Derivatives ------- -------- ------- ----------- ------- ------- ------- ----------- Earning Assets Time deposits................ $ 2,800 5.76% 5.76% $ 2,163 5.68% 5.68% Federal funds sold & trading account............ 419 7.59 7.59 444 5.98 5.98 Investment securities........ 3,692 6.25 6.19 0.06% 4,662 6.22 6.15 0.07% Loans........................ 34,088 8.89 8.78 0.11 31,939 9.03 8.92 0.11 ------- ------- Total Earning Assets......... $40,999 8.42 8.33 0.09 $39,208 8.48 8.38 0.10 ======= ======= Interest Bearing Funds Savings, NOW, regular MMA.... 7,951 1.07 1.27 (0.20) $10,072 1.61 1.85 (0.24) Premium MMA.................. 5,156 3.92 3.92 - 3,515 3.87 3.87 - Certificates................. 8,483 5.14 5.17 (0.03) 9,067 5.15 5.27 (0.12) ------- ------- Total retail.............. 21,590 3.35 3.44 (0.09) 22,654 3.39 3.54 (0.15) ------- ------- Commercial & foreign deposits 3,077 5.32 5.32 - 1,635 4.83 4.83 - Federal funds purchased & short-term borrowings..... 3,414 5.56 5.56 - 2,958 5.18 5.18 - Long-term debt............... 3,683 6.50 6.64 (0.14) 2,536 6.38 6.53 (0.15) ------- ------- Total wholesale........... 10,174 5.83 5.88 (0.05) 7,129 5.53 5.58 (0.05) ------- ------- Total Interest Bearing Funds. $31,764 4.14 4.21 (0.07) $29,783 3.88 4.01 (0.13) ======= =======
28 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued MARKET RISK - continued It is important to note that derivatives usage, its impact on individual balance sheet items and fluctuations in fair value should be viewed in the context of overall risk management. As previously stated, if CoreStates did not use derivatives, it would adjust cash positions to create the same interest sensitivity position with approximately the same income results. However, if cash transactions were used, the income of those activities would not be carried as an income adjustment to other balance sheet products. Fluctuations in the impact of derivatives shown on the above table are a function of market conditions and do not indicate changes in risk positions. The third category of derivative activity is the hedging of anticipated asset sales. As fixed-rate assets are accumulated for future sale, CoreStates is exposed to a decline in sale price due to rising interest rates. Therefore, CoreStates will enter into an interest rate swap or a forward rate agreement which will increase in value if rates rise. The increased value on the derivative is used to offset the decline in value of the cash asset. Gains/losses on the derivative are deferred until the asset sale and recognized as part of the sale transaction. CoreStates securitizes and sells its longer term fixed-rate home equity loans and fixed-rate mortgages on a recurring basis. Home equity loans are held for several months prior to sale while sufficient volume for securitization is accumulated. Forward rate locks are used to hedge rate changes during that warehouse period. Options on mortgage-backed securities as well as both mandatory and optional forward sale commitments are used to hedge the mortgage pipeline. Interest rate swaps are agreements between two parties to exchange interest cash flows. Generally, one party receives a fixed rate and pays a variable rate, while the counterparty pays the fixed rate and receives the variable rate. As of December 31, 1997, the rates CoreStates has contracted to receive are fixed for longer time periods than the rates CoreStates has contracted to pay. Therefore, if interest rates fall, this portfolio will provide higher interest income, offsetting a decline in interest income in relationship portfolios; conversely if rates rise, the swap portfolio will produce less interest income which will be offset by increased interest income in the relationship portfolios. CoreStates also uses interest rate futures in a similar manner. While swaps are used in both short- and long-term maturities, futures are used primarily to extend the rate sensitivity of short-term assets to periods less than one year. CoreStates' use of financial futures is largely concentrated in Eurodollar and LIBOR contracts. CoreStates' use of interest rate futures is a function of the mix of maturities/resets on short-term lending portfolios, volumes and terms of short-term retail certificates and market funding sources and the availability and attractiveness of other short-term assets. These portfolios include significant volumes and the terms are subject to maturity shifts between one month and one year. The repricing schedule below summarizes the notional amount and associated interest rate of CoreStates' interest rate swaps categorized by whether CoreStates receives or pays the rate shown. The swaps are stratified by repricing date or maturity depending on whether the payments are floating or fixed, respectively. Floating rates included in the repricing schedule are based on the rates in effect on December 31, 1997. 29 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued MARKET RISK - continued Repricing Schedule of Interest Rate Swaps - ----------------------------------------- At December 31, 1997 - -------------------- (in millions)
Years -------------------------------------------------------------------- 0-1 1-2 2-3 3-4 4-5 over 5 Total ---------- ---------- --------- -------- ------- --------- ------- Receive Fixed/Pay Floating: Receive Notional................ $1,288 $1,527 $1,385 $1,630 $ 768 $ 894 $7,492 Rate.................... 6.34% 6.74% 6.42% 6.56% 6.38% 6.76% 6.54% Pay Notional................ $7,492 $7,492 Rate.................... 6.03% 6.03% Pay Fixed/Receive Floating: Pay Notional................ $ 14 $ 25 $ 39 Rate.................... 8.27% 9.26% 8.91% Receive Notional................ $ 39 $ 39 Rate.................... 6.00% 6.00% Receive Floating/Pay Floating: (Basis Swaps) Notional................ $ 963 $ 963 Receive Rate.................... 5.91% 5.91% Pay Rate.................... 6.04% 6.04% Receive Fixed/Pay Floating(a): (Forward Start) Receive Notional................ $ 150 $ 189 $ 75 $ 46 $ 460 Rate.................... 7.14% 6.52% 6.86% 7.00% 6.82% Start Date Notional................ $ 150 $ 310 $ 460
- ---------------------------------------- (a) Pay rate will be determined on forward start date. 30 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued MARKET RISK - continued The following schedule illustrates CoreStates' interest rate risk related derivative activity during 1997 and 1996: Activity in Derivatives Products - -------------------------------- Years Ended December 31, 1997 and 1996 - -------------------------------------- (in millions)
Interest Interest Interest rate caps rate rate and Other Notional Amounts swaps futures floors derivatives Total - ---------------- -------- --------- -------- ----------- --------- At December 31, 1995...................... $ 9,716 $ 619 $ 1,486 $ 106 $ 11,927 Additions................................. 3,712 14,260 341 761 19,074 Terminated contracts...................... (213) (10,428) - - (10,641) Maturities/amortization................... (4,072) - (287) (450) (4,809) -------- --------- -------- ----------- --------- At December 31, 1996...................... 9,143 4,451 1,540 417 15,551 Additions................................. 2,557 8,731 75 292 11,655 Terminated/restructured contracts(a)...... (441) (12,093) - - (12,534) Maturities/amortization................... (2,305) - (206) (458) (2,969) -------- --------- -------- ----------- --------- At December 31, 1997...................... $ 8,954 $ 1,089 $ 1,409 $ 251 $ 11,703 ======== ========= ======== =========== =========
- -------------------- (a) At December 31, 1997, CoreStates had $1.3 million deferred gains and $6.5 million deferred losses related to terminated derivative contracts. CoreStates' use of derivatives declined during 1997 primarily due to changes in the use of interest rate futures. A decrease in retail deposits, particularly savings certificates, along with increased placement and loan volumes reduced the need for short- term hedges. Activity in other categories generally represents routine rollovers. Trading and Customer Related Derivative Activities - CoreStates also engages in derivative market activities to provide risk management services for its customers and to manage securities trading positions in the securities unit. The securities unit underwrites, brokers, and distributes securities to municipalities, institutional investors and individual investors. In addition, the unit buys, sells and securitizes mortgage loans and brokers loan servicing portfolios. The following schedule details the outstanding notional amounts and related fair values of trading and customer related derivative transactions as of December 31, 1997 and 1996. 31 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued MARKET RISK - continued Trading and Customer Related Derivatives - ---------------------------------------- At December 31, - -------------- (in millions)
1997 -------------------------------------------------------- Positive Negative Notional Net assets Market Market Interest Rate Swaps: amount (liability)(a) Value Value ----------- -------------- --------- --------- CoreStates receives fixed........ $ 1,521 $ 17.7 $21.6 $ (3.9) CoreStates pays fixed............ 2,005 (39.1) 4.1 (43.2) Futures................................... 777 (1.9) 0.1 (2.0) Rate Locks: CoreStates receives fixed........ 130 (0.7) - (0.7) CoreStates pays fixed............ 130 0.8 0.8 - Interest Rate Caps/Floors: Sold............................. 1,491 (3.1) - (3.1) Purchased........................ 1,562 3.0 3.0 - Commitments to purchase/sell whole mortgage loans and securities (including when-issued securities): Sold............................. 145 (1.7) - (1.7) Purchased........................ 64 - - - Other Options: Sold............................. 881 39.8 39.8 - Purchased........................ 247 0.7 0.7 - Foreign exchange contracts (b)............ 2,241 4.0 35.2 (31.2) ------- ------- ------- ------- Total Trading and Customer Related Derivatives...................... $11,194 $ 19.5 $ 105.3 $ (85.8) ======= ======= ======= =======
1996 -------------------------------------------------------- Positive Negative Notional Net assets Market Market Interest Rate Swaps: amount (liability)(a) Value Value ----------- -------------- --------- --------- CoreStates receives fixed........ $ 355 $ 1.5 $ 2.7 $ (1.2) CoreStates pays fixed............ 353 (1.0) 1.3 (2.3) Futures................................... 39 0.4 0.4 - Rate Locks: CoreStates receives fixed........ 30 (0.1) - (0.1) CoreStates pays fixed............ 30 0.1 0.1 - Interest Rate Caps/Floors: Sold............................. 705 (2.7) - (2.7) Purchased........................ 704 2.7 2.7 - Commitments to purchase/sell whole mortgage loans and securities (including when-issued securities): Sold............................. 83 (0.2) 0.1 (0.3) Purchased........................ 19 - - - Other Options: Sold............................. 206 6.5 7.1 (0.6) Purchased........................ 334 0.8 0.8 - Foreign exchange contracts (b)............ 1,766 (0.5) 28.0 (28.5) ------- ------- ------- ------- Total Trading and Customer Related Derivatives...................... $ 4,624 $ 7.5 $ 43.2 $ (35.7) ======= ======= ======= =======
- ------------ (a) Average net assets (liabilities) during 1997 and 1996 were substantially the same as the net assets (liabilities) at December 31, 1997 and 1996, respectively. (b) Foreign exchange contracts purchased and sold at December 31, 1997 were $987 million and $1,254 million, respectively, and at December 31, 1996 were $836 million and $930 million, respectively. 32 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued MARKET RISK - continued Liquidity Liquidity management allows a financial institution to meet potential cash needs at a reasonable price under various operating conditions. Liquidity comes from a variety of sources: the maturing of short-term assets, readily marketable unpledged securities, and the ability to attract new funds. The ability to securitize or sell other assets, such as loans, also enhances liquidity, as does the structure and stability of existing funding sources. It is CoreStates' practice to maintain a high degree of liquidity through a strong funding base of core deposits combined with modest and diversified use of market sources and relatively short-term maturities of discretionary asset portfolios. CoreStates maintains sufficient liquidity to meet its obligations in a timely and cost-effective manner. Management monitors current and projected cash flows, and adjusts positions as necessary to maintain adequate levels of liquidity. CoreStates emphasizes diversification of funding sources. By using a variety of markets, limiting funds borrowed from a single investor, and staggering maturities, the risk of potential funding pressure is significantly reduced. Management also maintains a detailed liquidity contingency plan designed to adequately respond to situations such as a decline in asset quality or credit ratings, which could lead to liquidity concerns. Management analyzes potential changes in major funding sources during difficult times, the amount of runoff that may be expected, as well as available options to replace those funds. The plan includes specific action steps to be taken in the event of funding disturbances. The cornerstone of CoreStates' liquidity is a sizable and stable base of core deposits acquired through customer relationships. Core deposits are comprised of interest bearing consumer savings products and non-interest bearing deposits. Core deposits declined from 70.2% of average assets in 1996 to 65.4% of assets in 1997. The decline was attributable to consumer deposit disintermediation due to the relatively low interest rate environment in 1997 and alternative investment opportunities available to consumers. Core deposits are supplemented by discretionary funding sources from direct customer contacts as well as syndicated public debt issuance in both domestic and international markets. These sources include large denominated certificates of deposits, deposits in foreign branches, as well as Federal funds, repurchase agreements, commercial paper and long-term debt. To maintain its relative liquidity strength given the core deposit erosion, CoreStates established two new long-term funding initiatives in 1997. On October 3, 1997, CoreStates Capital Corp and CoreStates Bank, N.A. applied to list up to $4 billion of debt securities ("the Programme") on the Luxembourg Stock Exchange. Under the Programme, CoreStates Capital Corp and CoreStates Bank, N.A. may each issue up to $2 billion of debt securities ("the Notes") with maturities ranging from 30 days to 30 years. The Notes are direct, unconditional and unsecured, general obligations of the relevant issuer. On October 29, 1997, CoreStates Bank, N.A. issued $500 million, 5 year, floating rate notes under the Programme. On November 7, 1997, CoreStates Bank, N.A. and CoreStates Bank of Delaware, N.A. established a $3 billion Senior and Subordinated Bank Note program ("the Bank Note Program"). This program accommodates maturities up to thirty years and subordinated debt issuances. In the fourth quarter of 1997, CoreStates Bank, N.A. issued $232 million in senior notes with maturities ranging from one to two years and $286 million in senior notes with maturities less than 270 days. During 1997, CoreStates' ability to raise funds was further evidenced by the issuance of $450 million of Trust Capital Securities which were marketed to institutional investors, both domestically and internationally. 33 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued MARKET RISK - continued Under an existing shelf registration filed with the Securities Exchange Commission, CoreStates is able to issue a broad range of debt and capital securities. At December 31, 1997, CoreStates had securities of $579 million that were registered but unissued under this shelf. During 1997, approximately $506 million of debt having various terms and interest rates was issued under the shelf registration. Maturities and retirements of long-term debt during 1997 were approximately $374 million. The tables on pages 95 and 97 illustrate the maturity characteristics of CoreStates' domestic certificates of deposit over $100 thousand, loan portfolio and investment portfolio, respectively. For information regarding the maturity characteristics of CoreStates' short-term funds borrowed and long-term debt, see notes 11 and 12 to the financial statements. Investment Portfolio Within the context of the policies and practices previously outlined, CoreStates maintains a portfolio of marketable debt securities to contribute to a balanced interest rate risk position and to provide liquidity reserves. Interest rate risk management disciplines require strict matching of interest rate sensitivities and, therefore, CoreStates generally does not consider changes in the market value of individual portfolios as significant to the management of its interest sensitivity. The investment securities portfolio at December 31, 1997 consisted of investments held-to-maturity with a carrying value of $1,351 million and investments available-for-sale with a carrying value of $2,109 million, compared to $1,689 million and $2,394 million, respectively on December 31, 1996. In addition to debt securities, the available-for-sale portfolio also includes a bank stock portfolio and other marketable equity securities. The accumulated net unrealized gain on available-for-sale securities was $49 million at December 31, 1997, compared to $43 million at December 31, 1996. SOURCES AND USES OF FUNDS Total assets were $48.5 billion at year-end 1997, an increase of 6.5% from year-end 1996. The loan portfolio grew to $34.8 billion at year-end 1997, up $2,483 million, or 7.7%, from year-end 1996. The increase in loans was primarily in the commercial portfolio and the international portfolio. Loan growth at banking subsidiaries was funded primarily by a $623 million, or 15.3%, reduction in the investment portfolio and increased use of discretionary funding such as commercial time deposits and short-term borrowings. The book value of loans sold during 1997 was approximately $890 million and was primarily comprised of approximately $550 million of residential mortgages, $150 million of student loans and $190 million of fixed-rate home equity loans. The impact of loan sales on results of operations was not material. Total deposits increased $461 million, or 1.4%, from year-end 1996 principally as the result of a $1,825 million, or 242%, increase in commercial time deposits. Interest-bearing consumer deposits declined $1,321 million, or 5.9%, from year-end 1996, principally as a result of the relatively low interest rate environment in 1997 and alternative investment opportunities available to consumers. The decline in consumer deposits was offset by increases in various types of market sources of funds including euro-medium term notes, commercial time deposits, Federal funds purchased, Trust Capital Securities and commercial paper. Total assets averaged $45.7 billion in 1997, up $1,924 million, or 4.4%, from 1996. Average loans increased $2,149 million, or 6.7%. As reflected in the chart, "Earning Asset Mix", loans comprised 83.1% of CoreStates' average earning assets in 1997, compared to 81.5% in 1996. 34 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued SOURCES AND USES OF FUNDS - continued Earning Asset Mix - ----------------- 1993 to 1997 - ------------ (percentage of average earning assets)
Earning Asset Mix -------------------------------------------------- Short-term money market Investment investments Securities Loans -------------- ---------- ------ 1997 7.9% 9.0% 83.1% 1996 6.6 11.9 81.5 1995 6.3 16.0 77.7 1994 5.2 18.6 76.2 1993 4.9 20.5 74.6
The accompanying chart, "Funding Mix", illustrates that 57.2% of CoreStates' funds were derived from consumer deposits in 1997, compared with 61.9% in 1996. The decline in consumer deposits as a percentage of total CoreStates funding in 1997 primarily resulted from consumer deposit disintermediation due to the relatively low interest rate environment in 1997 and alternative investment opportunities available to consumers, and from an increased dependence on discretionary funding sources to fund loan growth. Funding to accommodate current business needs and future growth at non-bank subsidiaries is expected to continue to be supported by discretionary funding sources. Funding Mix - ----------- 1993 to 1997 - ------------ (percentage of average earning assets*)
Funding Mix ------------------------------------------------ Other Non- Retail Interest Interest Deposits Bearing Bearing -------- -------- -------- 1997 57.2% 18.4% 24.4% 1996 61.9 12.3 25.8 1995 62.5 13.9 23.6 1994 62.5 12.9 24.6 1993 64.0 12.1 23.9
* excluding short-term money market investments 35 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued REVIEW AND ANALYSIS OF EARNINGS Operating Revenue Operating revenue has two primary sources, net interest income and non-interest income. Net interest income comprised 70% of CoreStates' total revenue in 1997 compared to 71% in 1996. On the accompanying chart ("Operating Revenue"), net interest income is presented excluding the earnings benefit of balances maintained by commercial customers as compensation for transaction oriented non-credit products. Non-interest income and the previously mentioned earnings benefit of balances maintained are presented separately. Net interest income and non-interest income are discussed in further detail on the following pages. Operating Revenue - ----------------- (tax equivalent net interest income plus non-interest income - in millions)
Operating Revenue --------------------------------------------------- Derived Loan and from Non- Investment Non-credit Interest Interest Balances Income Total ---------- ---------- -------- -------- 1997 $1,900.7 $238.7 $925.8 $3,065.2 1996 1,941.0 226.7 899.1 3,066.8 1995 1,993.6 206.6 882.2 3,082.4 1994 1,921.0 186.5 788.5 2,896.0 1993 1,888.0 172.6 832.7 2,893.3
Operating revenue for 1997 was relatively flat compared to 1996. Excluding the impact of the common stock repurchase program, operating revenue would have increased 2%. Tax equivalent net interest income declined $28.2 million, or 1.3%, while non-interest income increased $26.7 million, or 3.0%, due to broad based fee growth. The decline in net interest income for 1997 was primarily due to the funding costs associated with the common stock repurchase program. Operating revenue for 1996, as adjusted for significant and unusual items was down $26.3 million, or 0.9% in comparison to 1995 due to a decline in tax equivalent net interest income of $32.5 million, or 1.5%. The decline in net interest income for 1996 was primarily due to the impact of a $1.0 billion reduction in average interest earning assets and the impact of reduced spreads on loans and deposits. 36 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued REVIEW AND ANALYSIS OF EARNINGS - continued Net Interest Income For analytical purposes, net interest income is adjusted to a taxable equivalent basis to recognize the income from tax exempt assets as if the interest were taxable. Net interest income on a taxable equivalent basis decreased $28.2 million, or 1.3% in 1997, and $32.5 million, or 1.5% in 1996. The decline in net interest income for 1997 was solely the result of the impacts of the $58.8 million cost of funding the common stock repurchase program; the higher replacement cost of funding due to a decline of $2.6 billion, or 16.9%, in average customer savings deposits, NOW accounts and customer certificates; and a narrowing of interest rate spreads earned on loans. These decreases were partially offset by the impacts of an increase in average loan volume of $2.1 billion, or 6.7% primarily in the commercial loan portfolio and relatively short-term international lending; and also by the favorable repricing of deposits. The net interest margin decreased 31 basis points to 5.22% for the same reasons as the decline in net interest income. The strength of CoreStates' net interest income and net interest margin stems from the combination of wide spreads on both loans and deposits and on a balance sheet which has a relatively high portion of loans and a large base of non-interest bearing funding. The following table compares taxable equivalent net interest income for the years ended December 31, 1997, 1996 and 1995. Taxable Equivalent Net Interest Income - -------------------------------------- For the Years Ended December 31, - -------------------------------- (in millions)
Percentage increase(decrease) ----------------- 1997 1996 1995 '97/'96 '96/'95 -------- -------- -------- ------- ------- Total interest income........... $3,429.3 $3,298.2 $3,475.1 4.0% (5.1)% Tax equivalent adjustment....... 23.6 26.2 33.3 (9.9) (21.3) -------- -------- -------- Tax equivalent interest income.. 3,452.9 3,324.4 3,508.4 3.9 (5.2) Total interest expense ......... 1,313.4 1,156.7 1,308.2 13.5 (11.6) -------- -------- -------- Taxable equivalent net interest income........................ $2,139.5 $2,167.7 $2,200.2 (1.3) (1.5) ======== ======== ======== Interest rate spread (a)........ 4.28% 4.60% 4.55% ==== ==== ==== Net interest margin (b)......... 5.22% 5.53% 5.47% ==== ==== ====
- ------------ (a) The interest rate spread represents the difference between the average yield on total interest earning assets and the average cost on total interest bearing liabilities. (b) The net interest margin is a key measure of net interest income performance. It represents the difference between tax equivalent interest income and interest expense (i.e., taxable equivalent net interest income) reflected as a percentage of average earning assets. The decline in net interest income for 1996 was primarily due to the impact of a $1.0 billion, or 2.5%, reduction in average interest earning assets and the impacts of reduced spreads on loans and deposits due to competitive pricing pressures. Compared to 1995, the relatively lower-yielding investment portfolio was reduced $1.8 billion, or 27.5%, on average during 1996, while the loan portfolio grew $0.7 billion, or 2.1%, on average. This adjustment in asset mix, combined with a $0.5 billion increase in interest free funding sources, resulted in a 6 basis point increase in the net interest margin for 1996. 37 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued REVIEW AND ANALYSIS OF EARNINGS - continued For further detailed information regarding average balances, yields and costs, see the consolidated average balance sheet on pages 85-88, and the rate/volume analysis on page 91. Non-Interest Income - ------------------- For the Years Ended December 31, - ------------------------------- (in millions)
Percentage increase(decrease) ------------------- 1997 1996 1995 '97/'96 '96/'95 -------- -------- ------- ------- ------- Service charges on deposits............. $242.3 $229.6 $233.6 5.5% (1.7)% Trust income (a)........................ 186.0 164.9 153.2 12.8 7.6 International services fees............. 113.8 101.8 94.3 11.8 8.0 Debit and credit card fees.............. 97.0 88.8 94.6 9.2 (6.1) Third party processing fees (b)......... 75.5 58.0 47.7 30.2 21.6 Income from investment in EPS, Inc...... 29.5 29.9 30.1 (1.3) (0.7) Income from trading activities.......... 34.4 25.2 35.4 36.5 (28.8) Investment banking fees................. 32.0 23.0 18.1 39.1 27.1 Mortgage banking income................. 8.8 11.3 16.1 (22.1) (29.8) Securities gains........................ 21.1 16.2 17.9 Corporate trust fees (a)................ - 2.3 9.7 Gains on sales of corporate trust....... 4.6 8.2 7.4 Other operating income.................. 80.8 96.6 91.5 (16.4) 5.6 ------ ------ ------ Non-interest income before significant and unusual items....... 925.8 855.8 849.6 8.2 0.7 ------ ------ ------ Certain net investment gains (c)........ - 43.3 13.6 Gain on sale of affiliate joint venture............................. - - 19.0 ------ ------ ------ Total non-interest income............ $925.8 $899.1 $882.2 3.0 1.9 ====== ====== ======
- --------------------- (a) For presentation purposes, fee income on the corporate trust business was presented on a separate line. CoreStates' and Meridian's corporate trust businesses were sold in the fourth quarters of 1995 and 1996, respectively. (b) Includes revenues for QuestPoint lockbox processing, document processing, check processing, and SynapQuest credit card and merchant processing. (c) See "Certain Net Investment Gains" on page 6 for more detail. Non-interest income for 1997 increased $70.0 million, or 8.2%, from the prior year before 1996 significant and unusual items. The increase primarily reflected growth in revenues from fee-based services. The largest contributors to that growth were trust income which increased $21.1 million, or 12.8%, third party processing fees which increased $17.5 million, or 30.2%, service charges on deposits which increased $12.7 million, or 5.5%, fees for international services which increased $12.0 million or 11.8%, income from trading activities which increased $9.2 million, or 36.5%, investment banking fees which increased $9.0 million, or 39.1%, and debit and credit card fees which increased $8.2 million, or 9.2%. Non-interest income for 1996, before the significant and unusual items noted in the above table, increased $6.2 million, or 0.7%. Increases in third party processing fees of 21.6%, international service charges of 8.0%, trust income of 7.6%, investment banking fees of 27.1%, and gains on the securitization of home equity loans were mostly offset by a 29.8% decrease in mortgage banking income, a 28.8% decline in income from trading activities, and a 1.7% decline in service charges on deposits. 38 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued REVIEW AND ANALYSIS OF EARNINGS - continued The following is a discussion of the more significant components of non-interest income: . Service charges on deposit accounts, paid in fees, increased $12.7 million, or 5.5%, in 1997, following a decrease of $4.0 million, or 1.7%, in 1996. After adding the value of service charges paid through the maintenance of deposit balances by commercial and correspondent customers, which is included in net interest income, total service charge compensation for 1997 was $480.9 million, up $24.6 million, or 5.4%, from 1996 mainly due to repricing on business deposit accounts. Total service charge compensation on this basis for 1996 was $456.3 million, an increase of $16.1 million or 3.7% over 1995 reflecting growth in transaction volume. . Trust income increased $21.1 million, or 12.8%, in 1997 and $11.7 million, or 7.6%, in 1996. The 1997 increase was primarily the result of increased asset values in Personal and Institutional Trust. Improvements in 1996 trust fees related to increased revenues from investment management generated from the implementation of the process redesigns and appreciation of asset market values, partially offset by a decline in fees from the employee benefit plan business. . Fees for international services increased $12.0 million, or 11.8%, in 1997, following an increase of $7.5 million, or 8.0%, in 1996. The growth in revenues for 1997 and 1996 reflects a continuing emphasis on non-credit products and international transaction processing services and resulting volume increases at overseas branches which were opened in recent years. For 1997, foreign exchange fees increased $2.7 million, or 11.8%, following a decrease of $0.7 million, or 2.0% for 1996. Fees for international transaction processing services increased $9.5 million, or 12.1%, in 1997 and $8.2 million, or 12.8%, in 1996. . Debit and credit card fees increased $8.2 million, or 9.2% in 1997, following a decrease of $5.8 million, or 6.1%, in 1996. Credit card fees were $40.1 million, $31.9 million, and $25.5 million for 1997, 1996 and 1995, respectively. Debit card fees for the same periods were $56.9 million, $56.9 million and $69.1 million, respectively. The improvement in credit card fees in 1997 and 1996 was due to increased volume on transaction-based fees, partially offset by pricing pressures on annual credit card fees in 1996. The decline in debit card fees for 1996 was attributable to a decrease in merchant fee income due to customer attrition from bank acquisitions, systems conversions, and repricing of unprofitable customers. . Third party processing fees increased $17.5 million, or 30.2%, in 1997 mostly as a result of the acquisition of five check processing centers in October, 1996. Third party processing fees increased $10.3 million, or 21.6% in 1996 primarily as a result of higher check processing and lockbox business in that year. . Investment banking fees increased $9.0 million, or 39.1 %, over 1996 primarily due to an increase in loan syndication fees. Excluding "certain net investment gains" in 1996, CoreStates recorded net securities gains of $21.1 million in 1997, compared to $16.2 million in 1996 and $17.9 million in 1995. Net investment securities gains for 1997 included gains of $22.7 million recorded on sales of bank stocks and losses of $4.8 million recorded on foreign equity securities. Investment securities gains for 1996 included $3.9 million recorded on sales of equity securities acquired in connection with prior loan arrangements, $4.6 million recorded on sales of bank stocks, and $1.4 million on the sale of foreign equity securities. Investment securities gains for 1995 included $7.8 million of gains recorded on sales of equity securities acquired in connection with prior loan arrangements. Other non-interest income for 1997 included gains on securitization of home equity loans of $4.9 million, compared to $8.9 million in 1996 and $0.5 million in 1995. Also included in other non-interest income are commissions on standby letters of credit which declined $3.2 million, or 18.6%, from 1996. 39 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued REVIEW AND ANALYSIS OF EARNINGS - continued
Non-Financial Expenses - ---------------------- Percentage For the Years Ended December 31, increase(decrease) - -------------------------------- -------------------- (in millions) 1997 1996 1995 '97/'96 '96/'95 --------- ---------- ---------- -------- -------- Salaries, wages and benefits........ $ 822.2 $ 826.4 $ 904.4 (0.5)% (8.6)% Net occupancy expense............... 143.1 157.4 159.5 (9.1) (1.3) Outside services hired.............. 157.7 155.0 146.3 1.7 5.9 Equipment expense................... 125.1 120.6 118.5 3.7 1.8 Amortization of intangible assets... 37.7 40.0 44.8 (5.8) (10.7) FDIC premiums....................... 5.3 4.3 42.0 23.3 (89.8) OREO expense (income)............... (0.2) (0.8) 6.4 Other operating expenses ........... 332.9 320.0 325.0 4.0 (1.5) --------- ---------- ---------- Non-financial expenses before significant and unusual items.... 1,623.8 1,622.9 1,746.9 0.1 (7.1) --------- ---------- ---------- Restructuring and merger-related charges.......................... 15.0(a) 139.7(c) 138.6(e) Other significant and unusual items............................ 57.0(b) 14.2(d) - --------- ---------- ---------- Total non-financial expenses..... $ 1,695.8 $ 1,776.8 $ 1,885.5 (4.6) (5.8) ========= ========== ==========
- ------------------------------- (a) Reflects restructuring and merger-related charges primarily related to costs incurred in the pending First Union merger and costs incurred in the creation of a strategic technology alliance with Andersen Consulting. See "Restructuring and Merger-Related charges" on page 5 for more detail. (b) Includes a $25.0 million charitable contribution, $20.0 million for certain legal matters and a special $12.0 million employee bonus. (c) Consists of net restructuring charges of $110.7 million primarily related to the Acquisition and charges of $29.0 million for merger implementation costs. See "Restructuring and Merger-Related Charges" on page 5 for more detail. (d) Reflects the SAIF special assessment. See "Other Significant One-time Charges" on page 6" for more detail. (e) Reflects net restructuring charges of $128.6 million related to the 1995 process redesigns and a $10.0 million charge related to the Acquisition. See "Restructuring and Merger-Related Charges" on page 5 for more detail. Comparison of 1997 to 1996 - Total non-financial expenses for 1997, before -------------------------- the significant and unusual items noted in the above table, were $1,623.8 million. This represents an increase of only $0.9 million, or 0.1%, when compared to 1996. This year-to-year stability reflects merger-related efficiencies partially offset by costs for technology investments. Salaries, wages and benefits decreased $4.2 million, or 0.5%, in 1997 reflecting a decline of $25.1 million, or 14.7%, in benefits partially offset by an increase of $20.8 million, or 3.2%, in salaries and wages. The increase in salaries and wages reflects slightly higher staffing levels in early 1997 as well as normal pay increases. The decline in benefits resulted primarily from reduced costs for post-retirement benefits. The number of full-time equivalent employees at December 31, 1997, 1996 and 1995 was: 18,847; 19,114; and 19,957, respectively. Comparison of 1996 to 1995 - Total non-financial expenses for 1996, before -------------------------- the significant and unusual items as noted in the above table, were $1,622.9 million, a decrease of $124.0 million, or 7.1% from 1995. This decline reflects the impacts of the process redesigns, merger-related efficiencies and a reduction in Federal Deposit Insurance Corporation ("FDIC") premiums. For the 1996 full year, CoreStates was not assessed premiums on deposits insured under the Bank Insurance Fund. SAIF deposits were assessed premiums during the first three quarters of 1996 and a special assessment as of September 30, 1996. Partially offsetting these declines, was an increase in expense for outside services hired of $8.7 million, or 5.9%, primarily due to the impacts of outsourcing certain functions and costs for competitive and technology investments. 40 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued REVIEW AND ANALYSIS OF EARNINGS - continued Salaries, wages and benefits decreased $78.0 million, or 8.6%, in 1996 reflecting reduced staff levels from the process redesigns and merger consolidations. For 1996, salaries and wages declined by 6.8%, while benefits expense declined 15.1%. The larger percentage decline in benefits expense was primarily due to reduced retiree medical expense. Provision for Income Taxes The provision for income taxes was $269.6 million in 1997 compared to $385.8 million in 1996 and $364.4 million in 1995. The $116.2 million decrease in 1997 tax expense was primarily due to a $109.0 million benefit resulting from the liquidation of an affiliate. The $21.4 million increase in 1996 tax expense was principally due to higher pre-tax income and non-deductible expenses. The provision for income taxes for 1997, 1996 and 1995 were at effective rates of 24.9%, 37.3%, and 35.7%, respectively. Accounting Standards Effective in 1998 FAS 125 and FAS 127- Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("FAS 125"), was issued in June 1996. FAS 125 requires an entity to recognize the financial and servicing assets it controls and the liabilities it has incurred and to derecognize financial assets when control has been surrendered in accordance with the criteria provided in the Statement. FAS 125 is applicable to transactions occurring after December 31, 1996, except for provisions dealing with securities lending, repurchase and dollar repurchase agreements, which are deferred by FAS 127 and became effective January 1, 1998. The adoption of FAS 125 did not have and the adoption of FAS 127 is not expected to have a material impact on CoreStates' results of operations or financial condition. FAS 130 - Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("FAS 130") establishes standards for the reporting and the presentation of comprehensive income, which is divided into net income and other comprehensive income. Other comprehensive income items are to be classified by their nature and by their related accumulated balances in the appropriate financial statements of a company. FAS 130 requires unrealized gains and losses on the Company's available-for-sale securities and the foreign currency translation adjustments, which currently are reported in shareholder's equity, to be included in other comprehensive income and the disclosure of total comprehensive income. This Standard requires that such items be presented with equal prominence on a comparative basis in the appropriate financial statements for fiscal years beginning after December 15, 1997. FAS 131 - Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("FAS 131") establishes standards and disclosure requirements for the way companies report information about operating segments, including related product information, both in annual and interim reports issued to stockholders. Operating segments are components of a company about which separate financial information is available and which are used in determining resource allocations and performance results. FAS 131 also establishes standards for related disclosures about products and services, geographic areas, and major customers. Information such as segment net earnings, appropriate revenue and expense items and certain balance sheet items are required to be presented, and such amounts are required to be reconciled to the company's combined financial information. Certain information related to FAS 131 is included in the BUSINESS LINE RESULTS section. FAS 131 is effective for annual financial statements issued for periods ending after December 31, 1997, although earlier application is encouraged. CoreStates intends to adopt FAS 131 in the first quarter of 1998. 41 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations: continued Fourth Quarter Results In the fourth quarter of 1997, CoreStates recorded net income of $216.6 million, or $1.09 per average common share, compared to $195.5 million, or $0.91 per average common share, in the fourth quarter of 1996. Diluted net income per share was $1.08 in the fourth quarter of 1997, compared to $0.90 in the fourth quarter of 1996. "Operating earnings," defined as net income before special items, was $198.6 million, or $0.99 per share, for the fourth quarter of 1997, an increase of 6.5% on a per share basis over fourth quarter of 1996 operating income of $201.6 million, or $0.93 per share. The increase in fourth quarter of 1997 operating earnings was driven by strong growth in non-interest income and the decline in average common shares outstanding due to the common stock repurchase program, which added $0.04 to earnings per share after considering the unfavorable impact of $15.8 million in funding costs. Selected financial results for the three months ended December 31, 1997 and 1996 based on operating earnings, which exclude the significant items listed below, were as follows (in millions, except per share):
Three Months Ended December 31, --------------------------- 1997 1996 --------- -------- Net income............................................ $ 216.6 $ 195.5 Exclude the following after-tax items: Special tax benefit.............................. (109.0) - Special provision for loan losses................ 44.9 - Restructuring and merger-related charges......... 9.6 6.1 Other............................................ 36.5 - --------- -------- Operating earnings.................................... $ 198.6 $ 201.6 ========= ======== Operating earnings per common share: Basic............................................ $1.00 $0.93 Diluted.......................................... $0.99 $0.93 Return on average total assets........................ 1.66% 1.81% Return on average shareholders' equity................ 24.84% 21.03%
42 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Management's Report on Internal Controls Over Financial Reporting Financial Statements CoreStates Financial Corp is responsible for the preparation, integrity, and fair presentation of its published financial statements as of December 31, 1997, and the year then ended. The consolidated financial statements of CoreStates Financial Corp have been prepared in accordance with generally accepted accounting principles and, as such, include some amounts that are based on judgments and estimates of management. Internal Control over Financial Reporting Management is responsible for establishing and maintaining effective internal control over financial reporting. The system contains monitoring mechanisms and actions are taken to correct deficiencies identified. There are inherent limitations in the effectiveness of any internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal control can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control may vary over time. Management assessed CoreStates Financial Corp's internal control over financial reporting as of December 31, 1997. This assessment was based on criteria for effective internal control over financial reporting described in "Internal Control - Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that CoreStates Financial Corp maintained effective internal control over financial reporting as of December 31, 1997. Chief Financial Officer /s/ Albert W. Mandia Chairman and Chief Executive Officer /s/ Terrence A. Larsen 43 REPORT OF INDEPENDENT AUDITORS The Board of Directors and Shareholders CoreStates Financial Corp We have audited the accompanying consolidated balance sheets of CoreStates Financial Corp as of December 31, 1997 and 1996, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the 1995 financial statements of Meridian Bancorp, Inc. and United Counties Bancorporation, which statements reflect combined net interest income constituting 31.3% of the related consolidated total for the year ended December 31, 1995. Those statements were audited by other auditors whose reports thereon have been furnished to us, and our opinion, insofar as it relates to data included for Meridian Bancorp, Inc. and United Counties Bancorporation, is based solely on the reports of other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the reports of other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the reports of other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of CoreStates Financial Corp at December 31, 1997 and 1996, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. /s/ Ernst & Young LLP Philadelphia, Pennsylvania January 20, 1998 44 CoreStates Financial Corp and Subsidiaries CONSOLIDATED STATEMENT OF INCOME (in thousands, except per share amounts)
Year Ended December 31, ---------------------------------------------- 1997 1996 1995 ----------- ----------- ----------- INTEREST INCOME Interest and fees on loans: Taxable income..................................................... $2,995,604 $2,845,898 $2,902,265 Tax exempt income.................................................. 20,310 25,335 30,390 Interest on investment securities: Taxable income..................................................... 202,425 254,576 349,138 Tax exempt income.................................................. 18,455 23,190 31,018 Interest on time deposits in banks.................................... 163,454 122,752 121,993 Interest on Federal funds sold, securities purchased under agreements to resell and other............................... 29,067 26,453 40,276 ---------- --------- ---------- Total interest income.............................................. 3,429,315 3,298,204 3,475,080 ---------- --------- ---------- INTEREST EXPENSE Interest on deposits: Domestic savings................................................... 383,333 295,650 396,176 Domestic time...................................................... 436,135 497,956 492,610 Overseas branches and subsidiaries................................. 64,896 48,174 52,261 ---------- --------- ---------- Total interest on deposits...................................... 884,364 841,780 941,047 Interest on short-term funds borrowed................................. 189,835 153,129 214,119 Interest on long-term debt............................................ 239,248 161,811 152,989 ---------- --------- ---------- Total interest expense.......................................... 1,313,447 1,156,720 1,308,155 ---------- --------- ---------- Net interest income................................................ 2,115,868 2,141,484 2,166,925 Provision for losses on loans......................................... 263,000 228,767 144,002 ---------- --------- ---------- Net interest income after provision for losses on loans............ 1,852,868 1,912,717 2,022,923 ---------- --------- ---------- NON-INTEREST INCOME Service charges on deposit accounts................................... 242,285 229,592 233,592 Trust income.......................................................... 186,031 167,138 162,776 Fees for international services....................................... 113,767 101,761 94,396 Debit and credit card fees............................................ 96,983 88,811 94,659 Income from investment in EPS, Inc.................................... 29,486 29,902 30,114 Income from trading activities........................................ 34,445 25,216 35,403 Securities gains...................................................... 21,111 59,512 31,475 Other gains........................................................... - 8,200 26,400 Other operating income................................................ 201,662 188,943 173,407 ----------- --------- ---------- Total non-interest income.......................................... 925,770 899,075 882,222 ----------- --------- ---------- NON-FINANCIAL EXPENSES Salaries, wages and benefits.......................................... 834,184 826,442 904,377 Net occupancy......................................................... 143,112 157,358 159,530 Equipment expenses.................................................... 125,070 120,602 118,532 Restructuring and merger-related charges.............................. 15,000 139,702 138,600 Other operating expenses.............................................. 578,411 532,724 564,489 ----------- --------- ---------- Total non-financial expenses....................................... 1,695,777 1,776,828 1,885,528 ----------- --------- ---------- INCOME BEFORE INCOME TAXES............................................ 1,082,861 1,034,964 1,019,617 Provision for income taxes............................................ 269,582 385,820 364,441 ----------- --------- ---------- NET INCOME............................................................ $ 813,279 $ 649,144 $ 655,176 =========== ========= ========== PER COMMON SHARE DATA Net income: Basic.............................................................. $4.00 $2.97 $2.95 ===== ===== ===== Diluted............................................................ $3.96 $2.94 $2.92 ===== ===== ===== Cash dividends declared............................................... $1.91 $1.73 $1.44 ===== ===== =====
See accompanying notes to the financial statements. 45 CoreStates Financial Corp and Subsidiaries CONSOLIDATED BALANCE SHEET (in thousands)
December 31, -------------------------------- 1997 1996 ------------ ------------ ASSETS Cash and due from banks................................... $ 3,829,893 $ 3,462,287 Time deposits, principally Eurodollars.................... 3,122,444 2,443,154 Federal funds sold and securities purchased under agreements to resell.................................. 41,207 509,694 Trading account assets.................................... 495,472 122,317 Investment securities available-for-sale.................. 2,109,254 2,394,166 Investment securities held-to-maturity (market value: 1997-$1,347,819; 1996-$1,692,243)..................... 1,351,137 1,689,058 Total loans, net of unearned discounts of $249,702 in 1997 and $234,607 in 1996................. 34,813,886 32,331,297 Less: Allowance for loan losses....................... (634,432) (710,327) ------------ ------------ Net loans......................................... 34,179,454 31,620,970 ------------ ------------ Due from customers on acceptances......................... 641,859 738,077 Premises and equipment.................................... 629,965 625,876 Other assets.............................................. 2,060,280 1,888,595 ------------ ------------ Total assets...................................... $ 48,460,965 $ 45,494,194 ============ ============ LIABILITIES Deposits: Domestic: Non-interest bearing.............................. $ 9,252,376 $ 9,330,445 Interest bearing.................................. 23,490,992 22,986,955 Overseas branches and subsidiaries.................... 1,444,522 1,409,756 ------------ ------------ Total deposits.................................... 34,187,890 33,727,156 ------------ ------------ Short-term funds borrowed................................. 4,323,319 2,633,157 Bank acceptances outstanding.............................. 641,464 727,728 Other liabilities......................................... 1,616,624 1,661,162 Long-term debt............................................ 4,454,236 3,049,297 ------------ ------------ Total liabilities................................. 45,223,533 41,798,500 ------------ ------------ COMMITMENTS AND CONTINGENT LIABILITIES SHAREHOLDERS' EQUITY Preferred stock: authorized 10.0 million shares; no shares issued.............................. - - Common stock: $1 par value; authorized 350.0 million shares; issued 223.599 million shares in 1997 and 1996 (including treasury shares of 23.235 million in 1997 and 8.900 million in 1996, and unallocated shares held by Employee Stock Ownership Plan ("ESOP") of 2.148 million in 1997 and 2.267 million in 1996)............ 223,599 223,599 Other common shareholders' equity, net.................... 3,013,833 3,472,095 ------------ ------------ Total shareholders' equity........................ 3,237,432 3,695,694 ------------ ------------ Total liabilities and shareholders' equity........ $ 48,460,965 $ 45,494,194 ============ ============
See accompanying notes to the financial statements. 46 CoreStates Financial Corp and Subsidiaries Page 1 of 2 CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (in thousands)
Common Capital Retained Treasury Unallocated stock surplus earnings stock ESOP shares Total -------- ---------- ---------- --------- ----------- ---------- Balances at December 31, 1994.......................... $229,827 $1,200,658 $2,360,312 $ (24,297) $ (35,568) $3,730,932 Net income............................................. 655,176 655,176 Net change in unrealized gain on investments available-for-sale, net of tax..................... 41,187 41,187 Treasury shares acquired (10,307 shares)............... (335,528) (335,528) Repurchase and retirement of common stock (595 shares)....................................... (595) (4,093) (12,446) (17,134) Common stock issued under employee benefit plans (1,002 new shares; 3,089 treasury shares).......... 999 26,825 (25,483) 96,670 99,011 Common stock issued under dividend reinvestment plan (417 treasury shares).............................. (9) (2) 12,690 12,679 Purchase of shares for Employee Stock Ownership Plan (876 shares) ...................................... (20,922) (20,922) Employee Stock Ownership Plan shares committed for release (123 shares)............................... 1,786 2,824 4,610 Cash paid for fractional shares........................ (24) (24) Foreign currency translation adjustments............... (29) (29) Common dividends declared.............................. (294,393) (294,393) -------- ---------- ---------- --------- --------- ---------- Balances at December 31, 1995.......................... 230,231 1,225,167 2,724,298 (250,465) (53,666) 3,875,565 Net income............................................. 649,144 649,144 Net change in unrealized gain on investments available-for-sale, net of tax..................... (25,070) (25,070) Treasury shares acquired (11,055 shares)............... (533,932) (533,932) Treasury shares issued in merger (7,300 shares)........ (7,300) (33,288) (192,042) 232,630 - Repurchase and retirement of common stock (1,340 shares)..................................... (1,340) (43,559) (12,804) (57,703) Common stock issued under employee benefit plans (1,824 new shares; 2,330 treasury shares).......... 1,824 75,618 (48,119) 100,826 130,149 Common stock issued under dividend reinvestment plan (184 new shares; 353 treasury shares)............. 184 8,225 (68) 13,361 21,702 Purchase of shares for Employee Stock Ownership Plan (65 shares).................................. (38) (3,509) (3,547) Employee stock ownership plan shares committed for release (126 shares)................. 2,397 3,018 5,415 Cash paid for fractional shares........................ (342) (342) Foreign currency translation adjustments............... 5,448 5,448 Common dividends declared.............................. (371,135) (371,135) -------- ---------- ---------- --------- -------- ---------- Balances at December 31, 1996.......................... 223,599 1,234,522 2,729,310 (437,580) (54,157) 3,695,694
(continued) 47 CoreStates Financial Corp and Subsidiaries Page 2 of 2 CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY: continued (in thousands)
Common Capital Retained Treasury Unallocated stock surplus earnings stock ESOP shares Total -------- ---------- ---------- ---------- ----------- ---------- Net income............................................ 813,279 813,279 Net change in unrealized gain on investments available-for-sale, net of tax.................... 5,149 5,149 Treasury shares acquired (17,100 shares).............. (1,007,832) (1,007,832) Common stock issued under employee benefit plans (2,209 treasury shares)........................... 22,665 (70,325) 133,198 85,538 Common stock issued under dividend reinvestment plan (556 treasury shares)............................. 676 (1,058) 30,383 30,001 Employee stock ownership plan shares committed for release (119 shares)................ 4,423 2,846 7,269 Foreign currency translation adjustments.............. (748) (748) Common dividends declared............................. (390,918) (390,918) -------- ---------- ---------- ---------- ----------- ---------- Balances at December 31, 1997......................... $223,599 $1,262,286 $3,084,689 $(1,281,831) $(51,311) $3,237,432 ======== ========== ========== ========== =========== ==========
See accompanying notes to the financial statements. 48 CoreStates Financial Corp and Subsidiaries Page 1 of 2 CONSOLIDATED STATEMENT OF CASH FLOWS (in thousands)
Year Ended December 31, ------------------------------------------------ OPERATING ACTIVITIES 1997 1996 1995 ------------ ------------ ------------ Net income........................................................... $ 813,279 $ 649,144 $ 655,176 Adjustments to reconcile net income to net cash provided by operating activities: Restructuring and merger-related charges.......................... 15,000 139,702 138,600 Provision for losses on loans..................................... 263,000 228,767 144,002 Provision for losses and writedowns on other real estate owned...................................... 5,500 3,387 15,971 Depreciation and amortization..................................... 126,749 110,512 122,996 Deferred income tax expense....................................... 100,751 9,156 28,420 Securities gains.................................................. (21,111) (59,512) (31,475) Gains on sale of mortgage servicing............................... - - (2,387) Other gains....................................................... - (8,200) (26,400) (Increase) decrease in loans held-for-sale........................ (395,583) 93,039 82,226 (Increase) decrease in trading account assets.................... (373,155) 24,901 200,833 Increase (decrease) in due to factored clients.................... 143,486 1,805 (86,921) (Increase) decrease in interest receivable........................ (34,460) 45,046 2,009 Increase in interest payable...................................... 23,014 10,163 45,044 Decrease in merger-related accrual ............................... (59,451) (100,258) (33,270) Other, net........................................................ (101,623) 216,135 ( 84,141) ------------ ------------ ------------ NET CASH PROVIDED BY OPERATING ACTIVITIES 505,396 1,363,787 1,170,683 ------------ ------------ ------------ INVESTING ACTIVITIES Net increase in loans................................................ (3,592,259) (2,989,441) (1,914,405) Proceeds from sales of loans......................................... 898,828 1,577,270 1,087,732 Loans originated or acquired--non-bank subsidiaries.................. (37,198,437) (39,054,032) (35,767,440) Principal collected on loans--non-bank subsidiaries.................. 37,056,155 39,039,627 35,407,667 Net increase in time deposits, principally Eurodollars............... (679,290) (533,894) (33,172) Purchases of investments held-to-maturity............................ (650,362) (490,995) (686,652) Purchases of investments available-for-sale.......................... (568,161) (2,062,012) (589,327) Proceeds from maturities of investments held-to-maturity............. 995,449 1,524,670 2,175,780 Proceeds from maturities of investments available-for-sale........... 807,037 854,898 161,477 Proceeds from sales of investments available-for-sale................ 122,037 1,500,504 546,728 Net decrease in Federal funds sold and securities purchased under agreements to resell................... 468,487 210,243 203,693 Purchases of premises and equipment.................................. (90,085) (101,469) (125,216) Proceeds from sales and paydowns on other real estate owned................................................. 12,896 31,465 66,834 Other, net........................................................... 33,493 141,063 11,303 ------------ ------------ ------------ NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES....................................................... (2,384,212) (352,103) 545,002 ------------ ------------ ------------
(continued) 49 CoreStates Financial Corp and Subsidiaries Page 2 of 2 CONSOLIDATED STATEMENT OF CASH FLOWS: continued (in thousands)
Year Ended December 31, ----------------------------------------------- 1997 1996 1995 ------------ ------------ ------------ FINANCING ACTIVITIES Net increase (decrease) in deposits........................... 460,734 172,155 (660,745) Payment for sales of deposits................................. - (368,110) (154,360) Proceeds from issuance of long-term debt...................... 2,033,056 1,340,099 582,251 Retirement of long-term debt.................................. (630,547) (501,165) (533,480) Net increase (decrease) in short-term funds borrowed.......... 1,690,162 (1,043,856) 215,764 Cash dividends paid........................................... (391,781) (328,114) (286,565) Purchases of treasury stock................................... (1,007,832) (533,932) (335,528) Repurchase and retirement of common stock..................... - (57,703) (17,134) Common stock issued under employee benefit plans.............. 62,873 87,726 99,011 Other, net.................................................... 29,757 21,360 12,655 ------------ ------------ ------------ NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES...................................... 2,246,422 (1,211,540) (1,078,131) ------------ ------------ ------------ INCREASE (DECREASE) IN CASH AND DUE FROM BANKS................................................ 367,606 (199,856) 637,554 Cash and due from banks at January 1,......................... 3,462,287 3,662,143 3,024,589 ------------ ------------ ------------ CASH AND DUE FROM BANKS AT DECEMBER 31,....................... $ 3,829,893 $ 3,462,287 $ 3,662,143 ============ ============ ============ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the year for: Interest.................................................. $ 1,290,433 $ 1,146,557 $ 1,263,681 ============ ============ ============ Income taxes.............................................. $ 193,532 $ 331,940 $ 284,987 ============ ============ ============ Net cash received on interest rate swaps...................... $ 54,230 $ 68,103 $ 7,493 ============ ============ ============
See accompanying notes to the financial statements. 50 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of presentation The consolidated financial statements include the accounts of CoreStates Financial Corp ("the Corporation") and all of its subsidiaries, including: CoreStates Bank, N.A. ("CBNA"); CoreStates Bank of Delaware, N.A. ("CBD"); Congress Financial Corporation; and CoreStates Capital Corp ("CSCC"). All material intercompany transactions have been eliminated. Certain amounts in prior years have been reclassified for comparative purposes. The Corporation is a bank holding company incorporated under the laws of the Commonwealth of Pennsylvania, primarily operating in the eastern Pennsylvania, northern Delaware and the central and southern New Jersey markets. Through its subsidiaries, the Corporation is engaged in the business of providing global and specialized banking (including international banking services), regional banking, retail credit services, trust and asset management and third party processing services to a diversified customer base. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Changes in accounting principles Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("FAS 125"), was issued in June 1996. FAS 125 requires an entity to recognize the financial and servicing assets it controls and the liabilities it has incurred and to derecognize financial assets when control has been surrendered in accordance with the criteria provided in the Statement. FAS 125 is applicable to transactions occurring after December 31, 1996, except for provisions dealing with securities lending, repurchase and dollar repurchase agreements, which are deferred by FAS 127 and became effective January 1, 1998. The adoption of FAS 125 did not, and the adoption of FAS 127 is not expected to, have a material impact on the Corporation's results of operations or financial condition. Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("FAS 128") was issued in February 1997. FAS 128, which was adopted on December 31, 1997, required entities to change the method used to compute earnings per share. Under FAS 128, basic earnings per share excludes the dilutive effect of stock options and diluted earnings per share includes the dilutive effect of stock options even if the dilutive effect is immaterial. All periods presented have been restated to comply with FAS 128. Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("FAS 123") was adopted by the Corporation in 1996 and establishes accounting and reporting standards for stock-based employee compensation plans such as stock option and restricted stock plans ("stock-based plans"). FAS 123 defines a fair value method of accounting for measuring compensation expense for stock-based plans and encourages all entities to adopt that method of accounting. However, FAS 123 also permits entities to continue to measure compensation expense for stock-based plans using the intrinsic value method prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees." Under the fair value method, compensation expense would be measured as the value of an award under a stock-based plan on the date the award is granted, and would be recognized over the vesting period of the award. Under the intrinsic value method, compensation expense is measured as the excess, if any, of the market price of the stock underlying the award on the date the award is granted, over the exercise price. Under the Corporation's stock-based long-term incentive plan, awards have no intrinsic value on the date of grant as the exercise price equals the market price on that date. The Corporation did not adopt the fair value method of accounting for stock-based plans, and will continue to use the intrinsic value method to measure compensation expense. Effective January 1, 1995, the Corporation adopted Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan" ("FAS 114") and Statement No. 118, "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures" ("FAS 118"). FAS 114 addresses accounting for impairment of certain loans and requires that impaired loans within the scope of FAS 114 be measured based on the present value of expected cash flows discounted at the loan's effective interest rate, or be measured at the loan's observable market price or the fair value of its collateral. FAS 118 amended the income recognition policies and clarified disclosure requirements of FAS 114. The adoption of these standards did not have an impact on CoreStates' provision for loan losses or allowance for loan losses, nor change CoreStates' methodology for recognizing income on impaired loans. 51 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued Income taxes Deferred tax assets and liabilities are recognized for the tax consequences of temporary differences by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The Corporation and its subsidiaries file a consolidated Federal income tax return. Investments Held-to-maturity securities, consisting primarily of debt securities, are carried at cost adjusted for amortization of premiums and accretion of discounts, both computed on the interest method. The Corporation has both the ability and positive intent to hold these securities until maturity. Trading account assets are carried at market value. Gains on trading account assets include both realized and unrealized gains and losses on the portfolio. All other securities are classified as available-for-sale and are carried at fair value, with unrealized gains and losses, net of tax, reported as a component of shareholders' equity. The net unrealized gain on available-for-sale securities included in retained earnings was $31,704 at December 31, 1997 and $26,555 at December 31, 1996. Realized securities gains and losses are determined using the adjusted cost of a specific security sold. Interest and dividends on investment securities are recognized as income when earned. Loans Interest on commercial loans is recognized on the daily principal amounts outstanding. Loan fees are generally considered adjustments of interest rate yields and are amortized into interest income on loans over the terms of the related loans. Interest on installment loans is principally recognized on the interest method. Commercial loans are placed on a non-accrual status, generally recognizing interest as income when received, when, in the opinion of management, the collectability of principal or interest payments becomes doubtful or when such payments are 90 days or more past due, unless the loan is well secured and in the process of collection. The deferral or non-recognition of interest does not constitute forgiveness of the borrower's obligation. Consumer loans, excluding residential mortgage loans and credit card loans, are charged off after reaching 120 days past due. Residential mortgage loans are placed on non-accrual status after reaching 120 days past due and are written down to the fair value of underlying collateral at that time. Credit card loans are charged off after reaching 150 days past due. Prior to the second quarter of 1996, credit card loans were charged off after reaching 180 days past due. Loans classified as held for sale are included in other assets and are carried at their net realizable value. Other real estate owned When a property is acquired through foreclosure of a loan secured by real estate, that property is recorded at the lower of the cost basis in the loan or the estimated fair value of the property less estimated disposal costs. Writedowns at the time of foreclosure are charged against the allowance for loan losses. Subsequent writedowns for changes in the fair value of the property are charged to other non-financial expense. Allowance for loan losses The allowance for loan losses is maintained at a level believed adequate by management to absorb estimated probable credit losses. Factors included in management's determination of an adequate level of allowance for loan losses are a statistical analysis of historical loss levels throughout an economic cycle and one year of projected charge-offs, establishing a minimum level below which the allowance for loan losses is considered inadequate and a maximum level above which is considered inappropriate. A quarterly evaluation of loss potential on specific credits, products, industries, portfolios and markets, as well as indicators for loan growth, the economic environment and concentrations assist in validating the position of the allowance for loan losses within those boundaries. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change. 52 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued The Corporation adopted FAS 114 effective January 1, 1995. Under FAS 114, the allowance for loan losses related to "impaired loans" is based on discounted cash flows using the impaired loan's initial effective interest rate as the discount rate, or the fair value of the collateral for collateral dependent loans. A loan is impaired when it meets the criteria to be placed on non-accrual status or is a renegotiated loan. Loans which are evaluated for impairment pursuant to FAS 114 are assessed on a loan-by-loan basis, and include only commercial non-accrual and renegotiated loans. Large groups of smaller balance homogeneous loans, such as commercial loans less than $250 and credit cards, lease financing receivables, loans secured by first and second liens on residential properties, and other consumer loans are evaluated collectively for impairment. Additions to the allowance arise from the provision for loan losses charged to operations or from the recovery of amounts previously charged off. Loan charge-offs reduce the allowance. Loans are charged off when there has been permanent impairment of the related carrying values. Premises and equipment Premises and equipment are stated at cost, less accumulated depreciation and amortization. The provision for depreciation and amortization is computed, generally, on the straight-line method at rates based on the following range of lives: buildings - 10 to 45 years; equipment - 3 to 12 years; and leasehold improvements - 3 to 15 years. Intangible assets (included in other assets) Goodwill and other acquired intangibles, such as core deposits, are amortized over the estimated periods to be benefited generally ranging from 5 to 25 years. An impairment review is performed periodically on these assets. Retirement plans The Corporation maintains non-contributory defined benefit pension plans for substantially all employees. Benefits are primarily based on the employee's years of credited service, average annual salary and primary social security benefit, as defined in the plans. It is the Corporation's policy to fund the plans on a current basis to the extent deductible under existing tax regulations. The Corporation provides postretirement health care and life insurance benefits for substantially all retired employees. In order to participate in the health care plan, an employee must retire with at least 10 years of service. The postretirement health care plan is contributory, with retiree contributions based on years of service. It is the Corporation's policy to fund these plans on a current basis to the extent deductible under existing tax regulations. Employee Stock Ownership Plan ("ESOP") Compensation expense in 1996 and 1995 was recognized based on the average fair value of shares committed to be released to employees. Effective January 1, 1997, the ESOP was combined with the Corporation's 401(k) Savings Plan. The remaining shares in the ESOP will be released to substantially all employees of the Corporation and compensation expense will be recorded as a portion of the Corporation's match of employee contributions to the 401(k) Savings Plan. Shares are released based on the fair value of the shares at the date the compensation expense is recorded. Foreign exchange/currency Forward exchange contracts are valued at current rates of exchange. Gains or losses on forward exchange contracts intended to hedge an identifiable foreign currency commitment, if any, are deferred and included in the measurement of the related foreign currency transaction. All other gains or losses on forward exchange contracts are included in fees for international services. Currency gains and losses in connection with non-dollar denominated loans and deposits, which are included in interest income and expenses, are recognized pro rata over the contract terms. Foreign currency translation adjustments are recorded directly to retained earnings. The cumulative foreign currency translation gain (loss) was $3,100, $3,848 and $(1,600) at December 31, 1997, 1996 and 1995, respectively. 53 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued Derivative interest rate contracts The Corporation uses various interest rate contracts such as, interest rate swaps, futures, forward rate agreements, caps and floors, tender option bonds, Treasury float agreements, and forward commitments to purchase and sell loans and securities, primarily to manage the interest rate risk of specific assets, liabilities or anticipated transactions, to manage interest rate risk in securities trading positions and to provide for the needs of its customers. For contracts held for purposes other than trading, gains or losses are deferred and recognized as adjustments to interest income or expense of the underlying assets or liabilities and the interest differentials are recognized as adjustments of the related interest income or expense. Gains or losses resulting from early terminations of these contracts are deferred and amortized over the remaining term of the underlying assets or liabilities. Any fees received or disbursed which represent adjustments to the yield on interest rate contracts are capitalized and amortized over the term of the interest rate contracts. If the underlying assets or liabilities related to a derivative matures, is sold, extinguished, or terminates, the amount of the previously unrecognized gain or loss is recognized at that time in the consolidated income statement. The Corporation's trading and customer-related derivative positions mostly include tender option bonds, Treasury float agreements, and forward commitments to purchase and sell loans and securities, and interest rate caps, floors, and swaps. Gains and losses and net interest spread earned on these products are generally included in non-interest income. Treasury float agreements represent purchased option contracts. Forward commitments to purchase and sell loans and securities consist primarily of forward commitments to sell mortgage-backed securities, which are used to hedge mortgage loans held in the trading account. These commitments are marked to fair value with unrealized gains and losses recorded in income from trading activities. Contracts held or issued for customers are valued at market with gains or losses included in income from trading activities. Earnings per common share Basic earnings per common share for all periods presented are calculated by dividing net income by weighted average common shares outstanding. Diluted earnings per share for all periods presented are calculated by dividing net income by the sum of weighted average common shares outstanding and potentially dilutive shares (primarily stock options). For purposes of computing earnings per share, only shares committed to be released and shares allocated in the ESOP are considered outstanding. Unless otherwise noted, all "per share" amounts are on a diluted basis. Treasury stock The purchase of the Corporation's common stock is recorded at cost. At the date of subsequent reissuance, the treasury stock account is reduced by the cost of shares reissued on a last-in-first-out basis. Cash dividends declared per share Cash dividends declared per share for the periods prior to the acquisition of Meridian Bancorp, Inc. ("Meridian") on April 9, 1996, assume that the Corporation would have declared cash dividends equal to the cash dividends per share actually declared by the Corporation. 2. MERGERS AND ACQUISITIONS Pending merger On November 18, 1997, the Corporation entered into an Agreement and Plan of Mergers (the "Merger Agreement"), which provides, among other things, for the merger (the "Merger") of the Corporation into First Union Corporation ("First Union"). Pursuant to the Merger Agreement, each outstanding share of the Corporation's common stock would be converted into 1.62 shares of First Union's common stock (the "Exchange Ratio"), subject to possible adjustment under certain circumstances. The Merger is intended to be accounted for as a pooling of interests. Consummation of the Merger is subject to various conditions, including: (i) receipt of the approval of the Merger Agreement by the Corporation's and First Union's stockholders, and approval by First Union's stockholders of an amendment to First Union's Articles of Incorporation to increase the number of authorized shares of First Union's common stock from 750,000,000 to 2,000,000,000, which such approvals were obtained on February 27, 1998; (ii) receipt of requisite regulatory approvals from the Board of Governors of the Federal Reserve System and other federal and state regulatory authorities; (iii) receipt of opinions as to the tax and accounting treatment of certain aspects of the Merger; (iv) listing, subject to notice of issuance, of First Union's common stock to be issued in the Merger; and (v) satisfaction of certain other conditions. 54 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 2. MERGERS AND ACQUISITIONS - continued The Merger Agreement may be terminated under certain circumstances, including by the Corporation's Board of Directors by giving notice to First Union if either (x) both (i) the average closing price of First Union's common stock for the ten full trading days ending on the date the Federal Reserve Board approves the Merger (the "Average Closing Price") is less than the product of the closing price of First Union's common stock (the "Starting Price") on the first full trading day after public announcement of execution of the Merger Agreement (the "Starting Date") and 0.85, and (ii) the number obtained by dividing the Average Closing Price by the Starting Price is less than the number obtained by (a) dividing the weighted average of the closing prices of a specified group index of bank stocks during the above-mentioned ten-day period by the weighted average closing prices of such bank stocks on the Starting Date and (b) subtracting 0.15, or (y) the Average Closing Price is less than the product of the Starting Price and 0.75. In the event CoreStates gives notice of its intent to terminate the Merger Agreement pursuant to the conditions set forth in the preceding sentence, First Union may determine, in its sole discretion, to increase the Exchange Ratio to eliminate the Corporation's right to terminate the Merger Agreement. A summary of selected unaudited historical financial information for First Union for the three years ended December 31, 1997 follows (in millions, except per share):
Year ended December 31, -------------------------------------- 1997 1996 1995 ---------- ---------- ---------- Net interest income.............................. $5,743 $ 5,465 $ 5,128 Provision for losses on loans.................... 840 449 258 Non-interest income.............................. 3,396 2,636 2,176 Non-financial expenses........................... 5,589 5,153 4,657 Provision for income taxes....................... 814 875 848 Net income....................................... 1,896 1,624 1,541 Per common share: Net income - basic............................ $3.03 $2.61 $2.44 Net income - diluted.......................... 2.99 2.58 2.38 Cash dividends declared....................... 1.22 1.10 0.98
Meridian acquisition On April 9, 1996, the Corporation acquired Meridian Bancorp, Inc. ("Meridian"), a Pennsylvania bank holding company with $15.2 billion in assets and $12.1 billion in deposits. The Corporation issued approximately 81.1 million shares of common stock to shareholders of Meridian based on an exchange ratio of 1.225 shares of the Corporation's common stock for each share of Meridian common stock. On February 23, 1996, Meridian acquired United Counties Bancorporation ("United Counties"), a New Jersey bank holding company with $1.6 billion in assets in a transaction accounted for as a pooling of interests. Accordingly, the consolidated accounts of Meridian include United Counties for all periods presented. 55 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands, except per share amounts) 2. MERGERS AND ACQUISITIONS - continued The Meridian acquisition was accounted for under the pooling of interests method of accounting; accordingly, the consolidated financial statements include the consolidated accounts of Meridian for all periods presented. Financial information on a separate company basis for the year ended December 31, 1995 for the Corporation and Meridian (including United Counties) was as follows (in millions, except per share):
1995 --------------------------- The (Unaudited) Corporation Meridian ------------ ---------- Net interest income............................... $ 1,488,534 $ 678,391 Provision for losses on loans..................... 105,000 38,877 Non-interest income............................... 605,666 276,556 Non-financial expenses............................ 1,274,398 612,695 Provision for income taxes........................ 262,565 101,372 Net income........................................ 452,237 202,003 Per common share: Net income - basic............................. 3.22 3.03 Net income - diluted........................... 3.19 2.98 Cash dividends declared........................ 1.44 1.45
The restated consolidated statement of income for 1995 reflects a conforming accounting adjustment for Statement of Financial Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" ("FAS 106"). The Corporation elected to recognize immediately the January 1, 1992 transitional liability of $128,706 pre-tax, $84,946 after-tax, as the cumulative effect of a change in accounting principle in the first quarter of 1992. Meridian adopted FAS 106 on January 1, 1993, the date required under that statement. As permitted by FAS 106, Meridian elected to amortize its liability over 20 years. As permitted under pooling of interests accounting, the restated financial information is prepared as if Meridian adopted FAS 106 effective January 1, 1992 and immediately recognized the $28,827, $18,738 after-tax, transitional liability. Restated salaries, wages and benefits have been adjusted accordingly. 3. FAIR VALUES OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments" ("FAS 107"), requires disclosure of fair value information about financial instruments, whether or not required to be recognized in the balance sheet, for which it is practicable to estimate that value. FAS 107 defines a financial instrument as cash, evidence of ownership interest in an entity, or a contractual obligation or right that will be settled with another financial instrument. In cases where quoted market prices are not available, fair values are based on estimates using discounted cash flow or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Fair value estimates derived through those techniques cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. FAS 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Corporation. 56 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 3. FAIR VALUES OF FINANCIAL INSTRUMENTS - continued The following table summarizes the carrying amount and fair value estimates of financial instruments at December 31, 1997 and 1996.
1997 1996 ----------------------------- ----------------------------- Carrying Carrying or Notional Fair or Notional Fair Amount Value Amount Value ------------ ------------ ------------ ------------ Assets: Cash and short-term assets.................................... $ 6,993,544 $ 6,993,544 $ 6,415,135 $ 6,415,135 Investment securities......................................... 3,460,391 3,457,073 4,083,224 4,086,409 Trading account assets........................................ 495,472 495,472 122,317 122,317 Net loans, excluding leases................................... 32,822,537 33,136,437 30,388,757 30,391,968 Loans held for sale........................................... 841,318 841,318 445,735 445,735 Liabilities: Demand and savings deposits................................... 22,160,650 22,160,650 22,629,513 22,629,513 Time deposits, including overseas branches and subsidiaries... 12,027,240 12,226,204 11,097,643 11,321,471 Short-term borrowings......................................... 4,323,319 4,323,319 2,633,157 2,633,157 Long-term debt................................................ 4,454,236 4,480,927 3,049,297 3,059,173 Off-balance sheet asset (liability): Letters of credit............................................. 3,291,983 (32,920) 2,893,214 (28,931) Commitments to extend credit.................................. 23,875,236 (28,581) 19,569,566 (21,204) Mortgage loans sold and loan servicing acquired with recourse.................................... 299,322 (8,559) 361,410 (9,637) Derivative financial instruments.............................. 22,896,165 147,582 20,173,225 96,629
Fair value estimates, methods, and assumptions for the Corporation's financial instruments are set forth below: Cash and due from banks and short-term instruments The carrying amounts reported in the balance sheet for cash and due from banks and short-term instruments approximate their fair values. Short-term instruments include: time deposits; Federal funds sold; and securities purchased under agreements to resell, all of which generally have original maturities of less than 90 days. Investment securities Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. Trading account assets Fair values for the Corporation's trading account assets, which also are the amounts recognized in the balance sheet, are based on quoted market prices where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments or are derived from pricing models or formulas using discounted cash flows. Loans Fair values are estimated for loans in groups with similar financial and risk characteristics. Loans are segregated by type including: commercial and industrial; commercial real estate; residential real estate; credit card and other consumer; financial institutions; factoring receivables; and foreign. Each loan type is further segmented into fixed and variable rate interest terms and by performing and non-performing categories in order to estimate fair values. The fair value of fixed-rate performing loans is calculated by discounting scheduled principal and interest cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan type at December 31, 1997 and 1996. The estimate of maturity is based on the Corporation's historical experience with repayments for each loan type, modified by an estimate of the effect of current economic and lending conditions. For performing residential mortgage loans, fair value is estimated by referring to secondary market source pricing. 57 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 3. FAIR VALUES OF FINANCIAL INSTRUMENTS - continued For credit card loans, cash flows and maturities are estimated based on contractual interest rates and historical experience and are discounted using secondary market rates adjusted for differences in servicing and credit costs. This estimate does not include the benefit that relates to cash flows which could generate from new loans to existing cardholders over the remaining life of the portfolio. For variable rate loans that reprice frequently and which have experienced no significant change in credit risk, fair values are based on carrying amounts. Fair value for non-performing loans is based on discounting estimated cash flows using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding cash flows and discount rates are determined using available market information and specific borrower information. Deposit liabilities The fair values disclosed for demand deposits (non-interest bearing checking accounts, NOW accounts, savings accounts, and money market accounts) are, by FAS 107 definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts for variable-rate, fixed-term certificates of deposit approximate their fair values. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates offered on certificates at December 31, 1997 and 1996, respectively, to an estimate of aggregate expected maturities for those certificates of deposit. The estimated fair values do not include the benefit that results from funding provided by core deposit liabilities as compared to the cost of borrowing funds in the financial markets. Short-term funds borrowed The carrying amounts of Federal funds purchased, securities sold under agreements to repurchase, commercial paper and other short-term borrowings approximate their fair values. Long-term debt The fair values for long-term debt are based on quoted market prices where available. If quoted market prices are not available, fair values are estimated using discounted cash flow analyses based on the Corporation's borrowing rates at December 31, 1997 and 1996 for comparable types of borrowing arrangements. Off-balance sheet derivative financial instruments and commitments Fair values for the Corporation's futures, forwards, interest rate swaps, options, interest rate caps and floors, foreign exchange contracts, tender option bonds and Treasury float contracts are based on quoted market prices (futures); current settlement values (forwards); quoted market prices of comparable instruments (foreign currency exchange contracts); or, if there are no directly comparable instruments, on pricing models or formulas using current assumptions (interest rate swaps, interest rate caps and floors, tender option bonds, Treasury float contracts and options). The fair value of commitments to extend credit, other than credit card lines, is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The value of commitments to extend credit under credit card lines is embodied in the benefit that relates to estimated cash flows from new loans expected to be generated from existing cardholders over the remaining life of the portfolio. The fair value of standby and commercial letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate the agreements or otherwise settle the obligations with the counterparties. 4. LOAN PORTFOLIO For a breakdown of the loan portfolio by type of loan and for information on non-performing loans, refer to Supplemental Financial Data under the captions Loan Portfolio and Non-Performing Assets (pages 92 and 93). The Corporation has traditionally maintained limits on industry, country and borrower concentrations as a way to diversify and manage credit risk. The Corporation manages industry concentrations by applying limits to a family of industries that have common risk characteristics. 58 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 4. LOAN PORTFOLIO - continued At December 31, 1997 and 1996, the Corporation had loans totaling $125,224 and $110,948, respectively, to its officers, directors and companies in which the directors had a 10% or more voting interest. These loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectability. The 1997 additions and reductions were $373,282 and $359,006, respectively. Included in other assets at December 31, 1997 and 1996 were $841,000 and $446,000, respectively, of loans held for sale and carried at lower of cost or market. The book value of real estate loans transferred to other real estate owned during 1997, 1996 and 1995 was $8,563, $19,536, and $29,337, respectively. The following presents information on derivative financial instruments used to manage interest rate risk associated with loans:
1997 1996 ------------ ------------ At December 31, Notional value......................... $6,283,000 $ 9,118,000 Unrealized gains....................... 71,000 64,000 Unrealized losses...................... 6,000 19,000 Effect on loan yield for the years ended December 31, From................................... 8.78% 8.92% To..................................... 8.89 9.03
59 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 5. INVESTMENT SECURITIES The carrying and fair values of investment securities at December 31, 1997 and 1996 were as follows:
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------- ----------- ----------- ----------- 1997 - ---- Held-to-Maturity - ---------------- U.S. Treasury and Government agencies........................ $ 379,968 $ 3,076 $ 793 $ 382,251 State and municipal............................ 292,119 8,247 194 300,172 Mortgage-backed................................ 156,047 175 499 155,723 Other: Domestic................................... 473,738 146 13,476 460,408 Foreign.................................... 49,265 - - 49,265 ----------- ------- -------- ----------- Total held-to-maturity.................. $ 1,351,137 $11,644 $ 14,962 $ 1,347,819 =========== ======= ======== =========== Available-for-Sale - ------------------ U.S. Treasury and Government agencies........................ $ 1,149,771 $ 5,286 $ 751 $ 1,154,306 State and municipal............................ 43,279 493 90 43,682 Mortgage-backed................................ 439,653 4,098 2,072 441,679 Other: Domestic................................... 347,556 10,024 394 357,186 Foreign.................................... 80,197 32,886 682 112,401 ----------- ------- -------- ----------- Total available-for-sale................ $ 2,060,456 $52,787 $ 3,989 $ 2,109,254 =========== ======= ======== =========== 1996 - ---- Held-to-Maturity - ---------------- U.S. Treasury and Government agencies........................ $ 362,736 $ 3,501 $ 815 $ 365,422 State and municipal............................ 366,012 8,548 95 374,465 Mortgage-backed................................ 463,796 52 1,023 462,825 Other: Domestic................................... 442,082 340 7,529 434,893 Foreign................................... 54,432 224 18 54,638 ----------- ------- -------- ----------- Total held-to-maturity.................. $ 1,689,058 $12,665 $ 9,480 $ 1,692,243 =========== ======= ======== =========== Available-for-Sale - ------------------ U.S. Treasury and Government agencies........................ $ 1,512,966 $ 9,207 $ 1,061 $ 1,521,112 State and municipal............................ 59,864 468 335 59,997 Mortgage-backed................................ 505,527 4,494 4,854 505,167 Other: Domestic................................... 186,029 14,096 939 199,186 Foreign.................................... 87,741 20,974 11 108,704 ----------- ------- -------- ----------- Total available-for-sale................ $ 2,352,127 $49,239 $ 7,200 $ 2,394,166 =========== ======= ======== ===========
On November 15, 1995, the FASB issued a Special Report, "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities", which permitted an enterprise to reassess the appropriateness of the classification of all investment securities held between November 15, 1995 and December 31, 1995. Based on its reassessment, the Corporation reclassified $1,726,739 in investment securities previously classified as held-to-maturity to the available-for-sale category. Unrealized gains on transferred investments were $12,160, unrealized losses were $8,340, and the fair value was $1,730,559. Marketable equity securities are carried in the available-for-sale portfolio and have been written up by $42,052 at December 31, 1997 and $34,808 at December 31, 1996, the aggregate of their excess fair values over cost, through after-tax credits to retained earnings. The Corporation recorded pre-tax gains of $23,668 in 1997, $13,210 in 1996, and $ 7,654 in 1995 on sales of certain domestic equity securities. During 1997 and 1996, the Corporation recorded pre-tax gains of $4,939 and $28,656, on the exchange of certain domestic equity securities. During 1997, 1996 and 1995, the Corporation recorded pre-tax gains of $559, $18,924, and $939 on sales of foreign equity securities. 60 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 5. INVESTMENT SECURITIES - continued At December 31, 1997 and 1996, there were no investments in securities of any single, non-Federal issuer in excess of 10% of shareholders' equity. Securities with a carrying value of $1,998,066 were pledged at December 31, 1997 to secure public deposits, trust deposits, and for certain other purposes as required by law. The amortized cost and estimated fair value of debt securities at December 31, 1997, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to prepay obligations without prepayment penalties.
Amortized Fair Cost Value ----------- ----------- Held-to-Maturity - ---------------- Due in one year or less........................ $ 245,009 $ 245,032 Due after one year through five years.......... 315,218 318,726 Due after five years through ten years......... 170,726 174,986 Due after ten years............................ 167,196 169,758 Mortgage-backed securities..................... 156,047 155,723 ----------- ----------- $ 1,054,196 $ 1,064,225 =========== =========== Available-for-Sale - ------------------ Due in one year or less........................ $ 736,623 $ 737,858 Due after one year through five years.......... 565,386 569,185 Due after five years through ten years......... 63,362 63,653 Due after ten years............................ 97,075 97,321 Mortgage-backed securities..................... 439,653 441,679 ----------- ----------- $ 1,902,099 $ 1,909,696 =========== ===========
Proceeds from sales of investments in debt securities during 1997, 1996, and 1995 were $63,587, $1,411,398, and $560,022, respectively. Gross gains of $2,710 in 1997, $4,100 in 1996, and $11,180 in 1995, and gross losses of $422 in 1997, $5,378 in 1996, and $1,894 in 1995, were realized on those sales. 61 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 6. REGULATORY AND CAPITAL MATTERS The Corporation and its subsidiaries are subject to the regulations of certain Federal and state agencies including minimum risk-based and leverage capital guidelines issued by the Federal Reserve Board and Comptroller of the Currency. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Corporation's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation must meet specific capital guidelines that involve quantitative measures of the Corporation's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Corporation's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. At December 31, 1997, management believes that the Corporation and its principal bank subsidiary, CBNA, meet all capital adequacy requirements to which they are subject. The following table illustrates the Corporation's and CBNA's risk-based and leverage capital ratios at December 31, 1997 and 1996:
Per Regulatory Guidelines ----------------------------------------------------- Actual Minimum "Well-Capitalized" --------------------- --------------------- ------------------------- Amount Ratio Amount Ratio Amount Ratio ---------- ------- ---------- ------- ---------- ------- December 31, 1997 Tier 1 capital (a): Consolidated.......................... $3,756,680 8.48% $1,771,948 4% $2,657,922 6% CBNA.................................. 2,901,577 6.82 1,700,741 4 2,551,111 6 Total capital (b): Consolidated.......................... 5,306,410 11.98 3,543,897 8 4,429,871 10 CBNA.................................. 4,617,721 10.86 3,401,481 8 4,251,852 10 Tier 1 leverage ratio: Consolidated.......................... 3,756,680 7.97 1,414,618 3 2,357,697 5 CBNA.................................. 2,901,577 6.50 1,340,100 3 2,233,499 5 December 31, 1996 Tier 1 capital (a): Consolidated.......................... $3,725,318 9.45% $1,576,914 4% $2,365,372 6% CBNA.................................. 3,270,045 8.90 1,471,992 4 2,207,987 6 Total capital (b): Consolidated.......................... 5,215,789 13.23 3,153,829 8 3,942,286 10 CBNA.................................. 4,206,434 11.43 2,943,983 8 3,679,979 10 Tier 1 leverage ratio: Consolidated.......................... 3,725,318 8.46 1,321,090 3 2,201,817 5 CBNA.................................. 3,270,045 7.80 1,257,745 3 2,096,241 5
- -------------------- (a) Consists primarily of common shareholders' equity and Trust Capital Securities, less goodwill and certain intangible assets. (b) Consists of Tier 1 capital plus qualifying subordinated debt and the allowance for loan losses, within permitted limits. The primary source of funds for cash dividend payments by the Corporation to its shareholders is dividends received from its banking subsidiaries. The approval of the Comptroller of the Currency is required for a nationally chartered bank to pay dividends if the total of all dividends declared in any calendar year exceeds the bank's net profits (as defined by national banking regulations) for that year combined with its retained net profits for the preceding two calendar years. Under this formula, CBNA can declare dividends without approval of the Comptroller of the Currency of approximately $32,000 plus an additional amount equal to CBNA's retained net profits for 1998 up to the date of any such dividend declaration. Due to the special provision for losses on credit card outstandings recorded in the fourth quarter of 1997, CBD is unable to pay dividends without prior approval of the Comptroller of the Currency. The Federal Reserve Act requires that extensions of credit by CBNA to certain affiliates, including the Corporation, be secured by specified amounts and types of collateral, that extensions of credit to any such affiliate generally be limited to 10% of capital and surplus (as defined in that Act) and that extensions of credit to all such affiliates be limited to 20% of capital and surplus. The Corporation's banking subsidiaries are required to maintain reserve balances with the Federal Reserve Bank. The average amount of those reserve balances for the years ended December 31, 1997 and 1996 were approximately $211,000 and $257,000, respectively. 62 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 7. ALLOWANCE FOR LOAN LOSSES The following represents an analysis of changes in the allowance for loan losses for the years ended December 31, 1997, 1996 and 1995:
1997 1996 1995 ---------- --------- ---------- Balance at beginning of period..................... $ 710,327 $ 670,265 $ 681,124 Provision charged to operating expense............. 263,000 228,767 144,002 Recoveries of loans previously charged off......... 84,301 92,985 85,226 Loan charge-offs................................... (321,196) (281,690) (240,087) Allowance for loans designated as held for sale.... (102,000) - - ---------- --------- ---------- Balance at end of period........................... $ 634,432 $ 710,327 $ 670,265 ========== ========= ==========
The following presents information on loans that are considered impaired under FAS 114:
At December 31, 1997 1996 1995 ---------- --------- ---------- Recorded investment in impaired loans.............. $183,978 $183,330 Impaired loans against which a portion of the allowance for loan losses is specifically allocated......................... 130,614 74,609 Amount of allowance for loan losses specifically allocated to impaired loans....... 46,436 15,105 For the years ended December 31, Average recorded investment in impaired loans.......................................... 173,375 197,854 $257,746 Interest income recognized on impaired loans.......................................... 15,075 8,977 14,354
8. PREMISES AND EQUIPMENT Premises and equipment on the consolidated balance sheet is presented net of accumulated depreciation and amortization of $536,137 and $667,412 at December 31, 1997 and 1996, respectively. Depreciation and amortization of premises and equipment for the years ended December 31, 1997, 1996, and 1995, was $87,606, $95,897, and $98,033, respectively. 9. OPERATING LEASES Rental expense, reduced by sublease rental income, charged to operations was $89,300, $90,982 and $85,419 for 1997, 1996 and 1995, respectively. 63 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 10. DEPOSITS The following presents a breakdown of deposits at December 31, 1997 and 1996:
1997 1996 ------------ ------------ Domestic: Non-interest bearing checking.............. $ 9,252,376 $ 9,330,445 Savings, NOW and money market accounts......................... 12,908,274 13,299,068 Time deposits.............................. 10,582,718 9,687,887 ------------ ------------ Total domestic deposits................. 32,743,368 32,317,400 Overseas branches and subsidiaries............. 1,444,522 1,409,756 ------------ ------------ Total deposits.......................... $34,187,890 $ 33,727,156 =========== ============
Domestic time deposits in denominations of $100 or more at December 31, 1997, 1996, and 1995 were:
1997 1996 1995 ----------- ----------- ----------- Commercial certificates of deposit............. $2,489,415 $ 754,437 $ 695,970 Other domestic time deposits, principally savings certificates........... 608,968 613,126 501,058 ----------- ----------- ----------- Total........................... $3,098,383 $ 1,367,563 $ 1,197,028 ========== =========== ===========
Interest expense on domestic time deposits in denominations of $100 or more for the years ended December 31, 1997, 1996, and 1995 was:
1997 1996 1995 --------- ------- -------- Interest expense: Commercial certificates of deposit......... $ 98,669 $30,857 $ 36,520 Other domestic time deposits, principally savings certificates................ 31,294 25,451 30,057 --------- ------- -------- Total........................... $129,963 $56,308 $ 66,577 ======== ======= ========
Substantially all of the deposits of overseas branches and subsidiaries were time deposits in denominations of $100 or more for each of the three years presented. The following presents information on derivative financial instruments used to manage interest rate risk associated with deposits:
1997 1996 ---------- ----------- At December 31, Notional value............................. $3,789,000 $ 5,314,000 Unrealized gains........................... 30,000 50,000 Unrealized losses.......................... 6,000 16,000 Effect on deposit interest expense for the year ended December 31, From....................................... 3.68% 3.62% To......................................... 3.60 3.49
64 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 11. SHORT-TERM FUNDS BORROWED Short-term funds borrowed at December 31, 1997, 1996 and 1995 include the following:
Weighted Maximum Average Average Balance outstanding outstanding interest at end of during during rate during year year(e) year year(f) ----------- ---------- ----------- ----------- 1997 - ---- Federal funds purchased (a).......................... $ 1,422,208 $1,550,412 $ 860,000 5.84% Securities sold under agreements to repurchase (b)... 571,804 767,480 627,000 4.86 Commercial paper (c)................................. 865,835 1,147,909 914,000 5.61 Other short-term funds borrowed (d).................. 1,463,472 1,507,363 1,013,000 5.71 ----------- ----------- Total short-term funds borrowed ................ $ 4,323,319 $ 3,414,000 5.56 =========== =========== 1996 - ---- Federal funds purchased (a).......................... $ 532,334 $1,977,950 $ 873,000 5.54% Securities sold under agreements to repurchase (b)... 656,397 836,722 749,000 4.52 Commercial paper (c)................................. 675,181 1,106,078 962,000 5.44 Other short-term funds borrowed (d).................. 769,245 842,410 374,000 4.96 ----------- ----------- Total short-term funds borrowed ................ $ 2,633,157 $ 2,958,000 5.18 =========== =========== 1995 - ---- Federal funds purchased (a).......................... $ 1,129,432 $2,060,375 $ 1,432,000 6.02% Securities sold under agreements to repurchase (b)... 812,281 863,937 771,000 5.03 Commercial paper (c)................................. 1,255,656 1,388,927 1,051,000 5.94 Other short-term funds borrowed (d).................. 479,644 1,005,699 498,000 5.33 ----------- ----------- Total short-term funds borrowed ................ $ 3,677,013 $ 3,752,000 5.71 =========== ===========
(a) Federal funds purchased generally represent the overnight Federal funds transactions of banking subsidiaries with correspondent banks. (b) Securities sold under agreements to repurchase usually mature within one to thirty days or are due on demand. (c) Commercial paper issued by CSCC is used to finance the short-term borrowing requirements of certain banking-related activities. Commercial paper is issued with maturities of not more than nine months and there are no provisions for extension, renewal or automatic rollover. At December 31, 1997, the Corporation had a $700,000 revolving credit facility from unaffiliated banks. The facility was established in support of commercial paper borrowings, Medium Term Note (see Note 12) issuance and general corporate purposes. Unless extended by the Corporation in accordance with the terms of the facility agreement, the facility expires February 2000. There were no borrowings under this facility at December 31, 1997. The interest rate charged for usage of these lines varies with money market conditions. (d) Other short-term funds borrowed include term Federal funds purchased, short-term Bank Notes and demand notes payable to the U.S. Treasury. (e) Represents the maximum amount outstanding at any month end during the year. (f) The weighted average interest rate is calculated primarily on a daily average of short-term funds borrowed. 65 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 12. LONG-TERM DEBT Long-term debt at December 31, 1997 and 1996 includes the following:
1997 1996 ----------- ----------- CoreStates Financial Corp: 6 5/8% Notes due 2000 (a).............................. $ 150,000 $ 150,000 7 7/8% Subordinated Notes due 2002 (b)................. 100,000 100,000 8 5/8% Mortgages due 2001.............................. 5,963 6,603 Unamortized Discounts.................................. (221) (271) ----------- ----------- 255,742 256,332 ----------- ----------- CSCC: 6 3/4% Guaranteed Subordinated Notes due 2006 (c)................................... 200,000 200,000 5 7/8% Guaranteed Subordinated Notes due 2003 (c)................................... 200,000 200,000 6 5/8% Guaranteed Subordinated Notes due 2005 (c)................................... 175,000 175,000 9 5/8% Guaranteed Subordinated Notes due 2001 (c)................................... 150,000 150,000 9 3/8% Guaranteed Subordinated Notes due 2003 (c)................................... 100,000 100,000 Medium Term Notes (d).................................. 1,641,000 1,509,000 Unamortized Discounts.................................. (4,003) (4,990) ----------- ----------- 2,461,997 2,329,010 ----------- ----------- Trust Capital Securities: 8% Trust Capital Securities due 2026 (e)............... 300,000 300,000 Libor + .57% Trust Capital Securities due 2027 (f)..... 300,000 - Libor + .65% Trust Capital Securities due 2027 (f)..... 150,000 - Unamortized Discounts.................................. (5,872) (6,491) ----------- ----------- 744,128 293,509 ----------- ----------- Other subsidiaries:` Libor + .05% Eurodollar Notes due 2002 (g)............. 500,000 - Bank Note Program (h).................................. 232,130 - 6 5/8% Subordinated Notes due 2003 (i)................. 150,000 150,000 Federal Home Loan Bank Borrowings (j).................. 100,000 2,888 Various other.......................................... 12,488 18,175 Unamortized Discounts.................................. (2,249) (617) ----------- ----------- 992,369 170,446 ----------- ----------- Total long-term debt (k)............................... $4,454,236 $3,049,297 =========== ===========
(a) The Notes are unsecured and senior in right of payment to all subordinated indebtedness of the Corporation. The Notes are not redeemable by the Corporation or the holders prior to the maturity date and are not entitled to the benefit of any sinking fund. (b) The Notes are unsecured and subordinate in right of payment to all present and future senior indebtedness of the Corporation. The Notes are not redeemable by the Corporation or the holders prior to the maturity date and are not entitled to the benefit of any sinking fund. (c) The Notes are not subject to redemption prior to maturity and are unconditionally guaranteed, on a subordinated basis, as to payment of principal and interest by the Corporation. The Notes are subordinated to all existing and future senior CSCC indebtedness and the guarantee is subordinated to all outstanding senior Corporation indebtedness. 66 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 12. LONG-TERM DEBT - continued (d) CSCC can issue Medium Term Notes (Senior and Subordinated) with maturities of nine months or greater from date of issue. The interest rate or interest rate formula on each Note is established by CSCC at the time of issuance. The Senior Notes are unconditionally guaranteed as to payment of principal and interest by the Corporation. The Subordinated Notes are unconditionally guaranteed, on a subordinated basis, as to payment of principal and interest by the Corporation. The Subordinated Notes are subordinated to all existing and future senior CSCC indebtedness and the guarantee is subordinated to all existing and future senior Corporation indebtedness. At December 31, 1997, $1,641,000 of debt is outstanding with maturities up to five years. Interest rates are predominately variable. Under an existing shelf registration statement filed with the Securities and Exchange Commission, the Corporation had debt and capital securities that were registered but unissued of approximately $579,000 at December 31, 1997. (e) The Trust Capital Securities evidence a preferred ownership interest in a trust, of which 100% of the common equity is owned by CBNA. The Trust Capital Securities are unconditionally guaranteed by CBNA. The proceeds from issuance of the Trust Capital Securities are invested in 8% Junior Subordinated Deferrable Interest Debentures of CBNA due 2026. These Subordinated Debt Securities have provisions enabling certain actions such as redemption or the deferment of the semiannual payments of interest, which will impact the Trust Capital Securities. CBNA may redeem the Subordinated Debt Securities in whole or in part, on or after December 15, 2006. In addition, Subordinated Debt Securities may be redeemed by CBNA at any time upon the occurrence of certain events. In the event of such a redemption of the Subordinated Debt Securities, the proceeds of such payment or repayment shall concurrently be applied to redeem the Trust Capital Securities. (f) The Trust Capital Securities evidence a preferred ownership interest in a trust, of which 100% of the common equity is owned by CBNA. The Trust Capital Securities are unconditionally guaranteed by CBNA. The proceeds from issuance of the Trust Capital Securities are invested in Floating Rate Junior Subordinated Deferrable Interest Debentures of CBNA due 2027. These Subordinated Debt Securities have provisions enabling certain actions such as redemption or the deferment of the semiannual payments of interest, which will impact the Trust Capital Securities. CBNA may redeem the Subordinated Debt Securities in whole or in part, on or after February 15, 2007 and January 15, 2007 for the $300,000 and $150,000 Trust Capital Securities, respectively. In addition, Subordinated Debt Securities may be redeemed by CBNA at any time upon the occurrence of certain events. In the event of such a redemption of the Subordinated Debt Securities, the proceeds of such payment or repayment shall concurrently be applied to redeem the Trust Capital Securities. (g) On October 3, 1997, CSCC and CBNA applied to list up to $4.0 billion of debt securities ("the Programme") on the Luxembourg Stock Exchange. Under this Programme, CSCC and CBNA may each issue up to $2.0 billion of debt securities ("the Notes") with maturities from 30 days to 30 years. The Notes are direct, unconditional and unsecured general obligations of the relevant issuer. On October 29, 1997, CBNA issued $500 million 5 year floating rate notes under the Programme. (h) On November 7, 1997, CBNA and CBD established a $3.0 billion Senior and Subordinated Bank Note program ("the Bank Note Program") which accommodates subordinated debt issuance with maturities up to 30 years. In the fourth quarter of 1997, CBNA issued $232 million in senior notes with maturities ranging from one to two years. 67 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 12. LONG-TERM DEBT - continued (i) The Notes were issued by CBNA and are unsecured and subordinate to the claims of depositors and other creditors. The Notes are not redeemable by CBNA or the holders prior to the maturity date and are not entitled to the benefit of any sinking fund. (j) The borrowing matured in January 1998 and carries a fixed interest rate of 5.63%. These borrowings require membership in the Federal Home Loan Bank of Pittsburgh and the maintenance of available collateral with a fair value which approximates the total amount of the outstanding debt. (k) The consolidated aggregate maturities for long-term debt for the years ending December 31, 1998 through 2002 are: $758,417; $831,982; $390,590; $298,477, and $599,782, respectively. The following presents information on derivative financial instruments used to manage interest rate risk associated with long-term debt:
1997 1996 ---------- ----------- At December 31, Notional value............................. $1,531,000 $ 1,019,000 Unrealized gains........................... 34,000 16,000 Unrealized losses.......................... 7,000 13,000 Effect on long-term debt cost for the years ended December 31, From....................................... 6.64% 6.53% To......................................... 6.50 6.38
68 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 13. RETIREMENT AND BENEFIT PLANS The fair value of the assets in the Corporation's defined benefit pension plans exceeded the projected benefit obligation by $126,512 at December 31, 1997, based on current and estimated future salary levels. The excess of the fair value of plan assets is reconciled to the accrued pension cost included in other liabilities as follows:
December 31, ---------------------------- 1997 1996 ---------- --------- Plan assets at fair value(a)................................. $1,046,610 $ 902,947 ---------- --------- Present value of benefit obligation: Accumulated benefits based on salaries to date, including vested benefits of $753,667 in 1997 and $667,536 in 1996................................................. 776,522 688,102 Additional benefits based on estimated future salary levels 143,576 157,687 ----------- --------- Projected benefit obligation................................. 920,098 845,789 ----------- --------- Amount the fair value of plan assets exceeds the projected benefit obligation at December 31,.......... 126,512 57,158 Reconciliation: Unrecognized prior service cost........................... 15,278 30,770 Unrecognized net asset from date of initial application... (13,685) (20,016) Net deferred actuarial gain............................... (156,939) (91,835) ---------- -------- Accrued pension expense included in other liabilities $ (28,834) $(23,923) ========== ========
- --------------- (a) Primarily U.S. Government securities, U.S. agency securities, fixed income securities, common stock, and commingled funds managed by subsidiary banks. Net pension cost for the years ended December 31, 1997, 1996 and 1995 included the following expense (income) components:
1997 1996 1995 ---------- ---------- --------- Service cost benefits earned during the period.............. $ 20,963 $ 29,020 $ 24,492 Interest cost on projected benefit obligation............... 63,290 60,793 54,497 Actual return on plan assets................................ (183,388) (121,868) (162,143) Net amortization and deferral............................... 105,847 53,887 96,484 ---------- ---------- --------- Net pension cost....................................... $ 6,712 $ 21,832 $ 13,330 ========== ========== =========
The weighted average discount rate used in determining the actuarial present value of the projected benefit obligation for the Corporation was 7.25% and 7.5%, respectively, at December 31, 1997 and 1996. The rate of increase on future compensation levels was 5.0% in both 1997 and 1996. The expected long-term rate of return on plan assets was 9.0% in 1997, 8.5% in 1996, and 7.5% - - 9.5% in 1995. The Corporation sponsors a 401(k) savings plan for substantially all its employees whereby the Corporation may make matching contributions equal to a percentage of the contribution made by participants. Contribution expense related to the savings plan for the employer's match was $20,964 in 1997, $18,955 in 1996, and $18,192 in 1995. The ESOP is a leveraged plan funded through a direct loan from the Corporation. The ESOP has acquired a total of 2,515,000 shares of common stock for distribution to eligible employees ratably over a 20 year period. Compensation cost has been recognized based on the fair market value of the shares committed to be released to employees. Total compensation cost recognized was $5,378 in 1996 and $3,600 in 1995. Dividends on allocated shares are paid to participants and are charged to retained earnings. Dividends on unallocated shares are used by the ESOP to reduce its loan. Effective January 1, 1997 the ESOP was combined with the Corporation's 401(k) savings plan and expense related to the ESOP of $7,269 for 1997 was included in the 401(k) savings plan employer's match. 69 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 13. RETIREMENT AND BENEFIT PLANS - continued The Corporation and its subsidiaries provide postretirement health care and life insurance benefits for substantially all retired employees. Postretirement benefits are provided through an insurance company whose premiums are based on the benefits paid during the year. The postretirement health care plan is contributory, with retiree contributions based on years of service. The liability for postretirement benefits included in other liabilities at December 31, 1997 and 1996 was as follows:
1997 1996 ---------- ---------- Accumulated postretirement benefit obligation: Retirees............................................................. $ (56,396) $ (68,702) Fully eligible active plan participants.............................. (2,597) (1,827) Other active plan participants....................................... (42,211) (29,748) --------- --------- Accumulated postretirement benefit obligation........................... (101,204) (100,277) Plan assets at fair value (a)........................................... 62,553 52,591 --------- --------- Unfunded obligation at December 31,..................................... (38,651) (47,686) Unrecognized prior service cost......................................... (43,433) (45,239) Unrecognized net gain................................................... (45,984) (51,157) --------- --------- Accrued postretirement benefit obligation included in other liabilities $(128,068) $(144,082) ========= =========
- ------------------ (a) Primarily municipal bonds and short-term investments. Net periodic postretirement benefit cost for the years ended December 31, 1997, 1996 and 1995 included the following expense (income) components:
1997 1996 1995 ------- ------- ------- Service cost benefits earned during the period............ $ 2,482 $ 2,769 $ 3,044 Interest cost on accumulated postretirement benefit obligation.................................... 7,103 7,947 11,932 Actual return on plan assets.............................. (1,770) (1,527) (1,107) Net amortization and deferral............................. (7,223) (6,069) (1,436) ------- ------- ------- Net periodic postretirement benefit cost.................. $ 592 $ 3,120 $12,433 ======= ======= =======
For measurement purposes, the rate of increase in the per capita cost of covered health care benefits was assumed to be 5.5% per year and remains at that level until a predetermined benefit cap is reached. This fixed dollar cap was established as the per capita projected cost level in 1997 associated with the Corporation's indemnity medical plan. The health care cost trend rate assumption has an effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rates by 1 percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1997 by $4,355 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year then ended by $386. The expected long-term rate of return on plan assets was 6.0%. The weighted-average discount rate used in determining the Corporation's accumulated postretirement benefit obligation was 7.25% and 7.5%, respectively, at December 31, 1997 and 1996. 70 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 14. LONG-TERM INCENTIVE PLAN The Corporation has outstanding options granted under the Corporation's long-term incentive plan (the "Plan"). As provided in the Plan, a variety of incentives can be issued to eligible participants including restricted stock awards, incentive stock options, non-qualified stock options, or stock appreciation rights. Meridian and United Counties had maintained similar plans. Options granted under those plans were assumed by the Corporation upon consummation of their respective acquisitions. The Plan provides for a maximum number of options available to be granted each year equal to 1.5% of outstanding common shares as of January 1 of that year. Options under the Plan are granted to purchase the Corporation's common shares at market value on the date of grant and are exercisable one year from the date of grant for a period not exceeding ten years from the date of grant. Stock appreciation rights may be granted in conjunction with the granting of an option. Information on option activity for 1997 and 1996 follows:
1997 1996 --------------------------------------------------------------------------------- Shares under Weighted-Average Shares Under Weighted-Average Option Exercise Price Option Exercise Price ------------ ---------------- -------------- ------------------ Balance at beginning of year............. 5,789,064 $29.98 8,581,554 $23.86 Options granted.......................... 1,634,052(a) 51.50 1,968,001 (a) 41.49 Options exercised........................ (2,201,107) 28.32 (4,519,411) 23.27 Options canceled......................... (155,110) 50.04 (241,080) 31.84 ------------ -------------- Balance at end of year................... 5,066,899 37.00 5,789,064 29.98 ========= ========= Shares exercisable....................... 3,585,769 31.00 4,405,540 25.37 ========= =========
(a) The fair value of options granted during 1997 and 1996 was $14.5 million and $12.6 million, respectively. The following table summarizes information about options outstanding at December 31, 1997:
Options Outstanding Options Exercisable ------------------------------------------------------------ ---------------------------------- Weighted-Average Range of Number Remaining Weighted-Average Number Weighted-Average Exercise Prices Outstanding Contractual Life Price Exercise Exercisable Exercise Price --------------- ----------- ---------------- ---------------- ----------- ---------------- $ 8.20 to $19.50 195,977 2.8 years $15.30 195,977 $15.30 $20.53 to $29.95 2,306,766 6.2 27.10 2,306,766 27.10 $37.96 to $51.50 2,564,156 8.7 47.55 1,083,026 42.16 ---------- ---------- $ 8.20 to $51.50 5,066,899 7.3 37.00 3,585,769 31.00 ========== ==========
The Corporation uses the intrinsic value method of accounting to measure compensation expense. If the fair value method had been used to measure compensation expense, net income would have been reduced by $9.8 million, or $0.05 per share, $7.4 million, or $0.03 per share, and $7.2 million, or $0.03 per share, to $803.4 million, or $3.91 per share, $641.8 million, or $2.91 per share, and $647.9 million, or $2.88 per share, for the years ended December 31, 1997, 1996 and 1995, respectively. The fair value of options granted in 1997, 1996 and 1995 was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions, respectively: risk-free interest rates of 5.49% to 7.80%, dividend yield of 4.0%, volatility factors of the expected market price of the Corporation's common stock of .148 to .223, and a weighted-average expected life of the options of 6 years. 71 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 14. LONG-TERM INCENTIVE PLAN - continued The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Corporation's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. 15. OFF-BALANCE SHEET DERIVATIVE FINANCIAL INSTRUMENTS, COMMITMENTS AND CONTINGENT LIABILITIES In the normal course of business, there are outstanding commitments and contingent liabilities which are not reflected in the financial statements. These include various financial instruments with off-balance sheet risk used in connection with the Corporation's asset and liability management, the management of interest rate risk in securities trading positions and to provide for the needs of customers. These involve varying degrees of credit, interest rate and liquidity risk, but do not represent unusual risks for the Corporation and management does not anticipate any significant losses as a result of these transactions. Derivative Financial Instruments Held or Issued for Purposes Other Than Trading The Corporation uses off-balance sheet derivative financial instruments, such as interest rate swaps, futures and caps, to manage interest rate risk. The Corporation's exposure to interest rate risk stems from the mismatch between the sensitivity to movements in interest rates of the Corporation's assets and liabilities and from the spread risk between the rates on those assets and liabilities and financial market rates. The use of derivatives to manage interest rate risk falls into three categories: interest sensitivity adjustments, interest rate spread protection and hedging anticipated asset sales. Interest rate swaps and futures are generally used to lengthen the interest rate sensitivity of short-term assets and to shorten the repricing characteristics of longer term liabilities. Interest rate caps are used to manage spread risk. Interest rate caps are also used to offset the risk of upward interest rate movement on adjustable rate mortgages and other products with imbedded caps as well as to reduce the risk that interest rate spreads narrow on prime based products. Gains or losses are used to adjust the basis of the related asset or liability and interest differentials are adjustments of the related interest income or expense. In connection with anticipated sales of longer term assets acquired through merger or generated in the loan origination process, the Corporation uses interest rate swaps, rate locks and option agreements to reduce interest rate sensitivity as the assets are readied for sale. Hedge gains or losses are used to adjust the basis of the assets held for sale. Derivative financial instruments used in the management of interest rate risk at December 31, 1997 are summarized by category in the table on page 27. A summary of interest rate swap contracts categorized by whether the Corporation receives or pays fixed rates and stratified by repricing or maturity date is on page 30. Foreign currency derivatives used for hedging activities have not had a material impact on income or liquidity of the Corporation for any of the years presented. 72 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 15. OFF-BALANCE SHEET DERIVATIVE FINANCIAL INSTRUMENTS, COMMITMENTS AND CONTINGENT LIABILITIES - continued Derivative Financial Instruments Held or Issued for Trading Purposes In its business of providing risk management services for its customers, the Corporation purchases and sells certain derivatives including interest rate swaps, caps and floors. In addition, as part of its international business, the Corporation enters into foreign exchange contracts on behalf of customers. These contracts are matched against forward sale or purchase contracts. Customer related derivative financial instrument transactions are generally marked to market and any gains or losses are recorded in the income statement. The Corporation also holds derivatives in connection with its securities trading activities and, at times, as a position taken in the expectation of profiting from favorable movements in interest rates. These products include tender option bonds and Treasury float contracts. Included in the income statement are trading revenues from derivatives of $33,901 of which $25,531 represents net foreign exchange gains included in fees for international services. Customer and trading related derivative financial instruments at December 31, 1997 and 1996 are summarized by type of instrument in the table on page 32. The following is a summary of off-balance sheet commitments and derivative financial instruments as of December 31, 1997 and 1996, including fair values. See Note 3 for a discussion of fair value.
1997 1996 ------------------------------ ------------------------------ Notional Fair Notional Fair or Value or Value Contractual of Asset Contractual of Asset Amount (Liability) Amount (Liability) ------------ ----------- ------------ ----------- Standby letters of credit, net of participations (a) $ 1,817,591 $ (18,176) $ 1,630,621 $ (16,306) Commercial letters of credit....................... 1,474,392 (14,744) 1,262,593 (12,625) Commitments to extend credit (b)................... 19,332,394 (28,581) 15,396,553 (21,204) Unused commitments under credit card lines......... 4,542,842 - 4,173,013 - When-issued securities (c): Commitments to purchase...................... 47,838 (5) 1,770 - Commitments to sell.......................... 106,310 (455) 75,120 (140) Commitments to purchase/sell whole mortgage loans and securities (c): Commitments to purchase..................... 15,782 30 17,280 30 Commitments to sell......................... 39,120 (1,254) 7,965 (70) Mortgage loans sold and loan servicing acquired with recourse (d).............................. 299,322 (8,559) 361,410 (9,637) Interest rate futures contracts (e): Commitments to purchase........................ 1,866,100 (1,764) 4,489,800 2,781 Commitments to purchase foreign and U.S. currencies (f)............................ 2,240,895 4,025 1,766,122 (488) Interest rate swaps, notional principal amounts (g).................................... 12,479,564 97,670 9,850,708 67,673 Interest rate caps and floors (h): Written........................................ 1,693,886 (3,091) 908,799 (2,842) Purchased...................................... 2,768,289 11,003 2,039,331 17,383 Tender option bonds (i)............................ 849,854 37,876 148,711 5,976 Treasury float contracts (j)....................... 246,781 646 270,358 682 Other derivatives.................................. 541,746 2,901 597,261 5,644
73 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 15. OFF-BALANCE SHEET DERIVATIVE FINANCIAL INSTRUMENTS, COMMITMENTS AND CONTINGENT LIABILITIES - continued (a) Standby letters of credit ("SBLC") are used in various transactions to enhance the credit standing of the Corporation's customers and are subjected to the same risk, credit review and approval process as loans. SBLC's are irrevocable assurances that the Corporation will make payment in the event that a customer cannot perform its contractual obligations to third parties. (b) Commitments to extend credit represent the Corporation's obligation to fund various types of loans, including home equity lines, lines of credit, revolving lines of credit and other types of commitments. (c) The Corporation has commitments to purchase/sell mortgage-backed securities or loans with delivery at a future date but typically within 120 days. The fair value of these instruments is affected by interest rates. In a declining interest rate environment, commitments to sell mortgage-backed securities or loans will decline in value. In a rising interest rate environment, commitments to buy mortgage-backed securities or loans will decrease in value. Forward agreements to sell securities are used in transactions with municipalities that generally have a debt payment due in the future. Under these agreements, the Corporation agrees to deliver primarily United States Treasury securities that will mature on or before the required payment date. The type and associated interest rate of these securities is established when the agreement is entered. The primary risk associated with forward agreements is interest rate risk to the extent the required securities have not been purchased. If interest rates fall, securities yielding the higher agreed upon fixed rate will be more expensive for the Corporation to purchase. When-issued securities and commitments to purchase/sell whole mortgage loans and securities are entirely customer and trading-related products. (d) The Corporation originates and sells residential mortgage loans as part of various mortgage-backed security programs sponsored by the United States government agencies or government-sponsored agencies, such as the Government National Mortgage Association, Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association. Certain sales and other servicing acquired are subject to recourse provisions in the event of default by the borrower. The Corporation provides for potential losses under these recourse provisions by establishing reserves at the time of sale and evaluates the adequacy of these reserves on an ongoing basis. (e) Exchange traded futures contracts represent agreements to exchange dollar amounts at a specified future date for interest rate differentials between an agreed interest rate and a reference rate, computed on a notional amount. Credit and market risk exist with respect to these instruments. Exchange traded futures contracts entail daily cash settlement; therefore, the credit risk amount represents a one-day receivable. (f) Commitments to purchase foreign and U.S. currencies are primarily executed for the needs of customers. These foreign exchange contracts are structured similar to interest rate futures and forward contracts. The risk associated with a foreign exchange contract arises from the counterparty's ability to make payment at settlement and that the value of a foreign currency might change in relation to the U.S. dollar. The Corporation's exposure, if any, to counterparty failure equals the current market value of the contract, which at December 31, 1997 and 1996 was $35,257 and $27,962, respectively. Included in fees for international services are net foreign exchange gains of $25,531, $22,557, and $22,943 for the years ended December 31, 1997, 1996 and 1995, respectively. (g) Interest rate swaps generally represent the contractual exchange of fixed and variable rate interest payments based on a notional principal amount and an interest reference rate. Credit risk exists with respect to these instruments arising from the possible failure of the counterparty to make required payments on those contracts which are favorable to the Corporation. The Corporation's exposure to counterparty failure equals the current replacement cost of the contract. At December 31, 1997 and 1996, the replacement cost of the Corporation's interest rate swap contracts was $163,903 and $118,929, respectively. The risk of counterparty failure is controlled by limiting transactions to an approved list of counterparties and requiring collateral in certain instances. Net cash received on interest rate swaps during 1997 and 1996 totaled $54,230 and $68,103, respectively. 74 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 15. OFF-BALANCE SHEET DERIVATIVE FINANCIAL INSTRUMENTS, COMMITMENTS AND CONTINGENT LIABILITIES - continued (h) Interest rate caps and floors are written by the Corporation to enable customers to transfer, modify or reduce their interest rate risk. Interest rate caps and floors are similar to interest rate swaps except that payments are made only if current interest rates move above or below a predetermined rate. The risk associated with interest rate caps and floors is an unfavorable change in interest rates. As a writer of interest rate caps and floors, the Corporation receives a premium in exchange for bearing the risk of an unfavorable change in interest rates. The Corporation generally reduces risk by entering into offsetting cap and floor positions that essentially counterbalance each other. The Corporation also enters interest rate caps to offset the risk of upward interest rate movement on assets with embedded caps as well as to limit spread risk. As a purchaser of interest rate caps, the Corporation pays a premium in exchange for the right to receive payments if interest rates rise above predetermined levels. The Corporation has also purchased interest rate floors in which the Corporation has paid a fee for the right to receive payments if rates fall below a predetermined level. Similar to interest rate swaps, credit risk exists with respect to the possible failure of the counterparty to make required payments on those contracts which are favorable to the Corporation. Exposure to counterparty failure equals the current replacement cost of the contract which totaled $11,003 and $17,383, respectively, at December 31, 1997 and 1996. (i) Tender option bonds are instruments associated with tax-free municipal bonds. The Corporation will transfer a tax-free, fixed rate, long-term security into a trust. The trust, in turn, issues short-term securities to third parties. The trust satisfies the short-term interest payments using the interest proceeds from the municipal bond. The Corporation receives the spread between the long-term fixed interest payment and the short-term security. (j) A Treasury float contract is created because a municipality, which has defeased a bond issue with government securities, has a mismatch in the timing of the maturity of the securities and the date the funds are needed to pay the debt service. The Corporation will pay an up-front fee for the right to sell government securities to the municipality, generally at par. The Corporation retains any profit between the sales price and the price at which the Corporation acquired the securities. Contingent Liabilities In the normal course of business, the Corporation and its subsidiaries are subject to numerous pending and threatened legal actions and proceedings, some for which the relief or damages sought are substantial. Management does not believe the outcome of these actions and proceedings will have a materially adverse effect on the consolidated financial position of the Corporation. 75 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 16. PROVISION FOR INCOME TAXES The provision for income taxes for the years ended December 31, 1997, 1996 and 1995 consists of the following:
1997 1996 1995 -------- -------- -------- Current: Federal....................................... $142,688 $344,142 $303,647 State......................................... 14,368 20,401 24,134 -------- -------- -------- Total domestic........................... 157,056 364,543 327,781 Foreign....................................... 11,775 12,121 8,240 -------- -------- -------- Total current............................ 168,831 376,664 336,021 Deferred Federal and state expense............... 100,751 9,156 28,420 -------- -------- -------- Total provision for income taxes......... $269,582 $385,820 $364,441 ======== ======== ========
The significant components of the Corporation's deferred tax assets and liabilities at December 31, 1997 and 1996 are as follows:
1997 1996 --------- --------- Deferred tax assets: Allowance for loan losses.................... $270,169 $ 261,180 Postretirement and postemployment benefits... 48,550 57,191 Reserves..................................... 50,186 56,489 Other 80,135 77,181 -------- --------- Total deferred tax assets............... 449,040 452,041 -------- --------- Deferred tax liabilities: Auto leasing portfolio....................... 136,253 142,196 FAS 115 fair value accounting................ 17,094 14,298 Partnership investments...................... 4,558 3,781 Tax over book depreciation................... 43,711 38,446 Affiliate income............................. 38,862 32,873 Other 70,584 71,802 -------- --------- Total deferred tax liabilities.......... 311,062 303,396 -------- --------- Net deferred tax assets.......................... $137,978 $ 148,645 ======== =========
At December 31, 1997, cumulative deductible temporary differences related to the deferred tax asset are approximately $1,283,000. Cumulative taxable temporary differences related to deferred tax liabilities at December 31, 1997 are estimated at $889,000. At December 31, 1997, the Corporation has determined that it is not required to establish a valuation allowance for the deferred tax asset since it is more likely than not that the deferred tax asset of $449,040 will be realized principally through carryback to taxable income in prior years, future reversals of existing taxable temporary differences, future taxable income and to a lesser extent, tax planning strategies. The Corporation's conclusion that it is "more likely than not" that the deferred tax asset will be realized is based on a history of growth in earnings and the prospects for continued growth, including an analysis of potential uncertainties that may affect future operating results. The Corporation will continue to review the tax criteria of "more likely than not" for the recognition of deferred tax assets on a quarterly basis. 76 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 16. PROVISION FOR INCOME TAXES - continued The consolidated effective tax rates are reconciled to the statutory rate as follows:
1997 1996 1995 ----- ----- ----- Statutory rate..................................... 35.0% 35.0% 35.0% Difference resulting from: Tax-exempt income.............................. (1.4) (1.6) (2.0) State, local and foreign income tax............ 1.0 1.6 1.5 Liquidation of affiliate....................... (10.1) - - Other, net..................................... 0.4 2.3 1.2 ----- ----- ----- Effective tax rate................................. 24.9% 37.3% 35.7% ===== ===== =====
Foreign earnings of certain subsidiaries would be taxed only upon their transfer to the United States. No transfers or dividends are contemplated at this time. Taxes payable upon remittance of such accumulated earnings of $21,323 at December 31, 1997 would approximate $7,065. Taxes, other than income taxes, included in other operating expenses for the years ended December 31, 1997, 1996 and 1995 are $107,553, $101,109 and $105,913, respectively. 77 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 17. QUARTERLY FINANCIAL DATA (UNAUDITED) The following represents summarized quarterly financial data of the Corporation, which, in the opinion of management, reflects all adjustments (comprising only normal recurring accruals) necessary for a fair presentation:
Three Months Ended ----------------------------------------------------------------------- Dec. 31 Sept. 30 June 30 March 31 -------- -------- -------- -------- 1997 Interest income............................... $888,593 $873,034 $850,359 $817,329 ======== ======== ======== ======== Interest expense.............................. $363,676 $342,540 $316,006 $291,225 ======== ======== ======== ======== Net interest income........................... $524,917 $530,494 $534,353 $526,104 ======== ======== ======== ======== Provision for losses on loans................. $120,000(a) $ 50,000 $ 50,000 $ 43,000 ======== ======== ======== ======== Securities gains.............................. $ 6,254 $ 5,023 $ 5,015 $ 4,819 ======== ======== ======== ======== Net income ................................... $216,626(b)(c) $198,814 $199,726 $198,113 ======== ======== ======== ======== Net income per common share: Basic...................................... $1.09 $1.00 $0.97 $0.94 ======== ======== ======== ======== Diluted.................................... 1.08 0.98 0.97 0.93 ======== ======== ======== ======== Average common shares outstanding: Basic...................................... 197,920 199,817 204,982 211,276 ======== ======== ======== ======== Diluted.................................... 200,416 202,704 206,712 213,162 ======== ======== ======== ======== Common stock price information: High....................................... $81 3/8 $68 13/16 $57 7/8 $55 Low........................................ 65 11/16 53 1/4 46 1/2 47 1/2 Quarter-end................................ 80 1/2 66 3/16 53 3/4 47 1/2 1996 Interest income............................... $835,649 $823,082 $815,755 $823,718 ======== ======== ======== ======== Interest expense.............................. $298,561 $282,735 $282,360 $293,064 ======== ======== ======== ======== Net interest income........................... $537,088 $540,347 $533,395 $530,654 ======== ======== ======== ======== Provision for losses on loans................. $ 40,000 $ 40,000 $110,000(d) $ 38,767 ======== ======== ======== ======== Securities gains.............................. $ 4,036 $ 31,135 $17,393 $ 6,948 ======== ======== ======== ======== Net income ................................... $195,546 $196,857 $79,597(d)(e) $177,144 ======== ======== ======== ======== Net income per common share: Basic...................................... $0.91 $0.89 $0.36(d)(e) $0.81 ======== ======== ======== ======== Diluted.................................... 0.90 0.88 0.36 0.80 ======== ======== ======== ======== Average common shares outstanding: Basic...................................... 215,866 220,409 219,478 219,512 ======== ======= ======== ======= Diluted.................................... 218,020 222,270 220,621 221,253 ======== ======= ======= ======= Common stock price information: High....................................... $55 3/8 $44 $43 1/8 $44 Low........................................ 42 3/4 35 1/2 35 3/4 36 1/8 Quarter-end................................ 51 7/8 43 1/4 38 1/2 42 3/8
(a) Includes a $70.0 million, $44.9 million after-tax or $0.22 per share, special provision for loan losses primarily related to management's decision to sell approximately $450 million of credit card outstandings. (b) Includes a tax benefit of $109.0 million, or $0.54 per share, related to the liquidation of an affiliate. (c) Includes restructuring and merger-related charges of $15.0 million, $9.6 million after-tax or $0.05 per share, and other significant one-time charges of $57.0 million, $36.5 million after-tax or $0.18 per share. (d) Includes a provision for loan losses of $70.0 million, $45.5 million after-tax or $0.20 per share, related to the Meridian acquisition. (e) Includes net restructuring and merger-related charges of $139.7 million, $105.3 million after-tax or $0.47 per share, primarily recorded in the second quarter and related to costs associated with the Meridian acquisition. 78 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 18. JOINT VENTURE In December 1992, the Corporation entered into a joint venture with three other banking companies creating Electronic Payment Services, Inc. ("EPS"). The joint venture combines the partners' separate consumer electronic transaction processing businesses and provides automated teller machine ("ATM") and electronic point-of-sale ("POS") processing services. The Corporation contributed to EPS its wholly-owned subsidiaries of Money Access Service Inc. ("MAC"), a regional ATM network, and BUYPASS Corporation, a third-party processor of electronic POS transactions. At the formation of EPS, the Corporation had equal ownership with two partners in the joint venture, each with 31%. The fourth partner owned 7%. As part of the 1992 transaction, the Corporation received a cash payment of $79,350 and $245,400 of EPS 5% cumulative redeemable preferred stock. The exchange of assets involved in the transaction resulted in a 1992 pre-tax gain to the Corporation of $41,072, $25,670 after-tax. The exchange also generated a deferred gain of approximately $138,000. In December 1993, the Corporation and EPS mutually agreed to enter into a recapitalization of EPS involving the EPS preferred stock held by the Corporation. In exchange for substantially all of the preferred stock, the Corporation received from EPS a ten-year 6.45% note providing for equal principal payments over the life of the note. The recapitalization did not affect the amount of deferred gain, but changed the timing of deferred gain income recognition from a five-year period beginning in 1996 to a ten-year period which began in 1994. On March 27, 1995, EPS added a new partner and increased the ownership interests of an existing partner to that of a full partner, resulting in a decrease in the Corporation's share of ownership from 31% to 20%. As a direct result of this change in ownership interests, the Corporation recognized a pre-tax gain of $19,000, $11,800 after-tax or $0.05 per share, in 1995. Included in the pre-tax gain amount was $4,000 related to the acceleration of deferred gain recognition. The Corporation's investment in EPS at December 31, 1997, net of $87,000 deferred gain, is $59,156 and is included in other assets. "Income from investment in EPS, Inc.", which is included in non-interest income, reflects the Corporation's share in EPS net income, interest income on the 6.45% note and amortization of the deferred gain. 79 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 19. RESTRUCTURING AND MERGER-RELATED CHARGES A summary of restructuring and merger-related charges for the years ended December 31, 1997, 1996 and 1995 were as follows:
1997 1996 1995 --------- --------- ---------- Merger-related restructuring charges............. $ 6,200 $ 161,598 $ 10,000 Strategic technology alliance charges............ 8,800 - - Meridian merger-related implementation costs..... - 29,019 - Process redesign restructuring charges........... - - 142,000 Gains on sales of branches....................... - (43,064) (3,988) Pension curtailment gains........................ - (7,851) (9,412) --------- --------- ---------- Total........................................ $15,000 $ 139,702 $ 138,600 ========= ========= ==========
In 1997, CoreStates recorded pre-tax restructuring and merger-related charges of $15,000, $9,612 after-tax or $0.05 per share, primarily related to costs incurred in the pending First Union merger and costs incurred in the creation of a strategic technology alliance with Andersen Consulting. Cash outflow related to these costs in 1997 was $11,700. In 1996, the Corporation recorded merger-related restructuring charges of $161,598, $120,150 after-tax or $0.54 per share, in connection with the acquisitions of Meridian and United Counties. The charges included direct and incremental costs associated with these acquisitions. The components of the merger-related restructuring charges were as follows:
Requiring Cash Cash Outflow Provision Outflow to Date --------- --------- -------- Severance costs......................... $ 70,469 $ 70,469 $ 65,941 Branch closing costs.................... 33,469 15,102 6,585 Office reconfiguration costs............ 19,059 2,792 (5,764) Merger transaction costs................ 14,624 14,624 13,461 System consolidation writedowns......... 6,391 - - Miscellaneous........................... 17,586 17,593 12,316 -------- -------- -------- Total............................. $161,598 $120,580 $ 92,539 ======== ======== ========
The severance costs relate to severance packages, which were or are expected to be paid to approximately 1,350 employees who have been displaced as a result of the Meridian consolidation. Restructuring and merger-related charges in 1996 also included $29,019, $18,263 after-tax or $0.07 per share, of implementation costs that were incurred in the process of consolidating Meridian and United Counties businesses and operations. The Corporation recorded restructuring credits of $50,915, $33,096 after-tax or $0.14 per share and $13,400, $8,549 after-tax or $0.03 per share in 1996 and 1995, respectively, related to gains on the curtailment of pension benefits associated with employees displaced during 1996 and 1995 and gains on the sale of branches which were sold as a result of consolidating the Meridian and United Counties branches and the process redesigns. Upon consummation of the Meridian merger, the Corporation recorded a $70 million provision for loan losses in connection with a change in strategic direction related to Meridian's problem assets and to conform its consumer lending charge-off policies to those of the Corporation. 80 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 19. RESTRUCTURING AND MERGER-RELATED CHARGES - continued In 1995, the Corporation recorded restructuring charges of $142,000, $90,800 after-tax or $0.40 per share, in connection with process redesigns commenced during that year. The objectives of the process redesigns were: (i) to enhance customer focus; (ii) to accelerate "cultural changes" which were already in progress; and (iii) to improve productivity. The charges included direct and incremental costs associated with the process redesigns. The components of the process redesign restructuring charges were as follows:
Requiring Cash Cash Outflow Provision Outflow to Date ---------- ---------- ---------- Severance costs........................ $ 87,900 $ 87,900 $ 87,328 Office reconfiguration and branch closing costs...................... 44,300 16,600 6,901 Outplacement costs..................... 2,500 2,500 2,358 Miscellaneous.......................... 7,300 5,300 4,653 ---------- ---------- ---------- Total............................. $ 142,000 $ 112,300 $ 101,240 ========== ========== ==========
The following table summarizes the activity in the restructuring and merger-related accrual for the year ended December 31, 1997: 1997 -------- Balance at beginning of year................ $108,205 Provision charged against income............ 15,000 Cash outflow................................ (59,451) Writedowns of assets........................ (30,269) -------- Balance at December 31,..................... $ 33,485 ========= 81 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 20. EARNINGS PER COMMON SHARE The following table sets forth the computation of basic and diluted earnings per share:
Year ended December 31, --------------------------------------------- 1997 1996 1995 -------- -------- -------- Earnings - -------- (a) Net income.............................. $813,279 $649,144 $655,176 ======== ======== ======== Average Common Shares - --------------------- (b) Average common shares outstanding....... 203,452 218,812 222,268 Average potentially dilutive shares..... 2,116 1,886 2,398 -------- ------- ------- (c) Average common and potentially dilutive shares....................... 205,568 220,698 224,666 ======= ======= ======= Net Income Per Common Share - --------------------------- Basic (a / b)............................... $4.00 $2.97 $2.95 ===== ===== ===== Diluted (a / c)............................. $3.96 $2.94 $2.92 ===== ===== =====
21. FINANCIAL STATEMENTS OF THE PARENT COMPANY
STATEMENT OF INCOME Year ended December 31, ---------------------------------------- 1997 1996 1995 --------- --------- --------- REVENUES - -------- Dividends from subsidiaries: Banks.................................................... $ 625,000 $ 657,744 $ 373,023 Other subsidiaries....................................... 90,940 27,217 91,917 --------- -------- --------- Total dividends from subsidiaries..................... 715,940 684,961 464,940 Management fees and other income from subsidiaries.......... 189,000 178,179 190,027 Securities gains (losses)................................... - (22) 16,343 Other income................................................ 444 3,054 3,241 --------- -------- --------- Total revenues........................................ 905,384 866,172 674,551 --------- -------- --------- EXPENSES - -------- Interest on: Funds borrowed........................................... 13,361 5,606 19,685 Long-term debt........................................... 18,436 22,843 21,578 --------- -------- --------- Total interest expense................................ 31,797 28,449 41,263 Other operating expenses.................................... 181,663 245,836 219,463 --------- -------- --------- Total expenses........................................ 213,460 274,285 260,726 --------- -------- --------- Income before income tax benefit and equity in undistributed income of subsidiaries................... 691,924 591,887 413,825 Income tax benefit.......................................... (6,953) (14,911) (11,977) --------- -------- --------- Income before equity in undistributed income of subsidiaries 698,877 606,798 425,802 --------- -------- --------- Equity in undistributed income (excess dividends) of subsidiaries: Banks.................................................. 62,503 (52,497) 203,909 Other subsidiaries..................................... 51,899 94,843 25,465 --------- -------- --------- 114,402 42,346 229,374 Total equity in undistributed income of subsidiaries.. --------- -------- --------- NET INCOME.................................................. $ 813,279 $649,144 $ 655,176 - ---------- ========= ======== =========
82 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 21. FINANCIAL STATEMENTS OF THE PARENT COMPANY - continued
BALANCE SHEET December 31, -------------------------- 1997 1996 ---------- ---------- ASSETS - ------ Cash ...................................................... $ 1,508 $ 1,374 Time deposits............................................... - 887 Investment-securities available-for-sale.................... 15,512 97,786 Investments and receivables - subsidiaries: Investments in subsidiaries at equity in underlying net assets: Banks.................................................... 3,220,941 3,389,148 Other subsidiaries....................................... 655,274 558,062 ---------- ---------- Total investments in subsidiaries..................... 3,876,215 3,947,210 Receivables - subsidiaries................................ 113,715 40,814 ---------- ---------- Total investments and receivables-subsidiaries........ 3,989,930 3,988,024 Other assets................................................ 42,258 80,039 ---------- ---------- Total assets.......................................... $4,049,208 $4,168,110 ========== ========== LIABILITIES - ----------- Funds borrowed - subsidiaries............................... $ 359,123 $ - Dividends payable and other liabilities..................... 196,911 214,925 Long-term debt.............................................. 255,742 257,491 ---------- ---------- Total liabilities..................................... 811,776 472,416 ---------- ---------- SHAREHOLDERS' EQUITY - -------------------- Total shareholders' equity............................ 3,237,432 3,695,694 ---------- ---------- Total liabilities and shareholders' equity............ $4,049,208 $4,168,110 ========== ==========
The Corporation has guaranteed certain borrowings of its subsidiaries at December 31, 1997 in the amount of $3,331,835 which includes $865,835 for commercial paper. The maturities for parent company long-term debt for the years ending December 31, 1998 through 2002 are: $1,607; $1,751; $151,855; $696 and $99,833, respectively. 83 CoreStates Financial Corp and Subsidiaries NOTES TO THE FINANCIAL STATEMENTS (dollar amounts in thousands) 21. FINANCIAL STATEMENTS OF THE PARENT COMPANY - continued
Statement of Cash Flows Year Ended December 31, ----------------------------------------- 1997 1996 1995 ---------- ----------- ---------- OPERATING ACTIVITIES Net income............................................................. $ 813,279 $ 649,144 $ 655,176 Adjustments to reconcile net income to net cash provided by operating activities: Undistributed income of subsidiaries............................... (114,402) (42,346) (229,374) Securities losses (gains).......................................... - 22 (16,343) Deferred income tax expense (benefit).............................. 2,644 180 (785) Net decrease (increase) in other assets............................ 29,749 (6,969) 24,265 Net increase (decrease) in other liabilities....................... 2,577 8,454 (22,761) Other, net......................................................... 6,073 7,288 7,840 ---------- ----------- ---------- NET CASH PROVIDED BY OPERATING ACTIVITIES............................ 739,920 615,773 418,018 ---------- ----------- ---------- INVESTING ACTIVITIES Net capital returned from subsidiaries................................. 190,000 270,226 190,900 (Increase) decrease in receivables from subsidiaries................... (72,901) 107,069 (3,593) Purchases of investment securities..................................... (53,493) (707,008) (170,988) Proceeds from maturities and sales of investment securities............ 135,767 717,536 118,483 Other, net............................................................. - - (1,380) ---------- ----------- ---------- NET CASH PROVIDED BY INVESTING ACTIVITIES.......................... 199,373 387,823 133,422 ---------- ----------- ---------- FINANCING ACTIVITIES Repayment of funds borrowed............................................ - - (75,000) Retirement of long-term debt........................................... (1,749) (77,401) (1,471) Proceeds from issuance of long-term debt............................... - - 149,877 Net increase (decrease) in financing from and due to subsidiaries...... 369,329 (115,498) (94,054) Cash dividends paid.................................................... (391,781) (328,114) (286,565) Purchases of treasury stock............................................ (1,007,832) (533,932) (335,528) Repurchase and retirement of common stock.............................. - (57,703) (17,134) Common stock issued under employee benefit plans....................... 62,873 87,726 99,011 Other, net............................................................. 30,001 21,360 6,777 ---------- ----------- ---------- NET CASH USED IN FINANCING ACTIVITIES.................................. (939,159) (1,003,562) (554,087) ----------- ----------- ---------- INCREASE (DECREASE) IN CASH AND DUE FROM BANKS....................... 134 34 (2,647) Cash and due from banks at January 1,................................ 1,374 1,340 3,987 ---------- ----------- ---------- CASH AND DUE FROM BANKS AT DECEMBER 31,.............................. $ 1,508 $ 1,374 $ 1,340 ========== =========== ========== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the year for: Interest............................................................. $ 28,187 $ 25,267 $ 40,745 ========== =========== ========== Income taxes......................................................... $ - $ - $ 43 ========== =========== ==========
84 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Page 1 of 2 SUPPLEMENTAL FINANCIAL DATA CONSOLIDATED AVERAGE BALANCE SHEET AND TAXABLE EQUIVALENT INCOME/EXPENSE AND RATES
1997 1996 ---------------------------------- -------------------------------- Average Income/ Average Income/ balance Rate expense balance Rate expense -------- ------ ------------- ---------- ------- --------- INTEREST EARNING ASSETS (000,000) (000) (000,000) (000) Time deposits, principally Eurodollars (a)..... $ 2,800 5.76% $ 161,418 $ 2,163 5.68% $ 122,752 Investment securities (b): U.S. Government.............................. 2,257 6.09 137,487 3,262 6.02 196,511 State and municipal.......................... 391 7.86 30,744 497 8.05 40,008 Other........................................ 1,044 5.99 62,578 903 5.95 53,723 ------- --------- ------- --------- Total investment securities........... 3,692 6.25 230,809 4,662 6.23 290,242 ------- --------- ------- --------- Federal funds sold and securities purchased under agreements to resell.................. 137 6.08 8,323 332 5.71 18,966 Trading account securities..................... 282 8.32 23,473 112 6.77 7,581 Loans (b)(c)(d): Domestic: Commercial, industrial and other........... 15,193 8.79 1,335,058 13,398 9.03 1,209,870 Real estate................................ 9,288 8.21 762,769 10,094 8.49 857,105 Consumer................................... 4,862 12.02 584,347 4,536 11.67 529,503 Financial institutions..................... 911 7.06 64,332 847 6.45 54,648 Factoring receivables...................... 500 9.66 48,280 497 10.09 50,156 Lease financing............................ 1,213 7.94 96,331 1,180 8.05 95,018 Foreign...................................... 2,121 6.50 137,760 1,387 6.39 88,563 ------- --------- ------- --------- Total loans, net of discounts........ 34,088 8.89 3,028,877 31,939 9.03 2,884,863 ------- --------- ------- --------- Total interest earning assets (d).... $40,999 8.42 3,452,900 $39,208 8.48 3,324,404 ======= ---- --------- ======= ---- --------- FUNDING SOURCES Interest bearing liabilities (b): Deposits in domestic offices (e): Commercial................................. $ 1,770 5.57 98,669 $ 601 5.13 30,857 NOW accounts............................... 390 1.34 4,697 1,439 1.14 15,112 Money Market Accounts...................... 9,075 2.62 236,152 7,585 2.64 199,566 Consumer savings........................... 3,642 1.20 43,815 4,563 1.77 80,972 Consumer certificates...................... 8,483 5.14 436,135 9,067 5.15 467,099 Time deposits of overseas branches and subsidiaries......................... 1,307 4.97 64,896 1,034 4.66 48,174 ------- --------- ------- --------- Total interest bearing deposits...... 24,667 3.60 884,364 24,289 3.49 841,780 ------- --------- ------- --------- Short-term funds borrowed: Federal funds purchased and securities sold under agreements to repurchase...... 1,487 5.43 80,681 1,622 5.07 82,214 Commercial paper........................... 914 5.61 51,289 962 5.44 52,353 Other...................................... 1,013 5.71 57,865 374 4.96 18,562 ------- --------- ------- --------- Total short-term funds borrowed...... 3,414 5.56 189,835 2,958 5.18 153,129 ------- --------- ------- --------- Long-term debt............................... 3,683 6.50 239,248 2,536 6.38 161,811 ------- --------- ------- --------- Total interest bearing liabilities... 31,764 4.14 1,313,447 29,783 3.88 1,156,720 Portion of non-interest bearing funding sources...................................... 9,235 9,425 ------- --------- ------- --------- Total funding sources................ $40,999 3.20 1,313,447 $39,208 2.95 1,156,720 ======= ---- --------- ======= ---- --------- Net interest income and net interest margin.... 5.22% $2,139,453 5.53% $2,167,684 ==== ========== ==== =========
1995 --------------------------------- Average Income/ balance Rate expense --------- ------ ----------- INTEREST EARNING ASSETS (000,000) (000) Time deposits, principally Eurodollars (a)...... $ 1,929 6.32% $ 121,993 Investment securities (b): U.S. Government............................... 4,946 5.87 290,474 State and municipal........................... 665 8.42 56,018 Other......................................... 819 6.15 50,366 ------- --------- Total investment securities............ 6,430 6.17 396,858 ------- --------- Federal funds sold and securities purchased under agreements to resell................... 322 6.12 19,695 Trading account securities...................... 280 7.42 20,785 Loans (b)(c)(d): Domestic: Commercial, industrial and other............ 12,526 9.52 1,192,478 Real estate................................. 11,283 9.09 1,025,924 Consumer.................................... 4,238 11.11 470,771 Financial institutions...................... 715 7.04 50,307 Factoring receivables....................... 577 10.65 61,442 Lease financing............................. 1,094 8.16 89,290 Foreign....................................... 834 7.05 58,807 ------- --------- Total loans, net of discounts......... 31,267 9.43 2,949,019 ------- --------- Total interest earning assets (d)..... $40,228 8.72 3,508,350 ======= ---- --------- FUNDING SOURCES Interest bearing liabilities (b) Deposits in domestic offices (e): Commercial.................................. $ 669 5.58 37,321 NOW accounts................................ 3,377 1.51 46,724 Money Market Accounts....................... 6,023 3.29 197,431 Consumer savings............................ 5,040 2.28 114,700 Consumer certificates....................... 9,132 5.39 492,610 Time deposits of overseas branches and subsidiaries.......................... 1,089 4.80 52,261 ------- --------- Total interest bearing deposits....... 25,330 3.76 941,047 ------- --------- Short-term funds borrowed: Federal funds purchased and securities sold under agreements to repurchase....... 2,203 5.68 125,117 Commercial paper............................ 1,051 5.94 62,459 Other....................................... 498 5.33 26,543 ------- --------- Total short-term funds borrowed....... 3,752 5.71 214,119 ------- --------- Long-term debt................................ 2,262 6.76 152,989 ------- --------- Total interest bearing liabilities.... 31,344 4.17 1,308,155 Portion of non-interest bearing funding sources....................................... 8,884 ------- Total funding sources................. $40,228 3.25 1,308,155 ======= ---- --------- Net interest income and net interest margin..... 5.47% $2,200,195 ==== ==========
(a) Yields and income on time deposits include net Eurodollar trading profits. (b) The net impact of off-balance sheet derivatives used for managing interest rate risk is recognized as an adjustment to interest income or expense of the related hedged asset or liability. (c) Yields and income on loans include fees on loans. (d) Non-performing loans are included in interest earning assets. (e) Average interest bearing demand deposits in domestic offices are reduced by specified reserve amounts for purposes of rate calculations. 85 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Page 2 of 2 SUPPLEMENTAL FINANCIAL DATA: continued CONSOLIDATED AVERAGE BALANCE SHEET AND TAXABLE EQUIVALENT INCOME/EXPENSE AND RATES
1997 1996 1995 -------------------------- ------------------------ ----------------------- Average Income/ Average Income/ Average Income/ balance Rate expense balance Rate expense balance Rate expense -------- ---- ------- ------- ---- ------- -------- ---- ------- (000,000) (000) (000,000) (000) (000,000) (000) NON-INTEREST EARNING ASSETS Cash..................................... $ 2,824 $ 2,845 $ 2,779 Allowance for loan losses................ (694) (701) (685) Other assets............................. 2,589 2,442 2,383 ------- ------- ------- Total non-interest earning assets... $ 4,719 $ 4,586 $ 4,477 ======= ======= ======= Total average assets..................... $45,718 $43,794 $44,705 ======= ======= ======= NON-INTEREST BEARING FUNDING SOURCES Demand deposits: Domestic............................... $ 7,905 $ 7,699 $ 7,352 Foreign................................ 395 379 420 Other liabilities........................ 2,290 2,043 1,847 Shareholders' equity..................... 3,364 3,890 3,742 Non-interest bearing funding sources used to fund earning assets................. (9,235) (9,425) (8,884) ------- ------- ------- Total net non-interest bearing funding sources................. $ 4,719 $ 4,586 $ 4,477 ======= ======= ======= SUPPLEMENTARY AVERAGES Net Federal funds purchased and securities sold under agreements to repurchase...... $ 1,350 5.36% $ 72,358 $ 1,290 4.90% $63,248 $ 1,881 5.60% $105,422 Certificates of deposit in domestic offices over $100,000.................. 2,371 5.48 129,963 1,090 5.17 56,308 1,170 5.69 66,577 Average prime rate....................... 8.44 8.27 8.84
86 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Page 1 of 2 SUPPLEMENTAL FINANCIAL DATA: continued CONSOLIDATED AVERAGE BALANCE SHEET AND TAXABLE EQUIVALENT INCOME/EXPENSE AND RATES
1994 1993 ----------------------------------- ------------------------------ Average Income/ Average Income/ balance Rate expense balance Rate expense ------- ----- ---------- ------- ----- ---------- INTEREST EARNING ASSETS (000,000) (000) (000,000) (000) Time deposits, principally Eurodollars (a)...... $ 1,623 4.37% $ 70,996 $ 1,423 3.39% $ 48,214 Investment securities (b): U.S. Government............................... 5,498 5.48 301,515 6,120 6.09 372,738 State and municipal........................... 778 7.97 62,027 890 8.26 73,500 Other......................................... 1,087 5.54 60,252 1,023 5.34 54,649 ------- ---------- ------- ---------- Total investment securities............ 7,363 5.76 423,794 8,033 6.24 500,887 ------- ---------- ------- ---------- Federal funds sold and securities purchased under agreements to resell................... 289 4.38 12,652 336 3.26 10,959 Trading account securities...................... 139 6.78 9,419 150 7.38 11,072 Loans (b)(c)(d): Domestic: Commercial, industrial and other............ 11,164 8.30 927,082 10,135 7.80 790,553 Real estate................................. 11,978 7.95 951,681 12,459 7.78 968,967 Consumer.................................... 4,117 10.44 429,832 3,851 10.79 415,390 Financial institutions...................... 626 8.00 50,106 716 6.15 44,058 Factoring receivables....................... 587 9.95 58,389 554 9.62 53,312 Lease financing............................. 1,041 8.45 87,982 897 9.31 83,466 Foreign....................................... 597 5.39 32,155 551 5.00 27,565 ------- ---------- ------- ---------- Total loans, net of discounts......... 30,110 8.43 2,537,227 29,163 8.17 2,383,311 ------- ---------- ------- ---------- Total interest earning assets (d)..... $39,524 7.73 3,054,088 $39,105 7.56 2,954,443 ======= ---- ---------- ======= ---- --------- FUNDING SOURCES Interest bearing liabilities (b): Deposits in domestic offices (e): Commercial.................................. $ 580 4.15 24,061 $ 752 3.97 29,842 NOW accounts................................ 3,540 1.15 37,384 3,343 1.43 43,308 Money Market Accounts....................... 6,386 2.27 144,475 6,672 2.01 134,091 Consumer savings............................ 5,509 1.87 103,142 5,269 1.93 101,471 Consumer certificates....................... 7,993 4.28 341,843 8,519 4.32 368,122 Time deposits of overseas branches and subsidiaries............................ 831 3.56 29,602 718 2.57 18,453 ------- ---------- ------- ---------- Total interest bearing deposits....... 24,839 2.77 680,507 25,273 2.79 695,287 ------- ---------- ------- ---------- Short-term funds borrowed: Federal funds purchased and securities sold under agreements to repurchase......... 2,092 4.17 87,276 1,951 2.99 58,291 Commercial paper............................ 757 4.24 32,089 606 3.14 19,051 Other....................................... 587 5.15 30,253 480 4.45 21,347 ------- ---------- ------- ---------- Total short-term funds borrowed....... 3,436 4.35 149,618 3,037 3.25 98,689 ------- ---------- ------- ---------- Long-term debt (b)............................ 2,040 5.71 116,419 1,894 5.27 99,837 ------- ---------- ------- ---------- Total interest bearing liabilities.... 30,315 3.12 946,544 30,204 2.96 893,813 Portion of non-interest bearing funding sources......................................... 9,209 8,901 ------- ---------- ------- Total funding sources................. $39,524 2.40 946,544 $39,105 2.29 893,813 ======= ---- ---------- ======= ---- ---------- Net interest income and net interest margin..... 5.33% $2,107,544 5.27% $2,060,630 ==== ========== ==== ==========
(a) Yields and income on time deposits include net Eurodollar trading profits. (b) The net impact of off-balance sheet derivatives used for managing interest interest rate risk is recognized as an adjustment to interest income or expense of the related hedged asset or liability. (c) Yields and income on loans include fees on loans. (d) Non-performing loans are included in interest earning assets. (e) Average bearing demand deposits in domestic offices are reduced by specified reserve amounts for purposes of rate calculations. 87 CORESTATES FINANCIAL CORP AND SUBSIDIARIES Page 2 of 2 SUPPLEMENTAL FINANCIAL DATA: continued CONSOLIDATED AVERAGE BALANCE SHEET AND TAXABLE EQUIVALENT INCOME/EXPENSE AND RATES
1994 1993 ------------------------------- -------------------------------- Average Income/ Average Income/ balance Rate expense balance Rate expense ------- ---- ------- ---------- ---- ------- (000,000) (000) (000,000) (000) NON-INTEREST EARNING ASSETS Cash....................................... $ 2,982 $ 2,956 Allowance for loan losses.................. (692) (641) Other assets............................... 2,017 2,016 ------- ------- Total non-interest earning assets..... $ 4,307 $ 4,331 ======= ======= TOTAL AVERAGE ASSETS....................... $43,831 $43,436 ======= ======= NON-INTEREST BEARING FUNDING SOURCES Demand deposits: Domestic................................. $ 7,698 $ 7,646 Foreign.................................. 417 369 Other liabilities.......................... 1,775 1,771 Shareholders' equity....................... 3,626 3,446 Non-interest bearing funding sources used to fund earning assets................... (9,209) (8,901) ------- ------- Total net non-interest bearing funding sources................... $ 4,307 $ 4,331 ======= ======= Supplementary Averages Net Federal funds purchased and securities sold under agreements to repurchase.... $ 1,803 4.14% $74,624 $ 1,615 2.93% $47,332 Certificates of deposit in domestic offices over $100,000.................... 1,157 4.03 46,637 1,346 3.84 51,715 Average prime rate......................... 6.60 6.00
88 CoreStates Financial Corp and Subsidiaries Supplemental Financial Data: Continued CONDENSED CONSOLIDATED STATEMENT OF INCOME AND SELECTED FINANCIAL DATA (in thousands, except per share amounts) Condensed Consolidated Statement of Income
Year Ended December 31, ------------------------------------------------------------------------------ 1997 1996 1995 1994 1993 ----------- ---------- ---------- --------- ----------- Interest income and fees........................ $3,429,315 $3,298,204 $3,475,080 $3,014,559 $2,904,949 Interest expense................................ 1,313,447 1,156,720 1,308,155 946,544 893,813 ---------- ---------- ---------- ---------- ---------- Net interest income.......................... 2,115,868 2,141,484 2,166,925 2,068,015 2,011,136 Provision for losses on loans................... 263,000 228,767 144,002 279,195 189,372 ---------- ---------- ---------- ---------- ---------- Net interest income after provision for losses on loans.............. 1,852,868 1,912,717 2,022,923 1,788,820 1,821,764 Non-interest income............................. 925,770 899,075 882,222 788,487 832,720 Non-financial expenses.......................... 1,695,777 1,776,828 1,885,528 1,918,242 1,869,544 ---------- ---------- ---------- --------- ---------- Income before income taxes...................... 1,082,861 1,034,964 1,019,617 659,065 784,940 Provision for income taxes...................... 269,582 385,820 364,441 225,859 246,854 ---------- ---------- ---------- --------- ---------- Income before cumulative effect of a change in accounting principle............... 813,279 649,144 655,176 433,206 538,086 Cumulative effect of a change in accounting principle, net of tax............. - - - - (15,740)(f) ---------- ---------- ---------- ---------- ---------- Net income...................................... $ 813,279 $ 649,144 $ 655,176 $ 433,206 $ 522,346 ========== ========== ========== ========== ========== Per common share data: Income before cumulative effect of a change in accounting principle: Basic...................................... $4.00(a) $2.97(b) $2.95(c) $1.91(d) $2.35(f) Diluted.................................... 3.96(a) 2.94(b) 2.92(c) 1.90(d) 2.32(f) Net income: Basic...................................... 4.00(a) 2.97(b) 2.95(c) 1.91(d) 2.29(e) Diluted.................................... 3.96(a) 2.94(b) 2.92(c) 1.90(d) 2.26(e) Dividends paid............................... 1.88 1.68 1.36 1.20 1.11 Dividends declared (e)....................... 1.91 1.73 1.44 1.24 1.14 Average common shares outstanding............... 203,452 218,812 222,268 226,234 228,580 Average diluted common shares outstanding....... 205,568 220,698 224,666 227,938 231,437 Operating Ratios: Income before cumulative effect of a change in accounting principle as a percent of: Average common shareholders' equity........ 24.18%(a) 16.69%(b) 17.51%(c) 11.95%(d) 15.61% Average total assets....................... 1.78 (a) 1.48 (b) 1.47 (c) 0.99 (d) 1.24 Average total shareholders' equity as a percent of average total assets...................... 7.36 8.88 8.37 8.27 7.93 Dividends declared as a percent of income before cumulative effect of a change in accounting principle.................................... 47.75 58.25 48.81 64.92 48.51 Full Time Equivalent Staff...................... 18,847 19,114 19,957 22,621 23,569
(a) Includes the impact of the following significant items: a special tax benefit of $0.54 per share, a special provision for losses on loans of $0.22 per share, restructuring and merger-related charges of $0.05 per share, and other significant charges of $0.18 per share. Excluding the impact of these items, net income per share was $3.87, return on average common shareholders' equity was 23.64%, and return on average total assets was 1.74%. (b) Includes the impact of after-tax net restructuring and merger-related charges of $0.68 per share, after-tax gains of $0.12 per share on certain net investment gains, and an after-tax charge of $0.04 per share resulting from a special assessment on deposits insured under the SAIF. Excluding the impact of these items, net income per share was $3.54, return on average common shareholders' equity was 20.07%, and return on average total assets was 1.78%. (c) Includes the impact of after-tax net restructuring charges of $0.37 per share, merger-related charges of $0.04 per share, after-tax gains of $0.04 per share on the exchange of equity securities, and an after-tax gain of $0.05 per share related to a change in ownership interests in a joint venture. Excluding the impact of these items, net income per share was $3.24, return on average common shareholders' equity was 19.43%, and return on average total assets was 1.63%. (d) Includes the impact of after-tax merger-related charges of $0.73 per share recorded for the acquisitions of Constellation and Independence. Excluding the impact of these merger-related charges, net income per share was $2.63, return on average common shareholders' equity was 16.54%, and return on average total assets was 1.37%. (e) Cash dividends declared per share for the periods prior to the acquisitions of Meridian on April 9, 1996, Independence on June 27, 1994 and Constellation on March 16, 1994 assume that the Corporation would have declared cash dividends equal to the cash dividends per share actually declared by the Corporation. (f) In 1993, the Corporation changed its method of accounting for post-employment benefits. 89 CoreStates Financial Corp and Subsidiaries Supplemental Financial Data: Continued CONDENSED CONSOLIDATED BALANCE SHEET
(in thousands, except per share amounts) December 31, --------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ------------- ------------- ------------ ------------ ------------ ASSETS Cash and due from banks......................... $ 3,829,893 $ 3,462,287 $ 3,662,143 $ 3,024,589 $ 3,187,390 Time deposits, principally Eurodollars.......... 3,122,444 2,443,154 1,909,260 1,874,066 1,421,317 Federal funds sold.............................. 41,207 509,694 719,937 923,630 256,221 Trading account securities...................... 495,472 122,317 147,218 347,376 43,009 Investment securities........................... 3,460,391 4,083,224 5,632,232 7,261,905 7,768,755 Loans........................................... 34,813,886 32,331,297 31,175,378 30,134,394 29,111,809 Allowance for loan losses....................... (634,432) (710,327) (670,265) (681,124) (636,915) Due from customers on acceptances............... 641,859 738,077 560,707 352,347 342,065 Premises, equipment and other assets............ 2,690,245 2,514,471 2,860,632 2,810,890 2,714,941 ------------- ------------- ------------ ------------ ------------ Total assets............................ $48,460,965 $45,494,194 $45,997,242 $46,048,073 $44,208,592 ============= ============= ============ ============ ============ LIABILITIES Deposits: Domestic: Non-interest bearing........................ $ 9,252,376 $ 9,330,445 $ 8,937,147 $ 8,625,125 $ 8,767,602 Interest bearing............................ 23,490,992 22,986,955 23,883,726 25,023,283 24,298,434 Overseas branches and subsidiaries............ 1,444,522 1,409,756 1,142,947 1,125,997 797,987 ------------- ------------- ------------ ------------ ------------ Total deposits.......................... 34,187,890 33,727,156 33,963,820 34,774,405 33,864,023 ------------- ------------- ------------ ------------ ------------ Short-term funds borrowed....................... 4,323,319 2,633,157 3,677,013 3,461,249 2,766,750 Bank acceptances outstanding.................... 641,464 727,728 549,048 346,239 347,011 Other liabilities............................... 1,616,624 1,661,162 1,719,697 1,571,985 1,515,718 Long-term debt.................................. 4,454,236 3,049,297 2,212,099 2,163,263 2,010,581 ------------- ------------- ------------ ------------ ------------ Total liabilities....................... 45,223,533 41,798,500 42,121,677 42,317,141 40,504,083 ------------- ------------- ------------ ------------ ------------ SHAREHOLDERS' EQUITY Total shareholders' equity...................... 3,237,432 3,695,694 3,875,565 3,730,932 3,704,509 ------------- ------------- ------------ ------------ ------------ Total liabilities and shareholders' equity $48,460,965 $45,494,194 $45,997,242 $46,048,073 $44,208,592 ============= ============= ============ ============ ============ Book value per common share..................... $16.33 $17.40 $17.61 $16.23 $16.13 ====== ====== ====== ====== ======
90 CoreStates Financial Corp and Subsidiaries Supplemental Financial Data: continued Rate/Volume Analysis Taxable Equivalent Basis (in thousands)
1997 vs. 1996 1996 vs. 1995 ------------------------------------------------------------------------------------- Increase (decrease) in interest Increase (decrease) in interest Income/ Change attributable to Income/ Change attributable to --------- ------------------------ ---------- -------------------------- expense Volume Rate expense Volume Rate --------- --------- -------- ---------- ---------- ---------- Interest earning assets Time deposits, principally Eurodollars........................ $ 38,666 $ 36,182 $ 2,484 $ 759 $ 14,789 $ (14,030) Investment securities................. (59,433) (60,644) 1,211 (106,616) (107,831) 1,215 Federal funds sold.................... (10,643) (11,135) 492 (729) 612 (1,341) Trading account securities............ 15,892 11,509 4,383 (13,204) (12,466) (738) Loans: Domestic........................... 94,817 137,129 (42,312) (96,416) 35,955 (132,371) Foreign............................ 49,197 46,903 2,294 32,260 38,953 (6,693) --------- --------- -------- ---------- ---------- ---------- Total interest income........... 128,496 159,944 (31,448) (183,946) (29,988) (153,958) --------- --------- -------- ---------- ---------- ---------- Interest bearing funds Deposits: Domestic: Commercial...................... 67,812 59,970 7,842 (6,464) (3,794) (2,670) Other........................... (41,950) (19,032) (22,918) (88,716) (17,507) (71,209) Overseas............................ 16,722 12,722 4,000 (4,087) (2,640) (1,447) Short-term funds borrowed: Federal funds purchased............. (1,533) (6,845) 5,312 (42,903) (33,001) (9,902) Other............................... 38,239 29,083 9,156 (18,087) (11,896) (6,191) Long-term debt........................ 77,437 73,179 4,258 8,822 18,522 (9,700) --------- --------- -------- ---------- ---------- ---------- Total interest expense.......... 156,727 149,077 7,650 (151,435) (50,316) (101,119) --------- --------- -------- ---------- ---------- ---------- Net interest income................... $ (28,231) $ 10,867 $(39,098) $ (32,511) $ 20,328 $ (52,839) - ------------------- ========= ========= ======== ========== ========== ==========
Notes to Rate/Volume Analysis Changes in interest income or expense not arising solely as a result of volume or rate variances are allocated to rate variances due to the interest sensitivity of consolidated assets and liabilities. Included in interest income is $79.0 million, $70.7 million and $69.8 million of loan fees for the years 1997, 1996 and 1995, respectively. Non-performing loans are included in interest earning assets. The changes in interest expense on domestic deposits attributable to volume and rate are adjusted by specific reserves as average balances are reduced by such reserve amounts for purposes of rate calculations. The income effects of off-balance sheet derivatives used for managing interest rate risk are associated with the interest income or expense of the related hedged asset or liability. 91 CoreStates Financial Corp and Subsidiaries Supplemental Financial Data: Continued LOAN PORTFOLIO The following are summaries of certain loan categories, net of unearned discounts, for the five years ended December 31, 1997 (in thousands):
1997 1996 1995 1994 1993 ------------- ------------ ------------ ------------ ------------ Domestic loans: Commercial, industrial and other......... $15,949,264 $ 13,906,646 $12,597,470 $11,834,603 $10,707,727 Real estate loans: Construction and development........... 651,064 554,924 607,845 599,331 652,940 Residential............................ 3,915,702 4,073,272 5,288,476 5,552,775 5,655,726 Other, primarily commercial mortgages and commercial loans secured by owner-occupied real estate........... 4,284,281 4,541,697 4,712,473 5,059,676 5,165,790 ------------- ------------ ------------ ------------ ------------ Total real estate loans............ 8,851,047 9,169,893 10,608,794 11,211,782 11,474,456 ------------- ------------ ------------ ------------ ------------ Consumer loans: Installment............................ 2,973,719 3,027,943 2,734,081 2,660,718 2,674,121 Credit card............................ 1,205,932 1,674,921 1,527,447 1,492,004 1,269,980 ------------- ------------ ------------ ------------ ------------ Total consumer loans............... 4,179,651 4,702,864 4,261,528 4,152,722 3,944,101 ------------- ------------ ------------ ------------ ------------ Financial institutions................... 1,568,015 1,153,715 961,289 675,047 879,700 Factoring receivables.................... 454,850 411,280 557,272 622,380 555,211 Lease financing.......................... 1,356,917 1,232,213 1,167,356 1,043,932 999,311 ------------- ------------ ------------ ------------ ------------ Total domestic loans.............. 32,359,744 30,576,611 30,153,709 29,540,466 28,560,506 ------------- ------------ ------------ ------------ ------------ Foreign loans: Loans to or guaranteed by foreign banks.................................. 1,864,883 1,369,015 615,166 301,080 332,288 Commercial and industrial................ 587,071 385,426 406,503 283,535 218,655 Loans to other financial institutions.... 2,188 245 - 9,313 360 ------------- ------------ ------------ ------------ ------------ Total foreign loans................ 2,454,142 1,754,686 1,021,669 593,928 551,303 ------------- ------------ ------------ ------------ ------------ Total loans.................. $34,813,886 $ 32,331,297 $31,175,378 $30,134,394 $29,111,809 =========== ============ =========== =========== ===========
Risk Elements FOREIGN OUTSTANDINGS (in thousands) While the associated risks are clearly recognized, international lending is a part of the Corporation's wide range of international services. It is the Corporation's intent to remain involved in providing the international financial services needed for the increasingly global competition faced by customers. At December 31, 1997, 1996 and 1995, there were no aggregate foreign outstandings (defined as loans, investments, acceptances and time deposits) to borrowers in a foreign country that exceeded 1% of total assets. Outstandings below 1%, but over .75% of total assets were $389,000 in Japan at December 31, 1996. There were no outstandings below 1%, but over .75% of total assets at December 31, 1997 or December 31, 1995. 92 CoreStates Financial Corp and Subsidiaries Supplemental Financial Data: Continued Risk Elements NON-PERFORMING ASSETS The following represents the Corporation's non-accrual loans, renegotiated loans and other real estate owned for the five years ended December 31, 1997 (in thousands):
1997 1996 1995 1994 1993 ---------- --------- ---------- --------- --------- Non-accrual loans Domestic........................................ $253,909 $220,770 $223,602 $348,885 $449,340 Foreign......................................... - - - 158 171 ---------- --------- ---------- --------- --------- Total non-accrual loans.................... 253,909 220,770 223,602 349,043 449,511 ---------- --------- ---------- --------- --------- Renegotiated loans (a).......................... 10 18 7,202 8,067 66,399 ---------- --------- ---------- --------- --------- Total non-performing loans................. 253,919 220,788 230,804 357,110 515,910 ---------- --------- ---------- --------- --------- Other real estate owned (OREO).................. 14,342 24,175 37,502 83,546 109,871 ---------- --------- ---------- --------- --------- Total non-performing assets..................... $268,261 $244,963 $268,306 $440,656 $625,781 ========== ========= ========== ========= ========= Non-performing assets as a percentage of loans plus OREO................. 0.77% 0.76% 0.86% 1.46% 2.14% ==== ==== ==== ==== ==== Non-performing assets as a percentage of total assets.................... 0.55% 0.54% 0.58% 0.96% 1.42% ==== ==== ==== ==== ====
- ------------------- (a) There were no foreign renegotiated loans in any periods presented. The following reflects the effect of non-accrual and renegotiated loans on both interest income and net interest income for the three years ended December 31, 1997 (in thousands):
1997 1996 1995 --------- ----------- ----------- Interest income which would have been recorded in accordance with original terms: Domestic................................... $20,935 $20,244 $27,452 Foreign.................................... - - 8 ------- -------- -------- Total.................................... 20,935 20,244 27,460 ------- -------- -------- Interest income reflected in total operating income: Domestic................................... 15,075 8,977 14,354 ------- -------- -------- Total.................................... 15,075 8,977 14,354 ------- -------- -------- Net reduction in interest income and net interest income....................................... $ 5,860 $11,267 $13,106 ======= ======== =======
ACCRUING LOANS PAST DUE 90 DAYS OR MORE Accruing loans 90 days or more past due as to payment of interest or principal for the five years ended December 31, 1997 were as follows (in thousands):
1997 1996 1995 1994 1993 ------- --------- -------- -------- -------- Total (a)....................................... $94,302(b) $113,268 $88,671 $77,860 $80,718 ======= ========= ======== ======== ========
- ------------------- (a) There were no foreign loans past due 90 days or more in any periods presented. (b) Includes $9,463 of loans held for sale past due 90 days or more. 93 CoreStates Financial Corp and Subsidiaries Supplemental Financial Data: Continued CONSOLIDATED ALLOWANCE FOR LOAN LOSSES The following table summarizes the distribution of loan charge-offs and recoveries by type of loan for the five years ended December 31, 1997 (in thousands):
1997 1996 1995 1994 1993 ---------- ---------- --------- --------- --------- Balance at beginning of year: Domestic................................ $675,327 $645,265 $661,124 $626,915 $610,039 Foreign................................. 35,000 25,000 20,000 10,000 10,000 ---------- ---------- --------- --------- --------- 710,327 670,265 681,124 636,915 620,039 ---------- ---------- --------- --------- --------- Allowance for loans purchased at date of purchase: Domestic............................... - - - 24,931 5,797 ---------- ---------- --------- --------- --------- Allowance for loans designated as held for sale or sold at date of sale: Domestic............................... (102,000) - - (2,377) Foreign................................ - - - - (353) ---------- ---------- --------- --------- --------- (102,000) - - (2,377) (353) ---------- ---------- --------- --------- --------- Recoveries, by type of loan: Domestic: Commercial, industrial and other.. 31,725 39,726 35,535 29,845 48,659 Real estate.......................... 21,282 27,870 26,477 24,058 12,438 Consumer............................. 20,366 16,140 15,599 18,613 17,157 Financial institutions............... 361 837 231 654 2,246 Lease financing...................... 10,567 6,283 7,091 8,128 5,417 Foreign................................. - 2,129 293 2,616 12,645 ---------- ---------- --------- --------- --------- Total recoveries................. 84,301 92,985 85,226 83,914 98,562 ---------- ---------- --------- --------- --------- Charge-offs, by type of loan: Domestic: Commercial, industrial and other..... 89,078 67,181 71,199 124,610 123,661 Real estate.......................... 34,838 64,459 67,184 149,738 91,103 Consumer (b)......................... 177,143 132,798 89,472 57,208 53,222 Financial institutions............... - 5,776 2,052 41 816 Lease financing...................... 20,137 11,476 10,180 9,857 7,700 ---------- ---------- --------- --------- --------- Total loans charged off.......... 321,196 281,690 240,087 341,454 276,502 ---------- ---------- --------- --------- --------- Total net charge-offs.................... 236,895 188,705 154,861 257,540 177,940 ---------- ---------- --------- --------- --------- Provision charged to operating expense: Domestic................................ 254,000 220,896 139,295 271,811 201,664 Foreign................................. 9,000 7,871 4,707 7,384 (12,292)(a) ---------- ---------- --------- --------- --------- 263,000 228,767 144,002 279,195 189,372 ---------- ---------- --------- --------- --------- Balance at end of year: Domestic................................ 590,432 675,327 645,265 661,124 626,915 Foreign................................. 44,000 35,000 25,000 20,000 10,000 ---------- ---------- --------- --------- --------- $634,432 $710,327 $670,265 $681,124 $636,915 ---------- ---------- --------- --------- --------- Ratios Net charge-offs as a percentage of average loans outstanding............ 0.69% 0.59% 0.50% 0.86% 0.61% ==== ==== ==== ==== ==== Allowance for loan losses as a percentage of year-end loans............ 1.82% 2.20% 2.15% 2.26% 2.19% ==== ==== ==== ==== ====
- --------------------- (a) Reflects reallocation of the foreign allowance for loan losses to the domestic allowance for loan losses. (b) Excludes writedown of $102 million related to credit cards held for sale. 94 CoreStates Financial Corp and Subsidiaries Supplemental Financial Data: Continued DISTRIBUTION OF ALLOWANCE FOR LOAN LOSSES (a) The distribution of the allowance for loan losses and the percentage of each loan type to total loans for the five years ended December 31, 1997 is illustrated in the table below (in millions):
1997 1996 1995 1994 1993 ------------------ ----------------- ------------------ ------------------ ------------------ % % % % % of Loan of Loan of Loan of Loan of Loan category category category category category to to to to to total total total total total Allowance loans Allowance loans Allowance loans Allowance loans Allowance loans --------- -------- --------- -------- --------- -------- --------- -------- --------- -------- Loan type Domestic: Commercial and industrial.... $273.0 46% $300.2 44% $321.4 41% $314.5 41% $314.9 38% Real estate: Construction............... 40.0 2 48.7 2 33.7 2 60.9 2 74.0 2 Other.................... 104.3 23 125.4 28 118.6 33 127.8 36 105.1 39 Consumer..................... 133.1 12 161.0 14 151.1 14 125.1 13 113.4 13 Other domestic loans........ 40.0 10 40.0 7 20.5 7 32.8 6 19.5 6 Foreign......................... 44.0 7 35.0 5 25.0 3 20.0 2 10.0 2 ------- --- ----- --- ----- --- ------ --- ------ --- Total........................ $634.4 100% $710.3 100% $670.3 100% $681.1 100% $636.9 100% ======= === ====== === ====== === ====== === ====== ===
(a) This distribution is made for analytical purposes. It does not represent specific allocations of the allowance. The total allowance is available to absorb losses from any segment of the portfolio. COMMERCIAL CERTIFICATES OF DEPOSIT OVER $100,000 ISSUED BY DOMESTIC OFFICES (in thousands)
December 31, ------------------------------------------------------ 1997 1996 ------------------------ ------------------------ Amount Percent Amount Percent ----------- ------- --------- ------- Maturity Distribution 3 months or less................... $ 574,902 23.1% $ 654,313 86.7% 3 through 6 months................. 620,003 24.9 19,539 2.6 6 through 12 months................ 795,965 32.0 75,951 10.1 Over 12 months..................... 498,545 20.0 4,634 0.6 ----------- ----- --------- ----- Total.............................. $2,489,415 100.0% $ 754,437 100.0% =========== ===== ========= =====
95 CoreStates Financial Corp and Subsidiaries Supplemental Financial Data: Continued INTEREST SENSITIVITY ANALYSIS AT DECEMBER 31, 1997 (in millions)
Rate Maturity Period ------------------------------------------------------------------------------------ 1-90 91-181 182-365 1-2 2-5 > 5 Days Days Days Years Years Years Total -------- ------- ------- ------- -------- -------- ------- EARNING ASSETS Federal funds sold, resale agreements and trading account securities................ $ 537 $ 537 Time deposits................................ 2,052 $ 786 $ 284 3,122 Investment securities........................ 1,155 409 534 $ 722 $ 446 $ 194 3,460 Interest rate swaps.......................... 1,277 264 794 1,545 4,166 908 8,954 Asset financial futures...................... 320 366 26 24 - - 736 -------- ------- ------- ------- -------- -------- ------- Total discretionary assets.............. 5,341 1,825 1,638 2,291 4,612 1,102 16,809 Total loans(a)............................... 23,481 1,819 2,037 2,685 3,807 985 34,814 -------- ------- ------- ------- -------- -------- ------- Total earning assets......................... 28,822 3,644 3,675 4,976 8,419 2,087 51,623 -------- ------- ------- ------- -------- -------- ------- FUNDING SOURCES Federal funds purchased, repurchase agreements and other short-term funds borrowed.................................. 4,289 31 3 - - - 4,323 Domestic and foreign time deposits(b)........ 3,810 75 47 4 51 1 3,988 Long-term debt............................... 2,699 1 6 106 521 1,121 4,454 Interest rate swaps.......................... 8,487 - 132 310 25 - 8,954 Liability financial futures.................. 736 - - - - - 736 -------- ------- ------- ------- -------- -------- ------- Total discretionary liabilities......... 20,021 107 188 420 597 1,122 22,455 -------- ------- ------- ------- -------- -------- ------- Savings certificates......................... 1,838 1,930 1,574 1,569 835 161 7,907 Money market, savings and NOW accounts(c).... 5,247 541 1,081 1,932 3,962 - 12,763 Net non-interest bearing funds(d)(e)......... 2,834 - - - - 5,664 8,498 -------- ------- ------- ------- -------- -------- ------- Total savings certificates and indefinite maturity liabilities.................... 9,919 2,471 2,655 3,501 4,797 5,825 29,168 -------- ------- ------- ------- -------- -------- ------- Total net funding sources.................... 29,940 2,578 2,843 3,921 5,394 6,947 51,623 -------- ------- ------- ------- -------- -------- ------- Period gap................................... (1,118) 1,066 832 1,055 3,025 (4,860) - Cumulative gap............................... (1,118) (52) 780 1,835 4,860 - - Adjustments(f)............................... 652 (967) (693) (1,015) (2,951) 4,974 - -------- ------- ------- ------- -------- -------- ------- Adjusted period gap.......................... $ (466) $ 99 $ 139 $ 40 $ 74 $ 114 $ - ======== ======= ======= ======= ======== ======== ======= Cumulative gap............................ $ (466) $ (367) $ (228) $ (188) $ (114) $ - $ - ======== ======= ======= ======= ======== ======== =======
Notes to Interest Sensitivity Analysis: - --------------------------------------- (a) Non-performing loans are included in 1-90 days. (b) Deposit volumes exclude time deposits not at interest. (c) Adjustments to the interest sensitivity of savings, NOW and money market account balances reflect managerial assumptions based on historical experience, simulation results as to the behavior of both the balances and rates on these products in potential future rate environments, and CoreStates' intent for positioning the products. Certain items classified as savings certificates on the balance sheet are classified as money market, savings and NOW accounts on the Interest Sensitivity Analysis. (d) Net non-interest bearing funds is the sum of non-interest bearing liabilities, shareholders' equity minus non-interest earning assets. (e) The estimated volume of stable net non-interest bearing funds is allocated to the over 1 year interest sensitivity period. Allocations to the under 1 year periods include: estimated volumes that are expected to vary inversely with interest rates; and the temporary difference between the actual volume of total net non-interest bearing funds on December 31, 1997 and the trend volume at the current level of interest rates. (f) Adjustments reflect managerial assumptions as to the appropriate investment maturities for non-interest bearing funding sources, along with the funding of current investment and loan commitments. 96 CoreStates Financial Corp and Subsidiaries Supplemental Financial Data: Continued Loan Maturity and Interest Sensitivity, Net of Unearned Discounts The contractual maturity of commercial loans outstanding at December 31, 1997 was as follows (in thousands):
Due after one Due in one year through Due after year or less five years five years Total ------------- ----------- ----------- ------------ Commercial (includes Real Estate - Commercial Mortgages and Foreign Loans)...... $ 18,143,085 $ 5,427,596 $ 1,440,695 $ 25,011,376 Real Estate - Construction..................... 220,489 313,845 116,730 651,064 ------------- ----------- ----------- ------------ Total loans (excluding loans to individuals)(a).............................. $ 18,363,574 $ 5,741,441 $ 1,557,425 $ 25,662,440 ============= =========== =========== ============
- --------------------- (a) Loans due after one-year totaling $5,196,989 have fixed interest rates. The remaining 29% of such loans or $2,101,877 have floating or adjustable rates. INVESTMENT SECURITIES (a) (in thousands) Carrying Value at December 31,
1997 1996 1995 ------------ ----------- ----------- U.S. Treasury and government agencies............. $ 1,534,274 $ 1,883,848 $ 2,564,646 State and municipal............................... 335,801 426,009 549,035 Mortgage-backed................................... 597,726 968,963 1,758,883 Other............................................. 992,590 804,404 759,668 ------------ ----------- ----------- Total......................................... $ 3,460,391 $ 4,083,224 $ 5,632,232 ============ =========== ===========
(a) Held-to-maturity and available-for-sale portfolios combined. Maturity Distribution and Weighted Average Yield at December 31, 1997 (a)
U.S. Treasury Total and Government State and ------------------------ Agencies Municipal Other Amount Yield (b) -------------- --------- --------- ---------- --------- 1 year or less..................... $ 869,371 $ 49,128 $ 48,594 $ 967,093 6.06% 1 year through 5 years............. 623,630 136,529 189,460 949,619 6.50 5 years through 10 years........... 13,459 116,996 104,236 234,691 7.01 After 10 years..................... 27,814 33,148 650,300 711,262 6.36 -------- -------- --------- ----------- Subtotal...................... $ 1,534,274 $335,801 $ 992,590 2,862,665 ========= ======== ========= Mortgage-backed.................... 597,726 6.08 ----------- Total......................... $ 3,460,391 6.31 ===========
(a) Held-to-maturity and available-for-sale portfolios combined. (b) The weighted average yield has been computed on a tax equivalent basis using an effective tax rate of 35%. The amount of the tax equivalent adjustment by range of maturity is as follows: 1 year or less - $1,153; 1 year to 5 years - $3,393; 5 years to 10 years - $3,180 and after 10 years - $2,203. 97 EX-99.C 7 FIRST UNION CORPORATION FINANCIAL STATEMENTS Exhibit 99(c) Consolidated Financial Statements of First Union Corporation and Subsidiaries December 31, 1997 1 FIRST UNION CORPORATION AND SUBSIDIARIES MANAGEMENT'S STATEMENT OF RESPONSIBILITY - ------------------------------------------------------------------------------- Management of First Union Corporation and its subsidiaries (the "Corporation") is committed to the highest standards of quality customer service and the enhancement of stockholder value. Management expects the Corporation's employees to respect its customers and to assign the highest priority to customer needs. The accompanying consolidated financial statements were prepared in conformity with generally accepted accounting principles and include, as necessary, best estimates and judgments by management. Other financial information contained in this annual report is presented on a basis consistent with the consolidated financial statements unless otherwise indicated. To ensure the integrity, objectivity and fairness of the information in these consolidated financial statements, management of the Corporation has established and maintains internal control supplemented by a program of internal audits. The internal control is designed to provide reasonable assurance that assets are safeguarded and transactions are executed, recorded and reported in accordance with management's intentions and authorizations and to comply with applicable laws and regulations. To enhance the reliability of internal control, management recruits and trains highly qualified personnel, and maintains sound risk management practices. The consolidated financial statements have been audited by KPMG Peat Marwick LLP, independent auditors, in accordance with generally accepted auditing standards. KPMG Peat Marwick LLP reviews the results of its audit with both management and the Audit Committee of the Board of Directors of the Corporation. The Audit Committee, composed entirely of outside directors, meets periodically with management, internal auditors and KPMG Peat Marwick LLP to determine that each is fulfilling its responsibilities and to support actions to identify, measure and control risks and augment internal controls. Edward E. Crutchfield Chairman and Chief Executive Officer Robert T. Atwood Executive Vice President and Chief Financial Officer January 21, 1998 2 FIRST UNION CORPORATION AND SUBSIDIARIES INDEPENDENT AUDITORS' REPORT - -------------------------------------------------------------------------------- Board of Directors and Stockholders First Union Corporation We have audited the consolidated balance sheets of First Union Corporation and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1997. These consolidated financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We have conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Union Corporation and subsidiaries at December 31, 1997 and 1996, and the results of their operations and cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles. KPMG Peat Marwick LLP Charlotte, North Carolina January 21, 1998 3
FIRST UNION CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS - ------------------------------------------------------------------------------------------------------------------ December 31, ------------------------ (In millions, except per share data) 1997 1996 - ------------------------------------------------------------------------------------------------------------------ ASSETS Cash and due from banks $ 6,445 7,076 Interest-bearing bank balances 710 319 Federal funds sold and securities purchased under resale agreements 7,740 7,802 - ------------------------------------------------------------------------------------------------------------------ Total cash and cash equivalents 14,895 15,197 - ------------------------------------------------------------------------------------------------------------------ Trading account assets 5,457 4,480 Securities available for sale (amortized cost $21,020 in 1997; $16,799 in 1996) 21,415 16,805 Investment securities (market value $2,322 in 1997; $2,636 in 1996) 2,175 2,501 Loans, net of unearned income ($3,386 in 1997; $2,431 in 1996) 96,873 102,316 Allowance for loan losses (1,212) (1,502) - ------------------------------------------------------------------------------------------------------------------ Loans, net 95,661 100,814 - ------------------------------------------------------------------------------------------------------------------ Premises and equipment 4,233 4,257 Due from customers on acceptances 854 764 Other intangible assets 2,674 2,905 Other assets 9,910 4,124 - ------------------------------------------------------------------------------------------------------------------ Total assets $ 157,274 151,847 - ------------------------------------------------------------------------------------------------------------------ LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Noninterest-bearing deposits 21,753 20,383 Interest-bearing deposits 81,136 82,319 - ------------------------------------------------------------------------------------------------------------------ Total deposits 102,889 102,702 Short-term borrowings 27,357 24,987 Bank acceptances outstanding 855 765 Other liabilities 5,108 3,906 Long-term debt 8,042 8,060 - ------------------------------------------------------------------------------------------------------------------ Total liabilities 144,251 140,420 - ------------------------------------------------------------------------------------------------------------------ Guaranteed preferred beneficial interests in Corporation's junior subordinated deferrable interest debentures 991 495 - ------------------------------------------------------------------------------------------------------------------ STOCKHOLDERS' EQUITY Preferred stock - - Common stock, $3.33-1/3 par value; authorized 750,000,000 shares, outstanding 636,393,722 shares in 1997; 640,781,862 shares in 1996 2,121 2,136 Paid-in capital 1,384 1,668 Retained earnings 8,273 7,126 Unrealized gain on debt and equity securities, net 254 2 - ------------------------------------------------------------------------------------------------------------------ Total stockholders' equity 12,032 10,932 - ------------------------------------------------------------------------------------------------------------------ Total liabilities and stockholders' equity $ 157,274 151,847 - ------------------------------------------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements. 4
FIRST UNION CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME - --------------------------------------------------------------------------------------------------------------------- Years Ended December 31, -------------------------------------- (In millions, except per share data) 1997 1996 1995 - --------------------------------------------------------------------------------------------------------------------- INTEREST INCOME Interest and fees on loans $ 8,771 8,310 7,866 Interest and dividends on securities available for sale 1,267 1,282 833 Interest and dividends on investment securities Taxable income 114 130 416 Nontaxable income 57 70 118 Trading account interest 315 302 122 Other interest income 409 366 198 - --------------------------------------------------------------------------------------------------------------------- Total interest income 10,933 10,460 9,553 - --------------------------------------------------------------------------------------------------------------------- INTEREST EXPENSE Interest on deposits 3,264 3,190 3,075 Interest on short-term borrowings 1,408 1,312 942 Interest on long-term debt 518 493 407 - --------------------------------------------------------------------------------------------------------------------- Total interest expense 5,190 4,995 4,424 - --------------------------------------------------------------------------------------------------------------------- Net interest income 5,743 5,465 5,129 Provision for loan losses 840 449 259 - --------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 4,903 5,016 4,870 - --------------------------------------------------------------------------------------------------------------------- NONINTEREST INCOME Trading account profits 204 131 81 Service charges on deposit accounts 854 734 684 Mortgage banking income 247 194 180 Capital management income 882 607 461 Securities available for sale transactions 31 36 45 Investment security transactions 3 4 6 Fees for other banking services 151 172 172 Equipment lease rental income 187 112 32 Sundry income 837 646 515 - --------------------------------------------------------------------------------------------------------------------- Total noninterest income 3,396 2,636 2,176 - --------------------------------------------------------------------------------------------------------------------- NONINTEREST EXPENSE Salaries 2,221 1,994 1,811 Other benefits 495 457 396 - --------------------------------------------------------------------------------------------------------------------- Personnel expense 2,716 2,451 2,207 Occupancy 401 389 394 Equipment 524 448 352 Advertising 103 61 90 Telecommunications 121 113 101 Travel 110 99 84 Postage, printing and supplies 170 178 161 FDIC assessment 23 41 129 Professional fees 134 102 196 External data processing 94 146 101 Other intangible amortization 277 250 235 Merger-related and restructuring charges 269 281 94 SAIF special assessment - 135 - Sundry expense 647 459 513 - --------------------------------------------------------------------------------------------------------------------- Total noninterest expense 5,589 5,153 4,657 - --------------------------------------------------------------------------------------------------------------------- Income before income taxes 2,710 2,499 2,389 Income taxes 814 875 848 - --------------------------------------------------------------------------------------------------------------------- Net income 1,896 1,624 1,541 Dividends on preferred stock - 9 26 - --------------------------------------------------------------------------------------------------------------------- Net income applicable to common stockholders $ 1,896 1,615 1,515 - --------------------------------------------------------------------------------------------------------------------- PER COMMON SHARE DATA Basic earnings $ 3.03 2.61 2.44 Diluted earnings 2.99 2.58 2.38 Cash dividends $ 1.22 1.10 0.98 AVERAGE COMMON SHARES (In thousands) Basic 625,649 619,237 619,777 Diluted 633,772 625,224 637,186 - --------------------------------------------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements. 5
FIRST UNION CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY - ------------------------------------------------------------------------------------------------------------------- (Shares in thousands, Preferred Stock Common Stock Paid-in Retained ------------------------- ------------------------- dollars in millions) Shares Amount Shares Amount Capital Earnings - ------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1994, as originally reported 5,213 $ 230 285,361 $ 951 2,361 5,022 Common stock issued in 1997 two-for-one stock split - - 285,361 951 (951) - - ------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1994, as restated 5,213 230 570,722 1,902 1,410 5,022 Stockholders' equity of pooled bank not restated prior to 1995 - - 64,501 215 277 641 Net income - - - - - 1,541 Purchase of common stock primarily for acquisitions - - (51,154) (171) (1,037) - Common stock issued for stock options exercised - - 13,791 46 215 (51) Common stock issued through dividend reinvestment plan - - 2,368 7 44 1 Common stock issued for purchase accounting acquisitions - - 25,090 84 527 - Converted preferred stock (1,574) (40) 3,316 12 53 (25) Pre-merger transactions of pooled bank (251) (7) (7,812) (26) (161) (383) Cash dividends paid by First Union Corporation 8.90% per Series 1990 preferred share - - - - - (7) $0.98 per common share - - - - - (336) Acquired banks Preferred shares - - - - - (19) Common shares - - - - - (213) Unrealized gain on debt and equity securities - - - - - - - ------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1995 3,388 183 620,822 2,069 1,328 6,171 Net income - - - - - 1,624 Redemption of preferred stock (433) (109) - - - - Purchase of common stock primarily for purchase accounting acquisitions - - (30,568) (100) (868) - Common stock issued for stock options exercised - - 10,930 36 217 - Common stock issued through dividend reinvestment plan - - 1,380 5 35 - Common stock issued for purchase accounting acquisitions - - 31,994 106 902 - Converted preferred stock (2,955) (74) 6,224 20 54 - Cash dividends paid by First Union Corporation Preferred shares - - - - - (9) $1.10 per common share - - - - - (611) Acquired bank Common shares - - - - - (49) Unrealized loss on debt and equity securities - - - - - - - ------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1996 - - 640,782 2,136 1,668 7,126 - ------------------------------------------------------------------------------------------------------------------- Unrealized Gain (Loss) on Debt and (Shares in thousands, Equity dollars in millions) Securities Total - ------------------------------------------------------------- Balance, December 31, 1994, as originally reported (290) 8,274 Common stock issued in 1997 two-for-one stock split - - - ------------------------------------------------------------- Balance, December 31, 1994, as restated (290) 8,274 Stockholders' equity of pooled bank not restated prior to 1995 (22) 1,111 Net income - 1,541 Purchase of common stock primarily for acquisitions - (1,208) Common stock issued for stock options exercised - 210 Common stock issued through dividend reinvestment plan - 52 Common stock issued for purchase accounting acquisitions - 611 Converted preferred stock - - Pre-merger transactions of pooled bank - (577) Cash dividends paid by First Union Corporation 8.90% per Series 1990 preferred share - (7) $0.98 per common share - (336) Acquired banks Preferred shares - (19) Common shares - (213) Unrealized gain on debt and equity securities 468 468 - ------------------------------------------------------------- Balance, December 31, 1995 156 9,907 Net income - 1,824 Redemption of preferred stock - (109) Purchase of common stock primarily for purchase accounting acquisitions - (968) Common stock issued for stock options exercised - 253 Common stock issued through dividend reinvestment plan - 40 Common stock issued for purchase accounting acquisitions - 1,008 Converted preferred stock - - Cash dividends paid by First Union Corporation Preferred shares - (9) $1.10 per common share - (611) Acquired bank Common shares - (49) Unrealized loss on debt and equity securities (154) (154) - ------------------------------------------------------------- Balance, December 31, 1996 2 10,932 - -------------------------------------------------------------
6
(Shares in thousands, Preferred Stock Common Stock Paid-in Retained ----------------------------- -------------------------- dollars in millions) Shares Amount Shares Amount Capital Earnings - ---------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1996 - - 640,782 2,136 1,668 7,126 Net income - - - - - 1,896 Purchase of common stock - - (23,973) (80) (944) - Common stock issued for stock options exercised - - 11,344 38 301 - Common stock issued through dividend reinvestment plan - - 624 2 23 - Common stock issued through public offering - - 7,500 25 333 - Common stock issued for purchase accounting acquisitions - - 117 - 3 - Cash dividends paid by First Union Corporation $1.22 per common share - - - - - (711) Acquired bank Common shares - - - - - (38) Unrealized gain on debt and equity securities - - - - - - - ------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 1997 - $ - 636,394 $ 2,121 1,384 8,273 - ------------------------------------------------------------------------------------------------------------------------ See accompanying Notes to Consolidated Financial Statements. Unrealized Gain (Loss) on Debt and (Shares in thousands, Equity dollars in millions) Securities Total - ------------------------------------------------------- Balance, December 31, 1996 2 10,932 Net income - 1,896 Purchase of common stock - (1,024) Common stock issued for stock options exercised - 339 Common stock issued through dividend reinvestment plan - 25 Common stock issued through public offering - 358 Common stock issued for purchase accounting acquisitions - 3 Cash dividends paid by First Union Corporation $1.22 per common share - (711) Acquired bank Common shares - (38) Unrealized gain on debt and equity securities 252 252 - ------------------------------------------------------- Balance, December 31, 1997 254 12,032 - ------------------------------------------------------- See accompanying Notes to Consolidated Financial Statements.
7
FIRST UNION CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - -------------------------------------------------------------------------------------------------------------------------------- Years Ended December 31, ------------------------------------ (In millions) 1997 1996 1995 - -------------------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES Net income $ 1,896 1,624 1,541 Adjustments to reconcile net income to net cash provided (used) by operating activities Accretion and amortization of securities discounts and premiums, net 40 37 (34) Provision for loan losses 840 449 259 Provision for foreclosed properties 2 (1) (3) Gain on sale of mortgage servicing rights (1) (49) (1) Securities available for sale transactions (31) (36) (45) Investment security transactions (3) (4) (5) Depreciation and amortization 795 668 582 Deferred income taxes 545 540 396 Trading account assets, net (977) (2,092) (677) Mortgage loans held for resale (568) (102) (386) (Gain) loss on sales of premises and equipment 5 (3) 11 Gain on sale of segregated assets (7) (12) (18) Other assets, net (797) 1,021 186 Other liabilities, net 657 (254) 102 - -------------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 2,396 1,786 1,908 - -------------------------------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES Increase (decrease) in cash realized from Sales of securities available for sale 9,121 19,953 8,943 Maturities of securities available for sale 1,471 3,307 2,294 Purchases of securities available for sale (14,806) (18,059) (10,089) Calls and underdeliveries of investment securities 4 10 33 Maturities of investment securities 505 803 2,640 Purchases of investment securities (190) (172) (3,668) Origination of loans, net 1,688 (1,816) (6,697) Sales of premises and equipment 160 60 47 Purchases of premises and equipment (558) (1,047) (667) Other intangible assets, net (44) (18) (72) Purchase of bank-owned separate account life insurance (2,011) - - Cash equivalents acquired, net of purchases of banking organizations 6 (484) 2,527 - -------------------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by investing activities (4,654) 2,537 (4,709) - -------------------------------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES Increase (decrease) in cash realized from Purchases (sales) of deposits, net 160 (2,593) (3,230) Securities sold under repurchase agreements and other short-term borrowings, net 2,370 2,423 6,983 Issuance of guaranteed preferred beneficial interests 495 495 - Issuances of long-term debt 1,148 1,817 3,346 Increase in long-term debt due to a spin-off of an acquired company - - 1,388 Payments of long-term debt (1,166) (1,421) (777) Sales of common stock 722 293 262 Purchases of preferred stock - - (7) Redemption of preferred stock - (109) - Purchases of common stock (1,024) (968) (1,208) Cash dividends paid (749) (669) (575) - -------------------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by financing activities 1,956 (732) 6,182 - -------------------------------------------------------------------------------------------------------------------------------- Increase (decrease) in cash and cash equivalents (302) 3,591 3,381 Cash and cash equivalents, beginning of year 15,197 11,606 8,225 - -------------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of year $ 14,895 15,197 11,606 - -------------------------------------------------------------------------------------------------------------------------------- CASH PAID FOR Interest $ 5,960 5,040 4,338 Income taxes 308 242 471 NONCASH ITEMS Increase in securities available for sale - 289 6,983 Decrease in investment securities - - (6,304) Increase in other assets - - 15 Increase in assets available for sale and a decrease in loans 3,200 - - Increase in foreclosed properties and a decrease in loans 8 39 67 Conversion of preferred stock to common stock - 74 40 Issuance of common stock for purchase accounting acquisitions 3 1,008 611 Effect on stockholders' equity of an unrealized gain (loss) on debt and equity securities included in Securities available for sale 389 (262) 664 Other assets (deferred income taxes) $ 137 (108) 196 - --------------------------------------------------------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements. 8 FIRST UNION CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997, 1996 AND 1995 - -------------------------------------------------------------------------------- NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES GENERAL First Union Corporation (the "Parent Company") is a bank holding company whose principal wholly owned subsidiaries are national banking associations using the name First Union National Bank; First Union Capital Markets Corp., an investment banking firm; First Union Mortgage Corporation, a mortgage banking firm; First Union Brokerage Services, Inc., a securities brokerage firm; and certain business trusts as more fully described in Note 11. The accounting and reporting policies of First Union Corporation and subsidiaries (the "Corporation") are in accordance with generally accepted accounting principles and conform to general practices within the banking, investment banking and mortgage banking industries. The consolidated financial statements include accounts of the Parent Company and all its subsidiaries. In consolidation, all significant intercompany accounts and transactions are eliminated. The Corporation is a diversified financial services company with principal operations in Connecticut, Delaware, Florida, Georgia, Maryland, New Jersey, New York, North Carolina, Pennsylvania, South Carolina, Tennessee, Virginia and Washington, D.C. Its foreign banking operations are immaterial. Management of the Corporation has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash and due from banks, interest-bearing bank balances and federal funds sold and securities purchased under resale agreements. Generally, both cash and cash equivalents are considered to have maturities of three months or less, and accordingly, the carrying amount of such instruments is deemed to be a reasonable estimate of fair value. SECURITIES The classification of securities is determined at the date of commitment or purchase. Gains or losses on the sale of securities are recognized on a specific identification, trade date basis. Trading account assets, primarily debt securities, and trading derivatives, which include interest rate futures, options, caps, floors and forward contracts, are recorded at market value. Included in noninterest income are realized and unrealized gains and losses resulting from such market value adjustments and from recording the results of sales of trading account securities. Securities available for sale, primarily debt securities, are recorded at market value with a corresponding adjustment net of tax recorded as a component of stockholders' equity. Securities available for sale are used as a part of the Corporation's interest rate risk management strategy and may be sold in response to changes in interest rates, changes in prepayment risk and other factors. Investment securities, primarily debt securities, are stated at cost, net of the amortization of premium and the accretion of discount. The Corporation intends and has the ability to hold such securities until maturity. The market value of securities, including securities sold not owned, is generally based on quoted market prices or dealer quotes. If a quoted market price is not available, market value is estimated using quoted market prices for similar securities. INTEREST RATE SWAPS, FLOORS AND CAPS The Corporation uses interest rate swaps, floors and caps for interest rate risk management, in connection with providing risk management services to customers and for trading for its own account. Interest rate swaps, floors and caps used to achieve interest rate risk management objectives are designated as hedges of specific assets and liabilities. The net interest payable or receivable on swaps, floors and caps is accrued and recognized as an adjustment to interest income or interest expense of the related asset or liability. Premiums paid for purchased floors and caps are amortized over the term of the floors and caps as a yield adjustment of the related asset or liability. Floors and caps are written only to adjust the amount or term of purchased floors and caps to more effectively reduce interest rate risk, and a net written position is not created. Premiums received on floors and caps offset the premium paid on the floors and caps they adjust. On the early termination of swaps, floors and caps, the net proceeds received or paid, including premiums, are deferred and included in other assets or liabilities, and they are amortized over the shorter of the remaining contract life or the maturity of the related asset or liability. 9 - -------------------------------------------------------------------------------- On disposition or settlement of the asset or liability being hedged, deferral accounting is discontinued and any deferred amount is recognized in earnings. Additionally, the fair value of the swap, floor and cap agreements, and changes in fair value as a result of changes in market interest rates, are not recognized in the consolidated financial statements. These hedges are designed to be effective hedges of the hedged items, and if determined to be ineffective, they are recorded at market value. The rate indices specified in the floors and caps have been, and they are expected to be, highly correlated with the interest rates of the hedged items. Interest rate swaps, floors and caps entered into for trading purposes and sold to customers are recorded at market value with both realized and unrealized gains and losses recognized as trading profits. The fair value of these financial instruments represents the estimated amount the Corporation would receive or pay to terminate the contracts or agreements, and it is determined using a valuation model that considers current market yields, quoted prices and other relevant variables. INTEREST RATE FUTURES, FORWARD AND OPTION CONTRACTS The Corporation uses interest rate futures, forward and option contracts for interest rate risk management and in connection with hedging interest rate products sold to customers. Interest rate futures and option contracts are used to hedge interest rate risk arising from specific financial instruments. Gains and losses on interest rate futures are (i) deferred and included in the carrying value of the related assets or liabilities, and (ii) amortized over the estimated lives of those assets and liabilities as a yield adjustment. Premiums paid for option contracts are included in other assets, and they are amortized over the option term as a yield adjustment of the related asset or liability. On the early termination of futures contracts, the deferred amounts are amortized over the remaining maturity of the related asset or liability. On disposition or settlement of the asset or liability being hedged, deferral accounting is discontinued and any deferred amount is recognized in earnings. Additionally, interest rate futures and forwards that are designed as hedges are expected to reduce overall interest rate risk, and they have been, and they are expected to be, highly correlated with the interest rate risk of the hedged items. Interest rate futures and forwards that do not reduce overall interest rate risk or that are not highly correlated are recorded at market value. Interest rate futures, forward and option contracts used to hedge risk management products sold to customers are recorded at market value, and both the realized and unrealized gains and losses are recognized as trading profits. The market value of these financial instruments is based on dealer or exchange quotes. LOANS Commercial, financial and agricultural loans include industrial revenue bonds, highly leveraged transaction loans and certain other loans that are made primarily on the strength of the borrower's general credit standing and ability to generate repayment cash flows from income sources even though such bonds and loans may be secured by real estate or other assets. Commercial real estate construction and mortgage loans represent interim and permanent financing of commercial properties that are secured by real estate. Retail real estate mortgage loans represent 1-4 family first mortgage loans. Bankcard installment loans include credit card, instant cash reserve, signature and First Choice unsecured revolving lines of credit. Retail installment loans represent all other consumer loans, including home equity and second mortgage loans. Mortgage notes held for sale are valued at the lower of cost or market value as determined by outstanding commitments from investors or current investor yield requirements calculated on the aggregate loan basis. Gains or losses resulting from sales of mortgage loans are recognized when the proceeds are received from investors. In many lending transactions, collateral is taken to provide an additional measure of security. Generally, the cash flow or earning power of the borrower represents the primary source of repayment, and collateral liquidation is a secondary source of repayment. The Corporation determines the need for collateral on a case-by-case or product-by-product basis. Factors considered include the current and prospective creditworthiness of the customer, terms of the instrument and economic conditions. Unearned income is generally accreted to interest income using the constant yield method. Interest income is recorded on an accrual basis. A loan is considered to be impaired when based on current information, it is probable the Corporation will not receive all amounts due in accordance with the contractual terms of a loan agreement. Discounted cash flows using stated loan rates or the estimated collateral fair value are used in determining the value of impaired loans. 10 - -------------------------------------------------------------------------------- When the ultimate collectibility of an impaired loan's principal is in doubt, wholly or partially, all cash receipts are applied to principal. Once the recorded principal balance has been reduced to zero, future cash receipts are applied to interest income, to the extent any interest has been foregone, and then they are recorded as recoveries of any amounts previously charged off. When this doubt does not exist, cash receipts are applied under the contractual terms of the loan agreement. A loan is also considered impaired if its terms are modified in a troubled debt restructuring after January 1, 1995. For these accruing impaired loans, cash receipts are typically applied to principal and interest receivable in accordance with the terms of the restructured loan agreement. Interest income is recognized on these loans using the accrual method of accounting. As of December 31, 1997 and 1996, there were no accruing impaired loans. The accrual of interest is generally discontinued on all loans, except consumer loans, that become 90 days past due as to principal or interest unless collection of both principal and interest is assured by way of collateralization, guarantees or other security. Generally, loans past due 180 days or more are placed on nonaccrual status regardless of security. Consumer loans and bankcard products that become approximately 120 days and 180 days past due, respectively, are generally charged to the allowance for loan losses. When borrowers demonstrate over an extended period the ability to repay a loan in accordance with the contractual terms of a loan the Corporation has classified as nonaccrual, such loan is returned to accrual status. Fair values are estimated for loans with similar financial characteristics. These loans are segregated by type of loan, considering credit risk and prepayment characteristics. Each loan category is further segmented into fixed and adjustable rate categories. The fair values of performing loans for all portfolios are calculated by discounting estimated cash flows through expected maturity dates. These cash flows are discounted using estimated market yields that reflect the credit and interest rate risks inherent in each category of loans. Such market yields also reflect a component for the estimated cost of servicing the portfolio. A prepayment assumption is used as an estimate of the number of loans that will be repaid prior to their scheduled maturity. For performing residential mortgage loans, fair values are estimated using a discounted cash flow analysis utilizing yields of comparable mortgage-backed securities. The loan portfolio is segmented into homogeneous pools based on loan types, coupon rates, maturities, prepayment characteristics and credit risk. These pools are compared with similar mortgage-backed securities to arrive at an appropriate discount rate; whole loan liquidity and risk characteristics are considered within the comparison. The fair value of nonperforming loans is calculated by estimating the timing and amount of cash flows. These cash flows are discounted using estimated market yields commensurate with the risk associated with such cash flows. Estimates of cash flows are made using knowledge of the borrower and available market data. The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. Generally, for fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of commitments and letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties. ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is the amount considered adequate to provide for potential losses in the portfolio. Management's evaluation of the adequacy of the allowance is based on a review of individual loans, recent loss experience, current economic conditions, the risk characteristics of the various classifications of loans, the fair value of underlying collateral and other factors. Management believes the allowances for losses on loans and real estate owned are adequate. While management uses available information to recognize losses on loans and real estate owned, future additions to the allowances may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation's bank subsidiaries' allowances for losses on loans and real estate owned. Such agencies may require such subsidiaries to recognize changes to the allowances based on their judgments about information available to them at the time of their examination. 11 - -------------------------------------------------------------------------------- PREMISES AND EQUIPMENT Premises and equipment are carried at cost less accumulated depreciation and amortization. Depreciation and amortization are computed on a straight-line basis for financial purposes and on straight-line and accelerated bases for tax purposes, using estimated lives generally as follows: buildings, 10 to 50 years; furniture and equipment, 3 to 10 years; and leasehold improvements and capitalized leases, over the lives of the respective leases. INTANGIBLE ASSETS Generally, goodwill is amortized on a straight-line basis over periods ranging from 15 to 25 years. The Corporation's unamortized goodwill is periodically reviewed to ensure that there are no conditions which exist indicating that the recorded amount of goodwill is not recoverable from future undiscounted cash flows. The review process includes an evaluation of the earnings history of each subsidiary, its contribution to the Corporation, capital levels and other factors. If events or changes in circumstances indicate further evaluation is warranted, the undiscounted net cash flows of the operations to which goodwill relates are estimated. If the estimated undiscounted net cash flows are less than the carrying amount of goodwill, a loss is recognized to reduce goodwill's carrying value to fair value, and when appropriate, the amortization period is also reduced. Unamortized goodwill associated with disposed assets is charged to current earnings. Credit card premiums are amortized principally over the estimated period of benefit not to exceed 10 years using the sum-of-the-years' digits method. Deposit base premiums are amortized principally over a 10-year period using accelerated methods. Annually, the fair value of the unamortized balance of such premiums is estimated on a discounted cash flow basis, and if such value is less than such balance, the difference is charged to noninterest expense. FORECLOSED PROPERTIES Foreclosed properties are included in other assets, and they represent other real estate that has been acquired through loan or in-substance foreclosures or deeds received in lieu of loan payments. Generally, such properties are appraised annually, and they are recorded at the lower of cost or fair value less estimated selling costs. When appropriate, adjustments to cost are charged or credited to the allowance for foreclosed properties. TRANSFERS AND SERVICING OF FINANCIAL ASSETS The Corporation records the securitization or transfer of assets as sales when the assets securitized or transferred have been isolated from the Corporation and the transferee obtains the unconditional right to pledge or exchange the assets, or the transferee is a qualifying special purpose entity. Transfers not meeting these criteria are generally treated as secured borrowings. Gains or losses on the securitization or transfer of assets determined to be sales are based on the fair value of the assets obtained and liabilities assumed less the carrying value of the assets sold. Any servicing assets or other interests retained remain on the balance sheet at their allocated carrying value based on relative fair value. Servicing assets purchased are initially recorded at fair value. Gains or losses resulting from the securitization or transfer of assets are recorded in noninterest income. Retained residual interests subject to prepayment risk are recorded as trading account assets or as securities available for sale. Servicing assets and liabilities are included in other assets and other liabilities, and they are amortized to noninterest income in proportion to net servicing income. Servicing assets are evaluated for impairment based on the fair value of those assets. Fair values are estimated based on market prices for similar servicing assets and on the discounted estimated future net cash flows based on market consensus loan prepayment estimates, historical prepayment rates, interest rates, and other economic factors. For purposes of impairment evaluation, the servicing assets are stratified based on predominant risk characteristics of the underlying loans, including loan type (conventional or government), amortization type (fixed or adjustable), note rate, and in certain instances, period of origination. To the extent the carrying value of the servicing asset exceeds fair value by individual stratum, a valuation allowance is established. Servicing assets amounted to $421 million and $282 million at December 31, 1997 and 1996, respectively. PENSION AND SAVINGS PLANS Substantially all employees with one year of service are eligible for participation in a non-contributory, defined benefit pension plan and a matching savings plan. Pension cost is determined annually by an actuarial valuation, which includes service costs for the current year and amortization of amounts related to prior years. The Corporation's funding policy is to contribute to the pension plan the amount required to fund the benefits expected to be earned for the current year and to amortize amounts related to prior years using the projected unit credit valuation method. The difference between the pension cost included in current income and the funded amount is included in other assets or other liabilities, as appropriate. Actuarial assumptions are evaluated annually. 12 - -------------------------------------------------------------------------------- The matching savings plan permits eligible employees to make basic contributions to the plan of up to six percent of base compensation and supplemental contributions of up to nine percent of base compensation. Annually, on approval of the Board of Directors, employee basic contributions may be matched up to six percent of the employee's base compensation. INCOME TAXES The operating results of the Parent Company and its eligible subsidiaries are included in a consolidated federal income tax return. Each subsidiary pays its allocation of federal income taxes to the Parent Company or receives payment from the Parent Company to the extent tax benefits are realized. Where state income tax laws do not permit consolidated income tax returns, applicable state income tax returns are filed. INCOME PER COMMON SHARE Basic earnings per share is computed by dividing net income applicable to common stockholders by the weighted average number of shares of common stock outstanding for the period. Diluted earnings per share is computed by dividing such net income by the sum of such weighted average number of shares and the potentially dilutive shares, including restricted stock awards, that could occur through the issuance of common stock options or convertible securities. 13 - -------------------------------------------------------------------------------- NOTE 2: ACQUISITIONS On November 28, 1997, the Corporation acquired Signet Banking Corporation ("Signet"), a bank holding company based in Virginia. The merger was accounted for as a pooling of interests, and accordingly, all historical financial information for the Corporation has been restated to include Signet historical information for all periods presented herein. At September 30, 1997, Signet had assets of $11 billion, net loans of $7 billion, deposits of $8 billion and net income applicable to common stockholders of $73 million. As a result of the merger, each of the 61 million net outstanding shares of Signet common stock was converted into 1.10 shares of the Corporation's common stock and common stock equivalents, except that cash was paid for fractional share interests. Additionally, merger-related and restructuring charges associated with the Signet merger of $269 million ($194 million after tax) are included as a component of noninterest expense in 1997. The remaining unpaid balance of the initial accrual of $269 million is $169 million at December 31, 1997. The remaining restructuring charges will be paid primarily in 1998, and they include $17 million of noncash charges. At December 31, 1997, the Corporation had two pending acquisitions, both of which were consummated in January 1998. The first relates to the purchase accounting acquisition of Covenant Bancorp, Inc. ("Covenant"), which at December 31, 1997, had assets of $415 million, for 1.6 million shares of the Corporation's common stock, substantially all of which were repurchased in the open market at a cost of $79 million. The second relates to the pooling of interests accounting acquisition of Wheat First Butcher Singer, Inc. ("Wheat First"), which at December 31, 1997 had assets of $1 billion and stockholders' equity of $171 million for 10.3 million shares of the Corporation's common stock. Financial information related to Wheat First is not considered material to the historical results of the Corporation, and accordingly, the Corporation's financial statements will not be restated. The Corporation entered into an Agreement and Plan of Mergers on November 18, 1997, providing for the pooling of interests acquisition of CoreStates Financial Corp ("CoreStates"), a multi-bank holding company based in Pennsylvania, and for the exchange of 1.62 shares of the Corporation's common stock for each share of CoreStates common stock, subject to increase under certain circumstances. The Corporation expects to take an after-tax, merger-related and restructuring charge of $795 million in 1998. Additionally, the Corporation expects to consummate the merger in the first half of 1998, subject to regulatory approvals and other conditions of closing. At December 31, 1997, CoreStates had assets of $48 billion, net loans of $35 billion, deposits of $34 billion, stockholders' equity of $3 billion and net income applicable to common stockholders of $813 million. Certain pro forma financial information related to the Corporation and CoreStates and which does not include information related to Covenant or Wheat First follows. 14
Years Ended December 31, ---------------------------------------------- (In millions, except per share data) 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------------ (Unaudited) Interest income $ 14,362 13,758 13,028 Interest expense 6,452 6,151 5,732 Provision for loan losses 1,103 678 403 Noninterest income 4,322 3,535 3,058 Noninterest expense 7,336 6,930 6,542 Income taxes 1,084 1,261 1,213 - ------------------------------------------------------------------------------------------------------------------------------ Net income 2,709 2,273 2,196 Dividends on preferred stock - 9 26 - ------------------------------------------------------------------------------------------------------------------------------ Net income applicable to common stockholders $ 2,709 2,264 2,170 - ------------------------------------------------------------------------------------------------------------------------------ Basic earning per share $ 2.84 2.33 2.21 Diluted earning per share $ 2.80 2.30 2.17 - ------------------------------------------------------------------------------------------------------------------------------ Assets $ 205,735 197,341 188,855 Loans, net of unearned income 131,687 134,647 127,905 Deposits 137,077 136,429 134,112 Stockholders' equity $ 15,269 14,628 13,783 - ------------------------------------------------------------------------------------------------------------------------------
On January 1, 1996, the Corporation acquired First Fidelity Bancorporation ("First Fidelity"), a multi-bank holding company based in New Jersey. The merger was accounted for as a pooling of interests, and accordingly, all historical financial information for the Corporation has been restated to include First Fidelity historical information for all periods presented herein. At December 31, 1995, First Fidelity had assets of $35 billion, net loans of $25 billion, deposits of $28 billion and net income applicable to common stockholders of $398 million. As a result of the merger, each of the 79 million net outstanding shares of First Fidelity common stock was converted into 1.35 shares of the Corporation's common stock and common stock equivalents, except that cash was paid for fractional share interests. In addition, the 3 million net outstanding shares of First Fidelity Series B Convertible Preferred Stock were converted into a like number of shares of the Corporation's Series B Convertible Class A Preferred Stock (the "Series B Stock") having substantially identical terms as the First Fidelity Series B, the 350,000 outstanding shares of First Fidelity Series D Adjustable Rate Cumulative Preferred Stock were converted into a like number of shares of the Corporation's Series D Adjustable Rate Cumulative Class A Preferred Stock (the "Series D Stock") having substantially identical terms as the First Fidelity Series D, and the 3 million net outstanding First Fidelity Depository Receipts (each representing a 1/40th interest in a share of First Fidelity Series F 10.64% Preferred Stock (74,130 net outstanding shares) were converted into a like number of the Corporation's Depository Receipts (each representing a 1/40th interest in the Corporation's Series F 10.64% Class A Preferred Stock (the "Series F Stock") having substantially identical terms as the First Fidelity Series F. See Note 12 for information related to the redemption of the Series B Stock, the Series D Stock and the Series F Stock. Additionally, merger-related and restructuring charges associated with the First Fidelity merger of $281 million ($181 million after tax) and $94 million ($73 million after tax) are included as a component of noninterest expense in 1996 and 1995, respectively. The remaining unpaid balance of the initial accrual of $375 million was $29 million at December 31, 1996 , and it was paid in 1997. In 1996, various banking subsidiaries of the Parent Company also acquired twelve financial institutions and certain other assets which in the aggregate amounted to the addition of $7.8 billion in assets, $4.8 billion in net loans and $5.1 billion in deposits. The purchase method of accounting, which requires (i) no restatement of the Corporation's historical financial statements, and (ii) the inclusion of the acquired company's financial information on a fair value basis only from the date of consummation, was used in these transactions. With respect to these transactions, the Parent Company issued 32 million shares of its common stock in exchange for the common stock of certain of the acquired financial institutions, and it paid cash for the other financial institutions and assets, which in the aggregate amounted to $1.1 billion. These transactions resulted in an increase to stockholders' equity of $1.0 billion, and the increase was reduced by the Parent Company's purchase in the open market of 24 million shares of its common stock for $764 million in 1996. These transactions also resulted in an increase in goodwill of $595 million, which will be amortized on a straight-line basis over 25 years, and in deposit base premium of $70 million, which will be amortized on an accelerated basis over 10 years. 15
- --------------------------------------------------------------------------------------------------------------------------------- NOTE 3: SECURITIES AVAILABLE FOR SALE December 31, 1997 ---------------------------------------------------------------------------------------- Gross Unrealized 1 Year 1-5 5-10 After 10 ------------------ Amortized (In millions) or Less Years Years Years Total Gains Losses Cost - --------------------------------------------------------------------------------------------------------------------------------- MARKET VALUE U.S. Treasury $ 175 785 1,420 178 2,558 (116) - 2,442 U.S. Government agencies 1 5,542 7,702 4 13,249 (232) 3 13,020 Collateralized mortgage obligations 317 1,794 142 - 2,253 (25) 7 2,235 State, county and municipal 6 3 20 63 92 - - 92 Other 83 2,147 176 857 3,263 (42) 10 3,231 - --------------------------------------------------------------------------------------------------------------------------------- Total $ 582 10,271 9,460 1,102 21,415 (415) 20 21,020 - --------------------------------------------------------------------------------------------------------------------------------- MARKET VALUE Debt securities $ 582 10,205 9,460 394 20,641 (404) 19 20,256 Sundry securities - 66 - 708 774 (11) 1 764 - --------------------------------------------------------------------------------------------------------------------------------- Total $ 582 10,271 9,460 1,102 21,415 (415) 20 21,020 - --------------------------------------------------------------------------------------------------------------------------------- AMORTIZED COST Debt securities $ 569 10,077 9,224 386 20,256 Sundry securities - 66 - 698 764 - ------------------------------------------------------------------------------------------- Total $ 569 10,143 9,224 1,084 21,020 - ------------------------------------------------------------------------------------------- December 31, 1996 ---------------------------------------------------------------------------------------- Gross Unrealized 1 Year 1-5 5-10 After 10 ------------------ Amortized (In millions) or Less Years Years Years Total Gains Losses Cost - --------------------------------------------------------------------------------------------------------------------------------- MARKET VALUE U.S. Treasury $ 183 1,868 50 2 2,103 (9) 14 2,108 U.S. Government agencies 9 2,490 8,969 26 11,494 (43) 60 11,511 Collateralized mortgage obligations 32 928 - - 960 (5) 5 960 State, county and municipal 13 7 13 26 59 (1) - 58 Other 97 1,050 89 953 2,189 (42) 15 2,162 - --------------------------------------------------------------------------------------------------------------------------------- Total $ 334 6,343 9,121 1,007 16,805 (100) 94 16,799 - --------------------------------------------------------------------------------------------------------------------------------- MARKET VALUE Debt securities $ 334 6,326 9,121 187 15,968 (84) 94 15,978 Sundry securities - 17 - 820 837 (16) - 821 - --------------------------------------------------------------------------------------------------------------------------------- Total $ 334 6,343 9,121 1,007 16,805 (100) 94 16,799 - --------------------------------------------------------------------------------------------------------------------------------- AMORTIZED COST Debt securities $ 333 6,298 9,149 198 15,978 Sundry securities - 16 - 805 821 - ------------------------------------------------------------------------------------------- Total $ 333 6,314 9,149 1,003 16,799 - -------------------------------------------------------------------------------------------
16 - ------------------------------------------------------------------------------ Securities available for sale with an aggregate amortized cost of $4.9 billion at December 31, 1997, are pledged to secure U.S. Government and other public deposits and for other purposes as required by various statutes or agreements. Included in "U.S. Government agencies" and "Other" at December 31, 1997, are $2.7 billion of securities that are denominated in currencies other than the U.S. dollar. The currency exchange rates were hedged utilizing both on- and off-balance sheet instruments to minimize the exposure to currency revaluation risks. At December 31, 1997, these securities had a weighted average maturity of 3.75 years and a weighted average yield of 5.31 percent. The weighted average U.S. equivalent yield for comparative purposes of these securities was 6.57 percent based on a weighted average funding cost differential of (1.26) percent. Expected maturities differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Generally, the aging of mortgage-backed securities included in U.S. Government agencies and collateralized mortgage obligations is based on their weighted average maturities at December 31, 1997 and 1996. At December 31, 1997 and 1996, collateralized mortgage obligations had a weighted average yield based on amortized cost of 6.68 percent and 7.35 percent, respectively. At December 31, 1997 and 1996, there were forward commitments to purchase securities at a cost of $6.4 billion and $127 million, respectively, that at December 31, 1997 and 1996, had a market value of $6.4 billion and $127 million, respectively. Gross gains and losses realized on the sale of debt securities in 1997 were $51 million and $43 million, respectively, and on sundry securities such gains were $23 million. Gross gains and losses realized on the sale of debt securities in 1996 were $159 million and $125 million, respectively, and on sundry securities such gains were $2 million. Gross gains and losses realized on the sale of debt securities in 1995 were $72 million and $44 million, respectively, and on sundry securities such gains were $17 million. At December 31, 1997, stockholders' equity includes an after-tax amount of $254 million, which is based on net unrealized appreciation in the securities available for sale portfolio of $395 million. At December 31, 1996, stockholders' equity includes an after-tax amount of $2 million, which is based on net unrealized appreciation in the securities available for sale portfolio of $6 million. 17
- ----------------------------------------------------------------------------------------------------------------------------- NOTE 4: INVESTMENT SECURITIES December 31, 1997 ------------------------------------------------------------------------------------ Gross Unrealized 1 Year 1-5 5-10 After 10 ------------------ Market (In millions) or Less Years Years Years Total Gains Losses Value - ----------------------------------------------------------------------------------------------------------------------------- CARRYING VALUE U.S. Government agencies $ - 703 313 - 1,016 25 (1) 1,040 Collateralized mortgage obligations 30 337 - - 367 9 - 376 State, county and municipal 63 172 187 302 724 112 - 836 Other 2 12 34 20 68 2 - 70 - ----------------------------------------------------------------------------------------------------------------------------- Total $ 95 1,224 534 322 2,175 148 (1) 2,322 - ----------------------------------------------------------------------------------------------------------------------------- CARRYING VALUE Debt securities $ 95 1,224 534 303 2,156 148 (1) 2,303 Sundry securities - - - 19 19 - - 19 - ----------------------------------------------------------------------------------------------------------------------------- Total $ 95 1,224 534 322 2,175 148 (1) 2,322 - ----------------------------------------------------------------------------------------------------------------------------- MARKET VALUE Debt securities $ 96 1,262 576 369 2,303 Sundry securities - - - 19 19 - ----------------------------------------------------------------------------------------- Total $ 96 1,262 576 388 2,322 - ----------------------------------------------------------------------------------------- December 31, 1996 ------------------------------------------------------------------------------------ Gross Unrealized 1 Year 1-5 5-10 After 10 ------------------ Market (In millions) or Less Years Years Years Total Gains Losses Value - ----------------------------------------------------------------------------------------------------------------------------- CARRYING VALUE U.S. Government agencies $ - 776 318 - 1,094 22 (3) 1,113 Collateralized mortgage obligations 67 414 - - 481 8 - 489 State, county and municipal 61 219 145 380 805 105 (1) 909 Other 1 11 9 100 121 4 - 125 - ----------------------------------------------------------------------------------------------------------------------------- Total $ 129 1,420 472 480 2,501 139 (4) 2,636 - ----------------------------------------------------------------------------------------------------------------------------- CARRYING VALUE Debt securities $ 129 1,420 472 426 2,447 139 (4) 2,582 Sundry securities - - - 54 54 - - 54 - ----------------------------------------------------------------------------------------------------------------------------- Total $ 129 1,420 472 480 2,501 139 (4) 2,636 - ----------------------------------------------------------------------------------------------------------------------------- MARKET VALUE Debt securities $ 130 1,456 494 502 2,582 Sundry securities - - - 54 54 - ---------------------------------------------------------------------------------------- Total $ 130 1,456 494 556 2,636 - ----------------------------------------------------------------------------------------
18 - -------------------------------------------------------------------------------- Investment securities with an aggregate carrying value of $1.6 billion at December 31, 1997, are pledged to secure U.S. Government and other public deposits and for other purposes as required by various statutes or agreements. Expected maturities differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Generally, the aging of mortgage-backed securities included in U.S. Government agencies and collateralized mortgage obligations is based on their weighted average maturities at December 31, 1997 and 1996. At December 31, 1997 and 1996, collateralized mortgage obligations had a weighted average yield of 7.66 percent and 7.64 percent, respectively. There were no commitments to purchase or sell investment securities at December 31, 1997 and 1996. Gross gains realized on calls of sundry securities in 1997 were $3 million. Gross gains and losses realized on repurchase agreement underdeliveries and calls of investment securities in 1996 were $5 million and $1 million, respectively. Gross gains and losses realized on repurchase agreement underdeliveries and calls of investment securities in 1995 were $6 million and $1 million, respectively. 19
- ------------------------------------------------------------------------------------------------------------------ NOTE 5: LOANS Years Ended December 31, ------------------------ (In millions) 1997 1996 - ------------------------------------------------------------------------------------------------------------------ COMMERCIAL Commercial, financial and agricultural $ 28,111 25,997 Real estate - construction and other 2,386 2,919 Real estate - mortgage 8,576 9,758 Lease financing 8,056 5,951 Foreign 1,431 1,087 - ------------------------------------------------------------------------------------------------------------------ Total commercial 48,560 45,712 - ------------------------------------------------------------------------------------------------------------------ RETAIL Real estate - mortgage 25,382 29,108 Installment loans - Bankcard 2,708 5,620 Installment loans - other 19,297 20,827 Vehicle leasing 4,312 3,480 - ------------------------------------------------------------------------------------------------------------------ Total retail 51,699 59,035 - ------------------------------------------------------------------------------------------------------------------ Total loans $ 100,259 104,747 - ------------------------------------------------------------------------------------------------------------------
Directors and executive officers of the Parent Company and their related interests were indebted to the Corporation in the aggregate amounts of $2.4 billion and $1.3 billion at December 31, 1997 and 1996, respectively. From January 1, 1997, through December 31, 1997, directors and executive officers of the Parent Company and their related interests borrowed $1.5 billion and repaid $376 million. In the opinion of management, these loans do not involve more than the normal risk of collectibility, nor do they present other unfavorable features. At December 31, 1997 and 1996, nonaccrual and restructured loans amounted to $624 million and $698 million, respectively. Interest related to nonaccrual and restructured loans for the years ended December 31, 1997, 1996 and 1995, amounted to $51 million, $57 million and $73 million, respectively. Interest collected on such loans and included in the results of operations for each of the years in the three-year period then ended amounted to $21 million, $13 million and $18 million, respectively. Included in other assets at December 31, 1997, are $3.2 billion of credit card receivables and other unsecured installment loans with a carrying value of $2.8 billion that are being held for accelerated disposition. At December 31, 1997 and 1996, impaired loans, which are included in nonaccrual loans, amounted to $301 million and $370 million, respectively. Included in the allowance for loan losses is $43 million related to $253 million of impaired loans at December 31, 1997, and $36 million related to $237 million of impaired loans at December 31, 1996. The rest of the impaired loans are recorded at or below fair value. For the years ended December 31, 1997 and 1996, the average recorded investment in impaired loans was $306 million and $477 million, respectively; and $22 million and $19 million, respectively, of interest income was recognized on loans while they were impaired. All this income was recognized on loans using a cash-basis method of accounting. Loan fair values are disclosed in Note 17. 20
- -------------------------------------------------------------------------------------------------------------- NOTE 6: ALLOWANCE FOR LOAN LOSSES Years Ended December 31, ------------------------------- (In millions) 1997 1996 1995 - -------------------------------------------------------------------------------------------------------------- Balance, beginning of year $ 1,502 1,638 1,578 Provision for loan losses 840 449 259 Allowance of loans acquired, transferred to accelerated disposition or sold (495) 50 193 - -------------------------------------------------------------------------------------------------------------- 1,847 2,137 2,030 - -------------------------------------------------------------------------------------------------------------- Loan losses 753 794 526 Loan recoveries 118 159 134 - -------------------------------------------------------------------------------------------------------------- Loan losses, net 635 635 392 - -------------------------------------------------------------------------------------------------------------- Balance, end of year $ 1,212 1,502 1,638 - --------------------------------------------------------------------------------------------------------------
21
- --------------------------------------------------------------------------------------------------------------- NOTE 7: PREMISES AND EQUIPMENT Years Ended December 31, ------------------------------ (In millions) 1997 1996 1995 - --------------------------------------------------------------------------------------------------------------- Land $ 495 499 487 Buildings 2,269 2,154 1,947 Equipment 3,702 3,508 2,014 Capitalized leases 40 41 40 - --------------------------------------------------------------------------------------------------------------- 6,506 6,202 4,488 Accumulated depreciation and amortization (2,273) (1,945) (1,743) - --------------------------------------------------------------------------------------------------------------- Premises and equipment, net $ 4,233 4,257 2,745 - --------------------------------------------------------------------------------------------------------------- Net premises and equipment pledged as security for mortgage notes $ 26 62 63 - --------------------------------------------------------------------------------------------------------------- Depreciation and amortization $ 444 360 294 - ---------------------------------------------------------------------------------------------------------------
22
- ---------------------------------------------------------------------------------------------------------------- NOTE 8: FORECLOSED PROPERTIES Years Ended December 31, -------------------------------- (In millions) 1997 1996 1995 - ---------------------------------------------------------------------------------------------------------------- Foreclosed properties $ 115 121 219 - ---------------------------------------------------------------------------------------------------------------- Allowance for foreclosed properties, beginning of year 17 25 42 Provision for foreclosed properties 2 (1) (3) Transfer from allowance for segregated assets - 1 - Dispositions, net (3) (8) (14) - ---------------------------------------------------------------------------------------------------------------- Allowance for foreclosed properties, end of year 16 17 25 - ---------------------------------------------------------------------------------------------------------------- Foreclosed properties, net $ 99 104 194 - ----------------------------------------------------------------------------------------------------------------
23 - -------------------------------------------------------------------------------- NOTE 9: SHORT-TERM BORROWINGS Short-term borrowings of the Corporation at December 31, 1997, 1996 and 1995, which includes securities sold under repurchase agreements and accrued interest thereon, and the related maximum amount outstanding at the end of any month during such periods are presented below.
Years Ended December 31, Maximum Outstanding ------------------------------ ----------------------------- (In millions) 1997 1996 1995 1997 1996 1995 - -------------------------------------------------------------------------------------------------------------- Securities sold under repurchase agreements $ 19,772 17,882 12,142 20,457 21,422 12,513 Federal funds purchased 1,996 2,679 4,165 2,626 3,951 4,671 Fixed and variable rate bank notes 268 843 2,586 1,076 2,462 2,586 Interest-bearing demand deposits issued to the U. S. Treasury 323 391 365 398 605 764 Commercial paper 871 1,021 1,162 1,541 1,122 1,382 Other 4,127 2,171 984 4,575 3,573 3,188 - ------------------------------------------------------------------------------- Total $ 27,357 24,987 21,404 - --------------------------------------------------------------------------------------------------------------
At December 31, 1997, 1996 and 1995, the combined weighted average interest rates related to federal funds purchased and securities sold under repurchase agreements were 6.14 percent, 6.06 percent and 5.46 percent, respectively. Maturities related to such instruments in each of the years in the three-year period then ended were not greater than 350 days. At December 31, 1997, 1996 and 1995, the weighted average interest rates for fixed and variable rate bank notes were 5.71 percent, 5.53 percent and 5.70 percent, respectively. Weighted average maturities related to such notes in each of the years in the three-year period then ended were 153 days, 109 days and 90 days, respectively. At December 31, 1997, 1996 and 1995, the weighted average interest rates for commercial paper were 5.59 percent, 5.49 percent and 5.49 percent, respectively. Weighted average maturities related to such commercial paper in each of the years in the three-year period then ended were 4 days, 21 days and 21 days, respectively. Included in "Other" are Federal Home Loan Bank borrowings and securities sold short of $286 million and $3.5 billion, respectively, at December 31, 1997; $211 million and $1.9 billion, respectively, at December 31, 1996; and $230 million and $439 million, respectively, at December 31, 1995. Substantially all short-term borrowings are due within 90 days, and accordingly, the carrying amount of such borrowings is deemed to be a reasonable estimate of fair value. 24
- -------------------------------------------------------------------------------------------------------------------- NOTE 10: LONG-TERM DEBT 1997 1996 --------------------- ----------------------- Estimated Estimated Carrying Fair Carrying Fair (In millions) Amount Value Amount Value - -------------------------------------------------------------------------------------------------------------------- DEBENTURES AND NOTES ISSUED BY THE PARENT COMPANY 7-1/2% debentures $ - - 16 16 Notes Floating rate extendible, due June 15, 2005 (a) 10 10 10 10 6.60%, due June 15, 2000 (par value $250) (b) 249 252 - - Floating rate, due February 24, 1998 (par value $300) (b) 300 300 300 300 6-3/4%, due January 15, 1998 (par value $250) (b) 250 250 250 251 Subordinated notes 7.18%, due April 15, 2011 (par value $60) 59 65 59 60 8%, due August 15, 2009 (par value $150) 149 162 149 155 6-3/8%, due January 15, 2009 (par value $150) (b) 148 148 148 138 6%, due October 30, 2008 (par value $200) (b) 198 192 197 178 7-1/2%, due July 15, 2006 (par value $300) (b) 298 321 297 306 7%, due March 15, 2006 (par value $200) (b) 199 207 198 198 6-7/8%, due September 15, 2005 (par value $250) (b) 249 257 249 246 7.05%, due August 1, 2005 (par value $250) (b) 248 259 248 249 6-5/8%, due July 15, 2005 (par value $250) (b) 249 253 248 240 8.77%, due November 15, 2004 (par value $150) 149 171 149 157 Floating rate, due July 22, 2003 (par value $150) (b) 149 150 149 149 7-1/4%, due February 15, 2003 (par value $150) (b) 149 156 149 152 8%, due November 15, 2002 (par value $225) (b) 224 237 224 236 8-1/8%, due June 24, 2002 (par value $250) (b) 249 267 249 264 9.45%, due August 15, 2001 (par value $150) (b) 149 165 148 164 Fixed rate medium-term, varying rates and terms to June 5, 2001 (c) 54 58 54 62 9.45%, due June 15, 1999 (par value $250) (b) 249 262 249 266 Subordinated debentures 6.55%, due October 15, 2035 (par value $250) 249 256 249 243 7-1/2%, due April 15, 2035 (par value $250) 246 279 246 261 6.824%/7.574%, due August 1, 2026 (par value $300) 298 317 298 304 - -------------------------------------------------------------------------------------------------------------------- Total debentures and notes issued by the Parent Company 4,771 4,994 4,533 4,605 - --------------------------------------------------------------------------------------------------------------------
25
- -------------------------------------------------------------------------------------------------------------------- 1997 1996 --------------------- ----------------------- Estimated Estimated Carrying Fair Carrying Fair (In millions) Amount Value Amount Value - -------------------------------------------------------------------------------------------------------------------- DEBENTURES AND NOTES OF SUBSIDIARIES Debentures and notes 9-3/4% senior, due September 1, 2003 (par value $145) 120 140 158 159 Varying rates and terms to November 1, 2002 59 61 65 69 Subordinated notes Bank, varying rates and terms to December 15, 2036 975 986 1,397 1,409 6.80%, due June 15, 2003 (par value $150) (b) 149 153 149 154 9-5/8%, due August 15, 1999 (par value $150) (b) 150 156 149 161 9-5/8%, due June 1, 1999 (par value $100) (b) (d) 100 105 100 107 Floating rate, due April 15, 1998 (c) (d) 100 100 100 100 Floating rate - - 50 50 Floating rate - - 25 25 Subordinated capital notes 9-5/8%, due June 15, 1999 (par value $75) (b) (d) 75 79 74 80 9-7/8%, due May 15, 1999 (par value $75) (b) (d) 75 79 75 82 8-1/2%, due April 1, 1998 (par value $150) (b) 149 150 149 153 10-1/2% collateralized mortgage obligations - - 37 41 - -------------------------------------------------------------------------------------------------------------------- Total debentures and notes of subsidiaries 1,952 2,009 2,528 2,590 - -------------------------------------------------------------------------------------------------------------------- OTHER DEBT Advances from the Federal Home Loan Bank 1,285 1,285 930 930 Mortgage notes and other debt of subsidiaries, varying rates and terms 11 11 44 45 Capitalized leases, rates generally ranging from 7-1/2% to 15.20% 23 23 25 25 - -------------------------------------------------------------------------------------------------------------------- Total other debt 1,319 1,319 999 1,000 - -------------------------------------------------------------------------------------------------------------------- Total $ 8,042 8,322 8,060 8,195 - --------------------------------------------------------------------------------------------------------------------
(a) Redeemable in whole or in part at the option of the Parent Company. (b) Not redeemable prior to maturity. (c) Redeemable at the option of the Parent Company. (d) Assumed by the Parent Company. The fair value of long-term debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Corporation for debt of the same remaining maturities. The interest rate on the floating rate extendible notes is 6.0875 percent to March 16, 1998. The interest rate on the floating rate notes due February 24, 1998, is 5.1875 percent. The 7.18 percent subordinated notes are redeemable in whole and not in part at the option of the Parent Company on April 15, 2000 and on each October 15 and April 15 thereafter. The 8 percent subordinated notes due August 15, 2009, are redeemable in whole and not in part at the option of the Parent Company on August 15, 2004. The 8.77 percent subordinated notes are redeemable in whole or in part at the option of the Parent Company on November 15, 1999. The interest rate on the floating rate subordinated notes is 5.93359 percent to January 22, 1998. Fixed rate medium-term senior and subordinated notes can be issued periodically. Interest rates, maturities, redemption and other terms are determined at the date of issuance. At December 31, 1997, the Parent Company had issued medium-term subordinated notes with fixed rates of interest ranging from 9.49 percent to 9.93 percent. Holders of the 6.55 percent subordinated debentures and the 7-1/2 percent subordinated debentures may elect to redeem a part or all of such debentures on October 15, 2005, and April 15, 2005, respectively. Otherwise such debentures are not redeemable prior to maturity. Holders of the 6.824 percent/7.754 percent subordinated debentures may elect to redeem a part or all of such debentures on August 1, 2006, or August 1, 2016. Otherwise such debentures are not redeemable prior to maturity. 26 - -------------------------------------------------------------------------------- The 9-3/4 percent senior notes were issued by an acquired subsidiary prior to the acquisition, and in accordance with a covenant defeasance related thereto, the subsidiary has announced that it will redeem all such notes on September 2, 1998, the earliest date the notes can be redeemed, at a redemption price equal to 103.375 percent of the principal amount then outstanding plus any accrued and unpaid interest to such date. The subsidiary has deposited with the trustee sufficient cash and securities to effect the redemption of the notes on such date. At December 31, 1997, bank notes of $175 million had floating rates of interest ranging from 5.69 percent to 6.14 percent, and $800 million of the notes had fixed rates of interest ranging from 6.18 percent to 7.80 percent. The interest rate on the floating rate subordinated notes is 5.875 percent to April 15, 1998. In February 1998, $2.4 billion of senior or subordinated debt securities or equity securities remained available for issuance under a shelf registration statement filed with the Securities and Exchange Commission. The weighted average rate paid for long-term debt in 1997, 1996 and 1995 was 6.52 percent, 6.28 percent and 6.71 percent, respectively. Interest rate swap agreements entered into at the time of issuance of certain long-term debt reduced related interest expense. Long-term debt maturing in each of the five years subsequent to December 31, 1997, is as follows (in millions): 1998, $2,072; 1999, $859; 2000, $381; 2001, $196; and 2002, $516. 27 - -------------------------------------------------------------------------------- NOTE 11: GUARANTEED PREFERRED BENEFICIAL INTERESTS IN CORPORATION'S JUNIOR SUBORDINATED DEFERRABLE INTEREST DEBENTURES First Union Institutional Capital I, a statutory business trust (the "Trust") created by the Parent Company had outstanding at December 31, 1997 and 1996, $495 million (par value $500 million) of 8.04% Capital Securities which will mature on December 1, 2026 (the "Capital Securities"). The principal assets of the Trust are $515 million of the Parent Company's 8.04% Junior Subordinated Deferrable Interest Debentures, which will mature on December 1, 2026 (the "Subordinated Debentures"). Additionally, the Trust has issued $15 million of common securities (the "Common Securities") to the Parent Company. The estimated fair value of each of the Capital Securities and the related Subordinated Debentures at December 31, 1997 and 1996, was $536 million and $500 million, respectively. The Capital Securities, the Subordinated Debentures and the Common Securities are redeemable in whole or in part on or after December 1, 2006, or at any time in whole but not in part from the date of issuance on the occurrence of certain events. On January 6, 1997, and January 16, 1997, First Union Institutional Capital II and First Union Capital I, respectively, both statutory business trusts (the "Trusts") created by the Parent Company, issued $250 million of 7.85% Capital Securities and $250 million of 7.935% Capital Securities, Series A, respectively, (together the "Securities") which will mature on January 1, 2027, and January 15, 2027, respectively. The principal combined assets of the Trusts are $515 million of the Parent Company's subordinated debentures with like maturities and like interest rates to the Securities. Additionally, the Trusts have issued $15 million in the aggregate of common securities to the Parent Company. The 7.85% Capital Securities and the 7.935% Capital Securities, Series A, both had $248 million outstanding at December 31, 1997 and estimated fair values of $263 million and $265 million, respectively. The related subordinated debentures had a combined estimated fair value of $528 million. The Securities, the assets of the Trusts and the common securities issued by the Trusts are redeemable in whole or in part on or after January 1, 2007, and January 15, 2007, respectively, or at any time in whole but not in part from the date of issuance on the occurrence of certain events. The Capital Securities and the Securities may be included in tier 1 capital for regulatory capital adequacy determination purposes. Distributions to the holders of the Capital Securities and the Securities are included in sundry expense. The obligations of the Parent Company with respect to the issuance of the Capital Securities and the Securities constitute a full and unconditional guarantee by the Parent Company of the Trusts' obligations with respect to the Capital Securities or Securities. Subject to certain exceptions and limitations, the Parent Company may elect from time to time to defer subordinated debenture interest payments, which would result in a deferral of distribution payments on the related Capital Securities or Securities. 28
- ------------------------------------------------------------------------------------------------------------------------- NOTE 12: PREFERRED STOCK 1997 1996 1995 ---------------------- ---------------------- ---------------------- (Shares in thousands, dollars in millions) Shares Amount Shares Amount Shares Amount - ------------------------------------------------------------------------------------------------------------------------- Series B Stock Balance, beginning of year - $ - 2,964 $ 74 4,788 120 Purchases of preferred stock - - - (250) (6) Conversions of preferred stock into common stock - - (2,955) (74) (1,574) (40) Redemption of preferred stock - - (9) - - - Balance, end of year - - - 2,964 74 - ------------------------------------------------------------------------------------------------------------------------- Series D Stock - - Balance, beginning of year - - 350 35 350 35 Redemption of preferred stock - - (350) (35) - - Balance, end of year - - - 350 35 - ------------------------------------------------------------------------------------------------------------------------- Series F Stock - - Balance, beginning of year - - 74 74 75 75 Purchases of preferred stock - - - - (1) (1) Redemption of preferred stock - - (74) (74) - - Balance, end of year - - - - 74 74 - -------------------------------------------------------------------------------------------------------------------------- Total - $ - - $ - 3,388 183 - --------------------------------------------------------------------------------------------------------------------------
The Corporation is authorized to issue up to 40 million shares of class A preferred stock, no-par value, and 10 million shares of preferred stock, no-par value, each in one or more series. In connection with the First Fidelity merger, the Corporation issued three new series of preferred stock, which are described in Note 2 and all of which were redeemed or converted into the Corporation's common stock as more fully described herein. On November 15, 1996, the Corporation redeemed all of the outstanding shares of the Series B Stock at a redemption price of $25.00 per share (plus accrued and unpaid dividends), substantially all of which were converted into 3 million shares of common stock. On July 1, 1996, the Corporation redeemed all of the outstanding shares of the Series D Stock and the Series F Stock at an aggregate redemption price of $109 million (plus accrued and unpaid dividends). 29
- ---------------------------------------------------------------------------------------------------------------------------- NOTE 13: COMMON STOCK, CAPITAL RATIOS AND EARNINGS PER COMMON SHARE Option Prices or Grant Date Balance, Grants Exercises Forfeitures Balance, (Options and shares Market Beginning or New or and Other End of in thousands) Values of 1997 Shares Purchases Reductions 1997 - ---------------------------------------------------------------------------------------------------------------------------- 1984 Master Stock Plan Options granted - 134 - (127) (7) - Available 1,034 - - 7 1,041 1988 Master Stock Plan Options granted $7.38-$17.94 1,542 - (477) (2) 1,063 Available 2,228 - - 2 2,230 1992 Master Stock Plan Options granted $22.38-$29.25 4,288 - (705) (10) 3,573 Restricted stock granted $22.38-$29.25 1,892 - (582) (54) 1,256 Available 1,798 - - 10 1,808 1996 Master Stock Plan Options granted $29.25-$40.13 2,724 4,397 (423) (104) 6,594 Restricted stock granted $29.25-$43.16 1,808 2,229 (490) (120) 3,427 Available 23,434 (6,626) - 104 16,912 1996 Employee Plan $27.26 6,922 - (4,210) (175) 2,537 Dividend Reinvestment Plan - 7,014 - (1,207) - 5,807 Option plans of acquired companies Options granted $6.17-$26.00 3,870 - (1,277) (114) 2,479 Options granted $1.73-$52.07 2,547 931 (1,203) (79) 2,196 Options granted $3.41-$31.57 1,852 - (1,291) (35) 526 Options granted $2.99-$4.20 18 - (2) (6) 10 Options granted $51.76-$295.13 136 - - (15) 121 - ---------------------------------------------------------------------------------------------------------------------------- Weighted Average Exercise Prices, (Options and shares End of in thousands) 1997 Exercisable - ---------------------------------------------------------- 1984 Master Stock Plan Options granted $ - - Available - - 1988 Master Stock Plan Options granted $ 14.39 1,063 Available - - 1992 Master Stock Plan Options granted $ 23.52 3,573 Restricted stock granted - - Available - - 1996 Master Stock Plan Options granted $ 36.41 2,253 Restricted stock granted - - Available - - 1996 Employee Plan $ 27.26 2,537 Dividend Reinvestment Plan - - Option plans of acquired companies Options granted $ 16.24 2,437 Options granted $ 21.34 2,196 Options granted $ 15.53 526 Options granted $ 3.90 10 Options granted $ 126.67 121 - ------------------------------------------------------------
COMMON STOCK SPLIT All common stock and per share data has been restated to reflect a two-for one stock split that was paid on July 31, 1997. OPTION AND OTHER PLANS Under the terms of the 1984, 1988, 1992 and 1996 Master Stock Plans (the "Plans"), stock options may be periodically granted to key personnel at a price not less than the fair market value of the shares at the date of grant. The exercise periods for options granted under the Plans are (i) determined at the date of grant, (ii) not exercisable for one year following the date of grant, and (iii) for periods no longer than ten years. Restricted stock may also be granted under the Plans. The stock is subject to certain restrictions over a specified period (generally, five years), during which time the holder is entitled to full voting rights and dividend privileges. Compensation cost recognized for restricted stock during 1997 and 1996 was $43 million and $23 million, respectively. Employees, based on their eligibility and compensation, were granted options to purchase shares of common stock under the 1996 Employee Stock Purchase Plan (the "Plan") at a price equal to 85 percent of the fair market value of the shares as of the Plan date. From the Plan date, and generally for approximately a two-year period thereafter, employees have the option to purchase all or a portion of the optioned shares. The Plan provides that at the end of such two-year period (the "Final Purchase Date"), the option price will be the lesser of 85 percent of the fair market value as of the Plan date or 85 percent of the fair market value as of the Final Purchase Date. Under the terms of the Dividend Reinvestment Plan, a participating stockholder's cash dividends and optional cash payments are used to purchase Parent Company common stock. Under the terms of the Parent Company's merger agreements with certain acquired companies, all options with respect to their common stock were converted into options to purchase Parent Company common stock. In accordance with a Shareholder Protection Rights Agreement dated December 18, 1990, as amended, the Parent Company issued a dividend of one right for each share of Parent Company common stock outstanding as of such date. These continue to attach to all common stock issued after December 18, 1990. The rights will become exercisable if any person or group commences a tender or exchange offer that would result in (i) their becoming the beneficial owner of 15 percent or more of the Parent Company's common stock, or (ii) any person being determined by the Federal Reserve Board to control the Corporation within the meaning of the Bank Holding Company Act of 1956, as amended. 30 - -------------------------------------------------------------------------------- The rights will also become exercisable if a person or group acquires beneficial ownership of 15 percent or more of the Parent Company's common stock. Each right (other than rights owned by such person or group) will entitle its holder to purchase, for an exercise price of $105.00, a number of shares of the Parent Company's common stock (or at the option of the Board of Directors, shares of junior participating class A preferred stock) having a market value of twice the exercise price. If any person or group acquires beneficial ownership of between 15 percent and 50 percent of the Parent Company's common stock, the Board of Directors may, at its option, exchange for each outstanding right (other than rights owned by such person or group) either two shares of common stock or two one-hundredths of a share of junior participating class A preferred stock having economic and voting terms similar to two shares of common stock. The rights are subject to adjustment if certain events occur, and they will expire on December 28, 2000, if not redeemed or terminated sooner. On January, 1, 1996, the Corporation adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," as amended ("FAS 123"), which requires either the (i) fair value of employee stock-based compensation plans be recorded as a component of compensation expense in the statement of income as of the date of grant of awards related to such plans, or (ii) impact of such fair value on net income and earnings per share be disclosed on a pro forma basis in a footnote to financial statements for awards granted after December 15, 1994, if the accounting for such awards continues to be in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," ("APB 25"). The Corporation has elected to continue such accounting under the provisions of APB 25. As determined in accordance with FAS 123, certain pro forma information which is based on the estimated fair value of the Corporation's outstanding stock options for each of the three years ended December 31, 1997, 1996 and 1995, is as follows: pro forma net income, $1.865 billion, $1.552 billion and $1.508 billion, respectively; pro forma basic earnings per common share, $2.98, $2.51 and $2.43, respectively; and pro forma diluted earnings per common share, $2.94, $2.48 and $2.37, respectively. The Black-Scholes option pricing model methodology was used in preparing such pro forma information. Option pricing models require the use of highly subjective assumptions, including expected stock price volatility, which when changed can materially affect fair value estimates. Accordingly, the model does not necessarily provide a reliable single measure of the fair value of the Corporation's stock options. CAPITAL RATIOS Risk-based capital ratio guidelines require a minimum ratio of tier 1 capital to risk-weighted assets of 4 percent and a minimum ratio of total capital to risk-weighted assets of 8 percent. The minimum leverage ratio of tier 1 capital to adjusted average quarterly assets is from 3 percent to 5 percent. At December 31, 1997, the Corporation's tier 1 capital ratio, total capital ratio and leverage ratio were 8.41 percent, 13.40 percent and 6.81 percent, respectively. At December 31, 1996, such ratios were 7.33 percent, 12.33 percent and 6.13 percent, respectively. The Corporation does not anticipate or foresee any conditions that would reduce such ratios to levels at or below minimum or that would cause its deposit-taking banking affiliates to be less than well capitalized. Additional information related to the consolidated capital ratios of the Corporation for each of the years in the two-year period ended December 31, 1997, can be found in "Management's Analysis of Operations" - "Stockholders' Equity; Regulatory Capital" on page 22 and in Table 18 on page T-15, which are incorporated herein by reference. EARNINGS PER COMMON SHARE The reconciliation between basic and diluted earnings per common share is below.
Years Ended December 31, ---------------------------------- (Dollars in millions, except per share data) 1997 1996 1995 - ---------------------------------------------------------------------------------------------------------- Basic Net income $ 1,896 1,624 1,541 Preferred stock dividends - (9) (26) - ---------------------------------------------------------------------------------------------------------- Net income applicable to common stockholders $ 1,896 1,615 1,515 - ---------------------------------------------------------------------------------------------------------- Basic earnings per common share $ 3.03 2.61 2.44 - ---------------------------------------------------------------------------------------------------------- Average common shares (In thousands) 625,649 619,237 619,777 - ---------------------------------------------------------------------------------------------------------- Diluted Net income applicable to common stockholders $ 1,896 1,615 1,515 Dividends on convertible preferred stock - - 9 - ---------------------------------------------------------------------------------------------------------- Net income applicable to common stockholders $ 1,896 1,615 1,524 - ---------------------------------------------------------------------------------------------------------- Diluted earnings per common share $ 2.99 2.58 2.38 - ---------------------------------------------------------------------------------------------------------- Average common shares (In thousands) 625,649 619,237 619,777 Options 8,123 5,987 8,577 Convertible preferred stock - - 8,832 - ---------------------------------------------------------------------------------------------------------- Average common shares - diluted (In thousands) 633,772 625,224 637,186 - ----------------------------------------------------------------------------------------------------------
31 - -------------------------------------------------------------------------------- NOTE 14: PERSONNEL EXPENESE Personnel expense for each of the years in the three-year period ended December 31, 1997, is presented below. Years Ended December 31, ------------------------------- (In millions) 1997 1996 1995 - -------------------------------------------------------------------------------- Salaries $ 2,221 1,994 1,811 Pension cost 51 59 29 Savings plan 66 61 60 Other benefits 378 337 307 - -------------------------------------------------------------------------------- Total $ 2,716 2,451 2,207 - -------------------------------------------------------------------------------- Pension expense for nonqualified plans was $19 million, $13 million and $12 million for the years ended December 31, 1997, 1996 and 1995, respectively. The accumulated benefit obligation for nonqualified plans was $121 million, $101 million and $62 million for the years ended December 31, 1997, 1996 and 1995, respectively, including vested benefits of $120 million, $100 million and $61 million, respectively. Such plans have no assets. The assumed rates used in actuarial computations were the same as those used in the qualified pension plan computations. The Corporation has tax-qualified defined benefit pension plans (together, the "Plan") covering substantially all of its employees with one year of service. The benefits are based on years of service and the employee's highest five-year average compensation. Contributions are made each year to a trust in an amount that is determined by an actuary to meet the minimum requirements of ERISA and to fall at or below the maximum amount that can be deducted on the Corporation's tax return. At December 31, 1997, Plan assets include U.S. Government and Government agency securities, equity securities and other investments. Also included are two million shares of the Parent Company's common stock. All Plan assets are held by first Union National Bank (North Carolina)(the "Bank") in a Bank- administered trust fund. The Plan's funded status for each of the years in the three year period ended December 31, 1997, is presented below.
Years Ended December 31, ------------------------------------ (In millions) 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------------------ ACTUARIAL PRESENT VALUE OF BENEFIT OBLIGATIONS Accumulated benefit obligation including vested benefits of $844, 1997; $746, 1996; and $679, 1995 $ 909 807 739 - ------------------------------------------------------------------------------------------------------------------------------------ Projected benefit obligation for service rendered to date (1,139) (1,006) (934) Plan assets at fair value 1,400 1,214 1,069 - ------------------------------------------------------------------------------------------------------------------------------------ Plan assets in excess of projected benefit obligation 261 208 135 Prior service cost 33 38 42 Unrecognized net loss from past experience different from that assumed and effects of changes in assumptions 85 109 154 Unrecognized net transition asset (17) (21) (25) - ------------------------------------------------------------------------------------------------------------------------------------ Prepaid pension cost included in other assets $ 362 334 306 - ------------------------------------------------------------------------------------------------------------------------------------ ASSUMED RATES USED IN ACTUARIAL COMPUTATIONS Discount rate at beginning of year 7.50-7.75 % 7.00-7.50 8.25-8.75 Discount rate at end of year 7.25 7.50-7.75 7.00-7.50 Weighted average rate of increase in future compensation levels 4.25 4.50-5.00 4.50-5.00 Long-term average rate of return 8.50-9.00 % 8.50 8.50-9.75 - ------------------------------------------------------------------------------------------------------------------------------------
32 - -------------------------------------------------------------------------------- Certain components of net pension cost for each of the year in the three-year period ended December 31, 1997, are presented below.
Years Ended December 31, ------------------------------- (In millions) 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------------------ NET PENSION COST Service cost-benefits earned during the period $ 63 64 43 Interest cost on projected benefit obligation 75 67 60 Actual (return) on Plan assets (215) (110) (154) Net amortization and deferral 109 26 68 - ------------------------------------------------------------------------------------------------------------------------------------ Net pension cost $ 32 47 17 - ------------------------------------------------------------------------------------------------------------------------------------
The Corporation and its subsidiaries provide certain health care and life insurance benefits for retired employees. Substantially all the Corporation's employees may become eligible for these benefits if they reach retirement age while working for the Corporation. Life insurance benefits are provided through an insurance company. Medical and other benefits are provided through a tax-exempt trust formed by the Corporation. The Corporation recognizes the cost of providing these benefits by expensing annual insurance premiums, trust funding allocations and administrative expenses. The amount expensed for group insurance for active employees in 1997, 1996 and 1995 was $118 million, $117 million and $106 million, respectively. The status of postretirement benefits other than pensions and certain amounts recognized in the Corporation's consolidated financial statements for each of the years in the three-year period ended December 31, 1997, are presented below.
Years Ended December 31, ------------------------------------ (In millions) 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------------------ ACTUARIAL PRESENT VALUE OF POSTRETIREMENT BENEFITS OBLIGATION Retirees $ 179 187 226 Fully eligible active employees 6 5 5 Other active participants 64 51 47 - ------------------------------------------------------------------------------------------------------------------------------------ Accumulated postretirement benefit obligation $ 249 243 278 - ------------------------------------------------------------------------------------------------------------------------------------ Plan assets at fair value 4 6 6 Projected benefit obligation in excess of plan assets $ 245 237 272 Unrecognized prior service cost (11) - 10 Unrecognized net gain (loss) from past experience different from that assumed and effects of changes in assumptions 58 41 (18) Unrecognized net transition obligation (60) (66) (84) - ------------------------------------------------------------------------------------------------------------------------------------ Prepaid pension cost included in other assets $ 232 212 180 - ------------------------------------------------------------------------------------------------------------------------------------ ASSUMED RATES USED IN ACTUAL COMPUTATIONS Weighted average discount rate 7.25 % 7.50-7.75 7.00-7.50 Rate of increase in future compensation levels, depending on age 4.25 4.50 4.00-9.00 Health care cost trend rate Prior to age 65 6.00 11.67 5.00- grading 12.25 to 5.50 After age 65 5.00 10.67 5.00- grading % to 5.50 11.25 - ------------------------------------------------------------------------------------------------------------------------------------ EFFECT OF ONE PERCENT INCREASE IN HEALTH CARE COST TREND RATE Service costs $ - - - Interest costs 1 1 1 Accumulated postretirement benefit obligation $ 11 13 19 - ------------------------------------------------------------------------------------------------------------------------------------ POSTRETIREMENT COSTS Service cost-benefits earned during the period $ 5 5 4 Interest cost on projected benefit obligation 19 20 19 Actual (return) on Plan assets - (1) (1) Amortization of transition obligation 4 6 4 - ------------------------------------------------------------------------------------------------------------------------------------ Net cost $ 28 30 26 - ------------------------------------------------------------------------------------------------------------------------------------
33 - -------------------------------------------------------------------------------- NOTE 15: INCOME TAXES The Corporation accounts for income taxes in accordance with the provisions of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Accordingly, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The provision for income taxes for each of the years in the three-year period ended December 31, 1997, is presented below.
Years Ended December 31, --------------------------------- (In millions) 1997 1996 1995 - ---------------------------------------------------------------------------------------------------------------- CURRENT INCOME TAX EXPENSE Federal $ 244 283 416 State 25 52 36 - ---------------------------------------------------------------------------------------------------------------- Total 269 335 452 - ---------------------------------------------------------------------------------------------------------------- DEFERRED INCOME TAX EXPENSE Federal 520 535 345 State 25 5 51 - ---------------------------------------------------------------------------------------------------------------- Total 545 540 396 - ---------------------------------------------------------------------------------------------------------------- Total $ 814 875 848 - ----------------------------------------------------------------------------------------------------------------
The reconciliation of federal income tax rates and amounts to the effective income tax rates and amounts for each of the years in the three-year period ended December 31, 1997, is presented below.
Year Ended December 31, ---------------------------------------------------------------------------------- 1997 1996 1995 ------------------------ ------------------------ ----------------------- Percent of Percent of Percent of Pre-tax Pre-tax Pre-tax (In millions) Amount Income Amount Income Amount Income - -------------------------------------------------------------------------------------------------------------------------- Income before income taxes $ 2,710 $ 2,499 $ 2,389 ========= ========== ========= Tax at federal income tax rate $ 948 35.0 % $ 875 35.0 % $ 836 35.0 % Reasons for difference in federal income tax rate and effective tax rate Tax-exempt interest, net of cost to carry (37) (1.4) (45) (1.8) (60) (2.5) Non-taxable distributions from corporate reorganizations (155) (5.7) - - - - State income taxes, net of federal tax benefit 32 1.2 37 1.5 57 2.4 Goodwill amortization 45 1.6 37 1.5 33 1.4 Change in the beginning-of-the-year deferred tax assets valuation allowance (11) (0.4) (12) (0.5) 3 0.1 Other items, net (8) (0.3) (17) (0.7) (21) (0.9) - --------------------------------------------------------------------------------------------------------------------------- Total $ 814 30.0 % $ 875 35.0 % $ 848 35.5 % - ---------------------------------------------------------------------------------------------------------------------------
34 - -------------------------------------------------------------------------------- The sources and tax effects of temporary differences give rise to significant portions of deferred income tax liabilities (assets) for each of the years in the three-year period ended December 31, 1997, are presented below.
Years Ended December 31, ---------------------------------- (In millions) 1997 1996 1995 - ---------------------------------------------------------------------------------------- DEFERRED INCOME TAX LIABILITIES Depreciation $ 263 96 73 Unrealized gain on debt and equity securities 137 1 84 Intangible assets 114 97 77 Leasing activities 1,922 1,367 857 Loan products 45 24 7 Prepaid pension assets 130 109 90 Loan loss reserve recapture 30 49 72 Other 46 67 66 - ---------------------------------------------------------------------------------------- Total deferred income tax liabilities 2,687 1,810 1,326 - ---------------------------------------------------------------------------------------- DEFERRED INCOME TAX ASSETS Provision for loan losses, net (587) (542) (582) Accrued expenses, deductible when paid (416) (291) (286) Foreclosed properties (7) (9) (16) Sale and leaseback transactions (15) (10) (17) Deferred income (8) (15) (16) Purchase accounting adjustments (primarily loans and securities) (79) (144) (63) Net operating loss carryforwards (71) (55) (38) First American segregated assets - (4) (20) Other (115) (87) (57) - ----------------------------------------------------------------------------------------- Total deferred income tax assets (1,298) (1,157) (1,095) - ----------------------------------------------------------------------------------------- Deferred tax assets valuations allowance 24 35 43 - ----------------------------------------------------------------------------------------- Net deferred income tax liabilities $ 1,413 688 274 - -----------------------------------------------------------------------------------------
Changes to the deferred tax assets valuation allowance for each of the years in the three-year period ended December 31, 1997, are presented below.
Years Ended December 31, ---------------------------------- (In millions) 1997 1996 1995 - ---------------------------------------------------------------------------------------- Deferred tax assets valuation allowance, beginning of year $ 35 43 37 Current year deferred provision, change in deferred tax assets valuation allowance (11) (12) 3 Purchase acquisitions - 4 3 - ---------------------------------------------------------------------------------------- Deferred tax assets valuation allowance, end of year $ 24 35 43 - ----------------------------------------------------------------------------------------
A portion of the current year change in the net deferred tax liability (asset) relates to unrealized gains and losses on debt and equity securities available for sale. The related 1997, 1996 and 1995 deferred tax expense (benefit) of $136 million, $(83) million and $252 million, respectively, have been recorded directly to stockholders' equity. Purchase acquisitions also increased (decreased) the net deferred tax liability by $44 million, $(43) million and $1 million in 1997, 1996 and 1995, respectively. The realization of deferred tax assets may be based on the utilization of carrybacks to prior taxable periods, the anticipation of future taxable income in certain periods and the utilization of tax planning strategies. Management has determined that it is more likely than not that the deferred tax assets can be supported by carrybacks to federal taxable income in excess of $1.2 billion in the two-year federal carryback period and by expected future taxable income that will far exceed amounts necessary to fully realize remaining deferred tax assets resulting from net operating loss carryforwards and from the scheduling of temporary differences. The valuation allowance primarily relates to certain state temporary differences and to federal and state net operating loss carryforwards. To the extent that the valuation allowance attributable to purchase acquisitions of $22 million is subsequently recognized, such income tax benefit will reduce goodwill. 35 - -------------------------------------------------------------------------------- At December 31, 1997, the Corporation has net operating loss carryforwards of $35 million which are available to offset future federal taxable income through 2007, subject to annual limitations. The Corporation also has net operating loss carryforwards of $1.7 billion, which are available to offset future state taxable income through 2012. Income tax expense related to securities available for sale transactions was $11 million, $14 million, and $14 million in 1997, 1996 and 1995, respectively. Income tax expense related to investment security transactions was $1 million, $1 million, and $2 million in 1997, 1996 and 1995, respectively. The Internal Revenue Service (the "IRS") is examining the Corporation's federal income tax returns for the years 1991 through 1996, and the IRS is examining federal income tax returns for certain acquired subsidiaries for periods prior to acquisition. In 1995, the IRS examination of the Corporation's federal income tax returns for the years through 1990 was settled with no material impact to the Corporation's financial position or results of operations. In 1996 and 1995, tax liabilities for certain acquired subsidiaries for periods prior to their acquisition by the Corporation were settled with the IRS with no significant impact on the Corporation's financial position or results of operations. 36 - -------------------------------------------------------------------------------- NOTE 16: OFF-BALANCE SHEET RISK, COMMITMENTS AND CONTINGENT LIABILITIES The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers, to reduce its own exposure to fluctuations in interest rates and to conduct lending activities. These financial instruments include commitments to extend credit; standby and commercial letters of credit; forward and futures contracts; interest rate swaps; options, interest rate caps, floors, collars and swaptions; foreign currency and exchange rate swap commitments; commodity swaps; and commitments to purchase and sell securities. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of amounts recognized in the consolidated financial statements. The Corporation's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby and commercial letters of credit is represented by the contract amount of those instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. For forward and futures contracts, interest rate swaps, options, interest rate caps, floors, collars and swaptions, the contract or notional amounts do not represent the exposure to credit loss. The Corporation controls the credit risk of its forward and futures contracts, interest rate swap agreements, foreign currency and exchange rate swaps, and securities transactions through collateral arrangements, credit approvals, limits and monitoring procedures. Our policy requires all swaps and options to be governed by an International Swaps and Derivatives Association Master Agreement. Bilateral collateral agreements are in place for substantially all dealer counterparties. Collateral for dealer transactions is delivered by either party when the credit risk associated with a particular transaction, or group of transactions to the extent netting exists, exceeds defined thresholds of credit risk. Thresholds are determined based on the strength of the individual counterparty, and they are bilateral. As of December 31, 1997, the total credit risk in excess of thresholds was $301 million. The fair value of collateral held approximated the total credit risk in excess of the thresholds. For non-dealer transactions, the need for collateral is evaluated on an individual transaction basis, and it is primarily dependent on the financial strength of the counterparty. The carrying amount of financial instruments used for interest rate risk management includes amounts for deferred gains and losses. The amount of deferred gains and losses was $13 million and $7 million, respectively, at December 31, 1997. Net gains of $3 million will increase net interest income in 1998. Net gains of $3 million in the aggregate will increase net interest income in subsequent years. Additional information related to derivative financial instruments and financial instruments held or issued for the purposes of trading activity or other than for trading can be found below and in Tables 19 through Table 21 on pages T-16 through T-21, which are incorporated herein by reference. Off-balance sheet derivative and other financial instruments and their related fair values as of December 31, 1997 and 1996, are presented below. 37
- -------------------------------------------------------------------------------------------------------------------------------- December 31, 1997 December 31, 1996 ------------------------------------ --------------------------------------- Contract Contract Estimated or Estimated or Carrying Fair Notional Carrying Fair Notional (In millions) Amount Value Amount Amount Value Amount - -------------------------------------------------------------------------------------------------------------------------------- FINANCIAL INSTRUMENTS WHOSE CONTRACT AMOUNTS REPRESENT CREDIT RISK Commitments to extend credit $ - 208 63,832 - 151 52,243 Standby and commercial letters of credit - 59 5,983 - 49 5,176 FINANCIAL INSTRUMENTS WHOSE CONTRACT OR NOTIONAL AMOUNTS EXCEED THE AMOUNT OF CREDIT RISK Forward and futures contracts Trading and dealer activities 81 81 27,690 62 62 20,740 Interest rate risk management Asset rate conversions - 1 725 - 1 57 Asset hedges - - - - 5 662 Rate sensitivity hedges - (7) 14,301 - (5) 29,612 Interest rate swap agreements Trading and dealer activities (204) (204) 42,424 (45) (45) 24,110 Interest rate risk management Asset rate conversions 4 118 11,655 3 109 20,330 Liability rate conversions 12 263 6,883 21 90 7,811 Purchased options, interest rate caps, floors, collars and swaptions Trading and dealer activities 250 250 10,615 68 68 9,781 Interest rate risk management Asset rate conversions 3 2 500 5 5 550 Liability rate conversions 1 - 250 2 - 250 Rate sensitivity hedges 33 35 3,951 8 4 12,946 Written options, interest rate caps, floors, collars and swaptions Trading and dealer activities (136) (136) 12,692 (56) (56) 9,668 Foreign currency and exchange rate swap commitments Trading and dealer activities 44 44 5,221 2 2 4,149 Foreign currency risk management - - 56 - - - Commodity swaps Trading and dealer activities - - 24 3 3 67 Commitments to purchase trading securities (1) (1) 375 (2) (2) 597 Commitments to sell trading securities $ (1) (1) 1,103 1 1 522 - --------------------------------------------------------------------------------------------------------------------------------
38 - -------------------------------------------------------------------------------- Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses, and they may require payment of a fee. Since many of the commitments are expected to expire without being drawn on, the total commitment amounts do not necessarily represent future cash requirements. Standby and commercial letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. Except for short-term guarantees of $2.9 billion, guarantees extend for more than one year, and they expire in varying amounts primarily through 2019. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Corporation holds various assets as collateral supporting those commitments for which collateral is deemed necessary. Forward and futures contracts are contracts for delayed deliveries of securities or money market instruments in which the seller agrees to make delivery at a specified future date of a specified instrument, at a specified price or yield. Risks arise from the possible inability of counterparties to meet the terms of their contracts and from movements in securities values and interest rates. The Corporation enters into a variety of interest rate contracts, including options, interest rate caps, floors, collars and swaptions written, and interest rate swap agreements, in its trading activities and in managing its interest rate exposure. Interest rate caps, floors, collars and swaptions written by the Corporation enable customers to transfer, modify or reduce their interest rate risk. Interest rate options are contracts that allow the holder of the option to purchase or sell a financial instrument at a specified price and within a specified period of time from the seller or writer of the option. As a writer of options, the Corporation receives a premium at the outset and bears the risk of an unfavorable change in the price of the financial instrument underlying the option. Interest rate swap transactions generally involve the exchange of fixed and floating rate interest payment obligations without the exchange of the underlying principal amounts. Entering into interest rate swap agreements involves not only the risk of dealing with counterparties and their ability to meet the terms of the contracts but also the interest rate risk associated with unmatched positions. Notional principal amounts often are used to express the volume of these transactions, but the amounts potentially subject to credit risk are much smaller. The Corporation also acts as an intermediary in arranging interest rate swap transactions for customers. Generally, futures contracts are exchange traded, and all other off-balance sheet instruments are transacted in the over-the-counter markets. In the normal course of business, the Corporation has entered into certain transactions that have recourse options. These recourse options, if acted on, would not have a material impact on the Corporation's financial position. Substantially all time drafts accepted by December 31, 1997, met the requirements for discount with Federal Reserve Banks. Average daily Federal Reserve Bank balance requirements for the year ended December 31, 1997, amounted to $261 million. Minimum operating lease payments due in each of the five years subsequent to December 31, 1997, are as follows (in millions): 1998, $153; 1999, $136; 2000, $122; 2001, $108; 2002, $101; and subsequent years, $661. Rental expense for all operating leases for the three years ended December 31, 1997, was $227 million, 1997; $223 million, 1996; and $202 million, 1995. The Parent Company and certain of its subsidiaries have been named as defendants in various legal actions arising from their normal business activities in which damages in various amounts are claimed. Although the amount of any ultimate liability with respect to such matters cannot be determined, in the opinion of management, based on the opinions of counsel, any such liability will not have a material impact on the Corporation's consolidated financial position. 39 - -------------------------------------------------------------------------------- NOTE 17: CARRYING AMOUNT AND FAIR VALUE OF FINANCIAL INSTRUMENTS Information about the fair value of on-balance sheet financial instruments at December 31, 1997 and 1996, which should be read in conjunction with Note 16 and certain other notes to the consolidated financial statements presented elsewhere herein, is set forth below.
December 31, 1997 December 31, 1996 ------------------------ ------------------------ Estimated Estimated Carrying Fair Carrying Fair (In millions) Amount Value Amount Value - ------------------------------------------------------------------------------------------------------------------------ FINANCIAL ASSETS Cash and cash equivalents $ 14,895 14,895 15,197 15,197 Trading account assets 5,457 5,457 4,480 4,480 Securities available for sale 21,415 21,415 16,805 16,805 Investment securities 2,175 2,322 2,501 2,636 Loans Commercial, financial and agricultural 28,046 28,119 25,928 26,239 Real estate - construction and other 2,381 2,407 2,915 2,972 Real estate - commercial mortgage 8,559 8,697 9,745 9,950 Lease financing 5,304 5,304 4,041 4,042 Foreign 1,421 1,420 1,079 1,076 Real estate - mortgage 25,364 25,773 29,098 29,461 Installment loans - Bankcard 2,708 2,751 5,620 5,669 Installment loans - other and Vehicle leasing 23,090 23,111 23,890 23,879 - ------------------------------------------------------------------------------------------------------------------------ Loans, net of unearned income 96,873 97,582 102,316 103,288 Allowance for loan losses (1,212) - (1,502) - - ------------------------------------------------------------------------------------------------------------------------ Loans, net 95,661 97,582 100,814 103,288 - ------------------------------------------------------------------------------------------------------------------------ Other assets $ 8,472 8,472 3,132 3,140 - ------------------------------------------------------------------------------------------------------------------------ LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Noninterest-bearing deposits 21,753 21,753 20,383 20,383 Interest-bearing deposits Savings and NOW accounts 30,118 30,118 28,869 28,869 Money market accounts 15,494 15,494 14,899 14,899 Other consumer time 29,231 29,648 33,541 33,983 Foreign 2,483 2,483 1,897 1,897 Other time 3,810 3,835 3,113 3,129 - ------------------------------------------------------------------------------------------------------------------------ Total deposits 102,889 103,331 102,702 103,160 Short-term borrowings 27,357 27,357 24,987 24,987 Other liabilities 3,690 3,690 2,779 2,779 Long-term debt 8,042 8,322 8,060 8,195 Guaranteed preferred beneficial interests in Corporation's junior subordinated deferrable interest debentures $ 991 1,064 495 500 - ------------------------------------------------------------------------------------------------------------------------
40 - -------------------------------------------------------------------------------- Estimated fair values for the commercial loan portfolio were based on weighted average discount rates ranging from 6.62 percent to 7.58 percent and 7.34 percent to 7.68 percent at December 31, 1997 and 1996, respectively, and for the retail portfolio from 8.05 percent to 14.71 percent and 8.35 percent to 14.14 percent, respectively. The fair value of noninterest-bearing deposits, savings and NOW accounts, and money market accounts is the amount payable on demand at December 31, 1997 and 1996. The fair value of fixed-maturity certificates of deposit is estimated based on the discounted value of contractual cash flows using the rates currently offered for deposits of similar remaining maturities. The fair value estimates above do not include the benefit that results from the low-cost funding provided by deposit liabilities compared to the cost of borrowing funds in the market. Fair value estimates are based on existing financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, the Corporation has a substantial trust department, which includes mutual fund activities, that contributes net fee income annually. The trust department is not considered a financial instrument, and its value has not been incorporated into fair value estimates. Other significant assets and liabilities that are not considered financial assets or liabilities include the mortgage banking operation, brokerage network, deferred tax assets, premises and equipment, and goodwill. In addition, tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates, and they have not been considered in any of the estimates. The fair value of off-balance sheet derivative financial instruments has not been considered in determining on-balance sheet fair value estimates. 41 - -------------------------------------------------------------------------------- NOTE 18: FIRST UNION CORPORATION (PARENT COMPANY) The Parent Company's principal assets are its investments in its subsidiaries, interest-bearing balances with bank subsidiaries, securities purchased under resale agreements, securities available for sale and loans to subsidiaries. The significant sources of income of the Parent Company are dividends from its subsidiary bank holding companies, interest and fees charged on loans made to its subsidiaries, interest on eurodollars purchased from bank subsidiaries, interest on securities available for sale and fees charged to its subsidiaries for providing various services. In addition, the Parent Company serves as the primary source of funding for the mortgage banking and other activities of its nonbank subsidiaries, including First Union Capital Markets Corp. Lines of credit in the aggregate amount of $350 million are available to the Parent Company at an annual facility fee of 8.00 basis points to 18.75 basis points and a utilization fee of 6.25 basis points. The facility fee is based on the daily average commitment amount, and the utilization fee is based on the daily average principal amount outstanding. Generally, interest rates will be determined when credit line usage occurs, and they will vary based on the type of loan extended to the Parent Company. The lines of credit expire in December 1998. Certain regulatory and other requirements restrict the (i) lending of funds by the bank subsidiaries to the Parent Company and to the Parent Company's nonbank subsidiaries, and (ii) amount of dividends that can be paid to the Parent Company by the bank subsidiaries and certain of the Parent Company's other subsidiaries. On December 31, 1997, the Parent Company was indebted to subsidiary banks in the amount of $375 million that, under the terms of revolving credit agreements, was collateralized by certain interest-bearing balances, securities available for sale, loans, premises and equipment and was payable on demand. On such date, a subsidiary bank had loans outstanding to Parent Company nonbank subsidiaries in the amount of $139 million that, under the terms of a revolving credit agreement, were collateralized by securities available for sale and certain loans and were payable on demand. Industry regulators limit dividends that can be paid by the Corporation's subsidiaries. National banks are limited in their ability to pay dividends in two principal ways. First, dividends cannot exceed the bank's undivided profits, less statutory bad debt in excess of the bank's allowance for loan losses; and second, in any year, dividends may not exceed a bank's net profits for that year, plus its retained earnings from the preceding two years, less any required transfers to surplus. The Parent Company's subsidiaries, including its bank subsidiaries, had available retained earnings of $426 million at December 31, 1997, for the payment of dividends to the Parent Company without such regulatory or other restrictions. Subsidiary net assets of $10.7 billion were restricted from being transferred to the Parent Company at December 31, 1997, under such regulatory or other restrictions. Dividends from subsidiaries includes $835 million in equity transfers to the Parent Company related to internal bank consolidations in 1997. At both December 31, 1997 and 1996, the estimated fair value of the Parent Company's loans was $2.7 billion. See Note 11 for information related to the Parent Company's junior subordinated deferrable interest debentures. The Parent Company's condensed balance sheets as of December 31, 1997 and 1996, and the related condensed statements of income and cash flows for the three-year period ended December 31, 1997, are presented below. The condensed financial statements of the Parent Company as of December 31, 1996, and for the two-year period then ended reflect the November 28, 1997, merger of Signet's parent company into the Parent Company on a net basis within the investment in wholly owned subsidiaries and equity in undistributed net income of subsidiaries line classifications, as appropriate. 42
- -------------------------------------------------------------------------------------------------------------------- CONDENSED BALANCE SHEETS December 31, ---------------------- (In millions) 1997 1996 - -------------------------------------------------------------------------------------------------------------------- ASSETS Interest-bearing balances with bank subsidiary $ 4,215 2,160 Securities purchased under resale agreements 381 306 - -------------------------------------------------------------------------------------------------------------------- Total cash and cash equivalents 4,596 2,466 - -------------------------------------------------------------------------------------------------------------------- Securities available for sale (amortized cost $436 in 1997; $256 in 1996) 437 265 Investment securities 28 - Loans, net of unearned income ($1 in 1997 and $1 in 1996) 154 108 Allowance for loan losses - (1) - -------------------------------------------------------------------------------------------------------------------- Loans, net 154 107 - -------------------------------------------------------------------------------------------------------------------- Loans due from subsidiaries Banks 1,835 1,785 Bank holding companies 174 311 Other subsidiaries 494 512 Investments in wholly owned subsidiaries Arising from investments in equity in undistributed net income of subsidiaries Banks 9,125 6,168 Bank holding companies 2,357 5,288 Other subsidiaries 619 513 - -------------------------------------------------------------------------------------------------------------------- 12,101 11,969 Arising from purchase acquisitions 101 93 - -------------------------------------------------------------------------------------------------------------------- Total investments in wholly owned subsidiaries 12,202 12,062 - -------------------------------------------------------------------------------------------------------------------- Other assets 585 416 - -------------------------------------------------------------------------------------------------------------------- Total $ 20,505 17,924 - -------------------------------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Deposits 1 - Commercial paper 871 1,021 Other short-term borrowings with affiliates 755 651 Other liabilities 704 203 Long-term debt 5,121 4,607 Junior subordinated deferrable interest debentures 1,021 510 - -------------------------------------------------------------------------------------------------------------------- Total liabilities 8,473 6,992 Stockholders' equity 12,032 10,932 - -------------------------------------------------------------------------------------------------------------------- Total $ 20,505 17,924 - --------------------------------------------------------------------------------------------------------------------
43
- -------------------------------------------------------------------------------------------------------------------- CONDENSED STATEMENTS OF INCOME Years Ended December 31, ---------------------------------- (In millions) 1997 1996 1995 - -------------------------------------------------------------------------------------------------------------------- INTEREST INCOME Interest and fees on loans $ 177 158 134 Interest and dividends on securities available for sale 26 8 4 Interest and dividends on investment securities 3 - - Other interest income from subsidiaries 172 73 84 - -------------------------------------------------------------------------------------------------------------------- Total interest income 378 239 222 - -------------------------------------------------------------------------------------------------------------------- INTEREST EXPENSE Interest on short-term borrowings 82 68 71 Interest on long-term debt 416 278 234 - -------------------------------------------------------------------------------------------------------------------- Total interest expense 498 346 305 - -------------------------------------------------------------------------------------------------------------------- Net interest income (120) (107) (83) Provision for loan losses (1) - - - -------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses (119) (107) (83) - -------------------------------------------------------------------------------------------------------------------- NONINTEREST INCOME Dividends from subsidiaries Banks 1,601 610 508 Bank holding companies 452 1,693 275 Other subsidiaries 25 15 10 Securities available for sale transactions 6 - 10 Investment security transactions 3 - - Sundry income 537 362 320 - -------------------------------------------------------------------------------------------------------------------- Total noninterest income 2,624 2,680 1,123 - -------------------------------------------------------------------------------------------------------------------- NONINTEREST EXPENSE 468 316 279 - -------------------------------------------------------------------------------------------------------------------- Income before income taxes (benefits) and equity in undistributed net income of subsidiaries 2,037 2,257 761 Income taxes (benefits) 20 (18) (14) - -------------------------------------------------------------------------------------------------------------------- Income before equity in undistributed net income of subsidiaries 2,017 2,275 775 Equity in undistributed net income of subsidiaries (121) (651) 766 - -------------------------------------------------------------------------------------------------------------------- Net income 1,896 1,624 1,541 Dividends on preferred stock - 9 26 - -------------------------------------------------------------------------------------------------------------------- Net income applicable to common stockholders $ 1,896 1,615 1,515 - --------------------------------------------------------------------------------------------------------------------
44
- -------------------------------------------------------------------------------------------------------------------- CONDENSED STATEMENTS OF CASH FLOWS Years Ended December 31, ---------------------------------- (In millions) 1997 1996 1995 - -------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES Net income $ 1,896 1,499 1,430 Adjustments to reconcile net income to net cash provided (used) by operating activities Equity in undistributed net income of subsidiaries 121 776 (655) Accretion and revaluation losses on securities available for sale 2 1 (4) Provision for loan losses (1) - - Securities available for sale transactions (6) - (10) Investment security transactions (3) - - Depreciation and amortization 13 10 6 Deferred income taxes (benefits) (48) 5 1 Other assets, net (114) 130 (294) Other liabilities, net 497 (82) 1 - -------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 2,357 2,339 475 - -------------------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES Increase (decrease) in cash realized from Sales of securities available for sale 161 104 99 Purchases of securities available for sale (335) (171) (125) Sales of investment securities 18 - - Purchases of investment securities (43) - - Advances to subsidiaries, net 105 (328) (595) Investments in subsidiaries 6 (851) 363 Longer-term loans originated or acquired (382) (244) (101) Principal repaid on longer-term loans 336 212 97 Purchases of premises and equipment, net (18) (26) (7) - -------------------------------------------------------------------------------------------------------------------- Net cash used by investing activities (152) (1,304) (269) - -------------------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES Increase (decrease) in cash realized from Deposits 1 - - Commercial paper (150) 79 546 Other short-term borrowings, net 104 190 161 Issuance of junior subordinated deferrable interest debentures 511 510 - Issuances of long-term debt 525 852 1,292 Payments of long-term debt (15) (287) (272) Sales of common stock 722 279 249 Purchases of preferred stock - - (7) Redemption of preferred stock - (109) - Purchases of common stock (1,024) (968) (1,199) Cash dividends paid (749) (620) (529) - -------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by financing activities (75) (74) 241 - -------------------------------------------------------------------------------------------------------------------- Increase in cash and cash equivalents 2,130 961 447 Cash and cash equivalents, beginning of year 2,466 1,505 1,058 - -------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of year $ 4,596 2,466 1,505 - -------------------------------------------------------------------------------------------------------------------- CASH PAID FOR Interest $ 436 321 288 Income taxes 200 225 338 NONCASH ITEMS Increase in investments in subsidiaries as a result of acquisitions of institutions for common stock 3 1,008 611 Assumption of long-term debt of liquidated affiliate - - 74 Effect on stockholders' equity of an unrealized gain (loss) on debt and equity securities included in Parent Company Securities available for sale (8) (60) 27 Other liabilities 4 3 24 Parent Company subsidiaries Securities available for sale 397 (153) 458 Other assets $ 133 (92) 136 - --------------------------------------------------------------------------------------------------------------------
45 FINANCIAL TABLES
Table 6 SELECTED QUARTERLY DATA - -------------------------------------------------------------------------------------------------------------------------- 1997 1996 ------------------------------------------------------------------------------------------- (In millions, except per share data) Fourth Third Second First Fourth Third Second First - -------------------------------------------------------------------------------------------------------------------------- Interest income $ 2,746 2,791 2,771 2,625 2,648 2,634 2,637 2,541 Interest expense 1,330 1,328 1,311 1,221 1,276 1,251 1,256 1,212 - -------------------------------------------------------------------------------------------------------------------------- Net interest income 1,416 1,463 1,460 1,404 1,372 1,383 1,381 1,329 Provision for loan losses 325 175 178 162 150 124 94 81 - -------------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 1,091 1,288 1,282 1,242 1,222 1,259 1,287 1,248 Securities available for sale transactions 12 10 5 4 16 2 3 15 Investment security transactions - 2 1 - 1 - 2 1 Noninterest income 905 835 809 813 757 667 605 567 Merger-related and restructuring charges (a) 210 - 59 - - - - 281 SAIF special assessment (b) - - - - - 135 - - Noninterest expense 1,450 1,292 1,295 1,283 1,238 1,199 1,173 1,127 - -------------------------------------------------------------------------------------------------------------------------- Income before income taxes (benefits) 348 843 743 776 758 594 724 423 Income taxes (benefits) (14) 296 260 272 264 208 254 149 - -------------------------------------------------------------------------------------------------------------------------- Net income 362 547 483 504 494 386 470 274 Dividends on preferred stock - - - - 1 1 3 4 - -------------------------------------------------------------------------------------------------------------------------- Net income applicable to common stockholders $ 362 547 483 504 493 385 467 270 - -------------------------------------------------------------------------------------------------------------------------- PER COMMON SHARE DATA Basic earnings $ 0.57 0.88 0.78 0.80 0.80 0.63 0.75 0.43 Diluted earnings 0.56 0.87 0.77 0.79 0.79 0.62 0.74 0.43 Cash dividends 0.32 0.32 0.29 0.29 0.29 0.29 0.26 0.26 Common stock price High 52 7/8 50 11/16 47 7/8 47 3/4 38 1/2 33 7/8 32 1/4 31 3/8 Low 46 15/16 45 7/8 39 1/8 36 5/8 33 1/2 30 1/2 28 3/4 25 3/4 Period-end $ 51 1/4 50 1/16 46 1/4 40 1/2 37 33 3/8 30 3/8 30 1/8 - -------------------------------------------------------------------------------------------------------------------------- SELECTED RATIOS (c) After merger-related and restructuring charges and SAIF special assessment Return on assets (d) 0.94 % 1.43 1.28 1.40 1.33 1.06 1.28 0.78 Return on common stockholders' equity (e) 12.29 19.63 18.09 19.15 19.23 15.70 18.73 11.14 Stockholders' equity to assets 7.77 % 7.38 7.03 7.27 6.93 6.71 6.81 7.10 - -------------------------------------------------------------------------------------------------------------------------- SELECTED RATIOS (c) Before merger-related and restructuring charges and SAIF special assessment Return on assets (d) 1.35 % 1.43 1.38 1.40 1.33 1.30 1.28 1.29 Return on common stockholders' equity (e) 17.53 % 19.56 19.47 19.15 18.61 18.73 18.26 18.38 - -------------------------------------------------------------------------------------------------------------------------- (a) Merger-related restructuring charges amounted to $194 million after tax in 1997 and $181 million after tax in 1996. (b) The SAIF special assessment amounted to $87 million after tax in 1996. (c) Based on average balances. (d) Based on net income. (e) Based on net income applicable to common stockholders, excluding average net unrealized gains or losses on debt and equity securities.
46 MANAGEMENT'S ANALYSIS OF OPERATIONS STOCKHOLDERS' EQUITY; Regulatory Capital Page 22 - -------------------------------------------------------------------------------- Federal banking regulations require that bank holding companies and their subsidiary banks maintain minimum levels of capital. These banking regulations measure capital using three formulas including tier 1 capital, total capital and leverage capital. The minimum level for the ratio of total capital to risk-weighted assets (including certain off-balance sheet financial instruments, such as standby letters of credit and interest rate swaps) is currently 8 percent. At least half of total capital is to be composed of common equity, retained earnings and a limited amount of qualifying preferred stock, less certain intangible assets (tier 1 capital). The rest may consist of a limited amount of subordinated debt, nonqualifying preferred stock and a limited amount of the loan loss allowance (together with tier 1 capital, total capital). At December 31, 1997, the tier 1 and total capital ratios were 8.41 percent and 13.40 percent, respectively, compared with 7.33 percent and 12.33 percent at December 31, 1996. Amounts prior to 1997 are not restated for the Signet acquisition. In addition the Federal Reserve Board has established minimum leverage ratio requirements for bank holding companies. These requirements provide for a minimum leverage ratio of tier 1 capital to adjusted average quarterly assets equal to 3 percent for bank holding companies that meet specified criteria, including having the highest regulatory rating. All other bank holding companies are generally required to maintain a leverage ratio of at least 4 to 5 percent. The leverage ratio at December 31, 1997, was 6.81 percent and at December 31, 1996, it was an unrestated 6.13 percent. The requirements also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. The Federal Reserve Board has indicated it will continue to consider a tangible tier 1 leverage ratio (deducting all intangibles) in evaluating proposals for expansion or new activity. The Federal Reserve Board has not advised us of any specific minimum leverage ratio applicable to us. Each subsidiary bank is subject to similar capital requirements. None of our subsidiary banks has been advised of any specific minimum capital ratios applicable to it. The regulatory agencies also have adopted regulations establishing capital tiers for banks. Banks in the highest capital tier, or well capitalized, must have a leverage ratio of 5 percent, a tier 1 capital ratio of 6 percent and a total capital ratio of 10 percent. At December 31, 1997, our deposit-taking subsidiary banks met the capital and leverage ratio requirements for well capitalized banks. We expect to maintain these ratios at the required levels by the retention of earnings and, if necessary, the issuance of additional capital. Failure to meet certain capital ratio or leverage ratio requirements could subject a bank to a variety of enforcement remedies, including termination of deposit insurance by the FDIC. First Union Home Equity Bank, N.A., First Union Trust Company, N.A., and First Union Direct Bank, N.A., are not deposit-taking banks. Table 18 CAPITAL RATIOS
- ------------------------------------------------------------------------------------------------------------------------ Years Ended December 31, ----------------------------------------------------------------------- (In millions) 1997 1996 1995 1994 1993 1992 - ------------------------------------------------------------------------------------------------------------------------ CONSOLIDATED CAPITAL RATIOS (a) Qualifying capital Tier 1 capital $ 10,215 7,633 6,551 4,467 4,343 3,189 Total capital 16,279 12,842 11,198 7,451 6,961 4,948 Adjusted risk-based assets 121,503 104,126 97,830 57,594 47,529 34,574 Adjusted leverage ratio assets $ 149,921 124,419 119,421 73,011 70,786 48,672 Ratios Tier 1 capital 8.41 % 7.33 6.70 7.76 9.14 9.22 Total capital 13.40 12.33 11.45 12.94 14.64 14.31 Leverage 6.81 6.13 5.49 6.12 6.13 6.55 Stockholders' equity to assets Year-end 7.65 7.14 6.86 6.98 7.36 6.99 Average 7.37 % 6.82 7.23 7.52 7.11 6.89 - ------------------------------------------------------------------------------------------------------------------------ BANK CAPITAL RATIOS (b) Tier 1 capital First Union National Bank (North Carolina) 6.97 % 6.43 6.46 7.32 8.24 7.22 First Union National Bank (New Jersey) 10.70 8.98 9.16 - - - First Union Bank of Delaware 11.83 13.61 25.45 - - - First Union Home Equity Bank 10.95 8.40 7.50 7.60 - - Total capital First Union National Bank (North Carolina) 10.20 10.20 10.15 10.69 11.35 10.60 First Union National Bank (New Jersey) 13.99 12.22 10.95 - - - First Union Bank of Delaware 13.09 14.87 26.74 - - - First Union Home Equity Bank 13.20 10.77 10.09 12.10 - - Leverage First Union National Bank (North Carolina) 6.02 5.95 5.72 6.10 5.52 5.46 First Union National Bank (New Jersey) 7.06 7.06 7.43 - - - First Union Bank of Delaware 6.24 10.60 17.20 - - - First Union Home Equity Bank 10.16 % 7.84 6.48 7.22 - - - ------------------------------------------------------------------------------------------------------------------------
(a) Risk-based capital ratio guidelines require a minimum ratio of tier 1 capital to risk-weighted assets of 4.00 percent and a minimum ratio of total capital to risk-weighted assets of 8.00 percent. The minimum leverage ratio of tier 1 capital to adjusted average quarterly assets is from 3.00 to 5.00 percent. The 1992-1996 capital ratios presented herein have not been restated to reflect the Signet pooling of interests acquisition. (b) By the end of 1997, all First Union bank affiliates were merged into First Union National Bank (North Carolina), except those included herein. Accordingly, historical information related to such affiliates is not presented, and historical ratios for First Union National Bank (North Carolina) are not restated. On February 26, 1998, First Union National Bank (New Jersey) and First Union National Bank (North Carolina) were combined. The combined banks will operate as First Union National Bank. 47 FINANCIAL TABLES
Table 19 OFF-BALANCE SHEET DERIVATIVE FINANCIAL INSTRUMENTS (a) - ---------------------------------------------------------------------------------------------------------------------- Weighted Average Rate Estimated ---------- ------- ----------------- Maturity December 31, 1997 Notional In Fair (In millions) Amount Receive Pay Years (b) Value Comments - ---------------------------------------------------------------------------------------------------------------------- ASSET RATE CONVERSIONS Interest rate swaps $ 11,655 6.46 % 5.87 % 3.59 Converts floating rate loans to fixed Carrying amount $ 4 rate. Adds to liability sensitivity. Unrealized gross gain 121 Similar characteristics to a fixed Unrealized gross loss (7) income security funded with variable rate liabilities. Includes $1.4 billion of callable swaps expected to mature in December 1999 if swap rates are below 6.99 percent. -------- Total 118 -------- Forward interest rate swaps 725 6.20 - 2.97 Converts floating rate loans to fixed Carrying amount - rates in future periods. Effective Unrealized gross gain 1 December 1998 with put options on Unrealized gross loss _ forward swaps referenced under "Rate Sensitivity Hedges" linked to -------- this item. Total 1 -------- Interest rate floors 500 6.07 5.84 1.19 Paid a premium to convert floating Carrying amount 3 rate loans to fixed rate when 3 Unrealized gross gain _ month LIBOR is below an average Unrealized gross loss (1) of 6.07 percent. -------- Total 2 - ----------------------------------------- -------- Total asset rate conversions $ 12,880 6.43 % 5.86 % 3.46 $ 121 - --------------------------------------------------------------------------------- LIABILITY RATE CONVERSIONS - Interest rate swaps $ 6,883 7.05 % 5.93 % 9.37 Converts $4.6 billion of fixed rate Carrying amount $ 12 long-term debt to floating rate by Unrealized gross gain 258 matching the terms of the swap Unrealized gross loss (7) to the debt issue. Also converts $648 million of fixed rate CDs to variable rate, $650 million of fixed rate bank notes to floating rate and $1 billion of fixed rate trust capital securities to variable rate. Total 263 -------- Interest rate floors 250 4.43 - 3.45 $250 million floor offsets a Carrying amount 1 corresponding rate purchased floor Unrealized gross gain - in long-term debt. Unrealized gross loss (1) -------- Total - - ----------------------------------------- -------- Total liability rate conversions $ 7,133 6.96 % 5.93 % 9.17 $ 263 - --------------------------------------------------------------------------------- (Continued)
48 FINANCIAL TABLES
Table 19 OFF-BALANCE SHEET DERIVATIVE FINANCIAL INSTRUMENTS (a) - ---------------------------------------------------------------------------------------------------------------------- Weighted Average Rate Estimated ------------------- ------------------ Maturity December 31, 1997 Notional In Fair (In millions) Amount Receive Pay Years (b) Value Comments - ------------------------------------------------------------------------------------------------------------------------ RATE SENSITIVITY HEDGES Put options on forward swaps$ 725 -% 6.20 % 0.95 Paid a premium for the right to Carrying amount $ 5 terminate $725 million of forward Unrealized gross gain interest rate swaps based on Unrealized gross loss interest rates in effect in December -------- 1998. Reduces liability sensitivity. Total 5 -------- Interest rate caps (LIBOR) 158 5.88 7.03 1.86 Paid a premium for the right to lock Carrying amount 1 in 3 month LIBOR reset rates on Unrealized gross gain - pay variable rate swaps. Unrealized gross loss (1) -------- Total - -------- Interest rate caps (CMT) 2,200 - 5.70 3.96 Paid a premium for the right to lock Carrying amount 26 in 1 year Treasury rates for the Unrealized gross gain - purpose of converting floating rate Unrealized gross loss - liabilities to fixed rate. -------- Total 26 -------- Short eurodollar futures 12,301 - 6.13 0.42 Locks in 3 month LIBOR reset rates Carrying amount - on pay variable rate swaps. $4.8 Unrealized gross gain - billion effective March 1998 and Unrealized gross loss (10) June 1998 and $2.8 billion effective -------- September 1998. Total (10) -------- Short Deutschemark futures 56 - 3.94 0.21 Locks in 3 month Deutschemark Carrying amount - funding levels in March 1998 for a Unrealized gross gain - portion of the German bonds in the Unrealized gross loss - foreign bond portfolio. -------- Total - -------- Long eurodollar futures 2,000 6.62 - 1.33 Converts floating rate LIBOR-based Carrying amount - loans to fixed rate. Adds to liability Unrealized gross gain 3 sensitivity. Similar characteristics to Unrealized gross loss - fixed income security funded with variable rate liabilities. $500 million effective December 1998, March 1999, June 1999 and September 1,999 -------- Total 3 -------- Call Options on eurodollar futures 768 6.79 - 0.46 Paid a premium for the right to buy Carrying amount - Eurodollar futures that convert Unrealized gross gain 2 floating rate LIBOR-based loans to Unrealized gross loss - fixed rate. Interest rate risk limited to premium paid. $256 million effective March 1998, June 1998 and September 1998. -------- Total 2 -------- CMT Floor 100 6.42 5.84 3.34 First Union Mortgage Corporation Carrying amount 1 paid a premium for a CMT floor in Unrealized gross gain 1 order to offset the decline in value Unrealized gross loss - of mortgage servicing in a falling rate environment. -------- Total 2 - ----------------------------------------- -------- Total rate sensitivity hedges $ 18,308 6.61 % 6.07 % 1.00 $ 28 - ---------------------------------------------------------------------------------- (a) Includes only off-balance sheet derivative financial instruments related to interest rate risk management activities. (b) Estimated maturity approximates average life except for eurodollar futures, average life of .25 years. London Interbank Offered Rates (LIBOR) - The average of interbank offered rates on dollar deposits in the London market, based on quotations at five major banks. Weighted average pay rates are generally based on one to six month LIBOR. Pay rates reset at predetermined reset dates over the life of the contract. Rates shown are the pay rates in effect as of December 31, 1997. Weighted average receive rates are fixed rates set at the time the contract was transacted. Carrying amount includes accrued interest receivable/payable and unamortized premiums paid/received. (Continued)
49 FINANCIAL TABLES
Table 19 OFF-BALANCE SHEET DERIVATIVE FINANCIAL INSTRUMENTS (a) - ---------------------------------------------------------------------------------------------------------------------- Weighted Average Rate Estimated ----------------- ----------------- Maturity December 31, 1996 Notional In Fair (In millions) Amount Receive Pay Years (b) Value Comments - ------------------------------------------------------------------------------------------------------------------------ ASSET RATE CONVERSIONS Interest rate swaps $ 20,330 6.24 % 5.52 % 1.89 Converts floating rate loans to fixed Carrying amount $ 3 rate. Adds to liability sensitivity. Unrealized gross gain 129 Similar characteristics to a fixed Unrealized gross loss (23) income security funded with variable rate liabilities. Includes $4.8 billion of indexed amortizing swaps, with $1.3 billion maturing within 1 year and $3.5 billion within 4 years. -------- Total 109 -------- Interest rate floors 550 5.98 5.50 1.96 Paid a premium to convert floating Carrying amount 5 rate loans to fixed rate when 3 Unrealized gross gain - month LIBOR is below 6.00 Unrealized gross loss - percent (approximately). Total 5 -------- Forward bullet interest rate swaps 57 7.83 - 1.21 Converts floating rate loans to fixed Carrying amount - rates in future periods. Effective Unrealized gross gain 1 March 1997. Unrealized gross loss - -------- Total 1 - ----------------------------------------- -------- Total asset rate conversions $ 20,937 6.24 % 5.50 % 1.89 $ 115 - ---------------------------------------------------------------------------------- LIABILITY RATE CONVERSIONS Interest rate swaps $ 7,811 6.81 % 5.68 % 5.57 - Converts $4.2 billion of fixed rate Carrying amount $ 21 long-term debt to floating rate by Unrealized gross gain 122 matching the terms of the swap Unrealized gross loss (53) to the debt issue. Rate sensitivity remains unchanged due to the direct linkage of the swap to the debt issue. Also converts $2.6 billion of fixed rate CDs to variable rate and $1.1 billion of fixed rate bank notes to floating rate. -------- Total 90 -------- Other financial instruments 250 4.42 - 4.45 $150 million floor offsets a Carrying amount 2 corresponding rate floor in long- Unrealized gross gain - term debt. Unrealized gross loss (2) -------- Total - - ----------------------------------------- -------- Total liability rate conversions $ 8,061 6.74 % 5.50 % 5.54 $ 90 - ---------------------------------------------------------------------------------- ASSET HEDGES Forward sale of Treasury notes$ 662 - % 5.74 % 0.03 Sold U.S. Treasury notes forward to Carrying amount $ - hedge the market value of similar Unrealized gross gain 5 U.S. Treasury notes in the available Unrealized gross loss - for sale portfolio. Total 5 - ----------------------------------------- -------- Total asset hedges $ 662 - % 5.74 % 0.03 $ 5 - ---------------------------------------------------------------------------------- (Continued)
50 FINANCIAL TABLES
Table 19 OFF-BALANCE SHEET DERIVATIVE FINANCIAL INSTRUMENTS (a) - ---------------------------------------------------------------------------------------------------------------------- Weighted Average Rate Estimated ------------------ ------------------ Maturity December 31, 1996 Notional In Fair (In millions) Amount Receive Pay Years (b) Value Comments - ---------------------------------------------------------------------------------------------------------------------- RATE SENSITIVITY HEDGES Put options on eurodollar futures $ 12,678 - % 6.37 % 0.31 Paid a premium for the right to lock Carrying amount $ 6 in the 3 month LIBOR reset rates on Unrealized gross gain - pay variable rate swaps. $7.6 billion Unrealized gross loss (5) effective March 1997; $5.1 billion effective June 1997. -------- Total 1 -------- Interest rate caps 168 5.54 7.03 2.70 Paid a premium for the right to lock Carrying amount 1 in 3 month LIBOR reset rates on Unrealized gross gain - pay variable rate swaps. Unrealized gross loss - -------- Total 1 -------- Short futures 15,062 - 5.84 0.22 Locks in 3 month LIBOR reset rates Carrying amount - on pay variable rate swaps. $15.0 Unrealized gross gain - billion effective March 1997; Unrealized gross loss (11) $89 million effective June 1997. -------- Total (11) -------- CMT floor 100 6.42 6.37 4.34 First Union Mortgage Corporation Carrying amount 1 paid a premium for a CMT floor in Unrealized gross gain 1 order to offset the decline in value of Unrealized gross loss - mortgage servicing in a falling rate environment. -------- Total 2 -------- Long eurodollar futures 14,550 6.29 - 1.28 Converts floating rate LIBOR-based Carrying amount - loans to fixed rate. Adds to liability Unrealized gross gain 8 sensitivity. Similar characteristics to Unrealized gross loss (2) fixed income security funded with variable rate liabilities. $4.6 billion effective September 1997; $2.0 billion effective December 1997, March 1998, June 1998 and September 1998; $500 million effective December 1998, March 1999, June 1999 and September 1999. -------- Total 6 - ----------------------------------------- -------- Total rate sensitivity hedges $ 42,558 6.28 % 6.09 % 0.63 $ (1) - ---------------------------------------------------------------------------------- (a) Includes only off-balance sheet derivative financial instruments related to interest rate risk management activities. (b) Estimated maturity approximates duration except for forward bullets, average duration of 1.0 years; and long eurodollar futures, average duration of .25 years. London Interbank Offered Rates (LIBOR) - The average of interbank offered rates on dollar deposits in the London market, based on quotations at five major banks. Weighted average pay rates are generally based on one to six month LIBOR. Pay rates related to forward interest rate swaps are set on the future effective date. Pay rates reset at predetermined reset dates over the life of the contract. Rates shown are the rates in effect as of December 31, 1996. Weighted average receive rates were set at the time the contract was transacted. Carrying amount includes accrued interest receivable/payable, unamortized premiums paid/received and any related margin accounts.
51 FINANCIAL TABLES
Table 20 OFF-BALANCE SHEET DERIVATIVES - EXPECTED MATURITIES (a) - -------------------------------------------------------------------------------------------------------------------------- December 31, 1997 1 Year 1-2 2-5 5-10 After 10 (In millions) or Less Years Years Years Years Total - -------------------------------------------------------------------------------------------------------------------------- ASSET RATE CONVERSIONS Notional amount $ 1,072 601 8,429 2,778 - 12,880 Weighted average receive rate 5.44 % 5.96 6.59 6.41 - 6.43 Estimated fair value $ (6) 1 116 10 - 121 - -------------------------------------------------------------------------------------------------------------------------- LIABILITY RATE CONVERSIONS Notional amount $ 953 338 954 3,300 1,588 7,133 Weighted average receive rate 6.01 % 7.83 7.41 6.82 7.35 6.96 Estimated fair value $ 1 10 45 123 84 263 - -------------------------------------------------------------------------------------------------------------------------- RATE SENSITIVITY HEDGES Notional amount $ 13,680 1,560 3,068 - - 18,308 Weighted average receive rate 6.66 % 6.60 6.26 - - 6.61 Estimated fair value $ (7) 3 32 - - 28 - -------------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------------- December 31, 1996 1 Year 1-2 2-5 5-10 After 10 (In millions) or Less Years Years Years Years Total - -------------------------------------------------------------------------------------------------------------------------- ASSET RATE CONVERSIONS Notional amount $ 11,083 1,532 8,322 - - 20,937 Weighted average receive rate 6.12 % 5.28 6.57 - - 6.24 Estimated fair value $ 34 (21) 102 - - 115 - -------------------------------------------------------------------------------------------------------------------------- LIABILITY RATE CONVERSIONS Notional amount $ 1,370 1,414 767 3,950 560 8,061 Weighted average receive rate 6.59 % 5.98 7.44 6.93 6.74 6.74 Estimated fair value $ 11 5 30 58 (14) 90 - -------------------------------------------------------------------------------------------------------------------------- ASSET HEDGES Notional amount $ 662 - - - - 662 Weighted average receive rate - % - - - - - Estimated fair value $ 5 - - - - 5 - -------------------------------------------------------------------------------------------------------------------------- RATE SENSITIVITY HEDGES Notional amount $ 34,300 6,555 1,703 - - 42,558 Weighted average receive rate 5.90 % 6.58 6.55 - - 6.28 Estimated fair value $ (10) 6 3 - - (1) - -------------------------------------------------------------------------------------------------------------------------- (a) Includes only off-balance sheet derivative financial instruments related to interest rate risk management activities. Pay rates are generally based on one to six month LIBOR and reset at predetermined reset dates. Current pay rates are not necessarily indicative of future pay rates, and therefore, they have been excluded from the above table. Weighted average pay rates are indicated in Table 19.
52 FINANCIAL TABLES
Table 21 OFF-BALANCE SHEET DERIVATIVES ACTIVITY (a) - --------------------------------------------------------------------------------------------------------------------- Asset Liability Rate Rate Rate Asset Sensitivity (In millions) Conversions Conversions Hedges Hedges Total - --------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1995 $ 18,543 7,432 1,016 29,674 56,665 Additions 7,740 2,583 662 80,229 91,214 Maturities/Amortizations (5,241) (1,954) (697) (41,023) (48,915) Terminations (105) - (319) (26,322) (26,746) - --------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1996 20,937 8,061 662 42,558 72,218 Additions 3,694 1,628 - 41,480 46,802 Maturities/Amortizations (11,251) (1,725) (662) (51,744) (65,382) Terminations (500) (831) - (13,986) (15,317) - --------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1997 $ 12,880 7,133 - 18,308 38,321 - --------------------------------------------------------------------------------------------------------------------- (a) Includes only off-balance sheet derivative financial instruments related to interest rate risk management activities.
53 EX-99.D 8 INDEPENDENT AUDITORS' REPORT OF KPMG PEAT MARWICK LLP Exhibit 99(d) Independent Auditors' Report ---------------------------- The Board of Directors Meridian Bancorp, Inc.: We have audited the accompanying consolidated balance sheet of Meridian Bancorp, Inc. and subsidiaries as of December 31, 1995, and the related consolidated statements of income, changes in shareholders' equity and cash flows for the year ended December 31, 1995. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Meridian Bancorp, Inc. and subsidiaries as of December 31, 1995 and the results of their operations and their cash flows for the year ended December 31, 1995, in conformity with generally accepted accounting principles. Philadelphia, PA January 17, 1996, Except as to note 2, which is as of February 23, 1996 /s/ KPMG Peat Marwick LLP EX-99.E 9 INDEPENDENT AUDITORS' REPORT OF KPMG PEAT MARWICK LLP EXHIBIT (99)(e) INDEPENDENT AUDITORS' REPORT - -------------------------------------------------------------------------------- The Board of Directors and Stockholders United Counties Bancorporation We have audited the accompanying consolidated balance sheet of United Counties Bancorporation and subsidiaries as of December 31, 1995, and the related consolidated statements of income, changes in shareholders' equity and cash flows for the year ended December 31, 1995. These consolidated financial statements are the responsibility of the Bancorporation's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of United Counties Bancorporation and subsidiaries at December 31, 1995 and the results of their operations and their cash flows for the year ended December 31, 1995 in conformity with generally accepted accounting principles. Short Hills, New Jersey January 16, 1996, except for note 20, which is as of February 23, 1996 /s/ KPMG Peat Marwick LLP -----END PRIVACY-ENHANCED MESSAGE-----