1
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 1-15403
MARSHALL & ILSLEY CORPORATION
(Exact name of registrant as specified in its charter)
Wisconsin 39-0968604
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
770 North Water Street
Milwaukee, Wisconsin 53202
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (414) 765-7801
None
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined by Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Outstanding at
Class April 30, 2004
----- ----------------
Common Stock, $1.00 Par Value 222,139,949
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2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MARSHALL & ILSLEY CORPORATION
CONSOLIDATED BALANCE SHEETS (Unaudited)
($000's except share data)
March 31, December 31, March 31,
2004 2003 2003
------------- ------------- -------------
Assets
------
Cash and cash equivalents:
Cash and due from banks $ 690,920 $ 810,088 $ 957,805
Federal funds sold and security resale agreements 22,867 44,076 11,045
Money market funds 43,371 57,462 185,551
------------- ------------- -------------
Total cash and cash equivalents 757,158 911,626 1,154,401
Investment securities:
Trading securities, at market value 46,554 16,197 22,245
Short-term investments, at cost which
approximates market value 69,364 45,551 77,945
Available for sale at market value 5,207,164 4,786,446 4,355,890
Held to maturity at amortized cost, market value $864,765
($873,949 December 31, and $980,528 March 31, 2003) 802,452 820,886 921,662
------------- ------------- -------------
Total investment securities 6,125,534 5,669,080 5,377,742
Mortgage loans held for sale 112,984 34,623 221,812
Loans and leases
Loans and leases, net of unearned income 25,942,941 25,150,317 23,977,886
Less: Allowance for loan and lease losses 353,687 349,561 338,253
------------- ------------- -------------
Net loans and leases 25,589,254 24,800,756 23,639,633
Premises and equipment 434,376 438,485 438,820
Goodwill and other intangibles 1,104,195 1,104,552 1,093,868
Accrued interest and other assets 1,352,934 1,413,521 1,322,396
------------- ------------- -------------
Total Assets $ 35,476,435 $ 34,372,643 $ 33,248,672
============= ============= =============
Liabilities and Shareholders' Equity
------------------------------------
Deposits:
Noninterest bearing $ 4,359,686 $ 4,715,283 $ 4,278,218
Interest bearing 18,791,325 17,554,822 17,047,956
------------- ------------- -------------
Total deposits 23,151,011 22,270,105 21,326,174
Funds purchased and security repurchase agreements 2,791,246 765,072 3,730,611
Other short-term borrowings 1,827,355 4,167,929 1,780,463
Accrued expenses and other liabilities 1,083,344 1,106,221 1,010,058
Long-term borrowings 3,221,121 2,734,623 2,272,324
------------- ------------- -------------
Total liabilities 32,074,077 31,043,950 30,119,630
Shareholders' equity:
Series A convertible preferred stock, $1.00 par value;
2,000,000 shares authorized -- -- --
Common stock, $1.00 par value; 240,832,522 shares issued 240,833 240,833 240,833
Additional paid-in capital 553,968 564,269 566,004
Retained earnings 3,167,467 3,061,246 2,767,034
Accumulated other comprehensive income,
net of related taxes 38,230 2,694 (50,209)
Less: Treasury common stock, at cost: 18,768,505 shares
(17,606,489 December 31, and
14,296,874 March 31,2003) 569,056 513,562 373,959
Deferred compensation 29,084 26,787 20,661
------------- ------------- -------------
Total shareholders' equity 3,402,358 3,328,693 3,129,042
------------- ------------- -------------
Total Liabilities and Shareholders' Equity $ 35,476,435 $ 34,372,643 $ 33,248,672
============= ============= =============
See notes to financial statements.
3
MARSHALL & ILSLEY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
($000's except share data)
Three Months Ended March 31,
----------------------------
2004 2003
------------- -------------
Interest income
---------------
Loans and leases $ 325,952 $ 330,185
Investment securities:
Taxable 48,317 45,819
Exempt from federal income taxes 14,171 14,787
Trading securities 89 64
Short-term investments 544 734
------------- -------------
Total interest income 389,073 391,589
Interest expense
----------------
Deposits 55,549 62,827
Short-term borrowings 15,836 22,050
Long-term borrowings 39,052 42,227
------------- -------------
Total interest expense 110,437 127,104
------------- -------------
Net interest income 278,636 264,485
Provision for loan and lease losses 9,027 25,692
------------- -------------
Net interest income after provision for loan and lease losses 269,609 238,793
Other income
------------
Data processing services 186,124 157,088
Item processing 11,432 10,274
Trust services 36,250 30,040
Service charges on deposits 25,523 26,238
Gains on sale of mortgage loans 5,199 13,313
Other mortgage banking revenue 1,765 4,215
Net investment securities gains (losses) (529) 1,569
Life insurance revenue 6,680 7,243
Other 40,985 40,452
------------- -------------
Total other income 313,429 290,432
Other expense
-------------
Salaries and employee benefits 203,928 197,225
Net occupancy 19,195 18,635
Equipment 28,168 28,697
Software expenses 11,225 10,310
Processing charges 13,049 12,018
Supplies and printing 5,706 5,254
Professional services 9,072 10,696
Shipping and handling 16,424 13,953
Amortization of intangibles 5,452 6,919
Other 50,109 31,884
------------- -------------
Total other expense 362,328 335,591
------------- -------------
Income before income taxes 220,710 193,634
Provision for income taxes 74,601 65,604
------------- -------------
Net income $ 146,109 $ 128,030
============= =============
Net income per common share
Basic $ 0.66 $ 0.57
Diluted 0.65 0.56
Dividends paid per common share $ 0.180 $ 0.160
Weighted average common shares outstanding:
Basic 222,301 226,225
Diluted 226,025 227,774
See notes to financial statements.
4
MARSHALL & ILSLEY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
($000's)
Three Months Ended March 31,
----------------------------
2004 2003
------------- -------------
Net Cash Provided by Operating Activities $ 155,723 $ 214,673
Cash Flows From Investing Activities:
Proceeds from sales of securities available for sale 4,412 7,049
Proceeds from maturities of securities available for sale 253,449 713,537
Proceeds from maturities of securities held to maturity 18,494 21,111
Purchases of securities available for sale (660,834) (832,039)
Net increase in loans (850,516) (469,376)
Purchases of assets to be leased (52,302) (162,816)
Principal payments on lease receivables 76,067 210,290
Fixed asset purchases, net (12,613) (13,915)
Purchase acquisitions, net of cash equivalents acquired (6,803) (3,541)
Other 3,906 4,854
------------- -------------
Net cash used in investing activities (1,226,740) (524,846)
Cash Flows From Financing Activities:
Net increase in deposits 871,889 929,955
Proceeds from issuance of commercial paper 1,412,913 1,735,063
Payments for maturity of commercial paper (1,393,722) (1,763,649)
Net decrease in other short-term borrowings (325,207) (320,939)
Proceeds from issuance of long-term debt 575,596 392
Payments of long-term debt (109,247) (231,673)
Dividends paid (39,888) (36,145)
Purchases of treasury stock (98,381) --
Other 22,596 5,038
------------- -------------
Net cash provided by financing activities 916,549 318,042
------------- -------------
Net (decrease) increase in cash and cash equivalents (154,468) 7,869
Cash and cash equivalents, beginning of year 911,626 1,146,532
------------- -------------
Cash and cash equivalents, end of period $ 757,158 $ 1,154,401
============= =============
Supplemental cash flow information:
Cash paid during the period for:
Interest $ 112,835 $ 148,833
Income taxes 6,366 18,886
See notes to financial statements.
5
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements
March 31, 2004 & 2003 (Unaudited)
1. The accompanying unaudited consolidated financial statements should be
read in conjunction with Marshall & Ilsley Corporation's ("M&I" or
"Corporation") 2003 Annual Report on Form 10-K. The unaudited
financial information included in this report reflects all adjustments
consisting only of normal recurring accruals and adjustments which are
necessary for a fair statement of the financial position and results
of operations as of and for the three months ended March 31, 2004 and
2003. The results of operations for the three months ended March 31,
2004 and 2003 are not necessarily indicative of results to be expected
for the entire year. Certain amounts in the 2003 consolidated
financial statements and analyses have been reclassified to conform
with the 2004 presentation.
2. New Accounting Pronouncements
On December 8, 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the "Act") was signed into law. The Act
introduces a prescription drug benefit program under Medicare (Medicare
Part D) as well as a 28% federal subsidy to sponsors of retiree health
care benefit plans that provide a benefit that is at least actuarially
equivalent to Medicare Part D.
At December 31, 2003, the Corporation had elected to defer recognition
of the effect of the Act in accordance with Financial Accounting
Standards Board Staff Position (FSP) 106-1, Accounting and Disclosure
Requirements Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003, until such time as specific authoritative
guidance on the accounting for the federal subsidy was issued.
In March 2004, the Financial Accounting Standards Board issued proposed
FSP 106-b, Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug, Improvement and Modernization Act of 2003.
FSP 106-b addresses the employers' accounting for the effects of the
Act. The accounting for the subsidy applies only to the sponsor of a
single-employer defined benefit postretirement health care plan. The
proposed rule would be effective for fiscal quarters beginning after
June 15, 2004 with retroactive application of the guidance generally
required.
As of and for the three months ended March 31, 2004, any measures of
the accumulated postretirement benefit obligation or net periodic
postretirement benefit cost do not reflect the effects of the Act. The
Corporation is still in the process of determining the financial
statement impact of the Act.
During March 2004, the Securities and Exchange Commission issued Staff
Accounting Bulletin 105, "Application of Accounting Principles to Loan
Commitments" (SAB 105). SAB 105 provides guidance to the application
of generally accepted accounting principles to loan commitments
accounted for as derivative instruments and is generally focused on
commitments to originate mortgage loans that will be sold after they
are funded. SAB 105 generally prohibits an entity from considering
expected future cash flows related to the associated servicing of the
loan or other internally-developed intangible assets in determining the
fair value of the loan commitment. In addition, SAB 105 will require
expanded disclosures on an entity's accounting policy related to loan
commitments accounted for as derivatives including methods and
assumptions used to estimate fair value and any associated hedging
strategies.
SAB 105 is effective for commitments to originate mortgage loans to be
held for sale that are entered into after March 31, 2004. Loan
commitments accounted for as derivatives are not material to the
Corporation and it does not employ any formal hedging strategies. As
a result, the Corporation does not anticipate that implementing SAB 105
will have a material effect on its consolidated financial statements.
6
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
March 31, 2004 & 2003 (Unaudited)
3. Comprehensive Income
The following tables present the Corporation's comprehensive income
($000's):
Three Months Ended March 31, 2004
-----------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
------------- ------------- -------------
Net income $ 146,109
Other comprehensive income:
Unrealized gains (losses) on securities:
Arising during the period $ 42,444 $ (14,897) 27,547
Reclassification for securities
transactions included in net income -- -- --
------------- ------------- -------------
Unrealized gains (losses) 42,444 (14,897) 27,547
Net gains (losses) on derivatives
hedging variability of cash flows:
Arising during the period 3,297 (1,154) 2,143
Reclassification adjustments for
hedging activities included in net income 8,994 (3,148) 5,846
------------- ------------- -------------
Net gains (losses) $ 12,291 $ (4,302) 7,989
------------- ------------- -------------
Other comprehensive income (loss) 35,536
-------------
Total comprehensive income $ 181,645
=============
Three Months Ended March 31, 2003
-----------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
------------- ------------- -------------
Net income $ 128,030
Other comprehensive income:
Unrealized gains (losses) on securities:
Arising during the period $ (11,807)$ 4,135 (7,672)
Reclassification for securities
transactions included in net income (1,675) 586 (1,089)
------------- ------------- -------------
Unrealized gains (losses) (13,482) 4,721 (8,761)
Net gains (losses) on derivatives
hedging variability of cash flows:
Arising during the period (10,484) 3,669 (6,815)
Reclassification adjustments for
hedging activities included in net income 15,067 (5,273) 9,794
------------- ------------- -------------
Net gains (losses) $ 4,583 $ (1,604) 2,979
------------- ------------- -------------
Other comprehensive income (loss) (5,782)
-------------
Total comprehensive income $ 122,248
=============
7
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
March 31, 2004 & 2003 (Unaudited)
4. A reconciliation of the numerators and denominators of the basic and
diluted per share computations are as follows (dollars and shares in
thousands, except per share data):
Three Months Ended March 31, 2004
--------------------------------------------
Income Average Shares Per Share
(Numerator) (Denominator) Amount
-------------- ------------- -------------
Basic Earnings Per Share
Income Available to Common Shareholders $ 146,109 222,301 $ 0.66
=============
Effect of Dilutive Securities
Stock Options, Restricted Stock
and Other Plans -- 3,724
-------------- -------------
Diluted Earnings Per Share
Income Available to Common Shareholders $ 146,109 226,025 $ 0.65
=============
Three Months Ended March 31, 2003
--------------------------------------------
Income Average Shares Per Share
(Numerator) (Denominator) Amount
-------------- ------------- -------------
Basic Earnings Per Share
Income Available to Common Shareholders $ 128,030 226,225 $ 0.57
=============
Effect of Dilutive Securities
Stock Options, Restricted Stock
and Other Plans -- 1,549
-------------- -------------
Diluted Earnings Per Share
Income Available to Common Shareholders $ 128,030 227,774 $ 0.56
=============
Options to purchase shares of common stock not included in the
computation of diluted net income per share because the exercise prices
of the options were greater than the average market price of the common
shares are as follows:
Three Months Ended March 31,
-----------------------------------------
2004 2003
------------------- -------------------
Shares 9,000 11,903,905
Price Range $39.340 - $40.150 $26.875 - $33.938
Statement of Financial Accounting Standards No. 123 (SFAS 123),
"Accounting for Stock-Based Compensation," establishes financial
accounting and reporting standards for stock based employee
compensation plans.
SFAS 123 defines a fair value based method of accounting for employee
stock options or similar equity instruments. Under the fair value
based method, compensation cost is measured at the grant date based on
the fair value of the award using an option-pricing model that takes
into account the stock price at the grant date, the exercise price, the
expected life of the option, the volatility of the underlying stock,
expected dividends and the risk-free interest rate over the expected
life of the option. The resulting compensation cost is recognized over
the service period, which is usually the vesting period.
Compensation cost can also be measured and accounted for using the
intrinsic value based method of accounting prescribed in Accounting
Principles Board Opinion No. 25 (APBO 25)," Accounting for Stock Issued
to Employees." Under the intrinsic value based method, compensation
cost is the excess, if any, of the quoted market price of the stock at
grant date or other measurement date over the amount paid to acquire
the stock.
8
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
March 31, 2004 & 2003 (Unaudited)
The largest difference between SFAS 123 and APBO 25 as they relate to
the Corporation is the amount of compensation cost attributable to the
Corporation's fixed stock option plans and employee stock purchase plan
(ESPP). Under APBO 25 no compensation cost is recognized for fixed
stock option plans because the exercise price is equal to the quoted
market price at the date of grant and therefore there is no intrinsic
value. SFAS 123 compensation cost would equal the calculated fair
value of the options granted. Under APBO 25 no compensation cost is
recognized for the ESPP because the discount (15%) and the plan meets
the definition of a qualified plan of the Internal Revenue Code and
meets the requirements of APBO 25. Under SFAS 123 the safe-harbor
discount threshold is 5% for a plan to be non-compensatory. SFAS 123
compensation cost would equal the initial discount (15% of beginning
of plan period price per share) plus the value of a one year call
option on 85% of a share of stock for each share purchased.
As permitted by SFAS 123, the Corporation continues to measure
compensation cost for such plans using the accounting method prescribed
by APBO 25.
Had compensation cost for the Corporation's ESPP and options granted
after January 1, 1995 been determined consistent with SFAS 123, the
Corporation's net income and earnings per share would have been reduced
to the following estimated pro forma amounts:
Three Months Ended
March 31,
-------------------------
2004 2003
----------- -----------
Net Income, as reported $ 146,109 $ 128,030
Add: Stock-based employee compensation
expense included in reported
net income, net of tax 1,422 1,018
Less: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of tax (6,224) (5,530)
----------- -----------
Pro forma net income $ 141,307 $ 123,518
=========== ===========
Basic earnings per share:
As reported $ 0.66 $ 0.57
Pro forma 0.64 0.55
Diluted earnings per share:
As reported $ 0.65 $ 0.56
Pro forma 0.62 0.54
5. Business Combinations
The following acquisition, which was not considered a material business
combination, was completed during the first quarter of 2004:
On January 1, 2004, the Banking segment completed the purchase
of certain assets and the assumption of certain liabilities of
AmerUs Home Lending, Inc. ("AmerUs"), an Iowa-based corporation
engaged in the business of brokering and servicing mortgage and
home equity loans for $15.0 million in cash. Although not
material to the Corporation, this acquisition enhances the
Corporation's wholesale lending activities by expanding its
broker network and acquiring technology that enhances the
efficiency of the wholesale lending process. AmerUs's total
revenue in 2003 amounted to $14.0 million. Initial goodwill,
subject to the completion of appraisals and valuations of the
assets acquired and liabilities assumed, amounted to $5.0
million. The estimated identifiable intangible asset to be
amortized (customer relationships) with an estimated useful life
of 3 years amounted to $0.3 million. The goodwill and
intangibles resulting from this transaction are deductible for
tax purposes.
9
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
March 31, 2004 & 2003 (Unaudited)
Recently Announced Acquisitions
_______________________________
In April and May 2004, the Corporation's data processing
segment, Metavante, announced the signing of two separate
definitive agreements to acquire for cash certain assets of the
privately held Kirchman Corporation ("Kirchman"), of Orlando,
Florida, and all of the outstanding common stock of the
privately held Advanced Financial Solutions, Inc. and its
affiliated companies (collectively "AFS"), of Oklahoma City,
Oklahoma. Kirchman is a provider of automation software and
compliance services to the banking industry. It is expected
that this acquisition will allow Metavante to provide financial
institution customers with core-processing software that they
can run in-house, a product that Metavante presently does not
offer. AFS is a provider of image-based payment, transaction
and document software technologies. AFS also operates an
electronic check-clearing network through one of its affiliates.
It is expected that this acquisition will allow Metavante to
expand its current product offerings in payment and transaction
processing and image related services, provide the technology
and expertise to help banks facilitate the necessary change to
comply with the Check Clearing for the 21st Century Act (known
as Check 21 and capture another leg in the payments segment-
electronic check image exchange. The combined revenue of
Kirchman and AFS amounted to approximately $136.0 million in
their most recently completed fiscal years. The transactions
are expected to be neutral to the Corporation's diluted earning
per share in 2004.
Total cash consideration for these two acquisitions is
approximately $305.0 million, subject to certain adjustments.
With respect to the AFS transaction, additional contingent
consideration may be paid based on the attainment of certain
performance objectives each year, beginning on the date of
closing and ending December 31, 2004, and each year thereafter
through 2007. The preliminary estimate of the intangible
assets, including goodwill, that will be initially recognized
upon completion of both transactions is approximately $290.0
million. Contingent payments, if made, would be reflected as
adjustments to goodwill. Both transactions are expected to
close in the second quarter of 2004, subject to regulatory
approval.
6. Selected investment securities, by type, held by the Corporation are
as follows ($000's):
March 31, December 31, March 31,
2004 2003 2003
------------- ------------- -------------
Investment securities available for sale:
U.S. treasury and government agencies $ 4,204,236 $ 3,886,278 $ 3,384,400
State and political subdivisions 357,737 299,321 267,376
Mortgage backed securities 142,583 149,990 179,992
Other 502,608 450,857 524,122
------------- ------------- -------------
Total $ 5,207,164 $ 4,786,446 $ 4,355,890
============= ============= =============
Investment securities held to maturity:
U.S. treasury and government agencies $ -- $ -- $ 30
State and political subdivisions 799,632 818,065 918,604
Other 2,820 2,821 3,028
------------- ------------- -------------
Total $ 802,452 $ 820,886 $ 921,662
============= ============= =============
The following table provides the gross unrealized losses and fair value,
aggregated by investment category and the length of time the individual
securities have been in a continuous unrealized loss position, at March
31, 2004 ($000's):
Less than 12 Months 12 Months or More Total
---------------------- ---------------------- ----------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
---------- ---------- ---------- ---------- ---------- ----------
U.S. treasury and
government agencies $ 314,633 $ 1,378 $ -- $ -- $ 314,633 $ 1,378
State and political
subdivisions 21,954 395 -- -- 21,954 395
Other -- -- 6,352 31 6,352 31
---------- ---------- ---------- ---------- ---------- ----------
Total $ 336,587 $ 1,773 $ 6,352 $ 31 $ 342,939 $ 1,804
========== ========== ========== ========== ========== ==========
The Corporation believes that the unrealized losses in the investment
securities portfolio resulted from increases in market interest rates
and not from deterioration in the creditworthiness of the issuer.
10
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
March 31, 2004 & 2003 (Unaudited)
7. The Corporation's loan and lease portfolio, including mortgage loans
held for sale, consists of the following ($000's):
March 31, December 31, March 31,
2004 2003 2003
------------- ------------- -------------
Commercial, financial and agricultural $ 7,288,396 $ 7,104,844 $ 7,009,023
Cash flow hedging instruments at fair value 36,058 5,830 2,644
------------- ------------- -------------
Total commercial, financial and agricultural 7,324,454 7,110,674 7,011,667
Real estate:
Construction 1,343,985 1,330,526 1,150,770
Residential mortgage 7,696,362 7,270,531 6,745,651
Commercial mortgage 7,362,506 7,149,149 6,754,730
------------- ------------- -------------
Total real estate 16,402,853 15,750,206 14,651,151
Personal 1,761,886 1,747,738 1,804,091
Lease financing 566,732 576,322 732,789
------------- ------------- -------------
Total loans and leases $ 26,055,925 $ 25,184,940 $ 24,199,698
============= ============= =============
8. Sale of Receivables
During the first quarter of 2004, $94.5 million of automobile loans were
sold in securitization transactions. Gains of $0.9 million were
recognized and are reported in Other income in the Consolidated
Statements of Income. Other income associated with auto
securitizations, primarily servicing fees, amounted to $1.0 million in
the current quarter.
Key economic assumptions used in measuring the retained interests at the
date of securitization resulting from securitizations completed during
the first quarter were as follows (rate per annum):
Prepayment speed (CPR) 19-35 %
Weighted average life (in months) 15.4
Expected credit losses (based on original balance) 0.03-0.66 %
Residual cash flow discount rate 12.0 %
Variable returns to transferees Forward one month LIBOR
At March 31, 2004, securitized automobile loans and other automobile
loans managed together with them, along with delinquency and credit loss
information consisted of the following:
Securitized Portfolio Total Managed
------------- ----------- -------------
Loan balances $ 1,016,712 $ 209,033 $ 1,225,745
Principal amounts of loans 60 days or more past due 690 147 837
Net credit losses year to date 763 72 835
9. Goodwill and Other Intangibles:
The changes in the carrying amount of goodwill for the three months
ended March 31, 2004 are as follows ($000's):
Banking Metavante Others Total
---------- ---------- ---------- ----------
Goodwill balance as of January 1, 2004 $ 809,772 $ 155,329 $ 4,687 $ 969,788
Goodwill acquired during the period 4,986 -- -- 4,986
Purchase accounting adjustments -- 1,458 -- 1,458
Goodwill amortization -- -- -- --
---------- ---------- ---------- ----------
Goodwill balance as of March 31, 2004 $ 814,758 $ 156,787 $ 4,687 $ 976,232
========== ========== ========== ==========
Goodwill acquired for the Banking segment in the first quarter of 2004
was the initial goodwill associated with the AmerUs Home Lending, Inc.
acquisition.
11
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
March 31, 2004 & 2003 (Unaudited)
Purchase accounting adjustments for Metavante in the first quarter of
2004 represents the effect of adjustments made to the initial estimates
of fair value associated with the November 2003 acquisition of Printing
For Systems, Inc.
At March 31, 2004, the Corporation's other intangible assets consisted
of the following ($000's):
March 31, 2004
------------------------------------
Gross Accum- Net
Carrying ulated Carrying
Amount Amort Value
---------- ---------- ----------
Other intangible assets:
Core deposit intangible $ 159,474 $ 66,596 $ 92,878
Data processing contract rights/customer lists 35,265 11,161 24,104
Trust customers 5,475 456 5,019
Tradename 2,775 1,273 1,502
---------- ---------- ----------
$ 202,989 $ 79,486 $ 123,503
========== ========== ==========
Mortgage loan servicing rights $ 4,460
==========
10. The Corporation's deposit liabilities consists of the following
($000's):
March 31, December 31, March 31,
2004 2003 2003
------------- ------------- -------------
Noninterest bearing demand $ 4,359,686 $ 4,715,283 $ 4,278,218
Savings and NOW 9,093,090 9,301,744 9,265,264
CD's $100,000 and over 5,242,748 4,480,111 3,279,520
Cash flow hedge-Institutional CDs 22,943 13,071 19,714
------------- ------------- -------------
Total CD's $100,000 and over 5,265,691 4,493,182 3,299,234
Other time deposits 2,591,887 2,646,639 2,853,089
Foreign deposits 1,840,657 1,113,257 1,630,369
------------- ------------- -------------
Total deposits $ 23,151,011 $ 22,270,105 $ 21,326,174
============= ============= =============
11. Derivative Financial Instruments and Hedging Activities
Trading Instruments and Other Free Standing Derivatives
_______________________________________________________
The Corporation enters into various derivative contracts primarily to
focus on providing derivative products to customers which enables them
to manage their exposures to interest rate risk. The Corporation's
market risk from unfavorable movements in interest rates is generally
economically hedged by concurrently entering into offsetting derivative
contracts. The offsetting derivative contracts generally have nearly
identical notional values, terms and indices.
Interest rate lock commitments on residential mortgage loans intended
to be held for sale are considered free-standing derivative
instruments. The option to sell the mortgage loans at the time the
commitments are made are also free-standing derivative instruments.
The change in fair value of these derivative instruments due to changes
in interest rates tend to offset each other and act as economic hedges.
Trading and free-standing derivative contracts are not linked to
specific assets and liabilities on the balance sheet or to forecasted
transactions in an accounting hedge relationship and, therefore, do not
qualify for hedge accounting under SFAS 133. They are carried at fair
value with changes in fair value recorded as a component of other
noninterest income.
At March 31, 2004, free standing interest rate swaps consisted of $0.8
billion in notional amount of receive fixed/pay floating with an
aggregate positive fair value of $14.7 million and $0.6 billion in
notional amount of pay fixed/receive floating with an aggregate
negative fair value of $11.1 million.
12
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
March 31, 2004 & 2003 (Unaudited)
At March 31, 2004, interest rate caps purchased amounted to $13.8
million in notional amount with a positive fair value of $0.2 million
and interest rate caps sold amounted to $13.8 million in notional
amount with a negative fair value of $0.2 million.
Fair Value Hedges
_________________
The Corporation has fixed rate callable and institutional CDs and fixed
rate long-term debt which expose the Corporation to variability in fair
values due to changes in market interest rates.
To limit the Corporation's exposure to changes in fair value due to
changes in interest rates, the Corporation has entered into receive-
fixed / pay-floating interest rate swaps with identical call features,
thereby creating the effect of floating rate deposits and floating rate
long-term debt. The Corporation has determined that the hedges on the
long-term debt qualify for the special short-cut accounting prescribed
by SFAS 133, resulting in no ineffectiveness.
The following table presents additional information with respect to
selected fair value hedges.
Fair Value Hedges
March 31, 2004 Weighted
Notional Fair Average
Hedged Hedging Amount Value Remaining
Item Instrument ($ in mil) ($ in mil) Term (Yrs)
-------------------------- --------------------- ------------- ------------- ------------
Fixed Rate CDs Receive Fixed Swap $ 438.0 $ (3.4) 6.8
Medium Term Notes Receive Fixed Swap 370.4 14.8 9.3
Fixed Rate Bank Notes Receive Fixed Swap 225.0 1.5 5.9
The impact from fair value hedges to total net interest income for the
quarter ended March 31, 2004 was a positive $9.5 million. The impact
to net interest income due to ineffectiveness was immaterial.
Cash Flow Hedges
________________
The Corporation has variable rate loans and variable rate short-term
borrowings, which expose the Corporation to variability in interest
payments due to changes in interest rates. The Corporation believes it
is prudent to limit the variability of a portion of its interest
receipts and payments. To meet this objective, the Corporation enters
into various types of derivative financial instruments to manage
fluctuations in cash flows resulting from interest rate risk.
The Corporation regularly originates and holds floating rate commercial
loans that reprice monthly on the first business day to one-month
LIBOR. As a result, the Corporation's interest receipts are exposed to
variability in cash flows due to changes in one-month LIBOR.
In order to hedge the interest rate risk associated with the floating
rate commercial loans indexed to one-month LIBOR, the Corporation has
entered into receive fixed/pay LIBOR-based floating interest rate swaps
designated as cash flow hedges against the first LIBOR-based interest
payments received that, in the aggregate for each period, are interest
payments on such principal amount of its then existing LIBOR-indexed
floating-rate commercial loans equal to the notional amount of the
interest rate swaps outstanding.
Hedge effectiveness is assessed at inception and each quarter on an on-
going basis using regression analysis that takes into account reset
date differences for certain designated interest rate swaps that reset
quarterly. Each month the Corporation makes a determination that it is
probable that the Corporation will continue to receive interest
payments on at least that amount of principal of its existing LIBOR-
indexed floating-rate commercial loans that reprice monthly on the
first business day of each month to one-month LIBOR equal to the
notional amount of the interest rate swaps outstanding.
Ineffectiveness is measured using the hypothetical derivative method
and is recorded as a component of interest income on loans.
13
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
March 31, 2004 & 2003 (Unaudited)
The interest rate swaps change the variable-rate cash flow exposure on
the loans and short-term borrowings to fixed-rate cash flows.
Changes in the fair value of the interest rate swaps designated as cash
flow hedges are reported in accumulated other comprehensive income.
These amounts are subsequently reclassified to interest income or
interest expense as a yield adjustment in the same period in which the
related interest on the variable rate loans and short-term borrowings
affects earnings. Ineffectiveness arising from differences between the
critical terms of the hedging instrument and hedged item is recorded in
interest income or expense.
The following table summarizes the Corporation's cash flow hedges.
Cash Flow Hedges
March 31, 2004 Weighted
Notional Fair Average
Hedged Hedging Amount Value Remaining
Item Instrument ($ in mil) ($ in mil) Term (Yrs)
-------------------------- --------------------- ------------- ------------- ------------
Variable Rate Loans Receive Fixed Swap $ 1,150.0 $ 36.1 5.6
Institutional CDs Pay Fixed Swap 2,070.0 (22.9) 1.5
Fed Funds Purchased Pay Fixed Swap 360.0 (25.4) 2.8
FHLB Advances Pay Fixed Swap 610.0 (13.6) 3.6
The impact to total net interest income from cash flow hedges,
including amortization of terminated cash flow hedges, for the quarter
ended March 31, 2004 was a negative $9.0 million. The impact due to
ineffectiveness was immaterial.
12. Segments
The following represents the Corporation's operating segments as of and
for the three months ended March 31, 2004 and 2003. There have not
been any changes to the way the Corporation organizes its segments.
Charges for services from the holding company had previously been
excluded from segment income. Beginning with the presentation of
segment information in the Corporation's Annual Report on Form 10-K for
the year ended December 31, 2003, management determined that it was
more meaningful to include such charges in evaluating the performance
of its segments. Prior year segment information has been restated to
include such costs and conform to the current year presentation. Fees
- Intercompany represent intercompany revenues charged to other
segments for providing certain services. Expenses - Intercompany
represent fees charged by other segments for certain services received.
For each segment, Expenses - Intercompany are not the costs of that
segment's reported intercompany revenues. Intersegment expenses and
assets have been eliminated. ($ in millions):
Three Months Ended March 31, 2004
------------------------------------------------------------------------------------------
Reclass-
ifications Consol-
Corporate & Elim- Sub- Excluded idated
Banking Metavante Others Overhead nations total Charges Income
---------- --------- --------- --------- -------- --------- --------- ----------
Revenues:
Net interest income $ 274.8 $ (0.2) $ 6.4 $ (2.4) $ -- $ 278.6 $ -- $ 278.6
Fees - Other 83.1 186.1 43.3 0.9 -- 313.4 -- 313.4
Fees - Intercompany 15.7 18.9 4.8 17.5 (56.9) -- -- --
---------- --------- --------- --------- --------- --------- -------- ----------
Total revenues 373.6 204.8 54.5 16.0 (56.9) 592.0 -- 592.0
Expenses:
Expenses - Other 152.2 164.0 29.8 16.8 (0.5) 362.3 -- 362.3
Expenses - Intercompany 33.2 10.9 12.2 0.1 (56.4) -- -- --
---------- --------- --------- --------- --------- --------- -------- ----------
Total expenses 185.4 174.9 42.0 16.9 (56.9) 362.3 -- 362.3
Provision for loan
and lease losses 8.3 -- 0.7 -- -- 9.0 -- 9.0
---------- --------- --------- --------- --------- --------- -------- ----------
Income before taxes 179.9 29.9 11.8 (0.9) -- 220.7 -- 220.7
Income tax expense 58.9 11.8 4.5 (0.6) -- 74.6 -- 74.6
---------- --------- --------- --------- --------- --------- -------- ----------
Segment income $ 121.0 $ 18.1 $ 7.3 $ (0.3) $ -- $ 146.1 $ -- $ 146.1
========== ========= ========= ========= ========= ========= ======== ==========
Identifiable assets $ 34,415.8 $ 979.9 $ 642.3 $ 496.2 $(1,057.8) $ 35,476.4 $ -- $ 35,476.4
========== ========= ========= ========= ========= ========= ======== ==========
Return on average equity 16.1% 18.8% 11.6% 17.4%
========== ========= ========= ==========
14
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
March 31, 2004 & 2003 (Unaudited)
Three Months Ended March 31, 2003
------------------------------------------------------------------------------------------
Reclass-
ifications Consol-
Corporate & Elim- Sub- Excluded idated
Banking Metavante Others Overhead nations total Charges Income
---------- --------- --------- --------- -------- --------- --------- ----------
Revenues:
Net interest income $ 262.5 $ (1.0) $ 7.8 $ (4.8) $ -- $ 264.5 $ -- $ 264.5
Fees - Other 91.6 157.1 41.2 0.6 (0.1) 290.4 -- 290.4
Fees - Intercompany 13.5 16.9 7.2 15.5 (53.1) -- -- --
---------- --------- --------- --------- --------- --------- -------- ----------
Total revenues 367.6 173.0 56.2 11.3 (53.2) 554.9 -- 554.9
Expenses:
Expenses - Other 143.1 141.6 30.6 17.3 0.5 333.1 2.5 335.6
Expenses - Intercompany 33.5 9.3 10.7 0.2 (53.7) -- -- --
---------- --------- --------- --------- --------- --------- -------- ----------
Total expenses 176.6 150.9 41.3 17.5 (53.2) 333.1 2.5 335.6
Provision for loan
and lease losses 17.6 -- 8.1 -- -- 25.7 -- 25.7
---------- --------- --------- --------- --------- --------- -------- ----------
Income before taxes 173.4 22.1 6.8 (6.2) -- 196.1 (2.5) 193.6
Income tax expense 56.6 9.2 3.1 (2.3) -- 66.6 (1.0) 65.6
---------- --------- --------- --------- --------- ---------- -------- ---------
Segment income $ 116.8 $ 12.9 $ 3.7 $ (3.9) $ -- $ 129.5 $ (1.5) $ 128.0
========== ========= ========= ========= ========= ========== ======== ==========
Identifiable assets $ 32,161.9 $ 838.2 $ 651.7 $ 403.3 $ (806.4) $ 33,248.7 $ -- $ 33,248.7
========== ========= ========= ========= ========= ========== ======== ==========
Return on average equity 16.4% 15.8% 6.5% 16.8%
========== ========= ========= ==========
Metavante's segment income for the three months ended March 31, 2003
excludes certain transition expenses associated with the integration of
the July 2002 acquisition of Paytrust, Inc. Such expenses are included
in "Excluded Charges."
Total Revenue by type in Others consists of the following:
Three Months Ended
March 31,
---------------------
2004 2003
--------- ---------
Trust Services $ 35.5 $ 29.9
Residential Mortgage Banking 6.2 12.7
Capital Markets (0.7) 1.8
Brokerage and Insurance 6.8 5.8
Commercial Leasing 4.0 3.8
Commercial Mortgage Banking 1.6 1.3
Others 1.1 0.9
--------- ---------
Total revenue $ 54.5 $ 56.2
========= =========
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION
AND RESULTS OF OPERATIONS
MARSHALL & ILSLEY CORPORATION
CONSOLIDATED AVERAGE BALANCE SHEETS (Unaudited)
($000's)
Three Months Ended March 31,
------------------------------
2004 2003
------------- -------------
Assets
------
Cash and due from banks $ 771,175 $ 763,722
Investment securities:
Trading securities 23,267 18,374
Short-term investments 212,512 257,382
Other investment securities:
Taxable 4,533,085 3,883,443
Tax-exempt 1,146,670 1,197,289
------------- -------------
Total investment securities 5,915,534 5,356,488
Loans and leases:
Loans and leases, net of unearned income 25,427,518 23,900,481
Less: Allowance for loan and lease losses 356,146 345,055
------------- -------------
Net loans and leases 25,071,372 23,555,426
Premises and equipment, net 438,386 443,518
Accrued interest and other assets 2,647,182 2,515,467
------------- -------------
Total Assets $ 34,843,649 $ 32,634,621
============= =============
Liabilities and Shareholders' Equity
------------------------------------
Deposits:
Noninterest bearing $ 4,316,158 $ 3,860,497
Interest bearing 18,198,398 17,286,492
------------- -------------
Total deposits 22,514,556 21,146,989
Funds purchased and security repurchase agreements 2,521,642 3,019,683
Other short-term borrowings 906,913 589,980
Long-term borrowings 4,242,589 3,697,993
Accrued expenses and other liabilities 1,283,938 1,079,911
------------- -------------
Total liabilities 31,469,638 29,534,556
Shareholders' equity 3,374,011 3,100,065
------------- -------------
Total Liabilities and Shareholders' Equity $ 34,843,649 $ 32,634,621
============= =============
16
OVERVIEW
________
The first quarter of 2004 was a strong quarter for the Corporation in terms
of earnings growth. Loan and deposit growth, the continued improvement in
credit quality, revenue and earnings growth by both the data processing
segment ("Metavante") and trust services reporting unit and continued expense
management resulted in double-digit earnings growth in the first quarter of
2004 compared to the first quarter of 2003. During the first quarter of
2004, the Corporation experienced lower revenue from mortgage loan sales
compared to the same period last year.
Net income for the first quarter of 2004 amounted to $146.1 million compared
to $128.0 million for the same period in the prior year, an increase of $18.1
million, or 14.1%. Diluted earnings per share was $0.65 for the three months
ended March 31, 2004, compared with $0.56 for the three months ended March
31, 2003, an increase of 16.1%. The return on average assets and average
equity was 1.69% and 17.42% for the quarter ended March 31, 2004, and 1.59%
and 16.75%, respectively, for the quarter ended March 31, 2003.
Although the Corporation experienced a strong first quarter, management is
not expecting comparable earnings growth for the year ended December 31,
2004. Management believes that low double digit earnings growth in 2004 is
achievable, however, with the economy recovering slowly and modest evidence
of job growth in the markets the Corporation serves, management remains
cautious in its expectations that each positive attribute experienced this
quarter will continue or improve in future quarters. Management continues to
believe that the outlook provided in the Corporation's Annual Report on Form
10-K for 2003 is still representative of its expectations for the year ended
December 31, 2004. The Corporation's actual results for the year ended
December 31, 2004 could differ materially from those expected by management.
See "Forward-Looking Statements" in this Form 10-Q and the Corporation's 2003
Annual Report on Form 10-K for a discussion of the various risk factors that
could cause actual results to be different than expected results.
NOTEWORTHY TRANSACTIONS
_______________________
Some of the more notable transactions that occurred in the first quarters of
2004 and 2003 consisted of the following:
During the first quarter of 2004, the Corporation's Banking segment completed
the purchase of certain assets and the assumption of certain liabilities for
cash of AmerUs Home Lending, Inc. ("AmerUs"), an Iowa-based corporation
engaged in the business of brokering and servicing mortgage and home equity
loans. Although not material to the Corporation, this acquisition enhances
the Corporation's wholesale lending activities by expanding its broker
network and acquiring technology that enhances the efficiency of the
wholesale lending process.
During the first quarter of 2004, the Corporation used its strong earnings
base to take advantage of the continued low interest rate environment and
prepaid and retired $55.0 million of higher cost fixed rate debt that
resulted in a charge to earnings of $4.9 million. The loss is reported in
other in Other expense in the Consolidated Statements of Income.
During the first quarter of 2003, Metavante completed the integration of its
acquisition of Paytrust, Inc. ("Paytrust"). Such acquisition-related
transition expenses amounted to $2.5 million and are reported in various line
items in Other expense in the Consolidated Statements of Income.
NET INTEREST INCOME
___________________
Net interest income for the first quarter of 2004 amounted to $278.6 million
compared to $264.5 million reported for the first quarter of 2003. Loan
growth, slower prepayment activity across all asset classes, growth in
noninterest bearing deposits and the impact of prepaying higher cost debt in
the latter part of 2003 all contributed to the increase in net interest
income. Factors negatively affecting net interest income included the impact
from lengthening liabilities in order to reduce future volatility in net
interest income due to interest rate movements and cash expenditures for
repurchases of common stock and acquisitions in the prior year.
Average earning assets in the first quarter of 2004 increased $2.1 billion or
7.1% compared to the first quarter in 2003. Average loans and leases
accounted for $1.5 billion of the quarter over quarter growth. Average
investment securities increased $0.6 billion. Other short-term investments
and trading securities were relatively unchanged in the first quarter of 2004
compared to the first quarter of 2003.
Average interest bearing liabilities increased $1.3 billion or 5.2% in the
first quarter of 2004 compared to the same period in 2003. Average interest
bearing deposits increased $0.9 billion or 5.3% in the first quarter of 2004
compared to the first quarter of last year. Average total borrowings
increased $0.4 billion or 5.0% in the first quarter of 2004 compared to the
same period in 2003.
17
Average noninterest bearing deposits increased $0.5 billion or 11.8% in the
three months ended March 31, 2004 compared to the same period last year.
The growth and composition of the Corporation's quarterly average loan and
lease portfolio for the current quarter and previous four quarters are
reflected in the following table. ($ in millions):
Consolidated Average Loans and Leases
_____________________________________
2004 2003 Growth Pct.
-------- ----------------------------------- -----------------
First Fourth Third Second First Prior
Quarter Quarter Quarter Quarter Quarter Annual Quarter
-------- -------- -------- -------- -------- ------- ---------
Commercial
Commercial $ 7,142 $ 6,839 $ 6,912 $ 7,043 $ 6,827 4.6% 4.4%
Commercial real estate
Commercial mortgages 7,246 7,076 6,986 6,859 6,677 8.5 2.4
Construction 1,075 1,071 1,014 977 934 15.1 0.3
-------- -------- -------- -------- -------- ------- ---------
Total commercial real estate 8,321 8,147 8,000 7,836 7,611 9.3 2.1
Commercial lease financing 399 384 392 390 394 1.2 3.6
-------- -------- -------- -------- -------- ------- ---------
Total Commercial 15,862 15,370 15,304 15,269 14,832 6.9 3.2
Personal
Residential real estate
Residential mortgages 2,958 2,811 2,751 2,705 2,623 12.8 5.2
Construction 269 246 210 189 175 54.2 9.4
-------- -------- -------- -------- -------- ------- ---------
Total residential real estate 3,227 3,057 2,961 2,894 2,798 15.3 5.6
Personal loans
Student 102 95 84 97 107 (4.6) 7.8
Credit card 230 213 200 191 187 23.0 7.9
Home equity loans and lines 4,439 4,215 4,100 4,075 4,048 9.6 5.3
Other 1,391 1,516 1,692 1,551 1,561 (10.9) (8.3)
-------- -------- -------- -------- -------- ------- ---------
Total personal loans 6,162 6,039 6,076 5,914 5,903 4.4 2.0
Personal lease financing 177 198 255 322 367 (51.8) (10.7)
-------- -------- -------- -------- -------- ------- ---------
Total Personal 9,566 9,294 9,292 9,130 9,068 5.5 2.9
-------- -------- -------- -------- -------- ------- ---------
Total Consolidated Average
Loans and Leases $ 25,428 $ 24,664 $ 24,596 $ 24,399 $ 23,900 6.4% 3.1%
======== ======== ======== ======== ======== ======= =========
Total consolidated average loans and leases increased $1.5 billion or 6.4% in
the first quarter of 2004 compared to the first quarter of 2003. Total
average commercial loan and lease growth amounted to $1.0 billion or 6.9% in
the current quarter compared to the first quarter of the prior year. The
growth in average commercial loans and leases in the first quarter of 2004
compared to the first quarter of 2003 was primarily due to the growth in
average commercial real estate loans which increased $0.7 billion. Total
average personal loans and leases increased $0.5 billion or 5.5% in the first
quarter of 2004 compared to the first quarter of 2003. This growth was
driven primarily by growth in home equity loans and lines and residential
real estate loans which each increased approximately $0.4 billion. Average
indirect auto loans and leases declined approximately $0.4 billion in the
current quarter compared to the first quarter of the prior year. From a
production standpoint, residential real estate loan closings declined
approximately $0.5 billion or 39.5% in the first quarter of 2004 compared to
the first quarter of 2003. However, loan closings in the first quarter of
2004 were only 2.3% behind loan closings in the fourth quarter of 2003 and
early indications, as measured by application volume, suggest that loan
closings in the second quarter of 2004 may exceed the loan closings in the
first quarter of 2004.
Compared to the fourth quarter of 2003, total average consolidated loans and
leases increased $0.8 billion or 3.1% in the first quarter of 2004. Total
average commercial loan and lease growth amounted to $0.5 billion or 3.2% in
the current quarter compared to the fourth quarter of the prior year. The
growth in average commercial loans and leases in the first quarter of 2004
compared to the fourth quarter of 2003 was primarily due to the growth in
average commercial loans which increased $0.3 billion. Total average
personal loans and leases increased $0.3 billion or 2.9% in the first quarter
of 2004 compared to the fourth quarter of 2003. Average personal loan and
lease growth was driven primarily by growth in home equity loans and lines
and residential real estate loans which each increased approximately $0.2
billion. Average indirect auto loans and leases declined approximately $0.1
billion in the first quarter of 2004 compared to the fourth quarter of 2003.
18
In prior quarters, commercial loan growth was largely attributable to new
customers. Existing customers were generally not increasing their credit
needs but appeared to be focused on successfully managing their businesses
through the slower economic conditions and lower revenue levels. The growth
in average commercial loans since the fourth quarter of 2003 has been a
combination of loans to new customers and increased activity from existing
customers whose businesses are in a variety of industries in Wisconsin and
generally throughout the Corporation's markets outside of the state. While
it may be too early to determine if this is the early stage of more robust
business loan demand, the Corporation's commercial lending activities have
historically fared well as the economy strengthens in its markets. Home
equity loans and lines, which includes M&I's wholesale activity, continue to
be the primary consumer loan product. The Corporation anticipates these
products will continue to drive growth in the consumer side of its banking
activities.
Generally, the Corporation sells residential real estate production in the
secondary market, although selected loans with adjustable rate
characteristics are periodically retained in the portfolio. Residential real
estate loans sold to investors amounted to $0.3 billion in the first quarter
of 2004 compared to $1.0 billion in the first quarter of the prior year.
Approximately $58.4 million of loans sold were attributable to the AmerUs
acquisition. At March 31, 2004 and 2003, the Corporation had approximately
$113.0 million and $221.8 million of mortgage loans held for sale,
respectively. Gains from the sale of mortgage loans amounted to $5.2 million
in the first quarter of 2004 compared to $13.3 million in the first quarter
of last year. Approximately $1.6 million of the gain in the first quarter of
2004 was attributable to the AmerUs acquisition.
Auto loans securitized and sold in the first quarter of 2004 amounted to $0.1
billion compared to $0.2 billion in the first quarter of last year. Gains
from the sale and securitization of auto loans amounted to $0.9 million in
the current quarter compared to $2.3 million in the same period last year.
The Corporation anticipates that it will continue to divest itself of
selected assets through sale or securitization in future periods.
The growth and composition of the Corporation's quarterly average deposits
for the current and previous four quarters are as follows ($ in millions):
Consolidated Average Deposits
_____________________________
2004 2003 Growth Pct.
-------- ----------------------------------- -----------------
First Fourth Third Second First Prior
Quarter Quarter Quarter Quarter Quarter Annual Quarter
-------- -------- -------- -------- -------- ------- ---------
Bank issued deposits
Noninterest bearing deposits
Commercial $ 2,976 $ 3,112 $ 2,991 $ 2,799 $ 2,666 11.6% (4.4)%
Personal 855 855 828 818 761 12.4 0.1
Other 485 502 530 456 433 11.6 (3.4)
-------- -------- -------- -------- -------- ------- ---------
Total noninterest
bearing deposits 4,316 4,469 4,349 4,073 3,860 11.8 (3.4)
Interest bearing deposits
Savings and NOW 3,303 3,282 3,273 3,139 2,896 14.1 0.6
Money market 5,780 6,015 6,040 6,135 6,274 (7.9) (3.9)
Foreign activity 909 799 759 861 867 4.8 13.7
-------- -------- -------- -------- -------- ------- ---------
Total interest
bearing deposits 9,992 10,096 10,072 10,135 10,037 (0.4) (1.0)
Time deposits
Other CDs and time deposits 2,611 2,659 2,707 2,791 2,905 (10.1) (1.8)
CDs greater than $100,000 632 633 617 628 662 (4.6) (0.2)
-------- -------- -------- -------- -------- ------- ---------
Total time deposits 3,243 3,292 3,324 3,419 3,567 (9.1) (1.5)
-------- -------- -------- -------- -------- ------- ---------
Total bank issued deposits 17,551 17,857 17,745 17,627 17,464 0.5 (1.7)
Wholesale deposits
Money market 75 74 73 75 77 (1.7) 2.2
Brokered CDs 3,854 3,270 2,938 3,048 2,682 43.7 17.8
Foreign time 1,035 1,282 1,399 1,392 924 11.9 (19.3)
-------- -------- -------- -------- -------- ------- ---------
Total wholesale deposits 4,964 4,626 4,410 4,515 3,683 34.8 7.3
-------- -------- -------- -------- -------- ------- ---------
Total consolidated
average deposits $ 22,515 $ 22,483 $ 22,155 $ 22,142 $ 21,147 6.5% 0.1%
======== ======== ======== ======== ======== ======= =========
19
Total average consolidated deposits increased $1.4 billion or 6.5% in the
first quarter of 2004 compared to the first quarter of 2003. Average
noninterest bearing deposits increased $0.5 billion or 11.8% while average
bank-issued interest bearing activity accounts were relatively unchanged in
the current quarter compared to the first quarter of the prior year. Average
bank-issued time deposits declined $0.3 billion in the first quarter of 2004
compared to the first quarter of 2003. M&I's markets continue to experience
some unprofitable pricing on single service time deposit relationships to the
extent of pricing time deposits above comparable wholesale levels. The
Corporation has elected not to pursue such relationships.
The growth in bank issued deposits, especially noninterest bearing deposits,
includes both commercial and retail banking and was influenced by the lower
interest rate environment. In commercial banking, the focus remains on
developing deeper relationships through the sale of treasury management
products and services along with revised incentive plans focused on growing
deposits. The retail banking strategy continues to focus on aggressively
selling the right products to meet the needs of customers and enhance the
Corporation's profitability. Specific retail deposit initiatives include
bank-at-work, single service calling, and retention calling programs.
Historically, noninterest bearing balances have decreased in the first
quarter compared to the fourth quarter followed by consistent growth in
balances throughout the remainder of the year. The decline in average
noninterest bearing deposits in the first quarter of 2004 compared to the
fourth quarter of 2003 reflects the historical pattern of seasonality in
average noninterest deposit balances. The Corporation believes that annual
deposit growth better reflects trends due to this seasonality that occurs
between quarters. Management expects the annual growth in noninterest
bearing balances in 2004 to be more modest than that experienced in 2003.
Compared with the first quarter of 2003, average wholesale deposits increased
$1.3 billion in the current quarter. The Corporation continues to make
greater use of wholesale funding alternatives, especially institutional
certificates of deposits. These deposits are funds in the form of deposits
generated through distribution channels other than M&I's own banking
branches. These deposits allow the Corporation's bank subsidiaries to gather
funds across a wider geographic base and at pricing levels considered
attractive, where the underlying depositor may be retail or institutional.
Access to and use of these funding sources also provide the Corporation with
the flexibility to not pursue unprofitable single service time deposit
relationships as previously discussed.
During the first quarter of 2004, a fixed rate advance from the Federal Home
Loan Bank ("FHLB") aggregating $55.0 million with an annual coupon interest
rate of 5.06% was prepaid and retired resulting in a charge to earnings of
$4.9 million. In addition, $45.0 million of FHLB fixed rate advances with an
annual coupon interest rate of 5.48% matured. During the first quarter of
2004, $225.0 million of senior bank notes with an annual weighted average
coupon interest rate of 2.81% were issued. In addition, $200.0 million of
amortizing senior bank notes with a semi-annual coupon interest rate of 2.90%
were issued. New FHLB advances in the first quarter of 2004 amounted to
$150.0 million with an annual coupon interest rate of 2.07%.
20
The Corporation's consolidated average interest earning assets and interest
bearing liabilities, interest earned and interest paid for the three months
ended March 31, 2004 and 2003, are presented in the following tables ($ in
millions):
Consolidated Yield and Cost Analysis
____________________________________
Three Months Ended Three Months Ended
March 31, 2004 March 31, 2003
-------------------------------- -------------------------------
Average Average
Average Yield or Average Yield or
Balance Interest Cost (b) Balance Interest Cost (b)
----------- --------- --------- ----------- --------- ---------
Loans and leases: (a)
Commercial loans and leases $ 7,540.9 $ 87.4 4.67 % $ 7,220.8 $ 83.8 4.70 %
Commercial real estate loans 8,321.3 111.2 5.37 7,611.9 111.9 5.96
Residential real estate loans 3,226.7 44.6 5.56 2,797.6 44.0 6.39
Home equity loans and lines 4,438.2 59.1 5.35 4,048.3 59.5 5.96
Personal loans and leases 1,900.4 24.3 5.14 2,221.9 31.6 5.76
------------ --------- --------- ----------- --------- ---------
Total loans and leases 25,427.5 326.6 5.17 23,900.5 330.8 5.61
Investment securities (b):
Taxable 4,533.1 48.3 4.34 3,883.4 45.8 4.87
Tax Exempt (a) 1,146.7 21.4 7.70 1,197.3 22.2 7.66
----------- --------- --------- ----------- --------- ---------
Total investment securities 5,679.8 69.7 5.01 5,080.7 68.0 5.52
Trading securities (a) 23.3 0.1 1.57 18.4 0.1 1.48
Other short-term investments 212.5 0.5 1.03 257.4 0.7 1.16
----------- --------- --------- ----------- --------- ---------
Total interest earning assets $ 31,343.1 $ 396.9 5.11 % $ 29,257.0 $ 399.6 5.56 %
=========== ========= ========= =========== ========= =========
Interest bearing deposits:
Bank issued deposits:
Bank issued interest
bearing activity deposits $ 9,991.9 $ 15.5 0.63 % $ 10,036.2 $ 22.4 0.91 %
Bank issued time deposits 3,242.3 19.2 2.38 3,567.3 23.7 2.70
----------- --------- --------- ----------- --------- ---------
Total bank issued deposits 13,234.2 34.7 1.06 13,603.5 46.1 1.38
Wholesale deposits 4,964.2 20.8 1.69 3,683.0 16.7 1.84
----------- --------- --------- ----------- --------- ---------
Total interest bearing deposits 18,198.4 55.5 1.23 17,286.5 62.8 1.47
Short-term borrowings 3,428.5 15.8 1.86 3,609.6 22.1 2.48
Long-term borrowings 4,242.6 39.1 3.70 3,698.0 42.2 4.63
----------- --------- --------- ----------- --------- ---------
Total interest bearing liabilities $ 25,869.5 $ 110.4 1.72 % $ 24,594.1 $ 127.1 2.10 %
=========== ========= ========= =========== ========= =========
Net interest margin (FTE) as a
percent of average earning assets $ 286.5 3.69 % $ 272.5 3.79 %
========= ========= ========= =========
Net interest spread (FTE) 3.39 % 3.46 %
========= =========
(a) Fully taxable equivalent basis (FTE), assuming a Federal income tax
rate of 35%, and excluding disallowed interest expense.
(b) Based on average balances excluding fair value adjustments for
available for sale securities.
The net interest margin, as a percent of average earning assets on a fully
taxable equivalent basis ("FTE"), decreased 10 basis points from 3.79 percent
in the first quarter of 2003 to 3.69 percent in the first quarter of 2004.
The yield on average interest earning assets decreased 45 basis points in the
first quarter of 2004 compared to the first quarter of the prior year. The
cost of bank issued interest bearing deposits in the current quarter
decreased 32 basis points from the same quarter of the previous year. The
increase in noninterest bearing deposits as previously discussed provided a
benefit to the net interest margin. The cost of other funding sources
(wholesale deposits and total borrowings) decreased 58 basis points in the
current quarter compared to the first quarter of last year.
Net interest income was affected by a number of factors. Loan growth, the
early retirement of higher cost debt in the latter part of 2003, and lower
levels of prepayment activity were beneficial to net interest income in the
first three months of 2004. The low absolute level of interest rates and
increased level of prepayments experienced in the first three quarters of
2003 shortened the expected life of many of the Corporation's financial
assets. Lower reinvestment rates and a conscious slowing in deposit
repricing resulting from selectively lowering deposit rates, has adversely
impacted net interest income.
21
Management expects the net interest margin as a percent of average earning
assets will likely trend down a few basis points over the remainder of 2004.
As the economy improves, the Corporation's capacity to generate loans will
likely exceed its ability to generate appropriately priced deposits. Net
interest income and the net interest margin can vary and continue to be
influenced by loan and deposit growth, product spreads, pricing competition
in the Corporation's markets, prepayment activity, future interest rate
changes and various other factors.
PROVISION FOR LOAN AND LEASE LOSSES AND CREDIT QUALITY
______________________________________________________
The following tables present comparative consolidated credit quality
information as of March 31, 2004, and the prior four quarters.
Nonperforming Assets
____________________
($000's)
2004 2003
----------- -----------------------------------------------
First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter
----------- ----------- ----------- ----------- -----------
Nonaccrual $ 149,550 $ 166,387 $ 180,535 $ 195,448 $ 205,373
Renegotiated 261 278 286 304 312
Past due 90 days or more 6,296 6,111 6,479 7,561 6,439
Total nonperforming loans and leases 156,107 172,776 187,300 203,313 212,124
Other real estate owned 13,172 13,235 13,642 10,527 8,259
Total nonperforming assets $ 169,279 $ 186,011 $ 200,942 $ 213,840 $ 220,383
Allowance for loan and lease losses $ 353,687 $ 349,561 $ 348,100 $ 348,100 $ 338,253
Consolidated Statistics
_______________________
2004 2003
----------- -----------------------------------------------
First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter
----------- ----------- ----------- ----------- -----------
Net charge-offs to average
loans and leases annualized 0.08% 0.13% 0.13% 0.16% 0.44%
Total nonperforming loans and leases
to total loans and leases 0.60 0.69 0.76 0.82 0.88
Total nonperforming assets to total loans
and leases and other real estate owned 0.65 0.74 0.82 0.86 0.91
Allowance for loan and lease losses
to total loans and leases 1.36 1.39 1.41 1.40 1.40
Allowance for loan and lease losses
to total nonperforming loans and leases 227 202 186 171 159
22
Nonaccrual Loans and Leases By Type
___________________________________
($000's)
2004 2003
----------- -----------------------------------------------
First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter
----------- ----------- ----------- ----------- -----------
Commercial
Commercial, financial and agricultural $ 45,714 $ 56,096 $ 66,571 $ 77,389 $ 93,400
Lease financing receivables 7,381 13,308 4,538 6,350 6,755
----------- ----------- ----------- ----------- -----------
Total commercial 53,095 69,404 71,109 83,739 100,155
Real estate
Construction and land development 78 800 353 460 2,017
Commercial mortgage 46,172 42,857 47,012 46,346 42,241
Residential mortgage 49,528 52,098 60,287 63,843 59,547
----------- ----------- ----------- ----------- -----------
Total real estate 95,778 95,755 107,652 110,649 103,805
Personal 677 1,228 1,774 1,060 1,413
----------- ----------- ----------- ----------- -----------
Total nonaccrual loans and leases $ 149,550 $ 166,387 $ 180,535 $ 195,448 $ 205,373
=========== =========== =========== =========== ===========
Reconciliation of Allowance for Loan and Lease Losses
_____________________________________________________
($000's)
2004 2003
----------- -----------------------------------------------
First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter
----------- ----------- ----------- ----------- -----------
Beginning balance $ 349,561 $ 348,100 $ 348,100 $ 338,253 $ 338,409
Provision for loan and lease losses 9,027 9,807 7,852 19,642 25,692
Allowance of banks and loans acquired 27 -- -- -- --
Loans and leases charged-off
Commercial 2,904 4,497 4,317 6,619 2,256
Real estate 3,138 5,142 3,238 3,739 3,130
Personal 3,653 3,661 2,528 2,942 2,969
Leases 1,001 2,494 880 1,191 20,060
----------- ----------- ----------- ----------- -----------
Total charge-offs 10,696 15,794 10,963 14,491 28,415
Recoveries on loans and leases
Commercial 2,886 3,810 1,400 2,624 902
Real estate 1,555 2,508 591 772 495
Personal 756 762 831 732 733
Leases 571 368 289 568 437
----------- ----------- ----------- ----------- -----------
Total recoveries 5,768 7,448 3,111 4,696 2,567
----------- ----------- ----------- ----------- -----------
Net loans and leases charge-offs 4,928 8,346 7,852 9,795 25,848
----------- ----------- ----------- ----------- -----------
Ending balance $ 353,687 $ 349,561 $ 348,100 $ 348,100 $ 338,253
=========== =========== =========== =========== ===========
Nonperforming assets consist of nonperforming loans and leases and other real
estate owned (OREO).
OREO is principally comprised of commercial and residential properties
acquired in partial or total satisfaction of problem loans and amounted to
$13.2 million at March 31, 2004, compared to $13.2 million at December 31,
2003 and $8.3 million at March 31, 2003.
Nonperforming loans and leases consist of nonaccrual, renegotiated or
restructured loans, and loans and leases that are delinquent 90 days or more
and still accruing interest. The balance of nonperforming loans and leases
can fluctuate widely based on the timing of cash collections, renegotiations
and renewals.
Maintaining nonperforming assets at an acceptable level is important to the
ongoing success of a financial services institution. The Corporation's
comprehensive credit review and approval process are critical to ensuring
that the amount of nonperforming assets on a long-term basis is minimized
within the overall framework of acceptable levels of credit risk. In
addition to the negative impact on net interest income and credit losses,
nonperforming assets also increase operating costs due to the expense
associated with collection efforts.
23
At March 31, 2004, nonperforming loans and leases amounted to $156.1 million
or 0.60% of consolidated loans and leases compared to $172.8 million or 0.69%
of consolidated loans and leases at December 31, 2003, a decrease of $16.7
million or 9.6%. Nonaccrual loans and leases accounted for all of the
decrease in nonperforming loans and leases since December 31, 2003. The net
decrease was primarily due to continued reductions and positive resolutions
in several portfolio segments and across most loan types. Commercial
mortgages were the only loan type that experienced an increase in nonaccrual
loans since December 31, 2003, and that increase was primarily attributable
to two loans placed on nonaccrual during the first quarter.
Net charge-offs amounted to $4.9 million or 0.08% of average loans and leases
in the first quarter of 2004 compared to $8.3 million or 0.13% of average
loans and leases in the fourth quarter of 2003 and $25.8 million or 0.44% of
average loans and leases in the first quarter of 2003. Included in net-
charge-offs in the first quarter of 2003 was $19.0 million related to
obligations of Midwest Airlines, Inc. The net charge-off activity
experienced in the current quarter is the lowest level experienced in any
individual quarter since the first quarter of 2000 and is the result of lower
than average charge-offs and higher than average recoveries.
Credit quality continued to show improvement as evidenced by the decline in
nonperforming loans and leases and net charge-offs which were lower than
expected based on the state of the economy in the markets the Corporation
serves. At year-end 2003, the Corporation disclosed that it expects net
charge-offs in 2004 to range from 0.15% to 0.20% for the year and
nonperfoming loans and leases as a percent of total loans and leases
outstanding to be in the range of 70-80 basis points. Based on this
quarter's experience, it appears that the Corporation's credit quality ratios
may be at the low end of the range in the near term. Management continues to
believe that the long-term impact of the recent recession may still provide
some unanticipated results within the loan and lease portfolio and until the
economy demonstrates a sustained period of strengthening, some degree of
stress and uncertainty continues to exist.
The provision for loan and lease losses amounted to $9.0 million for the
three months ended March 31, 2004 compared to $9.8 million for the three
months ended December 31, 2003 and $25.7 million for the three months ended
March 31, 2003. The Corporation has not substantively changed any aspect to
its overall approach in the determination of the allowance for loan and lease
losses. There have been no material changes in assumptions or estimation
techniques as compared to prior periods that impacted the determination of
the current period allowance. The allowance for loan and lease losses to
total loans and leases outstanding was 1.36% at March 31, 2004 and 1.40% at
March 31, 2003.
OTHER INCOME
____________
Total other income in the first quarter of 2004 amounted to $313.4 million
compared to $290.4 million in the same period last year, an increase of $23.0
million or 7.9%. The increase in other income was primarily due to growth in
data processing services and trust services revenue and was partially offset
by lower mortgage banking revenue.
Data processing services revenue amounted to $186.1 million in the first
quarter of 2004 compared to $157.1 million in the first quarter of 2003, an
increase of $29.0 million or 18.5%. Revenue associated with Metavante's
November 2003 acquisition of Printing For Systems, Inc. contributed
approximately $11.9 million to the revenue growth. Overall, revenue growth
was generally strong throughout all aspects of the segment. Total buyout
revenue, which varies from period to period, increased $0.9 million in the
current quarter compared to the first quarter of last year. Due to the
normal seasonal nature of revenues in the first quarter, management expects
data processing services revenue in the second quarter to be relatively flat
compared to the first quarter but will continue to demonstrate revenue growth
over the comparative periods of the prior year. Management continues to
believe that the revenue and segment income outlook that was provided in the
2003 Annual Report on Form 10-K for the year ended December 31, 2004 is
achievable.
For the three months ended March 31, 2004, item processing revenue amounted
to $11.4 million compared to $10.3 million for the three months ended March
31, 2003, an increase of $1.1 million or 11.3%. The increase in revenues is
due to new customers and increased volumes processed.
Trust services revenue amounted to $36.3 million in the first quarter of 2004
compared to $30.0 million in the first quarter of 2003, an increase of $6.3
million or 20.7%. Revenue associated with the segments of the employee
benefit plan business purchased from a national banking association located
in Missouri contributed approximately $1.6 million to the revenue growth. The
remainder of the increase in revenue was due to sales efforts, positive
equity market performance and some shifting of funds into equities. Assets
under management were approximately $16.6 billion at March 31, 2004, compared
to $15.7 billion at December 31, 2003, and $13.2 billion at March 31, 2003.
24
Total mortgage banking revenue was $7.0 million in the first quarter of 2004
compared with $17.5 million in the first quarter of 2003, a decrease of $10.5
million. For the three months ended March 31, 2004, the Corporation sold
$0.3 billion of loans to the secondary market. Retained interests in the
form of mortgage servicing rights amounted to $0.4 million in the first three
months of 2004. For the three months ended March 31, 2003, the Corporation
sold $1.0 billion of loans to the secondary market. Retained interests in
the form of mortgage servicing rights amounted to $0.6 million in the first
three months of 2003. Approximately $58.4 million of the loans sold and $1.6
million of the gain recognized in the first quarter of 2004 was attributable
to the AmerUs acquisition.
Net investment securities losses in the first quarter of 2004 amounted to
$0.5 million compared to net investment securities gains in the first quarter
of 2003 of $1.6 million. Activity in both periods was primarily attributable
to the Corporation's Capital Markets Group which varies from period to
period.
Other income in the first quarter of 2004 amounted to $41.0 million compared
to $40.5 million in the first quarter of 2003, an increase of $0.5 million or
1.3%. Auto securitization income decreased $0.9 million compared to the same
period of the prior year. The quarter over quarter decline was primarily due
to lower gains from the sale of auto loans which was offset by increased
servicing fee income. Auto loans securitized and sold in the first quarter
of 2004 amounted to $0.1 billion compared to $0.2 billion in the first
quarter of last year. Gains from the sale of other real estate decreased
$1.1 million in the three months ended March 31, 2004 compared to the three
months ended March 31, 2003. The decrease was primarily due to the sale of
one large property in the first quarter of 2003. Growth in various other
sources of fee income and a small increase on the gain on sale of student
loans in the first quarter of 2004 compared to the first quarter of 2003
offset the income declines previously discussed.
OTHER EXPENSE
_____________
Total other expense for the three months ended March 31, 2004 amounted to
$362.3 million compared to $335.6 million for the three months ended March
31, 2003, an increase of $26.7 million or 8.0%. Total other expense for the
first quarter of 2004 includes the charge for the early retirement of some
higher cost fixed rate debt and the operating expenses associated with
Metavante's acquisition of Printing For Systems, Inc. in November 2002, the
purchase of certain employee benefit plan segments beginning in the third
quarter of 2003 by the Trust Services reporting unit and the purchase of
AmerUs Home Lending, Inc. by the Banking segment on January 1, 2004. Such
operating expenses have all been included in the Corporation's consolidated
operating expenses since the acquisitions were completed. Total other
expense for the three months ended March 31, 2003 includes the transition
costs associated with the completion of Metavante's integration of Paytrust.
The estimated aggregate impact of these items was an increase to total other
expense over the comparative periods of approximately $12.6 million.
Excluding the impact of these items, total other expense growth in the first
quarter of 2004 compared to the first quarter of 2003 was approximately $14.1
million or 4.3%.
Expense control is sometimes measured in the financial services industry by
the efficiency ratio statistic. The efficiency ratio is calculated by taking
total other expense divided by the sum of total other income (including
Capital Markets revenue but excluding investment securities gains or losses)
and net interest income on a fully taxable equivalent basis. The
Corporation's efficiency ratios for the three months ended March 31, 2004,
and prior four quarters were:
Efficiency Ratios
_________________
March 31, December 31, September 30, June 30, March 31,
2004 2003 2003 2003 2003
------------- ------------- ------------- ------------- -------------
Consolidated Corporation 60.4 % 63.9 % 69.4 % 59.0 % 59.6 %
Consolidated Corporation
Excluding Metavante 49.2 % 52.1 % 60.6 % 48.2 % 48.5 %
Salaries and employee benefits expense amounted to $203.9 million in the
first quarter of 2004 compared to $197.2 million in the first quarter of
2003, an increase of $6.7 million or 3.4%. The impact of salaries and
benefits associated with acquisitions in the current quarter were offset by
the salaries and benefits associated with the Paytrust integration activities
in the first quarter of the prior year.
Occupancy and equipment expense amounted to $47.4 million in the first
quarter of 2004 and was relatively unchanged over the comparative periods.
Occupancy and equipment expense associated with the Paytrust integration
activities in the first quarter of the prior year was approximately $0.8
million.
25
Software expenses, processing charges, supplies and printing, professional
services and shipping and handling expenses totaled $55.5 million in the
first quarter of 2004 compared to $52.2 million in the first quarter of 2003,
an increase of $3.3 million or 6.2%. The Banking segment and Metavante
contributed approximately $1.0 million and $4.0 million to the expense
growth, respectively. Expenses associated with residential mortgage loan
production was approximately $1.8 million lower in the first quarter of 2004
compared to the first quarter of the prior year.
Intangible amortization amounted to $5.5 million in the first quarter of 2004
compared to $6.9 million in the first quarter of 2003, a decrease of $1.4
million. Amortization and valuation reserve adjustments associated with
mortgage servicing rights decreased amortization expense $0.6 million in the
first quarter of 2004 compared to the first quarter of 2003. The carrying
value of the Corporation's mortgage servicing rights was $4.5 million at
March 31, 2004. Amortization of core deposit intangibles which is based on
a declining balance method, decreased $1.1 million in the first quarter of
2004 compared to the first quarter of the prior year.
Other expense amounted to $50.1 million in the first quarter of 2004 compared
to $31.9 million in the first quarter of 2003, an increase of $18.2 million
or 57.2%. As previously discussed, during the first quarter of 2004, the
Corporation prepaid and retired $55.0 million of higher cost fixed rate debt
that resulted in a charge to earnings of $4.9 million. The cost associated
with card plastic sales increased $5.6 million in the first quarter of 2004
compared to the first quarter of the prior year. The increase was primarily
attributable to Metavante's acquisition of Printing For Systems, Inc.
Increased advertising expenses contributed approximately $1.8 million to the
increase in other expense in the current quarter compared to the first
quarter in the prior year.
Other expense is affected by the capitalization of costs, net of amortization
and write-downs associated with software development and customer data
processing conversions. Net software and conversion amortization was $3.0
million in the first quarter of 2004 and in the first quarter of 2003 net
capitalization amounted to $3.1 million resulting in an increase to other
expense over the comparative quarters of $6.1 million.
INCOME TAXES
____________
The provision for income taxes for the three months ended March 31, 2004
amounted to $74.6 million or 33.8% of pre-tax income compared to $65.6
million or 33.9% of pre-tax income for the three months ended March 31, 2003.
LIQUIDITY AND CAPITAL RESOURCES
_______________________________
Shareholders' equity was $3.40 billion or 9.6% of total consolidated assets
at March 31, 2004, compared to $3.33 billion or 9.7% of total consolidated
assets at December 31, 2003, and $3.13 billion or 9.4% of total consolidated
assets at March 31, 2003. The increase at March 31, 2004 was primarily due
to earnings net of dividends paid. The gain in accumulated other
comprehensive income was $35.5 million higher since December 31, 2003. The
net unrealized gain associated with available for sale investment securities
increased $27.5 million since December 31, 2003, while the unrealized loss
associated with the change in fair value of the Corporation's derivative
financial instruments designated as cash flow hedges declined $8.0 million
since December 31, 2003, resulting in the net increase in shareholders'
equity.
The Corporation has a Stock Repurchase Program under which up to 12 million
shares can be repurchased annually. During the first quarter of 2004, 2.3
million common shares were acquired at an aggregate cost of $88.5 million or
$38.98 per common share. See Item 2 in Part II of this Form 10-Q for the
monthly purchase activity relating to the Corporation's Stock Repurchase
Program. During the first quarter of 2003, there were no common shares
repurchased.
26
The Corporation continues to have a strong capital base and its regulatory
capital ratios are significantly above the minimum requirements as shown in
the following tables.
RISK-BASED CAPITAL RATIOS
_________________________
($ in millions)
March 31, 2004 December 31, 2003
--------------------------------- ---------------------------------
Amount Ratio Amount Ratio
--------------------------------- ---------------------------------
Tier 1 Capital $ 2,573 8.93 % $ 2,538 8.87 %
Tier 1 Capital
Minimum Requirement 1,153 4.00 1,144 4.00
-------------------------------- --------------------------------
Excess $ 1,420 4.93 % $ 1,394 4.87 %
================================ ================================
Total Capital $ 3,555 12.34 % $ 3,511 12.28 %
Total Capital
Minimum Requirement 2,305 8.00 2,288 8.00
-------------------------------- --------------------------------
Excess $ 1,250 4.34 % $ 1,223 4.28 %
================================ ================================
Risk-Adjusted Assets $ 28,812 $ 28,601
================= =================
LEVERAGE RATIOS
---------------
($ in millions)
March 31, 2004 December 31, 2003
--------------------------------- ---------------------------------
Amount Ratio Amount Ratio
--------------------------------- ---------------------------------
Tier 1 Capital $ 2,573 7.64 % $ 2,538 7.80 %
Minimum Leverage
Requirement 1,011 - 1,685 3.00 - 5.00 977 - 1,628 3.00 - 5.00
-------------------------------- --------------------------------
Excess $ 1,562 - 888 4.64 - 2.64 % $ 1,561 - 910 4.80 - 2.80 %
================================ ================================
Adjusted Average
Total Assets $ 33,696 $ 32,553
================= =================
M&I manages its liquidity to ensure that funds are available to each of its
banks to satisfy the cash flow requirements of depositors and borrowers and
to ensure the Corporation's own cash requirements are met. M&I maintains
liquidity by obtaining funds from several sources.
The Corporation's most readily available source of liquidity is its
investment portfolio. Investment securities available for sale, which
totaled $5.2 billion at March 31, 2004, represent a highly accessible source
of liquidity. The Corporation's portfolio of held-to-maturity investment
securities, which totaled $0.8 billion at March 31, 2004, provides liquidity
from maturities and amortization payments. The Corporation's mortgage loans
held-for-sale provide additional liquidity. These loans represent recently
funded home mortgage loans that are prepared for delivery to investors, which
generally occurs within thirty to ninety days after the loan has been funded.
Depositors within M&I's defined markets are another source of liquidity.
Core deposits (demand, savings, money market and consumer time deposits)
averaged $16.0 billion in the first quarter of 2004. The Corporation's
banking affiliates may also access the federal funds markets or utilize
collateralized borrowings such as treasury demand notes or FHLB advances.
The banking affiliates may use wholesale deposits. Wholesale deposits are
funds in the form of deposits generated through distribution channels other
than the Corporation's own banking branches. These deposits allow the
Corporation's banking subsidiaries to gather funds across a national
geographic base and at pricing levels considered attractive, where the
underlying depositor may be retail or institutional. Access to wholesale
deposits also provides the Corporation with the flexibility to not pursue
single service time deposit relationships in markets that have experienced
some unprofitable pricing levels. Wholesale deposits averaged $5.0 billion
in the first quarter of 2004.
The Corporation utilizes certain financing arrangements to meet its balance
sheet management, funding, liquidity, and market or credit risk management
needs. The majority of these activities are basic term or revolving
securitization vehicles. These vehicles are generally funded through term-
amortizing debt structures or with short-term commercial paper designed to be
paid off based on the underlying cash flows of the assets securitized. These
vehicles provide access to funding sources substantially separate from the
general credit risk of the Corporation and its subsidiaries. See Note 7 to
the Consolidated Financial Statements for an update of the Corporation's
securitization activities in the first quarter of 2004.
27
The Corporation's lead bank, M&I Marshall & Ilsley Bank ("Bank"), has
implemented a bank note program which permits it to issue up to $7.0 billion
of short-term and medium-term notes which are offered and sold only to
institutional investors. This program is intended to enhance liquidity by
enabling the Bank to sell its debt instruments in private markets in the
future without the delays which would otherwise be incurred. Bank notes
outstanding at March 31, 2004, amounted to $2.6 billion of which $0.6 billion
is subordinated and qualifies as supplementary capital for regulatory capital
purposes. During the first quarter of 2004, the Bank issued $0.4 billion of
senior notes.
The national capital markets represent a further source of liquidity to M&I.
M&I has filed a shelf registration statement which is intended to permit M&I
to raise funds through sales of corporate debt securities with a relatively
short lead time. Under the shelf registration statement, the Corporation may
issue up to $0.5 billion of medium-term Series E notes with maturities
ranging from 9 months to 30 years and at fixed or floating rates. At March
31, 2004, Series E notes issued amounted to $0.3 billion. The Corporation
may issue up to $0.5 billion of medium-term MiNotes with maturities ranging
from 9 months to 30 years and at fixed or floating rates. The MiNotes are
issued in smaller denominations to attract retail investors. At March 31,
2004, MiNotes issued amounted to $0.1 billion. Approximately $1.3 million of
MiNotes were issued during the first quarter of 2004. Additionally, the
Corporation has a commercial paper program. At March 31, 2004, commercial
paper outstanding amounted to $0.3 billion.
Short-term borrowings represent contractual debt obligations with maturities
of one year or less and amounted to $3.3 billion at March 31, 2004. Long-
term borrowings amounted to $4.5 billion at March 31, 2004. The scheduled
maturities of long-term borrowings at March 31, 2004 are as follows: $1.3
billion is due in less than one year; $1.0 billion is due in one to three
years; $0.9 billion is due in three to five years; and $1.3 billion is due in
more than five years. There have been no other substantive changes to the
Corporation's contractual obligations as reported in the Corporation's Annual
Report on Form 10-K for the year ended December 31, 2003.
OFF-BALANCE SHEET ARRANGEMENTS
______________________________
At March 31, 2004, there have been no substantive changes with respect to the
Corporation's off-balance sheet activities. See Note 7 to the Consolidated
Financial Statements for an update of the Corporation's securitization
activities in the first quarter of 2004. Based on the off-balance sheet
arrangements with which it is presently involved, the Corporation does not
believe that such off-balance sheet arrangements either have, or are
reasonably likely to have, a material impact to its current or future
financial condition, results of operations, liquidity or capital.
CRITICAL ACCOUNTING POLICIES
____________________________
The Corporation has established various accounting policies which govern the
application of accounting principles generally accepted in the United States
in the preparation of the Corporation's consolidated financial statements.
The significant accounting policies of the Corporation are described in the
footnotes to the consolidated financial statements contained in the
Corporation's Annual Report on Form 10-K and updated as necessary in its
Quarterly Reports on Form 10-Q. Certain accounting policies involve
significant judgments and assumptions by management that may have a material
impact on the carrying value of certain assets and liabilities. Management
considers such accounting policies to be critical accounting policies. The
judgments and assumptions used by management are based on historical
experience and other factors, which are believed to be reasonable under the
circumstances. Because of the nature of judgments and assumptions made by
management, actual results could differ from these judgments and estimates
which could have a material impact on the carrying values of assets and
liabilities and the results of the operations of the Corporation. Management
continues to consider the following to be those accounting policies that
require significant judgments and assumptions:
Allowance for Loan and Lease Losses
___________________________________
The allowance for loan and lease losses represents management's estimate of
probable losses inherent in the Corporation's loan and lease portfolio.
Management evaluates the allowance each quarter to determine that it is
adequate to absorb these inherent losses. This evaluation is supported by a
methodology that identifies estimated losses based on assessments of
individual problem loans and historical loss patterns of homogeneous loan
pools. In addition, environmental factors, including economic conditions and
regulatory guidance, unique to each measurement date are also considered.
This reserving methodology has the following components:
Specific Reserve. The Corporation's internal risk rating system is used to
identify loans and leases rated "Classified" as defined by regulatory
agencies. In general, these loans have been internally identified as credits
requiring management's attention due to underlying problems in the borrower's
business or collateral concerns. Subject to a minimum size, a quarterly
review of these loans is performed to identify the specific reserve necessary
to be allocated to each of these loans. This analysis considers expected
future cash flows, the value of collateral and also other factors that may
impact the borrower's ability to make payments when due. Included in this
group are those nonaccrual or renegotiated loans that meet the criteria as
being "impaired" under the definition in SFAS 114. A loan is impaired when,
based on current information and events, it is probable that a creditor will
be unable to collect all amounts due according to the contractual terms of
the loan agreement. For impaired loans, impairment is measured using one of
three alternatives: (1) the present value of expected future cash flows
discounted at the loan's effective interest rate; (2) the loan's observable
market price, if available; or (3) the fair value of the collateral for
collateral dependent loans and loans for which foreclosure is deemed to be
probable.
28
Collective Loan Impairment. This component of the allowance for loan and
lease losses is comprised of two elements. First, the Corporation makes a
significant number of loans and leases, which due to their underlying similar
characteristics, are assessed for loss as homogeneous pools. Included in the
homogeneous pools are loans and leases from the retail sector and commercial
loans under a certain size, which have been excluded from the specific
reserve allocation previously discussed. The Corporation segments the pools
by type of loan or lease and using historical loss information, estimates a
loss reserve for each pool.
The second element reflects management's recognition of the uncertainty and
imprecision underlying the process of estimating losses. Based on
management's judgment, reserves are allocated to industry segments or product
types due to environmental conditions unique to the measurement period.
Consideration is given to both internal and external environmental factors
such as economic conditions in certain geographic or industry segments of the
portfolio, economic trends in the retail lending sector, risk profile, and
portfolio composition. Reserves are allocated using estimates of loss
exposure that management has identified based on these economic trends or
conditions. The internal risk rating system is then used to identify those
loans within these industry segments that based on financial, payment or
collateral performance, warrant closer ongoing monitoring by management. The
specific loans mentioned earlier are excluded from this analysis.
The following factors were taken into consideration in determining the
adequacy of the allowance for loan and lease losses at March 31, 2004:
In general, the Corporation's borrowing customers appear to be
successfully managing their businesses through the slower economic
conditions. While there appear to be some signs of improvement in the
economy and the Corporation's customer base is beginning to see some
signs of increased business activity, the customers remain cautious of
there being any substantive increase in revenues until later in the
year. As a result, the recession's lagging impact may continue to
affect the operating performance of M&I's customers in the near term.
At March 31, 2004, special reserves continue to be carried for
exposures to manufacturing, healthcare, production agriculture
(including dairy and cropping operations), truck transportation, and
the airline and travel industries. The majority of the commercial
charge-offs incurred during the past two years were in these industry
segments. While most loans in these categories are still performing,
the Corporation continues to believe these sectors have been more
adversely affected by the economic slowdown. Reduced revenues causing
a declining utilization of the industry's capacity levels have impacted
manufacturing. As a result, collateral values and the amounts realized
through the sale or liquidation of manufacturing plant and equipment
have declined.
During the first quarter of 2004, the Corporation's commitments to
Shared National Credits were approximately $2.2 billion with usage
averaging around 41%. Many of these borrowers are in industries
impacted by the recent months economic climate. In addition, many of
the Corporation's largest charge-offs have come from Shared National
Credits. Approximately $3.1 million of the net charge-offs in 2003
came from Shared National Credits. Although these factors result in an
increased risk profile, as of March 31, 2004, Shared National Credit
nonperforming loans were approximately 0.14% and 0.25% of this
segment's total commitments and outstandings, respectively. The
Corporation's exposure to Shared National Credits is monitored closely
given the economic uncertainty as well as this segment's loss
experience.
The Corporation's primary lending areas are Wisconsin, Arizona,
Minnesota and Missouri. The acquisitions in Minnesota and Missouri
continue to represent relatively new geographic regions for the
Corporation. Each of the regions has cultural and environmental
factors that are unique to them. Although mitigated by the
implementation of the Corporation's credit underwriting and monitoring
processes, the uncertainty regarding the inherent losses in their
respective loan and lease portfolios continues to present increased
risks.
At March 31, 2004, nonperforming loans and leases amounted to $156.1
million or 0.60% of consolidated loans and leases compared to $172.8
million or 0.69% of consolidated loans and leases at December 31, 2003,
a decrease of $16.7 million or 9.6%. Nonaccrual loans and leases
accounted for all of the decrease in nonperforming loans and leases
since December 31, 2003. The net decrease was primarily due to
continued reductions and positive resolutions in several portfolio
segments and across most loan types. Commercial mortgages was the only
loan type that experienced an increase in nonaccrual loans since
December 31, 2003 and that increase was primarily attributable to two
loans placed on nonaccrual during the current quarter.
29
Net charge-offs amounted to $4.9 million or 0.08% of average loans and
leases in the first quarter of 2004 compared to $8.3 million or 0.13%
of average loans in the fourth quarter of 2003 and $25.8 million or
0.44% of average loans in the first quarter of 2003. Included in net-
charge-offs in the first quarter of 2003 was $19.0 million related to
the carrying value of lease obligations for airplanes leased to Midwest
Airlines, Inc. The net charge-off activity experienced in the current
quarter is the lowest level experienced in any individual quarter since
the first quarter of 2000 and is the result of lower than average
charge-offs and higher than average recoveries.
Credit quality continued to show improvement as evidenced by the
decline in nonperforming loans and leases and net charge-offs which
were lower than expected based on the state of the economy in the
markets the Corporation serves. In the 2003 Annual Report on Form 10-
K, the Corporation disclosed that it expects net charge-offs in 2004 to
range from 0.15% to 0.20% for the year and nonperfoming loans and
leases as a percent of total loans and leases outstanding to be in the
range of 70-80 basis points. Based on this quarter's experience, it
appears that the Corporation's credit quality ratios may be at the low
end of the range in the near term. At the present time, there is no
specific industry that is of immediate concern; however, management
continues to believe that the long-term impact of the recent recession
may still provide some unanticipated results within the loan and lease
portfolio and until the economy demonstrates a sustained period of
strengthening, some degree of stress and uncertainty continues to
exist.
Based on the above loss estimates, senior lending and financial management
determine their best estimate of the required reserve. Management's
evaluation of the factors described above resulted in an allowance for loan
and lease losses of $353.7 million or 1.36% of loans and leases outstanding
at March 31, 2004 compared to $349.6 million or 1.39% of loans and leases
outstanding at December 31, 2003. The resulting provision for loan and lease
losses was the amount required to establish the allowance for loan and lease
losses to the required level after considering charge-offs and recoveries.
Management recognizes there are significant estimates in the process and the
ultimate losses could be significantly different from those currently
estimated.
The Corporation has not substantively changed any aspect to its overall
approach in the determination of the allowance for loan and lease losses.
There have been no material changes in assumptions or estimation techniques
as compared to prior periods that impacted the determination of the current
period allowance.
Capitalized Software and Conversion Costs
_________________________________________
Direct costs associated with the production of computer software that will be
licensed externally or used in a service bureau environment are capitalized.
Capitalization of such costs is subject to strict accounting policy criteria,
although the appropriate time to initiate capitalization requires management
judgment. Once the specific capitalized project is put into production, the
software cost is amortized over its estimated useful life, generally four
years. Each quarter, the Corporation performs net realizable value tests to
ensure the assets are recoverable. Such tests require management judgment as
to the future sales and profitability of a particular product which involves,
in some cases, multi-year projections. Technology changes and changes in
customer requirements can have a significant impact on the recoverability of
these assets and can be difficult to predict. Should significant adverse
changes occur, estimates of useful life may have to be revised or write-offs
would be required to recognize impairment. For the three months ended March
31, 2004 and 2003, the amount of software costs capitalized amounted to $10.1
million and $15.3 million, respectively. Amortization expense of software
costs amounted to $11.4 million for the three months ended March 31, 2004
compared to $10.7 million for the three months ended March 31, 2003.
Direct costs associated with customer system conversions to the data
processing operations are capitalized and amortized on a straight-line basis
over the terms, generally five to seven years, of the related servicing
contracts.
Capitalization only occurs when management is satisfied that such costs are
recoverable through future operations or penalties (buyout fees) in case of
early termination. For the three months ended March 31, 2004 and 2003, the
amount of conversion costs capitalized amounted to $1.6 million and $2.6
million, respectively. Amortization expense of conversion costs amounted to
$3.3 million and $4.1 million for the three months ended March 31, 2004 and
2003, respectively.
30
Net unamortized costs were ($ in millions):
March 31,
-------------------------
2004 2003
----------- -----------
Software $ 133.5 $ 145.9
Conversions 29.0 34.5
----------- -----------
Total $ 162.5 $ 180.4
=========== ===========
The Corporation has not substantively changed any aspect to its overall
approach in the determination of the amount of costs that are capitalized for
software development or conversion activities. There have been no material
changes in assumptions or estimation techniques as compared to prior periods
that impacted the determination of the periodic amortization of such costs.
Financial Asset Sales and Securitizations
_________________________________________
The Corporation utilizes certain financing arrangements to meet its balance
sheet management, funding, liquidity, and market or credit risk management
needs. The majority of these activities are basic term or revolving
securitization vehicles. These vehicles are generally funded through term-
amortizing debt structures or with short-term commercial paper designed to be
paid off based on the underlying cash flows of the assets securitized. These
financing entities are contractually limited to a narrow range of activities
that facilitate the transfer of or access to various types of assets or
financial instruments. In certain situations, the Corporation provides
liquidity and/or loss protection agreements. In determining whether the
financing entity should be consolidated, the Corporation considers whether
the entity is a qualifying special-purpose entity (QSPE) as defined in
Statement of Financial Accounting Standards (SFAS) No. 140, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities. For non-consolidation a QSPE must be demonstrably distinct,
have significantly limited permitted activities, hold assets that are
restricted to transferred financial assets and related assets, and can sell
or dispose of non-cash financial assets only in response to specified
conditions.
In December 2003, the Corporation adopted FASB Interpretation No. 46 ("FIN
46R"), Consolidation of Variable Interest Entities (revised December 2003).
This interpretation addresses consolidation by business enterprises of
variable interest entities and explains how to identify variable interest
entities and how an entity assesses its interests in a variable interest
entity to decide whether to consolidate that entity. FIN 46R requires
existing unconsolidated variable interest entities to be consolidated by
their primary beneficiaries if the entities do not effectively disperse risks
among parties involved. Variable interest entities that effectively disperse
risks will not be consolidated unless a single party holds an interest or
combination of interests that effectively recombines risks that were
previously dispersed. Transferors to QSPEs and grandfathered QSPEs subject
to the reporting requirements of SFAS 140 are outside the scope of FIN 46R
and do not consolidate those entities.
With respect to its existing securitization activities, the Corporation does
not believe FIN 46R impacts its consolidated financial statements because its
transfers are generally to QSPEs.
The Corporation sells financial assets in a two-step process that results in
a surrender of control over the assets as evidenced by true-sale opinions
from legal counsel, to unconsolidated entities that securitize the assets.
The Corporation retains interests in the securitized assets in the form of
interest-only strips and a cash reserve account. Gain or loss on sale of the
assets depends in part on the carrying amount assigned to the assets sold
allocated between the asset sold and retained interests based on their
relative fair values at the date of transfer. The value of the retained
interests is based on the present value of expected cash flows estimated
using management's best estimates of the key assumptions-credit losses,
prepayment speeds, forward yield curves, and discount rates commensurate with
the risks involved. Actual results can differ from expected results.
The Corporation reviews the carrying values of the retained interests monthly
to determine if there is a decline in value that is other than temporary and
periodically reviews the propriety of the assumptions used based on current
historical experience as well as the sensitivities of the carrying value of
the retained interests to adverse changes in the key assumptions. The
Corporation believes that its estimates result in a reasonable estimate of
fair value of the retained interests.
The Corporation periodically sells automobile loans to an unconsolidated
multi-seller special purpose entity commercial paper conduit in
securitization transactions in which servicing responsibilities and
subordinated interests are retained. The outstanding balances of automobile
loans sold in these securitization transactions were $1,016.7 million at
March 31, 2004. At March 31, 2004, the carrying amount of retained interests
amounted to $44.1 million.
31
The Corporation also sells, from time to time, debt securities classified as
available for sale that are highly rated to an unconsolidated bankruptcy
remote QSPE whose activities are limited to issuing highly rated asset-backed
commercial paper with maturities up to 180 days which is used to finance the
purchase of the investment securities. The Bank provides liquidity back-up
in the form of Liquidity Purchase Agreements. In addition, the Bank acts as
counterparty to interest rate swaps that enable the QSPE to hedge its
interest rate risk. Such swaps are designated as free-standing derivative
financial instruments in the Corporation's Consolidated Balance Sheet.
Under the terms of the Administration Agreement, the Bank, as administrator
of the QSPE, is required to sell interests in the securities funded by the
QSPE to the Bank as the liquidity purchaser under the liquidity agreements,
if at any time (after giving effect to any issuance of new commercial paper
notes and the receipt of payments under any swap agreement) the QSPE has
insufficient funds to repay any maturing commercial paper note and the Bank,
as liquidity agent, has received a notice of such deficiency. The Bank, as
the liquidity provider, will be obligated to purchase interests in such
securities under the terms of the liquidity agreement to repay the maturing
commercial paper notes unless (i) after giving effect to such purchase, the
aggregate of securities purchased under the relevant liquidity agreement
would exceed the aggregate maximum liquidity purchase amount under such
liquidity agreement or (ii) certain bankruptcy events with respect to the
QSPE have occurred; provided that the Bank is not required to purchase any
defaulted security. For this purpose, a defaulted security is any security
that is rated below "Caa2" by Moody's and below "CCC" by Standard & Poors.
To date, the Bank has never acquired interests in any securities under the
terms of the liquidity agreements.
A subsidiary of the Bank has entered into interest rate swaps with the QSPE
designed to counteract the interest rate risk associated with third party
beneficial interest (commercial paper) and the transferred assets. The
beneficial interests in the form of commercial paper have been issued by the
QSPE to parties other than the Bank and its subsidiary or any other
affiliates. The notional amounts do not exceed the amount of beneficial
interests. The swap agreements do not provide the QSPE or its administrative
agent any decision-making authority other than those specified in the
standard ISDA Master Agreement.
At March 31, 2004, highly rated investment securities in the amount of $295.1
million were outstanding in the QSPE to support the outstanding commercial
paper.
Income Taxes
____________
Income taxes are accounted for using the asset and liability method. Under
this method, deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax basis. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The
effect on tax assets and liabilities of a change in tax rates is recognized
in the income statement in the period that includes the enactment date.
The determination of current and deferred income taxes is based on complex
analyses of many factors, including interpretation of Federal and state
income tax laws, the difference between tax and financial reporting basis of
assets and liabilities (temporary differences), estimates of amounts
currently due or owed such as the timing of reversals of temporary
differences and current accounting standards. The Federal and state taxing
authorities who make assessments based on their determination of tax laws
periodically review the Corporation's interpretation of Federal and state
income tax laws. Tax liabilities could differ significantly from the
estimates and interpretations used in determining the current and deferred
income tax liabilities based on the completion of taxing authority
examinations.
FORWARD-LOOKING STATEMENTS
__________________________
Items 2 and 3 of this Form 10-Q, "Management's Discussion and Analysis of
Financial Position and Results of Operations" and "Quantitative and
Qualitative Disclosures about Market Risk," respectively, contain forward-
looking statements within the meaning of the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. Such forward-looking
statements include, without limitation, statements regarding expected
financial and operating activities and results which are preceded by words
such as "expects", "anticipates" or "believes". Such statements are subject
to important factors that could cause the Corporation's actual results to
differ materially from those anticipated by the forward-looking statements.
These factors include those referenced in Item 1, Business, of the
Corporation's Annual Report on Form 10-K for the period ending December 31,
2003 under the heading "Forward-Looking Statements" and as may be described
from time to time in the Corporation's subsequent SEC filings, and such
factors are incorporated herein by reference.
32
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following updated information should be read in conjunction with the
Corporation's 2003 Annual Report on Form 10-K. Updated information regarding
the Corporation's use of derivative financial instruments is contained in
Note 11, Notes to Financial Statements contained in Item 1 herein.
Market risk arises from exposure to changes in interest rates, exchange
rates, commodity prices, and other relevant market rate or price risk. The
Corporation faces market risk through trading and other than trading
activities. While market risk that arises from trading activities in the form
of foreign exchange and interest rate risk is immaterial to the Corporation,
market risk from other than trading activities in the form of interest rate
risk is measured and managed through a number of methods.
Interest Rate Risk
___________________
The Corporation uses financial modeling techniques to identify potential
changes in income under a variety of possible interest rate scenarios.
Financial institutions, by their nature, bear interest rate and liquidity
risk as a necessary part of the business of managing financial assets and
liabilities. The Corporation has designed strategies to limit these risks
within prudent parameters and identify appropriate risk/reward tradeoffs in
the financial structure of the balance sheet.
The financial models identify the specific cash flows, repricing timing and
embedded option characteristics of the assets and liabilities held by the
Corporation. Policies are in place to assure that neither earnings nor fair
value at risk exceed appropriate limits. The use of a limited array of
derivative financial instruments has allowed the Corporation to achieve the
desired balance sheet repricing structure while simultaneously meeting the
desired objectives of both its borrowing and depositing customers.
The models used include measures of the expected repricing characteristics of
administered rate (NOW, savings and money market accounts) and non-rate
related products (demand deposit accounts, other assets and other
liabilities). These measures recognize the relative insensitivity of these
accounts to changes in market interest rates, as demonstrated through current
and historical experiences. However, during the second quarter of 2003, the
Corporation increased the proportion of these accounts modeled as rate
sensitive, in order to recognize the instability of some of the recent growth
in balances in these accounts. This modeling treatment will be maintained
until the incremental balances can be observed across a more complete
interest rate cycle. In addition to contractual payment information for most
other assets and liabilities, the models also include estimates of expected
prepayment characteristics for those items that are likely to materially
change their payment structures in different rate environments, including
residential mortgage products, certain commercial and commercial real estate
loans and certain mortgage-related securities. Estimates for these
sensitivities are based on industry assessments and are substantially driven
by the differential between the contractual coupon of the item and current
market rates for similar products.
This information is incorporated into a model that allows the projection of
future income levels in several different interest rate environments.
Earnings at risk is calculated by modeling income in an environment where
rates remain constant, and comparing this result to income in a different
rate environment, and then dividing this difference by the Corporation's
budgeted operating income before taxes for the calendar year. Since future
interest rate moves are difficult to predict, the following table presents
two potential scenarios - a gradual increase of 100bp across the entire yield
curve over the course of a year (+25bp per quarter), and a gradual decrease
of 100bp across the entire yield curve over the course of a year (-25bp per
quarter) for the balance sheet as of the indicated dates:
Impact to Annual Pretax Income as of
-------------------------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
2004 2003 2003 2003 2003
------------- ------------- ------------- ------------- -------------
Hypothetical Change in Interest Rate
------------------------------------
100 basis point gradual:
Rise in rates (0.7)% (0.6)% (1.1)% (0.6)% 0.9 %
Decline in rates (2.1)% (1.8)% (1.6)% (2.0)% (1.4)%
These results are based solely on the modeled parallel changes in market
rates, and do not reflect the earnings sensitivity that may arise from other
factors such as changes in the shape of the yield curve and the changes in
spread between key market rates. These results also do not include any
management action to mitigate potential income variances within the
simulation process. Such action could potentially include, but would not be
limited to, adjustments to the repricing characteristics of any on- or off-
balance sheet item with regard to short-term rate projections and current
market value assessments.
33
Actual results will differ from simulated results due to the timing,
magnitude, and frequency of interest rate changes, as well as changes in
market conditions and management strategies.
Another component of interest rate risk is measuring the fair value at risk
for a given change in market interest rates. The Corporation also uses
computer modeling techniques to determine the present value of all asset and
liability cash flows (both on- and off-balance sheet), adjusted for
prepayment expectations, using a market discount rate. The net change in the
present value of the asset and liability cash flows in different market rate
environments is the amount of fair value at risk from those rate movements.
As of March 31, 2004, the fair value of equity at risk for a gradual 100bp
shift in rates has not changed materially since December 31, 2003.
Equity Risk
___________
In addition to interest rate risk, the Corporation incurs market risk in the
form of equity risk. M&I's Capital Markets Group invests in private, medium-
sized companies to help establish new businesses or recapitalize existing
ones. Exposure to the change in equity values for the companies that are
held in their portfolio exist, however, fair values are difficult to
determine until an actual sale or liquidation transaction actually occurs.
As of March 31, 2004, M&I Trust Services administered $71.5 billion in assets
and directly managed a portfolio of $16.6 billion. Exposure exists to
changes in equity values due to the fact that fee income is partially based
on equity balances. While this exposure is present, quantification remains
difficult due to the number of other variables affecting fee income.
Interest rate changes can also have an effect on fee income for the above
stated reasons.
ITEM 4. CONTROLS AND PROCEDURES
We maintain a set of disclosure controls and procedures that are designed to
ensure that information required to be disclosed by us in the reports filed
by us under the Securities Exchange Act of 1934, as amended, is recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms. We carried out an evaluation, under the supervision
and with the participation of our management, including our Chief Executive
Officer and President and our Executive Vice President and Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based
on that evaluation, our Chief Executive Officer and President and our
Executive Vice President and Chief Financial Officer concluded that our
disclosure controls and procedures are effective as of the end of the period
covered by this report.
There have been no changes in our internal control over financial reporting
identified in connection with the evaluation discussed above that occurred
during our last fiscal quarter that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
34
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF
EQUITY SECURITIES
E. Shares Purchased
The following table reflects the purchases of Marshall & Ilsley
Corporation stock for the specified period:
Total Number of
Shares Purchased as Maximum Number of
Average Part of Publicly Shares that May Yet
Total Number of Price Paid Announced Plans or Be Purchased Under
Period Shares Purchased per Share Programs the Plans or Programs
------------------- ----------------- ------------ -------------------- ---------------------
January 1 to
January 31, 2004 625,900 $ 38.53 625,900 11,374,100
February 1 to
February 29, 2004 1,317,200 39.03 1,317,200 10,056,900
March 1 to
March 31, 2004 326,900 39.67 326,900 9,730,000
The Corporation's Share Repurchase Program was publicly reconfirmed in
April 2003 and again in April 2004. The Share Repurchase Program
authorizes the purcahse of up to 12 million shares annually and renews
each year at that level unless changed or terminated by subsequent
Board action.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits:
Exhibit 10(a) - Change of Control Agreement dated as of
February 19, 2004 between the Corporation
and Frank R. Martire.
Exhibit 10(b) - Letter Agreement dated April 12, 2004
between the Corporation and Thomas M. Bolger.
Exhibit 11 - Statement Regarding Computation of Earnings
Per Share, Incorporated by Reference to NOTE 4
of Notes to Financial Statements contained in
Item 1 - Financial Statements (unaudited) of
Part 1 - Financial Information herein.
Exhibit 12 - Statement Regarding Computation of Ratio of
Earnings to Fixed Charges.
Exhibit 31(a) - Certification of Chief Executive Officer
pursuant to Rule 13a-14(a) under the
Securities Exchange Act of 1934, as amended.
Exhibit 31(b) - Certification of Chief Financial Officer
pursuant to Rule 13a-14(a) under the
Securities Exchange Act of 1934, as amended.
Exhibit 32(a) - Certification of Chief Executive Officer
pursuant to 18 U.S.C. Section 1350.
Exhibit 32(b) - Certification of Chief Financial Officer
pursuant to 18 U.S.C. Section 1350.
B. Reports on Form 8-K:
On January 14, 2004, the Corporation furnished Items 7 and 12 in a
Current Report on Form 8-K relating to the release of earnings for the
quarter and year ended December 31, 2003.
35
SIGNATURES
__________
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MARSHALL & ILSLEY CORPORATION
(Registrant)
/s/ Patricia R. Justiliano
__________________________________
Patricia R. Justiliano
Senior Vice President and
Corporate Controller
(Chief Accounting Officer)
/s/ James E. Sandy
__________________________________
James E. Sandy
Vice President
May 10, 2004
36
EXHIBIT INDEX
Exhibit Number Description of Exhibit
______________ ____________________________________________
10(a) Change of Control Agreement dated as of
February 19, 2004 between the Corporation
and Frank R. Martire.
10(b) Letter Agreement dated April 12, 2004
between the Corporation and Thomas M. Bolger.
(11) Statement Regarding Computation of Earnings Per
Share,Incorporated by Reference to NOTE 4 of Notes to
Financial Statements contained in Item 1 -
FinancialStatements (unaudited) of Part 1 - Financial
Information herein.
(12) Statement Regarding Computation of Ratio of Earnings
to Fixed Charges.
(31)(a) Certification of Chief Executive Officer pursuant to
Rule 13a-14(a) under the Securities Exchange Act of
1934, as amended.
(31)(b) Certification of Chief Financial Officer pursuant to
Rule 13a-14(a) under the Securities Exchange Act of
1934, as amended.
(32)(a) Certification of Chief Executive Officer pursuant to
18 U.S.C .Section 1350.
(32)(b) Certification of Chief Financial Officer pursuant to
18 U.S.C. Section 1350.