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 September 30, 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 October 31, 2004
----- ----------------
Common Stock, $1.00 Par Value 223,432,418
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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)
September 30, December 31, September 30,
2004 2003 2003
-----------------------------------------
Assets
------
Cash and cash equivalents:
Cash and due from banks $ 887,273 $ 810,088 $ 866,337
Federal funds sold and security resale agreements 84,499 44,076 16,370
Money market funds 51,949 57,462 110,937
------------ ------------ ------------
Total cash and cash equivalents 1,023,721 911,626 993,644
Investment securities:
Trading securities, at market value 35,592 16,197 40,165
Short-term investments, at cost which
approximates market value 25,532 45,551 85,253
Available for sale at market value 5,322,536 4,786,446 4,626,406
Held to maturity at amortized cost, market value $802,785
($873,949 December 31, and $923,052 September 30, 2003) 756,649 820,886 871,018
------------ ------------ ------------
Total investment securities 6,140,309 5,669,080 5,622,842
Mortgage loans held for sale 87,563 34,623 42,820
Loans and leases
Loans and leases, net of unearned income 28,057,336 25,150,317 24,592,476
Less: Allowance for loan and lease losses 358,072 349,561 348,100
------------ ------------ ------------
Net loans and leases 27,699,264 24,800,756 24,244,376
Premises and equipment 461,208 438,485 435,379
Goodwill and other intangibles 2,041,541 1,104,552 1,082,395
Accrued interest and other assets 1,525,918 1,413,521 1,327,806
------------ ------------ ------------
Total Assets $ 38,979,524 $ 34,372,643 $ 33,749,262
============ ============ ============
Liabilities and Shareholders' Equity
Deposits:
Noninterest bearing $ 4,753,267 $ 4,715,283 $ 4,682,267
Interest bearing 20,132,514 17,554,822 17,626,670
------------ ------------ ------------
Total deposits 24,885,781 22,270,105 22,308,937
Funds purchased and security repurchase agreements 1,094,483 765,072 2,449,867
Other short-term borrowings 3,527,748 4,167,929 1,916,617
Accrued expenses and other liabilities 1,396,958 1,106,221 1,042,401
Long-term borrowings 4,486,258 2,734,623 2,694,281
------------ ------------ ------------
Total liabilities 35,391,228 31,043,950 30,412,103
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 513,289 564,269 558,453
Retained earnings 3,381,436 3,061,246 2,960,574
Accumulated other comprehensive income, net of related taxes 20,842 2,694 (6,530)
Less: Treasury common stock, at cost: 17,751,447 shares
(17,606,489 December 31, and
14,766,946 September 30, 2003) 538,233 513,562 394,922
Deferred compensation 29,871 26,787 21,249
------------ ------------ ------------
Total shareholders' equity 3,588,296 3,328,693 3,337,159
------------ ------------ ------------
Total Liabilities and Shareholders' Equity $ 38,979,524 $ 34,372,643 $ 33,749,262
============ ============ ============
See notes to financial statements.
3
MARSHALL & ILSLEY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
($000's except per share data)
Three Months Ended
September 30,
--------------------------
2004 2003
------------ ------------
Interest income
---------------
Loans and leases $ 356,694 $ 322,953
Investment securities:
Taxable 51,753 33,323
Exempt from federal income taxes 15,042 14,380
Trading securities 78 66
Short-term investments 653 518
------------- -------------
Total interest income 424,220 371,240
Interest expense
----------------
Deposits 73,957 52,276
Short-term borrowings 14,352 19,643
Long-term borrowings 54,773 40,653
------------- -------------
Total interest expense 143,082 112,572
Net interest income 281,138 258,668
Provision for loan and lease losses 6,872 7,852
------------- -------------
Net interest income after provision for loan and lease losses 274,266 250,816
Other income
------------
Data processing services 238,960 166,290
Item processing 10,311 11,194
Trust services 37,510 32,029
Service charges on deposits 25,029 25,402
Gains on sale of mortgage loans 6,967 19,356
Other mortgage banking revenue 1,905 4,848
Net investment securities gains 465 16,741
Life insurance revenue 6,767 7,439
Other 40,014 41,739
------------- -------------
Total other income 367,928 325,038
Other expense
-------------
Salaries and employee benefits 231,468 199,387
Net occupancy 20,306 12,298
Equipment 30,456 27,978
Software expenses 13,468 11,693
Processing charges 12,478 13,239
Supplies and printing 5,456 5,351
Professional services 11,748 11,072
Shipping and handling 15,840 12,495
Amortization of intangibles 8,268 3,389
Other 58,608 113,113
------------- -------------
Total other expense 408,096 410,015
Income before income taxes 234,098 165,839
Provision for income taxes 78,649 25,540
------------- -------------
Net income $ 155,449 $ 140,299
============= =============
Net income per common share
Basic $ 0.70 $ 0.62
Diluted 0.69 0.61
Dividends paid per common share $ 0.210 $ 0.180
Weighted average common shares outstanding (000's) :
Basic 222,612 226,724
Diluted 226,235 228,935
See notes to financial statements.
4
MARSHALL & ILSLEY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
($000's except per share data)
Nine Months Ended
September 30,
--------------------------
2004 2003
------------ ------------
Interest income
---------------
Loans and leases $ 1,017,171 $ 984,147
Investment securities:
Taxable 148,693 120,395
Exempt from federal income taxes 43,635 43,619
Trading securities 222 188
Short-term investments 1,601 1,959
------------- -------------
Total interest income 1,211,322 1,150,308
Interest expense
Deposits 187,505 175,377
Short-term borrowings 44,448 62,667
Long-term borrowings 135,587 125,168
------------- -------------
Total interest expense 367,540 363,212
Net interest income 843,782 787,096
Provision for loan and lease losses 25,126 53,186
------------- -------------
Net interest income after provision for loan and lease losses 818,656 733,910
Other income
------------
Data processing services 622,428 481,368
Item processing 32,645 31,038
Trust services 111,682 93,252
Service charges on deposits 75,635 76,831
Gains on sale of mortgage loans 21,142 49,671
Other mortgage banking revenue 6,395 13,824
Net investment securities gains 13 15,694
Life insurance revenue 20,543 23,200
Other 120,859 125,331
------------- -------------
Total other income 1,011,342 910,209
Other expense
-------------
Salaries and employee benefits 647,277 590,068
Net occupancy 57,739 49,134
Equipment 84,868 84,647
Software expenses 37,174 32,374
Processing charges 37,339 35,863
Supplies and printing 16,968 16,491
Professional services 31,108 32,308
Shipping and handling 50,351 37,706
Amortization of intangibles 19,158 17,803
Other 163,120 184,885
------------- -------------
Total other expense 1,145,102 1,081,279
Income before income taxes 684,896 562,840
Provision for income taxes 231,629 159,859
------------- -------------
Net income $ 453,267 $ 402,981
============= =============
Net income per common share
Basic $ 2.04 $ 1.78
Diluted 2.01 1.77
Dividends paid per common share $ 0.600 $ 0.520
Weighted average common shares outstanding (000's) :
Basic 222,289 226,480
Diluted 225,892 228,307
See notes to financial statements.
5
MARSHALL & ILSLEY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
($000's)
Nine Months Ended
September 30,
------------------------------
2004 2003
-------------- --------------
Net Cash Provided by Operating Activities $ 679,583 $ 686,639
Cash Flows From Investing Activities:
-------------------------------------
Proceeds from sales of securities available for sale 11,358 11,905
Proceeds from maturities of securities available for sale 1,011,633 2,421,686
Proceeds from maturities of securities held to maturity 64,512 72,735
Purchases of securities available for sale (1,503,844) (2,846,463)
Purchases of securities held to maturity -- (1,000)
Net increase in loans (3,158,085) (1,130,000)
Purchases of assets to be leased (148,455) (446,201)
Principal payments on lease receivables 224,034 610,481
Fixed asset purchases, net (54,821) (46,228)
Purchase acquisitions, net of cash equivalents acquired (909,689) (3,041)
Other 17,056 12,892
-------------- --------------
Net cash used in investing activities (4,446,301) (1,343,234)
Cash Flows From Financing Activities:
-------------------------------------
Net increase in deposits 2,615,409 1,910,688
Proceeds from issuance of commercial paper 4,877,029 5,521,502
Payments for maturity of commercial paper (5,005,472) (5,520,344)
Net decrease in other short-term borrowings (712,411) (1,378,138)
Proceeds from issuance of long-term debt 2,739,571 1,226,858
Payments of long-term debt (450,437) (1,108,898)
Dividends paid (133,076) (117,554)
Purchases of treasury stock (98,382) (52,424)
Other 46,582 22,017
-------------- --------------
Net cash provided by financing activities 3,878,813 503,707
-------------- --------------
Net increase (decrease) in cash and cash equivalents 112,095 (152,888)
Cash and cash equivalents, beginning of year 911,626 1,146,532
-------------- --------------
Cash and cash equivalents, end of period $ 1,023,721 $ 993,644
============== ==============
Supplemental cash flow information:
Cash paid during the period for:
Interest $ 330,261 $ 371,074
Income taxes 213,466 230,023
See notes to financial statements.
6
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements
September 30, 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
and nine months ended September 30, 2004 and 2003. The results of
operations for the three and nine months ended September 30, 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 Pronouncement
On March 31, 2004, the Financial Accounting Standards Board ("FASB")
ratified the consensuses reached by the Emerging Issues Task Force
("EITF") in EITF Issue No. 03-1, "The Meaning of Other-Than-
Temporary Impairment and Its Application to Certain Investments"
("Issue 03-1"). Issue 03-1 provides guidance that should be used to
determine when an investment is considered impaired, whether that
impairment is other than temporary, and the measurement of an
impairment loss. The guidance also includes accounting
considerations subsequent to recognition of an other-than-temporary
impairment and requires certain disclosures about unrealized losses
that have not been recognized as other-than-temporary impairments.
For equity securities (including cost method investments) and debt
securities that can be contractually prepaid or otherwise settled in
such a way that the investor would not recover substantially all of
its cost, an impairment should be deemed other than temporary unless
(a) the investor has the ability and intent to hold an investment
for a reasonable period of time sufficient for a forecasted recovery
of fair value up to the cost of the investment, and (b) evidence
indicating the cost of the investment is recoverable within a
reasonable period of time outweighs evidence to the contrary.
For debt securities that can not be contractually prepaid or
otherwise settled in such a way that the investor would not recover
substantially all of its cost, an impairment should be deemed other
than temporary if (a) the investor does not have the ability and
intent to hold an investment until a forecasted recovery of fair
value up to the cost of the investment, which in certain cases may
mean until maturity, or (b) it is probable that the investor will be
unable to collect all amounts due according to the contractual terms
of the debt security.
Although not presumptive, a pattern of selling investments prior to
the forecasted recovery of fair value may call into question the
investor's intent.
The guidance for evaluating whether an investment is other-than-
temporarily impaired was to be applied to other-than-temporary
impairment evaluations made in reporting periods beginning after
June 15, 2004. On September 30, 2004, the Financial Accounting
Standards Board ("FASB") voted unanimously to defer the effective
date of certain paragraphs of Issue 03-1 which effectively deferred
application of Issue 03-1's guidance on how to evaluate and
recognize an impairment loss that is other than temporary which
includes debt securities that are impaired solely because of
interest rate and/or sector spread increases.
The deferral is not a suspension of the accounting requirements that
currently exist. The disclosure requirements were not affected by
the deferral. The delay of the effective date of certain paragraphs
of Issue 03-1 will be superseded concurrent with the final issuance
of a FASB Staff Position that will provide implementation guidance
for securities analyzed for impairment under those paragraphs of
Issue 03-1.
As shown in Note 6 in Notes to Financial Statements, at September
30, 2004 the Corporation had gross unrealized losses associated with
its investment securities portfolios of $10.1 million. Of that
amount, $5.0 million has been in a continuous unrealized loss
position for less than twelve months. By comparison, at June 30,
2004 the Corporation had gross unrealized losses associated with its
investment securities portfolios of $67.4 million. Of that amount,
$60.8 million had been in a continuous unrealized loss position for
less than twelve months at June 30, 2004. The Corporation believes
that the decline in unrealized losses are the result of increases in
market interest rates and it is probable that the Corporation will
collect all amounts due according to the contractual terms of the
investment securities.
7
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2004 & 2003 (Unaudited)
3. Comprehensive Income
The following tables present the Corporation's comprehensive income
($000's):
Three Months Ended September 30, 2004
----------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
------------- -------------- ------------
Net income $ 155,449
Other comprehensive income:
Unrealized gains (losses) on securities:
Arising during the period $ 98,391 $ (34,737) 63,654
hedging variability of cash flows:
transactions included in net income (378) 132 (246)
------------- --------------- -----------
Unrealized gains (losses) 98,013 (34,605) 63,408
Net gains (losses) on derivatives
hedging variability of cash flows:
Arising during the period 6,090 (2,131) 3,959
Reclassification adjustments for
hedging activities included in net income 8,288 (2,901) 5,387
------------- --------------- -----------
Net gains (losses) $ 14,378 $ (5,032) 9,346
------------- --------------- -----------
Other comprehensive income (loss) 72,754
-----------
Total comprehensive income $ 228,203
===========
Three Months Ended September 30, 2003
----------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
------------- -------------- ------------
Net income $ 140,299
Other comprehensive income:
Unrealized gains (losses) on securities:
Arising during the period $ (22,345)$ 9,207 (13,138)
Reclassifications for securities
transactions included in net income -- -- --
------------- --------------- -----------
Unrealized gains (losses) (22,345) 9,207 (13,138)
Net gains (losses) on derivatives
hedging variability of cash flows:
Arising during the period 16,256 (5,689) 10,567
Reclassification adjustments for
hedging activities included in net income 57,182 (20,014) 37,168
------------- --------------- -----------
Net gains (losses) $ 73,438 $ (25,703) 47,735
------------- --------------- -----------
Other comprehensive income (loss) 34,597
-----------
Total comprehensive income $ 174,896
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8
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2004 & 2003 (Unaudited)
Nine Months Ended September 30, 2004
----------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
------------- -------------- ------------
Net income $ 453,267
Other comprehensive income:
Unrealized gains (losses) on securities:
Arising during the period $ (2,004)$ 648 (1,356)
Reclassifications for securities
transactions included in net income (368) 129 (239)
------------- --------------- -----------
Unrealized gains (losses) (2,372) 777 (1,595)
Net gains (losses) on derivatives
hedging variability of cash flows:
Arising during the period 5,102 (1,786) 3,316
Reclassification adjustments for
hedging activities included in net income 25,273 (8,846) 16,427
------------- --------------- -----------
Net gains (losses) $ 30,375 $ (10,632) 19,743
------------- --------------- -----------
Other comprehensive income (loss) 18,148
-----------
Total comprehensive income $ 471,415
===========
Nine Months Ended September 30, 2003
----------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
------------- -------------- ------------
Net income $ 402,981
Other comprehensive income:
Unrealized gains (losses) on securities:
Arising during the period $ (29,974)$ 11,886 (18,088)
Reclassifications for securities
transactions included in net income (1,675) 586 (1,089)
------------- --------------- -----------
Unrealized gains (losses) (31,649) 12,472 (19,177)
Net gains (losses) on derivatives
hedging variability of cash flows:
Arising during the period (6,597) 2,309 (4,288)
Reclassification adjustments for
hedging activities included in net income 94,403 (33,041) 61,362
------------- --------------- -----------
Net gains (losses) $ 87,806 $ (30,732) 57,074
------------- --------------- -----------
Other comprehensive income (loss) 37,897
-----------
Total comprehensive income $ 440,878
===========
9
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 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 September 30, 2004
------------------------------------------
Income Average Shares Per Share
(Numerator) (Denominator) Amount
-------------- ------------ ------------
Basic Earnings Per Share
Income Available to Common Shareholders $ 155,449 222,612 $ 0.70
===========
Effect of Dilutive Securities
Stock Options, Restricted Stock
and Other Plans -- 3,623
-------------- ------------
Diluted Earnings Per Share
Income Available to Common Shareholders $ 155,449 226,235 $ 0.69
===========
Three Months Ended September 30, 2003
------------------------------------------
Income Average Shares Per Share
(Numerator) (Denominator) Amount
-------------- ------------ ------------
Three Months Ended September 30, 2003
Income Average Shares Per Share
(Numerator) (Denominator) Amount
Basic Earnings Per Share
Income Available to Common Shareholders $ 140,299 226,724 $ 0.62
===========
Effect of Dilutive Securities
Stock Options, Restricted Stock
and Other Plans -- 2,211
-------------- ------------
Diluted Earnings Per Share
Income Available to Common Shareholders $ 140,299 228,935 $ 0.61
===========
Nine Months Ended September 30, 2004
------------------------------------------
Income Average Shares Per Share
(Numerator) (Denominator) Amount
-------------- ------------ ------------
Basic Earnings Per Share
Income Available to Common Shareholders $ 453,267 222,289 $ 2.04
===========
Effect of Dilutive Securities
Stock Options, Restricted Stock
and Other Plans -- 3,603
-------------- ------------
Diluted Earnings Per Share
Income Available to Common Shareholders $ 453,267 225,892 $ 2.01
===========
Nine Months Ended September 30, 2003
------------------------------------------
Income Average Shares Per Share
(Numerator) (Denominator) Amount
-------------- ------------ ------------
Basic Earnings Per Share
Income Available to Common Shareholders $ 402,981 226,480 $ 1.78
===========
Effect of Dilutive Securities
Stock Options, Restricted Stock
and Other Plans -- 1,827
-------------- ------------
Diluted Earnings Per Share
Income Available to Common Shareholders $ 402,981 228,307 $ 1.77
===========
10
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2004 & 2003 (Unaudited)
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 September 30, Nine Months Ended September 30,
-------------------------------------- --------------------------------------
2004 2003 2004 2003
------------------ ------------------ ------------------ ------------------
Shares 56,500 3,465,078 162,500 6,366,792
Price Range $39.420 - $41.150 $31.510 - $33.938 $39.000 - $41.150 $29.420 - $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.
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
under 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 Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net Income, as reported $ 155,449 $ 140,299 $ 453,267 $ 402,981
Add: Stock-based employee compensation expense
included in reported net income, net of tax 1,410 984 4,264 3,020
Less: Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of tax (6,486) (5,820) (19,400) (17,873)
------------ ----------- ----------- -----------
Pro forma net income $ 150,373 $ 135,463 $ 438,131 $ 388,128
============ =========== =========== ===========
Basic earnings per share:
As reported $ 0.70 $ 0.62 $ 2.04 $ 1.78
Pro forma 0.68 0.60 1.97 1.71
Diluted earnings per share:
As reported $ 0.69 $ 0.61 $ 2.01 $ 1.77
Pro forma 0.66 0.59 1.93 1.70
11
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2004 & 2003 (Unaudited)
5. Business Combinations
The following acquisitions, which were not considered material
business combinations, were completed during the third quarter of
2004:
On July 1, 2004, Metavante completed the acquisition of all of the
outstanding common stock of the privately held Advanced Financial
Solutions, Inc. and its affiliated companies (collectively "AFS"),
of Oklahoma City, Oklahoma for $140.3 million in cash, subject to
adjustment. 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.
Additional contingent consideration up to $115.0 million may be paid
based on the attainment of certain financial goals each year,
beginning on the date of closing and ending December 31, 2004, and
each year thereafter through 2007. Contingent payments, if made,
would be reflected as adjustments to goodwill. Initial goodwill,
subject to the completion of appraisals and valuations of the assets
acquired and liabilities assumed, amounted to $99.6 million. The
estimated identifiable intangible asset to be amortized (customer
relationships) with an estimated useful life of 12 years amounted to
$22.9 million. The goodwill and intangibles resulting from this
transaction are partially deductible for tax purposes.
On July 30, 2004, Metavante completed the acquisition of all of the
outstanding common stock of NYCE Corporation ("NYCE"), for $610.7
million in cash, subject to certain adjustments which may include a
return of a portion of the purchase price based on certain future
revenue measures. NYCE owns and operates one of the largest
electronic funds transfer networks in the United States and provides
debit card authorization processing services for automated teller
machines (ATMs) and on-line and off-line signature based debit card
transactions. It is expected that this acquisition will enable
Metavante to expand its electronic funds transfer (EFT) business.
Initial goodwill, subject to the completion of appraisals and
valuations of the assets acquired and liabilities assumed, amounted
to $453.0 million. The estimated identifiable intangible asset to
be amortized (customer relationships) with an estimated useful life
of 15 years amounted to $172.0 million. The goodwill and
intangibles resulting from this transaction are not deductible for
tax purposes.
On September 8, 2004, Metavante acquired certain assets of Response
Data Corp. ("RDC"), for approximately $35.0 million in cash. RDC is
a New Jersey-based provider of credit card balance transfer, bill
pay and convenience check processing. It is expected that this
acquisition will enable Metavante to expand its payment solutions
product offerings by adding credit card balance transfer bill
payment. Initial goodwill, subject to the completion of appraisals
and valuations of the assets acquired and liabilities assumed,
amounted to $26.8 million. The estimated identifiable intangible
asset to be amortized (customer relationships) with an estimated
useful life of 10 years amounted to $6.4 million. The goodwill and
intangibles resulting from this transaction are deductible for tax
purposes.
Recently Announced Acquisitions
_______________________________
On October 15, 2004, Metavante announced the signing of a definitive
agreement to acquire all of the outstanding common stock of
VECTORsgi Holdings, Inc. ("VECTOR"). VECTOR is a provider of
banking transaction applications, including electronic check-image
processing and image exchange, item processing, dispute resolution
and e-commerce for financial institutions and corporations. It is
expected that this acquisition will complement the recently
completed acquisition of AFS, as both companies specialize in
providing electronic check-imaging technology. The transaction is
expected to close in the fourth quarter of 2004, pending regulatory
approval. The aggregate cash purchase price for VECTOR is $100.0
million, with up to an additional $35.0 million to be paid based on
meeting certain performance criteria. Upon completion, the
transaction is expected to result in intangible assets, including
goodwill, of approximately $91.0 million.
In conjunction with the announcement of the acquisition of VECTOR,
the Corporation announced that to finance, in part the acquisition
of VECTOR, and for other corporate purposes, it plans to issue and
sell approximately $150 million of common stock in the fourth
quarter of 2004 in order to maintain its capital at desired levels.
Any such sale of shares of the Corporation's common stock is subject
to market conditions and changes in the timing, amount and terms.
This Form 10-Q does not constitute an offer of any securities for
sale.
12
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2004 & 2003 (Unaudited)
6. Selected investment securities, by type, held by the Corporation are
as follows ($000's):
September 30, December 31, September 30,
2004 2003 2003
------------- ------------- -------------
Investment securities available for sale:
U.S. treasury and government agencies $ 4,171,521 $ 3,886,278 $ 3,738,303
State and political subdivisions 479,822 299,321 285,201
Mortgage backed securities 158,410 149,990 118,974
Other 512,783 450,857 483,928
------------- ------------- -------------
Total $ 5,322,536 $ 4,786,446 $ 4,626,406
============= ============= =============
Investment securities held to maturity:
State and political subdivisions $ 754,349 $ 818,065 $ 868,195
Other 2,300 2,821 2,823
------------- ------------- -------------
Total $ 756,649 $ 820,886 $ 871,018
============= ============= =============
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 September 30, 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 $ 497,974 $ 3,705 $ 450,465 $ 4,494 $ 948,439 $ 8,199
State and political subdivisions 66,246 928 13,437 526 79,683 1,454
Other 49,429 394 6,302 39 55,731 433
----------- ----------- ----------- ----------- ----------- -----------
Total $ 613,649 $ 5,027 $ 470,204 $ 5,059 $ 1,083,853 $ 10,086
=========== =========== =========== =========== =========== ===========
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.
7. The Corporation's loan and lease portfolio, including mortgage loans
held for sale, consists of the following ($000's):
September 30, December 31, September 30,
2004 2003 2003
------------- ------------- -------------
Commercial, financial and agricultural $ 7,923,699 $ 7,104,844 $ 6,866,523
Cash flow hedging instruments at fair value 7,816 5,830 19,784
------------- ------------- -------------
Total commercial, financial and agricultural 7,931,515 7,110,674 6,886,307
Real estate:
Construction 1,505,469 1,330,526 1,283,880
Residential mortgage 8,649,178 7,270,531 6,876,820
Commercial mortgage 7,999,229 7,149,149 7,021,572
------------- ------------- -------------
Total real estate 18,153,876 15,750,206 15,182,272
Personal 1,524,747 1,747,738 1,954,821
Lease financing 534,761 576,322 611,896
------------- ------------- -------------
Total loans and leases $ 28,144,899 $ 25,184,940 $ 24,635,296
============= ============= =============
13
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2004 & 2003 (Unaudited)
8. Sale of Receivables
During the third quarter of 2004, $103.5 million of automobile loans
were sold in securitization transactions. Losses of $0.7 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 $1.4 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 third quarter were as follows (rate per annum):
Prepayment speed (CPR) 19-35 %
Weighted average life (in months) 15.1
Expected credit losses
(based on original balance) 0.22-0.74 %
Residual cash flow discount rate 12.0 %
Variable returns to transferees Forward one month LIBOR yield curve
At September 30, 2004, securitized automobile loans and other
automobile loans managed together with them, along with delinquency
and credit loss information consisted of the following ($000's):
Total
Securitized Portfolio Managed
------------- ------------- -------------
Loan balances $ 1,136,833 $ 169,200 $ 1,306,033
Principal amounts of loans 60 days or more past 852 168 1,020
Net credit losses year to date 1,773 79 1,852
9. Goodwill and Other Intangibles:
The changes in the carrying amount of goodwill for the nine months
ended September 30, 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 4,986 724,333 -- 729,319
Purchase accounting adjustments -- 1,114 -- 1,114
Goodwill amortization -- -- -- --
------------- ------------- ------------- -------------
Goodwill balance as of
September 30, 2004 $ 814,758 $ 880,776 $ 4,687 $ 1,700,221
============= ============= ============= =============
Goodwill acquired for the Metavante segment includes initial
goodwill relating to the acquisitions of AFS, NYCE and RDC in the
third quarter of 2004 and the initial goodwill associated with the
Kirchman acquisition in the second quarter of 2004.
Goodwill acquired for the Banking segment consists of the initial
goodwill associated with the AmerUs Home Lending, Inc. acquisition
in the first quarter of 2004.
Purchase accounting adjustments for Metavante in the first quarter
of 2004 represent the effect of adjustments made to the initial
estimates of fair value associated with the November 2003
acquisition of Printing For Systems, Inc.
14
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2004 & 2003 (Unaudited)
At September 30, 2004, the Corporation's other intangible assets
consisted of the following ($000's):
September 30, 2004
---------------------------------------------
Accum-
Gross ulated Net
Carrying Amort- Carrying
Amount ization Value
------------- ------------- -------------
Other intangible assets:
Core deposit intangible $ 159,474 $ 72,881 $ 86,593
Data processing contract rights/customer lists 261,608 16,490 245,118
Trust customers 5,475 794 4,681
Tradename 2,775 1,735 1,040
------------- ------------- -------------
$ 429,332 $ 91,900 $ 337,432
============= ============= =============
Mortgage loan servicing rights $ 3,888
=============
10. The Corporation's deposit liabilities consists of the following
($000's):
September 30, December 31, September 30,
2004 2003 2003
------------- ------------- -------------
Noninterest bearing demand $ 4,753,267 $ 4,715,283 $ 4,682,267
Savings and NOW 10,081,369 9,301,744 9,261,984
Cash flow hedge-Brokered MMDA (147) -- --
------------- ------------- -------------
Total Savings and NOW 10,081,222 9,301,744 9,261,984
CD's $100,000 and over 5,988,784 4,480,111 3,878,947
Cash flow hedge-Institutional CDs 5,089 13,071 16,821
------------- ------------- -------------
Total CD's $100,000 and over 5,993,873 4,493,182 3,895,768
Other time deposits 2,686,482 2,646,639 2,701,047
Foreign deposits 1,370,937 1,113,257 1,767,871
Fair value hedging instruments -- -- --
------------- ------------- -------------
Total deposits $ 24,885,781 $ 22,270,105 $ 22,308,937
============= ============= =============
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 enable
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. For purposes of estimating the fair value of the free-
standing derivative at the balance sheet date, the Corporation
assumes the fair value of the written option at inception is zero
and measures the change in market interest rates from the date of
commitment to the balance sheet date. The change in market rates
and the expected duration of the loan form the basis for estimating
fair value, which may result in an asset or liability. 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. Loan
commitments accounted for as derivatives are not material to the
Corporation and the Corporation does not employ any formal hedging
strategies.
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.
15
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2004 & 2003 (Unaudited)
At September 30, 2004, free standing interest rate swaps consisted
of $1.1 billion in notional amount of receive fixed/pay floating
with an aggregate positive fair value of $1.4 million and $1.0
billion in notional amount of pay fixed/receive floating with an
aggregate negative fair value of $2.6 million.
At September 30, 2004, interest rate caps purchased amounted to
$13.8 million in notional amount with a positive fair value of $0.1
million and interest rate caps sold amounted to $13.8 million in
notional amount with a negative fair value of $0.1 million.
At September 30, 2004, the notional value of interest rate futures
designated as trading was $2.7 billion with an immaterial fair
value.
Fair Value Hedges
_________________
The Corporation has fixed rate callable and institutional CDs and
fixed rate long-term debt which expose the Corporation to
variability in fair values due to changes in market interest rates.
To limit the Corporation's exposure to changes in fair value due to
changes in interest rates, the Corporation has entered into receive-
fixed / pay-floating interest rate swaps with identical call
features, thereby creating the effect of floating rate deposits and
floating rate long-term debt. The Corporation has determined that
the hedges on the long-term debt qualify for the special short-cut
accounting prescribed by SFAS 133, resulting in no ineffectiveness.
The following table presents additional information with respect to
selected fair value hedges.
Fair Value Hedges
September 30, 2004 Weighted
Notional Fair Average
Hedged Hedging Amount Value Remaining
Item Instrument ($ in mil) ($ in mil) Term (Yrs)
-------------------------- ---------------------- ----------- ----------- ----------
Fixed Rate CDs Receive Fixed Swap $ 550.0 $ (5.6) 11.1
Medium Term Notes Receive Fixed Swap 365.3 2.4 8.8
Fixed Rate Bank Notes Receive Fixed Swap 206.8 (2.2) 5.4
Institutional CDs Receive Fixed Swap 5.0 (0.2) 14.5
The impact from fair value hedges to total net interest income for
the three and nine months ended September 30, 2004 was a positive
$11.0 million and $31.4 million, respectively. The impact to net
interest income due to ineffectiveness was immaterial.
Cash Flow Hedges
________________
The Corporation has variable rate loans, variable rate deposits and
variable rate 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.
16
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2004 & 2003 (Unaudited)
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.
The interest rate swaps change the variable-rate cash flow exposure
on the loans, deposits and 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, variable
rate deposits and variable rate 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
September 30, 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 $ 7.8 5.1
Institutional CDs Pay Fixed Swap 2,730.0 (5.1) 1.5
Fed Funds Purchased Pay Fixed Swap 360.0 (14.9) 2.3
FHLB Advances Pay Fixed Swap 670.0 1.4 2.7
Money Market Account Pay Fixed Swap 250.0 0.1 2.8
The impact to total net interest income from cash flow hedges,
including amortization of terminated cash flow hedges, for the three
and nine months ended September 30, 2004 was a negative $8.3 million
and $25.3 million, respectively. The impact due to ineffectiveness
was immaterial.
12. Postretirement Health Plan
The Corporation sponsors a defined benefit health plan that provides
health care benefits to eligible current and retired employees.
Eligibility for retiree benefits is dependent upon age, years of
service, and participation in the health plan during active service.
The plan is contributory and in 1997 and 2002 the plan was amended.
Employees hired or retained from mergers after September 1, 1997
will be granted access to the Corporation's plan upon becoming an
eligible retiree; however, such retirees must pay 100% of the cost
of health care benefits. The plan continues to contain other cost-
sharing features such as deductibles and coinsurance.
17
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2004 & 2003 (Unaudited)
Net periodic postretirement benefit costs for the three and nine
month periods ended September 30, 2004 and 2003 includes the
following components ($000's):
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Service cost $ 630 $ 535 $ 1,892 $ 1,605
Interest on APBO 1,024 1,335 3,756 4,005
Expected return on assets (225) -- (225) --
Prior service amortization (1,121) (680) (2,481) (2,041)
Actuarial loss amortization 564 501 1,689 1,504
Other -- 165 -- 495
---------- ---------- ---------- ----------
$ 872 $ 1,856 $ 4,631 $ 5,568
========== ========== ========== ==========
Benefit payments and expenses, net of participant contributions for
the three and nine months ended September 30, 2004 amounted to $0.8
million and $2.7 million, respectively. In addition, in the first
quarter of 2004, the Corporation made a discretionary contribution
to the retirement health benefit trust in the amount of $7.2
million. The expected benefit payments and expenses, net of
participant contributions, and excluding discretionary
contributions, for the year ended December 31, 2004 is $3.4 million.
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 May 2004, the Financial Accounting Standards Board issued FSP
106-2, "Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug, Improvement and Modernization Act of
2003". FSP 106-2 requires companies to account for the effect of
the subsidy on benefits attributable to past service as an actuarial
experience gain and as a reduction of the service cost component of
net postretirement health care costs for amounts attributable to
current service, if the benefit provided is at least actuarially
equivalent to Medicare Part D.
During the third quarter of 2004, the Corporation elected to adopt
FSP 106-2 and to retroactively recognize the Act from January 1,
2004. The Corporation and its actuarial advisors determined that
benefits provided to certain participants are expected to be at
least actuarially equivalent to Medicare Part D, and, accordingly
the Corporation will be entitled to some subsidy. The expected
subsidy reduces the accumulated postretirement benefit obligation at
January 1, 2004 by approximately $7.0 million and net periodic cost
for the nine months ended September 30, 2004 by approximately $1.0
million as compared with the amount determined without considering
the effects of the subsidy.
Assumptions used to develop this reduction include those used in the
determination of the annual postretirement health care expense and
also include expectations of how the federal program will ultimately
operate. There are currently no written regulations that provide
this level of detail regarding the ultimate operation of the subsidy
program. It is expected that final regulations will be published in
early 2005.
18
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2004 & 2003 (Unaudited)
13. Segments
The following represents the Corporation's operating segments as of
and for the three and nine months ended September 30, 2004 and 2003.
There have not been any changes to the way the Corporation organizes
its segments. Charges for services from the holding company had
previously been excluded from segment income. Beginning with the
presentation of segment information in the Corporation's Annual
Report on Form 10-K for the year ended December 31, 2003, management
determined that it was more meaningful to include such charges in
evaluating the performance of its segments. Prior year segment
information has been restated to include such costs and conform to
the current year presentation. Fees - Intercompany represent
intercompany revenues charged to other segments for providing
certain services. Expenses - Intercompany represent fees charged by
other segments for certain services received. For each segment,
Expenses - Intercompany are not the costs of that segment's reported
intercompany revenues. Intersegment expenses and assets have been
eliminated. ($ in millions):
Three Months Ended September 30, 2004
------------------------------------------------------------------------------------------
Reclass-
ifications Consol-
Corporate & Elimi- Sub- Excluded idated
Banking Metavante Others Overhead nations total Charges Income
---------- --------- --------- --------- --------- ---------- --------- --------
Revenues:
Net interest income $ 284.4 $ (7.7) $ 5.9 $ (1.5) $ -- $ 281.1 $ -- $ 281.1
Fees - Other 82.1 239.0 45.4 1.4 -- 367.9 -- 367.9
Fees - Intercompany 15.1 20.9 5.6 17.5 (59.1) -- -- --
---------- --------- --------- --------- --------- ---------- -------- ---------
Total revenues 381.6 252.2 56.9 17.4 (59.1) 649.0 -- 649.0
Expenses:
Expenses - Other 153.1 206.1 31.4 18.2 (0.7) 408.1 -- 408.1
Expenses - Intercompany 38.3 11.2 11.1 (2.2) (58.4) -- -- --
---------- --------- --------- --------- --------- ---------- -------- ---------
Total expenses 191.4 217.3 42.5 16.0 (59.1) 408.1 -- 408.1
Provision for loan
and lease losses 6.5 -- 0.4 -- -- 6.9 -- 6.9
---------- --------- --------- --------- --------- ---------- -------- ---------
Income before taxes 183.7 34.9 14.0 1.4 -- 234.0 -- 234.0
Income tax expense 61.5 13.6 5.5 (2.0) -- 78.6 -- 78.6
---------- --------- --------- --------- --------- ---------- -------- ---------
Segment income $ 122.2 $ 21.3 $ 8.5 $ 3.4 $ -- $ 155.4 $ -- $ 155.4
========== ========= ========= ========= ========= ========== ======== =========
Identifiable assets $ 36,819.1 $ 2,154.0 $ 607.2 $ 850.4 $ (1,451.2)$ 38,979.5 $ -- $ 38,979.5
========== ========= ========= ========= ========= ========== ======== =========
Return on average equity 16.2% 19.9% 14.7% 17.6%
========== ========= ========= =========
Three Months Ended September 30, 2003
------------------------------------------------------------------------------------------
Reclass-
ifications Consol-
Corporate & Elimi- Sub- Excluded idated
Banking Metavante Others Overhead nations total Charges Income
---------- --------- --------- --------- --------- ---------- --------- --------
Revenues:
Net interest income $ 255.1 $ (0.4) $ 8.0 $ (4.0) $ -- $ 258.7 $ -- $ 258.7
Fees - Other 101.8 166.3 55.9 1.2 (0.2) 325.0 -- 325.0
Fees - Intercompany 14.8 17.3 9.9 15.5 (57.5) -- -- --
---------- --------- --------- --------- --------- ---------- -------- ---------
Total revenues 371.7 183.2 73.8 12.7 (57.7) 583.7 -- 583.7
Expenses:
Expenses - Other 197.2 157.8 27.5 26.9 0.6 410.0 -- 410.0
Expenses - Intercompany 39.1 11.0 10.7 (2.5) (58.3) -- -- --
---------- --------- --------- --------- --------- ---------- -------- ---------
Total expenses 236.3 168.8 38.2 24.4 (57.7) 410.0 -- 410.0
Provision for loan
and lease losses 7.3 -- 0.6 -- -- 7.9 -- 7.9
---------- --------- --------- --------- --------- ---------- -------- ---------
Income before taxes 128.1 14.4 35.0 (11.7) -- 165.8 -- 165.8
Income tax expense 15.9 0.9 13.9 (5.2) -- 25.5 -- 25.5
---------- --------- --------- --------- --------- ---------- -------- ---------
Segment income $ 112.2 $ 13.5 $ 21.1 $ (6.5) $ -- $ 140.3 $ -- $ 140.3
========== ========= ========= ========= ========= ========== ======== =========
Identifiable assets $ 32,597.0 $ 904.1 $ 601.0 $ 487.4 $ (840.2) $ 33,749.3 $ -- $ 33,749.3
========== ========= ========= ========= ========= ========== ======== =========
Return on average equity 15.2% 15.1% 35.0% 16.9%
========== ========= ========= =========
19
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2004 & 2003 (Unaudited)
Nine Months Ended September 30, 2004
------------------------------------------------------------------------------------------
Reclass-
ifications Consol-
Corporate & Elimi- Sub- Excluded idated
Banking Metavante Others Overhead nations total Charges Income
---------- --------- --------- --------- --------- ---------- --------- --------
Revenues:
Net interest income $ 839.5 $ (8.8) $ 18.9 $ (5.8) $ -- $ 843.8 $ -- $ 843.8
Fees - Other 250.7 622.5 134.6 3.5 -- 1,011.3 -- 1,011.3
Fees - Intercompany 47.4 58.9 17.4 52.7 (176.4) -- -- --
---------- --------- --------- --------- --------- ---------- -------- ---------
Total revenues 1,137.6 672.6 170.9 50.4 (176.4) 1,855.1 -- 1,855.1
Expenses:
Expenses - Other 457.8 541.3 91.0 56.0 (1.0) 1,145.1 -- 1,145.1
Expenses - Intercompany 109.9 34.3 34.8 (3.6) (175.4) -- -- --
---------- --------- --------- --------- --------- ---------- -------- ---------
Total expenses 567.7 575.6 125.8 52.4 (176.4) 1,145.1 -- 1,145.1
Provision for loan
and lease losses 23.4 -- 1.7 -- -- 25.1 -- 25.1
---------- --------- --------- --------- --------- ---------- -------- ---------
Income before taxes 546.5 97.0 43.4 (2.0) -- 684.9 -- 684.9
Income tax expense 180.3 38.0 16.9 (3.6) -- 231.6 -- 231.6
---------- --------- --------- --------- --------- ---------- -------- ---------
Segment income $ 366.2 $ 59.0 $ 26.5 $ 1.6 $ -- $ 453.3 $ -- $ 453.3
========== ========= ========= ========= ========= ========== ======== =========
Identifiable assets $ 36,819.1 $ 2,154.0 $ 607.2 $ 850.4 $(1,451.2) $ 38,979.5 $ -- $ 38,979.5
========== ========= ========= ========= ========= ========== ======== =========
Return on average equity 16.2% 19.4% 14.4% 17.6%
========== ========= ========= =========
Nine Months Ended September 30, 2003
------------------------------------------------------------------------------------------
Reclass-
ifications Consol-
Corporate & Elimi- Sub- Excluded idated
Banking Metavante Others Overhead nations total Charges Income
---------- --------- --------- --------- --------- ---------- --------- --------
Revenues:
Net interest income $ 779.5 $ (2.0) $ 23.7 $ (14.1) $ -- $ 787.1 $ -- $ 787.1
Fees - Other 287.4 481.4 137.8 3.8 (0.2) 910.2 -- 910.2
Fees - Intercompany 42.9 52.3 26.4 46.6 (168.2) -- -- --
---------- --------- --------- --------- --------- ---------- -------- ---------
Total revenues 1,109.8 531.7 187.9 36.3 (168.4) 1,697.3 -- 1,697.3
Expenses:
Expenses - Other 485.4 441.9 90.0 60.9 0.6 1,078.8 2.5 1,081.3
Expenses - Intercompany 110.1 30.7 31.7 (3.5) (169.0) -- -- --
---------- --------- --------- --------- --------- ---------- -------- ---------
Total expenses 595.5 472.6 121.7 57.4 (168.4) 1,078.8 2.5 1,081.3
Provision for loan
and lease losses 43.9 -- 9.3 -- -- 53.2 -- 53.2
---------- --------- --------- --------- --------- ---------- -------- ---------
Income before taxes 470.4 59.1 56.9 (21.1) -- 565.3 (2.5) 562.8
Income tax expense 127.5 19.4 22.5 (8.6) -- 160.8 (1.0) 159.8
---------- --------- --------- --------- --------- ---------- -------- ---------
Segment income $ 342.9 $ 39.7 $ 34.4 $ (12.5) $ -- $ 404.5 $ (1.5) $ 403.0
========== ========= ========= ========= ========= ========== ======== =========
Identifiable assets $ 32,597.0 $ 904.1 $ 601.0 $ 487.4 $ (840.2) $ 33,749.3 $ -- $ 33,749.3
========== ========= ========= ========= ========= ========== ======== =========
Return on average equity 15.8% 15.4% 19.6% 16.9%
========== ========= ========= =========
Metavante's segment income for the nine months ended September 30,
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 Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Trust Services $ 36.9 $ 31.8 $ 109.6 $ 93.0
Residential Mortgage Banking 8.3 13.3 23.5 40.9
Capital Markets (0.2) 16.2 (0.5) 18.2
Brokerage and Insurance 5.7 5.9 19.2 17.5
Commercial Leasing 3.8 4.0 12.0 11.5
Commercial Mortgage Banking 1.5 1.5 4.5 4.1
Others 0.9 1.1 2.6 2.7
--------- --------- --------- ---------
Total revenue $ 56.9 $ 73.8 $ 170.9 $ 187.9
========= ========= ========= =========
20
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
September 30,
------------------------------
2004 2003
------------- -------------
Assets
------
Cash and due from banks $ 853,162 $ 742,287
Investment securities:
Trading securities 23,439 26,769
Short-term investments 165,125 259,646
Other investment securities:
Taxable 4,710,840 3,990,121
Tax-exempt 1,224,094 1,166,772
------------- -------------
Total investment securities 6,123,498 5,443,308
Loans and leases:
Loans and leases, net of unearned income 27,499,589 24,596,403
Less: Allowance for loan and lease losses 362,296 351,514
------------- -------------
Net loans and leases 27,137,293 24,244,889
Premises and equipment, net 458,070 437,404
Accrued interest and other assets 3,443,717 2,571,807
------------- -------------
Total Assets $ 38,015,740 $ 33,439,695
============= =============
Liabilities and Shareholders' Equity
------------------------------------
Deposits:
Noninterest bearing $ 4,637,961 $ 4,348,872
Interest bearing 19,996,303 17,805,959
------------- -------------
Total deposits 24,634,264 22,154,831
Funds purchased and security repurchase agreements 1,761,838 2,660,662
Other short-term borrowings 731,731 441,924
Long-term borrowings 5,899,749 3,775,716
Accrued expenses and other liabilities 1,470,299 1,116,672
------------- -------------
Total liabilities 34,497,881 30,149,805
Shareholders' equity 3,517,859 3,289,890
------------- -------------
Total Liabilities and Shareholders' Equity $ 38,015,740 $ 33,439,695
============= =============
21
MARSHALL & ILSLEY CORPORATION
CONSOLIDATED AVERAGE BALANCE SHEETS (Unaudited)
($000's)
Nine Months Ended
September 30,
------------------------------
2004 2003
------------- -------------
Assets
------
Cash and due from banks $ 808,936 $ 750,837
Investment securities:
Trading securities 22,950 23,321
Short-term investments 180,716 266,537
Other investment securities:
Taxable 4,638,611 3,972,106
Tax-exempt 1,180,816 1,179,967
------------- -------------
Total investment securities 6,023,093 5,441,931
Loans and leases:
Loans and leases, net of unearned income 26,482,061 24,301,069
Less: Allowance for loan and lease losses 359,443 347,291
------------- -------------
Net loans and leases 26,122,618 23,953,778
Premises and equipment, net 443,834 440,886
Accrued interest and other assets 2,951,399 2,539,814
------------- -------------
Total Assets $ 36,349,880 $ 33,127,246
============= =============
Liabilities and Shareholders' Equity
------------------------------------
Deposits:
Noninterest bearing $ 4,489,782 $ 4,095,794
Interest bearing 19,066,853 17,722,429
------------- -------------
Total deposits 23,556,635 21,818,223
Funds purchased and security repurchase agreements 2,186,105 2,770,397
Other short-term borrowings 872,162 533,319
Long-term borrowings 4,952,207 3,724,792
Accrued expenses and other liabilities 1,349,872 1,083,064
------------- -------------
Total liabilities 32,916,981 29,929,795
Shareholders' equity 3,432,899 3,197,451
------------- -------------
Total Liabilities and Shareholders' Equity $ 36,349,880 $ 33,127,246
============= =============
22
OVERVIEW
________
Net income for the third quarter of 2004 amounted to $155.4 million
compared to $140.3 million for the same period in the prior year, an
increase of $15.1 million, or 10.8%. Diluted earnings per share was $0.69
for the three months ended September 30, 2004, compared with $0.61 for the
three months ended September 30, 2003, an increase of 13.1%. The return
on average assets and average equity was 1.63% and 17.58% for the quarter
ended September 30, 2004, and 1.66% and 16.92%, respectively, for the
quarter ended September 30, 2003.
Net income for the nine months ended September 30, 2004 amounted to $453.3
million compared to $403.0 million for the nine months ended September 30,
2003, an increase of $50.3 million, or 12.5%. Diluted earnings per share
was $2.01 for the nine months ended September 30, 2004, compared with
$1.77 for the nine months ended September 30, 2003, an increase of 13.6%.
The return on average assets and average equity was 1.67% and 17.64% for
the nine months ended September 30, 2004, and 1.63% and 16.85%,
respectively, for the nine months ended September 30, 2003.
Earnings growth for the three and nine months ended September 30, 2004
compared to the three and nine months ended September 30, 2003 was
attributable to a number of factors. The increase in net interest income
was driven by loan and deposit growth and the impact of refinancing higher
cost debt in current and prior periods. Net interest income growth was
somewhat mitigated by the financing costs associated with Metavante's
acquisitions. The continued improvement in credit quality resulted in
lower provisions for loan and lease losses. Metavante and the
Corporation's trust services reporting unit continued to exhibit growth in
revenue and earnings. Metavante's growth in revenue and earnings
reflects, in part, the impact of its acquisitions including three
acquisitions completed in the third quarter of 2004, one acquisition
completed in the second quarter of 2004 and one acquisition completed in
the fourth quarter of 2003. For the three and nine months ended September
30, 2004, the Corporation experienced lower revenue from mortgage loan
sales compared to the same periods last year which reflects, in part, less
refinancing activity. These factors along with continued expense
management resulted in double-digit earnings growth in the three and nine
months ended September 30, 2004 compared to the three and nine months
ended September 30, 2003.
Management continues to believe 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 in the first three quarters of 2004 will continue or
improve in future quarters. 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 AND EVENTS
__________________________________
Some of the more notable transactions and events that occurred in the
three and nine months ended September 30, 2004 and 2003 consisted of the
following:
Third Quarter 2004
__________________
On July 1, 2004, Metavante completed the acquisition of all of the
outstanding common stock of the privately held Advanced Financial
Solutions, Inc. and its affiliated companies (collectively "AFS"), of
Oklahoma City, Oklahoma for $140.3 million in cash, subject to adjustment.
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. See Note 5, Business Combinations in the Notes to Financial
Statements.
On July 30, 2004, Metavante completed the acquisition of all of the
outstanding common stock of NYCE Corporation ("NYCE"), for $610.7 million
in cash, subject to certain adjustments. NYCE owns and operates one of
the largest electronic funds transfer networks in the United States and
provides debit card authorization processing services for automated teller
machines (ATMs) and on-line and off-line signature based debit card
transactions. It is expected that this acquisition will enable Metavante
to expand its electronic funds transfer (EFT) business. See Note 5,
Business Combinations in the Notes to Financial Statements.
23
On July 29, 2004, the Corporation completed two financing transactions
aggregating $1.0 billion. The net proceeds were used for general
corporate purposes, including the long-term financing for the recently
completed Metavante acquisitions. The financing transactions consisted of
the following:
The Corporation issued $600.0 million of 4.375% Senior Notes due August 1,
2009. Interest is payable semi-annually each February 1st and August 1st
with the first payment due February 1, 2005.
The Corporation and M&I Capital Trust B also issued 16,000,000 units of
Common SPACESSM. Each unit has a stated value of $25.00 for an aggregate
value of $400.0 million. Each Common SPACES consists of (i) a stock
purchase contract under which the investor agrees to purchase for $25.00,
a fraction of a share of the Corporation's common stock on the stock
purchase date and (ii) a 1/40, or 2.5%, undivided beneficial interest in a
preferred security of M&I Capital Trust B, also referred to as the
STACKSSM, with an initial liquidation amount of $1,000.00. The stock
purchase date is expected to be August 15, 2007, but could be deferred for
quarterly periods until August 15, 2008. The Common SPACES qualify as
tier 1 capital for regulatory capital purposes. See LIQUIDITY AND CAPITAL
RESOURCES and OFF-BALANCE SHEET ARRANGEMENTS for further discussion of
Common SPACES.
On September 8, 2004, Metavante acquired certain assets of Response Data
Corp. ("RDC"), for approximately $35.0 million in cash. RDC is a New
Jersey-based provider of credit card balance transfer, bill pay and
convenience check processing. It is expected that this acquisition will
enable Metavante to expand its payment solutions product offerings by
adding credit card balance transfer bill payment. See Note 5, Business
Combinations in the Notes to Financial Statements.
During the third quarter of 2004, the Corporation prepaid $300 million of
floating rate debt. In conjunction with this transaction, the Corporation
terminated a related interest rate swap designated as a cash flow hedge
that resulted in a charge to earnings of $2.0 million. The loss is
reported in other in Other expense in the Consolidated Statements of
Income.
Second Quarter 2004
___________________
On May 27, 2004, Metavante completed the purchase of certain assets and
the assumption of certain liabilities for $157.4 million in cash of the
privately held Kirchman Corporation ("Kirchman") of Orlando, Florida.
Kirchman provides automation software and compliance services to the
banking industry. The acquisition of Kirchman provides Metavante with
core processing software that financial institutions can run in-house, a
solution that Metavante previously did not offer.
During the second quarter of 2004, the Corporation filed a shelf
registration statement with the Securities and Exchange Commission which
will enable the Corporation to issue various securities, including debt
securities, common stock, preferred stock, depositary shares, purchase
contracts, units, warrants, and trust preferred securities, up to an
aggregate amount of $3.0 billion. At September 30, 2004, approximately
$1.6 billion was available for future securities issuances.
First Quarter 2004
___________________
During the first quarter of 2004, the Corporation's Banking segment
completed the purchase for cash 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. 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 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.
Third Quarter 2003
__________________
During the third quarter of 2003, one of the portfolio companies held by
the Corporation's Capital Markets group was sold at a gain. The gain of
$16.2 million is reported in net investment securities gains in the
Consolidated Statements of Income.
Several income tax audits covering multiple tax jurisdictions were
resolved during the third quarter of 2003 which positively affected the
banking segment by approximately $25.0 million and Metavante by $4.9
million. The impact is reported in the provision for income taxes in the
Consolidated Statements of Income.
24
In conjunction with previous acquisitions, Metavante had made certain
operating decisions with respect to facility and platform consolidations.
During the third quarter of 2003, Metavante elected to retain one of the
facilities and the related platforms that previously had been set for
closure. As a result of these decisions, $8.5 million of liabilities
established for the facility closure, consisting of severance of $2.4
million and lease costs of $6.1 million were no longer required. As a
result of a change in product strategy, $15.7 million of related
capitalized software costs were determined to have no future value and
were written off. The financial statement impact of these decisions is
reflected in Salaries and employee benefits expense, Net occupancy expense
and Other expense in the Consolidated Statements of Income.
As a result of the financial impact of the previously described
transactions and decisions which occurred in the third quarter of 2003 and
in consideration of the low interest rate environment, the Corporation
acquired and extinguished $730.3 million in par value of its longer-term
and higher cost debt obligations. These debt obligations were replaced
with debt obligations that have a lower cost and slightly longer
maturities. The cost of acquiring and extinguishing the existing debt
obligations amounted to $54.7 million and is reported as a component of
Other expense in the Consolidated Statements of Income.
The aggregate net income impact of these transactions and decisions was
approximately $0.5 million and was not material to reported net income or
earnings per share for the three and nine months ended September 30, 2003.
Second Quarter 2003
___________________
During the second quarter of 2003, the Corporation redeemed all of the
Floating Rate Debentures held by its subsidiary, MVBI Capital Trust. MVBI
Capital Trust then redeemed all of its currently outstanding Floating
Rate Trust Preferred Securities at an aggregate redemption price of $14.95
million. In conjunction with the redemption, the Corporation terminated
the associated interest rate swap designated as a cash flow hedge. The
loss in Accumulated other comprehensive income and unamortized debt
issuance costs aggregating $2.0 million were charged to other in Other
expense in the Consolidated Statements of Income during the second quarter
of 2003.
During the second quarter of 2003, the Corporation recognized impairment
losses on the interest-only strips which represent retained interests
associated with its auto securitization activities in the amount of $4.1
million. The loss is reported in Net investment securities gains (losses)
in the Consolidated Statements of Income.
First Quarter 2003
__________________
During the first quarter of 2003, Metavante completed the integration of
its acquisition of Paytrust, Inc. ("Paytrust"). 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 third quarter of 2004 amounted to $281.1
million compared to $258.7 million reported for the third quarter of 2003.
For the nine months ended September 30, 2004, net interest income amounted
to $843.8 million compared to $787.1 million for the nine months ended
September 30, 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 of lengthening liabilities in order to
reduce future volatility in net interest income due to interest rate
increases, cash expenditures for current year acquisitions and cash
expenditures for repurchases of common stock and acquisitions in the prior
year.
Average earning assets in the third quarter of 2004 amounted to $33.6
billion compared to $30.0 billion in the third quarter of 2003, an
increase of $3.6 billion, or 11.9%. Increases in average loans and leases
accounted for $2.9 billion of the quarter over quarter growth. Average
investment securities increased $0.8 billion. Average earning assets for
the nine months ended September 30, 2004 amounted to $32.5 billion
compared to $29.7 billion for the nine months ended September 30, 2003, an
increase of $2.8 billion, or 9.3%. Increases in average loans and leases
accounted for $2.2 billion of the growth over the respective periods.
Average investment securities increased $0.7 billion.
25
Average interest bearing liabilities increased $3.7 billion or 15.0% in
the third quarter of 2004 compared to the third quarter of 2003. Average
interest bearing deposits increased $2.2 billion or 12.3% in the third
quarter of 2004 compared to the third quarter of last year. Average total
borrowings increased $1.5 billion or 22.0% in the third quarter of 2004
compared to the same period in 2003. For the nine months ended September
30, 2004, average interest bearing liabilities increased $2.3 billion or
9.4% compared to the same period in 2003. Average interest bearing
deposits increased $1.3 billion or 7.6% in the first nine months of 2004
compared to the first nine months of last year. Average total borrowings
increased $1.0 billion or 14.0% in the first nine months of 2004 compared
to the same period in 2003.
Average noninterest bearing deposits increased $0.3 billion or 6.6% in the
three months ended September 30, 2004 compared to the same period last
year. On a year-to-date basis, average noninterest bearing deposits
increased $0.4 billion or 9.6% in the first nine months of 2004 compared
to the first nine months of 2003.
The growth and composition of the Corporation's quarterly average loan and
lease portfolio for the current quarter and previous four quarters are
reflected in the following table. ($ in millions):
Consolidated Average Loans and Leases
______________________________________
2004 2003 Growth Pct.
----------------------------- ------------------- ------------------
Third Second First Fourth Third Prior
Quarter Quarter Quarter Quarter Quarter Annual Quarter
--------- --------- --------- --------- --------- -------- ---------
Commercial Loans and Leases
Commercial $ 7,796 $ 7,463 $ 7,142 $ 6,839 $ 6,912 12.8% 4.5%
Commercial real estate
Commercial mortgages 7,826 7,512 7,246 7,076 6,986 12.0 4.2
Construction 1,100 1,071 1,075 1,071 1,014 8.5 2.7
-------- -------- -------- -------- -------- ------ ------
Total commercial real estate 8,926 8,583 8,321 8,147 8,000 11.6 4.0
Commercial lease financing 395 393 399 384 392 0.6 0.4
-------- -------- -------- -------- -------- ------ ------
Total Commercial
Loans and Leases 17,117 16,439 15,862 15,370 15,304 11.8 4.1
Personal Loans and Leases
Residential real estate
Residential mortgages 3,452 3,210 2,958 2,811 2,751 25.5 7.6
Construction 342 292 269 246 210 62.5 16.9
-------- -------- -------- -------- -------- ------ ------
Total residential real estate 3,794 3,502 3,227 3,057 2,961 28.1 8.3
Personal loans
Student 79 83 102 95 84 (5.3) (3.5)
Credit card 214 244 230 213 200 6.7 (12.5)
Home equity loans and lines 4,894 4,688 4,439 4,215 4,100 19.4 4.4
Other 1,256 1,388 1,391 1,516 1,692 (25.8) (9.5)
-------- -------- -------- -------- -------- ------ ------
Total personal loans 6,443 6,403 6,162 6,039 6,076 6.0 0.6
Personal lease financing 146 164 177 198 255 (42.8) (11.1)
-------- -------- -------- -------- -------- ------ ------
Total Personal Loans and Leases 10,383 10,069 9,566 9,294 9,292 11.7 3.1
-------- -------- -------- -------- -------- ------ ------
Total Consolidated Average
Loans and Leases $ 27,500 $ 26,508 $ 25,428 $ 24,664 $ 24,596 11.8% 3.7%
======== ======== ======== ======== ======== ====== =======
Total consolidated average loans and leases increased $2.9 billion or
11.8% to $27.5 billion in the third quarter of 2004 compared to the third
quarter of 2003. Total average commercial loan and lease growth amounted
to $1.8 billion or 11.8% in the current quarter compared to the third
quarter of the prior year. The growth in average commercial loans and
leases in the third quarter of 2004 compared to the third quarter of 2003
was evenly split between commercial and industrial loans and commercial
real estate loans which each contributed approximately $0.9 billion,
respectively to the quarter over quarter loan growth. Total average
personal loans and leases increased $1.1 billion or 11.7% to $10.4 billion
in the third quarter of 2004 compared to the third 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 $0.8
billion. Average indirect auto loans and leases declined approximately
$0.5 billion in the current quarter compared to the third quarter of the
prior year. From a production standpoint, residential real estate loan
closings in the third quarter of 2004 were $0.2 billion or 19.6% lower
than loan closings in the second quarter of 2004 and were approximately
$0.6 billion or 35.9% lower in the third quarter of 2004 compared to the
third quarter of 2003. Early indications, as measured by application
volume, suggest that loan closings in the fourth quarter of 2004 may
approximate third quarter production.
26
For the nine month period, total consolidated average loans and leases
increased $2.2 billion or 9.0% in the first nine months of 2004 compared
to the first nine months of 2003. Total average commercial loan and lease
growth amounted to $1.3 billion or 8.8% in the nine months ended September
30, 2004 compared to the nine months ended September 30, 2003. The growth
in average commercial loans and leases in the first nine months of 2004
compared to the same period in 2003 was primarily due to the growth in
average commercial real estate loans which increased $0.8 billion. Total
average personal loans and leases increased $0.8 billion or 9.2% in the
first nine months of 2004 compared to the first nine months of 2003. This
growth was driven primarily by growth in home equity loans and lines and
residential real estate loans which each increased approximately $0.6
billion. Average indirect auto loans and leases declined approximately
$0.4 billion in the nine months ended September 30, 2004 compared to the
nine months ended September 30, 2003. From a production standpoint,
residential real estate loan closings declined approximately $1.5 billion
or 33.7% in the first nine months of 2004 compared to the first nine
months of 2003.
The growth in average commercial loans in the first nine months of 2004
has been a combination of loans to new customers and increased activity
from existing customers whose businesses are in a variety of industries
located in Wisconsin and throughout the Corporation's markets outside of
the state. When compared to two or three years ago, the business activity
in the Corporation's markets has shown some signs of recovery however, the
Corporation continues to observe modest capital spending and does not
expect that to change in the near term. As a result of customers'
improved profitability and stronger cash flows the Corporation has
experienced a reduction in nonperforming loans and leases and loan growth.
While it may be too early to determine if this is the early stage of more
robust and sustainable 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.
The Corporation sells residential real estate production in the secondary
market and 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 third quarter of 2004
compared to $1.1 billion in the third quarter of the prior year.
Approximately $81.1 million of loans sold were attributable to the AmerUs
acquisition. For the nine months ended September 30, 2004, residential
real estate loans sold to investors amounted to $1.2 billion compared to
$3.2 billion in the nine months ended September 30, 2003. Approximately
$198.2 million of loans sold in the first nine months of 2004 were
attributable to the AmerUs acquisition. At September 30, 2004 and 2003,
the Corporation had approximately $87.6 million and $42.8 million of
mortgage loans held for sale, respectively. Gains from the sale of
mortgage loans amounted to $7.0 million in the third quarter of 2004
compared to $19.4 million in the third quarter of last year. For the nine
months ended September 30, 2004 and 2003, gains from the sale of mortgage
loans amounted to $21.1 million and $49.7 million, respectively.
Approximately $1.8 million and $4.5 million of the gain in the third
quarter and first nine months of 2004, respectively, were attributable to
the AmerUs acquisition.
Auto loans securitized and sold in the third quarter of 2004 amounted to
$0.1 billion compared to $0.2 billion in the third quarter of last year.
For the nine months ended September 30, 2004 and 2003, auto loans
securitized and sold amounted to $0.5 billion, respectively. For the
three and nine months ended September 30, 2004, losses from the sale and
securitization of auto loans amounted to $0.6 million and $2.9 million,
respectively. For the three and nine months ended September 30, 2003,
gains from the sale and securitization of auto loans amounted to $0.8
million and $6.1 million, respectively. The losses incurred in 2004 are
primarily due to lower loan interest spreads associated with new auto loan
production in a rising interest rate environment.
The Corporation anticipates that it will continue to divest itself of
selected assets through sale or securitization in future periods.
27
The growth and composition of the Corporation's quarterly average deposits
for the current and previous four quarters are as follows ($ in millions):
Consolidated Average Deposits
_____________________________
2004 2003 Growth Pct.
----------------------------- ------------------- ------------------
Third Second First Fourth Third Prior
Quarter Quarter Quarter Quarter Quarter Annual Quarter
--------- --------- --------- --------- --------- -------- ---------
Bank issued deposits
Noninterest bearing deposits
Commercial $ 3,280 $ 3,143 $ 2,988 $ 3,125 $ 3,004 9.2% 4.3%
Personal 902 908 855 855 828 8.9 (0.6)
Other 456 463 473 489 517 (11.7) (1.5)
-------- -------- -------- -------- -------- ------ ------
Total noninterest
bearing deposits 4,638 4,514 4,316 4,469 4,349 6.6 2.8
Interest bearing deposits
Savings and NOW 3,452 3,395 3,303 3,282 3,273 5.5 1.7
Money market 5,612 5,657 5,780 6,015 6,040 (7.1) (0.8)
Foreign activity 849 943 909 799 759 11.9 (9.9)
-------- -------- -------- -------- -------- ------ ------
Total interest
bearing deposits 9,913 9,995 9,992 10,096 10,072 (1.6) (0.8)
Time deposits
Other CDs and time deposits 2,653 2,582 2,611 2,659 2,707 (2.0) 2.7
CDs greater than $100,000 805 660 632 633 617 30.4 22.0
-------- -------- -------- -------- -------- ------ ------
Total time deposits 3,458 3,242 3,243 3,292 3,324 4.0 6.7
-------- -------- -------- -------- -------- ------ ------
Total bank issued deposits 18,009 17,751 17,551 17,857 17,745 1.5 1.5
Wholesale deposits
Money market 747 72 75 74 73 923.1 933.5
Brokered CDs 5,009 4,498 3,854 3,270 2,938 70.5 11.4
Foreign time 869 1,188 1,035 1,282 1,399 (37.9) (26.9)
-------- -------- -------- -------- -------- ------ ------
Total wholesale deposits 6,625 5,758 4,964 4,626 4,410 50.3 15.1
-------- -------- -------- -------- -------- ------ ------
Total consolidated
average deposits $ 24,634 $ 23,509 $ 22,515 $ 22,483 $ 22,155 11.2% 4.8%
======== ======== ======== ======== ======== ====== =======
Total consolidated average deposits increased $2.5 billion or 11.2% in the
third quarter of 2004 compared to the third quarter of 2003. Average
noninterest bearing deposits increased $0.3 billion or 6.6% while average
bank-issued interest bearing activity accounts declined $0.2 billion or
1.6% in the current quarter compared to the third quarter of the prior
year. Average bank-issued time deposits increased $0.1 billion or 4.0% in
the third quarter of 2004 compared to the third quarter of 2003 and
increased $0.2 billion or 6.7% since the second quarter of 2004. The
Corporation has experienced success in competing for these deposits
without pricing above comparable wholesale levels.
For the nine months ended September 30, 2004, total average consolidated
deposits increased $1.7 billion or 8.0% compared to the nine months ended
September 30, 2003. Average noninterest bearing deposits increased $0.4
billion or 9.6% while average bank-issued interest bearing activity
accounts declined $0.1 billion or 1.1% in the first nine months of 2004
compared to the first nine months of 2003.
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. The Corporation
continues to emphasize the sale of checking products. However, management
expects the annual growth in noninterest bearing balances in 2004 to be
more modest than that experienced in 2003.
28
For the three and nine months ended September 30, 2004, average wholesale
deposits increased $2.2 billion and $1.6 billion, respectively, compared
to the three and nine months ended September 30, 2003. The Corporation
continues to make greater use of wholesale funding alternatives,
especially brokered money market deposits and 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.
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 amounted to $150.0
million with an annual coupon interest rate of 2.07% in the first quarter
of 2004 and $500.0 million with an annual weighted coupon interest rate of
3.29% in the second quarter of 2004. During the second quarter of 2004,
the Corporation issued $100.0 million of Series E medium term notes with
an annual coupon rate of 1.72% and $2.6 million of MiNotes with an annual
weighted average coupon interest rate of 4.97%.
As previously discussed, during the third quarter of 2004, the Corporation
completed two financing transactions aggregating $1.0 billion, which
consisted of $600.0 million of 4.375% Senior Notes and 16,000,000 units of
Common SPACESSM. Each unit has a stated value of $25.00 for an aggregate
value of $400.0 million. See LIQUIDITY AND CAPITAL RESOURCES and OFF-
BALANCE SHEET ARRANGEMENTS for further discussion of Common SPACES. The
net proceeds were used for general corporate purposes, including the long-
term financing for the recently completed Metavante acquisitions. In
addition to the financing transactions previously discussed, during the
third quarter of 2004, the Corporation's lead bank, M&I Marshall & Ilsley
Bank ("M&I Bank") issued $200.0 million of 3.95% senior notes which mature
in 2009. New FHLB floating rate advances amounted to $360.0 million. M&I
Bank also prepaid $300.0 million of floating rate FHLB advances and
terminated receive floating pay fixed interest rate swaps designated as
cash flow hedges against the FHLB advances. The termination of the
interest rate swap resulted in a charge to earnings of $2.0 million.
During the third quarter of 2004, the Corporation issued $9.5 million of
MiNotes with an annual weighted average coupon interest rate of 4.01%.
MiNotes in the amount of $6.7 million with an annual weighted average
coupon interest rate of 5.93% were called by or put to the Corporation in
accordance with the existing terms of the MiNote agreements.
29
The Corporation's consolidated average interest earning assets and
interest bearing liabilities, interest earned and interest paid for the
three and nine months ended September 30, 2004 and 2003, are presented in
the following tables ($ in millions):
Consolidated Yield and Cost Analysis
____________________________________
Three Months Ended Three Months Ended
September 30, 2004 September 30, 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 $ 8,190.5 $ 99.3 4.82 % $ 7,304.4 $ 83.9 4.55 %
Commercial real estate loans 8,926.4 120.8 5.38 8,000.0 110.9 5.50
Residential real estate loans 3,794.1 52.2 5.48 2,961.2 42.7 5.72
Home equity loans and lines 4,893.4 63.3 5.15 4,098.6 56.7 5.49
Personal loans and leases 1,695.2 21.7 5.09 2,232.2 29.4 5.23
---------- -------- -------- ---------- -------- --------
Total loans and leases 27,499.6 357.3 5.17 24,596.4 323.6 5.22
Investment securities (b):
Taxable 4,710.8 51.7 4.36 3,990.1 33.3 3.34
Tax Exempt (a) 1,224.1 22.6 7.46 1,166.8 21.7 7.50
---------- -------- -------- ---------- -------- --------
Total investment securities 5,934.9 74.3 4.99 5,156.9 55.0 4.27
Trading securities (a) 23.5 0.1 1.38 26.8 0.1 0.99
Other short-term investments 165.1 0.7 1.57 259.6 0.5 0.79
---------- -------- -------- ---------- -------- --------
Total interest earning assets $ 33,623.1 $ 432.4 5.12 % $ 30,039.7 $ 379.2 5.02 %
========== ======== ======== ========== ======== ========
Interest bearing deposits:
Bank issued deposits:
Bank issued interest
bearing activity deposits $ 9,913.0 $ 19.8 0.79 % $ 10,072.1 $ 16.2 0.64 %
Bank issued time deposits 3,457.7 21.5 2.47 3,324.3 20.3 2.42
---------- -------- -------- ---------- -------- --------
Total bank issued deposits 13,370.7 41.3 1.23 13,396.4 36.5 1.08
Wholesale deposits 6,625.6 32.7 1.96 4,409.6 15.8 1.42
---------- -------- -------- ---------- -------- --------
Total interest bearing deposits 19,996.3 74.0 1.47 17,806.0 52.3 1.16
Short-term borrowings 2,493.6 14.3 2.29 3,102.6 19.6 2.51
Long-term borrowings 5,899.7 54.8 3.69 3,775.7 40.7 4.27
---------- -------- -------- ---------- -------- --------
Total interest bearing liabilities $ 28,389.6 $ 143.1 2.01 % $ 24,684.3 $ 112.6 1.81 %
========== ======== ======== ========== ======== ========
Net interest margin (FTE) as a
percent of average earning assets $ 289.3 3.42 % $ 266.6 3.53 %
======== ======== ======== ========
Net interest spread (FTE) 3.11 % 3.21 %
======== ========
(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.
30
Consolidated Yield and Cost Analysis
____________________________________
Nine Months Ended Nine Months Ended
September 30, 2004 September 30, 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 $ 7,863.6 $ 276.4 4.70 % $ 7,319.6 $ 254.2 4.64 %
Commercial real estate loans 8,611.4 345.8 5.36 7,817.3 335.2 5.73
Residential real estate loans 3,508.6 144.1 5.49 2,884.9 130.6 6.05
Home equity loans and lines 4,674.2 183.5 5.24 4,074.1 175.2 5.75
Personal loans and leases 1,824.3 69.3 5.08 2,205.2 90.8 5.50
---------- -------- -------- ---------- -------- --------
Total loans and leases 26,482.1 1,019.1 5.14 24,301.1 986.0 5.42
Investment securities (b):
Taxable 4,638.6 148.7 4.30 3,972.1 120.4 4.10
Tax Exempt (a) 1,180.8 65.7 7.58 1,180.0 65.6 7.58
---------- -------- -------- ---------- -------- --------
Total investment securities 5,819.4 214.4 4.95 5,152.1 186.0 4.89
Trading securities (a) 23.0 0.2 1.34 23.3 0.2 1.11
Other short-term investments 180.7 1.6 1.18 266.5 1.9 0.98
---------- -------- -------- ---------- -------- --------
Total interest earning assets $ 32,505.2 $1,235.3 5.08 % $ 29,743.0 $1,174.1 5.29 %
========== ======== ======== ========== ======== ========
Interest bearing deposits:
Bank issued deposits:
Bank issued interest
bearing activity deposits $ 9,966.6 $ 51.1 0.69 % $ 10,081.2 $ 59.3 0.79 %
Bank issued time deposits 3,314.4 59.9 2.41 3,435.9 65.6 2.55
---------- -------- -------- ---------- -------- --------
Total bank issued deposits 13,281.0 111.0 1.12 13,517.1 124.9 1.24
Wholesale deposits 5,785.8 76.5 1.77 4,205.3 50.5 1.61
---------- -------- -------- ---------- -------- --------
Total interest bearing deposits 19,066.8 187.5 1.31 17,722.4 175.4 1.32
Short-term borrowings 3,058.3 44.4 1.94 3,303.7 62.6 2.54
Long-term borrowings 4,952.2 135.6 3.66 3,724.8 125.2 4.49
---------- -------- -------- ---------- -------- --------
Total interest bearing liabilities $ 27,077.3 $ 367.5 1.81 % $ 24,750.9 $ 363.2 1.96 %
========== ======== ======== ========== ======== ========
Net interest margin (FTE) as a
percent of average earning assets $ 867.8 3.57 % $ 810.9 3.65 %
======== ======== ======== ========
Net interest spread (FTE) 3.27 % 3.33 %
======== ========
(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 11 basis points from 3.53
percent in the third quarter of 2003 to 3.42 percent in the third quarter
of 2004. The cost of bank issued interest bearing deposits in the current
quarter increased 15 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) increased
3 basis points in the current quarter compared to the third quarter of
last year. The Corporation estimates that the additional interest expense
associated with the $1.0 billion of debt issued in late July 2004 to
finance Metavante's recent acquisitions lowered the net interest margin as
a percent of average earning assets on a FTE basis by approximately 9
basis points in the third quarter of 2004. The Corporation estimates that
the additional interest expense associated with this debt will lower the
net interest margin as a percent of average earning assets on a FTE basis
by approximately 13 basis points in the fourth quarter of 2004. Unlike a
bank acquisition or loan growth, where the primary source of revenue is
interest income, the revenue impact of Metavante's acquisitions is
recorded in Other income and is not a component of the net interest margin
statistic.
On a year to date basis, the net interest margin, as a percent of average
earning assets on a FTE basis, decreased 8 basis points from 3.65 percent
in the nine months ended September 30, 2003 to 3.57 percent in the nine
months ended September 30, 2004. The yield on average interest earning
assets decreased 21 basis points in the first nine months of 2004 compared
to the first nine months of the prior year. The cost of bank issued
interest bearing deposits decreased 12 basis points in the nine months
ended September 30, 2004 compared to the same period of the previous year.
As previously discussed, the increase in noninterest bearing deposits
provided a benefit to the net interest margin. The cost of other funding
sources (wholesale deposits and total borrowings) decreased 36 basis
points in the nine months ended September 30, 2004, compared to the nine
months ended September 30, 2003. The Corporation estimates that the
additional interest expense associated with the $1.0 billion of debt
issued in late July 2004 to finance Metavante's recent acquisitions
lowered the net interest margin as a percent of average earning assets on
a FTE basis by approximately 3 basis points in the nine months ended
September 30, 2004.
31
Net interest income for the quarter and first nine months of 2004 was
affected by a number of factors. Loan growth, the early retirement of
higher cost debt primarily in the latter part of 2003, and lower levels of
prepayment activity were beneficial to net interest income in 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 and the additional interest expense
associated with the $1.0 billion of debt issued in late July 2004 to
finance Metavante's recent acquisitions, has adversely impacted net
interest income.
Management expects the net interest margin as a percent of average earning
assets will likely trend down 6 to 8 basis points in the fourth quarter of
2004 compared to the third quarter of 2004 as a result of the following:
loan spreads tend to be more narrow, particularly as interest rates
increase; as the economy improves, the Corporation's capacity to generate
loans will likely exceed its ability to generate appropriately priced
deposits; and the impact of a full quarter of interest expense, compared
to two months of interest expense in the third quarter of 2004, from the
financing of Metavante's recent acquisitions. 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 September 30, 2004, and as of the end of the prior four
quarters.
Nonperforming Assets
____________________
($000's)
2004 2003
------------------------------- --------------------
Third Second First Fourth Third
Quarter Quarter Quarter Quarter Quarter
--------- --------- --------- --------- ---------
Nonaccrual $ 139,154 $ 137,845 $ 149,550 $ 166,387 $ 180,535
Renegotiated 244 253 261 278 286
Past due 90 days or more 3,148 6,902 6,296 6,111 6,479
--------- --------- --------- --------- ---------
Total nonperforming loans and leases 142,546 145,000 156,107 172,776 187,300
Other real estate owned 7,098 10,394 13,172 13,235 13,642
--------- --------- --------- --------- ---------
Total nonperforming assets $ 149,644 $ 155,394 $ 169,279 $ 186,011 $ 200,942
========= ========= ========= ========= =========
Allowance for loan and lease losses $ 358,072 $ 357,898 $ 353,687 $ 349,561 $ 348,100
========= ========= ========= ========= =========
Consolidated Statistics
_______________________
2004 2003
------------------------------- --------------------
Third Second First Fourth Third
Quarter Quarter Quarter Quarter Quarter
--------- --------- --------- --------- ---------
Net charge-offs to average
loans and leases annualized 0.10 % 0.08 % 0.08 % 0.13 % 0.13 %
Total nonperforming loans and
leases to total loans and leases 0.51 0.53 0.60 0.69 0.76
Total nonperforming assets to
total loans and leases and
other real estate owned 0.53 0.57 0.65 0.74 0.82
Allowance for loan and lease
losses to total loans and leases 1.27 1.32 1.36 1.39 1.41
Allowance for loan and lease
losses to total nonperforming
loans and leases 251 247 227 202 186
32
Nonaccrual Loans and Leases By Type
___________________________________
($000's)
2004 2003
------------------------------- --------------------
Third Second First Fourth Third
Quarter Quarter Quarter Quarter Quarter
--------- --------- --------- --------- ---------
Commercial
Commercial, financial
and agricultural $ 49,714 $ 39,473 $ 45,714 $ 56,096 $ 66,571
Lease financing receivables 5,476 6,398 7,381 13,308 4,538
--------- --------- --------- --------- ---------
Total commercial 55,190 45,871 53,095 69,404 71,109
Real estate
Construction and land development 207 1,724 78 800 353
Commercial mortgage 33,817 38,561 46,172 42,857 47,012
Residential mortgage 48,715 50,776 49,528 52,098 60,287
--------- --------- --------- --------- ---------
Total real estate 82,739 91,061 95,778 95,755 107,652
Personal 1,225 913 677 1,228 1,774
--------- --------- --------- --------- ---------
Total nonaccrual loans and leases $ 139,154 $ 137,845 $ 149,550 $ 166,387 $ 180,535
========= ========= ========= ========= =========
Reconciliation of Allowance for Loan and Lease Losses
_____________________________________________________
($000's)
2004 2003
------------------------------- --------------------
Third Second First Fourth Third
Quarter Quarter Quarter Quarter Quarter
--------- --------- --------- --------- ---------
Beginning balance $ 357,898 $ 353,687 $ 349,561 $ 348,100 $ 348,100
Provision for loan and lease losses 6,872 9,227 9,027 9,807 7,852
Allowance of banks and loans acquired -- -- 27 -- --
Loans and leases charged-off
Commercial 4,403 4,015 2,904 4,497 4,317
Real estate 3,047 2,765 3,138 5,142 3,238
Personal 3,207 2,616 3,653 3,661 2,528
Leases 252 536 1,001 2,494 880
--------- --------- --------- --------- ---------
Total charge-offs 10,909 9,932 10,696 15,794 10,963
Recoveries on loans and leases
Commercial 2,366 2,279 2,886 3,810 1,400
Real estate 611 1,336 1,555 2,508 591
Personal 900 906 756 762 831
Leases 334 395 571 368 289
--------- --------- --------- --------- ---------
Total recoveries 4,211 4,916 5,768 7,448 3,111
--------- --------- --------- --------- ---------
Net loans and leases charge-offs 6,698 5,016 4,928 8,346 7,852
--------- --------- --------- --------- ---------
Ending balance $ 358,072 $ 357,898 $ 353,687 $ 349,561 $ 348,100
========= ========= ========= ========= =========
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
$7.1 million at September 30, 2004, compared to $10.4 million at June 30,
2004 and $13.2 million at March 31, 2004.
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.
33
At September 30, 2004, nonperforming loans and leases amounted to $142.5
million or 0.51% of consolidated loans and leases compared to $145.0
million or 0.53% of consolidated loans and leases at June 30, 2004, $156.1
million or 0.60% of consolidated loans and leases at March 31, 2004 and
$172.8 million or 0.69% of consolidated loans and leases at December 31,
2003. Both in terms of absolute dollars and percent of total loans and
leases outstanding, nonperforming loans at September 30, 2004 is the sixth
consecutive quarter-end in which there was a decline in nonperforming
loans. Nonaccrual loans and leases have been the primary source 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 improving credit conditions
throughout the loan and lease portfolios.
Net charge-offs amounted to $6.7 million or 0.10% of average loans and
leases in the third quarter of 2004 compared to $5.0 million or 0.08% of
average loans and leases in the second quarter of 2004, $4.9 million or
0.08% of average loans and leases in the first quarter of 2004 and $8.3
million or 0.13% of average loans and leases in the fourth quarter of
2003. The net charge-off activity experienced in the first and second
quarters of 2004 are the lowest levels experienced in any individual
quarter since the second quarter of 2000. This lower level of net charge-
offs has to some extent been the result of higher than normal recoveries.
Based on the status of some of the larger charge-offs recognized in recent
quarters, management expects recoveries will likely return to a lower
level in future periods. Recoveries in the third quarter of 2004 were
$0.7 million lower than recoveries in the second quarter of 2004 and $1.6
million lower than recoveries in the first quarter of 2004.
Credit quality continued to show improvement as evidenced by the decline
in nonperforming loans and leases and net charge-offs. 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 its experience in the first nine months of 2004,
the Corporation expects credit quality ratios will be below these ranges
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 some degree of stress and
uncertainty continues to exist.
The provision for loan and lease losses amounted to $6.9 million for the
three months ended September 30, 2004 compared to $9.2 million for the
three months ended June 30, 2004 and $7.9 million for the three months
ended September 30, 2003. The allowance for loan and lease losses as a
percent of total loans and leases outstanding was 1.27% at September 30,
2004, 1.32% at June 30, 2004 and 1.39% at December 31, 2003.
OTHER INCOME
____________
Total other income in the third quarter of 2004 amounted to $367.9 million
compared to $325.0 million in the same period last year, an increase of
$42.9 million or 13.2%. For the nine months ended September 30, 2004,
total other income amounted to $1,011.3 million compared to $910.2 million
for the nine months ended September 30, 2003, an increase of $101.1
million or 11.1%. The increase in other income was primarily due to
growth in data processing services and trust services revenue (primarily
the Metavante acquisitions described below) and was partially offset by
lower mortgage banking revenue and lower net investment securities gains.
Data processing services revenue amounted to $239.0 million in the third
quarter of 2004 compared to $166.3 million in the third quarter of 2003,
an increase of $72.7 million or 43.7%. For the nine months ended September
30, 2004, data processing services revenue amounted to $622.4 million
compared to $481.4 million for the nine months ended September 30, 2003,
an increase of $141.0 million or 29.3%. Revenue associated with
Metavante's acquisitions completed in the third quarter of 2004 (AFS, NYCE
and RDC) along with the May 2004 acquisition of Kirchman and the November
2003 acquisition of Printing For Systems, Inc. contributed approximately
$64.5 million and $91.4 million to the revenue growth in the three and
nine months ended September 30, 2004, over the comparable three and nine
months ended September 30, 2003. Overall, revenue growth was generally
strong throughout all aspects of this segment. Buyout revenue, which
varies from period to period, was not significant to data processing
services revenue for the three and nine months ended September 30, 2004
and 2003, respectively. By way of an update to the outlook previously
provided in prior filings, management anticipates Metavante's total
revenue (internal and external) to range from $945 million to $955 million
and segment income to range from $79 million to $82 million for the year
ended December 31, 2004. See Note 5, Business Combinations in Notes to
Financial Statements for an update on Metavante's recently announced
acquisition.
34
For the three months ended September 30, 2004, item processing revenue
amounted to $10.3 million compared to $11.2 million for the three months
ended September 30, 2003, a decrease of $0.9 million or 7.9%. Lower
volumes, some lost business and lower buyout fees, which vary period to
period, all contributed to the quarter over quarter decline. For the nine
months ended September 30, 2004, item processing revenue amounted to $32.6
million compared to $31.0 million for the nine months ended September 30,
2003, an increase of $1.6 million or 5.2%. The increase in revenues is
due to volumes processed.
Trust services revenue amounted to $37.5 million in the third quarter of
2004 compared to $32.0 million in the third quarter of 2003, an increase
of $5.5 million or 17.1%. For the nine months ended September 30, 2004,
trust services revenue amounted to $111.7 million compared to $93.3
million for the nine months ended September 30, 2003, an increase of $18.4
million or 19.8%. Revenue associated with the employee benefit plan
business purchased from a national banking association located in Missouri
contributed approximately $2.7 million and $7.1 million to the revenue
growth in the three and nine months ended September 30, 2004 compared to
the same periods in the prior year. 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 $17.4 billion at September 30, 2004, compared to $15.7
billion at December 31, 2003, and $14.5 billion at September 30, 2003.
Total mortgage banking revenue was $8.9 million in the third quarter of
2004 compared with $24.2 million in the third quarter of 2003, a decrease
of $15.3 million. For the nine months ended September 30, 2004, total
mortgage banking revenue was $27.5 million compared with $63.5 million for
the nine months ended September 30, 2003, a decrease of $36.0 million.
For the three and nine months ended September 30, 2004, the Corporation
sold $0.3 billion and $1.2 billion of residential mortgage loans to the
secondary market. Retained interests in the form of mortgage servicing
rights amounted to $1.1 million for the nine months ended September 30,
2004. By comparison, for the three and nine months ended September 30,
2003, the Corporation sold $1.1 billion and $3.2 billion of residential
mortgage loans to the secondary market. Retained interests in the form of
mortgage servicing rights amounted to $1.7 million for the nine months
ended September 30, 2003. Approximately $81.1 million of the residential
mortgage loans sold and $1.8 million of the reported gain recognized in
the third quarter of 2004 and $198.2 million of the residential mortgage
loans sold and $4.5 million of the reported gain recognized in the first
nine months of 2004 was attributable to the AmerUs acquisition.
Net investment securities activities for the three and nine months ended
September 30, 2004 were not significant. For the three months ended
September 30, 2003, net investment securities gains amounted to $16.7
million. As previously discussed, $16.2 million represents the gain from
the sale of one of the portfolio companies held by the Corporation's
Capital Markets group. For the nine months ended September 30, 2003, net
investment securities gains amounted to $15.7 million. Gains recognized
by the Corporation's Capital Markets group amounted to $17.9 million,
including the transaction previously discussed. These gains were offset
by $4.1 million of impairment losses recognized in the second quarter of
2003 on the interest-only strips which represent retained interests
associated with auto loan securitization activity.
Other income in the third quarter of 2004 amounted to $40.0 million
compared to $41.7 million in the third quarter of 2003, a decrease of $1.7
million. For the nine months ended September 30, 2004, other income
amounted to $120.9 million compared to $125.3 million for the nine months
ended September 30, 2003, a decrease of $4.4 million. Gains from the sale
of branches in the three and nine months ended September 30, 2003 amounted
to $1.6 million and $2.5 million, respectively. Lower trading income and
lower auto securitization income, as previously discussed, was offset by
increases in card related fees and other sources of income in the three
and nine months ended September 30, 2004 compared to the three and nine
months ended September 30, 2003.
OTHER EXPENSE
_____________
Total other expense for the three months ended September 30, 2004 amounted
to $408.1 million compared to $410.0 million for the three months ended
September 30, 2003, a decrease of $1.9 million. For the nine months ended
September 30, 2004, total other expense amounted to $1,145.1 million
compared to $1,081.3 million for the nine months ended September 30, 2003,
an increase of $63.8 million or 5.9%.
35
Total other expense for the three and nine months ended September 30, 2004
include the operating expenses associated with Metavante's acquisition of
Printing For Systems, Inc. in November 2003, Kirchman in May 2004, the
employee benefit plan business purchased by the Trust Services reporting
unit beginning in the third quarter of 2003 and the purchase of AmerUs by
the Banking segment on January 1, 2004. Also included in total other
expense for part of the three and nine months ended September 30, 2004 are
the operating expenses associated with Metavante's acquisitions of AFS on
July 1, 2004, NYCE on July 30, 2004 and RDC on September 8, 2004. Such
operating expenses have all been included in the Corporation's
consolidated operating expenses since the acquisitions were completed. In
addition, total other expense for the three and nine months ended
September 30, 2004 include losses from prepaying debt and terminating the
related interest rate swaps designated as hedges. For the three and nine
months ended September 30, 2004, such losses amounted to $2.0 million and
$6.9 million, respectively. Salaries and employee benefits expense for
the three and nine months ended September 30, 2004 include a $1.0 million
benefit for the retroactive recognition of the effect of the Medicare
Prescription Drug, Improvement and Modernization Act of 2003 ("Medicare
Act"). Other expense for the nine months ended September 30, 2004 include
Metavante's $4.9 million write-down of capitalized software costs
associated with a product that was impaired due to limited growth
potential and the decision to discontinue marketing the product to new
customers.
Total other expense for the three and nine months ended September 30, 2003
also includes losses from prepaying debt and terminating the related
interest rate swaps designated as hedges. For the three and nine months
ended September 30, 2003, such losses amounted to $54.7 million and $56.7
million, respectively. During the third quarter of 2003, Metavante
reversed $8.5 million of liabilities established for a facility closure,
consisting of severance of $2.4 million and lease costs of $6.1 million,
as a result of a decision to retain one of the facilities and the related
platforms that previously had been set for closure. Also during the third
quarter of 2003, $15.7 million of related capitalized software costs were
determined to have no future value and were written off due to a change in
product strategy. Total other expense for the nine months ended September
30, 2003 includes $2.5 million of transition costs associated with the
completion of Metavante's integration of Paytrust.
For the three months ended September 30, 2004, the estimated aggregate
impact of these items was a decrease to total other expense over the
comparative period of approximately $9.7 million. For the nine months
ended September 30, 2004, the estimated aggregate impact of these items
was an increase to total other expense over the nine months ended
September 30, 2003 of approximately $24.3 million. Excluding the impact
of these items, total other expense growth in the third quarter of 2004
compared to the third quarter of 2003 was approximately $7.8 million or
2.2% and for the nine months ended September 30, 2004 compared to the nine
months ended September 30, 2003, was approximately $39.5 million or 3.9%.
The Corporation estimates that including the operating expenses of
Metavante's acquisitions completed during the third quarter of 2004 for a
full quarter compared to a partial quarter will increase operating
expenses in the fourth quarter of 2004 by approximately $14 million.
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
September 30, 2004, and prior four quarters were:
Efficiency Ratios
_________________
Three Months Ended
-------------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
2004 2004 2004 2003 2003
------------- ------------- ------------- ------------- -------------
Consolidated Corporation 62.2 % 60.2 % 60.4 % 63.9 % 69.4 %
Consolidated Corporation
Excluding Metavante 49.0 % 48.8 % 49.2 % 52.1 % 60.6 %
Salaries and employee benefits expense amounted to $231.5 million in the
third quarter of 2004 compared to $199.4 million in the third quarter of
2003, an increase of $32.1 million or 16.1%. For the nine months ended
September 30, 2004, salaries and employee benefits expense amounted to
$647.3 compared to $590.1 million for the nine months ended September 30,
2003, an increase of $57.2 million or 9.7%. Salaries and benefits
associated with acquisitions and increases in performance-based incentive
compensation were the primary drivers of the growth in salaries and
employee benefits expense in the third quarter and first nine months of
2004 compared to the respective periods in 2003. Salaries and expense
growth for the nine months ended September 30, 2004 compared to the nine
months ended September 30, 2003 was offset by the salaries and benefits
expense associated with the Paytrust integration activities in the first
quarter of 2003 and the benefit associated with the retroactive
recognition of the effect of the Medicare Act in the third quarter of
2004.
36
For the third quarter of 2004, occupancy and equipment expense amounted to
$50.8 million compared to $40.3 million in the third quarter of 2003, an
increase of $10.5 million or 26.0%. For the nine months ended September
30, 2004, occupancy and equipment expense amounted to $142.6 million
compared to $133.8 million for the nine months ended September 30, 2003,
an increase of $8.8 million or 6.6%. Included in equipment expense for
the three and nine months ended September 30, 2004, was approximately $0.4
million of charges associated with a product impairment as previously
discussed. Occupancy and equipment expense for the three and nine months
ended September 30, 2003 include a $6.1 million reversal of lease costs
due to the decision to retain a facility previously identified for closure
and $0.8 million of expense associated with the Paytrust integration
activities in the first quarter of the 2003. For the three and nine
months ended September 30, 2004, the Corporation estimates that the
acquisitions contributed approximately $5.7 million and $6.6 million to
occupancy and equipment expense in the respective periods.
Software expenses, processing charges, supplies and printing, professional
services and shipping and handling expenses totaled $59.0 million in the
third quarter of 2004 compared to $53.9 million in the third quarter of
2003, an increase of $5.1 million or 9.5%. For the nine months ended
September 30, 2004, software expenses, processing charges, supplies and
printing, professional services and shipping and handling expenses totaled
$172.9 million compared to $154.7 million for the nine months ended
September 30, 2003, an increase of $18.2 million or 11.8%. For the three
and nine months ended September 30, 2004 compared to the three and nine
months ended September 30, 2003, Metavante contributed approximately $8.0
million and $21.1 million to the expense growth in these expense items
respectively. A significant part of that expense growth was due to its
acquisitions. Expense growth in these areas by other segments and the
holding company were offset by lower expenses associated with residential
mortgage loan production which were approximately $1.8 million less in the
third quarter of 2004 compared to the third quarter of the prior year.
Expenses associated with residential mortgage loan production were
approximately $5.6 million less in the nine month ended September 30, 2004
compared to the nine months ended September 30, 2003.
Amortization of intangibles amounted to $8.3 million in the third quarter
of 2004 compared to $3.4 million in the third quarter of 2003, an increase
of $4.9 million. For the nine months ended September 30, 2004,
amortization of intangibles amounted to $19.2 million compared to $17.8
million for the nine months ended September 30, 2003, an increase of $1.4
million. Amortization and valuation reserve adjustments associated with
mortgage servicing rights increased amortization expense $2.3 million in
the third quarter of 2004 compared to the third quarter of 2003 and
decreased amortization expense $0.4 million in the first nine months of
2004 compared to the first nine months of 2003. The carrying value of the
Corporation's mortgage servicing rights was $3.9 million at September 30,
2004. Amortization of core deposit intangibles, which is based on a
declining balance method, decreased $0.6 million in the third quarter of
2004 compared to the third quarter of the prior year and decreased $2.4
million in the nine months ended September 30, 2004 compared to the nine
months ended September 30, 2003. Included in amortization of intangibles
for the nine months ended September 30, 2004 is Metavante's $0.2 million
write-off of a customer-related intangible associated with an impaired
product as previously discussed. For the three and nine months ended
September 30, 2004, the Corporation estimates that the acquisitions
contributed approximately $3.4 million and $4.1 million to intangibles
amortization expense in the respective periods.
Other expense amounted to $58.6 million in the third quarter of 2004
compared to $113.1 million in the third quarter of 2003, a decrease of
$54.5 million. Losses recognized for the prepayment and termination of
interest rate swaps on long-term borrowings amounted to $2.0 million in
the third quarter of 2004 compared to $54.7 million in the third quarter
of 2003. The Corporation estimates that the acquisitions contributed
approximately $13.3 million to other expense in the third quarter of 2004
compared to the third quarter of 2003. For the nine months ended
September 30, 2004, other expense amounted to $163.1 million compared to
$184.9 million for the nine months ended September 30, 2003, a decrease of
$21.8 million. Losses recognized for the prepayment and termination of
interest rate swaps on long-term borrowings amounted to $6.9 million in
the first nine months of 2004 compared to $56.7 million in the first nine
months of 2003. The Corporation estimates that the acquisitions
contributed approximately $24.0 million to other expense growth in the
nine months ended September 30, 2004 compared to the nine months ended
September 30, 2003.
37
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 $3.5 million in the third quarter of 2004 compared to
$16.2 million in the third quarter of 2003, resulting in a decrease to
other expense over the comparative quarters of $12.7 million. As
previously discussed, during the third quarter of 2003, $15.7 million of
capitalized software costs were determined to have no future value and
were written off due to a change in product strategy. The Corporation
estimates that the Metavante acquisitions contributed approximately $0.4
million to net capitalized software development amortization in the third
quarter of 2004 compared to the third quarter of 2003. For the nine
months ended September 30, 2004 net software and conversion amortization
was $13.3 million compared to $7.8 million for the nine months ended
September 30, 2003, an increase of $5.5 million. As previously discussed,
net capitalized software development amortization for the nine months
ended September 30, 2004 includes the $4.9 million write-down of
capitalized software costs associated with a product that was impaired due
to limited growth potential and the decision to discontinue marketing the
product to new customers. The Corporation estimates that the acquisitions
contributed approximately $2.2 million to the growth in net capitalized
software development amortization in the nine months ended September 30,
2004 compared to the nine months ended September 30, 2003.
INCOME TAXES
____________
The provision for income taxes for the three months ended September 30,
2004 amounted to $78.6 million or 33.6% of pre-tax income compared to
$25.5 million or 15.4% of pre-tax income for the three months ended
September 30, 2003. For the nine months ended September 30, 2004, the
provision for income taxes amounted to $231.6 million or 33.8% of pre-tax
income compared to $159.9 million or 28.4% of pre-tax income for the nine
months ended September 30, 2003.
In the normal course of business, the Corporation and its affiliates are
routinely subject to examinations from federal and state tax authorities.
During the third quarter of 2003, several income tax audits covering
multiple tax jurisdictions were resolved which positively affected the
banking segment by approximately $25.0 million and Metavante by $4.9
million and resulted in a lower provision for income taxes in the
Consolidated Statements of Income for the three and nine months ended
September 30, 2003. Excluding the impact of the income tax audits, the
pro forma effective income tax rate for both the three and nine months
ended September 30, 2003 would have been 33.8%.
LIQUIDITY AND CAPITAL RESOURCES
_______________________________
Shareholders' equity was $3.59 billion or 9.2% of total consolidated
assets at September 30, 2004, compared to $3.33 billion or 9.7% of total
consolidated assets at December 31, 2003, and $3.34 billion or 9.9% of
total consolidated assets at September 30, 2003. The increase in
shareholders' equity at September 30, 2004 was primarily due to earnings
net of dividends paid.
During the third quarter of 2004, the Corporation and M&I Capital Trust B
issued 16,000,000 units of Common SPACESSM. Each unit has a stated value
of $25.00 for an aggregate value of $400.0 million. Each Common SPACES
consists of (i) a stock purchase contract under which the investor agrees
to purchase for $25, a fraction of a share of the Corporation's common
stock on the stock purchase date and (ii) a 1/40, or 2.5%, undivided
beneficial interest in a preferred security of M&I Capital Trust B, also
referred to as the STACKSSM, with each share having an initial liquidation
amount of $1,000. The stock purchase date is expected to be August 15,
2007, but could be deferred for quarterly periods until August 15, 2008.
The net proceeds were used for general corporate purposes, including the
long-term financing for the recently completed Metavante acquisitions.
On the stock purchase date, the number of shares of common stock the
Corporation will issue upon settlement of the stock purchase contracts
depends on the applicable market value per share of the Corporation's
common stock, which will be determined just prior to the stock purchase
date, and other factors. The Corporation currently estimates that it will
issue approximately 8.8 million to 10.9 million common shares to settle
shares issuable pursuant to the stock purchase contracts. Before issuance
of the common shares upon settlement of the stock purchase contracts, the
stock purchase contracts will be reflected in diluted earnings per share
calculations using the treasury stock method. Under the treasury stock
method, the Corporation expects there will be some dilutive effect on
earnings per share for periods when the average market price of the
Corporation's common stock for the reporting period is above $46.28 and
that there could be some dilutive effect on earnings per share for periods
when the average market price of the Corporation's common stock for the
reporting period is above the average market price of the Corporation's
common stock for the twenty trading days ending on the third trading day
immediately preceding the end of the reporting period. There was no
dilutive effect on earnings per share for the three and nine months ended
September 30, 2004.
38
The Common SPACES qualify as tier 1 capital for regulatory capital
purposes.
Holders of the STACKS are entitled to receive quarterly cumulative cash
distributions through the stock purchase date fixed initially at an annual
rate of 3.90% of the liquidation amount of $1,000 per STACKS. In
addition, the Corporation will make quarterly contract payments under the
stock purchase contract at the annual rate of 2.60% of the stated amount
of $25 per stock purchase contract. The Corporation recognized the
present value of the quarterly contract payments under the stock purchase
contract as a liability with an offsetting reduction in shareholders'
equity. That liability along with the allocated portion of the fees and
expenses incurred for the offering of Common SPACES resulted in a
reduction in shareholders' equity of $34.0 million.
At September 30, 2004, the net gain in accumulated other comprehensive
income amounted to $20.8 million which represents a positive change in
accumulated other comprehensive income of $18.1 million since December 31,
2003. Net accumulated other comprehensive income associated with
available for sale investment securities was a net gain of $41.8 million
at December 31, 2003, compared to a net gain of $40.2 million at September
30, 2004, resulting in a net loss of $1.6 million over the nine month
period. The unrealized loss associated with the change in fair value of
the Corporation's derivative financial instruments designated as cash flow
hedges declined $19.7 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 second and third
quarters of 2004, no common shares were acquired under the program. For
the nine months ended September 30, 2004, 2.3 million common shares were
acquired at an aggregate cost of $88.5 million or an average price of
$38.98 per common share. As a result of the Metavante acquisitions, the
Corporation does not expect that it will acquire common shares under the
Stock Repurchase Program in the near term. See Item 2 in Part II of this
Form 10-Q for the monthly purchase activity relating to the Corporation's
Stock Repurchase Program in 2004. For the three months ended September
30, 2003, 1.6 million common shares were acquired at an aggregate cost of
$50.2 million or $31.33 per common share. For the nine months ended
September 30, 2003, 1.7 million common shares were acquired at an
aggregate cost of $54.5 million or $31.19 per common share.
The Corporation continues to have a strong capital base and its regulatory
capital ratios are significantly above the minimum requirements as shown
in the following tables.
RISK-BASED CAPITAL RATIOS
_________________________
($ in millions)
September 30, 2004 December 31, 2003
--------------------------------- ---------------------------------
Amount Ratio Amount Ratio
--------------------------------- ---------------------------------
Tier 1 Capital $ 2,310 7.25 % $ 2,538 8.87 %
Tier 1 Capital
Minimum Requirement 1,274 4.00 1,144 4.00
-------------------------------- --------------------------------
Excess $ 1,036 3.25 % $ 1,394 4.87 %
================================ ================================
Total Capital $ 3,293 10.34 % $ 3,511 12.28 %
Total Capital
Minimum Requirement 2,547 8.00 2,288 8.00
-------------------------------- --------------------------------
Excess $ 746 2.34 % $ 1,223 4.28 %
================================ ================================
Risk-Adjusted Assets $ 31,836 $ 28,601
================= =================
LEVERAGE RATIOS
_______________
($ in millions)
September 30, 2004 December 31, 2003
--------------------------------- ---------------------------------
Amount Ratio Amount Ratio
--------------------------------- ---------------------------------
Tier 1 Capital $ 2,310 6.40 % $ 2,538 7.80 %
Minimum Leverage
Requirement 1,083 - 1,804 3.00 - 5.00 977 - 1,628 3.00 - 5.00
-------------------------------- --------------------------------
Excess $ 1,227 - 506 3.40 - 1.40 % $ 1,561 - 910 4.80 - 2.80 %
================================ ================================
Adjusted Average
Total Assets $ 36,078 $ 32,553
================= =================
In conjunction with the recently announced acquisition of VECTORsgi
Holdings, Inc. ("VECTOR") by Metavante, the Corporation announced that in
part, for the acquisition of VECTOR and for other corporate purposes, it
plans to issue and sell approximately $150 million of common stock in the
fourth quarter of 2004 in order to maintain its capital at desired levels.
Any such sale of shares of the Corporation's common stock is subject to
market conditions and changes in the timing, amount and terms. This Form
10-Q does not constitute an offer of any securities for sale.
39
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 $5.3 billion at September 30, 2004, represent a highly accessible
source of liquidity. The Corporation's portfolio of held-to-maturity
investment securities, which totaled $0.8 billion at September 30, 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 $16.4 billion in the third 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 $6.6
billion in the third 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 8 to the Consolidated Financial Statements for
an update of the Corporation's securitization activities in the third
quarter of 2004.
The Corporation's lead bank, M&I Marshall & Ilsley Bank ("the 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 September 30, 2004, amounted to $2.8
billion of which $0.6 billion is subordinated and qualifies as
supplementary capital for regulatory capital purposes. Bank notes issued
during the third quarter of 2004 amounted to $200.0 million.
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 Series E medium-term notes
with maturities ranging from 9 months to 30 years and at fixed or floating
rates. At September 30, 2004, Series E notes issued amounted to $0.4
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 September 30, 2004, MiNotes issued amounted
to $0.1 billion. Approximately $9.5 million of MiNotes were issued during
the third quarter of 2004. Additionally, the Corporation has a commercial
paper program. At September 30, 2004, commercial paper outstanding
amounted to $0.3 billion.
During the second quarter of 2004, the Corporation filed a shelf
registration statement with the Securities and Exchange Commission which
will enable the Corporation to issue various securities, including debt
securities, common stock, preferred stock, depositary shares, purchase
contracts, units, warrants, and trust preferred securities, up to an
aggregate amount of $3.0 billion. On July 29, 2004, the Corporation
issued $600 million of senior notes and $400 million of Common SPACES
under the shelf registration statement. At September 30, 2004,
approximately $1.6 billion was available for future securities issuances.
Short-term borrowings represent contractual debt obligations with
maturities of one year or less and amounted to $2.8 billion at September
30, 2004. Long-term borrowings amounted to $6.3 billion at September 30,
2004. The scheduled maturities of long-term borrowings at September 30,
2004 are as follows: $1.8 billion is due in less than one year; $2.2
billion is due in one to three years; $1.1 billion is due in three to five
years; and $1.2 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.
40
OFF-BALANCE SHEET ARRANGEMENTS
______________________________
During the third quarter of 2004, the Corporation formed M&I Capital Trust
B ("Trust"). Concurrently, the Corporation and the Trust issued
16,000,000 units of Common SPACESSM. Each unit has a stated value of
$25.00 for an aggregate value of $400.0 million. Each Common SPACES
consists of (i) a stock purchase contract under which the investor agrees
to purchase for $25, a fraction of a share of the Corporation's common
stock on the stock purchase date and (ii) a 1/40, or 2.5%, undivided
beneficial interest in a preferred security of the Trust, also referred to
as the STACKSSM, with each share having an initial liquidation amount of
$1,000. The stock purchase date is expected to be August 15, 2007, but
could be deferred for quarterly periods until August 15, 2008. The net
proceeds were used for general corporate purposes, including the long-term
financing for the recently completed Metavante acquisitions.
On the stock purchase date, the number of shares of common stock the
Corporation will issue upon settlement of the stock purchase contracts
depends on the applicable market value per share of the Corporation's
common stock, which will be determined just prior to the stock purchase
date, and other factors. The Corporation currently estimates that it will
issue approximately 8.8 million to 10.9 million common shares to settle
the stock purchase contracts. The Corporation will make quarterly contract
payments under the stock purchase contract at the annual rate of 2.60% of
the stated amount of $25 per stock purchase contract. The Corporation
recognized the present value of the quarterly contract payments under the
stock purchase contract as a liability with an offsetting reduction in
shareholders' equity. That liability along with the allocated portion of
the fees and expenses incurred for the offering of Common SPACES resulted
in a reduction in shareholders' equity of $34.0 million.
The Trust is not consolidated in the Corporation's financial statements,
however, the aggregate principal amount of the subordinated debt
securities the Corporation issued to the Trust, which is the sole asset of
the Trust, is reported in long-term borrowings in the Corporation's
consolidated balance sheet. The interest paid on the subordinated debt
securities, initially at an annual rate of 3.90%, is reported as interest
expense on long-term borrowings in the consolidated statement of income.
In conjunction with this transaction, the Corporation has irrevocably
guaranteed, on a junior subordinated basis, the payment in full of the
following: any accumulated and unpaid distributions required to be paid on
the STACKS, to the extent the Trust has funds available to make the
payment; the redemption price for any STACKS called for redemption, to the
extent the Trust has funds available to make the payment; and upon a
voluntary or involuntary dissolution, winding-up or liquidation of the
Trust, other than in connection with a distribution of the subordinated
debt securities to the holders of the STACKS, the lesser of: (1) the
aggregate of the accreted liquidation amount and all accumulated and
unpaid distributions on the STACKS to the date of payment, to the extent
the Trust has funds available to make the payment; and (2) the amount of
assets of the Trust remaining available for distribution to holders of the
STACKS upon liquidation of the Trust.
At September 30, 2004, there have been no other substantive changes with
respect to the Corporation's off-balance sheet activities. See Note 8 to
the Consolidated Financial Statements for an update of the Corporation's
securitization activities in the third 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 on its
current or future financial condition, results of operations, liquidity or
capital resources.
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:
41
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.
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 September 30, 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 future periods. 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 September 30, 2004, special reserves continue to be carried
for exposures to manufacturing, healthcare, production
agriculture (including dairy and cropping operations), truck
transportation, and the airline 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
plants and equipment have declined.
42
During the third quarter of 2004, the Corporation's commitments
to Shared National Credits were approximately $2.6 billion with
usage averaging around 38%. 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 September 30, 2004, Shared National Credit
nonperforming loans were approximately 0.23% and 0.27% 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 September 30, 2004, nonperforming loans and leases amounted
to $142.5 million or 0.51% of consolidated loans and leases
compared to $145.0 million or 0.53% of consolidated loans and
leases at June 30, 2004, $156.1 million or 0.60% of
consolidated loans and leases at March 31, 2004 and $172.8
million or 0.69% of consolidated loans and leases at December
31, 2003. Both in terms of absolute dollars and percent of
total loans and leases outstanding, nonperforming loans at
September 30, 2004 represents the sixth consecutive quarter-end
in which there was a decline in nonperforming loans.
Nonaccrual loans and leases have been the primary source 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 improving credit conditions throughout the loan
and lease portfolios.
Net charge-offs amounted to $6.7 million or 0.10% of average
loans and leases in the third quarter of 2004 compared to $5.0
million or 0.08% of average loans and leases in the second
quarter of 2004, $4.9 million or 0.08% of average loans and
leases in the first quarter of 2004 and $8.3 million or 0.13%
of average loans and leases in the fourth quarter of 2003. The
net charge-off activity experienced in the first and second
quarters of 2004 are the lowest levels experienced in any
individual quarter since the second quarter of 2000. This
lower level of net charge-offs has to some extent been the
result of higher than normal recoveries. Based on the status
of some of the larger charge-offs recognized in recent
quarters, management expects recoveries will likely return to a
lower level in future periods. Recoveries in the third quarter
of 2004 were $0.7 million lower than recoveries in the second
quarter of 2004 and $1.6 million lower than recoveries in the
first quarter of 2004.
Credit quality continued to show improvement as evidenced by
the decline in nonperforming loans and leases and net charge-
offs. 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 the first nine months'
experience, the Corporation's expects that credit quality
ratios will be below these ranges 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 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 $358.1 million or 1.27% of loans and leases
outstanding at September 30, 2004 compared to $357.9 million or 1.32% of
loans and leases outstanding at June 30, 2004. 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 materially 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. However, on an on-going basis the
Corporation continues to refine the methods used in determining
management's best estimate of the allowance for loan and lease losses.
43
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 September 30, 2004 and
2003, the amount of software costs capitalized amounted to $10.3 million
and $11.8 million, respectively. Amortization expense of software costs
amounted to $13.4 million for the three months ended September 30, 2004
compared to $26.8 million for the three months ended September 30, 2003.
For the nine months ended September 30, 2004 and 2003, the amount of
software costs capitalized amounted to $30.7 million and $43.8 million,
respectively. Amortization expense of software costs amounted to $41.5
million for the nine months ended September 30, 2004 compared to $48.3
million for the nine months ended September 30, 2003.
Based on a strategic product review performed during the second quarter of
2004, Metavante determined that a certain product had limited growth
potential and that future marketing of the product to new customers should
be discontinued. As a result of the strategic product review and net
realizable value test on this product, Metavante determined that the
capitalized software associated with the product was impaired and recorded
a write-down. Amortization expense of software costs for the nine months
ended September 30, 2004 includes $4.9 million for the write-down of the
capitalized software costs associated with the impaired product.
In conjunction with previous acquisitions, Metavante had made certain
operating decisions with respect to platform consolidations. Amortization
expense of software costs for the three and nine months ended September
30, 2003 includes $15.7 million for the write-off of capitalized software
costs that were deemed to have no future value due to a change in product
strategy.
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 September 30, 2004
and 2003, the amount of conversion costs capitalized amounted to $2.8
million and $3.2 million, respectively. Amortization expense of
conversion costs amounted to $3.2 million and $4.4 million for the three
months ended September 30, 2004 and 2003, respectively. For the nine
months ended September 30, 2004 and 2003, the amount of conversion costs
capitalized amounted to $7.2 million and $9.4 million, respectively.
Amortization expense of conversion costs amounted to $9.7 million and
$12.7 million for the nine months ended September 30, 2004 and 2003,
respectively.
Net unamortized costs were ($ in millions):
September 30,
-------------------------
2004 2003
----------- -----------
Software $ 160.8 $ 137.7
Conversions 28.2 32.6
----------- -----------
Total $ 189.0 $ 170.3
=========== ===========
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.
44
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.
During the second quarter of 2003, the Corporation recognized an
impairment loss of $4.1 million, which is included in net investment
securities gains in the Consolidated Statements of Income for the nine
months ended September 30, 2003. The difference between revised
assumptions based on actual and projected experience compared to the
initial expected assumptions were deemed to be other than temporary.
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 $1,136.8
million at September 30, 2004. At September 30, 2004, the carrying amount
of retained interests amounted to $46.5 million.
The Corporation also sells, from time to time, debt securities classified
as available for sale that are highly rated to an unconsolidated
bankruptcy remote QSPE whose activities are limited to issuing highly
rated asset-backed commercial paper with maturities up to 180 days which
is used to finance the purchase of the investment securities. The 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.
45
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 interests (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 September 30, 2004, highly rated investment securities in the amount of
$297.6 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.
During the third quarter of 2003, several income tax audits covering
multiple tax jurisdictions were resolved which positively affected the
banking segment by approximately $25.0 million and Metavante by $4.9
million and resulted in a lower provision for income taxes in the
Consolidated Statements of Income for the three and nine months ended
September 30, 2003.
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.
46
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
-----------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
2004 2004 2004 2003 2003
------------ ------------ ------------ ------------ -------------
Hypothetical Change in Interest Rate
100 basis point gradual:
Rise in rates 0.4 % (0.6)% (0.7)% (0.6)% (1.1)%
Decline in rates (0.4)% 0.6 % (2.1)% (1.8)% (1.6)%
47
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. The results changed from the
prior period primarily due to the layering on of additional fixed-rate
funding over the quarter. 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.
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 September 30, 2004, the fair value of equity at
risk for a gradual 100bp shift in rates was no more than 2.0% of the
market value of the Corporation.
Equity Risk
___________
In addition to interest rate risk, the Corporation incurs market risk in
the form of equity risk. 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 exists, however, fair values are
difficult to determine until an actual sale or liquidation transaction
actually occurs.
As of September 30, 2004, M&I Trust Services administered $71.5 billion in
assets and directly managed a portfolio of $17.4 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.
48
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(1) per Share Programs the Plans or Programs
----------------- ------------------- ----------- -------------------- ----------------------
January 1 to
January 31, 2004 634,313 $ 38.54 625,900 11,374,100
February 1 to
February 29, 2004 1,319,864 $ 39.03 1,317,200 10,056,900
March 1 to
March 31, 2004 326,900 $ 39.67 326,900 9,730,000
April 1 to
April 30, 2004 1,214 $ 36.68 -- 9,730,000
May 1 to
May 31, 2004 -- $ -- -- 9,730,000
June 1 to
June 30, 2004 -- $ -- -- 9,730,000
July 1 to
July 31, 2004 2,080 $ 34.54 -- 9,730,000
August 1 to
August 31, 2004 2,876 $ 38.46 -- 9,730,000
September 1 to
September 30, 2004 6,710 $ 39.08 -- 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 purchase of up to 12 million shares annually and
renews each year at that level unless changed or terminated by
subsequent Board action.
(1) Does not include 25,918 shares purchased by rabbi trusts,
at an average price paid per share of $38.42, pursuant to
nonqualified deferred compensation plans for the nine
months ended September 30, 2004.
49
ITEM 6. EXHIBITS
Exhibit 10(a) - Change of Control Agreement dated January 10, 2001
between M&I and Thomas R. Ellis.
Exhibit 10(b) - Form of Amendment to Change of Control Agreements
dated October 18, 2001 between M&I and
Ms. Justiliano and Messrs. Ellis, Hogan, O'Neill,
Renard, Roberts, Root, Williams and Wilson.
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.
50
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
November 9, 2004
51
EXHIBIT INDEX
Exhibit Number Description of Exhibit
______________ ____________________________________________
(10)(a) Change of Control Agreement dated January 10, 2001
between M&I and Thomas R. Ellis.
(10)(b) Form of Amendment to Change of Control Agreements
dated October 18, 2001 between M&I and
Ms. Justiliano and Messrs. Ellis, Hogan, O'Neill,
Renard, Roberts, Root, Williams and Wilson.
(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.
(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.