-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, CWlKMNH8u3X6wFQQ7OWjF2ty/0WQZZKeeXN1yq5/Jog4W4J07bGoDckZrONBnFGR hgzLJBMnySQCEhYfOXX2bQ== 0000950144-00-003638.txt : 20000327 0000950144-00-003638.hdr.sgml : 20000327 ACCESSION NUMBER: 0000950144-00-003638 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000324 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST TENNESSEE NATIONAL CORP CENTRAL INDEX KEY: 0000036966 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 620803242 STATE OF INCORPORATION: TN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-15185 FILM NUMBER: 578277 BUSINESS ADDRESS: STREET 1: 165 MADISON AVE CITY: MEMPHIS STATE: TN ZIP: 38103 BUSINESS PHONE: 9015234638 MAIL ADDRESS: STREET 1: 165 MADISON AVE CITY: MEMPHIS STATE: TN ZIP: 38103 FORMER COMPANY: FORMER CONFORMED NAME: FIRST TENNESSEE BANKS INC DATE OF NAME CHANGE: 19600201 10-K405 1 FIRST TENNESSEE NATIONAL CORPORATION 1 SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1999 - 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 000-4491 FIRST TENNESSEE NATIONAL CORPORATION (Exact name of registrant as specified in its charter) TENNESSEE 62-0803242 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 165 MADISON AVENUE, MEMPHIS, TENNESSEE 38103 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including Area Code: 901-523-5630 Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Name of Exchange on which Registered - ------------------- ------------------------------------ $0.625 PAR VALUE COMMON CAPITAL STOCK NEW YORK STOCK EXCHANGE, INC. (INCLUDING RIGHTS ATTACHED THERETO) Securities registered pursuant to Section 12(g) of the Act: NONE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] YES [ ] NO Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] At February 25, 2000, the aggregate market value of the voting stock of the registrant held by non-affiliates of the registrant was approximately $2.9 billion. At February 25, 2000, the registrant had 129,901,800 shares of common stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE: 1. Portions of the Annual Report to Shareholders for the year ended 12/31/99-Parts I, II and IV. 2. Portions of Proxy Statement furnished to shareholders in connection with Annual Meeting of Shareholders scheduled for 4/18/00 - Part III. 2 PART I ITEM 1 BUSINESS General. First Tennessee National Corporation (the "Corporation") is a Tennessee corporation incorporated in 1968 and registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. On March 13, 2000, the Board of Governors of the Federal Reserve System acted to approve the Corporation's election to become a financial holding company pursuant to the provisions of the Gramm- Leach-Bliley Act. See "Financial Modernization Legislation" below. At December 31, 1999, the Corporation had total assets of $18.4 billion and ranked second in terms of total assets among Tennessee- headquartered bank holding companies and ranked 41st nationally. Through its principal subsidiary, First Tennessee Bank National Association (the "Bank"), and its other banking and banking-related subsidiaries, the Corporation provides a broad range of financial services. The Corporation is engaged in the commercial banking business. Significant operations are also conducted in the mortgage banking, capital markets, and transaction processing divisions, which are described in more detail in the response to Item 7 of Part II hereof and Note 21 to the Consolidated Financial Statements. During 1999 approximately 66% of revenues were provided by fee income and approximately 34% of revenues were provided by net interest income. As a bank holding company, the Corporation coordinates the financial resources of the consolidated enterprise and maintains systems of financial, operational and administrative control that allow coordination of selected policies and activities. The Bank is a national banking association with principal offices in Memphis, Tennessee. It received its charter in 1864 and operates primarily on a regional basis. During 1999 it generated gross revenue (net interest income plus noninterest income) of approximately $1.6 billion and contributed 96% of consolidated net income from continuing operations. At December 31, 1999, the Bank had $17.5 billion in total assets, $10.7 billion in total deposits, and $10.9 billion in net loans. Within the State of Tennessee at December 31, 1999, the Bank ranked second in terms of total assets and ranked first in deposit market share in four of the state's five metropolitan regions. Nationally, it ranked 50th among banks in terms of total assets as of September 30, 1999. On December 31, 1999, the Corporation's subsidiary banks had 419 locations (199 financial centers and 220 free-standing ATM machines) in 22 Tennessee counties, including all of the major metropolitan areas of the state, 11 banking locations (including 4 free-standing ATMs) in Mississippi and 7 banking locations (including 4 free-standing ATMs) in Arkansas, and consumer finance offices in 10 states nationwide. FT Mortgage Companies (which changed its name to First Horizon Home Loan Corporation in March 2000), a subsidiary of the Bank, and its affiliates, at December 31, 1999, provided mortgage banking services through approximately 166 offices in 32 states and ranked in the top 10 nationally in retail mortgage loan originations and in the top 20 nationally in mortgage loan servicing. First Tennessee Capital Markets, a division of the Bank, had at December 31, 1999, offices in 6 states and ranked as one of the leading underwriters of U.S. agency debt. The Corporation provides the following services through its subsidiaries: general banking services for consumers, businesses, financial institutions, and governments 1 3 - mortgage banking services - capital markets--primarily sales and underwriting of bank-eligible securities and mortgage loans and advisory services - transaction processing - credit card merchant processing, automated teller machine network, nationwide check clearing operation, and remittance processing - trust, fiduciary, and agency services - credit card products - discount brokerage, brokerage, venture capital and equipment finance - investment and financial advisory services, including investment advisor to First Funds, a family of mutual funds - mutual fund sales as agent - insurance sales as agent - check processing software and systems - private mortgage reinsurance - consumer finance lending. An element of the Corporation's business strategy is to seek acquisitions that would enhance long-term shareholder value. The Corporation has an acquisitions department charged with this responsibility which is constantly reviewing and developing opportunities to achieve this element of the Corporation's strategy. Acquisitions which closed during the past three years are described in Note 2 to the Consolidated Financial Statements contained in the Corporation's 1999 Annual Report to Shareholders (the "1999 Annual Report"), which note is incorporated herein by reference. All of the Corporation's subsidiaries are listed in Exhibit 21. The Bank has filed notice with the Comptroller of the Currency ("Comptroller") as a government securities broker/dealer. The Capital Markets division of the Bank is registered with the Securities and Exchange Commission ("SEC") as a municipal securities dealer with offices in Memphis, Tennessee; Mobile, Alabama; Chicago, Illinois; Overland Park, Kansas; Dallas, Texas; and New York, New York. The subsidiary banks are supervised and regulated as described below. Highland Capital Management Corp. and Martin and Company, Inc., are registered with the SEC as investment advisers. First Tennessee Brokerage, Inc. is registered as an investment adviser in all states in which registration is required. Hickory Venture Capital Corporation is licensed as a Small Business Investment Company. First Tennessee Brokerage, Inc. and First Tennessee Securities Corporation are registered as broker-dealers with the SEC and all states in which registration is required. FT Mortgage Companies is licensed as a mortgage lender (or exempt from licensing) in all states where it does business and is regulated by the Comptroller as well as various state regulators. First Tennessee Insurance Services ("FTIS"), a department of the Bank with offices in Dandridge, Tennessee, is licensed in several states as a non-resident insurance agency. Certain employees of FTIS are licensed as insurance agents in Tennessee and other states. FT Reinsurance Company is licensed by the state of Vermont as a monoline insurance company. FT Insurance Corporation is an insurance agency, which will be licensed in all states in which licensing is required. Expenditures for research and development activities were not material for the years 1997, 1998 or 1999. Neither the Corporation nor any of its significant subsidiaries is dependent upon a single customer or very few customers. At December 31, 1999, the Corporation and its subsidiaries had 10,657 full-time-equivalent employees, not including contract labor for certain services. 2 4 For additional information on the business of the Corporation, refer to the Management's Discussion and Analysis and Glossary sections contained in the 1999 Annual Report, which sections are incorporated herein by reference. Supervision and Regulation. The Corporation is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the "BHCA"), and is registered with the Board of Governors of the Federal Reserve System (the "Federal Reserve"). The Corporation is required to file with the Board annual reports and such additional information as the Board may require pursuant to the BHCA. The Board may also make examinations of the Corporation and its subsidiaries. The following summary of the BHCA and of the other acts described herein is qualified in its entirety by express reference to each of the particular acts. General As a bank holding company, the Corporation is subject to the regulation and supervision of the Federal Reserve under the BHCA. Under the BHCA, bank holding companies may not in general directly or indirectly acquire the ownership or control of more than 5% of the voting shares or substantially all of the assets of any company, including a bank, without the prior approval of the Federal Reserve Board. The BHCA also restricts the types of activities in which a bank holding company and its subsidiaries may engage. Generally, activities are limited to banking and activities found by the Federal Reserve to be so closely related to banking as to be a proper incident thereto. See, however, "-Financial Modernization Legislation" below. In addition, the BHCA permits the Federal Reserve to approve an application by a bank holding company to acquire a bank located outside the acquirer's principal state of operations without regard to whether the transaction is prohibited under state law. See " --Interstate Banking and Branching Legislation." Effective September 29, 1995, the Tennessee Bank Structure Act of 1974 was amended to, among other things, prohibit (subject to certain exceptions) a bank holding company from acquiring a bank for which the home state is Tennessee (a "Tennessee bank") if, upon consummation, the company would directly or indirectly control 30% or more of the total deposits in insured depository institutions in Tennessee. As of June 30, 1999, the Corporation estimates that it held approximately 15% of such deposits. Subject to certain exceptions, the Tennessee Bank Structure Act prohibits a bank holding company from acquiring a bank in Tennessee which has been in operation for less than five years. Tennessee law permits a Tennessee Bank to establish branches in any county in Tennessee. Management cannot predict the extent to which the business of the Corporation and its subsidiaries may be affected by recent federal and Tennessee legislation relating to interstate and intrastate acquisitions and branching activities. The Corporation's subsidiary banks (the "Subsidiary Banks") are subject to supervision and examination by applicable federal and state banking agencies. The Bank and First National Bank of Springdale, Springdale, Arkansas, are national banking associations subject to regulation and supervision by the Comptroller as their primary federal regulator. The remaining Subsidiary Banks are Cleveland Bank and Trust Company, Cleveland, Tennessee, and Peoples and Union Bank, Lewisburg, Tennessee, which are Tennessee state-chartered banks, and Peoples Bank, Senatobia, Mississippi, which is a Mississippi state-chartered bank, none of which is a member of the Federal Reserve System, and therefore each is subject to the regulations of and supervision by the Federal Deposit Insurance Corporation (the "FDIC") as well as state banking authorities. In addition, all of the Subsidiary Banks are insured by, and 3 5 subject to regulation by, the FDIC. The Subsidiary Banks are also subject to various requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted and the interest that may be charged thereon and limitations on the types of investments that may be made, activities that may be engaged in, and types of services that may be offered. Various consumer laws and regulations also affect the operations of the Subsidiary Banks. In addition to the impact of regulation, commercial banks are affected significantly by the actions of the Federal Reserve as it attempts to control the money supply and credit availability in order to influence the economy. Payment of Dividends The Corporation is a legal entity separate and distinct from its banking and other subsidiaries. The principal source of cash flow of the Corporation, including cash flow to pay dividends on its stock or principal (premium, if any) and interest on debt securities, is dividends from the Subsidiary Banks. There are statutory and regulatory limitations on the payment of dividends by the Subsidiary Banks to the Corporation, as well as by the Corporation to its shareholders. Each Subsidiary Bank that is a national bank is required by federal law to obtain the prior approval of the Comptroller for the payment of dividends if the total of all dividends declared by the board of directors of such Subsidiary Bank in any year will exceed the total of (i) its net profits (as defined and interpreted by regulation) for that year plus (ii) the retained net profits (as defined and interpreted by regulation) for the preceding two years, less any required transfers to surplus. A national bank also can pay dividends only to the extent that retained net profits (including the portion transferred to surplus) exceed bad debts (as defined by regulation). State-chartered banks are subject to varying restrictions on the payment of dividends under applicable state laws. Tennessee law imposes dividend restrictions on Tennessee state banks substantially similar to those imposed under federal law on national banks, as described above. Mississippi law prohibits Mississippi state banks from declaring a dividend without the prior written approval of the Mississippi Banking Commissioner. If, in the opinion of the applicable federal bank regulatory authority, a depository institution or a holding company is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the depository institution or holding company, could include the payment of dividends), such authority may require that such institution or holding company cease and desist from such practice. The federal banking agencies have indicated that paying dividends that deplete a depository institution's or holding company's capital base to an inadequate level would be such an unsafe and unsound banking practice. Moreover, the Federal Reserve, the Comptroller and the FDIC have issued policy statements which provide that bank holding companies and insured depository institutions generally should only pay dividends out of current operating earnings. In addition, under the Federal Deposit Insurance Act ("FDIA"), an FDIC-insured depository institution may not make any capital distributions (including the payment of dividends) or pay any management fees to its holding company or pay any dividend if it is undercapitalized or if such payment would cause it to become undercapitalized. 4 6 At December 31, 1999, under dividend restrictions imposed under applicable federal and state laws, the Subsidiary Banks, without obtaining regulatory approval, could legally declare aggregate dividends of approximately $293 million. Under Tennessee law, the Corporation is not permitted to pay dividends if, after giving effect to such payment, it would not be able to pay its debts as they become due in the usual course of business or the Corporation's total assets would be less than the sum of its total liabilities plus any amounts needed to satisfy any preferential rights if the Corporation was dissolving. The payment of dividends by the Corporation and the Subsidiary Banks may also be affected or limited by other factors, such as the requirement to maintain adequate capital above regulatory guidelines and debt covenants. Transactions with Affiliates There are various legal restrictions on the extent to which the Corporation and its nonbank subsidiaries (including, in certain situations, subsidiaries of the Subsidiary Banks) can borrow or otherwise obtain credit from the Subsidiary Banks. There are also legal restrictions on the Subsidiary Banks' purchases of or investments in the securities of and purchases of assets from the Corporation and its nonbank subsidiaries, a Subsidiary Bank's loans or extensions of credit to third parties collateralized by the securities or obligations of the Corporation and its nonbank subsidiaries, the issuance of guaranties, acceptances and letters of credit on behalf of the Corporation and its nonbank subsidiaries, and certain bank transactions with the Corporation and its nonbank subsidiaries, or with respect to which the Corporation and its nonbank subsidiaries act as agent, participate or have a financial interest. Subject to certain limited exceptions, a Subsidiary Bank (including for purposes of this paragraph all subsidiaries of such Subsidiary Bank) may not extend credit to the Corporation or to any other affiliate (other than another Subsidiary Bank and certain exempted affiliates) in an amount which exceeds 10% of the Subsidiary Bank's capital stock and surplus and may not extend credit in the aggregate to all such affiliates in an amount which exceeds 20% of its capital stock and surplus. Further, there are legal requirements as to the type, amount and quality of collateral which must secure such extensions of credit by the Subsidiary Banks to the Corporation or to such other affiliates. Also, extensions of credit and other transactions between a Subsidiary Bank and the Corporation or such other affiliates must be on terms and under circumstances, including credit standards, that are substantially the same or at least as favorable to such Subsidiary Bank as those prevailing at the time for comparable transactions with non-affiliated companies. Also, the Corporation and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. Capital Adequacy The Federal Reserve has adopted risk-based capital guidelines for bank holding companies. The minimum guideline for the ratio of total capital ("Total Capital") to risk-weighted assets (including certain off- balance-sheet items, such as standby letters of credit) is 8%, and the minimum ratio of Tier 1 Capital (defined below) to risk-weighted assets is 4%. At least half of the Total Capital must be composed of common stock, minority interests in the equity accounts of consolidated subsidiaries, noncumulative perpetual preferred stock and a limited amount of cumulative perpetual preferred stock, less goodwill and certain other intangible assets ("Tier 1 Capital"). The remainder may consist of qualifying subordinated debt, certain types of mandatory convertible securities and perpetual debt, other preferred stock and a limited amount of loan loss reserves. At December 31, 1999, the Corporation's consolidated Tier 1 Capital and Total Capital ratios were 8.77% and 12.00%, respectively. The Federal Reserve Board, the FDIC and the OCC have adopted rules to incorporate market and interest-rate risk components into their risk-based capital standards and that explicitly identify concentration of credit risk and certain risks arising from non-traditional activities, and the management of such risks, as important factors to consider in assessing an institution's overall capital adequacy. Amendments to the risk-based capital requirements, incorporating market risk, became effective January 1, 1998. Under these market risk requirements, capital is allocated to support the amount of market risk related to a financial institution's ongoing trading activities for banks with relatively large trading activities. Institutions will be able to satisfy this additional requirement, in part, by issuing short-term subordinated debt that qualifies as Tier 3 capital. In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding 5 7 companies. These guidelines provide for a minimum ratio of Tier 1 Capital to quarterly average assets, less goodwill and certain other intangible assets (the "Leverage Ratio"), of 3% for bank holding companies that meet certain specific criteria, including having the highest regulatory rating. All other bank holding companies generally are required to maintain a Leverage Ratio of at least 3%, plus an additional cushion of 100 to 200 basis points. The Corporation's Leverage Ratio at December 31, 1999 was 6.53%. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the Federal Reserve has indicated that it will consider a "tangible Tier 1 Capital leverage ratio" (deducting all intangibles) and other indicia of capital strength in evaluating proposals for expansion or new activities. Each of the Subsidiary Banks is subject to risk-based and leverage capital requirements similar to those described above adopted by the Comptroller or the FDIC, as the case may be. The Corporation believes that each of the Subsidiary Banks was in compliance with applicable minimum capital requirements as of December 31, 1999. Neither the Corporation nor any of the Subsidiary Banks has been advised by any federal banking agency of any specific minimum Leverage Ratio requirement applicable to it. Failure to meet capital guidelines could subject a bank to a variety of enforcement remedies, including the termination of deposit insurance by the FDIC, and to certain restrictions on its business and in certain circumstances to the appointment of a conservator or receiver. See "--Prompt Corrective Action." On February 17, 2000, the federal banking regulators proposed for comment regulations previously released on November 5, 1997. This proposal would 1) assign a risk-based charge to positions in securitized transactions according to the relative credit risk of those positions, as measured by credit ratings received from nationally recognized rating agencies, 2) treat recourse obligations and direct credit substitutes more consistently under risk-based capital rules, 3) define "recourse" and revise the definition of "direct credit substitute" ("recourse" is defined as any retained risk of loss associated with any transferred asset that exceeds a pro rata share of the bank's or bank holding company's remaining claim on the asset, if any, and "direct credit substitute" is defined as any assumed risk of loss associated with any asset or other claim that exceeds the bank's or bank holding company's pro rata share of the asset or claim, if any), 4) permit the limited use of an institution's internal risk- rating system and other alternative approaches in determining the risk-based capital requirement for unrated direct credit substitutes associated with asset-backed commercial paper programs and other structured finance programs, and 5) require banking organizations to hold additional risk-based capital against risks presents by the early amortization feature of revolving asset securitization. The Corporation can not predict at this time the effect adoption of this proposal would have on the financial condition or results of operations of the Bank or the Corporation. On June 4, 1999, the Basle Committee proposed a new capital adequacy framework. The new capital framework would consist of minimum capital requirements, a supervisory review process, and effective use of market discipline. The minimum capital requirements would be based on the current framework, but, among other changes, would replace the existing risk weights for sovereigns, banks, securities firms, corporate borrowers and asset securitizations with risk weights based on external credit ratings, including risk weights greater than 100% for low quality exposures. The new framework would include capital charges for interest-rate risk, for banks with an interest-rate risk that is significantly above average, and for other risks, principally operational risk. The supervisory review aspect of the new framework would seek to ensure that a bank's capital position is consistent with its overall risk profile and strategy. The supervisory review process would also encourage early supervisory intervention when a bank's capital position deteriorates. The third aspect of the new framework, market discipline, would press for detailed disclosure of a bank's capital adequacy in order to encourage high disclosure standards and to enhance the role of market participants in encouraging banks to hold adequate capital. The Basle Committee plans to set forth more definitive proposals regarding the new framework in the year 2000. The Corporation cannot predict at this time whether the new capital adequacy framework will be adopted or in what form, or the effect it would have on the financial condition or results of operations of the Bank or the Corporation. 6 8 Holding Company Structure and Support of Subsidiary Banks Because the Corporation is a holding company, its right to participate in the assets of any subsidiary upon the latter's liquidation or reorganization will be subject to the prior claims of the subsidiary's creditors (including depositors in the case of the Subsidiary Banks) except to the extent that the Corporation may itself be a creditor with recognized claims against the subsidiary. In addition, depositors of a bank, and the FDIC as their subrogee, would be entitled to priority over the creditors in the event of liquidation of a bank subsidiary. Under Federal Reserve policy, the Corporation is expected to act as a source of financial strength to, and to commit resources to support, each of the Subsidiary Banks. This support may be required at times when, absent such Federal Reserve policy, the Corporation may not be inclined to provide it. In addition, any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment. Cross-Guarantee Liability Under the FDIA, a depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC after August 9, 1989 in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to any commonly controlled FDIC-insured depository institution "in danger of default." "Default" is defined generally as the appointment of a conservator or receiver and "in danger of default" is defined generally as the existence of certain conditions indicating that a default is likely to occur in the absence of regulatory assistance. The FDIC's claim for damages is superior to claims of shareholders of the insured depository institution or its holding company but is subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institution. The Subsidiary Banks are subject to these cross- guarantee provisions. As a result, any loss suffered by the FDIC in respect of any of the Subsidiary Banks would likely result in assertion of the cross-guarantee provisions, the assessment of such estimated losses against the Corporation's other Subsidiary Banks and a potential loss of the Corporation's investment in such Subsidiary Banks. Prompt Corrective Action The FDIA requires, among other things, the federal banking regulators to take "prompt corrective action" in respect of FDIC-insured depository institutions that do not meet minimum capital requirements. Under the FDIA, insured depository institutions are divided into five capital tiers: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." Under applicable regulations, an institution is defined to be well capitalized if it maintains a Leverage Ratio of at least 5%, a Tier 1 Capital ratio of at least 6% and a Total Capital ratio of at least 10% and is not subject to a directive, order or written agreement to meet and maintain specific capital levels. An institution is defined to be adequately capitalized if it meets all of its minimum capital requirements as described above. An institution will be considered undercapitalized if it fails to meet any minimum required measure, significantly undercapitalized if it has a Total Risk-Based Capital ratio of less than 6%, a Tier 1 Risk-Based Capital ratio of less than 3% or a Leverage Ratio of less than 3% and critically undercapitalized if it fails to maintain a level of tangible equity equal to at least 2% of total assets. An institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it receives an unsatisfactory examination rating. The FDIA generally prohibits an FDIC-insured depository institution from making any capital distribution (including payment of dividends) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to restrictions on borrowing from the Federal Reserve System. In addition, undercapitalized depository institutions are subject to growth limitations and are required to submit capital restoration plans. An insured depository institution's holding company must guarantee the capital plan, up to an amount equal to the lesser of 5% of the depository institution's 7 9 assets at the time it becomes undercapitalized or the amount of the capital deficiency when the institution fails to comply with the plan, for the plan to be accepted by the applicable federal regulatory authority. The federal banking agencies may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution's capital. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized. Significantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets and cessation of receipt of deposits from correspondent banks. Critically undercapitalized depository institutions are subject to appointment of a receiver or conservator, generally within 90 days of the date on which they become critically undercapitalized. The Corporation believes that at December 31, 1999 all of the Subsidiary Banks had sufficient capital to qualify as "well capitalized" under the regulatory capital requirements discussed above. Interstate Banking and Branching Legislation The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "IBBEA") authorizes interstate acquisitions of banks and bank holding companies without geographic limitation beginning one year after enactment. In addition, since June 1, 1997, a bank may merge with a bank in another state as long as neither of the states has opted out of interstate branching between the date of enactment of the IBBEA and May 31, 1997. Tennessee did not opt out of interstate branching. The IBBEA further provides that states may enact laws permitting interstate merger transactions prior to June 1, 1997. Tennessee did not enact such a law. A bank may establish and operate a de novo branch in a state in which the bank does not maintain a branch if that state explicitly permits de novo branching. Once a bank has established branches in a state through an interstate merger transaction, the bank may establish and acquire additional branches at any location in the state where any bank involved in the interstate merger transaction could have established or acquired branches under applicable federal or state law. A bank that has established a branch in a state through de novo branching may establish and acquire additional branches in such state in the same manner and to the same extent as a bank having a branch in such state as a result of an interstate merger. If a state opts out of interstate branching within the specified time period, no bank in any other state may establish a branch in the opting out of state, whether through an acquisition or de novo. Financial Modernization Legislation The Gramm-Leach-Bliley Act was enacted into law on November 12, 1999. The Act repeals or modifies a number of significant provisions of current laws, including the Glass-Steagall Act and the Bank Holding Company Act of 1956, which impose restrictions on banking organizations' ability to engage in certain types of activities. The Act generally allows bank holding companies such as the Corporation broad authority to engage in activities that are financial in nature or incidental to such a financial activity, including insurance underwriting and brokerage; merchant banking; securities underwriting, dealing and market-marking; real estate development; and such additional activities as the Federal Reserve in consultation with the Secretary of the Treasury determines to be financial in nature or incidental thereto. A bank holding company may engage in these activities directly or through subsidiaries by qualifying as a "financial holding company." To qualify a bank holding company must file a declaration with the Federal Reserve and certify that all of its subsidiary depository institutions are well-managed and well-capitalized. The Act also permits national banks such as the Bank to engage in certain of these activities through financial subsidiaries. To control or hold an interest in a financial subsidiary, a national bank must meet the following requirements: (1) the national bank must receive approval from the Comptroller for the financial subsidiary to engage in the activities, (2) the national bank and its depository institution affiliates must each be well-capitalized and well-managed, (3) the aggregate consolidated total assets of all of the national bank's financial subsidiaries must not exceed 45% of the national bank's consolidated total assets or, if less, $50 billion, (4) the national bank must have in place adequate policies and procedures to identify and manage financial and 8 10 operational risks and to preserve the separate identities and limited liability of the national bank and the financial subsidiary, and (5) if the financial subsidiary will engage in principal transactions and the national bank is one of the one hundred largest banks, the national bank must have outstanding at least one issue of unsecured long-term debt that is currently rated in one of the three highest investment grade rating categories (or if in the second fifty largest banks, such comparable alternative criteria as the Secretary of the Treasury and the Federal Reserve jointly establish). No new financial activity may be commenced under the Act unless the national bank and all of its depository institution affiliates have at least "satisfactory" CRA ratings. Certain restrictions apply if the bank holding company or the national bank fails to continue to meet one or more of the requirements listed above. In addition, the Act contains a number of other provisions that may affect the Bank's operations, including functional regulation of the Bank's securities and investment management operations by the SEC and the Bank's insurance operations by the States and limitations on the use and disclosure to third parties of customer information. The Act is generally effective March 11, 2000, although certain provisions take effect later, such as functional regulation (May 12, 2001) and compliance with privacy regulations (six months after issuance, which must occur by May 12, 2000). The Corporation cannot predict at this time the potential effect that the Act will have on its business and operations, although the Corporation expects that the general effect of the Act will be to increase competition in the financial services industry generally. FDIC Insurance Assessments; DIFA The FDIC reduced the insurance premiums it charges on bank deposits insured by the Bank Insurance Fund ("BIF") to the statutory minimum of $2,000 for "well capitalized" banks, effective January 1, 1996. Premiums related to deposits assessed by the Savings Association Insurance Fund ("SAIF"), including savings association deposits acquired by banks, continued to be assessed at a rate of between 23 cents and 31 cents per $100 of deposits. On September 30, 1996, the Deposit Insurance Funds Act of 1996 ("DIFA") was enacted and signed into law. DIFA provided for a special assessment to recapitalize the SAIF to bring the SAIF up to statutory required levels. The assessment imposed a one-time fee to banks that own previously acquired thrift deposits of $ .526 per $100 of thrift deposits they held at March 31, 1995. The pre-tax cost to the Corporation of the one-time assessment in the third quarter of 1996 was $3.8 million. DIFA further provides for assessments to be imposed on insured depository institutions with respect to deposits insured by the BIF (in addition to assessments currently imposed on depository institutions with respect to SAIF-insured deposits) to pay for the cost of Financing Corporation ("FICO") bonds. All banks are being assessed to pay the interest due on FICO bonds since January 1, 1997. The cost to the Corporation on an annual basis has been immaterial. Under the FDIA, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by a federal bank regulatory agency. Depositor Preference Federal law provides that deposits and certain claims for administrative expenses and employee compensation against an insured depository institution would be afforded a priority over other general unsecured claims against such an institution, including federal funds and letters of credit, in the "liquidation or other resolution" of such an institution by any receiver. Competition. The Corporation and its subsidiaries face substantial competition in all aspects of the businesses in which they engage from national and state banks located in Tennessee and large out-of-state banks as well as from savings and loan associations, credit unions, other financial institutions, consumer finance companies, trust companies, investment counseling firms, money market mutual funds, insurance companies, securities firms, mortgage banking companies and others. For certain information on the competitive position of the Corporation and the Bank, refer to page 1. Also, refer to the subsections entitled "Supervision and Regulation" and "Effect of 9 11 Governmental Policies," both of which are relevant to an analysis of the Corporation's competitors. Due to the intense competition in the financial industry, the Corporation makes no representation that its competitive position has remained constant, nor can it predict whether its position will change in the future. Sources and Availability of Funds. Specific reference is made to the Management's Discussion and Analysis and Glossary sections, including the subsection entitled "Deposits, Other Sources of Funds, and Liquidity Management," contained in the 1999 Annual Report, which sections are incorporated herein by reference. Effect of Governmental Policies. The Bank is affected by the policies of regulatory authorities, including the Federal Reserve System and the Comptroller. An important function of the Federal Reserve System is to regulate the national money supply. Among the instruments of monetary policy used by the Federal Reserve are: purchases and sales of U.S. Government securities in the marketplace; changes in the discount rate, which is the rate any depository institution must pay to borrow from the Federal Reserve; and changes in the reserve requirements of depository institutions. These instruments are effective in influencing economic and monetary growth, interest rate levels and inflation. The monetary policies of the Federal Reserve System and other governmental policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. Because of changing conditions in the national economy and in the money market, as well as the result of actions by monetary and fiscal authorities, it is not possible to predict with certainty future changes in interest rates, deposit levels, loan demand or the business and earnings of the Corporation and the Bank or whether the changing economic conditions will have a positive or negative effect on operations and earnings. Various bills are from the time to time introduced in the United States Congress and the Tennessee General Assembly and other state legislatures, and regulations are proposed by the bank regulatory agencies which could affect the business of the Corporation and its subsidiaries. It cannot be predicted whether or in what form any of these proposals will be adopted or the extent to which the business of the Corporation and its subsidiaries may be affected thereby. Statistical Information Required by Guide 3. The statistical information required to be displayed under Item I pursuant to Guide 3, "Statistical Disclosure by Bank Holding Companies," of the Exchange Act Industry Guides is incorporated herein by reference to the Consolidated Financial Statements and the notes thereto and the Management's Discussion and Analysis and Glossary sections in the 1999 Annual Report; certain information not contained in the 1999 Annual Report, but required by Guide 3, is contained in the tables immediately following: 10 12 FIRST TENNESSEE NATIONAL CORPORATION ADDITIONAL GUIDE 3 STATISTICAL INFORMATION BALANCES AT DECEMBER 31 (Thousands) (Unaudited) INVESTMENT PORTFOLIO
1999 1998 1997 - ------------------------------------------------------------------------------------------------------------------------ Mortgage-backed securities & collateralized mortgage obligations $2,579,259 $2,068,529 $1,641,918 U.S. Treasury and other U.S. government agencies 165,477 151,215 366,012 States and political subdivisions 41,603 60,807 76,620 Other 314,953 145,738 101,983 ---------- ---------- ----------- Total $3,101,292 $2,426,289 $2,186,533 ========== ========== =========== LOAN PORTFOLIO 1999 1998 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------ Commercial $4,430,516 $4,116,918 $3,768,554 $3,521,473 $3,330,929 Consumer 3,281,832 3,018,782 2,855,240 2,683,959 2,525,889 Credit card receivables 607,205 594,467 581,451 564,803 529,104 Real estate construction 485,580 375,890 404,196 297,797 238,863 Permanent mortgage 528,907 423,200 663,494 641,245 689,458 Nonaccrual 29,118 27,807 38,415 18,926 19,040 ---------- ---------- ---------- ---------- --------- Total $9,363,158 $8,557,064 $8,311,350 $7,728,203 $7,333,283 ========== ========== ========== ========== ========== SHORT-TERM BORROWINGS AT DECEMBER 31 1999 1998 1997 - ------------------------------------------------------------------------------------------------------------------------ Federal funds purchased and securities sold under agreements to repurchase $2,856,282 $2,912,018 $2,085,679 Commercial paper 16,272 23,203 23,176 Other short-term borrowings 1,533,957 1,404,071 679,212 ---------- ---------- ---------- Total $4,406,511 $4,339,292 $2,788,067 ========== ========== ==========
11 13 FOREIGN OUTSTANDINGS AT DECEMBER 31
1999 1998 1997 ------------------------ ----------------------- ----------------------- % Total % Total % Total (Dollars in thousands) Amount Assets Amount Assets Amount Assets - ------------------------------------------------------------------------------------------------------------------------------- BY COUNTRY: Israel $1,061 .01% $1,313 .01% $ 1,020 .01% Taiwan 759 .01 161 -- 537 -- Canada 370 -- 433 -- 985 .01 Saudi Arabia 33 -- 570 -- 86 -- Switzerland 9 -- 14 -- 4,523 .03 Denmark -- -- 6,000 .03 6,000 .04 Indonesia -- -- -- -- 1,318 .01 All other 632 -- 702 .01 692 .01 - ----------------------------------------------------------------------------------------------------------------------------- Total $2,864 .02% $9,193 .05% $15,161 .11% ============================================================================================================================= BY TYPE: Loans: Banks and other financial institutions $1,174 .01% $7,971 .04% $13,942 .10% Governments and other institutions 1,000 .01 1,000 .01 1,000 .01 - ----------------------------------------------------------------------------------------------------------------------------- Total Loans 2,174 .02 8,971 .05 14,942 .11 Cash 480 -- 129 -- 199 -- Customers' acceptances 187 -- 93 -- 20 -- Accrued interest receivable 23 -- -- -- -- -- - ----------------------------------------------------------------------------------------------------------------------------- Total $2,864 .02% $9,193 .05% $15,161 .11% =============================================================================================================================
12 14 MATURITIES OF SHORT-TERM PURCHASED FUNDS AT DECEMBER 31, 1999
0-3 3-6 6-12 Over 12 (Dollars in thousands) Months Months Months Months Total - ----------------------------------------------------------------------------------------------------------------------------- Certificates of deposit $100,000 and more $1,996,528 $129,138 $118,930 $132,375 $2,376,971 Federal funds purchased and securities sold under agreements to repurchase 2,856,282 -- -- -- 2,856,282 Commercial paper and other short-term borrowings 778,195 666,700 100,000 5,334 1,550,229 - ----------------------------------------------------------------------------------------------------------------------------- Total $5,631,005 $795,838 $218,930 $137,709 $6,783,482 =============================================================================================================================
CONTRACTUAL MATURITIES OF COMMERCIAL AND NONACCRUAL LOANS AT DECEMBER 31, 1999
Within After 1 Year After (Dollars in thousands) 1 Year Within 5 Years 5 Years Total - ---------------------------------------------------------------------------------------------------------------------------- Commercial $2,481,604 $1,645,608 $303,304 $4,430,516 Real estate construction 382,563 83,135 19,882 485,580 Nonaccrual 12,403 6,812 9,903 29,118 - ---------------------------------------------------------------------------------------------------------------------------- Total commercial and nonaccrual loans* $2,876,570 $1,735,555 $333,089 $4,945,214 ============================================================================================================================ For maturities over one year: Interest rates - floating $ 625,077 $120,942 $ 746,019 Interest rates - fixed 1,110,478 212,147 1,322,625 - ---------------------------------------------------------------------------------------------------------------------------- Total $1,735,555 $333,089 $2,068,644 ============================================================================================================================ * Net of unearned income
13 15 ITEM 2 PROPERTIES The Corporation has no properties that it considers materially important to its financial statements. ITEM 3 LEGAL PROCEEDINGS The Corporation is a party to no material pending legal proceedings the nature of which are required to be disclosed pursuant to the Instructions contained in the Form of this Report. ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted during the fourth quarter of 1999 to a vote of security holders, through the solicitation of proxies or otherwise. ITEM 4A EXECUTIVE OFFICERS OF REGISTRANT The following is a list of executive officers of the Corporation as of March 1, 2000. The executive officers are elected at the April meeting of the Corporation's Board of Directors following the annual meeting of shareholders for a term of one year and until their successors are elected and qualified.
Name and Age Offices and Positions - Year First Elected to Office - ------------ ---------------------------------------------------- Susan Schmidt Bies Executive Vice President (1985) and Auditor Age: 52 (1998) of the Corporation and the Bank and Risk Management Manager (1995) J. Kenneth Glass President - Retail Financial Services Age: 53 of the Bank (1999) and Executive Vice President of the Corporation (1995) Ralph Horn Chairman of the Board (1996) and Chief Age: 58 Executive Officer (1994) of the Corporation and the Bank and President of the Corporation (1991) and the Bank (1993) Harry A. Johnson, III Executive Vice President (1990) and Age: 51 General Counsel (1988) of the Corporation and the Bank James F. Keen Senior Vice President Age: 49 and Corporate Controller of the Corporation (1988) and principal accounting officer
14 16 John C. Kelley. Jr. President - Business Financial Services/Memphis Age: 56 Financial Services of the Bank (1999) and Executive Vice President of the Corporation (1995) Sarah L. Meyerrose Executive Vice President of the Age: 44 Corporation and the Bank and Employee Services Division Manager (1998) John P. O'Connor, Jr. Executive Vice President of the Corporation Age: 56 (1990) and the Bank (1987) and Chief Credit Officer (1988) Elbert L. Thomas, Jr. Executive Vice President (1995) and Age: 51 Chief Financial Officer (1995) of the Corporation and the Bank
Each of the executive officers has been employed by the Corporation or its subsidiaries during each of the last five years. Prior to April of 1999, Mr. Glass was President - Tennessee Banking Group of the Bank. Prior to April of 1999, Mr. Kelley was President - Memphis Banking Group of the Bank. Prior to February of 1995, Ms. Bies was Chief Financial Officer of the Corporation and Bank. Mr. Thomas was a Senior Vice President of the Corporation and the Bank prior to December of 1995. Prior to February of 1995, Mr. Thomas was Manager of Corporate Development. The Personnel Division changed its name to the Employee Services Division in April of 1999. From July of 1995 to June of 1998, Ms. Meyerrose was President, Kingsport/Bristol of the Bank, and prior to July of 1995 she was Executive Vice President Retail, Johnson City of the Bank. PART II ITEM 5 MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS (a) Market for the Corporation's Common Stock: The Corporation's common stock, $0.625 par value, is listed and trades on the New York Stock Exchange, Inc. under the symbol FTN. As of December 31, 1999, there were 9,893 shareholders of record of the Corporation's common stock. Additional information called for by this Item is incorporated herein by reference to the Summary of Quarterly Financial Information Table, the Selected Financial and Operating Data Table, Note 17 to the Consolidated Financial Statements, and the "Deposits, Other Sources of Funds, and Liquidity Management" subsection of the Management's Discussion and Analysis section contained in the 1999 Annual Report and to the "Payment of Dividends" and "Transactions with Affiliates" subsections contained in Item 1 of Part I of this Form 10-K, which is incorporated herein by reference. (b) Sale of Unregistered Securities: During 1999 all sales of shares of the Corporation's common stock without registration under the Securities Act of 1933, as amended, were previously disclosed in Form 10-Q's filed during 1999 except for 15 17 the shares issued in connection with the acquisition by the Corporation of Elliott Ames, Inc. ("Elliot Ames"), Los Altos, California, on October 1, 1999. Elliot Ames was merged with and into FT Mortgage Companies, an indirect, wholly-owned subsidiary of the Corporation. At closing, the Corporation acquired from the five shareholders of Elliot Ames all 25,000 shares of Elliot Ames's common stock, no par value, in exchange for an initial closing payment of 242,423 shares of the Corporation's common stock, $0.625 par value. On February 7, 2000, an additional 49,391 shares of the Corporation's common stock were issued to the Elliott Ames shareholders in payment of the balance of the acquisition price. No underwriter was involved in this transaction. The shares were sold in a private offering pursuant to an exemption from registration under Section 4(2) of the Securities Act of 1933, based on the limited number of shareholders receiving the Corporation's common stock. (c) Description of the Corporation's Capital Stock: Authorized Capital Stock. The authorized capital stock of the Corporation currently consists of 5,000,000 shares of preferred stock, without par value ("preferred stock"), which may be issued from time to time by resolution of the Corporation's Board of Directors (the "Board") and 400,000,000 shares of common stock, $0.625 par value (the "common stock"). As of December 31, 1999, there were 129,878,459 shares of common stock and no shares of preferred stock outstanding. As of that date, approximately 27.5 million shares of common stock were reserved for issuance under various employee stock plans and the Corporation's dividend reinvestment plan, and no shares of preferred stock were reserved for issuance. Although shares have been reserved for issuance under the employee stock plans, the plans generally permit the Corporation to repurchase shares on the open market or privately for issuance under such plans. The Board has authorized management to repurchase shares from time to time for the plans. A total of 1.3 million shares were repurchased and 1.9 million shares were issued for the plans in 1999. Pursuant to Board authority, the Corporation plans to continue to purchase shares from time to time for the plans and will evaluate the level of capital and take action designed to generate or use capital as appropriate for the interest of the shareholders. Also, the Corporation has on file with the SEC one effective shelf registration pursuant to which it may offer from time to time, at its discretion, senior or subordinated debt securities, preferred stock, including depository shares, and common stock at an aggregate initial offering price not to exceed $225 million (net of prior issuances) and another effective shelf registration pursuant to which up to $200 million of capital securities (guaranteed preferred beneficial interests in the Corporation's subordinated debentures) is available for issuance. Preferred Stock. The Board is authorized, without further action by the shareholders, to provide for the issuance of up to 5,000,000 shares of preferred stock, from time to time in one or more series and, with respect to each such series, has the authority to fix the powers (including voting power), designations, preferences and relative, participating, optional or other special rights and the qualifications, limitations or restrictions thereof. Common Stock. The Board is authorized to issue a maximum of 400,000,000 shares of common stock. The holders of the common stock are entitled to receive, ratably, such dividends as may be declared by the Board from funds legally available therefor, provided that if any shares of preferred stock are at the time outstanding, the payment of dividends on common stock or other distributions (including purchases of common stock) may be subject to the declaration and payment of full cumulative dividends, and the absence of arrearages in any mandatory sinking fund, on outstanding shares of preferred stock. The holders of the outstanding shares of common stock are entitled to one vote for each such share on all matters presented to shareholders and are not entitled to cumulate votes for the election of directors. Upon any dissolution, 16 18 liquidation or winding up of the Corporation resulting in a distribution of assets to the shareholders, the holders of common stock are entitled to receive such assets ratably according to their respective holdings after payment of all liabilities and obligations and satisfaction of the liquidation preferences of any shares of preferred stock at the time outstanding. The shares of common stock have no preemptive, redemption, subscription or conversion rights. Under the Corporation's Charter, the Board is authorized to issue authorized shares of common stock without further action by the shareholders. However, the common stock is traded on the New York Stock Exchange, Inc. which requires shareholder approval of the issuance of additional shares of common stock in certain situations. The Transfer Agent for the common stock is Norwest Bank Minnesota, National Association. The Board is divided into three classes, which results in approximately 1/3 of the directors being elected each year. In addition, the Charter and the Bylaws, among other things, generally give to the Board the authority to fix the number of directors on the Board and to remove directors from and fill vacancies on the Board, other than removal for cause and the filling of vacancies created thereby which are reserved to shareholders exercising at least a majority of the voting power of all outstanding voting stock of the Corporation. To change these provisions of the Bylaws, other than by action of the Board, and to amend these provisions of the Charter or to adopt any provision of the Charter inconsistent with such Bylaw provisions, would require approval by the holders of at least 80% of the voting power of all outstanding voting stock. Such classification of the Board and such other provisions of the Charter and the Bylaws may have a significant effect on the ability of the shareholders of the Corporation to change the composition of an incumbent Board or to benefit from certain transactions which are opposed by the Board. Shareholder Protection Rights Plan. On October 20, 1998, the Board adopted a Shareholder Protection Rights Agreement (the "Rights Plan") and declared a dividend of one right on each share of common stock outstanding on November 2, 1998, or issued thereafter and prior to the time the rights separate and thereafter pursuant to options and convertible securities outstanding at the time the rights separate. The Rights Plan became operative upon the expiration on September 18, 1999 of a substantially identical plan that was adopted in 1989. Until the earlier of (i) the 10th business day (subject to certain adjustments by the Board) after commencement of a tender or exchange offer which, if consummated, would result in a person or group owning 10% or more (but not more than 50%) of the outstanding shares of common stock (an "Acquiring Person") and (ii) the tenth business day (the "Flip-in Date") after the first date of public announcement by the Corporation that a person has become an Acquiring Person, the Rights will be evidenced by the common stock certificates, will automatically trade with the common stock, and will not be exercisable. Thereafter, separate rights certificates will be distributed, and each right will entitle its holder to purchase one one-hundredth of a share of Participating Preferred Stock having economic and voting terms similar to those of one share of common stock for $150.00, subject to adjustment (the "Exercise Price"). The Rights will expire on the earliest of (i) the Exchange Time (defined below), (ii) December 31, 2009, and (iii) the date on which the Rights are redeemed as described below. The Board may amend the Rights Plan in any respect prior to the Flip-in Date. The Board may, at its option, at any time prior to the close of business on the Flip-in Date, redeem all the Rights at a price of $0.001 per Right, as adjusted from time to time pursuant to the Rights Plan. If a Flip-in Date occurs, each Right (other than Rights beneficially owned by the Acquiring Person or its affiliates, associates or transferees, which Rights will become void) will entitle its holder to purchase a 17 19 number of shares of common stock or Participating Preferred Stock having a market value of twice the Exercise Price for an amount in cash equal to the then-current Exercise Price. In addition, the Board may, at its option, at any time after a Flip-in Date, elect to exchange the Rights (other than Rights beneficially owned by the Acquiring Person or its affiliates, associates or transferees) for shares of common stock or a Participating Preferred Stock at an exchange ratio of one share of common stock or 1/100th of a share of Participating Preferred Stock per Right (the "Exchange Time"). Also, if after an Acquiring Person controls the Corporation's Board of Directors, the Corporation is involved in a merger or sells more than 50% of its assets or earning power or is involved with an Acquiring Person in certain self-dealing transactions (or has entered into an agreement to do any of the foregoing) and, in the case of a merger, the Acquiring Person will receive different treatment than all other shareholders, each Right will entitle its holder to purchase a number of shares of common stock of the Acquiring Person having a market value of twice the Exercise Price for an amount in cash equal to the then-current Exercise Price. The Rights will not prevent a takeover of the Corporation. The Rights, however, may have certain anti-takeover effects. The Rights may cause substantial dilution to a person or group that acquires 10% or more of the outstanding common stock unless the Rights are first redeemed by the Corporation's Board. ITEM 6 SELECTED FINANCIAL DATA The information called for by this Item is incorporated herein by reference to the Selected Financial and Operating Data Table in the 1999 Annual Report. ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION The information called for by this Item is incorporated herein by reference to the Management's Discussion and Analysis section, Glossary section, and the Consolidated Historical Performance Statements of Income and Consolidated Average Balance Sheets and Related Yields and Rates tables in the 1999 Annual Report. ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information called for by this Item is incorporated herein by reference to Notes 1 and 23 to the Consolidated Financial Statements and the "Risk Management-Interest Rate Risk Management" subsection of the Management's Discussion and Analysis section contained in the 1999 Annual Report. ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information called for by this Item is incorporated herein by reference to the Consolidated 18 20 Financial Statements and the notes thereto and to the Summary of Quarterly Financial Information Table in the 1999 Annual Report. ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE The information called for by this Item is inapplicable. PART III ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information called for by this Item as it relates to directors and nominees for director of the Corporation is incorporated herein by reference to the "Election of Directors" section of the Corporation's Proxy Statement furnished to shareholders in connection with the Annual Meeting of Shareholders scheduled for April 18, 2000 (herein referred to as the "2000 Proxy Statement"). The information required by this Item as it relates to executive officers of the Corporation is incorporated herein by reference to Item 4A in Part I of this Report. The information required by this Item as it relates to compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated herein by reference to the "Section 16(a) Beneficial Ownership Reporting Compliance" section of the 2000 Proxy Statement. ITEM 11 EXECUTIVE COMPENSATION The information called for by this Item is incorporated herein by reference to the "Executive Compensation" section of the 2000 Proxy Statement (excluding the Board Compensation Committee Report and the Total Shareholder Return Performance Graph). ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information called for by this Item is incorporated herein by reference to the "Stock Ownership Information and Table" section of the 2000 Proxy Statement. The Corporation is unaware of any arrangements which may result in a change in control of the Corporation. ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information called for by this Item is incorporated herein by reference to the "Certain Relationships and Related Transactions" section of the 2000 Proxy Statement. 19 21 PART IV ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as a part of this Report: Financial Statements: - Consolidated Statements of Condition as of December 31, 1999 and 1998 - Consolidated Statements of Income for the years ended December 31, 1999, 1998 and 1997 - Consolidated Statements of Shareholders' Equity for the years ended December 31, 1999, 1998 and 1997 - Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997 - Notes to the Consolidated Financial Statements - Report of Independent Public Accountants The consolidated financial statements of the Corporation, the notes thereto, and the report of independent public accountants, in the 1999 Annual Report, as listed above, are incorporated herein by reference. Financial Statement Schedules: Not applicable. Exhibits: Exhibits marked with an "*" represent a management contract or compensatory plan or arrangement required to be identified and filed as an exhibit. (3)(i) Restated Charter of the Corporation, as amended, incorporated herein by reference to Exhibit 3(i) to the Corporation's 1997 Annual Report on Form 10-K. (3)(ii) Bylaws of the Corporation, as amended and restated, incorporated herein by reference to Exhibit 3(b) to the Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999. (4)(a) Shareholder Protection Rights Agreement, dated as of October 20, 1998, between the Corporation and First Tennessee Bank National Association, as Rights Agent, including as Exhibit A the forms of Rights Certificate and Election to Exercise and as Exhibit B the form of Articles of Amendment designating Participating Preferred Stock, incorporated herein by reference to Exhibits 1, 2, and 3 to the Corporation's Registration Statement on Form 8-A filed 10-23-98. (4)(b) The Corporation and certain of its consolidated subsidiaries have outstanding certain long-term debt. See Note 10 in the Corporation's 1999 Annual Report. None of such debt exceeds 10% of the total assets of the Corporation and its consolidated subsidiaries. Thus, copies of constituent instruments defining the rights of holders of such debt are not required to be included as exhibits. The Corporation agrees to furnish copies of such instruments to the Securities and Exchange Commission upon request. *(10)(a) Management Incentive Plan, as amended and restated, incorporated herein by reference to 20 22 Exhibit 10(a) to the Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999. *(10)(b) 2000 Employee Stock Option Plan, incorporated herein by reference to Exhibit 10(n) to the Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999. *(10)(c) 1997 Employee Stock Option Plan, as amended and restated, incorporated herein by reference to Exhibit 10(b) to the Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999. *(10)(d) 1992 Restricted Stock Incentive Plan, as amended and restated, incorporated herein by reference to Exhibit 10(d) to the Corporation's Quarterly Report on Form 10-Q for the quarter ended March 31, 1999. *(10)(e) 1984 Stock Option Plan, as amended, 1-21-97 amendment and 10-22-97 amendment, incorporated herein by reference to Exhibit 10(e) to the Corporations 1992, 1996 and 1997 Annual Reports on Form 10-K. *(10)(f) 1990 Stock Option Plan, as amended, 1-21-97 amendment and 10-22-97 amendment, incorporated herein by reference to Exhibit 10(f) to the Corporation's 1992, 1996 and 1997 Annual Reports on Form 10-K. *(10)(g) Survivor Benefits Plan, as amended and restated, incorporated herein by reference to Exhibit 10(g) to the Corporation's 1997 Annual Report on Form 10-K. *(10)(h) Amendment and Restated Directors and Executives Deferred Compensation Plan and form of individual agreement, incorporated herein by reference to Exhibit 10(h) to the Corporation's 1996 Annual Report on Form 10-K. *(10)(i) Amended and Restated Pension Restoration Plan, as amended and restated, incorporated herein by reference to Exhibit 10(i) to the Corporation's 1998 Annual Report on Form 10-K. *(10)(j) Director Deferral Agreements with schedule, incorporated herein by reference to Exhibit 10(k) to the Corporation's 1992 Annual Report on Form 10-K and Exhibit 10(j) to the Corporation's 1995 Annual Report on Form 10-K. *(10)(k) Form of Severance Agreements dated 1-28-97, incorporated herein by reference to Exhibit 10(k) to the Corporation's 1996 Annual Report on Form 10-K. *(10)(l) 1995 Employee Stock Option Plan, as amended and restated, incorporated herein by reference to Exhibit 10(l) to the Corporation's 1998 Annual Report on Form 10-K. *(10)(m) Non-Employee Directors' Deferred Compensation Stock Option Plan, as amended and restated, incorporated herein by reference to Exhibit 10(m) to the Corporation's 1997 Annual Report on Form 10-K. *(10)(n) 2000 Non-Employee Directors' Deferred Compensation Stock Option Plan, incorporated herein by reference to Exhibit 10(o) to the Corporation's Quarterly Report on Form 10-Q form the quarter ended September 30, 1999. *(10)(o) George Lewis - Non-compete and Early Retirement Agreement. (13) The portions of the 1999 Annual Report to Shareholders that have been incorporated by reference into this Form 10-K. (21) Subsidiaries of the Corporation. (23) Accountants' Consents (24) Powers of Attorney (27) Financial Data Schedule (99) Annual Report on Form ll-K for the Corporation's Savings Plan and Trust, for fiscal year ended 12-31-99, as authorized by SEC Rule 15d-21 (to be filed as an Amendment to Form l0-K). (b) No reports on Form 8-K were filed during the fourth quarter of 1999. 21 23 Pursuant to the requirements of Section 13 or 15(d) 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. FIRST TENNESSEE NATIONAL CORPORATION Date: March 24, 2000 By: Elbert L. Thomas, Jr. ----------------------------------------------- Elbert L. Thomas, Jr., Executive Vice President and Chief Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date --------- ----- ---- Ralph Horn* Chairman of the Board, President and March 24, 2000 - ----------------------- Chief Executive Officer (principal executive Ralph Horn officer) and a Director Elbert L. Thomas, Jr.* Executive Vice President March 24, 2000 - ----------------------- and Chief Financial Officer Elbert L. Thomas, Jr. (principal financial officer) James F. Keen* Senior Vice President and March 24, 2000 - ----------------------- Corporate Controller (principal James F. Keen accounting officer) Robert C. Blattberg* Director March 24, 2000 - ----------------------- Robert C. Blattberg Carlos H. Cantu* Director March 24, 2000 - ----------------------- Carlos H. Cantu George E. Cates* Director March 24, 2000 - ----------------------- George E. Cates J. Kenneth Glass* Director March 24, 2000 - ----------------------- J. Kenneth Glass James A. Haslam, III* Director March 24, 2000 - ----------------------- James A. Haslam, III John C. Kelley, Jr.* Director March 24, 2000 - ----------------------- John C. Kelley, Jr.
22 24 R. Brad Martin* Director March 24, 2000 - ----------------------- R. Brad Martin Joseph Orgill, III* Director March 24, 2000 - ----------------------- Joseph Orgill, III Director March , 2000 - ----------------------- Vicki R. Palmer Michael D. Rose* Director March 24, 2000 - ----------------------- Michael D. Rose William B. Sansom* Director March 24, 2000 - ----------------------- William B. Sansom *By: Clyde A. Billings, Jr. March 24, 2000 -------------------------------- Clyde A. Billings, Jr. As Attorney-in-Fact
23 25
EXHIBIT INDEX Item No. Description - -------- ----------- (3)(i) Restated Charter of the Corporation, as amended, incorporated herein by reference to Exhibit 3(i) to the Corporation's 1997 Annual Report on Form 10-K. (3)(ii) Bylaws of the Corporation, as amended and restated, incorporated herein by reference to Exhibit 3(b) tot he Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999. (4)(a) Shareholder Protection Rights Agreement, dated as of October 20, 1998, between the Corporation and First Tennessee Bank National Association, as Rights Agent, including as Exhibit A the forms of Rights Certificate and Election to Exercise and as Exhibit B the form of Articles of Amendment designating Participating Preferred Stock, incorporated herein by reference to Exhibits 1, 2, and 3 to the Corporation's Registration Statement on Form 8-A filed 10-23-98. (4)(b) The Corporation and certain of its consolidated subsidiaries have outstanding certain long-term debt. See Note 10 in the Corporation's 1999 Annual Report. None of such debt exceeds 10% of the total assets of the Corporation and its consolidated subsidiaries. Thus, copies of constituent instruments defining the rights of holders of such debt are not required to be included as exhibits. The Corporation agrees to furnish copies of such instruments to the Securities and Exchange Commission upon request. *(10)(a) Management Incentive Plan, as amended and restated, incorporated herein by reference to Exhibit 10(a) to the Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999. *(10)(b) 2000 Employee Stock Option Plan, incorporated herein by reference to Exhibit 10(n) to the Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999. *(10)(c) 1997 Employee Stock Option Plan, as amended and restated, incorporated herein by reference to Exhibit 10(b) to the Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999. *(10)(d) 1992 Restricted Stock Incentive Plan, as amended and restated, incorporated herein by reference to Exhibit 10(d) to the Corporation's Quarterly Report on Form 10-Q for the quarter ended March 31, 1999. *(10)(e) 1984 Stock Option Plan, as amended, 1-21-97 amendment, and 10-22-97 amendment, incorporated herein by reference to Exhibit 10(e) to the Corporation's 1992, 1996 and 1997 Annual Reports on Form 10-K. *(10)(f) 1990 Stock Option Plan, as amended, 1-21-97 amendment, and 10-22-97 amendment, incorporated herein by reference to Exhibit 10(f) to the Corporation's 1992, 1996 and 1997 Annual Reports on Form 10-K. *(10)(g) Survivor Benefits Plan, as amended and restated, incorporated herein by reference to Exhibit 10(g) to the Corporation's 1997 Annual Report on Form 10-K. *(10)(h) Amended and Restated Directors and Executives Deferred Compensation Plan and form of individual agreement, incorporated herein by reference to Exhibit 10(h) to the Corporation's 1996 Annual Report on Form 10-K. *(10)(i) Amended and Restated Pension Restoration Plan, as amended and restated, incorporated herein by reference to Exhibit 10(i) to the Corporation's 1998 Annual Report on Form 10-K. *(10)(j) Director Deferral Agreements with schedule, incorporated herein by reference to Exhibit 10(k) to the Corporation's 1992 Annual Report on Form 10-K and Exhibit 10(j) to the Corporation's 1995 Annual Report on Form 10-K. *(10)(k) Form of Severance Agreements dated 1-28-97, incorporated herein by reference to Exhibit 10(k) to the Corporation's 1996 Annual Report on Form 10-K. *(10)(l) 1995 Employee Stock Option Plan, as amended and restated, incorporated herein by reference to Exhibit 10(l) to the Corporation's 1998 Annual Report on Form 10-K. *(10)(m) Non-Employee Directors Deferred Compensation Stock Option Plan, as amended and restated, incorporated herein by reference to Exhibit 10(m) to the Corporation's 1997 Annual Report on Form 10-K. *(10)(n) 2000 Non-Employee Directors' Deferred Compensation Stock Option Plan, incorporated herein by reference to Exhibit 10(o) to the Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999. *(10)(o) George Lewis Non-compete and Early Retirement Agreement. (13) The portions of the 1999 Annual Report to Shareholders that have been incorporated by reference into this Form 10-K. (21) Subsidiaries of the Corporation. (23) Accountants' Consents (24) Powers of Attorney (27) Financial Data Schedule (99) Annual Report on Form ll-K for the Corporation's Savings Plan and Trust, for fiscal year ended December 31, 1999, as authorized by SEC Rule 15d-21 (to be filed as an amendment to Form 10-K). * Exhibits marked with an "*" represent a management contract or compensatory plan or arrangement required to be identified and filed as an exhibit.
EX-10.(O) 2 GEORGE LEWIS NON-COMPETE AND EARLY RETIREMENT 1 EXHIBIT 10(o) October 26, 1999 George Lewis First Tennessee Bank 165 Madison Ave. Memphis, TN 38101 Dear George: This letter describes the components of the special non-compete agreement package approved by the Human Resources Committee for you from First Tennessee Bank, N. A. COVENANT NOT TO COMPETE Beginning with your acceptance and for the next four years following, you agree to reveal promptly to First Tennessee any material matter coming to your attention pertaining to the business or interest of First Tennessee, which can be reasonably and legally revealed, and you further agree not to accept employment or engage as a partner, member, principal, consultant, director or otherwise in any financial services business which is in competition with First Tennessee and has a business location within (50) miles of Memphis or any of its affiliated banking offices in Tennessee, unless you have received the prior written consent of the Employee Services Division Manager. In consideration of the paragraph above, you will receive payments of approximately $94,179 annually for four years. You will receive payments of approximately $3,622.29 every two weeks beginning October 23, 1999 with the first payment on the November 5, 1999 payroll. In the event of a Change in Control as defined in the FTNC Pension Plan, you will be paid a lump sum payment equal to present value (based on a discount rate of 4.2%) of the remaining scheduled payments as indicated on the attached Exhibit 1. (to be added later) If you should die before the full four years of payments have been paid, the payments will cease upon your death. PENSION Based on an election of the Life Only Option for your normal retirement benefit under the FTNC Pension Plan, you will also receive approximately $7,848.29 each month beginning October 1, 2003 or a lesser amount on an earlier date if you so choose. At your death, the payments will cease. The pension benefit will be eligible for any cost of living increases that may be provided to retirees through the FTNC Pension Plan. DEFERRED COMPENSATION Your account in the Directors and Executives Deferral Plan will continue to accrue interest at the applicable rate. The first payment will be made on or about the January 31st following your 65th birthday or January 31, 2004. The monthly payment based on the current applicable rate will be $1,804.33 per month ($21,652 annually) for a period of 180 months (or 15 years). 2 A summary of your total projected benefits under the Deferral Plan will be provided to you in an Amendment to Directors and Executives Deferred Compensation Plan and Related Deferral and Acknowledgment Agreement(s). RESTRICTED STOCK: There are currently 17,987 shares of restricted FTNC stock in your TARSAP account. The removal of these restrictions will be accelerated to the date of your acceptance of this agreement. GROSS-UP PAYMENT In the event of a Change in Control, the Company agrees to provide the benefit of a Gross-up Payment as defined in paragraph 5 (viii) of your severance agreement, to the extent you are subject to the excise tax described in the section. MEDICAL INSURANCE You may continue your medical coverage provided you make the necessary premium payments. At your death, your spouse will have free coverage for two years and at the end of the two years, she can continue coverage by paying the necessary premiums unless she remarries or becomes covered by another group medical plan. First Tennessee reserves the right to change premiums, make plan revisions or terminate the plan at any time. SURVIVOR'S INCOME BENEFIT At your death a survivor's income benefit would be paid under the Company's Survivor Benefits Plan to your beneficiary. The benefit would be equal to two times your final year's base salary (exclusive of incentive or bonus compensation). This survivor's benefit, based on your current salary, would be $550,000. In the event of a Change in Control, your benefit under the Plan cannot be reduced. GROUP LIFE INSURANCE AND VOLUNTARY GROUP LIFE You have $50,000 of group term life insurance that will cease as of October 22, 1999. You have no voluntary group life insurance on your life. You may convert your group life insurance coverage to a whole life insurance policy within 31 days after your coverage ends. CONFIDENTIALITY AND NON-DISCLOSURE In consideration of the covenant not to compete described in paragraph one (1) above, beginning with your acceptance and for the next four years following, you agree unless required by law to do so, not to reveal to parties not employed by First Tennessee or its affiliates, without the prior written consent of First Tennessee, any matters that, if so revealed, could in any manner adversely affect First Tennessee. This obligation of confidentiality and non-disclosure shall also apply, for the same four (4) year period beginning with your acceptance, to the content and substance of this Agreement, except of course, it may be disclosed to any attorney or financial, tax, or other consultant from whom you seek advice. If you fail to observe any of the terms of this Agreement and continue such breach for a period of thirty (30) days after First Tennessee shall have requested you to perform the same, or if you accept employment with or enter into any competing business described above and continue either directly or indirectly for a period of fourteen (14) days after First Tennessee has notified you that it considers such activities in violation of this Agreement, then no further payments shall be due or payable by First Tennessee either to you or your beneficiary or beneficiaries and First Tennessee shall have no further liability under this Agreement. 3 The agreement, payments and deferred compensation payments which have been approved by the Human Resource Committee are, of course, conditioned on acceptance of the terms of this letter, expressed by your signature in the space provided below. If you have any questions, please let me know. Sincerely, /s/ Sarah Meyerrose Sarah Meyerrose Executive Vice President READ, UNDERSTOOD AND ACCEPTED /s/ George P. Lewis ----------------------------- George P. Lewis Date: ------------------------ EX-13 3 1999 ANNUAL REPORT TO SHAREHOLDERS 1 EXHIBIT 13 TABLE OF CONTENTS MANAGEMENT'S DISCUSSION AND ANALYSIS General Information Forward-Looking Statements INCOME STATEMENT ANALYSIS - 1999 COMPARED TO 1998 Noninterest Income Securities Gains/(Losses) Net Interest Income Provision For Loan Losses Noninterest Expense Income Taxes INCOME STATEMENT ANALYSIS - 1998 COMPARED TO 1997 BALANCE SHEET REVIEW Earning Assets Deposits, Other Sources of Funds and Liquidity Management Capital RISK MANAGEMENT OTHER GLOSSARY CONSOLIDATED STATEMENTS OF CONDITION CONSOLIDATED STATEMENTS OF INCOME CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY CONSOLIDATED STATEMENTS OF CASH FLOWS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS CONSOLIDATED HISTORICAL STATEMENTS OF INCOME CONSOLIDATED AVERAGE BALANCE SHEETS AND RELATED YIELDS AND RATES CORPORATE OFFICERS AND BOARDS OF DIRECTORS 2 EXHIBIT 13 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION GENERAL INFORMATION - ------------------- First Tennessee National Corporation (First Tennessee) is headquartered in Memphis, Tennessee, and is a nationwide, diversified financial services institution which provides banking and other financial services to its customers through various regional and national business lines. The REGIONAL BANKING GROUP includes the retail/commercial bank, the credit card division, and the trust division. The NATIONAL LINES OF BUSINESS include FT Mortgage Companies and affiliates (also referred to as mortgage banking), First Tennessee Capital Markets (also referred to as capital markets), and transaction processing (credit card merchant processing, automated teller machine network, nationwide check clearing operation, and remittance processing). Certain revenue and expenses are allocated and equity is assigned to the various business lines to reflect the inherent risk in each business line, based on management's best estimates. These allocations are periodically reviewed and may be revised from time to time to more accurately reflect current business conditions and risks; the previous history is restated to ensure comparability. For the purpose of this management discussion and analysis (MD&A), noninterest income (also called fee income) and total revenue exclude securities gains and losses. Net interest income has been adjusted to a fully taxable equivalent (FTE) basis for certain tax-exempt loans and investments included in earning assets. Earning assets, including loans, have been expressed as averages, net of unearned income. First Tennessee Bank National Association, the primary bank subsidiary, is also referred to as FTBNA in this discussion. The following financial discussion should be read with the accompanying consolidated financial statements and notes. A glossary is included at the end of the MD&A to assist with terminology. FORWARD-LOOKING STATEMENTS - -------------------------- Management's discussion and analysis may contain forward-looking statements with respect to First Tennessee's beliefs, plans, goals, expectations, and estimates. These statements are contained in certain sections that follow such as Noninterest Income, Net Interest Income, Risk Management, and Other. Forward-looking statements are statements that are not based on historical information but rather are related to future operations, strategies, financial results or other developments. The words "believe", "expect", "anticipate", "intend", "estimate","should", "is likely", and other expressions which indicate future events and trends identify forward-looking statements. Forward-looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies many of which are beyond a company's control, and many of which, with respect to future business decisions and actions (such as acquisitions and divestitures), are subject to change. Examples of uncertainties and contingencies include, among other important factors, general and local economic and business conditions; expectations of the timing and amount of interest rate movements (which can have a significant impact on a financial services institution); market and monetary fluctuations; inflation; competition within and outside the financial services industry; technology; and new products and services in the industries in which First Tennessee operates. Other factors are those inherent in originating loans, including prepayment risks and fluctuating collateral values and changes in customer profiles. Additionally, the policies of the Office of the Comptroller of the Currency (OCC) and the Board of Governors of the Federal Reserve System, unanticipated regulatory and judicial proceedings, and changes in laws and regulations applicable to First Tennessee and First Tennessee's success in executing its business plans and strategies and managing the risks involved in the foregoing, could cause actual results to differ. First Tennessee assumes no obligation to update any forward-looking statements that are made from time to time. INCOME STATEMENT ANALYSIS - 1999 COMPARED TO 1998 Earnings in 1999 were $247.5 million, the ninth consecutive year of record earnings, and an increase of 9 percent from $226.4 million earned in 1998. Diluted earnings per share were $1.85 in 1999, up 8 percent over the $1.72 earned in 1998 (adjusted for the 1998 two-for-one-stock split). Basic earnings per share were $1.90 in 1999, up 7 percent over the $1.77 earned in 1998. The 3 difference between the net income growth and the earnings per share growth reflects the larger number of shares outstanding in 1999 due to reduced shares repurchased. Return on average assets (ROA) was 1.33 percent in 1999 compared with 1.35 percent in 1998. Return on average shareholders' equity (ROE) was 20.9 percent in 1999 compared with 22.7 percent in 1998. Strong internal equity generation and retention caused the decline in this ratio. At December 31, 1999, First Tennessee was ranked among the top 50 bank holding companies nationally in market capitalization ($3.7 billion) and assets ($18.4 billion). At December 31, 1998, market capitalization was $4.9 billion and total assets were $18.7 billion. The decline in the market capitalization was due to a 25 percent decrease in the stock price between these two period-ends. Total revenue for 1999 grew 12 percent ($188.2 million) with growth in noninterest income of 14 percent ($139.2 million) and growth in net interest income of 9 percent ($49.0) million. Mortgage banking led the increase in fee income with growth of 13 percent ($74.4 million). NONINTEREST INCOME - ------------------ Noninterest income, also called fee income, provides the majority of First Tennessee's revenue. During 1999 fee income increased 14 percent, to a record $1,120.8 million from $981.6 million, and contributed 66 percent to total revenue in 1999 compared with 64 percent in 1998. This high contribution level ranks First Tennessee among the top ten of the largest 50 bank holding companies in the nation for this ratio. Table 1 - Analysis of Noninterest Income provides six years of detail by category with growth rates. The discussion following the table details various line items reported in the table. TABLE 1 - ANALYSIS OF NONINTEREST INCOME
Compound Annual Growth Rates (%) ------------------ (Dollars in thousands) 1999 1998 1997 1996 1995 1994 99/98 99/94 - --------------------------------------------------------------------------------------------------------------------------- NONINTEREST INCOME: Mortgage banking $ 632,771 $ 558,366 $ 330,131 $ 275,406 $ 213,563 $ 188,270 13.3 + 27.4 + Capital markets 126,835 147,353 98,310 85,871 82,814 77,478 13.9 - 10.4 + Deposit transactions and cash management 106,240 90,444 86,047 78,228 74,124 65,797 17.5 + 10.1 + Trust services and investment management 59,807 51,198 40,941 34,704 34,435 27,895 16.8 + 16.5 + Merchant processing 49,711 37,462 32,111 24,185 19,164 14,699 32.7 + 27.6 + Cardholder fees 25,579 21,046 19,833 17,155 14,885 15,572 21.5 + 10.4 + Equity securities gains/(losses) 2,313 3,940 (854) (2,495) 3,195 24,251 41.3 - 37.5 - Debt securities gains/(losses) (56) 36 141 (186) (751) (4,298) N/A 58.0 + All other income and commissions: Other service charges 17,430 14,863 10,474 9,891 7,709 7,334 17.3 + 18.9 + Check clearing fees 11,143 9,199 13,043 16,873 17,585 16,124 21.1 + 7.1 - Insurance premiums and commissions 10,912 8,725 6,457 5,644 6,606 5,797 25.1 + 13.5 + Other 80,419 42,871 31,496 25,873 19,282 17,247 87.6 + 36.1 + - --------------------------------------------------------------------------------------------------------- Total other income 119,904 75,658 61,470 58,281 51,182 46,502 58.5 + 20.9 + - --------------------------------------------------------------------------------------------------------- Total noninterest income $ 1,123,104 $ 985,503 $ 668,130 $ 571,149 $ 492,611 $ 456,166 14.0 + 19.7 + ========================================================================================================= Certain previously reported amounts have been reclassified to agree with current presentation.
4 MORTGAGE BANKING FT Mortgage Companies, a subsidiary of FTBNA, originates and services residential mortgage loans. Following origination, the mortgage loans, primarily first-lien, are sold to investors in the secondary market while the rights to service such loans are usually retained. Various hedging strategies are used to mitigate changes in the market value of the loan during the time period beginning with a price commitment to the customer and ending with the delivery of the loan to the investor. Closed loans held during this time period are referred to as the mortgage warehouse. Income from origination fees and profits from the sale of loans are recognized at the time a mortgage loan is sold into the secondary market, not when the loan is originated. Gains or losses from mortgage warehouse hedging activities are reflected in secondary marketing activities. Secondary marketing activities also include product pricing decisions as well as the income from the sale of loans including the capitalized net present value of the mortgage servicing rights. Servicing rights permit the collection of fees for gathering and processing monthly mortgage payments for the owner of the mortgage loans. FT Mortgage Companies employs hedging strategies to offset the risk of prepayment and mitigate the loss of value of its mortgage servicing rights due to a decline in interest rates. The financial effect of hedging mortgage servicing rights is reported in miscellaneous income. As shown in Table 2 - Mortgage Banking, total mortgage banking fee income increased 13 percent in 1999. Mortgage banking noninterest income consists of various revenue streams from the origination process, servicing, and other activities such as sales of servicing. TABLE 2 - MORTGAGE BANKING
Compound Annual Growth Rates (%) --------------------- (Dollars and volume in millions) 1999 1998 1997 99/98 99/97 - ----------------------------------------------------------------------------------------------------------------- NONINTEREST INCOME: Secondary marketing activities $ 242.7 $ 223.4 $ 128.8 8.6 + 37.3 + Loan origination fees 172.7 159.7 83.5 8.2 + 43.8 + Servicing fees 167.8 117.9 94.4 42.3 + 33.3 + Sale of mortgage servicing rights 16.4 (.5) 9.1 N/A 34.2 + Miscellaneous 33.2 57.9 14.3 42.6 - 52.4 + - ------------------------------------------------------------------------------------------- Total noninterest income $ 632.8 $ 558.4 $ 330.1 13.3 + 38.5 + =========================================================================================== Refinance originations $ 7,155 $ 13,146 $ 3,192 45.6 - 49.7 + New loan originations 12,708 10,105 7,432 25.8 + 30.8 + - ------------------------------------------------------------------------------------------- Mortgage loan originations $ 19,863 $ 23,251 $ 10,624 14.6 - 36.7 + =========================================================================================== Servicing portfolio $ 44,628 $ 39,738 $ 26,929 12.3 + 28.7 + - ------------------------------------------------------------------------------------------- Certain previously reported amounts have been adjusted to current presentation. N/A = not applicable
Origination activity fell 15 percent as interest rates increased throughout 1999. During 1999, $19.9 billion of mortgage loans were originated compared with record originations of $23.3 billion in 1998. Based upon the latest industry survey of origination volume, FT Mortgage Companies ranked as one of the top ten retail mortgage loan originators in the nation during 1999. A focus on retail home purchase loans and continued expansion of the origination franchise led to an increase in market share over this period. Although total origination volume declined, loans sold into the secondary market increased 7 percent in 1999 due to the build-up in the warehouse during 1998 to $4.2 billion at year-end and the subsequent decline to $2.0 billion by year-end 1999. Fees derived from the mortgage origination process (origination fees, profits from the sale of loans and other secondary marketing activities) increased 8 percent in 1999, from $383.1 million to $415.4 million, consistent with the percentage increase in loans sold. Mortgage servicing fee income increased 42 percent in 1999, from $117.9 million to $167.8 million. The mortgage servicing portfolio (which includes servicing for ourselves and others) grew to $44.6 billion at December 31, 1999, compared with $39.7 billion at December 31, 1998. The growth in the servicing portfolio was driven by origination volume exceeding prepayments with the majority of this growth generated through FT Mortgage's retail loan origination network. The 12 percent servicing portfolio growth during 1999 was derived from loan originations of $19.9 billion, purchased servicing of $1.7 billion, less $8.9 billion of bulk servicing sales and servicing released originations, and 5 principal reductions of $7.8 billion from payments and payoffs received in the normal course of business. Also see Note 6 - Capitalized Mortgage Servicing Rights for information summarizing the changes in mortgage servicing rights. The decrease in miscellaneous income, from $57.9 million in 1998 to $33.2 million, was primarily due to a decrease in gains recognized from servicing hedges during 1999. Gains from hedging activities will vary from period to period depending on interest rates. During 1999 and 1998, $17.9 million and $38.1 million, respectively, of miscellaneous income came from gains on certain mortgage servicing hedges. Bulk sales of mortgage servicing rights during 1999 resulted in recognized gains of $16.4 million. Going forward, it is expected that origination volume will be adversely impacted by the current rising interest rate environment. Rising interest rates and changing markets will also put pressure on the profit margin of originated loans and the ability to make the necessary adjustments to hedge positions in order to mitigate any loss in the value of originated loans. In periods of increasing interest rates, the value of mortgage servicing rights generally increases and the value of hedges related to the servicing rights generally declines. Mortgage banking performance is affected by numerous factors including the volume and mix of loans produced and sold, loan pricing decisions, interest rate levels and volatility, the creditworthiness of applicants, the level of prepayments, the effectiveness of hedging activities and estimated future prepayments, as well as other factors referred to in the Forward-Looking Statements section of this MD&A. CAPITAL MARKETS First Tennessee Capital Markets generates fee income primarily from the purchase and sale of securities as both principal and agent. Inventory positions are limited to the procurement of securities solely for distribution to customers by the sales staff. Inventory is hedged to protect against movements in interest rates. During 1999 noninterest income decreased 14 percent from $147.4 million in 1998 to $126.8 million. This decrease primarily resulted from a change in product mix due to concerns by customers about interest rates. These concerns motivated many customers to remain liquid during the latter half of the year and place their money in cash and short-term investments. Customers also had higher cash needs related to year-end 1999 (Y2K) and the funding of additional loan growth. Total securities bought and sold by the capital markets division increased 25 percent in 1999, from $427.0 billion to $534.3 billion. Total underwritings during 1999 were $35.1 billion, a decrease of 33 percent from $52.6 billion underwritten in 1998. Going forward, if there continues to be a widespread expectation of rising interest rates, our customers are likely to remain liquid, investing in short-term securities. This trend is expected to put pressure on achieving growth in revenue during 2000. Once the expectation of rising interest rates lessens, customers' demand for longer-term securities should return. Actual results could differ because of several factors, including those presented in the Forward-Looking Statements section of this MD&A. DEPOSIT TRANSACTIONS AND CASH MANAGEMENT Deposit transactions include services related to retail deposit products (such as service charges on checking accounts) and cash management products and services such as electronic transaction processing (automated clearing house (ACH) and Electronic Data Interchange (EDI)), account reconciliation services, cash vault services, lockbox processing, and information reporting (Prime Connection). Noninterest income from deposit transactions and cash management increased 17 percent in 1999, from $90.4 million to $106.2 million. The increase in 1999 was led by increased sales volume of various cash management products and services and growth in customer service charges. 6 TRUST SERVICES AND INVESTMENT MANAGEMENT Trust services and investment management fees come from the product lines of investment management, personal trust, employee benefits, and custodial and corporate trust services. During 1999 total noninterest income from trust services and investment management grew 17 percent, from $51.2 million to $59.8 million. This growth was driven by strong performance by the investment advisory companies, 12 percent growth in assets under management and successful cross-sell efforts, particularly to our targeted market. Assets under management grew from $8.9 billion at December 31, 1998, to $9.9 billion at December 31, 1999. The growth in fee income was as follows: the asset management business lines grew 23 percent; personal trust was up 14 percent; corporate trust services, which acts as trustee on public bond issues, grew 36 percent; and employee benefits increased 4 percent. Highland Capital Management Corp. (Highland Capital) and Martin and Company, Inc. (Martin), both wholly owned subsidiaries, provide investment advisory services to the managed asset segments. Highland Capital manages the First Funds Growth and Income Portfolio and the First Funds Bond Portfolio. Martin manages the First Funds Tennessee Tax-Free Portfolio and the First Funds Intermediate Bond Portfolio. First Funds is a family of mutual funds advised by FTBNA. The Growth and Income Portfolio (Institutional Class) attained national recognition during 1999 by maintaining the five-star Morningstar rating for domestic equity funds. The Tennessee Tax Free Portfolio (Institutional Class) was awarded the 1999 Lipper Performance Achievement Certificate for the one-year period ending December 31, 1999, in recognition of ranking number one in the category of Tennessee municipal debt funds based on cumulative total return for the period. Lipper, a Reuters company, ranks mutual funds based upon total return performance within a universe of funds similar in investment objective. MERCHANT PROCESSING Credit card merchant processing involves converting transactions from plastic media such as check cards, debit cards, credit cards, purchase cards, and private label credit cards into cash for merchants that sell goods and services to consumers and businesses. Fee income from merchant processing grew 33 percent in 1999, from $37.5 million to $49.7 million, due to a special assessment from a large customer, pricing changes, expansion and change in the mix of the customer base to a larger portion of direct customers. During 1999, 148 million transactions were processed compared with a record 157 million transactions processed in 1998. CARDHOLDER Cardholder fees result from issuing and servicing credit cards, and include the collection of late charges and annual fees, as well as interchange fees received for accepting credit card payments. Cardholder noninterest income increased 22 percent in 1999, from $21.0 million to $25.6 million, principally from higher interchange collections due to strong purchasing volume and moderate growth (2 percent) in the credit card portfolio as well as price increases. ALL OTHER NONINTEREST INCOME All other noninterest income grew 58 percent in 1999, from $75.7 million to $119.9 million. Growth in this category was positively impacted during 1999 by the revenue ($16.7 million) generated from the remittance processing operation acquired in June 1999 from National Processing Co. (NPC); a gain ($6.1 million) on the recognition of stock received as a result of the demutualization of an insurance company; and a gain ($4.2 million) from the sale of a bank branch in Tunica, Mississippi. Excluding these three items, all other income and commissions would have grown 23 percent. Additional contributing factors to the growth rate were other service charges, insurance premiums and commissions and check clearing fees. Other service charges are generated from banking services performed, but are not directly related to deposit transactions. This includes fees for money orders, travelers' checks, savings bonds, safe deposit box rentals, mutual fund services, safekeeping, and servicing of securitization transactions. During 1999, other service charges grew 17 percent, from $14.9 million to $17.4 million, primarily from growth in investment/mutual fund sales 7 and servicing REMIC securities and other securitized transactions. Check clearing fees increased 21 percent, from $9.2 million to $11.1 million, primarily from return item growth and lockbox volume growth. Insurance premiums and commissions increased 25 percent, from $8.7 million in 1998 to $10.9 million in 1999, due to increased sales efforts throughout the year. The other category increased 88 percent, from $42.9 million to $80.4 million. Excluding the three items mentioned earlier in this paragraph, the growth in the other category would have been 24 percent. SECURITIES GAINS/(LOSSES) - ------------------------- In 1999 there were $2.3 million of net equity securities gains compared with $3.9 million of net equity securities gains for 1998. The majority of the security gains in both 1999 and 1998 were from the sales of venture capital investments at First Tennessee's subsidiary, Hickory Venture Capital Corporation. 8 NET INTEREST INCOME - ------------------- During 1999 net interest income increased 9 percent, from $544.3 million to $592.5 million, principally from strong loan growth, improvement in the regional banking group's net interest margin (margin) and increased net interest income from mortgage banking. The regional banking group's margin improved from 4.87 percent in 1998 to 4.96 percent in 1999 primarily due to a drop in funding costs. The consolidated margin remained stable at 3.80 percent in 1999 and 1998. The margin is affected by the activity levels and related funding for First Tennessee's national lines of business as these nonbank business lines typically produce different margins than traditional banking activities. In mortgage banking, because the spread between the rates on mortgage loans temporarily in the warehouse and the related short-term funding rates is less than the comparable spread earned in the regional banking group, the overall margin is compressed. The average mortgage warehouse was larger in 1999 despite lower originations because of the higher level of activity at year-end 1998. Capital markets tends to compress the margin because of its strategy to reduce market risk by hedging its inventory in the cash markets which effectively eliminates net interest income on these positions. As a result, First Tennessee's consolidated margin cannot be readily compared to that of other bank holding companies. Table 3 - Net Interest Margin Composition details the computation of the net interest margin for the regional banking group and the impact that the other business lines had on the consolidated margin for the years 1997 through 1999. TABLE 3 - NET INTEREST MARGIN COMPOSITION
1999 1998 1997 - ----------------------------------------------------------------------------------------------------------- REGIONAL BANKING GROUP: Yields on earning assets 7.91% 8.20% 8.25% Rates paid on interest-bearing liabilities 3.88 4.36 4.54 - ----------------------------------------------------------------------------------------------------------- Net interest spread 4.03 3.84 3.71 - ----------------------------------------------------------------------------------------------------------- Effect of interest-free sources .78 .89 .89 Loan fees .14 .14 .11 FRB interest and penalties .01 -- -- - ----------------------------------------------------------------------------------------------------------- Net interest margin-Regional Banking Group 4.96% 4.87% 4.71% - ----------------------------------------------------------------------------------------------------------- MORTGAGE BANKING (1.02) (.92) (.37) CAPITAL MARKETS (.16) (.17) (.12) TRANSACTION PROCESSING .02 .02 .01 - ----------------------------------------------------------------------------------------------------------- Consolidated net interest margin 3.80% 3.80% 4.23% ===========================================================================================================
Interest rate sensitivity is primarily a function of the repricing structure of First Tennessee's balance sheet (Statement of Condition). Table 4 - Rate Sensitivity Analysis at December 31, 1999, shows the assets and liabilities as of year-end, subject to repricing in specified time intervals with each maturity interval referring to the earliest repricing opportunity (i.e., the earlier of scheduled contractual maturity or repricing date) for each asset and liability category. The resulting gap is one tool, though not a predominant management tool, used to measure the sensitivity of net interest income to changes in interest rates. It should be noted that the required gap analysis does not take into account future management actions that could be undertaken to alter the simulated results, the effect of interest-free sources, or a change in the slope of the yield curve. (For additional information see Risk Management-Interest Rate Risk Management section.) Because of Y2K concerns, higher short-term interest rates and liquidity needs, a higher portion of purchased funds were kept short-term at year-end 1999, affecting the 3-month gaps and the simulation analysis. 9 TABLE 4 - RATE SENSITIVITY ANALYSIS AT DECEMBER 31, 1999
Within 3 After 3 Months After 6 Months After 1 Year After (Dollars in millions) Months Within 6 Months Within 12 Months Within 5 Years 5 Years Total - ---------------------------------------------------------------------------------------------------------------------------- EARNING ASSETS: Loans $ 5,100 $ 369 $ 611 $ 2,397 $ 886 $ 9,363 Investment securities 395 244 402 1,760 300 3,101 Mortgage loans held for sale 2,050 -- -- -- -- 2,050 Federal funds sold and securities purchased under agreements to resell 280 -- -- -- -- 280 Other earning assets 150 -- -- -- -- 150 - ---------------------------------------------------------------------------------------------------------------------------- Total earning assets $ 7,975 $ 613 $ 1,013 $ 4,157 $ 1,186 $ 14,944 ============================================================================================================================ EARNING ASSET FUNDING: Savings $ 37 $ -- $ -- $ 222 $ 88 $ 347 Checking interest 151 -- -- 367 781 1,299 Money market 1,940 -- -- -- 255 2,195 CD's under $100,000 and other time 509 523 551 723 36 2,342 CD's $100,000 and more 1,979 132 139 113 14 2,377 Short-term borrowed funds 4,332 75 -- -- -- 4,407 Term borrowings -- -- -- 51 308 359 - ---------------------------------------------------------------------------------------------------------------------------- Total earning asset funding $ 8,948 $ 730 $ 690 $ 1,476 $ 1,482 $ 13,326 ============================================================================================================================ RATE SENSITIVITY GAP: Period $ (973) $ (117) $ 323 $ 2,681 $ (296) Cumulative (973) (1,090) (767) 1,914 1,618 - --------------------------------------------------------------------------------------------------------------- RATE SENSITIVITY GAP ADJUSTED FOR INTEREST RATE SWAPS: Period $(1,078) $ (12) $ 323 $ 2,681 $ (296) Cumulative (1,078) (1,090) (767) 1,914 1,618 - --------------------------------------------------------------------------------------------------------------- ADJUSTED GAP AS A PERCENTAGE OF TOTAL EARNING ASSETS: Period (7.2)% (.1)% 2.2 % 17.9% (2.0)% Cumulative (7.2) (7.3) (5.1) 12.8 10.8 - --------------------------------------------------------------------------------------------------------------- Interest-sensitive categories represent ranges in which assets and liabilities can be repriced, not necessarily their actual maturities. The 'After 5 Years' column includes assets and liabilities with interest sensitivity of more than five years or with indefinite repricing schedules. Noninterest earning/bearing balances have been excluded from this analysis.
In order to reflect more appropriately the repricing structure of First Tennessee's balance sheet, management has made certain adjustments to the balances shown in the table. Based on historical and industry data, an estimate of the expected prepayments on consumer loans and investment securities is reflected in the balances in the table. Changes in the economic and interest rate environments may also affect these expected prepayments. Similarly, an adjustment to deposits is made to reflect the behavioral characteristics of certain core deposits that do not have specified contractual maturities (i.e., interest checking, savings and money market deposit accounts). Historically, balances on these deposit accounts have remained relatively stable despite changes in market interest rates. Management has classified certain of these accounts as non-interest sensitive based on management's historical pricing practices and runoff experience. At December 31, 1999, the balance sheet was liability sensitive to interest rate movements and within internal guideline limits, with $767 million more liabilities than assets scheduled to reprice within one year (5 percent of earning assets). Table 4 does not take into account the effect of interest-free sources which can be significant to First Tennessee. When the interest-free sources are added to the rate sensitivity 10 analysis, the balance sheet is less liability sensitive with $558 million of liabilities repricing faster than assets within one year (4 percent of earning assets). Simulation analysis is the primary tool used by First Tennessee to manage the exposure of net interest income and margin to volatile interest rates, changing market spreads, forecasted changes in balance sheet mix, and rate sensitivity. This type of analysis computes the amount of net interest income at risk from dynamic changes in the market place and related rate, pricing and balance sheet movements. The simulation models create various at risk scenarios looking at increases and/or decreases in interest rates from an instantaneous movement, or a staggered movement over a certain time period. Management reviews these different scenarios to determine probable actions. The models are then updated to incorporate management action. A level of acceptable net interest income at risk based on a staggered increase or decrease in interest rates of 300 basis points is a component of internal guidelines. Based on First Tennessee's rate sensitivity position during 1999, there was no net interest income at risk in 1999 when modeling a 300 basis point staggered decline in rates. Conversely, the net interest income at risk averaged approximately 2 percent of projected 1999 net interest income when modeling a 300 basis point staggered increase in rates. Based on the rate sensitivity position at December 31, 1999, net interest income exposure over the next 12 months to a 300 basis point staggered increase in interest rates is estimated to be approximately 3 percent of projected 2000 net interest income. There is projected to be no net interest income exposure to a 300 basis point staggered decline in interest rates. A 300 basis point gradual increase or decrease in interest rates is a hypothetical rate scenario. These scenarios are used as one estimate of risk, and do not necessarily represent management's current view of future interest rates or market developments and may well vary from actual results for a number of reasons, including those presented in the Forward-Looking Statements section of this MD&A discussion. Based on First Tennessee's existing balance sheet mix and the current interest rate environment, the regional banking group's margin is expected to be relatively stable. Going forward, the consolidated margin will continue to be influenced by the activity levels in the nonbanking lines of business, especially from mortgage banking as the level of origination volume is strongly tied to refinance activity. Information in this section includes forward-looking statements. Actual results could differ because of several factors, including those presented in the Forward-Looking Statements section of this MD&A discussion. Table 5 - Analysis of Changes in Net Interest Income provides rate and volume changes in interest income and interest expense for earning assets and interest-bearing liabilities for the past three years. 11 TABLE 5 - ANALYSIS OF CHANGES IN NET INTEREST INCOME
1999 Compared to 1998 1998 Compared to 1997 (Fully taxable equivalent) Increase / (Decrease) Due to* Increase / (Decrease) Due to* - -------------------------------------------------------------------------------------- ------------------------------------ (Dollars in thousands) Rate** Volume** Total Rate** Volume** Total - -------------------------------------------------------------------------------------------------------------------------------- INTEREST INCOME - FTE: Loans: Commercial $ (14,663) $ 24,209 $ 9,546 $(4,538) $ 27,874 $ 23,336 Consumer (6,035) 26,332 20,297 6,184 3,128 9,312 Permanent mortgage 941 (2,078) (1,137) 237 (12,580) (12,343) Credit card receivables (1,913) 1,180 (733) (2,479) 2,304 (175) Real estate construction (1,901) (493) (2,394) (626) 6,535 5,909 Nonaccrual (575) 30 (545) 294 (218) 76 - -------------------------------------------------- Total loans (24,712) 49,746 25,034 (97) 26,212 26,115 - -------------------------------------------------- Investment securities: U.S. Treasury and other U.S. government agencies (1,909) (5,450) (7,359) (482) (11,037) (11,519) States and municipalities (168) (1,443) (1,611) (213) (1,094) (1,307) Other 1,138 26,708 27,846 174 32,025 32,199 - -------------------------------------------------- -------- --------- Total investment securities 382 18,494 18,876 298 19,075 19,373 - -------------------------------------------------- -------- --------- Other earning assets: Mortgage loans held for sale 3,655 21,975 25,630 (6,199) 135,013 128,814 Investment in bank time deposits (20) (1,478) (1,498) (25) 1,493 1,468 Federal funds sold and securities purchased under agreements to resell (986) 4,783 3,797 (297) (724) (1,021) Capital markets securities inventory (1,311) 2,067 756 (1,266) 18,468 17,202 - -------------------------------------------------- -------- --------- Total other earning assets 735 27,950 28,685 (5,162) 151,625 146,463 - -------------------------------------------------- -------- --------- Total earning assets (25,956) 98,551 72,595 (32,040) 223,991 191,951 - --------------------------------------------------------------------------------------- -------------------------------------- Total interest income - FTE $ 72,595 $ 191,951 - --------------------------------------------------------------------------------------- -------------------------------------- INTEREST EXPENSE: Interest-bearing deposits: Savings $ (1,388) $ 51 $ (1,337) $ (466) $ (609) $ (1,075) Checking interest and money market (13,657) 4,749 (8,908) 3,517 14,531 18,048 Certificates of deposit under $100,000 and other time (10,847) (10,251) (21,098) (3,860) (11,783) (15,643) Certificates of deposit $100,000 and more (7,380) 61,821 54,441 (575) 64,317 63,742 - -------------------------------------------------- ---------- --------- Total interest-bearing deposits (25,766) 48,864 23,098 4,039 61,033 65,072 - -------------------------------------------------- ---------- --------- Federal funds purchased and securities sold under agreements to repurchase (10,024) (7,858) (17,882) (450) 33,248 32,798 Commercial paper and other short-term borrowings (4,625) 18,970 14,345 (2,902) 36,050 33,148 Term borrowings (3,411) 8,266 4,855 (1,378) 5,401 4,023 - -------------------------------------------------- --------- --------- Total interest-bearing liabilities (41,549) 65,965 24,416 4,795 130,246 135,041 - -------------------------------------------------------------------------------------------------------------------------------- Total interest expense $ 24,416 $ 135,041 - -------------------------------------------------------------------------------------------------------------------------------- Net interest income - FTE $ 48,179 $ 56,910 ================================================================================================================================ * The changes in interest due to both rate and volume have been allocated to change due to rate and change due to volume in proportion to the absolute amounts of the changes in each. ** Variances are computed on a line-by-line basis and are non-additive.
12 PROVISION FOR LOAN LOSSES - ------------------------- The provision for loan losses is the charge to operating earnings that management determines to be necessary to maintain the allowance for loan losses at an adequate level reflecting management's estimate of the risk of loss inherent in the loan portfolio. The provision for loan losses increased 13 percent, to $57.9 million in 1999 compared with $51.3 million in 1998, due to increased inherent losses in the loan portfolio and a change in the loan mix related to growth in loans with higher risk/reward profiles. A more detailed discussion follows in the Risk Management-Credit Risk Management/Asset Quality section. NONINTEREST EXPENSE - ------------------- Noninterest expense, also called operating expense, increased 14 percent in 1999, from $1,121.8 million to $1,275.3 million. This growth rate was affected by the NPC acquisition. Excluding this acquisition, total operating expense would have increased 12 percent. Table 6 - Analysis of Noninterest Expense provides detail by category for the past six years with growth rates. Table 7- Operating Expense Composition gives a breakdown of total expenses by business line for the prior three years. TABLE 6 - ANALYSIS OF NONINTEREST EXPENSE
Compound Annual Growth Rates (%) ----------------- (Dollars in thousands) 1999 1998 1997 1996 1995 1994 99/98 99/94 - ------------------------------------------------------------------------------------------------------------------------------ NONINTEREST EXPENSE: Employee compensation, incentives and benefits $ 633,640 $ 563,576 $409,783 $385,380 $340,508 $349,769 12.4 + 12.6 + Amortization of mortgage servicing rights 103,471 95,507 37,452 26,041 14,980 14,936 8.3 + 47.3 + Operations services 64,545 58,505 49,879 44,109 38,798 33,679 10.3 + 13.9 + Occupancy 73,052 51,421 42,848 39,815 37,867 34,102 42.1 + 16.5 + Equipment rentals, depreciation and maintenance 57,807 45,771 40,093 34,121 31,845 29,202 26.3 + 14.6 + Communications and courier 51,937 41,468 34,899 32,981 29,880 30,653 25.2 + 11.1 + Amortization of intangible assets 10,492 11,114 9,631 9,491 8,100 6,406 5.6 - 10.4 + All other expense: Amortization of hedge instruments 49,414 13,345 4,867 -- -- -- 270.3 + N/A Contract employment 43,685 35,937 17,420 11,288 5,744 5,323 21.6 + 52.3 + Advertising and public relations 30,187 25,184 18,722 17,629 12,972 10,678 19.9 + 23.1 + Legal and professional fees 22,492 24,551 13,999 12,050 13,403 13,747 8.4 - 10.3 + Supplies 22,006 20,195 15,267 14,383 11,866 11,472 9.0 + 13.9 + Travel and entertainment 18,698 19,485 13,802 10,394 8,211 10,144 4.0 - 13.0 + Computer software 15,410 11,629 6,731 4,076 3,004 2,619 32.5 + 42.5 + Distribution on guaranteed preferred securities 8,070 8,070 8,070 -- -- -- - N/A Foreclosed real estate 6,585 31,019 10,827 7,533 4,962 3,862 78.8 - 11.3 + Fed service fees 6,471 5,307 5,799 7,814 9,489 8,544 21.9 + 5.4 - Deposit insurance premium 1,790 1,578 1,485 5,129 9,957 16,923 13.4 + 36.2 - Contribution to charitable foundation -- -- -- -- -- 9,379 N/A N/A Other 55,500 58,107 43,470 42,252 28,129 34,245 4.5 - 10.1 + - ------------------------------------------------------------------------------------------------------------- Total other expense 280,308 254,407 160,459 132,548 107,737 126,936 10.2 + 17.2 + - ------------------------------------------------------------------------------------------------------------- Total noninterest expense $1,275,252 $1,121,769 $785,044 $704,486 $609,715 $625,683 13.7 + 15.3 + ============================================================================================================= Certain previously reported amounts have been reclassified to agree with current presentation.
13 Employee compensation, incentives, and benefits (personnel expense), the largest component of noninterest expense, increased 12 percent in 1999, from $563.6 million to $633.6 million. Excluding NPC, personnel expense increased 10 percent. Personnel expense includes commissions paid in several lines of business, such as capital markets and mortgage banking. As the revenue increases or decreases and/or as the product mix changes in these business lines, the amount of commissions also changes. The growth in personnel expense during 1999 was favorably impacted by lower commissions and workforce reductions at capital markets and changes in management incentive compensation plans. The effect was diminished by increases in non-origination functions at mortgage banking. Personnel expense decreased 14 percent at capital markets and increased 17 percent at mortgage banking. Excluding these two business lines and NPC, personnel expense increased 13 percent due in part to market expansion in our other business lines. TABLE 7 - OPERATING EXPENSE COMPOSITION
(Dollars in millions) 1999 1998 1997 - ----------------------------------------------------------------------------------------------------- Regional banking group $ 447.9 $ 402.9 $352.3 Mortgage banking 636.0 536.9 292.7 Capital markets 96.7 111.0 74.2 Transaction processing 86.0 62.3 57.7 Corporate 8.7 8.7 8.1 - ----------------------------------------------------------------------------------------------------- Total operating expense $1,275.3 $1,121.8 $785.0 =====================================================================================================
The regional banking group increased operating expenses 11 percent, from $402.9 million to $447.9 million, and accounted for 29 percent of the overall expense growth. This growth rate was affected by investments made to expand consumer lending, to grow insurance and investment management, and to open new branches in targeted growth markets. Costs were also incurred related to the marketing campaign to increase awareness of our new brand. Operating expense in the mortgage banking division increased 18 percent, from $536.9 million to $636.0 million, and accounted for 65 percent of the overall expense growth. In addition to the higher personnel expense, mortgage banking expense growth was also impacted by increased amortization expense of servicing hedge instruments and mortgage servicing rights related to a larger servicing portfolio, additional technology-related expenses including conversion and training, and costs related to consolidating facilities including lease abandonment costs. Capital markets decreased operating expenses 13 percent, from $111.0 million to $96.7 million due primarily to lower commissions and incentives, and workforce reductions. Transaction processing experienced growth in operating expense of 38 percent, from $62.3 million to $86.0 million, and accounted for 15 percent of the overall expense growth. This growth was mainly related to the operation of the NPC locations acquired. INCOME TAXES - ------------ The effective tax rate decreased to a 34.8 percent rate in 1999 from a 35.9 percent rate in 1998. This decrease was largely due to an adjustment of deferred tax liabilities resulting from a lower expected effective state tax rate. 14 INCOME STATEMENT ANALYSIS - 1998 COMPARED TO 1997 Earnings in 1998 were $226.4 million, an increase of 15 percent from $197.5 million earned in 1997. Basic earnings per share increased 15 percent from $1.54 in 1997 to $1.77 in 1998. Diluted earnings per share increased 15 percent from $1.50 in 1997 to $1.72 in 1998. Return on average shareholders' equity was 22.7 percent in 1998 compared with 22.5 percent in 1997. Return on average assets was 1.35 percent in 1998 and 1.49 percent in 1997. The decline in the return on average assets was caused by the 26 percent growth in average assets of which 55 percent came from growth in the mortgage warehouse, a lower earning asset, from a record year of originations. Noninterest income increased 47 percent during 1998, from $668.8 million to a record $981.5 million and contributed 64 percent to total revenue. During 1998 mortgage banking fees increased 69 percent, from $330.1 million to $558.4 million, due primarily to growth in the mortgage origination process (loan origination fees and secondary marketing activities). During 1998 originations were a record $23.3 billion compared with $10.6 billion in 1997. The servicing portfolio was $39.7 billion on December 31, 1998, compared with $26.9 billion on December 31, 1997. See Table 2 for a breakout of mortgage banking fee income. Capital markets' fee income increased 50 percent in 1998, from $98.3 million to $147.4 million, and securities bought and sold increased 88 percent, from $226.6 billion to $427.0 billion. The increased core volume growth, paralleling the growth in revenue, came from continued expansion of the customer base, additional product penetration, and strong performance in all of the offices including the newly opened New York office and the first full year of operations for the Chicago office. The majority of the remaining volume growth was due to additional emphasis on short-term U.S. agency notes. During 1998 deposit transactions and cash management fees increased 5 percent, from $86.1 million to $90.4 million, due to increased sales volume and pricing increases. Trust services and investment management fees increased 25 percent, from $40.9 million to $51.2 million, as a result of acquisition activity, increased assets under management and strong market performance. Merchant processing fees grew 17 percent, from $32.1 million to $37.5 million, because of the addition of new merchants and higher activity levels. Cardholder fees grew 6 percent, from $19.8 million to $21.0 million. All other noninterest income grew 23 percent in 1998, from $61.5 million to $75.7 million, and was spread over various categories. In 1998 there were $3.9 million of net equity securities gains compared with $.8 million of net equity securities losses for 1997. The gains in 1998 were from the investment subsidiary, Hickory Venture Capital Corporation. During 1998 net interest income increased 12 percent, from $487.4 million to $544.3 million, principally from the growth in earning assets. The increase in earning assets, combined with the narrower spread earned on the mortgage warehouse, led to the decline in the consolidated net interest margin from 4.23 percent to 3.80 percent in 1998. See Table 3 for the detailed computation of the net interest margin for the regional banking group and the impact that the other business lines had on the consolidated margin. The provision for loan losses was $51.3 million in 1998 compared with $51.1 million in 1997. The provision for loan losses remained relatively stable in 1998 due to improvements in mortgage banking and credit card asset quality, which was principally negated by the increased inherent risk in the loan portfolio from loan growth and a change in loan mix partially due to securitizations. During 1998 noninterest expense increased 43 percent, from $785.0 million to $1,121.8 million, primarily because of growth in the commission-based business lines. Table 7 - Operating Expense Composition gives a breakdown of total expenses by business line. Mortgage banking accounted for 73 percent of the overall expense growth in 1998 and was driven by increased mortgage origination volume and a larger servicing portfolio. Capital markets accounted for 11 percent of the overall expense growth. Excluding these two business lines, overall operating expenses increased 13 percent during 1998. Investments to expand consumer lending beyond our traditional markets, growth in the insurance business, consolidation expenses in merchant processing, and investments in marketing and technology contributed to this growth rate. Personnel expense, the largest component of noninterest expense, increased 38 percent, from $409.8 million in 1997 to $563.6 million in 1998. Excluding mortgage banking and capital markets, personnel expense increased 13 percent due in part to market expansion in other business lines. Amortization of mortgage servicing rights increased 155 percent, from $37.4 million in 1997 to $95.5 million in 1998, as a result of a larger servicing portfolio and additional prepayments. All other expense increased 62 percent, from $141.8 million in 1997 to $229.2 million in 1998, with the growth in mortgage banking accounting for 84 percent of this increase. 15 BALANCE SHEET REVIEW At December 31, 1999, First Tennessee reported total assets of $18.4 billion compared with $18.7 billion at the end of 1998 and $14.4 billion at the end of 1997. Average assets were $18.6 billion in 1999 compared with $16.7 billion in 1998 and $13.3 billion in 1997. The 11 percent increase in average assets during 1999 was primarily due to growth in earning assets, accounting for 66 percent of the growth. The large increase in period-end and average balances from 1997 to 1998 was principally driven by the growth in the mortgage warehouse. EARNING ASSETS - -------------- Earning assets primarily consist of loans, investment securities and mortgage loans held for sale. For 1999, earning assets averaged $15.6 billion compared with $14.3 billion for 1998 and $11.5 billion for 1997. Average earning assets were 84 percent of total average assets in 1999, 86 percent in 1998 and 87 percent in 1997. The decline in this ratio was due to significant growth in mortgage servicing rights (68 percent in 1999 and 52 percent in 1998). LOANS Total loans averaged $8.8 billion and grew 7 percent, or $576.7 million during 1999 and averaged $8.2 billion and grew 4 percent, or $297.0 million during 1998. Average loans represented 57 percent of average earning assets in 1999; 58 percent of average earning assets in 1998 and 69 percent in 1997. The composition ratio was lower in 1999 and 1998 due to securitization activity in those two years. During 1999 and 1998 certain consumer real estate loans, permanent mortgage loans and automobile receivables were securitized. The majority of these securities are owned by subsidiaries of First Tennessee, including FTBNA. Including these transactions in both periods, total average loans would have grown 10 percent in both 1999 and 1998. Additional loan information is provided in Table 8 - Average Loans and Note 4 - Loans. TABLE 8 - AVERAGE LOANS
1999 1998 Percent Growth Percent Growth Percent (Dollars in thousands) 1999 of Total Rate 1998 of Total Rate 1997 of Total - ----------------------------------------------------------------------------------------------------------------------------- Commercial $ 4,272.0 48% 7.7% $ 3,966.3 48% 9.4% $ 3,624.8 46% Consumer 3,085.0 35 10.4 2,794.4 34 1.2 2,760.0 35 Permanent mortgage 456.2 5 (5.3) 481.6 6 (24.6) 638.4 8 Credit card receivables 573.4 7 1.8 563.5 7 3.5 544.7 7 Real estate construction 400.2 5 (1.3) 405.4 5 20.2 337.4 4 Nonaccrual 32.0 -- 3.3 30.9 -- (22.4) 39.8 -- - ----------------------------------------------------------------------------------------------------------------------------- Total loans, net of unearned $ 8,818.8 100% 7.0% $ 8,242.1 100% 3.7% $ 7,945.1 100% =============================================================================================================================
Commercial loans averaged $4.3 billion and grew 8 percent, or $305.7 million during 1999, and averaged $4.0 billion and grew 9 percent, or $341.5 million in 1998. Commercial loans continued as the single largest loan category in 1999. The increase in commercial loans, influenced by strong economic growth in Tennessee, came from acquisitions of new relationships in our targeted markets as a result of new sales support systems and training programs implemented in 1997 and 1998. Additional commercial loan information is provided in Table 9 - Contractual Maturities of Commercial Loans at December 31, 1999. 16 TABLE 9 - CONTRACTUAL MATURITIES OF COMMERCIAL LOANS AT DECEMBER 31, 1999
After 1 Year (Dollars in thousands) Within 1 Year Within 5 Years After 5 Years Total - --------------------------------------------------------------------------------------------------------------------------- Commercial $ 2,481,604 $ 1,645,608 $ 303,304 $ 4,430,516 Real estate construction 382,563 83,135 19,882 485,580 Commercial nonaccrual 5,083 1,526 445 7,054 - --------------------------------------------------------------------------------------------------------------------------- Total commercial loans, net of unearned income $ 2,869,250 $ 1,730,269 $ 323,631 $ 4,923,150 =========================================================================================================================== For maturities over one year: Interest rates - floating $ 621,744 $ 114,978 $ 736,722 Interest rates - fixed 1,108,525 208,653 1,317,178 - --------------------------------------------------------------------------------------------------------------------------- Total $ 1,730,269 $ 323,631 $ 2,053,900 ===========================================================================================================================
The consumer loan portfolio consists of real estate, automobile, student and other consumer installment loans that require periodic payments of principal and interest. Consumer loans averaged $3.1 billion and grew 10 percent, or $290.6 million, in 1999, and averaged $2.8 billion and grew 1 percent, or $34.4 million in 1998. Real estate loans, principally secured by first and/or second liens on residential property, led the increase in consumer loans and accounted for 68 percent of the consumer loan portfolio in both 1999 and 1998. First Horizon Equity Lending (previously known as Gulf Pacific Mortgage), a division of FTBNA, is active in originating second mortgages and contributed 64 percent of the increase in consumer loans. Average consumer loans would have grown 17 percent and 11 percent, in 1999 and 1998, respectively, if loans securitized during these periods had been included in the growth rate calculation. Total credit card receivables (i.e., outstanding balances on Visa, Mastercard and private label accounts) averaged $573.4 million and grew 2 percent, or $9.9 million in 1999, and averaged $563.5 million and grew 3 percent, or $18.8 million in 1998. Visa/Mastercard balances grew 3 percent in 1999 due to increased use of debt by consumers, as well as targeted promotional campaigns to regional banking customers. The permanent mortgage portfolio includes certain mortgage loans that First Tennessee periodically decides to retain. Permanent mortgage loans averaged $456.2 million in 1999 and declined 5 percent, or $25.4 million. In 1998 permanent mortgage loans averaged $481.6 million and decreased 25 percent, or $156.8 million. Excluding the impact from loans securitized during these periods, the permanent mortgage portfolio would have remained relatively flat in 1999 and would have increased 6 percent in 1998. The real estate construction loan portfolio averaged $400.2 million in 1999 and declined 1 percent, or $5.2 million. In comparison, this portfolio averaged $405.4 million in 1998 and grew 20 percent, or $67.9 million. The decline in 1999 was representative of the slowdown in construction projects within the regional banking group partially offset by growth in construction loans originated by mortgage banking. The increase in 1998 reflected the economic growth in Tennessee, favorable market conditions, and growth in residential construction loans primarily originated by mortgage banking. Going forward, First Tennessee expects moderate loan growth due to recent increases in interest rates and anticipated slower growth in the national and regional economies. In the consumer-related loan portfolios, growth in targeted lending activities including the opening of additional consumer finance (First Horizon Money Center) offices is expected to help sustain and generate growth. As loan growth continues to outpace deposit growth, First Tennessee will continue to evaluate alternative sources of funding which may include loan sales, securitizations, syndications, and debt offerings. 17 INVESTMENT SECURITIES The investment portfolio of First Tennessee consists principally of debt securities used as a source of income, liquidity and collateral for repurchase agreements or public fund deposits. Additionally, the investment portfolio is used as a tool to manage risk from movements in interest rates. At December 31, 1999, the securities portfolio totaled $3.1 billion. The investment portfolio is classified into two categories: securities available for sale (AFS) and securities held to maturity (HTM). Table 10 - Contractual Maturities of Investment Securities at December 31, 1999, shows information pertaining to the composition, yields and maturities of the investment securities portfolio. TABLE 10 - CONTRACTUAL MATURITIES OF INVESTMENT SECURITIES AT DECEMBER 31, 1999 (AMORTIZED COST)
After 1 Year After 5 Years Within 1 Year Within 5 Years Within 10 Years After 10 Years ------------------ ------------------ -------------------- ---------------------- (Dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield - ------------------------------------------------------------------------------------------------------------------------ SECURITIES HELD TO MATURITY: States and municipalities* $ 4,102 7.06% $ 8,865 7.61% $ 7,743 7.32% $ 5,182 7.74% Privately issued CMOs -- -- -- -- 441,722 6.87 301,322 7.51 - ------------------------------------------------------------------------------------------------------------------------ Total $ 4,102 7.06% $ 8,865 7.61% $449,465 6.88% $ 306,504 7.51% ======================================================================================================================== SECURITIES AVAILABLE FOR SALE: Mortgage-backed securities and collateralized mortgage obligations** $ 28,692 7.40% $ 58,936 6.46% $ 38,589 6.64% $1,754,672 6.61% U.S. Treasury and other U.S. government agencies 92,892 6.35 70,334 6.19 3,593 6.32 1,192 6.44 States and municipalities* 1,712 8.74 6,252 8.27 7,182 8.48 300 9.44 Other 1,299 12.55 9,244 9.53 8,323 6.99 284,840 *** 7.61 - ------------------------------------------------------------------------------------------------------------------------ Total $124,595 6.68% $144,766 6.60% $ 57,687 6.90% $2,041,004 6.75% ======================================================================================================================== * Weighted average yields on tax-exempt obligations have been computed by adjusting allowable tax-exempt income to a fully taxable equivalent basis using a tax rate of 35 percent. ** Includes $1.7 billion of government agency issued mortgage-backed securities and collateralized mortgage obligations which, when adjusted for early paydowns, have an estimated average life of 4.2 years. *** Includes $158 million of equity securities with no stated maturity.
Average investment securities increased 11 percent, or $276.9 million, in 1999 to $2.7 billion. During 1998 average investment securities increased 13 percent, or $286.3 million. In both years all of the growth came from securitization transactions and the retention of a portion of the resulting securities. Excluding these transactions, investment securities would have declined 1 percent in 1999 and 7 percent in 1998. Investment securities represented 17 percent of earning assets in 1999 and 1998 compared with 19 percent in 1997. At December 31, 1999, the AFS securities totaled $2.3 billion and had an average life of 4.6 years. AFS securities consisted primarily of mortgage-backed securities, collateralized mortgage obligations (CMOs), U.S. Treasuries, U.S. government agencies, equities, and interest only strips. At December 31, 1999, these securities had approximately $35.7 million of net unrealized losses that resulted in a decrease in book equity of approximately $21.8 million, net of $13.9 million of deferred income tax benefit. At December 31, 1998, the AFS securities portfolio totaled $2.4 billion and had approximately $20.9 million of net unrealized gains that resulted in an increase in book equity of approximately $12.9 million, net of $8.0 million of deferred income taxes. At December 31, 1997, the AFS securities portfolio totaled $2.1 billion and had approximately $25.3 million of net unrealized gains that resulted in an increase in book equity of approximately $15.6 million, net of $9.7 million of deferred income taxes. At December 31, 1999, the HTM securities totaled $768.9 million and had an average life of 5.1 years. HTM securities include privately issued CMOs (also referred to as REMIC securities) and municipal securities. The growth in privately issued CMOs over the past two years has occurred through the use of a Real Estate Mortgage Investment Conduit (REMIC). Through this structure, consumer real estate loans have been securitized and retained. These securities had an average life of 5.0 years. Municipal bonds made up the remainder of this 18 classification and had an average life of 7.5 years. The HTM securities portfolio had a net unrealized loss at December 31, 1999, of $34.1 million. At December 31, 1998, the HTM securities totaled $609.8 million and had a net unrealized gain of $.6 million, and at December 31, 1997, the HTM securities portfolio totaled $53.2 million and had a net unrealized gain of $1.1 million. MORTGAGE LOANS HELD FOR SALE (MORTGAGE WAREHOUSE) In 1999 the mortgage warehouse represented approximately 21 percent of total earning assets, compared with 20 percent of earning assets in 1998, up from 10 percent in 1997 due to record originations during 1998. During 1999 the mortgage warehouse averaged $3.2 billion and increased 11 percent, or $306.5 million, from 1998. During 1998 the mortgage warehouse averaged $2.9 billion and increased 189 percent, or $1.9 billion, from 1997. Since the mortgage warehouse loans are generally held in inventory for a short period of time, there may be significant differences between average and period-end balances. At year-end 1999, the mortgage warehouse totaled $2.0 billion compared with $4.2 billion and $1.2 billion at year-end 1998 and 1997, respectively. DEPOSITS, OTHER SOURCES OF FUNDS AND LIQUIDITY MANAGEMENT - --------------------------------------------------------- DEPOSITS During 1999 core deposits grew 1 percent, or $134.3 million, and averaged $9.1 billion. This compares with growth of 8 percent, or $639.8 million, and an average balance of $9.0 billion in 1998. In 1997, these deposits averaged $8.4 billion. Growth in 1999 was comparable to regional market growth and came primarily from expansion of First Tennessee's targeted customer base. Interest-bearing core deposits remained relatively flat and averaged $6.3 billion during 1999 and 1998. This compares with 1998 growth of 3 percent, or $201.7 million, from an average of $6.1 billion in 1997. Noninterest-bearing deposits grew 7 percent, or $174.6 million, during 1999, primarily from growth in demand deposits, and averaged $2.8 billion. In comparison, noninterest-bearing deposits grew 20 percent, or $438.1 million, from growth in mortgage escrow accounts, a cash management investment product and demand deposits, and averaged $2.7 billion in 1998. Noninterest-bearing deposits averaged $2.2 billion in 1997. OTHER SOURCES OF FUNDS Short-term purchased funds averaged $7.1 billion for 1999, up 24 percent, or $1.4 billion, from the previous year. This increase was primarily used to fund a larger balance sheet principally due to growth in earning assets. Short-term purchased funds increased 74 percent, or $2.4 billion in 1998, and averaged $5.7 billion and $3.3 billion during 1998 and 1997, respectively. The growth in 1998 was primarily used to fund growth in the mortgage warehouse from a record year of originations. Short-term purchased funds accounted for 43 percent of First Tennessee's funding (core deposits plus purchased funds and term borrowings) in 1999, 38 percent in 1998, and 28 percent in 1997. See Note 9 - Short-Term Borrowings for additional information. Term borrowings include senior and subordinated borrowings and advances with maturities greater than one year. On average, term borrowings increased $118.4 million during 1999 and averaged $371.1 million, compared with an increase of 36 percent, or $67.2 million, and an average balance of $252.7 million in 1998. The increase in 1999 was primarily due to a full-year effect on averages from the $250 million of subordinated debt issued in 1998. Term borrowings averaged $185.5 million in 1997. Term borrowings at December 31, 1999, were $358.7 million, a decrease of 13 percent, or $55.8 million, from 1998 year-end. See Note 10 - Term Borrowings for additional information. 19 LIQUIDITY MANAGEMENT The objective of liquidity management is to ensure the continuous availability of funds to meet the demands of depositors and borrowers. The Asset/Liability Committee, a committee consisting of senior management that meets regularly, is responsible for managing these needs by taking into account the marketability of assets; the sources, stability and availability of funding; and the level of unfunded commitments. Core deposits are First Tennessee's primary source of funding and one of the most stable sources of liquidity for a bank. In 1999, the total loan to core deposit ratio was 97 percent compared with 92 percent and 95 percent in 1998 and 1997, respectively. This ratio increased in 1999 as loan growth continued to outpace deposit growth. FTBNA has a bank note program available for additional liquidity, under which the bank may borrow funds from time to time, at maturities of 30 days to 30 years. At December 31, 1999, approximately $3.0 billion was available under the bank note program as a long-term (greater than one year) funding source. Parent company liquidity is maintained by cash flows stemming from dividends and interest payments collected from subsidiaries, which represent the primary source of funds to pay dividends to shareholders and interest to debtholders. The amount of dividends from bank subsidiaries is subject to certain regulatory restrictions which are described in Note 17 - Restrictions, Contingencies and Other Disclosures. The parent company statements are presented in Note 24 - Parent Company Financial Information. The parent company also has the ability to enhance its liquidity position by raising equity or incurring debt. Under an effective shelf registration statement on file with the Securities and Exchange Commission (SEC), First Tennessee, as of December 31, 1999, may offer from time to time at its discretion, debt securities, and common and preferred stock aggregating up to $225 million. In addition, First Tennessee also has an effective capital securities shelf registration statement on file with the SEC under which up to $200 million of capital securities is available for issuance. Maintaining adequate credit ratings on debt issues is critical to liquidity because it affects the ability of First Tennessee to attract funds from various sources on a cost-competitive basis. The various credit ratings are detailed in Table 11 - Credit Ratings at December 31, 1999. TABLE 11 - CREDIT RATINGS AT DECEMBER 31, 1999
Thomson Fitch Standard & Poor's Moody's BankWatch IBCA - ------------------------------------------------------------------------------------------------------- FIRST TENNESSEE NATIONAL CORPORATION Overall rating B Subordinated capital notes due 2005 BBB+ Baa1 Capital securities due 2027* BBB A3 A- Commercial paper TBW-1 - ------------------------------------------------------------------------------------------------------- FIRST TENNESSEE BANK NATIONAL ASSOCIATION Short-term/long-term deposits A-1/A P-1/A1 TBW-1 F1/A+ Other short-term/long-term funding** A-1/A P-1/A1 Subordinated bank notes A- A3 Counterparty credit rating A A1 - ------------------------------------------------------------------------------------------------------- * Guaranteed preferred beneficial interests in First Tennessee's subordinated debentures. ** Other funding includes certificates of deposit and senior bank notes.
CAPITAL - ------- Total capital (shareholders' equity plus qualifying capital securities) at December 31, 1999, was $1.3 billion, up 12 percent, or $141.9 million, from December 31, 1998. Shareholders' equity (excluding the qualifying capital securities) was $1.2 billion at year-end 1999, up 13 percent from 1998 which was up 15 percent from year-end 1997. The increase in total capital in 1999 and 1998 came from retention of net income after dividends, equity issued for acquisitions and stock option exercises, reduced by shares repurchased. The Consolidated Statements of Shareholders' Equity highlights the changes in equity since December 31, 1996. 20 Capital adequacy is an important indicator of financial stability and performance. Management's objectives are to maintain a level of capitalization that is sufficient to sustain asset growth, take advantage of profitable growth opportunities and promote depositor and investor confidence. Overall, First Tennessee's capital position remained strong as shown in Table 12 - Capital Ratios. The capital ratios improved in 1999 after declining in 1998 when the growth in average earnings assets (26 percent), driven by growth in the mortgage warehouse, outpaced the increase in shareholders' equity (19 percent). Unrealized market valuations had no material effect on the ratios during 1998 and 1997. However, in 1999, excluding the effects of unrealized market valuations would have increased the period-end equity to assets ratio to 6.86 percent. TABLE 12 - CAPITAL RATIOS
1999 1998 1997 - -------------------------------------------------------------------------- Average total capital to average assets* 6.91% 6.55% 7.36% Average shareholders' equity to average assets 6.37 5.96 6.62 Period-end shareholders' equity to assets 6.76 5.87 6.63 Period-end double leverage 108.9 112.5 113.2 - -------------------------------------------------------------------------- * Total capital includes shareholders' equity and guaranteed preferred beneficial interests in First Tennessee's junior subordinated debentures.
Banking regulators define minimum capital ratios for bank holding companies and their subsidiaries. Based on the risk-based capital rules and definitions prescribed by the banking regulators, should an institution's capital ratios decline below predetermined levels, it would become subject to a series of increasingly restrictive regulatory actions. The system categorizes a financial institution's capital position into one of five categories ranging from well-capitalized to critically under-capitalized. For an institution to qualify as well-capitalized, Tier 1 Capital, Total Capital and Leverage capital ratios must be at least 6 percent, 10 percent and 5 percent, respectively. As of December 31, 1999, First Tennessee and all of its banking affiliates had sufficient capital to qualify as well-capitalized institutions as shown in Note 14 - Regulatory Capital. At the January 1998 meeting of the board of directors, a two-for-one stock split was approved. The stock split was effective February 20, 1998, and changed the par value of First Tennessee's common stock from $1.25 to $.625 per share and the shares of authorized common stock increased from 200 million to 400 million. All share-related information has been restated in this document to reflect the stock split. At December 31, 1999, book value per common share was $9.52 compared with $8.50 for 1998 and $7.44 for 1997. Average shares outstanding for the three-year period were: 130.6 million in 1999, 128.2 million in 1998 and 128.4 million in 1997. Period-end shares outstanding for this same three year-period were: 129.9 million, 129.0 million and 128.2 million, respectively. The higher number of shares outstanding in 1999 was due to more shares issued for stock option exercises and acquisitions than shares repurchased. First Tennessee's shares are traded on The New York Stock Exchange under the symbol FTN and are listed in the financial section of most newspapers as FstTN Ntl. The sales price ranges, net income per share and dividends declared by quarter, for each of the last two years, are presented in Table 20 - Summary of Quarterly Financial Information. At December 31, 1999, the closing sales price of First Tennessee's common stock was $28.50 per share. This price was 299 percent of year-end book value per share, and the annual dividend yield for 1999 was 2.1 percent based on dividends declared in 1999 and the closing market price of $38.0625 on December 31, 1998. The quarterly dividend was increased at the October 20, 1999, board of directors' meeting to $.22 per share, payable January 1, 2000, up 16 percent from $.19 per share. Management has authority to repurchase common stock from time to time for various benefit programs. During 1999, 1.3 million shares were repurchased while 1.9 million were issued for benefit plans and .3 million were issued for acquisitions. During 1998, 1.9 million shares were repurchased while 2.1 million were issued for benefit plans and .5 million were issued for acquisitions. During 1997, First Tennessee repurchased 7.5 million shares of its common stock (of which 3.8 million shares, at a cost of $83.3 million, were purchased under an accelerated purchase program) and issued 1.9 million shares for benefit plans. Pursuant to board authority, First Tennessee plans to continue to purchase shares from time to time for its stock option plans and will evaluate the level of capital and take action designed to generate or use capital as appropriate for the interests of the shareholders. 21 RISK MANAGEMENT INTEREST RATE RISK MANAGEMENT - ----------------------------- The primary purpose of managing interest rate risk is to minimize the volatility to earnings from interest rates and preserve the value of First Tennessee's capital. The Asset/Liability Committee is responsible for coordinating the financial management of net interest income, liquidity, investment portfolio, off-balance sheet hedging, and other such activities. Interest rate risk is managed by structuring the balance sheet to maximize overall profitability, increase revenue, and achieve the desired level of net interest income while managing interest rate sensitivity risk and liquidity. Derivative financial instruments are used to aid in managing the exposure of the balance sheet, net interest income, fee income, and expenses to changes in interest rates. Interest rate sensitivity risk is defined as the risk that future changes in interest rates will reduce income. First Tennessee's net interest income and its financial condition are affected by changes in the level of market interest rates as the repricing characteristics of its loans and other assets do not necessarily match those of its deposits, other borrowings and capital. For example, some fixed-rate assets that reprice within one year are funded with floating-rate debt. This position will benefit net interest income in a declining interest rate environment and will negatively impact net interest income in a rising interest rate environment. In the case of floating-rate assets and liabilities, First Tennessee may also be exposed to basis risk, which results from changing spreads between loans and deposit rates. The interest rate sensitivity analysis cannot be used in isolation to determine the level of interest rate exposure because it does not fully capture the impact of changes in the balance sheet mix, administered rates (such as the prime lending rate), embedded options, lagged interest rate changes, and certain other factors. Accordingly, First Tennessee uses simulation analysis as its primary tool to manage interest rate risk exposure in the regional banking group. This type of analysis computes net interest income at risk under a variety of market interest rate scenarios to more dynamically identify interest rate risk exposures. This simulation, which considers forecasted balance sheet changes, prepayment speeds, deposit mix, pricing impacts, and other changes in the net interest spread, provides an estimate of the annual net interest income at risk for given changes in interest rates. This estimate includes assumptions that are inherently uncertain and, as a result, the model cannot precisely estimate net interest income or precisely predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes and changes in market conditions, and management's strategies, among other factors. Rate shock analysis using multiple interest rate movements up and down is used by mortgage banking to determine the amount of interest rate risk and market value exposure of loan commitments in the pipeline and the mortgage warehouse and of mortgage servicing rights. Various factors are used in this analysis including the magnitude and direction of interest changes, prepayment speeds, and other factors that could affect mortgage banking. Derivative financial instruments are used by mortgage banking for two purposes. Forward contracts and option contracts are used to protect the value of the pipeline and mortgage warehouse against rises in interest rates between the time an interest rate is committed to the customer and the mortgage is sold into the secondary market. Interest rate contracts are utilized to protect against the prepayment risk of the mortgage servicing rights that generally accompanies declines in interest rates. As interest rates fall, the value of the mortgage servicing rights should decrease and the value of the servicing hedge should increase. Conversely, as interest rates rise, the value of mortgage servicing rights should increase and the value of the servicing hedge should decrease. There can be no assurance that in all periods of changing interest rates, the change in value of the derivatives hedging the servicing portfolio will offset the change in value of the mortgage servicing rights. Capital markets buys and sells various types of securities for its customers. When these securities settle on a delayed basis, they are considered forward contracts. Inventory positions are limited to the procurement of securities solely for distribution to customers by the sales staff, and ALCO policies and guidelines have been established to limit the risk in managing this inventory. The derivative financial instruments listed in Table 13 are shown at the notional and fair values. Table 13 - Risk Sensitivity Analysis also details First Tennessee's interest rate sensitivity profile at December 31, 1999, based 22 on projected cashflows using contractual maturity for loans and expected repayment dates for securities. Note 23 - Financial Instruments with Off-Balance Sheet Risk should be referred to for additional information. See Net Interest Income discussion for additional assumptions and information. The information provided in this section including the discussion regarding simulation analysis and rate shock analysis is forward-looking. Actual results could differ because of interest rate movements, the ability of management to execute its business plans and other factors, including those presented in the Forward-Looking Statements section of this MD&A. 23 TABLE 13 - RISK SENSITIVITY ANALYSIS
CAPITAL MARKETS Fair (Dollars in millions) 2000 2001 2002 2003 2004 2005+ Total Value - -------------------------------------------------------------------------------------------------------------------------------- ASSETS: Capital markets securities inventory: Floating $ 147 $ -- $ -- $ -- $ -- $ -- $ 147 $ 147 Average interest rate 6.15% -- -- -- -- -- 6.15% - -------------------------------------------------------------------------------------------------------------------------------- INTEREST RATE DERIVATIVES: Interest rate forward contracts: Commitments to buy $1,241 $ -- $ -- $ -- $ -- $ -- $1,241 $ 12 Weighted average settlement price 98.30% -- -- -- -- -- 98.30% Commitments to sell $1,340 $ -- $ -- $ -- $ -- $ -- $1,340 $ (12) Weighted average settlement price 98.34% -- -- -- -- -- 98.34% - -------------------------------------------------------------------------------------------------------------------------------- HELD FOR PURPOSES OTHER THAN TRADING Fair (Dollars in millions) 2000 2001 2002 2003 2004 2005+ Total Value - --------------------------------------------------------------------------------------------------------------------------- ASSETS: Loans, net of unearned income*: Floating $3,738 $ 243 $ 175 $ 90 $ 169 $ 135 $4,550 $4,550 Average interest rate 8.82% 8.44% 8.10% 7.24% 7.87% 8.42% 8.69% Fixed $1,981 $ 504 $ 368 $ 494 $ 302 $1,134 $4,783 $4,707 Average interest rate 8.39% 8.82% 8.64% 7.88% 8.00% 8.24% 8.34% Mortgage loans held for sale Floating $2,050 $ -- $ -- $ -- $ -- $ -- $2,050 $2,027 Average interest rate 7.03% -- -- -- -- -- 7.03% Investment securities: Fixed $1,041 $ 541 $ 479 $ 405 $ 335 $ 300 $3,101 $3,067 Average interest rate 6.54% 6.46% 6.55% 6.55% 6.51% 6.30% 6.50% Liquid assets**: Floating $ 283 $ -- $ -- $ -- $ -- $ -- $ 283 $ 283 Average interest rate 4.87% -- -- -- -- -- 4.87% - --------------------------------------------------------------------------------------------------------------------------- LIABILITIES: Interest-bearing deposits: Fixed $5,967 $ 591 $ 377 $ 242 $ 209 $1,174 $8,560 $8,563 Average interest rate 4.64% 4.48% 3.79% 2.82% 2.66% 2.08% 4.14% Short-term borrowings: Floating $4,391 $ -- $ -- $ -- $ -- $ -- $4,391 $4,389 Average interest rate 5.24% -- -- -- -- -- 5.24% Fixed $ 16 $ -- $ -- $ -- $ -- $ -- $ 16 $ 16 Average interest rate 4.63% -- -- -- -- -- 4.63% Term borrowings: Fixed $ -- $ -- $ 50 $ -- $ -- $ 309 $ 359 $ 327 Average interest rate -- -- 5.42% -- -- 6.24% 6.13% Guaranteed preferred beneficial interest in First Tennessee's junior subordinated debentures: Fixed $ -- $ -- $ -- $ -- $ -- $ 100 $ 100 $ 92 Average interest rate -- -- -- -- -- 8.07% 8.07% - --------------------------------------------------------------------------------------------------------------------------- * Excludes nonaccrual loans. ** Consists of federal funds sold, securities purchased under agreements to resell and investments in time deposits.
24 TABLE 13 - RISK SENSITIVITY ANALYSIS (CONTINUED)
Fair (Dollars in millions) 2000 2001 2002 2003 2004 2005+ Total Value - ---------------------------------------------------------------------------------------------------------------------------------- INTEREST RATE DERIVATIVES - (notional value) Mortgage banking: Pipeline and warehouse hedging Forward contracts: Commitments to sell $2,137 $ -- $ -- $ -- $ -- $ -- $ 2,137 $ 20 Weighted average settlement price 99.90% -- -- -- -- -- 99.90% Option contracts**: Caps purchased $ -- $ -- $ 950 $ 950 $ -- $ -- $ 1,900 $ 16 Weighted average strike price -- -- 7.12% 7.41% -- -- 7.26% Servicing portfolio hedging Floors purchased $ -- $7,025 $ -- $11,400 $1,250 $ 600 $20,275 $ 27 Weighted average strike price -- 4.67% -- 4.66% 4.78% 4.88% 4.68% Caps purchased $ -- $ -- $ -- $ 250 $ 250 $ -- $ 500 $ 10 Weighted average strike price -- -- -- 6.50% 7.25% -- 6.88% Caps written $ -- $ -- $ -- $ 250 $ 250 $ -- $ 500 $(17) Weighted average strike price -- -- -- 5.75% 6.50% -- 6.13% Swaps $ -- $ -- $ -- $ -- $ 625 $ -- $ 625 $(13) Weighted average strike price -- -- -- -- 6.49% -- 6.49% Swap options purchased $ -- $ -- $ -- $ -- $ -- $1,000 $ 1,000 $ 14 Weighted average strike price -- -- -- -- -- 6.25% 6.25% Interest rate risk management: Swaps $ 415 $ -- $ -- $ -- $ -- $ -- $ 415 $ (1) Average pay rate (floating) 6.05% -- -- -- -- -- 6.05% Average receive rate (fixed) 5.25% -- -- -- -- -- 5.25% Swaps $ 742 $ -- $ -- $ -- $ -- $ -- $ 742 * Average pay rate (floating) 6.07% -- -- -- -- -- 6.07% Average receive rate (floating) 5.87% -- -- -- -- -- 5.87% Caps: Purchased $ -- $ -- $ 20 $ -- $ -- $ -- $ 20 * Weighted average strike price -- -- 8.00% -- -- -- 8.00% Written $ -- $ -- $ 20 $ -- $ -- $ -- $ 20 * Weighted average strike price -- -- 8.00% -- -- -- 8.00% - ----------------------------------------------------------------------------------------------------------------------------------- * Amount is less than $500,000. ** Option contracts in total had a net book value of $151 million at December 31, 1999.
25 CREDIT RISK MANAGEMENT / ASSET QUALITY - -------------------------------------- First Tennessee manages credit risk and asset quality through diversification in the loan portfolio and adherence to its credit policy process. First Tennessee's goal is not to avoid risk but to manage it and include it in the pricing decision. Management strives to identify loans experiencing difficulty early enough to correct the deficiencies. In addition, problem loans and nonperforming loans are recognized in a timely manner. Both charge-offs and asset writedowns are recorded promptly, based on realistic assessments of current collateral values and the borrower's ability to repay. At December 31, 1999, First Tennessee did not have any concentrations of 10 percent or more of total loans in any single industry. ALLOWANCE FOR LOAN LOSSES AND CHARGE-OFFS Management's policy is to maintain the allowance for loan losses at a level sufficient to absorb the estimated losses inherent in the loan portfolio. The allowance for loan losses is increased by the provision for loan losses and recoveries and is decreased by charged-off loans. The adequacy of reserves is analyzed quarterly for the purpose of maintaining coverage of estimated losses inherent in the loan portfolio. An analytical model is used to test the adequacy of the reserves, based on historical loss experience, current trends and reasonably foreseeable events. This methodology determines an estimated loss percentage (reserve rate) which is applied against the balance of loans in each segment of the loan portfolio at the evaluation date. COMMERCIAL AND COMMERCIAL REAL ESTATE LOANS To assess the quality of individual commercial loans, all commercial loans are internally assigned a credit rating, ranging from grades A to F. Analyzing the migration of loan grades assists the credit risk management of the portfolio. A reserve rate is established for each loan grade based on a historical three-year moving average of actual charge-offs. The reserve rate is then adjusted for current trends, both internal and external, that may affect the asset quality of the loan portfolio. Some of the factors considered in making these adjustments include: levels of and trends in delinquencies; classified loans and nonaccrual loans; trends in outstandings and maturities; effects of changes in lending policies and underwriting guidelines; introduction of new loan products with different risk characteristics; experience, ability and depth of lending management and staff; migration trends of loan grades; and recent charge-off trends that may skew the historical three-year moving average. Finally, the reserve rates for each loan grade are reviewed quarterly to reflect local, regional and national economic trends; concentrations of cyclical industries; and the economic prospects for industry concentrations. To supplement management's process in setting these additional adjustments, an economic model is used that evaluates the correlation between historical charge-offs and a number of state and national economic indicators. Also, all classified loans $1 million and greater are evaluated separately, and a specific reserve is set based on the exposure (the difference between the outstanding loan amount and the estimated net realizable value of the collateral) and the probability of loss. Table 14 - Reserve Rates shows the percentage of allowance for loan losses to outstanding balances by loan category. The reserve rate for commercial loans declined from .96 percent in 1998 to .90 percent in 1999, following a slight increase from .95 percent in 1997. The decline in the reserve rate primarily reflects a reduction in the C grade loss factor due to declining charge-off rates from the historical three-year moving average study. The reserve rate for impaired loans decreased from 50.0 percent in 1998 to 42.9 percent in 1999 following an increase from 33.3 percent in 1997. This decline is due to a few large impaired loans which required higher reserves in 1998 and were either charged-off or paid out during 1999. The charge-off ratio (see Table 17 - Net Charge-off Ratios) increased to .17 percent in 1999 from .05 percent in both 1998 and 1997. 26 TABLE 14 - RESERVE RATES
1999 1998 1997 - -------------------------------------------------------------------------- Commercial and commercial real estate* .90% .96% .95% Impaired** 42.86 50.00 33.33 Consumer 1.07 1.19 .98 Credit card receivables 3.95 4.04 4.99 - -------------------------------------------------------------------------- * Excludes impaired and nonaccrual loans. ** Includes nonaccrual loans. Certain previously reported amounts have been restated to agree with current presentation.
CONSUMER LOANS Reserve rates are also established for each segment of the consumer portfolio based on historical loss trends and are adjusted to reflect current trends. Some of the factors for making these adjustments include: changes in underwriting guidelines or credit scoring models; trends in consumer payment patterns, delinquencies and personal bankruptcy; staffing levels in the collection area; changes in the mix of loan products outstanding; experience, ability and depth of lending management and staff; value of underlying collateral; and recent charge-off trends. The reserve rates are also adjusted for changing economic conditions and the adequacy of the reserves to cover inherent loss in case of error. The reserve rate for consumer loans decreased from 1.19 percent in 1998 to 1.07 percent in 1999. The reserve rates are impacted by two components, changes in the loss factor and changes in the loan mix. The installment loan reserve factors were reduced to reflect improving historical charge-off trends. Also the reserve factor, on a pool of higher risk unsecured consumer loans generated in the last half of 1998, was lower due to the reduction in outstandings and charge-offs taken in 1999 but reserved at year-end 1998. These changes in the reserve factor more than offset the increases in the reserve factor for loan mix changes described below. The consumer loan charge-off ratio increased from .36 percent in 1998 to .66 percent in 1999. CREDIT CARD The establishment of the reserve rate for the credit card portfolio is based on both delinquency rates and historical charge-offs. As shown in Table 14, the reserve rate decreased slightly in 1999 to 3.95 percent from 4.04 percent in 1998. The decline parallels the improving trend of net charge-offs as shown in Table 17. The credit card receivables net charge-off ratio decreased 28 basis points to 3.64 percent in 1999 from 3.92 percent in 1998. The credit card charge-off ratio was again favorable to the industry average in 1999. TOTAL LOANS The total allowance for loan losses increased 3 percent, or $3.6 million, from year-end 1998, at which time it had increased 8 percent, or $10.2 million, since year-end 1997. Period-end loans grew 9 percent in 1999 and 3 percent in 1998. The ratio of allowance for loan losses to loans, net of unearned income, declined to 1.49 percent at December 31, 1999, from 1.59 percent at December 31, 1998, as historical loss factors improved and the loan mix changed. The ratio of allowance for loan losses to loans was 1.51 percent at December 31, 1997. Table 15 - Loans and Foreclosed Real Estate at December 31 gives a breakdown of the allowance allocation by major loan types and commercial loan grades at December 31, 1999, compared with the same period in 1998. This table also shows the amount of the general reserve. A general reserve is maintained on the commercial loan portfolio based on management's judgment regarding the risk of error in grading the loans and in the specific allowances for individual loans or pools of loans. The general reserve has well defined criteria that must be met before any of this reserve is used. Table 16 - Analysis of Allowance for Loan Losses summarizes by category, loans charged off and recoveries of loans previously charged off. This table also shows the additions to the reserve (provision), which have been charged against operating earnings. 27 Net charge-offs increased to $51.7 million for the year ended December 31, 1999. Net charge-offs were $37.8 million for 1998 and $43.0 million for 1997. The increase in the level of net charge-offs was due to higher consumer loan charge-offs, which included those products with higher risk/return profiles, and a return to a more normal level of commercial loan charge-offs. Commercial loan net charge-offs increased to $7.9 million in 1999 from $2.3 million in 1998. Consumer loan net charge-offs increased from $10.0 million in 1998 to $20.4 million in 1999. Credit card receivables net charge-offs decreased $1.3 million from $22.1 million for 1998 to $20.8 million for 1999. Permanent mortgage loan net charge-offs increased to $.4 million in 1999 from a slight net recovery position in 1998, excluding the net charge-offs on the repurchased mortgages discussed below. The ratio of net charge-offs to average loans increased to .59 percent for 1999 from .46 percent for 1998 and .54 percent for 1997. Within the course of normal mortgage banking activities, a small percentage of nonperforming assets is created when FHA/VA borrowers are delinquent in their monthly payments prior to the completion of the insuring process. Additionally, loans that have been sold may be found not to meet an investor's origination criteria and could be required to be repurchased. From this pool, there were net charge-offs of $2.1 million in 1999, a decline from $3.4 million in 1998 and $3.2 million in 1997. These net charge-offs had the affect of adding .03 percent to the total net charge-off ratio (see Table 17). Going forward, in light of current economic conditions, anticipated trends and First Tennessee's loan portfolio mix, management believes overall asset quality will remain stable and net charge-offs as a percentage of average loans should remain relatively consistent with the levels experienced in 1999. As securitizations, loan sales or other balance sheet management tools are employed which could result in a change in the mix of commercial and consumer loans, charge-off rates could be higher or lower commensurate with the inherent risk of the portfolio. The information provided in this section contains forward-looking statements. Actual results could differ because of several factors, including those presented in the Forward-Looking Statements section of this MD&A discussion. 28 TABLE 15 - LOANS AND FORECLOSED REAL ESTATE AT DECEMBER 31
1999 1998 ------------------------------------------------------------------ -------------------- Construction Allowance Allowance and Commercial for Loan for Loan (Dollars in millions) Commercial Development Real Estate TOTAL Loss Total Loss - -------------------------------------------------------------------------------------------------------------------------------- Internal grades*: A $ 235 $ -- $ 1 $ 236 $ -- $ 252 $ -- B 688 7 59 754 1 733 1 C 2,290 296 543 3,129 19 2,772 20 C- 465 30 121 616 9 580 7 D 66 3 8 77 4 81 4 E 39 -- 2 41 5 26 4 F 26 1 6 33 6 20 7 - --------------------------------------------------------------------------------------------------------------------------------- 3,809 337 740 4,886 44 4,464 43 Impaired loans: Contractually past due 1 -- 2 3 2 5 2 Contractually current 3 -- 1 4 1 7 4 Nonaccrual loans: Contractually past due -- -- -- -- -- -- -- Contractually current -- -- -- -- -- -- -- - --------------------------------------------------------------------------------------------------------------------------------- Total commercial and commercial real estate loans $3,813 $337 $740 $4,893 $ 47 $4,476 $ 49 - --------------------------------------------------------------------------------------------------------------------------------- Retail: Consumer 3,282 35 3,019 36 Credit card 607 24 594 24 Permanent mortgages 529 1 423 1 Mortgage banking nonaccrual 22 7 16 3 - --------------------------------------------------------------------------------------------------------------------------------- Total retail loans 4,440 67 4,052 64 - --------------------------------------------------------------------------------------------------------------------------------- Other/Unfunded commitments 30 4 29 2 General reserve -- 22 -- 21 - --------------------------------------------------------------------------------------------------------------------------------- Total loans $9,363 $140 $8,557 $136 ================================================================================================================================= Foreclosed real estate: Foreclosed property $ 4 $ 1 $ 1 $ 6 $ 5 Foreclosed property - mortgage banking 12 11 - --------------------------------------------------------------------------------------------------------------------------------- Total foreclosed real estate $ 18 $ 16 ================================================================================================================================= Loans are expressed net of unearned income. All amounts in the Allowance for Loan Loss columns have been rounded to the nearest million dollars. Grade A loans have reserve amounts of less than $500,000. Certain previously reported amounts have been restated to agree with current presentation. * Based on internal loan classifications. Definitions of each credit grade are provided below: GRADE A: Established, stable companies with excellent earnings, liquidity, and capital. Possess many of the same characteristics as Standard & Poor's (S&P) AA rated companies. GRADE B: Established, stable companies with good earnings, liquidity, and capital. Possess many of the same characteristics as S&P A rated companies. GRADE C: Established, stable companies with satisfactory earnings, liquidity, and capital and with consistent, positive trends relative to industry norms. GRADE C-: Established, stable companies with either inconsistent and/or marginal earnings, or liquidity, or capital. Overall acceptable credits with minor weaknesses which warrant additional servicing. GRADE D: Financial condition adversely affected by temporary lack of earnings or liquidity or changes in the operating environment. An action plan is required to rehabilitate the credit or have it refinanced elsewhere. GRADE E: Significant developing weaknesses or adverse trends in earnings, liquidity, capital, or operating environment. No discernible market for refinancing is available. GRADE F: Significantly higher than normal probability that: (1) legal action or liquidation of collateral is required; (2) there will be a loss; or (3) both will occur. This grade is believed to be substantially equivalent to the regulators' classifications of substandard or doubtful. IMPAIRED: A loan for which it is probable that all amounts due, according to the contractual terms of the loan agreement, will not be collected. NONACCRUAL: A loan that is placed on nonaccrual status is not included in any of these six grades, but is placed in a separate nonaccrual category. Commercial and real estate loans are placed on nonaccrual status automatically once they become 90 days or more past due.
29 TABLE 16 - ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
(Dollars in thousands) 1999 1998 1997 1996 1995 1994 - --------------------------------------------------------------------------------------------------------------------------------- ALLOWANCE FOR LOAN LOSSES: Beginning balance $ 136,013 $ 125,859 $ 117,748 $ 112,567 $ 109,859 $ 110,720 Provision for loan losses 57,923 51,351 51,115 35,677 20,592 17,182 Allowance from acquisitions -- 140 -- -- 2,632 -- Adjustment due to divestiture (893) -- -- -- -- -- Securitization adjustment (1,790) (3,575) -- -- -- -- Charge-offs: Commercial 10,224 5,379 6,388 3,355 5,614 6,458 Consumer 24,610 14,976 16,574 15,531 12,373 9,180 Credit card receivables 22,867 24,242 27,420 22,964 16,874 12,674 Real estate construction -- 442 245 10 44 -- Permanent mortgage* 2,524 3,483 3,648 522 326 884 - --------------------------------------------------------------------------------------------------------------------------------- Total charge-offs 60,225 48,522 54,275 42,382 35,231 29,196 - --------------------------------------------------------------------------------------------------------------------------------- Recoveries: Commercial 2,310 3,372 4,340 3,712 6,728 4,001 Consumer 4,167 4,938 4,919 5,720 5,732 4,415 Credit card receivables 2,022 2,179 1,689 2,112 2,022 1,890 Real estate construction 8 148 171 171 59 373 Permanent mortgage 68 123 152 171 174 474 - --------------------------------------------------------------------------------------------------------------------------------- Total recoveries 8,575 10,760 11,271 11,886 14,715 11,153 - --------------------------------------------------------------------------------------------------------------------------------- Net charge-offs 51,650 37,762 43,004 30,496 20,516 18,043 - --------------------------------------------------------------------------------------------------------------------------------- Ending balance $ 139,603 $ 136,013 $ 125,859 $ 117,748 $ 112,567 $ 109,859 ================================================================================================================================= LOANS, OUTSTANDING At DECEMBER 31** $ 9,363,158 $ 8,557,064 $ 8,311,350 $ 7,728,203 $ 7,333,283 $ 6,498,042 - --------------------------------------------------------------------------------------------------------------------------------- Average loans, outstanding during the year** $ 8,818,766 $ 8,242,135 $ 7,945,143 $ 7,472,095 $ 6,887,218 $ 5,984,424 - --------------------------------------------------------------------------------------------------------------------------------- RATIOS**: Allowance to loans 1.49% 1.59% 1.51% 1.52% 1.54% 1.69% Net charge-offs to average loans .59 .46 .54 .41 .30 .30 Net charge-offs to allowance 37.0 27.8 34.2 25.9 18.2 16.4 - --------------------------------------------------------------------------------------------------------------------------------- * Permanent mortgage charge-offs include $2.1 million, $3.4 million and $3.2 million of charge-offs for 1999, 1998 and 1997, respectively, related to the repurchase of loans originated and previously sold by FT Mortgage Companies. ** Net of unearned income.
30 TABLE 17 - NET CHARGE-OFF RATIOS
1999 1998 1997 - -------------------------------------------------------------------------------------------- BREAKDOWN BY LOAN CATEGORY: Commercial and commercial real estate .17% .05% .05% Consumer .66 .36 .42 Credit card receivables 3.64 3.92 4.72 Permanent mortgage* .08 (.01) .05 ============================================================================================ Total net charge-offs excluding repurchased mortgages .56% .42% .50% Impact of repurchased mortgages .03 .04 .04 - -------------------------------------------------------------------------------------------- Total net charge-offs .59% .46% .54% ============================================================================================ * Excludes repurchased mortgage loans originated and previously sold by FT Mortgage Companies. A negative ratio indicates that recoveries exceeded charge-offs. Loans are averages expressed net of unearned income.
NONPERFORMING ASSETS Nonperforming loans consist of impaired, other nonaccrual and restructured loans. These, along with foreclosed real estate and other assets, represent nonperforming assets. Impaired loans are those loans for which it is probable that all amounts due, according to the contractual terms of the loan agreement, will not be collected and for which recognition of interest income has been discontinued. Nonaccrual loans are those loans on which recognition of interest income has been discontinued. Restructured loans generally take the form of an extension of the original repayment period and/or a reduction or deferral of interest or principal because of a deterioration in the financial position of the borrower. Nonperforming assets increased 6 percent, or $2.8 million, in 1999 and total nonperforming loans increased 5 percent, or $1.3 million in 1999 with improvement (lower level) noted in the regional banking group and a higher level in mortgage banking due to increased production at the end of 1998 and the beginning of 1999. In 1998 nonperforming assets declined 13 percent, or $6.6 million, and nonperforming loans decreased 28 percent, or $10.6 million. At December 31, 1999, foreclosed properties amounted to $17.9 million, an increase of 10 percent. At December 31, 1998, foreclosed properties totaled $16.2 million, an increase of 33 percent from the previous year. Of the $1.7 million increase in 1999, $.9 million came from mortgage banking from the repurchased mortgage loans already discussed. Information regarding nonperforming assets and loans is presented in Table 18 - Nonperforming Assets at December 31. As shown in the table, the ratio of nonperforming assets to total loans was .50 percent at December 31, 1999. In the regional banking group, the ratio of nonperforming assets to total loans was .15 percent. Table 19 - Changes in Nonperforming Assets gives additional information related to nonperforming assets for 1997 through 1999. 31 TABLE 18 - NONPERFORMING ASSETS AT DECEMBER 31
(Dollars in thousands) 1999 1998 1997 1996 1995 1994 - ----------------------------------------------------------------------------------------------------------------------------- AMOUNTS: Impaired loans* $ 7,514 $ 12,111 $ 8,712 $ 10,322 $ 11,865 Other nonaccrual loans 21,604 15,696 29,703 8,604 7,175 - ----------------------------------------------------------------------------------------------------------------------------- Total nonaccrual loans 29,118 27,807 38,415 18,926 19,040 $ 16,853 Restructured loans -- -- -- -- -- 158 - ----------------------------------------------------------------------------------------------------------------------------- Total nonperforming loans 29,118 27,807 38,415 18,926 19,040 17,011 Foreclosed real estate 17,870 16,242 12,202 7,823 11,794 19,215 Other assets 91 199 235 196 1,022 2,055 - ----------------------------------------------------------------------------------------------------------------------------- Total nonperforming assets $ 47,079 $ 44,248 $ 50,852 $ 26,945 $ 31,856 $ 38,281 - ----------------------------------------------------------------------------------------------------------------------------- Non-government guaranteed past due loans** $ 19,178 $ 21,745 $ 21,015 $ 20,011 $ 19,796 $ 11,213 Government guaranteed past due loans** 10,671 9,858 11,059 10,736 10,820 10,030 ============================================================================================================================= RATIOS***: Nonperforming loans to total loans .31% .32% .46% .24% .26% .26% Nonperforming assets to total loans plus foreclosed real estate and other assets .50 .52 .61 .35 .43 .59 Nonperforming assets and non-government guaranteed past due loans to total loans plus foreclosed real estate and other assets .71 .77 .86 .61 .70 .76 - ----------------------------------------------------------------------------------------------------------------------------- * For the years 1997, 1996 and 1995 impaired loans included $196,000, $279,000 and $303,000 of restructured loans, respectively. ** Loans that are 90 days or more past due as to principal and/or interest and not yet impaired or on nonaccrual status. *** Total loans are net of unearned income. Certain previously reported amounts have been adjusted to agree with current presentation.
TABLE 19 - CHANGES IN NONPERFORMING ASSETS
(Dollars in millions) 1999 1998 1997 - ------------------------------------------------------------------------------------------------------------------------------ Beginning balance $ 44.2 $ 50.9 $ 26.9 Additional nonperforming assets 88.1 124.5 104.2 Payments (74.1) (123.0) (71.5) Charge-offs (11.1) (8.2) (8.7) - ------------------------------------------------------------------------------------------------------------------------------ Ending balance $ 47.1 $ 44.2 $ 50.9 ==============================================================================================================================
PAST DUE LOANS AND POTENTIAL PROBLEM ASSETS Past due loans are loans contractually past due 90 days or more as to interest or principal payments, but which have not yet been put on nonaccrual status. The ratio of past due loans to total loans was .32 percent at year-end 1999, down from .37 percent at December 31, 1998. Past due loans were $29.8 million at December 31, 1999, compared with $31.6 million for 1998. Additional historical past due loan information can be found in Table 18. Potential problem assets, which are not included in nonperforming assets, increased to $75.0 million at December 31, 1999, from $63.3 million at December 31, 1998, and were 1 percent of total loans in 1999 and 1998. Potential problem assets represent those assets where information about possible credit problems of borrowers has caused management to have serious doubts about the borrower's ability to comply with present repayment terms. This definition is believed to be substantially consistent with the standards established by the Office of the Comptroller of the Currency for loans classified substandard or doubtful. 32 OTHER YEAR 2000 Many computer programs were originally designed to store and process data using two digits rather than four to define a calendar year. This could cause programs that have date sensitive software to recognize a date using "00" as the year 1900 rather than the year 2000. First Tennessee began planning its Year 2000 remediation strategy to fix this computer issue in 1995. As a result, First Tennessee modified or replaced certain systems. New systems acquired provided new functionality to meet the expanding needs of customers. Costs of new systems were capitalized and are being amortized, and spending for maintenance and modification associated with Year 2000 was expensed as incurred. The total gross cost of Year 2000 compliance was approximately $40 million of which approximately 40 percent of this cost is capitalized. Consistent with current corporate accounting policy, the capitalized costs are being amortized on a straight-line basis over a maximum period of five years from the point the systems project was substantially complete and ready for its intended use. Management is not aware that the company has experienced any material Year 2000 computer-related problems and believes that the actions taken related to Year 2000 prevented the occurrence of any such material problems. EARNINGS DISCLOSURE On January 18, 2000, First Tennessee publicly released its fourth quarter and 1999 earnings. This release disclosed diluted earnings per share of $1.91, ROE of 21.5 percent and ROA of 1.37 percent for full year 1999. On February 28, 2000, First Tennessee publicly disclosed revised 1999 diluted earnings per share of $1.85 and revised ROE and ROA of 20.9 percent and 1.33 percent, respectively. This revision is reflected in all of the financial information presented in this document. The February 28, 2000, press release also discussed the earnings outlook for 2000. There have been various market factors that have adversely impacted the profitability of mortgage banking and capital markets. The primary factors impacting these two business lines have been the persistent, rapid rise in interest rates, and the widely held expectation that this trend will continue. As a result, mortgage banking has recently experienced lower origination volumes and pricing pressures (especially related to wholesale originations) which also affect the secondary marketing activities. The expected trend in interest rates has also continued to affect the level and mix of securities demanded by capital markets' customers even though Y2K concerns have subsided. Therefore, management currently estimates first quarter 2000 earnings to be $.09 to $.12 below comparable first quarter 1999 results of $.40. This estimate includes an approximate $5 million loss from planned sales of certain mortgage loans originated prior to the recent rise in interest rates. For full year 2000, management estimates earnings will be impacted by the anticipated continuation of trends in mortgage banking and capital markets through at least mid-year, the projected first quarter earnings decrease and current expectations of economic conditions. As a result, our current estimated diluted earnings per share growth rate is between approximately 8 percent and 10 percent over the revised $1.85 earned in 1999. The information provided in this section includes forward-looking statements. Actual results could differ because of several factors, including those presented in the Forward-Looking Statements section of this MD&A discussion. FINANCIAL MODERNIZATION LEGISLATION The Gramm-Leach-Bliley Act (the "Act") was enacted into law on November 12, 1999. The Act repeals or modifies a number of significant provisions of current laws, which impose restrictions on banking organizations' ability to engage in certain types of activities. The Act generally allows bank holding companies such as First Tennessee broad authority to engage in activities that are financial in nature or incidental to such financial activity, including insurance underwriting and brokerage; merchant banking; and securities underwriting, dealing and market-making. A bank holding company may engage in these activities directly or through subsidiaries by qualifying as a "financial holding company". To qualify, a bank holding company must file a declaration with the Federal Reserve and certify that all of its subsidiary depository institutions are well-managed and well-capitalized. Subsequent to year-end 1999, First Tennessee has filed such a declaration. 33 The Act also permits national banks to engage in certain of these activities through financial subsidiaries. To control or hold an interest in a financial subsidiary, a national bank must meet the following requirements: (1) the national bank must receive approval from the Comptroller for the financial subsidiary to engage in the activities, (2) the national bank and its depository institution affiliates must each be well-capitalized and well-managed, (3) the aggregate consolidated total assets of all of the national bank's financial subsidiaries must not exceed 45 percent of the national bank's consolidated total assets or, if less, $50 billion, (4) the national bank must have in place adequate policies and procedures to identify and manage financial and operational risks and to preserve the separate identities and limited liability of the national bank and the financial subsidiary, and (5) if the financial subsidiary will engage in principal transactions and the national bank is one of the one hundred largest banks, the national bank must have outstanding at least one issue of unsecured long-term debt that is currently rated in one of the three highest investment grade rating categories or meet alternative criteria as may be specified for the second fifty largest banks. First Tennessee has two subsidiaries that have filed notifications with the OCC and currently meet all of the other above requirements. No new financial activity may be commenced under the Act unless the national bank and all of its depository institution affiliates have at least "satisfactory" CRA (Community Reinvestment Act) ratings. In addition, the Act contains a number of other provisions that may affect operations, including functional regulation of First Tennessee's securities and investment management operations by the Securities and Exchange Commission, limitations on the insurance powers of the national banks, and limitations on the use and the disclosure to third parties of customer information. The Act is effective March 11, 2000, although certain provisions take effect later. First Tennessee cannot predict at this time the potential effect that the Act will have on its business and operations, although management expects that the general effect of the Act will be to increase competition in the financial services industry. SFAS NO. 133 - "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES" In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS 133 establishes accounting and reporting standards requiring that every derivative instrument (including certain instruments embedded in other contracts) be recorded on the balance sheet as either an asset or liability measured at its fair value. SFAS 133 requires that changes in the instrument's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows the instrument's gains and losses to offset related results on the hedged item in the income statement, and requires that a company formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. Upon adoption of SFAS 133, all freestanding derivative instruments will be remeasured at fair value with differences between the previous book value and fair value reported as a one-time accounting adjustment. Likewise, offsetting gains and losses on hedged assets, liabilities and firm commitments will be recognized as adjustments of their respective book values at the adoption date as part of this accounting adjustment. Except to the extent that they relate to hedges of the variable cash flow exposure of forecasted transactions, a portion of the net accounting adjustment (net of hedge difference and hedged item difference) will be reported in net income in the period of adoption. To the extent the adoption adjustment relates to hedges of the variable cash flow exposure of forecasted transactions, the remainder of the accounting adjustment will be reported as a cumulative effect adjustment of comprehensive income. SFAS 133, as amended, is effective for fiscal years beginning after June 15, 2000. First Tennessee will adopt SFAS 133 on January 1, 2001. In Note 23 - Financial Instruments with Off-Balance Sheet Risk, the Mortgage Banking and Interest Rate Risk Management sections present the book values and fair values of freestanding derivative instruments that would be required to be recognized in First Tennessee's balance sheet as assets or liabilities at their fair value. Management has not yet quantified the effects SFAS 133 may have on its financial statements including the offsetting gains or losses that may be recognized on hedged assets, liabilities and firm commitments. Changes in the fair value of existing and future freestanding derivative instruments, hedged assets, liabilities and firm commitments, changes in the book value, including normal amortization, of these instruments and hedged assets and liabilities, and changes in hedging practices could have a substantial impact on the amount of the one-time accounting adjustment and its impact on net income. In addition, management is in the process of evaluating the methods and instruments 34 currently used in hedging market exposure. The impact of adopting SFAS 133 could be material at the adoption date. SFAS 133 could also increase the volatility of earnings and other comprehensive income in the future. The actual result of the adoption of SFAS 133 could also be affected by interest rate movements, ability of management to execute its business strategies, various actions management may take to reduce the impact of SFAS 133, ongoing interpretation and amendment activity by the FASB related to SFAS 133, and other factors, including those presented in the Forward-Looking Statements section of this MD&A. QUARTERLY FINANCIAL INFORMATION - ------------------------------- TABLE 20 - SUMMARY OF QUARTERLY FINANCIAL INFORMATION
1999 1998 ----------------------------------------------- ---------------------------------------------- (Dollars in millions except Fourth Third Second First Fourth Third Second First per share data) Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter - -------------------------------------------------------------------------------------------------------------------------------- SUMMARY INCOME INFORMATION: Interest income $ 310.6 $ 303.2 $ 293.2 $ 300.2 $ 312.4 $ 288.3 $ 276.1 $ 257.0 Interest expense 162.9 155.9 146.8 152.1 165.9 153.6 143.9 129.9 Provision for loan losses 14.0 14.1 15.0 14.8 11.9 13.1 12.8 13.5 Noninterest income before securities transactions 255.5 284.4 294.3 286.6 303.8 267.9 219.9 190.0 Securities gains /(losses) .5 1.9 (.1) -- 3.9 -- -- -- Noninterest expense 293.4 314.4 330.7 336.8 339.8 292.7 258.4 230.9 Net income 64.1 69.4 61.0 53.0 65.5 61.8 52.7 46.4 - -------------------------------------------------------------------------------- ---------------------------------------------- BASIC EARNINGS PER SHARE $ .49 $ .53 $ .47 $ .41 $ .51 $ .48 $ .41 $ .36 DILUTED EARNINGS PER SHARE .48 .52 .45 .40 .50 .47 .40 .35 - -------------------------------------------------------------------------------- ---------------------------------------------- COMMON STOCK INFORMATION: Closing price per share: High $ 36 1/16 $ 39 15/16 $ 45 3/16 $ 41 1/8 $ 38 1/16 $33 3/4 $ 35 3/4 $33 1/8 Low 27 9/16 28 1/8 37 35 1/8 25 1/2 23 13/16 29 29 15/64 Period-end 28 1/2 28 1/8 38 5/16 36 5/8 38 1/16 27 5/16 31 9/16 32 1/8 Dividends declared per share .22 .19 .19 .19 .19 .165 .165 .165 - -------------------------------------------------------------------------------------------------------------------------------- Per share data reflects the 1998 two-for-one stock split.
35 GLOSSARY ALLOWANCE FOR LOAN LOSSES - Valuation reserve representing the amount considered by management to be adequate to cover estimated losses inherent in the loan portfolio. BASIS POINT - The equivalent of one-hundredth of one percent (0.01). One hundred basis points equals one percent. This unit is generally used to measure movements in interest yields and rates. BASIS RISK - Refers to changes in the relationship between various interest rate segments (e.g. the difference between the Prime and the Fed Funds Rates). BOOK VALUE PER SHARE - A ratio determined by dividing shareholders' equity at the end of a period by the number of common shares outstanding at the end of that period. CHARGE-OFFS - The amount charged against the allowance for loan losses to reduce specific loans to their collectible amount. CLASSIFIED LOAN - A loan that has caused management to have serious doubts about the borrower's ability to comply with present repayment terms. Included in this category are grade F performing and nonperforming loans. In compliance with the standards established by the Office of the Comptroller of the Currency (OCC) these loans are classified as substandard, doubtful, and loss depending on the severity of the loan's deterioration. COMMERCIAL PAPER - A short-term unsecured debt obligation of the parent company with maturities typically of 30 days to 270 days. COMMERCIAL AND STANDBY LETTERS OF CREDIT - Commercial letters of credit are issued or confirmed by an entity to ensure the payment of its customers' payables and receivables. Standby letters of credit are issued by an entity to ensure its customers' performance in dealing with others. COMMITMENT TO EXTEND CREDIT - Agreements to make or acquire a loan or lease as long as agreed-upon terms (e.g., expiration date, covenants, or notice) are met. Generally these commitments have fixed expiration dates or other termination clauses and may require payment of a fee. CORE DEPOSITS - Core deposits consist of all interest-bearing and noninterest-bearing deposits, except certificates of deposit over $100,000. They include checking interest deposits, money market deposit accounts, time and other savings, plus demand deposits. DERIVATIVE FINANCIAL INSTRUMENT - Futures, forwards, swaps, option contracts, or other financial instruments with similar characteristics, such as interest rate caps or floors, or fixed-rate loan commitments. DILUTED EARNINGS PER SHARE - Net income, divided by average shares outstanding plus the number of shares that would be outstanding if all dilutive common shares had been issued. Dilutive common shares, for example, would be outstanding options where the average stock price exceeds the price at which the option was granted. DIVIDEND PAYOUT RATIO - Cash dividends per share paid as a percent of net income per share. DOUBLE LEVERAGE RATIO - A ratio that measures the degree to which parent company debt supports investments in subsidiaries. It is calculated by dividing the parent company's investment in subsidiaries by total consolidated equity. EARNING ASSETS - Assets that generate interest or dividend income or yield-related fee income, such as loans and investment securities. EARNINGS PER SHARE, ALSO CALLED BASIC EARNINGS OR BASIC NET INCOME PER SHARE - Net income, divided by the average number of common shares outstanding in the period. (See also diluted earnings per share) 36 FEDERAL FUNDS SOLD/PURCHASED - Excess balances of depository institutions which are loaned to each other, generally on an overnight basis. FULLY TAXABLE-EQUIVALENT INCOME (FTE) - Income which has been adjusted by increasing tax-exempt income to a level that would yield the same after-tax income had that income been subject to taxation. HEDGE - An instrument used to reduce risk by entering into a transaction which offsets existing or anticipated exposures to changes in interest rates. INTEREST-FREE SOURCES - Noninterest bearing liabilities (such as demand deposits, other liabilities, and shareholders' equity) net of nonearning assets (such as cash, fixed assets, and other assets). INTEREST RATE CAPS AND FLOORS - Contracts with notional principal amounts that require the seller, in exchange for a fee, to make payments to the purchaser if a specified market interest rate exceeds a fixed upper "capped" level or falls below a fixed lower "floor" level on specified future dates. INTEREST RATE FORWARD AND FUTURES CONTRACTS - Contracts representing commitments either to purchase or sell at a specified future date a specified security or financial instrument at a specified price, and may be settled in cash or through delivery. These obligations are generally short term in nature. INTEREST RATE OPTION (OPTIONS) - A contract that grants the holder (purchaser), for a fee, the right to either purchase or sell a financial instrument at a specified price within a specified period of time or on a specified date from the writer (seller) of the option. INTEREST RATE SENSITIVITY - The relationship of changes in interest income and interest expense to fluctuations in interest rates over a defined period of time. INTEREST RATE SWAP (SWAP) - An agreement in which two entities agree to exchange, at specified intervals, interest payment streams calculated on an agreed upon notional principal amount with at least one stream based on a floating rate index. INTEREST SENSITIVITY GAP - The difference between interest-rate sensitive assets and interest-rate sensitive liabilities over a designated time period. A net asset exists when interest-rate sensitive assets exceed interest-rate sensitive liabilities. A net liability position exists when liabilities exceed assets. LEVERAGE RATIO - Tier 1 capital divided by quarterly average assets excluding any adjustments for available for sale securities unrealized gains/(losses), goodwill, and certain other intangible assets. LIQUIDITY - The ability of a corporation to generate adequate funds to meet its cash flow requirements. It is measured by the ability to quickly convert assets into cash with minimal exposure to interest rate risk, by the size and stability of the core deposit base, and by additional borrowing capacity within the money markets. MARKET CAPITALIZATION - Market value of a firm computed by multiplying the number of shares outstanding by the current stock price. MORTGAGE PIPELINE - Interest rate commitments made to customers on mortgage loans that have not yet been closed and funded. MORTGAGE WAREHOUSE - A mortgage loan that has been closed and funded and is awaiting sale and delivery into the secondary market. MORTGAGE SERVICING RIGHTS - The right to service mortgage loans, generally owned by someone else, for a fee. Loan servicing includes collecting payments; remitting funds to investors, insurance companies, and taxing authorities; collecting delinquent payments; and foreclosing on properties when necessary. NET INTEREST INCOME (NII) - Interest income less interest expense. 37 NET INTEREST MARGIN - A measurement of how effectively the bank utilizes its earning assets in relationship to the interest cost of funding them. It is computed by dividing fully taxable-equivalent net interest income by average earning assets. NET INTEREST SPREAD - The difference between the average yield earned on earning assets on a fully taxable equivalent basis and the average rate paid for interest-bearing liabilities. NONACCRUAL LOANS - Loans on which interest accruals have been discontinued due to the borrower's financial difficulties. Interest income on these loans is reported on a cash basis as it is collected after recovery of principal. NONPERFORMING ASSETS - Interest earning assets on which interest income is not being accrued, restructured loans on which interest rates or terms of repayment have been materially revised, real estate properties acquired through foreclosure, and repossessed assets. NOTIONAL PRINCIPAL AMOUNT - An amount on which payments for interest rate swaps and interest rate options, caps and floors are based. The "notional amount" is not paid or received. PRICE/EARNINGS RATIO - The relationship of the market price of a share of common stock to the diluted earnings per share of the stock, expressed as a multiple. PROVISION FOR LOAN LOSSES - The periodic charge to earnings for potential losses in the loan portfolio. PURCHASED FUNDS - The combination of certificates of deposit greater than $100,000, federal funds purchased, securities sold under agreement to repurchase, bank notes, commercial paper, and other short-term borrowings. RECOVERIES - The amount added to the allowance for loan losses when funds are received on a loan which was previously charged off. REPURCHASE AGREEMENT - A method of short-term financing where one party agrees to buy back, at a future date (generally overnight) and an agreed-upon price, a security it sells to another party. RESTRUCTURED LOANS - Loans where the institution, for economic or legal reasons related to the debtor's financial difficulties, grants a concession to the debtor that it would not otherwise consider. RETURN ON AVERAGE ASSETS (ROA) - A measure of profitability that indicates how effectively an institution utilized its assets. It is calculated by dividing annualized net income by total average assets. RETURN ON AVERAGE EQUITY (ROE) - A measure of profitability that indicates what an institution earned on its shareholders' investment. ROE is calculated by dividing net income by total average shareholders' equity. REVENUE - The sum of net interest income and noninterest income. For some comparisons, securities gains/losses are excluded. RISK-ADJUSTED ASSETS - A regulatory risk-based calculation that takes into account the broad differences in risks among a banking organization's assets and off-balance sheet instruments. SECURITIZED ASSETS OR SECURITIZATION - The process by which financial assets are packaged, underwritten and sold as securities. SHAREHOLDER RETURN, ALSO CALLED TOTAL RETURN - The sum of dividend income and price appreciation of an equity security for a given period of time divided by the price of the security at the beginning of the period. TIER 1 CAPITAL RATIO - Ratio consisting of shareholders' equity before any adjustments for available for sale securities unrealized gains/(losses), reduced by goodwill, certain other intangible assets and the disallowable portion of mortgage servicing rights divided by risk-adjusted assets. TOTAL CAPITAL RATIO - Tier 1 capital plus the allowable portion of the allowance for loan losses and qualifying subordinated debt divided by risk-adjusted assets. 38 FIRST TENNESSEE NATIONAL CORPORATION CONSOLIDATED STATEMENTS OF CONDITION
December 31 -------------------------------- (Dollars in thousands) 1999 1998 - ------------------------------------------------------------------------------------------------------------------------- ASSETS: Cash and due from banks (Note 17) $ 956,077 $ 811,881 Federal funds sold and securities purchased under agreements to resell 279,537 124,239 - ------------------------------------------------------------------------------------------------------------------------- Total cash and cash equivalents 1,235,614 936,120 - ------------------------------------------------------------------------------------------------------------------------- Investment in bank time deposits 3,263 1,211 Capital markets securities inventory 147,041 358,304 Mortgage loans held for sale 2,049,945 4,227,443 Securities available for sale (Note 3) 2,332,356 1,816,485 Securities held to maturity (market value of $734,853 at December 31, 1999, and $610,364 at December 31, 1998) (Note 3) 768,936 609,804 Loans, net of unearned income (Note 4) 9,363,158 8,557,064 Less: Allowance for loan losses 139,603 136,013 - ------------------------------------------------------------------------------------------------------------------------- Total net loans 9,223,555 8,421,051 - ------------------------------------------------------------------------------------------------------------------------- Premises and equipment, net (Note 5) 305,519 254,292 Real estate acquired by foreclosure 17,870 16,242 Mortgage servicing rights, net (Note 6) 826,210 664,438 Intangible assets, net (Note 7) 133,568 132,845 Capital markets receivables and other assets 1,329,513 1,295,726 - ------------------------------------------------------------------------------------------------------------------------- TOTAL ASSETS $ 18,373,390 $ 18,733,961 ========================================================================================================================= LIABILITIES AND SHAREHOLDERS' EQUITY: Deposits: Interest-bearing (Note 8) $ 8,560,462 $ 8,665,175 Noninterest-bearing 2,798,239 3,057,864 - ------------------------------------------------------------------------------------------------------------------------- Total deposits 11,358,701 11,723,039 - ------------------------------------------------------------------------------------------------------------------------- Federal funds purchased and securities sold under agreements to repurchase (Note 9) 2,856,282 2,912,018 Commercial paper and other short-term borrowings (Note 9) 1,550,229 1,427,274 Capital markets payables and other liabilities 908,048 1,057,646 Term borrowings (Note 10) 358,663 414,450 - ------------------------------------------------------------------------------------------------------------------------- Total liabilities 17,031,923 17,534,427 - ------------------------------------------------------------------------------------------------------------------------- Guaranteed preferred beneficial interests in First Tennessee's junior subordinated debentures (Note 11) 100,000 100,000 - ------------------------------------------------------------------------------------------------------------------------- SHAREHOLDERS' EQUITY: Preferred stock - no par value (5,000,000 shares authorized, but unissued) -- -- Common stock - $.625 par value (shares authorized - 400,000,000; shares issued - 129,878,459 at December 31, 1999 and 128,974,362 at December 31, 1998) 81,174 80,609 Capital surplus 130,636 96,778 Undivided profits 1,053,722 908,977 Accumulated other comprehensive income (Note 13) (21,752) 12,872 Deferred compensation on restricted stock incentive plans (5,674) (1,209) Deferred compensation obligation 3,361 1,507 - ------------------------------------------------------------------------------------------------------------------------- Total shareholders' equity 1,241,467 1,099,534 - ------------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 18,373,390 $ 18,733,961 ========================================================================================================================= See accompanying notes to consolidated financial statements.
39 FIRST TENNESSEE NATIONAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31 --------------------------------------------------- (Dollars in thousands except per share data) 1999 1998 1997 - ------------------------------------------------------------------------------------------------------------------ INTEREST INCOME: Interest and fees on loans $ 751,555 $ 725,907 $ 699,617 Interest on investment securities: Taxable 175,933 155,956 135,321 Tax-exempt 2,661 3,658 4,502 Interest on mortgage loans held for sale 231,284 205,654 76,840 Interest on capital markets securities inventory 31,371 30,541 13,399 Interest on other earning assets 14,360 12,061 11,614 - ------------------------------------------------------------------------------------------------------------------ Total interest income 1,207,164 1,133,777 941,293 - ------------------------------------------------------------------------------------------------------------------ INTEREST EXPENSE: Interest on deposits: Savings 5,776 7,113 8,188 Checking interest and money market 104,263 113,171 95,123 Certificates of deposit under $100,000 and other time 123,781 144,879 160,522 Certificates of deposit $100,000 and more 165,913 111,472 47,730 Interest on short-term borrowings 193,128 196,665 130,719 Interest on term borrowings 24,793 19,938 15,915 - ------------------------------------------------------------------------------------------------------------------ Total interest expense 617,654 593,238 458,197 - ------------------------------------------------------------------------------------------------------------------ NET INTEREST INCOME 589,510 540,539 483,096 Provision for loan losses 57,923 51,351 51,115 - ------------------------------------------------------------------------------------------------------------------ NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 531,587 489,188 431,981 - ------------------------------------------------------------------------------------------------------------------ NONINTEREST INCOME: Mortgage banking 632,771 558,366 330,131 Capital markets 126,835 147,353 98,310 Deposit transactions and cash management 106,240 90,444 86,047 Trust services and investment management 59,807 51,198 40,941 Merchant processing 49,711 37,462 32,111 Cardholder fees 25,579 21,046 19,833 Equity securities gains/(losses) 2,313 3,940 (854) Debt securities gains/(losses) (56) 36 141 All other income and commissions (Note 12) 119,904 75,658 61,470 - ------------------------------------------------------------------------------------------------------------------ Total noninterest income 1,123,104 985,503 668,130 - ------------------------------------------------------------------------------------------------------------------ ADJUSTED GROSS INCOME AFTER PROVISION FOR LOAN LOSSES 1,654,691 1,474,691 1,100,111 - ------------------------------------------------------------------------------------------------------------------ NONINTEREST EXPENSE: Employee compensation, incentives and benefits 633,640 563,576 409,783 Amortization of mortgage servicing rights 103,471 95,507 37,452 Operations services 64,545 58,505 49,879 Occupancy 73,052 51,421 42,848 Equipment rentals, depreciation and maintenance 57,807 45,771 40,093 Communications and courier 51,937 41,468 34,899 Amortization of intangible assets 10,492 11,114 9,631 All other expense (Note 12) 280,308 254,407 160,459 - ------------------------------------------------------------------------------------------------------------------ Total noninterest expense 1,275,252 1,121,769 785,044 - ------------------------------------------------------------------------------------------------------------------ INCOME BEFORE INCOME TAXES 379,439 352,922 315,067 Applicable income taxes (Note 15) 131,906 126,542 117,595 - ------------------------------------------------------------------------------------------------------------------ NET INCOME $ 247,533 $ 226,380 $ 197,472 ================================================================================================================== EARNINGS PER SHARE (Note 16) $ 1.90 $ 1.77 $ 1.54 - ------------------------------------------------------------------------------------------------------------------ DILUTED EARNINGS PER SHARE (Note 16) $ 1.85 $ 1.72 $ 1.50 - ------------------------------------------------------------------------------------------------------------------ WEIGHTED AVERAGE SHARES OUTSTANDING 130,572,763 128,235,006 128,365,434 - ------------------------------------------------------------------------------------------------------------------ See accompanying notes to consolidated financial statements.
40 FIRST TENNESSEE NATIONAL CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Accumulated Deferred Deferred Other Compen- Compen- Common Common Capital Undivided Comprehensive sation sation (Amounts in thousands) Shares Total Stock Surplus Profits Income Asset Liability - --------------------------------------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1996 133,715 $ 954,526 $ 83,572 $ 48,657 $ 823,175 $ 2,697 $(3,575) $ -- Net income -- 197,472 -- -- 197,472 -- -- -- Other comprehensive income: Unrealized market adjustments, net of tax and reclassification adjustment -- 12,636 -- -- -- 12,636 -- -- ------------------------------------------------------------------------------------------- Comprehensive income -- 210,108 -- -- 197,472 12,636 -- -- ------------------------------------------------------------------------------------------- Cash dividends declared -- (79,362) -- -- (79,362) -- -- -- Common stock issued: Federal Flood Certification Corporation acquisition 74 1,362 47 1,315 -- -- -- -- For exercise of stock options 1,900 24,174 1,187 22,987 -- -- -- -- Tax benefit from non-qualified stock options -- 4,962 -- 4,962 -- -- -- -- Common stock repurchased (7,480) (169,492) (4,675) (34,928) (129,889) -- -- -- Amortization on restricted stock incentive plans -- 1,275 -- -- -- -- 1,275 -- Other -- 6,543 -- 6,543 -- -- -- -- - --------------------------------------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1997 128,209 954,096 80,131 49,536 811,396 15,333 (2,300) -- Net income -- 226,380 -- -- 226,380 -- -- -- Other comprehensive income: Unrealized market adjustments, net of tax and reclassification adjustment -- (2,461) -- -- -- (2,461) -- -- ------------------------------------------------------------------------------------------- Comprehensive income -- 223,919 -- -- 226,380 (2,461) -- -- ------------------------------------------------------------------------------------------- Cash dividends declared -- (87,768) -- -- (87,768) -- -- -- Common stock issued: Acquisitions: McGuire Mortgage Company 351 8,951 219 8,732 -- -- -- -- Keystone Mortgage, Inc. 190 5,164 119 5,045 -- -- -- -- For exercise of stock options 2,087 26,546 1,305 23,734 -- -- -- 1,507 Tax benefit from non-qualified stock options -- 17,135 -- 17,135 -- -- -- -- Common stock repurchased (1,867) (61,836) (1,167) (19,638) (41,031) -- -- -- Amortization on restricted stock incentive plans -- 1,212 -- -- -- -- 1,212 -- Other 4 12,115 2 12,234 -- -- (121) -- - --------------------------------------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1998 128,974 1,099,534 80,609 96,778 908,977 12,872 (1,209) 1,507 Net income -- 247,533 -- -- 247,533 -- -- -- Other comprehensive income: Unrealized market adjustments, net of tax and reclassification adjustment -- (34,624) -- -- -- (34,624) -- -- ------------------------------------------------------------------------------------------- Comprehensive income -- 212,909 -- -- 247,533 (34,624) -- -- ------------------------------------------------------------------------------------------- Cash dividends declared -- (102,788) -- -- (102,788) -- -- -- Common stock issued: Acquisitions: Cambridge Mortgage Company 22 704 14 690 -- -- -- -- Elliot Ames, Inc. 242 6,800 151 6,649 -- -- -- -- For exercise of stock options 1,904 32,306 1,190 30,942 -- -- -- 174 Tax benefit from non-qualified stock options -- 11,616 -- 11,616 -- -- -- -- Common stock repurchased (1,286) (41,213) (804) (40,409) -- -- -- -- Amortization on restricted stock incentive plans -- 2,149 -- -- -- -- 2,149 -- Other 22 19,450 14 24,370 -- -- (6,614) 1,680 - --------------------------------------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1999 129,878 $ 1,241,467 $ 81,174 $ 130,636 $ 1,053,722 $(21,752) $(5,674) $3,361 ================================================================================================================================= See accompanying notes to consolidated financial statements.
41 FIRST TENNESSEE NATIONAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31 -------------------------------------- (Dollars in thousands) 1999 1998 1997 - ---------------------------------------------------------------------------------------------------------------------- OPERATING Net income $ 247,533 $ 226,380 $ 197,472 ACTIVITIES Adjustments to reconcile net income to net cash provided/(used) by operating activities: Provision for loan losses 57,923 51,351 51,115 Provision for deferred income tax 81,633 83,454 45,521 Depreciation and amortization of premises and equipment 53,719 40,431 32,784 Amortization of mortgage servicing rights 103,471 95,507 37,452 Amortization of intangible assets 10,492 11,114 9,631 Net other amortization and accretion 51,524 15,283 5,916 Market value adjustment on foreclosed property 5,633 16,820 9,145 Gain on sale of securitized loans -- (643) -- Gain on early retirement of debt (1,420) -- -- Gain on equity interest from demutualization (6,143) -- -- Equity securities (gains)/losses (2,313) (3,940) 854 Debt securities (gains)/losses 56 (36) (141) Net gains on disposals of fixed assets (1,405) (703) (698) Gain on sale of bank branches (4,245) (567) -- Net (increase)/decrease in: Capital markets securities inventory 220,779 (105,064) (102,838) Mortgage loans held for sale 1,858,685 (2,968,356) (453,286) Capital markets receivables 149,690 (143,893) (24,433) Interest receivable 1,859 (25,013) (7,609) Other assets (639,096) (722,144) (343,697) Net increase/(decrease) in: Capital markets payables (127,795) 112,110 33,152 Interest payable (2,356) (8,919) 2,977 Other liabilities (60,694) 181,366 46,655 - ---------------------------------------------------------------------------------------------------------------------- Total adjustments 1,749,997 (3,371,842) (657,500) - ---------------------------------------------------------------------------------------------------------------------- Net cash provided/(used) by operating activities 1,997,530 (3,145,462) (460,028) - ---------------------------------------------------------------------------------------------------------------------- INVESTING Held to maturity securities - maturities 216,146 160,471 12,656 ACTIVITIES Available for sale securities: Sales 71,053 53,643 104,067 Maturities 683,613 944,145 767,625 Purchases (880,343) (675,358) (808,952) Premises and equipment: Sales 11,927 2,733 4,212 Purchases (106,420) (80,414) (56,099) Net increase in loans (1,270,333) (1,102,674) (637,790) Proceeds from loan securitizations -- 72,756 -- Net (increase)/decrease in investment in bank time deposits (2,052) 1,076 (600) Sale of bank branches, net of cash and cash equivalents (4,778) (7,654) -- Acquisitions, net of cash and cash equivalents acquired (6,973) (9,243) (185) - ---------------------------------------------------------------------------------------------------------------------- Net cash used by investing activities (1,288,160) (640,519) (615,066) - ---------------------------------------------------------------------------------------------------------------------- FINANCING Common stock: ACTIVITIES Exercise of stock options 34,457 24,943 24,309 Cash dividends paid (98,704) (84,521) (78,348) Repurchase of shares (41,262) (61,854) (169,520) Term borrowings: Issuance 52,421 247,613 -- Payments (107,200) (2,301) (65,923) Issuance of guaranteed preferred beneficial interests in First Tennessee's junior subordinated debentures -- -- 100,000 Net increase in: Deposits (316,797) 2,063,738 638,717 Short-term borrowings 67,209 1,532,862 529,511 - ---------------------------------------------------------------------------------------------------------------------- Net cash provided/(used) by financing activities (409,876) 3,720,480 978,746 - ---------------------------------------------------------------------------------------------------------------------- Net increase/(decrease) in cash and cash equivalents 299,494 (65,501) (96,348) - ---------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at beginning of period 936,120 1,001,621 1,097,969 - ---------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of period $ 1,235,614 $ 936,120 $ 1,001,621 ====================================================================================================================== Total interest paid $ 619,740 $ 601,749 $ 454,881 Total income taxes paid 48,802 28,348 61,007 - ---------------------------------------------------------------------------------------------------------------------- See accompanying notes to consolidated financial statements.
42 FIRST TENNESSEE NATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF ACCOUNTING. The consolidated financial statements of First Tennessee National Corporation (First Tennessee), including its subsidiaries, are prepared in conformity with generally accepted accounting principles and follow general practices within the industries in which it operates. This preparation requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. These estimates and assumptions are based on information available as of the date of the financial statements and could differ from actual results. PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION. The consolidated financial statements include the accounts of First Tennessee and its majority-owned subsidiaries. Affiliates that are not majority owned are accounted for by the equity method. All significant intercompany transactions and balances have been eliminated. For purposes of comparability, certain prior period amounts have been reclassified to conform with current year presentation. None of these reclassifications had any effect on net income or earnings per share for any of the periods presented. Prior year financial statements are restated to include the accounts of companies that are acquired and accounted for as poolings of interests. Business combinations accounted for as purchases are included in the financial statements from the respective dates of acquisition. STATEMENTS OF CASH FLOWS. For purposes of these statements, cash and due from banks, federal funds sold, and securities purchased under agreements to resell are considered cash and cash equivalents. Federal funds are usually sold for one-day periods, and securities purchased under agreements to resell are short-term, highly liquid investments. The following significant non-cash stock transactions have been adjusted for a two-for-one stock split that First Tennessee effected February 20, 1998. In 1997, First Tennessee issued approximately 74,000 shares of its common stock related to the acquisition of Federal Flood Certification Corporation. First Tennessee acquired Keystone Mortgage, Inc. and McGuire Mortgage Company in 1998 for approximately 187,000 shares and 341,000 shares of First Tennessee stock, respectively. In 1999, approximately 22,000 shares were issued related to the acquisition of Cambridge Mortgage Company and approximately 242,000 shares were issued related to the acquisition of Elliot Ames, Inc. CAPITAL MARKETS SECURITIES INVENTORY. Inventories purchased in connection with underwriting or dealer activities are carried at market value. Gains and losses, both realized and unrealized, on these inventories are reflected in noninterest income as capital markets income. INVESTMENT SECURITIES. Securities that First Tennessee has the ability and positive intent to hold to maturity are classified as securities held to maturity and are carried at amortized cost. Securities that may be sold prior to maturity for asset/liability management purposes and equity securities are classified as securities available for sale and are carried at fair value. The unrealized gains and losses on securities available for sale are excluded from earnings and are reported, net of tax, as a component of other comprehensive income within shareholders' equity. The amortized cost of all securities is adjusted for amortization of premium and accretion of discount to maturity, or earlier call date if appropriate, using the level yield method. Such amortization and accretion is included in interest income from securities. Realized gains and losses and declines in value judged to be other than temporary are computed by the specific identification method and reported in noninterest income. SECURITIES PURCHASED UNDER RESALE AGREEMENTS AND SECURITIES SOLD UNDER REPURCHASE AGREEMENTS. First Tennessee Capital Markets enters into short-term purchases of securities under agreements to resell as a means of converting proceeds from securities sold short into interest earning assets. Securities delivered under these transactions are delivered to either the dealer custody account at the Federal Reserve Bank or to the applicable counterparty. Securities sold under agreements to repurchase (securities sold) are offered to cash management customers as an automated, collateralized investment account. Securities sold are also used by the regional banking group to obtain favorable borrowing rates on its purchased funds. Under these transactions, securities are delivered to the counterparty's custody account. In the normal course of business, First Tennessee does not use this as a primary funding source. MORTGAGE BANKING. First Tennessee's mortgage lenders originate first-lien mortgage loans for the purpose of selling them in the secondary market. Mortgage loans held for sale, including the estimated value of mortgage loan commitments, are recorded at the lower of aggregate cost or market value. Gains and losses realized from the sale of these assets and adjustments to market value are included in noninterest income. Servicing rights related to the mortgages sold are ordinarily retained. Accounting standards require the recognition of mortgage servicing rights (MSRs) as separate assets by allocating the total cost between the loan and the servicing right based on their relative fair values. First Tennessee uses a cash flow valuation model to determine the fair value of the servicing rights created. These valuations are tested for reasonableness against prices obtained from flow and bulk sales of servicing and are validated through an independent 43 market valuation. Model assumptions are periodically reviewed and may be revised from time to time to more accurately reflect current assumptions such as prepayment speeds. For purposes of impairment evaluation and measurement, the MSRs are stratified based on the predominant risk characteristics of the underlying loans. For First Tennessee, these strata include adjustable rate conventional and government; fixed rate conventional and government by interest rate band. The MSRs are amortized as noninterest expense over the period of and in proportion to the estimated net servicing revenues. A quarterly value impairment analysis is performed using a discounted cash flow methodology that is disaggregated by predominant risk characteristics. Impairment, if any, is recognized through a valuation allowance for individual strata. See further detail about mortgage banking policies in the derivative financial instruments disclosure below. LOANS. Loans are stated at principal amounts outstanding, net of unearned income. Interest on loans is recognized at the applicable interest rate on the principal amount outstanding. Impaired loans are generally carried on a nonaccrual status. Loans are ordinarily placed on nonaccrual status when, in management's opinion, the collection of principal or interest is unlikely, or when the collection of principal or interest is 90 days or more past due. Consumer installment loans and credit card receivables are not placed on nonaccrual status, but are charged off when past due 120 days and 180 days, respectively. Accrued but uncollected interest is reversed and charged against interest income when the loan is placed on nonaccrual status. On consumer loans, accrued but uncollected interest is reversed when the loan is charged off. Management may elect to continue the accrual of interest when the estimated net realizable value of collateral is sufficient to recover the principal balance and accrued interest. Interest payments received on nonaccrual and impaired loans are normally applied to principal. Once all principal has been received, additional interest payments are recognized on a cash basis as interest income. ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is maintained at a level that management determines is adequate to absorb estimated losses inherent in the loan portfolio. Management's evaluation process used to determine the adequacy of the allowance combines three factors: historical loss experience derived from analytical models, current trends and reasonably foreseeable events. The actual amounts realized could differ in the near term from the amounts assumed in arriving at the allowance for possible loan losses reported in the financial statements. All losses of principal are charged to the account when the loss actually occurs or when a determination is made that a loss is probable. Additions are made to the allowance through periodic provisions charged to current operations and recovery of principal on loans previously charged off. PREMISES AND EQUIPMENT. Premises and equipment are carried at cost less accumulated depreciation and amortization and include additions that materially extend the useful lives of existing premises and equipment. All other maintenance and repair expenditures are expensed as incurred. Gains and losses on dispositions are reflected in noninterest income and expense. Depreciation and amortization are computed principally on the straight-line method over the estimated useful lives of the assets and are expensed to noninterest expense. Leasehold improvements are amortized over the lesser of the lease periods or the estimated useful lives using the straight-line method. REAL ESTATE ACQUIRED BY FORECLOSURE. Real estate acquired by foreclosure consists of properties that have been acquired in satisfaction of debt. These properties are carried at the lower of the outstanding loan amount or the estimated fair market value minus the estimated cost to sell the real estate. Losses arising at foreclosure are charged to the allowance for loan losses. Required developmental costs associated with foreclosed property under construction are capitalized and included in determining the estimated net realizable value of the property which is reviewed periodically, and any write-downs are charged against current earnings as market adjustments. INTANGIBLE ASSETS. Intangible assets consist of "Premium on purchased deposits and assets" and "Goodwill." The "Premium on purchased deposits and assets" represents identified intangible assets, which are amortized over their estimated useful lives, except for those assets related to deposit bases that are primarily amortized over 10 years. "Goodwill" represents the excess of cost over net assets of acquired subsidiaries less identifiable intangible assets and is amortized to noninterest expense using the straight-line method over periods ranging from 15 to 40 years. Management evaluates whether events or circumstances have occurred that indicate the remaining useful life or carrying value of goodwill should be revised. DERIVATIVE FINANCIAL INSTRUMENTS. First Tennessee utilizes derivative financial instruments in order to manage exposure to fluctuations in interest rates and to meet the financial needs of customers. For interest rate risk management purposes, First Tennessee primarily utilizes interest rate swaps. Mortgage banking operations mainly use mandatory forward delivery commitments and purchased and written options to hedge against risks associated with the warehouse, the pipeline, or the servicing portfolio. Capital markets uses various derivatives, including interest rate swaps, futures, forward and option contracts and securities underwriting commitments in order to meet the needs of its customers with forwards being the most commonly used instrument. 44 To qualify as a hedge used to manage interest rate risk, the following criteria must be met: (1) the asset or liability to be hedged exposes First Tennessee to interest rate risk; (2) the instrument alters or reduces sensitivity to interest rate changes; and (3) the instrument is designated and effective as a hedge. For interest rate contracts used to hedge interest rate risk, income and expense are deferred and amortized over the lives of the hedged assets or liabilities. The amortization of this income and expense is an adjustment to interest income or expense of the hedged item. Fees are deferred and amortized over the lives of the contracts. Any related assets or liabilities are recorded on the balance sheet in other assets or other liabilities. For those derivatives used to manage interest rate risk that are terminated prior to maturity, realized gains and losses are deferred and amortized straight-line over the remaining original life of the agreement as an adjustment to the hedged asset or liability. If the underlying hedged asset or liability is sold or prepaid, the related portion of any unrecognized gain or loss on the derivative is recognized in current earnings as part of the gain or loss on the sale or prepayment. Forward and option contracts are used by mortgage banking operations to hedge against interest rate risk in the warehouse and the pipeline are reviewed periodically for correlation with expected changes in value. Option contracts used to hedge against interest rate risk in the servicing portfolio are designated to specific risk tranches of servicing rights. Forward and option contracts used to hedge the pipeline and the warehouse are considered in the lower of cost or market valuation of the pipeline and the warehouse with any related gains or losses being recognized in mortgage banking noninterest income. Premiums paid for purchased options are deferred and reported in other assets and are amortized over the lives of the contracts to mortgage banking noninterest income. Options used to hedge the servicing portfolio are adjusted for changes in intrinsic value with gains and losses recognized as a basis adjustment of the related mortgage servicing rights risk tranche. Premiums are deferred and amortized on a straight-line basis over the contract life to other noninterest expense. Any unamortized premiums related to the options are reported in other assets. For derivatives hedging the warehouse and pipeline that are terminated prior to maturity, gains and losses are recognized in current earnings as mortgage banking noninterest income unless such gains and losses are related to future loan deliveries, in which case they are deferred and recognized at the time the related loans are sold. For derivatives hedging the servicing portfolio that are terminated prior to maturity, gains and losses are split between the return of time value premium and the intrinsic value. Gains or losses from the change in the intrinsic value are deferred as a basis adjustment to the related mortgage servicing rights risk tranche, and the gains or losses resulting from the return of time value premium are recognized in current earnings in mortgage banking noninterest income. Any contracts that fail to qualify for hedge accounting are measured at fair value with any gains or losses included in current earnings in noninterest income. Derivative contracts utilized in trading activities by capital markets are measured at fair value, and gains or losses are recognized in capital markets noninterest income as they occur. Related assets are recorded on the balance sheet as capital markets securities inventory or receivables and any liabilities are recognized as capital markets payables. Cash flows from derivative contracts are reported as operating activities on the Consolidated Statements of Cash Flows. INCOME TAXES. The provision for income taxes is based on income reported for consolidated financial statement purposes and includes deferred taxes resulting from the recognition of certain revenues and expenses in different periods for tax reporting purposes. First Tennessee files a consolidated federal income tax return except for a credit life insurance company and a Real Estate Investment Trust which both file separate returns. EARNINGS PER SHARE. Earnings per share is computed by dividing net income by the weighted average number of common shares outstanding for each period. Diluted earnings per share is computed by dividing net income by the weighted average number of common shares outstanding adjusted to include the number of additional common shares that would have been outstanding if the dilutive potential common shares resulting from options granted under First Tennessee's stock option plans had been issued. First Tennessee utilizes the treasury stock method in this calculation. Previously reported per share amounts have been restated for the effect of the February 20, 1998, two-for-one stock split. ACCOUNTING CHANGES. On January 1, 1999, First Tennessee adopted Statement of Financial Accounting Standards (SFAS) No. 134, "Accounting for Mortgage-Backed Securities Retained after Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise." This Statement amends SFAS No. 65, which required that retained securities be classified as trading securities. SFAS No. 134 allows these securities to be classified as trading, held to maturity or available for sale based on the intent and ability of the enterprise. 45 On January 1, 1999, First Tennessee adopted Statement of Position (SOP) 98-5, "Reporting on the Costs of Start-up Activities." This Statement requires that the costs of start-up activities, including organization costs, be expensed as incurred. The impact of adopting this standard was immaterial to First Tennessee. On January 1, 1998, First Tennessee adopted SFAS No. 130, "Reporting Comprehensive Income," which establishes standards for reporting comprehensive income and its components in the financial statements. Comprehensive income is the total of net income and all other nonowner changes in equity. The only component of other comprehensive income for First Tennessee is unrealized holding gains/(losses) on available for sale securities. On January 1, 1998, First Tennessee adopted SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," which allows for the capitalization of internal and external personnel costs for the development or modification of qualified internal use software. For the year ending December 31, 1998, First Tennessee adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." This standard requires a business to report financial and descriptive information about its reportable operating segments. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision-maker in deciding how to allocate resources and in assessing performance. For the year ending December 31, 1998, First Tennessee adopted SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." The new standard revises the required disclosures for employee benefit plans but does not change the measurement or recognition of such plans. On January 1, 1997, First Tennessee adopted SFAS No. 125, "Accounting for the Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." The Statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings based on a control-oriented "financial components" approach. Under this approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and liabilities it has incurred, derecognizes financial assets when control has been surrendered and derecognizes liabilities when extinguished. The adoption of this standard required a change in the method used to recognize mortgage servicing rights, increasing both the amortization expense as well as the servicing income. SFAS No. 128, "Earnings per Share," was adopted as of January 1, 1997. This standard specifies the computation, presentation and disclosure requirements for earnings per share (EPS). The objective of SFAS No. 128 is to simplify the computation and to make the United States' standard more compatible with EPS standards of other countries and with that of the International Accounting Standards Committee. First Tennessee now presents on the income statement both earnings per share and diluted earnings per share for all periods presented. In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS 133 establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded on the balance sheet as either an asset or liability measured at its fair value. SFAS 133 requires that changes in the derivative instrument's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative instrument's gains and losses to offset related results on the hedged item in the income statement, and requires that a company formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. Upon adoption of SFAS 133, all freestanding derivative instruments will be remeasured at fair value with differences between the derivatives' previous book value and fair value reported as a one-time accounting adjustment. Likewise, offsetting gains and losses on hedged assets, liabilities and firm commitments will be recognized as adjustments of their respective book values at the adoption date as part of this accounting adjustment. Except to the extent that they relate to hedges of the variable cash flow exposure of forecasted transactions, a portion of the net accounting adjustment (net of hedge difference and hedged item difference) will be reported in net income in the period of adoption. To the extent the adoption adjustment relates to hedges of the variable cash flow exposure of forecasted transactions, the remainder of the accounting adjustment will be reported as a cumulative effect adjustment of comprehensive income. SFAS 133, as amended by SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133", is effective for fiscal years beginning after June 15, 2000. First Tennessee will adopt SFAS 133 on January 1, 2001. Management has not yet quantified the effects SFAS 133 will have on its financial statements including the offsetting gains or losses that may be recognized on hedged assets, liabilities and firm commitments. Changes in the fair value of existing and future freestanding derivative instruments, hedged assets, liabilities and firm commitments, changes in the carrying value, including normal amortization, of derivative instruments and hedged assets and liabilities, and changes in hedging practices could have a substantial impact on the amount of the one-time accounting adjustment and its impact on net income. In addition, management is in the process of evaluating the methods and instruments currently used in hedging market exposure. The impact of adopting SFAS 133 could be material at the adoption date. SFAS 133 could also increase the volatility of earnings and other comprehensive income in the future. 46 NOTE 2 - ACQUISITIONS/DIVESTITURES On October 1, 1999, First Tennessee acquired Elliot Ames, Inc. of Los Altos, California, for approximately 292,000 shares of its common stock. Elliot Ames was merged into FT Mortgage Companies, an indirect wholly-owned subsidiary of First Tennessee. This acquisition was accounted for as a purchase and was immaterial to First Tennessee. On July 20, 1999, First Tennessee completed the sale of substantially all of the assets and liabilities of Planters Bank of Tunica, Mississippi, a wholly-owned subsidiary, to First Security Bank of Batesville, Mississippi. This transaction was completed for approximately $10.5 million and was immaterial to First Tennessee. On June 1, 1999, First Tennessee Bank National Association (FTBNA), a wholly-owned subsidiary of First Tennessee, acquired from National Processing Co. their remittance processing business locations in Atlanta, Dallas, Louisville and Phoenix for approximately $6.0 million. The acquisition of these units was accounted for as a purchase and was immaterial to First Tennessee. On March 31, 1999, First Tennessee acquired Cambridge Mortgage Company of Seattle, Washington, for approximately 22,000 shares of its common stock. Cambridge was merged into FT Mortgage Companies, an indirect wholly-owned subsidiary of First Tennessee. This acquisition was accounted for as a purchase and was immaterial to First Tennessee. The following table provides information concerning acquisitions completed during the three years ended December 31, 1999. Acquisitions accounted for as purchases are included in the financial statements from the date of the acquisition. All share information reflects the 1998 two-for-one stock split.
Common Shares Date of Issued Method of Acquisition Location Acquisition (thousands) Accounting - ------------------------------------------------------------------------------------------------------------------------ Elliot Ames, Inc. Los Altos, California 10/1/99 292 Purchase Cambridge Mortgage Co. Seattle, Washington 3/31/99 22 Purchase McGuire Mortgage Company Prairie Village, Kansas 12/31/98 341 Purchase Keystone Mortgage, Inc. Kirkland, Washington 7/1/98 187 Purchase Martin & Company, LLP Knoxville, Tennessee 1/2/98 $19.5 million cash Purchase Federal Flood Certification Corporation Dallas, Texas 7/14/97 74 Purchase - ------------------------------------------------------------------------------------------------------------------------
47 NOTE 3 - INVESTMENT SECURITIES The following tables summarize First Tennessee's securities held to maturity and available for sale at December 31, 1999 and 1998:
AT DECEMBER 31, 1999* ------------------------------------------------------ Gross Gross Estimated Amortized Unrealized Unrealized Fair (Dollars in thousands) Cost Gains Losses Value - ------------------------------------------------------------------------------------------------------------ SECURITIES HELD TO MATURITY: States and municipalities $ 25,892 $ 163 $ (171) $ 25,884 Private issue CMOs** 743,044 -- (34,075) 708,969 - ------------------------------------------------------------------------------------------------------------ Total securities held to maturity $ 768,936 $ 163 $(34,246) $ 734,853 ============================================================================================================ SECURITIES AVAILABLE FOR SALE: U.S. Treasury and other U.S. government agencies $ 168,011 $ 139 $ (2,673) $ 165,477 Government agency issued MBSs 297,161 888 (4,495) 293,554 Government agency issued CMOs 1,397,718 335 (41,388) 1,356,665 States and municipalities 15,446 275 (10) 15,711 Private issue CMOs 186,010 -- (14) 185,996 Other 145,597 3,386 (2,525) 146,458 Equity*** 158,109 10,935 (549) 168,495 - ------------------------------------------------------------------------------------------------------------ Total securities available for sale $2,368,052 $15,958 $(51,654) $2,332,356 ============================================================================================================ * Includes $1.7 billion of securities pledged to secure public deposits, securities sold under agreements to repurchase and for other purposes. ** Represents First Tennessee's Real Estate Mortgage Investment Conduit. *** Equity securities include venture capital investment securities. At December 31, 1998* ----------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair (Dollars in thousands) Cost Gains Losses Value - ----------------------------------------------------------------------------------------------------------- SECURITIES HELD TO MATURITY: States and municipalities $ 40,832 $ 1,267 $ (141) $ 41,958 Private issue CMOs** 568,972 5,752 (6,318) 568,406 - ----------------------------------------------------------------------------------------------------------- Total securities held to maturity $ 609,804 $ 7,019 $(6,459) $ 610,364 =========================================================================================================== SECURITIES AVAILABLE FOR SALE: U.S. Treasury and other U.S. government agencies $ 149,512 $ 1,790 $ (87) $ 151,215 Government agency issued MBSs 193,082 2,636 (281) 195,437 Government agency issued CMOs 1,297,152 7,061 (1,112) 1,303,101 States and municipalities 19,124 851 -- 19,975 Private issue CMOs 1,001 18 -- 1,019 Other 11,401 239 (6) 11,634 Equity*** 124,294 9,829 (19) 134,104 - ----------------------------------------------------------------------------------------------------------- Total securities available for sale $1,795,566 $22,424 $(1,505) $1,816,485 =========================================================================================================== * Includes $1.7 billion of securities pledged to secure public deposits, securities sold under agreements to repurchase and for other purposes. ** Represents First Tennessee's Real Estate Mortgage Investment Conduit. *** Equity securities include venture capital investment securities.
48 Provided below are the amortized cost and estimated fair value by contractual maturity for the securities portfolios at December 31, 1999:
Held to Maturity Available for Sale ----------------------- ----------------------- Estimated Estimated By Contractual Maturity Amortized Fair Amortized Fair (Dollars in thousands) Cost Value Cost Value - --------------------------------------------------------------------------------------------------------- Within 1 year $ 4,102 $ 4,108 $ 95,903 $ 94,990 After 1 year; within 5 years 8,865 8,917 85,830 84,294 After 5 years; within 10 years 7,743 7,782 19,098 18,672 After 10 years 5,182 5,077 128,223 129,690 - --------------------------------------------------------------------------------------------------------- Subtotal 25,892 25,884 329,054 327,646 - --------------------------------------------------------------------------------------------------------- Mortgage-backed securities and CMOs 743,044 708,969 1,880,889 1,836,215 Equity securities -- -- 158,109 168,495 - --------------------------------------------------------------------------------------------------------- Total $768,936 $734,853 $2,368,052 $2,332,356 ========================================================================================================= Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The table below provides information on realized gross gains and realized gross losses on sales from the available for sale portfolio for the years ended December 31:
Available Available for Sale - for Sale - (Dollars in thousands) Debt Equity Total - ----------------------------------------------------------------------------------------------------- 1999 Gross gains on sales $ 10 $3,122 $3,132 Gross losses on sales (84) (24) (108) - ----------------------------------------------------------------------------------------------------- 1998 Gross gains on sales $ 323 $6,804 $7,127 Gross losses on sales (292) -- (292) - ----------------------------------------------------------------------------------------------------- 1997 Gross gains on sales $ 373 $ 214 $ 587 Gross losses on sales (441) -- (441) - -----------------------------------------------------------------------------------------------------
Losses totaling $.8 million, $2.9 million and $1.1 million for the years 1999, 1998 and 1997, respectively, were recognized for securities that, in the opinion of management, have been permanently impaired. 49 NOTE 4 - LOANS A summary of the major categories of loans outstanding at December 31 is shown below:
(Dollars in thousands) 1999 1998 - --------------------------------------------------------------------------------------------------------------------------- Commercial $ 4,430,516 $ 4,116,918 Consumer: Real estate* 2,265,466 2,041,579 Auto 454,427 443,674 Student 301,139 274,763 Other 260,800 258,766 - --------------------------------------------------------------------------------------------------------------------------- Total consumer 3,281,832 3,018,782 Permanent mortgage 528,907 423,200 Credit card receivables 607,205 594,467 Real estate construction 485,580 375,890 Nonaccrual 29,118 27,807 - --------------------------------------------------------------------------------------------------------------------------- Loans, net of unearned income** 9,363,158 8,557,064 Allowance for loan losses 139,603 136,013 - --------------------------------------------------------------------------------------------------------------------------- Total net loans $ 9,223,555 $ 8,421,051 =========================================================================================================================== * Consumer real estate loans included $2.1 billion and $2.0 billion of first and second liens and home equity loans at December 31, 1999 and 1998, respectively. ** Loans are presented net of $.2 million and $4.7 million of unearned income at December 31, 1999 and 1998, respectively.
Nonperforming loans consist of loans which management has identified as impaired, other nonaccrual loans and loans which have been restructured. At December 31, 1999 and 1998, there were no outstanding commitments to advance additional funds to customers whose loans had been restructured. The following table presents nonperforming loans at December 31:
(Dollars in thousands) 1999 1998 - --------------------------------------------------------------------------------------------------------------------------- Impaired loans $ 7,514 $ 12,111 Other nonaccrual loans 21,604 15,696 - --------------------------------------------------------------------------------------------------------------------------- Total nonperforming loans $ 29,118 $ 27,807 ===========================================================================================================================
Interest income received during 1999 for impaired loans was $.5 million and for other nonaccrual loans was $.9 million. Under their original terms, interest income would have been approximately $1.2 million for the impaired loans and $1.8 million for the other nonaccrual loans outstanding at December 31, 1999. The average balance of impaired loans was approximately $12.5 million for 1999 and $9.1 million for 1998. 50 Activity in the allowance for loan losses related to non-impaired and impaired loans for years ended December 31 is summarized as follows:
(Dollars in thousands) Non-impaired Impaired Total - ----------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1996 $ 114,217 $ 3,531 $ 117,748 Provision for loan losses 46,007 5,108 51,115 Charge-offs (48,974) (5,301) (54,275) Loan recoveries 10,857 414 11,271 - ----------------------------------------------------------------------------------------------------------------------------- Net charge-offs (38,117) (4,887) (43,004) - ----------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1997 122,107 3,752 125,859 Transfer of allowance due to securitizations (3,575) - (3,575) Allowance from acquisitions 140 - 140 Provision for loan losses 48,474 2,877 51,351 Charge-offs (43,384) (5,138) (48,522) Loan recoveries 9,810 950 10,760 - ----------------------------------------------------------------------------------------------------------------------------- Net charge-offs (33,574) (4,188) (37,762) - ----------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1998 133,572 2,441 136,013 Transfer of allowance due to securitizations (1,790) - (1,790) Adjustment due to divestiture (893) - (893) Provision for loan losses 49,962 7,961 57,923 Charge-offs (50,156) (10,069) (60,225) Loan recoveries 6,283 2,292 8,575 - ----------------------------------------------------------------------------------------------------------------------------- Net charge-offs (43,873) (7,777) (51,650) - ----------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1999 $ 136,978 $ 2,625 $ 139,603 =============================================================================================================================
Certain executive officers and directors (and their associates) of First Tennessee were loan customers during 1999 and 1998. Such loans are at normal credit terms, including interest rates and collateral, and do not represent more than a normal risk of collection. The following is a summary of related party loans outstanding and the activity for the years ended December 31:
(Dollars in thousands) 1999 1998 - ----------------------------------------------------------------------------------------------------------------------------- Balance at beginning of year $ 70,731 $ 85,867 Additions 279,183 165,049 Deletions: Repayments (274,936) (141,738) No longer related (6,780) (38,447) - ----------------------------------------------------------------------------------------------------------------------------- Total deletions (281,716) (180,185) - ----------------------------------------------------------------------------------------------------------------------------- BALANCE AT END OF YEAR $ 68,198 $ 70,731 =============================================================================================================================
Included in "Other assets" and in "Other liabilities" on the Consolidated Statements of Condition are amounts due from customers on acceptances and bank acceptances outstanding of $7.4 million and $6.9 million at December 31, 1999 and 1998, respectively. 51 NOTE 5 - PREMISES, EQUIPMENT AND LEASES Premises and equipment at December 31 are summarized below:
(Dollars in thousands) 1999 1998 - ---------------------------------------------------------------------------------------------------------------------------- Land $ 34,404 $ 32,026 Buildings 171,876 154,758 Leasehold improvements 56,033 41,009 Furniture, fixtures and equipment 278,949 229,062 - ---------------------------------------------------------------------------------------------------------------------------- Premises and equipment, at cost 541,262 456,855 Less accumulated depreciation and amortization 235,743 202,563 - ---------------------------------------------------------------------------------------------------------------------------- Premises and equipment, net $ 305,519 $ 254,292 ============================================================================================================================
First Tennessee is obligated under a number of noncancelable operating leases for premises and equipment with terms up to 20 years, which may include the payment of taxes, insurance and maintenance costs. Minimum future lease payments for operating leases on premises and equipment at December 31, 1999, are shown below:
(Dollars in thousands) - ---------------------------------------------------------------------------------------------------------------------------- 2000 $ 39,347 2001 33,406 2002 26,123 2003 18,192 2004 11,225 2005 and after 40,048 - ---------------------------------------------------------------------------------------------------------------------------- Total minimum lease payments $ 168,341 ============================================================================================================================ Payments required under capital leases are not material.
Aggregate minimum income under sublease agreements for these periods is $2.5 million. Rent expense incurred under all operating lease obligations was as follows for the years ended December 31:
(Dollars in thousands) 1999 1998 1997 - ---------------------------------------------------------------------------------------------------------------------------- Rent expense, gross $ 56,656 $ 35,857 $ 29,820 Rent income (2,810) (1,901) (1,670) - ---------------------------------------------------------------------------------------------------------------------------- Rent expense, net $ 53,846 $ 33,956 $ 28,150 ============================================================================================================================
52 NOTE 6 - CAPITALIZED MORTGAGE SERVICING RIGHTS Following is a summary of changes in capitalized mortgage servicing rights, net of accumulated amortization, included in the Consolidated Statements of Condition:
(Dollars in thousands) - ----------------------------------------------------------------------------------------------------------------------------- December 31, 1996 $ 266,027 Addition of mortgage servicing rights 182,959 Amortization (37,452) Sales of mortgage servicing rights (2,613) - ----------------------------------------------------------------------------------------------------------------------------- December 31, 1997 408,921 Addition of mortgage servicing rights 435,893 Amortization (95,507) Net hedge gains applied (84,557) Sales of mortgage servicing rights (312) - ----------------------------------------------------------------------------------------------------------------------------- December 31, 1998 664,438 Addition of mortgage servicing rights 420,046 Amortization (103,471) Net hedge losses applied 70,529 Sales of mortgage servicing rights (133,066) Purchase of mortgage servicing rights 28,388 Conversion to interest only strip* (120,654) - ----------------------------------------------------------------------------------------------------------------------------- DECEMBER 31, 1999 $ 826,210 ============================================================================================================================= *Excess of servicing fair value over the contractually specified servicing.
The mortgage servicing rights at December 31, 1999 and 1998, had estimated market values of approximately $876.3 million and $685.1 million, respectively. These balances represent the rights to service approximately $41.5 billion and $34.0 billion of mortgage loans at December 31, 1999 and 1998. In addition, First Tennessee had approximately $1.3 billion and $1.6 billion in unpaid principal balance of mortgage loans for which the servicing rights were not capitalized at December 31, 1999 and 1998. These mortgage servicing rights had estimated market values of $5.2 million and $10.2 million, respectively. No valuation allowance due to impairment was required as of December 31, 1999 or 1998. NOTE 7 - INTANGIBLE ASSETS Following is a summary of intangible assets, net of accumulated amortization, included in the Consolidated Statements of Condition:
Premium on Purchased Deposits (Dollars in thousands) Goodwill and Assets - --------------------------------------------------------------------------------------------------------------------------- December 31, 1996 $ 87,643 $ 31,822 Amortization expense (4,343) (5,288) Acquisitions 377 2,200 - --------------------------------------------------------------------------------------------------------------------------- December 31, 1997 83,677 28,734 Amortization expense (5,463) (5,651) Acquisitions 29,256 2,292 - --------------------------------------------------------------------------------------------------------------------------- December 31, 1998 107,470 25,375 Amortization expense (5,665) (4,827) Acquisitions 10,491 724 - --------------------------------------------------------------------------------------------------------------------------- DECEMBER 31, 1999 $ 112,296 $ 21,272 ===========================================================================================================================
53 NOTE 8 - TIME DEPOSIT MATURITIES Following is a table of maturities for time deposits outstanding at December 31, 1999, which include "Certificates of deposit under $100,000 and other time" and "Certificates of deposit $100,000 and more". "Certificates of deposit $100,000 and more" totaled $2.4 billion at December 31, 1999. Time deposits are included in "Interest-bearing" deposits on the Consolidated Statements of Condition.
(Dollars in thousands) - ---------------------------------------------------------------------------------------------------------------------------- 2000 $ 3,835,616 2001 451,129 2002 231,892 2003 89,948 2004 and after 110,451 - ---------------------------------------------------------------------------------------------------------------------------- Total $ 4,719,036 ============================================================================================================================
NOTE 9 - SHORT-TERM BORROWINGS Short-term borrowings include federal funds purchased and securities sold under agreements to repurchase, commercial paper, and other borrowed funds which include term federal funds purchased, short-term bank notes, and advances from the Federal Home Loan Bank. The advances from the Federal Home Loan Bank, which totaled $200 million at December 31, 1999, are collateralized 150 percent with first-lien permanent mortgage loans of FTBNA. Federal funds purchased and securities sold under agreements to repurchase and commercial paper generally have maturities of less than 90 days. Other short-term borrowings have original maturities of one year or less. The detail of these borrowings for the years 1999, 1998 and 1997 is presented in the following table:
Federal Funds Purchased and Securities Sold Other Under Agreements Commercial Short-term (Dollars in thousands) to Repurchase Paper Borrowings - ---------------------------------------------------------------------------------------------------------------------------- 1999 Average balance $ 2,292,857 $ 18,268 $ 1,613,124 Year-end balance 2,856,282 16,272 1,533,957 Maximum month-end outstanding 2,856,282 21,221 1,801,230 Average rate for the year 4.57% 4.18% 5.44% Average rate at year-end 4.61 4.63 6.00 - ---------------------------------------------------------------------------------------------------------------------------- 1998 Average balance $ 2,456,449 $ 22,337 $ 1,263,121 Year-end balance 2,912,018 23,203 1,404,071 Maximum month-end outstanding 3,733,294 26,958 1,511,624 Average rate for the year 4.99% 4.59% 5.79% Average rate at year-end 4.79 4.12 5.19 - ---------------------------------------------------------------------------------------------------------------------------- 1997 Average balance $ 1,790,130 $ 20,792 $ 642,235 Year-end balance 2,085,679 23,176 679,212 Maximum month-end outstanding 2,085,679 24,170 873,739 Average rate for the year 5.01% 4.64% 6.23% Average rate at year-end 5.56 4.70 6.07 - ----------------------------------------------------------------------------------------------------------------------------
At December 31, 1999, $50 million of borrowings under unsecured lines of credit from non-affiliated banks were available to the parent company to provide for general liquidity needs at an annual facility fee of .10 percent. 54 NOTE 10 - TERM BORROWINGS The following table presents information pertaining to term borrowings (debt with original maturities greater than one year) for First Tennessee and its subsidiaries at December 31:
(Dollars in thousands) 1999 1998 - ------------------------------------------------------------------------------------------------------------------ FIRST TENNESSEE NATIONAL CORPORATION: Subordinated capital notes: Matures on November 15, 2005 -- 6 3/4% $ 74,520 $ 74,438 Matured on June 1, 1999 -- 10 3/8% -- 74,962 FIRST TENNESSEE BANK NATIONAL ASSOCIATION: Notes payable to Federal Home Loan Bank*: Matures on September 16, 2002 -- 5.42% 50,000 -- Matures through November 1, 2009 -- 8.10% 1,983 2,183 Matures through January 1, 2028 -- 4.00% 41 41 Matures through May 1, 2028 -- 4.00% 39 40 Matures through June 1, 2029 -- 4.00% 43 -- Matured on January 29, 1999 -- 7.95% -- 15,000 Subordinated bank notes: Matures on April 1, 2008 -- 6.40% 89,420 99,277 Matures on December 1, 2008 -- 5.75% 140,274 148,409 Industrial Development Bond Payable to City of Alcoa, Tennessee; matured 1999 -- 6.50% -- 100 FT REAL ESTATE SECURITIES COMPANY, INC.: Preferred stock minority interest 99 -- FIRST NATIONAL BANK OF SPRINGDALE Notes payable to Federal Home Loan Bank*: Matures through April 1, 2009 -- 5.885% 1,000 -- Matures through June 2, 2009 -- 5.885% 600 -- Matures through May 1, 2009 -- 5.698% 644 -- - ------------------------------------------------------------------------------------------------------------------ Total $358,663 $414,450 ================================================================================================================== * These Federal Home Loan Bank borrowings are collateralized with first-lien permanent mortgage loans.
Annual principal repayment requirements as of December 31, 1999, are as follows:
(Dollars in thousands) - ------------------------------------------------------------------------------------------------------------------ 2000 $ 336 2001 371 2002 50,374 2003 378 2004 381 2005 and after 309,234 - ------------------------------------------------------------------------------------------------------------------
All subordinated capital and bank notes are unsecured and are subordinate to other present and future senior indebtedness. These notes qualify as Tier 2 risk-based capital under the Federal Reserve Board and Office of the Comptroller of the Currency guidelines for assessing capital adequacy. The subordinated capital and bank notes may not be redeemed or prepaid prior to maturity. 55 NOTE 11 - GUARANTEED PREFERRED BENEFICIAL INTERESTS IN FIRST TENNESSEE'S JUNIOR SUBORDINATED DEBENTURES On December 30, 1996, First Tennessee, through its underwriters, sold to institutional investors $100 million of capital securities. First Tennessee Capital I (Capital I), a Delaware business trust wholly owned by First Tennessee, issued $100 million of Capital Securities, Series A at 8.07%. The proceeds were upstreamed to First Tennessee as junior subordinated debt under the same terms and conditions. First Tennessee has, through various contractual arrangements, fully and unconditionally guaranteed all of Capital I's obligations with respect to the capital securities. These capital securities qualify as Tier I capital and are presented in the Consolidated Statements of Condition as "Guaranteed Preferred Beneficial Interests in First Tennessee's Junior Subordinated Debentures." The sole asset of Capital I is $103 million of junior subordinated debentures issued by First Tennessee. These junior subordinated debentures also carry an interest rate of 8.07 percent. Both the capital securities of Capital I and the junior subordinated debentures of First Tennessee will mature on January 6, 2027; however, under certain circumstances, the maturity of both may be shortened to a date not earlier than January 6, 2017. During 1997, under an accelerated purchase program, a portion of the proceeds from this issuance was used to repurchase 3.8 million shares of First Tennessee's common stock at a cost of $83.3 million. NOTE 12 - OTHER INCOME AND OTHER EXPENSE Following is detail concerning "All other income and commissions" and "All other expense" as presented in the Consolidated Statements of Income:
(Dollars in thousands) 1999 1998 1997 - ------------------------------------------------------------------------------------------------------------------------- ALL OTHER INCOME AND COMMISSIONS: Other service charges $ 17,430 $ 14,863 $ 10,474 Check clearing fees 11,143 9,199 13,043 Insurance premiums and commissions 10,912 8,725 6,457 Other 80,419 42,871 31,496 - ------------------------------------------------------------------------------------------------------------------------- Total $119,904 $ 75,658 $ 61,470 ========================================================================================================================= ALL OTHER EXPENSE: Amortization of hedge instruments $ 49,414 $ 13,345 $ 4,867 Contract employment 43,685 35,937 17,420 Advertising and public relations 30,187 25,184 18,722 Legal and professional fees 22,492 24,551 13,999 Supplies 22,006 20,195 15,267 Travel and entertainment 18,698 19,485 13,802 Computer software 15,410 11,629 6,731 Distributions on guaranteed preferred securities 8,070 8,070 8,070 Foreclosed real estate 6,585 31,019 10,827 Fed service fees 6,471 5,307 5,799 Deposit insurance premium 1,790 1,578 1,485 Other 55,500 58,107 43,470 - ------------------------------------------------------------------------------------------------------------------------- Total $280,308 $254,407 $160,459 =========================================================================================================================
56 NOTE 13 - COMPONENTS OF OTHER COMPREHENSIVE INCOME Following is detail of "Accumulated other comprehensive income" as presented in the Consolidated Statements of Condition:
Accumulated Gain/(Loss) Tax Other Before-Tax (Expense)/ Comprehensive (Dollars in thousands) Amount Benefit Income - ------------------------------------------------------------------------------------------------------------------- December 31, 1996 $ 2,697 Other comprehensive income: Unrealized market adjustments for the period $ 19,842 $ (7,642) 12,200 Less: adjustment for net losses included in net income (713) 277 (436) - ------------------------------------------------------------------------------------------------ ------------- December 31, 1997 $ 20,555 $ (7,919) 15,333 ================================================================================================ Other comprehensive income: Unrealized market adjustments for the period $ (51) $ 19 (32) Less: adjustment for net gains included in net income 3,976 (1,547) 2,429 - ------------------------------------------------------------------------------------------------ ------------- December 31, 1998 $ (4,027) $ 1,566 12,872 ================================================================================================ Other comprehensive income: Unrealized market adjustments for the period $(54,472) $ 21,227 (33,245) Less: adjustment for net gains included in net income 2,257 (878) 1,379 - ------------------------------------------------------------------------------------------------ ------------- DECEMBER 31, 1999 $(56,729) $ 22,105 $(21,752) ================================================================================================ =============
NOTE 14 - REGULATORY CAPITAL First Tennessee is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on First Tennessee's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices must be met. Capital amounts and classification are also subject to qualitative judgment by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require First Tennessee to maintain minimum amounts and ratios of total and Tier 1 capital to risk-weighted assets, and of Tier 1 capital to average assets (leverage). Management believes, as of December 31, 1999, that First Tennessee met all capital adequacy requirements to which it was subject. The most recent notification from the Office of the Comptroller of the Currency at January 20, 1999, categorized First Tennessee as well capitalized. To be categorized as well capitalized First Tennessee must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. In the opinion of management, no conditions or events have occurred since that notification that would change First Tennessee's category. 57 The actual capital amounts and ratios of First Tennessee and FTBNA (the primary banking subsidiary of First Tennessee) are presented in the table below:
First Tennessee National First Tennessee Bank Corporation National Association ---------------------------- ------------------------ (Dollars in thousands) Amount Ratio Amount Ratio - ---------------------------------------------------------------------------------------------------------------------- AS OF DECEMBER 31, 1999: Actual: Total Capital $ 1,666,565 12.00% $ 1,494,824 11.18% Tier 1 Capital 1,218,075 8.77 1,128,553 8.44 Leverage 1,218,075 6.53 1,128,553 6.35 For Capital Adequacy Purposes: Total Capital 1,111,462 >= 8.00 1,069,575 >= 8.00 Tier 1 Capital 555,731 >= 4.00 534,788 >= 4.00 Leverage 746,400 >= 4.00 711,379 >= 4.00 To Be Well Capitalized Under Prompt Corrective Action Provisions: Total Capital 1,389,327 >= 10.00 1,336,969 >= 10.00 Tier 1 Capital 833,596 >= 6.00 802,181 >= 6.00 Leverage 933,000 >= 5.00 889,224 >= 5.00 - ---------------------------------------------------------------------------------------------------------------------- As of December 31, 1998: Actual: Total Capital $ 1,576,009 11.91% $ 1,424,980 11.24% Tier 1 Capital 1,038,484 7.85 968,458 7.64 Leverage 1,038,484 5.54 968,458 5.43 For Capital Adequacy Purposes: 1,013,884 >= 8.00 Total Capital 1,058,613 >= 8.00 506,942 >= 4.00 Tier 1 Capital 529,307 >= 4.00 713,870 >= 4.00 Leverage 749,176 >= 4.00 To Be Well Capitalized Under Prompt Corrective Action Provisions: Total Capital 1,323,267 >= 10.00 1,267,355 >= 10.00 Tier 1 Capital 793,960 >= 6.00 760,413 >= 6.00 Leverage 936,470 >= 5.00 892,338 >= 5.00 - ----------------------------------------------------------------------------------------------------------------------
The following table details the actual regulatory capital ratios for other bank subsidiaries at December 31, 1999:
FNB Peoples and CBT(1) Springdale(2) Peoples(3) Union(4) - ------------------------------------------------------------------------------------------------------------------------ AS OF DECEMBER 31, 1999: Total Capital 12.27% 16.27% 17.05% 11.17% Tier 1 Capital 11.01 15.27 15.80 10.07 Leverage 7.40 9.51 10.22 6.84 - ------------------------------------------------------------------------------------------------------------------------ (1) Cleveland Bank and Trust Company (2) First National Bank of Springdale (3) Peoples Bank of Senatobia (4) Peoples and Union Bank
58 NOTE 15 - INCOME TAXES The components of income tax expense are as follows:
(Dollars in thousands) 1999 1998 1997 - ---------------------------------------------------------------------------------------------------------------------------- Current: Federal $ 64,615 $ 45,374 $ 68,665 State (14,342) (2,286) 3,409 Deferred: Federal 60,276 68,528 34,674 State 21,357 14,926 10,847 - ---------------------------------------------------------------------------------------------------------------------------- Total $ 131,906 $ 126,542 $ 117,595 ============================================================================================================================
The effective tax rates for 1999, 1998 and 1997 were 34.82 percent, 35.86 percent and 37.32 percent, respectively. Income tax expense was different than the amounts computed by applying the statutory federal income tax rate to income before income taxes because of the following:
(Dollars in thousands) 1999 1998 1997 - ----------------------------------------------------------------------------------------------------------------------------- Federal income tax rate 35% 35% 35% - ----------------------------------------------------------------------------------------------------------------------------- Tax computed at statutory rate $ 132,803 $ 123,523 $ 110,274 Increase/(decrease) resulting from: Tax-exempt interest (1,454) (2,145) (2,494) State income taxes 4,760 8,222 9,073 Other (4,203) (3,058) 742 - ----------------------------------------------------------------------------------------------------------------------------- Total $ 131,906 $ 126,542 $ 117,595 ===-=========================================================================================================================
A deferred tax asset or liability is recognized for the tax consequences of temporary differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The tax consequence is calculated by applying enacted statutory tax rates, applicable to future years, to these temporary differences. Temporary differences which gave rise to deferred tax (assets)/liabilities at December 31, 1999 and 1998, were as follows:
(Dollars in thousands) 1999 1998 - ----------------------------------------------------------------------------------------------------------------------------- DEFERRED TAX ASSETS: Loss reserves $ (67,278) $ (66,332) Net operating loss carryforwards (4,700) (4,381) Investments in securities (13,757) (1,303) Other (14,365) (9,362) - ----------------------------------------------------------------------------------------------------------------------------- Gross deferred tax assets (100,100) (81,378) - ----------------------------------------------------------------------------------------------------------------------------- DEFERRED TAX LIABILITIES: Capitalized mortgage servicing rights 283,272 216,413 Depreciation and amortization 10,945 9,754 Investments in securities 10,423 8,044 Deferred loan fees 7,988 2,218 Federal Home Loan Bank stock 7,783 6,120 Other 28,113 26,756 - ----------------------------------------------------------------------------------------------------------------------------- Gross deferred tax liabilities 348,524 269,305 - ----------------------------------------------------------------------------------------------------------------------------- Net deferred tax liabilities $ 248,424 $ 187,927 =========-===================================================================================================================
59 NOTE 16 - EARNINGS PER SHARE The following table shows a reconciliation of earnings per share to diluted earnings per share. All share and per share data have been adjusted to reflect the 1998 two-for-one stock split.
(Dollars in thousands, except per share data) 1999 1998 1997 - ------------------------------------------------------------------------------------------------------------------- EARNINGS PER SHARE COMPUTATION: Net income $ 247,533 $ 226,380 $ 197,472 Weighted average shares outstanding 130,161,432 128,056,450 128,365,434 Shares attributable to deferred compensation 411,331 178,556 -- - ------------------------------------------------------------------------------------------------------------------- Total weighted average shares outstanding 130,572,763 128,235,006 128,365,434 Earnings per share $ 1.90 $ 1.77 $ 1.54 =================================================================================================================== DILUTED EARNINGS PER SHARE COMPUTATION: Net income $ 247,533 $ 226,380 $ 197,472 Weighted average shares outstanding 130,572,763 128,235,006 128,365,434 Dilutive effect due to stock options 3,406,177 3,627,484 3,621,498 - ------------------------------------------------------------------------------------------------------------------- Weighted average shares outstanding, as adjusted 133,978,940 131,862,490 131,986,932 Diluted earnings per share $ 1.85 $ 1.72 $ 1.50 ===================================================================================================================
NOTE 17 - RESTRICTIONS, CONTINGENCIES AND OTHER DISCLOSURES RESTRICTIONS ON CASH AND DUE FROM BANKS. The commercial banking subsidiaries of First Tennessee are required to maintain average reserve and clearing balances with the Federal Reserve Bank under the Federal Reserve Act and Regulation D. The balances required at December 31, 1999 and 1998, were $203.2 million and $213.4 million, respectively. These reserves are included in "Cash and due from banks" on the Consolidated Statements of Condition. RESTRICTIONS ON DIVIDENDS. Dividends are paid by First Tennessee from its assets which are mainly provided by dividends from its subsidiaries. Certain regulatory restrictions exist regarding the ability of the banking subsidiaries to transfer funds to First Tennessee in the form of cash, dividends, loans or advances. As of December 31, 1999, the banking subsidiaries had undivided profits of $1,003.8 million of which $293.5 million was available for distribution to First Tennessee as dividends without prior regulatory approval. RESTRICTIONS ON INTERCOMPANY TRANSACTIONS. Under Federal banking law, banking subsidiaries may not extend credit to the parent company in excess of 10 percent of the banks' capital stock and surplus, as defined, or $157.5 million at December 31, 1999. The parent company had borrowings of $53.2 million from FTBNA at December 31, 1999. Certain loan agreements also define other restricted transactions related to additional borrowings. CONTINGENCIES. In June 1998, a judgment entered in the circuit court of Houston County, Alabama became final, approving a settlement of a class action filed against FTBNA on behalf of persons in Alabama who had financed with FTBNA their purchases of satellite dish television systems (satellite systems). All individual lawsuits previously filed in state court in Alabama relating to the financing of satellite systems by FTBNA were finally settled in 1997. In May 1996, FTBNA was also named as a defendant in a purported nationwide class action lawsuit filed in federal court in Alabama in which plaintiffs assert that FTBNA and another defendant engaged in unfair and deceptive practices in connection with the financing of satellite systems. The complaint alleges violations of the Truth in Lending Act (TILA) and the federal RICO statute, and fraud by suppression with respect to Alabama residents. In addition to these theories, plaintiffs proceed against FTBNA on an agency theory. The complaint seeks unquantified compensatory, triple, and punitive damages. FTBNA has filed a motion requesting the dismissal of plaintiffs' RICO and fraudulent suppression claims, but the court has not ruled on the motion. The plaintiffs have filed motions seeking certification of a nationwide class on the TILA and RICO claims and a statewide subclass on the fraud claims. In February, 2000, the Magistrate Judge filed a recommendation granting in part and denying in part plaintiffs' motion, concluding that the case should be certified as a nationwide class action on the TILA statutory damages claim which has a cap of $500,000 plus attorney fees. The Magistrate Judge also stated that it was his recommendation that no other classes be certified. FTBNA is filing objections to the Magistrate Judge's recommendation. In addition to 60 the Alabama lawsuits, in September 1997, a nationwide class action was filed in state court in Tennessee relating to the same satellite systems financing program. The complaint asserts that material facts were withheld from the purchasers in connection with the financing, that FTBNA and First Tennessee were unjustly enriched from the sale of such systems, and that FTBNA and First Tennessee violated the Tennessee Consumer Protection Act. The trial court entered an order of conditional class certification and FTBNA and First Tennessee have requested a review of that certification order for the purpose of having the conditional order set aside. In 1999, three additional cases relating to the financing of satellite systems by FTBNA were filed. One case, originally filed in the Circuit Court of Humphreys County, Mississippi, was removed to the United States District court for the Northern District of Mississippi where it is now pending. Plaintiffs allege violations of a Mississippi statute, Mississippi common law, and seek recission and cancellation of the contracts. The complaint seeks $45 million in actual damages and $900 million in punitive damages. In a second case, filed in the Circuit Court of Clark County, Arkansas, plaintiffs allege various statutory and common law causes of action under the laws of the state of Arkansas, including violation of Arkansas usury statute in connection with FTBNA's financing of satellite purchases. Unquantified punitive and actual damages are being sought. The third case, filed in Circuit Court of Dallas County, Arkansas, was filed by a plaintiff seeking recovery on behalf of herself and other Arkansas customers of FTBNA for recovery of certain finance charges and/or interest paid to FTBNA and for recovery of damages pursuant to the Arkansas Home Solicitation Sales Act relative to the purchase and financing of home satellite systems. The complaint seeks actual and punitive damages in an unquantified amount for the plaintiff and class members. The complaint also asserts that FTBNA violated the Arkansas Home Solicitation Sales Act in not disclosing certain information required to be disclosed. FTBNA and First Tennessee deny liability, deny that any co-defendant is their agent, and intend to defend these actions vigorously. In January 2000, the Tennessee Court of Appeals reversed an award of $9 million in punitive damages which had previously been rendered against FTBNA and affirmed an award of $209,156 in compensatory damages against FTBNA as well as a $60,000 award in favor of First Tennessee against the plaintiff. In July 1998, a judgment had been rendered in the Chancery Court of Shelby County, Tennessee against FTBNA as the successor by merger to Community Bank of Germantown for $9 million in punitive damages. The court had previously entered a judgment against FTBNA in the amount of $209,156 compensatory damages in August 1997, and a judgment in favor of FTBNA against the plaintiff in the amount of $60,000. The plaintiff had claimed that Community Bank of Germantown had obtained additional collateral on a loan by promising to make a new loan to the plaintiff, which was never made. The litigation was pending at the time of First Tennessee's acquisition of Community Bank of Germantown in February 1995. FTBNA had appealed the decision of the Chancery Court. In addition to these cases, various other claims and lawsuits are pending against First Tennessee and its subsidiaries. Although First Tennessee cannot predict the outcome of the foregoing actions, after consulting with counsel, it is management's opinion that when resolved, the amount, if any, will not have a material adverse effect on the consolidated financial statements of First Tennessee and its subsidiaries. OTHER DISCLOSURES - BANK OWNED LIFE INSURANCE. First Tennessee has purchased life insurance on certain of its employees and is the beneficiary on these policies. At December 31, 1999, the cash surrender value of these policies, which is included in "Capital markets receivables and other assets" on the Consolidated Statements of Condition, was $182.7 million. There are no restrictions on the proceeds from these benefits, and First Tennessee has not borrowed against the cash surrender value of these policies. NOTE 18 - SHAREHOLDER PROTECTION RIGHTS AGREEMENT On October 20, 1998, First Tennessee adopted a Shareholder Protection Rights Agreement (the "Agreement") and declared a dividend of one right on each outstanding share of common stock held on November 2, 1998, or issued thereafter and prior to the time the rights separate and thereafter pursuant to options and convertible securities outstanding at the time the rights separate. The Agreement provides that until the earlier of the tenth business day (subject to certain adjustments by the board of directors) after a person or group commences a tender or exchange offer that will, subject to certain exceptions, result in such person or group owning 10 percent or more of First Tennessee's common stock, or the tenth business day (subject to certain adjustments by the board) after the public announcement by First Tennessee that a person or group owns 10 percent or more of First Tennessee's common stock, the rights will be evidenced by the common stock certificates, will automatically trade with the common stock, and will not be exercisable. Thereafter, separate rights certificates will be distributed, and each right will entitle its holder to purchase one one-hundredth of a share of participating preferred stock having economic and voting terms similar to those of one share of common stock for an exercise price of $150. 61 If any person or group acquires 10 percent or more of First Tennessee's common stock, then each right (other than rights beneficially owned by holders of 10 percent or more of the common stock or affiliates, associates or transferees thereof, which rights become void) will entitle its holder to purchase, for the exercise price, a number of shares of First Tennessee common stock or participating preferred stock having a market value of twice the exercise price. Also, if there is a 10 percent shareholder and First Tennessee is involved in certain significant transactions, each right will entitle its holder to purchase, for the exercise price, a number of shares of common stock of the other party having a market value of twice the exercise price. If any person or group acquires 10 percent or more (but not more than 50 percent) of First Tennessee's common stock, First Tennessee's board of directors may, at its option, exchange one share of First Tennessee common stock or one one-hundredth of a share of participating preferred stock for each right (other than rights which have become void). The board of directors may amend the Agreement in any respect prior to the tenth business day after announcement by First Tennessee that a person or group has acquired 10 percent or more of First Tennessee's common stock. The rights will expire on the earliest of one of the following three times: the time of the exchange described in the second preceding sentence; December 31, 2009; or the date the rights are redeemed as described in the following sentence. The rights may be redeemed by the board of directors for $0.001 per right until 10 business days after First Tennessee announces that any person or group owns 10 percent or more of First Tennessee's common stock. NOTE 19 - SAVINGS, PENSION AND OTHER EMPLOYEE BENEFITS SAVINGS PLAN. Substantially all employees of First Tennessee are covered by a contributory savings plan in conjunction with a flexible benefits plan. During the year, First Tennessee makes contributions to each employee's flexible benefits plan account. These contributions are based on length of service and a percentage of the employee's salary. The employees have the option to direct a portion or all of the contribution into their savings plan accounts. Employees may also make pre-tax and after-tax personal contributions to the savings plan. First Tennessee matches the majority of employee pre-tax contributions invested in First Tennessee's common stock at a rate of $.50 for each $1.00 invested up to 6 percent of the employee's qualifying salary. Contributions made by First Tennessee to the flexible benefits plan were $18.8 million for 1999, $15.7 million for 1998 and $13.7 million for 1997. PENSION PLAN. Substantially all employees of First Tennessee are covered by a noncontributory, defined benefit pension plan. Pension benefits are based on years of service, average compensation near retirement and estimated social security benefits at age 65. The annual funding is based on an actuarially determined amount using the entry age cost method. OTHER EMPLOYEE BENEFITS. First Tennessee provides postretirement medical insurance to full-time employees retiring under the provisions of the First Tennessee Pension Plan. The postretirement medical plan is contributory with retiree contributions adjusted annually. The plan is based on criteria that are a combination of the employee's age and years of service and utilizes a two-step approach. For any employee retiring on or after January 1, 1995, First Tennessee will contribute a fixed amount based on years of service and age at time of retirement. ACTUARIAL ASSUMPTIONS. The actuarial assumptions used in the defined benefit pension plan and the other employee benefit plans were as follows:
Pension Benefits Postretirement Benefits - ---------------------------------------------------------------------------------- ----------------------------- 1999 1998 1997 1999 1998 1997 - ----------------------------------------------------------------------------------------------------------------- WEIGHTED-AVERAGE ASSUMPTIONS AS OF SEPTEMBER 30 MEASUREMENT DATE Discount rate 7.50% 6.75% 7.25% 7.50% 6.75% 7.25% Expected return on plan assets 10.00 10.00 10.00 10.00 10.00 10.00 Expected return on plan assets dedicated to employees who retired prior to January 1, 1993 N/A N/A N/A 6.50 6.50 6.50 Rate of compensation increase 4.00 4.00 4.00 N/A N/A N/A - -----------------------------------------------------------------------------------------------------------------
62 The components of net periodic benefit cost for the plan years 1999, 1998, and 1997 were as follows:
Pension Benefits Postretirement Benefits ----------------------------- -------------------------- (Dollars in thousands) 1999 1998 1997 1999 1998 1997 - ----------------------------------------------------------------------------------------------------------------- COMPONENTS OF NET PERIODIC BENEFIT COST Service cost $ 8,341 $ 7,258 $ 5,737 $ 832 $ 712 $ 584 Interest cost 11,468 9,971 8,187 1,711 1,637 1,781 Expected return on plan assets (20,950) (18,773) (16,071) (1,480) (1,374) (906) Amortization of prior service cost 322 322 290 3 3 3 Recognized gains & losses 311 - - - (107) - Amortization of transition obligation or asset (460) (460) (460) 989 989 989 - ----------------------------------------------------------------------------------------------------------------- Net periodic benefit cost/(benefit) $ (968) $ (1,682) $ (2,317) $ 2,055 $ 1,860 $ 2,451 =================================================================================================================
The following table sets forth the plans' funded status reconciled to the amounts shown in the Consolidated Statements of Condition:
Pension Benefits Postretirement Benefits ------------------------ ------------------------ (Dollars in thousands) 1999 1998 1999 1998 - --------------------------------------------------------------------------------------------------------- CHANGE IN BENEFIT OBLIGATION Benefit obligation at beginning of plan year $ 172,065 $ 139,467 $ 26,064 $ 23,241 Service cost 8,341 7,258 832 712 Interest cost 11,468 9,971 1,711 1,637 Amendments 228 - 43 - Actuarial (gain)/loss (13,131) 19,939 (1,837) 1,981 Benefits paid (4,932) (4,570) (1,754) (1,507) - --------------------------------------------------------------------------------------------------------- Benefit obligation at end of plan year $ 174,039 $ 172,065 $ 25,059 $ 26,064 ========================================================================================================= CHANGE IN PLAN ASSETS Fair value of plan assets at beginning of plan year $ 228,601 $ 218,342 $ 16,860 $ 12,210 Actual return on plan assets 32,029 13,288 2,986 1,181 Employer contribution 2,854 1,541 1,037 4,976 Benefits paid (4,932) (4,570) (1,754) (1,507) - --------------------------------------------------------------------------------------------------------- Fair value of plan assets at end of plan year $ 258,552 $ 228,601 $ 19,129 $ 16,860 ========================================================================================================= NET FUNDED STATUS AT SEPTEMBER 30 $ 84,513 $ 56,536 $ (5,930) $ (9,204) Unrecognized net actuarial gain/(loss) (15,926) 8,595 (5,423) (2,080) Unrecognized net transitional (asset)/obligation (1,400) (1,860) 12,851 13,840 Unrecognized prior service cost 2,588 2,682 75 35 - --------------------------------------------------------------------------------------------------------- Prepaid/(accrued) benefit cost at September 30 69,775 65,953 1,573 2,591 Contributions paid from October 1 to December 31 - - 972 1,037 - --------------------------------------------------------------------------------------------------------- Prepaid/(accrued) benefit cost at December 31 $ 69,775 $ 65,953 $ 2,545 $ 3,628 =========================================================================================================
63 The following table sets forth the amounts and types of mutual funds managed by FTBNA that are included in plan assets.
Pension Benefits Postretirement Benefits --------------------- ----------------------- (Dollars in thousands) 1999 1998 1999 1998 - ------------------------------------------------------------------------------------------------------------------- First Funds Capital Appreciation Portfolio Class I $ 28,717 $ 26,033 $ 1,528 $ 1,165 First Funds Growth & Income Portfolio Class I 121,391 98,346 6,164 4,358 First Funds Bond Portfolio Class I 93,231 102,920 4,275 4,147 - -------------------------------------------------------------------------------------------------------------------
The cost of health care benefits was projected to increase at an annual per capita rate of 6.75 percent in 1999 and decrease to a rate of 5.75 percent by the year 2000 and remain at an even level thereafter. In 1998, the annual rate of increase was assumed to be 7.75 percent decreasing evenly to a rate of 5.75 percent by the year 2000 and remaining at an even level thereafter. In 1997, the annual rate of increase was assumed to be 8.75 percent decreasing evenly to a rate of 5.75 percent by the year 2000 and remaining at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. A one-percentage-point change in assumed health care cost trend rates would have the following effects:
(Dollars in thousands) 1% Increase 1% Decrease - ------------------------------------------------------------------------------------------------------------------- Adjusted total service and interest cost components $ 2,629 $ 2,489 Adjusted postretirement benefit obligation at end of plan year 26,194 24,149 - -------------------------------------------------------------------------------------------------------------------
First Tennessee provides benefits to former and inactive employees after employment but before retirement. The obligation/(benefit) recognized in accordance with accounting standards was $.2 million in 1999, $(.2) million in 1998 and $.6 million in 1997. Medical and group life insurance expenses incurred for active employees are shown in the following table:
(Dollars in thousands) 1999 1998 1997 - ------------------------------------------------------------------------------------------------------------------- Medical plan expense based on claims incurred $ 14,558 $ 12,322 $ 10,802 Participants 7,567 6,689 5,652 - ------------------------------------------------------------------------------------------------------------------- Group life insurance expense based on benefits incurred $ 1,392 $ 1,120 $ 949 Participants 10,860 10,097 8,457 - -------------------------------------------------------------------------------------------------------------------
NOTE 20 - STOCK OPTION, RESTRICTIVE STOCK INCENTIVE, AND DIVIDEND REINVESTMENT PLANS At its January 1998 meeting, the board of directors authorized a two-for-one split of First Tennessee's common stock. The shares were distributed February 20, 1998, to shareholders of record on February 6, 1998. Share and per share amounts in the accompanying text and tables have been adjusted for this stock split. STOCK OPTION PLANS. First Tennessee issues non-qualified stock options under various plans to employees, non-employee directors, and bank advisory board members. The plans provide for the issuance of First Tennessee common stock at a price equal to its fair market value at the date of grant; however, the exercise price may be less than the fair market value if the grantee has agreed to receive the options in lieu of compensation. The foregone compensation plus the exercise price must equal the fair market value of the stock on the date of grant. All options expire 10 years from the date of grant, except for those options that were part of compensation deferral, which expire 20 years from the date of grant. There were 6,975,674 shares available for option plan grants at December 31, 1999. 64 As a result of plan amendments adopted by the board of directors during 1997, employees may defer the receipt of shares upon the exercise of stock options. The summary of stock option activity is shown below:
Weighted Options Average Outstanding Exercise Price - ----------------------------------------------------------------------------- January 1, 1997 10,036,636 $ 10.62 Options granted 4,791,158 20.53 Stock options exercised (1,904,284) 12.76 Stock options canceled (770,280) 15.99 ---------- December 31, 1997 12,153,230 13.85 ========== Options exercisable 8,554,866 13.67 - ----------------------------------------------------------------------------- January 1, 1998 12,153,230 $ 13.85 Options granted 4,069,623 30.16 Stock options exercised* (2,468,821) 11.73 Stock options canceled (499,430) 21.20 ---------- December 31, 1998 13,254,602 18.96 ========== Options exercisable 10,185,877 16.97 - ----------------------------------------------------------------------------- January 1, 1999 13,254,602 $ 18.96 Options granted 6,151,908 34.28 Stock options exercised* (1,982,652) 17.10 Stock options canceled (524,348) 32.27 ---------- December 31, 1999 16,899,510 24.33 ========== Options exercisable 12,316,124 21.06 - ----------------------------------------------------------------------------- * Stock options exercised for 1999 and 1998, respectively, included 40,916 and 367,826 options converted to stock equivalents as part of the deferred compensation program.
The following table summarizes information about stock options outstanding at December 31, 1999:
Weighted Weighted Weighted Average Average Average Exercise Exercise Remaining Price - Price - Options Contractual Options Options Options Exercise Price Range Outstanding Life Outstanding Exercisable Exercisable - --------------------------------------------------------------------------------------------------- $ 4.00 - $14.00 3,577,235 6.79 years $ 9.39 3,573,635 $ 9.39 $14.01 - $24.00 4,328,270 10.23 years 19.20 3,523,270 18.76 $24.01 - $34.00 6,070,557 17.55 years 30.28 5,181,929 30.55 $34.01 - $44.00 2,923,448 8.94 years 37.83 37,290 39.36 - ---------------------------------------------------------------------------------------------------
First Tennessee accounts for these plans under APB Opinion No. 25 pursuant to which recognized compensation costs are negligible. Had compensation cost for these plans been determined consistent with SFAS No. 123, First Tennessee's net income and earnings per share would have been reduced to the following pro forma amounts:
December 31 ----------------------------------------- (Dollars in thousands except per share data) 1999 1998 1997 - ------------------------------------------------------------------------------------------ Net income, as reported $ 247,533 $ 226,380 $ 197,472 Pro forma net income 237,948 221,252 189,366 Basic earnings per share, as reported 1.90 1.77 1.54 Pro forma basic earnings per share 1.82 1.73 1.48 - ------------------------------------------------------------------------------------------
65 Total compensation costs that would have been recognized in income under SFAS No. 123 for all stock-based compensation awards was $15.7 million for 1999, $8.4 million for 1998 and $13.3 million for 1997. Because the SFAS No. 123 method of accounting has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years. First Tennessee used the Black-Scholes Option Pricing Model to estimate the fair value of stock options granted in 1999, 1998 and 1997, with the following assumptions:
1999 1998 1997 - -------------------------------------------------------------------------------------------------------- Expected dividend yield 3.03% 3.06% 3.31% Expected option lives of options issued at market 4.83 YEARS 6.21 years 6.01 years Expected option lives of options issued below market 2.15 YEARS 2.20 years 2.36 years Expected volatility 20.04% 18.94% 17.29% Risk-free interest rates 5.30% 5.54% 6.51% - -------------------------------------------------------------------------------------------------------- Weighted Average Fair Number Value per Option Issued at Grant Date - -------------------------------------------------------------------------------------------------------- 1999: Options issued at market on the date of grant 2,720,585 $ 7.71 Options issued below market on the date of grant 3,431,323 8.01 - -------------------------------------------------------------------------------------------------------- 1998: Options issued at market on the date of grant 1,584,613 $ 8.35 Options issued below market on the date of grant 2,485,010 6.69 - -------------------------------------------------------------------------------------------------------- 1997: Options issued at market on the date of grant 2,989,752 $ 4.87 Options issued below market on the date of grant 1,801,406 4.81 - --------------------------------------------------------------------------------------------------------
RESTRICTED STOCK INCENTIVE PLANS. First Tennessee has authorized the issuance of its common stock for awards to executive employees who have a significant impact on the profitability of First Tennessee under restricted stock incentive plans. Additionally, one of the plans provides for 6,000 shares of restricted stock to be granted to each new non-employee director upon election to the board of directors with restrictions lapsing as defined in the plans. In 1999, First Tennessee granted 170,112 restricted shares under the plans. In 1998, 3,849 restricted shares were granted, and no restricted shares were granted in 1997. Compensation expense related to these plans was $2.1 million, $1.2 million and $1.3 million for the years 1999, 1998 and 1997, respectively. There were 634,318 shares available for restricted stock incentive grants at December 31, 1999. The board of directors approved amendments to the restricted stock plan during 1998 permitting deferral by participants of the receipt of restricted stock prior to the lapse of restrictions. DIVIDEND REINVESTMENT PLAN. The Dividend Reinvestment and Stock Purchase Plan, as amended in 1995, authorizes the sale of First Tennessee's common stock from authorized, but unissued common stock or from shares acquired on the open market to shareholders who choose to invest all or a portion of their cash dividends and make optional cash payments of $25 to $10,000 per quarter without paying commissions. Since 1988, shares for this plan have been purchased on the open market. The price of the shares purchased directly from First Tennessee is the mean between the high and low sales price on the investment date. The price of shares purchased on the open market is the average price paid. 66 NOTE 21 - BUSINESS SEGMENT INFORMATION First Tennessee provides traditional retail/commercial banking and other financial services to its customers. These products and services are categorized into two broad groups: a regional banking group and national lines of business. The regional banking group provides a comprehensive package of financial services including traditional banking, trust services, investments, asset management, insurance and credit card services to its customers. Banking subsidiaries offer general banking products through financial centers in 22 Tennessee counties, in northern Mississippi and in northwest Arkansas as well as through consumer finance offices in 10 states nationwide. The national lines of business include mortgage banking, capital markets and transaction processing. Mortgage banking offers first and second mortgages through origination offices in 32 states and also services a multi-billion dollar portfolio. Capital markets offers investment securities and advisory services such as portfolio analysis, tax planning and loan securitization to institutional clients nationwide through offices in Chicago, Dallas, Kansas City, Memphis, Mobile and New York. Transaction processing includes credit card merchant processing, an automated teller machine network, nationwide check clearing and remittance processing. The Other segment is used to isolate corporate items such as expense related to guaranteed preferred beneficial interests in First Tennessee's junior subordinated debentures and securities gains or losses which include any venture capital gains or losses and related incentive costs. First Tennessee's reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different technology and marketing strategies. The measurements used in reporting these segments are the same as those reviewed monthly by the chief operating decision-maker. Total revenue, expense and asset levels reflect those which are specifically identifiable or which are allocated based on an internal allocation method. Net interest income is allocated to the segments using a combination of matched funding and multiple pool transfer pricing methods. In addition to expenses paid directly by the segments, allocated expenses may be charged to the lines of business based on the utilization of resources. Equity is allocated to the segments through risk analysis that incorporates the appropriate level of credit, operating, market and franchise risk factors. Because the allocations are based on internally developed assignments and allocations, they are to an extent subjective. This assignment and allocation has been consistently applied for all periods presented. The following table reflects the approximate amounts of consolidated revenue, expense, tax, and assets for the three years ended December 31, for each segment: 67
Regional Banking Mortgage Capital Transaction (Dollars in thousands) Group Banking Markets Processing Other Consolidated - ------------------------------------------------------------------------------------------------------------------------------ 1999 Interest income $ 877,572 $ 273,149 $ 38,659 $ 17,784 $ -- $ 1,207,164 Interest expense 367,533 214,254 33,760 2,107 -- 617,654 - ------------------------------------------------------------------------------------------------------------------------------ Net interest income 510,039 58,895 4,899 15,677 -- 589,510 Other revenues 254,898 640,323 126,905 98,721 2,257 1,123,104 Depreciation and amortization 41,249 172,673 1,363 3,921 -- 219,206 Other expenses* 456,486 471,354 95,386 82,118 8,625 1,113,969 - ------------------------------------------------------------------------------------------------------------------------------ Pre-tax income 267,202 55,191 35,055 28,359 (6,368) 379,439 Income taxes 89,205 21,145 13,199 10,776 (2,419) 131,906 - ------------------------------------------------------------------------------------------------------------------------------ Net income $ 177,997 $ 34,046 $ 21,856 $ 17,583 $(3,949) $ 247,533 ============================================================================================================================== Average assets $12,039,221 $5,300,788 $779,893 $500,853 $ -- $18,620,755 - ------------------------------------------------------------------------------------------------------------------------------ Expenditures for long-lived assets $ 61,037 $ 35,625 $ 1,259 $ 8,499 $ -- $ 106,420 - ------------------------------------------------------------------------------------------------------------------------------ 1998 Interest income $ 850,002 $ 228,113 $ 37,555 $ 18,107 $ -- $ 1,133,777 Interest expense 382,003 175,363 33,101 2,771 -- 593,238 - ------------------------------------------------------------------------------------------------------------------------------ Net interest income 467,999 52,750 4,454 15,336 -- 540,539 Other revenues 207,186 562,601 147,360 64,380 3,976 985,503 Depreciation and amortization 30,647 127,062 1,748 2,878 -- 162,335 Other expenses* 419,272 414,120 109,283 59,372 8,738 1,010,785 - ------------------------------------------------------------------------------------------------------------------------------ Pre-tax income 225,266 74,169 40,783 17,466 (4,762) 352,922 Income taxes 79,435 26,951 15,329 6,637 (1,810) 126,542 - ------------------------------------------------------------------------------------------------------------------------------ Net income $ 145,831 $ 47,218 $ 25,454 $ 10,829 $(2,952) $ 226,380 ============================================================================================================================== Average assets $11,200,707 $4,304,449 $729,081 $486,494 $ -- $16,720,731 - ------------------------------------------------------------------------------------------------------------------------------ Expenditures for long-lived assets $ 56,988 $ 33,861 $ 1,782 $ 5,633 $ -- $ 98,264 - ------------------------------------------------------------------------------------------------------------------------------ 1997 Interest income $ 817,327 $ 86,151 $ 19,632 $ 17,434 $ 749 $ 941,293 Interest expense 377,953 59,561 17,007 3,676 -- 458,197 - ------------------------------------------------------------------------------------------------------------------------------ Net interest income 439,374 26,590 2,625 13,758 749 483,096 Other revenues 179,021 330,467 98,311 61,257 (926) 668,130 Depreciation and amortization 26,550 54,587 1,197 3,449 -- 85,783 Other expenses* 370,158 244,813 73,049 54,235 8,121 750,376 - ------------------------------------------------------------------------------------------------------------------------------ Pre-tax income 221,687 57,657 26,690 17,331 (8,298) 315,067 Income taxes 81,739 22,427 10,002 6,580 (3,153) 117,595 - ------------------------------------------------------------------------------------------------------------------------------ Net income $ 139,948 $ 35,230 $ 16,688 $ 10,751 $(5,145) $ 197,472 ============================================================================================================================== Average assets $10,662,569 $1,767,923 $366,416 $483,665 $ -- $13,280,573 - ------------------------------------------------------------------------------------------------------------------------------ Expenditures for long-lived assets $ 32,280 $ 19,981 $ 1,408 $ 2,430 $ -- $ 56,099 - ------------------------------------------------------------------------------------------------------------------------------ * Includes loan loss provision.
68 NOTE 22 - FAIR VALUE OF FINANCIAL INSTRUMENTS Accounting standards require the disclosure of estimated fair values of all asset, liability and off-balance sheet financial instruments. The following fair value estimates are determined as of a specific point in time utilizing various assumptions and estimates. The use of assumptions and various valuation techniques, as well as the absence of secondary markets for certain financial instruments, will likely reduce the comparability of fair value disclosures between financial institutions. In some cases, book value is a reasonable estimate of fair value due to the relatively short period of time between origination of the instrument and its expected realization. The following table summarizes the book value and estimated fair value of financial instruments recorded in the Consolidated Statements of Condition as of December 31, 1999 and 1998:
AT DECEMBER 31, 1999 At December 31, 1998 ---------------------------- ----------------------------- Book Fair Book Fair (Dollars in thousands) Value Value Value Value - ------------------------------------------------------------------------------------------------------------------------------ ASSETS: Loans, net of unearned income: Floating $ 4,550,445 $ 4,550,465 $ 4,081,673 $ 4,081,677 Fixed 4,783,595 4,706,826 4,447,584 4,432,309 Nonaccrual 29,118 29,118 27,807 27,807 Allowance for loan losses (139,603) (139,603) (136,013) (136,013) - ------------------------------------------------------------------------------------------------------------------------------- Total net loans 9,223,555 9,146,806 8,421,051 8,405,780 Liquid assets 429,841 429,841 483,754 483,754 Mortgage loans held for sale* 2,049,945 2,027,052 4,227,443 4,220,385 Securities available for sale 2,332,356 2,332,356 1,816,485 1,816,485 Securities held to maturity 768,936 734,853 609,804 610,364 Nonearning assets 1,162,332 1,162,332 1,170,477 1,170,477 - ------------------------------------------------------------------------------------------------------------------------------- LIABILITIES: Deposits: Defined maturity $ 4,719,036 $ 4,721,510 $ 4,671,206 $ 4,679,626 Undefined maturity 6,639,665 6,639,665 7,051,833 7,051,833 - ------------------------------------------------------------------------------------------------------------------------------- Total deposits 11,358,701 11,361,175 11,723,039 11,731,459 Short-term borrowings 4,406,511 4,404,640 4,339,292 4,339,673 Term borrowings 358,663 326,708 414,450 420,147 Other noninterest-bearing liabilities 185,399 184,255 315,805 314,735 Guaranteed preferred beneficial interests in First Tennessee's junior subordinated debentures 100,000 91,559 100,000 111,857 - ------------------------------------------------------------------------------------------------------------------------------- * Mortgage loans held for sale had an additional fair value related to mortgage servicing rights of approximately $16.6 million and $46.5 million at December 31, 1999 and 1998, respectively. Information on the fair value of off-balance sheet financial instruments can be found in Note 23 - Financial Instruments with Off-Balance Sheet Risk.
The following describes the assumptions and methodologies used to estimate the fair value for financial instruments: FLOATING RATE LOANS. With the exception of floating rate 1-4 family residential mortgage loans, the fair value is approximated by the book value. Floating rate 1-4 family residential mortgage loans reprice annually and will lag movements in market rates; whereas, commercial and consumer loans typically reprice monthly. The fair value for floating rate 1-4 family mortgage loans is calculated by discounting future cash flows to their present value. Future cash flows are discounted to their present value by using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same time period. Prepayment assumptions based on historical prepayment speeds have been applied to the floating rate 1-4 family residential mortgage portfolio. FIXED RATE LOANS. The fair value is estimated by discounting future cash flows to their present value. Future cash flows are discounted to their present value by using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same time period. Prepayment assumptions based on historical prepayment speeds have been applied to the fixed rate mortgage and installment loan portfolios. NONACCRUAL LOANS. The fair value is approximated by the book value. 69 ALLOWANCE FOR LOAN LOSSES. The fair value is approximated by the book value. Additionally, the credit exposure known to exist in the loan portfolio is embodied in the allowance for loan losses. LIQUID ASSETS. The fair value is approximated by the book value. For the purpose of this disclosure, liquid assets consist of federal funds sold, securities purchased under agreements to resell, capital markets securities inventory and investment in bank time deposits. MORTGAGE LOANS HELD FOR SALE. Fair values are based primarily on quoted market prices. SECURITIES AVAILABLE FOR SALE. Fair values are based primarily on quoted market prices. SECURITIES HELD TO MATURITY. Fair values are based primarily on quoted market prices. NONEARNING ASSETS. The fair value is approximated by the book value. For the purpose of this disclosure, nonearning assets include cash and due from banks, accrued interest receivable and capital markets receivables. DEFINED MATURITY DEPOSITS. The fair value is estimated by discounting future cash flows to their present value. Future cash flows are discounted by using the current market rates of similar instruments applicable to the remaining maturity. For the purpose of this disclosure, defined maturity deposits include all certificates of deposit and other time deposits. UNDEFINED MATURITY DEPOSITS. The fair value is considered to be equal to the book value. For the purpose of this disclosure, undefined maturity deposits include demand deposits, checking interest accounts, savings accounts, and money market accounts. SHORT-TERM BORROWINGS. The fair value of federal funds purchased, securities sold under agreements to repurchase, commercial paper, bank notes and other short-term borrowings is approximated by the book value. The fair value for Federal Home Loan Bank borrowings is determined using discounted future cash flows. TERM BORROWINGS. The fair value is approximated by the present value of the contractual cash flows discounted by the investor's yield which considers First Tennessee's and FTBNA's debt ratings. OTHER NONINTEREST-BEARING LIABILITIES. For the purpose of this disclosure, other noninterest-bearing liabilities include accrued interest payable and capital markets payables. Accrued interest, which is not payable until maturity, has been discounted to its present value given current market rates and the maturity structure of the financial instrument. The fair value of capital markets payables approximates the book value. GUARANTEED PREFERRED BENEFICIAL INTERESTS. The fair value is approximated by the present value of the contractual cash flows discounted by the investor's yield which considers First Tennessee's debt rating. NOTE 23 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK First Tennessee utilizes various financial instruments as part of its risk management strategy and as a means to meet customers' needs. These instruments are subject to credit and market risks that are not reflected on the balance sheet. The activities that currently employ financial instruments with off-balance sheet risk are mortgage banking, interest rate risk management and capital markets operations. First Tennessee also enters into commitments for lending related purposes to meet customers' financial needs. Controls and monitoring procedures for these instruments have been established and are routinely revised. The Asset/Liability Committee (ALCO) monitors the usage and effectiveness of financial instruments. ALCO, in conjunction with senior credit officers, also periodically reviews and revises counterparty credit limits. Credit Risk represents the maximum potential loss due to possible non-performance by obligors and counterparties under the terms of contracts. First Tennessee manages credit risk by entering into financial instrument transactions through national exchanges, primary dealers or approved counterparties, and using mutual margining agreements whenever possible to limit potential exposure. With exchange-traded contracts, the credit risk is limited to the clearinghouse used. For non-exchange traded instruments, credit risk may occur when there is a gain in the fair value of the financial instrument and the counterparty fails to perform according to the terms of the contract and/or when the collateral proves to be of insufficient value. Market Risk represents the potential loss due to the decrease in the value of a financial instrument caused primarily by changes in interest rates, prepayment speeds or the prices of debt instruments. The measurement of market risk associated with financial instruments is meaningful only when all related and offsetting on- and off-balance sheet hedges are aggregated, and the resulting net positions are identified. 70 LENDING RELATED First Tennessee enters into fixed and variable loan commitments with customers. When these commitments have contract rate adjustments that lag changes in market rates, the financial instruments have characteristics similar to option contracts. First Tennessee follows the same credit policies and underwriting practices in making commitments as it does for on-balance sheet instruments. Each counterparty's creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if any, is based on management's credit evaluation of the counterparty. Commitments to Extend Credit are contractual obligations to lend to a customer as long as all established contractual conditions are met. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The majority of First Tennessee's loan commitments have maturities less than one year and reflect the prevailing market rates at the time of the commitment. Since commitments may expire without being fully drawn upon, the total contract amount does not necessarily represent future cash requirements. Other Commitments include standby and commercial letters of credit and loan purchases agreements. Standby and commercial letters of credit are conditional commitments issued by First Tennessee to guarantee the performance and/or payment of a customer to a third party in connection with specified transactions. Loan purchase agreements are used as credit enhancement to third party special purpose entities (SPEs) that originate or purchase qualifying loans that are funded with commercial paper. The credit risk involved in issuing commercial and standby letters of credit is essentially the same as that involved in extending loan facilities to customers. The following is a summary of the maximum credit exposure of each class of lending related off-balance sheet financial instruments outstanding at December 31:
(Dollars in millions) 1999 1998 - ----------------------------------------------------------------------------------------------------------------------------- Commitments to extend credit: Consumer credit card lines $ 2,065.7 $ 2,246.3 Consumer home equity 595.6 534.0 Commercial real estate and construction and land development 743.0 363.6 Mortgage banking 1,348.2 1,783.8 Commercial and other 1,478.8 1,835.9 - ----------------------------------------------------------------------------------------------------------------------------- Total loan commitments 6,231.3 6,763.6 Other commitments: Standby letters of credit 266.9 480.1 Other 85.0 7.5 - ----------------------------------------------------------------------------------------------------------------------------- Total loan and other commitments $ 6,583.2 $ 7,251.2 =============================================================================================================================
The following table shows the notional or contractual amounts and related fair values for the off-balance sheet financial instruments at December 31:
1999 1998 ----------------------- -------------------------- Notional Fair Notional Fair (Dollars in millions) Value Value Value Value - ----------------------------------------------------------------------------------------------------------------------------- Loan commitments $ 6,231.3 $ .1 $ 6,763.6 $ 2.9 Commercial and standby letters of credit 283.7 4.7 487.6 6.0 - ----------------------------------------------------------------------------------------------------------------------------- Foreign exchange contracts: Contracts to buy $ (.5) * $ (.5) * Contracts to sell .5 * .5 * - ----------------------------------------------------------------------------------------------------------------------------- Net position $ -- $ -- ============================================================================================================================= * Amount is less than $100,000. Mortgage banking loan commitments had an additional fair value related to mortgage servicing rights of approximately $8.0 million at December 31, 1999, and $13.2 million at December 31, 1998.
71 NOTE 23 MORTGAGE BANKING First Tennessee uses both forward sales commitments and option contracts to protect the market value of mortgage loan commitments in the pipeline and the mortgage warehouse loans awaiting sale in the secondary market. Adverse market interest rate changes, between the time a customer receives a rate-lock commitment and the time the loan is sold to an investor, can erode the value of that mortgage. Therefore, First Tennessee enters into forward sales commitments and option contracts to mitigate the interest rate risk associated with the origination and sale of mortgage loans. First Tennessee enters into interest rate contracts to mitigate the loss in value of its mortgage servicing rights from the effects of increased prepayment activity that generally results from declining interest rates. With respect to the purchased interest rate contracts, First Tennessee is not exposed to loss beyond the initial amount used to purchase the hedge instruments. These financial instruments are included in this discussion to more completely disclose the servicing hedging position. The credit risk inherent in these transactions relates to the possibility of counterparties not performing according to the terms of the contract. This credit risk is controlled through credit approvals, risk control limits and on-going monitoring procedures through ALCO. The credit risk is represented by the aggregate fair value of only those interest rate contracts that currently have a positive fair value. Interest Rate Forward Contracts are over-the-counter contracts where two parties agree to purchase and sell a specific quantity of a financial instrument at a specified price, with delivery or settlement at a specified date. Interest Rate Option Contracts give the purchaser the right, but not the obligation, to buy or sell a specified quantity of a financial instrument, at a specified price, during a specified period of time. Caps and Floors are options that are linked to a notional principal amount and an underlying indexed interest rate. Exposure to loss on all interest rate contracts will increase or decrease as interest rates fluctuate. The following disclosures of the fair value of interest rate contracts are made using available market information and appropriate valuation methodologies. Fair value is defined as the amount First Tennessee would receive or pay in the market to replace the contracts as of the valuation date.
1999 1998 ------------------------------------ -------------------------- Notional Book Fair Notional Fair (Dollars in millions) Value Value Value Value Value - ----------------------------------------------------------------------------------------------------------------------------- Interest rate contracts: Mortgage pipeline and warehouse hedging: Forward contracts - commitments to sell $ 2,137.0 - $ 19.6 $ 3,925.9 $ (3.1) Option contracts - caps purchased* 1,900.0 $ 17.5 16.2 - - Option contracts - call options written* - - - (150.0) (1.3) Servicing portfolio hedging*: Option contracts - call options purchased - - - 150.0 1.1 Floors: Purchased 20,275.0 133.1 26.8 16,750.0 264.2 Written - - - (5,400.0) (79.7) Caps: Purchased 500.0 7.3 9.8 1,250.0 4.4 Written (500.0) (11.5) (17.1) (1,250.0) (9.2) Swap options purchased 1,000.0 17.1 13.7 - - Swaps 625.0 (12.7) (12.7) - - - ----------------------------------------------------------------------------------------------------------------------------- * Option contracts in total had a book value at December 31, 1998, of $173.7 million.
Residential first-lien mortgage loans are originated by First Tennessee to be sold in the secondary market. Some of these loans are sold with provisions of recourse. As of December 31, 1999 and 1998, the outstanding principal amount of these loans and the amount of credit risk was $213.2 million and $154.7 million, respectively. A reserve has been established to cover any inherent losses. These loans are reviewed on a regular basis to ensure that reserves are adequate to provide for foreclosure losses. In addition, First Tennessee originates, sells and services loans guaranteed by the Veterans Administration (VA). A VA guaranty typically covers only the lesser of $46,000 or 25 percent to 50 percent of the unpaid loan balance. In the event of foreclosure, First Tennessee, as a servicer of VA loans, has credit risk to the extent that the outstanding loan balance exceeds the VA guarantee and the value of the underlying real estate. As of December 31, 1999 and 1998, the outstanding principal balance of VA loans serviced was $5.1 billion and $4.5 billion, respectively. These loans are reviewed on a regular basis, and a reserve has been established to cover any inherent losses. 72 INTEREST RATE RISK MANAGEMENT First Tennessee's ALCO focuses on managing market risk by controlling and limiting earnings volatility attributable to changes in interest rates. Interest rate risk exists to the extent that interest-earning assets and liabilities have different maturity or repricing characteristics. First Tennessee uses off-balance sheet financial instruments that are designed to moderate the impact on earnings as interest rates change. Interest Rate Swaps involve the exchange of interest payments at specified intervals between two parties without the exchange of any underlying principal. Notional amounts are used in such contracts to calculate interest payments due to counterparties and do not represent credit exposure. The primary risks associated with swaps are the exposure to movements in interest rates and the ability of counterparties to meet the terms of the contracts.
Weighted Notional Fair Average Final (Dollars in millions) Value Value Receive Rate Maturity In - --------------------------------------------------------------------------------------------------------- 1999 Interest rate contracts: Swaps - receive fixed/pay floating* $ 415.0 $ (.7) 5.245% 2000 Swaps - receive floating/pay floating* 741.7 (.3) 5.870% 2000 Caps: Purchased 20.0 .1 Strike 8% 2002 Written (20.0) (.1) Strike 8% 2002 Equity contracts: Purchased options 1.9 .7 2003 - --------------------------------------------------------------------------------------------------------- 1998 Interest rate contracts: Swaps - receive fixed/pay floating* $ 432.0 $ .7 5.837% 1999 Swaps - receive floating/pay floating* 150.0 (.2) 4.937% 1999 Caps: Purchased 20.0 .1 Strike 8% 2002 Written (20.0) (.1) Strike 8% 2002 Equity contracts: Purchased options 1.9 .7 2003 - --------------------------------------------------------------------------------------------------------- * The weighted average rate paid on interest rate swaps at December 31, 1999, was 6.062 percent and 5.280 percent at December 31, 1998.
73 CAPITAL MARKETS Capital markets buys and sells mortgage securities, municipal bonds and other securities for trading purposes. When these securities settle on a delayed basis, they are considered forward contracts. These transactions are measured at fair value, and gains or losses are recognized in earnings as they occur. Capital markets utilize futures contracts, from time to time, to manage exposure arising from the inventory position. Credit risk related to these transactions is controlled through credit approvals, risk control limits and on-going monitoring procedures through ALCO.
AT FOR THE YEAR ENDED DECEMBER 31, 1999 DECEMBER 31, 1999 ----------------------- ------------------------ NET AVERAGE NOTIONAL FAIR GAIN/ FAIR (Dollars in millions) VALUE VALUE (LOSS) VALUE - -------------------------------------------------------------------------------------------------- Forward contracts: Commitments to buy: Gain position $(1,026.3) $ 13.5 Loss position (215.0) (1.6) Commitments to sell: Gain position 258.6 2.7 Loss position 1,081.2 (15.0) - -------------------------------------------------------------------------------------------------- Net position $ 98.5 $ (.4) $ 114.1 $ (1.1) ==================================================================================================
At For the Year Ended December 31, 1998 December 31, 1998 ----------------------- ------------------------ Net Average Notional Fair Gain/ Fair (Dollars in millions) Value Value (Loss) Value - -------------------------------------------------------------------------------------------------- Forward contracts: Commitments to buy: Gain position $ (855.7) $ 2.3 Loss position (1,639.6) (3.9) Commitments to sell: Gain position 1,707.6 2.5 Loss position 779.5 (2.8) - -------------------------------------------------------------------------------------------------- Net position $ (8.2) $ (1.9) $ 136.5 $ (2.1) ==================================================================================================
74 NOTE 24 - PARENT COMPANY FINANCIAL INFORMATION Following are condensed statements of the parent company:
STATEMENTS OF CONDITION December 31 - ---------------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) 1999 1998 - ---------------------------------------------------------------------------------------------------------------------------- ASSETS: Cash $ 2 $ 1 Securities purchased from subsidiary bank under agreements to resell 34,726 36,279 - ---------------------------------------------------------------------------------------------------------------------------- Total cash and cash equivalents 34,728 36,280 Investment in bank time deposits 76,325 53,171 Securities available for sale 54,708 59,160 Notes receivable--long-term -- 75,000 Investments in subsidiaries at equity: Bank 1,318,122 1,202,910 Non-bank 34,333 33,944 Other assets 46,003 45,052 - ---------------------------------------------------------------------------------------------------------------------------- TOTAL ASSETS $ 1,564,219 $ 1,505,517 ============================================================================================================================ LIABILITIES AND SHAREHOLDERS' EQUITY: Commercial paper and other short-term borrowings $ 16,272 $ 23,204 Accrued employee benefits and other liabilities 75,667 73,325 Term borrowings 230,813 309,454 - ---------------------------------------------------------------------------------------------------------------------------- Total liabilities 322,752 405,983 Shareholders' equity 1,241,467 1,099,534 - ---------------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,564,219 $ 1,505,517 ============================================================================================================================
STATEMENTS OF INCOME Year Ended December 31 - -------------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) 1999 1998 1997 - -------------------------------------------------------------------------------------------------------------------------- Dividend income: Bank $ 116,070 $ 122,484 $ 175,965 Non-bank 7,957 6,059 3,557 - -------------------------------------------------------------------------------------------------------------------------- Total dividend income 124,027 128,543 179,522 Interest income 10,147 12,117 11,287 Other income 250 432 460 - -------------------------------------------------------------------------------------------------------------------------- Total income 134,424 141,092 191,269 - -------------------------------------------------------------------------------------------------------------------------- Interest expense: Short-term debt 840 1,112 1,132 Term borrowings 20,355 23,594 22,729 - -------------------------------------------------------------------------------------------------------------------------- Total interest expense 21,195 24,706 23,861 Compensation, employee benefits and other expense 14,672 12,085 10,903 - -------------------------------------------------------------------------------------------------------------------------- Total expense 35,867 36,791 34,764 - -------------------------------------------------------------------------------------------------------------------------- Income before income taxes and equity in undistributed net income of subsidiaries 98,557 104,301 156,505 Applicable income taxes (12,061) (10,522) (10,458) - -------------------------------------------------------------------------------------------------------------------------- Income before equity in undistributed net income of subsidiaries 110,618 114,823 166,963 Equity in undistributed net income of subsidiaries: Bank 136,012 110,566 29,439 Non-bank 903 991 1,070 - -------------------------------------------------------------------------------------------------------------------------- NET INCOME $ 247,533 $ 226,380 $ 197,472 ==========================================================================================================================
75 STATEMENTS OF CASH FLOWS
Year Ended December 31 - ----------------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) 1999 1998 1997 - ----------------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES: Net income $ 247,533 $ 226,380 $ 197,472 Less undistributed net income of subsidiaries 136,915 111,557 30,509 - ----------------------------------------------------------------------------------------------------------------------------- Income before undistributed net income of subsidiaries 110,618 114,823 166,963 Adjustments to reconcile income to net cash provided by operating activities: Provision/(benefit) for deferred income taxes (807) (1,207) 1,797 Depreciation and amortization 3,048 2,101 2,176 Net change in interest receivable and other assets (2,112) (5,145) (4,809) Net change in interest payable and other liabilities 17,192 19,415 5,678 - ----------------------------------------------------------------------------------------------------------------------------- Total adjustments 17,321 15,164 4,842 - ----------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 127,939 129,987 171,805 - ----------------------------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES: Securities: Sales and prepayments 9,452 -- 40 Purchases (5,000) (35,400) (3,900) Increase in investment in bank time deposits (23,154) (48,077) (854) Principle collected on advances to subsidiaries 75,500 -- -- Proceeds from sale of a subsidiary 6,652 -- -- Cash investments in subsidiaries (1,758) (9,719) (3,278) - ----------------------------------------------------------------------------------------------------------------------------- Net cash provided/(used) by investing activities 61,692 (93,196) (7,992) - ----------------------------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES: Common stock: Exercise of stock options 34,457 24,943 24,309 Cash dividends (98,696) (84,521) (78,348) Repurchase of shares (41,262) (61,854) (169,520) Term borrowings: Issuance 5,000 35,000 106,793 Payment (83,750) -- -- Increase/(decrease) in short-term borrowings (6,932) 28 (9,472) - ----------------------------------------------------------------------------------------------------------------------------- Net cash used by financing activities (191,183) (86,404) (126,238) - ----------------------------------------------------------------------------------------------------------------------------- Net increase/(decrease) in cash and cash equivalents (1,552) (49,613) 37,575 - ----------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at beginning of year 36,280 85,893 48,318 - ----------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 34,728 $ 36,280 $ 85,893 ============================================================================================================================= Total interest paid $ 22,225 $ 24,035 $ 19,167 Total income taxes paid 46,750 25,631 60,050 - -----------------------------------------------------------------------------------------------------------------------------
76 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders and Board of Directors of First Tennessee National Corporation: We have audited the accompanying consolidated statements of condition of First Tennessee National Corporation (a Tennessee corporation) and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of First Tennessee National Corporation and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. Arthur Andersen LLP Memphis, Tennessee, February 28, 2000. 77 FIRST TENNESSEE NATIONAL CORPORATION CONSOLIDATED HISTORICAL STATEMENTS OF INCOME (UNAUDITED) Growth Rates (%)
----------------- (Dollars in millions except per share data) 1999 1998 1997 1996 1995 1994 99/98 99/94* - ------------------------------------------------------------------------------------------------------------------------------- INTEREST INCOME: Interest and fees on loans: Commercial $ 332.1 $ 322.5 $ 298.9 $277.2 $264.4 $211.6 3.0 + 9.4 + Consumer 278.3 258.0 248.7 229.9 206.0 166.8 7.9 + 10.8 + Permanent mortgage 37.5 38.7 51.0 51.7 52.1 44.0 3.1 - 3.1 - Credit card receivables 67.0 67.7 67.9 67.6 65.5 56.6 1.0 - 3.4 + Real estate construction 36.6 39.0 33.1 27.1 23.0 11.4 6.2 - 26.3 + Investment securities: Taxable 175.9 155.9 135.3 136.0 130.9 128.9 12.8 + 6.4 + Tax-exempt 2.7 3.7 4.5 5.1 4.6 5.2 27.0 - 12.3 - Other earning assets: Mortgage loans held for sale 231.3 205.7 76.9 82.1 54.7 56.0 12.4 + 32.8 + Investments in bank time deposits .5 2.0 .5 .7 .2 .2 75.0 - 20.1 + Federal funds sold and securities purchased under agreements to resell 13.9 10.1 11.1 5.0 8.5 7.6 37.6 + 12.8 + Capital markets securities inventory 31.4 30.5 13.4 14.1 12.6 12.8 3.0 + 19.7 + - ----------------------------------------------------------------------------------------------------------- Total interest income 1,207.2 1,133.8 941.3 896.5 822.5 701.1 6.5 + 11.5 + - ----------------------------------------------------------------------------------------------------------- INTEREST EXPENSE: Deposits: Savings 5.8 7.1 8.2 9.4 10.8 13.4 18.3 - 15.4 - Checking interest and money market 104.3 113.2 95.1 92.7 95.8 65.7 7.9 - 9.7 + Certificates of deposit under $100,000 and other time 123.8 144.9 160.5 166.5 167.8 122.0 14.6 - .3 + Certificates of deposit $100,000 and more 165.9 111.5 47.7 46.3 30.6 18.7 48.8 + 54.7 + Federal funds purchased and securities sold under agreements to repurchase 104.7 122.6 89.8 78.0 80.9 40.5 14.6 - 20.9 + Commercial paper and other short-term borrowings 87.1 72.6 39.2 29.3 25.7 35.6 20.0 + 19.6 + Federal Reserve Bank penalties 1.3 1.5 1.8 2.3 2.2 1.1 13.3 - 3.4 + Term borrowings 24.8 19.9 15.9 20.8 18.0 9.6 24.6 + 20.9 + - ----------------------------------------------------------------------------------------------------------- Total interest expense 617.7 593.3 458.2 445.3 431.8 306.6 4.1 + 15.0 + - ----------------------------------------------------------------------------------------------------------- NET INTEREST INCOME 589.5 540.5 483.1 451.2 390.7 394.5 9.1 + 8.4 + Provision for loan losses 57.9 51.3 51.1 35.7 20.6 17.2 12.8 + 27.5 + - ----------------------------------------------------------------------------------------------------------- NET INTEREST INCOME AFTER PROVISION 531.6 489.2 432.0 415.5 370.1 377.3 8.7 + 7.1 + - ----------------------------------------------------------------------------------------------------------- NONINTEREST INCOME: Mortgage banking 632.8 558.4 330.1 275.4 213.6 188.2 13.3 + 27.4 + Capital markets 126.8 147.4 98.3 85.9 82.8 77.5 13.9 - 10.4 + Deposit transactions and cash management 106.2 90.4 86.1 78.2 74.1 65.8 17.5 + 10.1 + Trust services and investment management 59.8 51.2 40.9 34.7 34.4 27.9 16.8 + 16.5 + Merchant processing 49.7 37.5 32.1 24.2 19.2 14.7 32.7 + 27.6 + Cardholder fees 25.6 21.0 19.8 17.2 14.9 15.6 21.5 + 10.4 + Equity securities gains/(losses) 2.3 3.9 (.8) (2.5) 3.2 24.3 40.9 - 37.4 - Debt securities gains/(losses) - - .1 (.2) (.8) (4.3) N/A N/A All other income and commissions 119.9 75.7 61.5 58.3 51.2 46.5 58.5 + 20.9 + - ----------------------------------------------------------------------------------------------------------- Total noninterest income 1,123.1 985.5 668.1 571.2 492.6 456.2 14.0 + 19.7 + - ----------------------------------------------------------------------------------------------------------- ADJUSTED GROSS INCOME AFTER PROVISION 1,654.7 1,474.7 1,100.1 986.7 862.7 833.5 12.2 + 14.7 + - ----------------------------------------------------------------------------------------------------------- NONINTEREST EXPENSE: Employee compensation, incentives and benefits 633.6 563.6 409.8 385.4 340.5 349.8 12.4 + 12.6 + Amortization of mortgage servicing rights 103.5 95.5 37.4 26.0 15.0 14.9 8.3 + 47.3 + Operations services 64.6 58.5 49.9 44.1 38.8 33.7 10.3 + 13.9 + Occupancy 73.1 51.4 42.8 39.8 37.9 34.1 42.1 + 16.5 + Equipment rentals, depreciation and maintenance 57.8 45.8 40.1 34.1 31.8 29.2 26.3 + 14.6 + Communications and courier 51.9 41.5 34.9 33.0 29.9 30.7 25.2 + 11.1 + Amortization of intangible assets 10.5 11.1 9.6 9.5 8.1 6.4 5.6 - 10.4 + All other expense 280.3 254.4 160.5 132.6 107.7 126.9 10.2 + 17.2 + - ----------------------------------------------------------------------------------------------------------- Total noninterest expense 1,275.3 1,121.8 785.0 704.5 609.7 625.7 13.7 + 15.3 + - ----------------------------------------------------------------------------------------------------------- INCOME BEFORE INCOME TAXES 379.4 352.9 315.1 282.2 253.0 207.8 7.5 + 12.8 + Applicable income taxes 131.9 126.5 117.6 102.3 88.1 60.7 4.3 + 16.8 + - ----------------------------------------------------------------------------------------------------------- NET INCOME $ 247.5 $ 226.4 $ 197.5 $179.9 $164.9 $147.1 9.3 + 11.0 + =========================================================================================================== FULLY TAXABLE EQUIVALENT ADJUSTMENT $ 3.0 $ 3.8 $ 4.3 $ 5.4 $ 5.0 $ 4.8 20.8 - 9.0 - - ----------------------------------------------------------------------------------------------------------- EARNINGS PER SHARE $ 1.90 $ 1.77 $ 1.54 $ 1.34 $ 1.21 $ 1.07 7.3 + 12.2 + - ----------------------------------------------------------------------------------------------------------- DILUTED EARNINGS PER SHARE $ 1.85 $ 1.72 $ 1.50 $ 1.32 $ 1.20 $ 1.07 7.6 + 11.6 + - ----------------------------------------------------------------------------------------------------------- * Compound annual growth rate. Certain previously reported amounts have been reclassified to agree with current presentation. Per share data reflect the 1998 and 1996 two-for-one stock splits.
78 FIRST TENNESSEE NATIONAL CORPORATION CONSOLIDATED AVERAGE BALANCE SHEETS AND RELATED YIELDS AND RATES (UNAUDITED)
1999 1998 Average ------------------------------- ---------------------------- Balance Interest Average Interest Average Growth(%) (Fully taxable equivalent) Average Income/ Yields/ Average Income/ Yields/ ---------- (Dollars in millions) Balance Expense Rates Balance Expense Rates 99/98 - ------------------------------------------------------------------------------------------------------------------------------ ASSETS: Earning assets: Loans, net of unearned income: Commercial $ 4,272.0 $ 332.7 7.79% $ 3,966.3 $ 323.1 8.15% 7.7 + Consumer 3,085.0 278.3 9.02 2,794.4 258.1 9.23 10.4 + Permanent mortgage 456.2 37.5 8.22 481.6 38.7 8.03 5.3 - Credit card receivables 573.4 67.0 11.68 563.5 67.7 12.02 1.8 + Real estate construction 400.2 36.5 9.13 405.4 38.9 9.60 1.3 - Nonaccrual loans 32.0 .4 1.22 30.9 .9 3.03 3.6 + - ------------------------------------------------------------------------------------------------------------------- Total loans, net of unearned income 8,818.8 752.4 8.53 8,242.1 727.4 8.83 7.0 + - ------------------------------------------------------------------------------------------------------------------- Investment securities: U.S. Treasury and other U.S. government agencies 1,711.1 110.5 6.46 1,795.2 117.8 6.56 4.7 - States and municipalities 50.7 3.8 7.56 69.8 5.4 7.80 27.4 - Other 940.9 66.2 7.04 560.8 38.4 6.84 67.8 + - ------------------------------------------------------------------------------------------------------------------- Total investment securities 2,702.7 180.5 6.68 2,425.8 161.6 6.66 11.4 + - ------------------------------------------------------------------------------------------------------------------- Other earning assets: Mortgage loans held for sale 3,217.7 231.3 7.19 2,911.2 205.7 7.06 10.5 + Investment in bank time deposits 9.8 .5 4.76 40.8 2.0 4.81 76.0 - Federal funds sold and securities purchased under agreements to resell 292.6 13.9 4.75 193.4 10.1 5.22 51.3 + Capital markets securities inventory 542.1 31.6 5.82 507.2 30.8 6.07 6.9 + - ------------------------------------------------------------------------------------------------------------------- Total other earning assets 4,062.2 277.3 6.82 3,652.6 248.6 6.80 11.2 + - ------------------------------------------------------------------------------------------------------------------- Total earning assets 15,583.7 1,210.2 7.77 14,320.5 1,137.6 7.94 8.8 + Allowance for loan losses (141.2) (133.1) 6.1 + Cash and due from banks 779.3 697.6 11.7 + Premises and equipment, net 288.5 222.4 29.7 + Capital markets receivables and other assets 2,110.5 1,613.3 30.8 + - ------------------------------------------------------------------------------------------------------------------- Total assets/Interest income $ 18,620.8 $1,210.2 $16,720.7 $1,137.6 11.4 + =================================================================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY: Interest-bearing liabilities: Interest-bearing deposits: Savings $ 350.0 $ 5.8 1.65% $ 347.5 $ 7.1 2.05% .7 + Checking interest and money market 3,551.2 104.3 2.94 3,403.7 113.2 3.32 4.3 + Certificates of deposit under $100,000 and other time 2,398.4 123.8 5.16 2,588.7 144.9 5.60 7.4 - - ------------------------------------------------------------------------------------------------------------------- Total interest-bearing core deposits 6,299.6 233.9 3.71 6,339.9 265.2 4.18 .6 - Certificates of deposit $100,000 and more 3,163.9 165.9 5.24 1,992.5 111.5 5.59 58.8 + Federal funds purchased and securities sold under agreements to repurchase 2,292.9 104.7 4.57 2,456.4 122.6 4.99 6.7 - Commercial paper and other short-term borrowings 1,631.4 88.4 5.42 1,285.5 74.1 5.76 26.9 + Term borrowings 371.1 24.8 6.69 252.7 19.9 7.91 46.9 + - ------------------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 13,758.9 617.7 4.49 12,327.0 593.3 4.81 11.6 + Demand deposits 1,866.6 1,749.0 6.7 + Other noninterest-bearing deposits 972.0 915.0 6.2 + Capital markets payables and other liabilities 736.5 633.7 16.2 + Guaranteed preferred beneficial interests in First Tennessee's junior subordinated debentures 100.0 100.0 - Shareholders' equity 1,186.8 996.0 19.2 + - ------------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity/Interest expense $ 18,620.8 $ 617.7 $16,720.7 $ 593.3 11.4 + =================================================================================================================== Net interest income-tax equivalent basis/Yield $ 592.5 3.80% $ 544.3 3.80% Fully taxable equivalent adjustment (3.0) (3.8) - ------------------------------------------------------------------------------------------------------------------- Net interest income $ 589.5 $ 540.5 =================================================================================================================== Net interest spread 3.28% 3.13% Effect of interest-free sources used to fund earning assets .52 .67 - ------------------------------------------------------------------------------------------------------------------- Net interest margin 3.80% 3.80% =================================================================================================================== Certain previously reported amounts have been reclassified to agree with current presentation. Yields and corresponding income amounts are adjusted to a fully taxable equivalent. Earning assets yields are expressed net of unearned income. Rates are expressed net of unamortized debenture cost for long-term debt. Net interest margin is computed using total net interest income.
79 FIRST TENNESSEE NATIONAL CORPORATION CONSOLIDATED AVERAGE BALANCE SHEETS AND RELATED YIELDS AND RATES
1997 1996 ---------------------------- --------------------------- Interest Average Interest Average (Fully taxable equivalent) Average Income/ Yields/ Average Income Yields/ (Dollars in millions) Balance Expense Rates Balance Expense Rates - ------------------------------------------------------------------------------------------------------------------- ASSETS: Earning assets: Loans, net of unearned income: Commercial $ 3,624.8 $ 299.8 8.27% $ 3,383.5 $ 278.2 8.22% Consumer 2,760.0 248.7 9.01 2,607.5 229.9 8.82 Permanent mortgage 638.4 51.0 7.99 660.0 51.7 7.83 Credit card receivables 544.7 67.9 12.47 530.2 67.6 12.74 Real estate construction 337.4 33.0 9.79 275.1 27.0 9.82 Nonaccrual loans 39.8 .9 2.16 15.8 1.5 9.62 ------------------------------------------------------------------------------------------------------------------ Total loans, net of unearned income 7,945.1 701.3 8.83 7,472.1 655.9 8.78 ------------------------------------------------------------------------------------------------------------------ Investment securities: U.S. Treasury and other U.S. government agencies 1,963.3 129.3 6.59 2,031.2 131.0 6.45 States and municipalities 83.7 6.8 8.06 98.1 7.9 8.02 Other 92.4 6.1 6.65 73.9 4.8 6.51 ------------------------------------------------------------------------------------------------------------------ Total investment securities 2,139.4 142.2 6.65 2,203.2 143.7 6.52 ------------------------------------------------------------------------------------------------------------------ Other earning assets: Mortgage loans held for sale 1,005.9 76.9 7.64 1,059.4 82.1 7.74 Investment in bank time deposits 9.8 .5 5.05 14.6 .7 5.05 Federal funds sold and securities purchased under agreements to resell 207.1 11.1 5.37 94.2 5.0 5.30 Capital markets securities inventory 204.8 13.6 6.65 218.5 14.5 6.66 ------------------------------------------------------------------------------------------------------------------ Total other earning assets 1,427.6 102.1 7.15 1,386.7 102.3 7.38 ------------------------------------------------------------------------------------------------------------------ Total earning assets 11,512.1 945.6 8.21 11,062.0 901.9 8.15 Allowance for loan losses (123.6) (117.1) Cash and due from banks 658.6 662.8 Premises and equipment, net 195.1 181.4 Capital markets receivables and other assets 1,038.4 799.2 ------------------------------------------------------------------------------------------------------------------ Total assets/Interest income $ 13,280.6 $ 945.6 $12,588.3 $ 901.9 ================================================================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY: Interest-bearing liabilities: Interest-bearing deposits: Savings $ 376.5 $ 8.2 2.17% $ 424.3 $ 9.4 2.23% Checking interest and money market 2,963.7 95.1 3.21 2,715.9 92.7 3.41 Certificates of deposit under $100,000 and other time 2,798.0 160.5 5.74 2,885.2 166.5 5.77 ------------------------------------------------------------------------------------------------------------------ Total interest-bearing core deposits 6,138.2 263.8 4.30 6,025.4 268.6 4.46 Certificates of deposit $100,000 and more 843.0 47.7 5.66 835.8 46.3 5.54 Federal funds purchased and securities sold under agreements to repurchase 1,790.1 89.8 5.01 1,588.1 78.0 4.91 Commercial paper and other short-term borrowings 663.0 41.0 6.18 520.1 31.6 6.07 Term borrowings 185.5 15.9 8.60 253.7 20.8 8.24 ------------------------------------------------------------------------------------------------------------------ Total interest-bearing liabilities 9,619.8 458.2 4.76 9,223.1 445.3 4.83 Demand deposits 1,695.8 1,816.1 Other noninterest-bearing deposits 530.1 268.2 Capital markets payables and other liabilities 457.5 383.4 Guaranteed preferred beneficial interests in First Tennessee's junior subordinated debentures 98.6 -- Shareholders' equity 878.8 897.5 ------------------------------------------------------------------------------------------------------------------ Total liabilities and shareholders' equity/Interest $ 13,280.6 $ 458.2 $12,588.3 $ 445.3 expense ================================================================================================================== Net interest income-tax equivalent basis/Yield $ 487.4 4.23% $ 456.6 4.13% Fully taxable equivalent adjustment (4.3) (5.4) ------------------------------------------------------------------------------------------------------------------ Net interest income $ 483.1 $ 451.2 ================================================================================================================== Net interest spread 3.45% 3.32% Effect of interest-free sources used to fund earning assets .78 .81 ------------------------------------------------------------------------------------------------------------------ Net interest margin 4.23% 4.13% ================================================================================================================== Certain previously reported amounts have been reclassified to agree with current presentation. Yields and corresponding income amounts are adjusted to a fully taxable equivalent. Earning assets yields are expressed net of unearned income. Rates are expressed net of unamortized debenture cost for long-term debt. Net interest margin is computed using total net interest income.
80 FIRST TENNESSEE NATIONAL CORPORATION CONSOLIDATED AVERAGE BALANCE SHEETS AND RELATED YIELDS AND RATED
1995 1994 Average -------------------------- ---------------------------- Balance Interest Average Interest Average Growth(%) (Fully taxable equivalent) Average Income/ Yields/ Average Income/ Yields/ --------- (Dollars in millions) Balance Expense Rates Balance Expense Rates 99/94* - -------------------------------------------------------------------------------------------------------------------------- ASSETS: Earning assets: Loans, net of unearned income: Commercial $ 3,148.4 $ 265.3 8.43% $ 2,775.7 $ 212.4 7.65% 9.0 + Consumer 2,367.1 206.0 8.70 2,082.6 166.8 8.01 8.2 + Permanent mortgage 658.4 52.1 7.91 557.5 44.0 7.90 3.9 - Credit card receivables 480.4 65.5 13.63 432.7 56.6 13.08 5.8 + Real estate construction 216.4 23.0 10.65 117.3 11.4 9.71 27.8 + Nonaccrual loans 16.5 1.4 8.48 18.6 1.3 7.25 11.5 + - --------------------------------------------------------------------------------------------------------------- Total loans, net of unearned income 6,887.2 613.3 8.90 5,984.4 492.5 8.23 8.1 + - --------------------------------------------------------------------------------------------------------------- Investment securities: U.S. Treasury and other U.S. government agencies 2,004.3 125.9 6.28 2,063.4 122.8 5.95 3.7 - States and municipalities 81.4 7.0 8.63 84.3 7.8 9.26 9.7 - Other 75.3 4.9 6.53 101.0 5.9 5.91 56.3 + - --------------------------------------------------------------------------------------------------------------- Total investment securities 2,161.0 137.8 6.38 2,248.7 136.5 6.07 3.7 + - --------------------------------------------------------------------------------------------------------------- Other earning assets: Mortgage loans held for sale 706.1 54.7 7.75 767.9 56.0 7.29 33.2 + Investment in bank time deposits 3.1 .2 5.79 5.3 .2 3.88 13.1 + Federal funds sold and securities purchased under agreements to resell 157.5 8.5 5.42 191.9 7.6 3.97 8.8 + Capital markets securities inventory 179.8 13.0 7.22 208.0 13.1 6.28 21.1 + - --------------------------------------------------------------------------------------------------------------- Total other earning assets 1,046.5 76.4 7.30 1,173.1 76.9 6.55 28.2 + - --------------------------------------------------------------------------------------------------------------- Total earning assets 10,094.7 827.5 8.20 9,406.2 705.9 7.50 10.6 + Allowance for loan losses (113.0) (113.1) 4.5 + Cash and due from banks 659.0 659.7 3.4 + Premises and equipment, net 166.0 149.1 14.1 + Capital markets receivables and other assets 552.8 477.9 34.6 + - --------------------------------------------------------------------------------------------------------------- Total assets/Interest income $11,359.5 $ 827.5 $10,579.8 $ 705.9 12.0 + =============================================================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY: Interest-bearing liabilities: Interest-bearing deposits: Savings $ 459.5 $ 10.8 2.35% $ 544.3 $ 13.4 2.47% 8.5 - Checking interest and money market 2,378.9 95.8 4.03 2,295.6 65.7 2.86 9.1 + Certificates of deposit under $100,000 and other time 2,872.6 167.8 5.84 2,529.4 122.0 4.82 1.1 - - --------------------------------------------------------------------------------------------------------------- Total interest-bearing core deposits 5,711.0 274.4 4.81 5,369.3 201.1 3.75 3.2 + Certificates of deposit $100,000 and more 531.9 30.6 5.75 460.2 18.7 4.06 47.0 + Federal funds purchased and securities sold under agreements to repurchase 1,491.1 80.9 5.43 1,045.6 40.5 3.87 17.0 + Commercial paper and other short-term borrowings 404.2 27.9 6.90 683.2 36.7 5.37 19.0 + Term borrowings 208.9 18.0 8.63 101.8 9.6 9.41 29.5 + - --------------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 8,347.1 431.8 5.17 7,660.1 306.6 4.00 12.4 + Demand deposits 1,746.8 1,742.7 1.4 + Other noninterest-bearing deposits 142.7 142.2 46.9 + Capital markets payables and other liabilities 300.1 275.3 21.8 + Guaranteed preferred beneficial interests in First Tennessee's junior subordinated debenture -- -- N/A Shareholders' equity 822.8 759.5 9.3 + - --------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity/Interest expense $11,359.5 $ 431.8 $10,579.8 $ 306.6 12.0 + =============================================================================================================== Net interest income-tax equivalent basis/Yield $ 395.7 3.92% $ 399.3 4.25% Fully taxable equivalent adjustment (5.0) (4.8) - --------------------------------------------------------------------------------------------------------------- Net interest income $ 390.7 $ 394.5 =============================================================================================================== Net interest spread 3.03% 3.50% Effect of interest-free sources used to fund earning .89 .75 - --------------------------------------------------------------------------------------------------------------- Net interest margin 3.92% 4.25% =============================================================================================================== * Compound annual growth rate Certain previously reported amounts have been reclassified to agree with current presentation. Yields and corresponding income amounts are adjusted to a fully taxable equivalent. Earning assets yields are expressed net of unearned income. Rates are expressed net of unamortized debenture cost for long-term debt. Net interest margin is computed using total net interest income.
81 FIRST TENNESSEE NATIONAL CORPORATION SELECTED FINANCIAL AND OPERATING DATA
(Dollars in millions except per share data) 1999 1998 1997 1996 1995 1994 - -------------------------------------------------------------------------------------------------------------------------------- SUMMARY INCOME STATEMENTS Interest income $ 1,207.2 $ 1,133.6 $ 941.3 $ 896.5 $ 822.5 $ 701.1 Less interest expense 617.7 593.3 458.2 445.3 431.8 306.6 - -------------------------------------------------------------------------------------------------------------------------------- Net interest income 589.5 540.5 483.1 451.2 390.7 394.5 Provision for loan losses 57.9 51.3 51.1 35.7 20.6 17.2 - -------------------------------------------------------------------------------------------------------------------------------- Net interest income after provision 531.6 489.2 432.0 415.5 370.1 377.3 Noninterest income 1,123.1 985.5 668.1 571.2 492.6 456.2 - -------------------------------------------------------------------------------------------------------------------------------- Adjusted gross income after provision 1,654.7 1,474.7 1,100.1 986.7 862.7 833.5 Noninterest expense 1,275.3 1,121.8 785.0 704.5 609.7 625.7 - -------------------------------------------------------------------------------------------------------------------------------- Income before income taxes 379.4 352.9 315.1 282.2 253.0 207.8 Applicable income taxes 131.9 126.5 117.6 102.3 88.1 60.7 - -------------------------------------------------------------------------------------------------------------------------------- Net income $ 247.5 $ 226.4 $ 197.5 $ 179.9 $ 164.9 $ 147.1 ================================================================================================================================ COMMON STOCK DATA Basic earnings per share $ 1.90 $ 1.77 $ 1.54 $ 1.34 $ 1.21 $ 1.07 Diluted earnings per share 1.85 1.72 1.50 1.32 1.20 1.07 Cash dividends declared per share .79 .685 .615 .5475 .485 .435 Year-end book value per share 9.52 8.50 7.44 7.14 6.50 5.69 Closing price of common stock per share: High 45 3/16 38 1/16 33 3/4 19 5/16 15 7/16 11 15/16 Low 27 9/16 23 13/16 18 3/8 14 7/16 9 13/16 9 5/16 Year-end 28 1/2 38 1/16 33 3/8 18 3/4 15 1/8 10 3/16 Dividends per share/year-end closing price 2.8% 1.8% 1.8% 2.9% 3.2% 4.3% Dividends per share/earnings per share (payout ratio) 42.7 39.8 41.0 41.5 40.4 40.7 Price/earnings ratio 15.4x 22.1x 22.3x 14.2x 12.6x 9.5x Market capitalization $ 3,715.1 $ 4,920.8 $ 4,279.0 $ 2,507.2 $ 2,032.1 $ 1,388.5 Average shares outstanding (thousands) 130,573 128,235 128,365 134,393 136,050 136,884 Period-end shares outstanding (thousands) 129,878 128,974 128,209 133,715 134,356 136,296 Volume of shares traded (thousands) 96,207 107,837 135,205 109,038 131,296 93,384 - -------------------------------------------------------------------------------------------------------------------------------- SELECTED AVERAGE BALANCES Total assets $18,620.8 $16,720.7 $13,280.6 $12,588.3 $11,359.5 $10,579.8 Total loans* 8,818.8 8,242.1 7,945.1 7,472.1 6,887.2 5,984.4 Investment securities 2,702.7 2,425.8 2,139.4 2,203.2 2,161.0 2,248.7 Earning assets 15,583.7 14,320.5 11,512.1 11,062.0 10,094.7 9,406.2 Deposits 12,302.1 10,996.4 9,207.1 8,945.5 8,132.4 7,714.4 Term borrowings 371.1 252.7 185.5 253.7 208.9 101.8 Shareholders' equity 1,186.8 996.0 878.8 897.5 822.8 759.5 - -------------------------------------------------------------------------------------------------------------------------------- SELECTED RATIOS Return on average shareholders' equity 20.9% 22.7% 22.5% 20.1% 20.0% 19.4% Return on average assets 1.33 1.35 1.49 1.43 1.45 1.39 Net interest margin 3.80 3.80 4.23 4.13 3.92 4.25 Allowance for loan losses to loans* 1.49 1.59 1.51 1.52 1.54 1.69 Net charge-offs to average loans* .59 .46 .54 .41 .30 .30 Average total capital to average assets** 6.91 6.55 7.36 7.13 7.24 7.18 Average shareholders' equity to average assets 6.37 5.96 6.62 7.13 7.24 7.18 Average tangible equity to average tangible assets 5.70 5.23 5.81 6.20 6.36 6.36 Average shareholders' equity to average net loans 13.46 12.28 11.24 12.20 12.15 12.94 - -------------------------------------------------------------------------------------------------------------------------------- RETURN TO SHAREHOLDERS Stock appreciation (25.1)% 14.0% 78.0% 24.0% 48.5% 5.8% Dividend yield 2.1 2.1 3.3 3.6 4.8 4.5 Annual return (23.0) 16.1 81.3 27.6 53.3 10.3 - -------------------------------------------------------------------------------------------------------------------------------- * Net of unearned income. ** Total capital includes shareholders' equity and guaranteed preferred beneficial interests in First Tennessee's junior subordinated debentures. See accompanying notes to consolidated financial statements. Common stock data reflects the 1998 and 1996 two-for-one stock splits.
EX-21 4 SUBSIDIARIES OF THE CORPORATION 1 EXHIBIT 21 PARENTS AND SUBSIDIARIES The following is a list of all subsidiaries of First Tennessee National Corporation at December 31, 1999. Each subsidiary is 100% owned by its immediate parent, and all are included in the Consolidated Financial Statements:
Type of Ownership Jurisdiction of Subsidiary By the Corporation Incorporation ---------- ------------------ --------------- Cleveland Bank & Trust Company Direct Tennessee First National Bank of Springdale Direct United States First Tennessee Bank National Association(1) Direct United States Check Consultants, Incorporated Indirect Tennessee Check Consultants Company of Tennessee, Inc. Indirect Tennessee Community Leasing Corporation* Indirect Tennessee Community Money Center, Inc.* Indirect Tennessee East Tennessee Service Corporation* Indirect Tennessee Upper East Tennessee Insurance Agency* Indirect Tennessee Federal Flood Certification Corporation Indirect Texas First Express Remittance Processing, Inc. Indirect Tennessee First Funds, Inc.* Indirect Tennessee First Horizon Insurance Services, Inc. Indirect Tennessee First Horizon Money Center, Inc. Indirect Tennessee First Horizon Strategic Alliances, Inc. Indirect Tennessee First Tennessee ABS, Inc. Indirect Delaware First Tennessee Brokerage, Inc. Indirect Tennessee First Tennessee Capital Assets Corporation Indirect Tennessee First Tennessee Commercial Loan Management, Inc. Indirect Tennessee First Tennessee Equipment Finance Corporation Indirect Tennessee First Tennessee Housing Corporation Indirect Tennessee CC Community Development Holdings, Inc. Indirect Tennessee First Tennessee Merchant Equipment, Inc.* Indirect Tennessee First Tennessee Merchant Services, Inc.(3) Indirect Tennessee FT Real Estate Information Mortgage Solutions Holdings, Inc. Indirect Delaware FT Real Estate Information Mortgage Solutions, Inc. Indirect Delaware FT Real Estate Securities Holding Company, Inc. Indirect Arkansas FT Real Estate Securities Company, Inc. Indirect Arkansas First Tennessee Securities Corporation Indirect Tennessee FT Insurance Corporation Indirect Tennessee FT Mortgage Holding Corporation Indirect Illinois FT Mortgage Companies(2) Indirect Kansas First Tennessee Mortgage Services, Inc. Indirect Tennessee First Horizon Asset Securities Inc. Indirect Delaware FT Reinsurance Company Indirect Vermont Hickory Venture Capital Corporation Indirect Alabama JPO, Inc. Indirect Tennessee TSMM Corporation Indirect Tennessee FTB Futures Corporation* Direct Tennessee Hickory Capital Corporation Direct Tennessee Highland Capital Management Corp. Direct Tennessee Martin & Company, Inc. Direct Tennessee Mountain Financial Company* Direct Tennessee Norlen Life Insurance Company Direct Arizona Peoples and Union Bank Direct Tennessee Peoples Bank Direct Mississippi *Inactive.
2 (1) Divisions of this subsidiary do business in certain jurisdictions under the following names: First Express, First Horizon Equity Lending, First Horizon Money Center, First Securities Company in Mobile, First Tennessee Capital Markets, Garland Capital Management, Garland Trust, Gulf Pacific Mortgage. (2) The subsidiary changed its name to First Horizon Home Loan Corporation in March 2000. Divisions of this subsidiary do business in certain jurisdictions under the following names: Atlantic Coast Mortgage, Carl I. Brown Mortgage, CIB Mortgage, Customer One Mortgage, Elliot Ames, Emerald Mortgage, EquiBanc Mortgage Corporation, 1st Coastal Mortgage, First Tennessee Mortgage Company, Inc., FTB Mortgage Services, Keystone Mortgage, HomeBanc Mortgage Corporation, McGuire Mortgage, MNC Mortgage, Mortgage Resources, Patriot Financial Group, Premier Mortgage, Premier Mortgage Resources, Priority One, Mortgage Bankers, Select Mortgage Resources, Sunbelt National Mortgage. (3) The subsidiary changed its name to First Horizon Merchant Services, Inc. in January 2000. EX-23 5 ACCOUNTANTS' CONSENTS 1 EXHIBIT 23 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report dated February 28, 2000, included in First Tennessee National Corporation's 1999 Annual Report to Shareholders, into the Company's 1999 Annual Report on Form 10-K, and previously filed registration statement file Nos. 33-8029, 33-9846, 33-40398, 33-44142, 33-52561, 33-57241, 33-58975, 33-63809, 33-64471, 333-16225, 333-16227, 333-17457, 333-17457-01, 333-17457-02, 333-17457-03, 333-17457-04, 333-70075, 333-91137, 333-92145, and 333-92147 and to all references to our firm included therein. Arthur Andersen LLP Memphis, Tennessee March 24, 2000 EX-24 6 POWERS OF ATTORNEY 1 EXHIBIT 24 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below does hereby constitute and appoint ELBERT L. THOMAS, JR., JAMES F. KEEN, CLYDE A. BILLINGS, JR., and TERESA A. ROSENGARTEN, jointly and each of them severally, his or her true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him or her and in his or her name, place and stead, in any and all capacities, to execute and sign the Annual Report on Form 10-K for the fiscal year ended December 31, 1999 to be filed with the Securities and Exchange Commission, pursuant to the provisions of the Securities Exchange Act of 1934, by First Tennessee National Corporation ("Corporation") and, further, to execute and sign any and all amendments thereto and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, or their or his or her substitute or substitutes, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all the acts that said attorneys-in-fact and agents, or any of them, or their or his or her substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Signature Title Date --------- ----- ---- Ralph Horn Chairman of the Board, March 20, 2000 - ------------------------------------- President and Chief Executive Ralph Horn Officer and a Director (principal executive officer) Elbert L. Thomas, Jr. Executive Vice President and March 20, 2000 - ------------------------------------- Chief Financial Officer Elbert L. Thomas, Jr. (principal financial officer) James F. Keen Senior Vice President and March 20, 2000 - ------------------------------------- Corporate Controller (principal James F. Keen accounting officer) Robert C. Blattberg Director March 20, 2000 - ------------------------------------- Robert C. Blattberg Carlos H. Cantu Director March 20, 2000 - ------------------------------------- Carlos H. Cantu
Page 1 of 2 2 George E. Cates Director March 20, 2000 - ------------------------------------- George E. Cates J. Kenneth Glass Director March 20, 2000 - ------------------------------------- J. Kenneth Glass James A. Haslam, III Director March 20, 2000 - ------------------------------------- James A. Haslam, III John C. Kelley, Jr. Director March 20, 2000 - ------------------------------------- John C. Kelley, Jr. R. Brad Martin Director March 20, 2000 - ------------------------------------- R. Brad Martin Joseph Orgill, III Director March 20, 2000 - ------------------------------------- Joseph Orgill, III - ------------------------------------- Director March , 2000 Vicki R. Palmer Michael D. Rose Director March 20, 2000 - ------------------------------------- Michael D. Rose William B. Sansom Director March 20, 2000 - ------------------------------------- William B. Sansom
Page 2 of 2 EX-27 7 FINANCIAL DATA SCHEDULE
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FIRST TENNESSEE NATIONAL CORPORATION'S DECEMBER 31, 1999, FINANCIAL STATEMENTS FILED IN ITS 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCES TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1999 JAN-01-1999 DEC-31-1999 956,077 3,263 279,537 147,041 2,332,356 768,936 734,853 11,413,103 139,603 18,373,390 11,358,701 4,406,511 908,048 358,663 100,000 0 81,174 1,160,293 18,373,390 982,839 178,594 45,731 1,207,164 399,733 617,654 589,510 57,923 2,257 1,275,252 379,439 247,533 0 0 247,533 1.90 1.85 3.80 29,118 30,663 0 45,152 136,013 60,225 8,575 139,603 139,603 0 0 FIRST TENNESSEE NATIONAL CORPORATION EFFECTED A TWO-FOR-ONE STOCK SPLIT ON FEBRUARY 20, 1998. THIS CURRENT FINANCIAL DATA SCHEDULE AND THE DECEMBER 31, 1997 FINANCIAL DATA SCHEDULE FILED WITH THE 1997 FORM 10-K REFLECT THIS STOCK SPLIT. FINANCIAL DATA SCHEDULES PRIOR TO DECEMBER 31, 1997, HAVE NOT BEEN RESTATED TO REFLECT THE STOCK SPLIT.
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