1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 1-15403
MARSHALL & ILSLEY CORPORATION
(Exact name of registrant as specified in its charter)
Wisconsin 39-0968604
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
770 North Water Street
Milwaukee, Wisconsin 53202
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (414) 765-7801
None
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated
filer (as defined by Rule 12b-2 of the Exchange Act).
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Outstanding at
Class July 31, 2005
----- ----------------
Common Stock, $1.00 Par Value 232,803,375
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2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MARSHALL & ILSLEY CORPORATION
CONSOLIDATED BALANCE SHEETS (Unaudited)
($000's except share data)
June 30, December 31, June 30,
2005 2004 2004
-------------- ------------- --------------
Assets
------
Cash and cash equivalents:
Cash and due from banks $ 976,073 $ 838,668 $ 823,790
Federal funds sold and security resale agreements 217,139 72,515 259,964
Money market funds 51,410 76,955 52,144
------------- ------------- -------------
Total cash and cash equivalents 1,244,622 988,138 1,135,898
Investment securities:
Trading securities, at market value 22,539 18,418 27,982
Interest bearing deposits at other banks 14,362 23,105 24,091
Available for sale, at market value 5,572,628 5,358,999 5,144,611
Held to maturity, market value $698,534
($765,101 December 31, and $802,354 June 30, 2004) 668,107 726,386 769,899
------------- ------------- -------------
Total investment securities 6,277,636 6,126,908 5,966,583
Loans held for sale 193,092 81,662 84,301
Loans and leases:
Loans and leases, net of unearned income 31,952,759 29,455,110 27,111,014
Less: Allowance for loan and lease losses 360,138 358,110 357,898
------------- ------------- -------------
Net loans and leases 31,592,621 29,097,000 26,753,116
Premises and equipment, net 448,730 467,225 433,562
Goodwill and other intangibles 2,159,624 2,126,433 1,269,059
Accrued interest and other assets 1,567,395 1,550,036 1,429,099
------------- ------------- -------------
Total Assets $ 43,483,720 $ 40,437,402 $ 37,071,618
============= ============= =============
Liabilities and Shareholders' Equity
------------------------------------
Deposits:
Noninterest bearing $ 5,088,947 $ 4,888,426 $ 4,709,873
Interest bearing 20,972,493 21,566,661 20,515,413
------------- ------------- -------------
Total deposits 26,061,440 26,455,087 25,225,286
Federal funds purchased and security repurchase agreements 1,705,817 1,488,855 1,263,129
Other short-term borrowings 3,456,383 2,041,181 2,298,897
Accrued expenses and other liabilities 1,576,211 1,535,866 1,149,379
Long-term borrowings 6,470,684 5,026,599 3,700,764
------------- ------------- -------------
Total liabilities 39,270,535 36,547,588 33,637,455
Shareholders' equity:
---------------------
Series A convertible preferred stock, $1.00 par value;
2,000,000 shares authorized -- -- --
Common stock, $1.00 par value; 244,432,222 shares
issued (244,432,222 shares at December 31, 2004
and 240,832,522 shares at June 30, 2004) 244,432 244,432 240,833
Additional paid-in capital 676,386 671,815 549,579
Retained earnings 3,763,977 3,508,477 3,272,646
Accumulated other comprehensive income,
net of related taxes 15,508 23,338 (51,912)
Less: Treasury stock, at cost: 14,782,208 shares
(17,091,528 December 31, and
18,056,286 June 30, 2004) 448,212 518,231 547,469
Deferred compensation 38,906 40,017 29,514
------------- ------------- -------------
Total shareholders' equity 4,213,185 3,889,814 3,434,163
------------- ------------- -------------
Total Liabilities and Shareholders' Equity $ 43,483,720 $ 40,437,402 $ 37,071,618
============= ============= =============
See notes to financial statements.
3
MARSHALL & ILSLEY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
($000's except per share data)
Three Months Ended
June 30,
----------------------------
2005 2004
------------- -------------
Interest income
---------------
Loans and leases $ 461,532 $ 334,525
Investment securities:
Taxable 53,265 48,623
Exempt from federal income taxes 16,103 14,422
Trading securities 47 55
Short-term investments 2,294 404
------------- -------------
Total interest income 533,241 398,029
Interest expense
----------------
Deposits 122,803 57,999
Short-term borrowings 28,391 14,260
Long-term borrowings 77,284 41,762
------------- -------------
Total interest expense 228,478 114,021
Net interest income 304,763 284,008
Provision for loan and lease losses 13,725 9,227
------------- -------------
Net interest income after provision
for loan and lease losses 291,038 274,781
Other income
------------
Data processing services 271,664 197,344
Item processing 10,716 10,902
Trust services 41,107 37,922
Service charges on deposits 23,936 25,083
Gains on sale of mortgage loans 9,489 8,976
Other mortgage banking revenue 984 2,725
Net investment securities gains 29,422 77
Life insurance revenue 8,055 7,096
Other 47,193 39,860
------------- -------------
Total other income 442,566 329,985
Other expense
-------------
Salaries and employee benefits 262,389 211,881
Net occupancy 20,789 18,238
Equipment 30,076 26,244
Software expenses 14,143 12,481
Processing charges 13,517 11,812
Supplies and printing 5,791 5,806
Professional services 12,802 10,288
Shipping and handling 16,751 18,087
Amortization of intangibles 8,106 5,438
Other 68,204 54,403
------------- -------------
Total other expense 452,568 374,678
Income before income taxes 281,036 230,088
Provision for income taxes 92,549 78,379
------------- -------------
Net income $ 188,487 $ 151,709
============= =============
Net income per common share
Basic $ 0.82 $ 0.68
Diluted 0.81 0.67
Dividends paid per common share $ 0.240 $ 0.210
Weighted average common shares outstanding (000's):
Basic 228,630 221,950
Diluted 232,747 225,502
See notes to financial statements.
4
MARSHALL & ILSLEY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
($000's except per share data)
Six Months Ended
June 30,
----------------------------
2005 2004
------------- -------------
Interest income
---------------
Loans and leases $ 878,376 $ 660,477
Investment securities:
Taxable 105,208 96,940
Exempt from federal income taxes 31,510 28,593
Trading securities 116 145
Short-term investments 3,638 947
------------- -------------
Total interest income 1,018,848 787,102
Interest expense
Deposits 226,293 113,548
Short-term borrowings 50,353 30,096
Long-term borrowings 145,658 80,814
------------- -------------
Total interest expense 422,304 224,458
Net interest income 596,544 562,644
Provision for loan and lease losses 21,851 18,254
------------- -------------
Net interest income after provision
for loan and lease losses 574,693 544,390
Other income
------------
Data processing services 544,031 383,468
Item processing 21,281 22,334
Trust services 81,453 74,172
Service charges on deposits 47,506 50,606
Gains on sale of mortgage loans 16,426 14,175
Other mortgage banking revenue 2,017 4,490
Net investment securities gains (losses) 35,271 (452)
Life insurance revenue 14,264 13,776
Other 89,851 80,845
------------- -------------
Total other income 852,100 643,414
Other expense
-------------
Salaries and employee benefits 500,921 415,809
Net occupancy 43,153 37,433
Equipment 61,086 54,412
Software expenses 27,495 23,706
Processing charges 28,442 24,861
Supplies and printing 12,287 11,512
Professional services 23,688 19,360
Shipping and handling 36,386 34,511
Amortization of intangibles 16,198 10,890
Other 139,358 104,512
------------- -------------
Total other expense 889,014 737,006
Income before income taxes 537,779 450,798
Provision for income taxes 179,712 152,980
------------- -------------
Net income $ 358,067 $ 297,818
============= =============
Net income per common share
Basic $ 1.57 $ 1.34
Diluted 1.54 1.32
Dividends paid per common share $ 0.450 $ 0.390
Weighted average common shares outstanding (000's) :
Basic 228,097 222,125
Diluted 232,125 225,764
See notes to financial statements.
5
MARSHALL & ILSLEY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
($000's)
Six Months Ended
June 30,
----------------------------
2005 2004
------------- -------------
Net Cash Provided by Operating Activities $ 349,951 $ 418,748
Cash Flows From Investing Activities:
-------------------------------------
Proceeds from sales of securities available for sale 82,409 8,890
Proceeds from maturities of securities available for sale 575,259 740,921
Proceeds from maturities of securities held to maturity 58,468 51,142
Purchases of securities available for sale (857,602) (1,183,926)
Net increase in loans (2,526,610) (2,118,630)
Purchases of assets to be leased (142,589) (104,414)
Principal payments on lease receivables 100,071 151,108
Purchases of premises and equipment, net (18,022) (28,519)
Acquisitions, net of cash and cash equivalents acquired (15,910) (165,673)
Other 3,270 11,207
------------- -------------
Net cash used in investing activities (2,741,256) (2,637,894)
Cash Flows From Financing Activities:
-------------------------------------
Net (decrease) increase in deposits (369,087) 2,970,412
Proceeds from issuance of commercial paper 2,566,764 3,029,442
Principal payments on commercial paper (2,582,429) (3,027,527)
Net increase (decrease) in other short-term borrowings 1,197,465 (1,444,961)
Proceeds from issuance of long-term borrowings 2,030,041 1,178,185
Payments of long-term borrowings (123,569) (117,094)
Dividends paid (102,567) (86,417)
Purchases of common stock -- (98,381)
Other 31,171 39,759
------------- -------------
Net cash provided by financing activities 2,647,789 2,443,418
------------- -------------
Net increase (decrease) in cash and cash equivalents 256,484 224,272
Cash and cash equivalents, beginning of year 988,138 911,626
------------- -------------
Cash and cash equivalents, end of period $ 1,244,622 $ 1,135,898
============= =============
Supplemental cash flow information:
Cash paid during the period for:
Interest $ 355,298 $ 194,136
Income taxes 169,032 138,953
See notes to financial statements.
6
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements
June 30, 2005 & 2004 (Unaudited)
1. The accompanying unaudited consolidated financial statements should
be read in conjunction with Marshall & Ilsley Corporation's ("M&I"
or "Corporation") 2004 Annual Report on Form 10-K. The unaudited
financial information included in this report reflects all
adjustments consisting only of normal recurring accruals and
adjustments which are necessary for a fair statement of the
financial position and results of operations as of and for the three
and six months ended June 30, 2005 and 2004. The results of
operations for the three and six months ended June 30, 2005 and 2004
are not necessarily indicative of results to be expected for the
entire year. Certain amounts in the 2004 consolidated financial
statements and analyses have been reclassified to conform with the
2005 presentation.
2. New Accounting Pronouncements
The Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 154, Accounting Changes and
Error Corrections ("SFAS 154"). This statement is effective for
accounting changes and corrections of errors made after January 1,
2006. SFAS 154 generally requires retrospective application of
prior periods' financial statements of a voluntary change in
accounting principle. However, this statement does not change the
transition provisions of any existing accounting pronouncement,
including those that are in a transition phase as of the effective
date of SFAS 154.
In December 2004, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 123 (revised
2004), Share-based Payment ("SFAS 123(R)"). SFAS 123(R) replaces
FASB Statement No. 123, Accounting for Stock-Based Compensation and
supercedes Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees. SFAS 123(R) requires that
compensation costs relating to share-based payment transactions be
recognized in financial statements. That cost is measured based on
the fair value of the equity or liability instruments issued. SFAS
123(R) covers a wide range of share-based compensation arrangements
including share options, restricted share plans, performance based
awards, share appreciation rights, and employee share purchase
plans. SFAS 123(R) also provides guidance on measuring the fair
value of share-based payment awards.
The Corporation was originally required to adopt SFAS 123(R)
beginning in the third quarter of 2005. In April 2005, the
Securities and Exchange Commission ("SEC") announced the adoption of
a new rule that amends the compliance dates for SFAS 123(R). The
new rule allows companies to implement SFAS 123(R) at the beginning
of their next fiscal year. The Corporation plans to adopt SFAS
123(R) effective January 1, 2006.
On March 29, 2005 the SEC released Staff Accounting Bulletin No.
107, "Share-based Payment" ("SAB 107"). SAB 107 expresses views of
the SEC Staff regarding the application of SFAS 123(R). SAB 107 is
intended to assist both public entities in applying the provisions
of SFAS 123(R) and investors and other users of financial statements
in analyzing the information provided under SFAS 123(R).
On May 31, 2005, the FASB issued FSP EITF 00-19-1, "Application of
EITF Issue No. 00-19 to Freestanding Financial Instruments
Originally Issued as Employee Compensation." The guidance in this
FSP should be applied in accordance with the effective date and
transition provisions of Statement 123(R). This FSP clarifies that
a requirement to deliver registered shares, in and of itself, will
not result in liability classification for freestanding financial
instruments originally issued as employee compensation.
7
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2005 & 2004 (Unaudited)
3. Comprehensive Income
The following tables present the Corporation's comprehensive income
(000's):
Three Months Ended June 30, 2005
-------------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
------------- ------------- -------------
Net income $ 188,487
Other comprehensive income:
Unrealized gains (losses) on securities:
Arising during the period $ 49,028 $ (17,313) 31,715
Reclassification for securities
transactions included in net income (144) 50 (94)
------------- ------------- -------------
Unrealized gains (losses) 48,884 (17,263) 31,621
Net gains (losses) on derivatives
hedging variability of cash flows:
Arising during the period 403 (141) 262
Reclassification adjustments for
hedging activities included in net income (34) 12 (22)
------------- ------------- -------------
Net gains (losses) $ 369 $ (129) 240
------------- ------------- -------------
Other comprehensive income (loss) 31,861
-------------
Total comprehensive income $ 220,348
=============
Three Months Ended June 30, 2004
-------------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
------------- ------------- -------------
Net income $ 151,709
Other comprehensive income:
Unrealized gains (losses) on securities:
Arising during the period $ (142,839) $ 50,282 (92,557)
Reclassification for securities
transactions included in net income 10 (3) 7
------------- ------------- -------------
Unrealized gains (losses) (142,829) 50,279 (92,550)
Net gains (losses) on derivatives
hedging variability of cash flows:
Arising during the period (4,286) 1,500 (2,786)
Reclassification adjustments for
hedging activities included in net income 7,991 (2,797) 5,194
------------- ------------- -------------
Net gains (losses) $ 3,705 $ (1,297) 2,408
------------- ------------- -------------
Other comprehensive income (loss) (90,142)
-------------
Total comprehensive income $ 61,567
=============
8
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2005 & 2004 (Unaudited)
Six Months Ended June 30, 2005
-------------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
------------- ------------- -------------
Net income $ 358,067
Other comprehensive income:
Unrealized gains (losses) on securities:
Arising during the period $ (26,691) $ 9,426 (17,265)
Reclassification for securities
transactions included in net income (118) 41 (77)
------------- ------------- -------------
Unrealized gains (losses) (26,809) 9,467 (17,342)
Net gains (losses) on derivatives
hedging variability of cash flows:
Arising during the period 11,594 (4,058) 7,536
Reclassification adjustments for
hedging activities included in net income 3,040 (1,064) 1,976
------------- ------------- -------------
Net gains (losses) $ 14,634 $ (5,122) 9,512
------------- ------------- -------------
Other comprehensive income (loss) (7,830)
-------------
Total comprehensive income $ 350,237
=============
Six Months Ended June 30, 2004
-------------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
------------- ------------- -------------
Net income $ 297,818
Other comprehensive income:
Unrealized gains (losses) on securities:
Arising during the period $ (100,395) $ 35,385 (65,010)
Reclassification for securities
transactions included in net income 10 (3) 7
------------- ------------- -------------
Unrealized gains (losses) (100,385) 35,382 (65,003)
Net gains (losses) on derivatives
hedging variability of cash flows:
Arising during the period (989) 346 (643)
Reclassification adjustments for
hedging activities included in net income 16,985 (5,945) 11,040
------------- ------------- -------------
Net gains (losses) $ 15,996 $ (5,599) 10,397
------------- ------------- -------------
Other comprehensive income (loss) (54,606)
-------------
Total comprehensive income $ 243,212
=============
4. A reconciliation of the numerators and denominators of the basic and
diluted per share computations are as follows (dollars and shares in
thousands, except per share data):
Three Months Ended June 30, 2005
--------------------------------------------
Income Average Shares Per Share
(Numerator) (Denominator) Amount
------------- ------------- -------------
Basic Earnings Per Share
Income Available to Common Shareholders $ 188,487 228,630 $ 0.82
=============
Effect of Dilutive Securities
Stock Options, Restricted Stock
and Other Plans -- 4,117
------------- -------------
Diluted Earnings Per Share
Income Available to Common Shareholders $ 188,487 232,747 $ 0.81
=============
9
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2005 & 2004 (Unaudited)
Three Months Ended June 30, 2004
--------------------------------------------
Income Average Shares Per Share
(Numerator) (Denominator) Amount
------------- ------------- -------------
Basic Earnings Per Share
Income Available to Common Shareholders $ 151,709 221,950 $ 0.68
=============
Effect of Dilutive Securities
Stock Options, Restricted Stock
and Other Plans -- 3,552
------------- -------------
Diluted Earnings Per Share
Income Available to Common Shareholders $ 151,709 225,502 $ 0.67
=============
Six Months Ended June 30, 2005
--------------------------------------------
Income Average Shares Per Share
(Numerator) (Denominator) Amount
------------- ------------- -------------
Basic Earnings Per Share
Income Available to Common Shareholders $ 358,067 228,097 $ 1.57
=============
Effect of Dilutive Securities
Stock Options, Restricted Stock
and Other Plans -- 4,028
------------- -------------
Diluted Earnings Per Share
Income Available to Common Shareholders $ 358,067 232,125 $ 1.54
=============
Six Months Ended June 30, 2004
--------------------------------------------
Income Average Shares Per Share
(Numerator) (Denominator) Amount
------------- ------------- -------------
Basic Earnings Per Share
Income Available to Common Shareholders $ 297,818 222,125 $ 1.34
=============
Effect of Dilutive Securities
Stock Options, Restricted Stock
and Other Plans -- 3,639
------------- -------------
Diluted Earnings Per Share
Income Available to Common Shareholders $ 297,818 225,764 $ 1.32
=============
Options to purchase shares of common stock not included in the
computation of diluted net income per share because the exercise
prices of the options were greater than the average market price of
the common shares are as follows:
Three Months Ended June 30, Six Months Ended June 30,
------------------------------------- -------------------------------------
2005 2004 2005 2004
----------------- ----------------- ----------------- -----------------
Shares 8 33 34 33
Price Range $43.310 - $44.200 $39.090 - $41.150 $42.710 - $44.200 $39.090 - $41.150
Statement of Financial Accounting Standards No. 123 ("SFAS 123"),
"Accounting for Stock-Based Compensation," establishes financial
accounting and reporting standards for stock based employee
compensation plans.
SFAS 123 defines a fair value based method of accounting for
employee stock options or similar equity instruments. Under the
fair value based method, compensation cost is measured at the grant
date based on the fair value of the award using an option-pricing
model that takes into account the stock price at the grant date, the
exercise price, the expected life of the option, the volatility of
the underlying stock, expected dividends and the risk-free interest
rate over the expected life of the option. The resulting
compensation cost is recognized over the service period, which is
usually the vesting period.
10
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2005 & 2004 (Unaudited)
Compensation cost can also be measured and accounted for using the
intrinsic value based method of accounting prescribed in Accounting
Principles Board Opinion No. 25 ("APBO 25"), "Accounting for Stock
Issued to Employees." Under the intrinsic value based method,
compensation cost is the excess, if any, of the quoted market price
of the stock at grant date or other measurement date over the amount
paid to acquire the stock.
The largest difference between SFAS 123 and APBO 25 as they relate
to the Corporation is the amount of compensation cost attributable
to the Corporation's fixed stock option plans and employee stock
purchase plan ("ESPP"). Under APBO 25 no compensation cost is
recognized for fixed stock option plans because the exercise price
is equal to the quoted market price at the date of grant and
therefore there is no intrinsic value. SFAS 123 compensation cost
would equal the calculated fair value of the options granted. Under
APBO 25 no compensation cost is recognized for the ESPP because the
discount (15%) and the plan meets the definition of a qualified plan
under the Internal Revenue Code and meets the requirements of APBO
25. Under SFAS 123 the safe-harbor discount threshold is 5% for a
plan to be non-compensatory. SFAS 123 compensation cost would equal
the initial discount (15% of beginning of plan period price per
share) plus the value of a one year call option on 85% of a share of
stock for each share purchased.
As permitted by SFAS 123, the Corporation continues to measure
compensation cost for such plans using the accounting method
prescribed by APBO 25. See Note 2.
Had compensation cost for the Corporation's ESPP and options granted
after January 1, 1995 been determined consistent with SFAS 123, the
Corporation's net income and earnings per share would have been
reduced to the following estimated pro forma amounts ($000's except
per share data):
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ ------------------------
2005 2004 2005 2004
---------- ---------- ---------- ----------
Net Income, as reported $ 188,487 $ 151,709 $ 358,067 $ 297,818
Add: Stock-based employee compensation
expense included in reported
net income, net of tax 4,560 1,432 5,632 2,854
Less: Total stock-based employee compensation
expense determined under fair
value based method for all awards,
net of tax (9,477) (6,784) (15,045) (12,972)
--------- --------- --------- ---------
Pro forma net income $ 183,570 $ 146,357 $ 348,654 $ 287,700
========= ========= ========= =========
Basic earnings per share:
As reported $0.82 $0.68 $1.57 $1.34
Pro forma 0.80 0.66 1.53 1.30
Diluted earnings per share:
As reported $0.81 $0.67 $1.54 $1.32
Pro forma 0.78 0.65 1.50 1.27
The fair value of each option grant was estimated as of the date of
grant using the Black-Scholes closed form option-pricing model for
options granted prior to September 30, 2004. A form of a lattice
option-pricing model was used for options granted after September
30, 2004.
5. Recently Announced Acquisitions
The following acquisitions, which are not considered to be material
business combinations, were announced during the second quarter of
2005:
In May 2005, Metavante announced the signing of a definitive
agreement to acquire Med-i-Bank, Inc. ("MBI") of Waltham,
Massachusetts. MBI provides electronic payment services for
employee benefit and consumer-directed healthcare accounts. MBI
offers flexible spending accounts, health reimbursement arrangement
and health savings account systems for third-party administrators
and health plans. On July 22, 2005, Metavante completed the
acquisition of all of the outstanding capital stock of MBI for
$150.5 million. Total consideration consisted of 2.9 million shares
of the Corporation's common stock valued at $133.8 million and
$16.7 million in cash. Initial goodwill, subject to the completion
of appraisals and valuations of the assets acquired and liabilities
assumed, amounted to $123.4 million. The estimated identifiable
intangible asset to be amortized (customer relationships) with an
estimated useful life of 10 years amounted to $25.0 million. The
goodwill and intangibles resulting from this transaction are not
deductible for tax purposes.
11
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2005 & 2004 (Unaudited)
In June 2005, Metavante signed a definitive agreement to acquire
TREEV LLC ("TREEV"), of Herndon, Virginia. On August 8, 2005,
Metavante completed the acquisition of all of the outstanding stock
of TREEV for $19.5 million. Total consideration consisted of 0.4
million shares of the Corporation's common stock valued at $16.4
million and $3.0 million in cash. TREEV provides browser-based
document and report management software and consulting services to
the financial-services industry in both lending and deposit
environments. TREEV will complement Metavante's check-imaging
products and services by providing solutions for document storage
and retrieval, including electronic report storage.
In June 2005, Metavante agreed to buy GHR Systems, Inc. ("GHR") for
$65 million. This transaction will add consumer finance and
mortgage loan origination solutions to Metavante's financial
services lines. GHR of Wayne, Pennsylvania provides loan
origination technologies for the residential mortgage and consumer
finance industries, offering point of sale products for any channel
together with comprehensive underwriting, processing and closing
technologies. It is expected that this transaction will be funded
with approximately $55 million of the Corporation's common stock and
$10 million in cash. The transaction is expected to close in the
third quarter of 2005 pending regulatory approval and satisfaction
of other customary closing conditions.
6. Selected investment securities, by type, held by the Corporation are
as follows ($000's):
June 30, December 31, June 30,
2005 2004 2004
------------- ------------- -------------
Investment securities available for sale:
U.S. treasury and government agencies $ 4,254,711 $ 4,157,374 $ 4,096,353
State and political subdivisions 671,782 504,027 397,764
Mortgage backed securities 144,070 150,658 141,448
Other 502,065 546,940 509,046
------------- ------------- -------------
Total $ 5,572,628 $ 5,358,999 $ 5,144,611
============= ============= =============
Investment securities held to maturity:
State and political subdivisions $ 665,807 $ 724,086 $ 767,580
Other 2,300 2,300 2,319
------------- ------------- -------------
Total $ 668,107 $ 726,386 $ 769,899
============= ============= =============
The following table provides the gross unrealized losses and fair
value, aggregated by investment category and the length of time the
individual securities have been in a continuous unrealized loss
position, at June 30, 2005 ($000's):
Less than 12 months 12 months or more Total
------------------------- ------------------------- -------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
------------ ------------ ------------ ------------ ------------ ------------
U.S. treasury and
government agencies $ 1,936,074 $ 14,752 $ 727,179 $ 14,305 $ 2,663,253 $ 29,057
State and political
subdivisions 44,000 393 53,690 728 97,690 1,121
Mortgage backed securities 92,158 804 -- -- 92,158 804
Other 6,999 1 972 10 7,971 11
------------ ------------ ------------ ------------ ------------ ------------
Total $ 2,079,231 $ 15,950 $ 781,841 $ 15,043 $ 2,861,072 $ 30,993
============ ============ ============ ============ ============ ============
The Corporation believes that the unrealized losses in the
investment securities portfolio resulted from increases in market
interest rates and not from deterioration in the creditworthiness of
the issuer.
12
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2005 & 2004 (Unaudited)
7. The Corporation's loan and lease portfolio, including loans held for
sale, consisted of the following ($000's):
June 30, December 31, June 30,
2005 2004 2004
------------- ------------- -------------
Commercial, financial and agricultural $ 9,147,994 $ 8,483,046 $ 7,785,955
Cash flow hedging instruments at fair value (4,549) (1,583) (26,772)
------------- ------------- -------------
Commercial, financial and agricultural 9,143,445 8,481,463 7,759,183
Real estate:
Construction 2,984,601 2,265,227 1,875,852
Residential mortgage 9,313,118 8,548,029 7,720,641
Commercial mortgage 8,585,700 8,164,099 7,696,070
------------- ------------- -------------
Total real estate 20,883,419 18,977,355 17,292,563
Personal 1,526,442 1,540,024 1,590,166
Lease financing 592,545 537,930 553,403
------------- ------------- -------------
Total loans and leases $ 32,145,851 $ 29,536,772 $ 27,195,315
============= ============= =============
8. Sale of Receivables
During the second quarter of 2005, automobile loans with principal
balances of $115.4 million were sold in securitization transactions.
Net losses of $1.9 million were recognized and are reported in Other
income in the Consolidated Statements of Income. Other income
associated with auto securitizations, primarily servicing fees,
amounted to $3.5 million in the current quarter.
Key economic assumptions used in measuring the retained interests at
the date of securitization resulting from securitizations completed
during the second quarter were as follows (rate per annum):
Prepayment speed (CPR) 15-40 %
Weighted average life (in months) 20.0
Expected credit losses (based on original balance) 0.22-0.74 %
Residual cash flow discount rate 12.0 %
Variable returns to transferees Forward one month
LIBOR yield curve
At June 30, 2005, securitized automobile loans and other automobile
loans managed together with them, along with delinquency and credit
loss information consisted of the following ($000's):
Total
Securitized Portfolio Managed
------------- ------------- -------------
Loan balances $ 950,358 $ 246,847 $ 1,197,205
Principal amounts of loans
60 days or more past due 908 443 1,351
Net credit losses year to date 1,010 342 1,352
9. Goodwill and Other Intangibles
The changes in the carrying amount of goodwill for the six months
ended June 30, 2005 are as follows ($000's):
Banking Metavante Others Total
------------- ------------- ------------- -------------
Goodwill balance as of
January 1, 2005 $ 815,086 $ 978,418 $ 5,412 $ 1,798,916
Goodwill acquired during the period -- 20,675 -- 20,675
Purchase accounting adjustments (114) 20,270 3,598 23,754
------------- ------------- ------------- -------------
Goodwill balance as of
June 30, 2005 $ 814,972 $ 1,019,363 $ 9,010 $ 1,843,345
============= ============= ============= =============
Goodwill acquired for the Metavante segment includes initial
goodwill relating to the acquisition of Prime Associates, Inc. in
the first quarter of 2005.
13
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2005 & 2004 (Unaudited)
Purchase accounting adjustments for Metavante for the six months
ended June 2005 represent adjustments made to the initial estimates
of fair value associated with the acquisitions of Kirchman
Corporation, Advanced Financial Solutions, Inc. and its affiliated
companies, NYCE Corporation, Response Data Corp., NuEdge Systems
LLC, and VECTORsgi Holdings, Inc. Purchase accounting adjustments
for Metavante also include the effect of a contingent payment made
in the first quarter of 2005 in connection with the Printing For
Systems, Inc. acquisition. Purchase accounting adjustments for the
Others segment included the effect of a contingent payment made for
an acquisition made by the Corporation's Trust subsidiary in 2004,
net of the reduction of goodwill allocated to the sale of a small
business line. Purchase accounting adjustments for the Banking
segment was the reduction of goodwill allocated to a branch
divestiture.
At June 30, 2005, the Corporation's other intangible assets
consisted of the following ($000's):
June 30, 2005
-------------------------------------------
Accum-
Gross ulated Net
Carrying Amort- Carrying
Amount ization Value
------------- ------------- -------------
Other intangible assets:
Core deposit intangible $ 152,816 $ 74,538 $ 78,278
Data processing contract rights/customer lists 254,780 25,150 229,630
Trust customers 4,750 1,011 3,739
Tradename 2,775 2,325 450
Other Intangibles 1,250 277 973
------------- ------------- -------------
$ 416,371 $ 103,301 $ 313,070
============= ============= =============
Mortgage loan servicing rights $ 3,209
=============
10. The Corporation's deposit liabilities consisted of the following
($000's):
June 30, December 31, June 30,
2005 2004 2004
------------- ------------- -------------
Noninterest bearing demand $ 5,088,947 $ 4,888,426 $ 4,709,873
Savings and NOW 9,999,393 10,118,415 9,101,821
Cash flow hedge-Brokered MMDA (2,998) (1,445) --
------------- ------------- -------------
Total Savings and NOW 9,996,395 10,116,970 9,101,821
CD's $100,000 and over 5,980,536 5,592,947 5,379,731
Cash flow hedge-Institutional CDs (13,944) (8,977) (8,613)
------------- ------------- -------------
Total CD's $100,000 and over 5,966,592 5,583,970 5,371,118
Other time deposits 3,006,936 2,721,214 2,632,467
Foreign deposits 2,002,570 3,144,507 3,410,007
------------- ------------- -------------
Total deposits $ 26,061,440 $ 26,455,087 $ 25,225,286
============= ============= =============
11. Derivative Financial Instruments and Hedging Activities
The following is an update of the Corporation's use of derivative
financial instruments and its hedging activities as described in its
Annual Report on Form 10-K for the year ended December 31, 2004.
Generally there were no substantive changes in the types of
derivative financial instruments the Corporation employs or its
hedging activities in the six months ended June 30, 2005.
Trading Instruments and Other Free Standing Derivatives
-------------------------------------------------------
Loan commitments accounted for as derivatives are not material to
the Corporation and the Corporation does not employ any formal
hedging strategies.
Trading and free-standing derivative contracts are not linked to
specific assets and liabilities on the balance sheet or to
forecasted transactions in an accounting hedge relationship and,
therefore, do not qualify for hedge accounting under SFAS 133. They
are carried at fair value with changes in fair value recorded as a
component of other noninterest income.
14
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2005 & 2004 (Unaudited)
At June 30, 2005, free standing interest rate swaps consisted of
$1.8 billion in notional amount of receive fixed/pay floating with
an aggregate negative fair value of $1.7 million and $1.0 billion in
notional amount of pay fixed/receive floating with an aggregate
positive fair value of $1.5 million.
At June 30, 2005, interest rate caps purchased amounted to $33.8
million in notional amount with a positive fair value of $0.2
million and interest rate caps sold amounted to $33.8 million in
notional amount with a negative fair value of $0.2 million.
At June 30, 2005, the notional value of interest rate futures
designated as trading was $4.1 billion with an immaterial fair
value.
Fair Value Hedges
-----------------
The following table presents updated information with respect to
selected fair value hedges.
Fair Value Hedges Weighted
June 30, 2005 Notional Fair Average
Amount Value Remaining
Hedged Hedging ($ in ($ in Term
Item Instrument millions) millions) (Yrs)
-------------------- ------------------ -------- --------- ---------
Fixed Rate CDs Receive Fixed Swap $ 747.5 $ (9.7) 9.2
Medium Term Notes Receive Fixed Swap 366.9 (1.6) 8.1
Fixed Rate
Bank Notes Receive Fixed Swap 838.6 7.7 8.0
Institutional CDs Receive Fixed Swap 120.0 (0.1) 1.5
The impact from fair value hedges to total net interest income for
the three and six months ended June 30, 2005 was a positive $9.1
million and $19.1 million, respectively. The impact to net interest
income due to ineffectiveness was immaterial.
Cash Flow Hedges
----------------
The following table updates the Corporation's cash flow hedges.
Cash Flow Hedges Weighted
June 30, 2005 Notional Fair Average
Amount Value Remaining
Hedged Hedging ($ in ($ in Term
Item Instrument millions) millions) (Yrs)
-------------------- ------------------ -------- --------- ---------
Variable Rate Loans Receive Fixed Swap $ 1,150.0 $ (4.5) 4.4
Institutional CDs Pay Fixed Swap 2,305.0 13.9 1.1
Federal Funds
Purchased Pay Fixed Swap 300.0 (6.2) 1.9
FHLB Advances Pay Fixed Swap 920.0 8.9 2.9
Floating Rate
Bank Notes Pay Fixed Swap 125.0 (0.3) 1.8
Money Market Account Pay Fixed Swap 250.0 3.0 2.0
The impact to total net interest income from cash flow hedges,
including amortization of terminated cash flow hedges was immaterial
for the three months ended June 30, 2005 and $3.0 million for the
six months ended June 30, 2005. The impact due to ineffectiveness
was immaterial.
15
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2005 & 2004 (Unaudited)
12. Postretirement Health Plan
The Corporation sponsors a defined benefit health plan that provides
health care benefits to eligible current and retired employees.
Eligibility for retiree benefits is dependent upon age, years of
service, and participation in the health plan during active service.
The plan is contributory and in 1997 and 2002 the plan was amended.
Employees hired or retained from mergers after September 1, 1997
will be granted access to the Corporation's plan upon becoming an
eligible retiree; however, such retirees must pay 100% of the cost
of health care benefits. The plan continues to contain other cost-
sharing features such as deductibles and coinsurance.
Net periodic postretirement benefit costs for the three and six
month periods ended June 30, 2005 and 2004 included the following
components ($000's):
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ----------------------
2005 2004 2005 2004
----------- ---------- ---------- ----------
Service cost $ 552 $ 631 $ 1,105 $ 1,262
Interest on APBO 1,159 1,366 2,318 2,732
Expected return on assets (150) -- (299) --
Prior service amortization (680) (680) (1,361) (1,360)
Actuarial loss amortization 264 562 528 1,125
Other -- -- -- --
----------- ---------- ---------- ----------
$ 1,145 $ 1,879 $ 2,291 $ 3,759
=========== ========== ========== ==========
Benefit payments and expenses, net of participant contributions, for
the three and six months ended June 30, 2005 amounted to $1.0
million and $2.0 million, respectively.
16
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2005 & 2004 (Unaudited)
13. Segments
The following represents the Corporation's operating segments as of
and for the three and six months ended June 30, 2005 and 2004.
There have not been any changes to the way the Corporation organizes
its segments. Fees - intercompany represent intercompany revenues
charged to other segments for providing certain services. Expenses
- intercompany represent fees charged by other segments for certain
services received. For each segment, Expenses - intercompany are
not the costs of that segment's reported intercompany revenues.
Intersegment revenues, expenses and assets have been eliminated ($
in millions):
Three Months Ended June 30, 2005
---------------------------------------------------------------------------------
Reclass-
ifications Consol-
Corporate & Elimi- idated
Banking Metavante Others Overhead nations Income
------------ ------------ ------------ ------------ ----------- -------------
Net interest income $ 307.2 $ (6.6) $ 6.1 $ (2.0) $ -- $ 304.7
Other income
Fees - other 91.9 271.7 70.7 8.3 -- 442.6
Fees - intercompany 14.2 23.1 5.6 21.6 (64.5) --
------------ ------------ ------------ ------------ ----------- -------------
Total other income 106.1 294.8 76.3 29.9 (64.5) 442.6
Other expense
Expenses - other 158.5 227.6 32.9 34.7 (1.1) 452.6
Expenses - intercompany 41.5 9.5 12.0 0.4 (63.4) --
------------ ------------ ------------ ------------ ----------- -------------
Total other expense 200.0 237.1 44.9 35.1 (64.5) 452.6
Provision for loan
and lease losses 13.4 -- 0.3 -- -- 13.7
------------ ------------ ------------ ------------ ----------- -------------
Income (loss) before taxes 199.9 51.1 37.2 (7.2) -- 281.0
Income tax expense
(benefit) 60.4 20.3 14.4 (2.6) -- 92.5
------------ ------------ ------------ ------------ ----------- -------------
Segment income $ 139.5 $ 30.8 $ 22.8 $ (4.6) $ -- $ 188.5
============ ============ ============ ============ =========== =============
Identifiable assets $ 41,164.6 $ 2,454.4 $ 759.5 $ 733.1 $(1,627.9) $ 43,483.7
============ ============ ============ ============ =========== =============
Return on average equity 16.3 % 19.7 % 34.5 % 18.3 %
============ ============ ============ =============
Three Months Ended June 30, 2004
---------------------------------------------------------------------------------
Reclass-
ifications Consol-
Corporate & Elimi- idated
Banking Metavante Others Overhead nations Income
------------ ------------ ------------ ------------ ----------- -------------
Net interest income $ 280.2 $ (0.9) $ 6.6 $ (1.9) $ -- $ 284.0
Other income
Fees - other 85.6 197.4 45.8 1.2 -- 330.0
Fees - intercompany 16.6 19.2 7.0 17.6 (60.4) --
------------ ------------ ------------ ------------ ----------- -------------
Total other income 102.2 216.6 52.8 18.8 (60.4) 330.0
Other expense
Expenses - other 152.4 171.3 29.7 21.0 0.3 374.7
Expenses - intercompany 38.5 12.2 11.5 (1.5) (60.7) --
------------ ------------ ------------ ------------ ----------- -------------
Total other expense 190.9 183.5 41.2 19.5 (60.4) 374.7
Provision for loan
and lease losses 8.5 -- 0.7 -- -- 9.2
------------ ------------ ------------ ------------ ----------- -------------
Income (loss) before taxes 183.0 32.2 17.5 (2.6) -- 230.1
Income tax expense
(benefit) 60.0 12.6 6.9 (1.1) -- 78.4
------------ ------------ ------------ ------------ ----------- -------------
Segment income $ 123.0 $ 19.6 $ 10.6 $ (1.5) $ -- $ 151.7
============ ============ ============ ============ =========== =============
Identifiable assets $ 35,778.8 $ 1,218.0 $ 610.0 $ 624.2 $ (1,159.4) $ 37,071.6
============ ============ ============ ============ =========== =============
Return on average equity 16.4 % 19.3 % 16.8 % 17.9 %
============ ============ ============ =============
17
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2005 & 2004 (Unaudited)
Six Months Ended June 30, 2005
---------------------------------------------------------------------------------
Reclass-
ifications Consol-
Corporate & Elimi- idated
Banking Metavante Others Overhead nations Income
------------ ------------ ------------ ------------ ----------- -------------
Net interest income $ 603.9 $ (14.7) $ 11.1 $ (3.8) $ -- $ 596.5
Other income
Fees - other 179.1 544.1 118.9 10.0 -- 852.1
Fees - intercompany 28.8 45.2 10.3 43.3 (127.6) --
------------ ------------ ------------ ------------ ----------- -------------
Total other income 207.9 589.3 129.2 53.3 (127.6) 852.1
Other expense
Expenses - other 312.1 457.0 64.0 56.4 (0.5) 889.0
Expenses - intercompany 80.8 19.9 24.5 1.9 (127.1) --
------------ ------------ ------------ ------------ ----------- -------------
Total other expense 392.9 476.9 88.5 58.3 (127.6) 889.0
Provision for loan
and lease losses 21.2 -- 0.6 -- -- 21.8
------------ ------------ ------------ ------------ ----------- -------------
Income (loss) before taxes 397.7 97.7 51.2 (8.8) -- 537.8
Income tax expense
(benefit) 125.0 38.8 19.8 (3.9) -- 179.7
------------ ------------ ------------ ------------ ----------- -------------
Segment income $ 272.7 $ 58.9 $ 31.4 $ (4.9) $ -- $ 358.1
============ ============ ============ ============ =========== =============
Identifiable assets $ 41,164.6 $ 2,454.4 $ 759.5 $ 733.1 $ (1,627.9) $ 43,483.7
============ ============ ============ ============ =========== =============
Return on average equity 16.3 % 19.7 % 24.7 % 17.8 %
============ ============ ============ =============
Six Months Ended June 30, 2004
---------------------------------------------------------------------------------
Reclass-
ifications Consol-
Corporate & Elimi- idated
Banking Metavante Others Overhead nations Income
------------ ------------ ------------ ------------ ----------- -------------
Net interest income $ 555.1 $ (1.1) $ 13.0 $ (4.3) $ -- $ 562.7
Other income
Fees - other 168.7 383.5 89.1 2.1 -- 643.4
Fees - intercompany 32.2 38.1 11.8 35.1 (117.2) --
------------ ------------ ------------ ------------ ----------- -------------
Total other income 200.9 421.6 100.9 37.2 (117.2) 643.4
Other expense
Expenses - other 304.6 335.3 59.6 37.8 (0.3) 737.0
Expenses - intercompany 71.6 23.1 23.6 (1.4) (116.9) --
------------ ------------ ------------ ------------ ----------- -------------
Total other expense 376.2 358.4 83.2 36.4 (117.2) 737.0
Provision for loan
and lease losses 16.9 -- 1.4 -- -- 18.3
------------ ------------ ------------ ------------ ----------- -------------
Income (loss) before taxes 362.9 62.1 29.3 (3.5) -- 450.8
Income tax expense
(benefit) 118.9 24.4 11.4 (1.7) -- 153.0
------------ ------------ ------------ ------------ ----------- -------------
Segment income $ 244.0 $ 37.7 $ 17.9 $ (1.8) $ -- $ 297.8
============ ============ ============ ============ =========== =============
Identifiable assets $ 35,778.8 $ 1,218.0 $ 610.0 $ 624.2 $ (1,159.4) $ 37,071.6
============ ============ ============ ============ =========== =============
Return on average equity 16.3 % 19.1 % 14.2 % 17.7 %
============ ============ ============ =============
Total revenue, net interest income plus other income, by type in
Others consisted of the following:
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ----------------------
2005 2004 2005 2004
----------- ---------- ---------- ----------
Trust Services $ 40.6 $ 37.2 $ 80.2 $ 72.7
Residential Mortgage Banking 6.1 9.0 11.1 15.2
Capital Markets 21.5 0.3 22.2 (0.4)
Brokerage and Insurance 7.2 6.7 14.3 13.5
Commercial Leasing 4.2 4.2 7.6 8.2
Commercial Mortgage Banking 1.6 1.4 2.8 3.0
Others 1.2 0.6 2.1 1.7
----------- ---------- ---------- ----------
Total revenue $ 82.4 $ 59.4 $ 140.3 $ 113.9
=========== ========== ========== ==========
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
MARSHALL & ILSLEY CORPORATION
CONSOLIDATED AVERAGE BALANCE SHEETS (Unaudited)
($000's)
Three Months Ended
June 30,
----------------------------
2005 2004
------------- -------------
Assets
------
Cash and due from banks $ 938,451 $ 801,986
Investment securities:
Trading securities 25,582 22,138
Short-term investments 271,731 164,685
Other investment securities:
Taxable 4,828,606 4,671,113
Tax-exempt 1,333,700 1,171,209
------------- -------------
Total investment securities 6,459,619 6,029,145
Loans and leases:
Loans and leases, net of unearned income 31,294,058 26,507,894
Less: Allowance for loan and lease losses 361,488 359,856
------------- -------------
Net loans and leases 30,932,570 26,148,038
Premises and equipment, net 445,382 434,888
Accrued interest and other assets 3,877,271 2,757,888
------------- -------------
Total Assets $ 42,653,293 $ 36,171,945
============= =============
Liabilities and Shareholders' Equity
------------------------------------
Deposits:
Noninterest bearing $ 4,826,304 $ 4,513,599
Interest bearing 20,643,276 18,995,645
------------- -------------
Total deposits 25,469,580 23,509,244
Federal funds purchased and security repurchase agreements 2,393,989 2,279,498
Other short-term borrowings 998,363 979,383
Long-term borrowings 7,920,117 4,703,870
Accrued expenses and other liabilities 1,729,455 1,294,056
------------- -------------
Total liabilities 38,511,504 32,766,051
Shareholders' equity 4,141,789 3,405,894
------------- -------------
Total Liabilities and Shareholders' Equity $ 42,653,293 $ 36,171,945
============= =============
19
MARSHALL & ILSLEY CORPORATION
CONSOLIDATED AVERAGE BALANCE SHEETS (Unaudited)
($000's)
Six Months Ended
June 30,
----------------------------
2005 2004
------------- -------------
Assets
------
Cash and due from banks $ 928,733 $ 786,580
Investment securities:
Trading securities 24,355 22,703
Short-term investments 229,595 188,598
Other investment securities:
Taxable 4,825,732 4,602,099
Tax-exempt 1,306,082 1,158,940
------------- -------------
Total investment securities 6,385,764 5,972,340
Loans and leases:
Loans and leases, net of unearned income 30,592,745 25,967,707
Less: Allowance for loan and lease losses 361,220 358,001
------------- -------------
Net loans and leases 30,231,525 25,609,706
Premises and equipment, net 448,079 436,637
Accrued interest and other assets 3,857,632 2,702,534
------------- -------------
Total Assets $ 41,851,733 $ 35,507,797
============= =============
Liabilities and Shareholders' Equity
------------------------------------
Deposits:
Noninterest bearing $ 4,760,154 $ 4,414,879
Interest bearing 20,592,326 18,597,021
------------- -------------
Total deposits 25,352,480 23,011,900
Federal funds purchased and security repurchase agreements 2,170,661 2,400,570
Other short-term borrowings 973,360 943,148
Long-term borrowings 7,564,611 4,473,229
Accrued expenses and other liabilities 1,729,499 1,288,997
------------- -------------
Total liabilities 37,790,611 32,117,844
Shareholders' equity 4,061,122 3,389,953
------------- -------------
Total Liabilities and Shareholders' Equity $ 41,851,733 $ 35,507,797
============= =============
20
OVERVIEW
--------
Current operating trends and financial results have been positive and are
a confirmation of the Corporation's overall strategy of driving earnings
per share growth by: (1) expanding banking operations into faster growing
regions beyond Wisconsin; (2) increasing the number of financial
institutions to which the Corporation provides correspondent banking
services; (3) expanding trust services and other wealth management product
and service offerings for high net-worth individuals; and (4) growing
Metavante's business through organic growth and acquisitions.
The Corporation continues to focus on its key metrics of growing revenues
through balance sheet growth, fee-based income growth and strong credit
quality. Management believes that the Corporation has demonstrated solid
fundamental performance in each of these key areas and as a result, the
second quarter and first half of 2005 produced strong financial results.
Net income for the second quarter of 2005 amounted to $188.5 million
compared to $151.7 million for the same period in the prior year, an
increase of $36.8 million, or 24.2%. Diluted earnings per share were
$0.81 for the three months ended June 30, 2005, compared with $0.67 for
the three months ended June 30, 2004, an increase of 20.9%. The return on
average assets and average equity was 1.77% and 18.25%, respectively, for
the quarter ended June 30, 2005, and 1.69% and 17.92%, respectively, for
the quarter ended June 30, 2004.
For the six months ended June 30, 2005, net income amounted to $358.1
million compared to $297.8 million for the first half of 2004, an increase
of $60.3 million, or 20.2%. Diluted earnings per share were $1.54 for the
six months ended June 30, 2005, compared with $1.32 for the six months
ended June 30, 2004, an increase of 16.7%. The return on average assets
and average equity was 1.73% and 17.78%, respectively, for the first six
months of 2005, and 1.69% and 17.67%, respectively, for the first six
months of 2004.
Earnings growth for the three and six months ended June 30, 2005 compared
to the three and six months ended June 30, 2004 was attributable to a
number of factors. The increase in net interest income was driven by loan
and deposit growth. Net interest income growth was somewhat mitigated by
the financing costs associated with Metavante's 2004 acquisitions. On a
comparative basis, net charge-offs and the resulting provisions for loan
and lease losses were higher in the second quarter and first half of 2005
than the second quarter and first half of 2004. Despite the increase, net
charge-offs for the three and six months ended June 30, 2005 continue to
be below the Corporation's five-year historical average. Metavante and
the trust services reporting unit continued to exhibit growth in both
revenue and earnings. Metavante's growth in revenue and earnings
reflects, in part, the impact of its acquisition and divestiture
activities and higher transaction volumes in payment processing and
electronic banking. The acquisition and divestiture activities included
one acquisition completed in the first quarter of 2005 and six
acquisitions and two divestitures completed in 2004. For the three and
six months ended June 30, 2005, the Corporation realized a gain due to the
sale of an entity associated with the Corporation's investment in an
independent private equity and venture capital partnership. In addition,
during the first quarter of 2005 the Corporation realized a gain due to
the change in control of PULSE EFT Associates. These factors along with
continued expense management resulted in double-digit earnings growth in
the three and six months ended June 30, 2005 compared to the three and six
months ended June 30, 2004.
Management continues to believe that there are some key factors that could
affect future operating trends and financial results. Management believes
that credit losses will likely return to historical levels. While it is
unclear when this will occur, management does not believe that current net
charge-off levels are sustainable indefinitely. Rapidly shifting and
unstable yield curves make balance sheet management vulnerable to
potential earnings volatility. While the Corporation has taken what it
believes to be a conservative position relative to a generally rising
interest rate environment, shifts in customer behavior and re-pricing
characteristics present a persistent challenge.
Based on its performance in the first half of 2005, management expects
Metavante's total 2005 revenues (internal and external) will be at the
upper end of the $1.1 to $1.2 billion revenue range previously provided
and segment earnings will be in the range of $115.0 million to $120.0
million, excluding the impact of recently announced acquisitions. In the
Banking segment, management expects double digit loan growth for the
remainder of 2005. However, it is possible that loan growth will not be
at the same levels experienced during the first half of the current year.
The Corporation's actual results for the year ended December 31, 2005
could differ materially from those expected by management. See "Forward-
Looking Statements" in this Form 10-Q and the Corporation's 2004 Annual
Report on Form 10-K for a discussion of the various risk factors that
could cause actual results to be different than expected results.
21
NOTEWORTHY TRANSACTIONS AND EVENTS
----------------------------------
Some of the more noteworthy transactions and events that occurred in the
three and six months ended June 30, 2005 and 2004 consisted of the
following:
Second quarter 2005
-------------------
As announced in the Corporation's Form 8-K dated May 26, 2005, the
Corporation realized a gain due to the sale of an entity associated with
its investment in an independent private equity and venture capital
partnership. The gross gain amounted to $29.0 million and is reported in
Net investment securities gains (losses) in the Consolidated Statements of
Income. On an after-tax basis, and net of related compensation expense,
the gain amounted to $16.2 million or $0.07 per diluted share for the
three and six months ended June 30, 2005.
During the second quarter Metavante announced three acquisitions. It is
expected that these will be funded primarily with the Corporation's common
stock. See Note 5 in Notes to Financial Statements for further
discussion.
First quarter 2005
------------------
On February 9, 2005, Metavante completed the acquisition of all of the
outstanding common stock of Prime Associates, Inc. ("Prime") of Clark, New
Jersey for $24.5 million. Total consideration consisted of 563,114 shares
of Marshall & Ilsley Corporation common stock valued at $24.0 million and
$0.5 million in cash. Prime is a provider of anti-money laundering and
fraud interdiction software and data products for financial institutions,
insurance companies and securities firms.
During the first quarter of 2005, the Corporation's banking segment's
investment in certain membership interests of PULSE EFT Associates
("PULSE") was liquidated by PULSE due to a change in control. The cash
received resulted in a gain of $5.3 million which is reported in Net
investment securities gains (losses) in the Consolidated Statements of
Income. An additional $0.3 million was received in the second quarter of
2005.
Second quarter 2004
-------------------
On May 27, 2004, Metavante completed the purchase of certain assets and
the assumption of certain liabilities of Kirchman Corporation
("Kirchman"). Kirchman is a provider of automation software and
compliance services to the banking industry. This acquisition provided
Metavante with core-processing software that financial institutions can
run in-house, a solution Metavante previously did not offer.
First quarter 2004
------------------
On January 1, 2004, the Corporation's Banking segment completed the
purchase for cash of certain assets and the assumption of certain
liabilities of AmerUs Home Lending, Inc. ("AmerUs"), an Iowa-based
corporation engaged in the business of brokering and servicing mortgage
and home equity loans. Although not material to the Corporation, this
acquisition enhances the Corporation's wholesale lending activities by
expanding its broker network.
During the first quarter of 2004, the Corporation prepaid and retired
$55.0 million of higher cost fixed rate debt that resulted in a charge to
earnings of $4.9 million. The loss is reported in other in Other expense
in the Consolidated Statements of Income.
NET INTEREST INCOME
-------------------
Net interest income is the difference between interest earned on earning
assets and interest owed on interest bearing liabilities. Net interest
income represented approximately 40.8% and 41.2% of the Corporation's source
of revenues for the three and six months ended June 30, 2005 compared to
46.3% and 46.7% , respectively for the three and six months ended June 30,
2004.
Net interest income for the second quarter of 2005 amounted to $304.8 million
compared to $284.0 million reported for the second quarter of 2004, an
increase of $20.8 million or 7.3%. For the six months ended June 30, 2005,
net interest income amounted to $596.5 million compared to $562.6 million for
the six months ended June 30, 2004, an increase of $33.9 million or 6.0%.
Loan growth and the growth in noninterest bearing deposits were the primary
contributors to the increase in net interest income. Factors negatively
affecting net interest income compared to the prior year three and six month
periods included the impact of lengthening liabilities in order to reduce
future volatility in net interest income due to interest rate changes and the
interest expense associated with the incremental debt issued in the third
quarter of 2004 to fund Metavante's acquisitions in 2004.
22
Average earning assets in the second quarter of 2005 amounted to $37.8
billion compared to $32.5 billion in the second quarter of 2004, an increase
of $5.3 billion or 16.0%. Average loans and leases accounted for $4.8
billion of the growth in average earning assets in the second quarter of 2005
compared to the second quarter of 2004. Average investment securities
increased $0.3 billion over the prior quarter. Average earning assets for
the six months ended June 30, 2005 amounted to $37.0 billion compared to
$31.9 billion for the six months ended June 30, 2004, an increase of $5.1
billion or 15.8%. Average loans and leases accounted for $4.6 billion of the
growth in average earning assets over the respective periods. Average
investment securities increased $0.4 billion.
Average interest bearing liabilities increased $5.0 billion or 18.5% in the
second quarter of 2005 compared to the second quarter of 2004. Average
interest bearing deposits increased $1.6 billion or 8.7% in the second
quarter of 2005 compared to the second quarter of last year. Average total
borrowings increased $3.4 billion or 42.1% in the second quarter of 2005
compared to the same period in 2004. For the six months ended June 30, 2005,
average interest bearing liabilities increased $4.9 billion or 18.5% compared
to the same period in 2004. Average interest bearing deposits increased $2.0
billion or 10.7% in the first six months of 2005 compared to the first six
months of last year. Average total borrowings increased $2.9 billion or
37.0% in the first half of 2005 compared to the same period in 2004.
Average noninterest bearing deposits increased $0.3 billion or 6.9% in the
three months ended June 30, 2005 compared to the same period last year. On
a year-to-date basis, average noninterest bearing deposits increased $0.3
billion or 7.8% in the first six months of 2005 compared to the first six
months of 2004.
The growth and composition of the Corporation's quarterly average loan and
lease portfolio for the current quarter and previous four quarters are
reflected in the following table ($ in millions):
Consolidated Average Loans and Leases
--------------------------------------
2005 2004 Growth Pct.
------------------- ------------------------------ ------------------
Second First Fourth Third Second Prior
Quarter Quarter Quarter Quarter Quarter Annual Quarter
--------- --------- --------- --------- --------- -------- ---------
Commercial Loans and Leases
---------------------------
Commercial $ 8,932 $ 8,460 $ 8,076 $ 7,796 $ 7,463 19.7 % 5.6 %
Commercial real estate
Commercial mortgages 8,509 8,275 8,042 7,826 7,512 13.3 2.8
Construction 1,358 1,241 1,143 1,100 1,071 26.8 9.4
--------- --------- --------- --------- --------- -------- ---------
Total commercial real estate 9,867 9,516 9,185 8,926 8,583 15.0 3.7
Commercial lease financing 425 398 402 395 393 8.2 6.8
--------- --------- --------- --------- --------- -------- ---------
Total Commercial
Loans and Leases 19,224 18,374 17,663 17,117 16,439 16.9 4.6
Personal Loans and Leases
-------------------------
Residential real estate
Residential mortgages 3,986 3,562 3,234 2,929 2,743 45.3 11.9
Construction 1,382 1,167 1,017 865 759 82.0 18.4
--------- --------- --------- --------- --------- -------- ---------
Total residential
real estate 5,368 4,729 4,251 3,794 3,502 53.3 13.5
Personal loans
Student 78 88 85 79 83 (6.0) (11.6)
Credit card 217 217 208 214 244 (11.4) (0.3)
Home equity
loans and lines 5,098 5,131 5,035 4,894 4,688 8.7 (0.6)
Other 1,186 1,217 1,251 1,256 1,388 (14.5) (2.5)
--------- --------- --------- --------- --------- -------- ---------
Total personal loans 6,579 6,653 6,579 6,443 6,403 2.7 (1.1)
Personal lease financing 123 128 135 146 164 (24.9) (3.8)
--------- --------- --------- --------- --------- -------- ---------
Total Personal
Loans and Leases 12,070 11,510 10,965 10,383 10,069 19.9 4.9
--------- --------- --------- --------- --------- -------- ---------
Total Consolidated Average
Loans and Leases $ 31,294 $ 29,884 $ 28,628 $ 27,500 $ 26,508 18.1 % 4.7 %
========= ========= ========= ========= ========= ======== =========
Total consolidated average loans and leases increased $4.8 billion or
18.1% in the second quarter of 2005 compared to the second quarter of
2004. Total average commercial loan and lease growth was $2.8 billion, a
16.9% increase in the current quarter compared to the second quarter of
the prior year. Approximately 52.7% of the growth in total average
commercial loans and leases was attributable to commercial and industrial
loans. Total average personal loans and leases increased $2.0 billion or
19.9% in the second quarter of 2005 compared to the second quarter of
2004. This growth was driven primarily by growth in residential real
estate loans and home equity loans and lines. Average indirect auto loans
and leases declined in the current quarter compared to the second quarter
of the prior year which reflects, in part, the effect of the sale and
securitization of indirect auto loans. From a production standpoint,
residential real estate loan closings in the second quarter of 2005 were
$0.3 billion or 21.1% greater than loan closings in the second quarter of
2004 and were $0.4 billion or 34.4% greater than loan closings in the
first quarter of 2005.
23
For the six months ended June 30, 2005, total consolidated average loans
and leases increased $4.6 billion or 17.8% compared to the six months
ended June 30, 2004. Total average commercial loan and lease growth was
$2.6 billion, a 16.4% increase in the first six months of 2005 compared to
the first six months of the prior year. Approximately 52.6% of the growth
in total average commercial loans and leases was attributable to
commercial and industrial loans. Total average personal loans and leases
increased $2.0 billion or 20.1% in the first half of 2005 compared to the
first half of 2004. This growth was driven primarily by growth in
residential real estate loans and home equity loans and lines. Year-to-
date average indirect auto loans and leases declined in the first six
months of 2005 compared to the same period of the prior year which, as
previously discussed, reflects in part, the effect of the sale and
securitization of indirect auto loans. From a production standpoint,
residential real estate loan closings in the first half of 2005 were $0.6
billion or 29.4% greater than loan closings in the first half of 2004.
Total average commercial loan and lease growth continued to be strong in
the second quarter and first six months of 2005. This growth was spread
relatively evenly throughout the first two quarters, was experienced in
all of the Corporation's markets and came from both relatively new and
existing customers across a variety of industries. Management attributes
the loan growth to the strength of the local economies in the markets the
Corporation serves, sales success and continued customer satisfaction.
The Corporation continues to believe that double-digit loan growth is a
reasonable expectation for the year ended December 31, 2005. However, it
is uncertain whether the growth rates experienced in the first half of
2005 can be sustained for the remainder of the year.
Home equity loans and lines, which includes M&I's wholesale activity,
continue to be the primary consumer loan product. The Corporation
anticipates these products will continue to drive growth in the consumer
side of its banking activities.
The Corporation sells some of its residential real estate production
(residential real estate and home equity loans) in the secondary market.
Selected residential real estate loans with rate and term characteristics
that are considered desirable are periodically retained in the portfolio.
For the three months ended June 30, 2005 and 2004 real estate loans sold
to investors amounted to $0.5 billion, respectively. For the six months
ended June 30, 2005, real estate loans sold to investors amounted to $0.9
billion compared to $0.8 billion in the six months ended June 30, 2004.
At June 30, 2005 and 2004, the Corporation had approximately $153.8
million and $84.3 million of mortgage loans held for sale, respectively.
Gains from the sale of mortgage loans amounted to $9.5 million in the
second quarter of 2005 compared to $9.0 million in the second quarter of
2004. For the six months ended June 30, 2005, gains from the sale of
mortgage loans amounted to $16.4 compared to $14.2 million in the six
months ended June 30, 2004.
Auto loans securitized and sold in the second quarter of 2005 amounted to
$0.1 billion compared to $0.3 billion in the second quarter of 2004. For
the six months ended June 30, 2005, auto loans securitized and sold
amounted to $0.2 billion compared to $0.4 billion in the six months ended
June 30, 2004. For the three months ended June 30, 2005, net losses from
the sale and securitization of auto loans amounted to $1.9 million
compared to net losses of $3.2 million in the second quarter of 2004. For
the six months ended June 30, 2005, net gains from the sale and
securitization of auto loans were approximately break-even compared to net
losses of $2.3 million for the six month ended June 30, 2004. The losses
incurred were primarily due to lower loan interest spreads associated with
new auto loan production in a rising interest rate environment. Auto
loans held for sale amounted to $39.3 million at June 30, 2005.
The Corporation anticipates that it will continue to divest itself of
selected assets through sale or securitization in future periods.
24
The growth and composition of the Corporation's quarterly average deposits
for the current and previous four quarters are as follows ($ in millions):
Consolidated Average Deposits
-----------------------------
2005 2004 Growth Pct.
------------------- ------------------------------ ------------------
Second First Fourth Third Second Prior
Quarter Quarter Quarter Quarter Quarter Annual Quarter
--------- --------- --------- --------- --------- -------- ---------
Bank issued deposits
--------------------
Noninterest bearing deposits
Commercial $ 3,377 $ 3,263 $ 3,427 $ 3,280 $ 3,143 7.4 % 3.5 %
Personal 958 930 923 902 908 5.6 3.0
Other 491 500 521 456 463 6.1 (1.9)
--------- --------- --------- --------- --------- -------- ---------
Total noninterest
bearing deposits 4,826 4,693 4,871 4,638 4,514 6.9 2.8
Interest bearing deposits
Savings and NOW 3,149 3,281 3,402 3,452 3,395 (7.3) (4.0)
Money market 5,819 5,692 5,654 5,612 5,657 2.9 2.2
Foreign activity 882 904 887 849 943 (6.4) (2.4)
--------- --------- --------- --------- --------- -------- ---------
Total interest
bearing deposits 9,850 9,877 9,943 9,913 9,995 (1.5) (0.3)
Time deposits
Other CDs and time deposits 2,951 2,787 2,685 2,653 2,582 14.3 5.8
CDs greater than $100,000 1,243 1,074 906 805 660 88.3 15.8
--------- --------- --------- --------- --------- -------- ---------
Total time deposits 4,194 3,861 3,591 3,458 3,242 29.4 8.6
Total bank issued deposits 18,870 18,431 18,405 18,009 17,751 6.3 2.4
Wholesale deposits
------------------
Money market 1,077 1,073 1,096 747 72 1,389.6 0.3
Brokered CDs 4,437 4,761 4,960 5,009 4,498 (1.4) (6.8)
Foreign time 1,086 969 811 869 1,188 (8.5) 12.2
--------- --------- --------- --------- --------- -------- ---------
Total wholesale deposits 6,600 6,803 6,867 6,625 5,758 14.6 (3.0)
--------- --------- --------- --------- --------- -------- ---------
Total consolidated
average deposits $ 25,470 $ 25,234 $ 25,272 $ 24,634 $ 23,509 8.3 % 0.9 %
========= ========= ========= ========= ========= ======== =========
Total consolidated average deposits increased $2.0 billion or 8.3% in the
second quarter of 2005 compared to the second quarter of 2004. Average
noninterest bearing deposits increased $0.3 billion or 6.9% while average
bank-issued interest bearing deposits increased $0.8 billion or 6.1% in
the current quarter compared to the second quarter of the prior year. For
the six months ended June 30, 2005, total consolidated average deposits
increased $2.3 billion or 10.2% compared to the six months ended June 30,
2004. Average noninterest bearing deposits increased $0.3 billion or 7.8%
while average bank-issued interest bearing deposits increased $0.7 billion
or 5.0% in the first six months of 2005 compared to the first six months
of the prior year. The Corporation has recently experienced success in
competing for bank issued time deposits without pricing above comparable
wholesale levels.
The growth in bank issued deposits, especially noninterest bearing
deposits, includes both commercial and retail banking. Noninterest bearing
deposits are subject to seasonality and are influenced by the interest
rate environment. In commercial banking, the focus remains on developing
deeper relationships through the sale of treasury management products and
services along with revised incentive plans focused on growing deposits.
The retail banking strategy continues to focus on aggressively selling the
right products to meet the needs of customers and enhance the
Corporation's profitability. The Corporation continues to emphasize the
sale of checking products.
25
For the three months ended June 30, 2005, average wholesale deposits
increased $0.8 billion, or 14.6% compared to the three months ended June
30, 2004. For the six months ended June 30, 2005, average wholesale
deposits increased $1.3 billion, or 25.0% compared to the six months ended
June 30, 2004. The Corporation continues to make greater use of wholesale
funding alternatives, especially brokered money market deposits and
institutional certificates of deposit. These deposits are funds in the
form of deposits generated through distribution channels other than M&I's
own banking branches. These deposits allow the Corporation's bank
subsidiaries to gather funds across a wider geographic base and at pricing
levels considered attractive, where the underlying depositor may be retail
or institutional. Access to and use of these funding sources also provide
the Corporation with the flexibility to not pursue unprofitable single
service time deposit relationships.
During the second quarter of 2005, $350.0 million of subordinated bank
notes were issued. The subordinated bank notes mature in 2015 and have a
coupon rate of 4.85%. Senior bank notes in an aggregate amount of $525.0
million were also issued during the second quarter of 2005. The senior
bank notes are floating rate and mature at various time in 2007 and 2010.
Approximately $125.0 million of the senior bank notes were converted to a
fixed rate through the use of an interest rate swap. In addition, during
the second quarter of 2005, the Corporation issued $3.6 million of MiNotes
with an annual weighted average coupon interest rate of 4.51%. The
MiNotes mature at various times in 2010 and 2012. Series E medium-term
notes in the amount of $100.0 million with an annual coupon rate of 1.72%
matured during the second quarter of 2005.
During the first quarter of 2005, a new floating rate advance from the
Federal Home Loan Bank ("FHLB") aggregating $250.0 million was obtained.
The FHLB advance matures in 2011 and was converted to a fixed rate through
the use of an interest rate swap. During the first quarter of 2005, $900.0
million of senior bank notes with an annual weighted average coupon
interest rate of 4.13% were issued. The notes mature at various times
beginning in 2008 through 2017. In addition, during the first quarter of
2005, the Corporation issued $4.5 million of MiNotes with an annual
weighted average coupon interest rate of 5.02%. The MiNotes mature at
various times beginning 2012 through 2023.
During the first quarter of 2004, a fixed rate FHLB advance aggregating
$55.0 million with an annual coupon interest rate of 5.06% was prepaid and
retired resulting in a charge to earnings of $4.9 million.
26
The Corporation's consolidated average interest earning assets and
interest bearing liabilities, interest earned and interest paid for the
three and six months ended June 30, 2005 and 2004, are presented in the
following tables ($ in millions):
Consolidated Yield and Cost Analysis
------------------------------------
Three Months Ended Three Months Ended
June 30, 2005 June 30, 2004
--------------------------- ---------------------------
Average Average
Average Yield or Average Yield or
Balance Interest Cost (b) Balance Interest Cost (b)
--------------------------- ---------------------------
Loans and leases: (a)
Commercial loans and leases $ 9,357.0 $ 134.1 5.75 % $ 7,855.9 $ 89.7 4.59 %
Commercial real estate loans 9,867.4 149.4 6.07 8,582.9 113.9 5.34
Residential real estate loans 5,367.6 79.3 5.92 3,501.8 47.2 5.42
Home equity loans and lines 5,098.3 76.1 5.99 4,688.6 61.1 5.24
Personal loans and leases 1,603.8 23.3 5.83 1,878.7 23.3 5.00
---------- ------- ------- ---------- ------- -------
Total loans and leases 31,294.1 462.2 5.92 26,507.9 335.2 5.09
Investment securities (b):
Taxable 4,828.6 53.3 4.41 4,671.1 48.6 4.19
Tax Exempt (a) 1,333.7 23.9 7.34 1,171.2 21.7 7.59
---------- ------- ------- ---------- ------- -------
Total investment securities 6,162.3 77.2 5.03 5,842.3 70.3 4.87
Trading securities (a) 25.6 0.1 0.78 22.1 0.1 1.05
Other short-term investments 271.7 2.2 3.39 164.7 0.4 1.00
---------- ------- ------- ---------- ------- -------
Total interest earning assets $ 37,753.7 $ 541.7 5.76 % $ 32,537.0 $ 406.0 5.02 %
========== ======= ======= ========== ======= =======
Interest bearing deposits:
Bank issued deposits:
Bank issued interest
bearing activity deposits $ 9,850.0 $ 41.8 1.70 % $ 9,995.5 $ 15.8 0.64 %
Bank issued time deposits 4,193.2 31.6 3.02 3,241.8 19.2 2.38
---------- ------- ------- ---------- ------- -------
Total bank issued deposits 14,043.2 73.4 2.10 13,237.3 35.0 1.06
Wholesale deposits 6,600.1 49.4 3.00 5,758.3 23.0 1.61
---------- ------- ------- ---------- ------- -------
Total interest bearing deposits 20,643.3 122.8 2.39 18,995.6 58.0 1.23
Short-term borrowings 3,392.3 28.4 3.36 3,258.9 14.2 1.76
Long-term borrowings 7,920.1 77.3 3.91 4,703.9 41.8 3.57
---------- ------- ------- ---------- ------- -------
Total interest
bearing liabilities $ 31,955.7 $ 228.5 2.87 % $ 26,958.4 $ 114.0 1.70 %
========== ======= ======= ========== ======= =======
Net interest margin (FTE) as a
percent of average earning assets $ 313.2 3.33 % $ 292.0 3.61 %
======= ======= ======= =======
Net interest spread (FTE) 2.89 % 3.32 %
======= =======
(a) Fully taxable equivalent basis (FTE), assuming a Federal income tax
rate of 35%, and excluding disallowed interest expense.
(b) Based on average balances excluding fair value adjustments for
available for sale securities.
27
Consolidated Yield and Cost Analysis
------------------------------------
Six Months Ended Six Months Ended
June 30, 2005 June 30, 2004
---------------------------- ----------------------------
Average Average
Average Yield or Average Yield or
Balance Interest Cost (b) Balance Interest Cost (b)
---------------------------- ----------------------------
Loans and leases: (a)
Commercial loans and leases $ 9,108.7 $ 252.6 5.59 % $ 7,698.4 $ 177.2 4.63 %
Commercial real estate loans 9,692.9 286.6 5.96 8,452.1 225.0 5.35
Residential real estate loans 5,050.1 145.9 5.83 3,364.2 91.9 5.49
Home equity loans and lines 5,114.4 148.7 5.86 4,563.4 120.1 5.29
Personal loans and leases 1,626.6 45.8 5.68 1,889.6 47.6 5.07
---------- -------- -------- ---------- -------- -------
Total loans and leases 30,592.7 879.6 5.80 25,967.7 661.8 5.13
Investment securities (b):
Taxable 4,825.7 105.2 4.39 4,602.1 96.9 4.26
Tax Exempt (a) 1,306.1 46.9 7.41 1,158.9 43.1 7.64
---------- -------- ------- ---------- -------- -------
Total investment securities 6,131.8 152.1 5.02 5,761.0 140.0 4.93
Trading securities (a) 24.4 0.1 0.99 22.7 0.2 1.33
Other short-term investments 229.6 3.7 3.20 188.6 0.9 1.01
---------- -------- ------- ---------- -------- -------
Total interest earning assets $ 36,978.5 $1,035.5 5.65 % $ 31,940.0 $ 802.9 5.06 %
========== ======== ======= ========== ======== =======
Interest bearing deposits:
Bank issued deposits:
Bank issued interest
bearing activity deposits $ 9,863.4 $ 75.5 1.54 % $ 9,993.7 $ 31.3 0.63 %
Bank issued time deposits 4,028.1 57.6 2.89 3,242.0 38.4 2.38
---------- -------- ------- ---------- -------- -------
Total bank issued deposits 13,891.5 133.1 1.93 13,235.7 69.7 1.06
Wholesale deposits 6,700.8 93.2 2.80 5,361.3 43.8 1.65
---------- -------- ------- ---------- -------- -------
Total interest bearing deposits 20,592.3 226.3 2.22 18,597.0 113.5 1.23
Short-term borrowings 3,144.0 50.3 3.23 3,343.7 30.1 1.81
Long-term borrowings 7,564.6 145.7 3.88 4,473.3 80.8 3.63
---------- -------- ------- ---------- -------- -------
Total interest
bearing liabilities $ 31,300.9 $ 422.3 2.72 % $ 26,414.0 $ 224.4 1.71 %
========== ======== ======= ========== ======== =======
Net interest margin (FTE) as a
percent of average earning assets $ 613.2 3.35 % $ 578.5 3.65 %
======== ======= ======== =======
Net interest spread (FTE) 2.93 % 3.35 %
======= =======
(a) Fully taxable equivalent basis (FTE), assuming a Federal income tax
rate of 35%, and excluding disallowed interest expense.
(b) Based on average balances excluding fair value adjustments for
available for sale securities.
The net interest margin, as a percent of average earning assets on a fully
taxable equivalent basis ("FTE"), decreased 28 basis points from 3.61% in the
second quarter of 2004 to 3.33% in the second quarter of 2005. For the six
months ended June 30, 2005, the net interest margin, as a percent of average
earning assets on a FTE basis was 3.35% compared to 3.65% for the six months
ended June 30, 2004, a decrease of 30 basis points. The decrease in net
interest margin in 2005 was offset, in part, by the increase in noninterest
bearing deposits as previously discussed. When comparing the net interest
margin percentage for the three and six months ended June 30, 2005 to the
three and six months ended June 30, 2004, the Corporation estimates that the
additional interest expense associated with the $1.0 billion of debt issued
in late July 2004 to finance Metavante's acquisitions lowered the net
interest margin by approximately 12 basis points in the second quarter and
first half of 2005. Unlike a bank acquisition or loan growth, where the
primary source of revenue is interest income, the revenue impact of
Metavante's acquisitions is recorded in Other income and is not a component
of the net interest margin statistic. Compared to the first quarter of 2005,
the net interest margin, as a percent of average earning assets on a FTE
basis, decreased 3 basis points from 3.36% in the first quarter of 2005 to
3.33% in the second quarter of 2005.
28
The contraction of the net interest margin as a percent of average earning
assets is primarily driven by the continued growth in loan balances beyond
the Corporation's capacity to generate bank-issued deposit growth below the
wholesale costs of funds. Management expects modest downward pressure on the
net interest margin percentage to continue. Net interest income and the net
interest margin percentage can vary and continue to be influenced by loan and
deposit growth, product spreads, pricing competition in the Corporation's
markets, prepayment activity, future interest rate changes and various other
factors.
PROVISION FOR LOAN AND LEASE LOSSES AND CREDIT QUALITY
------------------------------------------------------
The following tables present comparative consolidated credit quality
information as of June 30, 2005, and the prior four quarters:
Nonperforming Assets
--------------------
($000's)
2005 2004
---------------------- ----------------------------------
Second First Fourth Third Second
Quarter Quarter Quarter Quarter Quarter
---------- ---------- ---------- ---------- ----------
Nonaccrual $ 126,920 $ 124,416 $ 127,722 $ 139,154 $ 137,845
Renegotiated 176 220 236 244 253
Past due 90 days or more 4,514 5,314 4,405 3,148 6,902
---------- ---------- ---------- ---------- ----------
Total nonperforming
loans and leases 131,610 129,950 132,363 142,546 145,000
Other real estate owned 9,124 6,770 8,056 7,098 10,394
---------- ---------- ---------- ---------- ----------
Total nonperforming assets $ 140,734 $ 136,720 $ 140,419 $ 149,644 $ 155,394
========== ========== ========== ========== ==========
Allowance for loan
and lease losses $ 360,138 $ 358,280 $ 358,110 $ 358,072 $ 357,898
========== ========== ========== ========== ==========
Consolidated Statistics
-----------------------
2005 2004
---------------------- ----------------------------------
Second First Fourth Third Second
Quarter Quarter Quarter Quarter Quarter
---------- ---------- ---------- ---------- ----------
Net charge-offs to average
loans and leases annualized 0.15 % 0.11 % 0.18 % 0.10 % 0.08 %
Total nonperforming loans
and leases to total
loans and leases 0.41 0.42 0.45 0.51 0.53
Total nonperforming assets
to total loans and leases
and other real estate 0.44 0.45 0.48 0.53 0.57
Allowance for loan and
lease losses to total
loans and leases 1.12 1.17 1.21 1.27 1.32
Allowance for loan and
lease losses to total
nonperforming loans
and leases 274 276 271 251 247
29
Nonaccrual Loans and Leases By Type
-----------------------------------
($000's)
2005 2004
---------------------- ----------------------------------
Second First Fourth Third Second
Quarter Quarter Quarter Quarter Quarter
---------- ---------- ---------- ---------- ----------
Commercial
Commercial, financial
and agricultural $ 35,777 $ 37,587 $ 41,047 $ 49,714 $ 39,473
Lease financing receivables 3,990 4,882 4,463 5,476 6,398
---------- ---------- ---------- ---------- ----------
Total commercial 39,767 42,469 45,510 55,190 45,871
Real estate
Construction and
land development 1,500 785 578 207 1,724
Commercial mortgage 37,107 28,115 31,852 33,817 38,561
Residential mortgage 47,797 52,056 49,206 48,715 50,776
---------- ---------- ---------- ---------- ----------
Total real estate 86,404 80,956 81,636 82,739 91,061
Personal 749 991 576 1,225 913
---------- ---------- ---------- ---------- ----------
Total nonaccrual
loans and leases $ 126,920 $ 124,416 $ 127,722 $ 139,154 $ 137,845
========== ========== ========== ========== ==========
Reconciliation of Allowance for Loan and Lease Losses
-----------------------------------------------------
($000's)
2005 2004
---------------------- ----------------------------------
Second First Fourth Third Second
Quarter Quarter Quarter Quarter Quarter
---------- ---------- ---------- ---------- ----------
Beginning balance $ 358,280 $ 358,110 $ 358,072 $ 357,898 $ 353,687
Provision for loan
and lease losses 13,725 8,126 12,837 6,872 9,227
Allowance of banks
and loans acquired -- -- -- -- --
Loans and leases charged-off
Commercial 3,767 6,036 5,453 4,403 4,015
Real estate 8,190 3,339 4,342 3,047 2,765
Personal 3,765 3,416 3,345 3,207 2,616
Leases 380 246 6,178 252 536
---------- ---------- ---------- ---------- ----------
Total charge-offs 16,102 13,037 19,318 10,909 9,932
Recoveries on loans and leases
Commercial 2,264 2,604 5,100 2,366 2,279
Real estate 413 1,380 387 611 1,336
Personal 782 719 765 900 906
Leases 776 378 267 334 395
---------- ---------- ---------- ---------- ----------
Total recoveries 4,235 5,081 6,519 4,211 4,916
---------- ---------- ---------- ---------- ----------
Net loans and leases charge-offs 11,867 7,956 12,799 6,698 5,016
---------- ---------- ---------- ---------- ----------
Ending balance $ 360,138 $ 358,280 $ 358,110 $ 358,072 $ 357,898
========== ========== ========== ========== ==========
Nonperforming assets consist of nonperforming loans and leases and other real
estate owned ("OREO").
OREO is principally comprised of commercial and residential properties
acquired in partial or total satisfaction of problem loans and amounted to
$9.1 million at June 30, 2005, compared to $6.8 million at March 31, 2005 and
$8.1 million at December 31, 2004. The increase in OREO at June 30, 2005
compared to March 31, 2005 was primarily attributable to acquired non-
residential properties.
Nonperforming loans and leases consist of nonaccrual, renegotiated or
restructured loans, and loans and leases that are delinquent 90 days or more
and still accruing interest. The balance of nonperforming loans and leases
can fluctuate widely based on the timing of cash collections, renegotiations
and renewals.
30
Maintaining nonperforming assets at an acceptable level is important to the
ongoing success of a financial services institution. The Corporation's
comprehensive credit review and approval process are critical to ensuring
that the amount of nonperforming assets on a long-term basis is minimized
within the overall framework of acceptable levels of credit risk. In
addition to the negative impact on net interest income and credit losses,
nonperforming assets also increase operating costs due to the expense
associated with collection efforts.
At June 30, 2005, nonperforming loans and leases amounted to $131.6 million
or 0.41% of consolidated loans and leases compared to $130.0 million or 0.42%
of consolidated loans and leases at March 31, 2005, and $132.4 million or
0.45% of consolidated loans and leases at December 31, 2004. At June 30,
2005 nonperforming loans and leases increased slightly compared to
nonperforming loans and leases at March 31, 2005. The ratio of nonperforming
loans and leases to consolidated loans and leases at June 30, 2005
represents the ninth consecutive quarter that the Corporation has experienced
a decline in that ratio. Nonaccrual loans and leases continue to be the
primary source of nonperforming loans and leases. Since December 31, 2004,
the decline in nonaccrual commercial loans and leases and nonaccrual
residential real estate loans was offset by increases in nonaccrual
commercial real estate loans and nonaccrual construction and land development
loans.
Net charge-offs amounted to $11.9 million or 0.15% of average loans and
leases in the second quarter of 2005 compared to $8.0 million or 0.11% of
average loans and leases in the first quarter of 2005 and $12.8 million or
0.18% of average loans and leases in the fourth quarter of 2004. The lower
level of net charge-offs experienced throughout 2004 and the first half of
2005 has to some extent been the result of higher than normal recoveries.
Based on the status of some of the larger charge-offs recognized in recent
quarters, management expects recoveries will likely return to lower levels
in future periods. Recoveries in the second quarter of 2005 were $0.8
million lower than recoveries in the first quarter of 2005 and $2.3 million
lower than recoveries in the fourth quarter of 2004. The ratio of recoveries
to charge-offs was 26.3% in the second quarter of 2005 which was slightly
below the Corporation's five year historical average ratio of recoveries to
charge-offs of 26.9%. For the six month ended June 30, 2005, the ratio of
recoveries to charge-offs was 32.0%.
Management continues to expect the longer term level of nonperforming loans
and leases to be in the range of 50-60 basis points of total loans and leases
and expects net charge-offs to trend to historical levels. While it is
unclear when this will occur, management does not believe that current net
charge-off levels are sustainable indefinitely.
The provisions for loan and lease losses amounted to $13.7 million for the
three months ended June 30, 2005 compared to $8.1 million for the three
months ended March 31, 2005 and $9.2 million for the three months ended June
30, 2004. For the six months ended June 30, 2005, the provision for loan and
lease losses amounted to $21.9 million compared to $18.3 million for the six
months ended June 30, 2004. The allowance for loan and lease losses as a
percent of consolidated loans and leases outstanding was 1.12% at June 30,
2005, 1.17% at March 31, 2005 and 1.32% at June 30, 2004.
OTHER INCOME
------------
Other income or noninterest sources of revenue represented approximately
59.2% and 53.7% of the Corporation's total sources of revenues for the three
months ended June 30, 2005 and 2004, respectively. Total other income in the
second quarter of 2005 amounted to $442.6 million compared to $330.0 million
in the same period last year, an increase of $112.6 million or 34.1%. For
the six months ended June 30, 2005, other income represented approximately
58.8% of the Corporation's total sources of revenues and amounted to $852.1
million. By comparison, for the six months ended June 30, 2004, other income
represented approximately 53.4% of the Corporation's total sources of
revenues and amounted to $643.4 million. For the six months ended June 30,
2005 other income increased $208.7 million or 32.4% compared to the six
months ended June 30, 2004.
The increase in other income in the second quarter and first half of 2005
compared to the same periods in 2004 was primarily due to growth in data
processing services and trust services revenue and, as previously discussed,
the gain from the sale of an entity associated with the Corporation's
investment in an independent private equity and venture capital partnership.
31
Data processing services revenue amounted to $271.7 million in the second
quarter of 2005 compared to $197.3 million in the second quarter of 2004, an
increase of $74.4 million or 37.7%. For the six months ended June 30, 2005,
data processing services revenue amounted to $544.0 million compared to
$383.5 million in the six months ended June 30, 2004, an increase of $160.5
million or 41.9%. Overall, revenue growth was generally stronger than
expected throughout this segment and was driven by revenue associated with
acquisitions and higher transaction volumes in payment processing and
electronic banking. Revenue associated with Metavante's acquisitions
completed in 2005 and 2004 net of revenue lost from the 2004 divestitures
(collectively "acquisitions"), contributed a significant portion of the
revenue growth in the three and six months ended June 30, 2005, over the
comparable three and six months ended June 30, 2004, respectively. The
acquisition related revenue growth includes cross sales of acquired products
to clients across the entire segment. Total buyout revenue, which varies
from period to period, increased $0.2 million in the current quarter compared
to the second quarter of last year and was $3.0 million higher in the first
half of 2005 compared to the first half of 2004.
Based on its performance in the first half of 2005, management expects
Metavante's total 2005 revenues (internal and external) will be at the upper
end of the $1.1 to $1.2 billion revenue range previously provided and segment
earnings will be in the range of $115.0 million to $120.0 million, excluding
the impact of recently announced acquisitions.
Trust services revenue amounted to $41.1 million in the second quarter of
2005 compared to $37.9 million in the second quarter of 2004, an increase of
$3.2 million or 8.4%. For the six months ended June 30, 2005, trust services
revenue amounted to $81.5 million compared to $74.2 million for the six
months ended June 30, 2004, an increase of $7.3 million or 9.8%. The
increase in revenue was due to sales efforts that continue to emphasize
cross-selling and integrated delivery. Assets under management were
approximately $18.5 billion at June 30, 2005, compared to $18.3 billion at
December 31, 2004, and $17.1 billion at June 30, 2004.
Service charges on deposits amounted to $23.9 million in the second quarter
of 2005 compared to $25.1 million in the second quarter of 2004, a decrease
of $1.2 million. For the six months ended June 30, 2005, service charges on
deposits amounted to $47.5 million compared to $50.6 million for the six
months ended June 30, 2004, a decrease of $3.1 million. A portion of this
source of fee income is sensitive to changes in interest rates. In a rising
interest rate environment customers receive a higher earnings credit for
maintaining balances which results in lower fee income. Service charges on
deposits associated with commercial demand deposits accounted for the
majority of the decline in this revenue in both the three and six months
ended June 30, 2005 compared to the three and six months ended June 30, 2004.
Total mortgage banking revenue was $10.5 million in the second quarter of
2005 compared with $11.7 million in the second quarter of 2004, a decrease
of $1.2 million. Total mortgage banking revenue was $18.4 million in the
first six months of 2005 compared with $18.7 million in the first six months
of 2004. For the three months ended June 30, 2005 and 2004, the Corporation
sold $0.5 billion of residential mortgage and home equity loans to the
secondary market. For the six months ended June 30, 2005 and 2004, the
Corporation sold $0.9 billion and $0.8 billion of residential mortgage and
home equity loans to the secondary market, respectively. Retained interests
in the form of mortgage servicing rights on residential mortgage loans
amounted to $0.5 million for the six months ended June 30, 2005 and $0.7
million for the six months ended June 30, 2004.
Net investment securities gains amounted to $29.4 million and $35.3 million
for the three and six months ended June 30, 2005, respectively. As
previously discussed, during the second quarter of 2005, the Corporation
realized a gain due to the sale of an entity associated with its investment
in an independent private equity and venture capital partnership. The gross
gain amounted to $29.0 million. During the first quarter of 2005, the
Corporation's banking segment's investment in certain membership interests
of PULSE was liquidated by PULSE. The cash received resulted in a gain of
$5.3 million. An additional $0.3 million was received in the second quarter
of 2005. Net investment securities activities for the three and six months
ended June 30, 2004 were not significant.
Other income in the second quarter of 2005 amounted to $47.2 million compared
to $39.9 million in the second quarter of 2004, an increase of $7.3 million
or 18.4%. For the six months ended June 30, 2005, other income amounted to
$89.9 million compared to $80.8 million for the six months ended June 30,
2004, an increase of $9.1 million or 11.1%. Higher auto securitization
income, as previously discussed, and increases in loan related and card
related fees were the primary contributors to the increase in other income
in the three and six months ended June 30, 2005 compared to the three and six
months ended June 30, 2004. Other income for the three and six months ended
June 30, 2005 includes a gain from a branch divestiture of $0.9 million. In
addition, other income for the six months ended June 30, 2005 includes a gain
of $0.8 million from the required sale of a facility that was completed
during the first quarter of 2005.
OTHER EXPENSE
-------------
Total other expense for the three months ended June 30, 2005 amounted to
$452.6 million compared to $374.7 million for the three months ended June 30,
2004, an increase of $77.9 million or 20.8%. For the six months ended June
30, 2005, total other expense amounted to $889.0 million compared to $737.0
million for the six months ended June 30, 2004, an increase of $152.0 million
or 20.6%.
32
Total other expense for the three and six months ended June 30, 2005 included
the operating expenses associated with Metavante's acquisitions of Kirchman
Corporation in May 2004, Advanced Financial Solutions, Inc. and its
affiliated companies in July 2004, the NYCE Corporation in July 2004,
Response Data Corp. in September 2004, NuEdge Systems LLC in October 2004,
VECTORsgi Holdings, Inc. in November 2004 and Prime Associates, Inc. on
February 9, 2005. Total other expense for the three and six months ended
June 30, 2005 excluded the operating expenses associated with the 401k
Retirement Plan Services operations and the direct customer base of
Paytrust.com that were sold in the fourth quarter of 2004.
Metavante's acquisitions and divestitures had a significant impact on the
period-to-period comparability of operating expenses in 2005 compared to
2004. Approximately $54.9 million of the operating expense growth in the
second quarter of 2005 compared to the second quarter of 2004 was
attributable to the acquisitions and divestitures. Approximately $117.4
million of the operating expense growth in the first six months of 2005
compared to the first six months of 2004 was attributable to the acquisitions
and divestitures. The operating expenses of the acquired and divested
entities have been included in or excluded from the Corporation's
consolidated operating expenses from the dates the transactions were
completed.
Other expense for the three and six months ended June 30, 2004, included a
product impairment charge by Metavante that amounted to $5.5 million. As
previously discussed, other expense for the six months ended June 30, 2004
included a charge to earnings of $4.9 million because the Corporation prepaid
and retired $55.0 million of higher cost fixed rate debt during the first
quarter of 2004.
The Corporation estimates that its expense growth in the three and six months
ended June 30, 2005 compared to the three and six months ended June 2004,
excluding the effects of the acquisitions and divestitures, the debt
prepayment and the impairment charge, was approximately $28.5 million or 7.9%
and $45.0 million or 6.3%, respectively.
Expense control is sometimes measured in the financial services industry by
the efficiency ratio statistic. The efficiency ratio is calculated by taking
total other expense divided by the sum of total other income (including
Capital Markets revenue but excluding investment securities gains or losses)
and net interest income on a fully taxable equivalent basis. The
Corporation's efficiency ratios for the three months ended June 30, 2005, and
prior four quarters were:
Efficiency Ratios
-----------------
Three Months Ended
----------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
2005 2005 2004 2004 2004
------------ ------------ ------------ ------------ ------------
Consolidated Corporation 59.9 % 62.0 % 61.6 % 62.2 % 60.2 %
Consolidated Corporation
Excluding Metavante 47.7 % 48.8 % 47.0 % 49.0 % 48.8 %
Salaries and employee benefits expense amounted to $262.4 million in the
second quarter of 2005 compared to $211.9 million in the second quarter of
2005, an increase of $50.5 million or 23.8%. For the six months ended June
30, 2005, salaries and employee benefits expense amounted to $500.9 million
compared to $415.8 million for the six months ended June 30, 2004, an
increase of $85.1 million or 20.5%. Salaries and benefits associated with
acquisitions and divestitures previously discussed accounted for
approximately $25.7 million and $55.1 million of the increase in salaries and
employee benefits expense in the second quarter and first six months of 2005
compared to the second quarter and first six months of 2004, respectively.
Long-term incentive plans, which are tied to consolidated performance and the
Corporation's common stock price, and business-line performance incentives,
which increased due to significant business success especially in the current
quarter, accounted for over half of the remaining increase in salaries and
employee benefit expense in the three and six months ended June 30, 2005
compared to the three and six months ended June 30, 2004. From June 30, 2004
to June 30, 2005, the Corporation's common stock price increased 13.7%.
For the second quarter of 2005, occupancy and equipment expense amounted to
$50.9 million compared to $44.5 million in the second quarter of 2004, an
increase of $6.4 million or 14.3%. For the six months ended June 30, 2005,
occupancy and equipment expense amounted to $104.2 million compared to $91.8
million for the six months ended June 30, 2004, an increase of $12.4 million
or 13.5%. The acquisitions and divestitures accounted for approximately all
of the increase in occupancy and equipment expense in the three and six
months ended June 30, 2005 compared to the three and six months ended June
30, 2004, respectively.
33
Software expenses, processing charges, supplies and printing, professional
services and shipping and handling expenses totaled $63.0 million in the
second quarter of 2005 compared to $58.5 million in the second quarter of
2004, an increase of $4.5 million or 7.7%. For the six months ended June 30,
2005, software expenses, processing charges, supplies and printing,
professional services and shipping and handling expenses totaled $128.3
million compared to $114.0 million, for the six months ended June 30, 2004,
an increase of $14.3 million or 12.6%. The acquisitions and divestitures
accounted for approximately $6.6 million of the increase in these expense
items in the second quarter of 2005 compared to the second quarter of 2004.
The increase in these expense items due to the acquisitions and divestitures
in the second quarter of 2005 compared to the second quarter of 2004 were
offset by lower shipping and handling charges at Metavante and lower
processing charges in the other business segments. The acquisitions and
divestitures accounted for approximately all of the increase in these expense
items in the six months ended June 30, 2005 compared to the six months ended
June 30, 2004.
Amortization of intangibles amounted to $8.1 million in the second quarter
of 2005 compared to $5.4 million in the second quarter of 2004, an increase
of $2.7 million. For the six months ended June 30, 2005, amortization of
intangibles amounted to $16.2 million compared to $10.9 million for the six
months ended June 30, 2004, an increase of $5.3 million. Amortization and
valuation reserve adjustments associated with mortgage servicing rights
decreased amortization expense $0.1 million and $0.8 million in the second
quarter of 2005 and first six months of 2005 compared to the second quarter
and first six months of 2004, respectively. The carrying value of the
Corporation's mortgage servicing rights was $3.2 million at June 30, 2005.
Amortization of core deposit intangibles, which is based on a declining
balance method, decreased $0.6 million and $1.1 million in the second quarter
and first six months of 2005 compared to the second quarter and first six
months of the prior year. For the three and six months ended June 30, 2005
compared to the three and six months ended June 30, 2004, the acquisitions
and divestitures contributed approximately $3.9 million and $7.9 million,
respectively to the increase in intangibles amortization expense in the
respective periods.
Other expense amounted to $68.2 million in the second quarter of 2005
compared to $54.4 million in the second quarter of 2004, an increase of $13.8
million or 25.4%. The acquisitions and divestitures accounted for
approximately $10.6 million of the increase in other expense in the second
quarter of 2005 compared to the second quarter of 2004. For the six months
ended June 30, 2005, other expense amounted to $139.4 million compared to
$104.5 million for the six months ended June 30, 2004, an increase of $34.9
million or 33.3%. The acquisitions and divestitures accounted for
approximately $23.5 million of the increase in other expense in the first six
months of 2005 compared to the first six months of 2004. As previously
discussed, other expense for the six months ended June 30, 2004 includes a
charge to earnings of $4.9 million for the early retirement of $55.0 million
of higher cost fixed rate debt during the first quarter of 2004.
Other expense is affected by the capitalization of costs, net of amortization
associated with software development and customer data processing
conversions. Net software and conversion amortization was $5.6 million in
the second quarter of 2005 compared to $6.7 million in the second quarter of
2004, resulting in a decrease to other expense over the comparative quarters
of $1.1 million. For the six months ended June 30, 2005 net software and
conversion amortization was $11.4 million compared to $9.8 million for the
six months ended June 30, 2004, resulting in an increase to other expense
over the comparative six months of $1.6 million. The acquisitions and
divestitures increased net software and conversion amortization expense in
the three and six months ended June 30, 2005 compared to the three and six
months ended June 30, 2004 by $1.2 million and $2.8 million, respectively.
Included in net software and conversion amortization for the three and six
months ended June 30, 2004 is Metavante's write-off of capitalized software
associated with an impaired product as previously discussed.
Higher expenses associated with credit cards, advertising and promotion and
various other expenses accounted for the remaining increase in other expense
in the three and six months ended June 30, 2005 compared to the three and
six months ended June 30, 2004, respectively.
INCOME TAXES
------------
The provision for income taxes for the three months ended June 30, 2005
amounted to $92.5 million or 32.9% of pre-tax income compared to $78.4
million or 34.1% of pre-tax income for the three months ended June 30, 2004.
For the six months ended June 30, 2005 the provision for income taxes
amounted to $179.7 million or 33.4% of pre-tax income compared to $153.0
million or 33.9% of pre-tax income for the six months ended June 30, 2004.
In the normal course of business, the Corporation and its affiliates are
routinely subject to examinations from federal and state tax authorities.
During the second quarter of 2005, an income tax issue was resolved which
primarily affected the banking segment and resulted in a lower provision for
income taxes in the consolidated statements of income for the three and six
months ended June 30, 2005.
34
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
Shareholders' equity was $4.2 billion or 9.7% of total consolidated assets
at June 30, 2005, compared to $3.9 billion or 9.6% of total consolidated
assets at December 31, 2004, and $3.4 billion or 9.3% of total consolidated
assets at June 30, 2004. The increase in shareholders' equity at June 30,
2005 was primarily due to earnings net of dividends paid. In the second
quarter of 2005, the Corporation's Board of Directors authorized an increase
in the quarterly cash dividend paid on the Corporation's common stock, from
$0.21 per share to $0.24 per share, or 14.3%. Shareholders' equity at June
30, 2005 includes the effect of certain common stock issuances in the first
quarter of 2005. During the first quarter of 2005, the Corporation issued
563,114 shares of its common stock valued at $24.0 million in conjunction
with Metavante's acquisition of Prime Associates, Inc. Also during the first
quarter of 2005, the Corporation issued 355,046 shares of its common stock
valued at $14.4 million to fund its 2004 obligations under its retirement and
employee stock ownership plans.
At June 30, 2005, the net gain in accumulated other comprehensive income
amounted to $15.5 million which represented a negative change in accumulated
other comprehensive income of $7.8 million since December 31, 2004. Net
accumulated other comprehensive income associated with available for sale
investment securities was a net gain of $13.7 million at June 30, 2005,
compared to a net gain of $31.1 million at December 31, 2004, resulting in
a net loss of $17.4 million over the six month period. Net accumulated other
comprehensive income associated with the change in fair value of the
Corporation's derivative financial instruments designated as cash flow hedges
was a net gain of $9.5 million over the six month period.
The Corporation has a Stock Repurchase Program under which it may repurchase
up to 12 million shares of its common stock annually. No shares were
acquired under the program in the second quarter or first six months of 2005.
For the six months ended June 30, 2004, 2.3 million shares were acquired at
an aggregate cost of $88.5 million or an average price of $38.98 per common
share. As a result of the Metavante acquisitions, the Corporation does not
expect that it will acquire shares of its common stock under the Stock
Repurchase Program in the near term.
The Corporation continues to have a strong capital base and its regulatory
capital ratios are significantly above the minimum requirements as shown in
the following tables.
RISK-BASED CAPITAL RATIOS
-------------------------
($ in millions)
June 30, 2005 December 31, 2004
--------------------------------- ---------------------------------
Amount Ratio Amount Ratio
--------------------------------- ---------------------------------
Tier 1 Capital $ 2,809 7.55 % $ 2,520 7.42 %
Tier 1 Capital
Minimum Requirement 1,488 4.00 1,358 4.00
-------------------------------- --------------------------------
Excess $ 1,321 3.55 % $ 1,162 3.42 %
================================ ================================
Total Capital $ 4,434 11.92 % $ 3,802 11.20 %
Total Capital
Minimum Requirement 2,976 8.00 2,716 8.00
-------------------------------- --------------------------------
Excess $ 1,458 3.92 % $ 1,086 3.20 %
================================ ================================
Risk-Adjusted Assets $ 37,198 $ 33,948
================= =================
LEVERAGE RATIOS
---------------
($ in millions)
June 30, 2005 December 31, 2004
--------------------------------- ---------------------------------
Amount Ratio Amount Ratio
--------------------------------- ---------------------------------
Tier 1 Capital $ 2,809 6.91 % $ 2,520 6.72 %
Minimum Leverage
Requirement 1,219 - 2,032 3.00 - 5.00 1,126 - 1,876 3.00 - 5.00
-------------------------------- --------------------------------
Excess $ 1,590 - 777 3.91 - 1.91 % $ 1,394 - 644 3.72 - 1.72 %
================================ ================================
Adjusted Average
Total Assets $ 40,648 $ 37,509
================= =================
35
M&I manages its liquidity to ensure that funds are available to each of its
banks to satisfy the cash flow requirements of depositors and borrowers and
to ensure the Corporation's own cash requirements are met. M&I maintains
liquidity by obtaining funds from several sources.
The Corporation's most readily available source of liquidity is its
investment portfolio. Investment securities available for sale, which
totaled $5.6 billion at June 30, 2005, represent a highly accessible source
of liquidity. The Corporation's portfolio of held-to-maturity investment
securities, which totaled $0.7 billion at June 30, 2005, provides liquidity
from maturities and amortization payments. The Corporation's loans held-for-
sale provide additional liquidity. These loans represent recently funded
loans that are prepared for delivery to investors, which generally occurs
within thirty to ninety days after the loan has been funded.
Depositors within M&I's defined markets are another source of liquidity.
Core deposits (demand, savings, money market and consumer time deposits)
averaged $16.7 billion in the second quarter of 2005. The Corporation's
banking affiliates may also access the federal funds markets or utilize
collateralized borrowings such as treasury demand notes or FHLB advances.
The banking affiliates may use wholesale deposits. Wholesale deposits are
funds in the form of deposits generated through distribution channels other
than the Corporation's own banking branches. These deposits allow the
Corporation's banking subsidiaries to gather funds across a national
geographic base and at pricing levels considered attractive, where the
underlying depositor may be retail or institutional. Access to wholesale
deposits also provides the Corporation with the flexibility to not pursue
single service time deposit relationships in markets that have experienced
some unprofitable pricing levels. Wholesale deposits averaged $6.6 billion
in the second quarter of 2005.
The Corporation utilizes certain financing arrangements to meet its balance
sheet management, funding, liquidity, and market or credit risk management
needs. The majority of these activities are basic term or revolving
securitization vehicles. These vehicles are generally funded through term-
amortizing debt structures or with short-term commercial paper designed to
be paid off based on the underlying cash flows of the assets securitized.
These vehicles provide access to funding sources substantially separate from
the general credit risk of the Corporation and its subsidiaries. See Note
8 to the Consolidated Financial Statements for an update of the Corporation's
securitization activities in the second quarter of 2005.
The Corporation's lead bank, M&I Marshall & Ilsley Bank ("the Bank"), has
implemented a bank note program which permits it to issue up to $7.0 billion
of short-term and medium-term notes which are offered and sold only to
institutional investors. This program is intended to enhance liquidity by
enabling the Bank to sell its debt instruments in private markets in the
future without the delays which would otherwise be incurred. Bank notes
outstanding at June 30, 2005, amounted to $4.8 billion of which $1.3 billion
is subordinated and qualifies as supplementary capital for regulatory capital
purposes. Bank notes issued during the second quarter of 2005 amounted to
$875.0 million.
The national capital markets represent a further source of liquidity to M&I.
M&I has filed a number of shelf registration statements that are intended to
permit M&I to raise funds through sales of corporate debt and/or equity
securities with a relatively short lead time.
During the second quarter of 2004, the Corporation filed a shelf registration
statement with the Securities and Exchange Commission which will enable the
Corporation to issue various securities, including debt securities, common
stock, preferred stock, depositary shares, purchase contracts, units,
warrants, and trust preferred securities, up to an aggregate amount of $3.0
billion. At June 30, 2005, approximately $1.45 billion was available for
future securities issuances.
During the fourth quarter of 2004, the Corporation filed a shelf registration
statement with the Securities and Exchange Commission which will enable the
Corporation to issue up to 6.0 million shares of its common stock which may
be offered and issued from time to time in connection with the acquisition
by M&I, Metavante and/or other consolidated subsidiaries of businesses that
the Corporation determines to be to its advantage as they become available.
At June 30, 2005, 5.4 million shares of common stock were available for
future issuances.
Under other shelf registration statements, the Corporation may issue up to
$0.6 billion of medium-term Series F notes with maturities ranging from 9
months to 30 years and at fixed or floating rates. At June 30, 2005, no
Series F notes had been issued. The Corporation may issue up to $0.5 billion
of medium-term MiNotes with maturities ranging from 9 months to 30 years and
at fixed or floating rates. The MiNotes are issued in smaller denominations
to attract retail investors. At June 30, 2005, MiNotes issued amounted to
$0.2 billion. Additionally, the Corporation has a commercial paper program.
At June 30, 2005, commercial paper outstanding amounted to $0.3 billion.
36
Short-term borrowings represent contractual debt obligations with maturities
of one year or less and amounted to $3.1 billion at June 30, 2005. Long-term
borrowings amounted to $8.5 billion at June 30, 2005. The scheduled
maturities of long-term borrowings including estimated interest payments at
June 30, 2005 are as follows: $2.4 billion is due in less than one year; $2.7
billion is due in one to three years; $2.1 billion is due in three to five
years; and $3.7 billion is due in more than five years. As previously
discussed, during the first quarter of 2005, the Corporation issued shares
of its common stock valued at $14.4 million to fund a portion of its 2004
obligations under its retirement and employee stock ownership plans. There
have been no other substantive changes to the Corporation's contractual
obligations as reported in the Corporation's Annual Report on Form 10-K for
the year ended December 31, 2004.
OFF-BALANCE SHEET ARRANGEMENTS
------------------------------
At June 30, 2005, there have been no substantive changes with respect to the
Corporation's off-balance sheet activities as disclosed in the Corporation's
2004 Annual Report on Form 10-K. See Note 8 to the Consolidated Financial
Statements for an update of the Corporation's securitization activities in
the second quarter of 2005. The Corporation continues to believe that based
on the off-balance sheet arrangements with which it is presently involved,
such off-balance sheet arrangements neither have, or are reasonably likely
to have, a material impact to its current or future financial condition,
results of operations, liquidity or capital.
CRITICAL ACCOUNTING POLICIES
----------------------------
The Corporation has established various accounting policies which govern the
application of accounting principles generally accepted in the United States
in the preparation of the Corporation's consolidated financial statements.
The significant accounting policies of the Corporation are described in the
footnotes to the consolidated financial statements contained in the
Corporation's Annual Report on Form 10-K and updated as necessary in its
Quarterly Reports on Form 10-Q. Certain accounting policies involve
significant judgments and assumptions by management that may have a material
impact on the carrying value of certain assets and liabilities. Management
considers such accounting policies to be critical accounting policies. The
judgments and assumptions used by management are based on historical
experience and other factors, which are believed to be reasonable under the
circumstances. Because of the nature of judgments and assumptions made by
management, actual results could differ from these judgments and estimates
which could have a material impact on the carrying values of assets and
liabilities and the results of the operations of the Corporation. Management
continues to consider the following to be those accounting policies that
require significant judgments and assumptions:
Allowance for Loan and Lease Losses
-----------------------------------
The allowance for loan and lease losses represents management's estimate of
probable losses inherent in the Corporation's loan and lease portfolio.
Management evaluates the allowance each quarter to determine that it is
adequate to absorb these inherent losses. This evaluation is supported by
a methodology that identifies estimated losses based on assessments of
individual problem loans and historical loss patterns of homogeneous loan
pools. In addition, environmental factors, including economic conditions and
regulatory guidance, unique to each measurement date are also considered.
This reserving methodology has the following components:
Specific Reserve. The Corporation's internal risk rating system is used to
identify loans and leases that meet the criteria as being "impaired" under
the definition in SFAS 114. A loan is impaired when, based on current
information and events, it is probable that a creditor will be unable to
collect all amounts due according to the contractual terms of the loan
agreement. For impaired loans, impairment is measured using one of three
alternatives: (1) the present value of expected future cash flows discounted
at the loan's effective interest rate; (2) the loan's observable market
price, if available; or (3) the fair value of the collateral for collateral
dependent loans and loans for which foreclosure is deemed to be probable.
In general, these loans have been internally identified as credits requiring
management's attention due to underlying problems in the borrower's business
or collateral concerns. Subject to a minimum size, a quarterly review of
these loans is performed to identify the specific reserve necessary to be
allocated to each of these loans. This analysis considers expected future
cash flows, the value of collateral and also other factors that may impact
the borrower's ability to make payments when due.
Collective Loan Impairment. This component of the allowance for loan and
lease losses is comprised of two elements. First, the Corporation makes a
significant number of loans and leases, which due to their underlying similar
characteristics, are assessed for loss as homogeneous pools. Included in the
homogeneous pools are loans and leases from the retail sector and commercial
loans under a certain size that have been excluded from the specific reserve
allocation previously discussed. The Corporation segments the pools by type
of loan or lease and, using historical loss information, estimates a loss
reserve for each pool.
The second element reflects management's recognition of the uncertainty and
imprecision underlying the process of estimating losses. The internal risk
rating system is used to identify those loans within certain industry
segments that based on financial, payment or collateral performance, warrant
closer ongoing monitoring by management. The specific loans mentioned
earlier are excluded from this analysis. Based on management's judgment,
reserve ranges are allocated to industry segments due to environmental
conditions unique to the measurement period. Consideration is given to both
internal and external environmental factors such as economic conditions in
certain geographic or industry segments of the portfolio, economic trends,
risk profile, and portfolio composition. Reserve ranges are then allocated
using estimates of loss exposure that management has identified based on
these economic trends or conditions.
37
The following factors were taken into consideration in determining the
adequacy of the allowance for loan and lease losses at June 30, 2005:
In general, the Corporation's borrowing customers appear to have
successfully managed their businesses through the slower economic
conditions, the economy is improving and the Corporation's customer base
is showing signs of increased business activity as evidenced by the loan
growth in this quarter.
At June 30, 2005, allowances for loan and lease losses continue to be
carried for exposures to manufacturing, healthcare, production
agriculture (including dairy and cropping operations), truck
transportation, accommodation, general contracting, motor vehicle and
parts dealers and the airline industries. The majority of the
commercial charge-offs incurred during the past two years were in these
industry segments. While most loans in these categories are still
performing, the Corporation continues to believe these sectors have been
more adversely affected by the previous economic slowdown. Reduced
revenues causing a declining utilization of the industry's capacity
levels have impacted manufacturing. As a result, collateral values and
the amounts realized through the sale or liquidation of manufacturing
plant and equipment have declined accordingly.
During the second quarter of 2005, the Corporation's commitments to
Shared National Credits were approximately $2.9 billion with usage
averaging around 40%. Many of the Corporation's largest charge-offs
have come from the Shared National Credit portfolio. Although these
factors result in an increased risk profile, as of June 30, 2005 Shared
National Credit nonperforming loans amounted to $4.0 million. The
Corporation's exposure to Shared National Credits is monitored closely
given this lending group's loss experience.
The Corporation's primary lending areas are Wisconsin, Arizona,
Minnesota and Missouri. The Minnesota and Missouri markets continue to
represent relatively new geographic regions for the Corporation. Each
of these regions has cultural and environmental factors that are unique
to them. The uncertainty regarding the inherent losses in their
respective loan portfolios continue to present increased risks which
have been mitigated by the implementation of the Corporation's credit
underwriting and monitoring processes. At June 30, 2005, total
nonperforming loans and leases as a percent of total loans and leases
for the Minnesota and Missouri regions combined was somewhat higher than
the consolidated total of nonperforming loans and leases as a percent
of total consolidated loans and leases.
At June 30, 2005, nonperforming loans and leases amounted to $131.6
million or 0.41% of consolidated loans and leases compared to $130.0
million or 0.42% of consolidated loans and leases at March 31, 2005, and
$132.4 million or 0.45% of consolidated loans and leases at December 31,
2004. At June 30, 2005 nonperforming loans and leases increased
slightly compared to nonperforming loans and leases at March 31, 2005.
The ratio of nonperforming loans and leases to consolidated loans and
leases at June 30, 2005 represents the ninth consecutive quarter that
the Corporation has experienced a decline in that ratio. Nonaccrual
loans and leases continue to be the primary source of nonperforming
loans and leases. Since December 31, 2004, the decline in nonaccrual
commercial loans and leases and nonaccrual residential real estate loans
was offset by increases in nonaccrual commercial real estate loans and
nonaccrual construction and land development loans.
Net charge-offs amounted to $11.9 million or 0.15% of average loans and
leases in the second quarter of 2005 compared to $8.0 million or 0.11%
of average loans and leases in the first quarter of 2005 and $12.8
million or 0.18% of average loans and leases in the fourth quarter of
2004. The lower level of net charge-offs experienced throughout 2004
and the first half of 2005 has to some extent been the result of higher
than normal recoveries. Based on the status of some of the larger
charge-offs recognized in recent quarters, management expects recoveries
will likely return to lower levels in future periods. Recoveries in the
second quarter of 2005 were $0.8 million lower than recoveries in the
first quarter of 2005 and $2.3 million lower than recoveries in the
fourth quarter of 2004. The ratio of recoveries to charge-offs was
26.3% in the second quarter of 2005 which was slightly below the
Corporation's five year historical average ratio of recoveries to
charge-offs of 26.9%. For the six month ended June 30, 2005, the ratio
of recoveries to charge-offs was 32.0%.
38
Management continues to expect the longer term level of nonperforming
loans and leases to be in the range of 50-60 basis points of total loans
and leases and expects net charge-offs to trend to historical levels.
While it is unclear when this will occur, management does not believe
that current net charge-off levels are sustainable indefinitely.
Based on the above loss estimates, management determined its best estimate
of the required allowance for loans and leases. Management's evaluation of
the factors described above resulted in an allowance for loan and lease
losses of $360.1 million or 1.12% of loans and leases outstanding at June 30,
2005. The allowance for loan and lease losses was $358.1 million or 1.21%
of loans and leases outstanding at December 31, 2004 and $357.9 million or
1.32% of loans and leases outstanding at June 30, 2004. Consistent with the
credit quality trends noted above, the provision for loan and lease losses
amounted to $13.7 million and $21.9 million for the three and six months
ended June 30, 2005, respectively. The resulting provisions for loan and
lease losses are the amounts required to establish the allowance for loan and
lease losses at the required level after considering charge-offs and
recoveries. Management recognizes there are significant estimates in the
process and the ultimate losses could be significantly different from those
currently estimated.
The Corporation has not materially changed any aspect of its overall approach
in the determination of the allowance for loan and lease losses. There have
been no material changes in assumptions or estimation techniques as compared
to prior periods that impacted the determination of the current period
allowance. However, on an on-going basis the Corporation continues to refine
the methods used in determining management's best estimate of the allowance
for loan and lease losses.
Capitalized Software and Conversion Costs
-----------------------------------------
Direct costs associated with the production of computer software that will
be licensed externally or used in a service bureau environment are
capitalized. Capitalization of such costs is subject to strict accounting
policy criteria, although the appropriate time to initiate capitalization
requires management judgment. Once the specific capitalized project is put
into production, the software cost is amortized over its estimated useful
life, generally four years. Each quarter, the Corporation performs net
realizable value tests to ensure the assets are recoverable. Such tests
require management judgment as to the future sales and profitability of a
particular product which involves, in some cases, multi-year projections.
Technology changes and changes in customer requirements can have a
significant impact on the recoverability of these assets and can be difficult
to predict. Should significant adverse changes occur, estimates of useful
life may have to be revised or write-offs would be required to recognize
impairment. For the three months ended June 30, 2005 and 2004, the amount
of software costs capitalized amounted to $9.9 million and $10.4 million,
respectively. Amortization expense of software costs amounted to $15.4
million for the three months ended June 30, 2005 compared to $16.7 million
for the three months ended June 30, 2004. For the six months ended June 30,
2005 and 2004, the amount of software costs capitalized amounted to $18.9
million and $20.4 million, respectively. Amortization expense of software
costs amounted to $30.3 million for the six months ended June 30, 2005
compared to $28.1 million for the six months ended June 30, 2004.
Based on a strategic product review performed during the second quarter of
2004, Metavante determined that a certain product had limited growth
potential and that future marketing of the product should be discontinued.
As a result of the strategic product review and net realizable value test on
this product, Metavante determined that the capitalized software associated
with the product was impaired and recorded a write-down. Amortization
expense for the three and six months ended June 30, 2004, includes $4.9
million for the write-down of the capitalized software costs associated with
the impaired product.
Direct costs associated with customer system conversions to the data
processing operations are capitalized and amortized on a straight-line basis
over the terms, generally five to seven years, of the related servicing
contracts.
Capitalization only occurs when management is satisfied that such costs are
recoverable through future operations or penalties (buyout fees) in case of
early termination. For the three months ended June 30, 2005 and 2004, the
amount of conversion costs capitalized amounted to $2.7 million and $2.8
million, respectively. Amortization expense of conversion costs amounted to
$2.8 million and $3.2 million for the three months ended June 30, 2005 and
2004, respectively. For the six months ended June 30, 2005 and 2004, the
amount of conversion costs capitalized amounted to $5.6 million and $4.4
million, respectively. Amortization expense of conversion costs amounted to
$5.6 million and $6.5 million for the six months ended June 30, 2005 and
2004, respectively.
39
Net unamortized costs were ($ in millions):
June 30,
-------------------------
2005 2004
----------- -----------
Software $ 151.6 $ 139.1
Conversions 26.5 28.6
----------- -----------
Total $ 178.1 $ 167.7
=========== ===========
The Corporation has not substantively changed any aspect to its overall
approach in the determination of the amount of costs that are capitalized for
software development or conversion activities. There have been no material
changes in assumptions or estimation techniques as compared to prior periods
that impacted the determination of the periodic amortization of such costs.
Financial Asset Sales and Securitizations
-----------------------------------------
The Corporation utilizes certain financing arrangements to meet its balance
sheet management, funding, liquidity, and market or credit risk management
needs. The majority of these activities are basic term or revolving
securitization vehicles. These vehicles are generally funded through term-
amortizing debt structures or with short-term commercial paper designed to
be paid off based on the underlying cash flows of the assets securitized.
These financing entities are contractually limited to a narrow range of
activities that facilitate the transfer of or access to various types of
assets or financial instruments. In certain situations, the Corporation
provides liquidity and/or loss protection agreements. In determining whether
the financing entity should be consolidated, the Corporation considers
whether the entity is a qualifying special-purpose entity ("QSPE") as defined
in Statement of Financial Accounting Standards ("SFAS") No. 140, Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities. For non-consolidation, a QSPE must be demonstrably distinct,
have significantly limited permitted activities, hold assets that are
restricted to transferred financial assets and related assets, and can sell
or dispose of non-cash financial assets only in response to specified
conditions.
In December 2003, the Corporation adopted Financial Accounting Standards
Board Interpretation No. 46 ("FIN 46R"), Consolidation of Variable Interest
Entities (revised December 2003). This interpretation addresses
consolidation by business enterprises of variable interest entities. Under
current practice, entities generally have been included in consolidated
financial statements because they are controlled through voting interests.
This interpretation explains how to identify variable interest entities and
how an entity assesses its interests in a variable interest entity to decide
whether to consolidate that entity. FIN 46R requires existing unconsolidated
variable interest entities to be consolidated by their primary beneficiaries
if the entities do not effectively disperse risks among parties involved.
Variable interest entities that effectively disperse risks will not be
consolidated unless a single party holds an interest or combination of
interests that effectively recombines risks that were previously dispersed.
Transferors to QSPEs and "grandfathered" QSPEs subject to the reporting
requirements of SFAS 140 are outside the scope of FIN 46R and do not
consolidate those entities. FIN 46R also requires certain disclosures by the
primary beneficiary of a variable interest entity or an entity that holds a
significant variable interest in a variable interest entity.
With respect to the Corporation's securitization activities, the adoption of
FIN 46R did not have an impact on its consolidated financial statements
because its transfers are generally to QSPEs.
The Corporation sells financial assets in a two-step process that results in
a surrender of control over the assets as evidenced by true-sale opinions
from legal counsel, to unconsolidated entities that securitize the assets.
The Corporation retains interests in the securitized assets in the form of
interest-only strips and a cash reserve account. Gain or loss on sale of the
assets depends in part on the carrying amount assigned to the assets sold
allocated between the asset sold and retained interests based on their
relative fair values at the date of transfer. The value of the retained
interests is based on the present value of expected cash flows estimated
using management's best estimates of the key assumptions - credit losses,
prepayment speeds, forward yield curves and discount rates commensurate with
the risks involved. Actual results can differ from expected results.
The Corporation reviews the carrying values of the retained interests monthly
to determine if there is a decline in value that is other than temporary and
periodically reviews the propriety of the assumptions used based on current
historical experience as well as the sensitivities of the carrying value of
the retained interests to adverse changes in the key assumptions. The
Corporation believes that its estimates result in a reasonable carrying value
of the retained interests.
The Corporation regularly sells automobile loans to an unconsolidated multi-
seller special purpose entity commercial paper conduit in securitization
transactions in which servicing responsibilities and subordinated interests
are retained. The outstanding balances of automobile loans sold in these
securitization transactions were $950.4 million at June 30, 2005. At June
30, 2005 the carrying amount of retained interests amounted to $28.7 million.
40
The Corporation also sells, from time to time, debt securities classified as
available for sale that are highly rated to an unconsolidated bankruptcy
remote QSPE whose activities are limited to issuing highly rated asset-backed
commercial paper with maturities up to 180 days which is used to finance the
purchase of the investment securities. The Corporation provides liquidity
back-up in the form of Liquidity Purchase Agreements. In addition, the
Corporation acts as counterparty to interest rate swaps that enable the QSPE
to hedge its interest rate risk. Such swaps are designated as free-standing
derivative financial instruments in the Corporation's Consolidated Balance
Sheet.
At June 30, 2005, highly rated investment securities in the amount of $274.5
million were outstanding in the QSPE to support the outstanding commercial
paper.
Income Taxes
------------
Income taxes are accounted for using the asset and liability method. Under
this method, deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax basis. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The
effect on tax assets and liabilities of a change in tax rates is recognized
in the income statement in the period that includes the enactment date.
The determination of current and deferred income taxes is based on complex
analyses of many factors, including interpretation of Federal and state
income tax laws, the difference between tax and financial reporting basis of
assets and liabilities (temporary differences), estimates of amounts
currently due or owed, such as the timing of reversals of temporary
differences and current accounting standards. The Federal and state taxing
authorities who make assessments based on their determination of tax laws
periodically review the Corporation's interpretation of Federal and state
income tax laws. Tax liabilities could differ significantly from the
estimates and interpretations used in determining the current and deferred
income tax liabilities based on the completion of taxing authority
examinations.
FORWARD-LOOKING STATEMENTS
--------------------------
Items 2 and 3 of this Form 10-Q, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Quantitative and
Qualitative Disclosures about Market Risk," respectively, contain forward-
looking statements within the meaning of the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. Such forward-looking
statements include, without limitation, statements regarding expected
financial and operating activities and results which are preceded by words
such as "expects", "anticipates" or "believes". Such statements are subject
to important factors that could cause the Corporation's actual results to
differ materially from those anticipated by the forward-looking statements.
These factors include those referenced in Item 1, Business, of the
Corporation's Annual Report on Form 10-K for the period ending December 31,
2004 under the heading "Forward-Looking Statements" and as may be described
from time to time in the Corporation's subsequent SEC filings, and such
factors are incorporated herein by reference.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following updated information should be read in conjunction with the
Corporation's 2004 Annual Report on Form 10-K. Updated information regarding
the Corporation's use of derivative financial instruments is contained in
Note 11, Notes to Financial Statements contained in Item 1 herein.
Market risk arises from exposure to changes in interest rates, exchange
rates, commodity prices, and other relevant market rate or price risk. The
Corporation faces market risk through trading and other than trading
activities. While market risk that arises from trading activities in the
form of foreign exchange and interest rate risk is immaterial to the
Corporation, market risk from other than trading activities in the form of
interest rate risk is measured and managed through a number of methods.
Interest Rate Risk
------------------
The Corporation uses financial modeling techniques to identify potential
changes in income under a variety of possible interest rate scenarios.
Financial institutions, by their nature, bear interest rate and liquidity
risk as a necessary part of the business of managing financial assets and
liabilities. The Corporation has designed strategies to limit these risks
within prudent parameters and identify appropriate risk/reward tradeoffs in
the financial structure of the balance sheet.
The financial models identify the specific cash flows, repricing timing and
embedded option characteristics of the assets and liabilities held by the
Corporation. Policies are in place to assure that neither earnings nor fair
value at risk exceed appropriate limits. The use of a limited array of
derivative financial instruments has allowed the Corporation to achieve the
desired balance sheet repricing structure while simultaneously meeting the
desired objectives of both its borrowing and depositing customers.
The models used include measures of the expected repricing characteristics
of administered rate (NOW, savings and money market accounts) and non-rate
related products (demand deposit accounts, other assets and other
liabilities). These measures recognize the relative insensitivity of these
accounts to changes in market interest rates, as demonstrated through current
and historical experiences. However, during the second quarter of 2003, the
Corporation increased the proportion of these accounts modeled as rate
sensitive, in order to recognize the instability of some of the recent
balance growth in these accounts. This modeling treatment will be maintained
until the incremental balances can be observed across a more complete
interest rate cycle. In addition to contractual payment information for most
other assets and liabilities, the models also include estimates of expected
prepayment characteristics for those items that are likely to materially
change their payment structures in different rate environments, including
residential mortgage products, certain commercial and commercial real estate
loans and certain mortgage-related securities. Estimates for these
sensitivities are based on industry assessments and are substantially driven
by the differential between the contractual coupon of the item and current
market rates for similar products.
This information is incorporated into a model that allows the projection of
future income levels in several different interest rate environments.
Earnings at risk are calculated by modeling income in an environment where
rates remain constant, and comparing this result to income in a different
rate environment, and then dividing this difference by the Corporation's
budgeted operating income before taxes for the calendar year. Since future
interest rate moves are difficult to predict, the following table presents
two potential scenarios - a gradual increase of 100bp across the entire yield
curve over the course of the year (+25bp per quarter), and a gradual decrease
of 100bp across the entire yield curve over the course of the year (-25bp per
quarter) for the balance sheet as of the indicated dates:
Impact to Annual Pretax Income as of
--------------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
2005 2005 2004 2004 2004
------------ ------------ ------------ ------------ ------------
Hypothetical Change in Interest Rate
------------------------------------
100 basis point gradual:
Rise in rates 0.3 % (0.2)% (0.1)% 0.4 % (0.6)%
Decline in rates (0.6)% 0.3 % 0.2 % (0.4)% 0.6 %
These results are based solely on the modeled parallel changes in market
rates, and do not reflect the earnings sensitivity that may arise from other
factors such as changes in the shape of the yield curve and changes in spread
between key market rates. These results also do not include any management
action to mitigate potential income variances within the simulation process.
Such action could potentially include, but would not be limited to,
adjustments to the repricing characteristics of any on- or off-balance sheet
item with regard to short-term rate projections and current market value
assessments.
Actual results will differ from simulated results due to the timing,
magnitude, and frequency of interest rate changes as well as changes in
market conditions and management strategies.
Another component of interest rate risk is measuring the fair value at risk
for a given change in market interest rates. The Corporation also uses
computer modeling techniques to determine the present value of all asset and
liability cash flows (both on- and off-balance sheet), adjusted for
prepayment expectations, using a market discount rate. The net change in the
present value of the asset and liability cash flows in different market rate
environments is the amount of fair value at risk from those rate movements.
As of June 30, 2005 the fair value of equity at risk for a gradual 100bp
shift in rates was no more than 2.0% of the market value of the Corporation.
Equity Risk
-----------
In addition to interest rate risk, the Corporation incurs market risk in the
form of equity risk. The Corporation invests directly and indirectly through
investment funds, in private medium-sized companies to help establish new
businesses or recapitalize existing ones. Exposure to the change in equity
values for the companies that are held in their portfolio exists. However,
fair values are difficult to determine until an actual sale or liquidation
transaction actually occurs. At June 30, 2005 the carrying value of total
active capital markets investments amounted to approximately $32.7 million.
42
As of June 30, 2005, M&I Trust Services administered $78.5 billion in assets
and directly managed a portfolio of $18.5 billion. Exposure exists to
changes in equity values due to the fact that fee income is partially based
on equity balances. While this exposure is present, quantification remains
difficult due to the number of other variables affecting fee income.
Interest rate changes can also have an effect on fee income for the above
stated reasons.
ITEM 4. CONTROLS AND PROCEDURES
We maintain a set of disclosure controls and procedures that are designed to
ensure that information required to be disclosed by us in the reports filed
by us under the Securities Exchange Act of 1934, as amended, is recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms. We carried out an evaluation, under the supervision
and with the participation of our management, including our Chief Executive
Officer and our Senior Vice President and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Rule 13a-15 of the Exchange Act. Based on that
evaluation, our Chief Executive Officer and our Senior Vice President and
Chief Financial Officer concluded that our disclosure controls and procedures
are effective as of the end of the period covered by this report.
There have been no changes in our internal control over financial reporting
identified in connection with the evaluation discussed above that occurred
during our last fiscal quarter that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
43
PART II - OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table reflects the purchases of Marshall & Ilsley Corporation
stock for the specified period:
Total Number of Maximum Number
Shares Purchased of Shares that
as Part of May Yet Be
Total Number Average of Publicly Purchased Under
of Shares Price Paid Announced Plans the Plans
Period Purchased(1) per Share or Programs or Programs
----------------- ------------- ----------- ------------------ -----------------
January 1 to
January 31, 2005 18,100 $ 43.35 -- 12,000,000
February 1 to
February 28, 2005 13,523 $ 37.77 -- 12,000,000
March 1 to
March 31, 2005 1,000 $ 30.32 -- 12,000,000
April 1 to
April 30, 2005 6,048 $ 41.97 -- 12,000,000
May 1 to
May 31, 2005 1,108 $ 41.89 -- 12,000,000
June 1 to
June 30, 2005 4,888 $ 43.51 -- 12,000,000
------------ --------- ---------------
Total 51,532 $ 41.79 --
============ ========= ===============
The Corporation's Share Repurchase Program was publicly reconfirmed in April
2004 and again in April 2005. The Share Repurchase Program authorizes the
purchase of up to 12 million shares annually and renews each year at that
level unless changed or terminated by subsequent Board action.
(1) Includes shares purchased by rabbi trusts pursuant to nonqualified
deferred compensation plans.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Corporation held its Annual Meeting of Shareholders on April 26,
2005.
(b) Votes cast for the election of five directors to serve until the 2008
Annual Meeting of Shareholders are as follows:
Director For Withheld Abstentions Non-Vote
--------------------- ------------- ------------- ---------------- -------------
Andrew N. Baur 182,359,417 6,515,109 -- --
John W. Daniels, Jr. 181,912,241 6,962,285 -- --
John A. Mellowes 176,385,088 12,489,438 -- --
Robert J. O'Toole 186,210,789 2,663,737 -- --
John S. Shiely 186,234,471 2,640,055 -- --
44
The continuing directors of the Corporation are as follows:
Richard A. Abdoo Jon F. Chait
Ted D. Kellner Bruce E. Jacobs
Katharine C. Lyall Dennis J. Kuester
Peter M. Platten, III Edward L. Meyer, Jr.
James A. Urdan San W. Orr, Jr.
James B. Wigdale Debra S. Waller
George E. Wardeberg
(c) Votes cast for the ratification of the appointment of Deloitte &
Touche LLP to audit the statements of the Company for the fiscal year
ending December 31, 2005 are as follows:
For Withheld Abstentions Non-Vote
------------- ------------- ---------------- -------------
Ratification of
Auditors 184,696,099 2,681,021 1,497,406 --
ITEM 6. EXHIBITS
Exhibit 10(a) - Form of Restricted Stock Agreement.
Exhibit 10(b) - Change of Control Agreement dated as of
January 12, 2005 between the Corporation
and Ronald E. Smith.
Exhibit 11 - Statement Regarding Computation of Earnings
Per Share, Incorporated by Reference to
NOTE 4 of Notes to Financial Statements
contained in Item 1 - Financial Statements
(unaudited) of Part 1 - Financial Information
herein.
Exhibit 12 - Statement Regarding Computation of Ratio of
Earnings to Fixed Charges
Exhibit 31(a) - Certification of Chief Executive Officer
pursuant to Rule 13a-14(a) under the Securities
Exchange Act of 1934, as amended.
Exhibit 31(b) - Certification of Chief Financial Officer
pursuant to Rule 13a-14(a) under the Securities
Exchange Act of 1934, as amended.
Exhibit 32(a) - Certification of Chief Executive Officer
pursuant to 18 U.S.C. Section 1350.
Exhibit 32(b) - Certification of Chief Financial Officer
pursuant to 18 U.S.C. Section 1350.
45
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MARSHALL & ILSLEY CORPORATION
(Registrant)
/s/ Patricia R. Justiliano
__________________________________
Patricia R. Justiliano
Senior Vice President and
Corporate Controller
(Chief Accounting Officer)
/s/ James E. Sandy
__________________________________
James E. Sandy
Vice President
August 9, 2005
46
EXHIBIT INDEX
-------------
Exhibit Number Description of Exhibit
______________ ____________________________________________
(10)(a) Form of Restricted Stock Agreement.
(10)(b) Change of Control Agreement dated as of
January 12, 2005 between the Corporation
and Ronald E. Smith.
(11) Statement Regarding Computation of Earnings
Per Share, Incorporated by Reference to
NOTE 4 of Notes to Financial Statements
contained in Item 1 - Financial Statements
(unaudited) of Part 1 - Financial Information
herein.
(12) Statement Regarding Computation of Ratio
of Earnings to Fixed Charges.
(31)(a) Certification of Chief Executive Officer
pursuant to Rule 13a-14(a) under the
Securities Exchange Act of 1934, as amended.
(31)(b) Certification of Chief Financial Officer
pursuant to Rule 13a-14(a) under the
Securities Exchange Act of 1934, as amended.
(32)(a) Certification of Chief Executive Officer
pursuant to 18 U.S.C. Section 1350.
(32)(b) Certification of Chief Financial Officer
pursuant to 18 U.S.C. Section 1350.