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 September 30, 2006
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 a large
accelerated filer, an accelerated filer, or a non-accelerated filer. See
definition of "accelerated filer and large accelerated filer" in Rule 12b-
2 of the Exchange Act. (Check one): Large accelerated filer [X]
Accelerated filer [ ] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company
(as defined by Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Outstanding at
Class October 31, 2006
----- ----------------
Common Stock, $1.00 Par Value 255,108,173
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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)
As Adjusted Note 12
---------------------------
September 30, December 31, September 30,
2006 2005 2005
-------------- ------------- --------------
Assets
------
Cash and cash equivalents:
Cash and due from banks $ 1,250,479 $ 1,155,263 $ 1,079,664
Federal funds sold and security resale agreements 200,305 209,869 252,183
Money market funds 36,291 49,219 40,264
------------- ------------- -------------
Total cash and cash equivalents 1,487,075 1,414,351 1,372,111
Investment securities:
Trading securities, at market value 45,306 29,779 28,414
Interest bearing deposits at other banks 17,141 40,659 13,551
Available for sale, at market value 6,820,115 5,701,703 5,675,681
Held to maturity, market value $542,514
($638,135 December 31, 2005 and
$679,996 September 30, 2005) 528,383 618,554 654,214
------------- ------------- -------------
Total investment securities 7,410,945 6,390,695 6,371,860
Loans held for sale 161,505 277,847 225,570
Loans and leases:
Loans and leases, net of unearned income 41,103,547 33,889,066 32,880,738
Less: Allowance for loan and lease losses 417,375 363,769 362,257
------------- ------------- -------------
Net loans and leases 40,686,172 33,525,297 32,518,481
Premises and equipment, net 567,622 490,687 469,062
Goodwill and other intangibles 3,221,054 2,461,461 2,387,539
Accrued interest and other assets 1,948,384 1,652,379 1,650,670
------------- ------------- -------------
Total Assets $ 55,482,757 $ 46,212,717 $ 44,995,293
============= ============= =============
Liabilities and Shareholders' Equity
------------------------------------
Deposits:
Noninterest bearing $ 5,565,420 $ 5,525,019 $ 5,224,241
Interest bearing 27,894,324 22,149,202 21,767,120
------------- ------------- -------------
Total deposits 33,459,744 27,674,221 26,991,361
Federal funds purchased and security repurchase agreements 2,580,797 2,327,258 2,376,198
Other short-term borrowings 4,425,557 3,299,476 3,120,939
Accrued expenses and other liabilities 1,571,608 1,507,621 1,520,023
Long-term borrowings 7,488,993 6,668,670 6,374,864
------------- ------------- -------------
Total liabilities 49,526,699 41,477,246 40,383,385
Shareholders' equity:
---------------------
Series A convertible preferred stock, $1.00 par value;
2,000,000 shares authorized -- -- --
Common stock, $1.00 par value; 261,972,424 shares issued
(244,587,222 shares at December 31, 2005 and 244,432,222
shares at September 30, 2005) 261,972 244,587 244,432
Additional paid-in capital 1,752,275 970,739 945,219
Retained earnings 4,246,875 3,871,614 3,750,349
Accumulated other comprehensive (loss) income,
net of related taxes (43,102) (37,291) 6,013
Less: Treasury stock, at cost: 7,146,762 shares
(9,148,493 December 31, 2005 and
9,985,846 September 30, 2005) 226,203 277,423 302,796
Deferred compensation 35,759 36,755 31,309
------------- ------------- -------------
Total shareholders' equity 5,956,058 4,735,471 4,611,908
------------- ------------- -------------
Total Liabilities and Shareholders' Equity $ 55,482,757 $ 46,212,717 $ 44,995,293
============= ============= =============
See notes to financial statements.
3
MARSHALL & ILSLEY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
($000's except per share data)
As Adjusted
Note 12
---------------
Three Months Three Months
Ended Ended
September 30, September 30,
2006 2005
--------------- ---------------
Interest and fee income
-----------------------
Loans and leases $ 766,679 $ 510,790
Investment securities:
Taxable 73,512 53,836
Exempt from federal income taxes 15,220 16,388
Trading securities 174 58
Short-term investments 4,418 2,651
------------- -------------
Total interest and fee income 860,003 583,723
Interest expense
----------------
Deposits 290,648 145,473
Short-term borrowings 49,734 27,952
Long-term borrowings 126,445 88,504
------------- -------------
Total interest expense 466,827 261,929
Net interest income 393,176 321,794
Provision for loan and lease losses 10,250 9,949
------------- -------------
Net interest income after provision for loan and lease losses 382,926 311,845
Other income
------------
Data processing services 339,538 295,977
Wealth management 54,589 48,286
Service charges on deposits 25,727 23,599
Gains on sale of mortgage loans 11,668 13,925
Other mortgage banking revenue 1,731 1,840
Net investment securities gains 4,513 7,358
Life insurance revenue 7,280 6,433
Net derivative gains - discontinued hedges 43,805 --
Other 32,267 32,722
------------- -------------
Total other income 521,118 430,140
Other expense
-------------
Salaries and employee benefits 314,345 278,025
Net occupancy 26,657 22,290
Equipment 35,170 32,317
Software expenses 17,896 14,997
Processing charges 25,643 16,158
Supplies and printing 6,782 5,624
Professional services 16,242 14,320
Shipping and handling 21,432 16,882
Amortization of intangibles 12,145 6,106
Other 70,306 63,831
------------- -------------
Total other expense 546,618 470,550
------------- -------------
Income before income taxes 357,426 271,435
Provision for income taxes 118,559 91,761
------------- -------------
Net income $ 238,867 $ 179,674
============= =============
Net income per common share
---------------------------
Basic $ 0.94 $ 0.77
Diluted 0.92 0.75
Dividends paid per common share $ 0.270 $ 0.240
Weighted average common shares outstanding (000's):
---------------------------------------------------
Basic 253,799 232,590
Diluted 259,667 238,162
See notes to financial statements.
4
MARSHALL & ILSLEY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
($000's except per share data)
As Adjusted
Note 12
---------------
Nine Months Nine Months
Ended Ended
September 30, September 30,
2006 2005
--------------- ---------------
Interest and fee income
-----------------------
Loans and leases $ 2,074,062 $ 1,404,485
Investment securities:
Taxable 202,288 159,044
Exempt from federal income taxes 46,968 47,898
Trading securities 442 174
Short-term investments 12,994 6,289
------------- -------------
Total interest and fee income 2,336,754 1,617,890
Interest expense
----------------
Deposits 760,940 371,766
Short-term borrowings 132,193 78,305
Long-term borrowings 348,527 234,162
------------- -------------
Total interest expense 1,241,660 684,233
Net interest income 1,095,094 933,657
Provision for loan and lease losses 32,298 31,800
------------- -------------
Net interest income after provision for loan and lease losses 1,062,796 901,857
Other income
------------
Data processing services 1,027,494 861,274
Wealth management 163,697 143,483
Service charges on deposits 73,282 70,655
Gains on sale of mortgage loans 32,628 30,351
Other mortgage banking revenue 5,507 4,785
Net investment securities gains 6,603 42,634
Life insurance revenue 21,654 20,697
Net derivative gains - discontinued hedges 1,788 --
Other 100,311 93,042
------------- -------------
Total other income 1,432,964 1,266,921
Other expense
-------------
Salaries and employee benefits 898,808 792,076
Net occupancy 77,236 65,443
Equipment 106,222 93,403
Software expenses 52,682 42,492
Processing charges 82,242 44,600
Supplies and printing 19,377 17,911
Professional services 41,727 38,008
Shipping and handling 67,003 53,268
Amortization of intangibles 33,024 22,304
Other 217,686 203,889
------------- -------------
Total other expense 1,596,007 1,373,394
------------- -------------
Income before income taxes 899,753 795,384
Provision for income taxes 297,272 266,649
------------- -------------
Net income $ 602,481 $ 528,735
============= =============
Net income per common share
---------------------------
Basic $ 2.44 $ 2.30
Diluted 2.38 2.25
Dividends paid per common share $ 0.780 $ 0.690
Weighted average common shares outstanding (000's):
---------------------------------------------------
Basic 247,361 229,611
Diluted 252,751 234,847
See notes to financial statements.
5
MARSHALL & ILSLEY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
($000's)
Nine Months Nine Months
Ended Ended
September 30, September 30,
2006 2005
--------------- ---------------
Net Cash Provided by Operating Activities $ 745,155 $ 456,187
Cash Flows From Investing Activities:
-------------------------------------
Proceeds from sales of securities available for sale 587,685 91,618
Proceeds from maturities of securities available for sale 908,524 929,455
Proceeds from maturities of securities held to maturity 91,171 72,658
Purchases of securities available for sale (1,799,606) (1,326,992)
Net increase in loans (3,426,859) (3,508,934)
Purchases of assets to be leased (201,325) (199,818)
Principal payments on lease receivables 172,444 161,294
Purchases of premises and equipment, net (79,034) (51,165)
Acquisitions, net of cash and cash equivalents acquired (129,641) (34,911)
Other 1,996 7,878
------------- -------------
Net cash used in investing activities (3,874,645) (3,858,917)
Cash Flows From Financing Activities:
-------------------------------------
Net increase in deposits 2,077,817 564,440
Proceeds from issuance of commercial paper 3,667,971 4,317,523
Principal payments on commercial paper (3,533,509) (4,283,274)
Net increase in other short-term borrowings 434,388 1,429,942
Proceeds from issuance of long-term borrowings 1,948,752 2,479,979
Payments of long-term borrowings (1,219,679) (602,244)
Dividends paid (192,946) (158,598)
Purchases of common stock (41,791) --
Proceeds from exercise of stock options 69,010 46,737
Other (7,799) (7,802)
------------- -------------
Net cash provided by financing activities 3,202,214 3,786,703
------------- -------------
Net increase in cash and cash equivalents 72,724 383,973
Cash and cash equivalents, beginning of year 1,414,351 988,138
------------- -------------
Cash and cash equivalents, end of period $ 1,487,075 $ 1,372,111
============= =============
Supplemental cash flow information:
-----------------------------------
Cash paid during the period for:
Interest $ 1,147,728 $ 628,729
Income taxes 269,234 275,879
See notes to financial statements.
6
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements
September 30, 2006 & 2005 (Unaudited)
1.The accompanying unaudited consolidated financial statements should be
read in conjunction with Marshall & Ilsley Corporation's ("M&I" or
"Corporation") Annual Report on Form 10-K for the year ended December
31, 2005. The unaudited financial information included in this report
reflects all adjustments consisting of normal recurring accruals and the
adjustments as discussed in Note 12 which are necessary for a fair
statement of the financial position and results of operations as of and
for the three and nine months ended September 30, 2006 and 2005. The
results of operations for the three and nine months ended September 30,
2006 and 2005 are not necessarily indicative of results to be expected
for the entire year. Certain amounts in the 2005 consolidated financial
statements and analyses have been reclassified to conform with the 2006
presentation.
2.New Accounting Pronouncements
In October 2006, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standard No. 158, Employers'
Accounting for Defined Benefit Pension and Other Postretirement Plans,
an amendment of FASB Statements No. 87, 88, 106 and 132(R) ("SFAS 158").
SFAS 158 applies to all plan sponsors who offer defined benefit
postretirement benefit plans and requires an entity to recognize in its
statement of financial position an asset for a defined benefit
postretirement plan's overfunded status or a liability for a plan's
underfunded status; to measure a defined benefit postretirement plan's
assets and obligations that determine its funded status as of the end of
the Company's fiscal year; and to recognize changes in the funded status
of a defined benefit postretirement plan as a component of other
comprehensive income in the year in which the changes occur. SFAS 158
does not change the amount of net periodic benefit cost included in net
income or change the various measurement conventions associated with
postretirement benefit plan accounting.
The requirement to recognize the funded status of a defined benefit
postretirement plan is effective for the Corporation on December 31,
2006. The requirement to measure plan assets and benefit obligations as
of the date of the Corporation's fiscal year-end statement of financial
position is effective on December 31, 2008. The impact of adopting SFAS
158 for the Corporation's defined benefit health plan, which provides
health care benefits to eligible current and retired employees, is not
expected to be material.
In October 2006, the FASB issued Staff Position (FSP)123R-5, Amendment
of FASB Staff Position FAS 123(R)-1. This FSP provides that for
instruments that were originally issued as employee compensation and
then modified solely to reflect an equity restructuring that occurs when
the holders are no longer employees, no change in the recognition or the
measurement (due to a change in classification) of those instruments is
required if: (1) there is no increase in fair value of the award or the
antidilution provision is not added to the terms of the award in
contemplation of an equity restructuring; and (2) all holders of the
same class of equity instruments are treated in the same manner. This
FSP did not impact the Corporation, as its accounting policy was already
consistent with the FSPs provisions.
In September, 2006, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 108 ("SAB 108"), which provides guidance
regarding the process of quantifying financial statement misstatements
and addresses the diversity in practice in quantifying financial
statement misstatements and the potential under current practice for the
build up of improper amounts on the balance sheet.
The techniques most commonly used in practice to accumulate and quantify
misstatements are generally referred to as the "rollover" and "iron
curtain" approaches. The rollover approach quantifies a misstatement
based on the amount of the error originating in the current year income
statement. This approach ignores the effect of correcting the portion
of the current year balance sheet misstatement that originated in prior
years. The iron curtain approach quantifies a misstatement based on the
effects of correcting the misstatement existing in the balance sheet at
the end of the current year, irrespective of the misstatement's year(s)
of origination. This approach ignores the effect on the current period
income statement.
7
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2006 & 2005 (Unaudited)
The SEC staff has indicated in SAB 108 that it does not believe that the
exclusive reliance on either the rollover or iron curtain approach
appropriately quantifies all misstatements that could be material to
users of financial statements. The staff believes registrants must
quantify the impact of correcting all misstatements, including both the
carryover and reversing effects of prior year misstatements, on the
current year financial statements. The staff believes that this can be
accomplished by quantifying an error under both the rollover and iron
curtain approaches as described above and by evaluating the error
measured under each approach. Early application of this guidance is
encouraged and application is required beginning with the first fiscal
year ending after November 15, 2006. The Corporation elected early
application of the guidance contained in SAB 108. See Note 3.
In September 2006, the FASB issued Statement of Financial Accounting
Standard No. 157, Fair Value Measurements ("SFAS 157"). SFAS 157
provides enhanced guidance for using fair value to measure assets and
liabilities. The standard applies whenever other standards require (or
permit) assets or liabilities to be measured at fair value. The
standard does not expand the use of fair value in any new circumstances.
Under the standard, fair value refers to the price that would be
received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants in the market in which the
reporting entity is engaged. SFAS 157 will be effective for the Company
on January 1, 2008. The Corporation is currently evaluating the
financial statement impact, if any, of adopting SFAS 157.
In July 2006, the FASB issued Staff Position FSP-FAS 13-2, Accounting
for a Change in the Timing of Cash Flows Related to Income Taxes
Generated by a Leveraged Lease Transaction. FSP-FAS 13-2 will require
companies to treat a change or projected change in the timing of cash
flows relating to income taxes in a leveraged lease transaction as a
change of an important assumption, requiring a recalculation in
accordance with FASB No. 13, Accounting for Leases. FSP-FAS 13-2 is
effective January 1, 2007. The adoption of FSP-FAS 13-2 will have no
impact, as the Corporation has not entered into any leveraged lease
transactions.
In June 2006, the Financial Accounting Standards Board issued FASB
Interpretation No. 48 ("FIN 48"), Accounting for Uncertainty in Income
Taxes - an interpretation of FASB Statement No. 109. FIN 48 clarifies
the accounting for uncertainty in income taxes recognized in financial
statements in accordance with FASB Statement No. 109, Accounting for
Income Taxes. FIN 48 prescribes a recognition threshold and
measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax
return. FIN 48 also provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure and
transition.
The provisions of FIN 48 will be effective beginning January 1, 2007,
with the cumulative effect of the change in accounting principle
recorded as an adjustment to opening retained earnings. The Corporation
is currently evaluating the financial statement impact, if any, of
adopting FIN 48.
On June 28, 2006, the FASB ratified EITF Issue No. 06-3, How Taxes
Collected from Customers and Remitted to Governmental Authorities Should
Be Presented in the Income Statement (That Is, Gross versus Net
Presentation). Certain taxes such as sales taxes and other excise taxes
are levied by various taxing authorities based on sales activity.
Although generally levied on the purchaser of the goods or services, the
selling party usually collects and remits the sales tax to the
government. However, in certain jurisdictions, sales taxes are levied
on sellers of the goods and services as opposed to the purchasers.
Under this EITF consensus these taxes may be presented gross as revenue
and an offsetting expense or may be presented net and excluded from
revenue. The guidance in this EITF consensus will be effective January
1, 2007 with early application permitted. This EITF consensus will not
impact the Corporation's results of operations or financial position and
the Corporation will continue to report these taxes on a net basis.
Taxes subject to this consensus primarily relate to the Corporation's
data processing subsidiary, Metavante Corporation ("Metavante").
8
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2006 & 2005 (Unaudited)
In March 2006, the FASB issued Statement of Financial Accounting
Standard No. 156, Accounting for Servicing of Financial Assets - an
amendment of FASB Statement No. 140 ("SFAS 156"). This statement
amends FASB No. 140, Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities, which requires an entity to
recognize a servicing asset or servicing liability each time it
undertakes an obligation to service a financial asset by entering into a
servicing contract in certain situations. SFAS 156 requires that all
separately recognized servicing assets and servicing liabilities be
initially measured at fair value, if practicable. This statement
permits the subsequent measurement of servicing assets and servicing
liabilities using either a fair value method or an amortization method.
The standard permits a one-time reclassification of available-for-sale
securities to trading securities by entities with recognized servicing
rights, without calling into question the treatment of other available-
for-sale securities under Statement 115, provided that the available-
for-sale securities are identified in some manner as offsetting the
entity's exposure to changes in fair value of servicing assets or
servicing liabilities that a servicer elects to subsequently measure at
fair value. The Corporation will be required to adopt SFAS 156
beginning January 1, 2007. Management believes that the adoption of
this standard will not have a material impact on the Corporation's
results of operations or financial position.
In February 2006, the FASB issued Statement of Financial Accounting
Standards No. 155, Accounting for Certain Hybrid Financial Instruments -
an amendment of FASB Statements No. 133 and 140 ("SFAS 155"). This
statement amends FASB Statements No. 133, Accounting for Derivative
Instruments and Hedging Activities, and No. 140, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities. SFAS 155 will require the Corporation to evaluate
interests in securitized financial assets acquired after the statement's
effective date to identify interests that are freestanding derivatives
or that are hybrid financial instruments that contain an embedded
derivative requiring bifurcation. SFAS 155 permits fair value
remeasurement for any hybrid financial instrument that contains an
embedded derivative that otherwise would require bifurcation. The
amended rule also clarifies which interest-only strips and principal-
only strips are not subject to the requirements of SFAS 133 and further
clarifies that concentrations of credit risk in the form of
subordination are not embedded derivatives. SFAS 155 also amends FASB
Statement No. 140 to eliminate the prohibition on a qualifying special-
purpose entity from holding a derivative financial instrument that
pertains to a beneficial interest other than another derivative
financial instrument.
In October 2006, the FASB began deliberating an amendment of SFAS 155,
which may provide a narrow scope exception for securitized interests (1)
that only contain an embedded derivative that is tied to the prepayment
risk of the underlying prepayable financial assets, and (2) where the
investor does not control the right to accelerate the settlement. The
Corporation will be required to adopt SFAS 155 for all financial
instruments acquired or issued after January 1, 2007. The Corporation
is currently evaluating the financial statement impact, if any, of
adopting SFAS 155.
3.Net derivative gains - discontinued hedges
The Corporation utilizes interest rate swaps to hedge its risk in
connection with certain financial instruments. The Corporation had
applied hedge accounting under Statement of Financial Accounting
Standards No. 133 ("SFAS 133"), Accounting for Derivative Instruments
and Hedging Activities to these transactions from inception. Due to the
recent expansion of certain highly technical interpretations of SFAS
133, specifically hedge designation under the "matched-term" method,
interest rate swaps designated as fair value hedges with an aggregate
notional amount of $1,864.5 million and negative fair value of $24.9
million and interest rate swaps designated as cash flow hedges with an
aggregate notional amount of $1,300.0 million and negative fair value of
$26.8 million at September 30, 2006 did not qualify for hedge
accounting. As a result, any fluctuation in the fair value of the
derivatives should have been recorded through the income statement with
no corresponding offset to the hedged items, or accumulated other
comprehensive income.
As previously discussed, the Corporation has elected early application
of SAB 108. In accordance with SAB 108, the Corporation adjusted its
opening retained earnings and its opening accumulated other
comprehensive income for 2006 and financial results for the first two
quarters of 2006 (included in the nine month period ended September 30,
2006 in the accompanying condensed consolidated financial statements) to
reflect a change in its hedge accounting under SFAS 133.
9
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2006 & 2005 (Unaudited)
The cumulative effect of adjusting the reported carrying amount of the
assets, liabilities and accumulated other comprehensive income at
January 1, 2006, resulted in a decrease to retained earnings of $34.2
million and reduced the net loss in accumulated other comprehensive
income by $16.2 million. In aggregate total Shareholders' Equity was
reduced by $18.0 million. For the three and nine months ended September
30, 2006, net derivative gains - discontinued hedges amounted to $43.8
million and $1.8 million, respectively.
The aggregate impact of the adjustments is summarized below (dollars in
millions, except per share data):
As of and for the Three Months ended March 31, 2006
---------------------------------------------------
Previously As
Reported Adjustment Adjusted
------------ ------------ ------------
Loans and leases, net of unearned income $ 35,034 $ 43 $ 35,077
Accrued interest and other assets 1,683 (13) 1,670
Total deposits 28,093 6 28,099
Accrued expenses and other liabilities 1,616 48 1,664
Retained earnings 4,002 (48) 3,954
Accumulated other comprehensive (loss)
income, net of related taxes (44) 24 (20)
Net interest income $ 324.6 $ 0.5 $ 325.1
Net derivative losses - discontinued hedges -- (21.4) (21.4)
Other income 33.9 (0.5) 33.4
Income before income taxes 281.3 (21.4) 259.9
Provision for income taxes 94.5 (7.7) 86.8
Net income 186.8 (13.7) 173.1
Net income per common share:
Basic $ 0.79 $ (0.05) $ 0.74
Diluted 0.78 (0.06) 0.72
As of and for the Three Months ended June 30, 2006
--------------------------------------------------
Previously As
Reported Adjustment Adjusted
------------ ------------ ------------
Loans and leases, net of unearned income $ 40,230 $ 52 $ 40,282
Accrued interest and other assets 1,931 (17) 1,914
Total deposits 32,958 6 32,964
Accrued expenses and other liabilities 1,450 61 1,511
Retained earnings 4,138 (62) 4,076
Accumulated other comprehensive (loss)
income, net of related taxes (101) 30 (71)
Net interest income $ 374.1 $ 2.7 $ 376.8
Net derivative losses - discontinued hedges -- (20.7) (20.7)
Other income 37.4 (2.7) 34.7
Income before income taxes 303.1 (20.7) 282.4
Provision for income taxes 99.4 (7.5) 91.9
Net income 203.7 (13.2) 190.5
Net income per common share:
Basic $ 0.81 $ (0.06) $ 0.75
Diluted 0.79 (0.05) 0.74
For the Six Months ended June 30, 2006
--------------------------------------
Previously As
Reported Adjustment Adjusted
------------ ------------ ------------
Net interest income $ 698.6 $ 3.3 $ 701.9
Net derivative losses - discontinued hedges -- (42.0) (42.0)
Other income 71.3 (3.3) 68.0
Income before income taxes 584.3 (42.0) 542.3
Provision for income taxes 193.8 (15.1) 178.7
Net income 390.5 (26.9) 363.6
Net income per common share:
Basic $ 1.60 $ (0.11) $ 1.49
Diluted 1.57 (0.11) 1.46
10
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2006 & 2005 (Unaudited)
4.Comprehensive Income
The following tables present the Corporation's comprehensive income
($000's):
Three Months Ended
September 30, 2006
------------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
-------------- ------------- -------------
Net income $ 238,867
Other comprehensive income:
Unrealized gains (losses) on securities:
Arising during the period $ 100,128 $ (35,054) 65,074
Reclassification for securities
transactions included in net income (2,255) 790 (1,465)
------------- ------------ ------------
Unrealized gains (losses) 97,873 (34,264) 63,609
Net gains (losses) on derivatives
hedging variability of cash flows:
Arising during the period (45,838) 16,043 (29,795)
Reclassification adjustments for
hedging activities included in net income (8,109) 2,838 (5,271)
------------- ------------ ------------
Net gains (losses) $ (53,947) $ 18,881 (35,066)
------------- ------------ ------------
Other comprehensive income (loss) 28,543
------------
Total comprehensive income $ 267,410
============
Three Months Ended
September 30, 2005 As Adjusted
------------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
-------------- ------------- -------------
Net income $ 179,674
Other comprehensive income:
Unrealized gains (losses) on securities:
Arising during the period $ (14,376) $ 5,079 (9,297)
Reclassification for securities
transactions included in net income (557) 195 (362)
------------- ------------ ------------
Unrealized gains (losses) (14,933) 5,274 (9,659)
Net gains (losses) on derivatives
hedging variability of cash flows:
Arising during the period 2,772 (970) 1,802
Reclassification adjustments for
hedging activities included in net income (2,520) 882 (1,638)
------------- ------------ ------------
Net gains (losses) $ 252 $ (88) 164
------------- ------------ ------------
Other comprehensive income (loss) (9,495)
------------
Total comprehensive income $ 170,179
============
11
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2006 & 2005 (Unaudited)
Nine Months Ended
September 30, 2006
------------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
-------------- ------------- -------------
Net income $ 602,481
Other comprehensive income:
Unrealized gains (losses) on securities:
Arising during the period $ (2,435) $ 811 (1,624)
Reclassification for securities
transactions included in net income (4,196) 1,469 (2,727)
------------- ------------ ------------
Unrealized gains (losses) (6,631) 2,280 (4,351)
Net gains (losses) on derivatives
hedging variability of cash flows:
Arising during the period 14,043 (4,915) 9,128
Reclassification adjustments for
hedging activities included in net income (16,289) 5,701 (10,588)
------------- ------------ ------------
Net gains (losses) $ (2,246) $ 786 (1,460)
------------- ------------ ------------
Other comprehensive income (loss) (5,811)
------------
Total comprehensive income $ 596,670
============
Nine Months Ended
September 30, 2005 As Adjusted
------------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
-------------- ------------- -------------
Net income $ 528,735
Other comprehensive income:
Unrealized gains (losses) on securities:
Arising during the period $ (41,067) $ 14,505 (26,562)
Reclassification for securities
transactions included in net income (675) 236 (439)
------------- ------------ ------------
Unrealized gains (losses) (41,742) 14,741 (27,001)
Net gains (losses) on derivatives
hedging variability of cash flows:
Arising during the period 14,366 (5,028) 9,338
Reclassification adjustments for
hedging activities included in net income 520 (182) 338
------------- ------------ ------------
Net gains (losses) $ 14,886 $ (5,210) 9,676
------------- ------------ ------------
Other comprehensive income (loss) (17,325)
------------
Total comprehensive income $ 511,410
============
5.A reconciliation of the numerators and denominators of the basic and
diluted per share computations are as follows (dollars and shares in
thousands, except per share data):
Three Months Ended
September 30, 2006
---------------------------------------
Income Average Shares Per Share
(Numerator) (Denominator) Amount
------------ --------------- ----------
Basic Earnings Per Share
Income Available to Common Shareholders $ 238,867 253,799 $ 0.94
=========
Effect of Dilutive Securities
Stock Options, Restricted Stock
and Other Plans -- 5,868
----------- --------------
Diluted Earnings Per Share
Income Available to Common Shareholders $ 238,867 259,667 $ 0.92
=========
12
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2006 & 2005 (Unaudited)
Three Months Ended
September 30, 2005 As Adjusted
---------------------------------------
Income Average Shares Per Share
(Numerator) (Denominator) Amount
------------ --------------- ----------
Basic Earnings Per Share
Income Available to Common Shareholders $ 179,674 232,590 $ 0.77
=========
Effect of Dilutive Securities
Stock Options, Restricted Stock
and Other Plans -- 5,572
----------- --------------
Diluted Earnings Per Share
Income Available to Common Shareholders $ 179,674 238,162 $ 0.75
=========
Nine Months Ended
September 30, 2006
---------------------------------------
Income Average Shares Per Share
(Numerator) (Denominator) Amount
------------ --------------- ----------
Basic Earnings Per Share
Income Available to Common Shareholders $ 602,481 247,361 $ 2.44
=========
Effect of Dilutive Securities
Stock Options, Restricted Stock
and Other Plans -- 5,390
----------- --------------
Diluted Earnings Per Share
Income Available to Common Shareholders $ 602,481 252,751 $ 2.38
=========
Nine Months Ended
September 30, 2005 As Adjusted
---------------------------------------
Income Average Shares Per Share
(Numerator) (Denominator) Amount
------------ --------------- ----------
Basic Earnings Per Share
Income Available to Common Shareholders $ 528,735 229,611 $ 2.30
=========
Effect of Dilutive Securities
Stock Options, Restricted Stock
and Other Plans -- 5,236
----------- -------------
Diluted Earnings Per Share
Income Available to Common Shareholders $ 528,735 234,847 $ 2.25
=========
Options to purchase shares of common stock not included in the
computation of diluted net income per share because the stock options
were antidilutive are as follows (shares in thousands):
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------ ------------------------------------
2006 2005 2006 2005
----------------- ----------------- ----------------- -----------------
Shares 27 21 109 41
Price Range $46.970 - $48.540 $44.950 - $47.020 $45.070 - $48.540 $43.530 - $47.020
13
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2006 & 2005 (Unaudited)
6.Business Combinations
The following acquisition, which is not considered to be a material
business combination, was completed during the third quarter of 2006:
On September 1, 2006, Metavante completed the acquisition of VICOR, Inc.
("VICOR") of Richmond, California. Total consideration in this
transaction amounted to $75.1 million. VICOR is a provider of corporate
payment processing software and solutions that simplify and automate the
processing of complex payments for businesses and financial
institutions. Initial goodwill, subject to the completion of appraisals
and valuation of the assets acquired and liabilities assumed, amounted
to $55.3 million. The estimated identifiable intangible asset to be
amortized (customer relationships) with an estimated weighted average
life of 7.0 years amounted to $17.3 million. The goodwill and
intangibles resulting from this transaction are not deductible for tax
purposes.
7.Selected investment securities, by type, held by the Corporation were as
follows ($000's):
September 30, December 31, September 30,
2006 2005 2005
--------------- --------------- ---------------
Investment securities available for sale:
U.S. treasury and government agencies $ 5,378,721 $ 4,379,148 $ 4,349,134
State and political subdivisions 773,446 703,892 701,290
Mortgage backed securities 121,493 116,464 125,562
Other 546,455 502,199 499,695
-------------- -------------- --------------
Total $ 6,820,115 $ 5,701,703 $ 5,675,681
============== ============== ==============
Investment securities held to maturity:
State and political subdivisions $ 526,883 $ 616,554 $ 651,914
Other 1,500 2,000 2,300
-------------- -------------- --------------
Total $ 528,383 $ 618,554 $ 654,214
============== ============== ==============
The following table provides the gross unrealized losses and fair value,
aggregated by investment category and the length of time the individual
securities have been in a continuous unrealized loss position, at
September 30, 2006 ($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 $ 1,497,718 $ 17,961 $ 2,471,718 $ 76,673 $ 3,969,436 $ 94,634
State and
political subdivision 32,045 247 70,034 1,176 102,079 1,423
Mortgage backed securities 26,299 6 95,107 1,999 121,406 2,005
Other 17,994 173 -- -- 17,994 173
------------ ---------- ----------- ---------- ----------- ------------
Total $ 1,574,056 $ 18,387 $ 2,636,859 $ 79,848 $ 4,210,915 $ 98,235
============ ========== =========== ========== =========== ============
The investment securities in the above table were temporarily impaired
at September 30, 2006. This temporary impairment represents the amount
of loss that would have been realized if the investment securities had
been sold on September 30, 2006. The temporary impairment in the
investment securities portfolio is predominantly the result of increases
in market interest rates since the investment securities were acquired
and not from deterioration in the creditworthiness of the issuer.
14
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2006 & 2005 (Unaudited)
8.The Corporation's loan and lease portfolio, including loans held for
sale, consisted of the following ($000's):
September 30, December 31, September 30,
2006 2005 2005
--------------- --------------- ---------------
Commercial, financial and agricultural $ 11,794,846 $ 9,599,361 $ 9,281,803
Cash flow hedging instruments at fair value (3,067) (33,886) (26,604)
-------------- -------------- --------------
Commercial, financial and agricultural 11,791,779 9,565,475 9,255,199
Real estate:
Construction 5,813,466 3,641,942 3,265,174
Residential mortgage 6,078,175 5,050,803 4,752,479
Home equity loans and lines of credit 4,415,980 4,833,480 4,916,249
Commercial mortgage 11,002,939 8,825,104 8,733,067
-------------- -------------- --------------
Total real estate 27,310,560 22,351,329 21,666,969
Personal 1,469,106 1,617,761 1,587,552
Lease financing 693,607 632,348 596,588
-------------- -------------- --------------
Total loans and leases $ 41,265,052 $ 34,166,913 $ 33,106,308
============== ============== ==============
9.Financial Asset Sales
During the third quarter of 2006, the Corporation sold automobile loans
with principal balances of $116.0 million in securitization
transactions. The net gains and losses from the sale and securitization
of auto loans for the three and nine months ended September 30, 2006,
respectively were not significant. Other income associated with auto
securitizations, primarily servicing income, amounted to $2.3 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 quarter were as follows (rate per annum):
Prepayment speed (CPR) 15-42 %
Weighted average life (in months) 20.5
Expected credit losses
(based on original balance 0.36-1.32 %
Residual cash flow discount rate 12.0 %
Variable returns to transferees Forward one-month LIBOR yield curve
At September 30, 2006, 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 $ 991,819 $ 166,023 $ 1,157,842
Principal amounts of loans
60 days or more 2,852 621 3,473
Net credit losses year to date 3,246 1,001 4,247
10.Goodwill and Other Intangibles
The changes in the carrying amount of goodwill for the nine months ended
September 30, 2006 were as follows ($000's):
Banking Metavante Others Total
------------- ------------- ------------- -------------
Goodwill balance as of January 1, 2006 $ 809,376 $ 1,272,039 $ 7,804 $ 2,089,219
Goodwill acquired during the period 614,801 77,033 21,251 713,085
Purchase accounting adjustments 1,001 (22,242) -- (21,241)
------------ ------------ ------------ ------------
Goodwill balance as of September 30, 2006 $ 1,425,178 $ 1,326,830 $ 29,055 $ 2,781,063
============ ============ ============ ============
15
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2006 & 2005 (Unaudited)
Goodwill acquired during the third quarter of 2006 for the Metavante
segment included initial goodwill of $55.3 million for the acquisition
of VICOR. Goodwill acquired during the second quarter of 2006 for the
Banking segment included initial goodwill of $485.4 million for the
acquisition of Gold Banc Corporation, Inc. ("Gold Banc") and $129.4
million in initial goodwill relating to the acquisition of Trustcorp
Financial, Inc. ("Trustcorp"). Goodwill acquired for the Metavante
segment includes initial goodwill of $21.7 million relating to the
acquisition of AdminiSource Corp ("AdminiSource") in the first quarter
of 2006. Goodwill for the Others segment includes initial goodwill
relating to the acquisition of FirstTrust Indiana of $13.4 million in
the first quarter of 2006, and initial goodwill allocated to the Trust
reporting unit of $7.9 million from the acquisition of Gold Banc in the
second quarter of 2006.
During the third quarter of 2006, purchase accounting adjustments of
$1.1 million for the Banking segment included adjustments to the initial
estimates of fair value associated with the acquisitions of Gold Banc
and Trustcorp, offset by a reduction of goodwill of $0.1 million
attributable to a branch divestiture in the first quarter of 2006.
Purchase accounting adjustments for the Metavante segment represent
adjustments made to the initial estimates of fair value associated with
the acquisitions of GHR Systems, Inc., Brasfield Corporation,
AdminiSource, Med-i-Bank, Inc., LINK2GOV Corp., TREEV LLC and NYCE
Corporation ("NYCE") and its affiliate companies. During the first
quarter, Metavante received $29.9 million as a return of the purchase
price associated with the NYCE acquisition.
At September 30, 2006, the Corporation's other intangible assets
consisted of the following ($000's):
September 30, 2006
-----------------------------------------
Accum-
Gross ulated Net
Carrying Amort- Carrying
Amount ization Value
------------- ------------- -------------
Other intangible assets
Core deposit intangible $ 207,805 $ 91,259 $ 116,546
Data processing contract rights/customer lists 360,438 52,031 308,407
Trust customers 6,750 1,755 4,995
Tradename 8,275 1,119 7,156
Other Intangibles 1,250 621 629
------------ ------------ ------------
$ 584,518 $ 146,785 $ 437,733
============ ============ ============
Mortgage loan servicing rights $ 2,258
============
Amortization expense of other intangible assets for the three and nine
months ended September 30, 2006 amounted to $12.1 million and $33.0
million, respectively. Amortization expense of other intangible assets
for the three and nine months ended September 30, 2005 was $6.1 million
and $22.3 million, respectively.
The estimated amortization expense of other intangible assets and
mortgage loan servicing rights for the next five annual fiscal years are
($000's):
2007 $ 45,743
2008 42,193
2009 39,347
2010 37,152
2011 35,511
16
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2006 & 2005 (Unaudited)
11.The Corporation's deposit liabilities consisted of the following
($000's):
September 30, December 31, September 30,
2006 2005 2005
--------------- --------------- ---------------
Noninterest bearing demand $ 5,565,420 $ 5,525,019 $ 5,224,241
Savings and NOW 11,754,890 10,462,831 10,194,871
Cash flow hedge-Brokered MMDA -- (5,326) (4,966)
-------------- -------------- --------------
Total Savings and NOW 11,754,890 10,457,505 10,189,905
CD's $100,000 and over 9,013,765 5,652,359 6,116,679
Cash flow hedge-Institutional CDs (679) (13,767) (17,911)
-------------- -------------- --------------
Total CD's $100,000 and over 9,013,086 5,638,592 6,098,768
Other time deposits 4,827,972 3,434,476 3,228,265
Foreign deposits 2,298,376 2,618,629 2,250,182
-------------- -------------- --------------
Total deposits $ 33,459,744 $ 27,674,221 $ 26,991,361
============== ============== ==============
12.Share-Based Compensation Plans
The Corporation has equity incentive plans which provide for the grant
of nonqualified and incentive stock options, stock appreciation rights,
rights to purchase shares of restricted stock and the award of
restricted stock units to key employees and directors of the Corporation
at prices ranging from zero to the market value of the shares at the
date of grant. The equity incentive plans generally provide for the
grant of options to purchase shares of the Corporation's common stock
for a period of ten years from the date of grant. Stock options granted
generally become exercisable over a period of three years from the date
of grant. However, stock options granted to directors of the
Corporation vest immediately and stock options granted after 1996
provide accelerated or immediate vesting for grants to individuals who
meet certain age and years of service criteria at the date of grant.
Restrictions on stock or units issued pursuant to the equity incentive
plans generally lapse within a three to seven year period.
The Corporation also has a Long-Term Incentive Plan. Under the plan,
performance units may be awarded from time to time. Once awarded,
additional performance units will be credited to each participant based
on dividends paid by the Corporation on its common stock. At the end of
a designated vesting period, participants will receive a cash award
equal to the Corporation's average common stock price over the last five
days of the vesting period multiplied by some percent (0%-275%) of the
initial performance units credited plus those additional units credited
as dividends based on the established performance criteria. The vesting
period is three years from the date the performance units were awarded.
The Corporation also has a qualified employee stock purchase plan (the
"ESPP") which gives employees who elect to participate in the plan the
right to acquire shares of the Corporation's common stock at the
purchase price which is 85 percent of the lesser of the fair market
value of the Corporation's common stock on the first or last day of the
one-year offering period ("look-back feature") which has historically
been from July 1 to June 30. Effective July 1, 2006, the ESPP plan was
amended to eliminate the look-back feature and to provide employees who
elect to participate in the plan the right to acquire shares of the
Corporation's common stock at the purchase price which is 85 percent of
the fair market value of the Corporation's common stock on the last day
of each three month period within the one-year offering period.
Employee contributions under the ESPP are made ratably during the
period.
Effective January 1, 2006, the Corporation adopted Statement of
Financial Accounting Standard No. 123 (revised 2004), Share-Based
Payment ("SFAS 123(R)"). SFAS 123(R) replaces FASB Statement No. 123
Accounting for Stock-Based Compensation ("SFAS 123"), and supercedes
Accounting Principles Board Opinion No. 25 ("APBO 25") Accounting for
Stock Issued to Employees. Statement 123(R) requires that compensation
cost 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. Statement 123(R) covers a
wide range of share-based compensation arrangements including stock
options, restricted stock plans, performance-based awards, stock
appreciation rights, and employee stock purchase plans. Statement
123(R) also provides guidance on measuring the fair value of share-based
payments awards.
17
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2006 & 2005 (Unaudited)
The Corporation elected the Modified Retrospective Application method to
implement this new accounting standard. Under that method, compensation
cost is recognized beginning on the effective date of SFAS 123(R) based
upon (a) the requirements of SFAS 123(R) for all share-based payments
granted after the effective date and (b) the fair value method of
accounting provisions of SFAS 123 for all awards granted to employees
prior to the effective date of SFAS 123(R) that remain unvested on the
effective date.
As permitted under SFAS 123, the Corporation previously recognized
compensation cost using the intrinsic value method of accounting
prescribed in APBO 25. Under the intrinsic value 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. Under APBO 25, no compensation cost was recognized for the
nonqualified and incentive stock options because the exercise price was
equal to the quoted market price of the Corporation's common stock at
the date of grant and therefore, those options had no intrinsic value on
the date of grant. Under APBO 25, no compensation cost was recognized
for the Corporation's ESPP because the discount (15%) and the plan met
the definition of a qualified plan under the Internal Revenue Code and
the requirements of APBO 25.
Under the fair value method of accounting, 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
for stock options that vest is recognized over the service period, which
is usually the vesting period. The fair value method of accounting
provided under SFAS 123 is generally similar to the fair value method of
accounting under SFAS 123(R).
Under the Modified Retrospective Application method, in addition to
recognizing compensation cost beginning on the effective date of SFAS
123(R), financial statements prior to the effective date have been
adjusted based on pro forma amounts previously disclosed under SFAS 123
for all periods for which SFAS 123 was effective.
The impact to Shareholders' equity as a result of applying the Modified
Retrospective Application method to adopt SFAS 123(R) is as follows
($000's):
December 31, September 30,
2005 2005
---------------- ----------------
Decrease to Retained Earnings $ (149,544) $ (141,745)
Increase to Additional
Paid-in Capital 217,205 209,788
--------------- ---------------
Net Increase to
Shareholders' equity $ 67,661 $ 68,043
=============== ===============
The net increase to Shareholders' equity represents the deferred income
tax benefit outstanding associated with the cumulative effect on net
income from January 1, 1995 to December 31, 2005 and September 30, 2005,
respectively, from recognizing share-based compensation previously not
reported.
18
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2006 & 2005 (Unaudited)
The Corporation's net income and earnings per share as adjusted for the
ESPP and stock options is as follows for the three and nine months ended
September 30, 2005 ($000's except per share data):
Three Months Nine Months
Ended Ended
September 30, September 30,
2005 2005
------------- -------------
Net Income, as originally reported $ 184,147 $ 542,214
Less: Stock-based employee compensation
expense previously not included in net
income under the intrinsic method of
accounting, net of tax (4,473) (13,479)
------------ ------------
Adjusted net income $ 179,674 $ 528,735
============ ============
Basic earnings per share:
As originally reported $ 0.79 $ 2.36
Adjusted 0.77 2.30
Diluted earnings per share:
As originally reported $ 0.78 $ 2.32
Adjusted 0.75 2.25
The Consolidated Statements of Cash Flows was not materially impacted.
Activity relating to nonqualified and incentive stock options for the
three months ended September 30, 2006 and 2005 was:
Weighted-
Average
Number Option Price Exercise
of Shares Per Share Price
------------ ---------------- -------------
Shares under option at June 30, 2005 21,810,577 $ 13.09 - 44.96 $ 31.07
Options granted 29,500 43.17 - 47.02 44.92
Options lapsed or surrendered (33,072) 28.55 - 41.95 39.85
Options exercised (437,254) 13.09 - 41.95 23.68
------------ --------------- ------------
Shares under option at September 30, 2005 21,369,751 $ 13.09 - 47.02 $ 31.23
============ =============== ============
Shares under option at June 30, 2006 23,892,507 $ 5.71 - 47.02 $ 33.32
Options granted 65,150 45.07 - 48.54 46.49
Options lapsed or surrendered (65,552) 26.14 - 47.02 42.40
Options exercised (767,297) 5.71 - 44.33 25.45
------------ --------------- ------------
Shares under option at September 30, 2006 23,124,808 $ 5.71 - 48.54 $ 33.60
============ =============== ============
19
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2006 & 2005 (Unaudited)
Activity relating to nonqualified and incentive stock options for the
nine months ended September 30, 2006 and 2005 was:
Weighted-
Average
Number Option Price Exercise
of Shares Per Share Price
------------ ---------------- -------------
Shares under option at December 31, 2004 22,878,097 $ 10.13 - 44.20 $ 30.70
Options granted 182,750 40.49 - 47.02 42.64
Options lapsed or surrendered (186,436) 22.80 - 41.95 36.54
Options exercised (1,504,660) 10.13 - 41.95 23.89
------------ --------------- ------------
Shares under option at September 30, 2005 21,369,751 $ 13.09 - 47.02 $ 31.23
============ =============== ============
Shares under option at December 31, 2005 24,655,317 $ 15.94 - 47.02 $ 33.09
Options granted 535,550 41.30 - 48.54 44.23
Vested options exchanged in acquisitions 532,133 5.71 - 43.67 12.99
Options lapsed or surrendered (302,391) 26.14 - 47.02 41.96
Options exercised (2,295,801) 5.71 - 44.33 24.79
------------ --------------- ------------
Shares under option at September 30, 2006 23,124,808 $ 5.71 - 48.54 $ 33.60
============ =============== ============
Stock option awards to directors of the Corporation generally occur
during the second quarter and stock option awards to employees primarily
occur in the fourth quarter. Generally, the Corporation uses shares of
treasury stock to satisfy stock options exercised.
The ranges of nonqualified and incentive stock options outstanding at
September 30, 2006 were:
Weighted-Average
Weighted-Average Remaining
Weighted-Average Aggregate Contractual
Number of Shares Exercise Price Intrinsic Value Life (In Years)
----------------------- ------------------- ------------------- -------------------
Out- Exer- Out- Exer- Out- Exer- Out- Exer-
Price Range standing cisable standing cisable standing cisable standing cisable
-------------- ----------- ----------- --------- --------- --------- --------- --------- ---------
$ 5.50 - 24.99 2,332,558 2,332,55 $ 20.75 $ 20.75 $ 27.43 $ 27.43 4.0 4.0
25.00 - 27.99 1,565,864 1,565,864 25.83 25.83 22.35 22.35 2.8 2.8
28.00 - 30.49 3,826,232 3,823,832 28.59 28.58 19.59 19.60 5.0 5.0
30.50 - 32.49 4,621,234 4,619,234 31.43 31.43 16.75 16.75 4.5 4.5
32.50 - 38.49 3,249,727 2,403,247 34.92 34.93 13.26 13.25 7.0 7.0
38.50 - 42.49 3,388,303 1,535,571 41.87 41.84 6.31 6.34 8.1 8.1
Over $42.50 4,140,890 625,657 43.02 42.99 5.16 5.19 9.1 9.1
----------- ----------- -------- -------- -------- -------- -------- --------
23,124,808 16,905,963 $ 33.60 $ 30.66 $ 14.58 $ 17.52 6.1 5.2
=========== =========== ======== ======== ======== ======== ======== ========
The fair value of each stock option grant was estimated as of the date
of grant using the Black-Scholes closed form option-pricing model for
stock options granted prior to September 30, 2004. A form of a lattice
option-pricing model was used for stock options granted after September
30, 2004.
The grant date fair values and assumptions used to determine such value
are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ------------------------------
2006 2005 2006 2005
-------------- -------------- -------------- --------------
Weighted-average grant date
date fair value $8.59 $7.40 $8.47 $7.92
Assumptions:
Risk-free interest rates 4.63 - 5.45 % 3.33 - 4.45 % 4.22 - 5.66 % 3.33 - 4.45 %
Expected volatility 18.50 % 18.00 % 18.20 -18.50 % 13.12 -18.50 %
Expected term (in years) 6.3 - 6.5 5.0 - 6.2 6.3 - 6.9 5.0 - 7.8
Expected dividend yield 2.28 % 2.19 % 2.20 - 2.28 % 1.92 - 2.19 %
20
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2006 & 2005 (Unaudited)
The total intrinsic value of nonqualified and incentive stock options
exercised during the three months ended September 30, 2006 and 2005 was
$16.6 million and $9.7 million, respectively. For the nine months ended
September 30, 2006 and 2005, the total intrinsic value of nonqualified
and incentive stock options exercised was $47.2 million and $29.6
million, respectively. The total fair value of shares vested during the
three months ended September 30, 2006 and 2005 amounted to $0.4 million
and $0.5 million, respectively. For the nine months ended September 30,
2006 and 2005, the total fair value of shares vested amounted to $1.1
million and $1.5 million, respectively.
There was approximately $18.2 million of total unrecognized compensation
expense related to unvested nonqualified and incentive stock options at
September 30, 2006. The total unrecognized compensation expense will be
recognized over a weighted average period of 2.3 years. For awards with
graded vesting, compensation expense was recognized using an accelerated
method prior to the adoption of SFAS 123(R) and is recognized on a
straight line basis for awards granted after the effective date.
For the three months ended September 30, 2006 and 2005, the expense for
nonqualified and incentive stock options that was included in Salaries
and employee benefits expense in the Consolidated Statements of Income
amounted to $6.6 million and $5.9 million, respectively. For the nine
months ended September 30, 2006 and 2005, the expense for nonqualified
and incentive stock options that was included in Salaries and employee
benefits expense in the Consolidated Statements of Income amounted to
$19.9 million and $17.6 million, respectively. These amounts are
considered non-cash expenses for the Statements of Cash Flow purposes.
Stock option awards for directors of the Corporation generally occur
during the second quarter. For the second quarter ended June 30, 2006
and 2005 and for the nine months ended September 30, 2006 and 2005, the
expense for Director's nonqualified and incentive stock options that was
included in Other expense in the Consolidated Statements of Income
amounted to $0.6 million and $0.7 million, respectively.
Activity relating to the Corporation's Restricted Stock Purchase Rights
was:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ------------------------------
2006 2005 2006 2005
-------------- -------------- -------------- --------------
Restricted stock purchase rights
outstanding - Beginning of Year -- -- -- --
Restricted stock purchase
rights granted 6,000 11,500 57,000 26,000
Restricted stock purchase
rights exercised (6,000) (11,500) (57,000) (26,000)
------------- -------------- -------------- --------------
Restricted stock purchase rights
outstanding - End of Period -- -- -- --
============= ============== ============== ==============
Weighted-average grant
date market value $ 47.26 $ 44.55 $ 44.82 $ 43.10
Aggregate compensation
expense ($000's) $ 1,481 $ 1,057 $ 4,128 $ 3,084
Unamortized compensation
expense ($000's) $ 10,860 $ 8,483 $ 10,860 $ 8,483
Restrictions on stock issued pursuant to the exercise of stock purchase
rights generally lapse within a three to seven year period.
Accordingly, the compensation related to issuance of the rights is
amortized over the vesting period. At September 30, 2006, the
unamortized compensation expense will be recognized over a weighted
average period of 1.4 years. Aggregate compensation expense for the
three and nine months ended September 30, 2006 amounted to $1.5 million
and $4.1 million, respectively. For the three and nine months ended
September 30, 2005, the aggregate compensation expense amounted to $1.1
million and $3.1 million, respectively. These amounts are considered
non-cash expenses for the Statements of Cash Flow purposes.
As participants in the Long-Term Incentive Plan will receive a cash
award at the end of the designated vesting period, this plan meets the
definition of a liability award. Unlike equity awards, liability awards
are remeasured at fair value at each balance sheet date until
settlement. For the three months ended September 30, 2006 and 2005 the
expense for the Long-Term Incentive Plan that is included in Salaries
and employee benefits expense in the Consolidated Statements of Income
amounted to $5.2 million and $2.9 million, respectively. For the nine
months ended September 30, 2006 and 2005, the expense for the Long-Term
Incentive Plan that was included in Salaries and employee benefits
expense in the Consolidated Statements of Income amounted to $8.7
million and $9.5 million, respectively.
21
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2006 & 2005 (Unaudited)
Under SFAS 123(R), compensation expense is recognized for the ESPP. The
compensation cost per share was approximately equal to the sum of: 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 common stock
and the value of a one year put option on 15% of a share of common stock
for each share purchased. The compensation cost per share for the ESPP
was $9.96 and $8.04 for the plan year ended June 30, 2006 and 2005,
respectively. The total estimated shares to be purchased were estimated
at the beginning of the plan period based on total expected
contributions for the plan period and 85% of the market price at that
date. The Corporation estimated that 346,342 shares would be purchased
on July 1, 2006 for the purpose of determining compensation expense.
Effective July 1, 2006 the ESPP plan was amended to eliminate the look-
back feature and to provide employees, who elect to participate in the
ESPP, the right to acquire shares of the Corporation's common stock at
the purchase price, which is 85 percent of the fair market value of the
Corporation's common stock on the last day of each three month period
within the one-year offering period. ESPP participants purchased 89,388
shares on October 2, 2006. Employee contributions under the ESPP are
made ratably during the plan period. Employees may withdraw from the
ESPP prior to the end of the one year offering period.
For the three months ended September 30, 2006 and 2005, the total
expense for the ESPP that was included in Salaries and employee benefits
expense in the Consolidated Statements of Income amounted to $0.6
million and $0.9 million, respectively. For the nine months ended
September 30, 2006 and 2005, the total expense for the ESPP that was
included in Salaries and employee benefits expense in the Consolidated
Statements of Income amounted to $2.5 million and $2.3 million,
respectively. These amounts are considered non-cash expenses for the
Statements of Cash Flow purposes.
13.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, 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 for these commitments.
Trading and free-standing derivative contracts are not linked to
specific assets and liabilities on the balance sheet or to forecasted
transactions in an accounting hedge relationship and, therefore, do not
qualify for hedge accounting under SFAS 133. They are carried at fair
value with changes in fair value recorded as a component of other
noninterest income.
At September 30, 2006, free standing interest rate swaps consisted of
$5.1 billion in notional amount of receive fixed / pay floating with an
aggregate negative fair value of $70.2 million and $1.7 billion in
notional amount of pay fixed / receive floating with an aggregate
positive fair value of $19.6 million.
At September 30, 2006, interest rate caps purchased amounted to $22.5
million in notional amount with an immaterial fair value and interest
rate caps sold amounted to $22.5 million in notional amount with an
immaterial fair value.
At September 30, 2006, the notional value of interest rate futures
designated as trading was $4.4 billion with a positive fair value of
$0.1 million.
Fair Value Hedges
-----------------
The Corporation has fixed rate long-term debt and fixed rate
institutional CDs which expose the Corporation to variability in fair
values due to changes in market interest rates.
22
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2006 & 2005 (Unaudited)
To limit the Corporation's exposure to changes in interest rates, the
Corporation has entered into receive fixed / pay floating interest rate
swaps.
The Corporation structures the interest rate swaps so that all of the
critical terms of the fixed rate borrowings and fixed rate institutional
CDs match the receive fixed leg of the interest rate swaps at inception
of the hedging relationship. As a result, the Corporation expects the
hedging relationship to be highly effective in achieving offsetting
changes in fair value due to changes in benchmark interest rates both at
inception and on an on-going basis.
At September 30, 2006, certain interest rate swaps designated as fair
value hedges met the criteria required to qualify for the shortcut
method of accounting. Based on the shortcut method of accounting
treatment, no ineffectiveness is assumed.
At September 30, 2006, no component of the derivative instruments' gain
or loss was excluded from the assessment of hedge effectiveness for
derivative financial instruments designated as fair value hedges.
The following table presents additional information with respect to
selected fair value hedges.
Fair Value Hedges
September 30, 2006 Weighted
Notional Fair Average
Hedged Hedging Amount Value Remaining
Item Instrument ($ in mil)($ in mil) Term (Yrs)
---------------------- ------------------- --------- --------- ----------
Fair Value Hedges that Qualify for Shortcut Accounting
------------------------------------------------------
Fixed Rate
Bank Notes Receive Fixed Swap $ 409.1 $ (13.1) 8.3
Other Fair Value Hedges
-----------------------
Medium Term Notes Receive Fixed Swap $ 80.0 $ (4.2) 13.8
Fixed Rate
Bank Notes Receive Fixed Swap 625.0 (13.3) 4.1
Institutional CDs Receive Fixed Swap 65.0 (0.1) 24.6
The impact from fair value hedges to total net interest income for the
three and nine months ended September 30, 2006 was a negative $1.1
million and a positive $0.3 million, respectively. The impact to net
interest income due to ineffectiveness was not material.
Cash Flow Hedges
----------------
The Corporation has variable rate loans, deposits and borrowings that
expose the Corporation to variability in interest rate payments due to
changes in interest rates. The Corporation believes it is prudent to
limit the variability of a portion of its interest receipts and
payments. To meet this objective, the Corporation enters into various
types of derivative financial instruments to manage fluctuations in cash
flows resulting from interest rate risk. At September 30, 2006, these
instruments consisted of interest rate swaps.
The Corporation regularly originates and holds floating rate commercial
loans that reprice monthly on the first business day to one-month LIBOR.
As a result, the Corporation's interest receipts are exposed to
variability in cash flows due to changes in one-month LIBOR.
In order to hedge the interest rate risk associated with the floating
rate commercial loans indexed to one-month LIBOR, the Corporation has
entered into receive fixed / pay LIBOR-based floating interest rate
swaps designated as cash flow hedges against the first LIBOR-based
interest payments received that, in the aggregate for each period, are
interest payments on such principal amount of its then existing LIBOR-
indexed floating-rate commercial loans equal to the notional amount of
the interest rate swaps outstanding.
23
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2006 & 2005 (Unaudited)
Hedge effectiveness is assessed at inception and each quarter on an on-
going basis using regression analysis that takes into account reset date
differences for certain designated interest rate swaps that reset
quarterly. Each month the Corporation makes a determination that it is
probable that the Corporation will continue to receive interest payments
on at least that amount of principal of its existing LIBOR-indexed
floating-rate commercial loans that reprice monthly on the first
business day to one-month LIBOR equal to the notional amount of the
interest rate swaps outstanding. Ineffectiveness is measured using the
hypothetical derivative method and is recorded as a component of
interest income on loans.
The Corporation regularly issues floating rate institutional CDs indexed
to three-month LIBOR. As a result, the Corporation's interest payments
are exposed to variability in cash flows due to changes in three-month
LIBOR.
In order to hedge the interest rate risk associated with floating rate
institutional CDs, the Corporation has entered into pay fixed / receive
LIBOR-based floating interest rate swaps designated as cash flow hedges
against the interest payments on the forecasted issuance of floating
rate institutional CDs.
For certain institutional CDs, hedge effectiveness is assessed at
inception and each quarter on an on-going basis using regression
analysis that regresses daily observations of three-month LIBOR to
itself with a five day mismatch on either side for potential reset date
differences between the interest rate swaps and the floating rate
institutional CDs. The regression analysis is based on a rolling five
years of daily observations. Ineffectiveness is measured using the
hypothetical derivative method and is recorded as a component of
interest expense on deposits.
The Corporation regularly purchases overnight borrowings indexed to the
Federal funds rate. As a result, the Corporation's interest payments
are exposed to variability in cash flows due to changes in the Federal
funds effective rate.
In order to hedge the interest rate risk associated with overnight
borrowings, the Corporation has entered into pay fixed / receive
floating interest rate swaps designated as cash flow hedges against
interest payments on the forecasted issuance of floating rate overnight
borrowings. The floating leg of the interest rate swap resets monthly
to the H15 Federal Effective index. The H15 Federal Effective index is
not a benchmark rate, therefore hedge effectiveness is assessed at
inception and each quarter on an on-going basis using regression
analysis. Each month the Corporation makes a determination that it is
probable that the Corporation will continue to make interest payments on
at least that amount of outstanding overnight floating-rate borrowings
equal to the notional amount of the interest rate swaps outstanding.
Ineffectiveness is measured using the hypothetical derivative method and
is recorded as a component of interest expense on short-term borrowings.
The Corporation structures the remaining interest rate swaps so that all
of the critical terms of the LIBOR-based floating rate deposits and
borrowings match the floating leg of the interest rate swaps at
inception of the hedging relationship. As a result, the Corporation
expects those hedging relationships to be highly effective in achieving
offsetting changes in cash flows due to changes in benchmark interest
rates both at inception and on an on-going basis.
At September 30, 2006, one interest rate swap designated as a cash flow
hedge met the criteria required to qualify for the shortcut method of
accounting. Based on the shortcut method of accounting treatment, no
ineffectiveness is assumed.
At September 30, 2006, no component of the derivative instruments' gain
or loss was excluded from the assessment of hedge effectiveness for
derivative financial instruments designated as cash flow hedges.
24
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2006 & 2005 (Unaudited)
The following table summarizes the Corporation's cash flow hedges.
Cash Flow Hedges
September 30, 2006 Weighted
Notional Fair Average
Hedged Hedging Amount Value Remaining
Item Instrument ($ in mil)($ in mil) Term (Yrs)
----------------------- ------------------- --------- --------- ----------
Cash Flow Hedges that Qualify for Shortcut Accounting
-----------------------------------------------------
Floating Rate
Bank Notes Pay Fixed Swap $ 125.0 $ 0.9 0.5
Other Cash Flow Hedges
----------------------
Variable Rate Loans Receive Fixed Swap $ 100.0 $ (3.1) 1.8
Institutional CDs Pay Fixed Swap 1,980.0 0.7 1.7
Federal Funds
Purchased Pay Fixed Swap 250.0 (0.4) 0.9
FHLB Advances Pay Fixed Swap 1,410.0 7.4 4.4
Floating Rate
Bank Notes Pay Fixed Swap 550.0 (5.8) 3.2
The impact to total net interest income from cash flow hedges, including
amortization of terminated cash flow hedges for the three and nine
months ended September 30, 2006 was a positive $8.1 million and a
positive $16.3 million, respectively. For each of the three and nine
months ended September 30, 2006, the impact due to ineffectiveness was
not material.
For the three and nine months ended September 30, 2005, the total effect
on net interest income resulting from derivative financial instruments
was a positive $9.3 million and a positive $25.4 million, respectively,
including the amortization of terminated derivative financial
instruments.
14.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 nine month
periods ended September 30, 2006 and 2005 included the following
components ($000's):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -------------------------
2006 2005 2006 2005
----------- ----------- ----------- -----------
Service cost $ 570 $ 553 $ 1,710 $ 1,658
Interest on APBO 1,022 1,158 3,066 3,476
Expected return on assets (232) (149) (696) (448)
Prior service amortization (681) (680) (2,041) (2,041)
Actuarial loss amortization 379 264 1,136 792
---------- ---------- ---------- ----------
Total postretirement benefit costs $ 1,058 $ 1,146 $ 3,175 $ 3,437
========== ========== ========== ==========
Benefit payments and expenses, net of participant contributions, for the
three and nine months ended September 30, 2006 amounted to $1.0 million
and $3.1 million, respectively.
25
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2006 & 2005 (Unaudited)
15.Segments
The following represents the Corporation's operating segments as of and
for the three and nine months ended September 30, 2006 and 2005.
Effective January 1, 2006, the Corporation transferred a portion of its
Item Processing business from the Banking segment to Metavante. Prior
period segment information has been adjusted for the transfer. There
have not been any other changes to the way the Corporation organizes its
segments. Fees - intercompany represent intercompany revenue charged to
other segments for providing certain services. Expenses - intercompany
represent fees charged by other segments for certain services received.
For each segment, Expenses - intercompany are not the costs of that
segment's reported intercompany revenues. Intrasegment revenues,
expenses and assets have been eliminated ($ in millions):
Three Months Ended September 30, 2006
---------------------------------------------------------------------------------
Reclass-
ifications Consol-
Corporate & Elimi- idated
Banking Metavante Others Overhead nations Income
------------ ------------ ------------ ------------ ----------- ------------
Net interest income $ 399.4 $ (6.7) $ 6.7 $ (8.7) $ 2.5 $ 393.2
Other income
------------
Fees - external 120.2 339.5 55.3 6.1 -- 521.1
Fees - internal
Fees - intercompany 16.1 31.7 5.4 25.0 (78.2) --
Float income - intercompany -- 2.5 -- -- (2.5) --
----------- ----------- ----------- ----------- ---------- -----------
Total other income 136.3 373.7 60.7 31.1 (80.7) 521.1
Other expense
-------------
Expenses - other 187.0 289.8 40.3 29.1 0.4 546.6
Expenses - intercompany 47.8 12.2 12.7 5.9 (78.6) --
----------- ----------- ----------- ----------- ---------- -----------
Total other expense 234.8 302.0 53.0 35.0 (78.2) 546.6
Provision for loan
and lease losses 9.9 -- 0.4 -- -- 10.3
----------- ----------- ----------- ----------- ---------- -----------
Income (loss) before taxes 291.0 65.0 14.0 (12.6) -- 357.4
Income tax expense (benefit) 97.8 23.8 4.9 (8.0) -- 118.5
----------- ----------- ----------- ----------- ---------- -----------
Segment income (loss) $ 193.2 $ 41.2 $ 9.1 $ (4.6) $ -- $ 238.9
========== =========== =========== =========== ========== ===========
Identifiable assets $ 52,611.5 $ 2,924.7 $ 879.4 $ 694.4 $ (1,627.2) $ 55,482.8
========== =========== =========== =========== ========== ===========
Return on average equity 15.5% 14.1% 12.0% 16.2%
========== =========== =========== ===========
Three Months Ended September 30, 2005
---------------------------------------------------------------------------------
Reclass-
ifications Consol-
Corporate & Elimi- idated
Banking Metavante Others Overhead nations Income
------------ ------------ ------------ ------------ ----------- ------------
Net interest income $ 323.3 $ (9.0) $ 6.5 $ (2.6) $ 3.6 $ 321.8
Other income
------------
Fees - external 76.4 296.0 49.3 8.4 -- 430.1
Fees - internal
Fees - intercompany 15.4 21.8 7.1 21.6 (65.9) --
Float income - intercompany -- 3.6 -- -- (3.6) --
----------- ----------- ----------- ----------- ---------- -----------
Total other income 91.8 321.4 56.4 30.0 (69.5) 430.1
Other expense
-------------
Expenses - other 156.8 251.7 35.0 27.0 -- 470.5
Expenses - intercompany 43.0 11.3 11.5 0.1 (65.9) --
----------- ----------- ----------- ----------- ---------- -----------
Total other expense 199.8 263.0 46.5 27.1 (65.9) 470.5
Provision for loan
and lease losses 9.7 -- 0.2 -- -- 9.9
Income (loss) before taxes 205.6 49.4 16.2 0.3 -- 271.5
Income tax expense (benefit) 67.2 18.3 6.1 0.2 -- 91.8
----------- ----------- ----------- ----------- ---------- -----------
Segment income (loss)
As Adjusted $ 138.4 $ 31.1 $ 10.1 $ 0.1 $ -- $ 179.7
=========== =========== =========== =========== ========== ===========
Identifiable assets $ 42,392.1 $ 2,727.3 $ 743.9 $ 649.5 $ (1,517.5) $ 44,995.3
=========== =========== =========== =========== ========== ===========
Return on average equity 15.3% 14.6% 14.4% 15.9%
=========== =========== =========== ===========
26
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
September 30, 2006 & 2005 (Unaudited)
Nine Months Ended September 30, 2006
---------------------------------------------------------------------------------
Reclass-
ifications Consol-
Corporate & Elimi- idated
Banking Metavante Others Overhead nations Income
------------ ------------ ------------ ------------ ----------- ------------
Net interest income $ 1,112.1 $ (22.5) $ 18.3 $ (21.2) $ 8.4 $ 1,095.1
Other income
------------
Fees - external 232.4 1,027.5 165.7 7.4 -- 1,433.0
Fees - internal
Fees - intercompany 49.8 82.3 15.9 75.0 (223.0) --
Float income - intercompany -- 8.4 -- -- (8.4) --
----------- ----------- ----------- ----------- ---------- -----------
Total other income 282.2 1,118.2 181.6 82.4 (231.4) 1,433.0
Other expense
-------------
Expenses - other 524.8 880.4 121.3 69.7 (0.2) 1,596.0
Expenses - intercompany 137.9 37.8 37.9 9.2 (222.8) --
----------- ----------- ----------- ----------- ---------- -----------
Total other expense 662.7 918.2 159.2 78.9 (223.0) 1,596.0
Provision for loan
and lease losses 30.9 -- 1.4 -- -- 32.3
----------- ----------- ----------- ----------- ---------- -----------
Income (loss) before taxes 700.7 177.5 39.3 (17.7) -- 899.8
Income tax expense (benefit) 232.1 61.4 14.2 (10.4) -- 297.3
----------- ----------- ----------- ----------- ---------- -----------
Segment income (loss) $ 468.6 $ 116.1 $ 25.1 $ (7.3) $ -- $ 602.5
=========== =========== =========== =========== ========== ===========
Identifiable assets $ 52,611.5 $ 2,924.7 $ 879.4 $ 694.4 $ (1,627.2) $ 55,482.8
=========== =========== =========== =========== ========== ===========
Return on average equity 13.8% 13.9% 11.7% 14.8%
=========== =========== =========== ===========
Nine Months Ended September 30, 2006
---------------------------------------------------------------------------------
Reclass-
ifications Consol-
Corporate & Elimi- idated
Banking Metavante Others Overhead nations Income
------------ ------------ ------------ ------------ ----------- ------------
Net interest income $ 941.4 $ (29.0) $ 18.9 $ (6.5) $ 8.9 $ 933.7
Other income
------------
Fees - external 220.1 861.2 167.0 18.6 -- 1,266.9
Fees - internal
Fees - intercompany 46.7 64.7 17.5 64.8 (193.7) --
Float income - intercompany -- 8.9 -- -- (8.9) --
----------- ----------- ----------- ----------- ---------- -----------
Total other income 266.8 934.8 184.5 83.4 (202.6) 1,266.9
Other expense
-------------
Expenses - other 457.3 730.1 100.5 85.9 (0.4) 1,373.4
Expenses - intercompany 122.5 32.7 36.1 2.0 (193.3) --
----------- ----------- ----------- ----------- ---------- -----------
Total other expense 579.8 762.8 136.6 87.9 (193.7) 1,373.4
Provision for loan
and lease losses 30.9 -- 0.9 -- -- 31.8
----------- ----------- ----------- ----------- ---------- -----------
Income (loss) before taxes 597.5 143.0 65.9 (11.0) -- 795.4
Income tax expense (benefit) 190.2 55.6 25.4 (4.5) -- 266.7
----------- ----------- ----------- ----------- ---------- -----------
Segment income (loss)
As Adjusted $ 407.3 $ 87.4 $ 40.5 $ (6.5) $ -- $ 528.7
=========== =========== =========== =========== ========== ===========
Identifiable assets $ 42,392.1 $ 2,727.3 $ 743.9 $ 649.5 $ (1,517.5) $ 44,995.3
=========== =========== =========== =========== ========== ===========
Return on average equity 15.8% 16.7% 20.2% 16.6%
=========== =========== =========== ===========
Total revenue, which consists of net interest income plus total other
income, by type in Others consisted of the following ($ in millions):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2006 2005 2006 2005
----------- ----------- ----------- -----------
Trust Services $ 48.0 $ 42.8 $ 143.2 $ 123.0
Residential Mortgage Banking 5.5 6.8 16.4 17.9
Capital Markets 0.7 0.5 1.0 22.8
Brokerage and Insurance 7.1 6.6 21.7 20.9
Commercial Leasing 2.8 3.8 8.6 11.4
Commercial Mortgage Banking 2.3 1.5 5.6 4.3
Others 1.0 0.9 3.4 3.1
---------- ---------- ---------- ----------
Total revenue $ 67.4 $ 62.9 $ 199.9 $ 203.4
========== ========== ========== ==========
27
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
September 30,
--------------------------------
2006 2005
--------------- ---------------
Assets
------
Cash and due from banks $ 1,038,594 $ 993,351
Investment securities:
----------------------
Trading securities 53,516 26,350
Short-term investments 302,893 272,662
Other investment securities:
Taxable 5,880,439 4,839,664
Tax-exempt 1,286,137 1,369,506
-------------- --------------
Total investment securities 7,522,985 6,508,182
Loans and leases:
-----------------
Loans and leases, net of unearned income 40,608,373 32,479,305
Less: Allowance for loan and lease losses 420,233 363,913
-------------- --------------
Net loans and leases 40,188,140 32,115,392
Premises and equipment, net 569,935 458,778
Accrued interest and other assets 5,264,373 4,059,705
-------------- --------------
Total Assets $ 54,584,027 $ 44,135,408
============== ==============
Liabilities and Shareholders' Equity
------------------------------------
Deposits:
---------
Noninterest bearing $ 5,462,260 $ 5,049,451
Interest bearing 27,458,681 21,302,690
-------------- --------------
Total deposits 32,920,941 26,352,141
Federal funds purchased and security repurchase agreements 2,759,105 2,055,778
Other short-term borrowings 904,766 803,193
Long-term borrowings 10,366,447 8,685,936
Accrued expenses and other liabilities 1,773,140 1,740,788
-------------- --------------
Total liabilities 48,724,399 39,637,836
Shareholders' equity 5,859,628 4,497,572
-------------- --------------
Total Liabilities and Shareholders' Equity $ 54,584,027 $ 44,135,408
============== ==============
28
MARSHALL & ILSLEY CORPORATION
CONSOLIDATED AVERAGE BALANCE SHEETS (Unaudited)
($000's)
Nine Months Ended
September 30,
--------------------------------
2006 2005
--------------- ---------------
Assets
------
Cash and due from banks $ 1,016,658 $ 950,509
Investment securities:
----------------------
Trading securities 46,058 25,027
Short-term investments 330,894 244,109
Other investment securities:
Taxable 5,562,657 4,830,427
Tax-exempt 1,314,087 1,327,456
-------------- --------------
Total investment securities 7,253,696 6,427,019
Loans and leases:
-----------------
Loans and leases, net of unearned income 38,350,036 31,228,509
Less: Allowance for loan and lease losses 401,807 362,127
-------------- --------------
Net loans and leases 37,948,229 30,866,382
Premises and equipment, net 544,002 451,684
Accrued interest and other assets 4,927,715 3,925,729
-------------- --------------
Total Assets $ 51,690,300 $ 42,621,323
============== ==============
Liabilities and Shareholders' Equity
------------------------------------
Deposits:
---------
Noninterest bearing $ 5,271,374 $ 4,857,646
Interest bearing 25,795,580 20,831,716
-------------- --------------
Total deposits 31,066,954 25,689,362
Federal funds purchased and security repurchase agreements 2,511,986 2,131,946
Other short-term borrowings 973,525 916,014
Long-term borrowings 9,943,731 7,942,493
Accrued expenses and other liabilities 1,744,446 1,691,305
-------------- --------------
Total liabilities 46,240,642 38,371,120
Shareholders' equity 5,449,658 4,250,203
-------------- --------------
Total Liabilities and Shareholders' Equity $ 51,690,300 $ 42,621,323
============== ==============
29
OVERVIEW
--------
The Corporation's overall strategy is to drive earnings per share growth
by: (1) expanding banking operations not only in Wisconsin but also into
faster growing regions beyond Wisconsin; (2) increasing the number of
financial institutions to which the Corporation provides correspondent
banking services and products; (3) expanding trust services and other
wealth management product and service offerings; and (4) growing
Metavante's business through organic growth, cross sales of technology
products 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
third quarter and first nine months of 2006 produced strong financial
results.
Net income for the third quarter of 2006 amounted to $238.9 million
compared to $179.7 million for the same period in the prior year, an
increase of $59.2 million, or 32.9%. Diluted earnings per share were
$0.92 for the three months ended September 30, 2006 compared to $0.75 for
the three months ended September 30, 2005. The return on average assets
and average equity was 1.74% and 16.17%, respectively, for the quarter
ended September 30, 2006, and 1.62% and 15.85%, respectively, for the
quarter ended September 30, 2005.
Net income for the first nine months of 2006 amounted to $602.5 million
compared to $528.7 million for the same period in the prior year, an
increase of $73.8 million, or 13.9%. Diluted earnings per share were
$2.38 for the nine months ended September 30, 2006, compared with $2.25
for the nine months ended September 30, 2005, an increase of 5.8%. The
return on average assets and average equity was 1.56% and 14.78%,
respectively, for the nine months ended September 30, 2006, and 1.66% and
16.63%, respectively, for the nine months ended September 30, 2005.
Net income for three and nine months ended September 30, 2006, includes
the impact of the mark-to-market adjustments associated with certain
interest rate swaps. Based on expanded interpretations of SFAS 133,
specifically hedge designation under the "matched-terms" method, it was
recently determined that certain transactions do not qualify for hedge
accounting. The impact, which is reported in Net derivative gains-
discontinued hedges in the Consolidated Statements of Income, was
immaterial to the results of operations for the nine months ended
September 30, 2006, increasing net income by $1.1 million and having no
effect on diluted earnings per share. For the three months ended
September 30, 2006, the impact resulted in an increase to net income of
$28.0 million and an increase to diluted earnings per share of $0.11 per
share. The interest rate swaps were designed to hedge the change in fair
values or cash flows of the underlying assets or liabilities and have
performed effectively as economic hedges. Applying fair value accounting
(versus hedge accounting) results in greater earnings volatility from
period to period, in particular on a linked-quarter basis. Management
believes the non-cash changes in earnings based on market volatility are
not reflective of the core performance trends of the Corporation.
Excluding the non-cash changes in earnings based on market volatility, for
the three months ended September 30, 2006 net income and diluted earnings
per share would have been $210.9 million and $0.81 per share respectively,
and the return on average assets and return on average equity would have
been 1.53% and 14.22%, respectively.
The Corporation is terminating the affected interest rate swaps early in
the fourth quarter of 2006 and expects the results of operations for the
fourth quarter to reflect losses aggregating approximately $0.05 per
diluted share from terminating the affected interest rate swaps. The
Corporation strives to manage its interest rate risk position to be
relatively neutral.
30
Earnings growth for the three and nine months ended September 30, 2006
compared to the three and nine months ended September 30, 2005 was
attributable to a number of factors. The increase in net interest income
was due to strong organic loan and bank issued deposit growth and the
contribution from the two banking acquisitions that were completed on
April 1, 2006. Strong credit quality has resulted in net charge-offs that
continue to be below the Corporation's five-year historical average.
Metavante continued to exhibit growth in both revenue and earnings which
was attributable, in part, to the impact of its acquisition activities as
well as success in retaining and cross-selling products and services to
its core customer base. Metavante's acquisition activities included one
acquisition completed in the third quarter of 2006, one acquisition
completed in the first quarter of 2006, two acquisitions completed in the
fourth quarter of 2005, three acquisitions completed in the third quarter
of 2005 and one acquisition completed in the first quarter of 2005. Net
investment securities gains for the three and nine months ended September
30, 2006 amounted to $4.5 million and $6.6 million, respectively compared
to $7.4 million and $42.6 million for the three and nine months ended
September 30, 2005, respectively. During the second quarter of 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. The gross gain amounted to $29.0 million and is
reported in Net investment securities gains 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.
The increase in expenses for the three and nine months ended September 30,
2006 compared to the three and nine months ended September 30, 2005 were
primarily due to the banking and Metavante acquisitions. These factors
along with continued organic expense management resulted in the reported
earnings growth in the three and nine months ended 2006 compared to the
three and nine months ended September 30, 2005.
Management continues to believe that the 2006 outlook provided in the
Corporation's Annual Report on Form 10-K for the year ended December 31,
2005 is generally still representative of its expectations for the year
ended December 31, 2006. Management expects Metavante revenue will be at
the high end of the previously forecasted revenue projection of $1.4
billion to $1.5 billion including all closed acquisitions and the transfer
of external item processing which is discussed in the next section. The
Corporation's actual results for the year ended December 31, 2006 could
differ materially from those expected by management. See "Forward-Looking
Statements" in this Form 10-Q and "Risk Factors" in Item 1A of the
Corporation's Annual Report on Form 10-K for the year ended December 31,
2005, for a discussion of the various risk factors that could cause actual
results to differ materially from expected results.
NOTEWORTHY TRANSACTIONS AND EVENTS
----------------------------------
Some of the more noteworthy transactions and events that occurred in the
three and nine months ended September 30, 2006 and 2005 consisted of the
following:
Third quarter 2006
------------------
As previously discussed, the Corporation recently determined that certain
transactions did not qualify for hedge accounting. The impact of the mark-
to-market adjustments associated with certain interest rate swaps and
reported in Net derivative gains-discontinued hedges in the Consolidated
Statements of Income, resulted in an increase to net income of $28.0
million and an increase to diluted earnings per share of $0.11 per share
for the three months ended September 30, 2006. The impact to the nine
months ended September 30, 2006 was not material. Management believes the
non-cash changes in earnings based on market volatility are not reflective
of the core performance trends of the Corporation. See Note 3 in Notes to
Financial Statements for further discussion.
For the three months ended September 30, 2006, Salaries and employee
benefits expense included $7.2 million of expense for stock options and
the Corporation's employee stock purchase plan ("ESPP"), which reduced net
income by $4.7 million or $0.02 per diluted share. The Corporation
expects that the additional compensation expense associated with stock
options and the ESPP will be dilutive to the Corporation's operating
results by $0.04 per diluted share in the fourth quarter of 2006. The
Corporation's largest stock option awards have historically been granted
during the fourth quarter and expense for stock options is larger in the
fourth quarter compared to the other quarters in any given year. Under
the existing plans, awards to individuals who meet certain age and years
of service criteria at the date of grant immediately vest and therefore
the full fair value of those awards are immediately expensed. For the
year ended December 31, 2006, the Corporation expects that the additional
compensation expense associated with stock options and the ESPP will be
dilutive to the Corporation's operating results by approximately $0.10 per
diluted share compared to $0.11 per diluted share for the year ended
December 31, 2005 as adjusted. See Note 12 in Notes to Financial
Statements for further information.
Second quarter 2006
-------------------
The results of operations and financial position as of and for the three
and six months ended June 30, 2006 include the effect of the previously
announced acquisitions of Gold Banc Corporation, Inc. ("Gold Banc") and
Trustcorp Financial, Inc. ("Trustcorp") which were both completed on April
1, 2006. As of April 1, 2006, the combined assets of Gold Banc and
Trustcorp amounted to approximately $4.9 billion. The acquired companies
had combined loans of $3.9 billion and combined bank issued deposits of
$3.1 billion. The combined purchase price for these companies, which
included approximately $146.0 million of cash, amounted to $898.2 million.
In the aggregate, 16.74 million shares of the Corporation's common stock
were issued, and fully vested stock options to purchase 0.5 million of its
common stock were exchanged in these transactions.
For the three months ended June 30, 2006, Salaries and employee benefits
expense included $7.6 million and Other expense included $0.6 million of
expense for stock options and the Corporation's ESPP which reduced net
income by $5.3 million or $0.02 per diluted share.
Beginning with the second quarter of 2006, trust services revenue,
brokerage and investment advisor revenue and noninterest revenue from the
private banking business have been combined and reported in the line item
Wealth management in the Consolidated Statements of Income in response to
requests by users of the Corporation's financial information. All prior
periods have been adjusted for this reclassification.
31
First quarter 2006
------------------
On January 1, 2006, the Corporation adopted the accounting standard that
requires share-based compensation to be expensed. The Corporation elected
the Modified Retrospective Application method to implement this new
accounting standard. Under that method all prior period consolidated and
segment financial information was adjusted to reflect the effect of
expensing awards issued under share-based compensation plans which were
not previously expensed. Prior to the adoption of the new standard, the
Corporation used the intrinsic method of accounting for stock options.
Under that method generally, no compensation expense was recognized for
stock option awards or the Corporation's ESPP. Shareholders' equity as of
January 1, 2006 increased $67.7 million due to the deferred income tax
benefit recognized from applying the Modified Retrospective Application
method of adoption. For the three months ended March 31, 2006, Salaries
and employee benefits expense includes $7.5 million of expense for stock
options and the ESPP, which reduced net income by $4.9 million or $0.02
per diluted share.
Beginning with the first quarter of 2006, the Corporation included certain
loan and lease fees, primarily prepayment fees, in reported interest
income on loans and leases. Previously, these fees were reported in Other
income. Such fees are in addition to loan origination fees that are
capitalized and amortized over the life of a loan or lease on a basis that
produces a level yield in accordance with existing accounting standards.
Including these fees in interest income may result in more volatility in
net interest income and the net interest margin. However, management
believes this reclassification will improve comparability of the net
interest margin between the Corporation and its peer banking group. All
prior periods have been adjusted for this reclassification.
On January 1, 2006 the Banking segment transferred its external item
processing business, including all check-processing client relationships,
to Metavante. This transfer, together with recent investments in
electronic check image technology, enables Metavante to provide its
clients with an end-to-end image solution that includes check truncation
at the point of first presentment, image exchange through the Endpoint
Exchange Network and final settlement. As a result of the transfer, the
previously reported Other income line, Item processing, was reclassified
to Data processing services in the Consolidated Statements of Income and
prior period segment financial information for both the Banking segment
and Metavante has been adjusted for the transfer. See Note 15 in Notes to
Financial Statements for segment information.
Third quarter 2005
------------------
As a result of adopting the accounting standard that requires share-based
compensation to be expensed, as previously discussed, adjusted Salaries
and employee benefits expense included $6.8 million of expense for stock
options and the ESPP, which reduced previously reported net income by $4.5
million or $0.02 per diluted share for the three months ended September
30, 2005.
Net investment securities gains as reported in the Consolidated Statements
of Income for the third quarter were primarily due to an equity investment
that the Corporation liquidated in a cash tender offer. That transaction
resulted in a pre-tax gain of $6.6 million or $0.02 per diluted share for
the three and nine months ended September 30, 2005.
Second quarter 2005
-------------------
As a result of adopting the accounting standard that requires share-based
compensation to be expensed, as previously discussed, adjusted Salaries
and employee benefits expense included $6.6 million and adjusted Other
expense included $0.7 million of expense for stock options and the ESPP,
which reduced previously reported net income by $4.7 million or $0.02 per
diluted share for the three months ended June 30, 2005.
During the second quarter of 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. The gross
gain amounted to $29.0 million and was reported in Net investment
securities gains 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.
First quarter 2005
------------------
As a result of adopting the accounting standard that requires share-based
compensation to be expensed, as previously discussed, adjusted Salaries
and employee benefits expense for the three months ended March 31, 2005
included $6.5 million of expense for stock options and the ESPP which
reduced previously reported net income by $4.3 million or $0.02 per
diluted share.
32
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 43.0% of the Corporation's source of
revenues for the three months ended September 30, 2006 compared to 42.8%
for the three months ended September 30, 2005. For the nine months ended
September 30, 2006, net interest income represented approximately 43.3% of
the Corporation's source of revenues compared to 42.4% for the nine months
ended September 30, 2005.
Net interest income for the third quarter of 2006 amounted to $393.2
million compared to $321.8 million reported for the third quarter of 2005,
an increase of $71.4 million or 22.2%. For the nine months ended
September 30, 2006, net interest income amounted to $1,095.1 million
compared to $933.7 million for the nine months ended September 30, 2005,
an increase of $161.4 million or 17.3%. Both acquisition-related and
organic loan growth, as well as the growth in noninterest bearing and
other bank issued deposits, were the primary contributors to the increase
in net interest income. Factors negatively affecting net interest income
compared to the prior year included the impact of the financing costs
associated with the 2006 banking acquisitions and Metavante's
acquisitions, common stock buybacks and a general shift in the bank issued
deposit mix from lower cost to higher cost deposit products in response to
increasing interest rates.
Average earning assets in the third quarter of 2006 amounted to $48.1
billion compared to $39.0 billion in the third quarter of 2005, an
increase of $9.1 billion or 23.5%. Average loans and leases accounted for
$8.1 billion of the growth in average earning assets in the third quarter
of 2006 compared to the third quarter of 2005. Average investment
securities increased $1.0 billion over the prior year quarter. The growth
in average investment securities was primarily due to the banking
acquisitions.
Average interest bearing liabilities increased $8.6 billion or 26.3% in
the third quarter of 2006 compared to the third quarter of 2005. Average
interest bearing deposits increased $6.1 billion or 28.9% in the third
quarter of 2006 compared to the third quarter of 2005. Average total
borrowings, primarily long-term borrowings, increased $2.5 billion or
21.5% in the third quarter of 2006 compared to the same period in 2005.
For the nine months ended September 30, 2006, average earning assets
amounted to $45.6 billion compared to $37.7 billion in the nine months
ended September 30, 2005, an increase of $7.9 billion or 21.1%. Average
loans and leases accounted for $7.1 billion of the growth in average
earning assets in the nine months ended September 30, 2006 compared to the
nine months ended September 30, 2005. Average investment securities
increased $0.8 billion over the comparative nine month periods. The growth
in average investment securities was primarily due to the banking
acquisitions.
Average interest bearing liabilities increased $7.4 billion or 23.3% in
the nine months ended September 30, 2006 compared to the nine months ended
September 30, 2005. Average interest bearing deposits increased $5.0
billion or 23.8% in the nine months ended September 30, 2006 compared to
the nine months ended September 30, 2005. Average total borrowings,
primarily long-term borrowings, increased $2.4 billion or 22.2% over the
comparative nine month periods.
Average noninterest bearing deposits increased $0.4 billion or 8.2% in the
three months ended September 30, 2006 compared to the three months ended
September 30, 2005. For the nine months ended September 30, 2006 compared
to the nine months ended September 30, 2005, average noninterest bearing
deposits increased $0.4 billion or 8.5%.
33
The growth and composition of the Corporation's quarterly average loan and
lease portfolio for the current quarter and previous four quarters are
reflected in the following table ($ in millions):
Consolidated Average Loans and Leases
-------------------------------------
2006 2005 Growth Pct.
------------------------------ ------------------- -----------------
Third Second First Fourth Third Prior
Quarter Quarter Quarter Quarter Quarter Annual Quarter
---------- --------- --------- --------- --------- -------- ---------
Commercial Loans and Leases
---------------------------
Commercial $ 11,559 $ 11,441 $ 9,877 $ 9,290 $ 9,126 26.7 % 1.0 %
Commercial real estate
Commercial mortgages 10,838 10,746 8,839 8,850 8,661 25.1 0.8
Construction 3,227 2,834 1,742 1,564 1,484 117.4 13.9
-------- -------- -------- -------- -------- ------ ------
Total commercial real estate 14,065 13,580 10,581 10,414 10,145 38.6 3.6
Commercial lease financing 529 504 493 471 462 14.4 5.0
-------- -------- -------- -------- -------- ------ ------
Total Commercial Loans
and Leases 26,153 25,525 20,951 20,175 19,733 32.5 2.5
Personal Loans and Leases
Residential real estate
Residential mortgages 5,924 5,621 5,190 4,855 4,537 30.6 5.4
Construction 2,471 2,365 2,085 1,862 1,633 51.3 4.5
-------- -------- -------- -------- -------- ------ ------
Total residential
real estate 8,395 7,986 7,275 6,717 6,170 36.1 5.1
Personal loans
Student 47 51 99 78 74 (36.7) (8.5)
Credit card 246 237 227 233 228 7.8 3.6
Home equity loans
and lines 4,474 4,596 4,706 4,822 4,905 (8.8) (2.7)
Other 1,143 1,167 1,289 1,245 1,241 (7.9) (2.0)
-------- -------- -------- -------- -------- ------ ------
Total personal loans 5,910 6,051 6,321 6,378 6,448 (8.4) (2.3)
Personal lease financing 150 136 132 132 128 17.5 10.4
-------- -------- -------- -------- -------- ------ ------
Total Personal Loans and Leases 14,455 14,173 13,728 13,227 12,746 13.4 2.0
-------- -------- -------- -------- -------- ------ ------
Total Consolidated Average
Loans and Leases $ 40,608 $ 39,698 $ 34,679 $ 33,402 $ 32,479 25.0 % 2.3 %
======== ======== ======== ======== ======== ======= =======
Total consolidated average loans and leases increased $8.1 billion or
25.0% in the third quarter of 2006 compared to the third quarter of 2005.
Excluding the effect of the banking acquisitions, total consolidated
average loan and lease organic growth was 11.6% in the third quarter of
2006 compared to the third quarter of 2005. Approximately $3.9 billion of
the growth in total consolidated average loans and leases was attributable
to the banking acquisitions and $4.2 billion of the growth was organic.
Of the $3.9 billion of average growth attributable to the banking
acquisitions, $2.8 billion was attributable to average commercial real
estate loans, $0.8 billion was attributable to average commercial loans
and leases and $0.3 billion was attributable to average residential real
estate loans. Of the $4.2 billion of average loan and lease organic
growth, $1.7 billion was attributable to average commercial loans and
leases, $1.1 billion was attributable to average commercial real estate
loans, and $2.0 billion was attributable to residential real estate loans.
From a production standpoint, residential real estate loan closings in the
third quarter of 2006 were $1.2 billion compared to $1.4 billion in the
second quarter of 2006 and $1.7 billion in the third quarter of 2005.
Average home equity loans and lines declined $0.4 billion in the third
quarter of 2006 compared to the third quarter of 2005.
For the nine months ended September 30, 2006, total consolidated average
loans and leases increased $7.1 billion or 22.8% compared to the nine
months ended September 30, 2005. Excluding the effect of the banking
acquisitions, total consolidated average loan and lease organic growth was
13.3% for the nine months ended September 30, 2006 compared to the nine
months ended September 30, 2005. Approximately $2.6 billion of the growth
in total consolidated average loans and leases was attributable to the
banking acquisitions and $4.5 billion of the growth was organic. Of the
$2.6 billion of average growth attributable to the banking acquisitions,
$1.9 billion was attributable to average commercial real estate loans,
$0.5 billion was attributable to average commercial loans and leases and
the remainder was primarily attributable to average residential real
estate loans. Of the $4.5 billion of average loan and lease organic
growth, $1.7 billion was attributable to average commercial loans and
leases, $1.0 billion was attributable to average commercial real estate
loans, and $2.3 billion was attributable to residential real estate loans.
From a production standpoint, residential real estate loan closings in the
nine months ended September 30, 2006 and 2005 amounted to $3.8 billion and
$4.4 billion, respectively. Average home equity loans and lines declined
$0.5 billion in the nine months ended September 30, 2006 compared to the
nine months ended September 30, 2005.
34
Total average commercial loan and lease organic growth continued to be
strong in the third quarter and first nine months of 2006. Management
attributes the loan growth to the strength of the local economies in the
markets the Corporation serves, new business and continued customer
satisfaction. Management continues to expect that year over year organic
commercial loan growth (as a percentage) will reach low double digits in
2006. The basis for this expectation includes continued success in
attracting new customers in all of the Corporation's markets and continued
modest economic growth in the primary markets that the Corporation serves.
Recently the Corporation has experienced some slowing in the construction
market for both commercial and residential developers, and to some extent
throughout the commercial real estate business.
Home equity loans and lines, which includes M&I's wholesale activity,
continue to be one of the Corporation's primary consumer loan products.
Average home equity loans and lines declined in the third quarter of 2006
compared to the third quarter of 2005. This is consistent with what is
occurring in many parts of the country. The softer home equity market,
combined with the Corporation's continued sales of certain loans at
origination, which is partly in response to the Corporation's demand for
home equity products with higher loan-to-value characteristics, will
impact balance sheet organic loan growth. Management does not expect this
trend to change in the near term.
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 September 30, 2006 and 2005, real estate loans
sold to investors amounted to $0.6 billion and $0.8 billion, respectively.
For the nine months ended September 30, 2006, real estate loans sold to
investors amounted to $1.8 billion compared to $1.7 billion for the nine
months ended September 30, 2005. At September 30, 2006 and 2005, the
Corporation had approximately $101.0 million and $191.6 million of
mortgage loans held for sale, respectively. Gains from the sale of
mortgage loans amounted to $11.7 million in the third quarter of 2006
compared to $13.9 million in the third quarter of 2005. For the nine
months ended September 30, 2006, gains from the sale of mortgage loans
amounted to $32.6 million compared to $30.4 million in the nine months
ended September 30, 2005.
Auto loans securitized and sold in the third quarters of 2006 and 2005
amounted to $0.1 billion and $0.2 billion, respectively. For the nine
months ended September 30, 2006 and September 30, 2005, auto loans
securitized and sold amounted to $0.4 billion, respectively. The net
gains and losses from the sale and securitization of auto loans for the
three and nine months ended September 30, 2006 and 2005, respectively,
were not significant.
The Corporation anticipates that it will continue to divest itself of
selected assets through sale or securitization in future periods.
35
The growth and composition of the Corporation's quarterly average deposits
for the current and previous four quarters are as follows ($ in millions):
Consolidated Average Deposits
-----------------------------
2006 2005 Growth Pct.
------------------------------ ------------------- -----------------
Third Second First Fourth Third Prior
Quarter Quarter Quarter Quarter Quarter Annual Quarter
---------- --------- --------- --------- --------- -------- ---------
Bank issued deposits
--------------------
Noninterest bearing deposits
Commercial $ 3,948 $ 3,873 $ 3,473 $ 3,687 $ 3,589 10.0 % 1.9 %
Personal 953 998 943 942 932 2.2 (4.6)
Other 561 533 526 566 528 6.2 5.4
-------- -------- -------- -------- -------- ------ ------
Total noninterest
bearing deposits 5,462 5,404 4,942 5,195 5,049 8.2 1.1
Interest bearing deposits
Savings and NOW 3,081 3,251 2,831 2,911 3,049 1.0 (5.2)
Money market 7,795 7,389 6,599 6,354 6,047 28.9 5.5
Foreign activity 1,151 1,000 1,034 1,084 932 23.5 15.1
-------- -------- -------- -------- -------- ------ ------
Total interest
bearing deposits 12,027 11,640 10,464 10,349 10,028 19.9 3.3
Time deposits
Other CDs and
time deposits 4,843 4,769 3,509 3,354 3,095 56.5 1.5
CDs greater than $100,000 3,137 2,878 2,035 1,703 1,421 120.6 9.0
-------- -------- -------- -------- -------- ------ ------
Total time deposits 7,980 7,647 5,544 5,057 4,516 76.7 4.4
-------- -------- -------- -------- -------- ------ ------
Total bank issued deposits 25,469 24,691 20,950 20,601 19,593 30.0 3.1
Wholesale deposits
Money market 795 737 893 1,074 1,068 (25.5) 7.9
Brokered CDs 5,510 5,382 3,874 4,752 4,615 19.4 2.4
Foreign time 1,147 1,931 1,762 897 1,076 6.6 (40.6)
-------- -------- -------- -------- -------- ------ ------
Total wholesale deposits 7,452 8,050 6,529 6,723 6,759 10.3 (7.4)
-------- -------- -------- -------- -------- ------ ------
Total consolidated
average deposits $ 32,921 $ 32,741 $ 27,479 $ 27,324 $ 26,352 24.9 % 0.5 %
======== ======== ======== ======== ======== ======= =======
Average total bank issued deposits increased $5.9 billion or 30.0% in the
third quarter of 2006 compared to the third quarter of 2005. Excluding the
effect of the banking acquisitions, average total bank issued deposit
organic growth was 12.4% in the third quarter of 2006 compared to the
third quarter of 2005. Approximately $3.1 billion of the growth in
average total bank issued deposits was attributable to the banking
acquisitions and $2.8 billion of the growth was organic. Of the $3.1
billion of average growth attributable to the banking acquisitions, $0.4
billion was attributable to average noninterest bearing deposits, $1.0
billion was attributable to average interest bearing deposits and $1.7
billion was attributable to average time deposits. Of the $2.8 billion of
average bank issued deposit organic growth, $1.0 billion was attributable
to average interest bearing deposits and $1.8 billion was attributable to
average time deposits.
For the nine months ended September 30, 2006, average total bank issued
deposits increased $4.8 billion or 25.0% compared to the nine months ended
September 30, 2005. Excluding the effect of the banking acquisitions,
average total bank issued deposit organic growth was 12.8% in the nine
months ended September 30, 2006 compared to the nine months ended
September 30, 2005. Approximately $2.1 billion of the growth in average
total bank issued deposits was attributable to the banking acquisitions
and $2.7 billion of the growth was organic. Of the $2.1 billion of
average growth attributable to the banking acquisitions, $0.3 billion was
attributable to average noninterest bearing deposits, $0.6 billion was
attributable to average interest bearing deposits and $1.2 billion was
attributable to average time deposits. Of the $2.7 billion of average bank
issued deposit organic growth, $0.2 billion was attributable to average
noninterest bearing deposits, $0.8 billion was attributable to average
interest bearing deposits and $1.7 billion was attributable to average
time deposits.
Noninterest bearing deposit balances tend to exhibit some seasonality with
a trend of balances declining somewhat in the early part of the year
followed by growth in balances throughout the remainder of the year. A
portion of the noninterest balances, especially commercial balances, is
sensitive to the interest rate environment. Larger balances tend to be
maintained when overall interest rates are low and smaller balances tend
to be maintained as overall interest rates increase.
36
As interest rates have risen, the Corporation has increasingly been able
to competitively price deposit products which has contributed to the
growth in average bank issued interest bearing deposits and average bank
issued time deposits. In addition, rising interest rates have resulted in
a shift in the bank issued deposit mix. In their search for higher
yields, both new and existing customers have been migrating their deposit
balances to higher cost money market and time deposit products.
In commercial banking, the focus remains on developing deeper
relationships by capitalizing on cross-sale opportunities. Incentive
plans based on the sale of treasury management products and services are
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.
Wholesale deposits are funds in the form of deposits generated through
distribution channels other than M&I's own banking branches. The
Corporation continues to make use of wholesale funding alternatives,
especially brokered and institutional certificates of deposit. 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. For the three
months ended September 30, 2006, average wholesale deposits increased $0.7
billion, or 10.3% compared to the three months ended September 30, 2005.
For the nine months ended September 30, 2006 average wholesale deposits
increased $0.6 billion, or 9.3% compared to the nine months ended
September 30, 2005. Average wholesale deposits for the three and nine
months ended September 30, 2006 include $0.6 billion and $0.4 billion,
respectively, of wholesale deposits that were assumed in the 2006 banking
acquisitions.
At September 30, 2006, long-term borrowings from the 2006 banking
acquisitions amounted to $209.0 million. Approximately $30.0 million was
subordinated, $80.0 million was advances from the Federal Home Loan Bank
("FHLB") and $99.0 million was subordinated debt associated with four
separate issuances of trust preferred securities. During the third
quarter of 2006, $20.0 million of the acquired FHLB advances were paid.
During the third quarter of 2006, the Corporation obtained $500.0 million
in new FHLB floating rate advances maturing in 2013 and issued $250.0
million of fixed rate global bank notes maturing in 2011. FHLB floating
rate advances in the aggregate amount of $310.0 million and $198.4 million
of Series E medium term notes matured during the third quarter of 2006.
During the second quarter of 2006, $400.0 million of floating rate global
senior bank notes were issued. These floating rate senior bank notes
mature in 2011 and have a coupon rate that is indexed to the three-month
London Inter-Bank Offered Rate ("LIBOR").
During the first quarter of 2006, the Corporation issued $250.0 million of
fixed rate senior notes. The fixed rate senior notes mature in 2011 and
have a coupon rate of 5.35%. Also during the first quarter of 2006,
$500.0 million of floating rate senior bank notes were issued. These
floating rate senior bank notes mature in 2008 and have a coupon rate that
is indexed to the three-month LIBOR. During the first quarter of 2006,
$250.0 million of senior bank notes - Extendible Liquidity Securities
matured.
During the third 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 third quarter of 2005. The senior
bank notes are floating rate and mature at various times in 2007 and 2010.
During the first quarter of 2005 the Corporation obtained a new floating
rate advance from the FHLB aggregating $250.0 million. The FHLB advance
matures in 2011. During the first quarter of 2005, $900.0 million of
senior bank notes with an annual weighted average coupon interest rate of
4.13% were issued. The notes mature at various times beginning in 2008
through 2017.
37
The Corporation's consolidated average interest earning assets and
interest bearing liabilities, interest earned and interest paid for the
three and nine months ended September 30, 2006 and 2005, are presented in
the following tables ($ in millions):
Consolidated Yield and Cost Analysis
------------------------------------
Three Months Ended Three Months Ended
September 30, 2006 September 30, 2005
---------------------------- ----------------------------
Average Average
Average Yield or Average Yield or
Balance Interest Cost (b) Balance Interest Cost (b)
---------------------------- ----------------------------
Loans and leases: (a)
Commercial loans and leases $ 12,088.3 $ 232.2 7.62 % $ 9,588.0 $ 149.2 6.17 %
Commercial real estate loans 14,064.5 270.3 7.63 10,145.5 161.8 6.33
Residential real estate loans 8,395.4 150.6 7.12 6,169.5 96.1 6.18
Home equity loans and lines 4,473.7 84.4 7.49 4,905.1 78.1 6.32
Personal loans and leases 1,586.5 29.6 7.40 1,671.2 26.2 6.21
----------- ------- ------- ---------- ------- -------
Total loans and leases 40,608.4 767.1 7.49 32,479.3 511.4 6.25
Investment securities (b):
Taxable 5,880.5 73.5 4.85 4,839.7 53.8 4.40
Tax Exempt (a) 1,286.1 22.1 6.86 1,369.5 24.2 7.16
----------- ------- ------- ---------- ------- -------
Total investment securities 7,166.6 95.6 5.20 6,209.2 78.0 4.99
Trading securities (a) 53.5 0.2 1.38 26.3 0.1 0.90
Other short-term investments 302.9 4.4 5.79 272.7 2.7 3.86
----------- ------- ------- ---------- ------- -------
Total interest earning assets $ 48,131.4 $ 867.3 7.13 % $ 38,987.5 $ 592.2 6.03 %
========== ======= ======= ========== ======= =======
Interest bearing deposits:
Bank issued deposits:
Bank issued interest
bearing activity deposits $ 12,026.4 $ 105.2 3.47 % $ 10,027.5 $ 52.0 2.06 %
Bank issued time deposits 7,979.7 91.5 4.55 4,516.3 37.4 3.29
----------- ------- ------- ---------- ------- -------
Total bank issued deposits 20,006.1 196.7 3.90 14,543.8 89.4 2.44
Wholesale deposits 7,452.6 94.0 5.00 6,758.9 56.1 3.29
----------- ------- ------- ---------- ------- -------
Total interest bearing deposits 27,458.7 290.7 4.20 21,302.7 145.5 2.71
Short-term borrowings 3,663.9 49.7 5.39 2,859.0 27.9 3.88
Long-term borrowings 10,366.4 126.4 4.84 8,685.9 88.5 4.04
----------- ------- ------- ---------- ------- -------
Total interest bearing liabilities $ 41,489.0 $ 466.8 4.46 % $ 32,847.6 $ 261.9 3.16 %
========== ======= ======= ========== ======= =======
Net interest margin (FTE) $ 400.5 3.29 % $ 330.3 3.36 %
======= ======= ======= =======
Net interest spread (FTE) 2.67 % 2.87 %
======= =======
(a) Fully taxable equivalent ("FTE") basis, 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.
38
Consolidated Yield and Cost Analysis
------------------------------------
Nine Months Ended Nine Months Ended
September 30, 2006 September 30, 2005
----------------------------- -----------------------------
Average Average
Average Yield or Average Yield or
Balance Interest Cost (b) Balance Interest Cost (b)
----------------------------- -----------------------------
Loans and leases: (a)
Commercial loans and leases $ 11,473.9 $ 627.1 7.31 % $ 9,270.2 $ 406.3 5.86 %
Commercial real estate loans 12,754.5 700.0 7.34 9,845.4 451.8 6.14
Residential real estate loans 7,889.6 413.1 7.00 5,427.3 243.3 5.99
Home equity loans and lines 4,590.9 248.0 7.22 5,043.9 232.5 6.16
Personal loans and leases 1,641.1 87.3 7.11 1,641.7 72.5 5.91
---------- -------- ------- ---------- -------- -------
Total loans and leases 38,350.0 2,075.5 7.24 31,228.5 1,406.4 6.02
Investment securities (b):
Taxable 5,562.7 202.3 4.77 4,830.4 159.0 4.39
Tax Exempt (a) 1,314.1 68.4 7.03 1,327.5 71.1 7.32
---------- -------- ------- ---------- -------- -------
Total investment securities 6,876.8 270.7 5.19 6,157.9 230.1 5.01
Trading securities (a) 46.0 0.5 1.37 25.0 0.2 0.96
Other short-term investments 330.9 13.0 5.25 244.1 6.3 3.44
---------- -------- ------- ---------- -------- -------
Total interest earning assets $ 45,603.7 $2,359.7 6.90 % $ 37,655.5 $1,643.0 5.84 %
========== ======== ======= ========== ======== =======
Interest bearing deposits:
Bank issued deposits:
Bank issued interest
bearing activity deposits $ 11,382.5 $ 274.4 3.22 % $ 9,918.7 $ 127.5 1.72 %
Bank issued time deposits 7,065.9 225.8 4.27 4,192.6 95.1 3.03
---------- -------- ------- ---------- -------- -------
Total bank issued deposits 18,448.4 500.2 3.62 14,111.3 222.6 2.11
Wholesale deposits 7,347.2 260.8 4.75 6,720.4 149.2 2.97
---------- -------- ------- ---------- -------- -------
Total interest bearing deposits 25,795.6 761.0 3.94 20,831.7 371.8 2.39
Short-term borrowings 3,485.5 132.2 5.07 3,048.0 78.3 3.43
Long-term borrowings 9,943.7 348.5 4.69 7,942.5 234.2 3.94
---------- -------- ------- ---------- -------- -------
Total interest bearing liabilities $ 39,224.8 $1,241.7 4.23 % $ 31,822.2 $ 684.3 2.87 %
========== ======== ======= ========== ======== =======
Net interest margin (FTE) $1,118.0 3.27 % $ 958.7 3.41 %
======== ======= ======== =======
Net interest spread (FTE) 2.67 % 2.97 %
======= =======
(a) Fully taxable equivalent ("FTE") basis, 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 FTE decreased 7 basis points from 3.36% in the
third quarter of 2005 to 3.29% in the third quarter of 2006. For the nine
months ended September 30, 2006, the net interest margin FTE was 3.27%
compared to 3.41% for the nine months ended September 30, 2005, a decrease
of 14 basis points. Beginning with the first quarter of 2006, the
Corporation included certain loan and lease fees in interest income on
loans and leases. All prior periods have been adjusted for this
reclassification. The net interest margin FTE increased by approximately
9 basis points for both of the three and nine month periods ended
September 30, 2005, respectively from the previously reported amounts due
to this reclassification.
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. Net interest
income and the net interest margin percentage for the three months ended
September 30, 2006 was positively impacted by prepayment activity and the
receipt of interest payments on nonaccrual loans. Similar to the general
trends being experienced throughout the industry, the Corporation
continues to be challenged by narrowing loan spreads in a solid economy
with a flat yield curve, loan growth that may exceed the Corporation's
ability to generate appropriately priced deposits and the shift in the
bank issued deposit mix by new and existing depositors into higher
yielding products. Management expects these trends to continue and
expects that there will be modest downward pressure on the net interest
margin FTE for the remainder of 2006.
39
PROVISION FOR LOAN AND LEASE LOSSES AND CREDIT QUALITY
------------------------------------------------------
The following tables present comparative consolidated credit quality
information as of September 30, 2006, and the prior four quarters:
Nonperforming Assets
--------------------
($000's)
2006 2005
----------------------------------- -----------------------
Third Second First Fourth Third
Quarter Quarter Quarter Quarter Quarter
----------- ----------- ----------- ----------- -----------
Nonaccrual $ 213,920 $ 193,028 $ 144,484 $ 134,718 $ 141,408
Renegotiated 130 133 138 143 148
Past due 90 days or more 5,132 4,855 4,523 5,725 5,743
Total nonperforming loans and leases 219,182 198,016 149,145 140,586 147,299
Other real estate owned 15,152 11,701 8,207 8,869 8,774
---------- ---------- ---------- ---------- ----------
Total nonperforming assets $ 234,334 $ 209,717 $ 157,352 $ 149,455 $ 156,073
========== ========== ========== ========== ==========
Allowance for loan and lease losses $ 417,375 $ 415,201 $ 368,760 $ 363,769 $ 362,257
========== ========== ========== ========== ==========
Consolidated Statistics
-----------------------
2006 2005
----------------------------------- -----------------------
Third Second First Fourth Third
Quarter Quarter Quarter Quarter Quarter
----------- ----------- ----------- ----------- -----------
Net charge-offs to average
loans and leases annualized 0.08 % 0.10 % 0.07 % 0.14 % 0.10 %
Total nonperforming loans and leases
to total loans and leases 0.53 0.49 0.42 0.41 0.44
Total nonperforming assets to total loans
and leases and other real estate owned 0.57 0.52 0.45 0.44 0.47
Allowance for loan and lease losses
to total loans and leases 1.01 1.03 1.05 1.06 1.09
Allowance for loan and lease losses
to total nonperforming loans and lease 190 210 247 259 246
Nonaccrual Loans and Leases By Type
-----------------------------------
($000's)
2006 2005
----------------------------------- -----------------------
Third Second First Fourth Third
Quarter Quarter Quarter Quarter Quarter
----------- ----------- ----------- ----------- -----------
Commercial
Commercial, financial
and agricultural $ 56,541 $ 59,558 $ 50,103 $ 43,730 $ 47,644
Lease financing receivables 539 454 1,399 1,539 3,012
---------- ---------- ---------- ---------- ----------
Total commercial 57,080 60,012 51,502 45,269 50,656
Real estate
Construction and land development 47,265 33,115 3,276 913 3,057
Commercial mortgage 34,191 34,260 30,633 28,644 30,351
Residential mortgage 73,842 64,151 57,425 57,982 56,488
---------- ---------- ---------- ---------- ----------
Total real estate 155,298 131,526 91,334 87,539 89,896
Personal 1,542 1,490 1,648 1,910 856
---------- ---------- ---------- ---------- ----------
Total nonaccrual loans and leases $ 213,920 $ 193,028 $ 144,484 $ 134,718 $ 141,408
========== ========== ========== ========== ==========
40
Reconciliation of Allowance for Loan and Lease Losses
-----------------------------------------------------
($000's)
2006 2005
----------------------------------- -----------------------
Third Second First Fourth Third
Quarter Quarter Quarter Quarter Quarter
----------- ----------- ----------- ----------- -----------
Beginning balance $ 415,201 $ 368,760 $ 363,769 $ 362,257 $ 360,138
Provision for loan and lease losses 10,250 11,053 10,995 12,995 9,949
Allowance of banks and loans acquired -- 45,258 -- -- --
Loans and leases charged-off
Commercial 4,073 6,125 3,869 9,481 2,256
Real estate 4,971 3,385 2,901 3,110 6,576
Personal 3,516 3,088 3,727 5,213 3,186
Leases 165 1,253 189 226 337
---------- ---------- ---------- ---------- ----------
Total charge-offs 12,725 13,851 10,686 18,030 12,355
Recoveries on loans and leases
Commercial 2,251 847 2,715 4,256 2,634
Real estate 783 1,224 263 374 575
Personal 1,031 1,149 971 781 787
Leases 584 761 733 1,136 529
---------- ---------- ---------- ---------- ----------
Total recoveries 4,649 3,981 4,682 6,547 4,525
---------- ---------- ---------- ---------- ----------
Net loans and leases charged-off 8,076 9,870 6,004 11,483 7,830
---------- ---------- ---------- ---------- ----------
Ending balance $ 417,375 $ 415,201 $ 368,760 $ 363,769 $ 362,257
========== ========== ========== ========== ==========
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
$15.2 million at September 30, 2006, compared to $11.7 million at June 30,
2006 and $8.8 million at September 30, 2005. Approximately $2.2 million
of the OREO outstanding at September 30, 2006 is attributable to the OREO
acquired from the two banking acquisitions that were completed on April 1,
2006. The increase in OREO from June 30, 2006 to September 30, 2006 was
primarily due to the OREO acquired in satisfaction of commercial real
estate and construction and land development problem loans.
Nonperforming loans and leases consist of nonaccrual, renegotiated or
restructured loans, and loans and leases that are delinquent 90 days or
more and still accruing interest. The balance of nonperforming loans and
leases can fluctuate widely based on the timing of cash collections,
renegotiations and renewals.
Maintaining nonperforming assets at an acceptable level is important to
the ongoing success of a financial services institution. The
Corporation's comprehensive credit review and approval process are
critical to ensuring that the amount of nonperforming assets on a long-
term basis is minimized within the overall framework of acceptable levels
of credit risk. In addition to the negative impact on net interest income
and credit losses, nonperforming assets also increase operating costs due
to the expense associated with collection efforts.
At September 30, 2006, nonperforming loans and leases amounted to $219.2
million or 0.53% of consolidated loans and leases compared to $198.0
million or 0.49% of consolidated loans and leases at June 30, 2006, and
$147.3 million or 0.44% of consolidated loans and leases at September 30,
2005. Approximately $51.9 million of total nonperforming loans at
September 30, 2006 was attributable to the banking acquisitions.
Excluding the effect of the acquisitions, nonperforming loans and leases
would have amounted to $167.3 million or 0.45% of consolidated loans and
leases at September 30, 2006 and $155.3 million or 0.43% of consolidated
loans and leases at June 30, 2006. Excluding the acquisitions, the pro
forma ratio of nonperforming loans and leases to consolidated loans and
leases at September 30 and June 30, 2006 and the actual ratio at each
quarter end throughout 2005 and the first quarter of 2006 has remained in
a fairly narrow range. Nonaccrual loans and leases continue to be the
primary source of nonperforming loans and leases.
41
Net charge-offs amounted to $8.1 million or 0.08% of average loans and
leases in the third quarter of 2006 compared to $9.9 million or 0.10% of
average loans and leases in the second quarter of 2006 and $7.8 million or
0.10% of average loans and leases in the third quarter of 2005. The lower
level of net charge-offs experienced throughout 2005 and the first nine
months of 2006 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. The ratio of recoveries to
charge-offs was 36.5% and 35.7% for the three and nine months ended
September 30, 2006, respectively and continues to be above the
Corporation's five year historical average ratio of recoveries to charge-
offs of 27.9%.
The housing slowdown is impacting the performance of some of the
Corporation's construction and land development loans. A re-balancing of
supply and demand within the national housing market has reduced both
absorption rates and valuations causing stress for some borrowers within
this loan segment. These loans are geographically dispersed and are in
both the Corporation's core and acquired loan portfolios. The Corporation
has taken these exposures into consideration in determining the adequacy
of its allowance for loan and lease losses.
As a result of these portfolio trends, management is revising the expected
level of nonperforming loans and leases to be in the range of 65 to 75
basis points of total loans and leases and continues to expect net charge-
offs to trend to historical levels (five year average net charge-offs
ratio was 0.17%).
The provisions for loan and lease losses amounted to $10.3 million for the
three months ended September 30, 2006 compared to $11.1 million for the
three months ended June 30, 2006 and $9.9 million for the three months
ended September 30, 2005. For the nine months ended September 30, 2006,
the provisions for loan and lease losses amounted to $32.3 million
compared to $31.8 million for the nine months ended September 30, 2005.
The allowance for loan and lease losses as a percent of consolidated loans
and leases outstanding was 1.01% at September 30, 2006, 1.03% at June 30,
2006 and 1.09% at September 30, 2005.
OTHER INCOME
------------
Other income or noninterest sources of revenue represented approximately
57.0% and 57.2% of the Corporation's total sources of revenues for the
three months ended September 30, 2006 and 2005, respectively. Total other
income in the third quarter of 2006 amounted to $521.1 million compared to
$430.1 million in the same period last year, an increase of $91.0 million
or 21.2%. For the nine months ended September 30, 2006 and 2005,
noninterest sources of revenue represented approximately 56.7% and 57.6%,
respectively of the Corporation's total sources of revenues. Total other
income for the nine months ended September 30, 2006 amounted to $1,433.0
million compared to $1,266.9 million for the nine months ended September
30, 2005, an increase of $166.1 million or 13.1%. The increase in other
income was primarily due to growth in data processing services and wealth
management services revenue. As previously discussed, other income for
the three months ended September 30, 2006 included significant mark-to-
market adjustments for derivative financial instruments that did not
qualify for hedge accounting and other income for the nine months ended
September 30, 2005 includes significant investment securities gains.
Data processing services revenue (Metavante) amounted to $339.5 million in
the third quarter of 2006 compared to $296.0 million in the third quarter
of 2005, an increase of $43.5 million or 14.7%. For the nine months ended
September 30, 2006, Data processing services revenue amounted to $1,027.5
million compared to $861.3 million for the nine months ended September 30,
2005, an increase of $166.2 million or 19.3%. Revenue growth continued
throughout the segment due to revenue associated with acquisitions, higher
transaction volumes in core processing activity, payment processing and
electronic banking and an increase in healthcare eligibility and payment
card production. Revenue associated with Metavante's acquisitions
completed in 2006 and 2005 contributed a significant portion of the
revenue growth in the three and nine months ended September 30, 2006,
compared to the three and nine months ended September 30, 2005. The
acquisition related revenue growth includes cross sales of acquired
products to clients across the entire segment. Metavante estimates that
total revenue growth (internal and external) for the nine months ended
September 30, 2006 compared to the nine months ended September 30, 2005
excluding the acquisitions ("organic revenue growth"), was approximately
8.0%. To determine the estimated organic revenue growth rate, Metavante
adjusts its prior year revenue for the acquisitions as if they had been
consummated on January 1 of the prior year. Total external buyout
revenue, which varies from period to period, increased $7.2 million and
$9.1 million in the three and nine months ended September 30, 2006
compared to the three and nine months ended September 30, 2005,
respectively.
42
As previously reported, on January 1, 2006 the Banking segment transferred
its external item processing business, including all check-processing
client relationships, to Metavante. As a result of the transfer, the
previously reported Other income line, Item processing, was reclassified
to Data processing services in the Consolidated Statements of Income and
prior period segment financial information for both the Banking segment
and Metavante has been adjusted for the transfer.
Management continues to expect that Metavante revenue (internal and
external) for the year ended December 31, 2006 will be at the high end of
the previously forecasted revenue projection of $1.4 billion to $1.5
billion. Organic revenue growth rates and segment income are expected to
exceed prior year levels. These expectations include the impact of all
closed acquisitions and the transfer of external item processing.
As previously discussed, beginning with the second quarter of 2006, trust
services revenue, brokerage and investment advisor revenue and noninterest
revenue from the private banking business have been combined and reported
in the line item Wealth management in the Consolidated Statements of
Income in response to requests by users of the Corporation's financial
information. All prior periods have been adjusted for this
reclassification.
Wealth management revenue amounted to $54.6 million in the third quarter
of 2006 compared to $48.3 million in the third quarter of 2005, an
increase of $6.3 million or 13.1%. For the nine months ended September
30, 2006, wealth management revenue amounted to $163.7 million compared to
$143.5 million for the nine months ended September 30, 2005, an increase
of $20.2 million or 14.1%. For the three and nine months ended September
30, 2006, wealth management revenue attributable to the previously
reported January 3, 2006 acquisition of certain assets of First Trust
Indiana and the acquisition of Gold Banc amounted to $2.0 million and $5.4
million, respectively. Continued success in the cross-selling and
integrated delivery initiatives, improved investment performance and
improving results in institutional sales efforts and outsourcing
activities were the primary contributors to the remaining revenue growth
over the respective periods. Assets under management were approximately
$21.0 billion at September 30, 2006 compared to $20.4 billion at June 30,
2006, and $18.7 billion at September 30, 2005.
Service charges on deposits amounted to $25.7 million in the third quarter
of 2006 compared to $23.6 million in the third quarter of 2005. For the
nine months ended September 30, 2006, service charges on deposits amounted
to $73.3 million compared to $70.7 million for the nine months ended
September 30, 2005. The banking acquisitions contributed $2.2 million and
$4.3 million of service charges on deposits for the three and nine months
ended September 30, 2006, respectively. A portion of this source of fee
income is sensitive to changes in interest rates. In a rising interest
rate environment, customers that pay for services by maintaining eligible
deposit balances receive a higher earnings credit which results in lower
fee income. Excluding the effect of the banking acquisitions, lower
service charges on deposits associated with commercial demand deposits
accounted for the majority of the decline in this revenue in the three and
nine months ended September 30, 2006 compared to the three and nine months
ended September 30, 2005, respectively.
Total mortgage banking revenue was $13.4 million in the third quarter of
2006 compared with $15.8 million in the third quarter of 2005, a decrease
of $2.4 million or 15.0%. For the nine months ended September 30, 2006,
total mortgage banking revenue amounted to $38.1 million compared to $35.1
million for the nine months ended September 30, 2005, an increase of $3.0
million or 8.5%. For the three months ended September 30, 2006 and 2005,
the Corporation sold $0.6 billion and $0.8 billion of residential mortgage
and home equity loans to the secondary market, respectively. For the nine
months ended September 30, 2006 and 2005, the Corporation sold $1.8
billion and $1.7 billion of residential mortgage and home equity loans to
the secondary market, respectively. As previously discussed, the
Corporation continues to sell home equity loans at origination which is
partly in response to the demand for home equity products with higher
loan-to-value characteristics. Retained interests in the form of mortgage
servicing rights on residential mortgage loans sold amounted to $0.6
million for the nine months ended September 30, 2006 and $0.8 million for
the nine months ended September 30, 2005. At September 30, 2006, mortgage
servicing rights amounted to $2.3 million.
43
Net investment securities gains amounted to $4.5 million in the third
quarter of 2006 compared to $7.4 million in the third quarter of 2005.
For the nine months ended September 30, 2006, net investment securities
gains amounted to $6.6 million compared to $42.6 million for the nine
months ended September 30, 2005. During the third quarter of 2005, an
equity investment the Corporation had in a company was liquidated in a
cash tender offer resulting in a gain of $6.6 million. 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 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 pre-tax
gain of $5.3 million. An additional $0.3 million was received in the
third quarter of 2005.
Net derivative gains-discontinued hedges for the three and nine months
ended September 30, 2006 amounted to $43.8 million and $1.8 million,
respectively. The mark-to-market adjustments represent the non-cash
changes in earnings based on market volatility associated with certain
interest rate swaps that do not qualify for hedge accounting. The
interest rate swaps were designed to hedge the change in fair values or
cash flows of the underlying assets or liabilities and have performed
effectively as economic hedges. Applying fair value accounting (versus
hedge accounting) results in greater earnings volatility from period to
period, in particular on a linked-quarter basis. Management believes
these non-cash changes in earnings based on market volatility are not
reflective of the core performance trends of the Corporation.
Other income in the third quarter of 2006 amounted to $32.3 million
compared to $32.7 million in the third quarter of 2005, a decrease of $0.4
million or 1.4%. For the nine months ended September 30, 2006, other
income amounted to $100.3 million compared to $93.0 million for the nine
months ended September 30, 2005, an increase of $7.3 million or 7.8%.
Other income for the three and nine months ended September 30, 2006
included $1.3 million and $3.0 million, respectively, of income
attributable to the banking acquisitions.
OTHER EXPENSE
-------------
Total other expense for the three months ended September 30, 2006 amounted
to $546.6 million compared to $470.6 million for the three months ended
September 30, 2005, an increase of $76.0 million or 16.2%. For the nine
months ended September 30, 2006, total other expense amounted to $1,596.0
million compared to $1,373.4 million for the nine months ended September
30, 2005, an increase of $222.6 million or 16.2%.
Total other expense for the three and nine months ended September 30, 2006
included the operating expenses associated with Metavante's 2005 and 2006
acquisitions, the 2006 banking acquisitions and the 2006 acquisition of
certain assets of First Trust Indiana. The operating expenses of the
acquired entities have been included in the Corporation's consolidated
operating expenses from the dates the transactions were completed, which
had a significant impact on the period to period comparability of
operating expenses in 2006 compared to 2005. Approximately $51.1 million
of the operating expense growth in the third quarter of 2006 compared to
the third quarter of 2005 and $160.1 million of the operating expense
growth in the nine months ended September 30, 2006 compared to the nine
months ended September 30, 2005 was attributable to the acquisitions
including conversion and integration expenses related to the banking
acquisitions.
The Corporation estimates that its expense growth in the three months
ended September 30, 2006 compared to the three months ended September 30,
2005, excluding the effects of the acquisitions, was approximately $25.0
million or 5.4%. For the nine months ended September 30, 2006 compared to
the nine months ended September 30, 2005, the Corporation estimates that
its expense growth, excluding the effects of the acquisitions, was
approximately $62.5 million or 4.6%.
44
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 derivative gains-discontinued hedges) and net
interest income on a fully taxable equivalent basis. The Corporation's
efficiency ratios for the three months ended September 30, 2006, and prior
four quarters were:
Efficiency Ratios
-----------------
Three Months Ended
--------------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
2006 2006 2006 2005 2005
-------------- -------------- -------------- -------------- --------------
Consolidated Corporation 62.6 % 62.9 % 62.8 % 64.1 % 62.5 %
Consolidated Corporation
Excluding Metavante 52.4 % 51.2 % 48.8 % 51.5 % 50.8 %
Salaries and employee benefits expense amounted to $314.3 million in the
third quarter of 2006 compared to $278.0 million in the third quarter of
2005, an increase of $36.3 million or 13.1%. For the nine months ended
September 30, 2006, Salaries and employee benefits expense amounted to
$898.8 million compared to $792.1 million for the nine months ended
September 30, 2005, an increase of $106.7 million or 13.5%. Salaries and
benefits associated with the acquisitions previously discussed accounted
for approximately $18.5 million and $63.1 million of the increase in
Salaries and employee benefits expense in the three and nine months ended
September 30, 2006 compared to the three and nine months ended September
30, 2005, respectively.
For the third quarter of 2006, occupancy and equipment expense amounted to
$61.8 million compared to $54.6 million in the third quarter of 2005, an
increase of $7.2 million or 13.2%. The acquisitions accounted for
approximately $6.6 million of the increase in occupancy and equipment
expense in the three months ended September 30, 2006 compared to the three
months ended September 30, 2005. For the nine months ended September 30,
2006, occupancy and equipment expense amounted to $183.5 million compared
to $158.8 million for the nine months ended September 30, 2005, an
increase of $24.6 million or 15.5%. The acquisitions accounted for
approximately $19.4 million of the increase in occupancy and equipment
expense in the nine months ended September 30, 2006 compared to the nine
months ended September 30, 2005. The remaining increase in occupancy and
equipment expense for the three and nine months ended September 30, 2006
compared to the three and nine months ended September 30, 2005 was
primarily attributable to the banking segment and wealth management.
Software expenses, processing charges, supplies and printing, professional
services and shipping and handling expenses totaled $88.0 million in the
third quarter of 2006 compared to $68.0 million in the third quarter of
2005, an increase of $20.0 million or 29.4%. For the nine months ended
September 30, 2006, software expenses, processing charges, supplies and
printing, professional services and shipping and handling expenses totaled
$263.0 million compared to $196.3 million for the nine months ended
September 30, 2005, an increase of $66.7 million or 34.0%. The
acquisitions accounted for $14.4 million and $49.5 million of the expense
growth for the three and nine months ended September 30, 2006 compared to
the three and nine months ended September 30, 2005, respectively.
Metavante's expense growth accounted for the majority of the remaining
increase in expense for these items in the three and nine months ended
September 30, 2006 compared to the three and nine months ended September
30, 2005, respectively.
Amortization of intangibles amounted to $12.1 million in the third quarter
of 2006 compared to $6.1 million in the third quarter of 2005, an increase
of $6.0 million. For the nine months ended September 30, 2006,
amortization of intangibles amounted to $33.0 million compared to $22.3
million for the nine months ended September 30, 2005, an increase of $10.7
million. The increase in amortization associated with the acquisitions
amounted to $4.6 million and $11.6 million for the three and nine months
ended September 30, 2006 compared to the three and nine months ended
September 30, 2005, respectively. Those increases were offset by lower
amortization of core deposit intangibles, which is based on a declining
balance method and lower amortization of Metavante's contract intangibles
from previous acquisitions.
45
Other expense amounted to $70.3 million in the third quarter of 2006
compared to $63.8 million in the third quarter of 2005, an increase of
$6.5 million or 10.1%. For the nine months ended September 30, 2006,
other expense amounted to $217.7 million compared to $203.9 million for
the nine months ended September 30, 2005, an increase of $13.8 million or
6.8%.
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 $0.5
million in the third quarter of 2006 compared to $2.1 million in the third
quarter of 2005, a decrease of $1.6 million. For the nine months ended
September 30, 2006, net software and conversion amortization was $2.6
million compared to $13.6 million for the nine months ended September 30,
2005, a decrease of $11.0 million.
The acquisitions accounted for $6.9 million and $15.4 million of the
growth in other expense for the three and nine months ended September 30,
2006 compared to the three and nine months ended September 30, 2005,
respectively. Excluding the impact of the acquisitions and costs
associated with software development and customer data processing
conversions, other expense increased $1.0 million or 1.7% in the third
quarter of 2006 compared to the third quarter of 2005 and increased $9.3
million or 4.9% for the nine months ended September 30, 2006 compared to
the nine months ended September 30, 2005.
INCOME TAXES
------------
The provision for income taxes for the three months ended September 30,
2006 amounted to $118.6 million or 33.2% of pre-tax income compared to
$91.8 million or 33.8% of pre-tax income for the three months ended
September 30, 2005. For the nine months ended September 30, 2006, the
provision for income taxes amounted to $297.3 million or 33.0% of pre-tax
income compared to $266.6 million or 33.5% of pre-tax income for the nine
months ended September 30, 2005.
RECONCILIATION OF NON-GAAP TO GAAP RESULTS
------------------------------------------
The Company has provided non-GAAP (Generally Accepted Accounting
Principles) operating results for the three months ended September 30,
2006, as a supplement to its GAAP financial results. The Company believes
that these non-GAAP financial measures are useful because they allow
investors to assess, on a consistent basis, the Company's core operating
performance, exclusive of items management believes are not reflective of
day-to-day operations of the Company. Management uses such non-GAAP
financial measures to evaluate financial results and to establish
operational goals. These non-GAAP financial measures should be considered
a supplement to, and not as a substitute for, financial measures prepared
in accordance with GAAP.
Three Months
Ended September 30, 2006
---------------------------
Per
Amount Diluted
($ in millions) Share
--------------- -----------
Net Income $ 238.9 $ 0.92
Net Derivative Gains -
Discontinued Hedges (after-tax) (28.0) (0.11)
-------------- ----------
Net Income as Adjusted $ 210.9 $ 0.81
============== ==========
Average Shareholders' Equity $ 5,860
Cumulative Net Derivative Gains -
Discontinued Hedges (after-tax) 23
--------------
Adjusted Average Shareholders' Equity $ 5,883
==============
Based on Net Income as Adjusted:
Return on Assets 1.53 %
Return on Equity 14.22
46
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
Shareholders' equity was $6.0 billion or 10.7% of total consolidated
assets at September 30, 2006, compared to $4.7 billion or 10.2% of total
consolidated assets at December 31, 2005, and $4.6 billion or 10.2% of
total consolidated assets at September 30, 2005.
As described in Note 3 to the Consolidated Financial Statements, in
conjunction with the adoption of SAB 108 and the determination that
certain interest rate swaps do not qualify for hedge accounting, the
cumulative effect of adjusting the reported carrying amount of the
affected assets, liabilities and accumulated other comprehensive income as
of January 1, 2006 resulted in a net reduction to Shareholders' equity of
$18.0 million.
During the second quarter of 2006, the Corporation issued 13,672,665
shares of its common stock and exchanged fully vested stock options to
purchase 119,816 of its common stock with a total value of $603.9 million
in conjunction with the Corporation's acquisition of Gold Banc
Corporation, Inc. Also during the second quarter of 2006, the Corporation
issued 3,069,328 shares of its common stock and exchanged fully vested
stock options to purchase 412,317 of its common stock with a total value
of $148.3 million in conjunction with the Corporation's acquisition of
Trustcorp Financial, Inc. During the first quarter of 2006, the
Corporation issued 527,864 shares of its common stock valued at $23.2
million in conjunction with Metavante's acquisition of AdminiSource Inc.
Also during the first quarter of 2006, the Corporation issued 385,192
shares of its common stock valued at $16.9 million to fund its 2005
obligations under its retirement and employee stock ownership plans.
The Corporation has a Stock Repurchase Program under which it may
repurchase up to 12 million shares of its common stock annually. During
the first quarter of 2006, the Corporation repurchased 1.0 million shares
at an aggregate cost of $41.8 million or an average price of $41.79 per
common share. There were no purchases under the program during the second
or third quarters of 2006.
In 2005, the Corporation entered into an equity distribution agreement
whereby the Corporation may offer and sell up to 3.5 million shares of its
common stock from time to time through certain designated sales agents.
However, the Corporation will not sell more than the number of shares of
its common stock necessary for the aggregate gross proceeds from such
sales to reach $150.0 million. No sales occurred in the three or nine
months ended September 30, 2006. The aggregate gross proceeds available
for future sales was approximately $143.3 million at September 30, 2006.
At September 30, 2006, the net loss in accumulated other comprehensive
income amounted to $43.1 million, which represented a negative change in
accumulated other comprehensive income of $5.8 million since December 31,
2005. Net accumulated other comprehensive income associated with
available for sale investment securities was a net loss of $40.6 million
at September 30, 2006, compared to a net loss of $36.3 million at December
31, 2005, resulting in a net loss of $4.3 million over the nine month
period.
The Corporation continues to have a strong capital base and its regulatory
capital ratios are significantly above the minimum requirements as shown
in the following tables. The risk-based capital and leverage ratios at
December 31, 2005 have not been adjusted for the adoption of SFAS 123(R).
RISK-BASED CAPITAL RATIOS
-------------------------
($ in millions)
September 30, 2006 December 31, 2005
--------------------------------- ---------------------------------
Amount Ratio Amount Ratio
--------------------------------- ---------------------------------
Tier 1 Capital $ 3,700 7.69 % $ 3,046 7.67 %
Tier 1 Capital
Minimum Requirement 1,925 4.00 1,588 4.00
----------------- ------------- ----------------- -------------
Excess $ 1,775 3.69 % $ 1,458 3.67 %
================= ============= ================= =============
Total Capital $ 5,319 11.05 % $ 4,659 11.74 %
Total Capital
Minimum Requirement 3,850 8.00 3,176 8.00
----------------- ------------- ----------------- -------------
Excess $ 1,469 3.05 % $ 1,483 3.74 %
================= ============= ================= =============
Risk-Adjusted Assets $ 48,133 $ 39,698
================= =================
47
LEVERAGE RATIOS
---------------
($ in millions)
September 30, 2006 December 31, 2005
--------------------------------- ---------------------------------
Amount Ratio Amount Ratio
--------------------------------- ---------------------------------
Tier 1 Capital $ 3,700 7.16 % $ 3,046 7.08 %
Minimum Leverage
Requirement 1,550 - 2,584 3.00 - 5.00 1,291 - 2,152 3.00 - 5.00
----------------- ------------- ----------------- -------------
Excess $ 2,150 - 1,116 4.16 - 2.16 % $ 1,755 - 894 4.08 - 2.08 %
================= ============= ================= =============
Adjusted Average
Total Assets $ 51,680 $ 43,039
================= =================
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 $6.8 billion at September 30, 2006, represent a highly accessible
source of liquidity. The Corporation's portfolio of held-to-maturity
investment securities, which totaled $0.5 billion at September 30, 2006,
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 are generally sold 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 $21.2 billion in the third quarter of 2006. 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, which include foreign
(Eurodollar) 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 $7.5
billion in the third quarter of 2006.
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 9 to the Consolidated Financial Statements for
an update of the Corporation's securitization activities in the third
quarter of 2006.
The Corporation's lead bank, M&I Marshall & Ilsley Bank (the "Bank"), has
implemented a bank note program. During the second quarter of 2006, the
Bank amended the bank note program into a global bank note program which
permits it to issue and sell up to a maximum of US$13.0 billion aggregate
principal amount (or the equivalent thereof in other currencies) at any
one time outstanding of its senior global bank notes with maturities of
seven days or more from their respective date of issue and subordinated
global bank notes with maturities more than five years from their
respective date of issue. The notes may be fixed rate or floating rate
and the exact terms will be specified in the applicable Pricing Supplement
or the applicable Program Supplement. This program is intended to enhance
liquidity by enabling the Bank to sell its debt instruments in global
markets in the future without the delays which would otherwise be
incurred. Bank notes outstanding at September 30, 2006 amounted to $6.65
billion of which $1.3 billion is subordinated and qualifies as
supplementary capital for regulatory capital purposes.
The national capital markets represent a further source of liquidity to
the Corporation. The Corporation has filed a number of shelf registration
statements that are intended to permit the Corporation to raise funds
through sales of corporate debt and/or equity securities with a relatively
short lead time.
During the third quarter of 2005, the Corporation amended the shelf
registration statement originally filed with the Securities and Exchange
Commission during the third quarter of 2004 to include the equity
distribution agreement. The amended shelf registration statement enables
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. Approximately $1.3 billion is available for future
securities issuances.
48
During the fourth quarter of 2004, the Corporation filed a shelf
registration statement with the Securities and Exchange Commission
enabling 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 acquisitions by M&I, Metavante and/or other consolidated subsidiaries
of the Corporation. At September 30, 2006, there were 3.1 million shares
of common stock available for future issuances.
Under another shelf registration statement, 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 September 30,
2006, Series F notes issued amounted to $250.0 million in aggregate
principal amount. The Corporation may issue up to $0.5 billion of medium-
term MiNotes with maturities ranging from 9 months to 30 years and at
fixed or floating rates. The MiNotes are issued in smaller denominations
to attract retail investors. At September 30, 2006, MiNotes issued
amounted to $0.2 billion in aggregate principal amount. Additionally, the
Corporation has a commercial paper program. At September 30, 2006,
commercial paper outstanding amounted to $0.5 billion in aggregate
principal amount.
Short-term borrowings represent contractual debt obligations with
maturities of one year or less and amounted to $4.1 billion at September
30, 2006. Long-term borrowings amounted to $10.4 billion at September 30,
2006. The scheduled maturities of long-term borrowings including
estimated interest payments at September 30, 2006 are as follows: $3.3
billion is due in less than one year; $3.0 billion is due in one to three
years; $2.8 billion is due in three to five years; and $4.3 billion is due
in more than five years. During the first quarter of 2006, the
Corporation issued shares of its common stock valued at $16.9 million to
fund a portion of its 2005 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, 2005.
OFF-BALANCE SHEET ARRANGEMENTS
------------------------------
In conjunction with the acquisitions of Gold Banc and Trustcorp, the
Corporation acquired all of the common interests in four Trusts that
issued cumulative preferred capital securities which are supported by
junior subordinated deferrable interest debentures in the aggregate
principal amounts of $16.0 million, $30.0 million, $38.0 million and $15.0
million, respectively and full guarantees assumed by the Corporation. The
Corporation does not consolidate these Trusts in accordance with United
States generally accepted accounting principles. At September 30, 2006,
there have been no other substantive changes with respect to the
Corporation's off-balance sheet activities as disclosed in the
Corporation's Annual Report on Form 10-K for the year ended December 31,
2005. See Note 9 to the Consolidated Financial Statements for an update
of the Corporation's securitization activities in the third quarter of
2006. 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, nor 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 for the year
ended December 31, 2005, 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:
49
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.
The following factors were taken into consideration in determining the
adequacy of the allowance for loan and lease losses at September 30, 2006:
The housing slowdown is impacting the performance of some of the
Corporation's construction and land development loans. A re-balancing
of supply and demand within the national housing market has reduced both
absorption rates and valuations causing stress for some borrowers within
this loan segment. These loans are geographically dispersed and are in
both the Corporation's core and acquired loan portfolios. The
Corporation has taken these exposures into consideration in determining
the adequacy of its allowance for loan and lease losses.
At September 30, 2006, 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 three years were in
these industry segments. While most loans in these categories are still
performing, the Corporation continues to believe these sectors present a
higher than normal risk due to their financial and external
characteristics. Reduced revenues causing a declining utilization of the
industry's capacity levels can affect collateral values and the amounts
realized through sale or liquidation.
During the third quarter of 2006, the Corporation's commitments to
Shared National Credits were approximately $3.7 billion with usage
averaging around 49%. Over time, 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
September 30, 2006, there were no Shared National Credit nonperforming
loans. 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 vast majority of the assets acquired from
Gold Banc are in entirely new markets for the Corporation. Included in
these new markets are the Kansas City metropolitan area, Tulsa,
Oklahoma, and Tampa, Sarasota and Bradenton, Florida. Each of these
regions and markets has cultural and environmental factors that are
unique to them.
50
At September 30, 2006, nonperforming loans and leases amounted to $219.2
million or 0.53% of consolidated loans and leases compared to $198.0
million or 0.49% of consolidated loans and leases at June 30, 2006, and
$147.3 million or 0.44% of consolidated loans and leases at September
30, 2005. Approximately $51.9 million of total nonperforming loans at
September 30, 2006 was attributable to the banking acquisitions.
Excluding the effect of the acquisitions, nonperforming loans and leases
would have amounted to $167.3 million or 0.45% of consolidated loans and
leases at September 30, 2006 and $155.3 million or 0.43% of consolidated
loans and leases at June 30, 2006. Excluding the acquisitions, the pro
forma ratio of nonperforming loans and leases to consolidated loans and
leases at September 30 and June 30, 2006 and the actual ratio at each
quarter end throughout 2005 and the first quarter of 2006 has remained
in a fairly narrow range. Nonaccrual loans and leases continue to be
the primary source of nonperforming loans and leases.
Net charge-offs amounted to $8.1 million or 0.08% of average loans and
leases in the third quarter of 2006 compared to $9.9 million or 0.10% of
average loans and leases in the second quarter of 2006 and $7.8 million
or 0.10% of average loans and leases in the third quarter of 2005. The
lower level of net charge-offs experienced throughout 2005 and the first
nine months of 2006 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. The ratio of
recoveries to charge-offs was 36.5% and 35.7% for the three and nine
months ended September 30, 2006, respectively and continues to be above
the Corporation's five year historical average ratio of recoveries to
charge-offs of 27.9%.
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 $417.4 million or 1.01% of loans and leases outstanding at
September 30, 2006. The allowance for loan and lease losses was $363.8
million or 1.06% of loans and leases outstanding at December 31, 2005 and
$362.3 million or 1.09% of loans and leases outstanding at September 30,
2005. Consistent with the credit quality trends noted above, the
provision for loan and lease losses amounted to $10.3 million for the
three months ended September 30, 2006 and $32.3 million for the nine
months ended September 30, 2006. By comparison, the provision for loan
and lease losses amounted to $9.9 million for the three months ended
September 30, 2005 and $31.8 million for the nine months ended September
30, 2005. 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 September 30, 2006 and
2005, the amount of software costs capitalized amounted to $11.5 million
and $10.7 million, respectively. Amortization expense of software costs
amounted to $12.8 million for the three months ended September 30, 2006
compared to $13.1 million for the three months ended September 30, 2005.
For the nine months ended September 30, 2006 and 2005, the amount of
software costs capitalized amounted to $36.5 million and $29.6 million,
respectively. Amortization expense of software costs amounted to $40.4
million for the nine months ended September 30, 2006 compared to $43.4
million for the nine months ended September 30, 2005.
51
Direct costs associated with customer system conversions to the data
processing operations are capitalized and amortized on a straight-line
basis over the terms, generally five to seven years, of the related
servicing contracts.
Capitalization only occurs when management is satisfied that such costs
are recoverable through future operations or penalties (buyout fees) in
case of early termination. For the three months ended September 30, 2006
and 2005, the amount of conversion costs capitalized amounted to $3.4
million and $2.7 million, respectively. Amortization expense of
conversion costs amounted to $2.6 million and $2.4 million for the three
months ended September 30, 2006 and 2005, respectively. For the nine
months ended September 30, 2006 and 2005, the amount of conversion costs
capitalized amounted to $8.9 million and $8.3 million, respectively.
Amortization expense of conversion costs amounted to $7.6 million and $8.1
million for the nine months ended September 30, 2006 and 2005,
respectively.
Net unamortized costs were ($ in millions):
September 30,
--------------------------
2006 2005
------------ ------------
Software $ 152.8 $ 153.2
Conversions 28.5 28.0
----------- -----------
Total $ 181.3 $ 181.2
=========== ===========
The Corporation has not substantively changed any aspect of 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.
Transferors to QSPEs and "grandfathered" QSPEs subject to the reporting
requirements of SFAS 140 are outside the scope of FIN 46R and do not
consolidate those entities. With respect to 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.
52
For the three and nine months ended September 30, 2006, the Corporation
determined that there was a decline in the value of the retained interests
that was other than temporary because actual credit losses exceeded
expected credit losses. The amount of the impairment was $0.4 million and
is reported in Net investment securities gains in the Consolidated
Statements of Income.
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 $991.8
million at September 30, 2006. At September 30, 2006 the carrying amount
of retained interests amounted to $34.6 million.
The Corporation also sells, from time to time, debt securities classified
as available for sale that are highly rated to an unconsolidated
bankruptcy remote QSPE whose activities are limited to issuing highly
rated asset-backed commercial paper with maturities up to 180 days which
is used to finance the purchase of the investment securities. The
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 September 30, 2006, highly rated investment securities in the amount of
$304.7 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.
In June 2006, the Financial Accounting Standards Board issued FASB
Interpretation No. 48, ("FIN 48"), Accounting for Uncertainty in Income
Taxes an interpretation of FASB Statement No. 109. FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in financial
statements in accordance with FASB Statement No. 109, Accounting for
Income Taxes. FIN 48 prescribes a recognition threshold and measurement
attribute for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. FIN 48 also
provides guidance on derecognition, classification, interest and
penalties, accounting in interim periods, disclosure and transition.
The provisions of FIN 48 are effective beginning January 1, 2007, with the
cumulative effect of the change in accounting principle recorded as an
adjustment to opening retained earnings. The Corporation is currently
evaluating the financial statement impact, if any, of adopting FIN 48.
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 1A, Risk
Factors, of the Corporation's Annual Report on Form 10-K for the year
ended December 31, 2005 and 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.
53
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following updated information should be read in conjunction with the
Corporation's Annual Report on Form 10-K for the year ended December 31,
2005. Updated information regarding the Corporation's use of derivative
financial instruments is contained in Note 13, 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. 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
--------------------------------------------------------------------------
As Historically Reported
Pro Forma --------------------------------------------
September 30, September 30, June 30, March 31, December 31,
2006 2006 2006 2006 2005
-------------- -------------- -------------- -------------- --------------
Hypothetical Change in Interest Rate
------------------------------------
100 basis point gradual:
Rise in rates 0.7 % (3.2)% (0.3)% (0.2)% (0.2)%
Decline in rates (0.8)% 2.2 % 0.3 % 0.1 % 0.0 %
54
The results as of September 30, 2006 reflect the effect of mark-to-market
accounting (versus hedge accounting) for certain interest rate swaps that
the Corporation determined did not qualify for hedge accounting as
previously discussed. The interest rate swaps were designed to hedge the
change in fair value or cash flows of the underlying assets or liabilities
and have performed effectively as economic hedges. Prior period results
as shown and previously reported, were based on the assumption that the
affected interest rate swaps qualified for hedge accounting. As
previously stated, the Corporation is terminating the affected interest
rate swaps early in the fourth quarter of 2006 in order to eliminate the
earnings volatility associated with fluctuations in valuations under mark-
to-market accounting. The Corporation expects the results of operations
for the fourth quarter to reflect losses aggregating approximately $0.05
per diluted share from terminating the affected interest rate swaps. The
pro forma results as of September 30, 2006, assumes that the affected
interest rate swaps were terminated on September 30, 2006.
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 September 30, 2006, 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. These investments
expose the Corporation to the change in equity values for the portfolio
companies. However, fair values are difficult to determine until an
actual sale or liquidation transaction actually occurs. At September 30,
2006, the carrying value of total active capital markets investments
amounted to approximately $38.1 million.
As of September 30, 2006, M&I Trust Services administered $91.0 billion in
assets and directly managed a portfolio of $21.0 billion. The Corporation
is exposed to changes in equity values due to the fact that fee income is
partially based on equity balances. Quantification of this exposure is
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 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 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.
55
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, 2006 443,919 $ 41.92 437,700 11,562,300
February 1 to
February 28, 2006 565,972 41.70 562,300 11,000,000
March 1 to
March 31, 2006 2,434 41.84 -- 11,000,000
April 1 to
April 30, 2006 123,064 44.22 -- 11,000,000
May 1 to
May 31, 2006 3,129 45.08 -- 11,000,000
June 1 to
June 30, 2006 2,635 45.04 -- 11,000,000
July 1 to
July 31, 2006 4,458 46.31 -- 11,000,000
August 1 to
August 31, 2006 3,566 20.27 -- 11,000,000
September 1 to
September 30, 2006 3,799 46.91 -- 11,000,000
------------ ---------- ----------------
Total 1,152,976 $ 42.04 1,000,000
============ ========== ================
(1) Includes shares purchased by rabbi trusts pursuant to nonqualified
deferred compensation plans.
The Corporation's Share Repurchase Program was publicly reconfirmed in
April 2005 and again in April 2006. 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.
ITEM 6. EXHIBITS
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 I - 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.
56
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MARSHALL & ILSLEY CORPORATION
(Registrant)
/s/ Patricia R. Justiliano
__________________________________
Patricia R. Justiliano
Senior Vice President and
Corporate Controller
(Chief Accounting Officer)
/s/ James E. Sandy
__________________________________
James E. Sandy
Vice President
November 9, 2006
57
EXHIBIT INDEX
-------------
Exhibit Number Description of 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 I - 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.