UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter Ended June 30, 2001 Commission File Number 0-8076 FIFTH THIRD BANCORP (Exact name of Registrant as specified in its charter) Ohio 31-0854434 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification Number) Fifth Third Center Cincinnati, Ohio 45263 (Address of principal executive offices) Registrant's telephone number, including area code: (513) 579-5300 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_______ ----- There were 577,285,634 shares of the Registrant's Common Stock, without par value, outstanding as of July 31, 2001.
FIFTH THIRD BANCORP INDEX <TABLE> <S> <C> Part I. Financial Information Item 1. Financial Statements Condensed Consolidated Balance Sheets - June 30, 2001 and 2000 and December 31, 2000 3 Condensed Consolidated Statements of Income - Three and Six Months Ended June 30, 2001 and 2000 4 Condensed Consolidated Statements of Cash Flows - Six Months Ended June 30, 2001 and 2000 5 Condensed Consolidated Statements of Changes in Shareholders' Equity - Six Months Ended June 30, 2001 and 2000 6 Notes to Condensed Consolidated Financial Statements 7 - 15 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 16 - 19 Item 3. Quantitative and Qualitative Disclosures About Market Risk 20 Part II. Other Information 21 - 22 </TABLE> 2
<TABLE> <CAPTION> Fifth Third Bancorp and Subsidiaries Condensed Consolidated Balance Sheets (unaudited) - -------------------------------------------------------------------------------------------------------------- June 30, December 31, June 30, ($000's) 2001 2000 2000 - -------------------------------------------------------------------------------------------------------------- Assets - -------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> Cash and Due from Banks $ 1,585,300 1,706,538 1,425,500 Securities Available for Sale (a) 18,719,861 19,028,803 18,302,233 Securities Held to Maturity (b) 19,395 552,563 617,312 Other Short-Term Investments 700,074 232,524 131,231 Loans Held for Sale 2,932,347 1,654,996 1,578,543 Loans and Leases Commercial Loans 10,690,126 10,674,980 10,595,844 Construction Loans 3,495,358 3,222,553 2,644,306 Commercial Mortgage Loans 6,596,721 6,226,839 6,008,736 Commercial Lease Financing 2,934,245 3,158,436 2,748,035 Residential Mortgage Loans 4,439,013 5,635,286 6,206,877 Consumer Loans 11,886,770 11,551,102 10,256,379 Consumer Lease Financing 2,503,772 3,006,942 3,810,119 Unearned Income (970,914) (945,748) (976,921) Reserve for Credit Losses (617,270) (609,340) (602,204) - -------------------------------------------------------------------------------------------------------------- Total Loans and Leases 40,957,821 41,921,050 40,691,171 Bank Premises and Equipment 819,061 803,793 809,663 Accrued Income Receivable 545,633 558,695 508,953 Other Assets 3,554,148 3,199,377 2,830,549 - -------------------------------------------------------------------------------------------------------------- Total Assets $ 69,833,640 69,658,339 66,895,155 ============================================================================================================== Liabilities - -------------------------------------------------------------------------------------------------------------- Deposits Demand $ 7,621,352 7,152,381 6,364,057 Interest Checking 11,567,613 10,319,753 9,265,895 Savings and Money Market 7,162,973 6,914,353 6,821,492 Time Deposits 18,751,747 23,972,954 21,814,192 - -------------------------------------------------------------------------------------------------------------- Total Deposits 45,103,685 48,359,441 44,265,636 Federal Funds Borrowed 4,356,098 2,178,703 3,896,454 Short-Term Bank Notes - - 2,740,000 Other Short-Term Borrowings 5,160,677 5,920,594 5,676,656 Accrued Taxes, Interest and Expenses 1,964,855 1,694,965 1,246,171 Other Liabilities 555,465 358,414 461,398 Long-Term Debt 5,452,136 4,311,310 2,587,003 Guaranteed Preferred Beneficial Interests in Convertible Subordinated Debentures 172,500 172,500 172,500 - -------------------------------------------------------------------------------------------------------------- Total Liabilities 62,765,416 62,995,927 61,045,818 - -------------------------------------------------------------------------------------------------------------- Shareholders' Equity - -------------------------------------------------------------------------------------------------------------- Common Stock (c) 1,280,024 1,263,418 1,260,177 Preferred Stock (d) 9,250 9,250 9,250 Capital Surplus 1,271,182 1,144,079 1,073,044 Retained Earnings 4,422,847 4,226,047 3,940,792 Unrealized Gains (Losses) on Securities Available for Sale 84,921 28,012 (329,443) Deferred Compensation - (2,727) - Treasury Stock - (5,667) (104,483) - -------------------------------------------------------------------------------------------------------------- Total Shareholders' Equity 7,068,224 6,662,412 5,849,337 - -------------------------------------------------------------------------------------------------------------- Total Liabilities and Shareholders' Equity $ 69,833,640 69,658,339 66,895,155 ============================================================================================================== </TABLE> (a) Amortized cost: June 30, 2001 - $18,587,032, December 31, 2000 - $18,986,346 and June 30, 2000 -$18,790,934. (b) Market values: June 30, 2001 - $19,395, December 31, 2000 - $557,275 and June 30, 2000 - $601,551. (c) Common Shares: Stated value $2.22 per share; authorized at June 30, 2001 - 1,300,000,000, December 31, 2000 and June 30, 2000 - 650,000,000; outstanding at June 30, 2001 - 576,587,585, December 31, 2000 - 569,056,843 (excludes 104,455 treasury shares) and June 30, 2000 - 566,309,657 (excludes 2,197,666 treasury shares). (d) 490,750 shares of no par value preferred stock are authorized of which none had been issued as of June 30, 2001; 7,250 shares of 8.00% Series D convertible perpetual preferred stock with a stated value of $1,000 were authorized, issued and outstanding at June 30, 2001; 2,000 shares of 8.00% Series E perpetual preferred stock with a stated value of $1,000 were authorized, issued and outstanding at June 30, 2001 See Notes to Consolidated Financial Statements 3
<TABLE> <CAPTION> Fifth Third Bancorp and Subsidiaries Condensed Consolidated Statements of Income (unaudited) - ------------------------------------------------------------------------------------------- ------------------------ Three Months Six Months Ended Ended June 30, June 30, ------------------------ ------------------------ ($000's) 2001 2000 2001 2000 =========================================================================================== ======================== <S> <C> <C> <C> <C> Interest Income Interest and Fees on Loans and Leases $ 919,792 882,124 $ 1,858,970 1,712,614 Interest on Securities Taxable 287,161 326,936 587,271 622,709 Exempt from Income Taxes 17,666 18,708 34,763 37,435 - ------------------------------------------------------------------------------------------- ------------------------ Total Interest on Securities 304,827 345,644 622,034 660,144 Interest on Other Short-Term Investments 3,797 3,290 6,602 6,977 - ------------------------------------------------------------------------------------------- ------------------------ Total Interest Income 1,228,416 1,231,058 2,487,606 2,379,735 - ------------------------------------------------------------------------------------------- ------------------------ Interest Expense Interest on Deposits Interest Checking 84,128 82,441 170,919 147,371 Savings and Money Market 53,798 49,091 115,941 109,612 Time Deposits 274,763 330,941 591,687 595,676 - ------------------------------------------------------------------------------------------- ------------------------ Total Interest on Deposits 412,689 462,473 878,547 852,659 Interest on Federal Funds Borrowed 61,503 81,541 110,031 158,260 Interest on Short-Term Bank Notes - 22,503 - 44,914 Interest on Other Short-Term Borrowings 61,111 69,534 138,707 136,706 Interest on Long-Term Debt and Notes 85,396 34,358 164,200 71,487 - ------------------------------------------------------------------------------------------- ------------------------ Total Interest Expense 620,699 670,409 1,291,485 1,264,026 - ------------------------------------------------------------------------------------------- ------------------------ Net Interest Income 607,717 560,649 1,196,121 1,115,709 Provision for Credit Losses 25,618 35,309 91,557 67,293 Merger-Related Provision for Credit Losses 35,437 8,000 35,437 12,000 - ------------------------------------------------------------------------------------------- ------------------------ Net Interest Income After Provision for Credit Losses 546,662 517,340 1,069,127 1,036,416 Other Operating Income Data Processing Income 78,371 59,155 147,936 112,205 Service Charges on Deposits 91,871 75,894 169,700 143,366 Mortgage Banking Revenue 53,157 63,548 113,622 128,917 Investment Advisory Income 80,409 70,283 157,524 141,769 Other Service Charges and Fees 118,226 96,667 242,113 195,051 Securities Gains (Losses) 2,788 (150) 7,107 (60) - ------------------------------------------------------------------------------------------- ------------------------ Total Other Operating Income 424,822 365,397 838,002 721,248 - ------------------------------------------------------------------------------------------- ------------------------ Operating Expenses Salaries, Wages and Incentives 216,225 193,167 419,429 388,389 Employee Benefits 38,933 38,252 76,817 81,453 Equipment Expenses 21,567 25,221 43,631 49,852 Net Occupancy Expenses 37,049 33,486 73,647 67,390 Other Operating Expenses 199,319 162,798 384,948 325,511 Merger-Related Charges 219,229 64,848 219,229 86,973 - ------------------------------------------------------------------------------------------- ------------------------ Total Operating Expenses 732,322 517,772 1,217,701 999,568 - ------------------------------------------------------------------------------------------- ------------------------ Income Before Income Taxes 239,162 364,965 689,428 758,096 Applicable Income Taxes 110,274 117,192 254,140 245,852 - ------------------------------------------------------------------------------------------- ------------------------ Net Income 128,888 247,773 435,288 512,244 Cumulative Effect of Change in Accounting Principle, Net of Tax - - 6,781 - Dividend on Preferred Stock 185 185 370 370 - ------------------------------------------------------------------------------------------- ------------------------ Net Income Available to Common Shareholders $ 128,703 247,588 $ 428,137 511,874 =========================================================================================== ======================== Per Share: Earnings $ 0.22 0.44 $ 0.75 0.91 Diluted Earnings $ 0.22 0.43 $ 0.73 0.89 Cash Dividends $ 0.20 0.18 $ 0.40 0.34 =========================================================================================== ======================== Average Shares (000's): Outstanding 574,545 566,272 572,873 566,025 Diluted 590,234 578,856 588,416 578,118 =========================================================================================== ======================== </TABLE> See Notes to Consolidated Financial Statements 4
<TABLE> <CAPTION> Fifth Third Bancorp and Subsidiaries Condensed Consolidated Statements of Cash Flows (unaudited) - --------------------------------------------------------------------------------------------------------------------------- Six Months Ended June 30, ------------------------------ ($000's) 2001 2000 - --------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> Operating Activities Net Income $ 428,507 512,244 Adjustments to Reconcile Net Income to Net Cash Provided by (Used in) Operating Activities: Provision for Credit Losses 91,557 67,293 Depreciation, Amortization and Accretion 97,344 92,183 Provision for Deferred Income Taxes 37,551 103,237 Realized Securities Gains (10,160) (1,876) Realized Securities Losses 3,053 1,936 Proceeds from Sales of Residential Mortgage Loans Held for Sale 4,217,714 5,447,807 Net Gain (Loss) on Sales of Loans (109,110) (69,134) Increase in Residential Mortgage Loans Held for Sale (5,404,905) (5,835,235) (Increase) Decrease in Accrued Income Receivable 18,758 (41,399) Increase in Other Assets (235,669) (310,137) Increase in Accrued Taxes, Interest and Expenses 191,757 113,701 Increase in Other Liabilities 164,129 138,096 - --------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by (Used in) Operating Activities (509,474) 218,716 =========================================================================================================================== Investing Activities Proceeds from Sales of Securities Available for Sale 4,097,814 3,320,894 Proceeds from Calls, Paydowns and Maturities of Securities Available for Sale 5,390,413 951,213 Purchases of Securities Available for Sale (7,239,510) (5,792,803) Proceeds from Calls, Paydowns and Maturities of Securities Held to Maturity 14,294 45,788 Purchases of Securities Held to Maturity - (10,786) (Increase) Decrease in Other Short-Term Investments (467,550) 256,645 (Increase) Decrease in Loans and Leases 577,100 (3,309,244) Purchases of Bank Premises and Equipment (93,027) (61,898) Proceeds from Disposal of Bank Premises and Equipment 33,260 6,714 Net Cash Paid in Acquisitions (146,807) - - --------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by (Used in) Investing Activities 2,165,987 (4,593,477) =========================================================================================================================== Financing Activities Increase in Transaction Account Deposits 1,628,309 55,034 Decrease in Consumer Time Deposits (581,660) (48,322) Increase (Decrease) in CDs - $100,000 and Over, including Foreign (5,131,436) 2,403,118 Increase in Federal Funds Borrowed 2,126,580 653,113 Increase in Short-Term Bank Notes - 922,600 Decrease in Other Short-Term Borrowings (777,398) (461,090) Proceeds from Issuance of Long-Term Debt and Notes 2,373,328 1,851,741 Proceeds from Issuance of Subordinated Bank Notes - 100,000 Repayment of Long-Term Debt (1,248,752) (1,368,683) Payment of Cash Dividends (228,979) (213,051) Exercise of Stock Options 62,908 26,753 Proceeds from Sale of Common Stock - 10,881 Purchases of Stock - (45,773) Other (651) 21,697 - --------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by (Used In) Financing Activities (1,777,751) 3,908,018 =========================================================================================================================== Decrease in Cash and Due from Banks (121,238) (466,743) Cash and Due from Banks at Beginning of Period 1,706,538 1,892,244 - --------------------------------------------------------------------------------------------------------------------------- Cash and Due from Banks at End of Period $ 1,585,300 1,425,501 =========================================================================================================================== </TABLE> See Notes to Consolidated Financial Statements 5
<TABLE> <CAPTION> Fifth Third Bancorp and Subsidiaries Condensed Consolidated Statements of Changes in Shareholders' Equity (unaudited) - -------------------------------------------------------------------------------------------------------------------------- Six Months Ended June 30, --------------------------------- ($000's) 2001 2000 - -------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> Balance at December 31 $ 6,662,412 5,562,795 Net Income 428,507 512,244 Nonowner Changes in Equity, Net of Tax: Change in Unrealized Gains (Losses) on Securities Available for Sale 56,909 (27,582) - -------------------------------------------------------------------------------------------------------------------------- Net Income and Nonowner Changes in Equity 485,416 484,662 Cash Dividends Declared: Fifth Third Bancorp: Common Stock (2001 - $.40 per share and 2000 - $.34 per share) (209,691) (158,027) Preferred Stock (185) - Pooled Companies Prior to Acquisition: Common Stock (50,872) (56,221) Preferred Stock (185) (370) Stock Options Exercised including Treasury Shares Issued 62,908 26,753 Shares Purchased - (45,773) Stock Issued in Acquisitions and Other 118,421 35,518 - -------------------------------------------------------------------------------------------------------------------------- Balance at June 30 $ 7,068,224 $ 5,849,337 ========================================================================================================================== </TABLE> See Notes to Consolidated Financial Statements 6
FINANCIAL INFORMATION --------------------- Item 1. Notes to Condensed Consolidated Financial Statements - ------------------------------------------------------------- 1. In the opinion of management, the unaudited Condensed Consolidated Financial Statements include all adjustments (which consist of normal recurring accruals) necessary, to present fairly the consolidated financial position as of June 30, 2001 and 2000, the results of operations for the three and six months ended June 30, 2001 and 2000, the statements of cash flows for the six months ended June 30, 2001 and 2000 and the statements of changes in shareholders' equity for the six months ended June 30, 2001 and 2000. In accordance with accounting principles generally accepted in the United States of America for interim financial information, these statements do not include certain information and footnote disclosures required for complete annual financial statements. Financial information as of December 31, 2000 has been derived from the Consolidated Financial Statements of Fifth Third Bancorp (the "Registrant" or "Fifth Third"). The results of operations for the three and six months ended June 30, 2001 and 2000 and the statements of cash flows for the six months ended June 30, 2001 and 2000 are not necessarily indicative of the results to be expected for the full year. For further information, refer to the Consolidated Financial Statements and footnotes thereto for the year ended December 31, 2000, included in the Registrant's Annual Report on Form 10-K. Certain reclassifications have been made to prior periods' consolidated financial statements and related notes to conform with the current period presentation. As described in note 2, the accompanying prior period Condensed Consolidated Financial Statements of the Registrant, have been restated to include the financial results of Old Kent. 2. Business Combinations: --------------------- On January 2, 2001, the Registrant completed the acquisition of Resource Management, Inc., d.b.a. Maxus Investment Group ("Maxus"), an Ohio corporation. Maxus was a privately-held diversified financial services company that provides investment management and brokerage services, headquartered in Cleveland, Ohio. In connection with this acquisition, the Registrant issued 470,162 shares of Fifth Third common stock and paid $18,090,000 in cash for the outstanding capital stock of Maxus. This transaction was accounted for as a purchase transaction. The results of operations of Maxus have been included in the Condensed Consolidated Financial Statements of the Registrant since January 2, 2001. The pro forma prior period results are not material. On March 9, 2001, the Registrant completed the acquisition of Capital Holdings, Inc. ("Capital Holdings") and its subsidiary, Capital Bank N.A., headquartered in Sylvania, Ohio. At December 31, 2000, Capital Holdings had total assets of $1.1 billion and total deposits of $874 million. In connection with this acquisition, the Registrant issued 4,505,385 shares of Fifth Third common stock for the outstanding common shares of Capital Holdings. This transaction was tax-free and was accounted for as a pooling of interest. The accompanying prior period Condensed Consolidated Financial Statements of the Registrant have not been restated for Capital Holdings due to immateriality. On April 2, 2001, the Registrant completed the acquisition of Old Kent Financial Corporation ("Old Kent"), a publicly-traded financial holding company headquartered in Grand Rapids, Michigan. At December 31, 2000, Old Kent had total assets of $23.8 billion and total deposits of $17.4 billion. In connection with this acquisition, the Registrant issued 7
Item 1. Notes to Condensed Consolidated Financial Statements (continued) ------------------------------------------------------------------------- 103,716,638 shares of Fifth Third common stock, 7,250 shares of Fifth Third series D convertible perpetual preferred stock and 2,000 shares of Fifth Third series E perpetual preferred stock to the shareholders of Old Kent. This transaction was tax-free and was accounted for as a pooling of interest. The accompanying prior period Condensed Consolidated Financial Statements of the Registrant, have been restated to include the financial results of Old Kent. Certain reclassifications were made to Old Kent's financial statements to conform presentation. The summarized operating results for the separate companies and the combined amounts presented in the condensed consolidated financial statements follow: <TABLE> <CAPTION> Three Months Ended March 31, 2001 - ---------------------------------------------------------------------------------------------------------------------------- ($000's) Fifth Third Old Kent Combined - ---------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> - ---------------------------------------------------------------------------------------------------------------------------- Net Interest Income $ 392,935 $195,469 $ 588,404 Other Operating Income 292,492 120,688 413,180 Net Income 244,304 55,315 299,619 Three Months Ended June 30, 2000 - ---------------------------------------------------------------------------------------------------------------------------- ($000's) Fifth Third Old Kent Combined - ---------------------------------------------------------------------------------------------------------------------------- Net Interest Income $ 364,720 $195,929 $ 560,649 Other Operating Income 248,061 117,336 365,397 Net Income 192,088 55,685 247,773 Six Months Ended June 30, 2000 - ---------------------------------------------------------------------------------------------------------------------------- ($000's) Fifth Third Old Kent Combined - ---------------------------------------------------------------------------------------------------------------------------- Net Interest Income $ 728,164 $387,545 $1,115,709 Other Operating Income 488,224 233,024 721,248 Net Income 398,457 113,787 512,244 </TABLE> The combined results are not necessarily indicative of the results that would have occurred had the acquisition been consummated in the past or which might be attained in the future. During the second quarter of 2001, the Registrant incurred merger-related costs totaling $254,666,000 ($209,530,000 after tax, or $.36 per diluted share) in connection with the Old Kent merger transaction. The significant components of the second quarter merger charge include employee-related costs of $72 million, professional fees of $45 million, credit quality charges of $35 million, duplicate facilities and equipment of $38 million, conversion costs of $32 million and $33 million of other merger-related costs (including losses incurred on the sales of Old Kent's subprime mortgage lending portfolio and small-ticket leasing portfolio in order to align Old Kent with the Registrant's asset liability management policies). As previously announced, additional merger-related charges will be incurred in the second half of fiscal 2001 as the Registrant completes the remaining conversions of Old Kent's Michigan operations, including headquarters and back-office functions in Grand Rapids and the remaining rationalization of Old Kent's mortgage banking business. 8
Item 1. Notes to Condensed Consolidated Financial Statements (continued) - ------------------------------------------------------------------------ Employee-related costs include the severance packages negotiated with approximately 1,400 people (including all levels of the previous Old Kent organization from the executive management level to back office support staff) and the change-in-control payments made pursuant to pre-existing employment agreements. Employee-related payments made through June 30, 2001 totaled approximately $41 million, including payment to the approximate 400 people that have been terminated through June 30, 2001. Credit quality charges relate to conforming Old Kent commercial and consumer loans to the Registrant's credit policies. Specifically, these loans were conformed to the Registrant's credit rating and review systems as documented in the Registrant's credit policies. Commercial credit quality charges largely relate to Old Kent concentrations in real estate investment property lending and sub prime lending and their related collateral quality valuations as well as Old Kent's overall higher commercial lending authorities, as compared to the Registrant's standards. Consumer credit quality charges largely relate to the application of the Registrant's more conservative grading of high LTV loans and purchased home equity loan portfolios. Based on the conforming ratings, reserves were established based on the present value of expected future cash flows discounted at the loan's effective interest rate or fair value of the underlying collateral. The Registrant evaluated the collectibility of both principal and interest in assessing the need for a loss accrual. During the second quarter of 2001, the Registrant charged-off $35 million in loans related to these factors. Duplicate facilities and equipment charges of $38 million largely include negotiated terminations of several office leases and writedowns of duplicative software. Conversion costs of $32 million include vendor contract termination costs related to certain application systems and the conversion of affiliates and banking centers in certain locations (including signage and all customer relationships). 3. For the first six months of 2001, the Registrant paid $1,328,890,000 in interest and paid $7,500,000 in Federal income taxes. For the same period in 2000, the Registrant paid $1,282,428,000 in interest and paid $96,444,000 in Federal income taxes. During the first six months of 2001 and 2000, the Registrant had noncash investing activities consisting of the securitization of $1,782,911,000 and $1,120,261,000 of residential mortgage loans, respectively. 4. Effective January 1, 2001, the Registrant adopted Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended, which establishes accounting and reporting standards for derivative instruments and hedging activities and requires recognition of all derivatives as either assets or liabilities in the statement of financial condition and measurement of those instruments at fair value. On the date the Registrant enters into a derivative contract, the Registrant designates the derivative instrument as either a fair value hedge, cash flow hedge or as a free-standing derivative instrument. For a fair value hedge, changes in the fair value of the derivative 9
Item 1. Notes to Condensed Consolidated Financial Statements (continued) - ------------------------------------------------------------------------ instrument and changes in the fair value of the hedged asset or liability or of an unrecognized firm commitment attributable to the hedged risk are recorded in current period net income. For a cash flow hedge, changes in the fair value of the derivative instrument to the extent that it is effective are recorded in other comprehensive income within shareholders' equity and subsequently reclassified to net income in the same period(s) that the hedged transaction impacts net income. For free-standing derivative instruments, changes in the fair values are reported in current period net income. Prior to entering a hedge transaction, the Registrant formally documents the relationship between hedging instruments and hedged items, as well as the risk management objective and strategy for undertaking various hedge transactions. This process includes linking all derivative instruments that are designated as fair value or cash flow hedges to specific assets and liabilities on the balance sheet or to specific forecasted transactions along with a formal assessment at both inception of the hedge and on an ongoing basis as to the effectiveness of the derivative instrument in offsetting changes in fair values or cash flows of the hedged item. If it is determined that the derivative instrument is not highly effective as a hedge, hedge accounting is discontinued and the fair value of the derivative instrument is recorded in net income. The Registrant maintains an overall interest rate risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings and cash flows caused by interest rate volatility. The Registrant's interest rate risk management strategy involves modifying the repricing characteristics of certain assets and liabilities so that changes in interest rates do not adversely affect the net interest margin and cash flows. Derivative instruments that the Registrant uses as part of its interest rate risk management strategy include interest rate and principal only swaps, interest rate floors, forward contracts and both futures contracts and options on futures contracts. Interest rate swap contracts are exchanges of interest payments, such as fixed-rate payments for floating-rate payments, based on a common notional amount and maturity date. Forward contracts are contracts in which the buyer agrees to purchase and the seller agrees to make delivery of a specific financial instrument at a predetermined price or yield. Principal only ("PO") swaps are total return swaps based on the underlying PO true value. Futures contracts are contracts that represent the obligation to buy or sell a predetermined amount of debt subject to the contracts specific delivery requirements at a predetermined date and a predetermined price. Options on futures contracts represent the right but not the obligation to buy or sell. The Registrant also enters into foreign exchange contracts for the benefit of customers. By policy, the Registrant hedges the exposure of these free-standing derivatives entered into for the benefit of customers by entering into offsetting third-party forward contracts with approved reputable counterparties with matching terms and currencies that are generally settled daily. Risks arise from the possible inability of counterparties to meet the terms of their contracts and from any resultant exposure to movement in foreign currency exchange rates, limiting the Registrant's exposure to the replacement value of the contracts rather than the notional principal or contract amounts. Free- standing derivatives also include derivative transactions entered into for risk management purposes that do not otherwise qualify for hedge accounting. The registrant will enter into interest rate swap agreements with commercial clients and an unconsolidated qualifying special purpose entity. The Registrant will hedge its interest rate exposure on these transactions by executing offsetting swap agreements with primary dealers. FAIR VALUE HEDGES - The Registrant enters into interest rate swaps to convert its nonprepayable, fixed-rate long-term debt to floating-rate debt. The Registrant's practice is to convert fixed-rate debt to floating-rate debt. Decisions to convert fixed-rate debt to floating are made primarily by consideration of the asset/liability mix of the Registrant, the 10
Item 1. Notes to Condensed Consolidated Financial Statements (continued) ------------------------------------------------------------------------- desired asset/liability sensitivity and by interest rate levels. For the quarter ended June 30, 2001, the Registrant met certain criteria required to qualify for shortcut method accounting on its fair value hedges of this type. Based on this shortcut method accounting treatment, no ineffectiveness is assumed and fair value changes in the interest rate swap are recorded as changes in the value of both swap and long term debt in the Condensed Consolidated Balance Sheet. Additionally, the Registrant enters into a combination of derivative instruments (PO swaps, floors, forward contracts and interest rate swaps) to hedge changes in fair value of its fixed rate mortgage servicing rights as it relates to changes in the benchmark rate. For the three and six months ended June 30, 2001, the Registrant recognized a gain of $2.3 million and a loss of $5.5 million, respectively, in noninterest income, which represents the ineffective portion of all fair value hedges on mortgage servicing rights. As of June 30, 2001, there were no instances of designated hedges no longer qualifying as fair value hedges. The Registrant has approximately $329.8 million of fair value hedges included in other assets in the June 30, 2001 Condensed Consolidated Balance Sheet. CASH FLOW HEDGES - The Registrant enters into interest rate swaps to convert floating-rate liabilities to fixed rates. The liabilities are typically grouped and share the same risk exposure for which they are being hedged. As of June 30, 2001, $1.6 million in deferred losses related to existing hedges were recorded in other comprehensive income. Gains and losses on derivative contracts that are reclassified from cumulative other comprehensive income to current period earnings are included in the line item in which the hedged item's effect in earnings is recorded. As of June 30, 2001, $1.6 million in deferred losses on derivative instruments included in other comprehensive income are expected to be reclassified into earnings during the next twelve months. All components of each derivative instrument's gain or loss are included in the assessment of hedge effectiveness. Additionally, the Registrant enters into forward contracts to hedge the forecasted sale of its mortgage loans. For the three months ended June 30, 2001, the Registrant met certain criteria to qualify for matched terms accounting on the hedged loans for sale. Based on this treatment, fair value changes in the forward contracts are recorded as changes in the value of both the forward contract and loans held for sale in the Condensed Consolidated Balance Sheet. For the three months ended June 30, 2001, there were no cash flow hedges that were discontinued related to forecasted transactions deemed not probable of occurring. The maximum term over which the Registrant is hedging its exposure to the variability of future cash flows for all forecasted transactions, excluding those forecasted transactions related to the payments of variable interest in existing financial instruments, is five years for hedges converting floating-rate loans to fixed and one year for hedges of forecasted sales of mortgage loans. The Registrant has approximately $1.6 million of cash flow hedges related to floating-rate liabilities included in other short-term borrowings and $6.5 million of cash flow hedges related to loans held for sale included in other assets in the June 30, 2001 Condensed Consolidated Balance Sheet. FREE-STANDING DERIVATIVE INSTRUMENTS - The Registrant enters into various derivative contracts which primarily focus on providing derivative products to customers. These derivative contracts are not linked to specific assets and liabilities on the balance sheet or to forecasted transactions and, therefore, do not qualify for hedge accounting. Additionally, interest rate lock commitments issued on residential mortgage loans intended 11
Item 1. Notes to Condensed Consolidated Financial Statements (continued) ------------------------------------------------------------------------- to be held for resale are considered free-standing derivative instruments. The interest rate exposure on these commitments is economically hedged primarily with forward contracts. The commitments and free-standing derivative instruments are marked to market and recorded as a component of mortgage banking noninterest income in the Condensed Consolidated Statement of Income. For the three and six months ended June 30, 2001, the Registrant recorded a gain of $4.9 million and $11 million, respectively, on foreign exchange contracts for customers and a gain of $2.9 million and $2.7 million, respectively on the net change in interest rate locks and forward contracts. The Registrant has approximately $2.6 million of free-standing derivatives related to customer transactions included in accrued income receivable and $3.8 million of free-standing derivatives related to interest rate locks included in other assets in the June 30, 2001 Condensed Consolidated Balance Sheet. 5. In September 2000, the Financial Accounting Standards Board ("FASB") issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." The statement is effective for transfers and servicing of financial assets occurring after March 31, 2001, with certain disclosure and reclassification requirements effective for financial statements for fiscal years ending after December 15, 2000. Included in SFAS No. 140, which replaced SFAS No. 125 of the same name, are the accounting and reporting standards related to securitizations and Qualifying Special Purpose Entities ("QSPE"). The adoption of SFAS No. 140 did not have a material effect on the Registrant. 6. On July 20, 2001, the FASB issued SFAS No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Other Intangible Assets." These Statements make significant changes to the accounting for business combinations, goodwill, and intangible assets. SFAS No. 141 eliminates the pooling of interests method of accounting for business combinations with limited exceptions for combinations initiated prior to July 1, 2001. In addition, it further clarifies the criteria for recognition of intangible assets separately from goodwill. This statement is effective for business combinations completed after June 30, 2001. The Registrant has not yet determined the impact of adopting this standard. SFAS No. 142 discontinues the practice of amortizing goodwill and indefinite lived intangible assets and initiates an annual review for impairment. Impairment would be examined more frequently if certain indicators are encountered. Intangible assets with a determinable useful life will continue to be amortized over that period. The amortization provisions apply to goodwill and intangible assets acquired after June 30, 2001. Goodwill and intangible asset balances at June 30, 2001 will be affected when the Registrant adopts the Statement. The Registrant has not yet determined the impact of adopting this standard. In July 2001, the SEC issued Staff Accounting Bulletin ("SAB") No. 102 "Selected Loan Loss Allowance Methodology and Documentation Issues." This bulletin further clarifies the staff's view on the development, documentation and application of a systematic methodology for determining allowances for loan and lease losses in accordance with generally accepted accounting principles. The Registrant does not anticipate any material changes to its existing methodology as a result of adoption of this standard. 12
Item 1. Notes to Condensed Consolidated Financial Statements (continued) ------------------------------------------------------------------------- 7. In accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," the Registrant has determined its principal segments to be retail banking, commercial banking, investment advisory services and data processing. Retail banking provides a full range of deposit products and consumer loans and leases. Commercial banking offers services to business, government and professional customers. Investment advisory services provides a full range of investment alternatives for individuals, companies and not-for-profit organizations. Data processing, through Midwest Payment Systems ("MPS"), provides electronic funds transfer ("EFT") services, merchant transaction processing, operates the Registrant's Jeanie ATM network and provides other data processing services to affiliated and unaffiliated customers. General corporate and other includes the investment portfolio, certain non-deposit funding, unassigned equity, the net effect of funds transfer pricing and other items not allocated to operating segments. Total revenues exclude securities gains and losses. The Registrant did not allocate resources or assess the ongoing operating performance of acquired entities prior to acquisition. Therefore, financial information prior to acquisition is shown separately as acquired entities. Following acquisition, results of operations are included in the Registrant's segment information for the acquired entities. Results of operations and selected financial information by operating segment for the three and six months ended June 30, 2001 and 2000 are as follows: <TABLE> <CAPTION> Three Months Ended Investment General June 30, Commercial Retail Advisory Data Acquired Corporate ($000's) Banking Banking Services Processing (a) Entities And Other Eliminations (a) Total - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> <C> <C> <C> <C> 2001 Total Revenues $280,074 $466,051 $103,137 $86,535 $ - $ 99,787 $ (5,833) $1,029,751 - ------------------------------------------------------------------------------------------------------------------------------------ Net Income $ 94,656 $114,386 $ 24,357 $23,859 $ - $(128,370) $ - $ 128,888 - ------------------------------------------------------------------------------------------------------------------------------------ 2000 Total Revenues $157,281 $315,601 $ 63,267 $60,672 $313,255 $ 20,809 $ (4,689) $ 926,196 - ------------------------------------------------------------------------------------------------------------------------------------ Net Income $ 60,649 $102,865 $ 21,025 $18,921 $ 55,685 $ (11,372) $ - $ 247,773 - ------------------------------------------------------------------------------------------------------------------------------------ <CAPTION> Six Months Ended Investment General June 30, Commercial Retail Advisory Data Acquired Corporate ($000's) Banking Banking Services Processing (a) Entities And Other Eliminations (a) Total - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> <C> <C> <C> <C> 2001 Total Revenues $465,611 $785,182 $170,024 $158,971 $316,074 $142,679 $(11,525) $2,027,016 - ------------------------------------------------------------------------------------------------------------------------------------ Net Income $165,256 $216,619 $ 43,286 $ 46,780 $ 55,315 $(98,749) $ - $ 428,507 - ------------------------------------------------------------------------------------------------------------------------------------ Identifiable Assets (in millions) $ 20,099 $ 26,240 $ 1,082 $ 307 $ - $ 22,106 $ - $ 69,834 - ------------------------------------------------------------------------------------------------------------------------------------ 2000 Total Revenues $310,247 $613,891 $125,633 $115,020 $620,991 $ 60,089 $ (8,854) $1,837,017 - ------------------------------------------------------------------------------------------------------------------------------------ Net Income $122,013 $194,800 $ 39,878 $ 35,814 $113,787 $ 5,952 $ - $ 512,244 - ------------------------------------------------------------------------------------------------------------------------------------ Identifiable Assets (in millions) $ 10,961 $ 15,415 $ 479 $ 92 $ 22,171 $ 17,777 $ - $ 66,895 - ------------------------------------------------------------------------------------------------------------------------------------ </TABLE> (a) Data Processing services revenues provided to the banking segments by MPS are eliminated in the Consolidated Statements of Income. 13
Item 1. Notes to Condensed Consolidated Financial Statements (continued) - ------------------------------------------------------------------------ 8. The Registrant has elected to present the disclosures required by SFAS No. 130, "Reporting Comprehensive Income," in the Condensed Consolidated Statement of Changes in Shareholders' Equity on page 6. The caption "Net Income and Nonowner Changes in Equity" represents total comprehensive income as defined in the statement. Disclosure of the reclassification adjustments and related tax effects allocated to nonowner changes in equity and accumulated nonowner changes in equity for the six months are as follows: <TABLE> <CAPTION> Six Months Ended June 30, ($000's) 2001 2000 - ----------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> Reclassification Adjustments, Before Tax - ----------------------------------------------------------------------------------------------------------------------------- Change in Unrealized Gains (Losses) Arising During Period $97,577 (43,612) Reclassification Adjustment for (Gains) Losses Included in Net Income (7,107) 60 - ----------------------------------------------------------------------------------------------------------------------------- Net Unrealized Gains (Losses) on Securities Available for Sale $90,470 (43,552) ============================================================================================================================= Related Tax Effects - ----------------------------------------------------------------------------------------------------------------------------- Change in Unrealized Gains (Losses) Arising During Period $35,698 (15,985) Reclassification Adjustment for (Gains) Losses Included in Net Income (2,137) 15 - ----------------------------------------------------------------------------------------------------------------------------- Net Unrealized Gains (Losses) on Securities Available for Sale $33,561 (15,970) ============================================================================================================================= Reclassification Adjustments, Net of Tax - ----------------------------------------------------------------------------------------------------------------------------- Change in Unrealized Gains (Losses) Arising During Period $61,879 (27,627) Reclassification Adjustment for (Gains) Losses Included in Net Income (4,970) 45 - ----------------------------------------------------------------------------------------------------------------------------- Net Unrealized Gains (Losses) on Securities Available for Sale $56,909 (27,582) ============================================================================================================================= Accumulated Nonowner Changes in Equity - ----------------------------------------------------------------------------------------------------------------------------- Beginning Balance-Unrealized Holding Gains (Losses) on Securities Available for Sale $28,012 (301,861) Current Period Change 56,909 (27,582) - ----------------------------------------------------------------------------------------------------------------------------- Ending Balance-Unrealized Holding Gains (Losses) on Securities Available for Sale $84,921 (329,443) ============================================================================================================================= </TABLE> 14
Item 1. Notes to Condensed Consolidated Financial Statements (continued) ------------------------------------------------------------------------- 9. The reconciliation of earnings per share to earnings per diluted share follows: <TABLE> <CAPTION> Three Months Ended June 30, 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------- Net Average Per-Share Net Average Per-Share ($000's) Income Shares Amount Income Shares Amount - ------------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> EPS Net Income $128,888 $247,773 Less: Dividend on Preferred Stock 185 185 - ------------------------------------------------------------------------------------------------------------------------------- Income Available to Common Shareholders $128,703 574,545 $0.22 $247,588 566,272 $0.44 Effect of Dilutive Securities Stock Options 10,965 7,860 Convertible Preferred Stock 145 308 145 308 Interest on 6% Convertible Subordinated Debentures due 2028, Net of Applicable Income Taxes 1,640 4,416 1,640 4,416 - ------------------------------------------------------------------------------------------------------------------------------- Earnings Per Diluted Share Income Available to Common Shareholders Plus Assumed Conversions $130,488 590,234 $0.22 $249,373 578,856 $0.43 =============================================================================================================================== <CAPTION> Six Months Ended June 30, 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------- Net Average Per-Share Net Average Per-Share ($000's) Income Shares Amount Income Shares Amount - ------------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> EPS Net Income $428,507 $512,244 Less: Dividend on Preferred Stock 370 370 - ------------------------------------------------------------------------------------------------------------------------------- Income Available to Common Shareholders $428,137 572,873 $0.75 $511,874 566,025 $0.91 Effect of Dilutive Securities Stock Options 10,819 7,369 Convertible Preferred Stock 290 308 290 308 Interest on 6% Convertible Subordinated Debentures due 2028, Net of Applicable Income Taxes 3,280 4,416 3,280 4,416 - -------------------------------------------------------------------------------------------------------------------------------- Earnings Per Diluted Share Income Available to Common Shareholders Plus Assumed Conversions $431,707 588,416 $0.73 $515,444 578,118 $0.89 =============================================================================================================================== </TABLE> 15
Item 2. Management's Discussion and Analysis of Financial Condition and Results - ------------------------------------------------------------------------------- of Operations - ------------- The following is management's discussion and analysis of certain significant factors which have affected the Registrant's financial condition and results of operations during the periods included in the Condensed Consolidated Financial Statements which are a part of this filing. This report includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, that involve inherent risks and uncertainties. A number of important factors could cause actual results to differ materially from those in the forward-looking statements. Those factors include the economic environment, competition, products and pricing in geographic and business areas in which the Registrant operates, prevailing interest rates, changes in government regulations and policies affecting financial services companies, credit quality and credit risk management, changes in the banking industry including the effects of consolidation resulting from possible mergers of financial institutions, acquisitions and integration of acquired businesses. The Registrant undertakes no obligation to release revisions to these forward-looking statements or reflect events or circumstances after the date of this report. Results of Operations - --------------------- The Registrant's operating earnings were $338.2 million for the second quarter of 2001 and $644.4 million for the first six months of 2001, up 14 percent and 11 percent, respectively, compared to $296.7 million and $578.5 million for the same periods last year. Operating earnings per diluted share were $.58 for the second quarter, up 12 percent over last year's $.52, and $1.10 for the first six months of 2001, up 9 percent from $1.01 for the same period last year. Net interest income on a fully taxable equivalent basis for the second quarter of 2001 was $619.4 million, an 8 percent increase over $572.8 million for the same period last year, resulting principally from a 7.5 percent growth in average interest-earning assets and a 2 basis points ("bp") increase in net interest margin, from 3.74 percent during the second quarter of 2000 to 3.76 percent in the second quarter of 2001. For the six-month period, net interest income on a fully taxable equivalent basis increased to $1.2 billion, or 7 percent, from the $1.1 billion reported in the same period last year, resulting principally from a 7.5 percent growth in average interest-earning assets while net interest margin remained constant at 3.78 percent. The negative effect of a decline in the yield on average interest-earning assets of 60bp over second quarter 2000 and 20bp over the first six months of 2000, was offset by a decrease in funding costs of 55bp over second quarter 2000 and 10bp over the first six months of 2000. The decline in funding costs was primarily due to the repricing of borrowed funds and lower year-over-year deposit rates on existing accounts. The provision for credit losses was $25.6 million in the 2001 second quarter compared to $35.3 million in the same period last year. Net charge-offs for the quarter were $42.1 million compared to $26 million in the 2000 second quarter and $48.4 million last quarter. Net charge-offs as a percent of average loans and leases outstanding increased 13bp to .39 percent from .26 percent in the same period last year. Nonperforming assets as a percentage of total loans, leases and other real estate owned was .44 percent at June 30, 2001 compared to .39 percent at June 30, 2000 and .52 percent last quarter. Underperforming assets were $316.3 million at June 30, 2001, or .76 percent of total loans, leases and other real estate owned, up 10bp compared to the 16
Item 2. Management's Discussion and Analysis of Financial Condition and Results - ------------------------------------------------------------------------------- of Operations (continued) - ------------------------- $271.6 million, or .66 percent, at June 30, 2000 and the $332.1 million or .77 percent last quarter. The Registrant maintains a reserve to absorb probable loan and lease losses inherent in the portfolio. The reserve for credit losses is maintained at a level the Registrant considers to be adequate to absorb probable loan and lease losses inherent in the portfolio, based on evaluations of the collectibility and historical loss experience of loans and leases. Credit losses are charged and recoveries are credited to the reserve. Provisions for credit losses are based on the Registrant's review of the historical credit loss experience and such factors which, in management's judgement, deserve consideration under existing economic conditions in estimating probable credit losses. The reserve is based on ongoing quarterly assessments of the probable estimated losses inherent in the loan and lease portfolio. In determining the appropriate level of reserves, the Registrant estimates losses using a range derived from "base" and "conservative" estimates. The Registrant's methodology for assessing the appropriate reserve level consists of several key elements. Larger commercial loans that exhibit potential or observed credit weaknesses are subject to individual review. Where appropriate, reserves are allocated to individual loans based on management's estimate of the borrower's ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to the Registrant. Included in the review of individual loans are those that are impaired as provided in Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan." Any reserves for impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or fair value of the underlying collateral. The Registrant evaluates the collectibility of both principal and interest when assessing the need for a loss accrual. Historical loss rates are applied to other commercial loans not subject to specific reserve allocations. The loss rates are derived from a migration analysis, which computes the net charge-off experience sustained on loans according to their internal risk grade. These grades encompass ten categories that define a borrower's ability to repay their loan obligations. Homogenous loans, such as consumer installment, residential mortgage loans, and automobile leases are not individually risk graded. Reserves are established for each pool of loans based on the expected net charge-offs for one year. Loss rates are based on the average net charge-off history by loan category. Historical loss rates for commercial and consumer loans may be adjusted for significant factors that, in management's judgement, reflect the impact of any current conditions on loss recognition. Factors which management considers in the analysis include the effects of the national and local economies, trends in the nature and volume of loans (delinquencies, charge-offs, nonaccrual and problem loans), changes in the internal lending policies and credit standards, collection practices, and examination results from bank regulatory agencies and the Registrant's internal credit examiners. An unallocated reserve is maintained to recognize the imprecision in estimating and measuring loss when evaluating reserves for individual loans or pools of loans. Reserves on individual loans and historical loss rates are reviewed 17
Item 2. Management's Discussion and Analysis of Financial Condition and Results - ------------------------------------------------------------------------------- of Operations (continued) - ------------------------- quarterly and adjusted as necessary based on changing borrower and/or collateral conditions and actual collection and charge-off experience. The Registrant has not substantively changed any aspect to its overall approach in the determination of the allowance for loan losses. There have been no material changes in assumptions or estimation techniques as compared to prior periods that impacted the determination of the current period allowance. The overall decrease between periods in total non-performing and under-performing assets was somewhat offset as a result of the consideration of historical loss rates and did not materially affect the current period allowance. The overall decrease in loan and lease balances outstanding as of June 30, 2001, combined with the effect of securitizations, did, however, have a favorable impact on the current period allowance. Total other operating income, excluding securities gains, increased 15 percent to $422 million compared to $365.5 million in the second quarter 2000, and increased to $830.9 million for the first six months of 2001, or 15 percent over the same period last year. Compared to the same periods in 2000, data processing income increased 32 percent, to $78.4 million in the 2001 second quarter and 32 percent, to $147.9 million, in the six-month period. Increases in electronic funds transfers ("EFT") and higher transaction volume from increased debit and ATM card usage, coupled with expansion of business-to-business e-commerce, contributed to the increase in data processing income. Compared to the same periods in 2000, investment advisory income increased 14 percent to $80.4 million in the second quarter and 11 percent to $157.5 million in the six month period. These increases reflect strong growth in personal trust revenue and brokerage revenue on the strength of a more productive sales force and increased market activity. Service charges on deposits increased 21 percent over the same period last year and 18 percent for the six-month period primarily due to continued sales success in treasury management services and Retail and Commercial deposit campaigns. Other service charges and fees increased 22 percent over the same period last year, and 24 percent for the six-month period, primarily due to increases in loan origination fees across nearly all categories from continued strong loan demand. Compared to the same periods in 2000, for the second quarter and six months ended June 30, 2001, commercial banking fees increased 36 percent and 31 percent, credit card fees increased 22 percent and 18 percent, and loan and lease fees increased 31 percent and 23 percent, respectively. Operating earnings include a nonrecurring pretax merger-related charge of $254.7 million and $72.8 million in the second quarter of 2001 and 2000, respectively, and $254.7 million and $99 million for the six months ended June 30, 2001 and 2000, respectively. These merger-related charges were incurred in connection with Fifth Thirds's integration of Old Kent in 2001 and Old Kent's integration of Grand Premier Financial, Inc. and Merchant Bancorp, Inc. in 2000. The merger- related charges incurred in 2001 consist of employee-related costs of $72 million, professional fees of $45 million, credit quality charges of $35 million, duplicate facilities and equipment of $38 million, conversion costs of $32 million and $33 million of other merger related costs. Excluding these merger related charges, the efficiency ratio (operating expenses divided by the sum of taxable equivalent net interest income and other operating income) was 49.3 percent for the second quarter of 2001 and 48.7 percent for the 2001 six- month period. These ratios represent a slight decline from the 48.3 percent achieved in the second quarter of 2000 and an improvement over the 49.1 percent for the six months ended 2000. The slight decline in the second quarter efficiency ratio was primarily due to increased operating expenses partially offset by increased revenues, while the six month improvement was due to revenue growth outpacing expense increases. Total operating expenses, excluding the merger-related charges, increased to $513.1 million or 13 percent as compared to the second quarter of 2000 and increased 9 percent to $998.5 million as compared to the 2000 six-month period. Salaries, incentives and benefits increased 10 percent in the second quarter of 2001 and 6 percent during the six-month period as compared to 2000. Net occupancy expense increased 11 percent during the second quarter and 9 percent during the six-month period primarily due to rent expense incurred, while total other operating expenses increased 22 percent in the second quarter and 18 percent for the six-month period. 18
Item 2. Management's Discussion and Analysis of Financial Condition and Results - ------------------------------------------------------------------------------- of Operations (continued) - ------------------------ Financial Condition - ------------------- The Registrant's balance sheet remains strong with high-quality assets and solid capital levels. Total assets were $69.8 billion at June 30, 2001 compared to $69.7 billion at December 31, 2000 and $66.9 billion at June 30, 2000, an increase of .3 percent and 4 percent, respectively. On an operating basis, return on average equity was 18.9 percent and return on average assets was 1.89 percent for the second quarter of 2001 compared to 21.1 percent and 1.80 percent, respectively, for the same quarter of last year. Net interest income growth continues to be fueled by interest-earning asset mix and growth and an increase in net interest margin. Average interest-earning assets increased to $66.2 billion for the second quarter of 2001, an increase of $4.6 billion, or 7 percent, over the same period last year and 2000 year-end. Average interest-earning assets increased primarily due to growth in commercial loans and leases and consumer loans and leases. Transaction account deposits grew 17 percent, or $3.9 billion, over the same period last year and $2 billion, or 8 percent, over 2000 year-end. Deposits growth during the period is primarily attributable to the success of promotional campaigns emphasizing customer deposit accounts. Liquidity and Capital Resources - ------------------------------- The maintenance of an adequate level of liquidity is necessary to ensure sufficient funds are available to meet customer loan demand and deposit withdrawals. The banking subsidiaries' liquidity sources consist of short-term marketable securities, maturing loans and federal funds loaned and selected securitizable loan assets. Liquidity has also been obtained through liabilities such as customer-related core deposits, funds borrowed, certificates of deposit and public funds deposits. At June 30, 2001, shareholders' equity was $7.1 billion compared to $5.8 billion at June 30, 2000, an increase of $1.2 billion, or 21 percent. Shareholders' equity as a percentage of total assets as of June 30, 2001 was 10.12 percent. The Federal Reserve Board has adopted risk-based capital guidelines which assign risk weightings to assets and off-balance sheet items and also define and set minimum capital requirements (risk-based capital ratios). The guidelines also define "well-capitalized" ratios of Tier 1, total capital and leverage as 6 percent, 10 percent and 5 percent, respectively. The Registrant exceeded these "well-capitalized" ratios at June 30, 2001 and 2000. Estimated at June 30, 2001, the Registrant had a Tier 1 risk-based capital ratio of 11.69 percent, a total risk-based capital ratio of 13.77 percent and a leverage ratio of 9.28 percent. At June 30, 2000, the Registrant had a Tier 1 risk-based capital ratio of 11.22 percent, a total risk-based capital ratio of 13.21 percent and a leverage ratio of 9.08 percent. Foreign Currency Exposure - ------------------------- At June 30, 2001 and 2000, the Registrant maintained foreign office deposits of $1.5 billion and $3.8 billion, respectively. These foreign deposits represent U.S. dollar denominated deposits in our foreign branch located in the Cayman Islands. In addition, the Registrant enters into foreign exchange derivative contracts for the benefit of customers involved in international trade to hedge their exposure to foreign currency fluctuations. By policy, the Registrant enters into offsetting third-party forward contracts with approved reputable counterparties with matching terms and currencies that are generally settled daily. 19
Item 3. Quantitative and Qualitative Disclosures about Market Risk - ------------------------------------------------------------------ Interest rate risk management focuses on maintaining consistent growth in net interest income within Board-approved policy limits. The Registrant uses an earnings simulation model to analyze net interest income sensitivity to movements in interest rates. Given an immediate, sustained 200 basis point upward shock to the yield curve used in the simulation model, it is estimated net interest income for the Registrant would decrease by 2.22 percent over one year and decrease by .86 percent over two years. A 200 basis point immediate, sustained downward shock in the yield curve would decrease net interest income by an estimated 6.95 percent over one year and decrease net interest income by an estimated 4.49 percent over two years. For further discussion of the Registrants' market risk see the Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Market Risk, included in the Annual Report on Form 10-K for the year ended December 31, 2000. 20
PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K - ----------------------------------------- (a) List of Exhibits (3)(i) Amended Articles of Incorporation, as amended, incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2001 (3)(ii) Code of Regulations, as amended, incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2001 (b) Reports on Form 8-K The Registrant filed a report on Form 8-K dated April 4, 2001 related to 1) the consummation of the merger of Old Kent Financial Corporation with and into Fifth Third Financial Corporation, a wholly-owned subsidiary of Fifth Third Bancorp and 2) to include Old Kent's audited financial information for each of the three years in the period ended December 31, 2000. The Registrant filed a report on Form 8-K/A dated April 17, 2001 related to the consummation of the merger of Old Kent Financial Corporation with and into Fifth Third Financial Corporation, a wholly- owned subsidiary of Fifth Third Bancorp. This report stated that unaudited pro forma financial information for this transaction through March 31, 2001 would be filed by an amendment. 21
Item 6. Exhibits and Reports on Form 8-K (continued) - ----------------------------------------------------- The Registrant filed a report on Form 8-K dated June 1, 2001 related to 1) quarterly and annual unaudited condensed financial statements and supplemental financial data that include the effect of the Registrant's acquisition of Old Kent Financial Corporation; and 2) Regulation FD Disclosures to assist investors, financial analysts and other interested parties in their analysis of the Registrant. The Registrant filed a report on Form 8-K/A dated June 15, 2001 related to 1) the consummation of the merger of Old Kent Financial Corporation with and into Fifth Third Financial Corporation, a wholly- owned subsidiary of Fifth Third Bancorp, previously reported in Fifth Third Bancorp's Current Report on Form 8-K filed with the SEC on April 4, 2001 and amended on April 17, 2001 and 2) to include unaudited pro forma financial information for this transaction through March 31, 2001. 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. Fifth Third Bancorp ------------------- Registrant Date: August 14, 2001 /s/ Neal E. Arnold ------------------ Neal E. Arnold Executive Vice President and Chief Financial Officer 22