ITEM 1. BUSINESS
General
AMCORE Financial, Inc. (“AMCORE” or the “Company”) is a registered bank holding company incorporated under the laws of the State of Nevada in 1982. The corporate headquarters is located at 501 Seventh Street in Rockford, Illinois. The operations are divided into four business segments: Commercial Banking, Retail Banking, Trust and Asset Management, and Mortgage Banking. AMCORE owns directly or indirectly all of the outstanding common stock of each of its subsidiaries. AMCORE provides its subsidiaries with advice and counsel on policies and operating matters among other things.
AMCORE provides free of charge, through the Company’s Internet site at www.AMCORE.com/SEC, access to annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, as soon as reasonably practicable after electronically filing such material with the Securities and Exchange Commission (SEC). However, the information found on AMCORE’s website is not part of this or any other report. The Company has adopted a code of ethics applicable to all employees. The AMCORE Financial, Inc. Code of Ethics is posted on the Company’s website at www.AMCORE.com/governance. The Company intends that this website posting and future postings of amendments, waivers or modifications of the Code of Ethics shall contain all required disclosures, however, a Form 8-K will be filed for amendments and waivers in order to meet the more stringent NASDAQ rules.
Banking Segments
General - AMCORE directly owns AMCORE Bank, N.A. (BANK), a nationally chartered bank. AMCORE also directly owns AMCORE Consumer Finance Company, Inc. (FINANCE), a consumer finance company and indirectly owns Property Exchange Company, a qualified intermediary, which is a subsidiary of the BANK.
Geographic and Economic Information - The BANK conducts business at 63 locations throughout northern Illinois and south central Wisconsin (the “Service Areas”). The Banking segments’ Service Area is dispersed among four basic economic areas: the Rockford, Illinois metropolitan area (Rockford), the Madison, Wisconsin metropolitan area (Madison), the northwestern and far-western Chicago suburbs (Chicagoland) and community banking branches which are not otherwise specified (Community Banking). Locations in the Chicagoland, Rockford and Madison Service Areas are concentrated along the “I-90 Corridor” where populations are the greatest and where the density and diversity of mid-sized businesses are highest. Recently, the Company’s growth strategy has focused on expansion along the I-90 Corridor Service Area. At the same time, AMCORE exited certain Community Banking markets that no longer fit its growth objectives. For additional information see the “Branch Strategy” discussion under Item 7, Management’s Discussion And Analysis Of Financial Condition And Results Of Operations.
The Service Areas along the I-90 Corridor have similar economic characteristics of population growth and business diversity among service, retail and manufacturing. Among the three Service Areas along the I-90 Corridor, the Rockford Service Area has the highest concentration of manufacturing activities. The Community Banking Service Areas, on the other hand, have less growth potential and have a greater concentration of smaller-sized business and agricultural concentrations. At the end of 2003, economic conditions in the Madison Service Area were characterized as strong with low unemployment. In the Chicagoland Service Area, economic conditions were stable with strong development activity and loan growth. In the Rockford Service Area, economic conditions were characterized as declining with high unemployment, primarily due to tightening of employment opportunities in the manufacturing sector with cutbacks and layoffs. Economic conditions in Community Banking Service Areas were relatively stable with the exception of the agricultural sector which was experiencing some weakness.
The BANK has 43 locations throughout northern Illinois, excluding the far northwestern counties, including the Illinois cities of Rockford, Algonquin, Elgin, Carpentersville, Crystal Lake, Des Plaines, Lincolnshire, McHenry, Schaumburg, Oak Brook, Aurora, St. Charles, Woodstock, Dixon, Freeport, Mendota, Peru, Princeton, Sterling
and the surrounding communities. The BANK conducts business at 20 locations throughout south central Wisconsin, including the Wisconsin cities of Madison, Monroe, Baraboo, Portage, Mt. Horeb, Waukesha and the surrounding communities.
Through its banking locations, AMCORE provides various personal banking, commercial banking and related financial services. AMCORE also conducts banking business through six supermarket branches, which gives the customer convenient access to bank services seven days a week.
Investment Portfolio and Policies - As a complement to its Commercial and Retail Banking segments, the BANK also carries a securities investment portfolio. The level of assets that the Company holds in securities is dependent upon a variety of factors. Chief among these factors is the optimal utilization of the Company’s capital. After consideration of loan demand, excess capital is available to allocate to high-quality investment activities that can generate additional income for the Company, while still maintaining strong capital ratios. In addition to producing additional interest spreads for the BANK, the investment portfolio is used as a source of liquidity, to manage interest rate risk and to meet pledging requirements of the BANK. The investment portfolio is governed by an investment policy designed to provide maximum flexibility in terms of liquidity and to contain risk from changes in interest rates. Individual holdings are diversified, maximum terms and durations are limited and minimum credit ratings are enforced and monitored. The BANK does not engage in trading activities. The amount of securities that the Company is permitted to invest in that have a higher degree of risk of loss are defined and limited by Company policy. The investment portfolio is managed on a day-to-day basis by a professional investment manager from AMCORE’s Trust and Asset Management segment. Portfolio performance and changing risk profiles are regularly monitored by the Investment Committee of AMCORE’s Board of Directors.
Sources of Fundings - Liquidity management is the process by which the Company, through its Asset and Liability Committee (ALCO) and treasury function, ensures that adequate liquid funds are available to meet its financial commitments on a timely basis, at a reasonable cost and within acceptable risk tolerances. These commitments include funding credit obligations to borrowers, funding of mortgage originations pending delivery to the secondary market, withdrawals by depositors, repayment of debt when due or called, maintaining adequate collateral for secured deposits and borrowings, paying dividends to its parent company, payment of operating expenses, funding capital expenditures and maintaining deposit reserve requirements.
Liquidity is derived primarily from core deposit growth and retention; principal and interest payments on loans; principal and interest payments, sale, maturity and prepayment of investment securities; net cash provided by operations; and access to other funding sources. Other funding sources include brokered certificates of deposit (CD’s), federal funds purchased lines (FED funds), Federal Home Loan Bank (FHLB) advances, repurchase agreements, commercial paper and back-up lines of credit (via the BANK’s parent company), the sale or securitization of loans, and access to other capital markets. Core deposits from the BANK’s retail and commercial customers are considered by management to be the primary, most stable and most cost-effective source of funding and liquidity for the BANK.
Retail Banking Segment - Retail banking services to individuals include deposit (demand, savings and time deposit accounts) and lending activities. Principal lending types include installment loans (primarily direct and indirect automobile lending), mortgage and home equity loans, overdraft protection, personal credit lines and bank card programs.
Mortgage and home equity lending have the lowest risk profile due to the nature of the collateral. Installment loans have an intermediate risk due to the lower principal amounts and the depreciating nature of the collateral. Personal lines and overdraft have the highest degree of risk since the loans are unsecured. The bank card programs are a fee service for originating the relationship and no credit risk is retained by the BANK. The BANK manages its retail lending risk via a centralized credit administration process, risk scoring, loan-to-value and other underwriting standards and knowledge of its customers and their credit history. As a general rule, the BANK does not actively engage in retail lending activities outside its geographic market areas.
The Vintage Mutual Funds, a proprietary family of mutual funds, are also marketed through most banking locations. The Private Banking Group also markets Vintage Mutual Funds and meets other special needs of high net worth individuals. Automated teller machines located throughout AMCORE’s market area make banking transactions available to customers when the bank facilities and hours are not convenient.
Commercial Banking Segment - A wide range of financial services are provided to commercial, small business and governmental organizations. These services include, among others, lending, deposits, letters of credit and cash management services. The BANK has a limited portfolio of equipment leases and does not actively promote this type of financing with its commercial customers. The Commercial Banking Segment lending products are tailored to the specific customer needs (facilities acquisition and expansion, equipment purchases and working capital needs). Commercial lending has a higher risk profile than does retail lending due to the larger dollar amounts involved, the nature of the collateral and a greater variety of economic risks that could potentially affect the loan customer.
The BANK manages its commercial lending risks through a centralized underwriting process, serial sign-off requirements as dollar amounts increase, lending limits, monitoring concentrations, regular loan review and grading of credits and an active work-out management process for troubled credits.
The BANK is a significant lender in the Small Business Administration (SBA) program, with a total loan portfolio of $46.8 million as of December 31, 2003, and has earned Preferred Lender Status from the SBA in both Illinois and Wisconsin. SBA loans are popular with small business customers offering them another source of financing.
Mortgage Banking Segment - AMCORE Mortgage, Inc. was merged into AMCORE Bank, N.A. effective January 1, 2003, however, continues as a reportable segment. The mortgage banking segment is a full service operation providing a broad spectrum of mortgage products to meet its customer needs. Residential mortgage loans are originated, of which non-conforming adjustable rate, fixed-rate and balloon mortgages are normally placed in the BANK’s real estate portfolio. The conforming adjustable rate, fixed-rate and balloon residential mortgage loans are normally sold in the secondary market. The mortgage banking segment services most of the loans that are sold. See Note 18 of the Notes to Consolidated Financial Statements included under Item 8 of this document for further information on AMCORE’s business segments.
Other Financial Services - The BANK provides various services to consumers, commercial customers and correspondent banks. Services available include safe deposit box rental, securities safekeeping, foreign currency exchange, lock box and other services.
The BANK also offers several electronic banking services to commercial and retail customers. AMCORE Online provides retail customers with online capability to access deposit and loan account balances, transfer funds between accounts, make loan payments, view statements and pay bills. AMCORE Online For Business facilitates access to commercial customers’ accounts via personal computers. It also permits the transfer of funds between accounts and the initiation of wire transfers and ACH activity to accounts at other financial institutions. The AMCORE TeleBank service provides retail and commercial customers the opportunity to use their telephone 24 hours a day to obtain balance and other information on their checking and savings accounts, certificates of deposit, personal installment loans and retail mortgage loans; all from a completely automated system. Through Vintage Mutual Funds WebAccess or via telephone, shareholders can access all of their accounts and purchase, redeem or exchange shares.
Trust and Asset Management Segment
AMCORE Investment Group, N.A. (AIG) is a nationally chartered non-depository bank and owns AMCORE Investment Services, Inc. (AIS) and Investors Management Group, Ltd. (IMG). AIG provides trust services, employee benefit plan and estate administration and various other services to corporations and individuals.
AIS, a wholly-owned subsidiary of AIG, is incorporated under the laws of the State of Illinois and is a member of the National Association of Security Dealers (NASD). AIS is a full-service brokerage company that offers a full range of investment alternatives including annuities, mutual funds, stocks and bonds. AIS customers can get real time stock market quotes, investment account information, and place trades for market hours execution 24 hours a day, 7 days a week through AMCORETrade.com.
IMG is incorporated under the laws of the State of Iowa and is a wholly-owned subsidiary of AIG. IMG is an asset management company whose primary customers include trust customers, retirement plans, foundations, endowments, private investors, Vintage Mutual Funds family, insurance companies, banks, public entities and individuals. IMG also provides the mutual fund administration for the Vintage Mutual Funds.
Competition
Active competition exists for all services offered by AMCORE’s bank and non-bank affiliates with other national and state banks, savings and loan associations, credit unions, finance companies, personal loan companies, brokerage and mutual fund companies, mortgage bankers, insurance agencies, financial advisory services, and other financial institutions serving the affiliates’ respective market areas. The principal competitive factors in the banking and financial services industry are quality of services to customers, ease of access to services and pricing of services, including interest rates paid on deposits, interest rates charged on loans, and fees charged for fiduciary and other professional services.
Since 1982, when Illinois multi-bank holding company legislation became effective, there have been many bank mergers and acquisitions in Illinois. These combinations have had the effect of increasing the assets and deposits of bank holding companies involved in such activities. Illinois legislation, effective December 1, 1990, permitted bank acquisitions in Illinois by institutions headquartered in any other state which has reciprocal legislation, further increasing competition. See “Supervision and Regulation” below in this Item 1.
On September 29, 1994, Congress passed laws allowing interstate banking and interstate branching. A year later, nationwide interstate banking became effective allowing institutions to make acquisitions in any state. Beginning July 1, 1997, interstate branching became effective, and banks can merge with affiliate banks or establish de novo branches in any state. Individual states, however, have the right to opt out of interstate branching. Illinois and Wisconsin have not opted out, however Iowa has retained the de novo rules for branching.
Employment
AMCORE had 1,491 full-time equivalent employees as of February 1, 2004. AMCORE provides a variety of benefit plans to its employees including health, dental, group term life and disability insurance, childcare reimbursement, flexible spending accounts, retirement, profit sharing, 401(k), stock option, stock purchase and dividend reinvestment plans.
Supervision and Regulation
AMCORE is subject to regulations under the Bank Holding Company Act of 1956, as amended (the Act), and is registered with the Federal Reserve Board (FRB) under the Act. AMCORE is required by the Act to file quarterly and annual reports of its operations and such additional information as the FRB may require and is subject, along with its subsidiaries, to examination by the FRB.
The acquisition of five percent or more of the voting shares or all or substantially all of the assets of any bank by a bank holding company requires the prior approval of the FRB and is subject to certain other federal and state law limitations. The Act also prohibits, with certain exceptions, a bank holding company from acquiring direct or indirect ownership or control of more than five percent of the voting shares of any company which is not a bank
and from engaging in any business other than banking, managing and controlling banks or furnishing services to banks and their subsidiaries, except that holding companies may engage in, and may own shares of companies engaged in, certain businesses found by the FRB to be “so closely related to banking as to be a proper incident thereto.” On August 31, 1993, the FRB approved an amendment to add certain activities and to reduce the burden on bank holding companies that desire to conduct these activities by simplifying the regulatory review process.
Under current regulations of the FRB, a bank holding company and its non-bank subsidiaries are permitted, among other activities, to engage in such banking-related businesses as sales and consumer finance, equipment leasing, computer service bureau and software operations, mortgage banking, brokerage and financial advisory services. The Act does not place territorial restrictions on the activities of non-bank subsidiaries of bank holding companies. In addition, federal legislation prohibits acquisition of “control” of a bank or bank holding company without prior notice to certain federal bank regulators. “Control” is defined in certain cases as acquisition of ten percent or more of the outstanding shares of a bank or bank holding company.
There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the Federal Deposit Insurance Corporation (FDIC) insurance fund in the event the depository institution becomes in danger of default or is in default. For example, under a policy of the Federal Reserve with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and commit resources to support such institutions in circumstances where it might not do so absent such policy. In addition, the “cross-guarantee” provisions of federal law require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default.
The federal banking agencies have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institutions in question are “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized,” as such terms are defined under regulations issued by each of the federal banking agencies.
In late 1992, Congress passed the Federal Deposit Insurance Corporation Improvement Act of 1992 that included many provisions that have had significant effects on the cost structure and operational and managerial standards of commercial banks. In addition to provisions for recapitalization of the Bank Insurance Fund, this Act contains provisions that revise bank supervision and regulation, including, among many other things, the monitoring of capital levels, outline additional management reporting and external audit requirements, and add consumer provisions that include Truth-in-Savings disclosures.
The Gramm-Leach-Bliley Act (GLB Act) was enacted November 1999, and, among other things, established a comprehensive framework to permit affiliations among commercial banks, insurance companies and securities firms. To date, the GLB Act has not materially affected the Company’s operations. However, to the extent the GLB Act permits banks, securities firms and insurance companies to affiliate, the financial services industry may experience further consolidation. This could result in a growing number of larger financial institutions that offer a wider variety of financial services than the Company currently offers and that can aggressively compete in the markets the Company currently serves.
The foregoing references to applicable statutes and regulations are brief summaries thereof and are not intended to be complete and are qualified in their entirety by reference to the full text of such statutes and regulations.
AMCORE is supervised and examined by the FRB. The BANK and AIG are supervised and regularly examined by the Office of the Comptroller of the Currency (OCC) and are subject to examination by the FRB. In addition, the BANK is subject to periodic examination by the FDIC.
FINANCE is regulated by the Illinois Department of Financial Institutions. AIS and IMG are supervised and examined by the NASD and are regulated by the SEC.
Subsidiary Dividends and Capital
Legal limitations exist as to the extent to which the BANK can lend or pay dividends to AMCORE and/or its affiliates. The payment of dividends by a national bank without prior regulatory approval is limited to the current year’s net income plus the adjusted retained net income for the two preceding years. The payment of dividends by any bank or bank holding company is affected by the requirement to maintain adequate capital pursuant to the capital adequacy guidelines issued by the FRB and regulations issued by the FDIC and the OCC (collectively “Agencies”). As of December 31, 2003, approximately $49.9 million was available for payment to AMCORE in the form of dividends without prior regulatory approval. The BANK is also limited as to the amount it may lend to AMCORE and its affiliates. At December 31, 2003, the maximum amount available to AMCORE and its affiliates in the form of loans approximated $26.4 million. There were no loans outstanding from the BANK to affiliates at December 31, 2003. See Note 19 of the Notes to Consolidated Financial Statements.
The FRB issues risk-based capital guidelines for bank holding companies. These capital rules require minimum capital levels as a percent of risk-weighted assets. In order to be adequately capitalized under these guidelines, banking organizations must have minimum capital ratios of 4% and 8% for Tier 1 capital and total capital, respectively. The FRB also established leverage capital requirements intended primarily to establish minimum capital requirements for those banking organizations that have historically invested a significant portion of their funds in low risk assets. Federally supervised banks are required to maintain a minimum leverage ratio of not less than 4%. Refer to the Capital Management section of Item 7 for a summary of AMCORE’s capital ratios as of December 31, 2003 and 2002. See also Note 20 of the Notes to Consolidated Financial Statements.
Governmental Monetary Policies and Economic Conditions
The earnings of all subsidiaries are affected not only by general economic conditions, but also by the policies of various regulatory authorities. In particular, the FRB influences general economic conditions and interest rates through various monetary policies and tools. It does so primarily through open-market operations in U.S. Government securities, varying the discount rate on member and non-member bank borrowings, and setting reserve requirements against bank deposits. FRB monetary policies have had a significant effect on the operating results of banks in the past and are expected to do so in the future. The general effect of such policies upon the future business and earnings of each of the subsidiary companies cannot accurately be predicted.
Interest rate sensitivity has a major impact on the earnings of banks. As market rates change, yields earned on assets may not necessarily move to the same degree as rates paid on liabilities. For this reason, AMCORE attempts to minimize earnings volatility related to fluctuations in interest rates through the use of a formal asset/liability management program and certain derivative activities. See Item 7A and Note 11 of the Notes to Consolidated Financial Statements included under Item 8 for additional discussion of interest rate sensitivity and related derivative activities.
Executive Officers of the Registrant
The following table contains certain information about the executive officers of AMCORE. There are no family relationships between any director or executive officer of AMCORE.
ITEM 2.
ITEM 2. PROPERTIES
On December 31, 2003, AMCORE had 82 locations, of which 55 were owned and 27 were leased. The Commercial, Retail and Mortgage Banking segments had 80 locations, of which 55 were owned and 25 were leased. The Trust and Asset Management segment had two leased facilities. All of these offices are considered by management to be well maintained and adequate for the purpose intended. See Item 1 and Note 5 of the Notes to Consolidated Financial Statements included under Item 8 of this document for further information on properties. In addition, AMCORE had 147 ATM machine locations that were available without fee to AMCORE customers.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Management believes that no litigation is threatened or pending in which the Company faces potential loss or exposure which will materially affect the Company’s consolidated financial position or consolidated results of operations. Since the Company’s subsidiaries act as depositories of funds, trustee and escrow agents, they occasionally are named as defendants in lawsuits involving claims to the ownership of funds in particular accounts. This and other litigation is incidental to the Company’s business.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of 2003.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
See Items 6 and 8 of this document for information on the Company’s stock price ranges and dividends. AMCORE’s common stock trades on the NASDAQ National Market System under the symbol “AMFI.” There were approximately 8,800 holders of record of AMCORE’s common stock as of March 1, 2004. See Item 12 of this document for information on the Company’s equity compensation plans.
The Company’s policy is to declare regular quarterly dividends based upon the Company’s earnings, financial position, capital requirements and such other factors deemed relevant by the Board of Directors. This dividend policy is subject to change, however, and the payment of dividends by the Company is necessarily dependent upon the availability of earnings and the Company’s financial condition in the future. The payment of dividends on the Common Stock is also subject to regulatory capital requirements.
The Company’s principal source of funds for dividend payments to its stockholders is dividends received from the BANK. Under applicable banking laws, the declaration of dividends by the BANK in any year, in excess of its net profits, as defined, for that year, combined with its retained net profits of the preceding two years, must be approved by the Office of the Comptroller of the Currency. For further discussion of restrictions on the payment of dividends, see Item 7, Management’s Discussion and Analysis of the Results of Operations and Financial Condition and Note 19 of the Notes to the Consolidated Financial Statements.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Five Year Comparison of Selected Financial Data
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion highlights the significant factors affecting AMCORE Financial, Inc. and Subsidiaries (“AMCORE” or the “Company”) consolidated financial condition as of December 31, 2003 compared to December 31, 2002 and the consolidated results of operations for the three years ended December 31, 2003. The discussion should be read in conjunction with the Consolidated Financial Statements, accompanying Notes to the Consolidated Financial Statements, and selected financial data appearing elsewhere within this report.
FACTORS INFLUENCING FORWARD-LOOKING STATEMENTS
This report on Form 10-K contains, and our periodic filings with the Securities and Exchange Commission and written or oral statements made by the Company’s officers and directors to the press, potential investors, securities analysts and others will contain, forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934, and the Company intends that such forward-looking statements be subject to the safe harbors created thereby with respect to, among other things, the financial condition, results of operations, plans, objectives, future performance and business of AMCORE. Statements that are not historical facts, including statements about beliefs and expectations, are forward-looking statements. These statements are based upon beliefs and assumptions of AMCORE’s management and on information currently available to such management. The use of the words “believe”, “expect”, “anticipate”, “plan”, “estimate”, “should”, “may”, “will” or similar expressions are forward looking statements. Forward-looking statements speak only as of the date they are made, and AMCORE undertakes no obligation to update publicly any of them in light of new information or future events.
Contemplated, projected, forecasted or estimated results in such forward-looking statements involve certain inherent risks and uncertainties. A number of factors - many of which are beyond the ability of the Company to control or predict - could cause actual results to differ materially from those in its forward-looking statements. These factors include, among others, the following possibilities: (I) heightened competition, including specifically the intensification of price competition, the entry of new competitors and the formation of new products by new or existing competitors; (II) adverse state, local and federal legislation and regulation; (III) failure to obtain new customers and retain existing customers; (IV) inability to carry out marketing and/or expansion plans; (V) ability to attract and retain key executives or personnel; (VI) changes in interest rates including the effect of prepayment; (VII) general economic and business conditions which are less favorable than expected; (VIII) equity and fixed income market fluctuations; (IX) unanticipated changes in industry trends; (X) unanticipated changes in credit quality and risk factors; (XI) success in gaining regulatory approvals when required; (XII) changes in Federal Reserve Board monetary policies; (XIII) unexpected outcomes on existing or new litigation in which AMCORE, its subsidiaries, officers, directors or employees are named defendants; (XIV) technological changes; (XV) changes in accounting principles generally accepted in the United States of America; (XVI) changes in assumptions or conditions affecting the application of “critical accounting estimates”; and (XVII) inability of third-party vendors to perform critical services to the Company or its customers; and (XVIII) disruption of operations caused by the conversion of data processing systems.
CRITICAL ACCOUNTING ESTIMATES
The financial condition and results of operations for AMCORE presented in the Consolidated Financial Statements, accompanying notes to the Consolidated Financial Statements, selected financial data appearing elsewhere within this report, and management’s discussion and analysis are, to a large degree, dependent upon the Company’s accounting policies. The selection and application of these accounting policies involve judgments, estimates and uncertainties that are susceptible to change.
Presented below are discussions of those accounting policies that management believes requires its most difficult, subjective and complex judgments about matters that are inherently uncertain (Critical Accounting Estimates) and are most important to the portrayal and understanding of the Company’s financial condition and results of operation. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood. See also Note 1 of the Notes to Consolidated Financial Statements.
Loans and Allowance for Estimated Losses
Loans are the Company’s largest income earning asset category. Loans are recorded at the amount advanced to the borrower plus certain costs incurred by AMCORE to originate the loan, less certain origination fees that are collected from the borrower. The carrying amount of loans is reduced as principal payments are made. Payments made by the borrower are allocated between interest income and principal payment based upon the outstanding principal amount, the contractual rate of interest and other contractual terms. The carrying amount is further adjusted to reflect amortization of the origination costs net of origination fees. These items are amortized over the expected life of the loan.
The accrual of interest income is generally discontinued (Non-Accrual Status) when management believes that collection of principal and/or interest is doubtful or when payment becomes 90 to 120 days past due, except for loans that are well secured and are in a short-term, well-defined process of collection. Payments received from the borrower after a loan is placed on Non-Accrual Status are applied to reduce the principal balance of the loan until such time that collectibility of remaining principal and interest is no longer doubtful.
Management periodically evaluates the loan portfolio in order to establish an estimated allowance for loan losses (Allowance) that are probable as of the respective reporting date and considered adequate to absorb probable losses. This evaluation includes specific loss estimates on certain individually reviewed loans, statistical loss estimates for loan groups or pools that are based on historical loss experience and other loss estimates that are based upon the size, quality, and concentration characteristics of the various loan portfolios, adverse situations that may affect a borrower’s ability to repay, and current economic and industry conditions, among other things. If the Allowance is not adequate, additions to the Allowance are charged against earnings for the period as a provision for loan losses (Provision). Conversely, this evaluation could result in a decrease in the Allowance and Provision.
Actual loan losses are charged against (reduce) the Allowance when management believes that the collection of principal will not occur. Unpaid interest attributable to prior years for loans that are placed on Non-Accrual Status is also charged against the Allowance. Unpaid interest for the current year for loans that are placed on Non-Accrual Status is reversed against the interest income previously recognized. Subsequent recoveries of amounts previously charged to the Allowance, if any, are credited to (increase) the Allowance. The Allowance is also subject to periodic examination by regulators whose review includes a determination as to its adequacy to absorb probable losses.
Those judgments and assumptions that are most critical to the application of this accounting policy are the initial and on-going credit-worthiness of the borrower, the amount and timing of future cash flows of the borrower that are available for repayment of the loan, the sufficiency of underlying collateral, the enforceability of third-party guarantees, the frequency and subjectivity of loan reviews and risk gradings, emerging or changing trends that might not be fully captured in the historical loss experience, and charges against the Allowance for actual losses that are greater or less than previously estimated. These judgments and assumptions are dependent upon or can be influenced by a variety of factors including the breadth and depth of experience of lending officers, credit administration and the corporate loan review staff that periodically review the status of the loan, changing economic and industry conditions, changes in the financial condition of the borrower and changes in the value and availability of the underlying collateral and guarantees.
While the Company strives to reflect all known risk factors in its evaluations, judgment errors may occur. If different assumptions or conditions were to prevail, the amount and timing of interest income and loan losses could be materially different. These factors are most pronounced during economic downturns and may continue into an economic recovery, as specific credit performance may not be immediately affected by the stress of the downturn. Since, as described above, so many factors can affect the amount and timing of losses on loans it is difficult to predict, with any degree of certainty, the affect on income if different conditions or assumptions were to prevail. Nonetheless, if any combination of the above judgments or assumptions were to adversely affect the adequacy of the Allowance by ten percent, an additional Provision of approximately $4.2 million would be necessary. See also Table 2 and Note 4 of the Notes to Consolidated Financial Statements.
Mortgage Servicing Rights
The Company recognizes as separate assets the rights to service mortgage loans for others. Mortgage servicing rights that are retained when mortgage loans are sold are recorded by allocating the previous carrying amount of the sold loan between the servicing rights retained and the loans that are sold. This allocation is based upon the relative fair values of the mortgage servicing rights and the loans sold. Because it is retained as an asset, the amount allocated to mortgage servicing rights will have a favorable impact on the amount of gain or loss that is recognized on the sale of the loans.
The mortgage servicing rights asset is amortized over the projected period of and in proportion to the estimated amount of net servicing income. Amortization of the servicing rights asset will reduce the amount of income that is recorded in the respective period from the servicing of the mortgage loans.
Each reporting period, the Company re-evaluates the fair value of its remaining mortgage servicing rights assets. The amount by which the unamortized carrying amount of mortgage servicing rights exceeds the new estimate of fair value is charged against earnings for the period. Rather than directly reducing the unamortized carrying amount of the servicing rights asset, a valuation allowance is established for the same amount as the charge against earnings. In subsequent reporting periods, depending upon current estimates of fair value, the valuation allowance may be reversed. The reversal is limited to the remaining amount of the valuation allowance and will result in an increase in recorded earnings.
The periodic re-evaluation of fair value is based upon current estimates of the present value of remaining net servicing cash flows that incorporate numerous assumptions including the cost of servicing the loans, discount rates, prepayment rates and default rates. This re-evaluation is done by stratifying mortgage servicing rights assets into pools based upon one or more predominant risk characteristics of the underlying loans that are being serviced. Risk characteristics include loan type and interest rate. Valuation allowances required for one pool cannot be offset by the amount that the fair value of another pool exceeds its unamortized carrying amount.
Judgments and assumptions that are most critical to the application of this accounting policy are the appropriate risk-weighted discount rates used to determine the present value of estimated net future cash flows, prepayment speeds that will determine the amount and period of servicing revenue that is expected to be earned, estimated costs to service the loans and estimated interest earned on amounts collected for real estate tax and property insurance premiums that are held in escrow until payment is due. These assumptions are based upon actual performance of the underlying loans and the general market consensus regarding changes in mortgage and other interest rates. For example, declining mortgage interest rates typically result in accelerated mortgage prepayments, which tend to shorten the life and reduce the value of the servicing rights asset.
In addition to the judgments and assumptions affecting the application of this accounting policy, the adoption of Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended by SFAS No. 138, permitted mortgage servicers to restratify their mortgage servicing rights pools. Upon consideration, the Company determined that its existing stratification was preferable
to other alternatives and chose not to restratify its pools. This represented the selection of an accounting policy that could have produced different results for 2001 and later years had the Company chose to restratify its pools. In general, the greater the number of pools, the greater the likelihood of earnings volatility associated with valuation allowances. Conversely, the fewer the number of pools the less likely there will be earnings volatility.
If different assumptions and conditions were to prevail, materially different amortization and valuation allowances than those that were recorded may be required. Since, as described above, so many factors can affect the value of mortgage servicing rights it is difficult to predict, with any degree of certainty, the affect on income if different conditions or assumptions were to prevail. Nonetheless, if any combination of the above judgments or assumptions were to adversely affect their value by an additional ten percent, an additional impairment charge of approximately $1.1 million would be necessary. See also Note 7 of the Notes to Consolidated Financial Statements.
Loan Securitizations and Sale of Receivables
During 2003 and 2001, the Company sold certain indirect automobile loans in securitization transactions. Upon the sale, the net carrying amount of the loans were removed from the consolidated balance sheet in exchange for cash, and certain retained residual interests. The retained interests included rights to service the loans that were sold (the “Servicing Rights”) and an interest in residual cash flows (the “Interest Only Strip”). The Interest Only Strip includes the excess of interest collected on the loans over the amount required to be paid to the investors and the securitization agent (the “Excess Spread”) plus an interest in sales proceeds that were not remitted by the securitization trust at the time of the initial sale of the loans to the extent it exceeds projected credit losses (the “Credit Enhancement” or “Overcollateralization”). The carrying value of the loans removed from the balance sheet included the unpaid principal balance of the loans, net of an allocable portion of the Allowance for Loan and Lease Losses, minus the portion of the carrying value of the loans that were allocated to the retained residual interests. These allocations were based upon the relative fair values of the retained residual interests and the loans sold. Because they are retained assets, the amount allocated and recorded for the residual interests had a favorable impact on the amount of gain or loss that was recognized on the sale of the loans.
Since the projected income from the Servicing Rights approximates what is considered “adequate compensation” for servicing the loans, no asset or liability was recorded for Servicing Rights. Income from servicing is recognized as earned pursuant to the terms of the servicing agreement and to the extent cash collections from the borrowers exceed payments to the investors and agent. Cash collections in excess of the Servicing Rights income that is earned is next applied to the Interest Only Strip. The value allocated to the Interest Only Strip is reduced and interest income is recorded assuming a constant yield based upon the discount rate used to estimate its fair value. At the end of the estimated life of the securitization, the carrying value of the Interest Only Strip that is attributable to the Excess Spread will be fully amortized. At that time the carrying value of the Interest Only Strip that is attributable to the Overcollateralization will have accreted to the amount of the sales proceeds that were not remitted by the securitization trust at the time of the initial sale of the loans less credit losses and excess Overcollateralization previously refunded by the securitization trust because it exceeds contractual requirements. At that time cash is expected to be released by the securitization trust in an amount that equals the accreted value of the Overcollateralization.
Because the Company’s retained residual interests are subordinated to the interests of securitization investors and the trust agent, there is risk that the carrying value of the Interest Only Strip will not be fully recovered, resulting in a loss charged to earnings. These include the risk the asset will have a shorter life than originally estimated (prepayment risk), that actual credit losses may exceed expected credit losses (credit risk) and that interest paid to the securitization trust and investors will be greater than projected (interest rate risk). The Company’s risk of loss is limited to its interest in the Interest Only Strip. Neither the investors nor the securitization trust have any other recourse to the Company’s other assets, thus a loss in excess of the carrying value of the Interest Only Strip is not possible. Each reporting period, the fair values of the Interest Only Strips are re-evaluated based upon current estimates and assumptions of the net present value of residual future cash flows net of remaining expected credit
losses and anticipated refunds of Overcollaterization. Changes in fair value are generally recorded net of tax as a component of OCI. If this re-evaluation results in fair values that are less than the amortized carrying value of the Interest Only Strip, and if the decline is considered other than temporary, in accordance with Emerging Issues Task Force (EITF) Issue No. 99-20 “Recognition of Interest Income and Impairment on Purchased and Retained Interests in Securitized Financial Assets,” the decline is charged against earnings for the current period. Finally, each reporting period, new Interest Only Strip amortization schedules are developed based upon current estimates, assumptions, adjusted carrying values and revised constant yields.
Judgments and assumptions that are most critical to the application of this accounting policy are estimated defaults, delinquencies and credit losses, projected prepayment speeds, projected interest rates, and discount rates. These assumptions are based upon demonstrated credit performance, the prepayment history of the underlying loans and market consensus on future interest rates. These are, in turn, most highly influenced by general economic conditions, with the greatest adverse affect during economic downturns and periods of rapidly falling interest rates.
If different assumptions and conditions were to prevail, noticeably different results could occur because the recorded value of the Interest Only Strips may need to be written off or written down faster than planned and cash flows from the retained residual interests may be less than expected. Since, as described above, so many factors can affect the value of the Interest Only Strips it is difficult to predict, with any degree of certainty, the affect on income if different conditions or assumptions were to prevail. Nonetheless, if any combination of the above judgments or assumptions were to adversely affect their value by an additional ten percent and the decline was determined to be other than temporary, an impairment charge of approximately $1.3 million would be necessary. See also Note 8 of the Notes to Consolidated Financial Statements.
OVERVIEW OF OPERATIONS
AMCORE reported net income of $43.5 million for the year ended December 31, 2003. This compares to $43.5 million and $42.2 million reported for the years ended December 2002 and 2001, respectively. This represents an increase of $33,000 or 0.1% when comparing 2003 and 2002, and an increase of $1.2 million or 2.9% when comparing 2002 and 2001.
Diluted earnings per share for 2003 were $1.73 compared to a record $1.75 in 2002 and $1.64 in 2001. This represents a decrease of $0.02 per share or 1.1%, when comparing 2003 and 2002, and an increase of $0.11 per share or 6.7%, when comparing 2002 and 2001. The 1.1% decrease in 2003 earnings on a diluted per share basis compared to 2002 contrasts to a slight increase in earnings on a dollar basis, reflecting the dilutive impact to per share earnings of the increase of 179,000 in average diluted shares outstanding during 2003. The increase is due to the reissuance of treasury shares pursuant to stock-based employee incentive plans. The 6.7% increase in 2002 earnings on a diluted per share basis over 2001 compares favorably to the 2.9% increase on a dollar basis, reflecting the accretive impact to per share earnings of stock repurchase programs. During 2002, average diluted shares outstanding declined 819,000.
AMCORE’s return on average equity for 2003 was 11.90% versus 13.19% in 2002 and 13.50% in 2001. AMCORE’s return on average assets for 2003 was 0.98% compared to 1.02% in 2002 and 1.04% in 2001.
Both AMCORE and the Company’s banking subsidiary (the “BANK”) continue to significantly exceed the minimum capital requirements established by regulators for banks and bank holding companies. In addition, the BANK continues to be “well capitalized” as defined by regulatory guidelines. See Note 20 of the Notes to Consolidated Financial Statements.
Branch Strategy
During 2001, the Company launched the first phase (“Phase I”) of a strategic initiative to reallocate capital to higher growth midwestern markets, particularly along the I-90 growth corridor between Chicago’s northwest suburbs and Madison, Wisconsin and, more recently, the Milwaukee, Wisconsin market (the “Branch
Expansion”). The Company’s strategy is to move into a new market where there are strong population growth rates and high concentrations of mid-size businesses, with a seasoned commercial service staff in a leased facility (limited branch office or “LBO”). Once a book of business is developed and the branch becomes profitable, a more permanent site for a full service facility is sought. At the same time, AMCORE has exited certain markets that no longer fit its growth objectives (the “Branch Sales”).
During 2001, the BANK sold seven Illinois branches and in 2002 closed one additional branch. For the seven Illinois Branch Sales, $65.1 million in loans, $170.8 million in deposits and $1.4 million in premises and equipment were sold to the respective buyers resulting in a pre-tax gain of $10.6 million or a net after-tax gain of $6.3 million (the “Branch Gain(s)”). Loans and deposits for the closed branch were transferred to nearby BANK branches. During the first quarter of 2003, the BANK sold six Wisconsin branches located in Clinton, Darien, Montello, Kingston, Dalton and Westfield. Combined loans, deposits and premises and equipment of $47.8 million, $124.6 million and $2.1 million, respectively, were sold to the respective buyers of the Wisconsin branches, resulting in a pre-tax gain of $8.2 million or a net after-tax gain of $4.9 million (also referred to as “Branch Gain(s)”).
Branch Expansion activities in 2001 included two new offices: one on Rockford’s east side and one in Geneva, Illinois, a Chicago suburb. During 2002, the BANK opened four LBO’s and three full-service branches. The LBO’s included three in the Chicago suburbs of Schaumburg, Lincolnshire and Des Plaines, Illinois and one on the east side of Madison, Wisconsin. The full-service branches included one each in St. Charles and McHenry, Illinois and one along the beltway in Madison. As a result of the new office openings, an LBO in Geneva, Illinois and a smaller full-service branch in downtown McHenry, Illinois were closed.
During 2003, the BANK opened 11 new branches, including four LBO’s in Freeport, Oak Brook and Aurora, Illinois and Waukesha, Wisconsin, a suburb of Milwaukee, and seven full-service branches in Machesney Park, Elgin, South Elgin and Algonquin, Illinois, two in Madison, Wisconsin and one on Rockford’s northwest side. In connection with the opening of these locations the Company closed two in-store branches, one LBO and one full-service facility. Combined, the new locations opened since April 1, 2001 have $557.8 million in loans and $266.3 million in deposits outstanding as of December 31, 2003. The impact of the Branch Expansion was dilutive $0.08 in 2003 compared to dilution of $0.04 and $0.02 in 2002 and 2001, respectively.
During second quarter 2003, the Company announced the second phase of its Branch Expansion program (“Phase II”), authorizing $30 million in incremental capital investment. These funds will be used to open new full-service facilities and upgrade several LBO’s to full-service facilities in selected high-growth midwestern communities. Increased capabilities in these markets will accelerate the Company’s ability to generate deposits, which will better support loan growth and decrease its use of wholesale funding. Phase II calls for a total of 10 additional branches opening in 2004 through 2006. When both phases of the Branch Expansion are complete, AMCORE will have a total of 24 new branches opened since April 2001, net of closed branches. Total offices by the end of 2006 are expected to number 74. More than two-thirds of its offices will be located in high growth markets. See Table 7 for a tabular presentation of the Company’s Branch Expansion plans. Phase II, when considered with Phase I expansion, is expected to dilute earnings by $0.04 to $0.08 per share in 2004. By 2005, the combined Branch Expansion initiative is expected to be accretive in the range of $0.10 to $0.15 per share.
During 2002, as a complement to its Branch Expansion, the BANK added 37 additional automated teller machines (“ATMs”) in 15 communities in northern Illinois and southern Wisconsin. The ATMs are primarily located in Kelley-Williamson Mobil stations as part of a co-branding relationship, and are owned and operated by an unaffiliated third party. During 2003, the co-branding relationship was expanded and an additional 37 ATM’s were added. The BANK currently owns and operates 73 ATMs throughout Illinois (58) and Wisconsin (15). The co-branded relationship increased the Illinois and Wisconsin ATM presence to 113 and 34, respectively, or 147 overall.
Organizational Changes and Related Charges
During 2003, the Company incurred $431,000 in net after-tax severance related charges (the “Severance Charges”) related to the reduction in 43 retail positions, including one senior position.
During 2002, Kenneth E. Edge was named President and Chief Executive Officer, effective July 1, 2002, and Chairman of the Board of the Company, effective January 1, 2003. Mr. Edge, who previously served as AMCORE’s President and Chief Operating Officer, replaced Robert J. Meuleman following Mr. Meuleman’s retirement. Mr. Meuleman continued as Chairman until his retirement at the end of 2002. In connection with these changes, and in an effort to gain efficiencies, the position of Chief Operating Officer was not replaced. The net present value of early retirement obligations, pursuant to Meuleman’s Separation, Release and Consulting Agreement, including certain enhanced post retirement benefits and continued participation in the Company’s Long-Term Incentive Plan (the “Separation Agreement”), at $784,000 net of tax (the “Retirement Obligation”), was accrued in 2002. Amounts due for consulting services subsequent to retirement date have been expensed as earned.
During 2001, AMCORE announced certain business changes designed to better integrate banking and asset management services to its customers. To better support these structural changes, AMCORE streamlined its management team resulting in the departure of certain senior managers. Additional changes were made in 2002. Severance Charges related to these structural changes were $215,000 and $464,000 after-tax in 2002 and 2001, respectively.
Loan Securitizations and Securities Sales
During 2003 and 2001, the BANK sold $106.0 million and $29.9 million, respectively, of indirect automobile loans in securitization transactions (the “Auto Loan Sales”). Net after-tax gains of $1.5 million and $494,000, were recorded for the respective years (the “Auto Loan Sales Gains”). See Note 8 of the Notes to Consolidated Financial Statements.
During 2001, AMCORE recognized $2.0 million in net security losses related to investment portfolio restructuring (the “Security Portfolio Restructuring”); a strategy designed to reduce interest rate risk. The restructuring plan focused on the disposal of securities having a higher degree of interest rate risk associated with changes in prepayment speeds and on securities with low yields and/or longer durations. The restructuring was intended to improve the stability and quality of future earnings and values.
Accounting Changes
On January 1, 2003, the Company adopted Financial Accounting Standards Board (FASB) Financial Interpretation No. (“FIN”) 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”. FIN 45 expands the information required to be disclosed by guarantors for obligations under certain types of guarantees. It also requires initial recognition at fair value of a liability for such guarantees. In addition, FIN 34, “Disclosure of Indirect Guarantees of Others,” was rescinded, though the guidance contained therein was carried forward into FIN 45 without modification. The initial recognition and initial measurement requirements of FIN 45 were effective prospectively for guarantees issued or modified after December 31, 2002. Adoption of the Interpretation did not have a material effect on the Company’s Consolidated Financial Statements. See Note 15 of the Notes to the Consolidated Financial Statements.
On January 1, 2002, the Company adopted SFAS No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets”, with respect to business combinations that were completed prior to July 1, 2001. These statements required that the Company evaluate its existing intangible assets and goodwill classifications. Goodwill and intangible assets with indefinite useful lives may no longer be amortized, but instead must be tested for impairment at least annually. The useful life and residual values of all other intangibles
must also be reassessed. As of the date of adoption, the Company had unamortized goodwill in the amount of $15.6 million and unamortized identifiable intangible assets (the “Core Deposit Intangibles”) in the amount of $282,000 that were subject to the transition provisions of SFAS Nos. 141 and 142. The Company had no other intangible assets subject to these standards.
Amortization expense related to goodwill was $2.0 million for 2001. Amortization of Core Deposit Intangibles was $141,000 in 2003 and 2002, compared to $96,000 in 2001. Core Deposit Intangibles were fully amortized as of December 31, 2003. The increase in 2002 over 2001 reflects the reassessment of and reduction in useful life. Fair value exceeded carrying value for all reporting units that have allocated goodwill at both the transitional and annual evaluation dates. Thus, no transitional or annual impairment loss was recognized and no cumulative effect of a change in accounting principle was recorded. In October 2002, the FASB issued SFAS No. 147, “Acquisitions of Certain Financial Institutions” (SFAS No. 147). SFAS No. 147 requires financial institutions to evaluate their accounting for past acquisitions to determine whether revisions are needed. SFAS No. 147 applies to all new and past financial-institution acquisitions, including “branch acquisitions” that qualify as acquisitions of a business, but excludes acquisitions between mutual institutions. The Company does not have any acquisitions affected by this new standard. See Note 5 of the Notes to Consolidated Financial Statements
On January 1, 2001, the Company adopted Statement of Financial Accounting Standard (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended by SFAS No. 138, effective beginning January 1, 2001 and SFAS No. 149, effective beginning June 30, 2003. This statement outlines accounting and reporting standards for derivative instruments and hedging activities. Net income for 2001 includes a cumulative effect of $225,000 net of tax, or $0.01 per diluted share, attributable to the adoption of the new accounting standard (the “Accounting Change”). See Note 11 of the Notes to Consolidated Financial Statements.
Extinguishment of Debt
In the first quarter of 2004, as the result of the adoption of FIN 46 (Revised December, 2003) “Consolidation of Variable Interest Entities,” the Company will be required to de-consolidate the Trust. The Company expects that the de-consolidation of the Trust, including the impact on the Debt Extinguishment, will not have a material effect on the Company’s Consolidated Financial Statements.
During 2001, AMCORE reacquired for its own portfolio at par $15.0 million in capital trust preferred securities (the “Trust Preferred”), which were accounted for as a retirement (the “Debt Extinguishment”), with the coupon rate of 9.35 percent. The Debt Extinguishment resulted in an after-tax extraordinary charge of $204,000, or $0.01 per diluted share (the “Extraordinary Item”). Prior to the Debt Extinguishment the Company had $40.0 million of Trust Preferred outstanding through AMCORE Capital Trust I (“Trust”), a statutory business trust. As a result of the Debt Extinguishment there are now, on a consolidated basis, $25.0 million of Trust Preferred effectively outstanding. See Note 10 of the Notes to Consolidated Financial Statements.
Stock Repurchase Programs
During 2002 and 2001 the Company reacquired shares pursuant to various share repurchase authorizations (the “Stock Repurchase Programs”). Shares so acquired became treasury shares available for general corporate purposes. During 2002, the Company repurchased 82,000 shares at an average price of $22.20. During 2001, the Company repurchased 1.8 million shares at an average price of $21.42. No shares remain to be purchased under any authorization. The Company also regularly repurchases shares to replenish treasury for shares reissued in connection with AMCORE’s stock option plans and other employee benefit plans.
EARNINGS REVIEW OF CONSOLIDATED INCOME STATEMENT
The following highlights a comparative discussion of the major components of net income and their impact for the last three years.
Net Interest Income
Net interest income is the difference between income earned on interest-earning assets and the interest expense incurred on interest-bearing liabilities. The interest income on certain loans and investment securities is not subject to Federal income tax. For analytical purposes, the interest income and rates on these types of assets are adjusted to a “fully taxable equivalent” or FTE basis. The FTE adjustment was calculated using AMCORE’s statutory Federal income tax rate of 35%. Adjusted interest income is as follows (in thousands):
Net interest income on a fully taxable equivalent basis increased $6.3 million or 4.6% in 2003 and increased $9.7 million or 7.6% in 2002. The increase in net interest income in 2003 was primarily attributable to higher average earning assets. The increase in net interest income in 2002 was primarily the result of decreased funding costs and an increase in average earning assets.
The net interest spread is the difference between the average rates on interest-earning assets and the average rates on interest-bearing liabilities. The interest rate margin represents net interest income divided by average earning assets. These ratios can also be used to analyze net interest income. Since a significant portion of the Company’s funding is derived from interest-free sources, primarily demand deposits, other liabilities and stockholders’ equity, the effective rate paid for all funding sources is lower than the rate paid on interest-bearing liabilities alone.
As Table 1 indicates, the interest rate spread improved eight basis points to 3.23% in 2003 from 3.15% in 2002, which was an improvement of 27 basis points from the 2001 level of 2.88%. The interest rate margin was 3.54% in 2003, an increase of one basis point from 3.53% in 2002. The 2002 level was an increase of 11 basis points from 3.42% in 2001.
The level of net interest income is the result of the relationship between the total volume and mix of interest-earning assets and the rates earned and the total volume and mix of interest-bearing liabilities and the rates paid. The rate and volume components associated with interest earning assets and interest-bearing liabilities can be segregated to analyze the year-to-year changes in net interest income. Changes due to rate/volume variances have been allocated between changes due to average volume and changes due to average rate based on the absolute value of each to the total change of both categories. Because of changes in the mix of the components of interest-earning assets and interest-bearing liabilities, the computations for each of the components do not equal the calculation for interest-earning assets as a total and interest-bearing liabilities as a total. Table 1 analyzes the changes attributable to the volume and rate components of net interest income.
Changes Due to Volume
In 2003, net interest income on an FTE basis increased due to average volume by $7.5 million. This was comprised of an $11.0 million increase in interest income that was partially offset by a $3.5 million increase in
interest expense. In 2002, net interest income on an FTE basis increased due to average volume by $4.7 million. This was comprised of an $11.9 million increase in interest income that was partially offset by a $7.2 million increase in interest expense.
The 2003 increase in interest income of $11.0 million was driven by a $236.3 million or 8.9% increase in average loans offset by a decline of $81.7 million or 7.0% in average investment securities. The growth in average loans came from an increase of $271.8 million in commercial real estate lending driven mostly by the Branch Expansion while average consumer and average commercial loans increased $32.4 million and $16.5 million, respectively. Partially offsetting these increases was an $84.3 million average decline in residential real estate loans, due to the impact of refinancings, as fixed mortgage interest rates reached 45-year lows. Strong loan growth, particularly in new markets, has allowed the Company to reshape its balance sheet to an improved mix of earning assets, contributing to the decline in average investment securities.
The increase in average loans, offset by the decline in investment securities, was funded by a $142.7 million or 5.3% increase in average bank-issued deposits and by a $98.5 million or 25.6% increase in average brokered certificate of deposits (CD’s). The increase in average bank-issued deposits which includes a $37.2 million increase in non-interest bearing deposits was attributable to a Company-wide initiative to attract deposits, especially transaction deposits, and the Branch Expansion. This growth occurred despite the transfer of $124.6 million of deposits in connection with the Wisconsin Branch Sales. AMCORE recognizes the importance of continued bank-issued deposit growth, not only as a means of funding the Branch Expansion loan growth, but also to continue the strategy of reducing wholesale funding balances. The transition to full-service branches in new growth markets as the Branch Expansion develops, continued emphasis on attracting and retaining primary transaction accounts, and Auto Loan Sales are all means by which the Company has and expects to implement these strategies. To this end, the Company was able to decrease average borrowings by $101.5 million or 13.5% compared to 2002.
The 2002 increase in interest income of $11.9 million was largely the result of a $147.1 million or 5.8% increase in average loans. Average installment and consumer loans, primarily indirect automobile lending, increased $127.9 million, while average commercial real estate and average commercial, financial and agricultural loans increased $87.9 million and $28.2 million, respectively. The combined increase in commercial lending was primarily driven by AMCORE’s Branch Expansion in the Chicago suburban and Madison area markets. These increases were partially offset by a decline in average residential real estate loans of $97.0 million due to the impact of refinancings, as mortgage interest rates hit 45 year lows.
The 2002 increase in average earning assets was funded by a $154.9 million increase in average deposits. The increase was comprised of a $78.4 million increase in average brokered deposits and a $76.5 million or 2.9% increase in average bank-issued deposits. The growth in bank-issued deposits reflects company-wide initiatives to attract additional bank-issued deposits as well as deposit growth attributable to the Branch Expansion. Over 95% of the bank-issued deposit growth was attributable to primary transaction account business, which is one of the Company’s lowest cost funding sources.
Changes Due to Rate
During 2003, net interest income on an FTE basis declined due to average rates by $1.1 million when compared with 2002. This was comprised of a $36.9 million decrease in interest income that was partly offset by a $35.8 million decline in interest expense. During 2002, net interest income on an FTE basis increased due to average rates by $5.0 million, when compared with 2001. This was comprised of a $41.4 million decline in interest income that was more than offset by a $46.4 million decrease in interest expense.
The yield on earning assets declined 92 basis points in 2003, compared to 2002. The yield on average securities fell by 109 basis points, while the yield on average loans fell by 89 basis points. The decline in security yields was affected by the prepayment of higher-yielding mortgage-related securities, including accelerated premium
amortization, that occurred as mortgage interest rates fell. These securities were replaced with lower yielding securities due to the current low interest rate environment. While nearly all loan categories were affected, the largest dollar decline was attributable to commercial real estate loans. Loans that refinanced during the year, variable priced loans and new loan production were all adversely impacted by the reductions in interest rates that have been in decline since January of 2001.
The rate on interest-bearing liabilities declined 100 basis points during 2003 compared to 2002, due to lower bank-issued deposit, wholesale deposit, short-term and long-term borrowing rates. While rates fell on all deposit products, the decrease was most pronounced on CD’s. Average rates on CD’s have declined as older CD’s bearing higher rates have matured and re-priced since the decline in interest rates that have occurred over the past three years. The Company also benefited from an expired interest rate swap that had increased funding costs in 2002, as well as new swaps entered into during 2002 that lowered the cost of wholesale deposits during 2003. The decrease in borrowing rates was largely the result of lower rates paid on reverse repurchase agreements that renewed at lower rates as short-term interest rates have declined.
The yield on earning assets declined 107 basis points in 2002, compared to 2001. The yield on average loans fell by 119 basis points and was primarily attributable to commercial real estate and commercial loans. Falling interest rates during the year impacted pricing on new loan volume, variable priced loans and loans that refinanced during the year. The yield on average securities decreased by 87 basis points, also the result of declining interest rates. Yields on securities were also affected by the sale of higher risk securities in the 2001 Security Portfolio Restructuring well as the pre-payment of higher yielding mortgage-related securities that occurred as mortgage interest rates fell.
The rate paid on interest-bearing liabilities declined 134 basis points in 2002, compared to 2001. This was primarily due to decreased rates paid on deposits and short-term borrowings. The decrease in deposit costs was largely driven by CD’s and the Company’s indexed money market deposit accounts (AMDEX) that benefited from the decline in short-term interest rates. The decrease in short-term borrowing costs was mainly due to reverse repurchase agreements that renewed at lower rates, also due to the decline in short-term interest rates.
The current interest rate environment is expected to result in improved interest rate spreads and margins in 2004, compared to 2003. Specifically, the Company expects continuing benefits from deposit re-pricing during the coming year. Among those factors that could cause margins and spreads not to improve as anticipated by the Company in 2004 include, unexpected changes in interest rates, changes in the shape of the yield curve, the effect of prepayments or renegotiated rates, changes in the mix of earning assets and the mix of liabilities, including greater than anticipated use of expensive wholesale sources to fund the Branch Expansion and greater than expected loan delinquencies resulting in non-accrual status.
Provision for Loan Losses
The Provision (see Critical Accounting Estimates discussion) was $24.9 million for 2003, and increased by $12.3 million or 98.2% compared to 2002. Increases in net charge-offs, higher specific loss estimates on individually reviewed loans, increased concentrations, increasing loan balances in emerging markets, higher levels of delinquencies and continued economic weakness were all among the factors leading to the increased Provision. Comparable additions to the Allowance in 2002 were not necessary. The Provision decreased $4.1 million or 24.7% in 2002 from the $16.7 million in 2001. While non-accrual loans and net charge-offs were up year-over-year in 2002, the total of non-accrual loans, loans past due 90 days or more and restructured loans were down compared to 2001. As a result, although non-accrual loans and net-charge-offs were up, there was a decrease in the Provision year-over-year.
AMCORE recorded net charge-offs of $16.6 million, $11.3 million and $11.0 million in 2003, 2002 and 2001, respectively. Net charge-offs represented 57 basis points of average loans in 2003 versus 42 basis points in 2002 and 44 basis points in 2001. Commercial net charge-offs increased $3.3 million in 2003 compared to 2002.
Installment and consumer net charge-offs increased $1.7 million in 2003 compared to 2002, reflecting continuing increases in losses on repossessed vehicles. Residential real-estate net charge-offs increased $795,000 while commercial real-estate net charge-offs declined $413,000 in 2003 compared to 2002. Commercial net charge-offs declined $1.3 million in 2002, compared to 2001, reflecting settlement activity that occurred in 2001. Installment and consumer loan net charge-offs increased $1.4 million over the same period, the result of the continued sluggish economy and increasing loss levels on repossessed vehicles. Real estate loan net charge-offs were up $78,000 year-to-year.
Non-Interest Income
Total non-interest income is comprised primarily of fee based revenues from trust and asset management activities, bank-related service charges on deposits and mortgage revenues. Net security gains or losses and increases in cash surrender value (CSV) of BANK and Company-owned life insurance (COLI) are also included in this category. For 2003 and 2001, this category also included Branch Gains and Auto Loan Sales Gains.
Non-interest income totaled $92.0 million in 2003, an increase of $21.7 million or 30.8% from the $70.3 million in 2002. In addition to a $9.6 million increase in mortgage revenues, the increase included $8.2 million of Branch Gains and $2.5 million of Auto Loan Sale Gains.
Non-interest income totaled $70.3 million in 2002, a decline of $6.8 million or 8.8% from the $77.1 million in 2001. Increases of $3.1 million attributable to services charges on deposits and $2.8 million of security gains were offset by the Branch Gains of $10.6 million included in non-interest income in 2001.
Trust and asset management income, the Company’s largest source of fee based revenues, totaled $22.5 million in 2003, a decrease of $2.2 million or 8.8% from $24.7 million in 2002. This follows a decrease in 2002 of $2.2 million or 8.17% from $26.9 million in 2001. Declining equity markets over the past three years have challenged the investment industry with the S & P 500 losing 24.3% of its value from 2000 to 2003. These declines have negatively impacted the value of AMCORE-administered assets, upon which fees are partially based, leading to the decrease in fee revenue. Also contributing to the decline was the loss of a major public fund customer effective October 1, 2003 and specific investment performance on related Vintage Mutual Funds. Unless replaced with new business, the loss of the public fund customer could adversely affect trust and asset management income in 2004. Revenues from this customer were $916,000 in 2003, $1.1 million in 2002 and $932,000 in 2001. A shift by clients to a higher mix of fixed income and money market assets also affected prior year results.
The trust and asset management segment manages or administers $5.4 billion of investments, inclusive of traditional assets as well as the management of the BANK’s fixed income portfolio of approximately $1.1 billion. Assets under administration at December 31, 2002 and 2001 were $4.6 billion and $4.9 billion, respectively. Assets in the Vintage Mutual Funds totaled $827 million, $877 million and $1.2 billion at December 31, 2003, 2002 and 2001, respectively. In addition to overall market performance, trust and asset management revenues are dependent upon the Company’s ability to attract and retain accounts, specific investment performance and other economic factors. Fees from Money Market funds can also be negatively affected as the federal funds purchased (FED Funds) rate approaches 1.00%, a level generally viewed as a minimum acceptable return by investors. Thus, waivers of fees on money market funds have been and may continue to be required to provide competitive returns for investors.
Service charges on deposits totaled $18.6 million in 2003, an increase of $742,000 or 4.2% from the $17.9 million in 2002. During 2002, service charges on deposits increased $3.1 million or 21.0% from $14.8 million in 2001. Deposit growth initiatives, which primarily affected retail accounts, contributed to the increases in both 2003 and 2002. Additionally, in 2002, increased commercial account maintenance fees contributed to the increase.
Mortgage revenues include fees generated from underwriting, originating and servicing of mortgage loans along with gains realized from the sale of these loans, net of servicing rights amortization and impairment (see Critical Accounting Estimates). Mortgage revenues were $17.6 million in 2003, an increase of $9.6 million or 121.1% from the $7.9 million reported in 2002. During 2002, mortgage revenues declined $542,000 or 6.4% from $8.5 million in 2001. Contributing to the $9.6 million increase in 2003 was a $3.4 million recapture of mortgage servicing right impairment reserves compared to an impairment charge of $2.6 million in 2002. An impairment charge of $780,000 was recorded in 2001. For the third year in a row, declining mortgage interest rates resulted in record closing volumes. In 2003, closing volumes were $893.7 million, compared to $718.0 million in 2002, and $634.2 million in 2001.
Refinancing activity declined significantly in the fourth quarter of 2003 resulting in declining mortgage revenues. This trend in refinancing activity is expected to continue into 2004. The Company has, however, added 13 mortgage loan originators, primarily in the Branch Expansion markets, to capitalize on growth opportunities in new purchase home mortgages. New purchase new home mortgages increased 31.5% in 2003 compared to 2002. The growth of new purchase home mortgages is expected to continue in 2004.
As of December 31, 2003, the carrying value of AMCORE’s capitalized mortgage servicing rights was $11.2 million and were $10.6 million as of December 31, 2002. The fair value of the Company’s capitalized mortgage servicing rights was $11.7 million. The unpaid principal balance of mortgage loans serviced for others, which are not included on the Consolidated Balance Sheets, including loans held for sale, was $1.2 billion as of December 31, 2003. See Note 7 of the Notes to Consolidated Financial Statements.
COLI income totaled $7.0 million in 2003; a $1.3 million or 23.5% increase over the $5.7 million in 2002. This compares to a $435,000 increase in 2002 over the $5.2 million reported in 2001. The 2003 increase over 2002, included the impact of compounding, increased average investments year-over-year and $467,000 in net death benefits. The 2002 increase was primarily due to compounding. Both years’ increases were partially offset by lower yields due to declining interest rates. AMCORE uses COLI as a tax-advantaged means of financing its future obligations with respect to certain non-qualified retirement and deferred compensation plans in addition to other employee benefit programs. As of December 31, 2003, the CSV of COLI stood at $116.5 million, which included additional net investments of $1.1 million during 2003.
Other non-interest income includes customer service charges, bank card fees, brokerage commissions, insurance commissions, gains on fixed asset and loan sales and other miscellaneous income. In 2003, other non-interest income was $11.2 million, a decline of $410,000 or 3.5% from $11.6 million in 2002. The decrease was due to a $700,000 decline in derivative related income due to the mark-to-market losses in 2003 as opposed to gains in 2002, a decline of $440,000 in insurance commission income, a $309,000 gain in 2002 associated with an excess retirement plan asset reversion and lower gains on sale of fixed assets of $303,000. These decreases were partly offset by increases in brokerage commission income of $609,000, servicing income in connection with the Auto Loan Sales of $350,000, customer service fees of $252,000, and bank card fees of $138,000. In 2002, other non-interest income was $11.6 million; a $1.0 million or 9.6% increase from $10.6 million in 2001. The increase was attributable to improved brokerage commission income of $636,000, a $607,000 increase in derivative related income due mark-to-market gains in 2002 as opposed to losses in 2001, higher bank card fees of $419,000, a $365,000 gain on the sale of excess land and the $309,000 retirement plan asset reversion gain. These increases were partly offset by a 2001 gain of $1.0 million from cash received on the merger of an ATM service provider.
Net securities gains totaled $4.4 million in 2003 and $2.5 million in 2002 compared to net losses of $303,000 in 2001. The level of security gains or losses is dependent on the size of the available for sale portfolio, pledging requirements, interest rate levels, AMCORE’s liquidity needs and balance sheet risk objectives. The increase in 2003, compared to 2002, was attributable to the gain realized on the disposition of securities with longer duration and unfavorable call structures, which facilitated the Company’s efforts to reduce the duration of its investment portfolio as well as fund loan growth. The increase in 2002, compared to 2001, was attributable to the Security Portfolio Restructuring and continuation of a security portfolio de-leveraging strategy that began in 1999.
Operating Expenses
Total operating expenses were $146.1 million in 2003, an increase of $15.1 million or 11.6% from $131.0 million in 2002, which was a $7.4 million or 6.0% increase from $123.6 million in 2001. Operating expenses in 2003 included $5.1 million in expenses related to the Branch Expansion, a $1.6 million charge for the early extinguishment of debt, $707,000 in Severance Charges and a $623,000 impairment charge on a private equity fund investment. Operating expenses in 2002 included $1.7 million in expenses related to the Branch Expansion, the $1.3 million Retirement Obligation and a $352,000 Severance Charge. Operating expenses in 2001 included Severance Charges of $760,000. Pursuant to SFAS No. 142, the Company discontinued the amortization of goodwill, effective January 1, 2002.
Amortization expense related to goodwill was $2.0 million in 2001. The efficiency ratio was 63.36% in 2003, 65.16% in 2002 and 62.78% in 2001. The efficiency ratio is calculated by dividing total operating expenses by the sum of net interest income and non-interest income.
Compensation expense is the largest component of operating expenses, totaling $67.2 million in 2003. This was a $6.7 million or 11.0% increase from $60.5 million in 2002, which was a $5.1 million or 9.3% increase from $55.3 million in 2001. The 2003 increase included $4.0 million in net staff additions associated with the Branch Expansion strategy, higher commissions of $923,000 mainly driven by increased mortgage closings, the $707,000 Severance Charge and $434,000 in increased incentive costs. The 2002 increase included $1.3 million in net staff additions associated with the Branch Expansion strategy, $922,000 in increased incentive costs, higher commissions of $819,000, mainly driven by increased mortgage closings, and $527,000 of the Retirement Obligation. Severance Charges decreased $408,000 when compared to 2001.
Employee benefit costs were $17.4 million in 2003, an increase of $1.2 million or 7.3% from $16.2 million in 2002, which was a $2.0 million or 14.0% increase from $14.2 million in 2001. Health care costs rose $874,000 in 2003 due to staff additions and medical cost inflation and payroll tax expense increased $649,000 in 2003 due to higher compensation expense. These increases were offset by lower deferred compensation and other benefit costs of $243,000. The 2002 increase was primarily attributable to $757,000 of the Retirement Obligation, $665,000 in retirement and deferred compensation costs and $538,000 in payroll tax costs.
Net occupancy expense was $8.8 million in 2003, an increase of $918,000 or 11.7% from 2002. This follows an increase of $303,000 or 4.0% from 2001 levels. The 2003 and 2002 increases included net increases due to the Branch Expansion strategy.
Equipment expense increased $1.8 million or 23.1% to $9.6 million in 2003 and decreased $173,000 or 2.2% to $7.8 million in 2002. The 2003 increase was primarily due to increased depreciation and amortization on new computer hardware and software resulting from the conversion of the Company’s core data processing system during 2003 (the “System Conversion”). Also necessitated by the System Conversion were personal computer (PC) replacements and the acceleration of existing hardware and software depreciation and amortization. The Branch Expansion also contributed to higher PC equipment expense in 2003. The 2002 decrease reflects lower net electronic data processing equipment and software expenses.
Data processing expenses include costs related to core bank data processing, trust and other external processing systems. This category declined $1.7 million or 24.9% to $5.1 million in 2003, primarily due to lower processing costs resulting from the System Conversion from an outsourced data processing system to a new in-house data processing system. Expenses in 2002 were $6.8 million; a $738,000 or 12.2% increase from $6.0 million in 2001 primarily due to increased core bank data processing.
Professional fees totaled $4.6 million in 2003, an increase of $321,000 or 7.5% from 2002 due to higher legal, tax and accounting services. Professional fees were $4.3 million in 2002, an increase of $149,000 or 3.6% from $4.1 million in 2001. Audit and consulting fee increases were partly offset by decreased legal fees.
Communication expense was $4.7 million in 2003 an increase of $565,000 or 13.7% from 2002 due to increased courier, telephone and postage expenses due to the Branch Expansion and postal rate increases. Communication expense was $4.1 million in 2002, an increase of $196,000 or 5.0% from $3.9 million in 2001. The increase was due to higher courier and postage costs partially related to the Branch Expansion.
Advertising and business development expenses were $5.2 million in 2003, an increase of $461,000 or 9.8% from 2002 due to increases in advertising expense as the company continues to grow as a result of the Branch Expansion into new markets and totally-free checking promotions. Advertising and business development expenses were $4.7 million in 2002, an increase of $120,000 or 2.6% from $4.6 million in 2001. This reflects increases in branch and market level public relations and business development expenses, which were partly funded by a decrease in newspaper and direct mail advertising.
Intangibles amortization was $141,000 in 2003 and 2002, compared to $2.1 million in 2001. The decrease in 2002 relates to the discontinuation of goodwill amortization pursuant to SFAS No. 142. This is more fully explained in the “Accounting Changes” section, above. The Core Deposit Intangibles were fully amortized at December 31, 2003. See also Notes 1 and 6 of the Notes to Consolidated Financial Statements.
Other expenses were $23.5 million in 2003, an increase of $4.9 million or 26.3% from 2002. The increase was primarily due to the $1.6 million in prepayment penalties related to restructuring of Federal Home Loan Bank (“FHLB”) advances, increased loan processing costs of $1.5 million associated with increased mortgage activity and the $623,000 private equity fund impairment charge. Other increases included higher recruiting expenses and losses on disposals of fixed assets, both of which were related to the Branch Expansion. Other expenses were $18.6 million in 2002, an increase of $878,000 or 4.9% from $17.7 million in 2001. The 2002 increase was largely the result of higher loan processing expenses of $633,000, mainly associated with collection and repossession activities, $315,000 of investment related impairment charges and $291,000 in increased travel and entertainment costs. These were partly offset by a $388,000 reduction in expenses related to foreclosed real estate.
Income Taxes
Income tax expense totaled $16.1 million in 2003, compared with $14.0 million and $14.4 million in 2002 and 2001, respectively. The effective tax rates were 27.0%, 24.4% and 25.4% in 2003, 2002 and 2001, respectively. Effective tax rates are lower than the statutory tax rates due primarily to investments in tax-exempt municipal bonds and increases in CSV and death benefits on COLI that are not taxable. The increase in effective tax rate in 2003 over the prior year is due to a decrease in the size of these tax-exempt items relative to total pre-tax earnings as well as an increase in state income taxes which in 2002 benefited from the favorable resolution of various tax audits and other pending tax issues. See Note 16 of the Notes to Consolidated Financial Statements.
EARNINGS REVIEW BY BUSINESS SEGMENT
AMCORE’s internal reporting and planning process focuses on four primary lines of business (“Segment(s)”): Commercial Banking, Retail Banking, Trust and Asset Management, and Mortgage Banking. Note 18 of the Notes to Consolidated Financial Statements presents a condensed income statement and total assets for each Segment.
The financial information presented was derived from the Company’s internal profitability reporting system that is used by management to monitor and manage the financial performance of the Company. This information is based on internal management accounting policies which have been developed to reflect the underlying economics of the Segments and, to the extent practicable, to portray each Segment as if it operated on a stand-alone basis. Thus, each Segment, in addition to its direct revenues, expenses, assets and liabilities, includes an
appropriate allocation of shared support function expenses. The Commercial, Retail and Mortgage Banking Segments also include funds transfer adjustments to appropriately reflect the cost of funds on loans made and funding credits on deposits generated. Apart from these adjustments, the accounting policies used are similar to those described in Note 1 of the Notes to Consolidated Financial Statements.
Since there are no comprehensive authorities for management accounting equivalent to accounting principles generally accepted in the United States of America, the information presented is not necessarily comparable with similar information from other financial institutions. In addition, methodologies used to measure, assign and allocate certain items may change from time-to-time to reflect, among other things, accounting estimate refinements, changes in risk profiles, changes in customers or product lines, and changes in management structure. During the first quarter of 2003, the Company also changed the classification of mortgage loans not sold into the secondary market that are retained by the BANK. All revenues from these loans, along with related Provisions and expenses, are now reported as part of the Mortgage Banking Segment instead of the Retail Banking Segment. Prior period Segment results have been restated to reflect this change.
Total Segment results differ from consolidated results primarily due to intersegment eliminations, certain corporate administration costs, items not otherwise allocated in the management accounting process and treasury and investment activities. The impact of these items is aggregated to reconcile the amounts presented for the Segments to the consolidated results and is included in the “Other” column of Note 18 of the Notes to Consolidated Financial Statements.
Commercial Banking
The Commercial Banking Segment (“Commercial”) provides commercial banking services to large and small business customers through the BANK’s 63 banking locations. The services provided by this Segment include lending, business checking and deposits, treasury management and other traditional as well as electronic commercial banking services.
Commercial earnings for 2003 were $24.8 million, an increase of $2.1 million or 9.2% from 2002. Earnings in 2002 totaled $22.7 million and were $7.5 million or 49.4% higher than 2001 earnings of $15.2 million. The increase for 2003 was attributable to increased net interest income and non-interest income that was partially offset by increased Provision, operating expenses and income taxes.
Net interest income increased $13.8 million in 2003. The increase was due to higher average loan volumes, particularly commercial real estate loans, lower priced deposits and decreased cost of funds allocations, which more than compensated for lower yields on loans. The lower yields on loans, reduced rates on deposits and decreased cost of funds allocations were all attributable to declining short-term interest rates over the past three years, which have impacted new product (loans and deposits) pricing as well as the re-pricing of variable priced products and fixed-price product renewals. Strong loan demand, aided by the Branch Expansion, was more than sufficient to replace average loan balances transferred in the Branch Sales, leading to the increased volumes.
Non-interest income increased $2.4 million and was attributable to Commercial’s allocable portion of the Branch Gain of $2.2 million.
The 2003 Provision increased $10.3 million and was attributable to a $4.0 million increase in net charge-offs, a $3.1 million increase in both specific loss estimates and other loss estimates. These estimates are based upon increased concentrations, including commercial real estate; deteriorating loan quality and collateral values, including loans that are secured by receivables, inventory and specialized equipment; growth in new markets; increased delinquencies; continued weakness in the overall economy, particularly the manufacturing segment; and other factors.
Operating expenses increased $2.4 million in 2003. The increase was largely due to higher personnel expenses, which included the impact of the Branch Expansion strategy.
Income taxes increased $1.3 million in 2003, due to higher income before taxes.
The Commercial Segment represented 53.5%, 61.5% and 49.5% of total Segment earnings in 2003, 2002 and 2001, respectively. Commercial Segment total assets were $2.0 billion at December 31, 2003 and represented 44.8% of total consolidated assets.
Retail Banking
The Retail Banking Segment (“Retail”) provides retail-banking services to individual customers through the BANK’s 63 banking locations in northern Illinois and south central Wisconsin. The services provided by this Segment include direct and indirect lending, checking, savings, money market and CD accounts, safe deposit rental, automated teller machines, and other traditional and electronic retail banking services.
Retail earnings for 2003 were $10.2 million compared to $4.7 million in 2002, an increase of $5.6 million or 118.5%. This followed an increase of $1.3 million or 37.7% in 2002 from 2001 earnings of $3.4 million. The increase in 2003 was the result of higher non-interest income and lower operating expense partially offset by increased income taxes and Provision.
Net interest income increased by $111,000 for 2003 due to higher average loan volumes, particularly indirect automobile loans, and lower priced deposits. These factors offset lower yields on loans and reduced funds credit allocations. The lower yields on loans, reduced rates on deposits and decreased funds credit allocations were all attributable to declining rates over the past three years, which have impacted new product (loans and deposits) pricing as well as the re-pricing of variable priced products and fixed-price product renewals. The growth in overall average loan balances occurred despite the Auto Loan Sale and the transfer of loans associated with the Wisconsin Branch Sales totaling $129.5 million, both of which occurred in March 2003.
Non-interest income increased $8.4 million in 2003. Of the increase, $6.0 million was attributable to the Branch Gain and $2.5 million related to the Auto Loan Sale Gain.
The 2003 Provision increased $1.9 million primarily due to an increase of $1.6 million in net charge-offs due to higher loss levels on repossessed automobiles.
Operating expenses decreased by $2.2 in 2003. The decline is due to lower allocations for support function expenses.
Income taxes increased $3.5 million in 2003 and were primarily the result of higher income before taxes.
The Retail Segment represented 22.1%, 12.7% and 11.1% of total segment earnings in 2003, 2002 and 2001, respectively. Retail Segment total assets were $810.4 million at December 31, 2003 and represented 17.8% of total consolidated assets.
Trust and Asset Management
The Trust and Asset Management Segment (“TAM”) provides trust, investment management, employee benefit recordkeeping and administration and brokerage services. It also acts as an advisor and provides fund administration to the Vintage Mutual Funds and various public fund programs. These products are distributed nationally (i.e. Vintage Equity Fund is available through Charles Schwab, OneSource™), regionally to institutional investors and corporations, and locally through the BANK’s locations.
TAM earnings for 2003 were $2.4 million, a $1.3 million or 35.5% decline from 2002 earnings of $3.7 million. This followed an increase of $207,000 or 5.9% from 2001 earnings of $3.5 million. The decrease in 2003 was primarily due to declines in non-interest income net of lower operating expenses and income taxes.
TAM non-interest income declined $1.5 million in 2003. Declines in fee-based revenue were partially offset by increased brokerage commission income. Lower AMCORE-managed asset values and specific investment performance on selected Vintage Mutual Funds contributed to the decrease in trust and asset management revenues. Declining equity markets over the past three years have challenged the investment industry with the S & P 500 losing 24.3% of its value from 2000 to 2003. These declines have negatively impacted the value of AMCORE-administered assets, upon which fees are partially based, leading to the decrease in fee revenue. Also contributing to the decline was the loss of a major public fund customer effective October 1, 2003. Unless replaced with new business the loss of the public fund client could continue to adversely affect TAM revenues. Revenues from this customer were $916,000 in 2003 and $1.1 million in 2002. A shift to a higher mix of fixed income and money market assets also affected prior year results. Net brokerage commissions on the other hand have been particularly strong and are primarily the result of increased fixed-annuity sales. In addition, processing costs associated with annuity sales, which are netted against commissions, have declined as the TAM segment is now processing its own sales.
Operating expenses decreased $566,000 for 2003 due to lower personnel costs and lower advertising costs.
Income taxes declined $788,000 in 2003 due to the decline in pre-tax earnings.
The TAM Segment represented 5.1%, 10.0% and 11.3% of total segment earnings in 2003, 2002 and 2001, respectively. TAM Segment total assets were $18.8 million at December 31, 2003 and represented 0.4% of total consolidated assets.
Mortgage Banking
The Mortgage Banking Segment (“Mortgage”) provides a variety of mortgage lending products to meet its customers’ needs. It sells the majority of the long-term, fixed-rate loans to the secondary market and continues to service most of the loans sold.
Mortgage earnings were $8.9 million in 2003, an increase of $3.1 million or 53.4% compared to $5.8 million in 2002. This followed a decline of $2.8 million or 32.5% from $8.6 million in 2001. The increase in 2003 was due to increased mortgage volume, primarily driven by refinancing activity, and the $3.4 million recapture of mortgage servicing right impairment in 2003 compared to a $2.6 million impairment charge in 2002.
Net interest income decreased $1.4 million in 2003. This was primarily due to lower rates on mortgage loans retained in portfolio and on mortgage loans held for sale. Average balances on mortgage loans held in portfolio continued their decline, as fixed mortgage rates reached 45-year lows, and contributed to the decrease in net interest income. Partially offsetting these decreases were lower net cost of funds allocations.
Non-interest income includes fees generated from the underwriting, originating and servicing of mortgage loans along with the gains realized from the sale of these loans, net of servicing right amortization and impairment. Non-interest income for 2003 increased $9.0 million. Closing volumes increased 24.5% to $893.7 million in 2003, from $718.0 million in 2002. Also contributing to the increase in non-interest income was the recapture of mortgage servicing right impairment reserves of $3.4 million in 2003 compared to an impairment charge of $2.6 million in the prior year, which resulted in a $5.9 million change year over year.
Operating expenses totaled $14.9 million, an increase of $2.6 million from 2002. The increases were primarily due to higher salaries, commissions and processing costs that were paid due to the increase in mortgage volumes.
Income taxes increased $1.6 million in 2003. The increase was due to higher pre-tax earnings.
The unpaid principal balance of mortgage loans serviced for others, including mortgage loans held for sale, was $1.21 billion as of December 31, 2003 compared to $1.02 billion at the prior year-end.
The Mortgage Segment represented 19.3%, 15.8% and 28.1% of total segment earnings in 2003, 2002 and 2001, respectively. Mortgage Segment total assets were $255.8 million at December 31, 2003 and represented 5.6% of total consolidated assets.
BALANCE SHEET REVIEW AND LIQUIDITY RISK MANAGEMENT
Liquidity management is the process by which the Company, through its Asset and Liability Committee (ALCO) and treasury function, ensures that adequate liquid funds are available to meet its financial commitments on a timely basis, at a reasonable cost and within acceptable risk tolerances. These commitments include funding credit obligations to borrowers, funding of mortgage originations pending delivery to the secondary market, withdrawals by depositors, repayment of debt when due or called, maintaining adequate collateral for public deposits, paying dividends to shareholders, payment of operating expenses, funding capital expenditures and maintaining deposit reserve requirements.
Liquidity is derived primarily from bank-issued deposit growth and retention; principal and interest payments on loans; principal and interest payments, sale, maturity and prepayment of investment securities; net cash provided from operations; and access to other funding sources. Other funding sources include brokered CD’s, federal funds purchased lines (FED funds), FHLB advances, repurchase agreements, commercial paper and back-up lines of credit, the sale or securitization of loans, and access to other capital markets.
The parent company requires adequate liquidity to pay its expenses, repay debt when due and pay stockholder dividends. Liquidity is primarily provided to the parent through the BANK and other subsidiaries in the form of dividends. In 2003, dividends from subsidiaries amounted to $23.0 million, compared to $30.5 million in 2002. In 2002, the parent required higher dividends from its subsidiaries to fund Stock Repurchase Programs. In 2003, lower dividends were paid by the BANK to the parent in order to support the BANK’s Branch Expansion. While the BANK is limited in the amount of dividends it can pay, as of December 31, 2003, approximately $49.9 million was available for payment to the parent in the form of dividends without prior regulatory approval. See Note 20 of the Notes to Consolidated Financial Statements.
Cash and Cash Equivalents
Cash and cash equivalents decreased $37.3 million from December 31, 2002 to December 31, 2003, as the net cash used for investing activities of $211.4 million more than offset the cash provided by operating activities of $94.2 million plus the cash provided by financing activities of $79.9 million. This compares to an increase in cash and cash equivalents of $11.0 million from December 31, 2001 to December 31, 2002, as the net cash provided by financing activities of $424.1 million plus the cash provided by operating activities of $88.7 million more than offset the net cash used for investing activities of $501.8 million during 2002.
The $94.2 million of cash provided by operating activities during 2003 compares with $88.7 million provided in 2002, representing a $5.5 million increase in cash provided between the two years. The change was attributable to the increase in proceeds from the sale of loans held for sale, net of increased originations of such loans, primarily attributable to the Mortgage segment’s origination and sale of loans into the secondary market.
The $211.4 million of cash used for investing activities during 2003 compares with $501.8 million cash used in 2001, for a decrease of $290.4 million in cash used between the two years. This was primarily the result of an increase of $306.1 million in proceeds from the sales and maturities of securities, a $107.2 million increase in proceeds from sale of loans and less growth in loan originations of $138.3 million. These changes were partially offset by a $259.3 million increase in security purchases.
The $79.9 million of cash provided by financing activities during 2003 compares with $424.1 million cash provided during 2002, or a decrease of $344.2 million in cash provided between the two years. This was primarily due to $202.9 million less growth in demand, savings and time deposit accounts, a $100.3 million decrease in short term borrowings and $65.4 million in cash required to fund the Branch Sales in 2003. An increase in long-term borrowings of $38.9 million partially offset these decreases.
Securities
Total securities as of December 31, 2003 were $1.17 billion, a decrease of $8.1 million or 0.7% from the prior year-end. At December 31, 2003 and 2002, the total securities portfolio comprised 27.8% and 28.3%, respectively, of total earning assets, including COLI. The decrease in investment securities includes reductions in corporate obligations and municipal securities and also reflects mortgage prepayment activity as well as actions taken by AMCORE to improve liquidity and to reduce duration.
The securities portfolio serves an important role in the overall context of balance sheet management in terms of balancing capital utilization and liquidity needs. The decision to purchase or sell securities is based upon the current assessment of economic and financial conditions, including the interest rate environment. The portfolio’s scheduled maturities and the prepayment of mortgage and asset backed securities represent a significant source of liquidity. Approximately $14.4 million, or 1.2%, of the securities portfolio will contractually mature in 2004. This does not include mortgage and asset backed securities. Mortgage and asset backed security maturities may differ from contractual maturities because borrowers may have the right to prepay obligations, typically without penalty. For example, scheduled maturities for 2003, excluding mortgage and asset backed securities, were $24.2 million, whereas proceeds from actual maturities, which included prepayments of mortgage and asset backed securities, were $623.0 million. This compares to proceeds of $366.5 million and $336.7 million in 2002 and 2001, respectively. As of December 31, 2003, $318.9 million of investment securities were unpledged and available as a source of liquidity.
Mortgage and asset backed securities as of December 31, 2003 totaled $871.7 million and represent 74.8% of total securities. The distribution of mortgage and asset backed securities includes $372.4 million of U.S. government agency mortgage-backed pass through securities, $467.9 million of agency collateralized mortgage obligations and $31.4 million of private issue collateral mortgage obligations, all of which are rated AAA except for $2.6 million of securities rated either Aa2 or A2.
At December 31, 2003, securities available for sale totaled $1.17 billion, which included gross unrealized gains of $19.7 million and gross unrealized losses of $6.2 million, of which the combined effect, net of tax, is included as accumulated other comprehensive income (OCI) in stockholders’ equity. For comparative purposes, at December 31, 2002, gross unrealized gains of $35.3 million and gross unrealized losses of $4.0 million were included in the securities available for sale portfolio. There were no held to maturity securities at December 31, 2003 or 2002. For further analysis of the securities portfolio see Table 4 and Note 3 of the Notes to Consolidated Financial Statements.
Loans Held for Sale
At December 31, 2003, mortgage origination fundings awaiting delivery to the secondary market were $32.4 million, compared to $79.9 million at December 31, 2002. Residential mortgage loans are originated by the BANK’s Mortgage Segment, of which non-conforming adjustable rate, fixed-rate and balloon residential mortgages are normally retained by the BANK. The conforming adjustable rate, fixed-rate and balloon residential mortgage loans are sold in the secondary market to eliminate interest rate risk, as well as to generate gains on the sale of these loans and servicing income. All loans of the Mortgage Segment are considered held for sale and are recorded at the lower of cost or market value.
For the second year in a row, declining mortgage interest rates resulted in record closing volumes, increasing the pressure on short-term liquidity needs. In 2003, closing volumes were $893.7 million, compared to $718.0 million in 2002. During the fourth quarter of 2003, refinancing activity began to decline as mortgage interest rates rose, relieving the pressure on short-term liquidity needs. This trend is expected to continue into 2004. Outstanding residential mortgage commitments, a potential use of liquidity, were $41.8 million at December 31, 2003.
Loans
Loans represent the largest component of AMCORE’s earning asset base, while the funding of loan originations is its most significant liquidity need. At year-end 2003, total loans were $2.99 billion, an increase of $108.6 million or 3.8% as compared to 2002. Loan growth included the impact of the Branch Expansion and was reduced by $106.0 million in loans sold in the Auto Loan Sale and $47.8 million of loans transferred in the Branch Sales. Average loans increased $236.3 million or 8.9% during 2003. See Table 2 and Note 4 of the Notes to Consolidated Financial Statements.
Total commercial real estate loans increased $274.2 million or 25.7%, while residential real estate loans declined $87.1 million. Installment and consumer loans declined $50.1 million or 8.3%. Commercial, financial and agricultural loans decreased $27.8 million or 3.7%. Increased balances in commercial real estate loans were mostly driven by the Branch Expansion. Residential real estate loan balances were affected by refinancings, as mortgage interest rates fell to 45 year lows during 2003.
The scheduled repayments and maturities of loans represent a substantial source of liquidity. Table 3 shows selected loan maturity data as of December 31, 2003. In addition to same branch and Branch Expansion loan growth, potential uses of liquidity include $634.9 million in commitments to extend credit and $189.8 in letters of credit.
Deposits
Total deposits at December 31, 2003, were $3.37 billion, an increase of $73.8 million or 2.2% when compared to 2002. The increase included $168.4 million in higher Bank-issued deposit balances partly offset by a $94.6 million decline in brokerage CD’s and the transfer of $124.6 million in deposits in the Branch Sales. Average deposits increased $105.6 million or 4.5% during 2003.
Bank-issued deposits, which exclude brokered CD’s, are considered by management to be the primary, most stable and most cost-effective source of funding and liquidity. Total bank-issued deposits were $2.94 billion at the end of 2003; a $168.4 million or 6.1% increase from the prior year-end. The increase is attributable to company-wide initiatives to attract additional deposits as well as the Branch Expansion. Bank-issued deposits represent 87.4% and 84.2% of total deposits at December 31, 2003 and 2002, respectively. Table 5 shows the maturity distribution of time deposits $100,000 and over. The BANK also has capacity, over time, to place sufficient amounts of additional brokered CD’s as a source of mid to long-term funds.
Borrowings
Borrowings totaled $741.7 million at year-end 2003 and were comprised of $557.1 million of short-term and $184.6 million of long-term borrowings. See Notes 9 and 10 of the Notes to Consolidated Financial Statements.
AMCORE has $25.0 million of Trust Preferred securities outstanding through the Trust. The securities pay cumulative cash distributions semiannually at an annual rate of 9.35%. The securities are redeemable from March 25, 2007 until March 25, 2017, at a declining premium of 104.675% to 100.0% of the principal amount. After March 25, 2017, they are redeemable at par until June 15, 2027, when redemption is mandatory. The capital securities qualify as Tier 1 capital for regulatory purposes. During 2001, AMCORE retired at par $15.0 million in Trust Preferred securities with the coupon rate of 9.35 percent. Prior to the Debt Extinguishment that occurred in 2001, $40.0 million of Trust Preferred securities were outstanding.
The parent company has a commercial paper placement agreement with an unrelated financial institution that provides for the issuance of non-rated short-term unsecured debt obligations at negotiated rates and terms, not to exceed $50.0 million. In the event the agent is unable to place the parent company’s commercial paper on a particular day, the proceeds are provided by overnight borrowings on a reciprocal line of credit with the same financial institution. At December 31, 2003, $10.0 million in commercial paper was outstanding.
As of December 31, 2003, sources of readily available liquidity totaled $506.0 million and included $121.0 million of unused FED funds lines, $21.0 million of FHLB advances, unused collateral sufficient to support $324.0 million in FED discount window advances and $40.0 million in unused commercial paper and backup line of credit borrowings.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
Off-Balance Sheet Arrangements
During the ordinary course of its business, the Company engages in financial transactions that are not recorded on its Consolidated Balance Sheet, are recorded in amounts that are different than their full principal or notional amount, or are recorded on an equity or cost basis rather than being consolidated. Such transactions serve a variety of purposes including management of the Company’s liquidity and credit concentration risks, optimization of capital utilization, meeting the financial needs of its customers and fulfilling Community Reinvestment Act obligations in the markets that it serves.
The Company’s largest off-balance sheet arrangement relates to the Auto Loan Sales that occurred during 2001 and the first quarter of 2003. Structured as sales pursuant to Statement of Financial Accounting Standard (“SFAS”) No. 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities,” the Auto Loan Sales are a component of the Company’s liquidity and credit concentration risk management strategy. The Auto Loan Sales are also helpful as a capital management tool.
In the Auto Loan Sales, indirect automobile loan receivables are transferred to a multi-seller variable-interest entity (“VIE”). Since the Company is not the primary beneficiary of the VIE, consolidation is not required under the terms of Financial Accounting Standards Board Interpretation (“FIN”) 46 (Revised December 2003) “Consolidation of Variable Interest Entities.” As a result, the net carrying amount of the loans is removed from the consolidated balance sheet and certain retained residual interests are recorded. The Company’s retained interests are subordinate to the interests of investors in the VIE and are subject to prepayment risk, interest-rate risk and credit risk on the transferred auto loans. Neither the investors nor the VIE have any other recourse to the Company’s other assets for failure of automobile loan debtors to pay when due. The Company also retains the rights to service the loans that are sold.
As of December 31, 2003, the balance of automobile loans serviced and not included on the Company’s Consolidated Balance Sheet was $93.1 million, compared to $41.9 million at December 31, 2002. The carrying value of retained interests was $13.0 million and $6.4 million at the end of 2003 and 2002, respectively. The carrying value of the retained interests is the maximum estimated exposure to loss of the retained residual interests. See Critical Accounting Estimates and Note 8 of the Notes to Consolidated Financial Statements.
The Company also originates mortgage loans that it sells to the secondary market. The Company typically retains the right to service the loans that are sold. As of December 31, 2003, the unpaid principal balance of mortgage loans serviced for others was $1.21 billion, compared to $1.02 billion at December 31, 2002. These loans are not recorded on the Company’s consolidated balance sheets. The Company, as of December 31, 2003 and 2002, and in accordance with SFAS No. 140, had recorded $11.2 million and $10.6 million, respectively, of capitalized mortgage servicing rights, less impairment valuation allowances of $0 and $3.4 million, respectively. See Critical Accounting Estimate and Note 7 of the Notes to Consolidated Financial Statements.
The Company, as a provider of financial services, routinely enters into commitments to extend credit to its BANK customers, including performance and standby letters of credit. While these represent a potential outlay by the Company, a significant amount of the commitments may expire without being drawn upon. Commitments and letters of credit are subject to the same credit policies, underwriting standards and approval process as loans made by the Company.
At December 31, 2003, a liability in the amount of $802,000, representing the fair value of the guarantee obligations associated with certain of the financial and standby letters of credit, has been recorded in accordance with FIN 45. This amount will be amortized into income over the life of the commitments. There were no such recorded guarantee obligations at the end of 2002. The notional amount of all letters of credit, including those exempted from the scope of FIN 45, was $189.8 million and $161.4 million at the end of December 31, 2003 and 2002, respectively. See Note 15 of the Notes to Consolidated Financial Statements.
The carrying value of mortgage loan commitments at December 31, 2003 and 2002 was an asset of $342,000 and $1.7 million, respectively. These amounts represent the fair value of those commitments marked-to-market in accordance with SFAS 138, “Accounting for Derivative Instruments and Hedging Activities.” The total notional amount of mortgage loan commitments was $27.4 million at December 31, 2003 and $85.1 million at December 31, 2002. See Note 11 of the Notes to Consolidated Financial Statements.
At December 31, 2003 and 2002, the Company had extended $634.9 million and $587.4 million, respectively, in loan commitments other than the mortgage loan commitments and letters of credit described above. These amounts represented the notional amount of the commitment. No asset or liability has been recorded.
The Company has a number of non-marketable equity investments that have not been consolidated in its financial statements. At both December 31, 2003 and 2002, these investments included $5.5 million in private equity fund investments that were reported under either the cost or equity method, depending on the percentage of ownership. Not included in the carrying amount were commitments to fund an additional $1.9 million and $3.2 million, for the respective year-ends, at some future date. At December 31, 2003 the Company also has recorded investments of $4.3 million, $23.0 million, and $9.0 million, respectively, in stock of the Federal Reserve Bank, FHLB and preferred stock of Freddie Mac. The amounts were $4.4 million, $21.3 million, and $9.0 million, respectively, at December 31, 2002. These investments are recorded at historical cost, with income recorded when dividends are declared. Other investments, comprised of various affordable housing tax credit projects (“AHTCP”), totaled approximately $742,000 and $918,000 at December 31, 2003 and 2002, respectively. Those investments without guaranteed yields were reported on the equity method, while those with guaranteed yields were reported using the effective yield method. With the possible exception of the AHTCPs, consolidation of these investments will not be required pursuant to FIN 46 (Revised December 2003) since the Company is not the primary beneficiary in the investments. The Company has determined that consolidation will not be required for all but one of the AHTCPs. The Company is still in the process of obtaining relevant information to determine whether consolidation of the remaining AHTCP will be necessary. This determination is required to be completed by the end of the first quarter of 2004. Consolidation of this entity, if required, will not have a material effect on the Consolidated Financial Statements. The maximum exposure to loss for all non-marketable equity investments is the sum of the carrying amounts plus additional commitments.
The Company’s subsidiaries also hold assets in a fiduciary or agency capacity that are not included in the Consolidated Financial Statements because they are not assets of the Company. The total assets managed or administered by the Company at December 31, 2003 and 2002, excluding the BANK’s investment portfolio, were $4.3 billion and $4.6 billion, respectively.
Contractual Obligations
In the ordinary course of its business, the Company enters into certain contractual arrangements. These obligations include issuance of debt to fund operations, property leases and derivative transactions. During 2003, the Company entered into five operating lease arrangements in connection with the Branch Expansion. There were no residual guarantees on these leases. The Company also terminated certain operating leases during the year in connection with its Branch Expansion with no related penalties. During the first quarter of 2003, the Company incurred $1.6 million in prepayment penalties to restructure a portion of its FHLB advances. During the first quarter of 2003, the Company sold $106.0 million of Auto Loan Sales, retaining the right to service
those loans and an Interest Only Strip initially valued at $9.2 million. The Company recorded a $2.5 million pre-tax gain on the Auto Loan Sale. During year, the Company entered into fair value hedges of FHLB borrowings for total notional amount of $74.0 million and fair value hedges of brokered CD’s for total notional amount of $25.0 million. Other than these transactions, there were no material changes in the Company’s contractual obligations since December 31, 2002. See Table 6 and Notes 5, 8, 10 and 11 of the Notes to Consolidated Financial Statements.
(1) Branch offices for which purchase contracts were signed during 2003, but the closing on the property takes place in 2004.
ASSET QUALITY REVIEW AND CREDIT RISK MANAGEMENT
AMCORE’s credit risk is centered in the loan portfolio, which on December 31, 2003 totaled $2.99 billion, or 69.5%, of earning assets. The objective in managing loan portfolio risk is to quantify and manage credit risk on a portfolio basis as well as reduce the risk of a loss resulting from a customer’s failure to perform according to the terms of a transaction. To achieve this objective, AMCORE strives to maintain a loan portfolio that is diverse in terms of loan type, industry concentration, and borrower concentration.
The Company is also exposed to credit risk with respect to its $116.5 million investment in COLI. AMCORE manages this risk by diversifying its holdings among various carriers and by periodic internal credit reviews. All carriers have “Secure” ratings from A. M. Best that range from a low of “A” (Excellent) to “A++” (Superior).
Allowance for Loan Losses
The determination by management of the appropriate level of the Allowance (see Critical Accounting Estimates discussion) amounted to $42.1 million at December 31, 2003, compared to $35.2 million at December 31, 2002, an increase of $6.9 million or 19.6%. This increase includes a $3.3 million increase in specific loss estimates on certain individually reviewed loans, a $266,000 decrease for statistical loss estimates on loan groups or pools based upon historical loss experience, a $2.9 million increase for other loss estimates that are based upon the size, quality and concentration characteristics of the various loan portfolios, adverse situations that may affect the borrower’s ability to repay, and current economic and industry conditions and a $1.0 million increase in unallocated loss estimates. Factors leading to the $2.9 million increase in other loss estimates were increased loan concentrations; growth in emerging markets with lending staff that are new to the Company’s lending culture and where our knowledge of the customer base and local conditions are not as strong as existing markets; increased delinquencies; deteriorating collateral values including used cars and loans that are secured by receivables, inventory and specialized equipment; and, continued effects of recent weakness in the overall economy, particularly the manufacturing segment.
Allocations of the Allowance for commercial, financial and agricultural loans increased $2.3 million in 2003. Allocations of the Allowance for real estate loans increased $1.8 million. Allocations of the Allowance for installment and consumer loans declined $265,000. Allocations for impaired loans increased $1.6 million during the year. The amount of the unallocated Allowance increased $1.5 million from one year ago to $3.0 million. A detailed analysis of the Allowance and the allocation of the Allowance by category for the past five years are shown in Table 2.
As of December 31, 2003, the Allowance as a percent of total loans and of non-accrual loans was 1.41% and 133%, respectively. These compare to the same ratios for the prior year of 1.22% and 108%. Net charge-offs as a percent of average loans increased to 0.57% for 2003 versus 0.42% in 2002. Commercial net charge-offs increased $3.3 million in 2003, compared to 2002 primarily due to weakness in the manufacturing sector. Commercial Real estate loan net charge-offs declined $413,000 year-to-year, while residential real estate loan net charge offs increased $795,000. Installment and consumer loan charge-offs increased $1.7 million, the result of the continued sluggish economy and earlier recognition and increasing loss levels on repossessed vehicles.
Non-performing Assets
Non-performing assets consist of non-accrual loans, loans 90 days past due and still accruing, other real estate owned and other foreclosed assets. Non-performing assets totaled $41.4 million as of year-end 2003, a decrease of $132,000 or 0.3% from the $41.5 million at year-end 2002. Total non-performing assets represented 0.91% and 0.92% of total assets at December 31, 2003 and December 31, 2002, respectively.
Non-performing loans which includes non-accrual loans and loans 90 days past due and still accruing declined $1.1 million or 3.1% to total $35.0 million at December 31, 2003, when compared to the prior year-end. As of December 31, 2003, non-performing loans to total loans were 1.17% compared to 1.25% at year-end 2002. Table 2 presents non-performing loans for each of the past five years.
Foreclosed real estate and other foreclosed assets increased $983,000, or 18.1%, to $6.4 million at December 31, 2003, when compared to year-end 2002. The increase is primarily attributable to the addition of three commercial properties.
Concentration of Credit Risks
As previously discussed, AMCORE strives to maintain a diverse loan and lease portfolio in an effort to minimize the effect of credit risk. Summarized below are the characteristics of classifications that exceed 10% of total loans.
Commercial, financial, and agricultural loans were $733.2 million at December 31, 2003, and comprised 24.5% of gross loans, of which 1.21% were non-performing. Net charge-offs of commercial loans represented 0.95% during 2003, and 0.45% during 2002, of the year-end balance of the category.
Construction and commercial real estate loans were $1.3 billion at December 31, 2003, comprising 44.9% of gross loans, of which 0.96% were classified as non-performing. Net charge-offs of this category of loans represent 0.07% during 2003, and 0.12% during 2002, of the year-end balance of the category.
Residential real estate loans, which includes home equity and permanent residential financing, totaled $362.3 million at December 31, 2003, and represent 12.1% of gross loans, of which 2.20% were non-performing. Net charge-offs of residential real estate loans represent 0.52% of the category total in 2002 and 0.24% of the year-end balance in 2001.
Installment and consumer loans were $554.5 million at December 31, 2003, and comprised 18.5% of gross loans, of which 0.35% were non-performing. Net charge-offs of consumer loans represented 1.22% and 0.85% of the year-end category total for 2003 and 2002, respectively. Consumer loans are comprised primarily of in-market indirect auto loans and direct installment loans. Indirect auto loans totaled $476.9 million at December 31, 2003. Both direct loans and indirect auto loans are approved and funded through a centralized department utilizing the same credit scoring system to provide a standard methodology for the extension of consumer credit.
CAPITAL MANAGEMENT
Capital Management
Total stockholders’ equity at December 31, 2003, was $375.6 million, an increase of $19.9 million or 5.6% from December 31, 2002. The decrease in stockholders’ equity was primarily due to $27.1 million in earnings for the year in excess of dividends paid net of a decrease in OCI of $12.1 million. The decrease in OCI relates to decreases in net after-tax unrealized gains on the Company’s available for sale investment portfolio and net after-tax mark-to-market adjustments on derivatives accounted for as cash flow hedges.
AMCORE paid $16.4 million of cash dividends during 2003, which represent $0.66 per share, or a dividend payout ratio of 37.7%. This compares to $0.64 per share paid in 2002, which represented a payout ratio of 36.4%. The book value per share increased $0.63 per share to $14.98 at December 31, 2003, up from $14.35 at December 31, 2002.
During 2002 and 2001 the Company reacquired shares pursuant to various Stock Repurchase Programs. During 2002, the Company repurchased 82,000 shares at an average price of $22.20. During 2001, the Company repurchased 1.8 million shares at an average price of $21.42. No shares remain to be purchased under any authorization. The Company also regularly repurchases shares to replenish treasury for shares reissued in connection with AMCORE’s stock option plans and other employee benefit plans.
AMCORE has outstanding $25.0 million of Trust Preferred securities through Trust. The Trust Preferred securities qualify as Tier 1 capital for regulatory capital purposes.
The BANK is categorized as a “well-capitalized” institution based on regulatory guidelines. AMCORE’s leverage ratio of 8.49% at December 31, 2003 exceeds the regulatory guidelines of 5% for well-capitalized institutions. AMCORE’s ratio of Tier 1 capital at 10.57% and total risk based capital at 11.76% significantly exceed the regulatory minimums (as the following table indicates), as of December 31, 2003. See Note 18 of the Notes to Consolidated Financial Statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As part of its normal operations, AMCORE is subject to interest-rate risk on the interest-earning assets it invests in (primarily loans and securities) and the interest-bearing liabilities it funds with (primarily customer deposits, brokered deposits and borrowed funds), as well as its ability to manage such risk. Fluctuations in interest rates may result in changes in the fair market values of AMCORE’s financial instruments, cash flows and net interest income. Like most financial institutions, AMCORE has an exposure to changes in both short-term and long-term interest rates. In the near-term, AMCORE expects that its interest-rate risk will be greater should interest rates decline.
While AMCORE manages other risks in its normal course of operations, such as credit and liquidity risk, it considers interest-rate risk to be its most significant market risk. Other types of market risk, such as foreign currency exchange risk and commodity price risk, do not arise in the normal course of AMCORE’s business activities and operations. In addition, since AMCORE does not hold a trading portfolio, it is not exposed to significant market risk from trading activities. During 2003, there were no material changes in AMCORE’s primary market risk exposures. Based upon current expectations, no material changes are anticipated in the future in the types of market risks facing AMCORE.
Table 6 and Note 12 of the Notes to Consolidated Financial Statements summarize AMCORE’s market risk and interest sensitivity position as of December 31, 2003. The amounts and assumptions should not be relied upon as indicative of expected actual results since, like most financial institutions, AMCORE’s net interest income can be significantly impacted by external factors. These factors include, but are not limited to: overall economic conditions, policies and actions of regulatory authorities, the amounts of and rates at which assets and liabilities re-price, variances in prepayment of loans and securities other than those that are assumed, early withdrawal of deposits, exercise of call options on borrowings or securities, competition, a general rise or decline in interest rates, changes in the slope of the yield-curve, changes in historical relationships between indices and balance sheet growth.
AMCORE’s asset and liability management process is utilized to manage market and interest rate risk through structuring the balance sheet and off-balance sheet positions to maximize net interest income while maintaining acceptable levels of risk to changes in market interest rates. While achievement of this goal requires a balance between earnings, liquidity and interest rate risk, there are opportunities to enhance revenues through managed risk. Interest rate sensitivity analysis is performed monthly using various simulations with an asset/liability modeling system. These analyses are reviewed by the Asset and Liability Committee (ALCO), whose actions attempt to minimize any sudden or sustained negative impact that interest rate movements may have on net interest income. ALCO reviews the impact of liquidity, capital adequacy and rate sensitivity, among other things, and determines appropriate policy direction to maintain or meet established ALCO guidelines.
The Company may, from time-to-time, use derivative contracts to help manage its exposure to changes in interest rates and in conjunction with its mortgage banking operations. The derivatives used most often are interest rate swaps, caps, collars and floors (collectively “Interest Rate Derivatives”), mortgage loan commitments and forward contracts and are more fully described in Note 11 of the Notes to Consolidated Financial Statements. Interest Rate Derivatives are contracts with a third party (the “Counter-party”) to exchange interest payment streams based upon an assumed principal amount (the “Notional Principal Amount”). The Notional Principal Amount is not advanced from the Counter-party. It is used only as a reference point to calculate the exchange of interest payment streams.
AMCORE does not have any derivatives that are held or issued for trading purposes. The only credit risk exposure AMCORE has is in relation to the counter-parties, which all have investment grade credit ratings. All counter-parties are expected to meet any outstanding interest payment obligations.
The total notional amount of swap contracts outstanding was $159.0 million and $90.0 million as of December 31, 2003 and 2002, respectively. As of December 31, 2003, swap contracts had an aggregate positive
carrying and fair value of $2.6 million. There were no collars outstanding at December 31, 2003 or 2002. The total notional amount of caps outstanding was $20.0 million at December 31, 2003, with $40.0 million of outstanding caps as of the end of 2002. As of the end of 2003, the caps had an aggregate carrying and fair value of $0. See Table 6. For further discussion of derivative contracts, see Notes 11 and 12 of the Notes to Consolidated Financial Statements.
Based upon an immediate increase in interest rates of 100 basis points and no change in the slope of the yield curve, the potential decrease in net interest income for 2004 would be approximately $764,000 or -0.48% of base forecasted net interest income. This analysis assumes no growth in assets or liabilities and replacement of maturing instruments with like-kind instruments. At the end of 2002, comparable assumptions would have resulted in a potential increase in 2003 net income of $3.3 million or 2.12%. Thus, AMCORE’s earnings at risk for rising rates has increased since the end of 2002, as the Company moved from an asset sensitive position to a slightly liability sensitive position.
Conversely, an immediate decrease in interest rates of 100 basis points and no change in the slope of the yield curve would result in a potential decrease in net interest income for 2004 of $7.1 million or 4.48% of base forecasted net interest income. At the end of 2002, a similar decrease in rates would have resulted in a potential decrease in net interest income of $7.7 million or 5.01%. AMCORE’s sensitivity to declining interest rates has remained relatively stable since the end of 2002. AMCORE continues to be sensitive to compression as rates on most earning assets would be adversely affected by the full 100 basis point decline whereas many interest paying liabilities may already be paying less than one percent and thus cannot decline the full 100 basis points. Other factors include the negative convexity of the mortgage-backed products and the large volume of floating rate commercial loans.
The amounts and assumptions used in the rising and falling rate scenarios should not be viewed as indicative of expected actual results. In addition to rising or falling interest rates, AMCORE’s net interest income can be significantly impacted by a variety of external factors, such as those previously noted. In addition, as interest rates move, the ALCO is likely to adjust interest rate risk management strategies to limit, to the extent possible, the adverse impact that such changes in interest rates might otherwise have on AMCORE’s net interest income, as well as maximize potential positive impacts such movements might have.
TABLE 1
ANALYSIS OF NET INTEREST INCOME AND AVERAGE BALANCE SHEET
The above table shows the changes in interest income (tax equivalent “FTE”) and interest expense attributable to volume and rate variances.
The change in interest income (tax equivalent) due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
(1) The interest on tax-exempt securities and tax-exempt loans is calculated on a tax equivalent basis assuming a federal tax rate of 35%.
(2) The average balances of the securities are based on amortized historical cost.
(3) The yield-related fees recognized from the origination of loans held for sale are in addition to the interest earned on the loans during the period in which they are warehoused for sale as shown above.
(4) The balances of nonaccrual loans are included in average loans outstanding. Interest on loans includes yield related loan fees of $2.9 million, $2.9 million, and $3.3 million for 2003, 2002, and 2001 respectively.
TABLE 2
ANALYSIS OF LOAN PORTFOLIO AND LOSS EXPERIENCE
The allocation of the allowance for loan and lease losses at December 31, was as follows:
* Not applicable
TABLE 3
MATURITY AND INTEREST SENSITIVITY OF LOANS
TABLE 4
MATURITY OF SECURITIES
(1) Yields were calculated on a tax equivalent basis assuming a federal tax rate of 35%.
(2) Yields were calculated based on amortized cost.
(3) Mortgage-backed and asset-backed security maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without penalties. Therefore, these securities are not included within the maturity categories above.
TABLE 5
MATURITY OF TIME DEPOSITS $100,000 OR MORE
TABLE 6
INTEREST RATE SENSITIVITY
The following table provides information about the Company’s derivative financial instruments and other financial instruments used for purposes other than trading that are sensitive to changes in interest rates. For loans, securities, and liabilities with contractual maturities, the table presents principal cash flows and related weighted-average interest rates by contractual maturities as well as any anticipated prepayments.
For deposits that have no contractual maturity (demand deposit accounts, interest-bearing checking, savings, and money market deposits) the table was constructed based on historical Company data and analysis.
For interest rate swaps and caps, the table presents notional amounts and, if applicable, weighted-average interest rates by contractual maturity date or call date. Notional amounts are used to calculate the contractual payments to be exchanged under the contracts.
Pursuant to Statement of Financial Accounting Standards, (SFAS) NO. 133, “Accounting for Derivative Instruments and Hedging Activities,” as modified by SFAS No. 138 and amended by SFAS No. 149, all derivatives are recognized at fair value in the Consolidated Balance Sheets. Changes in fair value for derivatives that are not hedges are recognized in the Consolidated Statement of Income (Income Statement) as they arise. If
the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of the derivative are either offset in the Income Statement or are recorded as a component of other comprehensive income in the Consolidated Statement of Stockholders’ Equity. See Note 11 of the Notes to Consolidated Financial Statements for further information on derivative instruments.
TABLE 7
AMCORE BRANCH EXPANSION PLANS
* LBO is a limited branch office.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
AMCORE FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
AMCORE FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
See accompanying notes to consolidated financial statements
AMCORE FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
See accompanying notes to consolidated financial statements.
AMCORE FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Balance changes resulting from branch sales are excluded from individual line items such as deposits, loans, and fixed assets.
See accompanying notes to consolidated financial statements.
AMCORE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of AMCORE Financial, Inc. and subsidiaries (Company) conform to accounting principles generally accepted in the United States of America. The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the balance sheet date and revenues and expenses for the period. Actual results could differ from those estimates.
Description of the Business
The Company is a bank holding company headquartered in Rockford, Illinois, and conducts its principal business activities at locations within northern Illinois, south central Wisconsin and Iowa. The primary business of the Company is the extension of credit and the collection of deposits with commercial and industrial, agricultural, real estate and consumer loan customers throughout northern Illinois and south central Wisconsin conducted through its banking subsidiary (BANK). The BANK also offers products and services through its mortgage-banking segment. Although the Company has a diversified loan portfolio, adverse changes in the local economy would have a direct impact on the credit risk in the portfolio.
The Company also offers a variety of financial products and services through its financial services subsidiaries. These include personal and employee benefit trust administration for individuals, estates and corporations, investment management, mutual fund administration, brokerage, and credit life and accident and health insurance in conjunction with the lending activities of the BANK.
Principles of Consolidation
The financial statements include the consolidated accounts of the Company. All significant intercompany accounts and transactions have been eliminated in consolidation.
Cash and Cash Equivalents
For purposes of reporting cash flows, the Company considers cash on hand, amounts due from banks, and cash items in process of clearing to be cash and cash equivalents. Cash flows for federal funds sold and other short-term investments, interest-earning deposits in banks, loans, demand deposits and savings accounts, time deposits and short-term borrowings are reported net.
Loans Held for Sale
Loans originated and intended for sale in the secondary market are recorded at the lower of cost or fair value in the aggregate. The BANK routinely engages in forward sales contracts on mortgage loans originated and held for sale into the secondary market in order to minimize its risk of loss between the time the loan is originated and the time it is sold. Mortgage loans subject to a forward contract are marked-to-market pursuant to Statement of Financial Accounting Standards (SFAS) No. 133. See discussion under Derivative Financial Instruments and Hedge Activities later in this note. Gains and losses on the sale of loans are included in mortgage revenues and other non-interest income.
Securities and Other Investments
Debt securities are classified into three categories: held to maturity, available for sale and trading. Securities for which the Company has the ability and the intent to hold to maturity are classified as held to maturity and are reported at amortized cost. Securities held for resale are classified as trading securities and are reported at fair value with unrealized gains and losses recorded in earnings. Securities, which are neither held to maturity nor trading, are classified as available for sale and are reported at fair value with unrealized gains and losses reported in Other Comprehensive Income (OCI). The level yield method is used for the amortization and accretion of premiums and discounts. The cost of securities sold is determined on a specific identification method. There were no held to maturity or trading securities outstanding at December 31, 2003 and 2002.
Non-marketable equity securities, which include private equity fund investments, are reported under the cost or equity method depending on percentage of ownership. Also included are investments in Federal Reserve Bank, Federal Home Loan Bank and Federal Home Loan Mortgage Company stock. Investments in affordable housing tax credit projects without guaranteed yields are reported on the equity method. Those with guaranteed yields are reported using the effective yield method. See discussion of Financial Accounting Standards Board Interpretation No. (“FIN”) 46 below. Private equity fund and affordable housing tax credit investments are reported as other assets on the Consolidated Balance Sheet.
When it is determined that securities or other investments are impaired and the impairment is other than temporary, an impairment loss is recorded in earnings and a new basis is established. See Note 3 of the Notes to Consolidated Financial Statements for additional information.
Loans and Allowance for Estimated Losses
Loans that management has the ability and intent to hold for the foreseeable future are recorded at the amount advanced to the borrower plus certain costs incurred by AMCORE to originate the loan, less certain origination fees that are collected from the borrower. The carrying amount of loans is reduced as principal payments are made. Payments made by the borrower are allocated between interest income and principal payment based upon the outstanding principal amount, the contractual rate of interest and other contractual terms. The carrying amount is further adjusted to reflect amortization of the origination costs net of origination fees. These items are amortized over the expected life of the loan using methods that approximate the level-yield method. Unearned interest on discounted installment loans has been recognized as income using methods which approximate level rates of return over the terms of the loans.
The accrual of interest income is generally discontinued (Non-Accrual Status) when management believes that collection of principal and/or interest is doubtful or when payment becomes 90 to 120 days past due, except for loans that are well secured and are in a well-defined, short-term process of collection. Payments received from the borrower after a loan is placed on Non-Accrual Status are applied to reduce the principal balance of the loan until such time that collectibility of remaining principal and interest is no longer doubtful. Unpaid interest that has previously been recorded as income is written-off when a loan is placed on Non-Accrual Status. The outstanding loan balance is written-off against the allowance for loan losses when management determines that probability of collection of principal will not occur. See Note 4 of the Notes to Consolidated Financial Statements for additional information.
Management periodically evaluates the loan portfolio in order to establish an estimated allowance for loan losses (Allowance) that are probable as of the respective reporting date. This evaluation includes specific loss estimates on certain individually reviewed loans, statistical loss estimates for loan groups or pools that are based on historical loss experience and general loss estimates that are based upon the size, quality, and concentration characteristics of the various loan portfolios, adverse situations that may affect a borrower’s ability to repay, and current economic and industry conditions, among other things. Additions to the Allowance are charged against earnings for the period as a provision for loan losses (Provision). Actual loan losses are charged against (reduce) the Allowance when management believes that the collection of principal will not occur. Unpaid interest attributable to prior years for loans that are placed on Non-Accrual Status are also charged against the Allowance. Unpaid interest for the current year for loans that are placed on Non-Accrual Status are reversed against the interest income previously recognized. Subsequent recoveries of amounts previously charged to the Allowance, if any, are credited to (increase) the Allowance. See Note 4 of the Notes to the Consolidated Financial Statements for additional information.
Premises and Equipment
Premises and equipment including leasehold improvements are stated at cost less accumulated depreciation and amortization. Capitalized leases are recorded at the present value of minimum lease payments over the life of the lease (limited to the fair value of the property at the inception of the lease) less accumulated amortization.
Depreciation is computed principally on the straight-line method over the estimated useful life of the assets. Leasehold improvements and capitalized leases are amortized using the straight-line method over the terms of the respective leases or their useful lives, whichever is shorter. See Note 5 of the Notes to Consolidated Financial Statements for additional information.
Intangible Assets
Certain intangible assets, such as core deposit intangibles and goodwill, have arisen from the purchase of subsidiaries. Core deposit intangibles represent a valuation of acquired deposit relationships and are amortized based on the present value of the future net income or cost savings derived from the related deposits. Goodwill represents the excess of the purchase price over the fair value of the identifiable net assets acquired.
On January 1, 2002, the Company adopted SFAS No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets”, with respect to business combinations that were completed prior to July 1, 2001. These statements require that the Company evaluate its existing intangible assets and goodwill classifications. Goodwill and intangible assets with indefinite useful lives may no longer be amortized, but instead must be tested for impairment at least annually. The useful life and residual values of all other intangibles must also be reassessed. As of the date of adoption, the Company had unamortized goodwill in the amount of $15.6 million and unamortized identifiable intangible assets (the “Core Deposit Intangibles”) in the amount of $282,000, which were subject to the transition provisions of SFAS Nos. 141 and 142. The Company had no other intangible assets subject to these standards. Fair value exceeded carrying value for all reporting units that have allocated goodwill at both the transitional and annual evaluation dates. Thus, no transitional or annual impairment loss was recognized and no cumulative effect of a change in accounting principle was recorded.
In October 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 147, “Acquisitions of Certain Financial Institutions” (SFAS No. 147). SFAS No. 147 requires financial institutions to evaluate their accounting for past acquisitions to determine whether revisions are needed. SFAS No. 147 applies to all new and past financial-institution acquisitions, including “branch acquisitions” that qualify as acquisitions of a business, but excludes acquisitions between mutual institutions. The Company does not have any acquisitions affected by this new standard. See Note 6 of the Notes to Consolidated Financial Statements.
Foreclosed Real Estate
Foreclosed real estate comprises real properties acquired in partial or full satisfaction of loans. These properties are carried as other assets at the lower of cost or fair value less estimated costs to sell the properties. When the property is acquired through foreclosure, any excess of the related loan balance over the fair value less expected sales costs, is charged against the Allowance. Subsequent declines in value or losses and gains upon sale, if any, are charged or credited to other operating expense. Losses on the sales within 90 days of foreclosure are charged against the Allowance.
Mortgage Servicing Rights
The Company recognizes as separate assets the rights to service mortgage loans for others. Mortgage servicing rights that are retained when mortgage loans are sold are recorded by allocating the previous carrying amount of the sold loan between the servicing rights retained and the loans that are sold. This allocation is based upon the relative fair values of the mortgage servicing rights and the loans sold. Because it is retained as an asset, the amount allocated to mortgage servicing rights will have a favorable impact on the amount of gain or loss that is recognized on the sale of the loans.
The mortgage servicing rights asset is amortized over the projected period of and in proportion to the estimated amount of net servicing income. Amortization of the servicing rights asset will reduce the amount of income that is recorded in the respective period from the servicing of the mortgage loans.
Each reporting period, the Company re-evaluates the fair value of its remaining mortgage servicing rights assets. The amount that the carrying amount of mortgage servicing rights exceeds the new estimate of fair value is charged against earnings for the period. Rather than directly reducing the carrying amount of the servicing rights asset, a valuation allowance is established for the same amount as the charge against earnings. In subsequent reporting periods, depending upon current estimates of fair value, the valuation allowance may be reversed. The reversal is limited to the remaining amount of the valuation allowance and will result in an increase in recorded earnings.
The periodic re-evaluation of fair value is based upon current estimates of the present value of remaining net servicing cash flows that incorporate numerous assumptions including the cost of servicing the loans, discount rates and prepayment rates. This re-evaluation is done by stratifying mortgage servicing rights assets into pools based upon one or more predominant risk characteristics of the underlying loans that are being serviced. Risk characteristics include loan type and interest rate. Valuation allowances required for one pool cannot be offset by the amount that the fair value of another pool exceeds its carrying amount. See Note 7 of the Notes to Consolidated Financial Statements for additional information.
Loan Securitization and Sales of Receivables
When the Company sells receivables in securitizations of automobile loans, the net carrying amount of the loans is removed from the balance sheet, and certain retained residual interests are recorded. The retained interests include rights to service the loans that are sold (the “Servicing Rights”) and an interest in residual cash flows (the “Interest Only Strip”). The Interest Only Strip includes the excess of interest collected on the loans over the amount required to be paid to the investors and the securitization agent (the “Excess Spread”) plus an interest in sales proceeds that are not remitted by the securitization trust at the time of the initial sale of the loans to the extent it exceeds projected credit losses (the “Credit Enhancement” or “Overcollateralization”). The carrying value of the loans removed from the balance sheet include the unpaid principal balance of the loans, net of an allocable portion of the Allowance for Loan Losses, minus the portion of the carrying value of the loans that are allocated to the retained residual interests. These allocations are based upon the relative fair values of the retained residual interests and the loans sold. Because they are retained assets, the amount allocated and recorded for the residual interests have a favorable impact on the amount of gain or loss that is recognized on the sale of the loans.
Since the projected income from the Servicing Rights approximates what is considered “adequate compensation” for servicing the loans, no asset or liability is recorded for Servicing Rights. Income from servicing is recognized as earned pursuant to the terms of the servicing agreement and to the extent cash collections from the borrowers exceed payments to the investors and agent. Cash collections in excess of the Servicing Rights income that is earned is next applied to the Interest Only Strip. The value allocated to the Interest Only Strip is reduced and interest income is recorded assuming a constant yield based upon the discount rate used to estimate its fair value. At the end of the estimated life of the securitization, the carrying value of the Interest Only Strip that is attributable to the Excess Spread will be fully amortized. At that time, the carrying value of the Interest Only Strip that is attributable to the Overcollateralization will have accreted to the amount of the sales proceeds that were not remitted by the securitization trust at the time of the initial sale of the loans less credit losses and excess Overcollateralization previously refunded by the securitization trust because it exceeded contractual requirements. At that time cash is expected to be released by the securitization trust in an amount that equals the accreted value of the Overcollateralization.
Because the Company’s retained residual interests are subordinated to the interests of securitization investors and the trust agent, there is risk that the carrying value of the Interest Only Strip will not be fully recovered, resulting in a loss charged to earnings. These include risk the asset will have a shorter life than originally estimated (prepayment risk), that actual credit losses may exceed expected credit losses (credit risk) and that interest paid to the securitization trust and investors will be greater than projected (interest rate risk). The Company’s risk of loss is limited to its interest in the Interest Only Strip. Neither the investors nor the securitization trust have any other recourse to the Company, thus, a loss in excess of the accreted value of the Interest Only Strip is not possible.
Each reporting period, the fair values of the Interest Only Strips are re-evaluated based upon current estimates and assumptions of the net present value of residual future cash flows net of remaining expected credit losses and anticipated refunds of Overcollateralization. Changes in fair value are generally recorded net of tax as a component of OCI. If this re-evaluation results in fair values that are less than the amortized carrying value of the Interest Only Strip, and if the decline is considered other than temporary, in accordance with Emerging Issues Task Force (“EITF”) Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Interests in Securitized Financial Assets”, the decline is charged against earnings for the current period. Finally, each reporting period, new Interest Only Strip amortization schedules are developed based upon current estimates, assumptions, adjusted carrying values and revised constant yields. See Note 8 of the Notes to Consolidated Financial Statements for additional information.
Impairment of Long-Lived Assets
Long-lived assets including certain identifiable intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impairment loss would be recognized by a reduction to the carrying amount of the asset, thus establishing a new cost basis, with an offsetting charge to expense.
Trust and Managed Assets
Assets that are held by subsidiaries in a fiduciary or agency capacity are not included in the consolidated financial statements as they are not assets of the Company. The total assets either administered or managed by the Company at December 31, 2003 and 2002 were $4.3 billion and $4.6 billion, respectively.
Derivative Financial Instruments and Hedging Activities
The Company uses certain financial instruments called derivatives to help manage (Hedge) its risk or exposure to changes in interest rates and in conjunction with its mortgage banking operations. The derivatives used most often are interest rate swaps, caps, collars and floors (collectively, “Interest Rate Derivatives”), mortgage loan commitments and forward contracts. Interest Rate Derivatives are contracts with a third party (the “Counter-party”) to exchange interest payment streams based upon an assumed principal amount (the “Notional Principal Amount”). The Notional Principal Amount is not advanced from the Counter-party. It is used only as a reference point to calculate the exchange of interest payment streams. The Company also has a deposit product whose interest rate is tied to the S&P 500 Index.
Interest rate swaps are used by the Company to convert assets and liabilities with variable-rate cash flows to assets and liabilities with fixed-rate cash flows (the “Hedged Items”). Under this arrangement, the Company receives payments from or makes payments to the Counter-party at a specified floating-rate index that is applied to the Notional Principal Amount. This periodic receipt or payment essentially offsets floating-rate interest payments that the Company makes to its depositors or lenders or receives from its loan customers. In exchange for the receipts from or payments to the Counter-party, the Company makes payments to or receives a payment from the Counter-party at a specified fixed-rate that is applied to the Notional Principal Amount. Thus, what was a floating rate obligation or a floating rate asset before entering into the derivative arrangement is transformed into a fixed rate obligation or asset. These types of hedges are considered cash flow hedges. The Company also uses interest rate swaps to convert fixed-rate liabilities to floating-rate liabilities. This is typically done when a fixed-rate liability has been incurred to fund a variable-rate loan or investment. The interest rate swap has the effect of matching the interest rate risk on the funding with the interest rate risk on the loans or investment. This type of hedge is considered a fair value hedge.
Interest rate caps and collars are derivative instruments that are variations of an interest rate swap. They also involve an exchange of interest payment streams with a Counter-party based upon a Notional Principal Amount. In the case of an interest rate cap, the exchange of income streams does not take effect unless the specified
floating-rate index rises above a pre-determined level. In an interest rate cap, the Company retains the risk of rising interest rates up to the pre-determined level, while benefiting from declines in interest rates. In the case of an interest rate collar, the exchange of income streams does not take effect unless the specified floating-rate index rises above or falls below pre-determined levels. In an interest rate collar, the Company retains the risk and benefits of changes in interest rates within the pre-determined levels. The Company has also used interest rate floors to manage its exposure to declining mortgage interest rates of its mortgage servicing rights asset. These floors were terminated during 2001. The net amount payable or receivable from each Interest Rate Derivative contract is recorded as an adjustment to interest income or interest expense.
Historically, most of the Interest Rate Derivatives have been accounted for off-balance sheet since the Notional Principal Amount is never advanced from the Counter-party and, with the exception of the interest rate floor contracts, since they qualified as Hedges under previous accounting standards. Upon the adoption of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as modified by SFAS No. 138, effective beginning January 1, 2001, and amended by SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities”, effective beginning June 30, 2003, all derivatives must be recognized at fair value on the Company’s Balance Sheet. In the event a derivative does not qualify for Hedge accounting treatment pursuant to SFAS No. 133, changes in the fair value of the derivative are included in other income or expense as they occur. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of the derivative are either offset in the Income Statement or recorded as a component of OCI in the Consolidated Statement of Stockholders’ Equity. If the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in the Income Statement. To the extent that fair value hedges are highly effective, changes in the fair value of the derivatives will largely be offset by changes in the fair values of the hedged items. If the derivative is designated as a cash flow hedge, changes in the fair value due to the passage of time (Time Value) are excluded from the assessment of hedge effectiveness and therefore flow through the Income Statement for each period. The effective portion of the remaining changes in the fair value of the derivative (Intrinsic Value) are recorded in OCI and are subsequently recognized in the Income Statement when the hedged item affects earnings. Ineffective portions of changes in the fair value of cash flow hedges are recognized in the Income Statement. Hedge ineffectiveness is caused when the change in expected future cash flows or fair value of a hedged item does not exactly offset the change in the future expected cash flows or fair value of the derivative instrument, and is generally due to differences in the interest rate indices or interest rate reset dates. All derivatives, with the exception of the deposit product tied to the S&P 500 Index, qualify and have been designated as hedges pursuant to SFAS No. 133.
Also considered derivatives under SFAS No. 133 are 1-4 family residential mortgage loan commitments (the “Commitments”) and forward mortgage loan sales (the “Forward Contracts”) to the secondary market (collectively “Mortgage Loan Derivatives”). While historically Mortgage Loan Derivatives were accounted for off-balance sheet, they are now reported at fair value on the Balance Sheet pursuant to SFAS No. 133. Changes in the fair value of the Mortgage Loan Derivatives are included in other income or expense as they occur. However, since the Company’s Forward Contracts qualify and have been designated as fair value Hedges of its portfolio of loans held for sale (the “Warehouse Loans”) as well as a Hedge of its Commitments, the Warehouse Loans are also adjusted to fair value. The change in fair value of Warehouse Loans is recorded in other income or expense as they occur. To the extent that the Company’s Forward Contracts are highly effective, the changes in the fair value of the Forward Contracts will largely offset changes in fair value of the Commitments and Warehouse Loans.
Fees paid or received on derivative financial contracts and gains or losses on sales or terminations of derivative contracts are amortized over their contractual life as a component of the interest reported on the asset or liability hedged. See Note 11 of the Notes to Consolidated Financial Statements for additional information.
Stock-Based Employee Compensation Plans
The Company has stock-based employee compensation plans, which are described more fully in Note 13 of the Notes to Consolidated Financial Statements. The Company accounts for these plans under the recognition and measurement principles of Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to
Employees”, and related Interpretations, according to the intrinsic value method for all periods presented. No stock-based employee compensation cost is reflected in net income because all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Therefore, the options have no intrinsic value at the date of grant. Had compensation cost for these grants been determined based on the grant date fair values of awards (the method described in SFAS No. 123, “Accounting for Stock-Based Compensation”), reported net income and earnings per common share would have been reduced to the pro forma amounts shown below:
The fair value of each option grant is estimated at the grant date using the Black-Scholes option-pricing model with the following weighted-average assumptions for grants in 2003, 2002 and 2001, respectively: dividend rates of 2.51%, 2.95%, and 2.86%, price volatility of 30.43%, 40.53% and 33.86%; risk-free interest rates of 3.12%, 5.28% and 5.24%; and expected lives of 5.5, 5.5 and 6.1 years. The average fair value of each option granted during 2003 was $5.94.
Legal and Other Contingencies
The Company recognizes as an expense legal and other contingencies when, based upon available information, it is probable that a liability has been incurred and the amount or range of amounts can be reasonably estimated. See Note 15 of the Notes to Consolidated Financial Statements for additional information.
Income Taxes
Deferred taxes are provided on a liability method whereby net operating losses, tax credit carryforwards, and deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. See Note 16 of the Notes to Consolidated Financial Statements for additional information.
Earnings Per Share
Basic earnings per share is based on dividing net income by the weighted average number of shares of common stock outstanding during the periods. Diluted earnings per share reflects the potential dilution that could occur if stock options granted pursuant to incentive stock option plans were exercised or converted into common stock, based on the treasury stock method, and any shares contingently issuable, that then shared in the earnings of the Company. See Note 17 of the Notes to Consolidated Financial Statements for additional information.
Segment Information
The Company discloses operating segments based on the “management” approach. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company’s reportable segments. See Note 18 of the Notes to Consolidated Financial Statements for further information.
New Accounting Standards
The Company adopted SFAS No. 141, “Business Combinations” (SFAS No. 141) and SFAS No. 142, “Goodwill and Other Intangible Assets” (SFAS No. 142). SFAS No. 141 requires all business combinations initiated after June 30, 2001 to be accounted for under the purchase method and addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. See Note 6 of the Notes to Consolidated Financial Statements.
In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS No. 144). SFAS No. 144 addresses financial accounting and reporting for the impairment of long-lived assets to be held and used and for long-lived assets to be disposed of and supercedes SFAS No. 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of”. SFAS No. 144 provides guidance for recognition and measurement of an impairment loss and how and when to test for impairment. The Company does not have any impaired long-lived assets at this time.
In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS No. 146). Under previous accounting guidance, a company recognized a liability for an exit cost when it committed to an exit plan. SFAS No. 146 redefines the recognition and related measurement of a liability and the timing of the reporting of expenses related to exit, disposal or restructuring activities initiated after December 31, 2002. Commitment to a plan to exit an activity, dispose of long-lived assets or restructure is no longer the determining factor of when to record a liability for the anticipated costs. Instead, companies will record exit, disposal or restructuring costs when they are incurred (obligated) and can be measured at fair value, and they will subsequently adjust the recorded liability for changes in estimated cash flows. Under SFAS No. 146, some of these costs might qualify for immediate recognition, others might be recognized over one or more quarters, and still others might not be recorded until incurred in some much later period. The Company incurred some exit and disposal costs during 2003 related to the elimination of some retail positions and the termination of certain leases. The future impact to the Company will be determined by any future activities in these areas.
In October 2002, the FASB issued SFAS No. 147, “Acquisitions of Certain Financial Institutions” (SFAS No. 147). SFAS No. 147 requires financial institutions to evaluate their accounting for past acquisitions to determine whether revisions are needed. SFAS No. 147 applies to all new and past financial-institution acquisitions, including “branch acquisitions” that qualify as acquisitions of a business, but excludes acquisitions between mutual institutions. The Company does not have any acquisitions that qualify for this new standard.
In November 2002, the FASB issued FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN 45 expands the information required to be disclosed by guarantors for obligations under certain types of guarantees. It also requires initial recognition at fair value of a liability for such guarantees. In addition, Financial Interpretation 34, “Disclosure of Indirect Guarantees of Others,” is rescinded, though the guidance contained therein has been carried forward into FIN 45 without modification. The initial recognition and initial measurement requirements of the FIN 45 are effective prospectively for guarantees issued or modified after December 31, 2002. Adoption of FIN 45 did not have a material effect on the Company’s Consolidated Financial Statements. See Note 15 of the Notes to the Consolidated Financial Statements.
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure” (SFAS No. 148). SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation”, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this SFAS No. 148 amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. See Note 13 of the Notes to the Consolidated Financial Statements.
In January 2003, the FASB issued FIN 46, “Consolidation of Variable Interest Entities”, which was subsequently replaced by a revised FIN 46 in December 2003. FIN 46 is an interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” and applies to certain variable interest entities (“VIEs”) in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for the first reporting period ending after December 15, 2003 or March 15, 2004, depending upon the nature of the VIE. The Company has no VIEs subject to the earlier effective date, and thus will adopt FIN 46 for the reporting period ending March 31, 2004. The Company invests in various affordable housing tax credit projects (“AHTCPs”), but only one is potentially subject to FIN 46. The Company is still in the process of obtaining relevant information to determine whether consolidation of the AHTCP will be necessary. Consolidation, if required, is not expected to have a material effect on the Company’s Consolidated Financial Statements. Upon adoption of FIN 46, the Company will be required to de-consolidate its investment in AMCORE Capital Trust I (“Trust”) a statutory business trust. See Note 10 of the Notes to the Consolidated Financial Statements. The Company expects that the de-consolidation of the Trust, including the impact on the Debt Extinguishment, will not have a material effect on the Company’s Consolidated Financial Statements. The Company has $25.0 million of capital securities (“Trust Preferred”) outstanding through the Trust that presently qualifies as Tier 1 Capital for regulatory capital purposes. The classification of the Trust Preferred as Tier 1 Capital may be impacted by the potential de-consolidation of the Trust. Any such disqualification is not expected to have a material impact on the Company’s capital adequacy. The Company does not have any other investments affected by the Interpretation.
In April 2003, the FASB issued SFAS No. 149 to amend and clarify financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133. In addition, SFAS No. 149 requires that contracts with comparable characteristics be accounted for similarly. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 (with certain exceptions) and for hedging relationships designated after June 30, 2003. The adoption of SFAS No. 149 did not have a material effect on the Company’s Consolidated Financial Statements.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity” (SFAS No. 150). SFAS No. 150 establishes standards regarding the manner in which an issuer classifies and measures certain types of financial instruments having characteristics of both liabilities and equity. Pursuant to SFAS No. 150, such freestanding financial instruments (i.e., those entered into separately from an entity’s other financial instruments or equity transactions or that are legally detachable and separately exercisable) must be classified as liabilities or, in some cases, assets. In addition, SFAS No. 150 requires that financial instruments containing obligations to repurchase the issuing entity’s equity shares and, under certain circumstances, obligations that are settled by delivery of the issuer’s shares be classified as liabilities. SFAS No. 150 amends SFAS No. 128, “Earnings Per Share”, and SFAS No. 133, and nullifies (or partially nullifies) various EITF consensuses. SFAS No. 150 was effective for financial instruments entered into or modified after May 31, 2003 and for contracts in existence at the start of the first interim period beginning after June 15, 2003. On November 7, 2003, the FASB issued Staff Position (“FSP”) No. 150-3 which deferred the application of several provisions of SFAS No. 150. The adoption of SFAS No. 150 and FSP No. 150-3 did not, and are not expected to, have a material effect on the Company’s Consolidated Financial Statements.
In November 2003, the FASB ratified a consensus reached by the Emerging Issues Task Force in EITF 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” which is effective for fiscal years ending after December 15, 2003. The consensus requires certain quantitative and qualitative disclosures for debt and marketable equity securities classified as available-for-sale or held-to-maturity under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized. These disclosures are contained in Note 3 of the Notes to Consolidated Financial Statements.
Reclassifications
Certain prior year amounts may be reclassified to conform to the current year presentation.
NOTE 2 - MERGERS, ACQUISITIONS AND DIVESTITURES
Completed Divestitures:
During 2003, the Company sold six Wisconsin branches in Clinton, Darien, Montello, Kingston, Dalton and Westfield, resulting in $8.2 million pre-tax or $4.9 million in after-tax gains, net of associated costs. For the six branches sold, $47.8 million in loans, $124.6 in deposits and $2.1 million in premises and equipment were transferred to the respective buyers. The net cash paid by the Company to settle the divestitures was $65.4 million.
During 2001, the Company sold seven Illinois branches in Aledo, Gridley, Mount Morris, Ashton, Rochelle, Wyanet and Sheffield. For the seven branches sold, $65.1 million in loans, $170.8 million in deposits and $1.4 million in premises and equipment were transferred to the respective buyers resulting in $10.6 million in pre-tax or $6.3 million in after-tax gains, net of associated costs. The net cash paid by the Company to settle the divestitures was $93.1 million.
NOTE 3 - SECURITIES
Summary information for investment securities, categorized by security type, was as follows :
Summary of unrealized loss information for investment securities, categorized by security type, at December 31, 2003 was as follows:
(1) Of the $956,000 total unrealized losses twelve months or longer, $952,000 related to a single asset-backed bond collateralized by fixed rate manufactured housing contracts and installment loan agreements. At December 31, 2003, the S&P quality rating for this bond was an ‘A’ and the security was sufficiently collateralized such that credit loss is considered remote. The security has an average life of seven years and the Company has the ability to hold the security until all principal paydowns have been received. In the event of prepayment, it is expected that the Company would recover substantially all of its recorded investment.
The amortized cost and fair value of securities available for sale as of December 31, 2003, by contractual maturity are shown below. Mortgage-backed security maturities may differ from contractual maturities because the underlying mortgages may be called or prepaid without any penalties. Therefore, these securities are not included in the maturity categories in the following maturity summary.
At December 31, 2003, 2002, and 2001, securities with a fair value of approximately $846.5 million, $908.7 million, and $846.0 million, respectively, were pledged to secure public deposits, securities sold under agreements to repurchase and for other purposes required by law.
Realized gross gains resulting from the sale of securities available for sale were $4.7 million, $2.6 million, $2.5 million for 2003, 2002 and 2001, respectively. Realized gross losses were $358,000, $90,000, and $2.8 million for 2003, 2002 and 2001, respectively. An impairment loss of $1.8 million was recorded during the second quarter of 2001 related to specific securities for which a decision to sell had been made. All of these securities were disposed of prior to year end 2001 and were included in the gross losses of $2.8 million.
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES
The composition of the loan portfolio at December 31, 2003 and 2002 was as follows:
(1) These loans are not considered impaired since they are part of a small balance homogeneous portfolio.
An analysis of the allowance for loan losses for the years ended December 31, follows:
The Company’s banking subsidiary has had, and is expected to have in the future, banking transactions with directors, executive officers, their immediate families and affiliated companies in which they are a principal stockholder (commonly referred to as related parties). These transactions were made in the ordinary course of business on substantially the same terms as comparable transactions with other borrowers.
Related party loan transactions during 2003 and 2002 were as follows:
NOTE 5 - PREMISES, EQUIPMENT AND LEASE COMMITMENTS
A summary of premises and equipment at December 31, 2003 and 2002 follows:
Certain branch offices and equipment are leased under noncancellable operating leases. There were 27 leases in effect on branch locations and other properties at December 31, 2003. Of these, one branch lease is classified as a capital lease. All leases expire at various dates through the year 2035. However, in the normal course of business, it is expected that these leases will be renewed or replaced by leases on other properties since most of the Company’s leases contain renewal options for multi-year periods at fixed rentals or calculable rentals. Some leases contain escalation clauses calling for rentals to be adjusted for increased operating expenses or proportionately adjusted for increases in the consumer or other price indices. The following summary reflects the future minimum lease payments required under operating and capital leases that, as of December 31, 2003, have remaining noncancellable lease terms in excess of one year.
The following is an analysis of the leased property under capital leases:
NOTE 6 - GOODWILL AND OTHER INTANGIBLE ASSETS
On January 1, 2002, the Company adopted SFAS No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets”, with respect to business combinations that were completed prior to July 1, 2001. These statements required that the Company evaluate its existing intangible assets and goodwill classifications. Goodwill and intangible assets with indefinite useful lives may no longer be amortized, but instead must be tested for impairment at least annually. The useful life and residual values of all other intangibles were also reassessed. As of the date of adoption, the Company had unamortized goodwill in the amount of $15.6 million and unamortized identifiable intangible assets (Core Deposit Intangibles) in the amount of $282,000, which were subject to the transition provisions of SFAS Nos. 141 and 142.
The Company’s intangible asset values by segment at December 31, 2003 are as follows:
The current and estimated amortization expense by segment is as follows:
The core deposit intangibles are fully amortized as of December 31, 2003.
Changes in the carrying amount of goodwill for the year ended December 31, 2003 were related to the sale of six bank branches in the first quarter of 2003. The changes in the carrying amount of goodwill for the year ended December 31, 2003 are as follows:
Fair value exceeded carrying value for all reporting units that have allocated goodwill at both the transitional and annual evaluation dates. Thus, no transitional or annual impairment loss was recognized and no cumulative effect of a change in accounting principle was recorded.
SFAS No. 142 requires disclosure of what reported income before extraordinary items and net income would have been in all periods presented exclusive of amortization expense recognized in those periods related to goodwill, intangible assets that will no longer be amortized, any deferred credit related to an excess over cost, equity method goodwill, and changes in amortization periods for intangible assets that will continue to be amortized. The table below reconciles net income as reported to how the prior period would have been reported had SFAS No. 142 been in effect.
See Note 7 of the Notes to Consolidated Financial Statements for information regarding the Company’s Originated Mortgage Servicing Right asset.
NOTE 7 - MORTGAGE SERVICING RIGHTS
The unpaid principal balance of mortgage loans serviced for others, which are not included on the consolidated balance sheets, was $1.21 billion and $1.02 billion at December 31, 2003 and 2002, respectively. Of this amount, the Company has recorded originated capitalized mortgage servicing rights on mortgage loans serviced balances of $1.18 billion and $1.00 billion at December 31, 2003 and 2002, respectively. The remaining balance of originated loans sold and serviced for others also have servicing rights associated with them; however, these servicing rights arose prior to the adoption of SFAS No. 122, as amended by SFAS Nos. 125 and 140, and accordingly, have not been capitalized.
The carrying value and fair value of capitalized mortgage servicing rights consisted of the following as of December 31, 2003 and 2002.
The following is a disclosure of the key assumptions used in estimating the fair value of originated capitalized mortgage servicing rights.
Estimated fair market value of servicing is the present value of the expected future cash flows over the projected life of the loan. Assumptions used in the present value calculation are based on actual performance of the underlying servicing along with general market consensus. The expected cash flow is the net amount of all mortgage servicing income and expense items. The expected cash flow is discounted at an interest rate appropriate for the associated risk given current market conditions. Significant assumptions as of December 31, 2003 and 2002 include:
The following is an analysis of the mortgage servicing rights activity and the related valuation allowance for 2003 and 2002. For the purpose of measuring impairment, loans are stratified and evaluated based on loan type and investor as determined by materiality and reasonableness.
The estimated mortgage servicing rights amortization expense, which is part of the Mortgage Banking Segment, is as follows:
The weighted-average amortization period for mortgage servicing rights retained during the fourth quarter of 2003 was 10.8 years.
NOTE 8 - SALE OF RECEIVABLES
During 2003, the Company sold $106.0 million of indirect automobile loans, reporting a pre-tax gain of $2.5 million ($1.5 million after-tax). There were no sales during the comparable period in 2002. Upon sale, the net carrying amount of the loans is removed from the consolidated balance sheet in exchange for cash and certain retained interests. The retained interests included rights to service the loans that were sold (the “Servicing Rights”) and an interest in residual cash flows (the “Interest-Only Strip”). The Interest-Only Strip includes the excess of interest collected on the loans over the amount required to be paid to the investors and the securitization agent (the “Excess Spread”) plus an interest in sales proceeds that were not remitted by the securitization trust at the time of the initial sale of the loans to the extent it exceeds projected credit losses (the “Credit Enhancement” or “Overcollateralization”). These retained interests were allocated a carrying value of $9.2 million at the time of the sale.
The Company receives monthly servicing fees equal to 0.75 percent per annum of the outstanding beginning principal balance of the loans serviced for the month and rights to future cash flows arising after the investors in the securitization trust have received the returns for which they have contracted. The investors and the securitization trust have no other recourse to the Company’s other assets for failure of debtors to pay when due. The Company’s retained interests are subordinate to investor's interests. The value of the Interest-Only Strip is subject to prepayment risk and interest rate risk on the Excess Spread and credit risk on the transferred automobile loans on the Overcollateralization.
Key economic assumptions used in measuring the retained interests at the date of the securitization and as of December 31, 2003 including the sensitivity of the current fair value of residual cash flows to immediate 10 percent and 20 percent adverse changes in those assumptions are as follows:
These sensitivities are hypothetical and should be used with caution. Changes in fair value based on a 10 percent variation should not be extrapolated because the relationship of the change in assumption to the change in fair value may not always be linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the retained interests is calculated without changing any other assumption; in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments and increased credit losses), which might magnify or counteract the sensitivities.
Total cash flows attributable to the indirect automobile loan securitization transactions was an inflow of $6.4 million and $2.1 million for 2003 and 2002, respectively. The following table summarizes the various cash flows received from and paid to the securitization trust:
Other retained interests represents net cash flows received from retained interests by the transferor other than servicing fees. Other cash flows include, for example, gross cash flows from Interest-Only Strips, net of reductions in such cash flows for loan defaults, including the release of excess Overcollateralization funds.
The following table presents quantitative information about delinquencies (loans 30 or more days past due plus non-accruals), net credit losses, and components of securitized indirect automobile loans and other assets managed together with them. Loan amounts represent the principal amount of the loan only. Retained interests held for securitized assets are excluded from this table because they are recognized separately.
Actual and projected static pool credit losses, as a percentage of indirect automobile loans securitized are 1.33%, 1.57% and 1.85% as of the years ended December 31, 2003, 2004, and 2005, respectively. Static pool losses are calculated by summing the actual and projected future credit losses and dividing them by the original balance of each pool of assets. The amounts shown here for each year are a weighted average for all indirect automobile loan securitizations.
NOTE 9 - SHORT TERM BORROWINGS
At December 31, 2003, 2002 and 2001 short-term borrowings consisted of:
Additional details on securities sold under agreements to repurchase are as follows:
The Company has a commercial paper agreement with an unrelated financial institution (Agent) that provides for the Company to issue non-rated short-term unsecured debt obligations at negotiated rates and terms, not to exceed $50.0 million. In the event the Agent is unable to place the Company’s commercial paper on a particular day, the proceeds are provided by overnight borrowings on a line of credit with the same financial institution. This agreement may be terminated at any time by written notice of either the Agent or the Company. As of December 31, 2003, $40.0 million was available.
NOTE 10 - LONG-TERM BORROWINGS
Long-term borrowings consisted of the following at December 31, 2003 and 2002:
The Company periodically borrows additional funds from the Federal Home Loan Bank (FHLB) in connection with the purchase of mortgage-backed securities and the financing of 1-4 family real estate loans. Certain FHLB borrowings have prepayment penalties and call features associated with them. The average maturity of these borrowings at December 31, 2003 is 3.9 years, with a weighted average borrowing rate of 4.16%. The Company reclassifies FHLB borrowings to short term borrowings when the remaining maturity becomes less than one year.
Reductions of FHLB borrowings with call features, assuming they are called at the earliest call date, total $77.0 million in 2004.
The Company has $25.0 million of capital securities outstanding through AMCORE Capital Trust I (“Trust”), a statutory business trust. All of the common securities of the Trust are owned by the Company. The capital securities pay cumulative cash distributions semiannually at an annual rate of 9.35%. The securities are redeemable from March 25, 2007 until March 25, 2017 at a declining rate of 104.675% to 100% of the principal amount. After March 25, 2017, they are redeemable at par until June 15, 2027 when redemption is mandatory.
Prior redemption is permitted under certain circumstances such as changes in tax or regulatory capital rules. The proceeds of the capital securities were invested by the Trust in junior subordinated debentures which represents all of the assets of the Trust. The Company fully and unconditionally guarantees the capital securities through the combined operation of the debentures and other related documents. The Company’s obligations under the guarantee are unsecured and subordinate to senior and subordinated indebtedness of the Company.
Other long-term borrowings includes a capital lease with a net carrying value of $1.1 million on a branch facility leased by the Company. The Company is amortizing the capitalized lease obligation and depreciating the facility over the remaining non-cancelable term of the original lease, which expires or renews in 2021.
Scheduled reductions of long-term borrowings are as follows:
During 2003, the Company extinguished $15.8 million of above-market interest rate FHLB debt early and replaced the debt with lower cost funding. A prepayment penalty of $1.6 million on the early extinguishment is recorded in other operating expenses in the Consolidated Statements of Income for the year ended December 31, 2003.
NOTE 11 - DERIVATIVE INSTRUMENTS AND HEDGE ACCOUNTING
The Company adopted SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” on January 1, 2001. This Statement, as amended by SFAS No. 138 and SFAS No. 149, outlines accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities.
The Company uses certain financial instruments called derivatives to help manage (“Hedge”) its risk or exposure to changes in interest rates and in conjunction with its mortgage banking operations. The derivatives used most often are interest rate swaps, caps, collars and floors (collectively, “Interest Rate Derivatives”), mortgage loan commitments and forward contracts. Interest Rate Derivatives are contracts with a third party (the “Counter-party”) to exchange interest payment streams based upon an assumed principal amount (the “Notional Principal Amount”). The Notional Principal Amount is not advanced from the Counter-party. It is used only as a reference point to calculate the exchange of interest payment streams. The Company also has a deposit product whose interest rate is tied to the S & P 500 Index.
Interest rate swaps are used by the Company to convert assets and liabilities with variable-rate cash flows to assets and liabilities with fixed-rate cash flows (the “Hedged Items”). Under this arrangement, the Company receives payments from or makes payments to the Counter-party at a specified floating-rate index that is applied to the Notional Principal Amount. This periodic receipt or payment essentially offsets floating-rate interest payments that the Company makes to its depositors or lenders or receives from its loan customers. In exchange for the receipts from or payments to the Counter-party, the Company makes payments to or receives a payment from the Counter-party at a specified fixed-rate that is applied to the Notional Principal Amount. Thus, what was a floating rate obligation or a floating rate asset before entering into the derivative arrangement is transformed into a fixed rate obligation or asset. These types of Hedges are considered cash flow Hedges. The Company also
uses interest rate swaps to convert fixed-rate liabilities to floating-rate liabilities. This is typically done when a fixed rate liability has been incurred to fund a variable-rate loan or investment. The interest rate swap has the effect of matching the interest rate risk on the funding with the interest rate risk on the loans or investment. This type of Hedge is considered a fair value Hedge. The longest-term derivative that the Company has used to Hedge its interest rate exposure (cash flow Hedge) expires in September 2004, while the longest-term fair value Hedge expires in March 2013.
Interest rate caps and collars are derivative instruments that are variations of an interest rate swap. They also involve an exchange of interest payment streams with a Counter-party based upon a Notional Principal Amount. In the case of an interest rate cap, the exchange of income streams does not take effect unless the specified floating-rate index rises above a pre-determined level. In an interest rate cap, the Company retains the risk of rising interest rates up to the pre-determined level, while benefiting from declines in interest rates. In the case of an interest rate collar, the exchange of income streams does not take effect unless the specified floating-rate index rises above or falls below pre-determined levels. In an interest rate collar, the Company retains the risk and benefits of changes in interest rates within the pre-determined levels. The Company has also used interest rate floors to manage its exposure to declining mortgage interest rates of its mortgage servicing rights asset. These floors were terminated during 2001. The net amount payable or receivable from each Interest Rate Derivative contract is recorded as an adjustment to interest income or interest expense.
All derivatives are recognized at fair value in the Consolidated Balance Sheets. Changes in fair value for derivatives that are not Hedges are recognized in the Consolidated Statement of Income (“Income Statement”) as they arise. If the derivative is a Hedge, depending on the nature of the Hedge, changes in the fair value of the derivative are either offset in the Income Statement or recorded as a component of other comprehensive income (“OCI”) in the Consolidated Statement of Stockholders’ Equity. If the derivative is designated as a fair value Hedge, the changes in the fair value of the derivative and of the Hedged Item attributable to the Hedged risk are recognized in the Income Statement. To the extent that fair value Hedges are highly effective, changes in the fair value of the derivatives will largely be offset by changes in the fair values of the Hedged Items. If the derivative is designated as a cash flow Hedge, changes in the fair value of the derivative due to the passage of time (“Time Value”) are excluded from the assessment of Hedge effectiveness and therefore flow through the Income Statement for each period. The effective portion of the remaining changes in the fair value of the derivative (“Intrinsic Value”) are recorded in OCI and are subsequently recognized in the Income Statement when the Hedged Item affects earnings. Ineffective portions of changes in the fair value of cash flow Hedges are recognized in the Income Statement. Hedge ineffectiveness is caused when the change in expected future cash flows or fair value of a Hedged Item does not exactly offset the change in the future expected cash flows or fair value of the derivative instrument, and is generally due to differences in the interest rate indices or interest rate reset dates. All derivatives, with the exception of the deposit product tied to the S&P 500 Index and $162,000 in swaps left unhedged due to the call of the Hedged Items, qualify and have been designated as Hedges.
Also considered derivatives under SFAS No. 133 are 1-4 family residential mortgage loan commitments (the “Commitments”) and forward mortgage loan sales (the “Forward Contracts”) to the secondary market (collectively “Mortgage Loan Derivatives”) which are reported at fair value on the balance sheet. Changes in the fair value of the Mortgage Loan Derivatives are included in other income or expense as they occur. However, since the Company’s Forward Contracts qualify and have been designated as fair value Hedges of its portfolio of loans held for sale (the “Warehouse Loans”) as well a Hedge of its Commitments, the Warehouse Loans are also adjusted to fair value. The change in fair value of Warehouse Loans is recorded in other income or expense as it occurs. To the extent that the Company’s Forward Contracts are highly effective, the changes in the fair value of the Forward Contracts will largely offset changes in the fair value of the Commitments and Warehouse Loans.
The method that the Company uses to assess whether or not a Hedge is expected to be highly effective in achieving offsetting changes in cash flows or fair values of the risk that is being hedged (Prospective Considerations) and the method that it uses to determine that the Hedge has been highly effective in achieving those offsets (Retrospective Evaluations) are defined and documented at the inception of each Hedge. Hedges that are similar in nature are assessed in a similar manner.
Many of the Company’s Hedges employ “shortcut” accounting because the critical terms of the derivative and the Hedged Item are the same. As a result, complete offsets in cash flows or fair values are expected and no ineffectiveness is recognized in earnings. These Hedges are monitored on a quarterly basis to verify that there have been no changes in the derivative or the Hedged Item that would invalidate this conclusion.
Those Hedges that do not qualify for “shortcut” accounting use statistical analysis for the Prospective Consideration of expected Hedge effectiveness and calculations of actual dollar offsets for the Retrospective Evaluation of Hedge effectiveness. In those instances where exact offset is not achieved, the difference (ineffectiveness) is recognized in earnings for the period. These assessments are performed quarterly using the defined and documented methodology consistently throughout the period of the respective Hedge.
The Company implemented SFAS No. 133 on January 1, 2001, and, as such, the impact of the transition to this standard on the Company’s earnings and financial position was dependent on the composition of the hedging portfolio at that date. The after-tax transition adjustment due to the adoption of SFAS No. 133 resulted in an increase in consolidated assets of $2.1 million, an increase in consolidated liabilities of $3.4 million, a reduction in OCI of $1.5 million, and an increase in net income of $225,000. The increase in net income was mostly attributable to the $353,000 favorable Time Value component of the market value of the cash flow Hedges. As part of the adoption of this standard, $10.7 million of held to maturity securities were reclassified to available for sale securities resulting in an unrealized loss of $15,000 recorded in OCI.
The Income Statement for 2003 included the following derivative related activity in other non-interest income: $3,000 loss due to the decrease in the Time Value component of the market value of cash flow Hedges, $4,000 income on the change in value of derivatives that do not qualify for hedge accounting, $24,000 loss related to the ineffective portion of the fair value Hedges, $345,000 loss related to Mortgage Loan Derivatives (net of the corresponding mark-to-market adjustment on Hedged Warehouse Loans held for sale), and no income or loss related to the S & P 500 Index embedded derivative. These items, net of taxes of $143,000, totaled a $225,000 loss recorded for the twelve months ended December 31, 2003.
The Income Statement for 2002 included the following derivative related activity in other non-interest income: $47,000 loss due to the decrease in the Time Value component of the market value of cash flow Hedges, $29,000 income related to the ineffective portion of the cash flow Hedges, $350,000 income related to Mortgage Loan Derivatives (net of the corresponding mark-to-market adjustment on Hedged Warehouse Loans held for sale), and no income or loss related to the S & P 500 Index embedded derivative. These items, net of taxes of $129,000, total $203,000 in income recorded for the twelve months ended December 31, 2002.
In addition to the transition adjustment, the Income Statement for 2001 included the following derivative related activity in other non-interest income: $303,000 loss due to the decrease in the Time Value component of the market value of cash flow Hedges, $29,000 loss related to the ineffective portion of the cash flow Hedges, $48,000 income related to Mortgage Loan Derivatives (net of the corresponding mark-to-market adjustment on Hedged Warehouse Loans held for sale), and $9,000 income related to the S & P 500 Index embedded derivative. These items, net of taxes of $107,000, totaled a $168,000 loss recorded for the twelve months ended December 31, 2001.
Reclassification from OCI to the Income Statement occurs each period as continuing cash flow payments bring the Intrinsic Value component of the market value of each cash flow Hedge closer to zero. Derivative losses of $4.0 million and $3.4 million (pre-tax) were reclassified from OCI to the Income Statement as additional interest expense during the twelve months ended December 31, 2002 and 2001, respectively, mostly through the normal postings of cash receipts and cash payments related to the derivatives and the Hedged Items. During 2002, swaps that were Hedging loan cash flows were sold, for which the Company received $3.3 million plus accrued interest. The gain continued to be classified in OCI and amortized into income over the original term of the swap. For the year ended December 31, 2003, $2.3 million of this pre-tax gain was amortized (reclassified) from OCI into
income. For the year ended December 31, 2002, $96,000 of this pre-tax gain was amortized (reclassified) from OCI into income. The remaining pre-tax gain of $970,000 included in OCI at December 31, 2003 is expected to be reclassified into earnings during the next twelve months. There were no other outstanding cash flow Hedges included in OCI during the twelve months ended December 31, 2003.
NOTE 12 - FAIR VALUE OF FINANCIAL INSTRUMENTS AND OFF-BALANCE SHEET RISK
The fair value amounts have been estimated by the Company using available market information and appropriate valuation methodologies as discussed below. Considerable judgment was required, however, to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented below are not necessarily indicative of the amounts the Company could realize in a current market exchange.
The following table shows the carrying amounts and fair values of financial instruments at December 31, 2003 and 2002 that have liquid markets in which fair value is assumed to be equal to the carrying amount, have readily available quoted market prices, are based on quoted prices for similar financial instruments or represent quoted surrender values:
The carrying amounts and fair values of accruing loans and leases at December 31, 2003 and 2002 were as follows:
Fair values of loans were estimated for portfolios with similar characteristics. The fair value of loans was calculated by discounting contractual and prepayment cash flows using estimated market discount rates which reflect the interest rate risk inherent in the loan. The fair value of non-accrual loans was $31.7 million and $32.5 million in 2003 and 2002, respectively. (See Note 4 of the Notes to Consolidated Financial Statements for additional information).
The carrying value of interest receivable and payable approximates fair value due to the relatively short period of time between accrual and expected realization. At December 31, 2003 and 2002, interest receivable was $18.9 million and $22.6 million, respectively, and interest payable was $14.2 million and $20.7 million, respectively.
The following table shows the carrying amounts and fair values of financial instrument liabilities at December 31, 2003 and 2002:
The fair value of deposits with no stated maturity, such as non-interest bearing demand deposits, savings, NOW and money market accounts, is equal to the carrying amount in accordance with SFAS No. 107. There is, however, additional value to the deposits of the Company, a significant portion of which has not been recognized in the consolidated financial statements. This value results from the cost savings of these core funding sources versus obtaining higher-rate funding in the market. The fair value of time deposits was determined by discounting contractual cash flows using currently offered rates for deposits with similar remaining maturities.
The fair value of derivatives was estimated based on the amount the Company would pay or would be paid to terminate the contracts or agreements, using current rates and, when appropriate, the current creditworthiness of the counter-party. The carrying amounts of certain derivatives shown include accrued net settlements and the unamortized balance of premiums or discounts.
The above fair value estimates were made at a discrete point in time based on relevant market information and other assumptions about the financial instruments. As no active market exists for a significant portion of the Company’s financial instruments, fair value estimates were based on judgments regarding current economic conditions, future expected cash flows and loss experience, risk characteristics and other factors. These estimates are subjective in nature and involve uncertainties and therefore cannot be calculated with precision. There may be inherent weaknesses in calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows could significantly affect the results. In addition, the fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to assess the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant investments in subsidiaries, specifically the trust and asset management operations, are not considered financial instruments and the franchise values have not been included in the fair value estimates. Similarly, premises and equipment and intangible assets have not been considered.
Many of the above financial instruments are also subject to credit risk. Credit risk is the possibility that the Company will incur a loss due to the other party’s failure to perform under its contractual obligations. The Company’s exposure to credit loss in the event of non-performance by the other party with regard to commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for actual extensions of credit. The credit risk involved for commitments to extend credit and in issuing letters of credit is essentially the same as that involved in extending loans to customers. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies, but may include accounts receivable, securities, inventory, property and equipment and income-producing commercial properties. The Company is also exposed to credit risk with
respect to its $116.5 million investment in BANK and Company owned life insurance. AMCORE manages this risk by diversifying its holdings among various carriers and by periodic internal credit reviews. All carriers have “Secure” ratings from A. M. Best that range from a low of “A” (Excellent) to “A++” (Superior).
The interest rate swap contracts involve the exchange of fixed for variable or variable for fixed interest rate payments and are based on the notional amount of the contract. The cap contract is also based on the notional amount of the contract. The notional amounts of these contracts only identify the size of the contracts and are used to calculate the interest payment amounts. The contracts are occasionally purchased at a premium or discount, which is amortized over the lives of the contracts. The only credit risk exposure AMCORE has is in relation to the counter-parties which all have investment grade credit ratings. All counter-parties are expected to meet any outstanding interest payment obligations.
A summary of the contract amount of the Company’s exposure to off-balance sheet credit risk as of December 31, 2003 and 2002, is as follows:
Commitments to extend credit are contractual agreements entered into with customers as long as there is no violation of any condition established on the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
Letters of credit are conditional, but irrevocable, commitments issued by the Company to guarantee the payment of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions.
NOTE 13 - STOCK INCENTIVE PLANS
At December 31, 2003, the Company has stock-based compensation plans as described below. The Company accounts for these plans under the recognition and measurement principles of APB Opinion No. 25 and related interpretations.
Stock Incentive Plans. In 2000, stockholders approved the adoption of the AFI 2000 Stock Incentive Plan (Plan). The Plan provides for the grant of stock options, reload options, stock appreciation rights, performance units, restricted stock awards and stock bonus awards to key employees. The total number of shares approved and available for grant under the Plan in its first year was 2.5% of the total shares of stock outstanding as of the effective date and 1.5% of outstanding shares in each subsequent Plan year (not to exceed 425,000 in any such year). Options to purchase shares of common stock of the Company and restricted stock awards were granted to key employees pursuant to both the Plan and previous stock incentive plans.
Stock Options. Non-Qualified Stock Options are issued at an option price equal to the fair market value of the shares on the grant date. The options granted under the plans generally vest within three to five years and expire from seven to ten years from the date of grant. The following table presents certain information with respect to stock options issued pursuant to these incentive plans.
Investors Management Group (IMG) was acquired by the Company in 1998. The above line item “Options issued pursuant to IMG earnout” were contingent based upon IMG’s performance from 1998 through 2000.
Performance Units. Performance Units (Units) were granted prior to 1999 and entitled holders to cash or stock payments if certain three-year return on equity performance targets were met. In addition, a dividend was paid on each Unit at a rate equivalent to the rate of dividends paid on each share of the Company’s common stock. The expense related to these Units for the years ended December 31, 2002 and 2001 was approximately $62,000 and $154,000, respectively. There was no expense in 2003. The following table presents certain information with respect to issuances and payouts pursuant to these incentive plans.
Restricted Stock Awards. Pursuant to the Plan, the Company issued common stock with restrictions to certain key employees. The shares are restricted as to transfer, but are not restricted as to dividend payment and voting rights. Transfer restrictions lapse at the end of three years contingent upon earnings and return on equity performance goals being met for each of the three years and contingent upon continued employment. If performance goals are not met, the restrictions lapse and shares vest at the end of nine years. The Company amortizes the expense over the performance period or, if the goals are not met, the vesting period. The expense related to these awards for the years ended December 31, 2003, 2002 and 2001 was approximately $168,000, $305,000 and $222,000, respectively. The following table presents certain information with respect to restricted stock awards granted pursuant to these incentive plans.
Directors’ Stock Plans. The Restricted Stock Plan for Non-Employee Directors provides that each current eligible non-employee director and each subsequently elected non-employee director receive, in lieu of a cash retainer, shares of common stock of the Company, the fair value of which is equal to three times the annual retainer. The shares vest annually over a three-year period based upon the anniversary date of the original award and continued service as a director. The expense related to the Stock Plan for the years ended December 31, 2003, 2002 and 2001 was approximately $93,000, $69,000 and $88,000, respectively.
In 2001, stockholders approved the adoption of the AFI 2001 Stock Option Plan for Non-Employee Directors (Option Plan). The Option Plan provides that each current eligible non-employee director and each subsequently elected non-employee director receive Options to purchase common stock of the Company. Each option granted under the Option Plan is issued with an option price equal to the fair market value of the underlying common stock at the date of grant and expires in seven to ten years from the date of grant. Options granted are generally exercisable one year after date of grant. In 2002 each eligible non-employee director received a grant that will vest at the rate of one-third per year beginning one year after the date of grant. The only grant issued in 2003 was to the newly elected non-employee director. The following table presents certain information with respect to stock options issued pursuant to the Option Plan and previous stock option plans.
Options Summary. The following table presents certain information as of December 31, 2003 with respect to issuances of stock options pursuant to all plans discussed above.
Employee Stock Purchase Plan. In 1999, stockholders approved the adoption of the AMCORE Stock Option Advantage Plan through which eligible employees may purchase from the Company shares of its common stock. The Company intends that the plan be an “employee stock purchase plan” (ESPP) within the meaning of Section 423 of the Internal Revenue Code of 1986. The Company has reserved 250,000 shares of common stock for issuance under the ESPP.
The Company’s employee stock purchase plan is intended to give employees a convenient means of purchasing shares of common stock through payroll deductions. Each employee of the Company whose customary employment with the Company is more than 20 hours per week and more than five months in any calendar year,
is eligible to participate, subject to IRS contribution limitations. Each participating employee’s contributions are used to purchase the Corporation’s common stock on the last day of each quarter at the exercise price. The exercise price is 85% of the lower of the closing price of the Company’s common stock on the Nasdaq National Market on the first or last day of each offering period. No charge to earnings is recorded with respect to the ESPP.
The shares issued pursuant to the ESPP were as follows: 44,180 shares at prices ranging from $18.51 to $22.29 in 2003; 46,468 shares at prices ranging from $17.21 to $19.70 in 2002 and 39,394 shares at prices ranging from $14.45 to $19.00 in 2001.
Shares issued pursuant to the ESPP are prohibited from sale by a participant until two years after the date of purchase. Dividends earned are credited to a participant’s account and used to purchase shares at the next purchase date. The Company shall have the option to purchase all, or any portion of, the shares owned by such participant that, at the time of termination, are subject to the restriction on transfer.
In accordance with APB Opinion No. 25, no compensation cost has been recognized for stock option grants issued during 2003 pursuant to all option plans. Had compensation cost for these grants been determined based on the grant date fair values of awards (the method described in SFAS No. 123, “Accounting for Stock-Based Compensation”), reported net income and earnings per common share would have been reduced to the pro forma amounts shown below:
The fair value of each option grant is estimated at the grant date using the Black-Scholes option-pricing model with the following weighted-average assumptions for grants in 2003, 2002 and 2001, respectively: dividend rates of 2.51%, 2.95%, and 2.86%, price volatility of 30.43%, 40.53% and 33.86%; risk-free interest rates of 3.12%, 5.28% and 5.24%; and expected lives of 5.5, 5.5 and 6.1 years. The average fair value of each option granted during 2003 was $5.94.
NOTE 14 - BENEFIT PLANS
Employee Benefit Plans. All subsidiaries of the Company participate in the AMCORE Financial Security Plan (Security Plan), a qualified profit sharing plan under Section 401(a) of the Internal Revenue Code. The Security Plan offers participants a personal retirement account, a cash profit sharing payment and a personal savings account 401(k). The expense related to the Security Plan and other similar plans from acquired companies for the years ended December 31, 2003, 2002 and 2001 was approximately $5.01 million, $4.31 million and $3.79 million, respectively.
In addition to the Security Plan, certain health care and life insurance benefits are made available to active employees. The Company’s share of cost of these benefits is expensed as incurred. Group health benefits are offered to retirees with 100% of the cost borne by the retiree.
The Company provides a deferred compensation plan (entitled “AMCORE Financial, Inc. Deferred Compensation Plan”) for senior officers. This plan provides the opportunity to defer salary and bonuses.
The Company provides additional retirement benefits to certain key executives through plans that are non-qualified, non-contributory and unfunded.
Under one such arrangement, the additional retirement benefits replace what would have been provided under the qualified plans in the absence of limits placed on qualified plan benefits by the Internal Revenue Code of 1986. The expense related to this arrangement was $206,000, $377,000 and $441,000 for 2003, 2002 and 2001, respectively.
Another arrangement provides supplemental retirement benefits that are based upon three percent of final base salary, times the number of years of service. Benefits under this plan may not exceed 70% or be less than 45% of a participant’s final base salary less offsets for social security and other employer sponsored retirement plans. The measurement date for obligations for this plan are determined in January when estimated offsets from employer sponsored retirement plans are annually re-evaluated. The following table summarizes the costs and obligations to participants for the years ended December 31.
The modifications in 2002 related to the retiring chairman and chief executive officer. The projected benefit obligation was adjusted to accelerate the retirement date to January 1, 2003, convert the obligation to the form of a single-life fifteen-year certain annuity and to decrease the discount rate to six percent. Payments commenced for the retiring executive in January of 2003.
Directors Benefits. The Company pays a lifetime annual retainer to certain retired directors. Effective January 1, 1993, the Company adopted SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions” to account for these benefits. This statement requires employers to recognize postretirement benefits on an accrual basis rather than on a cash basis. The expense in 2003, 2002 and 2001 related to this plan was $70,000, $139,000 and $59,000, respectively. The transition obligation, representing the present value of future payments upon adoption of accrual basis accounting was approximately $842,000 and is being amortized over a twenty-year period.
NOTE 15 - CONTINGENCIES AND GUARANTEES
Contingencies:
Management believes that no litigation is threatened or pending in which the Company faces potential loss or exposure which will materially affect the Company’s consolidated financial position or consolidated results of operations. Since the Company’s subsidiaries act as depositories of funds, trustee and escrow agents, they occasionally are named as defendants in lawsuits involving claims to the ownership of funds in particular accounts. This and other litigation is incidental to the Company’s business.
Guarantees:
The Company, in the normal course of its business, regularly offers financial and performance standby letters of credit to its BANK customers. Financial and performance standby letters of credit are a conditional but irrevocable form of guarantee. Under a financial standby letter of credit, the Company guarantees payment to a third party obligee upon the default of payment by the BANK customer, and upon receipt of complying documentation from the obligee. Under a performance standby letter of credit, the Company guarantees payment to a third party obligee upon nonperformance by the BANK customer and upon receipt of complying documentation from the obligee.
Both financial and standby letters of credit are typically issued for a period of one year to five years, but can be extended depending on the BANK customer’s needs. As of December 31, 2003, the maximum remaining term for any outstanding standby letters of credit was approximately seven years, expiring on December 15, 2010.
A fee of one to two percent of face value is normally charged to the BANK customer and is recognized as income over the life of the standby letter of credit. The carrying value of deferred fees, as of December 31, 2003 was $1.3 million.
At December 31, 2003, the contractual amount of these letters of credit, which represents the maximum potential amount of future payments that the Company would be obligated to pay under the guarantees, was $185.1 million, with $156.7 million in financial standby letters of credit and $28.4 million in performance standby letters of credit.
The issuance of either a financial or standby letter of credit is normally backed by collateral. The collateral can take various forms including bank accounts, investments, fixed assets, inventory, accounts receivable and real estate, among other things. At the time that the letters of credit are issued, the value of the collateral is usually in an amount that is considered sufficient to cover the contractual amount of the standby letters of credit.
NOTE 16 - INCOME TAXES
The components of income tax expense were as follows:
The effective tax rate for 2001 includes $130,000 of tax benefit and $143,000 of tax expense for the Extraordinary Item and the Accounting Change, respectively. Income tax expense was less than the amounts computed by applying the federal statutory rate of 35% due to the following:
The tax effects of existing temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows:
Net operating loss carryforwards for state income tax purposes of approximately $1.87 million at December 31, 2002 were fully utilized during 2003. As a result, the associated deferred tax asset of $148,000 ($96,000 net of federal) and the corresponding valuation allowance of $96,000 were reversed.
Realization of the deferred tax asset over time is dependent upon the existence of taxable income in carryback periods or the Company generating sufficient taxable earnings in future periods. In determining that realization of the deferred tax asset was more likely than not, the Company gave consideration to a number of factors including its taxable income during carryback periods, its recent earnings history, its expectations for earnings in the future, and, where applicable, the expiration dates associated with tax carryforwards.
Retained earnings at December 31, 2003 includes $3.18 million for which no provision for income tax has been made. This amount represents allocations of income to thrift bad debt deductions for tax purposes only. This amount will only be taxable upon the occurrence of certain events. At this time, management does not foresee the occurrence of any of these events.
Tax benefits of $1.43 million, $1.08 million, and $1.21 million have been credited directly to paid in capital, with a corresponding decrease in the liability for current income taxes payable, for stock related incentives during the years ended December 31, 2003, 2002 and 2001 respectively.
NOTE 17 - EARNINGS PER SHARE
Earnings per share calculations are as follows:
As prescribed by SFAS No. 128, “Earnings Per Share”, basic EPS is computed by dividing income available to common stockholders (numerator) by the weighted-average number of common shares outstanding (denominator) during the period. Shares issued during the period and shares reacquired during the period are weighted for the portion of the period that they were outstanding.
The computation of diluted EPS is similar to the computation of basic EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued and to include shares contingently issuable pursuant to employee incentive plans. Securities (e.g. options) that do not have a current right to participate fully in earnings but that may do so in the future by virtue of their option rights are potentially dilutive shares. The dilutive shares are calculated based on the treasury stock method meaning that, for the purposes of this calculation, all outstanding options are assumed to have been exercised during the period and the resulting proceeds used to repurchase Company stock at the average market price during the period. In computing diluted EPS, only potential common shares that are dilutive - those that reduce earnings per share or increase loss per share - are included. Exercise of options is not assumed if the result would be antidilutive.
NOTE 18 - SEGMENT INFORMATION
AMCORE’s internal reporting and planning process focuses on four primary lines of business or (Segment(s)): Commercial Banking, Retail Banking, Trust and Asset Management, and Mortgage Banking. The financial information presented was derived from the Company’s internal profitability reporting system that is used by management to monitor and manage the financial performance of the Company. This information is based on internal management accounting policies which have been developed to reflect the underlying economics of the Segments and, to the extent practicable, to portray each Segment as if it operated on a stand-alone basis. Thus, each Segment, in addition to its direct revenues, expenses, assets and liabilities, includes an appropriate allocation of shared support function expenses. The Commercial, Retail and Mortgage Banking Segments also include fund transfer adjustments to appropriately reflect the cost of funds on loans made and funding credits on deposits generated. Apart from these adjustments, the accounting policies used are similar to those described in Note 1 of the Notes to Consolidated Financial Statements.
Since there are no comprehensive authorities for management accounting equivalent to accounting principles generally accepted in the United States of America, the information presented is not necessarily comparable with similar information from other financial institutions. In addition, methodologies used to measure, assign and allocate certain items may change from time-to-time to reflect, among other things, accounting refinements, changes in risk profiles, changes in customers or product lines, and changes in management structure. During the first quarter of 2003 the Company also changed the classification of mortgage loans not sold into the secondary market that are retained by the BANK. All revenues from these loans, along with the related Provisions and expenses, are now reported as part of the Mortgage Banking Segment instead of the Retail Banking Segment. Prior Period Segment results have been restated to reflect this change.
Total Segment results differ from consolidated results primarily due to intersegment elimination, certain corporate administration costs, items not otherwise allocated in the management accounting process and treasury and investment activities. The impact of these items is aggregated to reconcile the amounts presented for the Segments to the consolidated results and are included in the “Other” column. For ease of comparison, the Segment profit percentage in the following table is computed on earnings before the early extinguishment of debt and the cumulative effect of accounting change (the “Operating Profit” or “Operating Loss”).
The Company provides Commercial, Retail and Mortgage Banking services through its 63 banking locations. The Commercial Banking Segment provides services including lending, business checking and deposits, cash management, merchant card services and other traditional as well as electronic commercial banking services to large and small business customers. The Retail Banking Segment provides services including direct and indirect lending, checking, savings, money market and CD accounts, safe deposit rental, automated teller machines and other traditional and electronic retail banking services to individual customers. The Mortgage Banking segment provides a variety of mortgage lending products to meet its customer needs. It sells the majority of the long-term, fixed rate loans to the secondary market and continues to service most of the loans sold. The Trust and Asset Management segment provides trust, investment management, employee benefit recordkeeping and administration and brokerage services. It also acts as advisor and provides fund administration to the Vintage Mutual Funds and various public fund programs. These products are distributed nationally (i.e. Vintage Equity Fund is available through Charles Schwab, One Source™), regionally to institutional investors and corporations, and locally through the BANK’s locations.
NOTE 19 - RESTRICTIONS ON SUBSIDIARY DIVIDENDS, LOANS OR ADVANCES
Federal banking regulations place certain restrictions on dividends paid and loans or advances made by the BANK to the Company and its affiliates. The total amount of dividends which may be paid at any date is generally limited to the retained earnings of the BANK. Loans or advances to the Company and for each affiliate are limited to 10 percent of the BANK’s capital stock and surplus, but no more than 20 percent in aggregate. Loans and advances must be made on a secured basis.
At December 31, 2003, the BANK’s retained earnings available for the payment of dividends without prior regulatory approval was $49.9 million. The amount available for loans or advances by the BANK to the Company and its affiliates amounted to $26.4 million.
In addition, dividends paid by the BANK to the Company would be prohibited if the effect thereof would cause the BANK’s capital to be reduced below applicable minimum capital requirements. See also Note 20 of the Notes to Consolidated Financial Statements.
NOTE 20 - CAPITAL REQUIREMENTS
The Company and the BANK (Regulated Companies) are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Regulated Companies must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Their capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Regulated Companies to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital to risk-weighted assets, and of Tier 1 Capital to average assets. Tier 1 Capital includes common stockholders’ equity, qualifying preferred stock and Trust Preferred securities, less goodwill and certain other deductions (including the unrealized net gains and losses, after applicable taxes, on available-for-sale securities carried at fair value). Total Capital includes Tier 1 Capital plus preferred stock not qualifying as Tier 1 Capital, mandatory convertible debt, subordinated debt, certain unsecured senior debt issued by the Company, the allowance for loan and lease losses and net unrealized gains on marketable equity securities, subject to limitations by the guidelines.
As of December 31, 2003, the most recent notification from the Company’s regulators categorized the BANK as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized a bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the BANK’s category.
Management believes, as of December 31, 2003, that the Regulated Companies meet all capital adequacy requirements to which they are subject. The Company’s and the BANK’s actual capital amounts and ratios are presented in the table.
NOTE 21 - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY
CONDENSED PARENT COMPANY BALANCE SHEETS
CONDENSED PARENT COMPANY STATEMENTS OF INCOME
CONDENSED PARENT COMPANY STATEMENTS OF CASH FLOWS
CONDENSED QUARTERLY EARNINGS & STOCK PRICE SUMMARY (unaudited)
The financial information contains all normal and recurring reclassifications for a fair and consistent presentation.
Quotes have been obtained from the National Association of Security Dealers. These quotes do not reflect retail mark-ups, mark-downs or commissions nor are they necessarily representative of actual transactions.
Independent Auditors’ Report
The Board of Directors
AMCORE Financial, Inc.:
We have audited the accompanying consolidated balance sheets of AMCORE Financial, Inc. and subsidiaries (the Company) as of December 31, 2003 and 2002, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2003. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of AMCORE Financial, Inc. and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and cash flows for each of the years in the three-year period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 6 to the consolidated financial statements, effective January, 1, 2002 the Company adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets. Additionally, as discussed in Note 11 to the consolidated financial statements, effective January 1, 2001 the Company adopted Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by Statement of Financial Accounting Standards No. 138.
Chicago, Illinois
March 10, 2004
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective.
Changes in Internal Controls
There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the last fiscal quarter that have materially affected, or are reasonable likely to materially affect, the Company’s internal control over financial reporting.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) Directors of the Registrant. The Proxy Statement and Notice of 2004 Annual Meeting, dated March 12, 2004, are incorporated herein by reference.
(b) Executive Officers of the Registrant. The information is presented in Item 1 of this document.
(c) Code of Ethics. The Company has adopted a code of ethics applicable to all employees, including the principal executive officer, principal financial officer and principal accounting officer of the Company. The AMCORE Financial, Inc. Code of Ethics is posted on the Company’s website at www.AMCORE.com/governance. See Part I, Item 1 of this report on Form 10-K for additional information.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The Proxy Statement and Notice of 2004 Annual Meeting, dated March 12, 2004, are incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The Proxy Statement and Notice of 2004 Annual Meeting, dated March 12, 2004, are incorporated herein by reference.
Equity Compensation Plan Information
The following table sets forth information as of the end of the Company’s 2003 fiscal year with respect to all incentive/option plans under which equity securities are authorized for issuance.
(1) Does not include individual options to purchase 40,762 shares as of December 31, 2003, with a weighted average exercise price of $9.77 that were assumed by the Company in acquisitions. Includes options that have not vested and, therefore, are not currently exercisable. See Note 13 of the Notes to Consolidated Financial Statements - Stock Incentive Plans for additional information on vesting schedules. For purposes of determining diluted shares for earnings per share calculations, only options which are ‘in-the-money’ are included in the calculation. See Note 17 of the Notes to Consolidated Financial Statements - Earnings Per Share for additional information.
(2) The AMCORE Financial, Inc. 2000 Stock Incentive Plan (Plan) provides for the grant of stock options, reload options, stock appreciation rights, performance units, restricted stock awards and stock bonus awards to key employees. The Plan contains an “evergreen” provision that allows 2.5% of total outstanding shares be reserved for issuance under the Plan as of the effective date and 1.5% of total outstanding shares in each subsequent plan year not to exceed 425,000 shares in any one year, plus shares reserved for issuance but unissued in a prior plan year during the term of the Plan provided that the total shares available for issuance under the Plan and other similar plans does not exceed twelve percent of the total outstanding shares at the beginning of the plan year.
(3) The Restricted Stock Plan for Non-Employee Directors only provides for the issuance of restricted shares. The remaining shares available for grant under this plan which are included in the totals above is 223,030.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Proxy Statement and Notice of 2004 Annual Meeting, dated March 12, 2004, are incorporated herein by reference. See also Note 4 of the Notes to Consolidated Financial Statements.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The Proxy Statement and Notice of 2004 Annual Meeting, dated March 12, 2004, are incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)1. FINANCIAL STATEMENTS
The following Consolidated Financial Statements of AMCORE are filed as a part of this document under Item 8. Financial Statements and Supplementary Data.
Consolidated Balance Sheets - December 31, 2003 and 2002
Consolidated Statements of Income for the years ended December 31, 2003, 2002 and 2001
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2003, 2002 and 2001
Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001
Notes to Consolidated Financial Statements - December 31, 2003, 2002 and 2001
Independent Auditors’ Report
(a)2. FINANCIAL STATEMENT SCHEDULES
All financial statement schedules have been included in the consolidated financial statements or are either not applicable or not significant.
(a)3. EXHIBITS
(b) A report on Form 8-K, dated October 14, 2003, was filed concerning the Company’s results of operations for the quarter ended September 30, 2003.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Act of 1934, this report has been signed below on the 12th day of March, 2004 by the following persons on behalf of the Registrant in the capacities indicated.
Name
Title
Directors: Paula A. Bauer, Karen L. Branding, Paul Donovan, Kenneth E. Edge, John W. Gleeson, John A. Halbrook, Frederick D. Hay, William R. McManaman, Jack D. Ward and Gary L. Watson
Kenneth E. Edge*
John R. Hecht *
Attorney in Fact*
EXHIBIT INDEX