1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 1-15403
MARSHALL & ILSLEY CORPORATION
(Exact name of registrant as specified in its charter)
Wisconsin 39-0968604
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
770 North Water Street
Milwaukee, Wisconsin 53202
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (414) 765-7801
None
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated filer. See
definition of "accelerated filer and large accelerated filer" in Rule 12b-
2 of the Exchange Act. (Check one): Large accelerated filer [X]
Accelerated filer [ ] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company
(as defined by Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Outstanding at
Class July 31, 2006
----- ----------------
Common Stock, $1.00 Par Value 254,295,652
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2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MARSHALL & ILSLEY CORPORATION
CONSOLIDATED BALANCE SHEETS (Unaudited)
($000's except share data)
As Adjusted Note 11
---------------------------
June 30, December 31, June 30,
2006 2005 2005
-------------- ------------- --------------
Assets
------
Cash and cash equivalents:
Cash and due from banks $ 1,280,941 $ 1,155,263 $ 976,073
Federal funds sold and security resale agreements 221,497 209,869 217,139
Money market funds 40,831 49,219 51,410
------------- ------------- -------------
Total cash and cash equivalents 1,543,269 1,414,351 1,244,622
Investment securities:
Trading securities, at market value 54,928 29,779 22,539
Interest bearing deposits at other banks 18,252 40,659 14,362
Available for sale, at market value 6,627,287 5,701,703 5,572,628
Held to maturity, market value $559,869
($638,135 December 31, 2005 and $698,534 June 30, 2005) 547,686 618,554 668,107
------------- ------------- -------------
Total investment securities 7,248,153 6,390,695 6,277,636
Loans held for sale 157,041 277,847 193,092
Loans and leases:
Loans and leases, net of unearned income 40,230,299 33,889,066 31,952,759
Less: Allowance for loan and lease losses 415,201 363,769 360,138
------------- ------------- -------------
Net loans and leases 39,815,098 33,525,297 31,592,621
Premises and equipment, net 569,240 490,687 448,730
Goodwill and other intangibles 3,154,828 2,461,461 2,159,624
Accrued interest and other assets 1,931,237 1,652,379 1,567,395
------------- ------------- -------------
Total Assets $ 54,418,866 $ 46,212,717 $ 43,483,720
============= ============= =============
Liabilities and Shareholders' Equity
------------------------------------
Deposits:
Noninterest bearing $ 5,773,090 $ 5,525,019 $ 5,088,947
Interest bearing 27,184,702 22,149,202 20,972,493
------------- ------------- -------------
Total deposits 32,957,792 27,674,221 26,061,440
Federal funds purchased and security repurchase agreements 2,378,380 2,327,258 1,705,817
Other short-term borrowings 4,399,478 3,299,476 3,456,383
Accrued expenses and other liabilities 1,449,603 1,507,621 1,510,461
Long-term borrowings 7,476,087 6,668,670 6,470,684
------------- ------------- -------------
Total liabilities 48,661,340 41,477,246 39,204,785
Shareholders' equity:
---------------------
Series A convertible preferred stock, $1.00 par value;
2,000,000 shares authorized -- -- --
Common stock, $1.00 par value; 261,972,933 shares issued
(244,587,222 shares at December 31, 2005 and
244,432,222 shares at June 30, 2005) 261,973 244,587 244,432
Additional paid-in capital 1,747,576 970,739 870,380
Retained earnings 4,137,607 3,871,614 3,626,707
Accumulated other comprehensive income,
net of related taxes (101,251) (37,291) 15,508
Less: Treasury stock, at cost: 8,000,318 shares
(9,148,493 December 31, 2005 and
14,782,208 June 30, 2005) 253,201 277,423 448,212
Deferred compensation 35,178 36,755 29,880
------------- ------------- -------------
Total shareholders' equity 5,757,526 4,735,471 4,278,935
------------- ------------- -------------
Total Liabilities and Shareholders' Equity $ 54,418,866 $ 46,212,717 $ 43,483,720
============= ============= =============
See notes to financial statements.
3
MARSHALL & ILSLEY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
($000's except per share data)
As Adjusted
Note 11
---------------
Three Months Three Months
Ended June 30, Ended June 30,
2006 2005
--------------- ---------------
Interest and fee income
-----------------------
Loans and leases $ 714,243 $ 469,774
Investment securities:
Taxable 70,908 53,265
Exempt from federal income taxes 15,749 16,103
Trading securities 198 47
Short-term investments 5,011 2,294
------------- ------------
Total interest and fee income 806,109 541,483
Interest expense
----------------
Deposits 271,592 122,803
Short-term borrowings 43,124 28,391
Long-term borrowings 117,336 77,284
------------- ------------
Total interest expense 432,052 228,478
------------- ------------
Net interest income 374,057 313,005
Provision for loan and lease losses 11,053 13,725
------------- ------------
Net interest income after provision for loan and lease losses 363,004 299,280
Other income
------------
Data processing services 344,976 282,363
Wealth management 56,309 48,129
Service charges on deposits 25,005 23,711
Gains on sale of mortgage loans 10,219 9,489
Other mortgage banking revenue 2,062 1,702
Net investment securities gains 960 29,422
Life insurance revenue 7,408 8,055
Other 37,434 31,453
------------- ------------
Total other income 484,373 434,324
Other expense
-------------
Salaries and employee benefits 307,060 268,975
Net occupancy 25,698 20,789
Equipment 38,113 30,076
Software expenses 17,348 14,143
Processing charges 29,586 13,517
Supplies and printing 6,473 5,791
Professional services 14,036 12,802
Shipping and handling 21,669 16,751
Amortization of intangibles 12,004 8,106
Other 72,269 68,903
------------- ------------
Total other expense 544,256 459,853
------------- ------------
Income before income taxes 303,121 273,751
Provision for income taxes 99,372 90,006
------------- ------------
Net income $ 203,749 $ 183,745
============= ============
Net income per common share
Basic $ 0.81 $ 0.80
Diluted 0.79 0.79
Dividends paid per common share $ 0.270 $ 0.240
Weighted average common shares outstanding (000's):
Basic 252,764 228,630
Diluted 258,298 233,904
See notes to financial statements.
4
MARSHALL & ILSLEY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
($000's except per share data)
As Adjusted
Note 11
---------------
Six Months Six Months
Ended June 30, Ended June 30,
2006 2005
--------------- ---------------
Interest and fee income
-----------------------
Loans and leases $ 1,303,126 $ 893,695
Investment securities:
Taxable 128,776 105,208
Exempt from federal income taxes 31,748 31,510
Trading securities 268 116
Short-term investments 8,576 3,638
------------- -------------
Total interest and fee income 1,472,494 1,034,167
Interest expense
----------------
Deposits 469,718 226,293
Short-term borrowings 82,459 50,353
Long-term borrowings 221,680 145,658
------------- -------------
Total interest expense 773,857 422,304
------------- -------------
Net interest income 698,637 611,863
Provision for loan and lease losses 22,048 21,851
------------- -------------
Net interest income after provision for loan and lease losses 676,589 590,012
Other income
------------
Data processing services 687,956 565,297
Wealth management 109,108 95,197
Service charges on deposits 47,555 47,056
Gains on sale of mortgage loans 20,960 16,426
Other mortgage banking revenue 3,776 2,945
Net investment securities gains 2,090 35,276
Life insurance revenue 14,374 14,264
Other 71,324 60,320
------------- -------------
Total other income 957,143 836,781
Other expense
-------------
Salaries and employee benefits 584,463 514,051
Net occupancy 50,579 43,153
Equipment 71,052 61,086
Software expenses 34,786 27,495
Processing charges 56,599 28,442
Supplies and printing 12,595 12,287
Professional services 25,485 23,688
Shipping and handling 45,571 36,386
Amortization of intangibles 20,879 16,198
Other 147,380 140,058
------------- -------------
Total other expense 1,049,389 902,844
------------- -------------
Income before income taxes 584,343 523,949
Provision for income taxes 193,826 174,888
------------- -------------
Net income $ 390,517 $ 349,061
============= =============
Net income per common share
Basic $ 1.60 $ 1.53
Diluted 1.57 1.50
Dividends paid per common share $ 0.510 $ 0.450
Weighted average common shares outstanding (000's) :
Basic 244,088 228,097
Diluted 249,379 233,310
See notes to financial statements.
5
MARSHALL & ILSLEY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
($000's)
Six Months Six Months
Ended June 30, Ended June 30,
2006 2005
--------------- ---------------
Net Cash Provided by Operating Activities $ 436,972 $ 349,951
Cash Flows From Investing Activities:
-------------------------------------
Proceeds from sales of securities available for sale 558,720 82,409
Proceeds from maturities of securities available for sale 587,188 575,259
Proceeds from maturities of securities held to maturity 71,539 58,468
Purchases of securities available for sale (1,366,562) (857,602)
Net increase in loans (2,609,407) (2,526,610)
Purchases of assets to be leased (101,711) (142,589)
Principal payments on lease receivables 105,735 100,071
Purchases of premises and equipment, net (56,977) (18,022)
Acquisitions, net of cash and cash equivalents acquired (66,911) (15,910)
Other (1,684) 3,270
------------- -------------
Net cash used in investing activities (2,880,070) (2,741,256)
Cash Flows From Financing Activities:
-------------------------------------
Net increase (decrease) in deposits 1,596,693 (369,087)
Proceeds from issuance of commercial paper 2,019,445 2,566,764
Principal payments on commercial paper (1,972,059) (2,582,429)
Net increase in other short-term borrowings 521,658 1,197,465
Proceeds from issuance of long-term borrowings 1,199,051 2,030,041
Payments of long-term borrowings (670,666) (123,569)
Dividends paid (124,524) (102,567)
Purchases of common stock (41,790) --
Proceeds from exercise of stock options 49,408 36,372
Other (5,200) (5,201)
------------- -------------
Net cash provided by financing activities 2,572,016 2,647,789
------------- -------------
Net increase in cash and cash equivalents 128,918 256,484
Cash and cash equivalents, beginning of year 1,414,351 988,138
------------- -------------
Cash and cash equivalents, end of period $ 1,543,269 $ 1,244,622
============= =============
Supplemental cash flow information:
-----------------------------------
Cash paid during the period for:
Interest $ 688,262 $ 355,298
Income taxes 174,028 169,032
See notes to financial statements.
6
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements
June 30, 2006 & 2005 (Unaudited)
1. The accompanying unaudited consolidated financial statements should be
read in conjunction with Marshall & Ilsley Corporation's ("M&I" or
"Corporation") Annual Report on Form 10-K for the year ended December
31, 2005. The unaudited financial information included in this report
reflects all adjustments consisting of normal recurring accruals and the
adjustments as discussed in Note 11 which are necessary for a fair
statement of the financial position and results of operations as of and
for the three and six months ended June 30, 2006 and 2005. The results
of operations for the three and six months ended June 30, 2006 and 2005
are not necessarily indicative of results to be expected for the entire
year. Certain amounts in the 2005 consolidated financial statements and
analyses have been reclassified to conform with the 2006 presentation.
2. New Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 48 ("FIN 48") Accounting for Uncertainty in
Income Taxes an interpretation of FASB Statement No. 109. FIN 48
clarifies the accounting for uncertainty in income taxes recognized in
financial statements in accordance with FASB Statement No. 109,
Accounting for Income Taxes. FIN 48 prescribes a recognition threshold
and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax
return. FIN 48 also provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure and
transition.
The provisions of FIN 48 are effective beginning January 1, 2007, with
the cumulative effect of the change in accounting principle recorded as
an adjustment to opening retained earnings. The Corporation is
currently evaluating the financial statement impact, if any, of adopting
FIN 48.
On June 28, 2006, the FASB ratified EITF Issue No. 06-3, How Taxes
Collected from Customers and Remitted to Governmental Authorities Should
Be Presented in the Income Statement (That Is, Gross versus Net
Presentation). Certain taxes such as sales taxes and other excise taxes
are levied by various taxing authorities based on sales activity.
Although generally levied on the purchaser of the goods or services, the
selling party usually collects and remits the sales tax to the
government. However, in certain jurisdictions sales taxes are levied on
sellers of the goods and services as opposed to the purchasers. Under
this consensus these taxes may be presented gross as revenue and an
offsetting expense or may be presented net and excluded from revenue.
The guidance in this consensus is effective January 1, 2007 with early
application permitted. This consensus will not impact the Corporation's
results of operations or financial position and the Corporation will
continue to report these taxes on a net basis. Taxes subject to this
consensus primarily relate to the Corporation's data processing
subsidiary, Metavante.
7
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2006 & 2005 (Unaudited)
3. Comprehensive Income
The following tables present the Corporation's comprehensive income
($000's):
Three Months Ended June 30, 2006
------------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
-------------- ------------ -------------
Net income $ 203,749
Other comprehensive income:
Unrealized gains (losses) on securities:
Arising during the period $ (86,639) $ 30,269 (56,370)
Reclassification for securities
transactions included in net income (1,493) 522 (971)
------------- ------------ ------------
Unrealized gains (losses) (88,132) 30,791 (57,341)
Net gains (losses) on derivatives
hedging variability of cash flows:
Arising during the period 3,536 (1,238) 2,298
Reclassification adjustments for
hedging activities included in net income (3,794) 1,328 (2,466)
------------- ------------ ------------
Net gains (losses) $ (258) $ 90 (168)
------------- ------------ ------------
Other comprehensive income (loss) (57,509)
------------
Total comprehensive income $ 146,240
============
Three Months Ended June 30, 2005
As Adjusted
------------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
-------------- ------------ -------------
Net income $ 183,745
Other comprehensive income:
Unrealized gains (losses) on securities:
Arising during the period $ 49,028 $ (17,313) 31,715
Reclassification for securities
transactions included in net income (144) 50 (94)
------------- ------------ ------------
Unrealized gains (losses) 48,884 (17,263) 31,621
Net gains (losses) on derivatives
hedging variability of cash flows:
Arising during the period 403 (141) 262
Reclassification adjustments for
hedging activities included in net income (34) 12 (22)
------------- ------------ ------------
Net gains (losses) $ 369 $ (129) 240
------------- ------------ ------------
Other comprehensive income (loss) 31,861
------------
Total comprehensive income $ 215,606
============
8
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2006 & 2005 (Unaudited)
Six Months Ended June 30, 2006
------------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
-------------- ------------ -------------
Net income $ 390,517
Other comprehensive income:
Unrealized gains (losses) on securities:
Arising during the period $ (102,563) $ 35,865 (66,698)
Reclassification for securities
transactions included in net income (1,941) 679 (1,262)
------------- ------------ ------------
Unrealized gains (losses) (104,504) 36,544 (67,960)
Net gains (losses) on derivatives
hedging variability of cash flows:
Arising during the period 11,873 (4,156) 7,717
Reclassification adjustments for
hedging activities included in net income (5,719) 2,002 (3,717)
------------- ------------ ------------
Net gains (losses) $ 6,154 $ (2,154) 4,000
------------- ------------ ------------
Other comprehensive income (loss) (63,960)
------------
Total comprehensive income $ 326,557
============
Six Months Ended June 30, 2005
As Adjusted
------------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
-------------- ------------ -------------
Net income $ 349,061
Other comprehensive income:
Unrealized gains (losses) on securities:
Arising during the period $ (26,691) $ 9,426 (17,265)
Reclassification for securities
transactions included in net income (118) 41 (77)
------------- ------------ ------------
Unrealized gains (losses) (26,809) 9,467 (17,342)
Net gains (losses) on derivatives
hedging variability of cash flows:
Arising during the period 11,594 (4,058) 7,536
Reclassification adjustments for
hedging activities included in net income 3,040 (1,064) 1,976
------------- ------------ ------------
Net gains (losses) $ 14,634 $ (5,122) 9,512
------------- ------------ ------------
Other comprehensive income (loss) (7,830)
------------
Total comprehensive income $ 341,231
============
9
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2006 & 2005 (Unaudited)
4. A reconciliation of the numerators and denominators of the basic and
diluted per share computations are as follows (dollars and shares in
thousands, except per share data):
Three Months Ended June 30, 2006
---------------------------------------
Income Average Shares Per Share
(Numerator) (Denominator) Amount
------------ --------------- ----------
Basic Earnings Per Share
Income Available to Common Shareholders $ 203,749 252,764 $ 0.81
=========
Effect of Dilutive Securities
Stock Options, Restricted Stock
and Other Plans -- 5,534
---------- --------------
Diluted Earnings Per Share
Income Available to Common Shareholders $ 203,749 258,298 $ 0.79
=========
Three Months Ended June 30, 2005
As Adjusted
---------------------------------------
Income Average Shares Per Share
(Numerator) (Denominator) Amount
------------ --------------- ----------
Basic Earnings Per Share
Income Available to Common Shareholders $ 183,745 228,630 $ 0.80
=========
Effect of Dilutive Securities
Stock Options, Restricted Stock
and Other Plans -- 5,274
---------- --------------
Diluted Earnings Per Share
Income Available to Common Shareholders $ 183,745 233,904 $ 0.79
=========
Six Months Ended June 30, 2006
---------------------------------------
Income Average Shares Per Share
(Numerator) (Denominator) Amount
------------ --------------- ----------
Basic Earnings Per Share
Income Available to Common Shareholders $ 390,517 244,088 $ 1.60
=========
Effect of Dilutive Securities
Stock Options, Restricted Stock
and Other Plans -- 5,291
---------- --------------
Diluted Earnings Per Share
Income Available to Common Shareholders $ 390,517 249,379 $ 1.57
=========
Six Months Ended June 30, 2005
As Adjusted
---------------------------------------
Income Average Shares Per Share
(Numerator) (Denominator) Amount
------------ --------------- ----------
Basic Earnings Per Share
Income Available to Common Shareholders $ 349,061 228,097 $ 1.53
=========
Effect of Dilutive Securities
Stock Options, Restricted Stock
and Other Plans -- 5,213
---------- --------------
Diluted Earnings Per Share
Income Available to Common Shareholders $ 349,061 233,310 $ 1.50
=========
10
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2006 & 2005 (Unaudited)
Options to purchase shares of common stock not included in the
computation of diluted net income per share because the stock options
were antidilutive are as follows (shares in thousands):
Three Months Ended June 30, Six Months Ended June 30,
------------------------------------ ------------------------------------
2006 2005 2006 2005
----------------- ----------------- ----------------- -----------------
Shares 47 8 131 34
Price Range $45.110 - $47.020 $43.310 - $44.200 $44.200 - $47.020 $42.710 - $44.200
5. Business Combinations
The following acquisitions, which are not considered to be material
business combinations individually or in the aggregate, were completed
during the second quarter of 2006:
On April 1, 2006, Marshall & Ilsley Corporation completed the
acquisition of Gold Banc Corporation, Inc. ("Gold Banc"), a bank holding
company headquartered in Leawood, Kansas, which offers commercial
banking, retail banking, trust and asset management products and
services through various subsidiaries. Gold Banc had consolidated
assets of $4.2 billion at the time of the merger. Total consideration
in this transaction, including the effect of terminating Gold Banc's
employee stock ownership plan, amounted to $716.2 million, consisting of
13,673,072 shares of M&I common stock valued at $601.0 million, the
exchange of 119,816 vested options valued at $2.9 million and total cash
consideration of $112.3 million. Gold Banc's largest subsidiary, Gold
Bank, a Kansas state-chartered bank, was merged with and into M&I
Marshall & Ilsley Bank on April 1, 2006, at which time the 32 Gold Bank
branch offices in Florida, Kansas, Missouri and Oklahoma became
interstate branch offices of M&I Marshall & Ilsley Bank. Initial
goodwill, subject to the completion of appraisals and valuation of the
assets acquired and liabilities assumed, amounted to $493.3 million.
Approximately $485.4 million of the goodwill was assigned to the Banking
segment and the remainder was assigned to the Corporation's Trust
reporting unit. The estimated identifiable intangible asset to be
amortized (core deposits) with an estimated weighted average life of 5.0
years amounted to $44.1 million. The goodwill and intangibles resulting
from this transaction are not deductible for tax purposes.
On April 1, 2006, Marshall & Ilsley Corporation completed the
acquisition of St. Louis-based Trustcorp Financial, Inc. ("Trustcorp").
With the acquisition of Trustcorp, which had consolidated assets of
$735.7 million at the time of the merger, the Corporation acquired
Missouri State Bank and Trust Company, which provides commercial banking
services in Missouri through seven bank locations. In July 2006,
Missouri State Bank and all of its branches were merged with and into
Southwest Bank, the Corporation's St. Louis-based banking affiliate.
Total consideration in this transaction amounted to $182.0 million,
consisting of 3,069,430 shares of M&I common stock valued at $134.9
million, the exchange of 412,317 vested options valued at $13.4 million
and cash consideration of $33.7 million. Initial goodwill, subject to
the completion of appraisals and valuation of the assets acquired and
liabilities assumed, amounted to $129.4 million. The estimated
identifiable intangible asset to be amortized (core deposits) with an
estimated weighted average life of 7.5 years amounted to $10.9 million.
The goodwill and intangibles resulting from this transaction are
partially deductible for tax purposes.
The common stock issued and vested options exchanged in the acquistion
of Gold Banc and Trustcorp are non-cash transactions for purposes of the
Consolidated Statements of Cash Flows.
Recent acquisition activities
-----------------------------
On June 29, 2006, Metavante announced the signing of a definitive
agreement to acquire VICOR, Inc. ("VICOR") of Richmond, California.
VICOR is a provider of software and solutions that simplify and
automate the processing of complex payments for businesses and financial
institutions. The acquisition is expected to close in the third quarter
of 2006, pending regulatory approval and other customary closing
conditions. The purchase is not expected to have a material impact on
the financial results of Metavante or the Corporation.
11
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2006 & 2005 (Unaudited)
6. Selected investment securities, by type, held by the Corporation were as
follows ($000's):
June 30, December 31, June 30,
2006 2005 2005
-------------- -------------- --------------
Investment securities available for sale:
U.S. treasury and government agencies $ 5,219,287 $ 4,379,148 $ 4,254,711
State and political subdivisions 748,967 703,892 671,782
Mortgage backed securities 101,945 116,464 144,070
Other 557,088 502,199 502,065
------------- ------------- -------------
Total $ 6,627,287 $ 5,701,703 $ 5,572,628
============= ============= =============
Investment securities held to maturity:
State and political subdivisions $ 546,186 $ 616,554 $ 665,807
Other 1,500 2,000 2,300
------------- ------------- -------------
Total $ 547,686 $ 618,554 $ 668,107
============= ============= =============
The following table provides the gross unrealized losses and fair value,
aggregated by investment category and the length of time the individual
securities have been in a continuous unrealized loss position, at June
30, 2006 ($000's):
Less than 12 Months 12 Months or More Total
------------------------- ------------------------- --------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
------------ ----------- ------------ ----------- ------------ ------------
U.S. treasury and
government agencies $ 3,090,843 $ 78,238 $ 1,936,556 $ 86,669 $ 5,027,399 $ 164,907
State and political
subdivisions 328,100 7,300 82,492 4,070 410,592 11,370
Mortgage backed securities 36,796 910 65,149 2,912 101,945 3,822
Other 1,822 62 -- -- 1,822 62
----------- ---------- ----------- ---------- ----------- -----------
Total $ 3,457,561 $ 86,510 $ 2,084,197 $ 93,651 $ 5,541,758 $ 180,161
=========== ========== =========== ========== =========== ===========
The investment securities in the above table were temporarily impaired
at June 30, 2006. This temporary impairment represents the amount of
loss that would have been realized if the investment securities had been
sold on June 30, 2006. The temporary impairment in the investment
securities portfolio is predominantly the result of increases in market
interest rates since the investment securities were acquired and not
from deterioration in the creditworthiness of the issuer.
12
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2006 & 2005 (Unaudited)
7. The Corporation's loan and lease portfolio, including loans held for
sale, consisted of the following ($000's):
June 30, December 31, June 30,
2006 2005 2005
-------------- -------------- --------------
Commercial, financial and agricultural $ 11,763,501 $ 9,599,361 $ 9,147,994
Cash flow hedging instruments at fair value (55,541) (33,886) (4,549)
------------- ------------- -------------
Commercial, financial and agricultural 11,707,960 9,565,475 9,143,445
Real estate:
Construction 5,402,120 3,641,942 2,984,601
Residential mortgage 5,816,886 5,050,803 4,335,593
Home equity loans and lines of credit 4,537,014 4,833,480 4,977,525
Commercial mortgage 10,860,893 8,825,104 8,585,700
------------- ------------- -------------
Total real estate 26,616,913 22,351,329 20,883,419
Personal 1,408,973 1,617,761 1,526,442
Lease financing 653,494 632,348 592,545
------------- ------------- -------------
Total loans and leases $ 40,387,340 $ 34,166,913 $ 32,145,851
============= ============= =============
8. Financial Asset Sales
During the second quarter of 2006, automobile loans with principal
balances of $177.7 million were sold in securitization transactions.
The net gains and losses from the sale and securitization of auto loans
for the three and six months ended June 30, 2006 and 2005, respectively,
were not significant. Other income associated with auto
securitizations, primarily servicing income, amounted to $3.0 million in
the current quarter.
Key economic assumptions used in measuring the retained interests at the
date of securitization resulting from securitizations completed during
the quarter were as follows (rate per annum):
Prepayment speed (CPR) 17-42 %
Weighted average life (in months) 20.8
Expected credit losses
(based on original balance) 0.36-1.03 %
Residual cash flow discount rate 12.0 %
Variable returns to transferees Forward one-month LIBOR yield curve
At June 30, 2006, securitized automobile loans and other automobile
loans managed together with them, along with delinquency and credit loss
information consisted of the following ($000's):
Total
Securitized Portfolio Managed
------------- ------------- -------------
Loan balances $ 1,028,361 $ 152,716 $ 1,181,077
Principal amounts of loans
60 days or more past due 2,075 390 2,465
Net credit losses year to date 1,230 807 2,037
9. Goodwill and Other Intangibles
The changes in the carrying amount of goodwill for the six months ended
June 30, 2006 were as follows ($000's):
Banking Metavante Others Total
------------- ------------- ------------- -------------
Goodwill balance as of January 1, 2006 $ 809,376 $ 1,272,039 $ 7,804 $ 2,089,219
Goodwill acquired during the period 614,801 21,767 21,251 657,819
Purchase accounting adjustments (121) (22,224) -- (22,345)
------------ ------------ ------------ ------------
Goodwill balance as of June 30, 2006 $ 1,424,056 $ 1,271,582 $ 29,055 $ 2,724,693
============ ============ ============ ============
13
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2006 & 2005 (Unaudited)
Goodwill acquired during the second quarter of 2006 for the Banking
segment includes initial goodwill of $485.4 million for the acquisition
of Gold Banc and $129.4 million in initial goodwill relating to the
acquisition of Trustcorp. Goodwill acquired for the Metavante segment
includes initial goodwill relating to the acquisition of AdminiSource in
the first quarter of 2006. Goodwill for the Others segment includes
initial goodwill relating to the acquisition of FirstTrust Indiana of
$13.4 million in the first quarter of 2006, and initial goodwill
allocated to the Trust reporting unit of $7.9 million from the
acquisition of Gold Banc in the second quarter of 2006.
Purchase accounting adjustments for Metavante for the six months ended
June 30, 2006 represent adjustments made to the initial estimates of
fair value associated with the acquisitions of Everlink Payment
Services, Inc., GHR Systems, Inc., Brasfield, AdminiSource, Med-i-Bank,
Inc., LINK2GOV Corp. and NYCE Corporation ("NYCE") and its affiliate
companies. During the first quarter, Metavante received $29.9 million
as a return of the purchase price associated with the NYCE acquisition.
Purchase accounting adjustments for the Banking segment were
attributable to the reduction of goodwill allocated to a branch
divestiture.
At June 30, 2006, the Corporation's other intangible assets consisted of
the following ($000's):
June 30, 2006
-----------------------------------------
Accum-
Gross ulated Net
Carrying Amort- Carrying
Amount ization Value
------------- ------------- -------------
Other intangible assets
Core deposit intangible $ 207,805 $ 86,516 $ 121,289
Data processing contract rights/customer lists 338,608 45,367 293,241
Trust customers 6,750 1,580 5,170
Tradename 8,275 996 7,279
Other Intangibles 1,250 552 698
------------ ------------ ------------
$ 562,688 $ 135,011 $ 427,677
============ ============ ============
Mortgage loan servicing rights $ 2,458
============
Amortization expense of other intangible assets for the three and six
months ended June 30, 2006 amounted to $12.0 million and $20.9 million,
respectively. Amortization expense of other intangible assets for the
three and six months ended June 30, 2005 was $8.1 million and $16.2
million, respectively.
The estimated amortization expense of other intangible assets and
mortgage loan servicing rights for the next five annual fiscal years are
($000's):
2007 $ 44,441
2008 40,863
2009 37,775
2010 35,455
2011 33,688
14
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2006 & 2005 (Unaudited)
10. The Corporation's deposit liabilities consisted of the following
($000's):
June 30, December 31, June 30,
2006 2005 2005
-------------- -------------- --------------
Noninterest bearing demand $ 5,773,090 $ 5,525,019 $ 5,088,947
Savings and NOW 11,549,045 10,462,831 9,999,393
Cash flow hedge-Brokered MMDA (5,633) (5,326) (2,998)
------------- ------------- -------------
Total Savings and NOW 11,543,412 10,457,505 9,996,395
CD's $100,000 and over 8,107,033 5,652,359 5,980,536
Cash flow hedge-Institutional CDs (17,419) (13,767) (13,944)
------------- ------------- -------------
Total CD's $100,000 and over 8,089,614 5,638,592 5,966,592
Other time deposits 4,801,124 3,434,476 3,006,936
Foreign deposits 2,750,552 2,618,629 2,002,570
------------- ------------- -------------
Total deposits $ 32,957,792 $ 27,674,221 $ 26,061,440
============= ============= =============
11. Share-Based Compensation Plans
The Corporation has Equity Incentive Plans which provide for the grant
of nonqualified and incentive stock options, stock appreciation rights,
rights to purchase shares of restricted stock and the award of
restricted stock units to key employees and directors of the Corporation
at prices ranging from zero to the market value of the shares at the
date of grant. The Equity Incentive Plans generally provide for the
grant of options to purchase shares of the Corporation's common stock
for a period of ten years from the date of grant. Stock options granted
generally become exercisable over a period of three years from the date
of grant. However, stock options granted to directors of the
Corporation vest immediately and stock options granted after 1996
provide accelerated or immediate vesting for grants to individuals who
meet certain age and years of service criteria at the date of grant.
Restrictions on stock or units issued pursuant to the Equity Incentive
Plans generally lapse within a three to seven year period.
The Corporation also has a Long-Term Incentive Plan. Under the plan,
performance units may be awarded from time to time. Once awarded,
additional performance units will be credited to each participant based
on dividends paid by the Corporation on its common stock. At the end of
a designated vesting period, participants will receive a cash award
equal to the Corporation's average common stock price over the last five
days of the vesting period multiplied by some percent (0%-275%) of the
initial performance units credited plus those additional units credited
as dividends based on the established performance criteria. The vesting
period is three years from the date the performance units were awarded.
The Corporation also has a qualified employee stock purchase plan (the
"ESPP") which gives employees who elect to participate in the plan the
right to acquire shares of the Corporation's common stock at the
purchase price which is 85 percent of the lesser of the fair market
value of the Corporation's common stock on the first or last day of the
one-year offering period ("look-back feature") which has historically
been from July 1 to June 30. Effective July 1, 2006, the ESPP plan was
amended to eliminate the look-back feature and to provide employees who
elect to participate in the plan the right to acquire shares of the
Corporation's common stock at the purchase price which is 85 percent of
the fair market value of the Corporation's common stock on the last day
of each three month period within the one-year offering period.
Effective January 1, 2006, the Corporation adopted Statement of
Financial Accounting Standard No. 123 (revised 2004), Share-Based
Payment ("SFAS 123(R)"). SFAS 123(R) replaces FASB Statement No. 123
Accounting for Stock-Based Compensation ("SFAS 123"), and supercedes
Accounting Principles Board Opinion No. 25 ("APBO 25") Accounting for
Stock Issued to Employees. Statement 123(R) requires that compensation
cost relating to share-based payment transactions be recognized in
financial statements. That cost is measured based on the fair value of
the equity or liability instruments issued. Statement 123(R) covers a
wide range of share-based compensation arrangements including stock
options, restricted stock plans, performance-based awards, stock
appreciation rights, and employee stock purchase plans. Statement 123(R)
also provides guidance on measuring the fair value of share-based
payments awards.
15
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2006 & 2005 (Unaudited)
The Corporation elected the Modified Retrospective Application method to
implement this new accounting standard. Under that method, compensation
cost is recognized beginning on the effective date based upon (a) the
requirements of SFAS 123(R) for all share-based payments granted after
the effective date and (b) the fair value method of accounting
provisions of SFAS 123 for all awards granted to employees prior to the
effective date of SFAS 123(R) that remain unvested on the effective
date.
As permitted under SFAS 123, the Corporation previously recognized
compensation cost using the intrinsic value method of accounting
prescribed in APBO 25. Under the intrinsic value method, compensation
cost is the excess, if any, of the quoted market price of the stock at
grant date or other measurement date over the amount paid to acquire the
stock. Under APBO 25, no compensation cost was recognized for the
nonqualified and incentive stock options because the exercise price was
equal to the quoted market price of the Corporation's common stock at
the date of grant and therefore, those options had no intrinsic value on
the date of grant. Under APBO 25, no compensation cost was recognized
for the Corporation's ESPP because the discount (15%) and the plan met
the definition of a qualified plan of the Internal Revenue Code and met
the requirements of APBO 25.
Under the fair value method of accounting, compensation cost is measured
at the grant date based on the fair value of the award using an option-
pricing model that takes into account the stock price at the grant date,
the exercise price, the expected life of the option, the volatility of
the underlying stock, expected dividends and the risk-free interest rate
over the expected life of the option. The resulting compensation cost
for stock options that vest is recognized over the service period, which
is usually the vesting period. The fair value method of accounting
provided under SFAS 123 is generally similar to the fair value method of
accounting under SFAS 123(R).
Under the Modified Retrospective Application method, in addition to
recognizing compensation cost beginning on the effective date, financial
statements prior to the effective date have been adjusted based on pro
forma amounts previously disclosed under SFAS 123 for all periods for
which SFAS 123 was effective.
The impact to Shareholders' equity as a result of applying the Modified
Retrospective Application method to adopt SFAS 123(R) is as follows
($000's):
December 31, June 30,
2005 2005
------------ ------------
Decrease to Retained Earnings $ (149,544) $ (137,271)
Increase to Additional Paid-in Capital 217,205 203,021
----------- -----------
Net Increase to Shareholders' equity $ 67,661 $ 65,750
=========== ===========
The net increase to Shareholders' equity represents the deferred income
tax benefit outstanding associated with the cumulative effect on net
income from January 1, 1995 to December 31, 2005 and June 30, 2005,
respectively, from recognizing share-based compensation previously not
reported.
16
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2006 & 2005 (Unaudited)
The Corporation's net income and earnings per share as adjusted for the
ESPP and stock options is as follows for the three and six months ended
June 30, 2005 ($000's except per share data):
Three Months Six Months
Ended June 30, Ended June 30,
2005 2005
------------- -------------
Net Income, as originally reported $ 188,487 $ 358,067
Less: Stock-based employee compensation
expense previously not included in
net income under the intrinsic method
of accounting, net of tax (4,742) (9,006)
------------ ------------
Restated net income $ 183,745 $349,061
============ ============
Basic earnings per share:
As originally reported $0.82 $1.57
Restated 0.80 1.53
Diluted earnings per share:
As originally reported $0.81 $1.54
Restated 0.79 1.50
The Consolidated Statements of Cash Flows was not materially impacted.
Activity relating to nonqualified and incentive stock options for the
three months ended June 30, 2006 and 2005 was:
Weighted-
Average
Number Option Price Exercise
of Shares Per Share Price
------------ --------------- ------------
Shares under option at March 31, 2005 22,380,226 $10.13 - 44.20 $30.86
Options granted 102,750 41.72 - 44.96 42.24
Options lapsed or surrendered (77,815) 22.80 - 41.95 34.72
Options exercised (594,584) 10.13 - 38.25 24.50
------------ --------------- ------------
Shares under option at June 30, 2005 21,810,577 $13.09 - 44.96 $31.07
============ =============== ============
Shares under option at March 31, 2006 23,806,283 $15.94 - 47.02 $33.30
Options granted 398,500 43.36 - 45.72 43.99
Vested options exchanged in acquisitions 532,133 5.71 - 43.67 12.99
Options lapsed or surrendered (64,918) 31.72 - 44.96 42.60
Options exercised (779,491) 5.71 - 42.82 23.22
------------ --------------- ------------
Shares under option at June 30, 2006 23,892,507 $ 5.71 - 47.02 $33.32
============ =============== ============
17
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2006 & 2005 (Unaudited)
Activity relating to nonqualified and incentive stock options for the
six months ended June 30, 2006 and 2005 was:
Weighted-
Average
Number Option Price Exercise
of Shares Per Share Price
------------ --------------- ------------
Shares under option at December 31, 2004 22,878,097 $10.13 - 44.20 $30.70
Options granted 153,250 40.49 - 44.96 42.20
Options lapsed or surrendered (149,339) 22.80 - 41.95 36.03
Options exercised (1,071,431) 10.13 - 41.95 23.99
------------ --------------- ------------
Shares under option at June 30, 2005 21,810,577 $13.09 - 44.96 $31.07
============ =============== ============
Shares under option at December 31, 2005 24,655,317 $15.94 - 47.02 $33.09
Options granted 470,400 41.30 - 45.72 43.92
Vested options exchanged in acquisitions 532,133 5.71 - 43.67 12.99
Options lapsed or surrendered (238,172) 31.72 - 44.96 41.73
Options exercised (1,527,171) 5.71 - 42.82 24.46
------------ --------------- ------------
Shares under option at June 30, 2006 23,892,507 $ 5.71 - 47.02 $33.32
============ =============== ============
Stock option awards to directors of the Corporation generally occur
during the second quarter and stock option awards to employees primarily
occur in the fourth quarter. Generally, the Corporation uses shares of
treasury stock to satisfy stock options exercised.
The ranges of nonqualified and incentive stock options outstanding at
June 30, 2006 were:
Weighted-Average
Weighted-Average Remaining
Weighted-Average Aggregate Contractual
Number of Shares Exercise Price Intrinsic Value Life (In Years)
----------------------- ------------------- ------------------- -------------------
Out- Exer- Out- Exer- Out- Exer- Out- Exer-
Price Range standing cisable standing cisable standing cisable standing cisable
-------------- ----------- ----------- --------- --------- --------- --------- --------- ---------
$ 5.50 - 24.99 2,579,983 2,579,983 $20.32 $20.32 $25.42 $25.42 4.0 4.0
$25.00 - 28.49 1,724,245 1,724,245 25.93 25.93 19.81 19.81 3.1 3.1
$28.50 - 30.49 4,025,390 4,022,990 28.59 28.59 17.15 17.15 5.2 5.2
$30.50 - 32.49 4,708,106 4,700,704 31.43 31.43 14.31 14.31 4.7 4.7
$32.50 - 35.49 3,092,706 2,281,898 34.77 34.76 10.97 10.98 7.3 7.2
$35.50 - 42.49 3,632,670 1,696,229 41.59 41.41 4.15 4.33 8.3 8.3
Over $42.50 4,129,407 617,943 42.97 42.96 2.77 2.78 9.4 9.4
----------- ----------- --------- --------- --------- --------- --------- ---------
23,892,507 17,623,992 $33.32 $30.41 $12.42 $15.33 6.3 5.4
=========== =========== ========= ========= ========= ========= ========= =========
The fair value of each stock option grant was estimated as of the date
of grant using the Black-Scholes closed form option-pricing model for
stock options granted prior to September 30, 2004. A form of a lattice
option-pricing model was used for stock options granted after September
30, 2004.
The grant date fair values and assumptions used to determine such value
are as follows:
Three Months Ended June 30, Six Months Ended June 30,
------------------------------ --------------------------------
2006 2005 2006 2005
-------------- -------------- -------------- ----------------
Weighted-average grant
date fair value $7.93 $8.38 $7.92 $8.02
Assumptions:
Risk-free interest rates 4.87 - 5.66 % 3.33 - 4.45 % 4.22 - 5.66 % 3.33 - 4.45 %
Expected volatility 18.20 % 18.50 % 18.20 - 18.50 % 13.12 - 18.50 %
Expected term (in years) 6.3 - 6.9 5.1 - 7.8 6.3 - 6.9 5.1 - 7.8
Expected dividend yield 2.20 % 2.19 % 2.20 % 1.92 - 2.19 %
18
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2006 & 2005 (Unaudited)
The total intrinsic value of nonqualified and incentive stock options
exercised during the three months ended June 30, 2006 and 2005 was $17.2
million and $11.2 million, respectively. For the six months ended June
30, 2006 and 2005, the total intrinsic value of nonqualified and
incentive stock options exercised was $30.7 million and $19.9 million,
respectively. The total fair value of shares vested during the three
months ended June 30, 2006 and 2005 amounted to $1.1 million and $1.2
million, respectively. For the six months ended June 30, 2006 and 2005,
the total fair value of shares vested amounted to $1.6 million and $1.5
million, respectively.
There was approximately $24.7 million of total unrecognized compensation
expense related to unvested nonqualified and incentive stock options at
June 30, 2006. The total unrecognized compensation expense will be
recognized over a weighted average period of 2.0 years. For awards with
graded vesting, compensation expense was recognized using an accelerated
method prior to the adoption of SFAS 123(R) and is recognized on a
straight line basis for awards granted after the effective date.
For the three months ended June 30, 2006 and 2005 the expense for
nonqualified and incentive stock options that is included in Salaries
and employee benefits expense in the Consolidated Statements of Income
amounted to $6.7 million and $5.9 million, respectively. For the six
months ended June 30, 2006 and 2005 the expense for nonqualified and
incentive stock options that is included in Salaries and employee
benefits expense in the Consolidated Statements of Income amounted to
$13.3 million and $11.7 million, respectively. These amounts are
considered non-cash expenses for the Statements of Cash Flow purposes.
For the three and six months ended June 30, 2006 and 2005 the expense
for Director's nonqualified and incentive stock options that is included
in Other expense in the Consolidated Statements of Income amounted to
$0.6 million and $0.7 million, respectively.
Activity relating to the Corporation's Restricted Stock Purchase Rights
was:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
2006 2005 2006 2005
---------- --------- ---------- ---------
Restricted stock purchase rights
outstanding - Beginning of Year -- -- -- --
Restricted stock purchase rights granted 44,000 7,000 51,000 14,500
Restricted stock purchase rights exercised (44,000) (7,000) (51,000) (14,500)
---------- --------- ---------- ---------
Restricted stock purchase rights
outstanding - End of Period -- -- -- --
========== ========= ========== =========
Weighted-average grant date market value $44.67 $42.61 $44.54 $41.95
Aggregate compensation expense ($000's) $1,377 $977 $2,647 $2,027
Unamortized compensation expense ($000's) $12,298 $9,027 $12,298 $9,027
Restrictions on stock issued pursuant to the exercise of stock purchase
rights generally lapse within a three to seven year period.
Accordingly, the compensation related to issuance of the rights is
amortized over the vesting period. At June 30, 2006, the unamortized
compensation expense will be recognized over a weighted average period
of 1.8 years. Aggregate compensation expense for the three and six
months ended June 30, 2006 amounted to $1.4 million and $2.6 million,
respectively. For the three and six months ended June 30, 2005, the
aggregate compensation expense amounted to $1.0 million and $2.0
million, respectively. These amounts are considered non-cash expenses
for the Statements of Cash Flow purposes.
As participants in the Long-Term Incentive Plan will receive a cash
award at the end of the designated vesting period, this plan meets the
definition of a liability award. Unlike equity awards, liability awards
are remeasured at fair value at each balance sheet date until
settlement. For the three months ended June 30, 2006 and 2005 the
expense for the Long-Term Incentive Plan that is included in Salaries
and employee benefits expense in the Consolidated Statements of Income
amounted to $5.4 million and $6.0 million, respectively. For the six
months ended June 30, 2006 and 2005 the expense for the Long-Term
Incentive Plan that is included in Salaries and employee benefits
expense in the Consolidated Statements of Income amounted to $3.5
million and $6.6 million, respectively.
19
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2006 & 2005 (Unaudited)
Under SFAS 123(R), compensation expense is recognized for the ESPP. The
compensation cost per share is approximately equal to the sum of: the
initial discount (15% of beginning of plan period price per share), plus
the value of a one year call option on 85% of a share of common stock
and the value of a one year put option on 15% of a share of common stock
for each share purchased. The compensation cost per share for the ESPP
was $9.96 and $8.04 for the three and six months ended June 30, 2006 and
2005, respectively. Employee contributions under the ESPP are made
ratably during the plan period. Employees may withdraw from the plan
prior to the end of the one year offering period. The total estimated
shares to be purchased are estimated at the beginning of the plan period
based on total expected contributions for the plan period and 85% of the
market price at that date. The Corporation estimated that 346,342
shares would be purchased on July 1, 2006 for the purpose of determining
compensation expense. For the three months ended June 30, 2006 and 2005
the total expense for the ESPP that is included in Salaries and employee
benefits expense in the Consolidated Statements of Income amounted to
$0.9 million and $0.7 million, respectively. For the six months ended
June 30, 2006 and 2005 the total expense for the ESPP that is included
in Salaries and employee benefits expense in the Consolidated Statements
of Income amounted to $1.8 million and $1.4 million, respectively.
These amounts are considered non-cash expenses for the Statements of
Cash Flow purposes.
As previously discussed, effective July 1, 2006 the ESPP plan was
amended to eliminate the look-back feature and to provide employees, who
elect to participate in the plan, the right to acquire shares of the
Corporation's common stock at the purchase price, which is 85 percent of
the fair market value of the Corporation's common stock on the last day
of each three month period within the one-year offering period. The
effect of the amendment will be to lower the amount of expense in future
quarters. The Corporation estimates that the quarterly savings in
expense will be approximately $0.3 million.
12. Derivative Financial Instruments and Hedging Activities
The following is an update of the Corporation's use of derivative
financial instruments and its hedging activities as described in its
Annual Report on Form 10-K for the year ended December 31, 2005.
Generally there were no substantive changes in the types of derivative
financial instruments the Corporation employs or its hedging activities
in the six months ended June 30, 2006.
Trading Instruments and Other Free Standing Derivatives
Loan commitments accounted for as derivatives are not material to the
Corporation and the Corporation does not employ any formal hedging
strategies for these commitments.
Trading and free-standing derivative contracts are not linked to
specific assets and liabilities on the balance sheet or to forecasted
transactions in an accounting hedge relationship and, therefore, do not
qualify for hedge accounting under SFAS 133. They are carried at fair
value with changes in fair value recorded as a component of other
noninterest income.
At June 30, 2006, free standing interest rate swaps consisted of $2.1
billion in notional amount of receive fixed / pay floating with an
aggregate negative fair value of $46.3 million and $1.4 billion in
notional amount of pay fixed / receive floating with an aggregate
positive fair value of $44.8 million.
At June 30, 2006, interest rate caps purchased amounted to $20.5 million
in notional amount with a positive fair value of $0.1 million and
interest rate caps sold amounted to $20.5 million in notional amount
with a negative fair value of $0.1 million.
At June 30, 2006, the notional value of interest rate futures designated
as trading was $3.4 billion with a negative fair value of $0.3 million.
20
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2006 & 2005 (Unaudited)
Fair Value Hedges
The Corporation has fixed rate CDs and fixed rate long-term debt which
expose the Corporation to variability in fair values due to changes in
market interest rates.
To limit the Corporation's exposure to changes in interest rates, the
Corporation has entered into received-fixed / pay floating interest rate
swaps.
The Corporation structures the interest rate swaps so that all of the
critical terms of the fixed rate CDs and fixed rate borrowings match the
receive fixed leg of the interest rate swaps at inception of the hedging
relationship. As a result, the Corporation expects the hedging
relationship to be highly effective in achieving offsetting changes in
fair value due to changes in market interest rates both at inception and
on an on-going basis.
At June 30, 2006, certain interest rate swaps designated as fair value
hedges met the criteria required to qualify for the shortcut method of
accounting. Based on the shortcut method of accounting treatment, no
ineffectiveness is assumed.
At June 30, 2006, no component of the derivative instruments' gain or
loss was excluded from the assessment of hedge effectiveness for
derivative financial instruments designated as fair value hedges.
The following table presents additional information with respect to
selected fair value hedges.
Fair Value Hedges
June 30, 2006 Weighted
Notional Fair Average
Hedged Hedging Amount Value Remaining
Item Instrument ($ in mil)($ in mil) Term (Yrs)
---------------------- ------------------- --------- --------- ----------
Fair Value Hedges that Qualify for Shortcut Accounting
Fixed Rate
Bank Notes Receive Fixed Swap $ 427.3 $ (27.7) 8.3
Other Fair Value Hedges
Fixed Rate CDs Receive Fixed Swap $1,045.1 $ (40.9) 7.8
Medium Term Notes Receive Fixed Swap 359.3 (13.1) 6.9
Fixed Rate
Bank Notes Receive Fixed Swap 625.0 (24.6) 4.4
Institutional CDs Receive Fixed Swap 65.0 (1.5) 24.8
Brokered Bullet CDs Receive Fixed Swap 627.9 (2.5) 0.6
The impact from fair value hedges to total net interest income for the
three and six months ended June 30, 2006 was a negative $1.1 million and
a positive $0.6 million, respectively. The impact to net interest
income due to ineffectiveness was not material.
Cash Flow Hedges
The Corporation has variable rate loans, deposits and borrowings that
expose the Corporation to variability in interest rate payments due to
changes in interest rates. The Corporation believes it is prudent to
limit the variability of a portion of its interest receipts and
payments. To meet this objective, the Corporation enters into various
types of derivative financial instruments to manage fluctuations in cash
flows resulting from interest rate risk. At June 30, 2006, these
instruments consisted of interest rate swaps.
The Corporation regularly originates and holds floating rate commercial
loans that reprice monthly on the first business day to one-month LIBOR.
As a result, the Corporation's interest receipts are exposed to
variability in cash flows due to changes in one-month LIBOR.
21
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2006 & 2005 (Unaudited)
In order to hedge the interest rate risk associated with the floating
rate commercial loans indexed to one-month LIBOR, the Corporation has
entered into receive fixed / pay LIBOR-based floating interest rate
swaps designated as cash flow hedges against the first LIBOR-based
interest payments received that, in the aggregate for each period, are
interest payments on such principal amount of its then existing LIBOR-
indexed floating-rate commercial loans equal to the notional amount of
the interest rate swaps outstanding.
Hedge effectiveness is assessed at inception and each quarter on an on-
going basis using regression analysis that takes into account reset date
differences for certain designated interest rate swaps that reset
quarterly. Each month the Corporation makes a determination that it is
probable that the Corporation will continue to receive interest payments
on at least that amount of principal of its existing LIBOR-indexed
floating-rate commercial loans that reprice monthly on the first
business day to one-month LIBOR equal to the notional amount of the
interest rate swaps outstanding. Ineffectiveness is measured using the
hypothetical derivative method and is recorded as a component of
interest income on loans.
The Corporation regularly issues floating rate institutional CDs indexed
to three-month LIBOR. As a result, the Corporation's interest payments
are exposed to variability in cash flows due to changes in three-month
LIBOR.
In order to hedge the interest rate risk associated with floating rate
institutional CDs, the Corporation has entered into pay fixed / receive
LIBOR-based floating interest rate swaps designated as cash flow hedges
against the interest payments on the forecasted issuance of floating
rate institutional CDs.
For certain institutional CDs, hedge effectiveness is assessed at
inception and each quarter on an on-going basis using regression
analysis that regresses daily observations of three-month LIBOR to
itself with a five day mismatch on either side for potential reset date
differences between the interest rate swaps and the floating rate
institutional CDs. The regression analysis is based on a rolling five
years of daily observations. Ineffectiveness is measured using the
hypothetical derivative method and is recorded as a component of
interest expense on deposits.
The Corporation regularly purchases overnight borrowings indexed to the
Federal funds rate. As a result, the Corporation's interest payments
are exposed to variability in cash flows due to changes in the Federal
funds effective rate.
In order to hedge the interest rate risk associated with overnight
borrowings, the Corporation has entered into pay fixed / receive
floating interest rate swaps designated as cash flow hedges against
interest payments on the forecasted issuance of floating rate overnight
borrowings. The floating leg of the interest rate swap resets monthly
to the H15 Federal Effective index. The H15 Federal Effective index is
not a benchmark rate, therefore hedge effectiveness is assessed at
inception and each quarter on an on-going basis using regression
analysis. Each month the Corporation makes a determination that it is
probable that the Corporation will continue to make interest payments on
at least that amount of outstanding overnight floating-rate borrowings
equal to the notional amount of the interest rate swaps outstanding.
Ineffectiveness is measured using the hypothetical derivative method and
is recorded as a component of interest expense on short-term borrowings.
The Corporation structures the remaining interest rate swaps so that all
of the critical terms of the LIBOR-based floating rate deposits and
borrowings match the floating leg of the interest rate swaps at
inception of the hedging relationship. As a result, the Corporation
expects those hedging relationships to be highly effective in achieving
offsetting changes in cash flows due to changes in market interest rates
both at inception and on an on-going basis.
At June 30, 2006, one interest rate swap designated as a cash flow hedge
met the criteria required to qualify for the shortcut method of
accounting. Based on the shortcut method of accounting treatment, no
ineffectiveness is assumed.
At June 30, 2006, no component of the derivative instruments' gain or
loss was excluded from the assessment of hedge effectiveness for
derivative financial instruments designated as cash flow hedges.
22
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2006 & 2005 (Unaudited)
The following table summarizes the Corporation's cash flow hedges.
Cash Flow Hedges
June 30, 2006 Weighted
Notional Fair Average
Hedged Hedging Amount Value Remaining
Item Instrument ($ in mil)($ in mil) Term (Yrs)
---------------------- ------------------- --------- --------- ----------
Cash Flow Hedges that Qualify for Shortcut Accounting
Floating Rate
Bank Notes Pay Fixed Swap $ 125.0 $ 1.5 0.8
Other Cash Flow Hedges
Variable Rate Loans Receive Fixed Swap $ 1,150.0 $ (55.5) 3.4
Institutional CDs Pay Fixed Swap 1,980.0 17.4 2.0
Federal Funds
Purchased Pay Fixed Swap 250.0 0.7 1.1
FHLB Advances Pay Fixed Swap 1,220.0 35.7 2.5
Floating Rate
Bank Notes Pay Fixed Swap 300.0 4.2 2.2
Money Market Accounts Pay Fixed Swap 250.0 5.6 1.0
The impact to total net interest income from cash flow hedges, including
amortization of terminated cash flow hedges for the three and six months
ended June 30, 2006 was a positive $3.8 million and a positive $5.7
million, respectively. The impact due to ineffectiveness was not
material.
For the three and six months ended June 30, 2005, the total effect on
net interest income resulting from derivative financial instruments was
a positive $9.1 million and a positive $16.1 million, respectively,
including the amortization of terminated derivative financial
instruments.
13. Postretirement Health Plan
The Corporation sponsors a defined benefit health plan that provides
health care benefits to eligible current and retired employees.
Eligibility for retiree benefits is dependent upon age, years of
service, and participation in the health plan during active service.
The plan is contributory and in 1997 and 2002 the plan was amended.
Employees hired or retained from mergers after September 1, 1997 will be
granted access to the Corporation's plan upon becoming an eligible
retiree; however, such retirees must pay 100% of the cost of health care
benefits. The plan continues to contain other cost-sharing features
such as deductibles and coinsurance.
Net periodic postretirement benefit costs for the three and six month
periods ended June 30, 2006 and 2005 included the following components
($000's):
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ -------------------------
2006 2005 2006 2005
----------- ----------- ----------- -----------
Service cost $ 570 $ 552 $ 1,140 $ 1,105
Interest on APBO 1,022 1,159 2,044 2,318
Expected return on assets (232) (150) (464) (299)
Prior service amortization (680) (680) (1,360) (1,361)
Actuarial loss amortization 378 264 757 528
---------- ---------- ---------- ----------
Total postretirement benefit costs $ 1,058 $ 1,145 $ 2,117 $ 2,291
========== ========== ========== ==========
Benefit payments and expenses, net of participant contributions, for the
three and six months ended June 30, 2006 amounted to $1.1 million and
$2.1 million, respectively.
23
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2006 & 2005 (Unaudited)
14. Segments
The following represents the Corporation's operating segments as of and
for the three and six months ended June 30, 2006 and 2005. Effective
January 1, 2006, the Corporation transferred a portion of its Item
Processing business from the Banking segment to Metavante. Prior period
segment information has been adjusted for the transfer. There have not
been any other changes to the way the Corporation organizes its
segments. Beginning with the third quarter of 2005, total other income
for Metavante includes float income which represents interest income on
balances invested in an affiliate bank which arises from Electronic Bill
Payment activities. This income was formerly reported as a component of
Net Interest Income for Metavante. Segment information for all periods
has been adjusted for this reclassification. Fees - intercompany
represent intercompany revenue charged to other segments for providing
certain services. Expenses - intercompany represent fees charged by
other segments for certain services received. For each segment,
Expenses - intercompany are not the costs of that segment's reported
intercompany revenues. Intrasegment revenues, expenses and assets have
been eliminated ($ in millions):
Three Months Ended June 30, 2006
---------------------------------------------------------------------------------
Reclass-
ifications Consol-
Corporate & Elimi- idated
Banking Metavante Others Overhead nations Income
------------ ------------ ------------ ------------ ----------- ------------
Net interest income $ 381.3 $ (7.5) $ 5.9 $ (8.3) $ 2.7 $ 374.1
Other income
Fees - external 82.0 345.0 56.0 1.4 -- 484.4
Fees - internal
Fees - intercompany 16.8 25.8 5.7 25.0 (73.3) --
Float income -
intercompany -- 2.7 -- -- (2.7) --
----------- ----------- ----------- ----------- ---------- -----------
Total other income 98.8 373.5 61.7 26.4 (76.0) 484.4
Other expense
Expenses - other 179.3 294.6 41.6 28.4 0.4 544.3
Expenses - intercompany 46.9 13.0 12.7 1.1 (73.7) --
----------- ----------- ----------- ----------- ---------- -----------
Total other expense 226.2 307.6 54.3 29.5 (73.3) 544.3
Provision for loan
and lease losses 10.6 -- 0.5 -- -- 11.1
----------- ----------- ----------- ----------- ---------- -----------
Income before taxes 243.3 58.4 12.8 (11.4) -- 303.1
Income tax expense 80.8 18.0 4.7 (4.1) -- 99.4
----------- ----------- ----------- ----------- ---------- -----------
Segment income (loss) $ 162.5 $ 40.4 $ 8.1 $ (7.3) $ -- $ 203.7
=========== =========== =========== =========== ========== ===========
Identifiable assets $ 51,578.5 $ 2,790.6 $ 821.4 $ 684.9 $ (1,456.5) $ 54,418.9
=========== =========== =========== =========== ========== ===========
Return on average equity 13.3% 14.5% 11.2% 14.4%
=========== =========== =========== ===========
Three Months Ended June 30, 2005
---------------------------------------------------------------------------------
Reclass-
ifications Consol-
Corporate & Elimi- idated
Banking Metavante Others Overhead nations Income
------------ ------------ ------------ ------------ ----------- ------------
Net interest income $ 314.9 $ (9.6) $ 6.8 $ (2.1) $ 3.0 $ 313.0
Other income
Fees - external 73.5 282.3 70.1 8.4 -- 434.3
Fees - internal
Fees - intercompany 15.5 21.9 5.6 21.6 (64.6) --
Float income -
intercompany -- 3.0 -- -- (3.0) --
----------- ----------- ----------- ----------- ---------- -----------
Total other income 89.0 307.2 75.7 30.0 (67.6) 434.3
Other expense
Expenses - other 153.6 237.6 33.7 36.4 (1.4) 459.9
Expenses - intercompany 40.7 10.1 12.0 0.4 (63.2) --
----------- ----------- ----------- ----------- ---------- -----------
Total other expense 194.3 247.7 45.7 36.8 (64.6) 459.9
Provision for loan
and lease losses 13.4 -- 0.3 -- -- 13.7
----------- ----------- ----------- ----------- ---------- -----------
Income (loss) before taxes 196.2 49.9 36.5 (8.9) -- 273.7
Income tax expense (benefit) 59.1 19.9 14.3 (3.3) -- 90.0
----------- ----------- ----------- ----------- ---------- -----------
Segment income (loss)
As Adjusted $ 137.1 $ 30.0 $ 22.2 $ (5.6) $ -- $ 183.7
=========== =========== =========== =========== ========== ===========
Identifiable assets $ 41,149.6 $ 2,469.0 $ 759.5 $ 733.1 $ (1,627.5) $ 43,483.7
=========== =========== =========== =========== ========== ===========
Return on average equity 16.0% 18.6% 33.0% 17.5%
=========== =========== =========== ===========
24
MARSHALL & ILSLEY CORPORATION
Notes to Financial Statements - Continued
June 30, 2006 & 2005 (Unaudited)
Six Months Ended June 30, 2006
---------------------------------------------------------------------------------
Reclass-
ifications Consol-
Corporate & Elimi- idated
Banking Metavante Others Overhead nations Income
------------ ------------ ------------ ------------ ----------- ------------
Net interest income $ 708.9 $ (15.8) $ 11.6 $ (12.0) $ 5.9 $ 698.6
Other income
Fees - external 155.5 688.0 110.4 3.2 -- 957.1
Fees - internal
Fees - intercompany 33.7 50.6 10.5 49.9 (144.7) --
Float income -
intercompany -- 5.9 -- -- (5.9) --
----------- ----------- ----------- ----------- ---------- -----------
Total other income 189.2 744.5 120.9 53.1 (150.6) 957.1
Other expense
Expenses - other 337.7 590.7 81.1 40.5 (0.6) 1,049.4
Expenses - intercompany 90.1 25.6 25.1 3.3 (144.1) --
----------- ----------- ----------- ----------- ---------- -----------
Total other expense 427.8 616.3 106.2 43.8 (144.7) 1,049.4
Provision for loan
and lease losses 21.0 -- 1.0 -- -- 22.0
----------- ----------- ----------- ----------- ---------- -----------
Income before taxes 449.3 112.4 25.3 (2.7) -- 584.3
Income tax expense 148.6 37.5 9.3 (1.6) -- 193.8
----------- ----------- ----------- ----------- ---------- -----------
Segment income (loss) $ 300.7 $ 74.9 $ 16.0 $ (1.1) $ -- $ 390.5
=========== =========== =========== =========== ========== ===========
Identifiable assets $ 51,578.5 2,790.6 821.4 684.9 (1,456.5) $ 54,418.9
=========== =========== =========== =========== ========== ===========
Return on average equity 13.9% 13.8% 11.5% 15.0%
=========== =========== =========== ===========
Six Months Ended June 30, 2005
---------------------------------------------------------------------------------
Reclass-
ifications Consol-
Corporate & Elimi- idated
Banking Metavante Others Overhead nations Income
------------ ------------ ------------ ------------ ----------- ------------
Net interest income $ 618.1 $ (20.0) $ 12.4 $ (3.9) $ 5.3 $ 611.9
Other income
Fees - external 143.6 565.3 117.7 10.2 -- 836.8
Fees - internal
Fees - intercompany 31.4 42.8 10.3 43.2 (127.7) --
Float income -
intercompany -- 5.3 -- -- (5.3) --
----------- ----------- ----------- ----------- ---------- -----------
Total other income 175.0 613.4 128.0 53.4 (133.0) 836.8
Other expense
Expenses - other 300.5 478.6 65.6 59.0 (0.8) 902.9
Expenses - intercompany 79.5 21.1 24.5 1.8 (126.9) --
----------- ----------- ----------- ----------- ---------- -----------
Total other expense 380.0 499.7 90.1 60.8 (127.7) 902.9
Provision for loan
and lease losses 21.2 -- 0.6 -- -- 21.8
----------- ----------- ----------- ----------- ---------- -----------
Income before taxes 391.9 93.7 49.7 (11.3) -- 524.0
Income tax expense 122.9 37.4 19.4 (4.8) -- 174.9
----------- ----------- ----------- ----------- ---------- -----------
Segment income (loss)
As Adjusted $ 269.0 $ 56.3 $ 30.3 $ (6.5) $ -- $ 349.1
=========== =========== =========== =========== ========== ===========
Identifiable assets $ 41,149.6 $ 2,469.0 $ 759.5 $ 733.1 $ (1,627.5) $ 43,483.7
=========== =========== =========== =========== ========== ===========
Return on average equity 16.0% 18.1% 23.4% 17.1%
=========== =========== =========== ===========
Total revenue, which consists of net interest income plus total other
income, by type in Others consisted of the following ($ in millions):
Three Months Six Months
Ended June 30, Ended June 30,
------------------------ ------------------------
2006 2005 2006 2005
----------- ----------- ----------- -----------
Trust Services $ 49.2 $ 40.6 $ 95.2 $ 80.2
Residential Mortgage Banking 5.8 6.1 10.9 11.1
Capital Markets (0.3) 21.6 0.3 22.3
Brokerage and Insurance 7.4 7.2 14.6 14.3
Commercial Leasing 2.9 4.1 5.8 7.6
Commercial Mortgage Banking 1.6 1.6 3.3 2.8
Others 1.0 1.3 2.4 2.2
---------- ---------- ---------- ----------
Total revenue $ 67.6 $ 82.5 $ 132.5 $ 140.5
========== ========== ========== ==========
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
MARSHALL & ILSLEY CORPORATION
CONSOLIDATED AVERAGE BALANCE SHEETS (Unaudited)
($000's)
Three Months Ended June 30,
------------------------------
2006 2005
-------------- --------------
Assets
------
Cash and due from banks $ 1,030,657 $ 938,451
Investment securities:
Trading securities 50,268 25,582
Short-term investments 374,212 271,731
Other investment securities:
Taxable 5,818,278 4,828,606
Tax-exempt 1,316,122 1,333,700
------------- -------------
Total investment securities 7,558,880 6,459,619
Loans and leases:
Loans and leases, net of unearned income 39,649,733 31,294,058
Less: Allowance for loan and lease losses 416,328 361,488
------------- -------------
Net loans and leases 39,233,405 30,932,570
Premises and equipment, net 565,369 445,382
Accrued interest and other assets 5,199,418 3,877,271
------------- -------------
Total Assets $ 53,587,729 $ 42,653,293
============= =============
Liabilities and Shareholders' Equity
Deposits:
Noninterest bearing $ 5,404,147 $ 4,826,304
Interest bearing 27,331,590 20,643,276
------------- -------------
Total deposits 32,735,737 25,469,580
Federal funds purchased and security repurchase agreements 2,332,734 2,393,989
Other short-term borrowings 1,085,859 998,363
Long-term borrowings 10,050,166 7,920,117
Accrued expenses and other liabilities 1,691,978 1,664,868
------------- -------------
Total liabilities 47,896,474 38,446,917
Shareholders' equity 5,691,255 4,206,376
------------- -------------
Total Liabilities and Shareholders' Equity $ 53,587,729 $ 42,653,293
============= =============
26
MARSHALL & ILSLEY CORPORATION
CONSOLIDATED AVERAGE BALANCE SHEETS (Unaudited)
($000's)
Six Months Ended June 30,
------------------------------
2006 2005
-------------- --------------
Assets
------
Cash and due from banks $ 1,005,507 $ 928,733
Investment securities:
Trading securities 42,267 24,355
Short-term investments 345,127 229,595
Other investment securities:
Taxable 5,401,133 4,825,732
Tax-exempt 1,328,293 1,306,082
------------- -------------
Total investment securities 7,116,820 6,385,764
Loans and leases:
Loans and leases, net of unearned income 37,159,330 30,592,745
Less: Allowance for loan and lease losses 392,442 361,220
------------- -------------
Net loans and leases 36,766,888 30,231,525
Premises and equipment, net 530,820 448,079
Accrued interest and other assets 4,769,638 3,857,632
------------- -------------
Total Assets $ 50,189,673 $ 41,851,733
============= =============
Liabilities and Shareholders' Equity
------------------------------------
Deposits:
Noninterest bearing $ 5,174,349 $ 4,760,154
Interest bearing 24,944,683 20,592,326
------------- -------------
Total deposits 30,119,032 25,352,480
Federal funds purchased and security repurchase agreements 2,386,379 2,170,661
Other short-term borrowings 1,008,475 973,360
Long-term borrowings 9,728,869 7,564,611
Accrued expenses and other liabilities 1,682,305 1,666,152
------------- -------------
Total liabilities 44,925,060 37,727,264
Shareholders' equity 5,264,613 4,124,469
------------- -------------
Total Liabilities and Shareholders' Equity $ 50,189,673 $ 41,851,733
============= =============
27
OVERVIEW
--------
The Corporation's overall strategy is to drive earnings per share growth
by: (1) expanding banking operations not only in Wisconsin but also into
faster growing regions beyond Wisconsin; (2) increasing the number of
financial institutions to which the Corporation provides correspondent
banking services and products; (3) expanding trust services and other
wealth management product and service offerings; and (4) growing
Metavante's business through organic growth, cross sales of technology
products and acquisitions.
The Corporation continues to focus on its key metrics of growing revenues
through balance sheet growth, fee-based income growth and strong credit
quality. Management believes that the Corporation has demonstrated solid
fundamental performance in each of these key areas and as a result, the
second quarter and first half of 2006 produced strong financial results.
Net income for the second quarter of 2006 amounted to $203.7 million
compared to $183.7 million for the same period in the prior year, an
increase of $20.0 million, or 10.9%. Diluted earnings per share were
$0.79 for the three months ended June 30, 2006 and 2005, respectively.
The return on average assets and average equity was 1.53% and 14.36%,
respectively, for the quarter ended June 30, 2006, and 1.73% and 17.52%,
respectively, for the quarter ended June 30, 2005.
Net income for the first half of 2006 amounted to $390.5 million compared
to $349.1 million for the same period in the prior year, an increase of
$41.4 million, or 11.9%. Diluted earnings per share were $1.57 for the
six months ended June 30, 2006, compared with $1.50 for the six months
ended June 30, 2005, an increase of 4.7%. The return on average assets
and average equity was 1.57% and 14.96%, respectively, for the six months
ended June 30, 2006, and 1.68% and 17.07%, respectively, for the six
months ended June 30, 2005.
Earnings growth for the three and six months ended June 30, 2006 compared
to the three and six months ended June 30, 2005 was attributable to a
number of factors. The increase in net interest income was due to strong
organic loan and bank-issued deposit growth and the contribution from the
two banking acquisitions that were completed on April 1, 2006. Strong
credit quality has resulted in net charge-offs that continue to be below
the Corporation's five-year historical average. Metavante continued to
exhibit growth in both revenue and earnings which was attributable, in
part, to the impact of its acquisition activities as well as success in
retaining and cross-selling products and services to its core customer
base. Metavante's acquisition activities included one acquisition
completed in the first quarter of 2006, two acquisitions completed in the
fourth quarter of 2005, three acquisitions completed in the third quarter
of 2005 and one acquisition completed in the first quarter of 2005. Net
investment securities gains were not significant in the three or six
months ended June 30, 2006. During the second quarter of 2005, the
Corporation realized a gain due to the sale of an entity associated with
the Corporation's investment in an independent private equity and venture
capital partnership. The gross gain amounted to $29.0 million and is
reported in Net investment securities gains in the Consolidated Statements
of Income. On an after-tax basis, and net of related compensation
expense, the gain amounted to $16.2 million or $0.07 per diluted share.
The increase in expenses for the three and six months ended June 30, 2006
compared to the three and six months ended June 30, 2005 were primarily
due to the banking and Metavante acquisitions. These factors along with
continued organic expense management resulted in the reported earnings
growth in the three and six months ended 2006 compared to the three and
six months ended June 30, 2005.
Management continues to believe that the 2006 outlook provided in the
Corporation's Annual Report on Form 10-K for the year ended December 31,
2005 is generally still representative of its expectations for the year
ended December 31, 2006. Management expects Metavante revenue will be at
the high end of the previously forecasted revenue projection of $1.4
billion to $1.5 billion including all closed acquisitions and the transfer
of external item processing which is discussed in the next section. The
Corporation's actual results for the year ended December 31, 2006 could
differ materially from those expected by management. See "Forward-Looking
Statements" in this Form 10-Q and "Risk Factors" in Item 1A of the
Corporation's Annual Report on Form 10-K for the year ended December 31,
2005, for a discussion of the various risk factors that could cause actual
results to differ materially from expected results.
28
NOTEWORTHY TRANSACTIONS AND EVENTS
----------------------------------
Some of the more noteworthy transactions and events that occurred in the
three and six months ended June 30, 2006 and 2005 consisted of the
following:
Second quarter 2006
The results of operations and financial position as of and for the three
and six months ended June 30, 2006 include the effect of the previously
announced acquisitions of Gold Banc Corporation, Inc. and Trustcorp
Financial, Inc. which were both completed on April 1, 2006. As of April
1, 2006, the combined assets of Gold Banc Corporation, Inc. and Trustcorp
Financial, Inc. amounted to approximately $4.9 billion. The acquired
companies had combined loans of $3.9 billion and combined bank issued
deposits of $3.1 billion. The combined purchase price for these
companies, which included approximately $146.0 million of cash, amounted
to $898.2 million. In the aggregate, 16.74 million shares of the
Corporation's common stock were issued and fully vested stock options to
purchase 0.5 million of its common stock were exchanged in these
transactions.
For the three months ended June 30, 2006, Salaries and employee benefits
expense includes $7.6 million and Other expense includes $0.6 million of
expense for stock options and the Corporation's employee stock purchase
plan ("ESPP"), which reduced net income by $5.3 million or $0.02 per
diluted share. The Corporation expects that the additional compensation
expense associated with stock options and the ESPP will be dilutive to the
Corporation's operating results by $0.02 per diluted share in the third
quarter of 2006 and $0.04 per diluted share in the fourth quarter of 2006.
The Corporation's largest stock option awards have historically been
granted during the fourth quarter and expense for stock options is larger
in the fourth quarter compared to the other quarters in any given year.
Under the existing plans, awards to individuals who meet certain age and
years of service criteria at the date of grant immediately vest and
therefore the full fair value of those awards are immediately expensed.
For the year ended December 31, 2006, the Corporation expects that the
additional compensation expense associated with stock options and the ESPP
will be dilutive to the Corporation's operating results by approximately
$0.10 per diluted share compared to $0.11 per diluted share for the year
ended December 31, 2005 as adjusted. See Note 11 in Notes to Financial
Statements for further information.
Beginning with the second quarter of 2006, trust services revenue,
brokerage and investment advisor revenue and noninterest revenue from the
private banking business have been combined and reported in the line item
Wealth management in the Consolidated Statements of Income in response to
requests by users of the Corporation's financial information. All prior
periods have been adjusted for this reclassification.
First quarter 2006
On January 1, 2006 the Corporation adopted the accounting standard that
requires share-based compensation to be expensed. The Corporation elected
the Modified Retrospective Application method to implement this new
accounting standard. Under that method all prior period consolidated and
segment financial information was adjusted to reflect the effect of
expensing share-based compensation plans which were not previously
expensed. Prior to the adoption of the new standard, the Corporation used
the intrinsic method of accounting for stock options. Under that method
generally, no compensation expense was recognized for stock option awards
or the Corporation's ESPP. Shareholders' equity as of January 1, 2006
increased $67.7 million due to the deferred income tax benefit recognized
from applying the Modified Retrospective Application method of adoption.
For the three months ended March 31, 2006, Salaries and employee benefits
expense includes $7.5 million of expense for stock options and the ESPP,
which reduced net income by $4.9 million or $0.02 per diluted share.
Beginning with the first quarter of 2006, the Corporation included certain
loan and lease fees, primarily prepayment fees, in reported interest
income on loans and leases. Previously, these fees were reported in Other
income. Such fees are in addition to loan origination fees that are
capitalized and amortized over the life of a loan or lease on a basis that
produces a level yield in accordance with existing accounting standards.
Including these fees in interest income may result in more volatility in
net interest income and the net interest margin. However, management
believes this reclassification will improve comparability of the net
interest margin between the Corporation and its peer banking group. All
prior periods have been adjusted for this reclassification.
29
On January 1, 2006 the Banking segment transferred its external item
processing business, including all check-processing client relationships,
to Metavante. This transfer, together with recent investments in
electronic check image technology, enables Metavante to provide its
clients with an end-to-end image solution that includes check truncation
at the point of first presentment, image exchange through the Endpoint
Exchange Network and final settlement. As a result of the transfer, the
previously reported Other income line, Item processing, was reclassified
to Data processing services in the Consolidated Statements of Income and
prior period segment financial information for both the Banking segment
and Metavante has been adjusted for the transfer. See Note 14 in Notes to
Financial Statements for segment information.
Second quarter 2005
As a result of adopting the accounting standard that requires share-based
compensation to be expensed, as previously discussed, adjusted Salaries
and employee benefits expense includes $6.6 million and adjusted Other
expense includes $0.7 million of expense for stock options and the
Corporation's ESPP, which reduced previously reported net income by $4.7
million or $0.02 per diluted share for the three months ended June 30,
2005.
During the second quarter of 2005, the Corporation realized a gain due to
the sale of an entity associated with the Corporation's investment in an
independent private equity and venture capital partnership. The gross
gain amounted to $29.0 million and is reported in Net investment
securities gains in the Consolidated Statements of Income. On an after-
tax basis, and net of related compensation expense, the gain amounted to
$16.2 million or $0.07 per diluted share.
First quarter 2005
As a result of adopting the accounting standard that requires share-based
compensation to be expensed, as previously discussed, adjusted Salaries
and employee benefits expense for the three months ended March 31, 2005
includes $6.5 million of expense for stock options and the ESPP which
reduced previously reported net income by $4.3 million or $0.02 per
diluted share.
NET INTEREST INCOME
-------------------
Net interest income is the difference between interest earned on earning
assets and interest owed on interest bearing liabilities. Net interest
income represented approximately 43.6% of the Corporation's source of
revenues for the three months ended June 30, 2006 compared to 41.9% for
the three months ended June 30, 2005. For the six months ended June 30,
2006 net interest income represented approximately 42.2% of the
Corporation's source of revenues compared to 42.2% for the six months
ended June 30, 2005.
Net interest income for the second quarter of 2006 amounted to $374.1
million compared to $313.0 million reported for the second quarter of
2005, an increase of $61.1 million or 19.5%. For the six months ended
June 30, 2006, net interest income amounted to $698.6 million compared to
$611.9 million reported for the six months ended June 30, 2005, an
increase of $86.7 million or 14.2%. Both acquisition related and organic
loan growth, as well as the growth in noninterest bearing and other bank-
issued deposits, were the primary contributors to the increase in net
interest income. Factors negatively affecting net interest income
compared to the prior year included the impact of the financing costs
associated with the 2006 banking acquisitions and Metavante's
acquisitions, common stock buybacks and a general shift in the bank-issued
deposit mix from lower cost to higher cost deposit products in response to
increasing interest rates.
Average earning assets in the second quarter of 2006 amounted to $47.2
billion compared to $37.8 billion in the second quarter of 2005, an
increase of $9.4 billion or 25.0%. Average loans and leases accounted for
$8.4 billion of the growth in average earning assets in the second quarter
of 2006 compared to the second quarter of 2005. Average investment
securities increased $1.0 billion over the prior year quarter. The growth
in average investment securities was primarily due to the banking
acquisitions.
Average interest bearing liabilities increased $8.8 billion or 27.7% in
the second quarter of 2006 compared to the second quarter of 2005.
Average interest bearing deposits increased $6.7 billion or 32.4% in the
second quarter of 2006 compared to the second quarter of last year.
Average total borrowings, primarily long-term borrowings, increased $2.2
billion or 19.1% in the second quarter of 2006 compared to the same period
in 2005.
30
For the six months ended June 30, 2006, average earning assets amounted to
$44.3 billion compared to $37.0 billion in the six months ended June 30,
2005, an increase of $7.3 billion or 19.7%. Average loans and leases
accounted for $6.6 billion of the growth in average earning assets in the
six months ended June 30, 2006 compared to the six months ended June 30,
2005. Average investment securities increased $0.6 billion over the
comparative six month periods. The growth in average investment securities
was primarily due to the banking acquisitions.
Average interest bearing liabilities increased $6.8 billion or 21.6% in
the six months ended June 30, 2006 compared to the six months ended June
30, 2005. Average interest bearing deposits increased $4.4 billion or
21.1% in the six months ended June 30, 2006 compared to the six months
ended June 30, 2005. Average total borrowings, primarily long-term
borrowings, increased $2.4 billion or 22.6% over the comparative six month
periods.
Average noninterest bearing deposits increased $0.6 billion or 12.0% in
the three months ended June 30, 2006 compared to the three months ended
June 30, 2005. For the six months ended June 30, 2006 compared to the six
months ended June 30, 2005, average noninterest bearing deposits increased
$0.4 billion or 8.7%
The growth and composition of the Corporation's quarterly average loan and
lease portfolio for the current quarter and previous four quarters are
reflected in the following table ($ in millions):
Consolidated Average Loans and Leases
-------------------------------------
2006 2005 Growth Pct.
------------------- ------------------------------ -----------------
Second First Fourth Third Second Prior
Quarter Quarter Quarter Quarter Quarter Annual Quarter
--------- --------- --------- --------- --------- -------- ---------
Commercial Loans and Leases
---------------------------
Commercial $ 11,393 $ 9,839 $ 9,290 $ 9,126 $ 8,932 27.5 % 15.8 %
Commercial real estate
Commercial mortgages 10,746 8,839 8,850 8,661 8,509 26.3 21.6
Construction 2,834 1,742 1,564 1,484 1,358 108.7 62.7
-------- -------- -------- -------- -------- ------- -------
Total commercial real estate 13,580 10,581 10,414 10,145 9,867 37.6 28.4
Commercial lease financing 504 493 471 462 425 18.6 2.2
-------- -------- -------- -------- -------- ------- -------
Total Commercial Loans
and Leases 25,477 20,913 20,175 19,733 19,224 32.5 21.8
Personal Loans and Leases
-------------------------
Residential real estate
Residential mortgages 5,621 5,190 4,855 4,537 3,986 41.0 8.3
Construction 2,365 2,085 1,862 1,633 1,382 71.2 13.4
-------- -------- -------- -------- -------- ------- -------
Total residential
real estate 7,986 7,275 6,717 6,170 5,368 48.8 9.8
Personal loans
Student 51 99 78 74 78 (33.7) (48.0)
Credit card 237 227 233 228 217 9.5 (4.4)
Home equity loans
and lines 4,596 4,706 4,822 4,905 5,098 (9.9) (2.3)
Other 1,167 1,289 1,245 1,241 1,186 (1.6) (9.4)
-------- -------- -------- -------- -------- ------- -------
Total personal loans 6,051 6,321 6,378 6,448 6,579 (8.0) (4.3)
Personal lease financing 136 132 132 128 123 10.3 2.8
-------- -------- -------- -------- -------- ------- -------
Total Personal Loans
and Leases 14,173 13,728 13,227 12,746 12,070 17.4 3.2
-------- -------- -------- -------- -------- ------- -------
Total Consolidated Average
Loans and Leases $ 39,650 $ 34,641 $ 33,402 $ 32,479 $ 31,294 26.7 % 14.5 %
======== ======== ======== ======== ======== ======= =======
Total consolidated average loans and leases increased $8.4 billion or
26.7% in the second quarter of 2006 compared to the second quarter of
2005. Excluding the effect of the banking acquisitions, total
consolidated average loan and lease organic growth was 12.6% in the second
quarter of 2006 compared to the second quarter of 2005. Approximately $3.9
billion of the growth in total consolidated average loans and leases was
attributable to the banking acquisitions and $4.5 billion of the growth
was organic. Of the $3.9 billion of average growth attributable to the
banking acquisitions, $2.8 billion was attributable to average commercial
real estate loans, $0.8 billion was attributable to average commercial
loans and leases and $0.3 billion was attributable to average residential
real estate loans. Of the $4.5 billion of average loan and lease organic
growth, $1.7 billion was attributable to average commercial loans and
leases, $0.9 billion was attributable to average commercial real estate
loans, and $2.4 billion was attributable to residential real estate loans.
From a production standpoint, residential real estate loan closings in the
second quarter of 2006 were $1.4 billion compared to $1.2 billion in the
first quarter of 2006 and $1.6 billion in the second quarter of 2005.
Average home equity loans and lines declined $0.5 billion in the second
quarter of 2006 compared to the second quarter of 2005.
31
For the six months ended June 30, 2006, total consolidated average loans
and leases increased $6.6 billion or 21.5% compared to the six months
ended June 30, 2005. Excluding the effect of the banking acquisitions,
total consolidated average loan and lease organic growth was 14.1% for the
six months ended June 30, 2006 compared to the six months ended June 30,
2005. Approximately $2.0 billion of the growth in total consolidated
average loans and leases was attributable to the banking acquisitions and
$4.6 billion of the growth was organic. Of the $2.0 billion of average
growth attributable to the banking acquisitions, $1.4 billion was
attributable to average commercial real estate loans, $0.4 billion was
attributable to average commercial loans and leases and the remainder was
primarily attributable to average residential real estate loans. Of the
$4.6 billion of average loan and lease organic growth, $1.6 billion was
attributable to average commercial loans and leases, $1.0 billion was
attributable to average commercial real estate loans, and $2.5 billion was
attributable to residential real estate loans. From a production
standpoint, residential real estate loan closings in the first half of
2006 and the first half of 2005 amounted to $2.6 billion and $2.7 billion,
respectively. Average home equity loans and lines declined $0.5 billion
in the six months ended June 30, 2006 compared to the six months ended
June 30, 2005.
Total average commercial loan and lease organic growth continued to be
strong in the second quarter and first half of 2006. Management
attributes the loan growth to the strength of the local economies in the
markets the Corporation serves, new business and continued customer
satisfaction. Management continues to expect that year over year organic
commercial loan growth (as a percentage) will reach low double digits in
2006. The basis for this expectation includes continued success in
attracting new customers in all of the Corporation's markets and continued
modest economic growth in the primary markets that the Corporation serves.
Recently the Corporation has experienced some slowing in the construction
market for both commercial and residential developers, and to some extent
throughout the commercial real estate business. As a result, management
expects that year over year organic commercial real estate loan growth (as
a percentage) will reach mid single digits in 2006.
Home equity loans and lines, which includes M&I's wholesale activity,
continue to be one of the primary consumer loan products. Average home
equity loans and lines declined in the second quarter and first half of
2006 compared to the second quarter and first half of 2005. This is
consistent with what is occurring in many parts of the country. The
softer home equity market, combined with the Corporation's continued sales
of certain loans at origination, which is partly in response to the demand
for home equity products with higher loan-to-value characteristics, will
impact balance sheet organic loan growth. Management does not expect this
trend to change in the near term.
The Corporation sells some of its residential real estate production
(residential real estate and home equity loans) in the secondary market.
Selected residential real estate loans with rate and term characteristics
that are considered desirable are periodically retained in the portfolio.
For the three months ended June 30, 2006 and 2005 real estate loans sold
to investors amounted to $0.6 billion and $0.5 billion, respectively. For
the six months ended June 30, 2006, real estate loans sold to investors
amounted to $1.2 billion compared to $0.9 billion for the six months ended
June 30, 2005. At June 30, 2006 and 2005, the Corporation had
approximately $123.4 million and $153.8 million of mortgage loans held for
sale, respectively. Gains from the sale of mortgage loans amounted to
$10.2 million in the second quarter of 2006 compared to $9.5 million in
the second quarter of 2005. For the six months ended June 30, 2006, gains
from the sale of mortgage loans amounted to $21.0 million compared to
$16.4 million in the six months ended June 30, 2005.
Auto loans securitized and sold in the second quarters of 2006 and 2005
amounted to $0.2 billion and $0.1 billion, respectively. For the six
months ended June 30, 2006, auto loans securitized and sold amounted to
$0.3 billion compared to $0.2 billion in the six months ended June 30,
2005. The net gains and losses from the sale and securitization of auto
loans for the three and six months ended June 30, 2006 and 2005,
respectively, were not significant.
The Corporation anticipates that it will continue to divest itself of
selected assets through sale or securitization in future periods.
32
The growth and composition of the Corporation's quarterly average deposits
for the current and previous four quarters are as follows ($ in millions):
Consolidated Average Deposits
-----------------------------
2006 2005 Growth Pct.
------------------- ------------------------------ -----------------
Second First Fourth Third Second Prior
Quarter Quarter Quarter Quarter Quarter Annual Quarter
--------- --------- --------- --------- --------- -------- ---------
Bank issued deposits
--------------------
Noninterest bearing deposits
Commercial $ 3,873 $ 3,473 $ 3,687 $ 3,589 $ 3,377 14.7 % 11.5 %
Personal 998 943 942 932 958 4.2 5.9
Other 533 526 566 528 491 8.5 1.2
-------- -------- -------- -------- -------- ------- -------
Total noninterest
bearing deposits 5,404 4,942 5,195 5,049 4,826 12.0 9.4
Interest bearing deposits
Savings and NOW 3,251 2,831 2,911 3,049 3,149 3.2 14.8
Money market 7,389 6,599 6,354 6,047 5,819 27.0 12.0
Foreign activity 1,000 1,034 1,084 932 882 13.4 (3.2)
-------- -------- -------- -------- -------- ------- -------
Total interest
bearing deposits 11,640 10,464 10,349 10,028 9,850 18.2 11.2
Time deposits
Other CDs and
time deposits 4,769 3,509 3,354 3,095 2,951 61.7 35.9
CDs greater than $100,000 2,878 2,035 1,703 1,421 1,243 131.5 41.4
-------- -------- -------- -------- -------- ------- -------
Total time deposits 7,647 5,544 5,057 4,516 4,194 82.4 37.9
-------- -------- -------- -------- -------- ------- -------
Total bank issued deposits 24,691 20,950 20,601 19,593 18,870 30.8 17.9
Wholesale deposits
------------------
Money market 732 887 1,074 1,068 1,077 (32.1) (17.5)
Brokered CDs 5,382 3,874 4,752 4,615 4,437 21.3 38.9
Foreign time 1,931 1,762 897 1,076 1,086 77.8 9.6
-------- -------- -------- -------- -------- ------- -------
Total wholesale deposits 8,045 6,523 6,723 6,759 6,600 21.9 23.3
-------- -------- -------- -------- -------- ------- -------
Total consolidated
average deposits $ 32,736 $ 27,473 $ 27,324 $ 26,352 $ 25,470 28.5 % 19.2 %
======== ======== ======== ======== ======== ======= =======
Average total bank issued deposits increased $5.8 billion or 30.8% in the
second quarter of 2006 compared to the second quarter of 2005. Excluding
the effect of the banking acquisitions, total average bank issued deposits
organic growth was 12.6% in the second quarter of 2006 compared to the
second quarter of 2005. Approximately $3.0 billion of the growth in
average total bank issued deposits was attributable to the banking
acquisitions and $2.8 billion of the growth was organic. Of the $3.0
billion of average growth attributable to the banking acquisitions, $0.4
billion was attributable to average noninterest bearing deposits, $0.9
billion was attributable to average interest bearing deposits and $1.7
billion was attributable to average time deposits. Of the $2.8 billion of
average bank issued deposit organic growth, $0.2 billion was attributable
to average noninterest bearing deposits, $0.8 billion was attributable to
average interest bearing deposits and $1.8 billion was attributable to
average time deposits.
For the six months ended June 30, 2006, average total bank issued deposits
increased $4.2 billion or 22.4% compared to the six month ended June 30,
2005. Excluding the effect of the banking acquisitions, total average bank
issued deposits organic growth was 13.1% in the six months ended June 30,
2006 compared to the six months ended June 30, 2005. Approximately $1.5
billion of the growth in average total bank issued deposits was
attributable to the banking acquisitions and $2.7 billion of the growth
was organic. Of the $1.5 billion of average growth attributable to the
banking acquisitions, $0.2 billion was attributable to average noninterest
bearing deposits, $0.5 billion was attributable to average interest
bearing deposits and $0.8 billion was attributable to average time
deposits. Of the $2.7 billion of average bank issued deposit organic
growth, $0.2 billion was attributable to average noninterest bearing
deposits, $0.8 billion was attributable to average interest bearing
deposits and $1.7 billion was attributable to average time deposits.
Noninterest bearing deposit balances tend to exhibit some seasonality with
a trend of balances declining somewhat in the early part of the year
followed by growth in balances throughout the remainder of the year. A
portion of the noninterest balances, especially commercial balances, is
sensitive to the interest rate environment. Larger balances tend to be
maintained when overall interest rates are low and smaller balances tend
to be maintained as overall interest rates increase.
33
As interest rates have risen, the Corporation has increasingly been able
to competitively price deposit products which has contributed to the
growth in average bank-issued interest bearing deposits and average bank
issued time deposits. In addition, rising interest rates have resulted in
a shift in the bank issued deposit mix. In their search for higher
yields, both new and existing customers have been migrating their deposit
balances to higher cost money market and time deposit products.
In commercial banking, the focus remains on developing deeper
relationships by capitalizing on cross-sale opportunities. Incentive
plans based on the sale of treasury management products and services are
focused on growing deposits. The retail banking strategy continues to
focus on aggressively selling the right products to meet the needs of
customers and enhance the Corporation's profitability.
Wholesale deposits are funds in the form of deposits generated through
distribution channels other than M&I's own banking branches. The
Corporation continues to make use of wholesale funding alternatives,
especially brokered and institutional certificates of deposit. These
deposits allow the Corporation's bank subsidiaries to gather funds across
a wider geographic base and at pricing levels considered attractive, where
the underlying depositor may be retail or institutional. For the three
months ended June 30, 2006, average wholesale deposits increased $1.4
billion, or 21.9% compared to the three months ended June 30, 2005. For
the six months ended June 30, 2006 average wholesale deposits increased
$0.6 billion, or 8.8% compared to the six months ended June 30, 2005.
Average wholesale deposits for the three and six months ended June 30,
2006 include $0.6 billion and $0.3 billion, respectively, of wholesale
deposits that were assumed in the acquisitions. During the first quarter
of 2006, a significant portion of longer-term institutional certificates
of deposits matured and were re-financed at a higher cost.
At June 30, 2006, long-term borrowings from the banking acquisitions
amounted to $229.0 million. Approximately $30.0 million is subordinated,
$100.0 million of advances from the Federal Home Loan Bank ("FHLB") and
$99.0 million is subordinated debt associated with four separate issuances
of trust preferred securities. During the second quarter of 2006, $400.0
million of floating rate global senior bank notes were issued. These
floating rate senior bank notes mature in 2011 and have a coupon rate that
is indexed to the three-month London Inter-Bank Offered Rate ("LIBOR").
During the first quarter of 2006, the Corporation issued $250.0 million of
fixed rate senior notes. The fixed rate senior notes mature in 2011 and
have a coupon rate of 5.35%. Also during the first quarter of 2006,
$500.0 million of floating rate senior bank notes were issued. These
floating rate senior bank notes mature in 2008 and have a coupon rate that
is indexed to the three-month LIBOR. During the first quarter of 2006,
$250.0 million of senior bank notes - Extendible Liquidity Securities
matured.
During the second quarter of 2005, $350.0 million of subordinated bank
notes were issued. The subordinated bank notes mature in 2015 and have a
coupon rate of 4.85%. Senior bank notes in an aggregate amount of $525.0
million were also issued during the second quarter of 2005. The senior
bank notes are floating rate and mature at various times in 2007 and 2010.
During the first quarter of 2005 the Corporation obtained a new floating
rate advance from the FHLB aggregating $250.0 million. The FHLB advance
matures in 2011. During the first quarter of 2005, $900.0 million of
senior bank notes with an annual weighted average coupon interest rate of
4.13% were issued. The notes mature at various times beginning in 2008
through 2017.
34
The Corporation's consolidated average interest earning assets and
interest bearing liabilities, interest earned and interest paid for the
three and six months ended June 30, 2006 and 2005, are presented in the
following tables ($ in millions):
Consolidated Yield and Cost Analysis
------------------------------------
Three Months Ended Three Months Ended
June 30, 2006 June 30, 2005
--------------------------- ---------------------------
Average Average
Average Yield or Average Yield or
Balance Interest Cost (b) Balance Interest Cost (b)
--------------------------- ---------------------------
Loans and leases: (a)
Commercial loans and leases $ 11,896.4 $ 215.4 7.26 % $ 9,357.0 $ 136.3 5.84 %
Commercial real estate loans 13,580.4 248.6 7.34 9,867.4 151.4 6.15
Residential real estate loans 7,985.7 139.7 7.01 5,367.6 79.9 5.97
Home equity loans and lines 4,595.7 82.6 7.21 5,098.3 79.2 6.23
Personal loans and leases 1,591.5 28.5 7.20 1,603.8 23.6 5.91
---------- ------- ------- ---------- ------- -------
Total loans and leases 39,649.7 714.8 7.23 31,294.1 470.4 6.03
Investment securities (b):
Taxable 5,818.3 70.9 4.79 4,828.6 53.3 4.41
Tax Exempt (a) 1,316.1 22.9 7.04 1,333.7 23.9 7.34
---------- ------- ------- ---------- ------- -------
Total investment securities 7,134.4 93.8 5.19 6,162.3 77.2 5.03
Trading securities (a) 50.3 0.2 1.70 25.6 0.1 0.78
Other short-term investments 374.2 5.0 5.37 271.7 2.2 3.39
---------- ------- ------- ---------- ------- -------
Total interest earning assets $ 47,208.6 $ 813.8 6.90 % $ 37,753.7 $ 549.9 5.84 %
========== ======= ======= ========== ======= =======
Interest bearing deposits:
Bank issued deposits:
Bank issued interest
bearing activity deposits $ 11,639.6 $ 94.6 3.26 % $ 9,850.0 $ 41.8 1.70 %
Bank issued time deposits 7,646.9 80.9 4.24 4,193.2 31.6 3.02
---------- ------- ------- ---------- ------- -------
Total bank issued deposits 19,286.5 175.5 3.65 14,043.2 73.4 2.10
Wholesale deposits 8,045.1 96.1 4.79 6,600.1 49.4 3.00
---------- ------- ------- ---------- ------- -------
Total interest bearing deposits 27,331.6 271.6 3.99 20,643.3 122.8 2.39
Short-term borrowings 3,418.6 43.1 5.06 3,392.3 28.4 3.36
Long-term borrowings 10,050.1 117.3 4.68 7,920.1 77.3 3.91
---------- ------- ------- ---------- ------- -------
Total interest bearing liabilities $ 40,800.3 $ 432.0 4.25 % $ 31,955.7 $ 228.5 2.87 %
========== ======= ======= ========== ======= =======
Net interest margin (FTE) $ 381.8 3.24 % $ 321.4 3.42 %
======= ======= ======= =======
Net interest spread (FTE) 2.65 % 2.97 %
======= =======
(a) Fully taxable equivalent ("FTE") basis, assuming a Federal income
tax rate of 35%, and excluding disallowed interest expense.
(b) Based on average balances excluding fair value adjustments for
available for sale securities.
35
Consolidated Yield and Cost Analysis
------------------------------------
Six Months Ended Six Months Ended
June 30, 2006 June 30, 2005
--------------------------- ---------------------------
Average Average
Average Yield or Average Yield or
Balance Interest Cost (b) Balance Interest Cost (b)
--------------------------- ---------------------------
Loans and leases: (a)
Commercial loans and leases $ 11,118.8 $ 390.6 7.09 % $ 9,108.7 $ 257.1 5.69 %
Commercial real estate loans 12,088.7 429.7 7.17 9,692.9 290.0 6.03
Residential real estate loans 7,632.5 262.5 6.94 5,050.1 147.2 5.88
Home equity loans and lines 4,650.5 163.6 7.09 5,114.4 154.3 6.08
Personal loans and leases 1,668.8 57.7 6.97 1,626.6 46.4 5.75
---------- -------- ------- ---------- -------- -------
Total loans and leases 37,159.3 1,304.1 7.08 30,592.7 895.0 5.90
Investment securities (b):
Taxable 5,401.1 128.8 4.72 4,825.7 105.2 4.39
Tax Exempt (a) 1,328.3 46.3 7.12 1,306.1 46.9 7.41
---------- -------- ------- ---------- -------- -------
Total investment securities 6,729.4 175.1 5.18 6,131.8 152.1 5.02
Trading securities (a) 42.3 0.3 1.37 24.4 0.1 0.99
Other short-term investments 345.1 8.6 5.01 229.6 3.6 3.20
---------- -------- ------- ---------- -------- -------
Total interest earning assets $44,276.1 $1,488.1 6.77 % $ 36,978.5 $1,050.8 5.73 %
========== ======== ======= ========== ======== =======
Interest bearing deposits:
Bank issued deposits:
Bank issued interest
bearing activity deposits $11,055.2 $ 169.2 3.09 % $ 9,863.4 $ 75.5 1.54 %
Bank issued time deposits 6,601.4 134.2 4.10 4,028.1 57.6 2.89
---------- -------- ------- ---------- -------- -------
Total bank issued deposits 17,656.6 303.4 3.47 13,891.5 133.1 1.93
Wholesale deposits 7,288.0 166.2 4.60 6,700.8 93.2 2.80
---------- -------- ------- ---------- -------- -------
Total interest bearing deposits 24,944.6 469.6 3.80 20,592.3 226.3 2.22
Short-term borrowings 3,394.9 82.5 4.90 3,144.0 50.3 3.23
Long-term borrowings 9,728.9 221.7 4.59 7,564.6 145.7 3.88
---------- -------- ------- ---------- -------- -------
Total interest bearing liabilities $38,068.4 $ 773.8 4.10 % $ 31,300.9 $ 422.3 2.72 %
========== ======== ======= ========== ======== =======
Net interest margin (FTE) $ 714.3 3.25 % $ 628.5 3.43 %
======= ======== ======= =======
Net interest spread (FTE) 2.67 % 3.01 %
======== =======
(a) Fully taxable equivalent ("FTE") basis, assuming a Federal income
tax rate of 35%, and excluding disallowed interest expense.
(b) Based on average balances excluding fair value adjustments for
available for sale securities.
The net interest margin FTE decreased 18 basis points from 3.42% in the
second quarter of 2005 to 3.24% in the second quarter of 2006. For the
six months ended June 30, 2006, the net interest margin FTE was 3.25%
compared to 3.43% for the six months ended June 30, 2005, a decrease of 18
basis points. Beginning with the first quarter of 2006, the Corporation
included certain loan and lease fees in interest income on loans and
leases. All prior periods have been adjusted for this reclassification.
For the three and six months ended June 30, 2005, the net interest margin
FTE increased by approximately 9 basis points and 8 basis points,
respectively from the previously reported amounts due to this
reclassification. Compared to the first quarter of 2006, the net interest
margin FTE decreased 2 basis points from 3.26% in the first quarter of
2006 to 3.24% in the second quarter of 2006.
Similar to the general trends being experienced throughout the industry,
the Corporation continues to be challenged by narrowing loan spreads in a
solid economy with a flat yield curve, loan growth that may exceed the
Corporation's ability to generate appropriately priced deposits and the
shift in the bank issued deposit mix by new and existing depositors into
higher yielding products. Management expects these trends to continue and
expects that there will be modest downward pressure on the net interest
margin FTE for the remainder of 2006. Net interest income and the net
interest margin percentage can vary and continue to be influenced by loan
and deposit growth, product spreads, pricing competition in the
Corporation's markets, prepayment activity, future interest rate changes
and various other factors.
36
PROVISION FOR LOAN AND LEASE LOSSES AND CREDIT QUALITY
------------------------------------------------------
The following tables present comparative consolidated credit quality
information as of June 30, 2006, and the prior four quarters:
Nonperforming Assets
--------------------
($000's)
2006 2005
----------------------- -----------------------------------
Second First Fourth Third Second
Quarter Quarter Quarter Quarter Quarter
----------- ----------- ----------- ----------- -----------
Nonaccrual $ 193,028 $ 144,484 $ 134,718 $ 141,408 $ 126,920
Renegotiated 133 138 143 148 176
Past due 90 days or more 4,855 4,523 5,725 5,743 4,514
---------- ---------- ---------- ---------- ----------
Total nonperforming loans and leases 198,016 149,145 140,586 147,299 131,610
Other real estate owned 11,701 8,207 8,869 8,774 9,124
---------- ---------- ---------- ---------- ----------
Total nonperforming assets $ 209,717 $ 157,352 $ 149,455 $ 156,073 $ 140,734
========== ========== ========== ========== ==========
Allowance for loan and lease losses $ 415,201 $ 368,760 $ 363,769 $ 362,257 $ 360,138
========== ========== ========== ========== ==========
Consolidated Statistics
-----------------------
2006 2005
----------------------- -----------------------------------
Second First Fourth Third Second
Quarter Quarter Quarter Quarter Quarter
----------- ----------- ----------- ----------- -----------
Net charge-offs to average
loans and leases annualized 0.10 % 0.07 % 0.14 % 0.10 % 0.15 %
Total nonperforming loans and leases
to total loans and leases 0.49 0.42 0.41 0.44 0.41
Total nonperforming assets to total loans
and leases and other real estate owned 0.52 0.45 0.44 0.47 0.44
Allowance for loan and lease losses
to total loans and leases 1.03 1.05 1.06 1.09 1.12
Allowance for loan and lease losses
to total nonperforming loans and leases 210 247 259 246 274
Nonaccrual Loans and Leases By Type
-----------------------------------
($000's)
2006 2005
----------------------- -----------------------------------
Second First Fourth Third Second
Quarter Quarter Quarter Quarter Quarter
----------- ----------- ----------- ----------- -----------
Commercial
Commercial, financial
and agricultural $ 59,558 $ 50,103 $ 43,730 $ 47,644 $ 35,777
Lease financing receivables 454 1,399 1,539 3,012 3,990
---------- ---------- ---------- ---------- ----------
Total commercial 60,012 51,502 45,269 50,656 39,767
Real estate
Construction and land development 33,115 3,276 913 3,057 1,500
Commercial mortgage 34,260 30,633 28,644 30,351 37,107
Residential mortgage 64,151 57,425 57,982 56,488 47,797
---------- ---------- ---------- ---------- ----------
Total real estate 131,526 91,334 87,539 89,896 86,404
Personal 1,490 1,648 1,910 856 749
---------- ---------- ---------- ---------- ----------
Total nonaccrual loans and leases $ 193,028 $ 144,484 $ 134,718 $ 141,408 $ 126,920
========== ========== ========== ========== ==========
37
Reconciliation of Allowance for Loan and Lease Losses
-----------------------------------------------------
($000's)
2006 2005
----------------------- -----------------------------------
Second First Fourth Third Second
Quarter Quarter Quarter Quarter Quarter
----------- ----------- ----------- ----------- -----------
Beginning balance $ 368,760 $ 363,769 $ 362,257 $ 360,138 $ 358,280
Provision for loan and lease losses 11,053 10,995 12,995 9,949 13,725
Allowance of banks and loans acquired 45,258 -- -- -- --
Loans and leases charged-off
Commercial 6,125 3,869 9,481 2,256 3,767
Real estate 3,385 2,901 3,110 6,576 8,190
Personal 3,088 3,727 5,213 3,186 3,765
Leases 1,253 189 226 337 380
---------- ---------- ---------- ---------- ----------
Total charge-offs 13,851 10,686 18,030 12,355 16,102
Recoveries on loans and leases
Commercial 847 2,715 4,256 2,634 2,264
Real estate 1,224 263 374 575 413
Personal 1,149 971 781 787 782
Leases 761 733 1,136 529 776
---------- ---------- ---------- ---------- ----------
Total recoveries 3,981 4,682 6,547 4,525 4,235
---------- ---------- ---------- ---------- ----------
Net loans and leases charge-offs 9,870 6,004 11,483 7,830 11,867
---------- ---------- ---------- ---------- ----------
Ending balance $ 415,201 $ 368,760 $ 363,769 $ 362,257 $ 360,138
========== ========== ========== ========== ==========
Nonperforming assets consist of nonperforming loans and leases and other
real estate owned ("OREO").
OREO is principally comprised of commercial and residential properties
acquired in partial or total satisfaction of problem loans and amounted to
$11.7 million at June 30, 2006, compared to $8.2 million at March 31, 2006
and $9.1 million at June 30, 2005. The increase in OREO of $3.5 million
from March 31, 2006 to June 30, 2006 is predominantly due to the OREO
acquired in the banking acquisitions.
Nonperforming loans and leases consist of nonaccrual, renegotiated or
restructured loans, and loans and leases that are delinquent 90 days or
more and still accruing interest. The balance of nonperforming loans and
leases can fluctuate widely based on the timing of cash collections,
renegotiations and renewals.
Maintaining nonperforming assets at an acceptable level is important to
the ongoing success of a financial services institution. The
Corporation's comprehensive credit review and approval process are
critical to ensuring that the amount of nonperforming assets on a long-
term basis is minimized within the overall framework of acceptable levels
of credit risk. In addition to the negative impact on net interest income
and credit losses, nonperforming assets also increase operating costs due
to the expense associated with collection efforts.
At June 30, 2006, nonperforming loans and leases amounted to $198.0
million or 0.49% of consolidated loans and leases compared to $149.1
million or 0.42% of consolidated loans and leases at March 31, 2006, and
$131.6 million or 0.41% of consolidated loans and leases at June 30, 2005.
Approximately $42.7 million or 87% of the $48.9 million increase in
nonperforming loans from March 31, 2006 to June 30, 2006 was attributable
to the banking acquisitions. Excluding the effect of the acquisitions,
nonperforming loans and leases would have amounted to $155.3 million or
0.43% of consolidated loans and leases at June 30, 2006. Excluding the
acquisitions, the pro forma ratio of nonperforming loans and leases to
consolidated loans and leases at June 30, 2006 and the actual ratio at
each quarter end throughout 2005 has remained in a fairly narrow range and
continues to be below management's expectations. Nonaccrual loans and
leases continue to be the primary source of nonperforming loans and
leases.
38
Net charge-offs amounted to $9.9 million or 0.10% of average loans and
leases in the second quarter of 2006 compared to $6.0 million or 0.07% of
average loans and leases in the first quarter of 2006 and $11.9 million or
0.15% of average loans and leases in the second quarter of 2005. The
lower level of net charge-offs experienced throughout 2005 and the first
six months of 2006 has to some extent been the result of higher than
normal recoveries. Based on the status of some of the larger charge-offs
recognized in recent quarters, management expects recoveries will likely
return to lower levels in future periods. The ratio of recoveries to
charge-offs was 28.7% for the three months ended June 30, 2006 which was
closer to average historical experience. The ratio of recoveries to
charge-offs was 35.3% for the six months ended June 30, 2006 which
continues to be above the Corporation's five year historical average ratio
of recoveries to charge-offs of 27.9%.
Management continues to expect the longer term level of nonperforming
loans and leases to be in the range of 50-60 basis points of total loans
and leases and expects net charge-offs to trend to historical levels.
With respect to the banking acquisitions, management expects the level of
nonperforming loans to decline slowly over the next couple of years and
expects net charge-off levels to increase modestly.
The provisions for loan and lease losses amounted to $11.0 million for the
three months ended June 30, 2006 compared to $11.0 million for the three
months ended March 31, 2006 and $13.7 million for the three months ended
June 30, 2005. For the six months ended June 30, 2006, the provisions for
loan and lease losses amounted to $22.0 million compared to $21.9 million
for the six months ended June 30, 2005. The allowance for loan and lease
losses as a percent of consolidated loans and leases outstanding was 1.03%
at June 30, 2006, 1.05% at March 31, 2006 and 1.12% at June 30, 2005.
OTHER INCOME
------------
Other income or noninterest sources of revenue represented approximately
56.4% and 58.1% of the Corporation's total sources of revenues for the
three months ended June 30, 2006 and 2005, respectively. Total other
income in the second quarter of 2006 amounted to $484.4 million compared
to $434.3 million in the same period last year, an increase of $50.1
million or 11.5%. For the six months ended June 30, 2006 and 2005,
noninterest sources of revenue represented approximately 57.8% of the
Corporation's total sources of revenues, respectively. Total other income
for the six months ended June 30, 2006 amounted to $957.1 million compared
to $836.8 million for the six months ended June 30, 2005, an increase of
$120.3 million or 14.4%. The increase in other income was primarily due
to growth in data processing services and wealth management services
revenue. Other income for the three and six months ended June 30, 2005
includes significant investment securities gains as previously discussed.
Data processing services revenue (Metavante) amounted to $345.0 million in
the second quarter of 2006 compared to $282.4 million in the second
quarter of 2005, an increase of $62.6 million or 22.2%. For the six
months ended June 30, 2006, Data processing services revenue amounted to
$688.0 million compared to $565.3 million for the six months ended June
30, 2005, an increase of $122.7 million or 21.7%. Revenue growth
continued throughout the segment due to revenue associated with
acquisitions, higher transaction volumes in core processing activity,
payment processing and electronic banking and an increase in healthcare
eligibility and payment card production. Revenue associated with
Metavante's acquisitions completed in 2006 and 2005 contributed a
significant portion of the revenue growth in the three and six months
ended June 30, 2006, compared to the three and six months ended June 30,
2005. The acquisition related revenue growth includes cross sales of
acquired products to clients across the entire segment. Metavante
estimates that total revenue growth (internal and external) for the six
months ended June 30, 2006 compared to the six months ended June 30, 2005
excluding the acquisitions ("organic revenue growth"), was approximately
8.2%. To determine the estimated organic revenue growth rate, Metavante
adjusts its prior year revenue for the acquisitions as if they had been
consummated on January 1 of the prior year. The linked-quarter data
processing services revenue growth will tend to be somewhat more cyclical
and seasonal in nature. Total buyout revenue, which varies from period to
period, increased $3.0 million and $1.8 million in the three and six
months ended June 30, 2006 compared to the three and six months ended June
30, 2005, respectively.
As previously reported, on January 1, 2006 the Banking segment transferred
its external item processing business, including all check-processing
client relationships, to Metavante. As a result of the transfer, the
previously reported Other income line, Item processing, was reclassified
to Data processing services in the Consolidated Statements of Income and
prior period segment financial information for both the Banking segment
and Metavante has been adjusted for the transfer.
Management continues to expect that Metavante revenue (internal and
external) for the year ended December 31, 2006 will be at the high end of
the previously forecasted revenue projection of $1.4 billion to $1.5
billion. Organic revenue growth rates are expected to exceed prior year
levels and segment income is expected to continue to improve. These
expectations include the impact of all closed acquisitions and the
transfer of external item processing.
39
As previously discussed, beginning with the second quarter of 2006, trust
services revenue, brokerage and investment advisor revenue and noninterest
revenue from the private banking business have been combined and reported
in the line item Wealth management in the Consolidated Statements of
Income in response to requests by users of the Corporation's financial
information. All prior periods have been adjusted for this
reclassification.
Wealth management revenue amounted to $56.3 million in the second quarter
of 2006 compared to $48.1 million in the second quarter of 2005, an
increase of $8.2 million or 17.0%. For the six months ended June 30,
2006, Wealth management revenue amounted to $109.1 million compared to
$95.2 million for the six months ended June 30, 2005, an increase of $13.9
million or 14.6%. For the three and six months ended June 30, 2006,
wealth management revenue attributable to the previously reported January
3, 2006 acquisition of certain assets of First Trust Indiana and the April
1, 2006 acquisition of Gold Banc Corporation, Inc. amounted to $2.3
million and $3.4 million, respectively. Continued success in the cross-
selling and integrated delivery initiatives, improved investment
performance and improving results in institutional sales efforts and
outsourcing activities were the primary contributors to the remaining
revenue growth over the respective periods. Assets under management were
approximately $20.4 billion at June 30, 2006 compared to $19.8 billion at
March 31, 2006, and $18.5 billion at June 30, 2005.
Service charges on deposits amounted to $25.0 million in the second
quarter of 2006 compared to $23.7 million in the second quarter of 2005.
For the six months ended June 30, 2006, service charges on deposits
amounted to $47.6 million compared to $47.1 million for the six months
ended June 30, 2005. The banking acquisitions contributed $2.1 million of
service charges on deposits for the three and six months ended June 30,
2006. A portion of this source of fee income is sensitive to changes in
interest rates. In a rising interest rate environment, customers that pay
for services by maintaining eligible deposit balances receive a higher
earnings credit which results in lower fee income. Excluding the effect of
the banking acquisitions, lower service charges on deposits associated
with commercial demand deposits accounted for the majority of the decline
in this revenue in the three and six months ended June 30, 2006 compared
to the three and six months ended June 30, 2005, respectively.
Total mortgage banking revenue was $12.3 million in the second quarter of
2006 compared with $11.2 million in the second quarter of 2005, an
increase of $1.1 million or 9.7%. For the six months ended June 30, 2006,
total mortgage banking revenue amounted to $24.7 million compared to $19.4
million for the six months ended June 30, 2005, an increase of $5.3
million or 27.7%. For the three months ended June 30, 2006 and 2005, the
Corporation sold $0.6 billion and $0.5 billion of residential mortgage and
home equity loans to the secondary market, respectively. For the six
months ended June 30, 2006 and 2005, the Corporation sold $1.2 billion and
$0.9 billion of residential mortgage and home equity loans to the
secondary market, respectively. As previously discussed, the Corporation
continues to sell home equity loans at origination which is partly in
response to the demand for home equity products with higher loan-to-value
characteristics. Retained interests in the form of mortgage servicing
rights on residential mortgage loans sold amounted to $0.4 million for the
six months ended June 30, 2006 and $0.5 million for the six months ended
June 30, 2005. At June 30, 2006 mortgage servicing rights amounted to
$2.5 million.
Net investment securities gains for the three and six months ended June
30, 2006 were not significant. Net investment securities gains for the
three and six months ended June 30, 2005 amounted to $29.4 million and
$35.3 million, respectively. As previously discussed, during the second
quarter of 2005, the Corporation realized a gain due to the sale of an
entity associated with its investment in an independent private equity and
venture partnership. The gross gain amounted to $29.0 million. During
the first quarter of 2005, the Corporation's banking segment's investment
in certain membership interests of PULSE was liquidated by PULSE. The
cash received resulted in a pre-tax gain of $5.3 million. An additional
$0.3 million was received in the second quarter of 2005.
Other income in the second quarter of 2006 amounted to $37.4 million
compared to $31.5 million in the second quarter of 2005, an increase of
$5.9 million or 19.0%. For the six months ended June 30, 2006, other
income amounted to $71.3 million compared to $60.3 million for the six
months ended June 30, 2005, an increase of $11.0 million or 18.2%. Other
income for the three and six months ended June 30, 2006 includes $2.8
million of income attributable to the banking acquisitions. The remaining
increase in other income for the three and six months ended June 30, 2006
compared to the three and six months ended June 30, 2005 was primarily due
to increases in card related fees and trading and investment fees.
OTHER EXPENSE
-------------
Total other expense for the three months ended June 30, 2006 amounted to
$544.3 million compared to $459.9 million for the three months ended June
30, 2005, an increase of $84.4 million or 18.4%. For the six months ended
June 30, 2006, total other expense amounted to $1,049.4 million compared
to $902.8 million for the six months ended June 30, 2005, an increase of
$146.6 million or 16.2%.
40
Total other expense for the three and six months ended June 30, 2006
included the operating expenses associated with Metavante's 2005 and 2006
acquisitions, the 2006 banking acquisitions and the 2006 acquisition of
certain assets of First Trust Indiana. The operating expenses of the
acquired entities have been included in the Corporation's consolidated
operating expenses from the dates the transactions were completed, which
had a significant impact on the period to period comparability of
operating expenses in 2006 compared to 2005. Approximately $65.6 million
of the operating expense growth in the second quarter of 2006 compared to
the second quarter of 2005 and $109.6 million of the operating expense
growth in the six months ended June 30, 2006 compared to the six months
ended June 30, 2005 was attributable to the acquisitions. In addition,
expenses for the three and six months ended June 30, 2006 include
conversion and integration expenses related to the banking acquisitions.
The Corporation estimates that its expense growth in the three and six
months ended June 30, 2006 compared to the three and six months ended June
30, 2005, excluding the effects of the acquisitions, was approximately
$18.8 million and $36.9 million, respectively, and the estimated growth
rate was approximately 4.1% over the respective comparative periods.
Expense control is sometimes measured in the financial services industry
by the efficiency ratio statistic. The efficiency ratio is calculated by
taking total other expense divided by the sum of total other income
(including Capital Markets revenue but excluding investment securities
gains or losses) and net interest income on a fully taxable equivalent
basis. The Corporation's efficiency ratios for the three months ended
June 30, 2006, and prior four quarters were:
Efficiency Ratios
-----------------
Three Months Ended
--------------------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
2006 2006 2005 2005 2005
-------------- -------------- -------------- -------------- --------------
Consolidated Corporation 62.9 % 62.8 % 64.1 % 62.5 % 60.9 %
Consolidated Corporation
Excluding Metavante 51.2 % 48.8 % 51.5 % 50.8 % 49.9 %
The Consolidated Corporation Excluding Metavante efficiency ratio for the
remainder of 2006 is expected to decline somewhat from the second quarter
2006 and is expected to continue to decline slightly until the banking
acquisitions are fully integrated.
Salaries and employee benefits expense amounted to $307.1 million in the
second quarter of 2006 compared to $269.0 million in the second quarter of
2005, an increase of $38.1 million or 14.2%. For the six months ended
June 30, 2006, Salaries and employee benefits expense amounted to $584.5
million compared to $514.1 million for the six months ended June 30, 2005,
an increase of $70.4 million or 13.7%. Salaries and benefits associated
with the acquisitions previously discussed accounted for approximately
$27.5 million and $45.1 million of the increase in Salaries and employee
benefits expense in the three and six months ended June 30, 2006 compared
to the three and six months ended June 30, 2005, respectively.
For the second quarter of 2006, occupancy and equipment expense amounted
to $63.8 million compared to $50.9 million in the second quarter of 2005,
an increase of $12.9 million or 25.5%. The acquisitions accounted for
approximately $9.7 million of the increase in occupancy and equipment
expense in the three months ended June 30, 2006 compared to the three
months ended June 30, 2005. For the six months ended June 30, 2006,
occupancy and equipment expense amounted to $121.6 million compared to
$104.2 million for the six months ended June 30, 2005, an increase of
$17.4 million or 16.7%. The acquisitions accounted for approximately
$12.7 million of the increase in occupancy and equipment expense in the
six months ended June 30, 2006 compared to the six months ended June 30,
2005. The remaining increase in occupancy and equipment expense for the
three and six months ended June 30, 2006 compared to the three and six
months ended June 30, 2005 was primarily attributable to the banking
segment and wealth management.
41
Software expenses, processing charges, supplies and printing, professional
services and shipping and handling expenses totaled $89.1 million in the
second quarter of 2006 compared to $63.0 million in the second quarter of
2005, an increase of $26.1 million or 41.4%. For the six months ended
June 30, 2006, software expenses, processing charges, supplies and
printing, professional services and shipping and handling expenses totaled
$175.0 million compared to $128.3 million for the six months ended June
30, 2005, an increase of $46.7 million or 36.4%. The acquisitions
accounted for $19.6 million and $35.5 million of the expense growth for
the three and six months ended June 30, 2006 compared to the three and six
months ended June 30, 2005, respectively. Metavante's expense growth
accounted for the majority of the remaining increase in expense for these
items in the three and six months ended June 30, 2006 compared to the
three and six months ended June 30, 2005, respectively.
Amortization of intangibles amounted to $12.0 million in the second
quarter of 2006 compared to $8.1 million in the second quarter of 2005, an
increase of $3.9 million. For the six months ended June 30, 2006,
amortization of intangibles amounted to $20.9 million compared to $16.2
million for the six months ended June 30, 2005, an increase of $4.7
million. The increase in amortization associated with the acquisitions
amounted to $5.1 million and $7.1 million for the three and six months
ended June 30, 2006 compared to the three and six months ended June 30,
2005, respectively. Those increases were offset by lower amortization of
core deposit intangibles, which is based on a declining balance method and
lower amortization of Metavante's contract intangibles from previous
acquisitions.
Other expense amounted to $72.3 million in the second quarter of 2006
compared to $68.9 million in the second quarter of 2005, an increase of
$3.4 million or 4.9%. For the six months ended June 30, 2006, other
expense amounted to $147.4 million compared to $140.1 million for the six
months ended June 30, 2005, an increase of $7.3 million or 5.2%.
Other expense is affected by the capitalization of costs, net of
amortization associated with software development and customer data
processing conversions. Net software and conversion capitalization was
$0.6 million in the second quarter of 2006 compared to net software and
conversion amortization of $5.7 million in the second quarter of 2005,
resulting in a decrease to other expense over the comparative quarters of
$6.3 million. For the six months ended June 30, 2006, net software and
conversion amortization was $2.1 million compared to net software and
conversion amortization of $11.4 million for the six months ended June 30,
2005, resulting in a decrease to other expense over the comparative six
months of $9.3 million.
The acquisitions accounted for $3.8 million and $9.3 million of the growth
in other expense for the three and six months ended June 30, 2006 compared
to the three and six months ended June 30, 2005, respectively. The cost
of card plastic and cost of equipment associated with Metavante's revenues
and travel and other costs associated with the conversion and integration
of the banking acquisitions accounted for the remainder of the increase in
other expense for the three and six months ended June 30, 2006 compared to
the three and six months ended June 30, 2005, respectively.
INCOME TAXES
------------
The provision for income taxes for the three months ended June 30, 2006
amounted to $99.4 million or 32.8% of pre-tax income compared to $90.0
million or 32.9% of pre-tax income for the three months ended June 30,
2005. For the six months ended June 30, 2006, the provision for income
taxes amounted to $193.8 million or 33.2% of pre-tax income compared to
$174.9 million or 33.4% of pre-tax income for the six months ended June
30, 2005. During the second quarter of 2006, an income tax benefit was
recognized for the integration and realignment of Metavante subsidiaries
that resulted in a lower provision for income taxes in the consolidated
statements of income for the three and six months ended June 30, 2006.
During the second quarter of 2005, an income tax issue was resolved which
primarily affected the banking segment and resulted in a lower provision
for income taxes in the consolidated statements of income for the three
and six months ended June 30, 2005.
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
Shareholders' equity was $5.8 billion or 10.6% of total consolidated
assets at June 30, 2006, compared to $4.7 billion or 10.2% of total
consolidated assets at December 31, 2005, and $4.3 billion or 9.8% of
total consolidated assets at June 30, 2005.
During the second quarter of 2006, the Corporation issued 13,673,072
shares of its common stock and exchanged fully vested stock options to
purchase 119,816 of its common stock with a total value of $603.9 million
in conjunction with the Corporation's acquisition of Gold Banc
Corporation, Inc. Also during the second quarter of 2006, the Corporation
issued 3,069,430 shares of its common stock and exchanged fully vested
stock options to purchase 412,317 of its common stock with a total value
of $148.3 million in conjunction with the Corporation's acquisition of
Trustcorp Financial, Inc. During the first quarter of 2006, the
Corporation issued 527,864 shares of its common stock valued at $23.2
million in conjunction with Metavante's acquisition of AdminiSource Inc.
Also during the first quarter of 2006, the Corporation issued 385,192
shares of its common stock valued at $16.9 million to fund its 2005
obligations under its retirement and employee stock ownership plans.
42
On April 25, 2006, the Corporation announced that its Board of Directors
increased the quarterly cash dividend on its common stock 12.5%, from
$0.24 per share to $0.27 per share.
The Corporation has a Stock Repurchase Program under which it may
repurchase up to 12 million shares of its common stock annually. During
the first quarter of 2006, the Corporation repurchased 1.0 million shares
at an aggregate cost of $41.8 million or an average price of $41.79 per
common share. There were no purchases under the program in the second
quarter of 2006.
In 2005, the Corporation entered into an equity distribution agreement
whereby the Corporation may offer and sell up to 3.5 million shares of its
common stock from time to time through certain designated sales agents.
However, the Corporation will not sell more than the number of shares of
its common stock necessary for the aggregate gross proceeds from such
sales to reach $150.0 million. No sales occurred in the three or six
months ended June 30, 2006. The aggregate gross proceeds available for
future sales was approximately $143.3 million at June 30, 2006.
At June 30, 2006, the net loss in accumulated other comprehensive income
amounted to $101.3 million, which represented a negative change in
accumulated other comprehensive income of $64.0 million since December 31,
2005. Net accumulated other comprehensive income associated with
available for sale investment securities was a net loss of $104.3 million
at June 30, 2006, compared to a net loss of $36.3 million at December 31,
2005, resulting in a net loss of $68.0 million over the six month period.
Net accumulated other comprehensive income associated with the change in
fair value of the Corporation's derivative financial instruments
designated as cash flow hedges was a net gain of $4.0 million over the six
month period.
The Corporation continues to have a strong capital base and its regulatory
capital ratios are significantly above the minimum requirements as shown
in the following tables. The risk-based capital and leverage ratios at
December 31, 2005 have not been adjusted for the adoption of SFAS 123(R).
RISK-BASED CAPITAL RATIOS
-------------------------
($ in millions)
June 30, 2006 December 31, 2005
--------------------------------- ---------------------------------
Amount Ratio Amount Ratio
--------------------------------- ---------------------------------
Tier 1 Capital $ 3,623 7.65 % $ 3,046 7.67 %
Tier 1 Capital
Minimum Requirement 1,894 4.00 1,588 4.00
----------------- ------------- ----------------- -------------
Excess $ 1,729 3.65 % $ 1,458 3.67 %
================= ============= ================= =============
Total Capital $ 5,283 11.15 % $ 4,659 11.74 %
Total Capital
Minimum Requirement 3,789 8.00 3,176 8.00
----------------- ------------- ----------------- -------------
Excess $ 1,494 3.15 % $ 1,483 3.74 %
================= ============= ================= =============
Risk-Adjusted Assets $ 47,361 $ 39,698
================= =================
LEVERAGE RATIOS
---------------
($ in millions)
June 30, 2006 December 31, 2005
--------------------------------- ---------------------------------
Amount Ratio Amount Ratio
--------------------------------- ---------------------------------
Tier 1 Capital $ 3,623 7.13 % $ 3,046 7.08 %
Minimum Leverage
Requirement 1,524 - 2,540 3.00 - 5.00 1,291 - 2,152 3.00 - 5.00
----------------- ------------- ----------------- -------------
Excess $ 2,099 - 1,083 4.13 - 2.13 % $ 1,755 - 894 4.08 - 2.08 %
================= ============= ================= =============
Adjusted Average
Total Assets $ 50,807 $ 43,039
================= =================
M&I manages its liquidity to ensure that funds are available to each of
its banks to satisfy the cash flow requirements of depositors and
borrowers and to ensure the Corporation's own cash requirements are met.
M&I maintains liquidity by obtaining funds from several sources.
43
The Corporation's most readily available source of liquidity is its
investment portfolio. Investment securities available for sale, which
totaled $6.6 billion at June 30, 2006, represent a highly accessible
source of liquidity. The Corporation's portfolio of held-to-maturity
investment securities, which totaled $0.5 billion at June 30, 2006,
provides liquidity from maturities and amortization payments. The
Corporation's loans held for sale provide additional liquidity. These
loans represent recently funded loans that are prepared for delivery to
investors, which generally occurs within thirty to ninety days after the
loan has been funded.
Depositors within M&I's defined markets are another source of liquidity.
Core deposits (demand, savings, money market and consumer time deposits)
averaged $20.8 billion in the second quarter of 2006. The Corporation's
banking affiliates may also access the federal funds markets or utilize
collateralized borrowings such as treasury demand notes or FHLB advances.
The banking affiliates may use wholesale deposits, which include foreign
(Eurodollar) deposits. Wholesale deposits are funds in the form of
deposits generated through distribution channels other than the
Corporation's own banking branches. These deposits allow the
Corporation's banking subsidiaries to gather funds across a national
geographic base and at pricing levels considered attractive, where the
underlying depositor may be retail or institutional. Access to wholesale
deposits also provides the Corporation with the flexibility to not pursue
single service time deposit relationships in markets that have experienced
some unprofitable pricing levels. Wholesale deposits averaged $8.0
billion in the second quarter of 2006.
The Corporation utilizes certain financing arrangements to meet its
balance sheet management, funding, liquidity, and market or credit risk
management needs. The majority of these activities are basic term or
revolving securitization vehicles. These vehicles are generally funded
through term-amortizing debt structures or with short-term commercial
paper designed to be paid off based on the underlying cash flows of the
assets securitized. These vehicles provide access to funding sources
substantially separate from the general credit risk of the Corporation and
its subsidiaries. See Note 8 to the Consolidated Financial Statements for
an update of the Corporation's securitization activities in the second
quarter of 2006.
The Corporation's lead bank, M&I Marshall & Ilsley Bank (the "Bank"), has
implemented a bank note program. During the second quarter of 2006, the
Bank amended the bank note program into a global bank note program which
permits it to issue and sell up to a maximum of US$13.0 billion aggregate
principal amount (or the equivalent thereof in other currencies) at any
one time outstanding of its senior global bank notes with maturities of
seven days or more from their respective date of issue and subordinated
global bank notes with maturities more than five years from their
respective date of issue. The notes may be fixed rate or floating rate
and the exact terms will be specified in the applicable Pricing Supplement
or the applicable Program Supplement. This program is intended to enhance
liquidity by enabling the Bank to sell its debt instruments in global
markets in the future without the delays which would otherwise be
incurred. Senior global bank notes outstanding at June 30, 2006 amounted
to $0.4 billion.
Other bank notes outstanding at June 30, 2006 amounted to $6.0 billion of
which $1.3 billion is subordinated and qualifies as supplementary capital
for regulatory capital purposes. Bank notes issued during the first
quarter of 2006 amounted to $500.0 million.
The national capital markets represent a further source of liquidity to
M&I. M&I has filed a number of shelf registration statements that are
intended to permit M&I to raise funds through sales of corporate debt
and/or equity securities with a relatively short lead time.
During the third quarter of 2005, the Corporation amended the shelf
registration statement originally filed with the Securities and Exchange
Commission during the second quarter of 2004 to include the equity
distribution agreement. The amended shelf registration statement enables
the Corporation to issue various securities, including debt securities,
common stock, preferred stock, depositary shares, purchase contracts,
units, warrants, and trust preferred securities, up to an aggregate amount
of $3.0 billion. Approximately $1.3 billion is available for future
securities issuances.
During the fourth quarter of 2004, the Corporation filed a shelf
registration statement with the Securities and Exchange Commission
enabling the Corporation to issue up to 6.0 million shares of its common
stock, which may be offered and issued from time to time in connection
with acquisitions by M&I, Metavante and/or other consolidated subsidiaries
of the Corporation. At June 30, 2006, there were 3.1 million shares of
common stock available for future issuances.
44
Under another shelf registration statement, the Corporation may issue up
to $0.6 billion of medium-term Series F notes with maturities ranging from
9 months to 30 years and at fixed or floating rates. At June 30, 2006,
Series F notes issued amounted to $250.0 million. The Corporation may
issue up to $0.5 billion of medium-term MiNotes with maturities ranging
from 9 months to 30 years and at fixed or floating rates. The MiNotes are
issued in smaller denominations to attract retail investors. At June 30,
2006, MiNotes issued amounted to $0.2 billion. Additionally, the
Corporation has a commercial paper program. At June 30, 2006, commercial
paper outstanding amounted to $0.3 billion.
Short-term borrowings represent contractual debt obligations with
maturities of one year or less and amounted to $4.1 billion at June 30,
2006. Long-term borrowings amounted to $10.1 billion at June 30, 2006.
The scheduled maturities of long-term borrowings including estimated
interest payments at June 30, 2006 are as follows: $3.1 billion is due in
less than one year; $2.9 billion is due in one to three years; $3.0
billion is due in three to five years; and $4.0 billion is due in more
than five years. During the first quarter of 2006, the Corporation issued
shares of its common stock valued at $16.9 million to fund a portion of
its 2005 obligations under its retirement and employee stock ownership
plans. There have been no other substantive changes to the Corporation's
contractual obligations as reported in the Corporation's Annual Report on
Form 10-K for the year ended December 31, 2005.
OFF-BALANCE SHEET ARRANGEMENTS
------------------------------
In conjunction with the acquisitions of Gold Banc Corporation, Inc. and
Trustcorp Financial, Inc., the Corporation acquired all of the common
interests in four Trusts that issued cumulative preferred capital
securities which are supported by junior subordinated deferrable interest
debentures in the amounts of $16.0 million, $30.0 million, $38.0 million
and $15.0 million, respectively and full guarantees assumed by the
Corporation. The Corporation does not consolidate these Trusts in
accordance with United States generally accepted accounting principles.
At June 30, 2006, there have been no other substantive changes with
respect to the Corporation's off-balance sheet activities as disclosed in
the Corporation's Annual Report on Form 10-K for the year ended December
31, 2005. See Note 8 to the Consolidated Financial Statements for an
update of the Corporation's securitization activities in the second
quarter of 2006. The Corporation continues to believe that based on the
off-balance sheet arrangements with which it is presently involved, such
off-balance sheet arrangements neither have, nor are reasonably likely to
have, a material impact to its current or future financial condition,
results of operations, liquidity or capital.
CRITICAL ACCOUNTING POLICIES
----------------------------
The Corporation has established various accounting policies which govern
the application of accounting principles generally accepted in the United
States in the preparation of the Corporation's consolidated financial
statements. The significant accounting policies of the Corporation are
described in the footnotes to the consolidated financial statements
contained in the Corporation's Annual Report on Form 10-K for the year
ended December 31, 2005, and updated as necessary in its Quarterly Reports
on Form 10-Q. Certain accounting policies involve significant judgments
and assumptions by management that may have a material impact on the
carrying value of certain assets and liabilities. Management considers
such accounting policies to be critical accounting policies. The
judgments and assumptions used by management are based on historical
experience and other factors, which are believed to be reasonable under
the circumstances. Because of the nature of judgments and assumptions
made by management, actual results could differ from these judgments and
estimates which could have a material impact on the carrying values of
assets and liabilities and the results of the operations of the
Corporation. Management continues to consider the following to be those
accounting policies that require significant judgments and assumptions:
Allowance for Loan and Lease Losses
-----------------------------------
The allowance for loan and lease losses represents management's estimate
of probable losses inherent in the Corporation's loan and lease portfolio.
Management evaluates the allowance each quarter to determine that it is
adequate to absorb these inherent losses. This evaluation is supported by
a methodology that identifies estimated losses based on assessments of
individual problem loans and historical loss patterns of homogeneous loan
pools. In addition, environmental factors, including economic conditions
and regulatory guidance, unique to each measurement date are also
considered. This reserving methodology has the following components:
45
Specific Reserve. The Corporation's internal risk rating system is used
to identify loans and leases that meet the criteria as being "impaired"
under the definition in SFAS 114. A loan is impaired when, based on
current information and events, it is probable that a creditor will be
unable to collect all amounts due according to the contractual terms of
the loan agreement. For impaired loans, impairment is measured using one
of three alternatives: (1) the present value of expected future cash flows
discounted at the loan's effective interest rate; (2) the loan's
observable market price, if available; or (3) the fair value of the
collateral for collateral dependent loans and loans for which foreclosure
is deemed to be probable. In general, these loans have been internally
identified as credits requiring management's attention due to underlying
problems in the borrower's business or collateral concerns. Subject to a
minimum size, a quarterly review of these loans is performed to identify
the specific reserve necessary to be allocated to each of these loans.
This analysis considers expected future cash flows, the value of
collateral and also other factors that may impact the borrower's ability
to make payments when due.
Collective Loan Impairment. This component of the allowance for loan and
lease losses is comprised of two elements. First, the Corporation makes a
significant number of loans and leases, which due to their underlying
similar characteristics, are assessed for loss as homogeneous pools.
Included in the homogeneous pools are loans and leases from the retail
sector and commercial loans under a certain size that have been excluded
from the specific reserve allocation previously discussed. The
Corporation segments the pools by type of loan or lease and, using
historical loss information, estimates a loss reserve for each pool.
The second element reflects management's recognition of the uncertainty
and imprecision underlying the process of estimating losses. The internal
risk rating system is used to identify those loans within certain industry
segments that based on financial, payment or collateral performance,
warrant closer ongoing monitoring by management. The specific loans
mentioned earlier are excluded from this analysis. Based on management's
judgment, reserve ranges are allocated to industry segments due to
environmental conditions unique to the measurement period. Consideration
is given to both internal and external environmental factors such as
economic conditions in certain geographic or industry segments of the
portfolio, economic trends, risk profile, and portfolio composition.
Reserve ranges are then allocated using estimates of loss exposure that
management has identified based on these economic trends or conditions.
The following factors were taken into consideration in determining the
adequacy of the allowance for loan and lease losses at June 30, 2006:
In general, the Corporation's customer base is still showing signs of
increased business activity as evidenced by the continued loan growth in
this quarter.
At June 30, 2006, allowances for loan and lease losses continue to be
carried for exposures to manufacturing, healthcare, production
agriculture (including dairy and cropping operations), truck
transportation, accommodation, general contracting, motor vehicle and
parts dealers and the airline industries. The majority of the
commercial charge-offs incurred during the past three years were in
these industry segments. While most loans in these categories are still
performing, the Corporation continues to believe these sectors present a
higher than normal risk due to their financial and external
characteristics. Reduced revenues causing a declining utilization of
the industry's capacity levels can affect collateral values and the
amounts realized through the sale or liquidation.
During the second quarter of 2006, the Corporation's commitments to
Shared National Credits were approximately $3.6 billion with usage
averaging around 47%. Over time, many of the Corporation's largest
charge-offs have come from the Shared National Credit portfolio.
Although these factors result in an increased risk profile, as of June
30, 2006, there were no Shared National Credit nonperforming loans. The
Corporation's exposure to Shared National Credits is monitored closely
given this lending group's loss experience.
The Corporation's primary lending areas are Wisconsin, Arizona,
Minnesota and Missouri. The vast majority of the assets acquired from
Gold Banc Corporation, Inc. are in entirely new markets for the
Corporation. Included in these new markets are the Kansas City
metropolitan area, Tulsa, Oklahoma, and Tampa, Sarasota and Bradenton,
Florida. Each of these regions and markets has cultural and
environmental factors that are unique to them.
46
At June 30, 2006, nonperforming loans and leases amounted to $198.0
million or 0.49% of consolidated loans and leases compared to $149.1
million or 0.42% of consolidated loans and leases at March 31, 2006, and
$131.6 million or 0.41% of consolidated loans and leases at June 30,
2005. Approximately $42.7 million or 87% of the $48.9 million increase
in nonperforming loans from March 31, 2006 to June 30, 2006 was
attributable to the banking acquisitions. Excluding the effect of the
acquisitions, nonperforming loans and leases would have amounted to
$155.3 million or 0.43% of consolidated loans and leases at June 30,
2006. Excluding the acquisitions, the pro forma ratio of nonperforming
loans and leases to consolidated loans and leases at June 30, 2006 and
the actual ratio at each quarter end throughout 2005 has remained in a
fairly narrow range and continues to be below management's expectations.
Nonaccrual loans and leases continue to be the primary source of
nonperforming loans and leases.
Net charge-offs amounted to $9.9 million or 0.10% of average loans and
leases in the second quarter of 2006 compared to $6.0 million or 0.07%
of average loans and leases in the first quarter of 2006 and $11.9
million or 0.15% of average loans and leases in the second quarter of
2005. The lower level of net charge-offs experienced throughout 2005
and the first six months of 2006 has to some extent been the result of
higher than normal recoveries. Based on the status of some of the
larger charge-offs recognized in recent quarters, management expects
recoveries will likely return to lower levels in future periods. The
ratio of recoveries to charge-offs was 28.7% for the three months ended
June 30, 2006 which was closer to average historical experience. The
ratio of recoveries to charge-offs was 35.3% for the six months ended
June 30, 2006 which continues to be above the Corporation's five year
historical average ratio of recoveries to charge-offs of 27.9%.
Based on the above loss estimates, management determined its best estimate
of the required allowance for loans and leases. Management's evaluation
of the factors described above resulted in an allowance for loan and lease
losses of $415.2 million or 1.03% of loans and leases outstanding at June
30, 2006. The allowance for loan and lease losses was $363.8 million or
1.06% of loans and leases outstanding at December 31, 2005 and $360.1
million or 1.12% of loans and leases outstanding at June 30, 2005.
Consistent with the credit quality trends noted above, the provision for
loan and lease losses amounted to $11.1 million for the three months ended
June 30, 2006 and $22.0 million for the six months ended June 30, 2006.
By comparison, the provision for loan and lease losses amounted to $13.7
million for the three months ended June 30, 2005 and $21.9 million for the
six months ended June 30, 2005. The resulting provisions for loan and
lease losses are the amounts required to establish the allowance for loan
and lease losses at the required level after considering charge-offs and
recoveries. Management recognizes there are significant estimates in the
process and the ultimate losses could be significantly different from
those currently estimated.
The Corporation has not materially changed any aspect of its overall
approach in the determination of the allowance for loan and lease losses.
There have been no material changes in assumptions or estimation
techniques as compared to prior periods that impacted the determination of
the current period allowance. However, on an on-going basis the
Corporation continues to refine the methods used in determining
management's best estimate of the allowance for loan and lease losses.
Capitalized Software and Conversion Costs
-----------------------------------------
Direct costs associated with the production of computer software that will
be licensed externally or used in a service bureau environment are
capitalized. Capitalization of such costs is subject to strict accounting
policy criteria, although the appropriate time to initiate capitalization
requires management judgment. Once the specific capitalized project is
put into production, the software cost is amortized over its estimated
useful life, generally four years. Each quarter, the Corporation performs
net realizable value tests to ensure the assets are recoverable. Such
tests require management judgment as to the future sales and profitability
of a particular product which involves, in some cases, multi-year
projections. Technology changes and changes in customer requirements can
have a significant impact on the recoverability of these assets and can be
difficult to predict. Should significant adverse changes occur, estimates
of useful life may have to be revised or write-offs would be required to
recognize impairment. For the three months ended June 30, 2006 and 2005,
the amount of software costs capitalized amounted to $13.7 million and
$9.9 million, respectively. Amortization expense of software costs
amounted to $13.4 million for the three months ended June 30, 2006
compared to $15.4 million for the three months ended June 30, 2005. For
the six months ended June 30, 2006 and 2005, the amount of software costs
capitalized amounted to $25.0 million and $18.9 million, respectively.
Amortization expense of software costs amounted to $27.6 million for the
six months ended June 30, 2006 compared to $30.3 million for the six
months ended June 30, 2005.
Direct costs associated with customer system conversions to the data
processing operations are capitalized and amortized on a straight-line
basis over the terms, generally five to seven years, of the related
servicing contracts.
47
Capitalization only occurs when management is satisfied that such costs
are recoverable through future operations or penalties (buyout fees) in
case of early termination. For the three months ended June 30, 2006 and
2005, the amount of conversion costs capitalized amounted to $3.1 million
and $2.7 million, respectively. Amortization expense of conversion costs
amounted to $2.8 million and $2.9 million for the three months ended June
30, 2006 and 2005, respectively. For the six months ended June 30, 2006
and 2005, the amount of conversion costs capitalized amounted to $5.5
million and $5.6 million, respectively. Amortization expense of
conversion costs amounted to $5.0 million and $5.6 million for the six
months ended June 30, 2006 and 2005, respectively.
Net unamortized costs were ($ in millions):
June 30,
--------------------------
2006 2005
------------ ------------
Software $ 152.5 $ 151.6
Conversions 27.7 26.5
----------- -----------
Total $ 180.2 $ 178.1
=========== ===========
The Corporation has not substantively changed any aspect of its overall
approach in the determination of the amount of costs that are capitalized
for software development or conversion activities. There have been no
material changes in assumptions or estimation techniques as compared to
prior periods that impacted the determination of the periodic amortization
of such costs.
Financial Asset Sales and Securitizations
-----------------------------------------
The Corporation utilizes certain financing arrangements to meet its
balance sheet management, funding, liquidity, and market or credit risk
management needs. The majority of these activities are basic term or
revolving securitization vehicles. These vehicles are generally funded
through term-amortizing debt structures or with short term commercial
paper designed to be paid off based on the underlying cash flows of the
assets securitized. These financing entities are contractually limited to
a narrow range of activities that facilitate the transfer of or access to
various types of assets or financial instruments. In certain situations,
the Corporation provides liquidity and/or loss protection agreements. In
determining whether the financing entity should be consolidated, the
Corporation considers whether the entity is a qualifying special-purpose
entity ("QSPE") as defined in Statement of Financial Accounting Standards
("SFAS") No. 140, Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities. For non-consolidation, a QSPE
must be demonstrably distinct, have significantly limited permitted
activities, hold assets that are restricted to transferred financial
assets and related assets, and can sell or dispose of non-cash financial
assets only in response to specified conditions.
In December 2003, the Corporation adopted Financial Accounting Standards
Board Interpretation No. 46 ("FIN 46R"), Consolidation of Variable
Interest Entities (revised December 2003). This interpretation addresses
consolidation by business enterprises of variable interest entities.
Transferors to QSPEs and "grandfathered" QSPEs subject to the reporting
requirements of SFAS 140 are outside the scope of FIN 46R and do not
consolidate those entities. With respect to the Corporation's
securitization activities, the adoption of FIN 46R did not have an impact
on its consolidated financial statements because its transfers are
generally to QSPEs.
The Corporation sells financial assets in a two-step process that results
in a surrender of control over the assets as evidenced by true-sale
opinions from legal counsel, to unconsolidated entities that securitize
the assets. The Corporation retains interests in the securitized assets
in the form of interest-only strips and a cash reserve account. Gain or
loss on sale of the assets depends in part on the carrying amount assigned
to the assets sold allocated between the asset sold and retained interests
based on their relative fair values at the date of transfer. The value of
the retained interests is based on the present value of expected cash
flows estimated using management's best estimates of the key assumptions -
credit losses, prepayment speeds, forward yield curves and discount rates
commensurate with the risks involved. Actual results can differ from
expected results.
The Corporation reviews the carrying values of the retained interests
monthly to determine if there is a decline in value that is other than
temporary and periodically reviews the propriety of the assumptions used
based on current historical experience as well as the sensitivities of the
carrying value of the retained interests to adverse changes in the key
assumptions. The Corporation believes that its estimates result in a
reasonable carrying value of the retained interests.
48
The Corporation regularly sells automobile loans to an unconsolidated
multi-seller special purpose entity commercial paper conduit in
securitization transactions in which servicing responsibilities and
subordinated interests are retained. The outstanding balances of
automobile loans sold in these securitization transactions were $1,028.4
million at June 30, 2006. At June 30, 2006 the carrying amount of
retained interests amounted to $35.4 million.
The Corporation also sells, from time to time, debt securities classified
as available for sale that are highly rated to an unconsolidated
bankruptcy remote QSPE whose activities are limited to issuing highly
rated asset-backed commercial paper with maturities up to 180 days which
is used to finance the purchase of the investment securities. The
Corporation provides liquidity back-up in the form of Liquidity Purchase
Agreements. In addition, the Corporation acts as counterparty to interest
rate swaps that enable the QSPE to hedge its interest rate risk. Such
swaps are designated as free-standing derivative financial instruments in
the Corporation's Consolidated Balance Sheet.
At June 30, 2006, highly rated investment securities in the amount of
$301.7 million were outstanding in the QSPE to support the outstanding
commercial paper.
Income Taxes
------------
Income taxes are accounted for using the asset and liability method.
Under this method, deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities
and their respective tax basis. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in
the years in which those temporary differences are expected to be
recovered or settled. The effect on tax assets and liabilities of a
change in tax rates is recognized in the income statement in the period
that includes the enactment date.
The determination of current and deferred income taxes is based on complex
analyses of many factors, including interpretation of Federal and state
income tax laws, the difference between tax and financial reporting basis
of assets and liabilities (temporary differences), estimates of amounts
currently due or owed, such as the timing of reversals of temporary
differences and current accounting standards. The Federal and state
taxing authorities who make assessments based on their determination of
tax laws periodically review the Corporation's interpretation of Federal
and state income tax laws. Tax liabilities could differ significantly
from the estimates and interpretations used in determining the current and
deferred income tax liabilities based on the completion of taxing
authority examinations.
In June 2006, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 48, ("FIN 48"), Accounting for Uncertainty in
Income Taxes an interpretation of FASB Statement No. 109. FIN 48
clarifies the accounting for uncertainty in income taxes recognized in
financial statements in accordance with FASB Statement No. 109, Accounting
for Income Taxes. FIN 48 prescribes a recognition threshold and
measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax
return. FIN 48 also provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure and
transition.
The provisions of FIN 48 are effective beginning January 1, 2007, with the
cumulative effect of the change in accounting principle recorded as an
adjustment to opening retained earnings. The Corporation is currently
evaluating the financial statement impact, if any, of adopting FIN 48.
FORWARD-LOOKING STATEMENTS
--------------------------
Items 2 and 3 of this Form 10-Q, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Quantitative and
Qualitative Disclosures about Market Risk," respectively, contain forward-
looking statements within the meaning of the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. Such forward-looking
statements include, without limitation, statements regarding expected
financial and operating activities and results which are preceded by words
such as "expects", "anticipates" or "believes". Such statements are
subject to important factors that could cause the Corporation's actual
results to differ materially from those anticipated by the forward-looking
statements. These factors include those referenced in Item 1A, Risk
Factors, of the Corporation's Annual Report on Form 10-K for the year
ended December 31, 2005 and under the heading "Forward-Looking
Statements," and as may be described from time to time in the
Corporation's subsequent SEC filings, and such factors are incorporated
herein by reference.
49
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following updated information should be read in conjunction with the
Corporation's Annual Report on Form 10-K for the year ended December 31,
2005. Updated information regarding the Corporation's use of derivative
financial instruments is contained in Note 12, Notes to Financial
Statements contained in Item 1 herein.
Market risk arises from exposure to changes in interest rates, exchange
rates, commodity prices, and other relevant market rate or price risk.
The Corporation faces market risk through trading and other than trading
activities. While market risk that arises from trading activities in the
form of foreign exchange and interest rate risk is immaterial to the
Corporation, market risk from other than trading activities in the form of
interest rate risk is measured and managed through a number of methods.
Interest Rate Risk
------------------
The Corporation uses financial modeling techniques to identify potential
changes in income under a variety of possible interest rate scenarios.
Financial institutions, by their nature, bear interest rate and liquidity
risk as a necessary part of the business of managing financial assets and
liabilities. The Corporation has designed strategies to limit these risks
within prudent parameters and identify appropriate risk/reward tradeoffs
in the financial structure of the balance sheet.
The financial models identify the specific cash flows, repricing timing
and embedded option characteristics of the assets and liabilities held by
the Corporation. Policies are in place to assure that neither earnings
nor fair value at risk exceed appropriate limits. The use of a limited
array of derivative financial instruments has allowed the Corporation to
achieve the desired balance sheet repricing structure while simultaneously
meeting the desired objectives of both its borrowing and depositing
customers.
The models used include measures of the expected repricing characteristics
of administered rate (NOW, savings and money market accounts) and non-rate
related products (demand deposit accounts, other assets and other
liabilities). These measures recognize the relative insensitivity of
these accounts to changes in market interest rates, as demonstrated
through current and historical experiences. In addition to contractual
payment information for most other assets and liabilities, the models also
include estimates of expected prepayment characteristics for those items
that are likely to materially change their payment structures in different
rate environments, including residential mortgage products, certain
commercial and commercial real estate loans and certain mortgage-related
securities. Estimates for these sensitivities are based on industry
assessments and are substantially driven by the differential between the
contractual coupon of the item and current market rates for similar
products.
This information is incorporated into a model that allows the projection
of future income levels in several different interest rate environments.
Earnings at risk are calculated by modeling income in an environment where
rates remain constant, and comparing this result to income in a different
rate environment, and then dividing this difference by the Corporation's
budgeted operating income before taxes for the calendar year. Since
future interest rate moves are difficult to predict, the following table
presents two potential scenarios - a gradual increase of 100bp across the
entire yield curve over the course of the year (+25bp per quarter), and a
gradual decrease of 100bp across the entire yield curve over the course of
the year (-25bp per quarter) for the balance sheet as of the indicated
dates:
Impact to Annual Pretax Income as of
--------------------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
2006 2006 2005 2005 2005
-------------- -------------- -------------- -------------- --------------
Hypothetical Change in Interest Rate
------------------------------------
100 basis point gradual:
Rise in rates (0.3)% (0.2)% (0.2)% (0.1)% 0.3 %
Decline in rates 0.3 % 0.1 % 0.0 % 0.0 % (0.6)%
These results are based solely on the modeled parallel changes in market
rates, and do not reflect the earnings sensitivity that may arise from
other factors such as changes in the shape of the yield curve and changes
in spread between key market rates. These results also do not include any
management action to mitigate potential income variances within the
simulation process. Such action could potentially include, but would not
be limited to, adjustments to the repricing characteristics of any on- or
off-balance sheet item with regard to short-term rate projections and
current market value assessments.
50
Actual results will differ from simulated results due to the timing,
magnitude, and frequency of interest rate changes as well as changes in
market conditions and management strategies.
Another component of interest rate risk is measuring the fair value at
risk for a given change in market interest rates. The Corporation also
uses computer modeling techniques to determine the present value of all
asset and liability cash flows (both on- and off-balance sheet), adjusted
for prepayment expectations, using a market discount rate. The net change
in the present value of the asset and liability cash flows in different
market rate environments is the amount of fair value at risk from those
rate movements. As of June 30, 2006, the fair value of equity at risk for
a gradual 100bp shift in rates was no more than 2.0% of the market value
of the Corporation.
Equity Risk
-----------
In addition to interest rate risk, the Corporation incurs market risk in
the form of equity risk. The Corporation invests directly and indirectly
through investment funds, in private medium-sized companies to help
establish new businesses or recapitalize existing ones. These investments
expose the Corporation to the change in equity values for the portfolio
companies. However, fair values are difficult to determine until an
actual sale or liquidation transaction actually occurs. At June 30, 2006,
the carrying value of total active capital markets investments amounted to
approximately $39.1 million.
As of June 30, 2006, M&I Trust Services administered $89.1 billion in
assets and directly managed a portfolio of $20.4 billion. The Corporation
is exposed to changes in equity values due to the fact that fee income is
partially based on equity balances. Quantification of this exposure is
difficult due to the number of other variables affecting fee income.
Interest rate changes can also have an effect on fee income for the above
stated reasons.
ITEM 4. CONTROLS AND PROCEDURES
We maintain a set of disclosure controls and procedures that are designed
to ensure that information required to be disclosed by us in the reports
filed by us under the Securities Exchange Act of 1934, as amended, is
recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms. We carried out an evaluation,
under the supervision and with the participation of our management,
including our Chief Executive Officer and our Chief Financial Officer, of
the effectiveness of the design and operation of our disclosure controls
and procedures pursuant to Rule 13a-15 of the Exchange Act. Based on that
evaluation, our Chief Executive Officer and our Chief Financial Officer
concluded that our disclosure controls and procedures are effective as of
the end of the period covered by this report.
There have been no changes in our internal control over financial
reporting identified in connection with the evaluation discussed above
that occurred during our last fiscal quarter that have materially
affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
51
PART II - OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table reflects the purchases of Marshall & Ilsley
Corporation stock for the specified period:
Total Number of Maximum Number
Shares Purchased of Shares that
as Part of May Yet Be
Total Number Average of Publicly Purchased Under
of Shares Price Paid Announced Plans the Plans
Period Purchased(1) per Share or Programs or Programs
----------------- ------------- ----------- ------------------ -----------------
January 1 to
January 31, 2006 443,919 $ 41.92 437,700 11,562,300
February 1 to
February 28, 2006 565,972 41.70 562,300 11,000,000
March 1 to
March 31, 2006 2,434 41.84 -- 11,000,000
April 1 to
April 30, 2006 123,064 44.22 -- 11,000,000
May 1 to
May 31, 2006 3,129 45.08 -- 11,000,000
June 1 to
June 30, 2006 2,635 45.04 -- 11,000,000
------------ ---------- ----------------
Total 1,141,153 $ 42.07 1,000,000
============ ========== ================
(1) Includes shares purchased by rabbi trusts pursuant to nonqualified
deferred compensation plans.
The Corporation's Share Repurchase Program was publicly reconfirmed in
April 2005 and again in April 2006. The Share Repurchase Program
authorizes the purchase of up to 12 million shares annually and renews
each year at that level unless changed or terminated by subsequent Board
action.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a)
The Corporation held its Annual Meeting of Shareholders on April 25,
2006.
(b)
Votes cast for the election of five directors to serve as Class I
directors until the 2009 Annual Meeting of Shareholders are as follows:
Director For Withheld
--------------------- ----------- -----------
Mark F. Furlong 190,663,322 4,510,194
Ted D. Kellner 188,042,220 7,131,296
Katharine C. Lyall 191,780,574 3,392,942
Peter M. Platten, III 185,630,211 9,543,305
James B. Wigdale 190,741,495 4,432,021
52
The continuing directors of the Corporation are as follows:
Jon F. Chait Malcolm M. Aslin
Bruce E. Jacobs Andrew N. Baur
Dennis J. Kuester John W. Daniels, Jr.
Edward L. Meyer, Jr. John A. Mellowes
San W. Orr, Jr. Robert J. O'Toole
Debra S. Waller John S. Shiely
George E. Wardeberg
(c)
Votes cast for the ratification of the appointment of Deloitte & Touche
LLP to audit the statements of the Company for the fiscal year ending
December 31, 2006 are as follows:
For Against Abstentions
----------- ---------- -----------
Ratification
of Auditors 192,281,360 1,415,784 1,476,372
Votes cast to approve the Company's 2006 Equity Incentive Plan are as
follows:
For Against Abstentions Non-Vote
----------- ---------- ----------- ----------
Ratification
of Plan 119,283,686 38,900,515 3,647,656 33,341,659
Votes cast for the shareholder proposal to request the Board of
Directors of the Company to declassify the board are as follows:
For Against Abstentions Non-Vote
----------- ---------- ----------- ----------
Request to
declassify the
Board of
Directors 79,363,430 78,488,983 3,979,444 33,341,659
ITEM 6. EXHIBITS
Exhibit 10 - Change of Control Agreement, dated June 19, 2006,
between the Corporation and Gregory A. Smith,
incorporated by reference to Item 1.01 of the
Corporation's amended Current Report on Form 8-K/A
filed June 19, 2006, SEC File No. 1-15403. *
Exhibit 11 - Statement Regarding Computation of Earnings
Per Share, Incorporated by Reference to NOTE 4
of Notes to Financial Statements contained in
Item 1 - Financial Statements (unaudited) of
Part I - Financial Information herein.
Exhibit 12 - Statement Regarding Computation of Ratio of
Earnings to Fixed Charges
Exhibit 31(a) - Certification of Chief Executive Officer
pursuant to Rule 13a-14(a) under the Securities
Exchange Act of 1934, as amended.
Exhibit 31(b) - Certification of Chief Financial Officer
pursuant to Rule 13a-14(a) under the Securities
Exchange Act of 1934, as amended.
Exhibit 32(a) - Certification of Chief Executive Officer
pursuant to 18 U.S.C. Section 1350.
Exhibit 32(b) - Certification of Chief Financial Officer
pursuant to 18 U.S.C. Section 1350.
____________________________________________
* Management contract or compensatory plan or arrangement.
53
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MARSHALL & ILSLEY CORPORATION
(Registrant)
/s/ Patricia R. Justiliano
__________________________________
Patricia R. Justiliano
Senior Vice President and
Corporate Controller
(Chief Accounting Officer)
/s/ James E. Sandy
__________________________________
James E. Sandy
Vice President
August 9, 2006
54
EXHIBIT INDEX
-------------
Exhibit Number Description of Exhibit
______________ ____________________________________________
(10) Change of Control Agreement, dated June 19, 2006,
between the Corporation and Gregory A. Smith,
incorporated by reference to Item 1.01 of the
Corporation's amended Current Report on Form 8-K/A
filed June 19, 2006, SEC File No. 1-15403. *
(11) Statement Regarding Computation of Earnings
Per Share, Incorporated by Reference to
NOTE 4 of Notes to Financial Statements
contained in Item 1 - Financial Statements
(unaudited) of Part I - Financial Information
herein.
(12) Statement Regarding Computation of Ratio
of Earnings to Fixed Charges.
(31)(a) Certification of Chief Executive Officer
pursuant to Rule 13a-14(a) under the
Securities Exchange Act of 1934, as amended.
(31)(b) Certification of Chief Financial Officer
pursuant to Rule 13a-14(a) under the
Securities Exchange Act of 1934, as amended.
(32)(a) Certification of Chief Executive Officer
pursuant to 18 U.S.C. Section 1350.
(32)(b) Certification of Chief Financial Officer
pursuant to 18 U.S.C. Section 1350.
____________________________________________
* Management contract or compensatory plan or arrangement.