<PAGE> 1
SCHEDULE 14A
(RULE 14A-101)
INFORMATION REQUIRED IN PROXY STATEMENT
SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(A) OF THE SECURITIES
EXCHANGE ACT OF 1934 (AMENDMENT NO. )
Filed by the Registrant [X]
Filed by a Party other than the Registrant [ ]
Check the appropriate box:
<TABLE>
<S> <C>
[ ] Preliminary Proxy Statement [ ] Confidential, for Use of the Commission
Only (as permitted by Rule 14a-6(e)(2))
[X] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to Rule 14a-11(c) or Rule 14a-12
</TABLE>
First Tennessee National Corporation
- --------------------------------------------------------------------------------
(Name of Registrant as Specified In Its Charter)
- --------------------------------------------------------------------------------
(Name of Person(s) Filing Proxy Statement, if other than the Registrant)
Payment of Filing Fee (Check the appropriate box):
[X] No fee required.
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.
(1) Title of each class of securities to which transaction applies:
(2) Aggregate number of securities to which transaction applies:
(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (set forth the amount on which the
filing fee is calculated and state how it was determined):
(4) Proposed maximum aggregate value of transaction:
(5) Total fee paid:
[ ] Fee paid previously with preliminary materials:
[ ] Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number,
or the Form or Schedule and the date of its filing.
(1) Amount Previously Paid:
(2) Form, Schedule or Registration Statement No.:
(3) Filing Party:
(4) Date Filed:
<PAGE> 2
THE ART OF CREATING VALUE
FIRST TENNESSEE NATIONAL CORPORATION
1998 PROXY STATEMENT & 1997 FINANCIAL INFORMATION
[LOGO](R)FIRST
TENNESSEE
<PAGE> 3
March 20, 1998
[LOGO] (R) FIRST TENNESSEE
Dear Shareholders:
You are cordially invited to attend First Tennessee National
Corporation's 1998 annual meeting of shareholders. We will hold the meeting on
April 21, 1998, in the Auditorium, First Tennessee Building, 165 Madison
Avenue, Memphis, Tennessee, at 10:00 a.m. We have enclosed the formal notice of
the annual meeting, our 1998 proxy statement, and a form of proxy.
At the meeting, we will ask you to elect four Class II directors and
ratify the appointment of Arthur Andersen LLP as our independent auditors for
1998. The attached proxy statement contains information about these matters.
This year we have included detailed financial information relating to our
activities and operating performance during 1997 in an appendix to the proxy
statement instead of a separate annual report to shareholders. In our
continuing effort to improve disclosure and provide information in a more
user-friendly manner, we have prepared a new Summary Annual Report, which is
also enclosed.
Your vote is important. Based on recent action by the Tennessee
legislature, we are pleased to offer you the option this year of voting by
telephone via an 800 number. You may still vote by mail, or if you attend the
meeting and want to vote your shares, then prior to the balloting you should
request that your form of proxy be withheld from voting. We request that you
vote by telephone or return your proxy card in the postage-paid envelope as
soon as possible.
Sincerely yours,
/s/ Ralph Horn
--------------------------------------
Ralph Horn
Chairman of the Board,
President and Chief Executive Officer
<PAGE> 4
FIRST TENNESSEE NATIONAL CORPORATION
165 Madison Avenue
Memphis, Tennessee 38103
NOTICE OF ANNUAL SHAREHOLDERS' MEETING
April 21, 1998
The annual meeting of shareholders of First Tennessee National
Corporation will be held on April 21, 1998, at 10:00 a.m., local time, in the
Auditorium, First Tennessee Building, 165 Madison Avenue, Memphis, Tennessee.
The items of business are:
1. Election of four Class II directors to serve until the 2001 annual
meeting of shareholders, or until their successors are duly elected
and qualified.
2. Ratification of appointment of auditors.
These items are described more fully in the following pages, which are
made a part of this notice. The close of business February 27, 1998, is the
record date for the meeting. All shareholders of record at that time are
entitled to vote at the meeting.
Management would appreciate your signing and returning the accompanying
form of proxy promptly, so that if you are unable to attend the meeting your
shares can nevertheless be voted.
/s/ Lenore S. Creson
--------------------
Lenore S. Creson
Corporate Secretary
Memphis, Tennessee
March 20, 1998
IMPORTANT NOTICE
PLEASE (1) VOTE BY TELEPHONE OR (2) MARK, DATE,
SIGN AND PROMPTLY MAIL THE ENCLOSED FORM OF PROXY
IN THE ENCLOSED ENVELOPE SO THAT YOUR SHARES WILL
BE REPRESENTED AT THE MEETING.
<PAGE> 5
PROXY STATEMENT
FIRST TENNESSEE NATIONAL CORPORATION
165 Madison Avenue
Memphis, Tennessee 38103
<TABLE>
<CAPTION>
Table of Contents Page
- ----------------- ----
<S> <C>
General Matters 1
Stock Ownership Table 2
VOTE ITEM NO. 1 - ELECTION OF DIRECTORS 3
Nominees 4
Continuing Directors 4
The Board of Directors and its Committees 5
Shareholder Proposals 6
Executive Compensation 6
Summary Compensation Table 7
Option/SAR Grants Table 9
Aggregated Option/SAR Exercises and Values Table 10
Pension Plan Table 10
Employment Contracts and Termination of Employment and
Change-in-Control Arrangements 11
Compensation Committee Interlocks and Insider Participation 12
Certain Relationships and Related Transactions 12
Board Compensation Committee Report on Executive Compensation 13
Total Shareholder Return Performance Graph 18
Compensation of Directors 18
Section 16(a) Beneficial Ownership Reporting Compliance 19
VOTE ITEM NO. 2 - RATIFICATION OF APPOINTMENT OF AUDITORS 19
Other Matters 19
Availability of Annual Report on Form 10-K 20
Appendix - Financial Information A-1
</TABLE>
GENERAL MATTERS
The following proxy statement will be mailed to shareholders beginning on
or about March 20, 1998. The Board of Directors is soliciting proxies to be
used at our annual meeting of the shareholders to be held on April 21, 1998, at
10:00 a.m. local time in the Auditorium, First Tennessee Building, 165 Madison
Avenue, Memphis, Tennessee, and at any adjournment or adjournments thereof.
The accompanying form of proxy is for use at the meeting if you will be
unable to attend in person. You may revoke the proxy at any time before it is
exercised. All shares represented by valid proxies received pursuant to this
solicitation, and not revoked before they are exercised, will be voted in the
manner specified therein. If no specification is made, the proxies will be
voted in favor of:
1. Election of four Class II directors to serve until the 2001 annual
meeting of shareholders or until their successors are duly elected
and qualified.
2. Ratification of appointment of auditors.
We will bear the entire cost of soliciting the proxies. In following up
the original solicitation of the proxies by mail, we may request brokers and
others to send proxies and proxy material to the beneficial owners of the
shares and may reimburse them for their expenses in so doing. If necessary, we
may also use several of our regular employees to solicit proxies from the
shareholders, either personally or by telephone or by special letter, for which
they will receive no compensation in addition to their normal compensation.
<PAGE> 6
Our common stock is the only class of voting securities. There were
128,125,070 shares of common stock outstanding and entitled to vote as of
February 27, 1998, the record date for the annual shareholders' meeting. Each
share is entitled to one vote. A majority of the votes entitled to be cast at
the annual meeting constitutes a quorum for purposes of the meeting. A
plurality of the votes cast is required to elect the nominees as directors. To
approve the ratification of the appointment of auditors, the votes cast in
favor of the item must exceed the votes cast in opposition to it. An
"abstention" will be considered present for quorum purposes, but will not
otherwise have any effect on either of the vote items. Broker "non-votes" will
not be considered present for quorum purposes but will not otherwise have any
effect on either of the vote items.
We know of no person who owned beneficially, as that term is defined by
Rule 13d-3 of the Securities Exchange Act of 1934, more than five percent (5%)
of our common stock on December 31, 1997.
The following table sets forth certain information as of December 31,
1997, concerning beneficial ownership of our common stock by each director and
nominee, each executive officer named in the Summary Compensation Table, and
directors and executive officers as a group:
Stock Ownership Table
<TABLE>
<CAPTION>
===================================================================================================
Name of Amount and Nature of Percent of Class
Beneficial Owner Beneficial Ownership
(Number of Shares)(1)
- ---------------------------------------------------------------------------------------------------
<S> <C> <C>
Robert C. Blattberg 43,084 (2) (5) 0.03
- ---------------------------------------------------------------------------------------------------
Carlos H. Cantu 21,730 (2) (5) 0.02
- ---------------------------------------------------------------------------------------------------
George E. Cates 28,718 (2) (5) 0.02
- ---------------------------------------------------------------------------------------------------
J. Kenneth Glass 355,232 (3) (4) 0.28
- ---------------------------------------------------------------------------------------------------
James A. Haslam, III 30,252 (2) (5) 0.02
- ---------------------------------------------------------------------------------------------------
Ralph Horn 1,164,104 (3) (4) 0.90
- ---------------------------------------------------------------------------------------------------
John C. Kelley, Jr. 370,628 (3) (4) 0.29
- ---------------------------------------------------------------------------------------------------
George P. Lewis 429,384 (3) (4) 0.33
- ---------------------------------------------------------------------------------------------------
R. Brad Martin 28,933 (2) (5) 0.02
- ---------------------------------------------------------------------------------------------------
Joseph Orgill, III 239,956 (2) (5) 0.19
- ---------------------------------------------------------------------------------------------------
Vicki R. Palmer 42,772 (2) (5) 0.03
- ---------------------------------------------------------------------------------------------------
Michael D. Rose 80,260 (2) (5) 0.06
- ---------------------------------------------------------------------------------------------------
William B. Sansom 53,603 (2) (5) 0.04
- ---------------------------------------------------------------------------------------------------
Gordon P. Street, Jr. 39,362 (2) (5) 0.03
- ---------------------------------------------------------------------------------------------------
Elbert L. Thomas, Jr. 170,760 (3) (4) 0.13
- ---------------------------------------------------------------------------------------------------
Directors and Executive Officers
as a Group (20 persons) 4,111,092 (3) (4) 3.16
===================================================================================================
</TABLE>
[Notes to table are on page 3.]
2
<PAGE> 7
(1) All share amounts have been adjusted to reflect the 2-for-1 stock split
that was paid February 20, 1998. The respective directors and officers
have sole voting and investment powers with respect to all of such shares
except as specified in note (2) and note (4).
(2) Includes 3,000 shares of restricted stock (5,400 shares as to Messrs.
Cantu, Cates and Haslam and 4,200 shares as to Mr. Martin and Mrs.
Palmer) with respect to which each nonemployee director possesses sole
voting power, but no investment power.
(3) Includes 197,058; 501,990; 203,402; 63,408; 107,892; and 1,810,724 shares
as to which Messrs. Glass, Horn, Kelley, Lewis and Thomas and the
directors and executive officers group, respectively, have the right to
acquire beneficial ownership within 60 days through the exercise of stock
options granted under our stock option plans. Also includes shares held
at December 31, 1997, for 401(k) Savings Plan accounts.
(4) Includes 46,816; 120,000; 46,816; 30,044; 29,876; and 412,640 shares of
restricted stock with respect to which Messrs. Glass, Horn, Kelley,
Lewis, Thomas and the director and executive officer group, respectively,
have sole voting power but no investment power.
(5) Includes the following shares as to which the named nonemployee directors
have the right to acquire beneficial ownership through the exercise of
stock options granted under our director plan, all of which are 100%
vested: Dr. Blattberg - 36,724; Mr. Cantu - 15,668; Mr. Cates - 18,656;
Mr. Haslam - 14,710; Mr. Martin - 9,928; Mr. Orgill - 39,800; Mrs. Palmer
- 36,664; Mr. Rose - 33,500; Mr. Sansom - 45,778; and Mr. Street -
32,462.
VOTE ITEM NO. 1 - ELECTION OF DIRECTORS
The Board of Directors is divided into three Classes. The term of office
of each Class expires in successive years. The term of Class II directors
expires at this annual meeting. The terms of Class I and Class III directors
expire as stated below. The Board of Directors proposes the election of four
Class II directors. Each director elected at the meeting will hold office until
the specified annual meeting of shareholders and until his or her successor
shall be elected and qualified.
If any nominee proposed by the Board of Directors is unable to accept
election, which the Board of Directors has no reason to anticipate, the persons
named in the enclosed form of proxy will vote for the election of such other
persons as management may recommend, unless the Board decides to reduce the
number of directors pursuant to the Bylaws.
We have provided below certain information about the nominees and
directors (including age, current principal occupation which has continued for
at least five years unless otherwise indicated, name and principal business of
the organization in which his or her occupation is carried on, directorships in
other reporting companies, and year first elected to our Board). All of our
directors are also directors of First Tennessee Bank National Association (the
"Bank" or "FTB"). The Bank is our principal operating subsidiary.
3
<PAGE> 8
NOMINEES FOR DIRECTOR
Class II
For a Three-Year Term Expiring at 2001 Annual Meeting
ROBERT C. BLATTBERG (55) is the Polk Brothers Distinguished Professor of
Retailing, J. L. Kellogg Graduate School of Management, Northwestern
University, Evanston, Illinois. Dr. Blattberg is a director of one other public
company, Factory Card Outlet of America. Dr. Blattberg has been a director
since 1984 and is a member of the Audit Committee.
J. KENNETH GLASS (51) is President-Tennessee Banking Group of the Bank and
Executive Vice President of First Tennessee. Mr. Glass has been an Executive
Vice President of First Tennessee since 1995. Prior to 1993 he was Executive
Vice President of the Bank and Tennessee Banking Group Manager. Mr. Glass has
been a director since December 17, 1996.
JOHN C. KELLEY, JR. (54) is President-Memphis Banking Group of the Bank and
Executive Vice President of First Tennessee. Mr. Kelley has been an Executive
Vice President of First Tennessee since 1991. Prior to 1993 he was Executive
Vice President of the Bank and Corporate Services Group Manager. Mr. Kelley has
been a director since December 17, 1996.
MICHAEL D. ROSE (56) is a private investor. Prior to December 19, 1997, he was
Chairman of the Board of Promus Hotel Corporation, Memphis, Tennessee, a
franchisor and operator of hotel brands. Prior to January 1997, Mr. Rose was
also Chairman of the Board of Harrah's Entertainment, Inc. Prior to June 30,
1995, Mr. Rose was Chairman of The Promus Companies Incorporated, and prior to
April 1994, its Chief Executive Officer. Mr. Rose is a director of five other
public companies, Promus Hotel Corporation, Ashland, Inc., Darden Restaurants,
Inc., General Mills, Inc., and Stein Mart, Inc. Mr. Rose has been a director
since 1984 and is a member of the Human Resources Committee.
CONTINUING DIRECTORS
Class III
Term Expiring at 1999 Annual Meeting
CARLOS H. CANTU (64) is President and Chief Executive Officer of The
ServiceMaster Company, Downers Grove, Illinois, a company that provides
consumer services and supportive management services. Prior to January 1994, he
was President and CEO of ServiceMaster Consumer Services LP. Mr. Cantu is a
director of one other public company, Haggar Corporation. Mr. Cantu has been a
director since April 16, 1996 and is a member of the Human Resources Committee.
GEORGE E. CATES (60) is Chairman of the Board and Chief Executive Officer of
Mid-America Apartment Communities, Inc., ("Mid-America") Memphis, Tennessee, a
real estate investment trust. Prior to January 1994, Mr. Cates was Chairman and
Chief Executive Officer of the Cates Co., Inc., Mid-America's predecessor. Mr.
Cates has been a director of the Corporation since April 16, 1996.
JAMES A. HASLAM, III (43) is Chief Executive Officer and Chief Operating
Officer of Pilot Corporation, Knoxville, Tennessee, a national retail operator
of convenience stores and travel centers. Mr. Haslam is a director of one other
public company, Plasti-Line, Inc. Mr. Haslam has been a director since April
16, 1996 and is a member of the Audit Committee.
4
<PAGE> 9
RALPH HORN (56) is Chairman of the Board, President, and Chief Executive
Officer of First Tennessee and the Bank. Mr. Horn was elected President, Chief
Operating Officer, and a Director of First Tennessee in August 1991, Chief
Executive Officer in April 1994, and Chairman of the Board, effective January
1, 1996. Mr. Horn is a director of one other public company, Harrah's
Entertainment, Inc.
Class I
Term Expiring at 2000 Annual Meeting
R. BRAD MARTIN (46) is Chairman of the Board and Chief Executive Officer of
Proffitt's, Inc., Knoxville, Tennessee, a retail merchandising company. Mr.
Martin is a director of one other public company, Harrah's Entertainment, Inc.
He has been a director since 1994 and is Chairman of the Human Resources
Committee.
JOSEPH ORGILL, III (60) is Chairman of the Board of Orgill, Inc., Memphis,
Tennessee, wholesale hardware distributors. Prior to January 1996, Orgill,
Inc., was a subsidiary of West Union Corporation, Memphis, Tennessee, of which
Mr. Orgill remains Chairman of the Board. Mr. Orgill has been a director since
1969.
VICKI R. PALMER (44) is Corporate Vice President and Treasurer of Coca-Cola
Enterprises Inc., Atlanta, Georgia, bottler of soft drink products. Mrs. Palmer
has been a director since 1993 and is Chairperson of the Audit Committee.
WILLIAM B. SANSOM (56) is Chairman of the Board and Chief Executive Officer of
The H. T. Hackney Co., Knoxville, Tennessee, a diversified wholesale
distribution firm serving the food, gas, oil and industrial markets in the
Southeast. He is a director of one other public company, Martin Marietta
Materials. Mr. Sansom has been a director since 1984 and is a member of the
Human Resources Committee.
The Board of Directors and its Committees
During 1997, the Board of Directors held five meetings. The average
attendance at Board and committee meetings exceeded 92%. No director attended
fewer than 75 percent of the meetings of the Board and the committees of the
Board on which he or she served.
The Board has several standing committees, including the Audit Committee
and the Human Resources Committee. The Human Resources Committee serves as both
a nominating committee and a compensation committee. The Audit Committee and
the Human Resources Committee are each composed of directors who are not First
Tennessee employees. Currently, Messrs. Blattberg, Haslam, and Street and Mrs.
Palmer are serving on the Audit Committee and Messrs. Cantu, Martin, Rose and
Sansom are serving on the Human Resources Committee.
The Audit Committee is responsible for causing corporate audits and
examinations to be made by independent auditors and supervising our internal
audit program. The Committee approves, subject to shareholder ratification, the
engagement of our independent auditors and reviews the scope and results of
their examination. Other committee functions include review of our internal
controls and our annual report to the SEC and proxy materials. During 1997 the
Audit Committee held four meetings.
As a nominating committee, the Human Resources Committee primarily
considers recommendations for nominees to the Board of Directors, reviews the
performance of incumbent directors and senior officers in determining whether
to recommend them to the Board of Directors for reelection, reviews succession
plans, and between annual meetings elects persons to offices
5
<PAGE> 10
except the offices of Chairman, CEO and President. As a compensation committee,
the Human Resources Committee's primary functions include recommending to the
Board major policies concerning compensation, periodically reviewing corporate
compensation and management of human resources, fixing the compensation of
executive officers, reviewing remuneration structures for non-executive
officers, and making recommendations to the Board concerning compensation
arrangements for directors and adoption or amendment of employee benefit and
management compensation plans. During 1997 the Human Resources Committee held
five meetings.
It is our practice to encourage communication between management and
shareholders. Management in turn communicates appropriate information to the
Board. The Human Resources Committee, as a committee of the Board, follows this
procedure in considering nominations for directorships and does not receive
nominations directly from shareholders.
SHAREHOLDER PROPOSALS
If you intend to present a shareholder proposal at the 1999 annual
meeting, it must be received by the Corporate Secretary, First Tennessee
National Corporation, P. O. Box 84, Memphis, Tennessee, 38101, not later than
November 20, 1998, for inclusion in the proxy statement and form of proxy
relating to that meeting.
In addition, Section 7 of Article III and Section 11 of Article II of our
Bylaws provide that a shareholder who wishes to nominate a person for election
to the Board or submit a proposal at a shareholder meeting must comply with
certain procedures, which require written notification to us, generally not
less than 30 nor more than 60 days prior to the date of the shareholder
meeting. If, however, we give fewer than 40 days' notice or public disclosure
of the shareholder meeting date to shareholders, then we must receive the
shareholder notification not later than 10 days after the earlier of the date
notice of the shareholder meeting was mailed or publicly disclosed. The
shareholder must disclose certain information about the nominee or item
proposed, the shareholder and any other shareholders known to support the
nominee or proposal.
EXECUTIVE COMPENSATION
The Summary Compensation Table provides information for the last three
years about the Chief Executive Officer ("CEO") and our other four most highly
compensated executive officers. The amounts include all compensation earned
during each year, including amounts deferred, by the named officers for all
services rendered in all capacities to us and our subsidiaries. Information is
provided for each entire year in which an individual served during any portion
of the year as an executive officer. Additional information is provided in
tabular form below about option grants and exercises in 1997, year-end option
values, and pension benefits, along with a report of the Board's Human
Resources Committee on executive compensation and certain other information
concerning compensation of executive officers and directors.
6
<PAGE> 11
Summary Compensation Table
<TABLE>
<CAPTION>
Annual Compensation Long-Term Compensation
----------------------------------- ---------------------------------------
Awards (3) Payouts
----------------------------------------
(a) (b) (c) (d) (e) (f) (g) (h) (i)
Securities
Name Other Restricted Underlying All Other
and Annual Stock Options/ LTIP Compensation
Principal Salary Bonus Compensation Award(s) SARs Payouts
Position Year ($) ($) ($) ($)(1) (#)(2) $ ($)(7)
-------- ---- ----- ---- --- ------ ------- --- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Ralph Horn 1997 $523,077 (4) $313,846 $ 10,806 $ 0 113,872 (4) $ 0 $138,930
Chairman, President 1996 497,866 (4) 224,040 10,560 0 108,026 (4) 0 146,322
& CEO 1995 457,241 222,905 20,874 (6) 0 0 0 217,291
FTNC and FTB
J. Kenneth Glass 1997 343,577(4) 186,549 6,720 0 55,632 (4) 0 96,426
President- 1996 316,461 123,040 6,720 536,796 31,076 0 88,310
Tennessee 1995 245,692 102,407 14,568 (6) 0 0 0 103,520
Banking Grp.-FTB
John C. Kelley, Jr. 1997 338,077 181,294 6,720 0 48,608 0 116,175
President-Memphis 1996 310,961 120,902 6,720 536,796 30,542 0 105,483
Banking Grp.-FTB 1995 240,192 104,330 14,568 (6) 0 0 0 109,897
George P. Lewis 1997 215,795 104,661 0 0 10,310 0 27,117
Exec. Vice Pres., 1996 205,519 74,912 0 320,046 13,408 0 26,735
Manager Money 1995 195,733 84,418 0 0 0 0 31,366
Mgmt. Grp.-FTB
Elbert L. Thomas, Jr. 1997 202,277 (4) 101,139(5) 0 0 45,764 (4)(5) 0 17,621
Exec. Vice Pres. & 1996 190,000 (4) 76,950(5) 0 320,046 69,720 (4)(5) 0 10,716
CFO 1995 145,603 60,689 0 170,642 0 0 8,573
FTNC and FTB
</TABLE>
(1) Restricted stock awards are valued on the basis of the fair
market value of a share of stock on the date of the award:
$14.77 (1-16-96) and $10.41 (2-28-95). On 12-31-97, the named
officers held the following shares of restricted stock with
market values as indicated: Mr. Horn - 120,000 shares
($4,005,000); Mr. Glass - 46,816 shares ($1,562,484); Mr.
Kelley - 46,816 shares ($1,562,484); Mr. Lewis - 30,044
shares ($1,002,719); Mr. Thomas - 29,876 shares ($997,112).
Dividends are paid on restricted stock at the same rate as
all other shares of our common stock. Mr. Thomas was awarded
16,400 shares of restricted stock on 2-28-95. 2,732 of such
shares vested 3-1-96; 5,468 shares vested on 2-28-97 and
8,200 shares vested on 2-27-98 because corporate performance
criteria were met. Otherwise, such shares would have vested
2-1-05.
2) All amounts represent shares subject to option. No stock
appreciation rights (SAR's) were awarded.
(3) All share amounts and share values have been revised to
reflect the two-for-one stock splits, paid 2-20-98 and
2-16-96.
(4) In both 1996 and 1995 Mr. Horn elected to receive a deferred
compensation stock option in lieu of $100,000 of salary
earned for the following year. The amounts in column (c)
includes these amounts, in lieu of which an option for 27,700
shares was granted on 7-1-97 and an option for 43,384 shares
was granted on 7-1-96. In 1996 Mr. Glass elected to receive a
deferred compensation stock option in lieu of $30,000 of
salary earned for 1997. The amount in column (c) includes
this amount, in lieu of which
7
<PAGE> 12
options for 3,018 shares and 4,156 shares were granted on 1-2-98 and
7-1-97, respectively. In 1996 and 1995 Mr. Thomas elected to receive a
deferred compensation stock option in lieu of $60,000 of 1997 salary and
$90,000 of 1996 salary. The amounts in column (c) includes these amounts,
in lieu of which options for 6,036 shares, 8,310 shares, 16,804 shares
and 18,742 shares were granted on 1-2-98, 7-1-97, 1-2-97, and 7-1-96,
respectively.
(5) In both 1996 and 1995 Mr. Thomas elected to receive a deferred
compensation stock option in lieu of his annual bonus for the following
year. The amount in column (d) for 1997 includes a bonus of $101,139 and
the amount for 1996 includes a bonus of $76,950 in lieu of which options
for 21,704 and 21,892 shares, respectively, were granted on 2-19-98 and
2-24-97.
(6) The amounts in column (e) for all years represent automobile allowance
tax gross-up payments. In late 1995 it was determined that the payment
for 1996, generally paid in January, would be accelerated to December of
1995. Thus, the 1995 amount reflects the gross-up amount for two years.
(7) Elements of "All Other Compensation" for 1997 consist of the following:
<TABLE>
<CAPTION>
Mr. Horn Mr. Glass Mr. Kelley Mr. Lewis Mr. Thomas
-------- --------- ---------- -------- ----------
<S> <C> <C> <C>
Above MktRate: $ 59,190 $59,229 $64,353 $2,443 $0
SurBen/SERP: 54,940 17,397 32,022 14,524 7,935
Flex $: 5,400 5,400 5,400 5,400 5,400
401(k) Match: 4,750 4,750 4,750 4,750 4,286
Auto Allowance: 14,650 9,650 9,650 0 0
Total: $138,930 $96,426 $116,175 $27,117 $17,621
</TABLE>
"Above Mkt Rate" represents above-market interest accrued on deferred
compensation.
"Sur Ben/SERP" represents insurance premiums with respect to our
supplemental life insurance and excess pension plans. Under the Survivor
Benefits Plan a benefit of 2 1/2 times final annual base salary is paid
upon the participant's death prior to retirement (or 2 times final salary
upon death after retirement).
"Flex $" represents the Corporation's contribution to the Flexible
Benefits Plan, based on salary, service and corporate performance.
"401(k) Match" represents the Corporation's 50% matching contribution to
the 401(k) Savings Plan, which is based on the amount contributed by the
participant, up to 6% of compensation.
8
<PAGE> 13
The following table provides information about stock options granted to
the officers named in the Summary Compensation Table during 1997. No stock
appreciation rights (SAR's) were granted during 1997.
Option/SAR Grants in Last Fiscal Year Table
Individual Grants
<TABLE>
<CAPTION>
(c) % of Total
(b) Number of Securities Options/SARs (h) Alternatives to (f) and
Underlying Granted to (d) Exercise or (g): Grant Date Value.
Options/SARs Employees in Fiscal Base Price Grant Date Present Value
(a) Name Granted (#)(1) Year ($/sh) (1) (e) Expiration Date ($)(4)
-------- --------------- ------------------- --------------- ------------------- -------------------------
<S> <C> <C> <C> <C> <C>
Mr. Horn 86,172 1.84% $21.13 4-16-07 $376,544
27,700 (2) 0.59 20.46 (2) 7-1-17 198,303
Mr. Glass 48,458 1.03 21.13 4-16-07 213,494
4,156 (2) 0.09 20.46 (2) 7-1-17 29,753
Mr. Kelley 48,068 1.02 21.13 4-16-07 210,042
Mr. Lewis 10,310 0.22 21.13 4-16-07 45,051
Mr. Thomas 21,892 (3) 0.47 19.92 (2) 2-24-17 151,497
9,714 0.21 21.13 4-16-07 42,447
8,310 (2) 0.18 20.46 (2) 7-1-17 59,491
</TABLE>
(1) All share amounts and prices reflect the two-for-one stock split,
paid 2-20-98. All options except those marked with footnote (2) or (3)
were granted 4-16-97 and vest 50% after four years from the date of grant
and 100% after five years, with accelerated vesting if certain
performance criteria (our stock price equals or exceeds $28.89 on 4-15-00
or on 5 consecutive days before 4-16-00) are met. The performance
criteria were met and the options vested 10-9-97. No SAR's were granted.
The exercise price per share equals the fair market value of one share of
our common stock on the date of grant. Under the terms of all options,
including those marked with footnote (2) and (3), participants are
permitted to pay the exercise price of the options with our stock;
participants are permitted to defer receipt of shares upon an exercise
and thereby defer gain; options exercised more than one year prior to the
end of their term are eligible for a reload option grant when the
exercise price is paid with our stock, with the reload option grant for
the number of shares surrendered and having an exercise price equal to
fair market value at the time of the first exercise and a term equal to
the remainder of the first option's term; the option plan provides for
tax withholding rights upon approval of the plan committee; and upon a
Change in Control (as defined in the subsection entitled "Employment
Contracts and Termination of Employment and Change-in-Control
Arrangements), all options vest.
(2) Mr. Horn's, Mr. Glass's, and Mr. Thomas's options were granted on
7-1-97 in lieu of $100,000 of Mr. Horn's 1997 salary, $15,000 of Mr.
Glass's 1997 salary, and $30,000 of Mr. Thomas's 1997 salary and vest
100% at the time of grant. No SAR's were granted. The exercise price per
share equals 85% of the fair market value ($24.07) of one share of
Corporation common stock on the grant date.
(3) Mr. Thomas's option was granted 2-24-97 in lieu of his bonus of
$76,950 for 1996 and contains the same terms as described for his option
granted in lieu of salary.
(4) A variation of the Black-Scholes option pricing model has been used.
The following assumptions were made for purposes of calculating the Grant
Date Value of the options granted 4-16-97, 7-1-97, and 2-24- 97,
respectively: an exercise price of $21.13, $20.46, and $19.92; an option
term of 10 years, 20 years, and 20 years; an interest rate of 6.89 %,
6.22%, and 6.42%; volatility of 22.74 %, 23.01%, and 22.45%; a dividend
yield of 2.84%, 2.49%, and 2.56%; a reduction of 24.18%, 0%, and 0% to
reflect the probability of forfeiture due to termination prior to
vesting; and reduction of 12.71%, 13.44%, and 13.46% to reflect the
probability of a shortened option term due to termination prior to the
option expiration date. The actual value, if any, realized by a
participant upon the exercise of an option may differ and will depend on
the future market value of our common stock.
9
<PAGE> 14
The following table provides information about stock options and SAR's
held at December 31, 1997, and exercises during 1997 by the officers named in
the Summary Compensation Table. The values in column (e) reflect the spread
between the market value at December 31, 1997 of the shares underlying the
option and the exercise price of the option.
Aggregated Option/SAR Exercises in Last Fiscal Year and
Fiscal Year-End Option/SAR Values Table
<TABLE>
<CAPTION>
(a) (b) (c) (d) (e)
--------- ------------------ ------------ -------------------- -----------------
Number of Value of
Securities Underlying Unexercised
Unexercised In-the-Money
Options/SARs at Options/SARs at
FY-End (#) FY-End ($)
--------------------- -----------------
Shares Acquired Value Exercisable/ Exercisable/
Name on Exercise (#) (2) Realized ($) Unexercisable(1)(2) Unexercisable (1)
---- ------------------- ------------ ------------------- -----------------
<S> <C> <C> <C> <C>
Mr. Horn 0 0 501,990/17,212 $10,914,594/$396,908
Mr. Glass 0 0 197,058/4,092 $4,379,267/$94,362
Mr. Kelley 0 0 203,402/4,092 $4,631,460/$94,362
Mr. Lewis 0 0 63,408/3,274 $1,439,770/$75,498
Mr. Thomas 0 0 107,892/2,456 $1,931,093/$56,635
</TABLE>
(1) No SAR's are attached to any of the options in the table. Option values
are based on $33.38 per share, the average of the high and low sales
price on 12-31-97.
(2) All share amounts reflect the two-for-one stock split paid 2-20-98.
The following table provides information about estimated combined
benefits under both our Pension Plan and our Pension Restoration Plan.
Pension Plan Table
<TABLE>
<CAPTION>
Covered
Compensation Years of Service*
------------
15 Yrs. 20 Yrs. 25 Yrs. 30 Yrs. 35 Yrs. 40 Yrs.
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
$100,000 $ 42,572 $ 51,462 $ 60,350 $ 64,298 $ 68,250 $ 72,203
150,000 57,374 71,200 85,022 91,435 97,854 104,274
200,000 72,176 90,938 109,695 118,572 127,458 136,345
250,000 86,978 110,676 134,367 145,709 157,062 168,416
300,000 101,780 130,414 159,040 172,846 186,666 200,487
350,000 116,582 150,152 183,712 199,983 216,270 232,558
400,000 131,384 169,890 208,385 227,120 245,874 264,629
450,000 146,186 189,628 233,057 254,257 275,478 296,700
500,000 160,988 209,366 257,730 281,394 305,082 328,771
550,000 175,790 229,104 282,402 308,531 334,686 360,842
600,000 190,592 248,842 307,075 335,668 364,290 392,913
</TABLE>
10
<PAGE> 15
*Benefit shown is subject to limitations fixed by the Secretary of the
Treasury pursuant to Section 415 of the Internal Revenue Code of 1986, as
amended. The limitation is $125,000 for 1997 or 100% of the employee's
average income in his three highest paid years, whichever is less.
However, a benefit as high as $136,425 could be accrued prior to 1983 and
such higher benefit may be paid to the employee who attained that level
prior to 1983.
Our Pension Plan is integrated with social security under an "offset"
formula, applicable to all participants. Retirement benefits are based upon a
participant's average base salary for the highest 60 consecutive months of the
last 120 months of service ("Covered Compensation"), service, and social
security benefits. Benefits are normally payable in monthly installments after
age 65. The normal form of benefit payment for a married participant is a
qualified joint and survivor annuity with the surviving spouse receiving for
life 50% of the monthly amount the participant received. The normal form of
benefit payment for an unmarried participant is an annuity payable for life and
10 years certain. For purposes of the plan "compensation" is defined as the
total cash remuneration reportable on the employee's IRS form W-2, plus pre-tax
contributions under the Savings Plan and employee contributions under the
Flexible Benefits Plan, excluding bonuses, commissions, and incentive and
contingent compensation. Our Pension Restoration Plan is an unfunded plan
covering employees in the highest salary grades, including Messrs. Horn, Glass,
and Kelley, whose benefits under the Pension Plan have been limited under Tax
Code Section 415, as described in the note to the Pension Table, and Tax Code
Section 401(a)(17), which limits compensation to $160,000 for purposes of
certain benefit calculations. "Compensation" is defined in the same manner as
it is for purposes of the pension plan. Under the Pension Restoration Plan
participants receive the difference between the monthly pension payable if tax
code limitations did not apply and the actual pension payable. The estimated
credited years of service and the compensation covered by the plans for each of
the individuals named in the Summary Compensation Table are as follows: Mr.
Horn, 34 ($423,077); Mr. Glass, 23 ($313,577); Mr. Kelley, 28 ($338,077); Mr.
Lewis, 36 ($215,795); and Mr. Thomas, 7 ($142,277).
Employment Contracts and Termination of Employment
and Change-in-Control Arrangements
We have entered into contracts with 50 officers, including each of the
named executive officers, which may be terminated upon 3 year' prior notice.
These contracts provide generally for a payment (which, for the named executive
officers is equal to three times annual base salary plus annual target bonus)
in the event of a termination of the officer's employment by us other than "for
cause" or by the employee for "good reason" (as such terms are defined in the
contracts) within 36 months after a "Change-in-Control" or the officer's
termination of employment for any reason (other than "cause") during the 30-day
period commencing one year after a Change-in-Control. The contracts provide
generally for an excise tax gross-up with respect to any taxes incurred under
Internal Revenue Code Section 4999 following a Change-in-Control and for 3
years continued welfare benefits. The term "Change-in-Control" is defined to
include:
- a merger or other business combination, unless (i) more than
60% (50% for purposes of the 30-day termination period and
for benefit plans other than the severance contracts) of the
voting power of the corporation resulting from the business
combination is represented by our voting securities
outstanding immediately prior thereto, (ii) no person or
other entity beneficially owns 20% or more of the resulting
corporation, and (iii) at least two-thirds (a majority for
purposes of the 30-day termination period and for benefit
plans other than the severance contracts) of the members of
the board of directors of the resulting corporation were our
directors at the time of board approval of the business
combination,
11
<PAGE> 16
- the acquisition by a person or other entity of 20 percent or more
of our outstanding voting stock,
- a change in a majority of the Board of Directors, or
- shareholder approval of a plan of complete liquidation or a sale of
substantially all of our assets.
A Change-in-Control has the following effect on certain benefit plans in
which the named executive officers participate:
- Target annual bonuses are prorated through the date of the
Change-in-Control and paid.
- Restricted stock, stock options and accrued benefits under our
Pension Restoration Plan vest.
- Excess funding in the pension plan is allocated, according to a
formula, to participants and retirees.
- Deferred compensation under individual deferral agreements which
accrue interest based on the 10-year Treasury rate and certain
other benefits are paid over to previously established rabbi
trusts. Funds in such trusts will remain available for the benefit
of our general creditors prior to distribution.
- Our Survivor Benefits Plan generally cannot be amended to reduce
benefits.
- Under the Directors and Executives Deferred Compensation Plan, a
lump sum payout is made to participating employees and certain
terminated employees of the present value, using a discount rate of
4.2%, of the participant's scheduled projected distributions,
assuming employment through normal retirement date and continued
interest accruals at above-market rates, described in the
"Compensation of Directors" section below.
Compensation Committee Interlocks
and Insider Participation
Messrs. Cantu, Martin, Rose, and Sansom, all of whom are non-employee
directors, served as members of the Board of Director's Human Resources
Committee ("Committee"), which is our compensation committee, during all or a
portion of 1997. No interlocking relationships existed with respect to any of
the members of the Committee.
Certain Relationships and Related Transactions
Our banking subsidiaries have had banking transactions in the ordinary
course of business with our executive officers and directors and their
associates which are reported in a note to our financial statements, and they
expect to have such transactions in the future. Such transactions, including
nominees, which at December 31, 1997, amounted to 9.0 percent of our
shareholders' equity, have been on substantially the same terms, including
interest rates, except for one individual as described below, and collateral on
loans, as those prevailing at the same time for comparable transactions with
others and have not involved more than normal risk of collectibility or
presented other unfavorable features. Two loans were made to a person not
individually named in the Summary Compensation Table aggregating an amount less
than $40,000 under an employee program which provided a below market interest
rate at a time prior to that person becoming an executive officer.
12
<PAGE> 17
Notwithstanding anything to the contrary set forth in any of our previous
filings under the Securities Act of 1933, as amended, or the Securities
Exchange Act of 1934, as amended, that might incorporate future filings by
reference, including this proxy statement, in whole or in part, the following
Board Compensation Committee Report on Executive Compensation and the Total
Shareholder Return Performance Graph shall not be incorporated by reference
into any such filings.
Board Compensation Committee Report on Executive Compensation
Our Bylaws require the Board of Directors or a Board committee to
determine the compensation of executive officers. The Board has designated the
Human Resources Committee ("Committee") to perform this function. The Committee
is composed entirely of independent, nonemployee directors who have no
interlocking relationships with us. The Committee has set forth below its
report on the compensation policies applicable to executive officers and the
bases for the compensation of the Chief Executive Officer ("CEO") during 1997.
Our executive compensation programs are designed to align the interests
of the executive officers with our performance and the interests of our
shareholders. Approximately 60 percent of the executive officers' annual
compensation potential is at risk based on corporate performance and total
shareholder return (defined below). Compensation programs have been designed to
reward executive officers in both cash and our stock based on performance that
also rewards shareholders. When corporate performance does not meet criteria
established by the Committee, incentive compensation is reduced accordingly. In
addition, the executive compensation program has been designed to attract and
retain qualified executive officers. Executive compensation consists generally
of the following components:
- base salary
- annual incentive bonus
- long-term incentive awards
- deferral of compensation at above-market rates or through stock option
grants
- customary employee and other benefits typically offered to similarly
situated executives
Base salary and annual bonus are based on an evaluation of the
individual's position and responsibilities based on independent criteria and
external market data and personal and corporate performance. The Committee does
not assign a specific weight to any of the factors but places greater emphasis
on corporate and personal performance in the overall mix.
Long-term incentive awards consist of restricted stock awards containing
provisions for acceleration of vesting upon achievement of corporate
performance criteria and stock options. It is not our practice to "reprice"
stock options or to price them at less than fair market value on the date of
grant. We have offered deferred compensation at above-market rates and
deferrals through the use of stock options with deferrals since 1995 limited to
stock options or a 10-year Treasury rate of interest. Except for our stock fund
within our 401(k) plan, other benefits provided to the executive officers are
not tied to corporate performance.
13
<PAGE> 18
The Committee reviewed external market data provided by an independent
consulting firm from fourteen highest-performing companies in the American
Banker Top 50, a peer group of banking organizations against which we measure
our strategic performance. We selected the highest- performing companies based
generally on the following one and five-year return measures:
- return on assets
- return on equity
- earnings per share growth
- stock price performance
- total shareholder return
The purpose of the review was to determine compensation practices of these
companies. The Committee also reviewed available compensation data on the other
banking organizations in the American Banker Top 50. The compensation peer
group used by the independent consulting firm did not include all of the
banking organizations listed in the Total Shareholder Return Performance Graph
("TSR graph") for the 1997 peer group because compensation data on every
organization included in the TSR graph was not available. The median asset size
of the compensation highest- performing peer group was $28.9 billion. The
median asset size of the American Banker Top 50 was $38.9 billion. In actual
practice the compensation of executive officers approximates the median of the
compensation highest-performing peer group, normalized for asset size. We do
not, however, have a specific policy that mandates how our compensation
practices will compare to the peer group.
All compensation paid to executive officers during 1997 is fully
deductible on our corporate federal income tax return with the exception of
certain compensation paid to the CEO, as described below. Section 162(m) of the
Tax Code generally disallows a tax deduction to public companies, including us,
for compensation exceeding $1 million paid during the year to the CEO and the
four other highest paid executive officers at year end. Certain
performance-based compensation is not, however, subject to the deduction limit.
Under Tax Code regulations the salary and TARSAP (defined below) portions of
compensation do not meet the performance-based compensation criteria of Section
162(m). While some portion of compensation may not qualify as wholly-deductible
in certain years, any such amount is not expected to be material to us. The
Committee's practice is to consider ways to maximize the deductibility of
executive compensation while retaining the discretion deemed necessary to
compensate executive officers in a manner commensurate with performance and the
competitive market of executive talent.
(i) The CEO's Compensation
Base Salary: The Committee establishes the CEO's base salary annually
based on the following:
- corporate performance
- achievement of objectives in his individualized written personal plan
- competitive practices within the industry.
The CEO develops his personal plan and submits it to the Committee for review
and recommendation. The Board of Directors approves the plan, which generally
contains strategic, quality and financial goals. A salary increase of 5.0
percent for Mr. Horn was approved in January of 1997 based on achievement of
1996 corporate return on common equity (ROE) objectives, Bank return on assets
objectives, personal plan objectives, and competitive practices. Although no
specific weight is assigned to these factors, the Committee places greater
emphasis on corporate and personal performance than on competitive practices
within the industry. Base salary represents approximately 30 percent of the
CEO's total compensation potential.
14
<PAGE> 19
Annual Bonus: The CEO's annual bonus is based entirely on our corporate
performance against financial objectives established by the Committee at the
beginning of each year. The financial objectives for 1997 were based on ROE and
earnings per share (EPS). The degree of our success in reaching these corporate
targets determines a payout of zero percent to 100 percent of the CEO's annual
bonus potential. The CEO may be awarded an annual bonus of a maximum of 60
percent of his salary dollars earned during 1997. This percentage was increased
from 50 percent in 1996, based on an analysis of competitive practices within
the industry. During 1997, our corporate performance resulted in a payout of
100 percent of the maximum.
Long-term Awards: The CEO's long-term incentive compensation consists of
restricted stock and stock options.
Our restricted stock program has since 1990 included performance criteria
as a condition to early vesting of awards to executive officers. The objective
of this time accelerated restricted stock award plan ("TARSAP") feature is to
associate more closely the long-term compensation of executive officers with
shareholder interests. Under the TARSAP feature restricted stock is granted
with accelerated vesting if performance criteria established by the Committee
are met with respect to specified performance periods. Performance periods are
for three years and overlap: e.g., 1995- 1997, 1996-1998, 1997-1999.
Performance criteria since inception have been based, for all participants,
including the CEO, on total shareholder return (appreciation in the market
value of our stock with dividends reinvested-"TSR") targets established at the
beginning of each performance period. Targets are based on our percentile
ranking in a peer group (the "100-bank peer group") of approximately the 100
largest banking organizations by asset size traded on U.S. exchanges, including
the Nasdaq Stock Market's National Market System, with the condition that TSR
must be a positive number. The 100-bank peer group is different from the peer
group used to compare shareholder returns. The 100-bank peer group was
originally selected in 1990, prior to the adoption of SEC rules requiring
disclosure of a shareholder return performance graph, because the Committee
believed that it was an appropriate index with which to associate more closely
long-term compensation of executives with shareholder interests. The restricted
stock program which contains the 100-bank peer group has produced the desired
results, and thus, the Committee has continued to use it for the restricted
stock program. In January of 1998, the Committee approved vesting the TARSAP
shares for the 1995-1997 performance period. The Committee's decision was based
on a TSR for the period January 1, 1995 through December 31, 1997 of 254
percent, which exceeded the target and ranked us in the top thirty-five percent
of the peer group. The Committee accelerated the lapsing of the restrictions on
these shares, which was originally scheduled for April 21, 1998, to February
27, 1998, to coincide with the anticipated payment date for executive officer
annual bonuses. In addition to the TSR targets, the Committee adopted
alternative criteria for the accelerated vesting of TARSAP awards made in 1996
and future years based upon our percentile ranking within the 100-bank peer
group with respect to operating EPS growth rate (or exceeding a minimum
operating EPS growth rate) and average operating ROE, with the condition that
TSR must be a positive number.
The total compensation paid to the CEO for 1997 that is not
"performance-based" under the Tax Code exceeded the $1.0 million threshold
established by Section 162(m), and we will not receive a tax deduction for that
portion of compensation. Although the plan under which the TARSAP program was
established was approved by the shareholders, the TARSAP program does not
qualify as performance-based compensation under Section 162(m); however, this
program qualifies for favorable accounting treatment, thus reducing the
program's expense. The 221 percent increase in the price of our stock during
the performance period with the commensurate increase in the value of the
TARSAP award has resulted in the CEO's total nonperformance-based compensation
exceeding the $1.0 million threshold. The amount of the tax deduction foregone
is not considered material.
15
<PAGE> 20
In addition to performance-based restricted stock awards, the Committee
generally awards stock options to executive officers, including the CEO, as a
part of a broad-based stock option program under which awards are made to all
of our employees, both full-time and part-time. The CEO's option award (which
is the first grant disclosed in the "Option/SAR Grants in Last Fiscal Year
Table") was based on an estimated value of the option which in combination with
the restricted stock award provides the basis for a competitive long-term
incentive package. Because the value of the option to the CEO is a function of
the price growth of our stock, the amount realized by the CEO is tied directly
to increases in shareholder value. In addition, the option grant contained a
performance-based, accelerated vesting feature, which is described in part (ii)
of this report.
Other Benefits: The CEO's compensation reported in the Summary
Compensation Table also includes accrual of above-market rates of interest on
compensation deferred prior to 1996 and the cost of insurance to fund a
supplemental retirement plan and life insurance benefit, which are not directly
based on corporate performance. Above-market rates are accrued for deferred
compensation of the CEO and other named executive officers to retain key
officers. Generally, the plan under which this benefit is offered requires that
the amount deferred be automatically recalculated at market rates if
termination occurs prior to retirement.
(ii) Other Executive Officer Compensation
Base Salary: The CEO recommends and the Committee approves the base
salary for executive officers other than the CEO. Recommendations are generally
based on corporate performance (as measured by financial, quality and strategic
objectives), individual overall performance during the prior year, and
competitiveness in the market place. Corporate performance objectives for 1996,
which were achieved, were the same for executive officers as the CEO: corporate
ROE and Bank return on assets objectives. It is our policy to maintain a
competitive salary commensurate with the duties and responsibilities of the
executive officers. Salary is intended to represent approximately 40 percent of
an executive officer's potential annual compensation.
Annual Bonus: Executive officers' annual bonus is based on achievement of
corporate financial objectives and performance against personal objectives for
the year, which are recorded in individualized written personal plans.
Individual objectives must include financial, quality and strategic goals. The
degree of completion of goals determines the award. Financial objectives for
1997 were based on ROE and EPS. Although Mr. Horn has an individualized
personal plan, his annual bonus is based entirely on corporate financial
performance as described above for the CEO, and the Chief Credit Officer's
annual bonus is based solely on his individualized personal plan. The maximum
annual bonus of executive officers is between 40 percent and 60 percent of
salary dollars during the year, based on salary grade.
Long-term Awards: The executive officers named in the Summary
Compensation Table and all but one of the other executive officers participate
in the TARSAP program described above with respect to the CEO. The performance
criteria are identical. The number of shares awarded for a three-year
performance period is generally 50 percent of the participant's salary grade
mid-point, based on market value of the shares at the time of the award. We do
not provide a federal income tax gross-up to executive officers at the vesting
of restricted stock.
16
<PAGE> 21
In addition to performance-based restricted stock awards, the Committee
generally awards stock options annually on our stock to executive officers,
including the CEO, as a part of the option program discussed in part (i) of
this report. The number of shares awarded to executive officers is equal to a
percentage of salary (ranging from 100 percent to 200 percent depending on
salary grade, with 200 percent used for the CEO) divided by the market value of
one share of our stock at the time of grant. Executive officers may also be
awarded shares in addition to those calculated as a percent of salary if in the
opinion of the Committee additional shares are required to ensure a competitive
compensation opportunity. The exercise price is the market value at the time of
grant. Options are awarded based on personal performance and to encourage
future performance as well as for retention purposes (with a ten-year term and
vesting at 50 percent after four years and 100 percent after five years). The
April 1997 grant's exercise price was $21.13. This grant contained a provision
for accelerated vesting if the closing market price per share equals at least
$28.89 for five consecutive days in the three years following the grant or at
the end of the three year period. The April 1997 grant vested on October 9,
1997 as the provision for accelerated vesting was achieved. Options are not
granted based on prior corporate performance.
Other Benefits: We have adopted certain broad-based employee benefit
plans in which executive officers participate and certain other retirement,
life and health insurance plans and we provide customary personal benefits.
Except for our stock fund within our 401(k) plan, the benefits under these
plans are not tied to corporate performance. The executive officers named in
the Summary Compensation Table participate in the other benefits described
above with respect to the CEO.
Human Resources Committee
R. Brad Martin, Chairman
Carlos H. Cantu
Michael D. Rose
William B. Sansom
The following graph compares the yearly percentage change in our
cumulative total shareholder return with returns based on the Standard and
Poor's 500 index and a peer group index, which is described below and in a
footnote to the graph. It should be noted that the "total shareholder return"
reflected in the graph is not comparable to the "total shareholder return"
described in the Compensation Committee Report because the former has a
different measurement period and it has been adjusted and weighted for the
market capitalization of the companies in the peer group, as required by SEC
regulations. Our peer group consists of the American Banker Top 50 banking
organizations as measured by market capitalization.
17
<PAGE> 22
Total Shareholder Return Performance Graph
<TABLE>
<CAPTION>
1992 1993 1994 1995 1996 1997
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
First Tennessee $100 $109 $120 $185 $237 $432
S&P 500 100 110 112 153 188 251
1997 Peer Group 100 107 101 157 220 327
</TABLE>
The graph assumes $100 is invested on December 31, 1992, and dividends
are reinvested. Returns are market-capitalization weighted.
The 1997 peer group consists of the following: AmSouth Bancorporation,
Banc One Corporation, BankAmerica Corporation, BankBoston Corporation, Bankers
Trust New York Corporation, Bank of New York, Barnett Banks, Inc., Branch
Banking and Trust Company, The Chase Manhattan Corporation, Citicorp, Comerica
Incorporated, Compass Bancshares, CoreStates Financial Corp, Crestar Financial
Corporation, Fifth Third Bancorp, First American Corporation [TN], Firstar
Corporation, First Chicago NBD Corporation, First Empire State Corporation,
First of America Bank Corporation, First Security Corporation [DE], First Union
Corporation, Fleet Financial Group, Huntington Bancshares Incorporated, J.P.
Morgan, KeyCorp, Marshall & Ilsley Corporation, Mellon Bank Corporation,
Mercantile Bancorporation, Inc., National City Corporation, NationsBank
Corporation, Northern Trust Corporation, Norwest Corporation, Old Kent
Financial Corporation, PNC Bank Corp, Popular Inc., Regions Financial
Corporation, Republic New York Corporation, SouthTrust Corporation, Star Banc
Corporation, State Street Bank and Trust Company, Summit Bancorp, SunTrust
Banks, Inc., Synovus Financial Corporation, UnionBanCal Corporation, Union
Planters Corporation, U.S. Bancorp [DE], Wachovia Corporation and Wells Fargo
and Co.
Compensation of Directors
During 1997, each nonemployee director was paid a retainer quarterly at
an annual rate of $22,000 ($20,000 prior to April 15, 1997) plus a fee of
$1,000 for each Board and each committee meeting attended. The chairpersons of
the Audit and Human Resources Committees were paid monthly an additional
retainer at an annual rate of $3,000 ($2,400 prior to April 15, 1997) each. Our
practice is to hold Board and committee meetings jointly with the Bank's Board
and committees. All of our directors are also directors of the Bank. Directors
are not separately compensated for Bank Board or committee meetings except for
those infrequent meetings that do not occur jointly. Directors who are officers
are not separately compensated for their services as directors. Under the terms
18
<PAGE> 23
of our 1992 Restricted Stock Incentive Plan, which was approved by the
shareholders, all nonemployee directors received an automatic, nondiscretionary
award of 6,000 shares (adjusted for stock splits) of restricted stock on May 1,
1992, and all new nonemployee directors will receive such award upon election to
the Board. Restrictions lapse at the rate of 10 percent annually. Such shares
are forfeited if the director terminates for any reason other than death,
disability, retirement, or the acquisition by a person of 20 percent of the
voting power of our stock. Upon termination for any of the four listed reasons,
all shares vest. Directors may elect to defer their retainers and fees. Under
the Non- Employee Directors' Deferred Compensation Stock Option Plan, all
non-employee directors have elected, and new non-employee directors are
permitted to elect, to receive stock options in lieu of fees through 1999. The
exercise price per share is 85% of fair market value of one share of our common
stock on the date of grant, and the number of shares subject to option granted
equals the amount of fees deferred divided by 15% of the fair market value of
one share on the date of grant. Under the Directors and Executives Deferred
Compensation Plan, not offered with respect to compensation earned since 1995,
under which up to six annual deferrals may be elected, amounts deferred accrue
interest at rates ranging from 17-22% annually, based on age at the time of
deferral, with a reduction to a guaranteed rate based on 10-year Treasury
obligations if a participant terminates prior to a change-in-control for a
reason other than death, disability or retirement. Interim distributions in an
amount between 85% and 100% of the amount originally deferred are made in the
eighth through the eleventh years following the year of deferral, with the
amount remaining in a participant's account and accrued interest generally paid
monthly over the 15 years following retirement at age 65. Certain restrictions
and limitations apply on payments and distributions. Under other deferral
agreements, nonemployee directors have deferred and may defer amounts which
generally accrue interest at a rate tied to 10-year Treasury obligations.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended
("Exchange Act") requires our directors and officers to file with the SEC
initial reports of ownership and reports of changes in ownership of our common
stock and to furnish us with copies of all forms filed.
To our knowledge, based solely on a review of the copies of such reports
furnished to us and written representations that no other reports were
required, during the past fiscal year all Section 16(a) filing requirements
applicable to our officers and directors were complied with.
VOTE ITEM NO. 2 - RATIFICATION OF APPOINTMENT OF AUDITORS
The Board of Directors has appointed, subject to ratification by the
shareholders at the annual meeting, the firm of Arthur Andersen LLP,
independent accountants, to be our auditors for the year 1998. Representatives
of Arthur Andersen LLP are expected to be present at the annual meeting of
shareholders with the opportunity to make a statement and to respond to
appropriate questions.
OTHER MATTERS
The Board of Directors, at the time of the preparation of this proxy
statement, knows of no business to come before the meeting other than that
referred to herein. If any other business should come before the meeting, the
persons named in the enclosed proxy will have discretionary authority to vote
all proxies in accordance with their best judgment.
19
<PAGE> 24
AVAILABILITY OF ANNUAL REPORT ON FORM 10-K
A COPY OF OUR ANNUAL REPORT ON FORM 10-K, INCLUDING THE FINANCIAL
STATEMENTS AND SCHEDULES THERETO, WHICH IS FILED WITH THE SECURITIES AND
EXCHANGE COMMISSION, IS AVAILABLE FREE OF CHARGE TO EACH SHAREHOLDER OF RECORD
UPON WRITTEN REQUEST TO THE TREASURER, FIRST TENNESSEE NATIONAL CORPORATION, P.
O. BOX 84, MEMPHIS, TENNESSEE, 38101. Each such written request must set forth
a good faith representation that as of the record date specified in the notice
of annual shareholders' meeting the person making the request was a beneficial
owner of a security entitled to vote at the annual meeting of shareholders.
The exhibits to the Annual Report on Form 10-K will also be supplied upon
written request to the Treasurer and payment to us of the cost of furnishing
the requested exhibit or exhibits. A document containing a list of each exhibit
to Form 10-K, as well as a brief description and the cost of furnishing each
such exhibit, will accompany the Annual Report on Form 10-K.
BY ORDER OF THE
BOARD OF DIRECTORS
/s/ Lenore S. Creson
- --------------------
Corporate Secretary
March 20, 1998
20
<PAGE> 25
FINANCIAL INFORMATION
&
DISCUSSION
(APPENDIX TO PROXY)
A-1
<PAGE> 26
FINANCIAL INFORMATION AND DISCUSSION
TABLE OF CONTENTS
<TABLE>
<S> <C>
Selected Financial and Operating Data A-3
Management's Discussion and Analysis A-4
Financial Highlights of 1997 A-4
Income Statement Analysis (1997 Compared to 1996) A-5
Income Statement Analysis (1996 Compared to 1995) A-15
Balance Sheet Review A-16
Risk Management A-21
Other A-29
Glossary A-30
Report of Independent Public Accountants A-33
Consolidated Statements of Condition A-34
Consolidated Statements of Income A-35
Consolidated Statements of Shareholders' Equity A-36
Consolidated Statements of Cash Flows A-37
Notes to Consolidated Financial Statements A-38
Consolidated Historical Statements of Income A-69
Consolidated Average Balance Sheets and Related
Yields and Rates A-70
Corporate Officers and Board of Directors A-72
</TABLE>
A-2
<PAGE> 27
FIRST TENNESSEE NATIONAL CORPORATION
ANNUAL FINANCIAL STATEMENTS AND REVIEW OF OPERATIONS
SELECTED FINANCIAL AND OPERATING DATA
<TABLE>
<CAPTION>
(Dollars in millions except per share data) 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
SUMMARY INCOME STATEMENTS
Interest income $ 941.3 $ 896.5 $ 822.5
Less interest expense 458.2 445.3 431.8
- ---------------------------------------------------------------------------------------------------------
Net interest income 483.1 451.2 390.7
Provision for loan losses 51.1 35.7 20.6
- ---------------------------------------------------------------------------------------------------------
Net interest income after provision 432.0 415.5 370.1
Noninterest income 668.1 571.2 492.6
- ---------------------------------------------------------------------------------------------------------
Adjusted gross income after provision 1,100.1 986.7 862.7
Noninterest expense 785.0 704.5 609.7
- ---------------------------------------------------------------------------------------------------------
Income before income taxes 315.1 282.2 253.0
Applicable income taxes 117.6 102.3 88.1
- ---------------------------------------------------------------------------------------------------------
Net income $ 197.5 $ 179.9 $ 164.9
=========================================================================================================
COMMON STOCK DATA
Earnings per share $ 1.54 $ 1.34 $ 1.21
Diluted earnings per share 1.50 1.32 1.20
Cash dividends declared per share .615 .5475 .485
Year-end book value per share 7.44 7.14 6.50
Closing price of common stock per share:
High 33 3/4 19 5/16 15 7/16
Low 18 3/8 14 7/16 9 13/16
Year-end 33 3/8 18 3/4 15 1/8
Dividends per share/closing price 1.8-3.3% 2.8-3.8% 3.1-4.9%
Dividends/earnings 40.2 40.9 39.8
Closing price/diluted earnings per share 22.3x 14.2x 12.6x
Market capitalization $ 4,279.0 $ 2,507.2 $ 2,032.1
Average shares outstanding (thousands) 128,365 134,393 136,050
Period-end shares outstanding (thousands) 128,209 133,715 134,356
Volume of shares traded (thousands) 135,205 108,038 131,296
- ---------------------------------------------------------------------------------------------------------
SELECTED AVERAGE BALANCES
Total assets $13,280.6 $12,588.3 $11,359.5
Total loans* 7,945.1 7,472.1 6,887.2
Investment securities 2,139.4 2,203.2 2,161.0
Earning assets 11,512.1 11,062.0 10,094.7
Deposits 9,207.1 8,945.5 8,132.4
Term borrowings 185.5 253.7 208.9
Shareholders' equity 878.8 897.5 822.8
- ---------------------------------------------------------------------------------------------------------
SELECTED PERIOD-END BALANCES
Total assets $14,387.9 $13,058.9 $12,076.9
Total loans* 8,311.4 7,728.2 7,333.3
Investment securities 2,186.5 2,239.5 2,111.4
Earning assets 12,220.2 11,045.8 10,483.6
Deposits 9,671.8 9,033.1 8,582.2
Term borrowings 168.9 234.6 260.0
Shareholders' equity 954.1 954.5 873.2
- ---------------------------------------------------------------------------------------------------------
SELECTED RATIOS
Return on average shareholders' equity 22.47% 20.05% 20.04%
Return on average assets 1.49 1.43 1.45
Net interest margin 4.23 4.13 3.92
Allowance for loan losses to loans* 1.51 1.52 1.54
Net charge-offs to average loans* .54 .41 .30
Average total capital to average assets** 7.36 7.13 7.24
Average shareholders' equity to average
assets 6.62 7.13 7.24
Average tangible equity to average
tangible assets 5.81 6.20 6.36
Average shareholders' equity to average
net loans 11.24 12.20 12.15
- ---------------------------------------------------------------------------------------------------------
RETURN TO SHAREHOLDERS
Stock appreciation 78.0% 24.0% 48.5%
Dividend yield 3.3 3.6 4.8
Annual return 81.3 27.6 53.3
- ---------------------------------------------------------------------------------------------------------
</TABLE>
[FN]
* Net of unearned income.
** Total capital includes shareholders' equity and guaranteed preferred
beneficial interests in First Tennessee's junior subordinated debentures.
See accompanying notes to consolidated financial statements. Common stock data
reflects the 1998 and 1996 two-for-one stock splits.
</FN>
<PAGE> 28
FIRST TENNESSEE NATIONAL CORPORATION
ANNUAL FINANCIAL STATEMENTS AND REVIEW OF OPERATIONS
SELECTED FINANCIAL AND OPERATING DATA
<TABLE>
<CAPTION>
(Dollars in millions except per share data) 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
SUMMARY INCOME STATEMENTS
Interest income $ 701.1 $ 652.2 $ 644.3
Less interest expense 306.6 276.1 298.7
- ---------------------------------------------------------------------------------------------------------
Net interest income 394.5 376.1 345.6
Provision for loan losses 17.2 36.5 45.2
- ---------------------------------------------------------------------------------------------------------
Net interest income after provision 377.3 339.6 300.4
Noninterest income 456.2 388.1 253.8
- ---------------------------------------------------------------------------------------------------------
Adjusted gross income after provision 833.5 727.7 554.2
Noninterest expense 625.7 552.6 404.6
- ---------------------------------------------------------------------------------------------------------
Income before income taxes 207.8 175.1 149.6
Applicable income taxes 60.7 65.4 56.9
- ---------------------------------------------------------------------------------------------------------
Net income $ 147.1 $ 109.7 $ 92.7
=========================================================================================================
COMMON STOCK DATA
Earnings per share $ 1.07 $ .81 $ .72
Diluted earnings per share 1.07 .80 .71
Cash dividends declared per share .435 .375 .315
Year-end book value per share 5.69 5.26 4.79
Closing price of common stock per share:
High 11 15/16 11 3/4 9 1/2
Low 9 5/16 9 6 9/16
Year-end 10 3/16 9 5/8 9 3/16
Dividends per share/closing price 3.6-4.6% 3.2-4.2% 3.3-4.8%
Dividends/earnings 38.0 39.7 40.5
Closing price/diluted earnings per share 9.5x 12.0x 12.9x
Market capitalization $ 1,388.5 $ 1,319.8 $ 1,241.6
Average shares outstanding (thousands) 136,884 136,292 128,708
Period-end shares outstanding (thousands) 136,296 137,120 135,144
Volume of shares traded (thousands) 93,384 101,944 85,576
- ---------------------------------------------------------------------------------------------------------
SELECTED AVERAGE BALANCES
Total assets $10,579.8 $ 9,982.4 $ 8,911.5
Total loans* 5,984.4 4,996.4 4,698.4
Investment securities 2,248.7 3,015.3 2,803.9
Earning assets 9,406.2 8,953.6 8,112.9
Deposits 7,714.4 7,186.0 7,030.2
Term borrowings 101.8 102.8 132.8
Shareholders' equity 759.5 684.1 622.5
- ---------------------------------------------------------------------------------------------------------
SELECTED PERIOD-END BALANCES
Total assets $10,932.9 $10,800.7 $ 9,749.4
Total loans* 6,498.0 5,560.3 4,788.5
Investment securities 2,170.9 2,364.3 3,214.0
Earning assets 9,610.1 9,511.8 8,806.4
Deposits 7,880.3 7,602.7 7,365.6
Term borrowings 113.8 92.0 133.8
Shareholders' equity 774.9 721.1 647.6
- ---------------------------------------------------------------------------------------------------------
SELECTED RATIOS
Return on average shareholders' equity 19.36% 16.04% 14.88%
Return on average assets 1.39 1.10 1.04
Net interest margin 4.25 4.27 4.36
Allowance for loan losses to loans* 1.69 1.99 2.16
Net charge-offs to average loans* .30 .60 .84
Average total capital to average assets** 7.18 6.85 6.99
Average shareholders' equity to average
assets 7.18 6.85 6.99
Average tangible equity to average
tangible assets 6.38 6.28 6.38
Average shareholders' equity to average
net loans 12.94 14.00 13.55
- ---------------------------------------------------------------------------------------------------------
RETURN TO SHAREHOLDERS
Stock appreciation 5.8% 4.8% 33.0%
Dividend yield 4.5 4.1 4.6
Annual return 10.3 8.9 37.6
- ---------------------------------------------------------------------------------------------------------
</TABLE>
[FN]
* Net of unearned income.
** Total capital includes shareholders' equity and guaranteed preferred
beneficial interests in First Tennessee's junior subordinated debentures.
See accompanying notes to consolidated financial statements. Common stock data
reflects the 1998 and 1996 two-for-one stock splits.
</FN>
A-3
<PAGE> 29
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
First Tennessee National Corporation (First Tennessee) is headquartered in
Memphis, Tennessee, and is a nationwide, diversified financial services
institution which provides banking and other financial services to its customers
through various regional and national business lines. The Regional Banking Group
includes the retail/commercial bank, the credit card division and the trust
division. The National Lines of Business include FT Mortgage Companies and
affiliates (also referred to as mortgage banking), First Tennessee Capital
Markets (also referred to as capital markets), formerly known as the bond
division, and transaction processing (credit card merchant processing, automated
teller machine network and check clearing operations).
Certain revenues and expenses are allocated and equity is assigned to the
various business lines to reflect the inherent risk in each business line, based
on management's best estimates. These allocations are periodically reviewed and
may be revised from time to time to more accurately reflect current business
conditions and risks. In addition, certain reclassifications of accounts may
occur to reflect current reporting standards within the industry. In each case,
the previous history is restated to ensure comparability.
For purposes of this discussion, noninterest income (also called fee income) and
total revenues exclude securities gains and losses. Net interest income has been
adjusted to a fully taxable equivalent (FTE) basis for certain tax-exempt loans
and investments included in earning assets. Earning assets, including loans,
have been expressed as averages, net of unearned income.
Forward-looking statements (as defined in the Private Securities Litigation
Reform Act of 1995) are contained in certain sections that follow such as
Interest Rate Risk Management. These forward-looking statements may involve
significant risks and uncertainties. Although management believes that the
expectations reflected in such forward-looking statements are reasonable, actual
results may differ materially from the results discussed in these
forward-looking statements.
The following financial discussion should be read with the accompanying
consolidated financial statements and notes. A glossary is included at the end
of this section to assist with terminology.
FINANCIAL HIGHLIGHTS OF 1997
A detailed discussion follows these highlights.
* Earnings for 1997 reflect the seventh consecutive year of RECORD EARNINGS
for First Tennessee.
* Net income for the year INCREASED 10 PERCENT to $197.5 million from $179.9
million earned in 1996.
* Earnings per share (adjusted for the 1998 two-for-one stock split) were
$1.54 in 1997, UP 15 PERCENT over the $1.34 earned in 1996. Diluted
earnings per share were $1.50 in 1997 and $1.32 in 1996, an increase of 14
percent. The difference between the net income growth and the earnings per
share growth reflects the positive effect of share repurchase programs on
the computation of earnings per share.
* Returns remained at levels comparable to other high performing financial
services institutions as RETURN ON AVERAGE SHAREHOLDERS' EQUITY grew from
20.0 percent to 22.5 percent and RETURN ON AVERAGE ASSETS grew from 1.43
percent to 1.49 percent.
* Total revenues for 1997 GREW 12 PERCENT with growth in fee income of 17
percent and growth in net interest income of 7 percent. Mortgage banking
led the increase in fee income with growth of 20 percent. The net interest
margin improved 10 basis points to 4.23 percent.
* ASSET QUALITY REMAINED STRONG during 1997. Mortgage banking added a net
$25.1 million to nonperforming assets as a result of a repurchase program;
however, within the regional banking group, the ratio of nonperforming
assets to total loans improved from .20 percent to .17 percent at December
31, 1997.
A-4
<PAGE> 30
* In January 1998, a TWO-FOR-ONE STOCK SPLIT was approved which was payable
February 20, 1998. All financial information has been restated to reflect
the split.
* At December 31, 1997, First Tennessee was RANKED IN THE TOP 50 bank holding
companies nationally in market capitalization ($4.3 billion) and assets
($14.4 billion).
INCOME STATEMENT ANALYSIS - 1997 COMPARED TO 1996
NONINTEREST INCOME
- ------------------
Noninterest income, also called fee income, provides the majority of First
Tennessee's revenue. During 1997, fee income increased 17 percent, from $573.9
million to $668.8 million, and contributed 56 percent to total revenue in 1996
and 58 percent to total revenue in 1997. This high contribution level ranks
First Tennessee sixth among the largest 50 bank holding companies in the nation
for this ratio. Table 1 - Analysis of Noninterest Income provides six years of
detail by category with growth rates.
TABLE 1 - ANALYSIS OF NONINTEREST INCOME
<TABLE>
<CAPTION>
(Dollars in Thousands) 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
NONINTEREST INCOME:
Mortgage banking $ 330,131 $ 275,406 $ 213,563 $ 188,270
Capital markets 98,310 85,871 82,814 77,478
Deposit transactions and
cash management 86,047 78,228 74,124 65,797
Trust services and investment
management 40,941 34,704 34,435 27,895
Merchant processing 32,111 24,185 19,164 14,699
Cardholder 19,833 17,155 14,885 15,572
Equity securities gains/(losses) (854) (2,495) 3,195 24,251
Debt securities gains/(losses) 141 (186) (751) (4,298)
All other income and commissions:
Check clearing fees 13,043 16,873 17,585 16,124
Other service charges 10,474 9,891 7,709 7,334
Other 37,953 31,517 25,888 23,044
- ---------------------------------------------------------------------------------------
Total other income 61,470 58,281 51,182 46,502
- ---------------------------------------------------------------------------------------
Total noninterest income $ 668,130 $ 571,149 $ 492,611 $ 456,166
=======================================================================================
<CAPTION>
Compound Annual
Growth Rates (%)
----------------
(Dollars in Thousands) 1993 1992 97/96 97/92
- -----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage banking $ 139,542 $ 33,560 19.9 + 58.0 +
Capital markets 91,525 80,275 14.5 + 4.1 +
Deposit transactions and
cash management 59,580 54,621 10.0 + 9.5 +
Trust services and investment
management 25,556 22,807 18.0 + 12.4 +
Merchant processing 12,021 10,755 32.8 + 24.5 +
Cardholder 15,769 15,579 15.6 + 4.9 +
Equity securities gains/(losses) (479) 342 65.8 + N/A
Debt securities gains/(losses) 1,371 (1,535) N/A N/A
All other income and commissions:
Check clearing fees 14,569 12,956 22.7 - .1 +
Other service charges 9,296 6,942 5.9 + 8.6 +
Other 19,352 17,547 20.4 + 16.7 +
- --------------------------------------------------------------
Total other income 43,217 37,445 5.5 + 10.4 +
- --------------------------------------------------------------
Total noninterest income $ 388,102 $ 253,849 17.0 + 21.4 +
==============================================================
</TABLE>
[FN]
Certain previously reported amounts have been reclassified to agree with
current presentation.
</FN>
MORTGAGE BANKING
FT Mortgage Companies, an affiliate of First Tennessee Bank National Association
(FTBNA), originates and services residential mortgage loans. After origination,
mortgage loans are typically sold to investors, primarily in the secondary
market, while the rights to service such loans are usually retained. Various
hedging strategies are used to mitigate changes in the market value of the loan
associated with the time period between when a mortgage loan is priced to the
customer and when it is sold to an investor. Any gains or losses from these
hedging activities are reported as secondary marketing gains or losses
(secondary marketing activities). Fees related to secondary marketing activities
also include any pricing concessions that may be offered, as well as mortgage
servicing rights, when the value of future revenue from servicing the mortgage
is recorded. Servicing rights permit the collection of fees for gathering and
processing monthly mortgage payments for the owner or servicer of the mortgage
loans.
A-5
<PAGE> 31
First Tennessee employs hedging strategies to mitigate the prepayment
risk to these servicing revenue streams. Generally, any gains or losses from the
sale of mortgage servicing hedges are reported in miscellaneous income.
As shown in Table 2 - Mortgage Banking, total mortgage banking fee income
increased 20 percent in 1997, due primarily to 21 percent growth in the
servicing portfolio and enhanced profitability in the loan origination process
(origination fees and secondary marketing activities).
TABLE 2 - MORTGAGE BANKING
<TABLE>
<CAPTION>
Compound Annual
Growth Rates (%)
-------------------
(Dollars and volume in millions) 1997 1996 1995 97/96 97/95
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NONINTEREST INCOME:
Loan origination fees $ 83.5 $ 85.6 $ 59.6 2.5 - 18.4 +
Secondary marketing activities 122.0 98.7 62.8 23.6 + 39.4 +
Servicing fees 94.4 69.2 54.8 36.4 + 31.2 +
Sale of mortgage servicing rights 15.9 20.8 35.4 23.6 - 33.0 -
Miscellaneous 14.3 1.1 1.0 1,200.0 + 278.2 +
- ------------------------------------------------------------------
Total noninterest income $ 330.1 $ 275.4 $ 213.6 19.9 + 24.3 +
==================================================================
Mortgage loan originations $10,624 $10,396 $ 7,219 2.2 + 21.3 +
Servicing portfolio 26,929 22,288 16,663 20.8 + 27.1 +
- ------------------------------------------------------------------
</TABLE>
Income derived from the loan origination process (loan origination fees plus
secondary marketing activities) increased 12 percent in 1997, from $184.3
million to $205.5 million, as FT Mortgage Companies originated a record $10.6
billion of mortgage loans in 1997. This level of originations ranked FT Mortgage
Companies as one of the top retail mortgage originators in the nation. In 1996,
$10.4 billion of mortgage loans were originated. Refinance activity accounted
for approximately 29 percent of total loan originations in 1997, compared with
30 percent in 1996. During 1996, originations were strong due to declining
long-term interest rates (30 year mortgages) throughout much of the year. During
the first few months of 1997, long-term interest rates increased which adversely
affected loan originations. However, during the second half of 1997, long-term
interest rates began to decline again, resulting in record origination volume
during both the third and fourth quarters. The loan origination volume for 1997
was impacted by the use of more stringent loan quality standards and smaller
pricing concessions. As a result, loan origination fees declined while fees
related to secondary marketing activities increased.
Mortgage servicing fee income increased 36 percent in 1997, from $69.2 million
to $94.4 million. The mortgage servicing portfolio totaled $26.9 billion at
December 31, 1997, as compared with $22.3 billion at December 31, 1996. The
change in the portfolio during 1997 was created from originations of $10.6
billion, reductions from sales of servicing of $1.4 billion and principal
reductions of $4.6 billion from payments received in the normal course of
business. Revenues from the sale of mortgage servicing rights declined 23
percent in 1997, from $20.8 million to $15.9 million, as a result of less
servicing rights sold.
The growth in miscellaneous income came from gains of $6.0 million on the sales
of certain mortgage servicing hedges that were replaced with lower cost hedging
instruments and fees of $3.9 million related to a new program where First
Tennessee buys delinquent loans to reduce future foreclosure losses.
CAPITAL MARKETS
First Tennessee Capital Markets generates fee income primarily from the purchase
and sale of securities as both principal and agent. Inventory positions are
limited to the procurement of securities solely for distribution to customers by
the sales staff. Inventory is hedged to protect against movements in interest
rates.
During 1997, noninterest income increased 14 percent from $85.9 million in 1996
to $98.3 million. Total securities bought and sold by the capital markets
division increased 4 percent in 1997, from $217.8 billion to $226.6 billion.
Total underwritings during 1997 were $29.0 billion compared with $30.0 billion
in 1996. For 1997, First Tennessee Capital Markets ranked first in underwriting
U.S. government agency debt with maturities longer than one year.
A-6
<PAGE> 32
The increase in fee income during 1997 came from market expansion with the
opening of a new office and other customer base expansion initiatives. In
addition, a slowdown in national loan growth and the expectation that long-term
rates would continue to drop resulted in an increased demand for longer maturity
securities during the second half of the year, setting new record levels of fee
income within the capital markets division. First Tennessee Capital Assets
Corporation, a subsidiary that deals primarily in whole loan transactions, also
had increased activity during the year which contributed to overall fee growth.
DEPOSIT TRANSACTIONS AND CASH MANAGEMENT
Deposit transaction fees are received for services related to retail deposit
products (such as service charges on checking accounts) and cash management fees
are generated by products and services such as electronic transaction processing
(automated clearing house (ACH) and Electronic Data Interchange (EDI)), account
reconciliation services, cash vault services, lockbox processing and information
reporting (Prime Connection).
Noninterest income from deposit transactions and cash management increased 10
percent in 1997, from $78.2 million to $86.1 million. The increase in 1997 was a
result of higher transaction volume in ACH processing, wholesale and express
lockbox processing; new product sales; and pricing changes.
TRUST SERVICES AND INVESTMENT MANAGEMENT
Trust services includes fees from the asset management product lines of
investment management accounts, personal trusts and employee benefits; and also
from custodian and corporate trust services products. During 1997, noninterest
income from trust services grew 18 percent, from $34.7 million to $40.9 million.
The growth was led by the asset management business lines with increasing fees
in investment management of 28 percent, employee benefits of 18 percent and
personal trust of 15 percent. Noninterest income from corporate trust services,
an indenture trustee business that acts as trustee on public bond issues,
increased 5 percent.
Highland Capital Management Corp. (Highland), a wholly owned subsidiary,
provides investment advisory services to the managed assets segments, and those
segments grew 16 percent during 1997, reaching $6.7 billion on December 31,
1997, compared with $5.8 billion on December 31, 1996. Highland also provides
investment advice to First Funds Growth and Income and Bond Portfolios, two
portfolios of First Funds, a family of mutual funds managed by FTBNA. The Growth
and Income Fund was reported in a January 8, 1998, article in the Wall Street
Journal as one of the top 15 performers (out of 613) for growth and income
mutual funds for the 52-week period ending December 31, 1997.
MERCHANT PROCESSING
Credit card merchant processing involves converting plastic media payments such
as check cards, debit cards, credit cards, purchase cards, and private label
credit card transactions into cash for merchants selling goods and services to
consumers and businesses.
Fee income from merchant processing grew 33 percent in 1997, from $24.2 million
to $32.1 million. Merchant transaction volume grew 14 percent, from 110 million
transactions processed in 1996 to a record 125 million transactions processed in
1997. The growth in transaction volume came as a result of the economic growth
in the industries which First Tennessee serves as well as continued expansion
into the hospitality sector. Fee income also improved as the customer mix
changed.
A-7
<PAGE> 33
CARDHOLDER
Cardholder fees result from issuing and servicing credit cards and include the
collection of late charges and annual fees, as well as interchange fees received
from merchants for accepting a credit card payment.
Cardholder noninterest income increased 16 percent in 1997, from $17.2 million
to $19.8 million. The credit card portfolio remained relatively flat during the
year with growth of only 3 percent. The growth in fee income was driven
primarily by pricing changes consistent with overall repricing trends in the
industry.
SECURITIES GAINS/(LOSSES)
In 1997, there were $.8 million of equity securities losses compared with $2.5
million of equity securities losses for 1996 which included an equity securities
loss of $3.0 million in the venture capital company's investment portfolio. In
addition, there were $.1 million of debt securities gains in 1997 compared with
$.2 million of debt securities losses in 1996.
ALL OTHER NONINTEREST INCOME
All Other Noninterest income grew 5 percent in 1997, from $58.3 million to $61.5
million. Check clearing fees declined 23 percent, from $16.9 million to $13.0
million, reflecting the loss of two major customers and the continuing impact of
bank consolidations. Other service charges are generated from banking services
performed, but are not directly related to deposit transactions, such as fees
for money orders, travelers' checks, savings bonds, safe deposit box rentals,
mutual fund services and safekeeping. During 1997, these fees grew 6 percent,
from $9.9 million to $10.5 million, with the increase being spread over several
of these categories. The Other category increased 20 percent, from $31.5 million
to $38.0 million. Growth in annuity sales of over 100 percent was the primary
contributor to this growth. The remaining increase was spread over several
categories which included letter of credit fees, automated teller machine access
fees, the sale of fixed assets, and insurance premiums and commissions.
A-8
<PAGE> 34
NET INTEREST INCOME
- -------------------
During 1997, net interest income increased 7 percent, from $456.6 million to
$487.4 million, with earning assets increasing 4 percent, from $11.1 billion to
$11.5 billion, primarily due to growth in commercial and consumer loans. Total
interest-bearing liabilities grew 4 percent, from $9.2 billion to $9.6 billion,
for the year. Table 3 - Net Interest Income and Earning Assets provides detail
for the past three years.
TABLE 3 - NET INTEREST INCOME AND EARNING ASSETS
<TABLE>
<CAPTION>
(Dollars in millions) 1997 1996 1995
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Investment securities $ 2,139.4 $ 2,203.2 $ 2,161.0
Loans 7,945.1 7,472.1 6,887.2
Mortgage loans held for sale 1,005.9 1,059.4 706.1
Other earning assets 421.7 327.3 340.4
- -----------------------------------------------------------------------------------------------------
Total earning assets $11,512.1 $11,062.0 $10,094.7
- -----------------------------------------------------------------------------------------------------
Net interest income - FTE $ 487.4 $ 456.6 $ 395.7
Yields on earning assets 8.21% 8.15% 8.20%
Rates paid on interest-bearing liabilities excluding swap 4.76 4.75 4.95
- -----------------------------------------------------------------------------------------------------
Net interest spread excluding basis swap 3.45 3.40 3.25
- -----------------------------------------------------------------------------------------------------
Effect of interest-free sources .78 .80 .89
Basis swap impact - (.07) (.22)
- -----------------------------------------------------------------------------------------------------
Net interest margin 4.23% 4.13% 3.92%
=====================================================================================================
</TABLE>
The overall net interest margin (margin) improved 10 basis points in 1997. Seven
basis points of this annual improvement came from the expiration in May 1996 of
amortization expense related to a basis swap entered into in May 1993. Excluding
the basis swap, the net interest spread (the difference between the yield on
earning assets and the rates paid on interest-bearing liabilities) increased 5
basis points. Yields on earning assets (consumer and commercial loans) improved
because of higher interest rates, while interest-bearing liability costs
increased slightly. The small increase in rates paid on interest-bearing
liabilities reflected higher costs for wholesale and purchased funds, partially
offset by an overall improvement in deposit costs as many customers shifted from
higher cost certificates of deposit to lower cost money market accounts.
The margin is affected by the activity levels and related funding for First
Tennessee's specialty lines of business, as these nonbank business lines
typically produce different margins than traditional banking activities. For
example, in mortgage banking the negative impact occurs because the spread
between the rates on mortgage loans temporarily in the warehouse and the related
short-term funding rates is less than the comparable spread earned in the
regional banking group. Consequently, as the warehouse volume increases, so does
the negative effect on net interest margin. The increase in nonperforming loans
in mortgage banking during the first quarter of 1997 also negatively affected
the margin (See Asset Quality). Capital markets tends to negatively impact the
net interest margin because of its strategy to reduce market risk by hedging its
inventory in the cash markets which significantly reduces net interest income on
these positions. As a result, First Tennessee's consolidated margin cannot be
readily compared to that of other bank holding companies. Table 4 - Net Interest
Margin Composition provides a breakdown of margin by business line for the past
three years.
TABLE 4 - NET INTEREST MARGIN COMPOSITION
<TABLE>
<CAPTION>
1997 1996 1995
- --------------------------------------------------------------
<S> <C> <C> <C>
Regional banking group 4.71% 4.41% 4.12%
Capital markets (.12) (.09) (.11)
Mortgage banking (.37) (.22) (.14)
Transaction processing .01 .03 .05
- --------------------------------------------------------------
Total net interest margin 4.23% 4.13% 3.92%
==============================================================
</TABLE>
A-9
<PAGE> 35
The regional banking group's margin improved from 4.41 percent in 1996 to 4.71
percent in 1997, due to positive changes in the mix of deposit liabilities,
improvements in loan yields, and the termination of the basis swap. During 1997,
through targeted marketing efforts, the maturities of deposit liabilities
shortened and shifted from higher cost certificates of deposit to lower cost
money market deposit products.
Interest rate sensitivity is primarily a function of the repricing structure of
First Tennessee's balance sheet (Statement of Condition). Table 5 - Rate
Sensitivity Analysis at December 31, 1997, shows the assets and liabilities as
of year-end, subject to repricing in specified time intervals with each maturity
interval referring to the earliest repricing opportunity (i.e., the earlier of
scheduled contractual maturity or repricing date) for each asset and liability
category. The resulting gap is one measure of the sensitivity of earnings to
changes in interest rates.
In order to more appropriately reflect the repricing structure of First
Tennessee's balance sheet, management has made certain adjustments to the
balances shown in the table. Based on historical and industry data, an estimate
of the expected prepayments on consumer loans and investment securities is
reflected in the balances in the table. Changes in the economic and interest
rate environments may also affect these expected prepayments.
Similarly, an adjustment to deposits is made to reflect the behavioral
characteristics of certain core deposits that do not have specified contractual
maturities (i.e., interest checking, savings and money market deposit accounts).
Historically, balances on these deposit accounts have remained relatively stable
despite changes in market interest rates. Management has classified certain of
these accounts as non-interest sensitive based on management's historical
pricing practices and runoff experience. Approximately 85 percent of interest
checking and 99 percent of savings balances were classified as over one year at
December 31, 1997. At December 31, 1997, the balance sheet was asset sensitive
to interest rate movements and within guideline limits, with $605 million more
assets than liabilities scheduled to reprice within one year (5 percent of
earning assets). This point-in-time measurement indicates that over the course
of a year a downward movement in rates may negatively impact the margin since
assets will reprice faster than liabilities, while upward rate movements may
favorably impact margin. It should be noted that the gap analysis neither takes
into account future management actions that could be undertaken to alter the
simulated results, nor does it contemplate a change in the slope of the yield
curve. (For additional information see Risk Management-Interest Rate Risk
Management.)
Based on First Tennessee's simulation models, earnings at risk during 1997 from
a staggered increase in interest rates of 300 basis points averaged less than 3
percent of projected net interest income. At December 31, 1997, earnings
exposure to a 300 basis point change in interest rates over the next 12 months
was estimated to be less than 3 percent of projected 1998 net interest income. A
300 basis point staggered increase or decrease in interest rates is a
hypothetical rate scenario, used to estimate risk, and does not necessarily
represent management's current view of future interest rates or market
developments.
With First Tennessee's existing balance sheet mix and the current interest rate
environment, the regional banking group's margin is expected to be relatively
stable. Going forward, the consolidated margin will continue to be influenced by
the activity levels in the nonbanking lines of business, especially from
mortgage banking as this business line experiences fluctuations in origination
volume strongly tied to refinance activity.
Table 6 - Analysis of Changes in Net Interest Income provides rate and volume
changes in interest income and interest expense for earning assets and
interest-bearing liabilities for the past three years.
A-10
<PAGE> 36
TABLE 5 - RATE SENSITIVITY ANALYSIS AT DECEMBER 31, 1997
<TABLE>
<CAPTION>
Interest Sensitivity Period
----------------------------------------------------------------------------------------
Within 3 After 3 Months After 6 Months After 1 Year After
(Dollars in millions) Months Within 6 Months Within 12 Months Within 5 Years 5 Years Total
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
EARNING ASSETS:
Loans $4,271 $ 395 $ 896 $2,166 $583 $ 8,311
Investment securities 231 160 394 1,257 145 2,187
Mortgage loans held for sale 1,241 - - - - 1,241
Federal funds sold and securities
purchased under agreements to resell 226 - - - - 226
Other earning assets 255 - - - - 255
- ----------------------------------------------------------------------------------------------------------------------------------
Total earning assets $6,224 $ 555 $1,290 $3,423 $728 $12,220
==================================================================================================================================
EARNING ASSET FUNDING:
Savings $ 3 $ - $ - $219 $127 $ 349
Checking interest 190 - - 744 316 1,250
Money market 2,106 - - - - 2,106
CD's under $100,000 and other time 504 616 651 897 28 2,696
CD's $100,000 and more 374 117 113 120 11 735
Short-term borrowed funds 2,578 210 - - - 2,788
Term borrowings 2 - - 91 76 169
- ----------------------------------------------------------------------------------------------------------------------------------
Total earning asset funding $5,757 $ 943 $ 764 $2,071 $558 $10,093
==================================================================================================================================
RATE SENSITIVITY GAP:
Period $ 467 $(388) $ 526 $1,352 $ 170
Cumulative 467 79 605 1,957 2,127
- ---------------------------------------------------------------------------------------------------------------------
RATE SENSITIVITY GAP ADJUSTED FOR INTEREST
RATE FUTURES AND INTEREST RATE SWAPS:
Period $ 257 $(178) $ 526 $1,352 $ 170
Cumulative 257 79 605 1,957 2,127
- ---------------------------------------------------------------------------------------------------------------------
ADJUSTED GAP AS A PERCENTAGE OF TOTAL
EARNING ASSETS:
Period 2.1% (1.5)% 4.3% 11.1% 1.4%
Cumulative 2.1 .6 4.9 16.0 17.4
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
[FN]
Interest-sensitive categories represent ranges in which assets and liabilities
can be repriced, not necessarily their actual maturities. The 'After 5 Years'
column includes assets and liabilities with interest sensitivity of more than
5 years or with indefinite repricing schedules. Noninterest earning/bearing
balances have been excluded from this analysis.
</FN>
A-11
<PAGE> 37
TABLE 6 - ANALYSIS OF CHANGES IN NET INTEREST INCOME
<TABLE>
<CAPTION>
1997 Compared to 1996 1996 Compared to 1995
(Fully taxable equivalent) Increase/(Decrease) Due to* Increase/(Decrease) Due to*
--------------------------------------------------------------------
(Dollars in thousands) Rate** Volume** Total Rate** Volume** Total
- ------------------------------------------------------------------------------------------ --------------------------------
<S> <C> <C> <C> <C> <C> <C>
INTEREST INCOME - FTE:
Loans:
Commercial $ 2,349 $ 19,268 $ 21,617 $ (7,084) $ 20,005 $ 12,921
Consumer 5,596 13,203 18,799 2,238 21,688 23,926
Permanent mortgage 1,128 (1,792) (664) (553) 148 (405)
Credit card receivables (1,359) 1,712 353 (4,580) 6,639 2,059
Real estate construction (29) 6,021 5,992 (1,946) 5,930 3,984
Nonaccrual (1,775) 1,118 (657) 182 (60) 122
- ------------------------------------------------------- -------- --------
Total loans 5,307 40,133 45,440 (10,280) 52,887 42,607
- ------------------------------------------------------- -------- --------
Investment securities:
U.S. Treasury and other U.S. government agencies 2,940 (4,639) (1,699) 3,284 1,835 5,119
States and municipalities 66 (1,180) (1,114) (542) 1,387 845
Other 120 1,218 1,338 (27) (84) (111)
- ------------------------------------------------------- -------- --------
Total investment securities 2,950 (4,425) (1,475) 2,935 2,918 5,853
- ------------------------------------------------------- -------- --------
Other earning assets:
Mortgage loans held for sale (925) (4,281) (5,206) (171) 27,516 27,345
Investment in bank time deposits 3 (244) (241) (27) 581 554
Federal funds sold and securities
purchased under agreements to resell 77 6,047 6,124 (206) (3,337) (3,543)
Capital markets inventory 16 (949) (933) (1,097) 2,660 1,563
- ------------------------------------------------------- -------- --------
Total other earning assets (3,079) 2,823 (256) 617 25,302 25,919
- ------------------------------------------------------- -------- --------
Total earning assets 8,778 34,931 43,709 (6,631) 81,010 74,379
- ------------------------------------------------------------------------------------------ ------------------------------
Total interest income - FTE $ 43,709 $ 74,379
- ------------------------------------------------------------------------------------------ ------------------------------
INTEREST EXPENSE:
Interest-bearing deposits:
Savings $ (193) $ (1,066) $ (1,259) $ (559) $ (783) $ (1,342)
Checking interest and money market (5,502) 7,977 2,475 (15,908) 12,732 (3,176)
Certificates of deposit under $100,000 and other time (595) (5,417) (6,012) (2,160) 844 (1,316)
Certificates of deposit $100,000 and more 1,078 369 1,447 (1,245) 16,949 15,704
- ------------------------------------------------------- -------- --------
Total interest-bearing deposits (8,423) 5,074 (3,349) (19,774) 29,644 9,870
Federal funds purchased and securities
sold under agreements to repurchase 1,879 9,914 11,793 (8,130) 5,165 (2,965)
Commercial paper and other short-term borrowings 642 8,737 9,379 (3,683) 7,380 3,697
Term borrowings 933 (5,868) (4,935) (884) 3,716 2,832
- ------------------------------------------------------- -------- --------
Total interest-bearing liabilities (5,078) 17,966 12,888 (30,811) 44,245 13,434
- ------------------------------------------------------------------------------------------ --------------------------------
Total interest expense $ 12,888 $ 13,434
- ------------------------------------------------------------------------------------------ --------------------------------
Net interest income - FTE $ 30,821 $ 60,945
==============================================================================================================================
</TABLE>
[FN]
* The changes in interest due to both rate and volume have been allocated
to change due to rate and change due to volume in proportion to the
absolute amounts of the changes in each.
** Variances are computed on a line-by-line basis and are non-additive.
</FN>
A-12
<PAGE> 38
PROVISION FOR LOAN LOSSES
- -------------------------
The provision for loan losses is the charge to operating earnings that
management determines to be necessary to maintain the allowance for loan losses
at an adequate level reflecting management's estimate of the risk of loss
inherent in the loan portfolio. The provision for loan losses was $51.1 million
in 1997 compared with $35.7 million in 1996. The increase in provision primarily
relates to a higher estimate of inherent losses in the credit card portfolio
reflecting the national trend in credit card asset quality; commercial loans
associated with a more normal credit cycle; and mortgages repurchased during
1997. A more detailed discussion follows in the Risk Management-Credit Risk
Management/Asset Quality section.
NONINTEREST EXPENSE
- -------------------
Noninterest expense, also called operating expense, increased 11 percent in
1997, from $704.5 million to $785.0 million, primarily because of growth in
mortgage banking. Table 7 - Analysis of Noninterest Expense provides detail by
category for the past six years with growth rates. Table 8 - Operating Expense
Composition gives a breakdown of total expenses by business line for the prior
three years.
TABLE 7 - ANALYSIS OF NONINTEREST EXPENSE
<TABLE>
<CAPTION>
Compound Annual
Growth Rates (%)
----------------
(Dollars in thousands) 1997 1996 1995 1994 1993 1992 97/96 97/92
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
NONINTEREST EXPENSE:
Employee compensation,
incentives, and benefits $ 409,783 $ 385,380 $ 340,508 $ 349,769 $ 308,601 $ 214,303 6.3 + 13.8 +
Operations services 49,879 44,109 38,798 33,679 28,705 24,252 13.1 + 15.5 +
Occupancy 42,848 39,815 37,867 34,102 27,673 24,738 7.6 + 11.6 +
Equipment rentals, depreciation,
and maintenance 40,093 34,121 31,845 29,202 22,246 17,516 17.5 + 18.0 +
Amortization of mortgage
servicing rights 37,452 26,041 14,980 14,936 25,478 4,482 43.8 + 52.9 +
Communications and courier 34,899 32,981 29,880 30,653 24,775 18,049 5.8 + 14.1 +
Advertising and public relations 18,722 17,629 12,972 10,678 7,987 6,165 6.2 + 24.9 +
Amortization of intangible assets 9,631 9,491 8,100 6,406 5,871 9,866 1.5 + .5 -
All other expense:
Contract employment 17,420 11,288 5,744 5,323 5,631 1,893 54.3 + 55.9 +
Supplies 15,267 14,383 11,866 11,472 10,312 6,520 6.1 + 18.5 +
Legal and professional fees 13,999 12,050 13,403 13,747 11,274 11,391 16.2 + 4.2 +
Travel and entertainment 13,802 10,394 8,211 10,144 8,868 5,774 32.8 + 19.0 +
Foreclosed real estate 10,827 7,533 4,962 3,862 1,542 4,935 43.7 + 17.0 +
Distribution on guaranteed
preferred securities 8,070 - - - - - N/A N/A
Fed service fees 5,799 7,814 9,489 8,544 7,778 7,228 25.8 - 4.3 -
Deposit insurance premium 1,485 5,129 9,957 16,923 16,585 16,177 71.0 - 38.0 -
Contribution to charitable
foundation - - - 9,379 - - N/A N/A
Other 55,068 46,328 31,133 36,864 39,233 31,350 18.9 + 11.9 +
- ---------------------------------------------------------------------------------------------------------
Total other expense 141,737 114,919 94,765 116,258 101,223 85,268 23.3 + 10.7 +
- ---------------------------------------------------------------------------------------------------------
Total noninterest expense $ 785,044 $ 704,486 $ 609,715 $ 625,683 $ 552,559 $ 404,639 11.4 + 14.2 +
=========================================================================================================
</TABLE>
[FN]
Certain previously reported amounts have been reclassified to agree with current
presentation.
</FN>
A-13
<PAGE> 39
TABLE 8 - OPERATING EXPENSE COMPOSITION
<TABLE>
<CAPTION>
(Dollars in millions) 1997 1996 1995
- ----------------------------------------------------------------------------
<S> <C> <C> <C>
Regional banking group $354.1 $322.9 $293.3
Mortgage banking 290.9 256.0 195.6
Capital markets 74.2 66.7 61.6
Transaction processing 57.7 55.1 52.6
Corporate 8.1 3.8 6.6
- ----------------------------------------------------------------------------
Total operating expense $785.0 $704.5 $609.7
============================================================================
</TABLE>
Operating expense in the mortgage banking division increased 14 percent, from
$256.0 million to $290.9 million, and accounted for 43 percent of the overall
expense growth. Mortgage banking expense growth was driven by a larger servicing
portfolio, increased mortgage origination production costs and additional
expenses incurred to correct loan document deficiencies. Excluding mortgage
banking, overall operating expenses increased 10 percent during 1997.
During 1996, First Tennessee was assessed $3.8 million (pre-tax) as a one-time
fee for capitalizing the Savings Association Insurance Fund (SAIF). Excluding
this one-time assessment, the total operating expense growth in 1997 would have
been 12 percent.
Employee compensation, incentives, and benefits (personnel expense), the largest
component of noninterest expense, increased 6 percent in 1997, from $385.4
million to $409.8 million. Personnel expense includes commissions paid in
several lines of business, such as capital markets and mortgage banking. As the
revenues increase or decrease and/or as the product mix changes in these
business lines, the amount of commissions changes accordingly. Personnel expense
increased 2 percent in mortgage banking and 12 percent in capital markets during
1997.
Amortization of capitalized mortgage servicing rights increased 44 percent, from
$26.0 million to $37.4 million. This increase came as a result of a larger
capitalized servicing portfolio and the implementation of a new accounting
standard (Statement of Financial Accounting Standards (SFAS) No. 125,
"Accounting for the Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities") which led to reclassification of certain
amortization-related accounts.
All Other expense consists of many smaller expense categories such as contract
employment, supplies, travel and entertainment, Fed service fees, foreclosed
real estate expenses, deposit insurance premiums, contributions, and others.
During 1997, All Other expense increased 23 percent, from $115.0 million to
$141.8 million. The largest increase was expense associated with the qualifying
capital securities issued during the year ($8.1 million). Mortgage banking
accounted for approximately 89 percent of the remaining growth which included
contract employment, foreclosure credit losses and miscellaneous expenses.
Deposit insurance premium expense declined 71 percent and includes the one-time
SAIF assessment already discussed. The FDIC premium was set to zero at the
beginning of 1996 and currently only minimal administrative costs are being
assessed to banks. Most of the remaining growth was spread over several
categories.
A-14
<PAGE> 40
INCOME STATEMENT ANALYSIS - 1996 COMPARED TO 1995
Earnings in 1996 were $179.9 million, an increase of 9 percent from $164.9
million earned in 1995. 1996 reflected the sixth consecutive year of record
earnings. Earnings per share increased 11 percent from $1.21 in 1995 to $1.34 in
1996. Diluted earnings per share increased 10 percent from $1.20 in 1995 to
$1.32 in 1996. Return on average common equity was 20.1 percent in 1996 compared
with 20.0 percent in 1995. Return on average assets was 1.43 percent in 1996 and
1.45 percent in 1995.
Noninterest income increased 17 percent during 1996, from $490.2 million to
$573.9 million. Mortgage banking contributed 74 percent of the growth in fee
income between 1996 and 1995. During 1996, mortgage banking fees increased 29
percent, from $213.6 million to $275.4 million, from increased origination
volume and a larger servicing portfolio. During 1996, originations were $10.4
billion compared with $7.2 billion in 1995, and the servicing portfolio was
$22.3 billion at December 31, 1996, compared with $16.7 billion at December 31,
1995. Capital markets' fee income increased 4 percent in 1996, from $82.8
million to $85.9 million. The positive impact on fee income from expansion of
capital markets' nonbank customer base and resulting higher transaction volume
during the year was lessened due to reduced securities purchased by community
bank customers. During 1996, deposit transactions and cash management fees grew
6 percent, from $74.1 million to $78.2 million; merchant processing fees grew 26
percent, from $19.2 million to $24.2 million; and cardholder fees grew 15
percent, from $14.9 million to $17.2 million. Trust services and investment
management fees increased 15 percent, from $30.2 million to $34.7 million
excluding the impact of an accounting change which added $4.2 million to 1995
fees. With this accounting change, the income growth as reported was 1 percent.
All other noninterest income grew 14 percent in 1996, from $51.2 million to
$58.3 million. Approximately 20 percent of the increase came from the
implementation of a first-time ATM access fee to users who are not First
Tennessee customers.
In 1996, there were $2.5 million of equity securities losses and $.2 million of
debt securities losses compared with $3.2 million of equity securities gains and
$.8 million of debt securities losses in 1995.
During 1996, net interest income increased 15 percent, from $395.7 million to
$456.6 million. The net interest margin improved from 3.92 percent to 4.13
percent. The increase in the net interest margin reflected lower liability costs
and the steepening of the yield curve during 1996. Fifteen basis points of the
annual improvement came from the expiration in May 1996 of amortization expense
related to the basis swap.
The provision for loan losses increased 73 percent during 1996, from $20.6
million to $35.7 million. The level of provision was increased to reserve for
higher potential losses inherent in the loan portfolio.
During 1996, noninterest expense increased 16 percent, from $609.7 million to
$704.5 million, primarily because of growth in mortgage banking. Mortgage
banking accounted for 64 percent of the expense growth in 1996. Personnel
expense, the largest component, increased 13 percent, from $340.5 million in
1995 to $385.4 million in 1996. Amortization of mortgage servicing rights
increased 74 percent, from $15.0 million in 1995 to $26.0 million in 1996 as a
result of a larger capitalized servicing portfolio. Deposit insurance premiums
decreased 48 percent, from $10.0 million in 1995 to $5.1 million in 1996, as a
result of the reduction in the FDIC premium to zero at the beginning of 1996,
partially offset by the one-time SAIF assessment. All Other expense increased 21
percent, from $94.7 million in 1995 to $115.0 million in 1996, with the growth
in mortgage banking accounting for all of this increase.
A-15
<PAGE> 41
BALANCE SHEET REVIEW
At December 31, 1997, First Tennessee reported total assets of $14.4 billion
compared with $13.1 billion at the end of 1996 and $12.1 billion at the end of
1995. Average assets were $13.3 billion in 1997 compared with $12.6 billion in
1996 and $11.4 billion in 1995.
EARNING ASSETS
- --------------
Loans, investment securities and mortgage loans held for sale are the primary
earning assets. For 1997, earning assets averaged $11.5 billion compared with
$11.1 billion for 1996 and $10.1 billion for 1995. Average earning assets were
87 percent of total average assets in 1997, 88 percent in 1996 and 89 percent in
1995.
LOANS
Loans grew 6 percent, or $473.0 million, during 1997 and 8 percent, or $584.9
million, during 1996. Loans represented 69 percent of earning assets in 1997 and
68 percent of earning assets in both 1996 and 1995. Additional loan information
is provided in Table 9 - Contractual Maturities of Loans at December 31, 1997,
and Note 4 - Loans.
TABLE 9 - CONTRACTUAL MATURITIES OF LOANS AT DECEMBER 31, 1997
<TABLE>
<CAPTION>
After 1 Year
(Dollars in thousands) Within 1 Year Within 5 Years After 5 Years Total
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Commercial $2,307,366 $1,314,404 $ 146,784 $3,768,554
Consumer 73,601 1,469,049 1,312,590 2,855,240
Credit card receivables 581,451 - - 581,451
Real estate construction 295,750 95,262 13,184 404,196
Permanent mortgage 249,988 68,906 344,600 663,494
Nonaccrual 18,064 1,190 19,161 38,415
- ---------------------------------------------------------------------------------------------------------------------
Total loans, net of unearned income $3,526,220 $2,948,811 $ 1,836,319 $8,311,350
=====================================================================================================================
For maturities over one year:
Interest rates - floating $1,196,279 $ 331,746 $1,528,025
Interest rates - fixed 1,752,532 1,504,573 3,257,105
- ---------------------------------------------------------------------------------------------------------------------
Total $2,948,811 $ 1,836,319 $4,785,130
=====================================================================================================================
</TABLE>
Commercial loans continued as the single largest loan category and represented
approximately 46 percent of total loans between 1995 and 1997 (46 percent in
1997, 45 percent in 1996 and 46 percent in 1995). During 1997, commercial loans
grew 7 percent, or $241.3 million, compared with 7 percent growth, or $235.1
million, in 1996. The increase in commercial loans, influenced by strong
economic growth in Tennessee, came from expanded sales efforts intended to
increase lending to small businesses and middle market companies in Tennessee
and the Mid-South region.
The consumer loan portfolio consists of real estate, automobile, student and
other consumer installment loans that require periodic payments of principal and
interest. The consumer loan portfolio represented approximately 35 percent of
total loans between 1995 and 1997 (35 percent in both 1997 and 1996 and 34
percent in 1995). During 1997, consumer loans grew 6 percent, or $152.5 million,
compared with 10 percent growth, or $240.4 million in 1996. The growth came
primarily in real estate loans and was reduced by the decline in indirect auto
lending. First Tennessee significantly reduced its indirect auto loan portfolio
in 1997 because of insufficient loan spreads from this product. The real estate
loans are principally secured by first and/or second liens on residential
property. First Tennessee is active in originating second mortgages not only in
Tennessee through FTBNA, but also outside of this market primarily through Gulf
Pacific Mortgage, a division of FTBNA. Gulf Pacific Mortgage originated 17
percent more loans in 1997 than in 1996, with 90 percent of this growth in home
equity loans.
The permanent mortgage portfolio includes certain mortgage loans that First
Tennessee periodically decides to retain. The permanent mortgage portfolio
A-16
<PAGE> 42
represented approximately 9 percent of total loans between 1995 and 1997 (8
percent in 1997, 9 percent in 1996 and 10 percent in 1995). This portfolio of
loans declined 3 percent, or $21.6 million in 1997 as older loans paid down, and
it grew only $1.6 million in 1996.
From 1995 to 1997, credit card receivables (i.e., outstanding balances on credit
card accounts) represented approximately 7 percent of total loans. Credit card
receivables increased 3 percent, or $14.5 million, in 1997 and increased 10
percent, or $49.8 million, during 1996. The increased use of debt by consumers
led to this growth, while targeted promotional campaigns to regional banking
customers, cross-selling efforts to mortgage customers and selective pricing
programs helped retain customers during this intensely competitive period.
The real estate construction loan portfolio represented approximately 4 percent
of total loans from 1995 to 1997 (4 percent in both 1997 and 1996 and 3 percent
in 1995). During 1997, this portfolio grew 23 percent, or $62.3 million,
compared with 27 percent growth, or $58.7 million, in 1996. The increase is
reflective of economic growth in Tennessee, favorable market conditions, and
growth in residential construction loans primarily originated by mortgage
banking.
Going forward, with the anticipated slow growth in the national and regional
economies, First Tennessee expects moderate loan growth. In the consumer-related
loan portfolios, the opening of new finance company offices and targeted
promotional programs are expected to help sustain and generate growth. As loan
growth continues to outpace deposit growth, First Tennessee will continue to
evaluate alternative sources of funding which may include loan sales,
securitizations and syndications.
INVESTMENT SECURITIES
The investment portfolio of First Tennessee consists principally of debt
securities used as a source of income, liquidity and collateral for repurchase
agreements or public fund deposits. Additionally, the investment portfolio is
used as a tool to manage risk from movements in interest rates. Table 10 -
Contractual Maturities of Investment Securities at December 31, 1997, shows
information pertaining to the composition, yields and maturities of the
investment securities portfolio.
TABLE 10 - CONTRACTUAL MATURITIES OF INVESTMENT SECURITIES AT
DECEMBER 31, 1997 (AMORTIZED COST)
<TABLE>
<CAPTION>
After 1 Year After 5 Years
Within 1 Year Within 5 Years Within 10 Years After 10 Years
-----------------------------------------------------------------------------------------
(Dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
SECURITIES HELD TO MATURITY:
States and municipalities** $ 4,087 6.80% $ 11,275 6.49% $ 21,596 6.21% $ 16,272 6.53%
- -------------------------------------------------------------------------------------------------------------------------------
SECURITIES AVAILABLE FOR SALE:
Mortgage-backed securities and
collateralized mortgage
obligations* $ 15,617 6.93% $ 91,297 6.70% $178,996 7.07% $1,344,467 6.69%
U.S. Treasury and other U.S.
government agencies 115,488 6.20 235,378 6.35 12,802 6.46 489 6.99
States and municipalities** 2,903 8.95 7,943 8.92 11,292 9.02 401 13.05
Other 3,001 7.20 4,924 6.91 2,365 7.00 80,608 *** 6.45
- ------------------------------------------------------------------------------------------------------------------------------
Total $ 137,009 6.36% $339,542 6.51% $205,455 7.14 $1,425,965 6.68%
==============================================================================================================================
</TABLE>
[FN]
* Includes $1,629.2 million of government agency issued mortgage-backed
securities and collateralized mortgage obligations which, when adjusted
for early paydowns, have an estimated average life of 2.7 years.
** Weighted average yields on tax-exempt obligations have been computed by
adjusting allowable tax-exempt income to a fully taxable equivalent
basis using a tax rate of 35 percent.
*** Represents equity securities with no stated maturity.
</FN>
Average investment securities decreased 3 percent, or $63.8 million, in 1997,
and these funds were redeployed into higher earning assets. During 1996, average
investment securities increased 2 percent, or $42.2 million. Investment
securities represented 19 percent of earning assets in 1997 compared with 20
percent in 1996 and 21 percent in 1995.
A-17
<PAGE> 43
The investment portfolio is classified into two categories: securities available
for sale (AFS) and securities held to maturity (HTM). The securities portfolio
totaled $2.2 billion at December 31, 1997. The majority of these securities were
classified as AFS with an average life of 2.4 years. These securities consisted
primarily of mortgage-backed securities, collateralized mortgage obligations
(CMOs), U.S. Treasuries, U.S. government agencies and equities. At December 31,
1997, these securities had approximately $25.3 million of net unrealized gains
that resulted in an increase in book equity of approximately $15.6 million, net
of $9.7 million of deferred income taxes. At December 31, 1996, the AFS
securities portfolio totaled $2.2 billion and had approximately $5.9 million of
net unrealized gains that resulted in an increase in book equity of
approximately $3.7 million, net of $2.2 million of deferred income taxes. At
December 31, 1995, the AFS securities portfolio totaled $2.0 billion and had
approximately $18.2 million of net unrealized gains that resulted in an increase
in book equity of approximately $10.6 million, net of $7.6 million of deferred
income taxes.
At December 31, 1997, the HTM securities (which were all municipal bonds),
totaled $53.2 million and had an average life of 7.8 years. The HTM securities
portfolio had a net unrealized gain at December 31, 1997, of $1.1 million. At
December 31, 1996, the HTM securities totaled $65.9 million and had a net
unrealized gain of $.8 million, and at December 31, 1995, the HTM securities
portfolio totaled $74.7 million and had a net unrealized gain of $1.0 million.
Corporate guidelines call for all securities purchased for the investment
portfolio to be rated investment grade by Moody's Investors Service or Standard
& Poor's. At December 31, 1997, First Tennessee was in compliance with these
guidelines. Securities backed by the U.S. government or its agencies, both on a
direct and indirect basis, represented 94 percent of the investment portfolio at
December 31, 1997.
MORTGAGE LOANS HELD FOR SALE
Mortgage loans held for sale (mortgage warehouse) are loans that have been
originated and are awaiting securitization and/or delivery. These mortgages
represented approximately 9 percent of total earning assets between 1995 and
1997 (9 percent in 1997, 10 percent in 1996 and 7 percent in 1995). During 1997,
the mortgage warehouse averaged $1.0 billion and decreased 5 percent, or $53.5
million, from 1996. During 1996, the mortgage warehouse averaged $1.1 billion
and increased 50 percent, or $353.3 million, from 1995. Since the mortgage
warehouse loans are generally held in inventory for a short period of time (30
to 60 days), there may be significant differences between average and period-end
balances. At year-end 1997, the mortgage warehouse totaled $1.2 billion compared
with $787.4 million and $789.2 million at year-end 1996 and 1995, respectively.
DEPOSITS, OTHER SOURCES OF FUNDS, AND LIQUIDITY MANAGEMENT
- ----------------------------------------------------------
DEPOSITS
During 1997, core deposits grew 3 percent, or $254.4 million, and averaged $8.4
billion with the majority of the growth in non-interest bearing accounts. This
compares with growth of 7 percent, or $509.2 million, and an average balance of
$8.1 billion in 1996. In 1995, these deposits averaged $7.6 billion. Growth in
1997 was comparable to regional market growth and came primarily from expansion
of First Tennessee's targeted customer base.
Interest-bearing core deposits grew 2 percent, or $112.8 million, during 1997
and averaged $6.2 billion compared with 6 percent growth, or $314.4 million, and
an average balance of $6.0 billion in 1996. Interest-bearing core deposits
averaged $5.7 billion in 1995. Noninterest-bearing deposits grew 7 percent, or
$141.6 million, during 1997 and averaged $2.2 billion compared with 10 percent
growth, or $194.8 million, and an average balance of $2.1 billion in 1996.
Noninterest-bearing core deposits averaged $1.9 billion in 1995.
A-18
<PAGE> 44
OTHER SOURCES OF FUNDS
Purchased funds averaged $3.3 billion for 1997, up 12 percent, or $352.1
million, from the previous year. This increase was primarily due to loan growth
continuing to outpace deposit growth and the higher balance of nonearning
assets. Purchased funds increased 21 percent, or $516.8 million, and averaged
$2.9 billion and $2.4 billion during 1996 and 1995, respectively. Purchased
funds accounted for 28 percent of First Tennessee's funding (core deposits plus
purchased funds and term borrowings) in 1997, 26 percent in 1996, and 24 percent
in 1995. See Note 9 - Short-Term Borrowings for additional information.
Term borrowings include senior and subordinated borrowings and advances with
maturities greater than one year. Term borrowings decreased 27 percent, or $68.2
million, during 1997 and averaged $185.5 million compared with an increase of 21
percent, or $44.8 million, and an average balance of $253.7 million in 1996.
Term borrowings averaged $208.9 million in 1995. See Note 10 - Term Borrowings
for additional information.
LIQUIDITY MANAGEMENT
The objective of liquidity management is to ensure the continuous availability
of funds to meet the demands of depositors, investors and borrowers. The
Asset/Liability Committee, a committee consisting of senior management that
meets regularly, is responsible for managing these needs which takes into
account the marketability of assets; the sources, stability and availability of
funding; and the level of unfunded commitments. Core deposits are First
Tennessee's primary source of funding and one of the most stable sources of
liquidity for a bank. In both 1997 and 1996, core deposits funded 73 percent of
earning assets compared with 75 percent in 1995. FTBNA has a $3 billion bank
note program available for additional liquidity. Under this program, the bank
may borrow funds, from time to time, at maturities of 30 days to 30 years. At
December 31, 1997, approximately $2.8 billion was available under the bank note
program as a funding source.
Parent company liquidity is maintained by cash flows stemming from dividends and
interest payments collected from subsidiaries, which represent the primary
source of funds to pay dividends to shareholders and interest payments to
debtholders. The amount of dividends from bank subsidiaries is subject to
certain regulatory restrictions, which are described in Note 16 - Restrictions,
Contingencies and Other Disclosures. The parent company statements are presented
in Note 23 - Parent Company Financial Information. The parent company also has
the ability to enhance its liquidity position by raising equity or incurring
debt. Under an effective shelf registration statement on file with the
Securities and Exchange Commission (SEC), First Tennessee, as of December 31,
1997, may offer from time to time, at its discretion, debt securities, and
common and preferred stock aggregating up to $225 million. In addition, First
Tennessee also has an effective capital securities shelf registration statement
on file with the SEC under which up to $200 million of capital securities is
available for issuance.
Maintaining adequate credit ratings on debt issues is critical to liquidity
because it affects the ability of First Tennessee to attract funds from various
sources on a cost-competitive basis. The various credit ratings are detailed in
Table 11 - Credit Ratings at December 31, 1997.
TABLE 11 - CREDIT RATINGS AT DECEMBER 31, 1997
<TABLE>
<CAPTION>
Thomson Fitch
Standard & Poor's Moody's Bankwatch IBCA
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
FIRST TENNESSEE NATIONAL CORPORATION
Overall rating B
Subordinated capital notes due 1999 BBB+ Baa1
Subordinated capital notes due 2005 BBB+ Baa1
Capital securities due 2027* BBB A3 A-
Commercial paper TBW-1
- ----------------------------------------------------------------------------------------------------------------------
FIRST TENNESSEE BANK NATIONAL ASSOCIATION
Short-term/long-term deposits A-1/A P-1/A1 TBW-1
Other short-term/long-term funding** A-1/A P-1/A1
Counterparty credit rating A A1
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
[FN]
* Guaranteed preferred beneficial interests in First Tennessee's junior
subordinated debentures (See Note 11 for description of securities).
** Other funding includes certificates of deposit and bank notes.
</FN>
A-19
<PAGE> 45
CAPITAL
- -------
Total capital (shareholders' equity plus qualifying capital securities) at
December 31, 1997, was $1,054.1 million, up 10 percent, or $99.6 million, from
December 31, 1996. Shareholders' equity (excluding the qualifying capital
securities) was $954.1 million at year-end 1997, relatively flat compared to
year-end 1996. This followed an increase of 9 percent, or $81.3 million, from
year-end 1995. The increase in total capital in 1997 included the issuance of
qualifying capital securities and the retention of net income after dividends,
reduced by share repurchase programs during the year. The increase in 1996 was
primarily due to the retention of net income after dividends. The Consolidated
Statements of Shareholders' Equity highlights the changes in equity since
December 31, 1994.
Capital adequacy is an important indicator of financial stability and
performance. Management's objectives are to maintain a level of capitalization
that is sufficient to sustain asset growth, take advantage of profitable growth
opportunities and promote depositor and investor confidence. Overall, First
Tennessee's capital position remained strong as shown in Table 12 - Capital
Ratios. Unrealized market valuations had no material effect on the ratios during
the three year period. However, in 1997, excluding the effects of unrealized
market valuations would have lowered the period-end equity to assets ratio to
6.54 percent.
TABLE 12 - CAPITAL RATIOS
<TABLE>
<CAPTION>
1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Average total capital to average assets* 7.36% 7.13% 7.24%
Average shareholders' equity to average assets 6.62 7.13 7.24
Period-end shareholders' equity to assets 6.63 7.31 7.23
Period-end double leverage 113.2 107.6 107.2
- ---------------------------------------------------------------------------------
</TABLE>
[FN]
* Total capital includes shareholders' equity and guaranteed preferred
beneficial interests in First Tennessee's junior subordinated debentures.
</FN>
Banking regulators define minimum capital ratios for bank holding companies and
their subsidiaries. Based on the risk-based capital rules and definitions
prescribed by the banking regulators, should an institution's capital ratios
decline below predetermined levels, it would become subject to a series of
increasingly restrictive regulatory actions. The system categorizes a financial
institution's capital position into one of five categories ranging from
well-capitalized to critically under-capitalized. For an institution to qualify
as well-capitalized, Tier 1 Capital, Total Capital and Leverage capital ratios
must be at least 6 percent, 10 percent and 5 percent, respectively. As of
December 31, 1997, First Tennessee and all of its banking affiliates had
sufficient capital to qualify as well-capitalized institutions as shown in Note
12 - Regulatory Capital.
At the January 1998 meeting of the board of directors, a two-for-one stock split
was approved. The stock split was effective February 20, 1998, and changed the
par value of First Tennessee's common stock from $1.25 to $.625 per share and
the shares of authorized common stock increased from 200 million to 400 million.
All share-related information has been restated in this document to reflect the
stock split.
At December 31, 1997, book value per common share was $7.44 based on shares
outstanding of 128.2 million compared with book value per common share of $7.14
based on shares outstanding of 133.7 million at December 31, 1996. At December
31, 1995, book value per common share was $6.50 based on shares outstanding of
134.4 million. First Tennessee's shares are traded on The Nasdaq Stock Market
national market system under the symbol FTEN, and are listed in the financial
section of most newspapers as FstTN Ntl. The sales price ranges, earnings per
share and dividends by quarter for each of the last two years are presented in
Table 19 - Summary of Quarterly Financial Information.
At December 31, 1997, the closing sales price of First Tennessee's common stock
was $33.375 per share. This price was 449 percent of year-end book value per
share, and the annual dividend yield was 3.3 percent for 1997 based on dividends
declared in 1997 and the closing market price of $18.75 on December 31, 1996.
The quarterly dividend was last increased at the October 23, 1997, board of
directors' meeting to $.165 per share, up 10 percent from $.15 per share.
A-20
<PAGE> 46
Management has authority from the board of directors to repurchase stock, from
time to time, for the various benefit plans. During 1997, a total of 7.5 million
shares were repurchased, of which 3.8 million shares, at a cost of $83.3
million, were purchased under an accelerated purchase program, and the remaining
shares were repurchased for stock option exercises. During 1997, 1.9 million
shares were issued for benefit plans. During 1996, First Tennessee repurchased
1.7 million shares of its common stock, and 1.0 million shares were issued for
benefit plans. During 1995, 9.7 million shares were repurchased, with 6.8
million shares being issued for acquisitions and .9 million shares being issued
for benefit plans. On April 20, 1998, a grant of a broadly-based employee stock
option program will vest. As of December 31, 1997, options related to
approximately 1.3 million shares were outstanding options under this grant.
Pursuant to board authority, First Tennessee plans to continue to purchase
shares from time to time for its stock option plans, including the options that
will vest in 1998, and will evaluate the level of capital and take action
designed to generate or use capital to maximize the benefit to shareholders.
RISK MANAGEMENT
INTEREST RATE RISK MANAGEMENT
- -----------------------------
The primary purpose of managing interest rate risk is to effectively invest
First Tennessee's capital to manage and preserve the value created by its
banking and nonbanking businesses. This is done by managing the structure of the
balance sheet to maximize overall profitability, increase revenues, and achieve
the desired level of net interest income while managing interest sensitivity
risk and liquidity. Interest sensitivity risk is defined as the risk that future
changes in interest rates will reduce net interest income.
Interest rate risk occurs when assets and liabilities reprice at different times
as interest rates change. First Tennessee uses a variety of measurement tools to
monitor and control the overall interest rate risk exposure of both its on- and
off-balance sheet positions. One way to gauge the impact that future changes in
interest rates may have on earnings is through an interest rate sensitivity
analysis. This analysis examines the net position of assets, liabilities, and
derivative instruments subject to repricing in specified time periods. Table 13
- - Risk Sensitivity Analysis details First Tennessee's interest rate sensitivity
profile at December 31, 1997. Table 13 is based on projected cashflows by
expected maturity dates and does not necessarily reflect management's evaluation
of interest rate risk as these instruments may reprice more frequently than at
contractual maturity.
First Tennessee's net interest income and its financial condition are affected
by changes in the level of market interest rates as the repricing
characteristics of its loans and other assets do not necessarily match those of
its deposits, other borrowings and capital. For example, a portion of fixed-rate
assets that reprice within one year are funded with floating-rate debt. This
position will benefit net interest income in a declining interest rate
environment and will negatively impact net interest income in a rising interest
rate environment. In the case of floating-rate assets and liabilities, First
Tennessee may also be exposed to basis risk, which results from changing spreads
between loans and deposit rates. These changing spreads are not highly
correlated to changes in the level of interest rates and are driven by other
market conditions.
Because the interest rate sensitivity analysis does not fully capture the impact
of changes in the balance sheet mix, administered rates (such as the prime
lending rate), embedded options, or lagged interest rate changes, it cannot be
used in isolation to determine the level of interest rate risk exposure.
Accordingly, First Tennessee also performs an earnings simulation analysis under
a variety of market interest rate scenarios to identify more dynamic interest
rate risk exposures. This simulation, which considers forecasted balance sheet
changes, prepayment speeds, deposit mix, pricing impacts and other changes in
the net interest spread, provides an estimate of the annual earnings at risk for
given changes in interest rates. (See Net Interest Income discussion for
additional assumptions and information.)
A-21
<PAGE> 47
TABLE 13 - RISK SENSITIVITY ANALYSIS
<TABLE>
<CAPTION>
HELD FOR PURPOSES OTHER THAN TRADING
Fair
(Dollars in millions) 1998 1999 2000 2001 2002 2003+ Total Value
- -----------------------------------------------------------------------------------------------------------------
ASSETS:
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Loans, net of unearned
income*:
Floating $ 3,500 $ 287 $ 103 $ 83 $ 78 $ 100 $ 4,151 $4,151
Average interest rate 9.25% 8.37% 8.32% 8.40% 8.32% 8.19% 9.10%
Fixed $ 1,394 $ 801 $ 595 $ 445 $ 323 $ 564 $ 4,122 $4,138
Average interest rate 8.44% 8.74% 8.71% 8.62% 8.49% 8.15% 8.52%
Mortgage loans held for
sale Floating $ 1,241 $ - $ - $ - $ - $ - $ 1,241 $1,248
Average interest rate 7.49% - - - - - 7.49%
Investment securities:
Fixed $ 785 $ 460 $ 431 $ 215 $ 151 $ 145 $ 2,187 $2,188
Average interest rate 6.66% 6.60% 6.61% 6.69% 6.75% 6.78% 6.65%
Liquid assets**:
Floating $ 228 $ - $ - $ - $ - $ - $ 228 $ 228
Average interest rate 5.61% - - - - - 5.61%
- -----------------------------------------------------------------------------------------------------------------
LIABILITIES:
Interest-bearing
deposits:
Fixed $ 4,673 $ 895 $ 436 $ 341 $ 309 $ 482 $ 7,136 $7,175
Average interest rate 5.02% 4.78% 3.54% 3.00% 2.61% 1.99% 4.49%
Short-term borrowings:
Floating $ 2,765 $ - $ - $ - $ - $ - $ 2,765 $2,765
Average interest rate 5.29% - - - - - 5.29%
Fixed $ 23 $ - $ - $ - $ - $ - $ 23 $ 23
Average interest rate 4.67% - - - - - 4.67%
Term borrowings:
Fixed $ 2 $ 91 $ - $ - $ - $ 76 $ 169 $ 175
Average interest rate 7.14% 9.93% - - - 6.77% 8.47%
- -----------------------------------------------------------------------------------------------------------------
INTEREST RATE DERIVATIVES -
(notional value)
Mortgage banking:
Forward contracts:
Commitments to sell $ 1,645 $ - $ - $ - $ - $ - $ 1,645 $ (4)
Weighted average
settlement
price 100.17% - - - - - 100.17%
Option contracts****:
Put options purchased $ 26 $ - $ - $ - $ - $ - $ 26 ***
Weighted average strike
price 99.90% - - - - - 99.90%
Call options purchased $ 640 $ - $ - $ - $ - $ - $ 640 $ 3
Weighted average strike
price 114.86% - - - - - 114.86%
Floors purchased**** $ - $1,500 $1,100 $ 750 $ 400 $ - $ 3,750 $ 28
Weighted average strike
price - 5.00% 5.00% 5.56% 5.97% - 5.22%
Interest rate risk
management:
Swaps $ 210 $ - $ - $ - $ - $ - $ 210 ***
Average pay rate
(floating) 5.90% - - - - - 5.90%
Average receive rate
(fixed) 6.20% - - - - - 6.20%
Caps:
Purchased $ - $ - $ - $ - $ (20) $ - $ (20) ***
Weighted average strike
price - - - - 8.00% - 8.00%
Written $ - $ - $ - $ - $ 20 $ - $ 20 ***
Weighted average strike -
price - - - - 8.00% - 8.00%
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
[FN]
* Excludes nonaccrual loans.
** Consists of federal funds sold, securities purchased under agreements
to resell and investments in time deposits.
*** Amount is less than $500,000.
**** Put options purchased had a remaining book value of $.1 million; call
options purchased had a remaining book value of $1.7 million; and
floors purchased had a remaining book value of $16.0 million at
December 31, 1997.
</FN>
A-22
<PAGE> 48
TABLE 13 - RISK SENSITIVITY ANALYSIS (CONTINUED)
<TABLE>
<CAPTION>
CAPITAL MARKETS
Fair
(Dollars in millions) 1998 1999 2000 2001 2002 2003+ Total Value
- ----------------------------------------------------------------------------------------------------------------------------
ASSETS:
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Capital markets inventory:
Floating $ 253 $ - $ - $ - $ - $ - $ 253 $253
Average interest rate 6.36% - - - - - 6.36%
- ----------------------------------------------------------------------------------------------------------------------------
INTEREST RATE DERIVATIVES:
Interest rate forward contracts:
Commitments to buy $(1,599) $ - $ - $ - $ - $ - $(1,599) $(3)
Weighted average settlement
price 95.26% - - - - - 95.26%
Commitments to sell $ 1,671 $ - $ - $ - $ - $ - $ 1,671 $ 1
Weighted average settlement
price 96.68% - - - - - 96.68%
Interest rate option contracts:
Purchased $ (11) $ - $ - $ - $ - $ - $ (11) *
Weighted average strike
price 99.60% - - - - - 99.60%
Written $ 11 $ - $ - $ - $ - $ - $ 11 *
Weighted average strike
price 99.60% - - - - - 99.60%
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
[FN]
*Amount is less than $500,000.
</FN>
CREDIT RISK MANAGEMENT / ASSET QUALITY
- --------------------------------------
First Tennessee manages credit risk and asset quality through diversification in
the loan portfolio and adherence to its credit policy process. First Tennessee's
goal is not to avoid risk, but to manage it, and to include credit risk as part
of the pricing decision for each product. To accomplish this purpose, management
strives to identify loans experiencing difficulty early enough to correct the
deficiencies. In addition, nonperforming loans are recognized in a timely
manner, and charge-offs are recorded promptly based on realistic assessments of
current collateral values and the borrower's ability to repay. The adequacy of
reserves is assessed for the purpose of maintaining coverage of estimated losses
inherent in the loan portfolio.
At December 31, 1997, First Tennessee did not have any concentrations of 10
percent or more of total loans in any single industry.
ALLOWANCE FOR LOAN LOSSES
Management's policy is to maintain the allowance for loan losses at a level
sufficient to absorb the estimated losses inherent in the loan portfolio. The
allowance for loan losses is increased by the provision for loan losses and
recoveries and is decreased by charged-off loans. The evaluation process to
determine potential losses includes consideration of the industry, the general
economic environment, historical loss by loan type, and specific conditions of
the individual borrower. While management uses analytical modeling techniques to
identify potential losses on loans, future additions to the reserve may be
necessary based on loan growth and changes in economic conditions.
The allowance for loan losses is allocated according to the amount
systematically estimated as necessary to provide for the inherent losses within
the various categories of loans. This allocation is based primarily on previous
charge-off experience adjusted for changes in the risk characteristics of each
category. In addition, classified loans over $1 million are evaluated separately
and a specific reserve is set based on the expected loss of the individual loan.
The anticipated effect of economic conditions on loan portfolios is another
factor used in determining the allocable amounts.
The total allowance for loan losses increased 7 percent, or $8.1 million, in
1997 and 5 percent, or $5.2 million, in 1996. The ratio of allowance for loan
losses to loans, net of unearned income, was 1.51 percent at December 31, 1997,
compared with 1.52 percent at December 31, 1996, and 1.54 percent at December
31, 1995.
A-23
<PAGE> 49
Table 14 - Analysis of Allowance for Loan Losses summarizes, by category, loans
charged off and recoveries of loans previously charged off, and additions to the
reserve which have been charged against operating earnings. A general reserve is
also maintained to supplement specific allocations. Table 15 - Loans and
Foreclosed Real Estate at December 31 gives a breakdown of the allowance
allocation by major loan types and commercial loan grades at December 31, 1997,
compared with the same period in 1996.
TABLE 14 - ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
<TABLE>
<CAPTION>
(Dollars in thousands) 1997 1996 1995 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ALLOWANCE FOR LOAN LOSSES:
Beginning balance $ 117,748 $ 112,567 $ 109,859 $ 110,720 $ 103,223 $ 97,550
Provision for loan losses 51,115 35,677 20,592 17,182 36,461 45,248
Allowance from acquisitions - - 2,632 - 971 -
Charge-offs:
Commercial 6,388 3,355 5,614 6,458 16,905 20,597
Consumer 16,574 15,531 12,373 9,180 8,909 10,524
Credit card receivables 27,420 22,964 16,874 12,674 13,357 17,013
Real estate construction 245 10 44 - 2,320 173
Permanent mortgage* 3,648 522 326 884 1,170 2,339
- ---------------------------------------------------------------------------------------------------------------------------------
Total charge-offs 54,275 42,382 35,231 29,196 42,661 50,646
- ---------------------------------------------------------------------------------------------------------------------------------
Recoveries:
Commercial 4,340 3,712 6,728 4,001 6,266 5,833
Consumer 4,919 5,720 5,732 4,415 3,590 2,759
Credit card receivables 1,689 2,112 2,022 1,890 2,262 1,985
Real estate construction 171 171 59 373 159 215
Permanent mortgage 152 171 174 474 449 279
- ---------------------------------------------------------------------------------------------------------------------------------
Total recoveries 11,271 11,886 14,715 11,153 12,726 11,071
- ---------------------------------------------------------------------------------------------------------------------------------
Net charge-offs 43,004 30,496 20,516 18,043 29,935 39,575
- ---------------------------------------------------------------------------------------------------------------------------------
Ending balance $ 125,859 $ 117,748 $ 112,567 $ 109,859 $ 110,720 $ 103,223
=================================================================================================================================
LOANS, OUTSTANDING AT
DECEMBER 31** $ 8,311,350 $ 7,728,203 $ 7,333,283 $ 6,498,042 $ 5,560,348 $ 4,788,548
- ---------------------------------------------------------------------------------------------------------------------------------
Average loans, outstanding
during the year** $ 7,945,143 $ 7,472,095 $ 6,887,218 $ 5,984,424 $ 4,996,339 $ 4,698,381
- ---------------------------------------------------------------------------------------------------------------------------------
RATIOS**:
Allowance to loans 1.51% 1.52% 1.54% 1.69% 1.99% 2.16%
Net charge-offs to average loans .54 .41 .30 .30 .60 .84
Net charge-offs to allowance 34.2 25.9 18.2 16.4 27.0 38.3
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
[FN]
* Permanent mortgage charge-offs for 1997 include $3,170,000 of charge-offs
related to the mortgage loans repurchased since the beginning of 1997 (for
further information on repurchased mortgages see the Repurchased Mortgage
Loans discussion).
** Net of unearned income.
</FN>
A-24
<PAGE> 50
TABLE 15 - LOANS AND FORECLOSED REAL ESTATE AT DECEMBER 31
<TABLE>
<CAPTION>
1997 1996
- -------------------------------------------------------------------------------------------------- -------------------
Construction Allowance Allowance
and Commercial for Loan for Loan
(Dollars in millions) Commercial Development Real Estate TOTAL Loss Total Loss
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Internal grades*:
A $ 251 $ - $ - $ 251 $ 1 $ 225 $ -
B 567 5 84 656 2 636 1
C 1,824 235 459 2,518 22 2,251 23
C- 372 48 154 574 6 558 4
D 74 3 13 90 4 55 4
E 13 - 2 15 1 31 4
F 14 2 4 20 6 31 7
- -------------------------------------------------------------------------------------------------------------------------
3,115 293 716 4,124 42 3,787 43
Impaired loans:
Contractually past due 6 - 1 7 3 7 3
Contractually current 1 - - 1 - 3 1
Nonaccrual loans:
Contractually past due 1 - - 1 - 1 -
Contractually current - - - - - - -
- -------------------------------------------------------------------------------------------------------------------------
Total commercial and
commercial real estate loans $ 3,123 $ 293 $ 717 $ 4,133 $ 45 $ 3,798 $ 47
- -------------------------------------------------------------------------------------------------------------------------
Retail:
Consumer 2,855 26 2,684 24
Credit card 581 27 565 24
Permanent mortgages 664 3 642 3
Mortgage banking nonaccrual 29 3 8 1
- -------------------------------------------------------------------------------------------------------------------------
Total retail loans 4,129 59 3,899 52
- -------------------------------------------------------------------------------------------------------------------------
Other/Unfunded commitments 49 3 31 2
General reserve - 19 - 17
- -------------------------------------------------------------------------------------------------------------------------
Total loans $ 8,311 $ 126 $ 7,728 $ 118
=========================================================================================================================
Foreclosed real estate:
Foreclosed property $ 1 $ 2 $ 1 $ 4 $ 5
Foreclosed property -
mortgage banking 8 3
- -------------------------------------------------------------------------------------------------------------------------
Total foreclosed real estate $ 12 $ 8
=========================================================================================================================
</TABLE>
[FN]
Loans are expressed net of unearned income. All amounts in the Allowance for
Loan Loss columns have been rounded to the nearest million dollars. Grade A
loans have reserve amounts of less than $500,000.
*Based on internal loan classifications. Definitions of each credit grade are
provided below:
GRADE A: Established, stable companies with excellent earnings, liquidity, and
capital. Possess many of the same characteristics as Standard &
Poor's (S&P) AA rated companies.
GRADE B: Established, stable companies with good earnings, liquidity, and
capital. Possess many of the same characteristics as S&P A rated
companies.
GRADE C: Established, stable companies with satisfactory earnings, liquidity,
and capital and with consistent, positive trends relative to industry
norms.
GRADE C-:Established, stable companies with either inconsistent and/or
marginal earnings, or liquidity, or capital. Overall acceptable
credits with minor weaknesses which warrant additional servicing.
GRADE D: Financial condition adversely affected by temporary lack of earnings
or liquidity or changes in the operating environment. An action plan
is required to rehabilitate the credit or have it refinanced
elsewhere.
GRADE E: Significant developing weaknesses or adverse trends in earnings,
liquidity, capital, or operating environment. No discernible market
for refinancing is available.
GRADE F: Significantly higher than normal probability that: (1) legal action
or liquidation of collateral is required; (2) there will be a loss;
or (3) or both will occur. This grade is believed to be
substantially equivalent to the regulators' classifications of
substandard or doubtful.
IMPAIRED:A loan for which it is probable that all amounts due, according to
the contractual terms of the loan agreement, will not be collected.
NONACCRUAL: A loan that is placed on nonaccrual status is not included in any
of these six grades, but is placed in a separate nonaccrual category.
Commercial and real estate loans are placed on nonaccrual status
automatically once they become 90 days or more past due.
</FN>
A-25
<PAGE> 51
NET CHARGE-OFFS
Each lending product has, as a normal course of business, an expected level of
net charge-offs based on the desired profit margin of that product. The level of
charge-offs can vary from period to period due to the size, type and number of
individual credits. All of these factors are dependent on economic conditions
and may be cyclical.
Net charge-offs increased to $43.0 million at December 31, 1997. Net charge-
offs were $30.5 million for 1996 and $20.5 million for 1995. The ratio of net
charge-offs to average loans increased to .54 percent for 1997 from .41 percent
for 1996 and .30 percent for 1995. The increase in the level of net charge-offs
was primarily related to credit card receivables, repurchased mortgages
(discussed in more detail in the Repurchased Mortgage Loans section) and
commercial loans. Consumer loan net charge-offs remained relatively flat to 1996
levels. Excluding the repurchased mortgages, the ratio of net charge-offs to
average loans would have increased to .50 percent in 1997. Additional detail
regarding charge-offs and recoveries can be found in Table 14.
Table 16 - Charge-off Ratios provides charge-off information by loan type. The
commercial and commercial real estate net charge-off percentage increased in
1997 due to a larger increase in charge-offs than in recoveries, which reflects
a more normal tendency. In 1996 and 1995, commercial and commercial real estate
loan recoveries exceeded charge-offs. The consumer loan net charge-off
percentage increased 4 basis points between 1997 and 1996. Credit card
receivables net charge-offs as a percentage of average loans increased 79 basis
points between 1997 and 1996. The increase in credit card receivables net
charge-offs since 1995 reflected a deteriorating industry trend in overall
credit card quality. However, First Tennessee remained favorable to national
averages because of our regional targeted programs rather than the mass
preapproved direct mail solicitations used by many issuers in the industry. In
addition, during 1997, the credit card charge-off ratio peaked at 5.15 percent
in the second quarter of 1997, and improved to 4.59 percent in the fourth
quarter of 1997.
TABLE 16 - CHARGE-OFF RATIOS
<TABLE>
<CAPTION>
1997 1996 1995
- -----------------------------------------------------------------------------------
<S> <C> <C> <C>
Total net charge-offs excluding
repurchased mortgages .50% .41% .30%
Impact of repurchased mortgages .04 - -
- -----------------------------------------------------------------------------------
Total net charge-offs .54% .41% .30%
==================================================================================
BREAKDOWN BY LOAN CATEGORY:
Commercial and commercial real estate .05% (.01)% (.03)%
Consumer .42 .38 .28
Credit card receivables 4.72 3.93 3.09
Permanent mortgage* .05 .05 .02
- ----------------------------------------------------------------------------------
</TABLE>
[FN]
* Excludes repurchased mortgages.
A negative ratio indicates that recoveries exceeded charge-offs. Loans are
averages expressed net of unearned income.
</FN>
Going forward, in light of current economic conditions, anticipated trends and
First Tennessee's balance sheet mix, management believes overall asset quality
will remain positive and net charge-offs as a percentage of average loans should
remain relatively stable during 1998. Commercial loan charge-offs will continue
to rise and will approach a more normal charge-off level. Adverse industry
trends in credit card quality appear to be abating. As industry credit card
charge-offs improve, First Tennessee should experience parallel improvement in
credit card charge-offs.
A-26
<PAGE> 52
NONPERFORMING ASSETS
Nonperforming loans consist of impaired, other nonaccrual and restructured
loans. These, along with foreclosed real estate and other assets, represent
nonperforming assets. Impaired loans are those loans for which it is probable
that all amounts due, according to the contractual terms of the loan agreement,
will not be collected and for which recognition of interest income has been
discontinued. Nonaccrual loans are those loans on which recognition of interest
income has been discontinued. Restructured loans generally take the form of an
extension of the original repayment period and/or a reduction or deferral of
interest or principal because of a deterioration in the financial position of
the borrower.
Nonperforming assets increased 89 percent, or $23.9 million, in 1997 and
decreased 15 percent, or $4.9 million, in 1996. The increase in nonperforming
assets was primarily due to the repurchased mortgages (discussed in more detail
in the Repurchased Mortgage Loans section). Nonperforming assets in the regional
banking group declined 8 percent, or $1.2 million in 1997. Total nonperforming
loans increased 103 percent, or $19.5 million, in 1997 compared with a decrease
of 1 percent, or $.1 million, in 1996. In the regional banking group,
nonperforming loans declined 6 percent, or $.6 million in 1997. At December 31,
1997, foreclosed properties amounted to $12.2 million, an increase of 56 percent
from the $7.8 million of foreclosed properties reported in 1996. In the regional
banking group, foreclosed properties declined 12 percent, or $.6 million in
1997.
Information regarding nonperforming assets and loans is presented in Table 17
- - Nonperforming Assets at December 31. As shown in the table, the ratio of
nonperforming assets to total loans was .61 percent at December 31, 1997. In the
regional banking group, the ratio of nonperforming assets to total loans was .17
percent. Table 18 - Changes in Nonperforming Assets gives additional
information related to nonperforming assets for 1995 through 1997.
TABLE 17 - NONPERFORMING ASSETS AT DECEMBER 31
<TABLE>
<CAPTION>
(Dollars in thousands) 1997 1996 1995 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
AMOUNTS:
Impaired loans* $ 8,712 $ 10,322 $ 11,865
Other nonaccrual loans 29,703 8,604 7,175
- ---------------------------------------------------------------------------------------------------------------------------
Total nonaccrual loans 38,415 18,926 19,040 $ 16,853 $ 27,599 $ 32,761
Restructured loans - - - 158 1,195 2,493
- ---------------------------------------------------------------------------------------------------------------------------
Total nonperforming loans 38,415 18,926 19,040 17,011 28,794 35,254
Foreclosed real estate 12,202 7,823 11,794 19,215 35,048 29,690
Other assets 235 196 1,022 2,055 1,292 1,292
- ---------------------------------------------------------------------------------------------------------------------------
Total nonperforming assets $ 50,852 $ 26,945 $ 31,856 $ 38,281 $ 65,134 $ 66,236
===========================================================================================================================
Non-government
guaranteed past due loans** $ 21,015 $ 20,011 $ 19,796 $ 11,213 $ 13,634 $ 13,876
Government guaranteed
past due loans** 11,059 10,736 10,820 10,030 11,024 8,906
- ---------------------------------------------------------------------------------------------------------------------------
RATIOS***:
Nonperforming loans to total loans .46% .24% .26% .26% .52% .74%
Nonperforming assets to total loans plus
foreclosed real estate and other assets .61 .35 .43 .59 1.16 1.37
Nonperforming assets and
non-government guaranteed past due
loans to total loans plus foreclosed
real estate and other assets .86 .61 .70 .76 1.41 1.66
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
[FN]
* For the years 1997, 1996 and 1995 impaired loans included $196,000,
$279,000 and $303,000 of restructured loans, respectively.
** Loans that are 90 days or more past due as to principal and/or
interest and not yet impaired or on nonaccrual status.
*** Total loans are net of unearned income.
Certain previously reported amounts have been adjusted to agree with current
presentation.
</FN>
A-27
<PAGE> 53
TABLE 18 - CHANGES IN NONPERFORMING ASSETS
<TABLE>
<CAPTION>
(Dollars in millions) 1997 1996 1995
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Beginning balance $ 26.9 $ 31.9 $ 38.3
Additional nonperforming assets 104.2 22.6 23.5
Acquisitions - - 1.1
Return to accrual - - (.2)
Payments (71.5) (24.9) (26.0)
Charge-offs (8.7) (2.7) (4.8)
- -------------------------------------------------------------------------------
Ending balance $ 50.9 $ 26.9 $ 31.9
===============================================================================
</TABLE>
PAST DUE LOANS AND POTENTIAL PROBLEM ASSETS
Past due loans are loans contractually past due 90 days or more as to interest
or principal payments, but which have not yet been put on nonaccrual status. The
ratio of past due loans to total loans was essentially unchanged from 1996 to
1997 at .4 percent. Past due loans were $32.1 million at December 31, 1997,
compared with $30.7 million for 1996. Additional historical past due loan
information can be found in Table 17.
Potential problem assets, which are not included in nonperforming assets,
decreased to $70.3 million at December 31, 1997, from $78.4 million at December
31, 1996, and were 1 percent of total loans in 1997 and 1996. Potential problem
assets represent those assets where information about possible credit problems
of borrowers has caused management to have serious doubts about the borrower's
ability to comply with present repayment terms. This definition is believed to
be substantially consistent with the standards established by the Office of the
Comptroller of the Currency for loans classified substandard and doubtful.
REPURCHASED MORTGAGE LOANS
Within the course of normal mortgage banking activities, a small percentage of
nonperforming assets are created when FHA/VA borrowers are delinquent in their
monthly payments prior to the completion of the insuring process. Additionally,
loans which have been sold, may be found not to meet an investors' origination
criteria and could be required to be repurchased. In the first quarter of 1997,
these nonperforming assets increased $28.3 million to $39.9 million as several
events led to a backlog in the documentation and insuring operations. The
consolidation of the six independent mortgage companies into Dallas, combined
with the 1996 production volume surge during which refinancing activity was more
than double expected origination levels, created a document flow problem. As a
result, some loans became delinquent prior to being insured. The insuring
process is unique to government (FHA/VA) loans which are pooled (packaged) and
sold as mortgage-backed securities called GNMA securities. When a loan becomes
more than 90 days past due, the originator has the option of repurchasing the
loan out of the GNMA pool then, or waiting until the loan has been foreclosed.
When a repurchase does occur, the loan is classified as a nonperforming asset if
it has not been previously insured. Management of the nonperforming assets,
through curing the delinquencies or sale of foreclosed properties, has resulted
in a reduction in these assets, bringing the balance to $36.7 million at
year-end 1997. Additionally, First Tennessee has recently become the first
mortgage banking company in the nation to sign-on with FNMA's REO management and
liquidation program. Through this relationship, which includes the use of FNMA's
nationwide network of residential real estate service providers, our ability to
efficiently liquidate foreclosed properties will increase.
A-28
<PAGE> 54
OTHER
YEAR 2000
As with other companies, advances and changes in technology can have a
significant impact on the business and operations. Many computer programs were
originally designed to recognize calendar years by their last two digits.
Calculations performed using these truncated fields will not work properly with
dates from the year 2000 and beyond. This "Year 2000 computer issue" can create
risk for a company from unforeseen problems in its own computer systems and from
the company's vendors and customers.
First Tennessee began planning its Year 2000 conversion process in 1995. Among
other things, the process included the formation of a company-wide project
office that meets regularly to coordinate and review the status of conversion
initiatives. A comprehensive review to identify the systems affected by this
issue was completed, estimated cost projections were determined and an
implementation plan was compiled and is currently being executed and is on
schedule. As a result of the tasks already completed, First Tennessee expects to
either modify or replace certain existing systems. In addition, based on
business plans and expectations, new systems are being purchased which will be
Year 2000 compliant. Project completion is planned for first quarter of 1999 to
allow for adequate training, testing and production integration. First Tennessee
is also actively working to assess the compliance efforts of its major external
counterparties and vendors.
Spending for maintenance and modification associated with Year 2000 will be
expensed as incurred. Costs of new systems will be capitalized and amortized
consistent with the American Institute of Certified Public Accountants'
Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use." Based upon current information,
management presently believes that specific costs related to First Tennessee's
Year 2000 systems issues will not have a material impact on the operations, cash
flows or financial condition of First Tennessee.
TABLE 19 - SUMMARY OF QUARTERLY FINANCIAL INFORMATION
<TABLE>
<CAPTION>
1997 1996
----------------------------------------------- ------------------------------------------------
(Dollars in millions except FOURTH THIRD SECOND FIRST FOURTH THIRD SECOND FIRST
per share data) QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
SUMMARY INCOME INFORMATION:
Interest income $ 246.3 $ 241.8 $ 230.9 $ 222.3 $ 227.1 $ 225.7 $ 226.0 $ 217.7
Interest expense 121.3 118.2 111.9 106.8 109.3 110.7 113.0 112.3
Provision for loan losses 13.3 12.8 12.5 12.5 11.3 8.8 7.6 8.0
Noninterest income before
securities transactions 195.4 180.4 154.0 139.0 165.5 142.4 129.7 136.3
Securities gains/(losses) .1 - (.8) - (3.0) - - .3
Noninterest expense 214.6 204.1 186.0 180.3 186.0 174.9 168.0 175.6
Net income 57.8 54.7 46.4 38.6 53.3 46.8 42.4 37.4
- -------------------------------------------------------------------------------- -----------------------------------------------
NET INCOME PER COMMON SHARE $ .45 $ .43 $ .36 $ .30 $ .40 $ .35 $ .31 $ .28
DILUTED NET INCOME
PER COMMON SHARE .44 .42 .35 .29 .39 .34 .31 .27
- -------------------------------------------------------------------------------- -----------------------------------------------
COMMON STOCK INFORMATION:
Closing price per share:
High $33 3/4 $29 1/8 $24 7/8 $24 1/2 $19 5/16 $17 1/16 $17 1/2 $16 7/8
Low 28 24 1/16 21 18 3/8 17 1/16 14 7/16 15 1/4 14 9/16
Period-end 33 3/8 28 1/2 24 21 1/8 18 3/4 16 9/16 15 5/16 16 1/2
Dividends declared per share .165 .15 .15 .15 .15 .1325 .1325 .1325
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
[FN]
Per share data reflects the 1998 and 1996 two-for-one stock splits.
</FN>
A-29
<PAGE> 55
GLOSSARY
ALLOWANCE FOR LOAN LOSSES - Valuation reserve representing the amount considered
by management to be adequate to cover estimated losses inherent in the loan
portfolio.
BASIS POINT - The equivalent of one-hundredth of one percent (0.01). One hundred
basis points equals one percent. This unit is generally used to measure
movements in interest yields and rates.
BASIS RISK - Refers to changes in the relationship between various interest rate
segments (e.g. the difference between the Prime and the Fed Funds Rates).
BASIS SWAP - A notional principle swap that was intended to hedge the basis risk
of the loan portfolio. First Tennessee's basis swap was terminated in 1995 in
order to restructure the rate sensitive position and limit the loss going
forward in a rising rate scenario.
BOOK VALUE PER SHARE - A ratio determined by dividing shareholders' equity at
the end of a period by the number of common shares outstanding at the end of
that period.
CHARGE-OFFS - The amount charged against the allowance for loan losses to reduce
specific loans to their collectible amount.
CLASSIFIED LOAN - A loan that has caused management to have serious doubts about
the borrower's ability to comply with present repayment terms. Included in this
category are grade F performing and nonperforming loans. In compliance with the
standards established by the Office of the Comptroller of the Currency (OCC)
these loans are classified as substandard, doubtful, and loss depending on the
severity of the loan's deterioration.
COMMERCIAL PAPER - A short-term unsecured debt obligation of the parent company
with maturities typically of 30 days to 270 days.
COMMERCIAL AND STANDBY LETTERS OF CREDIT - Commercial letters of credit are
issued or confirmed by an entity to ensure the payment of its customers'
payables and receivables. Standby letters of credit are issued by an entity to
ensure its customers' performance in dealing with others.
COMMITMENT TO EXTEND CREDIT - Agreements to make or acquire a loan or lease as
long as agreed-upon terms (e.g., expiry, covenants, or notice) are met.
Generally these commitments have fixed expiration dates or other termination
clauses and may require payment of a fee.
CORE DEPOSITS - Core deposits consist of all interest-bearing and
noninterest-bearing deposits, except certificates of deposit over $100,000. They
include checking interest deposits, money market deposit accounts, time and
other savings, plus demand deposits.
DERIVATIVE FINANCIAL INSTRUMENT - Futures, forwards, swaps, option contracts, or
other financial instruments with similar characteristics, such as interest rate
caps or floors, or fixed-rate loan commitments.
DILUTED EARNINGS PER SHARE - Net income, divided by average shares outstanding
plus the number of shares that would be outstanding if all dilutive common
shares had been issued. Dilutive common shares, for example, would be
outstanding options where the average stock price exceeds the price at which the
option was granted.
DOUBLE LEVERAGE RATIO - A ratio that measures the degree to which parent company
debt supports investments in subsidiaries. It is calculated by dividing the
parent company's investment in subsidiaries by total consolidated equity.
EARNING ASSETS - Assets that generate interest or dividend income or
yield-related fee income, such as loans and investment securities.
EARNINGS PER SHARE, ALSO CALLED BASIC EARNINGS OR BASIC NET INCOME PER SHARE -
Net income, divided by the average number of common shares outstanding in the
period. (See also diluted earnings per share)
A-30
<PAGE> 56
FEDERAL FUNDS SOLD/PURCHASED - Excess balances of depository institutions which
are loaned to each other, generally on an overnight basis.
FULLY TAXABLE-EQUIVALENT INCOME (FTE) - Income which has been adjusted by
increasing tax-exempt income to a level that would yield the same after-tax
income had that income been subject to taxation.
HEDGE - An instrument used to reduce risk by entering into a transaction which
offsets existing or anticipated exposures to changes in interest rates.
INTEREST-FREE SOURCES - Noninterest bearing liabilities (such as demand
deposits, other liabilities, and shareholders' equity) net of nonearning assets
(such as cash, fixed assets, and other assets).
INTEREST RATE CAPS AND FLOORS - Contracts with notional principal amounts that
require the seller, in exchange for a fee, to make payments to the purchaser if
a specified market interest rate exceeds a fixed upper "capped" level or falls
below a fixed lower "floor" level on specified future dates.
INTEREST RATE FORWARD AND FUTURES CONTRACTS - Contracts representing commitments
either to purchase or sell at a specified future date a specified security or
financial instrument at a specified price, and may be settled in cash or through
delivery. These obligations are generally short term in nature.
INTEREST RATE OPTION (OPTIONS) - A contract that grants the holder (purchaser),
for a fee, the right to either purchase or sell a financial instrument at a
specified price within a specified period of time or on a specified date from
the writer (seller) of the option.
INTEREST RATE SENSITIVITY - The relationship of changes in interest income and
interest expense to fluctuations in interest rates over a defined period of
time.
INTEREST RATE SWAP (SWAP) - An agreement in which two entities agree to
exchange, at specified intervals, interest payment streams calculated on an
agreed upon notional principal amount with at least one stream based on a
floating rate index.
INTEREST SENSITIVITY GAP - The difference between interest-rate sensitive assets
and interest-rate sensitive liabilities over a designated time period. A net
asset exists when interest-rate sensitive assets exceed interest-rate sensitive
liabilities. A net liability position exists when liabilities exceed assets.
LEVERAGE RATIO - Tier 1 capital divided by quarterly average assets excluding
any adjustments for available for sale securities unrealized gains/(losses),
goodwill, and certain other intangible assets.
LIQUIDITY - The ability of a corporation to generate adequate funds to meet its
cash flow requirements. It is measured by the ability to quickly convert assets
into cash with minimal exposure to interest rate risk, by the size and stability
of the core deposit base, and by additional borrowing capacity within the money
markets.
MARKET CAPITALIZATION - Market value of a firm computed by multiplying the
amount of shares outstanding by the current stock price.
MORTGAGE SERVICING RIGHTS - The right to service mortgage loans, generally owned
by someone else, for a fee. Loan servicing includes collecting payments;
remitting funds to investors, insurance companies, and taxing authorities;
collecting delinquent payments; and foreclosing on properties when necessary.
NET INTEREST INCOME (NII) - Interest income less interest expense.
NET INTEREST MARGIN - A measurement of how effectively the bank utilizes its
earning assets in relationship to the interest cost of funding them. It is
computed by dividing fully taxable-equivalent net interest income by average
interest earning assets.
NET INTEREST SPREAD - The difference between the average yield earned on earning
assets on a fully taxable equivalent basis and the average rate paid for
interest-bearing liabilities.
A-31
<PAGE> 57
NONACCRUAL LOANS - Loans on which interest accruals have been discontinued due
to the borrower's financial difficulties. Interest income on these loans is
reported on a cash basis as it is collected after recovery of principal.
NONPERFORMING ASSETS - Interest earning assets on which interest income is not
being accrued, restructured loans on which interest rates or terms of repayment
have been materially revised, real estate properties acquired through
foreclosure, and repossessed assets.
NOTIONAL PRINCIPAL AMOUNT - An amount on which payments for interest rate swaps
and interest rate options, caps and floors are based. The "notional amount" is
not paid or received.
OPERATING MARGIN (also called Return on Revenue - ROR) - A measure of
profitability that indicates operation efficiency and productivity. It is
calculated by dividing the fully taxable-equivalent pre-tax profit before loan
loss provision by the fully taxable-equivalent net interest income plus
noninterest income.
PRICE/EARNINGS RATIO - The relationship of the market price of a share of common
stock to the earnings per share of the stock, expressed as a multiple.
PROVISION FOR LOAN LOSSES - The periodic charge to earnings for potential losses
in the loan portfolio.
PURCHASED FUNDS - The combination of certificates of deposit greater than
$100,000, federal funds purchased, securities sold under agreement to
repurchase, bank notes, commercial paper, and other short-term borrowings.
RECOVERIES - The amount added to the allowance for loan losses when funds are
received on a loan which was previously charged off.
REPURCHASE AGREEMENT - A method of short-term financing in which one party
agrees to buy back, at a future date (generally overnight) and an agreed-upon
price, a security it sells to another party.
RESTRUCTURED LOANS - Loans where the institution, for economic or legal reasons
related to the debtor's financial difficulties, grants a concession to the
debtor that it would not otherwise consider.
RETURN ON AVERAGE ASSETS (ROA) - A measure of profitability that indicates how
effectively an institution utilized its assets. It is calculated by dividing
annualized net income by total average assets.
RETURN ON AVERAGE EQUITY (ROE) - A measure of profitability that indicates what
an institution earned on its shareholders' investment. ROE is calculated by
dividing net income by total average shareholders' equity.
REVENUE - The sum of net interest income and noninterest income. For some
comparisons, securities gains/losses are excluded.
RISK-ADJUSTED ASSETS - A regulatory risk-based calculation that takes into
account the broad differences in risks among a banking organization's assets and
off-balance sheet instruments.
SECURITIZED ASSETS OR SECURITIZATION - The process by which financial assets are
packaged, underwritten and sold as securities.
SHAREHOLDER RETURN, ALSO CALLED TOTAL RETURN - The sum of dividend income and
price appreciation of an equity security for a given period of time divided by
the price of the security at the beginning of the period.
TIER 1 CAPITAL RATIO - Ratio consisting of shareholders' equity before any
adjustments for available for sale securities unrealized gains/(losses) reduced
by goodwill, certain other intangible assets and the disallowable portion of
mortgage servicing rights divided by risk-adjusted assets.
TOTAL CAPITAL RATIO - Tier 1 capital plus the allowable portion of the allowance
for loan losses and qualifying subordinated debt divided by risk-adjusted
assets.
A-32
<PAGE> 58
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of First Tennessee National
Corporation:
We have audited the accompanying consolidated statements of condition
of First Tennessee National Corporation (a Tennessee corporation) and
subsidiaries as of December 31, 1997 and 1996, and the related consolidated
statements of income, shareholders' equity and cash flows for each of the three
years in the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of First Tennessee
National Corporation and subsidiaries as of December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1997, in conformity with generally accepted
accounting principles.
/s/Arthur Andersen LLP
Memphis, Tennessee,
January 20, 1998
A-33
<PAGE> 59
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CONDITION FIRST TENNESSEE NATIONAL CORPORATION
- -------------------------------------------------------------------------------------------------------
December 31
------------------------------------
(Dollars in thousands) 1997 1996
- -------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS:
Cash and due from banks (Note 16) $ 775,760 $ 959,604
Federal funds sold and securities purchased under
agreements to resell 225,861 138,365
- -------------------------------------------------------------------------------------------------------
Total cash and cash equivalents 1,001,621 1,097,969
- -------------------------------------------------------------------------------------------------------
Investment in bank time deposits 2,522 1,922
Capital markets inventory 253,240 150,402
Mortgage loans held for sale 1,240,648 787,362
Securities available for sale (Note 3) 2,133,303 2,173,620
Securities held to maturity (market value of $54,323 at
December 31, 1997, and $66,677 at December 31, 1996) (Note 3) 53,230 65,914
Loans, net of unearned income (Note 4) 8,311,350 7,728,203
Less: Allowance for loan losses 125,859 117,748
- -------------------------------------------------------------------------------------------------------
Total net loans 8,185,491 7,610,455
- -------------------------------------------------------------------------------------------------------
Premises and equipment, net (Note 5) 206,895 185,624
Real estate acquired by foreclosure 12,202 7,823
Mortgage servicing rights, net (Note 6) 408,921 266,027
Intangible assets, net (Note 7) 112,411 119,465
Capital markets receivables and other assets 777,413 592,319
- -------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 14,387,897 $ 13,058,902
=======================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Deposits:
Interest-bearing (Note 8) $ 7,135,733 $ 6,677,669
Noninterest-bearing 2,536,046 2,355,393
- -------------------------------------------------------------------------------------------------------
Total deposits 9,671,779 9,033,062
- -------------------------------------------------------------------------------------------------------
Federal funds purchased and securities sold under
agreements to repurchase (Note 9) 2,085,679 1,881,187
Commercial paper and other short-term borrowings (Note 9) 702,388 377,369
Capital markets payables and other liabilities 705,062 578,113
Term borrowings (Note 10) 168,893 234,645
- -------------------------------------------------------------------------------------------------------
Total liabilities 13,333,801 12,104,376
- -------------------------------------------------------------------------------------------------------
Guaranteed preferred beneficial interests in
First Tennessee's junior subordinated debentures (Note 11) 100,000 -
- -------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY:
Preferred stock - no par value (5,000,000 shares
authorized, but unissued) - -
Common stock - $.625 par value (shares authorized -
400,000,000; shares issued - 128,209,142 at
December 31, 1997 and 133,715,038 at December 31, 1996) 80,131 83,572
Capital surplus 49,536 48,657
Undivided profits 811,396 823,175
Unrealized market adjustment 15,333 2,697
Deferred compensation on restricted stock incentive plans (2,300) (3,575)
- -------------------------------------------------------------------------------------------------------
Total shareholders' equity 954,096 954,526
- -------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 14,387,897 $ 13,058,902
=======================================================================================================
</TABLE>
[FN]
See accompanying notes to consolidated financial statements.
</FN>
A-34
<PAGE> 60
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF INCOME FIRST TENNESSEE NATIONAL CORPORATION
- ----------------------------------------------------------------------------------------------------------------
Year Ended December 31
----------------------------------------------------
(Dollars in thousands except per share data) 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
INTEREST INCOME:
Interest and fees on loans $ 699,617 $ 653,466 $ 611,026
Interest on investment securities:
Taxable 135,321 135,969 130,830
Tax-exempt 4,502 5,146 4,621
Interest on mortgage loans held for sale 76,840 82,046 54,701
Interest on capital markets inventory 13,399 14,139 12,630
Interest on other earning assets 11,614 5,731 8,720
- ----------------------------------------------------------------------------------------------------------------
Total interest income 941,293 896,497 822,528
- ----------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE:
Interest on deposits:
Savings 8,188 9,447 10,789
Checking interest and money market account 95,123 92,648 95,824
Certificates of deposit under $100,000 and other time 160,522 166,534 167,850
Certificates of deposit $100,000 and more 47,730 46,283 30,579
Interest on short-term borrowings 130,719 109,547 108,815
Interest on term borrowings 15,915 20,850 18,018
- ----------------------------------------------------------------------------------------------------------------
Total interest expense 458,197 445,309 431,875
- ----------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 483,096 451,188 390,653
Provision for loan losses 51,115 35,677 20,592
- ----------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 431,981 415,511 370,061
- ----------------------------------------------------------------------------------------------------------------
NONINTEREST INCOME:
Mortgage banking 330,131 275,406 213,563
Capital markets 98,310 85,871 82,814
Deposit transactions and cash management 86,047 78,228 74,124
Trust services and investment management 40,941 34,704 34,435
Merchant processing 32,111 24,185 19,164
Cardholder fees 19,833 17,155 14,885
Equity securities gains/(losses) (854) (2,495) 3,195
Debt securities gains/(losses) 141 (186) (751)
All other income and commissions (Note 13) 61,470 58,281 51,182
- ----------------------------------------------------------------------------------------------------------------
Total noninterest income 668,130 571,149 492,611
- ----------------------------------------------------------------------------------------------------------------
ADJUSTED GROSS INCOME AFTER PROVISION FOR LOAN LOSSES 1,100,111 986,660 862,672
- ----------------------------------------------------------------------------------------------------------------
NONINTEREST EXPENSE:
Employee compensation, incentives, and benefits 409,783 385,380 340,508
Operations services 49,879 44,109 38,798
Occupancy 42,848 39,815 37,867
Equipment rentals, depreciation, and maintenance 40,093 34,121 31,845
Amortization of mortgage servicing rights 37,452 26,041 14,980
Communications and courier 34,899 32,981 29,880
Advertising and public relations 18,722 17,629 12,972
Amortization of intangible assets 9,631 9,491 8,100
All other expense (Note 13) 141,737 114,919 94,765
- ----------------------------------------------------------------------------------------------------------------
Total noninterest expense 785,044 704,486 609,715
- ----------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 315,067 282,174 252,957
Applicable income taxes (Note 14) 117,595 102,267 88,069
- ----------------------------------------------------------------------------------------------------------------
NET INCOME $ 197,472 $ 179,907 $ 164,888
================================================================================================================
EARNINGS PER SHARE (Note 15) $ 1.54 $ 1.34 $ 1.21
- ----------------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER SHARE (Note 15) $ 1.50 $ 1.32 $ 1.20
- ----------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE SHARES OUTSTANDING 128,365,434 134,393,172 136,049,588
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
[FN]
See accompanying notes to consolidated financial statements.
</FN>
A-35
<PAGE> 61
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FIRST TENNESSEE NATIONAL CORPORATION
- ---------------------------------------------------------------------------------------------------------------------------
Unrealized Deferred
Common Common Capital Undivided Market Compen-
(Dollars in thousands) Shares Total Stock Surplus Profits Adjustment sation
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1994 136,295,832 $ 774,905 $ 85,185 $ 91,558 $ 625,231 $ (24,273) $ (2,796)
Adjustment related to change in
reporting date for acquisition
accounted for as a pooling of
interests - (7,757) - - (7,757) - -
- ---------------------------------------------------------------------------------------------------------------------------
ADJUSTED BALANCE, JANUARY 1, 1995 136,295,832 767,148 85,185 91,558 617,474 (24,273) (2,796)
Net income - 164,888 - - 164,888 - -
Cash dividends declared - (65,576) - - (65,576) - -
Common stock issued:
Peoples Commercial Services
Corporation acquisition 1,683,620 17,865 1,052 16,813 - - -
Financial Investment Corporation
acquisition 5,130,964 69,997 3,207 66,790 - - -
For exercise of stock options 875,556 4,834 547 4,287 - - -
Restricted: employee benefit plan 16,400 - 11 160 - - (171)
Common stock repurchased (9,654,216) (122,796) (6,034) (116,762) - - -
Change in unrealized market adjustment - 34,855 - - - 34,855 -
Amortization of deferred compensation
on restricted stock incentive plans - 1,165 - - - - 1,165
Other 8,316 844 5 764 75 - -
- ---------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1995 134,356,472 873,224 83,973 63,610 716,861 10,582 (1,802)
Net income - 179,907 - - 179,907 - -
Cash dividends declared - (73,593) - - (73,593) - -
Common stock issued:
For exercise of stock options 788,914 5,569 493 5,076 - - -
Restricted:
Employee benefit plan 204,392 - 128 2,890 - - (3,018)
Incentive to non-employee directors 18,000 - 11 285 - - (296)
Common stock repurchased (1,652,926) (28,356) (1,033) (27,323) - - -
Change in unrealized market adjustment - (7,885) - - - (7,885) -
Amortization of deferred compensation
on restricted stock incentive plans - 1,541 - - - - 1,541
Other 186 4,119 - 4,119 - - -
- ---------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1996 133,715,038 954,526 83,572 48,657 823,175 2,697 (3,575)
Net income - 197,472 - - 197,472 - -
Cash dividends declared - (79,362) - - (79,362) - -
Common stock issued:
Federal Flood Certification
Corporation acquisition 74,552 1,362 47 1,315 - - -
For exercise of stock options 1,899,888 24,174 1,187 22,987 - - -
Tax benefit from non-qualified
stock options - 4,962 - 4,962 - - -
Common stock repurchased (7,480,380) (169,492) (4,675) (34,928) (129,889) - -
Change in unrealized market adjustment - 12,636 - - - 12,636 -
Amortization of deferred compensation
on restricted stock incentive plans - 1,275 - - - - 1,275
Other 44 6,543 - 6,543 - - -
- ---------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1997 128,209,142 $ 954,096 $ 80,131 $ 49,536 $ 811,396 $ 15,333 $ (2,300)
===========================================================================================================================
</TABLE>
[FN]
See accompanying notes to consolidated financial statements.
</FN>
A-36
<PAGE> 62
CONSOLIDATED STATEMENTS OF CASH FLOWS FIRST TENNESSEE NATIONAL CORPORATION
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended December 31
-----------------------------------------------
(Dollars in thousands) 1997 1996 1995
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income $ 197,472 $ 179,907 $ 164,888
Adjustments to reconcile net income to net cash
provided/(used) by operating activities:
Provision for loan losses 51,115 35,677 20,592
Provision for deferred income tax 45,521 39,274 33,508
Depreciation and amortization of premises and equipment 32,784 28,806 25,289
Amortization of mortgage servicing rights 37,452 26,041 14,980
Amortization of intangible assets 9,631 9,491 8,100
Net other amortization and accretion 5,916 14,453 20,575
Market value adjustment on foreclosed property 9,145 6,479 4,266
Equity securities (gains)/losses 854 2,495 (3,195)
Debt securities (gains)/losses (141) 186 751
Net (gains)/losses on disposals of fixed assets (698) 270 1,421
Net (increase)/decrease in:
Capital markets inventory (102,838) 32,253 (12,624)
Mortgage loans held for sale (453,286) 1,821 (273,217)
Capital markets receivables (24,433) 29,174 (34,024)
Interest receivable (7,609) (865) (5,145)
Other assets (343,697) (250,156) (266,296)
Net increase/(decrease) in:
Capital markets payables 33,152 (39,643) 39,104
Interest payable 2,977 (626) 18,046
Other liabilities 46,655 (16,211) 152,620
- -------------------------------------------------------------------------------------------------------------------
Total adjustments (657,500) (81,081) (255,249)
- -------------------------------------------------------------------------------------------------------------------
Net cash provided/(used) by operating activities (460,028) 98,826 (90,361)
- -------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Held to maturity securities:
Maturities 12,656 10,184 89,457
Purchases - (1,462) (38,709)
Available for sale securities:
Sales 104,067 391,795 443,135
Maturities 767,625 476,770 189,229
Purchases (808,952) (1,016,553) (375,926)
Premises and equipment:
Sales 4,212 1,856 2,756
Purchases (56,099) (37,549) (38,545)
Net increase in loans (637,790) (424,844) (658,230)
Decrease in investment in bank time deposits (600) 197 415
Acquisitions, net of cash and cash equivalents acquired (185) 400 58,504
- -------------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (615,066) (599,206) (327,914)
- -------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Common stock:
Exercise of stock options 24,309 5,779 4,977
Cash dividends (78,348) (71,310) (62,694)
Repurchase of shares (169,520) (28,356) (122,796)
Term borrowings:
Issuance - - 164,182
Payments (65,923) (25,544) (18,035)
Issuance of guaranteed preferred beneficial interests
in First Tennessee's junior subordinated debentures 100,000 - -
Net increase/(decrease) in:
Deposits 638,717 444,121 306,737
Short-term borrowings 529,511 497,811 (56,200)
- -------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 978,746 822,501 216,171
- -------------------------------------------------------------------------------------------------------------------
Net increase/(decrease) in cash and cash equivalents (96,348) 322,121 (202,104)
- -------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at beginning of period 1,097,969 775,848 977,952
- -------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $1,001,621 $ 1,097,969 $ 775,848
===================================================================================================================
Total interest paid $ 454,881 $ 438,830 $ 396,063
Total income taxes paid 61,007 48,345 53,065
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
[FN]
See accompanying notes to consolidated financial statements.
</FN>
A-37
<PAGE> 63
FIRST TENNESSEE NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF ACCOUNTING. The consolidated financial statements of First Tennessee
National Corporation (First Tennessee), including its subsidiaries, are prepared
in conformity with generally accepted accounting principles and follow general
practice within the banking industry. This preparation requires management to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. These estimates and assumptions are based on
information available as of the date of the financial statements and could
differ from actual results.
PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION. The consolidated
financial statements include the accounts of First Tennessee and its
majority-owned subsidiaries. Affiliates that are not majority owned are
accounted for by the equity method. All significant intercompany transactions
and balances have been eliminated. For purposes of comparability, certain prior
period amounts have been reclassified to conform with current year presentation.
None of these reclassifications had any effect on net income or earnings per
share for any of the periods presented.
Prior year financial statements are restated to include the accounts of
companies that are acquired and accounted for as poolings of interests. Business
combinations accounted for as purchases are included in the financial statements
from the respective dates of acquisition.
STATEMENTS OF CASH FLOWS. For purposes of this statement, cash and due from
banks, federal funds sold, and securities purchased under agreements to resell
are considered cash and cash equivalents. Federal funds are usually sold for
one-day periods, and securities purchased under agreements to resell are
short-term, highly liquid investments.
The following significant non-cash stock transactions have been adjusted for a
two-for-one stock split that First Tennessee effected in February 1998 and for a
two-for-one stock split effected in February 1996. In 1995, First Tennessee
issued approximately 15,961,000 shares of its common stock related to the
acquisitions of Carl I. Brown and Company, Community Bancshares, Inc., Peoples
Commercial Services Corporation and Financial Investment Corporation.
CAPITAL MARKETS INVENTORY. Inventories purchased in connection with underwriting
or dealer activities are carried at market value. Gains and losses, both
realized and unrealized, on these inventories are reflected in noninterest
income as capital markets income.
INVESTMENT SECURITIES. Securities that First Tennessee has the ability and
positive intent to hold to maturity are classified as securities held to
maturity and are carried at amortized cost. Securities that may be sold prior to
maturity for asset/liability management purposes and equity securities are
classified as securities available for sale and are carried at fair value. The
unrealized gains and losses on securities available for sale are excluded from
earnings and are reported, net of tax, as a component of shareholders' equity.
The amortized cost of all securities is adjusted for amortization of premium and
accretion of discount to maturity, or earlier call date if appropriate, using
the level yield method. Such amortization and accretion is included in interest
income from securities. Realized gains and losses and declines in value judged
to be other than temporary are computed by the specific identification method
and reported in noninterest income.
SECURITIES PURCHASED UNDER RESALE AGREEMENTS AND SECURITIES SOLD UNDER
REPURCHASE AGREEMENTS. First Tennessee Capital Markets enters into short-term
purchases of securities under agreements to resell as a means of converting
proceeds from securities sold short into interest earning assets. Under these
transactions, the securities are delivered to the dealer custody account at the
Federal Reserve Bank.
Securities sold under agreements to repurchase (securities sold) are offered
to cash management customers as an automated, collateralized investment account.
Securities sold are also used by the regional banking group to obtain favorable
borrowing rates on its purchased funds. Under these transactions, securities are
delivered to the counterparty's custody account. In the normal course of
business, First Tennessee does not use this as a primary funding source.
MORTGAGE BANKING. First Tennessee's mortgage lenders originate loans with the
intent to sell them in the secondary market. Mortgage loans held for sale are
recorded at the lower of aggregate cost or market value. Gains and losses
realized from the sale of these assets and adjustments to market value are
included in noninterest income.
Servicing rights related to the mortgages sold are ordinarily retained.
Accounting standards require the recognition of mortgage servicing rights (MSRs)
as separate assets by allocating the total cost between the loan and the
servicing right based on their relative fair values. First Tennessee uses
valuations obtained from published pricing lists to determine the fair value of
the servicing rights created. These valuations are tested for reasonableness
A-38
<PAGE> 64
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
against prices obtained from flow and bulk sales of servicing and against prices
determined using a valuation model which calculates the present value of future
cash flows. Model assumptions are periodically reviewed and may be revised from
time to time to more accurately reflect current assumptions such as prepayment
speeds.
For purposes of impairment evaluation and measurement, the MSRs are stratified
based on the predominant risk characteristics of the underlying loans. For First
Tennessee, these strata include adjustable rate conventional and government;
fixed rate conventional and government by interest rate band; and multifamily.
The MSRs are amortized as noninterest expense over the period of and in
proportion to the estimated net servicing revenues. A quarterly value impairment
analysis is performed using a discounted cash flow methodology that is
disaggregated by predominant risk characteristics. Impairment, if any, is
recognized through a valuation allowance for individual strata. See further
detail about mortgage banking policies in the derivative financial instruments
disclosure below.
LOANS. Loans are stated at principal amounts outstanding, net of unearned
income. Interest on loans is recognized at the applicable interest rate on the
principal amount outstanding. Impaired loans are generally carried on a
nonaccrual status. Loans are ordinarily placed on nonaccrual status when, in
management's opinion, the collection of principal or interest is unlikely, or
when the collection of principal or interest is 90 days or more past due.
Consumer installment loans and credit card receivables are not placed on
nonaccrual status, but are charged off when past due 120 days and 180 days,
respectively.
Accrued but uncollected interest is reversed and charged against interest income
when the loan is placed on nonaccrual status. On consumer loans, accrued but
uncollected interest is reversed when the loan is charged off. Management may
elect to continue the accrual of interest when the estimated net realizable
value of collateral is sufficient to recover the principal balance and accrued
interest. Interest payments received on nonaccrual and impaired loans are
normally applied to principal. Once all principal has been received, additional
interest payments are recognized on a cash basis as interest income.
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is maintained at a
level that management determines is adequate to absorb losses inherent in the
loan portfolio. Management's assessment includes the systematic evaluation of
several factors: current and anticipated economic conditions and their impact on
specific borrowers and industry groups; the level of classified and
nonperforming loans; the historical loss experience by loan type; the results of
regulatory examinations of the portfolio; and, in specific cases, the estimated
value of underlying collateral. The actual amounts realized could differ in the
near term from the amounts assumed in arriving at the allowance for possible
loan losses reported in the financial statements.
All losses of principal are charged to the account when the loss actually
occurs or when a determination is made that a loss is probable. Additions are
made to the allowance through periodic provisions charged to current operations
and recovery of principal on loans previously charged off.
PREMISES AND EQUIPMENT. Premises and equipment are carried at cost less
accumulated depreciation and amortization and include additions that materially
extend the useful lives of existing premises and equipment. All other
maintenance and repair expenditures are expensed as incurred. Gains and losses
on dispositions are reflected in noninterest income and expense.
Depreciation and amortization are computed principally on the straight-line
method over the estimated useful lives of the assets and are expensed to
noninterest expense. Leasehold improvements are amortized over the lesser of the
lease periods or the estimated useful lives using the straight-line method.
REAL ESTATE ACQUIRED BY FORECLOSURE. Real estate acquired by foreclosure
consists of properties that have been acquired in satisfaction of debt. These
properties are carried at the lower of the outstanding loan amount or the
estimated fair market value minus the estimated cost to sell the real estate.
Losses arising at foreclosure are charged to the allowance for loan losses.
Required developmental costs associated with foreclosed property under
construction are capitalized and included in determining the estimated net
realizable value of the property which is reviewed periodically, and any
write-downs are charged against current earnings as market adjustments.
INTANGIBLE ASSETS. Intangible assets consist of "Premium on purchased deposits
and assets" and "Goodwill." The "Premium on purchased deposits and assets"
represents identified intangible assets, which are amortized over their
estimated useful lives, except for those assets related to deposit bases that
are primarily amortized over 10 years. "Goodwill" represents the excess of cost
over net assets of acquired subsidiaries less identifiable intangible assets and
is amortized to noninterest expense using the straight-line method over periods
ranging from 15 to 40 years. Management evaluates whether events or
circumstances have occurred that indicate the remaining useful life or carrying
value of goodwill should be revised.
A-39
<PAGE> 65
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
DERIVATIVE FINANCIAL INSTRUMENTS. First Tennessee utilizes derivative financial
instruments in order to manage exposure to fluctuations in interest rates and to
meet the financial needs of customers. For interest rate risk management
purposes, First Tennessee primarily utilizes interest rate swaps. Mortgage
banking operations mainly use mandatory forward delivery commitments and
purchased options to hedge against risks associated with the warehouse, the
pipeline, or the servicing portfolio. Capital markets uses various derivatives,
including interest rate swaps, futures, forward and option contracts and
securities underwriting commitments in order to meet the needs of its customers
with forwards being the most commonly used instrument.
To qualify as a hedge used to manage interest rate risk, the following criteria
must be met: (1) the asset or liability to be hedged exposes First Tennessee to
interest rate risk; (2) the instrument alters or reduces sensitivity to interest
rate changes; and (3) the instrument is designated and effective as a hedge.
For interest rate contracts used to hedge interest rate risk, income and expense
are deferred and amortized over the lives of the hedged assets or liabilities.
The amortization of this income and expense is an adjustment to interest income
or expense of the hedged item. Fees are deferred and amortized over the lives of
the contracts. Any related assets or liabilities are recorded on the balance
sheet in other assets or other liabilities.
For those derivatives used to manage interest rate risk that are terminated
prior to maturity, realized gains and losses are deferred and amortized
straight-line over the remaining original life of the agreement as an adjustment
to the hedged asset or liability. If the underlying hedged asset or liability is
sold or prepaid, the related portion of any unrecognized gain or loss on the
derivative is recognized in current earnings as part of the gain or loss on the
sale or prepayment.
Forward and option contracts used by mortgage banking operations to hedge
against interest rate risks in the warehouse and the pipeline are designated to
a specific asset and are reviewed periodically for a high correlation of
expected changes in value. Option contracts used to hedge against risks in the
servicing portfolio are designated to a specific risk tranche of servicing
rights, must reduce earnings risk, and are periodically reviewed for a high
correlation of expected changes in value.
Forward and option contracts used to hedge the warehouse are considered in the
lower of cost or market valuation of the warehouse with any related gains or
losses being recognized in mortgage banking noninterest income. Premiums paid
for purchased options are deferred and reported in other assets and are
amortized over the lives of the contracts to mortgage banking noninterest
income.
Options used to hedge the servicing portfolio are adjusted for changes in
intrinsic value with gains and losses recognized as a basis adjustment of the
related mortgage servicing rights risk tranche. Premiums are deferred and
amortized on a straight-line basis over the contract life to other noninterest
expense. The deferred gains and losses are recognized on the balance sheet in
mortgage servicing rights, and unamortized premiums are recorded in other
assets.
For derivatives hedging the warehouse and pipeline that are terminated prior to
maturity, gains and losses are recognized in current earnings as mortgage
banking noninterest income for excess coverage and are deferred and recognized
at the time the loan is sold if the sale is deferred to a future date. For
derivatives hedging the servicing portfolio that are terminated prior to
maturity, gains and losses are split between the return of time value premium
and the intrinsic value. Gains or losses from the change in the intrinsic value
are deferred as a basis adjustment to the related mortgage servicing rights risk
tranche, and the gains or losses resulting from the return of time value premium
are recognized in current earnings in other noninterest expense.
Any contracts that fail to qualify for hedge accounting are measured at fair
value with any gains or losses included in current earnings in noninterest
income.
Derivative contracts utilized in trading activities by capital markets are
measured at fair value, and gains or losses are recognized in capital markets
noninterest income as they occur. Related assets are recorded on the balance
sheet as capital markets inventory or receivables and any liabilities are
recognized as capital markets payables.
Cash flows from derivative contracts are reported as operating activities on the
Consolidated Statements of Cash Flows.
INCOME TAXES. The provision for income taxes is based on income reported for
consolidated financial statement purposes and includes deferred taxes resulting
from the recognition of certain revenues and expenses in different periods for
tax reporting purposes. First Tennessee files a consolidated federal income tax
return except for a credit life insurance company which files a separate return.
A-40
<PAGE> 66
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EARNINGS PER SHARE. Earnings per share is computed by dividing net income by the
weighted average number of common shares outstanding for each period. Diluted
earnings per share is computed by dividing net income by the weighted average
number of common shares outstanding adjusted to include the number of additional
common shares that would have been outstanding if the dilutive potential common
shares resulting from options granted under First Tennessee's stock option plans
had been issued. First Tennessee utilizes the treasury stock method in this
calculation. Previously reported per share amounts have been restated for the
effect of acquisitions accounted for as poolings of interests and for both the
February 20, 1998, and February 16, 1996, two-for-one stock splits.
ACCOUNTING CHANGES. On January 1, 1997, First Tennessee adopted Statement of
Financial Accounting Standards (SFAS) No. 125, "Accounting for the Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." The
Statement provides consistent standards for distinguishing transfers of
financial assets that are sales from transfers that are secured borrowings based
on a control-oriented "financial components" approach. Under this approach,
after a transfer of financial assets, an entity recognizes the financial and
servicing assets it controls and liabilities it has incurred, derecognizes
financial assets when control has been surrendered and derecognizes liabilities
when extinguished. The adoption of this standard required a change in the method
used to recognize mortgage servicing rights, increasing both the amortization
expense as well as the servicing income. In addition, certain construction loan
participations which were originally recorded as sales are now reflected as
borrowings.
SFAS No. 128, "Earnings per Share," was adopted as of January 1, 1997. This
standard specifies the computation, presentation and disclosure requirements for
earnings per share (EPS). The objective of SFAS No. 128 is to simplify the
computation and to make the United States' standard more compatible with EPS
standards of other countries and with that of the International Accounting
Standards Committee. First Tennessee now presents on the income statement both
earnings per share and diluted earnings per share for all periods presented.
On January 1, 1996, First Tennessee adopted SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of."
This standard requires that long-lived assets and certain identifiable
intangibles be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. If the expected undiscounted future cash flows from the use of the
asset and its eventual disposition are less than the carrying amount of the
asset, an impairment loss is recognized. The impairment loss is measured based
upon the present value of the expected future cash flows.
SFAS No. 123, "Accounting for Stock-Based Compensation," was adopted January 1,
1996. SFAS No. 123 defines a fair value-based method of accounting for
stock-based compensation plans. Under the fair value-based method, compensation
cost is measured at the grant date based upon the value of the award and is
recognized over the service period. The standard encourages all entities to
adopt this method of accounting; however, it allows an entity to continue to
measure compensation costs for its plans as prescribed in Accounting Principles
Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees." Under
this election, First Tennessee continues to account for stock-based compensation
in accordance with APB Opinion No. 25 and provides additional disclosure on the
pro forma impact of the fair value-based method under SFAS No. 123. See Note 19
- - Stock Option, Restrictive Stock Incentive, and Dividend Reinvestment Plans for
further disclosure.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income," which establishes standards for reporting
comprehensive income and its components in the financial statements.
Comprehensive income is the total of net income and all other nonowner changes
in equity. The only component of comprehensive income First Tennessee currently
would be required to report is unrealized holding gains/(losses) on
available-for-sale securities. First Tennessee will adopt this standard in the
first quarter of 1998.
A-41
<PAGE> 67
NOTE 2 - ACQUISITIONS
On July 14, 1997, First Tennessee acquired for approximately 75,000 shares of
its common stock all of the outstanding common stock of Federal Flood
Certification Corporation (Federal Flood), located in Dallas, Texas. Federal
Flood became a wholly owned subsidiary of First Tennessee Bank National
Association (FTBNA), the principal subsidiary of First Tennessee. The
acquisition was accounted for as a purchase and was immaterial to First
Tennessee.
The following table provides information concerning acquisitions completed
during the three years ended December 31, 1997. Acquisitions accounted for as
poolings of interests are included in First Tennessee's consolidated financial
statements for all periods presented. Acquisitions accounted for as purchases
are included in the financial statements from the date of the acquisition. All
share information reflects the 1998 and 1996 two-for-one stock splits.
<TABLE>
<CAPTION>
Date of
Acquisition Location Acquisition
- -----------------------------------------------------------------------------
<S> <C> <C>
Federal Flood Certification Corporation Dallas, Texas 7/14/97
Financial Investment Corporation Springdale, Arkansas 10/1/95
HomeBanc Mortgage Corporation* Atlanta, Georgia 7/1/95
Peoples Commercial Services Corporation Senatobia, Mississippi 4/1/95
Community Bancshares, Inc. Germantown, Tennessee 2/24/95
Carl I. Brown and Company Kansas City, Missouri 1/3/95
- -----------------------------------------------------------------------------
<CAPTION>
Common Shares
Issued Method of
Acquisition (thousands) Accounting
- ------------------------------------------------------------------------------
<S> <C> <C>
Federal Flood Certification Corporation 75 Purchase
Financial Investment Corporation 5,131 Purchase
HomeBanc Mortgage Corporation* $7 million cash Purchase
Peoples Commercial Services Corporation 1,684 Purchase
Community Bancshares, Inc. 5,684 Pooling
Carl I. Brown and Company 3,462 Pooling
- ------------------------------------------------------------------------------
</TABLE>
[FN]
* Acquired certain assets and liabilities.
</FN>
NOTE 3 - INVESTMENT SECURITIES
The following tables summarize First Tennessee's securities held to maturity and
available for sale at December 31, 1997 and 1996:
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997*
-----------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
(Dollars in thousands) Cost Gains Losses Value
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
SECURITIES HELD TO MATURITY:
States and municipalities $ 53,230 $ 1,270 $ (177) $ 54,323
- -------------------------------------------------------------------------------------------------------------
SECURITIES AVAILABLE FOR SALE:
U.S. Treasury and other
U.S. government agencies $ 364,157 $ 2,242 $ (387) $ 366,012
Government agency
issued MBS 248,876 4,305 (943) 252,238
Government agency
issued CMOs 1,380,289 9,040 (884) 1,388,445
States and municipalities 22,539 851 -- 23,390
Private issue CMOs 1,212 23 -- 1,235
Other 10,290 117 (608) 9,799
Equity** 80,608 13,040 (1,464) 92,184
- -------------------------------------------------------------------------------------------------------------
Total securities available for sale $2,107,971 $ 29,618 $ (4,286) $2,133,303
=============================================================================================================
</TABLE>
[FN]
* Includes $1,816,347,000 of securities pledged to secure public deposits,
securities sold under agreements to repurchase and for other purposes.
** Equity securities include venture capital investment securities.
</FN>
A-42
<PAGE> 68
NOTE 3 - INVESTMENT SECURITIES (CONTINUED)
<TABLE>
<CAPTION>
At December 31, 1996*
-----------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
(Dollars in thousands) Cost Gains Losses Value
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
SECURITIES HELD TO MATURITY:
States and municipalities $ 65,914 $ 1,083 $ (320) $ 66,677
- -------------------------------------------------------------------------------------------------------------
SECURITIES AVAILABLE FOR SALE:
U.S. Treasury and other
U.S. government agencies $ 469,483 $ 3,136 $ (513) $ 472,106
Government agency
issued MBS 318,924 4,248 (3,737) 319,435
Government agency
issued CMOs 1,263,693 4,865 (4,002) 1,264,556
States and municipalities 25,169 956 (8) 26,117
Private issue CMOs 1,502 19 -- 1,521
Other 17,381 138 (528) 16,991
Equity** 71,529 1,756 (391) 72,894
- -------------------------------------------------------------------------------------------------------------
Total securities available for sale $2,167,681 $ 15,118 $ (9,179) $2,173,620
=============================================================================================================
</TABLE>
[FN]
* Includes $1,682,483,000 of securities pledged to secure public deposits,
securities sold under agreements to repurchase and for other purposes.
** Equity securities include venture capital investment securities.
</FN>
Provided below are the amortized cost and estimated fair value by contractual
maturity for the securities portfolios at December 31, 1997:
<TABLE>
<CAPTION>
Held to Maturity Available for Sale
-------------------------- --------------------------
Estimated Estimated
By Contractual Maturity Amortized Fair Amortized Fair
(Dollars in thousands) Cost Value Cost Value
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Within 1 year $ 4,087 $ 4,110 $ 121,392 $ 121,421
After 1 year; within 5 years 11,275 11,433 248,245 249,699
After 5 years; within 10 years 21,596 22,172 26,459 27,139
After 10 years 16,272 16,608 890 942
- ---------------------------------------------------------------------------------------------------
Subtotal 53,230 54,323 396,986 399,201
- ---------------------------------------------------------------------------------------------------
Mortgage-backed securities and CMOs -- -- 1,630,377 1,641,918
Equity securities -- -- 80,608 92,184
- ---------------------------------------------------------------------------------------------------
Total $ 53,230 $ 54,323 $2,107,971 $2,133,303
===================================================================================================
</TABLE>
[FN]
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without call or
prepayment penalties.
</FN>
A-43
<PAGE> 69
NOTE 3 - INVESTMENT SECURITIES (CONTINUED)
The table below provides information on realized gross gains and realized gross
losses on sales from the available for sale portfolio for the years ended
December 31:
<TABLE>
<CAPTION>
Available Available
for Sale - for Sale -
(Dollars in thousands) Debt Equity Total
- ---------------------------------------------------------------
<S> <C> <C> <C>
1997
Gross gains on sales $ 373 $ 214 $ 587
Gross losses on sales (441) -- (441)
- ---------------------------------------------------------------
1996
Gross gains on sales $ 1,164 $ 540 $ 1,704
Gross losses on sales (1,385) -- (1,385)
- ---------------------------------------------------------------
1995
Gross gains on sales $ 514 $ 5,466 $ 5,980
Gross losses on sales (742) (114) (856)
- ---------------------------------------------------------------
</TABLE>
NOTE 4 - LOANS
A summary of the major categories of loans outstanding at December 31 is shown
below:
<TABLE>
<CAPTION>
(Dollars in thousands) 1997 1996
- ----------------------------------------------------------------------
<S> <C> <C>
Commercial $3,768,554 $3,521,473
Consumer:
Real estate* 1,954,590 1,753,933
Auto 505,536 571,473
Student 257,518 245,336
Other 137,596 113,217
- ----------------------------------------------------------------------
Total consumer 2,855,240 2,683,959
Permanent mortgage 663,494 641,245
Credit card receivables 581,451 564,803
Real estate construction 404,196 297,797
Nonaccrual 38,415 18,926
- ----------------------------------------------------------------------
Loans, net of unearned income** 8,311,350 7,728,203
Allowance for loan losses 125,859 117,748
- ----------------------------------------------------------------------
Total net loans $8,185,491 $7,610,455
======================================================================
</TABLE>
[FN]
* Consumer real estate loans included $1,910,323,000 and $1,705,758,000 of
first and second liens and home equity loans at December 31, 1997 and 1996,
respectively.
** Loans are presented net of $5,244,000 and $5,023,000 of unearned income at
December 31, 1997 and 1996, respectively.
</FN>
On January 1, 1995, First Tennessee adopted SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan" and SFAS No. 118, "Accounting by Creditors
for Impairment of a Loan - Income Recognition and Disclosures." On that date,
impaired loans included in nonperforming loans totaled $9,742,000 with a related
allowance of $2,542,000. Included in nonperforming loans are other nonaccrual
loans and loans which have been restructured. At December 31, 1997 and 1996,
there were no outstanding commitments to advance additional funds to customers
whose loans had been restructured. The following table presents nonperforming
loans at December 31:
<TABLE>
<CAPTION>
(Dollars in thousands) 1997 1996
- ----------------------------------------------------------
<S> <C> <C>
Impaired loans $ 8,712 $10,322
Other nonaccrual loans 29,703 8,604
- ----------------------------------------------------------
Total nonperforming loans $38,415 $18,926
==========================================================
</TABLE>
[FN]
Restructured impaired loans at December 31, 1997 and 1996, were $196,000 and
$279,000, respectively.
</FN>
A-44
<PAGE> 70
NOTE 4 - LOANS (CONTINUED)
Interest income received during 1997 for impaired loans was $197,000 and for
other nonaccrual loans was $669,000. Under their original terms, interest income
would have been approximately $1,005,000 for the impaired loans and $2,533,000
for the other nonaccrual loans outstanding at December 31, 1997. The average
balance of impaired loans was approximately $11,187,000 for 1997 and $9,784,000
for 1996.
Activity in the allowance for loan losses related to non-impaired and impaired
loans for years ended December 31 is summarized as follows:
<TABLE>
<CAPTION>
(Dollars in thousands) Non-impaired Impaired Total
- ----------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at December 31, 1994 $ 109,859 $ -- $ 109,859
Transfer of allowance (2,542) 2,542 --
Allowance from acquisitions 2,632 -- 2,632
Provision for loan losses 14,388 6,204 20,592
Charge-offs (29,766) (5,465) (35,231)
Loan recoveries 14,480 235 14,715
- ----------------------------------------------------------------------------
Net charge-offs (15,286) (5,230) (20,516)
- ----------------------------------------------------------------------------
Balance at December 31, 1995 109,051 3,516 112,567
Provision for loan losses 33,179 2,498 35,677
Charge-offs (39,555) (2,827) (42,382)
Loan recoveries 11,542 344 11,886
- ----------------------------------------------------------------------------
Net charge-offs (28,013) (2,483) (30,496)
- ----------------------------------------------------------------------------
Balance at December 31, 1996 114,217 3,531 117,748
Provision for loan losses 46,007 5,108 51,115
Charge-offs (48,974) (5,301) (54,275)
Loan recoveries 10,857 414 11,271
- ----------------------------------------------------------------------------
Net charge-offs (38,117) (4,887) (43,004)
- ----------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1997 $ 122,107 $ 3,752 $ 125,859
============================================================================
</TABLE>
Certain executive officers and directors (and their associates) of First
Tennessee were loan customers during 1997 and 1996. Such loans are at normal
credit terms, including interest rates and collateral, and do not represent more
than a normal risk of collection. The following is a summary of related party
loans outstanding and the activity for the years ended December 31:
<TABLE>
<CAPTION>
(Dollars in thousands) 1997 1996
- ------------------------------------------------------------
<S> <C> <C>
Balance at beginning of year $ 101,573 $ 128,911
Additions 307,895 292,615
Deletions:
Repayments (307,383) (254,775)
No longer related (16,218) (65,178)
- ------------------------------------------------------------
Total deletions (323,601) (319,953)
- ------------------------------------------------------------
BALANCE AT END OF YEAR $ 85,867 $ 101,573
============================================================
</TABLE>
Amounts due from customers on acceptances and bank acceptances outstanding were
$2,487,000 and $4,329,000 at December 31, 1997 and 1996, respectively.
A-45
<PAGE> 71
NOTE 5 - PREMISES, EQUIPMENT AND LEASES
Premises and equipment at December 31 are summarized below:
<TABLE>
<CAPTION>
(Dollars in thousands) 1997 1996
- --------------------------------------------------------------------------
<S> <C> <C>
Land $ 31,373 $ 29,130
Buildings 137,373 130,822
Leasehold improvements 27,833 20,272
Furniture, fixtures and equipment 183,826 176,151
- --------------------------------------------------------------------------
Premises and equipment, at cost 380,405 356,375
Less accumulated depreciation and amortization 173,510 170,751
- --------------------------------------------------------------------------
Premises and equipment, net $206,895 $185,624
==========================================================================
</TABLE>
First Tennessee is obligated under a number of noncancelable operating leases
for premises and equipment with terms up to 20 years, which may include the
payment of taxes, insurance and maintenance costs.
Minimum future lease payments for operating leases on premises and equipment at
December 31, 1997, are shown below:
<TABLE>
<CAPTION>
(Dollars in thousands)
- -----------------------------------------------------------------
<S> <C>
1998 $ 26,997
1999 23,272
2000 17,476
2001 14,286
2002 10,474
2003 and after 20,740
- -----------------------------------------------------------------
Total minimum lease payments $113,245
=================================================================
</TABLE>
[FN]
Payments required under capital leases are not material.
</FN>
Rent expense incurred under all operating lease obligations was as follows for
the years ended December 31:
<TABLE>
<CAPTION>
(Dollars in thousands) 1997 1996 1995
- ----------------------------------------------------------------
<S> <C> <C> <C>
Rent expense, gross $ 29,820 $ 27,746 $ 27,779
Rent income (1,670) (1,517) (1,776)
- ----------------------------------------------------------------
Rent expense, net $ 28,150 $ 26,229 $ 26,003
================================================================
</TABLE>
A-46
<PAGE> 72
NOTE 6 - CAPITALIZED MORTGAGE SERVICING RIGHTS
Following is a summary of changes in capitalized mortgage servicing rights, net
of accumulated amortization, included in the Consolidated Statements of
Condition:
<TABLE>
<CAPTION>
(Dollars in thousands)
- --------------------------------------------------------
<S> <C>
December 31, 1994 $ 72,722
Amortization (14,980)
Originated mortgage servicing rights 92,262
Purchased mortgage servicing rights, net (784)
- --------------------------------------------------------
December 31, 1995 149,220
Amortization (26,041)
Addition of mortgage servicing rights 144,988
Sales of mortgage servicing rights (2,140)
- --------------------------------------------------------
December 31, 1996 266,027
Amortization (37,452)
Addition of mortgage servicing rights 182,959
Sales of mortgage servicing rights (2,613)
- --------------------------------------------------------
DECEMBER 31, 1997 $ 408,921
========================================================
</TABLE>
The mortgage servicing rights at December 31, 1997 and 1996, had estimated
market values of approximately $437.7 million and $293.1 million, respectively.
These balances represent the rights to service approximately $24 billion and $19
billion of mortgage loans at December 31, 1997 and 1996. In addition, First
Tennessee had approximately $2 billion and $3 billion of mortgage loans for
which the servicing rights were not capitalized at December 31, 1997 and 1996.
These mortgage servicing rights had estimated market values of $15.8 million and
$30.6 million, respectively. No valuation allowance was required as of December
31, 1997 or 1996.
NOTE 7 - INTANGIBLE ASSETS
Following is a summary of intangible assets, net of accumulated amortization,
included in the Consolidated Statements of Condition:
<TABLE>
<CAPTION>
Premium on
Purchased
Deposits
(Dollars in thousands) Goodwill and Assets
- -------------------------------------------------------
<S> <C> <C>
December 31, 1994 $ 66,086 $ 25,639
Amortization expense (3,676) (4,424)
Acquisitions 29,382 15,978
- -------------------------------------------------------
December 31, 1995 91,792 37,193
Amortization expense (4,386) (5,105)
Acquisitions/Divestitures 237 (266)
- -------------------------------------------------------
December 31, 1996 87,643 31,822
Amortization expense (4,343) (5,288)
Acquisitions/Divestitures 377 2,200
- -------------------------------------------------------
December 31, 1997 $ 83,677 $ 28,734
=======================================================
</TABLE>
A-47
<PAGE> 73
NOTE 8 - TIME DEPOSIT MATURITIES
Following is a table of maturities for time deposits outstanding at December 31,
1997, which include "Certificates of deposit under $100,000 and other time" and
"Certificates of deposit $100,000 and more". "Certificates of deposit $100,000
and more" totaled $735,188,000 at December 31, 1997. Time deposits are included
in "Interest-bearing" deposits on the Consolidated Statements of Condition.
<TABLE>
<CAPTION>
(Dollars in thousands)
- -----------------------------------------------------
<S> <C>
1998 $2,360,733
1999 624,752
2000 214,870
2001 76,916
2002 and after 153,599
- -----------------------------------------------------
Total $3,430,870
=====================================================
</TABLE>
NOTE 9 - SHORT-TERM BORROWINGS
Short-term borrowings include federal funds purchased and securities sold under
agreements to repurchase, commercial paper, and other borrowed funds which
include term federal funds purchased, short-term bank notes, and advances from
the Federal Home Loan Bank. The advances from the Federal Home Loan Bank, which
totaled $250 million at December 31, 1997, are collateralized 150 percent with
first-lien permanent mortgage loans of FTBNA.
Federal funds purchased and securities sold under agreements to repurchase and
commercial paper generally have maturities of less than 90 days. Other
short-term borrowings have original maturities of one year or less.
The detail of these borrowings for the years 1997, 1996 and 1995 is presented in
the following table:
<TABLE>
<CAPTION>
Federal Funds
Purchased and
Securities Sold Other
Under Agreements Commercial Short-term
(Dollars in thousands) to Repurchase Paper Borrowings
- -----------------------------------------------------------------------------------
<S> <C> <C> <C>
1997
Average balance $1,790,130 $ 20,792 $ 642,235
Year-end balance 2,085,679 23,176 679,212
Maximum month-end outstanding 2,085,679 24,170 873,739
Average rate for the year 5.01% 4.64% 6.23%
Average rate at year-end 5.56 4.70 6.07
1996
Average balance $1,588,101 $ 22,207 $ 497,870
Year-end balance 1,881,187 22,648 354,721
Maximum month-end outstanding 1,881,187 33,790 699,113
Average rate for the year 4.91% 4.39% 6.15%
Average rate at year-end 5.65 4.43 5.92
1995
Average balance $1,491,033 $ 35,579 $ 368,630
Year-end balance 1,674,225 29,402 57,118
Maximum month-end outstanding 1,953,448 44,755 547,131
Average rate for the year 5.43% 5.14% 7.07%
Average rate at year-end 4.96 4.59 6.52
- -----------------------------------------------------------------------------------
</TABLE>
At December 31, 1997, $50.0 million of borrowings under unsecured lines of
credit from non-affiliated banks were available to the parent company to provide
for general liquidity needs at an annual facility fee of .10 percent.
A-48
<PAGE> 74
NOTE 10 - TERM BORROWINGS
The following table presents information pertaining to term borrowings (debt
with original maturities greater than one year) for First Tennessee and its
subsidiaries at December 31:
<TABLE>
<CAPTION>
(Dollars in thousands) 1997 1996
- -----------------------------------------------------------------------------------
<S> <C> <C>
FIRST TENNESSEE NATIONAL CORPORATION:
Subordinated capital notes:
Matures on June 1, 1999 -- 10 3/8% $ 74,873 $ 74,782
Matures on November 15, 2005 -- 6 3/4% 74,356 74,275
FIRST TENNESSEE BANK NATIONAL ASSOCIATION:
Notes payable to Federal Home Loan Bank*:
Matures on January 29, 1999 -- 7.95% 15,000 15,000
Matures through 1998 -- 7.50% 1,383 6,661
Matures through 2009 -- 8.10% 2,383 2,583
Matured on January 3, 1997 -- 7.95% -- 25,000
Matured on April 3, 1997 -- 7.95% -- 25,000
Matured on October 3, 1997 -- 8.05% -- 10,000
Industrial development bond payable to City of
Alcoa, Tennessee; matures 1999 -- 6.50% 200 300
CLEVELAND BANK AND TRUST COMPANY:
Industrial development bond payable to City of
Cleveland, Tennessee; matures through 1999 --
65% of prime (5.525% and 5.3625% at
December 31, 1997 and 1996, respectively) 698 1,044
- -----------------------------------------------------------------------------------
Total $168,893 $234,645
===================================================================================
</TABLE>
[FN]
* The Federal Home Loan Bank borrowings are collateralized 150 percent with
first-lien permanent mortgage loans of FTBNA.
</FN>
Annual principal repayment requirements as of December 31, 1997, are as follows:
<TABLE>
<CAPTION>
(Dollars in thousands)
- -----------------------------------------------------------------------
<S> <C>
1998 $ 1,929
1999 90,752
2000 200
2001 200
2002 200
2003-2010 76,383
- -----------------------------------------------------------------------
</TABLE>
At maturity, the 10 3/8 percent subordinated notes will be redeemed, at First
Tennessee's option, in cash from the proceeds of the sale of capital securities,
or exchanged for qualifying capital securities having a market value equal to
the principal amount of the notes. These notes are unsecured and subordinate to
all present and future senior debt of First Tennessee.
A-49
<PAGE> 75
NOTE 11 - GUARANTEED PREFERRED BENEFICIAL INTERESTS IN FIRST TENNESSEE'S
JUNIOR SUBORDINATED DEBENTURES
On December 30, 1996, First Tennessee, through its underwriters, sold to
institutional investors $100 million of capital securities. First Tennessee
Capital I (Capital I), a Delaware business trust wholly owned by First
Tennessee, issued $100 million of Capital Securities, Series A at 8.07%. The
proceeds were upstreamed to First Tennessee as junior subordinated debt under
the same terms and conditions. First Tennessee has, through various contractual
arrangements, fully and unconditionally guaranteed all of Capital I's
obligations with respect to the capital securities. These capital securities
qualify as Tier I capital and are presented in the Consolidated Statements of
Condition as "Guaranteed Preferred Beneficial Interests in First Tennessee's
Junior Subordinated Debentures." The sole asset of Capital I is $103 million of
junior subordinated debentures issued by First Tennessee. These junior
subordinated debentures also carry an interest rate of 8.07 percent. Both the
capital securities of Capital I and the junior subordinated debentures of First
Tennessee will mature on January 6, 2027; however, under certain circumstances,
the maturity of both may be shortened to a date not earlier than January 6,
2017. Although December 30, 1996, was the trade date for this sale, the
transaction settled on January 6, 1997. During 1997, under an accelerated
purchase program the proceeds from this issuance were used to repurchase 3.8
million shares at a cost of $83.3 million.
NOTE 12 - REGULATORY CAPITAL
First Tennessee is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory, and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on First Tennessee's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
specific capital guidelines that involve quantitative measures of assets,
liabilities and certain off-balance sheet items as calculated under regulatory
accounting practices must be met. Capital amounts and classification are also
subject to qualitative judgment by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require First Tennessee to maintain minimum amounts and ratios of total and Tier
1 capital to risk-weighted assets, and of Tier 1 capital to average assets
(leverage). Management believes, as of December 31, 1997, that First Tennessee
met all capital adequacy requirements to which it was subject.
The most recent notification from the Office of the Comptroller of the Currency
at November 30, 1997, categorized First Tennessee as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized First Tennessee must maintain minimum total risk-based, Tier 1
risk-based, and Tier 1 leverage ratios as set forth in the table. In the opinion
of management, at December 31, 1997, no conditions or events have occurred since
that notification that would change First Tennessee's category.
A-50
<PAGE> 76
NOTE 12 - REGULATORY CAPITAL (CONTINUED)
The actual capital amounts and ratios of First Tennessee and FTBNA (the primary
banking subsidiary of First Tennessee) are presented in the table below:
<TABLE>
<CAPTION>
First Tennessee National First Tennessee Bank
Corporation National Association
--------------------------- -----------------------
(Dollars in thousands) Amount Ratio Amount Ratio
- -----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
AS OF DECEMBER 31, 1997:
Actual:
Total Capital $1,213,578 11.65% $1,041,057 10.61%
Tier 1 Capital 938,456 9.01 848,817 8.65
Leverage 938,456 6.83 848,817 6.62
For Capital Adequacy Purposes:
Total Capital 833,448 >or= 8.00 785,138 >or= 8.00
Tier 1 Capital 416,724 >or= 4.00 392,569 >or= 4.00
Leverage 549,791 >or= 4.00 513,165 >or= 4.00
To Be Well Capitalized Under
Prompt Corrective
Action Provisions:
Total Capital 1,041,810 >or= 10.00 981,422 >or= 10.00
Tier 1 Capital 625,086 >or= 6.00 588,853 >or= 6.00
Leverage 687,239 >or= 5.00 641,456 >or= 5.00
- -----------------------------------------------------------------------------------
As of December 31, 1996:
Actual:
Total Capital $1,123,633 11.81% $993,977 11.11%
Tier 1 Capital 856,769 9.00 809,513 9.05
Leverage 856,769 6.80 809,513 6.93
For Capital Adequacy Purposes:
Total Capital 761,209 >or= 8.00 715,724 >or= 8.00
Tier 1 Capital 380,604 >or= 4.00 357,862 >or= 4.00
Leverage 504,151 >or= 4.00 467,236 >or= 4.00
To Be Well Capitalized Under
Prompt Corrective
Action Provisions:
Total Capital 951,511 >or= 10.00 894,655 >or= 10.00
Tier 1 Capital 570,906 >or= 6.00 536,793 >or= 6.00
Leverage 630,189 >or= 5.00 584,045 >or= 5.00
- -----------------------------------------------------------------------------------
</TABLE>
The following table details the actual regulatory capital ratios for other bank
subsidiaries at December 31, 1997:
<TABLE>
<CAPTION>
FNB Peoples
CBT Springdale FTBNA-MS Peoples and Union Planters
(1) (2) (3) (4) (5) (6)
- -----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
AS OF DECEMBER 31, 1997:
Total Capital 13.65% 17.91% 14.23% 18.93% 12.95% 19.07%
Tier 1 Capital 12.39 16.78 13.32 17.68 11.77 17.80
Leverage 7.84 9.41 9.23 9.96 7.55 8.39
- -----------------------------------------------------------------------------------
</TABLE>
[FN]
(1)Cleveland Bank and Trust Company (2)First National Bank of Springdale
(3)First Tennessee Bank National Association Mississippi
(4)Peoples Bank of Senatobia (5)Peoples and Union Bank (6)Planters Bank
</FN>
A-51
<PAGE> 77
NOTE 13 - OTHER INCOME AND OTHER EXPENSE
Following is detail concerning "All other income and commissions" and "All other
expense" as presented in the Consolidated Statements of Income:
<TABLE>
<CAPTION>
(Dollars in thousands) 1997 1996 1995
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
ALL OTHER INCOME AND COMMISSIONS:
Check clearing fees $ 13,043 $ 16,873 $ 17,585
Other service charges 10,474 9,891 7,709
Other 37,953 31,517 25,888
- ------------------------------------------------------------------------------------------
Total $ 61,470 $ 58,281 $ 51,182
==========================================================================================
ALL OTHER EXPENSE:
Contract employment $ 17,420 $ 11,288 $ 5,744
Supplies 15,267 14,383 11,866
Legal and professional fees 13,999 12,050 13,403
Travel and entertainment 13,802 10,394 8,211
Foreclosed real estate 10,827 7,533 4,962
Distributions on guaranteed preferred securities 8,070 -- --
Fed service fees 5,799 7,814 9,489
Deposit insurance premium 1,485 5,129 9,957
Other 55,068 46,328 31,133
- ------------------------------------------------------------------------------------------
Total $141,737 $114,919 $ 94,765
==========================================================================================
</TABLE>
NOTE 14 - INCOME TAXES
The components of income tax expense are as follows:
<TABLE>
<CAPTION>
(Dollars in thousands) 1997 1996 1995
- --------------------------------------------------------------------
<S> <C> <C> <C>
Current:
Federal $ 68,665 $ 52,090 $46,502
State 3,409 10,903 8,059
Deferred:
Federal 34,674 40,266 29,734
State 10,847 (992) 3,774
- --------------------------------------------------------------------
Total $117,595 $102,267 $88,069
====================================================================
</TABLE>
The effective tax rates for 1997, 1996 and 1995 were 37.32 percent, 36.24
percent and 34.82 percent, respectively. Income tax expense was different than
the amounts computed by applying the statutory federal income tax rate to income
before income taxes because of the following:
<TABLE>
<CAPTION>
(Dollars in thousands) 1997 1996 1995
- -----------------------------------------------------------------------------------
<S> <C> <C> <C>
Federal income tax rate 35% 35% 35%
- -----------------------------------------------------------------------------------
Tax computed at statutory rate $110,274 $ 98,761 $88,535
Increase/(decrease) resulting from:
Tax-exempt interest (2,494) (3,269) (2,922)
State income taxes 9,073 6,472 7,691
Adjustment of prior years'
estimated liabilities -- -- (5,675)
Other 742 303 440
- -----------------------------------------------------------------------------------
Total $117,595 $102,267 $88,069
===================================================================================
</TABLE>
A-52
<PAGE> 78
NOTE 14 - INCOME TAXES (CONTINUED)
A deferred tax asset or liability is recognized for the tax consequences of
temporary differences between the financial statement carrying amounts and the
tax bases of existing assets and liabilities. The tax consequence is calculated
by applying enacted statutory tax rates, applicable to future years, to these
temporary differences. Temporary differences which gave rise to deferred tax
(assets)/liabilities at December 31, 1997 and 1996, were as follows:
<TABLE>
<CAPTION>
(Dollars in thousands) 1997 1996
- ---------------------------------------------------------------------
<S> <C> <C>
DEFERRED TAX ASSETS:
Loss reserves $(52,101) $(50,121)
Net operating loss carryforwards (4,381) (6,791)
Other (8,896) (6,221)
- ---------------------------------------------------------------------
Gross deferred tax assets (65,378) (63,133)
- ---------------------------------------------------------------------
DEFERRED TAX LIABILITIES:
Capitalized mortgage servicing rights 115,704 74,838
Depreciation 6,553 7,150
Investments in loans and securities 9,424 1,694
Employee benefits 5,866 4,879
Purchase accounting adjustments 4,268 4,510
Intangible assets 6,187 4,870
Federal Home Loan Bank stock 4,683 3,614
Operations services 3,417 3,615
Other 14,448 9,888
- ---------------------------------------------------------------------
Gross deferred tax liabilities 170,550 115,058
- ---------------------------------------------------------------------
Net deferred tax liabilities $105,172 $ 51,925
=====================================================================
</TABLE>
NOTE 15 - EARNINGS PER SHARE
The following table shows a reconciliation of earnings per share to diluted
earnings per share. All share and per share data have been adjusted to reflect
the 1998 and 1996 two-for-one stock splits.
<TABLE>
<CAPTION>
(Dollars in thousands, except per share data) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
EARNINGS PER SHARE COMPUTATION:
Net income $ 197,472 $ 179,907 $ 164,888
Weighted average shares outstanding 128,365,434 134,393,172 136,049,588
Earnings per share $ 1.54 $ 1.34 $ 1.21
======================================================================================================
DILUTED EARNINGS PER SHARE COMPUTATION:
Net income $ 197,472 $ 179,907 $ 164,888
Weighted average shares outstanding 128,365,434 134,393,172 136,049,588
Dilutive effect due to stock options 3,621,498 1,986,370 1,296,764
- ------------------------------------------------------------------------------------------------------
Weighted average shares outstanding, as adjusted 131,986,932 136,379,542 137,346,352
Diluted earnings per share $ 1.50 $ 1.32 $ 1.20
======================================================================================================
</TABLE>
A-53
<PAGE> 79
NOTE 16 - RESTRICTIONS, CONTINGENCIES AND OTHER DISCLOSURES
RESTRICTIONS ON CASH AND DUE FROM BANKS. The commercial banking subsidiaries of
First Tennessee are required to maintain average reserve and clearing balances
with the Federal Reserve Bank. The balances required at December 31, 1997 and
1996, were $181,446,000 and $200,454,000, respectively. These reserves are
included in "Cash and due from banks" on the Consolidated Statements of
Condition.
RESTRICTIONS ON DIVIDENDS. Dividends are paid by First Tennessee from its assets
which are mainly provided by dividends from its subsidiaries. Certain regulatory
restrictions exist regarding the ability of the banking subsidiaries to transfer
funds to First Tennessee in the form of cash, dividends, loans or advances. As
of December 31, 1997, the banking subsidiaries had undivided profits of
$749,348,000 of which $205,732,000 was available for distribution to First
Tennessee as dividends without prior regulatory approval.
RESTRICTIONS ON INTERCOMPANY TRANSACTIONS. Under Federal banking law, banking
subsidiaries may not extend credit to the parent company in excess of 10 percent
of the banks' capital stock and surplus, as defined, or $115,916,000 at December
31, 1997. The parent company had borrowings of $21,950,000 from FTBNA at
December 31, 1997. Certain loan agreements also define other restricted
transactions related to additional borrowings.
CONTINGENCIES. In October 1997, the circuit court of Houston County, Alabama
entered a final judgment approving a settlement of a class action filed against
FTBNA on behalf of persons in Alabama who had financed with FTBNA their
purchases of satellite dish television systems ("satellite systems"). In
December 1997, after appeal time had expired, the Supreme Court of Alabama
released an opinion in an unrelated case indicating that a judgment would be
void if entered in a class action filed after another class action with
substantially similar allegations already had been filed. Because another
purported class action in Alabama (discussed below) was filed before this
action, this settlement could be void. The issue of the validity of the FTBNA
class action settlement is currently before the Supreme Court of Alabama. While
ready to proceed with the settlement if declared valid, no prediction at this
time can be made as to how the Supreme Court of Alabama will rule. All
individual lawsuits previously filed in state court in Alabama relating to the
financing of satellite systems by FTBNA have been finally settled.
FTBNA was also named as a defendant in a purported nationwide class action
lawsuit filed in federal court in Alabama in which plaintiffs assert that FTBNA
and another defendant engaged in unfair and deceptive practices in connection
with the financing of satellite systems. The complaint alleges violations of the
Truth in Lending Act and the federal RICO statute, and fraud by suppression with
respect to Alabama residents. In addition to these theories, plaintiffs proceed
against FTBNA on an agency theory. The complaint seeks unquantified
compensatory, triple, and punitive damages. FTBNA has filed a motion requesting
the dismissal of plaintiffs' RICO and fraudulent suppression claims, but the
court has not ruled on the motion. In addition to the Alabama lawsuits, in
September 1997, a nationwide class action was filed in state court in Tennessee
relating to the same satellite systems financing program. The complaint asserts
that material facts were withheld from the purchasers in connection with the
financing, that FTBNA and First Tennessee were unjustly enriched from the sale
of such systems, and that FTBNA and First Tennessee violated the Tennessee
Consumer Protection Act. The trial court entered an order of conditional class
certification and FTBNA and First Tennessee have requested a review of that
certification order for the purpose of having the conditional order set aside.
FTBNA and First Tennessee deny liability, deny that any co-defendant is their
agent, and intend to defend these actions vigorously.
In addition to satellite systems cases, various other claims and lawsuits are
pending against First Tennessee and its subsidiaries. Although First Tennessee
cannot predict the outcome of the foregoing actions, after consulting with
counsel, it is management's opinion that when resolved, the amount, if any, will
not have a material adverse effect on the consolidated financial statements of
First Tennessee and its subsidiaries.
OTHER DISCLOSURES - BANK OWNED LIFE INSURANCE. First Tennessee has purchased
life insurance on certain of its employees and is the beneficiary on these
policies. At December 31, 1997, the cash surrender value of these policies,
which is included in "Capital markets receivables and other assets" on the
Consolidated Statements of Condition, was $69,373,000. There are no restrictions
on the proceeds from these benefits, and First Tennessee has not borrowed
against the cash surrender value of these policies.
A-54
<PAGE> 80
NOTE 17 - SHAREHOLDER PROTECTION RIGHTS AGREEMENT
In September 1989, First Tennessee adopted a Shareholder Protection Rights
Agreement (the Agreement) and distributed a dividend of one right on each
outstanding share of common stock held on September 18, 1989, or issued
thereafter and prior to the time the rights separate. On January 21, 1997, First
Tennessee amended and restated the Agreement. As so amended, the Agreement
provides that until the 10th business day (subject to certain adjustments by the
board of directors) after a person or group commences a tender or exchange offer
that will result in such person or group owning 10 percent or more of First
Tennessee's common stock, or the public announcement by First Tennessee that a
person or group owns 10 percent or more of First Tennessee's common stock, the
rights will be evidenced by the common stock certificates, will automatically
trade with the common stock, and will not be exercisable. Thereafter, separate
rights certificates will be distributed, and each right will entitle its holder
to purchase one one-hundredth of a share of participating preferred stock having
economic and voting terms similar to those of one share of common stock for an
exercise price of $75.
If any person or group acquires 10 percent or more of First Tennessee's common
stock, then each right (other than rights beneficially owned by holders of 10
percent or more of the common stock or transferees thereof, which rights become
void) will entitle its holder to purchase, for the exercise price, a number of
shares of First Tennessee common stock or participating preferred stock having a
market value of twice the exercise price. Also, if there is a 10 percent
shareholder and First Tennessee is involved in certain significant transactions,
each right will entitle its holder to purchase, for the exercise price, a number
of shares of common stock of the other party having a market value of twice the
exercise price. If any person or group acquires between 10 percent and 50
percent of First Tennessee's common stock, First Tennessee's board of directors
may, at its option, exchange one share of First Tennessee common stock or one
one-hundredth of a share of participating preferred stock for each right. The
rights will expire on the earliest of one of the following three times: the time
of the exchange described in the preceding sentence; September 18, 1999; or the
date the rights are redeemed as described in the following sentence. The rights
may be redeemed by the board of directors for $0.0017 per right until 10
business days after First Tennessee announces that any person or group owns 10
percent or more of First Tennessee's common stock.
NOTE 18 - SAVINGS, PENSION AND OTHER EMPLOYEE BENEFITS
SAVINGS PLAN. Substantially all employees of First Tennessee are covered by a
contributory savings plan in conjunction with a flexible benefits plan. During
the year, First Tennessee makes contributions to each employee's flexible
benefits plan account. These contributions are based on length of service and a
percentage of the employee's salary. The employees have the option to direct a
portion or all of the contribution into their savings plan accounts. Employees
may also make pre-tax and after-tax personal contributions to the savings plan.
First Tennessee matches the majority of employee pre-tax contributions invested
in First Tennessee's common stock at a rate of $.50 for each $1.00 invested up
to 6 percent of the employee's qualifying salary. Contributions made by First
Tennessee to the flexible benefits plan were $13,716,000 for 1997, $13,202,000
for 1996 and $9,996,000 for 1995.
ACTUARIAL ASSUMPTIONS. The actuarial assumptions used in the defined benefit
pension plan and the other employee benefit plans were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Discount rate 7.25% 7.75% 7.25%
Weighted average rate of increase in future
compensation 4.0 4.0 4.7
Expected long-term rate of return on assets dedicated
to employees who retired prior to January 1, 1993 6.5 6.5 6.5
Expected long-term rate of return on assets 10.0 10.0 10.0
- --------------------------------------------------------------------------------------------
</TABLE>
PENSION PLAN. Substantially all employees of First Tennessee are covered by a
noncontributory, defined benefit pension plan. Pension benefits are based on
years of service, average compensation near retirement, and estimated social
security benefits at age 65. The annual funding is based on an actuarially
determined amount using the entry age cost method. First Tennessee's policy to
fund amounts which are actuarially determined is in accordance with the
applicable provisions of the Employee Retirement Income Security Act.
A-55
<PAGE> 81
NOTE 18 - SAVINGS, PENSION AND OTHER EMPLOYEE BENEFITS (CONTINUED)
Effective for the 1997 fiscal year, the measurement date for pension assets and
liabilities was changed from December 31 to September 30. The change in
measurement date had no effect on prior years' pension expense. The components
of pension expense for the years ended December 31 were as follows:
<TABLE>
<CAPTION>
(Dollars in thousands) 1997 1996 1995
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost-benefits earned during the year $ 5,737 $ 6,083 $ 5,210
Interest cost on projected benefit obligation 8,187 7,895 6,907
Gain on plan assets (45,198) (12,330) (27,516)
Net amortization and deferral 28,957 (2,398) 15,677
- ------------------------------------------------------------------------------------------
Pension expense/(benefit) $ (2,317) $ (750) $ 278
- ------------------------------------------------------------------------------------------
</TABLE>
The following table sets forth the plan's funded status and amounts recognized
in the Consolidated Statements of Condition:
<TABLE>
<CAPTION>
(Dollars in thousands) 1997 1996
- -----------------------------------------------------------------------------------------
<S> <C> <C>
Plan assets at fair value $218,342 $169,488
Actuarial present value of projected benefit
obligation* 139,467 107,403
- -----------------------------------------------------------------------------------------
Plan assets in excess of projected benefit obligation 78,875 62,085
Unrecognized net gain from past experience different
from that assumed and effects of changes in assumptions (16,829) (9,963)
Prior service cost not yet recognized in pension expense 3,004 2,848
Unrecognized net transitional asset (2,320) (2,780)
- --------------------------------------------------------------------------
Prepaid pension expense at September 30 62,730
Contributions paid from October 1 to December 31 82
- -----------------------------------------------------------------------------------------
Prepaid pension expense recognized in the
Consolidated Statements
of Condition as of December 31 $ 62,812 $ 52,190
=========================================================================================
</TABLE>
[FN]
* At December 31, 1997 and 1996, respectively, the actuarial present values of
the accumulated benefit obligation were $104,107,000 and $82,435,000, of
which vested benefits were $101,990,000 and $80,741,000. The accumulated
benefit obligation excludes projected future increases in compensation.
</FN>
OTHER EMPLOYEE BENEFITS. First Tennessee provides postretirement medical
insurance to full-time employees retiring under the provisions of the First
Tennessee Pension Plan. The postretirement medical plan is contributory with
retiree contributions adjusted annually. The plan is based on criteria that are
a combination of the employee's age and years of service and utilizes a two-step
approach. For any employee retiring on or after January 1, 1995, First Tennessee
will contribute a fixed amount based on years of service and age at time of
retirement.
Effective for the 1997 fiscal year, the measurement date for postretirement
benefit assets and liabilities was changed from December 31 to September 30. The
change in measurement date had no effect on prior years' postretirement
benefits. Postretirement benefit expense included the following components:
<TABLE>
<CAPTION>
(Dollars in thousands) 1997 1996 1995
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost $ 584 $ 608 $ 427
Interest cost on accumlated postretirement benefit
obligation (APBO) 1,781 1,689 1,762
Actual return on assets (2,478) (1,004) (1,867)
Amortization of transition obligation 989 989 989
Total of other components 1,575 121 1,048
- -------------------------------------------------------------------------------------------
Postretirement benefit expense $ 2,451 $ 2,403 $ 2,359
===========================================================================================
</TABLE>
A-56
<PAGE> 82
NOTE 18 - SAVINGS, PENSION AND OTHER EMPLOYEE BENEFITS (CONTINUED)
The following table sets forth the plan's funded status reconciled to the
amounts shown in the Consolidated Statements of Condition:
<TABLE>
<CAPTION>
(Dollars in thousands) 1997 1996
- -------------------------------------------------------------------------------------------
<S> <C> <C>
APBO:
Retirees $(14,596) $(16,083)
Actives (8,645) (7,779)
- -------------------------------------------------------------------------------------------
Total APBO (23,241) (23,862)
Plan assets at fair value 12,210 11,198
- -------------------------------------------------------------------------------------------
APBO in excess of plan assets (11,031) (12,664)
Unrecognized:
Net transition obligation 14,829 15,818
Prior service cost 38 41
Prepaid benefit cost (4,362) (1,270)
- ----------------------------------------------------------------------------
Prepaid postretirement benefit cost at September 30 (526)
Contributions paid from October 1 to December 31 4,976
- -------------------------------------------------------------------------------------------
Prepaid postretirement benefit cost as recognized
in the Consolidated Statements of Condition
as of December 31 $ 4,450 $ 1,925
===========================================================================================
</TABLE>
The cost of health care benefits was projected to increase at an annual per
capita rate of 8.75 percent in 1997 and decrease evenly to a rate of 5.75
percent by the year 2000 and remain at an even level thereafter. In 1996, the
annual rate of increase was assumed to be 9.75 percent decreasing evenly to a
rate of 5.75 percent by the year 2000 and remaining at an even level thereafter.
In 1995, the annual rate of increase was assumed to be 10.75 percent decreasing
evenly to a rate of 5.75 percent by the year 2000 and remaining at that level
thereafter. The health care cost trend rate assumption has a significant effect
on the amounts reported. The following table illustrates the effect of
increasing the assumed health care cost trend rate by 1 percent:
<TABLE>
<CAPTION>
Current Increased Percent
(Dollars in thousands) Trend Trend Change
- -----------------------------------------------------------------
<S> <C> <C> <C>
APBO at December 31, 1997 $23,241 $24,310 4.6+
Service and interest cost 2,365 2,465 4.2+
- -----------------------------------------------------------------
</TABLE>
The funding policy for the plan is to fund the maximum amount deductible under
the current tax regulations. The plan assets consist primarily of equity and
fixed income securities. The trust holding the plan assets for employees that
retired prior to January 1, 1993, is subject to federal income taxes at a 35
percent tax rate. The trust holding the plan assets for all other employees,
actives and those retired since 1992, is not subject to federal income taxes.
First Tennessee provides benefits to former and inactive employees after
employment but before retirement. The obligation/(benefit) recognized in
accordance with accounting standards was $.6 million in 1997, $(.3) million in
1996 and $1.9 million in 1995.
Medical and group life insurance expenses incurred for active employees are
shown in the following table:
<TABLE>
<CAPTION>
(Dollars in thousands) 1997 1996 1995
- -----------------------------------------------------------------------------------
<S> <C> <C> <C>
Medical plan expense based on claims incurred $10,802 $10,762 $8,673
Participants 5,652 5,267 5,304
- -----------------------------------------------------------------------------------
Group life insurance expense based on
benefits incurred $ 949 $ 865 $ 783
Participants 8,457 8,022 7,744
- -----------------------------------------------------------------------------------
</TABLE>
A-57
<PAGE> 83
NOTE 19 - STOCK OPTION, RESTRICTIVE STOCK INCENTIVE, AND DIVIDEND REINVESTMENT
PLANS
At its January 1998 meeting, the board of directors authorized a two-for-one
split of First Tennessee's common stock. The shares were distributed February
20, 1998, to shareholders of record on February 6, 1998. Share and per share
amounts in the accompanying text and tables have been adjusted for this stock
split and the 1996 two-for-one stock split.
STOCK OPTION PLANS. First Tennessee issues non-qualified stock options under
various plans to employees, non-employee directors, and bank advisory board
members. The plans provide for the issuance of First Tennessee common stock at a
price equal to its fair market value at the date of grant; however, the exercise
price may be less than the fair market value if the grantee has agreed to
receive the options in lieu of compensation. The foregone compensation plus the
exercise price must equal the fair market value of the stock on the date of
grant. All options expire 10 years from the date of grant, except for those
options that were part of compensation deferral, which expire 20 years from the
date of grant. There were 3,548,310 shares available for option plan grants at
December 31, 1997. The summary of stock option activity is shown below:
<TABLE>
<CAPTION>
Weighted
Options Average
Outstanding Exercise Price
- ----------------------------------------------------------
<S> <C> <C>
January 1, 1995 6,345,608 $ 7.25
Options granted 2,422,336 10.32
Stock options exercised (878,744) 5.53
Stock options canceled (520,732) 10.25
----------
December 31, 1995 7,368,468 8.25
==========
Options exercisable 3,307,196 6.20
- ----------------------------------------------------------
January 1, 1996 7,368,468 $ 8.25
Options granted 4,157,596 14.53
Stock options exercised (795,642) 7.16
Stock options canceled (693,786) 12.83
----------
December 31, 1996 10,036,636 10.62
==========
Options exercisable 4,571,800 8.40
- ----------------------------------------------------------
January 1, 1997 10,036,636 $10.62
Options granted 4,791,158 20.53
Stock options exercised (1,904,284) 12.76
Stock options canceled (770,280) 15.99
----------
December 31, 1997 12,153,230 13.85
==========
Options exercisable 8,554,866 13.67
- ----------------------------------------------------------
</TABLE>
The following table summarizes information about stock options outstanding at
December 31, 1997:
<TABLE>
<CAPTION>
Weighted Weighted
Weighted Average Average
Average Exercise Exercise
Remaining Price - Price -
Options Contractual Options Options Options
Exercise Price Range Outstanding Life Outstanding Exercisable Exercisable
- --------------------------------------------------------------------------------------------------------
<C> <C> <C> <C> <C> <C>
$ 4.00 - $10.00 2,533,226 4.45 years $ 6.07 2,533,226 $ 6.07
$10.01 - $15.00 4,094,444 9.76 years 11.31 1,744,480 11.81
$15.01 - $20.00 2,162,120 12.19 years 16.56 2,027,320 16.64
$20.01 - $30.00 3,363,440 11.84 years 21.05 2,249,840 21.02
- --------------------------------------------------------------------------------------------------------
</TABLE>
A-58
<PAGE> 84
NOTE 19 - STOCK OPTION, RESTRICTIVE STOCK INCENTIVE, AND DIVIDEND REINVESTMENT
PLANS (CONTINUED)
First Tennessee accounts for these plans under APB Opinion No. 25 pursuant to
which no compensation cost has been recognized. Had compensation cost for these
plans been determined consistent with SFAS No. 123, First Tennessee's net income
and earnings per share would have been reduced to the following pro forma
amounts:
<TABLE>
<CAPTION>
December 31
------------------------------------------
(Dollars in thousands except per share data) 1997 1996 1995
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income, as reported $197,472 $179,907 $164,888
Pro forma net income 189,366 178,068 164,354
Earnings per share, as reported 1.54 1.34 1.21
Pro forma earnings per share 1.48 1.32 1.21
- ---------------------------------------------------------------------------------------------
</TABLE>
Total compensation costs that would have been recognized in income under SFAS
No. 123 for all stock-based compensation awards was $13,267,000 for 1997,
$3,010,000 for 1996, and $874,000 for 1995.
Because the SFAS No. 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting pro forma compensation cost may
not be representative of that to be expected in future years. First Tennessee
used the Black-Scholes Option Pricing Model to estimate the fair value of stock
options granted in 1997, 1996 and 1995 with the following assumptions:
<TABLE>
<CAPTION>
1997 1996 1995
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Expected dividend yield 3.31% 3.76% 3.76%
Expected option lives of options issued at market 6.01 years 5.72 years 4.03 years
Expected option lives of options issued below market 2.36 years 2.65 years 5.96 years
Expected volatility 17.29% 16.75% 16.75%
Risk-free interest rates 6.51% 6.16% 6.62%
- ------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Weighted
Average Fair
Number Value per Option
Issued at Grant Date
- -----------------------------------------------------------------------------------
<S> <C> <C>
1997:
Options issued at market on the date of grant 2,989,752 $ 4.87
Options issued below market on the date of grant 1,801,406 4.81
- -----------------------------------------------------------------------------------
1996:
Options issued at market on the date of grant 2,811,422 $ 2.66
Options issued below market on the date of grant 1,346,174 3.48
- -----------------------------------------------------------------------------------
1995:
Options issued at market on the date of grant 2,143,600 $ 1.69
Options issued below market on the date of grant 278,736 4.26
- -----------------------------------------------------------------------------------
</TABLE>
RESTRICTED STOCK INCENTIVE PLANS. First Tennessee has authorized the issuance of
its common stock for awards to executive employees who have a significant impact
on the profitability of First Tennessee under restricted stock incentive plans.
Additionally, the plans provide for 6,000 shares of restricted stock to be
granted to each new non-employee director upon election to the board with
restrictions lapsing as defined in the plans. For 1997 First Tennessee granted
no restricted shares under the plans. For the years 1996 and 1995, First
Tennessee granted 222,392 and 16,400 restricted shares under the plans,
respectively. Compensation expense related to these plans was $1,275,000,
$1,541,000, and $1,165,000 for the years 1997, 1996 and 1995, respectively.
There were 757,936 shares available for restricted stock incentive grants at
December 31, 1997.
DIVIDEND REINVESTMENT PLAN. The Dividend Reinvestment and Stock Purchase Plan,
as amended in 1995, authorizes the sale of First Tennessee's common stock from
authorized, but unissued common stock or from shares acquired on the open market
to shareholders who choose to invest all or a portion of their cash dividends
and make optional cash payments of $25 to $10,000 per quarter without paying
commissions. Since 1988, shares for this plan have been purchased on the open
market. The price of the shares purchased directly from First Tennessee is the
mean between the high and low sales price on the investment date. The price of
shares purchased on the open market is the average price paid.
A-59
<PAGE> 85
NOTE 20 - BUSINESS SEGMENT INFORMATION
First Tennessee provides traditional retail/commercial banking and other
financial services to its customers. First Tennessee has two broad groups: a
regional banking group and national lines of business. The regional banking
group consists of the retail/commercial bank, credit card, and trust operations.
The national lines of business include capital markets, mortgage banking and
transaction processing. Banking subsidiaries offer general banking products in
21 Tennessee counties, in northern Mississippi and in northwest Arkansas.
Mortgage banking provides services in 30 states, and capital markets has offices
in Chicago, Dallas, Kansas City, Knoxville, Memphis, Mobile and New York.
Total revenue, expense, and asset levels reflect those which are specifically
identifiable or which are allocated based on an internal allocation method.
Because the allocations are based on internally developed assignments and
allocations, they are to an extent subjective. This assignment and allocation
has been consistently applied for all periods presented. The following table
reflects the approximate amounts of consolidated revenue, expense and assets for
the three years ended December 31, for each segment:
<TABLE>
<CAPTION>
Regional
Banking Mortgage Capital Transaction
(Dollars in thousands) Group Banking Markets Processing Corporate Consolidated
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1997
Interest income $ 817,327 $ 86,151 $ 19,632 $ 17,434 $ 749 $ 941,293
Interest expense 377,953 59,561 17,007 3,676 -- 458,197
- -------------------------------------------------------------------------------------------------------------------
Net interest income 439,374 26,590 2,625 13,758 749 483,096
Other revenues 179,021 330,467 98,311 61,257 (926) 668,130
Other expenses* 398,520 297,588 74,246 57,684 8,121 836,159
- -------------------------------------------------------------------------------------------------------------------
Pre-tax income $ 219,875 $ 59,469 $ 26,690 $ 17,331 $(8,298) $ 315,067
===================================================================================================================
Identifiable assets $11,199,768 $2,302,440 $375,624 $510,065 $ -- $14,387,897
- -------------------------------------------------------------------------------------------------------------------
1996
Interest income $ 779,224 $ 85,965 $ 16,461 $ 14,847 $ -- $ 896,497
Interest expense 380,348 48,493 13,652 2,816 -- 445,309
- -------------------------------------------------------------------------------------------------------------------
Net interest income 398,876 37,472 2,809 12,031 -- 451,188
Other revenues 157,831 274,728 85,871 55,400 (2,681) 571,149
Other expenses* 358,263 256,309 66,703 55,065 3,823 740,163
- -------------------------------------------------------------------------------------------------------------------
Pre-tax income $ 198,444 $ 55,891 $ 21,977 $ 12,366 $(6,504) $ 282,174
===================================================================================================================
Identifiable assets $10,826,758 $1,443,740 $316,459 $471,945 $ -- $13,058,902
- -------------------------------------------------------------------------------------------------------------------
1995
Interest income $ 730,936 $ 56,846 $ 18,393 $ 16,354 $ -- $ 822,529
Interest expense 382,223 30,237 17,105 2,310 -- 431,875
- -------------------------------------------------------------------------------------------------------------------
Net interest income 348,713 26,609 1,288 14,044 -- 390,654
Other revenues 144,925 213,612 82,814 48,856 2,404 492,611
Other expenses* 313,900 195,630 61,611 52,820 6,347 630,308
- -------------------------------------------------------------------------------------------------------------------
Pre-tax income $ 179,738 $ 44,591 $ 22,491 $ 10,080 $(3,943) $ 252,957
===================================================================================================================
Identifiable assets $10,075,967 $1,168,010 $349,443 $483,462 $ -- $12,076,882
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
[FN]
*Includes loan loss provision.
</FN>
Capital expenditures occurred primarily in the regional banking group and were
$56,099,000, $37,549,000 and $38,545,000 for the years ended December 31, 1997,
1996 and 1995, respectively. Depreciation and amortization in the mortgage
banking segment were $54,572,000, $41,689,000 and $23,211,000 for 1997, 1996 and
1995, respectively. The remainder of depreciation and amortization expense
occured primarily in the regional banking group and totaled $31,211,000,
$37,102,000 and $45,733,000 for 1997, 1996 and 1995, respectively.
A-60
<PAGE> 86
NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS
Accounting standards require the disclosure of estimated fair values of all
asset, liability and off-balance sheet financial instruments. The following fair
value estimates are determined as of a specific point in time utilizing various
assumptions and estimates. The use of assumptions and various valuation
techniques, as well as the absence of secondary markets for certain financial
instruments, will likely reduce the comparability of fair value disclosures
between financial institutions. In some cases, book value is a reasonable
estimate of fair value due to the relatively short period of time between
origination of the instrument and its expected realization. The following table
summarizes the book value and estimated fair value of financial instruments
recorded in the Consolidated Statements of Condition as of December 31, 1997 and
1996:
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997 At December 31, 1996
----------------------------- ------------------------------
Book Fair Book Fair
(Dollars in thousands) Value Value Value Value
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
ASSETS:
Loans, net of unearned income:
Floating $ 4,150,569 $ 4,151,045 $ 3,492,411 $ 3,492,699
Fixed 4,122,366 4,137,707 4,216,866 4,209,728
Nonaccrual 38,415 38,415 18,926 18,926
Allowance for loan losses (125,859) (125,859) (117,748) (117,748)
- -------------------------------------------------------------------------------------------------------------
Total net loans 8,185,491 8,201,308 7,610,455 7,603,605
Liquid assets 481,623 481,623 290,689 290,689
Mortgage loans held for sale 1,240,648 1,248,114 787,362 783,993
Securities available for sale 2,133,303 2,133,303 2,173,620 2,173,620
Securities held to maturity 53,230 54,323 65,914 66,677
Nonearning assets 966,201 966,201 1,145,796 1,145,796
- -------------------------------------------------------------------------------------------------------------
LIABILITIES:
Deposits:
Defined maturity $ 3,430,870 $ 3,470,409 $ 3,441,338 $ 3,455,330
Undefined maturity 6,240,909 6,240,909 5,591,724 5,591,724
- -------------------------------------------------------------------------------------------------------------
Total deposits 9,671,779 9,711,318 9,033,062 9,047,054
Short-term borrowings 2,788,067 2,788,067 2,258,556 2,258,556
Term borrowings 168,893 174,854 234,645 241,616
Other noninterest-bearing liabilities 212,565 210,919 176,340 173,727
- -------------------------------------------------------------------------------------------------------------
</TABLE>
[FN]
Information on the fair value of off-balance sheet financial instruments can be
found in Note 22 - Financial Instruments with Off-Balance Sheet Risk.
</FN>
The following describes the assumptions and methodologies used to estimate the
fair value for financial instruments:
FLOATING RATE LOANS. With the exception of floating rate 1-4 family residential
mortgage loans, the fair value is approximated by the book value. Floating rate
1-4 family residential mortgage loans reprice annually and will lag movements in
market rates; whereas, commercial and consumer loans typically reprice monthly.
The fair value for floating rate 1-4 family mortgage loans is calculated by
discounting future cash flows to their present value. Future cash flows are
discounted to their present value by using the current rates at which similar
loans would be made to borrowers with similar credit ratings and for the same
time period. Prepayment assumptions based on historical prepayment speeds have
been applied to the floating rate 1-4 family residential mortgage portfolio.
FIXED RATE LOANS. The fair value is estimated by discounting future cash flows
to their present value. Future cash flows are discounted to their present value
by using the current rates at which similar loans would be made to borrowers
with similar credit ratings and for the same time period. Prepayment assumptions
based on historical prepayment speeds have been applied to the fixed rate
mortgage and installment loan portfolios.
NONACCRUAL LOANS. The fair value is approximated by the book value.
ALLOWANCE FOR LOAN LOSSES. The fair value is approximated by the book value.
Additionally, the credit exposure known to exist in the loan portfolio is
embodied in the allowance for loan losses.
A-61
<PAGE> 87
NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
LIQUID ASSETS. The fair value is approximated by the book value. For the purpose
of this disclosure, liquid assets consist of federal funds sold, securities
purchased under agreements to resell, capital markets inventory and investment
in bank time deposits.
MORTGAGE LOANS HELD FOR SALE. Fair values are based primarily on quoted
market prices.
SECURITIES AVAILABLE FOR SALE. Fair values are based primarily on quoted
market prices.
SECURITIES HELD TO MATURITY. Fair values are based primarily on quoted market
prices.
NONEARNING ASSETS. The fair value is approximated by the book value. For the
purpose of this disclosure, nonearning assets include cash and due from banks,
accrued interest receivable, capital markets receivables and excess mortgage
servicing fees.
DEFINED MATURITY DEPOSITS. The fair value is estimated by discounting future
cash flows to their present value. Future cash flows are discounted by using the
current market rates of similar instruments applicable to the remaining
maturity. For the purpose of this disclosure, defined maturity deposits include
all certificates of deposit and other time deposits.
UNDEFINED MATURITY DEPOSITS. The fair value is considered to be equal to the
book value. For the purpose of this disclosure, undefined maturity deposits
include demand deposits, checking interest accounts, savings accounts and money
market accounts.
SHORT-TERM BORROWINGS. The fair value of federal funds purchased, securities
sold under agreements to repurchase, commercial paper, bank notes and other
short-term borrowings is approximated by the book value. The fair value for
Federal Home Loan Bank borrowings is determined using discounted future cash
flows.
TERM BORROWINGS. The fair value is approximated by the present value of the
contractual cash flows discounted by the investor's yield which considers First
Tennessee's debt rating.
OTHER NONINTEREST-BEARING LIABILITIES. For the purpose of this disclosure, other
noninterest-bearing liabilities include accrued interest payable and capital
markets payables. Accrued interest, which is not payable until maturity, has
been discounted to its present value given current market rates and the maturity
structure of the financial instrument. The fair value of capital markets
payables approximates the book value.
NOTE 22 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
First Tennessee utilizes various financial instruments as part of its risk
management strategy and as a means to meet customers' needs. These instruments
are subject to credit and market risks that are not reflected on the balance
sheet. The activities which currently employ financial instruments with
off-balance sheet risk are mortgage banking, interest rate risk management and
capital markets operations. First Tennessee also enters into commitments for
lending related purposes to meet customers' financial needs. Controls and
monitoring procedures for these instruments have been established and are
routinely revised. The Asset/Liability Committee (ALCO) monitors the usage and
effectiveness of financial instruments. ALCO, in conjunction with senior credit
officers, also periodically reviews and revises counterparty credit limits.
Credit Risk represents the maximum potential loss due to possible
non-performance by obligors and counterparties under the terms of contracts.
First Tennessee manages credit risk by entering into financial instrument
transactions through national exchanges, primary dealers or approved
counterparties, and using mutual margining agreements whenever possible to limit
potential exposure. With exchange-traded contracts, the credit risk is limited
to the clearinghouse used. For non-exchange traded instruments, credit risk may
occur when there is a gain in the fair value of the financial instrument and the
counterparty fails to perform according to the terms of the contract and/or when
the collateral proves to be of insufficient value.
Market Risk represents the potential loss due to the decrease in the value of a
financial instrument caused primarily by changes in interest rates, prepayment
speeds or the prices of debt instruments. The measurement of market risk
associated with financial instruments is meaningful only when all related and
offsetting on- and off-balance sheet hedges are aggregated, and the resulting
net positions are identified.
A-62
<PAGE> 88
NOTE 22 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK (CONTINUED)
LENDING RELATED
First Tennessee enters into fixed and variable loan commitments with customers.
When these commitments have contract rate adjustments that lag changes in market
rates, the financial instruments have characteristics similar to option
contracts. First Tennessee follows the same credit policies and underwriting
practices in making commitments as it does for on-balance sheet instruments.
Each customer's creditworthiness is evaluated on a case-by-case basis. The
amount of collateral obtained, if any, is based on management's credit
evaluation of the counterparty.
Commitments To Extend Credit are contractual obligations to lend to a customer
as long as all established contractual conditions are met. These commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. The majority of First Tennessee's loan commitments
have maturities less than one year and reflect the prevailing market rates at
the time of the commitment. Since commitments may expire without being fully
drawn upon, the total contract amount does not necessarily represent future cash
requirements.
Commercial and Standby Letters of Credit are conditional commitments issued by
First Tennessee to guarantee the performance and/or payment of a customer to a
third party in connection with specified transactions. The credit risk involved
in issuing commercial and standby letters of credit is essentially the same as
that involved in extending loan facilities to customers.
The following is a summary of the maximum credit exposure of each class of
lending related off-balance sheet financial instruments outstanding at December
31:
<TABLE>
<CAPTION>
(Dollars in millions) 1997 1996
- --------------------------------------------------------------------------
<S> <C> <C>
Commitments to extend credit:
Consumer credit card lines $1,867 $1,622
Consumer home equity 413 320
Commercial real estate and construction and
land development 371 300
Mortgage banking 762 548
Commercial and other 1,877 1,642
- --------------------------------------------------------------------------
Total loan commitments 5,290 4,432
Other commitments:
Standby letters of credit 513 470
Commercial letters of credit 6 3
- --------------------------------------------------------------------------
Total loan and other commitments $5,809 $4,905
==========================================================================
</TABLE>
The following table shows the notional or contractual amounts and related fair
values for the off-balance sheet financial instruments at December 31:
<TABLE>
<CAPTION>
1997 1996
------------------- -----------------------
Notional Fair Notional Fair
(Dollars in millions) Value Value Value Value
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Loan commitments $5,289.9 $5.4 $4,431.5 $ 2.2
Commercial and standby letters of credit 518.5 6.4 473.1 5.9
- ----------------------------------------------------------------------------------------------
Foreign exchange contracts:
Contracts to buy $ (2.5) * $ (.2) *
Contracts to sell 2.7 * .5 *
- ----------------------------------------------------------------------------------------------
Net position $ .2 $ .3
==============================================================================================
</TABLE>
[FN]
*Amount is less than $100,000.
Mortgage banking loan commitments have an additional off-balance sheet value
resulting from mortgage servicing rights of approximately $3.8 million at
December 31, 1997, and $5.2 million at December 31, 1996.
</FN>
A-63
<PAGE> 89
NOTE 22 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK (CONTINUED)
MORTGAGE BANKING
First Tennessee uses both forward sales commitments and option contracts to
protect the value of residential mortgage loans held for sale that are being
underwritten for future sale to investors in the secondary market. Adverse
market interest rate changes, between the time a customer receives a rate-lock
commitment and the fully funded loan is sold to an investor, can erode the value
of that mortgage. Therefore, First Tennessee enters into forward sales
commitments and option contracts to mitigate the interest rate risk associated
with the origination and sale of mortgage loans.
First Tennessee enters into interest rate contracts to hedge the decrease in the
value of its mortgage servicing rights that could result from falling mortgage
rates and increased mortgage prepayments. The credit risk inherent in these
transactions relates to the possibility of a counterparty not paying according
to the terms of the contract. This credit risk is controlled through credit
approvals, risk control limits and on-going monitoring procedures through ALCO.
The credit risk is represented by the aggregate fair value of only those
interest rate contracts that currently have a positive fair value.
<TABLE>
<CAPTION>
1997 1996
-------------------- ---------------------
Notional Fair Notional Fair
(Dollars in millions) Value Value Value Value
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest rate contracts:
Mortgage pipeline and warehouse hedging:
Forward contracts - commitments to sell $1,644.8 $(4.3) $1,089.0 $ 3.4
Option contracts - put options purchased** 26.0 * 13.0 (.1)
Servicing portfolio hedging:
Floors - purchased*** 3,750.0 27.5 2,080.0 16.2
Option contracts - call options purchased**** 640.0 2.5 -- --
- ------------------------------------------------------------------------------------------------------------
</TABLE>
[FN]
* Amount is less than $100,000.
** Put options purchased had a remaining book value of $.1 million at
December 31, 1997 and 1996.
*** Interest rate floors had a remaining book value of $16.0 million at
December 31, 1997 and $17.0 million at December 31, 1996.
**** Call options purchased had a remaining book value of $1.7 million at
December 31, 1997.
</FN>
Residential mortgage loans are originated by First Tennessee to be sold in the
secondary market. Some of these loans are sold with provisions of recourse. As
of December 31, 1997 and 1996, the outstanding principal amount of these loans
was $111.6 million and $469.7 million, respectively. The associated credit risk
on these loans sold with recourse was $111.6 million and $212.0 million for
December 31, 1997 and 1996, respectively. A reserve has been established to
cover any inherent losses. These loans are reviewed on a regular basis to ensure
that reserves are adequate to provide for foreclosure losses. In addition, First
Tennessee originates, sells and services loans guaranteed by the Veterans
Administration (VA). A VA guaranty typically covers only the lesser of $46,000
or 25 percent to 50 percent of the unpaid loan balance. In the event of
foreclosure, First Tennessee, as a servicer of VA loans, has credit risk to the
extent that the outstanding loan balance exceeds the VA guarantee and the value
of the underlying real estate. As of December 31, 1997 and 1996, the outstanding
principal balance of VA loans serviced was $3.2 billion and $2.4 billion. These
loans are reviewed on a regular basis, and a reserve has been established to
cover any inherent losses.
INTEREST RATE RISK MANAGEMENT
First Tennessee's ALCO focuses on managing market risk by controlling and
limiting earnings volatility attributable to changes in interest rates. Interest
rate risk exists to the extent that interest-earning assets and liabilities have
different maturity or repricing characteristics. First Tennessee uses
off-balance sheet financial instruments that are designed to moderate the impact
on earnings as interest rates move up or down.
Interest Rate Swaps involve the exchange of interest payments at specified
intervals between two parties without the exchange of any underlying principal.
Notional amounts are used in such contracts to calculate interest payments due
to each counterparty and do not represent credit exposure. The primary risks
associated with swaps are the exposure to movements in interest rates and the
ability of counterparties to meet the terms of the contracts.
A-64
<PAGE> 90
NOTE 22 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK (CONTINUED)
<TABLE>
<CAPTION>
Notional Fair Weighted Final
(Dollars in millions) Value Value Average Rate Maturity In
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1997
Interest rate contracts:
Swaps - receive fixed/pay floating* $210.0 $ .1 6.200% 1998
Caps:
Purchased $(20.0) $ (.1) Strike 8% 2002
Written 20.0 .1 Strike 8% 2002
- --------------------------------------------------------------------------------
Net position $ -- $ --
================================================================================
1996
Amortizing swap - receive fixed/pay floating $ 34.2 $ (.2) 4.885% 1997
- ----------------------------------------------------------------------------------------------------------
</TABLE>
[FN]
*The weighted average rate paid on interest rate swaps at December 31,1997, was
5.899 percent.
</FN>
CAPITAL MARKETS (FORMERLY THE BOND DIVISION)
The capital markets division buys and sells mortgage securities, municipal bonds
and other securities for trading purposes. When these securities settle on a
delayed basis, they are considered forward contracts. These transactions are
measured at fair value, and gains or losses are recognized in earnings as they
occur. Futures contracts are utilized by capital markets, from time to time, to
manage exposure arising from the inventory position. Credit risk related to
these transactions is controlled through credit approvals, risk control limits
and on-going monitoring procedures through ALCO.
<TABLE>
<CAPTION>
For the Year Ended
At December 31, 1997
December 31, 1997 ------------------
---------------------- Net Average
Notional Fair Gain/ Fair
(Dollars in millions) Value Value (Loss) Value
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Forward contracts:
Commitments to buy:
Gain position $ (424.1) $ 1.4
Loss position (1,174.4) (4.2)
Commitments to sell:
Gain position 1,062.5 2.6
Loss position 608.0 (1.9)
- --------------------------------------------------------------------------------
Net position $ 72.0 $(2.1) $61.2 $(1.5)
================================================================================
Option contracts:
Purchased $ (11.0) * $ -- *
Written 11.0 * -- *
- --------------------------------------------------------------------------------
Net position $ -- $ -- $ -- $ --
================================================================================
</TABLE>
[FN]
*Amount is less than $100,000.
</FN>
<TABLE>
<CAPTION>
At For the Year Ended
December 31, 1996 December 31, 1996
--------------------- ------------------
Net Average
Notional Fair Gain/ Fair
(Dollars in millions) Value Value (Loss) Value
- -----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Forward contracts:
Commitments to buy:
Gain position $ (566.9) $ 4.2
Loss position (606.3) (3.3)
Commitments to sell:
Gain position 616.1 2.8
Loss position 547.5 (4.8)
- -----------------------------------------------------------------------------
Net position $ (9.6) $ (1.1) $ 61.2 $ (.3)
=============================================================================
</TABLE>
[FN]
At December 31, 1996, there were no futures or option contracts outstanding. A
net loss of approximately $100,000 was recognized on futures contracts in 1996.
The average fair value for futures and option contracts was less than $100,000
in 1996.
</FN>
A-65
<PAGE> 91
NOTE 23 - PARENT COMPANY FINANCIAL INFORMATION
Following are condensed statements of the parent company:
<TABLE>
<CAPTION>
STATEMENTS OF CONDITION December 31
- ---------------------------------------------------------------------------------
(Dollars in thousands) 1997 1996
- ---------------------------------------------------------------------------------
<S> <C> <C>
ASSETS:
Cash $ 2 $ 3,094
Securities purchased from subsidiary
bank under agreements to resell 85,891 45,224
- ---------------------------------------------------------------------------------
Total cash and cash equivalents 85,893 48,318
Investment in bank time deposits 5,094 4,240
Securities available for sale 23,760 19,900
Notes receivable--long-term 75,000 75,000
Investments in subsidiaries at equity:
Bank 1,063,646 1,015,354
Non-bank 16,636 12,181
Other assets 36,051 33,472
- ---------------------------------------------------------------------------------
TOTAL ASSETS $1,306,080 $1,208,465
=================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Commercial paper and other
short-term borrowings $ 23,176 $ 32,648
Accrued employee benefits
and other liabilities 54,501 53,925
Term borrowings 274,307 167,366
- ---------------------------------------------------------------------------------
Total liabilities 351,984 253,939
Shareholders' equity 954,096 954,526
- ---------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,306,080 $1,208,465
=================================================================================
</TABLE>
A-66
<PAGE> 92
NOTE 23 - PARENT COMPANY FINANCIAL INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
STATEMENTS OF INCOME Year Ended December 31
- ------------------------------------------------------------------------------------
(Dollars in thousands) 1997 1996 1995
- ------------------------------------------------------------------------------------
<S> <C> <C> <C>
Dividend income:
Bank $ 175,965 $ 87,130 $ 97,791
Non-bank 3,557 2,850 3,982
- ------------------------------------------------------------------------------------
Total dividend income 179,522 89,980 101,773
Interest income 11,287 9,626 9,950
Other income 460 38 248
- ------------------------------------------------------------------------------------
Total income 191,269 99,644 111,971
- ------------------------------------------------------------------------------------
Interest expense:
Short-term debt 1,132 1,725 2,395
Term borrowings 22,729 13,150 9,569
- ------------------------------------------------------------------------------------
Total interest expense 23,861 14,875 11,964
Compensation, employee benefits, and
other expense 10,903 10,203 15,685
- ------------------------------------------------------------------------------------
Total expense 34,764 25,078 27,649
- ------------------------------------------------------------------------------------
Income before income taxes
and equity in undistributed
net income of subsidiaries 156,505 74,566 84,322
Applicable income taxes (10,458) (6,099) (6,825)
- ------------------------------------------------------------------------------------
Income before equity in undistributed
net income of subsidiaries 166,963 80,665 91,147
Equity in undistributed net
income of subsidiaries:
Bank 29,439 98,148 73,073
Non-bank 1,070 1,094 668
- ------------------------------------------------------------------------------------
NET INCOME $ 197,472 $ 179,907 $ 164,888
====================================================================================
</TABLE>
A-67
<PAGE> 93
NOTE 23 - PARENT COMPANY FINANCIAL INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
STATEMENTS OF CASH FLOWS Year Ended December 31
- ----------------------------------------------------------------------------------------------------------
(Dollars in thousands) 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income $ 197,472 $ 179,907 $ 164,888
Less undistributed net income
of subsidiaries 30,509 99,242 73,741
- ----------------------------------------------------------------------------------------------------------
Income before undistributed
net income of subsidiaries 166,963 80,665 91,147
Adjustments to reconcile income to net cash
provided by operating activities:
Provision/(benefit) for deferred income taxes 1,797 (2,763) (17)
Depreciation and amortization 2,176 2,087 1,926
Loss/(gain) on disposal of fixed assets 3 56 (225)
Net change in interest receivable and other assets (4,740) (1,541) (4,042)
Net change in interest payable and other liabilities 5,678 9,879 4,077
- ----------------------------------------------------------------------------------------------------------
Total adjustments 4,914 7,718 1,719
- ----------------------------------------------------------------------------------------------------------
Net cash provided by
operating activities 171,877 88,383 92,866
- ----------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Securities:
Maturities 40 270 5,151
Purchases (3,900) (18,660) (202)
Premises and equipment:
Sales -- 21 1,608
Purchases (72) (166) (426)
Investment in subsidiaries (3,093) -- 2,656
Increase in investment in bank time deposits (854) (4,140) (100)
Acquisitions, cash received/(paid) (185) 400 22,040
- ----------------------------------------------------------------------------------------------------------
Net cash provided/(used) by
investing activities (8,064) (22,275) 30,727
- ----------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Common stock:
Exercise of stock options 24,309 5,779 4,977
Cash dividends (78,348) (71,310) (62,694)
Repurchase of shares (169,520) (28,356) (122,796)
Term borrowings:
Issuance 106,793 18,250 74,183
Payments -- -- (13,950)
Decrease in short-term borrowings (9,472) (16,753) (18,419)
- ----------------------------------------------------------------------------------------------------------
Net cash used by
financing activities (126,238) (92,390) (138,699)
- ----------------------------------------------------------------------------------------------------------
Net increase/(decrease) in cash
and cash equivalents 37,575 (26,282) (15,106)
- ----------------------------------------------------------------------------------------------------------
Cash and cash equivalents
at beginning of year 48,318 74,600 89,706
- ----------------------------------------------------------------------------------------------------------
Cash and cash equivalents
at end of year $ 85,893 $ 48,318 $ 74,600
==========================================================================================================
Total interest paid $ 19,167 $ 14,706 $ 11,281
Total income taxes paid 60,050 47,812 46,225
- ----------------------------------------------------------------------------------------------------------
</TABLE>
A-68
<PAGE> 94
<TABLE>
<CAPTION>
CONSOLIDATED HISTORICAL STATEMENTS OF INCOME (UNAUDITED) FIRST TENNESSEE NATIONAL CORPORATION
- ------------------------------------------------------------------------------------------------------------------------------------
Growth Rates (%)
------------------
(Dollars in millions except per share data) 1997 1996 1995 1994 1993 1992 97/96 97/92*
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
INTEREST INCOME:
Interest and fees on loans:
Commercial $ 298.9 $ 277.2 $ 264.4 $ 211.6 $ 178.7 $ 180.4 7.8 + 10.6 +
Consumer 248.7 229.9 206.0 166.8 128.1 114.6 8.2 + 16.8 +
Permanent mortgage 51.0 51.7 52.1 44.0 45.9 59.0 1.4 - 2.9 -
Credit card receivables 67.9 67.6 65.5 56.6 51.1 53.2 .4 + 5.0 +
Real estate construction 33.1 27.1 23.0 11.4 7.3 6.0 22.1 + 40.7 +
Investment securities:
Taxable 135.3 136.0 130.9 128.9 175.8 187.1 .5 - 6.3 -
Tax-exempt 4.5 5.1 4.6 5.2 7.2 8.7 11.8 - 12.4 -
Other earning assets:
Mortgage loans held for sale 76.9 82.1 54.7 56.0 44.9 15.7 6.3 - 37.4 +
Investments in bank time deposits .5 .7 .2 .2 .2 2.5 28.6 - 27.5 -
Federal funds sold and securities
purchased under agreements to resell 11.1 5.0 8.5 7.6 3.7 6.8 122.0 + 10.3 +
Capital markets inventory 13.4 14.1 12.6 12.8 9.3 10.3 5.0 - 5.4 +
- ---------------------------------------------------------------------------------------------------------------
Total interest income 941.3 896.5 822.5 701.1 652.2 644.3 5.0 + 7.9 +
- ---------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE:
Deposits:
Savings 8.2 9.4 10.8 13.4 15.4 17.5 12.8 - 14.1 -
Checking interest and money
market account 95.1 92.7 95.8 65.7 54.3 65.4 2.6 + 7.8 +
Certificates of deposit under $100,000
and other time 160.5 166.5 167.8 122.0 117.3 147.3 3.6 - 1.7 +
Certificates of deposit $100,000 and more 47.7 46.3 30.6 18.7 16.2 20.5 3.0 + 18.4 +
Federal funds purchased and securities
sold under agreements to repurchase 89.8 78.0 80.9 40.5 29.2 22.5 15.1 + 31.9 +
Commercial paper and other short-term
borrowings 39.2 29.3 25.7 35.6 33.6 13.7 33.8 + 23.4 +
Federal Reserve Bank penalties 1.8 2.3 2.2 1.1 .5 .7 21.7 - 20.8 +
Term borrowings 15.9 20.8 18.0 9.6 9.6 11.1 23.6 - 7.5 +
- ---------------------------------------------------------------------------------------------------------------
Total interest expense 458.2 445.3 431.8 306.6 276.1 298.7 2.9 + 8.9 +
- ---------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 483.1 451.2 390.7 394.5 376.1 345.6 7.1 + 6.9 +
Provision for loan losses 51.1 35.7 20.6 17.2 36.5 45.2 43.1 + 2.5 +
- ---------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME AFTER PROVISION 432.0 415.5 370.1 377.3 339.6 300.4 4.0 + 7.5 +
- ---------------------------------------------------------------------------------------------------------------
NONINTEREST INCOME:
Mortgage banking 330.1 275.4 213.6 188.2 139.6 33.6 19.9 + 58.0 +
Capital markets 98.3 85.9 82.8 77.5 91.5 80.3 14.5 + 4.1 +
Deposit transactions and cash management 86.1 78.2 74.1 65.8 59.6 54.6 10.0 + 9.5 +
Trust services and investment management 40.9 34.7 34.4 27.9 25.5 22.8 18.0 + 12.4 +
Merchant processing 32.1 24.2 19.2 14.7 12.0 10.7 32.8 + 24.5 +
Cardholder fees 19.8 17.2 14.9 15.6 15.8 15.6 15.6 + 4.9 +
Equity securities gains/(losses) (.8) (2.5) 3.2 24.3 (.5) .3 65.8 + N/A
Debt securities gains/(losses) .1 (.2) (.8) (4.3) 1.4 (1.5) N/A N/A
All other income and commissions 61.5 58.3 51.2 46.5 43.2 37.4 5.5 + 10.4 +
- ---------------------------------------------------------------------------------------------------------------
Total noninterest income 668.1 571.2 492.6 456.2 388.1 253.8 17.0 + 21.4 +
- ---------------------------------------------------------------------------------------------------------------
ADJUSTED GROSS INCOME AFTER PROVISION 1,100.1 986.7 862.7 833.5 727.7 554.2 11.5 + 14.7 +
- ---------------------------------------------------------------------------------------------------------------
NONINTEREST EXPENSE:
Employee compensation, incentives and
benefits 409.8 385.4 340.5 349.8 308.6 214.3 6.3 + 13.8 +
Operations services 49.9 44.1 38.8 33.7 28.7 24.3 13.1 + 15.5 +
Occupancy 42.8 39.8 37.9 34.1 27.7 24.7 7.6 + 11.6 +
Equipment rentals, depreciation and
maintenance 40.1 34.1 31.8 29.2 22.2 17.5 17.5 + 18.0 +
Amortization of mortgage servicing rights 37.4 26.0 15.0 14.9 25.5 4.5 43.8 + 52.9 +
Communications and courier 34.9 33.0 29.9 30.7 24.8 18.0 5.8 + 14.1 +
Advertising and public relations 18.7 17.6 13.0 10.7 8.0 6.2 6.2 + 24.9 +
Amortization of intangible assets 9.6 9.5 8.1 6.4 5.8 9.8 1.5 + .5 -
All other expense 141.8 115.0 94.7 116.2 101.3 85.3 23.3 + 10.7 +
- ---------------------------------------------------------------------------------------------------------------
Total noninterest expense 785.0 704.5 609.7 625.7 552.6 404.6 11.4 + 14.2 +
- ---------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 315.1 282.2 253.0 207.8 175.1 149.6 11.7 + 16.1 +
Applicable income taxes 117.6 102.3 88.1 60.7 65.4 56.9 15.0 + 15.6 +
- ---------------------------------------------------------------------------------------------------------------
NET INCOME $ 197.5 $ 179.9 $ 164.9 $ 147.1 $ 109.7 $ 92.7 9.8 + 16.3 +
===============================================================================================================
FULLY TAXABLE EQUIVALENT ADJUSTMENT $ 4.3 $ 5.4 $ 5.0 $ 4.8 $ 6.3 $ 8.4 20.4 - 12.5 -
- ---------------------------------------------------------------------------------------------------------------
EARNINGS PER SHARE $ 1.54 $ 1.34 $ 1.21 $ 1.07 $ .81 $ .72 14.9 + 16.4 +
- ---------------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER SHARE $ 1.50 $ 1.32 $ 1.20 $ 1.07 $ .80 $ .71 13.6 + 16.1 +
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
[FN]
* Compound annual growth rate.
Certain previously reported amounts have been reclassified to agree with current
presentation. Per share data reflect the 1998 and 1996 two-for-one stock splits.
</FN>
A-69
<PAGE> 95
<TABLE>
<CAPTION>
CONSOLIDATED AVERAGE BALANCE SHEETS AND
RELATED YIELDS AND RATES (UNAUDITED) FIRST TENNESSEE NATIONAL CORPORATION
- ------------------------------------------------------------------------------------------------------------------------------------
1997 1996 Average
------------------------------- ----------------------------- Balance
Interest Average Interest Average Growth(%)
(Fully taxable equivalent) Average Income/ Yields/ Average Income/ Yields/ ---------
(Dollars in millions) Balance Expense Rates Balance Expense Rates 97/96
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS:
Earning assets:
Loans, net of unearned income:
Commercial $ 3,624.8 $299.8 8.27% $ 3,383.5 $278.2 8.22% 7.1 +
Consumer 2,760.0 248.7 9.01 2,607.5 229.9 8.82 5.8 +
Permanent mortgage 638.4 51.0 7.99 660.0 51.7 7.83 3.3 -
Credit card receivables 544.7 67.9 12.47 530.2 67.6 12.74 2.7 +
Real estate construction 337.4 33.0 9.79 275.1 27.0 9.82 22.6 +
Nonaccrual loans 39.8 .9 2.16 15.8 1.5 9.62 151.9 +
- -------------------------------------------------------------------------------------------------------------------------
Total loans, net of unearned income 7,945.1 701.3 8.83 7,472.1 655.9 8.78 6.3 +
- -------------------------------------------------------------------------------------------------------------------------
Investment securities:
U.S. Treasury and other U.S. government agencies 1,963.3 129.3 6.59 2,031.2 131.0 6.45 3.3 -
States and municipalities 83.7 6.8 8.06 98.1 7.9 8.02 14.7 -
Other 92.4 6.1 6.65 73.9 4.8 6.51 25.0 +
- -------------------------------------------------------------------------------------------------------------------------
Total investment securities 2,139.4 142.2 6.65 2,203.2 143.7 6.52 2.9 -
- -------------------------------------------------------------------------------------------------------------------------
Other earning assets:
Mortgage loans held for sale 1,005.9 76.9 7.64 1,059.4 82.1 7.74 5.1 -
Investment in bank time deposits 9.8 .5 5.05 14.6 .7 5.05 32.9 -
Federal funds sold and securities purchased
under agreements to resell 207.1 11.1 5.37 94.2 5.0 5.30 119.9 +
Capital markets inventory 204.8 13.6 6.65 218.5 14.5 6.66 6.3 -
- -------------------------------------------------------------------------------------------------------------------------
Total other earning assets 1,427.6 102.1 7.15 1,386.7 102.3 7.38 2.9 +
- -------------------------------------------------------------------------------------------------------------------------
Total earning assets 11,512.1 945.6 8.21 11,062.0 901.9 8.15 4.1 +
Allowance for loan losses (123.6) (117.1) 5.6 +
Cash and due from banks 658.6 662.8 .6 -
Premises and equipment, net 195.1 181.4 7.6 +
Capital markets receivables and other assets 1,038.4 799.2 29.9 +
- -------------------------------------------------------------------------------------------------------------------------
Total assets/Interest income $13,280.6 $945.6 $12,588.3 $901.9 5.5 +
=========================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing liabilities:
Interest-bearing deposits:
Savings $ 376.5 $ 8.2 2.17% $ 424.3 $ 9.4 2.23% 11.3 -
Checking interest and money market 2,963.7 95.1 3.21 2,715.9 92.7 3.41 9.1 +
Certificates of deposit under $100,000
and other time 2,798.0 160.5 5.74 2,885.2 166.5 5.77 3.0 -
Certificates of deposit $100,000 and more 843.0 47.7 5.66 835.8 46.3 5.54 .9 +
- -------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 6,981.2 311.5 4.46 6,861.2 314.9 4.59 1.7 +
Federal funds purchased and securities sold
under agreements to repurchase 1,790.1 89.8 5.01 1,588.1 78.0 4.91 12.7 +
Commercial paper and other short-term borrowings 663.0 41.0 6.18 520.1 31.6 6.07 27.5 +
Term borrowings 185.5 15.9 8.60 253.7 20.8 8.24 26.9 -
- -------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 9,619.8 458.2 4.76 9,223.1 445.3 4.83 4.3 +
Demand deposits 1,695.8 1,816.1 6.6 -
Other noninterest-bearing deposits 530.1 268.2 97.7 +
Capital markets payables and other liabilities 457.5 383.4 19.3 +
Guaranteed preferred beneficial interests in First
Tennessee's junior subordinated debentures 98.6 - N/A
Shareholders' equity 878.8 897.5 2.1 -
- -------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders'
equity/Interest expense $13,280.6 $458.2 $12,588.3 $445.3 5.5 +
=========================================================================================================================
Net interest income-tax equivalent basis/Yield $487.4 4.23% $456.6 4.13%
Fully taxable equivalent adjustment (4.3) (5.4)
- -------------------------------------------------------------------------------------------------------------------------
Net interest income $483.1 $451.2
=========================================================================================================================
Net interest spread 3.45% 3.32%
Effect of interest-free sources used to fund
earning assets .78 .81
- -------------------------------------------------------------------------------------------------------------------------
Net interest margin 4.23% 4.13%
=========================================================================================================================
</TABLE>
[FN]
Certain previously reported amounts have been reclassified to agree with current
presentation. Yields and corresponding income amounts are adjusted to a fully
taxable equivalent. Earning assets yields are expressed net of unearned income.
Rates are expressed net of unamortized debenture cost for long-term debt. Net
interest margin is computed using total net interest income.
</FN>
A-70
<PAGE> 96
<TABLE>
<CAPTION>
CONSOLIDATED AVERAGE BALANCE SHEETS AND
RELATED YIELDS AND RATES (UNAUDITED) FIRST TENNESSEE NATIONAL CORPORATION
- ------------------------------------------------------------------------------------------------------------------------------------
1995 1994
------------------------------- -------------------------------
Interest Average Interest Average
(Fully taxable equivalent) Average Income/ Yields/ Average Income/ Yields/
(Dollars in millions) Balance Expense Rates Balance Expense Rates
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS:
Earning assets:
Loans, net of unearned income:
Commercial $ 3,148.4 $265.3 8.43% $ 2,775.7 $212.4 7.65%
Consumer 2,367.1 206.0 8.70 2,082.6 166.8 8.01
Permanent mortgage 658.4 52.1 7.91 557.5 44.0 7.90
Credit card receivables 480.4 65.5 13.63 432.7 56.6 13.08
Real estate construction 216.4 23.0 10.65 117.3 11.4 9.71
Nonaccrual loans 16.5 1.4 8.48 18.6 1.3 7.25
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans, net of unearned income 6,887.2 613.3 8.90 5,984.4 492.5 8.23
- ------------------------------------------------------------------------------------------------------------------------------------
Investment securities:
U.S. Treasury and other U.S. government agencies 2,004.3 125.9 6.28 2,063.4 122.8 5.95
States and municipalities 81.4 7.0 8.63 84.3 7.8 9.26
Other 75.3 4.9 6.53 101.0 5.9 5.91
- ------------------------------------------------------------------------------------------------------------------------------------
Total investment securities 2,161.0 137.8 6.38 2,248.7 136.5 6.07
- ------------------------------------------------------------------------------------------------------------------------------------
Other earning assets:
Mortgage loans held for sale 706.1 54.7 7.75 767.9 56.0 7.29
Investment in bank time deposits 3.1 .2 5.79 5.3 .2 3.88
Federal funds sold and securities purchased
under agreements to resell 157.5 8.5 5.42 191.9 7.6 3.97
Capital markets inventory 179.8 13.0 7.22 208.0 13.1 6.28
- ------------------------------------------------------------------------------------------------------------------------------------
Total other earning assets 1,046.5 76.4 7.30 1,173.1 76.9 6.55
- ------------------------------------------------------------------------------------------------------------------------------------
Total earning assets 10,094.7 827.5 8.20 9,406.2 705.9 7.50
Allowance for loan losses (113.0) (113.1)
Cash and due from banks 659.0 659.7
Premises and equipment, net 166.0 149.1
Capital markets receivables and other assets 552.8 477.9
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets/Interest income $ 11,359.5 $827.5 $ 10,579.8 $705.9
====================================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing liabilities:
Interest-bearing deposits:
Savings $ 459.5 $ 10.8 2.35% $ 544.3 $ 13.4 2.47%
Checking interest and money market 2,378.9 95.8 4.03 2,295.6 65.7 2.86
Certificates of deposit under $100,000
and other time 2,872.6 167.8 5.84 2,529.4 122.0 4.82
Certificates of deposit $100,000 and more 531.9 30.6 5.75 460.2 18.7 4.06
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 6,242.9 305.0 4.89 5,829.5 219.8 3.77
Federal funds purchased and securities sold
under agreements to repurchase 1,491.1 80.9 5.43 1,045.6 40.5 3.87
Commercial paper and other short-term borrowings 404.2 27.9 6.90 683.2 36.7 5.37
Term borrowings 208.9 18.0 8.63 101.8 9.6 9.41
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 8,347.1 431.8 5.17 7,660.1 306.6 4.00
Demand deposits 1,746.8 1,742.7
Other noninterest-bearing deposits 142.7 142.2
Capital markets payables and other liabilities 300.1 275.3
Guaranteed preferred beneficial interests in First
Tennessee's junior subordinated debentures - -
Shareholders' equity 822.8 759.5
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders'
equity/Interest expense $ 11,359.5 $431.8 $ 10,579.8 $306.6
====================================================================================================================================
Net interest income-tax equivalent basis/Yield $395.7 3.92% $399.3 4.25%
Fully taxable equivalent adjustment (5.0) (4.8)
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income $390.7 $394.5
====================================================================================================================================
Net interest spread 3.03% 3.50%
Effect of interest-free sources used to fund
earning assets .89 .75
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest margin 3.92% 4.25%
====================================================================================================================================
</TABLE>
[FN]
Certain previously reported amounts have been reclassified to agree with current
presentation. Yields and corresponding income amounts are adjusted to a fully
taxable equivalent. Earning assets yields are expressed net of unearned income.
Rates are expressed net of unamortized debenture cost for long-term debt. Net
interest margin is computed using total net interest income.
</FN>
<PAGE> 97
<TABLE>
<CAPTION>
CONSOLIDATED AVERAGE BALANCE SHEETS AND
RELATED YIELDS AND RATES (UNAUDITED) FIRST TENNESSEE NATIONAL CORPORATION
- ------------------------------------------------------------------------------------------------------------------------------------
1993 1992
------------------------------ ----------------------------- Average
Interest Average Interest Average Growth(%)
(Fully taxable equivalent) Average Income/ Yields/ Average Income/ Yields/ ---------
(Dollars in millions) Balance Expense Rates Balance Expense Rates 97/92*
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS:
Earning assets:
Loans, net of unearned income:
Commercial $2,435.3 $179.4 7.37% $2,332.2 $182.9 7.84% 9.2 +
Consumer 1,524.9 128.1 8.40 1,231.8 114.6 9.30 17.5 +
Permanent mortgage 527.4 45.9 8.70 643.2 59.0 9.17 .1 -
Credit card receivables 396.5 51.1 12.90 388.1 53.2 13.72 7.0 +
Real estate construction 82.0 7.3 8.92 58.9 6.0 10.21 41.8 +
Nonaccrual loans 30.3 1.8 5.86 44.2 1.5 3.48 2.1 -
- -------------------------------------------------------------------------------------------------------------------------
Total loans, net of unearned income 4,996.4 413.6 8.28 4,698.4 417.2 8.88 11.1 +
- -------------------------------------------------------------------------------------------------------------------------
Investment securities:
U.S. Treasury and other U.S. government agencies 2,679.9 160.8 6.00 2,224.4 154.3 6.94 2.5 -
States and municipalities 109.2 10.8 9.92 127.2 13.0 10.26 8.0 -
Other 226.2 14.9 6.60 452.3 32.6 7.21 27.2 -
- -------------------------------------------------------------------------------------------------------------------------
Total investment securities 3,015.3 186.5 6.19 2,803.9 199.9 7.13 5.3 -
- -------------------------------------------------------------------------------------------------------------------------
Other earning assets:
Mortgage loans held for sale 615.3 44.9 7.29 188.8 15.7 8.29 39.7 +
Investment in bank time deposits 4.2 .2 3.84 40.6 2.5 6.08 24.7 -
Federal funds sold and securities purchased
under agreements to resell 142.0 3.7 2.63 222.8 6.8 3.05 1.5 -
Capital markets inventory 180.4 9.6 5.34 158.4 10.6 6.70 5.3 +
- -------------------------------------------------------------------------------------------------------------------------
Total other earning assets 941.9 58.4 6.20 610.6 35.6 5.82 18.5 +
- -------------------------------------------------------------------------------------------------------------------------
Total earning assets 8,953.6 658.5 7.35 8,112.9 652.7 8.05 7.2 +
Allowance for loan losses (109.6) (103.3) 3.7 +
Cash and due from banks 582.5 487.7 6.2 +
Premises and equipment, net 126.3 117.3 10.7 +
Capital markets receivables and other assets 429.6 296.9 28.5 +
- -------------------------------------------------------------------------------------------------------------------------
Total assets/Interest income $9,982.4 $658.5 $8,911.5 $652.7 8.3 +
=========================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing liabilities:
Interest-bearing deposits:
Savings $ 567.9 $ 15.4 2.72% $ 518.0 $ 17.5 3.38% 6.2 -
Checking interest and money market 2,221.9 54.3 2.44 2,090.3 65.4 3.13 7.2 +
Certificates of deposit under $100,000
and other time 2,439.4 117.3 4.81 2,621.5 147.3 5.62 1.3 +
Certificates of deposit $100,000 and more 414.0 16.2 3.91 472.7 20.5 4.34 12.3 +
- -------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 5,643.2 203.2 3.60 5,702.5 250.7 4.40 4.1 +
Federal funds purchased and securities sold
under agreements to repurchase 1,029.0 29.2 2.84 691.7 22.5 3.26 20.9 +
Commercial paper and other short-term borrowings 724.5 34.1 4.70 251.1 14.4 5.75 21.4 +
Term borrowings 102.8 9.6 9.39 132.8 11.1 8.33 6.9 +
- -------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 7,499.5 276.1 3.68 6,778.1 298.7 4.41 7.3 +
Demand deposits 1,542.8 1,327.7 5.0 +
Other noninterest-bearing deposits - - N/A
Capital markets payables and other liabilities 256.0 183.2 20.1 +
Guaranteed preferred beneficial interests in First
Tennessee's junior subordinated debentures - - N/A
Shareholders' equity 684.1 622.5 7.1 +
- -------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders'
equity/Interest expense $9,982.4 $276.1 $8,911.5 $298.7 8.3 +
=========================================================================================================================
Net interest income-tax equivalent basis/Yield $382.4 4.27% $354.0 4.36%
Fully taxable equivalent adjustment (6.3) (8.4)
- -------------------------------------------------------------------------------------------------------------------------
Net interest income $376.1 $345.6
=========================================================================================================================
Net interest spread 3.67% 3.64%
Effect of interest-free sources used to fund
earning assets .60 .72
- -------------------------------------------------------------------------------------------------------------------------
Net interest margin 4.27% 4.36%
=========================================================================================================================
</TABLE>
[FN]
Certain previously reported amounts have been reclassified to agree with current
presentation. Yields and corresponding income amounts are adjusted to a fully
taxable equivalent. Earning assets yields are expressed net of unearned income.
Rates are expressed net of unamortized debenture cost for long-term debt. Net
interest margin is computed using total net interest income. *Compound annual
growth rate
</FN>
A-71
<PAGE> 98
CORPORATE OFFICERS
RALPH HORN
Chairman of the Board, President and
Chief Executive Officer
J. KENNETH GLASS
President
Tennessee Banking Group
First Tennessee Bank National Association
JOHN C. KELLEY, JR.
President
Memphis Banking Group
First Tennessee Bank National Association
GEORGE P. LEWIS
Executive Vice President
Money Management Group
First Tennessee Bank National Association
SUSAN SCHMIDT BIES
Executive Vice President
Risk Management
HARRY A. JOHNSON, III
Executive Vice President
General Counsel
JOHN P. O'CONNOR, JR.
Executive Vice President
Chief Credit Officer
ELBERT L. THOMAS, JR.
Executive Vice President
Chief Financial Officer
G. ROBERT VEZINA
Executive Vice President
Personnel Division Manager
JAMES F. KEEN
Senior Vice President
Corporate Controller
RICHARD M. FAUST
Senior Vice President
Audit and Security
TERESA A. ROSENGARTEN
Vice President
Treasurer
LENORE S. CRESON
Corporate Secretary
CORPORATE DIRECTORS
ROBERT C. BLATTBERG
Polk Brothers Distinguished Professor of Retailing
J.L. Kellogg Graduate School of Management
Northwestern University
CARLOS H. CANTU
President and Chief Executive Officer
The ServiceMaster Company
GEORGE E. CATES
Chairman of the Board and Chief Executive Officer
Mid-America Apartment Communities, Inc.
J. KENNETH GLASS
President-Tennessee Banking Group
First Tennessee Bank National Association
JAMES A. HASLAM, III
Chief Executive Officer and Chief Operating Officer
Pilot Corporation
RALPH HORN
Chairman of the Board,
President and Chief Executive Officer
First Tennessee National Corporation
First Tennessee Bank National Association
JOHN C. KELLEY, JR.
President-Memphis Banking Group
First Tennessee Bank National Association
R. BRAD MARTIN
Chairman of the Board and Chief Executive Officer
Profitt's, Inc.
JOSEPH ORGILL, III
Chairman of the Board
Orgill, Inc.
VICKI R. PALMER
Corporate Vice President and Treasurer
Coca-Cola Enterprises, Inc.
MICHAEL D. ROSE
Private Investor
WILLIAM B. SANSOM
Chairman of the Board and Chief Executive Officer
The H.T. Hackney Co.
GORDON P. STREET, JR.
Chairman of the Board,
Chief Executive Officer and President
North American Royalities, Inc.
A-72
<PAGE> 99
APPENDIX
[FRONT]
[LOGO] FIRST
TENNESSEE
FIRST TENNESSEE NATIONAL CORPORATION
PROXY SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
The undersigned appoints James L. Boren, Jr., Lewis R. Donelson, and
George P. Lewis, or any one or more of them with full power of substitution, as
Proxy or Proxies, to represent and vote all shares of stock standing in my name
on the books of the Corporation at the close of business on February 27, 1998,
which I would be entitled to vote if personally present at the Annual Meeting
of Shareholders of First Tennessee National Corporation to be held in the
Auditorium, First Tennessee Building, 165 Madison Avenue, Memphis, Tennessee,
April 21, 1998, at 10 a.m. or any adjournments thereof, upon the matters set
forth in the notice of said meeting as stated on the reverse side. The Proxies
are further authorized to vote in their discretion as to any other matters
which may come before the meeting. The Board of Directors, at the time of
preparation of the Proxy Statement, knows of no business to come before the
meeting other than that referred to in the Proxy Statement.
THE SHARES COVERED BY THIS PROXY WILL BE VOTED IN ACCORDANCE WITH THE
INSTRUCTIONS GIVEN ON THE REVERSE SIDE AND WHEN NO INSTRUCTIONS ARE GIVEN WILL
BE VOTED FOR THE PROPOSALS DESCRIBED IN THE ACCOMPANYING NOTICE OF ANNUAL
MEETING AND PROXY STATEMENT AND ON THE REVERSE SIDE OF THIS PROXY.
(Continued, and to be signed and dated on reverse side)
YOU CAN NOW VOTE YOUR PROXY BY TELEPHONE.
(See instructions on reverse.)
<PAGE> 100
COMPANY #_____________
CONTROL #_____________
VOTE BY TELEPHONE
QUICK *** EASY *** IMMEDIATE
CALL TOLL FREE *** ON A TOUCH TONE TELEPHONE
1-800-240-6326 - ANYTIME
Your telephone vote authorizes the named proxies to vote your shares in the
same manner as if you marked, dated, signed and returned your proxy card. The
deadline for telephone voting is noon (ET), April 20, 1998.
AUTOMATED TELEPHONE VOTING INSTRUCTIONS:
1. Using a touch-tone telephone, dial 1-800-240-6326. Please make sure you
stay on the line until you receive a confirmation of your vote.
2. When prompted, enter the 3 digit Company Number located in the box on the
upper right hand corner of the proxy card.
3. When prompted, enter your 7 digit numeric Control Number that follows the
Company Number.
OPTION #1: TO VOTE AS THE (FIRST TENNESSEE NATIONAL CORPORATION) BOARD
OF DIRECTORS RECOMMENDS ON ALL PROPOSALS: PRESS 1
WHEN ASKED, PLEASE CONFIRM YOUR VOTE BY PRESSING 1 - THANK
YOU FOR VOTING.
OPTION #2 IF YOU CHOOSE TO VOTE ON EACH PROPOSAL SEPARATELY, PRESS
0. YOU WILL HEAR THESE INSTRUCTIONS:
Proposal 1: To vote FOR ALL nominees, press 1; to WITHHOLD
FOR ALL nominees, press 9; to WITHHOLD FOR AN
INDIVIDUAL nominee, Press 0 and listen to the
instructions.
Proposal 2: To vote FOR, press 1; AGAINST, press 9; ABSTAIN,
press 0
When asked, please confirm your vote by pressing 1 -
THANK YOU FOR VOTING.
IF YOU VOTE BY TELEPHONE, DO NOT MAIL BACK YOU PROXY
Please detach here
<TABLE>
<S> <C> <C>
The First Tennessee National Corporation [LOGO] FIRST TENNESSEE
Annual Meeting
First Tennessee Building
M-Level Auditorium
165 Madison Avenue
Memphis, Tennessee 38103
April 21, 1998
10:00 a.m. Central Daylight Time
[X] Please mark votes as in this example.
THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE FOR ALL ITEMS.
1. Election of four Class II directors to serve until the 2001 Annual Meeting of Shareholders.
Nominees: (01) Robert C. Blattberg, (02) J. Kenneth Glass, (03) John C. Kelley, Jr. and (04) Michael D. Rose
[ ] FOR [ ] WITHHELD
all nominees from all nominees
To withhold authority to vote for any nominee(s), --------------------------------------------------
write the number(s) of the nominee(s) in the box to the right.
--------------------------------------------------
2. Ratification of appointment of Arthur Andersen LLP as
auditors.
FOR AGAINST ABSTAIN
[ ] [ ] [ ]
Address change? Mark Box. Indicate changes below: [ ]
</TABLE>
The undersigned hereby acknowledges receipt of notice of said meeting and
the related proxy statement.
Date
-------------------------------
----------------------------------
----------------------------------
Signatures in Box
Shareholder sign here exactly as shown on the imprint on this card. When
signing as Attorney, Executor, Administrator, Trustee or Guardian, please give
full name. If more than one Trustee, all should sign. All Joint Owners should
sign.
