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  • 10-K (Mar 15, 2007)
  • 10-K (Mar 15, 2006)
  • 10-K (Mar 14, 2005)

 
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Amcore Financial 10-K 2008
Form 10-K
Table of Contents

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 10–K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2007

 

Commission file number 0–13393

 

 

 

AMCORE FINANCIAL, INC.

 

NEVADA   36–3183870
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)

 

501 Seventh Street, Rockford, Illinois 61104

Telephone Number (815) 968–2241

 

Securities Registered Pursuant to Section 12(b) of the Act:

Common Stock, $0.22 par value

Common Stock Purchase Rights

 

The NASDAQ Stock Market LLC

(Name of Exchange on which registered)

 

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   X  Yes           No

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.           Yes      X  No

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  X  Yes           No

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S–K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10–K or any amendment to this Form 10–K.      X  

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):

 

Large accelerated filer           Accelerated filer   X     Non-accelerated filer        

 

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).           Yes       X  No

 

As of February 15, 2008, 21,937,000 shares of common stock were outstanding. The aggregate market value of the common equity held by non-affiliates, computed by reference to the average bid and ask price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter was approximately $581.6 million.

 

 

 

Documents Incorporated by Reference:

 

Portions of the Proxy Statement and Notice of 2008 Annual Meeting, dated March 17, 2008, are incorporated by reference into Part III of the Form 10-K for the fiscal year ended December 31, 2007.

 

 

 


Table of Contents

AMCORE FINANCIAL, INC.

 

Form 10–K Table of Contents

 

PART I

        Page
Number

Item 1

   Business    1

Item 1A

   Risk Factors    9

Item 1B

   Unresolved Staff Comments    11

Item 2

   Properties    11

Item 3

   Legal Proceedings    11

Item 4

   Submission of Matters to a Vote of Security Holders    11

PART II

         

Item 5

   Market for the Registrant’s Common Equity and Related Stockholder Matters    12

Item 6

   Selected Financial Data    13

Item 7

   Management’s Discussion and Analysis of Financial Condition and Results of Operations   

14

Item 7A

   Quantitative and Qualitative Disclosures About Market Risk    41

Item 8

   Financial Statements and Supplementary Data    48

Item 9

   Changes In and Disagreements With Accountants on Accounting and Financial Disclosure   

93

Item 9A

   Controls and Procedures    93

Item 9B

   Other Information    95

PART III

         

Item 10

   Directors and Executive Officers of the Registrant    96

Item 11

   Executive Compensation    96

Item 12

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters   

96

Item 13

   Certain Relationships and Related Transactions    97

Item 14

   Principal Accountant Fees and Services    97

PART IV

         

Item 15

   Exhibits and Financial Statements Schedules    97

Signatures

   100


Table of Contents

PART I

 

ITEM 1.    BUSINESS

 

General

 

AMCORE Financial, Inc. (“AMCORE” or the “Company”) is a registered bank holding company incorporated under the laws of the State of Nevada in 1982. The Company’s corporate headquarters is located at 501 Seventh Street in Rockford, Illinois. The operations are divided into four business segments: Commercial Banking, Retail Banking, Investment Management and Trust and Mortgage Banking. AMCORE owns directly or indirectly all of the outstanding common stock of each of its subsidiaries and provides its subsidiaries with advice and counsel on policies and operating matters among other things.

 

AMCORE provides free of charge, through the Company’s Internet site at www.AMCORE.com/SEC, access to annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports, as soon as reasonably practicable after electronically filing such material with the Securities and Exchange Commission (SEC). However, the information found on AMCORE’s website is not part of this or any other report. The Company has adopted a code of ethics applicable to all employees. The AMCORE Financial, Inc. Code of Ethics is posted on the Company’s website at www.AMCORE.com/governance. The Company intends that this website posting and future postings of amendments, waivers or modifications of the Code of Ethics shall contain all required disclosures, however, a Form 8-K will be filed for amendments and waivers in order to meet the more stringent NASDAQ rules.

 

Banking Segments

 

General – AMCORE directly owns AMCORE Bank, N.A. (Bank), a nationally chartered bank. AMCORE also indirectly owns Property Exchange Company, a qualified intermediary, which is a subsidiary of the Bank, and dissolved the consumer finance subsidiary, AMCORE Consumer Finance Company, Inc.

 

Geographic and Economic Information – The Bank conducts business at 79 branch locations throughout northern Illinois and southern Wisconsin (the “Service Area”). The Banking segments’ Service Area is dispersed among five basic economic areas: the Rockford, Illinois metropolitan area (Rockford), the Madison, Wisconsin metropolitan area (Madison), the Chicago, Illinois metropolitan area (Chicagoland), the Milwaukee, Wisconsin suburbs (Milwaukee) and community banking branches which are not otherwise specified (Community Banking). Locations in the Chicagoland, Rockford, Madison and Milwaukee economic areas are generally bounded by Interstates 94 in the north, 294 and 94 in the east, 80 in the south and 90 and 39 in the west where population growth, homeownership and household income are high and where there is a high concentration of mid-sized businesses. The Company’s growth strategy has focused on expansion within this area.

 

Among the five economic areas, Rockford has the highest concentration of manufacturing activities. Community banking, on the other hand, has less growth potential and a greater concentration of smaller-sized business and agricultural activities. Economic conditions for the Company’s Wisconsin markets, including the Madison and Milwaukee metropolitan areas, were characterized by lower unemployment, compared to a year ago. For the Company’s Illinois locations, economic conditions were characterized by relatively stable unemployment rates, with the exception of the Rockford Metropolitan Statistical Areas or MSA, which showed modest increases in unemployment. Overall, the core Midwest economy continues to be stable, although during the last half of 2007 there were clear signs of deterioration in the real estate markets with tightened liquidity, lengthening of the sales cycle and declining collateral values.

 

The Bank has locations throughout northern Illinois, excluding the far northwestern counties, including the Illinois cities of Algonquin, Aurora, Belvidere, Carol Stream, Carpentersville, Chicago, Crystal Lake, Deerfield, Dixon, Elgin, Freeport, Gurnee, Joliet, Lake Zurich, Lincolnshire, Lombard, Machesney Park, McHenry, Mendota, Morton Grove, Naperville, Northbrook, Oregon, Orland Park, Peru, Princeton, Rockford, Rock Falls,

 

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Roscoe, Schaumburg, St. Charles, South Beloit, Sterling, Wheaton, Willowbrook, Woodridge, Woodstock and the surrounding communities. The Bank conducts business at 21 locations throughout southern Wisconsin, including the Wisconsin cities of Argyle, Baraboo, Belleville, Darlington, Lodi, Madison, Monroe, Mt. Horeb, New Glarus, Portage, Sauk City, Verona, Wauwatosa and the surrounding communities.

 

Through its banking locations, AMCORE provides various consumer banking, commercial banking and related financial services. AMCORE also conducts banking business through four supermarket branches, which gives the customer convenient access to banking services seven days a week.

 

Investment Portfolio and Policies – As a complement to its Commercial and Retail Banking segments, the Bank also carries a securities investment portfolio. The level of assets that the Company holds in securities is dependent upon a variety of factors. Chief among these factors is the optimal utilization of the Company’s liquidity and capital. After consideration of loan demand, excess capital is available to allocate to high-quality investment activities that can generate additional income for the Company, while still maintaining strong capital ratios. In addition to producing additional interest spreads for the Bank, the investment portfolio is used as a source of liquidity, to manage interest rate risk and to meet pledging requirements of the Bank. The investment portfolio is governed by an investment policy designed to provide maximum flexibility in terms of liquidity and to contain risk from changes in interest rates. Individual holdings are diversified, maximum terms and durations are limited and minimum credit ratings are enforced and monitored. The Bank does not engage in trading activities. The amount of securities that the Company is permitted to invest in that have a higher degree of risk of loss are defined and limited by Company policy. The investment portfolio is managed on a day-to-day basis by a third-party professional investment manager, under the direction of Company management within parameters established by the Company. Portfolio performance and changing risk profiles are regularly monitored by the Asset and Liability Committee (ALCO) and the Investment Committee of AMCORE’s Board of Directors.

 

Sources of Funding – Liquidity management is the process by which the Company, through ALCO and its capital markets and treasury function, ensures that adequate liquid funds are available to meet its financial commitments on a timely basis, at a reasonable cost and within acceptable risk tolerances. These commitments include funding credit obligations to borrowers, mortgage originations pending sale, withdrawals by depositors, and repayment of debt when due or called; maintaining adequate collateral for secured deposits and borrowings; payment of dividends by the Company; payment of operating expenses; funding capital expenditures and maintaining deposit reserve requirements.

 

Liquidity is derived primarily from bank-issued deposit growth and retention; principal and interest payments on loans; principal and interest payments from investment securities, sale, maturity and prepayment of investment securities; net cash provided by operations and access to other funding sources. Other funding sources include brokered certificates of deposit (CD), federal funds purchased lines (Fed Funds), Federal Reserve Bank discount window advances, Federal Home Loan Bank (FHLB) advances, repurchase agreements, subordinated debentures, the sale or securitization of loans, balances maintained at correspondent banks and access to other capital market instruments. Bank-issued deposits, which exclude wholesale deposits, are considered by management to be the primary, most stable and most cost-effective source of funding and liquidity. The Bank also has capacity, over time, to place additional brokered CD’s as a source of mid to long-term funds.

 

Retail Banking Segment – Retail banking provides services to individual customers through the Bank’s branch locations. The services provided by retail banking include direct and indirect lending, checking, savings, money market and CD accounts, safe deposit rental, ATMs, and other traditional and electronic services.

 

Home equity lending has the lowest risk profile due to the nature of the collateral. Installment loans have an intermediate risk due to the lower principal amounts and the depreciating nature of the collateral. Personal lines and overdraft protection have the highest degree of risk since the loans are unsecured. The bankcard programs are a fee service for originating the relationship and the Bank retains no credit risk. The Bank manages its retail lending risk via a centralized credit process, risk scoring, loan-to-value and other underwriting standards, and

 

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knowledge of its customers and their credit history. As a general rule, the Bank does not actively engage in retail lending activities outside its geographic market areas. For segment financial information, see Note 18 of the Notes to Consolidated Financial Statements.

 

Commercial Banking Segment – Commercial banking provides services to middle market and small business customers through the Bank’s full service branch and limited branch office (LBO) locations. The services provided by commercial banking include lending, business checking and deposits, treasury management and other traditional as well as electronic services.

 

Commercial lending has a higher risk profile than does retail lending due to the larger dollar amounts involved, the nature of the collateral and a greater variety of economic risks that could potentially affect the loan customer. The Bank manages its commercial lending risks through a centralized underwriting process, serial sign-off requirements as dollar amounts increase, lending limits, monitoring concentrations, regular loan review and grading of credits, and an active work-out management process for troubled credits. For segment financial information, see Note 18 of the Notes to Consolidated Financial Statements.

 

The Bank is a lender in the Small Business Administration (SBA) program, with a total loan portfolio of $39 million as of December 31, 2007, and has earned National Preferred Lender Status from the SBA. AMCORE has also achieved National Express Lender status, a national designation which significantly shortens the turnaround time from application to loan acceptance. The Bank received the highest rating of “Acceptable” from the most recent audit by the SBA. SBA loans are popular with small business customers, offering them another source of financing.

 

Mortgage Banking Segment – The Mortgage Banking Segment provides a variety of mortgage lending products to meet its customers’ needs. The Company sells most of the loans it originates to a national mortgage services company, which provides private-label loan processing and servicing support on both sold and retained loans, a relationship that the Company entered into during first quarter 2007. See Note 18 of the Notes to Consolidated Financial Statements.

 

As part of this arrangement, the Company sold the majority of its Originated Mortgage Servicing Rights (OMSR) portfolio. The arrangement offers AMCORE a greater breadth of products, more competitive pricing and greater processing efficiencies and is expected to better position the Company for future loan origination growth. As a result of this arrangement, AMCORE expects to better control the risks associated with its mortgage banking business. Additionally, the cost structure in the mortgage banking business has become almost entirely variable in nature, allowing the Company to better absorb fluctuations in mortgage volumes. These include the costs of originating loans that are netted against mortgage banking income or interest income, as well as processing and servicing costs of loans retained in the Bank’s portfolio and that are a component of operating expenses. The transition to the new processing and servicing arrangement was completed during the second quarter of 2007.

 

Other Financial Services – The Bank provides various services to consumers, commercial customers and correspondent banks. Services available include safe deposit box rental, securities safekeeping, international services, and lock box, among other things.

 

The Bank also offers several electronic banking services to commercial and retail customers. AMCORE Online provides retail customers with online capability to access deposit and loan account balances, transfer funds between accounts, make loan payments, view checks and pay bills. AMCORE Online For Business facilitates access to commercial customers’ accounts via personal computers. It also permits the transfer of funds between accounts and the initiation of wire transfers and ACH activity to accounts at other financial institutions. The AMCORE TeleBank service provides retail and commercial customers the opportunity to use their telephone 24 hours a day to obtain balance and other information on their checking and savings accounts, certificates of deposit, personal installment loans and retail mortgage loans; all from a completely automated system. Automated teller machines located throughout AMCORE’s market area make banking transactions available to customers when the bank facilities or hours of operation are not convenient.

 

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Investment Management and Trust Segment

 

AMCORE’s wholly owned subsidiary, AMCORE Investment Group, N.A. (AIGNA), is a nationally chartered non-depository bank. AIGNA provides its clients with wealth management services, which include trust services, estate administration and financial planning. AIGNA also provides employee benefit plan administration and recordkeeping services.

 

AIGNA’s wholly owned subsidiary, AMCORE Investment Services, Inc. (AIS), is incorporated under the laws of the State of Illinois and is a member of the Financial Industry Regulatory Authority (FINRA). AIS is a full–service brokerage company that offers a full range of investment alternatives including annuities, mutual funds, stocks, bonds and other insurance products. AIS customers can get real time stock market quotes, investment account information, and place trades for market hours execution 24 hours a day, 7 days a week through AMCORETrade.com.

 

In 2005, the Company transitioned $142 million in assets of its three Company-managed Vintage equity funds into two mutual funds managed by Federated Investors, Inc. and sold its asset management subsidiary, Investors Management Group, Ltd. (IMG), to West Bancorporation, Inc. With these transactions, AMCORE transitioned from being a developer of proprietary investment products to being a provider that offers its customers a wider array of investment product choices. The results of IMG for prior periods, the related sale and subsequent adjustments are reported as discontinued operations.

 

Competition

 

Active competition exists for all services offered by AMCORE’s bank and non–bank affiliates with other national and state banks, savings and loan associations, credit unions, finance companies, personal loan companies, brokerage and mutual fund companies, mortgage bankers, insurance agencies, financial advisory services, and other financial institutions serving the affiliates’ respective market areas. The principal competitive factors in the banking and financial services industry are quality of services to customers, ease of access to services and pricing of services, including interest rates paid on deposits, interest rates charged on loans, and fees charged for fiduciary and other professional services.

 

Employment

 

AMCORE had 1,401 full–time equivalent employees as of February 15, 2008. AMCORE provides a variety of benefit plans to its employees including health, dental, group term life and disability insurance, childcare reimbursement, flexible spending accounts, retirement, profit sharing, 401(k), stock option, stock purchase and dividend reinvestment plans.

 

Supervision and Regulation

 

AMCORE is subject to regulations under the Bank Holding Company Act of 1956, as amended (the “Act”), and is registered with the Federal Reserve Board (FRB) under the Act. AMCORE is required by the Act to file quarterly and annual reports of its operations and such additional information as the FRB may require and is subject, along with its subsidiaries, to examination by the FRB.

 

The acquisition of five percent or more of the voting shares or all or substantially all of the assets of any bank by a bank holding company requires the prior approval of the FRB and is subject to certain other federal and state law limitations. The Act also prohibits, with certain exceptions, a bank holding company from acquiring direct or indirect ownership or control of more than five percent of the voting shares of any company which is not a bank and from engaging in any business other than banking, managing and controlling banks or furnishing services to banks and their subsidiaries, except that holding companies may engage in, and may own shares of companies engaged in, certain businesses found by the FRB to be “so closely related to banking as to be a proper incident thereto.”

 

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Under current regulations of the FRB, a bank holding company and its non–bank subsidiaries are permitted, among other activities, to engage in such banking–related businesses as sales and consumer finance, equipment leasing, computer service bureau and software operations, mortgage banking, brokerage and financial advisory services. The Act does not place territorial restrictions on the activities of non–bank subsidiaries of bank holding companies. In addition, federal legislation prohibits acquisition of “control” of a bank or bank holding company without prior notice to certain federal bank regulators. “Control” is defined in certain cases as acquisition of ten percent or more of the outstanding shares of a bank or bank holding company.

 

There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the Federal Deposit Insurance Corporation (FDIC) insurance fund in the event the depository institution becomes in danger of default or is in default. For example, under a policy of the Federal Reserve with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and commit resources to support such institutions in circumstances where it might not do so absent such policy. In addition, the “cross-guarantee” provisions of federal law require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default.

 

The federal banking agencies have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institutions in question are “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized,” as such terms are defined under regulations issued by each of the federal banking agencies.

 

In late 1992, Congress passed the Federal Deposit Insurance Corporation Improvement Act of 1992 that included many provisions that have had significant effects on the cost structure and operational and managerial standards of commercial banks. This Act contains provisions that revised bank supervision and regulation, including, among many other things, the monitoring of capital levels, additional management reporting and external audit requirements, and the addition of consumer provisions that include Truth-in-Savings disclosures.

 

The Gramm-Leach-Bliley Act (GLB Act) was enacted November 1999, and, among other things, established a comprehensive framework to permit affiliations among commercial banks, insurance companies and securities firms. To date, the GLB Act has not materially affected the Company’s operations. However, to the extent the GLB Act permits banks, securities firms and insurance companies to affiliate, the financial services industry may experience further consolidation. This could result in a growing number of larger financial institutions that offer a wider variety of financial services than the Company currently offers and that can aggressively compete in the markets the Company currently serves.

 

Effective in 2007, pursuant to the Federal Deposit Insurance Reform Act of 2005 and implementing regulations, FDIC-insured financial institutions are subject to a new risk-based premium assessment system that significantly increases the premiums that are paid on FDIC-insured deposits. As part of the new rules, the Bank, like many financial institutions, was eligible for a one-time assessment credit that offset the increase in premiums. The credit offset the Bank’s 2007 premium increase and will offset a portion of the 2008 increase. This partial offset notwithstanding, the Bank anticipates a significant increase in its FDIC premiums in 2008.

 

The foregoing references to applicable statutes and regulations are brief summaries thereof and are not intended to be complete and are qualified in their entirety by reference to the full text of such statutes and regulations.

 

AMCORE is supervised and examined by the FRB. The Bank and AIGNA are supervised and regularly examined by the Office of the Comptroller of the Currency (OCC) and are subject to examination by the FRB. In addition, the Bank is subject to periodic examination by the FDIC. AIS is supervised and examined by FINRA and the SEC.

 

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Regulatory Developments – On May 31, 2005, the Bank entered into a written agreement with the OCC, the Bank’s primary regulator. The agreement describes commitments made by the Bank and outlines a series of steps to address and strengthen the Bank’s consumer compliance program. The Bank has implemented enhancements to its consumer compliance program to address the matters identified by the OCC. These enhancements are currently under review by the OCC to determine if they comply with the commitments made in the agreement or whether additional steps are necessary.

 

On August 10, 2006, the Bank entered into a Consent Order with the OCC. This order primarily imposes requirements on the Bank to take certain actions to strengthen its compliance monitoring policies, procedures, training and overall program relating to the Bank Secrecy Act/Anti-Money Laundering (BSA/AML) regulations. The Consent Order did not impose any fine or civil money penalty on the Bank, but it does make the Bank ineligible for certain expedited approvals. Also, as a result of the Consent Order, AMCORE and the Bank are required to obtain the consent of the regulators in connection with certain activities, including, among other things, changes in directors and senior executive officers and certain executive compensation arrangements. The Bank has been working to strengthen and enhance its BSA/AML program to comply with the terms of the Consent Order. The BSA/AML program enhancements are currently under review by the OCC to determine if they comply with the commitments under the Consent Order or whether additional steps are necessary.

 

On March 11, 2008, the OCC notified the Bank of its intent to enter into a written agreement to formalize the Bank’s commitment to address weaknesses in the Bank’s commercial lending area identified by the OCC in examinations during 2007. The terms of such agreement will likely include requirements for the Bank to improve credit underwriting and administration practices, among other things.

 

Subsidiary Dividends and Capital

 

Legal limitations exist as to the extent to which the Bank can lend or pay dividends to AMCORE and/or its affiliates. The payment of dividends by a national bank without prior regulatory approval is limited to the current year’s net income plus the adjusted retained net income for the two preceding years. The payment of dividends by any bank or bank holding company is affected by the requirement to maintain adequate capital pursuant to the capital adequacy guidelines issued by the FRB and regulations issued by the FDIC and the OCC (collectively the “Agencies”). In 2008, current Bank earnings will be available for payment of dividends without prior regulatory approval. An additional $40 million in dividends is available, subject to prior regulatory approval, without causing the Bank to be less than well-capitalized. In addition, dividends paid by the Bank to AMCORE Financial, Inc. would be prohibited if the effect thereof would cause the Bank’s capital to be reduced below applicable minimum capital requirements. At December 31, 2007, the maximum amount available to AMCORE and its affiliates in the form of loans approximated $27 million. There were no loans outstanding from the Bank to affiliates at December 31, 2007. See Note 19 of the Notes to Consolidated Financial Statements included under Item 8.

 

The FRB issues risk–based capital guidelines for bank holding companies. These capital rules require minimum capital levels as a percent of risk–weighted assets. In order to be adequately capitalized under these guidelines, banking organizations must have minimum capital ratios of 4% and 8% for Tier 1 capital and total capital, respectively. The FRB also established leverage capital requirements intended primarily to establish minimum capital requirements for those banking organizations that have historically invested a significant portion of their funds in low risk assets. Federally supervised banks are required to maintain a minimum leverage ratio of not less than 4%. Refer to the Liquidity and Capital Management section of Item 7 for a summary of AMCORE’s capital ratios as of December 31, 2007 and 2006. See also Note 20 of the Notes to Consolidated Financial Statements included under Item 8.

 

Governmental Monetary Policies and Economic Conditions

 

The earnings of all subsidiaries are affected not only by general economic conditions, but also by the policies of various regulatory authorities. In particular, the FRB influences general economic conditions and interest rates

 

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through various monetary policies and tools. It does so primarily through open–market operations in U.S. Government securities, varying the discount rate on member and non-member bank borrowings, and setting reserve requirements against bank deposits. FRB monetary policies have had a significant effect on the operating results of banks in the past and are expected to do so in the future. The general effect of such policies upon the future business and earnings of each of the subsidiary companies cannot accurately be predicted.

 

Interest rate sensitivity has a major impact on the earnings of banks. As market rates change, yields earned on assets may not necessarily move to the same degree as rates paid on liabilities. For this reason, AMCORE attempts to minimize earnings volatility related to fluctuations in interest rates through the use of a formal asset/liability management program and certain derivative activities. See Item 7A and Note 11 of the Notes to Consolidated Financial Statements included under Item 8 for additional discussion of interest rate sensitivity and related derivative activities.

 

Executive Officers of the Registrant

 

The following table contains certain information about the executive officers of AMCORE. There are no family relationships between any director or executive officer of AMCORE.

 

Name

   Age   

Principal Occupation Within the Last Five Years

Kenneth E. Edge

   62    Chairman of the Board since January 2003 and Director of the Company since May 2000. Chief Executive Officer from July 2002 until February 2008. From January 2003 through August 2007 he was also President of the Company, and was previously Chief Operating Officer of the Company. He was Chairman of the Board and Chief Executive Officer of the Bank and Chairman of the Board and Chief Executive Officer of AIGNA until February 2008. He was President of AIGNA from November 2003 to October 2007.

William R. McManaman

   60    Chief Executive Officer of the Company since February 2008 and Director of the Company since 1997. He has also been Chairman of the Board and Chief Executive Officer of the Bank and Chairman of the Board and Chief Executive Officer of AIGNA since February 2008, subject to regulatory approval. Previously Executive Vice President and Chief Financial Officer, Ubiquity Brands from April 2006 to September 2007; and Senior Vice President and Chief Financial Officer of First Health Group Corporation from March 2004 until January 2005. Prior to that Executive Vice President and Chief Financial Officer of Aurora Foods, Inc. until March 2004.

Donald H. Wilson

   48    President and Chief Operating Officer of AMCORE since August 2007 and Director of the Bank and AIGNA since February 2006, and was Executive Vice President and Chief Financial Officer from February 2006 to August 2007. He was previously Senior Vice President and Corporate Treasurer of Marshall & Ilsley Corporation.

James S. Waddell

   62    Executive Vice President, Chief Administrative Officer and Corporate Secretary of AMCORE. Director of the Bank and AIGNA.

Judith Carré Sutfin

   46    Executive Vice President and Chief Financial Officer of AMCORE since December 2007, and Director of the Bank and AIGNA since January 2008. Previously held various executive positions at LaSalle Bank Corporation, Chicago, Illinois, with the most recent position being that of Executive Vice President and Head of Business Decision Support.

Lori M. Burke

   55    Executive Vice President, Administrative Services of the Bank since October 2007. Executive Vice President and Chief Human Resources Officer from October 2006 to October 2007 and previously Senior Vice President and Human Resources Manager.

 

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Name

   Age   

Principal Occupation Within the Last Five Years

Russell Campbell

   51    Executive Vice President and Director of AIGNA since March 2007. Previously President and Chief Executive Officer at ABN AMRO Asset Management Holdings, Inc.

Eleanor F. Doar

   51    Executive Vice President and Marketing Director of the Bank and AIGNA since November 2006, and Director of the Bank and AIGNA since January 2003. Senior Vice President and Corporate Marketing Director of the Bank until November 2006. Previously was Marketing Manager for Vintage Mutual Funds Inc. until December 2005.

Guy W. Francesconi

   48    Executive Vice President and General Counsel since February 2006, and Corporate Secretary for the Bank and AIGNA since October 2007. Previously General Counsel to Merrill Lynch Capital and Merrill Lynch Business Financial Services.

John M. Gvozdjak

   51    Senior Vice President and Director of Operations/Technology of the Bank since March 2004. Previously Vice President of Information Services for National Manufacturing Co. in Sterling, Illinois.

Nancy J. Moore

   58    Senior Vice President, Mortgage Group since June 2007 and previously Senior Vice President and Residential Mortgage Production Manager of the Bank.

Richard E. Stiles

   52    Executive Vice President, Commercial Banking Group and Director of the Bank and AIGNA since April 2007. Previously Senior Vice President in the commercial banking group for Popular Inc.

Thomas R. Szmanda

   48    Executive Vice President, Retail Banking Group since September 2005 and Director of the Bank and AIGNA since November 2005. Senior Vice President and Chief Retail Officer of the Bank from October 2003 until September 2005. Previously Senior Vice President and Director of Retail Banking at Citizens Bank.

 

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ITEM 1A.    Risk Factors

 

The Company faces a variety of risks that are inherent in its business, including interest rate, credit, liquidity, price/market, transaction/operation, compliance/legal, strategic and reputation. Following is a discussion of these risk factors. While the Company’s business, financial condition and results of operations could be harmed by any of the following risks or other factors discussed elsewhere in this report, Management’s Discussion and Analysis and Notes to the Consolidated Financial Statements, the mere existence of risk is not necessarily reason for concern. However, the following risks could cause actual results to materially differ from those discussed in any forward-looking statement.

 

Interest Rate Risk

 

As part of its normal operations, the Company, like most financial institutions, is subject to interest-rate risk on the interest-earning assets in which it invests (primarily loans and securities) and the interest-bearing liabilities with which it funds (primarily customer deposits, brokered deposits and borrowed funds). This includes the risk that interest-earning assets may be more responsive to changes in interest rates than interest-bearing liabilities, or vice versa (repricing risk), the risk that the individual interest rates or rate indices underlying various interest-earning assets and interest-bearing liabilities may not change to the same degree over a given time period (basis risk), and the risk of changing interest rate relationships across the spectrum of interest-earning asset and interest-bearing liability maturities (yield curve risk).

 

Interest rates are sensitive to many factors that are beyond the Company’s control, including general economic conditions, the policies of various governmental and regulatory agencies and competition. These factors may cause fluctuations in interest rates that adversely affect the fair market values of the Company’s financial instruments, cash flows, and net income.

 

Credit Risk

 

The Company is exposed to the risk that third parties that owe it money, securities, or other assets will not perform their obligations. Credit risk arises anytime the Company extends, commits, invests, or otherwise exposes Company funds through contractual agreements, whether reflected on or off the balance sheet. These parties may default on their obligations due to bankruptcy, lack of liquidity, operational failure or other reasons. Credit risk includes the risk that the Company’s rights against third parties (including guarantors) may not be enforceable or realizable in all circumstances.

 

The Company’s credit risk is concentrated in its loan portfolio (including commitments) and its investment portfolio. The Company also has credit risk through other financial instruments including derivative contracts and Company owned life insurance policies. Credit risk is affected by a variety of factors including the credit-worthiness of the borrower or other party, the sufficiency of underlying collateral, the enforceability of third-party guarantees, changing economic and industry conditions and concentrations of credit by loan type, terms or geographic area, changes in the financial condition of the borrower or other party, and by credit and underwriting policies.

 

Liquidity Risk

 

Liquidity risk is the potential that the Company will be unable to meet its obligations as they come due, capitalize on growth opportunities as they arise, or pay regular dividends because of an inability to liquidate assets or obtain adequate funding in a timely basis, at a reasonable cost and within acceptable risk tolerances.

 

Liquidity is required to fund credit obligations to borrowers, mortgage originations pending sale, withdrawals by depositors, repayment of debt when due or called, dividends to shareholders, operating expenses and capital expenditures, among other things. Liquidity is derived primarily from bank-issued deposit growth and retention;

 

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principal and interest payments on loans; principal and interest payments from investment securities, sale, maturity and prepayment of investment securities; net cash provided from operations and access to other funding sources.

 

The Company’s liquidity can be affected by a variety of factors, including general economic conditions, market disruption, operational problems affecting third parties or the Company, unfavorable pricing, competition, the Company’s credit rating and regulatory restrictions.

 

Price/Market Risk

 

Price/market risk is the risk to earnings or capital arising from adverse changes in the value of financial instruments. While this includes credit and liquidity risk, the Company considers interest-rate risk to be its most significant market risk. When interest rates increase, the fair value of a financial instrument on the asset side of the balance sheet will decrease. Conversely, when rates decline the fair value of the same instrument will increase.

 

While this relationship applies to all fixed-rate financial instruments, the primary instruments whose carrying values are affected by price/market risk are traded instruments. Since the Company currently has only an available-for-sale portfolio and does not maintain investment securities in a trading account, market fluctuations are recorded through equity and not the statements of income. On-going adverse fair values could cause some security fair values to deteriorate to the extent that they are considered to be other than temporary. At that time, the Company would be required to write-down security values to their fair value as a charge to earnings.

 

Transaction/Operation Risk

 

Transaction/operation risk is a function of internal controls, information systems, employee integrity and operating processes. Significant deficiencies or material weaknesses in internal processes, controls, staff or systems could lead to impairment of liquidity, financial loss, disruption of the business, liability to clients, regulatory intervention or damage to the Company’s reputation. For example, the Company is highly dependent on its ability to process, on a daily basis, a large number of transactions. Failure of financial, accounting, data processing or other operating systems and controls to operate properly, becoming disabled, or to keep pace with increasing volumes, could adversely affect the Company’s ability to capture, process and accurately report these transactions.

 

Compliance/Legal Risk

 

The Company is subject to compliance with an expanding body of regulatory, supervisory and examination requirements including capital adequacy, safety/soundness, customer privacy, anti-money laundering, truth-in-savings/lending and financial reporting, to name a few. Failure or the inability to comply with these various requirements can lead to diminished reputation and investor confidence, reduced franchise value, loss of business, curtailment of expansion opportunities, fines and penalties, intervention or sanctions by regulators and costly litigation or expensive additional controls and systems. Refer to discussion included in Key Initiatives and Other Significant Items and Events in Item 7 for a summary of recent regulatory developments.

 

Strategic Risk

 

Strategic risk is the potential for adverse consequences to the Company of poor business decisions or improper implementation of those decisions. It includes identifying and defining goals for the continued growth and success of the Company, developing strategies to accomplish the goals, and acquiring, developing and retaining the physical resources and human capital necessary to successfully execute the strategies.

 

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Presently, the Company has four primary strategic initiatives: team strength, customer community, growth and productivity and process excellence. The Company’s ability to successfully execute these initiatives depends upon a variety of factors, including its ability to attract and retain experienced personnel, the continued availability of desirable business opportunities and locations, the competitive responses from other financial institutions in its new market areas, and the ability to manage growth.

 

Reputation Risk

 

Reputation risk arises from the possibility that negative publicity regarding the Company’s business practices, whether true or not, will cause a decline in its customer base or result in costly litigation. In a service industry, such as the financial services industry, where product choices between companies are not always clearly distinguishable and which in many cases are fungible, a company’s reputation for honesty, fair-dealing and good corporate governance may be one of its most important assets. Loss of or damage to that reputation can have severe consequences.

 

ITEM 1B.    Unresolved Staff Comments

 

None.

 

ITEM 2.    PROPERTIES

 

On December 31, 2007, AMCORE occupied 91 locations, of which 56 were owned and 35 were leased. The Commercial, Retail and Mortgage Banking segments occupied 90 locations, of which 56 were owned and 34 were leased. The Investment Management and Trust segment leased one facility. All of these locations are considered by management to be well maintained and adequate for the purpose intended. See Item 1 and Note 5 of the Notes to Consolidated Financial Statements included under Item 8 of this document for further information on properties. In addition, AMCORE had 324 ATM locations, some of which are owned and some of which are part of a co-branding agreement that were available without fee to AMCORE customers.

 

ITEM 3.    LEGAL PROCEEDINGS

 

Management believes that no litigation is threatened or pending in which the Company faces potential loss or exposure which will materially affect the Company’s consolidated financial position or consolidated results of operations. Since the Company’s subsidiaries act as depositories of funds, trustee and escrow agents, they occasionally are named as defendants in lawsuits involving claims to the ownership of funds in particular accounts. The Bank is also subject to counterclaims from defendants in connection with collection actions brought by the Bank. This and other litigation is incidental to the Company’s business.

 

During fourth quarter 2007, as a member of the VISA, Inc. organization (VISA), the Company accrued a $653,000 liability for its proportionate share of various claims against VISA. This amount consisted of $217,000 of claims settled by VISA but not yet paid, a $68,000 estimate of claims considered probable by VISA pursuant to Statement of Financial Accounting Standards (SFAS) No. 5, “Accounting for Contingencies” and $368,000 representing the Company’s estimate of certain indemnification obligations pursuant to Financial Interpretation (FIN) No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”.

 

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

No matters were submitted to a vote of security holders during the fourth quarter of 2007.

 

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PART II

 

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED  STOCKHOLDER MATTERS

 

See Items 6 and 8 of this document for information on the Company’s stock price ranges and dividends. AMCORE’s common stock trades on the NASDAQ Stock Market LLC under the symbol “AMFI.” There were approximately 10,500 holders of record of AMCORE’s common stock as of March 1, 2008. See Item 12 of this document for information on the Company’s equity compensation plans.

 

The Company’s policy is to declare regular quarterly dividends based upon the Company’s earnings, financial position, capital requirements and such other factors deemed relevant by the Board of Directors. This dividend policy is subject to change, however, and the payment of dividends by the Company is necessarily dependent upon the availability of earnings and liquidity and the Company’s expected financial condition in the future. The payment of dividends on the Common Stock is also subject to regulatory capital requirements. For further information on quarterly dividend payments, see the Condensed Quarterly Earnings and Stock Price Summary at the end of Item 8.

 

The Company’s principal source of funds for dividend payments to its stockholders is dividends received from the Bank. Under applicable banking laws, the declaration of dividends by the Bank in any year, in excess of its net profits, as defined, for that year, combined with its retained net profits of the preceding two years, must be approved by the Office of the Comptroller of the Currency. For further discussion of restrictions on the payment of dividends, see Item 7, Management’s Discussion and Analysis of the Results of Operations and Financial Condition and Note 19 of the Notes to the Consolidated Financial Statements.

 

The following table presents information relating to all Company repurchases of common stock during the fourth quarter of 2007:

 

Issuer Purchases of Equity Securities

 

Period

   (a) Total #
of Shares
Purchased
   (b) Average Price
Paid per Share
   (c) Total # of Shares
Purchased as Part of
Publicly Announced
Plans or Programs
   (d) Maximum # (or
Approx. Dollar Value) of
Shares that May Yet Be
Purchased Under the
Plans or Programs

Beginning Balance

            1,335,500

October 1 – 31, 2007

   97,987    $ 23.11    96,400    1,239,100

November 1 – 30, 2007

   450,000      23.05    450,000    789,100

December 1 – 31, 2007

   2,762      30.40    —      789,100
                     

Total during quarter

   550,749    $ 23.10    546,400    789,100
                     

 

On May 3, 2007, the Company’s Board of Directors authorized a share repurchase program that allows the repurchase of up to two million shares for a 12-month period, which will also be executed through open market or privately negotiated purchases. The Company may periodically repurchase shares in open-market transactions in accordance with Exchange Act Rule 10b-18 through a limited group of brokers to replenish the Company’s treasury stock for re-issuances related to stock option exercises and other employee benefit plans. Included in the repurchased shares above are direct repurchases from participants, at their discounted price, related to the administration of the Amended and Restated AMCORE Stock Option Advantage Plan. There were no shares tendered in the fourth quarter to effect stock option exercise transactions in the numbers above.

 

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ITEM 6. SELECTED FINANCIAL DATA

 

Five Year Comparison of Selected Financial Data

 

     2007     2006     2005     2004     2003  
     (in thousands, except per share data)  

FOR THE YEAR:

          

Interest income

   $ 344,016     $ 339,176     $ 280,609     $ 232,441     $ 226,679  

Interest expense

     183,432       174,218       118,975       80,855       90,061  
                                        

Net interest income

     160,584       164,958       161,634       151,586       136,618  

Provision for loan losses

     29,087       10,120       15,194       15,530       24,917  

Non-interest income

     70,997       75,589       66,413       65,914       81,535  

Operating expenses

     165,339       165,365       145,365       137,307       134,311  
                                        

Income from continuing operations before income taxes

     37,155       65,062       67,488       64,663       58,925  

Income taxes

     8,914       18,035       19,501       18,632       15,756  
                                        

Net income from continuing operations

   $ 28,241     $ 47,027     $ 47,987     $ 46,031     $ 43,169  

Discontinued operations:

          

(Loss) income from discontinued operations

     —         (131 )     707       (629 )     685  

Income tax (benefit) expense

     —         (379 )     3,753       (294 )     350  
                                        

Income (loss) from discontinued operations

   $ —       $ 248     $ (3,046 )   $ (335 )   $ 335  
                                        

Net income

   $ 28,241     $ 47,275     $ 44,941     $ 45,696     $ 43,504  
                                        

Return on average assets (1)

     0.54 %     0.88 %     0.94 %     0.97 %     0.98 %

Return on average equity (1)

     7.32       11.76       12.18       12.15       11.80  

Net interest margin

     3.35       3.38       3.51       3.56       3.49  
                                        

AVERAGE BALANCE SHEET:

          

Total assets

   $ 5,240,498     $ 5,369,268     $ 5,117,654     $ 4,749,072     $ 4,424,520  

Gross loans

     3,977,028       3,858,163       3,480,947       3,128,352       2,902,208  

Earning assets

     4,870,255       5,008,905       4,738,688       4,380,796       4,069,154  

Deposits

     4,117,440       4,224,826       3,978,225       3,566,237       3,335,177  

Long-term borrowings

     396,571       305,078       166,837       178,584       193,862  

Stockholders’ equity

     385,570       399,916       394,117       378,771       365,689  
                                        

ENDING BALANCE SHEET:

          

Total assets

   $ 5,192,778     $ 5,292,383     $ 5,344,902     $ 4,940,488     $ 4,543,628  

Gross loans

     3,932,684       3,946,551       3,721,864       3,278,800       2,992,309  

Earning assets

     4,796,993       4,863,678       4,935,124       4,559,580       4,193,474  

Deposits

     4,003,256       4,346,182       4,213,216       3,734,691       3,375,937  

Long-term borrowings

     368,858       342,012       169,730       165,018       184,610  

Stockholders’ equity

     368,567       400,046       398,517       386,578       375,584  
                                        

FINANCIAL CONDITION ANALYSIS:

          

Allowance for loan losses to year-end loans

     1.35 %     1.04 %     1.10 %     1.25 %     1.41 %

Allowance to non-accrual loans

     129.70       136.16       187.99       135.81       132.98  

Net charge-offs to average loans

     0.42       0.26       0.42       0.47       0.57  

Non-accrual loans to gross loans

     1.04       0.76       0.58       0.92       1.06  

Average long-term borrowings to average equity

     102.85       76.29       42.33       47.15       53.01  

Average equity to average assets

     7.36       7.45       7.70       7.98       8.27  
                                        

STOCKHOLDERS’ DATA:

          

Earnings Per Common Share

          

Basic:      Income from continuing operations

   $ 1.23     $ 1.92     $ 1.93     $ 1.84     $ 1.73  

               Discontinued operations

     —         0.01       (0.12 )     (0.01 )     0.02  
                                        

               Net Income

   $ 1.23     $ 1.93     $ 1.81     $ 1.83     $ 1.75  
                                        

Diluted:    Income from continuing operations

   $ 1.23     $ 1.91     $ 1.91     $ 1.82     $ 1.72  

               Discontinued operations

     —         0.01       (0.12 )     (0.01 )     0.01  
                                        

               Net Income

   $ 1.23     $ 1.92     $ 1.79     $ 1.81     $ 1.73  
                                        

Book value per share

   $ 16.80     $ 16.81     $ 16.06     $ 15.57     $ 14.98  

Dividends per share

     0.74       0.74       0.68       0.68       0.66  

Dividend payout ratio

     59.59 %     38.23 %     37.54 %     37.11 %     37.80 %

Average common shares outstanding

     22,887       24,466       24,814       24,955       24,896  

Average diluted shares outstanding

     22,897       24,562       25,087       25,251       25,090  
                                        

 

(1) Ratios from continuing operations.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion highlights the significant factors affecting AMCORE Financial, Inc. and Subsidiaries (“AMCORE” or the “Company”) consolidated financial condition as of December 31, 2007 compared to December 31, 2006, and the consolidated results of operations for the three years ended December 31, 2007. The discussion should be read in conjunction with the Consolidated Financial Statements, accompanying Notes to the Consolidated Financial Statements, and selected financial data appearing elsewhere within this report.

 

FACTORS INFLUENCING FORWARD-LOOKING STATEMENTS

 

This report on Form 10-K contains, and periodic filings with the Securities and Exchange Commission and written or oral statements made by the Company’s officers and directors to the press, potential investors, securities analysts and others will contain, forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934, and the Company intends that such forward-looking statements be subject to the safe harbors created thereby with respect to, among other things, the financial condition, results of operations, plans, objectives, future performance and business of AMCORE. Statements that are not historical facts, including statements about beliefs and expectations, are forward-looking statements. These statements are based upon beliefs and assumptions of AMCORE’s management and on information currently available to such management. The use of the words “believe”, “expect”, “anticipate”, “plan”, “estimate”, “should”, “may”, “will”, or similar expressions identify forward-looking statements. Forward-looking statements speak only as of the date they are made, and AMCORE undertakes no obligation to update publicly any forward-looking statements in light of new information or future events.

 

Contemplated, projected, forecasted or estimated results in such forward-looking statements involve certain inherent risks and uncertainties. A number of factors – many of which are beyond the ability of the Company to control or predict – could cause actual results to differ materially from those in its forward-looking statements. These factors include, among others, the following possibilities: (I) heightened competition, including specifically the intensification of price competition, the entry of new competitors and the formation of new products by new or existing competitors; (II) adverse state, local and federal legislation and regulation or adverse findings or rulings made by local, state or federal regulators or agencies regarding AMCORE and its operations; (III) failure to obtain new customers and retain existing customers; (IV) inability to carry out marketing and/or expansion plans; (V) ability to attract and retain key executives or personnel; (VI) changes in interest rates including the effect of prepayments; (VII) general economic and business conditions which are less favorable than expected; (VIII) equity and fixed income market fluctuations; (IX) unanticipated changes in industry trends; (X) unanticipated changes in credit quality and risk factors; (XI) success in gaining regulatory approvals when required; (XII) changes in Federal Reserve Board monetary policies; (XIII) unexpected outcomes on existing or new litigation in which AMCORE, its subsidiaries, officers, directors or employees are named defendants; (XIV) technological changes; (XV) changes in accounting principles generally accepted in the United States of America; (XVI) changes in assumptions or conditions affecting the application of “critical accounting estimates”; (XVII) inability of third-party vendors to perform critical services for the Company or its customers; (XVIII) disruption of operations caused by the conversion and installation of data processing systems; and (XIX) zoning restrictions or other limitations at the local level, which could prevent limited branch offices from transitioning to full-service facilities.

 

CRITICAL ACCOUNTING ESTIMATES AND ACCOUNTING CHANGES

 

Critical Accounting Estimates

 

The financial condition and results of operations for AMCORE presented in the Consolidated Financial Statements, accompanying Notes to the Consolidated Financial Statements, selected financial data appearing elsewhere within this report, and management’s discussion and analysis are, to a large degree, dependent upon

 

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the Company’s accounting policies. The selection and application of these accounting policies involve judgments, estimates and uncertainties that are susceptible to change.

 

Presented below are discussions of those accounting policies that management believes require its most difficult, subjective and complex judgments about matters that are inherently uncertain (Critical Accounting Estimates) and are most important to the portrayal and understanding of the Company’s financial condition and results of operations. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different portrayal of financial condition or results of operations is a reasonable likelihood. See also Note 1 of the Notes to Consolidated Financial Statements.

 

Allowance for loan losses – Loans, the Company’s largest income earning asset category, are periodically evaluated by management in order to establish an adequate allowance for loan losses (Allowance) to absorb estimated losses that are probable as of the respective reporting date. This evaluation includes specific loss estimates on certain individually reviewed loans where it is probable that the Company will be unable to collect all of the amounts due (principal or interest) according to the contractual terms of the loan agreement (impaired loans) and statistical loss estimates for loan groups or pools that are based on historical loss experience. Also included are other loss estimates that reflect the current credit environment and that are not otherwise captured in the historical loss rates. These include the quality and concentration characteristics of the various loan portfolios, adverse situations that may affect a borrower’s ability to repay, and economic and industry conditions, among other things. The Allowance is also subject to periodic examination by regulators, whose review may include their own assessment as to its adequacy to absorb probable losses.

 

Additions to the Allowance are charged against earnings for the period as a provision for loan losses (Provision). Conversely, this evaluation could result in a decrease in the Allowance and Provision. Actual loan losses are charged against and reduce the Allowance when management believes that the collection of principal will not occur. Unpaid interest attributable to prior years for loans that are placed on non-accrual status is also charged against and reduces the Allowance. Unpaid interest for the current year for loans that are placed on non-accrual status is charged against and reduces the interest income previously recognized. Subsequent recoveries of amounts previously charged to the Allowance, if any, are credited to and increase the Allowance.

 

Those judgments and assumptions that are most critical to the application of this accounting policy are the initial and on-going creditworthiness of the borrower, the amount and timing of future cash flows of the borrower that are available for repayment of the loan, the sufficiency of underlying collateral, the enforceability of third-party guarantees, the frequency and subjectivity of loan reviews and risk gradings, emerging or changing trends that might not be fully captured in the historical loss experience, and charges against the Allowance for actual losses that are greater or less than previously estimated. These judgments and assumptions are dependent upon or can be influenced by a variety of factors including the breadth and depth of experience of lending officers, credit administration and the corporate loan review staff that periodically review the status of the loan, changing economic and industry conditions, changes in the financial condition of the borrower and changes in the value and availability of the underlying collateral and guarantees.

 

While the Company strives to timely reflect all known risk factors in its evaluations, judgment errors may occur. If different assumptions or conditions were to prevail, the amount and timing of interest income and loan losses could be materially different. These factors are most pronounced during economic downturns and may continue into an economic recovery, as specific credit performance may not be immediately affected by the stress of the downturn or the benefit of the recovery. Since, as described above, so many factors can affect the amount and timing of losses on loans, it is difficult to predict with a high degree of certainty the effect to income if different conditions or assumptions were to prevail. Nonetheless, if any combination of the above judgments or assumptions were to have adversely affected the adequacy of the Allowance by ten percent during 2007, an additional Provision of $5.3 million may have been necessary. See also Table 2 and Note 4 of the Notes to Consolidated Financial Statements.

 

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Mortgage servicing rights – The Company sells most of the one-to-four family residential real estate loans that it originates. Historically, these were primarily sold to the Federal Home Loan Mortgage Corporation (FHLMC), a U.S. government-sponsored enterprise (GSE). Gains recorded on the sale of the loans included the right to service the loans on behalf of FHLMC, a right that was retained by the Company, and that resulted in an originated mortgage servicing rights (the “OMSR”) asset. The resulting OMSR asset was amortized as a charge against mortgage banking income in proportion to the principal amortization of the underlying serviced loans and as the actual servicing fee was collected.

 

Each reporting period, the Company re-evaluated the fair value of its remaining OMSR asset to determine whether or not the asset was impaired and needed to be written down to fair value or had recovered in value from a previous impairment write-down requiring a reversal of the previous impairment write-down. The initial OMSR gains, any subsequent impairment write-downs and impairment write-down reversals, resulted in a high degree of volatility in mortgage banking income. The amortization of the OMSR asset largely offset actual servicing fees collected. The initial valuation and periodic re-evaluation of OMSR fair value incorporated numerous judgments and assumptions including the cost of servicing the loans, discount rates, prepayment rates and default rates. These judgments and assumptions, along with the earnings volatility, resulted in this being a critical accounting estimate.

 

During 2007, the Company sold the majority of its OMSR portfolio. See discussions of significant transactions and other non-interest income, below. As a result of the sale, OMSRs are no longer considered a critical accounting estimate.

 

Loan securitizations and sale of receivables – The Company has periodically sold certain indirect automobile loans in securitization transactions in exchange for cash and certain retained residual interests. The retained interests included rights to service the loans sold, interest collected on the loans that exceeded the amount required to be paid to the investors, the securitization agent and the servicer, and an interest in the sales proceeds that was withheld as collateral for potential credit losses at the time of the initial loan sales.

 

Upon each sale, the Company recognized a gain and assets were recorded for retained residual interests. The Company’s retained residual interests were subordinated to the interests of investors and the securitization agent, and were also subject to prepayment, credit and interest rate risk. As a result, the carrying value was periodically re-evaluated to determine if they were impaired, and if so, whether the impairment was other than temporary, requiring a charge to earnings. Because of the judgments and assumptions involved in the initial recording and periodic re-evaluation, the accounting for the retained residual interests was considered a critical accounting estimate.

 

During 2007, the outstanding balances of the underlying loans fell to a level where the cost of servicing the loans became burdensome in relation to the benefits of servicing. As a result, the Company exercised its option to repurchase the loans from the securitization trust (the “Clean-up Call”) and the carrying value of the retained residual interests was written off. See discussion of net security (losses) gains under other non-interest income, below. The repurchased loans were recorded at fair value. Since the Company no longer has any retained residual interests, loan securitizations and sale of receivables is no longer considered a critical accounting estimate.

 

Accounting Changes

 

Income Taxes Uncertainties – In June 2006, the Financial Accounting Standards Board (FASB) issued Financial Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109” that clarifies the accounting for uncertain tax positions recognized in an enterprise’s financial statements in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, “Accounting for Income Taxes”. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in

 

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interim periods, disclosure, and transition. This interpretation was adopted in the first quarter of 2007. The adoption of this interpretation had no impact on the Company’s Consolidated Balance Sheets or Statements of Income.

 

Servicing of Financial Assets – During the first quarter of 2007, the Company adopted SFAS No. 156, “Accounting for Servicing of Financial Assets”, which amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” SFAS No. 156 requires an entity to separately recognize servicing assets and servicing liabilities and to report these balances at fair value upon inception. With the sale of the majority of the OMSRs during first quarter 2007, the adoption of this standard did not have a material impact on the Company’s Consolidated Balance Sheets or Statements of Income

 

Cash Surrender Value of Life Insurance – In September 2006, the FASB ratified Emerging Issues Task Force (EITF) Issue No. 06-5 “Accounting for Purchases of Life Insurance-Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin (TB) No. 85-4, Accounting for Purchases of Life Insurance.” The issue discusses whether an entity should consider the contractual ability to surrender all of the individual-life policies together when determining the amount that could be realized. Under some insurance contracts, the policies provide a greater surrender value if all individual policies are surrendered at the same time rather than if the policies were surrendered over a period of time. The EITF determined that any additional amounts included in the contractual terms should be considered when determining the realizable amounts. This issue was adopted in the first quarter of 2007 and did not have a material impact on the Company’s Consolidated Balance Sheets or Statements of Income.

 

Fair Value Measurements – In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. The standard applies to other accounting pronouncements that require or permit fair value measurements, but does not require any new fair value measurements. For some entities, the application of the standard may change how fair value is measured. The standard is effective for financial statements issued for fiscal years beginning after November 15, 2007, and all interim periods within those fiscal years. The adoption of this standard will not have a material affect on the Company’s Consolidated Balance Sheets or Statements of Income.

 

Split-Dollar Life Insurance – In September 2006, the FASB ratified EITF Issue No. 06-4 “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.” The issue requires companies to recognize a liability for future benefits on split dollar insurance arrangements if the benefit to the employee extends to postretirement periods. The issue is required to be applied to fiscal years beginning after December 15, 2007, with earlier application permitted. Adoption of this standard will not have a material impact on the Company’s Consolidated Balance Sheets or Statements of Income.

 

Fair Value Option for Financial Assets and Financial Liabilities – In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” The fair value option established by this standard permits all entities to choose to measure eligible items at fair value at specified election dates. Under SFAS No. 159, a business entity is required to report unrealized gains and losses on items for which the fair value option have been elected in earnings (or another performance indicator if the business entity does not report earnings) at each subsequent reporting date. The standard is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. As of January 1, 2008, the Company had not chosen to measure any new items at fair value.

 

Loan Commitments Recorded at Fair Value Through Earnings – In November 2007, the SEC issued Staff Accounting Bulletin (SAB) No. 109, which supersedes SAB No. 105, which applied only to derivative loan commitments that are accounted for at fair value through earnings. The new guidance states that, consistent with the guidance in SFAS No. 156, “Accounting for Servicing of Financial Assets”, and SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”, the expected net future cash flows related to the

 

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associated servicing of the loan should be included in the measurement of all written loan commitments that are accounted for at fair value through earnings. Adoption of this standard in first quarter 2008 is not expected to have a material impact on the Company’s Consolidated Balance Sheets or Statements of Income.

 

Minority Interests – In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interest in Consolidated Financial Statements – an amendment of ARB No. 51.” Among other things, SFAS No. 160 requires minority interests be recorded as a separate component of equity and that net income attributable to minority interests be clearly identified on the Statement of Income. SFAS No. 160 is effective for fiscal years and interim periods beginning on or after December 15, 2008. Earlier adoption is prohibited. Statement No. 160 is required to be applied prospectively, except for the presentation and disclosure requirements. Adoption of this standard in fiscal year 2009 is not expected to have a material impact on the Company’s Consolidated Balance Sheets or Statements of Income.

 

Business Combinations – In December 2007, the FASB issued SFAS No. 141R, “Business Combinations”, to improve financial reporting on business combination, including recognition and measurement of assets acquired, liabilities assumed, noncontrolling interests, and goodwill. This Statement applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity may not apply it before that date. Adoption of this standard is not expected to have a material impact on the Company’s Consolidated Balance Sheets or Statements of Income.

 

KEY INITIATIVES AND OTHER SIGNIFICANT ITEMS AND EVENTS

 

Key Initiatives

 

Credit quality – The Company continues to reinforce a credit quality culture by enhancing the credit risk measurement process. In 2007, a new risk grading matrix was implemented to provide better granularity of credit risk and to allow management more precise measurement of risk and profitability. The risk grading initiative established a foundation for continuing to build a more robust credit quality culture throughout the organization. This will lead to more standardization and centralization of the Company’s approval, underwriting and early troubled credit identification procedures into 2008 and beyond.

 

Cost efficiencies – The Company is targeting a three percent reduction per year in pre-FDIC insurance operating expenses in 2008 and 2009. The efficiency focus will cover all aspects of the business including enhancing the Company’s commercial straight through loan processing platform. The efficiencies expected from enhancing the commercial loan processing system are also expected to improve credit-underwriting efforts and benefit the credit quality initiative.

 

Core growth – The Company is focused on measuring business unit performance and closely aligning profitability with incentive compensation in order to drive strong core customer based growth. This enhancement to focus on profitability, rather than volume measures, has led to improved product pricing that is more reflective of true costs and market risks and will help the Company continue to strengthen it’s earnings stream.

 

Other Significant Items and Events

 

Key personnel changes – Russell Campbell joined the Company on March 12, 2007 as Executive Vice President and is responsible for directing all aspects of the trust, investment management and private banking businesses. Campbell brings more than 25 years of investment industry and leadership experience to AMCORE. He most recently held the position of President and CEO at ABN AMRO Asset Management Holdings Inc., an investment management affiliate of LaSalle Bank N.A., Chicago. Campbell replaced Patricia M. Bonavia, who retired.

 

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Richard E. Stiles joined the Company on April 9, 2007 as the Executive Vice President, Commercial Banking Group. Stiles is responsible for all aspects of the Bank’s commercial line of business including strategy, development and execution of business plans, products and services, sales management and profitability. Stiles brings nearly 25 years of commercial banking experience to AMCORE. He most recently held the position of senior vice president in the commercial banking group for Banco Popular, North America in Rosemont, IL. Stiles fills the position vacated by John R. Hecht, who resigned during the first quarter.

 

In August 2007, the Company announced that Donald H. Wilson was appointed President and Chief Operating Officer by the Company’s Board of Directors. Mr. Wilson previously held the position of Executive Vice President and Chief Financial Officer since early 2006.

 

In December 2007, the Company appointed Judith Carré Sutfin, Executive Vice President and Chief Financial Officer of the Company, succeeding Donald H. Wilson. Ms. Sutfin has 23 years of banking industry experience. She was most recently Executive Vice President and Head of Business Decision Support at LaSalle Bank Corporation, Chicago, Illinois, which was recently acquired by Bank of America.

 

On February 25, 2008, the Company announced that Kenneth E. Edge had elected to retire as Chief Executive Officer of the Company, effective as of February 22, 2008, and will remain as Chairman of the Board until immediately prior to the 2008 Annual Meeting of Stockholders.

 

Also, on February 22, 2008, the Board of Directors of the Company elected William R. McManaman as Chief Executive Officer, effective February 25, 2008. Prior to his appointment as Chief Executive Officer, Mr. McManaman, age 60, has served as a Director of the Company since 1997. He was previously Executive Vice President and Chief Financial Officer of Ubiquity Brands, a manufacturer and distributor of snacks, from April 2006 to September 2007. Prior to that he was Senior Vice President and Chief Financial Officer of First Health Group Corporation, a national managed care company serving the group health, workers’ compensation and state agency markets, from March 2004 until January 2005. Prior to that he was Executive Vice President and Chief Financial Officer of Aurora Foods, Inc., a manufacturer and distributor of both dry and frozen branded food products, until March 2004.

 

Branch expansion – During 2007 the Bank opened two new branches, one in Deerfield Illinois and one in Willowbrook, Illinois. Since the inception of the Company’s branch expansion strategy in April 2001, 31 new branches, net of closed offices, have opened, in the area generally bounded by Interstates 94 in the north, 294 and 94 in the east, 80 in the south and 90 and 39 in the west.

 

Significant transactions – During the first quarter of 2007, the Company entered into a strategic arrangement with a national mortgage services company to provide private-label loan processing and servicing support. As part of this arrangement, the Company sold the majority of its OMSR portfolio in which it recorded a $2.2 million gain. The arrangement offers AMCORE a greater breadth of products, more competitive pricing and greater processing efficiencies and is expected to better position the Company for future loan origination growth. As a result of this arrangement, AMCORE expects to better control the risks associated with its mortgage banking business. Additionally, the cost structure in the mortgage banking business has become almost entirely variable in nature, allowing the Company to better absorb fluctuations in mortgage volumes. These include the costs of originating loans that are netted against mortgage banking income or interest income, as well as processing and servicing costs of loans retained in the Bank’s portfolio and that are a component of operating expenses. The transition to the new processing and servicing arrangement was completed during the second quarter of 2007.

 

In the first quarter of 2007, AMCORE redeemed its $40 million, 9.35 percent coupon outstanding trust preferred securities (Trust Preferred) at a cost of $2.3 million that included both a call premium and unamortized issuance expenses (Extinguishment Loss). The redemption was funded with a new lower cost Trust Preferred issuance of $50 million at a rate of 6.45 percent. AMCORE will benefit from the lower interest rate on the new issuance and expects to recover the termination costs over a two-year period.

 

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On May 3, 2007, the Company’s Board of Directors authorized the repurchase (Repurchase Program) of up to two million shares of the Company’s stock. The authorization is for a twelve-month period and will be executed through open market or privately negotiated purchases. This authorization replaced a previous Repurchase Program that expired May 3, 2007. During 2006 and 2007, the Company repurchased 1.17 million shares and 2.12 million shares, respectively, pursuant to the Repurchase Programs. The average price for the repurchased shares repurchased was $30.73 for 2006 and $27.92 for 2007.

 

The Company reclassified a $5.6 million other-than-temporary impairment loss from other comprehensive income (OCI) in the third quarter 2007, relating to a decision to sell approximately $200 million of bonds purchased in 2003 and 2004 in order to reduce longer-term interest rate and liquidity risk. All of these securities were ultimately sold during fourth quarter 2007.

 

During the third quarter, the Company entered into a $20 million senior debt facility agreement. The Company has drawn $10 million against this facility and may borrow the remaining sums until August 8, 2008. Interest is charged on a monthly floating rate index based on LIBOR. The credit facility matures on July 31, 2010, but may be prepaid at anytime prior to that date without penalty.

 

Regulatory developments – On May 31, 2005, the Bank entered into a written agreement with the Office of the Comptroller of the Currency (OCC), the Bank’s primary regulator. The agreement describes commitments made by the Bank and outlines a series of steps to address and strengthen the Bank’s consumer compliance program. The Bank has implemented enhancements to its consumer compliance program to address the matters identified by the OCC. These enhancements are currently under review by the OCC to determine if they comply with the commitments made in the agreement or whether additional steps are necessary.

 

On August 10, 2006, the Bank entered into a Consent Order with the OCC. This order primarily imposes requirements on the Bank to take certain actions to strengthen its compliance monitoring policies, procedures, training and overall program relating to the Bank Secrecy Act/Anti-Money Laundering (BSA/AML) regulations. The Consent Order did not impose any fine or civil money penalty on the Bank, but it does make the Bank ineligible for certain expedited approvals. Also, as a result of the Consent Order, AMCORE and the Bank are required to obtain the consent of the regulators in connection with certain activities, including, among other things, changes in directors and senior executive officers and certain executive compensation arrangements. The Bank has been working to strengthen and enhance its BSA/AML program to comply with the terms of the Consent Order. The BSA/AML program enhancements are currently under review by the OCC to determine if they comply with the commitments made under the Consent Order or whether additional steps are necessary.

 

On March 11, 2008, the OCC notified the Bank of its intent to enter into a written agreement to formalize the Bank’s commitment to address weaknesses in the Bank’s commercial lending area identified by the OCC in examinations during 2007. The terms of such agreement will likely include requirements for the Bank to improve credit underwriting and administration practices, among other things.

 

Impact of inflation – Apart from operating expenses, the financial services industry is not directly affected by inflation, however, as the Federal Reserve Board (Fed) monitors economic trends and developments, it may change monetary policy in response to economic changes which would have an influence on interest rates. See discussion of Net Interest Income, changes due to rate, below.

 

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OVERVIEW OF OPERATIONS AND SIGNIFICANT CATEGORIES

 

Overview

 

AMCORE reported net income from continuing operations of $28.2 million for the year ended December 31, 2007. This compares to $47.0 million for the same period in 2006 and represents an $18.8 million or 40% decrease year to year. Diluted earnings per share from continuing operations was $1.23 in 2007, a $0.68 or 36% decline from $1.91 in 2006. AMCORE’s return on average equity and on average assets from continuing operations for 2007 was 7.32% and 0.54%, respectively, compared to 11.76% and 0.88%, respectively, in 2006.

 

Significant Categories

 

Changes in the most significant categories of 2007 net income from continuing operations, compared to 2006, were:

 

Net interest income – Declined $4.4 million due to lower average investment security volumes and spreads, partly offset by higher average loan volumes. Net interest margin was 3.35% in 2007 compared to 3.38% in 2006. Net interest margin declined as funding costs increased more rapidly than loan and investment yields.

 

Provision for loan losses – Increased $19.0 million, or 187%, to $29.1 million in 2007 from $10.1 million in 2006, reflecting a 69% increase in net charge-offs and a 119% increase in non-performing loans.

 

Non-interest income – Declined $4.6 million. The decline was primarily attributable to $5.9 million of net security losses in 2007 and a $2.8 million net insurance claim included in 2006 company owned life insurance income, that were partly offset by a $4.0 million increase in service charges on deposits in 2007 over 2006. There were no insurance claims in 2007. The $2.2 million gain on the sale of the Company’s OMSR portfolio was offset by a decline in community reinvestment act (CRA) related fund income year-over-year, and increased derivative mark-to-market losses.

 

Operating expenses – Were essentially flat at $165.3 million in 2007 compared to $165.4 million in 2006. Increased net occupancy expense, higher foreclosure related costs and increased fraud losses were offset by lower compensation expense, advertising/business development costs and professional fees.

 

Income taxes – Decreased $9.1 million, mainly due to lower earnings before income taxes. The effective tax rate was 24.0% in 2007 compared to 27.7% in 2006.

 

EARNINGS REVIEW OF CONSOLIDATED STATEMENTS OF INCOME

 

The following highlights a comparative discussion of the major components of net income and their impact for the last three years.

 

Net Interest Income

 

Net interest income is the Company’s largest source of revenue and represents the difference between income earned on loans and investments (interest-earning assets) and the interest expense incurred on deposits and borrowed funds (interest-bearing liabilities). Fluctuations in interest rates as well as volume and mix changes in interest-earning assets and interest-bearing liabilities can materially affect the level of net interest income. Because the interest that is earned on certain loans and investment securities is not subject to federal income tax, and in order to facilitate comparisons among various taxable and tax-exempt interest-earning assets, the following discussion of net interest income is presented on a “fully taxable equivalent,” or FTE basis. The FTE adjustment was calculated using AMCORE’s statutory federal income tax rate of 35%.

 

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Net interest spread is the difference between the average yields earned on interest-earning assets and the average rates incurred on interest-bearing liabilities. Net interest margin represents net interest income divided by average interest-earning assets. Since a portion of the Company’s funding is derived from interest-free sources, primarily demand deposits, other liabilities and stockholders’ equity, the effective interest rate incurred for all funding sources is lower than the interest rate incurred on interest-bearing liabilities alone.

 

Overview – Net interest income, on an FTE basis, declined $6.0 million or 4% in 2007 and increased $2.7 million or 2% in 2006. The decline in 2007 was primarily the result of a 22% decrease in average investment security balances and a seven basis point decline in net interest spread. The increase for 2006 was primarily driven by an 11% increase in average loan volumes.

 

     Years Ended December 31,
     2007    2006    2005
     (dollars in thousands)

Interest Income Book Basis

   $ 344,016    $ 339,176    $ 280,609

FTE Adjustment

     2,584      4,192      4,775
                    

Interest Income FTE Basis

     346,600      343,368      285,384

Interest Expense

     183,432      174,218      118,975
                    

Net Interest Income FTE Basis

   $ 163,168    $ 169,150    $ 166,409
                    

 

Net interest spread and margin (See Table 1, page 1) – Net interest spread declined seven basis points to 2.84% in 2007 from 2.91% in 2006, and decreased 26 basis points in 2006 from the 2005 level of 3.17%. The net interest margin was 3.35% in 2007, a decline of three basis points from 3.38% in 2006. The 2006 level was a decrease of 13 basis points from 3.51% in 2005.

 

The declines in net interest spread and net interest margin for both periods were driven by higher funding costs, as the rates incurred on interest-bearing liabilities increased more rapidly (declined slower) than the increase (decrease) in rates earned on interest-earning assets. Other factors contributing to the declines in spread were increases in non-interest earning assets (i.e., non-accrual loans), a divergence in recent financial markets with higher declines in prime rates compared to LIBOR-based rates and the substitution of debt for capital in the Repurchase Programs. Since the Company has a higher proportion of prime-based loans and a higher proportion of LIBOR-based liabilities, the aforementioned divergence in interest rates resulted in some reduction in net interest spread and net interest margin. While the Repurchase Program has improved the efficiency of the Company’s capital structure, it has also contributed to the compression in net interest spread and net interest margin.

 

Changes due to volume (See Table 1, page 2) – In 2007, net interest income (FTE) declined due to average volume by $4.7 million when compared to 2006. This decline was comprised of a $9.7 million decline in interest income that was partially offset by a $4.9 million decrease in interest expense. The decline in interest income was attributable to a $139 million decrease in interest-earning assets. The decrease was primarily driven by a $246 million or 22% reduction in average investment securities that was partially offset by a $119 million or 3% increase in average loans. The growth in average loans came from a combined increase of $116 million in commercial real estate and commercial loans. Average residential real estate loans increased $4 million, while average consumer loan balances declined $1 million. Average interest-bearing liabilities declined $123 million. This was comprised of a $43 million decrease in average bank-issued deposits and $80 million decrease in average wholesale funding. Average interest-bearing liabilities did not decrease as much as average interest-earning assets due to the Repurchase Program, which substituted debt for capital.

 

In 2006, net interest income (FTE) increased due to average volume by $9.7 million when compared to 2005. This was comprised of a $16.9 million increase in interest income that was partially offset by a $7.2 million increase in interest expense. The increase in interest income was primarily driven by a $377 million or 11%

 

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increase in average loans that was partially offset by a $100 million decline in average securities. Average commercial real estate and commercial loans increased a combined $331 million. Average residential real estate loans increased $48 million, and average consumer loan balances declined $2 million compared to the prior year. The increase in average loans was funded by a $125 million or 4% increase in average bank-issued deposits and a $122 million or 20% increase in average wholesale funding.

 

Changes due to rate (See Table 1, page 2) – In 2007, net interest income (FTE) declined due to average rates by $1.3 million when compared with 2006. This was comprised of a $12.9 million increase in interest income that was more than offset by a $14.2 million increase in interest expense. Both interest-earning asset yields and interest-bearing liability costs were affected by four 25 basis point increases in the federal funds (Fed Funds) rate that occurred during the first two quarters of 2006, which were followed by a 50 basis point and two 25 basis point decreases in late 2007. The yield on average earning assets increased 26 basis points to 7.12% during 2007, compared to 6.86% in 2006. During this same period of time, the rate paid on average interest bearing liabilities increased 32 basis points, to 4.27% from 3.95%.

 

During 2006, net interest income (FTE) declined due to average rates by $7.0 million when compared with 2005. This was comprised of a $41.1 million increase in interest income that was more than offset by a $48.0 million increase in interest expense. Both interest-earning asset yields and interest-bearing liability costs were affected by four 25 basis point increases in the Fed Funds rate that occurred throughout 2006. The yield on average interest-earning assets increased 84 basis points to 6.86% during 2006, compared to 6.02% in 2005. During this same period of time, the rate paid on average interest bearing liabilities increased 110 basis points, to 3.95% from 2.85%.

 

Interest rate risk – Like most financial institutions, AMCORE has an exposure to changes in both short-term and long-term interest rates. Among those factors that could affect net interest margin and net interest spread include: greater and more frequent changes in interest rates, including the impact of basis risk between various interest rate indices such as prime and LIBOR, changes in the shape of the yield curve, mismatch in the duration of interest-earning assets and the interest-bearing liabilities that fund them, the effect of prepayments or renegotiated rates, increased price competition on both deposits and loans, promotional pricing on deposits, changes in the mix of earning assets and the mix of liabilities, including greater or less use of wholesale sources, changes in the level of non-accrual loans, and in an environment such as is currently being experienced where there are rapid and substantial declines in interest rates, the limited ability to reduce certain low-cost deposit products rates (such as NOW accounts) to the same extent that interest-earning assets reprice.

 

Provision for Loan Losses

 

The 2007 Provision (see Critical Accounting Estimates discussion) was $29.1 million, an increase of $19.0 million or 187% from $10.1 million in 2006. The increase was primarily due to a 69% increase in net charge-offs and a 119% increase in non-performing loans in 2007 compared to 2006 that were driven by a general weakening of real estate conditions in the Company’s markets. These market conditions are expected to persist into 2008. Net charge-offs were $16.9 million or 42 basis points of average loans in 2007, compared to $10.0 million or 26 basis points of average loans in 2006. Non-performing loans were $70.8 million at December 31, 2007 compared to $32.4 million at December 31, 2006. Non-performing loans is the sum of non-accrual loans and loans that are ninety days past due but are still accruing interest.

 

The 2006 Provision was $10.1 million, a decrease of $5.1 million or 33% from $15.2 million in 2005. The decline was primarily due to lower net charge-offs, which declined 32% in 2006 compared to 2005. Net charge-offs were $10.0 million or 26 basis points of average loans in 2006, compared to $14.7 million or 42 basis points of average loans in 2005. Non-performing loans were $32.4 million at December 31, 2006 compared to $30.2 million at December 31, 2005.

 

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Non-Interest Income

 

Total non-interest income is comprised primarily of fee-based revenues from Investment Management and Trust and bank-related service charges on deposits. Income from bankcard fee income, Bank and Company owned life insurance (COLI), brokerage commission income and mortgage banking income are also included in this category.

 

Overview – For 2007, non-interest income totaled $71.0 million, a decline of $4.6 million or 6% from $75.6 million in 2006. The decline was primarily attributable to $5.9 million of net security losses in 2007 and a $2.8 million net insurance claim included in 2006 COLI, that were partly offset by a $4.0 million increase in service charges on deposits in 2007 compared to 2006.

 

For 2006, non-interest income totaled $75.6 million, an increase of $9.2 million or 14% from $66.4 million in 2005 due to increases in other non-interest income, COLI, service charges on deposits, bankcard fee income and Investment Management and Trust income.

 

Investment management and trust income – Investment Management and Trust income includes trust services, investment management, estate administration, financial planning and employee benefit plan recordkeeping and administration. Investment Management and Trust income totaled $16.8 million in 2007, an increase of $565,000 or 3% from $16.2 million in 2006. This followed an increase of $1.1 million or 7% in 2006 from $15.1 million in 2005. The increases for both 2007 and 2006 were primarily attributable to higher personal trust services and employee benefit income. At December 31, 2007 and 2006, total assets under administration were $2.7 billion.

 

Service charges on deposits – Service charges on deposits, the Company’s largest source of non-interest income, totaled $29.6 million in 2007, a $4.0 million or 16% increase over $25.6 million in 2006. This follows a 2006 increase of $2.1 million or 9% from $23.5 million in 2005. Service charges on consumer deposit accounts were the primary driver of the increases for both periods and were affected by enhancements to the Company’s fee structure and waiver policies on both retail and commercial deposits. While this pace of growth is not expected to continue, the current level of revenue is expected to be sustainable over time with some additional improvement in the near-term as a result of the declining interest rate levels that will reduce the deposit offset against activity fees for commercial accounts.

 

Mortgage Banking income – Mortgage banking income includes fees generated from the underwriting, originating and servicing of mortgage loans along with gains and fees realized from the sale of these loans, net of origination costs, OMSR amortization and impairment.

 

For 2007, mortgage banking income was $1.8 million, a decline of $2.1 million from $3.9 million in 2006. Total closings were $277 million in 2007 compared to $395 million in 2006. New purchase mortgage closings were $171 million or 62% of total closings in 2007, compared to $266 million or 67% of total closings in 2006. The 2007 decline in mortgage banking income was primarily due to lower servicing fee income and reduced sales volume due to slowdown in the housing markets that affected new purchase closings and higher mortgage interest rates that affected refinancing volumes. The decline in servicing fee income for 2007 is attributable to the sale of the Company’s OMSR portfolio, after which the Company no longer generates fee income in connection with the servicing of mortgage loans sold to the secondary market. The cost of servicing those loans, a component of operating expense, was also eliminated after the transition. The Company recorded a $2.2 million gain on the sale of the OMSR portfolio, net of transaction costs, during 2007. The net gain is included in other non-interest income. See Significant Transactions, discussed above, for additional information.

 

For 2006, mortgage banking income was $3.9 million, a decline of $154,000 from $4.1 million in 2005. Total closings were $395 million in 2006 compared to $463 million in 2005. New purchase mortgage closings were $266 million or 67% of total closings in 2006, compared to $284 million or 61% of total closings in 2005. The 2006 decline in mortgage banking income was primarily due to lower gains on the sales of mortgage loans into the secondary market that were nearly offset by lower amortization of mortgage servicing rights due to slower run-off of loans serviced.

 

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COLI income – COLI income totaled $5.4 million in 2007, a $2.5 million or 31% decline from $7.9 million in 2006. This compares with a $2.5 million or 46% increase in 2006 from $5.4 million in 2005. Both the 2007 decline and the 2006 increase were primarily due to $2.8 million in net insurance claims received in 2006. AMCORE uses COLI as a tax-advantaged means of financing its future obligations with respect to certain non-qualified retirement and deferred compensation plans in addition to other employee benefit programs. As of December 31, 2007, the cash surrender value (CSV) of COLI was $140 million, compared to $135 million at December 31, 2006.

 

Bankcard fee income – Bankcard fee income totaled $7.9 million in 2007, a $1.7 million or 26% increase over $6.2 million in 2006 and an increase of $1.3 million over bankcard fee income in 2005 of $4.9 million. A larger cardholder base, increased card utilization and an expanded ATM network contributed to the increase in bankcard fee income for both 2007 and 2006.

 

Other non-interest income – For 2007, brokerage commission income, gain on sale of loans, net security (losses) gains and other non-interest income totaled $9.5 million, a $6.2 million or 39% decline from 2006.

 

The decline was primarily due to $5.9 million of net security losses in 2007, compared to net security gains of $267,000 in 2006. The 2007 loss was mainly due to the sale of approximately $200 million of bonds purchased in 2003 and 2004 in order to reduce longer-term interest rate and liquidity risk. The proceeds of the sales were reinvested in shorter-term securities that enabled the Company to improve the repricing match of its assets and liabilities.

 

During 2007, the Company recorded a $2.2 million net gain on the sale of its OMSR portfolio, while brokerage commission income increased $1.0 million from 2006. These were offset by a $1.4 million decline in CRA related fund income year-over-year, and a $1.1 million increase in derivative mark-to-market losses. The derivative losses relate to economic hedges of various loan, deposit and COLI products that do not qualify for hedge accounting.

 

For 2006, brokerage commission income, gain on sale of loans, net security gains and other non-interest income totaled $15.7 million, a $2.3 million or 17% increase from 2005. The increase was primarily due to earnings from private equity fund investments, included in other non-interest income, totaling $4.1 million in 2006, compared to $1.6 million in 2005.

 

Operating Expenses

 

Overview – In 2007, total operating expense was $165.3 million, which was essentially flat with $165.4 million in 2006. Increased net occupancy expense, higher foreclosure related costs and increased fraud losses were offset by lower compensation expense, advertising/business development costs and professional fees. The $2.3 million Extinguishment Loss (see Significant Transactions, discussed above) incurred in 2007, offset a $2.1 million loss on the extinguishment of Federal Home Loan Bank (FHLB) debt that was incurred in 2006.

 

In 2006, total operating expense was $165.4 million, an increase of $20.0 million or 14%, from $145.4 million in 2005. The increase was primarily due to an $11.6 million increase in personnel costs, a $5.3 million increase in professional fees and a $2.1 million expense related to the extinguishment of high-cost FHLB debt.

 

The efficiency ratio was 71.4% in 2007, compared to 68.75% in 2006 and 63.74% in 2005. The efficiency ratio is calculated by dividing total operating expenses by revenues. Revenues are the sum of net interest income and non-interest income.

 

Personnel expense – Personnel expense includes compensation expense and employee benefits and is the largest component of operating expenses, totaling a combined $94.9 million in 2007, $97.9 million in 2006 and $86.3 million in 2005. For 2007, personnel expenses declined $3.0 million or 3% compared to 2006 and increased

 

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$11.6 million or 13% in 2006 compared to 2005. The 2007 decline was attributable to lower incentives and stock-based compensation costs. The 2006 increase included $2.2 million in stock-based compensation expense and $1.4 million in executive and director retirement costs. The remaining increase included the effects of branch expansion, additional compliance and legal staff hired in connection with the regulatory developments discussed above and severance costs. The increase in stock based compensation expense was due to the adoption of SFAS No. 123R in 2006. The increase in executive and director retirement costs was primarily due to the recognition of an actuarial adjustment for a legacy supplemental retirement plan.

 

Facilities expense – Facilities expense, which includes net occupancy expense and equipment expense, was a combined $24.6 million in 2007, $20.9 million in 2006 and $21.8 million in 2005. This was a $3.7 million or 18% increase in 2007 compared to 2006, but a decline of $926,000 or 4% in 2006 compared to 2005. The 2007 increase was primarily due to higher rental expense, real estate taxes, utility costs and snow removal expenses. The increase in rental expense was associated with new branches that were opened in 2007 and that were open for only part of 2006. The decline in 2006 was due to lower data processing equipment and software depreciation expense.

 

Professional fees – Professional fees include legal, consulting, auditing and external portfolio management fees and totaled $8.4 million in 2007, $9.3 million in 2006 and $4.0 million in 2005. The decline in 2007 from 2006 relates to lower external assistance on regulatory compliance matters (see Regulatory Developments discussion above). The 2006 increase was primarily attributable to increased costs for external assistance with regulatory compliance matters of $2.7 million, and $1.7 million for external investment management expenses associated with the transition to an open platform and investment management services for the Bank’s investment portfolio. These services were previously provided internally and were categorized as a component of personnel expense. The costs of outside assistance for compliance matters should continue to decline in 2008.

 

Other operating expenses – Other operating expenses includes data processing expense, communication expense, advertising and business development expenses and other costs, and were a combined $37.4 million in 2007, $37.3 million in 2006 and $33.2 million in 2005. For 2007, a $1.0 million increase in foreclosure related costs, a $1.1 million increase in fraud losses and a $653,000 charge for the Company’s proportionate membership interest share of various litigation claims against VISA, Inc. were offset by a $3.2 million reduction in advertising/business development costs. The increase in 2006 was due to a $2.1 million expense related to the FHLB debt extinguishment and increased advertising/business development costs and data processing expenses.

 

Income Taxes

 

Income tax expense totaled $8.9 million in 2007, compared to $18.0 million and $19.5 million in 2006 and 2005, respectively. The decline in 2007 was mainly due to lower income before taxes. The decline in 2006 was mainly due to lower income before taxes and a higher proportion of tax-exempt earnings, which included the non-taxable insurance claims.

 

The 2007 income tax expense was net of a $588,000 tax benefit associated with an increase in effective state income tax rates that were enacted during the year, and which increased the value of the Company’s recorded deferred income tax asset. A deferred tax asset primarily represents expenses reflected on the Company’s Consolidated Statement of Income whose tax deduction has been delayed or deferred to a later year’s tax return, due to differences in the timing of their recognition under generally accepted accounting principles versus income tax regulations. Since these deductions will be claimed in a future period, after the increase in the income tax rates becomes effective, they will result in a larger reduction in taxes paid than was previously recorded.

 

The effective tax rates were 24.0%, 27.7% and 28.9% in 2007, 2006 and 2005, respectively. Effective tax rates are lower than the statutory tax rates due primarily to investments in tax-exempt municipal bonds and increases in CSV and insurance claims on COLI that are not taxable. The decrease in effective tax rates in both 2007 and 2006 was due to a higher proportion of non-taxable COLI income net of lower tax-exempt municipal bond income. See Note 16 of the Notes to Consolidated Financial Statements.

 

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Discontinued Operations

 

In 2005, the Company transitioned $142 million in assets of its three Company-managed Vintage equity funds into two mutual funds managed by Federated Investors, Inc. (Federated) and sold its asset management subsidiary, Investors Management Group, Ltd. (IMG), to West Bancorporation, Inc. (West Banc). With these transactions, AMCORE transitioned from being a developer of proprietary investment products to being a provider that offer its customers a wider array of investment product choices. The results of IMG for prior periods, the related sale and subsequent adjustments are reported as discontinued operations.

 

For 2006, net income from discontinued operations was $248,000, compared to net losses of $3.0 million in 2005. The net income in 2006 resulted from the finalization of tax payments from the sale of IMG in the previous year. The net loss in 2005 included a $3.8 million after-tax loss on the sale of IMG to West Banc and an $824,000 after-tax gain on the Federated transaction in addition to IMG operating results for the year. The amount of the loss on the West Banc transaction is primarily due to the related tax expense of the transaction of $3.2 million, resulting from the Company’s carryover tax basis in IMG.

 

EARNINGS REVIEW BY BUSINESS SEGMENT

 

AMCORE’s internal reporting and planning process focuses on four primary lines of business (Segment(s)): Commercial Banking, Retail Banking, Investment Management and Trust, and Mortgage Banking. Note 18 of the Notes to Consolidated Financial Statements presents a condensed income statement and total assets for each Segment.

 

The financial information presented was derived from the Company’s internal profitability reporting system that is used by management to monitor and manage the financial performance of the Company. This information is based on internal management accounting policies which have been developed to reflect the underlying economics of the Segments and, to the extent practicable, to portray each Segment as if it operated on a stand-alone basis. Thus, each Segment, in addition to its direct revenues, expenses, assets and liabilities, includes an allocation of shared support function expenses. The Commercial, Retail and Mortgage Banking Segments also include funds transfer adjustments to appropriately reflect the cost of funds on loans made and funding credits on deposits generated. Apart from these adjustments, the accounting policies used are similar to those described in Note 1 of the Notes to Consolidated Financial Statements.

 

Since there are no comprehensive standards for management accounting that are equivalent to accounting principles generally accepted in the United States of America, the information presented is not necessarily comparable with similar information from other financial institutions. In addition, methodologies used to measure, assign and allocate certain items may change from time-to-time to reflect, among other things, accounting estimate refinements, changes in risk profiles, changes in customers or product lines, and changes in management structure. For example, during 2007, the Company refined its method for measuring fund transfer adjustments to include non-earning assets, liabilities, and equity, in addition to funds transfer adjustments for loans made and deposits generated. The effect of this change for 2007 was to increase net interest income of the Commercial Banking and Retail Banking Segments by $5.1 million and $1.9 million, respectively. Also during 2007, ATM related income and expenses previously included in the “Other” category were included in the Retail Banking segment consistent with internal management reporting. For the prior year periods, ATM activity has been reclassified to reflect this change.

 

Total Segment results differ from consolidated results primarily due to inter-segment eliminations, certain corporate administration costs, items not otherwise allocated in the management accounting process and treasury and investment activities such as the offset to the funds transfer adjustments made to the Segments, interest income on the securities investment portfolio, gains and losses on the sale of securities, COLI, CRA related fund income and derivative gains and losses. The impact of these items is aggregated to reconcile the amounts

 

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presented for the Segments to the consolidated results and is included in the “Other” column of Note 18 of the Notes to Consolidated Financial Statements. As a result of the Federated and West Banc transactions, the results of IMG for the current and prior periods are reported as discontinued operations.

 

Commercial Banking

 

The Commercial Banking Segment (Commercial) provides commercial banking services to middle market and small business customers through the Bank’s full service branch and LBO locations. The services provided by Commercial include lending, business checking and deposits, treasury management and other traditional as well as electronic services.

 

Overview – Commercial represented 52%, 74% and 73% of total Segment net income in 2007, 2006 and 2005, respectively. Commercial total assets were $3.1 billion at December 31, 2007 and represented 60% of total consolidated assets. This compares to $3.1 billion and 59% at December 31, 2006.

 

Comparison of 2007 to 2006 – Commercial net income for 2007 was $24.0 million, a decline of $10.7 million or 31% from 2006 net income of $34.7 million. The decline was due to a $20.6 million increase in Provision and a $4.6 million increase in non-interest expense that were partially offset by an $8.1 million increase in net interest income and a $6.8 million decrease in income taxes.

 

In addition to the $5.1 million effect of the change in funds transfer pricing noted above, the increase in net interest income was due to higher average loan volumes net of lower spreads. The increase in Provision was primarily due to increased net charge-offs, delinquencies and non-performing loans. The increase in non-interest expense was primarily due to higher facilities expense and allocated corporate support costs. Income taxes were lower due to a decline in income before tax.

 

Comparison of 2006 to 2005 – Commercial net income for 2006 was $34.7 million, an increase of $3.6 million or 12% from 2005 net income of $31.0 million. The increase was due to a $7.6 million increase in net interest income and a $6.1 million decrease in Provision that were partially offset by a $7.4 million increase in non-interest expense and a $2.3 million increase in income taxes.

 

The increase in net interest income was driven by higher average commercial real estate loan volumes and increased yields on commercial and commercial real estate loans. These increases were due in large part to branch expansion. The decrease in Provision was primarily due to lower net charge-offs. The increase in non-interest expense was primarily due to higher personnel and facilities expense as a result of branch expansion and higher loan processing and collection expenses. Income taxes were higher due to higher income before tax.

 

Retail Banking

 

The Retail Banking Segment (Retail) provides banking services to individual customers through the Bank’s branch locations. The services provided by Retail include direct and indirect lending, checking, savings, money market and certificate of deposit (CD) accounts, safe deposit rental, ATMs, and other traditional and electronic services.

 

Overview – Retail represented 39% of total segment net income in 2007 compared to 24% in 2006 and 25% in 2005. Retail total assets were $692 million at December 31, 2007 and represented 13% of total consolidated assets. This compares to $665 million and 13% at December 31, 2006.

 

Comparison of 2007 to 2006 – Retail net income for 2007 was $18.3 million, an increase of $7.0 million or 62% from 2006. The increase was due to a $5.2 million increase in net interest income, a $6.2 million increase in non-interest income and a $1.8 million decrease in Provision. These were partly offset by a $1.9 million increase in non-interest expense and a $4.4 million increase in income taxes.

 

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In addition to the $1.9 million affect of the change in funds transfer pricing noted above, the increase in net interest income was primarily due to increased funding credits on deposit balances. These were partially offset by higher interest expense due to rising short-term interest rates. The increase in non-interest income was due to higher service charges on deposits, bankcard fees and customer service fees. The decrease in Provision was due to one large credit loss that occurred in 2006. The increase in non-interest expense was due to higher facilities expense. Income taxes increased due to higher income before taxes.

 

Comparison of 2006 to 2005 – Retail net income for 2006 was $11.3 million, an increase of $527,000 or 5% from 2005. The increase was due to a $6.4 million increase in net-interest income and a $4.0 million increase in non-interest income. These increases were partly offset by an increase in Provision of $1.8 million, a $7.8 million increase in non-interest expense and a $342,000 increase in income taxes.

 

The increase in net interest income was due to increased funding credits on higher deposit balances and higher loan yields. These were partially offset by higher interest expense due to rising short-term interest rates. The increase in non-interest income was mainly due to higher service charges on deposits and bankcard income. The increase in Provision was primarily due to one large credit loss that occurred during the year. The increase in non-interest expense was due to higher personnel costs, loan processing and collection expenses, costs associated with expansion of the Company’s ATM network and increased allocations for corporate support functions. Income taxes increased due to higher income before taxes.

 

Investment Management and Trust

 

The Investment Management and Trust Segment (IMT) provides wealth management services, which includes trust services, investment management, estate administration, financial planning, employee benefit plan recordkeeping and administration and brokerage services.

 

Overview – IMT represented 6%, 3% and 3% of total segment net income in 2007, 2006 and 2005, respectively. IMT total assets were $13 million at December 31, 2007 and represented less than 1% of total consolidated assets. At December 31, 2006, IMT total assets were $14 million, also less than 1% of total consolidated assets.

 

Comparison of 2007 to 2006 – IMT net income for 2007 was $2.6 million, an increase of $1.1 million or 81% from 2006. An increase of $1.5 million in non-interest income and a decline of $324,000 in non-interest expense were partially offset by a $690,000 increase in income taxes.

 

The increase in non-interest income was attributable to higher personal trust services income, employee benefit income and brokerage commission income. Income taxes increased due to higher income before taxes.

 

Comparison of 2006 to 2005 – IMT net income for 2006 was essentially flat with 2005. An increase of $1.1 million in non-interest income was offset by a $1.1 million increase in non-interest expenses.

 

The increase in non-interest income was attributable to higher personal trust services and employee benefit income. The increase in non-interest expenses was primarily due to higher professional fees associated with the transition to an open platform.

 

Mortgage Banking

 

The Mortgage Banking Segment (Mortgage) provides a variety of mortgage lending products to meet its customers’ needs. It sells most of the loans it originates to a third-party mortgage services company, which provides private-label loan processing and servicing support on both sold and retained loans.

 

Overview – Mortgage represented 3% of total segment net income in 2007, compared to less than 1% in 2006 and 2005. Mortgage total assets were $264 million at December 31, 2007 and represented 5% of total consolidated assets. This compares to $306 million and 6% at December 31, 2006.

 

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Comparison of 2007 to 2006 – Mortgage net income for 2007 was $1.5 million, an increase of $2.0 million from 2006. The increase was primarily due to a $3.2 million decline in non-interest expense, net of a $1.3 million increase in income tax expense.

 

The decline in non-interest expense was primarily due to lower personnel and allocated corporate support costs as the cost of servicing mortgage loans has been substantially eliminated after the transition to the third party processor and servicer. The decrease in personnel costs was net of severance costs associated with job eliminations in connection with the transition. Income taxes increased due to higher income before taxes. The $2.2 million net gain on the sale of its OMSR portfolio was largely offset by lower mortgage banking income and net interest income.

 

Comparison of 2006 to 2005 – Mortgage results for 2006 reflected a net loss of $454,000, a decrease of $28,000 from 2005. The decrease was due to a $524,000 decline in net interest income and a $446,000 decline in non-interest income that were partially offset by a $776,000 decrease in Provision and a $149,000 decrease in non-interest expense.

 

Net interest income declined primarily due to increased funds transfer adjustments as a result of increasing short-term interest rates. Non-interest income declined from the prior year due to lower gains on the sale of mortgage loans into the secondary market that were partially offset by lower OMSR amortization due to a slower run-off of loans serviced. The decrease in Provision was primarily due to lower statistical loss estimates on loan pools and a decline in net charge-offs. The decline in operating expenses was due to lower personnel costs and loan processing and collection expenses.

 

BALANCE SHEET REVIEW

 

Total assets were $5.2 billion at December 31, 2007, a decrease of $100 million or 2% from December 31, 2006. Total liabilities decreased $68 million over the same period and stockholders’ equity decreased $31 million. The following discusses changes in the major components of the Consolidated Balance Sheet since December 31, 2006.

 

Cash and Cash Equivalents

 

Cash and cash equivalents decreased $14 million from December 31, 2006 to December 31, 2007, as the cash used for financing activities of $125 million exceeded the cash provided by operating activities of $62 million plus the cash provided by investing activities of $50 million. This compares to an increase of $2 million from December 31, 2005 to December 31, 2006, as the cash provided by operating activities of $65 million plus the cash provided by investing activities of $37 million exceeded the cash used for financing activities of $100 million.

 

The $62 million of cash provided by operating activities during 2007 compares with $65 million provided in 2006, representing a $3 million decrease in cash provided between the two years. The $50 million of cash provided by investing activities during 2007 compares with $37 million cash provided in 2006, for an increase of $13 million in cash provided between the two years. The increase was primarily due to a decline in cash used for loans of $240 million, which exceeded cash used to purchase securities, net of proceeds from the sale and maturity of securities, of $223 million. The $126 million of cash used in financing activities during 2007 compares with $100 million cash used in 2006, or an increase of $26 million in cash used between the two years. This was primarily due to a $107 million decline in cash flows for bank-issued demand, savings and time deposit accounts, a $369 million decline in wholesale deposit cash flows and $19 million increase in cash used for the Repurchase Program. These were partially offset by a $469 million combined increase in cash flows from long-term and short-term borrowings.

 

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Securities Available for Sale

 

Total securities available for sale as of December 31, 2007 were $843 million, a decline of $57 million or 6% from the prior year-end. At December 31, 2007, the total securities available for sale portfolio comprised 17% of total earning assets, including COLI, compared to 18% for 2006. Among the factors affecting the decision to purchase or sell securities are the current assessment of economic and financial conditions, including the interest rate environment, regulatory capital levels, the liquidity needs of the Company, and its pledging obligations.

 

As of December 31, 2007, mortgage and asset backed securities totaled $679 million and represented 81% of total available for sale securities. The distribution of mortgage and asset backed securities included $112 million of GSE mortgage-backed pass through securities, $469 million of GSE collateralized mortgage obligations, $61 million of private issue collateral mortgage obligations, and $37 million of private issue asset backed securities, all of which are rated Aaa.

 

The $843 million of total securities available for sale includes gross unrealized gains of $2 million and gross unrealized losses of $7 million. Unrealized gains and unrealized losses is the difference between a security’s fair value and carrying value. The fair value of a security is generally influenced by two factors, market risk and credit risk. Market risk is the exposure of the security to changes in interest rate. There is an inverse relationship to changes in the fair value of the security with changes in interest rates, meaning that when rates increase the value of the security will decrease. Conversely, when rates decline the value of the security will increase. Credit risk arises from the extension of credit to a counter-party, for example a purchase of corporate debt in security form, and the possibility that the counter-party may not meet its contractual obligations. The Company’s policy is to invest in securities with low credit risk, such as U.S. Treasuries, U.S. government agencies (such as the Government National Mortgage Association or “GNMA”), GSEs (such as FHLMC), state and political obligations, and highly-rated private issue mortgage and asset-backed securities. Unlike agency debt, GSE debt is not secured by the full faith and credit of the United States.

 

The combined effect of the Company’s gross unrealized gains and gross unrealized losses, net of tax, is included as OCI in stockholders’ equity, as none of the securities with gross unrealized losses are considered other than temporarily impaired. If it is determined that an investment is impaired and the impairment is other-than-temporary, an impairment loss is reclassified from OCI as a charge to earnings and a new carrying basis for the investment is established. The Company reclassified a $5.6 million other-than-temporary impairment loss from OCI in the third quarter 2007, relating to a decision to sell approximately $200 million of bonds purchased in 2003 and 2004 in order to reduce longer-term interest rate and liquidity risk. All of these securities were ultimately sold during fourth quarter 2007.

 

For comparative purposes, at December 31, 2006, gross unrealized gains of $2 million and gross unrealized losses of $19 million were included in the securities available for sale portfolio. For further analysis of the securities available for sale portfolio, see Table 4 and Note 3 of the Notes to Consolidated Financial Statements.

 

Loans Held for Sale

 

At December 31, 2007, mortgage origination fundings awaiting sale were $4 million, compared to $14 million at December 31, 2006. All loans held for sale are recorded at the lower of cost or market value. Residential mortgage loans are originated by the Company’s Mortgage Banking Segment, of which non-conforming adjustable rate, fixed-rate and balloon residential mortgages have historically been retained by the Bank. The conforming adjustable rate, fixed-rate and balloon residential mortgage loans were historically sold in the secondary market to eliminate interest rate risk, as well as to generate gains on the sale of these loans and servicing income. With the aforementioned third party mortgage loan processor arrangement, a majority of all mortgage loans are now being sold for a fee net of origination costs. See Significant Transactions, discussed above.

 

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Loans

 

Loans represent the largest component of AMCORE’s earning asset base. At year-end 2007, total loans were $3.9 billion, a decrease of $14 million from 2006, and represented 80% of total earning assets including COLI. See Table 2 and Note 4 of the Notes to Consolidated Financial Statements.

 

Total commercial real estate loans, including real estate construction loans, increased $14 million or 1%. Residential real estate loans decreased $25 million or 5%. Commercial, financial and agricultural loans increased $31 million or 4%. Installment and consumer loans increased $28 million or 9%, due to the Clean-up Call repurchase. See Loan Securitizations and Sale of Receivables discussion above.

 

Goodwill

 

Total goodwill at December 31, 2007 and 2006 was $6.1 million. See Note 6 of the Notes to the Consolidated Financial Statements for additional information. Goodwill is evaluated for impairment on an annual basis, or should events indicate impairment might be a possibility. No goodwill impairment charge has been required.

 

Deposits

 

Total deposits at December 31, 2007 were $4.0 billion, a decrease of $343 million or 8% when compared to 2006. The decrease was due to $199 million in wholesale deposits and $144 million in bank-issued deposits. Total bank-issued deposits were $3.4 billion at the end of 2007, a 4% decrease from the prior year-end balance of $3.5 billion. The decline in bank-issued deposits reflects the Company’s efforts to ensure that its deposit attraction strategies are priced at competitive, but profitable levels. This has led to some attrition in balances, as some customers, notably time deposit customers, moved balances to other institutions. Bank-issued deposits represent 85% and 82% of total deposits at December 31, 2007 and 2006, respectively. Table 5 shows the maturity distribution of time deposits $100,000 and over.

 

Borrowings

 

Borrowings totaled $766 million at year-end 2007 and were comprised of $397 million of short-term and $369 million of long-term borrowings. Comparable amounts at the end of 2006 were $137 million and $342 million, respectively, for a combined increase in borrowings of $287 million or 60%, replacing most of the $343 million decline in deposits. The increase in borrowings included $143 million in FHLB borrowings, primarily short-term, $69 million in Fed Fund purchased, $46 million in repurchase agreements, $10 million on the issuance of senior debt and a $10 increase in Trust Preferred securities. See Notes 9, 10 and 20 of the Notes to Consolidated Financial Statements.

 

The Company has $50 million of Trust Preferred securities that qualify as Tier 1 Capital for regulatory capital purposes for the Company. The Bank has two fixed/floating rate junior subordinated debentures totaling a combined $50 million that qualify as Tier 2 Capital for regulatory capital purposes for both the Bank and the Company.

 

Stockholders’ Equity

 

Total stockholders’ equity at December 31, 2007 was $369 million, a decrease of $31 million from December 31, 2006. The decrease in stockholders’ equity was due to a $52 million increase in treasury shares resulting from the Repurchase Program. This was partially offset by an $11 million increase in retained earnings and an $8 million reduction in accumulated other comprehensive loss. See discussion below under Liquidity and Capital Management.

 

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OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS

 

Off-Balance Sheet Arrangements

 

During the ordinary course of its business, the Company engages in financial transactions that are not recorded on its Consolidated Balance Sheets, are recorded in amounts that are different than their full principal or notional amount, or are recorded on an equity or cost basis rather than being consolidated. Such transactions serve a variety of purposes including management of the Company’s interest rate risk, liquidity and credit concentration risks, optimization of capital utilization, assistance in meeting the financial needs of its customers and satisfaction of CRA obligations in the markets that the Company serves.

 

Auto loan sales – Historically, the Company has periodically transferred indirect automobile loans in securitization transactions in exchange for cash and certain retained residual interests. The transfers were structured as sales pursuant to SFAS No. 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities.” The retained interests included rights to service the sold loans, interest collected on the loans over the amount required to be paid to the investors, the securitization agent and the servicer, plus an interest in the sales proceeds that was withheld as collateral for potential credit losses at the time of the initial loan sales. There were no sales in 2007, 2006 or 2005.

 

Upon each sale, indirect automobile loan receivables were transferred to a multi-seller variable-interest entity (VIE). Since the Company was not the primary beneficiary of the VIE, consolidation was not required under the terms of FIN No. 46R, “Consolidation of Variable Interest Entities.” As a result, the net carrying amount of the loans was removed from the Consolidated Balance Sheet, certain retained residual interests were recorded and the Company recorded a gain on the sale of the loans. The Company’s retained residual interests were subordinated to the interests of investors and the securitization agent, and were also subject to prepayment, credit and interest rate risk. The carrying value of the retained residual interests was periodically re-evaluated to determine if they were impaired, and if so, whether the impairment was other than temporary, requiring a charge to earnings. There were no other than temporary impairment changes in 2007, 2006 or 2005.

 

During 2007, the outstanding balances of the underlying loans fell to a level where the cost of servicing the loans became burdensome in relation to the benefits of servicing. As a result, the Company exercised its Clean-up Call option and repurchased the loans from the securitization trust. The carrying value of the retained residual interests was written off. As of December 31, 2007, the balance of the repurchased loans that are now included on the Company’s Consolidated Balance Sheet was $22 million. As of December 31, 2006, the balance of automobile loans serviced and not included on the Company’s Consolidated Balance Sheet was $55 million. The carrying value of retained residual interests was $5 million at the end of 2006. See Note 8 of the Notes to Consolidated Financial Statements.

 

Mortgage loan sales – Historically, the Company sold most of the mortgage loans that it originated to the secondary market, retaining the right to service the loans that are sold. As a result, the loans were removed from the Company’s Consolidated Balance Sheets, an OMSR asset was recorded and gains on the sale of the loans were recognized, pursuant to SFAS No 140. During 2007, the Company sold the majority of its OMSR portfolio. The Company now sells the majority of the mortgage loans that it originates, including the rights to service the loans sold, to a national mortgage services company in a private-label loan processing and servicing support arrangement. See above discussion of Significant Transactions. As of December 31, 2007, the unpaid principal balance of mortgage loans serviced for others was $16.5 million, compared to $1.5 billion at December 31, 2006. These loans are not recorded on the Company’s Consolidated Balance Sheets. As of December 31, 2007 and 2006, the Company had recorded $139,000 and $14 million, respectively, of OMSRs. There were no impairment valuation allowances for either period. See Note 7 of the Notes to Consolidated Financial Statements.

 

Derivatives – The Company periodically uses derivative contracts to help manage its exposure to changes in interest rates and in conjunction with its mortgage banking operations. The derivatives used most often are

 

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interest rate swaps, and on occasion caps, collars and floors (collectively the “Interest Rate Derivatives”), mortgage loan commitments and forward contracts. As of December 31, 2007 and 2006, there were no caps, collars or floors outstanding. Interest Rate Derivatives are contracts with a third-party (the “Counter-party”) to exchange interest payment streams based upon an assumed principal amount (the “Notional Principal Amount”). The Notional Principal Amount is not advanced to/from the Counter-party. It is used only as a reference point to calculate the exchange of interest payment streams and is not recorded on the Consolidated Balance Sheets. AMCORE does not have any derivatives that are held or issued for trading purposes but it does have some derivatives that do not qualify for hedge accounting. AMCORE monitors credit risk exposure to the Counter-parties. All Counter-parties, or their parent company, have investment grade credit ratings and are expected to meet any outstanding interest payment obligations.

 

The total notional amount of Interest Rate Derivatives outstanding was $141 million and $172 million as of December 31, 2007 and 2006, respectively. As of December 31, 2007, Interest Rate Derivatives had a net negative carrying and fair value of $1.7 million, compared to a net negative carrying and fair value of $1.2 million at December 31, 2006. The total notional amount of forward contracts outstanding for mortgage loans to be sold was $23 million and $25 million as of December 31, 2007 and 2006, respectively. As of December 31, 2007, the forward contracts had a net negative carrying and fair value of $96,000, compared to a net negative carrying and fair value of $59,000 at December 31, 2006. For further discussion of derivatives, see Notes 11 and 12 of the Notes to Consolidated Financial Statements.

 

Loan commitments and letters of credit – The Company, as a provider of financial services, routinely enters into commitments to extend credit to its Bank customers, including a variety of letters of credit. Letters of credit are a conditional but generally irrevocable form of guarantee on the part of the Bank to make payments to a third party obligee, upon the default of payment or performance by the Bank customer or upon consummation of the underlying transaction as intended. While these represent a potential outlay by the Company, a significant amount of the commitments and letters of credit may expire without being drawn upon. Commitments and letters of credit are subject to the same credit policies, underwriting standards and approval process as loans made by the Company.

 

At December 31, 2007 and 2006, liabilities in the amount of $111,000 and $149,000, respectively, representing the value of the guarantee obligations associated with certain of the letters of credit, had been recorded in accordance with FIN No. 45. These amounts are expected to be amortized into income over the lives of the commitments. The contractual amount of all letters of credit, including those exempted from the scope of FIN No. 45, was $192 million and $234 million at the end of 2007 and 2006, respectively. See Notes 12 and 15 of the Notes to Consolidated Financial Statements.

 

The carrying value of mortgage loan commitments recorded as an asset totaled $43,000 and $78,000 at December 31, 2007 and 2006, respectively. These amounts represent the fair value of those commitments marked-to-market in accordance with SFAS No. 138, “Accounting for Derivative Instruments and Hedging Activities” and in accordance with SAB No. 105. The total notional amount of mortgage loan commitments was $18 million at December 31, 2007 and $19 million at December 31, 2006. See Note 11 of the Notes to Consolidated Financial Statements.

 

At December 31, 2007 and 2006, the Company had extended $867 million and $945 million, respectively, in loan commitments other than the mortgage loan commitments and letters of credit described above. This amount represented the notional amount of the commitment. A contingent liability of $958,000 and $1.1 million has been recorded for the Company’s estimate of probable losses on unfunded commitments outstanding at December 31, 2007 and 2006, respectively.

 

Equity investments – The Company has a number of non-marketable equity investments that have not been consolidated in its financial statements but rather are recorded in accordance with either the cost or equity method of accounting depending on the percentage of ownership. At both December 31, 2007 and 2006, these

 

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investments included $4 million in CRA related investments. Not included in the carrying amount were commitments to fund an additional $1.6 and $1.2 million, respectively, at some future date. The Company also has recorded investments of $4 million, $20 million, and $56,000, respectively, in stock of the Federal Reserve Bank, the FHLB and preferred stock of Federal Agricultural Mortgage Corporation at year-end 2007. At December 31, 2006, these amounts were $4 million, $20 million, and $97,000, respectively. These investments are recorded at amortized historical cost or fair value, as applicable, with income recorded when dividends are declared.

 

Other investments, comprised of various affordable housing tax credit projects (AHTCP) and other CRA related investments, totaled approximately $698,000 and $733,000 at December 31, 2007 and 2006, respectively. Losses are limited to the remaining investment and there are no additional funding commitments on the AHTCPs by the Company. Those investments without guaranteed yields were reported on the equity method, while those with guaranteed yields were reported using the effective yield method. The maximum exposure to loss for all non-marketable equity investments is the sum of the carrying amounts plus additional commitments, if any, and the potential for the recapture of tax credits on AHTCP should it fail to qualify for the entire period required by tax regulations.

 

Other investments – The Company also holds $2 million in a common security investment in AMCORE Capital Trust II (the “Capital Trust”), to which the Company has $52 million in long-term debt outstanding. The Capital Trust, in addition to the $2 million in common securities issued to the Company, has $50 million in Trust Preferred securities outstanding. The $50 million in Trust Preferred securities were issued to non-affiliated investors during 2007 and are redeemable beginning in 2012. In its Consolidated Balance Sheets, the Company reflects its $2 million common security investment on the equity method and reports the entire $52 million as outstanding long-term debt. For regulatory purposes, however, the $50 million in Trust Preferred securities qualifies as Tier 1 capital for the Company.

 

Fiduciary and agency – The Company’s subsidiaries also hold assets in a fiduciary or agency capacity that are not included in the Consolidated Financial Statements because they are not assets of the Company. Total assets administered by the Company were $2.7 billion at December 31, 2007 and 2006.

 

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Contractual Obligations

 

In the ordinary course of its business, the Company enters into certain contractual arrangements. These obligations include issuance of debt to fund operations, property leases and derivative transactions. During 2007, the Company entered into five operating lease agreements. There are no residual value guarantees on these leases and no lease termination penalties or acceleration clauses. A $1.6 million land purchase contract entered into during 2006 was terminated during 2007. Also during 2007, the Company entered into a strategic arrangement with a national mortgage services company to provide private-label loan processing and servicing support. There are no minimum payment requirements, but there are penalties in the event of early termination of the agreement. With the predominant portion of its business being banking, the Company routinely enters into and exits various funding relationships including the issuance and extinguishment of long-term debt. See the discussion of Borrowings above, and Note 10 of the Notes to Consolidated Financial Statements. Other than these transactions, there were no material changes in the Company’s contractual obligations since the end of 2006. Amounts as of December 31, 2007 are listed in the following table:

 

     Payments due by period

Contractual Obligations

   Total    Less
Than 1
Year
   1-3
Years
   3-5
Years
   More
Than 5
Years
     (in thousands)

Time Deposits

   $ 1,582,466    $ 925,116    $ 497,753    $ 149,333    $ 10,264

Long-Term Debt (1)

     454,978      20,295      170,078      99,210      165,395

Capital Lease Obligations (2)

     2,708      225      450      461      1,572

Operating Leases

     105,570      4,361      9,147      7,468      84,774

Service Contracts

     2,650      1,050      1,376      224      —  

Interest Rate Swaps (3)

     33,837      8,173      11,982      7,092      6,590

Planned Pension Obligation Funding

     6,256      188      428      787      4,853
                                  

Total

   $ 2,188,645    $ 959,408    $ 691,214    $ 264,575    $ 273,448
                                  

 

(1) Includes related interest. Interest calculations on debt with call features were calculated through the first call date. Any debt with floating rates was calculated using the rate in effect at December 31, 2007. See Note 10 of Notes to the Consolidated Financial Statements.
(2) Includes related interest. See Note 5 of Notes to the Consolidated Financial Statements.
(3) Swap contract payments relate only to the “pay” side of the transaction. Any contracts with floating rates were calculated using the rate in effect at December 31, 2007.

 

ASSET QUALITY REVIEW AND CREDIT RISK MANAGEMENT

 

AMCORE’s credit risk is centered in its loan portfolio, which totaled $3.9 billion, or 80% of earning assets, including COLI on December 31, 2007. The objective in managing loan portfolio risk is to quantify and manage credit risk on a portfolio basis as well as reduce the risk of a loss resulting from a customer’s failure to perform according to the terms of a transaction. To achieve this objective, AMCORE strives to maintain a loan portfolio that is diverse in terms of loan type, industry concentration and borrower concentration.

 

The Company is also exposed to carrier credit risk with respect to its $140 million investment in COLI. AMCORE has managed this risk by utilizing “separate accounts” in which its credit exposure is to a specific investment portfolio rather than the carrier. The underlying investment portfolios (which are managed by parties other than AMCORE) consist of investment grade securities and the investment guidelines typically have a requirement to sell if the securities are downgraded. Separate accounts constitute the majority of AMCORE’s COLI portfolio. In terms of COLI accounts where AMCORE is directly exposed to carrier risk, this risk has been managed by diversifying its holdings among multiple carriers and by periodic internal credit reviews. All carriers have investment grade ratings from the major rating agencies.

 

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Allowance for Loan Losses

 

The Allowance is a significant estimate that is regularly reviewed by management to determine whether or not the amount is considered adequate to absorb inherent losses that are probable as of the reporting date. If not, an additional Provision is made to increase the Allowance. Conversely, this review could result in a decrease in the Allowance. This evaluation includes specific loss estimates on certain individually reviewed impaired loans and statistical loss estimates for loan groups or pools that are based on historical loss experience. Also included are other loss estimates, which reflect the current credit environment and that are not otherwise captured in the historical loss rates.

 

The determination by management of the appropriate level of the Allowance amounted to $53.1 million at December 31, 2007, compared to $40.9 million at December 31, 2006, an increase of $12.2 million or 30%. Specific loss estimates on individually reviewed impaired loans and loss estimates on loan pools based upon historical loss experience declined $1.6 million and $2.1 million, respectively, in 2007 compared to 2006. Other loss estimates to reflect the current credit environment increased $16.0 million. The increase in the Allowance was taken in light of sustained increases in the non-performing categories of the loan portfolio, increased delinquencies, higher net charge-offs and general weakening of real estate conditions in the Company’s markets.

 

At December 31, 2007, the Allowance as a percent of total loans and of non-accrual loans was 1.35% and 130%, respectively. These compare to the same ratios at December 31, 2006 of 1.04% and 136%. Net charge-offs were $16.9 million in 2007, an increase of $6.9 million from $10.0 million in 2006. This was 0.42% and 0.26% of average loans in 2007 and 2006, respectively. Increases included commercial and industrial loan net charge-offs of $1.7 million, commercial real estate net charge-offs of $4.3 million, residential real estate net charge-offs of $297,000 and consumer/installment net charge-offs of $631,000. Nearly one-fourth of the net charge-offs in 2007 were related to one large relationship.

 

Non-performing Assets

 

Non-performing assets consist of non-accrual loans, loans ninety days past due and still accruing interest, foreclosed real estate and other repossessed assets. Non-performing assets totaled $75.1 million as of December 31, 2007, an increase of $41.2 million or 121% from $33.9 million at December 31, 2006. The increase since December 31, 2006 consisted of a $10.9 million increase in non-accrual loans and an increase of $27.5 million in loans ninety days past due and still accruing interest, both driven by a general weakening of real estate conditions in the Company’s markets. These market conditions are expected to persist into 2008. Foreclosed assets increased by $2.7 million due to an increase in other real estate owned. Total non-performing assets represented 1.45% and 0.64% of total assets at December 31, 2007 and December 31, 2006, respectively.

 

While the Company strives to reflect all known risk factors in its evaluation, the ultimate loss could differ materially from the current estimate. See Critical Accounting Estimates for a discussion of the judgments and assumptions that are most critical in determining the adequacy of the Allowance.

 

In addition to the amount of non-accruing and delinquent loans over ninety days past due, management is aware that other possible credit problems of borrowers may exist. These include loans that are migrating from grades with lower risk of loss probabilities into grades with higher risk of loss probabilities, as performance and potential repayment issues surface. The Company monitors these loans and adjusts its historical loss rates in its Allowance evaluation accordingly. The most severe of these are credits that are classified as substandard assets due to either less than satisfactory performance history, lack of borrower’s sound worth or paying capacity, or inadequate collateral. As of December 31, 2007 and 2006, there were $5.6 million, and $460,000, respectively, in this risk category that were 60 to 89 days delinquent and $12.8 million and $1.9 million, respectively, that were 30 to 59 days past due. In addition, as of December 31, 2006, there were $684,000 of loans that were current, but had loss allocations of $139,000. There were none as of December 31, 2007.

 

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Concentration of Credit Risks

 

As previously discussed, AMCORE strives to maintain a diverse loan portfolio in an effort to minimize the effect of credit risk. Summarized below are the characteristics of classifications that exceed 10% of total loans.

 

Commercial, financial, and agricultural loans were $767 million at December 31, 2007, and comprised 20% of gross loans, of which 0.48% were non-performing. Net charge-offs of commercial loans in 2007 and 2006 were 0.64% and 0.43%, respectively, of the average balance of the category.

 

Commercial real estate and construction loans were $2.4 billion at December 31, 2007, comprising 60% of gross loans, of which 2.51% were classified as non-performing. Net charge-offs of construction and commercial real estate loans during 2007 and 2006 were 0.29% and 0.12%, respectively, of the average balance of the category.

 

The above commercial loan categories included $602 million of loans to nonresidential building operators and $456 million of loans to building contractors, which were 15% and 12% of total loans, respectively. There were no other loan concentrations within these categories that exceeded 10% of total loans.

 

Residential real estate loans, which include home equity and permanent residential financing, totaled $468 million at December 31, 2007, and represented 12% of gross loans, of which 1.46% were non-performing. Net charge-offs of residential real estate during 2007 and 2006 were 0.11% and 0.05%, respectively, of the average balance in this category.

 

Installment and consumer loans were $336 million at December 31, 2007, and comprised 8% of gross loans, of which 0.33% were non-performing. Net charge-offs of consumer loans during 2007 and 2006 were 1.36% and 1.15%, respectively, of the average balance of the category. Consumer loans are comprised primarily of in-market indirect auto loans and direct installment loans. Indirect auto loans totaled $271 million at December 31, 2007. Both direct loans and indirect auto loans are approved and funded through a centralized department utilizing the same credit scoring system to provide a standard methodology for the extension of consumer credit.

 

Contained within the concentrations described above, the Company has $1.6 billion of interest only loans, of which $991 million are included in the construction and commercial real estate loan category, $431 million are included in the commercial, financial, and agricultural loan category, and $150 million are in home equity loans and lines of credit. In general, these loans are considered well secured with a range of maturities of two to ten years. The Company does not have significant concentrations of negative amortization loans, high loan-to-value loans, option adjustable-rate mortgage loans or loans that initially have below market rates that significantly increase after the initial period.

 

LIQUIDITY AND CAPITAL MANAGEMENT

 

Liquidity Management

 

Overview – Liquidity management is the process by which the Company, through its Asset and Liability Committee (ALCO) and capital markets and treasury function, ensures that adequate liquid funds are available to meet its financial commitments on a timely basis, at a reasonable cost and within acceptable risk tolerances.

 

Liquidity is derived primarily from bank-issued deposit growth and retention; principal and interest payments on loans; principal and interest payments, sale, maturity and prepayment of investment securities; net cash provided from operations; and access to other funding sources. Other funding sources include brokered CDs, Fed Funds purchased lines, Federal Reserve Bank discount window advances, FHLB advances, repurchase agreements, the sale or securitization of loans, subordinated debentures, balances maintained at correspondent banks and access to other capital market instruments. Bank-issued deposits, which exclude wholesale deposits, are considered by management to be the primary, most stable and most cost-effective source of funding and liquidity. The Bank also has capacity, over time, to place additional brokered CD’s as a source of mid to long-term funds.

 

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Uses of liquidity include funding credit obligations to borrowers, funding of mortgage originations pending sale, withdrawals by depositors, repayment of debt when due or called, maintaining adequate collateral for public deposits, paying dividends to shareholders, payment of operating expenses, funding capital expenditures and maintaining deposit reserve requirements.

 

During 2007, wholesale funding, which includes borrowings and brokered deposits, increased $88 million. Wholesale funding represented 26% of total assets as of the end of both 2007, compared to 24% as of the end of 2006. The Company remains confident of its ability to meet and manage its short and long-term liquidity needs.

 

Investment securities portfolio – Scheduled maturities of the Company’s investment securities portfolio and the prepayment of mortgage and asset backed securities represent a significant source of liquidity. Approximately $26 million, or 3%, of the securities portfolio will contractually mature in 2008. See Table 4. This does not include mortgage and asset backed securities since their payment streams may differ from contractual maturities because borrowers may have the right to prepay obligations, typically without penalty. For example, scheduled maturities for 2007, excluding mortgage and asset backed securities, were $13 million, whereas actual proceeds from the portfolio, which included scheduled payments and prepayments of mortgage and asset backed securities, were $196 million. This compares to proceeds of $209 million and $213 million in 2006 and 2005, respectively.

 

At December 31, 2007, securities available for sale were $843 million or 16% of total assets compared to $900 million or 17% at December 31, 2006.

 

Loans – Funding of loans is the most significant liquidity need, representing 76% of total assets as of December 31, 2007. Since December 31, 2006, loans decreased $14 million. Loans held for sale, which represents mortgage origination funding awaiting sale, declined $10 million. The scheduled repayments and maturities of loans represent a substantial source of liquidity. Table 3 shows, for selected loan categories, that $828 million in maturities are scheduled for 2008.

 

Bank-issued deposits – Bank-issued deposits are the most cost-effective and reliable source of liquidity for the Company. During 2007, bank-issued deposits declined $144 million. Scheduled maturities of time deposits of $100,000 or more, as reflected in Table 5, are $383 million in 2008, of which $239 million are bank-issued.

 

Branch expansion – The Company’s branch expansion strategy poses a continuing challenge to short and long-term liquidity. The branch expansion has required, and will continue to require, other sources of liquidity to fund the expected loan growth net of expected deposit growth as well as the required investment in facilities.

 

Parent company – In addition to the overall liquidity needs of the Company, the parent company requires adequate liquidity to pay its expenses, repay debt when due, pay stockholder dividends and execute the Repurchase Program. Liquidity is primarily provided to the parent company through the Bank in the form of dividends. The Bank is limited by regulation in the amount of dividends that it can pay, without prior regulatory approval. During 2007 and 2006, the Company took steps to transfer excess liquidity to the parent company from the Bank, with dividend payments of $60 million and $55, respectively. For 2008, current Bank earnings may be paid as dividends without prior regulatory approval. An additional $40 million is available, subject to prior regulatory approval, without causing the Bank to be less than well-capitalized. See Note 19 of the Notes to Consolidated Financial Statements.

 

Other sources of liquidity – As of December 31, 2007, other sources of potentially available liquidity included approximately $250 million of unfunded Fed Funds lines, unused collateral sufficient to support $272 million in Federal Reserve Bank discount window advances, $192 million of unpledged debt investment securities, and $3 million of FHLB advances. The Company also has capacity, over time, to place sufficient amounts of brokered CDs as a source of mid to long-term liquidity. The Bank’s indirect auto portfolio, which at December 31, 2006 was $271 million, is a potential source of liquidity through future loans sales or securitizations. Fed funds lines are uncommitted lines and unpledged investment securities may not result in the same dollar of liquidity due to overcollateralization requirements.

 

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Other uses of liquidity – At December 31, 2007, other potential uses of liquidity totaled $1.1 billion and included $867 million in commitments to extend credit, $18 million in residential mortgage commitments primarily held for sale, and $192 million in letters of credit. At December 31, 2006, these amounts totaled $1.2 billion.

 

The Company entered into a stock redemption agreement (Redemption Agreement) on October 16, 1989, as amended June 30, 1993, pursuant to Section 303 of the Internal Revenue Code to pay death taxes and other related expenses of certain stockholders. Such redemptions may be subject to bank regulatory agency approvals or limited by debt covenant restrictions. During 2006, the Company redeemed 86,000 shares, at a cost of $2.6 million, pursuant to the Redemption Agreement. At this level, regulatory approvals were not required and debt covenant limitations did not apply.

 

Capital Management

 

Total stockholders’ equity at December 31, 2007 was $369 million, a decrease of $31 million from December 31, 2006. The decrease in stockholders’ equity was due to a $52 million increase in treasury shares resulting from the Repurchase Program. This was partially offset by an $11 million increase in retained earnings and an $8 million reduction in accumulated other comprehensive loss.

 

AMCORE paid $17 million of cash dividends during 2007, which represent $0.74 per share, or a dividend payout ratio of 59.6%. This compares to $18 million or $0.74 per share paid in 2006, which represented a payout ratio of 38.2%. The book value per share decreased $0.01 per share to $16.80 at December 31, 2007, down from $16.81 at December 31, 2006.

 

As part of the Repurchase Program, the Company repurchases shares in open market and private transactions in accordance with Exchange Act Rule 10b-18. These repurchases are used in part to replenish the Company’s treasury stock for reissuances related to stock options and other employee benefit plans. Also repurchased are direct repurchases from participants related to the administration of the Amended and Restated AMCORE Stock Option Advantage Plan. During 2007, the Company purchased 2.1 million shares in open-market and private transactions at an average price of $27.93 per share.

 

AMCORE has outstanding $52 million of capital securities through the Capital Trust. Of the $52 million, $50 million qualifies as Tier 1 capital for the Company’s regulatory capital purposes, which is the $52 million reduced by the $2 million of common equity securities owned by the Company. During 2006, the Company issued fixed/floating rate junior subordinated debentures in the amount of $50 million. The debt qualifies as Tier 2 Capital for Bank and Company regulatory capital purposes. The Bank has the capacity to issue, under regulatory guidelines, additional subordinated debt that would qualify as Tier 2 Capital.

 

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As the following table indicates, AMCORE’s total risk-based capital, Tier 1 capital and leverage ratio all significantly exceed the regulatory minimums, as of December 31, 2007. As of the most recent notification from the Company’s regulators, the Bank is considered “well capitalized” under the regulatory framework for prompt corrective action. See Note 20 of the Notes to Consolidated Financial Statements.

 

(Dollars in thousands)    December 31, 2007     December 31, 2006  
     Amount    Ratio     Amount    Ratio  

Total Capital (to Risk Weighted Assets)

   $ 519,487    11.68 %   $ 535,776    11.62 %

Total Capital Minimum

     355,697    8.00 %     368,885    8.00 %
                          

Amount in Excess of Regulatory Minimum

   $ 163,790    3.68 %   $ 166,891    3.62 %
                          

Tier 1 Capital (to Risk Weighted Assets)

   $ 415,371    9.34 %   $ 444,845    9.65 %

Tier 1 Capital Minimum

     177,849    4.00 %     184,443    4.00 %
                          

Amount in Excess of Regulatory Minimum

   $ 237,522    5.34 %   $ 260,402    5.65 %
                          

Tier 1 Capital (to Average Assets)

   $ 415,371    8.00 %   $ 444,845    8.26 %

Tier 1 Capital Minimum

     207,125    4.00 %     215,546    4.00 %
                          

Amount in Excess of Regulatory Minimum

   $ 207,246    4.00 %   $ 229,299    4.26 %
                          

Risk Weighted Assets

   $ 4,446,219      $ 4,611,068   
                  

Average Assets

   $ 5,193,119      $ 5,388,653   
                  

 

ITEM 7A.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

As part of its normal operations, AMCORE is subject to interest-rate risk on the assets it invests in (primarily loans and securities) and the liabilities it funds with (primarily customer deposits, brokered deposits and borrowed funds), as well as its ability to manage such risk. Fluctuations in interest rates may result in changes in the fair market values of AMCORE’s financial instruments, cash flows and net interest income. Like most financial institutions, AMCORE has an exposure to changes in both short-term and long-term interest rates.

 

While AMCORE manages other risks in its normal course of operations, such as credit and liquidity risk, it considers interest-rate risk to be its most significant market risk. Other types of market risk, such as foreign currency exchange risk and commodity price risk, do not arise in the normal course of AMCORE’s business activities and operations. In addition, since AMCORE does not hold a trading portfolio, it is not exposed to significant market risk from trading activities. During 2007, there were no material changes in AMCORE’s primary market risk exposures. Based upon current expectations, no material changes are anticipated in the future in the types of market risks facing AMCORE.

 

Like most financial institutions, AMCORE’s net income can be significantly influenced by a variety of external factors, including: overall economic conditions, policies and actions of regulatory authorities, the amounts of and rates at which assets and liabilities reprice, variances in prepayment of loans and securities other than those that are assumed, early withdrawal of deposits, exercise of call options on borrowings or securities, competition, a general rise or decline in interest rates, changes in the slope of the yield-curve, changes in historical relationships between indices (such as LIBOR and prime) and balance sheet growth or contraction. AMCORE’s asset and liability committee (ALCO) seeks to manage interest rate risk under a variety of rate environments by structuring the Company’s balance sheet and off-balance sheet positions. The risk is monitored and managed within approved policy limits.

 

The Company utilizes simulation analysis to quantify the impact on income before income taxes under various rate scenarios. Specific cash flows, repricing characteristics, and embedded options of the assets and liabilities held by the Company are incorporated into the simulation model. Earnings at risk is calculated by comparing the

 

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income before income taxes of a stable interest rate environment to the income before income taxes of a different interest rate environment in order to determine the percentage change.

 

The following table summarizes the affect on annual income before income taxes based upon an immediate increase or decrease in interest rates of 100 basis points and no change in the slope of the yield curve:

 

Change In Interest Rates    As of
December 31,
2007
  As of
December 31,
2006

+100

   +1.3%   -0.4%

-100

   -5.9%   -7.9%

 

The amounts and assumptions used in the simulation model should not be viewed as indicative of expected actual results. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and management strategies. The above results do not take into account any management action to mitigate potential risk.

 

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TABLE 1

 

ANALYSIS OF NET INTEREST INCOME AND AVERAGE BALANCE SHEET

 

    Years Ended December 31,  
    2007     2006     2005  
    Average
Balance
    Interest   Average
Rate
    Average
Balance
    Interest   Average
Rate
    Average
Balance
    Interest   Average
Rate
 
    (dollars in thousands)  

Assets:

                 

Investment securities (1) (2)

  $ 874,459     $ 39,391   4.50 %   $ 1,120,828     $ 50,926   4.54 %   $ 1,221,287     $ 55,943   4.58 %

Short-term investments

    8,551       494   5.77 %     7,071       380   5.38 %     8,841       304   3.44 %

Loans held for sale

    10,217       606   5.94 %     22,843       1,220   5.34 %     27,613       1,290   4.67 %

Loans:

                 

Commercial

    798,290       64,949   8.14 %     817,882       64,747   7.92 %     773,728       50,998   6.59 %

Commercial real estate

    2,371,388       182,143   7.68 %     2,236,353       170,389   7.62 %     1,949,384       128,871   6.61 %

Residential real estate

    493,466       34,728   7.04 %     489,110       33,420   6.83 %     440,944       27,065   6.14 %

Consumer

    313,884       24,289   7.74 %     314,818       22,286   7.08 %     316,891       20,913   6.60 %
                                                           

Total loans (1) (3)

  $ 3,977,028     $ 306,109   7.70 %   $ 3,858,163     $ 290,842   7.54 %   $ 3,480,947     $ 227,847   6.55 %
                                                           

Total interest-earning assets

  $ 4,870,255     $ 346,600   7.12 %   $ 5,008,905     $ 343,368   6.86 %   $ 4,738,688     $ 285,384   6.02 %

Allowance for loan losses

    (44,917 )         (41,912 )         (42,108 )    

Non-interest-earning assets

    415,160           402,275           421,074      
                                   

Total assets

  $ 5,240,498         $ 5,369,268         $ 5,117,654      
                                   

Liabilities and Stockholders’ Equity:

                 

Interest bearing deposits & savings deposits

  $ 1,813,939     $ 59,984   3.31 %   $ 1,771,301     $ 51,721   2.92 %   $ 1,738,931     $ 34,103   1.96 %

Time deposits

    1,139,694       53,053   4.66 %     1,225,364       50,542   4.12 %     1,134,894       34,417   3.03 %
                                                           

Total bank issued interest-bearing deposits

  $ 2,953,633     $ 113,037   3.83 %   $ 2,996,665     $ 102,263   3.41 %   $ 2,873,825     $ 68,520   2.38 %

Wholesale deposits

    665,935       34,150   5.13 %     740,897       35,746   4.82 %     619,104       23,303   3.76 %

Short-term borrowings

    276,439       13,728   4.97 %     372,743       17,687   4.75 %     514,711       16,869   3.28 %

Long-term borrowings

    396,571       22,517   5.68 %     305,078       18,522   6.07 %     166,837       10,283   6.16 %
                                                           

Total interest-bearing liabilities

  $ 4,292,578     $ 183,432   4.27 %   $ 4,415,383     $ 174,218   3.95 %   $ 4,174,477     $ 118,975   2.85 %

Non-interest bearing deposits

    497,872           487,264           485,296      

Other liabilities

    64,478           66,705           63,764      

Realized Stockholders’ Equity

    394,228           416,246           399,793      

Other Comprehensive Loss

    (8,658 )         (16,330 )         (5,676 )    
                                   

Total Liabilities & Stockholders’ Equity

  $ 5,240,498         $ 5,369,268         $ 5,117,654      
                                   

Net Interest Income (FTE)

    $ 163,168       $ 169,150       $ 166,409  
                             

Net Interest Spread (FTE)

      2.84 %       2.91 %       3.17 %
                             

Interest Rate Margin (FTE)

      3.35 %       3.38 %       3.51 %
                             

 

(1) The interest on tax-exempt securities and tax-exempt loans is calculated on a tax equivalent basis (FTE) assuming a federal tax rate of 35%. FTE adjustments totaled $2.6 million in 2007 , $4.2 million in 2006, and $4.8 million in 2005.
(2) The average balances of the securities are based on amortized historical cost.
(3) The balances of nonaccrual loans are included in average loans outstanding. Interest on loans includes yield related loan fees of $3.2 million, $3.1 million, and $2.6 million for 2007, 2006, and 2005 respectively.

 

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TABLE 1

 

ANALYSIS OF NET INTEREST INCOME AND AVERAGE BALANCE SHEET—(Continued)

 

     Years Ended December 31,  
     2007/2006     2006/2005  
     Increase/(Decrease)
Due to Change in
    Total Net
Increase
(Decrease)
    Increase/(Decrease)
Due to Change in
    Total Net
Increase
(Decrease)
 
        
     Average
Volume
    Average
Rate
      Average
Volume
    Average
Rate
   
     (in thousands)  

Interest Income:

            

Investment securities

   $ (11,102 )   $ (433 )   $ (11,535 )   $ (4,568 )   $ (449 )   $ (5,017 )

Short-term investments

     84       30       114       (70 )     146       76  

Loans held for sale

     (738 )     124       (614 )     (240 )     170       (70 )

Loans:

            

Commercial

     (1,571 )     1,773       202       3,040       10,709       13,749  

Commercial real estate

     10,362       1,392       11,754       20,392       21,126       41,518  

Residential real estate

     300       1,008       1,308       3,118       3,237       6,355  

Consumer

     (66 )     2,069       2,003       (138 )     1,511       1,373  
                                                

Total loans

     9,072       6,195       15,267       26,251       36,744       62,995  
                                                

Total Interest-Earning Assets

   $ (9,657 )   $ 12,889     $ 3,232     $ 16,930     $ 41,054     $ 57,984  
                                                

Interest Expense:

            

Interest bearing deposits

   $ 1,270     $ 6,993     $ 8,263     $ 646     $ 16,972     $ 17,618  

Time deposits

     (3,694 )     6,205       2,511       2,923       13,202       16,125  
                                                

Total bank issued interest-bearing deposits

     (1,487 )     12,261       10,774       3,043       30,700       33,743  

Wholesale deposits

     (3,758 )     2,162       (1,596 )     5,115       7,328       12,443  

Short-term borrowings

     (4,749 )     790       (3,959 )     (5,447 )     6,265       818  

Long-term borrowings

     5,259       (1,264 )     3,995       8,395       (156 )     8,239  
                                                

Total Interest-Bearing Liabilities

   $ (4,946 )   $ 14,160     $ 9,214     $ 7,210     $ 48,033     $ 55,243  
                                                

Net Interest Income (FTE)

   $ (4,711 )   $ (1,271 )   $ (5,982 )   $ 9,720     $ (6,979 )   $ 2,741  
                                                

 

The above analysis shows the changes in interest income (tax equivalent “FTE”) and interest expense attributable to volume and rate variances. The change in interest income (tax equivalent) due to both volume and rate have been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. Because of changes in the mix of the components of interest-earning assets and interest-bearing liabilities, the computations for each of the components do not equal the calculation for interest-earning assets as a total or interest-bearing liabilities as a total.

 

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TABLE 2

 

ANALYSIS OF LOAN PORTFOLIO AND LOSS EXPERIENCE

 

    2007     2006     2005     2004     2003  
    (dollars in thousands)  

LOAN PORTFOLIO AT YEAR END:

         
Commercial, financial and agricultural   $ 767,312     $ 798,168     $ 818,657     $ 764,339     $ 733,167  
Real estate-commercial     1,901,453       1,926,813       1,821,868       1,533,917       1,147,592  
Real estate-residential     468,420       493,500       459,823       412,753       362,254  
Real estate-construction     459,727       420,379       310,006       250,855       194,495  
Installment and consumer     335,772       307,691       311,497       316,838       554,514  
Direct lease financing     —         —         13       98       287  
                                       

Gross loans

  $ 3,932,684     $ 3,946,551     $ 3,721,864     $ 3,278,800     $ 2,992,309  

Allowance for loan losses

    (53,140 )     (40,913 )     (40,756 )     (40,945 )     (42,115 )
                                       
Net Loans   $ 3,879,544     $ 3,905,638     $ 3,681,108     $ 3,237,855     $ 2,950,194  
                                       

SUMMARY OF LOSS EXPERIENCE:

         
Allowance for loan losses, beginning of year   $ 40,913     $ 40,756     $ 40,945     $ 42,115     $ 35,214  
Amounts charged-off:          

Commercial, financial and agricultural

    6,967       4,792       11,064       8,263       9,035  

Real estate-commercial

    7,195       2,965       240       2,902       1,382  

Real estate-residential

    674       664       1,012       614       1,154  

Installment and consumer

    6,318       6,096       5,354       6,527       7,884  

Direct lease financing

    —         7       91       12       124  
                                       

Total Charge-offs

  $ 21,154     $ 14,524     $ 17,761     $ 18,318     $ 19,579  
                                       
Recoveries on amounts previously charged off:          

Commercial, financial and agricultural

    1,825       1,300       969       1,435       1,219  

Real estate-commercial

    267       356       231       176       617  

Real estate-residential

    149       436       192       176       14  

Installment and consumer

    2,053       2,469       1,700       1,907       1,114  

Direct lease financing

    —         —         —         2       6  
                                       

Total Recoveries

  $ 4,294     $ 4,561     $ 3,092     $ 3,696     $ 2,970  
                                       

Net Charge-offs

  $ 16,860     $ 9,963     $ 14,669     $ 14,622     $ 16,609  
Provision charged to expense     29,087       10,120       15,194       15,530       24,917  
Reductions due to sale of loans and other (1)     —         —         714       2,078       1,407  
                                       

Allowance for Loan Losses, end of year

  $ 53,140     $ 40,913     $ 40,756     $ 40,945     $ 42,115  
                                       

RISK ELEMENTS:

         
Non-accrual loans   $ 40,972     $ 30,048     $ 21,680     $ 30,148     $ 31,671  
Past due 90 days or more not included above   $ 29,826     $ 2,315     $ 8,533     $ 1,848     $ 3,304  
Troubled debt restructuring   $ 11     $ 12     $ 13     $ 14     $ —    

RATIOS:

         
Allowance for loan losses to year-end loans     1.35 %     1.04 %     1.10 %     1.25 %     1.41 %
Allowance to non-accrual loans     129.70 %     136.16 %     187.99 %     135.81 %     132.98 %
Net charge-offs to average loans     0.42 %     0.26 %     0.42 %     0.47 %     0.57 %
Recoveries to charge-offs     20.30 %     31.40 %     17.41 %     20.18 %     15.17 %
Non-accrual loans to loans     1.04 %     0.76 %     0.58 %     0.92 %     1.06 %

 

(1) 2005 includes estimated loss on unfunded commitments. See Note 15 of the Notes to Consolidated Financial Statements for further information.

 

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TABLE 2

 

ANALYSIS OF LOAN PORTFOLIO AND LOSS EXPERIENCE—(Continued)

 

The allocation of the allowance for loan and lease losses at December 31, was as follows:

 

    2007     2006     2005     2004     2003  
    Amount   Percent of
Loans in
Category
    Amount   Percent of
Loans in
Category
    Amount   Percent of
Loans in
Category
    Amount   Percent of
Loans in
Category
    Amount   Percent of
Loans in
Category
 
    (dollars in thousands)  

Commercial, financial and agricultural

  $ 37,550   20.1 %   $ 20,730   21.2 %   $ 20,602   22.2 %   $ 18,264   23.5 %   $ 18,234   25.7 %

Commercial RE

    8,702   59.6 %     8,106   58.0 %     8,760   56.0 %     11,969   48.5 %     12,490   41.1 %

Residential RE

    683   12.4 %     973   12.7 %     959   12.7 %     1,217   12.7 %     885   13.8 %

Installment and consumer

    6,205   7.9 %     6,410   8.1 %     6,436   9.1 %     5,796   15.3 %     7,529   19.4 %

Unallocated

    —     *       4,694   *       3,999   *       3,699   *       2,977   *  
                                                           

Total

  $ 53,140   100.0 %   $ 40,913   100.0 %   $ 40,756   100.0 %   $ 40,945   100.0 %   $ 42,115   100.0 %
                                                           

 

* Not applicable

 

TABLE 3

 

MATURITY AND INTEREST SENSITIVITY OF LOANS

 

     December 31, 2007
     Time Remaining to Maturity    Total    Loans Due After
One Year
     Due
Within
One
Year
   One To
Five
Years
   After
Five
Years
      Fixed
Interest
Rate
   Floating
Interest
Rate
     (in thousands)

Commercial, financial and agricultural

   $ 480,048    $ 241,592    $ 45,672    $ 767,312    $ 202,034    $ 85,230

Real estate-construction

     348,153      111,574      —        459,727      66,208      45,366
                                         

Total

   $ 828,201    $ 353,166    $ 45,672    $ 1,227,039    $ 268,242    $ 130,596
                                         

 

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TABLE 4

 

MATURITY OF SECURITIES

 

    December 31, 2007  
    Government
Sponsored
Enterprises (1)
    States and
Political
Subdivisions (2)
    Corporate
Obligations

and Other (3)
    Total  
    Amount   Yield     Amount   Yield     Amount   Yield     Amount   Yield  
    (dollars in thousands)  

Securities Available for Sale (4):

               

One year or less

  $ 19,922   3.80 %   $ 5,859   6.22 %   $ 85   3.26 %   $ 25,866   4.35 %

After one through five years

    —     —         63,938   5.72 %     —     —         63,938   5.72 %

After five through ten years

    —     —         36,000   5.86 %     —     —         36,000   5.86 %

After ten years

    —     —         13,523   6.30 %     24,843   2.84 %     38,366   4.06 %

Mortgage-backed and asset-backed securities (5)

    581,188   4.60 %     —     —         97,438   5.51 %     678,626   4.73 %
                                               

Total Securities Available for Sale

  $ 601,110   4.57 %   $ 119,320   5.85 %   $ 122,366   4.97 %   $ 842,796   4.81 %
                                               

 

(1) Includes U.S. Government agencies.
(2) Yields were calculated on a tax equivalent basis assuming a federal tax rate of 35%.
(3) The above schedule includes fair value of $25 million in equity investments which are included in the “corporate obligations and other” and the due “after ten years” classifications.
(4) Amounts are reported at fair value. Yields were calculated based on amortized cost.
(5) Includes $47 million of general obligations of FHLB, FNMA and FHLMC that are structured to have payment characteristics of a collateralized mortgage obligation security. Mortgage-backed and asset-backed security maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without penalties. Therefore, these securities are not included within the maturity categories above.

 

TABLE 5

 

MATURITY OF TIME DEPOSITS $100,000 OR MORE

 

     As of December 31, 2007
     Time Remaining to Maturity
     Due Within
Three Months
   Three to
Six Months
   Six to
Twelve Months
   After
Twelve Months
   Total
              
     (in thousands)

Certificates of deposit

   $ 132,265    $ 127,160    $ 123,917    $ 486,465    $ 869,807

Other time deposits

     —        —        —        838      838
                                  

Total

   $ 132,265    $ 127,160    $ 123,917    $ 487,303    $ 870,645
                                  

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

AMCORE FINANCIAL, INC. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

     December 31,  
             2007                     2006          
     (in thousands, except share data)  

ASSETS

    

Cash and cash equivalents

   $ 132,156     $ 146,060  

Interest earning deposits in banks and fed funds sold

     12,882       3,476  

Loans held for sale

     3,636       13,818  

Securities available for sale, at fair value

     842,796       899,833  

Gross loans

     3,932,684       3,946,551  

Allowance for loan losses

     (53,140 )     (40,913 )
                      

Net loans

   $ 3,879,544     $ 3,905,638  

Company owned life insurance

     140,022       134,583  

Premises and equipment, net

     94,121       91,561  

Goodwill

     6,148       6,148  

Foreclosed real estate, net

     4,108       1,247  

Other assets

     77,365       90,019  
                

Total Assets

   $ 5,192,778     $ 5,292,383  
                

LIABILITIES

    

Deposits:

    

Non-interest bearing deposits

   $ 508,389     $ 543,070  

Interest bearing deposits

     1,867,633       1,801,335  

Time deposits

     1,029,418       1,204,908  
                

Total bank issued deposits

   $ 3,405,440     $ 3,549,313  

Wholesale deposits

     597,816       796,869  
                

Total deposits

   $ 4,003,256     $ 4,346,182  

Short-term borrowings

     397,088       136,747  

Long-term borrowings

     368,858       342,012  

Other liabilities

     55,009       67,396  
                

Total Liabilities

   $ 4,824,211     $ 4,892,337  
                

STOCKHOLDERS’ EQUITY

    

Preferred stock, $1 par value; authorized 10,000,000 shares; none issued

   $ —       $ —    

Common stock, $0.22 par value; authorized 45,000,000 shares;

    
     December 31,
2007
   December 31,
2006
            

Issued

   30,001,115    29,972,232     

Outstanding

   21,940,303    23,792,320      6,666       6,660  

Treasury stock

   8,060,812    6,179,912      (187,944 )     (136,413 )

Additional paid-in capital

     77,433       76,452  

Retained earnings

     475,728       464,316  

Accumulated other comprehensive loss

     (3,316 )     (10,969 )
                      

Total Stockholders’ Equity

   $ 368,567     $ 400,046  
                      

Total Liabilities and Stockholders’ Equity

   $ 5,192,778     $ 5,292,383  
                      

 

See accompanying notes to consolidated financial statements.

 

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AMCORE FINANCIAL, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF INCOME

 

     Years ended December 31,  
     2007     2006     2005  
     (in thousands, except per share data)  

INTEREST INCOME

      

Interest and fees on loans

   $ 305,580     $ 290,149     $ 227,124  

Interest on securities:

      

Taxable

     33,520       40,929       44,366  

Tax-exempt

     3,816       6,498       7,525  
                        

Total Income on Securities

   $ 37,336     $ 47,427     $ 51,891  
                        

Interest on federal funds sold and other short-term investments

     295       241       261  

Interest and fees on loans held for sale

     606       1,220       1,290  

Interest on deposits in banks

     199       139       43  
                        

Total Interest Income

   $ 344,016     $ 339,176     $ 280,609  
                        

INTEREST EXPENSE

      

Interest on deposits

   $ 147,187     $ 138,009     $ 91,823  

Interest on short-term borrowings

     13,728       17,687       16,869  

Interest on long-term borrowings

     22,517       18,522       10,283  
                        

Total Interest Expense

   $ 183,432     $ 174,218     $ 118,975  
                        

Net Interest Income

     160,584       164,958       161,634  

Provision for loan losses

     29,087       10,120       15,194  
                        

Net Interest Income After Provision for Loan Losses

   $ 131,497     $ 154,838     $ 146,440  
                        

NON-INTEREST INCOME

      

Investment management and trust income

   $ 16,765     $ 16,200     $ 15,095  

Service charges on deposits

     29,618       25,622       23,545  

Mortgage banking income

     1,793       3,917       4,071  

Company owned life insurance income

     5,429       7,891       5,415  

Brokerage commission income

     4,174       3,146       2,819  

Bankcard fee income

     7,862       6,225       4,882  

Gain on sale of loans

     243       576       864  

Other

     11,033       11,745       8,727  
                        

Non-Interest Income, Excluding Net Security (Losses) Gains

   $ 76,917     $ 75,322     $ 65,418  

Net security (losses) gains

     (5,920 )     267       995  
                        

Total Non-Interest Income

   $ 70,997     $ 75,589     $ 66,413  

OPERATING EXPENSES

      

Compensation expense

   $ 75,822     $ 78,651     $ 69,315  

Employee benefits

     19,102       19,239       16,984  

Net occupancy expense

     14,652       11,443       11,367  

Equipment expense

     9,963       9,448       10,450  

Data processing expense

     3,369       2,998       2,360  

Professional fees

     8,397       9,317       4,002  

Communication expense

     5,258       5,088       4,716  

Advertising and business development

     4,166       7,409       6,530  

Other

     24,610       21,772       19,641  
                        

Total Operating Expenses

   $ 165,339     $ 165,365     $ 145,365  
                        

Income from continuing operations before income taxes

   $ 37,155     $ 65,062     $ 67,488  

Income taxes

     8,914       18,035       19,501  
                        

Income from continuing operations

   $ 28,241     $ 47,027     $ 47,987  
                        

Discontinued operations:

      

(Loss) income from discontinued operations

   $ —         (131 )     707  

Income tax (benefit) expense

     —         (379 )     3,753  
                        

Income (loss) from discontinued operations

   $ —       $ 248     $ (3,046 )
                        

Net Income

   $ 28,241     $ 47,275     $ 44,941  
                        

EARNINGS PER COMMON SHARE

                        

Basic:    Incomefrom continuing operations

   $ 1.23     $ 1.92     $ 1.93  

             Income (loss) from discontinued operations

     —         0.01       (0.12 )
                        

             Net Income

   $ 1.23     $ 1.93     $ 1.81  
                        

Diluted:Income from continuing operations

   $ 1.23     $ 1.91     $ 1.91  

             Income (loss) from discontinued operations

     —         0.01       (0.12 )
                        

             Net Income

   $ 1.23     $ 1.92     $ 1.79  
                        

DIVIDENDS PER COMMON SHARE

   $ 0.74     $ 0.74     $ 0.68  

AVERAGE COMMON SHARES OUTSTANDING

      

             Basic

     22,887       24,466       24,814  

             Diluted

     22,897       24,562       25,087  

See accompanying notes to consolidated financial statements.

 

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AMCORE FINANCIAL, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

 

    Common
Stock
  Treasury
Stock
    Additional
Paid-in
Capital
    Retained
Earnings
    Deferred
Compensation
    Accumulated
Other
Comprehensive
Income (Loss)
    Total
Stockholders’
Equity
 
    (in thousands, except share data)  

Balance at December 31, 2004

  $ 6,643   $ (102,832 )   $ 74,102     $ 407,045     $ (273 )   $ 1,893     $ 386,578  
                                                     

Comprehensive Income (Loss):

             

Net Income

    —       —         —         44,941       —         —         44,941  

Net unrealized holding losses on securities available for sale arising during the period

    —       —         —         —         —         (22,771 )     (22,771 )

Less reclassification adjustment for net security gains included in net income

    —       —         —         —         —         (995 )     (995 )

Income tax effect related to items of other comprehensive Income

    —       —         —         —         —         9,049       9,049  
                                                     

Comprehensive Income

    —       —         —         44,941       —         (14,717 )     30,224  

Cash dividends on common stock-$0.68 per share

    —       —         —         (16,873 )     —         —         (16,873 )

Purchase of 256,196 shares for the treasury

    —       (7,702 )     —         —         —         —         (7,702 )

Deferred Compensation and Other

    1     —         703       —         199       —         903  

Reissuance of 211,280 treasury shares for incentive plans

    —       6,294       (1,525 )     —         (220 )     —         4,549  

Issuance of 34,874 common shares for Employee Stock Plan

    8     —         830       —         —         —         838  
                                                     

Balance at December 31, 2005

  $ 6,652   $ (104,240 )   $ 74,110     $ 435,113     $ (294 )   $ (12,824 )   $ 398,517  
                                                     

Comprehensive Income (Loss):

             

Net Income

    —       —         —         47,275       —         —         47,275  

Net unrealized holding gains on securities available for sale arising during the period

    —       —         —         —         —         3,403       3,403  

Less reclassification adjustment for net security gains included in net income

    —       —         —         —         —         (267 )     (267 )

Income tax effect related to items of other comprehensive Income

    —       —         —         —         —         (1,205 )     (1,205 )
                                                     

Comprehensive Income

    —       —         —         47,275       —         1,931       49,206  

Cash dividends on common stock-$0.74 per share

    —       —         —         (18,072 )     —         —         (18,072 )

Purchase of 1,316,124 shares for the treasury

    —       (40,244 )     —         —         —         —         (40,244 )

Deferred Compensation and Other

    —       —         144       —         —         —         144  

Pension obligation adjustment

    —       —         —         —         —         (76 )     (76 )

Stock-based compensation.

    —       —         2,967       —         —         —         2,967  

Reclassification upon adoption of SFAS No. 123R

    —       —         342       —         294       —         636  

Reissuance of 264,451 treasury shares for incentive plans

    —       8,071       (1,939 )     —         —         —         6,132  

Issuance of 33,290 common shares for Employee Stock Plan

    8     —         828       —         —         —         836  
                                                     

Balance at December 31, 2006

  $ 6,660   $ (136,413 )   $ 76,452     $ 464,316     $ —       $ (10,969 )     400,046  
                                                     

Comprehensive Income (Loss):

             

Net Income

    —       —         —         28,241       —         —         28,241  

Net unrealized holding gains on securities available for sale arising during the period

    —       —         —         —         —         6,363       6,363  

Less reclassification adjustment for net security losses included in net income

    —       —         —         —         —         5,920       5,920  

Pension transition obligation amortization

    —       —         —         —         —         42       42  

Income tax effect related to items of other comprehensive income

    —       —         —         —         —         (4,672 )     (4,672 )
                                                     

Comprehensive Income

    —       —         —         28,241       —         7,653       35,894  

Cash dividends on common stock-$0.74 per share

    —       —         —         (16,829 )     —         —         (16,829 )

Purchase of 2,135,617 shares for the treasury

    —       (59,609 )     —         —         —         —         (59,609 )

Deferred Compensation and Other

    —       —         245       —         —         —         245  

Stock-based compensation

    —       —         1,685       —         —         —         1,685  

Reissuance of 254,717 treasury shares for incentive plans

    —       8,078       (1,608 )     —         —         —         6,470  

Issuance of 28,883 common shares for Employee Stock Plan

    6     —         659       —         —         —         665