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Marshall & Ilsley 10-K 2008
Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

x   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2007

OR

¨   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File No. 1-33488

 

MARSHALL & ILSLEY CORPORATION

(Exact name of registrant as specified in its charter)

Wisconsin   20-8995389

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

770 North Water Street  
Milwaukee, Wisconsin   53202
(Address of principal executive offices)   (Zip Code)

 

Registrant’s telephone number, including area code: (414) 765-7801

 

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class:  

Name of Each Exchange

on Which Registered:

Common Stock—$1.00 par value   New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

 

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

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

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

Indicate by check mark 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, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

(Check one): Large accelerated filer  x    Accelerated filer  ¨    Non-accelerated filer  ¨    Smaller reporting company  ¨

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

The aggregate market value of the voting stock held by nonaffiliates of the registrant (as Old M&I, predecessor to new Marshall & Ilsley Corporation—see Explanatory Note on page 2) as of June 30, 2007 was approximately $12,047,035,000. The number of shares of common stock outstanding as of January 31, 2008 was 261,783,265.

DOCUMENTS INCORPORATED BY REFERENCE

Part III incorporates information by reference from the Proxy Statement for the registrant’s Annual Meeting of Shareholders to be held on April 22, 2008.

 

 

 


Table of Contents

MARSHALL & ILSLEY CORPORATION

ANNUAL REPORT ON FORM 10-K

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2007

 

TABLE OF CONTENTS

 

          Page
   PART I   
ITEM 1.    BUSINESS    1
ITEM 1A.    RISK FACTORS    10
ITEM 1B.    UNRESOLVED STAFF COMMENTS    16
ITEM 2.    PROPERTIES    16
ITEM 3.    LEGAL PROCEEDINGS    16
ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS    17
   PART II   

ITEM 5.

   MARKET FOR REGISTRANT’S COMMON STOCK, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES    20
ITEM 6.    SELECTED FINANCIAL DATA    21
ITEM 7.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS    23
ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK    54
ITEM 8.    CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA FOR YEARS ENDED DECEMBER 31, 2007, 2006, AND 2005    56
ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE    122
ITEM 9A.    CONTROLS AND PROCEDURES    122
ITEM 9B.    OTHER INFORMATION    124
   PART III   
ITEM 10.    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT    125
ITEM 11.    EXECUTIVE COMPENSATION    125
ITEM 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS    125
ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS    125
ITEM 14.    PRINCIPAL ACCOUNTANT FEES AND SERVICES    125
   PART IV   
ITEM 15.    EXHIBITS AND FINANCIAL STATEMENT SCHEDULES    126

 

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PART I

 

ITEM 1.   BUSINESS

 

General

 

M&I, a Wisconsin corporation, is a registered bank holding company under the Bank Holding Company Act of 1956 (the “BHCA”) and is certified as a financial holding company under the Gramm-Leach-Bliley Act. As of December 31, 2007, M&I had consolidated total assets of approximately $59.8 billion and consolidated total deposits of approximately $35.2 billion, making M&I the largest bank holding company headquartered in Wisconsin. The executive offices of M&I are located at 770 North Water Street, Milwaukee, Wisconsin 53202 (telephone number (414) 765-7801). M&I’s principal assets are the stock of its bank and nonbank subsidiaries, which, as of February 15, 2008, consisted of five bank and trust subsidiaries and a number of companies engaged in businesses that the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) has determined to be closely-related or incidental to the business of banking. M&I provides its subsidiaries with financial and managerial assistance in such areas as budgeting, tax planning, auditing, compliance assistance, asset and liability management, investment administration and portfolio planning, business development, advertising and human resources management.

 

M&I provides diversified financial services to a wide variety of corporate, institutional, government and individual customers. M&I’s largest affiliates and principal operations are in Wisconsin; however, it has activities in other markets, particularly in certain neighboring Midwestern states, and in Arizona, Nevada and Florida. The Corporation’s principal activities consist of banking and wealth management services. Banking services, lending and accepting deposits from commercial banking and community banking customers are provided through its lead bank, M&I Marshall & Ilsley Bank (“M&I Bank”), Southwest Bank, an M&I Bank (formerly known as Southwest Bank of St. Louis) (“Southwest Bank”), which is headquartered in St. Louis, Missouri, M&I Bank FSB, a federal savings bank subsidiary of M&I located in Las Vegas, and an asset-based lending subsidiary headquartered in Minneapolis, Minnesota. In addition to branches located throughout Wisconsin, banking services are provided in branches located throughout Arizona, the Minneapolis, Minnesota, Kansas City, Missouri and St. Louis, Missouri metropolitan areas, Duluth, Minnesota, Belleville, Illinois, Las Vegas, Nevada, Florida and central Indiana, and through the Internet. Wealth Management, which includes Marshall & Ilsley Trust Company, N.A., M&I Brokerage Services, the private banking divisions of the Corporation’s bank subsidiaries and other subsidiaries related to the wealth management business, provides trust services, brokerage and insurance services, and investment management and advisory services to residents of Wisconsin, Arizona, Minnesota, Missouri, Florida, Nevada and Indiana. Other financial services provided by M&I include personal property lease financing, wholesale lending, investment services to institutional clients and venture capital.

 

In conjunction with the separation transaction involving M&I and its former subsidiary, Metavante Corporation, which is described in the Explanatory Note below, M&I reorganized its business segments. Based on the way M&I organizes its business, M&I has four reportable segments: Commercial Banking, Community Banking, Wealth Management and Treasury. Each of these segments is described in detail below. More information on M&I’s business segments is contained in Note 24 of the Notes to the Consolidated Financial Statements contained in Item 8, Consolidated Financial Statements and Supplementary Data.

 

Commercial Banking

 

M&I’s Commercial Banking segment provides financial expertise in Corporate, Commercial, Correspondent and Commercial Real Estate Banking. Commercial Banking provides a complete line of commercial, corporate and real estate banking products and services, including: traditional commercial loans and lines of credit, letters of credit, asset-based lending, equipment financing, mezzanine financing, global trade services, foreign exchange services, treasury management and other financial services to middle market, large corporate and public sector clients. Commercial Banking also supports the commercial real estate and correspondent banking markets with products and services including secured and unsecured lines of credit, letters of credit, construction loans for commercial and residential development and land acquisition and development loans.

 

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Community Banking

 

M&I’s Community Banking segment provides consumer and business banking products and services to customers primarily within the states in which M&I offers banking services. Community banking services are provided through branches located throughout Wisconsin, Arizona, the Minneapolis, Minnesota, Kansas City, Missouri and St. Louis, Missouri metropolitan areas, and Orlando, Florida metropolitan areas, Duluth, Minnesota, Belleville, Illinois, Las Vegas, Nevada, Florida’s west coast and central Indiana. Consumer products include loan and deposit products such as mortgages, home equity loan and lines, credit cards, student loans, personal lines of credit and term loans, demand deposit accounts, interest bearing transaction accounts and time deposits. Business banking products include secured and unsecured lines and term loans for working capital, inventory and general corporate use, commercial real estate construction loans, agricultural loans, demand deposit accounts, interest bearing transaction accounts and time deposits.

 

Wealth Management

 

The Wealth Management segment, which includes M&I’s Trust, Brokerage and Private Banking businesses, provides integrated asset management, trust and banking services through three business lines: Investment Management, Personal Services and Institutional Services. Investment Management is a multi-dimensional asset management service with a broad range of strategies, styles and product delivery options such as separately managed equity and fixed income strategies, managed asset allocation strategies, alternative investments and The Marshall Funds, M&I’s family of mutual funds. Personal Services includes Cedar Street Advisors, Personal Wealth Management and M&I Financial Advisors. Cedar Street Advisors manages the complex financial affairs of ultra-high net worth individuals and their families. Personal Wealth Management services assemble and implement an all-inclusive financial roadmap for high net worth individuals and families, providing for their private banking (credit and deposits), investment, estate and tax planning needs. M&I Financial Advisors uses a formulized financial planning process based on an individual’s resources, goals, and risk tolerance to develop a personalized financial plan, and then offers a full array of brokerage and insurance solutions to meet that plan. The Institutional Services business includes Retirement Plan Services, Taft-Hartley Services, Not-for-Profit Services, North Star Deferred Exchange and Trust Operations Outsourcing.

 

Treasury

 

Treasury provides management of interest rate risk, capital, liquidity, funding and investments to the Corporation and all of its subsidiary banks.

 

All Others

 

The Other segment includes an Investment Division and a National Consumer Banking Division. The Investment Division provides a variety of products and services designed to address its customers’ risk management and investment needs. These services include foreign exchange services, derivative solutions and investment services, currency conversion and foreign exchange risk management. These services are provided primarily to corporate, business banking and financial institution clients. The National Consumer Banking Division provides wholesale home equity consumer lending, indirect automobile financing, and affinity banking services.

 

Explanatory Note—Separation of Marshall & Ilsley Corporation and Metavante Corporation

 

Prior to November 1, 2007, Marshall & Ilsley Corporation consisted of two reportable business segments: Banking and Data Services (or Metavante). On November 1, 2007, Marshall & Ilsley Corporation separated the Banking and Data Services businesses into two separate publicly-traded companies: “new” Marshall & Ilsley Corporation and Metavante Technologies, Inc. (formerly known as Metavante Corporation and referred to in this report as “Metavante”). This event and the related transactions are referred to in this report as the “Separation.” The company known as Marshall & Ilsley Corporation prior to November 1, 2007 became a wholly-owned subsidiary of new Marshall & Ilsley Corporation (the ultimate parent company of the Banking business) and was converted into a Wisconsin limited liability company named M&I LLC. Where applicable, the company formerly known as Marshall & Ilsley Corporation and now known as M&I LLC is referred to in this report as “Old M&I.” Also on November 1, 2007,

 

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the company that is now the ultimate parent company of the Banking business changed its name to Marshall & Ilsley Corporation. Where it is necessary to distinguish this new entity from Marshall & Ilsley Corporation as a whole, the company that is now the ultimate parent company of the Banking business is referred to in this report as “New M&I.” In all other instances, unless otherwise noted, the terms “M&I” or the “Corporation” refer to Marshall & Ilsley Corporation, the ultimate parent of the Banking business, since November 1, 2007, and to Old M&I prior to November 1, 2007.

 

Additional information regarding the Separation may be found in Note 2 of the Notes to Consolidated Financial Statements contained in Item 8, Consolidated Financial Statements and Supplementary Data.

 

Risk Management

 

Managing risk is an essential component of successfully operating a financial services company. M&I has an enterprise-wide approach to risk governance, measurement, management and reporting risks inherent in its businesses. Risk management practices include key elements such as independent checks and balances, formal authority limits, policies and procedures and portfolio management. M&I’s internal audit department also evaluates risk management activities. These evaluations include performing internal audits and reporting the results to management and the Audit and Risk Management Committees, as appropriate.

 

M&I has established a number of management committees responsible for assessing and evaluating risks associated with the Company’s businesses including the Credit Policy Committee, Asset Liability Committee (ALCO) and the Enterprise Risk Committee. M&I has in place a Risk Management Committee of the Board of Directors for oversight and governance of its risk management function. The Risk Management Committee consists of four non-management directors and has the responsibility of overseeing management’s actions with respect to credit, market, liquidity, fiduciary, operational, compliance, legal and reputation risks as well as M&I’s overall risk profile. M&I’s Chief Risk Officer is responsible for reporting to this committee.

 

Operational Risk Management

 

Operational risk is the risk of loss from human errors, failed or inadequate processes or systems and external events. This risk is inherent in all businesses. Resulting losses could take the form of explicit charges, increased operational costs, harm to M&I’s reputation or lost opportunities.

 

M&I seeks to mitigate operational risk through a system of internal controls to manage this risk at appropriate levels. Primary responsibility for managing internal controls lies with the managers of M&I’s various business lines. M&I monitors and assesses the overall effectiveness of its system of internal controls on an ongoing basis. The Enterprise Risk Committee oversees M&I’s monitoring, management and measurement of operational risk. In addition, M&I has established several other executive management committees to monitor, measure and report on specific operational risks to the Corporation, including, business continuity planning, customer information security and compliance. These committees report to the Risk Management Committee of the Board of Directors on a regular basis.

 

Corporate Governance Matters

 

M&I has adopted a Code of Business Conduct and Ethics that applies to all of M&I’s employees, officers and directors, including M&I’s Chief Executive Officer, Chief Financial Officer and Controller. The Code of Business Conduct and Ethics is filed as an exhibit to this report and is also available on M&I’s website at www.micorp.com. M&I intends to disclose any amendment to or waiver of the Code of Business Conduct and Ethics that applies to M&I’s Chief Executive Officer, Chief Financial Officer or Controller on its website within five business days following the date of the amendment or waiver.

 

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M&I makes available free of charge through its website its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and its insiders’ Section 16 reports and all amendments to these reports as soon as reasonably practicable after these materials are filed with or furnished to the Securities and Exchange Commission. In addition, certain documents relating to corporate governance matters are available on M&I’s website described above. These documents include, among others, the following:

 

   

Charter for the Audit Committee of the Board of Directors;

 

   

Charter for the Compensation and Human Resources Committee of the Board of Directors;

 

   

Charter for the Nominating and Corporate Governance Committee of the Board of Directors;

 

   

Categorical Standards for Lending, Banking and Other Business Relationships Involving M&I’s Directors;

 

   

Corporate Governance Guidelines; and

 

   

Code of Business Conduct and Ethics.

 

Shareholders also may obtain a copy of any of these documents free of charge by calling the M&I Shareholder Information Line at 1 (800) 642-2657. Information contained on any of M&I’s websites is not deemed to be a part of this Annual Report.

 

Acquisitions Announced or Completed in 2007

 

On July 9, 2007, M&I announced the signing of a definitive agreement to acquire First Indiana Corporation (“First Indiana”) based in Indianapolis, Indiana. The acquisition was completed on January 2, 2008. First Indiana, with $2.1 billion in consolidated assets as of December 31, 2007, had 32 offices in central Indiana. The First Indiana branches became branches of M&I Bank on February 2, 2008.

 

On July 1, 2007, M&I completed its acquisition of Excel Bank Corporation (“Excel”). Excel, with $616.0 million in consolidated assets as of June 30, 2007, had four branches in the greater Minneapolis/St. Paul, Minnesota metropolitan area. The Excel branches became branches of M&I Bank on August 1, 2007.

 

M&I completed the acquisition of Chicago, Illinois-based North Star Financial Corporation (“North Star”) on April 20, 2007. North Star and its subsidiaries provided a variety of wealth management services through personal and other trusts and offers a variety of other products and services such as land trusts, 1031 exchanges for both real and personal property, and ESOP services, including consultative services relating to the transfer of small-business stock ownership. North Star’s businesses were integrated with the Corporation’s Wealth Management unit.

 

On April 1, 2007, the Corporation completed its acquisition of United Heritage Bankshares of Florida, Inc. (“United Heritage”). United Heritage Bank, a wholly-owned subsidiary of United Heritage, with $791.3 million in assets as of March 31, 2007, had 13 branches in the metropolitan Orlando area. The United Heritage Bank branches became M&I Bank branches in the second quarter of 2007.

 

More information on M&I’s acquisitions can be found in Note 5 of the Notes to the Consolidated Financial Statements contained in Item 8, Consolidated Financial Statements and Supplementary Data.

 

M&I continues to evaluate opportunities to acquire banking institutions and other financial service providers and frequently conducts due diligence activities in connection with possible transactions. As a result, M&I may engage in discussions, and in some cases, negotiations with prospective targets and may make future acquisitions for cash, equity or debt securities. The issuance of additional shares of M&I common stock would dilute a shareholder’s ownership interest in M&I. In addition, M&I’s acquisitions may involve the payment of a premium over book value, and therefore, some dilution of book value may occur with any future acquisition. Generally, it is M&I’s policy not to comment on such discussions or possible acquisitions until a definitive agreement has been signed. M&I’s strategy for growth includes strengthening its presence in core markets, expanding into attractive markets and broadening its product offerings.

 

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Principal Sources of Revenue

 

The table below shows the amount and percentages of M&I’s total consolidated revenues resulting from interest and fees on loans and leases, interest on investment securities, and Wealth Management revenues, for each of the last three years ($ in thousands):

 

     Interest and Fees on
Loans and Leases
    Interest on Investment
Securities
    Wealth Management
Revenues
     

Years Ended December 31,

   Amount    Percent of
Total
Revenues
    Amount    Percent of
Total
Revenues
    Amount    Percent of
Total
Revenues
    Total
Revenues

2007

   $ 3,243,109    73.7 %   $ 371,074    8.4 %   $ 262,835    6.0 %   $ 4,398,231

2006

     2,856,043    74.5       339,707    8.9       221,554    5.8       3,835,920

2005

     1,959,063    68.4       278,664    9.7       191,720    6.7       2,862,651

 

M&I business segment information is contained in Note 24 of the Notes to the Consolidated Financial Statements contained in Item 8, Consolidated Financial Statements and Supplementary Data.

 

Competition

 

M&I and its subsidiaries face substantial competition from hundreds of competitors in the markets they serve, some of which are larger and have greater resources than M&I. M&I’s bank subsidiaries compete for deposits and other sources of funds and for credit relationships with other banks, savings associations, credit unions, finance companies, mutual funds, life insurance companies (and other long-term lenders) and other financial and non-financial companies located both within and outside M&I’s primary market areas, many of which offer products functionally equivalent to bank products. M&I’s nonbank operations compete with numerous banks, finance companies, leasing companies, mortgage bankers, brokerage firms, financial advisors, trust companies, mutual funds and investment bankers in Wisconsin and throughout the United States.

 

Employees

 

As of December 31, 2007, M&I and its subsidiaries employed in the aggregate 9,670 employees. M&I considers employee relations to be excellent. None of the employees of M&I or its subsidiaries are represented by a collective bargaining group.

 

Supervision and Regulation

 

As registered bank holding companies, M&I and M&I LLC (referred to collectively in this section as “M&I”) are subject to regulation and examination by the Federal Reserve Board under the BHCA. As of February 15, 2008, M&I owned a total of five bank and trust subsidiaries, including two Wisconsin state banks, a Missouri state bank, a federal savings bank, and a national banking association. M&I’s two Wisconsin state bank subsidiaries are subject to regulation and examination by the Wisconsin Department of Financial Institutions, as well as by the Federal Reserve Board. M&I’s Missouri state bank subsidiary is subject to regulation and examination by the Missouri Department of Economic Development, Division of Finance, and the Federal Reserve Board. M&I’s federal savings bank subsidiary is subject to regulation and examination by the Office of Thrift Supervision. M&I’s national bank, through which trust operations are conducted, is subject to regulation and examination by the Office of the Comptroller of the Currency. In addition, all of M&I’s bank subsidiaries are subject to examination by the Federal Deposit Insurance Corporation (“FDIC”).

 

Under Federal Reserve Board policy, M&I is expected to act as a source of financial strength to each of its bank subsidiaries and to commit resources to support each bank subsidiary in circumstances when it might not do so absent such requirements. In addition, there are numerous federal and state laws and regulations which regulate the activities of M&I and its bank subsidiaries, including requirements and limitations relating to capital and reserve requirements,

 

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permissible investments and lines of business, transactions with officers, directors and affiliates, loan limits, consumer protection laws, privacy of financial information, predatory lending, fair lending, mergers and acquisitions, issuances of securities, dividend payments, inter-affiliate liabilities, extensions of credit and branch banking. Information regarding capital requirements for bank holding companies and tables reflecting M&I’s regulatory capital position at December 31, 2007 can be found in Note 16 of the Notes to the Consolidated Financial Statements contained in Item 8, Consolidated Financial Statements and Supplementary Data.

 

The federal regulatory agencies have broad power to take prompt corrective action if a depository institution fails to maintain certain capital levels. In addition, a bank holding company’s controlled insured depository institutions are liable for any loss incurred by the FDIC in connection with the default of, or any FDIC-assisted transaction involving, an affiliated insured bank or savings association. Current federal law provides that adequately capitalized and managed bank holding companies from any state may acquire banks and bank holding companies located in any other state, subject to certain conditions. Banks are permitted to create interstate branching networks in states that have not “opted out” of interstate branching. M&I Bank currently maintains interstate branches in Arizona, Florida, Indiana, Kansas, Minnesota and Missouri and Southwest Bank maintains an interstate branch in Illinois.

 

The laws and regulations to which M&I is subject are constantly under review by Congress, regulatory agencies and state legislatures. In 1999, Congress enacted the Gramm-Leach-Bliley Act (the “Act”). Among other things, the Act repealed certain restrictions on affiliations between banks and securities firms. The Act also amended the BHCA to permit bank holding companies that qualify as “financial holding companies” to engage in a broad list of “financial activities,” and any non-financial activity that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines is “complementary” to a financial activity and poses no substantial risk to the safety and soundness of depository institutions or the financial system. The Act treats various lending, insurance underwriting, insurance company, portfolio investment, financial advisory, securities underwriting, dealing and market-making, and merchant banking activities as financial in nature for this purpose.

 

Under the Act, a bank holding company may become certified as a financial holding company by filing a notice with the Federal Reserve Board, together with a certification that the bank holding company meets certain criteria, including capital, management, and Community Reinvestment Act requirements. New M&I registered as a financial holding company on November 1, 2007, immediately following the Separation.

 

The Federal Reserve Board has authority to prohibit bank holding companies from paying dividends if it deems such payment to be an unsafe or unsound practice. The Federal Reserve Board has indicated generally that it may be an unsafe or unsound practice for bank holding companies to pay dividends unless the company’s net income is sufficient to fund the dividends and the company’s expected rate of earnings retention is consistent with its capital needs, asset quality and overall financial condition. M&I depends, in part, upon dividends received from its subsidiary banks to fund its activities, including the payment of dividends. These subsidiary banks are subject to regulatory limitations on the amount of dividends they may pay.

 

In 2001, Congress enacted the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”). The USA PATRIOT Act is designed to deny terrorists and criminals the ability to obtain access to the United States financial system, and has significant implications for depository institutions, brokers, dealers and other businesses involved in the transfer of money. The USA PATRIOT Act mandates financial services companies to implement additional policies and procedures with respect to, or additional measures designed to address, any or all of the following matters, among others: money laundering, terrorist financing, identifying and reporting suspicious activities and currency transactions, and currency crimes.

 

The earnings and business of M&I and its bank subsidiaries also are affected by the general economic and political conditions in the United States and abroad and by the monetary and fiscal policies of various federal agencies. The Federal Reserve Board impacts the competitive conditions under which M&I operates by determining the cost of funds obtained from money market sources for lending and investing and by exerting influence on interest rates and credit conditions. In addition, legislative and economic factors can be expected to have an ongoing impact on the competitive environment within the financial services industry. The impact of fluctuating economic conditions and federal regulatory policies on the future profitability of M&I and its subsidiaries cannot be predicted with certainty.

 

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Selected Statistical Information

 

Statistical information relating to M&I and its subsidiaries on a consolidated basis is set forth as follows:

 

  (1)   Average Balance Sheets and Analysis of Net Interest Income for each of the last three years is included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

  (2)   Analysis of Changes in Interest Income and Interest Expense for each of the last two years is included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

  (3)   Nonaccrual, Past Due and Restructured Loans and Leases for each of the last five years is included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

  (4)   Summary of Loan and Lease Loss Experience for each of the last five years (including the allocation of the allowance for loans and leases) is included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

  (5)   Return on Average Shareholders’ Equity, Return on Average Assets and other statistical ratios for each of the last five years can be found in Item 6, Selected Financial Data.

 

  (6)   Potential Problem Loans and Leases for the last two years can be found in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The following tables set forth certain statistical information relating to M&I and its subsidiaries on a consolidated basis.

 

Investment Securities

 

The amortized cost of M&I’s consolidated investment securities at December 31 of each year are ($ in thousands):

 

     2007    2006    2005

U.S. Treasury and government agencies

   $ 5,849,041    $ 5,521,975    $ 4,456,610

States and political subdivisions

     1,267,876      1,300,907      1,307,403

Mortgage backed securities

     119,487      116,397      118,693

Other

     597,314      499,948      492,501
                    

Total

   $ 7,833,718    $ 7,439,227    $ 6,375,207
                    

 

The maturities, at amortized cost, and weighted average yields (for tax-exempt obligations on a fully taxable basis assuming a 35% tax rate) of investment securities at December 31, 2007 are ($ in thousands):

 

    Within One Year     After One But Within
Five Years
    After Five But
Within Ten Years
    After Ten Years     Total  
    Amount   Yield     Amount   Yield     Amount   Yield     Amount   Yield     Amount   Yield  

U.S. Treasury and government agencies

  $ 1,480,219   4.86 %   $ 3,201,316   4.85 %   $ 965,586   4.85 %   $ 201,920   4.85 %   $ 5,849,041   4.85 %

States and political subdivisions

    106,078   7.32       264,247   7.45       350,838   6.42       546,713   6.27       1,267,876   6.65  

Mortgage backed securities

    308   8.99       119,179   5.26       —     —         —     —         119,487   5.27  

Other

    60,651   6.02       87,380   4.99       141,167   4.14       308,116   3.81       597,314   4.29  
                                                           

Total

  $ 1,647,256   5.06 %   $ 3,672,122   4.88 %   $ 1,457,591   5.16 %   $ 1,056,749   5.28 %   $ 7,833,718   5.03 %
                                                           

 

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Types of Loans and Leases

 

M&I’s consolidated loans and leases, including loans held for sale, classified by type, at December 31 of each year are ($ in thousands):

 

     2007    2006    2005    2004    2003

Commercial, financial and agricultural

   $ 13,730,710    $ 11,993,761    $ 9,491,368    $ 8,396,060    $ 7,013,073

Industrial development revenue bonds

     62,547      54,429      74,107      85,394      97,601
                                  

Total commercial, financial and agriculture

     13,793,257      12,048,190      9,565,475      8,481,454      7,110,674

Real estate:

              

Construction

     6,691,716      6,088,206      3,641,942      2,265,227      1,766,697

Mortgage:

              

Residential

     11,518,406      10,670,840      9,884,283      8,548,029      6,834,360

Commercial

     12,002,162      10,965,607      8,825,104      8,164,099      7,149,149
                                  

Total mortgage

     23,520,568      21,636,447      18,709,387      16,712,128      13,983,509

Personal

     1,560,573      1,458,628      1,621,825      1,536,809      1,746,567

Lease financing

     730,144      703,580      632,348      537,930      576,322
                                  

Total loans and leases

     46,296,258      41,935,051      34,170,977      29,533,548      25,183,769

Less:

              

Allowance for loan and lease losses

     496,191      420,610      363,769      358,110      349,561
                                  

Net loans and leases

   $ 45,800,067    $ 41,514,441    $ 33,807,208    $ 29,175,438    $ 24,834,208
                                  

 

Loan and Lease Balances and Maturities

 

The analysis of selected loan and lease maturities at December 31, 2007 and the rate structure for the categories indicated are ($ in thousands):

 

    Maturity   Rate Structure of Loans and
Leases Due After One Year
    One Year
Or Less
  Over One
Year
Through
Five Years
  Over Five
Years
  Total   With Pre-
determined
Rate
  With
Floating
Rate
  Total

Commercial, financial and agricultural

  $ 8,314,764   $ 4,858,983   $ 557,657   $ 13,731,404   $ 1,585,312   $ 3,831,328   $ 5,416,640

Industrial development revenue bonds

    5,934     13,869     42,744     62,547     22,658     33,955     56,613

Real estate—construction

    3,556,153     3,051,387     84,176     6,691,716     369,962     2,765,601     3,135,563

Lease financing

    169,909     481,358     78,877     730,144     558,350     1,885     560,235
                                         

Total

  $ 12,046,760   $ 8,405,597   $ 763,454   $ 21,215,811   $ 2,536,282   $ 6,632,769   $ 9,169,051
                                         

 

Notes:

 

(1)   Scheduled repayments are reported in the maturity category in which the payments are due based on the terms of the loan agreements. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less.

 

(2)   The estimated effect arising from the use of interest rate swaps as shown in the rate structure of loans and leases is immaterial.

 

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Deposits

 

The average amount of and the average rate paid on selected deposit categories for each of the years ended December 31 is as follows ($ in thousands):

 

     2007     2006     2005  
     Amount    Rate     Amount    Rate     Amount    Rate  

Noninterest bearing demand deposits

   $ 5,469,774      $ 5,361,014      $ 4,972,890   

Interest bearing demand deposits

     2,110,546    1.49 %     2,122,694    1.47 %     2,030,996    0.89 %

Savings deposits

     11,267,486    3.98       9,205,997    3.71       8,118,331    2.23  

Time deposits

     15,221,091    4.93       15,446,731    4.60       11,584,446    3.14  
                           

Total deposits

   $ 34,068,897      $ 32,136,436      $ 26,706,663   
                           

 

The maturity distribution of time deposits issued in amounts of $100,000 and over outstanding at December 31, 2007 ($ in thousands) is:

 

Three months or less

   $ 3,564,477

Over three and through six months

     1,099,197

Over six and through twelve months

     1,149,242

Over twelve months

     2,262,775
      

Total

   $ 8,075,691
      

 

At December 31, 2007, time deposits issued by foreign offices totaled $2.6 billion. The majority of foreign deposits were in denominations of $100,000 or more.

 

Short-Term Borrowings

 

Information related to M&I’s Federal funds purchased and security repurchase agreements for the last three years is as follows ($ in thousands):

 

    2007     2006     2005  

Amount outstanding at year end

  $ 2,262,355     $ 2,838,618     $ 2,325,863  

Average amount outstanding during the year

    3,144,774       2,558,249       2,043,314  

Maximum outstanding at any month’s end

    4,078,168       3,533,812       2,757,845  

Weighted average interest rate at year end

    3.30 %     5.12 %     4.04 %

Weighted average interest rate during the year

    5.03       4.99       3.21  

 

Information relating to the Corporation’s short-term borrowings is included in Note 14 of the Notes to the Consolidated Financial Statements contained in Item 8, Consolidated Financial Statements and Supplementary Data.

 

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ITEM 1A. RISK FACTORS

 

Forward-Looking Statements

 

This report contains statements that may constitute forward-looking statements within the meaning of the safe-harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, such as statements other than historical facts contained or incorporated by reference in this report. These forward-looking statements include statements with respect to M&I’s financial condition, results of operations, plans, objectives, future performance and business, including statements preceded by, followed by or that include the words “believes,” “expects,” or “anticipates,” references to estimates or similar expressions. Future filings by M&I with the Securities and Exchange Commission, and future statements other than historical facts contained in written material, press releases and oral statements issued by, or on behalf of, M&I may also constitute forward-looking statements.

 

All forward-looking statements contained in this report or which may be contained in future statements made for or on behalf of M&I are based upon information available at the time the statement is made and M&I assumes no obligation to update any forward-looking statements, except as required by federal securities law. Forward-looking statements are subject to significant risks and uncertainties, and M&I’s actual results may differ materially from the results discussed in such forward-looking statements. Factors that might cause actual results to differ from the results discussed in forward-looking statements include, but are not limited to, the risk factors set forth below.

 

Risk Factors

 

M&I’s earnings are significantly affected by general business and economic conditions, including credit risk and interest rate risk.

 

M&I’s business and earnings are sensitive to general business and economic conditions in the United States and, in particular, the states where it has significant operations, including Wisconsin, Arizona, Indiana, Minnesota, Missouri, Kansas, Nevada and Florida. These conditions include short-term and long-term interest rates, inflation, monetary supply, fluctuations in both debt and equity capital markets, the strength of the U.S. and local economies, consumer spending, borrowing and saving habits, all of which are beyond M&I’s control. For example, an economic downturn, increase in unemployment or higher interest rates could decrease the demand for loans and other products and services and/or result in a deterioration in credit quality and/or loan performance and collectibility. Nonpayment of loans, if it occurs, could have an adverse effect on M&I’s financial condition and results of operations and cash flows. Higher interest rates also could increase M&I’s cost to borrow funds and increase the rate M&I pays on deposits.

 

M&I’s real estate loans expose the Corporation to increased credit risks.

 

A substantial portion of M&I’s loan and lease portfolio consists of real estate-related loans, including construction and residential and commercial mortgage loans. As a result, the recent deterioration in the U.S. real estate markets has led to an increase in non-performing loans and charge-offs, and the Corporation has had to increase its allowance for loan and lease losses. Further deterioration in the commercial or residential real estate markets or in the U.S. economy would increase M&I’s exposure to real estate-related credit risk and cause the Corporation to further increase its allowance for loan and lease losses, all of which would have a material adverse effect on M&I’s financial condition and results of operations.

 

Various factors may cause M&I’s allowance for loan and lease losses to increase.

 

M&I’s allowance for loan and lease losses represents management’s estimate of probable losses inherent in the Corporation’s loan and lease portfolio. Management evaluates the allowance each quarter to determine that it is adequate to absorb these inherent losses. This evaluation is supported by a methodology that identifies estimated losses based on assessments of individual problem loans and historical loss patterns of homogeneous loan pools. In addition, environmental factors, including economic conditions and regulatory guidance, unique to each measurement date are also considered. The determination of the appropriate level of the allowance for loan and lease losses is highly subjective and requires management to make significant estimates of current credit risks and future trends, all of which

 

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may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, many of which are outside of the Corporation’s control, may require an increase in the allowance for loan and lease losses. Any increase in the allowance for possible loan and lease losses will result in a decrease in net income and capital, and would have a material adverse effect on the Corporation’s financial condition and results of operations.

 

Terrorism, acts of war, international conflicts and natural disasters could negatively affect M&I’s business and financial condition.

 

Acts or threats of war or terrorism, international conflicts (including conflict in the Middle East), natural disasters, and the actions taken by the U.S. and other governments in response to such events, could disrupt business operations and negatively impact general business and economic conditions in the U.S. If terrorist activity, acts of war, other international hostilities or natural disasters disrupt business operations, trigger technology delays or failures, or damage physical facilities of M&I, its customers or service providers, or cause an overall economic decline, the financial condition and operating results of M&I could be materially adversely affected. The potential for future occurrences of these events has created many economic and political uncertainties that could seriously harm M&I’s business and results of operations in ways that cannot presently be predicted.

 

M&I’s earnings also are significantly affected by the fiscal and monetary policies of the federal government and its agencies, which could affect repayment of loans and thereby materially adversely affect M&I.

 

The policies of the Federal Reserve Board impact M&I significantly. The Federal Reserve Board regulates the supply of money and credit in the United States. Its policies directly and indirectly influence the rate of interest earned on loans and paid on borrowings and interest-bearing deposits and can also affect the value of financial instruments M&I holds. Those policies determine to a significant extent M&I’s cost of funds for lending and investing. Changes in those policies are beyond M&I’s control and are difficult to predict. Federal Reserve Board policies can affect M&I’s borrowers, potentially increasing the risk that they may fail to repay their loans. For example, a tightening of the money supply by the Federal Reserve Board could reduce the demand for a borrower’s products and services. This could adversely affect the borrower’s earnings and ability to repay its loan, which could materially adversely affect M&I.

 

The banking and financial services industry is highly competitive, which could adversely affect M&I’s financial condition and results of operations.

 

M&I operates in a highly competitive environment in the products and services M&I offers and the markets in which M&I serves. The competition among financial services providers to attract and retain customers is intense. Customer loyalty can be easily influenced by a competitor’s new products, especially offerings that provide cost savings to the customer. Some of M&I’s competitors may be better able to provide a wider range of products and services over a greater geographic area.

 

M&I believes the banking and financial services industry will become even more competitive as a result of legislative, regulatory and technological changes and the continued consolidation of the industry. Technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic funds transfer and automatic payment systems. Also, investment banks and insurance companies are competing in more banking businesses such as syndicated lending and consumer banking. Many of M&I’s competitors are subject to fewer regulatory constraints and have lower cost structures. M&I expects the consolidation of the banking and financial services industry to result in larger, better-capitalized companies offering a wide array of financial services and products.

 

Federal and state agency regulation could increase M&I’s cost structures or have other negative effects on M&I.

 

The Corporation and M&I LLC, their subsidiary banks and many of their non-bank subsidiaries are heavily regulated at the federal and state levels. This regulation is designed primarily to protect consumers, depositors and the banking system as a whole, not shareholders. Congress and state legislatures and federal and state regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or

 

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regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect M&I in substantial and unpredictable ways including limiting the types of financial services and products M&I may offer, increasing the ability of non-banks to offer competing financial services and products and/or increasing M&I’s cost structures. Also, M&I’s failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies and damage to its reputation.

 

M&I is subject to examinations and challenges by tax authorities, which, if not resolved in M&I’s favor, could adversely affect M&I’s financial condition and results of operations and cash flows.

 

In the normal course of business, M&I and its affiliates are routinely subject to examinations and challenges from federal and state tax authorities regarding the amount of taxes due in connection with investments it has made and the businesses in which it is engaged. Recently, federal and state taxing authorities have become increasingly aggressive in challenging tax positions taken by financial institutions. These tax positions may relate to tax compliance, sales and use, franchise, gross receipts, payroll, property and income tax issues, including tax base, apportionment and tax credit planning. The challenges made by tax authorities may result in adjustments to the timing or amount of taxable income or deductions or the allocation of income among tax jurisdictions. If any such challenges are made and are not resolved in M&I’s favor, they could have an adverse effect on M&I’s financial condition and results of operations and cash flows.

 

Consumers may decide not to use banks to complete their financial transactions, which could result in a loss of income to M&I.

 

Technology and other changes are allowing parties to complete financial transactions that historically have involved banks at one or both ends of the transaction. For example, consumers can now pay bills and transfer funds directly without banks. The process of eliminating banks as intermediaries, known as disintermediation, could result in the loss of fee income, as well as the loss of customer deposits and income generated from those deposits.

 

Maintaining or increasing M&I’s market share depends on market acceptance and regulatory approval of new products and services and other factors, and M&I’s failure to achieve such acceptance and approval could harm its market share.

 

M&I’s success depends, in part, on its ability to adapt its products and services to evolving industry standards and to control expenses. There is increasing pressure on financial services companies to provide products and services at lower prices. This can reduce M&I’s net interest margin and revenues from its fee-based products and services. In addition, M&I’s success depends in part on its ability to generate significant levels of new business in its existing markets and in identifying and penetrating new markets. Growth rates for card-based payment transactions and other product markets may not continue at recent levels. Further, the widespread adoption of new technologies, including Internet-based services, could require M&I to make substantial expenditures to modify or adapt its existing products and services or render M&I’s existing products obsolete. M&I may not successfully introduce new products and services, achieve market acceptance of its products and services, develop and maintain loyal customers and/or break into targeted markets.

 

The Corporation and M&I LLC rely on dividends from their subsidiaries for most of their revenue, and the banking subsidiaries hold a significant portion of their assets indirectly.

 

The Corporation and M&I LLC are separate and distinct legal entities from their subsidiaries. They receive substantially all of their revenue from dividends from their subsidiaries. These dividends are the principal source of funds to pay dividends on the Corporation’s common stock and interest on the Corporation’s and M&I LLC’s debt. The payment of dividends by a subsidiary is subject to federal law restrictions and to the laws of the subsidiary’s state of incorporation. Furthermore, a parent company’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors. In addition, M&I’s bank and savings association subsidiaries hold a significant portion of their mortgage loan and investment portfolios indirectly through their ownership interests in direct and indirect subsidiaries.

 

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M&I depends on the accuracy and completeness of information about customers and counterparties, and inaccurate or incomplete information could negatively impact M&I’s financial condition and results of operations.

 

In deciding whether to extend credit or enter into other transactions with customers and counterparties, M&I may rely on information provided to it by customers and counterparties, including financial statements and other financial information. M&I may also rely on representations of customers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit to a business, M&I may assume that the customer’s audited financial statements conform with generally accepted accounting principles and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. M&I may also rely on the audit report covering those financial statements. M&I’s financial condition and results of operations could be negatively impacted to the extent it relies on financial statements that do not comply with GAAP or that are materially misleading.

 

An interruption or breach in security of M&I’s or M&I’s third party service providers’ communications and information technologies could have a material adverse effect on M&I’s business.

 

M&I relies heavily on communications and information technology to conduct its business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in M&I’s customer relationship management, general ledger, deposit, loan and other systems. Despite M&I’s policies and procedures designed to prevent or limit the effect of such a failure, interruption or security breach of its information systems, there can be no assurance that any such events will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of M&I’s information systems could damage the Corporation’s reputation, result in a loss of customers or customer business, subject the Corporation to additional regulatory scrutiny, or expose the Corporation to civil litigation and possible financial liability, any of which could have a material adverse effect on the Corporation’s financial condition and results of operations.

 

In addition, M&I relies on third-party service providers for a substantial portion of its communications, information, operating and financial control systems technology. If any of these third-party service providers experiences financial, operational or technological difficulties, or if there is any other disruption in M&I’s relationships with them, M&I may be required to locate alternative sources of these services. There can be no assurance that M&I could negotiate terms as favorable to the Corporation or obtain services with similar functionality as it currently has without the expenditure of substantial resources, if at all. Any of these circumstances could have a material adverse effect M&I’s business.

 

M&I’s accounting policies and methods are the basis of how M&I reports its financial condition and results of operations, and they may require management to make estimates about matters that are inherently uncertain.

 

M&I’s accounting policies and methods are fundamental to how M&I records and reports its financial condition and results of operations. M&I’s management must exercise judgment in selecting and applying many of these accounting policies and methods in order to ensure that they comply with generally accepted accounting principles and reflect management’s judgment as to the most appropriate manner in which to record and report M&I’s financial condition and results of operations. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which might be reasonable under the circumstances yet might result in M&I’s reporting materially different amounts than would have been reported under a different alternative.

 

M&I has identified three accounting policies as being “critical” to the presentation of its financial condition and results of operations because they require management to make particularly subjective and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These critical accounting policies relate to: (1) the allowance for loan and lease losses; (2) financial asset sales and securitizations; and (3) income taxes. Because of the inherent uncertainty of estimates about these matters, no assurance can be given that the application of alternative policies or methods might not result in M&I’s reporting materially different amounts.

 

More information on M&I’s critical accounting policies is contained in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

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Changes in accounting standards could adversely affect M&I’s reported financial results.

 

The bodies that set accounting standards for public companies, including the Financial Accounting Standards Board (“FASB”), the Securities and Exchange Commission and others, periodically change or revise existing interpretations of the accounting and reporting standards that govern the way that M&I reports its financial condition and results of operations. These changes can be difficult to predict and can materially impact M&I’s reported financial results. In some cases, M&I could be required to apply a new or revised accounting standard, or a new or revised interpretation of an accounting standard, retroactively, which could have a negative impact on reported results or result in the restatement of M&I’s financial statements for prior periods.

 

M&I has an active acquisition program, which involves risks related to integration of acquired companies or businesses and the potential for the dilution of the value of M&I stock.

 

M&I regularly explores opportunities to acquire banking institutions and other financial services providers. M&I cannot predict the number, size or timing of future acquisitions. M&I typically does not publicly comment on a possible acquisition or business combination until it has signed a definitive agreement for the transaction. Once M&I has signed a definitive agreement, transactions of this type are generally subject to regulatory approvals and other customary conditions. There can be no assurance M&I will receive such regulatory approvals without unexpected delays or conditions or that such conditions will be timely met to M&I’s satisfaction, or at all.

 

Difficulty in integrating an acquired company or business may cause M&I not to realize expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits from the acquisition. Specifically, the integration process could result in higher than expected deposit attrition (run-off), loss of customers and key employees, the disruption of M&I’s business or the business of the acquired company, or otherwise adversely affect M&I’s ability to maintain existing relationships with clients, employees and suppliers or to enter into new business relationships. M&I may not be able to successfully leverage the combined product offerings to the combined customer base. These factors could contribute to M&I not achieving the anticipated benefits of the acquisition within the desired time frames, if at all.

 

Future acquisitions could require M&I to issue stock, to use substantial cash or liquid assets or to incur debt. In such cases, the value of M&I stock could be diluted and M&I could become more susceptible to economic downturns and competitive pressures.

 

M&I is dependent on senior management, and the loss of the services of any of M&I’s senior executive officers could cause M&I’s business to suffer.

 

M&I’s continued success depends to a significant extent upon the continued services of its senior management. The loss of services of any of M&I’s senior executive officers could cause M&I’s business to suffer. In addition, M&I’s success depends in part upon senior management’s ability to implement M&I’s business strategy.

 

M&I’s stock price can be volatile.

 

M&I’s stock price can fluctuate widely in response to a variety of factors including:

 

   

actual or anticipated variations in M&I’s quarterly results;

 

   

new technology or services offered by M&I’s competitors;

 

   

unanticipated losses or gains due to unexpected events, including losses or gains on securities held for investment purposes;

 

   

significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving M&I or its competitors;

 

   

changes in accounting policies or practices;

 

   

failure to integrate M&I’s acquisitions or realize anticipated benefits from M&I’s acquisitions;

 

   

changes in government regulations; or

 

   

credit quality ratings.

 

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General market fluctuations, industry factors and general economic and political conditions, such as economic slowdowns or recessions, interest rate changes, credit loss trends or currency fluctuations, also could cause M&I’s stock price to decrease regardless of its operating results.

 

M&I may be a defendant in a variety of litigation and other actions, which may have a material adverse effect on its business, operating results and financial condition.

 

M&I and its subsidiaries may be involved from time to time in a variety of litigation arising out of M&I’s business. M&I’s insurance may not cover all claims that may be asserted against it, and any claims asserted against M&I, regardless of merit or eventual outcome, may harm M&I’s reputation. Should the ultimate judgments or settlements in any litigation exceed M&I’s insurance coverage, they could have a material adverse effect on M&I’s business, operating results and financial condition and cash flows. In addition, M&I may not be able to obtain appropriate types or levels of insurance in the future, nor may M&I be able to obtain adequate replacement policies with acceptable terms, if at all.

 

M&I may not realize the anticipated benefits from the Separation.

 

The long-term success of the Separation will depend, in part, on the ability of M&I to realize the anticipated benefits of the Separation. These anticipated benefits include the availability of increased capital for M&I to continue its internal growth and acquisition strategies, M&I’s ability to use its capital stock as a form of currency in respect of certain acquisitions and equity-based compensation arrangements and the better alignment of employee incentive awards. There can be no assurance that these benefits will be realized.

 

The Separation may present significant challenges.

 

There is a significant degree of difficulty and management distraction inherent in the process of separating M&I and Metavante. Even though the transactions effecting the Separation are complete, these difficulties may continue for the foreseeable future. These difficulties may include any or all of the following:

 

   

difficulty preserving customer, distribution, supplier and other important relationships;

 

   

the potential difficulty in retaining key officers and personnel; and

 

   

difficulty separating corporate infrastructure, including systems, insurance, accounting, legal, finance, tax and human resources, for each of two new public companies.

 

As a separate entity, M&I no longer enjoys all of the benefits of scale that it achieved with the combined banking and Metavante businesses, which could adversely affect M&I’s results of operations.

 

Prior to the Separation, Old M&I benefited from the scope and scale of the banking and Metavante businesses in certain areas, including, among other things, risk management, employee benefits, regulatory compliance, administrative services, legal support and human resources. M&I’s loss of these benefits as a consequence of the Separation could have an adverse effect on M&I’s business, results of operations and financial conditions following completion of the Separation. In addition, it is possible that some costs will be greater at the separate companies than they were for the combined company due to the loss of volume discounts and the position of being a large customer to service providers and vendors.

 

If M&I’s share distribution and transactions related to the Separation do not qualify as tax-free distributions or reorganizations under the Internal Revenue Code, then M&I and M&I’s shareholders may be responsible for payment of significant U.S. federal income taxes.

 

In transactions related to the Separation, Old M&I distributed shares of its common stock to effect the Separation. If the share distribution does not qualify as a tax-free distribution under Section 355 of the Internal Revenue Code, Metavante would recognize a taxable gain that would result in significant U.S. federal income tax liabilities to Metavante. Metavante would be primarily liable for these taxes and M&I would be secondarily liable. Under the terms of a tax allocation agreement related to the Separation, M&I will generally be required to indemnify Metavante against any such taxes unless such taxes would not have been imposed but for an act of Metavante or its affiliates, subject to specified exceptions.

 

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Even if M&I’s share distribution otherwise qualifies as a tax-free distribution under Section 355 of the Internal Revenue Code, the distribution would result in significant U.S. federal income tax liabilities to Metavante if there is an acquisition of M&I’s common stock or Metavante’s stock as part of a plan or series of related transactions that includes M&I’s share distribution and that results in an acquisition of 50% or more of M&I’s outstanding common stock or Metavante stock. In this situation, M&I may be required to indemnify Metavante under the terms of a tax allocation agreement related to the Separation unless such taxes would not have been imposed but for specified acts of Metavante or its affiliates. In addition, mutual indemnity obligations in the tax allocation agreement could discourage or prevent a third party from making a proposal to acquire M&I.

 

As a result of the Separation, any financing M&I obtains in the future could involve higher costs.

 

As a result of the completion of the transactions relating to the Separation, any financing that M&I obtains will be with the support of a reduced pool of diversified assets, and therefore M&I may not be able to secure adequate debt or equity financing on desirable terms. The cost to M&I of financing without Metavante may be materially higher than the cost of financing prior to the Separation. If in the future M&I has a credit rating lower than it currently has, it will be more expensive for it to obtain debt financing than it was prior to the Separation.

 

M&I will be restricted in its ability to issue equity for at least two years following completion of the Separation, which could limit its ability to make acquisitions or to raise capital required to service its debt and operate its business.

 

The amount of equity that M&I can issue to make acquisitions (excluding acquisitions with respect to which M&I can prove the absence of “substantial negotiations” during applicable safe harbor periods) or raise additional capital will be limited for at least two years following completion of the Separation, except in limited circumstances. These limitations may restrict the ability of M&I to carry out its business objectives and to take advantage of opportunities such as acquisitions that could supplement or grow M&I’s business.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

Not applicable.

 

ITEM 2.   PROPERTIES

 

M&I and M&I Bank occupy offices on all or portions of 15 floors of a 21-story building located at 770 North Water Street, Milwaukee, Wisconsin. M&I Bank owns the building and its adjacent 10-story parking lot and leases the remaining floors to a professional tenant. In addition, various subsidiaries of M&I lease commercial office space in downtown Milwaukee office buildings near the 770 North Water Street facility. M&I Bank also owns or leases various branch offices throughout Wisconsin, as well as 137 branch offices among the Phoenix and Tucson, Arizona metropolitan areas, Kansas City and nearby communities, Florida’s west coast and Orlando, Florida, Minneapolis/St. Paul and Duluth, Minnesota, and central Indiana. Southwest Bank owns or leases 17 offices in the St. Louis metropolitan area. M&I Bank of Mayville, a special limited purpose subsidiary of M&I located in Mayville, Wisconsin, and M&I Bank FSB, a federal savings bank subsidiary of M&I located in Las Vegas, Nevada with one office in Milwaukee, Wisconsin, occupy modern facilities which are leased.

 

ITEM 3.   LEGAL PROCEEDINGS

 

M&I is not currently involved in any material pending legal proceedings, other than litigation of a routine nature and various legal matters which are being defended and handled in the ordinary course of business.

 

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

 

On October 25, 2007, Old M&I held a special meeting of its shareholders to vote on the proposals set forth below relating to the Separation. The number of votes for, against and abstaining from each such proposal at the special meeting are set forth below opposite each proposal:

 

Proposal

   For    Against    Abstain

1. Approve and adopt the Investment Agreement (the “Investment Agreement”), dated as of April 3, 2007, among M&I, Metavante Corporation, Metavante Holding Company (“New Metavante”), Montana Merger Sub Inc. (“Merger Sub”) and WPM, L.P. (“Investor”), and the transactions contemplated by the Investment Agreement, including the merger of Merger Sub with and into M&I with M&I continuing as the surviving corporation (the “Holding Company Merger”) and the issuance of shares of New Metavante Class A common stock to Investor (the “New Metavante Share Issuance”).

   200,652,022    1,709,341    2,343,339

2. Approve any adjournments of the special meeting for the purpose of soliciting additional proxies if there are not sufficient votes at the special meeting to approve and adopt the Investment Agreement and the transactions contemplated by the Investment Agreement, including the Holding Company Merger and the New Metavante Share Issuance, and any adjournments of the special meeting for any other purpose.

   175,664,966    18,024,597    2,643,844

 

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Table of Contents

Executive Officers of the Registrant

(Age as of March 1, 2008)

 

Name of Officer

  

Office

Walt A. Buckhanan

Age 46

   Vice President and Director of Corporate Diversity of Marshall & Ilsley Corporation since December 2007; Vice President and Diversity and Inclusion Manager from 2004 to 2007, Vice President and Strategic Sales Manager from February 2003 to 2004, and Vice President from 1993 to August 2001 of M&I Marshall & Ilsley Bank; Executive Vice President of North Milwaukee State Bank from August 2001 to February 2002.

Patricia M. Cadorin

Age 54

   Vice President since June 2001, and Director of Corporate Communications since July 2002, Marshall & Ilsley Corporation; Senior Vice President of M&I Marshall & Ilsley Bank since June 2005.

Ryan R. Deneen

Age 43

   Senior Vice President, Director of Corporate Tax of Marshall & Ilsley Corporation since December 2003; Director and President of M&I Business Credit Holdings, Inc., Manager of M&I MEDC Fund, LLC, Director of Milease, LLC, President and Secretary of M&I Marshall & Ilsley Holdings II, Inc., and Vice President and Assistant Secretary of M&I LLC; Partner with KPMG LLP, a public accounting firm, from 1997 to November 2003.

Thomas R. Ellis

Age 50

   Senior Vice President of Marshall & Ilsley Corporation since February 2005; Executive Vice President since February 2005, Senior Vice President from 1998 to February 2005 of M&I Marshall & Ilsley Bank; Director of Marshall & Ilsley Trust Company National Association, M&I Equipment Finance Company, M&I Business Credit LLC and M&I Capital Markets Group II, L.L.C.

Randall J. Erickson

Age 48

   Senior Vice President, General Counsel since June 2002, Chief Administrative Officer since April 2007, and Corporate Secretary from June 2002 to April 2007 of Marshall & Ilsley Corporation; General Counsel since June 2002, and Corporate Secretary from June 2002 to April 2007 of M&I Marshall & Ilsley Bank; Director, Vice President and Secretary of M&I LLC, M&I Capital Markets Group, LLC and M&I Ventures, LLC; Director of M&I Bank FSB, M&I Community Development Corporation, M&I Investment Partners Management, LLC, and Milease, LLC; Director and Secretary of M&I Capital Markets Group II, L.L.C.; Director and Vice President of SWB Holdings, Inc.; Administrative Trustee of MVBI Capital Trust; Successor Administrator of Trustcorp Statutory Trust I, EBC Statutory Trust I, EBC Statutory Trust II and First Indiana Capital Statutory Trust II; and Shareholder at Godfrey & Kahn, S.C., a Milwaukee-based law firm, from September 1990 to June 2002.

Mark F. Furlong

Age 50

   Chief Executive Officer since April 2007, President since April 2005, Executive Vice President from January 2002 to April 2005, Senior Vice President from April 2001 to January 2002, and Chief Financial Officer from April 2006 to June 2006 and April 2001 to October 2004 of Marshall & Ilsley Corporation; Director and President since July 2004, and Chief Executive Officer since April 2007 of M&I Marshall & Ilsley Bank; Director, Vice President and Treasurer of M&I Capital Markets Group, L.L.C. and M&I Ventures L.L.C.; Director of Marshall & Ilsley Trust Company National Association, M&I Bank Mayville, M&I Equipment Finance Company, and Milease, LLC; Senior Vice President of Southwest Bank, an M&I Bank; a Director since April 2006.

Mark R. Hogan

Age 53

   Senior Vice President and Chief Credit Officer since October 2001, Marshall & Ilsley Corporation; Executive Vice President since February 2005, Chief Credit Officer since November 1995 and Senior Vice President from 1995 to February 2005, M&I Marshall & Ilsley Bank; Director, M&I Equipment Finance Company, M&I Business Credit LLC and M&I Capital Markets Group II, L.L.C.; Director and Vice President of SWB Holdings, Inc.

Patricia R. Justiliano

Age 57

   Senior Vice President since 1994 and Corporate Controller since April 1989, Vice President from 1986 to 1994 of Marshall & Ilsley Corporation; Senior Vice President since April 2006, Vice President from January 1999 to April 2006, Controller since September 1998 of M&I Marshall & Ilsley Bank; Director, President and Treasurer of M&I Marshall & Ilsley Holdings, Inc., M&I Marshall & Ilsley Investment II Corporation, M&I Zion Investment II Corporation, M&I Zion Holdings Inc. and SWB of St. Louis Holdings, Inc.; Director and President of M&I Marshall & Ilsley Regional Holdings, Inc.; Director, Vice President and Treasurer of M&I Insurance Company of Arizona; Director and Treasurer of M&I Mortgage Reinsurance Corporation; Director of M&I Bank FSB, M&I Bank of Mayville, M&I Marshall and Ilsley Investment Corporation, M&I Servicing Corp., M&I Zion Investment Corporation, M&I Custody of Nevada, Inc., SWB Investment Corporation and Louisville Realty Corporation; Vice President and Treasurer of M&I LLC; Manger of SWB of St. Louis Holdings I, LLC and SWB of St. Louis Holdings II, LLC; Senior Vice President of Southwest Bank, an M&I Bank; and Trustee of SWB Investment II Corporation.

 

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Table of Contents

Name of Officer

  

Office

Brent J. Kelly

Age 46

   Senior Vice President and Director of Marketing since January 2006, Marshall & Ilsley Corporation; Senior Vice President, Sales & Marketing, of 1800Flowers.com from June 2002 to December 2005; Senior Vice President, Marketing Communications of Bank One Corporation from May 1998 to May 2002.

Beth D. Knickerbocker

Age 41

   Senior Vice President, Chief Risk Officer since January 2005, Vice President, Senior Compliance Counsel from May 2004 to January 2005 of Marshall & Ilsley Corporation; Attorney at Sutherland Asbill & Brennan LLP, a Washington, D.C. law firm, from December 2000 to May 2004.

Kenneth C. Krei

Age 58

   Senior Vice President of Marshall & Ilsley Corporation since July 2003; Chairman of the Board since January 2005, President and Chief Executive Officer of Marshall & Ilsley Trust Company National Association since July 2003; Chairman of the Board since January 2005 and Chief Executive Officer of M&I Investment Management Corp. since July 2003; Director and President of M&I Investment Partners Management, LLC; Chairman and Director of M&I Brokerage Services, Inc., M&I Insurance Services, Inc. and Marshall Funds; Director and Vice President of M&I Realty Advisors, Inc.; Executive Vice President, Investment Advisors at Fifth Third Bancorp from 2001 to 2003.

Thomas J. O’Neill

Age 47

   Senior Vice President since April 1997, Marshall & Ilsley Corporation; Executive Vice President since 2000, Senior Vice President from 1997 to 2000, Vice President from 1991 to 1997, M&I Marshall & Ilsley Bank; Director and President of M&I Bank FSB, M&I Dealer Finance, Inc., M&I Insurance Company of Arizona, Inc. and M&I Mortgage Reinsurance Corporation; Director and Vice President of M&I Community Development Corporation and M&I Realty Advisors, Inc.; Director of M&I Bank of Mayville, M&I Brokerage Services, Inc., Marshall & Ilsley Trust Company National Association, M&I Insurance Services, Inc., Regional Holding Company, Inc. and Louisville Realty Corporation; Manager of M&I MEDC Fund, LLC; and Senior Vice President of Southwest Bank, an M&I Bank.

Paul J. Renard

Age 47

   Senior Vice President, Director of Human Resources since 2000, Vice President and manager since 1994, Marshall & Ilsley Corporation; Senior Vice President of M&I Marshall & Ilsley Bank; and Vice President and Assistant Secretary of M&I LLC.

John L. Roberts

Age 55

   Senior Vice President of Marshall & Ilsley Corporation since 1994; Senior Vice President since 1994, Vice President from 1986 to 1994 and Controller from 1986 to 1995, M&I Marshall & Ilsley Bank; Director of M&I Bank FSB; President and Director of M&I Bank of Mayville.

Thomas A. Root

Age 51

   Senior Vice President since 1998, Audit Director since May 1996, Vice President from 1991 to 1998, Marshall & Ilsley Corporation; Senior Vice President since April 2006, Vice President from 1993 to April 2006 and Audit Director since 1999, M&I Marshall & Ilsley Bank.

Gregory A. Smith

Age 44

   Senior Vice President and Chief Financial Officer, Marshall & Ilsley Corporation, since June 2006; Chief Financial Officer, M&I Marshall & Ilsley Bank, since June 2006; Chief Financial Officer of Southwest Bank, an M&I Bank, M&I Bank FSB and M&I Bank of Mayville; Director and President of M&I LLC; Director of M&I Insurance Services, Inc., Marshall & Ilsley Trust Company National Association, M&I Brokerage Services, Inc. and Milease, LLC; Managing Director, Investment Banking, Credit Suisse from October 2004 to June 2006; Managing Director, Investment Banking, UBS Investment Bank from April 2000 to September 2004.

Michael C. Smith

Age 49

   Senior Vice President and Corporate Treasurer, Marshall & Ilsley Corporation, since March 2006; Senior Vice President since April 2006, M&I Marshall & Ilsley Bank; Director and President of M&I Northwoods III, L.L.C. and M&I Dealer Auto Securitization; Director of M&I Community Development Corporation, M&I Bank FSB, M&I Custody of Nevada, Inc., M&I Servicing Corp., M&I Marshall & Ilsley Investment Corporation, M&I Marshall & Ilsley Investment II Corporation, M&I Marshall & Ilsley Holdings, Inc., M&I Zion Holdings, Inc., M&I Zion Investment Corporation, M&I Zion Investment II Corporation, SWB Investment Corporation, SWB of St. Louis Holdings Inc. and M&I Marshall & Ilsley Regional Holdings, Inc.; Manager of SWB of St. Louis Holdings I, LLC and SWB of St. Louis Holdings II, LLC; Trustee of SWB Investment II Corporation; Senior Vice President, Southwest Bank, an M&I Bank; Successor Administrator of Trustcorp Statutory Trust I, EBC Statutory Trust I, EBC Statutory Trust II and First Indiana Capital Statutory Trust II; Treasurer, American International Group (AIG) from May 2001 to February 2006.

Ronald E. Smith

Age 61

   Senior Vice President since March 2005, Marshall & Ilsley Corporation; Executive Vice President since March 2005, Senior Vice President from 2001 to March 2005, M&I Marshall & Ilsley Bank.

 

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PART II

 

ITEM 5.   MARKET FOR REGISTRANT’S COMMON STOCK, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Stock Listing

 

M&I’s common stock is traded under the symbol “MI” on the New York Stock Exchange. Common dividends declared and the price range for M&I’s common stock for each of the last five years can be found in Item 8, Consolidated Financial Statements and Supplementary Data, Quarterly Financial Information.

 

A discussion of the regulatory restrictions on the payment of dividends can be found under Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and in Note 16 in Item 8, Consolidated Financial Statements and Supplementary Data.

 

Holders of Common Equity

 

At December 31, 2007 M&I had approximately 16,845 record holders of its common stock.

 

Shares Purchased

 

The following table reflects the purchases of M&I common stock for the specified period:

 

Period

   Total Number of Shares
Purchased (1)
   Average Price
Paid Per Share
   Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
   Maximum
Number of Shares
that May Yet be
Purchased Under
the Plans or
Programs

October 1 to October 31, 2007

   210,586    $ 42.64    67,825    5,678,855

November 1 to November 30, 2007

   2,626,025      32.58    2,625,000    3,053,855

December 1 to December 31, 2007

   1,825,354      26.18    1,819,744    1,234,111

 

(1)   Includes shares purchased by rabbi trusts pursuant to nonqualified deferred compensation plans for the three months ended December 31, 2007.

 

M&I’s Share Repurchase Program was publicly reconfirmed in April 2005, 2006 and 2007. The Share Repurchase Program authorizes the purchase of up to 12 million shares annually and renews each year at that level unless changed or terminated by subsequent Board action.

 

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Table of Contents

MARSHALL & ILSLEY CORPORATION

 

ITEM 6.   SELECTED FINANCIAL DATA

 

Consolidated Summary of Earnings

($000’s except share data)

 

    Years Ended December 31,  
    2007     2006     2005     2004     2003  

Interest and Fee Income:

         

Loans and leases

  $ 3,243,109     $ 2,856,043     $ 1,959,063     $ 1,432,756     $ 1,336,307  

Investment securities:

         

Taxable

    311,837       277,938       214,537       200,107       165,075  

Exempt from federal income taxes

    59,237       61,769       64,127       58,826       57,968  

Trading securities

    1,012       614       229       271       258  

Short-term investments

    18,001       14,707       7,452       2,079       2,447  

Loan to Metavante

    35,969       43,163       43,652       22,871       4,479  
                                       

Total interest and fee income

    3,669,165       3,254,234       2,289,060       1,716,910       1,566,534  

Interest Expense:

         

Deposits

    1,231,252       1,083,392       562,552       281,271       230,805  

Short-term borrowings

    236,671       186,746       106,220       61,144       80,957  

Long-term borrowings

    585,025       476,540       329,876       196,160       162,921  
                                       

Total interest expense

    2,052,948       1,746,678       998,648       538,575       474,683  
                                       

Net interest income

    1,616,217       1,507,556       1,290,412       1,178,335       1,091,851  

Provision for loan and lease losses

    319,760       50,551       44,795       37,963       62,993  
                                       

Net interest income after provision for loan and lease losses

    1,296,457       1,457,005       1,245,617       1,140,372       1,028,858  

Other Income:

         

Wealth management

    262,835       221,554       191,720       175,119       148,348  

Net investment securities gains

    34,814       9,701       45,514       35,336       21,572  

Other

    431,417       350,431       336,357       316,900       354,603  
                                       

Total other income

    729,066       581,686       573,591       527,355       524,523  

Other Expense:

         

Salaries and employee benefits

    659,871       613,394       549,859       494,462       474,629  

Other

    655,072       470,148       404,566       387,271       423,978  
                                       

Total other expense

    1,314,943       1,083,542       954,425       881,733       898,607  
                                       

Income before income taxes

    710,580       955,149       864,783       785,994       654,774  

Provision for income taxes

    213,641       307,435       278,124       256,955       183,502  
                                       

Income from Continuing Operations

    496,939       647,714       586,659       529,039       471,272  

Discontinued operations, net of tax

    653,997       160,124       119,531       76,814       51,175  
                                       

Net Income

  $ 1,150,936     $ 807,838     $ 706,190     $ 605,853     $ 522,447  
                                       

Basic earnings per common share:

         

Continuing Operations

  $ 1.91     $ 2.60     $ 2.54     $ 2.37     $ 2.08  

Discontinued operations

    2.51       0.64       0.52       0.35       0.23  
                                       

Net Income

  $ 4.42     $ 3.24     $ 3.06     $ 2.72     $ 2.31  
                                       

Diluted earnings per common share:

         

Continuing Operations

  $ 1.87     $ 2.54     $ 2.49     $ 2.32     $ 2.06  

Discontinued operations

    2.47       0.63       0.50       0.34       0.22  
                                       

Net Income

  $ 4.34     $ 3.17     $ 2.99     $ 2.66     $ 2.28  
                                       

Other Significant Data:

         

Return on Average Shareholders’ Equity

    17.23 %     14.42 %     16.21 %     17.00 %     15.87 %

Return on Average Assets

    1.98       1.53       1.63       1.63       1.57  

Dividend Payout Ratio

    27.65       33.12       31.10       30.45       30.70  

Average Equity to Average Assets Ratio

    11.48       10.64       10.07       9.59       9.89  

Ratio of Earnings to Fixed Charges*

         

Excluding Interest on Deposits

    1.85 x       2.42 x       2.96 x       3.99 x       3.62 x  

Including Interest on Deposits

    1.34 x       1.54 x       1.86 x       2.44 x       2.36 x  

 

*   See Exhibit 12 for detailed computation of these ratios.

 

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Consolidated Average Balance Sheets

($000’s except share data)

 

    Years Ended December 31,  
    2007     2006     2005     2004     2003  

Assets:

         

Cash and due from banks

  $ 1,005,362     $ 974,120     $ 923,387     $ 814,236     $ 755,015  

Investment securities:

         

Trading securities

    56,580       45,559       26,922       22,297       23,017  

Short-term investments

    352,235       297,859       229,273       163,043       258,478  

Other investment securities:

         

Taxable

    6,208,495       5,664,199       4,845,549       4,672,117       4,038,562  

Tax Exempt

    1,287,066       1,303,872       1,334,793       1,199,139       1,173,466  
                                       

Total investment securities

    7,904,376       7,311,489       6,436,537       6,056,596       5,493,523  

Loan to Metavante

    817,885       982,000       994,055       534,519       108,045  

Loans and Leases:

         

Commercial

    12,672,367       11,175,436       8,954,617       7,621,077       6,906,367  

Real estate

    28,865,495       25,808,422       20,728,918       17,215,467       14,938,082  

Personal

    1,416,411       1,478,816       1,521,801       1,633,794       1,874,344  

Lease financing

    695,756       661,466       567,344       552,551       674,871  
                                       

Total loans and leases

    43,650,029       39,124,140       31,772,680       27,022,889       24,393,664  

Less: Allowance for loan and lease losses

    448,222       406,390       362,886       360,408       347,838  
                                       

Net loans and leases

    43,201,807       38,717,750       31,409,794       26,662,481       24,045,826  

Premises and equipment, net

    458,819       415,150       330,273       330,492       324,945  

Accrued interest and other assets

    3,555,545       2,927,220       2,226,048       2,161,071       2,034,056  
                                       

Total assets of continuing operations

    56,943,794       51,327,729       42,320,094       36,559,395       32,761,410  

Assets of discontinued operations

    1,265,833       1,323,369       963,447       603,199       506,611  
                                       

Total Assets

  $ 58,209,627     $ 52,651,098     $ 43,283,541     $ 37,162,594     $ 33,268,021  
                                       

Liabilities and Shareholders’ Equity:

         

Deposits:

         

Noninterest bearing

  $ 5,469,774     $ 5,361,014     $ 4,972,890     $ 4,603,470     $ 4,202,358  

Interest bearing:

         

Bank issued deposits:

         

Bank issued interest bearing activity deposits

    13,490,042       11,927,756       10,415,477       10,324,517       10,308,802  

Bank issued time deposits

    8,555,413       7,592,019       4,597,332       3,424,119       3,428,775  
                                       

Total bank issued interest bearing deposits

    22,045,455       19,519,775       15,012,809       13,748,636       13,737,577  

Wholesale deposits

    6,553,668       7,255,647       6,720,964       6,057,542       4,311,424  
                                       

Total interest bearing deposits

    28,599,123       26,775,422       21,733,773       19,806,178       18,049,001  
                                       

Total deposits

    34,068,897       32,136,436       26,706,663       24,409,648       22,251,359  

Short-term borrowings

    4,693,890       3,637,634       2,924,834       2,907,922       3,139,797  

Long-term borrowings

    11,533,685       10,070,881       8,189,708       5,323,774       3,795,801  

Accrued expenses and other liabilities

    1,072,261       1,031,954       880,447       786,067       647,430  

Liabilities of discontinued operations

    160,430       173,287       224,575       170,940       141,807  
                                       

Total Liabilities

    51,529,163       47,050,192       38,926,227       33,598,351       29,976,194  

Shareholders’ Equity

    6,680,464       5,600,906       4,357,314       3,564,243       3,291,827  
                                       

Total Liabilities and Shareholders’ Equity

  $ 58,209,627     $ 52,651,098     $ 43,283,541     $ 37,162,594     $ 33,268,021  
                                       

Other Significant Data:

         

Book Value Per Share at Year End

  $ 26.86     $ 24.24     $ 20.27     $ 17.51     $ 15.24  

Average Common Shares Outstanding

    260,906,330       249,723,333       231,300,867       223,123,866       226,342,764  

Credit Quality Ratios:

         

Net Loan and Lease Charge-offs to Average Loans and Leases

    0.59 %     0.10 %     0.12 %     0.11 %     0.21 %

Total Nonperforming Loans and Leases* and OREO to End of Period Loans and Leases and OREO

    2.24       0.70       0.44       0.48       0.74  

Allowance for Loan and Lease Losses to End of Period Loans and Leases

    1.07       1.00       1.06       1.21       1.39  

Allowance for Loan and Lease Losses to Total Nonperforming Loans and Leases*

    54       157       259       271       202  

 

*   Loans and leases nonaccrual, restructured, and past due 90 days or more.

 

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

 

Overview

 

The Corporation’s overall strategy is to drive earnings per share growth by: (1) expanding banking operations not only in Wisconsin but also into faster growing regions beyond Wisconsin; (2) increasing the number of financial institutions to which the Corporation provides correspondent banking services and products; and (3) expanding trust services and other wealth management product and service offerings.

 

Net income in 2007 amounted to $1,150.9 million or $4.34 per diluted share. The return on average assets and return on average equity were 1.98% and 17.23%, respectively. By comparison, net income in 2006 was $807.8 million, diluted earnings per share was $3.17, the return on average assets was 1.53% and the return on average equity was 14.42%. For the year ended December 31, 2005, net income was $706.2 million or $2.99 per diluted share and the returns on average assets and average equity were 1.63% and 16.21%, respectively.

 

On November 1, 2007, Marshall & Ilsley Corporation (Accounting Predecessor to New Marshall & Ilsley Corporation) which is referred to as “M&I” or the “Corporation” and its wholly-owned subsidiary, Metavante Corporation (Accounting Predecessor to Metavante Technologies, Inc.), which is referred to as “Metavante,” became two separate publicly traded companies in accordance with the plan the Corporation announced in early April 2007. The Corporation believes this transaction, which the Corporation refers to as the “Separation” will provide substantial benefits to the shareholders of both companies by creating additional opportunities to focus on core businesses. New Marshall & Ilsley Corporation’s enhanced capital position is expected to be a source of strength in the current credit environment as well as drive earnings per share growth by enabling it to provide resources for continued organic growth, fund strategic initiatives within its business lines and pursue opportunities in new geographic markets.

 

As part of the Separation, the Corporation received capital contributions of $1,665 million in cash from Metavante, which consisted of a contribution from Metavante of $1,040 million and proceeds of $625 million from Metavante’s issuance of a 25% equity interest to WPM L.P., an affiliate of Warburg Pincus LLC (“Warburg Pincus”). In addition, the Corporation received $982 million in repayment of indebtedness that was due from Metavante. In considering the redeployment of the tangible capital generated from the Separation, the Corporation has established the following priorities: (1) prudently invest in the franchise which includes maintaining a strong capital base in the current credit environment; (2) pursue financially disciplined acquisitions in wealth management and banking; and (3) prudently allocate capital to common stock repurchases and to common stock dividends.

 

As a result of the Separation, the assets, liabilities and net income of Metavante have been de-consolidated from the Corporation’s historical consolidated financial statements and are now reported as discontinued operations. For the year ended December 31, 2007, discontinued operations in the Consolidated Statements of Income also includes the expenses and the tax-free gain that were attributable to the Separation transaction. For accounting purposes only, the investment by Warburg Pincus in Metavante for an equity interest representing 25% of Metavante was treated as a sale of 25% of Metavante’s common stock by the Corporation to Warburg Pincus for cash in the amount of $625 million. The sale resulted in a tax-free gain in the amount of $525.6 million. The assets and liabilities reported as discontinued operations do not directly reconcile to historical consolidated assets and liabilities reported by Metavante. The amounts reported as assets or liabilities of discontinued operations include adjustments for intercompany cash and deposits, receivables and payables, intercompany debt and reclassifications that were required to de-consolidate the financial information of the two companies.

 

Income from continuing operations in 2007 amounted to $496.9 million or $1.87 per diluted share compared to income from continuing operations in 2006 of $647.7 million or $2.54 per diluted share, a decrease of $150.8 million or $0.67 per diluted share. The decrease in income from continuing operations in 2007 compared to 2006 was primarily attributable to the increases in the provision for loan and lease losses.

 

Consistent with what many bank holding companies experienced in 2007, the deterioration in the national residential real estate markets had a negative impact on the Corporation’s loan and lease portfolio. The Corporation’s construction and development real estate loans, particularly in Arizona and the west coast of Florida, exhibited the

 

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most dramatic increase in stress and impairment. As a result, net charge-offs and the provision for loan and lease losses were significantly higher in 2007 when compared to the Corporation’s historical experience with net charge-offs and the provision for loan and lease losses. The provision for loan and lease losses amounted to $319.8 million in 2007 compared to $50.6 million in 2006, an increase of $269.2 million. On an after-tax basis, the increase in the provision for loan and lease losses in 2007 compared to 2006 amounted to approximately $175.0 million or $0.66 per diluted share.

 

Expenses in 2007 include losses associated with two debt terminations, litigation accruals that arose from the Corporation’s membership interests in Visa, Inc. (“Visa”) and a donation to support charitable works in the communities within the Corporation’s markets. In the aggregate, these expense and loss items amounted to approximately $134.5 million and resulted in a decrease to income from continuing operations of $87.4 million or $0.32 per diluted share.

 

Organic loan and bank-issued deposit growth, the two banking acquisitions completed in 2007 and a full year of the two banking acquisitions completed in 2006 contributed to the growth in net interest income and other banking sources of revenues. Continued growth in assets under management and assets under administration and acquisitions resulted in solid growth in fee income for Wealth Management. Increased investment securities gains and gains from branch sales were somewhat offset by lower mortgage banking revenue in 2007.

 

Income from continuing operations in 2006 amounted to $647.7 million or $2.54 per diluted share compared to income from continuing operations in 2005 of $586.7 million or $2.49 per diluted share, and increase of $61.0 million or $0.05 per diluted share.

 

The increase in income from continuing operations in 2006 compared to 2005 was attributable to a number of factors. The increase in net interest income was due to strong organic loan and bank issued deposit growth and the contribution from two banking acquisitions that were completed on April 1, 2006. Net charge-offs were below the Corporation’s five-year historical average in 2006. Growth in assets under management and assets under administration and acquisitions resulted in continued growth in fee income for Wealth Management. Although an unpredictable source of earnings, investment securities gains were $35.8 million lower in 2006 compared to 2005. Income from continuing operations for the year ended December 31, 2006, includes the impact of the mark-to-market adjustments associated with certain interest rate swaps. The impact, which is reported as Net derivative losses-discontinued hedges in the Consolidated Statements of Income, resulted in a decrease to income from continuing operations of $12.0 million or $0.05 per diluted share in 2006. These factors, along with continued expense management, all contributed to the growth in income from continuing operations in 2006.

 

With regard to the outlook in 2008, management expects that, even with the benefit of the cash received from Metavante, continued pricing competition for loan products, increased funding costs and the elevated levels of nonperforming loans make it more likely that modest net interest margin compression will continue. Commercial and industrial loan growth is expected to show mid single-digit growth rates. Commercial real estate growth is expected to be in the mid single-digit percentage range. Wealth management revenue is expected to show high single-digit to low double-digit growth rates depending on market volatility and direction.

 

With respect to credit quality, management expects 2008 will continue to be a difficult year for residential real estate markets. Management expects the provision for loan and lease losses will continue to be higher than its pre-2007 historical experience and estimates that the provision for loan and lease losses will be in the range of $50 million to $55 million per quarter in 2008. As the Corporation works toward the resolution of its nonperforming loans and leases, the provision for loan and lease losses could exceed management’s expectations in any quarter or quarters in 2008. Should real estate markets deteriorate more than management currently expects, the Corporation would experience increased levels of nonperforming assets, increased net charge-offs, a higher provision for loan and lease losses, lower net interest income and increased operating costs due to the expense associated with collection efforts and the operating expense of carrying nonperforming assets. There are however, numerous unknown factors at this time that will ultimately affect the timing and amount of nonperforming assets, net charge-offs and the provision for loan and lease losses that will be recognized in 2008.

 

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The Corporation’s actual results for 2008 could differ materially from those expected by management. See “Forward-Looking Statements” in Item 1A. of this Form 10-K for a discussion of the various risk factors that could cause actual results to differ materially from expected results.

 

The results of operations and financial condition for the periods presented include the effects of the banking-related and wealth management-related acquisitions from the dates of consummation of the acquisitions. All transactions were accounted for using the purchase method of accounting. See Note 5 in Notes to Consolidated Financial Statements for a discussion of the Corporation’s banking and wealth management acquisitions completed in 2007 and 2006.

 

Recently Completed Acquisition

 

The following acquisition, which is not considered to be a material business combination, was completed after December 31, 2007:

 

On January 2, 2008, the Corporation completed the acquisition of First Indiana Corporation (“First Indiana”) based in Indianapolis, Indiana. First Indiana, with $2.1 billion in consolidated assets as of December 31, 2007, had 32 offices in central Indiana that became branches of M&I Bank on February 2, 2008. Stockholders of First Indiana received $32.00 in cash for each share of First Indiana common stock outstanding, or approximately $530.2 million.

 

Significant Transactions

 

Some of the more significant transactions in 2007, 2006 and 2005 consisted of the following:

 

2007

 

During 2007, the Corporation completed two banking acquisitions and one wealth management acquisition and, as previously discussed, completed the transaction in which the Corporation and Metavante became two separate publicly traded companies.

 

During 2007, the Corporation sold three bank branches located in the Tulsa, Oklahoma market after management determined that exiting that market was a better allocation of resources as compared to the costs of further expansion in that market. The gain, which is a component of Other Income in the Consolidated Statements of Income, amounted to $29.0 million which increased income from continuing operations by $16.9 million or $0.06 per diluted share.

 

During 2007, the Corporation sold its investment in MasterCard Class B common shares in order to monetize the significant appreciation in the market price of the common stock of MasterCard since its initial public offering. The realized gain, which is reported in Net Investment Securities Gains in the Consolidated Statements of Income, amounted to $19.0 million which increased income from continuing operations by $12.4 million or $0.05 per diluted share.

 

During 2007, the Corporation called the $200 million 7.65% junior subordinated deferrable interest debentures and the related M&I Capital Trust A 7.65% trust preferred securities. The Corporation also terminated $1,000 million of Puttable Reset Securities (“PURS”), senior bank notes issued by M&I Bank, in 2007. The Corporation realized losses of $83.7 million from these transactions which are reported as Losses on Termination of Debt in the Consolidated Statements of Income. These losses reduced income from continuing operations by $54.4 million or $0.20 per diluted share.

 

During 2007, the Corporation recorded liabilities in connection with its share of the proposed settlement of the American Express antitrust litigation against Visa and other Visa litigation matters. While the Corporation is not a named defendant in any of these lawsuits, the Corporation and other Visa member banks are obligated to share in losses in connection with certain lawsuits under Visa by-laws. The expense, which is reported in Other Expense in the Consolidated Statements of Income, amounted to $25.8 million which decreased income from continuing operations by $16.8 million or $0.06 per diluted share.

 

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During 2007, the Corporation purchased $286.6 million of additional bank-owned life insurance. The net realizable value is reported, along with the Corporation’s other bank-owned life insurance, in Accrued Interest and Other Assets in the Consolidated Balance Sheets. The increase in net realizable value is reported in Life Insurance Revenue in the Consolidated Statements of Income.

 

The Corporation has a tradition of being committed to the betterment of the communities within the markets that it serves. Consistent with that tradition, the Corporation made a sizeable contribution to its charitable foundation in 2007. That expense, which is reported in Other Expense in the Consolidated Statements of Income, amounted to $25.0 million, which decreased income from continuing operations by $16.3 million or $0.06 per diluted share.

 

During 2007, the Corporation remarketed the 3.90% STACKSSM of M&I Capital Trust B that were originally issued in 2004 as components of the Corporation’s 6.50% Common SPACESSM. In connection with the remarketing, the annual interest rate on the remarketed STACKS was reset at 5.626%, M&I Capital Trust B was liquidated and $400 million of 5.626% senior notes that mature on August 17, 2009 were issued by the Corporation in exchange for the outstanding STACKS. Each Common SPACES also included a stock purchase contract requiring the holder to purchase, in accordance with a settlement rate formula, shares of the Corporation’s common stock. The Corporation issued 9,226,951 shares of its common stock in settlement of the stock purchase contracts in exchange for $400 million in cash.

 

Beginning in the second quarter and continuing throughout the remainder of 2007, the Corporation completed three accelerated common share repurchases as well as open market repurchases of shares of its common stock under its authorized Stock Repurchase Program. In total, 10,765,889 shares of the Corporation’s common stock were acquired in 2007 at an aggregate cost of $437.1 million.

 

2006

 

During 2006, the Corporation completed two banking acquisitions and one wealth management acquisition.

 

Income from continuing operations for the year ended December 31, 2006 includes the impact of the mark-to-market adjustments associated with certain interest rate swaps. Based on expanded interpretations of the accounting standard for derivatives and hedge accounting it was determined that certain transactions did not qualify for hedge accounting. As a result, any fluctuation in the fair value of the interest rate swaps was recorded in earnings with no corresponding offset to the hedged items or accumulated other comprehensive income. The affected interest rate swaps were terminated in 2006. The impact, which is reported as Net Derivative Losses-Discontinued Hedges in the Consolidated Statements of Income, resulted in a decrease to income from continuing operations of $12.0 million or $0.05 per diluted share.

 

On January 1, 2006, the Corporation adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (“SFAS 123(R)”), the new accounting standard that requires all share-based compensation to be expensed. For the Corporation, additional expense was reported for its stock option awards and its employee stock purchase plan. In conjunction with the adoption of SFAS 123(R), the Corporation elected the Modified Retrospective Application method to implement the new accounting standard. Under that method all prior period consolidated and segment financial information was adjusted based on pro forma amounts previously disclosed.

 

2005

 

During the second and third quarters of 2005, the Corporation realized a gain primarily due to the sale of an entity associated with its investment in an independent private equity and venture capital partnership. The gross pre-tax gain amounted to $29.4 million and is reported in Net Investment Securities Gains in the Consolidated Statements of Income. On an after-tax basis, and net of related compensation expense, the gain amounted to $16.5 million or $0.07 per diluted share for the twelve months ended December 31, 2005.

 

During the third quarter of 2005, the Corporation realized a gain due to the sale of an equity investment in a cash tender offer. The pre-tax gain amounted to $6.6 million and is reported in Net Investment Securities Gains in the Consolidated Statements of Income. On an after-tax basis, the gain amounted to $3.9 million or $0.02 per diluted share for the twelve months ended December 31, 2005.

 

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Net Interest Income

 

Net interest income in 2007 amounted to $1,616.2 million compared with net interest income of $1,507.6 million in 2006, an increase of $108.6 million or 7.2%. Positive contributors to the increase in net interest income in 2007 compared to 2006 included the impact of the acquisitions, organic loan and bank issued deposit growth and the effect of the cash received from Metavante for two months in 2007. Factors negatively affecting net interest income compared to the prior year included reduced interest income due to the increase in nonaccrual loans, the impact of the financing costs associated with the banking acquisitions and common stock buybacks, a general shift in the bank issued deposit mix from lower cost to higher cost deposit products and the acquisition of additional bank-owned life insurance.

 

Average earning assets in 2007 amounted to $52.4 billion compared to $47.4 billion in 2006, an increase of $5.0 billion or 10.4%. Increases in average loans and leases accounted for 91.3% of the growth in average earning assets.

 

Average interest bearing liabilities increased $4.3 billion or 10.7% in 2007 compared to 2006. The growth in average interest bearing liabilities in 2007 compared to 2006 was fairly evenly distributed between average interest bearing deposits ($1.8 billion), average short-term borrowings ($1.0 billion) and average long term borrowings ($1.5 billion).

 

Average noninterest bearing deposits increased $0.1 billion or 2.0% in 2007 compared to the prior year.

 

Net interest income in 2006 amounted to $1,507.6 million compared with net interest income of $1,290.4 million in 2005, an increase of $217.2 million or 16.8%. Both acquisition-related and organic loan growth, as well as the growth in noninterest bearing and other bank issued deposits, were the primary contributors to the increase in net interest income. Factors negatively affecting net interest income compared to the prior year included the impact of the financing costs associated with the 2006 banking acquisitions, common stock buybacks and a general shift in the bank issued deposit mix from lower cost to higher cost deposit products in response to increasing interest rates.

 

Average earning assets in 2006 amounted to $47.4 billion compared to $39.2 billion in 2005, an increase of $8.2 billion or 21.0%. Increases in average loans and leases accounted for 89.5% of the growth in average earning assets.

 

Average interest bearing liabilities increased $7.6 billion or 23.2% in 2006 compared to 2005. Approximately $5.0 billion or 66.0% of the growth in average interest bearing liabilities was attributable to interest bearing deposits and $1.9 billion or 24.6% of the growth in average interest bearing liabilities was attributable to long term borrowings.

 

Average noninterest bearing deposits increased $0.4 billion or 7.8% in 2006 compared to the prior year.

 

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The growth and composition of the Corporation’s average loan and lease portfolio for the current year and prior two years are reflected in the following table ($ in millions):

 

                    Percent
Growth
 
     2007    2006    2005    2007
vs
2006
    2006
vs
2005
 

Commercial:

             

Commercial

   $ 12,672.3    $ 11,175.4    $ 8,954.6    13.4 %   24.8 %

Commercial real estate:

             

Commercial mortgages

     11,382.9      10,345.6      8,575.8    10.0     20.6  

Construction

     3,738.9      2,793.0      1,412.8    33.9     97.7  
                                 

Total commercial real estate

     15,121.8      13,138.6      9,988.6    15.1     31.5  

Commercial lease financing

     514.5      516.2      439.4    (0.3 )   17.5  
                                 

Total commercial

     28,308.6      24,830.2      19,382.6    14.0     28.1  

Personal:

             

Residential real estate:

             

Residential mortgages

     6,672.7      5,735.9      4,239.5    16.3     35.3  

Construction

     2,793.5      2,394.3      1,513.0    16.7     58.2  
                                 

Total residential real estate

     9,466.2      8,130.2      5,752.5    16.4     41.3  

Consumer loans:

             

Student

     85.0      68.6      79.4    23.8     (13.6 )

Credit card

     244.7      231.4      214.9    5.8     7.7  

Home equity loans and lines

     4,277.4      4,539.6      4,987.9    (5.8 )   (9.0 )

Other

     1,086.8      1,178.8      1,227.5    (7.8 )   (4.0 )
                                 

Total consumer loans

     5,693.9      6,018.4      6,509.7    (5.4 )   (7.5 )

Personal lease financing

     181.3      145.3      127.9    24.7     13.6  
                                 

Total personal

     15,341.4      14,293.9      12,390.1    7.3     15.4  
                                 

Total consolidated average loans and leases

   $ 43,650.0    $ 39,124.1    $ 31,772.7    11.6 %   23.1 %
                                 

 

Average loans and leases increased $4.5 billion or 11.6% in 2007 compared to 2006. Excluding the effect of the banking acquisitions, total consolidated average loan and lease organic growth was 7.2% in 2007 compared to 2006. Approximately $1.6 billion of the growth in total consolidated average loans and leases was attributable to the banking acquisitions and $2.9 billion of the growth was organic. Of the $1.6 billion of average growth attributable to the banking acquisitions, $1.1 billion was attributable to average commercial real estate loans, $0.4 billion was attributable to average commercial loans and leases and the remainder was primarily attributable to average residential real estate loans. Of the $2.9 billion of average loan and lease organic growth, $1.1 billion was attributable to average commercial loans and leases, $0.9 billion was attributable to average commercial real estate loans, and $1.3 billion was attributable to residential real estate loans. Average home equity loans and lines decreased $0.3 billion in 2007 compared to 2006.

 

Total average commercial loan and lease organic growth continued to be positive in 2007 although not as strong as the prior year. New business, declining interest rates, increased exports due to the weaker U.S. dollar and the continued strength of the local economies in the markets the Corporation serves resulted in total average commercial loan and lease organic growth of 9.1% in 2007 compared to 2006. Management expects that organic commercial loan growth (as a percentage) will continue to moderate from 2007 growth levels, especially in industries that have some dependency on housing and related businesses. Management expects commercial loan and lease growth will reach mid single-digit growth rates in 2008.

 

Total average commercial real estate organic growth was 6.3% in 2007 compared to 2006. The demand for commercial real estate loans has softened which reflects the current housing market and is evidenced by slowing new construction in all of the Corporation’s markets and lower investor activity in new construction projects. Office and retail real estate have also shown signs of softening. Loan opportunities continue to exist in multi-family, medical office building, hospitality and warehousing. Management expects commercial real estate loan growth will most likely be in the mid single-digit percentage range in 2008.

 

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Average home equity loans and lines, which include the Corporation’s wholesale activity, declined $0.3 billion or 5.8% in 2007 compared to 2006. Consistent with what has occurred in many parts of the country, the market for home equity loans and lines continued to be challenging. An increased number of originations with selected credit, rate and term characteristics were retained on balance sheet in 2007. Management expects that the Corporation will continue to retain originations that meet its qualifications on balance sheet in the near term.

 

The Corporation sells some of its residential real estate loan production (residential real estate and home equity loans) in the secondary market. As previously discussed, selected residential real estate loans with credit, rate and term characteristics that are considered desirable are periodically retained in the portfolio. Residential real estate loans originated and sold to the secondary market amounted to $1.8 billion in 2007 compared to $2.3 billion in 2006. At December 31, 2007, residential mortgage loans held for sale amounted to $40.3 million compared to $139.3 million at December 31, 2006. The housing market and the decline in the national investor base adversely affected the origination-for-sale business in 2007. Gains from the sale of mortgage loans amounted to $28.6 million in 2007 compared to $47.3 million in 2006. The Corporation has more recently seen some renewed investor interest for home equity loans and lines, although it is difficult to assess how that will affect the origination-for-sale business in 2008.

 

The sub-prime mortgage banking environment has been experiencing considerable strain from rising delinquencies and liquidity pressures and some sub-prime lenders have failed. The increased scrutiny of the sub-prime lending market is one of the factors that have impacted general market conditions as well as perceptions of the mortgage origination business. The Corporation considers sub-prime loans to be those loans with high loan-to-value, temporary below market interest rates, which are sometimes referred to as teaser rates, or interest deferral options at the time of origination and credit scores that are less than 620. The Corporation believes that loans with these characteristics have contributed to the high levels of foreclosures and losses the industry is currently experiencing. The Corporation does not originate sub-prime mortgages or sub-prime home equity loans or lines. However, the Corporation may have loss exposure from loans to entities that are associated with sub-prime mortgage banking. The Corporation does not originate mortgage loans with variable interest-only payment plans, commonly referred to as “option ARMs.” Option ARMs may include low introductory interest plans with significant escalation in the rate when the agreement calls for the rate to reset. The borrower may also be able to fix the monthly payment amount, potentially resulting in negative amortization of the loan. The Corporation does not originate mortgage loans that permit negative amortization. A negative amortization provision in a mortgage allows the borrower to defer payment of a portion or all of the monthly interest accrued on the mortgage and to add the deferred interest amount to the mortgage’s principal balance subject to a stated maximum permitted amount of negative amortization. Once the maximum permitted amount of negative amortization is reached, the borrowers’ monthly payment is reset and is usually significantly higher than the monthly payment made during periods of negative amortization. The Corporation does participate in the Alt-A market. The Corporation’s Alt-A products are offered to borrowers with higher credit scores and lower loan-to-value ratios who choose the convenience of less than full documentation in exchange for higher reserve requirements and a higher mortgage rate. The Corporation’s adjustable rate mortgage loans are underwritten to fully-indexed rates.

 

At December 31, 2007, the Corporation’s combined average loan-to-value ratios and credit scores were 80.4% and 729, respectively for its residential real estate loan and home equity loan and line of credit portfolios, excluding residential construction loans to developers. The Corporation’s exposure to residential real estate and home equity borrowers with credit scores that were less than 620 was $299.2 million at December 31, 2007. The average loan-to-value ratio for residential real estate and home equity borrowers with credit scores that were less than 620 was approximately 79.9% at December 31, 2007.

 

Auto loans securitized and sold amounted to $0.2 billion in 2007 compared to $0.5 billion in 2006. During the second quarter of 2007, the Corporation opted to discontinue the sale and securitization of automobile loans into the secondary market on a recurring basis. Gains and losses from the sale and securitization of auto loans, including write-downs of auto loans held for sale, were not significant in 2007 or 2006. See Note 10 in Notes to Consolidated Financial Statements for further discussion of the Corporation’s securitization activities.

 

Average loans and leases increased $7.4 billion or 23.1% in 2006 compared to 2005. Excluding the effect of the banking acquisitions, total consolidated average loan and lease organic growth was 12.7% in 2006 compared to 2005. Approximately $2.9 billion of the growth in total consolidated average loans and leases was attributable to the banking acquisitions and $4.5 billion of the growth was organic. Of the $2.9 billion of average growth attributable to the

 

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banking acquisitions, $2.1 billion was attributable to average commercial real estate loans, $0.6 billion was attributable to average commercial loans and leases and the remainder was primarily attributable to average residential real estate loans. Of the $4.5 billion of average loan and lease organic growth, $1.7 billion was attributable to average commercial loans and leases, $1.1 billion was attributable to average commercial real estate loans, and $2.2 billion was attributable to residential real estate loans. Average home equity loans and lines decreased $0.5 billion in 2006 compared to 2005.

 

Residential real estate loans originated and sold to the secondary market amounted to $2.3 billion in 2006 compared to $2.4 billion in 2005. Gains from the sale of mortgage loans amounted to $47.3 million in 2006 compared to $47.1 million in 2005.

 

Auto loans securitized and sold amounted to $0.5 billion in each of 2006 and 2005. Net losses from the sale and securitization of auto loans, including write-downs of auto loans held for sale, amounted to $0.1 million in 2006 compared to $2.0 million in 2005. At December 31, 2006, auto loans held for sale amounted to $83.4 million.

 

The growth and composition of the Corporation’s consolidated average deposits for the current year and prior two years are reflected below ($ in millions):

 

                    Percent
Growth
 
     2007    2006    2005    2007
vs
2006
    2006
vs
2005
 

Bank issued deposits:

             

Noninterest bearing:

             

Commercial

   $ 3,915.8    $ 3,850.8    $ 3,510.7    1.7 %   9.7 %

Personal

     963.5      961.3      940.8    0.2     2.2  

Other

     590.5      548.9      521.4    7.6     5.3  
                                 

Total noninterest bearing

     5,469.8      5,361.0      4,972.9    2.0     7.8  

Interest bearing:

             

Activity accounts:

             

Savings and NOW

     2,905.0      3,031.5      3,096.2    (4.2 )   (2.1 )

Money market

     8,674.3      7,482.5      5,980.1    15.9     25.1  

Foreign activity

     1,910.8      1,413.7      1,339.2    35.2     5.6  
                                 

Total activity accounts

     13,490.1      11,927.7      10,415.5    13.1     14.5  

Time deposits:

             

Other CDs and time

     4,734.0      4,496.8      3,048.1    5.3     47.5  

CDs $100,000 and over

     3,821.4      3,095.2      1,549.2    23.5     99.8  
                                 

Total time deposits

     8,555.4      7,592.0      4,597.3    12.7     65.1  
                                 

Total interest bearing

     22,045.5      19,519.7      15,012.8    12.9     30.0  
                                 

Total bank issued deposits

     27,515.3      24,880.7      19,985.7    10.6     24.5  

Wholesale deposits:

             

Money market

     1,798.8      814.7      1,073.1    120.8     (24.1 )

Brokered CDs

     3,737.4      5,011.1      4,641.1    (25.4 )   8.0  

Foreign time

     1,017.4      1,429.9      1,006.8    (28.8 )   42.0  
                                 

Total wholesale deposits

     6,553.6      7,255.7      6,721.0    (9.7 )   8.0  
                                 

Total consolidated average deposits

   $ 34,068.9    $ 32,136.4    $ 26,706.7    6.0 %   20.3 %
                                 

 

Average total bank issued deposits increased $2.6 billion or 10.6% in 2007 compared to 2006. Excluding the effect of the banking acquisitions, average total bank issued deposit organic growth was 4.6% in 2007 compared to 2006. Approximately $1.4 billion of the growth in average total bank issued deposits was attributable to the banking acquisitions and $1.2 billion of the growth was organic. Of the $1.4 billion of average growth attributable to the banking acquisitions, $0.2 billion was attributable to average noninterest bearing deposits, $0.5 billion was attributable

 

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to average interest bearing activity deposits and $0.7 billion was attributable to average time deposits. Of the $1.2 billion of average bank issued deposit organic growth, $1.1 billion was attributable to average interest bearing activity deposits and $0.2 billion was attributable to average time deposits. Average organic noninterest bearing deposits declined $0.1 billion in 2007 compared to 2006.

 

Noninterest deposit balances tend to exhibit some seasonality with a trend of balances declining somewhat in the early part of the year followed by growth in balances throughout the remainder of the year. A portion of the noninterest balances, especially commercial balances, is sensitive to the interest rate environment. Larger balances tend to be maintained when overall interest rates are low and smaller balances tend to be maintained as overall interest rates increase. The Corporation has increasingly been able to competitively price deposit products which has contributed to the growth in average interest bearing bank issued deposits and average bank issued time deposits. The bank issued deposit mix continued to shift in 2007. In their search for higher yields, both new and existing customers have been migrating their deposit balances to higher cost money market and time deposit products.

 

Wholesale deposits are funds in the form of deposits generated through distribution channels other than the Corporation’s own banking branches. The Corporation continues to make use of wholesale funding alternatives. These deposits allow the Corporation’s bank subsidiaries to gather funds across a wider geographic base and at pricing levels considered attractive, where the underlying depositor may be retail or institutional. Average wholesale deposits decreased $0.7 billion in 2007 compared to 2006. Average wholesale deposits in 2007 include $0.2 billion of average wholesale deposits that were assumed in the 2007 and 2006 banking acquisitions.

 

Average total bank issued deposits increased $4.9 billion or 24.5% in 2006 compared to 2005. Excluding the effect of the banking acquisitions, average total bank issued deposit organic growth was 11.6% in 2006 compared to 2005. Approximately $2.3 billion of the growth in average total bank issued deposits was attributable to the banking acquisitions and $2.6 billion of the growth was organic. Of the $2.3 billion of average growth attributable to the banking acquisitions, $0.3 billion was attributable to average noninterest bearing deposits, $0.7 billion was attributable to average interest bearing activity deposits and $1.3 billion was attributable to average time deposits. Of the $2.6 billion of average bank issued deposit organic growth, $0.1 billion was attributable to average noninterest bearing deposits, $0.8 billion was attributable to average interest bearing activity deposits and $1.7 billion was attributable to average time deposits. Average wholesale deposits increased $0.5 billion in 2006 compared to 2005. Average wholesale deposits in 2006 include $0.4 billion of average wholesale deposits that were assumed in the 2006 banking acquisition.

 

Total borrowings increased $2.2 billion and amounted to $16.7 billion at December 31, 2007 compared to $14.5 billion at December 31, 2006. The increase was primarily attributable to short-term borrowings. The increased use of short-term borrowings reflects, in part, the widening of credit spreads and general lack of demand by investors for longer term bank debt that was prevalent during the second half of 2007. During the first quarter of 2007, the Corporation called the $200 million 7.65% junior subordinated deferrable interest debentures and the related M&I Capital Trust A 7.65% trust preferred securities. This transaction resulted in a loss of $9.5 million that is reported in Losses on Termination of Debt in the Consolidated Statements of Income and was primarily due to the contractual call premium paid to retire the debentures and trust preferred securities. During the third quarter of 2007, $370.0 million of floating rate Federal Home Loan Bank (“FHLB”) advances were extinguished and the pay fixed / receive floating interest rate swaps that were designated as cash flow hedges on the FHLB advances were terminated. The gain realized from these transactions was primarily due to the acceleration of the fair value adjustments for the interest rate swaps that were recorded in other comprehensive income. That gain amounted to $5.3 million and is reported in the Other line of Other Income in the Consolidated Statements of Income. Also during the third quarter of 2007, the Corporation remarketed the 3.90% STACKS of M&I Capital Trust B and issued $400.0 million of 5.626% senior notes of the Corporation that mature on August 17, 2009 in exchange for the STACKS. As a result of the illiquid market and prohibitive cost of remarketing, the $1.0 billion PURS were terminated in the fourth quarter of 2007. The loss which, was primarily the cost of purchasing the right to remarket the PURS through 2016, amounted to $74.2 million and is reported in Losses on Termination of Debt in the Consolidated Statements of Income.

 

The net interest margin on a fully taxable equivalent basis (“FTE”) as a percent of average earning assets was 3.14% in 2007 compared to 3.24% in 2006, a decrease of 10 basis points. The yield on average earning assets was 7.05% in 2007 compared to 6.91% in 2006, an increase of 14 basis points. The cost of interest bearing liabilities was 4.58% in 2007 compared to 4.31% in 2006, an increase of 27 basis points.

 

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Like the industry in general, there were many factors that presented a challenge to the Corporation’s net interest margin in 2007. Some of these factors included the movement of new and existing deposits into higher yielding products, loan growth that exceeded the Corporation’s ability to generate lower cost deposits, an interest rate environment characterized by an inverted yield curve, higher credit spreads and liquidity premiums for term financing and elevated levels of nonaccrual loans. The cash received from Metavante was beneficial to net interest income and the net interest margin, although that benefit was realized for only two months in 2007. Acquisitions for cash and common share repurchases reduced net interest income and were additional sources of contraction to the net interest margin. Management continues to believe that margin contraction is more likely than margin expansion. As a result, the net interest margin FTE as a percent of average earning assets could continue to have modest downward pressure in the near term. Net interest income and the net interest margin percentage can vary and continue to be influenced by loan and deposit growth, product spreads, pricing competition in the Corporation’s markets, prepayment activity, future interest rate changes, levels of nonaccrual loans and various other factors.

 

The net interest margin FTE as a percent of average earning assets was 3.24% in 2006 compared to 3.38% in 2005, a decrease of 14 basis points. The yield on average earning assets was 6.91% in 2006 compared to 5.92% in 2005, an increase of 99 basis points. The cost of interest bearing liabilities was 4.31% in 2006 compared to 3.04% in 2005, an increase of 127 basis points.

 

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Average Balance Sheets and Analysis of Net Interest Income

 

The Corporation’s consolidated average balance sheets, interest earned and interest paid, and the average interest rates earned and paid for each of the last three years are presented in the following table ($ in thousands):

 

    2007     2006     2005  
    Average
Balance
    Interest
Earned/
Paid
  Average
Yield or
Cost (3)
    Average
Balance
    Interest
Earned/
Paid
  Average
Yield or
Cost (3)
    Average
Balance
    Interest
Earned/
Paid
   Average
Yield or
Cost (3)
 

Loans and leases (1)(2)

  $ 43,650,029     $ 3,244,771   7.43 %   $ 39,124,140     $ 2,857,956   7.30 %   $ 31,772,680     $ 1,961,504    6.17 %

Investment securities:

                  

Taxable

    6,208,495       311,837   4.97       5,664,199       277,938   4.82       4,845,549       214,537    4.41  

Tax-exempt (1)

    1,287,066       85,706   6.71       1,303,872       89,865   6.97       1,334,793       95,001    7.26  

Federal funds sold and security resale agreements

    204,170       10,712   5.25       227,082       11,546   5.08       153,701       5,347    3.48  

Trading securities (1)

    56,580       1,101   1.95       45,559       659   1.45       26,922       240    0.89  

Other short-term investments

    148,065       7,289   4.92       70,777       3,161   4.47       75,572       2,105    2.79  

Loan to Metavante

    817,885       35,969   4.40       982,000       43,163   4.40       994,055       43,652    4.39  
                                                            

Total interest earning assets

    52,372,290       3,697,385   7.05 %     47,417,629       3,284,288   6.91 %     39,203,272       2,322,386    5.92 %

Cash and demand deposits
due from banks

    1,005,362           974,120           923,387       

Premises and equipment, net

    458,819           415,150           330,273       

Other assets

    3,555,545           2,927,220           2,226,048       

Allowance for loan and
lease losses

    (448,222 )         (406,390 )         (362,886 )     

Assets of discontinued operations

    1,265,833           1,323,369           963,447       
                                    

Total assets

  $ 58,209,627         $ 52,651,098         $ 43,283,541       
                                    

Interest bearing deposits:

                  

Bank issued deposits:

                  

Bank issued interest bearing activity deposits

  $ 13,490,042     $ 478,978   3.55 %   $ 11,927,756     $ 399,037   3.35 %   $ 10,415,477     $ 203,565    1.95 %

Bank issued time deposits

    8,555,413       420,428   4.91       7,592,019       334,371   4.40       4,597,332       148,038    3.22  
                                                            

Total bank issued deposits

    22,045,455       899,406   4.08       19,519,775       733,408   3.76       15,012,809       351,603    2.34  

Wholesale deposits

    6,553,668       331,846   5.06       7,255,647       349,984   4.82       6,720,964       210,949    3.14  
                                                            

Total interest bearing deposits

    28,599,123       1,231,252   4.31       26,775,422       1,083,392   4.05       21,733,773       562,552    2.59  

Short-term borrowings

    4,693,890       236,671   5.04       3,637,634       186,746   5.13       2,924,834       106,220    3.63  

Long-term borrowings

    11,533,685       585,025   5.07       10,070,881       476,540   4.73       8,189,708       329,876    4.03  
                                                            

Total interest bearing liabilities

    44,826,698       2,052,948   4.58 %     40,483,937       1,746,678   4.31 %     32,848,315       998,648    3.04 %

Noninterest bearing deposits

    5,469,774           5,361,014           4,972,890       

Other liabilities

    1,072,261           1,031,954           880,447       

Liabilities of discontinued operations

    160,430           173,287           224,575       

Shareholders’ equity

    6,680,464           5,600,906           4,357,314       
                                    

Total liabilities and shareholders’ equity

  $ 58,209,627         $ 52,651,098         $ 43,283,541       
                                    

Net interest income

    $ 1,644,437       $ 1,537,610       $ 1,323,738   
                              

Net yield on interest earning assets

      3.14 %       3.24 %        3.38 %
                              

 

Notes:

 

(1)   Fully taxable equivalent basis, assuming a Federal income tax rate of 35% for all years presented, and excluding disallowed interest expense.
(2)   Loans and leases on nonaccrual status have been included in the computation of average balances.
(3)   Based on average balances excluding fair value adjustments for available for sale securities.

 

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Table of Contents

Analysis of Changes in Interest Income and Interest Expense

 

The effects on interest income and interest expense due to volume and rate changes are outlined in the following table. Changes not due solely to either volume or rate are allocated to rate ($ in thousands):

 

     2007 versus 2006     2006 versus 2005  
     Increase (Decrease) Due
to Change in
          Increase (Decrease) Due
to Change in
       
     Average
Volume
(2)
    Average
Rate
    Increase
(Decrease)
    Average
Volume
(2)
    Average
Rate
    Increase
(Decrease)
 

Interest on earning assets:

            

Loans and leases (1)

   $ 330,390     $ 56,425     $ 386,815     $ 453,585     $ 442,867     $ 896,452  

Investment securities:

            

Taxable

     24,245       9,654       33,899       39,620       23,781       63,401  

Tax-exempt (1)

     (784 )     (3,375 )     (4,159 )     (1,427 )     (3,709 )     (5,136 )

Federal funds sold and security resale agreements

     (1,164 )     330       (834 )     2,554       3,645       6,199  

Trading securities (1)

     160       282       442       166       253       419  

Other short-term investments

     3,455       673       4,128       (134 )     1,190       1,056  

Loan to Metavante

     (7,221 )     27       (7,194 )     (529 )     40       (489 )

Total interest income change

   $ 339,899     $ 73,198     $ 413,097     $ 491,679     $ 470,223     $ 961,902  

Expense on interest bearing liabilities:

            

Interest bearing deposits:

            

Bank issued deposits:

            

Bank issued interest bearing activity deposits

   $ 52,337     $ 27,604     $ 79,941     $ 29,489     $ 165,983     $ 195,472  

Bank issued time deposits

     42,389       43,668       86,057       96,429       89,904       186,333  

Total bank issued deposits

     94,966       71,032       165,998       105,463       276,342       381,805  

Wholesale deposits

     (33,835 )     15,697       (18,138 )     16,789       122,246       139,035  

Total interest bearing deposits

     73,860       74,000       147,860       130,579       390,261       520,840  

Short-term borrowings

     54,186       (4,261 )     49,925       25,875       54,651       80,526  

Long-term borrowings

     69,191       39,294       108,485       75,811       70,853       146,664  

Total interest expense change

   $ 187,173     $ 119,097     $ 306,270     $ 232,123     $ 515,907     $ 748,030  

 

Notes:

 

(1)   Fully taxable equivalent basis, assuming a Federal income tax rate of 35% for all years presented, and excluding disallowed interest expense.
(2)   Based on average balances excluding fair value adjustments for available for sale securities.

 

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Summary of Loan and Lease Loss Experience and Credit Quality

 

The following table presents credit quality information as of and for the year ended December 31, 2007, as well as selected comparative years:

 

Consolidated Credit Quality Information

December 31, ($000’s)

 

     2007     2006     2005     2004     2003  

Nonperforming Assets by Type

          

Loans and Leases:

          

Nonaccrual

   $ 686,888     $ 264,890     $ 134,718     $ 127,722     $ 166,387  

Renegotiated

     224,398       125       143       236       278  

Past Due 90 Days or More

     13,907       2,991       5,725       4,405       6,111  
                                        

Total Nonperforming Loans and Leases

     925,193       268,006       140,586       132,363       172,776  

Other Real Estate Owned

     115,074       25,452       8,869       8,056       13,235  
                                        

Total Nonperforming Assets

   $ 1,040,267     $ 293,458     $ 149,455     $ 140,419     $ 186,011  
                                        

Allowance for Loan and Lease Losses

   $ 496,191     $ 420,610     $ 363,769     $ 358,110     $ 349,561  
                                        

Consolidated Statistics

          

Net Charge-offs to Average Loans and Leases

     0.59 %     0.10 %     0.12 %     0.11 %     0.21 %

Total Nonperforming Loans and Leases to Total Loans and Leases

     2.00       0.64       0.41       0.45       0.69  

Total Nonperforming Assets to Total Loans and Leases and Other Real Estate Owned

     2.24       0.70       0.44       0.48       0.74  

Allowance for Loan and Lease Losses to Total Loans and Leases

     1.07       1.00       1.06       1.21       1.39  

Allowance for Loan and Lease Losses to Nonperforming Loans and Leases

     54       157       259       271       202  

 

Nonperforming assets consist of nonperforming loans and leases and other real estate owned (“OREO”). Nonperforming loans and leases consist of nonaccrual, troubled-debt restructured loans which the Corporation refers as renegotiated, and loans and leases that are delinquent 90 days or more and still accruing interest. The balance of nonperforming loans and leases are affected by acquisitions and may be subject to fluctuation based on the timing of cash collections, renegotiations and renewals.

 

Generally, loans that are 90 days or more past due as to interest or principal are placed on nonaccrual. Exceptions to these rules are generally only for loans fully collateralized by readily marketable securities or other relatively risk free collateral. In addition, a loan may be placed on nonaccrual when management makes a determination that the facts and circumstances warrant such classification irrespective of the current payment status.

 

Maintaining nonperforming assets at an acceptable level is important to the ongoing success of a financial services institution. The Corporation employs a comprehensive credit review and approval process to help ensure that the amount of nonperforming assets on a long-term basis is minimized within the overall framework of acceptable levels of credit risk. In addition to the negative impact on net interest income and credit losses, nonperforming assets also increase operating costs due to the expense associated with collection efforts and the expenses of carrying OREO.

 

The Corporation had a significant increase in nonperforming assets and past due loans and leases in 2007 compared to 2006. The Corporation has been aggressive to isolate, identify and assess its underlying loan and lease portfolio credit quality and has developed and continues to develop strategies to reduce its loss exposure. The Corporation believes that its risk at the individual loan level remains manageable.

 

At December 31, 2007, nonaccrual loans amounted to $686.9 million or 1.48% of consolidated loans and leases compared to $264.9 million or 0.63% of consolidated loans and leases at December 31, 2006 and $134.7 million or 0.39% at December 31, 2005.

 

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The following table presents the major categories of nonaccrual loans at December 31, 2007 and 2006:

 

Major Categories of Nonaccrual Loans and Leases

($ in millions)

 

    December 31, 2007     December 31, 2006  
    Total
Loans &
Leases
  Pct of
Total
Loans
&
Leases
    Nonaccrual
Loans &
Leases
  Pct of
Nonaccrual
Loan &
Lease Type
    Total
Loans &
Leases
  Pct of
Total
Loans
&
Leases
    Nonaccrual
Loans &
Leases
  Pct of
Nonaccrual
Loan &
Lease Type
 

Commercial Loans & Leases

  $ 14,326   31.0 %   $ 48.8   0.34 %   $ 12,587   30.0 %   $ 51.5   0.41 %

Commercial Real Estate

               

Commercial Vacant Land & Construction

    4,957   10.7       216.1   4.36       4,115   9.8       40.7   0.99  

Other Commercial Real Estate

    11,097   24.0       84.1   0.76       10,236   24.4       53.1   0.52  
                                               

Total Commercial Real Estate

    16,054   34.7       300.2   1.87       14,351   34.2       93.8   0.65  

Residential Real Estate

               

1-4 Family

    4,593   9.9       59.6   1.30       4,000   9.5       22.7   0.57  

Residential Construction—Retail

    1,041   2.2       10.5   1.01       956   2.3       3.0   0.31  

Residential Vacant Land & Construction—Developer

    4,111   8.9       223.1   5.43       4,075   9.7       42.4   1.04  
                                               

Total Residential Real Estate

    9,745   21.0       293.2   3.01       9,031   21.5       68.1   0.75  

Consumer Loans & Leases

               

Home Equity Loans & Lines of Credit

    4,413   9.5       41.6   0.94       4,342   10.4       49.6   1.14  

Personal Loans & Leases

    1,758   3.8       3.1   0.18       1,624   3.9       1.9   0.11  
                                               

Total Consumer Loans & Leases

    6,171   13.3       44.7   0.72       5,966   14.3       51.5   0.86  
                                               

Total Loans & Leases

  $ 46,296   100.0 %   $ 686.9   1.48 %   $ 41,935   100.0 %   $ 264.9   0.63 %
                                               

 

The following table presents a geographical summary of nonaccrual loans at December 31, 2007:

 

Geographical Summary of Nonperforming Loans & Leases

($ in millions)

 

     December 31, 2007  
     Total
Loans &
Leases
   Pct of
Total
Loans
&

Leases
    Nonaccrual
Loans &
Leases
   Pct
Nonaccrual
of Total
Loans &
Leases
    Nonaccrual
Construction &
Development
Pct of Total
Nonaccrual
Loans &
Leases
 
            
            
            
            
            

Wisconsin

   $ 17,375    37.5 %   $ 92.7    0.53 %   12.5 %

Arizona

     7,706    16.7       181.6    2.36     74.9  

Minnesota

     4,965    10.7       48.9    0.98     44.7  

Missouri

     3,158    6.8       29.7    0.94     37.1  

Florida

     2,884    6.2       196.7    6.82     86.4  

Kansas & Oklahoma

     1,303    2.8       31.0    2.38     60.8  

Others

     8,905    19.3       106.3    1.19     65.7  
                                

Total Loans & Leases

   $ 46,296    100.0 %   $ 686.9    1.48 %   63.9 %
                                

 

Nonaccrual real estate loans, other than home equity loans and lines of credit, exhibited the largest increase in 2007 compared to 2006. Those increases reflect the effects of the deterioration in the national residential real estate markets. This housing-related stress exists in all of the Corporation’s markets and includes both core and acquired

 

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loans. More specifically, the Corporation’s construction and development real estate loans exhibited the most dramatic increase in stress and impairment especially in the west coast of Florida and Arizona. Nonaccrual construction and development loans represented 63.9% of total nonaccrual loans and leases at December 31, 2007. Approximately $260.0 million or 37.9% of the Corporation’s nonaccrual loans were less than 90 days past due at December 31, 2007.

 

The amount of nonaccrual commercial and consumer loans and leases decreased in 2007 compared to 2006. In addition, nonaccrual commercial and consumer loans and leases as a percent of total commercial and consumer loans and leases outstanding at December 31, 2007 showed improvement. Included in nonaccrual commercial loans and leases was approximately $5.0 million in nonaccrual loan balances associated with Franklin Credit Management Corp. (“Franklin”) and its subsidiaries that is discussed in more detail below.

 

Renegotiated loans amounted to $224.4 million at December 31, 2007 compared to $0.1 million at December 31, 2006. The entire increase in renegotiated loans relates to participations in commercial loans to Franklin and its subsidiaries. The original loans were used to acquire impaired first and second lien mortgage loans at discounts from other mortgage originators and to provide funding to a subsidiary of Franklin that originates sub-prime first mortgage loans. A forbearance agreement was executed between Franklin and its lenders providing for the forgiveness of certain debt owed by Franklin and the restructuring of the remaining debt. The Corporation’s total charge-off relating to Franklin amounted to $48 million including $19.7 million which was the Corporation’s pro rata share of the debt forgiven. At December 31, 2007, the Corporation’s total exposure to Franklin was approximately $229 million of which $224 million is classified as renegotiated and approximately $5 million, as previously discussed, is classified as nonaccrual. Franklin continued to be in compliance with the restructured terms and has reduced its loan balances by $15.0 million as of February 20, 2008. The Corporation anticipates the renegotiated portion of this credit relationship will be reclassified to performing next quarter.

 

Loans 90 days past due and still accruing amounted to $13.9 million at December 31, 2007 compared to $3.0 million at December 31, 2006 and $5.7 million at December 31, 2005. The increase in 2007 compared to 2006 was primarily associated with consumer loans and was driven by increases in home equity lines of credit and credit card loans.

 

Delinquency can be an indicator of potential problem loans and leases. At December 31, 2007, loans and leases past due 60-89 days and still accruing interest amounted to $183.5 million or 0.40% of total loans and leases outstanding compared to $89.1 million or 0.21% of total loans and leases outstanding at December 31, 2006, an increase of $94.4 million. Approximately $33.7 million or 35.7% of the increase relates to construction and land development loans, $28.0 million or 29.6% of the increase relates to other real estate-related loans and $31.8 million or 33.7% of the increase is related to commercial loans. Loans and leases past due 60-89 days and still accruing interest amounted to $33.0 million or 0.10% of total loans and leases outstanding at December 31, 2005.

 

In addition to its nonperforming loans and leases, the Corporation has loans and leases for which payments are presently current, but which management believes could possibly be classified as nonperforming in the near future. These loans are subject to constant management attention and their classification is reviewed on an ongoing basis. At December 31, 2007, such loans amounted to $469.2 million or 1.01% of total loans and leases outstanding compared to $109.1 million or 0.26% of total loans and leases outstanding at December 31, 2006 and $61.3 million or 0.18% of total loans and leases outstanding at December 31, 2005.

 

OREO is principally comprised of commercial and residential properties acquired in partial or total satisfaction of problem loans and amounted to $115.1 million, $25.5 million and $8.9 million at December 31, 2007, 2006 and 2005, respectively. Over half of the increase in OREO in 2007 compared to 2006 was attributable to construction and land development properties acquired in partial or total satisfaction of problem loans. At December 31, 2007 the composition of OREO was $65.9 million in construction and land development properties, $26.6 million in 1-4 family residential real estate properties and $22.6 million in commercial real estate properties. At December 31, 2007, the largest single exposure to an OREO property was less than $10 million. As a result of the soft real estate market and the increased possibility of foreclosures due to the elevated levels of nonperforming loans, management expects that OREO will continue to increase in 2008.

 

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The following table presents the reconciliation of the consolidated allowance for loan and lease losses for the year ended December 31, 2007, as well as selected comparative years:

 

Reconciliation of Consolidated Allowance for Loan and Lease Losses ($000’s)

 

    2007   2006   2005   2004   2003

Allowance for Loan and Lease Losses at Beginning of Year

  $ 420,610   $ 363,769   $ 358,110   $ 349,561   $ 338,409

Provision for Loan and Lease Losses

    319,760     50,551     44,795     37,963     62,993

Allowance of Banks and Loans Acquired

    11,713     45,258     —       27     —  

Loans and Leases Charged-off:

         

Commercial

    85,802     16,280     21,540     16,775     17,689

Real Estate—Construction and Development

    130,272     10,862     68     33     57

Real Estate—Mortgage

    33,660     11,878     21,147     13,259     15,192

Personal

    19,724     14,547     15,580     12,821     12,100

Leases

    1,887     1,863     1,189     7,967     24,625
                             

Total Charge-offs

    271,345     55,430     59,524     50,855     69,663

Recoveries on Loans and Leases:

         

Commercial

    6,714     6,910     11,758     12,631     8,736

Real Estate—Construction and Development

    912     82     1     2     88

Real Estate—Mortgage

    1,964     2,603     2,741     3,887     4,278

Personal

    3,946     4,247     3,069     3,327     3,058

Leases

    1,917     2,620     2,819     1,567     1,662
                             

Total Recoveries

    15,453     16,462     20,388     21,414     17,822
                             

Net Loans and Leases Charged-off

    255,892     38,968     39,136     29,441     51,841
                             

Allowance for Loan and Lease Losses at End of Year

  $ 496,191   $ 420,610   $ 363,769   $ 358,110   $ 349,561
                             

 

Net charge-offs amounted to $255.9 million or 0.59% of average loans and leases in 2007 compared to $39.0 million or 0.10% of average loans and leases in 2006 and $39.1 million or 0.12% of average loans and leases in 2005. The increase in net charge-offs in 2007 compared to prior years related primarily to the deterioration in the performance of the Corporation’s real estate loan portfolio. The Corporation’s construction and development real estate loans exhibited the most dramatic increase in impairment. In addition, loans whose performance is dependent on the housing market, such as the Franklin loan discussed above, were adversely affected by the deterioration in the national residential real estate markets.

 

Deteriorating conditions in the U.S. housing market became evident in the first half of 2007 and accelerated sharply in the second half of the year. Housing starts reached a 15-year low in September 2007 after being at a 33-year high in early 2006. Faced with these deteriorating conditions, some borrowers have been unable to either refinance or sell their properties and consequently have defaulted or are very close to defaulting on their loans. In a stressed housing market with increasing delinquencies and declining real estate values, such as currently exists, the adequacy of collateral securing the loan becomes a much more important factor in determining expected loan performance. The Corporation intensified its credit reviews in the current higher risk segments within its real estate portfolio. These reviews included re-assessing the timeliness and propriety of appraisals for collateral dependent loans especially in volatile real estate markets such as the west coast of Florida and Arizona. In addition, the Corporation re-evaluated the expected timing and amount of expected cash flows required to service debt under various scenarios for both nonperforming loans and performing loans that were considered to be at a higher risk of going into nonperforming status. In many cases, declining real estate values resulted in the determination that the collateral was insufficient to cover the recorded investment in the loan. For the year ended December 31, 2007, these factors resulted in the Corporation’s loan and lease portfolio experiencing significantly higher incidences of default and a significant increase in loss severity.

 

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Consistent with the credit quality trends noted above, the provision for loan and lease losses amounted to $319.8 million in 2007. By comparison, the provision for loan and lease losses amounted to $50.6 million and $44.8 million in 2006 and 2005, respectively. The provisions for loan and lease losses are the amounts required to establish the allowance for loan and lease losses at the required level after considering charge-offs and recoveries. The ratio of the allowance for loan and lease losses to total loans and leases was 1.07% at December 31, 2007 compared to 1.00% at December 31, 2006 and 1.06% at December 31, 2005.

 

The following table presents the allocation of the consolidated allowance for loan and lease losses at December 31, 2007, as well as selected comparative years:

 

Allocation of the Allowance for Loan and Lease Losses ($000’s)

 

     December 31, 2007     December 31, 2006     December 31, 2005  
     Amount    Percent of
Loans and
Leases to
Total Loans
and Leases
    Amount    Percent of
Loans and
Leases to
Total Loans
and Leases
    Amount    Percent of
Loans and
Leases to
Total Loans
and Leases
 

Balance at end of period applicable to:

               

Commercial, Financial & Agricultural

   $ 205,258    29.8 %   $ 251,475    28.7 %   $ 222,078    28.0 %

Real Estate

               

Residential Mortgage

     46,755    30.6       20,454    31.9       12,921    34.9  

Commercial Mortgage

     185,601    34.7       83,510    34.2       63,813    30.5  

Personal

     26,889    3.3       18,434    3.5       24,153    4.7  

Lease Financing

     31,688    1.6       46,737    1.7       40,804    1.9  
                                       

Total

   $ 496,191    100.0 %   $ 420,610    100.0 %   $ 363,769    100.0 %
                                       

 

     December 31, 2004     December 31, 2003  
     Amount    Percent of
Loans and
Leases to
Total Loans
and Leases
    Amount    Percent of
Loans and
Leases to
Total Loans
and Leases
 

Balance at end of period applicable to:

          

Commercial, Financial & Agricultural

   $ 244,042    28.7 %   $ 237,510    28.2 %

Real Estate

          

Residential Mortgage

     12,311    32.6       28,369    29.9  

Commercial Mortgage

     49,965    31.7       37,013    32.7  

Personal

     14,252    5.2       18,213    6.9  

Lease Financing

     37,540    1.8       28,456    2.3  
                          

Total

   $ 358,110    100.0 %   $ 349,561    100.0 %
                          

 

Management expects the stresses in the national housing markets will continue in 2008. The Corporation will continue to proactively manage its problem loans and nonperforming assets and be aggressive to isolate, identify and assess its underlying loan and lease portfolio credit quality. The Corporation believes that its risk at the individual loan level remains manageable and has developed and continues to develop strategies to mitigate its loss exposure. If the real estate market does not improve or continues to deteriorate, the Corporation expects the levels of nonaccrual loans and leases and OREO will continue to increase in 2008. Construction and development loans tend to be more complex and may take more time to attain a satisfactory resolution. Depending on the facts and circumstances, acquiring real estate collateral in partial or total satisfaction of problem loans may continue to be the best course of action to take in order to mitigate the Corporation’s exposure to loss. Management expects the provision for loan and lease losses in 2008 will continue to be higher than its pre-2007 historical experience would imply and estimates that a provision for loan and lease losses in the range of $50 million to $55 million per quarter may be appropriate in 2008. As the Corporation works towards the resolution of its nonperforming loans and leases, the provision for loan and lease losses could exceed management’s expectations in any quarter or quarters in 2008. The volatility in the housing markets, general economic conditions and numerous other unknown factors at this time will ultimately determine the timing and amount of net charge-offs and provision for loan and lease losses recognized in 2008 and those amounts could be significantly different than management’s current expectations.

 

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Other Income

 

Total other income amounted to $729.1 million in 2007 compared to $581.7 million in 2006. As previously discussed, total other income in 2006 includes a loss of $18.4 million from applying fair value accounting (versus hedge accounting) to interest rate swaps associated with transactions that did not qualify for hedge accounting. Excluding that loss, total other income amounted to $600.1 million in 2006 and the increase in total other income in 2007 compared to 2006 was $129.0 million or 21.5%. Wealth management revenue was a significant contributor to the growth in other income in 2007 compared to 2006. Gains from the sale of branches and investment securities gains offset lower mortgage banking revenue in 2007 compared to 2006.

 

Wealth management revenue was $262.8 million in 2007 compared to $221.6 million in 2006, an increase of $41.2 million or 18.6%. Wealth management revenue attributable to the April 20, 2007 acquisition of North Star Financial Corporation and a full year of revenue attributable to the April 1, 2006 acquisition of wealth management products and services from Gold Banc Corporation, Inc. (“Gold Banc”) contributed approximately $5.0 million to the growth in wealth management revenue in 2007 compared to 2006. Continued success in the cross-selling and integrated delivery initiatives, improved investment performance and improving results in institutional sales efforts and outsourcing activities were the primary contributors to the remaining revenue growth in 2006 and 2007. Assets under management were $25.7 billion at December 31, 2007 compared to $22.5 billion at December 31, 2006, an increase of $3.2 billion or 14.2%. Assets under administration increased by $10.2 billion or 10.7% and amounted to $105.7 billion at December 31, 2007. Management expects wealth management revenue to show high single-digit to low double-digit percentage growth rates in 2008. Wealth management revenue is affected by market volatility and direction which could cause wealth management revenue growth in 2008 to differ from the revenue growth expected by management.

 

Service charges on deposits amounted to $120.6 million in 2007 compared to $106.7 million in 2006, an increase of $13.9 million or 13.0%. The banking acquisitions contributed $3.3 million to the growth in service charges on deposits in 2007 compared to 2006. A portion of this source of fee income is sensitive to changes in interest rates. In a declining rate environment, customers that pay for services by maintaining eligible deposit balances receive a lower earnings credit that results in higher fee income. Excluding the effect of the banking acquisitions, higher service charges on deposits associated with commercial demand deposits accounted for the majority of the increase in revenue in 2007 compared to 2006.

 

Total mortgage banking revenue was $34.1 million in 2007 compared with $52.4 million in 2006, a decrease of $18.3 million or 35.0%. During 2007, the Corporation sold $1.8 billion of residential mortgage and home equity loans to the secondary market. During 2006, the Corporation sold $2.3 billion of loans to the secondary market. The retained interests in the form of mortgage servicing rights in 2007 and 2006 were not material and at December 31, 2007, the carrying value of mortgage servicing rights was insignificant.

 

Net investment securities gains amounted to $34.8 million in 2007 compared to $9.7 million in 2006. Net gains associated with the Corporation’s Capital Markets Group investments amounted to $7.6 million in 2007 compared to $4.6 million in 2006. During 2007, the Corporation sold its investment in MasterCard Class B common shares at a gain of $19.0 million and sold other equity securities at a gain of $7.2 million. The Corporation sold these equity securities in order to monetize the significant appreciation in market price of the securities over the period in which they were held. During 2007, the Corporation also sold $672.9 million of government agency investment securities designated as available for sale at a gain of $4.3 million. No individual available for sale investment security sold was temporarily impaired at the time of sale. Other than temporary impairment on the residual interests held in the form of interest-only strips associated with the Corporation’s auto securitization activities resulted in a loss of $1.9 million in 2007.

 

Life insurance revenue amounted to $37.7 million in 2007 compared to $29.1 million in 2006, an increase of $8.6 million or 29.6%. During 2007, the Corporation purchased $286.6 million of additional bank-owned life insurance. That purchase along with bank-owned life insurance acquired in the banking acquisitions were the primary contributors to the increase in life insurance revenue in 2007 compared to 2006.

 

Other noninterest income amounted to $239.0 million in 2007 compared to $180.7 million in 2006, an increase of $58.3 million or 32.3%. During 2007, the Corporation sold its three branches in the Tulsa, Oklahoma market at a gain of $29.0 million. As previously discussed, during 2007 $370.0 million of floating rate FHLB advances were extinguished and the pay fixed / receive floating interest rate swaps that were designated as cash flow hedges on the

 

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FHLB advances were terminated. The gain realized from these transactions was primarily due to the acceleration of the fair value adjustments for the interest rate swaps that were recorded in other comprehensive income and amounted to $5.3 million. The banking acquisitions contributed approximately $2.1 million to the year-over-year growth in other noninterest income. Card-related fees (credit, debit, ATM and stored value) increased $8.2 million in 2007 compared to 2006. Trading and investment commissions and fees increased other noninterest income by $11.0 million in 2007 compared to 2006.

 

Total other income amounted to $581.7 million in 2006 compared to $573.6 million in 2005, an increase of $8.1 million or 1.4%. As previously discussed, total other income in 2006 included a loss of $18.4 million from applying fair value accounting (versus hedge accounting) to interest rate swaps associated with transactions that did not qualify for hedge accounting. Excluding that loss, total other income amounted to $600.1 million in 2006 compared to $573.6 million in 2005, an increase of $26.5 million or 4.6%. Wealth management revenue was the primary contributor to the growth in other income in 2006 compared to 2005. That growth was offset by lower investment securities gains in 2006 compared to the prior year.

 

Wealth management revenue was $221.6 million in 2006 compared to $191.7 million in 2005, an increase of $29.9 million or 15.6%. Wealth management revenue attributable to the previously reported January 3, 2006 acquisition of certain assets of FirstTrust Indiana and the acquisition of wealth management products and services from Gold Banc amounted to $3.8 million and $3.7 million, respectively. Continued success in the cross-selling and integrated delivery initiatives, improved investment performance and improving results in institutional sales efforts and outsourcing activities were the primary contributors to the remaining revenue growth over the respective year. Assets under management were $22.5 billion at December 31, 2006 compared to $18.9 billion at December 31, 2005, an increase of $3.6 billion or 19.2%. Assets under administration increased by $12.7 billion or 15.3% and amounted to $95.5 billion at December 31, 2006.

 

Service charges on deposits amounted to $106.7 million in 2006 compared to $101.9 million in 2005, an increase of $4.8 million or 4.7%. The banking acquisitions contributed $6.4 million of service charges on deposits in 2006. A portion of this source of fee income is sensitive to changes in interest rates. In a rising rate environment, customers that pay for services by maintaining eligible deposit balances receive a higher earnings credit that results in lower fee income. Excluding the effect of the banking acquisitions, lower service charges on deposits associated with commercial demand deposits accounted for the majority of the decline in revenue in 2006 compared to 2005.

 

Total mortgage banking revenue was $52.4 million in 2006 compared with $50.5 million in 2005, an increase of $1.9 million or 3.8%. During 2006, the Corporation sold $2.3 billion of residential mortgage and home equity loans to the secondary market. During 2005, the Corporation sold $2.4 billion of loans to the secondary market. The retained interests in the form of mortgage servicing rights in 2006 and 2005 were not material and at December 31, 2006, the carrying value of mortgage servicing rights was insignificant.

 

Net investment securities gains amounted to $9.7 million in 2006 compared to $45.5 million in 2005. Net gains associated with the Corporation’s Capital Markets Group investments amounted to $4.6 million in 2006 compared to $32.3 million in 2005. During 2005, the Corporation realized a gain of $6.6 million due to the sale of an equity investment in a cash tender offer. In addition, during 2005, the Corporation’s banking segment’s investment in certain membership interests of PULSE was liquidated due to a change in control. The cash received resulted in a gain of $5.6 million.

 

As previously discussed, net derivative losses—discontinued hedges that amounted to $18.4 million in 2006, represent the mark-to-market adjustments associated with certain interest rate swaps. Based on expanded interpretations of the accounting standard for derivatives and hedge accounting, specifically hedge designation under the “matched-terms” method, it was determined that certain transactions did not qualify for hedge accounting. As a result, any fluctuation in the fair value of the interest rate swaps was recorded in earnings with no corresponding offset to the hedged items or accumulated other comprehensive income. The affected interest rate swaps were terminated in 2006 in order to avoid future earnings volatility due to mark-to-market accounting. Management believes the changes in earnings based on market volatility are not reflective of the core performance trends of the Corporation.

 

Other noninterest income amounted to $180.7 million in 2006 compared to $156.9 million in 2005, an increase of $23.8 million or 15.2%. The banking acquisitions contributed approximately $1.2 million to the year-over-year growth in other noninterest income. Card-related fees (credit, debit, ATM and stored value) increased $10.5 million in 2006

 

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compared to 2005. Trading and investment commissions and fees and lower auto securitization losses increased other noninterest income by $9.9 million in 2006 compared to 2005. Other noninterest income in 2005 includes gains from the sale of certain trust custody businesses and gains from branch divestitures that aggregated $5.1 million.

 

Other Expense

 

Total other expense amounted to $1,314.9 million in 2007 compared to $1,083.5 million in 2006, an increase of $231.4 million or 21.4%. Total other expense in 2007 includes losses on debt terminations of $83.7 million, charitable contribution expense of $25.0 million and loss accruals associated with the Visa litigation of $25.8 million. These items accounted for $134.5 million of the expense growth in 2007 compared to 2006.

 

The banking and wealth management acquisitions (the “Acquisitions”) impacted the year-to-year comparability of operating expenses in 2007 compared to 2006. Approximately $38.3 million of the 2007 versus 2006 operating expense growth was attributable to the Acquisitions. As all of the Acquisitions were accounted for using the purchase method of accounting, the operating expenses of the acquired entities are included in the consolidated operating expenses from the dates the Acquisitions were completed. Operating expenses associated with Acquisitions completed in 2006 are reflected for the full year in 2007 as opposed to a partial year in 2006. Acquisitions completed in 2007 directly affect the current year but have no impact on the prior year.

 

The Corporation estimates that its expense growth in 2007 compared to 2006, excluding the effect of the Acquisitions, losses on debt terminations, the charitable contribution and Visa litigation matters was approximately $58.6 million or 5.7%.

 

Expense control is sometimes measured in the financial services industry by the efficiency ratio statistic. The efficiency ratio is calculated by dividing total other expense by the sum of total other income (including Capital Markets Group-related investment gains but excluding other securities gains and losses and excluding derivative losses-discontinued hedges) and net interest income FTE. The Corporation’s efficiency ratios for the years ended December 31, 2007, 2006, and 2005 were:

 

Efficiency Ratios

   2007     2006     2005  

Consolidated Corporation

   56.0 %   50.8 %   50.7 %

 

The Corporation’s 2007 efficiency ratio statistic was adversely impacted by the losses on debt terminations, charitable contribution expense and loss accruals associated with the Visa litigation. Conversely, the Corporation’s 2007 efficiency ratio statistic was positively impacted by the divestiture of three branches in the Tulsa, Oklahoma market that were sold at a gain of $29.0 million. Excluding these items, the Corporation estimates that its pro forma efficiency ratio statistic for 2007 was approximately 50.9%. In addition to integrating the acquisition of First Indiana Corporation, the Corporation anticipates that it will continue updating many of its internal systems, expects to continue its de novo branch expansion in higher growth markets and may experience increased operating costs due to the expense associated with nonperforming assets in 2008. Management expects the efficiency ratio statistic will be in the range of 51.0% to 53.0% in 2008.

 

Salaries and employee benefits expense amounted to $659.9 million in 2007 compared to $613.4 million in 2006, an increase of $46.5 million or 7.6%. Salaries and benefits expense related to the Acquisitions contributed approximately $25.7 million to the expense growth in 2007 compared to 2006.

 

Net occupancy and equipment expense amounted to $112.0 million in 2007 compared to $104.0 million in 2006, an increase of $8.0 million. Net occupancy and equipment expense related to the Acquisitions contributed approximately $4.1 million to the expense growth in 2007 compared to 2006.

 

Software and processing expenses amounted to $156.2 million in 2007 compared to $142.3 million in 2006, an increase of $13.9 million or 9.8%. Increased volumes of processing associated with the Acquisitions along with increased expense associated with new and enhanced commercial and consumer internet banking and deposit system applications as well as other technology enhancements and reduced useful lives associated with lockbox and image

 

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software accounted for the increase in software and processing expenses in 2007 compared to 2006. Management expects the Corporation will continue to invest and implement state-of-the-art systems and technology to meet customers’ needs, manage and measure its business risks, ensure compliance with laws and regulations and increase efficiencies.

 

Supplies and printing expense and shipping and handling expense amounted to $42.5 million in 2007 compared to $41.3 million in 2006, an increase of $1.2 million or 3.0%. The Acquisitions contributed approximately $0.5 million to the expense growth in 2007 compared to 2006.

 

Professional services fees amounted to $42.5 million in 2007 compared to $34.1 million in 2006, an increase of $8.4 million or 24.6%. The Acquisitions contributed approximately $2.3 million to the expense growth in 2007 compared to 2006. Increased legal fees associated with problem loans and increased other professional fees associated with process improvement and customer security consulting also contributed to the increase in professional services fees in 2007 compared to 2006.

 

Amortization of intangibles amounted to $20.6 million in 2007 compared to $18.6 million in 2006. Amortization of intangibles increased $3.2 million in 2007 compared to 2006 due to the Acquisitions. Goodwill is subject to periodic tests for impairment. The Corporation updated the analysis during 2007 and concluded that there continues to be no impairment with respect to goodwill at any reporting unit. At December 31, 2007, none of the Corporation’s other intangible assets were determined to have indefinite lives.

 

Losses on termination of debt amounted to $83.7 million in 2007. During 2007, the Corporation called the $200 million 7.65% junior subordinated deferrable interest debentures and the related M&I Capital Trust A 7.65% trust preferred securities. The loss, which was primarily due to the contractual call premium, amounted to $9.5 million. The Corporation also terminated $1,000 million PURS in 2007. The loss, which was primarily the cost of purchasing the right to remarket the PURS through 2016, amounted to $74.2 million.

 

Other noninterest expense amounted to $197.6 million in 2007 compared to $129.9 million in 2006, an increase of $67.7 million or 52.1%. Included in other noninterest expense in 2007 was the $25.0 million charitable contribution and the Visa loss accrual in the amount of $25.8 million, as previously discussed. Excluding those items, other noninterest expense amounted to $146.8 million in 2007 compared to $129.9 million in 2006, an increase of $16.9 million or 13.0%. Expenses associated with other real estate owned increased $4.6 million in 2007 compared to 2006. The Acquisitions contributed approximately $5.9 million to the growth in other noninterest expense in 2007 compared to 2006.

 

The Visa litigation is discussed in Note 25 of the Notes to Consolidated Financial Statements contained in Item 8, Consolidated Financial Statements and Supplementary Data.

 

Total other expense amounted to $1,083.5 million in 2006 compared to $954.4 million in 2005, an increase of $129.1 million or 13.5%.

 

The Acquisitions impacted the year-to-year comparability of operating expenses in 2006 compared to 2005. Approximately $73.8 million of the 2006 operating expense growth compared to 2005 was attributable to the Acquisitions.

 

The Corporation estimates that its expense growth in 2006 compared to 2005, excluding the effect of the Acquisitions was approximately $55.3 million or 5.8%.

 

Salaries and employee benefits expense amounted to $613.4 million in 2006 compared to $549.9 million in 2005, an increase of $63.5 million or 11.6%. Salaries and benefits expense related to the Acquisitions contributed approximately $34.6 million to the expense growth in 2006 compared to 2005.

 

Net occupancy and equipment expense amounted to $104.0 million in 2006 compared to $85.3 million in 2005, an increase of $18.7 million or 22.0%. Net occupancy and equipment expense related to the Acquisitions contributed approximately $10.3 million to the expense growth in 2006 compared to 2005.

 

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Software and processing expenses amounted to $142.3 million in 2006 compared to $114.4 million in 2005, an increase of $27.9 million or 24.4%. In addition to the expense increase due to the increase in volumes of processing associated with the Acquisitions, other software and processing expenses directly related to the Acquisitions contributed approximately $9.0 million to the expense growth in 2006 compared to 2005. Increased expense associated with the development of new commercial internet banking applications as well as other technology enhancements and services accounted for the increase in software and processing expenses in 2006 compared to 2005.

 

Supplies and printing expense, professional services expense and shipping and handling expense amounted to $75.4 million in 2006 compared to $68.5 million in 2005, an increase of $6.9 million or 10.0%. The Acquisitions contributed approximately $3.8 million to the expense growth in 2006 compared to 2005.

 

Amortization of intangibles amounted to $18.6 million in 2006 compared to $13.1 million in 2005. Amortization of intangibles increased $8.0 million in 2006 compared to 2005 due to the Acquisitions.

 

The Acquisitions contributed the majority of the increase in other noninterest expense which amounted to $129.9 million in 2006 compared to $123.3 million in 2005, an increase of $6.6 million or 5.3%.

 

Income Tax Provision

 

The provision for income taxes was $213.6 million in 2007, $307.4 million in 2006, and $278.1 million in 2005. The effective tax rate in 2007 was 30.1% compared to 32.2% in both 2006 and 2005, respectively. The lower effective tax rate in 2007 reflects, in part, the effect of the increase in tax-exempt income, primarily life insurance revenue, as previously discussed and increased tax benefits from programs and activities that are eligible for federal income tax credits. Some of these programs and activities provide annual tax benefits in the form of federal income tax credits in future periods as long as the programs and activities continue to qualify under the federal tax regulations.

 

Liquidity and Capital Resources

 

Shareholders’ equity was $7.0 billion or 11.8% of total consolidated assets at December 31, 2007, compared to $6.2 billion or 10.9% of total consolidated assets at December 31, 2006.

 

In the second quarter of 2007, the Corporation’s Board of Directors authorized an increase in the quarterly cash dividend paid on the Corporation’s common stock, from $0.27 per share to $0.31 per share, or 14.8%.

 

Shareholders’ equity at December 31, 2007 includes the effect of certain common stock issuances during the current year. In 2007, the Corporation issued 403,508 shares of its common stock valued at $19.2 million to fund its 2006 obligations under its retirement and employee stock ownership plans. During 2007, the Corporation issued 4,410,647 shares of its common stock and exchanged fully vested stock options to purchase its common stock with a total value of $219.6 million in connection with the Corporation’s acquisition of United Heritage Bankshares of Florida, Inc. (“United Heritage”). Also during 2007, the Corporation issued 441,252 shares of its common stock with a total value of $21.0 million in connection with the Corporation’s acquisition of North Star Financial Corporation. During 2007, the Corporation remarketed the 3.90% STACKS of M&I Capital Trust B that were originally issued in 2004 as components of the Corporation’s 6.50% Common SPACES. In connection with the remarketing, the annual interest rate on the remarketed STACKS was reset at 5.626%, M&I Capital Trust B was liquidated and the Corporation issued $400 million of 5.626% senior notes that mature on August 17, 2009 in exchange for the outstanding STACKS. Each Common SPACES also included a stock purchase contract requiring the holder to purchase, in accordance with a settlement rate formula, shares of the Corporation’s common stock. The Corporation issued 9,226,951 shares of its common stock in settlement of the stock purchase contracts in exchange for $400 million in cash.

 

The Corporation has a Stock Repurchase Program under which up to 12 million shares of the Corporation’s common stock can be repurchased annually. During 2007, the Corporation completed three accelerated repurchase transactions as well as open market repurchase transactions under its authorized Stock Repurchase Program. In the aggregate, the Corporation acquired 10,765,889 shares of its common stock in these transactions. Total consideration in

 

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these transactions amounted to $437.1 million and consisted of cash of $434.5 million and common treasury stock valued at $2.6 million. In connection with the initial accelerated repurchase transaction completed in 2007, the Corporation used 54,035 shares of its treasury common stock to share-settle the final settlement obligation. During 2006, the Corporation repurchased 1.0 million shares of its common stock at an aggregate cost of $41.8 million.

 

At December 31, 2007, the net loss in accumulated other comprehensive income amounted to $53.7 million which represents a negative change in accumulated other comprehensive income of $36.2 million since December 31, 2006. Net accumulated other comprehensive income associated with available for sale investment securities was a net loss of $10.3 million at December 31, 2007, compared to a net loss of $22.0 million at December 31, 2006, resulting in a net gain of $11.7 million over the twelve month period. The unrealized loss associated with the change in fair value of the Corporation’s derivative financial instruments designated as cash flow hedges increased $46.5 million since December 31, 2006, resulting in a net decrease in shareholders’ equity. The accumulated other comprehensive income which represents the amount required to adjust the Corporation’s postretirement health benefit liability to its funded status amounted to an unrealized gain of $3.5 million as of December 31, 2007.

 

Federal and state banking laws place certain restrictions on the amount of dividends and loans which a bank may make to its parent company. Such restrictions have not had, and are not expected to have, any material effect on the Corporation’s ability to meet its cash obligations.

 

The Corporation manages its liquidity to ensure that funds are available to each of its banks to satisfy the cash flow requirements of depositors and borrowers and to ensure the Corporation’s own cash requirements are met. The Corporation maintains liquidity by obtaining funds from several sources.

 

The Corporation’s most readily available source of liquidity is its investment portfolio. Investment securities available for sale, which totaled $7.4 billion at December 31, 2007, represent a highly accessible source of liquidity. The Corporation’s portfolio of held-to-maturity investment securities, which totaled $0.4 billion at December 31, 2007, provides liquidity from maturities and interest payments. The Corporation’s loans held for sale provide additional liquidity. At December 31, 2007 these loans represent recently funded loans that are prepared for delivery to investors, which generally occurs within thirty to ninety days after the loan has been funded.

 

Depositors within M&I’s defined markets are another source of liquidity. Core deposits (demand, savings, money market and consumer time deposits) averaged $21.8 billion in 2007. The Corporation’s banking affiliates may also access the Federal funds markets or utilize collateralized borrowings such as treasury demand notes or FHLB advances.

 

The Corporation’s banking affiliates may use wholesale deposits, which include foreign (Eurodollar) deposits. Wholesale deposits, which averaged $6.6 billion in 2007, are funds in the form of deposits generated through distribution channels other than the Corporation’s own banking branches. These deposits allow the Corporation’s banking subsidiaries to gather funds across a national geographic base and at pricing levels considered attractive, where the underlying depositor may be retail or institutional. Access to wholesale deposits also provides the Corporation with the flexibility not to pursue single service time deposit relationships in markets that have experienced some unprofitable pricing levels.

 

The Corporation may use certain financing arrangements to meet its balance sheet management, funding, liquidity, and market or credit risk management needs. The majority of these activities are basic term or revolving securitization vehicles. These vehicles are generally funded through term-amortizing debt structures or with short-term commercial paper designed to be paid off based on the underlying cash flows of the assets securitized. These facilities provide access to funding sources substantially separate from the general credit risk of the Corporation and its subsidiaries.

 

The Corporation’s lead bank, M&I Marshall & Ilsley Bank (“M&I Bank”), has implemented a global bank note program that permits it to issue up and sell up to a maximum of US$13.0 billion aggregate principal amount (or the equivalent thereof in other currencies) at any one time outstanding of its senior global bank notes with maturities of seven days or more from their respective date of issue and subordinated global bank notes with maturities more than five years from their respective date of issue. The notes may be fixed rate or floating rate and the exact terms will be specified in the applicable Pricing Supplement or the applicable Program Supplement. This program is intended to

 

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enhance liquidity by enabling M&I Bank to sell its debt instruments in global markets in the future without the delays that would otherwise be incurred. At December 31, 2007, approximately $10.3 billion of new debt could be issued under M&I Bank’s global bank note program.

 

Bank notes outstanding at December 31, 2007, amounted to $5.6 billion of which $1.9 billion is subordinated. A portion of the subordinated bank notes qualifies as supplementary capital for regulatory capital purposes.

 

The national capital markets represent a further source of liquidity to the Corporation.

 

As a result of the Separation, on November 1, 2007, Marshall & Ilsley Corporation (Accounting Predecessor to New Marshall & Ilsley Corporation) became M&I LLC and amounts remaining under the existing shelf registration statements were deregistered. There will be no further issuances of debt by M&I LLC.

 

On November 6, 2007, New Marshall & Ilsley Corporation filed a shelf registration statement pursuant to which the Corporation is authorized to raise up to $1.9 billion through sales of corporate debt and/or equity securities with a relatively short lead time. In addition, the Corporation has a commercial paper program. At December 31, 2007, commercial paper outstanding amounted to $0.8 billion of which $0.2 billion represents commercial paper obligations of M&I LLC.

 

The market impact of the deterioration in the national residential real estate markets which includes the sub-prime mortgage crisis has been substantial. These events have resulted in a decline in market confidence and a subsequent strain on liquidity. However, the Separation provided the Corporation with over two billion dollars in cash and significantly increased its regulatory and tangible capital levels. Management expects that it will continue to make use of a wide variety of funding sources, including those that have not shown the levels of stress demonstrated in some of the national capital markets. Notwithstanding the current national capital market impact on the cost and availability of liquidity, management believes that it has adequate liquidity to ensure that funds are available to the Corporation and each of its banks to satisfy their cash flow requirements. If capital markets deteriorate more than management currently expects, the Corporation could experience further stress on its liquidity position and ability to increase assets.

 

Contractual Obligations

 

The following table summarizes the Corporation’s more significant contractual obligations at December 31, 2007. Excluded from the following table are a number of obligations to be settled in cash. These items are reflected in the Corporation’s consolidated balance sheet and include deposits with no stated maturity, trade payables, accrued interest payable and derivative payables that do not require physical delivery of the underlying instrument.

 

Contractual Obligations

   Note
Ref
    Payments Due by Period ($ in millions)
     Total    Less than
One Year
   One to
Three Years
   Three to
Five Years
   More than
Five Years

Certificate of Deposit and Other Time Deposit Obligations

   (1 )   $ 15,095.6    $ 11,811.3    $ 1,175.7    $ 980.1    $ 1,128.5

Short-term Debt Obligations

   (2 )     6,811.0      6,811.0      —        —        —  

Long-term Debt Obligations

   (3 )     11,739.3      2,111.1      3,923.1      3,680.4      2,024.7

Minimum Operating Lease Obligations

       203.4      27.0      50.3      38.0      88.1

Obligations to Purchase Foreign Currencies

   (4 )     479.3      479.3      —        —        —  

Purchase Obligations—Facilities (Additions, Repairs and Maintenance)

       29.2      29.1      0.1      —        —  

Purchase Obligations—Technology

       49.1      11.6      16.6      11.9      9.0

Purchase Obligations—Other

       0.7      0.6      0.1      —        —  

Other Obligations:

                

Unfunded Investment Obligations

   (5 )     26.3      16.5      8.2      1.1      0.5

Defined Contribution Pension Obligations

   (6 )     44.0      44.0      —        —        —  

Health and Welfare Benefits

   (7 )     —        —        —        —        —  
                                    

Total

     $ 34,477.9    $ 21,341.5    $ 5,174.1    $ 4,711.5    $ 3,250.8
                                    

 

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Notes:

 

In the banking industry, interest-bearing obligations are principally utilized to fund interest-bearing assets. As such, interest charges on certificate of deposit and other time deposit obligations and short-term debt obligations were excluded from amounts reported, as the potential cash outflows would have corresponding cash inflows from interest-bearing assets. The same, although to a lesser extent, is the case with respect to interest charges on long-term debt obligations. As long-term debt obligations may be used for purposes other than to fund interest-bearing assets, an estimate of interest charges is included in the amounts reported.

 

As of December 31, 2007, the Corporation has unrecognized tax benefits that if recognized, would impact the annual effective tax rate in future periods. Due to the uncertainty of the amounts to be ultimately paid as well as the timing of such payments, all uncertain tax liabilities that have not been paid have been excluded from the Contractual Obligations table. See Note 17 in Notes to Consolidated Financial Statements for further information regarding the Corporation’s income taxes.

 

  (1)   Certain retail certificates of deposit and other time deposits give customers rights to early withdrawal. Early withdrawals may be subject to penalties. The penalty amount depends on the remaining time to maturity at the time of early withdrawal. Brokered certificates of deposits may be redeemed early upon the death or adjudication of incompetence of the holder.
  (2)   See Note 14 in Notes to Consolidated Financial Statements for a description of the Corporation’s various short-term borrowings. Many short-term borrowings such as Federal funds purchased and security repurchase agreements and commercial paper are expected to be reissued and, therefore, do not necessarily represent an immediate need for cash.
  (3)   See Note 15 in Notes to Consolidated Financial Statements for a description of the Corporation’s various long-term borrowings. The amounts shown in the table include interest on both fixed and variable rate obligations. The interest associated with variable rate obligations is based upon rates in effect at December 31, 2007. The contractual amounts to be paid on variable rate obligations are affected by changes in market interest rates. Future changes in market interest rates could materially affect the contractual amounts to be paid.
  (4)   See Note 21 in Notes to Consolidated Financial Statements for a description of the Corporation’s foreign exchange activities. The Corporation generally matches commitments to deliver foreign currencies with obligations to purchase foreign currencies which minimizes the immediate need for cash.
  (5)   The Corporation also has unfunded obligations for certain investments in investment funds. Under the obligations for certain investments in investment funds the Corporation could be required to invest an additional $45.6 million if the investment funds identify and commit to invest in additional qualifying investments. The investment funds have limited lives and defined periods for investing in new qualifying investments or providing additional funds to existing investments. As a result, the timing and amount of the funding requirements for these obligations are uncertain and could expire with no additional funding requirements.
  (6)   See Note 19 in Notes to Consolidated Financial Statements for a description of the Corporation’s defined contribution program. The amount shown represents the unfunded contribution for the year ended December 31, 2007.
  (7)   The health and welfare benefit plans are periodically funded throughout each plan year with participant contributions and the Corporation’s portion of benefits expected to be paid.

 

The Corporation has generally financed its growth through the retention of earnings and the issuance of debt. It is expected that future growth can be financed through internal earnings retention, additional debt offerings, or the issuance of additional common or preferred stock or other capital instruments.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

The term off-balance sheet arrangement describes the means through which companies typically structure off-balance sheet transactions or otherwise incur risks of loss that are not fully transparent to investors or other users of financial information. For example, in many cases, in order to facilitate transfer of assets or otherwise finance the activities of an unconsolidated entity, a company may be required to provide financial support designed to reduce the

 

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risks to the entity or other third parties. That financial support may take many different forms such as financial guarantees, subordinated retained interests, derivative instruments or other contingent arrangements that expose the company to continuing risks or contingent liabilities regardless of whether or not they are recorded on the balance sheet.

 

Certain guarantees may be a source of potential risk to future liquidity, capital resources and results of operations. Guarantees may be in the form of contracts that contingently require the guarantor to make p