WesBanco 10-K 2005
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
For the fiscal year ended December 31, 2004
For the transition period from to
Commission File Number 0-8467
(Exact name of Registrant as specified in its charter)
Registrants telephone number, including area code: 304-234-9000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
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 þ 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 registrants 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. ¨
Indicate by check mark whether the Registrant is an accelerated filer as defined by Rule 12b-2 of the Exchange Act. Yes þ No ¨
The aggregate market value of the Registrants outstanding voting common stock held by nonaffiliates on June 30, 2004, determined using a per share closing price on that date of $29.13, was approximately $514,885,130.
As of February 28, 2005, there were 23,143,501 shares of WesBanco, Inc. common stock $2.0833 par value per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The portions of the definitive Proxy Statement of WesBanco, Inc. for the Annual Meeting of Shareholders to be held on April 20, 2005 (Proxy Statement), which will be filed within 120 days of December 31, 2004, referred to in Part III of this Form 10-K are incorporated by reference.
TABLE OF CONTENTS
WesBanco Inc. (WesBanco), a bank holding company, incorporated in 1968, headquartered in Wheeling, West Virginia, offers a full range of financial services including retail banking, corporate banking, personal and corporate trust services, brokerage services, mortgage banking and insurance. WesBanco offers these services through two reportable segments, community banking and trust and investment services. Additional information regarding WesBancos business segments is set forth under the heading, Note 24, Business Segments on page 100 of this Annual Report on Form 10-K.
On January 3, 2005, WesBanco completed the acquisition of Winton Financial Corporation (Winton) and the merger of Wintons subsidiary, The Winton Savings and Loan Company, Cincinnati, Ohio, with and into WesBancos commercial bank subsidiary, WesBanco Bank, Inc., (the Bank). WesBanco and Winton entered into the definitive Agreement and Plan of Merger on August 25, 2004. Winton and its banking subsidiary operated through seven branch offices and two residential mortgage loan production offices in the Cincinnati, Ohio, metropolitan market. The primary reasons for the merger with Winton were for entry into new higher growth markets and to further expand WesBancos branch network in the southwestern part of Ohio.
The aggregate purchase price for Winton was approximately $113.7 million, including approximately $6.3 million of direct acquisition costs, and the acquisition was consummated through the exchange of a combination of WesBanco common stock at a rate of 0.755 shares for 60% of Wintons shares outstanding and $20.75 per share in cash for the remaining 40% of their stock. The acquisition was completed through the issuance of approximately 2,297,000 shares of WesBanco newly issued common stock and $42.1 million in cash, paid from WesBancos available funding sources. As of September 30, 2004, Winton had total assets of approximately $552 million, loans of $487 million, deposits of $365 million, borrowings of $131 million and shareholders equity of $48 million. WesBancos acquisition of Winton is set forth under the heading Note 25, Subsequent Event (Unaudited)Acquisition of Winton Financial Corporation on pages 101 of this Annual Report on Form 10-K.
On August 31, 2004, WesBanco completed the acquisition of Western Ohio Financial Corporation (Western Ohio), Springfield, Ohio and the merger of Western Ohios subsidiary, Cornerstone Bank, with and into the Bank. WesBanco and Western Ohio entered into a definitive Agreement and Plan of Merger on April 1, 2004. On the date of acquisition Western Ohio operated through seven branches and 15 ATMs in the Dayton/Springfield, Ohio metropolitan area. The primary reasons for the merger with Western Ohio were for entry into new higher growth markets and to expand WesBancos existing branch network in the state of Ohio. The aggregate purchase price for the acquisition was approximately $67.9 million through the exchange of a combination of WesBancos common stock and cash for Western Ohio common stock. As of the date of the acquisition on August 31, 2004, Western Ohio had total assets of approximately $412 million, net loans of $334 million, deposits of $255 million, borrowings of $111 million and shareholders equity of $44 million. WesBancos acquisition of Western Ohio is set forth under the heading Note 3, Completed Business Combination on pages 74 and 75 of this Annual Report on Form 10-K.
On March 1, 2002, WesBanco completed the acquisition of American Bancorporation (American) and the merger of Americans subsidiary, Wheeling National Bank, Wheeling, West Virginia, with and into the Bank. As of the acquisition date, American operated 20 offices and had total assets of approximately $678 million. WesBancos merger with American expanded its market share in the tri-state area and included expansion into new markets with an office in Washington, Pennsylvania, an office in Cambridge, Ohio and four offices in Columbus, Ohio.
As of December 31, 2004, WesBanco operated a commercial bank, WesBanco Bank, Inc, through 80 offices, two loan production offices and 121 ATM machines located in West Virginia, Ohio, and Western
Pennsylvania. Total assets of the Bank as of December 31, 2004 approximated $4.0 billion. The Bank also offers trust and investment services as well as various alternative investment products including mutual funds and annuities. The market value of assets under management of the trust and investment services segment was approximately $2.7 billion at December 31, 2004 and $2.8 billion at December 31, 2003. These assets are held by the Bank in fiduciary or agency capacities for their customers and therefore are not included as assets on WesBancos Consolidated Balance Sheet.
WesBanco offers additional services through its non-banking subsidiaries, WesBanco Insurance Services, Inc., a multi-line insurance agency specializing in property, casualty and life insurance for personal and commercial clients and WesBanco Securities, Inc., a full service broker-dealer, which also offers discount brokerage services.
WesBanco Asset Management, Inc. and WesBanco Services, Inc., which were incorporated in November 2002, collectively hold certain investment securities and real estate loans of the Bank and assist in managing these assets.
WesBanco Properties, Inc. holds certain residential and commercial real estate properties. The commercial properties are leased to the Bank and to non-related third parties, while the residential properties are considered other real estate owned.
Hometown Finance, Inc. is a finance company, which holds nonconforming loans to customers that may not be held by the Bank due to regulatory restrictions. Hometown Finance is no longer actively obtaining new loans and at December 31, 2004 the outstanding loans were approximately $77 thousand.
WesBanco Inc. Capital Trust II, WesBanco Inc. Capital Statutory Trust III, and WesBanco Inc. Capital Trusts IV and V, (the Trusts), are all wholly-owned trust subsidiaries of WesBanco formed to facilitate the issuance of Pooled Trust Preferred Securities (trust preferred securities). WesBanco organized Trusts II and III in June 2003 and Trusts IV and V in June 2004 in connection with the four offerings of trust preferred securities. For more information regarding WesBancos issuance of trust preferred securities, please refer to, Note 13 Junior Subordinated Debt and Trust Preferred Securities on page 83 and 84 of this Annual Report on Form 10-K.
WesBanco also serves as investment adviser to a family of mutual funds under the name WesMark Funds which includes the WesMark Growth Fund, the WesMark Balanced Fund, the WesMark Bond Fund, the WesMark West Virginia Municipal Bond Fund, the WesMark Small Company Growth Fund and the Automated Cash Management Trust.
As of December 31, 2004, none of WesBancos subsidiaries were engaged in any operations in foreign countries and none had transactions with customers in foreign countries.
There were approximately 1,209 full-time equivalent employees employed by WesBanco and its subsidiaries as of December 31, 2004.
WEB SITE ACCESS TO WESBANCOS FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION
All of WesBancos electronic filings for 2004, filed with the Securities and Exchange Commission (SEC), including the Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, are made available at no cost on WesBancos website, www.wesbanco.com, through the Investor Relations link as soon as reasonably practicable after WesBanco files such material with, or furnishes it to, the SEC. WesBancos SEC filings are also available through the SECs website www.sec.gov.
Upon written request of any shareholder of record on December 31, 2004, WesBanco will provide, without charge, a printed copy of its 2004 Annual Report on Form 10-K, including financial statements and schedules, as required to be filed with the SEC. To obtain a copy of the 2004 Annual report on Form 10-K, contact: Linda Woodfin, WesBanco, Inc., 1 Bank Plaza, Wheeling, WV 26003.
Competition in the form of price and service from other banks, including local, regional and national banks and financial companies such as savings and loans, internet banks, credit unions, finance companies, and brokerage firms is intense in most of the markets served by WesBanco and its subsidiaries. WesBancos trust and investment services segment receives competition from commercial bank and trust companies, mutual fund companies, investment advisory firms, law firms, brokerage firms and other financial services companies. As a result of the deregulation of the financial services industry (see the discussion of the Gramm-Leach-Bliley Financial Modernization Act of 1999 in the section of this item so captioned) mergers between, and the expansion of, financial institutions both within and outside West Virginia have provided significant competitive pressure in major markets. Some of WesBancos competitors have greater resources and, as such, may have higher lending limits and may offer other services that are not provided by WesBanco. WesBanco generally competes on the basis of customer service and responsiveness to customer needs, available loan and deposit products, the rates of interest charged on loans, the rate of interest paid for funds, and the availability and pricing of trust, brokerage and insurance services. As WesBanco expands into new larger Ohio metropolitan markets it faces significant entrenched large bank competitors with already existing customer bases that exceed WesBancos initial entry position into that market. As a result, WesBanco may be forced to compete more aggressively for loans, deposits, trust and insurance products in order to successfully grow its market share, potentially reducing its future profit potential from such markets.
In addition to the impact of federal and state regulation, the bank and nonbank subsidiaries of WesBanco are affected significantly by the actions of the Federal Reserve Board as it attempts to control the money supply and credit availability in order to influence the economy.
SUPERVISION AND REGULATION
As a registered bank holding company, WesBanco is subject to the supervision of the Federal Reserve Board and is required to file with the Federal Reserve Board reports and other information regarding its business operations and the business operations of its subsidiaries. WesBanco is also subject to examination by the Federal Reserve Board and is required to obtain Federal Reserve Board approval prior to acquiring, directly or indirectly, ownership or control of voting shares of any bank, if, after such acquisition, it would own or control more than 5.0% of the voting stock of such bank. In addition, pursuant to federal law and regulations promulgated by the Federal Reserve Board, WesBanco may only engage in, or own or control companies that engage in, activities deemed by the Federal Reserve Board to be so closely related to banking as to be a proper incident thereto. Prior to engaging in most new business activities, WesBanco must obtain approval from the Federal Reserve Board.
The Bank is a West Virginia banking corporation and is member bank of the Federal Reserve System. It is subject to examination and supervision by the Federal Reserve Board and the West Virginia Division of Banking. Its deposits are insured by the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF) of the Federal Deposit Insurance Corporation (FDIC). WesBancos nonbank subsidiaries are also subject to examination and supervision by the Federal Reserve Board and examination by other federal and state agencies, including, in the case of certain securities activities, regulation by the SEC. The Bank maintains one designated financial subsidiary, WesBanco Insurance Services, Inc.
On July 22, 2003, the Bank entered into an informal agreement styled as a Memorandum of Understanding (the MOU) with the Federal Reserve Bank of Cleveland (the Federal Reserve) and the West Virginia
Department of Banking (collectively the regulatory agencies) to improve and strengthen the Banks Bank Secrecy Act and anti-money laundering controls and procedures. The Bank worked with the Federal Reserve and outside consultants to implement revised policies and enhanced procedures. On September 22, 2004 WesBanco, Inc. was informed by the Federal Reserve and the West Virginia Division of Banking that the informal agreement had been terminated by the regulatory agencies, effective September 20, 2004. The effect of the termination of the MOU was to release WesBanco from any and all regulatory requirements imposed under the MOU.
HOLDING COMPANY STRUCTURE
WesBanco has one state bank subsidiary, WesBanco Bank, Inc., as well as nonbank subsidiaries, which are described further in Item 1: BusinessGeneral section of this Annual Report on Form 10-K. The Bank is subject to affiliate transaction restrictions under federal law which limit the transfer of funds by the Bank to the parent and any nonbank subsidiaries of the parent, whether in the form of loans, extensions of credit, investments, or asset purchases. Such transfers by the Bank to its parent corporation or to any individual nonbank subsidiary of the parent are limited in amount to 10% of the Banks capital and surplus and, with respect to such parent together with all such nonbank subsidiaries of the parent, to an aggregate of 20% of the Banks capital and surplus. Furthermore, such loans and extensions of credit are required to be secured in specified amounts. In addition, all affiliate transactions must be conducted on terms and under circumstances that are substantially the same as such transactions with unaffiliated entities. WesBanco has a $3.5 million line of credit from the Bank, which was not drawn upon as of December 31, 2004.
The Federal Reserve Board has a policy to the effect that a bank holding company is expected to act as a source of financial and managerial strength to each of its subsidiary banks and to commit resources to support each such subsidiary bank. Under the source of strength doctrine, the Federal Reserve Board may require a bank holding company to make capital injections into a troubled subsidiary bank, and may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to such a subsidiary bank. This capital injection may be required at times when WesBanco may not have the resources to provide it. Any loans by a holding company to its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. Moreover, in the event of a bank holding companys bankruptcy, any commitment by such holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.
Dividends from the Bank are a significant source of funds for payment of dividends to WesBancos shareholders. For the year ended December 31, 2004, WesBanco declared cash dividends to its shareholders of approximately $20.2 million. There are, however, statutory limits on the amount of dividends that the Bank can pay to WesBanco without regulatory approval.
Under applicable federal regulations, appropriate bank regulatory agency approval is required if the total of all dividends declared by a bank in any calendar year exceeds the available retained earnings and exceeds the aggregate of the banks net profits (as defined by regulatory agencies) for that year and its retained net profits for the preceding two years, less any required transfers to surplus or a fund for the retirement of any preferred stock. At December 31, 2004, the Bank could pay dividends of up to $5.8 million to WesBanco without prior regulatory approval and without adversely affecting its well capitalized status. As of December 31, 2003 and 2002, the Bank could not have declared any dividends to be paid to WesBanco without prior approval from regulatory agencies. During the second quarter of 2003, federal and state regulatory agencies granted approval to the Bank to pay a $40.0 million dividend to WesBanco.
If, in the opinion of the applicable regulatory authority, a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice which, depending on the financial condition of the bank, could include the payment of dividends, such authority may require, after notice and hearing, that such bank cease and
desist from such practice. The Federal Reserve Board has issued policy statements which provide that insured banks and bank holding companies should generally only pay dividends out of current operating earnings.
Additional information regarding dividend restrictions is set forth in Note 22: Regulatory Matters on pages 97 and 98 of this Annual Report on Form 10-K.
The Bank is classified by the FDIC as a well-capitalized institution in the highest supervisory subcategory, and is therefore not obliged under current FDIC assessment practices to pay deposit insurance premiums on its deposits insured by the BIF. The FDIC may alter its assessment practices in the future if required by developments affecting the resources of the BIF. The FDIC is also conducting a comprehensive review of the deposit insurance system to study alternatives for pricing, funding and coverage.
The Banks deposits are insured by the FDIC up to $100,000 per insured depositor. Most of the Banks deposits are insured by the BIF (88%), but as a result of the acquisition of Western Ohio, a portion is insured by the SAIF (12%). The FDIC establishes deposit insurance rates semiannually in order to maintain the fund at a mandated minimum designated reserve ratio of 1.25% (equal to $1.25 per $100 of deposits). Both the BIF and SAIF exceeded such percentage at year-end. The Bank does not currently pay any deposit insurance assessment to either fund, due to the BIF and SAIF funding levels and as a result of the Banks designation by the FDIC as a well-capitalized institution in the highest supervisory subcategory under the FDICs risk-based assessment program. Annual insurance premiums on bank deposits insured by the BIF and the SAIF may vary between $0 per $100 of deposits for banks classified in the highest capital and supervisory evaluation category to $0.27 per $100 in deposits for banks in the lowest capital and supervisory evaluation category. Deposit insurance rates set by the FDIC may increase in the future if the designated reserve ratio measured semi-annually decreases below 1.25%, which could raise WesBancos rates materially.
In addition to risk-based insurance assessments, assessments are also imposed on deposits insured by either fund to pay for the cost of certain Financing Corporation (FICO) bonds. At year-end such assessment was $.0144 for the Bank per $100 of deposits annually for deposits insured by both the BIF and SAIF. For 2004, total FICO assessments were $0.4 million for the Bank.
The Federal Reserve Board has issued risk-based capital ratio and leverage ratio guidelines for bank holding companies such as WesBanco. The risk-based capital ratio guidelines establish a systematic analytical framework that makes regulatory capital requirements more sensitive to differences in risk profiles among banking organizations, takes off-balance sheet exposures into explicit account in assessing capital adequacy, and minimizes disincentives to holding liquid, low-risk assets. Under the guidelines and related policies, bank holding companies must maintain capital sufficient to meet both a risk-based asset ratio test and a leverage ratio test on a consolidated basis. The risk-based ratio is determined by allocating assets and specified off-balance sheet commitments into four weighted categories, with higher weighting being assigned to categories perceived as representing greater risk. A bank holding companys capital is then divided by total risk-weighted assets to yield the risk-based ratio. The leverage ratio is determined by relating core capital to total assets adjusted as specified in the guidelines. The Bank is subject to substantially similar capital requirements.
Generally, under the applicable guidelines, a financial institutions capital is divided into two tiers. Institutions that must incorporate market risk exposure into their risk-based capital requirements may also have a third tier of capital in the form of restricted short-term subordinated debt. Tier 1, or core capital, includes common equity, noncumulative perpetual preferred stock excluding auction rate issues, and minority interests in equity accounts of consolidated subsidiaries, less goodwill and, with certain limited exceptions, all other intangible assets. Bank holding companies, however, may include cumulative preferred stock in their Tier 1
capital, up to a limit of 25% of such Tier 1 capital. Tier 2, or supplementary capital, includes, among other things, cumulative and limited-life preferred stock, hybrid capital instruments, mandatory convertible securities, qualifying subordinated debt, and the allowance for loan and lease losses, subject to certain limitations. Total capital is the sum of Tier 1 and Tier 2 capital.
The Federal Reserve Board and the other federal banking regulators require that all intangible assets, with certain limited exceptions, be deducted from Tier 1 capital. Under the Federal Reserve Boards rules, the only types of intangible assets that may be included in (i.e., not deducted from) a bank holding companys capital are originated or purchased mortgage servicing rights, non-mortgage servicing assets, and purchased credit card relationships, provided that, in the aggregate, the total amount of these items included in capital does not exceed 100% of Tier 1 capital.
Under the risk-based guidelines, financial institutions are required to maintain a risk-based ratio, which is total capital to risk-weighted assets, of 8%, of which 4% must be Tier 1 capital. The appropriate regulatory authority may set higher capital requirements when an institutions circumstances warrant.
The Federal Reserve Board has established a minimum ratio of Tier 1 capital to total assets of 3.0% for strong bank holding companies rated composite 1 under the BOPEC (bank, other, parent, earnings, and capital) components rating system of bank holding companies, and for bank holding companies that have implemented the Boards risk-based capital measure for market risk. For all other bank holding companies, the minimum ratio of Tier 1 capital to total assets is 4.0%. Banking organizations with supervisory, financial, operational, or managerial weaknesses, as well as organizations that are anticipating or experiencing significant growth are expected to maintain capital ratios well above the minimum levels. Moreover, higher capital ratios may be required for any bank holding company if warranted by its particular circumstances or risk profile. In all cases, bank holding companies should hold capital commensurate with the level and nature of the risks, including the volume and severity of problem loans, to which they are exposed.
In early 2002, bank regulatory agencies established special minimum capital requirements for equity investments in nonfinancial companies. The requirements consist of a series of marginal capital charges that increase within a range from 8% to 25% as a financial institutions overall exposure to equity investments increases as a percentage of its Tier 1 capital. At December 31, 2004, capital charges relating to WesBancos equity investments in nonfinancial companies were immaterial.
Failure to meet applicable capital guidelines could subject the financial institution to a variety of enforcement remedies available to the federal regulatory authorities including limitations on the ability to pay dividends, the issuance by the regulatory authority of a capital directive to increase capital, and the termination of deposit insurance by the FDIC, as well as to the measures described below under Prompt Corrective Action as applicable to undercapitalized institutions.
As of December 31, 2004, WesBancos Tier 1 and total capital to risk-adjusted assets ratios were 13.43% and 14.54%, respectively. As of December 31, 2004, the Bank also had capital in excess of the minimum requirements. Neither WesBanco nor the Bank has been advised by the appropriate federal banking regulator of any specific leverage ratio applicable to it. As of December 31, 2004, WesBancos leverage ratio was 9.34%. WesBanco currently has $72.2 million in junior subordinated debt on its Consolidated Balance Sheet presented as a separate category of long-term debt. For regulatory purposes, trust preferred securities totaling $70.0 million underlying such junior subordinated debt is included in Tier 1 capital in accordance with regulatory reporting requirements. On May 6, 2004, the Federal Reserve Board proposed a rule that would retain trust preferred securities in Tier 1 capital, but with stricter quantitative limits and clearer qualitative standards. Under the proposal, after a three-year transition period, the aggregate amount of trust preferred securities and certain other capital elements would be limited to 25 percent of Tier 1 capital elements, net of goodwill. The amount of trust preferred securities and certain other elements in excess of the limit could be included in Tier 2 capital, subject to restrictions. On March 1, 2005, a final rule was promulgated by the Federal Reserve that confirms most elements of the May 6, 2004 proposal except for permitting a longer transition period of five years and other clarifications.
The risk-based capital standards of the Federal Reserve Board and the FDIC specify that evaluations by the banking agencies of a banks capital adequacy will include an assessment of the exposure to declines in the economic value of the banks capital due to changes in interest rates. These banking agencies issued a joint policy statement on interest rate risk describing prudent methods for monitoring such risk that rely principally on internal measures of exposure and active oversight of risk management activities by senior management.
The federal regulatory authorities risk-based capital guidelines are based upon the 1988 capital accord of the Basel Committee on Banking Supervision (the BIS). The BIS is a committee of central banks and bank supervisors/regulators from the major industrialized countries that develops broad policy guidelines for use by each countrys supervisors in determining the supervisory policies they apply. In June 2004, the BIS published a new capital accord to replace its 1988 capital accord. The new capital accord would, among other things, set capital requirements for operational risk and refine the existing capital requirements for credit risk and market risk. Operational risk is defined to mean the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems in connection with external events. The 1988 capital accord does not include separate capital requirements for operational risk. The United States federal regulatory authorities are currently expected to release proposed rules to implement the BISs new capital accord in mid-year 2005. It is currently anticipated that these authorities would release final rules in mid-year 2006, and that the final rules would become effective in January 2008. WesBanco cannot predict the timing or final form of the United States rules implementing the new capital accord and their impact on WesBanco. The new capital requirements that may arise from the final rules could increase the minimum capital requirements applicable to WesBanco and its subsidiaries.
PROMPT CORRECTIVE ACTION
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) requires federal banking regulatory authorities to take prompt corrective action with respect to depository institutions that do not meet minimum capital requirements. For these purposes, FDICIA establishes five capital tiers: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized.
An institution is deemed to be well-capitalized if it has a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, and a Tier 1 leverage ratio of 5% or greater and is not subject to a regulatory order, agreement, or directive to meet and maintain a specific capital level for any capital measure. An institution is deemed to be adequately capitalized if it has a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of 4% or greater, and, generally, a Tier 1 leverage ratio of 4% or greater and the institution does not meet the definition of a well-capitalized institution. An institution that does not meet one or more of the adequately capitalized tests is deemed to be undercapitalized. If the institution has a total risk-based capital ratio that is less than 6%, a Tier 1 risk-based capital ratio that is less than 3%, or a Tier 1 leverage ratio that is less than 3%, it is deemed to be significantly undercapitalized. Finally, an institution is deemed to be critically undercapitalized if it has a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2%. As of December 31, 2004, the Bank had capital levels that met the well capitalized standards under such regulations.
FDICIA generally prohibits a depository institution from making any capital distribution, including payment of a cash dividend, or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized institutions are subject to growth limitations and are required to submit a capital restoration plan. If any depository institution subsidiary of a holding company is required to submit a capital restoration plan, the holding company would be required to provide a limited guarantee regarding compliance with the plan as a condition of approval of such plan by the appropriate federal banking agency. If an undercapitalized institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized. Significantly undercapitalized institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. Critically undercapitalized institutions may not, beginning 60 days after becoming critically undercapitalized, make any payment of
principal or interest on their subordinated debt. In addition, critically undercapitalized institutions are subject to appointment of a receiver or conservator within 90 days of becoming critically undercapitalized.
GRAMM-LEACH-BLILEY ACT OF 1999 (THE GLB ACT)
Under the GLB Act enacted in 1999, banks are no longer prohibited by the Glass-Steagall Act from associating with, or having management interlocks with, a business organization engaged principally in securities activities. By qualifying as a new entity known as a financial holding company, a bank holding company may acquire new powers not otherwise available to it. In order to qualify, a bank holding companys depository subsidiaries must all be both well-capitalized and well managed, and must be meeting their Community Reinvestment Act obligations. The bank holding company must also declare its intention to become a financial holding company to the Federal Reserve Board and certify that its depository subsidiaries meet the capitalization and management requirements. The repeal of the Glass-Steagall Act and the availability of new powers both became effective on March 11, 2000. WesBanco has not elected to become a financial holding company under the GLB Act, though it has qualified a subsidiary of its bank as a financial subsidiary under the GLB Act.
Financial holding company powers relate to financial activities that are determined by the Federal Reserve Board, in coordination with the Secretary of the Treasury, to be financial in nature, incidental to an activity that is financial in nature, or complementary to a financial activity, provided that the complementary activity does not pose a safety and soundness risk. The statute itself defines certain activities as financial in nature, including but not limited to underwriting insurance or annuities; providing financial or investment advice; underwriting, dealing in, or making markets in securities; merchant banking, subject to significant limitations; insurance company portfolio investing, subject to significant limitations; and any activities previously found by the Federal Reserve Board to be closely related to banking.
National and state banks are permitted under the GLB Act, subject to capital, management, size, debt rating, and Community Reinvestment Act qualification factors, to have financial subsidiaries that are permitted to engage in financial activities not otherwise permissible. However, unlike financial holding companies, financial subsidiaries may not engage in insurance or annuity underwriting; developing or investing in real estate; or merchant banking, for at least five years, or insurance company portfolio investing. Other provisions of the GLB Act establish a system of functional regulation for financial holding companies and banks involving the SEC, the Commodity Futures Trading Commission, and state securities and insurance regulators; deal with bank insurance sales and title insurance activities in relation to state insurance regulation; prescribe consumer protection standards for insurance sales; and establish minimum federal standards of privacy to protect the confidentiality of the personal financial information of consumers and regulate its use by financial institutions. Federal bank regulatory agencies have issued certain rules since the adoption of the GLB Act relating to the implementation of the GLB Act.
ANTI-MONEY LAUNDERING INITIATIVES AND THE USA PATRIOT ACT
A major focus of governmental policy on financial institutions in recent years has been aimed at combating money laundering and terrorist financing. The USA PATRIOT Act of 2001 (the USA Patriot Act) substantially broadened the scope of United States anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States. The United States Treasury Department has issued a number of implementing regulations which apply to various requirements of the USA Patriot Act to financial institutions such as the WesBancos bank and broker-dealer subsidiaries. These regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing and to verify the identity of their customers. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for WesBanco and its subsidiaries.
You should carefully consider the risks described below, as well as the other information included or incorporated by reference in this Annual Report on Form 10-K, before making an investment in WesBancos common stock. The risks described below are not the only ones we face in our business. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also impair our business operations. If any of the following risks occur, our business, financial condition or operating results could be materially harmed. In such an event, our common stock could decline in price, and you may lose all or part of your investment.
WESBANCO MAY ENCOUNTER INTEGRATION DIFFICULTIES OR MAY FAIL TO REALIZE THE ANTICIPATED BENEFITS OF FUTURE ACQUISITIONS.
WesBanco may not be able to integrate an acquired companys operations without encountering difficulties including, without limitation, the loss of key employees and customers, the disruption of their respective ongoing businesses or possible inconsistencies in standards, controls, procedures and policies. Future results of the combined company may be materially different from those estimated by WesBanco and there can be no assurance that any enhanced earnings will result from the merger. Expenses associated with the acquisitions may be higher or lower than originally estimated, depending upon how costly or difficult it is to integrate the companies. Furthermore, these charges may decrease the capital of the combined company that could be used for profitable, income-earning investments in the future.
ACQUISITION OPPORTUNITIES MAY NOT BE AVAILABLE TO WESBANCO IN THE FUTURE.
WesBanco continually evaluates opportunities to acquire other businesses. However, WesBanco may not have the opportunity to make suitable acquisitions on favorable terms in the future, which could negatively impact the growth of its business. WesBanco expects that other banking and financial companies, many of which have significantly greater resources, will compete with it to acquire compatible businesses. This competition could increase prices for acquisitions that WesBanco would likely pursue, and its competitors may have greater resources than it does. Also, acquisitions of regulated business such as banks are subject to various regulatory approvals. If WesBanco fails to receive the appropriate regulatory approvals, it will not be able to consummate an acquisition that it believes is in its best interests.
Any future acquisitions may result in unforeseen difficulties, which could require significant time and attention from our management that would otherwise be directed at developing our existing business. In addition, we could discover undisclosed liabilities resulting from any acquisitions for which we may become responsible. Further, the benefits that we anticipate from these acquisitions may not develop.
WESBANCO MAY BE REQUIRED TO WRITE DOWN GOODWILL AND OTHER INTANGIBLE ASSETS, CAUSING ITS FINANCIAL CONDITION AND RESULTS TO BE NEGATIVELY AFFECTED.
When WesBanco acquires a business, a portion of the purchase price of the acquisition is allocated to goodwill and other identifiable intangible assets. The amount of the purchase price which is allocated to goodwill and other intangible assets is determined by the excess of the purchase price over the net identifiable assets acquired. At December 31, 2004, WesBancos goodwill and other identifiable intangible assets were approximately $83.9 million. Under current accounting standards, if WesBanco determines goodwill or intangible assets are impaired, it would be required to write down the value of these assets. WesBanco conducts an annual review to determine whether goodwill and other identifiable intangible assets are impaired. WesBanco recently completed such an impairment analysis and concluded that no impairment charge was necessary for the year ended December 31, 2004. WesBanco cannot provide assurance that it will not be required to take an impairment charge in the future. Any impairment charge would have a negative effect on its shareholders equity and financial results and may cause a decline in our stock price.
DUE TO INCREASED COMPETITION, WESBANCO MAY NOT BE ABLE TO ATTRACT AND RETAIN BANKING CUSTOMERS AT CURRENT LEVELS.
WesBanco faces competition from the following:
In particular, the Banks competitors include several major national financial and banking companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and mount extensive promotional and advertising campaigns. Additionally, banks and other financial institutions may have products and services not offered by WesBanco, which may cause current and potential customers to choose those institutions. Areas of competition include interest rates for loans and deposits, efforts to obtain deposits and range and quality of services provided. If WesBanco is unable to attract new and retain current customers, loan and deposit growth could decrease causing WesBancos results of operations and financial condition to be negatively impacted.
WESBANCO MAY NOT BE ABLE TO EXPAND ITS TRUST AND INVESTMENT SERVICES SEGMENT AND RETAIN ITS CURRENT CUSTOMERS.
As of December 31, 2004, WesBanco had approximately $2.7 billion in assets under management, with revenues earned from such assets accounting for 9.0% of WesBancos revenues. WesBanco may not be able to attract new and retain current investment management clients due to competition from the following:
Its ability to successfully attract and retain investment management clients is dependent upon its ability to compete with competitors investment products, level of investment performance, client services and marketing and distribution capabilities. Due to the changes in economic conditions, the performance of the trust and investment services segment may be negatively impacted by the financial markets in which investment customers assets are invested, causing the customer to seek other alternative investment options. If WesBanco is not successful, its results from operations and financial position may be negatively impacted.
CUSTOMERS MAY DEFAULT ON THE REPAYMENT OF LOANS.
The Banks customers may default on the repayment of loans, which may negatively impact WesBancos earnings due to loss of principal and interest income. Increased operating expenses may result from the allocation of management time and resources to the collection and work-out of the loan. Collection efforts may or may not be successful causing WesBanco to write off the loan or repossess the collateral securing the loan, which may or may not exceed the balance of the loan.
Management evaluates the adequacy of the allowance for loan losses at least quarterly, which includes testing certain individual loans as well as collective pools of loans for impairment. This evaluation includes an assessment of actual loss experience within each category of the portfolio, individual commercial and commercial real estate loans that exhibit credit weakness; current economic events, including employment statistics, trends in bankruptcy filings, and other pertinent factors; industry or geographic concentrations, and regulatory guidance. Additions to the allowance for loan loss result in an expense for the period.
WesBancos regulatory agencies periodically review the allowance for loan losses. Based on their assessment the regulatory agencies may require WesBanco to adjust the allowance for loan losses. These adjustments could negatively impact the results of operations or financial position.
ECONOMIC CONDITIONS IN WESBANCOS MARKET AREAS COULD NEGATIVELY IMPACT EARNINGS.
A downturn in the local and regional economies could negatively impact WesBancos banking business. The Bank serves both individuals and business customers throughout the state of West Virginia, Ohio and Western Pennsylvania. The ability of the Banks customers to repay their loans is strongly tied to the economic conditions in these areas. These economic conditions may also force customers to utilize deposits held by the Bank in order to pay current expenses causing the Banks deposit base to shrink. As a result the Bank may have to borrow funds at higher rates in order to meet liquidity needs. These events may have a negative impact on WesBancos earnings.
CURRENT MARKET INTEREST RATES AND COST OF FUNDS MAY NEGATIVELY IMPACT WESBANCOS BANKING BUSINESS.
Fluctuations in interest rates may negatively impact the business of the Bank. The Banks main source of income from operations is net interest income, which is equal to the difference between the interest income received on interest-bearing assets (usually loans and investment securities) and the interest expense incurred in connection with interest-bearing liabilities (usually deposits and borrowings). These rates are highly sensitive to many factors beyond WesBancos control, including general economic conditions, both domestic and foreign and the monetary and fiscal policies of various governmental and regulatory authorities. The Banks net interest income can be affected significantly by changes in market interest rates. Changes in relative interest rates may reduce the Banks net interest income as the difference between interest income and interest expense decreases. As a result, the Bank has adopted asset and liability management policies to minimize the potential adverse effects of changes in interest rates on net interest income, primarily by altering the mix and maturity of loans, investments and funding sources. However, even with these policies in place, WesBanco cannot assure you that a decrease in interest rates will not negatively impact its results from operations or financial position.
WesBancos cost of funds for banking operations may increase as a result of general economic conditions, interest rates and competitive pressures. The Bank has traditionally obtained funds principally through deposits and through borrowings. As a general matter, deposits are a cheaper source of funds than borrowings, because interest rates paid for deposits are typically less than interest rates charged for borrowings. If, as a result of general economic conditions, market interest rates, competitive pressures or otherwise, the value of deposits at the Bank decreases relative to its overall banking operations, the Bank may have to rely more heavily on borrowings as a source of funds in the future.
CHANGES IN REGULATORY CAPITAL REGULATIONS BY THE FEDERAL RESERVE BOARD MAY NEGATIVELY IMPACT WESBANCOS CAPITAL LEVELS.
WesBanco currently has $72.2 million in junior subordinated debt on its balance sheet. The junior subordinated debt is presented as a separate category of long-term debt on the Consolidated Balance Sheet. For regulatory purposes, the trust preferred securities underlying such junior subordinated debt are included in Tier 1 capital in accordance with regulatory reporting requirements. On May 6, 2004, the Federal Reserve Board proposed a rule (recently adopted with minor changes on March 1, 2005) that would retain trust preferred
securities in Tier 1 capital, but with stricter quantitative limits and clearer qualitative standards. Under the proposal, after a three-year transition period, the aggregate amount of trust preferred securities and certain other capital elements would be limited to 25 percent of Tier 1 capital elements, net of goodwill. The amount of trust preferred securities and certain other elements in excess of the limit could be included in Tier 2 capital, subject to restrictions. WesBancos trust preferred securities issued as of December 3, 2004 were not in the aggregate, in excess of such defined limit for Tier 1 capital. Should WesBanco issue additional trust preferred securities, WesBancos Tier 1 capital ratio may be limited by the rules proposed by the Board. WesBancos earnings may also be negatively impacted due to the possible prepayment penalties associated with the redemption of the trust preferred securities.
BORROWINGS FROM THE FEDERAL HOME LOAN BANK SYSTEM.
The Bank is currently a member bank of the Federal Home Loan Bank (FHLB) of Pittsburgh. Membership in this system allows the Bank to participate in various programs offered by its member banks. The Bank borrows funds from the FHLB, which are secured by a blanket lien on certain residential mortgage loans or securities with a market value at least equal to the outstanding balances. Recent weakness with certain FHLB Banks, including the Pittsburgh FHLB, may impact the collateral necessary to secure borrowings and limit the borrowings extended to its member banks, as well as require additional capital contributions by its member banks. Should this occur WesBancos short term liquidity needs could be negatively impacted. Should WesBanco cease using FHLB advances due to weakness in that particular bank, WesBanco may be forced to find alternative funding sources. Such alternative funding sources may include the issuance of additional trust preferred securities within allowed capital guidelines, utilization of existing lines of credit with third party banks along with seeking other lines of credit, borrowings under repurchase agreement lines, increasing deposit rates to attract additional funds, accessing brokered deposits as well as selling certain investment securities categorized as available for sale in order to maintain adequate levels of liquidity. At December 31, 2004 the Bank owns $27.2 million of FHLB of Pittsburgh stock, which paid a dividend approximating 2.43% for the fourth quarter of 2004, up from 1.60% for the third quarter of 2004, which may indicate the FHLB of Pittsburghs improving financial strength. This dividend may be eliminated by the FHLB of Pittsburgh at anytime in the future in order for the FHLB of Pittsburgh to restore its retained earnings. In such case, the FHLB stock owned by WesBanco may be deemed a non-earning asset.
WESBANCOS FINANCIAL CONDITION AND RESULTS OF OPERATIONS DEPEND
ON THE SUCCESSFUL GROWTH OF ITS SUBSIDIARIES.
WesBancos primary business activity for the foreseeable future will be to act as the holding company of the Bank and subsidiaries. Therefore, WesBancos future profitability will depend on the success and growth of these subsidiaries. In the future, part of WesBancos growth may come from buying other banks and buying or establishing other companies. Such entities may not be profitable after they are purchased or established, and they may lose money or be dilutive to earnings per share, particularly for the first few years. A new bank or company may bring with it unexpected liabilities, bad loans, or poor employee relations, or the new bank or company may lose customers and the associated revenue.
WESBANCOS ABILITY TO PAY DIVIDENDS IS LIMITED.
Holders of shares of WesBancos common stock are entitled to dividends if, and when, they are declared by WesBancos Board of Directors out of funds legally available for that purpose. Although the Board of Directors has declared cash dividends in the past, the current ability to pay dividends is largely dependent upon the receipt of dividends from the Bank. Federal and state laws impose restrictions on the ability of the Bank to pay dividends. Additional restrictions are placed upon WesBanco by the policies of federal regulators, including the Federal Reserve Boards November 14, 1985 policy statement, which provides that bank holding companies should pay dividends only out of the past years net income, and then only if their prospective rate of earnings retention appears consistent with their capital needs, asset quality, and overall financial condition. In general, future dividend policy is subject to the discretion of the Board of Directors and will depend upon a number of factors, including WesBancos and the Banks future earnings, capital requirements, regulatory constraints and financial condition.
The Registrants subsidiaries generally own their respective offices, related facilities and unimproved real property that is held for future expansion. As of December 31, 2004, WesBanco operated 80 banking offices in West Virginia, Ohio and Western Pennsylvania, and 2 loan production offices, of which 68 are owned and 14 are operated under annual leases or leases with terms exceeding one year. These leases expire at various dates through July 2024 and generally include options to renew.
The main office of the Registrant is located at 1 Bank Plaza, Wheeling, West Virginia, in a building owned by the Bank. The building contains approximately 100,000 square feet and serves as the main office for both WesBancos community banking segment and the trust and investment services segment. During 1998, an office building located adjacent to the main office was acquired by WesBanco Properties, Inc., a subsidiary of WesBanco. The Banks back office operations currently occupy approximately 70% of the office space available, with the remaining portion leased to unrelated businesses.
The consolidated investment in net bank premises and equipment at December 31, 2004 was $56.7 million compared to $53.2 million at December 31, 2003.
At various building locations, WesBanco provides commercial office space and will continue to look for opportunities to rent office space to unrelated businesses. Rental income totaled $0.5 million for 2004 compared to $0.7 million for 2003. For additional disclosures related to WesBancos properties, other fixed assets and leases, please refer to Note 6, Premises and Equipment on pages 79 and 80 of this Annual Report on Form 10-K.
On March 1, 2002, WesBanco consummated its acquisition of American Bancorporation through a series of corporate mergers. At the time of the consummation of this transaction, American Bancorporation was a defendant in a suit styled Martin, et al. v. The American Bancorporation Retirement Plan, et al., under Civil Action No. 5:2000-CV-168 (Broadwater), previously pending in the United States District Court for the Northern District of West Virginia. WesBanco became the principal defendant in this suit by reason of the merger. This case involves a class action suit against American Bancorporation by certain beneficiaries of the American Bancorporation Defined Benefit Retirement Plan (the Plan) seeking to challenge benefit calculations and methodologies used by the outside Plan Administrator in determining benefits under the Plan which was frozen by American Bancorporation, as to benefit accruals, some years ago. The Plan had been the subject of a predecessor action in a case styled American Bancorporation Retirement Plan, et al. v. McKain, Civil Action No. 5:93-CV-110, which was also litigated in the United States District Court for the Northern District of West Virginia. The McKain case resulted in an Order entered by the District Court on September 22, 1995, which directed American Bancorporation to follow a specific method for determining retirement benefits under the Plan. American Bancorporation has asserted that it has calculated the benefits in accordance with the requirements of the 1995 Order. The purported class of plaintiffs have asserted that they are not bound by the 1995 Order since they were not parties to that proceeding and are seeking a separate benefit determination. The District Court in the current case initially limited the class of plaintiffs to a group of approximately 37 individuals and granted partial summary judgment to significantly reduce the scope and extent of the underlying case. The Court subsequently granted summary judgment in favor of WesBanco on the remaining claims on March 31, 2004, and the plaintiff appealed the decision to the Fourth Circuit Court of Appeals. Oral arguments were recently held in the case and a decision is expected to be rendered within the next few months.
On August 1, 2002, WesBanco was named in a lawsuit filed by a former loan customer of WesBancos banking subsidiary over a failed purchase of an ambulance service enterprise operated by a local hospital. WesBancos banking subsidiary was subsequently substituted as the named defendant in the case now styled Matesic v. WesBanco Bank, Inc, et al., Civil Action No. 02-C-293(M), pending in the Circuit Court of Ohio
County, West Virginia. The suit alleges numerous counts and claims against multiple defendants over the purchase and subsequent failure of the ambulance service. WesBancos banking subsidiary made a loan to the plaintiffs company which became delinquent and the Bank recovered a portion of the loan through liquidation of pledged collateral. Allegations of fraudulent conduct and tortious interference are alleged against WesBancos banking subsidiary. The case is currently in its discovery phase.
A second suit involving essentially the same issues was filed by another party involved in the ambulance service and this case is styled Ellis v. OVMC, et al., Civil Action No. 03-C-578(G). This case has been consolidated with the Matesic case at the request of the defendants, including the Bank. The Bank does not believe that there is any merit to the allegations of the complaints.
On April 23, 2004, the Bank was served with a Complaint in a suit styled AUM Hospitality, et al. v. NTK Hotel Group, under Civil Action No. 04 CV H04 03681, presently pending in the Common Pleas Court of Franklin County, Ohio. This is a suit by current or former shareholders of a closely held corporation for fraudulent exercise of control over the corporation against a minority shareholder, David Patel, seeking damages against David Patel and others and seeking to set aside a $13 million first mortgage on a Hampton Inn located in Downtown Columbus with another lender, as well as the Banks $1.3 million second mortgage. The suit alleges that David Patel engaged in illegal conduct in exercising dominion and control over a corporation and that the mortgage instruments are invalid. The mortgage instruments secured funds for the construction of the Hampton Inn upon property owned by AUM Hospitality. The Bank has title insurance insuring its mortgage interest and the title insurance company assumed the defense of the claim. The Bank believes that it has substantial defenses to the claim and that it also has recourse to the title insurance company with respect to coverage provided under the title insurance policy.
The Bank has also been involved in a case styled Copier Word Processing Supply, Inc. v WesBanco, Inc., et al. under Civil Action No. 03-C-472, filed in the Circuit Court of Wood County, West Virginia on October 8, 2003. The suit alleges that a former office manager of the plaintiff converted checks payable to the plaintiff by forging the endorsement of its President, endorsing the instruments in her own right, and depositing such checks into her personal account at the Bank. The Complaint alleges such misconduct over an undetermined period and for an undetermined amount. The suit alleges negligence and conversion claims against the Bank over the deposit of the checks. Through continuing discovery, the Bank has now identified a number of checks which were deposited to the personal accounts of the former office manager over a period of approximately 10 years. Checks totaling approximately $212,000 were within the three year statute of limitations for which the comparative fault standard would be applicable under the West Virginia version of the Uniform Commercial Code. The plaintiff has been seeking approval of the Court to extend the limitations period applicable to the case under a continuing tort theory. The Circuit Court of Wood County recently rejected this argument and held the plaintiff to a three year period of limitations.
Trial of this matter was scheduled in the Circuit Court of Wood County, West Virginia, but has been recently postponed. The Bank believes that the accounting controls and practices of the Plaintiff were primarily at fault and substantially contributed to the loss. The Plaintiffs employee had previously been convicted of criminal fraud and the Bank believes that the failure of the plaintiff to supervise its employee, especially given her prior record, substantially contributed to the loss. Under a comparative fault analysis, the Bank believes that the plaintiff must bear a substantial portion of the loss. Under West Virginias comparative fault procedures, if the plaintiff is found to be more than 50% at fault, then the plaintiff may not be permitted a recovery at all in the case.
WesBanco is also involved in other lawsuits, claims, investigations and proceedings which arise in the ordinary course of business. There are no such other matters pending that WesBanco expects to be material in relation to its business, financial condition or results of operations.
WesBancos common stock is quoted on The NASDAQ Stock Market (NASDAQ), with a trading symbol of WSBC. The approximate number of holders of WesBancos $2.0833 par value common stock as of December 31, 2004 was 5,710. The number of holders does not include WesBanco employees who have had stock allocated to them through WesBancos KSOP. All WesBanco employees who meet the eligibility requirements of the KSOP are included in the Plan.
Quarterly price information, reflecting high and low sales prices as reported by NASDAQ and quarterly dividends per share for 2004 and 2003 are as presented below:
On June 17, 2004, WesBanco, Inc. formed two wholly-owned trust subsidiaries, WesBanco Capital Trust IV and V, under the laws of Delaware, by issuing $40.0 million in Floating Rate and Fixed/Floating Rate Junior Subordinated Deferrable Interest Debentures due June 17, 2034, to two statutory trusts each of which issued 20,000 shares of trust preferred securities each with a liquidation value of $20.0 million, based upon the debentures and a guarantee for each trust from WesBanco. In connection with the issuance of the trust preferred securities, each trust issued 619 shares of common securities to WesBanco with a liquidation value of $0.6 million. The trust preferred securities were issued and sold in two private placement offerings. For the Floating Rate portion of the issuance totaling $20 million, interest is payable quarterly at a rate of 3.96% for the first three months, resetting quarterly beginning on September 17, 2004 and thereafter, at a rate equal to the three-month London Interbank Offering Rate (LIBOR) index plus 2.65%. For the Fixed/Floating Rate portion of the issuance totaling $20 million, interest is payable quarterly at an initial rate of 6.91% for the first five years (no call period) resetting quarterly beginning on June 17, 2009 at a rate equal to the three-month LIBOR index plus 2.65%. The debentures mature on June 17, 2034, and may be redeemed at par anytime commencing in June 2009, without penalty, after the no call period. The debentures and trust preferred securities for both issuances provide that WesBanco has the right to elect to defer the payment of interest on the debentures and trust preferred securities for up to an aggregate of 20 quarterly periods. However, if WesBanco should defer the payment of interest or default on the payment of interest on one or both of the debentures, it may not declare or pay any dividends on its common stock during any such period. A portion of the proceeds received from the Trust Preferred Securities issuances were used to fund the acquisition of Western Ohio Financial Corporation. The remaining proceeds received from the issuances of the Trust Preferred Securities were used for general corporate purposes, which include, among other things, the Winton acquisition, share repurchases and other uses.
The trust preferred securities were sold to Preferred Term Securities X, Ltd. A placement fee totaling $0.2 million was paid to FTN Financial Capital Markets and Keefe, Bruyette & Woods, Inc. in connection with the private placements. Each private placement was limited to a single institutional investor, which qualifies as an accredited investor as defined in Rule 501(a) of Regulation D. The issuance of the debentures and the related trust preferred securities were exempt from registration under the Securities Act of 1933, as amended (the Securities Act).
On June 19, 2003, WesBanco formed a wholly-owned trust subsidiary, WesBanco Capital Trust II, under the laws of Delaware, by issuing a $13.0 million Junior Subordinated Note, due June 30, 2033, to a statutory trust which issued 13,000 shares of trust preferred securities with a liquidation value of $13.0 million, based upon this
note and a guarantee from WesBanco. In connection with the issuance of the trust preferred securities WesBanco Capital Trust II issued 410 common securities to WesBanco with a liquidation value of $0.4 million. The trust preferred securities were issued and sold in a private placement offering. Interest is payable quarterly at a rate of 5.80% for a five year no call period, which will then reset quarterly beginning on June 30, 2008 and thereafter, at a rate equal to the three-month LIBOR index plus 3.15%. The note matures on June 30, 2033, and may be redeemed on or after June 30, 2008, without penalty, after the no call period. The note and trust preferred securities provide that WesBanco has the right to elect to defer the payment of interest on the note and trust preferred securities for up to an aggregate of 20 quarterly periods. However, if WesBanco should defer the payment of interest or default on the payment of interest on the debenture, it may not, among other things, declare or pay any dividends on its common stock during any such period. The net proceeds received by WesBanco were used to reduce outstanding indebtedness, fund share repurchases and for general working capital purposes.
The trust preferred securities were sold to Trapeza CDO III, LLC. A discount in the amount of $0.3 million was earned by Trapeza CDO III, LLC in connection with the private placement. This private placement was limited to a single institutional investor which qualified as an accredited investor as defined in Rule 501(a) of Regulation D. The issuance of the note and the related trust preferred securities was exempt from registration under the Securities Act.
On June 26, 2003, WesBanco formed a wholly-owned trust subsidiary, WesBanco, Inc. Capital Statutory Trust III, under the laws of Connecticut, by issuing a $17.0 million Fixed/Floating Rate Junior Subordinated Deferrable Interest Debenture due June 26, 2033, to a statutory trust which issued 17,000 shares of trust preferred securities with a liquidation value of $17.0 million, based upon this debenture and a guarantee from WesBanco. In connection with the issuance of the trust preferred securities WesBanco, Inc. Capital Statutory Trust III issued 526 common securities to WesBanco with a liquidation value of $0.5 million. The trust preferred securities were issued and sold in a private placement offering. Interest is payable quarterly at a rate of 5.55% for a five year no call period, which will then reset quarterly beginning on June 26, 2008 and thereafter, at a rate equal to the three-month LIBOR index plus 3.10%. The debenture matures on June 30, 2033, and may be redeemed on or after June 30, 2008, without penalty, after the no call period. The debenture and trust preferred securities provide that WesBanco has the right to elect to defer the payment of interest on the debenture and trust preferred securities for up to an aggregate of 20 quarterly periods. However, if WesBanco should defer the payment of interest or default on the payment of interest on the debenture, it may not declare or pay any dividends on its common stock during any such period. The net proceeds received by WesBanco were used to reduce outstanding indebtedness, fund share repurchases and for general working capital purposes.
The trust preferred securities were sold to Preferred Term Securities X, Ltd. A discount in the amount of $0.5 million was earned by FTN Financial Capital Markets and Keefe, Bruyette & Woods, Inc. in connection with the private placement. This private placement was limited to a single institutional investor, which qualified as an accredited investor as defined in Rule 501(a) of Regulation D. The issuance of the debenture and the related trust preferred securities was exempt from registration under the Securities Act.
On June 30, 2003, WesBanco redeemed all of the 8.50% Junior Subordinated Deferrable Interest Debentures held by WesBanco Capital Trust I, by redeeming 1,265,000 shares of its outstanding 8.50% Cumulative Trust Preferred Securities. A total of $12.65 million of trust preferred securities were redeemed at a price of $10.00 per share. These securities were listed on the NASDAQ under the symbol WSBCP, and after they were redeemed the issue was delisted.
For additional disclosures relating to WesBancos Trust Preferred Securities, please refer to Note 13, Junior Subordinated Debt and Trust Preferred Securities on pages 83 and 84 of this Annual Report on Form 10-K.
Information regarding WesBancos compensation plans under which WesBancos equity securities are authorized for issuance as of December 31, 2004 is included under Item 12 of this Annual Report on Form 10-K.
As of December 31, 2004, WesBanco has an active one million share stock repurchase plan approved by the Board on April 17, 2003. The shares are purchased in its treasury for general corporate purposes, which may include reissuance for acquisitions, the dividend reinvestment plan and certain employee benefit plans. The timing, price and quantity of purchases are at the discretion of WesBanco, and the plan may be discontinued or suspended at any time.
The following table shows the activity in WesBancos stock repurchase plan for the quarter ended December 31, 2004:
Current SEC rules limit WesBancos ability to repurchase its shares during any period involving a pending acquisition(s), as was the case during the fourth quarter of 2004 with the pending acquisition of Winton.
The following consolidated selected financial data is derived from WesBancos audited financial statements as of and for the six years ended December 31, 2004. The following consolidated financial data should be read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and related notes included elsewhere in this report. All of WesBancos acquisitions during the six years ended December 31, 2004, are included with WesBancos results of operations since their respective dates of acquisition.
SIX YEAR SELECTED FINANCIAL SUMMARY
The following tables set forth unaudited consolidated selected quarterly statements of income for the years ended December 31, 2004 and 2003.
CONDENSED QUARTERLY STATEMENTS OF INCOME
Managements Discussion and Analysis represents an overview of the results of operations and financial condition of WesBanco, Inc. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes thereto.
Forward-looking statements in this report relating to WesBancos plans, strategies, objectives, expectations, intentions and adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The information contained in this report should be read in conjunction with WesBancos Form 10-Qs for the prior quarters ended September 30, 2004, June 30, 2004 and March 31, 2004, filed with the Securities and Exchange Commission (SEC), which are available at the SECs website www.sec.gov or at WesBancos website, www.wesbanco.com. Investors are cautioned that forward-looking statements, which are not historical fact, involve risks and uncertainties, including those detailed in this Annual Report on Form 10-K filed with the SEC under the section Risk Factors. Such statements are subject to important factors that could cause actual results to differ materially from those contemplated by such statements, including without limitation, the businesses of WesBanco and its recent acquisitions may not be integrated successfully or such integration may take longer to accomplish than expected; the expected cost savings and any revenue synergies from the mergers may not be fully realized within the expected timeframes; disruption from the mergers may make it more difficult to maintain relationships with clients, associates, or suppliers; the effects of changing regional and national economic conditions; changes in interest rates, spreads on earning assets and interest-bearing liabilities, and associated interest rate sensitivity; sources of liquidity available to the parent company and its related subsidiary operations; potential future credit losses and the credit risk of commercial, real estate, and consumer loan customers and their borrowing activities; actions of the Federal Reserve Board, Federal Deposit Insurance Corporation, the SEC, the National Association of Securities Dealers and other regulatory bodies; potential legislative and federal and state regulatory actions and reform; competitive conditions in the financial services industry; rapidly changing technology affecting financial services and/or other external developments materially impacting WesBancos operational and financial performance. WesBanco does not assume any duty to update forward-looking statements.
APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
WesBancos Consolidated Financial Statements are prepared in accordance with United States generally accepted accounting principles and follow general practices within the industries in which it operates. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility.
The most significant accounting policies followed by WesBanco are included in Note 1, Summary of Significant Accounting Policies, of the Consolidated Financial Statements. These policies, along with other Notes to the Consolidated Financial Statements and this Managements Discussion and Analysis, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the
methods, assumptions, and estimates underlying those amounts, management has identified the allowance for loan losses and the evaluation of goodwill and other intangible assets for impairment to be the accounting estimates that require the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available.
Allowance for Loan Losses: The allowance for loan losses represents managements estimate of probable losses inherent in the loan portfolio. Determining the amount of the allowance is considered a critical accounting estimate because it requires significant judgment about the collectibility of loans and the factors that deserve consideration in estimating probable credit losses. The allowance is increased by a provision charged to operating expense and reduced by charge-offs, net of recoveries.
Management evaluates the adequacy of the allowance for loan losses at least quarterly. This evaluation is inherently subjective, as it requires material estimates based on quantitative and qualitative factors that may be susceptible to significant change. The evaluation of the allowance includes an assessment of actual loss experience within each category of loans and testing of certain individual loans for impairment. The evaluation also considers the impact of economic trends and conditions in specific industries and geographical markets, which includes levels of unemployment, bankruptcy filings, and other pertinent information; an analysis of industry, property type, geographic or other loan concentrations; and regulatory guidance pertaining to the allowance for loan losses.
There are two primary components of the allowance for loan losses. Specific reserves are established for individual commercial and commercial real estate loans over a predetermined amount that are deemed impaired pursuant to Statement of Financial Accounting Standards (SFAS) No. 114, Accounting by Creditors for Impairment of a Loan. The determination of specific reserves takes into consideration anticipated future cash flows from the borrower to repay the loan, the observable market price for the loan, if any, or the estimated realizable value of the collateral, if any. General reserves are established pursuant to SFAS No. 5, Accounting for Contingencies, for loans in each category that are not specifically reserved. General reserves are based on historical loss rates with appropriate adjustments to reflect changing economic conditions, delinquency and non-performing loan trends, and other relevant factors. General reserves for commercial and commercial real estate loans are also supported by a migration analysis, which computes historical loss experience sustained on those loans within each internal risk grade.
Management relies on observable data from internal and external sources to evaluate each of the factors that are considered in the evaluation of the allowance, which includes adjusting assumptions and recognizing changing conditions, and reducing differences between estimated and actual observed losses from period to period. The evaluation of the allowance also takes into consideration the inherent imprecision of loss estimation models and techniques and includes general reserves for probable but undetected losses in each category of loans. While WesBanco continually refines and enhances the loss estimation models and techniques it uses to determine the appropriateness of the allowance for loan losses, there have been no material substantive changes to such models and techniques compared to prior periods. The variability of managements estimates and assumptions could alter the level of the allowance for loan losses and may have a material impact on WesBancos future financial condition and results of operations. While management allocates the allowance to different loan categories, the allowance is general in nature and is available to absorb credit losses for the entire loan portfolio. Please see the Allowance for Loan Losses section of this Managements Discussion and Analysis for more information.
Goodwill and Other Intangible Assets: In accordance with the provisions of SFAS No. 141, Business Combinations, WesBanco accounts for business combinations using the purchase method of accounting. Accordingly, the cost of an acquired business is allocated to each of the individual assets, including separable intangible assets, and liabilities of the business based on their relative fair values at the date of the acquisition, with the excess cost, if any, allocated to goodwill. As of December 31, 2004, the carrying value of goodwill and intangible assets is approximately $73.8 million and $10.2 million, respectively, which represents approximately 19.9% and 2.7% of total shareholders equity, respectively. As WesBanco continues to acquire additional
businesses, goodwill and other intangible assets subject to amortization and/or impairment testing may comprise an even larger percentage of total shareholders equity and in turn, increase the risk that its financial position or results of operations could be adversely impacted as discussed below.
Effective January 1, 2002, WesBanco adopted SFAS No. 142, Goodwill and Other Intangible Assets. Under SFAS No. 142, goodwill and intangible assets with indefinite useful lives are no longer amortized. Intangible assets, which consist primarily of core deposit intangibles with finite useful lives, are amortized using straight-line and accelerated methods over their weighted average useful lives, ranging from seven to eleven years.
In the fourth quarter of each year, the carrying values of goodwill and other intangible assets with indefinite useful lives are tested for impairment. The evaluation for impairment involves comparing the estimated current fair value of each reporting unit to its carrying value, including goodwill. If the estimated current fair value of a reporting unit exceeds its carrying value, no additional testing is required and an impairment loss is not recorded. Otherwise, additional testing is performed and to the extent such additional testing results in a conclusion that the carrying value of goodwill or an intangible asset exceeds its fair value, an impairment loss is recognized. WesBanco uses market capitalization and multiples of tangible book value methods to determine the estimated current fair value of its reporting units. A number of significant assumptions and estimates are involved in the application of these methods, which may produce results that would be different than the results that could be realized in an actual transaction. Additionally, the application of different methodologies based upon different assumptions could affect the conclusions reached regarding possible impairment.
Intangible assets with finite useful lives are evaluated for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. An impairment loss is recognized when the carrying amount of an intangible asset with a finite useful life is not recoverable from its undiscounted cash flows and is measured as the difference between the carrying amount and the fair value of the asset.
In the event WesBanco determined that either its goodwill or finite lived intangible assets were impaired, recognition of an impairment charge could have a significant adverse impact on its financial position or results of operations in the period in which the impairment occurred. Please refer to Note 1, Summary of Significant Accounting Policies and Note 7, Goodwill and Core Deposit Intangible of the Consolidated Financial Statements for additional information on goodwill and other intangible assets.
WesBanco is a multi-state bank holding company operating at year end through 80 banking offices, two loan production offices and 121 ATM machines in West Virginia, Ohio and Western Pennsylvania, offering retail banking, corporate banking, personal and corporate trust services, brokerage services, mortgage banking and insurance. WesBancos businesses are significantly impacted by economic factors such as market interest rates, federal monetary policies, local and regional economic conditions and the competitive environment influence upon WesBancos business volumes. WesBancos deposit levels are affected by numerous factors including personal savings rates, personal income, and competitive rates on alternative investments, as well as competition from other financial institutions within the markets we serve and liquidity needs of WesBanco. Loan levels are also subject to various factors including construction demand, business financing needs, consumer spending and interest rates and loan terms offered by competing lenders.
During 2004, WesBanco experienced several events that impacted its current results as well as laid the foundation for future growth. On August 31, 2004, WesBanco completed the April 1, 2004 announced acquisition of Western Ohio Financial Corporation (Western Ohio), which operates through seven branches and 15 ATMs in the Dayton-Springfield, Ohio metropolitan area. The aggregate purchase price for the acquisition was approximately $67.9 million through the exchange of a combination of WesBancos common stock and cash for Western Ohio common stock. The acquisition of Western Ohio added approximately $412
million in total assets, $334 million in net loans, $255 million in deposits, and $111 million in borrowings to WesBancos balance sheet. Please refer to Note 3, Completed Business Combination, of the Consolidated Financial Statements for more information on this acquisition.
On August 25, 2004, WesBanco announced the execution of a definitive Agreement and Plan of Merger with Winton Financial Corporation (Winton). The aggregate purchase price for the acquisition was approximately $113.7 million, including approximately $6.3 million of direct acquisition costs, through the exchange of a combination of WesBancos common stock and cash for Wintons common stock. As of September 30, 2004, Winton had assets of approximately $552 million, $487 million in loans, $365 million in deposits and $48 million in shareholders equity, and it operated through seven banking locations, two loan production offices and 7 ATMs in the greater Cincinnati, Ohio area. WesBanco completed this merger on January 3, 2005, with the data conversion completed in late February 2005. Please refer to Note 25, Subsequent Event, of the Consolidated Financial Statements for more information on this acquisition.
In July 2004, WesBanco opened its second branch in the Washington, Pennsylvania area at the Trinity Point shopping plaza allowing customers greater access to WesBancos banking services in that region.
In September 2004, various branches in WesBancos Wheeling, Weirton and Parkersburg, West Virginia regions and the Marietta, Ohio region suffered flood damage as the results of the remnants of Hurricane Ivan. In total 10 branches received moderate to severe damage due to the flooding, accordingly WesBanco recorded a total of $0.3 million in estimated flood cleanup costs in the third and fourth quarters 2004, with one branch later closed permanently in early 2005.
In November 2004, WesBanco appointed Dennis G. Powell as Executive Vice President and Chief Operating Officer. Mr. Powell brings numerous years of senior level banking experience to WesBanco. Mr. Powell most recently served as Executive Vice President/Director of Retail Banking with a $7 billion dollar financial institution in the Midwest.
WesBancos results of operations are primarily dependent on its net interest income, which is the difference between the interest that WesBanco earns on its loans and investments and the interest expense it pays on it deposits and borrowings. During 2004, WesBancos net interest income grew primarily due to organic growth in commercial and commercial real estate loans as well as an overall increase in average earning assets and to a lesser extent, the Western Ohio acquisition. The increase in net interest income was partially offset by a decline in the net interest margin due to lower rates on earning assets, slightly higher borrowing costs and a change in funding mix towards higher costing certificates of deposit and Federal Home Loan Bank (FHLB) borrowings.
Total average loans increased mainly as a result of continued growth in commercial lending coupled with the Western Ohio acquisition. WesBanco has experienced growth mainly in commercial and commercial real estate loans as a result of a greater focus on new business development in all markets with a concentrated effort in the newer markets of southwestern Pennsylvania and central Ohio, as these areas have shown potential higher levels of growth. WesBanco expects growth opportunities to continue in commercial lending as WesBancos footprint continues to grow in the central and western Ohio markets, and to a lesser extent, increased mortgage lending due to new marketing campaigns and increased consumer loan volume due to the introduction of new direct loan products and increased marketing of our home equity lending products. WesBanco continues to analyze the current and expected profit opportunities from its indirect lending program and due to heavy competition does not expect significant growth from this type of lending through automobile dealers.
During 2004, total average investment securities decreased slightly, while cash flows from the portfolio, which generally decrease as interest rates rise, slowed considerably over the levels experienced in 2003 as market interest rates rose in the second half of 2004. WesBanco has to some extent shifted the cash flows received on the investment portfolio due to prepayments and maturities into higher yielding loans due to the increase in loan demand.
Total average deposits increased over year-end 2003 levels primarily due to the Western Ohio acquisition in the latter half of 2004. The average cost of our deposits have decreased over the past two years primarily due to certificates of deposits re-pricing to current market rates, as well as the reduction of most deposit product rates in 2003. In 2004, more emphasis has been placed on lower interest cost transaction accounts, with a new campaign to market WesBancos free checking products and certain competitive special certificates of deposit offerings. WesBanco plans on continuing with this strategy in 2005, while also ensuring the competitiveness of its certificates of deposits and money market product offerings.
Asset quality, which began to improve throughout 2003, continued to show marked improvement throughout 2004. During 2004, WesBanco experienced lower levels of non-performing assets, reduced levels of delinquent loans and net charge-offs due to increased collection efforts, higher consumer loan recoveries, and overall economic recovery, which factors helped contributed to a lower provision for loan losses in 2004.
RESULTS OF OPERATIONS
WesBancos earnings for 2004 were $38.2 million or $1.90 per diluted share compared to $36.1 million or $1.80 per diluted share in 2003. The results for 2004 reflect the acquisition of Western Ohio and its banking subsidiary, Cornerstone Bank from the closing date of the acquisition on August 31, 2004. Please refer to Note 3, Completed Business Combination of the Consolidated Financial Statements for additional information on the Western Ohio acquisition. WesBancos 2004 financial performance was highlighted by growth in the loan portfolio, improved credit quality, an increase in net interest income, and increased non-interest income. These positive factors were partially offset by an overall increase in operating expenses primarily from an increase in salaries, wages, and employee benefit expense, as well as the incremental costs associated with the additional branch structure from the Western Ohio acquisition. Annualized return on average assets was 1.07% and return on average equity was 11.37% for the year ended December 31, 2004, compared to 1.08% and 11.38%, in 2003, respectively.
NET INTEREST INCOME
TABLE 1: NET INTEREST INCOME
Net interest income, which is WesBancos major revenue source, is the difference between interest income received by WesBanco on its earning assets (loans, securities and federal funds sold) and interest expense paid by WesBanco on its liabilities (deposits, short term and long term borrowings). Net interest income, which comprised 75.4% of total net revenues for 2004 compared to 75.6% for 2003, is affected by the general level of, and changes in interest rates, the steepness of the yield curve, changes in the amount and composition of interest earning assets and interest bearing liabilities, as well as the re-pricing of those assets and liabilities.
Net interest income increased in 2004 compared to 2003, due to a $221.0 million increase in average earning assets, with the majority of the increase attributable to the Western Ohio acquisition. The net interest margin was 3.60% for 2004 compared to 3.66% for 2003. The decrease in net interest margin for 2004 was primarily the result of lower yields earned on loans and investment securities as they continued to re-price downward earlier in the year, and as funding costs began to move higher later in the year. Also impacting the net
interest margin to a lesser extent were the acquired assets of Western Ohio, which had a net interest margin approximating 2.90% after purchase accounting adjustments. WesBanco anticipates future margin compression due to the January 2005 acquisition of Wintons assets, which is expected to have a net interest margin approximating 3.00% after purchase accounting adjustments. The current rising rate and competitive market environment is also placing upward pressure on deposit rates as WesBanco adjusts its rates based on its liquidity needs and competition for deposits by other institutions, while earning asset yields are not increasing as rapidly due both to WesBancos slight liability sensitive position (see Market Risk in Item 7A. Quantitative And Qualitative Disclosures About Market Risk of this Annual Report on Form 10-K) and intense rate pressure from new and existing loan customers. While these factors impacted net interest spreads by 3 basis points, a lower percentage of net non-costing liabilities to total net earning assets also reduced the net interest margin by 3 basis points.
Interest income increased in 2004 compared to 2003, primarily due to an increase in the volume of average earning assets, which was partially offset by a decrease in the yield on earning assets. As shown in Table 2, the yield on average earning assets for 2004 decreased by 27 basis points to 5.43% from 5.70% in 2003. This decrease was primarily due to lower rates realized on new earning assets as well as the re-pricing of existing earning assets, which was partially offset by the volume of average earning assets increasing $221.0 million for 2004, compared to 2003. The increase in average earning assets for 2004 was primarily due to organic growth in commercial and commercial real estate loans and the Western Ohio acquisition. Total average loans as a percentage of total average earning assets increased to 64.8% in 2004 compared to 60.1% for 2003. Despite recent Federal Reserve interest rate increases the variable portion of the loan portfolio may not re-price to the new interest rates immediately due to certain variable rate loans having initial fixed rate terms or interest rate adjustments that may not take effect immediately. The investment portfolio average yield decreased to 4.83% for 2004 compared to 4.94% for 2003. During 2004, the investment portfolio experienced a sharp decrease in the amount of cash flows from prepayments, maturities and calls compared to 2003, reducing the need to reinvest at lower rates and also resulting in lower premium amortization, which in 2003 more negatively impacted net interest income.
Interest expense decreased in 2004 compared to 2003, as shown in Table 2, due to the average rate paid on interest bearing liabilities for 2004 decreasing 24 basis points to 2.08%, compared to 2.32% for 2003. The decrease in rates paid on interest bearing liabilities was partially offset by the volume of average interest bearing liabilities increasing $189.2 million in 2004 compared to 2003. The decrease in rates paid on interest bearing liabilities was primarily due to WesBanco lowering rates on deposit products throughout 2003 which carried through into 2004 as well as the continued natural re-pricing of maturing certificates of deposits to WesBancos current offered rates and the maturity and renewal of certain FHLB borrowings at lower market rates. The latter half of 2004 was also impacted by the additional interest bearing liabilities obtained in the Western Ohio acquisition, causing an alteration in WesBancos funding mix to be more heavily reliant on certificates of deposits and FHLB borrowings, which are generally more expensive funding sources. In addition, WesBanco increased its total junior subordinated debt to assist in funding the cash portion of the Western Ohio acquisition, which as a higher costing source of funds also negatively impacted the total cost of interest bearing liabilities. Margin compression was also evident during the second half of 2004 due to the Federal Reserve initiating five rate increases of 25 basis points each. These increases contributed to a narrowing spread between the federal funds and intermediate term U.S. Treasuries which negatively impacted re-pricing of WesBancos longer-term assets, such as mortgage-backed securities and variable rate loans, a factor that is expected to continue at least through 2005. During 2004, customers continued to favor variable rate deposit products over fixed rate certificates of deposit, although as rates have begun to rise since the third quarter of 2004, WesBanco is beginning to see an increase in certificates of deposit with a corresponding decrease in money market accounts as customers seek the higher rates offered on longer term certificates of deposit. In 2005, $450.1 million in certificates of deposit are scheduled to mature. If interest rates continue to increase in 2005 these deposits could re-price upward based on WesBancos current rates at that time which could place additional stress on the net interest margin.
TABLE 2: AVERAGE BALANCE SHEETS AND NET INTEREST MARGIN ANALYSIS
TABLE 3: RATE/VOLUME ANALYSIS OF CHANGES IN INTEREST INCOME AND INTEREST EXPENSE (1)
PROVISION FOR LOAN LOSSES
The provision for loan losses is determined by management as the amount to be added to the allowance for loan losses after net charge-offs have been deducted to bring the allowance to a level considered appropriate to absorb probable losses in the loan portfolio. The provision for loan losses for the year ended December 31, 2004 decreased $1.9 million or 19.5% to $7.7 million compared to $9.6 million for the year ended December 31, 2003. This decrease is attributable to overall improvement in credit quality, a significant reduction in delinquent loans, lower charge-offs in all categories of loans, and higher consumer loan recoveries. For additional information, see the Allowance for Loan Losses section of Loans and Credit Risk included in this Managements Discussion and Analysis.
TABLE 4: NON-INTEREST INCOME
Non-interest income is a significant source of revenue and plays an important part in WesBancos results of operations. WesBanco offers its customers a wide range of retail, commercial, investment and electronic banking services, which are viewed as a vital component of WesBancos strategy of retaining and attracting customers, as well as providing additional non-interest income to WesBanco.
In 2004, WesBancos non-interest income comprised 24.6% of total net revenues compared to 24.4% in 2003. Trust fees, which are generally driven by market valuations increased in 2004 while the market value of assets decreased slightly from 2003. The market value of trust assets at December 31, 2004 was $2.7 billion, a decrease of $106.9 million or 3.9% from $2.8 billion at December 31, 2003. Contributing to the increase in trust fees in 2004, were recovering market values, the replacement of certain low fee custodial accounts with higher revenue services and corresponding relationships, as well as new account generation, and to a lesser extent a new fee schedule for certain account types applied in the second half of 2003.
The increase in service charges on deposit accounts was primarily due to growth in deposit accounts, a new fee schedule, as well as an increase in Automated Teller Machine (ATM) income and debit card interchange income. The growth in ATM and debit card income is primarily due to additional cards issued during special promotions in 2004 as well as increased customer use of ATM machines. Also contributing to this increase to a lesser degree was the additional depositor base obtained in the Western Ohio acquisition.
Bank-owned life insurance income decreased somewhat compared to 2003 primarily attributable to a decrease in the yields on the underlying variable-return investments. This decrease in return was partially offset by the income earned on the additional $9.3 million in bank-owned life insurance acquired from Western Ohio.
Net securities gains for 2004 were flat with 2003, while the cash flows from sales were relatively the same in both years. During 2004, WesBanco sold certain mortgage-backed securities and callable agency securities exhibiting high prepayment rates that would indicate extension risk in a rising rate environment. In addition, WesBanco sold a portion of the recently acquired investment securities from the 2004 Western Ohio acquisition in order to re-align the acquired investment portfolio with the investment strategies employed by WesBanco in managing its investment portfolio. Included in realized security gains was a pre-tax gain of $0.8 million on the sale of common equity securities for an institution that had agreed to merge with another financial institution.
In 2004, WesBanco sold $28.5 million in loans to the secondary market compared to $39.2 million in 2003. Included in other income were $0.3 million in net gains on the sales of these mortgage loans compared to $0.5 million for 2003. The lower volume for 2004 reflects increased competition for mortgage loans, weaker demand for certain mortgage types that WesBanco typically sells into the secondary market (30 year fixed rate loans) and customer refinancing of mortgages, mostly into WesBanco products that were retained in the loan portfolio (15 year or less fixed rate loans and various adjustable rate mortgage types). During 2003, net gains on sales of loans included a $0.9 million gain on the sale of a non-performing loan. This gain represented the difference between the selling price and the book balance of the loan, which had been charged-down in 2002.
TABLE 5: NON-INTEREST EXPENSE
WesBanco continually strives to bring new products and services to its customers by adding new and improved technology systems, added ATMs and branch upgrades for customer convenience, special promotions in order to increase its competitive presence in its current market areas, as well as exploring expansion into new market areas. In 2004 WesBancos branch structure grew to 80 branches from the 72 branches in 2003 due to the Western Ohio acquisition and the opening of our Trinity Point branch in Washington, Pennsylvania. In 2004 WesBanco also opened two new loan production offices in the Pittsburgh, Pennsylvania metropolitan area. With this growth and expansion comes an incremental increase in expenses and accordingly non-interest expenses increased $8.1 million or 9.9% over 2003, a portion of which was related to the additional four months of expenses from the August 31, 2004 Western Ohio acquisition. WesBancos efficiency ratio on a GAAP basis was 58.29% in 2004 compared to 56.12% in 2003.
The increase in salaries and wages, which comprise the largest component of operating expenses, was primarily due to the number of full-time equivalent employees increasing from 1,124 in at December 31, 2003 to 1,209 at December 31, 2004, with a portion of this increase attributable to the Western Ohio acquisition, as well as additional staffing in certain key areas. Later in the fourth quarter of 2004 WesBanco reduced personnel, with approximately 25 certain back office positions at Western Ohio being eliminated in conjunction with the acquisition and data processing system conversion. Also impacting salaries and wages were normal annual salary increases which normally take effect mid-year as well as additional production-related incentive compensation for employees meeting certain sales production goals, primarily in commercial and mortgage lending.
Employee benefit costs continue to increase primarily due to higher medical costs which are affecting nearly all companies, and to a lesser extent higher pension expense. Health insurance expense continued to climb in 2004, which contributed to an increase of $0.7 million or 20.4% over 2003, primarily due to higher insurance rates and an increase in the number of employees. For 2004 pension expense increased $0.2 million or 7.1% compared to 2003. WesBanco anticipates pension expense of approximately $2.3 million in 2005, compared to $2.4 million in 2004. In 2004, WesBanco also saw a rise in recruiting expenses, which was prompted by the need for certain key employee positions due to department and branch expansions in 2004.
For 2004, WesBancos net occupancy expense, which is comprised mainly of utility costs, office rental, general repairs and maintenance, maintenance agreements and depreciation expense increased, slightly over 2003 primarily due to the increase in the number of branches from the Western Ohio acquisition and the opening of two loan production offices in 2004.
WesBancos equipment expense, comprised of equipment depreciation, rental, repairs and maintenance, and service agreements increased over 2003 primarily due to an increase in service agreement expense. This increase
was due to WesBanco opting to have certain computer systems covered by service agreements as well as having additional equipment to cover due to the expanded ATM network and the additional Western Ohio branches.
WesBancos core deposit intangible expense represents the amortization of the capitalized core deposit intangible. The increase in core deposit intangible expense was primarily due to the additional amount of amortization expense from the core deposit intangible recorded in conjunction with the 2004 Western Ohio acquisition, which added an additional $0.2 million in expense to this category for 2004, while the remaining $1.2 million in core deposit intangible amortization expense is associated with deposits acquired in the 2002 American acquisition. Please refer to Notes 1, 3 and 7 of the Consolidated Financial Statements for more information on accounting for goodwill and core deposit intangibles.
For 2004, other operating expense increased in several key areas. One of the largest increases was ATM costs based on transaction volume, which increased $0.7 million for 2004, compared to 2003 as WesBanco added additional machines in certain areas that experienced higher transaction volumes. Debit card and ATM interchange expenses also saw a marked increase due to the number of new cards issued from a special debit card promotion, the increased usage of debit and ATM cards by WesBancos existing customer base and additional cards issued to Western Ohios customers. Marketing expenses also increased $0.7 million, compared to 2003, due to additional costs associated with certain product marketing campaigns, and increased marketing in the acquired areas of Dayton/Springfield, Ohio. WesBanco also recorded $1.0 million in losses on equity partnerships and amortization expense relating to low-income housing partnerships for 2004 compared to $0.6 million in 2003, which are partially offset by certain tax benefits that WesBanco received on equity partnerships. In September of 2004, several of WesBancos market areas were hit by flash floods due to the remnants of Hurricane Ivan which caused damage to approximately 10 branches. Accordingly, WesBanco recorded a total of $0.3 million in estimated flood cleanup costs in the third and fourth quarters 2004. One branch in the Wheeling, West Virginia area was permanently closed in January 2005 due to the extensive damage that it sustained, and three other branches were closed for three to five months until renovations were completed.
For the merger-related expenses recorded in 2004 nearly all of the expense represents four months of costs related to the Western Ohio acquisition while the 2003 expense is entirely related to certain residual executive employment agreement expense from the American acquisition. For 2005, WesBanco estimates that approximately $0.6 million in merger-related expenses from the 2005 Winton acquisition will be recorded.
WesBanco recorded a provision for federal and state income taxes of $9.0 million in 2004, which remained relatively consistent with the $8.7 million recorded in 2003. WesBancos effective tax rate decreased to 19.0% for 2004 from 19.4% for 2003. For 2005, it is currently anticipated that the effective tax rate will approximate between 21-22%.
Federal income tax expense increased $0.4 million to $8.5 million in 2004 from $8.1 million in 2003 primarily due to an increase in pre-tax income which was partially offset by an increase in low-income housing partnership tax credits. WesBancos West Virginia subsidiaries are subject to a state corporate net income tax, which is based upon federal taxable income, with certain modifications. The statutory West Virginia tax rate was 9.0% for 2004 and 2003. West Virginia income tax, included in the provision for income taxes, was $0.5 million for 2004 compared to $0.6 million for 2003. This decrease was primarily due to certain strategic business and tax-planning initiatives implemented in early 2003, utilizing a real estate investment trust.
WesBancos offices located in Ohio are subject to an Ohio franchise tax, which is assessed on capital at the beginning of the year, rather than a corporate net income tax. Ohio franchise taxes totaling $0.3 million are included in other operating expense and are relatively consistent with the amount recorded in 2003. For 2005, WesBanco anticipates that Ohio franchise tax will approximate $0.5 million due to the Western Ohio acquisition increasing the amount of taxable capital within the State of Ohio.
TABLE 6: COMPOSITION OF SECURITIES
Total investment securities, which represent a source of liquidity for WesBanco, decreased 2.4% from December 31, 2003 to December 31, 2004, primarily due to a decrease in U.S. Treasury and Federal Agencies in both the held to maturity and available for sale categories, which was partially offset by an increase in obligations of states and political subdivisions and mortgage-backed securities. For 2004, the investment portfolios yield on a tax equivalent basis was 4.83% which was slightly lower than 2003s yield of 4.94%. For 2004, cash flows from the portfolio due to calls, maturities and prepayments decreased to $322.8 million, which was substantially lower that the $563.5 million for 2003. This decrease was primarily due to lower levels of calls as evidenced by $168.6 million in securities being called in 2004 compared to $287.7 million for 2003.
At December 31, 2004, total unamortized premium and discount on the investment portfolio, as a percentage of the total investment portfolio, was 0.64% and 1.60%, respectively, compared to 0.88% and 1.68%
at December 31, 2003. The premium amortization on the investment portfolio recorded as a reduction to interest income for 2004 was $5.5 million, down from the $7.2 million experienced in 2003. Total premium on the investment portfolio, which relates primarily to collateralized mortgage obligations and mortgage-backed securities in the available for sale portion of the investment portfolio, is subject to increased amortization in times of accelerated prepayments, usually occurring when interest rates fall, and decreased amortization during periods of rising interest rates.
The discount accretion on the investment portfolio recorded into income was $1.8 million for 2004 compared to $1.7 million for 2003. The discount primarily relates to obligations of states and political subdivisions, which have longer average maturities, comprising 95.1% of the total discount.
At December 31, 2004, WesBanco had $432.3 million in investment securities in an unrealized loss position for less than 12 months and $89.8 million in investment securities in an unrealized loss position for more than 12 months, compared to $448.4 and $1.9 million for the same categories at December 31, 2003, respectively. The securities in an unrealized loss position may not be available to meet WesBancos short-term liquidity needs if management indicates its ability and intent to hold such loss position securities for a period of time sufficient for recovery of cost. WesBanco believes that the unrealized securities losses are all considered temporary impairment losses due to $497.1 million of the fair value of the securities at December 31, 2004 having fixed interest rates which causes their fair value to fluctuate in response to prevailing market interest rates. WesBanco does not believe any of the securities are impaired due to reasons of credit quality as none of the securities have had credit downgrades and all securities are paying principal and interest according to the contractual terms. At December 31, 2004 the single largest loss on any one security in the Less than 12 months category is $0.2 million and $0.1 million in the 12 months or more category, compared to $0.2 million and $18.0 thousand, respectively at December 31, 2003. Accordingly, as of December 31, 2004, management believes the unrealized losses are temporary and no impairment loss has been recorded in the Consolidated Statements of Income. Please refer to Note 4, Securities, of the Consolidated Financial Statements for more information.
Unrealized pre-tax gains and losses on available for sale securities (fair value adjustments) reflected a $1.6 million market loss as of December 31, 2004, compared to a $1.0 million market gain as of December 31, 2003. These fair value adjustments represent temporary fluctuations resulting from changes in market rates in relation to average yields in the available for sale portfolio and on an after-tax basis are accounted for as an adjustment to other comprehensive income in shareholders equity. WesBanco may impact the magnitude of the fair value adjustment by managing both the volume and average maturities of securities that are classified as available for sale as well as the portion of new investments allocated to this category versus the held to maturity portfolio. If these securities were held to their respective maturity dates, no fair value gain or loss would be realized. During 2004, proceeds from the sale of available for sale securities were $161.4 million, compared to $160.6 million for 2003. During the latter part of 2004, WesBanco sold a portion of the $50.0 million in securities that were acquired from Western Ohio, in order to re-align certain securities with the investment strategies of WesBanco. In the third quarter of 2004, WesBanco sold certain equity securities resulting in an after tax gain of approximately $0.5 million. On a year to date basis for 2004, gross security gains of $2.8 million and gross security losses of $46 thousand were realized, compared to $3.1 million and $0.3 million, respectively, for 2003.
TABLE 7: MATURITY DISTRIBUTION AND YIELD ANALYSIS OF SECURITIES
LOANS AND CREDIT RISK
The loan portfolio is WesBancos single largest balance sheet asset classification and the largest source of interest income. The risk that borrowers will be unable or unwilling to repay their obligations and default on loans is inherent in all lending activities. In addition to the inherent risk of a change in a borrowers repayment capacity, economic conditions and other factors beyond WesBancos control can adversely impact credit risk. WesBancos primary goal in managing credit risk is to minimize the impact of default by an individual borrower or group of borrowers. Credit risk is managed through the initial underwriting process as well as through ongoing monitoring and administration of the loan portfolio that varies by category. WesBancos credit policies establish standard underwriting guidelines for each type of loan and require an appropriate evaluation of the credit
characteristics of each borrower. This evaluation includes the borrowers repayment capacity; the adequacy of collateral, if any, to secure the loan; and other factors unique to each loan that may increase or mitigate its risk.
WesBancos loan portfolio consists of the five major categories of lending set forth in Table 8. WesBanco makes loans for business and consumer purposes. Business purpose loans consist of commercial and commercial real estate loans, while consumer purpose loans consist of residential real estate loans, home equity and other consumer loans. Each category entails certain distinct elements of risk that impact the manner in which those loans are underwritten, monitored, and administered. The elements of risk that are distinct to a particular category of loans are explained further within that category of loans section of this Managements Discussion and Analysis.
TABLE 8: COMPOSITION OF LOANS
The increase in total loans between December 31, 2003 and December 31, 2004 reflects strong organic growth and the Western Ohio acquisition. Organic growth contributed approximately $199.8 million of this increase and was fueled primarily by WesBancos success in originating commercial and commercial real estate loan relationships in the Columbus, Ohio and western Pennsylvania markets, as well as continued expansion of existing relationships in other markets. This organic growth is attributed to strong loan demand, increased calling efforts on prospective customers and the addition or repositioning of lending personnel undertaken in 2003. The Western Ohio acquisition added approximately $337.9 million to the loan portfolio at the time of the merger.
Table 9 summarizes the changes in each major category of loans between December 31, 2003 and December 31, 2004 as attributable to organic growth versus acquired growth. For purposes of this table, acquired growth includes Western Ohio loans and $17.3 million of residential real estate loan pools purchased from other lending institutions.
TABLE 9: SUMMARY OF CHANGES IN LOANS
BUSINESS PURPOSE LOANS
Most business purpose loans are originated directly by WesBanco. At times, WesBanco may also participate in syndicated loans originated by other lending institutions, including Shared National Credits, which are defined by banking regulatory agencies as lending arrangements with three or more participating financial institutions and credit exceeding $20 million in the aggregate. WesBanco conducts its own customary credit evaluation before purchasing or participating in these loans. The risks associated with syndicated loans are similar to those of directly originated business loans, however additional risk may arise from limited ability to control actions of the syndicate or the lead lender.
WesBanco maintains a loan grading system that categorizes business loans, according to their level of credit risk. This grading system encompasses six categories that define each borrowers ability to repay their loan obligations and other factors that affect the quality of each loan. All business purpose loans are assigned a grade at their inception, and grades are regularly reviewed and evaluated. When the risk of a loan increases beyond that which is considered acceptable in the assigned grade, its grade is adjusted to reflect the change in risk. The loan grading system provides management with an effective early warning system of potential problems, assists in identifying adverse trends and evaluating the overall quality of the portfolio, and facilitates evaluating the adequacy of the allowance for loan losses.
Commercial: The increase in commercial loans between December 31, 2003 and 2004 is the result of organic growth of $24.2 million and approximately $16.0 million acquired in the Western Ohio merger. General improvement in the economy, pent up demand by businesses to make capital improvements, and a general perception in the business community that the recovery is sustainable contributed to higher commercial loan demand in all markets throughout 2004.
The commercial category consists of loans to a wide variety of businesses and includes revolving lines of credit to finance accounts receivable, inventory and other working capital requirements, and term loans to finance fixed assets other than real estate. Loans guaranteed by the United States Small Business Administration or similar agencies are also included in this category. Most commercial lines of credit are renewable or may be cancelled by WesBanco annually. However, lines of credit may also be committed for more than one year when appropriate. Term loans secured by equipment and other types of collateral have terms that are consistent with the purpose of the loan and generally do not exceed ten years.
TABLE 10: MATURITY DISTRIBUTION OF COMMERCIAL LOANS
Loans to small and mid-size businesses, which are generally defined as those with annual revenues of $5 million or less, represent between 75% and 80% of the commercial loan portfolio. Participation in syndicated commercial loans totaled $22.0 million at December 31, 2004 and $3.1 million at December 31, 2003. This increase is primarily the result of approximately $13.0 million of new participation loans in the Central Ohio market and approximately $3.5 million in such loans acquired in the Western Ohio merger.
WesBanco categorizes commercial loans by industry according to the North American Industry Classification System, (NAICS). The commercial portfolio is not concentrated in any single industry, but reflects a diverse range of businesses from all sectors of the economy. Table 11 sets forth information pertaining to commercial loans by industry sector. Growth in commercial loans during 2004 did not materially change the industry mix and the portfolio is generally diversified with no significant concentration in any single sector.
TABLE 11: COMMERCIAL LOANS BY INDUSTRY SECTOR
The primary factors that are considered in underwriting commercial borrowers are their historical and projected earnings, cash flow, capital resources, liquidity and leverage. Other factors that are also considered include the borrowers industry, their competitive advantages and disadvantages, the quality of management, and other external influences that may impact the business. These factors are also evaluated to determine their potential impact on repayment capacity. The type and amount of the collateral varies from loan to loan depending on the financial strength of the borrower, the amount and terms of the loan, and the collateral available to be
pledged by the borrower. Unsecured credit is only extended to those borrowers that exhibit consistently strong repayment capacity and the financial condition to withstand any temporary impairment of their cash flow. Commercial borrowers are required to provide WesBanco with periodic financial statements and other information when warranted, depending on the size and type of loan.
Credit risk in the commercial category is mitigated by limiting total credit exposure to individual borrowers or groups of borrowers, industries and geographic markets, and by requiring collateral where appropriate. Credit risk is monitored by performing regular periodic reviews of borrowing relationships over a predetermined amount subsequent to their origination, verifying each borrowers compliance with applicable loan covenants, and evaluating the overall portfolio for levels of concentration. Certain types of collateral that fluctuate with business conditions, such as accounts receivable and inventory, may also be subject to regular reporting by the borrower to WesBanco and, in some instances, independent inspection or verification by WesBanco.
Commercial Real Estate: The substantial increase in commercial real estate loans between December 31, 2003 and 2004 is attributed to organic growth of $150.3 million primarily in the southwestern Pennsylvania and central Ohio markets and approximately $124.6 million acquired in the Western Ohio merger. Demand for commercial real estate remained strong in 2004 as investors continued to find investments in real estate more attractive than the equity and bond markets and demand was also strong for refinancing of existing commercial real estate projects earlier in the year from the drop in market rates in 2002 and 2003.
The commercial real estate category consists of loans to purchase, construct or refinance properties that are used by borrowers in the operation of their businesses and loans to finance investor-owned rental properties, including 1-to-4 family rental properties and multi-family apartment buildings. Commercial real estate loans generally have repayment terms ranging from 10 to 25 years depending on the type, age and condition of the property. Loans with amortization periods of more than 20 years will generally also have a maturity date or call option of 10 years or less.
TABLE 12: MATURITY DISTRIBUTION OF COMMERCIAL REAL ESTATE LOANS
Participation in syndicated commercial real estate loans totaled $49.9 million at December 31, 2004 and $28.1 million at December 31, 2003. This increase is primarily the result of approximately $7.0 million of new participation loans in the central Ohio and southwestern Pennsylvania markets and approximately $28.0 million in such loans acquired in the Western Ohio merger, net of approximately $21.0 million of participation loans repurchased by the originating bank during 2004.
Included in commercial real estate loans are construction loans totaling $54.0 million at December 31, 2004 and $33.0 million at December 31, 2003. This increase is attributed to an overall increase in commercial construction and residential housing development activity in certain of WesBancos markets. Commercial real estate construction loans are generally made only when WesBanco also commits to the permanent financing of the project, has a takeout commitment from another lender for the permanent loan, or the loan is expected to be repaid from the sale of subdivided property. Construction loans require payment of interest only during the construction period, which can range from as short as six months to up to three years for larger, multiple phase projects such as residential housing developments. This type of loan has the unique risk that the builder or developer may not complete the project, or not complete it on time or within budget.
Commercial real estate loans are not concentrated in any single property type. Table 13 sets forth information pertaining to commercial real estate loans by property type. Growth in commercial real estate loans during 2004 did not materially change the property mix and the portfolio is generally diversified with no significant concentration in any single property type.
TABLE 13: COMMERCIAL REAL ESTATE LOANS BY PROPERTY TYPE
The primary factors that are considered in underwriting commercial real estate loans are the borrowers historical and projected earnings, cash flow, capital resources, liquidity and leverage. Other factors that are also considered include the borrowers industry, their competitive advantages and disadvantages, the quality of management, and other external influences that may impact the business. These factors are also evaluated to determine their potential impact on repayment capacity. The primary factors that are considered in determining repayment capacity for investor-owned commercial real estate are the net operating income generated by the property, the type, quality and mix of tenants in the property, and the age, condition and location of the property. Environmental risk is also an important factor that is evaluated for commercial real estate loans. While real estate is the primary collateral, these loans may at times also be partially secured by other types of collateral. Real estate values are determined by obtaining appraisals of the property. Commercial real estate borrowers are required to provide WesBanco with periodic financial statements and other information such as rent rolls when warranted, depending on the size and type of property.
Credit risk in the commercial real estate category is mitigated by limiting total credit exposure to individual borrowers or groups of borrowers; and avoiding concentrations by property type or within geographic markets. Credit risk is further mitigated by requiring borrowers to have adequate down payments or equity in the property, thereby limiting the loan balance in relation to the appraised value of the property, unless there are sufficient mitigating factors that would reduce the risk of a higher loan to value ratio. Loan to value ratios are generally limited to 80% of the value of the property, but lower ratios may be required for certain types of properties, or when other factors exist that may increase the potential volatility of the market value of a particular property type.
Credit risk in the commercial real estate portfolio is monitored by performing regular periodic reviews of borrowing relationships over a predetermined amount subsequent to their origination, verifying each borrowers compliance with applicable loan covenants, and evaluating the overall portfolio for levels of concentration by property type. Commercial real estate risk is also managed by periodic site visits to financed properties and monitoring the factors in each of WesBancos markets that influence real estate collateral values such as rental
rates, occupancy, and capitalization rates. Construction loan risk is mitigated by generally making commercial real estate construction loans to developers with established reputations who operate in WesBancos markets, periodically inspecting construction in progress, and disbursing the loan as specified stages of each project are completed.
CONSUMER PURPOSE LOANS
Residential real estate and home equity loans are generally originated directly by WesBanco. At times, WesBanco also purchases residential real estate loan pools originated by other lending institutions to maintain an appropriate balance of this category relative to total loans or to change the interest rate risk profile of the portfolio. WesBanco conducts its own customary evaluation before purchasing pools of residential real estate loans. The risks associated with purchased loan pools are generally similar to those of directly originated residential real estate loans, however, the servicing of those loans, including the collecting of payments, maintenance of escrow accounts and if necessary, foreclosure processing is generally performed by another party other than WesBanco.
Consumer loans are originated directly by WesBanco and indirectly through automobile dealers and other sellers of consumer goods. WesBanco conducts its own customary evaluation of both direct and indirect consumer loans.
WesBanco does not make sub-prime consumer purpose loans, as that term is commonly used in the banking industry. WesBanco does extend credit to borrowers that may have one or more characteristics of a sub-prime loan, such as credit bureau scores that are less than, or debt-to-income ratios that are greater than policy guidelines. These loans are generally only made when the credit risk associated with the sub-prime characteristics of the borrower are properly justified and mitigated by obtaining acceptable co-makers or guarantors or requiring additional collateral, or by the deposit and other non-lending relationships of the borrower with WesBanco.
WesBanco does not maintain statistical information about the industry in which consumer borrowers are employed because such information is typically obtained only when each loan is originated and often becomes inaccurate as borrowers change employment during the term of their loans. Instead, WesBanco estimates such information based on consumer demographics, market share, and other available information when there is a significant risk of loss of employment within an industry or a significant employer in any of WesBancos markets. To managements knowledge, there are no concentrations of employment that would have a material adverse impact on the risk of consumer purpose loans.
Residential Real Estate: The increase in residential real estate loans between December 31, 2003 and 2004 is principally attributed to $168.9 million of loans acquired in the Western Ohio merger and the purchase of approximately $17.3 million of loans originated by other lending institutions. Organic loan growth was impacted by a reduction in new loan activity in 2004 after several years of higher volume driven by record low interest rates. However, the more stable interest rate environment combined with periodic increases in rates also slowed the rate of prepayments and alleviated portfolio attrition compared to 2003. Still, new loan origination did not keep pace with the scheduled amortization of loans and resulted in constrained organic growth in 2004.
The residential real estate category consists of loans to consumers to purchase, construct or refinance personal residences. WesBanco originates conforming and non-conforming mortgages to be held in its portfolio. Non-conforming mortgages are those loans that do not meet all of the documentation standards for sale in the secondary market. The average original amount of new loans originated was approximately $109,000 for 2004 compared to approximately $91,000 for 2003, while the average balance of residential real estate loans approximated $61,000 at December 31, 2004 compared to $56,000 at December 31, 2003.
Residential real estate loans can have terms ranging up to 30 years. Interest rates on residential real estate loans held in the portfolio may be fixed for up to 15 years. Loans with greater than 15 year amortization are
generally sold in the secondary market for asset/liability management purposes. Fifteen year fixed rate residential real estate loans totaled approximately $275.3 million at December 31, 2004 compared to $180.5 million at December 31, 2003. This increase in fixed rate loans is evenly attributable to organic loan origination, the Western Ohio acquisition and purchased pools of loans. The remainder of the portfolio has interest rates that adjust from between one and five years.
TABLE 14: MATURITY DISTRIBUTION OF RESIDENTIAL REAL ESTATE LOANS
Included in residential real estate loans are construction loans totaling $20.4 million at December 31, 2004 and $9.5 million at December 31, 2003. This category includes homes being built under contract for the eventual occupant of the residence. Loans to contractors to finance speculative residential construction are included in the commercial real estate category. The increase in residential construction loans is attributable to overall improvement in the economy to support new home starts as well as the favorable interest rate environment that existed for most of the year. Residential real estate construction loans are approved with the expectation that they will convert to a permanent mortgage loan upon completion of construction. Construction loans require payment of interest only during the construction period, which generally ranges from six to twelve months, but may be longer for larger residences.
Credit risk in the residential real estate category is mitigated by requiring borrowers to have adequate down payments or equity in the property, thereby limiting the amount of the loan in relation to the appraised value of the property. Loan requests that exceed credit policy loan-to-value guidelines generally must be supported by private mortgage insurance. Credit risk is also managed by monitoring delinquency levels and trends, and economic and other factors that influence real estate collateral values in each of WesBancos markets. Construction loans have a unique risk that the builder may not complete the residence, or not complete it on time or within budget. Construction risk is mitigated by evaluating the builders reputation and capacity to complete each project, periodically inspecting construction in progress, and disbursing the loan as specified stages of each project are completed.
Home Equity: The increase in home equity lines of credit between December 31, 2003 and 2004 is attributed to organic growth of approximately $9.9 million that was driven by marketing campaigns aimed at generating new home equity lines and approximately $26.6 million acquired in the Western Ohio merger. The average home equity line of credit approximated $30,000 at December 31, 2004, which is comparable to the average line at December 31, 2003. The average usage of home equity lines generally ranges from 55-60% of the total amount available to each borrower.
The home equity category consists of revolving lines of credit to consumers that are secured by first or second liens on residential real estate located primarily within WesBancos market areas. Most home equity lines of credit are available to the borrower as a revolving line of credit for up to 15 years, at which time the outstanding balance is required to be repaid over a term of not more than 7 years. Some home equity lines of credit are available to the borrower for an indefinite period of time but may be cancelled by WesBanco under certain circumstances.
TABLE 15: MATURITY DISTRIBUTION OF HOME EQUITY LINES OF CREDIT
Credit risk in the home equity category is similar to and therefore mitigated and monitored in much the same manner as described for residential real estate. Home equity lines are generally limited to an amount in relation to the value of the property net of the first mortgage, if any. The risk associated with the revolving availability of home equity lines is also mitigated by periodic reduction of the first mortgage amounts, which thereby increases the residual value of the collateral in relation to the amount of the home equity line.
Consumer: The increase in consumer loans between December 31, 2003 and 2004 is attributed to organic growth of approximately $6.3 million and approximately $1.8 million acquired in the Western Ohio merger. Organic growth resulted from a renewed focus on indirect lending as well as new products aimed at generating direct consumer loans. However, competition from zero-percent or low interest rate financing offered by large domestic automobile manufacturer finance companies continued to limit WesBancos ability to originate a substantial volume of indirect loans.
The consumer category consists of installment loans originated directly by WesBanco and, indirectly through dealers to finance purchases of automobiles, boats and other recreational vehicles, and lines of credit used by consumers that are either unsecured or secured by collateral other than residential real estate. Consumer loans are a homogeneous group of loans, generally smaller in amount, which are spread over a larger number of diverse individual borrowers. The maximum term for automobile loans and other installment loans is generally 72 months or less depending on the age of automobile and other factors for unsecured loans and loans secured by other collateral. Consumer lines of credit are generally available for an indefinite period of time as long as the borrowers credit characteristics do not materially or adversely change; however, WesBanco may cancel such lines under certain circumstances.
TABLE 16: MATURITY DISTRIBUTION OF CONSUMER LOANS
Credit risk in the consumer category includes the impact of a general economic downturn, an isolated adverse event that impacts a major employer, individual loss of employment or other personal calamities, and collateral values that depreciate faster than the repayment of the loan balance. Consumer credit risk is mitigated by continuously monitoring delinquency levels and trends, pursuing collection efforts at the earliest stage of delinquency, and continually evaluating underwriting standards to determine to the extent possible those credit characteristics that predict credit performance.
Loans Held For Sale: This category of loans consists of residential real estate loans originated for sale in the secondary market. The amount of new loans originated for sale decreased 36.2% to $29.7 million in 2004
compared to $46.5 million in 2003. This decrease is attributed to an overall industry-wide decline in new loan activity due to a more stable interest rate environment and to WesBancos focus on originating loans for its own portfolio to offset attrition from the amortization of existing loans and increased prepayments.
Credit risk associated with loans held for sale is mitigated by entering into sales commitments with secondary market purchasers of the loans at the time the loans are to be funded. This practice has the effect of minimizing the amount of such loans that are held in the portfolio at any point in time. WesBanco generally has not serviced these loans after their sale in the secondary market, but will begin servicing such loans in 2005 as a result of acquiring a secondary market servicing unit in connection with the Winton acquisition on January 3, 2005.
Loan commitments, which are not reported on the balance sheet, consist of available balances under lines and letters of credit for both business and consumer purpose loans. This includes commercial lines of credit, home equity and other consumer lines of credit, commercial and residential construction loans, and commercial and standby letters of credit as set forth in Table 17.
TABLE 17: SUMMARY OF LOAN COMMITMENTS
The increase in commitments to extend credit between December 31, 2003 and 2004 is attributed to organic growth in commercial lines of credit, including participation in lines originated by other financial institutions, commercial and residential real estate construction loans, and home equity lines of credit. Loan commitments acquired in the Western Ohio merger approximated $41.0 million, which consisted primarily of home equity lines of credit, participation in commercial real estate construction loans, and commercial letters of credit.
Commercial lines of credit and letters of credit are generally renewable or may be cancelled annually by WesBanco. However, lines of credit and letters of credit may also be committed for more than one year when appropriate. Home equity and other consumer lines of credit are generally available to the borrower beyond one year. Construction loan commitments are generally available to the borrower for up to one year for residential construction loans, but may extend beyond one year for certain types of commercial real estate projects. All loan commitments are cancelable by WesBanco regardless of their duration under certain circumstances.
TABLE 18: MATURITY DISTRIBUTION OF LOAN COMMITMENTS
GEOGRAPHIC DISTRIBUTION OF LOANS
WesBanco generally extends credit to borrowers that are primarily located within the market areas where WesBanco has branch offices. There are no significant loans to commercial borrowers or loans to finance commercial real estate located outside of WesBancos market areas unless the borrower also has significant other loan, deposit, trust or other business relationships with WesBanco. Residential real estate includes purchased pools of loans that include properties located outside of WesBancos markets. These loans do not present more than normal risk because of the underlying credit quality of the individual loans in the pool.
Table 19 approximates the geographic distribution by state for each major category of loans at December 31, 2004 based on the location of the borrowers business for commercial loans; the property for commercial real estate, residential real estate and home equity loans; and the borrowers primary residence for consumer loans. The Upper Ohio Valley market continues to represent a significant but reduced percentage of the loan portfolio, with loans in the northern panhandle of West Virginia and southeastern Ohio representing approximately 30% of total loans at December 31, 2004 compared to approximately 45% at December 31, 2003. This change in the geographic distribution of loans is the result of strong growth in other markets such as Columbus, Ohio and southwestern Pennsylvania as well as the acquisition of Western Ohio, which positioned WesBanco in the Springfield/Dayton, Ohio markets. The acquisition of Winton on January 3, 2005 will increase the percentage of commercial real estate, residential real estate, and home equity loans in Ohio to between approximately 45% and 50% of total loans in each of those categories, while total loans in Ohio will approximate 43%.
TABLE 19: GEOGRAPHIC DISTRIBUTION OF PORTFOLIO LOANS
NON-PERFORMING ASSETS, IMPAIRED LOANS AND LOANS PAST DUE 90 DAYS OR MORE
Non-performing assets consist of non-accrual and renegotiated loans, other real estate acquired through or in lieu of foreclosure, bank premises held for sale, and repossessed automobiles acquired to satisfy defaulted consumer loans. Other impaired loans include certain loans that are internally classified as substandard or doubtful.
Loans are placed on non-accrual status when they become past due 90 days or more unless they are both well secured and in the process of collection. Except for certain consumer and residential real estate loans as discussed in the Notes to the Consolidated Financial Statements, when a loan is placed on non-accrual, interest income may not be recognized as cash payments are received.
Loans are categorized as renegotiated when WesBanco, for economic or legal reasons related to a borrowers financial difficulties, grants a concession to the borrower that it would not otherwise consider. Concessions that may be granted include a reduction of the interest rate, the amount of accrued interest, or the face amount of the loan; as well as an extension of the maturity date or the amortization schedule. Loans may be removed from renegotiated status after they have performed according to the renegotiated terms for a period of time.
WesBanco considers loans that are classified as substandard or doubtful because of a borrowers diminished repayment capacity to be impaired when they are not fully secured by collateral or the observable market price for the loan is less than the outstanding balance. Such loans continue to accrue interest, have not been renegotiated, and may or may not have a record of delinquent payments.
Other real estate and repossessed assets consists primarily of real estate acquired through or in lieu of foreclosure and repossessed automobiles or other personal property. This category may also include bank premises held for sale and residential real estate of relocated employees, which do not arise as a result of lending activities.
TABLE 20: NON-PERFORMING ASSETS, OTHER IMPAIRED LOANS AND LOANS PAST DUE 90 DAYS OR MORE