Annual Report (Form 10-K), fiscal year 1994





ITEM 3: LEGAL PROCEEDINGS
Note 16 to the Consolidated Financial Statements, included in this Report under Item 8, is hereby incorporated in this Item 3 by reference.
ITEM 4:

ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the quarter ended December 31, 1994.
PART II
ITEM 5:

ITEM 5: MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Corporation's Common Stock is traded on the National Association of Securities Dealers Automated Quotation National Market System (the "NASDAQ National Market System") under the symbol FATN. At the close of business on February 9, 1995, there were approximately 9,260 holders of record of the Corporation's common stock. The following table sets out the quarterly high and low sales prices of the Corporation's common stock. The dividends declared during each quarter for the last two years are also shown. In the fourth quarter of 1994, the Corporation declared a dividend of $.25 per share, an increase of 19%.
STOCK PRICES
See SUPERVISION AND REGULATION, PAYMENT OF DIVIDENDS. See also, notes 8 and 16 to the Corporation's Consolidated Financial Statements, included in this Report under Item 8, which are incorporated herein by reference.
ITEM 6:

ITEM 6: SELECTED FINANCIAL DATA
The table "Selected Financial Data" on page 45 hereof is incorporated in this Item 6 by reference.
ITEM 7:

ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The following is Management's discussion and analysis of First American Corporation's results of operations and financial condition for 1994. It should be read in conjunction with the consolidated financial statements and accompanying notes and other data included herein. Tables referred to in this discussion may be found on pages 45 to 54.
OVERVIEW
Net income for 1994 was $90.7 million, or $3.48 per share, compared with $101.8 million, or $3.93 per share, in 1993. Net income for 1994 was increased by a $6.1 million negative provision for loan losses, net of tax, or $.24 per share, and reduced by $6.0 million of losses, net of tax, or $.23 per share, in the fourth quarter on sales of securities available for sale. Net income for 1993 was increased by a $28.6 million negative provision for loan losses, net of tax, or $1.10 per share, and reduced by a $6.5 million charitable contribution, net of tax, or $.25 per share, and the $.1 million cumulative effect of changes in accounting principles. With these transactions excluded in both years, net income increased 13% to $90.6 million in 1994, or $3.47 per share, versus $79.8 million in 1993, or $3.08 per share.
Return on average assets (ROA) and return on average equity (ROE) were 1.25% and 15.23%, respectively, during 1994.
Net interest income on a taxable equivalent basis increased 4% during 1994 to $283.1 million due primarily to loan growth. Average loans increased 17% from 1993 (14% excluding acquisitions).
Asset quality improved during 1994, marking the fourth straight year of improvement. Nonperforming assets equaled $21.1 million, or .43% of total loans and foreclosed properties at December 31, 1994. This is down 48% from $40.5 million, or .93% of total loans and foreclosed properties a year earlier. First American recorded net loan recoveries of $2.7 million during 1994, compared to net loan charge-offs of $6.3 million during 1993. In light of these and other factors, the Company's allowance for possible loan losses methodology produced a negative $10.0 million (pre-tax) provision for loan losses in 1994 in order to maintain the allowance for loan losses at an appropriate level.
[GRAPH 1 - See Appendix]
NET INCOME (LOSS) PER SHARE
[GRAPH 2- See Appendix]
RETURN ON AVERAGE EQUITY
[GRAPH 3 - See Appendix]
RETURN ON AVERAGE ASSETS
[GRAPH 4- See Appendix]
NET INTEREST INCOME
Excluding the $9.7 million (pre-tax) losses on sales of securities available for sale recorded in the fourth quarter of 1994, non-interest income rose 10% to $94.6 million. Excluding the $10.0 million (pre-tax) charitable contribution in 1993, non-interest expense rose only 2% to $229.6 million. With these transactions excluded, the operating efficiency ratio improved from 63.2% in 1993 to 60.8% in 1994.
Dividends paid in 1994 increased 60% to $.88 per share compared to $.55 per share in 1993. The Board of Directors voted to increase the quarterly cash dividend from $.21 per share to $.25 per share during the fourth quarter of 1994 based on First American's capital position and financial performance.
In December 1994, the Board of Directors authorized the repurchase of up to 800,000 shares of First American common stock to fund the Company's various employee benefit plans and potential future acquisitions.
In February 1995, First American signed a definitive merger agreement under which all of the outstanding shares of Heritage Federal Bancshares, Inc. (Heritage Federal) will be exchanged for approximately $89 million of First American common stock. Heritage Federal, a savings bank with $521.5 million in assets at December 31, 1994, is headquartered in Kingsport, Tennessee and operates 13 offices primarily in the East Tennessee areas of Tri-Cities, Anderson County and Roane County. The merger is expected to be completed during the fourth quarter of 1995, subject to approval by regulatory authorities and a vote of Heritage Federal shareholders.
TABLE 1 presents selected financial data for First American for the past five years. A more detailed discussion and analysis of the 1994 results of operations and financial condition follows.
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income is First American's largest source of income and was $283.1 million in 1994 on a taxable equivalent basis. This is up $11.6 million, or 4%, from $271.5 million in 1993. Net interest income is the difference between total interest income earned on loans, securities and other earning assets and total interest expense incurred on deposits and other interest-bearing liabilities. Throughout this discussion, tax-exempt interest income has been adjusted to a fully taxable equivalent basis in order to be comparable to interest income which is subject to Federal income tax. This adjustment has been calculated using a Federal income tax rate of 35%, adjusted for applicable non-deductible interest expense (for tax purposes) to purchase or carry tax-exempt obligations.
Interest income, interest expense and net interest income are all impacted by fluctuations in the volume and mix of earning assets and interest-bearing liabilities and the corresponding interest yields and costs. TABLE 2 highlights the effect that changes in volume, mix and rates had on net interest income from 1993 to 1994 and 1992 to 1993. TABLE 3 presents detailed average balance sheets, taxable equivalent interest income, interest expense, and corresponding yields and rates for the past five years.
Interest income was $475.5 million in 1994, an increase of $36.2 million, or 8%, from 1993. Of the $36.2 million increase, $31.2 million was due to a higher volume of earning assets (primarily loans) and $5.0 million resulted from an increase in average yields.
First American's two primary types of earning assets are securities and loans. During 1994, average earning assets rose $439.4 million, or 7%, to $6.62 billion. Average loans increased $672.3 million, or 17%, to $4.54 billion and average total securities declined $143.2 million, or 7%, to $1.98 billion. Changes in average balances and other pertinent items are discussed in more detail under the captions "Securities" and "Loans."
The average yield on earning assets rose seven basis points to 7.18%. The average yield on loans increased ten basis points to 7.74%, which reflects a higher interest rate environment in 1994 compared to 1993. The average yield on total securities dropped 41 basis points in 1994 to 6.07% from 6.48% during 1993. This drop in yield during the rising interest rate environment in 1994 reflects the fact that a portion of the Company's securities portfolio contains fixed rate securities which do not reprice upon a change in external interest rates. Thus, an increase in external interest rates does not affect fixed rate securities until those securities mature or are sold. Downward pressure on the Company's average securities yield during 1994 resulted from the fact that many of the fixed rate securities maturing throughout 1994 and in the latter part of 1993 were purchased during 1990 and 1991 when average rates were higher than average rates in effect during 1994 and the latter part of 1993.
Interest expense increased $24.6 million, or 15%, to $192.4 million in 1994. Of the $24.6 million increase, $13.7 million was due to higher average rates paid on interest-bearing funds and $10.9 million resulted from increased volumes of interest-bearing liabilities.
During 1994, average interest-bearing liabilities grew $330.3 million, or 7%, to $5.40 billion. Average interest-bearing deposits grew $182.4 million, or 4%, to $4.57 billion, average short-term borrowings increased $103.5 million, or 16%, to $740.4 million and average long-term debt increased $44.4 million, or 86%, to $95.9 million. Changes in average balances and other relevant information are discussed in more detail under the captions "Deposits" and "Other Borrowed Funds."
The average cost of interest-bearing funds in 1994 rose 25 basis points to 3.56%. As a reflection of the higher interest rate environment during 1994, the average rate on interest-bearing deposits increased ten basis points to 3.45% and the average rate on short-term borrowings rose 116 basis points to 3.85%. The 87 basis point decline in the average rate on long-term debt to 6.61% reflects the January 1994 repayment of $13.6 million of debentures with a rate of 7 5/8% and the 1994 addition of long-term debt at rates lower than those in effect when long-term debt agreements were entered into in previous years.
National and international interest rates significantly impact the market rates First American charges on loans, earns on investment securities, and pays on interest-bearing liabilities. The average national prime lending rate and certain longer-term market indices directly impact market rates charged on new or adjustable rate loans. Yields on many of the Company's newly purchased debt securities are affected by treasury security yields. Rates paid on interest-bearing liabilities are primarily impacted by changes in the Federal funds rate, LIBOR (London Interbank Offering Rate) and certain longer-term indices.
During periods of increasing rates like 1994, First American's yields on earning assets and rates paid on interest-bearing liabilities will generally rise. The increase will not be precisely the same size nor will it occur at the same time as increases in external indices. This is because some of First American's earning assets and interest-bearing liabilities do not reprice immediately or at the same time upon a change in external rates. Competitive factors also impact yields on earning assets and rates paid on interest-bearing liabilities. The following chart compares selected average interest rates for 1994 and 1993 and rates in effect on December 31, 1994 and 1993.
Net interest income increased primarily as a result of the increase in the volume of earning assets partially offset by a lower net interest spread. Net interest spread is the difference between the average yield on earning assets and the average rate paid on interest-bearing liabilities. First American's net interest spread decreased from 3.80% in 1993 to 3.62% in 1994. This 18 basis point decline reflects the 25 basis
point increase in the rates paid on interest-bearing liabilities which exceeded the seven basis point increase in yields on earning assets.
As the Company's net interest spread declined, the net interest margin, which is net interest income expressed as a percentage of average earning assets, decreased 12 basis points to 4.27% in 1994 from 4.39% in 1993. The net interest margin declined less than the net interest spread due to the increase in net non-interest funding. Net non-interest funding represents the excess of non-interest-bearing liabilities (such as demand deposits and shareholders' equity) over non-earning assets (such as cash and other assets).
Management anticipates net interest income will increase in 1995 due to expected growth in earning assets (primarily loans). However, we also anticipate that the net interest margin may decline in 1995 as external interest rates are expected to increase. This may cause the average rates on interest-bearing liabilities to increase initially at a faster pace than the Company's ability to increase average yields on interest-earning assets since, in aggregate, the former tends to reprice more rapidly than the latter. This topic is also addressed under the caption "Interest Rate Sensitivity."
Management continues to concentrate on improving the mix of earning assets, increasing the ratio of earning assets to total assets, and managing interest rate sensitivity. Various techniques are used to assist in managing the Company's interest rate sensitivity and are discussed under the caption "Asset/Liability Management."
PROVISION FOR LOAN LOSSES
This topic is addressed under the caption "Allowance and Provision for Possible Loan Losses."
NON-INTEREST INCOME
Non-interest income of $84.9 million in 1994 declined $.9 million, or 1%, from 1993. This decline is due in large part to losses on securities available for sale of $10.0 million during 1994 compared to losses of $2.0 million in 1993. Virtually all of the 1994 losses occurred during the fourth quarter when $85 million of securities available for sale were sold at a $9.7 million loss. The securities sold had the longest maturities and were the most depreciated in value in the available for sale category. The proceeds were invested in higher yielding securities with shorter maturities, which improved First American's overall interest rate sensitivity. The sale did not impact total shareholders' equity since the unrealized net losses on those securities had been previously recorded as a reduction in total shareholders' equity under Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities."
Non-interest income, excluding net securities losses totalled $94.9 million for 1994, an increase of $7.0 million (8%) from $87.9 million in 1993. This increase is primarily attributable to increases in service charges on deposit accounts ($3.0 million, an 8% increase); "other income" ($3.9 million, an 18% increase); and commissions and fees on fiduciary activities ($.8 million, a 5% increase). The increase in service charges on deposit accounts is primarily due to 8% growth in the number of retail deposit accounts. The increase in "other income" consists primarily of $2.6 million of increases from vendor incentives and insurance commissions. These increases in non-interest income were partially offset by a decline in investment services income ($.9 million, a 12% decrease) attributable to a decrease in the sale of investment products.
Management currently expects non-interest income to increase in 1995, as generating more fee income from existing products and developing new sources of fee income are two of our primary objectives over the next several years.
NON-INTEREST EXPENSE
Non-interest expense decreased $6.3 million, or 3%, during 1994 to $229.6 million. The decline was primarily due to a $10.0 million charitable contribution in 1993 to First American Foundation, a not-for-profit private foundation formed to facilitate the Company's charitable contributions. There was no similar contribution in 1994. Also contributing to the decrease in non-interest expense was a $3.3 million decrease in net foreclosed properties expense. Exclusive of the 1993 charitable contribution, 1994 non-interest expenses increased $3.7 million, or 2%.
First American's two recent acquisitions, which were recorded under the purchase method of accounting, resulted in a $4.2 million increase in non-interest expense. First American National Bank of Kentucky (FANBKY), acquired October 1, 1993, produced $1.2 million of non-interest expense in the three months it was owned during 1993 and $4.5 million in 1994, an increase of $3.3 million. First Fidelity Savings Bank, F.S.B. (First Fidelity), acquired April 1, 1994, generated $.9 million of non-interest expense for the nine months in 1994 it was part of First American. Exclusive of the non-interest expense of the two acquisitions and the 1993 charitable contribution, non-interest expense was $224.2 million in 1994 compared to $224.5 million in 1993. The acquisitions are described in NOTE 10 to the consolidated financial statements.
Salaries and employee benefits increased $12.7 million, or 11%, for the year ended December 31, 1994. Salaries expense increased $12.6 million, or 13%, in 1994, reflecting merit increases, higher incentive compensation, and additional employees. The number of full-time equivalent employees increased 4% from 3,138 at December 31, 1993, to 3,273 at December 31, 1994, primarily due to the transfer of certain software programming functions to First American that were previously
outsourced and the acquisition of First Fidelity. Though the October 1, 1993, acquisition of FANBKY did not cause the number of employees to increase from year-end 1993 to year-end 1994, it did result in a $1.2 million increase in salaries and employee benefits since it was part of First American for only three months during 1993 compared to a full year in 1994. Included within salaries expense, incentive compensation increased $1.6 million as a result of higher corporate and individual performances and an increase in the number of employees covered by incentive programs.
Systems and processing expense declined $5.1 million following the amendment in March 1994 to First American's agreement with an outside vendor that provides data processing and telecommunications services. The agreement was amended to transfer certain software programming functions to the Company. This amendment resulted in cost reductions in systems and processing expense and increases in other non-interest expense categories, such as salaries and benefits, which increased due to hiring approximately 50 additional computer systems personnel.
Net foreclosed properties expense decreased $3.3 million in 1994 ($5.7 million of net foreclosed properties income in 1994 versus income of $2.4 million in 1993). First American recorded net gains on disposals of foreclosed properties and in-substance foreclosures amounting to $6.4 million in 1994, as compared to $3.8 million in 1993. Operating costs associated with foreclosed properties declined from $1.4 million during 1993 to $.7 million in 1994, as the level of foreclosed properties decreased.
First American's operating efficiency ratio, which represents the ratio of operating expenses to taxable equivalent net interest income plus non-interest income, improved to 60.8% in 1994 (exclusive of the impact on non- interest income of the $9.7 million of losses on securities available for sale realized in the fourth quarter of 1994). The 1993 operating efficiency ratio was 63.2% (exclusive of the impact on non-interest expense of the $10 million Foundation contribution). Management continues to emphasize expense control as a means to improve efficiency and profitability. Our near-term objective is to improve the operating efficiency ratio to less than 59% for 1996.
[GRAPH 5 - See Appendix]
OPERATING EFFICIENCY RATIO
INCOME TAXES
Income tax expense was $54.1 million in 1994, which resulted in an effective tax rate of 37.4% of pre-tax income. Income tax expense for 1993 was $57.4 million which produced an effective tax rate of 36.0%. The lower effective tax rate in 1993 was primarily attributable to a $1.8 million benefit resulting from the Omnibus Budget Reconciliation Act of 1993 which became effective January 1, 1993. For additional information on income taxes of the Company and the status of Internal Revenue Service examinations, see NOTE 12 to the consolidated financial statements.
ASSET/LIABILITY MANAGEMENT
INTEREST RATE SENSITIVITY
The purpose of managing First American's interest rate sensitivity is to maintain growth in net interest income while limiting exposure to the potentially adverse effects of changes in interest rates. Through this process, Management seeks to maximize net interest income within liquidity, capital, and interest rate risk constraints. Asset/liability management is the responsibility of the Asset/Liability Committee, which is comprised of senior executives of First American. The Committee regularly reviews First American's balance sheet, net interest income performance, and forecasts of net interest income under numerous alternative simulated interest rate environments. The objective of the review is to identify risks and opportunities relative to balance sheet and margin strategies. Additionally, the Committee formulates and monitors compliance with policies and guidelines.
An important tool used in this process is the earnings simulation model. The model captures earning assets, interest-bearing liabilities and off-balance-sheet financial instruments and combines the various factors affecting interest rate sensitivity into an earnings projection that incorporates the Asset/Liability Committee's forecast of the most likely interest rate environment for the next 12 months. Interest rate sensitivity is determined by assessing the impact on net interest income of multiple rising and falling interest rate scenarios. The model is updated at least monthly and more often as considered necessary.
Management's asset/liability objective is to manage the interest sensitivity position so that net income will not be impacted more than 5% for changes in interest rates within 150 basis points of the Committee's most likely interest rate forecast over the next 12 months. A 5% impact on net income corresponds approximately to a 2.5% impact on net interest income. Throughout 1994, First American operated within this guideline. At December 31, 1994, the Asset/Liability Committee's assessment of the most likely interest rate scenario included a 100 basis point increase in the prime rate during the next 12 months from 8.5% at December 31, 1994, to 9.5% at December 31, 1995. This scenario also assumes that interest-
bearing deposit costs in aggregate will rise by a like amount in 1995. Management's objective is expected to be met even if the prime rate is 150 basis points higher or lower than forecast.
Another measure of interest rate sensitivity is the "static gap" approach, which compares the volume of assets to the volume of liabilities subject to repricing over a series of future time periods. TABLE 4 presents First American's interest rate sensitivity at December 31, 1994 and 1993, and reflects that First American is positioned more favorably for a lower interest rate environment than for a higher interest rate environment. At December 31, 1994, the net of interest-earning assets and interest-bearing liabilities repricing in a one-year period as a percent of earning assets was a cumulative net liability sensitivity of 10.9%. In other words, based on the December 31, 1994, balance sheet, the amount of liabilities repricing in 1995 in excess of the amount of assets repricing in 1995, together with the effect of related off-balance-sheet activities, was $767.4 million, or 10.9% of all earning assets. This compares with a cumulative one-year repricing net liability sensitivity of $1,020.8 million, or 15.6%, at year-end 1993.
For interest rate sensitivity purposes, First American classifies savings, NOW, and money market deposits, which in aggregate amount to $2.77 billion, as immediately rate-sensitive since none of these deposits carry contractual rate guarantees or early withdrawal penalties. The classification of savings and NOW accounts as immediately rate-sensitive is a conservative approach in measuring maximum interest rate sensitivity since, based on past experience, rates paid on NOW and regular savings balances ($1.18 billion at December 31, 1994) have generally not been immediately interest rate sensitive. If NOW and regular savings accounts are not considered interest-sensitive, the cumulative one-year repricing gap at December 31, 1994, would be net asset sensitive by $413.8 million, or 5.9% of earning assets.
DERIVATIVES
Generally, a derivatives transaction is a bilateral contract or payments exchange agreement whose value derives from the value of an underlying asset or underlying reference rate or index. First American has utilized off-balance-sheet derivative products for a number of years in managing its interest rate sensitivity. The use of non-complex, non-leveraged derivative products has reduced the Company's exposure to changes in the interest rate environment. By using derivatives, such as interest rate swaps and futures contracts, to alter the nature of (hedge) specific assets or liabilities on the balance sheet (for example, to change a variable to a fixed rate obligation), the derivative products offset fluctuations in net interest income from the otherwise unhedged position. In other words, if net interest income from the otherwise unhedged position changes (increases or decreases) by a given amount, the derivative product should produce close to the opposite result, making the combined amount (otherwise unhedged position impact plus the derivative product position
impact) essentially unchanged. Derivative products have enabled First American to improve its balance between interest-sensitive assets and interest-sensitive liabilities by managing interest rate sensitivity, while continuing to meet the credit and deposit needs of customers.
First American uses derivatives to reduce the negative effect of certain interest rate changes. In aggregate, many of First American's securities and loans with fixed rates may be funded with variable rate money market deposits. Consequently, net interest income can be negatively affected if short-term interest rates rise quickly. To reduce this exposure, the Company has entered into interest rate swaps on which the Company pays a fixed rate and receives a variable rate tied to three-month LIBOR. Thus, these swaps act to "fix" the rates paid on a portion of the money market account balances for the period of time covered by the swaps, which in turn reduces the potential negative impact on net interest income of rising interest rates. NOTE 15 to the consolidated financial statements presents the derivative financial instruments outstanding at December 31, 1994 and 1993.
At December 31, 1994, First American had interest rate and basis swaps with notional values totalling $1.7 billion with net positive fair values (unrealized net pre-tax gains) of $17.9 million. Notional amounts are key elements of derivative financial instrument agreements. However, notional amounts do not represent the amounts exchanged by the parties to derivatives and do not measure First American's exposure to credit or market risks. The amounts exchanged are based on the notional amounts and the other terms of the underlying derivative agreements. At December 31, 1993, the Company had interest rate and basis swaps with notional values totalling $1.1 billion and futures contracts with notional values of $.3 billion. These derivatives had a total of $3.0 million of net negative fair values (unrealized net pre-tax losses) at December 31, 1993.
As First American's individual derivative contracts approach maturity, they may be terminated and replaced with derivatives with longer maturities which offer more interest rate risk protection. NOTE 15 to the consolidated financial statements presents the deferred gains related to terminated derivative contracts. These deferred gains totalled $6.1 million at December 31, 1994, and $.1 million at December 31, 1993. Deferred gains and losses on off-balance-sheet derivative activities are recognized as interest income or interest expense over the original covered periods. Of the $6.1 million of deferred gains at December 31, 1994, $4.6 million will be recognized in net interest income during 1995 and $1.5 million will be recognized in 1996.
Net interest income for the year ended December 31, 1994, included derivative products net expense of $4.3 million, consisting of $1.4 million in additional interest income on loans, $.7 million reduction in interest income on securities, $4.6 million in additional interest expense on money market deposits and $.4 million in additional
interest expense on long-term debt. This compares to $8.3 million of derivatives products net expense in 1993 which consisted almost entirely of additional interest expense on money market deposits.
This net expense represents the net of all income and expenses related to derivatives. For example, when First American enters into an interest rate swap linked to money market deposits, it initially pays a fixed rate that is higher than the variable rate it receives. The net difference is a component of derivative products expense. If the index rate, which is generally 3-month LIBOR, increases, the out-of-pocket cost of the contract declines while the fair value of the contract increases. If First American terminates its position in the contract prior to maturity as part of its strategy in managing interest rate risk, any gain or loss is deferred and amortized. The amortization of deferred gains and losses is also a component of derivative products income or expense. The reduction in derivative products net expense from 1993 to 1994 resulted primarily from rising rates in 1994.
All derivatives activity is conducted under close Management and Board of Directors supervision and according to detailed policies and procedures governing these activities. Policy prohibits the use of leveraged and complex derivatives. The Board also sets limitations on the total notional amount of derivatives contracts that may be outstanding at any time.
Off-balance-sheet derivative activities give rise to credit risk when interest rate changes move in the Company's favor. In such cases, First American relies on the ability of the counterparts to off-balance-sheet derivative contracts to make contractual payments over the remaining lives of the contracts. Credit risk exposure due to off-balance-sheet derivative activities is closely monitored, and counterparts to these contracts are selected on the basis of their credit worthiness, as well as their market-making ability. As of December 31, 1994, all outstanding derivative transactions were with counterparts with credit ratings of A-2 or better. Enforceable bilateral netting contracts between First American and its counterparts allow for the netting of gains and losses in determining net credit exposure. First American's net credit exposure on outstanding derivatives was $18.3 million on December 31, 1994. Given the credit standing of the counterparts to the derivative contracts, Management believes that this credit exposure is reasonable in light of its objectives.
FINANCIAL CONDITION
SECURITIES
Securities generated 25% of total taxable equivalent interest income for the year ended December 31, 1994. In addition to producing interest income, the securities portfolio satisfies pledging requirements on deposits and is an important component of asset/liability, interest rate sensitivity and liquidity management, which
are discussed in more detail under the captions "Asset/Liability Management" and "Liquidity."
First American's total securities portfolio of $2,150.0 million at December 31, 1994, consisted of $664.7 million of securities available for sale (market value) and $1,485.3 million of securities held to maturity (amortized cost). This compares to a total securities portfolio of $2,050.8 million at December 31, 1993, which consisted of $1,392.9 million of securities available for sale and $657.8 million of securities held to maturity. The $827.5 million increase in securities held to maturity and $728.2 million decrease in securities available for sale reflect the 1994 transfer of $203.8 million of securities from the classification of available for sale to held to maturity, which is discussed in more detail at NOTE 3 to the consolidated financial statements. Additionally, Management determined that it had the intent and ability to hold to maturity $802.0 million of securities purchased during 1994, which exceeded the maturities of $177.8 million of held to maturity securities. Also during 1994, sales and maturities of available for sale securities exceeded purchases of those securities by $466.8 million.
Although total securities increased $99.2 million, or 5%, to $2.15 billion at December 31, 1994, total average securities declined $143.2 million, or 7%, to $1.98 billion during 1994. The decline in total average securities reflects the funding of new loans, as well as differences in the timing of maturities, sales, and purchases of securities in 1994 compared to 1993. The average yield of total securities in 1994 was 6.07%, down from 6.48% in 1993, as securities maturing in both years bore higher yields than yields on reinvestment securities despite generally rising interest rates throughout 1994.
The average estimated maturity of the total securities portfolio was 4.2 years at December 31, 1994 (3.8 years for securities held to maturity and 5.0 years for securities available for sale), compared with 4.9 years at year-end 1993 (4.4 years for securities held to maturity and 5.1 years for securities available for sale). The expected maturity for government and corporate securities is the stated maturity, and the expected maturity for mortgage-backed securities is based on current estimates of average maturities, which include prepayment assumptions. The average repricing life of the total securities portfolio was 2.3 years at December 31, 1994 (2.7 years for securities held to maturity and 1.4 years for securities available for sale). TABLE 5 presents the estimated average maturity and weighted average yields for securities held to maturity and securities available for sale at December 31, 1994.
All mortgage-backed securities classified as U.S. Government agencies and corporations were issued or guaranteed by the Government National Mortgage Association (Ginnie Mae), the Federal National Mortgage Association (Fannie Mae), or the Federal Home Loan Mortgage Corporation (Freddie Mac). Essentially all other mortgage-backed securities consisted of Planned Amortization Class (PAC)
collateralized mortgage obligations (CMOs), which were purchased because of their high credit quality and relatively certain average lives. On December 31, 1994, mortgage-backed security holdings included $289.0 million of floating rate mortgage-backed securities, of which $125.3 million were classified as held to maturity and $163.7 million were classified as available for sale. At year-end 1994, over 99.8% of the Company's debt securities were investment grade with the remaining .2% unrated.
LOANS
Loans represent First American's largest component of earning assets, producing 74% of interest income for the year ended December 31, 1994. During 1994, average loans increased $672.3 million, or 17%, to $4.54 billion. Excluding acquisitions, average loans increased 14%.
The increase in average loan volume is a reflection of positive economic conditions in Tennessee and selected markets in adjacent states and the success of First American's marketing efforts. During 1994, the U.S. economy continued to post gains, while the southeastern states outperformed the national averages. During this same time, the Tennessee economy led the southeast in a number of economic categories. Additionally, the Company's marketing efforts contributed to increased lending in certain target areas. Management currently expects loan growth to continue in 1995, although at a slower pace than 1994.
The average yield on loans was 7.74% during 1994 as compared to 7.64% during 1993. TABLE 3 contains average loan balances and TABLE 12 presents end of period loan balances by category for the past five years. TABLE 6 presents the maturities of loans, exclusive of consumer loans, outstanding at December 31, 1994.
Average commercial loans increased $262.7 million, or 15%, to $2.03 billion during 1994 from $1.77 billion during 1993. During 1994 and 1993, commercial loans averaged 45% and 46% of total loans, respectively.
The increase in the average balances of commercial loans occurred over a broad range of industry categories. The continued strong performance in the Tennessee and southeastern economies were important catalysts for First American's commercial loan growth. Also contributing were marketing campaigns aimed at the small business market (revenues under $10 million) and the middle market (revenues of $10 million to $100 million). As an example, during 1994 First American launched a small business equipment loan promotion guaranteeing 20-minute credit decisions. This was made possible by the 1993 re-engineering of the small business lending underwriting process. Efforts like these contributed to First American becoming a market leader in the state of Tennessee in the small business and middle markets.
[GRAPH 6 - See Appendix]
LOANS, NET OF DISCOUNT AND FEES
Consumer loans, which consist of consumer amortizing mortgages and other consumer loans, averaged $2.10 billion during 1994, as compared with $1.69 billion during 1993, an increase of $403.5 million, or 24%. Total average consumer loans were 46% of total loans at December 31, 1994, compared with 44% at year-end 1993.
Average consumer amortizing mortgages, which consist principally of residential mortgages, increased $309.9 million, or 40%, during 1994. Exclusive of acquisitions, average consumer amortizing mortgages increased 25%. This increase results primarily from increases in new and existing home sales in First American's markets.
Average other consumer loans increased $93.6 million, or 10%, in 1994, primarily due to an $84.2 million increase in average automobile installment loans. Average other consumer loans did not increase as much as some of the Company's peers in part because Management made a decision not to match the low pricing that developed during 1994 in certain consumer loan markets such as indirect auto lending. In addition, First American does not have a credit card portfolio, which is a product generating consumer loan growth for many of its peers.
Commercial real estate loans, which include real estate construction and real estate commercial mortgages, averaged $415.7 million during 1994, compared with $409.5 million during 1993. There have been, and continue to be, selective opportunities for commercial real estate lending in First American's markets. However, commercial real estate lending is not a high priority market for First American. Average total commercial real estate loans represented 9% of total loans at December 31, 1994, compared with 10% at December 31, 1993.
Essentially all of First American's loans are to borrowers residing in or doing business in Tennessee and selected markets in adjacent states. First American seeks to exercise prudent risk management in lending, including diversification by loan category and by industry segment, as well as by identification of credit risks. The Company's lending activities are performed by relationship managers organized by broad industry classification. Based on Standard Industrial Classification (SIC) codes, there were no industry concentrations within the commercial loan category in excess of 10% of total loans, at December 31, 1994 and 1993.
First American's ten largest outstanding loan relationships at December 31, 1994, amounted to $210.4 million, or 4% of total loans, compared to $225.7 million, or 5% of total loans, at year-end 1993. At December 31, 1994 and 1993, First American had no loans classified as highly leveraged transactions, as defined by banking regulations. First American had $.6 million international loans outstanding at December 31, 1994, and essentially no such loans at December 31, 1993.
NOTE 15 to the consolidated financial statements discusses off-balance-sheet loan commitments and risks.
ALLOWANCE AND PROVISION FOR POSSIBLE LOAN LOSSES
Management's policy is to maintain the allowance for possible loan losses at a level which is adequate to absorb estimated loan losses inherent in the loan portfolio. The provision for loan losses is a charge (credit) to earnings necessary, after loan charge-offs and recoveries, to maintain the allowance at an appropriate level. The level of the allowance is determined on a quarterly basis using procedures which include assessments of: (1) individual criticized and classified credits, other significant credits, and non-criticized/classified commercial and commercial real estate credits to estimate loss probability; (2) various consumer loan categories to estimate loss probabilities based primarily on historical loss experience; (3) unfunded commitments; and (4) various other factors, such as changes in credit concentrations, loan mix, and economic conditions which may not be specifically quantified in the loan analysis process. Determining the appropriate level of the allowance and the amount of the provision for loan losses involves uncertainties and matters of judgment and therefore cannot be determined with precision.
In order to maintain the allowance at an appropriate level during 1994, the methodology generally described above produced no provision for loan losses in each of the first three quarters of 1994 and a $10 million negative provision in the fourth quarter of 1994. This compares to a $42 million negative provision reported in 1993. The primary factors resulting in the negative $10 million provision for 1994 were the continued improvement in asset quality as discussed under the caption "Asset Quality" and favorable net loan charge-off experience.
During the years ended December 31, 1994 and 1993, total loan charge-offs were $15.3 million and $26.6 million, respectively, while total recoveries amounted to $18.0 million and $20.3 million, respectively, resulting in net recoveries of $2.7 million in 1994 and net charge-offs of $6.3 million in 1993. The ratio of net recoveries to average loans was .06% in 1994 compared to a ratio of net charge-offs to average loans of .16% in 1993.
Future provisions for loan losses depend on such factors as asset quality, net loan charge-offs, loan growth and other criteria discussed above. The appropriate level of the allowance for possible loan losses and the corresponding provision will continue to be determined quarterly based on the allowance assessment methodology. Management currently does not anticipate that there will be any significant provision for possible loan losses in 1995.
The allowance for possible loan losses was $127.1 million at December 31, 1994, as compared to $134.1 million at December 31, 1993. The $7.0 million
decline in the allowance during 1994 reflects the $10.0 million negative provision for loan losses and $2.7 million of net loan recoveries. The total allowance for possible loan losses represented 2.61% of net loans at December 31, 1994, compared to 3.09% at December 31, 1993.
[GRAPH 7 - See Appendix]
ALLOWANCE TO NET LOANS
[GRAPH 8 - See Appendix]
NET CHARGE-OFF (RECOVERY) RATIO
The allowance for possible loan losses is comprised of an allocated portion and an unallocated, or general, portion. The allocated portion is maintained to cover estimated losses applicable to specific segments of the loan portfolio. The unallocated portion is maintained to absorb losses which probably exist as of the evaluation date but are not identified by the more objective processes used for the allocated portion of the allowance for loan losses due to risk of error or imprecision. While the total allowance consists of an allocated portion and an unallocated portion, these terms are primarily used to describe a process. Both portions of the allowance are available to provide for inherent loss in the entire portfolio.
TABLE 7 presents a five-year recap of the activity in the allowance for possible loan losses. The table also contains the year-end allocation of the allowance for possible loan losses among the various loan portfolios and the unallocated portion of the allowance for each of the past five years.
ASSET QUALITY
Nonperforming assets, which include non-accrual and restructured loans and foreclosed properties, continued to decline during 1994. Nonperforming assets decreased 48% during 1994 to $21.1 million at December 31, 1994. This decline follows a 54% drop in 1993, a 37% decrease in 1992 and a 32% decline in 1991. Over the last four years, nonperforming assets have decreased 90%, or $188.6 million from $209.7 million at December 31, 1990, to $21.1 million at December 31, 1994. The ratio of nonperforming assets to total loans and foreclosed properties was .43% at December 31, 1994, compared with .93% a year earlier. The improvement in asset quality resulted from the continuation of efforts to improve asset quality and collect the full balance due on nonperforming assets, as well as from a reduction in the level of loans criticized or classified by First American's internal loan grading and review process. Management continues to focus on strengthening the credit culture by improving portfolio management concepts in the area of credit and industry concentrations, by refining credit risk rating systems, and maintaining a disciplined adherence to existing credit policies and procedures.
TABLE 8 summarizes changes in nonperforming assets for each of the past five years and presents the composition of the nonperforming asset balance at the end of each year.
Other potential problem loans consist of loans that are currently not considered nonperforming but on which information about possible credit problems has caused Management to doubt the ability of the borrowers to comply fully with present repayment terms. At December 31, 1994, loans totalling $75.1 million, while not considered nonperforming, were classified under the Company's internal loan grading system as substandard or worse. This was essentially the same level as a year ago.
Depending on the economy and other factors, these loans and others which may not be presently identified could become nonperforming assets in the future.
[GRAPH 9 - See Appendix]
NONPERFORMING ASSETS TO LOANS AND FORECLOSED PROPERTIES
DEPOSITS
Total deposits, First American's largest source of funding, averaged $5.73 billion during 1994, compared with $5.51 billion during 1993, an increase of $220.3 million, or 4%. Exclusive of acquisitions, average deposits increased 1% during 1994, primarily due to the success of First American's money market deposit account, the First American Investment Reserve ("FAIR") account. This account combines many features common among money market mutual funds including a minimum balance requirement of $1,000 and a competitive rate. FAIR account balances averaged $1.43 billion in 1994, up $108.1 million, or 8%, from 1993. The FAIR account is key to marketing and liquidity strategies in that it satisfies a known customer need while providing First American a stable core source of funding at rates favorable to many alternative sources of funding. On December 31, 1994, FAIR account balances outstanding were $1.54 billion and the interest rate paid was 4.60%.
First American's core deposit base, which represents total deposits excluding certificates of deposit $100,000 and over and foreign deposits, averaged $5.33 billion, or 93% of total deposits, during 1994, as compared with $5.14 billion, or 93% of total deposits, during 1993. Core deposits provide a stable, low-cost source of funds for the Company.
TABLE 9 details maturities of certificates of deposits $100,000 and over at December 31, 1994 and 1993.
OTHER BORROWED FUNDS
In addition to deposits, other sources of funding utilized by First American include short-term borrowings and long-term debt. Total short-term borrowings include Federal funds purchased from correspondent banks, securities sold under agreements to repurchase (repurchase agreements), and other short-term borrowings, principally funds due to the U.S. Treasury Department in tax and loan accounts.
Federal funds purchased and securities sold under repurchase agreements averaged $681.2 million during 1994, a 16% increase over the previous year. The average rate paid on Federal funds purchased and securities sold under repurchase agreements for 1994 was 3.80%, 116 basis points more than the 2.64% average rate paid in 1993. The net funds purchased position (Federal funds purchased and repurchase agreements less Federal funds sold and securities purchased under agreements to resell) at year-end 1994 was $829.0 million, up from $520.0 million at year-end 1993.
Other short-term borrowings averaged $59.2 million during 1994 compared with $49.8 million during 1993. The average rate paid on other short-term
borrowings was 4.51% in 1994, an increase of 132 basis points from 3.19% in 1993.
[GRAPH 10 - See Appendix]
CORE DEPOSITS
Long-term debt averaged $95.9 million during 1994 compared to $51.5 million during 1993. During 1994 long-term debt increased $186.1 million to $252.1 million as of December 31, 1994, due to two borrowings of $100 million each from the Federal Home Loan Bank. Each borrowing has a maturity of three years and interest which is payable and reprices monthly based on LIBOR. At December 31, 1994, the borrowings had an average interest rate of 6.08%.
On January 31, 1994, First American redeemed the remaining balance of $13.6 million of its 7 5/8% debentures due in 2002. These debentures were redeemed at a price of 101.22% of par.
The average rate paid on long-term borrowings was 6.61% in 1994 compared to 7.48% in 1993. The long-term debt to equity ratio was 40.9% at December 31, 1994, compared to 11.3% at December 31, 1993, which is reflective of the additional debt issued during 1994.
CAPITAL POSITION
Total shareholders' equity amounted to $616.7 million, or 7.95% of total assets, at December 31, 1994, compared to $581.7 million, or 8.09% of total assets at December 31, 1993. The $35.0 million increase in total shareholders' equity resulted principally from $67.7 million of earnings retention ($90.7 million of net income less $23.0 million of dividends). The impact of earnings retention was reduced by the $35.4 million change in net unrealized gains and losses on securities available for sale, net of tax. The Consolidated Statements of Changes in Shareholders' Equity details the changes in shareholders' equity during 1994, and NOTES 1 AND 3 to the consolidated financial statements provide further information regarding unrealized gains and losses on available for sale securities.
During 1994, First American paid dividends of $.88 per share, up 60% from $.55 per share during 1993. The dividend payout ratio was 25% during 1994 versus 14% during 1993. The Board of Directors voted to increase the quarterly cash dividend from $.21 per share to $.25 per share during the fourth quarter of 1994 based on First American's capital position and financial performance.
The Federal Reserve Board and the OCC risk-based capital guidelines and regulations for bank holding companies and national banks require minimum levels of capital based upon applying various risk ratings to defined categories of assets and to certain off-balance-sheet items. Under the risk-based capital requirements, total capital consists of Tier I capital (essentially realized common equity less intangible assets) and Tier II capital (essentially qualifying long-term debt and a portion of the allowance for possible loan losses). Assets by type, or category, are assigned risk-weights of 0% to 100%, depending on regulatory assigned levels of credit risk associated with such assets. Off-balance-sheet items are considered in the calculation
of risk-adjusted assets through conversion factors established by regulators. These items are assigned the same risk-weighting as on-balance-sheet items and are included in total risk-adjusted assets.
[GRAPH 11 - See Appendix]
AVERAGE EQUITY TO AVERAGE ASSETS
At December 31, 1994, these regulations required bank holding companies and national banks to maintain certain minimum capital ratios. As of December 31, 1994, the Company, its principal subsidiary, First American National Bank (FANB), and FANBKY all had ratios which exceeded the regulatory requirements to be classified as "well capitalized," the highest regulatory capital rating. TABLE 10 summarizes risk-based capital and related ratios for the Company and FANB.
In December 1994, the Board of Directors authorized the repurchase of up to 800,000 shares of First American's common stock. It is anticipated that stock repurchases will be made in the open market or in privately negotiated transactions from time to time during 1995, subject to market conditions and regulatory guidelines. Following these purchases, the Company is expected to continue to exceed all applicable regulatory capital requirements. It is anticipated that the repurchased shares will be used to fund First American's various employee benefit plans and potential future acquisitions.
LIQUIDITY
Liquidity management involves maintaining sufficient cash levels (including the ability to access markets to raise additional cash) to fund operations and to meet the requirements of borrowers, depositors, and creditors. Higher levels of liquidity bear higher corresponding costs, measured in terms of lower yields on short-term, more liquid earning assets, and higher interest expense involved in extending liability maturities. Liquid assets include cash and cash equivalents (less Federal Reserve Bank reserve requirements discussed at NOTE 2 to the consolidated financial statements), money market instruments, and securities that mature within one year. At December 31, 1994, the carrying value of First American's liquid assets amounted to $832.5 million, or 12% of earning assets, which compares with $702.1 million, or 11%, at December 31, 1993.
In addition, First American has securities available for sale maturing after one year which can be sold to meet liquidity needs. The market value of securities available for sale which mature after one year was $329.7 million at December 31, 1994. Since held to maturity securities are purchased with the intent to hold them to maturity, such securities are generally a source of liquidity only to the extent interest and principal payments are received thereon. NOTES 1 AND 3 to the consolidated financial statements discuss accounting for securities in further detail. Decisions to purchase securities or sell available for sale securities are based on current and expected economic and financial conditions, including the interest rate environment and loan demand, and other on-and off-balance-sheet positions. Maturity of securities is also discussed under the caption "Securities."
Liquidity is reinforced by maintaining a relatively stable funding base, which is achieved by diversifying funding sources, extending the contractual maturity of
liabilities, and limiting corporate reliance on volatile short-term purchased funds. First American's strategy is to fund assets to the maximum extent possible with core deposits, which provide a sizable source of relatively stable and low-cost funds. Core deposits totalled $5.45 billion, or 70% of total assets at December 31, 1994, compared with $5.36 billion, or 75%, at December 31, 1993.
Short-term funding needs can arise from declines in deposits or other funding sources, drawdowns of loan commitments, and requests for new loans. Relationships with a stable and growing customer base and a network of about 300 downstream correspondent banks routinely supply some of these funds. Additional funds, if needed, can be raised from national money markets. Short-term funding sources, comprised of non-core deposits and other interest-bearing liabilities totalled $1.35 billion, or 17% of total assets, at December 31, 1994, compared to $1.09 billion, or 15%, at December 31, 1993.
Shareholders' equity and long-term debt also contribute to liquidity by reducing the need to continually rely on short-term purchased funds. At December 31, 1994, the ratio of equity to assets was 7.95% compared to 8.09% at December 31, 1993. At the end of 1994, long-term debt totalled 3% of total assets and 41% of total shareholders' equity versus 1% of total assets and 11% of total shareholders' equity at December 31, 1993.
During the first quarter of 1993, First American filed a shelf registration statement with the Securities and Exchange Commission to issue $100 million of subordinated debt securities. The Company issued $50 million of subordinated notes under the shelf registration statement during second quarter 1993. The remaining $50 million shelf registration is available for future needs.
An additional source of liquidity is the Company's three-year $50 million revolving credit agreement which will expire March 31, 1997. First American had no borrowings outstanding under this agreement during 1994.
Management believes First American has sufficient liquidity to meet all reasonable borrower, depositor, and creditor needs in the present economic environment.
IMPACT OF INFLATION
First American's asset and liability structure is substantially different from that of an industrial company in that most of its assets and liabilities are monetary in nature. Management believes the impact of inflation on financial results depends upon the Company's ability to react to changes in interest rates and, by such reaction, reduce the inflationary impact on performance. Interest rates do not necessarily move in the same direction, or at the same magnitude, as the prices of
other goods and services. As discussed previously, Management seeks to manage the relationship between interest-sensitive assets and liabilities in order to protect against wide interest rate fluctuations, including those resulting from inflation.
EARNINGS PERFORMANCE FOR 1993 VERSUS 1992
The previous discussion has concentrated on First American's 1994 results of operations and financial condition. The following discussion recaps the Company's results of operations for 1993 compared to 1992.
Net income for 1993 was $101.8 million or $3.93 per share as compared with $42.0 million or $1.74 per share for 1992. The earnings improvement was primarily attributable to a $42.0 million negative provision for loan losses in 1993 compared to a $38.5 million charge in 1992, an $80.5 million decrease in the provision for loan losses. Net income for 1993 also included a $15.7 million increase in taxable equivalent net interest income, an $11.1 million improvement in non-interest income, and a $7.5 million increase in non-interest expense.
The negative provision for loan losses resulted primarily from continued improvement in asset quality as evidenced by a 64% decrease in nonperforming loans to $21.7 million at December 31, 1993, from $60.3 million at year-end 1992 and an 84% decline in net charge-offs to $6.3 million in 1993 from $38.4 million in 1992.
The 6% increase in 1993 net interest income (computed on a taxable equivalent basis) to $271.5 million was primarily due to an increase in average earning assets and a slightly improved net interest margin. Average earning assets increased 5% to $6.18 billion in 1993 from $5.90 billion in 1992, while the net interest margin on earning assets increased 5 basis points to 4.39%. During 1993, First American had a higher volume of interest-bearing liabilities repricing at a lower interest rate than earning assets repricing; thus, net interest income benefited from declining interest rates. The net interest spread increased 10 basis points to 3.80% in 1993 from 3.70% in 1992. The net interest margin and spread improvements in 1993 generally reflect a lower interest rate environment for First American.
The 15% improvement in non-interest income in 1993 was due primarily to increased fee income resulting from new products and services introduced in 1993. Approximately 55% of the increase was due to additional investment services income related to sales of annuities, mutual funds and other investment products.
The $7.5 million, or 3%, increase in non-interest expense in 1993 resulted primarily from a $10.0 million charitable contribution made during the fourth quarter of 1993 to First American Foundation. Non-interest expense in 1993 also included an $8.1 increase in salaries and employee benefits and a $13.1 million decline in net foreclosed properties expense. Exclusive of the contribution, non-interest expense
decreased $2.5 million or 1%. The operating ratio improved to 63.2% in 1993 (exclusive of the Foundation contribution) from 69.1% in 1992.
Income tax expense was $57.4 million in 1993, an increase of $39.9 million over the 1992 income tax expense of $17.5 million. The major factor for the increase was the increase in the Company's income before income tax expense.
TABLE 1: SELECTED FINANCIAL DATA: 1990-1994
* Adjusted to a taxable equivalent basis based on the statutory Federal income tax rates, adjusted for applicable state income taxes net of the related Federal tax benefit. ** Ratio of operating expenses to taxable equivalent net interest income plus non-interest income. For 1994, calculation excludes $9.7 million of losses in the fourth quarter on sales of securities available for sale. For 1993, calculation excludes the $10.0 million Foundation contribution. For 1990, calculation excludes the $34.3 million gain on sale of credit card receivables. N/A Information not considered meaningful.
TABLE 2: RATE-VOLUME RECAP
* Amounts are adjusted to a fully taxable basis, based on the statutory Federal income tax rates, adjusted for applicable state income taxes net of the related Federal tax benefit. The effect of volume changes is computed by multiplying the change in volume by the prior year rate. The effect of rate changes is computed by multiplying the change in rate by the prior year volume. Rate/volume changes are computed by multiplying the change in volume by the change in rate and are included in the effect on income of rate changes.
TABLE 3: CONSOLIDATED AVERAGE BALANCE SHEETS AND TAXABLE EQUIVALENT INCOME/EXPENSE AND YIELDS/RATES
* Loan fees and amortization of net deferred loan fees (costs), which are considered an integral part of the lending function and are included in yields and related interest categories, amounted to $4.4 million in 1994, $2.2 million in 1993, $(.8) million in 1992, $(2.7) million in 1991, and $(.3) million in 1990. Yields/rates and income/expense amounts are presented on a fully taxable equivalent basis based on the statutory Federal income tax rates adjusted for applicable state income taxes net of the related Federal tax benefit; related interest income includes taxable equivalent adjustments of $3.4 million in 1994, $4.0 million in 1993, $4.2 million in 1992, $6.6 million in 1991, and $11.1 million in 1990. Non-accrual and restructured loans are included in average loans and average earning assets. Consequently, yields on these items are lower than they would have been if these loans had earned at their contractual rates of interest.
N/A Information not considered meaningful.
TABLE 4: INTEREST RATE SENSITIVITY ANALYSIS
Each column includes earning assets and interest-bearing liabilities that are estimated to mature or reprice within the respective time frame. All floating rate balance sheet items are included as "within three months" regardless of maturity. Non-earning assets (cash and due from banks, premises and equipment, foreclosed properties, and other assets), non-interest-bearing liabilities (demand deposits and other liabilities) and shareholders' equity are considered to be non-interest-sensitive for purposes of this presentation and thus are not included in the above table.
In the table, all NOW, money market, and savings accounts are reflected as interest-sensitive within three months. NOW accounts, savings, and certain money market accounts are not totally interest-sensitive in all interest rate environments. If NOW and regular savings accounts were not considered interest-sensitive, the one year cumulative net asset interest-sensitive gap position and percent of earning assets would be $413.8 million and 5.87%, respectively, for 1994 as compared to a net asset interest-sensitive gap position and percent of earning assets of $201.0 million and 3.07%, respectively, for 1993.
TABLE 5: SECURITY PORTFOLIO ANALYSIS
* Yields presented on a taxable equivalent basis, based on the statutory Federal income tax rate, adjusted for applicable state income taxes net of the related Federal tax benefit. ** Securities held to maturity were reported on the balance sheet at amortized cost and securities available for sale were reported on the balance sheet at market value for a combined total of $2,150.0 million.
TABLE 6: MATURITIES OF LOANS, EXCLUSIVE OF CONSUMER LOANS
TABLE 7: ALLOWANCE FOR POSSIBLE LOAN LOSSES
TABLE 9: CERTIFICATES OF DEPOSIT $100,000 AND OVER
TABLE 10: RISK-BASED CAPITAL AND RELATED RATIOS
* Risk-based capital ratios were computed using realized equity (total shareholders' equity exclusive of net unrealized gains (losses) on securities available for sale, net of tax) and exclude the 7 5/8% debentures redeemed January 31, 1994.
TABLE 11: QUARTERLY FINANCIAL DATA
* Adjusted to a taxable equivalent basis based on the statutory Federal income tax rates, adjusted for applicable state income taxes net of the related Federal tax benefit.
TABLE 12: CONSOLIDATED YEAR-END BALANCE SHEETS
ITEM 8:


ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and schedule listed in Item 14(a)(1) and (2) are included in this Report beginning on Page 65 and are incorporated in this Item 8 by reference. The table "Quarterly Financial Data" on page 53 hereof, "Consolidated Year-End Balance Sheets" on page 54 hereof, and "Consolidated Average Balance Sheets and Taxable Equivalent Income/Expense and Yields/Rates" on pages 47-48 hereof are incorporated in this Item 8 by reference.
ITEM 9:

ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10:



ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Executive Officers of the Registrant
The following is a list of the Corporation's executive officers, their ages and their positions and offices during the last five years (listed alphabetically).
The additional information required by Item 405 of Regulation S-K is contained in the Corporation's Notice of 1995 Annual Meeting of Shareholders and Proxy Statement (the "1995 Proxy Statement") filed with the Securities and Exchange Commission within 120 days of the Corporation's year-end pursuant to Regulation 14A. Such information appears in the sections entitled "Election of Directors" and "Reports of Beneficial Ownership" in the 1995 Proxy Statement and is incorporated herein by reference.
ITEM 11:

ITEM 11: EXECUTIVE COMPENSATION
This information appears in the sections entitled "Executive Compensation", "Human Resources Committee Interlocks and Insider Participation", "Compensation of Directors" and "Retirement Plans" in the 1995 Proxy Statement, and is incorporated herein by reference.
ITEM 12:

ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This information appears in the section entitled "Security Ownership of Certain Beneficial Owners and Management" in the 1995 Proxy Statement, and is incorporated herein by reference.
ITEM 13:

ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This information appears in the sections entitled "Certain Transactions" and "Human Resources Committee Interlocks and Insider Participation" in the 1995 Proxy Statement, and is incorporated herein by reference.
PART IV
ITEM 14:

ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report:
1. Financial Statements
The Report of KPMG Peat Marwick LLP, Independent Certified Public Accountants
Consolidated Income Statements of First American Corporation and Subsidiaries for the three years ended December 31, 1994, 1993, and 1992
Consolidated Balance Sheets of First American Corporation and Subsidiaries at December 31, 1994 and
Consolidated Statements of Changes in Shareholders' Equity of First American Corporation and Subsidiaries for the three years ended December 31, 1994, 1993, and 1992
Consolidated Statements of Cash Flows of First American Corporation and Subsidiaries for the three years ended December 31, 1994, 1993, and 1992
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
All schedules are omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or the notes thereto.
The following reports and consents are submitted herewith:
Accountants' Consent by KPMG Peat Marwick LLP -- Exhibit 23
3. Exhibits
Exhibit Number Description ------- -----------
2 Agreement and Plan of Merger dated February 21, 1995 by and between First American Corporation and Heritage Bancshares, Inc. (previously filed as Exhibit 2 to Current Report on Form 8-K filed February 23, 1995 and incorporated herein by reference).
3.1 Restated Charter (previously filed as Exhibit 1 to the Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30, 1991, and incorporated herein by reference).
3.2 By-Laws of the Corporation currently in effect as amended April 21, 1994 included on page 102 hereof.
4.1 The Corporation agrees to provide the SEC, upon request, copies of instruments defining the rights of holders of long-term debt of the Corporation, and all of its subsidiaries for which consolidated or unconsolidated financial statements are required to be filed with the SEC.
4.2 Rights Agreement, dated December 14, 1988, between First American Corporation and First American Trust Company, N.A. (previously filed as Exhibit 1 to a Current Report on Form 8-K dated December 14, 1988, and incorporated herein by reference).
4.3(a) Indenture, dated as of December 15, 1972, between First Amtenn Corporation and the Chase Manhattan Bank, National Association, as Trustee (previously filed as Exhibit 4(b) to Registration Statement No. 2-46447 and incorporated herein by reference).
4.3(b) Indenture, dated as of April 22, 1993, between First American Corporation and Chemical Bank, as Trustee (previously filed as Exhibit 4.1 to Registration Statement No. 33-59844 and incorporated herein by reference).
4.3(c) Supplemental Indenture, dated as of April 22, 1993, between First American Corporation and Chemical Bank, as Trustee (previously filed as Exhibit 4.2 to Registration Statement No. 33-59844 and incorporated herein by reference).
10.3(a) First American STAR Award Plan (previously filed as Exhibit 10.03(b) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1986 and incorporated herein by reference).
10.3(b) First American Corporation 1991 Employee Stock Incentive Plan (previously filed as part of the Corporation's Notice of Annual Meeting and Proxy Statement dated March 18, 1991 for the annual meeting of shareholders held April 18, 1991 and incorporated herein by reference).
10.3(c) 1993 Non-Employee Director Stock Option Plan (previously filed as part of the Corporation's Notice of Annual Meeting and Proxy Statement dated March 18, 1993 for the annual meeting of shareholders held April 15, 1993 and incorporated herein by reference).
10.3(d) Consulting Agreement (previously filed as Exhibit 10.3(a) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference) with James F. Smith dated January 1, 1993.
10.3(e) First American Corporation 1992 Executive Early Retirement Program (previously filed as Exhibit 10.4(a) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).
10.3(f) First American Corporation Directors' Deferred Compensation Plan (previously filed as Exhibit 19.1 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).
10.3(g) First American Corporation Supplemental Executive Retirement Program dated as of January 1, 1989 (previously filed as Exhibit 19.2 to the Corporation's Annual
Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).
10.3(h) Form of Deferred Compensation Agreement approved by the Human Resources Committee of the Board of Directors of the Corporation on December 16, 1993 (previously filed as Exhibit 10.3(h) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference) and entered into by the Corporation and John Boyle and Dennis Bottorff, as amended and restated and included on page 125 hereof.
10.3(i) Restated and Amended First American Corporation First Incentive Reward Savings Thrift Plan (previously filed as Exhibit 4 to Registration Statement No. 33-57385 filed January 20, 1995 and incorporated herein by reference).
11 Calculation of earnings per share is included in note 1 to the consolidated financial statements contained herein on page 73 and incorporated herein by reference.
13 First American Corporation's Annual Report to Shareholders for the fiscal year ended December 31, 1994. Such report, except for the portions included herein, is furnished for the information of the Securities and Exchange Commission and is not "filed" as part of this Report.
21 List of Subsidiaries included on page 130 hereof.
23 Consent of KPMG Peat Marwick LLP, independent accountants included on page 131 hereof.
27 Financial Data Schedule included herewith.
Upon written or oral request, a copy of the above exhibits will be furnished at cost.
(b) No reports on Form 8-K were filed during the last quarter of 1994.
FIRST AMERICAN CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
INDEPENDENT AUDITORS' REPORT.
The Board of Directors and Shareholders First American Corporation:
We have audited the accompanying consolidated balance sheets of First American Corporation and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1994. These consolidated financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First American Corporation and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1994, in conformity with generally accepted accounting principles.
As discussed in note 13 to the consolidated financial statements, the Corporation adopted in 1993 the provisions of the Financial Accounting Standards Board's Statements of Financial Accounting Standards No. 109, Accounting for Income Taxes; No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions; No. 112, Employers' Accounting for Postemployment Benefits; and No. 115, Accounting for Certain Investments in Debt and Equity Securities.
/s/ KPMG Peat Marwick LLP ------------------------- KPMG Peat Marwick LLP
Nashville, Tennessee January 20, 1995
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
- -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements of First American Corporation have been prepared in conformity with generally accepted accounting principles including general practices of the banking industry. The following is a summary of the more significant accounting policies of the Corporation.
CONSOLIDATION
The consolidated financial statements include the accounts of the Corporation and its wholly-owned subsidiaries, including its principal subsidiary First American National Bank, as well as First American National Bank of Kentucky and First American Trust Company, N.A. All significant intercompany accounts and transactions have been eliminated in consolidation.
SECURITIES
Effective December 31, 1993, the Corporation adopted Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities." SFAS No. 115 requires investments in equity securities that have a readily determinable fair value and investments in debt securities to be classified into three categories, as follows: held to maturity debt securities, trading securities, and securities available for sale.
Under SFAS No. 115, classification of a debt security as held to maturity is based on the Corporation's positive intent and ability to hold such security to maturity. Securities held to maturity are stated at cost adjusted for amortization of premiums and accretion of discounts, unless there is a decline in value which is considered to be other than temporary, in which case the cost basis of such security is written down to market and the amount of the write-down is included in earnings.
Securities that are bought and held principally for the purpose of selling them in the near term are classified as trading account securities, which are valued at market with unrealized gains and losses included in earnings. Gains or losses on sales and adjustments to market value of trading account securities are included in non-interest income in the consolidated income statements.
Securities classified as available for sale, which are reported at market value with unrealized gains and losses excluded from earnings and reported, net of tax, in a separate component of shareholders' equity, include all securities not classified as trading account securities or securities held to maturity. These include securities used
as part of the Corporation's asset/liability strategy which may be sold in response to changes in interest rates, prepayment risk, the need or desire to increase capital, and other similar factors. Gains or losses on sale of securities available for sale are recognized at the time of sale, based upon specific identification of the security sold, and are included in non-interest income in the consolidated income statements.
DERIVATIVE FINANCIAL INSTRUMENTS
The Corporation enters into interest rate swap, forward interest rate swap, and basis swap transactions (swaps), as well as futures contracts, in connection with its asset/liability management program in managing interest rate exposure arising out of non-trading assets and liabilities. The impact of swaps is accrued based on expected settlement payments and is recorded as an adjustment to interest income and expense, in the period in which it accrues and in the category appropriate to the related asset or liability, over the life of the related agreements. The related amount receivable from or payable to the swap counterpart is included in other liabilities or assets in the consolidated balance sheets. Realized and unrealized gains and losses on futures contracts which are designated as effective hedges of interest rate exposure arising out of non-trading assets and liabilities are deferred and recognized as interest income or interest expense, in the category appropriate to the related asset or liability, over the covered periods or lives of the hedged assets or liabilities. Gains or losses on early terminations of derivative financial instruments that modify the underlying characteristics of specified assets or liabilities are deferred and amortized as an adjustment to the yield of the related assets or liabilities over the remaining covered period.
On a limited basis, the Corporation also enters into interest rate swap agreements, as well as interest rate cap and floor agreements, with customers desiring protection from possible adverse future fluctuations in interest rates. As an intermediary, the Corporation generally maintains a portfolio of matched offsetting interest rate contract agreements. At the inception of such agreements, the portion of the compensation related to credit risk and ongoing servicing, if any, is deferred and taken into income over the term of the agreements.
LOANS
Loans are stated at the principal amount outstanding. Unearned discount, deferred loan fees net of loan acquisition costs, and the allowance for possible loan losses are shown as reductions of loans. Loan origination and commitment fees and certain loan related costs are being deferred and the net amount amortized as an adjustment of the related loan's yield over the contractual life of the loan. Unearned discount represents the unamortized amount of finance charges, principally related to certain installment loans. Interest income on loans is generally computed on the outstanding loan balance. Interest income on installment loans which have unearned discounts is recognized primarily by the sum-of-the-month's digits method.
Interest income is generally accrued on all loans. Commercial loans are placed on non-accrual status when doubt as to timely collection of principal or interest exists, or when principal or interest is past due 90 days or more unless such loans are well-secured and in the process of collection. The decision to place a loan on non-accrual status is based on an evaluation of the borrower's financial condition, collateral, liquidation value, and other factors that affect the borrower's ability to pay. Generally, at the time a loan is placed on a non-accrual status, all interest accrued and uncollected on the loan in the current fiscal year is reversed from income, and all interest accrued and uncollected from the prior year is charged off against the allowance for possible loan losses. Thereafter, interest on non-accrual loans is recognized in interest income only to the extent that cash is received and future collection of principal is not in doubt. If the collectibility of outstanding principal is doubtful, such interest received is applied as a reduction of principal. A non-accrual loan may be restored to an accruing status when principal and interest are no longer past due and unpaid and future collection of principal and interest on a timely basis is not in doubt. Generally, consumer loans on which interest or principal is past due more than 120 days are charged off.
ALLOWANCE FOR POSSIBLE LOAN LOSSES
The provision for loan losses represents a charge (credit) to earnings necessary, after loan charge-offs and recoveries, to maintain the allowance for possible loan losses at an appropriate level which is adequate to absorb estimated losses inherent in the loan portfolio. Such estimated losses arise primarily from the loan portfolio but may also be derived from other sources, including commitments to extend credit and standby letters of credit. The level of the allowance for possible loan losses is determined on a quarterly basis using procedures which include: (1) an evaluation of individual criticized and classified credits as determined by internal reviews, of other significant credits, and of non-criticized/classified commercial and commercial real estate credits, to determine estimates of loss probability; (2) an evaluation of various consumer loan categories to determine an estimation of loss on such loans based primarily on historical loss experience of the category; (3) a review of unfunded commitments; and (4) an assessment of various other factors, such as changes in credit concentrations, loan mix, and economic conditions which may not be specifically quantified in the loan analysis process.
The allowance for possible loan losses consists of an allocated portion and an unallocated, or general, portion. The allocated portion is maintained to cover estimated losses applicable to specific segments of the loan portfolio. The unallocated portion is maintained to absorb losses which probably exist as of the evaluation date but are not identified by the more objective processes used for the allocated portion of the allowance for loan losses due to risk of error or imprecision. While the total allowance consists of an allocated portion and an unallocated portion, these terms are primarily used to describe a process. Both portions of the allowance are available to provide for inherent loss in the entire portfolio.
The allowance for possible loan losses is increased (decreased) by provisions for loan losses charged (credited) to expense and is reduced (increased) by loans charged off net of recoveries on loans previously charged off. The provision for loan losses is based on management's determination of the amount of the allowance necessary to provide for estimated loan losses based on its evaluation of the loan portfolio. Determining the appropriate level of the allowance and the amount of the provision for loan losses involves uncertainties and matters of judgment and therefore cannot be determined with precision.
FORECLOSED PROPERTIES
Foreclosed properties include property acquired through foreclosure and in-substance foreclosures. In-substance foreclosed properties are those properties where the borrower retains title but has little or no remaining equity in the property considering its fair value; where repayment can only be expected to come from the operation or sale of the property; and where the borrower has effectively abandoned control of the property or it is doubtful that the borrower will be able to rebuild equity in the property. Foreclosed properties are valued at the lower of cost or fair value minus estimated costs to sell. The fair value of the assets is the amount that the Corporation could reasonably expect to receive for them in a current sale between a willing buyer and a willing seller, that is, other than in a forced or liquidation sale. Cost includes loan principal, accrued interest, foreclosure expense, and expenditures for subsequent improvements. The excess of cost over fair value minus estimated costs to sell at the time of foreclosure is charged to the allowance for possible loan losses. Subsequent write-downs to fair value minus estimated costs to sell are included in foreclosed properties expense.
DEPRECIATION AND AMORTIZATION
Premises and equipment is stated at cost less accumulated depreciation and amortization, which is computed principally on the straight-line method based on the estimated useful lives of the respective assets.
For acquisitions accounted for as purchases, the net assets have been adjusted to their fair values as of the respective acquisition dates. The value of core deposit rights and the excess of the purchase price of subsidiaries over net assets acquired are being amortized on a straight-line basis over periods ranging from ten to twenty years. Core deposit rights and the excess of the purchase price of subsidiaries over net assets acquired, net of amounts amortized, are included in other assets in the consolidated balance sheets.
The carrying value of the excess of the purchase price of subsidiaries over net assets acquired (goodwill) will be reviewed if the facts and circumstances suggest that it may be impaired. If this review indicates that goodwill will not be recoverable, as determined based on the undiscounted cash flows of an entity acquired over the remaining amortization period, the Corporation's carrying value of the goodwill will be reduced by the estimated shortfall of cash flows.
EMPLOYEE BENEFIT PLANS
The Corporation provides a variety of benefit plans to eligible employees. Retirement plan expense is accrued each year, and plan funding represents at least the minimum amount required by the Employee Retirement Income Security Act of 1974, as amended. Differences between expense and funded amounts are carried in other assets or other liabilities. Beginning in 1993, the Corporation recognizes postretirement benefits other than pensions on an accrual basis, and effective December 31, 1993, other postemployment benefits are also recognized on an accrual basis. The Corporation also makes contributions to an employee thrift and profit-sharing plan based on employee contributions and performance levels of the Corporation.
INCOME TAXES
The Corporation files a consolidated Federal income tax return, except for its credit life insurance subsidiary, which files a separate return. Effective January 1, 1993, the Corporation adopted Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes," which requires a change from the deferred method of accounting under Accounting Principles Bulletin No. 11 to the asset and liability method of accounting for income taxes. Under SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets are reduced by a valuation allowance, if necessary, to an amount that more likely than not will be realized.
EARNINGS PER COMMON SHARE
Earnings per common share amounts are computed by dividing net income by the weighted average number of common shares outstanding during each year.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform with current year presentation.
NOTE 2: CASH AND DUE FROM BANKS
The Corporation's bank subsidiaries are required to maintain reserves, in the form of cash and balances with the Federal Reserve Bank, against its deposit liabilities. Approximately $161.5 million and $171.8 million of the cash and due from banks balance at December 31, 1994 and 1993, respectively, represented reserves maintained in order to meet Federal Reserve requirements.
NOTE 3: SECURITIES
SECURITIES HELD TO MATURITY
The amortized cost, gross unrealized gains, gross unrealized losses, and approximate market values of securities held to maturity at December 31, 1994 and 1993, are presented in the following table:
Included in U.S. Treasury and other U.S. Government agencies and corporations securities held to maturity were agency-issued mortgage-backed securities amounting to $1,035.4 million ($983.1 million market value) at December 31, 1994 and $480.5 million ($492.3 million market value) at December 31, 1993. Mortgage-backed securities included in other debt securities amounted to $156.2 million ($145.6 million market value) at December 31, 1994 and $6.9 million ($7.2 million market value) at December 31, 1993.
SECURITIES AVAILABLE FOR SALE
The amortized cost, gross unrealized gains, gross unrealized losses, and approximate market values of securities available for sale at December 31, 1994 and 1993, are presented in the following table:
Included in U.S. Treasury and other U.S. Government agencies and corporations securities available for sale were agency-issued mortgage-backed securities amounting to $326.8 million ($306.3 million market value) at December 31, 1994 and $992.7 million ($1,016.8 million market value) at December 31, 1993.
Effective December 31, 1993, the Corporation adopted SFAS No. 115 which requires investments in equity securities that have a readily determinable fair value and investments in debt securities to be classified into three categories, as follows: held to maturity debt securities, trading securities, and available for sale securities. In conjunction with the adoption of SFAS No. 115 on December 31, 1993, the Corporation reclassified $368.6 million of securities to the available for sale classification from the former investment, now held to maturity, category. At that date, unrealized appreciation on total securities available for sale amounted to $36.1 million, resulting in an increase in shareholders' equity of $22.0 million, net of taxes. There was no impact on the Corporation's consolidated net income as a result of the adoption of SFAS No. 115.
Included within total securities classified as available for sale at December 31, 1993, were $203.8 million of securities classified as such due to regulatory restrictions even though the Corporation had the intent and ability to hold such securities to maturity. Upon a regulatory revision in 1994, which allowed those securities to be classified as held to maturity, the Corporation transferred such securities from available for sale to held to maturity. At the time of transfer, the securities had an unrealized loss of $1.0 million ($.6 million net of taxes). In accordance with SFAS No. 115, such unrealized loss was retained as a component of shareholders' equity and is being amortized over the remaining lives of the securities.
Net realized losses from the sale of securities available for sale for the years ended December 31, 1994, 1993, and 1992, amounted to $10.0 million, $2.0 million, and $3.0 million, respectively. Gross realized gains and losses on such sales were as follows:
TOTAL SECURITIES
The amortized cost and approximate market values of debt securities at December 31, 1994, by average estimated maturity are shown below. The expected maturity for governmental and corporate securities is the stated maturity, and the
expected maturity for mortgage-backed securities and other asset-backed securities is based on current estimates of average maturities.
At December 31, 1994 and 1993, the Corporation held securities with amortized cost amounting to $484.6 million and $503.7 million, respectively, which were issued or guaranteed by the Federal National Mortgage Association and $714.1 million and $856.1 million, respectively, which were issued or guaranteed by the Federal Home Loan Mortgage Corporation.
Securities carried in the consolidated balance sheets at approximately $1,627.0 million and $1,310.0 million at December 31, 1994 and 1993, respectively, were pledged to secure public and trust deposits and for other purposes as required or permitted by law.
NOTE 4: LOANS AND ALLOWANCE FOR POSSIBLE LOAN LOSSES
The Corporation's bank subsidiaries make commercial, consumer, and real estate loans to its customers, located principally within the Corporation's primary market, which consists of Tennessee and selected markets in adjacent states. Although the bank subsidiaries have a diversified loan portfolio, a substantial portion of their debtors' ability to honor their contracts is dependent upon economic conditions in the Corporation's primary market.
Loans are either secured or unsecured based on the type of loan and the financial condition of the borrower. The loans are generally expected to be repaid from cash flow or proceeds from the sale of selected assets of the borrower; however, the Corporation is exposed to risk of loss on loans due to the borrower's difficulties, which may arise from any number of factors including problems within the respective industry or economic conditions, including those within the Corporation's primary market.
Transactions in the allowance for possible loan losses were as follows:
Net charge-offs (recoveries) by major loan categories were as follows:
At December 31, 1994 and 1993, loans on a non-accrual status amounted to $11.5 million and $21.7 million, respectively. Interest income not recognized on non-accrual loans was approximately $.3 million in 1994, $1.1 million in 1993, and $3.6 million in 1992. Interest income recognized on a cash basis on non-accrual loans was $.8 million, $1.2 million, and $1.0 million for the same respective periods.
Directors and executive officers (and their associates, including companies in which they hold ten percent or more ownership) of the Corporation and its significant subsidiary, First American National Bank, had loans outstanding with the Corporation and its subsidiaries of $11.7 million and $5.7 million at December 31, 1994 and 1993, respectively. During 1994, $39.5 million of new loans or advances on existing loans were made to such related persons and repayments from such persons totalled $33.5 million. The Corporation believes that such loans were made on substantially the same terms, including interest and collateral, as those prevailing at the time for comparable transactions with other borrowers and did not involve more than the normal risk of collectibility or present other unfavorable features at the time such loans were made.
During 1993, the Financial Accounting Standards Board issued SFAS No. 114, "Accounting by Creditors for Impairment of a Loan." SFAS No. 114 was amended in 1994 by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures." These pronouncements, which will be adopted prospectively by the Corporation on January 1, 1995, require that impaired loans be measured at the present value of expected future cash flows discounted at the loan's effective interest rate, at the loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. The Corporation's financial position and results of operations will not be materially impacted upon the adoption of SFAS No. 114 and No. 118.
NOTE 5: PREMISES AND EQUIPMENT AND LEASE COMMITMENTS
Premises and equipment is summarized as follows:
Depreciation and amortization expense of premises and equipment for 1994, 1993, and 1992 was $14.1 million, $13.8 million and $12.3 million, respectively.
Non-cancelable minimum operating lease commitments for real property amount to $8.8 million for 1995; $8.6 million for 1996; $8.2 million for 1997; $7.7 million for 1998; $7.4 million for 1999; and $38.5 million thereafter. In the normal course of business, management expects that leases will be renewed or replaced by other leases. Rent expense, net of rental income on bank premises, for 1994, 1993, and 1992 was $4.4 million, $3.5 million, and $4.1 million, respectively. Rental income on bank premises for 1994, 1993, and 1992 was $3.8 million, $4.0 million, and $3.8 million, respectively.
The Corporation has a data processing outsourcing agreement expiring in 2001 that has an average annual base expense, as amended in 1994, of $8.5 million. Total annual fees vary with cost of living adjustments and changes in services provided by the vendor, which services depend upon the Corporation's volume of business and system needs. The related expense is included in systems and processing expense in the consolidated income statements.
NOTE 6: INTANGIBLE ASSETS
Total intangible assets representing core deposit rights and excess of purchase price of subsidiaries over net assets acquired amounted to $25.6 million and $26.0 million at December 31, 1994 and 1993, respectively, and are included in other assets on the consolidated balance sheets. Amortization expense of intangible assets was $3.4 million, $2.5 million, and $2.4 million, in 1994, 1993, and 1992, respectively.
NOTE 7: SHORT-TERM BORROWINGS
Short-term borrowings are issued on normal banking terms and consisted of the following:
At December 31, 1994 and 1993, Federal funds purchased and securities sold under agreements to repurchase included Federal funds purchases of $25.0 million (due within three months) and $55.0 million (due within five months), respectively. Other short-term borrowings is essentially composed of U.S. Treasury tax and loan accounts.
The following table presents information regarding Federal funds purchased and securities sold under agreements to repurchase.
NOTE 8: LONG-TERM DEBT
Long-term debt consisted of the following:
At December 31, 1994, advances from the Federal Home Loan Bank were $201.2 million which consisted of $1.2 million maturing September 28, 2007, at an interest rate of 3.891%, and $200.0 million maturing in 1997 with the interest rate tied to one-month LIBOR. These advances are collateralized by a blanket pledge of 1-4 family mortgage loans.
During the first quarter of 1993, the Corporation filed a shelf registration statement with the Securities and Exchange Commission to issue $100.0 million of subordinated debt securities. The Corporation issued $50.0 million of subordinated notes under the shelf registration statement during second quarter 1993. The notes are non-callable.
On January 31, 1994, the Corporation redeemed the remaining balance of approximately $13.6 million of its 7 5/8% debentures due in 2002, at a price of 101.22% of par.
The Corporation owns a parking garage which was financed through an Industrial Revenue Bond due April 1, 1997. Indebtedness at December 31, 1994 and 1993, totalled $1.1 million and $1.4 million, respectively. Sinking fund requirements of this debt amount to $.3 million for 1995 and $.4 million for 1996; the balance of $.4 million is due in 1997. The interest rate on these bonds is 5.9% for the remaining life of the bonds.
During 1994, the Corporation entered into a three-year unsecured revolving credit agreement which provides for loans up to $50.0 million. Under the terms of the agreement, which expires in March 1997, the Corporation pays a fee for the availability of these funds computed at the rate of 1/4 of 1% per annum on the commitment. Interest to be paid on the outstanding balances will be computed based
on the prime interest rate of the lending banks, Eurodollar rates, or adjusted certificate of deposit rates, as selected by the Corporation. The Corporation had no revolving credit borrowings outstanding at December 31, 1994 or 1993.
The terms of these agreements provide for, among other things, restrictions on payment of cash dividends and purchases, redemptions, and retirement of capital shares. Under the Corporation's most restrictive debt covenant, approximately $88.6 million of retained earnings was available to pay dividends as of December 31, 1994.
NOTE 9: EMPLOYEE BENEFITS
RETIREMENT PLAN
The Corporation and its subsidiaries participate in a non-contributory retirement plan with death and disability benefits covering substantially all employees with one or more years of service. The benefits are based on years of service and average monthly earnings of a participant for the 60 consecutive months which produce the highest average earnings.
The following table sets forth the plan's funded status and amounts recognized in the Corporation's consolidated balance sheets at December 31, 1994 and 1993:
Net pension expense included the following components:
As of January 1, 1994, the Corporation elected to change its method of measuring the market-related value of plan assets from utilizing a calculation based on 50% book value plus 50% fair market value to utilization of 100% fair market value. The change had the effect of decreasing 1994 net periodic pension expense by $1.6 million.
The following table presents assumptions used in determining the actuarial present value of the projected benefit obligation for the pension plan:
SUPPLEMENTAL RETIREMENT PLAN
The Corporation has a supplemental retirement plan which provides supplemental retirement benefits to certain executives of the Corporation. The expense was $.2 million in 1994, $.1 million in 1993, and $.7 million in 1992. The higher level of expense in 1992 was due to early retirements. Benefit payments from the plan are made from general assets of the Corporation. The weighted average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation in 1994 were 8.0% and 4.5%, respectively, and in 1993 were 7.5% and 4.5%, respectively.
OTHER POSTRETIREMENT BENEFITS
In addition to pension benefits, the Corporation and its subsidiaries have defined postretirement benefit plans that provide medical insurance and death benefits for retirees and eligible dependents. Because the death benefit plan is not significant, it is combined with the health care plan for disclosure purposes.
Effective January 1, 1993, the Corporation adopted Statement of Financial Accounting Standards (SFAS) No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," which requires the cost of postretirement benefits other than pensions to be recognized on an accrual basis as employees perform services to earn such benefits. The Corporation's previous practice, like most companies, was to expense such costs on a pay-as-you-go basis. The Corporation recognized this change during 1993 as a cumulative effect of a change in accounting principle, resulting in a one-time non-cash charge of $17.5 million before taxes ($11.6 million after taxes). This charge represents the discounted present value of expected future retiree medical and death benefits attributed to employees' service rendered prior to 1993. See note 13.
The status of the plans at December 31, 1994 and 1993, was as follows:
The components of net periodic expense for postretirement benefits in 1994 and 1993 were as follows:
The Corporation continues to fund medical and death benefit costs principally on a pay-as-you-go basis. Postretirement benefit expense for 1992, which was recorded on a cash basis, has not been restated and was $.6 million.
For measurement purposes, an 11.00% annual rate of increase in the per capita cost of covered health care benefits was assumed for 1994, declining gradually to 5.5% per year by 2011 and remaining at that level thereafter. The discount rate used to determine the accumulated postretirement benefit obligation was 8.0% in 1994 and 7.5% in 1993, and the assumed long-term rate of compensation increase was 4.5% in 1994 and 1993.
The health care cost trend rate assumption has a significant effect on the accumulated postretirement benefit obligation and net periodic benefit costs. A 1% increase in the trend rate for health care costs would have increased the accumulated postretirement benefit obligation by $1.5 million as of December 31, 1994, and the net periodic expense (service cost and interest cost) would have increased by $.1 million for 1994.
POSTEMPLOYMENT BENEFITS
Effective December 31, 1993, the Corporation adopted SFAS No. 112, "Employers' Accounting for Postemployment Benefits," which requires employers to recognize a liability for postemployment benefits under certain circumstances. The Corporation's short-term and long-term disability benefits, survivor income benefits, and certain other benefits are governed by this statement. The Corporation recognized this item during the fourth quarter of 1993 as a cumulative effect of a change in accounting principle, resulting in a one-time non-cash charge of $2.0 million before taxes ($1.3 million after taxes). Prior to this date, postemployment benefit expenses were recognized on a pay-as-you-go basis. See note 13.
OTHER EMPLOYEE BENEFITS
The Corporation has executive incentive compensation plans covering certain officers and other key employees of the Corporation. The plans provide for incentives based on the attainment of annual and long-term performance goals. Executive incentive compensation plans also include stock option programs, which provide for the granting of statutory incentive stock options and non-statutory options to key employees. Additionally, the Corporation has a stock option plan for non-employee directors. As of December 31, 1994, the Corporation had 2,889,961 shares of common stock reserved for issuance under these plans.
During 1991 through 1994, the Corporation has issued 131,400 shares of restricted common stock to certain executive officers. The restrictions lapse within 15 years; however, if certain performance criteria are met, restrictions will lapse earlier. The amount recorded for the restricted stock issued is based on the market value of the Corporation's common stock on the award dates and is shown as deferred compensation in the consolidated statements of changes in shareholders' equity. Such compensation expense is recognized over a 3- to 15-year period.
Stock options granted under option programs have been at 85% to 133% of the market price on the day of grant. Each stock option is for one share of common stock. Some options are exercisable immediately, while some options are exercisable over a period of time and may be exercisable earlier if certain performance criteria are met. All options expire within a ten-year period from the date of grant. The market price of the Corporation's stock was $26.88 at December 31, 1994.
The following table presents a summary of stock option and restricted stock activity:
The Corporation has a combination savings thrift and profit-sharing plan ("FIRST Plan") available to substantially all full-time employees. In connection with the plan, 1,285,000 shares of the Corporation's common stock have been reserved for issuance. At year-end 1994, 1,279,000 of these shares had been issued. During 1994, 1993, and 1992, 149,360 shares, 94,193 shares, and 3,538 shares, respectively, were purchased in the open market for the FIRST Plan. During 1992, 62,961 shares were issued by the Corporation in connection with the FIRST Plan (none in 1994 or 1993). The plan is funded by employee and employer contributions. The Corporation's annual contribution to the plan is based upon the amount of basic contributions of participants, participants' compensation, and the achievement of
certain corporate performance standards and may be made in the form of cash or the Corporation's common stock with a market value equal to the cash contribution amount. Total plan expense in 1994, 1993, and 1992 was $3.4 million, $2.9 million, and $1.2 million, respectively. During 1994, 1993, and 1992, the Corporation matched participating employees' qualifying contributions by 100%, 100%, and 50%, respectively.
NOTE 10: ACQUISITIONS AND SALES
On April 1, 1994, the Corporation consummated its purchase of all of the outstanding shares of Fidelity Crossville Corporation (FCC), the parent company of First Fidelity Savings Bank, F.S.B. (First Fidelity) located in Crossville, Tennessee, for $6.5 million. First Fidelity was a Federal stock savings bank with offices in Crossville and Fairfield Glade, Tennessee with total assets of $48.7 million on March 31, 1994. In conjunction with the acquisition, First Fidelity was merged into First American National Bank and First Fidelity's two offices became branches of First American National Bank. The acquisition was accounted for using the purchase method. Accordingly, the purchase price was allocated to assets acquired and liabilities assumed based on their estimated fair values. The purchase price in excess of the fair value of net assets acquired of $3.1 million is being amortized on a straight-line basis over 10 years. First Fidelity's results of operations have been included in the Corporation's consolidated income statement since the date of acquisition.
On October 1, 1993, the Corporation acquired all of the outstanding shares of First American National Bank of Kentucky (FANBKY), formerly known as First Federal Savings and Loan Association of Bowling Green, a $219.0 million national bank headquartered in Bowling Green, Kentucky, for $27.5 million. This transaction was accounted for as a purchase. All financial data after the acquisition date has been adjusted to reflect the purchase and, consistent with the purchase method of accounting, the results of operations of FANBKY are included in the Corporation's consolidated income statement beginning October 1, 1993. Total fair value of net assets of FANBKY on the acquisition date was approximately $19.1 million. The excess of the purchase price over the fair value of the net assets acquired was $8.4 million at the acquisition date and is being amortized over 10 years. FANBKY operates three branches in Warren and Simpson Counties in southern Kentucky.
NOTE 11: FIRST AMERICAN FOUNDATION
The Corporation's non-interest expenses for 1993 included a $10.0 million charitable contribution to First American Foundation, a not-for-profit private foundation formed in 1993 to facilitate the Corporation's charitable contributions.
NOTE 12: INCOME TAXES
The components of income tax expense (benefit) for the years ended December 31 were:
The 1992 total income tax expense for financial reporting purposes included the benefit from utilization of tax credit carryforwards amounting to $5.6 million (general business credit carryforwards of $4.9 million and alternative minimum tax credits of $.7 million).
Current Federal income tax expense includes the utilization of alternative minimum tax credits amounting to $3.4 million in 1992.
The following table presents a reconciliation of the provision for income taxes as shown in the consolidated income statements with that which would be computed by applying the statutory Federal income tax rates of 35% for 1994 and 1993, and 34% for 1992 to income before income tax expense and the cumulative effect of changes in accounting principles.
Effective January 1, 1993, the Corporation prospectively adopted SFAS No. 109, which required a change from the deferred method (an income statement approach) of accounting for income taxes under Accounting Principles Bulletin No. 11 to the asset and liability method of accounting for income taxes. Under the asset and liability method of SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The cumulative effect of the adoption of SFAS No. 109 was a $12.8 million benefit. See note 13.
SFAS No. 109 requires that the tax benefit of deductible temporary differences be recorded as an asset to the extent that management assesses the utilization of such temporary differences to be "more likely than not." In accordance with SFAS No. 109, the realization of tax benefits of deductible temporary differences depends on whether the Corporation has sufficient taxable income within the carryback and carryforward period permitted by the tax law to allow for utilization of the deductible amounts. As of January 1, 1993, the Corporation had net deductible temporary differences of $165.5 million. For state purposes, Tennessee law does not permit carrybacks and thus a valuation allowance was established for the portion of the net deductible temporary differences for which realization was uncertain. A valuation allowance of $3.9 million was established (as of January 1, 1993).
The net change in the valuation allowance for 1994 was a decrease of $1.3 million. In 1993, the net change in the valuation allowance was a decrease of $2.6 million; consisting of an increase related to the adoption of SFAS No. 106 (accounting for postretirement benefits) of $1.1 million, an increase related to the adoption of SFAS 112 (accounting for postemployment benefits) of $.1 million, and a decrease of $3.8 million related to continuing operations.
Accumulated deferred taxes aggregated net assets of $50.1 million at December 31, 1994 and $38.2 million at December 31, 1993, and are included in other assets on the consolidated balance sheets. Management believes that it is more likely than not that the deferred tax assets, net of the valuation allowance (if any), will be realized. The tax effects of temporary differences that give rise to the significant portions of deferred tax assets and deferred tax liabilities at December 31, 1994 and 1993, are as follows:
The tax effects of timing differences that give rise to significant portions of deferred tax expense (benefit) for the year ended December 31, 1992 are as follows:
During 1994, the Corporation and the Internal Revenue Service (IRS) reached a settlement agreement related to the IRS's examination of the Corporation's 1989 and 1990 consolidated Federal income tax returns. Such settlement had no material impact on the Corporation's consolidated financial statements.
NOTE 13: CHANGES IN ACCOUNTING PRINCIPLES
The cumulative effect of changes in accounting principles reflected in the 1993 consolidated income statement relates to the Corporation's 1993 adoption of Statements of Financial Accounting Standards (SFAS), as follows:
SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," and No. 112, "Employers' Accounting for Postemployment Benefits," are discussed in note 9 (employee benefits), and SFAS No. 109, "Accounting for Income Taxes," is addressed in note 12 (income taxes). See note 3 for a discussion regarding the impact to the 1993 consolidated financial statements resulting from the December 31, 1993, adoption of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities."
NOTE 14: COMMON STOCK
In December 1994, the Board of Directors authorized the repurchase of up to 800,000 shares of the Corporation's common stock. It is anticipated that stock repurchases will be made in the open market or in privately negotiated transactions from time to time during 1995, subject to market conditions and regulatory guidelines. Following these purchases, the Corporation expects to continue to exceed all applicable regulatory capital requirements. It is anticipated that the repurchased
shares will be used to fund the Corporation's various employee benefit plans and potential future acquisitions.
On September 30, 1992, the Corporation completed an underwritten public offering of its common stock at $21.25 per share, resulting in the issuance of 2,012,500 shares. A $40.8 million addition to shareholders' equity in 1992 resulted from the offering.
NOTE 15: OFF-BALANCE-SHEET AND DERIVATIVE FINANCIAL INSTRUMENTS
In the normal course of business, the Corporation is a party to financial transactions which have off-balance-sheet risk. Such transactions arise in meeting customers' financing needs and from the Corporation's activities in reducing its own exposure to fluctuations in interest rates. Off-balance-sheet items involving customers consist primarily of commitments to extend credit and letters of credit, which generally have fixed expiration dates. These instruments may involve, to varying degrees, elements of credit and interest rate risk. To evaluate credit risk, the Corporation uses the same credit policies in making commitments and conditional obligations on these instruments as it does for instruments reflected on the balance sheet. Collateral obtained, if any, varies but may include deposits held in financial institutions; U.S. Treasury securities or other marketable securities; income-producing commercial properties; accounts receivable; property, plant, and equipment; and inventory. The Corporation's exposure to credit risk under commitments to extend credit and letters of credit is the contractual (notional) amount of the instruments. Interest rate swap transactions and futures contracts may have credit and interest rate risk significantly less than the contractual amount.
COMMITMENTS
Commitments to extend secured or unsecured credit are contractual agreements to lend money providing there is no violation of any condition. Commitments may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. At year-end 1994 and 1993, respectively, the Corporation had $1.9 billion and $1.3 billion of unfunded commitments to extend credit. Of these amounts, unfunded commitments for borrowers with loans on non-accrual status were $.5 million at December 31, 1994, and $5.3 million at December 31, 1993.
Standby letters of credit are commitments issued by the Corporation to guarantee the performance of a customer to a third party. As of December 31, 1994 and 1993, the Corporation had standby letters of credit issued amounting to approximately $188.8 million and $135.4 million, respectively. The Corporation also had commercial letters of credit of $54.2 million and $56.1 million at December 31, 1994 and 1993, respectively. Commercial letters of credit are conditional
commitments issued by the Corporation to facilitate trade for corporate customers. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
The Corporation contracts to buy and sell foreign exchange in order to meet the financing needs of its customers and to hedge its own exposure against market risk. At December 31, 1994 and 1993, the Corporation had $26.2 million and $12.7 million, respectively, of foreign exchange forward contracts, which is the sum of customers' contracts with the Corporation and the Corporation's offsetting contracts to minimize its exposure.
DERIVATIVES
The Corporation's principal objective in holding or issuing derivative financial instruments for purposes other than trading is the management of interest rate exposure arising out of nontrading assets and liabilities. The Corporation's earnings are subject to risk of interest rate fluctuations to the extent that interest-earning assets and interest-bearing liabilities mature or reprice at different times or in differing amounts. Asset/liability management activities are aimed at maximizing net interest income within liquidity, capital and interest rate risk constraints established by management. The Corporation's objective is that net income will not be impacted more than 5% from results simulated for the interest rate environment that the Corporation considers most likely, assuming that interest rates do not vary more than 150 basis points from the most likely scenario within the next 12 months.
To achieve its risk management objective, the Corporation uses a combination of derivative financial instruments, particularly interest rate swaps and futures contracts. The instruments utilized are noted in the following table along with their notional amounts and fair values at year-end 1994 and 1993.
(1) Fixed rate. (2) Variable rate which reprices quarterly based on 3-month LIBOR except for $25 million which reprices every 6 months based on 6-month LIBOR. (3) Variable rate which reprices quarterly based on 3-month LIBOR. (4) Forward swap periods begin in June 1995 for $200 million and December 1995 for $450 million. The rates to be paid are fixed and were set at the inception of the contracts. Variable rates are based on 3-month LIBOR but are currently unknown since they will not be established until the affected periods begin. (5) Variable rate which reprices quarterly based on 5-year constant maturity Treasury rate less a constant spread. (6) Represents $300 million short position of Eurodollar futures contracts which in aggregate simulated a $100 million 9-month interest rate swap.
Notional amounts are key elements of derivative financial instrument agreements. However, notional amounts do not represent the amounts exchanged by the parties to derivatives and do not measure the Corporation's exposure to credit or market risks. The amounts exchanged are based on the notional amounts and the other terms of the underlying derivative agreements. The Corporation's credit exposure at the reporting date from derivative financial instruments is represented by the fair value of instruments with a positive fair value at that date and is presented above along with the notional amounts of the instruments. Credit risk disclosures, however, relate to accounting losses that would be recognized if counterparts failed completely to perform their obligations.
The risk that counterparts to derivative financial instruments might default on their obligations is monitored on an ongoing basis. To manage the level of credit risk, the Corporation reviews the credit standing of its counterparts and enters into master netting agreements whenever possible, and when appropriate, obtains collateral. Master netting agreements incorporate rights of setoff that provide for the net settlement of subject contracts with the same counterparts in the event of default.
Interest rate swap contracts are primarily used to convert certain deposits and long-term debt to fixed interest rates or to convert certain groups of customer loans to fixed rates. The Corporation's net credit exposure with interest rate swap counterparts totalled $18.3 million at December 31, 1994, and $.5 million at December 31, 1993.
The table below summarizes, by notional amounts, the activity for each major category of derivative financial instruments.
The table below presents the deferred gains, included in other liabilities on the consolidated balance sheets, related to terminated derivative financial instruments at December 31, 1994 and 1993.
(1) $4,645 will be amortized into income during 1995 and $1,516 will be amortized during 1996. (2) Amortized into income during 1994.
NOTE 16: LEGAL AND REGULATORY MATTERS
The extent to which dividends may be paid to the Corporation from its subsidiaries is governed by applicable laws and regulations. For the Corporation's national bank subsidiaries, the approval of the OCC is required if dividends declared in any year exceed net profits for that year (as defined under the National Bank Act) combined with the retained net profits of the two preceding years. In addition, a national bank may not pay a dividend, make any other capital distribution, or pay management fees if such payment would cause it to fail to satisfy certain minimum capital requirements. In accordance with the most restrictive of these restrictions, at December 31, 1994, FANB and FANBKY had $167.6 million and $1.3 million, respectively, available for distribution as dividends to the Corporation. For the trust company bank subsidiary, approximately $1.4 million was available for distribution as dividends to the Corporation as of December 31, 1994.
The Corporation and seven other financial institutions are defendants in a class action lawsuit brought in the Circuit Court of Shelby County, Tennessee. The lawsuit alleges antitrust, unconscionability, usury, and contract claims arising out of the defendant's returned check charges. The asserted plaintiff class consists of depositors who have been charged returned check or overdraft fees. The plaintiffs are requesting compensatory and punitive damages of $25.0 million against each defendant. The antitrust, unconscionability, and usury claims were previously dismissed, and in December 1993, the Circuit Court granted the defendants' motion for summary judgment and dismissed the remaining claim. The plaintiffs have appealed. In addition, an antitrust lawsuit alleging a price fixing conspiracy has been filed by the plaintiffs against the Corporation and eight other financial institutions in the U.S. District Court for the Western District of Tennessee. In March 1994, the District Court granted the defendants' motion for summary judgment dismissing the action. The plaintiffs have also appealed in this lawsuit. Management believes these suits are without merit and, based upon information currently known and on advice of counsel, that they will not have a material adverse effect on the Corporation's consolidated financial statements.
Also, there are from time to time other legal proceedings pending against the Corporation and its subsidiaries. In the opinion of management and counsel, liabilities, if any, arising from such proceedings presently pending would not have a material adverse effect on the consolidated financial statements of the Corporation.
NOTE 17: FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards (SFAS) No. 107, "Disclosures about Fair Value of Financial Instruments," requires disclosure of fair value information about financial instruments for both on- and off-balance-sheet assets and liabilities for which it is practicable to estimate fair value. The techniques used for this valuation are significantly affected by the assumptions used, including the amount and timing of future cash flows and the discount rate. Such estimates involve uncertainties and matters of judgment and therefore cannot be determined with precision. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets. Accordingly, the aggregate fair value amounts presented are not meant to represent the underlying value of the Corporation.
The estimated fair values for the Corporation's off-balance-sheet financial instruments are summarized as follows:
The following methods and assumptions were used in estimating the fair value disclosures for financial instruments.
Cash and short-term investments -- The carrying amounts reported in the balance sheet approximate fair values since such instruments mature within 90 days or less and present no anticipated credit concerns.
Securities held to maturity, securities available for sale, and trading account securities -- Fair values are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
Loans -- For variable loans that reprice frequently, fair values are based on carrying values. The fair values for certain homogeneous categories of loans, such as residential mortgages, are estimated using quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair values for other loans are estimated by discounting estimated future cash flows using the current rates at which similar loans would be made to borrowers with similar credit risk and for similar maturities.
Deposits -- The fair value of deposits with no stated maturity, such as demand deposits, NOW accounts, money market accounts, and regular savings accounts, is equal to the amount payable on demand at the reporting date. The fair value of certificates of deposits and other fixed maturity time deposits is estimated using the rates currently offered for deposits of similar remaining maturities. Any foreign deposits are valued at the carrying value due to the frequency with which rates for such deposits are adjusted to a market rate.
Short-term borrowings -- Fair value is estimated to equal the carrying amount since these instruments have a relatively short maturity.
Long-term debt -- Rates for long-term debt with similar terms and remaining maturities are used to estimate fair value of existing debt.
Off-balance-sheet instruments -- The fair value of commitments to extend credit is based on unamortized deferred loan fees and costs. For letters of credit, fair value is estimated using fees currently charged to enter into similar agreements with similar maturities. The fair value of the Corporation's outstanding futures contracts is based on quoted market prices, and the estimated fair value of interest rate swaps is based on estimated costs to settle the obligations with the counterparts at the reporting date.
NOTE 18: PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information for First American Corporation (Parent Company only) was as follows:
CONDENSED BALANCE SHEETS
CONDENSED INCOME STATEMENTS
CONDENSED STATEMENTS OF CASH FLOWS
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
FIRST AMERICAN CORPORATION (Registrant)
BY: /s/ DENNIS C. BOTTORFF ----------------------------- DENNIS C. BOTTORFF, CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER
Date: March 16, 1995
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
/s/ William O. McCoy ----------------------- -------------------- SAMUEL E. BEALL, II WILLIAM O. MCCOY Director Director Dated: Dated: March 16, 1995
/s/ Earnest W. Deavenport, Jr. /s/ Dale W. Polley ------------------------------ ------------------ EARNEST W. DEAVENPORT, JR. DALE W. POLLEY Director Director Dated: March 16, 1995 Dated: March 16, 1995
/s/ Reginald D. Dickson /s/ Dr. Roscoe R. Robinson ----------------------- -------------------------- REGINALD D. DICKSON DR. ROSCOE R. ROBINSON Director Director Dated: March 16, 1995 Dated: March 16, 1995
/s/ T. Scott Fillebrown, Jr. /s/ James F. Smith, Jr. ---------------------------- ----------------------- T. SCOTT FILLEBROWN, JR. JAMES F. SMITH, JR. Director Director Dated: March 16, 1995 Dated: March 16, 1995
/s/ James A. Haslam, II /s/ Cal Turner, Jr. ----------------------- ------------------- JAMES A. HASLAM, II CAL TURNER, JR. Director Director Dated: March 16, 1995 Dated: March 16, 1995
/s/ Martha R. Ingram /s/ Ted H. Welch -------------------- ---------------- MARTHA R. INGRAM TED H. WELCH Director Director Dated: March 16, 1995 Dated: March 16, 1995
/s/ Walter G. Knestrick /s/ David K. Wilson ----------------------- ------------------- WALTER G. KNESTRICK DAVID K. WILSON Director Director Dated: March 16, 1995 Dated: March 16, 1995
/s/ Gene C. Koonce /s/ Toby S. Wilt ------------------ ---------------- GENE C. KOONCE TOBY S. WILT Director Director Dated: March 16, 1995 Dated: March 16, 1995
/s/ James R. Martin /s/ William S. Wire ------------------- ------------------- JAMES R. MARTIN WILLIAM S. WIRE Director Director Dated: March 16, 1995 Dated: March 16, 1995
/s/ Robert A. McCabe, Jr. ------------------------ ROBERT A. MCCABE, JR. Director Dated: March 16, 1995
For purposes of EDGAR filing for 12/31/94 Form 10-K:
APPENDIX TO ELECTRONIC FORMAT DOCUMENT
Graph #1: In the Overview section of Management's Discussion and Analysis, this bar graph depicts the Company's net income (loss) per share for 1990 through 1994. For 1994, this graph also depicts the Company's 1994 earnings per share based on earnings exclusive of negative loan loss provision and available for sale securities losses realized in the fourth quarter of 1994. For 1993, this graph also depicts the Company's 1993 based on earnings exclusive of negative loan loss provisions in the last three quarters of 1993 and charitable contribution to First American Foundation in the fourth quarter of 1993. This graph appears in the paper format version of the document and not in this electronic filing.
Graph #2: In the Overview section of Management's Discussion and Analysis, this bar graph depicts the Company's return on average equity for 1990 through 1994. For 1994, this graph also depicts the Company's 1994 return on average equity based on earnings exclusive of negative loan loss provision and available for sale securities losses realized in the fourth quarter of 1994. For 1993, this graph also depicts the Company's 1993 return on average equity based on earnings exclusive of negative loan loss provisions in the last three quarters of 1993 and charitable contribution to First American Foundation in the fourth quarter of 1993. This graph appears in the paper format version of the document and not in this electronic filing.
Graph #3: In the Overview section of Management's Discussion and Analysis, this bar graph depicts the Company's return on average assets for 1990 through 1994. For 1994, this graph also depicts the Company's 1994 return on average assets based on earnings exclusive of negative loan loss provision and available for sale securities losses realized in the fourth quarter of 1994. For 1993, this graph also depicts the Company's 1993 return on average assets based on earnings exclusive of negative loan loss provisions in the last three quarters of 1993 and charitable contribution to First American Foundation in the fourth quarter of 1993. This graph appears in the paper format version of the document and not in this electronic filing.
Graph #4: In the Net Interest Income section of Management's Discussion and Analysis, this bar graph depicts the Company's net interest income (taxable equivalent basis) for 1990 through 1994. This graph appears in the paper format version of the document and not in this electronic filing.
Graph #5: In the Non-Interest Expense section of Management's Discussion and Analysis, this bar graph depicts the Company's operating efficiency ratio for 1990 through 1994. For 1994, the ratio excludes available for sale securities losses realized in the fourth quarter of 1994. For 1993, the ratio excludes the charitable contribution to First American Foundation. For 1990, the ratio excludes the gain on the sale of credit card receivables. This graph appears in the paper format version of the document and not in this electronic filing.
Graph #6: In the Loans section of Management's Discussion and Analysis, this bar graph depicts the Company's loans, net of discount and fees, at year-end 1990 through 1994. This graph appears in the paper format version of the document and is not in this electronic filing.
Graph #7: In the Allowance and Provision for Possible Loan Losses section of Management's Discussion and Analysis, this bar graph depicts the Company's allowance to net loans at year-end 1990 through 1994. This graph appears in the paper format version of the document and is not in this electronic filing.
Graph #8: In the Allowance and Provision for Possible Loan Losses section of Management's Discussion and Analysis, this bar graph depicts the Company's net charge-offs (recoveries) to average loans for 1990 through 1994. This graph appears in the paper format version of the document and is not in this electronic filing.
Graph #9: In the Asset Quality section of Management's Discussion and Analysis, this bar graph depicts the Company's nonperforming assets to loans and foreclosed properties at year-end 1990 through 1994. This graph appears in the paper format version of the document and is not in this electronic filing.
Graph #10: In the Deposits section of Management's Discussion and Analysis, this bar graph depicts the Company's core deposits at year-end 1990 through 1994. This graph appears in the paper format version of the document and is not in this electronic filing.
Graph #11: In the Capital Position section of Management's Discussion and Analysis, this bar graph depicts the Company's average equity to average assets for 1990 through 1994. This graph appears in the paper format version of the document and not in this electronic filing.
EXHIBIT INDEX
NUMBER NAME PAGE - ------ ---- ----
Exhibit 3.2 By-laws of the Corporation 102
Exhibit 10.3(h) Amended Salary Deferral Agreement 125
Exhibit 21 List of Subsidiaries 130
Exhibit 23 Accountants' Consent 131
Exhibit 27 Financial Data Schedule