Form 10-Q
Table of Contents

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended September 30, 2004

 

Commission file number 1-7476

 


 

AmSouth Bancorporation

(Exact Name of registrant as specified in its charter)

 

Delaware   63-0591257

(State or other jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

AmSouth Center    
1900 Fifth Avenue North    
Birmingham, Alabama   35203
(Address of principal executive offices)   (Zip Code)

 

(205) 320-7151

(Registrant’s telephone number, including area code)

 

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

 

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

 

As of October 31, 2004, AmSouth Bancorporation had 355,103,000 shares of common stock outstanding.

 



Table of Contents

AMSOUTH BANCORPORATION

 

FORM 10-Q

 

INDEX

 

              Page

Part I.

  Financial Information     
   

Item 1.

   Financial Statements (Unaudited)     
        

Consolidated Statement of Condition – September 30, 2004, December 31, 2003 and September 30, 2003

   3
        

Consolidated Statement of Earnings – Three months and nine months ended September 30, 2004 and 2003

   4
        

Consolidated Statement of Shareholders’ Equity – Nine months ended September 30, 2004 and 2003

   5
        

Consolidated Statement of Cash Flows – Nine months ended September 30, 2004 and 2003

   6
         Notes to Consolidated Financial Statements    7
         Report of Independent Registered Public Accounting Firm    18
   

Item 2.

  

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

   19
   

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk    38
   

Item 4.

   Controls and Procedures    38

Part II.

  Other Information     
   

Item 1.

   Legal Proceedings    38
   

Item 2.

   Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities    39
   

Item 6.

   Exhibits    39

Signatures

   40

Exhibit Index

   41

 

Forward-Looking Statements

 

Statements made in this report that are not purely historical are forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995), including any statements regarding descriptions of management’s plans, objectives or goals for future operations, products or services, and forecasts of its revenues, earnings or other measures of performance. Forward-looking statements are based on current management expectations and, by their nature, are subject to risks and uncertainties. A number of factors-many of which are beyond AmSouth’s control-could cause actual conditions, events or results to differ materially from those described in the forward-looking statements. Factors which could cause results to differ materially from current management expectations include, but are not limited to: customers’ and other third parties’ reactions to the settlements with the United States and banking regulators referred to in this report and the effects of such settlements on AmSouth’s branch expansion plans; successful completion and realization of the benefits of the sale of AmSouth’s credit card portfolio; the execution of AmSouth’s strategic initiatives; legislation and regulation; general economic conditions, especially in the Southeast; the performance of the stock and bond markets; changes in interest rates, yield curves and interest rate spread relationships; prepayment speeds within the loan and investment security portfolios; deposit flows; the cost of funds; cost of federal deposit insurance premiums; demand for loan products; demand for financial services; competition, including a continued consolidation in the financial services industry; changes in the quality or composition of AmSouth’s loan and investment portfolios including capital market inefficiencies that may affect the marketability and valuation of available-for-sale securities; changes in consumer spending and saving habits; technological changes; the growth and profitability of AmSouth’s mortgage banking business, including mortgage-related income and fees, being less than expected; adverse changes in the financial performance and/or condition of AmSouth’s borrowers which could impact the repayment of such borrowers’ outstanding loans; changes in accounting and tax principles, policies or guidelines and in tax laws; other economic, competitive, governmental and regulatory factors affecting AmSouth’s operations, products, services and prices; the effects of weather and natural disasters, such as hurricanes; unexpected judicial actions and developments; results of investigations, examinations and reviews of regulatory and law enforcement authorities; the outcome of litigation, which is inherently uncertain and depends on the findings of judges and juries; the impact on AmSouth’s businesses, as well as on the risks set forth above, of various domestic or international military or terrorist activities or conflicts; and AmSouth’s success at managing the risks involved in the foregoing. Forward-looking statements speak only as of the date they are made. AmSouth does not undertake a duty to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made.

 

2


Table of Contents

PART I

FINANCIAL INFORMATION

Item 1.             Financial Statements (Unaudited)

 

AMSOUTH BANCORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CONDITION

(Unaudited)

 

     September 30
2004


   

December 31

2003


    September 30
2003


 
     (Dollars in thousands)  

ASSETS

                        

Cash and due from banks

   $ 1,073,175     $ 1,163,986     $ 1,116,554  

Federal funds sold and securities purchased under agreements to resell

     26,000       -0-       25,247  

Trading securities

     1,121       2,721       1,725  

Available-for-sale securities

     6,516,319       7,125,971       6,428,817  

Held-to-maturity securities (market value of $6,089,342, $4,948,556 and $4,673,011, respectively)

     6,068,666       4,928,195       4,629,726  

Loans held for sale

     240,879       102,292       140,913  

Loans

     33,210,442       30,088,814       29,859,153  

Less: Allowance for loan losses

     381,255       384,124       384,059  

Unearned income

     708,221       749,450       730,749  
    


 


 


Net loans

     32,120,966       28,955,240       28,744,345  

Other interest-earning assets

     37,151       40,218       33,102  

Premises and equipment, net

     1,053,923       964,692       927,407  

Cash surrender value - bank owned life insurance

     1,100,576       1,065,996       1,052,950  

Accrued interest receivable and other assets

     1,449,086       1,266,205       1,241,913  
    


 


 


     $ 49,687,862     $ 45,615,516     $ 44,342,699  
    


 


 


LIABILITIES AND SHAREHOLDERS’ EQUITY

                        

Deposits and interest-bearing liabilities:

                        

Deposits:

                        

Noninterest-bearing demand

   $ 6,798,077     $ 6,273,835     $ 5,839,977  

Interest-bearing checking

     6,817,361       6,183,832       5,746,617  

Money market and savings deposits

     7,814,945       7,592,020       7,739,210  

Time

     5,597,637       6,278,053       6,410,087  

Certificates of deposit of $100,000 or more

     3,963,015       2,818,490       2,864,383  

Foreign

     928,381       1,294,123       867,949  
    


 


 


Total deposits

     31,919,416       30,440,353       29,468,223  

Federal funds purchased and securities sold under agreements to repurchase

     2,497,632       2,026,253       2,221,105  

Other borrowed funds

     1,964,121       343,202       430,461  

Long-term Federal Home Loan Bank advances

     5,678,135       5,737,952       5,595,264  

Other long-term debt

     2,108,128       2,114,482       1,475,346  
    


 


 


Total deposits and interest-bearing liabilities

     44,167,432       40,662,242       39,190,399  

Accrued expenses and other liabilities

     2,069,872       1,723,605       1,999,466  
    


 


 


Total liabilities

     46,237,304       42,385,847       41,189,865  
    


 


 


Shareholders’ equity:

                        

Preferred stock — no par value:

                        

Authorized — 2,000,000 shares; Issued and outstanding — none

     -0-       -0-       -0-  

Common stock — par value $1 a share:

                        

Authorized — 750,000,000 shares; Issued — 416,753,000, 416,878,000 and 416,879,000 shares, respectively

     416,753       416,878       416,879  

Capital surplus

     714,278       715,663       712,286  

Retained earnings

     3,406,363       3,228,533       3,155,397  

Cost of common stock in treasury — 62,118,000, 64,987,000 and 66,257,000 shares, respectively

     (1,019,471 )     (1,076,644 )     (1,102,503 )

Deferred compensation on restricted stock

     (13,697 )     (14,501 )     (15,340 )

Accumulated other comprehensive loss

     (53,668 )     (40,260 )     (13,885 )
    


 


 


Total shareholders’ equity

     3,450,558       3,229,669       3,152,834  
    


 


 


     $ 49,687,862     $ 45,615,516     $ 44,342,699  
    


 


 


 

See notes to consolidated financial statements.

 

3


Table of Contents

AMSOUTH BANCORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF EARNINGS

(Unaudited)

 

    

Three Months Ended

September 30


   Nine Months Ended
September 30


     2004

   2003

   2004

   2003

     (In thousands except per share data)

INTEREST INCOME

                           

Loans

   $ 399,030    $ 381,886    $ 1,151,347    $ 1,170,288

Available-for-sale securities

     81,178      74,495      245,174      227,242

Held-to-maturity securities

     67,030      45,888      193,557      162,952

Trading securities

     39      67      136      128

Loans held for sale

     2,863      2,272      8,760      2,750

Federal funds sold and securities purchased under agreements to resell

     82      503      430      1,558

Other interest-earning assets

     51      69      149      333
    

  

  

  

Total interest income

     550,273      505,180      1,599,553      1,565,251
    

  

  

  

INTEREST EXPENSE

                           

Interest-bearing checking

     10,237      6,295      26,223      22,459

Money market and savings deposits

     10,599      9,144      29,602      36,960

Time deposits

     39,144      49,861      124,516      153,270

Certificates of deposit of $100,000 or more

     20,492      18,087      54,880      50,128

Foreign deposits

     4,361      1,658      10,548      5,017

Federal funds purchased and securities sold under agreements to repurchase

     11,707      3,917      26,537      14,391

Other borrowed funds

     2,555      1,076      6,441      3,206

Long-term Federal Home Loan Bank advances

     61,016      61,331      181,960      192,998

Other long-term debt

     14,256      10,358      42,033      30,971
    

  

  

  

Total interest expense

     174,367      161,727      502,740      509,400
    

  

  

  

NET INTEREST INCOME

     375,906      343,453      1,096,813      1,055,851

Provision for loan losses

     28,800      41,800      83,500      129,200
    

  

  

  

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES

     347,106      301,653      1,013,313      926,651
    

  

  

  

NONINTEREST REVENUES

                           

Service charges on deposit accounts

     96,508      87,535      284,100      244,768

Trust income

     28,587      25,918      87,402      77,543

Consumer investment services income

     17,565      17,937      59,906      50,296

Interchange income

     19,649      16,709      56,576      51,756

Bank owned life insurance policies

     11,377      13,616      34,656      40,510

Bankcard income

     7,697      6,622      22,062      19,514

Mortgage income

     4,164      11,975      15,565      39,121

Portfolio income

     5,920      17,600      23,732      39,436

Other noninterest revenues

     21,704      30,873      67,854      69,444
    

  

  

  

Total noninterest revenues

     213,171      228,785      651,853      632,388
    

  

  

  

NONINTEREST EXPENSES

                           

Salaries and employee benefits

     162,517      164,086      503,734      474,874

Net occupancy expense

     37,953      34,120      109,531      99,129

Equipment expense

     31,807      29,022      93,319      87,562

Postage and office supplies

     10,680      11,636      34,635      34,926

Marketing expense

     8,594      9,341      29,589      27,672

Professional fees

     7,339      7,558      25,368      23,696

Communications expense

     5,926      7,287      18,378      21,894

Amortization of intangibles

     1,043      1,198      3,369      3,594

Settlement agreement costs and related professional fees

     53,972      -0-      53,972      -0-

Other noninterest expenses

     42,647      42,308      124,627      121,437
    

  

  

  

Total noninterest expenses

     362,478      306,556      996,522      894,784
    

  

  

  

INCOME BEFORE INCOME TAXES

     197,799      223,882      668,644      664,255

Income taxes

     78,220      66,494      222,003      196,686
    

  

  

  

NET INCOME    $ 119,579    $ 157,388    $ 446,641    $ 467,569
    

  

  

  

Average common shares outstanding

     352,838      349,421      351,882      350,294

Earnings per common share

   $ .34    $ .45    $ 1.27    $ 1.33

Diluted average common shares outstanding

     358,272      353,317      357,169      353,971

Diluted earnings per common share

   $ .33    $ .45    $ 1.25    $ 1.32

 

See notes to consolidated financial statements.

 

4


Table of Contents

AMSOUTH BANCORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

(Unaudited)

 

    Common
Stock


    Capital
Surplus


    Retained
Earnings


    Treasury
Stock


   

Deferred

Compensation
on Restricted
Stock


   

Accumulated

Other
Comprehensive
Income/(Loss)


    Total

 
    (In thousands)  

BALANCE AT JANUARY 1, 2003

  $ 416,909     $ 706,081     $ 2,951,430     $ (1,045,428 )   $ (15,954 )   $ 102,959     $ 3,115,997  

Comprehensive income:

                                                       

Net income

    -0-       -0-       467,569       -0-       -0-       -0-       467,569  

Other comprehensive income, net of tax:

                                                       

Net change in unrealized gains and losses on available-for-sale securities*

    -0-       -0-       -0-       -0-       -0-       (87,321 )     (87,321 )

Net change in unrealized gains and losses on derivative instruments*

    -0-       -0-       -0-       -0-       -0-       (26,264 )     (26,264 )

Net change in unrealized gains and losses on minimum pension liability adjustment*

    -0-       -0-       -0-       -0-       -0-       (3,259 )     (3,259 )
                                                   


Comprehensive income

                                                    350,725  

Cash dividends declared

    -0-       -0-       (243,199 )     -0-       -0-       -0-       (243,199 )

Common stock transactions:

                                                       

Purchase of common stock

    -0-       -0-       -0-       (162,806 )     -0-       -0-       (162,806 )

Employee stock plans

    (30 )     6,191       (20,377 )     98,401       614       -0-       84,799  

Direct stock purchase and dividend reinvestment plan

    -0-       14       (26 )     7,330       -0-       -0-       7,318  
   


 


 


 


 


 


 


BALANCE AT SEPTEMBER 30, 2003

  $ 416,879     $ 712,286     $ 3,155,397     $ (1,102,503 )   $ (15,340 )   $ (13,885 )   $ 3,152,834  
   


 


 


 


 


 


 


BALANCE AT JANUARY 1, 2004

  $ 416,878     $ 715,663     $ 3,228,533     $ (1,076,644 )   $ (14,501 )   $ (40,260 )   $ 3,229,669  

Comprehensive income:

                                                       

Net income

    -0-       -0-       446,641       -0-       -0-       -0-       446,641  

Other comprehensive income, net of tax:

                                                       

Net change in unrealized gains and losses on available-for-sale securities*

    -0-       -0-       -0-       -0-       -0-       (11,418 )     (11,418 )

Net change in unrealized gains and losses on derivative instruments*

    -0-       -0-       -0-       -0-       -0-       (1,851 )     (1,851 )

Net change in unrealized gains and losses on minimum pension liability adjustment*

    -0-       -0-       -0-       -0-       -0-       (139 )     (139 )
                                                   


Comprehensive income

                                                    433,233  

Cash dividends declared

    -0-       -0-       (255,091 )     -0-       -0-       -0-       (255,091 )

Common stock transactions:

                                                       

Purchase of common stock

    -0-       -0-       -0-       (50,049 )     -0-       -0-       (50,049 )

Employee stock plans

    (125 )     (2,500 )     (11,421 )     99,080       804       -0-       85,838  

Direct stock purchase and dividend reinvestment plan

    -0-       1,115       (2,299 )     8,142       -0-       -0-       6,958  
   


 


 


 


 


 


 


BALANCE AT SEPTEMBER 30, 2004

  $ 416,753     $ 714,278     $ 3,406,363     $ (1,019,471 )   $ (13,697 )   $ (53,668 )   $ 3,450,558  
   


 


 


 


 


 


 



* See disclosure of reclassification adjustment amount and tax effect, as applicable, in Notes to Consolidated Financial Statements.

 

See notes to consolidated financial statements.

 

5


Table of Contents

AMSOUTH BANCORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS

(Unaudited)

 

    

Nine Months Ended

September 30


 

(In thousands)


   2004

    2003

 

OPERATING ACTIVITIES

                

Net income

   $ 446,641     $ 467,569  

Adjustments to reconcile net income to net cash provided by operating activities:

                

Provision for loan losses

     83,500       129,200  

Depreciation and amortization of premises and equipment

     81,851       73,300  

Amortization of premiums and discounts on held-to-maturity securities and available-for-sale securities

     32,089       38,858  

Originations and purchases of loans held for sale

     (861,821 )     (872,643 )

Proceeds from sales of loans held for sale

     726,219       706,961  

Net decrease in trading securities

     1,618       46,233  

Net gains on sales of available-for-sale securities

     (21,532 )     (34,419 )

Net loss (gain) on sales of mortgage loans

     24       (24,116 )

Net gain on sales of servicing assets

     (14,461 )     -0-  

Net gain on sales of other loans

     (9,224 )     (1,080 )

Net increase in accrued interest receivable, bank-owned life insurance and other assets

     (27,046 )     (76,595 )

Net (decrease) increase in accrued expenses and other liabilities

     (63,924 )     144,626  

Provision for deferred income taxes

     149,467       148,052  

Amortization of intangible assets

     3,369       3,594  

Other operating activities, net

     92,997       80,501  
    


 


Net cash provided by operating activities

     619,767       830,041  
    


 


INVESTING ACTIVITIES

                

Proceeds from maturities and prepayments of available-for-sale securities

     911,120       2,149,401  

Proceeds from sales of available-for-sale securities

     1,746,674       1,716,363  

Purchases of available-for-sale securities

     (2,057,117 )     (5,043,019 )

Proceeds from maturities, prepayments and calls of held-to-maturity securities

     1,284,069       2,273,346  

Purchases of held-to-maturity securities

     (2,352,380 )     (2,311,062 )

Net (increase) decrease in federal funds sold and securities purchased under agreements to resell

     (26,000 )     771  

Net decrease in other interest-earning assets

     3,067       30,710  

Net increase in loans, excluding guaranteed mortgage loan securitizations and sales of loans

     (3,780,828 )     (3,126,603 )

Purchases of mortgage loans

     (143,946 )     -0-  

Proceeds from sales of mortgage loans

     146,102       713,971  

Proceeds from sales of other loans and servicing assets

     430,412       50,148  

Net purchases of premises and equipment

     (171,082 )     (161,801 )
    


 


Net cash used in investing activities

     (4,009,909 )     (3,707,775 )
    


 


FINANCING ACTIVITIES

                

Net increase in deposits

     1,479,356       2,154,004  

Net increase in federal funds purchased and securities sold under agreements to repurchase

     471,379       451,558  

Net increase in other borrowed funds

     1,620,919       279,443  

Issuance of long-term Federal Home Loan Bank advances and other long-term debt

     350,587       2,750,000  

Payments for maturing Federal Home Loan Bank advances and other long-term debt

     (410,568 )     (2,545,709 )

Cash dividends paid

     (252,096 )     (243,858 )

Proceeds from employee stock plans, direct stock purchase and dividend reinvestment plan

     89,803       89,671  

Purchase of common stock

     (50,049 )     (162,806 )
    


 


Net cash provided by financing activities

     3,299,331       2,772,303  
    


 


Decrease in cash and cash equivalents

     (90,811 )     (105,431 )

Cash and cash equivalents at beginning of period

     1,163,986       1,221,985  
    


 


Cash and cash equivalents at end of period

   $ 1,073,175     $ 1,116,554  
    


 


 

See notes to consolidated financial statements.

 

6


Table of Contents

AMSOUTH BANCORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Nine months ended September 30, 2004 and 2003

 

Basis of Presentation- The consolidated financial statements conform to accounting principles generally accepted in the United States. The accompanying interim financial statements are unaudited; however, in the opinion of management, all adjustments necessary for the fair presentation of the consolidated financial statements have been included. All such adjustments are of a normal recurring nature. Certain amounts in the prior year’s financial statements have been reclassified to conform to the 2004 presentation. These reclassifications had no effect on net income. The notes included herein should be read in conjunction with the notes to consolidated financial statements included in AmSouth Bancorporation’s (AmSouth) 2003 annual report on Form 10-K.

 

The consolidated financial statements and notes are presented in accordance with the instructions for Form 10-Q. The consolidated financial statements include the accounts of AmSouth and all of its subsidiaries, all of which are wholly- owned. All significant intercompany balances and transactions have been eliminated.

 

The Financial Accounting Standards Board (FASB) issued a revised version of Interpretation No. 46 “Consolidation of Variable Interest Entities” (Interpretation 46), in December of 2003. This accounting guidance significantly changes how companies determine whether they must consolidate an entity depending on whether the entity is a voting rights entity or a variable interest entity (VIE). The revised Interpretation 46 is effective no later than the end of the first interim or annual period ending after December 15, 2003 for entities created after January 31, 2003, and for entities created before February 1, 2003, no later than the end of the first interim or annual period ending after March 15, 2004. As required, AmSouth adopted the guidance of Interpretation 46 for all entities.

 

In accordance with the new guidance, AmSouth considers a voting rights entity to be a subsidiary and consolidates it if AmSouth has a controlling financial interest in the entity. VIEs are consolidated by AmSouth if it is exposed to the majority of the VIE’s expected losses and/or residual returns (i.e., AmSouth is considered to be the primary beneficiary).

 

Unconsolidated investments in voting rights entities or VIEs in which AmSouth has significant influence over operating and financing decisions (usually defined as a voting or economic interest of 20% to 50%) are accounted for using the equity method. Unconsolidated investments in voting rights entities or VIEs in which AmSouth has a voting or economic interest of less than 20% are generally carried at cost.

 

Prior to the adoption of Interpretation 46, AmSouth generally determined whether consolidation of an entity was appropriate based on the nature and amount of equity contributed by third parties, the decision-making power granted to those parties and the extent of their control over the entity’s operating and financial policies. Entities controlled, generally through majority ownership, were consolidated and were considered subsidiaries.

 

Use of Estimates – The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, benefit plan obligations and expenses, and the valuation of derivative instruments used in hedging transactions and the corresponding value of items being hedged.

 

Recent Accounting Developments – In December 2003, the FASB issued a revision to Statement No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits” (Statement 132). Statement 132 requires enhanced disclosures for defined benefit pension plans. Statement 132 requires companies to provide more details about their plan assets, investment strategy, measurement dates, benefit obligations, cash flows, and

 

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components of net periodic benefit cost recognized during interim periods. The disclosures required by Statement 132 are effective for financial statements with fiscal years ending after December 15, 2003, except for disclosures regarding estimated future benefit payments. Disclosures regarding estimated future benefit payments will be required for fiscal years ending after June 15, 2004. The interim-period disclosures required by this statement are effective for interim periods beginning after December 15, 2003. See discussion on “Pension” later in Notes to Consolidated Financial Statements for the disclosures required by this statement. As Statement 132 relates to changes in disclosures, its adoption did not have an impact on AmSouth’s financial condition or results of operations.

 

In December 2003, the American Institute of Certified Public Accountants issued Statement of Position 03-3, “Accounting for Certain Loans and Debt Securities Acquired in a Transfer” (SOP 03-3). SOP 03-3 addresses accounting for differences between contractual cash flows expected to be collected and an investor’s initial investment in loans or debt securities acquired in a transfer if those differences are attributable, at least in part, to credit quality. It includes loans and debt securities acquired in purchase business combinations. SOP 03-3 limits the yield that may be accreted (accretable yield) to the excess of the investor’s estimate of undiscounted expected principal, interest and other cash flows (cash flows expected at acquisition to be collected) over the investor’s initial investment in the loan. SOP 03-3 requires that the excess of contractual cash flows over cash flows to be collected (nonaccretable difference) not be recognized as an adjustment of yield, loss accrual or valuation allowance. SOP 03-3 prohibits investors from displaying accretable yield and nonaccretable difference on the balance sheet. Subsequent increases in cash flows expected to be collected generally should be recognized prospectively through adjustment of the loan’s yield over its remaining life. Decreases in cash flows expected to be collected should be recognized as impairment. SOP 03-3 prohibits “carrying over” or creation of valuation allowances in the initial accounting of all loans acquired in a transfer that are within the scope of SOP 03-3. The prohibition of the valuation allowance carryover applies to the purchase of an individual loan, a pool of loans, a group of loans, and loans acquired in a purchase business combination. SOP 03-3 is effective for loans acquired in fiscal years beginning after December 15, 2004. AmSouth does not anticipate that the adoption of SOP 03-3 will have a material impact on its financial condition or results of operations.

 

On March 9, 2004, the Securities and Exchange Commission issued Staff Accounting Bulletin 105, “Application of Accounting Principles to Loan Commitments,” (SAB 105) to inform registrants of the Staff’s view that the fair value of recorded loan commitments should not consider the expected future cash flows related to the associated servicing of the future loan. The provisions of SAB 105 must be applied to loan commitments accounted for as derivatives that are entered into after March 31, 2004. The staff will not object to the application of existing accounting practices to loan commitments accounted for as derivatives that are entered into on or before March 31, 2004, with appropriate disclosures. On April 1, 2004, AmSouth adopted the provisions of SAB 105. AmSouth records the value of its mortgage loan commitments at fair market value for mortgages it intends to sell. AmSouth does not currently include and was not including the value of mortgage servicing or any other internally-developed intangible assets in the valuation of its mortgage loan commitments. Therefore, the adoption of SAB 105 did not have an impact on AmSouth’s financial condition or results of operations.

 

In March 2004, the Emerging Issues Task Force (EITF) reached a consensus on Issue 03-1, “Meaning of Other Than Temporary Impairment” (Issue 03-1). The Task Force reached a consensus on an other-than-temporary impairment model for debt and equity securities accounted for under Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities” and cost method investments. The basic model developed by the Task Force in evaluating whether an investment within the scope of Issue 03-1 is other-than-temporarily impaired is as follows: Step 1: Determine whether the investment is impaired. An investment is impaired if its fair value is less than its cost. Step 2: Evaluate whether the impairment is other-than-temporary. Step 3: If the impairment is other-than-temporary, recognize an impairment loss equal to the difference between the investment’s cost and its fair value. The three-step model used to determine other-than-temporary impairments shall be applied prospectively to all current and future investments in interim or annual reporting periods beginning after final guidance is issued. On September 30, 2004, the FASB issued FASB Staff Position EITF 03-1-1, “Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments””

 

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which delays the effective date of paragraphs 10-20 (Steps 2 and 3) of Issue 03-1 pertaining to measurement and recognition of other-than temporary impairment. The delay of the effective date will be superseded concurrent with the final issuance of FASB Staff Position EITF Issue 03-1-a which is expected to contain implementation guidance. The impact of adoption of paragraphs 10-20 of Issue 03-1 will not be known until the final implementation guidance is issued.

 

Cash Flows - For the nine months ended September 30, 2004 and 2003, AmSouth paid interest of $497.0 million and $512.3 million, respectively, on its deposits and obligations. During the nine months ended September 30, 2004 and 2003, AmSouth paid income taxes of $162.6 million and $61.7 million, respectively. Noncash transfers from loans to foreclosed properties for the nine months ended September 30, 2004 and 2003 were $32.4 million and $44.5 million, respectively. Noncash transfers from foreclosed properties to loans for the nine months ended September 30, 2004 and 2003 were $831 thousand and $458 thousand, respectively. During the nine months ended September 30, 2003, AmSouth had noncash transfers from loans to available-for-sale and held-to-maturity securities of approximately $405 million in connection with guaranteed mortgage loan securitizations.

 

Stock-Based Compensation – AmSouth has long-term incentive compensation plans that permit the granting of incentive awards in the form of stock options, restricted stock awards, restricted stock units, stock appreciation rights, performance shares, and performance units. Generally, the terms of these plans stipulate that the exercise price of options may not be less than the fair market value of AmSouth’s common stock on the date the options are granted. Options generally vest between one and three years from the date of grant, with all of the 2004 option grants vesting ratably over three years. All of the options granted during the first nine months of 2004 expire ten years from the date of grant. All other options outstanding generally expire not later than ten years from the date of grant.

 

AmSouth has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (Statement 123) which allows an entity to continue to measure compensation costs for those plans using the intrinsic value-based method of accounting prescribed by APB Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25). AmSouth has elected to follow APB 25 and related interpretations in accounting for its employee stock options. Accordingly, compensation cost for fixed and variable stock-based awards is measured by the excess, if any, of the fair market price of the underlying stock over the amount the individual is required to pay. Compensation cost for fixed awards is measured at the grant date, while compensation cost for variable awards is estimated until both the number of shares an individual is entitled to receive and the exercise or purchase price are known (measurement date). No option-based employee compensation cost is reflected in net income, as all options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. AmSouth does, however, currently recognize compensation expense related to restricted stock issuances as disclosed in the table below. The pro forma information below was determined as if AmSouth had accounted for all employee stock-based awards under the fair value method of Statement 123. For purposes of pro forma disclosures, the estimated fair value of the options and restricted stock awards is amortized to expense over the awards vesting period. AmSouth’s pro forma information follows:

 

    

For the three months
ended

September 30


      

For the nine months
ended

September 30


 

(In thousands, except per share data)


   2004

       2003

       2004

       2003

 

Net income:

                                         

As reported

   $ 119,579        $ 157,388        $ 446,641        $ 467,569  

Add: Stock-based compensation expense included in reported net income, net of tax

     517          460          1,340          1,433  

Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of tax

     (8,441 )        (6,824 )        (24,742 )        (20,189 )
    


    


    


    


Pro forma

   $ 111,655        $ 151,024        $ 423,239        $ 448,813  
    


    


    


    


Earnings per common share:

                                         

As reported

   $ .34        $ .45        $ 1.27        $ 1.33  

Pro forma

     .32          .43          1.20          1.28  

Diluted earnings per common share:

                                         

As reported

   $ .33        $ .45        $ 1.25        $ 1.32  

Pro forma

     .31          .43          1.19          1.27  

 

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This pro forma information includes expenses related to all stock options granted during the first nine months of 2004 and 2003, as well as the expense related to the unvested portion of prior year grants and assumes that the fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for the nine months ending September 30, 2004 and 2003, respectively: a risk-free interest rate of 3.92% and 3.81%, a dividend yield of 3.99% and 4.49%, a volatility factor of 30.89% and 31.40%, and a weighted-average expected life of 7.0 years for both periods. The weighted-average fair value of options granted during the nine months ended September 30, 2004 and 2003 was $5.69 and $4.49, respectively. The estimated fair value of the options is then amortized to expense over the options’ vesting period to determine the expense for the periods.

 

Derivatives – In accordance with Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (Statement 133), AmSouth recognizes all of its derivative instruments as either assets or liabilities in the statement of financial condition at fair value. For those derivative instruments that are designated and qualify as hedging instruments, AmSouth designates the hedging instrument, based upon the exposure being hedged, as either a fair value hedge or a cash flow hedge. Derivative instruments designated in a hedge relationship to mitigate exposure to changes in the fair value of an asset, liability or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges under Statement 133. Derivative instruments designated in a hedge relationship to mitigate exposure to variability in expected future cash flows or other types of forecasted transactions are considered cash flow hedges.

 

For derivative instruments that are designated and qualify as fair value hedges, the gain or loss on the derivative instrument as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in other noninterest revenue during the period of the change in fair values. For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of future cash flows of the hedged item, if any, is recognized in other noninterest revenue during the period of change. For derivative instruments not designated as hedging instruments, the gain or loss is recognized in current earnings during the period of change.

 

AmSouth, at the hedge’s inception and at least quarterly thereafter, performs a formal assessment to determine whether changes in the fair values or cash flows of the derivative instruments have been highly effective in offsetting changes in the fair values or cash flows of the hedged items and whether they are expected to be highly effective in the future. If it is determined a derivative instrument has not been or will not continue to be highly effective as a hedge, hedge accounting is discontinued prospectively, and the derivative instrument continues to be carried at fair value with all changes in fair value being recorded in noninterest revenue, but with no corresponding offset being recorded on the hedged item or in other comprehensive income for cash flow hedges.

 

Fair Value Hedging Strategy - AmSouth has entered into interest rate swap agreements for interest rate risk exposure management purposes. The interest rate swap agreements utilized by AmSouth effectively modify AmSouth’s exposure to interest rate risk by converting a portion of AmSouth’s fixed-rate long-term debt to floating rate. AmSouth also has an interest rate swap agreement which effectively converts portions of a fixed-rate certificate of deposit to floating rate. During the nine months ended September 30, 2004 and 2003, AmSouth recognized a net gain of $14 thousand and a net loss of $561 thousand, respectively, related to the ineffective portion of its hedging instruments.

 

AmSouth has entered into forward contracts to hedge the fair value of specific pools of mortgage loans held for sale from changes in interest rates. The impact of hedge ineffectiveness during the nine months ended September 30, 2004 was not material to the earnings of AmSouth. In addition, Statement 133 also requires AmSouth to treat its pipeline of mortgage banking loan commitments as derivatives. AmSouth’s derivative

 

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portfolio also included forward contracts entered into to offset the impact of changes in interest rates on AmSouth’s mortgage pipeline designated for future sale. Accordingly, the change in fair value of the forward contracts entered into to hedge the mortgage pipeline, while not qualifying as hedges under Statement 133, is somewhat offset by changes in the fair value of the mortgage pipeline. At September 30, 2003, AmSouth had open forward contracts to sell mortgage loans, but, did not begin designating the forward contracts as hedges until the fourth quarter of 2003.

 

Cash Flow Hedging Strategy – AmSouth has entered into interest rate swap agreements that effectively convert a portion of its floating-rate loans to a fixed-rate basis, thus reducing the impact of interest-rate changes on future interest income. Approximately $1.3 billion and $1.5 billion of AmSouth’s loans were designated as the hedged items to interest rate swap agreements at September 30, 2004 and 2003, respectively. AmSouth has entered into interest rate swap agreements to hedge the anticipated reissuance of Federal funds purchases which effectively convert a portion of its Federal funds purchased to fixed rate. Approximately $550 million of AmSouth’s Federal funds purchased were designated as the hedged items to the interest rate swap agreements at September 30, 2004. Approximately $300 million of these swaps expire in 2005, $50 million in 2006 and $200 million in 2007. During the third quarter of 2004, AmSouth entered into interest rate swap agreements in the notional amount of $450 million to hedge the future semi-annual interest payments on the forecasted issuance of ten-year fixed-rate subordinated debt. During the nine months ended September 30, 2004, AmSouth terminated $600 million of swaps that had been designated as hedging long-term floating rate bank notes. The loss related to the effective portion of these hedging relationships will be amortized into net interest income over the remaining life of the long-term floating rate bank notes. During the nine months ended September 30, 2004 and 2003, AmSouth recognized net income of $8 thousand and a net loss of $1 thousand, respectively, related to the ineffective portion of its cash flow hedging instruments.

 

Guarantees – AmSouth, as part of its ongoing business operations, issues financial guarantees in the form of financial and performance standby letters of credit. Standby letters of credit are contingent commitments issued by AmSouth generally to guarantee the performance of a customer to a third party. A financial standby letter of credit is a commitment by AmSouth to guarantee a customer’s repayment of an outstanding loan or debt instrument. In a performance standby letter of credit, AmSouth guarantees a customer’s performance under a contractual nonfinancial obligation for which it receives a fee. AmSouth has recourse against the customer for any amount it is required to pay to a third party under a standby letter of credit. Revenues are recognized ratably over the life of the standby letter of credit. At September 30, 2004, AmSouth had standby letters of credit outstanding with maturities ranging from less than one year to eleven years. The maximum potential amount of future payments AmSouth could be required to make under its standby letters of credit at September 30, 2004 was $3.3 billion and represents AmSouth’s maximum credit risk. At September 30, 2004, AmSouth had $21.4 million of liabilities and $21.4 million of receivables associated with standby letters of credit agreements entered into subsequent to December 31, 2002 as a result of AmSouth’s adoption of Interpretation 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” at January 1, 2003. At September 30, 2003, AmSouth had $9.8 million of liabilities and $9.8 million of receivables associated with standby letters of credit agreements entered into subsequent to December 31, 2002. Standby letters of credit agreements entered into prior to January 1, 2003, have a carrying value of zero. AmSouth holds collateral to support standby letters of credit when deemed necessary.

 

AmSouth Investment Services, Inc. (AIS), a subsidiary of AmSouth, guarantees the margin account balances issued by its brokerage clearing agent on behalf of AIS’s customers. If a customer defaults on the margin account, AIS has guaranteed to the brokerage clearing agent to buy in the account so as to bring the account into compliance with applicable margin or maintenance requirements. The margin account balance as of September 30, 2004 was $33.4 million. The total potential margin guarantee for AIS was $263.8 million as of September 30, 2004, which is equal to 70% of customers’ account balances. In the event a customer defaults, AmSouth would have recourse to the customer. AmSouth has no liability recorded on its balance sheet related to this agreement.

 

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Variable Interest Entities – A variable interest entity is defined by Interpretation 46 to be an entity which has one or both of the following characteristics: (1) The equity investment at risk is not sufficient to permit the entity to finance its activities without additional support from other parties, which is provided through other interests that will absorb some or all of the expected losses of the entity; and (2) The equity investors lack one or more of the following essential characteristics of a controlling financial interest: (a) direct or indirect ability to make decisions about the entity’s activities through voting rights or similar rights, (b) the obligation to absorb the expected losses of the entity if they occur, which makes it possible for the entity to finance its activities, or (c) the right to receive the expected residual returns of the entity if they occur, which is the compensation for risk of absorbing expected losses. Interpretation 46 does not require consolidation by transferors to qualifying special purpose entities. AmSouth has reviewed several areas of potential variable interest entities for consolidation. These areas included: investments in affordable housing, leveraged lease transactions, trust, and commercial real estate lending.

 

AmSouth has limited partnership investments in affordable housing projects, for which it provides funding as a limited partner and receives tax credits related to its investments in the projects based on its partnership share. At September 30, 2004, AmSouth had recorded investments in other assets on its balance sheet of approximately $159.0 million associated with limited partnership investments in affordable housing projects. AmSouth currently adjusts the carrying value of these investments for any losses incurred by the limited partnership through earnings. AmSouth has determined that these structures meet the definition of variable interest entities. AmSouth has determined that it will not need to consolidate any of these direct limited partnership investments. In some cases, AmSouth is the sole limited partner in a fund that invests in affordable housing projects. AmSouth has determined that it is required to consolidate these funds in which it is the sole limited partner. However, since these funds are not required to consolidate the underlying affordable housing projects in which they invest, there is no financial statement impact associated with their consolidation by AmSouth. AmSouth’s maximum exposure to loss on these limited partnerships is limited to the $159.0 million of recorded investment.

 

AmSouth also reviewed the structures utilized in its leveraged lease transactions. In these transactions, AmSouth, as the lessor, finances a minimal amount of the purchase but has total equity ownership. A third party (debt participant) finances the remainder. The property is then leased to another party. Based on its review, AmSouth determined that these lease structures meet the definition of variable interest entities. AmSouth’s current accounting for these leveraged leases, however, is not impacted by Interpretation 46. At September 30, 2004, AmSouth had a recorded investment in leveraged leases of $1.8 billion which represents AmSouth’s maximum exposure to loss on these leveraged lease transactions.

 

AmSouth, through its Trust area, acts as a fiduciary to trust entities which meet the definition of variable interest entities. AmSouth’s interest is limited to the right to receive fees. AmSouth has determined that it is not required to consolidate these entities. AmSouth’s exposure to future loss related to these entities is limited to fee revenues generated from these trusts.

 

AmSouth, as a commercial real estate lender, periodically lends money for the construction or acquisition of commercial real estate. At September 30, 2004, AmSouth had approximately $5.5 billion of commercial real estate loans outstanding and approximately $3.6 billion in unused commercial real estate commitments to lend money. AmSouth has determined that some of the entities to which it lends for commercial real estate purposes meet the definition of variable interest entities. AmSouth has reviewed these structures and determined that any that met the definition of a variable interest entity were not required to be consolidated. AmSouth’s maximum exposure to loss associated with these commercial real estate transactions is no greater than the outstanding balance in commercial real estate lending and any outstanding commitments to lend money associated with these transactions at September 30, 2004.

 

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Pension – Net periodic benefit (credit)/cost includes the following components for the three months ended September 30, 2004:

 

     Retirement Plans

    Other
Postretirement
Benefits


 

(In thousands)


   2004

    2003

    2004

    2003

 

Service cost

   $ 5,358     $ 4,704     $ 218     $ 214  

Interest cost

     10,515       10,029       601       628  

Expected return on plan assets

     (16,198 )     (15,336 )     (55 )     (59 )

Amortization of prior service cost/(credit)

     11       (75 )     (218 )     (218 )

Amortization of transitional obligation

     48       48       11       10  

Recognized actuarial loss (gain)

     4,028       408       304       259  
    


 


 


 


Net periodic benefit cost/(credit)

   $ 3,762     $ (222 )   $ 861     $ 834  
    


 


 


 


 

Net periodic benefit (credit)/cost includes the following components for the nine months ended September 30, 2004:

 

     Retirement Plans

    Other
Postretirement
Benefits


 

(In thousands)


   2004

    2003

    2004

    2003

 

Service cost

   $ 16,075     $ 14,110     $ 654     $ 641  

Interest cost

     31,543       30,088       1,804       1,885  

Expected return on plan assets

     (48,595 )     (46,009 )     (164 )     (179 )

Amortization of prior service cost/(credit)

     34       (225 )     (653 )     (653 )

Amortization of transitional obligation

     144       144       33       32  

Recognized actuarial loss (gain)

     12,085       1,225       911       778  
    


 


 


 


Net periodic benefit cost/(credit)

   $ 11,286     $ (667 )   $ 2,585     $ 2,504  
    


 


 


 


 

AmSouth made a $25.3 million contribution to its pension plan during the third quarter of 2004. In addition, AmSouth expects to make a contribution to other postretirement plans of approximately $2.9 million in 2004.

 

Contingencies – Various legal proceedings are pending against AmSouth and its subsidiaries. Some of these proceedings seek relief or allege damages that are substantial. The actions arise in the ordinary course of AmSouth’s business and include actions relating to its imposition of certain fees, lending, collections, loan servicing, deposit taking, investment, trust and other activities. Additionally, AmSouth and certain of its subsidiaries, which are regulated by one or more federal and state authorities, are the subject of regularly scheduled and special examinations, reviews and investigations conducted by such regulatory authorities and by law enforcement agencies resulting from these examinations, reviews and investigations. Although it is not possible to determine with certainty AmSouth’s potential exposure from these proceedings, based upon legal counsel’s opinion, management considers that any liability resulting from the proceedings would not have a material impact on the financial condition or results of operations of AmSouth.

 

AmSouth’s federal and state income tax returns are subject to review and examination by government authorities. In the normal course of these examinations, AmSouth is subject to challenges from federal and state authorities regarding amounts of taxes due. These challenges may alter the timing or amount of taxable income or deductions, or the allocation of income among tax jurisdictions. AmSouth is currently under examination by a number of the states in which it does business. As is the case with most larger corporate taxpayers, all of AmSouth’s corporate federal tax returns are examined by the Internal Revenue Service (IRS). AmSouth is currently under examination by the IRS for the years ended December 31, 1998, September 30, 1999 and December 31, 1999. In connection with this examination, the IRS has issued Notices of Proposed Adjustments

 

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with respect to AmSouth’s tax treatment of certain leveraged lease transactions that were entered into during the years ended December 31, 1998, September 30, 1999 and December 31, 1999. Management believes that AmSouth’s treatment of these leveraged lease transactions was in compliance with existing tax laws and regulations and intends to vigorously defend its position. AmSouth is also under examination by the IRS for the years ended December 31, 2000 through 2002. Management does not expect that resolution of the state or IRS audit issues will have a material impact on AmSouth’s financial position or operating results.

 

Comprehensive Income – Total comprehensive income consists of net income, the change in the unrealized gains or losses on AmSouth’s available-for-sale securities portfolio arising during the period, the change in the effective portion of cash flow hedges marked to market and a minimum pension liability related to an unfunded pension liability. In the calculation of comprehensive income, certain reclassification adjustments are made to avoid double counting items that are displayed as part of net income for a period that also had been displayed as part of other comprehensive income in that period or earlier periods.

 

The following tables detail the components of comprehensive income, including reclassification adjustments:

 

     Three Months Ended September 30

 
     2004

   2003

 

(Dollars in thousands)


  

Before

Tax


  

Tax

Effect


   

Net of

Tax


   Before
Tax


   

Tax

Effect


   

Net of

Tax


 

Net income

   $ 197,799    $ (78,220 )   $ 119,579    $ 223,882     $ (66,494 )   $ 157,388  

Other comprehensive income:

                                              

Unrealized holding gains and losses on available-for-sale securities arising during the period

     141,659      (53,418 )     88,241      (71,960 )     29,015       (42,945 )

Less: reclassification adjustment for net securities gains realized in net income

     5,329      (2,004 )     3,325      15,418       (5,798 )     9,620  
    

  


 

  


 


 


Net change in unrealized gains and losses on available-for-sale securities

     136,330      (51,414 )     84,916      (87,378 )     34,813       (52,565 )
    

  


 

  


 


 


Unrealized holding gains and losses on derivatives arising during the period

     19,599      (6,920 )     12,679      (22,059 )     7,521       (14,538 )

Less: reclassification adjustment for gains realized in net income

     2,317      (871 )     1,446      7,647       (2,876 )     4,771  
    

  


 

  


 


 


Net change in unrealized gains and losses on derivative instruments

     17,282      (6,049 )     11,233      (29,706 )     10,397       (19,309 )
    

  


 

  


 


 


Additional minimum benefit liability adjustment

     —        —         —        (5,222 )     1,963       (3,259 )
    

  


 

  


 


 


Comprehensive income

   $ 351,411    $ (135,683 )   $ 215,728    $ 101,576     $ (19,321 )   $ 82,255  
    

  


 

  


 


 


 

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     Nine Months Ended September 30

 
     2004

    2003

 

(Dollars in thousands)


   Before
Tax


   

Tax

Effect


   

Net of

Tax


   

Before

Tax


   

Tax

Effect


   

Net of

Tax


 

Net income

   $ 668,644     $ (222,003 )   $ 446,641     $ 664,255     $ (196,686 )   $ 467,569  

Other comprehensive income:

                                                

Unrealized holding gains and losses on available-for-sale securities arising during the period

     2,178       (160 )     2,018       (113,151 )     47,307       (65,844 )

Less: reclassification adjustment for net securities gains realized in net income

     21,532       (8,096 )     13,436       34,419       (12,942 )     21,477  
    


 


 


 


 


 


Net change in unrealized gains and losses on available-for-sale securities

     (19,354 )     7,936       (11,418 )     (147,570 )     60,249       (87,321 )
    


 


 


 


 


 


Unrealized holding gains and losses on derivatives arising during the period

     8,808       (3,386 )     5,422       (24,633 )     8,211       (16,422 )

Less: reclassification adjustment for gains realized in net income

     11,655       (4,382 )     7,273       15,773       (5,931 )     9,842  
    


 


 


 


 


 


Net change in unrealized gains and losses on derivative instruments

     (2,847 )     996       (1,851 )     (40,406 )     14,142       (26,264 )
    


 


 


 


 


 


Additional minimum benefit liability adjustment

     (223 )     84       (139 )     (5,222 )     1,963       (3,259 )
    


 


 


 


 


 


Comprehensive income

   $ 646,220     $ (212,987 )   $ 433,233     $ 471,057     $ (120,332 )   $ 350,725  
    


 


 


 


 


 


 

Earnings Per Common Share – The following table sets forth the computation of earnings per common share and diluted earnings per common share:

 

    

Three Months Ended

September 30


  

Nine Months Ended

September 30


(In thousands except per share data)


   2004

   2003

   2004

   2003

Earnings per common share computation:

                           

Numerator:

                           

Net income

   $ 119,579    $ 157,388    $ 446,641    $ 467,569

Denominator:

                           

Average common shares outstanding

     352,838      349,421      351,882      350,294

Earnings per common share

   $ .34    $ .45    $ 1.27    $ 1.33

Diluted earnings per common share computation:

                           

Numerator:

                           

Net income

   $ 119,579    $ 157,388    $ 446,641    $ 467,569

Denominator:

                           

Average common shares outstanding

     352,838      349,421      351,882      350,294

Dilutive shares contingently issuable

     5,434      3,896      5,287      3,677
    

  

  

  

Average diluted common shares outstanding

     358,272      353,317      357,169      353,971

Diluted earnings per common share

   $ .33    $ .45    $ 1.25    $ 1.32

 

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Shareholders’ Equity – On April 17, 2003, AmSouth’s Board of Directors approved a plan to repurchase up to 25 million shares of the company’s outstanding common stock. The common shares may be repurchased in the open market or in privately negotiated transactions. The reacquired common shares will be held as treasury shares and may be reissued for various corporate purposes, including employee benefit programs. During the nine month period ended September 30, 2004, AmSouth purchased 2.1 million shares under this authorization at a cost of $49.4 million. The total shares repurchased under this authorization through September 30, 2004 were 2.4 million shares at a cost of $55.6 million. Cash dividends of $.24 per common share were declared in the third quarter of 2004.

 

Business Segment Information - AmSouth has three reportable segments: Consumer Banking, Commercial Banking and Wealth Management. Treasury & Other includes balance sheet management activities that include the investment portfolio, non-deposit funding and the impact of derivatives used in asset/liability management. Income from bank owned life insurance policies, gains and losses related to the ineffective portion of derivative hedging instruments, net gains and losses on sales of fixed assets, taxable-equivalent adjustments associated with lease residual option benefits, the amortization of deposit intangibles, expenses related to the previously announced settlement agreements and related professional fees, and corporate expenses such as corporate overhead are also shown in Treasury & Other. In addition, Treasury & Other includes the reversal of revenues and expenses associated with Private Client Service (PCS) customers’ loans and deposit balances to eliminate any double counting which occurs as a result of including these revenues and expenses in the Wealth Management segment as well as in either the Commercial or Consumer segments.

 

The following is a summary of the segment performance for the three and nine months ended September 30, 2004 and 2003:

 

(In thousands)


  

Consumer

Banking


  

Commercial

Banking


   

Wealth

Management


   

Treasury &

Other


    Total

Three Months Ended September 30, 2004

                                     

Net interest income before internal funding

   $ 212,252    $ 120,199     $ $41,670     $ 1,785     $ 375,906

Internal funding

     75,966      (11,943 )     (604 )     (63,419 )     -0-
    

  


 


 


 

Net interest income/(expense)

     288,218      108,256       41,066       (61,634 )     375,906

Noninterest revenues

     121,193      34,560       47,625       9,793       213,171
    

  


 


 


 

Total revenues

     409,411      142,816       88,691       (51,841 )     589,077

Provision for loan losses

     20,785      4,493       364       3,158       28,800

Noninterest expenses

     192,031      47,059       50,593       72,795       362,478
    

  


 


 


 

Income/(Loss) before income taxes

     196,595      91,264       37,734       (127,794 )     197,799

Income taxes/(benefits)

     73,920      34,315       14,188       (44,203 )     78,220
    

  


 


 


 

Segment net income/(loss)

   $ 122,675    $ 56,949     $ 23,546     $ (83,591 )   $ 119,579
    

  


 


 


 

Revenues from external customers

   $ 333,445    $ 154,759     $ 44,483     $ 56,390     $ 589,077
    

  


 


 


 

Ending Assets

   $ 21,842,393    $ 12,949,523     $ 4,248,268     $ 10,647,678     $ 49,687,862
    

  


 


 


 

Three Months Ended September 30, 2003

                                     

Net interest income before internal funding

   $ 196,090    $ 111,642     $ $36,247     $ (526 )   $ 343,453

Internal funding

     82,672      (12,038 )     (3,007 )     (67,627 )     -0-
    

  


 


 


 

Net interest income/(expense)

     278,762      99,604       33,240       (68,153 )     343,453

Noninterest revenues

     115,695      32,461       45,011       35,618       228,785
    

  


 


 


 

Total revenues

     394,457      132,065       78,251       (32,535 )     572,238

Provision for loan losses

     35,064      4,967       271       1,498       41,800

Noninterest expenses

     183,757      44,577       50,185       28,037       306,556
    

  


 


 


 

Income/(Loss) before income taxes

     175,636      82,521       27,795       (62,070 )     223,882

Income taxes/(benefits)

     66,039      31,028       10,451       (41,024 )     66,494
    

  


 


 


 

Segment net income/(loss)

   $ 109,597    $ 51,493     $ 17,344     $ (21,046 )   $ 157,388
    

  


 


 


 

Revenues from external customers

   $ 311,785    $ 144,103     $ 42,459     $ 73,891     $ 572,238
    

  


 


 


 

Ending Assets

   $ 19,630,173    $ 11,382,398     $ 3,433,422     $ 9,896,706     $ 44,342,699
    

  


 


 


 

 

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(In thousands)


   Consumer
Banking


   Commercial
Banking


    Wealth
Management


    Treasury &
Other


    Total

Nine months ended September 30, 2004

                                     

Net interest income before internal funding

   $ 601,825    $ 343,818     $ 120,197     $ 30,973     $ 1,096,813

Internal funding

     235,926      (27,129 )     (1,856 )     (206,941 )     -0-
    

  


 


 


 

Net interest income/(expense)

     837,751      316,689       118,341       (175,968 )     1,096,813

Noninterest revenues

     356,222      106,926       151,633       37,072       651,853
    

  


 


 


 

Total revenues

     1,193,973      423,615       269,974       (138,896 )     1,748,666

Provision for loan losses

     69,215      6,928       1,007       6,350       83,500

Noninterest expenses

     575,623      140,852       159,814       120,233       996,522
    

  


 


 


 

Income/(Loss) before income taxes

     549,135      275,835       109,153       (265,479 )     668,644

Income taxes/(benefits)

     206,475      103,713       41,042       (129,227 )     222,003
    

  


 


 


 

Segment net income/(loss)

   $ 342,660    $ 172,122     $ 68,111     $ (136,252 )   $ 446,641
    

  


 


 


 

Revenues from external customers

   $ 958,047    $ 450,744     $ 143,398     $ 196,477     $ 1,748,666
    

  


 


 


 

Ending Assets

   $ 21,842,393    $ 12,949,523     $ 4,248,268     $ 10,647,678     $ 49,687,862
    

  


 


 


 

Nine Months Ended September 30, 2003

                                     

Net interest income before internal funding

   $ 596,838    $ 345,227     $ $109,671     $ 4,115     $ 1,055,851

Internal funding

     237,246      (50,747 )     (17,352 )     (169,147 )     -0-
    

  


 


 


 

Net interest income/(expense)

     834,084      294,480       92,319       (165,032 )     1,055,851

Noninterest revenues

     328,951      94,210       131,292       77,935       632,388
    

  


 


 


 

Total revenues

     1,163,035      388,690       223,611       (87,097 )     1,688,239

Provision for loan losses

     103,471      19,155       779       5,795       129,200

Noninterest expenses

     544,484      135,058       148,228       67,014       894,784
    

  


 


 


 

Income/(Loss) before income taxes

     515,080      234,477       74,604       (159,906 )     664,255

Income taxes/(benefits)

     193,670      88,163       28,051       (113,198 )     196,686
    

  


 


 


 

Segment net income/(loss)

   $ 321,410    $ 146,314     $ 46,553     $ (46,708 )   $ 467,569
    

  


 


 


 

Revenues from external customers

   $ 925,789    $ 439,437     $ 123,845     $ 199,168     $ 1,688,239
    

  


 


 


 

Ending Assets

   $ 19,630,173    $ 11,382,398     $ 3,433,422     $ 9,896,706     $ 44,342,699
    

  


 


 


 

 

Subsequent Events - On November 1, 2004, AmSouth entered into a definitive agreement to sell its credit card portfolio, comprising approximately 390,000 accounts and total receivables of approximately $550 million, to MBNA Corporation. As part of the agreement, AmSouth has also entered into an agent bank agreement, which will enable AmSouth customers to continue to receive credit card products, while also providing MBNA the exclusive credit-card related marketing rights to AmSouth’s current and prospective customers. The transaction is expected to close by year-end, subject to customary approvals and closing conditions.

 

AmSouth expects a pre-tax net gain of approximately $170 million from the credit card sale. In addition, AmSouth plans to replace approximately $1.4 billion of Federal Home Loan Bank borrowings with a variety of lower cost funding instruments. AmSouth will incur expenses related to the prepayment of these borrowings.

 

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Table of Contents

Report of Independent Registered Public Accounting Firm

 

The Board of Directors

AmSouth Bancorporation

 

We have reviewed the consolidated statements of condition of AmSouth Bancorporation and subsidiaries as of September 30, 2004 and 2003, and the related consolidated statements of earnings for the three-month and nine-month periods ended September 30, 2004 and 2003, the consolidated statement of shareholders’ equity for the nine-month periods ended September 30, 2004 and 2003, and the consolidated statements of cash flows for the nine-month periods ended September 30, 2004 and 2003. These financial statements are the responsibility of the Company’s management.

 

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

 

Based on our review, we are not aware of any material modifications that should be made to the consolidated interim financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

 

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statement of condition of AmSouth Bancorporation and subsidiaries as of December 31, 2003, and the related consolidated statements of earnings, shareholders’ equity, and cash flows for the year then ended not presented herein, and in our report dated February 17, 2004, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated statement of condition as of December 31, 2003, is fairly stated, in all material respects, in relation to the consolidated statement of condition from which it has been derived.

 

LOGO

 

Birmingham, Alabama

November 3, 2004

 

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Table of Contents
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Introduction

 

This discussion and analysis is part of our Quarterly Report on Form 10-Q to the Securities and Exchange Commission (SEC) and updates our Annual Report on Form 10-K for the year ended December 31, 2003, which we previously filed with the SEC. You should read this information together with the financial information contained in the 10-K. Certain prior period amounts presented in this discussion and analysis have been reclassified to conform to current period classifications.

 

AmSouth Bancorporation (AmSouth) is a regional bank holding company headquartered in Birmingham, Alabama, with approximately $50 billion in assets, more than 670 branch banking offices and more than 1,200 ATMs. AmSouth operates in Tennessee, Alabama, Florida, Mississippi, Louisiana, and Georgia. AmSouth is a leader among regional banks in the Southeast in several key businesses, such as Consumer Banking, which includes small business banking and mortgage lending, Commercial Banking, including equipment leasing, and Wealth Management, which includes annuity and mutual fund sales, trust and investment management services.

 

The preparation of consolidated financial statements requires management to make judgments in the application of certain of its accounting policies that involve significant estimates and assumptions about the effect of matters that are inherently uncertain. These estimates and assumptions are based on information available as of the date of the financial statements, and may materially impact the reported amounts of certain assets, liabilities, revenues and expenses as the information changes over time. Accordingly, different amounts could be reported as a result of the use of revised estimates and assumptions in the application of these accounting policies.

 

Accounting policies considered relatively more critical due to either the subjectivity involved in the estimate and/or the potential impact that changes in the estimates can have on the reported financial results include the accounting for the allowance for loan losses, pension accounting, and derivatives and hedge accounting. Information concerning these policies is included in the “Critical Accounting Estimates” section of Management’s Discussion and Analysis in AmSouth’s 2003 10-K. There were no significant changes in these accounting policies during the first nine months of 2004.

 

This discussion and analysis contains statements that are considered “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995. See page 2 for additional information regarding forward-looking statements.

 

Third Quarter Settlement Agreements

 

On October 12, 2004, AmSouth entered into a deferred prosecution agreement with the U.S. Attorney for the Southern District of Mississippi relating to deficiencies in the bank’s reporting of suspicious activities under the Bank Secrecy Act. AmSouth also entered into at the same time a cease and desist order with the Federal Reserve and the Alabama Department of Banking and an order with the Financial Crimes Enforcement Network (FinCEN), relating to AmSouth’s deficiencies in compliance with the Bank Secrecy Act.

 

Under the deferred prosecution agreement with the U.S. Attorney acting on behalf of the Department of Justice, AmSouth made a payment of $40 million to the United States. Provided that AmSouth complies with the obligations under the agreement for a period of twelve months, the U.S. Attorney has agreed not to take further action against the company in connection with this matter.

 

With respect to the Federal Reserve and the FinCEN order, AmSouth has been assessed a civil money penalty in the amount of $10 million and, in addition, the Federal Reserve has indicated it will restrict the company’s expansion activities, including our branch expansion program, until such time as it believes that AmSouth is in substantial compliance with the requirements of the order.

 

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Table of Contents

As part of these agreements, AmSouth has agreed to take additional actions to ensure compliance with the Bank Secrecy Act. Among other things, these actions include independent third party reviews of all of the company’s activities related to provisions of the Bank Secrecy Act, enhanced training of personnel, submission of written plans, and the adoption of approved policies and procedures. Going forward, AmSouth expects additional costs of approximately $6 - $9 million annually related to on-going compliance efforts with the Bank Secrecy Act, primarily personnel, consulting and technology costs.

 

Third Quarter and First Nine Months Overview

 

AmSouth reported net income of $120 million for the third quarter and $447 million for the first nine months of 2004, resulting in diluted earnings per share of $.33 for the third quarter and $1.25 for the first nine months of 2004. This compares to net income of $157 million for the third quarter and $468 million for the first nine months of 2003. Diluted earnings per share for the third quarter and first nine months of 2003 was $.45 and $1.32, respectively. AmSouth’s return on average assets (ROA) for the three and nine months ended September 30, 2004 was 0.98 percent and 1.26 percent, respectively. For the three and nine months ended September 30, 2003, ROA was 1.44 percent and 1.49 percent, respectively. Return on average equity (ROE) was 14.20 percent for the third quarter of 2004 and 18.05 percent for the nine months ended September 30, 2004. This compares to ROE of 20.18 percent for the third quarter of 2003 and 20.13 percent for the first nine months of 2003.

 

Net income for the third quarter and first nine months of 2004 includes a $50.0 million charge for payments related to the agreements reached with the U.S. Attorney for the Southern District of Mississippi, the Federal Reserve, the Alabama Department of Banking and FinCEN (the settlement agreements). Also included in net income during these periods is approximately $4.0 million of pre-tax professional fees related to the settlement agreements. Table 1, included on pages 30 and 31 of this report, reflects a reconciliation of certain amounts and ratios as reported under generally accepted accounting principles (GAAP) compared to those amounts and ratios excluding expenses for the settlement agreements and related professional fees. These expenses represent matters which management believes are not indicative of AmSouth’s legal and regulatory affairs arising in the normal course of business. Therefore, the presentation of this information is useful to investors in analyzing AmSouth’s financial condition and results of operations.

 

Excluding the impact of the settlement agreements and related professional fees, net income was a record $172 million and $499 million for the third quarter and first nine months of 2004, respectively, while diluted earnings per share was $.48 and $1.40 for the same periods, respectively. Also excluding the impact of the settlement agreements and related professional fees, for the third quarter and first nine months of 2004 ROA was 1.40 percent during both periods, while ROE was 20.43 percent and 20.17 percent, respectively.

 

AmSouth’s earnings during these periods reflect strong loan and deposit growth, continued improvement in credit quality, and effective expense control. These positive factors were partially offset by the impact of the unprecedented four major hurricanes that hit significant parts of AmSouth’s regional footprint during the third quarter of 2004. AmSouth lost 650 branch business days during the quarter due to being closed, and seven branches had major damage and are in the process of being rebuilt. Insurance covered a large portion of the property losses.

 

Loan balances on average for the third quarter increased $3.4 billion from the third quarter of 2003, with growth in both the commercial and consumer categories. This growth occurred despite the fact that consumer and small business loan production was negatively impacted in the geographic areas affected by the hurricanes during the third quarter of 2004. Quarterly average deposit balances increased $3.2 billion, with low-cost deposits increasing $2.3 billion.

 

A key driver for the third quarter and year-to-date results was the continued improvement in credit quality. Net charge-offs for the third quarter of 2004 declined $13 million, or 22 basis points, from the third quarter of 2003, and for the first nine months of 2004 declined $43 million, or 24 basis points, from the first nine months of 2003. Nonperforming assets as a percent of loans, foreclosed properties and repossessions declined to 37 basis

points compared to 55 basis points a year ago. Today’s credit quality reflects a stronger economic environment,

 

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as well as the benefits of AmSouth’s efforts to tighten underwriting standards in consumer and commercial lending, to strengthen the credit review function, to improve processes in the collection area, and to reduce exposure to certain segments of commercial lending.

 

Net interest income for the third quarter increased 9.4 percent compared to the same quarter of 2003 and increased 3.9 percent for the first nine months of 2004 compared to the same period of 2003. The improvement in net interest income reflects strong loan and deposit growth partially offset by a decline in the net interest margin. Other positives noted during the third quarter and first nine months of 2004 included growth in service charges income, trust income, and interchange income. These areas continue to reflect the results of several of AmSouth’s strategic initiatives. These improvements in noninterest revenue were offset by decreases in mortgage and portfolio income compared to the same periods a year ago. This reflects lower gains on sales of mortgage loans and servicing and lower securities gains. Also, during the third quarter of 2004 investment services income was particularly hard hit by an overall slowdown in capital markets activity and by lower sales volume in the storm-affected areas. Noninterest expenses for the third quarter of 2004 increased 18.2 percent compared to the same period in 2003. This increase related almost entirely to the impact of the settlement agreements and related professional fees during the third quarter of 2004. Year-to-date noninterest expenses increased 11.4 percent compared to the same period a year ago, which was also primarily related to the settlement agreements and related professional fees.

 

Statement of Condition

 

Total assets at September 30, 2004 were $49.7 billion, up 8.9 percent from $45.6 billion at December 31, 2003. This $4.1 billion increase in total assets was primarily the result of increases in AmSouth’s loan portfolio and its held-to-maturity (HTM) securities portfolio. Loans net of unearned income at September 30, 2004 increased $3.2 billion compared to year-end. This increase was attributable to $1.5 billion of growth in commercial and commercial real estate loans and $1.7 billion growth in consumer loans. AmSouth also had an increase in HTM securities of $1.1 billion. These increases were partially offset by a $610 million decline in available-for-sale (AFS) securities.

 

The increase in commercial loans was broad-based and balanced in all categories led by growth in commercial and industrial lending, real estate construction, and commercial real estate mortgages. These increases were driven by new business generation reflecting the benefits of sales calling efforts. The increase in consumer loans was driven by increases in residential first mortgages and equity loans and lines. AmSouth’s focus on consumer lending helped produce $3.4 billion of home equity originations and $3.1 billion of residential mortgage originations in the first nine months of 2004. Consumer loan production was negatively impacted during the third quarter of 2004 in areas affected by the hurricanes, partially offsetting the growth in consumer lending during 2004. Importantly, ending total loans at September 30, 2004 were $423 million higher than average balances for the third quarter, providing solid momentum as the fourth quarter begins.

 

The increase in AmSouth’s HTM securities portfolio reflected additional purchases of securities, primarily in shorter duration and well-structured mortgage-backed and collateralized mortgage obligation (CMO) securities, during the first nine months of 2004. The duration of the combined portfolios, which considers repricing frequency of variable rate securities, is approximately 3.6 years. The decrease in AmSouth’s AFS portfolio was the result of maturities, prepayments and sales of securities.

 

On the liability side of the balance sheet, total deposits at September 30, 2004 increased by $1.5 billion compared to December 31, 2003. The increase in total deposits was realized in most categories of deposits. Low-cost deposits, which include noninterest-bearing and interest-bearing checking, money market and savings accounts, increased by $1.4 billion. The growth in deposits reflects broad based sales efforts and improving trends in overall household growth across all lines of business and AmSouth’s branch expansion program. During the first nine months of 2004, AmSouth opened 31 new branches, including 25 new branches in Florida. The increase in deposits also reflects the issuance of $1.1 billion of institutional certificates of deposit of $100,000 or more, the majority of which mature in one year or less, partially offset by a decrease of $1.0 billion in time deposits and foreign deposits. This change in deposit mix reflects a more cost-effective funding strategy.

 

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The increase in other borrowed funds was primarily the result of a temporary increase in treasury, tax and loan note balances at September 30, 2004. During January 2004, AmSouth issued $150 million in floating rate bank notes continuing a program begun in 2003 as a part of AmSouth’s long-term funding strategy. Other long-term debt declined due to the maturing of $150 million of 7.75% Subordinated Notes Due 2004 during May 2004 which was not replaced.

 

Net Interest Income

 

Net interest income (NII) on a fully taxable equivalent basis for the three and nine months ended September 30, 2004 was $386.6 million and $1,128.6 million, up $32.3 million, or 9.1 percent compared to the same quarter last year and up $38.9 million or 3.6 percent on a year-to-date basis. The increase in NII reflected a higher level of earning assets and continued strong deposit growth. The net interest margin (NIM) was 3.44 percent for the third quarter of 2004, down 16 basis points from 3.60 percent, for the same quarter in 2003. The decline in the NIM can be largely attributed to the impact of the mix of loans, lower off-balance sheet income and the overall lower net spread on asset growth. See additional discussion of prepayment risk within the “Prepayment Risk” section. These factors will continue to generate moderate growth in NII and some slight compression in NIM.

 

Growth in interest-earning assets was only partially offset by the decline in NII associated with the lower NIM. Average interest-earning assets for the three and nine month periods ended September 30, 2004 were $44.6 billion and $43.3 billion, respectively, an increase of $5.5 billion and $5.3 billion from the same periods in 2003. As discussed above, the increase came principally from growth in the loan and the investment securities portfolios. The growth in the loan portfolio was primarily driven by commercial lending, residential mortgage production and equity lending. The growth in earning assets was funded primarily by deposit growth. The increase in deposits was across most categories of deposits. In addition, AmSouth funded part of the increase through the issuance of $800 million in bank notes during the fourth quarter of 2003 and first quarter of 2004 and the issuance of $500 million in subordinated debt late in the first quarter of 2003. Part of the growth in earning assets was also funded by growth in Federal funds purchased and securities sold under agreements to repurchase.

 

Asset/Liability Management

 

AmSouth maintains a formal asset and liability management process to quantify, monitor and control interest rate risk and to assist management in minimizing the income impact of varying interest rate environments. AmSouth accomplishes this process through the development and implementation of lending, funding, pricing and hedging strategies designed to maximize NII performance under varying interest rate environments subject to specific liquidity and interest rate risk guidelines.

 

An earnings simulation model is the primary tool used to assess the direction and magnitude of changes in NII resulting from changes in interest rates. Key assumptions in the model include prepayment speeds on mortgage-related assets; cash flows and maturities of derivatives and other financial instruments held for purposes other than trading; changes in market conditions, loan volumes and pricing; deposit volume, mix and rate sensitivity; customer preferences; and management’s financial and capital plans. These assumptions are inherently uncertain, and, as a result, the model cannot precisely estimate NII or precisely predict the impact of higher or lower interest rates on NII. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes and changes in market conditions and management’s strategies, among other factors.

 

Interest Sensitivity Analysis

 

AmSouth currently maintains an essentially neutral interest rate risk position. AmSouth evaluates net interest income under various balance sheet and interest rate scenarios, using its simulation analysis model. Management evaluates “base” net interest income under what is believed to be the most likely balance sheet structure and current interest rate environment. This “base” case is then evaluated against various changes in interest rate scenarios. Asset prepayment levels, the shape of the yield curve and the overall balance sheet mix and growth assumptions are adjusted to be consistent with each interest rate scenario.

 

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One scenario of the simulation model reviews the impact to NII if interest rates gradually increased or decreased by 100 basis points over a 12-month period. Based on the results of the simulation model as of September 30, 2004, AmSouth would expect NII to increase $3.0 million or approximately 0.19 percent and decrease $13.3 million or approximately 0.86 percent if interest rates gradually increase or decrease, respectively, from current rates by 100 basis points over a 12-month period. By comparison, as of September 30, 2003, the simulation model indicated that NII would increase $2.5 million or approximately 0.20 percent and decrease $15.0 million or approximately 1.02 percent if interest rates gradually increased or decreased, respectively, from their then-current rates by 100 basis points over a 12-month period.

 

Interest Rate Sensitivity

(Dollars in millions)

 

     September 30

   

Policy
Limit


 
     2004

    2003

   
     % Change

    $ Change

    % Change

    $ Change

   

+100 bp

   0.19 %   $ 3.0     0.20 %   $ 2.5     +/-2.5 %

-100 bp

   (0.86 )%   $ (13.3 )   (1.02 )%   $ (15.0 )   +/-2.5 %

 

Note: Assumes a parallel shift in the yield curve for U.S. Treasury securities occurring gradually over a 12-month time period.

 

AmSouth’s current level of interest rate risk is well within its policy guidelines. Current policy states that NII should not fluctuate more than 2.5 percent in the event that interest rates gradually increase or decrease 100 basis points over a period of twelve months. In analyzing its interest rate risk, AmSouth also runs additional scenarios to stress the assumptions used in the analysis above. For example, the simulations above are based on a parallel shift in the yield curve for U.S. Treasury securities occurring gradually over a 12-month time period. AmSouth, however, recognizes that changes in the yield curve can also affect NII even if Federal Reserve-set short term rates remain unchanged. NII at AmSouth, as at most other banks, is affected if long term rates rise or fall more rapidly than short term rates, and thereby cause the slope of the yield curve to change. For example, if long term rates were to fall faster than short term rates, thereby causing a flattening in the slope of the yield curve, this would negatively affect NII as mortgage-related and other fixed rate loans and securities, which are priced based on long term rates, would most likely be prepaid while the proceeds from such prepayments could likely not be reinvested at comparable rates. Accordingly, one of the stress tests regularly run by AmSouth is an immediate shift in the five years and beyond Treasury yield curve with all other short term interest rates unchanged. Based on the results of this modeling as of September 30, 2004, an immediate 50 basis point downward shift in the Treasury curve, if sustained for 12 months, would cause NII to decrease by approximately $14.3 million.

 

Thus far, AmSouth has been successful in managing the timing and magnitude of loan and deposit pricing as market and Federal Reserve-set interest rates have changed during 2004 and does not expect further moderate Federal Reserve rate increases to adversely impact near-term net interest income.

 

Derivative Instruments

 

As part of its activities to manage interest rate risk, AmSouth utilizes various derivative instruments such as interest rate swaps to hedge its interest rate risk. At September 30, 2004, AmSouth had interest rate swaps in the notional amount of approximately $3.3 billion, of which $2.3 billion were “receive fixed/pay floating” rate swaps and $1.0 billion were “pay fixed/receive floating.” AmSouth began entering into “pay fixed/receive floating” rate swaps during the fourth quarter of 2003 in anticipation of a rising interest rate cycle. Consistent with AmSouth’s overall asset/liability management process, “pay fixed/receive floating” rate swaps and additional long-term funding were put in place to achieve the desired interest rate risk profile. Of all of these swaps, $1.3 billion of

 

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notional value was used to hedge the cash flow of variable-rate commercial loans, $900 million of notional value was used to hedge the fair value of corporate and bank debt, $550 million was used to hedge the anticipated reissuance of Federal funds purchased, $450 million was used to hedge the future semi-annual interest payments on the forecasted issuance of ten-year fixed-rate subordinated debt, and $33 million was used to hedge the fair value of a fixed-rate certificate of deposit. AmSouth also had $100 million notional value of swaps that no longer qualified for hedge accounting. These swaps had previously been designated as fair value hedges of corporate debt. During the third quarter of 2004, these hedging relationships were determined to no longer be highly effective as defined by Statement 133 and AmSouth ceased hedge accounting on these swaps. The swaps that lost hedge accounting mature in the fourth quarter of 2005. No interest rate swaps matured during the third quarter of 2004 and there are no interest rate swaps scheduled to mature during the remainder of 2004. Interest rate swaps in the notional amount of $600 million were terminated during the first quarter of 2004. These swaps had been designated as cash flow hedges of floating rate bank notes. Of these swaps, $400 million were in place at December 31, 2003 and $200 million were entered into during the three months ended March 31, 2004. The effective portion of these hedging relationships is included in other comprehensive income and is being amortized into earnings over the remaining terms of the floating rate notes.

 

While not significant to the consolidated financial statements, AmSouth also utilizes forward contracts to protect against changes in interest rates and prices of its mortgages and mortgage pipeline for mortgages which it intends to sell. A portion of these forward contracts is designated as fair value hedges of mortgage loans held-for-sale. The remaining forward contracts are not designated as hedging instruments, but do provide some economic hedging of the mortgage pipeline.

 

In addition to using derivative instruments as an interest rate risk management tool, AmSouth also utilizes derivatives such as interest rate swaps, caps, floors, and foreign exchange contracts in its capacity as an intermediary on behalf of its customers. AmSouth minimizes its market and liquidity risks by taking offsetting positions. AmSouth manages its credit risk, or potential risk of loss from default by counterparties, through credit limit approval and monitoring procedures. Market value changes on intermediated swaps and other derivatives are recognized in income in the period of change. At September 30, 2004, AmSouth had $65.7 million of assets and $65.5 million of liabilities associated with $2.1 billion notional amount of interest rate contracts with corporate customers and $2.1 billion notional amount of offsetting interest rate contracts with other financial institutions to hedge AmSouth’s rate exposure on its corporate customers’ contracts.

 

Prepayment Risk

 

As part of its asset and liability management process, AmSouth actively monitors its exposure to prepayment risk. AmSouth, like most financial institutions, is subject to prepayment risk in falling interest rate environments. Prepayment risk is a significant risk to earnings and specifically to NII. For example, mortgage loans and other financial assets may be prepaid by a debtor so that the debtor may refund its obligations at new, lower rates. As loans and other financial assets prepay, AmSouth must reinvest these funds in the current lower yielding rate environment. Prepayments of assets carrying higher rates reduce AmSouth’s interest income and overall asset yields. Conversely, in a rising rate environment, these assets will prepay at a slower rate resulting in opportunity cost by not having the cash flow to reinvest at higher rates. Higher prepayments also impact the securities portfolio by increasing the amortization of any premiums associated with those securities, which also reduces interest income and the yield of the securities portfolio. Tools to hedge prepayment risk are limited and generally involve complex derivatives that AmSouth has chosen not to utilize.

 

AmSouth’s greatest exposure to prepayment risks primarily rests in its mortgage loan portfolio and its mortgage-backed and CMO securities portfolios. During the nine months ended September 30, 2004, AmSouth experienced less accelerated prepayments in both its mortgage loan portfolio and its mortgage-backed and CMO securities portfolios than during the nine months ended September 30, 2003. AmSouth estimates the impact of accelerated prepayments will have a less significant effect on the NIM in 2004 compared to 2003.

 

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Liquidity Management

 

AmSouth’s goal in liquidity management is to satisfy the cash flow requirements of depositors and borrowers while at the same time meeting its cash flow needs. This is accomplished through the active management of both the asset and liability sides of the balance sheet. The liquidity position of AmSouth is monitored on a daily basis by AmSouth’s Treasury Division. In addition, the Asset/Liability Committee, which consists of members of AmSouth’s senior management team, reviews liquidity on a regular basis and approves any changes in strategy that are necessary as a result of balance sheet or anticipated cash flow changes. Management also compares, on a monthly basis, AmSouth’s liquidity position to established corporate liquidity guidelines.

 

The primary sources of liquidity on the asset side of the balance sheet are maturities and cash flows from loans and investments as well as the ability to securitize or sell certain loans and investments. Liquidity on the liability side is generated primarily through growth in core deposits and the ability to obtain economical wholesale funding in national and regional markets through a variety of sources, including the Federal Home Loan Bank. See Table 10 for a breakout by maturity date of AmSouth’s contractual obligations and other commercial commitments.

 

Off-Balance Sheet Arrangements

 

As an additional source of liquidity, AmSouth periodically sells commercial loans to qualifying special purpose entities called conduits in securitization transactions. The conduits are financed by the issuance of securities to asset-backed commercial paper issuers and are accounted for as sales. These transactions allow AmSouth to utilize its balance sheet capacity and capital for higher yielding, interest-earning assets, while continuing to manage the customer relationship. At September 30, 2004, the outstanding balance of commercial loans sold to conduits was $607 million. While no longer utilized as a source of funding, AmSouth, in prior years, also sold residential mortgages and dealer indirect automobile loans to third-party conduits. The remaining outstanding balances associated with these transactions were $623 million of residential first mortgages and $23 million of dealer indirect automobile loans at September 30, 2004. These balances were down from $1.6 billion in outstanding loan balances in all three conduits at December 31, 2003. AmSouth provides credit enhancements to these securitizations by providing standby letters of credit, which create exposure to credit risk to the extent of the letters of credit. At September 30, 2004, AmSouth had $82.0 million of letters of credit supporting the conduit transactions. This credit risk is reviewed quarterly and a reserve for loss exposure is maintained in other liabilities.

 

AmSouth also provides liquidity lines of credit to support the issuance of commercial paper under 364-day commitments associated with these conduit transactions. These liquidity lines can be drawn upon in the unlikely event of a commercial paper market disruption or other factors, such as credit rating downgrades of one of the asset-backed commercial paper issuers or of AmSouth as the provider of liquidity and credit support, which could prevent the asset-backed commercial paper issuers from being able to issue commercial paper. At September 30, 2004, AmSouth had liquidity lines of credit supporting these transactions of $1.3 billion. To date, there have been no drawdowns of the liquidity lines; however, AmSouth includes this liquidity risk in its monthly liquidity risk analysis to ensure that it would have sufficient sources of liquidity to meet demand. AmSouth also reviews the impact of the potential drawdown of the liquidity lines on its regulatory capital requirements. As of September 30, 2004, this analysis showed that AmSouth would retain its well-capitalized position even if the liquidity lines were completely drawn down or if accounting rules were to be changed to require AmSouth to consolidate the conduits.

 

Credit Quality

 

AmSouth maintains an allowance for loan losses which management believes is adequate to absorb losses inherent in the loan portfolio. A formal review is prepared quarterly to assess the risk in the portfolio and to determine the adequacy of the allowance for loan losses. The review includes analyses of historical performance,

 

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Table of Contents

the level of nonperforming and adversely rated loans, specific analyses of certain problem loans, loan activity since the previous quarter, reports prepared by the Credit Review Department, consideration of current economic conditions, and other pertinent information. The level of allowance to net loans outstanding will vary depending on the overall results of this quarterly review. The review is presented to and subsequently approved by senior management and reviewed by the Audit Committee of the Board of Directors.

 

At September 30, 2004, the allowance for loan losses was $381.3 million, or 1.17 percent of loans net of unearned income, compared to $384.1 million, or 1.32 percent, at September 30, 2003 and $384.1 million, or 1.31 percent, at December 31, 2003. The coverage ratio of the allowance for loan losses to nonperforming loans was 410 percent at September 30, 2004, an increase of 92 basis points from the September 30, 2003 ratio. The ending balance in the allowance at September 30, 2004, reflects the mix of the loan portfolio and the results of the allowance review process. In addition, the ending balance reflects a reduction in the allowance of $3.1 million related to the sale of $152 million in equity loans during March 2004 and $85 million of recreational vehicle and marine loans during September 2004. Table 5 presents a five-quarter analysis of the allowance for loan losses.

 

Net charge-offs for the quarter ended September 30, 2004, were $28.7 million, or 0.36 percent of average loans, on an annualized basis, a decrease of $13.1 million from the $41.8 million, or 0.58 percent of average loans, reported in the same period a year earlier. For the nine months ended September 30, 2004, net charge-offs were $83.3 million, or 0.36 percent, compared to $126.7 million, or 0.60 percent, for the same period of 2003. The decrease in net charge-offs was the result of decreases in commercial and consumer net charge-offs.

 

In the third quarter commercial and commercial real estate net charge-offs decreased $4.0 million compared to the same period a year earlier and decreased $15.9 million for the first nine months of 2004 compared to the same period in 2003. The decreases in commercial and commercial real estate net charge-offs primarily reflected lower gross losses combined with higher recoveries of previously charged off loans. The decrease in commercial net charge-offs also reflected a stronger economic environment and higher quality underwriting standards.

 

In the third quarter consumer net charge-offs decreased $9.0 million compared to the same period a year earlier and decreased $27.5 million for the first nine months of 2004 compared to the same period in 2003. The decrease in consumer net charge-offs, both quarterly and year-to-date, primarily occurred in dealer indirect and equity loan and line charge-offs. Net charge-offs in the dealer indirect portfolio were $5.4 million for the third quarter of 2004 and $15.3 million for the first nine months of 2004, a decrease of $3.0 million and $15.6 million, respectively, from the corresponding periods in 2003. The decreases in dealer indirect net charge-offs reflected higher quality underwriting coupled with the runoff of older higher risk vintages, as well as strengthening used car auction prices and enhanced collection procedures. Net charge-offs in the equity loans and lines portfolio were $4.9 million for the third quarter of 2004 and $17.7 million for the first nine months of 2004, a decrease of $5.5 million and $8.9 million, respectively, from the corresponding periods in 2003. The decreases in equity loan and line net charge-offs reflected higher quality underwriting, enhanced collection procedures, and runoff of older higher risk vintages. In addition, beginning in late 2003, AmSouth began purchasing insurance to protect against the credit risk for certain originated equity loans and lines with loan-to-value ratios up to 100 percent. The insurance policy provides for the sale of the loan or line, at par, to the insurance company when the loan or line becomes 120 days delinquent. AmSouth’s policy is to charge down equity loans and lines to net realizable value when they become 180 days delinquent. Therefore, there are no material losses on these loans and lines expected in the future. The insurance premiums are paid monthly based on a percentage of the outstanding balances of the funded loans and lines. As of September 30, 2004, approximately $275.1 million of loans and lines were insured. Included in noninterest expense for the nine months ended September 30, 2004 is approximately $1.1 million in insurance premiums. Given the volume and premium levels to date, the impact on the provision and the allowance for loan losses has not been material. The reduced risk exposure is considered in the calculation of the allowance for loan losses.

 

The provision for loan losses for the third quarter and first nine months of 2004 was $28.8 million and $83.5 million, respectively, compared to $41.8 million and $129.2 million for the corresponding year-earlier periods. The decrease in the provision for loan losses is consistent with the overall improvement in the credit quality of AmSouth’s loan portfolio and a shift in the mix of the loan portfolio to include a larger proportion of residential mortgages.

 

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Table of Contents

At September 30, 2004, nonperforming assets as a percentage of loans net of unearned income, foreclosed properties and repossessions decreased 18 basis points to 0.37 percent compared to 0.55 percent at September 30, 2003, reflecting a $42.6 million decrease in nonperforming assets. Compared to year-end 2003, nonperforming assets declined $28.5 million as a result of a $17.2 million decline in nonaccrual loans, a $9.6 million decline in foreclosed properties and a $1.7 million decline in repossessions. Table 6 presents a five-quarter comparison of the components of nonperforming assets.

 

The decrease in nonaccrual loans was primarily the result of a $14.4 million decrease from December 31, 2003, in nonaccrual commercial and commercial real estate loans and a $6.3 million decrease in nonaccrual equity loans and lines, slightly offset by a $3.8 million increase in nonaccrual residential first mortgages. The decrease in nonaccrual commercial and commercial real estate loans reflects a downward trend in commercial problem loans. The decrease in nonaccruing equity loans and lines is reflective of improved portfolio quality. The increase in nonaccruing residential first mortgages is primarily a reflection of portfolio growth. AmSouth had no nonperforming assets considered troubled debt restructured loans at September 30, 2004 and 2003. The decrease in foreclosed properties was the result of slowing foreclosures and higher volumes of sales of foreclosed properties. The decrease in repossessions also reflects higher quality underwriting standards.

 

Included in nonperforming assets at September 30, 2004 and 2003, was $39.0 million and $60.0 million, respectively, of loans that were considered to be impaired, substantially all of which were on a nonaccrual basis. At September 30, 2004 and 2003, there was $7.7 million and $14.0 million, respectively, in the allowance for loan losses specifically allocated to $26.4 million and $41.3 million, respectively, of impaired loans. No specific reserves were required for $12.6 million and $18.7 million of impaired loans at September 30, 2004 and 2003, respectively. The average balance in impaired loans for the three months ended September 30, 2004 and 2003 was $42.0 million and $63.9 million, respectively, and $44.7 million and $80.3 million, respectively, for the nine months ended September 30, 2004 and 2003. AmSouth recorded no material interest income on its impaired loans during the nine months ended September 30, 2004. At September 30, 2004 and 2003, AmSouth had approximately $33.1 million and $34.5 million, respectively, of potential problem commercial loans which were not included in the nonaccrual loans or in the 90 days past due categories at quarter-end but for which management had concerns as to the ability of such borrowers to comply with their present loan repayment terms. Of the $34.5 million in 2003, only $4.0 million remained categorized as potential problem loans at September 30, 2004. The remaining balances either migrated to nonperforming status or were no longer considered potential problem loans at September 30, 2004. The lower level of potential problem loans at September 30, 2004, is reflective of an overall improvement in commercial asset quality between years.

 

Today’s credit quality reflects a stronger economic environment and the benefits of AmSouth’s efforts over the past few years to tighten underwriting standards in consumer and commercial lending, strengthen the credit review function, improve processes in the collections area, and reduce exposure to certain segments in commercial lending.

 

Internal portfolio credit trends point toward more stable credit quality. In particular, classified commercial loans and consumer delinquencies, generally, were lower compared to 2003. While credit quality trends should generally be sustained, we expect net charge-offs to increase due to normal seasonality during the fourth quarter.

 

Noninterest Revenues

 

Noninterest revenues (NIR) were $213.2 million during the third quarter of 2004 and $651.9 million for the first nine months of 2004. The quarterly and nine-month totals represent a 6.8 percent decrease and a 3.1 percent increase, respectively, from the corresponding periods in 2003. The changes in NIR were driven by various categories and factors discussed below.

 

Service charge revenues for the three months and nine months ended September 30, 2004 increased 10.3 percent and 16.1 percent, respectively, compared to the corresponding periods in 2003, primarily the result of increases in overdraft fees. The increase in overdraft fees continues to be the result of an increase in the volume

 

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of overdrafts. The additional volume has been due to several procedural changes made during 2002 and 2003 related to an on-going initiative to manage, in a consistent manner, customers’ available account balances. Enhancing these procedures enables AmSouth to better manage its risks, including fraud risk, arising from various transactions that can affect a customer’s account balance.

 

The increase in trust income of 10.3 percent and 12.7 percent for the three months and nine months ended September 30, 2004 compared to the corresponding periods in 2003 reflected the impact of a pricing increase, improved sales and improved market conditions.

 

Consumer investment services income decreased $0.4 million or 2.1 percent during the third quarter of 2004 compared to the same period in 2003. This decrease reflects a slowdown of capital markets activity and lower sales volumes in the geographic areas affected by the hurricanes during the third quarter of 2004. However, consumer investment services income increased $9.6 million for the nine months ended September 30, 2004 or 19.1 percent compared to the corresponding period in 2003, reflecting increases in annuity income, mutual fund fees, brokerage fees, insurance income, and other investment services income.

 

The increase in interchange income for the third quarter and first nine months of 2004 was 17.6 percent and 9.3 percent, respectively, compared to the same periods in 2003. This increase was primarily due to increases in transaction volumes and a pricing increase in early 2004.

 

These increases in NIR were offset by decreases in mortgage income, portfolio income and income from bank owned life insurance (BOLI). The decrease in mortgage income was primarily due to lower gains on the sales of mortgage loans and servicing, as more of the current production is in adjustable rate mortgages which are being retained on the balance sheet. The decline in portfolio income was due to lower gains on sales of securities in 2004 compared to 2003, reflecting changes in market rates. The decrease in BOLI income was primarily the result of lower rates and benefit payments during 2004 compared to 2003.

 

For the third quarter of 2004, other noninterest revenues decreased $9.2 million compared to the same period in 2003. The decrease in other noninterest revenues in the third quarter of 2004 versus the third quarter of 2003 reflects the impact of a $6.6 million gain on the sale of real property and $3.0 million in income related to the demutualization of one of AmSouth’s insurance providers recorded in the third quarter of 2003, as well as a $1.6 million decrease in income related to market adjustments on derivative instruments compared to the third quarter of 2003. Offsetting these items was a $2.8 million gain during the third quarter of 2004 related to the sale of recreational vehicle and marine loans. Other noninterest revenues decreased $1.6 million during the nine months ended September 30, 2004 compared to the same period in 2003.

 

Noninterest Expenses

 

Noninterest expenses (NIE) for the third quarter of 2004 increased $55.9 million or 18.2 percent compared to the same period in 2003 and increased $101.7 million or 11.4 percent for the first nine months of 2004 compared to the corresponding period in 2003. The increase in NIE on both a quarterly and year-to-date basis was primarily related to the $50.0 million charge for payments related to the settlement agreements and approximately $4.0 million for related professional fees. The increase in NIE on a year-to-date basis also includes increases in salaries and employee benefits, net occupancy expense, equipment expense and marketing expense, partially offset by lower communications expense.

 

The year-to-date increases in salaries and employee benefits reflected higher base salaries due to merit increases, partially offset by a decrease in headcount, and higher pension and thrift plan costs. The quarterly and year-to-date increases in net occupancy and equipment expense were due primarily to the continued investment in new branches. The year over year increase in marketing expense was due to initiatives to attract new business and various other marketing campaigns. The decrease in communication expense was primarily the result of lower expenses associated with the consolidation and renegotiation of services.

 

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Excluding the $50.0 million charge for payments related to the settlement agreements and approximately $4.0 million for related professional fees, NIE increased approximately $2.0 million or 0.6 percent in the third quarter of 2004 compared to the third quarter of 2003, reflecting effective management of costs. This increase is due to higher occupancy and equipment costs, partially offset by a reduction in salaries and benefits, reflecting lower headcount and incentives. Table 1, included on pages 30 and 31 of this report, reflects a reconciliation of NIE as reported under GAAP compared to NIE excluding expenses for the settlement agreements and related professional fees. These expenses represent matters which management believes are not indicative of AmSouth’s legal and regulatory affairs arising in the normal course of business. Therefore, the presentation of this information is useful to investors in analyzing AmSouth’s financial condition and results of operations.

 

Capital Adequacy

 

At September 30, 2004, shareholders’ equity totaled $3.5 billion or 6.94 percent of total assets while average equity as a percentage of average assets for the three month and nine month periods ended September 30, 2004 was 6.87 percent and 6.96 percent, respectively. Since December 31, 2003, shareholders’ equity increased $220.9 million primarily as a result of net income for the first nine months of 2004 of $446.6 million. The increase in shareholders’ equity from net income was partially offset by the declaration of dividends of $255.1 million and the purchase of 2.1 million shares of AmSouth common stock for $50.0 million during the first nine months of 2004. The increase in shareholders’ equity from net income was also partially offset by a decrease of $11.4 million associated with a lower valuation of the AFS portfolio and by a decrease of $1.9 million associated with the effective portion of cash flow hedges. The remaining increase was attributable to employee stock plans, direct stock purchases and dividend reinvestment.

 

Table 9 presents the capital amounts and risk-adjusted capital ratios for AmSouth and AmSouth Bank at September 30, 2004 and 2003. At September 30, 2004, AmSouth exceeded the regulatory minimum required risk-adjusted Tier 1 Capital Ratio of 4.00% and risk-adjusted Total Capital Ratio of 8.00%. In addition, the risk-adjusted capital ratios for AmSouth Bank were above the regulatory minimums, and the Bank was well capitalized at September 30, 2004.

 

Earnings Outlook

 

As a result of the $54.0 million charge in the third quarter, our full year guidance is now in the range of $1.72 to $1.77. Excluding the charge, our guidance for 2004 earnings per share in a range of $1.87 to $1.92 remains unchanged.

 

Subsequent Events

 

On November 1, 2004, AmSouth entered into a definitive agreement to sell its credit card portfolio, comprising approximately 390,000 accounts and total receivables of approximately $550 million, to MBNA Corporation. As part of the agreement, AmSouth has also entered into an agent bank agreement, which will enable AmSouth customers to continue to receive credit card products, while also providing MBNA the exclusive credit-card related marketing rights to AmSouth’s current and prospective customers. The transaction is expected to close by year-end, subject to customary approvals and closing conditions.

 

AmSouth expects a pre-tax net gain of approximately $170 million from the credit card sale. In addition, AmSouth plans to replace approximately $1.4 billion of Federal Home Loan Bank borrowings with a variety of lower cost funding instruments, saving between 240 and 250 basis points in average cost of funds based on current market rates while not changing the bank’s interest rate sensitivity. AmSouth will incur expenses related to the prepayment of these borrowings. AmSouth expects the transactions to be accretive to 2005 earnings.

 

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Table 1 - Financial Summary

 

     September 30

    % Change

                 
     2004

    2003

         
     (In thousands)                  

Balance sheet summary

                                          

End-of-period balances:

                                          

Loans net of unearned income

   $ 32,502,221     $ 29,128,404     11.6 %                    

Total assets

     49,687,862       44,342,699     12.1                      

Total deposits

     31,919,416       29,468,223     8.3                      

Shareholders’ equity

     3,450,558       3,152,834     9.4                      

Year-to-date average balances:

                                          

Loans net of unearned income

   $ 30,811,005     $ 28,257,539     9.0 %                    

Total assets

     47,498,616       42,067,539     12.9                      

Total deposits

     31,575,806       28,169,743     12.1                      

Shareholders’ equity

     3,304,939       3,105,990     6.4                      
     Three Months Ended
September 30


          Nine Months Ended
September 30


     
     2004

    2003

          2004

    2003

     
     (In thousands except per share data)      

Selected ratios

                                          

Average equity to assets

     6.87 %     7.14 %           6.96 %     7.38 %    

End-of-period equity to assets

     6.94       7.11             6.94       7.11      

End-of-period tangible equity to assets

     6.37       6.47             6.37       6.47      

Allowance for loan losses to loans net of unearned income

     1.17       1.32             1.17       1.32      

Common stock data

                                          

Cash dividends declared

   $ 0.24     $ 0.23           $ 0.72     $ 0.69      

Book value at end of period

     9.73       8.99             9.73       8.99      

Market value at end of period

     24.40       21.22             24.40       21.22      

Average common shares outstanding

     352,838       349,421             351,882       350,294      

Average common shares outstanding-diluted

     358,272       353,317             357,169       353,971      

 

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Table 1 - Financial Summary (continued)

 

     Three Months Ended
September 30


   

%

Change


    Nine Months Ended
September 30


   

%

Change


 
     2004

    2003

      2004

    2003

   
     (In thousands except per share data)  

Income statement reconciliations of GAAP amounts to adjusted amounts

                                            

Noninterest expense - as reported

   $ 362,478     $ 306,556     18.2 %   $ 996,522     $ 894,784     11.4 %

Costs incurred under settlement agreements and related professional fees

     (53,972 )     —       —         (53,972 )     —       —    
    


 


       


 


     

Noninterest expense excluding settlement costs

     308,506       306,556     0.6       942,550       894,784     5.3  

Income before income taxes - as reported

     197,799       223,882     (11.7 )     668,644       664,255     0.7  

Costs incurred under settlement agreements and related professional fees

     53,972       —       —         53,972       —       —    
    


 


       


 


     

Income before income taxes excluding settlement costs

     251,771       223,882     12.5       722,616       664,255     8.8  

Income taxes - as reported

     78,220       66,494     17.6       222,003       196,686     12.9  

Costs incurred under settlement agreements and related professional fees

     1,529       —       —         1,529       —       —    
    


 


       


 


     

Income taxes excluding settlement costs

     79,749       66,494     19.9       223,532       196,686     13.6  

Earnings summary (including reconciliations of GAAP amounts to adjusted amounts)

                                            

Net income - as reported

     119,579       157,388     (24.0 )     446,641       467,569     (4.5 )

Costs incurred under settlement agreements and related professional fees

     52,443       —       —         52,443       —       —    
    


 


       


 


     

Net income excluding settlement costs

     172,022       157,388     9.3       499,084       467,569     6.7  

Earnings per common share - as reported

     0.34       0.45     (24.4 )     1.27       1.33     (4.5 )

Costs incurred under settlement agreements and related professional fees

     0.15       —       —         0.15       —       —    
    


 


       


 


     

Earnings per common share excluding settlement costs

     0.49       0.45     8.9       1.42       1.33     6.8  

Diluted earnings per common share - as reported

     0.33       0.45     (26.7 )     1.25       1.32     (5.3 )

Costs incurred under settlement agreements and related professional fees

     0.15       —       —         0.15       —       —    
    


 


       


 


     

Diluted earnings per common share excluding settlement costs

     0.48       0.45     6.7       1.40       1.32     6.1  

Return on average assets (annualized) - as reported

     0.98 %     1.44 %           1.26 %     1.49 %      

Costs incurred under settlement agreements and related professional fees

     0.42       —               0.14       —          
    


 


       


 


     

Return on average assets (annualized) excluding settlement costs

     1.40       1.44             1.40       1.49        

Return on average equity (annualized) - as reported

     14.20       20.18             18.05       20.13        

Costs incurred under settlement agreements and related professional fees

     6.23       —               2.12       —          
    


 


       


 


     

Return on average equity (annualized) excluding settlement costs

     20.43       20.18             20.17       20.13        

Operating efficiency - as reported

     60.44       52.58             55.97       51.96        

Costs incurred under settlement agreements and related professional fees

     (9.00 )     —               (3.03 )     —          
    


 


       


 


     

Operating efficiency excluding settlement costs

     51.44       52.58             52.94       51.96        

Note: The information presented above is adjusted for the third quarter 2004 settlement agreements and related professional fees. These expenses represent matters which management believes are not indicative of AmSouth’s legal and regulatory affairs arising in the normal course of business.

 

31


Table of Contents

Table 2 - Quarterly Yields Earned on Average Interest-Earning Assets and Rates Paid on Average Interest-Bearing Liabilities

 

    2004

    2003

 
    Third Quarter

    Second Quarter

    First Quarter

    Fourth Quarter

    Third Quarter

 
   

Average

Balance


    Revenue/
Expense


 

Yield/

Rate


    Average
Balance


    Revenue/
Expense


 

Yield/

Rate


   

Average

Balance


    Revenue/
Expense


 

Yield/

Rate


   

Average

Balance


    Revenue/
Expense


 

Yield/

Rate


   

Average

Balance


    Revenue/
Expense


 

Yield/

Rate


 
    (Taxable equivalent basis-dollars in thousands)  

Assets

                                                                                                   

Interest-earning assets:

                                                                                                   

Loans net of unearned income (1) (2)

  $ 32,079,701     $ 405,127   5.02 %   $ 30,633,629     $ 382,677   5.02 %   $ 29,705,743     $ 381,957   5.17 %   $ 29,263,749     $ 388,273   5.26 %   $ 28,667,773     $ 388,365   5.37 %

Available-for-sale securities, amortized cost

    6,508,524       81,785   5.00       6,559,420       81,249   4.98       6,503,458       84,080   5.20       6,537,647       85,783   5.21       5,540,681       75,238   5.39  

Market valuation on available-for-sale securities

    (92,985 )                 (45,289 )                 26,689                   (4,433 )                 18,529              
   


             


             


             


             


           

Total available-for-sale securities (3)

    6,415,539                   6,514,131                   6,530,147                   6,533,214                   5,559,210              

Held-to-maturity securities

    5,865,560       70,976   4.81       5,929,467       67,685   4.59       5,276,021       66,333   5.06       4,621,250       55,758   4.79       4,467,344       49,463   4.39  
   


 

       


 

       


 

       


 

       


 

     

Total investment securities (4)

    12,281,099       152,761   4.91       12,443,598       148,934   4.80       11,806,168       150,413   5.14       11,154,464       141,541   5.03       10,026,554       124,701   4.94  

Other interest-earning assets

    231,207       3,035   5.22       378,235       3,531   3.75       285,883       2,909   4.09       187,197       1,940   4.11       399,336       2,911   2.89  
   


 

       


 

       


 

       


 

       


 

     

Total interest-earning assets (4)

    44,592,007       560,923   4.99       43,455,462       535,142   4.95       41,797,794       535,279   5.15       40,605,410       531,754   5.19       39,093,663       515,977   5.24  

Cash and other assets

    4,575,623                   4,672,343                   4,542,231                   4,476,047                   4,612,263              

Allowance for loan losses

    (381,316 )                 (385,514 )                 (386,932 )                 (383,627 )                 (390,219 )            
   


             


             


             


             


           
    $ 48,786,314                 $ 47,742,291                 $ 45,953,093                 $ 44,697,830                 $ 43,315,707              
   


             


             


             


             


           

Liabilities and Shareholders' Equity

                                                                                                   

Interest-bearing liabilities:

                                                                                                   

Interest-bearing checking

  $ 6,865,461       10,237   0.59     $ 6,829,555       8,640   0.51     $ 6,334,668       7,346   0.47     $ 5,878,840       6,627   0.45     $ 5,793,183       6,295   0.43  

Money market and savings deposits

    7,875,270       10,599   0.54       7,847,980       9,688   0.50       7,674,745       9,315   0.49       7,678,965       9,350   0.48       7,670,427       9,144   0.47  

Time deposits (5)

    5,573,226       39,144   2.79       5,827,430       40,565   2.80       6,217,736       44,807   2.90       6,323,696       46,840   2.94       6,480,037       49,861   3.05  

Certificates of deposit of $100,000 or more (5)

    3,810,251       20,492   2.14       3,305,622       17,147   2.09       2,949,048       17,241   2.35       2,864,675       17,543   2.43       2,826,776       18,087   2.54  

Foreign deposits

    1,611,387       4,361   1.08       1,527,336       3,598   0.95       1,205,037       2,589   0.86       1,206,100       2,589   0.85       828,492       1,658   0.79  

Federal funds purchased and securities sold under agreements to repurchase

    3,338,866       11,707   1.39       2,837,459       8,185   1.16       2,378,217       6,645   1.12       2,639,228       6,163   0.93       1,954,417       3,917   0.80  

Other interest-bearing liabilities

    8,165,955       77,827   3.79       8,163,063       75,411   3.72       8,187,362       77,196   3.79       7,493,701       73,304   3.88       7,365,016       72,765   3.92  
   


 

       


 

       


 

       


 

       


 

     

Total interest-bearing liabilities

    37,240,416       174,367   1.86       36,338,445       163,234   1.81       34,946,813       165,139   1.90       34,085,205       162,416   1.89       32,918,348       161,727   1.95  
           

 

         

 

         

 

         

 

         

 

Net interest spread (4)

                3.13 %                 3.14 %                 3.25 %                 3.30 %                 3.29 %
                 

               

               

               

               

Noninterest-bearing demand deposits

    6,643,642                   6,516,977                   6,103,216                   5,855,497                   5,605,708              

Other liabilities (5)

    1,551,933                   1,581,233                   1,644,705                   1,606,022                   1,696,861              

Shareholders' equity

    3,350,323                   3,305,636                   3,258,359                   3,151,106                   3,094,790              
   


             


             


             


             


           
    $ 48,786,314                 $ 47,742,291                 $ 45,953,093                 $ 44,697,830                 $ 43,315,707              
   


             


             


             


             


           

Net interest income/margin on a taxable equivalent basis (4)

            386,556   3.44 %             371,908   3.44 %             370,140   3.56 %             369,338   3.61 %             354,250   3.60 %
                 

               

               

               

               

Taxable equivalent adjustment: (6)

                                                                                                   

Loans

            6,097                   6,075                   6,242                   6,359                   6,479      

Available-for-sale securities

            607                   672                   661                   687                   743      

Held-to-maturity securities

            3,946                   3,751                   3,740                   3,508                   3,575      
           

               

               

               

               

     

Total taxable equivalent adjustment

            10,650                   10,498                   10,643                   10,554                   10,797      
           

               

               

               

               

     

Net interest income

          $ 375,906                 $ 361,410                 $ 359,497                 $ 358,784                 $ 343,453      
           

               

               

               

               

     

NOTES:
(1) Loans net of unearned income includes nonaccrual loans for all periods presented.
(2) Interest income includes loan fees of $6,741,000, $9,647,000, $8,627,000, $10,139,000 and $11,350,000, for the three months ended September 30, 2004, June 30, 2004, March 31, 2004, December 31, 2003 and September 30, 2003, respectively.
(3) Available-for-sale securities excludes certain noninterest-earning, marketable equity securities.
(4) The yield calculation for total investment securities, total interest-earning assets, net interest spread and net interest margin excludes the market valuation on available-for-sale securities.
(5) Statement 133 valuation adjustments related to time deposits, certificates of deposit of $100,000 or more and other interest-bearing liabilities are included in other liabilities.
(6) The taxable equivalent adjustment has been computed using a federal income tax rate of 35%, adjusted for applicable state income taxes net of the related federal tax benefit.

 

32


Table of Contents

Table 3 - Year-to-Date Yields Earned on Average Interest-Earning Assets

and Rates Paid on Average Interest-Bearing Liabilities

 

     2004

    2003

 
    

Nine Months Ended

September 30


   

Nine Months Ended

September 30


 
     Average
Balance


    Revenue/
Expense


   Yield/
Rate


    Average
Balance


    Revenue/
Expense


  

Yield/

Rate


 
     (Taxable equivalent basis-dollars in thousands)  

Assets

                                          

Interest-earning assets:

                                          

Loans net of unearned income (1) (2)

   $ 30,811,005     $ 1,169,760    5.07 %   $ 28,257,539     $ 1,190,224    5.63 %

Available-for-sale securities, amortized cost

     6,523,745       247,113    5.06       4,903,411       229,832    6.27  

Market valuation on available-for-sale securities

     (37,398 )                  117,477               
    


              


            

Total available-for-sale securities (3)

     6,486,347                    5,020,888               

Held-to-maturity securities

     5,690,989       204,995    4.81       4,455,098       174,251    5.23  
    


 

        


 

      

Total investment securities (4)

     12,177,336       452,108    4.94       9,475,986       404,083    5.77  

Other interest-earning assets

     298,196       9,476    4.24       304,189       4,769    2.10  
    


 

        


 

      

Total interest-earning assets (4)

     43,286,537       1,631,344    5.03       38,037,714       1,599,076    5.64  

Cash and other assets

     4,596,654                    4,417,836               

Allowance for loan losses

     (384,575 )                  (388,011 )             
    


              


            
     $ 47,498,616                  $ 42,067,539               
    


              


            

Liabilities and Shareholders’ Equity

                                          

Interest-bearing liabilities:

                                          

Interest-bearing checking

   $ 6,677,251       26,223    0.52     $ 5,713,290       22,459    0.53  

Money market and savings deposits

     7,799,609       29,602    0.51       7,542,305       36,960    0.66  

Time deposits (5)

     5,871,704       124,516    2.83       6,409,722       153,270    3.20  

Certificates of deposit of $100,000 or more (5)

     3,356,635       54,880    2.18       2,407,491       50,128    2.78  

Foreign deposits

     1,448,517       10,548    0.97       735,433       5,017    0.91  

Federal funds purchased and securities sold under agreements to repurchase

     2,853,292       26,537    1.24       1,989,953       14,391    0.97  

Other interest-bearing liabilities

     8,172,104       230,434    3.77       7,227,820       227,175    4.20  
    


 

        


 

      

Total interest-bearing liabilities

     36,179,112       502,740    1.86       32,026,014       509,400    2.13  
            

  

         

  

Net interest spread (4)

                  3.17 %                  3.51 %
                   

                

Noninterest-bearing demand deposits

     6,422,090                    5,361,502               

Other liabilities (5)

     1,592,475                    1,574,033               

Shareholders’ equity

     3,304,939                    3,105,990               
    


              


            
     $ 47,498,616                  $ 42,067,539               
    


              


            

Net interest income/margin on a taxable equivalent
basis (4)

             1,128,604    3.48 %             1,089,676    3.84 %
                   

                

Taxable equivalent adjustment: (6)

                                          

Loans

             18,413                    19,936       

Available-for-sale securities

             1,940                    2,590       

Held-to-maturity securities

             11,438                    11,299       
            

                

      

Total taxable equivalent adjustment

             31,791       <