SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of
The Securities Exchange Act of 1934
For the fiscal year ended Commission file
December 31, 1995 number 1-5805
CHEMICAL BANKING CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 13-2624428
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
270 Park Avenue, New York, N.Y. 10017
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 270-6000
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Number of Shares of Common Stock outstanding on February 29, 1996: 250,539,802
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of Chemical Banking Corporation Common Stock
held by non-affiliates of Chemical Banking Corporation on February 29, 1996 was
$17,810,000,000.
Part I
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ITEM 1: BUSINESS
On March 31, 1996, The Chase Manhattan Corporation ("Chase") will merge with and
into Chemical Banking Corporation (the "Corporation"). Upon consummation of the
merger, Chemical Banking Corporation will change its name to "The Chase
Manhattan Corporation". (See The Merger with Chase on page 15 for a more
complete description of the merger).
Because the merger, which will be accounted for as a pooling of interests,
occurred subsequent to December 31, 1995, the information presented in this
Annual Report on Form 10-K does not give effect to the impact of the merger.
Unless otherwise stated, the information presented relates to Chemical Banking
Corporation prior to the merger with Chase. However, supplemental financial
statements included on pages 97 through 103 present the combined financial
condition and results of operations of Chemical Banking Corporation and Chase as
if the merger had been in effect for all periods presented.
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OVERVIEW
The Corporation is a bank holding company organized under the laws of the State
of Delaware in 1968 and registered under the Bank Holding Company Act of 1956,
as amended (the "BHCA").
The Corporation conducts domestic and international financial services
business through various bank and non-bank subsidiaries. At December 31, 1995,
the principal bank subsidiaries of the Corporation were Chemical Bank, a New
York banking corporation ("Chemical Bank"), and Texas Commerce Bank National
Association, a subsidiary of Texas Commerce Equity Holdings, Inc. ("Texas
Commerce"), a Delaware bank holding company subsidiary of the Corporation. On
December 31, 1991, Manufacturers Hanover Corporation ("MHC") merged with and
into the Corporation (the "MHC Merger") and, on March 31, 1996, The Chase
Manhattan Corporation ("Chase") will merge with and into the Corporation (the
"Chase Merger"). At December 31, 1995, the Corporation was the fifth largest
bank holding company in the United States in terms of total assets and
Chemical Bank was the third largest bank in the United States in terms of
total assets.
The bank and non-bank subsidiaries of the Corporation operate nationally as
well as through overseas branches and an international network of representative
offices, subsidiaries and affiliated banks.
The financial services provided by the Corporation's domestic subsidiaries
include personal and commercial checking accounts, savings and time deposit
accounts, personal and business loans, consumer financing, leasing, real estate
financing, investment banking, mortgage banking, money transfer, cash
management, safe deposit facilities, personal trust and estate administration,
corporate and institutional trust and securities processing services, full
investment services, discount brokerage, United States Government and Federal
agency securities dealership, corporate debt and equity securities dealership
and underwriting, and United States corporate tax depository facilities.
Internationally, services also include correspondent banking arrangements,
merchant banking, and underwriting and trading of Eurosecurities.
The Corporation also provides products to ensure that a customer will have a
specific currency exchange or interest rate at some future date. These products
include interest rate and currency swaps, interest rate options, forward rate
agreements, forward interest rate contracts, foreign exchange contracts and
financial futures.
The Corporation retains a 20% interest in the CIT Group Holdings, Inc.
("CIT"). CIT, directly or through its subsidiaries, engages in diversified
financial services activities, primarily in the United States. For additional
information pertaining to CIT, see the sections entitled "Overview",
"Noninterest Revenue" and "Other Events" in the Management's Discussion and
Analysis section at pages 14, 16 and 39, respectively.
Certain amounts in prior periods have been reclassified to conform to the
current presentation.
ORGANIZATIONAL REVIEW
The Corporation's activities are internally organized, for management reporting
purposes, into various business sectors. A description of the Corporation's
business sectors, as well as developments that have occurred during 1995 with
respect to these business sectors, are discussed in the Management's Discussion
and Analysis section beginning on page 20.
COMPETITION
The Corporation and its subsidiaries and affiliates operate in a highly
competitive environment. The Corporation's bank subsidiaries compete with other
domestic and foreign banks, thrift institutions, credit unions, and money market
and other mutual funds for deposits and other sources of funds. In addition, the
Corporation and its bank and non-bank subsidiaries face increased competition
with respect to the diverse financial services and products they offer.
Competitors also include finance companies, brokerage firms, investment banking
companies,
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merchant banks, insurance companies, leasing companies, and a variety of other
financial services and advisory companies. Many of these competitors are not
subject to the same regulatory restrictions as are domestic bank holding
companies and banks, such as the Corporation and its bank subsidiaries.
GOVERNMENT MONETARY POLICIES AND ECONOMIC CONTROLS
The earnings and business of the Corporation are affected by general economic
conditions, both domestic and international. In addition, fiscal or other
policies that are adopted by various regulatory authorities of the United
States, by foreign governments, and by international agencies can have important
consequences on the financial performance of the Corporation. The Corporation is
particularly affected by the policies of the Board of Governors of the Federal
Reserve System (the "Federal Reserve Board"), which regulates the national
supply of bank credit. Among the instruments of monetary policy available to the
Federal Reserve Board are engaging in open-market operations in United States
Government securities; changing the discount rates of borrowings of depository
institutions; imposing or changing reserve requirements against depository
institutions' deposits and certain assets of foreign branches; and imposing or
changing reserve requirements against certain borrowings by banks and their
affiliates (including parent corporations such as the Corporation). These
methods are used in varying combinations to influence the overall growth of bank
loans, investments, and deposits, and the interest rates charged on loans or
paid for deposits.
The Corporation has economic, credit, legal, and other specialists who
monitor economic conditions, and domestic and foreign government policies and
actions. However, since it is difficult to predict changes in macroeconomic
conditions and in governmental policies and actions relating thereto, it is
difficult to foresee the effects of any such changes on the business and
earnings of the Corporation and its subsidiaries.
SUPERVISION AND REGULATION
The Corporation is subject to regulation as a registered bank holding company
under the BHCA. As such, the Corporation is required to file with the Federal
Reserve Board an annual report and other information required quarterly pursuant
to the BHCA. The Corporation is also subject to the examination powers of the
Federal Reserve Board.
Under the BHCA, the Corporation may not engage in any business other than
managing and controlling banks or furnishing certain specified services to
subsidiaries, and may not acquire voting control of non-banking corporations,
except those corporations engaged in businesses or furnishing services which the
Federal Reserve Board deems to be so closely related to banking as "to be a
proper incident thereto". Further, the Corporation is prohibited, with certain
exceptions, from acquiring direct or indirect ownership or control of more than
5% of the voting shares of any corporation that is engaged in activities that
are not closely related to banking, and may not acquire direct or indirect
ownership or control of more than 5% of the voting shares of any domestic bank
without the prior approval of the Federal Reserve Board.
Dividend Restrictions: Federal law imposes limitations on the payment of
dividends by the subsidiaries of the Corporation that are state member banks of
the Federal Reserve System (a "state member bank") or national banks. Non-bank
subsidiaries of the Corporation are not subject to such limitations. The amount
of dividends that may be paid by a state member bank, such as Chemical Bank, or
by a national bank, such as Texas Commerce Bank National Association, is limited
to the lesser of the amounts calculated under a "recent earnings" test and an
"undivided profits" test. Under the recent earnings test, a dividend may not be
paid if the total of all dividends declared by a bank in any calendar year is in
excess of the current year's net income combined with the retained net income of
the two preceding years, unless the bank obtains the approval of its appropriate
Federal banking regulator (which, in the case of a member bank, is the Federal
Reserve Board and, in the case of a national bank, is the Office of the
Comptroller of the Currency (the "Comptroller of the Currency")). Under the
undivided profits test, a dividend may not be paid in excess of a bank's
"undivided profits". The New York State Banking Department imposes a similar
recent earnings test on the payment of dividends by New York State-chartered
banks, such as Chemical Bank.
In accordance with the foregoing restrictions, the Corporation's bank
subsidiaries could, during 1996, without the approval of their relevant banking
regulators, pay dividends estimated at approximately $423 million to their
respective bank holding companies, plus an additional amount equal to their net
income from January 1, 1996 through the date in 1996 of any such dividend
payment.
In addition to the dividend restrictions described above, the Federal Reserve
Board, the Comptroller of the Currency and the Federal Deposit Insurance
Corporation ("FDIC") have authority under the Financial Institutions Supervisory
Act to prohibit or to limit the payment of dividends by the banking
organizations they supervise, including the Corporation and its subsidiaries
that are banks or bank holding companies, if, in the banking regulator's
opinion, payment of a dividend would constitute an unsafe or unsound practice in
light of the financial condition of the banking organization.
For a further discussion of the dividend restrictions imposed on the
Corporation's bank subsidiaries, see Note 15, "Restrictions on Cash and
Intercompany Fund Transfers" on page 62.
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Risk-Based Capital: The Federal banking regulatory authorities have also adopted
risk-based capital and leverage guidelines, which require that the
Corporation's capital-to-assets ratios meet certain minimum standards.
The risk-based capital ratio is determined by allocating assets and
specified off-balance sheet financial instruments into four weighted categories,
with higher levels of capital being required for the categories perceived as
representing greater risk. Under the guidelines, a banking organization's
capital is divided into two tiers. Tier 1 Capital includes common equity,
qualifying perpetual preferred stock, minority interests in the equity accounts
of consolidated subsidiaries, less goodwill and other non-qualifying intangibles
and other assets. Tier 2 Capital includes, among other items, perpetual
preferred equity not qualifying for Tier 1, limited-life preferred stock with an
original maturity of greater than 20 years, mandatory convertible debt,
subordinated debt and intermediate-term preferred stock with an original
weighted average maturity of at least five years, qualifying allowance for
credit losses, less required deductions as provided by regulation. The amount of
Tier 2 Capital may not exceed the amount of Tier 1 Capital. Total Capital is the
sum of Tier 1 Capital and Tier 2 Capital.
Banking organizations are required to maintain a Total risk-based capital
ratio (Total Capital to risk-weighted assets) of 8% of which at least 4% must
be Tier 1 Capital.
The Federal banking regulatory authorities have also established minimum
leverage ratio guidelines. The leverage ratio is defined as Tier 1 Capital
divided by average total assets (net of allowance for credit losses, goodwill
and certain intangible assets). The minimum leverage ratio is 3% for banking
organizations that have well-diversified risk (including no undue interest rate
risk); excellent asset quality; high liquidity; good earnings; and, in general,
are considered strong banking organizations. Other banking organizations are
expected to have ratios of at least 4% - 5% depending upon their particular
condition and growth plans. Higher capital ratios could be required if
warranted by the particular circumstances or risk profile of a given banking
organization.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") required each Federal banking regulator to revise its risk-based
capital standards within 18 months of enactment of the statute to ensure that
those standards take adequate account of interest rate risk, concentration of
credit risk and the risk of nontraditional activities. On December 15, 1994, the
Federal banking regulators adopted amendments to their respective risk-based
capital requirements that explicitly identify concentration of credit risk and
certain risks arising from nontraditional activities, and the management of such
risks, as important factors to consider in assessing an institution's overall
capital adequacy. The amendments do not, however, mandate any specific
adjustments to the risk-based capital calculation as a result of such factors.
On August 2, 1995, the Federal banking regulators published amendments to their
risk-based capital rules that include interest-rate risk as a qualitative factor
to be considered in assessing capital adequacy. Concurrent with the publication
of the amendments, the Federal banking regulators proposed a system for
measuring interest rate risk and announced their intention, after a trial period
to evaluate the reliability and accuracy of the proposed system, to initiate a
rulemaking process for the purpose of amending the risk-based capital rules to
include an explicit capital charge for interest-rate risk that will be based
upon the level of a banking organization's measured interest-rate risk exposure.
On July 14, 1995, the Federal banking regulators issued a proposal to amend
their risk-based capital rules to incorporate a measure for market risk in
foreign exchange and commodity activities and in the trading of debt and equity
instruments. Under the proposal, banking organizations with relatively large
trading activities would calculate their capital charges for market risk using
their own internal value-at-risk models (subject to parameters set by the
regulators) or, alternatively, risk management techniques developed by the
regulators. The effect of the proposed rules would be that, in addition to
existing capital requirements for credit risk, certain institutions, including
the Corporation, would be required to hold capital based on the measure of their
market risk exposure. These institutions would be able to satisfy this
additional requirement, in part, by issuing short-term subordinated debt that
qualifies as Tier 3 Capital. The proposed rule would go into effect at the end
of 1997.
FDICIA: FDICIA required the FDIC to establish a risk-based assessment system for
FDIC deposit insurance and revises certain provisions of the Federal Deposit
Insurance Act as well as certain other Federal banking statutes. In general,
FDICIA provides for expanded regulation of depository institutions and their
affiliates, including parent holding companies, by such institutions' Federal
banking regulators, and requires the Federal banking regulator to take "prompt
corrective action" with respect to a depository institution if such institution
does not meet certain capital adequacy standards.
Prompt Corrective Action: Pursuant to FDICIA, the Federal Reserve Board, the
FDIC and the Comptroller of the Currency adopted regulations setting forth a
five-tier scheme for measuring the capital adequacy of the depository
institutions they supervise. Under the regulations (commonly referred to as the
"prompt corrective action" rules), an institution would be placed in one of the
following capital categories: (i) well capitalized (an institution that has a
total risk-based capital ratio of at least 10%, a Tier 1 risk-based capital
ratio of at least 6% and a Tier 1 leverage ratio of at least 5%); (ii)
adequately capitalized (an institution that has a total risk-based capital ratio
of at least 8%, a Tier 1 risk-based capital ratio of at least 4% and a Tier 1
leverage ratio of at least 4%); (iii) undercapitalized (an institution that has
a total risk-based capital ratio of under 8% or a Tier 1 risk-based capital
ratio under 4% or a Tier 1 leverage ratio under 4%); (iv) significantly
undercapitalized (an institution that has a total risk-based capital ratio of
under 6% or a Tier 1 risk-based capital ratio under 3% or a Tier 1 leverage
ratio under 3%); and (v) critically undercapitalized (an institution that has a
ratio of tangible equity to total assets of 2% or less).
Supervisory actions by the appropriate Federal banking regulator will depend
upon an institution's classification within the five categories. All
institutions are generally prohibited from declaring any dividends, making any
other capital distribution, or paying a management fee to any controlling
person, if such payment would cause the institution to become undercapitalized.
Additional supervisory actions are mandated for an institution falling into one
of the three "undercapitalized" categories, with the severity of supervisory
action increasing at greater levels of capital deficiency. For example,
critically undercapitalized institutions are, among other things, restricted
from making any principal or interest payments on subordinated debt without
prior approval of their Federal banking regulator. The regulations apply only to
banks and not to bank holding companies, such as the Corporation; however, the
Federal Reserve Board is authorized to take appropriate action at the holding
company level based on the undercapitalized status of such holding company's
subsidiary banking institution. In certain instances relating to an
undercapitalized banking institution, the bank holding company would be required
to guarantee the performance of the undercapitalized subsidiary and may be
liable for civil money damages for failure to fulfill its commitments on such
guarantee.
At December 31, 1995, each of the Corporation's banking subsidiaries were
"well capitalized".
Brokered Deposits: The ability of depository institutions to accept brokered
deposits is regulated under FDICIA. The term "brokered deposits" is defined to
include deposits that are solicited by a bank's affiliates on its behalf. A
significant portion of Chemical Bank's wholesale deposits are solicited on its
behalf by a broker-dealer affiliate of Chemical Bank and are considered brokered
deposits. Under the rule, (i) an "undercapitalized" institution is prohibited
from accepting, renewing or rolling over brokered deposits, (ii) an "adequately
capitalized" institution must obtain a waiver from the FDIC before accepting,
renewing or rolling over brokered deposits and is not permitted to pay interest
on brokered deposits accepted in such institution's normal market area at rates
that "significantly exceed" rates paid on deposits of similar maturity in such
area, and (iii) a "well capitalized" institution may accept, renew or roll over
brokered deposits without restriction. The definitions of "well capitalized",
"adequately capitalized", and "undercapitalized" are the same as those utilized
in the "prompt corrective action" rules described above.
FDIC Insurance Assessments: Under the FDIC's risk-based insurance premium
assessment system, each depository institution is assigned to one of nine risk
classifications based upon certain capital and supervisory measures and,
depending upon its classification, is assessed insurance premiums on its
deposits. Effective June 1995, such premiums ranged from 4 basis points to
31 basis points of domestic deposits. Effective January 1, 1996, depository
institutions in the top risk classification category will pay only the statutory
minimum of $2,000 annually for deposit insurance and remaining depository
institutions will pay premiums ranging from 3 basis points to 30 basis points of
domestic deposits. Each of the Corporation's banks, including Chemical Bank and
Texas Commerce Bank National Association, will pay the statutory minimum
premium. The rate schedule is subject to future adjustments by the FDIC. In
addition, the FDIC has authority to impose special assessments from time to
time.
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Other FDICIA Rules: Other rules that have been adopted pursuant to FDICIA
include: (i) real estate lending standards for banks, which provide guidelines
concerning loan-to-value ratios for various types of real estate loans; (ii)
rules relating to consumer lending, including regulations governing advertising
and disclosures required for consumer deposit accounts; (iii) rules requiring
depository institutions to develop and implement internal procedures to evaluate
and control credit and settlement exposure to their correspondent banks; (iv)
rules implementing the FDICIA provision prohibiting, with certain exceptions,
FDIC-insured state banks from making equity investments of the types and amount,
or from engaging as principal in activities, not permissible for national banks;
(v) rules mandating enhanced financial reporting and audit requirements; (vi)
notice provisions in the case of branch closings; and (vii) rules addressing
certain "safety and soundness" issues.
POWERS OF THE FDIC UPON INSOLVENCY OF AN INSURED DEPOSITORY INSTITUTION: The
Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA")
imposes liability on an FDIC-insured depository institution (such as the
Corporation's bank subsidiaries) for costs incurred by the FDIC in connection
with the insolvency of other FDIC-insured institutions under common control with
such institution (commonly referred to as "cross-guarantees" of insured
depository institutions). An FDIC cross-guarantee claim against a depository
institution is superior in right of payment to claims of the holding company and
its affiliates against such depository institution.
In the event an insured depository institution becomes insolvent, or upon the
occurrence of certain other events specified in the Federal Deposit Insurance
Act, whenever the FDIC is appointed the conservator or receiver of such insured
depository institution, the FDIC has the power: (i) to transfer any of such
bank's assets and liabilities to a new obligor (including, but not limited to,
another financial institution acquiring all or a portion of the bank's business,
assets or liabilities), without the approval of such bank's creditors; (ii) to
enforce the terms of such bank's contracts pursuant to their terms; or (iii) to
repudiate or disaffirm any contract or lease to which such depository
institution is a party, the performance of which is determined by the FDIC to be
burdensome and the disaffirmance or repudiation of which is determined by the
FDIC to promote the orderly administration of such depository institution's
assets. Such provisions of the Federal Deposit Insurance Act would be applicable
to obligations and liabilities of those of the Corporation's subsidiaries that
are insured depository institutions, such as Chemical Bank and Texas Commerce
Bank National Association, including without limitation, obligations under
senior or subordinated debt issued by such banks to investors (hereinafter
referred to as "public noteholders") in the public markets.
In its resolution of the problems of an insured depository institution in
default or in danger of default, the FDIC is not permitted to take any action
that would have the effect of increasing the losses to a deposit insurance fund
by protecting depositors for more than the insured portion of their deposits or
by protecting creditors of the insured depository institution (including public
noteholders), other than depositors. In addition, the FDIC is authorized to
settle all uninsured and unsecured claims in the insolvency of an insured
institution by making a final settlement payment after the declaration of
insolvency based upon a percentage determined by the FDIC reflecting an average
of the FDIC's receivership recovery experience, regardless of the assets of the
insolvent institution actually available for distribution to creditors. Such a
payment would constitute full payment and disposition of the FDIC's obligations
to claimants.
The Omnibus Budget Reconciliation Act of 1993 included a "depositor
preference" provision, which provided that the claims of a receiver of an
insured depository institution for administrative expenses and the claims of
holders of deposit liabilities (including the FDIC, as subrogee of such holders)
have priority over the claims of other unsecured creditors of such institution,
including public noteholders, in the event of the liquidation or other
resolution of such institution.
As a result of the provisions described above, whether or not the FDIC ever
sought to repudiate any obligations held by public noteholders of any subsidiary
of the Corporation that is an insured depository institution, such as Chemical
Bank or Texas Commerce Bank National Association, the public noteholders would
be treated differently from, and could receive, if anything, substantially less
than, holders of deposit obligations of such depository institution.
OTHER SUPERVISION AND REGULATION: Under Federal Reserve Board policy, the
Corporation is expected to act as a source of financial strength to each bank
subsidiary and to commit resources to support such bank subsidiary in
circumstances where it might not do so absent such policy. Any loans by a bank
holding company to any of its subsidiary banks are subordinate in right of
payment to deposits and to certain other indebtedness of the subsidiary banks.
In the event of a bank holding company's bankruptcy, any commitment by the bank
holding company to a Federal bank regulatory agency to maintain the capital of a
subsidiary bank at a certain level will be assumed by the bankruptcy trustee and
entitled to a priority of payment.
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The bank subsidiaries of the Corporation are subject to certain restrictions
imposed by Federal law on extensions of credit to, and certain other
transactions with, the Corporation and certain other affiliates and on
investments in stock or securities thereof. Such restrictions prevent the
Corporation and other affiliates from borrowing from a bank subsidiary unless
the loans are secured in specified amounts. Without the prior approval of the
Federal Reserve Board, secured loans, other transactions and investments by any
bank subsidiary are generally limited in amount as to the Corporation and as to
each of the other affiliates to 10% of the bank's capital and surplus and as to
the Corporation and all such other affiliates to an aggregate of 20% of the
bank's capital and surplus. Federal law also requires that transactions between
a bank subsidiary and the Corporation or certain non-bank affiliates, including
extensions of credit, sales of securities or assets and the provision of
services, be conducted on terms at least as favorable to the bank subsidiary as
those that apply or that would apply to comparable transactions with
unaffiliated parties.
The Corporation's bank and non-bank subsidiaries are subject to direct
supervision and regulation by various other Federal and state authorities.
Chemical Bank, as a New York State-chartered bank and member bank of the Federal
Reserve System, is subject to supervision and regulation of the New York State
Banking Department as well as by the Federal Reserve Board and the FDIC. The
Corporation's national bank subsidiaries, such as Texas Commerce Bank National
Association and Chemical Bank National Association, are subject to substantially
similar supervision and regulation by the Comptroller of the Currency.
Supervision and regulation by each of the foregoing regulatory agencies
generally include comprehensive annual reviews of all major aspects of the
relevant bank's business and condition, as well as the imposition of periodic
reporting requirements and limitations on investments and other powers. The
activities of the Corporation's broker-dealers are subject to the regulations of
the Securities and Exchange Commission and the National Association of
Securities Dealers, Inc., and, in the case of Chemical Securities Inc. (the
Corporation's "Section 20" subsidiary ("CSI")), are subject to the supervision
and regulation of the Federal Reserve Board (which has imposed conditions
governing CSI's activities, including limitations on the gross revenues that may
be derived from certain of CSI's activities). Additionally, various securities
activities conducted by the bank subsidiaries of the Corporation, such as acting
as a transfer agent, the making available of mutual funds and providing other
types of investment management services, are subject to the regulations of the
Securities and Exchange Commission and, with respect to certain activities of
its mutual funds, the Federal Reserve Board. Numerous Federal and state consumer
laws impose requirements on the making, enforcement and collection of consumer
loans, including credit card loans, and on the types of disclosures that need to
be made in connection with such loans. Finally, the types of activities in which
the foreign branches of Chemical Bank and the international subsidiaries of the
Corporation may engage are subject to various restrictions imposed by the
Federal Reserve Board. Such foreign branches and international subsidiaries are
also subject to the laws and banking authorities of the countries in which they
operate.
FOREIGN OPERATIONS
For geographic distributions of average assets, total revenue, total expense,
income before income tax expense and net income, see Note Twenty Four,
"International Operations", on page 71. For a discussion of foreign loans, see
Note Five, "Loans", on page 55 and see the sections entitled "Foreign Portfolio"
and "Cross-Border Outstandings," on pages 27 and 28.
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ITEM 2: PROPERTIES
The headquarters of the Corporation is located in New York City at 270 Park
Avenue, which is a 50-story bank and office building owned by the Corporation.
This location contains approximately 1.3 million square feet of commercial
office and retail space. The Corporation also owns and occupies a 22-story bank
and office building at 4 New York Plaza with 900,000 square feet of commercial
office and retail space. The Corporation also occupies, under leasehold
agreements, office space at 55 Water Street, 95 Wall Street and various other
locations in New York City.
The Corporation, as lessee, also occupies offices in the United Kingdom. The
most significant office space leased in the United Kingdom is 168,000 square
feet at 125 London Wall, which lease expires in December 2017.
In addition, the Corporation and its subsidiaries own and occupy
administrative and operational facilities in Hicksville, New York; Houston,
Texas; McAllen, Texas; Austin, Texas; Arlington, Texas and El Paso, Texas.
The Corporation and its subsidiaries occupy branch offices and other
locations throughout the United States and in foreign countries under various
types of ownership and leasehold agreements which, when considered in the
aggregate, are not material to its operations.
5
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ITEM 3: LEGAL PROCEEDINGS
The Securities and Exchange Commission has commenced an investigation relating
to the $70 million loss incurred by the Corporation in the fourth quarter of
1994 resulting from unauthorized foreign exchange transactions involving the
Mexican peso. The Corporation is cooperating with this investigation. The
Corporation cannot determine at this time the outcome of the investigation but
believes it will not have a material adverse effect on the consolidated
financial condition of the Corporation.
LITIGATION RELATING TO THE CHASE MERGER:
On August 28, 1995, three complaints were filed in the Court of Chancery for New
Castle County, Delaware, in actions entitled Simon v. Chase Manhattan
Corporation, et al., Civil Action No. 14505, Rampel & Rampel, P.A. Profit
Sharing Plan v. Chase Manhattan Corp., et. al., Civil Action No. 14506 and
Goldstein v. Chase Manhattan Corp., et al., Civil Action 14508. The complaints,
each of which purports to initiate a class action on behalf of all Chase
stockholders, name Chase, the Corporation and certain current and former
directors of Chase as defendants. The complaints allege that (i) the Chase
Merger entails breaches of fiduciary duties owed by the director defendants to
Chase stockholders, (ii) the consideration provided in the Chase Merger by the
Corporation is inadequate, (iii) the Chase Merger is unfair to Chase
stockholders and a product of Chase directors' acting out of self-interest
and (iv) the Corporation aided and abetted the Chase directors' alleged breach
of fiduciary duties. The complaints seek, among other relief, an injunction
preventing consummation of the Chase Merger and damages in unspecified amounts.
The Corporation and Chase believe the actions to be without merit and intend
to contest them vigorously.
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ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The following matters were submitted to a vote at a Special Meeting of
Stockholders of the Corporation. The Special Meeting of the Stockholders was
held on December 11, 1995. A total of 195,065,240 shares, or 78.1% of the
249,904,977 shares entitled to vote at the Special Meeting, were represented at
the meeting.
(1) Approval and Adoption of the Agreement and Plan of
Merger ("the Merger Agreement")
- The approval and adoption of the Merger Agreement providing for a merger of
The Chase Manhattan Corporation with and into the Corporation, with the
combined entity adopting the Chase name was approved by 99.4% of the votes
cast. The proposal received a "for" vote of 193,265,800 and an "against"
vote of 1,164,519. The number of votes abstaining was 634,921. There were no
broker non-votes.
(2) Amendment and Restatement of the Corporation's
Certificate of Incorporation
- A proposal to amend and restate the Corporation's Restated Certificate of
Incorporation to increase the number of authorized shares of Common Stock,
par value $1.00 per share, from 400 million to 750 million shares and to
make certain other technical amendments was approved by 99.0% of the votes
cast. The proposal received a "for" vote of 192,109,363 and an "against"
vote of 1,916,798. The number of votes abstaining was 1,039,079. There were
no broker non-votes.
6
Unless otherwise noted, all of the Corporation's above-named executive officers
have continuously held senior-level positions with the Corporation and Chemical
Bank during the five fiscal years ended December 31, 1995. There are no family
relationships among the foregoing executive officers.
7
Part II
--------------------------------------------------------------------------------
ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The outstanding shares of the Corporation's Common Stock are listed on the New
York Stock Exchange and the International Stock Exchange of the United Kingdom
and the Republic of Ireland. For the quarterly high and low prices of the Common
Stock on the New York Stock Exchange and the quarterly dividends declared data
for the Corporation's common stock for the last two years, see the section
entitled "Quarterly Financial Information" on page 75.
At February 29, 1996, there were approximately 56,640 holders of record of
the Corporation's Common Stock.
--------------------------------------------------------------------------------
ITEM 6: SELECTED FINANCIAL DATA
For five-year selected financial data, see "Summary of Selected Financial Data"
on page 13.
--------------------------------------------------------------------------------
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Management's discussion and analysis of financial condition and results of
operations, entitled "Management's Discussion and Analysis", appears on pages 13
through 41.
--------------------------------------------------------------------------------
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements appear, together with the Notes thereto
and the report of Price Waterhouse LLP dated January 16, 1996 thereon, on pages
42 through 74.
Supplementary financial data for each full quarter within the two years ended
December 31, 1995 is included on page 75 in the table entitled "Quarterly
Financial Information". Also included is the "Consolidated Balance Sheet" for
Chemical Bank and Subsidiaries on page 76.
--------------------------------------------------------------------------------
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
8
Part III
-----------------------------------------------------------------------
ITEM 10:DIRECTORS AND EXECUTIVE OFFICERS OF THE CORPORATION
See Item 13 below.
-----------------------------------------------------------------------
ITEM 11:EXECUTIVE COMPENSATION
See Item 13 below.
-----------------------------------------------------------------------
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
See Item 13 below.
-----------------------------------------------------------------------
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Pursuant to Instruction G (3) to Form 10-K, the information to be provided by
Items 10, 11, 12 and 13 of Form 10-K (other than information pursuant to Rule
402 (i), (k) and (l) of Regulation S-K) are incorporated by reference to the
Corporation's definitive proxy statement for the annual meeting of stockholders,
to be held May 21, 1996, which proxy statement will be filed with Securities and
Exchange Commission pursuant to Regulation 14A within 120 days of the close of
the Corporation's 1995 fiscal year.
9
Part IV
------------------------------------------------------------------------
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) EXHIBITS
1. Financial Statements
The consolidated financial statements, the Notes thereto and the report
thereon listed in Item 8 are set forth commencing on page 42.
2. Financial Statement Schedules
None.
3. Exhibits
2.1 Agreement and Plan of Merger, dated as of August 27, 1995, between
Chemical Banking Corporation and The Chase Manhattan Corporation
(incorporated by reference to Exhibit 2.1 to the Registration
Statement on Form S-4 (File No. 33-63833) of Chemical Banking
Corporation).
2.2 Stock Option Agreement, dated as of August 27, 1995, between
Chemical Banking Corporation, as Issuer, and The Chase Manhattan
Corporation, as Grantee (incorporated by reference to Exhibit 2.2 to
the Registration Statement on Form S-4 (File No. 33-63833) of
Chemical Banking Corporation).
2.3 Stock Option Agreement, dated as of August 27, 1995, between The
Chase Manhattan Corporation, as Issuer, and Chemical Banking
Corporation, as Grantee (incorporated by reference to Exhibit 2.3 to
the Registration Statement on Form S-4 (File No. 33-63833) of
Chemical Banking Corporation.
2.4 Employee Benefits Agreement, dated as of August 27, 1995, between
Chemical Banking Corporation and The Chase Manhattan Corporation
(incorporated by reference to Exhibit 2.4 to the Registration
Statement on Form S-4 (File No. 33-63833) of Chemical Banking
Corporation).
3.1 (a) Restated Certificate of Incorporation of Chemical Banking
Corporation (incorporated by reference to Exhibit 3.1 of the Annual
Report on Form 10-K dated December 31, 1993 of Chemical Banking
Corporation).
3.1 (b) Certificate of Designations of Adjustable Rate Cumulative Preferred
Stock, Series L (incorporated by reference to Exhibit 2 to the
Registration Statement on Form 8-A dated June 6, 1994 of Chemical
Banking Corporation).
3.2 By-laws of Chemical Banking Corporation, as amended (incorporated by
reference to Exhibit 3.2 of the Annual Report on Form 10-K dated
December 31, 1993 of Chemical Banking Corporation).
4.1 (a) Form of Rights Agreement, dated as of April 13, 1989 between
Chemical Banking Corporation and Harris Trust Company of New York,
as amended (incorporated by reference to Exhibit 4 to the Current
Report on Form 8-K of Chemical Banking Corporation dated April 13,
1989).
4.1 (b) Letter of Appointment dated December 23, 1991 of Chemical Banking
Corporation appointing Chemical Bank, as successor Rights Agent
under the Rights Agreement (incorporated by reference to Exhibit
4.13(b) of the Annual Report on Form 10-K dated December 31, 1991 of
Chemical Banking Corporation).
4.2 Form of Indenture dated as of December 1, 1989 between Chemical
Banking Corporation and The Chase Manhattan Bank (National
Association), which Indenture includes the form of Debt Securities
(incorporated by reference to Exhibit 4.9 to the Registration
Statement on Form S-3 (File No. 33-32409) of Chemical Banking
Corporation).
4.3 Form of Indenture dated as of April 1, 1987, as amended and restated
as of December 15, 1992, between Chemical Banking Corporation and
Morgan Guaranty Trust Company of New York, as succeeded to by First
Trust of New York (National Association), as Trustee, which
Indenture includes the form of Subordinated Debt Securities
(incorporated by reference to Exhibit 4.1 to the Current Report on
Form 8-K dated December 22, 1992 of Chemical Banking Corporation).
4.4 (a) Form of Indenture dated as of June 1, 1982 between Manufacturers
Hanover Corporation and Morgan Guaranty Trust Company of New York,
as succeeded to by First Trust of New York (National Association),
as Trustee, which Indenture includes the form of Debt Securities
(incorporated by reference to Exhibit 4(a) to the Registration
Statement on Form S-3 (File No. 2-82433) of Manufacturers Hanover
Corporation).
4.4 (b) Form of First Supplemental Indenture dated as of January 15, 1986 to
the Indenture dated as of June 1, 1982 between Manufacturers Hanover
Corporation and Morgan Guaranty Trust Company of New York, as
succeeded to by First Trust of New York (National Association), as
Trustee, relating to the Senior Debt Securities (incorporated by
reference to Exhibit 1 to the Current Report on Form 8-K dated as of
January 29, 1986 of Manufacturers Hanover Corporation).
4.4 (c) Form of Second Supplemental Indenture dated as of March 13, 1991 to
the Indenture dated as of June 1, 1982 between Manufacturers Hanover
Corporation and Morgan Guaranty Trust Company of New York, as
succeeded to by First Trust of New York (National Association), as
Trustee, relating to the Senior Debt Securities (incorporated by
reference to Exhibit 4 to the Current Report on Form 8-K dated March
19, 1991 of Manufacturers Hanover Corporation).
10
------------------------------------------------------------------------
4.4 (d) Form of Third Supplemental Indenture dated as of December 31, 1991
among Chemical Banking Corporation, Manufacturers Hanover
Corporation and Morgan Guaranty Trust Company of New York, as
succeeded to by First Trust of New York (National Association), as
Trustee, to the Indenture dated as of June 1, 1982 (incorporated by
reference to Exhibit 4.14(d) of the Annual Report on Form 10-K dated
December 31, 1991 of Chemical Banking Corporation).
4.5 (a) Form of Indenture dated as of June 1, 1985 between Manufacturers
Hanover Corporation and IBJ Schroder Bank and Trust Company, as
Trustee, relating to 8 1/2% Subordinated Capital Notes Due February
15, 1999 (incorporated by reference to Exhibit 4 (b) to the Current
Report on Form 8-K dated February 27, 1987 of Manufacturers Hanover
Corporation).
4.5 (b) Form of First Supplemental Indenture dated as of December 31, 1991
among Chemical Banking Corporation, Manufacturers Hanover
Corporation and IBJ Schroder Bank and Trust Company to the Indenture
dated June 1, 1985 (incorporated by reference to Exhibit 4.18(b) to
the Annual Report on Form 10-K dated December 31, 1991 of Chemical
Banking Corporation).
4.6 (a) Form of Indenture dated as of May 15, 1993 between Margaretten
Financial Corporation and The Bank of New York, as Trustee, relating
to the 6 3/4% Guaranteed Notes due June 15, 2000 (incorporated by
reference to Exhibit 4(a) to Registration Statement on Form S-3 (No.
33-60262) of Margaretten Financial Corporation).
4.6 (b) Form of Supplemental Indenture dated as of July 22, 1994 to the
Indenture dated as of May 15, 1993 among Margaretten Financial
Corporation, Chemical Banking Corporation and The Bank of New York,
as Trustee, and Guarantee dated as of July 22, 1994 by Chemical
Banking Corporation (incorporated by reference to Exhibit 4.34 to
the Current Report on Form 8-K dated September 28, 1994 of Chemical
Banking Corporation).
10.1 Key Executive Performance Plan of Chemical Banking Corporation
(incorporated by reference to Exhibit 10.4 to the Annual Report
on Form 10-K for the year ended December 31, 1994 of Chemical
Banking Corporation).
10.2 Deferred Compensation Plan of Chemical Banking Corporation and
Participating Companies, as amended through January 1, 1993
(incorporated by reference to Exhibit 10.5 to the Annual Report
on Form 10-K for the year ended December 31, 1994 of Chemical
Banking Corporation).
10.3 Deferred Compensation Plan for Non-Employee Directors of Chemical
Banking Corporation and Chemical Bank, as amended and restated
effective December 15, 1992 (incorporated by reference to Exhibit
10.6 to the Annual Report on Form 10-K for the year ended December
31, 1992 of Chemical Banking Corporation).
10.4 Chemical Banking Corporation Long-Term Stock Incentive Plan, as
amended and restated as of May 19, 1992 (incorporated by reference
to Exhibit 10.7 to the Annual Report on Form 10-K for the year ended
December 31, 1992 of Chemical Banking Corporation).
10.5 Forms of employment agreements as entered into by Chemical Banking
Corporation and certain of its executive officers.
10.6 Post-Retirement Compensation Plan for Non-Employee Directors, as
amended and restated as of December 15, 1992 (incorporated by
reference to Exhibit 10.10 to the Annual Report on Form 10-K for the
year ended December 31, 1992 of Chemical Banking Corporation).
11
------------------------------------------------------------------------
10.7 Permanent Life Insurance Options Plan (incorporated by reference to
Exhibit 10.11 to the Annual Report on Form 10-K for the year ended
December 31, 1992 of Chemical Banking Corporation).
10.8 Executive Retirement Plan of Chemical Banking Corporation and
Certain Subsidiaries.
10.9 Supplemental Retirement Plan of Chemical Bank and Certain
Affiliated Companies, restated effective January 1, 1993 and as
amended through January 1, 1995.
11.1 Computation of Net Income per Common Share.
12.0 Computation of ratio of earnings to fixed charges.
12.1 Computation of ratio of earnings to fixed charges and preferred
stock dividend requirements.
21.1 List of Subsidiaries of Chemical Banking Corporation.
22.1 Annual Report on Form 11-K of the Chemical Savings Plan of Chemical
Bank and Certain Affiliates (to be filed by amendment pursuant to
Rule 15d-21 under the Securities Exchange Act of 1934).
22.2 Annual Report on Form 11-K of the Margaretten Financial Corporation
Savings Plan (to be filed by amendment pursuant to Rule 15d-21 under
the Securities Exchange Act of 1934).
23.1 Consent of Independent Accountants.
27.1 Financial Data Schedule.
99.0 Supplemental Pro Forma Financial Statements.
The Corporation hereby agrees to furnish to the Commission, upon request, copies
of instruments defining the rights of holders for the following outstanding
nonregistered long-term debt of the Corporation and its subsidiaries: Floating
Rate Subordinated Note Due 1998 of the Corporation; Subordinated Floating Rate
Notes Due 2003 of the Corporation; Floating Rate Note Due 2002 of the
Corporation; Zero-Coupon Note Due 2002 of the Corporation; Serial Zero Coupon
Guaranteed Notes Due 1984-2003 of the Corporation; 8.35% Senior Notes Due
January 27, 2000 of the Corporation; Floating Rate Senior Notes Due October 17,
2001 of the Corporation; Senior Floating Rate Notes Due to 2000 of the
Corporation; 7 1/4% Subordinated Notes Due 2002 of Chemical Bank; 7%
Subordinated Notes Due 2005 of Chemical Bank; Floating Rate Subordinated Notes
Due May 5, 2003 of Chemical Bank; Floating Rate Subordinated Notes Due June 15,
2000 of Chemical Bank; Floating Rate Subordinated Notes Due July 29, 2003 of
Chemical Bank; 6.58% Subordinated Notes Due 2005 of Chemical Bank; 6.70%
Subordinated Notes Due 2008 of Chemical Bank; 6.125% Subordinated Notes Due 2008
of Chemical Bank; Adjustable Rate Notes Due April 1, 2011 of Texas Commerce
Bancshares, Inc.; Floating Rate Subordinated Notes Due 1997 of Manufacturers
Hanover Corporation; Floating Rate Subordinated Capital Notes Due April 1997 of
Manufacturers Hanover Trust Company; and LIBOR Note, Series C, Due March 1998 of
Manufacturers Hanover Corporation. These instruments have not been filed as
exhibits hereto by reason that the total amount of each issue of such securities
does not exceed 10% of the total assets of the Corporation and its subsidiaries
on a consolidated basis.
(b) REPORTS ON FORM 8-K
- A Current Report on Form 8-K dated October 18, 1995 was filed setting forth
the Corporation's financial results for the 1995 third quarter.
- A Current Report on Form 8-K dated October 26, 1995 was filed setting forth
certain financial information for The Chase Manhattan Corporation and pro
forma combined financial information for the combined entity giving effect to
the merger.
- A Current Report on Form 8-K dated December 14, 1995 was filed announcing that
stockholders of the Corporation as well as stockholders of The Chase Manhattan
Corporation had approved the planned merger of the two companies.
- A Current Report on Form 8-K dated December 19, 1995 was filed announcing that
the Corporation had completed the sale of half of its 40% interest in The CIT
Group.
12
MANAGEMENT'S DISCUSSION AND ANALYSIS Chemical Banking Corporation
SUMMARY OF SELECTED FINANCIAL DATA and Subsidiaries
(a) On January 1, 1995, the Corporation adopted Statement of Financial
Accounting Standards No. 106, "Employer's Accounting for Postretirement Benefits
Other Than Pensions" ("SFAS 106"), for the accounting for other postretirement
benefits relating to the Corporation's foreign plans. On January 1, 1993, the
Corporation adopted SFAS 106 for its domestic plans, which resulted in a charge
of $415 million and Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes" ("SFAS 109")which resulted in an income tax
benefit of $450 million. (b) The 1991 amount excludes cash dividends of $.29 per
share of Class B Common Stock. The Class B Common Stock was converted into the
Corporation's Common Stock in the first quarter of 1992. (c) The Corporation
recognized its remaining Federal income tax benefits in 1993. The pro forma
section presents the earnings prior to 1994 on a fully-taxed basis and excludes
the impact of the $11 million accounting change in 1995, the $260 million
restructuring charge in 1994, the $115 million merger-related charge and $35
million benefit of accounting changes in 1993 and the $625 million restructuring
charge in 1991. (d) On January 1, 1994, the Corporation adopted Financial
Accounting Standards Board ("FASB") Interpretation No. 39 ("FASI 39"). Excluding
the gross up impact of FASI 39, the return on average assets for 1995 and 1994
was 1.14% and 0.86%, respectively. (e) Excludes restructuring charges,
foreclosed property expense and, in 1994 and 1993, gains on emerging markets
past-due interest bond sales. (f) Risk-based capital and leverage ratios exclude
the assets and off-balance sheet financial instruments of the Corporation's
securities subsidiary, Chemical Securities Inc., as well as the Corporation's
investment in this subsidiary.
13
MANAGEMENT'S DISCUSSION AND ANALYSIS
-------------------------------------------------------------------------------
On March 31, 1996, The Chase Manhattan Corporation ("Chase") will merge with and
into Chemical Banking Corporation (the "Corporation"). Upon consummation of the
merger, Chemical Banking Corporation will change its name to "The Chase
Manhattan Corporation" ("New Chase"). (See The Merger with Chase on page 15 for
a further description of the merger).
Because the merger, which will be accounted for as a pooling of interests,
occurred subsequent to December 31, 1995, the information presented in this
Annual Report on Form 10-K does not give effect to the impact of the merger.
Consequently, unless otherwise expressly stated, the information presented
relates to Chemical Banking Corporation prior to the merger with Chase.
Supplemental financial statements that reflect the combined financial condition
and results of operations of the Corporation and Chase, as if the merger had
been in effect for all periods presented, are included on pages 97 through 103.
--------------------------------------------------------------------------------
- OVERVIEW
Chemical Banking Corporation (the "Corporation") reported record net income of
$1,805 million for 1995, an increase of 39% from net income of $1,294 million in
1994. The 1994 results included a fourth quarter restructuring charge of $260
million ($152 million after-tax). The Corporation's primary earnings per share
were $6.73 in 1995, an increase of 46% from $4.60 in 1994. On a fully-diluted
basis, earnings per share were $6.47 in 1995, compared with $4.54 for the
prior year.
Excluding the fourth quarter of 1994 restructuring charge, net income for
1995 increased 25% from comparable earnings of $1,446 million in 1994. Primary
earnings per share increased 29% from $5.20 in 1994, while fully-diluted
earnings per share increased 26% from $5.13 a year ago. The 1995 results were
characterized by revenue growth, lower expenses and a disciplined use of
capital.
On December 1, 1994, the Corporation announced a two-year program ("Actions
to Improve Earnings Per Share") designed to produce earnings per share growth of
more than 15% in 1995 and in 1996, an efficiency ratio of 60% in 1995 and 57% by
1996, and a return on common stockholders' equity of 15% in 1995 and 16% by
1996.
The following table compares the Corporation's 1995 actual results with the
goals announced in the Corporation's Actions to Improve Earnings Per Share
program.
In connection with the capital discipline phase of the program, the
Corporation took the following actions during 1995:
- The Corporation completed two transactions in the fourth quarter as part of
its plan to free up capital through the sale of non-strategic businesses. On
October 6, 1995, the Corporation sold its banking operations in southern and
central New Jersey to PNC Bank Corp. for approximately $490 million. The sale
did not include the Corporation's franchise in northeastern New Jersey, where
it retains 39 branches and private banking operations. On December 15, 1995,
the Corporation completed the sale of half its 40% interest in the CIT Group
Holdings, Inc. ("CIT") to The Dai-Ichi Kangyo Bank for approximately $430
million. The two transactions resulted in a net after-tax gain of
approximately $25 million.
- In the 1995 first quarter, the Corporation sold its interest in Far East Bank
and Trust Company in the Philippines, resulting in an $85 million gain ($51
million after tax). This transaction was part of the Corporation's plan to
sell minority interests in overseas entities that are not considered
strategic.
- The Corporation formed a joint venture with Mellon Bank Corporation that
provides stock transfer and related shareholder services to publicly-held
companies. The joint venture is a 50/50 partnership, with both entities
sharing equally in the joint venture's initial capitalization, including
investments in new technology.
CREDIT PROFILE
The Corporation's nonperforming assets at December 31, 1995 were $906 million, a
decline of 20% from $1,139 million at year-end 1994. As a result of the
continued decline in nonperforming assets, the ratio of the allowance for credit
losses to nonperforming loans reached 278% at December 31, 1995, compared with
267% at December 31, 1994. Nonperforming assets have declined by $5,681 million,
or 86%, from their peak level of $6,587 million in September 1992.
CAPITAL
At December 31, 1995, the Corporation's Tier 1 Capital and Total Capital ratios
were 8.45% and 12.10%, respectively, well in excess of the minimum ratios
specified by the Board of Governors of the Federal Reserve System ("Federal
Reserve Board"). At December 31, 1995, the Corporation was "well capitalized",
as defined by the Federal Reserve Board.
14
Chemical Banking Corporation
and Subsidiaries
--------------------------------------------------------------------------------
-THE MERGER WITH CHASE
On March 31, 1996, Chase will merge with and into the Corporation. Upon
consummation of the merger, the Corporation will have in excess of $300 billion
in total assets and $20 billion in shareholders' equity making it the largest
banking institution in the United States.
Under the terms of the merger agreement, approximately 186 million shares of
the Corporation's common stock will be issued in exchange for all of the
outstanding shares of Chase's common stock (based on an exchange ratio of 1.04
shares of the Corporation's common stock for each share of Chase's common
stock). All of Chase's series of preferred stock will be exchanged on a
one-for-one basis for a corresponding series of the Corporation's preferred
stock having substantially the same terms as the Chase preferred stock so
converted. The merger will be accounted for as a pooling of interests. The
supplemental financial statements presented on pages 97 through 103 of this
report present the financial condition and results of operations of the
Corporation and Chase as if the merger had been in effect for all periods
presented.
At the time of the merger announcement on August 28, 1995, it was estimated
that annual cost savings from the merger would be $1.5 billion to be achieved
within three years of the merger date by consolidating certain operations and
eliminating redundant costs. In connection with the merger announcement, the
Corporation estimated that it would take a pre-tax merger charge of $1.5
billion, principally as a result of severance expenses associated with the
elimination of approximately 12,000 positions from a combined staff of 75,000
located in 39 states and 51 countries and expenses associated with the
elimination of offices and redundant operations. Since the date of the merger
announcement, the Corporation has continued to evaluate the costs anticipated
to be incurred in connection with the merger, as well as the cost savings from
the merger, and currently anticipates that the merger-related restructuring
charge, as well as the cost savings, will each be higher than originally
announced.
For further information regarding the merger, see Note Two of the Notes to
Consolidated Financial Statements.
--------------------------------------------------------------------------------
-RESULTS OF OPERATIONS
(a) Reflected on a taxable equivalent basis in order to permit comparisons of
yields on tax-exempt and taxable assets.
Reported net interest income for 1995 was $4,689 million, compared with
$4,674 million in 1994. The 1995 results were affected by the securitization of
$2.25 billion in credit card receivables and the sale of certain New Jersey
operations in the fourth quarter, which reduced 1995 net interest income by $49
million and $33 million, respectively. Excluding the impact of these factors,
the improvement in 1995 when compared with the prior year was primarily due to
an $11.6 billion increase in interest-earning assets (led by growth in consumer
loans) and a reduction in the cost of carrying nonperforming loans, partially
offset by narrower spreads.
The interest rate spread, which is the difference between the average rate on
interest-earning assets and the average rate on interest-bearing liabilities,
was 2.59% for 1995, compared with 3.07% for 1994. The net yield on
interest-earning assets, which is the average rate for interest-earning assets
less the average rate paid for all sources of funds, including the impact of
interest-free funds, was 3.33% in 1995, compared with 3.61% in 1994. The
declines in 1995 principally reflected narrower loan spreads due to increased
pressure on loan pricing, the impact of higher interest rates on wholesale
funding, and the securitization of credit card receivables. These factors
were partially offset by the reduction in nonperforming loans and an increased
contribution from noninterest-bearing funds.
The following table reflects the composition of interest-earning assets as a
percentage of total earning assets as well as the interest rate spread and the
net yield on interest-earning assets for the periods indicated.
15
MANAGEMENT'S DISCUSSION AND ANALYSIS
--------------------------------------------------------------------------------
The Corporation's average total loans in 1995 were $81.6 billion, compared
with $75.2 billion in 1994. The increase reflected the continued growth in
consumer loans (principally from residential mortgage and credit card
activities) and commercial lending, partially offset by a reduction in the
commercial real estate portfolio.
The growth in interest-earning assets was funded by a $9.6 billion increase
in interest-bearing liabilities. For 1995, average interest-bearing liabilities
were $121.7 billion, compared with $112.1 billion for 1994, principally due to a
higher level of foreign interest-bearing deposits and Federal funds purchased
and securities sold under repurchase agreements. The Corporation utilizes
repurchase agreements as a source of short-term funding for trading-related
positions and for its securities portfolio.
The negative impact on net interest income from nonperforming loans
(excluding nonperforming loans held for accelerated disposition) in 1995 was $53
million, compared with $65 million in 1994, reflecting the continued reduction
in the level of the Corporation's nonperforming loans.
The favorable impact on net interest income from the Corporation's
asset/liability derivative activities, whereby derivative instruments are used
in order to alter the yield on certain of the Corporation's assets and
liabilities, was $28 million for 1995, compared with $190 million for 1994. For
a further discussion of derivative instruments used in the Corporation's
asset/liability management ("ALM") activities as well as the Corporation's
sensitivity to interest rates, see the Asset/Liability Management section on
pages 32-36.
For additional information on average balances and net interest income, see
the Average Consolidated Balance Sheets, Interest and Rates on pages 78 to 83.
PROVISION FOR LOSSES
The provision for losses in 1995 was $478 million, compared with $550 million in
1994, as a result of a decline in loan net charge-offs due to an overall
improvement in the Corporation's credit profile. For a discussion of the
Corporation's net charge-offs, see page 24.
NONINTEREST REVENUE
Noninterest revenue totaled $3,766 million in 1995, an increase of 5% when
compared with 1994. The 1995 results reflected increased revenues from corporate
finance and syndication fees, fees for other financial services, credit card
revenue and securities gains. These increases were partially offset by declines
in trust and investment management fees, trading revenue, and losses on emerging
markets bond sales.
The following table presents the components of noninterest revenue for the
periods indicated.
FEES AND COMMISSIONS
Corporate finance and syndication fees include revenue from managing and
syndicating loan arrangements; providing financial advisory services in
connection with leveraged buyouts, recapitalizations and mergers and
acquisitions; and arranging private placements and underwriting debt and equity
securities. Corporate finance and syndication fees in 1995 reached a record
level of $531 million, a 31% increase from the prior year, reflecting increases
in global investment banking activities, especially loan syndications and new
issues of high-yield securities. During 1995, the Corporation acted as agent or
co-agent for approximately $423 billion of syndicated credit facilities,
compared with $319 billion in 1994, a reflection of the Corporation's large
client base and strong emphasis on distribution.
Trust and investment management fees are primarily comprised of corporate,
institutional and private banking (personal trust) activities provided to
corporations and individuals on a global basis. The Corporation's corporate and
institutional trust area provides customers with a full range of services such
as trustee and securities processing, as well as investment advisory and
administrative functions for customers' pension and other employee benefit
plans. The Corporation's private banking area provides a full range of services
for high-net worth individuals. The Corporation's family of proprietary mutual
funds, The Hanover Funds, are managed within the private banking area.
The following table reflects the components of trust and investment
management fees for the periods indicated.
16
Chemical Banking Corporation
and Subsidiaries
--------------------------------------------------------------------------------
Personal trust and investment management fees in 1995 remained consistent
with the prior year due to an increase in assets under management, offset by
pricing pressures. Corporate and institutional trust fees decreased 26% from the
1994 level largely due to the absence of $46 million in fees in 1995 related to
the joint venture with Mellon Bank Corporation. As a result of the shareholder
services joint venture between the Corporation and Mellon Bank Corporation,
effective January 1, 1995, revenues and expenses of the affected business units
were reflected on an equity basis within other revenue.
Credit card revenue increased $63 million from the 1994 level due to an
increased volume of retail credit card receivables from a growing cardholder
base, as well as increased fees related to the securitization of $2.25 billion
in credit card outstandings in the fourth quarter of 1995. For a further
discussion of the credit card portfolio and related securitization activity, see
page 25.
Fees for other financial services for 1995 were $850 million, an increase of
$17 million from a year ago. The following table reflects the components of fees
for other financial services for the periods indicated.
Mortgage servicing fees increased $15 million in 1995 reflecting a higher
level of mortgage servicing volume resulting from the acquisition of Margaretten
Financial Corporation ("Margaretten") on July 1, 1994, as well as additions to
the portfolio from mortgage originations. The Corporation's residential mortgage
servicing portfolio increased $1.9 billion to $54.6 billion in 1995. For a
further discussion on the Corporation's mortgage banking activities, see the
residential mortgage section on page 25.
The improvement in other fees for 1995 reflected higher brokerage commissions
of $17 million, due to higher transaction volume at the Corporation's discount
brokerage firm, Brown and Company.
Fees in lieu of compensating balances decreased by $16 million in 1995 when
compared with 1994. Customers often pay for cash management or other banking
services by maintaining noninterest-bearing deposits. As interest rates
increase, the required compensating balance for a given level of service will
decrease. As a result, during 1995, when short-term interest rates were higher
than in 1994, a greater volume of customers maintained a compensating balance in
lieu of paying a fee for services.
TRADING REVENUE
The following table sets forth the components of total trading-related revenue
for 1995 and 1994. Net interest income related to trading activities should be
reviewed in conjunction with the trading revenue amounts in the following table.
(a) Net interest income attributable to trading activities includes accruals on
interest-earning and interest-bearing trading-related positions as well as a
management allocation reflecting the funding cost or benefit associated with
trading positions.
(b) Includes interest rate swaps, cross-currency interest rate swaps, foreign
exchange forward contracts, interest rate futures, and forward rate agreements
and related hedges.
(c) Includes foreign exchange spot and option contracts.
(d) Includes U.S. and foreign government and government agency securities,
corporate debt securities, emerging markets debt instruments, debt-related
derivatives, equity securities, equity derivatives, and commodity derivatives.
The $109 million decrease in revenue from interest rate contracts during 1995
was primarily due to unexpected volatility in certain European interest rate
markets. During 1995, combined foreign exchange revenue increased $134 million,
benefiting from anticipated volatility in the currency markets (in particular
from changes in the Yen, Deutsche mark and Pound Sterling) and from the
Corporation's market-making activities, which increase during periods of
volatility. The 1994 foreign exchange amount reflects a $70 million loss
resulting from unauthorized foreign exchange transactions involving the Mexican
peso. The $116 million increase in combined debt instruments and other revenue
during 1995 was primarily due to a strong performance in high-yield securities
as well as increased stability in the prices of emerging markets securities
during the year.
Trading revenues are affected by many factors, including volatility of
currencies and interest rates, the volume of transactions executed by the
Corporation on behalf of its customers, the Corporation's success in proprietary
positioning, the improvements in its credit ratings, and the steps taken by
central banks and governments which affect financial markets. The Corporation
expects its trading revenues will fluctuate as these factors will vary from
period to period.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
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OTHER NONINTEREST REVENUE
The following table presents securities gains and the composition of other
revenue for 1995 and 1994.
Securities gains were $119 million in 1995, compared with $66 million in
1994. The higher level of securities gains, all of which resulted from sales
from the available-for-sale portfolio, were made in connection with the
Corporation's ALM activities. Included in the 1995 results was a $13 million
permanent impairment loss on Barings Bank PLC securities held by the Corporation
and an $11 million loss on available-for-sale securities sales recorded at
Chemical Bank New Jersey as part of the repositioning of the retained branches.
For further discussion of the Corporation's securities, see Note Four of the
Notes to Consolidated Financial Statements.
The Corporation's other revenue was $588 million in 1995, compared with $612
million in 1994. Revenue from equity-related investments, which includes income
from venture capital activities and emerging markets investments, was $378
million in 1995, an increase of 4% from 1994. There was no significant
individual transaction gain recognized in the 1995 results, while the 1994
results included the recognition of a $78 million gain related to a single
emerging market equity investment. At December 31, 1995, the Corporation had
equity-related investments with a carrying value of $2.0 billion. Average
revenue from equity-related investments was approximately $93 million per
quarter, based upon revenues during the last eight quarterly periods.
The 1995 results included net losses of $86 million related to the
disposition of emerging market available-for-sale securities. Such dispositions
are part of the Corporation's ongoing efforts to manage its exposure in its
available-for-sale portfolios. The 1994 results included net gains of $127
million from sales of emerging markets past-due interest bonds.
Residential mortgage originations/sales activities in 1995 increased by $70
million from 1994 results primarily due to a more favorable interest rate
environment in 1995 and the impact of the adoption in 1995 of Statement of
Financial Accounting Standards No. 122, "Accounting for Mortgage Servicing
Rights" ("SFAS 122"). For a further discussion of SFAS 122, see Note One of the
Notes to Consolidated Financial Statements on page 47.
All other revenue includes the Corporation's share of net income from its
interest in CIT which, after purchase accounting adjustments, was $77 million in
1995, an increase from $73 million in 1994. On December 15, 1995, the
Corporation reduced its interest in CIT from 40% to 20%.
NONINTEREST EXPENSE
Noninterest expense in 1995 was $5,001 million, compared with $5,509 million in
1994. Included in the results for 1994 was a $260 million restructuring charge
taken in connection with the Corporation's Actions to Improve Earnings Per
Share, and a $48 million restructuring charge related to the closing of 50 New
York State branches. Excluding the restructuring charges in 1994, noninterest
expense for 1995 decreased by $200 million, or 4% from 1994.
The improvement from the prior year reflects the benefits of certain
expense-reduction initiatives announced on December 1, 1994 by the Corporation
as part of its Actions to Improve Earnings Per Share. Also contributing to the
reduction in noninterest expense in 1995 was lower FDIC premium expense of $83
million reflecting a reduction in the FDIC assessment rate and the sale of
Chemical New Jersey Holdings to PNC Bank Corp. ("PNC") which resulted in a
noninterest expense reduction of approximately $31 million. Additionally, as a
result of the shareholder services joint venture agreement with Mellon Bank
Corporation, approximately $67 million of 1995 expenses associated with the
stock transfer and related shareholder servicing operations were recorded on an
equity basis within noninterest revenue. The decrease in noninterest expense
from 1994 was partially offset by the inclusion of a full year of noninterest
expense relating to Margaretten (compared with only six months of noninterest
expense in 1994), as Margaretten was acquired in July 1994.
The following table presents the components of noninterest expense for the
periods indicated.
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The Corporation's efficiency ratio improved to 59.4% in 1995 compared with
63.4% in 1994. Achieving an efficiency ratio of 60% in 1995 was a primary goal
of the Corporation's Actions to Improve Earnings Per Share. The computation of
the efficiency ratio (noninterest expense as a percentage of the total of net
interest income and noninterest revenue) excludes any restructuring charges,
foreclosed property expense and, in 1994, gains on emerging markets-related
past-due interest bond sales.
SALARIES AND EMPLOYEE BENEFITS
The increase in salaries in 1995 was primarily due to higher incentive costs as
a result of improved earnings for most businesses and a competitive recruiting
environment for specialized skills at selected businesses. Also contributing to
the increase in salaries was the vesting of various stock incentive awards
due to the improvement in the Corporation's stock price during 1995, the
continued growth in the Corporation's securities underwriting business and the
additional staff costs resulting from the 1994 Margaretten acquisition.
Partially offsetting these increases were the impact of personnel reductions
undertaken in 1995 and lower salaries expense as a result of the sale of the
southern and central New Jersey banking operations of Chemical New Jersey
Holdings and the equity accounting for the shareholder services joint venture
with Mellon Bank Corporation.
The following table presents the Corporation's full-time equivalent employees
at the dates indicated.
At December 31, 1995, there were approximately 2,800 positions eliminated
from the 3,700 positions targeted for elimination as part of the Corporation's
Actions to Improve Earnings Per Share.
OCCUPANCY AND EQUIPMENT EXPENSE
Occupancy expense was $520 million in 1995, a decrease of $53 million from 1994.
The decline from 1994 is largely the result of the consolidation of operational
and branch facilities and other expense-reduction initiatives.
Equipment expense in 1995 was $395 million, compared with $382 million in
1994. The higher level of equipment expense in 1995 was due to continued
technology enhancements to support the Corporation's investment in certain key
businesses (in particular its trading and consumer banking businesses).
FORECLOSED PROPERTY EXPENSE
Foreclosed property expense was a credit of $23 million in 1995, compared with
an expense of $41 million in 1994, reflecting the significant progress in
reducing the Corporation's nonperforming real estate portfolio. The 1995 amount
included proceeds received by Texas Commerce on the sale of certain foreclosed
properties previously written down. Included in the 1994 results was a $12
million charge in conjunction with the transfer of certain real estate assets to
the held-for-accelerated-disposition category.
RESTRUCTURING CHARGE
As part of the Actions to Improve Earnings Per Share announced in the fourth
quarter of 1994, the Corporation recorded a $260 million restructuring charge.
This charge was related to severance and other termination-related costs of $138
million associated with the elimination of 3,700 positions and costs of $122
million for the disposition of certain facilities, premises and equipment, and
the termination of leases. The staff reductions are tied to specific expense
reduction initiatives such as commercial lending re-engineering, branch network
rationalization, and the process improvement program at Texas Commerce and have
occurred within all business sectors of the Corporation.
During 1994, the Corporation also recorded a restructuring charge of $48
million related to the closing of 50 New York branches and a staff reduction of
650. For a further discussion of the Corporation's restructuring charges
included in noninterest expense, see Note Sixteen of the Notes to Consolidated
Financial Statements.
OTHER NONINTEREST EXPENSE
The following table presents the components of other expense for the periods
indicated.
(a) Certain prior period amounts have been reclassified to conform with the
current year's presentation.
Professional services, marketing expense and telecommunications expense all
decreased in 1995 when compared with 1994 primarily as a result of the
Corporation's sourcing and other expense-reduction initiatives. FDIC
assessments declined $83 million during 1995 reflecting a reduction in FDIC
assessment rates. Amortization of intangibles decreased by $14 million during
1995 due in part to the sale of the southern and central New Jersey banking
operations of Chemical New Jersey Holdings. All other expense, which includes
various smaller expense categories such as stationery and other supplies,
postage, shipping, travel and insurance, decreased by 12% in 1995 when compared
with 1994 reflecting the Corporation's sourcing and other expense-reduction
initiatives.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
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INCOME TAXES
The following table presents the Corporation's income tax expense and effective
tax rate for the periods indicated.
Included in the 1995 income tax expense is a tax benefit of approximately $25
million related to the sale of Chemical New Jersey Holdings and half of the
Corporation's 40% interest in CIT.
For additional information, refer to Note Seventeen of the Notes to
Consolidated Financial Statements.
--------------------------------------------------------------------------------
- LINES OF BUSINESS RESULTS
The Corporation conducts domestic and international financial services
businesses through various bank and non-bank subsidiaries. At December 31, 1995,
the principal bank subsidiaries of the Corporation were Chemical Bank and Texas
Commerce Bank National Association.
Lines-of-Business Results: Profitability of the Corporation is tracked with an
internal management information system that produces lines-of-business
performance data for all sectors. A set of management accounting policies has
been developed and implemented to ensure that the reported results reflect the
economics of their businesses. Lines-of-business results are subject to
restatement as appropriate whenever there are refinements in management
reporting policies or changes to the management organization. Thus, certain
amounts reported in prior periods have been restated to conform with the current
1995 presentation. Lines-of-business results are subject to further restatements
as may be necessary to reflect future changes in internal management reporting.
Guidelines exist for assigning expenses that are not directly incurred by
businesses, such as overhead and taxes, as well as for allocating shareholders'
equity and the provision for losses, utilizing a risk-based methodology.
Noninterest expenses of the Corporation are fully allocated to the business
units except for special corporate one-time charges. Management has developed a
risk-adjusted capital methodology that quantifies different types of risk -
credit, market, operating/business - within various businesses and assigns
capital accordingly. Credit risk is computed using a risk-grading system that is
consistently applied throughout the Corporation. A long-term expected tax rate
is assigned in evaluating the Corporation's businesses.
Commencing in 1995, Texas Commerce's results are reported on a management
accounting basis instead of a legal entity basis. The 1994 results for Texas
Commerce have been restated to conform to the current presentation. The results
for Texas Commerce are included within the Consumer and Relationship Banking
results.
(a) Total column includes Corporate sector. See description of Corporate sector
on page 22.
(b) Includes restructuring charges of $308 million in 1994.
(c) The provision is allocated to each sector utilizing a credit risk
methodology which is computed using a risk-grading system for that sector's loan
portfolio. The difference between the risk-based provision and the Corporation's
provision is included in the Corporate sector.
(d) The computation of the efficiency ratio (noninterest expense as a percentage
of the total of net interest income and noninterest revenue) excludes
restructuring charges, foreclosed property expense, and, in 1994, gains on
emerging markets past-due interest bond sales.
NM - Not meaningful.
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GLOBAL BANK
The Global Bank provides banking, financial advisory, trading and investment
services to corporations and public-sector clients worldwide through a network
of offices in 35 countries, including major operations in all key international
financial centers.
The Global Bank is comprised of three principal business lines: Global
Banking & Investment Banking (client management, loan syndications and portfolio
investments; high-yield finance; venture capital; mergers and acquisitions and
other advisory services); Global Markets (foreign exchange dealing; derivatives
trading and structuring, risk management and sales; securities structuring,
underwriting, trading and sales; and management of the Corporation's funding and
securities investment activities); and Regional Centers (all wholesale banking;
investment banking; capital markets and other activities outside of the United
States and the major cross-border financial centers). The Global Bank seeks to
optimize its risk profile and profitability by emphasizing originations,
underwriting, distribution, and risk management products.
The Global Bank's net income in 1995 was $931 million, an increase of $241
million from 1994. The sector's return on equity in 1995 was 23.6%, compared
with 16.2% in 1994. The increase in the 1995 results reflects higher corporate
finance and syndication fees, the gain related to the sale of the Corporation's
investment in Far East Bank and Trust Company and securities gains, partially
offset by lower trading revenue.
The following table sets forth the significant components of the Global
Bank's total revenue by business for the periods indicated.
Revenue for Global Banking & Investment Banking increased in 1995 by $251
million when compared with 1994. The increase from last year was primarily due
to higher fee revenue as a result of the Corporation's leading market share in
the loan syndication business and increased revenue from equity-related
investments in 1995.
Revenue for Global Markets decreased in 1995 when compared with 1994,
primarily as a result of a $69 million decline in trading revenue, reflecting
unexpected volatility of interest rates in the foreign trading markets. The
decrease in revenue from last year was also affected by lower net interest
income due to higher short-term interest rates in 1995.
Revenue for Regional Centers increased $180 million in 1995, when compared
with 1994. Increased commercial loan volume and improved interest rate
environments, primarily in Latin America, increased net interest income by $42
million for 1995, compared with 1994 results. Trading revenue increased $34
million, primarily in Europe. Also contributing to the increase in revenue for
1995 was the gain related to the sale of the Corporation's interest in Far East
Bank and Trust Company.
CONSUMER AND RELATIONSHIP BANKING
Consumer and Relationship Banking includes Metropolitan Banking (consumer
banking and commercial and professional banking); Retail Card Services; Mortgage
Bank; National Consumer Finance (home secured lending, student lending, and
other consumer lending); Middle Market (regional commercial banking); Private
Banking; Geoserve (cash management, funds transfer, trade, corporate trust and
securities services worldwide); and Texas Commerce. The Corporation maintains a
leading market share position in serving the financial needs of middle market
commercial enterprises and small businesses in the New York metropolitan area.
Private Banking serves a high net-worth clientele with banking, advisory and
investment services. Texas Commerce is a leader in providing financial products
and services to businesses and individuals throughout Texas and is the primary
bank for more large corporations and middle market companies than any other bank
in Texas.
On October 6, 1995, the Corporation sold Chemical New Jersey Holdings, Inc.
to PNC for approximately $490 million. The sale did not include Chemical's
franchise in northeastern New Jersey, where it retains 39 branches and its
private banking operations. For a further discussion of this sale, see Other
Events section on Page 39.
For 1995, Consumer and Relationship Banking's net income was $871 million, an
increase of $143 million from the prior year. The 1994 results included a $48
million restructuring charge ($28 million after-tax) related to the closing of
50 New York branches and a staff reduction of 650. Excluding the restructuring
charge, Consumer and Relationship Banking's earnings for 1995 increased by $115
million when compared with 1994 due to lower noninterest expense of $157 million
(relating to the reduced FDIC premium expense coupled with the positive effects
of the Corporation's Actions to Improve Earnings Per Share program), higher
noninterest revenue of $64 million and lower foreclosed property expense of $7
million. These factors were partially offset by a higher credit provision of $76
million. The higher credit provision in 1995 reflects the substantial growth in
credit card outstandings.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
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The following table sets forth the significant components of Consumer and
Relationship Banking's total revenue by business for the periods indicated.
(a) Effective January 1, 1995, revenues and expenses of the business units that
contributed to the shareholder services joint venture with Mellon Bank
Corporation were reflected on an equity basis within the Geoserve line. The 1994
amounts have been restated to disclose revenue related to the shareholder
services joint venture on a comparable basis.
Metropolitan Banking had revenue growth of $48 million in 1995, an increase
of 5% when compared with 1994. The improvement in 1995 was due mainly to
favorable deposit spreads, targeted customer segmentation and repricing
initiatives.
Retail Card Services revenue increased $106 million, or 10%, in 1995,
compared with 1994. An increase in Shell MasterCard outstandings and resulting
strong fee growth contributed to the increase in revenue. In the fourth quarter
of 1995, Retail Card Services securitized approximately $2.25 billion of credit
card receivables which reduced net interest income. However, this decrease was
offset by increased fee revenue and a lower provision for credit losses. Total
outstandings for Retail Card Services at the 1995 year-end were $8.7 billion,
compared with $9.3 billion at the end of 1994. The decrease in 1995 reflects the
aforementioned securitization.
The Mortgage Bank continues to be faced with fierce competition due to
industry overcapacity and higher interest rates, both of which have adversely
affected the 1995 results. Despite these factors, during 1995 the Mortgage Bank
recorded increased revenues when compared with 1994, primarily due to the
implementation of SFAS 122 as well as higher servicing-related revenues as a
result of the acquisition of Margaretten.
National Consumer Finance revenues have remained relatively stable in 1995,
when compared with 1994. National Consumer Finance outstandings increased in
1995 by more than 18% over 1994. Despite the increase in outstandings,
competitive pricing pressures largely offset the favorable impact from the
higher level of outstandings.
Middle Market revenues were essentially flat for 1995, when compared with
1994. Middle Market experienced favorable deposit spreads and a reduction in the
level of nonperforming assets in 1995; however, loan spreads and deposit volumes
have decreased primarily due to heightened competition.
Private Banking revenue increased $16 million, or 5%, in 1995, compared with
1994. Private Banking revenue for 1995 includes the adverse impact of an $11
million loss from the sale of Barings Bank PLC securities. Excluding this loss,
Private Banking's revenues for 1995 would have reflected a 9% increase over
1994. These positive results are attributable to loan and deposit growth,
favorable deposit spreads and higher fees generated by greater volume in the
brokerage business for 1995.
Geoserve revenues increased $12 million in 1995, when compared with 1994. The
improvement in 1995 reflects a 6% increase experienced by treasury management
products, partially offset by a decline in global securities and trust revenue.
Texas Commerce revenue increased $39 million, or 4%, in 1995, compared with
1994. The improvement in 1995 was due to higher net interest income resulting
from growth in loan volume and more favorable interest rate spreads.
Also, contributing to the increase in earnings for 1995 was lower foreclosed
property expense. The substantial decrease in foreclosed property expense is
attributable to the improvement in the Texas real estate market and payments
received related to certain foreclosed properties that were previously written
down.
TERMINAL BUSINESSES (LDC AND REAL ESTATE)
Terminal Businesses represents discontinued portfolios which are primarily the
refinancing country debt portfolio and the Corporation's commercial real
estate nonperforming portfolio, primarily at Chemical Bank. Terminal businesses
had net losses of $47 million for 1995 compared with net income of $42 million
in 1994. The unfavorable 1995 results, when compared with 1994, were primarily
due to losses of $86 million related to the disposition of available-for-sale
emerging markets securities, compared with gains of $127 million from sales of
such securities in 1994. Net interest income decreased $42 million in 1995 due
to a decline in loan outstandings. The improvements in credit provision and
foreclosed property expense reflects the significant progress made in managing
the Corporation's real estate portfolio. Total nonperforming assets for this
category at December 31, 1995 were $207 million, down $79 million from $286
million at December 31, 1994. The improvement in nonperforming asset levels
from last year is the result of increased liquidity in the real estate markets
and successful workout activities.
CORPORATE
Corporate includes the management results attributed to the parent company; the
Corporation's investment in CIT; and some effects remaining at the corporate
level after the implementation of management accounting policies, including
residual credit provision and tax expense. On December 15, 1995, the Corporation
completed the sale of half its 40% interest in the CIT to The Dai-Ichi Kangyo
Bank for approximately $430 million. Corporate had net income of $50 million for
1995, which includes an $11 million after-tax charge due to the adoption of SFAS
106 for foreign employees and a $6 million writedown associated with certain
nonperforming residential mortgages. In 1994, the net loss of $166 million
included a $152 million after-tax restructuring charge associated with the
Actions to Improve Earnings Per Share.
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- CREDIT RISK MANAGEMENT
Credit risk for both lending-related products and derivative and foreign
exchange products represents the possibility that a loss may occur if a borrower
or counterparty fails to honor fully the terms of a contract. Under the
direction of the Chief Credit Officer, risk policies are formulated, approved
and communicated throughout the Corporation. The Credit Risk Management
Committee, chaired by the Chief Credit Officer, is responsible for maintaining a
sound credit process, addressing risk issues, and reviewing the portfolio.
The Corporation's credit risk management is an integrated process operating
concurrently at the transaction and portfolio levels. For credit origination,
business professionals formulate strategies, target markets, and determine
acceptable levels of risk. Credit executives work with business originators
during the underwriting process to review adherence to risk policies.
Portfolio diversification lowers the Corporation's risk profile. In addition
to the diversification achieved by the expanse of the Corporation's businesses,
the Corporation diversifies by securitizing and selling credit assets such as
loans, thereby seeking to avoid unacceptable risk concentrations.
Loan Portfolio: The consumer and commercial segments of the portfolio have
different risk characteristics and different techniques are utilized to measure
and manage their respective credit risks. The consumer loan risk management
process utilizes sophisticated credit scoring and other analytical methods to
differentiate risk characteristics. Risk management procedures include
monitoring both loan origination credit standards and loan performance quality
indicators. The consumer portfolio review process also includes evaluating
product-line performance, geographic diversity and consumer economic trends.
Within the commercial segment, each credit facility is risk graded.
Facilities are subject to hold targets based on risk, and are often syndicated
in order to lower potential concentration risks. Syndication consists of
arranging a credit facility between a borrower and a group of lenders, in which
each lender assumes a share of the facility thereby limiting the Corporation's
risk with regard to the facility. The syndicated portions are not recorded on
the Corporation's consolidated balance sheet. These activities enable the
Corporation to function as a financial intermediary between other suppliers and
users of funds. In contrast, loan sales occur only after a loan is funded by the
Corporation. Such loans are generally sold to maturity and without recourse to
the Corporation.
Real estate problem assets are managed in special units staffed for
restructuring, workout and collection. The Corporation reassesses the market
value of real estate owned for possible impairment on a continual basis.
The loan review process includes industry specialists and country-risk
managers who provide expert insight into the portfolio. Industries and countries
are also evaluated in a process which is incorporated into credit-risk decisions
through the facility-risk grading system and by direct consultation with
originating officers.
Overseas extensions of credit require not only the normal credit-risk
analysis associated with the decision to extend financing to a particular
customer, but also an assessment of country risk. Country risk arises from
economic, social and political factors that might affect a borrower's ability to
repay in the currency of the extension of credit. Cross-border credit exposures
are those that borrowers must repay in a currency other than their local
currency or to a lender in a different country. One of the major risk factors
associated with cross-border credit exposures is the possibility that a
country's foreign exchange reserves may be insufficient or unavailable to permit
timely repayment by borrowers domiciled in that country, even if the borrowers
possess sufficient local currency. In addition, global economic, social and
political conditions, local and foreign government actions and associated events
can affect business activities in a country and a borrower's ability and/or
willingness to repay external debt obligations.
The Corporation has a country-risk assessment process by which it monitors
and analyzes the economic, social and political environments in all countries in
which it conducts business or in which its borrowers reside. These in-depth
assessments, conducted by a team of economists and political analysts, in
conjunction with local management, are utilized by the Corporation in connection
with its system of managing total country exposures.
Derivative and Foreign Exchange Financial Instruments: The Corporation seeks to
control the credit risk arising from derivative and foreign exchange
transactions through its credit approval process and the use of risk control
limits and monitoring procedures. The Corporation uses the same credit
procedures when entering into derivative and foreign exchange transactions as it
does for traditional lending products. The credit approval process involves,
first, evaluating each counterparty's creditworthiness,
23
MANAGEMENT'S DISCUSSION AND ANALYSIS
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then, where appropriate, assessing the applicability of such instruments to the
risks the counterparty is attempting to manage and determining if there are
specific transaction characteristics which alter the risk profile. Credit limits
are calculated and monitored on the basis of potential exposure which takes into
consideration current market value and estimates of potential future movements
in market values. If collateral is deemed necessary to reduce credit risk, the
amount and nature of the collateral obtained is based on management's credit
evaluation of the customer. Collateral held varies but may include cash,
securities, accounts receivable, inventory, property, plant and equipment, and
real estate.
LOAN PORTFOLIO
The Corporation's loans outstanding totaled $82.1 billion at December 31, 1995,
an increase of $3.4 billion from the 1994 year end, reflecting growth in both
the domestic consumer and the commercial and industrial loan portfolios.
The Corporation's nonperforming assets at December 31, 1995 were $906
million, a decrease of $233 million from the 1994 year-end level. The reduction
in nonperforming assets reflects the improvement in the Corporation's credit
profile as a result of a lower level of loans being placed on nonperforming
status, repayments, charge-offs and the Corporation's continuing loan workout
and collection activities.
Total net charge-offs were $553 million in 1995 compared with $947 million in
1994. The 1994 amount excluded a $148 million charge related to the decision to
designate certain real estate assets as held-for-accelerated-disposition. For a
further discussion of nonperforming assets and net charge-offs, see the various
credit portfolio sections that follow.
The following table presents the Corporation's loan and nonperforming asset
balances by portfolio at December 31, 1995 and 1994 and the related net
charge-off amounts for the periods indicated. Additionally, loans which were
past due 90 days or more as to principal or interest but not characterized as
nonperforming are also included in the table below.
(a) Consists of 1-4 family residential mortgages.
(b) Consists of installment loans (direct and indirect types of consumer
finance) and student loans. There are essentially no credit losses in the
student loan portfolio due to the existence of Federal and State government
agency guarantees. At December 31, 1995 and 1994, student loans which were past
due 90 days or more and still accruing were approximately $107 million and $105
million, respectively.
(c) Represents loans secured primarily by real property, other than loans
secured by mortgages on 1-4 family residential properties.
(d) Total loans include $727 million of loans considered impaired under SFAS No
114, "Accounting by Creditors for Impairment of a Loan" ("SFAS 114"). In
addition, on January 1, 1995, $122 million of assets for which the Corporation
did not have possession were reclassified from Assets Acquired as Loan
Satisfactions to Nonperforming Loans pursuant to the adoption of SFAS 114.
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DOMESTIC CONSUMER PORTFOLIO
The domestic consumer loan portfolio consists of one-to-four family residential
mortgages, credit cards and other consumer loans. The domestic consumer loan
portfolio totaled $33.4 billion at December 31, 1995, an increase of 11% from
the prior year end. As a percentage of the total loan portfolio, consumer loans
grew to 41% at the end of 1995, an increase from 38% at December 31, 1994.
Residential Mortgage Loans: Residential mortgage loans at December 31, 1995 were
$17.7 billion, an increase of $4.2 billion from the 1994 year-end, primarily
reflecting increases in adjustable-rate loan outstandings.
The following table presents the residential mortgage loans outstanding by
geographic region at the dates indicated.
RESIDENTIAL MORTGAGE LOANS BY GEOGRAPHIC REGION
(a) Includes mortgage loans in the Texas market of $1,505 million and $1,254
million at December 31, 1995 and December 31, 1994, respectively.
(b) Includes mortgage loans in the California market of $2,910 million and $758
million at December 31, 1995 and December 31, 1994, respectively.
Total nonperforming residential mortgage loans at December 31, 1995 were $123
million, compared with $92 million at December 31, 1994. Net charge-offs were
$52 million in 1995, an increase of 11% when compared with $47 million in 1994,
primarily resulting from the growth in residential mortgage loans during 1995.
The percentage of net charge-offs to average residential mortgage loans for 1995
declined to .32% from .37% for the prior year.
During the 1995 fourth quarter, the Corporation transferred $421 million of
residential mortgage loans into the accelerated disposition portfolio. For a
further discussion of the transfer, see the Assets Held for Accelerated
Disposition section on page 28.
The Corporation both originates and services residential mortgage loans as
part of its mortgage banking activities. After origination, the Corporation
typically sells loans to investors, primarily in the secondary market, while
retaining the rights to service such loans.
In addition to originating mortgage servicing rights, the Corporation also
purchases and sells mortgage servicing rights. The Corporation may purchase bulk
rights to service a loan portfolio or the Corporation may purchase loans
directly and then sell such loans while retaining the servicing rights. As
disclosed in Note One of the Notes to Consolidated Financial Statements, the
Corporation adopted Statement of Financial Accounting Standards No. 122,
"Accounting for Mortgage Servicing Rights" ("SFAS 122") in 1995. SFAS 122
requires that when a definitive plan exists to sell or securitize mortgage loans
and retain the servicing rights related thereto, a mortgage banking enterprise
should recognize as separate assets the rights to service mortgage loans for
others, irrespective of whether those servicing rights are acquired through the
purchase or origination of mortgage loans.
The following table presents the residential mortgage servicing activity
for 1995 and 1994.
Mortgage servicing rights (included in other assets) amounted to $496 million
at December 31, 1995, compared with $469 million at December 31, 1994. The
increase from the 1994 year-end level reflects the corresponding increase in the
Corporation's residential mortgage servicing portfolio and the recognition of
originated mortgage servicing rights as assets beginning in 1995 pursuant to
SFAS 122. Capitalized mortgage servicing rights are amortized into income in
proportion to, and over the period of, the estimated future net servicing income
stream of the underlying mortgage loans. The Corporation continually evaluates
prepayment exposure of the portfolio, adjusting the balance and remaining life
of the servicing rights as a result of prepayments and utilizing derivative
contracts to reduce its exposure to such prepayments. The mortgage loans to
which the Corporation's servicing rights relate are, to a substantial degree, of
recent vintage (i.e., originated in the period 1992 through 1995 when interest
rates were relatively low). For a further discussion, see the Other Market Risk
Management section on page 35.
Credit Card Loans: The Corporation evaluates its credit card exposure based on
its "managed receivables", which include credit card receivables on the balance
sheet as well as credit card receivables which have been securitized. During the
fourth quarter of 1995, the Corporation securitized $2.25 billion of credit card
receivables, compared with none in 1994. At December 31, 1995, the
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MANAGEMENT'S DISCUSSION AND ANALYSIS
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Corporation had $10.9 billion of managed receivables ($8.7 billion of
receivables on the balance sheet) compared with $9.3 billion at year-end 1994,
reflecting the continued strong growth in credit card outstandings, principally
due to the co-branded Shell Mastercard program.
The following table presents the Corporation's domestic credit card
receivables by geographic region at the dates indicated.
DOMESTIC CREDIT CARD RECEIVABLES BY GEOGRAPHIC REGION
(a) Includes credit card receivables in the Texas market of $670 million and
$658 million at December 31, 1995 and December 31, 1994, respectively.
(b) Includes credit card receivables in the California market of $1,226 million
and $1,252 million at December 31, 1995 and December 31, 1994, respectively.
Total credit card net charge-offs were $411 million in 1995, an increase of
$82 million from the 1994 level due largely to growth in outstandings in the
credit card portfolio.
The following table presents the Corporation's average managed credit card
receivables (credit card receivables on the balance sheet plus securitized
credit card receivables), 90 days and over and accruing, net credit losses as
well as related ratios for the managed credit card portfolio for the periods
presented.
(a) Includes $409 million of average securitized credit card receivables.
(b) Includes $12 million of net charge-offs related to securitized credit card
receivables.
Credit Card Securitization: During the 1995 fourth quarter, the Corporation
securitized $2.25 billion of credit card receivables.
The securitization of credit card receivables does not significantly affect
the Corporation's reported net income. The initial gains on these sales are
recorded at the time of the securitization. Given the revolving nature of the
receivables sold, recognition of servicing fees results in a pattern of
income recognition that is similar to the pattern that would be experienced if
the receivables had not been sold. Gains on securitizations were not material in
1995.
The term of each securitization transaction averages approximately five
years. However, because securitization changes the Corporation's status from
that of a lender to that of a loan servicer, there is a change in the
classification in which the revenue associated with the securitization is
reported in the income statement. For securitized receivables, amounts that
would previously have been reported as net interest income and as provision for
losses are instead reported as components of noninterest revenue (i.e., as
credit card revenue and as other revenue). Because credit losses become a
component of the cash flows arising from the securitized transaction, the
Corporation's revenues over the terms of a securitization transaction may vary
depending upon the credit performance of the securitized receivables. However,
the Corporation's exposure to credit losses on the securitized receivables is
contractually limited to these cash flows.
The following table outlines the impact of the securitizations of credit card
receivables by showing the favorable (unfavorable) change in the reported
consolidated statement of income line items.
Other Consumer Loans: Other consumer loans consists of installment loans (direct
and indirect types of consumer finance), automobile financings and student
loans. Other consumer loans were $7,009 million at December 31, 1995 compared
with $7,265 million at December 31, 1994. The decrease in loan outstandings at
December 31, 1995 was primarily due to the sale of the Corporation's banking
operations in southern and central New Jersey. Excluding the impact of this
sale, other consumer loans increased approximately 10% from the 1994 level due
to growth in the installment loan portfolio, primarily in Texas. Total net
charge-offs were $31 million in 1995, an increase of $12 million from the 1994
level. The percentage of net charge-offs to average other consumer loans
(excluding student loans) was .64% in 1995, compared with .41% in 1994. The
increase in the charge-offs percentage was largely due to charge-offs taken in
connection with small discontinued product lines. There are essentially no
credit losses in the student loan portfolio due to the existence of Federal
and State government agency guarantees.
DOMESTIC COMMERCIAL PORTFOLIO
Domestic Commercial and Industrial Portfolio: The domestic commercial and
industrial portfolio totaled $22.5 billion at December 31, 1995, compared with
$20.8 billion at December 31, 1994. The portfolio consists primarily of loans
made to large corporate and middle market customers and is diversified
geographically and by industry. The largest industry concentrations are oil and
gas and retailing which approximate $2.1 billion (or 2.6% of total loans) and
$1.7 billion (or 2.0% of total loans), respectively. All of the other industries
are each less than 2% of total loans.
26
Chemical Banking Corporation
and Subsidiaries
--------------------------------------------------------------------------------
The Corporation is a leading participant in loan originations and sales. This
loan distribution capability allows the Corporation to compete aggressively and
profitably in wholesale lending markets by enabling it to reduce larger
individual credit exposures and thereby to price more flexibly than if all loans
were held as permanent investments. The Corporation also benefits from increased
liquidity. During 1995, the Corporation acted as agent or co-agent for
approximately $423 billion in syndicated credit facilities, compared with $319
billion in 1994.
Nonperforming domestic commercial and industrial loans were $321 million at
December 31, 1995, compared with $354 million at December 31, 1994.
Domestic commercial and industrial loan net charge-offs in 1995 totaled $24
million, compared with $81 million in the prior year.
Domestic Commercial Real Estate Portfolio: The domestic commercial real estate
portfolio represents loans secured primarily by real property, other than loans
secured by one-to-four family residential properties (which are included in the
consumer loan portfolio). The domestic commercial real estate loan portfolio
totaled $4.9 billion at December 31, 1995, a decline from $5.7 billion at
December 31, 1994. The decrease from the 1994 year-end was principally
attributable to repayments.
The following table sets forth the major components of the domestic
commercial real estate loan portfolio at the dates indicated.
Commercial mortgages provide financing for the acquisition or refinancing of
commercial properties, and typically have terms ranging from two-to-five years.
Construction loans are generally originated to finance the construction of real
estate projects. When the real estate project has cash flows sufficient to
support a commercial mortgage, the loan is transferred from construction status
to commercial mortgage status.
The largest concentration of domestic commercial real estate loans is in the
New York/New Jersey and Texas markets, representing 48% and 32%, respectively,
of the domestic commercial real estate portfolio. No other state represents more
than 2% of the domestic commercial real estate loan portfolio.
Nonperforming domestic commercial real estate assets were $187 million at
December 31, 1995, compared with $249 million at December 31, 1994. The
improvement in nonperforming domestic commercial real estate asset levels in
1995 is the result of increased liquidity in the commercial real estate markets
coupled with successful workout activities.
Domestic commercial real estate net charge-offs in 1995 totaled $53 million,
compared with $165 million in the prior year. The lower net charge-offs are due
in part to the decision in December 1994 to designate certain real estate assets
for accelerated disposition. For a more detailed discussion see the Assets Held
for Accelerated Disposition section on page 28.
During 1995, the Corporation recorded a $26 million net recovery of
writedowns as a result of payments received on certain foreclosed properties
which had been previously written down. Net writedowns of domestic commercial
real estate owned totaled $68 million in 1994.
Domestic Financial Institutions Portfolio: The domestic financial institutions
portfolio includes loans to commercial banks and companies whose businesses
primarily involve lending, financing, investing, underwriting, or insurance.
Loans to domestic financial institutions were $4,123 million at December 31,
1995 or 5% of total loans outstanding at December 31, 1995, compared with $3,918
million at December 31, 1994. Loans to domestic financial institutions are
predominantly secured loans to broker-dealers, which account for approximately
half of the total portfolio. The portfolio maintained its strong credit quality
during 1995 as the Corporation had net recoveries of $3 million in 1995 compared
with net recoveries of $1 million in 1994.
FOREIGN PORTFOLIO
The foreign portfolio includes commercial and industrial loans, loans to
financial institutions, commercial real estate loans, loans to foreign
governments and official institutions, and consumer loans. At December 31, 1995,
the Corporation's total foreign loans were $17.3 billion, compared with $18.3
billion at December 31, 1994.
Included in foreign loans were commercial and industrial loans of $8.4
billion at the end of 1995, an increase of $.8 billion from the 1994 year-end.
Total foreign commercial real estate loans at December 31, 1995 were $.4
billion, compared with $.5 billion at December 31, 1994. The bulk of the foreign
real estate portfolio is located in the United Kingdom and Hong Kong.
Foreign nonperforming loans at December 31, 1995 were $230 million, a
decrease from $311 million at December 31, 1994.
The foreign portfolio experienced net recoveries of $15 million in 1995
compared with net charge-offs of $307 million in 1994. A $291 million charge was
incurred in 1994 in connection with management's final valuation of the emerging
markets portfolio, at which time the Corporation's medium- and long-term
outstandings to the various emerging markets countries were adjusted to
estimated net recoverable values of such loans. The remaining emerging markets
allowance was transferred to the general allowance for credit losses.
For year-end loan balances by type of loan included in the foreign portfolio,
refer to Note Five of the Notes to Consolidated Financial Statements.
27
MANAGEMENT'S DISCUSSION AND ANALYSIS
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CROSS-BORDER OUTSTANDINGS
The following table lists all countries in which the Corporation's
cross-border outstandings exceeded 1% of consolidated assets as of any of the
dates specified. The Corporation does not have significant local currency
outstandings in the individual countries listed in the following table that are
not hedged or funded by local currency borrowings.
CROSS-BORDER OUTSTANDINGS EXCEEDING ONE PERCENT OF TOTAL ASSETS(a)(b)
(a) Outstandings (including loans and accrued interest, interest-bearing
deposits with banks, securities, acceptances and other monetary assets, except
equity investments) represent those of both the public and private sectors and
are presented on a risk basis, i.e., net of written guarantees and tangible
liquid collateral when held outside the foreign country. At December 31, 1995,
outstandings to Norway and Korea amounted to $1,589 million and $1,469 million,
respectively, which were in excess of .75% of total assets. At December 31, 1994
and 1993, outstandings to Brazil amounted to $1,327 million and $1,328 million,
respectively, which were in excess of .75% of total assets in each respective
year. At December 31, 1993, outstandings to Italy amounted to $1,281 million,
which were in excess of .75% of 1993 total assets.
(b) At December 31, 1995, 1994 and 1993, the Corporation's total exposure to
Mexico was $1,156 million, $879 million and $708 million, respectively, which
was composed largely of trade and short-term credits. The above amounts exclude
bonds received as part of debt renegotiations (i.e., Brady Bonds) with a face
value of $1,486 million, $2,199 million and $2,195 million, respectively, and
current carrying value of $996 million, $1,827 million and $2,097 million,
respectively, which are collateralized by zero-coupon United States Treasury
obligations.
(c) Outstandings exclude equity received in debt-for-equity conversions, which
is recorded initially at fair market value and generally accounted for under the
cost method. Commitments (outstanding letters of credit, standby letters of
credit, guarantees and unused legal commitments) are excluded. At December 31,
1995, off-balance sheet commitments, after adjusting for transfers of risk,
amounted to $1,692 million for Japan, $970 million for the United Kingdom, and
$691 million for Germany.
(d) The average outstandings to Japan during 1995, 1994 and 1993 (based on
quarter-end amounts) were approximately $2.2 billion, $3.2 billion and $3.6
billion, respectively.
(e) The average outstandings to Germany during 1995, 1994 and 1993 (based on
quarter-end amounts) were approximately $3.8 billion, $2.2 billion and $1.2
billion, respectively.
The majority of outstandings to Japan and Germany are short-term in nature,
which mitigates the credit risk as transactions settle quickly. These
outstandings generally represent interbank placements and trading assets. Due to
the short-term nature of interbank placements and trading assets, the
Corporation's balances with Japan and Germany tend to fluctuate greatly and the
amount of outstandings at year-end tends to be a function of timing, rather than
representing a consistent trend.
ASSETS HELD FOR ACCELERATED DISPOSITION
In the fourth quarter of 1995, the Corporation transferred $421 million of
residential mortgage loans into the accelerated-disposition portfolio. This was
done as part of a decision to accelerate the disposition of residential mortgage
loans originally extended several years earlier under a reduced documentation
mortgage program that was discontinued.
In December 1994, the Corporation segregated real estate loans and real
estate owned and designated such assets as assets held for accelerated
disposition. In conjunction with this transfer, the Corporation reevaluated its
carrying values for these assets to facilitate their rapid disposition and
recorded a charge of $148 million to the allowance for credit losses. As a
result of these actions, these assets were excluded from the December 31, 1995
and 1994 nonperforming assets category.
The following table presents the reconciliation of Assets Held for
Accelerated Disposition for 1995 and 1994.
(a) Includes $412 million and $87 million of loans that were performing at
December 31, 1995 and 1994, respectively.
28
Chemical Banking Corporation
and Subsidiaries
--------------------------------------------------------------------------------
DERIVATIVE AND FOREIGN EXCHANGE FINANCIAL INSTRUMENTS
In the normal course of its business, the Corporation utilizes various
derivative and foreign exchange financial instruments to meet the financial
needs of its customers, to generate revenues through its trading activities, and
to manage its exposure to fluctuations in interest and currency rates.
Derivative and foreign exchange instruments represent contracts with
counterparties where payments are made to or from the counterparty based upon
specific interest rates, currency levels, other market rates, or on terms
predetermined by the contract. These instruments can provide a cost-effective
alternative to assuming and mitigating risk associated with traditional
on-balance sheet instruments. Derivative and foreign exchange transactions
involve, to varying degrees, credit risk (i.e., the possibility that a loss may
occur because a party to a transaction fails to perform according to the terms
of a contract) and market risk (i.e., the possibility that a change in interest
or currency rates will cause the value of a financial instrument to decrease or
become more costly to settle).
The effective management of credit and market risk is vital to the success of
the Corporation's trading activities and asset/liability management. Because of
the changing market environment, the monitoring and managing of these risks is a
continual process. For a further discussion of market risk, see the Market Risk
Management section on page 31.
The Corporation believes the true measure of credit risk exposure is the
replacement cost of the derivative or foreign exchange product (i.e., the cost
to replace the contract at current market rates should the counterparty default
prior to the settlement date). This is also referred to as repayment risk or the
mark-to-market exposure amount. The notional principal of derivative and foreign
exchange instruments is the amount on which interest and other payments in a
transaction are based. For derivative transactions, the notional principal
typically does not change hands; it is simply a quantity that is used to
calculate payments. While notional principal is the most commonly used volume
measure in the derivative and foreign exchange markets, it is not a measure of
credit or market risk. The notional principal of the Corporation's derivative
and foreign exchange products greatly exceeds the possible credit and market
loss that could arise from such transactions. As a result, the Corporation does
not consider the notional principal to be indicative of its credit or market
risk exposure.
Mark-to-market exposure is a measure, at a point in time, of the value of a
derivative or foreign exchange contract in the open market. When the
mark-to-market is positive, it indicates the counterparty owes the Corporation
and, therefore, creates a repayment risk for the Corporation. When the
mark-to-market is negative, the Corporation owes the counterparty. In this
situation, the Corporation does not have repayment risk.
When the Corporation has more than one transaction outstanding with a
counterparty, and there exists a legally enforceable master netting agreement
with the counterparty, the "net" mark-to-market exposure represents the netting
of the positive and negative exposures with the same counterparty. If there is a
net negative number, the Corporation's exposure to the counterparty is
considered zero. Net mark-to-market is, in the Corporation's view, the best
measure of credit risk when there is a legally enforceable master netting
agreement between the Corporation and the counterparty.
The Corporation routinely enters into derivative and foreign exchange product
transactions with regulated financial institutions, which the Corporation
believes have relatively low credit risk. At December 31, 1995, approximately
86% of the mark-to-market exposure of such activities were with commercial bank
and financial institution counterparties most of which are dealers in these
products. Non-financial institutions accounted for only approximately 14% of the
Corporation's derivative and foreign exchange mark-to-market exposure.
The Corporation does not deal, to any material extent, in derivatives which
dealers of derivatives (such as other banks and financial institutions) consider
to be "complex" (i.e., exotic and/or leveraged). As a result, the
mark-to-market exposure of such derivatives was approximately 2% of the
Corporation's total mark-to-market exposure of all its derivatives contracts
at December 31, 1995.
Many of the Corporation's contracts are short-term, which mitigates credit
risk as transactions settle quickly. The following table provides the remaining
maturities of derivative and foreign exchange contracts outstanding at December
31, 1995 and 1994, respectively. Percentages are based upon remaining contract
life of mark-to-market exposure amounts.
29
MANAGEMENT'S DISCUSSION AND ANALYSIS
--------------------------------------------------------------------------------
The following table summarizes the aggregate notional amounts of interest
rate and foreign exchange contracts as well as the credit exposure related to
these instruments (after taking into account the net effects of legally
enforceable master netting agreements) for the dates indicated below.
(a) The notional amounts of exchange-traded interest rate contracts, foreign
exchange contracts, and commodity contracts were $362.5 billion, $.8 billion and
$2.9 billion, respectively, at December 31, 1995. The credit risk exposure for
these contracts was minimal since exchange-traded contracts principally settle
daily in cash.
ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses is available to absorb potential credit losses
from the entire loan portfolio, as well as derivative and foreign exchange
transactions. The Corporation deems its allowance for credit losses at December
31, 1995 to be adequate. Although the Corporation considers that it has
sufficient reserves to absorb losses that may currently exist in the portfolio,
but are not yet identifiable, the precise loss content is subject to continuing
review based on quality indicators, industry and geographic concentrations,
changes in business conditions, and other external factors such as competition
and legal and regulatory requirements. The Corporation will continue to reassess
the adequacy of the allowance for credit losses.
During 1995, 1994 and 1993, the Corporation's actual credit losses arising
from derivative and foreign exchange transactions were immaterial. Additionally,
at December 31, 1995 and 1994, nonperforming derivatives contracts were
immaterial.
The following tables reflect the activity in the Corporation's allowance for
credit losses for the years ended December 31, 1995 and 1994 as well as the
allowance coverage ratios.
(a) Includes $28 million related to sale of the Corporation's banking operations
in southern and central New Jersey.
ALLOWANCE COVERAGE RATIOS
30
--------------------------------------------------------------------------------
- MARKET RISK MANAGEMENT
The Corporation's management of its market risk deals with the risks related to
its trading activities and asset/liability management activities.
TRADING ACTIVITIES
The Corporation uses its trading assets and liabilities, comprised of debt and
equity instruments and risk management instruments, to meet the financial needs
of its customers and to generate revenues through its trading activities. A
description of the classes of debt and equity instruments and risk management
instruments used in the Corporation's trading activities as well as the credit
risk and market risk factors involved in such activities are disclosed in Notes
Three and Nineteen of the Notes to Consolidated Financial Statements.
The Corporation has four fundamental trading activities which generate
revenue. The Corporation is primarily engaged in the generally stable businesses
of market-making, sales and arbitrage, while placing less emphasis on the
potentially less-stable business of positioning.
Market-making: The Corporation trades with the intention of making a profit
based on the spread between bid and ask prices. Market-making, compared with
other trading activities, is considered to be a relatively stable business by
the Corporation because revenue is related principally to market volumes, rather
than to anticipating correctly material changes in the prices of various
financial instruments. The Corporation considers market-making to be a key
trading activity in its over-the-counter traded businesses, particularly in its
derivative, foreign exchange, and government markets businesses.
Sales: The Corporation provides products for its clients at competitive prices.
The Corporation believes sales to be a relatively stable business because
revenue is related principally to the volume of products sold to the
Corporation's worldwide client base.
Arbitrage: The Corporation enters into a risk position and offsets that risk in
different but closely related markets or instruments. Because of the nature of
trading markets, where there are numerous instruments that relate to one
another, the Corporation believes it can effectively utilize this strategy. The
Corporation considers arbitrage to be a key fundamental of its trading business.
Positioning: The Corporation takes certain positions in the market in
anticipation of changes that may occur within the market. This strategy has the
lowest stability of all four trading activities and the Corporation's emphasis
in this area is less than in the other trading activities.
The Corporation manages the market risk associated with these trading
activities on an aggregate basis at the business unit level. Risk limits
originate with the Chairman of the Market Risk Committee who determines
instrument authorities and exposure levels of individual business units.
Criteria for risk limit determination include, among other factors, relevant
market analysis, market liquidity, prior track record, business strategy, and
management experience and depth. Procedures and policies specify authorized
instruments and exposure levels. Critical risk limits that are designated as
primary are centrally tracked and reported on a daily basis, while less-critical
risk limits are independently monitored and centrally reported on a periodic
basis. Individual business units often set additional internal limits.
The Market Risk Management Group (the "Group") performs independent analysis
of instrument authority, limit requests, and limit utilization. In addition, the
Group tracks market risk-related revenue and compares it to the actual market
risk incurred to produce such revenue and assesses risk levels and related
topics. Other focuses include measurement and calculation of value-at-risk,
criteria for official volatility and correlation statistics, and formulas for
determination of market-related credit exposure. Additionally, the Group reviews
the market risk related to new products (as one element of the Corporation's new
product process) and provides independent review of the mathematical and
simulation models utilized by business units. The Group combines efforts with
other functional units to assess cross-discipline risks in business units having
significant market risk. In addition to the Chairman of the Market Risk
Committee and the Group, the Board of Directors of the Corporation also reviews
the market risk related to trading activities.
The Corporation's business strategy seeks to manage the market risks
associated with its trading activities through product, functional and
geographic diversification. The Corporation trades in a wide range of products
which include not only foreign exchange and derivatives but also securities,
including emerging markets debt instruments. The Corporation's trading
activities are geographically diverse. Trading activities are undertaken in more
than 20 countries, with a majority of the Corporation's transactions in the
developed countries, such as the United States, Japan, Singapore, United Kingdom
and Western Europe.
The effects of market gains or losses on the Corporation's trading activities
are reported in trading revenue, as the trading instruments are marked-to-market
on a daily basis.
Measuring Market Risk: The Corporation's overall risk management process
utilizes a limit system incorporating three types of risk control:
value-at-risk, non-statistical limits, and stop loss advisories. Value-at-risk
is defined as the potential overnight dollar loss from adverse market movements
that would cover 97.5% of likely market movements, which are determined by using
two years of
31
MANAGEMENT'S DISCUSSION AND ANALYSIS
--------------------------------------------------------------------------------
historical price and rate data. The value-at-risk calculations employ nearly
3,100 volatilities and 1.24 million correlations (updated quarterly) of various
market instruments. The Corporation monitors value-at-risk figures for major
business units on a daily basis so that the potential for market loss can be
properly reflected. The methodology generally used to offset positions within a
business unit is deemed by the Corporation to be conservative. Only partial
credit for correlation between instruments within each business unit is
incorporated since correlations can exhibit instability during volatile market
environments. Aggregating across business units with no correlation offset
resulted in an aggregated daily average value-at-risk figure of $30 million in
1995. The historical correlation among business units is captured by using
actual trading results. Based on actual 1995 trading results, 95% of the
variation in the Corporation's daily trading results fell within a $19 million
band centered on the daily average amount for the year. The 1995 presentation of
the Corporation's measure of risk, based on actual trading results, has changed
from prior period disclosures.
Value-at-risk is an important concept, but it is not the sole control measure
used in the risk management process. Non-statistical limits include net open
positions, basis point values, position concentrations, and position ages. These
non-statistical measures are accorded the same importance as value-at-risk. Stop
loss advisories also are used to advise senior management when losses of a
certain threshold are sustained from a business activity. The use of
non-statistical measures and stop loss advisories to complement value-at-risk
limits reduces the likelihood that potential trading losses will reach the daily
average value-at-risk amount.
HISTOGRAM OF DAILY MARKET RISK-RELATED TRADING REVENUE FOR 1995
[GRAPH 1 -- SEE APPENDIX 1]
The above chart contains a histogram of the Corporation's daily market
risk-related revenue for 1995. Market risk-related revenue is defined as the
daily change in value in the trading portfolios plus any trading-related net
interest income or other revenue. Net interest income related to funding and
investment activity is excluded. The histogram covers the Corporation's major
trading units which constitute approximately 98% of its trading activity.
For the twelve months ended December 31, 1995, the Corporation posted
positive daily market risk-related revenue for 225 out of 266 business trading
days for international and domestic units. For 243 of the 266 days, the
Corporation's daily market risk-related revenue or losses occurred within the
negative $5 million to positive $10 million range, which is representative of
the Corporation's emphasis on market-making and sales activities. The low number
of outlier results (13 days having positive or negative market risk-related
revenues exceeding $10 million) exemplifies the Corporation's diversified
approach to market risk management as a business strategy.
ASSET/LIABILITY MANAGEMENT
The objective of the asset/liability management process is to manage and control
the sensitivity of the Corporation's income to changes in market interest rates.
The process operates under the authority and direction of the Asset and
Liability Policy Committee, comprised of the Office of the Chairman and senior
business and finance executives. The Committee seeks to ensure that the risk to
earnings from adverse movements in interest rates are kept within specified
limits deemed acceptable by the Corporation.
The Corporation's net interest income is affected by changes in the level of
market interest rates based upon differences in timing between the contractual
maturity or repricing (the "repricing") of its assets and liabilities. Interest
rate sensitivity arises in the ordinary course of the Corporation's banking
business as the repricing characteristics of its loans do not necessarily match
those of its deposits and other borrowings. This sensitivity can be altered by
adjusting the Corporation's investments and the maturities of its wholesale
funding activities, and with the use of derivative instruments.
The Corporation, as part of its asset/liability management process, employs a
variety of on-balance sheet and derivative instruments in managing its exposure
to fluctuations in market interest rates. The Corporation primarily uses its
securities portfolio, and to a lesser degree derivative instruments, to adjust
the interest rate repricing characteristics of specific on-balance sheet assets
and liabilities, or groups of assets and liabilities with similar repricing
characteristics. Derivative instruments include interest rate swaps, futures,
forward rate agreements and options and are generally accorded accrual
accounting treatment in the Corporation's financial statements. (See Note One of
the Notes to Consolidated Financial Statements for a discussion of the
Corporation's accounting policy relative to
32
derivative instruments used for asset/liability management and Note Nineteen of
the Notes to Consolidated Financial Statements for the aggregate notional
principal of derivative instruments).
Risk Management and Control: A key element of the Corporation's asset/liability
management process is that it allows the assumption of interest sensitivity at a
decentralized level by authorized units with close contacts to the markets.
These units are subject to individual authorities and limits administered
centrally which are intended to control the size of exposures by currency and
the instruments that can be used to manage the sensitivities.
The Asset and Liability Policy Committee has ultimate responsibility for the
Corporation's consolidated interest rate exposure. In addition to the individual
limits placed on the decentralized risk management units, the Committee has
established "global" limits for consolidated exposures along three dimensions of
risk. These limits cover net gap exposure, earnings at risk, and the sensitivity
of the Corporation's equity to changes in interest rate levels.
Measuring Interest Rate Sensitivity: Management uses a variety of techniques to
measure its interest rate sensitivity. One such tool is aggregate net gap
analysis, an example of which is presented below. Assets and liabilities are
placed in gap intervals based on their contractual maturities or repricing
dates. Assets and liabilities, for which no specific repricing dates exist,
are placed in gap intervals based on management's judgments concerning their
most likely repricing behaviors. Derivatives used in asset/liability
management are also included in the applicable gap intervals.
A net gap for each time period is calculated by subtracting the liabilities
repricing in that interval from the assets repricing. A negative gap - more
liabilities repricing than assets - will benefit net interest income in a
declining interest rate environment and will detract from net interest income in
a rising interest rate environment. Conversely, a positive gap - more assets
repricing than liabilities - will benefit net interest income if rates are
rising and will detract from net interest income in a falling rate environment.
INTEREST SENSITIVITY TABLE
(a) Represents net repricing effect of derivative positions, which include
interest rate swaps, futures, forward rate agreements and options that are used
as part of the Corporation's overall asset/liability management activities.
33
MANAGEMENT'S DISCUSSION AND ANALYSIS
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At December 31, 1995, the Corporation had $10,945 million more liabilities
than assets repricing within one year (including net repricing effect of
derivative positions), amounting to 6.0% of total assets. The
consolidated gaps include exposure to U.S. dollar interest rates as well as
exposure to non-U.S. dollar rates in currency markets in which the Corporation
does business. Since U.S. interest rates and non-U.S. interest rates may not
move in tandem, the overall cumulative gaps may tend to overstate the exposures
of the Corporation.
Gap analysis is the simplest representation of the Corporation's interest
rate sensitivity. However, it cannot reveal the impact of factors such as
administered rates (e.g., the prime lending rate), pricing strategies on
consumer and business deposits, changes in balance sheet mix, or the effect of
various options embedded in the balance sheet. Accordingly, the Asset and
Liability Policy Committee conducts simulations of net interest income under a
variety of market interest rate scenarios. These simulations provide the
Committee with an estimate of earnings at risk for given changes in interest
rates. The difference between these projections of net interest income (after
tax), as a percentage of projected net income, represent earnings at risk.
At December 31, 1995, based on these simulations, earnings at risk to an
immediate 100 basis point rise in market interest rates was estimated to be less
than four percent of projected 1996 after-tax net income excluding any
merger-related restructuring charges. The immediate 100 basis point rise in
interest rates is a hypothetical rate scenario, used to calibrate risk, and does
not necessarily represent management's current view of future market
developments.
All the measurements of risk described above are based upon the Corporation's
business mix and interest rate exposures at a particular point in time. The
exposures change continuously as a result of the Corporation's ongoing business
and its risk management initiatives. While management believes these measures
provide a meaningful representation of the Corporation's interest rate
sensitivity, they do not necessarily take into account all business developments
which have an effect on net income, such as changes in credit quality or the
size and composition of the balance sheet.
Interest rate swaps: Interest rate swaps are one of the various financial
instruments used in the Corporation's ALM activities. Although the Corporation
believes the results of its ALM activities should be evaluated on an integrated
basis, taking into consideration all on-balance sheet and related derivative
instruments and not a specific group of financial instruments, the interest rate
swap maturity table, which follows, provides an indication of the Corporation's
interest rate swaps activity.
The following table summarizes the outstanding ALM interest rate swaps
notional amounts at December 31, 1995, by yearly intervals. The decrease in
notional amounts from one period to the next period represents maturities of the
underlying contracts. The weighted average interest rates to be received and
paid on such swaps are presented for each yearly interval. Variable rates
presented are generally based on the short-term interest rates for relevant
currencies such as the London Interbank Offered Rate (LIBOR). Basis swaps are
interest rate swaps based on two floating rate indices (e.g., LIBOR and prime).
The table was prepared under the assumption that variable interest rates
remain constant at December 31, 1995 levels and, accordingly, the actual
interest rates to be received or paid will be different to the extent that such
variable rates fluctuate from December 31, 1995 levels. However, the Corporation
expects the impact of any interest rate changes to be largely mitigated by
corresponding changes in the interest rates and values associated with the
linked assets and liabilities.
34
--------------------------------------------------------------------------------
OUTSTANDING INTEREST RATE SWAPS NOTIONAL AMOUNTS AND RECEIVE/PAY RATES BY YEARLY
INTERVALS
(a) At December 31, 1995, approximately $17 billion of notional amounts are
interest rate swaps that, as part of the Corporation's asset/liability
management, are used in place of cash market instruments. Of this amount,
$10 billion is expected to mature in 1996, $4 billion in 1997 with the
remaining $3 billion in 1998 and thereafter. The unrecognized net gain related
to these positions was approximately $49 million. See Note One of the Notes
to Consolidated Financial Statements for a discussion of the Corporation's
accounting policy relative to derivative instruments used for ALM.
The following table summarizes certain of the Corporation's assets and
liabilities at December 31, 1995 with the notional or contract amount of related
derivatives used for ALM purposes.
DERIVATIVE PRODUCTS AND RELATED BALANCE SHEET POSITIONS
(a) At December 31, 1995, the total notional amounts of approximately $17
billion for interest rate swaps and $3 billion for other ALM contracts, both of
which are used in place of cash instruments (See Note One of the Notes to
Consolidated Financial Statements), have been excluded from the above table.
(b) Includes futures, forward rate agreements and options.
In the normal course of its ALM business, the Corporation does not generally
terminate its interest rate swaps. Deferred gains/losses primarily relate to
securities futures and forward contracts used in connection with
available-for-sale securities. The unrecognized gains/losses relating to ALM
activities primarily relate to interest rate swap contracts. The following
table reflects changes in value of the Corporation's ALM derivative contracts
(both deferred gains/losses and unrecognized gains/losses) for the year ended
1995. For further discussion of both the Corporation's deferred and
unrecognized gains/losses relating to its ALM activities, see Notes Nineteen and
Twenty Two, respectively.
CHANGE IN VALUE OF ALM DERIVATIVE PRODUCTS
(a) Amount includes $97 million in net unrecognized losses from daily margin
settlements on open futures contracts. For additional information, refer to Note
Twenty Two of the Notes to Consolidated Financial Statements.
The net deferred losses at December 31, 1995 are expected to be amortized
over the periods reflected in the following table. The amortization of deferred
gains and losses are recognized as yield adjustments in interest income or
interest expense.
AMORTIZATION OF NET DEFERRED GAINS/(LOSSES)
ON CLOSED ALM CONTRACTS
The Consolidated Balance Sheet includes net unamortized premiums paid on open
ALM option contracts amounting to $10 million at December 31, 1995 which will be
amortized in 1996.
OTHER MARKET RISK MANAGEMENT
The Corporation uses various derivative contracts to reduce risks associated
with its mortgage servicing, loan sales, other consumer loan activities and
capital-related foreign currency exposures.
35
MANAGEMENT'S DISCUSSION AND ANALYSIS
--------------------------------------------------------------------------------
The value of the Corporation's mortgage servicing rights is affected by the
level of prepayments made by mortgage holders resulting from changes in interest
rates. Purchased interest rate floor contracts are used to mitigate such risk.
Essentially all contracts linked to mortgage servicing assets mature within
three years. The Corporation also originates certain mortgage and consumer
loans for sale or securitization to third-party investors. To reduce the risk
of changes in value between the time that such loans are originated and the
date of sale, the Corporation enters into futures, forward, and purchased
option contracts. Contracts related to loans available for sale generally
mature within one year.
Foreign currency exposures, primarily the net investment in overseas
entities, are managed through the use of foreign exchange forward contracts
matching outstanding foreign currency positions on a currency-by-currency basis.
These contracts hedge the impact of foreign exchange rate changes on the
Corporation's net investment in its overseas entities.
--------------------------------------------------------------------------------
- OPERATING RISK MANAGEMENT
The Corporation, like all large financial institutions, is exposed to many types
of operating risk, including the risk of fraud by employees or outsiders,
unauthorized transactions by employees and errors relating to computer and
telecommunications systems. The Corporation maintains a system of controls that
is designed to keep operating risk at appropriate levels in view of the
financial strength of the Corporation, the characteristics of the businesses and
markets in which the Corporation operates, competitive circumstances and
regulatory considerations. However, from time to time in the past the
Corporation has suffered losses from operating risk, and there can be no
assurance that the Corporation will not suffer such losses in the future.
--------------------------------------------------------------------------------
- CAPITAL AND LIQUIDITY RISK MANAGEMENT
CAPITAL
The Corporation's level of capital at December 31, 1995 remained strong, with
capital ratios well in excess of regulatory guidelines. The Corporation's Tier 1
and Total Capital ratios were 8.45% and 12.10%, respectively, at December 31,
1995. These ratios, as well as the leverage ratio discussed below, exclude the
assets and off-balance sheet financial instruments of the Corporation's
securities subsidiary, Chemical Securities, Inc. ("CSI"), as well as the
Corporation's investment in such subsidiary. In addition, the provisions of SFAS
115 do not apply to the calculation of these ratios.
Total capitalization (the sum of Tier 1 Capital and Tier 2 Capital as
discussed below) increased by $1.3 billion during 1995 to $15.8 billion at
December 31, 1995. The Corporation manages its capital to execute its strategic
business plans and support its growth and investments, including acquisition
strategies in its core businesses. As part of the Corporation's Actions to
Improve Earnings Per Share, the Corporation completed two divestitures in the
fourth quarter of 1995 - the sale of Chemical New Jersey Holdings' banking
operations in southern and central New Jersey to PNC Bank Corp. and the sale of
half the Corporation's 40% interest in CIT.
During 1995, the Corporation repurchased approximately 14.4 million shares of
its outstanding common stock in the open market. These share repurchases were
largely undertaken to meet the anticipated needs of the Corporation's employee
stock option and incentive plans. During 1995, approximately 12.8 million shares
(11.9 million from treasury) were issued under various employee stock option and
incentive plans and 7.6 million shares of common stock were issued (from
treasury) due to the conversion of the Corporation's 10% convertible preferred
stock.
In the second quarter of 1995, the Board of Directors of the Corporation
increased the quarterly dividend on the outstanding shares of the Corporation's
common stock to $.50 per share, an increase of 14% from $.44 per share. On an
annualized basis, this represents an increase in the dividend rate to $2.00 per
share from $1.76 per share. For 1995, the Corporation's ratio of common
dividends to earnings applicable to common stock was 28%, compared with 35% in
1994.
The Corporation's total stockholders' equity at the 1995 year-end was $11.9
billion, compared with $10.7 billion at December 31, 1994. The $1.2 billion
increase primarily reflected the retention of earnings (net income of $1.8
billion less total common and preferred stock dividends of $.6 billion)
generated during 1995.
36
Chemical Banking Corporation
and Subsidiaries
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The tables which follow sets forth various capital ratios and components of
capital at the dates indicated.
CAPITAL RATIOS
(a) Tier 1 Capital or Total Capital divided by risk-weighted assets.
Risk-weighted assets include assets and off-balance sheet positions, weighted by
the type of instrument and the risk weight of the counterparty, collateral or
guarantor.
(b) Tier 1 Capital divided by adjusted average assets.
(c) Including the Corporation's securities subsidiary, the December 31, 1995
Tier 1 Capital, Total Capital and Tier 1 Leverage ratios were 8.65%, 12.56% and
6.18%, respectively, compared with 8.20%, 12.35% and 5.95%, respectively, at
December 31, 1994.
COMPONENTS OF CAPITAL
(a) Includes off-balance sheet risk-weighted assets in the amount of $41,704
million and $37,157 million, respectively, at December 31, 1995 and December 31,
1994.
Under the risk-based capital guidelines of the Federal bank regulatory
authorities, banking organizations are required to maintain certain ratios of
"Qualifying Capital" to "risk-weighted assets". "Qualifying Capital" is
classified into two tiers, referred to as Tier 1 Capital and Tier 2 Capital.
Under the guidelines, both the Corporation's and Chemical Bank's Tier 1 Capital
ratio and Total Capital ratio to risk-weighted assets were well in excess of the
minimum ratios of 4% and 8%, respectively. To be "well capitalized," a banking
organization must have a Tier 1 Capital ratio of at least 6%, Total Capital
ratio of at least 10%, and Tier 1 leverage ratio of at least 5%. At December 31,
1995, the capital ratios for each of the Corporation's banking subsidiaries
exceeded the ratios required to be well capitalized.
The Tier 1 leverage ratio is defined as Tier 1 Capital (as defined under the
risk-based capital guidelines) divided by average total assets (net of allowance
for credit losses, goodwill and certain intangible assets). The minimum leverage
ratio is 3% for banking organizations that have well-diversified risk (including
no undue interest rate risk); excellent asset quality; high liquidity; good
earnings; and, in general, are considered strong banking organizations. Other
banking organizations are expected to have ratios of at least 4%-5% depending
upon their particular condition and growth plans. Higher capital ratios could be
required if warranted by the particular circumstances or risk profile of a given
banking organization. The Federal Reserve Board has not advised the Corporation
of any specific minimum Tier 1 leverage ratio applicable to it.
At December 31, 1995, the Corporation had in place a Shareholders' Rights
Plan. The Shareholders' Rights Plan contains provisions intended to protect
stockholders in the event of unsolicited offers, attempts to acquire the
Corporation and other coercive or unfair takeover tactics that could impair the
Board of Directors' ability to represent stockholders' interests fully.
On January 18, 1996, the Corporation announced that it would redeem all
outstanding rights issued under its Shareholders' Rights Plan. The redemption
will be effective on the first regular common stock dividend record date
occurring after the consummation of the merger with Chase. The merger is
scheduled to be completed on March 31, 1996, and the rights would be redeemed
from all stockholders of record on the anticipated common stock dividend record
date of April 4, 1996. Under the Shareholder Rights Plan, the redemption price
is $0.01 per right. Payment of the redemption price is intended to be made at
the same time as payment of the 1996 first-quarter common stock dividend.
37
MANAGEMENT'S DISCUSSION AND ANALYSIS
--------------------------------------------------------------------------------
LIQUIDITY
The objective of liquidity management is to ensure the availability of
sufficient cash flows to meet all of the Corporation's financial commitments and
to capitalize on opportunities for the Corporation's business expansion.
Liquidity management addresses the Corporation's ability to meet deposit
withdrawals either on demand or at contractual maturity, to repay borrowings as
they mature, and to make new loans and investments as opportunities arise.
Liquidity is managed on a daily basis at both the parent company and the
subsidiary levels, enabling senior management to monitor effectively changes in
liquidity and to react accordingly to fluctuations in market conditions.
Contingency plans exist and could be implemented on a timely basis to minimize
the risk associated with dramatic changes in market conditions.
In managing liquidity, the Corporation takes into account the various legal
limitations on the extent to which banks may pay dividends to their parent
companies or finance or otherwise supply funds to certain of their affiliates.
For additional information, refer to Note Fifteen of the Notes to Consolidated
Financial Statements.
The primary source of liquidity for the bank subsidiaries of the Corporation
derives from their ability to generate core deposits (which includes all
deposits except noninterest-bearing time deposits, foreign deposits and
certificates of deposit of $100,000 or more). The Corporation considers funds
from such sources to comprise its subsidiary banks' "core" deposit base because
of the historical stability of such sources of funds. The average core deposits
at the Corporation's bank subsidiaries for 1995 were $54 billion. These deposits
fund a portion of the Corporation's asset base, thereby reducing the
Corporation's reliance on other, more volatile, sources of funds. The
Corporation's average core deposits as a percentage of average loans was 66% for
1995. Foreign deposits generated in the Corporation's global wholesale and
retail businesses are also considered to be an additional source of liquidity
for the Corporation.
The Corporation holds marketable securities and other short-term investments
which can be readily converted to cash. As part of the Corporation's on-going
capital management process, loan syndication networks and retail securitization
programs are maintained in order to facilitate the timely disposition of assets,
if and when deemed desirable.
The Corporation is an active participant in the capital markets. In addition
to issuing commercial paper and medium-term notes, the Corporation raises funds
through the issuance of long-term debt, common stock and preferred stock. During
1995, the Corporation issued $1,153 million of long-term debt, including $631
million through its medium-term note program.
The Corporation's long-term debt at December 31, 1995 was $7,329 million, a
decrease of $662 million from the 1994 year-end. The decrease resulted from
maturities of $1,218 million of the Corporation's long-term debt (including $499
million of senior medium-term notes and $719 million of other senior notes) and
the redemption of $600 million of senior notes. These decreases were partially
offset by additions to the Corporation's long-term debt of $1,153 million
(including $360 million of senior medium-term notes, $271 million of
subordinated medium-term notes and $522 million of other senior notes).
As previously discussed, during the second quarter of 1995, the Corporation
called all of the outstanding shares of its 10% convertible preferred stock for
redemption. Substantially all of the 10% convertible preferred stock was
converted prior to the redemption date, at the option of the holders thereof,
into approximately 7.6 million shares of the Corporation's common stock. The
shares of common stock issued upon such conversion were issued from treasury.
The following table shows the debt ratings of the Corporation as well as
Chemical Bank. These ratings upgrades enhanced and should continue to enhance
the Corporation's access to global capital and money markets, a primary source
of liquidity for an international money-center institution. The ability to
access this geographically diverse assortment of distribution channels and to
issue a wide variety of capital and money market instruments at various
maturities provides the Corporation with a full array of alternatives for
managing its liquidity position.
38
Chemical Banking Corporation
and Subsidiaries
--------------------------------------------------------------------------------
- OTHER EVENTS
JOINT VENTURE WITH MELLON BANK CORPORATION
The Corporation and Mellon Bank Corporation have formed a joint venture that
focuses on providing stock transfer and related shareholder services to
publicly-held companies. The joint venture is called Chemical Mellon Shareholder
Services, and is a 50/50 partnership, with Mellon Bank Corporation and the
Corporation sharing equally in the joint venture's initial capitalization,
including investments in new technology.
The joint venture was accounted for as an equity investment effective January
1, 1995, with revenues and expenses of the affected business units recorded in
other revenue.
SALE OF CHEMICAL BANK NEW JERSEY NATIONAL ASSOCIATION
On October 6, 1995, the Corporation sold Chemical New Jersey Holdings, Inc. and
its subsidiaries, including Chemical Bank New Jersey National Association, to
PNC Bank Corp. for approximately $490 million. The sale did not include the
Corporation's franchise in northeastern New Jersey or the Montclair, Morristown,
Ridgewood and Summit offices of Princeton Bank and Trust Company. These
remaining branches and offices are being repositioned as a strategic component
of the Corporation's regional banking in metropolitan New York. The after-tax
gain on the sale was approximately $45 million.
SALE OF HALF INTEREST IN CIT
On December 15, 1995, the Corporation sold half of its 40% interest in CIT to
The Dai-Ichi Kangyo Bank for approximately $430 million, resulting in an
after-tax loss of approximately $20 million. The Corporation has given Dai-Ichi
Kangyo a five-year option to purchase its remaining 20% interest and CIT has
given the Corporation public offering registration rights with respect to this
20% share, which would take effect at the end of the option period.
--------------------------------------------------------------------------------
- ACCOUNTING DEVELOPMENTS
ACCOUNTING FOR STOCK-BASED COMPENSATION
In October 1995, the Financial Accounting Standards Board, ("FASB") issued
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"). SFAS 123 establishes financial accounting and
reporting standards for stock-based compensation plans. Such plans include all
arrangements by which employees or others receive shares of stock or other
equity instruments of the Corporation, or arrangements by which the Corporation
incurs liabilities in amounts based on the price of the Corporation's stock.
Examples are stock options, restricted stock, restricted stock units, stock
appreciation rights and stock purchase plans.
SFAS 123 allows two alternative accounting methods: (1) a fair-value-based
method, or (2) an intrinsic value-based method which is already prescribed by
Accounting Policy Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25"). Both the accounting and disclosure requirements of SFAS
123 are effective for fiscal years beginning after December 15, 1995. The
Corporation intends to continue accounting for its employee stock compensation
plans under its current method (APB 25), and will adopt the disclosure
requirements of SFAS 123 in 1996.
39
MANAGEMENT'S DISCUSSION AND ANALYSIS
-------------------------------------------------------------------------------
- COMPARISON BETWEEN 1994 AND 1993
OPERATING HIGHLIGHTS
The Corporation's net income for 1994, including a fourth-quarter restructuring
charge of $260 million ($152 million after-tax), was $1,294 million, or $4.60
per primary share and $4.54 on a fully-diluted basis. Reported 1993 net income
was $1,604 million, or $5.71 per primary share and $5.62 on a fully-diluted
basis, which included the recognition of remaining income tax benefits of $331
million, a $115 million Manufacturers Hanover Corporation ("MHC") merger-related
charge ($67 million after-tax), and a net positive impact of $35 million related
to accounting changes.
Net income, before the fourth-quarter 1994 restructuring charge, was $1,446
million, or $5.20 per primary share and $5.13 on a fully-diluted basis. These
1994 results reflected an 11% increase from comparable pro forma earnings of
$1,305 million, or $4.53 per primary share and $4.47 on a fully-diluted basis in
1993.
On December 1, 1994, the Corporation announced its Actions to Improve
Earnings Per Share Program, designed to produce earnings per share growth of
more than 15% in 1995 and in 1996, as well as an efficiency ratio of 57% and a
return on common stockholders' equity of 16% by 1996.
NET INTEREST INCOME
The Corporation's net interest income was $4,674 million in 1994, compared with
$4,636 million in 1993. The rise in 1994 was attributable to an increase in
average interest-earning assets, which more than offset the effect of rising
interest rates.
Average interest-earning assets were $130.0 billion in 1994, an increase of
4% from $124.9 billion in 1993, reflecting a higher level of liquid assets and
securities. The composition of average interest-earning assets shifted during
the latter part of 1993 and early part of 1994 to support the Corporation's
trading businesses.
PROVISION FOR LOSSES AND NET CHARGE-OFFS
The provision for losses in 1994 was $550 million, compared with $1,259 million
in 1993, a decline of 56%. Net charge-offs in 1994 were $1,095 million compared
with $1,281 million in 1993. The 1994 results included a $148 million charge
related to the decision to designate certain assets as
held-for-accelerated-disposition as well as a $291 million charge incurred in
connection with management's final valuation of its emerging markets portfolio.
As a result of management's evaluation of the continuing improvement in the
Corporation's credit profile, the provision for losses in 1994 was lower than
the Corporation's net charge-offs.
NONINTEREST REVENUE
Noninterest revenue totaled $3,597 million in 1994, compared with $4,024 million
in 1993. The decrease from the prior year reflected lower trading revenue, a
decline in securities gains, and a decline in gains on the sales of emerging
markets-related past-due interest bonds (included in other revenue). These
decreases were partially offset by increased revenues from corporate finance
fees, credit card revenue, trust and investment management fees, as well as
increased revenues from equity-related investments (included in other revenue).
Corporate finance and syndication fees in 1994 reached a then record level of
$405 million, a 20% increase from the prior year, principally resulting from the
continued strong growth in loan syndication and other investment banking
activities.
Trust and investment management fees in 1994 were $421 million, an increase
of $15 million from 1993. The higher level of fees reflected a 5% increase in
personal trust fees, principally due to new customer relationships developed as
a result of the acquisition of Ameritrust Texas Corporation ("Ameritrust") by
Texas Commerce. Corporate and institutional trust fees also increased 5% from
the 1993 level largely due to the inclusion of Ameritrust results for the full
year in 1994 versus only three months in 1993.
Credit card revenue in 1994 was $315 million, an increase of 32% from 1993,
reflecting a growing cardholder base, primarily as a result of the Corporation's
co-branded Shell MasterCard program, which was launched in the fourth quarter of
1993.
Service charges on deposit accounts totaled $300 million in 1994, an increase
of 4% over 1993, principally reflecting pricing initiatives during the first
half of 1994 related to retail accounts, partially offset by a slightly smaller
deposit base.
Fees for other financial services for 1994 were $833 million, an increase of
$4 million from 1993, primarily due to increased mortgage servicing fees
reflecting a higher level of mortgage servicing volume from the Margaretten
acquisition as well as additions to the portfolio from mortgage originations.
Trading-related revenue in 1994 was $660 million, a decrease of 40% from the
prior year due to a difficult trading environment during 1994, when compared
with 1993. The interest rate environment in the U.S. and European markets was
volatile during 1994, while difficult conditions existed in the emerging debt
markets, and European government bond markets. Additionally, during 1994, the
Corporation incurred a $70 million loss resulting from unauthorized foreign
exchange transactions involving the Mexican peso.
Securities gains were $66 million in 1994, compared with $142 million in
1993. The decrease was due to the higher interest rate environment exerting
downward pressure on market prices.
The Corporation's other noninterest revenue for 1994 was $612 million,
compared with $710 million in 1993. Revenue from equity-related investments,
which includes income from venture
40
Chemical Banking Corporation
and Subidiaries
-------------------------------------------------------------------------------
capital activities and emerging markets investments, was $362 million in 1994,
an increase of 30% from 1993. Included in other noninterest revenue in 1994 was
$127 million of net gains from the sale of emerging markets-related past-due
interest bonds, compared with $306 million in 1993. All other noninterest
revenue was $123 million in 1994, compared with $126 million in 1993. Included
in the 1994 amount was equity income from CIT of $73 million, an increase from
$65 million in 1993.
NONINTEREST EXPENSE
Noninterest expense in 1994 was $5,509 million, compared with $5,293 million in
1993. Included in the results for 1994 was a $260 million restructuring charge
taken in connection with the aforementioned Actions to Improve Earnings Per
Share Program, and a $48 million restructuring charge related to the closing of
50 New York State branches. The 1993 results included a $115 million charge
related to the final assessment of costs associated with the merger with MHC and
a $43 million charge associated with the acquisition of certain assets of the
First City Banks by Texas Commerce. Excluding all restructuring charges in both
years, noninterest expense for 1994 was $5,201 million, an increase of 1% from
1993. Noninterest expense for 1994, when compared with the prior year, reflected
higher expenses associated with investments in certain key businesses such as
the Shell MasterCard program, the trading and securities businesses, Margaretten
and Ameritrust.
Salaries and employee benefits expenses in 1994 were $2,644 million, compared
with $2,466 million in 1993. The increase in 1994 was primarily due to the
Margaretten acquisition, the implementation of the Shell MasterCard program,
additional staff costs resulting from the 1993 acquisition of Ameritrust by
Texas Commerce, and the increase in the Corporation's securities underwriting
business.
Occupancy expense was $573 million in 1994, a decrease of $14 million from
1993. The decline from 1993 principally resulted from the termination of a
facilities lease in London at the beginning of 1994, the impact of branch
divestitures, and the continuing consolidation of the New York branch system.
Partially offsetting these factors were additional occupancy expense related to
the Margaretten acquisition, as well as costs associated with the consolidation
and relocation of certain data centers.
Equipment expense in 1994 was $382 million, an increase of $45 million,
principally due to higher costs incurred for system enhancements to support the
Corporation's trading activities, the consolidation of its data centers, and for
upgrades to its ATM technology.
Foreclosed property expense was $41 million in 1994, compared with $287
million in 1993, reflecting significant progress in managing the Corporation's
real estate portfolio. The 1994 expense benefited by approximately $42 million
of gains from the sale of foreclosed property. Also included in the 1994 results
was a $12 million charge in conjunction with the transfer of certain real estate
assets to the held for accelerated disposition category. Included in the 1993
results was a $20 million writedown related to the accelerated disposition of
nonperforming residential mortgage assets.
For 1994, other expense was $1,561 million, an increase of 7% from the 1993
level. The increase reflects higher professional services and telecommunication
costs, as well as the full-year impact in 1994 of expenses associated with the
First City Banks and Ameritrust acquisitions, and the inclusion of Margaretten
since its acquisition on July 1, 1994.
INCOME TAXES
The Corporation recorded income tax expense of $918 million in 1994, compared
with $539 million in 1993. Included in the 1993 income tax expense were
approximately $331 million of Federal income tax benefits.
The Corporation recognized its remaining available Federal income tax
benefits in accordance with SFAS 109 in the third quarter of 1993. As a result,
earnings, beginning in the fourth quarter of 1993, have been reported on a
fully-taxed basis.
The Corporation's effective tax rate was 41.5% in 1994, compared with 25.6%
in 1993. Excluding the $331 million of benefits recognized under SFAS 109 for
1993, the Corporation's effective tax rate for 1993 would have been 41.3%.
NONPERFORMING ASSETS
The Corporation's total nonperforming assets at December 31, 1994 were $1,139
million, a decline of 68% from $3,525 million at December 31, 1993. This
improvement in the Corporation's credit profile is a result of a significantly
lower level of loans being placed on nonperforming status, repayments,
charge-offs, the Corporation's continuing loan workout and collection
activities, as well as the impact of the strategic actions discussed below.
In October 1994, the Corporation sold a $341 million (face value) portfolio
of commercial real estate mortgage loans and real estate assets, which contained
approximately 86% nonperforming loans and foreclosed properties. Additionally,
in December 1994, the Corporation segregated approximately $735 million of real
estate loans and real estate owned (approximately $580 million nonperforming
assets) and designated such assets as Assets Held for Accelerated Disposition.
ALLOWANCE FOR CREDIT LOSSES
The total allowance for credit losses at December 31, 1994 was $2,480 million,
or 3.15% of total loans and 266.95% of nonperforming loans at year-end, compared
with $3,020 million, or 4.01% of total loans and 116.56% of nonperforming loans
at the 1993 year-end.
41
Chemical Banking Corporation
and Subsidiaries
MANAGEMENT'S REPORT ON RESPONSIBILITY FOR FINANCIAL REPORTING
-------------------------------------------------------------------------------
- TO OUR STOCKHOLDERS
The management of Chemical Banking Corporation and its subsidiaries has the
responsibility for preparing the accompanying consolidated financial statements
and for their integrity and objectivity. The statements were prepared in
accordance with generally accepted accounting principles. The consolidated
financial statements include amounts that are based on management's best
estimates and judgments. Management also prepared the other information in the
annual report and is responsible for its accuracy and consistency with the
consolidated financial statements.
Management maintains a comprehensive system of internal control to assure the
proper authorization of transactions, the safeguarding of assets, and the
reliability of the financial records. The system of internal control provides
for appropriate division of responsibility and is documented by written policies
and procedures that are communicated to employees. The Corporation maintains a
strong internal auditing program that independently assesses the effectiveness
of the internal controls and recommends possible improvements thereto.
Management believes that as of December 31, 1995, the Corporation maintains an
effective system of internal control.
The Audit Committee of the Board of Directors reviews the systems of internal
control and financial reporting. The Committee meets and consults regularly with
management, the internal auditors and the independent accountants to review the
scope and results of their work.
The accounting firm of Price Waterhouse LLP has performed an independent
audit of the Corporation's financial statements. Management has made available
to Price Waterhouse LLP all of the Corporation's financial records and related
data, as well as the minutes of stockholders' and directors' meetings.
Furthermore, management believes that all representations made to Price
Waterhouse LLP during its audit were valid and appropriate. The firm's report
appears below.
Walter V. Shipley
Chairman of the Board and Chief Executive Officer
Peter J. Tobin
Chief Financial Officer
Joseph L. Sclafani
Senior Vice President and Controller
January 16, 1996
REPORT OF INDEPENDENT ACCOUNTANTS
--------------------------------------------------------------------------------
- PRICE WATERHOUSE LLP 1177 AVENUE OF THE AMERICAS, NEW YORK, NY 10036
To the Board of Directors and Stockholders of Chemical Banking Corporation: In
our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income, of changes in stockholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Chemical Banking Corporation and its subsidiaries at December 31, 1995 and 1994,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 1995, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Corporation's management. Our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audits to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
As described in Notes Four, Thirteen and Seventeen to the consolidated
financial statements, in 1993 the Corporation changed its method of accounting
for certain investments in debt and marketable equity securities, postretirement
benefits other than pensions, and income taxes.
January 16, 1996
42
Chemical Banking Corporation
and Subsidiaries
CONSOLIDATED BALANCE SHEET
The Notes to Consolidated Financial Statements are an integral part of these
Statements.
43
Chemical Banking Corporation
and Subsidiaries
CONSOLIDATED STATEMENT OF INCOME
The Notes to Consolidated Financial Statements are an integral part of these
Statements.
44
Chemical Banking Corporation
and Subsidiaries
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(a) Primarily reflects the effect of common stock reissued from Treasury due to
the conversion of the Corporation's 10% convertible preferred stock.
(b) Balance was $0 million, ($10) million and ($10) million at December 31,
1995, 1994, and 1993, respectively.
The Notes to Consolidated Financial Statements are an integral part of these
Statements.
45
Chemical Banking Corporation
and Subsidiaries
CONSOLIDATED STATEMENT OF CASH FLOWS
The Notes to Consolidated Financial Statements are an integral part of these
Statements.
46
Chemical Banking Corporation
and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Chemical Banking Corporation (the "Corporation") is a bank holding company
organized under the laws of the State of Delaware in 1968 and registered under
the Bank Holding Company Act of 1956, as amended.
The Corporation conducts its domestic and international financial services
businesses through various bank and non-bank subsidiaries. The principal bank
subsidiaries of the Corporation are Chemical Bank, a New York banking
corporation ("Chemical Bank"), and Texas Commerce Bank National Association,
a subsidiary of Texas Commerce Equity Holdings, Inc. ("Texas Commerce"), a
Delaware bank holding company subsidiary of the Corporation.
The Corporation provides diversified financial services principally through
two sectors: the Global Bank and Consumer and Relationship Banking. The Global
Bank provides domestic and international corporate finance, wholesale banking,
and investment services and emphasizes originations, underwriting,
distribution, and risk management products. Consumer and Relationship Banking
serves a wide range of customer needs and includes consumer, commercial and
professional, middle market, and private banking; and trust, cash management,
funds transfer, and trade and securities services.
The accounting and financial reporting policies of the Corporation and its
subsidiaries conform to generally accepted accounting principles and prevailing
industry practices and, where applicable, the accounting and reporting
guidelines prescribed by the Securities and Exchange Commission and bank
regulatory authorities. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period.
The following is a description of significant accounting policies.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Corporation
and its majority-owned subsidiaries, after eliminating material intercompany
balances and transactions. Equity investments in less than majority-owned
companies (20%-50% ownership interest) are generally accounted for in
accordance with the equity method of accounting and are reported in Other
Assets. The Corporation's pro-rata share of earnings (losses) of these
companies is included in Other Revenue.
Assets held in an agency or fiduciary capacity by commercial banking
subsidiaries and by trust and investment advisory subsidiaries are not assets
of the Corporation and, accordingly, are not included in the Consolidated
Balance Sheet.
Certain amounts in prior periods have been reclassified to conform to the
current presentation.
FOREIGN CURRENCY TRANSLATION
Assets and liabilities denominated in foreign currencies are translated to U.S.
dollars using prevailing rates of exchange. Gains and losses on foreign
currency translation from operations for which the functional currency is other
than the U.S. dollar, together with related hedges and tax effects, are
reported in Stockholders' Equity. For foreign operations for which the U.S.
dollar is the functional currency, gains and losses resulting from converting
foreign currency assets and liabilities to the U.S. dollar, including the
related hedges, are reported in the income statement.
TRADING ACTIVITIES
The Corporation trades debt and equity instruments and risk management
instruments, as discussed below. These instruments are carried at their
estimated fair value. Quoted market prices, when available, are used as the
basis to determine the fair value of trading instruments. If quoted market
prices are not available, fair values are estimated on the basis of pricing
models, quoted prices of instruments with similar characteristics, or
discounted cash flows.
Realized and unrealized gains (losses) on these instruments are recognized in
Trading Revenue. A portion of the market valuation relating to certain risk
management instruments is deferred and accreted to income over the life of the
instruments to match ongoing servicing costs and credit risks, as appropriate.
Interest earned on debt and dividends earned on equity instruments and interest
payable on securities sold but not yet purchased are reported as interest
income and interest expense, respectively.
Debt and Equity Instruments and Securities Sold, Not Yet Purchased: Debt and
equity instruments include securities, loans, and other credit instruments held
for trading purposes and are reported as Trading Assets. Obligations to deliver
securities sold but not yet purchased are reported as Trading Liabilities.
Risk Management Instruments: The Corporation primarily deals in interest rate,
foreign exchange, and commodity contracts to generate trading revenues. Such
contracts include futures, forwards, swaps, and options (including interest
rate caps and floors). The estimated fair value of such contracts are reported
on a gross basis as Trading Assets-Risk Management Instruments (positive fair
values) and Trading Liabilities (negative fair values), except for contracts
executed with the same counterparty under legally-enforceable master netting
agreements, which are reported on a net basis.
DERIVATIVES USED IN ASSET/LIABILITY MANAGEMENT ACTIVITIES
As part of its asset/liability management activities, the Corporation primarily
uses interest rate swaps and futures and to a lesser extent forward rate
agreements and option contracts (including interest rate caps and floors) to
hedge exposures or to modify the interest rate characteristics of related
balance sheet instruments. Futures
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
contracts are designated as hedges when they reduce risk and there is high
correlation between the futures contract and the item being hedged, both at
inception and throughout the hedge period. Interest rate swaps, forward rate
agreements, and option contracts are generally used to modify the interest rate
characteristics of balance sheet instruments and are linked to specific assets
or groups of similar assets or to specific liabilities or groups of similar
liabilities.
The instruments that meet the above criteria are accounted for under the
accrual method, or available-for-sale fair value method, as discussed below.
Accrual Method: Under the accrual method, interest income or expense on the
derivative contract is accrued and there is no recognition of unrealized gains
and losses on the derivative in the balance sheet. Premiums on option contracts
are amortized to interest income or interest expense over the life of such
contracts.
Available-for-Sale Fair Value Method: Derivatives linked to available-for-sale
securities are carried at fair value. The accrual of interest receivable or
interest payable on these derivatives is reported in Interest Income on
Securities. Changes in the market values of these derivatives, exclusive of net
interest accruals, are reported in Stockholders' Equity, net of applicable
taxes, consistent with the reporting of unrealized gains and losses on the
related securities.
For both the accrual and available-for-sale fair value method, realized
gains and losses from the settlement or termination of derivatives contracts
are deferred on the balance sheet and are amortized to interest income or
interest expense over the appropriate risk management periods. Amortization
commences when the contract is settled or terminated. If the related assets or
liabilities are sold or otherwise disposed, the gain or loss on the derivative
contract is recognized as an adjustment to the gain or loss on disposition of
the related assets or liabilities.
Prior to January 1, 1995, the Corporation used interest rate contracts in
place of cash market instruments. Effective January 1, 1995, this practice was
discontinued. Accordingly, interest rate contracts entered into subsequent to
January 1, 1995 that do not meet the hedge or linkage criteria described above
are designated as trading activities and are accounted for at estimated fair
value.
SECURITIES PURCHASED UNDER RESALE AGREEMENTS AND SECURITIES SOLD UNDER
REPURCHASE AGREEMENTS
The Corporation enters into short-term purchases of securities under agreements
to resell (resale agreements) and sales of securities under agreements to
repurchase (repurchase agreements) of substantially identical securities. Such
agreements are carried on the balance sheet at the amount advanced or borrowed,
respectively, plus accrued interest. Interest earned on resale agreements and
interest incurred on repurchase agreements are reported as Interest Income and
Interest Expense, respectively. The Corporation offsets resale and repurchase
agreements executed with the same counterparty under legally-enforceable netting
agreements that meet the applicable netting criteria.
It is the Corporation's policy to obtain control or take possession of
securities purchased under resale agreements. The Corporation monitors the
market value of securities and adjusts the level of collateral for resale and
repurchase agreements, as appropriate.
AVAILABLE-FOR-SALE AND HELD-TO-MATURITY SECURITIES
Effective December 31, 1993, the Corporation adopted Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" ("SFAS 115"). For a further discussion of SFAS 115 and the
Financial Accounting Series Special Report on SFAS 115, issued during the 1995
fourth quarter, see Note Four.
Securities that may be sold in response to or in anticipation of changes in
interest rates and resulting prepayment risk, or other factors, are classified
as Available-for-Sale and are carried at fair value. Unrealized gains and
losses on these securities, along with any unrealized gains and losses on
related derivatives, are reported, net of applicable taxes, in Stockholders'
Equity. Securities that the Corporation has the positive intent and ability to
hold to maturity are classified as Held-to-Maturity and are carried at
amortized cost. During 1993, securities that might have been sold prior to
maturity were carried at the lower of aggregate cost or market value, with any
valuation adjustments reported in Securities Gains.
Interest and dividend income on securities, including amortization of
premiums and accretion of discounts, are reported in Interest Income on
Securities. Interest income is recognized using the interest method. The
specific identification method is used to determine realized gains and losses
on sales of securities, which are reported in Securities Gains. Individual
securities are reduced through writedowns against Securities Gains to reflect
other-than-temporary impairments in value.
The Corporation anticipates prepayments of principal in the calculation of
the effective yield for collateralized mortgage obligations ("CMOs") and
mortgage-backed securities. The prepayment of CMOs and mortgage-backed
securities is actively monitored through the Corporation's portfolio management
function. The Corporation typically invests in CMOs and mortgage-backed
securities with stable cash flows and relatively short duration, thereby
limiting the impact of interest rate fluctuations on the portfolio. Management
regularly does simulation testing regarding the impact that interest and market
rate changes would have on its CMO and mortgage-backed securities portfolios.
CMOs and mortgage-backed securities which management believes have high
prepayment risk are included in the available-for-sale portfolio.
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Chemical Banking Corporation
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LOANS
Loans are generally reported at the principal amount outstanding, net of
unearned income and net deferred loan fees (nonrefundable yield-related loan
fees, net of related direct origination costs), if any. Loans held for sale are
carried at the lower of aggregate cost or fair value. Certain loans meeting the
accounting definition of a security are classified as Loans but are measured
pursuant to SFAS 115. Interest income is recognized using the interest method
or on a basis approximating a level rate of return over the term of the loan.
The Corporation sells or securitizes certain commercial and consumer loans.
Such sales are generally without recourse to the Corporation. Gains or losses,
as appropriate, are reported in Other Revenue.
Nonaccrual loans are those loans on which the accrual of interest has
ceased. Loans, other than certain consumer loans discussed below, are placed
on nonaccrual status immediately if, in the opinion of management, principal or
interest is not likely to be paid in accordance with the terms of the loan
agreement, or when principal or interest is past due 90 days or more and
collateral, if any, is insufficient to cover principal and interest. Interest
accrued but not collected at the date a loan is placed on nonaccrual status is
reversed against interest income. In addition, the amortization of net deferred
loan fees is suspended when a loan is placed on nonaccrual status. Interest
income on nonaccrual loans is recognized only to the extent received in cash.
However, where there is doubt regarding the ultimate collectibility of the loan
principal, cash receipts, whether designated as principal or interest, are
thereafter applied to reduce the carrying value of the loan. Loans are restored
to accrual status only when interest and principal payments are brought current
and future payments are reasonably assured.
Consumer loans (exclusive of residential mortgage products which are
accounted for in accordance with the nonaccrual loan policy discussed above)
are generally charged to the allowance for credit losses upon reaching
specified stages of delinquency. Accrued interest is reversed against interest
income when such consumer loans are charged off.
Renegotiated loans are those for which concessions, such as the reduction of
interest rates or deferral of interest or principal payments, have been granted
due to a deterioration in the borrowers' financial condition. Interest on
renegotiated loans is accrued at the renegotiated rates. Certain renegotiated
loan agreements call for additional interest to be paid on a deferred or
contingent basis. Such interest is taken into income only as collected.
Effective January 1, 1995, the Corporation adopted Statement of Financial
Accounting Standards No. 114, "Accounting by Creditors for Impairment of a
Loan" ("SFAS 114"), and Statement of Financial Accounting Standards No. 118,
"Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosures" ("SFAS 118"). SFAS 114 requires that the carrying value of an
impaired loan be based on the present value of expected future cash flows
discounted at the loan's effective interest rate or, as a practical expedient,
at the loan's observable market price or the fair value of the collateral, if
the loan is collateral-dependent. Under SFAS 114, a loan is considered impaired
when, based on current information, it is probable that the borrower will be
unable to pay contractual interest or principal payments as scheduled in the
loan agreement. SFAS 114 applies to all loans except smaller-balance homogeneous
consumer loans, loans carried at fair value or the lower of cost or fair value,
debt securities, and leases. Generally, the Corporation applies SFAS 114 to
nonaccrual commercial loans and renegotiated loans. In addition, SFAS 114
modified the accounting for in-substance foreclosures ("ISF"). Effective
January 1, 1995, a collateralized loan is considered an ISF and reclassified to
Assets Acquired as Loan Satisfactions only when the Corporation has taken
physical possession of the collateral regardless of whether formal foreclosure
proceedings have taken place.
SFAS 118 permits a creditor to use existing methods for recognizing interest
revenue on impaired loans. The Corporation recognizes interest income on
impaired loans pursuant to the discussion above for nonaccrual and renegotiated
loans.
ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses provides for risks of losses inherent in the
credit-extension process. The allowance is a general allowance and is based on
periodic reviews and analyses of the portfolio, which comprises primarily loans
and derivatives and foreign exchange contracts. The periodic analyses include
consideration of such factors as the risk rating of individual credits, the
size and diversity of the portfolio, economic and political conditions, prior
loss experience, and results of periodic credit reviews of the portfolio. The
allowance for credit losses is increased by provisions for losses charged
against income and is reduced by charge-offs, net of recoveries. Charge-offs
are recorded when, in the judgment of management, an extension of credit is
deemed uncollectible, in whole or in part. Other charges to the allowance
include amounts related to loans transferred to Assets Held for Accelerated
Disposition.
PREMISES AND EQUIPMENT
Premises and equipment, including leasehold improvements, are carried at cost
less accumulated depreciation and amortization. Capital leases are included in
Premises and Equipment at the capitalized amount less accumulated amortization.
Depreciation and amortization of premises are included in Occupancy Expense,
while depreciation of equipment is included in Equipment Expense. Depreciation
and amortization are computed using the straight-line method over the estimated
useful life of the owned asset and, for leasehold improvements, over the
estimated useful life of the related asset or the lease term, whichever is
shorter. Maintenance and repairs are charged to expense as incurred, while
major improvements are capitalized.
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
OTHER ASSETS
Assets Acquired As Loan Satisfactions: Assets acquired in full or partial
satisfaction of loans are reported at the lower of cost or estimated fair value
less costs to sell. These assets are primarily real estate. Writedowns at the
date of transfer from Loans to assets acquired as loan satisfactions and within
six months after the date of transfer are charged to the Allowance for Credit
Losses. Writedowns of such assets subsequent to six months from the date of
transfer are included in Foreclosed Property Expense. Operating expenses, net
of related revenue, and gains and losses on sales of such assets are reported
net in Foreclosed Property Expense.
Assets Held for Accelerated Disposition: Assets held for accelerated
disposition consist primarily of real estate loans and real estate assets
acquired as loan satisfactions. At the date of transfer to the accelerated
disposition portfolio, these assets are recorded at their initial estimated
disposition value less costs to sell. Assets held for accelerated disposition
are carried at the lower of cost or current estimated disposition value. Any
adjustments to the carrying value of these assets or realized gains and losses
as assets are sold are reported in Other Revenue.
Equity and Equity-Related Investments: Equity and equity-related investments,
include venture capital activities and emerging markets investments.
Nonmarketable holdings are carried at cost, net of other-than-temporary
impairment losses. Marketable holdings are marked-to-market at a discount to
the public value. Income from these investments is reported in Other Revenue.
Intangibles: Goodwill and other acquisition intangibles, such as core deposits
and credit card relationships are amortized over the estimated periods to be
benefited, generally ranging from 10 to 25 years. An impairment review is
performed periodically on these assets. Goodwill amounted to $0.7 billion at
December 31, 1995 compared with $1.1 billion at December 31, 1994. The decrease
in goodwill during 1995 was primarily due to the sale of the Corporation's
banking operations in southern and central New Jersey and half of its 40%
interest in the CIT Group Holdings, Inc.
Mortgage Servicing Rights: In 1995, the Corporation adopted Statement of
Financial Accounting Standards No. 122, "Accounting for Mortgage Servicing
Rights" ("SFAS 122"). SFAS 122 amends Statement of Financial Accounting
Standards No. 65, "Accounting for Certain Mortgage Banking Activities" ("SFAS
65"), to require that when a definitive plan exists to sell or securitize
mortgage loans and to retain the servicing rights related thereto, a mortgage
banking enterprise should recognize as separate assets the rights to service
mortgage loans for others, irrespective of whether those servicing rights are
acquired through the purchase or the origination of the mortgage loans. Under
SFAS 65, only purchased mortgage servicing rights were permitted to be
recognized as separate assets. Capitalized mortgage servicing assets are
amortized into noninterest revenue in proportion to, and over the period of,
the estimated future net servicing income stream of the underlying mortgage
loans. SFAS 122 requires that capitalized mortgage servicing rights be
assessed for impairment based on the fair value of those rights. The
Corporation's policy for evaluating impairment is to stratify the mortgage
servicing rights by year of origination. Fair value is determined considering
market prices for similar assets and based on discounted cash flows using
market based prepayment estimates for similar coupons and incremental direct
and indirect costs.
FEE-BASED REVENUE
Corporate finance and syndication fees primarily include fees received for
managing and syndicating loan arrangements; providing financial advisory
services in connection with leveraged buyouts, recapitalizations, and mergers
and acquisitions; and arranging private placements and underwriting debt and
equity securities.
Trust and investment management fees primarily include fees received in
connection with personal, corporate, and employee benefit trust and investment
management activities.
Credit card revenues primarily include fees received in connection with
credit card activities such as annual, late payment, cash advance, and
interchange fees, as well as servicing fees earned in connection with
securitization activities.
Fees for other financial services primarily include fees received in
connection with mortgage servicing, loan commitments, standby letters of credit
and compensating balances and other fees.
Corporate finance and syndication fees are recognized when services to which
they relate have been provided. In addition, recognition of syndication fees is
subject to certain tests being satisfied. Trust and investment management fees
and fees for other financial services are generally recognized over the period
that the related service is provided. Credit card revenues are generally
recognized as billed, except for annual fees, which are recognized over a
twelve-month period.
INCOME TAXES
The Corporation recognizes both the current and deferred tax consequences of
all transactions that have been recognized in the financial statements.
Calculations are based on the provisions of enacted tax laws and the tax rates
in effect for current and future years. The deferred tax liability (asset) is
determined based on enacted tax rates which will be in effect when the
underlying items of income and expense are expected to be reported to the
taxing authorities. Net deferred tax assets, whose realization is dependent on
taxable earnings of future years, are recognized when a more-
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Chemical Banking Corporation
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likely-than-not criterion is met. Annual deferred tax expense (benefit) is
equal to the change in the deferred tax liability (asset) account from the
beginning to the end of the year. A current tax liability (asset) is recognized
for the estimated taxes payable or refundable for the current year.
EARNINGS PER SHARE
Primary earnings per share is computed by dividing net income after deducting
preferred stock dividends by average common and common equivalent shares which
reflect the dilutive effects of stock options during the respective period. The
dilutive effect of stock options is computed under the treasury stock method
using the average market price of the Corporation's common stock for the
period.
Earnings per common share, assuming full dilution, is computed based on the
average number of common shares outstanding during the period, including the
dilutive effect of stock options and any convertible preferred stock
outstanding during the period. The dilutive effect of outstanding stock options
is computed using the greater of the closing market price or the average market
price of the Corporation's common stock for the period. Any stock options
exercised or any preferred stocks converted are assumed to have occurred at the
beginning of the period. Net income applicable to common stock is adjusted for
dividends declared during the period on the convertible preferred stock.
During 1995, the Corporation changed its reporting of earnings per share
("EPS") for all periods from "simple" EPS (which is based solely on the average
number of common shares outstanding) to reporting "primary" and "fully-diluted"
EPS. Previously, the Corporation reported simple EPS, since the differences
between simple EPS and primary EPS or simple EPS and fully-diluted EPS were not
material (less than 3%).
STATEMENT OF CASH FLOWS
For purposes of preparing the Consolidated Statement of Cash Flows, the
Corporation defines cash and cash equivalents as those amounts included in the
balance sheet caption Cash and Due from Banks. Cash flows from loans and
deposits are reported on a net basis. Changes in assets and liabilities are net
of the effects of sales and acquisitions.
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2 AGREEMENT TO MERGE WITH CHASE MANHATTAN CORPORATION
On August 28, 1995, the Corporation and The Chase Manhattan Corporation
("Chase") announced a definitive agreement to merge in a stock-for-stock
transaction. The merger agreement provides that 1.04 shares of the Corporation's
common stock will be issued in exchange for each share of Chase common stock on
a tax-free basis. All of Chase's series of preferred stock will be exchanged on
a one-for-one basis for a corresponding series of the Corporation's preferred
stock having substantially the same terms as the Chase preferred stock so
converted.
The merger was approved by the common shareholders of both institutions at
special stockholder meetings on December 11, 1995. On January 5, 1996, the
Board of Governors of the Federal Reserve System (the "Federal Reserve Board")
and the Office of the State Bank Commissioner of Delaware approved the
applications for the merger. On January 11, 1996, the Corporation received
approval from the New York State Banking Department to merge with Chase. As a
result, both companies have received all regulatory approvals necessary to
consummate the merger. The merger is scheduled to be completed on March 31,
1996, and will be accounted for as a pooling of interests. The effects of the
merger have not been reflected in the financial statements herein.
At the time of the merger announcement, it was estimated that a one-time
pre-tax restructuring charge of $1.5 billion would be incurred upon consummation
of the merger, principally as a result of severance expenses associated with the
elimination of approximately 12,000 positions from a combined staff of 75,000
located in 39 states and 51 countries and expenses associated with the
elimination of offices and redundant operations. Since that date, the
Corporation has continued to evaluate the costs anticipated to be incurred in
connection with the merger, as well as the cost savings from the merger, and
currently anticipates that the merger-related restructuring charge, as well as
the cost savings, will each be higher than originally announced.
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3 TRADING ACTIVITIES
The Corporation uses its trading assets and liabilities to meet the financial
needs of its customers and to generate revenues through its trading activities.
The Corporation generates such trading revenue through market-making, sales,
arbitrage and, to a lesser degree, positioning. A description of the classes of
derivative and foreign exchange instruments used in the Corporation's trading
activities, as well as the credit and market risk factors involved in such
activities, are disclosed in Note Nineteen.
TRADING ASSETS AND LIABILITIES
Trading assets include debt and equity instruments and derivative contracts
with positive fair values. Trading liabilities are comprised of securities
sold, not yet purchased and derivative contracts with negative fair values.
Trading assets and trading liabilities (which are
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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carried at estimated fair value, after taking into account the effects of
legally enforceable master netting agreements on risk management instruments)
are presented in the following table for the dates indicated.
(a) Includes emerging markets instruments of $522 million in 1995 and $544
million in 1994.
TRADING REVENUE
The following table sets forth the components of total trading-related revenue.
(a) Net interest income attributable to trading activities includes accruals on
interest-earning and interest-bearing trading-related positions as well as a
management allocation reflecting the funding cost or benefit associated with
trading positions.
(b) Includes interest rate swaps, currency swaps, foreign exchange forward
contracts, interest rate futures, and forward rate agreements and related
hedges.
(c) Includes foreign exchange spot and option contracts.
(d) Includes U.S. and foreign government and government agency securities,
corporate debt securities, emerging markets debt instruments, debt-related
derivatives, equity securities, equity derivatives, and commodity derivatives.
(e) Reflects $70 million reduction as a result of losses sustained from
unauthorized foreign exchange transactions involving the Mexican peso.
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4 SECURITIES
See Note One for a discussion of the accounting policies relating to
securities. The amortized cost and estimated fair value of available-for-sale
securities and held-to-maturity securities, including the impact of related
derivatives, were as follows for the dates indicated:
52
Chemical Banking Corporation
and Subsidiaries
(a) The Corporation's portfolio of securities generally consists of
investment-grade securities. The fair value of actively-traded securities is
determined by the secondary market, while the fair value for
non-actively-traded securities is based on independent broker quotations.
(b) Collateralized mortgage obligations of private issuers generally have
underlying collateral consisting of obligations of U.S. Government and Federal
agencies and corporations.
(c) At December 31, 1993, the fair value of U.S. Treasury and Federal Agencies
and Other securities was $11,897 million and $3,943 million, respectively.
There were no Obligations of State and Political Subdivisions.
(d) At December 31, 1993, the amortized cost of U.S. Treasury and Federal
Agencies, Obligations of State and Political Subdivisions, and Other securities
was $9,142 million, $13 million, and $953 million, respectively.
Cash proceeds from the sale of available-for-sale securities during 1995,
1994 and 1993 were $51,445 million, $18,556 million, and $5,352 million,
respectively. Net gains from available-for-sale securities sold in 1995, 1994
and 1993 amounted to $119 million (gross gains of $436 million and gross losses
of $317 million), $66 million (gross gains of $141 million and gross losses of
$75 million), and $139 million (gross gains of $178 million and gross losses of
$39 million), respectively. There were no sales of held-to-maturity securities
during 1995 and 1994. Cash proceeds from the sales of held-to-maturity
securities during 1993 were $152 million. Gross gains from held-to-maturity
securities sold amounted to $3 million in 1993 (there were no losses from sales
of such securities in 1993).
During the fourth quarter of 1995, the Financial Accounting Standards Board
issued Financial Accounting Series Special Report, "A Guide to Implementation of
Statement 115 on Accounting for Certain Investments in Debt and Equity
Securities" ("SFAS 115 Implementation Guide"). In accordance with the adoption
of the SFAS 115 Implementation Guide, the Corporation reassessed the
classifications of all securities held. The result of the one-time reassessment
was the reclassification of $3,141 million of held-to-maturity securities to
available-for-sale securities and $11 million of held-to-maturity securities to
trading assets. Unrealized net gains related to the transfer of held-to-maturity
securities to available-for-sale securities were $11 million after-tax. The
amortized cost of the held-to-maturity securities transferred to trading assets
approximated the fair value. See Note Five for a discussion of loans accounted
for pursuant to SFAS 115.
Of the securities held in the Corporation's securities portfolios,
securities issued by the Federal Republic of Germany exceeded 10% of the
Corporation's total stockholders' equity at December 31, 1995, with a fair
value of $2,845 million and an amortized cost of $2,525 million. U.S.
Government and Federal Agencies were the only other issuers whose securities
exceeded 10% of the Corporation's total stockholders' equity at December 31,
1995.
The amortized cost, estimated fair value, and average yield of securities
and related derivatives at December 31, 1995 by contractual maturity range and
type of security are presented in the table which follow:
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(a) Securities with no stated maturity are included with securities with a
remaining maturity of ten years or more. Substantially all of the Corporation's
mortgage-backed securities are due in ten years or more based on contractual
maturity. The estimated duration of mortgage-backed securities, which reflects
anticipated future prepayments based on a consensus of dealers in the market,
is approximately 5 years.
(b) The average yield is based on amortized cost balances at the end of the
year. Yields are derived by dividing interest income, adjusted for the effect
of related derivatives on the available-for-sale securities and the
amortization of premiums and accretion of discounts, by total amortized cost.
Taxable-equivalent yields are used, where applicable.
(c) Includes investments in debt securities issued by foreign governments,
corporate debt securities, collateralized mortgage obligations of private
issuers, equity and other debt securities.
54
Chemical Banking Corporation
and Subsidiaries
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5 LOANS
The composition of the loan portfolio at each of the dates indicated was as
follows:
Certain loans that meet the accounting definition of a security are classified
as loans and are measured pursuant to SFAS 115, along with related derivatives.
Bonds that have been issued by foreign governments (such as Mexico, Venezuela
and Brazil) to financial institutions, including the Corporation, as part of a
debt renegotiation (i.e., "Brady Bonds") are subject to the provisions of SFAS
115.
In connection with the adoption of the SFAS 115 Implementation Guide in the
fourth quarter of 1995, the Corporation reassessed the classification of all
securities held. The result of the one-time reassessment was the
reclassification of the entire held-to-maturity portfolio of Brady Bonds, other
loans, and related derivatives (measured pursuant to SFAS 115), to
available-for-sale. The amount of the reclassification was $1,972 million at
amortized cost. Unrealized net losses related to the transfer were $454 million
after-tax.
A significant portion of the Brady Bonds within the available-for-sale
portfolio are collateralized by zero-coupon United States Treasury obligations.
The interest on Brady Bonds is also collateralized for up to two years.
Management continually evaluates and monitors the ability of each of the
countries within the portfolio to perform and believes that any unrealized
losses on its available-for-sale portfolio are temporary in nature. The
amortized cost and estimated fair value of loans measured pursuant to SFAS 115,
including the impact of related derivatives, for the dates indicated were as
follows:
The 1995 results included a net loss of $86 million (gross gains of $167
million and gross losses of $253 million) related to the disposition of
emerging market securities previously recorded as available-for-sale. The sale
was part of the Corporation's ongoing efforts to manage its emerging markets
exposure in its available-for-sale portfolio. The 1994 results included a net
gain of $127 million (gross gains of $146 million and gross losses of $19
million) on the disposition of emerging market securities. Cash proceeds from
the sale of these available-for-sale loans during 1995 and 1994 were $1,130
million and $411 million, respectively.
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
6 ALLOWANCE FOR CREDIT LOSSES
The table below summarizes the changes in the allowance for credit losses
during the periods indicated.
(a) Includes $28 million related to the sale of banking operations in southern
and central New Jersey.
(b) Includes $55 million related to the decision to accelerate the disposition
of certain nonperforming residential mortgage loans.
(c) Includes $19 million increase in the allowance related to the acquisition
by Texas Commerce of certain assets of First City Bancorporation of Texas, Inc.
Completion of the Brazilian refinancing package during 1994 essentially
brought to a close the broad rescheduling programs begun in the mid-1980s.
Accordingly, during the second quarter of 1994, the Corporation combined its
then remaining emerging markets allowance with its general allowance for credit
losses.
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7 NONPERFORMING ASSETS
The following table sets forth the nonperforming assets and contractually
past-due loans of the Corporation at the dates indicated.
NONPERFORMING ASSETS
(a) Includes $727 million of loans considered impaired under SFAS No. 114,
"Accounting by Creditors for Impairment of a Loan" ("SFAS 114"). In addition,
on January 1, 1995, $122 million of assets for which the Corporation did not
have possession were reclassified from Assets Acquired as Loan Satisfactions to
Nonperforming Loans pursuant to the adoption of SFAS 114.
(b) Accruing loans past-due 90 days or more as to principal and interest, which
are not characterized as nonperforming loans. Includes consumer loans,
exclusive of residential mortgage loans, which are generally not classified as
nonperforming but, rather, are charged off on a formula basis upon reaching
certain specified stages of delinquency.
The following table presents the Corporation's assets held for accelerated
disposition at the dates indicated:
ASSETS HELD FOR ACCELERATED DISPOSITION
(a) Includes $412 million and $87 million of loans that were performing at
December 31, 1995 and 1994, respectively.
The following table presents the amount of interest income recorded by the
Corporation on its nonaccrual and renegotiated loans and the amount of interest
income on the carrying value of such loans that would have been recorded had
these loans been current in accordance with their original terms (interest
at original rates).
56
Chemical Banking Corporation
and Subsidiaries
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IMPACT OF NONPERFORMING LOANS ON INTEREST INCOME(a)
(a) Excludes nonperforming loans held for accelerated disposition.
IMPAIRED LOANS
The following table presents the Corporation's impaired loans disclosures. The
Corporation uses the discounted cash flow method as its primary method for
valuing its impaired loans.
(a) Impaired loans for which the discounted cash flow, collateral value or
market price equals or exceeds the carrying value of the loan. Such loans do
not require an allowance under SFAS 114.
(b) The Allowance for Impaired Loans under SFAS 114 is a part of the
Corporation's overall Allowance for Credit Losses.
--------------------------------------------------------------------------------
8 SHORT-TERM AND OTHER BORROWED FUNDS
Federal funds purchased represent overnight funds. Securities sold under
repurchase agreements generally mature between one day and three months.
Commercial paper is generally issued in amounts not less than $100,000 and with
maturities of 270 days or less. Other borrowings consist of demand notes of one
year or less, and various other borrowings in domestic and foreign offices that
generally have maturities of one year or less.
At December 31, 1995, the Corporation had unused lines of credit available
for general corporate purposes, including the payment of commercial paper
borrowings, amounting to $750 million.
--------------------------------------------------------------------------------
9 FEES FOR OTHER FINANCIAL SERVICES AND OTHER REVENUE
Details of fees for other financial services were as follows:
Details of other revenue were as follows:
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
10 LONG-TERM DEBT
The accompanying table is a summary of long-term debt (net of unamortized
original issue debt discount, where applicable) displayed by remaining maturity
at December 31, 1995. The distribution by remaining maturity is based on
contractual maturity.
(a) The interest rates shown have been adjusted to reflect the effect of ALM
derivative contracts, primarily interest rate swaps, used to convert a majority
of the Corporation's fixed-rate debt to variable rates. The interest rates
shown for variable rate issues, including those converted to variable rate, are
those in effect at December 31, 1995.
The Corporation issues long-term debt denominated in various currencies,
predominately in U.S. dollars, with both fixed and variable interest rates.
Fixed-rate debt outstanding at December 31, 1995 matures at various dates
through 2010 at contractual interest rates ranging from 5.00% to 11.83%. The
consolidated weighted-average contractual interest rate on fixed-rate debt was
7.82% at both December 31, 1995 and 1994. Variable-rate debt outstanding, with
contractual interest rates ranging from 5.34% to 6.63% at December 31, 1995,
matures at various dates through 2005. The consolidated weighted-average
interest rates on variable-rate debt at December 31, 1995 and 1994 were 6.06%
and 5.64%, respectively.
Included in long-term debt are equity commitment notes and equity contract
notes totaling $693 million at both December 31, 1995 and 1994.
Equity commitment notes require that the Corporation issue, prior to the
maturity of such notes, shares of common stock or perpetual preferred stock or
other securities of the Corporation (collectively, "Capital Securities")
approved by the Federal Reserve Board equal to 100% of the original aggregate
principal amount of the notes.
Equity contract notes require the Corporation to exchange the notes at
maturity for Capital Securities with a market value equal to the principal
amount of the notes or, at the Corporation's option, to pay the principal of
the notes from amounts representing designated proceeds from the sale of
Capital Securities.
At December 31, 1995, the Corporation had designated proceeds from the sale
of Capital Securities in an amount sufficient to satisfy fully the dedication
requirements of its equity commitment and equity contract notes.
The Corporation has guaranteed several long-term debt issues of its
subsidiaries. Such guaranteed debt totaled $420 million and $435 million at
December 31, 1995 and 1994, respectively.
At December 31, 1995, long-term debt aggregating $200 million was redeemable
at the option of the Corporation, in whole or in part, prior to maturity, based
on the terms specified in the respective notes.
The aggregate principal amount of debt that matures in each of the five years
subsequent to December 31, 1995 is $860 million in 1996, $738 million in 1997,
$758 million in 1998, $699 million in 1999, and $1,043 million in 2000.
58
Chemical Banking Corporation
and Subsidiaries
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11 PREFERRED STOCK
At December 31, 1995, the Corporation was authorized to issue 200 million
shares of preferred stock, in one or more series, with a par value of $1 per
share. At December 31, 1995 and 1994, 26 million and 30 million shares,
respectively, of preferred stock were outstanding.
During 1995, the Corporation called all of the outstanding shares of its 10%
convertible preferred stock for redemption. Substantially all of the 10%
convertible preferred stock was converted prior to the redemption date, at the
option of the holders thereof, into approximately 7.6 million shares of the
Corporation's common stock. The shares of common stock issued upon the
conversion were issued from treasury.
At December 31, 1995, four million shares of preferred stock designated as
Junior Participating Preferred Stock were reserved for issuance under the
Corporation's Shareholders' Rights Plan (see Note Eighteen).
During 1994, the Corporation redeemed all 33.6 million outstanding shares of
its Adjustable Rate Cumulative Preferred Stock, Series C. The redemption price
was $12.36 per share (which included a premium of $.36 per share) plus accrued
but unpaid dividends to the date of redemption. During 1994, the Corporation
issued two million shares of Adjustable Rate Cumulative Preferred Stock, Series
L Preferred ("Adjustable Rate, Series L"), with a stated value of $100 per
share.
Dividends on shares of each preferred stock issue are payable quarterly and
are cumulative. All the preferred stocks outstanding have preference over the
Corporation's common stock with respect to the payment of dividends and the
distribution of assets in the event of a liquidation or dissolution of the
Corporation.
The following is a summary of the Corporation's preferred stocks outstanding
at December 31, 1995 and 1994:
(a) Such shares are represented by depositary shares, each representing
one-quarter share of preferred stock.
(b) Plus accrued but unpaid dividends.
(c) Floating rates are based on certain money market rates. The minimum and
maximum rates are 4.50% and 10.50%, respectively for the Adjustable Rate,
Series L.
--------------------------------------------------------------------------------
12 COMMON STOCK
At December 31,1995, the Corporation was authorized to issue 400 million shares
of common stock, $1 par value per share. In December 1995, the shareholders of
the Corporation approved an amendment to increase the number of authorized
shares of common stock to 750 million. The amendment will be effective upon
consummation of the merger with Chase. At December 31, 1995, 1994, and 1993,
the number of shares of common stock issued and outstanding were as follows:
During 1995, the Corporation repurchased approximately 14.4 million shares of
its outstanding common stock in the open market. These share repurchases have
been utilized to offset the effects of common stock issuances upon the exercise
of options in various outstanding employee stock option and incentive plans.
During 1995, approximately 12.8 million shares (11.9 million from treasury) were
issued under various employee stock option and incentive plans. Additionally, in
1995, 7.6 million shares of common stock were issued (also from treasury) upon
the conversion of the Corporation's 10% convertible preferred stock.
59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
As of December 31, 1995, approximately 15,131,468 shares of common stock
were reserved for issuance under various employee incentive and stock purchase
plans and under the Corporation's Dividend Reinvestment Plan. Under the
Corporation's Dividend Reinvestment Plan, stockholders may reinvest all or part
of their quarterly dividends in shares of common stock.
Common stock issued, or distributed from treasury, during 1995, 1994 and
1993 was as follows:
(a) Amount includes 8,886,969 of common stock issued related to the Employee
Stock Option Plan. See Note Fourteen for a discussion of the Corporation's
Employee Stock Option Plan.
(b) During 1995 and 1994, 19,530,163 and 1,055,455, respectively, of these
shares were distributed from treasury. No shares were distributed from treasury
in 1993.
13 POSTRETIREMENT BENEFITS
Pension Plans: The Corporation has a noncontributory pension plan that covers
substantially all domestic employees and provides for defined benefits pursuant
to a cash balance feature and a final-average-pay feature (the "noncontributory
pension plan"). Contributions will be made to the noncontributory pension plan
within the range of levels permitted under applicable law.
The accompanying tables present the aggregate funded status and the net
asset amounts included in other assets and the components of expense included
in employee benefits expense for the Corporation's noncontributory pension
plan.
FUNDED STATUS OF PENSION PLANS
COMPONENTS OF NET PENSION EXPENSE
In addition to the noncontributory pension plan, the Corporation also
maintains a number of defined benefit pension plans in foreign jurisdictions
covering the employees of certain foreign operations. Contributions are made to
the foreign plans in accordance with local plan and legal requirements.
The Corporation has elected not to prefund fully several defined benefit
plans based on plan and legal requirements. At December 31, 1995 and 1994, the
Corporation's accrued liability included in accrued expenses related to those
plans totaled $56 million and $46 million, respectively. The employee benefits
expense related to these plans was $12 million in 1995, $11 million in 1994,
and $8 million in 1993.
The Corporation has several defined contribution plans. The most significant
is a Savings Incentive Plan ("SIP") offered to domestic employees. Subject to
certain limits, the SIP allows employees to make tax-deferred investments and
earn matching contributions from the Corporation. Employee benefits expense
related to defined contribution plans totaled $58 million in 1995, $51 million
in 1994, and $42 million in 1993.
60
Chemical Banking Corporation
and Subsidiaries
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Postretirement Medical and Life Insurance Benefits: The Corporation provides
postretirement medical and life insurance benefits to substantially all
domestic employees hired prior to April 15, 1992, and to certain foreign
employees. The employees must meet certain age and length-of-service
requirements at retirement. The amount of benefits provided varies with length
of service and date of hire. The Corporation has not prefunded these benefits.
Effective January 1, 1995, the Corporation adopted SFAS No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions" ("SFAS 106"), for
postretirement medical benefits for its foreign employees. Consistent with the
January 1, 1993 adoption of SFAS 106 for domestic employees, the Corporation
elected to expense the entire unrecognized accumulated obligation as of the
date of adoption of SFAS 106 related to its foreign employees via a one-time
pre-tax charge of $17 million ($11 million after-tax).
The accompanying tables present the components of the liability included in
accrued expenses, and the periodic expense included in employee benefits
expense related to providing postretirement medical and life insurance
benefits. The discount rates and rates of increase in future compensation used
to determine the actuarial values for these benefits generally are consistent
with those used for the noncontributory pension plan. For 1995, the assumed
medical benefits cost trend rate used to measure the expected cost of benefits
was 11% for 1996, declining by 1% per year to a floor of 6%. The effect of a 1%
increase in the assumed medical benefits cost trend rate would be to increase
each of the December 31, 1995 accumulated obligation and related periodic
expense by approximately 8%.
COMPONENTS OF POSTRETIREMENT MEDICAL AND LIFE INSURANCE LIABILITY
The unrecognized net loss at December 31, 1995 resulted primarily from the
change in the discount rate at December 31, 1995.
COMPONENTS OF NET POSTRETIREMENT MEDICAL AND
LIFE INSURANCE EXPENSE
14 EMPLOYEE STOCK INCENTIVE PLANS
EXECUTIVE INCENTIVE PLANS
The Corporation has a long-term stock incentive plan (the "Plan") which
provides for stock-based awards, including stock options, restricted stock, and
restricted stock units, to certain key employees.
Pursuant to the Plan, stock options are issued at prices at least equal to
the market value of the Corporation's common stock on the grant date.
Generally, options cannot be exercised until one year after the grant date and
become exercisable over various periods as determined at the time of grant.
Options generally expire ten years after the grant date. No compensation
expense is required to be recognized in conjunction with such options granted
or exercised; amounts received upon the exercise of options are recorded as
common stock and capital surplus.
Restricted stock and restricted stock units are issued under the Plan at no
cost to the recipient. Restricted stock is awarded subject to the risk of
forfeiture until certain restrictions, including continued employment for a
specified number of years, have lapsed. The recipient is, however, entitled to
the voting rights and dividends on the stock. Restricted stock units entitle
their holders to receive shares of common stock after a certain period of
continued employment. The holders of restricted stock units are entitled to
receive cash payments equivalent to the dividends that would have been received
if the units were shares of common stock.
Most restricted stock and restricted stock units awarded under the
Plan during 1995 and 1994 vest when the Corporation's common stock price
reaches and sustains targeted prices for a minimum period of time. At December
31, 1995, more than half of all such awards had vested as a result of the first
two targets having been attained. During 1995, restricted stock and restricted
stock units totaling 858,680 were issued under the Plan. The number of such
awards issued under the Plan during 1994 totaled 901,300.
Compensation expense relating to most restricted stock and restricted stock
units (i.e., for awards where the number of shares to be issued at the end of
the restricted period is determined on the grant date) is equal to the market
value of the Corporation's common stock on the grant date; for other awards,
compensation expense generally is equal to the market value on the date the
restrictions lapse (i.e., for awards that are forfeitable in the event that
targets are not attained or that are payable in cash). Compensation expense is
recognized over the restricted period.
The following table presents a summary of the aggregate option transactions
under the Plan during 1995 and 1994.
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
At December 31, 1995 and 1994, 201,422 and 197,924 shares, respectively, of
the Corporation's common stock were reserved for issuance and available for
future awards under the Plan. In January of each year the Corporation reserves
additional shares equal to 1.5% of its outstanding shares of common stock for
future awards under the Plan.
EMPLOYEE STOCK OPTION PLAN
In 1994, the Corporation granted 20,025,250 non-qualified stock options to
purchase shares of its common stock to all full-time (500 options each) and
part-time (250 options each) employees (excluding senior officers). These
options were granted at the $40.50 market price of the Corporation's common
stock on June 15, 1994 and were exercisable in three installments if the
Corporation's common stock price closed at, or above, certain targeted prices
for a pre-specified period. During 1995, all three minimum target prices were
met and maintained for the specified periods, giving grant recipients the right
to exercise all of their options. Any options not exercised by June 14, 2004
will be forfeited as of that date.
Neither the grant nor the exercise of the options result in a charge to the
Corporation's earnings under current accounting rules.
The following table presents the activity in the employee stock option plan
during 1995 and 1994.
--------------------------------------------------------------------------------
15 RESTRICTIONS ON CASH AND INTERCOMPANY FUNDS TRANSFERS
Federal Reserve Board regulations require depository institutions to maintain
cash reserves with a Federal Reserve Bank. The average amount of reserve
balances deposited by the Corporation with various Federal Reserve Banks was
approximately $675 million during 1995 and $1 billion during 1994.
Restrictions imposed by Federal law prohibit the Corporation and certain
other affiliates from borrowing from banking subsidiaries unless the loans are
secured in specified amounts. Such secured loans to the Corporation or to each
of certain other affiliates generally are limited to 10% of the banking
subsidiary's capital and surplus; the aggregate amount of all such loans is
limited to 20% of the banking subsidiary's capital and surplus. The Corporation
was well within these limits throughout the year.
The principal sources of the Corporation's income (on a parent company-only
basis) are dividends and interest from Chemical Bank and the other banking and
non-banking subsidiaries of the Corporation. Federal law imposes limitations on
the payment of dividends by the subsidiaries of the Corporation that are state
member banks of the Federal Reserve System (a "state member bank") or are
national banks. Under such limitations, dividend payments by such banks are
limited to the lesser of (i) the amount of "undivided profits" (as defined) and
(ii) absent regulatory approval, an amount not in excess of "net income" (as
defined) for the current year plus "retained net income" (as defined) for the
preceding two years. Non-bank subsidiaries of the Corporation are not subject
to such limitations.
In accordance with the foregoing restrictions, the Corporation's bank
subsidiaries could, during 1996, without the approval of their relevant banking
regulators, pay dividends of approximately $423 million to their respective
bank holding companies, plus an additional amount equal to their net income
from January 1, 1996 through the date in 1996 of any such dividend payment. In
determining whether, and to what extent, to pay dividends, each subsidiary bank
must also consider the effect of applicable regulatory capital guidelines and
leverage limitations.
62
Chemical Banking Corporation
and Subsidiaries
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In addition to dividend restrictions, the Federal Reserve Board, the Office
of the Comptroller of the Currency, and the Federal Deposit Insurance
Corporation ("FDIC") have authority under the Financial Institutions
Supervisory Act to prohibit or to limit the payment of dividends by the banking
organizations they supervise, including the Corporation and its subsidiaries
that are banks or bank holding companies, if, in the banking regulator's
opinion, payment of a dividend would constitute an unsafe or unsound practice
in light of the financial condition of the banking organization.
-------------------------------------------------------------------------------
16 RESTRUCTURING CHARGES AND OTHER EXPENSE
Restructuring Charges: In December 1994, the Corporation announced a two-year
program to improve earnings per share and return on equity and, as a result,
recorded a pre-tax restructuring charge of $260 million. The charge is related
to severance and other termination-related costs of $138 million associated
with the elimination of 3,700 positions and costs of $122 million for the
disposition of certain facilities, premises and equipment, and the termination
of leases. The staff reductions have been tied to specific expense-reduction
initiatives, such as commercial lending re-engineering, branch network
rationalization, and the process improvement program at Texas Commerce and have
occurred within the Global Bank, Consumer and Relationship Banking and
Corporate sectors. At December 31, 1995, the Corporation had eliminated
approximately 2,800 of the 3,700 positions targeted for elimination. Also at
December 31, 1995, the reserve balance associated with this charge was
approximately $115 million.
During 1994, the Corporation also included in noninterest expense a
restructuring charge of $48 million related to the closing of 50 New York
branches and a staff reduction of 650.
In 1993, the Corporation completed an assessment of costs associated with
the merger of the Corporation and MHC on December 31, 1991, and, as a result,
included in noninterest expense a charge of $115 million. Also in 1993, the
Corporation's Texas Commerce subsidiary incurred a restructuring charge of $43
million in connection with the acquisition of assets and assumption of
liabilities of four banks (the "First City Banks") of the former First City
Bancorporation of Texas, Inc. from the FDIC.
At December 31, 1995, the remaining reserve related to the New York branch
restructuring charge taken in 1994 and both restructuring charges taken in 1993
was immaterial.
Other Expense: Details of other expense were as follows:
(a) Certain prior period amounts have been reclassified to conform with the
current year's presentation.
(b) Reflects the impact of a reduction in the FDIC assessment rate.
-------------------------------------------------------------------------------
17 INCOME TAXES
The Corporation accounts for income taxes pursuant to SFAS 109. The Corporation
adopted SFAS 109 as of January 1, 1993 on a prospective basis and recognized a
favorable cumulative effect on income tax expense of $450 million.
A valuation reserve was established as of January 1, 1993, in accordance
with the requirements of SFAS 109, for tax benefits available to the
Corporation but for which realization was in doubt. The Corporation's valuation
reserve for Federal taxes was $86 million at December 31, 1995, relating
primarily to tax benefits associated with foreign operations which are subject
to tax law limitations on realization.
Deferred income tax expense (benefit) results from differences between
amounts of assets and liabilities as measured for income tax return and
financial reporting purposes. The significant components of Federal deferred
tax assets and liabilities as of December 31, 1995 and 1994 are reflected in
the following table.
63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
A valuation reserve approximating $148 million at December 31, 1995, has
been established against all New York State and City deferred tax assets. The
Corporation has recorded deferred New York State and City tax liabilities of
approximately $130 million, net of deferred tax assets and related valuation
reserve, as of December 31, 1995. Foreign deferred taxes are approximately $150
million as of December 31, 1995 and a federal deferred tax asset has been
recorded in accordance with SFAS 109. The Corporation expects that when paid,
these foreign taxes will be creditable against its federal income tax liability.
The components of income tax expense included in the Consolidated Statement of
Income were as follows:
Not reflected in the preceding table are the tax effects of unrealized gains
and losses, with respect to available-for-sale securities that are recorded
directly in stockholders' equity, pursuant to SFAS 115 and certain tax benefits
associated with the Corporation's employee stock plans. Stockholders' equity
decreased by $19 million and $145 million, respectively, in 1995 and 1993 and
increased by $472 million in 1994 due to the tax effects.
The tax expense applicable to securities gains and losses for the years
1995, 1994 and 1993 was $47 million, $27 million, and $62 million,
respectively.
A reconciliation of the income tax expense computed at the applicable
statutory U.S. income tax rate to the actual income tax expense for the past
three years is shown in the following table.
The following table presents the domestic and foreign components of income
before income taxes for the past three years.
(a) For purposes of this disclosure, foreign income is defined as income
generated from operations located outside the United States.
---------------------------------------------------------------------------
18 SHAREHOLDERS' RIGHTS PLAN
At December 31, 1995, the Corporation had in place a Shareholders' Rights Plan.
The Shareholders' Rights Plan contains provisions intended to protect
stockholders in the event of unsolicited offers or attempts to acquire the
Corporation, including offers that do not treat all stockholders equally,
acquisitions in the open market of shares constituting control without offering
fair value to all stockholders, and other coercive or unfair takeover tactics
that could impair the Board of Directors' ability to represent stockholders'
interests fully. The Shareholders' Rights Plan provides that attached to each
share of common stock is one right (a "Right") to purchase a unit consisting of
one one-hundredth of a share of Junior Participating Preferred Stock for an
exercise price of $150 per unit, subject to adjustment.
The Rights have certain anti-takeover effects. The Rights may cause
substantial dilution to a person that attempts to acquire the Corporation
without the approval of the Board of Directors unless the offer is conditioned
on a substantial number of Rights being acquired. The Rights, however, should
not affect offers for all outstanding shares of common stock at a fair price
and otherwise in the best interests of the Corporation and its stockholders as
determined by the Board of Directors. The Board of Directors may, at its
option, redeem all, but not fewer than all, of the then outstanding Rights at
any time until the 10th business day following a public announcement that a
person or a group had acquired beneficial ownership of 20% or more of the
Corporation's outstanding common stock or total voting power.
64
Chemical Banking Corporation
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19 DERIVATIVE AND FOREIGN EXCHANGE FINANCIAL INSTRUMENTS
The Corporation utilizes various derivative and foreign exchange financial
instruments for trading purposes and for purposes other than trading, such as
asset/liability management. These financial instruments represent contracts
with counterparties where payments are made to or from the counterparty based
upon specific interest rates, currency levels, other market rates or on terms
predetermined by the contract. Such derivative and foreign exchange transactions
involve, to varying degrees, credit risk and market risk. For a discussion of
the credit and market risks involved with derivative and foreign exchange
financial instruments, reference is made to the first three paragraphs of the
Derivative and Foreign Exchange Financial Instruments section of the
Management's Discussion and Analysis ("MD&A") on page 29, the first ten
paragraphs of the Credit Risk Management section of the MD&A on page 23, and
paragraphs eight through eleven of the Market Risk Management section of the
MD&A on page 31.
Derivative and Foreign Exchange Instruments Used for Trading Purposes: The
credit risk associated with the Corporation's trading activities is disclosed
on the balance sheet. The effects of any market risk (gains or losses) on the
Corporation's trading activities have been reflected in trading revenue, as the
trading instruments are marked-to-market on a daily basis. See Note One for a
discussion of the Corporation's trading activities and Note Three for the types
and categories of these trading instruments.
Derivative and Foreign Exchange Instruments Used for Purposes Other than
Trading: The Corporation's principal objective in using derivatives for purposes
other than trading is for its asset/liability management. For a further
discussion of the Corporation's objectives and strategies for employing
derivative and foreign exchange instruments for asset/liability management
activities, reference is made to the first three paragraphs of the
Asset/Liability Management discussion in the MD&A on page 32 and the Other
Market Risk Management section on page 35.
The majority of the Corporation's derivatives used for asset/ liability
management are transacted through its trading units.
For the disclosure of the fair value associated with the Corporation's
asset/liability management activities, see Note Twenty Two.
At December 31, 1995, gross deferred gains and gross deferred losses
relating to closed derivative contracts used in asset/liability management
activities were $57 million and $187 million, respectively. See Note One on
page 47 for the accounting method used for these contracts and the
Amortization of Net Deferred Gains/Losses on Closed ALM Contracts table on page
35 of the MD&A.
The Corporation also uses selected derivative financial instruments to
manage the sensitivity to changes in market interest rates on anticipated
transactions; however, such transactions are not significant. Accordingly, at
December 31, 1995, deferred gains and losses associated with such transactions
were immaterial.
The following table summarizes the aggregate notional amounts of interest
rate and foreign exchange contracts as well as the credit exposure related to
these instruments (after taking into account the effects of legally enforceable
master netting agreements) for the dates indicated below. The table should be
read in conjunction with the preceding narrative as well as the descriptions of
these products and their risks immediately following.
65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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(a) The notional amounts of exchange-traded interest rate contracts, foreign
exchange contracts, and commodity contracts were $362.5 billion, $.8 billion
and $2.9 billion, respectively, at December 31, 1995. The credit risk amounts
of these contracts were minimal since exchange-traded contracts principally
settle daily in cash.
(b) Includes notional amounts of purchased options, written options and
cross-currency interest rate swaps of $42.1 billion, $46.1 billion and $32.9
billion, respectively, at December 31, 1995, compared with $34.2 billion,
$38.4 billion and $22.2 billion, respectively, at December 31, 1994.
Classes of Derivative and Foreign Exchange Instruments: The following classes
of derivative and foreign exchange instruments refer to instruments that are
used by the Corporation for purposes of both trading and asset/liability
management.
Interest rate futures and forwards are contracts for the delayed delivery of
securities or money market instruments in which the seller agrees to deliver on
a specified future date, a specified instrument, at a specified price or yield.
The credit risk inherent in futures and forwards is the risk that the exchange
party may default. Futures contracts settle in cash daily and, therefore, there
is minimal credit risk to the Corporation. The credit risk inherent in forwards
arises from the potential inability of counterparties to meet the terms of
their contracts. Both futures and forwards are also subject to the risk of
movements in interest rates or the value of the underlying securities or
instruments.
Forward rate agreements are contracts to exchange payments on a certain
future date, based on a market change in interest rates from trade date to
contract settlement date. The notional amount on which the interest payments are
based is not exchanged. The maturity of these agreements is typically less than
two years.
Interest rate swaps are contracts in which a series of interest rate flows
in a single currency are exchanged over a prescribed period. The notional
amount on which the interest payments are based is not exchanged. Most interest
rate swaps involve the exchange of fixed and floating interest payments.
Cross-currency interest rate swaps are contracts that involve the exchange of
both interest and principal amounts in two different currencies. The risks
inherent in interest rate and cross-currency swap contracts are the potential
inability of a counterparty to meet the terms of its contract and the risk
associated with changes in the market values of the contracts due to movements
in the underlying interest rates.
Interest rate options, which include caps and floors, are contracts which
transfer, modify, or reduce interest rate risk in exchange for the payment of a
premium when the contract is initiated. As a writer of interest rate caps,
floors, and other options, the Corporation receives a premium in exchange for
bearing the risk of unfavorable changes in interest rates. Conversely, as a
purchaser of an option, the Corporation pays a premium for the right, but not
the obligation, to buy or sell a financial instrument or currency at
predetermined terms in the future. Foreign currency options are similar to
interest rate option contracts, except that they are based on currencies
instead of interest rates.
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The Corporation's use of written options as part of its asset/liability
management is permitted only in those circumstances where they are specifically
linked to purchased options and in order to mitigate interest rate risk. All
unmatched written options are included in the trading portfolio and are
marked-to-market.
Foreign exchange contracts are contracts for the future receipt or delivery
of foreign currency at previously agreed-upon terms. The risks inherent in
these contracts are the potential inability of a counterparty to meet the terms
of its contract and the risk associated with changes in the market values of
the underlying currencies.
Stock index option contracts are contracts to pay or receive cash flows from
counterparties based upon the increase or decrease in the underlying index.
Commodity contracts include swaps, caps and floors and are similar to interest
rate contracts, except that they are based on commodity indices instead of
interest rates.
To reduce its exposure to market risk related to the above-mentioned classes
of derivative and foreign exchange instruments, the Corporation may enter into
offsetting positions.
To reduce credit risk, management may deem it necessary to obtain
collateral. The amount and nature of the collateral obtained is based on
management's credit evaluation of the customer. Collateral held varies but may
include cash, securities, accounts receivable, inventory, property, plant and
equipment, and real estate.
Derivatives and foreign exchange products are generally either negotiated
over-the-counter ("OTC") contracts or standardized contracts executed on a
recognized exchange. Standardized exchange-traded derivatives primarily include
futures and options. Negotiated OTC derivatives are generally entered into
between two counterparties that negotiate specific agreement terms, including
the underlying instrument, amount, exercise price, and maturity.
Included as part of the financial instruments presented in the preceding
notional table are transactions involving "when-issued securities", which the
Corporation enters into primarily as part of its trading activities.
When-issued securities are commitments to purchase or sell securities
authorized for issuance, but not yet actually issued. Accordingly, such
commitments are not recorded on the balance sheet until issued. However, these
commitments are marked-to-market with the resulting gains or losses reflected
in trading revenue.
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20 OFF-BALANCE SHEET LENDING-RELATED FINANCIAL INSTRUMENTS
In addition to using derivative and foreign exchange financial instruments, the
Corporation also utilizes lending-related financial instruments in order to
meet the financing needs of its customers. The Corporation issues commitments
to extend credit, standby and other letters of credit, and guarantees, and also
provides securities-lending services. For these instruments, the contractual
amount of the financial instrument represents the maximum potential credit risk
if the counterparty does not perform according to the terms of the contract. A
large majority of these commitments expire without being drawn upon. As a
result, total contractual amounts are not representative of the Corporation's
actual future credit exposure or liquidity requirements for such commitments.
The following table summarizes the lending-related contract amounts relating
to these financial instruments at December 31, 1995 and 1994.
OFF-BALANCE SHEET LENDING-RELATED FINANCIAL INSTRUMENTS
(a) Excludes credit card commitments of $20 billion and $19 billion at December
31, 1995 and 1994, respectively.
Unfunded commitments to extend credit are agreements to lend to a customer
who has complied with predetermined contractual conditions. Commitments
generally have fixed expiration dates.
Standby letters of credit and guarantees are conditional commitments issued
by the Corporation generally to guarantee the performance of a customer to a
third party in borrowing arrangements, such as commercial paper, bond
financing, construction, and similar transactions. The credit risk involved in
issuing standby letters of credit is essentially the same as that involved in
extending loan facilities to customers and may be reduced by participations to
third parties. The Corporation holds collateral to support those standby
letters of credit and guarantees written for which collateral is deemed
necessary. At December 31, 1995, all of the Corporation's standby letters of
credit and guarantees written expire in less than five years.
Customers' securities lent are customers' securities held by the
Corporation, as custodian, which are lent to third parties. The Corporation
obtains collateral, with a market value exceeding 100% of the contract amount,
which is used to indemnify customers against possible losses resulting from
third-party defaults.
67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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21 CONCENTRATIONS OF CREDIT RISK
Concentrations of credit risk arise when a number of customers are engaged in
similar business activities, or activities in the same geographic region, or
have similar economic features that would cause their ability to meet
contractual obligations to be similarly affected by changes in economic
conditions.
Concentrations of credit risk indicate the relative sensitivity of the
Corporation's performance to both positive and negative developments affecting
a particular industry. Based on the nature of the banking business, management
does not believe that any of these concentrations are unusual.
The accompanying table presents the Corporation's significant concentrations
of credit risk for all financial instruments, including both on-balance sheet
as well as off-balance sheet instruments (which primarily include
lending-related financial instruments). The Corporation has procedures to
monitor counterparty credit risk and to obtain collateral when deemed
necessary. Accordingly, management believes that the total credit exposure
shown below is not representative of the potential risk of loss inherent in the
portfolio.
The Corporation's balance sheet exposure to consumers was mainly residential
mortgages and credit card outstandings, with off-balance sheet exposure
concentrated in unfunded credit card commitments. For a geographic
concentration of residential mortgages and credit card outstandings, reference
is made to the tables entitled Residential Mortgage Loans by Geographic Region
and Domestic Credit Card Receivables by Geographic Region within the Domestic
Consumer Portfolio section of the MD&A on pages 25 and 26, respectively.
Geographic concentrations are a factor most directly affecting the credit
risk of the real estate and emerging markets segments of the Corporation's loan
portfolio. The Corporation's real estate portfolio is primarily concentrated in
the New York Metropolitan area and in Texas. Its emerging markets portfolio is
largely concentrated in Latin America, principally Mexico, Venezuela and
Brazil.
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22 FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosures About Fair
Value of Financial Instruments" ("SFAS 107"), requires the Corporation to
disclose fair value information about financial instruments for which it is
practicable to estimate the value, whether or not such financial instruments
are recognized on the balance sheet. Fair value is the amount at which a
financial instrument could be exchanged in a current transaction between
willing parties, other than in a forced sale or liquidation, and is best
evidenced by a quoted market price, if one exists.
Quoted market prices are not available for a significant portion of the
Corporation's financial instruments. As a result, the fair values presented are
estimates derived using present value or other valuation techniques and may not
be indicative of the net realizable value. In addition, the calculation of
estimated fair value is based on market conditions at a specific point in time
and may not be reflective of future fair values.
Certain financial instruments and all nonfinancial instruments are excluded
from the scope of SFAS 107. Accordingly, the fair value disclosures required by
SFAS 107 provide only a partial estimate of the fair value of the Corporation.
For example, the values associated with the various ongoing businesses which
the Corporation operates are excluded. The Corporation has developed long-term
relationships with its customers through its deposit base and its credit card
accounts, commonly referred to as core deposit intangibles and credit card
relationships. In addition, relationships with mortgage servicing customers
that originated prior to the adoption of SFAS 122 also provide significant
economic value not currently reflected in the balance sheet. In the opinion of
management, these items in the aggregate add significant value to the
Corporation, but their fair value is not disclosed in this Note.
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Fair values among financial institutions are not comparable due to the wide
range of permitted valuation techniques and the numerous estimates that must be
made. This lack of objective valuation standard introduces a great degree of
subjectivity to these derived or estimated fair values. Therefore, readers are
cautioned in using the information disclosed in this Note for purposes of
evaluating the financial condition of the Corporation compared with other
financial institutions.
The following summary presents the methodologies and assumptions used to
estimate the fair value of the Corporation's financial instruments required to
be valued pursuant to SFAS 107.
FINANCIAL ASSETS
Assets for Which Fair Value Approximates Carrying Value: The fair value of
certain financial assets carried at cost, including cash and due from banks,
deposits with banks, federal funds sold and securities purchased under resale
agreements, due from customers on acceptances, short-term receivables, and
accrued interest receivable, is considered to approximate their respective
carrying values due to their short-term nature and negligible credit losses.
The fair value of loans held for accelerated disposition is also considered to
approximate carrying value. As discussed in Note One, such loans are carried at
the lower of cost or current estimated disposition value.
Trading Assets: The Corporation carries trading assets, which includes debt and
equity instruments as well as the positive fair values of derivative and foreign
exchange instruments, at estimated fair value. The fair value of these
instruments were valued using either quoted market prices, pricing models,
quoted market prices of financial instruments with similar characteristics or
discounted cash flows. For the fair value of trading assets, see Note Three.
Securities: Securities held-to-maturity are carried at amortized cost.
Securities available-for-sale and interest rate contracts used in connection
with the available-for-sale portfolio are carried at fair value. The valuation
methodologies for securities are discussed in Note Four.
Loans: Loans are valued using methodologies suitable for each loan type.
Certain of these methodologies and key assumptions made are discussed below.
The fair value of the Corporation's commercial loan portfolio was estimated
by assessing the two main risk components of the portfolio: credit and
interest. The estimated cash flows were adjusted to reflect the inherent
credit risk and then discounted, using rates appropriate for each maturity that
incorporate the effects of interest rate changes. Generally, emerging market
loans were valued based on secondary market prices.
For consumer installment loans and residential mortgages, for which market
rates for comparable loans are readily available, the fair value was estimated
by discounting cash flows, adjusted for prepayments. The discount rates used
for consumer installment loans were current rates offered by commercial banks
and thrifts; for residential mortgages, secondary market yields for comparable
mortgage-backed securities, adjusted for risk, were used. The fair value of
credit card receivables was estimated by discounting expected cash flows. The
discount rates used incorporated the effects of interest rate changes only,
since the estimated cash flows were adjusted for credit risk.
Other Assets: Other Assets consist primarily of equity investments, including
venture capital investments. The fair value of these investments was determined
on an individual basis. The valuation methodologies included market values of
publicly-traded securities, independent appraisals, and cash flow analyses.
FINANCIAL LIABILITIES
Liabilities for Which Fair Value Approximates Carrying Value: SFAS 107 requires
that the fair value disclosed for deposit liabilities with no stated maturity
(i.e., demand, savings and certain money market deposits) be equal to the
carrying value. SFAS 107 does not allow for the recognition of the inherent
funding value of these instruments.
The fair value of foreign deposits, federal funds purchased and securities
sold under repurchase agreements, other borrowed funds, acceptances
outstanding, short-term payables, and accounts payable and accrued liabilities
are considered to approximate their respective carrying values due to their
short-term nature.
Domestic Time Deposits: The fair value of time deposits was estimated by
discounting cash flows based on contractual maturities at the interest rates
for funds of similar maturity.
Trading Liabilities-Risk Management Instruments: The Corporation records the
negative fair values on derivatives and foreign exchange instruments at
estimated fair value. These instruments were valued using either quoted market
prices, pricing models, quoted market prices of financial instruments with
similar characteristics or discounted cash flows. For the fair value of trading
liabilities, see Note Three.
Long-Term Debt: The valuation of long-term debt takes into account several
factors, including current market interest rates and the Corporation's credit
rating. Quotes were gathered from various investment banking firms for
indicative yields for the Corporation's securities over a range of maturities.
UNUSED COMMITMENTS AND LETTERS OF CREDIT
The Corporation has reviewed the unfunded portion of commitments to extend
credit as well as standby and other letters of credit, and has determined that
the fair value of such financial instruments is not material.
The following tables present the carrying value and estimated fair value at
December 31, 1995 and 1994, of financial assets and liabilities valued under
SFAS 107 and certain derivative contracts used for ALM activities related to
such financial assets and liabilities.
69
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(a) The carrying value and estimated fair value include the carrying value and
estimated fair value of derivative contracts used for ALM activities.
(b) The carrying value and estimated fair value of daily margin settlements on
open futures contracts are primarily included in Other Assets on the balance
sheet, except when used in connection with available-for-sale securities, which
are carried at fair value and are included in Securities: Available-for-Sale on
the balance sheet. The Corporation uses these contracts in its ALM activities to
modify the interest rate characteristics of balance sheet instruments such as
securities available-for-sale, loans and deposits. Gross unrecognized gains and
losses from daily margin settlements on open futures contracts were $4 million
and $101 million, respectively, at December 31, 1995. The unrecognized gains and
losses from such contracts are amortized to interest income after the contracts
close. See page 35 of the MD&A for a discussion of closed derivative contracts
related to ALM activities.
(c) The carrying value of derivatives used for asset/liability management is
primarily included in Other Assets on the balance sheet, except derivatives
used in connection with available-for-sale securities which are carried at fair
value and are included in Securities: Available-for-Sale on the balance sheet.
(d) Represents derivative contracts that, as part of the Corporation's
asset/liability management, are used in place of cash market instruments. For
further discussion, see Note One.
(e) Derivative Contacts Used for Asset/Liability Management Activities were
valued using market prices or pricing models consistent with methods used by
the Corporation in valuing similar instruments used for trading purposes.
(f) The average fair value of debt and equity instruments held for trading
purposes was $12,811 million during 1995 and $11,347 million during 1994. For a
further breakout of the fair value of Trading Assets - Debt and Equity
Instruments, see Note Three.
(g) The average fair value of Trading Assets - Risk Management Instruments and
Trading Liabilities - Risk Management Instruments in 1995 was $20,963 million
and $21,748 million, respectively. The average fair value of Trading Assets
Risk Management Instruments and Trading Liabilities - Risk Management
Instruments in 1994 was $17,779 million and $16,143 million, respectively.
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In addition to the derivative contracts in the above tables, the Corporation
also uses derivative contracts (primarily interest rate floors and swaps) to
manage the risks associated with its mortgage servicing activities; that
are not required to be fair valued under SFAS 107. At December 31, 1995, the
notional amount of such derivatives was $3.2 billion, the carrying value was
$7.7 million, and gross unrecognized gains and losses were $19.9 million and
$3.4 million, respectively, resulting in an estimated fair value of $24.2
million.
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23 COMMITMENTS AND CONTINGENCIES
At December 31, 1995, the Corporation and its subsidiaries were obligated under
a number of noncancelable operating leases for premises and equipment used
primarily for banking purposes. Certain leases contain rent escalation clauses
for real estate taxes and other operating expenses and renewal option clauses
calling for increased rents. No lease agreement imposes any restrictions on the
Corporation affecting its ability to pay dividends, engage in debt or equity
financing transactions, or to enter into further lease agreements. Future
minimum rental payments required under operating leases with initial or
remaining noncancelable lease terms in excess of one year as of December 31,
1995 were as follows:
Total rental expense in 1995, 1994 and 1993 was as follows:
At December 31, 1995 and 1994, assets amounting to $35 billion and $28 billion,
respectively, were pledged to secure public deposits and for other purposes. The
significant components of the $35 billion of assets pledged at December 31, 1995
were as follows: $13 billion were securities, $11 billion were loans, and the
remaining $11 billion were primarily trading account assets. These amounts
compare with $9 billion of securities, $9 billion of loans, and $10 billion of
trading account assets pledged at December 31, 1994.
The Corporation and its subsidiaries are defendants in a number of legal
proceedings. After reviewing with counsel all such actions and proceedings
pending against or involving the Corporation and its subsidiaries, management
does not expect the aggregate liability or loss, if any, resulting therefrom to
have a material adverse effect on the consolidated financial condition of the
Corporation.
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24 INTERNATIONAL OPERATIONS
The accompanying table presents average assets and income statement information
for 1995, 1994 and 1993 relating to international and domestic operations of
the Corporation by major geographic areas, based on the domicile of the
customer. The Corporation defines international activities as business
transactions that involve customers residing outside of the United States.
However, a definitive separation of the Corporation's domestic and foreign
businesses cannot be performed because many of the Corporation's domestic
operations service international business.
As these operations are highly integrated, estimates and subjective
assumptions have been made to apportion revenue and expenses between domestic
and international operations. Estimates of the following are allocated on a
management accounting basis: stockholders' equity, interest costs charged to
users of funds, and overhead, administrative, and other expenses incurred by
one area on behalf of another. The provision for losses is allocated based on
charge-off experience and risk characteristics of the portfolio.
The Corporation considers the balance in the allowance for credit losses to
be available for both domestic and foreign exposures; however, a portion of the
allowance is allocated to international operations based on a methodology
consistent with the allocation of the provision for losses.
Certain amounts in prior periods have been reclassified among the geographic
regions to conform to the current year's presentation.
71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
(a) Revenue is comprised of Net Interest Income and Noninterest Revenue.
(b) Expense is comprised of Noninterest Expense and Provision for Losses.
(c) No geographic region included in other international amounts to more than
10% of the total for the Corporation.
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25 PARENT COMPANY
Condensed financial information of Chemical Banking Corporation, the Parent
Company, is presented below.
For purposes of preparing the Statement of Cash Flows, cash and cash
equivalents are those amounts included in the balance sheet caption Cash with
Banks.
BALANCE SHEET
(a) At December 31, 1995, aggregate annual maturities for all issues for the
years 1996 through 2000 were $835 million, $518 million, $745 million, $685
million, and $730 million, respectively.
STATEMENT OF INCOME
73
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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74
Chemical Banking Corporation
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SUPPLEMENTARY DATA
QUARTERLY FINANCIAL INFORMATION 1995-1994
(a) On January 1, 1995, the Corporation adopted SFAS 106 for the accounting for
other postretirement benefits relating to the Corporation's foreign plans.
(b) Excluding the impact of the $260 million ($152 million after tax)
restructuring charge in the fourth quarter of 1994, proforma net income was
$331 million or $1.22 per primary share.
(c) The Corporation's common stock is listed and traded on the New York Stock
Exchange and the International Stock Exchange of the United Kingdom and
Republic of Ireland. The high, low and closing prices of the Corporation's
common stock are from the New York Stock Exchange Composite Transaction Tape.
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CONSOLIDATED BALANCE SHEET
76
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DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY; INTEREST RATES
AND INTEREST DIFFERENTIAL
A three-year summary of the Corporation's consolidated average balances,
interest rates and interest differentials on a taxable-equivalent basis for the
years 1993 through 1995, is provided on pages 78 and 79. Income computed on a
taxable-equivalent basis is income as reported in the Consolidated Statement of
Income adjusted to make income and earning yields on assets exempt from income
taxes (primarily Federal taxes) comparable to other taxable income. The
incremental tax rate used for calculating the taxable equivalent adjustment was
approximately 43% in each of the years 1993 through 1995. The majority of the
Corporation's securities are taxable.
Within the consolidated average balance sheet, interest and rate schedules,
the principal amounts of nonaccrual and renegotiated loans have been included
in the average loan balances used to determine the average interest rate earned
on loans. Interest accrued but not collected at the date a loan is placed on
nonaccrual status is reversed against interest income. Subsequent cash receipts
are applied either to the outstanding principal balance or recorded as interest
income, depending on management's assessment of the ultimate collectibility of
principal and interest. Interest income is accrued on renegotiated loans at the
renegotiated rates. Certain renegotiated loan agreements call for additional
interest to be paid on a deferred or a contingent basis. Such interest is taken
into income only as collected.
A summary of interest rates and interest differentials segregated between
domestic and foreign operations for the years 1993 through 1995 is presented on
pages 80 and 81 herein. Regarding the basis of segregation between the domestic
and foreign components, see Note Twenty Four of the Notes to Consolidated
Financial Statements at page 71. A portion of the Corporation's international
operations are being funded by domestic sources (intra-company funding).
Generally, the source of such domestic funds is the Parent Company which, in
order to optimize the Corporation's overall liquidity, deposits its excess
short-term funds with Chemical Bank's Nassau Branch to hold until such funds
are needed. Intra-company funding is very short-term in nature and the
Corporation believes such funds are not subject to cross-border risk.
Domestic net interest income was $3,913 million in 1995, an increase of $71
million from the prior year. The increase in 1995 was attributable to a higher
level of interest-earning assets and the reduction in the cost of carrying
nonperforming loans, partially offset by narrower spreads due to higher
short-term interest rates (for further discussion, see the section entitled
"Net Interest Income" in Management's Discussion and Analysis at page 15).
Net interest income from foreign operations was $802 million for 1995,
compared with $856 million in 1994. The decline reflected a lower net yield as
a result of the shift in the composition of the Corporation's foreign
interest-earning assets.
The tables on pages 82 and 83 herein present an analysis of the effect on
net interest income of volume and rate changes for the periods 1995 over 1994
and 1994 over 1993. In this analysis, the change due to the volume/rate
variance has been allocated to volume.
77
AVERAGE CONSOLIDATED BALANCE SHEET, INTEREST AND RATES
(a) On December 31, 1993, the Corporation adopted SFAS 115. Previously reported
amounts have not been restated to conform with the current presentation. (b)
For the years ended December 31, 1995 and 1994, the annualized rate for
securities available-for-sale based on amortized cost was 7.41% and 6.42%,
respectively. (c) Fees and commissions on loans included in loan interest
amounted to $111 million in 1995, $141 million in 1994 and $176 million in
1993. (d) The ratio of average stockholders' equity to average assets was 6.2%
for 1995, 6.6% for 1994 and 7.3% for 1993. (e) Includes securities sold but not
yet purchased.
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Chemical Banking Corporation
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79
INTEREST RATES AND INTEREST DIFFERENTIAL ANALYSIS OF
NET INTEREST INCOME - DOMESTIC AND FOREIGN
80
Chemical Banking Corporation
and Subsidiaries
81
CHANGE IN NET INTEREST INCOME, VOLUME AND RATE ANALYSIS
82
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83
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LOAN PORTFOLIO
The table below sets forth the amount of loans outstanding by type for the
dates indicated:
(a) For loans measured pursuant to SFAS 115 at December 31, 1995 and 1994, see
Note Five on page 55. At December 31, 1993, $3,783 million of loans, primarily
renegotiated loans, were measured under SFAS 115, including $1,962 million that
were classified as held-to-maturity and carried at amortized cost, and $1,821
million designated as available-for-sale and carried at fair value.
For a discussion of the Corporation's loan outstandings, see "Net Interest
Income" and "Loan Portfolio" on pages 15 and 24, respectively.
MATURITIES AND SENSITIVITY TO CHANGES IN INTEREST RATES
The following table shows loan maturity distribution based upon the stated
terms of the loan agreements, and sensitivity to changes in interest rates of
the loan portfolio, excluding consumer loans, at December 31, 1995:
(a) Includes demand loans, overdrafts and loans having no stated schedule of
repayments and no stated maturity.
(b) Substantially all foreign loans that meet the accounting definition of a
security mature in over 10 years.
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RISK ELEMENTS
The following table sets forth the nonperforming assets and contractually
past-due loans at the dates indicated:
(a) Includes loans previously classified as emerging markets loans. Previously
reported loan amounts have been reclassified to conform with the current
presentation.
(b) Includes $727 million of loans considered impaired under SFAS No. 114,
"Accounting by Creditors for Impairment of a Loan" ("SFAS 114"). In addition, on
January 1, 1995, $122 million of assets for which the Corporation did not have
possession were reclassified from Assets Acquired as Loan Satisfactions to
Nonperforming Loans pursuant to the adoption of SFAS 114.
(c) Accruing loans past-due 90 days or more as to principal and interest, which
are not characterized as nonperforming loans. Primarily consists of consumer
loans, exclusive of residential mortgage loans, which are generally not
classified as nonperforming but, rather, are charged off on a formula basis upon
reaching certain specified stages of delinquency.
See Note Seven, "Nonperforming Assets", on pages 56 and 57 for interest income
calculated on the carrying value of nonaccrual and renegotiated loans that
would have been recorded had these loans been current in accordance with their
original terms ( interest at original rates), and the amount of interest income
on these loans that was included in income for the periods indicated.
85
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ALLOWANCE FOR CREDIT LOSSES
The table below summarizes the changes in the allowance for credit losses
during the periods indicated.
(a) Includes losses on sales and swaps of loans previously classified as
emerging markets.
(b) Includes $28 million related to the sale of banking operations in
southern and central New Jersey.
(c) Includes $291 million related to management's final evaluation of the
emerging markets portfolio.
(d) Includes $55 million related to the decision to accelerate the disposition
of certain nonperforming residential mortgage loans.
(e) Includes $175 million of recoveries on the disposition of emerging markets
debt.
(f) Includes $19 million increase in allowance related to the acquisition by
Texas Commerce of certain assets of First City Bancorporation of Texas, Inc.
(g) Includes a $902 million charge to adjust Brazilian medium- and long-term
outstandings to an estimated net recoverable value.
ALLOWANCE FOR CREDIT LOSSES-FOREIGN
The following table shows the changes in the portion of the allowance for
credit losses allocated to loans related to foreign operations, including
activity related to countries engaged in debt rescheduling:
The consolidated year-end allowance for credit losses is available to absorb
potential credit losses from the entire loan portfolio, as well as derivative
and foreign exchange transactions.
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LOAN LOSS ANALYSIS
(a) Includes a $148 million charge for assets transferred to held for
accelerated disposition.
DEPOSITS
The following data provide a summary of the Corporation's average deposits and
average interest rates for the years 1993-1995:
(a) Substantially all of the foreign deposits are in denominations of $100,000
or more.
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The following table presents deposits by maturity range and type for the dates
indicated:
At December 31, 1995, total time and savings deposits in domestic offices
were $44,491 million, of which $4,993 million were time certificates of deposit
in denominations of $100,000 or more, $1,957 million were other time deposits
in denominations of $100,000 or more, and $29,782 million were money market
deposit accounts and other savings accounts. Deposits of $100,000 or more in
foreign offices totaled $32,253 million, substantially all of which were
interest-bearing.
At December 31, 1994, total time and savings deposits in domestic offices
were $46,799 million, of which $5,180 million were time certificates of deposit
in denominations of $100,000 or more, $2,169 million were other time deposits
in denominations of $100,000 or more, and $31,386 million were money market
deposit accounts and other savings accounts. Deposits of $100,000 or more in
foreign offices totaled $28,308 million, substantially all of which were
interest-bearing.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on behalf of the undersigned, thereunto duly authorized, on the 20th day of
February, 1996.
CHEMICAL BANKING CORPORATION
(Registrant)
By WALTER V. SHIPLEY
------------------------------------
(Walter V. Shipley,
Chairman of the Board and
Chief Executive Officer)
This report has been reviewed by each member of the Board of Directors and
pursuant to the requirements of the Securities Exchange Act of 1934, signed on
behalf of the registrant by members present at the meeting of the Board of
Directors on the date indicated. The Corporation does not exercise the power of
attorney to sign on behalf of any Director.
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90
APPENDIX I
NARRATIVE DESCRIPTION OF GRAPHIC IMAGE MATERIAL
Pursuant to Item 304 of Regulation S-T, the following is a description of the
graphic image material included in the foregoing Management's Discussion and
Analysis of Financial Condition and Results of Operations.
EXHIBIT INDEX
-------------
Exhibit
No. Description
------- -----------
2.1 Agreement and Plan of Merger, dated as of August 27, 1995, between
Chemical Banking Corporation and The Chase Manhattan Corporation
(incorporated by reference to Exhibit 2.1 to the Registration
Statement on Form S-4 (File No. 33-63833) of Chemical Banking
Corporation).
2.2 Stock Option Agreement, dated as of August 27, 1995, between
Chemical Banking Corporation, as Issuer, and The Chase Manhattan
Corporation, as Grantee (incorporated by reference to Exhibit 2.2 to
the Registration Statement on Form S-4 (File No. 33-63833) of
Chemical Banking Corporation).
2.3 Stock Option Agreement, dated as of August 27, 1995, between The
Chase Manhattan Corporation, as Issuer, and Chemical Banking
Corporation, as Grantee (incorporated by reference to Exhibit 2.3 to
the Registration Statement on Form S-4 (File No. 33-63833) of
Chemical Banking Corporation).
2.4 Employee Benefits Agreement, dated as of August 27, 1995, between
Chemical Banking Corporation and The Chase Manhattan Corporation
(incorporated by reference to Exhibit 2.4 to the Registration
Statement on Form S-4 (File No. 33-63833) of Chemical Banking
Corporation).
3.1 (a) Restated Certificate of Incorporation of Chemical Banking
Corporation (incorporated by reference to Exhibit 3.1 of the Annual
Report on Form 10-K dated December 31, 1993 of Chemical Banking
Corporation).
3.1 (b) Certificate of Designations of Adjustable Rate Cumulative Preferred
Stock, Series L (incorporated by reference to Exhibit 2 to the
Registration Statement on Form 8-A dated June 6, 1994 of Chemical
Banking Corporation).
3.2 By-laws of Chemical Banking Corporation, as amended (incorporated by
reference to Exhibit 3.2 of the Annual Report on Form 10-K dated
December 31, 1993 of Chemical Banking Corporation).
4.1 (a) Form of Rights Agreement, dated as of April 13, 1989 between
Chemical Banking Corporation and Harris Trust Company of New York,
as amended (incorporated by reference to Exhibit 4 to the Current
Report on Form 8-K of Chemical Banking Corporation dated April 13,
1989).
4.1 (b) Letter of Appointment dated December 23, 1991 of Chemical Banking
Corporation appointing Chemical Bank, as successor Rights Agent
under the Rights Agreement (incorporated by reference to Exhibit
4.13(b) of the Annual Report on Form 10-K dated December 31, 1991 of
Chemical Banking Corporation).
4.2 Form of Indenture dated as of December 1, 1989 between Chemical
Banking Corporation and The Chase Manhattan Bank (National
Association), which Indenture includes the form of Debt Securities
(incorporated by reference to Exhibit 4.9 to the Registration
Statement on Form S-3 (File No. 33-32409) of Chemical Banking
Corporation).
4.3 Form of Indenture dated as of April 1, 1987, as amended and restated
as of December 15, 1992, between Chemical Banking Corporation and
Morgan Guaranty Trust Company of New York, as succeeded to by First
Trust of New York (National Association), as Trustee, which
Indenture includes the form of Subordinated Debt Securities
(incorporated by reference to Exhibit 4.1 to the Current Report on
Form 8-K dated December 22, 1992 of Chemical Banking Corporation).
4.4 (a) Form of Indenture dated as of June 1, 1982 between Manufacturers
Hanover Corporation and Morgan Guaranty Trust Company of New York,
as succeeded to by First Trust of New York (National Association),
as Trustee, which Indenture includes the form of Debt Securities
(incorporated by reference to Exhibit 4(a) to the Registration
Statement on Form S-3 (File No. 2-82433) of Manufacturers Hanover
Corporation).
4.4 (b) Form of First Supplemental Indenture dated as of January 15, 1986 to
the Indenture dated as of June 1, 1982 between Manufacturers Hanover
Corporation and Morgan Guaranty Trust Company of New York, as
succeeded to by First Trust of New York (National Association), as
Trustee, relating to the Senior Debt Securities (incorporated by
reference to Exhibit 1 to the Current Report on Form 8-K dated as of
January 29, 1986 of Manufacturers Hanover Corporation).
4.4 (c) Form of Second Supplemental Indenture dated as of March 13, 1991 to
the Indenture dated as of June 1, 1982 between Manufacturers Hanover
Corporation and Morgan Guaranty Trust Company of New York, as
succeeded to by First Trust of New York (National Association), as
Trustee, relating to the Senior Debt Securities (incorporated by
reference to Exhibit 4 to the Current Report on Form 8-K dated March
19, 1991 of Manufacturers Hanover Corporation).
Exhibit
No. Description
------- -----------
4.4 (d) Form of Third Supplemental Indenture dated as of December 31, 1991
among Chemical Banking Corporation, Manufacturers Hanover
Corporation and Morgan Guaranty Trust Company of New York, as
succeeded to by First Trust of New York (National Association), as
Trustee, to the Indenture dated as of June 1, 1982 (incorporated by
reference to Exhibit 4.14(d) of the Annual Report on Form 10-K dated
December 31, 1991 of Chemical Banking Corporation).
4.5 (a) Form of Indenture dated as of June 1, 1985 between Manufacturers
Hanover Corporation and IBJ Schroder Bank and Trust Company, as
Trustee, relating to 8 1/2% Subordinated Capital Notes Due February
15, 1999 (incorporated by reference to Exhibit 4 (b) to the Current
Report on Form 8-K dated February 27, 1987 of Manufacturers Hanover
Corporation).
4.5 (b) Form of First Supplemental Indenture dated as of December 31, 1991
among Chemical Banking Corporation, Manufacturers Hanover
Corporation and IBJ Schroder Bank and Trust Company to the Indenture
dated June 1, 1985 (incorporated by reference to Exhibit 4.18(b) to
the Annual Report on Form 10-K dated December 31, 1991 of Chemical
Banking Corporation).
4.6 (a) Form of Indenture dated as of May 15, 1993 between Margaretten
Financial Corporation and The Bank of New York, as Trustee, relating
to the 6 3/4% Guaranteed Notes due June 15, 2000 (incorporated by
reference to Exhibit 4(a) to Registration Statement on Form S-3 (No.
33-60262) of Margaretten Financial Corporation).
4.6 (b) Form of Supplemental Indenture dated as of July 22, 1994 to the
Indenture dated as of May 15, 1993 among Margaretten Financial
Corporation, Chemical Banking Corporation and The Bank of New York,
as Trustee, and Guarantee dated as of July 22, 1994 by Chemical
Banking Corporation (incorporated by reference to Exhibit 4.34 to
the Current Report on Form 8-K dated September 28, 1994 of Chemical
Banking Corporation).
10.1 Key Executive Performance Plan of Chemical Banking Corporation
(incorporated by reference to Exhibit 10.4 to the Annual Report
on Form 10-K for the year ended December 31, 1994 of Chemical
Banking Corporation).
10.2 Deferred Compensation Plan of Chemical Banking Corporation and
Participating Companies, as amended through January 1, 1993
(incorporated by reference to Exhibit 10.5 to the Annual Report
on Form 10-K for the year ended December 31, 1994 of Chemical
Banking Corporation).
10.3 Deferred Compensation Plan for Non-Employee Directors of Chemical
Banking Corporation and Chemical Bank, as amended and restated
effective December 15, 1992 (incorporated by reference to Exhibit
10.6 to the Annual Report on Form 10-K for the year ended December
31, 1992 of Chemical Banking Corporation).
10.4 Chemical Banking Corporation Long-Term Stock Incentive Plan, as
amended and restated as of May 19, 1992 (incorporated by reference
to Exhibit 10.7 to the Annual Report on Form 10-K for the year ended
December 31, 1992 of Chemical Banking Corporation).
10.5 Forms of employment agreements as entered into by Chemical Banking
Corporation and certain of its executive officers.
10.6 Post-Retirement Compensation Plan for Non-Employee Directors, as
amended and restated as of December 15, 1992 (incorporated by
reference to Exhibit 10.10 to the Annual Report on Form 10-K for the
year ended December 31, 1992 of Chemical Banking Corporation).
Exhibit
No. Description
------- -----------
10.7 Permanent Life Insurance Options Plan (incorporated by reference to
Exhibit 10.11 to the Annual Report on Form 10-K for the year ended
December 31, 1992 of Chemical Banking Corporation).
10.8 Executive Retirement Plan of Chemical Banking Corporation and
Certain Subsidiaries.
10.9 Supplemental Retirement Plan of Chemical Bank and Certain
Affiliated Companies, restated effective January 1, 1993 and as
amended through January 1, 1995.
11.1 Computation of Net Income per Common Share.
12.0 Computation of ratio of earnings to fixed charges.
12.1 Computation of ratio of earnings to fixed charges and preferred
stock dividend requirements.
21.1 List of Subsidiaries of Chemical Banking Corporation.
22.1 Annual Report on Form 11-K of the Chemical Savings Plan of Chemical
Bank and Certain Affiliates (to be filed by amendment pursuant to
Rule 15d-21 under the Securities Exchange Act of 1934).
22.2 Annual Report on Form 11-K of the Margaretten Financial Corporation
Savings Plan (to be filed by amendment pursuant to Rule 15d-21 under
the Securities Exchange Act of 1934).
23.1 Consent of Independent Accountants.
27.1 Financial Data Schedule.
99.0 Supplemental Pro Forma Financial Statements.