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THE PNC FINANCIAL SERVICES GROUP, INC.
Quarterly Report on Form 10-Q
For the quarterly period ended June 30, 2002
Page 1 represents a portion of the second quarter 2002 Financial Review which is
not required by the Form 10-Q report and is not "filed" as part of the Form
10-Q.
The Quarterly Report on Form 10-Q and cross reference index is on page 45.
CONSOLIDATED FINANCIAL HIGHLIGHTS
THE PNC FINANCIAL SERVICES GROUP, INC.
Three months ended June 30 Six months ended June 30
Dollars in millions, except per share data ------------------------------ ----------------------------
Unaudited 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------
FINANCIAL PERFORMANCE
Revenue
Net interest income (taxable-equivalent basis)(a) $558 $569 $1,151 $1,128
Noninterest income 855 733 1,629 1,448
------------------------------ ----------------------------
Total revenue $1,413 $1,302 $2,780 $2,576
============================== ============================
Income from continuing operations $320 $295 $637 $560
Discontinued operations 5
------------------------------ ----------------------------
Income before cumulative effect of accounting change 320 295 637 565
Cumulative effect of accounting change (5)
------------------------------ ----------------------------
Net income $320 $295 $637 $560
============================== ============================
Per common share
DILUTED EARNINGS
Continuing operations $1.12 $1.00 $2.23 $1.89
Discontinued operations .02
------------------------------ ----------------------------
Before cumulative effect of accounting change 1.12 1.00 2.23 1.91
Cumulative effect of accounting change (.02)
------------------------------ ----------------------------
Net income $1.12 $1.00 $2.23 $1.89
============================== ============================
CASH DIVIDENDS DECLARED $.48 $.48 $.96 $.96
- ------------------------------------------------------------------------------------------------------------------------
SELECTED RATIOS
FROM CONTINUING OPERATIONS
Return on
Average common shareholders' equity 21.00% 18.13% 21.41% 17.36%
Average assets 1.93 1.67 1.91 1.58
Net interest margin 3.99 3.77 4.06 3.70
Noninterest income to total revenue 60.51 56.30 58.60 56.21
Efficiency(b) 57.36 57.46 57.09 57.60
FROM NET INCOME
Return on
Average common shareholders' equity 21.00% 18.13% 21.41% 17.36%
Average assets 1.93 1.67 1.91 1.55
Net interest margin 3.99 3.77 4.06 3.65
Noninterest income to total revenue 60.51 56.30 58.60 56.35
Efficiency(b) 57.36 57.46 57.09 57.48
========================================================================================================================
Certain prior period amounts included in these Consolidated Financial Highlights
have been reclassified to conform with the presentation as of and for the three
months and six months ended June 30, 2002. Amounts for 2002 reflect the
adoption, effective January 1, 2002, of the new accounting standard under which
goodwill is no longer amortized to expense. In addition, amounts included in
these Consolidated Financial Highlights are presented on a continuing operations
basis, unless otherwise noted.
(a) The interest income earned on certain assets is completely or partially
exempt from federal income tax. As such, these tax exempt instruments typically
yield lower returns than a taxable investment. In order to provide accurate
comparisons of yields and margins for all earning assets, the interest income
earned on tax exempt assets has been increased to make them fully equivalent to
other taxable interest income investments.
(b) The efficiency ratio is noninterest expense divided by the sum of
taxable-equivalent net interest income and noninterest income. Amortization and
distributions on capital securities are excluded for purposes of computing this
ratio. Residential mortgage banking risk management activities are also
excluded, as applicable, from net income for purposes of computing this ratio.
1
Dollars in millions, except per share data June 30 December 31 June 30
Unaudited 2002 2001 2001
- ---------------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA
Assets $66,913 $69,638 $70,078
Earning assets 55,778 57,875 58,307
Loans, net of unearned income 37,684 37,974 44,167
Allowance for credit losses (654) (560) (595)
Securities 12,313 13,908 10,982
Loans held for sale 2,441 4,189 1,870
Deposits 44,427 47,304 45,799
Borrowed funds 10,480 12,090 12,119
Allowance for unfunded loan commitments and letters of credit 73 70 80
Shareholders' equity 6,390 5,823 6,748
Common shareholders' equity 6,380 5,813 6,532
Book value per common share 22.46 20.54 22.60
Loans to deposits 85% 80% 96%
CAPITAL RATIOS
Tier I risk-based 8.2% 7.8% 9.0%
Total risk-based 12.0 11.8 12.8
Leverage 7.4 6.8 8.1
Common shareholders' equity to total assets 9.53 8.35 9.32
ASSET QUALITY RATIOS
Nonperforming assets to total loans,
loans held for sale and foreclosed assets 1.25% .93% 1.03%
Net charge-offs to average loans (for the three months ended) .78 7.30 .40
REFLECTING RECLASSIFICATION(c)
Allowance for credit losses to total loans 1.74% 1.47% 1.35%
Allowance for credit losses to nonperforming loans 201 265 159
AS PREVIOUSLY REPORTED
Allowance for credit losses to total loans 1.93% 1.66% 1.53%
Allowance for credit losses to nonperforming loans 229 299 180
================================================================================================================================
(c) The asset quality ratios presented for all periods reflect a
reclassification of a portion of the allowance for credit losses related to
unfunded loan commitments and letters of credit to a liability on the
Consolidated Balance Sheet. Amounts reclassified were $73 million at June
30, 2002, $70 million at December 31, 2001 and $80 million at June 30, 2001.
The reclassifications had the effect of lowering previously reported asset
quality ratios. The allowance for unfunded loan commitments and letters of
credit is available for potential credit losses as loan commitments are
funded. See Allowances For Credit Losses And Unfunded Loan Commitments And
Letters of Credit in the Consolidated Balance Sheet Review section of the
Financial Review for additional information.
2
FINANCIAL REVIEW
THE PNC FINANCIAL SERVICES GROUP, INC.
This Financial Review should be read in conjunction with The PNC Financial
Services Group, Inc. ("Corporation" or "PNC") unaudited Consolidated Financial
Statements and unaudited Statistical Information included herein and the
Financial Review, audited Consolidated Financial Statements and Statistical
Information included in the Corporation's 2001 Annual Report on Form 10-K ("2001
Form 10-K"). Certain prior-period amounts have been reclassified to conform with
the current year presentation. In addition, certain classification adjustments
were made to information reported in the Corporation's July 18, 2002 earnings
release. The term "loans" in this report excludes loans held for sale and
securities that represent interests in pools of loans. For information regarding
certain business and regulatory risks, see the Risk Factors and Risk Management
sections in this Financial Review and in the 2001 Form 10-K. Also, see the
Forward-Looking Statements section in this Financial Review for certain other
factors that could cause actual results to differ materially from
forward-looking statements or historical performance.
OVERVIEW
THE PNC FINANCIAL SERVICES GROUP, INC.
The Corporation is one of the largest diversified financial services companies
in the United States, operating businesses engaged in regional community
banking, corporate banking, real estate finance, asset-based lending, wealth
management, asset management and global fund services. The Corporation provides
certain products and services nationally and others in PNC's primary geographic
markets in Pennsylvania, New Jersey, Delaware, Ohio and Kentucky. The
Corporation also provides certain banking, asset management and global fund
services internationally.
PNC continues to pursue strategies to build a diverse and valuable business mix
designed to enhance shareholder value over time. PNC's focus is on increasing
the contribution from more highly-valued businesses such as asset management and
processing while reducing institutional lending leverage and improving the
risk/return characteristics of traditional banking businesses. In the near term,
PNC seeks to execute on its institutional lending initiatives and enhance
core deposit funding, liquidity and capital levels.
SUMMARY FINANCIAL RESULTS
Consolidated net income for the first six months of 2002 was $637 million or
$2.23 per diluted share compared with $560 million or $1.89 per diluted share
for the first six months of 2001. Results for the first six months of 2002
reflected the required adoption of Statement of Financial Accounting Standards
("SFAS") No. 142, "Goodwill and Other Intangible Assets," under which goodwill
is no longer amortized to expense. Excluding goodwill amortization expense from
2001 results, earnings would have been $606 million or $2.05 per diluted share.
Reported earnings in 2001 included income from discontinued operations of $.02
per diluted share and an after-tax loss of $.02 per diluted share related to the
cumulative effect of the accounting change for the adoption of SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended by
SFAS No. 137 and 138.
Return on average common shareholders' equity was 21.41% and return on average
assets was 1.91% for the first six months of 2002 compared with 17.36% and
1.58%, respectively, for the first six months of 2001. Comparable prior year
returns excluding goodwill amortization expense were 18.82% and 1.71%,
respectively.
Consolidated net income for the second quarter of 2002 was $320 million or $1.12
per diluted share, up from $295 million or $1.00 per diluted share for the
second quarter of 2001. Excluding goodwill amortization expense from second
quarter 2001 results, the Corporation earned $318 million or $1.08 per diluted
share a year ago. Return on average common shareholders' equity was 21.00% and
return on average assets was 1.93% for the second quarter of 2002 compared with
18.13% and 1.67%, respectively, for the second quarter of 2001. Comparable prior
year returns excluding goodwill amortization expense were 19.56% and 1.80%,
respectively.
The residential mortgage banking business, which was sold in January 2001, is
reflected in discontinued operations throughout the Corporation's consolidated
financial statements. Accordingly, the results of operations for the residential
mortgage banking business are shown separately on one line in the income
statement for all periods presented. The remainder of the presentation in this
Financial Review reflects continuing operations, unless otherwise noted. See
Note 2 Discontinued Operations in the Notes in Consolidated Financial Statements
for additional information.
The Corporation continued to make progress during the second quarter of 2002 in
addressing a number of key challenges outlined in the 2001 Form 10-K:
- - Overall balance sheet characteristics were strengthened during the
quarter:
- Transaction deposits grew 5% on average compared with the
prior year quarter, driven by the continued success of
Regional Community Banking marketing initiatives.
3
- Regulatory capital ratios at June 30, 2002 improved and were
7.4% for leverage, 8.2% for Tier I and 12.0% for total
risk-based capital.
- The loans to deposits ratio was 85% at June 30, 2002 compared
with 96% at June 30, 2001.
- The liquidation of institutional loans held for sale resulted
in a reduction of total credit exposure and outstandings of
approximately 60% since December 31, 2001 to $2.0 billion and
$1.1 billion, respectively, at June 30, 2002. Net gains in
excess of valuation adjustments related to the liquidation of
these assets totaled $55 million in the second quarter.
- - BlackRock earnings grew 33% to $35 million in the second quarter of
2002 compared with the second quarter of 2001.
- - PFPC announced renewed or new relationships with three mutual fund
companies during the second quarter of 2002.
The second quarter of 2002 was characterized by a continued weak economy and
difficult capital markets conditions. Total revenue increased 9% in the second
quarter of 2002 compared with the prior year including net gains in excess of
valuation adjustments related to the liquidation of institutional loans held for
sale. This increase more than offset the impact of higher credit costs and
noninterest expense. Nonperforming assets increased to $500 million at June 30,
2002 from $438 million at March 31, 2002 primarily due to a credit related to
Market Street. See Market Street in the Risk Management section of this
Financial Review for additional information. Management expects the remainder of
2002 will continue to be a challenging operating environment that will limit
opportunities for revenue growth. The Corporation's success during the remainder
of the year will depend on, among other factors, its ability to address its key
operating challenges including the continued liquidation of loans held for sale,
improving asset quality, the performance of PNC's fee-based businesses and
achieving operating and efficiency improvements in its traditional banking
businesses. See 2002 Operating Environment in the Financial Review section of
the 2001 Form 10-K for additional information. Also see the Risk Factors, Risk
Management and Forward-Looking Statements sections of this Financial Review.
Subsequent to the end of the second quarter, the Corporation announced that it
had reached a resolution with the Securities and Exchange Commission ("SEC")
concerning the SEC's previously disclosed inquiry into the transfer of certain
PNC assets to companies formed with American International Group, Inc. ("AIG")
in 2001. No fines or monetary penalties were assessed against the Corporation as
a result of the settlement and no further adjustments to PNC's 2001 consolidated
financial statements were required in connection with this action. PNC had
restated 2001 earnings on January 29, 2002 to reflect the consolidation of the
companies formed with AIG in PNC's consolidated financial statements. PNC also
announced that it had entered into an agreement with the Federal Reserve Bank of
Cleveland ("Federal Reserve"), and that PNC Bank, N.A. ("PNC Bank"), PNC's
principal bank subsidiary, had entered into an agreement with the Office of the
Comptroller of the Currency ("OCC"). See Regulatory Matters in the Risk
Management section of this Financial Review for additional information.
BALANCE SHEET HIGHLIGHTS
Total assets were $66.9 billion at June 30, 2002 compared with $69.6 billion at
December 31, 2001. Average interest earning assets declined $4.0 billion to
$56.6 billion for the first six months of 2002 compared with the first six
months of 2001 primarily due to a decline in average loans that was partially
offset by an increase in average securities and average loans held for sale.
Average loans declined $9.1 billion or 19% to $38.2 billion in 2002 compared
with the prior year and represented 67% of average earning assets for the first
six months of 2002 compared with 78% for the first six months of 2001. The
decreases were primarily due to a decline in residential mortgages and
institutional lending portfolios that more than offset an increase in PNC
Business Credit loans resulting from the acquisition in 2002 of a portion of
National Bank of Canada's ("NBOC") U.S. asset-based lending business.
Changes in loans held for sale are described in Strategic Repositioning and in
loans held for sale in the Consolidated Balance Sheet Review section of this
Financial Review.
Average securities increased $2.1 billion to $12.0 billion in the first six
months of 2002 compared with the first half of 2001 and represented 21% of
average earning assets for 2002 compared with 16% for 2001. The increases were
primarily due to net securities purchases upon redeployment of funds resulting
from loan downsizing and interest rate risk management activities.
Funding cost is affected by the volume and composition of funding sources as
well as related rates paid thereon. Average deposits comprised 66% and 64% of
total sources of funds for the first six months of 2002 and 2001, respectively,
with the remainder primarily comprised of wholesale funding obtained at
prevailing market rates.
Average interest-bearing demand and money market deposits increased $1.3 billion
or 6% to $22.0 billion for the first six months of 2002 compared with the first
six months of 2001, primarily reflecting the impact of ongoing strategic
marketing efforts to grow more valuable transaction accounts, while higher cost,
less valuable retail certificates of deposit were not emphasized. Average
borrowed funds for the first six months of 2002 decreased $2.2 billion compared
with the first six months of 2001 commensurate with the decline in average
earning assets. See the Consolidated Average Balance Sheet and Net Interest
Analysis for additional information.
4
REVIEW OF BUSINESSES
PNC operates seven major businesses engaged in regional community banking,
corporate banking, real estate finance, asset-based lending, wealth management,
asset management and global fund services.
Results of individual businesses are presented based on PNC's management
accounting practices and the Corporation's management structure. There is no
comprehensive, authoritative body of guidance for management accounting
equivalent to generally accepted accounting principles; therefore, the financial
results of individual businesses are not necessarily comparable with similar
information for any other company. Financial results are presented, to the
extent practicable, as if each business operated on a stand-alone basis. Also,
certain amounts for 2001 have been reclassified to conform with the 2002
presentation.
The management accounting process uses various balance sheet and income
statement assignments and transfers to measure performance of the businesses.
Methodologies change from time to time as management accounting practices are
enhanced and businesses change. Securities or borrowings and related net
interest income are assigned based on the net asset or liability position of
each business. Capital is assigned based on management's assessment of inherent
risks and equity levels at independent companies providing similar products and
services. The allowance for credit losses is allocated based on management's
assessment of risk inherent in the loan portfolios. The costs incurred by
support areas not directly aligned with the businesses are allocated primarily
based on utilization of services.
Total business results differ from consolidated results from continuing
operations primarily due to differences between management accounting practices
and generally accepted accounting principles, equity management activities,
minority interest in income of consolidated entities, residual asset and
liability management activities, eliminations and other corporate items, the
impact of which is reflected in the "Other" category. The operating results and
financial impact of the disposition of the residential mortgage banking
business, previously PNC Mortgage, are included in discontinued operations.
The impact of the institutional lending repositioning and other strategic
actions that occurred during 2001 is reflected in the business results presented
in the table below. The charges are separately identified in the business income
statements. Performance ratios in the results of individual businesses reflect
the impact of the charges.
RESULTS OF BUSINESSES (a)
Revenue Return on
Earnings (taxable-equivalent basis) Assigned Capital Average Assets
------------------------------------------------------------------------------------------
Six months ended June 30
Dollars in millions 2002 2001 2002 2001 2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Banking Businesses
Regional Community Banking $353 $337 $1,094 $1,100 27% 25% $38,920 $40,321
Corporate Banking 87 64 411 386 16 10 14,752 17,323
PNC Real Estate Finance 48 31 116 105 24 16 5,081 5,336
PNC Business Credit 4 30 90 71 3 38 3,898 2,430
- ------------------------------------------------------------------------------------ ----------------------
Total banking businesses 492 462 1,711 1,662 23 20 62,651 65,410
- ------------------------------------------------------------------------------------ ----------------------
Asset Management and Processing
PNC Advisors 64 83 354 389 25 30 3,029 3,420
BlackRock 66 52 303 269 25 26 734 571
PFPC 38 32 399 397 37 31 1,890 1,742
- ------------------------------------------------------------------------------------ ----------------------
Total asset management and
processing 168 167 1,056 1,055 27 29 5,653 5,733
- ------------------------------------------------------------------------------------ ----------------------
Total business results 660 629 2,767 2,717 24 22 68,304 71,143
Other (23) (69) 13 (141) (964) 181
- ------------------------------------------------------------------------------------ ----------------------
Results from continuing operations 637 560 2,780 2,576 21 17 67,340 71,324
Discontinued operations 5 103
Cumulative effect of accounting change (5)
- ------------------------------------------------------------------------------------ ----------------------
Total consolidated $637 $560 $2,780 $2,576 21 17 $67,340 $71,427
===================================================================================================================================
(a) Amounts for 2002 reflect, where applicable, the adoption, effective January
1, 2002, of the new accounting standard under which goodwill is no longer
amortized to expense.
5
REGIONAL COMMUNITY BANKING
Six months ended June 30
Taxable-equivalent basis
Dollars in millions 2002 2001
- ---------------------------------------------------------------
INCOME STATEMENT
Net interest income $741 $718
Other noninterest income 335 339
Net securities gains 18 43
- ---------------------------------------------------------------
Total revenue 1,094 1,100
Provision for credit losses 23 20
Noninterest expense 529 533
Goodwill amortization 18
Severance costs 3
- ---------------------------------------------------------------
Pretax earnings 542 526
Income taxes 189 189
- ---------------------------------------------------------------
Earnings $353 $337
===============================================================
AVERAGE BALANCE SHEET
Loans
Consumer
Home equity $6,883 $6,178
Indirect 600 895
Other consumer 669 867
- ---------------------------------------------------------------
Total consumer 8,152 7,940
Residential mortgage 4,757 9,603
Commercial 3,529 3,624
Vehicle leasing 1,823 1,799
Other 121 136
- ---------------------------------------------------------------
Total loans 18,382 23,102
Securities 11,180 9,346
Student and other loans held for sale 1,442 1,288
Assigned assets and other assets 7,916 6,585
- ---------------------------------------------------------------
Total assets $38,920 $40,321
===============================================================
Deposits
Noninterest-bearing demand $4,938 $4,488
Interest-bearing demand 6,023 5,517
Money market 12,320 11,919
- ---------------------------------------------------------------
Total transaction deposits 23,281 21,924
Savings 1,960 1,870
Certificates 10,259 12,741
- ---------------------------------------------------------------
Total deposits 35,500 36,535
Other liabilities 794 1,066
Assigned capital 2,626 2,720
- ---------------------------------------------------------------
Total funds $38,920 $40,321
===============================================================
PERFORMANCE RATIOS
Return on assigned capital 27% 25%
Noninterest income to total revenue 32 35
Efficiency 48 49
===============================================================
OTHER INFORMATION
June 30 December 31
In millions 2002 2001
- ---------------------------------------------------------------
Total nonperforming assets $65 $52
Vehicle leasing outstandings $1,661 $1,930
===============================================================
Regional Community Banking provides deposit, branch-based brokerage, electronic
banking and credit products and services to retail customers as well as deposit,
credit, treasury management and capital markets products and services to small
businesses primarily within PNC's geographic region. The strategic focus of
Regional Community Banking is on driving sustainable revenue growth,
aggressively managing the revenue/expense relationship and improving the
risk/return dynamic of this business.
Regional Community Banking contributed $353 million or 53% of total business
earnings for the first six months of 2002 compared with $337 million or 54% for
the first six months of 2001. Excluding net securities gains in both periods,
gains related to residential mortgage loan securitizations of $8 million in 2002
and $25 million in 2001, and $18 million of goodwill amortization expense in
2001, earnings for the first six months of 2002 increased 8% compared with the
prior-year period primarily due to higher revenue.
Total revenue was $1.1 billion for the first six months of 2002 and 2001.
Excluding net securities gains and loan securitization gains from both periods,
revenue increased 4% in the period-to-period comparison primarily due to higher
net interest income in 2002 resulting from a 6% increase in average transaction
deposits.
The provision for credit losses for the first six months of 2002 increased to
$23 million compared with $20 million in the prior year due to higher net
charge-offs on consumer loans. See Critical Accounting Policies and Judgments in
the Risk Factors section of this Financial Review for additional information.
Total loans decreased 20% on average in the first six months of 2002 compared
with the prior year. Home equity loans, the lead consumer lending product, grew
11% in the comparison. The overall decline resulted from the strategic reduction
of residential mortgage and indirect auto products. The increase in average
securities in the six month comparison reflects the Corporation's balance sheet
and interest rate risk management activities.
Total deposits declined 3% in the period-to-period comparison as increases in
transaction and savings deposits were more than offset by a decline in
certificates of deposit. Demand and money market deposits increased due to
ongoing strategic marketing efforts to add new accounts and retain existing
customers as funds shifted from certificates of deposit. Regional Community
Banking continues to focus on increasing transaction deposits, which serve as a
means to deepen customer relationships and support growth in consumer services
revenue.
As previously reported, the Corporation made the decision to discontinue its
vehicle leasing business in the fourth quarter of 2001. This portfolio, which
declined 14% since December 31, 2001, is expected to mature over a period of
approximately five years with an average remaining life of two years. See
Strategic Repositioning in the Consolidated Balance Sheet Review section and
Critical Accounting Policies And Judgments in the Risk Factors section of this
Financial Review for additional information.
6
CORPORATE BANKING
Six months ended June 30
Taxable-equivalent basis
Dollars in millions 2002 2001
- ---------------------------------------------------------------
INCOME STATEMENT
Net interest income $183 $275
Noninterest income 228 111
- ---------------------------------------------------------------
Total revenue 411 386
Provision for credit losses 95 32
Noninterest expense 183 196
Institutional lending repositioning 57
Goodwill amortization 2
Severance costs 3
- ---------------------------------------------------------------
Pretax earnings 133 96
Income taxes 46 32
- ---------------------------------------------------------------
Earnings $87 $64
===============================================================
AVERAGE BALANCE SHEET
Loans $9,815 $14,605
Loans held for sale 2,116 286
Other assets 2,821 2,432
- ---------------------------------------------------------------
Total assets $14,752 $17,323
===============================================================
Deposits $4,538 $4,862
Assigned funds and other liabilities 9,108 11,162
Assigned capital 1,106 1,299
- ---------------------------------------------------------------
Total funds $14,752 $17,323
===============================================================
PERFORMANCE RATIOS
Return on assigned capital 16% 10%
Noninterest income to total revenue 55 29
Efficiency 45 52
===============================================================
OTHER INFORMATION
June 30 December 31
In millions 2002 2001
- ---------------------------------------------------------------
Total nonperforming assets $261 $220
Institutional lending repositioning
Loans held for sale
Credit exposure 1,822 4,594
Outstandings 920 2,294
Exit portfolio
Credit exposure 1,178 2,662
Outstandings 12 192
===============================================================
Corporate Banking provides credit, equipment leasing, treasury management and
capital markets products and services primarily to mid-sized corporations and
government entities within PNC's geographic region. The strategic focus for
Corporate Banking is to adapt its institutional expertise to the middle market
with an emphasis on higher-margin noncredit products and services, especially
treasury management and capital markets, and to improve the risk/return
characteristics of the lending business. Corporate Banking intends to
continue its efforts to manage credit risk, liquidate loans held for sale and
sustain relationships with traditional customers for noncredit products.
During the first six months of 2002, Corporate Banking made significant progress
in the repositioning of its institutional lending business. The exit and held
for sale portfolios at June 30, 2002 had total credit exposure of $3.0 billion
including outstandings of $932 million, a reduction of approximately 60% from
December 31, 2001. Of these amounts, $1.8 billion of credit exposure and $920
million of outstandings were classified as held for sale. The Corporation is
continuing to pursue liquidation of the institutional held for sale portfolio.
Gains and losses may result from the liquidation of loans held for sale to the
extent actual performance differs from estimates inherent in the recorded
amounts or if valuations change. See Critical Accounting Policies and Judgments
in the Risk Factors Section and Strategic Repositioning in the Consolidated
Balance Sheet Review section of this Financial Review for additional
information.
Corporate Banking contributed $87 million or 13% of total business earnings for
the first six months of 2002 compared with $64 million or 10% for the first six
months of 2001. Results for this business continued to be adversely affected by
weak economic and market conditions combined with the impact of PNC's
institutional lending repositioning efforts.
Total revenue of $411 million for the first six months of 2002 increased $25
million compared with the same period in 2001. Net interest income for the first
six months in 2002 decreased $92 million compared with the first six months of
2001 primarily due to the impact of the decline in interest rates combined with
the reduction in average loans resulting from the ongoing institutional lending
repositioning. Noninterest income for the first six months of 2002 increased
$117 million compared with the same period in 2001 primarily due to $79 million
of net gains in excess of valuation adjustments related to institutional loans
held for sale and higher treasury management fees.
Total credit costs were $95 million for the first six months of 2002 compared
with $88 million for the first six months of 2001, which included $32 million
reflected in provision for credit losses and $56 million of institutional
lending repositioning charges. Valuation adjustments totaling $1 million for
loans previously designated as held for sale are also reflected in the 2001
institutional lending repositioning charge. The provision for credit losses for
the first six months of 2002 reflects reserve allocations related to Market
Street liquidity facilities and the impact of refinements to the Corporation's
reserve methodology related to impaired loans and pool reserves. See Market
Street in the Risk Management section of this Financial Review for further
information. Also, see Critical Accounting Policies And Judgments in the Risk
Factors section and Allowances For Credit Losses And Unfunded Loan Commitments
And Letters Of Credit in the Consolidated Balance Sheet Review section of this
Financial Review for additional information.
Treasury management and capital markets products offered through Corporate
Banking are sold by several businesses across the Corporation and related
revenue net of expense is included in the results of those businesses.
Consolidated revenue from treasury management was $170 million for the first six
months of both 2002 and 2001, as higher fee revenue was offset by lower income
earned on customers' deposit balances. Consolidated revenue from capital markets
was $62 million for the first six months of 2002, an increase of $5 million
compared with the first six months of 2001 primarily due to the comparative
impact of valuation losses associated with equity investments in 2001.
Nonperforming assets were $261 million at June 30, 2002 compared with $220
million at December 31, 2001. The increase was primarily due to the funding of
approximately $63 million resulting from a draw on a liquidity facility with
Market Street.
7
PNC REAL ESTATE FINANCE
Six months ended June 30
Taxable-equivalent basis
Dollars in millions 2002 2001
- ---------------------------------------------------------------
INCOME STATEMENT
Net interest income $60 $57
Noninterest income
Commercial mortgage banking 32 32
Other 24 16
- ---------------------------------------------------------------
Total noninterest income 56 48
- ---------------------------------------------------------------
Total revenue 116 105
Provision for credit losses (5) 7
Noninterest expense 74 68
Goodwill amortization 9
- ---------------------------------------------------------------
Pretax earnings 47 21
Income tax (benefit) expense (1) (10)
- ---------------------------------------------------------------
Earnings $48 $31
===============================================================
AVERAGE BALANCE SHEET
Loans
Commercial real estate $1,508 $1,831
Commercial - real estate related 2,237 2,326
- ---------------------------------------------------------------
Total loans 3,745 4,157
Commercial mortgages held for sale 282 210
Other loans held for sale 183 3
Other assets 871 966
- ---------------------------------------------------------------
Total assets $5,081 $5,336
===============================================================
Deposits $658 $364
Assigned funds and other
liabilities 4,025 4,572
Assigned capital 398 400
- ---------------------------------------------------------------
Total funds $5,081 $5,336
===============================================================
PERFORMANCE RATIOS
Return on assigned capital 24% 16%
Noninterest income to total revenue 48 46
Efficiency 58 60
===============================================================
OTHER INFORMATION
June 30 December 31
In millions 2002 2001
- ---------------------------------------------------------------
Total nonperforming assets $6 $6
Institutional lending repositioning
Loans held for sale
Credit exposure 124 324
Outstandings 105 244
Exit portfolio
Credit exposure 25 30
Outstandings 6 5
===============================================================
PNC Real Estate Finance specializes in financial solutions for the acquisition,
development, permanent financing and operation of commercial real estate
nationally. PNC Real Estate Finance offers treasury and investment management,
access to the capital markets, commercial mortgage loan servicing and other
products and services to clients that develop, own, manage or invest in
commercial real estate. PNC's commercial real estate financial services platform
provides processing services through Midland Loan Services, Inc., a leading
third-party provider of loan servicing and technology to the commercial real
estate finance industry, and national syndication of affordable housing equity
through Columbia Housing Partners, LP. These latter activities may require
additional regulatory approvals as a result of bank regulatory, supervisory and
examination activities. See Regulatory Matters in the Risk Management Section of
this Financial Review for additional information.
PNC Real Estate Finance seeks to have a more balanced and valuable revenue
stream by focusing on real estate processing businesses and increasing the value
of its lending business by seeking to sell more fee-based products to lending
customers.
PNC Real Estate Finance contributed $48 million or 7% of total business earnings
for the first six months of 2002 compared with $31 million or 5% for the first
six months of 2001. Net gains in excess of valuation adjustments related to
institutional loans held for sale, the benefit of no longer amortizing goodwill
and the impact of a loan recovery in the exited warehouse lending business more
than offset higher noninterest expense in 2002. Average loans decreased 10% in
the period-to-period comparison reflecting the impact of the institutional
lending repositioning.
Total revenue was $116 million for the first six months of 2002 compared with
$105 million for the first six months of 2001. The increase of $11 million or
10% was primarily due to net gains in excess of valuation adjustments of
$6 million related to institutional loans held for sale and higher net interest
income.
The commercial mortgage servicing portfolio grew 15% in the comparison to $71
billion at June 30, 2002.
COMMERCIAL MORTGAGE SERVICING PORTFOLIO
In billions 2002 2001
- ---------------------------------------------------------------
January 1 $68 $54
Acquisitions/additions 9 12
Repayments/transfers (6) (4)
- ---------------------------------------------------------------
June 30 $71 $62
===============================================================
The provision for credit losses for the six months ended June 30, 2002 included
the benefit of a recovery in the exited warehouse lending business. See Critical
Accounting Policies And Judgments in the Risk Factors section of this Financial
Review for additional information.
During the first six months of 2002, PNC Real Estate Finance made significant
progress in the repositioning of its institutional lending business. The exit
and held for sale portfolios at June 30, 2002 had total credit exposure of $149
million including outstandings of $111 million, a reduction of approximately
55% since December 31, 2001. Of these amounts, $124 million of credit exposure
and $105 million of outstandings were classified as held for sale. The
Corporation is continuing to pursue liquidation of the institutional held for
sale portfolio. Gains and losses may result from the liquidation of loans held
for sale to the extent actual performance differs from estimates inherent in
the recorded amounts or if valuations change. See Critical Accounting Policies
And Judgments in the Risk Factors Section and Strategic Repositioning in the
Consolidated Balance Sheet Review section of this Financial Review for
additional information.
8
PNC BUSINESS CREDIT
Six months ended June 30
Taxable-equivalent basis
Dollars in millions 2002 2001
- ---------------------------------------------------------------
INCOME STATEMENT
Net interest income $66 $51
Noninterest income 24 20
- ---------------------------------------------------------------
Total revenue 90 71
Provision for credit losses 57 8
Noninterest expense 27 15
Goodwill amortization 1
- ---------------------------------------------------------------
Pretax earnings 6 47
Income taxes 2 17
- ---------------------------------------------------------------
Earnings $4 $30
===============================================================
AVERAGE BALANCE SHEET
Loans $3,563 $2,305
Loans held for sale 89 66
Other assets 246 59
- ---------------------------------------------------------------
Total assets $3,898 $2,430
===============================================================
Deposits $73 $80
Assigned funds and other liabilities 3,572 2,189
Assigned capital 253 161
- ---------------------------------------------------------------
Total funds $3,898 $2,430
===============================================================
PERFORMANCE RATIOS
Return on assigned capital 3% 38%
Noninterest income to total revenue 27 28
Efficiency 30 21
===============================================================
OTHER INFORMATION
June 30 December 31
In millions 2002 2001
- ---------------------------------------------------------------
Total nonperforming assets $164 $109
Institutional lending repositioning
Loans held for sale
Credit exposure 73 40
Outstandings 41 30
===============================================================
PNC Business Credit provides asset-based lending, capital markets and treasury
management products and services to middle market customers nationally. PNC
Business Credit's lending services include loans secured by accounts receivable,
inventory, machinery and equipment, and other collateral, and its customers
include manufacturing, wholesale, distribution, retailing and service industry
companies.
In January 2002, PNC Business Credit acquired a portion of NBOC's U.S.
asset-based lending business in a purchase business combination. See Note 3 NBOC
Acquisition in the Notes to Consolidated Financial Statements for additional
information.
PNC Business Credit earned $4 million for the first six months of 2002 compared
with $30 million for the first six months of 2001. Earnings declined and
performance ratios were adversely impacted in the comparison as higher revenue
in 2002 was more than offset by an increase in the provision for credit losses.
Revenue was $90 million for the first six months of 2002, a $19 million or 27%
increase compared with the first six months of 2001 as both net interest income
and noninterest income increased. The increase in net interest income for the
first six months of 2002 reflected an increase of $1.3 billion or 55% in total
average loans for the period resulting primarily from the NBOC acquisition.
Noninterest income in the first six months of 2002 included a $15 million
benefit resulting from the reduction in the put option liability related to the
NBOC acquisition partially offset by $7 million of valuation adjustments in
excess of net gains related to the institutional loans held for sale.
Noninterest income for the first six months of 2001 also included $7 million of
gains on equity interests received as compensation in conjunction with lending
relationships.
The provision for credit losses for the first six months of 2002 was $57 million
compared with $8 million for the first six months of 2001. Net charge-offs were
$22 million for the first six months of 2002 compared with $8 million a year
ago. The provision for credit losses increased in the first six months of 2002
as additional reserves were required due to a decline in credit quality and the
impact of refinements to the Corporation's reserve methodology related to
impaired loans and pool reserves. PNC Business Credit loans, including those
acquired in the NBOC acquisition, are secured loans to borrowers, many with a
weak credit risk rating. As a result, these loans typically exhibit a higher
risk of default and a greater proportion of such loans may be classified as
nonperforming. PNC Business Credit attempts to manage this risk through direct
control of cash flows and collateral requirements. Compensation for this higher
risk of default is obtained by way of higher interest rates charged. The impact
of these loans on the provision for credit losses and the level of nonperforming
assets may be even more pronounced during periods of economic downturn
consistent with PNC Business Credit's recent experience. See Critical Accounting
Policies And Judgments in the Risk Factors section and Allowance For Credit
Losses And Unfunded Loan Commitments And Letters of Credit in the Consolidated
Balance Sheet Review section of this Financial Review for additional
information.
Total noninterest expense increased $12 million to $27 million and the
efficiency ratio increased to 30% during the first six months of 2002 compared
with the prior year period primarily due to costs added with the NBOC
acquisition.
Nonperforming assets were $164 million at June 30, 2002 compared with $109
million at December 31, 2001. The increase was primarily due to declines in
economic conditions. Increases in nonperforming assets in this business are
expected to continue at this point in the economic cycle. See Credit Risk in the
Risk Management section of the Financial Review included in the 2001 Form 10-K
for additional information.
PNC Business Credit included several credits in the Corporation's institutional
lending repositioning. Credit exposure of $73 million including $41 million of
outstandings classified as held for sale remained at June 30, 2002. The net
increase in credit exposure and outstandings from December 31, 2001 resulted
from the addition of certain credits from the NBOC acquisition. See Critical
Accounting Policies And Judgments in the Risk Factors section and Strategic
Repositioning in the Consolidated Balance Sheet Review section of this Financial
Review for additional information.
9
PNC ADVISORS
Six months ended June 30
Taxable-equivalent basis
Dollars in millions 2002 2001
- -----------------------------------------------------------------
INCOME STATEMENT
Net interest income $52 $68
Noninterest income
Investment management and trust 182 210
Brokerage 73 70
Other 47 41
- -----------------------------------------------------------------
Total noninterest income 302 321
- -----------------------------------------------------------------
Total revenue 354 389
Provision for credit losses 1 1
Noninterest expense 252 253
Goodwill amortization 3
- -----------------------------------------------------------------
Pretax earnings 101 132
Income taxes 37 49
- -----------------------------------------------------------------
Earnings $64 $83
=================================================================
AVERAGE BALANCE SHEET
Loans
Consumer $1,198 $1,098
Residential mortgage 574 911
Commercial 485 521
Other 345 405
- -----------------------------------------------------------------
Total loans 2,602 2,935
Other assets 427 485
- -----------------------------------------------------------------
Total assets $3,029 $3,420
=================================================================
Deposits $2,029 $2,045
Assigned funds and other liabilities 475 823
Assigned capital 525 552
- -----------------------------------------------------------------
Total funds $3,029 $3,420
=================================================================
PERFORMANCE RATIOS
Return on assigned capital 25% 30%
Noninterest income to total revenue 85 83
Efficiency 71 65
=================================================================
PNC Advisors provides a full range of tailored investment products and services
to affluent individuals and families, including full-service brokerage through
J.J.B. Hilliard, W.L. Lyons, Inc. ("Hilliard Lyons") and investment advisory
services to the ultra-affluent through Hawthorn. During the second quarter of
2002, Hilliard Lyons acquired from Regional Community Banking the branch-based
brokerage business that formerly operated under the PNC Brokerage brand name.
This business was combined with Hilliard's brokerage operations and continues
to provide services in the branch network under the PNC Investments brand name.
The revenue and expense related to the branches continues to be included in the
results of Regional Community Banking. Consolidated revenue from brokerage was
$110 million for the first six months of 2002 compared with $109 million in
2001. PNC Advisors also serves as investment manager and trustee for employee
benefit plans and charitable and endowment assets.
PNC Advisors is focused on selectively expanding Hilliard Lyons and Hawthorn,
increasing market share in PNC's primary geographic region and leveraging its
distribution platform. PNC Advisors expects to continue to focus on acquiring
new customers and growing and expanding existing customer relationships while
managing expenses.
PNC Advisors contributed $64 million or 10% of total business earnings for the
first six months of 2002 compared with $83 million or 13% for the first six
months of 2001. Earnings decreased in the comparison primarily due to lower
revenue.
Revenue for the first six months of 2002 decreased $35 million compared with the
prior year period due to weak equity markets, lower average loans, a narrower
net interest margin and the recognition of revenue accrual adjustments of $15
million in 2001. Assets under management and related noninterest income are
closely tied to the performance of the equity markets. Management expects that
revenues in this business will continue to be challenged at least until equity
market conditions improve for a sustained period. See Business and Economic
Conditions and Asset Management Performance in the Risk Factors section of the
Financial Review included in the 2001 Form 10-K for additional information
regarding matters that could impact PNC Advisors' revenue.
ASSETS UNDER MANAGEMENT (a)
June 30 - in billions 2002 2001
- -----------------------------------------------------------------
Personal investment management and trust $45 $49
Institutional trust 11 14
- -----------------------------------------------------------------
Total $56 $63
=================================================================
ASSET TYPE
June 30 - in billions 2002 2001
- -----------------------------------------------------------------
Equity $31 $40
Fixed income 18 16
Liquidity 7 7
- -----------------------------------------------------------------
Total $56 $63
=================================================================
(a) Excludes brokerage assets administered.
Assets under management decreased $7 billion due to the decline in the value of
the equity component of customers' portfolios. Brokerage assets administered by
Hilliard Lyons, including assets of the former PNC Brokerage Business, were
$33 billion at June 30, 2002 compared with $34 billion at June 30, 2001 and
were also impacted by weak equity market conditions.
PNC Advisors provides investment management services directly and through
BlackRock and unaffiliated investment managers. In July 2002, the Corporation
and BlackRock entered into a revised agreement with respect to investment
management services. The agreement includes a reduction in the rate of fees
received from BlackRock based on current market conditions and the impact of a
reduction in the level of PNC Advisors' customer assets managed by BlackRock.
Based on the current levels and mix of those assets in BlackRock investment
funds, the agreement is expected to reduce PNC Advisors' total revenue by
approximately 2% annually.
10
BLACKROCK
Six months ended June 30
Dollars in millions 2002 2001
- -----------------------------------------------------------------
INCOME STATEMENT
Investment advisory and
administrative fees $275 $252
Other income 28 17
- -----------------------------------------------------------------
Total revenue 303 269
Operating expense 173 147
Fund administration
and servicing costs - affiliates 25 32
Amortization of intangible assets 5
- -----------------------------------------------------------------
Total expense 198 184
- -----------------------------------------------------------------
Operating income 105 85
Nonoperating income 6 4
- -----------------------------------------------------------------
Pretax earnings 111 89
Income taxes 45 37
- -----------------------------------------------------------------
Earnings $66 $52
=================================================================
PERIOD-END BALANCE SHEET
Intangible assets $181 $187
Other assets 553 384
- -----------------------------------------------------------------
Total assets $734 $571
=================================================================
Liabilities $173 $142
Stockholders' equity 561 429
- -----------------------------------------------------------------
Total liabilities and
stockholders' equity $734 $571
=================================================================
PERFORMANCE DATA
Return on equity 25% 26%
Operating margin(a) 38 36
Diluted earnings per share $1.01 $.80
=================================================================
(a) Excludes the impact of fund administration and servicing costs - affiliates.
BlackRock is one of the largest publicly traded investment management firms in
the United States with approximately $250 billion of assets under management at
June 30, 2002. BlackRock manages assets on behalf of institutions and
individuals worldwide through a variety of fixed income, liquidity and equity
mutual funds, separate accounts and alternative investment products. Mutual
funds include the flagship fund families - BlackRock Funds and BlackRock
Provident Institutional Funds. In addition, BlackRock provides risk management
and investment system services to institutional investors under the BlackRock
Solutions brand name.
BlackRock continues to focus on delivering superior relative investment
performance to clients while pursuing strategies to build on core strengths and
to selectively expand the firm's expertise and breadth of distribution.
BlackRock contributed $66 million or 10% of total business earnings for the
first six months of 2002 compared with $52 million or 8% for the first six
months of 2001.
Earnings increased 27% in the period-to-period comparison primarily due to a 17%
increase in assets under management and increased sales of BlackRock Solutions
products and services.
Total revenue for the first six months of 2002 increased $34 million or 13%
compared with the first six months of 2001 primarily due to increases in
separate account assets under management, sales of alternative investment
products and performance fees. Current market conditions substantially reduce
the likelihood of performance fees for the remainder of 2002. See Business and
Economic Conditions and Asset Management Performance in the Risk Factors section
of the Financial Review included in the 2001 Form 10-K for additional
information regarding matters that could impact asset management revenue.
The 8% increase in total expenses in the period-to-period comparison supported
revenue growth and business expansion. Expense growth was mitigated by goodwill
amortization in the first six months of 2001 that did not recur in 2002 under
SFAS No. 142.
ASSETS UNDER MANAGEMENT
June 30 - in billions 2002 2001
- -----------------------------------------------------------------
Separate accounts
Fixed income $141 $111
Liquidity 6 7
Liquidity - securities lending 6 10
Equity 10 8
Alternative investment products 5 4
- -----------------------------------------------------------------
Total separate accounts 168 140
- -----------------------------------------------------------------
Mutual funds (a)
Fixed income 17 12
Liquidity 59 49
Equity 6 12
- -----------------------------------------------------------------
Total mutual funds 82 73
- -----------------------------------------------------------------
Total assets under management $250 $213
=================================================================
(a) Includes BlackRock Funds, BlackRock Provident Institutional Funds, BlackRock
Closed End Funds, Short Term Investment Funds and BlackRock Global Series
Funds.
BlackRock, Inc. is approximately 69% owned by PNC and is listed on the New York
Stock Exchange under the symbol BLK. Additional information about BlackRock is
available in its filings with the SEC and may be obtained electronically at the
SEC's home page at www.sec.gov.
In July 2002, BlackRock and the Corporation entered into a revised agreement
with respect to investment management services. The agreement includes a
reduction in the rate of fees paid to PNC Advisors based on current market
conditions and the impact of a reduction in the level of PNC Advisors' customer
assets managed by BlackRock. Based on the current levels and mix of those assets
in BlackRock investment funds, the agreement is expected to reduce fund
administration and servicing cost-affiliates by approximately 25% annually.
11
PFPC
Six months ended June 30
Dollars in millions 2002 2001
- ---------------------------------------------------------------
INCOME STATEMENT
Fund servicing revenue $399 $397
Operating expense 306 291
Goodwill amortization 20
(Accretion)/amortization of
other intangibles, net (10) (7)
- ---------------------------------------------------------------
Operating income 103 93
Nonoperating income (a) 6 7
Debt financing 45 47
- ---------------------------------------------------------------
Pretax earnings 64 53
Income taxes 26 21
- ---------------------------------------------------------------
Earnings $38 $32
===============================================================
AVERAGE BALANCE SHEET
Intangible assets $1,033 $1,079
Other assets 857 663
- ---------------------------------------------------------------
Total assets $1,890 $1,742
===============================================================
Assigned funds and other liabilities $1,682 $1,534
Assigned capital 208 208
- ---------------------------------------------------------------
Total funds $1,890 $1,742
===============================================================
PERFORMANCE RATIOS
Return on assigned capital 37% 31%
Operating margin 26 23
===============================================================
(a) Net of nonoperating expense.
PFPC is the largest full-service mutual fund transfer agent and second largest
provider of mutual fund accounting and administration services in the United
States, providing a wide range of fund services to the investment management
industry. PFPC also provides processing solutions to the international
marketplace through its Ireland and Luxembourg operations.
PFPC is focusing technological resources on targeting Web-based initiatives,
streamlining operations and developing flexible system architecture and
client-focused servicing solutions. To meet the growing needs of the European
marketplace, PFPC is also continuing its pursuit of offshore expansion.
During the second quarter of 2002, PFPC announced renewed relationships with the
Seligman Group of Funds and Eaton Vance Funds, and the selection of PFPC by
Wells Fargo Funds Management, LLC to provide fund accounting services. After
conversion of the Wells Fargo portfolios, PFPC expects to provide these new and
renewing customers with a variety of fund accounting/administration and transfer
agency services for approximately $120 billion of assets. The new relationship
is expected to help offset customer losses due to attrition and highly
competitive conditions.
PFPC contributed $38 million or 6% of total business earnings for the first six
months of 2002 compared with $32 million or 5% for the first six months of 2001.
Earnings in the first half of 2002 included the impact of a one-time benefit of
approximately $13 million of fees related to the renegotiation of a customer
contract. PFPC also benefited in 2002 from the adoption of the new goodwill
accounting standard that reduced amortization expense by $20 million compared
with the first six months of 2001. These benefits were partially offset by
higher facilities and technology-related costs. The cost of integration,
technology and infrastructure enhancements, coupled with a shift in both product
and client mix, continued to exert pressure on operating margins. Margins are
expected to remain under pressure at least until equity markets improve for a
sustained period.
Revenue of $399 million for the first six months of 2002 increased $2 million
compared with the first six months of 2001. Excluding the one-time benefit
described above, revenue declined in the comparison primarily due to lower
equity valuations, pricing and other competitive factors including customer
attrition. See Business and Economic Conditions and Fund Servicing in the Risk
Factors section of the Financial Review included in the 2001 Form 10-K for
additional information regarding matters that could impact fund servicing
revenue.
Operating expense increased $15 million or 5% in the period-to-period comparison
primarily due to increased staff levels for new product support combined with
additional investments in technology.
Operating income for the first six months of 2002 included accretion of a
discounted customer contract liability of $17 million. Accretion for the first
six months of 2001 was $15 million.
SERVICING STATISTICS
June 30 2002 2001
- ---------------------------------------------------------------
Accounting/administration net assets
($ in billions)
Domestic $485 $488
Foreign (a) 28 14
- ---------------------------------------------------------------
Total $513 $502
Custody assets ($ in billions) $323 $442
Shareholder accounts (in millions) 51 45
===============================================================
(a) Represents net assets serviced offshore.
Accounting/administration net assets have increased compared with the 2001
period as changes in domestic customer mix and successful offshore sales efforts
have offset the impact of weak equity markets. Custody assets have declined
primarily due to changes in customer relationships.
12
CONSOLIDATED INCOME STATEMENT REVIEW
NET INTEREST INCOME
Changes in net interest income and margin result from the interaction among the
volume and composition of earning assets, related yields and associated funding
costs. Accordingly, portfolio size, composition and yields earned and funding
costs can have a significant impact on net interest income and margin. See the
Balance Sheet Highlights section of this Financial Review and the Consolidated
Average Balance Sheet and Net Interest Analysis for additional information.
Taxable-equivalent net interest income of $1.151 billion for the first six
months of 2002 increased 2% compared with the first six months of 2001. The
increase was primarily due to the positive impact of transaction deposit growth
and a lower rate environment that was partially offset by the impact of
continued downsizing of the loan portfolio. The net interest margin widened 36
basis points to 4.06% for the first six months of 2002 compared with 3.70% for
the first six months of 2001. The improvement was primarily due to the impact of
changes in balance sheet composition and a lower interest rate environment in
2002, combined with a steep yield curve. See Interest Rate Risk in the Risk
Management section of this Financial Review for additional information.
Taxable-equivalent net interest income was $558 million and the net interest
margin was 3.99% for the second quarter of 2002 compared with $569 million and
3.77%, respectively, for the second quarter of 2001. The decrease in net
interest income resulted from the impact of a $4.4 billion or 7% decline in
average earning assets that was mitigated by the benefit of a wider net interest
margin in a lower interest rate environment. Continued downsizing of the
institutional lending portfolio and overall balance sheet leverage drove the
decline in average earning assets.
PROVISION FOR CREDIT LOSSES
The provision for credit losses was $171 million for the first six months of
2002 compared with $125 million for the first six months of 2001. The provision
for credit losses was $89 million for the second quarter of 2002 compared with
$45 million for the prior year quarter. The provision in all periods includes
amounts for potential losses on loans and credit exposure related to unfunded
loan commitments and letters of credit. The increases were primarily due to
additional reserves provided for PNC Business Credit and Corporate Banking.
The Corporate Banking increase related primarily to Market Street liquidity
facilities. See Market Street within this Financial Review for further
information.
Net charge-offs were $115 million or .61% of average loans for the first half of
2002 compared with $125 million or .53%, respectively, for the first half of
2001. Net charge-offs were $74 million or .78% of average loans for the second
quarter of 2002 compared with $45 million or .40%, respectively, for the second
quarter of 2001. Net charge-offs for the second quarter of 2002 included $45
million related to a customer of Market Street, which was fully reserved at
March 31, 2002.
NONINTEREST INCOME
Noninterest income was $1.629 billion for the first six months of 2002 compared
with $1.448 billion for the first six months of 2001. Second quarter 2002
noninterest income totaled $855 million compared with $733 million in the second
quarter of 2001.
Asset management fees were $451 million for the first six months of 2002, an
increase of $14 million compared with the first six months of 2001. Second
quarter 2002 asset management fees increased $16 million, to $230 million,
compared with the second quarter of 2001. Increases in separate account assets
under management, sales of alternative investment products and performance fees
at BlackRock benefited both 2002 periods. The impact of these items in 2002
more than offset the recognition of $15 million of revenue accrual adjustments
that benefited the first half of 2001. Consolidated assets under management
increased to $294 billion at June 30, 2002 compared with $260 billion at
June 30, 2001 due to growth at BlackRock.
Fund servicing fees increased $8 million, to $398 million, for the first six
months of 2002 compared with the year-ago period. Fund servicing fees increased
$7 million, to $202 million, for the second quarter of 2002 compared with the
second quarter of 2001. The increases in both 2002 periods reflect a one-time
benefit of approximately $13 million related to the renegotiation of a customer
contract recognized during the second quarter of 2002 at PFPC. Excluding this
benefit, fund servicing revenue declined in both comparisons as a result of the
impact of lower equity valuations, pricing and other competitive factors
including customer attrition.
Service charges on deposits totaled $109 million for the first six months of
2002, an increase of $5 million compared with the first half of 2001 as an
increase in average transaction deposits more than offset the impact of price
reductions for certain services. Service charges on deposits increased $1
million, to $55 million, for the second quarter of 2002. Brokerage fees of $110
million for the first half of 2002 increased $1 million compared with the
comparable prior year period. For the second quarter of 2002, brokerage fees
were flat compared with the prior year quarter.
13
Consumer services revenue increased $3 million to $116 million for the first
six months of 2002 compared with the first six months of 2001, with the entire
increase attributable to the second quarter of 2002. The increase reflected
additional fees from ATM and debit cards primarily due to an increase in
transaction volumes.
Corporate services revenue totaled $267 million for the first six months of
2002, up $115 million from $152 million for the first half of 2001. For the
second quarter of 2002, corporate services revenue increased $73 million, to
$149 million, compared with the second quarter of 2001. The increases in 2002
reflect net gains in excess of valuation adjustments related to institutional
loans held for sale totaling $78 million for the first six months of 2002 and
$55 million for the second quarter of 2002, and higher treasury management fees
in both periods.
Equity management (private equity activities) net losses on portfolio
investments were $15 million for the first six months of 2002 compared with net
losses of $69 million for the first half of 2001. For the second quarter of
2002, equity management net losses on portfolio investments totaled $13 million
compared with $30 million for the prior year quarter.
Net securities gains totaled $20 million for the first six months of 2002
compared with $46 million for the comparable prior year period. Net securities
gains were $16 million for the second quarter of 2002, down $1 million from the
second quarter of 2001.
Other noninterest income increased $7 million to $173 million for the first
half of 2002. Other noninterest income increased $6 million to $100 million in
the second quarter of 2002. A $14 million gain on the sale of a real estate
investment and a $10 million benefit resulting from the reduction in the put
option liability related to the NBOC acquisition contributed to the second
quarter and first six months increases. This increase was mitigated in the
comparison by $15 million of gains related to residential mortgage loan
securitizations and a higher level of revenue from trading activities a year
ago.
Net trading income included in other noninterest income totaled $53 million for
the first six months of 2002, compared with $77 million for the comparable prior
year period. For the second quarter of 2002, net trading income included in
other noninterest income was $29 million compared with $40 million for the prior
year quarter. The decrease resulted from lower derivatives trading income. See
Trading Activities in the Risk Management section of this Financial Review and
Note 7 Trading Activities to the Notes to Consolidated Financial Statements for
additional information.
NONINTEREST EXPENSE
Total noninterest expense was $1.615 billion for the first six months of 2002,
an increase of $40 million or 3% compared with the first half of 2001.
Noninterest expense for the second quarter of 2002 totaled $824 million, up $30
million compared with the second quarter of 2001. Excluding the effect of
goodwill amortization expense from the second quarter and first six months of
2001, noninterest expense increased $59 million and $99 million, respectively,
in the comparable 2002 periods. The increase for the second quarter of 2002
reflected higher operating expenses of $16 million, $6 million and $5 million at
BlackRock, PFPC and PNC Business Credit, respectively, related to increased
business volumes, and an increase of $11 million in legal costs. For the first
half of 2002, the increase was primarily due to higher operating expenses of $26
million, $15 million and $12 million at BlackRock, PFPC and PNC Business Credit,
respectively, and an additional $21 million of legal costs. In addition, other
noninterest expense for the second quarter and first six months of 2002 included
a $16 million adjustment related to incentive and retention arrangements in the
form of co-investment partnerships for certain equity management employees. See
Regulatory Matters in the Risk Management section of this Financial Review for
additional information.
The efficiency ratio was 57% for the first half of 2002 and for both the 2002
and 2001 second quarters, while the efficiency ratio for the first half of 2001
was 58%. Average full-time equivalent employees totaled approximately 24,000 and
24,700 for the first six months of 2002 and 2001, respectively. The decrease was
mainly in Regional Community Banking and Corporate Banking.
CONSOLIDATED BALANCE SHEET REVIEW
STRATEGIC REPOSITIONING
As previously reported, PNC took several actions in 2001 to accelerate the
strategic repositioning of its lending businesses that began in 1998. A total of
$12.0 billion of credit exposure (comprised of loans outstanding, unfunded
commitments and letters of credit) including $6.2 billion of outstandings were
designated for exit or transferred to held for sale during 2001, of which $10.1
billion and $4.3 billion, respectively, related to the institutional lending
portfolio. The remaining $1.9 billion of credit exposure and outstandings
related to PNC's vehicle leasing business that is being discontinued. At June
30, 2002, PNC's vehicle leasing business had $1.7 billion in assets that have
been designated for exit and are expected to mature over a period of
approximately 5 years with a weighted-average remaining life of three years.
See Critical Accounting Policies And Judgments in the Risk Factors section of
this Financial Review for additional information regarding certain risks
associated with executing these strategies.
Details of the credit exposure and outstandings by business in the institutional
lending held for sale and exit portfolios are included in the Corporate Banking,
PNC Real Estate Finance and PNC Business Credit sections of the Review of
Businesses within this Financial Review. A rollforward of the institutional
lending held for sale portfolio follows:
14
ROLLFORWARD OF INSTITUTIONAL LENDING HELD FOR SALE PORTFOLIO
In millions Credit Exposure Outstandings
- -------------------------------------------------------------------
January 1, 2002 $4,958 $2,568
Additions 119 236
Sales (1,565) (894)
Payments and other exposure
reductions (1,307) (686)
Valuation adjustments, net (186) (158)
- -------------------------------------------------------------------
June 30, 2002 $2,019 $1,066
===================================================================
During the second quarter and first six months of 2002, the liquidation of
institutional loans held for sale resulted in net gains in excess of valuation
adjustments of $55 million and $78 million, respectively. Details by business
follow:
INSTITUTIONAL LENDING HELD FOR SALE ACTIVITY
Three months ended
June 30, 2002 Net gains on Valuation
In millions liquidation Adjustments Total
- ----------------------------------------------------------------
Corporate Banking $134 $(84) $50
PNC Real Estate Finance 16 (4) 12
PNC Business Credit 2 (9) (7)
- ----------------------------------------------------------------
Total $152 $(97) $55
================================================================
Six months ended
June 30, 2002 Net gains on Valuation
In millions liquidation Adjustments Total
- ----------------------------------------------------------------
Corporate Banking $244 $(165) $79
PNC Real Estate Finance 17 (11) 6
PNC Business Credit 3 (10) (7)
- ----------------------------------------------------------------
Total $264 $(186) $78
================================================================
In addition to the actions taken regarding the institutional lending held for
sale and exit portfolios, the Corporation also recorded charges in 2001 totaling
$208 million in connection with other actions and additions to reserves.
Reserves related to these actions totaled $156 million at June 30, 2002. The
following table summarizes the second quarter and year-to-date 2002 changes to
these reserves:
ROLLFORWARD OF OTHER RESERVES RELATED TO FOURTH QUARTER 2001 ACTIONS
First Second At
Quarter Quarter June
2001 Utilized 2002 2002 30
In millions Charge in 2001 Activity Activity 2002
- ----------------------------------------------------------------
Vehicle leasing $135 $(11) $(3) $121
Asset impairment
and severance costs 37 (24) (10) $(2) 1
Facilities
consolidation
and other charges 36 (1) (1) 34
- ----------------------------------------------------------------
Total $208 $(35) $(14) $(3) $156
================================================================
The fourth quarter 2001 charge of $135 million in connection with the vehicle
leasing business included exit costs and additions to reserves related to
insured residual value exposures. At June 30, 2002, the related liability had
been reduced to $121 million as a result of goodwill impairment of $11 million
recorded in the fourth quarter of 2001 and a net $3 million reduction related to
severance and contractual payments recorded in the first six months of 2002 in
connection with PNC's exit of this business.
The liability for asset impairment and severance costs had been reduced to $1
million at June 30, 2002 as a result of asset write-downs of $24 million in the
fourth quarter of 2001 and $12 million of severance benefits paid in the first
six months of 2002.
In the fourth quarter of 2001, PFPC incurred $36 million of pretax charges
primarily related to a plan to consolidate certain facilities. The charges
primarily reflected termination costs related to exiting certain lease
agreements and the abandonment of related leasehold improvements. The
Corporation is continuing to pursue these initiatives and expects the related
facilities relocations to be completed by the end of 2002.
LOANS
Loans were $37.7 billion at June 30, 2002, a $.3 billion decrease from year-end
2001 primarily due to the comparative impact of residential mortgage loan sales
and securitizations in 2001 and transfers to held for sale and the managed
reduction of institutional loans, which more than offset the impact in 2002 of
the NBOC acquisition and growth in home equity loans.
DETAILS OF LOANS
June 30 December 31
In millions 2002 2001
- ----------------------------------------------------------------
Commercial
Manufacturing $3,838 $3,352
Retail/wholesale 4,333 3,856
Service providers 2,016 2,136
Real estate related 1,583 1,720
Financial services 1,326 1,362
Communications 110 139
Health care 471 517
Other 2,548 2,123
- ----------------------------------------------------------------
Total commercial 16,225 15,205
- ----------------------------------------------------------------
Commercial real estate
Mortgage 546 592
Real estate project 1,963 1,780
- ----------------------------------------------------------------
Total commercial real estate 2,509 2,372
- ----------------------------------------------------------------
Consumer
Home equity 7,654 7,016
Automobile 607 773
Other 1,325 1,375
- ----------------------------------------------------------------
Total consumer 9,586 9,164
- ----------------------------------------------------------------
Residential mortgage 4,750 6,395
Lease financing
Vehicle 1,661 1,930
Equipment 3,620 3,627
- ----------------------------------------------------------------
Total lease financing 5,281 5,557
- ----------------------------------------------------------------
Other 437 445
Unearned income (1,104) (1,164)
- ----------------------------------------------------------------
Total, net of unearned income $37,684 $37,974
================================================================
Loan portfolio composition continued to be diversified across PNC's footprint
among numerous industries and types of businesses. At June 30, 2002, loans of
$37.7 billion included $1.7 billion of vehicle leases and $18 million of
commercial loans that have been designated for exit.
15
NET UNFUNDED COMMITMENTS
June 30 December 31
In millions 2002 2001
- ----------------------------------------------------------------
Commercial $21,390 $20,233
Commercial real estate 780 711
Consumer 5,260 4,977
Lease financing 111 146
Other 118 139
Designated for exit or held for sale 2,248 4,837
- ----------------------------------------------------------------
Total $29,907 $31,043
================================================================
Commitments to extend credit represent arrangements to lend funds or provide
liquidity subject to specified contractual conditions. Commitments include loan
commitments and liquidity facilities provided to Market Street. Commercial
commitments are reported net of participations, assignments and syndications,
primarily to financial institutions, totaling $7.0 billion at June 30, 2002 and
$7.1 billion at December 31, 2001.
Net outstanding letters of credit totaled $3.9 billion and $4.0 billion at June
30, 2002 and December 31, 2001, respectively, and consisted primarily of standby
letters of credit that commit the Corporation to make payments on behalf of
customers if specified future events occur.
LOANS HELD FOR SALE
Loans held for sale were $2.4 billion at June 30, 2002 compared with $4.2
billion at December 31, 2001. See Strategic Repositioning in this Financial
Review for further information regarding details of the institutional lending
held for sale portfolio. Approximately $170 million of loans held at June 30,
2002 by companies formed with AIG are classified in the consolidated financial
statements as loans held for sale. Substantially all student loans are
classified as loans held for sale.
DETAILS OF LOANS HELD FOR SALE
June 30 December 31
In millions 2002 2001
- ----------------------------------------------------------------
Institutional lending repositioning
Commercial
Manufacturing $415 $810
Communications 186 690
Service providers 86 333
Retail/wholesale 57 114
Financial services 33 40
Health care 33 73
Real estate related 13 30
Other 137 223
- ----------------------------------------------------------------
Total commercial 960 2,313
- ----------------------------------------------------------------
Commercial real estate 106 248
Lease financing 7
- ----------------------------------------------------------------
Total institutional lending
repositioning 1,066 2,568
Student loans 1,123 1,340
Other 252 281
- ----------------------------------------------------------------
Total loans held for sale $2,441 $4,189
================================================================
NONPERFORMING, PAST DUE AND POTENTIAL PROBLEM ASSETS
Nonperforming assets include nonaccrual loans, troubled debt restructurings,
nonaccrual loans held for sale and foreclosed assets. In addition, certain
performing assets have interest payments that are past due or have the potential
for future repayment problems.
NONPERFORMING ASSETS BY TYPE
June 30 December 31
Dollars in millions 2002 2001
- ----------------------------------------------------------------
Nonaccrual loans
Commercial $285 $188
Commercial real estate 3 4
Consumer 11 3
Residential mortgage 6 5
Lease financing 18 11
- ----------------------------------------------------------------
Total nonaccrual loans 323 211
Troubled debt restructured loan 2
- ----------------------------------------------------------------
Total nonperforming loans 325 211
Nonperforming loans held for sale (a) 162 169
Foreclosed assets
Commercial real estate 1
Residential mortgage 5 3
Other 8 7
- ----------------------------------------------------------------
Total foreclosed assets 13 11
- ----------------------------------------------------------------
Total nonperforming assets $500 $391
================================================================
Nonperforming loans to total loans .86% .56%
Nonperforming assets to total loans,
loans held for sale and foreclosed assets 1.25 .93
Nonperforming assets to total assets .75 .56
================================================================
(a)Includes $6 million of a troubled debt restructured loan held for sale at
December 31, 2001.
Of the total nonperforming loans at June 30, 2002, 42% are related to PNC
Business Credit. These loans are to borrowers, many of which have weak credit
risk ratings. As a result, these loans typically exhibit a higher risk of
default and a greater proportion of such loans may be classified as
nonperforming. Increases in nonperforming assets in this business are expected
to continue at this point in the economic cycle. The above table excludes
nonperforming equity management assets carried at estimated fair value of $29
million and $18 million at June 30, 2002 and December 31, 2001, respectively,
and included in other assets on the Consolidated Balance Sheet.
The amount of nonperforming loans that were current as to principal and interest
was $122 million at June 30, 2002 and $93 million at December 31, 2001. The
amount of nonperforming loans held for sale that were current as to principal
and interest was $36 million at June 30, 2002 and $8 million at December 31,
2001.
NONPERFORMING ASSETS BY BUSINESS
June 30 December 31
In millions 2002 2001
- -----------------------------------------------------------------
Regional Community Banking $65 $52
Corporate Banking 261 220
PNC Real Estate Finance 6 6
PNC Business Credit 164 109
PNC Advisors 4 4
- -----------------------------------------------------------------
Total nonperforming assets $500 $391
=================================================================
16
At June 30, 2002, Corporate Banking, PNC Real Estate Finance and PNC Business
Credit had nonperforming loans held for sale of $133 million, $3 million and $26
million, respectively, which are included in the preceding table.
CHANGE IN NONPERFORMING ASSETS
In millions 2002 2001
- ----------------------------------------------------------------
January 1 $391 $372
Transferred from accrual 548 368
Returned to performing (19) (13)
Principal reductions (189) (97)
Asset sales (98) (23)
Charge-offs and valuation adjustments (133) (133)
- ----------------------------------------------------------------
June 30 $500 $474
================================================================
Credit quality was adversely affected for the first six months of 2002 and a
sustained weakness or further weakening of the economy, or other factors that
affect asset quality, could result in an increase in the number of
delinquencies, bankruptcies or defaults, and a higher level of nonperforming
assets, net charge-offs and provision for credit losses in future periods.
These risks may be particularly relevant to PNC Business Credit due to the
nature of its borrowers. See PNC Business Credit in the Review of Businesses
section of this Financial Review for additional information.
ACCRUING LOANS AND LOANS HELD FOR SALE PAST DUE 90 DAYS OR MORE
Percent of Total
Amount Outstandings
------------------------------------------
June 30 Dec. 31 June 30 Dec. 31
Dollars in millions 2002 2001 2002 2001
- ----------------------------------------------------------------
Commercial $76 $54 .47% .36%
Commercial real
estate 1 11 .04 .46
Consumer 29 36 .30 .39
Residential mortgage 46 56 .97 .88
Lease financing 1 2 .02 .05
- -------------------------------------------
Total loans 153 159 .41 .42
Loans held for sale 26 33 1.07 .79
- -------------------------------------------
Total loans and
loans held for
sale $179 $192 .45 .46
================================================================
Loans and loans held for sale not included in nonperforming or past due
categories, but where information about possible credit problems causes
management to be uncertain about the borrower's ability to comply with existing
repayment terms over the next six months, totaled $278 million and $101 million,
respectively, at June 30, 2002. Approximately one-half of these loans are in the
PNC Business Credit portfolio and all of the loans held for sale relate to the
institutional lending repositioning.
Credit risk represents the possibility that a borrower, counterparty or insurer
may not perform in accordance with contractual terms. Credit risk is inherent
in the financial services business and results from extending credit to
customers, purchasing securities and entering into financial derivative
transactions. The Corporation seeks to manage credit risk through, among
others, diversification, limiting credit exposure to any single industry or
customer, requiring collateral, selling participations to third parties, and
purchasing credit-related derivatives.
ALLOWANCES FOR CREDIT LOSSES AND UNFUNDED LOAN COMMITMENTS AND LETTERS OF CREDIT
The Corporation maintains an allowance for credit losses to absorb losses
inherent in the loan portfolio. The allowance is determined based on quarterly
assessments of the probable estimated losses inherent in the loan portfolio.
The methodology for measuring the appropriate level of the allowance consists
of several elements, including specific allocations to impaired loans,
allocations to pools of non-impaired loans and unallocated reserves. While
allocations are made to specific loans and pools of loans, the total reserve is
available for all loan losses. Enhancements and refinements to the reserve
methodology during the second quarter of 2002 resulted in a reallocation of the
allowance for credit losses among the Corporation's businesses and from
unallocated to specific and pool categories.
In addition to the allowance for credit losses, the Corporation maintains an
allowance for unfunded loan commitments and letters of credit. This amount,
reported as a liability on the Consolidated Balance Sheet, is determined using
estimates of the probability of the ultimate funding and potential losses
related to those credit exposures. The methodology used is similar to the
methodology used for determining the adequacy of the allowance for credit
losses. The allowance was previously included as a component of the allowance
for credit losses.
Specific allowances are established for loans considered impaired by a method
prescribed by SFAS No. 114, "Accounting by Creditors for Impairment of a Loan."
All nonperforming loans are considered impaired under SFAS No. 114. Specific
allowances are determined for individual loans over a dollar threshold by PNC's
Special Asset Committee based on an analysis of the present value of its
expected future cash flows discounted at its effective interest rate, its
observable market price or the fair value of the underlying collateral. A
minimum specific allowance is established on all impaired loans at the
applicable pool reserve allocation for similar loans.
Allocations to non-impaired commercial and commercial real estate loans (pool
reserve allocations) are assigned to pools of loans as defined by PNC's
business structure and internal risk rating categories. Key elements of the
pool reserve methodology include expected default probabilities ("EDP"), loss
given default ("LGD") and exposure at default ("EAD"). EDPs are derived from
historical default analyses and are a function of the borrower's risk rating
grade and expected loan term. LGDs are derived from historical loss data and are
a function of the loan's collateral value and other structural factors that may
affect the ultimate ability to collect on the loan. EADs are derived from
banking industry and PNC's own exposure at default data.
17
This methodology is sensitive to changes in key risk parameters such as EDPs and
LGDs. In general, a given change in any of the major risk parameters will have a
commensurate change in the pool reserve allocations to non-impaired commercial
loans. Additionally, other factors such as the rate of migration in the severity
of problem loans or changes in the maturity distribution of the loans will
contribute to the final pool reserve allocations.
Consumer (including residential mortgage) loan allocations are made at a total
portfolio level by consumer product line based on historical loss experience. A
four-quarter average loss rate is computed as net charge-offs for the prior four
quarters as a percentage of the average loan outstandings in those quarters.
This loss rate is applied to loans outstanding at the end of the current period.
The final loan reserve allocations are based on this methodology and
management's judgment of other qualitative factors which may include, among
others, regional and national economic conditions, business segment and
portfolio concentrations, historical versus estimated losses, model risk and
changes to the level of credit risk in the portfolio.
Unallocated reserves are established to provide coverage for risks not
considered in the specific, pool and consumer reserve methodologies, such as,
but not limited to, potential judgment and data errors. Furthermore, events may
have occurred as of the reserve evaluation date that are not yet reflected in
the risk measures or characteristics of the portfolio due to inherent lags in
information. Management's evaluation of these and other relevant factors
determines the level of unallocated reserves established at the evaluation date.
The Reserve Adequacy Committee provides oversight for the allowance evaluation
process, including quarterly evaluations and methodology and estimation changes.
The results of the evaluations are reported to the Credit Committee of the Board
of Directors.
ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES
June 30, 2002 December 31, 2001
--------------------- ----------------------
Loans to Loans to
Total Total
Dollars in millions Allowance Loans Allowance Loans
- -----------------------------------------------------------------
Commercial $507 43.1% $392 40.0%
Commercial
real estate 60 6.7 63 6.3
Consumer 29 25.4 39 24.1
Residential
mortgage 10 12.6 8 16.8
Other 48 12.2 58 12.8
- -----------------------------------------------------------------
Total $654 100% $560 100%
=================================================================
For purposes of this presentation, the unallocated portion of the allowance for
credit losses of $115 million at June 30, 2002 and $143 million at December 31,
2001 has been assigned to loan categories based on the relative specific and
pool allocation amounts. The unallocated portion of the allowance for credit
losses represented 18% of the total allowance and .31% of total loans at June
30, 2002, compared with 26% and .38%, respectively, at December 31, 2001.
The provision for credit losses for the first six months of 2002 and the
evaluation of the allowances for credit losses and unfunded loan commitments
and letters of credit as of June 30, 2002 reflected changes in loan portfolio
composition, the net impact of downsizing credit exposure, the impact of
refinements to the Corporation's reserve methodology and changes in asset
quality.
ROLLFORWARD OF ALLOWANCE FOR CREDIT LOSSES
In millions 2002 2001
- -----------------------------------------------------------------
January 1 $560 $598
Charge-offs (139) (148)
Recoveries 24 23
- -----------------------------------------------------------------
Net charge-offs (115) (125)
Provision for credit losses 171 125
Acquired allowance (NBOC acquisition) 41
Net change in allowance for unfunded loan
commitments and letters of credit (3) (3)
- -----------------------------------------------------------------
June 30 $654 $595
=================================================================
ROLLFORWARD OF ALLOWANCE FOR UNFUNDED LOAN COMMITMENTS AND LETTERS OF CREDIT
In millions 2002 2001
- -----------------------------------------------------------------
January 1 $70 $77
Net change in allowance for unfunded
loan commitments and letters of credit 3 3
- -----------------------------------------------------------------
June 30 $73 $80
=================================================================
The allowance for credit losses as a percent of nonperforming loans and total
loans was 201% and 1.74%, respectively, at June 30, 2002 compared with 265% and
1.47%, respectively, at December 31, 2001. The decline in the allowance as a
percent of nonperforming loans since December 31, 2001 resulted from increases
in nonperforming assets at PNC Business Credit and in Corporate Banking related
to a Market Street liquidity facility.
CHARGE-OFFS AND RECOVERIES
Percent
of
Six months ended June 30 Net Average
Dollars in millions Charge-offs Recoveries Charge-offs Loans
- --------------------------------------------------------------------------------
2002
Commercial $105 $14 $91 1.13%
Commercial real
estate 2 2 .16
Consumer 20 8 12 .26
Residential mortgage 2 1 1 .04
Lease financing 10 1 9 .42
- --------------------------------------------------------------
Total $139 $24 $115 .61
================================================================================
2001
Commercial $119 $12 $107 1.05%
Consumer 20 9 11 .24
Residential mortgage 1 1 .02
Lease financing 8 2 6 .30
- --------------------------------------------------------------
Total $148 $23 $125 .53
================================================================================
18
CREDIT DEFAULT SWAPS
Credit default swaps provide, for a fee, an assumption of a portion of the
credit risk associated with the underlying financial instruments. The
Corporation primarily uses such contracts to mitigate credit risk associated
with commercial lending activities. At June 30, 2002, credit default swaps of
$159 million in notional value were used by the Corporation to hedge credit risk
associated with commercial lending activities and are included in the Other
Derivatives table in the Financial Derivatives section of this Financial Review.
Net gains realized in connection with credit default swaps totaled $161,000 for
the second quarter and first six months of 2002. There were no gains or losses
in the first six months of the prior year.
SECURITIES
Total securities were $12.3 billion and represented 18% of total assets at June
30, 2002 compared with $13.9 billion and 20%, respectively, at December 31,
2001. The decreases were primarily due to the sale of mortgage-backed securities
during the first quarter of 2002.
At June 30, 2002, the securities available for sale balance included a net
unrealized gain of $100 million, which represented the difference between fair
value and amortized cost. The comparable amount at December 31, 2001 was a net
unrealized loss of $132 million. Net unrealized gains and losses in the
securities available for sale portfolio are included in accumulated other
comprehensive income or loss, net of tax or, for the portion attributable to a
hedged risk as part of a fair value hedge strategy, in net income. The expected
weighted-average life of securities available for sale was 3 years and 5 months
at June 30, 2002 compared with 4 years at December 31, 2001.
Securities designated as held to maturity are carried at amortized cost and are
assets of companies formed with AIG that are consolidated in PNC's financial
statements. The expected weighted-average life of securities held to maturity
was 20 years and 4 months at June 30, 2002 compared with 18 years and 11 months
at December 31, 2001.
DETAILS OF SECURITIES
Amortized Fair
In millions Cost Value
- -----------------------------------------------------------------
JUNE 30, 2002
SECURITIES AVAILABLE FOR SALE
Debt securities
U.S. Treasury and government agencies $630 $632
Mortgage-backed 7,545 7,587
Asset-backed 2,706 2,756
State and municipal 61 66
Other debt 59 60
Corporate stocks and other 872 872
- -----------------------------------------------------------------
Total securities available for sale $11,873 $11,973
- -----------------------------------------------------------------
SECURITIES HELD TO MATURITY
Debt securities
U.S. Treasury and government agencies $268 $262
Asset-backed 8 8
Other debt 64 64
- -----------------------------------------------------------------
Total securities held to maturity $340 $334
=================================================================
December 31, 2001
SECURITIES AVAILABLE FOR SALE
Debt securities
U.S. Treasury and government agencies $808 $807
Mortgage-backed 9,669 9,578
Asset-backed 2,799 2,776
State and municipal 62 64
Other debt 75 75
Corporate stocks and other 264 245
- -----------------------------------------------------------------
Total securities available for sale $13,677 $13,545
- -----------------------------------------------------------------
SECURITIES HELD TO MATURITY
Debt securities
U.S. Treasury and government agencies $260 $257
Asset-backed 8 8
Other debt 95 95
- -----------------------------------------------------------------
Total securities held to maturity $363 $360
=================================================================
EQUITY MANAGEMENT ACTIVITIES
At June 30, 2002, equity management investments totaled approximately $569
million, composed of portfolio investments and assets held by co-investment
partnerships. Approximately 56% of the amount is invested directly in a variety
of companies and approximately 44% is invested in various limited partnerships.
The valuation of equity management assets is subject to the performance of the
underlying companies as well as market conditions and may be volatile. The
Corporation continues to make equity management investments on a limited basis
and to manage private equity investments for others. As described in the
Corporation's July 18, 2002 Current Report on Form 8-K ("July 18, 2002 8-K"),
such activities are subject to limitation as a result of bank regulatory,
supervisory and examination activities and may have to be curtailed if the
Corporation is not successful in satisfying relevant regulatory requirements.
FUNDING SOURCES
Total funding sources were $54.9 billion at June 30, 2002 and $59.4 billion at
December 31, 2001, a decrease of $4.5 billion corresponding to a decrease of
$2.7 billion in total assets and increases in other liabilities and total
shareholders' equity of $1.2 billion and $.6 billion, respectively. Total
deposits decreased $2.9 billion from December 31, 2001 partly due to a $1.4
billion decrease in deposits in foreign offices and other time deposits.
19
Borrowed funds decreased consistent with declines in total assets and earning
assets.
DETAILS OF FUNDING SOURCES
June 30 December 31
In millions 2002 2001
- -----------------------------------------------------------------
Deposits
Demand and money market $31,154 $32,589
Savings 2,069 1,942
Retail certificates of deposit 10,555 10,727
Other time 340 472
Deposits in foreign offices 309 1,574
- -----------------------------------------------------------------
Total deposits 44,427 47,304
- -----------------------------------------------------------------
Borrowed funds
Federal funds purchased 37 167
Repurchase agreements 971 954
Bank notes and senior debt 5,434 6,362
Federal Home Loan Bank borrowings 1,277 2,047
Subordinated debt 2,332 2,298
Other borrowed funds 429 262
- ----------------------------------------------------------------
Total borrowed funds 10,480 12,090
- ----------------------------------------------------------------
Total $54,907 $59,394
================================================================
LIQUIDITY
Liquid assets consist of short-term investments and securities available for
sale. At June 30, 2002, such assets totaled $14.9 billion, with $6.8 billion
pledged as collateral for borrowings, trust and other commitments. Secured
advances from the Federal Home Loan Bank, of which PNC Bank, PNC's principal
bank subsidiary, is a member, are generally secured by residential mortgages,
other real-estate related loans and mortgage-backed securities. At June 30,
2002, approximately $9.8 billion of residential
mortgages and other real-estate related loans were available as collateral for
borrowings from the Federal Home Loan Bank. Funding can also be obtained through
alternative forms of borrowing, including federal funds purchased, repurchase
agreements and short-term and long-term debt issuance.
Liquidity for the parent company and subsidiaries is generated through the
issuance of securities in public or private markets and lines of credit. At June
30, 2002, the Corporation had unused capacity under effective shelf registration
statements of approximately $3.3 billion of debt or equity securities and $400
million of trust preferred capital securities. The Corporation had an unused
line of credit of $460 million at June 30, 2002.
The principal source of parent company revenue and cash flow is the dividends it
receives from PNC Bank. PNC Bank's dividend level may be impacted by its capital
needs, supervisory policies, corporate policies, contractual restrictions and
other factors. Also, there are legal limitations on the ability of national
banks to pay dividends or make other capital distributions. The amount
available for dividend payments to the parent company by all bank subsidiaries
without prior regulatory approval was approximately $350 million at June 30,
2002.
In addition to dividends from PNC Bank, other sources of parent company
liquidity include cash and short-term investments, as well as dividends and loan
repayments from other subsidiaries. As of June 30, 2002, the parent company had
approximately $650 million in funds available from its cash and short-term
investments or other funds available from unrestricted subsidiaries. Management
believes the parent company has sufficient liquidity available to meet current
obligations to its debt holders, vendors, and others and to pay dividends at
current rates through 2002.
CAPITAL
The access to and cost of funding new business initiatives including
acquisitions, the ability to engage in expanded business activities, the ability
to pay dividends, the ability to repurchase stock, the level of deposit
insurance costs, and the level and nature of regulatory oversight depend, in
part, on a financial institution's capital strength. At June 30, 2002, each
banking subsidiary of the Corporation was considered "well capitalized" based on
regulatory capital ratio requirements.
RISK-BASED CAPITAL
June 30 December 31
Dollars in millions 2002 2001
- ------------------------------------------------------------------
Capital components
Shareholders' equity
Common $6,380 $5,813
Preferred 10 10
Trust preferred capital securities 848 848
Minority interest 174 134
Goodwill and other intangibles (2,456) (2,174)
Net unrealized securities (gains) losses (65) 86
Net unrealized gains on cash flow
hedge derivatives (107) (98)
Nonfinancial equity investments (37)
Other, net (11) (20)
- ------------------------------------------------------------------
Tier I risk-based capital 4,736 4,599
Subordinated debt 1,469 1,616
Minority interest 36 36
Eligible allowance for credit losses 726 707
- ------------------------------------------------------------------
Total risk-based capital $6,967 $6,958
==================================================================
Assets
Risk-weighted assets and
off-balance-sheet instruments, and
market risk equivalent assets $58,016 $58,958
Average tangible assets 64,008 67,604
==================================================================
Capital ratios
Tier I risk-based 8.2% 7.8%
Total risk-based 12.0 11.8
Leverage 7.4 6.8
==================================================================
The capital position is managed through balance sheet size and composition,
issuance of debt and equity instruments, treasury stock activities, dividend
policies and retention of earnings.
On January 3, 2002 the Board of Directors authorized the Corporation to purchase
up to 35 million shares of its common stock through February 29, 2004. These
shares may be purchased in the open market or privately negotiated transactions.
This authorization terminated any prior authorization. During the first half of
2002, PNC
20
repurchased 320,000 shares of its common stock under this program. The
extent and timing of any further share repurchases will depend on a number of
factors including, among others, progress in disposing of loans held for sale,
regulatory capital considerations, alternative uses of capital and receipt of
regulatory approvals if then required. The Corporation does not currently intend
to repurchase additional shares through the remainder of 2002 under this
program.
RISK FACTORS
The Corporation is subject to a number of risks including, among others, those
described below, in the Consolidated Balance Sheet Review, Risk Management and
Forward-Looking Statements sections of this Financial Review and elsewhere in
this report. The Risk Factors section of the Financial Review included in the
2001 Form 10-K describes a number of risks applicable to the Corporation,
including: business and economic conditions, supervision and regulation,
monetary and other policies, competition, disintermediation, asset management
performance, fund servicing, acquisitions and terrorist activities. Reference is
made to the 2001 Form 10-K as supplemented by the July 18, 2002 8-K for a
detailed description of these risks which continue to have the potential to
impact the Corporation's business, financial condition and results of
operations.
CRITICAL ACCOUNTING POLICIES AND JUDGMENTS
The Corporation's consolidated financial statements are prepared based on the
application of certain accounting policies, the most significant of which are
described in Note 1 Accounting Policies in the Notes to Consolidated Financial
Statements. Certain of these policies require numerous estimates and strategic
or economic assumptions that may prove inaccurate or subject to variations and
may significantly affect PNC's reported results and financial position for the
period or in future periods. Changes in underlying factors, assumptions, or
estimates in any of these areas could have a material impact on PNC's future
financial condition and results of operations.
ALLOWANCES FOR CREDIT LOSSES AND UNFUNDED LOAN COMMITMENTS AND LETTERS OF CREDIT
The allowances for credit losses and unfunded loan commitments and letters of
credit are calculated with the objective of maintaining reserve levels believed
by management to be sufficient to absorb estimated probable credit losses.
Management's determination of the adequacy of the allowances is based on
periodic evaluations of the credit portfolio and other relevant factors.
However, this evaluation is inherently subjective as it requires material
estimates, including, among others, expected default probabilities, loss given
default, expected commitment usage, the amounts and timing of expected future
cash flows on impaired loans, value of collateral, estimated losses on consumer
loans and residential mortgages, and general amounts for historical loss
experience. The process also considers economic conditions, uncertainties in
estimating losses and inherent risks in the various credit portfolios. All of
these factors may be susceptible to significant change. Also, the allocation of
the allowance for credit losses to specific loan pools is based on historical
loss trends and management's judgment concerning those trends. Commercial loans
are the largest category of credits and are the most sensitive to changes in
assumptions and judgments underlying the determination of the allowance for
credit losses. Approximately $507 million or 78% of the total allowance for
credit losses at June 30, 2002 has been allocated to the commercial loan
category. This allocation also considers other relevant factors such as actual
versus estimated losses, regional and national economic conditions, business
segment and portfolio concentrations, industry competition and consolidation,
the impact of government regulations, and risk of potential estimation or
judgmental errors. To the extent actual outcomes differ from management
estimates, additional provision for credit losses may be required that would
adversely impact earnings in future periods.
LOANS HELD FOR SALE
Loans are classified as held for sale based on management's intent to sell them.
At the initial transfer date of a loan from portfolio to held for sale, any
lower of cost or market ("LOCOM") adjustment is recorded as a charge-off. This
results in a new cost basis. Any subsequent adjustment as a result of the LOCOM
analysis is recognized as a valuation adjustment with changes included in
noninterest income. Although the market value for certain held for sale assets
may be readily obtainable, other assets require significant judgments by
management as to the value that could be realized at the balance sheet date.
These assumptions include but are not limited to the cash flows generated from
the asset, the timing of a sale, the value of any collateral, the market
conditions for the particular credit, overall investor demand for these assets
and the determination of a proper discount rate. Changes in market conditions
and actual liquidation experience may result in additional valuation adjustments
that could adversely impact earnings in future periods.
EQUITY MANAGEMENT ASSET VALUATION
Equity management assets are valued at each balance sheet date based primarily
on either, in the case of limited partnership investments, the financial
statements received from the general partner or, with respect to direct
investments, the estimated fair value. Changes in the market value of these
investments are reflected in the Corporation's results of operations. The value
of limited partnership investments is based on the financial statements received
from the general partners. Due to the nature of the direct investments,
management must make assumptions as to future performance, financial condition,
liquidity, availability of capital, and market conditions, among others, to
determine the estimated fair value of the investments. Market conditions and
actual performance of the companies invested in could differ from these
assumptions resulting in lower valuations that could adversely impact earnings
in future periods.
21
LEASE RESIDUALS
Leases are carried at the aggregate of lease payments and the estimated residual
value of the leased property, less unearned income. The Corporation provides
financing for various types of equipment, aircraft, energy and power systems,
rolling stock and vehicles through a variety of lease arrangements. A
significant portion of the residual value is covered by residual value insurance
or guaranteed by governmental entities. Residual values are subject to judgments
as to the value of the underlying equipment that can be affected by changes in
economic and market conditions and the financial viability of the residual
guarantors and insurers. To the extent not guaranteed or assumed by a third
party, or otherwise insured against, the Corporation bears the risk of ownership
of the leased assets including the risk that the actual value of the leased
assets at the end of the lease term will be less than the residual value which
could result in a charge and adversely impact earnings in future periods.
GOODWILL AND OTHER INTANGIBLE ASSETS
See Note 5 Goodwill And Other Intangible Assets in the Notes to Consolidated
Financial Statements for further information on PNC's adoption of SFAS No. 142
effective January 1, 2002.
Goodwill arising from business acquisitions represents the value attributable to
unidentifiable intangible elements in the business acquired. The majority of the
Corporation's goodwill relates to value inherent in fund servicing and banking
businesses. The value of this goodwill is dependent upon the Corporation's
ability to provide quality, cost effective services in the face of competition
from other market leaders on a national and global basis. This ability in turn
relies upon continuing investments in processing systems, the development of
value-added service features, and the ease of use of the Corporation's services.
As such, goodwill value is supported ultimately by revenue which is driven by
the volume of business transacted and, for certain businesses, the market value
of assets under administration. A decline in earnings as a result of a lack of
growth or the Corporation's inability to deliver cost effective services over
sustained periods can lead to impairment of goodwill which could result in a
charge and adversely impact earnings in future periods.
Total goodwill was $2.3 billion and other intangible assets, net of accumulated
amortization, totaled $342 million at June 30, 2002.
RISK MANAGEMENT
In the normal course of business, the Corporation assumes various types of risk,
which include, among others, credit risk, interest rate risk, liquidity risk,
operational risk, and risk associated with trading activities, financial
derivatives and "off-balance-sheet" activities. PNC has risk management
processes designed to provide for risk identification, measurement and
monitoring. Credit risk and liquidity risk are described in the Consolidated
Balance Sheet Review section of this Financial Review. See the 2001 Form 10-K
for further information. These factors and others could impact the
Corporation's business, financial condition and results of operations.
INTEREST RATE RISK
The Corporation measures and manages both the short-term and long-term effects
of changing interest rates. An income simulation model measures the sensitivity
of net interest income to changing interest rates over the next twenty-four
month period. An economic value of equity model measures the sensitivity of the
value of existing on-balance-sheet and off-balance-sheet positions to changing
interest rates.
The Corporation's interest rate risk management policies provide that net
interest income should not decrease by more than 3% if interest rates gradually
increase or decrease from current rates by 100 basis points over a twelve-month
period and that the economic value of equity should not decline by more than
1.5% of the book value of assets for a 200 basis point instantaneous increase or
decrease in interest rates. In the scenario with a 200 basis point decline in
interest rates, rates are reduced to not less than zero. Policy exceptions, if
any, are reported to the Finance Committee of the Board of Directors.
At June 30, 2002, the Corporation was outside of Board-approved policy limits
assuming a gradual, parallel 100 basis point decrease in interest rates over the
next twelve months. In the current low rate environment, the probability of an
additional 100 basis point decline in rates is considered less likely than
usual. Therefore, management's actions have focused on attempting to reduce the
effects of more modest interest rate declines and on the effects of
significantly higher interest rates on the Corporation's net interest income and
economic value of equity.
Management has kept the Finance Committee of the Board of Directors apprised of
the Corporation's interest rate risk position and continues to model and report
the results of this and other interest rate scenarios.
22
The following table sets forth the sensitivity results for the quarters ended
June 30, 2002 and 2001.
INTEREST SENSITIVITY ANALYSIS
June 30 June 30
2002 2001
- ----------------------------------------------------------------
NET INTEREST INCOME SENSITIVITY SIMULATION
Effect on net interest income from
gradual interest rate change over
following 12 months of:
100 basis point increase 1.0% (0.5)%
100 basis point decrease (4.2)% (0.3)%
ECONOMIC VALUE OF EQUITY SENSITIVITY MODEL
Effect on value of on- and off-balance-sheet
positions as a percentage of assets from
instantaneous change in interest rates of:
200 basis point increase (0.9)% (1.3)%
200 basis point decrease 0.1% 0.4%
KEY PERIOD-END INTEREST RATES
One month LIBOR 1.84% 3.86%
Three-year swap 3.85% 5.31%
================================================================
TRADING ACTIVITIES
Most of PNC's trading activities are designed to provide capital markets
services to customers and not to position the Corporation's portfolio for gains
from market movements. Trading activities are confined to financial instruments
and financial derivatives. PNC participates in derivatives and foreign exchange
trading as well as underwriting and "market making" in equity securities as an
accommodation to customers. PNC also engages in trading activities as part of
risk management strategies. Net trading income was $53 million for the first six
months of 2002 compared with $81 million for the first six months of 2001. See
Note 7 Trading Activities in the Notes to Consolidated Financial Statements for
additional information.
Risk associated with trading, capital markets and foreign exchange activities is
managed using a value-at-risk approach that combines interest rate risk, foreign
exchange rate risk, spread risk and volatility risk. Using this approach,
exposure is measured as the potential loss due to a two standard deviation,
one-day move in interest rates. The combined period-end value-at-risk of all
trading operations using this measurement was estimated as less than $1 million
at June 30, 2002.
OPERATIONAL RISK
The Corporation is exposed to a variety of operational risks that can affect
each of its business activities, particularly those involving processing and
servicing. Operational risk is defined as the risk of loss resulting from
inadequate or failed internal processes, people or systems or from external
events such as the September 11th terrorist attacks. The risk of loss also
includes the potential legal actions that could result from operational
deficiencies or noncompliance with contracts, laws or regulations.
PNC monitors and evaluates operational risk on an ongoing basis via systems of
internal control, formal Corporate-wide policies and procedures, and an internal
audit function. In addition, in April 2002 the Corporation created a new
position, Chief Risk Officer. The Chief Risk Officer will direct credit policy,
balance sheet risk management, operational risk, audit, compliance, and
regulatory affairs, with the aim to help PNC sharpen its strategic focus and
integrated coordination of all risk management activities throughout the
Corporation.
FINANCIAL DERIVATIVES
As required, effective January 1, 2001, the Corporation implemented SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," as amended
by SFAS No. 137 and 138. The statement requires the Corporation to recognize all
derivative instruments at fair value as either assets or liabilities. Financial
derivatives are reported at fair value in other assets or other liabilities. The
2001 cumulative effect of the change in accounting principle resulting from the
adoption of SFAS No. 133 was an after-tax charge of $5 million reported in the
Consolidated Statement of Income and an after-tax accumulated other
comprehensive loss of $4 million reported in the Consolidated Balance Sheet.
23
The following table sets forth changes, during the first six months of 2002, in
the notional value of financial derivatives used for risk management and
designated as accounting hedges under SFAS No. 133.
FINANCIAL DERIVATIVES ACTIVITY
Weighted-
December 31 June 30 Average
Dollars in millions 2001 Additions Maturities Terminations 2002 Maturity
- -----------------------------------------------------------------------------------------------------------------------------------
Interest rate risk management
Interest rate swaps
Receive fixed $6,748 $2,250 $(1,250) $(2,600) $5,148 3 yrs. 9 mos.
Pay fixed 107 (20) 87 4 yrs. 1 mo.
Basis swaps 87 (30) 57 6 yrs. 3 mos.
Interest rate caps 25 25 3 yrs. 11 mos.
Interest rate floors 7 7 2 yrs. 10 mos.
Futures contracts 398 96 (261) 233 9 mos.
- -------------------------------------------------------------------------------------------------------------
Total interest rate risk
management 7,372 2,346 (1,250) (2,911) 5,557
- -------------------------------------------------------------------------------------------------------------
Commercial mortgage banking risk
management
Interest rate swaps 105 408 (328) 185 10 yrs. 7 mos.
Total rate of return swaps 150 150 (225) 75 3 mos.
- -------------------------------------------------------------------------------------------------------------
Total commercial mortgage
banking risk management 255 558 (225) (328) 260
- -------------------------------------------------------------------------------------------------------------
Total $7,627 $2,904 $(1,475) $(3,239) $5,817
===================================================================================================================================
The following table sets forth the notional value and the fair value of
financial derivatives used for risk management and designated as accounting
hedges under SFAS No. 133 at June 30, 2002. Weighted-average interest rates
presented are based on the implied forward yield curve at June 30, 2002.
FINANCIAL DERIVATIVES - 2002
Weighted-Average
Interest Rates
Notional -----------------------------
June 30, 2002 - dollars in millions Value Fair Value Paid Received
- ----------------------------------------------------------------------------------------------------------------------------------
Interest rate risk management
Asset rate conversion
Interest rate swaps (a)
Receive fixed designated to loans $2,735 $86 3.50% 4.46%
Pay fixed designated to loans 87 (6) 6.02 4.23
Basis swaps designated to loans 57 4.91 4.86
Interest rate caps designated to loans (b) 25 NM NM
Interest rate floors designated to loans (c) 7 NM NM
Futures contracts designated to loans 233 NM NM
- ---------------------------------------------------------------------------------------------------
Total asset rate conversion 3,144 80
- ---------------------------------------------------------------------------------------------------
Liability rate conversion
Interest rate swaps (a)
Receive fixed designated to borrowed funds 2,413 199 4.60 5.94
- ---------------------------------------------------------------------------------------------------
Total liability rate conversion 2,413 199
- ---------------------------------------------------------------------------------------------------
Total interest rate risk management 5,557 279
- ---------------------------------------------------------------------------------------------------
Commercial mortgage banking risk management
Pay fixed interest rate swaps designated to loans held for sale (a) 185 (8) 5.85 5.51
Pay total rate of return swaps designated to loans held for
sale (a) 75 (2) 6.06 1.45
- ---------------------------------------------------------------------------------------------------
Total commercial mortgage banking risk management 260 (10)
- ---------------------------------------------------------------------------------------------------
Total financial derivatives designated for risk management $5,817 $269
==================================================================================================================================
(a) The floating rate portion of interest rate contracts is based on
money-market indices. As a percent of notional value, 55% were based on
1-month LIBOR and 45% on 3-month LIBOR.
(b) Interest rate caps with notional values of $15 million require the
counterparty to pay the Corporation the excess, if any, of 3-month LIBOR
over a weighted-average strike of 6.40%. In addition, interest rate caps
with notional values of $6 million require the counterparty to pay the
excess, if any, of 1-month LIBOR over a weighted-average strike of 6.00%.
The remainder is based on other short-term indices. At June 30, 2002,
3-month LIBOR was 1.86% and 1-month LIBOR was 1.84%.
(c) Interest rate floors with notional values of $5 million require the
counterparty to pay the excess, if any, of the weighted-average strike of
4.50% over 3-month LIBOR. The remainder is based on other short-term
indices. At June 30, 2002, 3-month LIBOR was 1.86%.
NM- Not meaningful
24
The following table sets forth the notional value and the fair value of
financial derivatives used for risk management at December 31, 2001.
Weighted-average interest rates presented are based on the implied forward yield
curve at December 31, 2001.
FINANCIAL DERIVATIVES - 2001
Weighted-Average
Interest Rates
Notional -----------------------------
December 31, 2001 - dollars in millions Value Fair Value Paid Received
- ---------------------------------------------------------------------------------------------------------------------------------
Interest rate risk management
Asset rate conversion
Interest rate swaps (a)
Receive fixed designated to loans $4,335 $132 3.35% 5.23%
Pay fixed designated to loans 107 (5) 5.88 4.66
Basis swaps designated to loans 87 5.49 5.42
Interest rate caps designated to loans (b) 25 NM NM
Interest rate floors designated to loans (c) 7 NM NM
Futures contracts designated to loans 398 NM NM
- ---------------------------------------------------------------------------------------------------
Total asset rate conversion 4,959 127
- ---------------------------------------------------------------------------------------------------
Liability rate conversion
Interest rate swaps (a)
Receive fixed designated to borrowed funds 2,413 135 5.20 5.94
- ---------------------------------------------------------------------------------------------------
Total liability rate conversion 2,413 135
- ---------------------------------------------------------------------------------------------------
Total interest rate risk management 7,372 262
- ---------------------------------------------------------------------------------------------------
Commercial mortgage banking risk management
Pay fixed interest rate swaps designated to loans held for sale (a) 105 1 5.52 5.82
Pay total rate of return swaps designated to loans held for sale (a) 150 5.89 1.39
- ---------------------------------------------------------------------------------------------------
Total commercial mortgage banking risk management 255 1
- ---------------------------------------------------------------------------------------------------
Total financial derivatives designated for risk management $7,627 $263
=================================================================================================================================
(a) The floating rate portion of interest rate contracts is based on
money-market indices. As a percent of notional value, 65% were based on
1-month LIBOR, 34% on 3-month LIBOR and the remainder on other short-term
indices.
(b) Interest rate caps with notional values of $15 million require the
counterparty to pay the Corporation the excess, if any, of 3-month LIBOR
over a weighted-average strike of 6.40%. In addition, interest rate caps
with notional values of $6 million require the counterparty to pay the
excess, if any, of 1-month LIBOR over a weighted-average strike of 6.00%.
The remainder is based on other short-term indices. At December 31, 2001,
3-month LIBOR was 1.88% and 1-month LIBOR was 1.87%.
(c) Interest rate floors with notional values of $5 million require the
counterparty to pay the excess, if any, of the weighted-average strike of
4.50% over 3-month LIBOR. The remainder is based on other short-term
indices. At December 31, 2001, 3-month LIBOR was 1.88%.
NM- Not meaningful
25
OTHER DERIVATIVES
Additionally, the Corporation enters into other derivative transactions for risk
management purposes that are not designated as accounting hedges, primarily
consisting of interest rate floors and caps and basis swaps. Other noninterest
income for the first six months of 2002 included approximately $3 million of net
gains related to the derivatives held for risk management purposes not
designated as accounting hedges.
OTHER DERIVATIVES
At June 30, 2002
----------------------------------------------------------------------------------
Positive Negative Average
Notional Fair Fair Net Asset Fair
In millions Value Value Value (Liability) Value (a)
- ---------------------------------------------------------------------------------------------------------------------------------
Customer-related
Interest rate
Swaps $20,905 $344 $(367) $(23) $(15)
Caps/floors
Sold 2,689 (33) (33) (33)
Purchased 2,233 25 25 26
Foreign exchange 4,323 70 (65) 5 4
Other 5,755 71 (59) 12 11
- ---------------------------------------------------------------------------------------------------------------------------------
Total customer-related 35,905 510 (524) (14) (7)
=================================================================================================================================
Other risk management and proprietary
Interest rate
Basis swaps 2,238 6 6 6
Caps/floors
Sold (12)
Purchased 4,400 12
Other 450 8 (1) 7 6
- ---------------------------------------------------------------------------------------------------------------------------------
Total other risk management and proprietary 7,088 14 (1) 13 12
- ---------------------------------------------------------------------------------------------------------------------------------
Total other derivatives $42,993 $524 $(525) $(1) $5
=================================================================================================================================
(a) Represents average for six months ended June 30, 2002.
"OFF-BALANCE-SHEET" ACTIVITIES
As previously reported, PNC has reputation, legal, operational and fiduciary
risks in virtually every area of its business, many of which are not reflected
in assets and liabilities recorded on the balance sheet, and some of which are
conducted through limited purpose entities known as "special purpose entities."
These activities are part of the banking business and would be found in most
larger financial institutions with the size and activities of PNC. Most of these
involve financial products distributed to customers, trust and custody services,
and servicing, processing and funds transfer services, and the amounts involved
can be quite large in relation to the Corporation's assets, equity and earnings.
The primary accounting followed by PNC for these activities is to reflect the
earned income, operating expenses and any receivables or liabilities for
transaction settlements. See "Off-Balance-Sheet Activities" in the Risk
Management section of the Financial Review included in the 2001 Form 10-K for
further information. Also see Note 1 Accounting Policies in the Notes to
Consolidated Financial Statements.
The accounting for special purpose entities is currently under review by the
Financial Accounting Standards Board. An exposure draft has been issued and the
conditions for consolidation or non-consolidation of such entities could change.
MARKET STREET
Market Street is a multi-seller asset-backed commercial paper conduit that is
independently owned and managed. The activities of Market Street are limited to
the purchase of, or making of, loans secured by interests in pools of
receivables acquired from U.S. corporations unaffiliated with PNC that desire
access to the commercial paper market. Market Street funds the purchases by
issuing commercial paper. Market Street's commercial paper has been rated A1/P1
by Standard & Poor's and Moody's. Market Street had total assets of $4.3 billion
at June 30, 2002 compared with $5.2 billion at December 31, 2001. The accounting
rules for these types of entities are currently under review. See Note 1
Accounting Policies in the Notes to Consolidated Financial Statements for
additional information.
PNC Bank provides certain administrative services, a portion of the
program-level credit enhancement and participates with other banks in providing
liquidity facilities to Market Street in exchange for fees negotiated based on
market rates. Credit enhancement is provided in part by PNC Bank in the form of
a revolving credit facility with a five year term expiring December 31, 2004. At
June 30, 2002, approximately $149 million was outstanding on this facility
compared with $166 million at December 31, 2001. An additional $448 million was
provided by a major insurer. Also at June 30, 2002, Market Street had liquidity
26
facilities supporting individual pools of receivables totaling $6.4 billion, of
which $5.2 billion are provided by PNC Bank. The comparable amounts at
December 31, 2001 were $7.0 billion and $5.8 billion, respectively. Credit
exposure related to PNC's liquidity facilities provided to Market Street is
included in net unfunded commitments as described in Loans in the Consolidated
Balance Sheet Review section of this Financial Review.
As Market Street's program administrator, PNC received fees of $7.3 million for
the six months ended June 30, 2002. Commitment fees related to PNC's portion of
the liquidity facilities amounted to $4.5 million for the first six months of
2002.
As previously reported, during the second quarter of 2002 the Corporation
learned of an apparent fraud related to a seller of receivables to Market
Street. In April 2002, PNC funded approximately $50 million to Market Street
under a liquidity facility agreement. Reserves were specifically allocated to
cover this exposure at March 31, 2002 and a charge-off of $45 million
representing the total loan outstanding net of cash collateral was recorded
during the second quarter of 2002.
Also during the second quarter of 2002, the Corporation funded approximately $63
million resulting from a draw on a liquidity facility with Market Street. This
loan was classified as a nonperforming asset at June 30, 2002. PNC is a
beneficiary under an insurance policy that provides protection against losses
related to the underlying collateral of student loans. The insurance carrier has
initiated litigation to rescind the policy in an attempt to avoid payment of
claims. Management will vigorously contest the insurer's action and believes
that PNC is entitled to collect payment in full. The potential exposure related
to this liquidity draw without reference to the insurance coverage was
considered in determining the allocation of reserves within the allowance for
credit losses at June 30, 2002. Based on current facts and circumstances,
management expects that additional reserves will be required in the third
quarter of 2002.
PNC has reduced its credit exposure to Market Street since December 31, 2001 and
will continue to assess the nature and amount of liquidity facilities provided
to this conduit.
REGULATORY MATTERS
On July 18, 2002 the Corporation announced that it had reached a resolution with
the SEC concerning the SEC's previously disclosed inquiry into the transfer of
certain PNC assets to companies formed with AIG in 2001. PNC consented to an SEC
cease-and-desist order to settle the matter and neither admitted nor denied the
SEC's findings regarding disclosure, accounting and recordkeeping violations.
PNC also announced on July 18, 2002 that it had entered into an agreement with
the Federal Reserve, and that PNC Bank, PNC's principal bank subsidiary, had
entered into an agreement with the OCC which address such issues as risk,
management and financial controls, following the conclusion of scheduled
regulatory examinations. The Corporation will incur additional operating costs
in connection with its compliance with these agreements including, among others,
incremental staff, continued higher legal and consulting expenses, and higher
deposit insurance premiums.
The Corporation's Board of Directors is required by the Corporation's agreement
with the Federal Reserve to engage an independent consultant acceptable to the
Federal Reserve to conduct a review of the structure, functions and performance
of PNC's management and the Board of Directors oversight of management
activities (the "Corporate Review") and to prepare a written report that
includes findings, conclusions, and written descriptions of any management or
operational changes recommended as a result of the Corporate Review. PNC's Board
of Directors has selected independent consultants for this Corporate Review and
this selection has been approved by the Federal Reserve.
Reference is made to the July 18, 2002 8-K (the text of which is included as
Exhibit 99.4 to this Form 10-Q) for additional information regarding these
matters.
27
FORWARD LOOKING STATEMENTS
This report and other statements made by the Corporation may contain
forward-looking statements with respect to the Corporation's outlook or
expectations for earnings, revenues, returns or other future financial or
business performance, strategies and expectations and the impact of legal,
regulatory and supervisory matters on the Corporation's business operations and
performance. Forward-looking statements are typically identified by words or
phrases such as "believe," "feel," "expect," "anticipate," "intend," "outlook,"
"estimate," "forecast," "position," "poised," "target," "mission," "assume,"
"achievable," "potential," "strategy," "goal," "objective," "plan,"
"aspiration," "outcome," "continue," "remain," "maintain," "seek," "strive,"
"trend" and variations of such words and similar expressions, or future or
conditional verbs such as "will," "would," "should," "could," "might," "can,"
"may" or similar expressions.
The Corporation cautions that forward-looking statements are subject to numerous
assumptions, risks and uncertainties, which change over time. Forward-looking
statements speak only as of the date they are made, and the Corporation assumes
no duty to update forward-looking statements. Actual results could differ
materially from those anticipated in forward-looking statements and future
results could differ materially from historical performance.
In addition to factors mentioned elsewhere in this report or previously
disclosed in the Corporation's SEC reports (accessible on the SEC's website at
www.sec.gov), the following factors, among others, could cause actual results to
differ materially from forward-looking statements or historical performance:
(1) the resolution of disputes over certain closing date adjustments related to
the sale of the residential mortgage banking business;
(2) changes in political, economic or industry conditions, the interest rate
environment or financial and capital markets which could result in: a
deterioration in credit quality and increased credit losses; an adverse effect
on the allowance for credit losses; a reduction in demand for credit or
fee-based products and services; a reduction in net interest income, value of
assets under management and assets serviced, value of private equity
investments and of other debt and equity investments, value of loans held for
sale or value of other on-balance-sheet and off-balance-sheet assets; or
changes in the availability and terms of funding necessary to meet PNC's
liquidity needs;
(3) relative and absolute investment performance of assets under management;
(4) the introduction, withdrawal, success and timing of business initiatives and
strategies, decisions regarding further reductions in balance sheet leverage,
the timing and pricing of any sales of loans held for sale, and PNC's inability
to realize cost savings or revenue enhancements, implement integration plans and
other consequences of mergers, acquisitions, restructurings and divestitures;
(5) customer borrowing, repayment, investment and deposit practices and their
acceptance of PNC's products and services;
(6) the impact of increased competition;
(7) the means PNC chooses to redeploy available capital;
(8) the inability to manage risks inherent in PNC's business;
(9) the unfavorable resolution of legal proceedings or government inquiries; the
impact of increased litigation risk from recent regulatory developments; and the
impact of reputational risk created by recent regulatory developments on such
matters as business generation and retention, the ability to attract and retain
management, liquidity and funding;
(10) the denial of insurance coverage for claims made by PNC;
(11) an increase in the number of customer or counterparty delinquencies,
bankruptcies or defaults that could result in, among other things, increased
credit and asset quality risk, a higher loan loss provision and reduced
profitability;
(12) the impact, extent and timing of technological changes, the adequacy of
intellectual property protection and costs associated with obtaining rights in
intellectual property claimed by others;
(13) actions of the Federal Reserve Board;
(14) the impact of legislative and regulatory reforms;
(15) the impact of the regulatory examination process, the Corporation's failure
to satisfy the requirements of written agreements with regulatory agencies and
regulators' future use of supervisory and enforcement tools, and
(16) terrorist activities including the September 11th terrorist attacks, which
may adversely affect the general economy, financial and capital markets,
specific industries, and the Corporation.
Factors relating to interest rate risk, financial and other derivatives, and
regulatory matters are discussed in the Risk Management section of this
Financial Review. Other risk factors are described in the Risk Factors section
and elsewhere in this report.
28
CONSOLIDATED STATEMENT OF INCOME
THE PNC FINANCIAL SERVICES GROUP, INC.
Three months ended June 30 Six months ended June 30
------------------------------- -------------------------------
In millions, except per share data 2002 2001 2002 2001
Unaudited
- ----------------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans and fees on loans $588 $839 $1,187 $1,820
Securities 149 177 326 299
Loans held for sale 41 31 93 68
Other 26 32 56 64
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest income 804 1,079 1,662 2,251
- ----------------------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Deposits 172 334 348 731
Borrowed funds 77 180 169 401
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest expense 249 514 517 1,132
- ----------------------------------------------------------------------------------------------------------------------------------
Net interest income 555 565 1,145 1,119
Provision for credit losses 89 45 171 125
- ----------------------------------------------------------------------------------------------------------------------------------
Net interest income less provision for credit losses 466 520 974 994
- ----------------------------------------------------------------------------------------------------------------------------------
NONINTEREST INCOME
Asset management 230 214 451 437
Fund servicing 202 195 398 390
Service charges on deposits 55 54 109 104
Brokerage 55 55 110 109
Consumer services 61 58 116 113
Corporate services 149 76 267 152
Equity management (13) (30) (15) (69)
Net securities gains 16 17 20 46
Other 100 94 173 166
- ----------------------------------------------------------------------------------------------------------------------------------
Total noninterest income 855 733 1,629 1,448
- ----------------------------------------------------------------------------------------------------------------------------------
NONINTEREST EXPENSE
Staff expense 441 418 871 839
Net occupancy 59 54 117 107
Equipment 67 60 135 117
Marketing 13 16 26 25
Distributions on capital securities 14 16 29 33
Other 230 230 437 454
- ----------------------------------------------------------------------------------------------------------------------------------
Total noninterest expense 824 794 1,615 1,575
- ----------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations before minority interest
and income taxes 497 459 988 867
Minority interest in income of consolidated entities 12 8 22 16
Income taxes 165 156 329 291
- ----------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations 320 295 637 560
Income from discontinued operations (less applicable income
taxes of $0) 5
- ----------------------------------------------------------------------------------------------------------------------------------
Income before cumulative effect of accounting change 320 295 637 565
Cumulative effect of accounting change (less applicable
income tax benefit of $2) (5)
- ----------------------------------------------------------------------------------------------------------------------------------
Net income $320 $295 $637 $560
==================================================================================================================================
EARNINGS PER COMMON SHARE
Continuing operations and net income
Basic $1.13 $1.01 $2.25 $1.91
Diluted $1.12 $1.00 $2.23 $1.89
AVERAGE COMMON SHARES OUTSTANDING
Basic 283 288 283 289
Diluted 285 291 285 292
==================================================================================================================================
See accompanying Notes to Consolidated Financial Statements.
29
CONSOLIDATED BALANCE SHEET
THE PNC FINANCIAL SERVICES GROUP, INC.
In millions, except par value June 30 December 31
Unaudited 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks $2,839 $4,327
Short-term investments 2,895 1,335
Loans held for sale 2,441 4,189
Securities 12,313 13,908
Loans, net of unearned income of $1,104 and $1,164 37,684 37,974
Allowance for credit losses (654) (560)
- ---------------------------------------------------------------------------------------------------------------------------------
Net loans 37,030 37,414
Goodwill 2,314 2,036
Other intangible assets 342 337
Other 6,739 6,092
- ---------------------------------------------------------------------------------------------------------------------------------
Total assets $66,913 $69,638
=================================================================================================================================
LIABILITIES
Deposits
Noninterest-bearing $9,227 $10,124
Interest-bearing 35,200 37,180
- ---------------------------------------------------------------------------------------------------------------------------------
Total deposits 44,427 47,304
Borrowed funds
Federal funds purchased 37 167
Repurchase agreements 971 954
Bank notes and senior debt 5,434 6,362
Federal Home Loan Bank borrowings 1,277 2,047
Subordinated debt 2,332 2,298
Other borrowed funds 429 262
- ---------------------------------------------------------------------------------------------------------------------------------
Total borrowed funds 10,480 12,090
Allowance for unfunded loan commitments and letters of credit 73 70
Other 4,485 3,333
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities 59,465 62,797
- ---------------------------------------------------------------------------------------------------------------------------------
Minority interest 210 170
Mandatorily redeemable capital securities of subsidiary trusts 848 848
SHAREHOLDERS' EQUITY
Preferred stock 1
Common stock - $5 par value
Authorized 800 shares
Issued 353 shares 1,764 1,764
Capital surplus 1,102 1,077
Retained earnings 6,913 6,549
Deferred benefit expense (13) (16)
Accumulated other comprehensive income 170 5
Common stock held in treasury at cost: 69 and 70 shares (3,546) (3,557)
- ---------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 6,390 5,823
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities, minority interest, capital securities and
shareholders' equity $66,913 $69,638
====================================================================================================================================
See accompanying Notes to Consolidated Financial Statements.
30
CONSOLIDATED STATEMENT OF CASH FLOWS
THE PNC FINANCIAL SERVICES GROUP, INC.
Six months ended June 30 - in millions
Unaudited 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $637 $560
Income from discontinued operations (5)
Cumulative effect of accounting change 5
- ---------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations 637 560
Adjustments to reconcile income from continuing operations
to net cash provided by operating activities
Provision for credit losses 171 125
Depreciation, amortization and accretion 44 147
Deferred income taxes 226 171
Securities transactions (20) (45)
Valuation adjustments 30 9
Change in
Loans held for sale 1,948 26
Other (1,423) (255)
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 1,613 738
- ---------------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Net change in loans (619) (167)
Repayment of securities 1,346 1,153
Sales
Securities 7,858 8,823
Loans 2,099 2,557
Foreclosed assets 5 11
Purchases
Securities (7,181) (11,359)
Loans (22) (234)
Net cash (paid) received for divestitures/acquisitions (1,676) 503
Other (118) 11
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash provided by investing activities 1,692 1,298
- ---------------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Net change in
Noninterest-bearing deposits (897) 492
Interest-bearing deposits (1,980) (2,357)
Federal funds purchased (130) 2
Repurchase agreements 17 (38)
Sales/issuances
Federal Home Loan Bank borrowings 3,123
Other borrowed funds 11,591 18,982
Common stock 72 128
Repayments/maturities
Bank notes and senior debt (954) (1,615)
Federal Home Loan Bank borrowings (770) (1,155)
Subordinated debt (100)
Other borrowed funds (11,424) (18,838)
Acquisition of treasury stock (45) (279)
Series F preferred stock tender offer (96)
Cash dividends paid (273) (288)
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash used by financing activities (4,793) (2,039)
- ---------------------------------------------------------------------------------------------------------------------------------
DECREASE IN CASH AND DUE FROM BANKS (1,488) (3)
Cash and due from banks at beginning of year 4,327 3,662
- ---------------------------------------------------------------------------------------------------------------------------------
Cash and due from banks at end of period $2,839 $3,659
=================================================================================================================================
CASH PAID FOR
Interest 521 1,105
Income taxes 56 100
NON-CASH ITEMS
Transfer of mortgage loans to securities 3,775
Transfer from loans to loans held for sale 166 251
Transfer from loans to other assets 9 5
=================================================================================================================================
See accompanying Notes to Consolidated Financial Statements.
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THE PNC FINANCIAL SERVICES GROUP, INC.
BUSINESS
The PNC Financial Services Group, Inc. ("Corporation" or "PNC") is one of the
largest diversified financial services companies in the United States, operating
businesses engaged in regional community banking, corporate banking, real estate
finance, asset-based lending, wealth management, asset management and global
fund services. The Corporation provides certain products and services nationally
and others in PNC's primary geographic markets in Pennsylvania, New Jersey,
Delaware, Ohio and Kentucky. The Corporation also provides certain banking,
asset management and global fund services internationally. PNC is subject to
intense competition from other financial services companies and is subject to
regulation by various domestic and international authorities.
NOTE 1 ACCOUNTING POLICIES
BASIS OF FINANCIAL STATEMENT PRESENTATION
The unaudited consolidated interim financial statements include the accounts of
PNC and its subsidiaries, most of which are wholly owned, and entities formed
with American International Group, Inc. ("AIG"). Such statements have been
prepared in accordance with accounting principles generally accepted in the
United States. All significant intercompany accounts and transactions have been
eliminated. Certain prior-period amounts have been reclassified to conform with
the current period presentation. These reclassifications did not impact the
Corporation's financial condition or results of operations.
Investments that are not consolidated and are less than 50% owned
over which the Corporation has the ability to significantly influence operating
and financial policies of the investee are accounted for using the equity
method.
Equity management assets are included in other assets and are comprised of
limited partnerships and direct investments. Investments in limited partnerships
are valued based on the financial statements received from the general partner.
Direct investments are carried at estimated fair value. Changes in the value of
these assets are recognized in noninterest income.
Special Purpose Entities ("SPEs") are broadly defined as legal entities created
for a particular purpose. PNC utilizes SPEs in various legal forms to conduct
normal business activities including the sale or transfer of assets to third
parties. SPEs that meet the criteria for a Qualifying Special Purpose Entity
("QSPE") as defined in Statement of Financial Accounting Standards ("SFAS") No.
140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" are not required to be consolidated. SPEs that
are not QSPEs are reviewed for consolidation based on each SPE's individual
structure and operations. General factors to be considered in making this
determination include whether the majority owner (or owners) of the SPE are
independent of PNC, have made a substantive capital investment in the SPE, have
control of the SPE, and possess the substantive risks and rewards of ownership
of the SPE.
In June 2002, the Financial Accounting Standards Board ("FASB") issued an
exposure draft of a Proposed Interpretation, "Consolidation of Certain Special-
Purpose Entities" (an interpretation of Accounting Research Bulletin No. 51,
Consolidated Financial Statements) ("Proposed Interpretation"), which addresses
issues related to identifying and accounting for SPEs. The Proposed
Interpretation would require the consolidation of an SPE in which a business
enterprise has a controlling financial interest. In certain situations, changes
to contractual relationships that have been customary industry practice may be
required to ensure compliance with the non-consolidation provisions of the
Proposed Interpretation. The deadline for comments is August 30, 2002. The final
rules would be effective immediately for new transactions and January 1, 2003
for existing transactions. The effect of the Proposed Interpretation on the
Corporation's financial condition or results of operations cannot be determined
at this time.
In the opinion of management, the financial statements reflect all adjustments
of a normal recurring nature necessary for a fair statement of results for the
interim periods presented.
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the amounts reported. Actual results
will differ from such estimates and the differences may be material to the
consolidated financial statements.
The consolidated financial statements, notes to consolidated financial
statements and statistical information reflect the residential mortgage banking
business, which was sold on January 31, 2001, in discontinued operations, unless
otherwise noted.
The notes included herein should be read in conjunction with the audited
consolidated financial statements included in PNC's 2001 Annual Report on Form
10-K ("2001 Form 10-K").
DEPRECIATION AND AMORTIZATION
For financial reporting purposes, premises and equipment are depreciated
principally using the straight-line method over their estimated useful lives.
Accelerated methods are used for federal income tax purposes.
The estimated useful lives used for furniture and equipment range from one to 10
years, while buildings are depreciated over an estimated useful life of 39
years. Leasehold improvements are amortized over their estimated useful lives of
10 years, or the respective lease terms, whichever is shorter.
32
NOTE 2 DISCONTINUED OPERATIONS
In the first quarter of 2001, PNC closed the sale of its residential mortgage
banking business. Certain closing date adjustments are currently in dispute
between PNC and the buyer, Washington Mutual Bank, FA. The ultimate financial
impact of the sale will not be determined until the disputed matters are finally
resolved. See Note 10 Legal Proceedings for additional information.
The income of the residential mortgage banking business, which is presented on
one line in the Consolidated Statement of Income, is as follows:
INCOME FROM DISCONTINUED OPERATIONS
Six months ended June 30 - in millions 2001
- ---------------------------------------------------------------
Income from operations, after tax $15
Net loss on sale of business, after tax (10)
- ---------------------------------------------------------------
Total income from discontinued operations $5
===============================================================
There were no net assets of the residential mortgage banking business remaining
at either June 30, 2002 or December 31, 2001.
NOTE 3 NBOC ACQUISITION
In January 2002, PNC Business Credit acquired a portion of National Bank of
Canada's ("NBOC") U.S. asset-based lending business in a purchase business
combination. With this acquisition, PNC Business Credit established six new
marketing offices. The transaction was designed to allow PNC to acquire the
higher-quality portion of the portfolio, and provide NBOC a means for the
orderly liquidation and exit of the remaining portfolio.
PNC acquired 245 lending customer relationships representing approximately $2.6
billion of credit exposure including $1.5 billion of loan outstandings with the
balance representing unfunded loan commitments. PNC also acquired certain other
assets and assumed liabilities resulting in a total acquisition cost of
approximately $1.8 billion that was paid primarily in cash. Goodwill recorded
was approximately $277 million, of which approximately $101 million is
non-deductible for federal income tax purposes. The results of the acquired
business have been included in results of operations for PNC Business Credit
since the acquisition date.
NBOC retained a portfolio ("Serviced Portfolio") totaling approximately $662
million of credit exposure including $463 million of outstandings, which will be
serviced by PNC for an 18-month term unless a different date is mutually agreed
upon. In June 2002, NBOC and PNC reached final agreement as to the Serviced
Portfolio's financial information. As such, certain financial data previously
disclosed with regard to the NBOC Serviced Portfolio has been modified to
reflect this agreement. The Serviced Portfolio retained by NBOC primarily
represents the portion of NBOC's U.S. asset-based loan portfolio with the
highest risk. The loans are either to borrowers with deteriorating trends or
with identified weaknesses which if not corrected could jeopardize full
satisfaction of the loans or in industries to which PNC Business Credit wants to
limit its exposure. Approximately $138 million of the Serviced Portfolio
outstandings were nonperforming on the acquisition date. At the end of the
servicing term, NBOC has the right to transfer the then remaining Serviced
Portfolio to PNC ("Put Option"). NBOC's and PNC's strategy is to aggressively
liquidate the Serviced Portfolio during the servicing term. PNC intends to sell
or otherwise liquidate any remaining loans in the event NBOC puts them to PNC at
the end of the servicing term.
NBOC retains significant risks and rewards of owning the Serviced Portfolio,
including realized credit losses, during the servicing term as described below.
NBOC assigned $24 million of specific reserves to certain of the loans in the
Serviced Portfolio. Additionally, NBOC absorbs realized credit losses on the
Serviced Portfolio in addition to the specific reserves on individual identified
loans. If during the servicing term the realized credit losses in the Serviced
Portfolio exceed $50 million plus the specific reserves, then PNC Business
Credit will advance cash to NBOC for these excess losses ("Excess Loss
Payments"). PNC is to be reimbursed by NBOC for any Excess Loss Payments if the
Put Option is not exercised. If the Put Option is exercised, the Put Option
purchase price will be reduced by the amount of any Excess Loss Payments.
33
As part of the allocation of the purchase price for the business acquired, PNC
Business Credit established a liability of $112 million to reflect its
obligation under the Put Option. An independent third party valuation firm
valued the Put Option by estimating the difference between the anticipated fair
value of loans from the Serviced Portfolio expected to be outstanding at the put
date and the anticipated Put Option purchase price. The Put Option liability
will be revalued on a quarterly basis by the independent valuation firm with
changes in the value included in earnings. At June 30, 2002 the Put Option
liability was approximately $86 million. A $15 million reduction from the
acquisition date amount has been recognized in earnings for the first six months
of 2002 as other noninterest income. In addition, $11 million has been paid to
NBOC as Excess Loss Payments.
If the Put Option is exercised, then PNC would record the loans acquired as
loans held for sale at the purchase price less the balance of the Put Option
liability at that date, which should approximate fair value. The Put Option
purchase price will be NBOC's outstanding principal balance for the loans
remaining in the Serviced Portfolio adjusted for the realized credit losses
during the servicing term and Excess Loss Payments. As the realized credit
losses exceeded $50 million plus the specific reserves used, the Excess Loss
Payments made by PNC Business Credit to NBOC will be deducted from NBOC's
outstanding principal balance in determining the Put Option purchase price.
At June 30, 2002, the independent valuation firm estimated that loans
outstanding in the Serviced Portfolio at the put date would be $244 million and
that estimated credit losses on liquidating the Serviced Portfolio would be $77
million. Using these and other assumptions, if the Put were exercised at the end
of the servicing term, PNC would record the acquired loans at $146 million.
Actual results may differ materially from these assumptions.
Prior to closing of the acquisition, PNC Business Credit transferred $49 million
of nonperforming loans to NBOC in a transaction accounted for as a financing.
Those loans are subject to the terms of the servicing agreement and are included
in the Serviced Portfolio amounts set forth above. The loans were transferred to
loans held for sale on PNC's balance sheet at a loss of $9.9 million, which was
recognized as a charge-off in the first quarter of 2002. The carrying amount of
those loans held for sale was $11 million at June 30, 2002 and is included in
PNC's nonperforming assets. Excluding these loans, the Serviced Portfolio in
January 2002 was $608 million of credit exposure including $414 million of
outstandings of which $88 million was nonperforming. At June 30, 2002,
comparable amounts were $566 million, $272 million and $65 million
respectively.
NOTE 4 RECENT ACCOUNTING PRONOUNCEMENTS
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which replaces Emerging Issues Task Force
Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." SFAS No. 146 addresses the accounting and reporting for
one-time employee termination benefits, certain contract termination costs, and
other costs associated with exit or disposal activities such as facility
closings or consolidations and employee relocations. The standard is effective
for exit or disposal activities initiated after December 31, 2002. The
Corporation plans to adopt SFAS No. 146 prospectively as of January 1, 2003 and
it is not expected to have a material impact on PNC's consolidated financial
statements.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," which replaces SFAS No. 121. This statement
primarily defines one accounting model for long-lived assets to be disposed of
by sale, including discontinued operations, and addresses implementation issues
regarding the impairment of long-lived assets. The standard was effective
January 1, 2002 and is not expected to have a material impact on the
Corporation's consolidated financial statements.
34
NOTE 5 GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, the Corporation implemented SFAS No. 142, "Goodwill
and Other Intangible Assets," which changed the accounting for goodwill from the
amortization of goodwill to an impairment-only approach. The amortization of
goodwill, including goodwill recognized relating to past business combinations,
ceased upon adoption of the new standard. Impairment testing for goodwill at a
reporting unit level will be required on at least an annual basis.
In accordance with SFAS No. 142, the Corporation identified its reporting unit
structure for goodwill impairment testing purposes as of January 1, 2002.
Management performed the first step of the transitional goodwill impairment test
on its reporting units during the first quarter of 2002. The results of this
test indicated no impairment loss as the fair value of the reporting units
exceeded the carrying amount of the net assets (including goodwill) in all
cases. Fair value was determined by using a discounted cash flow methodology. As
a result of adopting this statement, the Corporation reassessed the useful lives
and the classification of identifiable intangible assets and determined that
they continue to be appropriate.
GOODWILL
A summary of the changes in goodwill by line of business for the six months
ended June 30, 2002, follows:
January 1 Goodwill June 30
In millions 2002 Acquired Adjustments 2002
- ---------------------------------------------------------------------
Regional Community Banking $438 $438
Corporate Banking 39 39
PNC Real Estate Finance 298 $4 302
PNC Business Credit 23 $277 (1) 299
PNC Advisors 151 1 152
BlackRock 175 175
PFPC 912 (3) 909
- ---------------------------------------------------------------------
Total $2,036 $277 $1 $2,314
=====================================================================
OTHER INTANGIBLE ASSETS
The gross carrying amount, accumulated amortization and net carrying amount of
other intangible assets by major category consisted of the following:
June 30 December 31
In millions 2002 2001
- ----------------------------------------------------------------
Customer-related intangibles
Gross carrying amount $198 $185
Accumulated amortization (56) (47)
- ----------------------------------------------------------------
Net carrying amount $142 $138
- ----------------------------------------------------------------
Mortgage and other loan servicing rights
Gross carrying amount $299 $286
Accumulated amortization (99) (87)
- ----------------------------------------------------------------
Net carrying amount $200 $199
================================================================
All of the Corporation's other intangible assets have finite lives and are
amortized primarily on a straight-line basis or, in the case of mortgage and
other loan servicing rights, over the estimated servicing period. For
customer-related intangibles, the estimated remaining useful lives range from
one to sixteen years, with a weighted-average remaining useful life of
approximately eight years. The Corporation's mortgage and other loan servicing
rights are amortized over a period of seven to ten years using the net present
value of the cash flows received from servicing the related loans.
The changes in the carrying amount of goodwill and net other intangible assets
for the six months ended June 30, 2002, are as follows:
CHANGES IN GOODWILL AND OTHER INTANGIBLES
Customer- Servicing
In millions Goodwill Related Rights
- ------------------------------- --------- --------- -----------
Balance at December 31, 2001 $2,036 $138 $199
Additions/adjustments 278 13 13
Amortization (9) (12)
- ------------------------------- --------- --------- -----------
Balance at June 30, 2002 $2,314 $142 $200
===============================================================
In conjunction with the first quarter 2002 NBOC acquisition, PNC Business Credit
recorded a customer-based intangible of $12.4 million that will be amortized
over seven years. Goodwill recorded in connection with the NBOC acquisition was
approximately $277 million.
Amortization expense on intangible assets for the second quarter and first six
months of 2002 was approximately $11 million and $22 million, respectively.
Amortization expense on existing intangible assets for the remainder of 2002 and
for 2003, 2004, 2005, 2006 and 2007 is estimated to be $24 million, $44 million,
$40 million, $38 million, $36 million and $34 million, respectively.
The following table sets forth reported and pro forma income from continuing
operations and basic and diluted earnings per share as if the nonamortization
provisions of SFAS No. 142 had been applied in the previous period.
PRO FORMA EFFECTS
Three months ended June 30
In millions, except per share data 2002 2001
- ---------------------------------------------------------------
Reported income from continuing
operations $320 $295
Goodwill amortization, net of taxes 23
- ---------------------------------------------------------------
Pro forma income from continuing
operations $320 $318
- ---------------------------------------------------------------
Basic earnings per share
Reported, from continuing operations $1.13 $1.01
Goodwill amortization, net of taxes .08
- ---------------------------------------------------------------
Pro forma basic earnings per share $1.13 $1.09
- ---------------------------------------------------------------
Diluted earnings per share
Reported, from continuing operations $1.12 $1.00
Goodwill amortization, net of taxes .08
- ---------------------------------------------------------------
Pro forma diluted earnings per share $1.12 $1.08
===============================================================
35
Six months ended June 30
In millions, except per share data 2002 2001
- ---------------------------------------------------------------
Reported income from continuing
operations $637 $560
Goodwill amortization, net of taxes 46
- ---------------------------------------------------------------
Pro forma income from continuing
operations $637 $606
- ---------------------------------------------------------------
Basic earnings per share
Reported, from continuing operations $2.25 $1.91
Goodwill amortization, net of taxes .16
- ---------------------------------------------------------------
Pro forma basic earnings per share $2.25 $2.07
- ---------------------------------------------------------------
Diluted earnings per share
Reported, from continuing operations $2.23 $1.89
Goodwill amortization, net of taxes .16
- ---------------------------------------------------------------
Pro forma diluted earnings per share $2.23 $2.05
===============================================================
NOTE 6 CASH FLOWS
During the first six months of 2002, acquisition activity that affected cash
flows consisted of $1.736 billion of acquired assets and $60 million of acquired
liabilities, resulting in net cash disbursements of $1.676 billion. The 2002
activity consisted solely of the NBOC acquisition as described in Note 3. During
the first six months of 2001, divestiture activity that affected cash flows
consisted of $383 million of divested net assets and cash receipts of $503
million, both of which were related to the sale of PNC's residential mortgage
banking business.
NOTE 7 TRADING ACTIVITIES
Most of PNC's trading activities are designed to provide capital markets
services to customers and not to position the Corporation's portfolio for gains
from market movements. PNC participates in derivatives and foreign exchange
trading as well as underwriting and "market making" in equity securities as an
accommodation to customers. PNC also engages in trading activities as part of
risk management strategies.
Net trading income for the first six months of 2002 totaled $53 million compared
with $81 million for the prior-year period and was included in noninterest
income as follows:
DETAILS OF TRADING ACTIVITIES
Six months ended June 30 - in millions 2002 2001
- ---------------------------------------------------------------
Corporate services $4
Other noninterest income
Securities underwriting and trading $30 28
Derivatives trading 10 37
Foreign exchange 13 12
- ---------------------------------------------------------------
Net trading income $53 $81
===============================================================
NOTE 8 NONPERFORMING ASSETS
Nonperforming assets were as follows:
June 30 December 31
In millions 2002 2001
- ----------------------------------------------------------------
Nonperforming loans $325 $211
Nonperforming loans held for sale (a) 162 169
Foreclosed assets 13 11
- ----------------------------------------------------------------
Total nonperforming assets (b) $500 $391
================================================================
(a) Includes a $6 million troubled debt restructured loan held for sale as of
December 31, 2001.
(b) Excludes $29 million and $18 million of equity management assets carried at
estimated fair value at June 30, 2002 and December 31, 2001, respectively.
NOTE 9 ALLOWANCES FOR CREDIT LOSSES AND UNFUNDED LOAN COMMITMENTS AND
LETTERS OF CREDIT
Changes in the allowance for credit losses were as follows:
In millions 2002 2001
- -----------------------------------------------------------------
Allowance at January 1 $560 $598
Charge-offs
Commercial (105) (119)
Commercial real estate (2)
Consumer (20) (20)
Residential mortgage (2) (1)
Lease financing (10) (8)
- ---------------------------------------------------------------
Total charge-offs (139) (148)
- ---------------------------------------------------------------
Recoveries
Commercial 14 12
Consumer 8 9
Residential mortgage 1
Lease financing 1 2
- ---------------------------------------------------------------
Total recoveries 24 23
- ---------------------------------------------------------------
Net charge-offs
Commercial (91) (107)
Commercial real estate (2)
Consumer (12) (11)
Residential mortgage (1) (1)
Lease financing (9) (6)
- ---------------------------------------------------------------
Total net charge-offs (115) (125)
- ---------------------------------------------------------------
Provision for credit losses 171 125
Acquired allowance (NBOC acquisition) 41
Net change in allowance for unfunded loan
commitments and letters of credit (3) (3)
- ---------------------------------------------------------------
Allowance at June 30 $654 $595
===============================================================
Changes in the allowance for unfunded loan commitments and letters
of credit were as follows:
In millions 2002 2001
- -----------------------------------------------------------------
Allowance at January 1 $70 $77
Net change in allowance for unfunded loan
commitments and letters of credit 3 3
- -----------------------------------------------------------------
Allowance at June 30 $73 $80
=================================================================
36
NOTE 10 LEGAL PROCEEDINGS
Note 24 to the Consolidated Financial Statements included in the 2001 Form 10-K
("Note 24") describes putative federal securities law class action litigation
against the Corporation, certain present or former officers and directors, and
its independent auditors for 2001; a dispute over certain closing date purchase
price adjustments related to the January 2001 sale of the Corporation's
residential mortgage banking business; and regulatory inquiries relating to
certain transactions with companies formed with AIG. There were no material
developments with respect to any of these matters or in management's assessment
of them from the information reported in Note 24 except as described in the
following paragraph.
As described in the Corporation's Current Report on Form 8-K filed on July 18,
2002, the Securities and Exchange Commission ("SEC"), with the consent of the
Corporation, instituted public administrative proceedings, made findings and
entered a cease-and-desist order against the Corporation and the Corporation
announced that it has entered into a written agreement with the Federal Reserve
Bank of Cleveland and its principal bank subsidiary, PNC Bank, National
Association, has entered into a written agreement with the Office of the
Comptroller of the Currency. The Corporation believes that the regulatory
inquiries described in Note 24 have been concluded as to the Corporation as a
result of these actions. See the Corporation's Current Report on Form 8-K filed
on July 18, 2002 (the text of which is included as Exhibit 99.4 to this Form
10-Q) for additional information regarding these matters.
The Corporation and persons to whom the Corporation may have indemnification
obligations, in the normal course of business, are subject to various other
pending and threatened legal proceedings in which claims for monetary damages
and other relief are asserted.
The Corporation has received a letter from a shareholder demanding that the
Corporation take legal action against parties allegedly responsible for the
events giving rise to the SEC consent order filed on July 18, 2002 and that it
consider legal action against directors of the Corporation who approved certain
bonus payments. Management has referred this demand to the Board of Directors.
On July 29, 2002, the Corporation was contacted by a field agent from the
Philadelphia regional office of the Pension and Welfare Benefits Administration
of the United States Department of Labor. The field agent made an informal
inquiry into the Corporation's restatement of earnings for 2001 as it relates to
the Corporation's common stock held under the Corporation's Incentive Savings
Plan. The Corporation intends to cooperate with the inquiry.
Management does not anticipate that the ultimate aggregate liability, if any,
arising out of such other legal proceedings will have a material adverse effect
on the Corporation's financial position. However, management is not in a
position to determine whether any pending or threatened legal proceedings will
have a material adverse effect on the Corporation's results of operations in any
future reporting period.
37
NOTE 11 SECURITIES
Unrealized
Amortized ---------------------------------- Fair
In millions Cost Gains Losses Value
- -------------------------------------------------------------------------------------------------------------------------------
JUNE 30, 2002
SECURITIES AVAILABLE FOR SALE
Debt securities
U.S. Treasury and government agencies $630 $2 $632
Mortgage-backed 7,545 55 $(13) 7,587
Asset-backed 2,706 50 2,756
State and municipal 61 5 66
Other debt 59 1 60
- -------------------------------------------------------------------------------------------------------------------------------
Total debt securities 11,001 113 (13) 11,101
Corporate stocks and other 872 14 (14) 872
- -------------------------------------------------------------------------------------------------------------------------------
Total securities available for sale $11,873 $127 $(27) $11,973
===============================================================================================================================
SECURITIES HELD TO MATURITY
Debt securities
U.S. Treasury and government agencies $268 $(6) $262
Asset-backed 8 8
Other debt 64 64
- -------------------------------------------------------------------------------------------------------------------------------
Total debt securities 340 (6) 334
- -------------------------------------------------------------------------------------------------------------------------------
Total securities held to maturity $340 $(6) $334
===============================================================================================================================
DECEMBER 31, 2001
SECURITIES AVAILABLE FOR SALE
Debt securities
U.S. Treasury and government agencies $808 $3 $(4) $807
Mortgage-backed 9,669 37 (128) 9,578
Asset-backed 2,799 8 (31) 2,776
State and municipal 62 2 64
Other debt 75 1 (1) 75
- -------------------------------------------------------------------------------------------------------------------------------
Total debt securities 13,413 51 (164) 13,300
Corporate stocks and other 264 (19) 245
- -------------------------------------------------------------------------------------------------------------------------------
Total securities available for sale $13,677 $51 $(183) $13,545
================================================================================================================================
SECURITIES HELD TO MATURITY
Debt securities
U.S. Treasury and government agencies $260 $(3) $257
Asset-backed 8 8
Other debt 95 95
- -------------------------------------------------------------------------------------------------------------------------------
Total debt securities 363 (3) 360
- -------------------------------------------------------------------------------------------------------------------------------
Total securities held to maturity $363 $(3) $360
===============================================================================================================================
The fair value of total securities at June 30, 2002 was $12.3 billion compared
with $13.9 billion at December 31, 2001. Securities represented 18% of total
assets at June 30, 2002 compared with 20% at December 31, 2001. The decline in
total securities compared with December 31, 2001 was primarily due to the sale
of mortgage-backed securities during the first quarter of 2002.
The expected weighted-average life of securities available for sale was 3 years
and 5 months at June 30, 2002 compared with 4 years at December 31, 2001.
The securities classified as held to maturity are carried at amortized cost and
are owned by companies formed with AIG that are consolidated in PNC's financial
statements. The expected weighted-average life of securities held to maturity
was 20 years and 4 months at June 30, 2002 and 18 years and 11 months at
December 31, 2001.
At June 30, 2002, the securities available for sale balance included a net
unrealized gain of $100 million, which represented the difference between fair
value and amortized cost. The comparable amount at December 31, 2001 was a net
unrealized loss of $132 million. Net unrealized gains and losses in the
securities available for sale portfolio are included in accumulated other
comprehensive income or loss, net of tax or, for the portion attributable to
changes in a hedged risk as part of a fair value hedge strategy, in net income.
38
Net securities gains were $20 million for the first six months of 2002 and $45
million for the first six months of 2001. Net securities gains in 2001 included
$1 million of net securities losses related to commercial mortgage banking
activities that were reported in corporate services revenue. There was no
comparable amount for the first six months of 2002.
Information relating to securities sold is set forth in the following table:
SECURITIES SOLD
Six months ended
June 30 Gross Gross Net Income
In millions Proceeds Gains Losses Gains Taxes
- ----------------------------------------------------------------
2002 $7,858 $31 $11 $20 $7
2001 8,823 52 7 45 16
================================================================
NOTE 12 EARNINGS PER SHARE
The following table sets forth basic and diluted earnings per share
calculations.
Three months ended Six months ended
June 30 June 30
-----------------------------------------------
In millions, except share and per share data 2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
CALCULATION OF BASIC EARNINGS PER COMMON SHARE
Income from continuing operations $320 $295 $637 $560
Less: Preferred dividends declared 1 5 1 10
- -----------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations applicable to basic earnings per common share 319 290 636 550
Income from discontinued operations applicable to basic earnings per common share 5
Cumulative effect of accounting change applicable to basic earnings per common share (5)
- -----------------------------------------------------------------------------------------------------------------------------------
Net income applicable to basic earnings per common share $319 $290 $636 $550
Basic weighted-average common shares outstanding (in thousands) 283,116 288,269 282,944 288,734
Basic earnings per common share from continuing operations $1.13 $1.01 $2.25 $1.91
Basic earnings per common share from discontinued operations .02
Basic earnings per common share from cumulative effect of accounting change (.02)
- -----------------------------------------------------------------------------------------------------------------------------------
Basic earnings per common share $1.13 $1.01 $2.25 $1.91
===================================================================================================================================
CALCULATION OF DILUTED EARNINGS PER COMMON SHARE
Income from continuing operations $320 $295 $637 $560
Less: Dividends declared on nonconvertible Series F preferred stock and other 1 5 1 9
- -----------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations applicable to diluted earnings per common share 319 290 636 551
Income from discontinued operations applicable to diluted earnings per common share 5
Cumulative effect of accounting change applicable to diluted earnings per common share (5)
- -----------------------------------------------------------------------------------------------------------------------------------
Net income applicable to diluted earnings per common share $319 $290 $636 $551
Basic weighted-average common shares outstanding (in thousands) 283,116 288,269 282,944 288,734
Weighted-average common shares to be issued using average market price and assuming:
Conversion of preferred stock Series A and B 99 107 100 109
Conversion of preferred stock Series C and D 802 884 812 892
Conversion of debentures 16 17 16 17
Exercise of stock options 858 1,830 973 2,044
Incentive share awards 423 309 423 305
- -----------------------------------------------------------------------------------------------------------------------------------
Diluted weighted-average common shares outstanding (in thousands) 285,314 291,416 285,268 292,101
Diluted earnings per common share from continuing operations $1.12 $1.00 $2.23 $1.89
Diluted earnings per common share from discontinued operations .02
Diluted earnings per common share from cumulative effect of accounting change (.02)
- -----------------------------------------------------------------------------------------------------------------------------------
Diluted earnings per common share $1.12 $1.00 $2.23 $1.89
===================================================================================================================================
39
NOTE 13 SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
The following table sets forth the activity in shareholders' equity for the
first six months of 2002.
Deferred Accumulated Other
In millions, except share and per Preferred Common Capital Retained Benefit Comprehensive Treasury
share data Stock Stock Surplus Earnings Expense Income (Loss) Stock Total
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 $1 $1,764 $1,077 $6,549 $(16) $5 $(3,557) $5,823
Net income 637 637
Other comprehensive income, net of
tax (a)
Net unrealized securities gains 151 151
Net unrealized gains on cash flow
hedge derivatives 9 9
Other 5 5
- -----------------------------------------------------------------------------------------------------------------------------------
Comprehensive income 802
- -----------------------------------------------------------------------------------------------------------------------------------
Cash dividends declared
Common ($.48 per share) (272) (272)
Preferred (1) (1)
Treasury stock activity
(655,000 net shares issued) (1) 16 11 26
Tax benefit of stock option and
other employee benefit plans 9 9
Deferred benefit expense 3 3
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 2002 $1,764 $1,102 $6,913 $(13) $170 $(3,546) $6,390
===================================================================================================================================
(a) A summary of the components of other comprehensive income follows:
Six months ended June 30, 2002
In millions Pretax amount Tax Benefit (Expense) After-tax Amount
- -----------------------------------------------------------------------------------------------------------------------------------
Unrealized securities gains $203 $(71) $132
Less: Reclassification adjustment for gains realized in net income (29) 10 (19)
- -----------------------------------------------------------------------------------------------------------------------------------
Net unrealized securities gains 232 (81) 151
- -----------------------------------------------------------------------------------------------------------------------------------
Unrealized gains on cash flow hedge derivatives 55 (19) 36
Less: Reclassification adjustment for gains realized in net income 41 (14) 27
- -----------------------------------------------------------------------------------------------------------------------------------
Net unrealized gains on cash flow hedge derivatives 14 (5) 9
- -----------------------------------------------------------------------------------------------------------------------------------
Other (b) 8 (3) 5
- -----------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income $254 $(89) $165
===================================================================================================================================
(b) Consists of interest-only strip valuation adjustments and foreign currency
translation adjustments.
COMPREHENSIVE INCOME
Comprehensive income from continuing operations was $520 million for the second
quarter of 2002 compared with $228 million for the second quarter of 2001.
Comprehensive income for the first half of 2002 was $802 million compared with
$543 million for the first six months of 2001. The increases in comprehensive
income in both 2002 periods are primarily due to net unrealized securities gains
in 2002 and higher income from continuing operations compared with the
respective prior year periods.
40
NOTE 14 SEGMENT REPORTING
PNC operates seven major businesses engaged in regional community banking,
corporate banking, real estate finance, asset-based lending, wealth management,
asset management and global fund services. Assets, revenue and earnings
attributable to foreign activities were not material in the periods presented.
Results of individual businesses are presented based on PNC's management
accounting practices and the Corporation's management structure. There is no
comprehensive, authoritative body of guidance for management accounting
equivalent to generally accepted accounting principles; therefore, the financial
results of individual businesses are not necessarily comparable with similar
information for any other company. Financial results are presented, to the
extent practicable, as if each business operated on a stand-alone basis. Also,
certain amounts for 2001 have been reclassified to conform with the 2002
presentation.
The management accounting process uses various balance sheet and income
statement assignments and transfers to measure performance of the businesses.
Methodologies change from time to time as management accounting practices are
enhanced and businesses change. Securities or borrowings and related net
interest income are assigned based on the net asset or liability position of
each business. Capital is assigned based on management's assessment of inherent
risks and equity levels at independent companies providing similar products and
services. The allowance for credit losses is allocated based on management's
assessment of risk inherent in the loan portfolios. The costs incurred by
support areas not directly aligned with the businesses are allocated primarily
based on the utilization of services.
Total business results differ from consolidated results from continuing
operations primarily due to differences between management accounting practices
and generally accepted accounting principles, equity management activities,
minority interest in income of consolidated entities, residual asset and
liability management activities, eliminations and other corporate items, the
impact of which is reflected in the "Other" category.
The impact of the institutional lending repositioning and other strategic
actions that occurred during 2001 is reflected in the business results.
BUSINESS SEGMENT PRODUCTS AND SERVICES
Regional Community Banking provides deposit, branch-based brokerage under the
PNC Investments brand name, electronic banking and credit products and services
to retail customers as well as deposit, credit, treasury management and capital
markets products and services to small businesses primarily within PNC's
geographic region.
Corporate Banking provides credit, equipment leasing, treasury management and
capital markets products and services primarily to mid-sized corporations and
government entities within PNC's geographic region.
PNC Real Estate Finance specializes in financial solutions for the acquisition,
development, permanent financing and operation of commercial real estate
nationally. PNC Real Estate Finance offers treasury and investment management,
access to the capital markets, commercial mortgage loan servicing and other
products and services to clients that develop, own, manage or invest in
commercial real estate. PNC's commercial real estate financial services platform
provides processing services through Midland Loan Services, Inc., a leading
third-party provider of loan servicing and technology to the commercial real
estate finance industry, and national syndication of affordable housing equity
through Columbia Housing Partners, LP.
PNC Business Credit provides asset-based lending, capital markets and treasury
management products and services to middle market customers nationally. PNC
Business Credit's lending services include loans secured by accounts receivable,
inventory, machinery and equipment, and other collateral, and its customers
include manufacturing, wholesale, distribution, retailing and service industry
companies.
PNC Advisors provides a full range of tailored investment products and services
to affluent individuals and families, including full-service brokerage through
J.J.B. Hilliard, W.L. Lyons, Inc. and investment advisory services to the
ultra-affluent through Hawthorn. PNC Advisors also serves as investment manager
and trustee for employee benefit plans and charitable and endowment assets.
BlackRock is one of the largest publicly traded investment management firms in
the United States with approximately $250 billion of assets under management at
June 30, 2002. BlackRock manages assets on behalf of institutions and
individuals worldwide through a variety of fixed income, liquidity and equity
mutual funds, separate accounts and alternative investment products. Mutual
funds include the flagship fund families - BlackRock Funds and BlackRock
Provident Institutional Funds. In addition, BlackRock provides risk management
and investment system services to institutional investors under the BlackRock
Solutions brand name.
PFPC is the largest full-service mutual fund transfer agent and second largest
provider of mutual fund accounting and administration services in the United
States, providing a wide range of fund services to the investment management
industry. PFPC also provides processing solutions to the international
marketplace through its Ireland and Luxembourg operations.
41
RESULTS OF BUSINESSES
PNC
Regional Real PNC
Three months ended June 30 Community Corporate Estate Business PNC Total
In millions Banking Banking Finance Credit Advisors BlackRock PFPC Other Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
2002 INCOME STATEMENT
Net interest income $356 $87 $29 $33 $26 $4 $(18) $38 $555
Noninterest income 186 129 35 12 145 157 201 (10) 855
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenue 542 216 64 45 171 161 183 28 1,410
Provision for credit losses 11 49 29 1 (1) 89
Depreciation and amortization 9 3 2 3 5 3 16 41
Other noninterest expense 254 83 36 13 119 97 145 36 783
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings before minority
interest and income taxes 268 81 26 3 48 59 35 (23) 497
Minority interest in income of
consolidated entities 12 12
Income taxes 92 27 1 17 24 14 (10) 165
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings $176 $54 $26 $2 $31 $35 $21 $(25) $320
===================================================================================================================================
Inter-segment revenue $2 $2 $10 $4 $2 $(20)
===================================================================================================================================
AVERAGE ASSETS $39,089 $14,292 $4,989 $3,978 $3,016 $734 $1,932 $(1,570) $66,460
===================================================================================================================================
2001 INCOME STATEMENT
Net interest income $363 $129 $28 $27 $36 $2 $(16) $(4) $565
Noninterest income 194 63 24 6 154 135 197 (40) 733
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenue 557 192 52 33 190 137 181 (44) 1,298
Provision for credit losses 10 31 (2) 3 1 2 45
Depreciation and amortization 17 3 6 4 6 12 19 67
Other noninterest expense 255 93 34 8 124 86 143 (16) 727
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings before minority
interest and income taxes 275 65 14 22 61 45 26 (49) 459
Minority interest in income of
consolidated entities 8 8
Income taxes 98 21 (3) 8 22 19 11 (20) 156
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings $177 $44 $17 $14 $39 $26 $15 $(37) $295
===================================================================================================================================
Inter-segment revenue $1 $1 $16 $5 $3 $(26)
===================================================================================================================================
AVERAGE ASSETS $40,028 $16,964 $5,220 $2,482 $3,336 $571 $1,749 $442 $70,792
===================================================================================================================================
Six months ended
June 30 - In millions
2002 INCOME STATEMENT
Net interest income $738 $181 $59 $66 $52 $6 $(36) $79 $1,145
Noninterest income 353 228 56 24 302 303 396 (33) 1,629
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenue 1,091 409 115 90 354 309 360 46 2,774
Provision for credit losses 23 95 (5) 57 1 171
Depreciation and amortization 18 5 3 5 10 4 35 80
Other noninterest expense 511 178 71 27 247 188 292 21 1,535
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings before minority
interest and income taxes 539 131 46 6 101 111 64 (10) 988
Minority interest in income of
consolidated entities 22 22
Income taxes 186 44 (2) 2 37 45 26 (9) 329
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings $353 $87 $48 $4 $64 $66 $38 $(23) $637
====================================================================================================================================
Inter-segment revenue $7 $4 $23 $8 $4 $(46)
====================================================================================================================================
AVERAGE ASSETS $38,920 $14,752 $5,081 $3,898 $3,029 $734 $1,890 $ (964) $67,340
====================================================================================================================================
2001 INCOME STATEMENT
Net interest income $715 $271 $56 $51 $68 $4 $(31) $(15) $1,119
Noninterest income 382 110 48 20 321 269 390 (92) 1,448
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenue 1,097 381 104 71 389 273 359 (107) 2,567
Provision for credit losses 20 88 7 8 1 1 125
Depreciation and amortization 35 6 11 1 8 12 22 36 131
Other noninterest expense 519 195 66 15 248 172 284 (55) 1,444
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings before minority 523 92 20 47 132 89 53 (89) 867
interest and income taxes
Minority interest in
income of consolidated
entities 16 16
Income taxes 186 28 (11) 17 49 37 21 (36) 291
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings $337 $64 $31 $30 $83 $52 $32 $(69) $560
====================================================================================================================================
Inter-segment revenue $2 $2 $35 $8 $3 $(50)
====================================================================================================================================
AVERAGE ASSETS $40,321 $17,323 $5,336 $2,430 $3,420 $571 $1,742 $181 $71,324
====================================================================================================================================
42
STATISTICAL INFORMATION
The PNC Financial Services Group, Inc.
CONSOLIDATED AVERAGE BALANCE SHEET AND NET INTEREST ANALYSIS
Six months ended June 30
-----------------------------------------------------------------------------
2002 2001
-------------------------------------- --------------------------------------
Taxable-equivalent basis Interest Average Interest Average
Dollars in millions Average Income/ Yields/ Average Income/ Yields/
Balances Expense Rates Balances Expense Rates
- -----------------------------------------------------------------------------------------------------------------------------------
ASSETS
Interest-earning assets
Loans held for sale $3,753 $ 93 4.95% $1,864 $68 7.19%
Securities
Securities available for sale
U.S. Treasury and government agencies and
corporations 3,237 86 5.28 3,813 111 5.82
Other debt 8,324 226 5.43 5,966 185 6.22
State, municipal and other 93 7 14.68 114 4 6.39
- --------------------------------------------------------------------------------- --------------------------
Total securities available for sale 11,654 319 5.46 9,893 300 6.07
Securities held to maturity 364 8 4.66
- --------------------------------------------------------------------------------- --------------------------
Total securities 12,018 327 5.44 9,893 300 6.07
Loans, net of unearned income
Commercial 16,287 483 5.90 20,575 797 7.70
Commercial real estate 2,461 66 5.31 2,576 103 7.92
Consumer 9,395 314 6.74 9,090 382 8.49
Residential mortgage 5,365 183 6.83 10,554 384 7.27
Lease financing 4,285 138 6.45 4,024 145 7.19
Other 398 8 4.21 490 18 7.36
- --------------------------------------------------------------------------------- --------------------------
Total loans, net of unearned income 38,191 1,192 6.24 47,309 1,829 7.72
Other 2,666 56 4.23 1,592 63 8.03
- --------------------------------------------------------------------------------- --------------------------
Total interest-earning assets/interest
income 56,628 1,668 5.89 60,658 2,260 7.44
Noninterest-earning assets
Investment in discontinued operations 103
Allowance for credit losses (596) (606)
Cash and due from banks 2,791 2,942
Other assets 8,517 8,330
- ------------------------------------------------------------------- --------
Total assets $67,340 $71,427
=================================================================== =======
LIABILITIES, MINORITY INTEREST, CAPITAL
SECURITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities
Interest-bearing deposits
Demand and money market $21,976 123 1.13 $20,707 296 2.88
Savings 2,031 5 .49 1,928 11 1.12
Retail certificates of deposit 10,562 198 3.77 13,190 374 5.73
Other time 888 17 3.89 551 18 6.58
Deposits in foreign offices 553 5 1.65 1,248 32 5.05
- --------------------------------------------------------------------------------- --------------------------
Total interest-bearing deposits 36,010 348 1.95 37,624 731 3.92
Borrowed funds
Federal funds purchased 1,066 9 1.59 2,775 72 5.14
Repurchase agreements 947 7 1.42 1,116 23 4.04
Bank notes and senior debt 5,558 76 2.71 5,540 158 5.68
Federal Home Loan Bank borrowings 1,793 4 .50 2,001 52 5.20
Subordinated debt 2,209 50 4.59 2,386 78 6.55
Other borrowed funds 437 23 10.58 383 18 9.51
- --------------------------------------------------------------------------------- --------------------------
Total borrowed funds 12,010 169 2.81 14,201 401 5.63
- --------------------------------------------------------------------------------- --------------------------
Total interest-bearing liabilities/
interest expense 48,020 517 2.16 51,825 1,132 4.38
Noninterest-bearing liabilities, minority
interest, capital securities and
shareholders' equity
Demand and other noninterest-bearing deposits 8,347 8,210
Accrued expenses and other liabilities 3,937 3,762
Minority interest 184 118
Mandatorily redeemable capital securities of
subsidiary trusts 848 848
Shareholders' equity 6,004 6,664
- ------------------------------------------------------------------- -------
Total liabilities, minority interest,
capital securities and shareholders'
equity $67,340 $71,427
- -----------------------------------------------------------------------------------------------------------------------------------
Interest rate spread 3.73 3.06
Impact of noninterest-bearing sources .33 .64
- ------------------------------------------------------------------------------------------------------------------------- ----------
Net interest income/margin $1,151 4.06% $1,128 3.70%
====================================================================================================================================
Nonaccrual loans are included in loans, net of unearned income. The impact of
financial derivatives used in interest rate risk management is included in the
interest income/expense and average yields/rates of the related assets and
liabilities. Basis adjustments related to hedged items are included in
noninterest-earning assets and noninterest-bearing liabilities. Average balances
of securities are based on amortized historical cost (excluding SFAS No. 115
adjustments to fair value which are included in other assets).
Loan fees for the six months ended June 30, 2002 and June 30, 2001 were $58
million and $59 million, respectively. Loan fees for the three months ended June
30, 2002, March 31, 2002 and June 30, 2001 were $29 million, $29 million and $30
million, respectively.
43
- -----------------------------------------------------------------------------------------------------------------------------------
Second Quarter 2002 First Quarter 2002 Second Quarter 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Average Interest Average Average Interest Average Average Interest Average
Balances Income/Expense Yields/Rates Balances Income/Expense Yields/Rates Balances Income/Expense Yields/Rates
- ------------------------------------------------------------------------------------------------------------------------------------
$3,235 $41 5.07% $4,276 $52 4.85% $1,723 $31 7.05%
2,972 39 5.21 3,506 47 5.33 3,696 54 5.79
7,607 101 5.33 9,048 125 5.50 7,910 122 6.18
92 4 15.13 94 3 14.24 101 2 7.33
- ------------------------------ -------------------------- ----------------------------
10,671 144 5.38 12,648 175 5.52 11,707 178 6.07
364 5 5.70 363 3 3.61
- ------------------------------ -------------------------- ----------------------------
11,035 149 5.39 13,011 178 5.47 11,707 178 6.07
16,311 243 5.90 16,264 240 5.90 20,271 375 7.31
2,470 33 5.26 2,452 33 5.36 2,572 48 7.40
9,509 158 6.67 9,278 156 6.82 9,096 188 8.29
4,979 85 6.79 5,756 98 6.85 8,459 152 7.18
4,244 68 6.39 4,327 70 6.52 4,149 74 7.08
402 4 4.26 394 4 4.16 459 7 6.66
- ------------------------------ -------------------------- ----------------------------
37,915 591 6.20 38,471 601 6.28 45,006 844 7.46
3,457 26 3.07 1,867 30 6.38 1,562 30 7.94
- ------------------------------ -------------------------- ----------------------------
55,642 807 5.78 57,625 861 5.99 59,998 1,083 7.19
(625) (567) (607)
2,705 2,877 2,907
8,738 8,294 8,494
- --------------- --------------- ---------------
$66,460 $68,229 $70,792
============== =============== ===============
$22,147 63 1.16 $21,802 60 1.11 $20,944 134 2.57
2,067 3 .50 1,994 2 .48 1,936 5 .94
10,518 97 3.68 10,608 101 3.86 12,662 175 5.54
948 8 3.45 827 9 4.40 537 8 6.48
243 1 1.66 867 4 1.65 1,096 12 4.17
- ------------------------------ -------------------------- ----------------------------
35,923 172 1.92 36,098 176 1.97 37,175 334 3.60
35 1.81 2,109 9 1.58 2,596 28 4.30
979 4 1.45 915 3 1.38 958 9 3.64
5,441 38 2.76 5,675 38 2.68 5,189 67 5.08
1,714 2 .52 1,873 2 .48 2,550 31 4.78
2,210 25 4.58 2,209 25 4.60 2,364 36 6.15
483 8 6.66 391 15 15.48 373 9 9.80
- ------------------------------ -------------------------- ----------------------------
10,862 77 2.83 13,172 92 2.80 14,030 180 5.09
- ------------------------------ -------------------------- ----------------------------
46,785 249 2.13 49,270 268 2.19 51,205 514 4.01
8,406 8,288 8,228
4,125 3,745 3,732
192 177 122
848 848 848
6,104 5,901 6,657
- --------------- --------------- ---------------
$66,460 $68,229 $70,792
- ------------------------------------------------------------------------------------------------------------------------------------
3.65 3.80 3.18
.34 .32 .59
- ------------------------------------------------------------------------------------------------------------------------------------
$558 3.99% $593 4.12% $569 3.77%
====================================================================================================================================
44
QUARTERLY REPORT ON FORM 10-Q
THE PNC FINANCIAL SERVICES GROUP, INC.
Securities and Exchange Commission
Washington, D.C. 20549
Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the quarterly period ended June 30, 2002.
Commission File Number 1-9718
THE PNC FINANCIAL SERVICES GROUP, INC.
Incorporated in the Commonwealth of Pennsylvania
IRS Employer Identification No. 25-1435979
Address: One PNC Plaza
249 Fifth Avenue
Pittsburgh, Pennsylvania 15222-2707
Telephone: (412) 762-2000
As of July 31, 2002 The PNC Financial Services Group, Inc. had 284,229,319
shares of common stock ($5 par value) outstanding.
The PNC Financial Services Group, Inc. (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 and (2) has been subject to such filing requirements for the
past 90 days.
The following sections of the Financial Review set forth in the cross-reference
index are incorporated in the Quarterly Report on Form 10-Q.
Cross-reference Page(s)
- ---------------------------------------------------------------
PART I FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Statement of Income for the
three months and six months ended June
30, 2002 and 2001 29
Consolidated Balance Sheet as of June
30, 2002 and December 31, 2001 30
Consolidated Statement of Cash Flows for
the six months ended June 30, 2002 and
2001 31
Notes to Consolidated Financial
Statements 32 - 42
Consolidated Average Balance Sheet and
Net Interest Analysis 43 - 44
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of
Operations 3 - 28
Item 3 Quantitative and Qualitative
Disclosures About Market Risk 22 - 28
- ---------------------------------------------------------------
PART II OTHER FINANCIAL INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As previously reported in the Corporation's Current Report on Form 8-K filed on
July 18, 2002, the SEC, with the consent of the Corporation, instituted public
administrative proceedings, made findings and entered a cease-and-desist order
against the Corporation and the Corporation announced that it has entered into a
written agreement with the Federal Reserve Bank of Cleveland and that its
principal bank subsidiary, PNC Bank, National Association, has entered into a
written agreement with the Office of the Comptroller of the Currency. The
Corporation believes that the regulatory inquiries described in the final
paragraph of Item 3 of the 2001 Form 10-K have been concluded as to the
Corporation as a result of these actions. See the Corporation's Current Report
on Form 8-K filed on July 18, 2002 (the text of which is included as Exhibit
99.4 to this Form 10-Q) for additional information regarding these matters.
The Corporation has received a letter from a shareholder demanding that the
Corporation take legal action against parties allegedly responsible for the
events giving rise to the SEC consent order filed on July 18, 2002 and that it
consider legal action against directors of the Corporation who approved certain
bonus payments. Management has referred this demand to the Board of Directors.
On July 29, 2002, the Corporation was contacted by a field agent from the
Philadelphia regional office of the Pension and Welfare Benefits Administration
of the United States Department of Labor. The field agent made an informal
inquiry into the Corporation's restatement of earnings for 2001 as it relates to
the Corporation's common stock held under the Corporation's Incentive Savings
Plan. The Corporation intends to cooperate with the inquiry.
Management does not anticipate that the ultimate aggregate liability, if any,
arising out of such other legal proceedings will have a material adverse effect
on the Corporation's financial position. However, management is not in a
position to determine whether any pending or threatened legal proceedings will
have a material adverse effect on the Corporation's results of operations in any
future reporting period.
ITEM 5. OTHER INFORMATION
Mr. William R. Johnson, a director of the Corporation and its principal banking
subsidiary, PNC Bank, National Association, has resigned from both Boards of
Directors effective August 12, 2002, citing personal reasons.
45
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
The following exhibit index lists Exhibits filed with this Quarterly Report on
Form 10-Q:
10.1 The PNC Financial Services Group, Inc. Supplemental Executive
Retirement Plan, as amended (a)
10.3 The PNC Financial Services Group, Inc. Key Executive Equity Program,
as amended (a)
12.1 Computation of Ratio of Earnings to Fixed Charges
12.2 Computation of Ratio of Earnings to Fixed Charges and
Preferred Stock Dividends
99.1 Agreement between The PNC Financial Services Group, Inc. and Federal
Reserve Bank of Cleveland (b)
99.2 Form of Agreement between PNC Bank, National Association and Office
of the Comptroller of the Currency (b)
99.3 Form of Order of the Securities and Exchange Commission Instituting
Public Administrative Proceedings Pursuant to Section 8A of the
Securities Act of 1933 and 21C of the Securities Exchange Act of
1934, Making Findings and Imposing Cease-and-Desist Order (b)
99.4 Excerpt of text of Item 5 of the Corporation's Current Report on
Form 8-K dated July 18, 2002
===============================================================================
(a) Denotes management compensatory plan.
(b) Incorporated herein by reference to Exhibits 99.1, 99.2 and 99.3,
respectively, of the Corporation's Current Report on Form 8-K dated July 18,
2002.
Copies of these Exhibits may be obtained electronically at the Securities and
Exchange Commission's home page at www.sec.gov. Copies may also be obtained
without charge by writing to Thomas F. Garbe, Director of Financial Accounting,
at corporate headquarters, by calling (412) 762-1553 or via e-mail at
financial.reporting@pnc.com.
The Corporation did not file any reports on Form 8-K during the quarter ended
June 30, 2002.
On July 18, 2002, the Corporation filed a Current Report on Form 8-K in
connection with the Corporation's announcement on that date that it had entered
into a written agreement with the Federal Reserve Bank of Cleveland and that its
principal subsidiary, PNC Bank, National Association, had entered into a written
agreement with the Office of the Comptroller of the Currency. These agreements
(together, the "Regulatory Agreements") address such issues as risk, management
and financial controls.
The Form 8-K dated July 18, 2002 also disclosed that the SEC, with the
Corporation's consent, entered an Order Instituting Public Administrative
Proceedings Pursuant to Section 8A of the Securities Act of 1933 and 21C of the
Securities Exchange Act of 1934, Making Findings and Imposing Cease-and-Desist
Order ("Commission Order"). In consenting to the entry of the Commission Order
and the SEC's jurisdiction, the Corporation did not admit or deny the SEC's
findings.
The Regulatory Agreements and the Commission Order were filed as Exhibits with
the July 18, 2002 Form 8-K filing.
On August 7, 2002, the Corporation filed a Current Report on Form 8-K to
disclose the resignation of one of the members of the Corporation's Board of
Directors and an executive promotion.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on August 14, 2002, on its
behalf by the undersigned thereunto duly authorized.
THE PNC FINANCIAL SERVICES GROUP, INC.
BY: /S/ ROBERT L. HAUNSCHILD
- -----------------------------
Robert L. Haunschild
Chief Financial Officer
46
CORPORATE INFORMATION
THE PNC FINANCIAL SERVICES GROUP, INC.
CORPORATE HEADQUARTERS
The PNC Financial Services Group, Inc.
One PNC Plaza
249 Fifth Avenue
Pittsburgh, Pennsylvania 15222-2707
(412) 762-2000
STOCK LISTING
The PNC Financial Services Group, Inc. common stock is listed on the New York
Stock Exchange under the symbol PNC.
INTERNET INFORMATION
The PNC Financial Services Group, Inc.'s financial reports and information about
its products and services are available on the Internet at www.pnc.com.
FINANCIAL INFORMATION
The Annual Report on Form 10-K is filed with the Securities and Exchange
Commission ("SEC"). Copies of this document and other filings, including
exhibits thereto, may be obtained electronically at the SEC's home page at
www.sec.gov. Copies may also be obtained without charge by writing to Thomas F.
Garbe, Director of Financial Accounting, at corporate headquarters, by calling
(412) 762-1553 or via e-mail at financial.reporting@pnc.com.
INQUIRIES
For financial services call 1-888-PNC-2265. Individual shareholders should
contact Shareholder Relations at (800) 982-7652.
Analysts and institutional investors should contact William H. Callihan, Vice
President, Investor Relations, at (412) 762-8257 or via e-mail at
investor.relations@pnc.com.
News media representatives and others seeking general information should
contact R. Jeep Bryant, Senior Vice President, Corporate Communications, at
(412) 762-4550 or via e-mail at corporate.communications@pnc.com.
COMMON STOCK PRICES/DIVIDENDS DECLARED
The table below sets forth by quarter the range of high and low sale and
quarter-end closing prices for The PNC Financial Services Group, Inc. common
stock and the cash dividends declared per common share.
Cash
Dividends
High Low Close Declared
===================================================================
2002 QUARTER
- -------------------------------------------------------------------
First $62.800 $52.500 $61.490 $.48
Second 60.400 49.120 51.770 .48
- -------------------------------------------------------------------
Total $.96
===================================================================
2001 QUARTER
- -------------------------------------------------------------------
First $75.813 $56.000 $67.750 $.48
Second 71.110 62.400 65.790 .48
Third 70.390 51.140 57.250 .48
Fourth 60.110 52.300 56.200 .48
- -------------------------------------------------------------------
Total $1.92
===================================================================
DIVIDEND REINVESTMENT AND STOCK PURCHASE PLAN
The PNC Financial Services Group, Inc. Dividend Reinvestment and Stock Purchase
Plan enables holders of common and preferred stock to purchase additional shares
of common stock conveniently and without paying brokerage commissions or service
charges. A prospectus and enrollment card may be obtained by writing to
Shareholder Relations at corporate headquarters.
REGISTRAR AND TRANSFER AGENT
The Chase Manhattan Bank
85 Challenger Road
Ridgefield Park, New Jersey 07660
(800) 982-7652
47