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THE PNC FINANCIAL SERVICES GROUP, INC.
Quarterly Report on Form 10-Q
For the quarterly period ended March 31, 2003
Pages 1 and 2 represent a portion of the first quarter 2003 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 51.
CONSOLIDATED FINANCIAL HIGHLIGHTS
THE PNC FINANCIAL SERVICES GROUP, INC.
For the three months ended - dollars in millions, except
per share data March 31 March 31
Unaudited 2003 2002
- ------------------------------------------------------------------------------------------------------------------------
FINANCIAL PERFORMANCE
Revenue
Net interest income (taxable-equivalent basis) (a) $506 $593
Noninterest income 795 790
----------------------------
Total revenue $1,301 $1,383
============================
Net income $262 $317
============================
Per common share
DILUTED EARNINGS
Net income $.92 $1.11
============================
CASH DIVIDENDS DECLARED $.48 $.48
- ------------------------------------------------------------------------------------------------------------------------
SELECTED RATIOS
Return on
Average common shareholders' equity 15.76% 21.83%
Average assets 1.61 1.89
Net interest margin 3.76 4.12
Noninterest income to total revenue (b) 61 57
Efficiency (c) 66 58
========================================================================================================================
Certain prior period amounts included in these Consolidated Financial Highlights
have been reclassified to conform to the current period presentation. See Page
30 of this Financial Review for a glossary of certain terms used in this report.
(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. A
reconciliation of net interest income as reported in the Consolidated
Statement of Income to net interest income on a taxable-equivalent basis
follows (in millions):
For the three months
ended
----------------------------
March 31 March 31
2003 2002
------------ ----------
Net interest income, GAAP basis $503 $590
Taxable-equivalent adjustment 3 3
------------ ----------
Net interest income, taxable-equivalent basis $506 $593
============ ==========
(b) Computed as total noninterest income divided by the sum of net interest
income and noninterest income. For the quarter ended March 31, 2002, the
ratio previously reported had been computed using taxable-equivalent net
interest income. The ratio for that quarter has been restated to conform to
the current period presentation.
(c) The efficiency ratio for all periods presented is computed as noninterest
expense divided by the sum of net interest income and noninterest income.
For the quarter ended March 31, 2002, the efficiency ratio previously
reported had been computed by excluding amortization expense and
distributions on capital securities from the calculation and had used
taxable-equivalent net interest income. The efficiency ratio for that
quarter has been restated to conform to the current period presentation.
1
March 31 December 31 March 31
Unaudited 2003 2002 2002
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA (dollars in millions, except per share data)
Assets $68,619 $66,377 $66,663
Earning assets 56,205 54,833 55,856
Loans, net of unearned income 35,245 35,450 38,539
Allowance for credit losses 680 673 613
Securities 14,973 13,763 11,092
Loans held for sale 1,702 1,607 3,648
Total deposits 47,081 44,982 44,910
Borrowed funds 8,534 9,116 10,988
Allowance for unfunded loan commitments and letters of credit 77 84 99
Shareholders' equity 6,792 6,859 5,979
Common shareholders' equity 6,783 6,849 5,969
Book value per common share 24.05 24.03 21.02
Loans to deposits 75% 79% 86%
ASSETS UNDER MANAGEMENT (billions) $313 $313 $285
CAPITAL RATIOS
Tier 1 Risk-based 8.7% 8.8% 7.7%
Total Risk-based 12.3 12.5 11.7
Leverage 8.0 8.1 6.9
Shareholders' equity to total assets 9.90 10.33 8.97
Common shareholders' equity to total assets 9.89 10.32 8.95
ASSET QUALITY RATIOS
Nonperforming assets to total loans,
loans held for sale and foreclosed assets 1.10% 1.13% 1.04%
Nonperforming loans to total loans .95 .87 .65
Net charge-offs to average loans (for the three months ended) .42 .39 .43
Allowance for credit losses to total loans (d) 1.93 1.90 1.59
Allowance for credit losses to nonperforming loans (d) 203 218 244
===================================================================================================================================
(d) The asset quality ratios presented for March 31, 2002 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. The amount reclassified totaled $99 million at
March 31, 2002. This reclassification had the effect of lowering the
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 2002 Annual Report on Form 10-K ("2002
Form 10-K"). Certain prior-period amounts have been reclassified to conform with
the current year presentation. 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, Risk Management and Liquidity sections in this Financial Review and the
Business section of the 2002 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. See Page 30 of this Financial Review for a glossary of
certain terms used in this report.
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; wholesale banking, including corporate banking, real estate finance and
asset-based lending; wealth management; asset management and global fund
processing 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 processing services internationally.
SUMMARY FINANCIAL RESULTS
Consolidated net income for the first three months of 2003 was $262 million, or
$.92 per diluted share, compared with net income of $317 million, or $1.11 per
diluted share, for the first quarter of 2002. Return on average common
shareholders' equity was 15.76% for the first quarter of 2003 compared with
21.83% for the first quarter of 2002. Return on average assets was 1.61% for the
first quarter of 2003 compared with 1.89% for the first quarter of 2002.
The Corporation's progress during the first quarter of 2003 in addressing
several of the challenges referred to in the 2002 Form 10-K included the
following:
Asset quality remained stable.
o The provision for credit losses was $36 million for the first quarter
of 2003 compared with $65 million for the fourth quarter of 2002 and
$82 million for the first quarter of 2002; and
o While nonperforming loans increased $26 million, to $335 million,
compared with the balance at December 31, 2002, total nonperforming
assets declined $10 million, to $408 million, at March 31, 2003.
Total revenues declined in the first quarter of 2003 compared with the first
quarter of 2002. However, growth in other facets of the business included the
following, as compared with the first quarter of 2002:
o BlackRock's earnings increased 12%, to $35 million;
o Regional Community Banking grew home equity loans 14% on average; and
o PNC's average transaction deposits grew 6%.
PNC's development of value-added customer relationships was evidenced by the
following:
o The number of Regional Community Banking checking relationships at
March 31, 2003 reflected growth of 6% compared with March 31, 2002;
o PNC Advisors experienced net customer inflows of assets totaling $500
million during the first quarter of 2003; and
o PFPC provided accounting/administration services for $573 billion of
pooled investment assets at March 31, 2003, up from $510 billion and
$543 billion at December 31, 2002 and March 31, 2002, respectively,
primarily resulting from new business activity, although shareholder
accounts serviced declined from December 31, 2002 and March 31, 2002,
primarily due to the loss of one large transfer agency client.
In addition, PNC repurchased 4.4 million common shares under its 35 million
share repurchase program during the first quarter of 2003.
3
Results for the first quarter of 2003 reflected a 6% decrease in total revenue
compared with the first quarter of 2002 as a decline in taxable-equivalent net
interest income due to a narrower net interest margin and downsizing of the loan
portfolio more than offset higher net securities gains. See Note (a) to net
interest income (taxable-equivalent basis) in the Consolidated Financial
Highlights for a reconciliation to net interest income as reported under
generally accepted accounting principles ("GAAP"). In addition, total
noninterest expense increased $49 million, or 6%, compared with the first
quarter of 2002 due to costs paid in connection with the liquidation of the
entities formed in 2001 in transactions with American International Group, Inc.
("AIG"), a facilities charge related to vacant leased space and subleases, and
higher incentive compensation and pension costs. Partially offsetting these
higher costs was a 56% decline in the provision for credit losses in the first
quarter of 2003 compared with the first quarter of 2002. The provision for
credit losses in the first quarter of 2002 included an addition to reserves
related to the Corporate Banking business and the PNC Business Credit portfolio.
Management expects that the balance of 2003 will continue to be a challenge to
the Corporation with limited growth opportunities. In addition to the economy,
the direction of interest rates, financial market conditions and the potential
for additional international hostilities, PNC's success during the remainder of
2003 will depend on its ability to meet its key operating challenges. These
challenges include the stability of asset quality, revenue growth and the
development of value-added customer relationships. Other factors that will
affect the Corporation's success include leveraging technology, continuing to
execute a share repurchase program, managing the revenue/expense relationship
and regulatory actions. Also, see the Risk Factors, Risk Management, Liquidity
and Forward-Looking Statements sections of this Financial Review.
BALANCE SHEET HIGHLIGHTS
Total assets were $68.6 billion at March 31, 2003 compared with $66.4 billion at
December 31, 2002 and $66.7 billion at March 31, 2002. Average interest-earning
assets for the first quarter of 2003 were $54.0 billion, down $3.6 billion, or
6%, compared with the first quarter of 2002. Declines in average loans of $3.3
billion and average loans held for sale of $2.5 billion compared with the first
quarter of 2002 were partially offset by an increase of $1.7 billion in average
federal funds sold.
Average loans for the first quarter of 2003 were $35.2 billion compared with
$38.5 billion for the first quarter of 2002. Average loans represented 65% of
total average interest-earning assets for the first three months of 2003
compared with 67% for the first three months of 2002. Declines in average
residential mortgage and commercial loans drove the decline compared with the
prior year quarter, partially offset by an increase in home equity loans.
Changes in loans held for sale are described in Loans Held For Sale in the
Consolidated Balance Sheet Review section of this Financial Review.
Average securities for the first quarter of 2003 were up slightly, to $13.1
billion, compared with the first quarter of 2002 and represented 24% of average
total interest-earning assets for the first quarter of 2003 compared with 23%
for the first quarter of 2002.
Funding cost is affected by the volume and composition of funding sources as
well as related rates paid thereon. Average deposits represented 67% of total
sources of funds for the first quarter of 2003 and 65% for the first quarter of
2002, with the remainder primarily comprised of wholesale funding obtained at
prevailing market rates.
Average interest-bearing demand and money market deposits totaled $22.8 billion
for the first quarter of 2003, up $1.0 billion compared with the first quarter
of 2002. This increase reflects the continued focus on the growth and retention
of more valuable transaction accounts as higher cost, less valuable retail
certificates of deposit were not emphasized. Average borrowed funds were $8.7
billion for the first quarter of 2003, down $4.5 billion compared with the first
quarter of 2002. This decline is consistent with the decline in average total
interest-earning assets in 2003 compared with the year-ago quarter. See the
Consolidated Average Balance Sheet and Net Interest Analysis for additional
information.
Total deposits were $47.1 billion at March 31, 2003 compared with $45.0 billion
at December 31, 2002. This increase included a deposit of approximately $900
million from a single customer received prior to the end of the first quarter of
2003. As expected, this deposit was subsequently withdrawn in April 2003.
4
REVIEW OF BUSINESSES
PNC operates seven major businesses engaged in regional community banking;
wholesale banking, including corporate banking, real estate finance and
asset-based lending; wealth management; asset management and global fund
processing services. Treasury management activities, which include cash and
investment management, receivables management, disbursement services and global
trade services; capital markets products, which include foreign exchange,
derivatives trading and loan syndications; and equipment leasing products are
offered through Corporate Banking and sold by several businesses across the
Corporation.
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 GAAP; 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 2002 have been
reclassified to conform with the 2003 presentation.
The management accounting process uses various balance sheet and income
statement assignments and transfers to measure performance of the businesses.
Methodologies are refined from time to time as management accounting practices
are enhanced and businesses change. There were no significant changes to the
measurement methods during the first quarter of 2003. 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 financial results differ from total consolidated results.
This is primarily due to differences between management accounting practices and
GAAP such as economic capital assignments rather than legal entity shareholders'
equity, unit cost allocations rather than actual expense assignments, and
policies that do not fully allocate holding company expenses; minority interest
in income of consolidated entities; eliminations and other corporate items. The
impact of these differences is reflected in the "Other" category. "Other" also
includes equity management activities and residual asset and liability
management activities which do not meet the criteria for disclosure as a
separate reportable segment. "Other" reflected a net loss of $25 million for the
first quarter of 2003 compared with earnings of $2 million for the first quarter
of 2002. The net loss for the first quarter of 2003 compared with the first
quarter of 2002 was primarily driven by a pretax charge of $23 million related
to leased facilities. Details of inter-segment revenues are included in Note 13
Segment Reporting.
"Other Information" included in the individual business tables that follow
is presented as of period end, except for net charge-offs, net gains (losses) on
loans held for sale and average full-time equivalent employees (FTEs), which
represent amounts for the periods presented.
RESULTS OF BUSINESSES
Return on
Assigned
Three months ended March 31 - Earnings (Loss) Revenue (a) Capital (b) Average Assets (c)
---------------------------------------------------------------------------------------
dollars in millions 2003 2002 2003 2002 2003 2002 2003 2002
================================================================================================================================
Banking Businesses
Regional Community Banking $152 $177 $518 $551 23% 27% $38,989 $38,749
Wholesale Banking
Corporate Banking 42 33 189 194 19 12 11,650 15,217
PNC Real Estate Finance 16 22 56 51 18 22 4,767 5,174
PNC Business Credit 14 2 44 45 24 3 3,628 3,817
- ------------------------------------------------------------------------------------ ----------------------
Total wholesale banking 72 57 289 290 20 13 20,045 24,208
PNC Advisors 16 33 147 183 12 25 2,870 3,042
- ------------------------------------------------------------------------------------ ----------------------
Total banking businesses 240 267 954 1,024 21 22 61,904 65,999
- ------------------------------------------------------------------------------------ ----------------------
Asset Management and Processing
businesses
BlackRock 35 31 143 146 22 25 836 667
PFPC 12 17 193 213 23 33 1,865 1,848
- ------------------------------------------------------------------------------------ ----------------------
Total asset management and
processing 47 48 336 359 22 27 2,701 2,515
- ------------------------------------------------------------------------------------ ----------------------
Total business results 287 315 1,290 1,383 21 23 64,605 68,514
Other (25) 2 11 1,350 (285)
- ------------------------------------------------------------------------------------ ----------------------
Total consolidated (a) $262 $317 $1,301 $1,383 16 22 $65,955 $68,229
================================================================================================================================
(a) Business revenue is presented on a taxable-equivalent basis except for
BlackRock and PFPC, which are presented on a book (GAAP) basis. A
reconciliation of total consolidated revenue on a book basis to total
consolidated revenue on a taxable-equivalent basis is as follows:
Three months ended March 31 - in millions 2003 2002
- -----------------------------------------------------------------------
Total consolidated revenue, book (GAAP) basis $1,298 $1,380
Taxable-equivalent adjustment 3 3
- -----------------------------------------------------------------------
Total consolidated revenue,
taxable-equivalent basis $1,301 $1,383
=======================================================================
(b) Percentages for BlackRock reflect return on equity.
(c) Period-end balances for BlackRock.
5
REGIONAL COMMUNITY BANKING
Three months ended March 31
Taxable-equivalent basis
Dollars in millions 2003 2002
- ----------------------------------------------------------------
INCOME STATEMENT
Net interest income $317 $384
Other noninterest income 163 164
Net securities gains 38 3
- ----------------------------------------------------------------
Total revenue 518 551
Provision for credit losses 8 12
Noninterest expense 278 266
- ----------------------------------------------------------------
Pretax earnings 232 273
Income taxes 80 96
- ----------------------------------------------------------------
Earnings $152 $177
================================================================
AVERAGE BALANCE SHEET
Loans
Consumer
Home equity $7,675 $6,733
Indirect 438 633
Other consumer 546 697
- ----------------------------------------------------------------
Total consumer 8,659 8,063
Residential mortgage 3,276 5,096
Commercial 3,939 3,511
Vehicle leasing 1,336 1,895
Other 117 122
- ----------------------------------------------------------------
Total loans 17,327 18,687
Securities 12,504 12,206
Education and other loans held for sale 1,197 1,488
Assigned assets and other assets 7,961 6,368
- ----------------------------------------------------------------
Total assets $38,989 $38,749
================================================================
Deposits
Noninterest-bearing demand $5,264 $4,879
Interest-bearing demand 6,112 6,053
Money market 12,361 12,292
- ----------------------------------------------------------------
Total transaction deposits 23,737 23,224
Savings 1,976 1,924
Certificates 9,360 10,310
- ----------------------------------------------------------------
Total deposits 35,073 35,458
Other liabilities 1,285 675
Assigned capital 2,631 2,616
- ----------------------------------------------------------------
Total funds $38,989 $38,749
================================================================
PERFORMANCE RATIOS
Return on assigned capital 23% 27%
Noninterest income to total revenue 39 30
Efficiency 54 48
- ----------------------------------------------------------------
OTHER INFORMATION
Total nonperforming assets (a) $86 $59
Vehicle leasing outstandings,
net of unearned income (b) $1,239 $1,805
Net charge-offs $13 $12
Average FTEs 9,404 9,699
ATMs 3,594 3,300
Branches 713 714
Financial consultants 674 580
Business banking centers 193 140
Checking relationships 1,555,000 1,465,000
Online banking users 647,287 466,213
Deposit households using online banking 38.6% 30.8%
================================================================
(a) Includes nonperforming loans of $76 million and $52 million at March 31,
2003 and 2002, respectively.
(b) At March 31.
Regional Community Banking provides deposit, lending, cash management and
investment services to two million consumer and small business customers within
PNC's geographic region.
The strategic focus of the Regional Community Bank is to generate sustainable
revenue growth by consistently increasing its base of satisfied and loyal
customers. Revenue growth is driven by building a base of transaction deposit
relationships which provide fee revenue and a low-cost funding source for loans
and investments. Additional revenue growth is generated by deepening
relationships with these customers through cross-selling of other products and
services.
Regional Community Banking increased the number of checking relationships by 6%
compared with March 31, 2002 causing increases in transaction deposits and fee
revenues. Customer growth was driven by simultaneous improvements in the rates
of customer acquisition and retention. The significant growth in online banking
users has helped to improve customer loyalty and retention. Despite these trends
and success in keeping deposit funding costs low, earnings have been impacted by
a reduction in average residential mortgages and vehicle leases (discussed
below) and lower investment yields in the relatively low interest rate
environment that continued in the first quarter of 2003.
Regional Community Banking earnings were $152 million for the first three months
of 2003 compared with $177 million in the first three months of 2002. The
decrease in earnings for the first quarter of 2003 reflected a 17% decline in
taxable-equivalent net interest income due to the lower interest rate
environment and the impact of a $1.8 billion decline in the average residential
mortgage loan portfolio that reflected prepayments.
Total revenue was $518 million for the first three months of 2003 compared with
$551 million for the same period in 2002. Revenue declined in the comparison
primarily due to lower securities and residential mortgage interest income that
was partially offset by lower deposit funding costs and higher net securities
gains. Noninterest income for deposit-related products increased $9 million or
10% compared with the first quarter of 2002. This deposit fee growth was offset
by lower brokerage revenue as well as declining residential mortgage and vehicle
leasing fees.
The provision for credit losses for the first three months of 2003 decreased to
$8 million compared with $12 million in the prior year period primarily due to
the impact of refinements made during the fourth quarter of 2002 to the
Corporation's reserve methodology related to impaired loans and pooled reserves.
Noninterest expense increased $12 million, to $278 million, in the first quarter
of 2003 compared with the prior year first quarter. The increase reflected
higher pension and occupancy costs.
Average total loans decreased 7% for the first quarter of 2003 compared with the
first quarter of 2002. Home equity loans, the lead consumer lending product,
grew 14% in the comparison. The overall decline in loans primarily resulted from
residential mortgage prepayments and a decline in vehicle leases and indirect
loans.
Average total deposits declined slightly in the first quarter of 2003 compared
with the year-ago quarter 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 while higher cost, less valuable
certificates of deposit continued not to be emphasized.
As previously reported, the Corporation decided to discontinue its vehicle
leasing business in the fourth quarter of 2001. As a result, this portfolio has
declined 31% since March 31, 2002 and is performing overall as expected. See
Loans in the Consolidated Balance Sheet Review section of this Financial Review
for additional information.
6
WHOLESALE BANKING - CORPORATE BANKING
Three months ended March 31
Taxable-equivalent basis
Dollars in millions 2003 2002
- ------------------------------------------------------------------
INCOME STATEMENT
Net interest income $76 $95
Noninterest income 113 99
- ------------------------------------------------------------------
Total revenue 189 194
Provision for credit losses 15 46
Noninterest expense 109 97
- ------------------------------------------------------------------
Pretax earnings 65 51
Income tax 23 18
- ------------------------------------------------------------------
Earnings $42 $33
==================================================================
AVERAGE BALANCE SHEET
Loans $8,604 $9,930
Loans held for sale 291 2,519
Other assets 2,755 2,768
- ------------------------------------------------------------------
Total assets $11,650 $15,217
==================================================================
Deposits $5,097 $4,475
Assigned funds and other liabilities 5,679 9,601
Assigned capital 874 1,141
- ------------------------------------------------------------------
Total funds $11,650 $15,217
==================================================================
PERFORMANCE RATIOS
Return on assigned capital 19% 12%
Noninterest income to total revenue 60 51
Efficiency 58 50
- ------------------------------------------------------------------
OTHER INFORMATION
Total nonperforming assets (a) $166 $191
Net charge-offs $18 $16
Average FTEs 1,971 2,206
INSTITUTIONAL LENDING REPOSITIONING
Loans held for sale
Credit exposure $315 $3,519
Outstandings $155 $1,714
Exit portfolio
Credit exposure $349 $1,945
Outstandings $4 $113
Net gains on loans held for sale (b) $17 $29
==================================================================
(a) Includes nonperforming loans of $114 million and $62 million at March 31,
2003 and 2002, respectively.
(b) Included in Noninterest income.
Corporate Banking provides credit, equipment leasing, treasury management and
capital markets products and services to mid-sized corporations, government
entities and selectively to large corporations primarily within PNC's geographic
region. Additionally, PNC, through the Corporate Banking line of business,
administers Market Street Funding Corporation ("Market Street"), a multi-seller
asset-backed commercial paper conduit. 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 emphasizing noncredit products.
Corporate Banking earned $42 million for the first quarter of 2003 compared with
$33 million for the first quarter of 2002. The increase in earnings was
primarily due to a decrease in the provision for credit losses that more than
offset the impact of lower total revenue and higher noninterest expense in the
first quarter of 2003.
Total revenue of $189 million for the first three months of 2003 decreased $5
million compared with the first three months of 2002. Taxable-equivalent net
interest income for the first three months of 2003 decreased $19 million
compared with the prior year period primarily due to the reduction in average
loans and average loans held for sale resulting from the institutional lending
repositioning. Noninterest income increased $14 million compared with the first
three months of 2002. This increase was primarily due to $23 million of net
securities gains recognized during the first quarter of 2003 in connection with
the liquidation of the entities formed in 2001 in transactions with AIG,
partially offset by lower net gains on loans held for sale.
The provision for credit losses decreased $31 million or 67% in the first
quarter of 2003 compared with the same period in 2002. The provision for credit
losses for the first quarter of 2002 reflected the impact of, among others,
reserve allocations for an apparent fraud related to Market Street.
Noninterest expense totaled $109 million in the first quarter of 2003 compared
with $97 million for the first quarter of 2002. The increase reflects $22
million of costs paid in connection with the liquidation of the entities formed
in 2001 in transactions with AIG, partially offset by lower staff-related costs
in the first quarter of 2003 as a result of the institutional lending
downsizing.
Treasury management, capital markets and equipment leasing 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 $89 million for
the first three months of 2003, an increase of $5 million compared with the same
period in 2002, reflecting higher fee revenue and income earned on customers'
deposit balances. Consolidated revenue from capital markets was $27 million for
the first three months of 2003, a decrease of $3 million compared with the same
period in 2002 primarily due to lower transaction volume attributable to the
weak economic and market conditions.
Nonperforming assets were $166 million at March 31, 2003 compared with $191
million at March 31, 2002. The decrease was primarily due to the Corporation's
continued liquidation of the institutional lending held for sale portfolio.
7
WHOLESALE BANKING - PNC REAL ESTATE FINANCE
Three months ended March 31
Taxable-equivalent basis
Dollars in millions 2003 2002
- -----------------------------------------------------------------
INCOME STATEMENT
Net interest income $28 $30
Noninterest income
Commercial mortgage banking 19 18
Other 9 3
- -----------------------------------------------------------------
Total noninterest income 28 21
- -----------------------------------------------------------------
Total revenue 56 51
Provision for credit losses 8 (5)
Noninterest expense 38 36
- -----------------------------------------------------------------
Pretax earnings 10 20
Income tax (benefit) (6) (2)
- -----------------------------------------------------------------
Earnings $16 $22
=================================================================
AVERAGE BALANCE SHEET
Loans
Commercial real estate $2,052 $2,228
Commercial - real estate related 1,397 1,555
- -----------------------------------------------------------------
Total loans 3,449 3,783
Commercial mortgages held for sale 315 318
Other loans held for sale 53 211
Other assets 950 862
- -----------------------------------------------------------------
Total assets $4,767 $5,174
=================================================================
Deposits $950 $617
Assigned funds and other liabilities 3,454 4,158
Assigned capital 363 399
- -----------------------------------------------------------------
Total funds $4,767 $5,174
=================================================================
PERFORMANCE RATIOS
Return on assigned capital 18% 22%
Noninterest income to total revenue 50 41
Efficiency 68 71
- -----------------------------------------------------------------
COMMERCIAL MORTGAGE SERVICING
PORTFOLIO (a)
January 1 $74 $68
Acquisitions/additions 5 4
Repayments/transfers (4) (3)
- -----------------------------------------------------------------
March 31 $75 $69
- -----------------------------------------------------------------
Gains on sales of commercial mortgages (b) $9 $8
=================================================================
OTHER INFORMATION
Total nonperforming assets (c) $12 $12
Net (recoveries) charge-offs $(5)
Average FTEs 770 792
Institutional lending repositioning
Loans held for sale
Credit exposure $19 $320
Outstandings $19 $234
Exit portfolio
Credit exposure $25 $25
Outstandings $5
Net gains (losses) on loans held for
sale (d) $1 $(6)
=================================================================
(a) Dollars in billions.
(b) Included in Commercial mortgage banking in the income statement above.
(c) Includes nonperforming loans of $10 million and $5 million at March 31,
2003 and 2002, respectively.
(d) Included in Noninterest income-Other above.
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. ("Midland").
Midland is a leading third-party provider of loan servicing and technology to
the commercial real estate finance industry. PNC MultiFamily Capital, which
includes the former Columbia Housing, is a national syndicator of affordable
housing equity and a national provider of multifamily mortgage loans. Certain
incremental activities related to PNC MultiFamily Capital will continue to
require regulatory approvals due to the existence of regulatory agreements
entered into by the Corporation in 2002.
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 earned $16 million for the first three months of 2003
compared with $22 million in the first three months of 2002. The decline in the
first three months of 2003 compared with the prior year period was primarily due
to higher provision for credit losses in 2003 compared with net recoveries in
the 2002 period. The recovery in 2002 occurred in the exited warehouse lending
business which had $6 million of net loan recoveries in the first quarter of
2002.
Total revenue was $56 million for the first quarter of 2003 compared with $51
million for the first quarter of 2002. The increase reflected a $7 million
increase in noninterest income partially offset by a $2 million decline in
taxable-equivalent net interest income. Noninterest income in the first quarter
of 2002 was negatively impacted by net losses on loans held for sale of $6
million. The decline in taxable-equivalent net interest income was primarily due
to a decline in average loans and loans held for sale.
Noninterest expense increased $2 million for the first three months of 2003
compared with the prior year period primarily due to increased occupancy costs
and higher benefits expense.
The income tax benefit for both the first quarter of 2003 and 2002 reflects the
impact of tax credits received on low income housing tax credit investments.
The commercial mortgage servicing portfolio increased $1 billion to $75 billion
at March 31, 2003 compared with the balance at December 31, 2002. Midland, as a
third-party servicer, is required to comply with various contractual
obligations, including the obligation to advance funds for delinquent borrower
payments and property protection purposes, subject to certain recoverability
provisions, and to monitor property taxes and insurance. A total of $84 million
of advances were outstanding at March 31, 2003, compared with $65 million at
March 31, 2002. Midland has priority to recover these advances before the
security holders of the related securitizations.
8
WHOLESALE BANKING - PNC BUSINESS CREDIT
Three months ended March 31
Taxable-equivalent basis
Dollars in millions 2003 2002
- -----------------------------------------------------------------
INCOME STATEMENT
Net interest income $32 $33
Noninterest income 12 12
- -----------------------------------------------------------------
Total revenue 44 45
Provision for credit losses 7 28
Noninterest expense 14 14
- -----------------------------------------------------------------
Pretax earnings 23 3
Income taxes 9 1
- -----------------------------------------------------------------
Earnings $14 $2
=================================================================
AVERAGE BALANCE SHEET
Loans $3,381 $3,484
Loans held for sale 18 92
Other assets 229 241
- -----------------------------------------------------------------
Total assets $3,628 $3,817
=================================================================
Deposits $82 $68
Assigned funds and other liabilities 3,309 3,500
Assigned capital 237 249
- -----------------------------------------------------------------
Total funds $3,628 $3,817
=================================================================
PERFORMANCE RATIOS
Return on assigned capital 24% 3%
Noninterest income to total revenue 27 27
Efficiency 32 31
- -----------------------------------------------------------------
OTHER INFORMATION
Total nonperforming assets (a) $139 $172
Net charge-offs $5 $17
NBOC put option liability $49 $107
NBOC put option valuation income (b) $6 $5
Marketing locations 24 23
Average FTEs 250 217
INSTITUTIONAL LENDING REPOSITIONING
Loans held for sale
Credit exposure $10 $35
Outstandings $7 $27
Net (losses) on loans held for sale (b) $(3)
=================================================================
(a) Includes nonperforming loans of $130 million and $128 million at March 31,
2003 and 2002, respectively.
(b) Included in Noninterest income above.
PNC Business Credit provides asset-based lending, treasury management and
capital markets 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 National Bank of
Canada's ("NBOC") U.S. asset-based lending business in a purchase business
combination. See Note 2 NBOC Acquisition for additional information.
PNC Business Credit earned $14 million for the first three months of 2003
compared with $2 million for the first three months of 2002. Higher first
quarter 2003 earnings compared with the same period of 2002 were primarily due
to a $21 million decline in the provision for credit losses in 2003.
Total revenue was $44 million for the first quarter of 2003, a $1 million
decrease compared with the first quarter of 2002 due to lower taxable-equivalent
net interest income reflecting declines in average loans and loans held for
sale. The difficult economic conditions have adversely impacted customer sales
which constrained their borrowing capacity and contributed to the decline in
average loans. Noninterest income for the first quarter of 2003 included a $6
million benefit resulting from a reduction in the put option liability related
to the NBOC acquisition compared with a $5 million benefit in the prior year
period.
The provision for credit losses for the first three months of 2003 was $7
million compared with $28 million for the same period of 2002. The first quarter
2002 provision included an $11 million addition to reserves that reflected
economic conditions and the growth of the loan portfolio. PNC Business Credit
loans, including those acquired in the NBOC acquisition, are secured loans to
borrowers, many of whom are highly leveraged, experiencing rapid growth, or have
elected to utilize asset-based financing. As a result, the risk profile of these
loans typically reflects a higher risk of default and a greater proportion being
classified as nonperforming. 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. PNC Business Credit attempts to manage this risk through the
stringent control of the borrowers' collateral. Therefore, net charge-offs on
asset-based loans have historically been relatively low due to recoveries
provided by the underlying collateral. Compensation for this higher risk of
default is obtained by way of higher interest rates charged.
Despite the impact of higher average FTEs and increased benefit costs, total
noninterest expense was flat compared with the first quarter of 2002 reflecting
expense control initiatives.
Nonperforming assets were $139 million at March 31, 2003 compared with $172
million at March 31, 2002. The decrease was primarily due to reductions to
credits through managed liquidation and run-offs.
9
PNC ADVISORS
Three months ended March 31
Taxable-equivalent basis
Dollars in millions 2003 2002
- -----------------------------------------------------------------
INCOME STATEMENT
Net interest income $21 $26
Noninterest income
Investment management and trust 76 92
Brokerage 26 39
Other 24 26
- -----------------------------------------------------------------
Total noninterest income 126 157
- -----------------------------------------------------------------
Total revenue 147 183
Noninterest expense 122 130
- -----------------------------------------------------------------
Pretax earnings 25 53
Income taxes 9 20
- -----------------------------------------------------------------
Earnings $16 $33
=================================================================
AVERAGE BALANCE SHEET
Loans
Consumer $1,280 $1,170
Residential mortgage 327 613
Commercial 439 475
Other 284 349
- -----------------------------------------------------------------
Total loans 2,330 2,607
Other assets 540 435
- -----------------------------------------------------------------
Total assets $2,870 $3,042
=================================================================
Deposits $2,085 $2,058
Assigned funds and other liabilities 263 455
Assigned capital 522 529
- -----------------------------------------------------------------
Total funds $2,870 $3,042
=================================================================
PERFORMANCE RATIOS
Return on assigned capital 12% 25%
Noninterest income to total revenue 86 86
Efficiency 83 71
- -----------------------------------------------------------------
ASSETS UNDER MANAGEMENT (a)
Personal investment management and trust $40 $48
Institutional trust 9 12
- -----------------------------------------------------------------
Total $49 $60
ASSET TYPE
Equity $25 $36
Fixed income 16 17
Liquidity 8 7
- -----------------------------------------------------------------
Total $49 $60
=================================================================
OTHER INFORMATION
Total nonperforming assets (loans) $5 $4
Brokerage assets administered (in
billions) (b) $31 $29
Full service brokerage offices 102 113
Financial consultants 585 669
Margin loans $247 $301
Average FTEs 3,290 3,421
=================================================================
(a) At March 31 - in billions. Excludes brokerage assets administered.
(b) Amount for 2003 reflects the second quarter 2002 acquisition by Hilliard
Lyons of Regional Community Banking's branch-based brokerage business.
PNC Advisors provides a full range of tailored investment, trust and private
banking 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 consulting and trust 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 and provides defined
contribution plan services and investment options through its Vested Interest(R)
product. PNC Advisors provides services to individuals and corporations
primarily within PNC's geographic region.
PNC Advisors continues to emphasize deepening customer relationships through a
focused retention program and a broad array of products. The business has been
adversely affected in both 2003 and 2002 by the depressed financial markets and
the impact on its clients. The business is addressing the industry-wide issue of
appropriate expense levels in light of the challenging equity markets and a
reduction in client wealth.
PNC Advisors earned $16 million for the first three months of 2003 compared with
$33 million in the first three months of 2002. The earnings decline was driven
by the impact of continued weak equity market conditions on asset management and
brokerage revenues and by lower taxable-equivalent net interest income
reflecting reduced loan levels and the lower interest rate environment.
Total revenue for the first quarter of 2003 decreased $36 million compared with
the prior year quarter. The run-off of residential mortgages along with a
narrower net interest margin resulted in a $5 million decline in net interest
income. Investment management and trust fees declined $16 million, resulting
from depressed financial market conditions and a net outflow of customers.
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 until equity market performance improves
for a sustained period. Assets under management at March 31, 2003 decreased $11
billion compared with the balance at March 31, 2002 due to the decline in the
value of the equity component of customers' portfolios and net customer outflows
during the last nine months of 2002. During the first quarter of 2003, PNC
Advisors had net customer inflows of $500 million that were more than offset by
market value depreciation.
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
Lyons' brokerage operations and now provides services in the branch network
under the PNC Investments brand name. Brokerage assets administered by Hilliard
Lyons were $31 billion at March 31, 2003 compared with $29 billion at March 31,
2002. However, the revenue and expense related to the branch-based brokerage
business continues to be included in the results of Regional Community Banking.
Consolidated revenue from brokerage was $41 million for the first three months
of 2003 compared with $55 million for the first three months of 2002.
10
BLACKROCK
Three months ended March 31
Dollars in millions 2003 2002
- ------------------------------------------------------------------
INCOME STATEMENT
Investment advisory and
administrative fees $127 $132
Other income 16 14
- ------------------------------------------------------------------
Total revenue 143 146
Operating expense 81 83
Fund administration and servicing costs 8 13
- ------------------------------------------------------------------
Total expense 89 96
- ------------------------------------------------------------------
Operating income 54 50
Nonoperating income (a) 3 3
- ------------------------------------------------------------------
Pretax earnings 57 53
Income taxes 22 22
- ------------------------------------------------------------------
Earnings $35 $31
==================================================================
PERIOD-END BALANCE SHEET
Goodwill and other intangible assets $183 $181
Other assets 653 486
- ------------------------------------------------------------------
Total assets $836 $667
==================================================================
Liabilities $168 $144
Stockholders' equity 668 523
- ------------------------------------------------------------------
Total liabilities and
stockholders' equity $836 $667
==================================================================
PERFORMANCE DATA
Return on equity 22% 25%
Operating margin (b) 40 38
Diluted earnings per share $.54 $.48
==================================================================
ASSETS UNDER MANAGEMENT (c)
Separate accounts
Fixed income $168 $124
Liquidity 6 5
Liquidity - securities lending 6 10
Equity 9 9
Alternative investment products 6 6
- ------------------------------------------------------------------
Total separate accounts 195 154
- ------------------------------------------------------------------
Mutual funds (d)
Fixed income 20 16
Liquidity 56 60
Equity 3 8
- ------------------------------------------------------------------
Total mutual funds 79 84
- ------------------------------------------------------------------
Total assets under management $274 $238
- ------------------------------------------------------------------
OTHER INFORMATION
Average FTEs 944 843
==================================================================
(a) Net of nonoperating expense.
(b) Calculated as operating income divided by total revenue less fund
administration and servicing costs. A reconciliation of this presentation
to operating margin calculated on a GAAP basis (operating income divided by
total revenue) follows in millions:
Operating income $54 $50
- ------------------------------------------------------------------
Total revenue $143 $146
Less fund administration and servicing costs 8 13
- ------------------------------------------------------------------
Revenue used for operating margin
calculation, as reported $135 $133
Operating margin, as reported 40% 38%
Operating margin, GAAP basis 38% 34%
PNC believes that operating margin, as reported, is an effective indicator of
management's ability to effectively employ BlackRock's resources. Fund
administration and servicing costs have been excluded from the operating margin
calculation because these costs are a fixed, asset-based expense which can
fluctuate based on the discretion of a third party.
(c) At March 31 - in billions.
(d) Includes BlackRock Funds, BlackRock Provident Institutional Funds,
BlackRock Closed End Funds, Short Term Investment Fund and BlackRock Global
Series.
The financial information presented reflects BlackRock on a stand-alone basis.
BlackRock is approximately 69% owned by PNC and is consolidated into PNC's
financial statements. Accordingly, approximately 31% of BlackRock's earnings are
recognized as a minority interest expense in the Consolidated Statement of
Income.
BlackRock is one of the largest publicly traded investment management firms in
the United States with approximately $274 billion of assets under management at
March 31, 2003. 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(R) 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 earned $35 million for the first quarter of 2003 compared with $31
million for the first quarter of 2002. Higher earnings for the first quarter of
2003 reflected the impact of lower total expenses that more than offset the
effect of lower revenue in the first quarter of 2003. Total revenue for the
first three months of 2003 decreased $3 million compared with the same period in
2002 reflecting declines in open-end fund revenue and fixed income hedge fund
performance fees that were partially offset by growth in separate account base
fees and other revenue.
Total expenses decreased $7 million, or 8%, in the first three months of 2003
compared with the prior year quarter as reductions in compensation and benefits
expenses and fund administration and servicing costs were partially offset by an
increase in general and administrative expenses.
Income taxes remained flat compared with the first quarter of 2002 despite an
increase in pretax earnings. The effective tax rate for 2003 has decreased due
to a decision that BlackRock will file certain combined and unitary state income
tax returns with PNC subsidiaries.
See Note 1 Accounting Policies for information regarding investments in variable
interest entities that are expected to be accounted for under the Financial
Accounting Standards Board's ("FASB") FASB Interpretation No. ("FIN") 46 and the
expected impact on BlackRock earnings.
BlackRock is listed on the New York Stock Exchange under the symbol BLK.
Additional information about BlackRock is available in its SEC filings at
www.sec.gov.
11
PFPC
Three months ended March 31
Dollars in millions 2003 2002
- -----------------------------------------------------------------
INCOME STATEMENT
Fund servicing revenue $193 $213
Operating expense 162 170
(Accretion)/amortization of
other intangibles, net (4) (5)
- -----------------------------------------------------------------
Operating income 35 48
Nonoperating income (a) 2 4
Debt financing 17 23
- -----------------------------------------------------------------
Pretax earnings 20 29
Income taxes 8 12
- -----------------------------------------------------------------
Earnings $12 $17
=================================================================
AVERAGE BALANCE SHEET
Goodwill and other intangible assets $1,025 $1,036
Other assets 840 812
- -----------------------------------------------------------------
Total assets $1,865 $1,848
- -----------------------------------------------------------------
Assigned funds and other liabilities $1,657 $1,640
Assigned capital 208 208
- -----------------------------------------------------------------
Total funds $1,865 $1,848
=================================================================
PERFORMANCE RATIOS
Return on assigned capital 23% 33%
Operating margin (b) 18 23
- -----------------------------------------------------------------
SERVICING STATISTICS (c)
Accounting/administration net assets (d)
Domestic $542 $520
Foreign (e) 31 23
- -----------------------------------------------------------------
Total $573 $543
Custody assets (d) $347 $339
Shareholder accounts (in millions) 48 49
- -----------------------------------------------------------------
OTHER INFORMATION
Average FTEs 5,437 6,046
- -----------------------------------------------------------------
(a) Net of nonoperating expense.
(b) Operating income divided by total fund servicing revenue.
(c) At March 31.
(d) In billions.
(e) Represents net assets serviced offshore.
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, offering 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.
The financial results for this business may be significantly impacted by the net
gain or loss of large clients or groups of smaller clients and by shifts in
client assets between higher and lower margin products. PFPC has been adversely
impacted by depressed financial market conditions, a shift in client assets from
equity to fixed income products and client attrition. Accordingly, management is
addressing the revenue/expense relationship of this business given current
conditions. Additionally, PFPC is increasingly focused on retaining its
long-standing customers and has recently been awarded several new servicing
contracts, partially offsetting the revenue impact of client attrition,
including the loss of one large transfer agency client that occurred in the
first quarter of 2003.
PFPC is also focusing technological resources on targeting Web-based
initiatives, streamlining operations and developing flexible systems
architecture and client-focused servicing solutions. To meet the growing needs
of the European marketplace, PFPC is also continuing to expand offshore.
During the first quarter of 2003, PNC purchased the minority
interests, representing approximately 2% of PFPC outstanding common stock, from
other PFPC shareholders and cashed out or converted all outstanding PFPC stock
options. The impact of this transaction was not material to PFPC's financial
results or the consolidated financial results of PNC.
PFPC earned $12 million for the first quarter of 2003 compared with $17 million
for the first quarter of 2002. Earnings for the first three months of 2003
declined compared with the prior year quarter as the effect of lower fund
servicing revenue more than offset lower operating and debt financing costs.
The depressed market conditions, a shift in product mix and the impact of client
attrition, coupled with the cost of technology and infrastructure enhancements,
exerted pressure on operating margins. Margins are expected to remain under
pressure at least until equity markets and investor sentiment and demand improve
for a sustained period.
Fund servicing revenue of $193 million for the first three months of 2003
decreased $20 million compared with the first three months of 2002. The positive
impact of new sales of accounting/administration services and offshore growth
could not overcome revenue declines resulting from client attrition and equity
market performance that impacted both shareholder activity levels and fund net
asset valuations.
Operating expense decreased $8 million or 5% in the period-to-period comparison
primarily due to reductions in staff and contract programmer expenses. In the
second half of 2002, PFPC began a series of initiatives designed to improve
efficiency. These included such projects as consolidating transfer agency
platforms, increasing automation and executing planned facilities consolidation.
PFPC's goal in 2003 is to reduce expenses by $40 million before factoring in the
impact of reinvestment in technology and new business. Accordingly, the
workforce has been reduced as average FTEs declined 10% for the first quarter
2003 compared with the first quarter of 2002.
During the second quarter of 2003, PFPC entered into an agreement to sell its
retirement services business to Wachovia Retirement Services, part of Wachovia
Corp., for an undisclosed amount. The transaction is expected to close later
this year. PFPC did not believe it had sufficient scale to generate shareholder
value in this product line. This transaction is not expected to have a material
effect on ongoing PFPC operating results.
Operating income for the first three months of 2003 and 2002 reflected the
accretion of a discounted client contract liability of $8 million and $9
million, respectively.
Accounting/administration net assets serviced have increased compared with March
31, 2002 primarily due to new business, which more than offset decreased asset
valuations due to equity market performance. The decline in shareholder accounts
serviced compared with March 31, 2002 was primarily due to the loss of one large
transfer agency client.
In the fourth quarter of 2001, PFPC incurred $36 million of pretax charges
related to a plan to consolidate certain facilities. The charges primarily
reflected costs related to exiting certain lease agreements and the abandonment
of related leasehold improvements. During the first three months of 2003, the
Corporation recognized a $5 million reduction of the related liability
consistent with the original consolidation plans. The remaining liability was $9
million at March 31, 2003.
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 net interest
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 was $506 million and the net interest
margin was 3.76% for the first quarter of 2003 compared with $593 million and
4.12%, respectively, for the first quarter of 2002. The declines in
taxable-equivalent net interest income and net interest margin compared with the
first quarter of 2002 were primarily due to the impact of the lower interest
rate environment in 2003 and a $3.6 billion or 6% decrease in average earning
assets. The decline in average earning assets resulted from continued downsizing
of the institutional lending portfolio and run-off of residential mortgages, the
impact of which was partially offset by a higher level of federal funds sold
that increased overall balance sheet liquidity. See Interest Rate Risk in the
Risk Management section of this Financial Review for additional information.
PROVISION FOR CREDIT LOSSES
The provision for credit losses was $36 million for the first quarter of 2003
compared with $82 million for the first quarter of 2002. Net charge-offs were
$36 million or .42% of average loans for the first quarter of 2003 compared with
$41 million, or .43%, respectively, for the first quarter of 2002. The provision
for credit losses in the first quarter of 2002 included an addition to reserves
related to the Corporate Banking business and the PNC Business Credit portfolio.
The Corporate Banking additional reserves were in connection with an apparent
fraud related to a seller of receivables to Market Street. The additional
reserves for PNC Business Credit reflected economic conditions and the growth of
its loan portfolio.
NONINTEREST INCOME
Total noninterest income was $795 million for the first quarter of 2003 compared
with $790 million for the first quarter of 2002. Asset management, fund
servicing and brokerage fees declined by $14 million, $19 million and $14
million, respectively, compared with the prior year quarter while net securities
gains increased by $52 million.
Asset management fees totaled $207 million for the first quarter of 2003, a
decline of $14 million compared with the first quarter of 2002. The decrease
compared with the prior year quarter reflected the continued negative impact of
the weak equity markets. Consolidated assets under management were $313 billion
at March 31, 2003, an increase of $28 billion from March 31, 2002. The increase
compared with March 31, 2002 reflected growth in fixed income assets managed by
BlackRock that was partially offset by declines in liquidity and equity assets.
Fund servicing fees were $193 million for the first three months of 2003
compared with $212 million for the first quarter of 2002. The positive impact of
new sales of accounting/administration services and offshore growth could not
overcome revenue declines resulting from client attrition and equity market
performance that impacted both shareholder activity levels and fund net asset
valuations.
Service charges on deposits totaled $57 million in the first quarter of 2003, an
increase of $3 million, or 6%, compared with the first quarter of 2002. The
increase was attributable to higher transaction volumes per account and a 6%
increase in checking relationships over the prior year quarter.
Brokerage fees declined $14 million, to $41 million, in the first three months
of 2003 compared with the year-ago quarter as lower sales commissions and lower
trading volumes resulted from the impact of depressed financial market
conditions.
13
Consumer services revenue totaled $59 million for the first quarter of 2003, an
increase of $4 million, or 7%, compared with the first quarter of 2002. The
increase reflects additional fees from ATM transactions arising from growth in
transaction volumes due to an increase in the number of ATM machines and
interchange rates and additional fees from debit card transactions arising from
higher transaction volumes. Visa recently settled litigation with major
retailers regarding pricing and usage of consumer debit cards. The settlement
will effectively lower prices paid by merchants to Visa and its member banks.
Although PNC was not a defendant in the litigation, the settlement will lower
future revenue from certain debit card transactions beginning in the third
quarter of 2003. Based on current cards issued and transaction mix and the
reduced fee effective August 1, 2003, the lost revenue impact to PNC is
estimated to be approximately $6 million in 2003.
Corporate services revenue was $116 million for the first three months of 2003
compared with $118 million for the prior year quarter. Net gains in excess of
valuation adjustments related to the liquidation of institutional loans held for
sale included in corporate services revenue totaled $15 million for the first
quarter of 2003 and $23 million for the first quarter of 2002. Treasury
management fees totaled $57 million for the first quarter of 2003, a $4 million
increase over the same period of 2002.
Equity management (private equity activities) net losses on portfolio
investments were $4 million in the first quarter of 2003 and $2 million for the
first quarter of 2002.
Net securities gains totaled $56 million for the first quarter of 2003 and $4
million for the first quarter of 2002. Net securities gains in 2003 included $25
million related to the liquidation of the three entities formed in 2001 in
transactions with AIG.
Other noninterest income was $70 million for the first three months of 2003, a
decline of $3 million from the first three months of 2002 primarily due to lower
gains on sales of loans. Net trading income included in other noninterest income
was $27 million for the first quarter of 2003 compared with $24 million for the
first quarter of 2002. See Note 5 Trading Activities in the Notes to
Consolidated Financial Statements for additional information.
NONINTEREST EXPENSE
Total noninterest expense was $856 million for the first quarter of 2003, an
increase of $49 million compared with the first quarter of 2002. The efficiency
ratio was 66% for the first three months of 2003 and 58% for the first three
months of 2002. First quarter 2003 noninterest expense included $29 million of
costs paid in connection with the liquidation of the three entities formed in
2001 in transactions with AIG and a facilities charge of $23 million related to
leased space consistent with the requirements of Statement of Financial
Accounting Standards ("SFAS") No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities." The financial impact of the liquidation costs
incurred in connection with the liquidation of the entities formed in 2001 in
transactions with AIG on first quarter 2003 pretax income was mostly offset by
related net securities gains included in noninterest income. The benefit of
efficiency initiatives was reflected in other categories of noninterest expense
for the first three months of 2003.
Average employees totaled approximately 23,600 and 24,100 for the first three
months of 2003 and 2002, respectively. The decrease was mainly in Regional
Community Banking, PNC Advisors and PFPC.
14
CONSOLIDATED BALANCE SHEET REVIEW
LOANS
Loans were $35.2 billion at March 31, 2003, a $.2 billion decrease from December
31, 2002 primarily due to runoff in the residential mortgage and auto lease
portfolios.
DETAILS OF LOANS
March 31 December 31
In millions 2003 2002
- ---------------------------------------------------------------
Commercial
Retail/wholesale $4,147 $4,161
Manufacturing 3,685 3,454
Service providers 1,978 1,906
Real estate related 1,441 1,481
Financial services 1,255 1,218
Communications 110 124
Health care 422 458
Other 2,035 2,185
- ---------------------------------------------------------------
Total commercial 15,073 14,987
- ---------------------------------------------------------------
Commercial real estate
Real estate project 1,749 1,750
Mortgage 492 517
- ---------------------------------------------------------------
Total commercial real estate 2,241 2,267
- ---------------------------------------------------------------
Consumer
Home equity 8,435 8,108
Automobile 476 484
Other 1,209 1,262
- ---------------------------------------------------------------
Total consumer 10,120 9,854
- ---------------------------------------------------------------
Residential mortgage 3,627 3,921
Lease financing
Equipment 3,500 3,560
Vehicle 1,346 1,521
- ---------------------------------------------------------------
Total lease financing 4,846 5,081
- ---------------------------------------------------------------
Other 356 415
Unearned income (1,018) (1,075)
- ---------------------------------------------------------------
Total, net of unearned income $35,245 $35,450
===============================================================
Loan portfolio composition continued to be diversified across PNC's footprint
among numerous industries and types of businesses.
Portfolio composition based on the total of loans and unfunded commitments
remained concentrated in investment grade equivalent exposure and secured
lending. Exposure to client relationships with greater than $50 million in loans
and unfunded commitments totaled $13.1 billion at March 31, 2003, compared with
$13.4 billion at December 31, 2002. Of the total exposure to relationships with
greater than $50 million in loans and unfunded commitments at March 31, 2003,
69% was investment grade equivalent.
WHOLESALE LENDING STATISTICS
March 31 December 31
2003 2002
- ------------------------------------------------------------------
Portfolio composition-total exposure
Investment grade equivalent 51% 52%
Non-investment grade-secured
lending 25 24
Non-investment grade 24 24
- ------------------------------------------------------------------
Total 100% 100%
- ------------------------------------------------------------------
Client relationships >$50 million-total
exposure $13,086 $13,392
Client relationships >$50
million-customers 145 140
- ------------------------------------------------------------------
The equipment lease financing portfolio totaled $3.5 billion at March 31, 2003
and included approximately $1.5 billion of cross border leases. These leases are
primarily leveraged leases of equipment located in foreign countries, primarily
in western Europe and Australia.
Aggregate residual value at risk on the total commercial lease portfolio at
March 31, 2003 was $1.2 billion. Steps have been taken to mitigate $.7 billion
of this residual risk, leaving $.5 billion of unmitigated risk.
At March 31, 2003, loans of $35.2 billion included $1.2 billion of vehicle
leases, net of unearned income, and $9 million of commercial and commercial real
estate loans that have been designated for exit.
At March 31, 2003, PNC's vehicle leasing business had $1.2 billion in assets
that have been designated for exit comprised of vehicle leases with an aggregate
residual value of $.9 billion and $.3 billion of estimated future customer lease
payments. As of March 31, 2003, there were approximately 59,300 active vehicle
leases scheduled to mature as follows: 18,300, 22,000, 12,800, 6,200 and less
than 100 in years 2003, 2004, 2005, 2006 and 2007, respectively. The associated
residual values are as follows: $340 million, $350 million, $180 million, $70
million and less than $.2 million, respectively.
A 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 March 31, 2003, the related liability was
$119 million. Until the remaining leases mature, the Corporation will continue
to be subject to risks inherent in the vehicle leasing business, including
credit risk and the risk that vehicles returned during or at the conclusion of
the lease term cannot be disposed of at a price at least as great as the
Corporation's remaining investment in the vehicles after application of any
available residual value insurance or related reserves. The assumptions that
were used to establish these reserves in 2001 are monitored and evaluated on an
ongoing basis. Accordingly, these reserves were considered adequate at March 31,
2003.
NET UNFUNDED COMMITMENTS
March 31 December 31
In millions 2003 2002
- ----------------------------------------------------------------
Commercial $18,740 $19,525
Commercial real estate 690 718
Consumer 5,450 5,372
Lease financing 89 103
Other 136 125
Institutional lending repositioning 547 1,015
- ----------------------------------------------------------------
Total $25,652 $26,858
================================================================
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 $6.2 billion at both March 31,
2003 and December 31, 2002.
15
Net outstanding letters of credit totaled $3.7 billion at both March 31, 2003
and December 31, 2002 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 $1.7 billion at March 31, 2003 compared with $1.6
billion at December 31, 2002.
DETAILS OF LOANS HELD FOR SALE
March 31 December 31
In millions 2003 2002
- -----------------------------------------------------------------
Institutional lending repositioning
Commercial
Manufacturing $99 $126
Communications 10 32
Service providers 7 16
Retail/wholesale 6 12
Financial services 12 17
Health care 11 21
Real estate related 2
Other 16 27
- -----------------------------------------------------------------
Total commercial 161 253
- -----------------------------------------------------------------
Commercial real estate 20 45
- -----------------------------------------------------------------
Total institutional lending
repositioning 181 298
Education loans 1,243 1,035
Other 278 274
- -----------------------------------------------------------------
Total loans held for sale $1,702 $1,607
=================================================================
Details of the credit exposure and outstandings by business in the institutional
lending held for sale and exit portfolios are included in the Wholesale Banking
sections of the Review of Businesses within this Financial Review. A rollforward
of the institutional lending held for sale portfolio follows:
ROLLFORWARD OF INSTITUTIONAL LENDING HELD FOR SALE PORTFOLIO
In millions Credit Exposure Outstandings
- -----------------------------------------------------------------
January 1, 2003 $626 $298
Additions 3
Sales (106) (66)
Payments and other exposure
reductions (153) (38)
Valuation adjustments, net (23) (16)
- -----------------------------------------------------------------
March 31, 2003 $344 $181
=================================================================
During the first three months of 2003 and 2002, the liquidation of institutional
loans held for sale resulted in net gains in excess of valuation adjustments of
$15 million and $23 million, respectively. Details by Wholesale Banking business
for the first three months of 2003 follow:
INSTITUTIONAL LENDING HELD FOR SALE ACTIVITY
Three months ended
March 31, 2003 Net gains on Valuation
In millions liquidation adjustments Total
- -----------------------------------------------------------------
Corporate Banking $30 $(13) $17
PNC Real Estate Finance 8 (7) 1
PNC Business Credit (3) (3)
- -----------------------------------------------------------------
Total $38 $(23) $15
=================================================================
Substantially all education loans are classified as loans held for sale. The
increase in education loans at March 31, 2003, compared with December 31, 2002,
reflected the seasonal nature of this loan activity.
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
March 31 December 31
Dollars in millions 2003 2002
- -------------------------------------------------------------------
Nonaccrual loans
Commercial $252 $226
Lease financing 51 57
Commercial real estate 13 7
Consumer 11 11
Residential mortgage 7 7
- -------------------------------------------------------------------
Total nonaccrual loans 334 308
Troubled debt restructured loan 1 1
- -------------------------------------------------------------------
Total nonperforming loans 335 309
Nonperforming loans held for sale (a) 61 97
Foreclosed assets
Residential mortgage 6 6
Other 6 6
- -------------------------------------------------------------------
Total foreclosed assets 12 12
- -------------------------------------------------------------------
Total nonperforming assets $408 $418
===================================================================
Nonperforming loans to total loans .95% .87%
Nonperforming assets to total loans,
loans held for sale and foreclosed
assets 1.10 1.13
Nonperforming assets to total assets .59 .63
===================================================================
(a) Includes troubled debt restructured loans held for sale of $12 million and
$17 million as of March 31, 2003 and December 31, 2002, respectively.
Of the total nonperforming loans at March 31, 2003, 39% are related to PNC
Business Credit. PNC Business Credit loans, including those acquired in the NBOC
acquisition, are secured loans to borrowers, many of whom are highly leveraged,
experiencing rapid growth, or have elected to utilize asset-based financing. As
a result, the risk profile of these loans typically reflects a higher risk of
default and a greater proportion being classified as nonperforming. The above
table excludes nonperforming equity management assets carried at estimated fair
value of $30 million and $40 million at March 31, 2003 and December 31, 2002,
respectively, and included in other assets on the Consolidated Balance Sheet.
Nonperforming equity management assets at March 31, 2003 and December 31, 2002,
include $3 million and $12 million, respectively, of troubled debt restructured
assets.
The amount of nonperforming loans that were current as to principal and interest
was $101 million at March 31, 2003 and $107 million at December 31, 2002. The
amount of nonperforming loans held for sale that were current as to principal
and interest was $21 million at March 31, 2003 and $46 million at December 31,
2002.
16
NONPERFORMING ASSETS BY BUSINESS
March 31 December 31
In millions 2003 2002
- ----------------------------------------------------------------
Regional Community Banking $86 $82
Corporate Banking 166 187
PNC Real Estate Finance 12 2
PNC Business Credit 139 142
PNC Advisors 5 5
- ----------------------------------------------------------------
Total nonperforming assets $408 $418
================================================================
At March 31, 2003, Corporate Banking and PNC Business Credit had nonperforming
loans held for sale of $52 million and $7 million, respectively, which are
included in the preceding table.
CHANGE IN NONPERFORMING ASSETS
In millions 2003 2002
- ----------------------------------------------------------------
January 1 $418 $391
Transferred from accrual 111 232
Returned to performing (1) (18)
Principal reductions (55) (63)
Asset sales (18) (69)
Charge-offs and valuation adjustments (47) (35)
- ----------------------------------------------------------------
March 31 $408 $438
================================================================
For the remainder of 2003, continued 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.
ACCRUING LOANS AND LOANS HELD FOR SALE PAST DUE 90 DAYS OR MORE
Percent of Total
Amount Outstandings
----------------------------------------
Mar. 31 Dec. 31 Mar. 31 Dec. 31
Dollars in millions 2003 2002 2003 2002
- ------------------------------------------------------------------
Commercial $17 $41 .11% .27%
Commercial real estate 6 10 .27 .44
Consumer 29 25 .29 .25
Residential mortgage 43 38 1.18 .97
Lease financing 2 1 .05 .02
- ------------------------------------------------------------------
Total loans 97 115 .28 .32
Loans held for sale 13 32 .76 1.99
- ------------------------------------------------------------------
Total loans and
loans held for sale $110 $147 .30% .40%
==================================================================
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 $223 million and $11 million,
respectively, at March 31, 2003. Approximately 45% of these loans are in the PNC
Business Credit portfolio and all of the loans held for sale relate to the
institutional lending repositioning.
ALLOWANCES FOR CREDIT LOSSES AND UNFUNDED LOAN COMMITMENTS AND LETTERS OF CREDIT
The Corporation maintains an allowance for credit losses to absorb losses from
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.
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 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.
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. Enhancements and
refinements to the reserve methodology in 2002 consisted of updating data
elements in the pool reserve model. Specifically, the EDP, EAD and LGD
parameters were enhanced to reflect updated historical performance 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 loans outstanding 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 probable losses 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
March 31, 2003 December 31, 2002
--------------------------------------------
Loans to Loans to
Total Total
Dollars in millions Allowance Loans Allowance Loans
- -----------------------------------------------------------------
Commercial $509 42.8% $504 42.3%
Commercial
real estate 60 6.3 52 6.4
Consumer 28 28.7 28 27.8
Residential mortgage 10 10.3 10 11.0
Lease financing
and other 73 11.9 79 12.5
- -----------------------------------------------------------------
Total $680 100.0% $673 100.0%
=================================================================
For purposes of this presentation, the unallocated portion of the allowance for
credit losses of $111 million at March 31, 2003 and $112 million at December 31,
2002 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 16% of the total allowance and .32% of total loans at March
31, 2003, compared with 17% and .32%, respectively, at December 31, 2002.
Enhancements and refinements to the reserve methodology during 2002 resulted in
a reallocation of the allowance for credit losses among the Corporation's
businesses and from unallocated to specific and pool categories.
The provision for credit losses for the first three months of 2003 and the
evaluation of the allowances for credit losses and unfunded loan commitments and
letters of credit as of March 31, 2003 reflected changes in loan portfolio
composition and changes in asset quality. The provision includes amounts for
probable losses on loans and credit exposure related to unfunded loan
commitments and letters of credit.
ROLLFORWARD OF ALLOWANCE FOR CREDIT LOSSES
In millions 2003 2002
- -----------------------------------------------------------------
January 1 $673 $560
Charge-offs (50) (57)
Recoveries 14 16
- -----------------------------------------------------------------
Net charge-offs (36) (41)
Provision for credit losses 36 82
Acquired allowance (NBOC acquisition) 41
Net change in allowance for unfunded
loan commitments and letters of credit 7 (29)
- -----------------------------------------------------------------
March 31 $680 $613
=================================================================
ROLLFORWARD OF ALLOWANCE FOR UNFUNDED LOAN COMMITMENTS AND LETTERS OF CREDIT
In millions 2003 2002
- -----------------------------------------------------------------
January 1 $84 $70
Net change in allowance for unfunded
loan commitments and letters of credit (7) 29
- -----------------------------------------------------------------
March 31 $77 $99
==================================================================
The allowance as a percent of nonperforming loans and total loans was 203% and
1.93%, respectively, at March 31, 2003. The comparable first quarter 2002
percentages were 244% and 1.59%, respectively.
18
CHARGE-OFFS AND RECOVERIES
Percent of
Three months ended March 31 Net Average
Dollars in millions Charge-offs Recoveries Charge-offs Loans
- --------------------------------------------------------------------------------
2003
Commercial $32 $10 $22 .59%
Commercial real estate
Consumer 10 3 7 .28
Residential mortgage
Lease financing 8 1 7 .73
- -------------------------------------------------------------------
Total $50 $14 $36 .42
================================================================================
2002
Commercial $39 $10 $29 .72%
Commercial real estate 2 2 .33
Consumer 10 4 6 .26
Residential mortgage 1 1
Lease financing 5 1 4 .37
- -------------------------------------------------------------------
Total $57 $16 $41 .43
================================================================================
CREDIT-RELATED INSTRUMENTS
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 March 31, 2003, credit default swaps with
$232 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 And Other Derivatives section of this
Financial Review. The comparable amount was $184 million at December 31, 2002.
Net losses realized in connection with credit default swaps for quarter ending
March 31, 2003 were not significant.
INTEREST RATE DERIVATIVE RISK PARTICIPATION AGREEMENTS
The Corporation enters into risk participation agreements to share credit
exposure with other financial counterparties related to interest rate derivative
contracts. Risk participation agreements executed by the Corporation to mitigate
credit risk had a total notional value of $35 million at March 31, 2003 compared
with $43 million at December 31, 2002. Additionally, risk participation
agreements entered into in which the Corporation assumed credit exposure had a
total notional value of $50 million at March 31, 2003 compared with $109 million
at December 31, 2002. These agreements are considered to be financial guarantees
and therefore are not included in the Financial And Other Derivatives section of
this Financial Review.
SECURITIES
Total securities were $15.0 billion and represented 22% of total assets at March
31, 2003 compared with $13.8 billion and 21%, respectively, at December 31,
2002. The increases were primarily due to purchases during the first quarter of
2003 of mortgage-backed and asset-backed securities partially offset by sales of
securities of United States government agencies and securities designated as
held to maturity at December 31, 2002.
At March 31, 2003, the securities available for sale balance included a net
unrealized gain of $257 million, which represented the difference between fair
value and amortized cost. The comparable amount at December 31, 2002 was a net
unrealized gain of $274 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 2 years and 8 months
at both March 31, 2003 and December 31, 2002.
Securities designated as held to maturity at December 31, 2002 were carried at
amortized cost and were assets of companies formed in 2001 in transactions with
AIG that were consolidated in PNC's financial statements. In January 2003, these
securities were sold and these companies were liquidated. The expected
weighted-average life of securities held to maturity was 20 years and 2 months
at December 31, 2002.
DETAILS OF SECURITIES
Amortized Fair
In millions Cost Value
- -----------------------------------------------------------------
MARCH 31, 2003
SECURITIES AVAILABLE FOR SALE
Debt securities
U.S. Treasury and government agencies $457 $459
Mortgage-backed 10,575 10,766
Asset-backed 3,147 3,208
State and municipal 57 59
Other debt 53 56
Corporate stocks and other 427 425
- -----------------------------------------------------------------
Total securities available for sale $14,716 $14,973
=================================================================
December 31, 2002
SECURITIES AVAILABLE FOR SALE
Debt securities
U.S. Treasury and government agencies $813 $826
Mortgage-backed 8,916 9,103
Asset-backed 2,699 2,780
State and municipal 61 63
Other debt 58 61
Corporate stocks and other 597 585
- -----------------------------------------------------------------
Total securities available for sale $13,144 $13,418
- -----------------------------------------------------------------
SECURITIES HELD TO MATURITY
Debt securities
U.S. Treasury and government agencies $276 $309
Asset-backed 8 8
Other debt 61 61
- -----------------------------------------------------------------
Total securities held to maturity $345 $378
=================================================================
19
EQUITY MANAGEMENT ACTIVITIES
At March 31, 2003, equity management (private equity activities) investments
carried at estimated fair value totaled approximately $577 million compared with
$530 million at December 31, 2002. As of March 31, 2003, approximately 51% of
the amount is invested directly in a variety of companies and approximately 49%
is invested in various limited partnerships. Equity management funding
commitments totaled $204 million at March 31, 2003 compared with $173 million at
December 31, 2002. The valuation of equity management assets is subject to the
performance of the underlying companies as well as market conditions and may be
volatile. There is a time lag in the Corporation's receipt of the financial
information that is the primary basis for the valuation of the limited
partnership interests. Consequently, PNC will recognize in the second quarter of
2003 valuation changes related to limited partnership investments that reflect
the impact of first quarter 2003 market conditions and performance of the
underlying companies. The Corporation continues to make private equity
investments at a more moderate pace than prior years and consistent with current
market conditions. Currently, emphasis is being placed on the management of
capital for other investors. See Equity Management Asset Valuation in the Risk
Factors section of this Financial Review for additional information.
FUNDING SOURCES
Total funding sources were $55.6 billion at March 31, 2003 and $54.1 billion at
December 31, 2002, an increase of $1.5 billion corresponding to an increase of
$2.2 billion in total assets and an increase in accrued expenses and other
liabilities of $.8 billion. Total deposits increased $2.1 billion from December
31, 2002 due to an increase in demand and money market deposits. This increase
included a deposit of approximately $900 million from a single customer received
prior to the end of the first quarter of 2003. As expected, this deposit was
subsequently withdrawn in April 2003.
DETAILS OF FUNDING SOURCES
March 31 December 31
In millions 2003 2002
- -------------------------------------------------------------------
Deposits
Demand and money market $34,643 $32,349
Savings 2,110 2,014
Retail certificates of deposit 9,392 9,839
Other time 367 317
Deposits in foreign offices 569 463
- -------------------------------------------------------------------
Total deposits 47,081 44,982
- -------------------------------------------------------------------
Borrowed funds
Federal funds purchased 34 38
Repurchase agreements 1,082 814
Bank notes and senior debt 3,850 4,400
Federal Home Loan Bank borrowings 1,146 1,256
Subordinated debt 2,234 2,423
Other borrowed funds 188 185
- -------------------------------------------------------------------
Total borrowed funds 8,534 9,116
- -------------------------------------------------------------------
Total $55,615 $54,098
===================================================================
LIQUIDITY
Liquid assets consist of short-term investments (federal funds sold and other
short-term investments) and securities available for sale. At March 31, 2003,
such assets totaled $18.9 billion, with $12.0 billion pledged as collateral for
borrowings, trust and other commitments. Secured advances from the Federal Home
Loan Bank, of which PNC Bank, N.A., ("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 March 31, 2003,
total unused borrowing capacity from the Federal Home Loan Bank under current
collateral requirements was $9.3 billion. 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 PNC's non-bank subsidiaries is also
generated through the issuance of securities in public or private markets and
lines of credit. At March 31, 2003, 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. In
March 2003, the Corporation entered into a new two-year $200 million credit
facility, which is intended to serve as a tool for managing corporate liquidity.
This facility, which is non-reciprocal, replaced the Corporation's $460 million
multi-bank facility that expired in March 2003.
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 statutory 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 $189 million at March 31, 2003.
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 March 31, 2003, the parent company had
approximately $938 million in funds available from its cash and short-term
investments or other funds available from unrestricted subsidiaries. Based on
the amount of funds currently available at the parent company level and the
amount of dividends currently payable by PNC Bank, management expects that the
parent company will have sufficient liquidity available to meet current
obligations to its debt holders, vendors, and others and to pay dividends at
current rates through 2003.
20
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 level of deposit insurance costs, and the level and nature
of regulatory oversight depend, in part, on a financial institution's capital
strength. Supervision and regulation is discussed in more detail in the Business
section of the 2002 Form 10-K. At March 31, 2003, each banking subsidiary of the
Corporation was considered "well capitalized" based on regulatory capital ratio
requirements.
RISK-BASED CAPITAL
March 31 December 31
Dollars in millions 2003 2002
- -------------------------------------------------------------------
Capital components
Shareholders' equity
Common $6,783 $6,849
Preferred 9 10
Trust preferred capital securities 848 848
Minority interest 244 234
Goodwill and other intangibles (2,485) (2,446)
Net unrealized securities gains (167) (179)
Net unrealized gains on cash flow
hedge derivatives (116) (135)
Equity investments in
nonfinancial companies (35) (34)
Other, net (23) (26)
- --------------------------------------------------------------------
Tier 1 risk-based capital 5,058 5,121
Subordinated debt 1,350 1,350
Minority interest 36
Eligible allowance for credit losses 727 726
- --------------------------------------------------------------------
Total risk-based capital $7,135 $7,233
====================================================================
Assets
Risk-weighted assets, including
off-balance sheet instruments and
market risk equivalent assets $58,159 $58,030
Adjusted average total assets 63,201 62,967
====================================================================
Capital ratios
Tier 1 risk-based 8.7% 8.8%
Total risk-based 12.3 12.5
Leverage 8.0 8.1
====================================================================
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.
Common shares outstanding at March 31, 2003 were 281.6 million. PNC's repurchase
program was adopted in January 2002 and permits the purchase of up to 35 million
shares of common stock through February 29, 2004. Under this program, PNC
purchased 4.4 million common shares during the first quarter of 2003 at a total
cost of $193 million. Management continues to be authorized to purchase up to a
total of $1.0 billion of its common stock during 2003. The extent and timing of
share repurchases during the remainder of the year will depend on a number of
factors including, among others, market and general economic conditions,
regulatory capital considerations, alternative uses of capital and the potential
impact on PNC's credit rating. Under applicable regulations, as long as PNC
remains subject to its written agreement with the Federal Reserve Bank of
Cleveland, it must obtain prior regulatory approval to repurchase its common
stock in amounts that exceed 10 percent of consolidated net worth in any
12-month period. A total of 4.7 million common shares have been repurchased
under this program from inception through March 31, 2003.
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 Business section of the 2002 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 and international hostilities. Reference
is made to the 2002 Form 10-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 be subject to variations
which may significantly affect PNC's reported results and financial position for
the period or in future periods. The use of estimates, assumptions, and
judgments are necessary when financial assets and liabilities are required to be
recorded at, or adjusted to reflect, fair value. Assets and liabilities carried
at fair value inherently result in more financial statement volatility. Fair
values and the information used to record valuation adjustments for certain
assets and liabilities are based on either quoted market prices or are provided
by other independent third-party sources, when available. When such information
is not available, management estimates valuation adjustments primarily by using
internal cash flow and other financial modeling techniques. 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.
See Note 3 Recent Accounting Pronouncements and Note 14 Commitments and
Guarantees regarding the Corporation's adoption of FIN 45 effective January
1, 2003. Also, see Note 1 Accounting Policies for further information regarding
investments in variable interest entities that are expected to be accounted for
under FIN 46 and that may have a material impact on PNC's financial condition
and results of operations.
21
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, exposure at default, 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 $509 million, or 75%, of the total
allowance for credit losses at March 31, 2003 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. See the Allowances For
Credit Losses And Unfunded Loan Commitments And Letters Of Credit section in the
Consolidated Balance Sheet Review and Note 7 Allowances For Credit Losses And
Unfunded Loan Commitments And Letters of Credit for additional information.
LOANS HELD FOR SALE
At the time management intends to sell credit exposure, management designates
the exposure as held for sale. At the initial transfer date to held for sale,
any lower of cost or market ("LOCOM") adjustment is recorded as a charge-off,
which on an outstanding loan results in a new cost basis. On the unfunded
portion of the total exposure, a liability is established. Any subsequent
adjustment as a result of LOCOM is recorded as a valuation allowance through
noninterest income on the loan portion classified as held-for-sale. Any
permanent reduction of the exposure, such as sale or termination of the
exposure, may have an impact on the exposure's valuation allowance or liability.
This change in valuation allowance or liability is recorded through 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 the asset 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. See the Loans Held For Sale section in the
Consolidated Balance Sheet Review for additional information.
EQUITY MANAGEMENT ASSET VALUATION
Equity management (private equity) assets are valued at each balance sheet date
based on primarily 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 of the investments. Changes in the
value of equity management investments are reflected in the Corporation's
results of operations. 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 and from the assumptions made by the general
partners, respectively, resulting in lower valuations that could adversely
impact earnings in future periods. Accordingly, the valuations may not represent
amounts that will ultimately be realized from these investments. See the Equity
Management Activities section in the Consolidated Balance Sheet Review and Note
1 Accounting Policies for additional information.
COMMERCIAL MORTGAGE SERVICING RIGHTS
Commercial mortgage servicing rights ("MSR") are intangible assets that
represent the value of rights that arise from the servicing of commercial loan
contracts. While servicing is inherent in most financial assets, it becomes a
distinct asset when (a) contractually separated from the underlying financial
asset by sale or securitization of the asset with servicing retained or (b)
through the separate purchase and assumption of the servicing. The Corporation's
MSR asset value (both originated and purchased) arises from estimates of future
revenues from contractually specified servicing fees, interest income and other
ancillary revenues, net of estimated operating expenses, which are expected to
yield an acceptable level of risk adjusted return for the servicer.
22
The fair value of the Corporation's MSR asset is estimated using a discounted
cash flow methodology, which calculates the net present value of future cash
flows of the servicing portfolio over the estimated life of the asset based on
various assumptions and market factors, the most significant of which include
interest rates for escrow and deposit balance earnings, estimated prepayment
speeds, estimated servicing costs, portfolio stratification, and discount rates.
The reasonableness of these factors is reviewed by management and is based on
expectations of the portfolio, market conditions, and loan characteristics.
The Corporation's commercial loan servicing portfolio is subject to various
risks, the most significant being interest rate and prepayment risk, which
subject the MSR asset to impairment risk. While the MSR asset is amortized over
its estimated life in proportion to estimated net servicing income, it is also
tested for impairment at a strata level on a quarterly basis. The impairment
testing includes a positive and negative scenario for sensitivity
characteristics. If the estimated fair value of the MSR is less than the
carrying value, an impairment loss would be recognized in the current period;
however, any fair value in excess of the cost basis would not be recognized as
income.
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, manufacturing and vehicles through a variety of lease
arrangements, including leveraged leases of equipment located in foreign
countries, primarily in western Europe and Australia. A significant portion of
the residual value is subject to a lessee requirement to either purchase or
provide residual value insurance. 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 in the United States and in the applicable
foreign countries and the financial viability of the residual guarantors and
insurers. To the extent not assumed by a third party or otherwise mitigated, 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. Residual values are reviewed on a regular basis for
potential impairment.
GOODWILL
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.
RISK MANAGEMENT
In the normal course of business, the Corporation assumes various types of risk,
which include, among other things, credit risk, market risk and operating risk.
Liquidity risk is described in the Consolidated Balance Sheet Review section of
this Financial Review. See the Business section and Financial Review of the 2002
Form 10-K for further information. These factors and others could impact the
Corporation's business, financial condition and results of operations.
PNC has risk management processes designed to provide for risk identification,
measurement and monitoring. As previously reported, PNC has taken a number of
actions to enhance these processes, including centralization of the risk
management function and the ongoing development of an enterprise-wide risk
profile. In 2002 and the first quarter of 2003, PNC has devoted significant
resources toward enhancing its corporate governance and risk management
processes and policies. During this period, the Corporation has strengthened
its executive management team and, working closely with its regulatory
agencies, enhanced internal oversight with the previously announced appointment
of a new chief regulatory officer, new chief risk officer and new chief
compliance officer. In addition, the Corporation has added four new outside
directors bringing further financial and industry expertise to the board of
directors.
CREDIT RISK
Credit risk represents the possibility that a borrower, counterparty, insurer or
guarantor 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. Credit risk is the most common risk in banking and the most
significant risk to PNC.
The Corporation actively measures sources of credit risk based on the calculated
expected and unexpected losses in the portfolio. Expected loss is a component in
calculating the appropriate level of the allowance for credit losses. See the
Allowances for Credit Losses and Unfunded Commitments and Letters of Credit
section in the Consolidated Balance Sheet Review for additional information. The
unexpected loss calculation seeks to capture the loss volatility in the
portfolio and is the foundation for economic capital measurement at both the
transaction and business level. Stress testing and
23
scenario analyses are performed regularly, providing guidance to management on
the potential impact of macroeconomic events on the level of credit risk.
Critical to the measurement of credit risk is the accuracy of risk ratings in
the commercial loan portfolio. Corporate risk management reviews and, if
necessary, adjusts risk ratings at the time of approval. Subsequent to approval,
problem commercial loans are reviewed quarterly through the Special Asset
Committees. Additionally, an independent Credit Risk Review function audits risk
rating accuracy.
Board-approved risk tolerances and Executive Credit Committee approved policies
and procedures set the portfolio objectives for the level and composition of
credit risk. Guidelines have been established for the levels of aggregate
borrower exposure, problem loans and other credit metrics. Compliance with
portfolio limits based on risk pools is monitored and reported quarterly.
The Corporation seeks to achieve credit portfolio objectives by maintaining a
customer base that is diverse in borrower exposure and industry. Reductions in
risk concentrations are achieved through participations with third parties, loan
sales and credit derivatives. Loan evaluation tools that identify deteriorating
borrower credit quality are employed to actively manage and reduce exposure.
Capital measurement and customer profitability are employed to seek to manage
the risk/return relationship.
INTEREST RATE RISK
Interest rate risk arises primarily through the Corporation's traditional
business activities of extending loans and accepting deposits. Many factors,
including economic and financial conditions, movements in interest rates and
consumer preferences affect the spread between interest earned on assets and
interest paid on liabilities. In managing interest rate risk, the Corporation
seeks to minimize its reliance on a particular interest rate scenario as a
source of earnings while maximizing net interest income and net interest margin.
To further these objectives, the Corporation uses securities purchases and
sales, short-term and long-term funding, financial derivatives and other capital
markets instruments.
The Corporation actively measures and monitors components of interest rate risk
including term structure or repricing risk, yield curve or nonparallel rate
shift risk, basis risk and options 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. Because the
assumptions employed in these models are inherently uncertain, actual results
will differ from simulated results. Such analyses are used by management to
identify risk and develop strategies.
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, in the subsequent year, net interest income should not decrease
by more than 6%. The policy further states that the economic value of equity
should not decrease 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 decrease in interest rates, no rates are reduced
below zero.
At March 31, 2003, the Corporation's exposure to a 100 basis point decline in
interest rates in the second year exceeds the approved policy limit. Consistent
with the Corporation's policies, this exception has been reported to and
approved by the Finance Committee of the Board of Directors. In the current low
rate environment, management's actions have focused on reducing exposure to more
modest rate declines and on the effects of rate increases on net interest income
and the economic value of equity.
The following table sets forth the sensitivity results for the quarters ended
March 31, 2003 and 2002.
INTEREST SENSITIVITY ANALYSIS
March 31 March 31
2003 2002
- --------------------------------------------------------------------
NET INTEREST INCOME SENSITIVITY SIMULATION
Effect on net interest income in first
year from gradual interest rate change
over following 12 months of:
100 basis point increase .6 % (.2)%
100 basis point decrease (3.0)% (3.7)%
Effect on net interest income in second
year from gradual interest rate
change over the preceding 12 months of:
100 basis point increase 3.7 % (.5)%
100 basis point decrease (11.8)% (9.2)%
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 (.8)% (1.0)%
200 basis point decrease (.8)% .4%
KEY PERIOD-END INTEREST RATES
One month LIBOR 1.30% 1.88%
Three-year swap 2.31% 4.73%
====================================================================
In addition to measuring the effect on net interest income assuming parallel
changes in current interest rates, PNC routinely simulates the effects of a
number of nonparallel interest rate environments. The following table reflects
the percentage change in net interest income over the next two 12 month periods
assuming the PNC economist's most likely rate forecast, implied market forward
rates, a lower/steeper rate scenario and a higher/flatter scenario.
All changes in forecasted net interest income are relative to results in a base
rate scenario where current market rates are assumed to remain unchanged over
the forecast horizon.
24
NET INTEREST INCOME SENSITIVITY TO ALTERNATIVE RATE SCENARIOS
PNC Market
In millions Economist Forward Low/Steep High/Flat
- -----------------------------------------------------------------------------
Change in forecasted net interest income:
- -----------------------------------------------------------------------------
First year sensitivity None (.1)% (.3)% (.4)%
Second year sensitivity 2.3% 1.3% .2% (1.3)%
=============================================================================
The graph below presents the yield curves for each of the alternative scenarios
and for the base rate scenario one year forward.
The hard copy version of this Quarterly Report on Form 10-Q contains a graph
entitled "Alternative Interest Rate Scenarios" that reflects the following data
points:
Forecasted Rates-One Year Forward
---------------------------------
1-month 2-year 3-year 5-year
LIBOR Swap Swap Swap
------- ------ ------ ------
Base Rates 1.31% 1.99% 2.56% 3.39%
PNC Economist 1.85 2.68 3.24 4.06
Market Forward 1.69 2.92 3.36 3.94
Low/Steep 1.02 1.99 2.64 3.61
High/Flat 1.66 1.99 2.46 3.12
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 $27 million for the first
three months of 2003 compared with $24 million for the first three months of
2002. See Note 5 Trading Activities in the Notes to Consolidated Financial
Statements for additional information.
The Corporation seeks to manage risk associated with trading, capital markets
and foreign exchange activities 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 market-to-market loss
within a 99% confidence interval of one-day moves in key market risk factors,
such as interest rates. The estimated combined period-end value-at-risk of all
trading operations using this measurement was less than $.6 million at both
March 31, 2003 and March 31, 2002.
OPERATING RISK
The Corporation is exposed to a variety of operating risks that can affect each
of its business activities, particularly those involving processing and
servicing. Operating risk is defined as the risk of loss resulting from
inadequate or failed internal processes, people or systems or from external
events. The risk of loss also includes losses that may arise from the potential
legal actions that could result from operating deficiencies or noncompliance
with contracts, laws or regulations. PNC monitors and evaluates operating risk
on an ongoing basis through systems of internal control, formal Corporate-wide
policies and procedures, and an internal audit function.
25
FINANCIAL AND OTHER DERIVATIVES
As previously reported, the Corporation uses a variety of financial derivatives
as part of the overall asset and liability risk management process to help
manage interest rate, market and credit risk inherent in the Corporation's
business activities, and substantially all of such instruments are used to seek
to manage risk related to changes in interest rates. Not all elements of
interest rate, market and credit risk are addressed through the use of financial
or other derivatives, and such instruments may be ineffective for their intended
purposes due to unanticipated market characteristics among other reasons.
The following table sets forth changes, during the first three months of 2003,
in the notional value of financial derivatives used for risk management and
designated as accounting hedges under SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended.
FINANCIAL DERIVATIVES ACTIVITY
Weighted-
December 31 March 31 Average
Dollars in millions 2002 Additions Maturities Terminations 2003 Maturity
- -------------------------------------------------------------------------------------------------------------------------------
Interest rate risk management
Interest rate swaps
Receive fixed $5,823 $(1,250) $4,573 3 yrs. 3 mos.
Pay fixed 67 $12 $(1) (15) 63 4 yrs. 1 mo.
Basis swaps 52 52 5 yrs. 7 mos.
Interest rate caps 16 16 4 yrs. 5 mos.
Interest rate floors 7 7 2 yrs.
Futures contracts 313 72 (119) 266 7 mos.
- -------------------------------------------------------------------------------------------------------------
Total interest rate risk
management 6,278 84 (1) (1,384) 4,977
- -------------------------------------------------------------------------------------------------------------
Commercial mortgage banking risk
management
Pay fixed interest rate swaps 273 228 (239) 262 10 yrs. 2 mos.
Total rate of return swaps 100 75 (100) 75 3 mos.
- -------------------------------------------------------------------------------------------------------------
Total commercial mortgage
banking risk management 373 303 (100) (239) 337
- -------------------------------------------------------------------------------------------------------------
Total $6,651 $387 $(101) $(1,623) $5,314
===============================================================================================================================
26
The following tables set 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 March 31, 2003 and December 31, 2002.
Weighted-average interest rates presented are based on contractual terms, if
fixed, or the implied forward yield curve at each respective date, if floating.
FINANCIAL DERIVATIVES - 2003
Weighted-Average Interest Rates
Notional -------------------------------
March 31, 2003 - dollars in millions Value Fair Value Paid Received
- ----------------------------------------------------------------------------------------------------------------------------
Interest rate risk management
Asset rate conversion
Interest rate swaps (a)
Receive fixed designated to loans $2,210 $121 1.74% 4.44%
Pay fixed designated to loans 63 (8) 5.96 2.84
Basis swaps designated to loans 52 3.45 3.40
Interest rate caps designated to loans (b) 16 NM NM
Interest rate floors designated to loans (c) 7 NM NM
Futures contracts designated to loans 266 NM NM
- --------------------------------------------------------------------------------------------
Total asset rate conversion 2,614 113
- --------------------------------------------------------------------------------------------
Liability rate conversion
Interest rate swaps (a)
Receive fixed designated to borrowed funds 2,363 334 3.04 5.93
- --------------------------------------------------------------------------------------------
Total liability rate conversion 2,363 334
- --------------------------------------------------------------------------------------------
Total interest rate risk management 4,977 447
- --------------------------------------------------------------------------------------------
Commercial mortgage banking risk management
Pay fixed interest rate swaps designated to loans held for sale (a) 262 (8) 4.50 4.37
Pay total rate of return swaps designated to loans held for sale (a) 75 (1) NM .77
- --------------------------------------------------------------------------------------------
Total commercial mortgage banking risk management 337 (9)
- --------------------------------------------------------------------------------------------
Total financial derivatives designated for risk management $5,314 $438
============================================================================================================================
(a) The floating rate portion of interest rate contracts is based on
money-market indices. As a percent of notional value, 50% were based on
1-month LIBOR and 50% on 3-month LIBOR.
(b) Interest rate caps with notional values of $12 million require the
counterparty to pay the Corporation the excess, if any, of 3-month LIBOR
over a weighted-average strike of 6.50%. In addition, interest rate caps
with notional values of $4 million require the counterparty to pay the
excess, if any, of Prime over a weighted-average strike of 5.03%. At March
31, 2003, 3-month LIBOR was 1.28% and Prime was 4.25%.
(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. In addition, interest rate floors with notional
values of $2 million require the counterparty to pay the excess, if any, of
the weighted-average strike of 7.25% over Prime. At March 31, 2003, 3-month
LIBOR was 1.28% and Prime was 4.25%.
NM- Not meaningful
FINANCIAL DERIVATIVES - 2002
Weighted-Average Interest Rates
Notional -------------------------------
December 31, 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 $3,460 $172 2.00% 4.08%
Pay fixed designated to loans 67 (7) 6.04 2.80
Basis swaps designated to loans 52 3.52 3.47
Interest rate caps designated to loans (b) 16 NM NM
Interest rate floors designated to loans (c) 7 NM NM
Futures contracts designated to loans 313 NM NM
- --------------------------------------------------------------------------------------------
Total asset rate conversion 3,915 165
- --------------------------------------------------------------------------------------------
Liability rate conversion
Interest rate swaps (a)
Receive fixed designated to borrowed funds 2,363 346 3.16 5.93
- --------------------------------------------------------------------------------------------
Total liability rate conversion 2,363 346
- --------------------------------------------------------------------------------------------
Total interest rate risk management 6,278 511
- --------------------------------------------------------------------------------------------
Commercial mortgage banking risk management
Pay fixed interest rate swaps designated to loans held for sale (a) 273 (13) 4.73 4.36
Pay total rate of return swaps designated to loans held for sale (a) 100 (3) NM .88
- --------------------------------------------------------------------------------------------
Total commercial mortgage banking risk management 373 (16)
- --------------------------------------------------------------------------------------------
Total financial derivatives designated for risk management $6,651 $495
============================================================================================================================
(a) The floating rate portion of interest rate contracts is based on
money-market indices. As a percent of notional value, 60% were based on
1-month LIBOR and 40% on 3-month LIBOR.
(b) Interest rate caps with notional values of $12 million require the
counterparty to pay the Corporation the excess, if any, of 3-month LIBOR
over a weighted-average strike of 6.50%. In addition, interest rate caps
with notional values of $4 million require the counterparty to pay the
excess, if any, of Prime over a weighted-average strike of 5.03%. At
December 31, 2002, 3-month LIBOR was 1.38% and Prime was 4.25%.
(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. In addition, interest rate floors with notional
values of $2 million require the counterparty to pay the excess, if any, of
the weighted-average strike of 7.25% over Prime. At December 31, 2002,
3-month LIBOR was 1.38% and Prime was 4.25%.
NM- Not meaningful
27
OTHER DERIVATIVES
To accommodate customer needs, PNC enters into customer-related financial
derivative transactions primarily consisting of interest rate swaps, caps,
floors and foreign exchange contracts. Risk exposure from customer positions is
managed through transactions with other dealers.
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 three months of 2003 related to the derivatives held for
risk management purposes not designated as accounting hedges was insignificant.
OTHER DERIVATIVES
At March 31, 2003
------------------------------------------------------------------------
Positive Negative Average
Notional Fair Fair Net Asset Fair
In millions Value Value Value (Liability) Value (a)
- --------------------------------------------------------------------------------------------------------------------------
Customer-related
Interest rate
Swaps $26,202 $576 $(584) $(8) $(17)
Caps/floors
Sold 1,869 (27) (27) (29)
Purchased 1,760 22 22 24
Futures 592 1 1 1
Foreign exchange 4,046 54 (48) 6 4
Equity 1,417 54 (54) 3
Other 353 11 (1) 10 11
- --------------------------------------------------------------------------------------------------------------------------
Total customer-related 36,239 718 (714) 4 (3)
==========================================================================================================================
Other risk management and proprietary
Interest rate basis swaps 1,177 4 (1) 3 3
Other 456 10 (2) 8 7
- --------------------------------------------------------------------------------------------------------------------------
Total other risk management and proprietary 1,633 14 (3) 11 10
- --------------------------------------------------------------------------------------------------------------------------
Total other derivatives $37,872 $732 $(717) $15 $7
==========================================================================================================================
(a) Represents average for three months ended March 31, 2003.
"OFF-BALANCE SHEET" ACTIVITIES
As previously reported, PNC has reputational, 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 2002 Form 10-K for
further information.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest
Entities." See Note 1 Accounting Policies in the Notes to Consolidated Financial
Statements for additional information.
MARKET STREET FUNDING CORPORATION
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 or making of loans secured by interests primarily 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 $2.8 billion
at March 31, 2003 compared with $3.0 billion at December 31, 2002. See Note 1
Accounting Policies for additional information.
PNC Bank provides certain administrative services, a portion of the
program-level credit enhancement and the majority of the 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 cash collateral
account which is funded by a credit loan facility with a five-year term expiring
December 31, 2004. At March 31, 2003, approximately $100 million was outstanding
on this facility compared with $96 million at December 31, 2002. An additional
$301 million was provided by a major insurer. Also at March 31, 2003, Market
Street had liquidity facilities supporting individual pools of receivables
totaling $3.7 billion, of which $2.8 billion was provided by PNC Bank. The
comparable amounts at December 31, 2002 were $3.9 billion and $3.2
28
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 $2.9 million for
the quarter ended March 31, 2003. Commitment fees related to PNC's portion of
the liquidity facilities amounted to $.9 million for the first quarter 2003.
INTERNAL CONTROLS AND DISCLOSURE CONTROLS AND PROCEDURES
As of March 31, 2003, an evaluation was performed under the supervision and with
the participation of the Corporation's management, including the Chief Executive
Officer and the Vice Chairman and Chief Financial Officer, of the effectiveness
of the design and operation of the Corporation's disclosure controls and
procedures. Based on that evaluation, the Corporation's management, including
the Chief Executive Officer and the Vice Chairman and Chief Financial Officer,
concluded that the Corporation's disclosure controls and procedures were
effective as of March 31, 2003.
There have been no significant changes in the Corporation's internal controls or
in other factors that could significantly affect internal controls subsequent to
March 31, 2003, the date as of which the most recent evaluation of such internal
controls was performed.
29
GLOSSARY OF TERMS
Accounting/administration net assets - Domestic and foreign assets for which PNC
provides accounting and administrative services.
Adjusted average total assets - Primarily comprised of total average quarterly
assets plus (less) unrealized losses (gains) on available-for-sale debt
securities, less goodwill and certain other intangible assets.
Annualized - Adjusted to reflect a full year of activity.
Assets under management - Assets held by PNC in a fiduciary capacity for
customers/clients. These assets are not included on PNC's balance sheet.
Assigned capital - Economic capital assignments based on management's assessment
of inherent risks and equity levels at independent companies providing similar
products and services in order to present, to the extent practicable, the
financial results of each business as if the business operated on a stand-alone
basis.
Charge-off - Process of removing a loan or portion of a loan from a bank's
balance sheet because the loan is considered uncollectible. A charge-off also is
recorded when a loan is transferred to held for sale and the loan's market value
is less than its carrying amount. This difference is a charge-off.
Common shareholders' equity to total assets - Common shareholders' equity
divided by total assets. Common shareholders' equity equals total shareholders'
equity less preferred stock and the portion of capital surplus and retained
interest related to the preferred stock.
Custody assets - Assets held on behalf of a customer under a safekeeping
arrangement and that are not reported on PNC's balance sheet. Assets held in
custody accounts at other institutions on behalf of PNC are included in the
appropriate asset categories as if held in the physical custody of PNC.
Efficiency ratio - Noninterest expense divided by the sum of net interest income
and noninterest income.
Institutional lending repositioning - A 2001 PNC strategic action taken to build
a more diverse and valuable business mix designed to create shareholder value
over time by reducing lending leverage and improving the risk/return
characteristics of the banking business.
Leverage ratio - Tier 1 risk-based capital divided by adjusted average total
assets.
Net interest margin - Annualized taxable-equivalent net interest income divided
by average earning assets.
Noninterest income to total revenue - Total noninterest income divided by total
revenue. Total noninterest income includes asset management, fund servicing,
service charges on deposits, brokerage, consumer services, corporate services,
equity management, net securities gains (losses) and other noninterest income.
Total revenue includes total noninterest income plus net interest income.
Nonperforming assets - Nonperforming assets include nonaccrual loans, troubled
debt restructured loans, nonaccrual loans held for sale and foreclosed assets.
Nonperforming loans - Nonperforming loans include loans to commercial, lease
financing, consumer, commercial real estate and residential mortgage customers
as well as troubled debt restructured loans. Nonperforming loans do not include
nonaccrual loans held for sale or foreclosed assets.
Operating margin - Operating income divided by total revenue.
Return on assigned capital - Annualized net income divided by assigned capital.
Return on average assets - Annualized earnings divided by average assets.
Earnings can be from net income or continuing operations, as indicated in PNC's
disclosures.
Return on average equity - Annualized earnings divided by average shareholders'
equity. Earnings can be from net income or continuing operations, as indicated
in PNC's disclosures.
Risk-weighted assets - Primarily computed by the assignment of specific
risk-weights, as defined by The Board of Governors of the Federal Reserve
System, to assets and off-balance sheet instruments.
Securitization - The process by which financial assets are legally transformed
into securities.
Shareholders' equity to total assets - Total shareholders' equity divided by
total assets.
Taxable-equivalent interest - 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 is increased to make
them fully equivalent to other taxable interest income investments.
Tier 1 and Total risk-based capital - Terms used by The Board of Governors of
the Federal Reserve System to describe the capital adequacy of a bank holding
company. Refer to the Capital section within the Consolidated Balance Sheet
Review of this Financial Review for the components of risk-based capital.
Tier 1 risk-based capital ratio - Tier 1 risk-based capital divided by
risk-weighted assets.
Total risk-based capital ratio - Total risk-based capital divided by
risk-weighted assets.
Total deposits - The sum of total transaction deposits, savings accounts,
certificates of deposit, other time deposits and deposits in foreign offices.
Total transaction deposits - The sum of noninterest-bearing demand deposits,
interest-bearing demand deposits and money market accounts.
30
FORWARD-LOOKING STATEMENTS
This report contains, and other statements that the Corporation may make may
contain, forward-looking statements with respect to the Corporation's outlook or
expectations for earnings, revenues, expenses, capital levels, asset quality or
other future financial or business performance, strategies or expectations, or
the impact of legal, regulatory or supervisory matters on the Corporation's
business operations or performance. Forward-looking statements are typically
identified by words or phrases such as "believe," "feel," "expect,"
"anticipate," "intend," "outlook," "estimate," "forecast," "project,"
"position," "target," "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 and does not undertake 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 PNC's website at
www.pnc.com and on the SEC's website at www.sec.gov), the following factors,
among others, could cause actual results to differ materially from those
anticipated in forward-looking statements or historical performance:
(1) changes in political, economic or industry conditions, the interest rate
environment or financial and capital markets, which, if adverse could result in:
a deterioration in credit quality, increased credit losses, and increased
funding of unfunded loan commitments and letters of credit; an adverse effect on
the allowances for credit losses and unfunded loan commitments and letters of
credit; 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;
(2) relative and absolute investment performance of assets under management;
(3) 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, or to implement integration
plans relating to or resulting from mergers, acquisitions, restructurings and
divestitures;
(4) customer borrowing, payment, repayment, investment and deposit practices and
their acceptance of PNC's products and services;
(5) the impact of increased competition;
(6) how PNC chooses to redeploy available capital, including the extent and
timing of any share repurchases and investments in PNC's businesses;
(7) the inability to manage risks inherent in PNC's business;
(8) the unfavorable resolution of legal proceedings or government inquiries or
other costs associated with such proceedings or 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;
(9) the denial of insurance coverage for claims made by PNC;
(10) 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 provision for credit losses and reduced
profitability;
(11) 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;
(12) actions of the Federal Reserve Board;
(13) the impact of legislative and regulatory reforms and changes in accounting
policies and principles;
(14) 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
(15) terrorist activities and international hostilities, including the situation
surrounding Iraq and North Korea, which may adversely affect the general
economy, financial and capital markets, specific industries, and the
Corporation.
Factors relating to credit risk, interest rate risk, trading activities,
operating risk, financial and other derivatives, and off-balance sheet
activities 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 or in the Business section of the Corporation's 2002
Form 10-K.
31
CONSOLIDATED STATEMENT OF INCOME
THE PNC FINANCIAL SERVICES GROUP, INC.
Three months ended March 31 - in millions, except per share data
Unaudited 2003 2002
- ----------------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans and fees on loans $507 $599
Securities 143 177
Loans held for sale 12 52
Other 30 30
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest income 692 858
- ----------------------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Deposits 132 176
Borrowed funds 57 92
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest expense 189 268
- ----------------------------------------------------------------------------------------------------------------------------------
Net interest income 503 590
Provision for credit losses 36 82
- ----------------------------------------------------------------------------------------------------------------------------------
Net interest income less provision for credit losses 467 508
- ----------------------------------------------------------------------------------------------------------------------------------
NONINTEREST INCOME
Asset management 207 221
Fund servicing 193 212
Service charges on deposits 57 54
Brokerage 41 55
Consumer services 59 55
Corporate services 116 118
Equity management (4) (2)
Net securities gains 56 4
Other 70 73
- ----------------------------------------------------------------------------------------------------------------------------------
Total noninterest income 795 790
- ----------------------------------------------------------------------------------------------------------------------------------
NONINTEREST EXPENSE
Staff expense 438 430
Net occupancy 90 58
Equipment 69 68
Marketing 15 13
Distributions on capital securities 14 15
Other 230 223
- ----------------------------------------------------------------------------------------------------------------------------------
Total noninterest expense 856 807
- ----------------------------------------------------------------------------------------------------------------------------------
Income before minority interest and income taxes 406 491
Minority interest in income of consolidated entities 11 10
Income taxes 133 164
- ----------------------------------------------------------------------------------------------------------------------------------
Net income $262 $317
==================================================================================================================================
EARNINGS PER COMMON SHARE
Basic $.93 $1.12
Diluted $.92 $1.11
AVERAGE COMMON SHARES OUTSTANDING
Basic 283 283
Diluted 284 285
==================================================================================================================================
See accompanying Notes to Consolidated Financial Statements.
32
CONSOLIDATED BALANCE SHEET
THE PNC FINANCIAL SERVICES GROUP, INC.
In millions, except par value March 31 December 31
Unaudited 2003 2002
- ---------------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks $3,626 $3,201
Federal funds sold 1,913 1,847
Other short-term investments 2,012 1,811
Loans held for sale 1,702 1,607
Securities 14,973 13,763
Loans, net of unearned income of $1,018 and $1,075 35,245 35,450
Allowance for credit losses (680) (673)
- ---------------------------------------------------------------------------------------------------------------------------------
Net loans 34,565 34,777
Goodwill 2,356 2,313
Other intangible assets 330 333
Other 7,142 6,725
- ---------------------------------------------------------------------------------------------------------------------------------
Total assets $68,619 $66,377
=================================================================================================================================
LIABILITIES
Deposits
Noninterest-bearing $11,263 $9,538
Interest-bearing 35,818 35,444
- ---------------------------------------------------------------------------------------------------------------------------------
Total deposits 47,081 44,982
Borrowed funds
Federal funds purchased 34 38
Repurchase agreements 1,082 814
Bank notes and senior debt 3,850 4,400
Federal Home Loan Bank borrowings 1,146 1,256
Subordinated debt 2,234 2,423
Other borrowed funds 188 185
- ---------------------------------------------------------------------------------------------------------------------------------
Total borrowed funds 8,534 9,116
Allowance for unfunded loan commitments and letters of credit 77 84
Accrued expenses 2,023 2,046
Other 3,020 2,172
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities 60,735 58,400
- ---------------------------------------------------------------------------------------------------------------------------------
Minority interest 244 270
Mandatorily redeemable capital securities of subsidiary trusts 848 848
SHAREHOLDERS' EQUITY
Common stock - $5 par value
Authorized 800 shares, issued 353 shares 1,764 1,764
Capital surplus 1,102 1,101
Retained earnings 7,311 7,187
Deferred benefit expense (28) (9)
Accumulated other comprehensive income 293 321
Common stock held in treasury at cost: 71 and 68 shares (3,650) (3,505)
- ---------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 6,792 6,859
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities, minority interest, capital securities and
shareholders' equity $68,619 $66,377
=================================================================================================================================
See accompanying Notes to Consolidated Financial Statements.
33
CONSOLIDATED STATEMENT OF CASH FLOWS
THE PNC FINANCIAL SERVICES GROUP, INC.
Three months ended March 31 - in millions
Unaudited 2003 2002
- ---------------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $262 $317
Adjustments to reconcile net income
to net cash provided by operating activities
Provision for credit losses 36 82
Depreciation, amortization and accretion 74 58
Deferred income taxes 117 125
Securities transactions (56) (4)
Valuation adjustments 1 37
Change in
Loans held for sale (101) 728
Other short-term investments (201) (60)
Other (133) 5
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash (used by) provided by operating activities (1) 1,288
- ---------------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Net change in
Loans 511 702
Federal funds sold (66) (710)
Repayment of securities 1,300 826
Sales
Securities 3,726 4,036
Foreclosed assets 2 1
Purchases
Securities (5,827) (2,362)
Loans (340) (13)
Net cash (paid) received for divestitures/acquisitions (22) (1,676)
Other (62) (39)
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash (used by) provided by investing activities (778) 765
- ---------------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Net change in
Noninterest-bearing deposits 1,725 (1,438)
Interest-bearing deposits 374 (956)
Federal funds purchased (4) (133)
Repurchase agreements 268 (127)
Sales/issuances
Other borrowed funds 6,154 6,812
Common stock 29 35
Repayments/maturities
Bank notes and senior debt (550) (870)
Federal Home Loan Bank borrowings (110) (260)
Subordinated debt (187)
Other borrowed funds (6,154) (6,488)
Acquisition of treasury stock (203) (33)
Cash dividends paid (138) (136)
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used by) financing activities 1,204 (3,594)
- ---------------------------------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH AND DUE FROM BANKS 425 (1,541)
Cash and due from banks at beginning of period 3,201 4,327
- ---------------------------------------------------------------------------------------------------------------------------------
Cash and due from banks at end of period $3,626 $2,786
=================================================================================================================================
CASH PAID FOR
Interest $200 $283
Income taxes (27) 11
NON-CASH ITEMS
Transfer (to) from loans (from) to loans held for sale, net (5) 160
Transfer from loans to other assets 2 4
=================================================================================================================================
See accompanying Notes to Consolidated Financial Statements.
34
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; wholesale banking including
corporate banking, real estate finance and asset-based lending; wealth
management; asset management and global fund processing 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 processing 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 ("consolidated financial
statements") include the accounts of PNC and its subsidiaries, most of which are
wholly owned, and certain general partnership interests. Such statements have
been prepared in accordance with accounting principles generally accepted in the
United States of America ("generally accepted accounting principles"). 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
consolidated financial condition or results of operations.
In the opinion of management, the consolidated 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
may differ from such estimates and the differences may be material to the
consolidated financial statements.
The notes included herein should be read in conjunction with the audited
consolidated financial statements included in PNC's 2002 Annual Report on Form
10-K ("2002 Form 10-K").
INVESTMENTS
PNC has interests in various types of investments. The accounting for these
investments is dependent on a number of factors including, but not limited to,
items such as marketability of the investment, ownership interest, PNC's intent
and the nature of the investment.
Venture capital investments, which include both direct investments in companies
and interests in limited partnerships, are reported at estimated fair values.
These estimates are based upon available information and may not necessarily
represent amounts that will ultimately be realized through distribution, sale or
liquidation of the investment. The valuation procedures applied to direct
investments include valuation techniques such as multiples of earnings before
interest, taxes, depreciation and amortization of the entity, independent
appraisals of the entity or the pricing used to value the entity in a recent
financing transaction. Limited partnership investments are valued based on the
financial statements received from the general partner, an independent third
party. All venture capital investments are included in the consolidated balance
sheet under other assets. Changes in the fair value of these assets are
recognized in noninterest income.
Equity investments other than venture capital investments are accounted for
under one of the following methods:
o Marketable equity securities are accounted for at fair value based on the
securities' quoted market price from a national securities exchange. Those
purchased with the intention of recognizing short-term profits are placed
in the trading account, carried at market value and classified as
short-term investments. Gains and losses on trading securities are included
in noninterest income. Marketable equity securities not classified as
trading are designated as securities available for sale and are carried at
fair value with unrealized gains and losses, net of income taxes, reflected
in accumulated other comprehensive income or loss.
o Investments in nonmarketable equity securities are recorded using the cost
or equity methods of accounting. The cost method is used for those
investments in which PNC does not have significant influence over the
investee. Under this method, there is no change to the cost basis unless
there is an other than temporary decline in value, which results in an
impairment charge. Dividends received on cost investments are included in
noninterest income. The equity method is used for those investments in
which PNC can have significant influence over the operations of the
investee. Under the equity method, PNC records its equity ownership share
of the net income or loss of the investee in noninterest income. PNC
records its nonmarketable equity securities in other assets.
Additionally, investments in limited partnerships are accounted for under either
the cost method or the equity method as described above for nonmarketable equity
securities. The equity method is used if the limited partner's ownership
interest in the partnership is greater than 3% to 5%. For the remaining limited
partnership investments, the cost method is used. Limited partnership
investments are included in other assets.
Debt securities are classified as securities and carried at amortized cost if
management has the positive intent and ability to hold the securities to
maturity. Debt securities purchased with the intention of recognizing short-term
profits are placed in the trading account, carried at market value and
classified as short-term investments. Gains and
35
losses on these securities are included in noninterest income. Debt securities
not classified as held to maturity or trading are designated as securities
available for sale and carried at fair value with unrealized gains and losses,
net of income taxes, reflected in accumulated other comprehensive income or
loss.
Interest on debt securities, including amortization of premiums and accretion of
discounts using the interest method, is included in interest income. Gains and
losses realized on the sale of debt securities available for sale are computed
on a specific security basis and included in noninterest income.
SPECIAL PURPOSE ENTITIES
Special Purpose Entities ("SPEs") are broadly defined as legal entities
structured 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 is
independent of PNC, has made a substantive capital investment in the SPE, has
control of the SPE, or possesses the substantive risks and rewards of ownership
of the SPE.
In response to demands to strengthen existing accounting guidance regarding the
consolidation of SPEs and other off-balance sheet entities, in January 2003 the
Financial Accounting Standards Board ("FASB") issued FASB Interpretation No.
("FIN") 46, "Consolidation of Variable Interest Entities".
In general, a variable interest entity ("VIE") is a corporation, partnership,
limited liability corporation, trust, grantor trust or any other legal structure
used to conduct activities or hold assets that either does not have equity
investors with voting rights that can directly or indirectly make decisions
about the entity's activities through those voting rights or similar rights or
has equity investors that do not provide sufficient financial resources for the
entity to support its activities. A VIE often holds financial assets, including
loans or receivables, real estate or other property.
FIN 46 requires a VIE to be consolidated if the company is subject to a majority
of the risk of loss from the VIE's activities, is entitled to receive a majority
of the entity's residual returns or both. A company that consolidates the VIE is
called the primary beneficiary. Upon consolidation, the primary beneficiary
generally must record all of the VIE's assets, liabilities and noncontrolling
interests at fair value with subsequent changes based upon consolidation
principles. FIN 46 also requires disclosures about VIEs that the company is not
required to consolidate but in which it has a significant variable interest.
The consolidation requirements of FIN 46 apply immediately to VIEs created after
January 31, 2003. The consolidation requirements apply to VIEs that existed
prior to that date in the first fiscal year or interim period beginning after
June 15, 2003.
Based on a preliminary review of the provisions of FIN 46, it is reasonably
possible that PNC and/or BlackRock will hold a significant variable interest in
certain existing VIEs that would require the Corporation to consolidate these
entities in the third quarter of 2003. A description of these existing VIEs
follows:
o PNC Bank, N.A. ("PNC Bank") provides credit enhancement, liquidity
facilities and certain administrative services to Market Street Funding
Corporation ("Market Street"), 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 primarily in pools of receivables from U.S. corporations 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 $2.8 billion and total liabilities of $2.8 billion at March 31,
2003. PNC Bank provides certain administrative services, a portion of the
program-level credit enhancement and the majority of 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 cash
collateral account which is funded by a credit loan facility with a
five-year term expiring on December 31, 2004. At March 31, 2003,
approximately $100 million was outstanding on this facility. An additional
$301 million was provided by a major insurer. Also at March 31, 2003,
Market Street had liquidity facilities available supporting individual
pools of receivables totaling $3.7 billion, of which $2.8 billion was
provided by PNC Bank. As Market Street's program administrator, PNC
received fees of $2.9 million for the three months ended March 31, 2003.
Commitment fees related to PNC's portion of the liquidity facilities
amounted to $.9 million for the first quarter. PNC holds no ownership
interest in Market Street.
o BlackRock, Inc. ("BlackRock"), a majority-owned subsidiary of PNC, acts as
collateral asset manager for four collaterialized bond obligation funds
("CBOs") and one collaterialized loan obligation fund ("CLO") organized as
corporations or limited liability companies. The funds invest in high yield
securities and offer opportunity for high return and are subject to greater
risk than traditional investment products. These funds are structured to
take advantage of the yield
36
differential between their assets and liabilities and have terms to
maturity from eight to twelve years. At March 31, 2003, aggregate assets
and debt in the CBOs and CLO were approximately $2.2 billion and $2.1
billion, respectively. BlackRock's equity ownership in these funds was
approximately $11.3 million at March 31, 2003. BlackRock's maximum
potential loss related to these VIEs is limited to the amount of its
respective equity ownership in each of these investment vehicles and
consequently BlackRock has no risk of loss with respect to the debt of
these investment vehicles. Additionally, BlackRock has neither guaranteed
nor is contractually liable for any of the VIEs' obligations.
Assuming the consolidation of the CBOs' and CLO's assets, liabilities and
results of operations effective July 1, 2003, BlackRock expects to record
an after-tax charge to earnings estimated to be in the range of $6 million
to $10 million. This charge represents the difference between the carrying
amounts of BlackRock's investments in these entities accounted for under
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," BlackRock's current accounting treatment, and the requirements
under FIN 46.
o PNC Real Estate Finance makes equity investments in various limited
partnerships that sponsor affordable housing projects utilizing the Low
Income Housing Tax Credit ("LIHTC") pursuant to Section 42 of the Internal
Revenue Code. The purpose of these investments is to achieve a satisfactory
return on capital, to facilitate the sale of additional affordable housing
product offerings and to assist PNC in achieving goals associated with the
Community Reinvestment Act. The activities of the limited partnerships
include the identification, development and operation of multi-family
housing that is leased to qualifying residential tenants generally within
PNC's region. The investments are funded through a combination of debt
and equity, with equity typically comprising 30 - 60% of the total project
capital. At March 31, 2003, PNC's maximum exposure to loss resulting from
those LIHTC investments in which PNC owns a 50% or greater interest and
which may be subject to the provisions of FIN 46 was $140 million. This
represents the combination of a recorded basis of $122 million and unfunded
commitments of $18 million.
In addition to the equity investments in various limited partnerships
discussed above, PNC Real Estate Finance is a national syndicator of
affordable housing equity. In these syndication transactions, PNC creates
funds in which PNC is the general partner, and in some cases may also
purchase a limited partnership interest in the fund. The fund's limited
partners can remove the general partner without cause at any time. The
purpose of this business is to generate income from the syndication of
these funds and to generate servicing fees from the management of the
funds. General partner activities include selecting, evaluating,
structuring, negotiating, and closing the fund's investments in operating
limited partnerships, as well as oversight of the ongoing operations of the
fund portfolio. Through March 31, 2003 the total proceeds raised from the
syndication of these funds was $922 million. At March 31, 2003, the net
book value of PNC's partnership interests in these funds was $63 million
and unfunded commitments totaled $7 million. Accordingly, PNC's maximum
loss exposure to these funds was $70 million as of March 31, 2003.
o Within the PNC Advisors' business segment, PNC GPI, Inc. ("GPI"), a wholly
owned subsidiary of the Corporation, is the general partner and in some
cases the commodity pool operator for, and PNC Bank is the investment
manager for, a number of private investment funds organized as limited
partnerships. In addition, PNC Bank is the investment manager for, and GPI
is the commodity pool operator for, two private investment funds organized
as offshore corporations. On March 31, 2003, the aggregate value of the
assets of these funds was $788 million. The value of GPI's ownership
interest at March 31, 2003 was $2.5 million, representing PNC's maximum
loss exposure to these funds.
o As part of its equity management activities, the Corporation has
subsidiaries that invest in and act as the investment manager for a private
equity fund that is organized as a limited partnership. The fund invests in
private equity investments for the purpose of generating capital
appreciation and profits. At March 31, 2003, aggregate assets and equity in
the fund were both approximately $43.9 million. PNC's ownership in the fund
was valued at approximately $11.5 million, representing PNC's maximum loss
exposure to this fund at March 31, 2003.
Management is in the process of finalizing changes to the equity ownership
and/or control structure of certain hedge funds previously identified in the
2002 Form 10-K that management believes will remove them from the scope of FIN
46. As a result, these entities will not be required to be consolidated in the
third quarter of 2003.
Beginning in 2003, BlackRock acts as trading adviser and special member to an
entity which has created a series of municipal securities trusts in which it has
retained interests. These trusts purchase fixed-rate, long-term, highly rated,
insured or escrowed municipal bonds financed by the issuance of trust
certificates. The trust certificates entitle the holder to receive future
payments of principal and variable interest and to tender such certificates at
the option of the holder on a periodic basis. A third party acts as placement
agent for the entity and the trusts and as liquidity provider to the trusts. The
aggregate assets and debt in this entity (including the trusts) was
approximately $96 million and $63 million, respectively. BlackRock's equity
ownership was approximately $5.0 million at March 31, 2003. Based on a
preliminary assessment, management has concluded that BlackRock is not the
primary beneficiary of this entity and therefore will not consolidate the entity
upon adoption of FIN 46.
37
PNC management will continue to assess this interpretation's final impact on the
Corporation's consolidated financial statements. In addition, the FASB is
discussing implementation guidelines associated with FIN 46 which could change
management's current assessment of its impact. Therefore, additional entities
may be subject to consolidation upon PNC's implementation of FIN 46.
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
up to 10 years, or the respective lease terms, whichever is shorter.
STOCK-BASED COMPENSATION
Prior to January 2003, the Corporation accounted for employee stock-based
compensation plans under the recognition and measurement provisions of APB
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations. No stock-based employee compensation expense related to stock
options was reflected in net income prior to 2003 as all options to purchase PNC
and subsidiary stock granted under these plans had an exercise price equal to
the market value of the underlying stock on the date of grant. Effective January
1, 2003, the Corporation adopted the fair value recognition provisions of SFAS
No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), as amended by
SFAS No. 148, "Accounting for Stock-based Compensation-Transition and
Disclosure," prospectively to all employee awards granted, modified or settled
after January 1, 2003. Results for prior years have not been restated. The cost
related to stock-based employee compensation included in net income for the
three month period ended March 31, 2003 is less than that which would have been
recognized if the fair value based method had been applied to all awards since
the original effective date of SFAS No. 123. The following table illustrates the
effect on net income and earnings per share if the Corporation had applied the
fair value recognition provisions of SFAS 123, as amended, to all outstanding
and unvested awards in each period.
PRO FORMA NET INCOME AND EARNINGS PER SHARE
Three months ended March 31
In millions, except per share data 2003 2002
- --------------------------------------------------------
Net income as reported $262 $317
Add: Stock-based employee
compensation expense included
in reported net income, net of
related tax effects 5 3
Deduct: Total stock-based
employee compensation expense
determined under the fair value
method for all awards, net of
related tax effects (12) (13)
- --------------------------------------------------------
Pro forma net income $255 $307
- --------------------------------------------------------
Earnings per share
Basic-as reported $.93 $1.12
Basic-pro forma $.90 $1.08
Diluted-as reported $.92 $1.11
Diluted-pro forma $.90 $1.08
========================================================
NOTE 2 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 loans outstanding 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 is
being serviced by PNC for an 18-month term. 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
38
Serviced Portfolio during the servicing term. During the first quarter of
2003, NBOC notified PNC of its intent to exercise the Put Option effective
July 15, 2003.
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. During the servicing term the realized credit losses in the Serviced
Portfolio exceeded $50 million plus the specific reserves, and PNC Business
Credit advanced cash to NBOC for these excess losses net of recoveries ("Excess
Loss Payments").
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 March 31, 2003, the Put Option
liability was approximately $49 million, a decline of $8 million from December
31, 2002. A $6 million reduction from the acquisition date amount has been
recognized in earnings for the first quarter of 2003 as other noninterest
income. In addition, $2 million was paid to NBOC as Excess Loss Payments during
the first quarter of 2003.
When the Put Option is exercised, PNC will record the loans acquired at the
purchase price less the balance of the Put Option liability at that date, which
should approximate fair value. Classification of the loans as held for sale or
portfolio will depend on management's intended disposition of the portfolio.
Management is considering various strategic alternatives regarding this
portfolio.
At March 31, 2003, the independent valuation firm estimated that loans
outstanding in the Serviced Portfolio at the put date would be $155 million. The
total credit losses over the 18-month term of the servicing agreement are
estimated to be $87 million. Using these and other assumptions, assuming the Put
were exercised at the end of the servicing term, PNC would record the acquired
loans at $104 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 zero at March 31, 2003. 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 March
31, 2003, comparable amounts were $209 million, $161 million and $49 million,
respectively. Credit exposure and outstandings have declined over 60% since the
acquisition date.
NOTE 3 RECENT ACCOUNTING PRONOUNCEMENTS
In November 2002, the FASB issued FIN 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others." FIN 45 elaborates on the existing disclosure requirements for most
guarantees, including loan guarantees such as standby letters of credit and
indemnifications. It also clarifies that at the time a company issues a
guarantee, the company must recognize an initial liability for the fair or
market value of the obligations it assumes under that guarantee and must
disclose that information in its interim and annual financial statements. The
provisions related to recognizing a liability at inception of the guarantee for
the fair value of the guarantor's obligations would not apply to guarantees
accounted for as derivatives. The initial recognition and measurement provisions
were applied on a prospective basis to guarantees issued or modified after
December 31, 2002 and did not have a material impact on the Corporation's
consolidated financial statements. See Note 14 Commitments and Guarantees for
further information.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure." This statement amends SFAS No. 123, to
provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, this statement amends the disclosure requirements of SFAS No. 123 to
require disclosures in both annual and interim financial statements regarding
the method of accounting for stock-based employee compensation and the effect of
the method used on reported results. See the Stock-Based Compensation section
of Note 1 Accounting Policies for additional information.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest
Entities." See the Special Purpose Entities section of Note 1 Accounting
Policies for further information.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This statement amends and
clarifies SFAS No. 133 for derivatives, including certain derivative instruments
embedded in other contracts, and for hedging activities under SFAS No. 133.
Except for certain specific implementation issues and provisions, the statement
is effective for contracts entered into or modified after (and for hedging
relationships designated after) June 30, 2003. The Corporation plans to adopt
SFAS No. 149 prospectively as of June 30, 2003 and it is not expected to have a
material impact on PNC's consolidated financial statements.
39
On May 15, 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." This
statement requires that certain financial instruments, which under prior GAAP
could be designated as equity, be classified as liabilities on the balance
sheet. SFAS No. 150 is effective for certain financial instruments entered into
or modified after May 31, 2003, and otherwise is effective July 1, 2003 for PNC.
The Corporation currently classifies its mandatorily redeemable capital
securities of subsidiary trusts in the mezzanine section of the Consolidated
Balance Sheet. These securities would be reclassified as debt under the
provisions of SFAS No. 150 effective July 1, 2003. Additionally, the related
dividends would be reclassified and included in interest expense in the
Consolidated Statement of Income. While SFAS No. 150 is not expected to have a
material effect on PNC's consolidated financial statements, PNC will more fully
assess the impact of this new standard prior to adoption.
NOTE 4 CASH FLOWS
During the first three months of 2003, divestiture activity that affected cash
flows consisted of a cash receipt of $20 million which was related to the
January 2003 settlement of all issues in dispute between the Corporation and
Washington Mutual, FA, in connection with the 2001 sale of the Corporation's
residential mortgage banking business. The settlement was reported in PNC's
fourth quarter 2002 results as discontinued operations. Also during the first
quarter of 2003, PNC purchased the minority interests in PFPC, representing
approximately 2% of PFPC outstanding common stock, from other PFPC shareholders
and cashed out or converted all outstanding PFPC stock options. Net cash
outflows during the first quarter of 2003 related to these actions totaled $42
million.
During the first three 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. This
activity consisted solely of the NBOC acquisition as described in Note 2.
NOTE 5 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 three months of 2003 totaled $27 million
compared with $24 million for the prior-year period and was included in
noninterest income as follows:
DETAILS OF TRADING ACTIVITIES
Three months ended March 31 - in millions 2003 2002
- ---------------------------------------------------------------
Other noninterest income
Securities underwriting and trading $17 $17
Derivatives trading 4 1
Foreign exchange 6 6
- ---------------------------------------------------------------
Net trading income $27 $24
===============================================================
NOTE 6 LEGAL PROCEEDINGS
The several putative class action complaints filed during 2002 were consolidated
in a consolidated class action complaint brought on behalf of purchasers of the
Corporation's common stock between July 19, 2001 and July 18, 2002. The
consolidated class action complaint names the Corporation, the Chairman and
Chief Executive Officer, the former Chief Financial Officer, the Controller, and
the Corporation's independent auditors for 2001 as defendants and seeks
unquantified damages, interest, attorneys' fees and other expenses. The
consolidated class action complaint alleges violations of federal securities
laws related to disclosures regarding the three 2001 transactions that gave rise
to a financial statement restatement announced by the Corporation on January 29,
2002, and related matters. The Corporation and all other defendants have filed a
motion to dismiss this lawsuit. Management believes there are substantial
defenses to this lawsuit and intends to defend it vigorously. The impact of the
final disposition of this lawsuit cannot be assessed at this time.
Also, in August 2002, the United States Department of Labor began a formal
investigation of the Administrative Committee of the Corporation's Incentive
Savings Plan ("Plan") in connection with the Committee's conduct relating to the
Corporation's common stock held by the Plan and the Corporation's restatement of
earnings for 2001. Both the Administrative Committee and the Corporation are
cooperating fully with the investigation. The impact of the final disposition of
this investigation cannot be assessed at this time.
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. 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,
at the present time, management is not in a position to determine whether any of
such other pending or threatened legal proceedings will have a material adverse
effect on the Corporation's results of operations in any future reporting
period.
40
NOTE 7 ALLOWANCES FOR CREDIT LOSSES AND UNFUNDED LOAN COMMITMENTS AND LETTERS
OF CREDIT
Changes in the allowance for credit losses were as follows:
In millions 2003 2002
- ---------------------------------------------------------------
Allowance at January 1 $673 $560
Charge-offs
Commercial (32) (39)
Commercial real estate (2)
Consumer (10) (10)
Residential mortgage (1)
Lease financing (8) (5)
- ---------------------------------------------------------------
Total charge-offs (50) (57)
- ---------------------------------------------------------------
Recoveries
Commercial 10 10
Commercial real estate
Consumer 3 4
Residential mortgage 1
Lease financing 1 1
- ---------------------------------------------------------------
Total recoveries 14 16
- ---------------------------------------------------------------
Net charge-offs
Commercial (22) (29)
Commercial real estate (2)
Consumer (7) (6)
Residential mortgage
Lease financing (7) (4)
- ---------------------------------------------------------------
Total net charge-offs (36) (41)
- ---------------------------------------------------------------
Provision for credit losses 36 82
Acquired allowance (NBOC acquisition) 41
Net change in allowance for unfunded loan
commitments and letters of credit 7 (29)
- ---------------------------------------------------------------
Allowance at March 31 $680 $613
===============================================================
Changes in the allowance for unfunded loan commitments and letters of credit
were as follows:
In millions 2003 2002
- ---------------------------------------------------------------
Allowance at January 1 $84 $70
Net change in allowance for unfunded
loan commitments and letters of credit (7) 29
- ---------------------------------------------------------------
Allowance at March 31 $77 $99
===============================================================
NOTE 8 NONPERFORMING ASSETS
Nonperforming assets were as follows:
March 31 December 31
In millions 2003 2002
- ---------------------------------------------------------------
Nonperforming loans (a) $335 $309
Nonperforming loans held for sale (b) 61 97
Foreclosed assets 12 12
- ---------------------------------------------------------------
Total nonperforming assets (c) $408 $418
===============================================================
(a) Includes a troubled debt restructured loan of $1 million as of March 31,
2003 and December 31, 2002.
(b) Includes troubled debt restructured loans held for sale of $12 million and
$17 million as of March 31, 2003 and December 31, 2002, respectively.
(c) Excludes equity management assets carried at estimated fair value of $30
million and $40 million as of March 31, 2003 and December 31, 2002,
respectively. These amounts include troubled debt restructured assets of $3
million and $12 million, respectively.
41
NOTE 9 SECURITIES
Unrealized
Amortized ------------------------------------- Fair
In millions Cost Gains Losses Value
- ---------------------------------------------------------------------------------------------------------------------------
MARCH 31, 2003
SECURITIES AVAILABLE FOR SALE
Debt securities
U.S. Treasury and government agencies $457 $2 $459
Mortgage-backed 10,575 196 $(5) 10,766
Asset-backed 3,147 62 (1) 3,208
State and municipal 57 2 59
Other debt 53 3 56
- ---------------------------------------------------------------------------------------------------------------------------
Total debt securities 14,289 265 (6) 14,548
Corporate stocks and other 427 2 (4) 425
- ---------------------------------------------------------------------------------------------------------------------------
Total securities available for sale $14,716 $267 $(10) $14,973
===========================================================================================================================
DECEMBER 31, 2002
SECURITIES AVAILABLE FOR SALE
Debt securities
U.S. Treasury and government agencies $813 $13 $826
Mortgage-backed 8,916 189 $(2) 9,103
Asset-backed 2,699 83 (2) 2,780
State and municipal 61 2 63
Other debt 58 3 61
- ---------------------------------------------------------------------------------------------------------------------------
Total debt securities 12,547 290 (4) 12,833
Corporate stocks and other 597 1 (13) 585
- ---------------------------------------------------------------------------------------------------------------------------
Total securities available for sale $13,144 $291 $(17) $13,418
===========================================================================================================================
SECURITIES HELD TO MATURITY
Debt securities
U.S. Treasury and government agencies $276 $33 $309
Asset-backed 8 8
Other debt 61 61
- ---------------------------------------------------------------------------------------------------------------------------
Total debt securities 345 33 378
- ---------------------------------------------------------------------------------------------------------------------------
Total securities held to maturity $345 $33 $378
===========================================================================================================================
Total securities at March 31, 2003 were $15.0 billion compared with $13.8
billion at December 31, 2002. Securities represented 22% of total assets at
March 31, 2003 compared with 21% at December 31, 2002. The increase in total
securities compared with December 31, 2002 was primarily due to purchases during
the first quarter of 2003 of mortgage-backed and asset-backed securities
partially offset by sales of securities of United States government agencies and
the sale of securities classified as held to maturity at December 31, 2002.
The expected weighted-average life of securities available for sale was 2 years
and 8 months at both March 31, 2003 and December 31, 2002.
The securities classified as held to maturity at December 31, 2002 were carried
at amortized cost and were owned by companies formed with AIG that were
consolidated in PNC's financial statements. In January 2003, these securities
were sold and these companies were liquidated.
The expected weighted-average life of securities held to maturity was 20 years
and 2 months at December 31, 2002.
At March 31, 2003, the securities available for sale balance included a net
unrealized gain of $257 million, which represented the difference between fair
value and amortized cost. The comparable amount at December 31, 2002 was a net
unrealized gain of $274 million. Net unrealized gains and losses in the
securities available for sale portfolio are included in shareholders' equity as
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.
Net securities gains were $56 million for the first three months of 2003,
including $25 million of gains related to the liquidation of the entities formed
in 2001 in transactions with AIG, compared with $4 million for the first three
months of 2002.
Information relating to securities sold is set forth in the following table:
SECURITIES SOLD
Three months
ended March 31 Gross Gross Net Income
In millions Proceeds Gains Losses Gains Taxes
- ---------------------------------------------------------------
2003 $3,726 $66 $10 $56 $20
2002 4,036 14 10 4 1
===============================================================
42
NOTE 10 GOODWILL AND OTHER INTANGIBLE ASSETS
In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS
142"), the Corporation plans to conduct its annual goodwill impairment test on
its reporting units during the fourth quarter of 2003, using data as of
September 30, 2003. Additionally, the Corporation will perform interim
impairment testing as needed based on the occurrence of adverse triggering
events as required by SFAS 142. The fair value of PNC's reporting units is
determined by using discounted cash flow and market comparability methodologies.
A summary of the changes in goodwill by business for the first three months of
2003 follows:
GOODWILL
Dec 31 Goodwill March 31
In millions 2002 Acquired 2003
- --------------------------------------------------------------
Regional Community
Banking $438 $438
Corporate Banking 39 39
PNC Real Estate
Finance 302 302
PNC Business Credit 298 298
PNC Advisors 152 152
BlackRock 175 175
PFPC 909 $43 952
- --------------------------------------------------------------
Total $2,313 $43 $2,356
==============================================================
During the first quarter of 2003, PNC purchased the minority interests,
representing approximately 2% of PFPC outstanding common stock, from other PFPC
shareholders and cashed out or converted all outstanding PFPC stock options.
This transaction resulted in the recognition of goodwill of $43 million during
the first quarter of 2003, as the purchase price exceeded the book value of the
shares acquired.
The gross carrying amount, accumulated amortization and net carrying amount of
other intangible assets by major category consisted of the following:
OTHER INTANGIBLE ASSETS
In millions March 31 December 31
2003 2002
- -------------------------------------------------------------
Customer-related intangibles
Gross carrying amount $201 $199
Accumulated amortization (72) (67)
- -------------------------------------------------------------
Net carrying amount $129 $132
- -------------------------------------------------------------
Mortgage and other loan
servicing rights
Gross carrying amount $319 $313
Accumulated amortization (118) (112)
- -------------------------------------------------------------
Net carrying amount $201 $201
- -------------------------------------------------------------
Total $330 $333
=============================================================
The majority 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, on an accelerated basis. For customer-related
intangibles, the estimated remaining useful lives range from less than one year
to fifteen years, with a weighted-average remaining useful life of approximately
seven years. The Corporation's mortgage and other loan servicing rights are
amortized primarily 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 three months ended March 31, 2003, are as follows:
CHANGES IN GOODWILL AND OTHER INTANGIBLES
Customer- Servicing
In millions Goodwill Related Rights
- ----------------------------------------------------------------
Balance at December 31, 2002 $2,313 $132 $201
Additions/adjustments 43 2 6
Amortization (5) (6)
- ----------------------------------------------------------------
Balance at March 31, 2003 $2,356 $129 $201
================================================================
Amortization expense on intangible assets for the first quarter of 2003 was
approximately $11 million. Amortization expense on existing intangible assets
for the remainder of 2003 and for 2004, 2005, 2006, 2007 and 2008 is estimated
to be $34 million, $46 million, $41 million, $38 million, $37 million and $35
million, respectively.
43
NOTE 11 EARNINGS PER SHARE
The following table sets forth basic and diluted earnings per share
calculations.
Three months ended March 31 - in millions, except share and per share data 2003 2002
- -------------------------------------------------------------------------------------------------------------------------------
CALCULATION OF BASIC EARNINGS PER COMMON SHARE
Net income applicable to basic earnings per common share $262 $317
Basic weighted-average common shares outstanding (in thousands) 282,710 282,770
- -------------------------------------------------------------------------------------------------------------------------------
Basic earnings per common share $.93 $1.12
===============================================================================================================================
CALCULATION OF DILUTED EARNINGS PER COMMON SHARE
Net income applicable to diluted earnings per common share $262 $317
Basic weighted-average common shares outstanding (in thousands) 282,710 282,770
Conversion of preferred stock Series A and B 93 102
Conversion of preferred stock Series C and D 754 821
Conversion of debentures 14 17
Restricted stock award 1
Exercise of stock options 242 1,090
Incentive share awards 373 428
- -------------------------------------------------------------------------------------------------------------------------------
Diluted weighted-average common shares outstanding (in thousands) 284,187 285,228
- -------------------------------------------------------------------------------------------------------------------------------
Diluted earnings per common share $.92 $1.11
===============================================================================================================================
44
NOTE 12 SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
The following table sets forth the activity in shareholders' equity for the
first three months of 2003. The value of the Corporation's preferred stock
outstanding as of March 31, 2003 and December 31, 2002 was less than $.5 million
at each date and, therefore, is excluded from the following table.
Shares Accumulated
Outstanding Deferred Other Compre-
Common Common Capital Retained Benefit hensive Income Treasury
In millions, except per share data Stock Stock Surplus Earnings Expense (Loss)(a) Stock Total
- ----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 285 $1,764 $1,101 $7,187 $(9) $321 $(3,505) $6,859
Net income 262 262
Other comprehensive income, net
of tax (a)
Net unrealized securities losses (11) (11)
Net unrealized losses on cash
flow hedge derivatives (18) (18)
Other 1 1
- ----------------------------------------------------------------------------------------------------------------------------------
Comprehensive income 234
- ----------------------------------------------------------------------------------------------------------------------------------
Cash dividends declared
Common ($.48 per share) (138) (138)
Treasury stock activity (3) (1) (145) (146)
Tax benefit of stock option plans 3 3
Stock options granted 2 2
Subsidiary stock transactions (3) (3)
Deferred benefit expense (19) (19)
- ----------------------------------------------------------------------------------------------------------------------------------
Balance at March 31, 2003 282 $1,764 $1,102 $7,311 $(28) $293 $(3,650) $6,792
==================================================================================================================================
(a) A summary of the components of other comprehensive income follows:
Three months ended March 31, 2003 Tax Benefit
In millions Pretax amount (Expense) After-tax Amount
- -----------------------------------------------------------------------------------------------------------------------------
Unrealized securities gains $21 $(7) $14
Less: Reclassification adjustment for gains realized in net income 38 (13) 25
- -----------------------------------------------------------------------------------------------------------------------------
Net unrealized securities losses (17) 6 (11)
- -----------------------------------------------------------------------------------------------------------------------------
Unrealized losses on cash flow hedge derivatives (9) 3 (6)
Less: Reclassification adjustment for gains realized in net income 19 (7) 12
- -----------------------------------------------------------------------------------------------------------------------------
Net unrealized losses on cash flow hedge derivatives (28) 10 (18)
- -----------------------------------------------------------------------------------------------------------------------------
Other (b) 2 (1) 1
- -----------------------------------------------------------------------------------------------------------------------------
Other comprehensive income $(43) $15 $(28)
=============================================================================================================================
(b) Consists of interest-only strip valuation adjustments and foreign currency
translation adjustments.
45
NOTE 13 SEGMENT REPORTING
PNC operates seven major businesses engaged in regional community banking;
wholesale banking, including corporate banking, real estate finance and
asset-based lending; wealth management; asset management and global fund
processing 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 2002 have been reclassified to conform with the 2003
presentation.
The management accounting process uses various balance sheet and income
statement assignments and transfers to measure performance of the businesses.
Methodologies are refined from time to time as management accounting practices
are enhanced and businesses change. There were no significant changes to the
measurement methods during the first quarter of 2003. 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 financial results differ from consolidated results. This is
primarily due to differences between management accounting practices and
generally accepted accounting principles, such as economic capital assignments
rather than legal entity shareholders' equity, unit cost allocations rather than
actual expense assignments, and policies that do not fully allocate holding
company expenses; minority interest in income of consolidated entities;
eliminations and other corporate items. The impact of those differences is
reflected in the "Other" category. "Other" also includes equity management
activities and residual asset and liability management activities which do not
meet the criteria for disclosure as a separate reportable segment.
BUSINESS SEGMENT PRODUCTS AND SERVICES
Regional Community Banking provides deposit, lending, cash management and
investment services to two million consumer and small business customers within
PNC's geographic region.
Wholesale Banking includes the results for Corporate Banking, PNC Real Estate
Finance and PNC Business Credit.
Corporate Banking provides credit, equipment leasing, treasury management and
capital markets products and services to mid-sized corporations, government
entities and selectively to large corporations primarily within PNC's geographic
region. Treasury management activities, which include cash and investment
management, receivables management, disbursement services and global trade
services; capital markets products, which include foreign exchange, derivatives
trading and loan syndications; and equipment leasing products are offered
through Corporate Banking and sold by several businesses across the Corporation.
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. PNC MultiFamily Capital, which includes the former
Columbia Housing, is a national syndicator of affordable housing equity and a
national provider of multifamily mortgage loans.
PNC Business Credit provides asset-based lending, treasury management and
capital markets 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, trust and private
banking products and services to affluent individuals and families, including
full-service brokerage through J.J.B. Hilliard, W.L. Lyons, Inc. and investment
consulting and trust 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 and provides defined contribution plan
services and investment options through its Vested Interest(R) product. PNC
Advisors provides services to individuals and corporations primarily within
PNC's geographic region.
BlackRock is one of the largest publicly traded investment management firms in
the United States with approximately $274 billion of assets under management at
March 31, 2003. 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(R) 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, offering 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.
46
RESULTS OF BUSINESSES
PNC
Regional Real PNC
Three months ended March 31 Community Corporate Estate Business PNC
In millions Banking Banking Finance Credit Advisors BlackRock PFPC Other Consolidated
- ----------------------------------------------------------------------------------------------------------------------------------
2003 INCOME STATEMENT
Net interest income $316 $75 $28 $32 $21 $3 $(14) $42 $503
Noninterest income 201 113 28 12 126 143 192 (20) 795
- ----------------------------------------------------------------------------------------------------------------------------------
Total revenue 517 188 56 44 147 146 178 22 1,298
Provision for credit losses 8 15 8 7 (2) 36
Depreciation and amortization 9 3 1 1 2 5 4 20 45
Other noninterest expense 269 106 37 13 120 84 154 28 811
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings before minority 231 64 10 23 25 57 20 (24) 406
interest and income taxes
Minority interest in income of
consolidated entities 11 11
Income taxes 79 22 (6) 9 9 22 8 (10) 133
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings $152 $42 $16 $14 $16 $35 $12 $(25) $262
==================================================================================================================================
Inter-segment revenue $6 $1 $6 $4 $2 $(19)
==================================================================================================================================
AVERAGE ASSETS $38,989 $11,650 $4,767 $3,628 $2,870 $836 $1,865 $1,350 $65,955
==================================================================================================================================
2002 INCOME STATEMENT
Net interest income $382 $94 $30 $33 $26 $3 $(18) $40 $590
Noninterest income 167 99 21 12 157 146 211 (23) 790
- ----------------------------------------------------------------------------------------------------------------------------------
Total revenue 549 193 51 45 183 149 193 17 1,380
Provision for credit losses 12 46 (5) 28 1 82
Depreciation and amortization 9 2 1 2 5 1 19 39
Other noninterest expense 257 95 35 14 128 91 163 (15) 768
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings before minority
interest and income taxes 271 50 20 3 53 53 29 12 491
Minority interest in income of
consolidated entities 10 10
Income taxes 94 17 (2) 1 20 22 12 164
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings $177 $33 $22 $2 $33 $31 $17 $2 $317
==================================================================================================================================
Inter-segment revenue $5 $2 $13 $4 $2 $(26)
==================================================================================================================================
AVERAGE ASSETS $38,749 $15,217 $5,174 $3,817 $3,042 $667 $1,848 $(285) $68,229
==================================================================================================================================
Certain revenue and expense amounts shown above differ from amounts included in
the "Review of Business" section of the Financial Review portion of this Form
10-Q due to classification differences and the presentation in the Financial
Review of business revenues on a taxable-equivalent basis (except for BlackRock
and PFPC).
NOTE 14 COMMITMENTS AND GUARANTEES
EQUITY FUNDING COMMITMENTS
The Corporation has commitments to make additional equity investments in certain
equity management entities and affordable housing limited partnerships. These
commitments totaled $239 million at March 31, 2003.
STANDBY LETTERS OF CREDIT
PNC issues standby letters of credit and has risk participation in standby
letters of credit issued by other financial institutions, in each case to
support obligations of its customers to third parties. If the customer fails to
meet its financial or performance obligation to the third party under the terms
of the contract, then upon their request PNC would be obligated to make payment
to the guaranteed party. Standby letters of credit and risk participations in
standby letters of credit outstanding on March 31, 2003 had terms ranging from
less than 1 year to 7 years. The aggregate maximum amount of future payments PNC
could be required to make under outstanding standby letters of credit and risk
participations in standby letters of credit was $4.6 billion at March 31, 2003.
Assets valued, as of March 31, 2003, at approximately $1.2 billion secured
certain specifically identified standby letters of credit and letter of credit
risk participations having aggregate potential future payments of approximately
$1.2 billion. In addition, a portion of the remaining standby letters of credit
and letter of credit risk participations issued on behalf of specific customers
are also secured by collateral or guarantees which secure that customer's other
obligations to PNC.
LIQUIDITY FACILITIES AND STANDBY BOND PURCHASE AGREEMENTS
PNC enters into liquidity facilities primarily to support individual pools of
receivables acquired by commercial paper conduits including Market Street. At
March 31, 2003, the aggregate commitments under these facilities was $3.1
billion, of which $2.8 billion was related to Market Street. Collateral or third
party insurance secures PNC's exposure under these facilities. PNC also enters
into Standby Bond Purchase Agreements to support municipal bond obligations. At
March 31, 2003, the aggregate of PNC's commitments under these facilities was
$350 million.
INDEMNIFICATIONS
PNC is a party to numerous acquisition or divestiture agreements, under which it
has purchased or sold, or agreed to purchase or sell, various types of assets.
These agreements can cover the purchase or sale of entire businesses, loan
portfolios, branch banks, partial interests in companies, or other types of
assets. They generally
47
include indemnification provisions under which PNC indemnifies the other
parties to these agreements against a variety of risks to the other parties as a
result of the transaction in question; when PNC is the seller, the
indemnification provisions will generally also provide protection relating to
the quality of the assets being sold and the extent of any liabilities being
assumed. Due to the nature of these indemnification provisions, it is not
possible to quantify the aggregate exposure to PNC resulting from them.
PNC provides indemnification in connection with securities offering transactions
in which it is involved. When PNC is the issuer of the securities, it provides
indemnification to the underwriter or placement agents analogous to the
indemnification provided purchasers of businesses from it, as described above.
When PNC is an underwriter or placement agent, it provides a limited
indemnification to the issuer related to its actions in connection with the
offering and, if there are other underwriters, indemnification to the other
underwriters intended to result in an appropriate sharing of the risk of
participating in the offering. Due to the nature of these indemnification
provisions, it is not possible to quantify the aggregate exposure to PNC
resulting from them.
PNC enters into certain types of agreements such as (i) agreements relating to
providing various servicing and processing functions to third parties, (ii)
agreements relating to the creation of trusts or other legal entities to
facilitate leasing transactions, commercial mortgage-backed securities
transactions (loan securitizations) and certain other off-balance sheet
transactions, (iii) syndicated credit agreements, as a syndicate member, and
(iv) sales of individual loans, which provide indemnification to third parties.
Due to the nature of these indemnification provisions, it is not possible to
calculate aggregate potential exposure under them.
PNC enters into certain types of agreements, such as leases with tenants, in
which PNC indemnifies third parties for acts by PNC's agents. While PNC does not
believe these indemnification liabilities are material, either individually or
in the aggregate, it is not possible to calculate potential exposure.
PNC enters into contracts for the delivery of technology service in which PNC
indemnifies the other party against claims of patent infringement by third
parties. Due to the nature of these indemnification provisions, it is not
possible to calculate potential exposure under this type of indemnification.
PNC engages in certain insurance activities which require its employees to be
bonded. PNC satisfies this requirement by issuing letters of credit in an
aggregate amount of approximately $5 million.
In the ordinary course of business PNC enters into contracts with third parties
pursuant to which the third parties provide services on behalf of PNC. In many
of the contracts PNC agrees to indemnify the third party service provider under
certain circumstances. The terms of the indemnity vary from contract to contract
and the amount of the indemnification liability, if any, cannot be determined.
PNC is a general or limited partner in certain asset management and investment
limited partnerships, many of which contain indemnification provisions which
would require PNC to make payments in excess of its remaining funding
commitments. While in certain of these partnerships the maximum liability to PNC
is limited to the sum of PNC's unfunded commitments and partnership
distributions received by PNC, in the others the indemnification liability is
unlimited. As a result, it is not possible to determine the aggregate potential
exposure for these indemnifications.
Pursuant to their bylaws, the Corporation and its subsidiaries provide
indemnification to directors, officers and, in some cases, employees and agents
against certain liabilities incurred as a result of their service on behalf of
or at the request of the Corporation and its subsidiaries and also advance on
behalf of covered individuals costs incurred in defending against certain
claims, subject to written undertakings by each such individual to repay all
amounts so advanced if it is ultimately determined that the individual is not
entitled to indemnification. The Corporation advanced such defense costs on
behalf of several such individuals with respect to pending litigation or
investigations during the first quarter of 2003. It is not possible to determine
the aggregate potential exposure resulting from the obligation to provide this
indemnity or to advance such costs.
In connection with the lending of securities held by its mutual fund processing
services business on behalf of certain of its customers, PNC provides
indemnification to those customers against the failure of the borrower to return
the securities. Each borrower's obligation to return the securities is fully
secured on a daily basis, and thus the exposure to the Corporation is limited to
temporary shortfalls in the collateral as a result of short-term fluctuations in
trading prices of the borrowed securities. At March 31, 2003, the aggregate
maximum potential exposure as a result of these indemnity obligations was $5.7
billion, although PNC held cash collateral at the time in excess of that amount.
CONTINGENT PAYMENTS IN CONNECTION WITH CERTAIN ACQUISITIONS
A number of the acquisition agreements to which PNC is a party and under which
it has purchased various types of assets, including the purchase of entire
businesses, partial interests in companies, or other types of assets, require
PNC to make additional payments in future years if certain predetermined goals,
such as revenue targets, are achieved or if other contingencies, such as
specified declines in the value of the consideration paid, occur within a
specified time. As certain of these provisions do not specify dollar
limitations, it is not possible to quantify the aggregate exposure to PNC
resulting from these agreements.
NBOC ACQUISITION PUT OPTION
See Note 2 NBOC Acquisition for a description of the Put Option. NBOC notified
PNC of its intent to exercise the Put Option effective July 15, 2003.
48
STATISTICAL INFORMATION
THE PNC FINANCIAL SERVICES GROUP, INC.
CONSOLIDATED AVERAGE BALANCE SHEET AND NET INTEREST ANALYSIS
-------------------------------------------------------------------
First Quarter 2003 Fourth Quarter 2002
-------------------------------------------------------------------
Interest Average Interest Average
Taxable-equivalent basis Average Income/ Yields/ Average Income/ Yields/
Dollars in millions Balances Expense Rates Balances Expense Rates
- -----------------------------------------------------------------------------------------------------------------------------------
Assets
Interest-earning assets
Loans held for sale $1,782 $12 2.65% $1,985 $18 3.48%
Securities
Securities available for sale
U.S. Treasury and government agencies/corporations 3,082 36 4.62 3,294 39 4.77
Other debt 9,345 103 4.39 8,646 103 4.74
State and municipal 57 1 9.04 61 1 8.92
Corporate stocks and other 527 3 2.59 509 2 2.14
- --------------------------------------------------------------------------------------- ---------------------
Total securities available for sale 13,011 143 4.39 12,510 145 4.66
Securities held to maturity 67 1 7.69 342 5 5.00
- --------------------------------------------------------------------------------------- ---------------------
Total securities 13,078 144 4.41 12,852 150 4.67
Loans, net of unearned income
Commercial 15,050 217 5.76 15,426 233 5.90
Commercial real estate 2,265 27 4.70 2,382 30 4.95
Consumer 9,974 149 6.06 9,739 156 6.37
Residential mortgage 3,619 55 6.10 3,554 57 6.44
Lease financing 3,909 58 6.02 4,000 62 6.14
Other 363 3 3.78 356 4 4.30
- --------------------------------------------------------------------------------------- ---------------------
Total loans, net of unearned income 35,180 509 5.82 35,457 542 6.03
Federal funds sold 1,813 6 1.24 1,426 5 1.43
Other 2,145 24 4.57 2,205 29 5.13
- --------------------------------------------------------------------------------------- ---------------------
Total interest-earning assets/interest income 53,998 695 5.17 53,925 744 5.45
Noninterest-earning assets
Allowance for credit losses (682) (655)
Cash and due from banks 2,695 2,717
Other assets 9,944 9,855
- --------------------------------------------------------------------------- ----------
Total assets $65,955 $65,842
=========================================================================== ==========
LIABILITIES, MINORITY INTEREST, CAPITAL SECURITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing liabilities
Interest-bearing deposits
Demand and money market $22,826 46 .81 $22,395 56 .99
Savings 2,058 2 .39 2,020 3 .44
Retail certificates of deposit 9,638 78 3.29 9,977 85 3.39
Other time 350 5 5.63 312 5 6.20
Deposits in foreign offices 497 1 .46 370 .69
- --------------------------------------------------------------------------------------- ---------------------
Total interest-bearing deposits 35,369 132 1.51 35,074 149 1.68
Borrowed funds
Federal funds purchased 37 1.86 46 1.81
Repurchase agreements 891 2 1.16 940 3 1.33
Bank notes and senior debt 4,267 23 2.14 4,417 27 2.38
Federal Home Loan Bank borrowings 1,210 (3) (1.11) 1,261 (1) (.37)
Subordinated debt 2,151 23 4.24 2,211 26 4.53
Other borrowed funds 146 12 33.23 170 13 30.18
- --------------------------------------------------------------------------------------- ---------------------
Total borrowed funds 8,702 57 2.63 9,045 68 2.93
- --------------------------------------------------------------------------------------- ---------------------
Total interest-bearing liabilities/interest expense 44,071 189 1.73 44,119 217 1.94
Noninterest-bearing liabilities, minority interest, capital
securities and shareholders' equity
Demand and other noninterest-bearing deposits 9,017 9,030
Allowance for unfunded commitments and letters of credit 84 79
Accrued expenses and other liabilities 4,928 4,829
Minority interest 251 261
Mandatorily redeemable capital securities of subsidiary trusts 848 848
Shareholders' equity 6,756 6,676
- --------------------------------------------------------------------------- ----------
Total liabilities, minority interest, capital
securities and shareholders' equity $65,955 $65,842
- ------------------------------------------------------------------------------------------------------------------------------------
Interest rate spread 3.44 3.51
Impact of noninterest-bearing sources .32 .36
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income/margin $506 3.76% $527 3.87%
====================================================================================================================================
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).
49
- -----------------------------------------------------------------------------------------------------------------------------
Third Quarter 2002 Second Quarter 2002 First Quarter 2002
- -----------------------------------------------------------------------------------------------------------------------------
Interest Average Interest Average Interest Average
Average Income/ Yields/ Average Income/ Yields/ Average Income/ Yields/
Balances Expense Rates Balances Expense Rates Balances Expense Rates
- -----------------------------------------------------------------------------------------------------------------------------
$2,125 $24 4.43% $3,235 $41 5.07% $4,276 $52 4.85%
2,962 37 5.07 2,972 39 5.21 3,506 47 5.33
7,205 95 5.27 7,146 99 5.54 8,674 123 5.69
60 1 9.05 61 1 9.33 62 2 9.09
541 4 2.53 492 5 3.63 406 3 2.99
- --------------------------- ------------------------ -------------------------
10,768 137 5.10 10,671 144 5.38 12,648 175 5.52
340 4 5.02 364 5 5.70 363 3 3.61
- --------------------------- ------------------------ -------------------------
11,108 141 5.10 11,035 149 5.39 13,011 178 5.47
15,698 236 5.89 16,311 243 5.90 16,264 240 5.90
2,501 33 5.16 2,470 33 5.26 2,452 33 5.36
9,649 160 6.56 9,509 158 6.67 9,278 156 6.82
4,296 71 6.63 4,979 85 6.79 5,756 98 6.85
4,124 65 6.31 4,244 68 6.39 4,327 70 6.52
419 5 4.16 402 4 4.26 394 4 4.16
- --------------------------- ------------------------ -------------------------
36,687 570 6.13 37,915 591 6.20 38,471 601 6.28
2,212 10 1.75 1,532 6 1.76 80 1 1.71
2,110 28 5.27 1,925 20 4.12 1,787 29 6.57
- --------------------------- ------------------------ -------------------------
54,242 773 5.64 55,642 807 5.78 57,625 861 5.99
(665) (625) (567)
2,619 2,705 2,877
9,662 8,738 8,294
- -------------- ----------- -----------
$65,858 $66,460 $68,229
- -------------- ----------- -----------
$21,994 62 1.12 $22,147 63 1.16 $21,802 60 1.11
2,050 2 .50 2,067 3 .50 1,994 2 .48
10,347 92 3.52 10,518 97 3.68 10,608 101 3.86
307 5 6.33 948 8 3.45 827 9 4.40
299 1 1.10 243 1 1.66 867 4 1.65
- --------------------------- ------------------------ -------------------------
34,997 162 1.84 35,923 172 1.92 36,098 176 1.97
42 2.97 35 1.81 2,109 9 1.58
990 4 1.51 979 4 1.45 915 3 1.38
5,154 35 2.63 5,441 38 2.76 5,675 38 2.68
1,272 (.15) 1,714 2 .52 1,873 2 .48
2,210 25 4.61 2,210 25 4.58 2,209 25 4.60
158 15 37.25 483 8 6.66 391 15 15.48
- --------------------------- ------------------------ -------------------------
9,826 79 3.16 10,862 77 2.83 13,172 92 2.80
- --------------------------- ------------------------ -------------------------
44,823 241 2.13 46,785 249 2.13 49,270 268 2.19
8,665 8,406 8,288
73 98 70
4,754 4,027 3,675
218 192 177
848 848 848
6,477 6,104 5,901
- ---------------- ------------- --------------
$65,858 $66,460 $68,229
- -----------------------------------------------------------------------------------------------------------------------------
3.51 3.65 3.80
.37 .34 .32
- -----------------------------------------------------------------------------------------------------------------------------
$532 3.88% $558 3.99% $593 4.12%
=============================================================================================================================
Loan fees for the three months ended March 31, 2003, December 31, 2002,
September 30, 2002, June 30, 2002 and March 31, 2002 were $27 million, $26
million, $22 million, $29 million and $29 million, respectively.
50
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 March 31, 2003.
Commission File Number 1-9718
THE PNC FINANCIAL SERVICES GROUP, INC.
Incorporated in the Commonwealth of Pennsylvania
IRS Employer Identification No. 25-1435979
Address of principal executive offices:
One PNC Plaza
249 Fifth Avenue
Pittsburgh, Pennsylvania 15222-2707
Telephone: (412) 762-2000
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, (2) has been subject to such filing requirements for the
past 90 days, and (3) is an accelerated filer (as defined in Rule 12b-2 of the
Exchange Act).
As of April 30, 2003, The PNC Financial Services Group, Inc. had 281,924,425
shares of common stock ($5 par value) outstanding.
PART I FINANCIAL INFORMATION
The following sections of the Financial Review set forth in the cross-reference
index are incorporated in the Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 2003.
Cross-reference Page(s)
- ---------------------------------------------------------------
PART I FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Statement of Income for the
three months ended March 31, 2003 and
2002 32
Consolidated Balance Sheet as of
March 31, 2003 and December 31, 2002 33
Consolidated Statement of Cash Flows for
the three months ended March 31, 2003
and 2002 34
Notes to Consolidated Financial
Statements 35 - 48
Consolidated Average Balance Sheet and
Net Interest Analysis 49 - 50
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of
Operations 3 - 31
Item 3 Quantitative and Qualitative
Disclosures About Market Risk 23 - 28
Item 4 Controls and Procedures 29
- ---------------------------------------------------------------
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The several putative class action complaints filed during 2002 in the United
States District Court for the Western District of Pennsylvania were consolidated
in a Consolidated Class Action Complaint filed on October 4, 2002 brought on
behalf of purchasers of the Corporation's common stock between July 19, 2001 and
July 18, 2002. The Consolidated Class Action Complaint names as defendants the
Corporation, the Chairman and Chief Executive Officer, the former Chief
Financial Officer, the Controller, and the Corporation's independent auditors
for 2001 and seeks unquantified damages, interest, attorneys' fees and other
expenses. The Consolidated Class Action Complaint alleges violations of federal
securities laws related to disclosures regarding the three 2001 transactions
that gave rise to a financial statement restatement announced by the Corporation
on January 29, 2002, and related matters. The Corporation and all other
defendants have filed a motion to dismiss this lawsuit. Management believes
there are substantial defenses to this lawsuit and intends to defend it
vigorously. The impact of the final disposition of this lawsuit cannot be
assessed at this time.
In August 2002, the United States Department of Labor began a formal
investigation of the Administrative Committee of the Corporation's Incentive
Savings Plan ("Plan") in connection with the Committee's conduct relating to the
Corporation's common stock held by the Plan and the Corporation's restatement of
earnings for 2001. Both the Administrative Committee and the Corporation are
cooperating fully with the investigation. The impact of the final disposition of
this investigation cannot be assessed at this time.
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. 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,
at the present time, management is not in a position to determine whether any of
such other pending or threatened legal proceedings will have a material adverse
effect on the Corporation's results of operations in any future reporting
period.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
An annual meeting of shareholders of The PNC Financial Services Group, Inc. was
held on April 22, 2003 for the purpose of considering and acting upon the
election of 16 directors to serve until the next annual meeting and until their
successors are elected and qualified.
51
Sixteen directors were elected and the votes cast for or against/withheld were
as follows:
Aggregate Votes
-------------------------------
Nominee For Against/Withheld
- ---------------------------------------------------------------
Paul W. Chellgren 236,167,908 4,760,125
Robert N. Clay 236,385,476 4,542,557
J. Gary Cooper 235,882,216 5,045,817
George A. Davidson, Jr. 235,013,143 5,914,890
Richard B. Kelson 234,986,593 5,941,440
Bruce C. Lindsay 235,092,000 5,836,033
Anthony A. Massaro 235,985,480 4,942,553
Thomas H. O'Brien 235,320,437 5,607,596
Jane G. Pepper 236,133,638 4,794,395
James E. Rohr 234,573,048 6,354,985
Lorene K. Steffes 236,346,086 4,581,947
Dennis F. Strigl 236,198,682 4,729,351
Stephen G. Thieke 235,168,300 5,759,733
Thomas J. Usher 235,878,219 5,049,814
Milton A. Washington 236,103,787 4,824,246
Helge H. Wehmeier 235,135,901 5,792,132
===============================================================
With respect to the preceding matter, holders of the Corporation's common and
voting preferred stock voted together as a single class. The following table
sets forth, as of the February 28, 2003 record date, the number of shares of
each class or series of stock that were issued and outstanding and entitled to
vote, the voting power per share, and the aggregate voting power of each class
or series:
Number of
Voting Shares
Rights Entitled Aggregate
Title of Class or Series Per Share to Vote Voting Power
- ----------------------------------------------------------------------
Common Stock 1 283,148,371 283,148,371
$1.80 Cumulative
Convertible
Preferred Stock -
Series A 8 9,106 72,848
$1.80 Cumulative
Convertible
Preferred Stock -
Series B 8 2,420 19,360
$1.60 Cumulative
Convertible
Preferred Stock -
Series C 4/2.4 183,222 305,370*
$1.80 Cumulative
Convertible
Preferred Stock -
Series D 4/2.4 268,952 448,253*
--------------
Total possible votes 283,994,202*
=======================================================================
* Represents greatest number of votes possible. Actual aggregate voting power
was less since each holder of such preferred stock was entitled to a number of
votes equal to the number of full shares of common stock into which such
holder's preferred stock was convertible.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
The following exhibit index lists Exhibits filed, or in the case of Exhibits
99.1 and 99.2 furnished, with this Quarterly Report on Form 10-Q:
EXHIBIT INDEX
10.19 The Corporation's Employee Stock Purchase Plan, as
amended
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 Certification of Chairman and Chief Executive Officer
pursuant to 18 U.S.C. Section 1350
99.2 Certification of Vice Chairman and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350
- -------------------------------------------------------------------
Copies of these Exhibits may be obtained electronically at the SEC's home page
at www.sec.gov or from the public reference section of the SEC, at prescribed
rates, at 450 Fifth Street NW, Washington, D.C. 20549. Copies may also be
obtained by any shareholder, without charge, upon written request addressed to
Computershare Investor Services, Post Office Box 3504, Chicago, Illinois
60690-3504, by calling (800) 982-7652 or via e-mail at
web.queries@computershare.com.
The Corporation filed the following Current Reports on Form 8-K ("Form 8-K")
during and subsequent to the first quarter of 2003 through the date of this
Quarterly Report on Form 10-Q on the dates indicated:
March 13, 2003
Item 9, Regulation FD Disclosure, related to certifications of the Corporation's
Chairman and Chief Executive Officer and Vice Chairman and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002. Conformed copies of such certifications were
furnished as Exhibits to this Form 8-K.
April 17, 2003
Item 12, Disclosure of Results of Operations and Financial Condition, regarding
the Corporation's release of first quarter 2003 earnings. A copy of the
Corporation's earnings press release was furnished as an Exhibit to this Form
8-K.
April 17, 2003
Item 12, Disclosure of Results of Operations and Financial Condition, regarding
supplementary financial information provided on the Corporation's website in
connection with its April 17, 2003 release of first quarter 2003 earnings and
related investor conference call. A copy of this supplementary financial
information was furnished as an Exhibit to this Form 8-K.
April 24, 2003
Item 12, Disclosure of Results of Operations and Financial Condition, regarding
a presentation by the Corporation's Chairman and Chief Executive Officer and the
Vice Chairman and Chief Financial Officer in connection with the Corporation's
April 22, 2003 Annual Meeting of Shareholders. A copy of the electronic slides
used with this presentation was furnished as an Exhibit to this Form 8-K.
May 1, 2003
Item 12, Disclosure of Results of Operations and Financial Condition, regarding
a presentation to investors by certain executives of the Corporation in
connection with the May 1, 2003 Goldman Sachs Bank Field Trip. A copy of the
electronic slides used with this presentation was furnished as an Exhibit to
this Form 8-K.
52
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on May 15, 2003, on its
behalf by the undersigned thereunto duly authorized and in the capacity
indicated.
THE PNC FINANCIAL SERVICES GROUP, INC.
/s/ William S. Demchak
- -----------------------------------------
William S. Demchak
Vice Chairman and Chief Financial Officer
(Principal Financial Officer)
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, James E. Rohr, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The PNC Financial
Services Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 15, 2003
/s/ James E. Rohr
- -----------------------
James E. Rohr
Chairman and Chief Executive Officer
53
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, William S. Demchak, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The PNC Financial
Services Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 15, 2003
/s/ William S. Demchak
- --------------------------------
William S. Demchak
Vice Chairman and Chief Financial Officer
54
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
PNC is subject to the reporting requirements of the Securities Exchange Act of
1934 and as such files annual, quarterly and current reports as well as proxy
materials with the Securities and Exchange Commission ("SEC"). Copies of these
and other filings, including exhibits thereto, may be obtained electronically at
the SEC's home page at www.sec.gov or at PNC's home page at www.pnc.com. Copies
may also be obtained without charge by contacting Shareholder Services at (800)
982-7652 or via e-mail at web.queries@computershare.com.
INQUIRIES
For financial services call 1-888-PNC-2265. Individual shareholders should
contact Shareholder Services at (800) 982-7652.
Analysts and institutional investors should contact William H. Callihan,
Director of 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
Brian Goerke, 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
=================================================================
2003 QUARTER
- -----------------------------------------------------------------
First $45.950 $41.630 $42.380 $.48
=================================================================
2002 QUARTER
- -----------------------------------------------------------------
First $62.800 $52.500 $61.490 $.48
Second 61.490 49.600 52.280 .48
Third 52.750 32.700 42.170 .48
Fourth 44.230 36.020 41.900 .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 contacting
Shareholder Services at (800) 982-7652.
REGISTRAR AND TRANSFER AGENT
Computershare Investor Services, LLC
2 North LaSalle Street
Chicago, Illinois 60602
(800) 982-7652
55