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THE PNC FINANCIAL SERVICES GROUP, INC.
Quarterly Report on Form 10-Q
For the quarterly period ended September 30, 2002
Page 1 represents a portion of the third quarter 2002 Financial Review which is
not required by the Form 10-Q report and is not "filed" as part of the Form
10-Q.
The Quarterly Report on Form 10-Q and cross reference index is on page 47.
CONSOLIDATED FINANCIAL HIGHLIGHTS
THE PNC FINANCIAL SERVICES GROUP, INC.
Three months ended Nine months ended
Dollars in millions, except per share data September 30 September 30
--------------------------- -----------------------
Unaudited 2002 2001 2002 2001
- --------------------------------------------------------------------------------------------------------------
FINANCIAL PERFORMANCE
Revenue
Net interest income (taxable-equivalent basis)(a) $ 532 $ 568 $1,683 $1,696
Noninterest income 758 720 2,387 2,168
------------------------ -----------------------
Total revenue $1,290 $1,288 $4,070 $3,864
======================== =======================
Income from continuing operations $ 285 $ 247 $ 922 $ 807
Discontinued operations 5
------------------------ -----------------------
Income before cumulative effect of accounting change 285 247 922 812
Cumulative effect of accounting change (5)
------------------------ -----------------------
Net income $ 285 $ 247 $ 922 $ 807
======================== =======================
Per common share
DILUTED EARNINGS
Continuing operations $ 1.00 $ .84 $ 3.23 $ 2.73
Discontinued operations .02
------------------------ -----------------------
Before cumulative effect of accounting change 1.00 .84 3.23 2.75
Cumulative effect of accounting change (.02)
------------------------ -----------------------
Net income $ 1.00 $ .84 $ 3.23 $ 2.73
======================== =======================
CASH DIVIDENDS DECLARED $ .48 $ .48 $ 1.44 $ 1.44
- --------------------------------------------------------------------------------------------------------------
SELECTED RATIOS
BASED ON CONTINUING OPERATIONS
Return on
Average common shareholders' equity 17.49% 14.83% 20.01% 16.49%
Average assets 1.72 1.42 1.84 1.53
Net interest margin 3.88 3.89 4.00 3.76
Noninterest income to total revenue 58.76 55.90 58.65 56.11
Efficiency (b) 58.98 57.83 57.69 57.68
BASED ON NET INCOME
Return on
Average common shareholders' equity 17.49% 14.83% 20.01% 16.49%
Average assets 1.72 1.42 1.84 1.51
Net interest margin 3.88 3.89 4.00 3.73
Noninterest income to total revenue 58.76 55.90 58.65 56.20
Efficiency (b) 58.98 57.83 57.69 57.60
==============================================================================================================
Certain prior period amounts included in these Consolidated Financial Highlights
have been reclassified to conform to the presentation as of and for the three
months and nine months ended September 30, 2002. Amounts for 2002 reflect the
adoption, effective January 1, 2002, of the new accounting standard under which
goodwill is no longer amortized to expense. In addition, amounts included in
these Consolidated Financial Highlights are presented on a continuing operations
basis, unless otherwise noted.
(a) The interest income earned on certain assets is completely or partially
exempt from federal income tax. As such, these tax exempt instruments typically
yield lower returns than a taxable investment. In order to provide accurate
comparisons of yields and margins for all earning assets, the interest income
earned on tax exempt assets has been increased to make them fully equivalent to
other taxable interest income investments.
(b) The efficiency ratio is noninterest expense divided by the sum of
taxable-equivalent net interest income and noninterest income. Amortization and
distributions on capital securities are excluded for purposes of computing this
ratio. Residential mortgage banking risk management activities are also
excluded, as applicable, from net income for purposes of computing this ratio.
1
Dollars in millions, except per share data September 30 December 31 September 30
Unaudited 2002 2001 2001
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA
Assets $67,659 $69,638 $71,894
Earning assets 55,650 57,875 57,546
Loans, net of unearned income 35,917 37,974 42,140
Allowance for credit losses (648) (560) (638)
Securities 12,536 13,908 11,051
Loans held for sale 1,989 4,189 2,242
Deposits 44,960 47,304 44,918
Borrowed funds 9,947 12,090 13,046
Allowance for unfunded loan commitments and letters of credit 79 70 82
Shareholders' equity 6,717 5,823 6,773
Common shareholders' equity 6,707 5,813 6,557
Book value per common share 23.62 20.54 23.09
Loans to deposits 80% 80% 94%
CAPITAL RATIOS
Tier I Risk-based 8.8% 7.8% 8.4%
Total Risk-based 12.5 11.8 12.0
Leverage 7.8 6.8 8.1
Common shareholders' equity to total assets 9.91 8.35 9.12
ASSET QUALITY RATIOS
Nonperforming assets to total loans,
loans held for sale and foreclosed assets 1.08% .93% 1.18%
Net charge-offs to average loans (for the three months ended) .79 7.30 .59
Allowance for credit losses to total loans (c) 1.80 1.47 1.51
Allowance for credit losses to nonperforming loans (c) 239 265 177
===================================================================================================================================
(c) The asset quality ratios presented for all periods reflect a
reclassification of a portion of the allowance for credit losses related to
unfunded loan commitments and letters of credit to a liability on the
Consolidated Balance Sheet. Amounts reclassified were $70 million at December
31, 2001 and $82 million at September 30, 2001. The reclassifications had the
effect of lowering previously reported asset quality ratios. The allowance for
unfunded loan commitments and letters of credit is available for potential
credit losses as loan commitments are funded. See Allowances For Credit Losses
And Unfunded Loan Commitments And Letters Of Credit in the Consolidated Balance
Sheet Review section of the Financial Review for additional information.
2
FINANCIAL REVIEW
THE PNC FINANCIAL SERVICES GROUP, INC.
This Financial Review should be read in conjunction with The PNC Financial
Services Group, Inc. ("Corporation" or "PNC") unaudited Consolidated Financial
Statements and unaudited Statistical Information included herein and the
Financial Review, audited Consolidated Financial Statements and Statistical
Information included in the Corporation's 2001 Annual Report on Form 10-K ("2001
Form 10-K"). Certain prior-period amounts have been reclassified to conform with
the current year presentation. The term "loans" in this report excludes loans
held for sale and securities that represent interests in pools of loans. For
information regarding certain business and regulatory risks, see the Risk
Factors and Risk Management sections in this Financial Review and the Business
section of the 2001 Form 10-K. Also, see the Forward-Looking Statements section
in this Financial Review for certain other factors that could cause actual
results to differ materially from forward-looking statements or historical
performance.
OVERVIEW
THE PNC FINANCIAL SERVICES GROUP, INC.
The Corporation is one of the largest diversified financial services companies
in the United States, operating businesses engaged in regional community
banking, corporate banking, real estate finance, asset-based lending, wealth
management, asset management and global fund services. The Corporation provides
certain products and services nationally and others in PNC's primary geographic
markets in Pennsylvania, New Jersey, Delaware, Ohio and Kentucky. The
Corporation also provides certain banking, asset management and global fund
services internationally.
SUMMARY FINANCIAL RESULTS
Consolidated net income for the first nine months of 2002 was $922 million or
$3.23 per diluted share compared with $807 million or $2.73 per diluted share
for the first nine months of 2001. Results for the first nine months of 2002
reflected the required adoption of Statement of Financial Accounting Standards
("SFAS") No. 142, "Goodwill and Other Intangible Assets," under which goodwill
is no longer amortized to expense. Excluding goodwill amortization expense from
2001 results, earnings would have been $877 million or $2.97 per diluted share.
Reported earnings in 2001 included income from discontinued operations of $.02
per diluted share and an after-tax loss of $.02 per diluted share related to the
cumulative effect of the accounting change for the adoption of SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended by
SFAS No. 137 and 138.
Return on average common shareholders' equity was 20.01% and return on average
assets was 1.84% for the first nine months of 2002 compared with 16.49% and
1.51%, respectively, for the first nine months of 2001.
Comparable prior year returns excluding goodwill amortization expense were
17.93% and 1.64%, respectively.
Consolidated net income for the third quarter of 2002 was $285 million or $1.00
per diluted share, up from $247 million or $.84 per diluted share for the third
quarter of 2001. Excluding goodwill amortization expense from third quarter 2001
results, the Corporation earned $271 million or $.92 per diluted share a year
ago. Return on average common shareholders' equity was 17.49% and return on
average assets was 1.72% for the third quarter of 2002 compared with 14.83% and
1.42%, respectively, for the third quarter of 2001. Comparable prior year
returns excluding goodwill amortization expense were 16.29% and 1.56%,
respectively.
The residential mortgage banking business, which was sold in January 2001, is
reflected in discontinued operations throughout the Corporation's consolidated
financial statements. Accordingly, the results of operations for the residential
mortgage banking business are shown separately on one line in the income
statement for all periods presented. The remainder of the presentation in this
Financial Review reflects continuing operations, unless otherwise noted. See
Note 2 Discontinued Operations in the Notes to Consolidated Financial Statements
for additional information.
Third quarter 2002 results reflected further progress in addressing a number of
key challenges outlined in the Corporation's 2001 Form 10-K:
- - Overall balance sheet characteristics were further strengthened:
- Regional Community Banking grew demand deposits by 7% on average
compared with the third quarter of 2001.
- Nonperforming assets declined 18% from June 30, 2002 to $409 million
at September 30, 2002.
- Balance sheet liquidity was strong as the loans to deposits ratio was
80% at September 30, 2002.
- Capital continued to be strengthened during the quarter and the ratio
of common shareholders' equity to total assets increased from 8.3% at
December 31, 2001 to 9.9% at September 30, 2002.
- Institutional loans held for sale were reduced $571 million during the
third quarter to $495 million at September 30, 2002 and have been
reduced 81% from December 31, 2001. Total credit exposure (comprised
of loans outstanding, unfunded commitments and letters of credit)
declined 78% from year end 2001.
3
- - BlackRock earnings grew 21% to $33 million compared with the third quarter
of 2001 and were comparable with $35 million earned in the second quarter
of 2002.
Although overall results for the third quarter of 2002 were higher compared with
the prior year third quarter, earnings declined compared with the second quarter
of 2002. Revenue declined from last quarter due to the impact of the depressed
financial markets on market-sensitive businesses and a lower level of average
earning assets. These effects were partially offset by the benefit of higher net
securities gains, lower credit costs and reduced expenses.
Management expects that the remainder of 2002 will continue to be a challenging
operating environment that will limit opportunities for revenue growth. In
addition to the economy, interest rates, financial market conditions and the
possibility of international hostilities, the Corporation's success during the
remainder of the year will depend on its ability to address its key operating
challenges. These challenges include the continued liquidation of loans held for
sale without significant valuation losses, the stability of asset quality,
revenue growth and development of value-added customer relationships,
successfully leveraging technology and managing the revenue/expense
relationship, and regulatory actions. See 2002 Operating Environment in the
Financial Review section of the 2001 Form 10-K for additional information. Also
see the Risk Factors, Risk Management and Forward-Looking Statements sections of
this Financial Review.
As previously reported, in July 2002 the Corporation announced that it had
reached a resolution with the Securities and Exchange Commission ("SEC")
concerning the SEC's previously disclosed inquiry into the transfer of certain
PNC assets to companies formed with American International Group, Inc. ("AIG")
in 2001. PNC also announced in July 2002 that it had entered into an agreement
with the Federal Reserve Bank of Cleveland ("Federal Reserve"), and that PNC
Bank, N.A. ("PNC Bank"), PNC's principal bank subsidiary, had entered into an
agreement with the Office of the Comptroller of the Currency ("OCC"). See
Regulatory Matters in the Risk Management section of this Financial Review for
additional information.
BALANCE SHEET HIGHLIGHTS
PNC's focus during the first nine months of 2002 was on retaining and growing
value-added transaction deposits while changing the mix of earning assets,
including a reduction of institutional loans held for sale.
Total assets were $67.7 billion at September 30, 2002 compared with $69.6
billion at December 31, 2001. Average interest-earning assets were $55.8 billion
for the first nine months of 2002, a decrease of $3.9 billion compared with the
first nine months of 2001. This decline was due to a decrease in average loans
that was partially offset by increases in average securities and average loans
held for sale.
Average loans for the first nine months of 2002 were $37.7 billion, a decrease
of $8.4 billion compared with the first nine months of 2001. Average loans
represented 68% of total average earning assets for the first nine months of
2002 compared with 77% for the first nine months of 2001. The decreases were
primarily due to a decline in residential mortgages and institutional lending
portfolios that more than offset an increase in PNC Business Credit loans
resulting from the acquisition in 2002 of a portion of National Bank of Canada's
("NBOC") U.S. asset-based lending business.
Changes in loans held for sale are described in Strategic Repositioning and in
Loans Held For Sale in the Consolidated Balance Sheet Review section of this
Financial Review.
Average securities of $11.7 billion for the first nine months of 2002 were up
$1.6 billion compared with the first nine months of 2001 and represented 21% of
average earning assets for 2002 compared with 17% for 2001. The increases were
primarily due to net securities purchases upon redeployment of funds resulting
from loan downsizing and interest rate risk management activities.
Funding cost is affected by the volume and composition of funding sources as
well as related rates paid thereon. Average deposits comprised 66% and 64% of
total sources of funds for the first nine months of 2002 and 2001, respectively,
with the remainder primarily comprised of wholesale funding obtained at
prevailing market rates.
Average interest-bearing demand and money market deposits totaled $22.0 billion
for the first nine months of 2002, an increase of $1.0 billion or 5% compared
with the comparable 2001 period. This increase reflects focused marketing
efforts to grow more valuable transaction accounts while higher cost, less
valuable retail certificates of deposit were not emphasized. Average borrowed
funds for the first nine months of 2002 decreased $2.4 billion compared with the
first nine months of 2001 commensurate with the decline in average earning
assets. See the Consolidated Average Balance Sheet and Net Interest Analysis for
additional information.
4
REVIEW OF BUSINESSES
PNC operates seven major businesses engaged in regional community banking,
corporate banking, real estate finance, asset-based lending, wealth management,
asset management and global fund services.
Results of individual businesses are presented based on PNC's management
accounting practices and the Corporation's management structure. There is no
comprehensive, authoritative body of guidance for management accounting
equivalent to generally accepted accounting principles; therefore, the financial
results of individual businesses are not necessarily comparable with similar
information for any other company. Financial results are presented, to the
extent practicable, as if each business operated on a stand-alone basis. Also,
certain amounts for 2001 have been reclassified to conform with the 2002
presentation.
The management accounting process uses various balance sheet and income
statement assignments and transfers to measure performance of the businesses.
Methodologies change from time to time as management accounting practices are
enhanced and businesses change. Securities or borrowings and related net
interest income are assigned based on the net asset or liability position of
each business. Capital is assigned based on management's assessment of inherent
risks and equity levels at independent companies providing similar products and
services. The allowance for credit losses is allocated based on management's
assessment of risk inherent in the loan portfolios. The costs incurred by
support areas not directly aligned with the businesses are allocated primarily
based on utilization of services.
Total business results differ from consolidated results from continuing
operations primarily due to differences between management accounting practices
and generally accepted accounting principles, equity management activities,
minority interest in income of consolidated entities, residual asset and
liability management activities, eliminations and other corporate items, the
impact of which is reflected in the "Other" category. The operating results and
financial impact of the disposition of the residential mortgage banking
business, previously PNC Mortgage, are included in discontinued operations.
The impact of the institutional lending repositioning and other strategic
actions that occurred during 2001 is reflected in the business results presented
in the table below. The charges or credits are separately identified in the
business income statements. Performance ratios in the results of individual
businesses reflect the impact of the charges or credits.
RESULTS OF BUSINESSES(a)
Revenue Return on
Earnings (taxable-equivalent basis) Assigned Capital Average Assets
Nine months ended September 30 ------------------------------------------------------------------------------------------
Dollars in millions 2002 2001 2002 2001 2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Banking Businesses
Regional Community Banking $545 $523 $1,671 $1,685 28% 26% $39,010 $40,188
Corporate Banking 117 48 588 576 15 5 14,275 16,984
PNC Real Estate Finance 67 47 171 162 23 16 5,017 5,288
PNC Business Credit 12 39 133 102 6 32 3,870 2,431
- -------------------------------------------------------------------------------------- ----------------------
Total banking businesses 741 657 2,563 2,525 23 19 62,172 64,891
- -------------------------------------------------------------------------------------- ----------------------
Asset Management and Processing
PNC Advisors 84 117 504 562 22 29 2,976 3,399
BlackRock 99 79 440 404 24 25 790 644
PFPC 57 49 578 596 37 31 1,891 1,759
- -------------------------------------------------------------------------------------- ----------------------
Total asset management and
processing 240 245 1,522 1,562 25 28 5,657 5,802
- -------------------------------------------------------------------------------------- ----------------------
Total business results 981 902 4,085 4,087 23 21 67,829 70,693
Other (59) (95) (15) (223) (988) (132)
- -------------------------------------------------------------------------------------- ----------------------
Results from continuing operations 922 807 4,070 3,864 20 16 66,841 70,561
Discontinued operations 5 68
Cumulative effect of accounting change (5)
- -------------------------------------------------------------------------------------- ----------------------
Total consolidated $922 $807 $4,070 $3,864 20 16 $66,841 $70,629
===================================================================================================================================
(a) Amounts for 2002 reflect, where applicable, the adoption, effective January
1, 2002, of the new accounting standard under which goodwill is no longer
amortized to expense.
5
REGIONAL COMMUNITY BANKING
Nine months ended September 30
Taxable-equivalent basis
Dollars in millions 2002 2001
- --------------------------------------------------------------
INCOME STATEMENT
Net interest income $1,078 $1,093
Net securities gains 84 85
Other noninterest income 509 507
- --------------------------------------------------------------
Total revenue 1,671 1,685
Provision for credit losses 37 35
Noninterest expense 797 800
Goodwill amortization 27
Severance costs 3
- --------------------------------------------------------------
Pretax earnings 837 820
Income taxes 292 297
- --------------------------------------------------------------
Earnings $545 $523
==============================================================
AVERAGE BALANCE SHEET
Loans
Consumer
Home equity $7,002 $6,295
Indirect 569 853
Other consumer 649 794
- --------------------------------------------------------------
Total consumer 8,220 7,942
Residential mortgage 4,435 8,691
Commercial 3,512 3,588
Vehicle leasing 1,750 1,872
Other 120 135
- --------------------------------------------------------------
Total loans 18,037 22,228
Securities 10,855 9,561
Student and other loans held for sale 1,354 1,270
Assigned assets and other assets 8,764 7,129
- --------------------------------------------------------------
Total assets $39,010 $40,188
==============================================================
Deposits
Noninterest-bearing demand $4,980 $4,516
Interest-bearing demand 6,012 5,602
Money market 12,311 12,020
- --------------------------------------------------------------
Total transaction deposits 23,303 22,138
Savings 1,966 1,870
Certificates 10,177 12,291
- --------------------------------------------------------------
Total deposits 35,446 36,299
Other liabilities 932 1,177
Assigned capital 2,632 2,712
- --------------------------------------------------------------
Total funds $39,010 $40,188
==============================================================
PERFORMANCE RATIOS
Return on assigned capital 28% 26%
Noninterest income to total revenue 35 35
Efficiency 48 48
==============================================================
OTHER INFORMATION
September 30 December 31
In millions 2002 2001
- ------------------------------ ------------ ------------
Total nonperforming assets $65 $52
Vehicle leasing outstandings,
net of unearned income $1,511 $1,930
==============================================================
Regional Community Banking provides deposit, branch-based brokerage, electronic
banking and credit products and services to retail customers as well as deposit,
credit, treasury management and capital markets products and services to small
businesses primarily within PNC's geographic region.
The strategic focus of Regional Community Banking is on driving sustainable
revenue growth, aggressively managing the revenue/expense relationship and
improving the risk/return dynamic of this business. In addition, Regional
Community Banking seeks to increase transaction deposits, which serve as a means
to deepen customer relationships and support growth in consumer services
revenue.
During the first nine months of 2002, Regional Community Banking experienced an
increase in consumer households served, grew transaction deposits and improved
the retention of existing customer accounts. Despite this trend and success in
keeping deposit funding costs low, this business was adversely impacted by a
change in mix of earning assets and lower yields in the relatively low interest
rate environment in 2002.
Regional Community Banking contributed $545 million or 56% of total business
earnings for the first nine months of 2002 compared with $523 million or 58% for
the first nine months of 2001. Excluding net securities gains in both periods,
gains related to residential mortgage loan securitizations of $8 million in 2002
and $26 million in 2001, and $27 million of goodwill amortization expense in
2001, earnings for the first nine months of 2002 were flat compared with the
prior-year period.
Total revenue was $1.7 billion for the first nine months of 2002 and 2001.
Excluding net securities gains and loan securitization gains from both periods,
revenue was flat in the period-to-period comparison primarily due to lower net
interest income in 2002 offset by higher noninterest income.
The provision for credit losses for the first nine months of 2002 increased to
$37 million compared with $35 million in the prior year due to higher net
charge-offs on residential mortgage loans. See Critical Accounting Policies And
Judgments in the Risk Factors section of this Financial Review for additional
information.
Total loans decreased 19% on average in the first nine months of 2002 compared
with the prior year. Home equity loans, the lead consumer lending product, grew
11% in the comparison. The overall decline resulted primarily from the reduction
of residential mortgage and indirect auto products and prepayments on
residential mortgages. The increase in average securities in the nine month
comparison reflects the Corporation's balance sheet and interest rate risk
management activities.
Total deposits declined 2% in the period-to-period comparison as increases in
transaction and savings deposits were more than offset by a decline in
certificates of deposit. Demand and money market deposits increased due to
ongoing strategic marketing efforts to add new accounts and retain existing
customers as funds shifted from certificates of deposit.
As previously reported, the Corporation made the decision to discontinue its
vehicle leasing business in the fourth quarter of 2001. This portfolio, which
has declined 22% since December 31, 2001, is expected to mature over a period of
approximately five years with an average remaining life of two years. See
Strategic Repositioning in the Consolidated Balance Sheet Review section and
Critical Accounting Policies And Judgments in the Risk Factors section of this
Financial Review for additional information.
6
CORPORATE BANKING
Nine months ended September 30
Taxable-equivalent basis
Dollars in millions 2002 2001
- ---------------------------------------------------------------
INCOME STATEMENT
Net interest income $271 $396
Noninterest income 317 180
- ---------------------------------------------------------------
Total revenue 588 576
Provision for credit losses 139 53
Noninterest expense 272 289
Institutional lending repositioning 158
Goodwill amortization 2
Severance costs 3
- ---------------------------------------------------------------
Pretax earnings 177 71
Income taxes 60 23
- ---------------------------------------------------------------
Earnings $117 $48
===============================================================
AVERAGE BALANCE SHEET
Loans $9,698 $14,285
Loans held for sale 1,674 312
Other assets 2,903 2,387
- ---------------------------------------------------------------
Total assets $14,275 $16,984
===============================================================
Deposits $4,608 $4,764
Assigned funds and other liabilities 8,596 10,946
Assigned capital 1,071 1,274
- ---------------------------------------------------------------
Total funds $14,275 $16,984
===============================================================
PERFORMANCE RATIOS
Return on assigned capital 15% 5%
Noninterest income to total revenue 54 20
Efficiency 46 59
===============================================================
OTHER INFORMATION
September 30 December 31
In millions 2002 2001
- ---------------------------------------------------------------
Total nonperforming assets $158 $220
INSTITUTIONAL LENDING REPOSITIONING
Loans held for sale
Credit exposure 964 4,594
Outstandings 415 2,294
Exit portfolio
Credit exposure 611 2,662
Outstandings 12 192
===============================================================
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, Corporate Banking administers Market Street Funding
Corporation ("Market Street"), a multi-seller asset-backed commercial paper
conduit that is independently owned and managed. 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.
During the first nine months of 2002, Corporate Banking made significant
progress in the repositioning of its institutional lending business. The exit
and held for sale portfolios at September 30, 2002 had total credit exposure of
$1.6 billion including outstandings of $427 million, a reduction in outstandings
of approximately 83% from December 31, 2001. Of these amounts, $964 million of
credit exposure and $415 million of outstandings were classified as held for
sale. The Corporation is continuing to pursue liquidation of the institutional
held for sale portfolio.
Gains and losses may result from the liquidation of loans held for sale to the
extent actual performance differs from estimates inherent in the recorded
amounts or if valuations change. See Critical Accounting Policies And Judgments
in the Risk Factors section and Strategic Repositioning in the Consolidated
Balance Sheet Review section of this Financial Review for additional
information.
Corporate Banking contributed $117 million or 12% of total business earnings for
the first nine months of 2002 compared with $48 million or 6% for the first nine
months of 2001. The 2001 period included significant charges associated with the
transfer of loans to held for sale in connection with the institutional lending
repositioning. Results for this business continued to be adversely affected by
weak economic and market conditions combined with the impact of PNC's
institutional lending downsizing efforts.
Total revenue of $588 million for the first nine months of 2002 increased $12
million compared with the same period in 2001. Net interest income for the first
nine months in 2002 decreased $125 million compared with the first nine months
of 2001 primarily due to the impact of the decline in interest rates combined
with the reduction in average loans resulting from the ongoing institutional
lending downsizing. Noninterest income for the first nine months of 2002
increased $137 million compared with the same period in 2001 primarily due to
$100 million of net gains in excess of valuation adjustments related to
institutional loans held for sale in 2002 and higher treasury management fees in
2002.
Total credit costs were $139 million for the first nine months of 2002 compared
with $129 million for the first nine months of 2001. Credit costs for the 2001
period included $53 million reflected in provision for credit losses and $76
million of institutional lending repositioning charges. Valuation adjustments
totaling $82 million for loans previously designated as held for sale are also
reflected in the 2001 institutional lending repositioning charge. Net
charge-offs were $125 million for the first nine months of 2002 compared with
$129 million a year ago. The provision for credit losses for the first nine
months of 2002 reflects $94 million related to two Market Street liquidity
facilities as well as the impact of refinements to the Corporation's reserve
methodology related to impaired loans and pooled reserves. See Market Street in
the Risk Management section of this Financial Review, Critical Accounting
Policies And Judgments in the Risk Factors section, and Allowances For Credit
Losses And Unfunded Loan Commitments And Letters Of Credit in the Consolidated
Balance Sheet Review section of this Financial Review for additional
information.
Treasury management and capital markets products offered through Corporate
Banking are sold by several businesses across the Corporation and related
revenue net of expense is included in the results of those businesses.
Consolidated revenue from treasury management was $257 million for the first
nine months of 2002, an increase of $6 million compared to the first nine months
of 2001, as higher fee revenue was partially offset by lower income earned on
customers' deposit balances. Consolidated revenue from capital markets was $88
million for the first nine months of 2002, a decrease of $1 million compared
with the first nine months of 2001 primarily due to lower fees as a result of
weak economic and market conditions partially offset by the comparative impact
of valuation losses associated with equity investments in 2001.
Nonperforming assets were $158 million at September 30, 2002 compared with $220
million at December 31, 2001. The decrease was primarily due to the
Corporation's continued liquidation of the institutional held for sale
portfolio.
7
PNC REAL ESTATE FINANCE
Nine months ended September 30
Taxable-equivalent basis
Dollars in millions 2002 2001
- ----------------------------------------------------------------
INCOME STATEMENT
Net interest income $87 $88
Noninterest income
Commercial mortgage banking 46 45
Other 38 29
- ----------------------------------------------------------------
Total noninterest income 84 74
- ----------------------------------------------------------------
Total revenue 171 162
Provision for credit losses (7) 12
Noninterest expense 119 104
Goodwill amortization 14
- ----------------------------------------------------------------
Pretax earnings 59 32
- --------------------------------------- ------------ -----------
Minority interest (benefit) expense (2)
Income tax (benefit) expense (6) (15)
- ----------------------------------------------------------------
Earnings $67 $47
================================================================
AVERAGE BALANCE SHEET
Loans
Commercial real estate $2,251 $2,321
Commercial - real estate related 1,474 1,778
- ----------------------------------------------------------------
Total loans 3,725 4,099
Commercial mortgages held for sale 252 234
Other loans held for sale 157 4
Other assets 883 951
- ----------------------------------------------------------------
Total assets $5,017 $5,288
================================================================
Deposits $702 $468
Assigned funds and other
liabilities 3,920 4,422
Assigned capital 395 398
- ----------------------------------------------------------------
Total funds $5,017 $5,288
================================================================
PERFORMANCE RATIOS
Return on assigned capital 23% 16%
Noninterest income to total revenue 49 46
Efficiency 63 58
================================================================
OTHER INFORMATION
September 30 December 31
In millions 2002 2001
- ----------------------------------------------------------------
Total nonperforming assets $3 $6
INSTITUTIONAL LENDING REPOSITIONING
Loans held for sale
Credit exposure 68 324
Outstandings 55 244
Exit portfolio
Credit exposure 25 30
Outstandings 13 5
================================================================
PNC Real Estate Finance specializes in financial solutions for the acquisition,
development, permanent financing and operation of commercial real estate
nationally. PNC Real Estate Finance offers treasury and investment management,
access to the capital markets, commercial mortgage loan servicing and other
products and services to clients that develop, own, manage or invest in
commercial real estate. PNC's commercial real estate financial services platform
provides processing services through Midland Loan Services, Inc. ("Midland"), a
leading third-party provider of loan servicing and technology to the commercial
real estate finance industry, and national syndication of affordable housing
equity through Columbia Housing Partners, L.P. Activities related to Columbia
Housing Partners, L.P. will require additional regulatory approvals as a result
of bank regulatory, supervisory and examination activities. See Regulatory
Matters in the Risk Management section of this Financial Review for additional
information.
PNC Real Estate Finance seeks to have a more balanced and valuable revenue
stream by focusing on real estate processing businesses and increasing the value
of its lending business by seeking to sell more fee-based products to lending
customers.
PNC Real Estate Finance contributed $67 million or 7% of total business earnings
for the first nine months of 2002 compared with $47 million or 5% for the first
nine months of 2001. Net gains in excess of valuation adjustments related to
institutional loans held for sale, the cessation of goodwill amortization in
2002 and the impact of a loan recovery in the exited warehouse lending business
more than offset higher noninterest expense in 2002. Average loans decreased 9%
in the period-to-period comparison reflecting the impact of the institutional
lending repositioning.
Total revenue was $171 million for the first nine months of 2002 compared with
$162 million for the first nine months of 2001. The increase of $9 million or 6%
was primarily due to net gains in excess of valuation adjustments of $6 million
related to institutional loans held for sale.
Noninterest expense increased $15 million for the first nine months of 2002
compared with the prior year period primarily due to impairment charges related
to low income housing partnership assets.
The commercial mortgage servicing portfolio grew 12% to $74 billion at September
30, 2002. Midland, as a third-party servicer, is required to comply with various
contractual obligations, including the obligations to advance funds for
delinquent borrower payments and property protection purposes, and to monitor
property taxes and insurance. A total of $77 million of advances were
outstanding at September 30, 2002. Midland has priority to recover these
advances before the security holders of the related securitizations.
COMMERCIAL MORTGAGE SERVICING PORTFOLIO
In billions 2002 2001
- ---------------------------------------------------------------
January 1 $68 $54
Acquisitions/additions 15 20
Repayments/transfers (9) (8)
- ---------------------------------------------------------------
September 30 $74 $66
===============================================================
The provision for credit losses for the nine months ended September 30, 2002
included the benefit of a recovery amount in the exited warehouse lending
business. See Critical Accounting Policies And Judgments in the Risk Factors
section of this Financial Review for additional information.
During the first nine months of 2002, PNC Real Estate Finance made significant
progress in downsizing its institutional lending business. The exit and held for
sale portfolios at September 30, 2002 had total credit exposure of $93 million
including outstandings of $68 million, a reduction in outstandings of
approximately 73% since December 31, 2001. Of these amounts, $68 million of
credit exposure and $55 million of outstandings were classified as held for sale
as of September 30, 2002. The Corporation is continuing to pursue liquidation of
the institutional held for sale portfolio. Gains and losses may result from the
liquidation of loans held for sale to the extent actual performance differs from
estimates inherent in the recorded amounts or if valuations change. See Critical
Accounting Policies And Judgments in the Risk Factors section and Strategic
Repositioning in the Consolidated Balance Sheet Review section of this Financial
Review for additional information.
8
PNC BUSINESS CREDIT
Nine months ended September 30
Taxable-equivalent basis
Dollars in millions 2002 2001
- ------------------------------------------------------------------
INCOME STATEMENT
Net interest income $101 $77
Noninterest income 32 25
- ------------------------------------------------------------------
Total revenue 133 102
Provision for credit losses 72 13
Noninterest expense 41 22
Institutional lending repositioning 4
Goodwill amortization 1
- ------------------------------------------------------------------
Pretax earnings 20 62
Income taxes 8 23
- ------------------------------------------------------------------
Earnings $12 $39
==================================================================
AVERAGE BALANCE SHEET
Loans $3,550 $2,304
Loans held for sale 83 66
Other assets 237 61
- ------------------------------------------------------------------
Total assets $3,870 $2,431
==================================================================
Deposits $78 $81
Assigned funds and other liabilities 3,540 2,189
Assigned capital 252 161
- ------------------------------------------------------------------
Total funds $3,870 $2,431
==================================================================
PERFORMANCE RATIOS
Return on assigned capital 6% 32%
Noninterest income to total revenue 24 21
Efficiency 30 22
==================================================================
OTHER INFORMATION
September 30 December 31
In millions 2002 2001
- ------------------------------------------------------------------
Total nonperforming assets $179 $109
INSTITUTIONAL LENDING REPOSITIONING
Loans held for sale
Credit exposure 46 40
Outstandings 25 30
==================================================================
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 NBOC's U.S.
asset-based lending business in a purchase business combination. See Note 3 NBOC
Acquisition in the Notes to Consolidated Financial Statements for additional
information.
PNC Business Credit contributed $12 million or 1% of total business earnings for
the first nine months of 2002 compared with $39 million or 4% for the first nine
months of 2001. Earnings declined and performance ratios were adversely impacted
in the comparison as higher revenue in 2002 was more than offset by an increase
in the provision for credit losses.
Revenue was $133 million for the first nine months of 2002, a $31 million or 30%
increase compared with the first nine months of 2001 as both net interest income
and noninterest income increased. The increase in net interest income for the
first nine months of 2002 reflected a net increase of $1.2 billion or 54% in
total average loans for the period resulting primarily from the NBOC
acquisition.
Noninterest income in the first nine months of 2002 included a $19 million
benefit resulting from the reduction in the put option liability related to the
NBOC acquisition partially offset by $11 million of valuation adjustments in
excess of net gains related to the institutional loans held for sale.
Noninterest income for the first nine months of 2001 included $7 million of
gains on equity interests received as compensation in conjunction with lending
relationships and $4 million of net valuation adjustments related to
institutional loans held for sale.
The provision for credit losses for the first nine months of 2002 was $72
million compared with $13 million for the first nine months of 2001. Net
charge-offs were $26 million for the first nine months of 2002 compared with $13
million a year ago. The provision for credit losses increased in the first nine
months of 2002 as additions to reserves were made due to a decline in credit
quality and the impact of refinements to the Corporation's reserve methodology
related to impaired loans and pooled reserves. PNC Business Credit loans,
including those acquired in the NBOC acquisition, are secured loans to
borrowers, many with a weak credit risk rating. As a result, these loans
typically exhibit a higher risk of default and a greater proportion of such
loans may be classified as nonperforming. 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 direct control of cash flows and collateral requirements. Compensation
for this higher risk of default is obtained by way of higher interest rates
charged. See Critical Accounting Policies And Judgments in the Risk Factors
section and Allowance For Credit Losses And Unfunded Loan Commitments And
Letters Of Credit in the Consolidated Balance Sheet Review section of this
Financial Review for additional information.
Total noninterest expense increased $19 million to $41 million and the
efficiency ratio increased to 30% during the first nine months of 2002 compared
with the first nine months of 2001 primarily due to costs added with the NBOC
acquisition.
Nonperforming assets were $179 million at September 30, 2002 compared with $109
million at December 31, 2001. The increase was primarily due to one credit. See
Credit Risk in the Risk Management section of the Financial Review included in
the 2001 Form 10-K for additional information.
PNC Business Credit included several credits in the Corporation's institutional
lending repositioning. Credit exposure of $46 million including $25 million of
outstandings classified as held for sale remained at September 30, 2002. The net
increase in credit exposure from December 31, 2001 resulted from certain credits
in connection with the NBOC acquisition. See Critical Accounting Policies And
Judgments in the Risk Factors section and Strategic Repositioning in the
Consolidated Balance Sheet Review section of this Financial Review for
additional information.
9
PNC ADVISORS
Nine months ended September 30
Taxable-equivalent basis
Dollars in millions 2002 2001
- -----------------------------------------------------------------
INCOME STATEMENT
Net interest income $76 $99
Noninterest income
Investment management and trust 258 302
Brokerage 102 100
Other 68 61
- -----------------------------------------------------------------
Total noninterest income 428 463
- -----------------------------------------------------------------
Total revenue 504 562
Provision for credit losses 3 1
Noninterest expense 368 371
Goodwill amortization 5
- -----------------------------------------------------------------
Pretax earnings 133 185
Income taxes 49 68
- -----------------------------------------------------------------
Earnings $84 $117
=================================================================
AVERAGE BALANCE SHEET
Loans
Consumer $1,216 $1,098
Residential mortgage 537 884
Commercial 467 543
Other 335 395
- -----------------------------------------------------------------
Total loans 2,555 2,920
Other assets 421 479
- -----------------------------------------------------------------
Total assets $2,976 $3,399
=================================================================
Deposits $2,004 $2,078
Assigned funds and other liabilities 452 774
Assigned capital 520 547
- -----------------------------------------------------------------
Total funds $2,976 $3,399
=================================================================
PERFORMANCE RATIOS
Return on assigned capital 22% 29%
Noninterest income to total revenue 85 82
Efficiency 73 66
=================================================================
PNC Advisors provides a full range of tailored investment products and services
to affluent individuals and families, including full-service brokerage through
J.J.B. Hilliard, W.L. Lyons, Inc. ("Hilliard Lyons") and investment advisory
services to the ultra-affluent through Hawthorn. During the second quarter of
2002, Hilliard Lyons acquired from Regional Community Banking the branch-based
brokerage business that formerly operated under the PNC Brokerage brand name.
This business was combined with Hilliard's brokerage operations and now provides
services in the branch network under the PNC Investments brand name. 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 $151 million for the first nine months of 2002
compared with $163 million for the first nine months of 2001. PNC Advisors also
serves as investment manager and trustee for employee benefit plans and
charitable and endowment assets.
PNC Advisors is focused on acquiring and retaining customers and growing
customer relationships. This business has been adversely impacted by depressed
financial market conditions and the loss of customers resulting from investment
performance. Management is addressing investment performance and the
revenue/expense relationship given current conditions.
PNC Advisors contributed $84 million or 8% of total business earnings for the
first nine months of 2002 compared with $117 million or 13% for the first nine
months of 2001. Earnings decreased in the comparison primarily due to lower
revenue.
Revenue for the first nine months of 2002 decreased $58 million compared with
the prior year period due to depressed financial market conditions, lower
average loans, a narrower net interest margin and the positive effect of the
recognition of revenue accrual adjustments of $15 million in 2001. The decline
in net interest income for the first nine months of 2002 compared with the first
nine months of 2001 was attributable to both a decline in average loans and a
lower interest rate environment in 2002. 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 conditions and investment performance improve for a
sustained period. See Business and Economic Conditions and Asset Management
Performance in the Risk Factors section of the Financial Review included in the
2001 Form 10-K for additional information regarding matters that could impact
PNC Advisors' revenue.
ASSETS UNDER MANAGEMENT(a)
September 30 - in billions 2002 2001
- ---------------------------------------------------------------
Personal investment management and trust $40 $46
Institutional trust 10 13
- ---------------------------------------------------------------
Total $50 $59
===============================================================
ASSET TYPE
September 30 - in billions 2002 2001
- ---------------------------------------------------------------
Equity $26 $35
Fixed income 17 17
Liquidity 7 7
- ---------------------------------------------------------------
Total $50 $59
===============================================================
(a) Excludes brokerage assets administered.
Assets under management decreased $9 billion primarily due to the decline in the
value of the equity component of customers' portfolios. Brokerage assets
administered by Hilliard Lyons, including assets of the former PNC Brokerage
business, were $31 billion at September 30, 2002 compared with $32 billion at
September 30, 2001 and were also impacted by weak equity market conditions.
PNC Advisors provides investment management services directly and through funds
and accounts managed by BlackRock and funds managed by unaffiliated investment
managers. In July 2002, the Corporation and BlackRock entered into a revised
agreement with respect to investment management services. The agreement includes
a reduction in the rate of fees received from BlackRock based on current market
conditions and the impact of a reduction in the level of PNC Advisors' customer
assets managed by BlackRock. Based on the current levels and mix of those assets
in BlackRock investment funds, the agreement is expected to reduce PNC Advisors'
total revenue by approximately $12 million on an annual basis.
10
BLACKROCK
Nine months ended September 30
Dollars in millions 2002 2001
- ------------------------------------------------------------------
INCOME STATEMENT
Investment advisory and
administrative fees $397 $376
Other income 43 28
- ------------------------------------------------------------------
Total revenue 440 404
Operating expense 246 222
Fund administration
and servicing costs-affiliates 33 47
Amortization of intangible assets 1 8
- ------------------------------------------------------------------
Total expense 280 277
- ------------------------------------------------------------------
Operating income 160 127
Nonoperating income 7 7
- ------------------------------------------------------------------
Pretax earnings 167 134
Income taxes 68 55
- ------------------------------------------------------------------
Earnings $99 $79
==================================================================
PERIOD-END BALANCE SHEET
Intangible assets $181 $184
Other assets 609 460
- ------------------------------------------------------------------
Total assets $790 $644
==================================================================
Liabilities $194 $186
Stockholders' equity 596 458
- ------------------------------------------------------------------
Total liabilities and $790 $644
stockholders' equity
==================================================================
PERFORMANCE DATA
Return on equity 24% 25%
Operating margin(a) 39 36
Diluted earnings per share $1.52 $1.22
==================================================================
(a) Excludes the impact of fund administration and servicing costs - affiliates.
The financial information presented above 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 were recognized as a minority interest expense in the consolidated
income statement.
BlackRock is one of the largest publicly traded investment management firms in
the United States with approximately $246 billion of assets under management at
September 30, 2002. BlackRock manages assets on behalf of institutions and
individuals worldwide through a variety of fixed income, liquidity and equity
mutual funds, separate accounts and alternative investment products. Mutual
funds include the flagship fund families - BlackRock Funds and BlackRock
Provident Institutional Funds. In addition, BlackRock provides risk management
and investment system services to institutional investors under the BlackRock
Solutions brand name. BlackRock continues to focus on delivering superior
relative investment performance to clients while pursuing strategies to build on
core strengths and to selectively expand the firm's expertise and breadth of
distribution.
BlackRock contributed $99 million or 10% of total business earnings for the
first nine months of 2002 compared with $79 million or 9% for the first nine
months of 2001. Earnings increased 25% in the period-to-period comparison
primarily due to a 9% increase in assets under management and increased sales of
BlackRock Solutions products and services.
Total revenue for the first nine months of 2002 increased $36 million or 9%
compared with the first nine months of 2001 primarily due to increases in
separate account assets under management, sales of alternative investment
products and performance fees. Current market conditions substantially reduce
the likelihood of performance fees for the remainder of 2002. See Business and
Economic Conditions and Asset Management Performance in the Risk Factors section
of the Financial Review included in the 2001 Form 10-K for additional
information regarding matters that could impact asset management revenue.
Excluding goodwill amortization, expenses increased $10 million, or 4%, in the
period-to-period comparison in support of revenue growth and business expansion.
Expense growth was mitigated by lower fund administration and servicing
costs-affiliates.
ASSETS UNDER MANAGEMENT
September 30 - in billions 2002 2001
- ------------------------------------------------------------------
Separate accounts
Fixed income $146 $119
Liquidity 5 7
Liquidity - securities lending 6 8
Equity 8 8
Alternative investment products 6 5
- ------------------------------------------------------------------
Total separate accounts 171 147
- ------------------------------------------------------------------
Mutual funds(a)
Fixed income 19 14
Liquidity 52 56
Equity 4 9
- ------------------------------------------------------------------
Total mutual funds 75 79
- ------------------------------------------------------------------
Total assets under management $246 $226
==================================================================
(a) Includes BlackRock Funds, BlackRock Provident Institutional Funds, BlackRock
Closed End Funds, Short Term Investment Funds and BlackRock Global Series
Funds.
In July 2002, BlackRock and the Corporation entered into a revised agreement
with respect to investment management services. The agreement includes a
reduction in the rate of fees paid to PNC Advisors based on current market
conditions and the impact of a reduction in the level of PNC Advisors' customer
assets managed by BlackRock. The lower levels of PNC client assets invested in
the BlackRock Funds and the effect of the revised investment services agreement
resulted in a reduction in fund administration and servicing costs-affiliates of
approximately $15 million for the nine months ended September 30, 2002. PNC
client-related revenue subject to fund administration and servicing payments
declined approximately $20 million for the nine months ended September 30, 2002.
BlackRock adopted a new long-term incentive and retention program for key
employees, subject to approval by regulators and BlackRock's stockholders at the
next annual meeting in May 2003. The program seeks to provide continuity of the
management team, whose contracts expire at the end of this year, while promoting
development of the firm's future leaders. Stock options on up to 3.5 million
shares of BlackRock stock may be granted at market, subject to vesting at
December 31, 2006. In addition, up to $240 million of deferred compensation may
be awarded, with payments subject to the achievement of performance hurdles no
later than March 2007. If the performance hurdles are achieved, up to $200
million of the deferred compensation plan will be funded with the surrender by
PNC of up to 4 million shares of PNC's 44.9 million shares of BlackRock
common stock. BlackRock will fund the remainder with up to $40 million in cash.
See BlackRock Long-Term Incentive and Retention Plan in this Financial Review
for further information. See Securities in this Financial Review for certain
fourth quarter expectations regarding BlackRock's collateralized bond
obligation investments.
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
Nine months ended September 30
Dollars in millions 2002 2001
- ---------------------------------------------------------------
INCOME STATEMENT
Fund servicing revenue $578 $596
Operating expense 457 436
Goodwill amortization 30
(Accretion)/amortization of
other intangibles, net (14) (11)
- ---------------------------------------------------------------
Operating income 135 141
Nonoperating income(a) 8 11
Debt financing 67 71
Facilities consolidation and other
(credits)/charges (19)
- ---------------------------------------------------------------
Pretax earnings 95 81
Income taxes 38 32
- ---------------------------------------------------------------
Earnings $57 $49
===============================================================
AVERAGE BALANCE SHEET
Intangible assets $1,030 $1,072
Other assets 861 687
- ---------------------------------------------------------------
Total assets $1,891 $1,759
===============================================================
Assigned funds and other liabilities $1,683 $1,551
Assigned capital 208 208
- ---------------------------------------------------------------
Total funds $1,891 $1,759
===============================================================
PERFORMANCE RATIOS
Return on assigned capital 37% 31%
Operating margin 27 24
===============================================================
(a) Net of nonoperating expense.
PFPC is the largest full-service mutual fund transfer agent and second largest
provider of mutual fund accounting and administration services in the United
States, providing a wide range of fund services to the investment management
industry. PFPC also provides processing solutions to the international
marketplace through its Ireland and Luxembourg operations.
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. During the first nine
months of 2002, PFPC was adversely impacted by depressed financial market
conditions, a shift in client assets from equity to fixed income products and
client attrition. Management is addressing the revenue/expense relationship of
this business given current conditions.
PFPC is focusing technological resources on targeting Web-based initiatives,
streamlining operations and developing flexible system architecture and
client-focused servicing solutions. To meet the growing needs of the European
marketplace, PFPC is also continuing its pursuit of offshore expansion.
PFPC contributed $57 million or 6% of total business earnings for the first nine
months of 2002 compared with $49 million or 5% for the first nine months of
2001. Earnings in the first nine months of 2002 included the impact of a
one-time benefit of approximately $13 million of fees related to the
renegotiation of a client contract and the benefit of a $19 million reduction in
reserves. These reserves were originally established in the fourth quarter of
2001 and primarily related to a previously announced plan to consolidate
selected facilities. The facilities strategy has been modified and certain
originally contemplated relocations will no longer occur. PFPC also benefited in
2002 from the adoption of the new goodwill accounting standard that reduced
amortization expense by $30 million compared with the first nine months of 2001.
These benefits were partially offset by higher staff and technology-related
costs. The cost of integration, technology and infrastructure investments,
coupled with a shift in both product and client mix, continued to exert pressure
on operating margins. Margins are expected to remain under pressure at least
until equity markets and investor sentiment and demand improve for a sustained
period.
Revenue of $578 million for the first nine months of 2002 decreased $18 million
compared with the first nine months of 2001. Notwithstanding the one-time $13
million benefit described above, revenue declined in the comparison primarily
due to depressed financial market conditions, pricing and other competitive
factors including client attrition. See Business and Economic Conditions and
Fund Servicing in the Risk Factors section of the Financial Review included in
the 2001 Form 10-K for additional information regarding matters that could
impact fund servicing revenue.
Operating expense increased $21 million or 5% in the period-to-period comparison
primarily due to increased staff levels for new product support combined with
additional costs associated with investments in technology.
Operating income for the first nine months of 2002 included accretion of a
discounted client contract liability of $26 million. Accretion for the first
nine months of 2001 was $22 million.
SERVICING STATISTICS
September 30 2002 2001
- ---------------------------------------------------------------
Accounting/administration net assets
($ in billions)
Domestic $464 $484
Foreign (a) 25 16
- ---------------------------------------------------------------
Total $489 $500
Custody assets ($ in billions) $311 $359
Shareholder accounts (in millions) 52 47
===============================================================
(a) Represents net assets serviced offshore.
Accounting/administration net assets have decreased compared with the 2001
period as the impact of depressed financial markets and changes in domestic
client mix have more than offset successful offshore sales efforts. Custody
assets have declined primarily due to changes in client relationships.
12
CONSOLIDATED INCOME STATEMENT REVIEW
NET INTEREST INCOME
Changes in net interest income and margin result from the interaction among the
volume and composition of earning assets, related yields and associated funding
costs. Accordingly, portfolio size, composition and yields earned and funding
costs can have a significant impact on net interest income and margin. See the
Balance Sheet Highlights section of this Financial Review and the Consolidated
Average Balance Sheet and Net Interest Analysis for additional information.
Taxable equivalent net interest income declined slightly, from $1.696 billion to
$1.683 billion, in the first nine months of 2002 compared with the first nine
months of 2001, while the net interest margin widened to 4.00% compared with
3.76% in the prior year period. The level of net interest income for the first
nine months of 2002 reflected the positive effects of a lower interest rate
environment and transaction deposit growth that was mitigated by the impact of
the continued downsizing of the loan portfolio. The widening of the net interest
margin for 2002 resulted from the impact of changes in balance sheet composition
and a lower interest rate environment, combined with a steep yield curve. See
Interest Rate Risk in the Risk Management section of this Financial Review for
additional information.
Taxable-equivalent net interest income was $532 million and net interest margin
was 3.88% for the third quarter of 2002 compared with $568 million and 3.89%,
respectively, for the third quarter of 2001. Net interest income declined
compared with the third quarter of 2001 primarily due to the impact of a $3.6
billion, or 6%, decrease in average earning assets. The decline in average
earning assets resulted from the continued downsizing of the institutional
lending portfolio in 2002 that was partially offset by a higher level of federal
funds sold that increased overall balance sheet liquidity.
PROVISION FOR CREDIT LOSSES
The provision for credit losses was $244 million for the first nine months of
2002 compared with $235 million for the first nine months of 2001. The provision
for credit losses was $73 million for the third quarter of 2002 compared with
$110 million for the prior year quarter. The provision for the first nine months
of 2002 reflects additions to reserves for PNC Business Credit and Corporate
Banking, and losses in Corporate Banking primarily related to Market Street
liquidity facilities. The provision for both periods of 2001 reflects the impact
of transfers of loans to held for sale and an increase in the allowance for
credit losses.
Net charge-offs were $188 million or .67% of average loans for the first nine
months of 2002 compared with $190 million or .55%, respectively, for the first
nine months of 2001. Net charge-offs were $73 million or .79% of average loans
for the third quarter of 2002 compared with $65 million or .59%, respectively,
for the third quarter of 2001. Net charge-offs for the first nine months and
third quarter of 2002 included $43 million related to a single credit supported
by vocational student loans that resulted from a draw during the second quarter
of 2002 by Market Street on a liquidity facility provided by PNC. See Market
Street within this Financial Review for further information. Net charge-offs for
the first nine months of 2002 also included a second quarter 2002 charge-off of
$45 million related to another Market Street customer.
NONINTEREST INCOME
Noninterest income was $2.387 billion for the first nine months of 2002 compared
with $2.168 billion for the first nine months of 2001. Third quarter 2002
noninterest income totaled $758 million compared with $720 million in the third
quarter of 2001.
Asset management fees totaled $651 million for the first nine months of 2002, up
$6 million compared with the first nine months of 2001. The increase in the
year-to-date 2002 period primarily reflected an increase in separate account
base fee revenue arising from growth in assets under management at BlackRock,
partially offset by lower asset management fees at PNC Advisors primarily due to
weak equity markets in 2002 and the recognition of $15 million of revenue
accrual adjustments that benefited the first nine months of 2001. Asset
management fees for the third quarter of 2002 declined $8 million, to $200
million, compared with the prior year third quarter. The decrease for the third
quarter of 2002 was primarily due to the impact of depressed financial market
conditions and lower performance fees compared with the third quarter of 2001.
Consolidated assets under management increased to $285 billion at September 30,
2002 compared with $270 billion at September 30, 2001 due to growth at
BlackRock.
Fund servicing fees decreased $7 million, to $578 million, for the first nine
months of 2002 compared with the first nine months of 2001. Excluding a one-time
benefit of approximately $13 million related to the renegotiation of a client
contract recognized during the second quarter of 2002 at PFPC, fund servicing
fees for the first nine months of 2002 declined $20 million. For the third
quarter of 2002, fund servicing fees declined $15 million, to $180 million. The
declines in both 2002 periods were due to the impact of depressed financial
market conditions, pricing and other competitive factors including customer
attrition.
13
Service charges on deposits were $166 million for the first nine months of 2002,
an increase of $6 million compared with the prior year-to-date period. Service
charges on deposits totaled $57 million for the third quarter of 2002 compared
with $56 million for the third quarter of 2001. For both 2002 periods, the
benefit of an increase in average transaction deposits offset the impact of
price reductions from comparable services. Brokerage fees declined $12 million,
to $151 million, for the first nine months of 2002 compared with the first nine
months of 2001. Brokerage fees totaled $41 million in the third quarter of 2002,
down $13 million from the third quarter of 2001. The third quarter decrease
reflected lower sales commissions resulting from the impact of depressed
financial market conditions, lower trading volumes and lower income from
insurance annuities.
Consumer services revenue for the first nine months of 2002 totaled $178
million, an increase of $7 million compared with the first nine months of 2001.
For the third quarter of 2002, consumer services revenue was $62 million,
compared with $58 million for the prior year quarter. The increases for both
periods reflected additional fees from ATM and debit card transactions arising
from increased transaction volumes.
Corporate services revenue was $375 million for the first nine months of 2002
compared with $149 million for the first nine months of 2001. Third quarter 2002
corporate services revenue was $108 million, compared with a net loss of $3
million for the third quarter of 2001. Excluding the impact of net gains and
valuation adjustments related to institutional loans held for sale in each
period, corporate services revenue was $280 million for the first nine months of
2002 and $235 million for the prior year-to-date period. Excluding the effect of
these items from third quarter results, corporate services revenue was $91
million for the third quarter of 2002 compared with $82 million for 2001. Growth
in treasury management fees drove the increase in both the nine-month and third
quarter 2002 amounts compared with the respective 2001 periods.
Equity management (private equity activities) net losses on portfolio
investments were $37 million for the first nine months of 2002 compared with net
losses of $82 million for the first nine months of 2001. For the third quarter
of 2002, equity management net losses on portfolio investments totaled $22
million compared with net losses of $13 million for the prior year quarter.
Net securities gains totaled $88 million for the first nine months of 2002
compared with $134 million for the comparable prior year period. Net securities
gains were $68 million for the third quarter of 2002 compared with $88 million
for the third quarter of 2001.
Other noninterest income was $237 million for the first nine months of 2002, a
decline of $6 million compared with the first nine months of 2001. A $19 million
benefit resulting from the reduction in the put option liability related to the
NBOC acquisition and a $14 million gain on the sale of a real estate investment
in 2002 were more than offset in the comparison by gains of $26 million related
to residential loan securitizations and a higher level of revenue from trading
activities in the first nine months of 2001. Other noninterest income decreased
$13 million, to $64 million, for the third quarter of 2002 compared with the
prior year quarter primarily due to lower trading revenues.
Net trading income included in other noninterest income totaled $77 million for
the first nine months of 2002 compared with $113 million for the comparable
prior year period. For the third quarter of 2002, net trading income included in
other noninterest income was $24 million compared with $36 million for the prior
year quarter. The decreases for both 2002 periods resulted from lower
derivatives trading income, including income in connection with an option
contract in 2001 that did not recur in 2002. See Trading Activities in the Risk
Management section of this Financial Review and Note 7 Trading Activities in the
Notes to Consolidated Financial Statements for additional information.
NONINTEREST EXPENSE
Total noninterest expense was $2.392 billion for the first nine months of 2002,
an increase of $26 million or 1% compared with the first nine months of 2001.
Noninterest expense totaled $777 million for the third quarter of 2002, a
decline of $14 million from the prior year third quarter. Excluding the impact
of goodwill amortization expense recorded in the first nine months and third
quarter of 2001, noninterest expense increased $114 million and $15 million,
respectively, in the comparable 2002 periods. The increase in noninterest
expense for the first nine months of 2002 was attributable primarily to
increases of $24 million, $21 million, and $19 million at BlackRock, PFPC and
PNC Business Credit, respectively. These increases reflected higher operating
expenses to support revenue growth, business expansion, and the NBOC
acquisition, respectively. In addition, other noninterest expense for the first
nine months of 2002 included a $15 million adjustment related to incentive and
retention arrangements in the form of co-investment partnerships for certain
equity management employees. Higher consulting, legal and accounting fees and
higher occupancy and equipment costs, partially offset by the benefit of a $19
million reduction in reserves at PFPC, drove the increase in expenses for the
third quarter of 2002 compared to the prior year quarter. The PFPC reserves were
originally established in the fourth quarter of 2001 and are primarily related
to a previously announced plan to consolidate selected facilities. The
facilities strategy has been modified and certain originally contemplated
relocations will no longer occur.
The efficiency ratio was 58% for the first nine months of 2002 and 2001, while
the efficiency ratio for the third quarters of 2002 and 2001 was 59% and 58%,
respectively. Average full-time equivalent employees totaled approximately
24,000 and 24,600 for the first nine months of 2002 and 2001, respectively. The
decrease was mainly in Corporate Banking, PNC Advisors and Regional Community
Banking.
14
CONSOLIDATED BALANCE SHEET REVIEW
STRATEGIC REPOSITIONING
As previously reported, PNC took several actions in 2001 to accelerate the
strategic repositioning of its lending businesses that began in 1998. A total of
$12.0 billion of credit exposure, including $6.2 billion of outstandings, were
designated for exit or transferred to held for sale during 2001, of which $10.1
billion and $4.3 billion, respectively, related to the institutional lending
portfolio. The remaining $1.9 billion of credit exposure and outstandings are
related to PNC's vehicle leasing business that is being discontinued. At
September 30, 2002, PNC's vehicle leasing business had $1.5 billion in assets
that have been designated for exit and are expected to mature over a period of
approximately five years with a weighted average remaining life of two years.
See Critical Accounting Policies And Judgments in the Risk Factors section of
this Financial Review for additional information regarding certain risks
associated with executing these strategies.
Details of the credit exposure and outstandings by business in the institutional
lending held for sale and exit portfolios are included in the Corporate Banking,
PNC Real Estate Finance and PNC Business Credit sections of the Review of
Businesses within this Financial Review. A rollforward of the institutional
lending held for sale portfolio follows:
ROLLFORWARD OF INSTITUTIONAL LENDING HELD FOR SALE PORTFOLIO
In millions Credit Exposure Outstandings
- ---------------------------------------------------------------
January 1, 2002 $4,958 $2,568
Additions 119 238
Sales (2,015) (1,191)
Payments and other exposure
reductions (1,743) (922)
Valuation adjustments, net (241) (198)
- ---------------------------------------------------------------
September 30, 2002 $1,078 $495
===============================================================
During the third quarter and first nine months of 2002, the liquidation of
institutional loans held for sale resulted in net gains in excess of valuation
adjustments of $17 million and $95 million, respectively. Details by business
follow:
INSTITUTIONAL LENDING HELD FOR SALE ACTIVITY
Three months ended
September 30, 2002 Net gains on Valuation
In millions liquidation Adjustments Total
- ---------------------------------------------------------------
Corporate Banking $68 $(47) $21
PNC Real Estate Finance 2 (2)
PNC Business Credit 2 (6) (4)
- ---------------------------------------------------------------
Total $72 $(55) $17
===============================================================
Nine months ended
September 30, 2002 Net gains on Valuation
In millions liquidation Adjustments Total
- ---------------------------------------------------------------
Corporate Banking $312 $(212) $100
PNC Real Estate Finance 19 (13) 6
PNC Business Credit 5 (16) (11)
- ---------------------------------------------------------------
Total $336 $(241) $95
===============================================================
In addition to the actions taken regarding the institutional lending held for
sale and exit portfolios, the Corporation also recorded charges in 2001 totaling
$208 million in connection with other actions and additions to reserves.
Reserves related to these actions totaled $134 million at September 30, 2002.
The following table summarizes the third quarter and year-to-date 2002 changes
to these reserves:
ROLLFORWARD OF OTHER RESERVES RELATED TO FOURTH QUARTER 2001 ACTIONS
First Third
Half Quarter At
2001 Utilized 2002 2002 Sept. 30
In millions Charge in 2001 Activity Activity 2002
- -------------------------------------------------------------------------
Vehicle leasing $135 $(11) $(3) $(2) $119
Asset impairment
and severance costs 37 (24) (12) (1)
Facilities
consolidation and
other charges 36 (2) (19) 15
- -------------------------------------------------------------------------
Total $208 $(35) $(17) $(22) $134
=========================================================================
The fourth quarter 2001 charge of $135 million in connection with the vehicle
leasing business included exit costs and additions to reserves related to
insured residual value exposures. At September 30, 2002, the related liability
had been reduced to $119 million as a result of goodwill impairment of $11
million recorded in the fourth quarter of 2001 and a net $5 million reduction
related to severance and contractual payments recorded in the first nine months
of 2002 in connection with PNC's exit of this business.
The liability for asset impairment and severance costs was eliminated as of
September 30, 2002 as a result of asset write-downs and severance benefits paid
totaling $24 million in the fourth quarter of 2001 and $13 million of severance
benefits paid in the first nine months of 2002.
In the fourth quarter of 2001, PFPC incurred $36 million of pretax charges
primarily related to a plan to consolidate certain facilities. The charges
primarily reflected costs related to exiting certain lease agreements and the
abandonment of related leasehold improvements. During the third quarter of 2002,
the Corporation recognized a $19 million reduction of these charges as the
facilities strategy has been modified and certain originally contemplated
relocations will no longer occur.
LOANS
Loans were $35.9 billion at September 30, 2002, a $2.1 billion decrease from
year-end 2001 primarily due to the impact of residential mortgage loan
prepayments and sales, transfers to held for sale and the managed reduction of
institutional loans, which more than offset the impact in 2002 of the NBOC
acquisition and growth in home equity loans.
15
DETAILS OF LOANS
September 30 December 31
In millions 2002 2001
- ---------------------------------------------------------------
Commercial
Manufacturing $3,726 $3,352
Retail/wholesale 4,247 3,856
Service providers 1,986 2,136
Real estate related 1,554 1,720
Financial services 1,252 1,362
Communications 115 139
Health care 450 517
Other 2,042 2,123
- ---------------------------------------------------------------
Total commercial 15,372 15,205
- ---------------------------------------------------------------
Commercial real estate
Mortgage 516 592
Real estate project 1,958 1,780
- ---------------------------------------------------------------
Total commercial real estate 2,474 2,372
- ---------------------------------------------------------------
Consumer
Home equity 7,905 7,016
Automobile 540 773
Other 1,283 1,375
- ---------------------------------------------------------------
Total consumer 9,728 9,164
- ---------------------------------------------------------------
Residential mortgage 3,829 6,395
Lease financing
Vehicle 1,676 2,201
Equipment 3,537 3,356
- ---------------------------------------------------------------
Total lease financing 5,213 5,557
- ---------------------------------------------------------------
Other 409 445
Unearned income (1,108) (1,164)
- ---------------------------------------------------------------
Total, net of unearned income $35,917 $37,974
===============================================================
Loan portfolio composition continued to be diversified across PNC's footprint
among numerous industries and types of businesses. At September 30, 2002, loans
of $35.9 billion included $1.5 billion of vehicle leases, net of unearned
income, and $25 million of commercial and commercial real estate loans that have
been designated for exit.
NET UNFUNDED COMMITMENTS
September 30 December 31
In millions 2002 2001
- ---------------------------------------------------------------
Commercial $21,263 $20,233
Commercial real estate 850 711
Consumer 5,373 4,977
Lease financing 60 146
Other 114 139
Designated for exit or held for sale 1,460 4,837
- ---------------------------------------------------------------
Total $29,120 $31,043
===============================================================
Commitments to extend credit represent arrangements to lend funds or provide
liquidity subject to specified contractual conditions. Commitments include loan
commitments and liquidity facilities provided to Market Street. Commercial
commitments are reported net of participations, assignments and syndications,
primarily to financial institutions, totaling $6.9 billion at September 30, 2002
and $7.1 billion at December 31, 2001.
Net outstanding letters of credit totaled $3.8 billion and $4.0 billion at
September 30, 2002 and December 31, 2001, respectively, and consisted primarily
of standby letters of credit that commit the Corporation to make payments on
behalf of customers if specified future events occur.
LOANS HELD FOR SALE
Loans held for sale were $2.0 billion at September 30, 2002 compared with $4.2
billion at December 31, 2001. See Strategic Repositioning in this Financial
Review for further information regarding details of the institutional lending
held for sale portfolio. Approximately $110 million of loans held at September
30, 2002 by companies formed with AIG are classified in the consolidated
financial statements as loans held for sale. Substantially all student loans are
classified as loans held for sale.
DETAILS OF LOANS HELD FOR SALE
September 30 December 31
In millions 2002 2001
- ----------------------------------------------------------------
Institutional lending repositioning
Commercial
Manufacturing $181 $810
Communications 60 690
Service providers 53 333
Retail/wholesale 26 114
Financial services 24 40
Health care 23 73
Real estate related 7 30
Other 65 223
- ----------------------------------------------------------------
Total commercial 439 2,313
- ----------------------------------------------------------------
Commercial real estate 56 248
Lease financing 7
- ----------------------------------------------------------------
Total institutional lending
repositioning 495 2,568
Student loans 1,225 1,340
Other 269 281
- ----------------------------------------------------------------
Total loans held for sale $1,989 $4,189
================================================================
NONPERFORMING, PAST DUE AND POTENTIAL PROBLEM ASSETS
Nonperforming assets include nonaccrual loans, troubled debt restructurings,
nonaccrual loans held for sale and foreclosed assets. In addition, certain
performing assets have interest payments that are past due or have the potential
for future repayment problems.
NONPERFORMING ASSETS BY TYPE
September 30 December 31
Dollars in millions 2002 2001
- -----------------------------------------------------------------
Nonaccrual loans
Commercial $232 $188
Commercial real estate 5 4
Consumer 12 3
Residential mortgage 5 5
Lease financing 15 11
- -----------------------------------------------------------------
Total nonaccrual loans 269 211
Troubled debt restructured loan 2
- -----------------------------------------------------------------
Total nonperforming loans 271 211
Nonperforming loans held for sale(a) 125 169
Foreclosed assets
Commercial real estate 1
Residential mortgage 6 3
Other 7 7
- -----------------------------------------------------------------
Total foreclosed assets 13 11
- -----------------------------------------------------------------
Total nonperforming assets $409 $391
=================================================================
Nonperforming loans to total loans .75% .56%
Nonperforming assets to total loans,
loans held for sale and foreclosed assets 1.08 .93
Nonperforming assets to total assets .60 .56
=================================================================
(a) Includes a troubled debt restructured loan held for sale of $11 million and
$6 million as of September 30, 2002 and December 31, 2001, respectively.
16
Of the total nonperforming loans at September 30, 2002, 56% are related to PNC
Business Credit. These loans are to borrowers, many of which have weak credit
risk ratings. As a result, these loans typically exhibit a higher risk of
default and a greater proportion of such loans may be classified as
nonperforming. The above table excludes nonperforming equity management assets
carried at estimated fair value of $42 million and $18 million at September 30,
2002 and December 31, 2001, respectively, and included in other assets on the
Consolidated Balance Sheet. Nonperforming equity management assets at September
30, 2002 include $13 million of troubled debt restructured assets.
The amount of nonperforming loans that were current as to principal and interest
was $165 million at September 30, 2002 and $93 million at December 31, 2001. The
amount of nonperforming loans held for sale that were current as to principal
and interest was $70 million at September 30, 2002 and $8 million at December
31, 2001.
NONPERFORMING ASSETS BY BUSINESS
September 30 December 31
In millions 2002 2001
- ----------------------------------------------------------------
Regional Community Banking $65 $52
Corporate Banking 158 220
PNC Real Estate Finance 3 6
PNC Business Credit 179 109
PNC Advisors 4 4
- ----------------------------------------------------------------
Total nonperforming assets $409 $391
================================================================
At September 30, 2002, Corporate Banking and PNC Business Credit had
nonperforming loans held for sale of $99 million and $26 million, respectively,
which are included in the preceding table.
CHANGE IN NONPERFORMING ASSETS
In millions 2002 2001
- ----------------------------------------------------------------
January 1 $391 $372
Transferred from accrual 711 589
Returned to performing (27) (14)
Principal reductions (310) (159)
Asset sales (145) (25)
Charge-offs and valuation adjustments (211) (237)
- ----------------------------------------------------------------
September 30 $409 $526
================================================================
Credit quality was adversely affected for the first nine months of 2002 and
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
------------------------------------------
Dollars in millions Sept. 30 Dec. 31 Sept. 30 Dec 31
2002 2001 2002 2001
- ----------------------------------------------------------------
Commercial $32 $54 .21% .36%
Commercial real estate 4 11 .16 .46
Consumer 40 36 .41 .39
Residential mortgage 40 56 1.04 .88
Lease financing 1 2 .02 .05
- -------------------------------------------
Total loans 117 159 .33 .42
Loans held for sale 14 33 .70 .79
- -------------------------------------------
Total loans and loans
held for sale $131 $192 .35% .46%
================================================================
Loans and loans held for sale not included in nonperforming or past due
categories, but where information about possible credit problems causes
management to be uncertain about the borrower's ability to comply with existing
repayment terms over the next six months, totaled $231 million and $42 million,
respectively, at September 30, 2002. Approximately one-fourth of these loans are
in the PNC Business Credit portfolio and all of the loans held for sale relate
to the institutional lending repositioning.
CREDIT RISK
Credit risk represents the possibility that a borrower, counterparty or insurer
may not perform in accordance with contractual terms. Credit risk is inherent in
the financial services business and results from extending credit to customers,
purchasing securities and entering into financial derivative transactions. The
Corporation seeks to manage credit risk through, among others, diversification,
limiting credit exposure to any single industry or customer, requiring
collateral, selling participations to third parties, and purchasing
credit-related derivatives.
ALLOWANCES FOR CREDIT LOSSES AND UNFUNDED LOAN COMMITMENTS AND LETTERS OF CREDIT
The Corporation maintains an allowance for credit losses to absorb losses
inherent in the loan portfolio. The allowance is determined based on quarterly
assessments of the probable estimated losses inherent in the loan portfolio. The
methodology for measuring the appropriate level of the allowance consists of
several elements, including specific allocations to impaired loans, allocations
to pools of non-impaired loans and unallocated reserves. While allocations are
made to specific loans and pools of loans, the total reserve is available for
all loan losses. Enhancements and refinements to the reserve methodology during
the second quarter of 2002 resulted in a reallocation of the allowance for
credit losses among the Corporation's businesses and from unallocated to
specific and pool categories.
In addition to the allowance for credit losses, the Corporation maintains an
allowance for unfunded loan commitments and letters of credit. This amount,
reported as a liability on the Consolidated Balance Sheet, is determined using
estimates of the probability of the ultimate funding and 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.
17
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.
This methodology is sensitive to changes in key risk parameters such as EDPs and
LGDs. In general, a given change in any of the major risk parameters will have a
commensurate change in the pool reserve allocations to non-impaired commercial
loans. Additionally, other factors such as the rate of migration in the severity
of problem loans or changes in the maturity distribution of the loans will
contribute to the final pool reserve allocations.
Consumer (including residential mortgage) loan allocations are made at a total
portfolio level by consumer product line based on historical loss experience. A
four-quarter average loss rate is computed as net charge-offs for the prior four
quarters as a percentage of the average loan outstandings in those quarters.
This loss rate is applied to loans outstanding at the end of the current period.
The final loan reserve allocations are based on this methodology and
management's judgment of other qualitative factors which may include, among
others, regional and national economic conditions, business segment and
portfolio concentrations, historical versus estimated losses, model risk and
changes to the level of credit risk in the portfolio.
Unallocated reserves are established to provide coverage for risks not
considered in the specific, pool and consumer reserve methodologies, such as,
but not limited to, potential judgment and data errors. Furthermore, events may
have occurred as of the reserve evaluation date that are not yet reflected in
the risk measures or characteristics of the portfolio due to inherent lags in
information. Management's evaluation of these and other relevant factors
determines the level of unallocated reserves established at the evaluation date.
The Reserve Adequacy Committee provides oversight for the allowance evaluation
process, including quarterly evaluations and methodology and estimation changes.
The results of the evaluations are reported to the Credit Committee of the Board
of Directors.
ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES
September 30, 2002 December 31, 2001
--------------------------------------------
Loans to Loans to
Dollars in millions Allowance Total Loans Allowance Total Loans
- -----------------------------------------------------------------
Commercial $500 42.8% $392 40.0%
Commercial
real estate 58 6.9 63 6.3
Consumer 29 27.1 39 24.1
Residential mortgage 10 10.7 8 16.8
Other 51 12.5 58 12.8
- -----------------------------------------------------------------
Total $648 100% $560 100%
=================================================================
For purposes of this presentation, the unallocated portion of the allowance for
credit losses of $111 million at September 30, 2002 and $143 million at December
31, 2001 has been assigned to loan categories based on the relative specific and
pool allocation amounts. The unallocated portion of the allowance for credit
losses represented 17% of the total allowance and .31% of total loans at
September 30, 2002, compared with 26% and .38%, respectively, at December 31,
2001.
The provision for credit losses for the first nine months of 2002 and the
evaluation of the allowances for credit losses and unfunded loan commitments and
letters of credit as of September 30, 2002 reflected changes in loan portfolio
composition, the net impact of downsizing credit exposure, the impact of
refinements to the Corporation's reserve methodology and changes in asset
quality. The provision includes amounts for potential losses on loans and credit
exposure related to unfunded loan commitments and letters of credit.
ROLLFORWARD OF ALLOWANCE FOR CREDIT LOSSES
In millions 2002 2001
- -----------------------------------------------------------------
January 1 $560 $598
Charge-offs (224) (219)
Recoveries 36 29
- -----------------------------------------------------------------
Net charge-offs (188) (190)
Provision for credit losses 244 235
Acquired allowance (NBOC acquisition) 41
Net change in allowance for unfunded
loan commitments and letters of credit (9) (5)
- -----------------------------------------------------------------
September 30 $648 $638
=================================================================
18
ROLLFORWARD OF ALLOWANCE FOR UNFUNDED LOAN COMMITMENTS AND LETTERS OF CREDIT
In millions 2002 2001
- -----------------------------------------------------------------
January 1 $70 $77
Net change in allowance for unfunded
loan commitments and letters of credit 9 5
- -----------------------------------------------------------------
September 30 $79 $82
=================================================================
The allowance for credit losses as a percent of nonperforming loans and total
loans was 239% and 1.80%, respectively, at September 30, 2002 compared with 265%
and 1.47%, respectively, at December 31, 2001. The decline in the allowance as a
percent of nonperforming loans since December 31, 2001 resulted from increases
in nonperforming loans at PNC Business Credit and in Corporate Banking related
to a Market Street liquidity facility.
CHARGE-OFFS AND RECOVERIES
Percent
of
Nine months ended September 30 Net Average
Dollars in millions Charge-offs Recoveries Charge-offs Loans
- -----------------------------------------------------------------
2002
Commercial $167 $23 $144 1.20%
Commercial real estate 2 2 .11
Consumer 30 11 19 .27
Residential mortgage 5 1 4 .11
Lease financing 20 1 19 .60
- ------------------------------------------------------
Total $224 $36 $188 .67
=================================================================
2001
Commercial $165 $13 $152 1.01%
Commercial real estate 6 1 5 .26
Consumer 31 13 18 .26
Residential mortgage 1 1 .01
Lease financing 16 2 14 .45
- ------------------------------------------------------
Total $219 $29 $190 .55
=================================================================
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 September 30, 2002, credit default swaps
with $168 million in notional value were used by the Corporation to hedge credit
risk associated with commercial lending activities and are included in the Other
Derivatives table in the Financial Derivatives section of this Financial Review.
Net gains realized in connection with credit default swaps totaled $409,000 for
the third quarter of 2002 and $570,000 for the first nine months of 2002. There
were no gains or losses in the first nine months of the prior year.
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. These agreements are considered to be financial guarantees and
therefore are not included in the Financial Derivatives section of this
Financial Review. Risk participation agreements executed by the Corporation to
mitigate credit risk had a total notional value of $45 million at September 30,
2002. Additionally, risk participation agreements entered into in which the
Corporation assumed credit exposure had a total notional value of $81 million at
September 30, 2002.
SECURITIES
Total securities were $12.5 billion and represented 19% of total assets at
September 30, 2002 compared with $13.9 billion and 20%, respectively, at
December 31, 2001. The decreases were primarily due to net sales of
mortgage-backed and asset-backed securities during 2002.
At September 30, 2002, the securities available for sale balance included a net
unrealized gain of $272 million, which represented the difference between fair
value and amortized cost. The comparable amount at December 31, 2001 was a net
unrealized loss of $132 million. Net unrealized gains and losses in the
securities available for sale portfolio are included in accumulated other
comprehensive income or loss, net of tax or, for the portion attributable to a
hedged risk as part of a fair value hedge strategy, in net income. The expected
weighted-average life of securities available for sale was 2 years and 6 months
at September 30, 2002 compared with 4 years at December 31, 2001.
Securities designated as held to maturity are carried at amortized cost and are
assets of companies formed with AIG that are consolidated in PNC's financial
statements. The expected weighted-average life of securities held to maturity
was 20 years and 3 months at September 30, 2002 compared with 18 years and 11
months at December 31, 2001.
DETAILS OF SECURITIES
Amortized Fair
In millions Cost Value
- -----------------------------------------------------------------
SEPTEMBER 30, 2002
SECURITIES AVAILABLE FOR SALE
Debt securities
U.S. Treasury and government agencies $839 $849
Mortgage-backed 8,511 8,695
Asset-backed 1,946 2,026
State and municipal 60 67
Other debt 57 60
Corporate stocks and other 509 497
- -----------------------------------------------------------------
Total securities available for sale $11,922 $12,194
- -----------------------------------------------------------------
SECURITIES HELD TO MATURITY
Debt securities
U.S. Treasury and government agencies $271 $315
Asset-backed 8 8
Other debt 63 63
- -----------------------------------------------------------------
Total securities held to maturity $342 $386
=================================================================
December 31, 2001
SECURITIES AVAILABLE FOR SALE
Debt securities
U.S. Treasury and government agencies $808 $807
Mortgage-backed 9,669 9,578
Asset-backed 2,799 2,776
State and municipal 62 64
Other debt 75 75
Corporate stocks and other 264 245
- -----------------------------------------------------------------
Total securities available for sale $13,677 $13,545
- -----------------------------------------------------------------
SECURITIES HELD TO MATURITY
Debt securities
U.S. Treasury and government agencies $260 $257
Asset-backed 8 8
Other debt 95 95
- -----------------------------------------------------------------
Total securities held to maturity $363 $360
=================================================================
Included in securities available for sale are certain investments in
collateralized bond obligations held by BlackRock. Based on an assessment as of
November 13, 2002, BlackRock management believes that some level of
impairment against these assets will need to be recorded in the fourth quarter
of 2002, with preliminary evaluations indicating that impairment charges could
approximate $3 million to $4 million. The charge would be recorded in
noninterest income.
19
EQUITY MANAGEMENT ACTIVITIES
At September 30, 2002, equity management investments carried at estimated fair
value totaled approximately $566 million. Approximately 55% of the amount is
invested directly in a variety of companies and approximately 45% is invested in
various limited partnerships. Equity management funding commitments totaled $179
million at September 30, 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 financial information that is the primary basis for the valuation of the
limited partnership interests. Consequently, PNC will recognize in the fourth
quarter of 2002 valuation changes related to limited partnership investments
that reflect the impact of third quarter 2002 market conditions and performance
of the underlying companies. The Corporation continues to make equity management
investments on a limited basis and to manage private equity investments for
others. As described in the Corporation's July 18, 2002 Current Report on Form
8-K ("July 18, 2002 8-K"), such activities are subject to limitation as a result
of bank regulatory, supervisory and examination activities and may have to be
curtailed if the Corporation is not successful in satisfying relevant regulatory
requirements.
FUNDING SOURCES
Total funding sources were $54.9 billion at September 30, 2002 and $59.4 billion
at December 31, 2001 and were comprised of the following:
DETAILS OF FUNDING SOURCES
September 30 December 31
In millions 2002 2001
- -----------------------------------------------------------------
Deposits
Demand and money market $32,124 $32,589
Savings 2,024 1,942
Retail certificates of deposit 10,197 10,727
Other time 315 472
Deposits in foreign offices 300 1,574
- -----------------------------------------------------------------
Total deposits 44,960 47,304
- -----------------------------------------------------------------
Borrowed funds
Federal funds purchased 35 167
Repurchase agreements 988 954
Bank notes and senior debt 4,962 6,362
Federal Home Loan Bank borrowings 1,270 2,047
Subordinated debt 2,423 2,298
Other borrowed funds 269 262
- -----------------------------------------------------------------
Total borrowed funds 9,947 12,090
- -----------------------------------------------------------------
Total $54,907 $59,394
=================================================================
LIQUIDITY
Liquid assets consist of short-term investments and securities available for
sale. At September 30, 2002, such assets totaled $17 billion, with $7.9 billion
pledged as collateral for borrowings, trust and other commitments. Secured
advances from the Federal Home Loan Bank, of which PNC Bank, PNC's principal
bank subsidiary, is a member, are generally secured by residential mortgages,
other real-estate related loans and mortgage-backed securities. At September 30,
2002, total borrowing capacity from the Federal Home Loan Bank under current
collateral requirements was $9.7 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 subsidiaries is generated through the
issuance of securities in public or private markets and lines of credit. At
September 30, 2002, the Corporation had unused capacity under effective shelf
registration statements of approximately $3.3 billion of debt or equity
securities and $400 million of trust preferred capital securities. The
Corporation had an unused line of credit of $460 million at September 30, 2002.
The principal source of parent company revenue and cash flow is the dividends it
receives from PNC Bank. PNC Bank's dividend level may be impacted by its capital
needs, supervisory policies, corporate policies, contractual restrictions and
other factors. Also, there are legal limitations on the ability of national
banks to pay dividends or make other capital distributions. The amount available
for dividend payments to the parent company by all bank subsidiaries without
prior regulatory approval was approximately $365 million at September 30, 2002.
In addition to dividends from PNC Bank, other sources of parent company
liquidity include cash and short-term investments, as well as dividends and loan
repayments from other subsidiaries. As of September 30, 2002, the parent company
had approximately $665 million in funds available from its cash and short-term
investments or other funds available from unrestricted subsidiaries. Management
believes the parent company has sufficient liquidity available to meet current
obligations to its debt holders, vendors, and others and to pay dividends at
current rates through 2002.
CAPITAL
The access to and cost of funding new business initiatives including
acquisitions, the ability to engage in expanded business activities, the ability
to pay dividends, the ability to repurchase stock, the level of deposit
insurance costs, and the level and nature of regulatory oversight depend on, in
part, a financial institution's capital strength. At September 30, 2002, each
banking subsidiary of the Corporation was considered "well capitalized" based on
regulatory capital ratio requirements.
20
RISK-BASED CAPITAL
September 30 December 31
Dollars in millions 2002 2001
- ------------------------------------------------------------------
Capital components
Shareholders' equity
Common $6,707 $5,813
Preferred 10 10
Trust preferred capital securities 848 848
Minority interest 218 134
Goodwill and other intangibles (2,450) (2,174)
Net unrealized securities (gains)
losses (177) 86
Net unrealized gains on cash flow
hedge derivatives (143) (98)
Nonfinancial equity investments (36)
Other, net (25) (20)
- ------------------------------------------------------------------
Tier I risk-based capital 4,952 4,599
Subordinated debt 1,351 1,616
Minority interest 36 36
Eligible allowance for credit losses 708 707
- ------------------------------------------------------------------
Total risk-based capital $7,047 $6,958
==================================================================
Assets
Risk-weighted assets and
off-balance-sheet instruments,
and market risk equivalent assets $56,568 $58,958
Average tangible assets 63,239 67,604
==================================================================
Capital ratios
Tier I risk-based 8.8% 7.8%
Total risk-based 12.5 11.8
Leverage 7.8 6.8
==================================================================
The capital position is managed through balance sheet size and composition,
issuance of debt and equity instruments, treasury stock activities, dividend
policies and retention of earnings.
On January 3, 2002 the Board of Directors authorized the Corporation to purchase
up to 35 million shares of its common stock through February 29, 2004. These
shares may be purchased in the open market or privately negotiated transactions.
This authorization terminated any prior authorization. During the first nine
months of 2002, PNC repurchased 320,000 shares of its common stock under this
program. The extent and timing of any further share repurchases will depend on a
number of factors including, among others, progress in disposing of loans held
for sale, regulatory capital considerations, alternative uses of capital and
receipt of regulatory approvals if then required. The Corporation does not
currently intend to repurchase additional shares through the remainder of 2002
under this program.
RISK FACTORS
The Corporation is subject to a number of risks including, among others, those
described below, in the Consolidated Balance Sheet Review, Risk Management and
Forward-Looking Statements sections of this Financial Review and elsewhere in
this report. The Business section of the 2001 Form 10-K describes a number of
risks applicable to the Corporation, including: business and economic
conditions, supervision and regulation, monetary and other policies,
competition, disintermediation, asset management performance, fund servicing,
acquisitions and terrorist activities. Reference is made to the 2001 Form 10-K
as supplemented by the July 18, 2002 8-K for a detailed description of these
risks which continue to have the potential to impact the Corporation's business,
financial condition and results of operations, including, among others, the risk
of international hostilities.
CRITICAL ACCOUNTING POLICIES AND JUDGMENTS
The Corporation's consolidated financial statements are prepared based on the
application of certain accounting policies, the most significant of which are
described in Note 1 Accounting Policies in the Notes to Consolidated Financial
Statements. Certain of these policies require numerous estimates and strategic
or economic assumptions that may prove inaccurate or subject to variations and
may significantly affect PNC's reported results and financial position for the
period or in future periods. Changes in underlying factors, assumptions, or
estimates in any of these areas could have a material impact on PNC's future
financial condition and results of operations.
ALLOWANCES FOR CREDIT LOSSES AND UNFUNDED LOAN COMMITMENTS AND LETTERS OF CREDIT
The allowances for credit losses and unfunded loan commitments and letters of
credit are calculated with the objective of maintaining reserve levels believed
by management to be sufficient to absorb estimated probable credit losses.
Management's determination of the adequacy of the allowances is based on
periodic evaluations of the credit portfolio and other relevant factors.
However, this evaluation is inherently subjective as it requires material
estimates, including, among others, expected default probabilities, loss given
default, expected commitment usage, the amounts and timing of expected future
cash flows on impaired loans, value of collateral, estimated losses on consumer
loans and residential mortgages, and general amounts for historical loss
experience. The process also considers economic conditions, uncertainties in
estimating losses and inherent risks in the various credit portfolios. All of
these factors may be susceptible to significant change. Also, the allocation of
the allowance for credit losses to specific loan pools is based on historical
loss trends and management's judgment concerning those trends.
Commercial loans are the largest category of credits and are the most sensitive
to changes in assumptions and judgments underlying the determination of the
allowance for credit losses. Approximately $500 million or 77% of the total
allowance for credit losses at September 30, 2002 has been allocated to the
commercial loan category. This allocation also considers other relevant factors
such as actual versus estimated losses, regional and national economic
conditions, business segment and portfolio concentrations, industry competition
and consolidation, the impact of government regulations, and risk of potential
estimation or judgmental errors. To the extent actual outcomes differ from
management estimates, additional provision for credit losses may be required
that would adversely impact earnings in future periods.
21
LOANS HELD FOR SALE
Loans are classified as held for sale based on management's intent to sell them.
At the initial transfer date of a loan from portfolio to held for sale, any
lower of cost or market ("LOCOM") adjustment is recorded as a charge-off. This
results in a new cost basis. Any subsequent adjustment as a result of the LOCOM
analysis is recognized as a valuation adjustment with changes included in
noninterest income. Although the market value for certain held for sale assets
may be readily obtainable, other assets require significant judgments by
management as to the value that could be realized at the balance sheet date.
These assumptions include, but are not limited to, the cash flows generated from
the asset, the timing of a sale, the value of any collateral, the market
conditions for the particular credit, overall investor demand for these assets
and the determination of a proper discount rate. Changes in market conditions
and actual liquidation experience may result in additional valuation adjustments
that could adversely impact earnings in future periods.
EQUITY MANAGEMENT ASSET VALUATION
Equity management assets are valued at each balance sheet date based 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.
LEASE RESIDUALS
Leases are carried at the aggregate of lease payments and the estimated residual
value of the leased property, less unearned income. The Corporation provides
financing for various types of equipment, aircraft, energy and power systems,
rolling stock and vehicles through a variety of lease arrangements. A
significant portion of the residual value is covered by residual value insurance
or guaranteed by governmental entities. Residual values are subject to judgments
as to the value of the underlying equipment that can be affected by changes in
economic and market conditions and the financial viability of the residual
guarantors and insurers. To the extent not guaranteed or assumed by a third
party, or otherwise insured against, the Corporation bears the risk of ownership
of the leased assets including the risk that the actual value of the leased
assets at the end of the lease term will be less than the residual value which
could result in a charge and adversely impact earnings in future periods.
GOODWILL AND OTHER INTANGIBLE ASSETS
See Note 4 Goodwill And Other Intangible Assets in the Notes to Consolidated
Financial Statements for further information on PNC's adoption of SFAS No. 142
effective January 1, 2002.
Goodwill arising from business acquisitions represents the value attributable to
unidentifiable intangible elements in the business acquired. The majority of the
Corporation's goodwill relates to value inherent in fund servicing and banking
businesses. The value of this goodwill is dependent upon the Corporation's
ability to provide quality, cost effective services in the face of competition
from other market leaders on a national and global basis. This ability in turn
relies upon continuing investments in processing systems, the development of
value-added service features, and the ease of use of the Corporation's services.
As such, goodwill value is supported ultimately by revenue which is driven by
the volume of business transacted and, for certain businesses, the market value
of assets under administration. A decline in earnings as a result of a lack of
growth or the Corporation's inability to deliver cost effective services over
sustained periods can lead to impairment of goodwill which could result in a
charge and adversely impact earnings in future periods.
Total goodwill was $2.3 billion and other intangible assets, net of accumulated
amortization, totaled $337 million at September 30, 2002.
RISK MANAGEMENT
In the normal course of business, the Corporation assumes various types of risk,
which include, among others, credit risk, interest rate risk, liquidity risk,
operational risk, and risk associated with trading activities, financial
derivatives and "off-balance-sheet" activities. Credit risk and liquidity risk
are described in the Consolidated Balance Sheet Review section of this Financial
Review. See the 2001 Form 10-K for further information. These factors and others
could impact the Corporation's business, financial condition and results of
operations.
PNC has risk management processes designed to provide for risk identification,
measurement and monitoring. PNC has taken a number of actions to enhance these
processes, including centralization of the risk management function, ongoing
development of an enterprise-wide risk profile and the addition of key risk
management positions. The Corporation has recently announced several management
appointments, as described below, to enhance the Corporation's risk management
structure.
22
As previously reported, in April 2002 the Corporation created a new position,
Chief Risk Officer. The Chief Risk Officer directs credit policy, balance sheet
risk management and operational risk management, with the aim to help PNC
sharpen its strategic focus and integrated coordination of all risk management
activities throughout the Corporation. The Corporation's General Auditor reports
directly to the Audit Committee of the Board of Directors and receives
administrative support from the Chief Risk Officer.
In July 2002, the Corporation announced the appointment of a Chief Regulatory
Officer effective August 1, 2002. The Chief Regulatory Officer, a newly-created
position, is responsible for the management of all issues related to PNC's
regulatory affairs and compliance.
In September 2002, PNC announced the appointment of a Chief Compliance Officer,
effective October 1, 2002 and subject to regulatory approval. The Chief
Compliance Officer reports to the Chief Regulatory Officer and is responsible
for corporate compliance risk management strategies, policies and program
development across all PNC business units, including PNC Bank. This will include
development of a centralized compliance risk management framework and
architecture while maintaining the principle of business accountability, working
with regulatory agencies on compliance matters, and implementing compliance
awareness programs and training.
In October 2002, PNC announced the appointment of a new Vice Chairman, pending
regulatory approval. This Vice Chairman will report to PNC's Chairman and Chief
Executive Officer and have broad administrative responsibilities and
responsibilities for assisting the Corporation in implementing corporate
governance enhancements. Reference is made to Regulatory Matters in this
Financial Review for additional information.
INTEREST RATE RISK
The Corporation measures and manages both the short-term and long-term effects
of changing interest rates. An income simulation model measures the sensitivity
of net interest income to changing interest rates over the next twenty-four
month period. An economic value of equity model measures the sensitivity of the
value of existing on-balance-sheet and off-balance-sheet positions to changing
interest rates.
The Corporation's interest rate risk management policies provide that net
interest income should not decrease by more than 3% if interest rates gradually
increase or decrease from current rates by 100 basis points over a twelve-month
period and that the economic value of equity should not decline by more than
1.5% of the book value of assets for a 200 basis point instantaneous increase or
decrease in interest rates. In the scenario with a 200 basis point decline in
interest rates, rates are reduced to not less than zero. Policy exceptions, if
any, are reported to the Finance Committee of the Board of Directors.
At September 30, 2002, the Corporation was within these Board-approved policy
limits. In the current rate environment, management's actions have focused on
attempting to reduce the effects of modest interest rate declines and on the
effects of higher interest rates on the Corporation's net interest income and
economic value of equity.
The following table sets forth the sensitivity results for the quarters ended
September 30, 2002 and 2001.
INTEREST SENSITIVITY ANALYSIS
September 30 September 30
2002 2001
- -----------------------------------------------------------------
NET INTEREST INCOME SENSITIVITY SIMULATION
Effect on net interest income from
gradual interest rate change over
following 12 months of:
100 basis point increase 0.3 % (0.3)%
100 basis point decrease (2.7)% (1.8)%
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 (1.0)% (1.3)%
200 basis point decrease (0.1)% 0.2%
KEY PERIOD-END INTEREST RATES
One month LIBOR 1.81% 2.63%
Three-year swap 2.56% 3.92%
=================================================================
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 $78 million for the first
nine months of 2002 compared with $118 million for the first nine months of
2001. See Note 7 Trading Activities in the Notes to Consolidated Financial
Statements for additional information.
Risk associated with trading, capital markets and foreign exchange activities is
managed using a value-at-risk approach that combines interest rate risk, foreign
exchange rate risk, spread risk and volatility risk. Using this approach,
exposure is measured as the potential loss due to a two standard deviation,
one-day move in interest rates. The combined period-end value-at-risk of all
trading operations using this measurement was estimated as less than $500
thousand at September 30, 2002.
23
OPERATIONAL RISK
The Corporation is exposed to a variety of operational risks that can affect
each of its business activities, particularly those involving processing and
servicing. Operational risk is defined as the risk of loss resulting from
inadequate or failed internal processes, people or systems or from external
events such as the September 11th terrorist attacks. The risk of loss also
includes losses that may arise from the potential legal actions that could
result from operational deficiencies or noncompliance with contracts, laws or
regulations.
PNC monitors and evaluates operational risk on an ongoing basis through systems
of internal control, formal Corporate-wide policies and procedures, and an
internal audit function.
FINANCIAL DERIVATIVES
As required, effective January 1, 2001, the Corporation implemented SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," as amended
by SFAS No. 137 and 138. The statement requires the Corporation to recognize all
derivative instruments at fair value as either assets or liabilities. Financial
derivatives are reported at fair value in other assets or other liabilities. The
2001 cumulative effect of the change in accounting principle resulting from the
adoption of SFAS No. 133 was an after-tax charge of $5 million reported in the
Consolidated Statement of Income and an after-tax accumulated other
comprehensive loss of $4 million reported in the Consolidated Balance Sheet.
The following table sets forth changes, during the first nine months of 2002, in
the notional value of financial derivatives used for risk management and
designated as accounting hedges under SFAS No. 133.
FINANCIAL DERIVATIVES ACTIVITY
Weighted-
December 31 September 30 Average
Dollars in millions 2001 Additions Maturities Terminations 2002 Maturity
- ------------------------------------------------------------------------------------------------------------------------------
Interest rate risk management
Interest rate swaps
Receive fixed $6,748 $2,500 $(1,250) $(2,600) $5,398 3 yrs. 6 mos.
Pay fixed 107 (25) 82 4 yrs.
Basis swaps 87 (75) 12 5 yrs. 1 mo.
Interest rate caps 25 (6) 19 4 yrs. 6 mos.
Interest rate floors 7 7 2 yrs. 6 mos.
Futures contracts 398 166 (345) 219 8 mos.
- ---------------------------------------------------- ------------ -------------- ------------- -------------
Total interest rate risk
management 7,372 2,666 (1,250) (3,051) 5,737
- ---------------------------------------------------- ------------ -------------- ------------- -------------
Commercial mortgage banking risk
management
Interest rate swaps 105 556 (427) 234 10 yrs. 3 mos.
Total rate of return swaps 150 200 (275) 75 2 mos.
- ---------------------------------------------------- ------------ -------------- ------------- -------------
Total commercial mortgage
banking risk management 255 756 (275) (427) 309
- ---------------------------------------------------- ------------ -------------- ------------- -------------
Total $7,627 $3,422 $(1,525) $(3,478) $6,046
==============================================================================================================================
24
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 September 30, 2002 and December 31, 2001.
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 - 2002
Weighted-Average Interest Rates
Notional -------------------------------
September 30, 2002 - dollars in millions Value Fair Value Paid Received
- ----------------------------------------------------------------------------------------------------------------------------------
Interest rate risk management
Asset rate conversion
Interest rate swaps(a)
Receive fixed designated to loans $2,985 $158 2.24% 4.31%
Pay fixed designated to loans 82 (10) 6.07 2.93
Basis swaps designated to loans 12 3.30 6.12
Interest rate caps designated to loans(b) 19 NM NM
Interest rate floors designated to loans(c) 7 NM NM
Futures contracts designated to loans 219 NM NM
- ---------------------------------------------------------------------------------------------------
Total asset rate conversion 3,324 148
- ---------------------------------------------------------------------------------------------------
Liability rate conversion
Interest rate swaps(a)
Receive fixed designated to borrowed funds 2,413 334 3.26 5.94
- ---------------------------------------------------------------------------------------------------
Total liability rate conversion 2,413 334
- ---------------------------------------------------------------------------------------------------
Total interest rate risk management 5,737 482
- ---------------------------------------------------------------------------------------------------
Commercial mortgage banking risk management
Pay fixed interest rate swaps designated to loans held for sale(a) 234 (18) 5.09 4.36
Pay total rate of return swaps designated to loans held for sale(a) 75 (4) 5.50 1.32
- ---------------------------------------------------------------------------------------------------
Total commercial mortgage banking risk management 309 (22)
- ---------------------------------------------------------------------------------------------------
Total financial derivatives designated for risk management $6,046 $460
==================================================================================================================================
(a) The floating rate portion of interest rate contracts is based on
money-market indices. As a percent of notional value, 57% were based on
1-month LIBOR and 43% on 3-month LIBOR.
(b) Interest rate caps with notional values of $15 million require the
counterparty to pay the Corporation the excess, if any, of 3-month LIBOR
over a weighted-average strike of 6.40%. In addition, interest rate caps
with notional values of $4 million require the counterparty to pay the
excess, if any, of Prime over a weighted-average strike of 5.03%. At
September 30, 2002, 3-month LIBOR was 1.79% and Prime was 4.75%.
(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 September 30, 2002,
3-month LIBOR was 1.79% and Prime was 4.75%.
NM- Not meaningful
FINANCIAL DERIVATIVES - 2001
Weighted-Average Interest Rates
Notional -------------------------------
December 31, 2001 - dollars in millions Value Fair Value Paid Received
- ---------------------------------------------------------------------------------------------------------------------------------
Interest rate risk management
Asset rate conversion
Interest rate swaps(a)
Receive fixed designated to loans $4,335 $132 3.35% 5.23%
Pay fixed designated to loans 107 (5) 5.88 4.66
Basis swaps designated to loans 87 5.49 5.42
Interest rate caps designated to loans(b) 25 NM NM
Interest rate floors designated to loans(c) 7 NM NM
Futures contracts designated to loans 398 NM NM
- ---------------------------------------------------------------------------------------------------
Total asset rate conversion 4,959 127
- ---------------------------------------------------------------------------------------------------
Liability rate conversion
Interest rate swaps(a)
Receive fixed designated to borrowed funds 2,413 135 5.20 5.94
- ---------------------------------------------------------------------------------------------------
Total liability rate conversion 2,413 135
- ---------------------------------------------------------------------------------------------------
Total interest rate risk management 7,372 262
- ---------------------------------------------------------------------------------------------------
Commercial mortgage banking risk management
Pay fixed interest rate swaps designated to loans held for sale(a) 105 1 5.52 5.82
Pay total rate of return swaps designated to loans held for sale(a) 150 5.89 1.39
- ---------------------------------------------------------------------------------------------------
Total commercial mortgage banking risk management 255 1
- ---------------------------------------------------------------------------------------------------
Total financial derivatives designated for risk management $7,627 $263
=================================================================================================================================
(a) The floating rate portion of interest rate contracts is based on
money-market indices. As a percent of notional value, 65% were based on
1-month LIBOR, 34% on 3-month LIBOR and the remainder on other short-term
indices.
(b) Interest rate caps with notional values of $15 million require the
counterparty to pay the Corporation the excess, if any, of 3-month LIBOR
over a weighted-average strike of 6.40%. In addition, interest rate caps
with notional values of $6 million require the counterparty to pay the
excess, if any, of 1-month LIBOR over a weighted-average strike of 6.00%.
The remainder is based on other short-term indices. At December 31, 2001,
3-month LIBOR was 1.88% and 1-month LIBOR was 1.87%.
(c) Interest rate floors with notional values of $5 million require the
counterparty to pay the excess, if any, of the weighted-average strike of
4.50% over 3-month LIBOR. The remainder is based on other short-term
indices. At December 31, 2001, 3-month LIBOR was 1.88%.
NM- Not meaningful
25
OTHER DERIVATIVES
Additionally, the Corporation enters into other derivative transactions for risk
management purposes that are not designated as accounting hedges, primarily
consisting of interest rate floors and caps and basis swaps. Other noninterest
income for the first nine months of 2002 included approximately $7 million of
net gains related to the derivatives held for risk management purposes not
designated as accounting hedges.
OTHER DERIVATIVES
At September 30, 2002
--------------------------------------------------------------------
Positive Negative Average
Notional Fair Fair Net Asset Fair
In millions Value Value Value (Liability) Value(a)
- ---------------------------------------------------------------------------------------------------------------------------------
Customer-related
Interest rate
Swaps $22,751 $599 $(620) $(21) $(18)
Caps/floors
Sold 2,337 (36) (36) (34)
Purchased 2,024 28 28 27
Foreign exchange 3,714 48 (43) 5 4
Other 4,836 90 (71) 19 13
- ---------------------------------------------------------------------------------------------------------------------------------
Total customer-related 35,662 765 (770) (5) (8)
=================================================================================================================================
Other risk management and proprietary
Interest rate
Basis swaps 2,225 5 5 6
Caps/floors
Sold (9)
Purchased 9
Other 419 7 (1) 6 6
- ---------------------------------------------------------------------------------------------------------------------------------
Total other risk management and proprietary 2,644 12 (1) 11 12
- ---------------------------------------------------------------------------------------------------------------------------------
Total other derivatives $38,306 $777 $(771) $6 $4
=================================================================================================================================
(a) Represents average for nine months ended September 30, 2002.
"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 2001 Form 10-K for
further information.
The accounting for special purpose entities is currently under review by the
Financial Accounting Standards Board. An exposure draft has been issued and the
conditions for consolidation or non-consolidation of such entities could change.
See Note 1 Accounting Policies in the Notes to Consolidated Financial Statements
for additional information.
MARKET STREET
Market Street is a multi-seller asset-backed commercial paper conduit that is
independently owned and managed. The activities of Market Street are limited to
the purchase 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 $4.2 billion
at September 30, 2002 compared with $5.2 billion at December 31, 2001. The
accounting rules for these types of entities are currently under review. See
Note 1 Accounting Policies in the Notes to Consolidated Financial Statements for
additional information.
PNC Bank provides certain administrative services, a portion of the
program-level credit enhancement and participates with other banks in providing
liquidity facilities to Market Street in exchange for fees negotiated based on
market rates. Credit enhancement is provided in part by PNC Bank in the form of
a revolving credit facility with a five year term expiring December 31, 2004. At
September 30, 2002, approximately $133 million was outstanding on this facility
compared with $166 million at December 31, 2001. An additional $397 million was
provided by a major insurer. Also at September 30, 2002,
26
Market Street had liquidity facilities supporting individual pools of
receivables totaling $6.0 billion, of which $4.8 billion are provided by PNC
Bank. The comparable amounts at December 31, 2001 were $7.0 billion and $5.8
billion, respectively. Credit exposure related to PNC's liquidity facilities
provided to Market Street is included in net unfunded commitments as described
in Loans in the Consolidated Balance Sheet Review section of this Financial
Review.
As Market Street's program administrator, PNC received fees of $10.7 million for
the nine months ended September 30, 2002. Commitment fees related to PNC's
portion of the liquidity facilities amounted to $6.3 million for the first nine
months of 2002.
As previously reported, during the second quarter of 2002 the Corporation funded
approximately $63 million resulting from a draw on a liquidity facility with
Market Street. This loan was classified as a nonperforming asset at June 30,
2002. During the third quarter of 2002, the Corporation charged off $43 million
of this amount against the allowance for credit losses. PNC is a beneficiary
under an insurance policy that provides protection against losses related to the
underlying collateral of student vocational loans. PNC is in litigation with the
insurance carrier regarding the policy covering these losses. Management
continues to vigorously pursue this claim and believes PNC is entitled to
payment under the policy. The potential exposure related to this liquidity draw
without reference to the insurance coverage was considered in determining the
allocation of reserves within the allowance for credit losses at September 30,
2002.
REGULATORY MATTERS
As previously reported, in July 2002 the Corporation announced that it had
reached a resolution with the SEC concerning the previously disclosed SEC
inquiry into the transfer of certain PNC assets to companies formed with AIG in
2001. PNC consented to an SEC cease-and-desist order to settle the matter and
neither admitted nor denied the SEC's findings. PNC also announced in July 2002
that it had entered into an agreement with the Federal Reserve, and that PNC
Bank, PNC's principal bank subsidiary, had entered into an agreement with the
OCC. These agreements address such issues as risk, management and financial
controls, and followed the conclusion of scheduled regulatory examinations. The
Corporation has incurred, and may continue to incur, additional operating costs
in connection with its compliance with these agreements including, among others,
incremental staff, continued higher legal and consulting expenses, and higher
deposit insurance premiums. Also, the conduct of existing merchant banking,
securities underwriting and dealing, and insurance activities is subject to
limitation as a result of bank regulatory, supervisory and examination
activities. Reference is made to the July 18, 2002 8-K for additional
information regarding these matters. Also, see PNC Real Estate Finance and
Equity Management Activities in this Financial Review for further information.
As required by the Corporation's agreement with the Federal Reserve, during the
third quarter of 2002 the Corporation's Board of Directors engaged an
independent consultant approved by the Federal Reserve to conduct a review of,
among other things, the structure, functions and performance of PNC's management
and the Board of Directors oversight of management activities (the "Corporate
Review") and to prepare a written report that includes findings, conclusions,
and written descriptions of any management or operational changes recommended as
a result of the Corporate Review. This confidential written report was provided
to the Corporation's Board of Directors and the Federal Reserve in October 2002.
The Corporation believes that it has made substantial progress to date in
enhancing its risk management and governance practices and improving its
regulatory relations, while addressing the various requirements set forth in its
written agreements with the Federal Reserve and the OCC. There can be no
assurance, however, as to the precise timing for determining that all required
corrective actions have been taken by the Corporation to the appropriate
satisfaction of the Federal Reserve and OCC. The Board of Directors of the
Corporation has recently reaffirmed its confidence going forward in the new
senior management team assembled and led by Chairman and Chief Executive James
E. Rohr. This team includes a number of new senior level executives recruited
over the past several months. The Board and senior management team are committed
to the goal of establishing the Corporation as an industry leader in the areas
of governance, corporate conduct, risk management and regulatory relations and
to meeting all of the Corporation's commitments to its regulators. While the
Corporation believes that substantial progress has been made in this pursuit to
date, the Corporation also recognizes that this remains an important ongoing
effort requiring dedication and a commitment of resources at all levels of the
institution.
27
STATUS OF DEFINED BENEFIT PENSION PLAN
As described in Note 21 to the Consolidated Financial Statements included in the
2001 Form 10-K, the Corporation has a noncontributory, qualified defined benefit
pension plan ("pension plan") covering most employees. Contributions to the
pension plan are actuarially determined with assets transferred to a trust to
fund benefits payable to plan participants. On an annual basis, management
reviews the actuarial assumptions related to the pension plan, including the
discount rate, rate of compensation increase and the expected return on plan
assets.
In accordance with SFAS No. 87, "Employers' Accounting for Pensions" and SFAS
No. 132, "Employers' Disclosures about Pensions and Other Postretirement
Benefits," the Corporation may be required to eliminate any prepaid pension
asset and recognize a minimum pension liability if the accumulated benefit
obligation exceeds the fair value of plan assets at year end. The corresponding
charge would be recognized as a component of other comprehensive income and
reduce total shareholders' equity, but would not impact net income.
The funded status of the pension plan obligation has been adversely affected by
declines in the equity markets and the continued low interest rate environment
during the first nine months of 2002. While management currently believes the
recognition of a minimum pension liability at December 31, 2002 is remote, the
final determination will depend on returns realized on the trust assets during
the fourth quarter of 2002, the discount rate used to value the pension
obligations and the level of additional pension contributions made during the
fourth quarter. If the recognition of a minimum pension liability is required,
the amount would be significant.
In addition, the Corporation expects 2003 pension plan expense to increase
significantly to within a range of approximately $50 million to $70 million
assuming no significant improvement in the equity markets during the fourth
quarter of 2002. Pension expense is estimated to be approximately $17 million
for full year 2002.
INTERNAL CONTROLS AND DISCLOSURE CONTROLS AND PROCEDURES
As of October 31, 2002, 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 October 31, 2002.
There have been no significant changes in the Corporation's internal controls or
in other factors that could significantly affect internal controls subsequent to
October 31, 2002, the date as of which the most recent evaluation of such
internal controls was performed.
STOCK-BASED COMPENSATION
PNC will expense stock-based compensation using the fair value-based method,
beginning with grants made in 2003. Assuming recurring stock option grants of
similar size and value to those expected to be made during 2002, this impact is
currently estimated to be approximately 5 cents per share for the year ending
December 31, 2003. The annual impact is expected to increase over the next three
years under the transitional guidance currently provided by SFAS No. 123,
"Accounting for Stock-Based Compensation." When fully implemented, the current
expected impact is a reduction of approximately 3 percent to earnings per share.
The Financial Accounting Standards Board recently issued an exposure draft of
proposed amendments to the disclosure and transition provisions of SFAS No. 123;
as a result, PNC's implementation of SFAS No. 123 may change in order to conform
to any final pronouncement.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 5 Recent Accounting Pronouncements in the Notes to Consolidated
Financial Statements for a summary of recently issued accounting pronouncements
and their applicability to the Corporation.
28
BLACKROCK LONG-TERM RETENTION AND INCENTIVE PLAN
In October 2002, BlackRock adopted a new long-term retention and incentive
program for key employees. The program permits BlackRock to grant up to 3.5
million stock options at market, subject to vesting at December 31, 2006, and up
to $240 million in deferred compensation awards (the "Compensation Awards"),
with payment subject to the achievement of certain performance hurdles no later
than March 2007. Initially, BlackRock expects to award 3.36 million stock
options and $130 million in Compensation Awards to more than 100 senior
professionals. The remainder of the program will be reserved for grants over the
next two years to professionals who exhibit leadership qualities and demonstrate
the potential to make significant contributions to BlackRock over time. If the
performance hurdles are achieved, up to $200 million of the Compensation Awards
will be funded with up to 4 million shares of BlackRock common stock to be
surrendered by PNC and distributed to program participants, less withholding. In
addition, distributed shares to program participants will include an option to
put such distributed shares back to BlackRock at fair market value. BlackRock
will fund the remainder of the Compensation Awards with up to $40 million in
cash.
The Awards will vest at the end of any three-month period beginning in 2005 or
2006 during which the daily average closing price of BlackRock's common stock is
at least $65 per share. If that performance hurdle is not achieved, the
Compensation Committee of the Board of Directors of BlackRock may, in its sole
discretion, vest a portion of the Compensation Awards if BlackRock realizes
compound annual growth in diluted earnings per share of at least 10% from
January 1, 2002 to December 31, 2006 and BlackRock's publicly-traded stock
performs in the top half of its peer group during that time.
There will be no expense recognition associated with the Compensation Awards
unless vesting occurs or a partial vesting determination by the BlackRock
Compensation Committee is considered probable and estimable. Once this
determination is made, BlackRock will record compensation expense for the pro
rata portion of the Compensation Awards earned to date. Compensation expense for
the remaining Compensation Awards will be recognized by BlackRock ratably
through March 31, 2007. In addition, at the time that the BlackRock common stock
portion of the Compensation Awards is distributed, BlackRock will record an
increase in stockholders' equity equal to the fair market value of the BlackRock
common stock distributed to employees from shares surrendered by PNC. There will
be no change in BlackRock's fully diluted shares upon vesting of the
Compensation Awards because shares surrendered by PNC to fund the Compensation
Awards are already issued and outstanding.
The terms of the program are subject to regulatory approval and to approval by
BlackRock's stockholders at their next annual meeting in May 2003.
In connection with the adoption of the program, BlackRock and PNC have amended
the BlackRock Initial Public Offering Agreement, which provides that, subject to
certain notice requirements and evaluation and cure periods, PNC must deposit
its shares of stock of BlackRock into a voting trust and refrain from soliciting
proxies from holders of outstanding BlackRock capital securities if, within
twelve months following a change of control of PNC or a change of control of
BlackRock (as defined in the amended agreement), a majority of BlackRock's
independent directors determine that such change of control has a material
adverse effect on BlackRock and that adverse effect is not cured within a
further three month period. Following the deposit of PNC's shares into a voting
trust, PNC must, subject to the terms and conditions of the amended agreement,
take one of the following three courses of action: (i) within two years, dispose
of its ownership interest in BlackRock voting stock, such that neither PNC nor
its affiliates is the beneficial owner of more than 4.9% of any class of voting
stock of BlackRock (and any shares of class B common stock deposited by PNC into
the voting trust will be converted to class A common stock upon the election of
this option (i)); (ii) proceed as expeditiously as is commercially reasonable to
purchase all the outstanding BlackRock capital securities not held by PNC or its
affiliates at the applicable Change of Control Price (which is defined in the
amended agreement); or (iii) proceed as expeditiously as is commercially
reasonable to sell its ownership interest in BlackRock capital securities, such
that neither PNC nor its affiliates is the beneficial owner of more than 4.9% of
any class of voting stock of BlackRock, to a third party in a transaction in
which such third party offers to purchase all the outstanding shares not held by
PNC or its affiliates at a price per share not less than the price per share
offered to PNC. If PNC takes action under (ii) or (iii) above, all awards under
the program will vest and be immediately payable and all stock options granted
under BlackRock's 1999 Stock Award and Incentive Plan will vest and be
exercisable.
BlackRock and PNC have also further amended BlackRock's Amended and Restated
Stockholders Agreement with PNC, which provides, among other things, for rights
of first refusal before shares of BlackRock class B common stock may be
transferred. The amendment provides that nothing contained in the agreement will
be deemed to prohibit PNC or its affiliates from effecting a distribution
(including, but not limited to, a spin-off or a split-off) of its BlackRock
common stock to the public shareholders of PNC if PNC should decide to do so.
29
FORWARD LOOKING STATEMENTS
This report and other statements made by the Corporation may contain
forward-looking statements with respect to the Corporation's outlook or
expectations for earnings, revenues, expenses, capital levels, asset quality or
other future financial or business performance, strategies, expectations and the
impact of legal, regulatory and supervisory matters on the Corporation's
business operations and performance. Forward-looking statements are typically
identified by words or phrases such as "believe," "feel," "expect,"
"anticipate," "intend," "outlook," "estimate," "forecast," "position," "poised,"
"target," "mission," "assume," "achievable," "potential," "strategy," "goal,"
"objective," "plan," "aspiration," "outcome," "continue," "remain," "maintain,"
"seek," "strive," "trend" and variations of such words and similar expressions,
or future or conditional verbs such as "will," "would," "should," "could,"
"might," "can," "may" or similar expressions.
The Corporation cautions that forward-looking statements are subject to numerous
assumptions, risks and uncertainties, which change over time. Forward-looking
statements speak only as of the date they are made, and the Corporation assumes
no duty to update forward-looking statements. Actual results could differ
materially from those anticipated in forward-looking statements and future
results could differ materially from historical performance.
In addition to factors mentioned elsewhere in this report or previously
disclosed in the Corporation's SEC reports (accessible on the SEC's website at
www.sec.gov), the following factors, among others, could cause actual results to
differ materially from forward-looking statements or historical performance:
(1) changes in political, economic or industry conditions, the interest rate
environment or financial and capital markets, which could result in: a
deterioration in credit quality and increased credit losses and increased
funding of unfunded loan commitments and letters of credit; an adverse effect on
the allowance for credit losses; a reduction in demand for credit or fee-based
products and services; a reduction in net interest income, value of assets under
management and assets serviced, value of private equity investments and of other
debt and equity investments, value of loans held for sale or value of other
on-balance-sheet and off-balance-sheet assets; or changes in the availability
and terms of funding necessary to meet PNC's liquidity needs;
(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 implement integration plans
relating to or resulting from mergers, acquisitions, restructurings and
divestitures;
(4) customer borrowing, 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;
(7) the inability to manage risks inherent in PNC's business;
(8) the resolution of legal proceedings involving closing date adjustments
related to the sale of the residential mortgage banking business;
(9) the unfavorable resolution of legal proceedings or government inquiries; the
impact of increased litigation risk from recent regulatory developments; and the
impact of reputational risk created by recent regulatory developments on such
matters as business generation and retention, the ability to attract and retain
management, liquidity and funding;
(10) the denial of insurance coverage for claims made by PNC;
(11) an increase in the number of customer or counterparty delinquencies,
bankruptcies or defaults that could result in, among other things, increased
credit and asset quality risk, a higher provision for credit losses and reduced
profitability;
(12) the impact, extent and timing of technological changes, the adequacy of
intellectual property protection and costs associated with obtaining rights in
intellectual property claimed by others;
(13) actions of the Federal Reserve Board;
(14) the impact of legislative and regulatory reforms;
(15) the impact of the regulatory examination process, the Corporation's failure
to satisfy the requirements of written agreements with regulatory agencies,
including the impact of limiting or curtailing equity management investments,
and regulators' future use of supervisory and enforcement tools, and
(16) terrorist activities or other hostilities, including the situation
surrounding Iraq, which may adversely affect the general economy, financial and
capital markets, specific industries, and the Corporation.
Factors relating to interest rate risk, financial and other derivatives, and
regulatory matters are discussed in the Risk Management section of this
Financial Review. Other risk factors are described in the Risk Factors section
and elsewhere in this report.
30
CONSOLIDATED STATEMENT OF INCOME
THE PNC FINANCIAL SERVICES GROUP, INC.
Three months ended September 30 Nine months ended September 30
------------------------------- -------------------------------
In millions, except per share data
Unaudited 2002 2001 2002 2001
- ----------------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans and fees on loans $567 $776 $1,754 $2,596
Securities 140 155 466 454
Loans held for sale 24 24 117 92
Other 38 29 94 93
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest income 769 984 2,431 3,235
- ----------------------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Deposits 162 280 510 1,011
Borrowed funds 79 139 248 540
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest expense 241 419 758 1,551
- ----------------------------------------------------------------------------------------------------------------------------------
Net interest income 528 565 1,673 1,684
Provision for credit losses 73 110 244 235
- ----------------------------------------------------------------------------------------------------------------------------------
Net interest income less provision for credit losses 455 455 1,429 1,449
- ----------------------------------------------------------------------------------------------------------------------------------
NONINTEREST INCOME
Asset management 200 208 651 645
Fund servicing 180 195 578 585
Service charges on deposits 57 56 166 160
Brokerage 41 54 151 163
Consumer services 62 58 178 171
Corporate services 108 (3) 375 149
Equity management (22) (13) (37) (82)
Net securities gains 68 88 88 134
Other 64 77 237 243
- ----------------------------------------------------------------------------------------------------------------------------------
Total noninterest income 758 720 2,387 2,168
- ----------------------------------------------------------------------------------------------------------------------------------
NONINTEREST EXPENSE
Staff expense 422 419 1,293 1,258
Net occupancy 64 55 181 162
Equipment 68 64 203 181
Marketing 14 13 40 38
Distributions on capital securities 15 15 44 48
Other 194 225 631 679
- ----------------------------------------------------------------------------------------------------------------------------------
Total noninterest expense 777 791 2,392 2,366
- ----------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations before minority interest
and income taxes 436 384 1,424 1,251
Minority interest in income of consolidated entities 4 9 26 25
Income taxes 147 128 476 419
- ----------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations 285 247 922 807
Income from discontinued operations (less applicable income
taxes of $0) 5
- ----------------------------------------------------------------------------------------------------------------------------------
Income before cumulative effect of accounting change 285 247 922 812
Cumulative effect of accounting change (less applicable
income tax benefit of $2) (5)
- ----------------------------------------------------------------------------------------------------------------------------------
Net income $285 $247 $922 $807
==================================================================================================================================
EARNINGS PER COMMON SHARE
Continuing operations and net income
Basic $1.00 $.85 $3.25 $2.76
Diluted $1.00 $.84 $3.23 $2.73
AVERAGE COMMON SHARES OUTSTANDING
Basic 284 286 283 288
Diluted 285 289 285 291
===================================================================================================================================
See accompanying Notes to Consolidated Financial Statements.
31
CONSOLIDATED BALANCE SHEET
THE PNC FINANCIAL SERVICES GROUP, INC.
In millions, except par value September 30 December 31
Unaudited 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks $3,403 $4,327
Short-term investments 4,765 1,335
Loans held for sale 1,989 4,189
Securities 12,536 13,908
Loans, net of unearned income of $1,108 and $1,164 35,917 37,974
Allowance for credit losses (648) (560)
- ---------------------------------------------------------------------------------------------------------------------------------
Net loans 35,269 37,414
Goodwill 2,313 2,036
Other intangible assets 337 337
Other 7,047 6,092
- ---------------------------------------------------------------------------------------------------------------------------------
Total assets $67,659 $69,638
=================================================================================================================================
LIABILITIES
Deposits
Noninterest-bearing $10,130 $10,124
Interest-bearing 34,830 37,180
- ---------------------------------------------------------------------------------------------------------------------------------
Total deposits 44,960 47,304
Borrowed funds
Federal funds purchased 35 167
Repurchase agreements 988 954
Bank notes and senior debt 4,962 6,362
Federal Home Loan Bank borrowings 1,270 2,047
Subordinated debt 2,423 2,298
Other borrowed funds 269 262
- ---------------------------------------------------------------------------------------------------------------------------------
Total borrowed funds 9,947 12,090
Allowance for unfunded loan commitments and letters of credit 79 70
Other 4,853 3,333
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities 59,839 62,797
- ---------------------------------------------------------------------------------------------------------------------------------
Minority interest 255 170
Mandatorily redeemable capital securities of subsidiary trusts 848 848
SHAREHOLDERS' EQUITY
Preferred stock 1
Common stock - $5 par value
Authorized 800 shares
Issued 353 shares 1,764 1,764
Capital surplus 1,103 1,077
Retained earnings 7,062 6,549
Deferred benefit expense (11) (16)
Accumulated other comprehensive income 325 5
Common stock held in treasury at cost: 69 and 70 shares (3,526) (3,557)
- ---------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 6,717 5,823
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities, minority interest, capital securities and
shareholders' equity $67,659 $69,638
=================================================================================================================================
See accompanying Notes to Consolidated Financial Statements.
32
CONSOLIDATED STATEMENT OF CASH FLOWS
THE PNC FINANCIAL SERVICES GROUP, INC.
Nine months ended September 30 - in millions
Unaudited 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $922 $807
Income from discontinued operations (5)
Cumulative effect of accounting change 5
- ---------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations 922 807
Adjustments to reconcile income from continuing operations
to net cash provided by operating activities
Provision for credit losses 244 235
Depreciation, amortization and accretion 65 200
Deferred income taxes 279 245
Securities transactions (88) (131)
Valuation adjustments 33 94
Change in
Loans held for sale 2,497 (104)
Short-term investments (3,430) (465)
Other (513)
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 522 368
- ---------------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Net change in loans 355 191
Repayment of securities 1,960 1,733
Sales
Securities 13,689 16,776
Loans 2,712 3,279
Foreclosed assets 8 13
Purchases
Securities (13,144) (20,159)
Loans (22) (246)
Net cash (paid) received for divestitures/acquisitions (1,676) 503
Other (223) (57)
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash provided by investing activities 3,659 2,033
- ---------------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Net change in
Noninterest-bearing deposits 6 338
Interest-bearing deposits (2,350) (3,084)
Federal funds purchased (132) 383
Repurchase agreements 34 65
Sales/issuances
Bank notes and senior debt 1,147
Federal Home Loan Bank borrowings 3,123
Other borrowed funds 16,525 27,606
Common stock 100 154
Repayments/maturities
Bank notes and senior debt (1,483) (1,915)
Federal Home Loan Bank borrowings (777) (1,155)
Subordinated debt (200)
Other borrowed funds (16,566) (27,879)
Acquisition of treasury stock (53) (608)
Series F preferred stock tender offer (96)
Cash dividends paid (409) (429)
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash used by financing activities (5,105) (2,550)
- ---------------------------------------------------------------------------------------------------------------------------------
DECREASE IN CASH AND DUE FROM BANKS (924) (149)
Cash and due from banks at beginning of year 4,327 3,662
- ---------------------------------------------------------------------------------------------------------------------------------
Cash and due from banks at end of period $3,403 $3,513
=================================================================================================================================
CASH PAID FOR
Interest $800 $1,525
Income taxes 115 105
NON-CASH ITEMS
Transfer of mortgage loans to securities 4,341
Transfer from loans to loans held for sale, net 266 577
Transfer from loans to other assets 11 5
=================================================================================================================================
See accompanying Notes to Consolidated Financial Statements.
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THE PNC FINANCIAL SERVICES GROUP, INC.
BUSINESS
The PNC Financial Services Group, Inc. ("Corporation" or "PNC") is one of the
largest diversified financial services companies in the United States, operating
businesses engaged in regional community banking, corporate banking, real estate
finance, asset-based lending, wealth management, asset management and global
fund services. The Corporation provides certain products and services nationally
and others in PNC's primary geographic markets in Pennsylvania, New Jersey,
Delaware, Ohio and Kentucky. The Corporation also provides certain banking,
asset management and global fund services internationally. PNC is subject to
intense competition from other financial services companies and is subject to
regulation by various domestic and international authorities.
NOTE 1 ACCOUNTING POLICIES
BASIS OF FINANCIAL STATEMENT PRESENTATION
The unaudited consolidated interim financial statements ("consolidated financial
statements") include the accounts of PNC and its subsidiaries, most of which are
wholly owned, and entities formed with American International Group, Inc.
("AIG"). Such statements have been prepared in accordance with accounting
principles generally accepted in the United States. All significant intercompany
accounts and transactions have been eliminated. Certain prior-period amounts
have been reclassified to conform with the current period presentation. These
reclassifications did not impact the Corporation's consolidated financial
condition or results of operations.
Investments that are not consolidated and are less than 50% owned over which the
Corporation has the ability to significantly influence operating and financial
policies of the investee are accounted for using the equity method.
Equity management assets are included in other assets and are comprised of
limited partnerships and direct investments. Investments in limited partnerships
are valued based on the financial statements received from the general partner.
Direct investments are carried at estimated fair value. Changes in the value of
these assets are recognized in noninterest income.
Special Purpose Entities ("SPEs") are broadly defined as legal entities created
for a particular purpose. PNC utilizes SPEs in various legal forms to conduct
normal business activities including the sale or transfer of assets to third
parties. SPEs that meet the criteria for a Qualifying Special Purpose Entity
("QSPE") as defined in Statement of Financial Accounting Standards ("SFAS") No.
140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" are not required to be consolidated. SPEs that
are not QSPEs are reviewed for consolidation based on each SPE's individual
structure and operations. General factors to be considered in making this
determination include whether the majority owner (or owners) of the SPE are
independent of PNC, have made a substantive capital investment in the SPE, have
control of the SPE, and possess the substantive risks and rewards of ownership
of the SPE.
In June 2002, the Financial Accounting Standards Board ("FASB") issued an
exposure draft of a Proposed Interpretation, "Consolidation of Certain
Special-Purpose Entities" (an interpretation of Accounting Research Bulletin No.
51, Consolidated Financial Statements) ("Proposed Interpretation"), which
addresses issues related to identifying and accounting for SPEs. The Proposed
Interpretation would require the consolidation of an SPE in which a business
enterprise has a controlling financial interest. In certain situations, changes
to contractual relationships that have been customary industry practice may be
required to ensure compliance with the non-consolidation provisions of the
Proposed Interpretation. The final rules would be effective immediately for new
transactions and April 1, 2003 for existing transactions. The effect of the
Proposed Interpretation on the Corporation's financial condition or results of
operations cannot be determined at this time.
In the opinion of management, the 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 consolidated financial statements, notes to consolidated financial
statements and statistical information reflect the residential mortgage banking
business, which was sold on January 31, 2001, in discontinued operations, unless
otherwise noted.
The notes included herein should be read in conjunction with the audited
consolidated financial statements included in PNC's 2001 Annual Report on Form
10-K ("2001 Form 10-K").
DEPRECIATION AND AMORTIZATION
For financial reporting purposes, premises and equipment are depreciated
principally using the straight-line method over their estimated useful lives.
Accelerated methods are used for federal income tax purposes.
The estimated useful lives used for furniture and equipment range from one to 10
years, while buildings are depreciated over an estimated useful life of 39
years. Leasehold improvements are amortized over their estimated useful lives of
up to 10 years, or the respective lease terms, whichever is shorter.
34
NOTE 2 DISCONTINUED OPERATIONS
In the first quarter of 2001, PNC closed the sale of its residential mortgage
banking business. Certain closing date adjustments are currently in dispute
between PNC and the buyer, Washington Mutual Bank, FA. The ultimate financial
impact of the sale will not be determined until the disputed matters are finally
resolved. See Note 10 Legal Proceedings for additional information.
The income of the residential mortgage banking business, which is presented on
one line in the Consolidated Statement of Income, is as follows:
INCOME FROM DISCONTINUED OPERATIONS
Nine months ended September 30 - in millions 2001
- ---------------------------------------------------------------
Income from operations, after tax $15
Net loss on sale of business, after tax (10)
- ---------------------------------------------------------------
Total income from discontinued operations $5
===============================================================
There were no net assets of the residential mortgage banking business remaining
at either September 30, 2002 or December 31, 2001.
NOTE 3 NBOC ACQUISITION
In January 2002, PNC Business Credit acquired a portion of National Bank of
Canada's ("NBOC") U.S. asset-based lending business in a purchase business
combination. With this acquisition, PNC Business Credit established six new
marketing offices. The transaction was designed to allow PNC to acquire the
higher-quality portion of the portfolio, and provide NBOC a means for the
orderly liquidation and exit of the remaining portfolio.
PNC acquired 245 lending customer relationships representing approximately $2.6
billion of credit exposure including $1.5 billion of 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 will be
serviced by PNC for an 18-month term unless a different date is mutually agreed
upon. In June 2002, NBOC and PNC reached final agreement as to the Serviced
Portfolio's financial information. As such, certain financial data previously
disclosed with regards to the NBOC Serviced Portfolio has been modified to
reflect the terms of this revised agreement. The Serviced Portfolio retained by
NBOC primarily represents the portion of NBOC's U.S. asset-based loan portfolio
with the highest risk. The loans are either to borrowers with deteriorating
trends or with identified weaknesses which if not corrected could jeopardize
full satisfaction of the loans or in industries to which PNC Business Credit
wants to limit its exposure. Approximately $138 million of the Serviced
Portfolio outstandings were nonperforming on the acquisition date. At the end of
the servicing term, NBOC has the right to transfer the then remaining Serviced
Portfolio to PNC ("Put Option"). NBOC's and PNC's strategy is to aggressively
liquidate the Serviced Portfolio during the servicing term. PNC intends to sell
or otherwise liquidate any remaining loans in the event NBOC puts them to PNC at
the end of the servicing term.
35
NBOC retains significant risks and rewards of owning the Serviced Portfolio,
including realized credit losses, during the servicing term as described below.
NBOC assigned $24 million of specific reserves to certain of the loans in the
Serviced Portfolio. Additionally, NBOC absorbs realized credit losses on the
Serviced Portfolio in addition to the specific reserves on individual identified
loans. If during the servicing term the realized credit losses in the Serviced
Portfolio exceed $50 million plus the specific reserves, then PNC Business
Credit will advance cash to NBOC for these excess losses net of recoveries
("Excess Loss Payments"). PNC is to be reimbursed by NBOC for any Excess Loss
Payments if the Put Option is not exercised. If the Put Option is exercised, the
Put Option purchase price will be reduced by the amount of any Excess Loss
Payments.
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 September 30, 2002 the Put Option
liability was approximately $78 million. A $19 million reduction from the
acquisition date amount has been recognized in earnings for the first nine
months of 2002 as other noninterest income. In addition, $15 million has been
paid to NBOC as Excess Loss Payments.
If the Put Option is exercised, then PNC would record the loans acquired as
loans held for sale at the purchase price less the balance of the Put Option
liability at that date, which should approximate fair value. The Put Option
purchase price will be NBOC's outstanding principal balance for the loans
remaining in the Serviced Portfolio adjusted for the realized credit losses
during the servicing term and Excess Loss Payments. As the realized credit
losses exceeded $50 million plus the specific reserves used, the Excess Loss
Payments made by PNC Business Credit to NBOC will be deducted from NBOC's
outstanding principal balance in determining the Put Option purchase price.
At September 30, 2002, the independent valuation firm estimated that loans
outstanding in the Serviced Portfolio at the put date would be $214 million. The
total credit losses over the 18-month term of the servicing agreement are
estimated to be $82 million. Using these and other assumptions, if the Put were
exercised at the end of the servicing term, PNC would record the acquired loans
at $125 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 $7 million at September 30, 2002 and is included
in PNC's nonperforming assets. Excluding these loans, the Serviced Portfolio in
January 2002 was $608 million of credit exposure including $414 million of
outstandings of which $88 million was nonperforming. At September 30, 2002,
comparable amounts were $450 million, $203 million and $66 million,
respectively.
36
NOTE 4 GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, the Corporation implemented SFAS No. 142, "Goodwill
and Other Intangible Assets," which changed the accounting for goodwill from the
amortization of goodwill to an impairment-only approach. The amortization of
goodwill, including goodwill recognized relating to past business combinations,
ceased upon adoption of the new standard. Impairment testing for goodwill at a
reporting unit level will be required on at least an annual basis.
In accordance with SFAS No. 142, the Corporation identified its reporting unit
structure for goodwill impairment testing purposes as of January 1, 2002.
Management performed the first step of the transitional goodwill impairment test
on its reporting units during the first quarter of 2002. The results of this
test indicated no impairment loss as the fair value of the reporting units
exceeded the carrying amount of the net assets (including goodwill) in all
cases. Fair value was determined by using a discounted cash flow methodology. As
a result of adopting this statement, the Corporation reassessed the useful lives
and the classification of identifiable intangible assets and determined that
they continue to be appropriate.
GOODWILL
A summary of the changes in goodwill by line of business for the nine months
ended September 30, 2002 follows:
January 1 Goodwill Sept. 30
In millions 2002 Acquired Adjustments 2002
- ----------------------------------------------------------------------
Regional Community
Banking $438 $438
Corporate Banking 39 39
PNC Real Estate Finance 298 $4 302
PNC Business Credit 23 $277 (2) 298
PNC Advisors 151 1 152
BlackRock 175 175
PFPC 912 (3) 909
- ----------------------------------------------------------------------
Total $2,036 $277 $2,313
======================================================================
OTHER INTANGIBLE ASSETS
The gross carrying amount, accumulated amortization and net carrying amount of
other intangible assets by major category consisted of the following:
September 30 December 31
In millions 2002 2001
- -----------------------------------------------------------------
Customer-related intangibles
Gross carrying amount $198 $185
Accumulated amortization (62) (47)
- -----------------------------------------------------------------
Net carrying amount $136 $138
- -----------------------------------------------------------------
Mortgage and other loan servicing rights
Gross carrying amount $306 $286
Accumulated amortization (105) (87)
- -----------------------------------------------------------------
Net carrying amount $201 $199
==================================================================
All of the Corporation's other intangible assets have finite lives and are
amortized primarily on a straight-line basis or, in the case of mortgage and
other loan servicing rights, on an accelerated basis. For customer-related
intangibles, the estimated remaining useful lives range from one to sixteen
years, with a weighted-average remaining useful life of approximately eight
years. The Corporation's mortgage and other loan servicing rights are amortized
over a period of seven to ten years using the net present value of the cash
flows received from servicing the related loans.
The changes in the carrying amount of goodwill and net other intangible assets
for the nine months ended September 30, 2002, are as follows:
CHANGES IN GOODWILL AND OTHER INTANGIBLES
Customer- Servicing
In millions Goodwill Related Rights
- ----------------------------------------------------------------
Balance at December 31, 2001 $2,036 $138 $199
Additions/adjustments 277 13 21
Amortization (15) (19)
- ----------------------------------------------------------------
Balance at September 30, 2002 $2,313 $136 $201
=================================================================
In conjunction with the first quarter 2002 NBOC acquisition, PNC Business Credit
recorded a customer-based intangible of $12.4 million that will be amortized
over seven years. Goodwill recorded in connection with the NBOC acquisition was
approximately $277 million.
Amortization expense on intangible assets for the third quarter and first nine
months of 2002 was approximately $12 million and $34 million, respectively.
Amortization expense on existing intangible assets for the remainder of 2002 and
for 2003, 2004, 2005, 2006 and 2007 is estimated to be $11 million, $45 million,
$42 million, $40 million, $38 million and $36 million, respectively.
The following table sets forth reported and pro forma income from continuing
operations and basic and diluted earnings per share as if the nonamortization
provisions of SFAS No. 142 had been applied in the previous period.
37
PRO FORMA EFFECTS
Three months ended September 30
In millions, except per share data 2002 2001
- ---------------------------------------------------------------
Reported income from continuing
operations $285 $247
Goodwill amortization, net of taxes 24
- ---------------------------------------------------------------
Pro forma income from continuing
operations $285 $271
- ---------------------------------------------------------------
Basic earnings per share
Reported, from continuing operations $1.00 $.85
Goodwill amortization, net of taxes .08
- ---------------------------------------------------------------
Pro forma basic earnings per share $1.00 $.93
- ---------------------------------------------------------------
Diluted earnings per share
Reported, from continuing operations $1.00 $.84
Goodwill amortization, net of taxes .08
- ---------------------------------------------------------------
Pro forma diluted earnings per share $1.00 $.92
===============================================================
Nine months ended September 30
In millions, except per share data 2002 2001
- ---------------------------------------------------------------
Reported income from continuing
operations $922 $807
Goodwill amortization, net of taxes 70
- ---------------------------------------------------------------
Pro forma income from continuing
operations $922 $877
- ---------------------------------------------------------------
Basic earnings per share
Reported, from continuing operations $3.25 $2.76
Goodwill amortization, net of taxes .24
- ---------------------------------------------------------------
Pro forma basic earnings per share $3.25 $3.00
- ---------------------------------------------------------------
Diluted earnings per share
Reported, from continuing operations $3.23 $2.73
Goodwill amortization, net of taxes .24
- ---------------------------------------------------------------
Pro forma diluted earnings per share $3.23 $2.97
===============================================================
NOTE 5 RECENT ACCOUNTING PRONOUNCEMENTS
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions." This statement clarified that, if certain criteria are
met, an acquisition of a less-than-whole financial institution (such as a branch
acquisition) should be accounted for as a business combination. SFAS No. 147
states that, in such instances, the excess of the fair value of liabilities
assumed over the fair value of tangible and identifiable intangible assets
acquired represents goodwill. Prior to SFAS No. 147, such excesses were
classified as an unidentifiable intangible asset subject to continuing
amortization under SFAS No. 142, "Goodwill and Other Intangible Assets." As a
result of SFAS No. 147, entities are required to reclassify and restate both the
goodwill asset and amortization expense as of the date SFAS No. 142 was adopted.
In addition, SFAS No. 147 amends SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," to include in its scope long-term
customer-relationship intangible assets of financial institutions such as
depositor- and borrower-relationship intangible assets. As a result, those
intangible assets are subject to the same undiscounted cash flow recoverability
test and impairment loss recognition and measurement provisions that SFAS No.
144 requires for other long-lived assets that are held and used by a company.
SFAS No. 147 became effective October 1, 2002 and will not have a material
impact on PNC's consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which replaces Emerging Issues Task Force
Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." SFAS No. 146 addresses the accounting and reporting for
one-time employee termination benefits, certain contract termination costs, and
other costs associated with exit or disposal activities such as facility
closings or consolidations and employee relocations. The standard is effective
for exit or disposal activities initiated after December 31, 2002. The
Corporation plans to adopt SFAS No. 146 prospectively as of January 1, 2003.
NOTE 6 CASH FLOWS
During the first nine months of 2002, acquisition activity that affected cash
flows consisted of $1.736 billion of acquired assets and $60 million of acquired
liabilities, resulting in net cash disbursements of $1.676 billion. The 2002
activity consisted solely of the NBOC acquisition as described in Note 3. During
the first nine months of 2001, divestiture activity that affected cash flows
consisted of $383 million of divested net assets and cash receipts of $503
million, both of which were related to the sale of PNC's residential mortgage
banking business.
NOTE 7 TRADING ACTIVITIES
Most of PNC's trading activities are designed to provide capital markets
services to customers and not to position the Corporation's portfolio for gains
from market movements. PNC participates in derivatives and foreign exchange
trading as well as underwriting and "market making" in equity securities as an
accommodation to customers. PNC also engages in trading activities as part of
risk management strategies.
Net trading income for the first nine months of 2002 totaled $78 million
compared with $118 million for the prior-year period and was included in
noninterest income as follows:
DETAILS OF TRADING ACTIVITIES
Nine months ended September 30 - in
millions 2002 2001
- ---------------------------------------------------------------
Corporate services $1 $5
Other noninterest income
Securities underwriting and trading 39 40
Derivatives trading 19 54
Foreign exchange 19 19
- ---------------------------------------------------------------
Net trading income $78 $118
===============================================================
38
NOTE 8 NONPERFORMING ASSETS
Nonperforming assets were as follows:
September 30 December 31
In millions 2002 2001
- ---------------------------------------------------------------
Nonperforming loans (a) $271 $211
Nonperforming loans held for sale (b) 125 169
Foreclosed assets 13 11
- ---------------------------------------------------------------
Total nonperforming assets (c) $409 $391
===============================================================
(a) Includes a troubled debt restructured loan of $2 million as of September
30, 2002.
(b) Includes a troubled debt restructured loan held for sale of $11 million
and $6 million as of September 30, 2002 and December 31, 2001,
respectively.
(c) Excludes $42 million, of which $13 million represented troubled debt
restructured assets, and $18 million of equity management assets carried at
estimated fair value at September 30, 2002 and December 31, 2001,
respectively.
NOTE 9 ALLOWANCES FOR CREDIT LOSSES AND UNFUNDED LOAN COMMITMENTS AND LETTERS OF
CREDIT
Changes in the allowance for credit losses were as follows:
In millions 2002 2001
- ---------------------------------------------------------------
Allowance at January 1 $560 $598
Charge-offs
Commercial (167) (165)
Commercial real estate (2) (6)
Consumer (30) (31)
Residential mortgage (5) (1)
Lease financing (20) (16)
- ---------------------------------------------------------------
Total charge-offs (224) (219)
- ---------------------------------------------------------------
Recoveries
Commercial 23 13
Commercial real estate 1
Consumer 11 13
Residential mortgage 1
Lease financing 1 2
- ---------------------------------------------------------------
Total recoveries 36 29
- ---------------------------------------------------------------
Net charge-offs
Commercial (144) (152)
Commercial real estate (2) (5)
Consumer (19) (18)
Residential mortgage (4) (1)
Lease financing (19) (14)
- ---------------------------------------------------------------
Total net charge-offs (188) (190)
- ---------------------------------------------------------------
Provision for credit losses 244 235
Acquired allowance (NBOC acquisition) 41
Net change in allowance for unfunded loan
commitments and letters of credit (9) (5)
- ---------------------------------------------------------------
Allowance at September 30 $648 $638
===============================================================
Changes in the allowance for unfunded loan commitments and letters of credit
were as follows:
In millions 2002 2001
- ---------------------------------------------------------------
Allowance at January 1 $70 $77
Net change in allowance for unfunded
loan commitments and letters of credit 9 5
- ---------------------------------------------------------------
Allowance at September 30 $79 $82
===============================================================
NOTE 10 LEGAL PROCEEDINGS
The following matters have been described in Note 24 to the Consolidated
Financial Statements included in the 2001 Form 10-K, Part I, Item 3 - Legal
Proceedings in the 2001 Form 10-K, Note 10 to the Consolidated Financial
Statements included in the Quarterly Report on Form 10-Q for the quarter ended
June 30, 2002 ("June 2002 10-Q") or Part II, Item 1 - Legal Proceedings in the
June 2002 Form 10-Q: putative federal securities law class action litigation
against the Corporation, certain present or former officers and directors, and
its independent auditors for 2001; a dispute over certain closing date purchase
price adjustments related to the January 2001 sale of the Corporation's
residential mortgage banking business; regulatory inquiries relating to certain
transactions with companies formed with AIG; a shareholder matter; and a
Department of Labor inquiry. There were no material developments with respect to
any of these matters or in management's assessment of them from the information
reported in the 2001 Form 10-K or the June 2002 10-Q except as described in the
following paragraphs.
Regarding the putative federal securities law class action litigation, the
putative class actions pending against the Corporation were consolidated in an
amended 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
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. Management believes there are
substantial defenses to this lawsuit and intends to file a motion to dismiss the
complaint and otherwise defend it vigorously.
Regarding the dispute over certain closing date purchase price adjustments
related to the Corporation's January 2001 sale of its residential mortgage
banking business, the Superior Court of the State of California for the County
of Los Angeles granted the Corporation's motion to compel arbitration and stay
the lawsuit on October 2, 2002 and ordered the parties to use their best efforts
to complete the arbitration by March 10, 2003.
Regarding the Department of Labor ("DOL") inquiry, a formal investigation by the
DOL is pending. The Corporation is cooperating with the investigation.
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,
management is not in a position to determine whether any pending or threatened
legal proceedings will have a material adverse effect on the Corporation's
results of operations in any future reporting period.
39
NOTE 11 SECURITIES
Unrealized
Amortized ----------------------------------- Fair
In millions Cost Gains Losses Value
- ----------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2002
SECURITIES AVAILABLE FOR SALE
Debt securities
U.S. Treasury and government agencies $839 $10 $849
Mortgage-backed 8,511 185 $(1) 8,695
Asset-backed 1,946 81 (1) 2,026
State and municipal 60 7 67
Other debt 57 3 60
- ----------------------------------------------------------------------------------------------------------------------------------
Total debt securities 11,413 286 (2) 11,697
Corporate stocks and other 509 6 (18) 497
- ----------------------------------------------------------------------------------------------------------------------------------
Total securities available for sale $11,922 $292 $(20) $12,194
==================================================================================================================================
SECURITIES HELD TO MATURITY
Debt securities
U.S. Treasury and government agencies $271 $44 $315
Asset-backed 8 8
Other debt 63 63
- ----------------------------------------------------------------------------------------------------------------------------------
Total debt securities 342 44 386
- ----------------------------------------------------------------------------------------------------------------------------------
Total securities held to maturity $342 $44 $386
==================================================================================================================================
DECEMBER 31, 2001
SECURITIES AVAILABLE FOR SALE
Debt securities
U.S. Treasury and government agencies $808 $3 $(4) $807
Mortgage-backed 9,669 37 (128) 9,578
Asset-backed 2,799 8 (31) 2,776
State and municipal 62 2 64
Other debt 75 1 (1) 75
- ---------------------------------------------------------------------------------------------------------------------------------
Total debt securities 13,413 51 (164) 13,300
Corporate stocks and other 264 (19) 245
- ----------------------------------------------------------------------------------------------------------------------------------
Total securities available for sale $13,677 $51 $(183) 13,545
==================================================================================================================================
SECURITIES HELD TO MATURITY
Debt securities
U.S. Treasury and government agencies $260 $(3) $257
Asset-backed 8 8
Other debt 95 95
- ----------------------------------------------------------------------------------------------------------------------------------
Total debt securities 363 (3) 360
- ----------------------------------------------------------------------------------------------------------------------------------
Total securities held to maturity $363 $(3) $360
==================================================================================================================================
Total securities at September 30, 2002 were $12.5 billion compared with $13.9
billion at December 31, 2001. Securities represented 19% of total assets at
September 30, 2002 compared with 20% at December 31, 2001. The decline in total
securities compared with December 31, 2001 was primarily due to net sales of
mortgage-backed and asset-backed securities during 2002.
The expected weighted-average life of securities available for sale was 2 years
and 6 months at September 30, 2002 compared with 4 years at December 31, 2001.
The securities classified as held to maturity are carried at amortized cost and
are owned by companies formed with AIG that are consolidated in PNC's financial
statements.
The expected weighted-average life of securities held to maturity was 20 years
and 3 months at September 30, 2002 and 18 years and 11 months at December 31,
2001.
At September 30, 2002, the securities available for sale balance included a net
unrealized gain of $272 million, which represented the difference between fair
value and amortized cost. The comparable amount at December 31, 2001 was a net
unrealized loss of $132 million. Net unrealized gains and losses in the
securities available for sale portfolio are included in 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.
40
Net securities gains were $88 million for the first nine months of 2002 and $131
million for the first nine months of 2001. Net securities gains in 2001 included
$3 million of net securities losses related to commercial mortgage banking
activities that were reported in corporate services revenue. There was no
comparable amount for the first nine months of 2002.
Information relating to securities sold is set forth in the following table:
SECURITIES SOLD
Nine months ended
September 30 Gross Gross Net Income
In millions Proceeds Gains Losses Gains Taxes
- -------------------------------------------------------------------
2002 $13,689 $100 $12 $88 $31
2001 16,776 142 11 131 46
===================================================================
NOTE 12 EARNINGS PER SHARE
The following table sets forth basic and diluted earnings per share
calculations.
Three months ended Nine months ended
September 30 September 30
-------------------------------------------
In millions, except share and per share data 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------
CALCULATION OF BASIC EARNINGS PER COMMON SHARE
Income from continuing operations $285 $247 $922 $807
Less: Preferred dividends declared 3 1 13
- --------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations applicable to basic earnings per common share 285 244 921 794
Income from discontinued operations applicable to basic earnings per common share 5
Cumulative effect of accounting change applicable to basic earnings per common share (5)
- --------------------------------------------------------------------------------------------------------------------------------
Net income applicable to basic earnings per common share $285 $244 $921 $794
Basic weighted-average common shares outstanding (in thousands) 283,689 286,282 283,195 287,908
Basic earnings per common share from continuing operations $1.00 $.85 $3.25 $2.76
Basic earnings per common share from discontinued operations .02
Basic earnings per common share from cumulative effect of accounting change (.02)
- --------------------------------------------------------------------------------------------------------------------------------
Basic earnings per common share $1.00 $.85 $3.25 $2.76
================================================================================================================================
CALCULATION OF DILUTED EARNINGS PER COMMON SHARE
Income from continuing operations $285 $247 $922 $807
Less: Dividends declared on nonconvertible Series F preferred stock and other 3 1 12
- --------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations applicable to diluted earnings per common share 285 244 921 795
Income from discontinued operations applicable to diluted earnings per common share 5
Cumulative effect of accounting change applicable to diluted earnings per common share (5)
- --------------------------------------------------------------------------------------------------------------------------------
Net income applicable to diluted earnings per common share $285 $244 $921 $795
Basic weighted-average common shares outstanding (in thousands) 283,689 286,282 283,195 287,908
Conversion of preferred stock Series A and B 95 103 99 107
Conversion of preferred stock Series C and D 786 861 803 882
Conversion of debentures 15 17 16 17
Exercise of stock options 207 1,530 654 1,873
Incentive share awards 422 421 426 347
- --------------------------------------------------------------------------------------------------------------------------------
Diluted weighted-average common shares outstanding (in thousands) 285,214 289,214 285,193 291,134
Diluted earnings per common share from continuing operations $1.00 $.84 $3.23 $2.73
Diluted earnings per common share from discontinued operations .02
Diluted earnings per common share from cumulative effect of accounting change (.02)
- --------------------------------------------------------------------------------------------------------------------------------
Diluted earnings per common share $1.00 $.84 $3.23 $2.73
================================================================================================================================
41
NOTE 13 SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
The following table sets forth the activity in shareholders' equity for the
first nine months of 2002.
Deferred Accumulated Other
In millions, except share and per Preferred Common Capital Retained Benefit Comprehensive Treasury
share data Stock Stock Surplus Earnings Expense Income (a) Stock Total
- --------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 $1 $1,764 $1,077 $6,549 $(16) $5 $(3,557) $5,823
Net income 922 922
Other comprehensive income, net of
tax (a)
Net unrealized securities gains 263 263
Net unrealized gains on cash flow
hedge derivatives 45 45
Other 12 12
- --------------------------------------------------------------------------------------------------------------------------------
Comprehensive income 1,242
- --------------------------------------------------------------------------------------------------------------------------------
Cash dividends declared
Common ($1.44 per share) (408) (408)
Preferred (1) (1)
Treasury stock activity
(1,177,000 net shares issued) (1) 16 31 46
Tax benefit of stock option plans 8 8
Subsidiary stock transactions 2 2
Deferred benefit expense 5 5
- --------------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2002 $1,764 $1,103 $7,062 $(11) $325 $(3,526) $6,717
================================================================================================================================
(a) A summary of the components of other comprehensive income follows:
Nine months ended September 30, 2002
In millions Pretax amount Tax Benefit (Expense) After-tax Amount
- -------------------------------------------------------------------------------------------------------------------------------
Unrealized securities gains $347 $(121) $226
Less: Reclassification adjustment for losses realized in net income (57) 20 (37)
- -------------------------------------------------------------------------------------------------------------------------------
Net unrealized securities gains 404 (141) 263
- -------------------------------------------------------------------------------------------------------------------------------
Unrealized gains on cash flow hedge derivatives 128 (45) 83
Less: Reclassification adjustment for gains realized in net income 59 (21) 38
- -------------------------------------------------------------------------------------------------------------------------------
Net unrealized gains on cash flow hedge derivatives 69 (24) 45
- -------------------------------------------------------------------------------------------------------------------------------
Other (b) 19 (7) 12
- -------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income $492 $(172) $320
===============================================================================================================================
(b) Consists of interest-only strip valuation adjustments and foreign
currency translation adjustments.
COMPREHENSIVE INCOME
Comprehensive income from continuing operations was $440 million for the third
quarter of 2002 compared with $459 million for the third quarter of 2001.
Comprehensive income for the first nine months of 2002 was $1.242 billion
compared with $1.002 billion for the first nine months of 2001. The increases in
comprehensive income in both 2002 periods are primarily due to net unrealized
securities gains in 2002 and higher income from continuing operations compared
with the respective prior year periods.
42
NOTE 14 SEGMENT REPORTING
PNC operates seven major businesses engaged in regional community banking,
corporate banking, real estate finance, asset-based lending, wealth management,
asset management and global fund services. Assets, revenue and earnings
attributable to foreign activities were not material in the periods presented.
Results of individual businesses are presented based on PNC's management
accounting practices and the Corporation's management structure. There is no
comprehensive, authoritative body of guidance for management accounting
equivalent to generally accepted accounting principles; therefore, the financial
results of individual businesses are not necessarily comparable with similar
information for any other company. Financial results are presented, to the
extent practicable, as if each business operated on a stand-alone basis. Also,
certain amounts for 2001 have been reclassified to conform with the 2002
presentation.
The management accounting process uses various balance sheet and income
statement assignments and transfers to measure performance of the businesses.
Methodologies change from time to time as management accounting practices are
enhanced and businesses change. Securities or borrowings and related net
interest income are assigned based on the net asset or liability position of
each business. Capital is assigned based on management's assessment of inherent
risks and equity levels at independent companies providing similar products and
services. The allowance for credit losses is allocated based on management's
assessment of risk inherent in the loan portfolios. The costs incurred by
support areas not directly aligned with the businesses are allocated primarily
based on the utilization of services.
Total business results differ from consolidated results from continuing
operations primarily due to differences between management accounting practices
and generally accepted accounting principles, equity management activities,
minority interest in income of consolidated entities, residual asset and
liability management activities, eliminations and other corporate items, the
impact of which is reflected in the "Other" category.
The impact of the institutional lending repositioning and other strategic
actions that occurred during 2001 is reflected in the business results.
BUSINESS SEGMENT PRODUCTS AND SERVICES
Regional Community Banking provides deposit, branch-based brokerage, electronic
banking and credit products and services to retail customers as well as deposit,
credit, treasury management and capital markets products and services to small
businesses primarily within PNC's geographic region.
Corporate Banking provides credit, equipment leasing, treasury management and
capital markets products and services to mid-sized corporations, government
entities and selectively to large corporations primarily within PNC's geographic
region.
PNC Real Estate Finance specializes in financial solutions for the acquisition,
development, permanent financing and operation of commercial real estate
nationally. PNC Real Estate Finance offers treasury and investment management,
access to the capital markets, commercial mortgage loan servicing and other
products and services to clients that develop, own, manage or invest in
commercial real estate. PNC's commercial real estate financial services platform
provides processing services through Midland Loan Services, Inc., a leading
third-party provider of loan servicing and technology to the commercial real
estate finance industry, and national syndication of affordable housing equity
through Columbia Housing Partners, LP.
PNC Business Credit provides asset-based lending, 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 products and services
to affluent individuals and families, including full-service brokerage through
J.J.B. Hilliard, W.L. Lyons, Inc. and investment advisory services to the
ultra-affluent through Hawthorn. PNC Advisors also serves as investment manager
and trustee for employee benefit plans and charitable and endowment assets.
BlackRock is one of the largest publicly traded investment management firms in
the United States with approximately $246 billion of assets under management at
September 30, 2002. BlackRock manages assets on behalf of institutions and
individuals worldwide through a variety of fixed income, liquidity and equity
mutual funds, separate accounts and alternative investment products. Mutual
funds include the flagship fund families - BlackRock Funds and BlackRock
Provident Institutional Funds. In addition, BlackRock provides risk management
and investment system services to institutional investors under the BlackRock
Solutions brand name.
PFPC is the largest full-service mutual fund transfer agent and second largest
provider of mutual fund accounting and administration services in the United
States, providing a wide range of fund services to the investment management
industry. PFPC also provides processing solutions to the international
marketplace through its Ireland and Luxembourg operations.
43
RESULTS OF BUSINESSES PNC
Regional Real PNC
Three months ended September 30 Community Corporate Estate Business PNC Black- Total
In millions Banking Banking Finance Credit Advisors Rock PFPC Other Consolidated
- ----------------------------------------------------------------------------------------------------------------------------------
2002 INCOME STATEMENT
Net interest income $336 $87 $26 $35 $24 $1 $(19) $38 $528
Noninterest income 240 89 28 8 126 137 177 (47) 758
- ----------------------------------------------------------------------------------------------------------------------------------
Total revenue 576 176 54 43 150 138 158 (9) 1,286
Provision for credit losses 14 44 (2) 15 2 73
Depreciation and amortization 9 3 4 1 2 5 4 17 45
Other noninterest expense 259 86 41 13 114 77 123 19 732
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings before minority
interest and income taxes 294 43 11 14 32 56 31 (45) 436
Minority interest in income of
consolidated entities (2) 6 4
Income taxes 102 13 (6) 6 12 23 12 (15) 147
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings $192 $30 $19 $8 $20 $33 $19 $(36) $285
==================================================================================================================================
Inter-segment revenue $8 $1 $8 $4 $2 $(23)
==================================================================================================================================
AVERAGE ASSETS $39,188 $13,337 $4,892 $3,814 $2,872 $790 $1,893 $(928) $65,858
==================================================================================================================================
2001 INCOME STATEMENT
Net interest income $374 $119 $31 $26 $31 $2 $(19) $1 $565
Noninterest income 210 (12) 26 1 142 135 196 22 720
- ----------------------------------------------------------------------------------------------------------------------------------
Total revenue 584 107 57 27 173 137 177 23 1,285
Provision for credit losses 15 41 5 5 44 110
Depreciation and amortization 16 3 5 1 5 7 11 19 67
Other noninterest expense 260 90 36 6 115 85 138 (6) 724
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings before minority
interest and income taxes 293 (27) 11 15 53 45 28 (34) 384
Minority interest in income of
consolidated entities 9 9
Income taxes 107 (11) (5) 6 19 18 11 (17) 128
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings $186 $(16) $16 $9 $34 $27 $17 $(26) $247
==================================================================================================================================
Inter-segment revenue $1 $1 $14 $5 $1 $(22)
==================================================================================================================================
AVERAGE ASSETS $39,925 $16,317 $5,194 $2,433 $3,358 $644 $1,792 $(607) $69,056
==================================================================================================================================
Nine months ended September 30
In millions
2002 INCOME STATEMENT
Net interest income $1,074 $267 $86 $101 $76 $7 $(55) $117 $1,673
Noninterest income 593 317 84 32 428 440 573 (80) 2,387
- ---------------------------------------------------------------------------------------------------------------------------------
Total revenue 1,667 584 170 133 504 447 518 37 4,060
Provision for credit losses 37 139 (7) 72 3 244
Depreciation and amortization 27 7 6 1 7 15 8 54 125
Other noninterest expense 770 265 113 40 361 265 415 38 2,267
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings before minority
interest and income taxes 833 173 58 20 133 167 95 (55) 1,424
Minority interest in income of
consolidated entities (2) 28 26
Income taxes 288 56 (7) 8 49 68 38 (24) 476
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings $545 $117 $67 $12 $84 $99 $57 $(59) $922
==================================================================================================================================
Inter-segment revenue $15 $5 $31 $12 $6 $(69)
==================================================================================================================================
AVERAGE ASSETS $39,010 $14,275 $5,017 $3,870 $2,976 $790 $1,891 $(988) $66,841
==================================================================================================================================
2001 INCOME STATEMENT
Net interest income $1,088 $391 $86 $77 $99 $7 $(50) $(14) $1,684
Noninterest income 592 98 74 21 463 404 586 (70) 2,168
- ----------------------------------------------------------------------------------------------------------------------------------
Total revenue 1,680 489 160 98 562 411 536 (84) 3,852
Provision for credit losses 35 129 12 13 1 45 235
Depreciation and amortization 51 9 16 2 13 19 33 55 198
Other noninterest expense 779 285 102 21 363 258 422 (62) 2,168
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings before minority
interest and income taxes 815 66 30 62 185 134 81 (122) 1,251
Minority interest in income of
consolidated entities 25 25
Income taxes 292 18 (17) 23 68 55 32 (52) 419
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings $523 $48 $47 $39 $117 $79 $49 $(95) $807
==================================================================================================================================
Inter-segment revenue $3 $3 $49 $13 $4 $(72)
==================================================================================================================================
AVERAGE ASSETS $40,188 $16,984 $5,288 $2,431 $3,399 $644 $1,759 $(132) $70,561
==================================================================================================================================
44
STATISTICAL INFORMATION
THE PNC FINANCIAL SERVICES GROUP, INC.
CONSOLIDATED AVERAGE BALANCE SHEET AND NET INTEREST ANALYSIS
Nine months ended September 30
----------------------------------------
2002
----------------------------------------
Taxable-equivalent basis Average Interest Average
Dollars in millions Balances Income/Expense Yields/Rates
- --------------------------------------------------------------------------------------------------------
Assets
Interest-earning assets
Loans held for sale $3,204 $117 4.83%
Securities
Securities available for sale
U.S. Treasury and government
agencies/corporations 3,144 123 5.22
Other debt 7,670 317 5.52
State and municipal 61 4 9.16
Corporate stocks and other 480 11 3.03
- ------------------------------------------------------------------------------------------
Total securities available for sale 11,355 455 5.35
Securities held to maturity 356 13 4.78
- ------------------------------------------------------------------------------------------
Total securities 11,711 468 5.33
Loans, net of unearned income
Commercial 16,089 719 5.90
Commercial real estate 2,474 99 5.26
Consumer 9,481 474 6.68
Residential mortgage 5,005 254 6.78
Lease financing 4,231 203 6.41
Other 405 13 4.19
- ------------------------------------------------------------------------------------------
Total loans, net of unearned income 37,685 1,762 6.21
Other 3,225 94 3.88
- ------------------------------------------------------------------------------------------
Total interest-earning assets/interest income 55,825 2,441 5.81
Noninterest-earning assets
Investment in discontinued operations
Allowance for credit losses (619)
Cash and due from banks 2,733
Other assets 8,902
- ---------------------------------------------------------------------------
Total assets $66,841
===========================================================================
LIABILITIES, MINORITY INTEREST, CAPITAL SECURITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing liabilities
Interest-bearing deposits
Demand and money market $21,982 185 1.13
Savings 2,037 8 .49
Retail certificates of deposit 10,490 289 3.69
Other time 692 22 4.25
Deposits in foreign offices 468 6 1.53
- -----------------------------------------------------------------------------------------
Total interest-bearing deposits 35,669 510 1.91
Borrowed funds
Federal funds purchased 721 9 1.61
Repurchase agreements 962 10 1.45
Bank notes and senior debt 5,421 111 2.69
Federal Home Loan Bank borrowings 1,617 4 .33
Subordinated debt 2,210 76 4.60
Other borrowed funds 343 38 14.73
- ------------------------------------------------------------------------------------------
Total borrowed funds 11,274 248 2.92
- ------------------------------------------------------------------------------------------
Total interest-bearing liabilities/interest expense 46,943 758 2.15
Noninterest-bearing liabilities, minority interest, capital
securities and shareholders' equity
Demand and other noninterest-bearing deposits 8,454
Allowance for unfunded commitments and letters of credit 80
Accrued expenses and other liabilities 4,157
Minority interest 196
Mandatorily redeemable capital securities of subsidiary trusts 848
Shareholders' equity 6,163
- ---------------------------------------------------------------------------
Total liabilities, minority interest, capital
securities and shareholders' equity $66,841
- --------------------------------------------------------------------------------------------------------
Interest rate spread 3.66
Impact of noninterest-bearing sources .34
- --------------------------------------------------------------------------------------------------------
Net interest income/margin $1,683 4.00%
========================================================================================================
Nine months ended September 30
----------------------------------------
2001
----------------------------------------
Taxable-equivalent basis Average Interest Average
Dollars in millions Balances Income/Expense Yields/Rates
- --------------------------------------------------------------------------------------------------------
Assets
Interest-earning assets
Loans held for sale $1,894 $92 6.38%
Securities
Securities available for sale
U.S. Treasury and government
agencies/corporations 3,846 167 5.77
Other debt 5,878 276 6.27
State and municipal 77 4 7.84
Corporate stocks and other 309 7 3.02
- ------------------------------------------------------------------------------------------
Total securities available for sale 10,110 454 5.99
Securities held to maturity 31 2 6.84
- ------------------------------------------------------------------------------------------
Total securities 10,141 456 5.99
Loans, net of unearned income
Commercial 20,144 1,130 7.40
Commercial real estate 2,567 146 7.50
Consumer 9,095 563 8.28
Residential mortgage 9,616 522 7.24
Lease financing 4,144 220 7.07
Other 478 25 6.93
- ------------------------------------------------------------------------------------------
Total loans, net of unearned income 46,044 2,606 7.51
Other 1,637 93 7.61
- ------------------------------------------------------------------------------------------
Total interest-earning assets/interest income 59,716 3,247 7.22
Noninterest-earning assets
Investment in discontinued operations 68
Allowance for credit losses (603)
Cash and due from banks 2,935
Other assets 8,513
- --------------------------------------------------------------------------
Total assets $70,629
==========================================================================
LIABILITIES, MINORITY INTEREST, CAPITAL SECURITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing liabilities
Interest-bearing deposits
Demand and money market $20,994 419 2.66
Savings 1,927 15 1.03
Retail certificates of deposit 12,716 516 5.43
Other time 534 26 6.48
Deposits in foreign offices 948 35 4.86
- ---------------------------------------------------------------- ------------------------
Total interest-bearing deposits 37,119 1,011 3.64
Borrowed funds
Federal funds purchased 2,326 85 4.82
Repurchase agreements 1,041 30 3.71
Bank notes and senior debt 5,349 213 5.26
Federal Home Loan Bank borrowings 2,155 74 4.54
Subordinated debt 2,368 110 6.15
Other borrowed funds 398 28 9.11
- ---------------------------------------------------------------- ------------------------
Total borrowed funds 13,637 540 5.23
- ---------------------------------------------------------------- ------------------------
Total interest-bearing liabilities/interest expense 50,756 1,551 4.07
Noninterest-bearing liabilities, minority interest, capital
securities and shareholders' equity
Demand and other noninterest-bearing deposits 8,290
Allowance for unfunded commitments and letters of credit 79
Accrued expenses and other liabilities 3,839
Minority interest 126
Mandatorily redeemable capital securities of subsidiary trusts 848
Shareholders' equity 6,691
- ---------------------------------------------------------------- --------
Total liabilities, minority interest, capital
securities and shareholders' equity $70,629
- ------------------------------------------------------------------------------------------------------
Interest rate spread 3.15
Impact of noninterest-bearing sources .61
- ------------------------------------------------------------------------------------------------------
Net interest income/margin $1,696 3.76%
========================================================================================================
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).
45
Third Quarter 2002 Second Quarter 2002 Third Quarter 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Average Interest Average Average Interest Average Average Interest Average
Balances Income/Expense Yields/Rates Balances Income/Expense Yields/Rates Balances Income/Expense Yields/Rates
- -----------------------------------------------------------------------------------------------------------------------------------
$2,125 $24 4.43% $3,235 $41 5.07% $1,955 $24 4.83%
2,962 37 5.07 2,972 39 5.21 3,908 56 5.69
7,205 95 5.27 7,146 99 5.54 6,175 95 6.17
60 1 9.05 61 1 9.33 66 1 8.95
541 4 2.53 492 5 3.63 388 2 2.11
- ------------------------------- ------------------------- --------------------------
10,768 137 5.10 10,671 144 5.38 10,537 154 5.86
340 4 5.02 364 5 5.70 92 2 6.92
- ------------------------------- ------------------------- --------------------------
11,108 141 5.10 11,035 149 5.39 10,629 156 5.87
15,698 236 5.89 16,311 243 5.90 19,296 333 6.76
2,501 33 5.16 2,470 33 5.26 2,548 43 6.67
9,649 160 6.56 9,509 158 6.67 9,102 181 7.86
4,296 71 6.63 4,979 85 6.79 7,771 138 7.11
4,124 65 6.31 4,244 68 6.39 4,381 75 6.76
419 5 4.16 402 4 4.26 456 7 6.04
- ------------------------------- ------------------------- --------------------------
36,687 570 6.13 37,915 591 6.20 43,554 777 7.04
4,324 38 3.46 3,457 26 3.07 1,725 30 6.86
- ------------------------------- ------------------------- --------------------------
54,244 773 5.64 55,642 807 5.78 57,863 987 6.75
(665) (625) (598)
2,619 2,705 2,921
9,660 8,738 8,870
- -------------- ---------- ----------
$65,858 $66,460 $69,056
============== ========== ==========
$21,994 62 1.12 $22,147 63 1.16 $21,559 123 2.25
2,050 2 .50 2,067 3 .50 1,925 4 .84
10,347 92 3.52 10,518 97 3.68 11,785 142 4.79
307 5 6.33 948 8 3.45 501 8 6.26
299 1 1.10 243 1 1.66 357 3 3.54
- ------------------------------- ------------------------- --------------------------
34,997 162 1.84 35,923 172 1.92 36,127 280 3.07
42 1 2.97 35 1.81 1,457 13 3.55
990 4 1.51 979 4 1.45 893 7 2.90
5,154 35 2.63 5,441 38 2.76 4,973 55 4.33
1,272 (1) (.15) 1,714 2 .52 2,459 22 3.48
2,210 25 4.61 2,210 25 4.58 2,332 32 5.54
158 15 37.25 483 8 6.66 413 10 8.87
- ------------------------------- ------------------------- --------------------------
9,826 79 3.16 10,862 77 2.83 12,527 139 4.35
- ------------------------------- ------------------------- --------------------------
44,823 241 2.13 46,785 249 2.13 48,654 419 3.40
8,665 8,406 8,448
73 98 80
4,754 4,027 4,141
218 192 142
848 848 848
6,477 6,104 6,743
- ---------------- ---------- -----------
$65,858 $66,460 $69,056
- ----------------------------------------------------------------------------------------------------------------------------------
3.51 3.65 3.35
.37 .34 .54
- ----------------------------------------------------------------------------------------------------------------------------------
$532 3.88% $558 3.99% $568 3.89%
==================================================================================================================================
Loan fees for the nine months ended September 30, 2002 and September 30, 2001
were $80 million and $89 million, respectively. Loan fees for the three months
ended September 30, 2002, June 30, 2002 and September 30, 2001 were $22 million,
$29 million and $29 million, respectively.
46
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 September 30, 2002.
Commission File Number 1-9718
THE PNC FINANCIAL SERVICES GROUP, INC.
Incorporated in the Commonwealth of Pennsylvania
IRS Employer Identification No. 25-1435979
Address: One PNC Plaza
249 Fifth Avenue
Pittsburgh, Pennsylvania 15222-2707
Telephone: (412) 762-2000
As of October 31, 2002 The PNC Financial Services Group, Inc. had 284,634,069
shares of common stock ($5 par value) outstanding.
The PNC Financial Services Group, Inc. (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months and (2) has been subject to such filing requirements for the
past 90 days.
The following sections of the Financial Review set forth in the cross-reference
index are incorporated in the Quarterly Report on Form 10-Q.
Cross-reference Page(s)
- ---------------------------------------------------------------
PART I FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Statement of Income for the
three months and nine months ended
September 30, 2002 and 2001 31
Consolidated Balance Sheet as of
September 30, 2002 and December 31,
2001 32
Consolidated Statement of Cash Flows for
the nine months ended September 30,
2002 and 2001 33
Notes to Consolidated Financial
Statements 34 - 44
Consolidated Average Balance Sheet and
Net Interest Analysis 45 - 46
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of
Operations 3 - 30
Item 3 Quantitative and Qualitative
Disclosures About Market Risk 22 - 30
Item 4 Controls and Procedures 28
- ---------------------------------------------------------------
PART II OTHER FINANCIAL INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The following matters have been described in Note 24 to the Consolidated
Financial Statements included in the 2001 Form 10-K, Part I, Item 3 - Legal
Proceedings in the 2001 Form 10-K, Note 10 to the Consolidated Financial
Statements included in the Quarterly Report on Form 10-Q for the quarter ended
June 30, 2002 ("June 2002 10-Q") or Part II, Item 1 - Legal Proceedings in the
June 2002 10-Q: putative federal securities law class action litigation against
the Corporation, certain present or former officers and directors, and its
independent auditors for 2001; a dispute over certain closing date purchase
price adjustments related to the January 2001 sale of the Corporation's
residential mortgage banking business; regulatory inquiries relating to certain
transactions with companies formed with AIG; a shareholder matter; and a
Department of Labor inquiry. There were no material developments with respect to
any of these matters or in management's assessment of them from the information
reported in the 2001 Form 10-K or the June 2002 10-Q except as described in the
following paragraphs.
Regarding the putative federal securities law class action litigation, the
putative class actions pending against the Corporation were consolidated in an
amended 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
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. Management believes there are
substantial defenses to this lawsuit and intends to file a motion to dismiss the
complaint and otherwise defend it vigorously.
Regarding the dispute over certain closing date purchase price adjustments
related to the Corporation's January 2001 sale of its residential mortgage
banking business, the Superior Court of the State of California for the County
of Los Angeles granted the Corporation's motion to compel arbitration and stay
the lawsuit on October 2, 2002 and ordered the parties to use their best efforts
to complete the arbitration by March 10, 2003.
Regarding the Department of Labor ("DOL") inquiry, a formal investigation by the
DOL is pending. The Corporation is cooperating with the investigation.
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,
management is not in a position to determine whether any pending or threatened
legal proceedings will have a material adverse effect on the Corporation's
results of operations in any future reporting period.
47
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
The following exhibit index lists Exhibits filed with this Quarterly Report on
Form 10-Q:
10.16 BlackRock, Inc. 2002 Long Term Retention and Incentive Plan (a)
10.17 Share Surrender Agreement, dated October 10, 2002, among BlackRock,
Inc., PNC Asset Management, Inc., and The PNC Financial Services
Group, Inc. (a)
10.18 Initial Public Offering Agreement, dated September 30, 1999, among
BlackRock, Inc., The PNC Financial Services Group, Inc., formerly
PNC Bank Corp., and PNC Asset Management, Inc. (b)
10.19 Amendment No. 1 to the Initial Public Offering Agreement, dated
October 10, 2002, among The PNC Financial Services Group, Inc.,
PNC Asset Management, Inc. and BlackRock, Inc. (a)
10.20 Amended and Restated Stockholders Agreement, dated September 30,
1999, by and among BlackRock, Inc., PNC Asset Management, Inc. and
certain employees of BlackRock, Inc. and its affiliates (b)
10.21 Amendment No. 1 to the Amended and Restated Stockholders Agreement,
dated October 10, 2002, by and among BlackRock, Inc., PNC Asset
Management, Inc. and certain employees of BlackRock, Inc., and its
affiliates (a)
12.1 Computation of Ratio of Earnings to Fixed Charges
12.2 Computation of Ratio of Earnings to Fixed Charges and
Preferred Stock Dividends
- -------------------------------------------------------------------------------
(a) Incorporated by reference to BlackRock, Inc.'s Quarterly Report on Form 10-Q
(Commission File No. 001-15305) for the quarter ended September 30, 2002.
(b) Incorporated by reference to BlackRock, Inc.'s Registration Statement on
Form S-1 (Registration No. 333-78367), as amended, originally filed with the
SEC on May 13, 1999.
Copies of these Exhibits may be obtained electronically at the Securities and
Exchange Commission's home page at www.sec.gov. Copies may also be obtained
without charge by writing to Thomas F. Garbe, Director of Financial Accounting,
at corporate headquarters, by calling (412) 762-1553 or via e-mail at
financial.reporting@pnc.com.
On July 18, 2002, the Corporation filed a Current Report on Form 8-K ("Form
8-K") in connection with the Corporation's announcement on that date that it had
entered into a written agreement with the Federal Reserve Bank of Cleveland and
that its principal subsidiary, PNC Bank, National Association, had entered into
a written agreement with the Office of the Comptroller of the Currency,
(together, the "Regulatory Agreements"). This Form 8-K also disclosed that the
SEC, with the Corporation's consent, entered an Order Instituting Public
Administrative Proceedings Pursuant to Section 8A of the Securities Act of 1933
and 21C of the Securities Exchange Act of 1934, Making Findings and Imposing
Cease-and-Desist Order ("Commission Order"). The Regulatory Agreements and the
Commission Order were filed as Exhibits with this Form 8-K filing.
On August 7, 2002, the Corporation filed a Form 8-K to disclose the resignation
of one of the members of the Corporation's Board of Directors and an executive
promotion.
On August 14, 2002, the Corporation filed a Form 8-K which included information
under Item 9 Regulation FD Disclosure related to certifications of the
Corporation's Chairman and Chief Executive Officer ("CEO") and then current
Senior Vice President and Chief Financial Officer ("former CFO") pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, and in connection with sworn written statements executed and
delivered by the Corporation's CEO and former CFO in accordance with the Order
issued by the SEC on June 27, 2002. Conformed copies of such certifications and
sworn written statements were filed as Exhibits with this Form 8-K filing.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on November 14, 2002, on its
behalf by the undersigned thereunto duly authorized.
THE PNC FINANCIAL SERVICES GROUP, INC.
By: /s/William S. Demchak
- ------------------------------
William S. Demchak
Vice Chairman and Chief 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 officers 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;
48
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 officers 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:
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 officers 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: November 14, 2002
/s/ James E. Rohr
- --------------------------
James E. Rohr
Chairman and Chief Executive Officer
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 officers 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 officers 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:
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 officers 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: November 14, 2002
/s/ William S. Demchak
- -----------------------
William S. Demchak
Vice Chairman and Chief Financial Officer
49
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. Copies may also be obtained without charge
by writing to Thomas F. Garbe, Director of Financial Accounting, at corporate
headquarters, by calling (412) 762-1553 or via e-mail at
financial.reporting@pnc.com.
INQUIRIES
For financial services call 1-888-PNC-2265. Individual shareholders should
contact Shareholder Relations at (800) 982-7652.
Analysts and institutional investors should contact William H. Callihan,
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
R. Jeep Bryant, Senior Vice President, Corporate Communications, at (412)
762-4550 or via e-mail at corporate.communications@pnc.com.
COMMON STOCK PRICES/DIVIDENDS DECLARED
The table below sets forth by quarter the range of high and low sale and
quarter-end closing prices for The PNC Financial Services Group, Inc. common
stock and the cash dividends declared per common share.
Cash
Dividends
High Low Close Declared
=================================================================
2002 QUARTER
- -----------------------------------------------------------------
First $62.800 $52.500 $61.490 $.48
Second 60.400 49.120 51.770 .48
Third 52.750 32.700 42.170 .48
- -----------------------------------------------------------------
Total $1.44
=================================================================
2001 QUARTER
- -----------------------------------------------------------------
First $75.813 $56.000 $67.750 $.48
Second 71.110 62.400 65.790 .48
Third 70.390 51.140 57.250 .48
Fourth 60.110 52.300 56.200 .48
- -----------------------------------------------------------------
Total $1.92
=================================================================
DIVIDEND REINVESTMENT AND STOCK PURCHASE PLAN
The PNC Financial Services Group, Inc. Dividend Reinvestment and Stock Purchase
Plan enables holders of common and preferred stock to purchase additional shares
of common stock conveniently and without paying brokerage commissions or service
charges. A prospectus and enrollment card may be obtained by writing to
Shareholder Relations at corporate headquarters.
REGISTRAR AND TRANSFER AGENT
The Chase Manhattan Bank
85 Challenger Road
Ridgefield Park, New Jersey 07660
(800) 982-7652
50