Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
Commission file number 1-10074
NATIONAL CITY CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE
(State or other jurisdiction of
incorporation or organization)
34-1111088
(I.R.S. Employer
Identification No.)
1900 EAST NINTH STREET
CLEVELAND, OHIO 44114
(Address of principal executive office)
216-222-2000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
YES [X] NO [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES [X] NO [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of Common Stock as of the latest practicable date.
Common stock -- $4.00 Par Value
Outstanding as of July 31, 2003 -- 614,164,116
[NATIONAL CITY LOGO]
QUARTER ENDED JUNE 30, 2003
FINANCIAL REPORT
AND FORM 10-Q
FINANCIAL REPORT AND FORM 10-Q
QUARTER ENDED JUNE 30, 2003
All reports filed electronically by National City Corporation (National City
or the Corporation) with the United States Securities and Exchange Commission
(SEC), including the Annual Report on Form 10-K, quarterly reports on Form 10-Q,
and current event reports on Form 8-K, as well as any amendments to those
reports, are accessible at no cost on the Corporation's Web site at
www.nationalcity.com/investorrelations. These filings are also accessible on the
SEC's Web site at www.sec.gov.
TABLE OF CONTENTS
PART I -- FINANCIAL INFORMATION Page
Financial Highlights 3
Item 1. Financial Statements:
Consolidated Statements of Income 4
Consolidated Balance Sheets 5
Consolidated Statements of Cash Flows 6
Consolidated Statements of Changes in Stockholders' Equity 7
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations:
Financial Review 44
Consolidated Average Balance Sheets 62
Daily Average Balances/Net Interest Income/Rates 63
Item 3. Quantitative and Qualitative Disclosures About Market Risk 66
Item 4. Controls and Procedures 66
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings 66
Item 2. Changes in Securities and Use of Proceeds (None)
Item 3. Defaults Upon Senior Securities (None)
Item 4. Submission of Matters to a Vote of Security Holders 66
Item 5. Other Information (None)
Item 6. Exhibits and Reports on Form 8-K 67
Signatures 72
2
PART I - FINANCIAL INFORMATION
FINANCIAL HIGHLIGHTS
----------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30 June 30
----------------------------------------------------------------------------------------------------------
(Dollars In Thousands, Except Per Share 2003 2002 2003 2002
Amounts)
----------------------------------------------------------------------------------------------------------
FOR THE PERIOD
Tax-equivalent net interest income $1,102,248 $970,357 $2,202,976 $1,975,707
Provision for loan losses 183,147 165,476 383,380 354,116
Fees and other income 1,030,155 729,291 1,896,446 1,420,152
Securities gains, net 31,407 44,033 31,577 97,565
Noninterest expense 1,026,237 973,922 2,035,103 1,848,811
Income tax expense and tax-equivalent
adjustment 337,835 211,501 599,377 451,584
----------------------------------------------------------------------------------------------------------
Net income $ 616,591 $392,782 $1,113,139 $ 838,913
==========================================================================================================
Net income per common share
Basic $1.01 $ .65 $1.82 $1.38
Diluted .99 .63 1.80 1.36
Dividends paid per common share .305 .295 .61 .59
Return on average common equity 28.10% 19.98% 25.80% 21.95%
Return on average assets 2.08 1.61 1.91 1.69
Net interest margin 4.11 4.42 4.16 4.39
Efficiency ratio 48.13 57.30 49.64 54.44
Average equity to average assets 7.39 8.05 7.39 7.71
Annualized net charge-offs to average
portfolio loans .88 .80 .91 .94
Average shares
Basic 612,119,565 609,336,050 611,822,337 608,579,919
Diluted 618,384,192 616,793,457 616,989,238 615,425,214
==========================================================================================================
AT PERIOD END
Assets $123,392,239 $99,130,782
Portfolio loans 75,838,729 68,674,348
Loans held for sale or securitization 26,845,876 9,826,569
Securities (at fair value) 7,377,350 8,800,004
Deposits 66,770,788 57,314,838
Stockholders' equity 9,060,692 7,947,785
Book value per common share $14.77 $13.02
Market value per common share 32.71 33.25
Equity to assets 7.34% 8.02%
Allowance for loan losses as
percentage of period-end portfolio
loans 1.51 1.50
Nonperforming assets to period-end
portfolio loans and other
nonperforming assets 1.08 1.15
Common shares outstanding 613,426,098 610,479,248
Full-time equivalent employees 32,414 32,158
==========================================================================================================
3
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF INCOME
------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30 June 30
------------------------------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share 2003 2002 2003 2002
Amounts)
------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans $1,409,904 $1,284,830 $2,808,148 $2,636,349
Securities:
Taxable 85,957 123,968 182,933 248,952
Exempt from Federal income taxes 8,579 9,143 17,143 18,434
Dividends 6,283 8,330 11,475 16,837
Federal funds sold and security resale
agreements 612 474 1,116 992
Other investments 9,698 9,171 20,214 17,978
------------------------------------------------------------------------------------------------------------
Total interest income 1,521,033 1,435,916 3,041,029 2,939,542
INTEREST EXPENSE
Deposits 234,353 287,481 478,704 588,725
Federal funds borrowed and security
repurchase agreements 40,685 32,241 82,270 74,170
Borrowed funds 4,600 4,969 13,598 18,225
Long-term debt and capital securities 145,813 148,588 277,584 298,268
------------------------------------------------------------------------------------------------------------
Total interest expense 425,451 473,279 852,156 979,388
------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 1,095,582 962,637 2,188,873 1,960,154
PROVISION FOR LOAN LOSSES 183,147 165,476 383,380 354,116
------------------------------------------------------------------------------------------------------------
Net interest income after provision
for loan losses 912,435 797,161 1,805,493 1,606,038
NONINTEREST INCOME
Mortgage banking revenue 476,574 247,475 870,282 442,692
Deposit service charges 142,126 125,763 276,862 244,550
Payment processing revenue 113,047 111,707 218,458 220,548
Trust and investment management fees 77,310 85,136 146,669 162,711
Card-related fees 44,036 31,873 85,117 64,009
Brokerage revenue 33,428 30,762 57,904 57,829
Other 143,634 96,575 241,154 227,813
------------------------------------------------------------------------------------------------------------
Total fees and other income 1,030,155 729,291 1,896,446 1,420,152
Securities gains, net 31,407 44,033 31,577 97,565
------------------------------------------------------------------------------------------------------------
Total noninterest income 1,061,562 773,324 1,928,023 1,517,717
NONINTEREST EXPENSE
Salaries, benefits, and other personnel 542,291 445,393 1,103,453 889,721
Equipment 62,763 61,325 127,455 123,624
Net occupancy 56,081 55,334 114,437 110,158
Third-party services 70,838 59,668 136,382 113,253
Card processing 51,194 52,112 103,520 105,928
Marketing and public relations 66,272 75,447 83,584 101,596
Other 176,798 224,643 366,272 404,531
------------------------------------------------------------------------------------------------------------
Total noninterest expense 1,026,237 973,922 2,035,103 1,848,811
------------------------------------------------------------------------------------------------------------
Income before income tax expense 947,760 596,563 1,698,413 1,274,944
Income tax expense 331,169 203,781 585,274 436,031
------------------------------------------------------------------------------------------------------------
NET INCOME $ 616,591 $ 392,782 $1,113,139 $ 838,913
============================================================================================================
NET INCOME PER COMMON SHARE
Basic $1.01 $.65 $1.82 $1.38
Diluted .99 .63 1.80 1.36
AVERAGE COMMON SHARES OUTSTANDING
Basic 612,119,565 609,336,050 611,822,337 608,579,919
Diluted 618,384,192 616,793,457 616,989,238 615,425,214
============================================================================================================
See Notes to Consolidated Financial Statements
4
CONSOLIDATED BALANCE SHEETS
-----------------------------------------------------------------------------------------------
JUNE 30 December 31 June 30
(In Thousands) 2003 2002 2002
===============================================================================================
ASSETS
Cash and demand balances due from banks $ 4,042,648 $ 3,756,426 $ 3,367,210
Federal funds sold and security resale
agreements 81,574 136,343 86,285
Securities available for sale, at fair
value 7,377,350 9,211,268 8,800,004
Other investments 842,893 869,147 728,936
Loans held for sale or securitization:
Commercial 12,591 14,840 --
Mortgage 26,833,285 24,723,549 9,826,569
-----------------------------------------------------------------------------------------------
Total loans held for sale or
securitization 26,845,876 24,738,389 9,826,569
Portfolio loans:
Commercial 24,179,811 24,722,060 25,448,978
Real estate -- commercial 9,462,072 9,384,851 7,978,960
Real estate -- residential 23,009,187 19,972,549 15,454,101
Home equity lines of credit 9,124,178 8,062,199 7,009,400
Credit card and other unsecured lines of
credit 2,124,368 2,030,024 1,870,138
Other consumer 7,939,113 7,962,729 10,912,771
-----------------------------------------------------------------------------------------------
Total portfolio loans 75,838,729 72,134,412 68,674,348
Allowance for loan losses (1,147,098) (1,098,588) (1,030,487)
-----------------------------------------------------------------------------------------------
Net portfolio loans 74,691,631 71,035,824 67,643,861
Properties and equipment 1,106,705 1,036,937 1,042,933
Other real estate owned 103,685 114,931 89,365
Mortgage servicing assets 733,420 615,193 1,068,400
Goodwill 1,102,799 1,078,281 1,078,281
Other intangible assets 74,502 74,573 80,500
Derivative assets 1,819,917 1,468,381 765,193
Accrued income and other assets 4,569,239 4,122,722 4,553,245
-----------------------------------------------------------------------------------------------
TOTAL ASSETS $123,392,239 $118,258,415 $99,130,782
===============================================================================================
LIABILITIES
Deposits:
Noninterest bearing $ 19,238,413 $ 16,156,081 $13,674,346
NOW and money market 25,415,374 23,022,449 20,239,550
Savings 2,426,424 2,477,067 2,596,261
Consumer time 13,646,875 14,686,005 15,253,091
Other 2,440,785 3,403,827 3,239,652
Foreign 3,602,917 5,373,339 2,311,938
-----------------------------------------------------------------------------------------------
Total deposits 66,770,788 65,118,768 57,314,838
Federal funds borrowed and security
repurchase agreements 12,112,317 6,528,258 5,212,463
Borrowed funds 2,667,925 11,493,909 6,659,291
Long-term debt 27,758,252 22,550,295 18,924,451
Corporation-obligated mandatorily
redeemable capital securities of
subsidiary trusts holding solely
debentures of the Corporation 180,000 180,000 180,000
Derivative liabilities 1,416,132 1,243,544 495,966
Accrued expenses and other liabilities 3,426,133 2,835,629 2,395,988
-----------------------------------------------------------------------------------------------
TOTAL LIABILITIES 114,331,547 109,950,403 91,182,997
===============================================================================================
STOCKHOLDERS' EQUITY
Preferred stock -- -- 698
Common stock 2,453,705 2,445,966 2,441,917
Capital surplus 1,057,467 989,346 964,599
Retained earnings 5,515,213 4,805,520 4,450,145
Accumulated other comprehensive income 34,307 67,180 90,426
-----------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 9,060,692 8,308,012 7,947,785
-----------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $123,392,239 $118,258,415 $99,130,782
===============================================================================================
See Notes to Consolidated Financial Statements
5
CONSOLIDATED STATEMENTS OF CASH FLOWS
---------------------------------------------------------------------------------------------------------
Six Months Ended
June 30
--------------------------------------------------------------------------------------------------------
(In Thousands) 2003 2002
--------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 1,113,139 $ 838,913
Adjustments to reconcile net income to net cash (used in) provided by
operating activities:
Provision for loan losses 383,380 354,116
Depreciation and amortization of properties and equipment 92,602 90,933
Amortization of intangible assets and mortgage servicing assets 295,945 157,002
Accretion of premiums and discounts on securities and debt (18,880) (5,591)
Mortgage servicing asset impairment charges (recoveries) (13,358) 74,247
Ineffective hedge and other derivative gains, net (620,096) (153,726)
Securities gains, net (31,577) (97,565)
Gains on loans sold or securitized, net (149,565) (355,590)
Other losses, net 119,282 79,283
Originations and purchases of loans held for sale or securitization (60,137,780) (29,079,557)
Principal payments on and proceeds from sales of loans held for sale
or securitization 56,358,981 34,251,818
Decrease in accrued interest receivable 19,536 40,315
Increase in accrued interest payable 3,409 7,457
Net change in other assets and liabilities 1,671,356 (50,647)
--------------------------------------------------------------------------------------------------------
Net cash (used in) provided by operating activities (913,626) 6,151,408
--------------------------------------------------------------------------------------------------------
LENDING AND INVESTING ACTIVITIES
Net decrease in federal funds sold, security resale agreements, and other
investments 81,023 62,180
Purchases of available-for-sale securities (1,831,232) (1,783,040)
Proceeds from sales of available-for-sale securities 1,235,013 853,413
Proceeds from maturities, calls, and prepayments of available-for-sale
securities 2,404,604 966,361
Net increase in loans (4,533,824) (1,074,131)
Proceeds from sales or securitizations of loans 846,551 1,607,403
Net increase in properties and equipment (168,527) (57,417)
Acquisitions, net of cash received (33,131) --
--------------------------------------------------------------------------------------------------------
Net cash (used in) provided by lending and investing activities (1,999,523) 574,769
--------------------------------------------------------------------------------------------------------
DEPOSIT AND FINANCING ACTIVITIES
Net increase (decrease) in deposits 1,663,477 (5,825,898)
Net increase (decrease) in federal funds borrowed and security
repurchase agreements 5,584,059 (1,380,925)
Net decrease in borrowed funds (8,825,984) (1,919,451)
Repayments of long-term debt (5,192,455) (2,059,780)
Proceeds from issuances of long-term debt, net 10,297,860 3,713,625
Dividends paid (373,012) (358,817)
Issuances of common stock 83,055 68,317
Repurchases of common stock (37,629) --
--------------------------------------------------------------------------------------------------------
Net cash provided by (used in) deposit and financing activities 3,199,371 (7,762,929)
--------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and demand balances due from banks 286,222 (1,036,752)
Cash and demand balances due from banks, January 1 3,756,426 4,403,962
--------------------------------------------------------------------------------------------------------
CASH AND DEMAND BALANCES DUE FROM BANKS, JUNE 30 $ 4,042,648 $ 3,367,21
--------------------------------------------------------------------------------------------------------
SUPPLEMENTAL INFORMATION
Cash paid for:
Interest $848,747 $971,931
Income taxes 666,283 352,369
Noncash items:
Transfers of loans to other real estate 93,296 80,407
Trade date purchase of debt securities not yet settled 12,813 --
Fair value of AMVESCAP PLC stock received in connection with the sale of
National Asset Management Corporation preferred stock -- 1,386
==========================================================================================================
See Notes to Consolidated Financial Statements
6
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
- ------------------------------------------------------------------------------------------------------------------------
Accumulated
Other
(Dollars in Thousands, Except Per Share Preferred Common Capital Retained Comprehensive
Amounts) Stock Stock Surplus Earnings Income Total
- ------------------------------------------------------------------------------------------------------------------------
Balance, January 1, 2002 $698 $2,429,419 $908,780 $3,970,049 $72,277 $7,381,223
Comprehensive income:
Net income 838,913 838,913
Other comprehensive income, net of
tax:
Change in unrealized gains and
losses on securities,
net of reclassification adjustment
for net gains
included in net income 67,530 67,530
Change in unrealized gains and
losses on derivative
instruments used in cash flow
hedging relationships,
net of reclassification
adjustment for net losses included
in net income (49,381) (49,381)
-----------
Total comprehensive income 857,062
Common dividends declared, $.59 per
share (358,797) (358,797)
Preferred dividends declared (20) (20)
Issuance of 3,124,519 common shares
under stock-based compensation plans,
including related tax effects 12,498 55,819 68,317
- ------------------------------------------------------------------------------------------------------------------------
Balance, June 30, 2002 $698 $2,441,917 $964,599 $4,450,145 $90,426 $7,947,785
========================================================================================================================
Balance, January 1, 2003 $ -- $2,445,966 $989,346 $4,805,520 $67,180 $8,308,012
Comprehensive income:
Net income 1,113,139 1,113,139
Other comprehensive income, net of
tax:
Change in unrealized gains and
losses on securities,
net of reclassification adjustment
for net gains
included in net income (40,027) (40,027)
Change in unrealized gains and
losses on derivative
instruments used in cash flow
hedging relationships,
net of reclassification adjustment
for net losses
included in net income 7,154 7,154
-----------
Total comprehensive income 1,080,266
Common dividends declared, $.61 per
share (373,012) (373,012)
Issuance of 3,316,039 common shares
under stock-based compensation plans,
including related tax effects 13,264 69,791 83,055
Repurchase of 1,381,300 common shares (5,525) (1,670) (30,434) (37,629)
- ------------------------------------------------------------------------------------------------------------------------
BALANCE, JUNE 30, 2003 $ -- $2,453,705 $1,057,467 $5,515,213 $34,307 $9,060,692
========================================================================================================================
See Notes to Consolidated Financial Statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NATURE OF OPERATIONS
National City Corporation (National City or the Corporation) is a financial
holding company headquartered in Cleveland, Ohio. National City operates through
an extensive distribution network in Ohio, Michigan, Pennsylvania, Indiana,
Kentucky, and Illinois and also conducts selected consumer lending businesses
and other financial services on a nationwide basis. Its primary businesses
include commercial and retail banking, consumer finance, asset management,
mortgage financing and servicing, and payment processing.
1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
The accompanying unaudited consolidated financial statements include the
accounts of the Corporation and its subsidiaries. All significant intercompany
transactions and balances have been eliminated. Certain prior period amounts
have been reclassified to conform with the current period presentation.
Investments in companies in which the Corporation has significant influence over
operating and financing decisions (principally defined as owning a voting or
economic interest of 20% to 50%) and limited partnership investments are
generally accounted for by the equity method of accounting. These investments
are normally included in other assets and National City's proportionate share of
income or loss is included in other noninterest income.
The Corporation, on a limited basis, uses special-purpose entities (SPEs),
primarily securitization trusts, to diversify its funding sources and to provide
financial services to its corporate customers. SPEs are not operating entities,
generally have no employees, and usually have a limited life. The basic SPE
structure involves the Corporation transferring assets to the SPE. The SPE funds
the purchase of those assets by issuing asset-backed securities to investors.
The legal documents governing the SPE describe how the cash received on the
assets held in the SPE must be allocated to the investors and other parties that
have rights to these cash flows. National City structures these SPEs to be
bankruptcy remote, thereby insulating investors from the impact of the creditors
of other entities, including the transferor of the assets.
7
Where the Corporation is a transferor of assets to an SPE, the assets sold to
the SPE are no longer recorded on the Corporation's balance sheet and the SPE is
not consolidated when the SPE is a qualifying special-purpose entity (QSPE).
Statement of Financial Accounting Standards (SFAS) No. 140, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,
provides specific criteria for determining when an SPE meets the definition of a
QSPE. In determining whether to consolidate non-qualifying SPEs where assets are
legally isolated from National City's creditors, the Corporation considers such
factors as the amount of third-party equity, the retention of risks and rewards,
and the extent of control available to third parties. The Corporation currently
services certain credit card receivables and automobile loans that were sold to
two separate securitization trusts. Both trusts meet the applicable QSPE
criteria under SFAS 140, and accordingly, are not consolidated on the
Corporation's balance sheet. Further discussion regarding these securitization
trusts is included in Note 5.
The accounting and reporting policies of National City conform with accounting
principles generally accepted in the United States. The preparation of financial
statements in conformity with generally accepted accounting principles requires
management to make estimates, assumptions, and judgments that affect the amounts
reported in the financial statements and accompanying notes. Actual realized
amounts could differ materially from those estimates. These interim financial
statements have been prepared in accordance with the instructions to Form 10-Q
and Rule 10-01 of Regulation S-X and serve to update National City's 2002 Annual
Report on Form 10-K (Form 10-K). These financial statements may not include all
information and footnotes necessary to constitute a complete set of financial
statements under generally accepted accounting principles applicable to annual
periods and accordingly should be read in conjunction with the financial
information contained in the Form 10-K. Management believes these unaudited
consolidated financial statements reflect all adjustments of a normal recurring
nature which are necessary for a fair presentation of the results for the
interim periods presented. The results of operations for the interim periods are
not necessarily indicative of the results that may be expected for the full year
or any other interim period. A summary of the Corporation's significant
accounting policies follows:
STATEMENT OF CASH FLOWS: Cash and demand balances due from banks are considered
"cash and cash equivalents" for financial reporting purposes.
BUSINESS COMBINATIONS: SFAS 141, Business Combinations, requires business
combinations initiated after June 30, 2001 to be accounted for by the purchase
method. Under the purchase method, net assets of the business acquired are
recorded at their estimated fair values as of the date of acquisition with any
excess of the cost of the acquisition over the fair value of the net tangible
and intangible assets acquired recorded as goodwill. Results of operations of
the acquired business are included in the income statement from the date of
acquisition.
Prior to SFAS 141, certain business combinations not accounted for as purchase
acquisitions were accounted for under the pooling-of-interests method, which
required the retroactive combining of the assets, liabilities, stockholders'
equity, and results of operations of the merged entity with the Corporation's
respective accounts at historical amounts. Prior period financial statements
were then restated to give effect to business combinations accounted for under
this method.
LOANS: Loans are generally reported at the principal amount outstanding, net of
unearned income. Loans held for sale or securitization are valued on an
aggregate basis at the lower of carrying amount or fair value.
Interest income is recognized on an accrual basis. Loan origination fees,
certain direct costs, and unearned discounts are deferred and amortized into
interest income as an adjustment to the yield over the term of the loan. Loan
commitment fees are generally deferred and amortized into fee income on a
straight-line basis over the commitment period. Other credit-related fees,
including letter and line of credit fees and loan syndication fees, are
recognized as fee income when earned.
Income on direct financing leases is recognized on a basis that achieves a
constant periodic rate of return on the outstanding investment. Income on
leveraged leases is recognized on a basis that achieves a constant periodic rate
of return on the outstanding investment in the lease, net of the related
deferred tax liability, in the years in which the net investment is positive.
Residual values on leased assets are reviewed regularly for other-than-temporary
impairment. When there is other-than-temporary impairment in the carrying value
of the Corporation's interest in the residual value of a leased asset, the
carrying value is reduced to the estimated fair value with the write-down
generally recognized in other noninterest expense in the income statement.
Commercial loans and leases and loans secured by real estate are designated as
nonperforming when either principal or interest payments are 90 days or more
past due (unless the loan or lease is sufficiently collateralized such that full
repayment of both principal and interest is expected and is in the process of
collection), terms are renegotiated below market levels, or when an individual
analysis of a borrower's creditworthiness indicates a credit should be placed on
nonperforming status. When a loan is placed on nonperforming status, uncollected
interest accrued in prior years is charged against the allowance for loan
losses, while uncollected interest accrued in the current year is charged
against interest income. Interest income during the period the loan is on
nonperforming status is recorded on a cash basis after recovery of principal is
reasonably assured.
8
Commercial loans and leases and commercial loans secured by real estate are
generally charged off to the extent principal and interest due exceed the net
realizable value of the collateral, with the charge-off occurring when the loss
is reasonably quantifiable but not later than when the loan becomes 180 days
past due. Loans secured by residential real estate are generally charged off to
the extent principal and interest due exceed 90% of the current appraised value
of the collateral and the loan becomes 180 days past due.
Commercial and commercial real estate loans exceeding $500,000 are evaluated for
impairment in accordance with the provisions of SFAS 114, Accounting by
Creditors for Impairment of a Loan, which requires an allowance to be
established as a component of the allowance for loan losses when it is probable
all amounts due will not be collected pursuant to the contractual terms of the
loan and the recorded investment in the loan exceeds its fair value. Fair value
is measured using either the present value of expected future cash flows
discounted at the loan's effective interest rate, the observable market price of
the loan, or the fair value of the collateral if the loan is collateral
dependent. All loans subject to evaluation and considered impaired are included
in nonperforming assets.
Consumer loans are subject to mandatory charge-off at a specified delinquency
date and are usually not classified as nonperforming prior to being charged off.
Closed-end consumer loans, which include installment and student loans and
automobile leases, are generally charged off in full no later than when the loan
becomes 120 days past due. Installment loans secured by home equity and
classified as residential real estate are also subject to this charge-off
policy. Open-end, unsecured consumer loans, such as credit card loans, are
generally charged off in full no later than when the loan becomes 150 days past
due.
ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is maintained at a
level believed adequate by management to absorb probable losses inherent in the
loan portfolio and is based on the size and current risk characteristics of the
loan portfolio, an assessment of individual problem loans and actual loss
experience, current economic events in specific industries and geographical
areas, including unemployment levels, and other pertinent factors, including
regulatory guidance and general economic conditions. Determination of the
allowance is inherently subjective as it requires significant estimates,
including the amounts and timing of expected future cash flows on impaired
loans, estimated losses on pools of homogeneous loans based on historical loss
experience, and consideration of current economic trends, all of which may be
susceptible to significant change. Loan losses are charged off against the
allowance, while recoveries of amounts previously charged off are credited to
the allowance. A provision for loan losses is charged to operations based on
management's periodic evaluation of the factors previously mentioned, as well as
other pertinent factors. Evaluations are conducted at least quarterly and more
often if deemed necessary. When loans are identified for sale or securitization,
attributed loan loss allowance is reclassified as a direct reduction to the
carrying value of the loans.
The allowance for loan losses consists of an allocated component and an
unallocated component. The components of the allowance for loan losses represent
an estimation done pursuant to either SFAS 5, Accounting for Contingencies, or
SFAS 114. The allocated component of the allowance for loan losses reflects
expected losses resulting from analyses developed through specific credit
allocations for individual loans and historical loss experience for each loan
category. The specific credit allocations are based on regular analyses of all
loans over a fixed-dollar amount where the internal credit rating is at or below
a predetermined classification. The historical loan loss element is determined
statistically using a loss migration analysis that examines loss experience and
the related internal gradings of loans charged off. The loss migration analysis
is performed quarterly and loss factors are updated regularly based on actual
experience. The allocated component of the allowance for loan losses also
includes consideration of concentrations and changes in portfolio mix and
volume.
The unallocated portion of the allowance reflects management's estimate of
probable inherent but undetected losses within the portfolio due to
uncertainties in economic conditions, delays in obtaining information, including
unfavorable information about a borrower's financial condition, the difficulty
in identifying triggering events that correlate perfectly to subsequent loss
rates, and risk factors that have not yet manifested themselves in loss
allocation factors. In addition, the unallocated allowance includes a component
that explicitly accounts for the inherent imprecision in loan loss migration
models. The Corporation has grown through acquisition, expanded the geographic
footprint in which it operates, and changed its portfolio mix in recent years.
As a result, historical loss experience data used to establish allocation
estimates may not precisely correspond to the current portfolio. Also, loss data
representing a complete economic cycle is not available for all sectors. The
uncertainty surrounding the strength and timing of economic cycles, including
management's concerns over the effects of the prolonged economic downturn in the
current cycle, also affects the allocation model's estimates of loss. The
historical losses used in the migration analysis may not be representative of
actual losses inherent in the portfolio that have not yet been realized.
OTHER REAL ESTATE OWNED: Other real estate owned (OREO) is comprised principally
of commercial and residential real estate properties obtained in partial or
total satisfaction of nonperforming loans. OREO also includes bank premises
qualifying as held for sale under SFAS 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. OREO obtained in satisfaction of a loan is
recorded at the estimated fair value less anticipated selling costs based upon
the property's appraised value at the date of transfer, with any difference
between the fair value of the property and the carrying value of the loan
charged to the allowance for loan losses. Bank premises are transferred at the
lower of carrying value or estimated fair value less anticipated selling costs.
Subsequent changes in value are reported as adjustments to the carrying amount,
not to exceed the initial carrying value of the assets at the time of transfer.
Changes in value subsequent to transfer are recorded in noninterest expense on
the income statement. Gains or losses not previously recognized resulting from
the sale of OREO are recognized in noninterest expense on the date of sale.
9
SECURITIES: Securities purchased with the intention of realizing short-term
profits are considered trading securities, carried at fair value, and included
in other investments. Realized and unrealized gains and losses are included in
securities gains or losses on the income statement. Interest on trading account
securities is recorded in interest income. As of June 30, 2003, December 31,
2002, and June 30, 2002, trading account securities totaled $26 million, $15
million, and $19 million, respectively.
Securities are classified as held to maturity when management has the positive
intent and ability to hold the securities to maturity. Securities held to
maturity, when present, are carried at amortized cost. As of June 30, 2003,
December 31, 2002, and June 30, 2002, there were no securities classified as
held to maturity.
Securities not classified as held to maturity or trading are classified as
available for sale. Securities available for sale are carried at fair value with
unrealized gains and losses reported in other comprehensive income, net of tax.
Realized gains and losses on the sale of and other-than-temporary impairment
charges on available-for-sale securities are recorded in securities gains or
losses on the income statement.
Interest and dividends on securities, including amortization of premiums and
accretion of discounts using the effective-interest method over the period to
maturity, are included in interest income. Realized gains and losses on the sale
of and other-than-temporary impairment charges on securities, except for the
Corporation's internally-managed equity portfolio comprised primarily of bank
and thrift common stock investments (bank stock fund), are determined using the
specific-identification method. On January 1, 2003, the Corporation changed to
the average-cost method to determine realized gains and losses and
other-than-temporary impairment charges on bank stock fund investments,
consistent with the manner in which the Corporation manages the investments in
this fund. Purchases and sales of securities are recognized on a trade-date
basis.
PRINCIPAL INVESTMENTS: Principal investments, which include direct investments
in private and public companies and indirect investments in private equity
funds, are carried at estimated fair value with changes in fair value recognized
in other noninterest income.
Direct investments include equity and mezzanine investments in the form of
common stock, preferred stock, limited liability company interests, warrants,
and subordinated debt. Direct mezzanine investments in the form of subordinated
debt and preferred stock, which earn interest or dividends, are included in
other investments on the balance sheet, while the remainder of the direct
investments are included in other assets. Indirect investments include ownership
interests in private equity funds managed by third-party general partners and
are included in other assets on the balance sheet.
The fair values of publicly traded investments are determined using quoted
market prices, subject to various discount factors, sales restrictions, and
regulation, when appropriate. Investments that are not publicly traded are
initially valued at cost and subsequent adjustments to fair value are estimated
in good faith by management. Factors used in determining the fair value of
direct investments include consideration of the company's business model,
current and projected financial performance, liquidity, management team, and
overall economic and market conditions. Factors used in determining the fair
value of indirect investments include evaluation of the general partner's
valuation techniques and overall economic and market conditions. The fair value
estimates of the investments are based upon currently available information and
may not necessarily represent amounts that will ultimately be realized, which
depend on future events and circumstances.
Interest and dividends on principal investments are recorded in interest income
on the statement of income. Principal investment fee income, fair value
adjustments, realized gain and losses on the return of capital, and principal
investment write-offs are recognized in other noninterest income.
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL AND SECURITIES SOLD UNDER
AGREEMENTS TO REPURCHASE: Securities purchased under agreements to resell and
securities sold under agreements to repurchase are generally accounted for as
collateralized financing transactions and are recorded at the amounts at which
the securities were acquired or sold plus accrued interest. Securities,
generally U.S. government and Federal agency securities, pledged as collateral
under these financing arrangements cannot be sold or repledged by the secured
party. The fair value of collateral either received from or provided to a third
party is continually monitored and additional collateral obtained or requested
to be returned to the Corporation as deemed appropriate.
GOODWILL AND OTHER INTANGIBLE ASSETS: Goodwill represents the excess of the cost
of an acquisition over the fair value of the net assets acquired. Other
intangible assets represent purchased assets that also lack physical substance
but can be distinguished from goodwill because of contractual or other legal
rights or because the asset is capable of being sold or exchanged either on its
own or in combination with a related contract, asset, or liability. On January
1, 2002, the Corporation adopted SFAS 142, Goodwill and Other Intangible Assets.
Under the provisions of SFAS 142, goodwill is no longer ratably amortized into
the income statement over an estimated life, but rather is tested at least
annually for impairment. Intangible assets which have finite lives continue to
be amortized over their estimated useful lives and also continue to be subject
to impairment testing. All of the Corporation's other intangible assets have
finite lives and are amortized on a straight-line basis over varying periods not
exceeding 10 years. Note 10 includes a summary of the Corporation's goodwill and
other intangible assets.
10
DEPRECIABLE ASSETS: Properties and equipment are stated at cost less accumulated
depreciation and amortization. Depreciation and amortization are calculated
using the straight-line method over the estimated useful lives of the assets.
Useful lives range from one to 10 years for furniture, fixtures, and equipment;
three to five years for software, hardware, and data handling equipment; and 10
to 40 years for buildings and building improvements. Land improvements are
amortized over a period of 15 years and leasehold improvements are amortized
over the term of the respective lease plus the first optional renewal period, if
applicable. Maintenance and repairs are charged to expense as incurred, while
improvements which extend the useful life are capitalized and depreciated over
the estimated remaining life of the asset.
Long-lived depreciable assets are evaluated periodically for impairment when
events or changes in circumstances indicate the carrying amount may not be
recoverable. Impairment exists when the expected undiscounted future cash flows
of a long-lived asset are less than its carrying value. In that event, the
Corporation recognizes a loss for the difference between the carrying amount and
the estimated fair value of the asset based on a quoted market price, if
applicable, or a discounted cash flow analysis. Impairment losses are recorded
in other noninterest expense on the income statement.
ASSET SECURITIZATIONS: National City uses the securitization of financial assets
as a source of funding. Financial assets, including pools of credit card
receivables and automobile loans, are transferred into trusts or to SPEs in
transactions which are effective under applicable banking rules and regulations
to legally isolate the assets from National City Bank (the Bank), a subsidiary
of the Corporation. Where the transferor is a depository institution such as a
bank subsidiary of the Corporation, legal isolation is accomplished through
compliance with specific rules and regulations of the relevant regulatory
authorities. In addition, National City purchases the guaranteed portion of
Small Business Administration (SBA) loans from third-party lenders and then
securitizes these loans into SBA guaranteed pooled securities through the use of
a fiscal and transfer agent approved by the SBA. The certificates are then sold
directly to institutional investors, achieving legal isolation.
SFAS 140 requires, for certain transactions completed after the initial adoption
date, a "true sale" analysis of the treatment of the transfer under state law as
if the Corporation was a debtor under the bankruptcy code. A "true sale" legal
analysis includes several legally relevant factors, such as the nature and level
of recourse to the transferor and the nature of retained servicing rights. The
analytical conclusion as to a true sale is never absolute and unconditional, but
contains qualifications based on the inherent equitable powers of a bankruptcy
court, as well as the unsettled state of the common law. Once the legal
isolation test has been met under SFAS 140, other factors concerning the nature
and extent of the transferor's control over the transferred assets are taken
into account in order to determine whether derecognition of assets is warranted,
including whether the SPE has complied with rules concerning qualifying
special-purpose entities.
A legal opinion regarding legal isolation for each credit card securitization
has been obtained by the Bank. The opinion rendered in connection with the 2002
credit card securitization included in its conclusion that the Federal Deposit
Insurance Corporation (FDIC) regulation, Treatment by the Federal Deposit
Insurance Corporation as Conservator or Receiver of Financial Assets Transferred
by an Insured Depository Institution in Connection with a Securitization or
Participation (Securitization Rule) would be applicable to the transfer of such
receivables. The Securitization Rule provides reasonable assurance that neither
the FDIC acting as conservator or receiver for the transferring bank subsidiary,
nor any other creditor of the bank, may reclaim or recover the receivables from
the securitization trust or recharacterize the receivables as property of the
transferring bank subsidiary or of the conservatorship or receivership for the
bank. The opinion further reasoned, even if the Securitization Rule did not
apply, then pursuant to various FDIC pronouncements, the FDIC would uphold the
effectiveness of the security interest granted in the financial assets. A legal
opinion was obtained for the first step in the automobile loan securitization
transaction in 2002, which was structured as a two-step securitization. While
noting the transaction fell within the meaning of a "securitization" under the
Securitization Rule, in accordance with accounting guidance, an analysis was
also rendered under state law as if the transferring Bank was a debtor under the
bankruptcy code. The "true sale" opinion provides reasonable assurance the
purchased assets would not be characterized as the property of the transferring
Bank's receivership or conservatorship estate in the event of insolvency and
also states the transferor would not be required to substantively consolidate
the assets and liabilities of the purchaser SPE with those of the transferor
upon such event. The process of securitizing SBA loans into pools of SBA
certificates is prescribed by the SBA and must be followed to obtain the SBA
guarantee. This process has been developed to meet the requirements for sale
treatment under SFAS 140.
In a securitization, the trust issues beneficial interests in the form of senior
and subordinated asset-backed securities backed or collateralized by the assets
sold to the trust. The senior classes of the asset-backed securities typically
receive investment grade credit ratings at the time of issuance. These ratings
are generally achieved through the creation of lower-rated subordinated classes
of asset-backed securities, as well as subordinated interests retained by an
affiliate of the Corporation. In all cases, the Corporation or its affiliate
retains interests in the securitized assets, which may take the form of seller
certificates, subordinated tranches, cash reserve balances, servicing assets,
and interest-only strips representing the cash flows generated by the assets in
excess of the contractual cash flows required to be paid to the investors and
for other obligations such as servicing fees.
An SBA approved fiscal and transfer agent associated with the SBA
securitizations issues certificates once all the necessary documents to support
the transaction have been provided. The Corporation retains beneficial interests
in the securitized assets in the form of interest-only strips. The SBA
guarantees the credit risk with respect to the loans sold.
11
In accordance with SFAS 140, securitized loans are removed from the balance
sheet and a net gain or loss is recognized in income at the time of initial sale
and each subsequent sale when the combined net sales proceeds and, if
applicable, retained interests differ from the loans' allocated carrying amount.
Net gains or losses resulting from securitizations are recorded in noninterest
income.
Retained interests in the subordinated tranches and interest-only strips are
recorded at their fair value and included in the available-for-sale or trading
securities portfolio. The Corporation's retained interests in the credit card
and automobile loan securitizations are classified as available-for-sale
securities. The retained interests in the SBA securitizations are classified as
trading securities and are included in other investments on the consolidated
balance sheet. Subsequent adjustments to the fair value of retained interests
classified as available-for-sale are recorded through other comprehensive income
within stockholders' equity or in other noninterest expense in the income
statement if the fair value has declined below the carrying amount and such
decline has been determined to be other-than-temporary. Fair value adjustments
and other-than-temporary adjustments to retained interests classified as trading
securities are recorded in other noninterest expense on the income statement.
The Corporation uses assumptions and estimates in determining the fair value
allocated to the retained interests at the time of sale and each subsequent sale
in accordance with SFAS 140. These assumptions and estimates include projections
concerning rates charged to customers, the expected life of the receivables,
credit loss experience, loan repayment rates, the cost of funds, and discount
rates commensurate with the risks involved.
On a quarterly basis, management reviews the historical performance of each
retained interest and the assumptions used to project future cash flows. If past
performance and future expectations dictate, assumptions are revised and the
present value of future cash flows is recalculated. Refer to Note 5 for further
analysis of the assumptions used in the determination of fair value.
When the Corporation retains the right to service the loans and receives related
fees that exceed the current market rate to service the receivables, a servicing
asset is recorded and included in other assets on the balance sheet. A servicing
asset is not recognized if the Corporation receives adequate compensation
relative to current market servicing prices to service the receivables sold.
Servicing assets created in a securitization are initially measured at their
allocated carrying amount based upon relative fair values at the date of
securitization and are subsequently carried at the lower of this initial
carrying value, adjusted for amortization, or fair value. Impairment, if any, is
recognized when and in the amount the carrying value exceeds its fair value as
determined by calculating the present value of the expected future net servicing
cash flows using the assumptions described previously. The amortization of
servicing assets occurs in proportion to, and over the period of, the estimated
net servicing income and is recorded in noninterest income on the income
statement.
For securitizations involving credit card receivables, the Corporation's
continuing involvement in the securitized assets includes maintaining an
undivided, pro rata interest in all credit card loan receivables that are in the
trust, referred to as seller's interest. The seller's interest ranks pari-passu
with the investors' interests in the trust. As the amount of the loans in the
securitized pool fluctuates due to customer payments, purchases, cash advances,
and credit losses, the carrying amount of the seller's interest will vary.
However, the Corporation is required to maintain its seller's interest at a
minimum level of 4% of the initial invested amount in each series to ensure
receivables are available for allocation to the investors' interests.
Also with regard to credit card securitizations, the trust is not required to
make principal payments to the investors during the revolving period, which
generally approximates 48 months. Instead, the trust uses principal payments
received on the accounts to purchase new loan receivables. Therefore, the
principal dollar amount of the investor's interest in the loans within the trust
remains unchanged. Once the revolving period ends, the trust distributes
principal payments to the investors according to the terms of the transaction.
Distribution of principal to the investors in the credit card trust may begin
earlier if the average annualized yield on the loans securitized (generally
equal to the sum of interest income, interchange and other fees, less principal
credit losses during the period) for three consecutive months drops below a
minimum yield (generally equal to the sum of the coupon rate payable to
investors plus contractual servicing fees), or certain other events occur.
The retained interests represent National City's maximum loss exposure with
respect to securitization vehicles. The investors in the asset-backed securities
issued by the SPEs have no further recourse against the Corporation if cash
flows generated by the securitized assets are inadequate to service the
obligations of the SPEs.
Transaction costs associated with revolving loan securitizations are deferred at
the time of sale and amortized over the revolving term of the securitization,
while transaction costs associated with fixed-term loan securitizations are
recognized as a component of the gain or loss at the time of sale.
DERIVATIVE INSTRUMENTS: The Corporation enters into derivative transactions
principally to protect against the risk of adverse price or interest rate
movements on the value of certain assets and liabilities and on future cash
flows. The Corporation is also required to recognize certain contracts and
commitments as derivatives when the characteristics of those contracts and
commitments meet the definition of a derivative.
12
Under the guidelines of SFAS 133, Accounting for Derivative Instruments and
Hedging Activities, as amended, all derivative instruments are required to be
carried at fair value on the balance sheet. SFAS 133 provides special hedge
accounting provisions, which permit the change in the fair value of the hedged
item related to the risk being hedged to be recognized in earnings in the same
period and in the same income statement line as the change in the fair value of
the derivative.
Derivative instruments designated in a hedge relationship to mitigate exposure
to changes in the fair value of an asset, liability, or firm commitment
attributable to a particular risk, such as interest rate risk, are considered
fair value hedges under SFAS 133. Derivative instruments designated in a hedge
relationship to mitigate exposure to variability in expected future cash flows,
or other types of forecasted transactions, are considered cash flow hedges. The
Corporation formally documents all relationships between hedging instruments and
hedged items, as well as its risk-management objective and strategy for
undertaking each hedge transaction.
Fair value hedges are accounted for by recording the fair value of the
derivative instrument and the fair value related to the risk being hedged of the
hedged asset or liability on the balance sheet with corresponding offsets
recorded in the income statement. The adjustment to the hedged asset or
liability is included in the basis of the hedged item, while the fair value of
the derivative is recorded as a freestanding asset or liability. Actual cash
receipts or payments and related amounts accrued during the period on
derivatives included in a fair value hedge relationship are recorded as
adjustments to the income or expense recorded on the hedged asset or liability.
Cash flow hedges are accounted for by recording the fair value of the derivative
instrument on the balance sheet as either a freestanding asset or liability,
with a corresponding offset recorded in other comprehensive income within
stockholders' equity, net of tax. Amounts are reclassified from other
comprehensive income to the income statement in the period or periods the hedged
forecasted transaction affects earnings.
Under both the fair value and cash flow hedge methods, derivative gains and
losses not effective in hedging the change in fair value or expected cash flows
of the hedged item are recognized immediately in the income statement. At the
hedge's inception and at least quarterly thereafter, a formal assessment is
performed to determine whether changes in the fair values or cash flows of the
derivative instruments have been highly effective in offsetting changes in the
fair values or cash flows of the hedged items and whether they are expected to
be highly effective in the future. If it is determined a derivative instrument
has not been or will not continue to be highly effective as a hedge, hedge
accounting is discontinued prospectively. SFAS 133 basis adjustments recorded on
hedged assets and liabilities are amortized over the remaining life of the
hedged item beginning no later than when hedge accounting ceases.
MORTGAGE SERVICING ASSETS: The Corporation sells mortgage loans in the secondary
market and typically retains the right to service the loans sold. Upon sale, a
mortgage servicing asset is established, which represents the then current fair
value of future net cash flows expected to be realized for performing the
servicing activities. Mortgage servicing assets, when purchased, are initially
recorded at cost. Mortgage servicing assets are carried at the lower of the
initial capitalized amount, net of accumulated amortization and hedge accounting
adjustments, or fair value. Certain mortgage servicing assets hedged with
derivative instruments as part of SFAS 133 hedge relationships may be adjusted
above their initial carrying value. Changes in fair value resulting from the
application of hedge accounting become part of the carrying values of mortgage
servicing assets.
The carrying values of mortgage servicing assets (initial capitalized amount,
net of accumulated amortization and hedge accounting adjustments) are amortized
in proportion to, and over the period of, estimated net servicing income.
Mortgage servicing assets are evaluated for impairment in accordance with SFAS
140. For purposes of determining impairment, the mortgage servicing assets are
stratified by certain risk characteristics, primarily loan type and note rate.
If temporary impairment exists within a risk stratification tranche, a valuation
allowance is established through a charge to income equal to the amount by which
the carrying value, including hedge accounting adjustments, exceeds the fair
value. If it is later determined all or a portion of the temporary impairment no
longer exists for a particular tranche, the valuation allowance is reduced
through a recovery of income.
Mortgage servicing assets are also reviewed for other-than-temporary impairment.
Other-than-temporary impairment exists when the recoverability of a recorded
valuation allowance is determined to be remote taking into consideration
historical and projected interest rates and loan pay-off activity. When this
situation occurs, the unrecoverable portion of the valuation allowance is
applied as a direct write-down to the carrying value of the mortgage servicing
asset. Unlike a valuation allowance, a direct write-down permanently reduces the
carrying value of the mortgage servicing asset and the valuation allowance,
precluding subsequent recoveries.
The fair value of mortgage servicing assets is estimated by calculating the
present value of estimated future net servicing cash flows, taking into
consideration actual and expected mortgage loan prepayment rates, discount
rates, servicing costs, and other economic factors, which are determined based
on current market conditions. The expected and actual rates of mortgage loan
prepayments are the most significant factors driving the value of mortgage
servicing assets. Increases in mortgage loan prepayments reduce estimated future
net servicing cash flows because the life of the underlying loan is reduced. In
determining the fair value of the mortgage servicing assets, mortgage interest
rates, which are used to determine prepayment rates, and discount rates are held
constant over the estimated life of the portfolio. Expected mortgage loan
prepayment rates are derived from a third-party model and adjusted to reflect
National City's actual prepayment experience.
13
Servicing fees, net of amortization, impairment, and related derivative gains
and losses are recorded in mortgage banking revenue on the income statement.
STOCK-BASED COMPENSATION: Effective January 1, 2003, the Corporation adopted the
fair value method of recording stock awards under SFAS 123, Accounting for
Stock-Based Compensation. Under the guidance of SFAS 148, Accounting for
Stock-Based Compensation - Transition and Disclosure, the Corporation began
applying the recognition provisions of SFAS 123 to all awards granted to
employees after January 1, 2003. Compensation expense for option awards granted
in 2003 will be determined based on the estimated fair value of the award at the
date of grant and recognized ratably in the income statement over the option's
vesting period. Stock options granted prior to January 1, 2003, will continue to
be accounted for under the recognition and measurement provisions of Accounting
Principles Board (APB) Opinion 25, Accounting for Stock Issued to Employees.
Under APB 25, compensation expense for employee stock options is generally not
recognized if the exercise price of the option equals or exceeds the market
price of the stock on the date of grant. Therefore, the cost related to
stock-based employee compensation included in the determination of net income
for 2003 is less than that which would have been recognized if the fair value
method had been applied to all unvested stock awards. The remaining outstanding
options accounted for under APB 25 vest through 2005. Compensation expense for
restricted share awards is ratably recognized over the period of service,
usually the restricted period, based upon the fair value of the stock on the
date of grant. The adoption of the recognition provisions of SFAS 123 did not
have a significant impact on the determination of compensation expense for
restricted share awards.
The following table illustrates the effect on net income and earnings per share
if the Corporation had applied the fair value recognition provisions of SFAS 123
to all stock option awards. Also included in the pro forma net income and
earnings per share is the after-tax expense, net of minority interest benefit,
related to option awards granted by the Corporation's 85%-owned payment
processing subsidiary, National Processing, Inc., on its common stock.
----------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30 June 30
----------------------------------------------------------------------------------------
(In Thousands, Except Per Share 2003 2002 2003 2002
Amounts)
----------------------------------------------------------------------------------------
Net income, as reported $616,591 $ 392,782 $1,113,139 $838,913
Add: option expense included in
reported net income, net of related
tax effects
National City common stock 1,980 -- 2,297 --
National Processing common stock 4 -- 4 --
Less: total option expense determined
under fair value method for all option
awards, net of related tax effects
National City common stock (12,527) (10,595) (23,701) (20,750)
National Processing common stock (1,525) (1,613) (3,199) (2,879)
----------------------------------------------------------------------------------------
Pro forma net income $604,523 $ 380,574 $1,088,540 $815,284
----------------------------------------------------------------------------------------
Pro forma net income per share:
Basic -- as reported $1.01 $.65 $1.82 $1.38
Basic -- pro forma .99 .62 1.78 1.34
Diluted -- as reported .99 .63 1.80 1.36
Diluted -- pro forma .98 .62 1.76 1.32
========================================================================================
The fair value of stock options granted were estimated at the date of grant
using the Black-Scholes option pricing model. The Black-Scholes option pricing
model was originally developed for use in estimating the fair value of traded
options, which have different characteristics from the Corporation's employee
stock options. The model is also sensitive to changes in assumptions, which can
materially affect the fair value estimate. The following weighted-average
assumptions were used to determine the fair value of options granted on National
City common stock:
----------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30 June 30
----------------------------------------------------------------------------------------
2003 2002 2003 2002
----------------------------------------------------------------------------------------
Risk-free interest rate 3.0% 3.9% 3.1% 3.9%
Expected dividend yield 4.5 4.2 4.5 4.2
Expected volatility 27.3 25.9 27.3 25.9
Expected option life (in years) 5 5 5 5
Weighted-average grant-date fair value of
options $5.53 $5.74 $5.39 $5.67
========================================================================================
The weighted-average assumptions used to value the National Processing option
grants are disclosed in National Processing, Inc.'s Quarterly Report on Form
10-Q for the quarter ended June 30, 2003, as filed with the United States
Securities and Exchange Commission (SEC) and is accessible at www.sec.gov.
14
ADVERTISING COSTS: Advertising costs are generally expensed as incurred.
INCOME TAXES: The Corporation and its subsidiaries file a consolidated Federal
income tax return. The provision for income taxes is based upon income in the
financial statements, rather than amounts reported on the Corporation's income
tax return.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized as income or
expense in the period that includes the enactment date.
STOCK REPURCHASES: Acquisitions of the Corporation's common stock are recorded
using the par value method, which requires the cash paid to be allocated to
common stock, capital surplus, and retained earnings.
2. RECENT ACCOUNTING PRONOUNCEMENTS
ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH
LIABILITIES AND EQUITY: In May 2003, the Financial Accounting Standards Board
(FASB) issued SFAS 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity. This statement establishes
standards for classifying and measuring certain financial instruments that
embody obligations of the issuer and have characteristics of both liabilities
and equity. The provisions of SFAS 150 became effective for the Corporation on
June 1, 2003 for any new qualifying financial instruments that were subsequently
entered into or modified. The provisions of SFAS 150 for all other qualifying
instruments within its scope are effective as of July 1, 2003. The adoption of
this standard did not have a material impact on the Corporation's results of
operations, financial position, or liquidity.
AMENDMENT OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES: In
April 2003, the FASB issued SFAS 149, Amendment of Statement 133 on Derivative
Instruments and Hedging Activities, which amends and clarifies financial
accounting and reporting for derivative instruments and hedging activities under
SFAS 133, as well as amends certain other existing FASB pronouncements. In
general, SFAS 149 is effective for derivative transactions entered into or
modified and for hedging relationships designated after June 30, 2003. The
adoption of this standard did not have a material impact on the Corporation's
results of operations, financial position, or liquidity.
CONSOLIDATION OF VARIABLE INTEREST ENTITIES: In January 2003, the FASB issued
Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities. FIN
46 provides guidance on how to identify a variable interest entity (VIE) and
determine when the assets, liabilities, noncontrolling interests, and results of
operations of a VIE are to be included in an entity's consolidated financial
statements. A VIE exists when either the total equity investment at risk is not
sufficient to permit the entity to finance its activities by itself, or the
equity investors lack one of three characteristics associated with owning a
controlling financial interest. Those characteristics include the direct or
indirect ability to make decisions about an entity's activities through voting
rights or similar rights, the obligation to absorb the expected losses of an
entity if they occur, and the right to receive the expected residual returns of
the entity if they occur.
The Corporation holds various investments and is involved with various entities
that, for purposes of FIN 46, are evaluated to determine whether consolidation
or further disclosure as a significant interest holder is required. Such
interests subject to evaluation include, but are not limited to, low-income
housing, trust preferred securities, small business commercial real estate,
historic tax credit projects, principal investments, leveraged leases, and
strategic investment funds.
FIN 46 was effective immediately for new entities created or acquired after
February 1, 2003, and became effective on July 1, 2003, for entities in which
the Corporation held a variable interest prior to February 1, 2003. There was no
material impact to the Corporation's financial condition or results of
operations as of and for the quarter ended June 30, 2003 as a result of applying
the provisions of FIN 46 to new entities created or acquired after February 1,
2003. Management continues to evaluate various interests acquired prior to
February 1, 2003 to assess whether consolidation or further disclosure of a VIE
is required under FIN 46.
GUARANTEES: In November 2002, the FASB issued Interpretation No. 45 (FIN 45),
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. This interpretation expands the
disclosures to be made by a guarantor about its obligations under certain
guarantees and requires the guarantor to recognize a liability for the
obligation assumed under a guarantee. In general, FIN 45 applies to contracts or
indemnification agreements that contingently require the guarantor to make
payments to the guaranteed party based on changes in an underlying that is
related to an asset, liability, or equity security of the guaranteed party.
Certain guarantee contracts are excluded from both the disclosure and
recognition requirements of this interpretation, while other guarantees are
subject to just the disclosure requirements of FIN 45 but not to the recognition
provisions. The disclosure requirements of FIN 45 were effective for the
Corporation as of December 31, 2002, and require disclosure of the nature of the
guarantee, the maximum potential amount of future payments the guarantor could
be required to make under the guarantee, and the current amount of the
liability, if any, for the guarantor's obligations under the guarantee. The
recognition requirements of FIN 45 are applied prospectively to guarantees
issued or modified after December 31, 2002. Significant
15
guarantees that have been entered into by the Corporation are disclosed in Note
19. The implementation of the accounting requirements of FIN 45 did not have a
material impact on the Corporation's results of operations, financial position,
or liquidity.
ACCOUNTING FOR STOCK-BASED COMPENSATION: In December 2002, the FASB issued SFAS
148, Accounting for Stock-Based Compensation -- Transition and Disclosure, which
provides guidance to transition from the intrinsic value method of accounting
for stock-based employee compensation under APB 25 to SFAS 123's fair value
method of accounting, if a company so elects.
Effective January 1, 2003, the Corporation adopted the fair value method of
recording stock awards under SFAS 123. Refer to Notes 1 and 20 for further
discussion on the Corporation's adoption of SFAS 148. National City estimates
the income statement impact associated with expensing stock-based compensation,
including stock options and restricted stock grants, will be approximately $32
million pretax and $23 million, or $.04 per diluted share, after tax, in 2003.
As the cost of anticipated future awards is phased in through 2007, the annual
impact will rise to approximately $.12 per diluted share, assuming options and
restricted stock are granted in future years at a similar level and under
similar market conditions to 2003. The actual impact per diluted share may vary
in the event the fair value or the number of options and shares granted
increases or decreases from the current estimate, or if the current accounting
guidance changes.
ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES: SFAS 146,
Accounting for Costs Associated with Exit or Disposal Activities, was issued in
July 2002 and was adopted by the Corporation on January 1, 2003. This statement
requires a cost associated with an exit or disposal activity, such as the sale
or termination of a line of business, the closure of business activities in a
particular location, or a change in management structure, to be recorded as a
liability at fair value when it becomes probable the cost will be incurred and
no future economic benefit will be gained by the company for such cost.
Applicable costs include employee termination benefits, contract termination
costs, and costs to consolidate facilities or relocate employees. SFAS 146
supersedes EITF Issue No. 94-3, Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity, which in some cases
required certain costs to be recognized before a liability was actually
incurred. The adoption of this standard did not have a material impact on the
Corporation's results of operations, financial position, or liquidity.
ASSET RETIREMENT OBLIGATIONS: In August 2001, the FASB issued SFAS 143,
Accounting for Asset Retirement Obligations. SFAS 143 requires an entity to
record a liability for an obligation associated with the retirement of an asset
at the time the liability is incurred by capitalizing the cost as part of the
carrying value of the related asset and depreciating it over the remaining
useful life of that asset. The standard became effective for the Corporation on
January 1, 2003 and its adoption did not have a material impact on the
Corporation's results of operations, financial position, or liquidity.
3. NON-GAAP FINANCIAL MEASURES
In January 2003, the SEC issued Regulation G, Conditions for Use of Non-GAAP
Financial Measures. A non-GAAP financial measure is a numerical measure of a
company's historical or future performance, financial position, or cash flow
that excludes (includes) amounts or adjustments that are included (excluded) in
the most directly comparable measure calculated in accordance with generally
accepted accounting principles (GAAP). Regulation G requires companies that
present non-GAAP financial measures to disclose a numerical reconciliation to
the most directly comparable measurement using GAAP. Management does not believe
it has used any non-GAAP financial measure in this Quarterly Report on Form
10-Q.
4. RESTRUCTURING CHARGES
In January 2003, the Corporation implemented various cost-reduction initiatives
focused on improving the long-term profitability of National City. In connection
with the cost-reduction initiatives, severance and related charges totaling $71
million were recorded in the first quarter of 2003. Of this amount, $67 million
was recorded to salaries, benefits, and other personnel expense on the income
statement and was associated with a voluntary retirement program and position
eliminations made across the Corporation's lines of business. The remaining $4
million was recorded to third-party services expense and was incurred for
outplacement services offered to employees whose positions were eliminated. A
liability for these severance and related charges was accrued during the first
quarter of 2003. A rollforward of the liability for severance and related
expenses is presented in the table below. Also included in the rollforward is
the accrued liability for severance expenses incurred in the normal course of
business.
- -------------------------------------------------------------------------
Three Months Six Months
Ended Ended
(In Thousands) June 30, 2003 June 30, 2003
- -------------------------------------------------------------------------
Beginning balance $ 72,469 $ 17,036
Severance and related charges and
adjustments (103) 71,034
Payments (45,507) (61,211)
- -------------------------------------------------------------------------
ENDING BALANCE $ 26,859 $ 26,859
=========================================================================
16
5. SECURITIZATION ACTIVITY
The Corporation periodically sells assets through securitization transactions.
During the first quarter of 2003, the Corporation sold four pools of SBA loans,
which were securitized, totaling $44 million and recognized a pretax loss of
$215 thousand, which was recorded in other noninterest income. Retained
interests in the form of interest-only strips were recognized with an initial
carrying value of approximately $4 million. The SBA loans securitized were sold
servicing released and transaction costs were expensed in conjunction with the
sale. No pools of SBA loans were sold during the second quarter of 2003.
On January 31, 2002, National City sold $425 million of credit card receivables
to the National City Credit Card Master Trust (trust) and recognized a pretax
gain of $25 million, which was recorded in other noninterest income. Retained
interests in the form of interest-only strips and subordinated tranches were
also recognized with initial carrying values of $5 million and $27 million,
respectively. Transaction costs of $2 million incurred in connection with the
securitization were deferred and are being amortized over the revolving term of
the securitization. The transaction costs deferred consisted primarily of
securities underwriting, filing, and professional services fees.
During 2001 and 2000, the Corporation sold $425 million and $600 million of
credit card receivables to the trust.
The Corporation established an automobile receivables trust into which it sold,
through securitization on March 27, 2002, $1.1 billion of fixed-rate, closed-end
automobile loans. A pretax gain of $25 million on this term securitization was
recorded in other noninterest income. Retained interests in the form of
interest-only strips, subordinated tranches, and dealer rebate receivables were
also recognized with initial carrying values of $41 million, $62 million, and $2
million, respectively. In addition, a servicing asset was established in the
amount of $17 million.
A summary of the components of managed loans, which represents both owned and
securitized loans, along with quantitative information about delinquencies and
net credit losses follows. The automobile loans presented represent the managed
portfolio of indirect prime automobile loans. The SBA loans represent
securitized loans originally purchased and then sold by the Corporation.
- --------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED SIX MONTHS ENDED
AS OF JUNE 30, 2003 JUNE 30, 2003 JUNE 30, 2003
----------------------------------------------------------------------------
Loans Past
Due
Principal 30 days or Average Net Credit Average Net Credit
(In Millions) Balance more Balances Losses Balances Losses
- --------------------------------------------------------------------------------------------------------
Type of loan:
Credit card $2,438.3 $95.1 $2,408.0 $36.7 $2,395.2 $64.4
Automobile 4,461.9 64.1 4,425.0 9.8 4,397.0 23.0
SBA 38.9 6.0 39.1 -- 32.5 --
- --------------------------------------------------------------------------------------------------------
Total loans managed or
securitized 6,939.1 165.2 6,872.1 46.5 6,824.7 87.4
Less:
Loans securitized:
Credit card 1,450.0 51.9 1,450.0 20.8 1,450.0 36.2
Automobile 653.7 9.2 698.2 2.3 744.3 5.0
SBA 38.9 6.0 39.1 -- 32.5 --
Loans held for
securitization:
Credit card -- -- -- -- -- --
Automobile -- -- -- -- -- --
SBA -- -- -- -- -- --
- --------------------------------------------------------------------------------------------------------
LOANS HELD IN PORTFOLIO $4,796.5 $98.1 $4,684.8 $23.4 $4,597.9 $46.2
========================================================================================================
17
- -------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
As of June 30, 2002 June 30, 2002 June 30, 2002
---------------------------------------------------------------------
Loans Past
Due
Principal 30 days or Average Net Credit Average Net Credit
(In Millions) Balance more Balances Losses Balances Losses
- -------------------------------------------------------------------------------------------------
Type of loan:
Credit card $2,268.6 $78.4 $2,216.6 $29.3 $2,214.2 61.0
Automobile 4,322.2 65.4 4,316.8 8.0 4,351.8 22.5
SBA -- -- -- -- -- --
- -------------------------------------------------------------------------------------------------
Total loans managed or
securitized 6,590.8 143.8 6,533.4 37.3 6,566.0 83.5
Less:
Loans securitized:
Credit card 1,450.0 44.8 1,450.0 18.3 1,379.6 36.1
Automobile 1,016.2 6.5 1,059.5 .1 551.1 .1
SBA -- -- -- -- -- --
Loans held for
securitization:
Credit card -- -- -- -- 70.4 --
Automobile -- -- -- -- 500.8 --
SBA -- -- -- -- -- --
- -------------------------------------------------------------------------------------------------
LOANS HELD IN PORTFOLIO $4,124.6 $92.5 $4,023.9 $18.9 $4,064.1 $47.3
=================================================================================================
The Corporation's on-balance-sheet credit card receivables are expected to
increase following the revolving period of the securitization, which generally
approximates 48 months.
Certain cash flows received from the structured entities associated with the
loan sales described above follow:
- ------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2003 JUNE 30, 2003
------------------------------------------------------------------
Credit Card Automobile SBA Credit Card Automobile SBA
- ------------------------------------------------------------------------------------------------------------
(In Millions)
- ------------------------------------------------------------------------------------------------------------
Proceeds from new securitizations $ -- $ -- $ -- $ -- $ -- $40.3
Proceeds from collections reinvested in
previous securitizations 760.0 -- -- 1,518.4 -- --
Servicing fees received 7.3 1.8 -- 14.6 3.8 --
Other cash flows received on retained
interest 19.7 3.9 .2 44.0 9.3 .3
Proceeds from sales of previously
charged-off accounts .3 -- -- .7 -- --
Purchases of delinquent or foreclosed
assets -- -- -- -- -- --
Repayments of servicing advances -- -- -- -- -- --
============================================================================================================
Three Months Ended Six Months Ended
June 30, 2002 June 30, 2002
------------------------------------------------------------------
Credit Card Automobile Credit Card Automobile
- ------------------------------------------------------------------------------------------------------------
(In Millions)
- ------------------------------------------------------------------------------------------------------------
Proceeds from new securitizations $ -- $ -- $ 397.4 $1,041.0
Proceeds from collections reinvested in
previous securitizations 759.7 -- 1,461.4 --
Servicing fees received 7.3 3.2 14.6 3.2
Other cash flows received on retained
interest 23.3 1.7 46.2 1.7
Proceeds from sales of previously
charged-of accounts .5 -- 1.0 --
Purchases of delinquent or foreclosed
assets -- -- -- --
Repayments of servicing advances -- -- -- --
- ------------------------------------------------------------------------------------------------------------
A summary of the fair values of the interest-only strips and servicing assets
retained, key economic assumptions used to arrive at the fair values, and the
sensitivity of the June 30, 2003 fair values to immediate 10% and 20% adverse
changes in those assumptions follows. The sensitivities are hypothetical.
Changes in fair value based on a 10% variation in assumptions generally cannot
be extrapolated because the relationship of the change in the assumption to the
change in fair value may not be linear. Also, the effect of a variation in a
particular assumption on the fair value of the retained interests is calculated
without changing any other assumption; in reality, changes in one factor may
result in changes in another (for example, increases in market interest rates
may result in lower prepayments and increased credit losses), which might
magnify or counteract the sensitivities.
18
- -------------------------------------------------------------------------------------------------------------
Weighted-
average Variable Monthly Expected
Life Annual Coupon Principal Annual Annual
Fair (in Rate To Repayment Credit Discount
(Dollars in Millions) Value months)(b) Investors(b) Rate(b) Losses(b) Rate(b) Yield(b)
- -------------------------------------------------------------------------------------------------------------
CREDIT CARD LOANS
Interest-only strips(a)
AS OF JUNE 30, 2003 $6.9 3.3 1.34% 17.47% 5.83% 15.00% 10.60%
Decline in fair value of 10%
adverse Change $.4 $.5 $2.3 -- $4.1
Decline in fair value of 20%
adverse Change .9 .9 4.6 -- 6.9
=============================================================================================================
(a) Represents interest-only strips recognized in connection with the credit
card securitization series 2000-1, 2001-1 and 2002-1
(b) Represents weighted-average assumptions and aggregate declines in fair
value for all credit card securitization series
- -------------------------------------------------------------------------------------------------------------
Weighted- Monthly Expected
average Prepayment Cumulative Annual Weighted-
Fair Life Speed Credit Discount average
(Dollars in Millions) Value (in months) (% ABS)(a) Losses(c) Rate Coupon
- -------------------------------------------------------------------------------------------------------------
AUTOMOBILE LOANS
SERIES 2002-A
Interest-only strip
AS OF JUNE 30, 2003 $19.3 16.3 1.40% 2.16% 12.00% 8.71%
Decline in fair value of
10% adverse Change $1.2 $2.2 $.4 $6.8
Decline in fair value of
20% adverse Change 2.2 4.1 .8 13.3
Servicing asset
AS OF JUNE 30, 2003(b) $7.2 12.2 1.40% 2.16% 12.00% 8.71%
Decline in fair value of
10% adverse Change $.4 -- $.1 --
Decline in fair value of
20% adverse Change .8 -- .2 $.1
=============================================================================================================
(a) Absolute prepayment speed
(b) Carrying value of servicing asset at June 30, 2003 was $7.2 million
(c) The expected static pool loss assumption performed consistent with the
expected cumulative credit loss assumptions
- -------------------------------------------------------------------------------------------------------------
Weighted-
average
Life Constant Annual Weighted-
Fair (in Prepayment Discount average
(Dollars in Millions) Value months)(a) Rate(a) Rate(a) Spread(a)
- -------------------------------------------------------------------------------------------------------------
SBA LOANS
Interest-only strips
AS OF JUNE 30, 2003 $3.5 53.0 16.13% 10.00% 2.82%
Decline in fair value of 10% adverse
change $.1 $.1 $.4
Decline in fair value of 20% adverse
change $.2 $.2 .7
=============================================================================================================
(a) Represents weighted-average assumptions and aggregate declines in fair
value for all securitized pools
6. ASSET-BACKED COMMERCIAL PAPER CONDUIT
During 2002, the Corporation served as the administrative agent and investment
advisor to a commercial paper conduit (North Coast Funding, LLC) that purchased
high-grade assets from the Corporation and certain corporate customers and then
issued high-grade commercial paper to third-party investors collateralized by
such assets. The conduit was established in 2000, and at that time, was
considered an unconsolidated qualified special-purpose entity under the
guidelines of SFAS 140.
19
Effective September 29, 2002, the asset sale agreement between North Coast
Funding, LLC and National City SPC, Inc. was amended to grant the conduit the
right to sell assets at its sole discretion. All parties to the conduit and the
rating agencies were informed of the intent to amend the agreement and the
independent third-party owner of the conduit approved the amendment. The nature
of the amendment caused the conduit to lose its status as a qualifying
special-purpose entity. As a result, under applicable accounting guidance, the
assets and liabilities and results of operations of the conduit were
consolidated in the financial statements of the Corporation. During the fourth
quarter of 2002, the remaining commercial paper borrowings held by third-party
investors matured and the conduit was legally dissolved.
7. LOANS AND ALLOWANCE FOR LOAN LOSSES
Total loans outstanding, net of unearned income including deferred loan fees and
costs, were $291 million, $390 million, and $477 million at June 30, 2003,
December 31, 2002, and June 30, 2002, respectively.
The loan portfolio includes lease financing receivables consisting of direct
financing and leveraged leases on equipment, which are included in commercial
loans on the consolidated balance sheet, and retail automobile lease financings,
which are included in other consumer loans on the consolidated balance sheet.
The direct financing and leveraged leased equipment consists primarily of
manufacturing and mining equipment, commercial trucks and trailers, railroad
equipment, and airplanes. The Corporation ceased originating retail automobile
leases in December 2000 and the portfolio is running off over time. A summary of
lease financings by type at June 30 follows:
- ------------------------------------------------------------------------------------------
(In Thousands) 2003 2002
- ------------------------------------------------------------------------------------------
COMMERCIAL
Direct financings $1,228,698 $1,530,017
Leveraged leases 304,796 317,908
- ------------------------------------------------------------------------------------------
TOTAL COMMERCIAL LEASE FINANCINGS 1,533,494 1,847,925
CONSUMER
Retail automobile lease financings 327,312 870,319
- ------------------------------------------------------------------------------------------
TOTAL NET INVESTMENT IN LEASE FINANCINGS $1,860,806 $2,718,244
==========================================================================================
The components of the net investment in lease financings at June 30 follow:
- ------------------------------------------------------------------------------------------
(In Thousands) 2003 2002
- ------------------------------------------------------------------------------------------
COMMERCIAL
Lease payments receivable $1,360,044 $1,687,270
Estimated residual value of leased assets 502,399 589,740
- ------------------------------------------------------------------------------------------
Gross investment in commercial lease financings 1,862,443 2,277,010
Unearned income (328,949) (429,085)
- ------------------------------------------------------------------------------------------
TOTAL NET INVESTMENT IN COMMERCIAL LEASE FINANCINGS 1,533,494 1,847,925
- ------------------------------------------------------------------------------------------
CONSUMER
Lease payments receivable 86,381 290,987
Estimated residual value of leased assets 262,889 657,627
------------------------------------------------------------------------------------------
Gross investment in consumer lease financings 349,270 948,614
Unearned income (21,958) (78,295)
- ------------------------------------------------------------------------------------------
TOTAL NET INVESTMENT IN CONSUMER LEASE FINANCINGS $ 327,312 $ 870,319
==========================================================================================
A rollforward of the residual value component of lease financings follows:
- -------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30 June 30
- ------------------------------------------------------------------------------------------
(In Thousands) 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------
COMMERCIAL
Beginning balance $509,556 $587,284 $561,438 $595,867
Additions 9,787 17,332 11,090 26,027
Maturities and terminations (16,483) (10,256) (32,274) (27,534)
Write-downs (461) (4,620) (37,855) (4,620)
- ------------------------------------------------------------------------------------------
ENDING BALANCE $502,399 $589,740 $502,399 $589,740
- ------------------------------------------------------------------------------------------
CONSUMER
Beginning balance $348,523 $786,586 $446,872 $862,428
Additions -- -- -- --
20
Maturities and terminations (85,634) (91,277) (158,728) (153,949)
Write-downs -- (37,682) (25,255) (50,852)
- ------------------------------------------------------------------------------------------
ENDING BALANCE $262,889 $657,627 $262,889 $657,627
==========================================================================================
The commercial lease residual value write-downs recorded during the first six
months of 2003 were primarily associated with various commercial aircraft
leases. The write-downs consisted of $16 million attributable to decreases in
the residual values of airplanes which were charged to other noninterest
expense, $6 million attributable to credit losses which were charged to the
allowance for loan losses, and $16 million attributable to the write-off of
unearned income and other related accounts.
The allowance for loan losses represents an estimation of probable credit losses
inherent in the loan portfolio. Activity in the allowance for loan losses
follows:
- -----------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30 June 30
- -----------------------------------------------------------------------------------------
(In Thousands) 2003 2002 2003 2002
- -----------------------------------------------------------------------------------------
BALANCE AT BEGINNING OF PERIOD $1,128,249 $1,000,043 $1,098,588 $ 997,331
Provision 183,147 165,476 383,380 354,116
Allowance related to loans sold or
securitized -- -- -- (4,477)
Charge-offs:
Commercial 101,180 71,963 204,783 177,919
Real estate - commercial 5,540 8,199 8,341 10,524
Real estate - residential 30,985 19,656 72,197 43,448
Home equity lines of credit 5,927 4,791 11,524 9,532
Credit cards and other unsecured
lines of credit 25,036 19,073 46,846 41,691
Other consumer 29,558 38,678 64,814 93,369
- -----------------------------------------------------------------------------------------
Total charge-offs 198,226 162,360 408,505 376,483
Recoveries:
Commercial 10,642 4,250 21,723 11,828
Real estate - commercial 353 1,060 864 1,751
Real estate - residential 5,675 1,135 16,192 1,982
Home equity lines of credit 1,700 1,216 3,212 2,209
Credit cards and other unsecured
lines of credit 1,888 1,622 4,045 4,208
Other consumer 13,670 18,045 27,599 38,022
- -----------------------------------------------------------------------------------------
Total recoveries 33,928 27,328 73,635 60,000
Net charge-offs 164,298 135,032 334,870 316,483
- -----------------------------------------------------------------------------------------
BALANCE AT END OF PERIOD $1,147,098 $1,030,487 $1,147,098 $1,030,487
=========================================================================================
Nonperforming loans totaled $707 million, $702 million, and $704 million as of
June 30, 2003, December 31, 2002, and June 30, 2002, respectively. For loans
classified as nonperforming at June 30, 2003, the contractual interest due and
actual interest recognized on those loans for the first half of 2003 was $33
million and $5 million, respectively. Included in nonperforming loans were
impaired loans, as defined under SFAS 114, aggregating $411 million, $391
million, and $412 million at June 30, 2003, December 31, 2002, and June 30,
2002, respectively. Average impaired loans for the first six months of 2003 and
2002 totaled $392 million and $311 million, respectively. The majority of the
loans deemed impaired were evaluated using the fair value of the collateral as
the measurement method. The related allowance allocated to impaired loans as of
June 30, 2003, December 31, 2002, and June 30, 2002 was $57 million, $76
million, and $76 million, respectively. At June 30, 2003, December 31, 2002, and
June 30, 2002, impaired loans with an associated allowance totaled $174 million,
$206 million, and $238 million, respectively, while impaired loans with no
associated allowance totaled $237 million, $185 million, and $174 million,
respectively, for these same period ends. There was no interest recognized
during the six months ended June 30, 2003 and 2002 on impaired loans while they
were considered impaired.
21
8. SECURITIES
Securities available for sale follow:
- --------------------------------------------------------------------------------
AMORTIZED FAIR
(In Thousands) COST VALUE
- --------------------------------------------------------------------------------
JUNE 30, 2003
U.S. Treasury and Federal agency debentures $ 972,870 $1,036,932
Mortgage-backed securities 3,654,974 3,794,784
Asset-backed and corporate debt securities 1,222,811 1,227,745
States and political subdivisions 691,150 753,733
Other 553,933 564,156
- --------------------------------------------------------------------------------
TOTAL SECURITIES $7,095,738 $7,377,350
- --------------------------------------------------------------------------------
December 31, 2002
U.S. Treasury and Federal agency debentures $1,084,077 $1,143,923
Mortgage-backed securities 4,552,641 4,779,566
Asset-backed and corporate debt securities 1,815,549 1,817,958
States and political subdivisions 650,747 702,669
Other 765,065 767,152
- --------------------------------------------------------------------------------
TOTAL SECURITIES $8,868,079 $9,211,268
- --------------------------------------------------------------------------------
June 30, 2002
U.S. Treasury and Federal agency debentures $ 979,058 $1,018,574
Mortgage-backed securities 5,659,146 5,834,447
Asset-backed and corporate debt securities 353,792 357,871
States and political subdivisions 676,812 720,604
Other 864,766 868,508
- --------------------------------------------------------------------------------
TOTAL SECURITIES $8,533,574 $8,800,004
================================================================================
The other category includes Federal Reserve Bank and Federal Home Loan Bank
stock, certain retained interests in securitizations, and the Corporation's
internally managed equity portfolio comprised primarily of bank and thrift
common stock investments (bank stock fund). The bank stock fund had a cost basis
and fair value of $61 million and $69 million, respectively, at June 30, 2003,
compared to a cost basis and fair value of $75 million and $71 million,
respectively, at December 31, 2002, and a cost basis and fair value of $155
million and $153 million, respectively, at June 30, 2002.
Gross unrealized gains for the total securities portfolio totaled $292 million,
$353 million, and $277 million at June 30, 2003, December 31, 2002, and June 30,
2002, respectively. Gross unrealized losses at the same period ends totaled $10
million, $10 million, and $11 million, respectively. Net unrealized gains and
losses in the available-for-sale securities portfolio are included, net of tax,
in accumulated other comprehensive income within stockholders' equity or, for
the portion attributable to changes in a hedged risk as part of a fair value
hedge strategy, in other noninterest income on the income statement.
For the six months ended June 30, 2003 and 2002, gross securities gains of $34
million and $98 million, respectively, were recognized. For the six months ended
June 30, 2003, gross securities losses of $2 million were recognized. There were
no gross securities losses recognized during the first six months of 2002.
At June 30, 2003, the carrying value of securities pledged to secure public and
trust deposits, U.S. Treasury notes, security repurchase agreements, and
derivative instruments totaled $6 billion.
At June 30, 2003, there were no securities of a single issuer, other than U.S.
Treasury and Federal agency debentures and other U.S. government-sponsored
agency securities, which exceeded 10% of stockholders' equity.
22
9. PRINCIPAL INVESTMENTS
The Corporation's principal investment portfolio is managed within the Wholesale
Banking line of business. The principal investment portfolio primarily consists
of investments in the consumer and retail, manufacturing, automotive, building
products, and commercial services industries with no single industry
constituting greater than 20% of the total portfolio. A rollforward of principal
investments follows:
- ----------------------------------------------------------------------------------------------------
Three Months Ended June 30 Six Months Ended June 30
(In Thousands) 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------
DIRECT INVESTMENTS
Carrying value at beginning of period $328,607 $290,474 $317,089 $286,333
Investments -- new fundings 28,441 30,147 44,163 40,872
Reclassifications (12,415) -- (12,415) --
Returns of capital and write-offs (5,149) (1,302) (9,669) (4,950)
Fair value adjustments (14,644) 132 (14,328) (2,804)
- ----------------------------------------------------------------------------------------------------
Carrying value at end of period $324,840 $319,451 $324,840 $319,451
- ----------------------------------------------------------------------------------------------------
INDIRECT INVESTMENTS:
Carrying value at beginning of period $264,638 $219,616 $254,899 $209,051
Investments -- new fundings 11,381 19,895 24,992 31,543
Reclassifications 12,415 -- 12,415 --
Returns of capital and write-offs (4,460) (1,223) (8,381) (2,297)
Fair value adjustments 110 (634) 159 (643)
- ----------------------------------------------------------------------------------------------------
Carrying value at end of period $284,084 $237,654 $284,084 $237,654
- ----------------------------------------------------------------------------------------------------
TOTAL PRINCIPAL INVESTMENTS:
Carrying value at beginning of period $593,245 $510,090 $571,988 $495,384
Investments -- new fundings 39,822 50,042 69,155 72,415
Reclassifications -- -- -- --
Returns of capital and write-offs (9,609) (2,525) (18,050) (7,247)
Fair value adjustments (14,534) (502) (14,169) (3,447)
- ----------------------------------------------------------------------------------------------------
CARRYING VALUE AT END OF PERIOD $608,924 $557,105 $608,924 $557,105
====================================================================================================
- ----------------------------------------------------------------------------------------------------
Three Months Ended June 30 Six Months Ended June 30
(In Thousands) 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------
PRINCIPAL INVESTMENT REVENUE (a) $6,842 $5,905 $15,535 $11,555
- ----------------------------------------------------------------------------------------------------
NET PRINCIPAL INVESTMENT GAINS (LOSSES)(b) (16,388) (1,860) (9,924) (3,767)
====================================================================================================
(a) Consists primarily of interest, dividends, and fee income
(b) Consists of fair value adjustments, realized gains and losses on the return
of capital, and principal investment write-offs
Accounting policies for principal investments are included in Note 1.
Commitments to fund principal investments are discussed in Note 19.
10. GOODWILL AND OTHER INTANGIBLE ASSETS
Refer to Note 1 for the accounting policies related to goodwill and other
intangible assets. At June 30, 2003, December 31, 2002 and June 30, 2002,
goodwill totaled $1.1 billion. A rollforward of goodwill by reporting unit
follows:
- ----------------------------------------------------------------------------------------
JANUARY 1 GOODWILL IMPAIRMENT JUNE 30
(In Thousands) 2003 ACQUIRED LOSSES 2003
- ----------------------------------------------------------------------------------------
Consumer and Small Business
Financial Services $ 512,731 $ 550 -- $ 513,281
Wholesale Banking 86,729 -- -- 86,729
National Consumer Finance 261,387 -- -- 261,387
Asset Management 126,207 -- -- 126,207
National Processing 91,227 23,968 -- 115,195
Parent and Other -- -- -- --
- ----------------------------------------------------------------------------------------
TOTAL $1,078,281 $24,518 -- $1,102,799
========================================================================================
23
On June 9, 2003, National Processing, Inc., the Corporation's 85%-owned payment
processing subsidiary, acquired Bridgeview Payment Solutions, Inc. (BPS) from
Bridgeview Bank and Trust Company for $32 million in cash. The preliminary
allocation of the purchase price increased goodwill by approximately $24
million. The remainder of the purchase price was primarily allocated to merchant
contracts, which were recorded as other intangible assets and are being
amortized on a straight-line basis over five years. The results of operations
for BPS have been included in the consolidated financial statements since the
date of acquisition.
In addition, during the second quarter of 2003, the Consumer and Small Business
Financial Services line of business acquired a teleconsulting business and
capitalized goodwill and other intangible assets of $550 thousand and $1
million, respectively. The other intangible assets capitalized are being
amortized over a period of four years.
The Corporation has finite-lived intangible assets capitalized on its balance
sheet in the form of core deposit, credit card, and merchant portfolios and
other intangibles. Merchant portfolio intangibles relate to merchant card
customer portfolios acquired by National Processing. These intangible assets
continue to be amortized over their estimated useful lives, which range from one
to 10 years.
A summary of core deposit, credit card, and merchant portfolios and other
intangible assets follows:
- -----------------------------------------------------------------------------------
JUNE 30 December 31 June 30
(In Thousands) 2003 2002 2002
- -----------------------------------------------------------------------------------
CORE DEPOSIT INTANGIBLES
Gross carrying amount $ 93,328 $ 93,328 $ 93,328
Less: accumulated amortization 71,665 65,169 58,672
- -----------------------------------------------------------------------------------
NET CARRYING AMOUNT 21,663 28,159 34,656
- -----------------------------------------------------------------------------------
CREDIT CARD INTANGIBLES
Gross carrying amount 17,323 17,323 16,405
Less: accumulated amortization 13,708 12,990 12,270
- -----------------------------------------------------------------------------------
NET CARRYING AMOUNT 3,615 4,333 4,135
- -----------------------------------------------------------------------------------
MERCHANT PORTFOLIOS AND OTHER
INTANGIBLES
Gross carrying amount 74,436 63,577 59,677
Less: accumulated amortization 25,212 21,496 17,968
- -----------------------------------------------------------------------------------
NET CARRYING AMOUNT 49,224 42,081 41,709
- -----------------------------------------------------------------------------------
TOTAL FINITE-LIVED INTANGIBLES
Gross carrying amount 185,087 174,228 169,410
Less: accumulated amortization 110,585 99,655 88,910
- -----------------------------------------------------------------------------------
NET CARRYING AMOUNT $ 74,502 $ 74,573 $ 80,500
===================================================================================
Amortization expense on finite-lived intangible assets totaled $6 million and $5
million for the three months ended June 30, 2003 and 2002, respectively.
Amortization expense on finite-lived intangible assets totaled $11 million and
$10 million for the six months ended June 30, 2003 and 2002, respectively.
Amortization expense on finite-lived intangible assets is expected to total $23
million, $22 million, $10 million, $8 million, and $7 million in 2003, 2004,
2005, 2006, and 2007, respectively.
11. MORTGAGE SERVICING ASSETS
The unpaid principal balance of residential mortgage loans serviced for third
parties was $119.9 billion at June 30, 2003, compared to $101.9 billion at
December 31, 2002 and $94.6 billion at June 30, 2002.
The net carrying value of mortgage servicing assets follows:
- -----------------------------------------------------------------------------------
JUNE 30 June 30
(In Thousands) 2003 2002
- -----------------------------------------------------------------------------------
Initial carrying value adjusted for amortization $1,182,188 $1,754,943
SFAS 133 hedge basis adjustments (325,927) (340,359)
- -----------------------------------------------------------------------------------
Carrying value before valuation allowance 856,261 1,414,584
Impairment valuation allowance (122,841) (346,184)
- -----------------------------------------------------------------------------------
NET CARRYING VALUE $ 733,420 $1,068,400
===================================================================================
24
Changes in the carrying value of mortgage servicing assets and the associated
valuation allowance follows:
- ---------------------------------------------------------------------------------------------------------------
Three Months Ended June 30 Six Months Ended June 30
(In Thousands) 2003 2002 2003 2002
- ---------------------------------------------------------------------------------------------------------------
MORTGAGE SERVICING ASSETS
Balance at beginning of period $1,109,696 $ 1,622,788 $ 998,743 $ 1,407,641
Additions 258,048 205,634 525,355 500,538
Amortization (137,079) (77,533) (285,000) (146,586)
SFAS 133 hedge basis adjustments (122,238) (331,515) (128,365) (337,542)
Application of valuation allowance to directly
write-down servicing assets (247,351) -- (247,351) --
Sales (4,815) (4,790) (7,121) (9,467)
- ---------------------------------------------------------------------------------------------------------------
CARRYING VALUE BEFORE VALUATION ALLOWANCE AT END OF
PERIOD $ 856,261 $ 1,414,584 $ 856,261 $ 1,414,584
===============================================================================================================
VALUATION ALLOWANCE
Balance at beginning of period $ (296,384) $ (258,928) $ (383,550) $ (271,937)
Impairment (charges) recoveries (73,808) (87,256) 13,358 (74,247)
Application of valuation allowance to directly
write-down servicing assets 247,351 -- 247,351 --
- ---------------------------------------------------------------------------------------------------------------
BALANCE AT END OF PERIOD $ (122,841) $ (346,184) $ (122,841) $ (346,184)
- ---------------------------------------------------------------------------------------------------------------
NET CARRYING VALUE OF MORTGAGE SERVICING ASSETS AT
END OF PERIOD $ 733,420 $ 1,068,400 $ 733,420 $ 1,068,400
===============================================================================================================
Mortgage servicing assets are evaluated for impairment and a valuation allowance
is established through a charge to income when the carrying value of the
mortgage servicing assets, including hedge accounting adjustments, exceeds the
fair value and is determined to be temporary. Other-than-temporary impairment is
recognized when the recoverability of a recorded valuation allowance is
determined to be remote taking into consideration historical and projected
interest rates and loan pay-off activity. When this situation occurs, the
unrecoverable portion of the valuation allowance is applied as a direct
write-down to the carrying value of the mortgage servicing asset. Unlike a
valuation allowance, a direct write-down permanently reduces the carrying value
of the mortgage servicing asset and the valuation allowance, precluding
subsequent recoveries. During the second quarter of 2003, management determined
that $247 million of previously established valuation allowance was not
recoverable and reduced both the asset and the valuation allowance.
The fair value of mortgage servicing assets is estimated by calculating the
present value of estimated future net servicing cash flows, taking into
consideration actual and expected mortgage loan prepayment rates, discount
rates, servicing costs, and other economic factors, which are determined based
on current market conditions. The expected and actual rates of mortgage loan
prepayments are the most significant factors driving the value of mortgage
servicing assets. Increases in mortgage loan prepayments reduce estimated future
net servicing cash flows because the life of the underlying loan is reduced. In
determining the fair value of the mortgage servicing assets, mortgage interest
rates, which are used to determine prepayment rates, and discount rates are held
constant over the estimated life of the portfolio. Expected mortgage loan
prepayment rates are derived from a third-party model and adjusted to reflect
National City's actual prepayment experience.
The key economic assumptions used to estimate the value of the mortgage
servicing assets at June 30, 2003 and June 30, 2002 are presented in the table
that follows. A sensitivity analysis of the current fair value of the mortgage
servicing assets to immediate 10% and 20% adverse changes in those assumptions
as of June 30, 2003 is also presented. These sensitivities are hypothetical.
Changes in fair value based on a 10% variation in assumptions generally cannot
be extrapolated because the relationship of the change in the assumption to the
change in fair value may not be linear. Also, the effect of a variation in a
particular assumption on the fair value of the mortgage servicing assets is
calculated independently without changing any other assumption. In reality,
changes in one factor may result in changes in another (for example, changes in
mortgage interest rates, which drive changes in prepayment rate estimates, could
result in changes in the discount rates), which might magnify or counteract the
sensitivities.
- -------------------------------------------------------------------------------
JUNE 30 June 30
(Dollars in Thousands) 2003 2002
- -------------------------------------------------------------------------------
Fair value $733,420 $1,068,400
Weighted-average life (in years) 1.7 3.9
Weighted-average constant prepayment rate (CPR) 46.69% 23.04%
Weighted-average discount rate 9.30 9.95
Prepayment rate:
Decline in fair value from 10% adverse change $ 59,839
Decline in fair value from 20% adverse change 118,074
Discount rate:
25
Decline in fair value from 10% adverse change 12,771
Decline in fair value from 20% adverse change 25,029
- -----------------------------------------------------------------------------
The key economic assumptions used in determining the fair value of mortgage
servicing assets capitalized during the first six months of 2003 and 2002 were
as follows:
2003 2002
- -----------------------------------------------------------------------------
Weighted-average CPR 36.01% 18.01%
Weighted-average life (in years) 3.3 4.4
Weighted-average discount rate 9.36% 10.91%
- -----------------------------------------------------------------------------
Since June 30, 2002, actual and expected mortgage loan prepayments increased due
to a decline in market interest rates. The increase in the prepayment rate has
in turn lowered the amount of serving asset capitalized at the time of loan sale
and reduced the fair value of the servicing assets. During the first half of
2003, a recovery of temporary impairment was recognized on certain mortgage
servicing assets whose values increased due to rising interest rates during the
period but which could not be recognized under SFAS 133.
Risk associated with declines in the estimated fair value of mortgage servicing
assets due to increases in mortgage loan prepayments is managed using derivative
instruments that are expected to increase in value when interest rates decline.
Because derivative instruments that reflect the exact opposite risk profile of
the mortgage servicing assets are effectively not available in the capital
markets, management uses a variety of derivative instruments whose fair value
changes are expected to offset changes in the value of the mortgage servicing
assets. Because the risk profile of the derivatives is not exactly the same as
the mortgage servicing assets, changes in the value of the derivative
instruments may not exactly offset the change in value of the mortgage servicing
assets. The Corporation manages the risk to an immediate reduction in the fair
value of its mortgage servicing assets within guidelines set forth by the
Asset/Liability Management Committee. Notes 1 and 22 provide further discussion
on how derivative instruments are accounted for, the nature of the derivative
instruments used, the risks associated with the use of derivative instruments,
and detail of ineffective hedge and other derivative gains and losses. During
the three and six months ended June 30, 2003, net gains totaling $307 million
and $390 million, respectively, were recognized on derivative instruments used
to hedge the value of mortgage servicing assets and included in mortgage banking
revenue on the income statement. A discussion of mortgage banking revenue is
included in the financial review on pages 50-51.
12. BORROWED FUNDS
Detail of borrowed funds follows:
- ----------------------------------------------------------------------------------------
JUNE 30 December 31 June 30
(In Thousands) 2003 2002 2002
- ----------------------------------------------------------------------------------------
U.S. Treasury notes $1,549,613 $ 8,881,947 $6,285,470
Senior bank notes 290,000 1,560,000 --
Commercial paper and other 828,312 1,051,962 373,821
- ----------------------------------------------------------------------------------------
TOTAL BORROWED FUNDS $2,667,925 $11,493,909 $6,659,291
========================================================================================
U.S. Treasury notes represent secured borrowings from the U.S. Treasury. These
borrowings are collateralized by qualifying securities and commercial and
residential real estate loans. The funds are placed at the discretion of the
U.S. Treasury. At June 30, 2003, $1.5 billion of notes were callable on demand
by the U.S. Treasury, compared to $7.9 billion and $6.3 billion at December 31,
2002 and June 30, 2002, respectively. At December 31, 2002, $1.0 billion of the
notes were term notes with a stated maturity of less than one month.
The senior bank notes are issued by National City's bank subsidiaries and have
maturities of six months or less.
Commercial paper borrowings are issued by the Corporation's subsidiary, National
City Credit Corporation, and have maturities of six months or less.
26
13. LONG-TERM DEBT
The composition of long-term debt follows:
- ----------------------------------------------------------------------------------------
JUNE 30 December 31 June 30
(In Thousands) 2003 2002 2002
- ----------------------------------------------------------------------------------------
3.20% senior notes due 2008 $ 303,998 $ -- $ --
6.625% subordinated notes due 2004 249,914 249,849 249,784
7.75% subordinated notes due 2004 199,722 199,594 199,466
8.50% subordinated notes due 2004 149,926 149,863 149,800
7.20% subordinated notes due 2005 259,705 260,849 258,549
5.75% subordinated notes due 2009 340,763 333,928 313,243
6.875% subordinated notes due 2019 841,560 808,353 739,198
Other 1,760 2,640 12,640
- ----------------------------------------------------------------------------------------
TOTAL HOLDING COMPANY 2,347,348 2,005,076 1,922,680
6.50% subordinated notes due 2003 -- 202,158 205,395
7.25% subordinated notes due 2010 277,526 272,007 254,894
6.30% subordinated notes due 2011 236,715 231,006 215,211
7.25% subordinated notes due 2011 198,362 198,263 198,165
6.25% subordinated notes due 2011 351,294 342,357 318,454
6.20% subordinated notes due 2011 567,184 550,307 509,174
4.63% subordinated notes due 2013 299,304 -- --
4.25% subordinated notes due 2018 237,485 -- --
Senior bank notes 19,239,182 14,998,141 11,553,862
Federal Home Loan Bank advances 4,003,852 3,750,980 3,746,616
- ----------------------------------------------------------------------------------------
TOTAL BANK SUBSIDIARIES 25,410,904 20,545,219 17,001,771
- ----------------------------------------------------------------------------------------
TOTAL LONG-TERM DEBT $27,758,252 $22,550,295 $18,924,451
========================================================================================
The amounts above represent the par value of the debt adjusted for any
unamortized discount or other basis adjustments related to hedging the debt with
derivative instruments. The Corporation uses derivative instruments, primarily
interest rate swaps, to manage interest rate risk by hedging the fair value of
certain fixed-rate debt by converting the debt to variable rate and by hedging
the cash flow variability associated with certain variable-rate debt by
converting the debt to fixed rate. Further discussion on derivative instruments
is included in Notes 1 and 22.
The subordinated notes of the holding company and bank subsidiaries qualify for
Tier 2 capital under the regulatory capital requirements of the federal banking
agencies. Further discussion on regulatory capital requirements is included in
Note 15.
At June 30, 2003, the par values of senior debt, subordinated debt, senior bank
notes, and long-term advances from the Federal Home Loan Bank (FHLB) totaled
$300 million, $3.8 billion, $19.1 billion and $4.0 billion, respectively.
All senior notes and subordinated notes of the holding company and subordinated
notes of the bank subsidiaries were issued at fixed rates, pay interest
semi-annually and may not be redeemed prior to maturity. Subordinated notes with
a par amount of $550 million were issued by the bank subsidiaries during the
first half of 2003. In March 2003, the holding company issued senior notes with
a par value of $300 million. At June 30, 2003, the entire balance of the
fixed-rate senior notes was effectively converted to variable-rate debt based
upon the three-month London Interbank Offering Rate (LIBOR) through the use of
interest rate swaps. Additionally, through the use of interest rate swaps, as of
June 30, $2.6 billion of fixed-rate subordinated debt was effectively converted
to variable-rate debt based on the three-month LIBOR rate.
Senior bank notes are issued by National City's bank subsidiaries. During the
first six months of 2003, senior bank notes with a par value of $8.9 billion
were issued by the bank subsidiaries. At June 30, 2003, senior bank notes
totaling $1.7 billion were contractually based on a fixed rate of interest and
$17.5 billion were contractually based on a variable rate of interest. The
weighted-average contractual interest rates for fixed and variable-rate senior
bank notes at June 30 were 2.83% and 1.29%, respectively. Through the use of
interest rate swaps, as of June 30, the entire balance of fixed-rate senior bank
notes had been effectively converted to variable-rate notes based on either the
one- or three-month LIBOR rate, the Federal Funds rate or the Prime rate and
$9.0 billion of the variable-rate senior bank notes had been effectively
converted to fixed-rate notes with a weighted-average fixed rate of 2.53%.
Additionally, $445 million of variable rate senior bank notes were capped at a
weighted-average rate of 4.15% through the use of interest rate caps.
FHLB advances at June 30, 2003, contractually consisted of $192 million of
fixed-rate obligations and $3.8 billion of variable-rate
27
obligations. The weighted-average contractual interest rates for fixed- and
variable-rate advances at June 30 were 5.63% and 1.18%, respectively. Through
the use of interest rate swaps, as of June 30, fixed-rate advances with a par
value of $100 million had been effectively converted to a variable rate based on
one-month LIBOR and variable-rate advances with a par value of $3.2 billion had
been effectively converted to fixed-rate advances with a weighted-average fixed
rate of 3.48%. Additionally, $555 million of variable rate FHLB advances were
capped at a weighted-average rate of 4.15% through the use of interest rate
caps. FHLB advances are collateralized by qualifying residential real estate
loans.
A credit agreement dated April 12, 2001, as amended, with a group of
unaffiliated banks allows the Corporation to borrow up to $375 million until
April 12, 2005 with a provision to extend the expiration date under certain
circumstances. The Corporation pays a variable annual facility fee based on the
Corporation's long-term debt rating. The fee is currently 10 basis points on the
amount of the credit facility. There were no borrowings outstanding under this
agreement at June 30, 2003, December 31, 2002, or June 30, 2002.
14. CORPORATION-OBLIGATED MANDATORILY REDEEMABLE CAPITAL SECURITIES OF
SUBSIDIARY TRUSTS HOLDING SOLELY DEBENTURES OF THE CORPORATION
The composition of capital securities follows:
- ------------------------------------------------------------------------------------
JUNE 30 December 31 June 30
(In Thousands) 2003 2002 2002
- ------------------------------------------------------------------------------------
8.12% capital securities of First of
America Capital Trust I due January
31, 2027 $150,000 $150,000 $150,000
9.85% capital securities of Fort Wayne
Capital Trust I due April 15, 2027 30,000 30,000 30,000
- ------------------------------------------------------------------------------------
TOTAL CAPITAL SECURITIES $180,000 $180,000 $180,000
====================================================================================
The corporation-obligated mandatorily redeemable capital securities (the capital
securities) of subsidiary trusts holding solely junior subordinated debt
securities of the Corporation (the debentures) were issued by two statutory
business trusts -- First of America Capital Trust I and Fort Wayne Capital Trust
I, of which 100% of the common equity is owned by the Corporation. The trusts
were formed for the purpose of issuing the capital securities and investing the
proceeds from the sale of such capital securities in the debentures. The
debentures held by each trust are the sole assets of that trust. Distributions
on the capital securities issued by each trust are payable semi-annually at a
rate per annum equal to the interest rate being earned by the trust on the
debentures held by that trust and are recorded as interest expense by the
Corporation. The capital securities are subject to mandatory redemption, in
whole or in part, upon repayment of the debentures. The Corporation has entered
into agreements which, taken collectively, fully and unconditionally guarantee
the capital securities subject to the terms of each of the guarantees.
The debentures held by First of America Capital Trust I and Fort Wayne Capital
Trust I qualify as Tier 1 capital under Federal Reserve Board guidelines and are
first redeemable, in whole or in part, by the Corporation on January 31, 2007
and April 15, 2007, respectively.
15. REGULATORY RESTRICTIONS AND CAPITAL RATIOS
The Corporation and its banking subsidiaries are subject to various regulatory
capital requirements of federal banking agencies that involve quantitative
measures of assets, liabilities, and certain off-balance-sheet items as
calculated under regulatory accounting practices. The capital amounts and
classifications are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors. Failure to meet minimum
capital requirements can result in certain mandatory and possible additional
discretionary actions by regulators that could have a material effect on
financial position and operations.
Regulatory and other capital measures follow:
- -------------------------------------------------------------------------------------------------------------
JUNE 30 December 31 June 30
2003 2002 2002
- -------------------------------------------------------------------------------------------------------------
(Dollars in Thousands) AMOUNT RATIO Amount Ratio Amount Ratio
- -------------------------------------------------------------------------------------------------------------
Total equity/assets $ 9,060,692 7.34% $ 8,308,012 7.03% $ 7,947,785 8.02%
Total common equity/assets 9,060,692 7.34 8,308,012 7.03 7,947,087 8.02
Tangible common equity/tangible
assets 7,883,391 6.45 7,155,158 6.11 6,788,306 6.93
Tier 1 capital 8,017,907 8.15 7,263,196 7.60 6,812,375 7.92
Total risk-based capital 12,217,728 12.42 10,996,661 11.51 10,519,062 12.24
Leverage 8,017,907 6.81 7,263,196 6.52 6,812,375 7.05
=============================================================================================================
The tangible common equity ratio excludes goodwill and other intangible assets
from both equity and assets.
Tier 1 capital consists of total equity plus qualifying capital securities and
minority interests, less unrealized gains and losses
28
accumulated in other comprehensive income, certain intangible assets, and
adjustments related to the valuation of mortgage servicing assets and certain
equity investments in nonfinancial companies (principal investments).
Total risk-based capital is comprised of Tier 1 capital plus qualifying
subordinated debt, the allowance for loan losses and a portion of unrealized
gains on certain equity securities.
Both the Tier 1 and the total risk-based capital ratios are computed by dividing
the respective capital amounts by risk-weighted assets, as defined.
The leverage ratio reflects Tier 1 capital divided by average total assets for
the period. Average assets used in the calculation excludes certain intangible
and mortgage servicing assets.
National City's Tier 1, total risk-based capital, and leverage ratios for the
current period above the required minimum levels of 4.00%, 8.00%, and 4.00%,
respectively. The capital levels at all of National City's subsidiary banks are
maintained at or above the well-capitalized minimums of 6.00%, 10.00%, and 5.00%
for the Tier 1 capital, total risk-based capital, and leverage ratios,
respectively. As of the most recent notification from the Federal Deposit
Insurance Corporation, which was June 30, 2003, the due date of the last
required quarterly regulatory financial filings, each of the Corporation's
subsidiary banks were considered well-capitalized under the regulatory framework
for prompt corrective action. There have been no conditions or events since
these filings were made that management believes have changed any subsidiary
bank's capital category. As of December 31, 2002 and June 30, 2002, each of the
subsidiary banks were also categorized as well-capitalized.
As discussed in Note 2, the Corporation is evaluating whether FIN 46 may impact
the accounting and reporting of trust preferred securities in its consolidated
financial statements. Regulatory agencies are also evaluating whether the
application of FIN 46 may affect the continued qualification of trust preferred
securities as Tier 1 capital for regulatory capital purposes. The Corporation
believes the impact of FIN 46 as it relates to the Corporation's trust preferred
securities will not be material to the Corporation's financial condition,
results of operation, liquidity, or regulatory capital ratios.
The Corporation's subsidiary banks are required to maintain noninterest bearing
reserve balances with the Federal Reserve Bank. The required reserve balance was
$104 million at June 30, 2003.
Under current Federal Reserve regulations, the banking subsidiaries are limited
in the amount they may loan to the holding company and its nonbank subsidiaries.
Loans to a single affiliate may not exceed 10% and loans to all affiliates may
not exceed 20% of the bank's capital stock, surplus and undivided profits, plus
the allowance for loan losses. Loans from subsidiary banks to nonbank
affiliates, including the holding company, are also required to be
collateralized.
Dividends paid by subsidiary banks to the holding company are also subject to
certain legal and regulatory limitations. At June 30, 2003, the subsidiary banks
may pay dividends of $1.6 billion, plus an additional amount equal to their net
profits for 2003, as defined by statute, up to the date of any such dividend
declaration, without prior regulatory approval.
16. STOCKHOLDERS' EQUITY
A summary of outstanding shares of preferred and common stock follows:
- ------------------------------------------------------------------------------------
JUNE 30 December 31 June 30
2003 2002 2002
- ------------------------------------------------------------------------------------
Preferred Stock, no par value,
authorized 5,000,000 shares -- -- 13,969
Common Stock, $4 par value,
authorized 1,400,000,000 shares 613,426,098 611,491,359 610,479,248
====================================================================================
On August 30, 2002, the Corporation redeemed all preferred shares outstanding,
stated value $50 per share, at a redemption price of $50.50137 per share,
representing a total cost of $37,119. Prior to redemption, holders of preferred
shares had the right at their option, to convert each share of preferred into
3.0291 shares of National City common stock at any time through August 20, 2002.
The holders of the preferred shares were entitled to receive cumulative
preferred dividends payable quarterly at the annual rate of 6%.
29
A summary of activity in accumulated other comprehensive income follows:
- ------------------------------------------------------------------------------------
Six Months Ended June 30
(In Thousands) 2003 2002
- ------------------------------------------------------------------------------------
<
Accumulated unrealized gains on securities
available for sale at January 1, net of tax $ 223,073 $105,656
Net unrealized (losses) gains for the period, net of
tax (benefit) expense of $(7,658) in 2003 and
$73,623 in 2002 (14,223) 136,729
Reclassification adjustment for gains included in net
income, net of tax expense of $5,773 in 2003 and
$28,366 in 2002 (25,804) (69,199)
- ------------------------------------------------------------------------------------
Effect on other comprehensive income for the period (40,027) 67,530
- ------------------------------------------------------------------------------------
Accumulated unrealized gains on securities available
for sale at June 30, net of tax $183,046 $173,186
====================================================================================
Accumulated unrealized losses on derivatives used in
cash flow hedging relationships at January 1, net
of tax $(155,893) $ (33,379)
Net unrealized losses for the period, net of tax
benefit of $27,203 in 2003 and $56,422 in 2002 (50,519) (104,784)
Reclassification adjustment for losses included in
net income, net of tax benefit of $31,054 in 2003
and $29,832 in 2002 57,673 55,403
- ------------------------------------------------------------------------------------
Effect on other comprehensive income for the period 7,154 (49,381)
- ------------------------------------------------------------------------------------
Accumulated unrealized losses on derivatives used in
cash flow hedging relationships at June 30, net of
tax $(148,739) $ (82,760)
====================================================================================
Accumulated other comprehensive income at
January 1, net of tax $ 67,180 $ 72,277
Other comprehensive (loss) income, net of tax (32,873) 18,149
- ------------------------------------------------------------------------------------
ACCUMULATED OTHER COMPREHENSIVE INCOME AT JUNE 30,
NET OF TAX $ 34,307 $ 90,426
====================================================================================
The Corporation had two share repurchase authorizations outstanding at June 30,
2003. In February 2003, the Corporation's Board of Directors authorized a share
repurchase program for the repurchase of up to 25 million shares of National
City common stock, subject to an aggregate purchase limit of $800 million. In
October 1999, the Corporation's Board of Directors authorized the repurchase of
up to 30 million shares of National City common stock, subject to an aggregate
purchase limit of $1.0 billion. Shares repurchased under both programs are held
for reissue in connection with the Corporation's stock compensation plans and
for general corporate purposes. During the first six months of 2003, the
Corporation repurchased 1.4 million shares of its common stock. There were no
share repurchases of National City common stock during the first six months of
2002. As of June 30, 2003, 37.9 million shares remain authorized for repurchase.
17. NET INCOME PER COMMON SHARE
Basic and diluted net income per common share calculations follow:
- ----------------------------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Three Months Ended June 30 Six Months Ended June 30
Amounts) 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------
BASIC
Net income $616,591 $392,782 $1,113,139 $838,913
Less preferred dividends -- 10 -- 20
- ----------------------------------------------------------------------------------------------------------
Net income applicable to common stock $616,591 $392,772 $1,113,139 $838,893
- ----------------------------------------------------------------------------------------------------------
Average common shares outstanding 612,120 609,336 611,822 608,580
- ----------------------------------------------------------------------------------------------------------
Net income per common share -- basic $1.01 $.65 $1.82 $1.38
==========================================================================================================
DILUTED
Net income $616,591 $392,782 $1,113,139 $838,913
- ----------------------------------------------------------------------------------------------------------
Average common shares outstanding 612,120 609,336 611,822 608,580
Stock award adjustment 6,264 7,415 5,167 6,803
Preferred stock adjustment -- 42 -- 42
- ----------------------------------------------------------------------------------------------------------
Average common shares outstanding -- 618,384 616,793 616,989 615,425
diluted
- ----------------------------------------------------------------------------------------------------------
Net income per common share -- diluted $.99 $.63 $1.80 $1.36
==========================================================================================================
Basic net income per common share is calculated by dividing net income, less
dividend requirements on convertible preferred stock, by the weighted-average
number of common shares outstanding for the period.
30
Diluted net income per common share takes into consideration the pro forma
dilution assuming outstanding convertible preferred stock and certain unvested
restricted stock and unexercised stock option awards were converted or exercised
into common shares. Net income is not adjusted for preferred dividend
requirements since the preferred shares are assumed to be converted from the
beginning of the period.
18. INCOME TAX EXPENSE
The composition of income tax expense follows:
- -----------------------------------------------------------------------------
Six Months Ended June 30
(In Thousands) 2003 2002
- -----------------------------------------------------------------------------
Applicable to income exclusive of
securities gains $579,501 $407,665
Applicable to securities gains 5,773 28,366
- -----------------------------------------------------------------------------
TOTAL INCOME TAX EXPENSE $585,274 $436,031
=============================================================================
The effective tax rate was 34.5% and 34.2% for the six months ended June 30,
2003 and 2002, respectively.
19. COMMITMENTS, CONTINGENT LIABILITIES, GUARANTEES, AND RELATED PARTY
TRANSACTIONS
COMMITMENTS: A summary of the contractual amount of significant commitments
follows:
- --------------------------------------------------------------------------------------------
JUNE 30 December 31 June 30
(In Thousands) 2003 2002 2002
- --------------------------------------------------------------------------------------------
Commitments to extend credit:
Revolving home equity and credit card lines $19,488,932 $22,138,518 $21,485,502
Other loans 49,538,345 35,018,220 32,987,137
Standby letters of credit 3,727,925 3,769,894 3,675,754
Commercial letters of credit 156,418 126,775 146,434
Net commitments to sell mortgage loans and
mortgage-backed securities 33,871,649 22,366,679 10,242,937
Commitments to fund principal investments 231,900 241,952 284,687
Commitments to fund civic and community
investments 169,037 206,158 166,551
============================================================================================
Commitments to extend credit are agreements to lend. Since many of the
commitments to extend credit may expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash-flow requirements.
Certain lending commitments for residential mortgage loans to be sold into the
secondary market are considered derivative instruments under the guidelines of
SFAS 133. The changes in the fair value of these commitments due to changes in
mortgage interest rates are recorded on the balance sheet as either derivative
assets or derivative liabilities and are included in other loans in the table
above. Further discussion on derivative instruments is included in Notes 1 and
22.
Standby and commercial letters of credit are conditional commitments issued to
guarantee the performance of a customer to a third party. Standby letters of
credit generally are contingent upon the failure of the customer to perform
according to the terms of the underlying contract with the third party, while
commercial letters of credit are issued specifically to facilitate commerce and
typically result in the commitment being drawn on when the underlying
transaction is consummated between the customer and the third party.
The credit risk associated with loan commitments and standby and commercial
letters of credit is essentially the same as that involved in extending loans to
customers and is subject to normal credit policies. Collateral may be obtained
based on management's credit assessment of the customer.
The Corporation enters into forward contracts for the future delivery or
purchase of fixed-rate residential mortgage loans and mortgage-backed securities
at a specified interest rate to reduce the interest rate risk associated with
loans held for sale, commitments to fund loans, and mortgage servicing assets.
These contracts are also considered derivative instruments under SFAS 133 and
changes in the fair value of these contracts due to interest rate risk are
recorded on the balance sheet as either derivative assets or derivative
liabilities. Further discussion on derivative instruments is included in Notes 1
and 22.
The Corporation has principal investment commitments to provide equity and
mezzanine capital financing to private and public companies through either
direct investments in specific companies or through investment funds and
partnerships. The timing of future
31
cash requirements to fund such commitments is generally dependent on the
investment cycle. This cycle, the period over which privately-held companies are
funded by private equity investors and ultimately sold, merged, or taken public
through an initial offering, can vary based on overall market conditions as well
as the nature and type of industry in which the companies operate.
The Corporation invests in low-income housing, small-business commercial real
estate, and historic tax credit projects to promote the revitalization of
low-to-moderate-income neighborhoods throughout the local communities of its
banking subsidiaries. As a limited partner in these unconsolidated projects, the
Corporation is allocated tax credits and deductions associated with the
underlying projects. The amount of commitments to fund civic and community
investments represent funds the Corporation has committed to invest in existing
and future projects.
Under an agreement with the formerly unconsolidated asset-backed commercial
paper conduit, National City had commitments to provide liquidity to the conduit
in the event funding could not be readily accessed in the commercial paper
market. The Corporation also provided standby letters of credit to the conduit
to provide partial credit protection to commercial paper holders. As a result of
the consolidation and subsequent dissolution of the conduit, National City no
longer has liquidity and standby letter of credit commitments to third parties
related to the conduit. At June 30, 2002, the Corporation had conduit-related
liquidity and letter of credit commitments of $4.2 billion and $84 million,
respectively. Further discussion of the asset-backed commercial paper conduit is
included in Note 6.
CONTINGENT LIABILITIES AND GUARANTEES: The Corporation enters into residential
mortgage loan sale agreements with investors in the normal course of business.
These agreements usually require the Corporation to make certain representations
concerning credit information, loan documentation, collateral, and insurability.
On occasion, investors have requested the Corporation to indemnify them against
losses on certain loans or to repurchase loans which the investors believe do
not comply with applicable representations. Upon completion of its own
investigation, the Corporation generally repurchases or provides indemnification
on certain loans. Indemnification requests are generally received within two
years subsequent to sale. Management maintains a liability for estimated losses
on loans expected to be repurchased or on which indemnification is expected to
be provided and regularly evaluates the adequacy of this recourse liability
based on trends in repurchase and indemnification requests, actual loss
experience, known and inherent risks in the loans, and current economic
conditions. Total loans sold, including loans sold with servicing released, were
$29 billion and $57 billion for the second quarter and first six months of 2003,
respectively, and were $17 billion and $34 billion for the same 2002 periods,
respectively. Total loans repurchased or indemnified during the second quarter
and first half of 2003 were $162 million and $362 million, respectively, and
total loans repurchased or indemnified for the same 2002 periods were $129
million and $193 million, respectively. In addition, total loans sold of $2.4
billion remained uninsured as of June 30, 2003. The volume and balance of
uninsured government loans may be affected by processing or notification delays.
Management believes the majority of the uninsured loans at June 30, 2003 will
become insured during the normal course of business. To the extent insurance is
not obtained, the loans may be subject to repurchase. Uninsured government loans
which were ultimately repurchased have been included in the repurchase totals
above. Losses charged against the liability for estimated losses, including
uninsured government loans, were $23 million and $30 million for the second
quarter and first six months of 2003, respectively. Losses charged against the
liability for the second quarter and first six months of 2002 were $26 million
and $35 million, respectively. At June 30, 2003, the liability for estimated
losses on repurchase and indemnification was $154 million, which was included in
accrued expenses and other liabilities.
The Corporation from time to time also enters into financial guarantee contracts
whereby a premium is received from another financial institution counterparty to
guarantee a portion of credit risk on interest rate swap contracts entered into
between the financial institution counterparty and its customer. The Corporation
becomes liable to pay the financial institution only if the financial
institution is unable to collect amounts owed to them by their customer. As of
June 30, 2003, the current liability, which represents the fair value of the
financial guarantee, and the maximum exposure to loss under these contracts
totaled $567 thousand and $4 million, respectively. The Corporation has not
entered into any significant risk participations since January 1, 2003. As a
result of the issuance of SFAS 149, similar contracts entered into by the
Corporation after June 30, 2003 will be required to be accounted for as
derivative instruments.
The guarantee liability for the Corporation's standby letters of credit was $6
million at June 30, 2003, which was recorded in other liabilities on the
consolidated balance sheet. The current liability reflects the fair value of the
guarantee associated with standby letters of credit originated since January 1,
2003, the implementation date for the recognition provisions of FIN 45. See
above for further discussion on standby letters of credit and their associated
outstanding commitments.
The Corporation, through its subsidiaries, National Processing, Inc. and
National City Bank of Kentucky, provides merchant card processing services.
Under the rules of VISA(R) and MasterCard(R), when a merchant processor acquires
card transactions, it has certain contingent liabilities for the transactions
processed. This contingent liability arises in the event of a billing dispute
between the merchant and a cardholder that is ultimately resolved in the
cardholder's favor. In such a case, the transaction is "charged back" to the
merchant and the disputed amount is credited or otherwise refunded to the
cardholder. If the Corporation is unable to collect this amount from the
merchant's account, and if the merchant refuses or is unable to reimburse the
Corporation for the chargeback due to liquidation or other reasons, the
Corporation will bear the loss for the amount of the refund paid to the
cardholder.
32
A cardholder, through its issuing bank, generally has until the later of up to
four months after the date a transaction is processed or the delivery of the
product or service to present a chargeback to the Corporation as the merchant
processor. Management believes the maximum potential exposure for chargebacks
would not exceed the total amount of merchant transactions processed through
VISA(R) and MasterCard(R) for the last four months, plus any outstanding
delayed-delivery transactions and unresolved chargebacks in the process of
resolution. For the period from March through June 2003, this amount totaled
approximately $49 billion. At June 30, 2003, the Corporation had $3 million of
unresolved chargebacks that were in process of resolution.
For the three months ended June 30, 2003 and 2002, the Corporation processed $36
million and $38 million, respectively, in chargebacks presented by issuing
banks. For the six months ended June 30, 2003 and 2002, the Corporation
processed $76 million and $87 million, respectively, in chargebacks presented by
issuing banks. Actual losses recorded for the three months ended June 30, 2003
and 2002 were each $1 million. Actual losses recorded for the six months ended
June 30, 2003 and 2002 were each $2 million. The Corporation accrues for
probable losses based on historical experience and at June 30, 2003 had $1
million recorded in accrued expenses and other liabilities for expected losses.
In most cases, a contingent liability for chargebacks is unlikely to arise, as
most products or services are delivered when purchased, and credits are issued
on returned items. Where the product or service is not provided, however, until
some time after the purchase (delayed-delivery), the potential for this
contingent liability increases. For the six months ended June 30, 2003, the
Corporation processed approximately $7.0 billion of merchant transactions
related to delayed-delivery purchases.
The Corporation currently processes card transactions for two of the largest
airlines in the United States. In May 2002, the Corporation announced its
decision to discontinue processing debit and credit card transactions for the
airline industry. The Corporation will honor its existing contractual
obligations to the two airlines it currently serves but does not intend to renew
such contracts when their current terms expire. The contracts currently in
effect have expiration dates of April 2004 and November 2005. One of the two
continuing airline merchants, United Airlines, Inc., is currently operating
under Chapter 11 protection. In the event of liquidation of United Airlines or
the Corporation's other airline customer, the Corporation could become
financially responsible for refunding tickets purchased through VISA(R) and
MasterCard(R) under the chargeback rules of those associations. At June 30,
2003, the estimated dollar value of tickets purchased, but as yet unflown, under
continuing merchant processing contracts, was approximately $931 million, of
which approximately $490 million pertained to United Airlines. Based upon
available information, these amounts represent management's best estimate of its
maximum potential chargeback exposure related to its continuing airline
customers. As of June 30, 2003, the Corporation held no significant collateral
under these contracts.
During the second quarter of 2003, the Corporation's obligation to process card
transactions for two other airline merchants, including U.S. Airways Group,
Inc., ceased with these merchants transitioning to new processors. At June 30,
2003, the estimated dollar value of tickets purchased, but as yet unflown, under
these concluding contracts was approximately $151 million. This amount
represents management's best estimate of its maximum potential chargeback
exposure under these concluded contracts. At June 30, 2003, the Corporation held
cash collateral of $9 million and third-party indemnifications of $125 million
against this remaining chargeback exposure.
Based on current conditions in the airline industry and other information
currently available to the Corporation, management believes the risk of a
material loss under the chargeback rules has increased since December 31, 2002
but is not probable at this time.
National City and its subsidiaries are also involved in a number of legal
proceedings arising out of their businesses and regularly face various claims,
including unasserted claims, which may ultimately result in litigation. It is
management's opinion that the Corporation's financial position, results of
operations, and cash flows would not be materially affected by the outcome of
any pending or threatened legal proceedings, commitments, or claims.
RELATED PARTY TRANSACTIONS: The Corporation has no material related party
transactions which would require disclosure. In compliance with applicable
banking regulations, the Corporation may extend credit to certain officers and
directors of the Corporation and its banking subsidiaries in the ordinary course
of business under substantially the same terms as comparable third-party lending
arrangements.
20. STOCK OPTIONS AND AWARDS
National City maintains various incentive and nonqualified stock option plans
and also maintains various restricted stock plans. These plans provide for the
granting of stock options, stock appreciation rights, and restricted shares to
eligible employees and directors. All of the Corporation's stock option and
restricted stock plans were approved by stockholders with the exception of the
150th anniversary commemorative grant in 1995.
33
STOCK OPTION PLANS: The stock option plans under which options may currently be
granted authorize the issuance to officers and key employees of up to 92 million
options to purchase shares of common stock at the market price of the common
stock on the date of grant. These options generally become exercisable to the
extent of 50% annually beginning one year from the date of grant and expire not
later than 10 years from the date of grant. In addition, stock options may be
granted that include the right to receive additional options if certain criteria
are met. The exercise price of an additional option is equal to the market price
of the common stock on the date the additional option is granted. Additional
options vest six months from the date of grant and have a contractual term equal
to the remaining term of the original option.
In 1995, National City granted a total of 5.6 million options to purchase common
stock at the market price of the common stock on the date of grant to virtually
all employees in commemoration of National City's 150th anniversary. The options
became exercisable to the extent of 33% per year beginning two years from the
date of grant. As of June 30, 2003, 575,300 of these options remained
outstanding and all were exercisable.
On January 1, 2003, the Corporation prospectively adopted the fair value method
of accounting for stock awards under SFAS 123. Further discussion of the impact
of the change is included in Notes 1 and 2. During the first six months of 2003,
compensation expense recognized related to National City's stock option plans
totaled $3 million. There was no expense recognized during the first six months
of 2002.
RESTRICTED STOCK PLANS: National City's restricted stock plans provide for the
issuance of up to 8 million shares of common stock to officers, key employees,
and outside directors. In general, restrictions on outside directors' shares
expire after nine months and restrictions on shares granted to key employees and
officers expire within a four-year period. Compensation expense for restricted
share awards is ratably recognized over the period of service, usually the
restricted period, based on the market price of the stock on the date of grant.
The weighted-average grant-date fair value of restricted share awards granted
during the second quarter and first half of 2003 were $28.45 and $27.96,
respectively, and $28.81 and $28.65, respectively, for the second quarter and
first half of 2002. Compensation expense recognized for restricted share plans
during the second quarter and first six months of 2003 were $3 million and $7
million, respectively, and $2 million and $4 million, respectively, for the
second quarter and first six months of 2002.
OPTION AND RESTRICTED STOCK AWARD ACTIVITY: Stock option and unvested restricted
stock award activity follows:
- -----------------------------------------------------------------------------
Weighted-
Average
Shares Outstanding Exercise
------------------------------------ Price Per
Awards Options Share
- -----------------------------------------------------------------------------
January 1, 2002 1,823,310 48,798,550 $25.79
Cancelled (54,885) (396,277) 29.03
Exercised (223,787) (3,722,801) 18.52
Granted 880,709 554,468 32.27
- -----------------------------------------------------------------------------
June 30, 2002 2,425,347 45,233,940 $26.44
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
January 1, 2003 2,539,171 52,963,738 $26.89
Cancelled (79,685) (497,673) 29.98
Exercised (238,142) (4,609,625) 20.31
Granted 343,636 961,980 31.66
- -----------------------------------------------------------------------------
JUNE 30, 2003 2,564,980 48,818,420 $27.57
=============================================================================
As of June 30, 2003 and 2002, 22,644,281 and 31,782,368 shares, respectively,
were available for grant under the Corporation's stock option and restricted
stock plans.
Cancelled activity includes both forfeited and expired awards and options.
34
Information about stock options outstanding at June 30, 2003 follows:
- --------------------------------------------------------------------------------------------------------------
Weighted-
Average
Weighted- Remaining Weighted-
Average Contractual Average
Range of Exercise Life Exercise
Exercise Prices Outstanding Price (in years) Exercisable Price
- --------------------------------------------------------------------------------------------------------------
$9.17-$11.99 97,710 $ 9.62 1.1 97,710 $ 9.62
12.00-16.99 2,176,966 14.51 1.6 2,176,966 14.51
17.00-21.99 6,652,267 17.79 5.9 6,652,267 17.79
22.00-26.99 1,110,912 25.16 3.6 1,092,412 25.14
27.00-31.99 29,787,170 28.88 7.2 15,882,808 29.14
32.00-37.81 8,993,395 34.10 4.9 8,425,557 34.12
- --------------------------------------------------------------------------------------------------------------
TOTAL 48,818,420 $27.57 6.3 34,327,720 $27.05
==============================================================================================================
At June 30, 2003 and 2002, options for 34,327,720 and 35,327,017 shares of
common stock, respectively, were exercisable.
21. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS
National City has a noncontributory, defined benefit pension plan covering
substantially all employees. Pension benefits are derived from a cash balance
formula, whereby credits based on salary, age, and years of service are credited
to employee accounts. Actuarially-determined pension costs are charged to
current operations. The funding policy is to pay at least the minimum amount
required by the Employee Retirement Income Security Act of 1974.
National City also has a benefit plan offering postretirement medical and life
insurance benefits. The medical portion of the plan is contributory and the life
insurance coverage is noncontributory to the participants. The Corporation has
no plan assets attributable to the plan and funds the benefits as claims arise.
Benefit costs related to this plan are recognized in the periods employees
provide service for such benefits. The Corporation reserves the right to
terminate or make plan changes at any time.
Using an actuarial measurement date of October 31, 2002 and 2001, components of
net periodic benefit and net periodic cost for the six months ended June 30
follow:
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30 Six Months Ended June 30
- ------------------------------------------------------------------------------------------------------------------------------------
(In Thousands) 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
PENSION BENEFITS
Service cost $ 12,791 $ 11,790 $ 25,581 $ 23,581
Interest cost 20,021 18,138 40,042 36,277
Expected return on plan assets (35,861) (39,924) (71,721) (79,848)
Amortization of prior service cost (1,189) (1,281) (2,378) (2,562)
Transition benefit (52) (640) (104) (1,280)
Recognized net actuarial (gain) loss 365 (2,274) 731 (4,548)
- ------------------------------------------------------------------------------------------------------------------------------------
NET PERIODIC BENEFIT $ (3,925) $(14,191) $ (7,849) $(28,380)
====================================================================================================================================
OTHER POSTRETIREMENT BENEFITS
Service cost $ 736 $ 622 $ 1,473 $ 1,244
Interest cost 2,336 2,245 4,671 4,490
Amortization of prior service cost 33 47 67 94
Transition obligation 351 350 701 701
Recognized net actuarial loss 397 315 794 630
- ------------------------------------------------------------------------------------------------------------------------------------
NET PERIODIC COST $ 3,853 $ 3,579 $ 7,706 $ 7,159
====================================================================================================================================
Actuarial assumptions used to calculate the net periodic pension benefit and
cost were as follows:
Pension Benefits Other Postretirement Benefits
- ------------------------------------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
WEIGHTED-AVERAGE ASSUMPTIONS
Discount rate 6.75% 7.00% 6.75% 7.00%
Rate of compensation increase 2.75-7.50 2.75-7.50 2.75-7.50 2.75-7.50
Expected return on plan assets 9.50 10.00 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
35
The Corporation also maintains nonqualified supplemental retirement plans for
certain key employees. All benefits provided under these plans are unfunded, and
payments to plan participants are made by the Corporation. At June 30, 2003,
December 31, 2002, and June 30, 2002, obligations of $85 million, $80 million,
and $77 million, respectively, were included in accrued expenses and other
liabilities for these plans. Expenses related to these plans totaled $4 million
and $8 million for the second quarter and first six months of 2003,
respectively, and $4 million and $7 million for the second quarter and first six
months of 2002, respectively.
Substantially all employees are eligible to contribute a portion of their pretax
compensation to a defined contribution plan. The Corporation may make
contributions to the plan for employees with one or more years of service in the
form of National City common stock in varying amounts depending on participant
contribution levels. In 2003 and 2002, the Corporation provided up to a 6.9%
matching contribution. Matching contributions totaled $17 million and $40
million for the second quarter and first six months of 2003, respectively, and
$13 million and $32 million for the second quarter and first six months of 2002,
respectively.
22. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Corporation uses derivative instruments primarily to protect against the
risk of adverse price or interest rate movements on the value of certain assets
and liabilities and on future cash flows. It also executes derivative
instruments with its commercial banking customers to facilitate their risk
management strategies. Derivative instruments represent contracts between
parties that usually require little or no initial net investment and result in
one party delivering cash or another type of asset to the other party based on a
notional amount and an underlying as specified in the contract. A notional
amount represents the number of units of a specific item, such as currency units
or shares. An underlying represents a variable, such as an interest rate,
security price, or price index. The amount of cash or other asset delivered from
one party to the other is determined based on the interaction of the notional
amount of the contract with the underlying. Derivatives are also implicit in
certain contracts and commitments.
Market risk is the risk of loss arising from an adverse change in interest
rates, exchange rates, or equity prices. The Corporation's primary market risk
is interest rate risk. Management uses derivative instruments to protect against
the risk of interest rate movements on the value of certain assets and
liabilities and on future cash flows. These instruments include interest rate
swaps, interest rate futures, interest rate options, forward agreements, and
interest rate caps and floors with indices that relate to the pricing of
specific assets and liabilities. The nature and volume of the derivative
instruments used to manage interest rate risk depend on the level and type of
assets and liabilities on the balance sheet and the risk management strategies
for the current and anticipated rate environments.
SFAS 133 requires all derivative instruments to be carried at fair value on the
balance sheet. SFAS 133 provides special hedge accounting provisions which
permit the change in the fair value of the hedged item related to the risk being
hedged to be recognized in earnings in the same period and in the same income
statement line as the change in fair value of the derivative. Note 1 provides
further detail on how derivative instruments are accounted for in the financial
statements. The Corporation usually designates derivative instruments used to
manage interest rate risk into SFAS 133 hedge relationships with the specific
assets, liabilities, or cash flows being hedged. Some derivative instruments
used for interest rate risk management are not designated in an SFAS 133 hedge
relationship. Such will be the case if the derivative instrument is being used
to offset risk related to an asset or liability that is accounted for at fair
value in the financial statements, if the derivative instrument has been moved
out of an SFAS 133 relationship because the hedge was deemed not effective, or
if operational or cost constraints make it prohibitive to apply hedge
accounting.
As with any financial instrument, derivative instruments have inherent risks,
primarily market and credit risk. Market risk associated with changes in
interest rates is managed by establishing and monitoring limits as to the degree
of risk that may be undertaken as part of the Corporation's overall market risk
monitoring process carried out by the Asset/Liability Management Committee. See
further discussion of this process in the Market Risk section of the Financial
Review.
Credit risk occurs when a counterparty to a derivative contract with an
unrealized gain fails to perform according to the terms of the agreement. Credit
risk is managed by limiting the aggregate amount of net unrealized gains in
agreements outstanding, monitoring the size and the maturity structure of the
derivative portfolio, applying uniform credit standards to all activities with
credit risk, and collateralizing gains. The Corporation has established
bilateral collateral agreements with its major derivative dealer counterparties
that provide for exchanges of marketable securities or cash to collateralize
either party's net gains. At June 30, 2003, these collateral agreements covered
99.8% of the notional amount of the total derivative portfolio, excluding
futures, forward commitments to sell or purchase mortgage loans or
mortgage-backed securities, and customer derivative contracts. At June 30, 2003,
the Corporation held cash, U.S. government, and U.S. government-sponsored agency
securities with a fair value of $467 million to collateralize net gains with
counterparties and had pledged or delivered to counterparties U.S. government
and U.S. government-sponsored agency securities with a fair value of $86 million
to collateralize net losses with counterparties. The Corporation typically does
not have collateral agreements covering open forward commitments to sell or
purchase mortgage loans or mortgage-backed securities due to the fact these
contracts usually mature within 90 days. Open futures contracts are also not
covered by collateral agreements because the contracts are cash settled with
counterparties daily. The credit risk associated with derivative instruments
executed with the
36
Corporation's commercial banking customers is essentially the same as that
involved in extending loans and is subject to normal credit policies. Collateral
may be obtained based on management's assessment of the customer.
Derivative contracts are valued using observable market prices, if available, or
cash flow projection models acquired from third parties. Pricing models used for
valuing derivative instruments are regularly validated by testing through
comparison with other third parties. The valuations presented in the following
tables are based on yield curves, forward yield curves, and implied volatilities
that were observable in the cash and derivatives markets on June 30, 2003,
December 31, 2002, and June 30, 2002.
FAIR VALUE HEDGES: The Corporation primarily uses interest rate swaps, interest
rate futures, interest rate caps and floors, interest rate options, interest
rate forwards, and forward purchase commitments to hedge the fair values of
mortgage servicing assets, certain fixed-rate residential and commercial loans,
and U.S. Treasury securities for changes in interest rates.
The Corporation also uses receive-fixed interest rate swaps to hedge the fair
values of certain fixed-rate funding products against changes in interest rates.
The funding products hedged include purchased deposits, long-term FHLB advances,
corporate and subordinated long-term debt, and senior bank notes.
For the three and six month periods ended June 30, 2003, the Corporation
recognized total net ineffective fair value hedge (losses) gains of $(32)
million and $106 million, respectively. For the same periods in 2002, the
Corporation recognized total net ineffective hedge gains in the amount of $141
million and $165 million, respectively. Of the total (losses) gains recognized,
net ineffective hedge (losses) gains related to mortgage loans held for sale and
servicing assets were $(38) million and $93 million for the three and six month
periods ended June 30, 2003, respectively, compared to net ineffective hedge
gains of $139 million and $159 million, respectively, for the same periods in
2002. Ineffective hedge gains (losses) for these hedged assets are included in
mortgage banking revenue on the income statement. Net ineffective hedge gains
related to hedging commercial loans, U.S. Treasury securities, and fixed-rate
funding products are included in other noninterest income on the income
statement and totaled $6 million and $13 million for the three and six month
periods ended June 30, 2003, respectively. Net ineffective hedge gains related
to these hedged assets and liabilities were $2 million and $6 million for the
same periods in 2002. There were no components of derivative instruments which
were excluded from the assessment of hedge effectiveness during the first six
months of 2003 and 2002.
CASH FLOW HEDGES: The Corporation hedges cash flow variability related to
variable-rate funding products, specifically FHLB advances and senior bank
notes, through the use of pay-fixed interest rate swaps and interest rate caps.
The Corporation also holds pay-fixed interest rate swaps and caps to hedge
forecasted cash flows associated with debt instruments expected to be issued
subsequent to 2003.
For the three and six month periods ended June 30, 2003, the Corporation
recognized net ineffective cash flow hedge gains of $1 million and $900
thousand, respectively. For the same periods in 2002, the Corporation recognized
net ineffective cash flow hedge losses of $400 thousand and $500 thousand,
respectively. These gains are included in other noninterest income on the income
statement. There were no components of derivative instruments which were
excluded from the assessment of hedge effectiveness during the first six months
of 2003 and 2002.
Gains and losses on derivative instruments reclassified from accumulated other
comprehensive income to current-period earnings are included in the line item in
which the hedged cash flows are recorded. At June 30, 2003, December 31, 2002
and June 30, 2002, accumulated other comprehensive income included a deferred
after-tax net loss of $149 million, $156 million and $83 million, respectively,
related to derivatives used to hedge funding cash flows. See Note 16 for further
detail of the amounts included in accumulated other comprehensive income. The
net after-tax derivative loss included in accumulated other comprehensive income
as of June 30, 2003, is projected to be reclassified into interest expense in
conjunction with the recognition of interest payments on funding products
through November 2005, with $116 million of net loss expected to be reclassified
within the next year. During the three and six month periods ended June 30,
2003, pretax losses of $50 million and $89 million, respectively, were
reclassified into interest expense as adjustments to interest payments on
variable-rate funding products. For the same 2002 periods, pretax losses of $41
million and $87 million, respectively, were reclassified into interest expense.
Also during the first six months of 2002, pretax gains of $2 million were
reclassified into other noninterest income as part of the gain on the automobile
loan securitization. There were no gains or losses reclassified into earnings
during the first six months of 2003 and 2002 arising from the determination that
the original forecasted transaction would not occur.
The tables on pages 39-40 provide further information regarding derivative
instruments designated in fair value and cash flow hedges at June 30, 2003,
December 31, 2002, and June 30, 2002.
37
OTHER DERIVATIVE ACTIVITIES: The Corporation's derivative portfolio also
includes derivative financial instruments not included in SFAS 133 hedge
relationships. Those derivatives include purchased derivatives, primarily swaps,
futures, and forwards, used for interest rate and other risk management
purposes, as well as mortgage banking loan commitments defined as derivatives
under SFAS 133, and derivatives executed with customers, primarily interest rate
swaps and options, to facilitate their interest rate risk management strategies.
The Corporation generally does not enter into derivative transactions for purely
speculative purposes. Gains and losses on mortgage-banking-related derivative
financial instruments are included in mortgage banking revenue on the income
statement, while gains and losses on other derivative financial instruments are
included in other noninterest income. A summary of derivative financial
instruments not in SFAS 133 hedge relationships by type of activity follows:
- ----------------------------------------------------------------------------------------------------------------------
Net Derivative Asset (Liability)
-------------------------------------------------
JUNE 30 December 31 June 30
(In Millions) 2003 2002 2002
- ----------------------------------------------------------------------------------------------------------------------
OTHER DERIVATIVE INSTRUMENTS
Mortgage-banking-related:
Mortgage servicing asset risk management $ 87.8 $ 12.0 $ 4.0
Mortgage loan commitments and associated
risk management 149.4 (33.2) (16.9)
- ----------------------------------------------------------------------------------------------------------------------
Total mortgage-banking related 237.2 (21.2) (12.9)
- ----------------------------------------------------------------------------------------------------------------------
Customer risk management 16.7 17.2 23.5
Other 11.8 (5.1) 6.3
- ----------------------------------------------------------------------------------------------------------------------
Total other 28.5 12.1 29.8
- ----------------------------------------------------------------------------------------------------------------------
TOTAL OTHER DERIVATIVE INSTRUMENTS $265.7 $ (9.1) $ 16.9
======================================================================================================================
- ----------------------------------------------------------------------------------------------------------------------
For the Three Months Ended For the Six Months Ended
June 30 June 30
-------------------------------- ---------------------------------
Net Gains (Losses) Net Gains (Losses)
-------------------------------- ---------------------------------
(In Millions) 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
OTHER DERIVATIVE ACTIVITIES
Mortgage-banking-related:
Mortgage servicing asset risk management $251.9 $ 9.4 $223.1 $ 7.7
Mortgage loan commitments and associated
risk management 99.6 18.7 218.1 (25.6)
- ----------------------------------------------------------------------------------------------------------------------
Total mortgage-banking related 351.5 28.1 441.2 (17.9)
- ----------------------------------------------------------------------------------------------------------------------
Customer risk management 3.2 2.2 6.6 4.3
Other 68.4 (2.0) 65.7 2.7
- ----------------------------------------------------------------------------------------------------------------------
Total other 71.6 .2 72.3 7.0
- ----------------------------------------------------------------------------------------------------------------------
TOTAL OTHER DERIVATIVE ACTIVITIES $423.1 $28.3 $513.5 $(10.9)
- ----------------------------------------------------------------------------------------------------------------------
38
Summary information regarding the interest rate derivatives portfolio used for
interest-rate risk management purposes and designated as accounting hedges under
SFAS 133 at June 30, 2003, December 31, 2002, and June 30, 2002 follows:
- ----------------------------------------------------------------------------------------------------------------------------------
JUNE 30, 2003 December 31, 2002
-------------------------------------------- ----------------------------------------------------
DERIVATIVE NET Derivative Net
-------------------- INEFFECTIVE ------------------------- Ineffective
NOTIONAL HEDGE GAINS Notional Hedge Gains
(In Millions) AMOUNT ASSET LIABILITY (LOSSES)(a) Amount Asset Liability (Losses)(a)
- ----------------------------------------------------------------------------------------------------------------------------------
FAIR VALUE HEDGES
Loans
Receive-fixed interest
rate swaps $ 60 $ 2.2 $ -- $ 60 $ 1.4 $ --
Receive-fixed interest rate
swaptions sold 55 -- -- 55 -- .4
Pay-fixed interest rate
swaps 3,422 293.7 3,539 -- 285.1
Callable pay-fixed
interest rate
swaps 44 -- 5.5 44 -- 5.6
Extendable pay-fixed
interest rate
swaps -- -- -- 1 -- --
Pay-fixed interest rate
swaptions sold 55 -- 6.4 55 -- 4.7
Interest rate caps sold 815 -- 1.1 765 -- 1.3
Interest rate floors sold 360 -- 11.0 260 -- 8.3
Interest rate futures
purchased 2,720 -- -- 3,301 -- --
Interest rate futures sold 3,724 -- -- 4,094 -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Total 11,255 2.2 317.7 $ 12.6 12,174 1.4 305.4 $ 10.5
- ----------------------------------------------------------------------------------------------------------------------------------
Mortgage loans held for sale
Forward commitments to sell
mortgage loans and
mortgage-backed securities 23,163 -- 312.4 22,909 -- 375.2
Receive-fixed interest
rate swaps 1,710 166.0 -- 2,490 218.3 --
Receive fixed interest rate
swaptions sold 700 -- 14.2 -- -- --
Pay-fixed interest rate
swaptions sold 700 -- 1.3 500 -- 7.0
Interest rate caps
purchased 5,250 4.6 -- 4,850 15.6 --
Interest rate futures
purchased 825 -- -- -- -- --
Interest rate futures sold -- -- -- 75 -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Total 32,348 170.6 327.9 54.9 30,824 233.9 382.2 30.8
- ----------------------------------------------------------------------------------------------------------------------------------
Available for sale securities
Pay-fixed interest rate
swaps 250 -- 1.2 .1 250 -- 4.7 2.6
- ----------------------------------------------------------------------------------------------------------------------------------
Total 250 -- 1.2 .1 250 -- 4.7 2.6
- ----------------------------------------------------------------------------------------------------------------------------------
Mortgage servicing assets
Forward commitments to
purchase mortgage loans
and mortgage-backed
securities 4,525 -- 23.5 4,025 46.5 --
Receive-fixed interest
rate swaps 2,451 348.8 1.3 2,920 376.1 --
Receive-fixed interest rate
swaptions purchased -- -- -- 670 34.1 --
Receive-fixed interest rate
swaptions sold 162 -- 2.5 2,008 -- 56.1
Pay-fixed interest rate
swaptions purchased 3,600 14.1 -- 3,370 55.7 --
Pay-fixed interest rate
swaptions sold 2,318 41.3 217.6 3,908 -- 184.3
Principal-only interest
rate swaps 222 17.9 3.9 726 46.7 .2
Interest rate caps
purchased 22,357 32.8 -- 24,340 61.6 --
Interest rate floors
purchased -- -- -- 75 .4 --
Interest rate futures
purchased 400 -- -- 1,308 -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Total 36,035 454.9 248.8 38.1 43,350 621.1 240.6 300.6
- ----------------------------------------------------------------------------------------------------------------------------------
Funding
Receive-fixed interest
rate swaps 4,950 558.7 10.4 4,395 453.8 --
Callable receive-fixed
interest rate swaps 445 17.5 .9 545 22.9 --
- ----------------------------------------------------------------------------------------------------------------------------------
Total 5,395 576.2 11.3 -- 4,940 476.7 -- 1.4
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL DERIVATIVES USED IN FAIR
VALUE HEDGES 85,283 1,203.9 906.9 105.7 91,538 1,333.1 932.9 345.9
- ----------------------------------------------------------------------------------------------------------------------------------
CASH FLOW HEDGES
Funding
Pay-fixed interest rate
swaps 14,055 .5 162.7 7,150 -- 181.2
Interest rate caps purchased 3,500 3.3 -- 8,500 14.9 --
- ----------------------------------------------------------------------------------------------------------------------------------
Total 17,555 3.8 162.7 .9 15,650 14.9 181.2 (.1)
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL DERIVATIVES USED IN CASH 17,555 3.8 162.7 .9 15,650 14.9 181.2 (.1)
FLOW HEDGES
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL DERIVATIVES USED FOR
INTEREST RATE RISK MANAGEMENT
AND DESIGNATED IN SFAS 133
RELATIONSHIPS $102,838 $1,207.7 $1,069.6 $106.6 $107,188 $1,348.0 $1,114.1 $345.8
==================================================================================================================================
(a) Represents net ineffective hedge gain (loss) on hedging strategy for the
six and twelve-month periods ended June 30, 2003 and December 31, 2002,
respectively
39
- ---------------------------------------------------------------------------------------------------------------
June 30, 2002
------------------------------------------------------------------
Derivative Net
---------------------------------- Ineffective
Notional Hedge Gains
(In Millions) Amount Asset Liability (Losses)(a)
- ---------------------------------------------------------------------------------------------------------------
FAIR VALUE HEDGES
Loans
Receive-fixed interest rate swaps $ 60 $ .3 $ --
Receive-fixed interest rate swaptions
purchased 55 -- 1.1
Pay-fixed interest rate swaps 3,471 -- 181.7
Callable pay-fixed interest rate swaps 50 -- 4.4
Pay-fixed interest rate swaptions sold 155 -- 7.9
Interest rate caps sold 765 -- 4.3
Interest rate floors sold 60 -- 3.8
Interest rate futures purchased 4,449 -- --
Interest rate futures sold 4,803 -- --
- ---------------------------------------------------------------------------------------------------------------
Total 13,868 .3 203.2 $ 4.4
- ---------------------------------------------------------------------------------------------------------------
Mortgage loans held for sale
Forward commitments to sell mortgage
loans and mortgage-backed securities 9,058 -- 100.0
Receive-fixed interest rate swaps 2,140 47.9 --
Pay-fixed interest rate swaps 1,300 -- 23.3
Interest rate caps purchased 5,250 37.9 --
- -------------------------------------------- ------------- ----------------- ---------------- -----------------
Total 17,748 85.8 123.3 30.6
- ---------------------------------------------------------------------------------------------------------------
Available for sale securities
Pay-fixed interest rate swaps 500 -- 10.8 1.0
- ---------------------------------------------------------------------------------------------------------------
Total 500 -- 10.8 1.0
- ---------------------------------------------------------------------------------------------------------------
Mortgage servicing assets
Forward commitments to purchase
mortgage loans and mortgage-
backed securities 2,530 7.3 1.4
Receive-fixed interest rate swaps 4,950 291.1
Pay-fixed interest rate swaps 1,350 4.4 21.7
Principal-only interest rate swaps 590 30.1 2.8
Interest rate caps purchased 15,695 50.4 --
Interest rate floors purchased 75 .2 --
Treasury call options 450 8.5 --
Treasury note futures 675 -- --
U.S. Government agency futures 100 -- --
- ---------------------------------------------------------------------------------------------------------------
Total 26,415 392.0 25.9 128.4
- ---------------------------------------------------------------------------------------------------------------
Funding
Receive-fixed interest rate swaps 3,695 201.3 --
Callable receive-fixed interest rate
swaps 810 19.0 1.6
- ---------------------------------------------------------------------------------------------------------------
Total 4,505 220.3 1.6 .7
- ---------------------------------------------------------------------------------------------------------------
TOTAL DERIVATIVES USED IN FAIR VALUE
HEDGES 63,036 698.4 364.8 165.1
- ---------------------------------------------------------------------------------------------------------------
Funding
Pay-fixed interest rate swaps 7,550 -- 104.5
Interest rate caps purchased 6,000 23.4 --
- ---------------------------------------------------------------------------------------------------------------
Total 13,550 23.4 104.5 (.5)
- ---------------------------------------------------------------------------------------------------------------
TOTAL DERIVATIVES USED IN CASH FLOW 13,550 23.4 104.5 (.5)
HEDGES
- ---------------------------------------------------------------------------------------------------------------
TOTAL DERIVATIVES USED FOR INTEREST
RATE RISK MANAGEMENT AND DESIG-
NATED IN SFAS 133 RELATIONSHIPS $76,586 $721.8 $469.3 $164.6
===============================================================================================================
(a) Represents net ineffective hedge gain (loss) on hedging strategy for
six-month period ended June 30, 2002
40
23. LINE OF BUSINESS RESULTS
National City operates five major lines of business: Consumer and Small Business
Financial Services, Wholesale Banking, National Consumer Finance, Asset
Management, and National Processing.
Consumer and Small Business Financial Services (CSBFS) provides banking services
to consumers and small businesses within National City's six-state footprint. In
addition to deposit gathering and direct lending services provided through the
retail bank branch network, call centers, and the Internet, the business line's
activities also include small business services, dealer finance, education
finance, retail brokerage, and lending-related insurance services. Consumer
lending products offered through CSBFS include home equity, automobile, marine,
and recreational vehicle installment loans, government or privately guaranteed
student loans, and credit cards and other unsecured personal and business lines
of credit. Major revenue sources include net interest income on loan and deposit
accounts, deposit account service fees, debit and credit card interchange and
service fees, and ATM surcharge and net interchange fees. CSBFS's expenses are
mainly personnel and branch network support costs.
Wholesale Banking provides credit-related and treasury management products, as
well as capital markets and international services, to large- and medium-sized
corporations. Major products and services include: lines of credit, term loans,
leases, investment real estate lending, asset-based lending, structured finance,
syndicated lending, equity and mezzanine capital, treasury management services,
and international payment and clearing services. The majority of revenue is
driven by loans to middle-market companies with annual revenue in the $5 million
to $500 million range across a diverse group of industries, generally within
National City's six-state footprint.
National Consumer Finance (NCF) originates conforming and nonconforming
residential mortgage and home equity loans within National City's six-state
footprint and nationally through retail branch offices, correspondent
relationships, and a network of brokers, real estate agents, and builders. NCF's
activities also include selling and servicing mortgage loans for third-party
investors. Conforming mortgage loans, which generally represent loans
collateralized by one-to-four-family residential real estate, having loan-
to-value collateral ratios of 80% or less, and made to borrowers in good credit
standing, are originated through National City Mortgage Co. ( NCMC), a business
unit within NCF, and are typically sold to primary market aggregators (Fannie
Mae, Freddie Mac, Ginnie Mae, or the Federal Home Loan Banks) and jumbo loan
investors. During the first six months of 2003 and 2002, approximately 56% and
55%, respectively, of NCMC mortgage loans were originated through wholesale and
correspondent channels, while 44% and 45%, respectively, were originated through
retail mortgage branches operated by NCMC nationally, or through CSBFS bank
branches within National City's six-state footprint. First Franklin Financial
Corporation, a business unit within NCF, originates nonconforming mortgage
loans, which do not meet the above conforming definition due to credit
characteristics, the underlying documentation, the loan-to-value ratio, or other
factors. First Franklin originates loans primarily through brokers, which are
either sold servicing-released to third parties or are retained in portfolio.
NCF's National Home Equity business unit originates prime-quality home equity
loans outside National City's six-state footprint. Significant revenue streams
for NCF include net interest income on loans and fee income related to the
origination, sale, and servicing of loans. Expenses include personnel costs,
branch office costs, and loan collection expenses.
The Asset Management business includes both institutional asset and personal
wealth management. The institutional asset management business provides
investment management, custody, retirement planning services, bond
administration and other corporate trust services to institutional clients. The
clients served include publicly traded corporations, charitable endowments and
foundations, as well as unions, residing primarily in National City's six-state
footprint and generally complementing its corporate banking relationships.
Personal wealth management services are provided by three business units --
Private Client Group, NatCity Investments, Inc., and Sterling. Products and
services include private banking services and tailored credit solutions,
customized investment management services, brokerage, estate and tax planning,
as well as trust management and administration for affluent individuals and
families. Sterling offers financial management services and alternative
investments for high net worth clients.
National Processing consists of National Processing, Inc., National City's
85%-owned payment processing subsidiary. National Processing authorizes,
processes, and performs financial settlement and reporting of card transactions,
including credit and debit transactions and also provides financial settlement
and reporting solutions to large and mid-size corporate customers in the travel
and health care industries. National Processing is the second largest acquirer
of card transactions in the United States.
The business units are identified by the product or services offered and the
channel through which the product or service is delivered. The reported results
reflect the underlying economics of the businesses. Expenses for centrally
provided services are allocated based upon estimated usage of those services.
The business units' assets and liabilities are match-funded and interest rate
risk is centrally managed as part of investment funding activities. Asset
securitizations are also considered funding activities and the effects of such
securitizations are included within the parent and other category. The assets
sold through securitization continue to be reflected as owned by the business
unit that manages those assets. Asset sales and other transactions between
business units are primarily conducted at fair value, resulting in gains or
losses that are eliminated for reporting consolidated results of operations.
Parent and other is primarily comprised of the results of investment funding
activities, including asset securitization activities, intersegment revenue
41
and expense eliminations, and unallocated corporate income and expense. The
intersegment revenue and expense amounts presented in the tables relate to
either services provided or asset sales between the operating segments. The
amounts do not include reimbursements related to expense allocations and the
effects of centrally managing interest rate risk. The accounting policies of the
individual business units are the same as those of the Corporation. Prior period
amounts have been restated to conform with the current period's presentation.
Operating results of the business units are discussed in the Line of Business
Results section of the Financial Review. Selected financial information by line
of business is included in the table below.
- -----------------------------------------------------------------------------------------------------------------------------------
CONSUMER AND
SMALL BUSINESS NATIONAL
FINANCIAL WHOLESALE CONSUMER ASSET NATIONAL PARENT CONSOLIDATED
(In Thousands) SERVICES BANKING FINANCE MANAGEMENT PROCESSING AND OTHER TOTAL
- -----------------------------------------------------------------------------------------------------------------------------------
QUARTER ENDED JUNE 30, 2003
Net interest income (expense)(a) $489,221 $258,776 $476,357 $25,978 $ 865 $(148,949) $1,102,248
Provision (benefit) for loan losses 73,761 104,339 25,428 2,733 -- (23,114) 183,147
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest income (expense) after
provision 415,460 154,437 450,929 23,245 865 (125,835) 919,101
Noninterest income 185,311 59,406 482,781 91,650 113,590 128,824 1,061,562
Noninterest expense 331,217 119,313 273,059 70,956 95,945 135,747 1,026,237
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before taxes 269,554 94,530 660,651 43,939 18,510 (132,758) 954,426
Income tax expense (benefit)(a) 101,892 36,157 260,362 16,609 7,444 (84,629) 337,835
- -----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $167,662 $58,373 $400,289 $27,330 $ 11,066 $(48,129) $616,591
===================================================================================================================================
Intersegment revenue (expense) $ (896) $ 5,286 $ 2,122 $ 1,650 $ 1,373 $ (9,535) $ --
Average assets (in millions) 25,737 31,194 48,293 2,890 542 10,404 119,060
===================================================================================================================================
Quarter ended June 30, 2002
Net interest income (expense)(a) $493,392 $255,592 $259,251 $25,379 $ 1,258 $(64,515) $970,357
Provision (benefit) for loan losses 74,303 83,600 19,157 8,863 -- (20,447) 165,476
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest income (expense) after
provision 419,089 171,992 240,094 16,516 1,258 (44,068) 804,881
Noninterest income 168,969 79,779 249,237 102,437 112,493 60,409 773,324
Noninterest expense 362,525 127,417 211,396 77,398 91,691 103,495 973,922
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before taxes 225,533 124,354 277,935 41,555 22,060 (87,154) 604,283
Income tax expense (benefit) (a) 85,251 47,047 104,234 15,707 9,861 (50,599) 211,501
- -----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $140,282 $77,307 $173,701 $25,848 $ 12,199 ($36,555) $392,782
===================================================================================================================================
Intersegment revenue (expense) $ (470) $ 2,868 $ 844 $ 3,592 $ 1,846 $ (8,680) $ --
Average assets (in millions) 24,449 31,041 29,039 2,974 453 9,965 97,921
===================================================================================================================================
(a) Includes tax-equivalent adjustment for tax-exempt interest income
CONSUMER AND
SMALL BUSINESS NATIONAL
FINANCIAL WHOLESALE CONSUMER ASSET NATIONAL PARENT CONSOLIDATED
(In Thousands) SERVICES BANKING FINANCE MANAGEMENT PROCESSING AND OTHER TOTAL
- -----------------------------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, 2003
Net interest income (expense)(a) $973,814 $511,862 $ 933,628 $ 51,106 $ 1,548 $(268,981) $2,202,977
Provision (benefit) for loan losses 144,226 220,068 55,914 4,317 -- (41,145) 383,380
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest income (expense) after
provision 829,588 291,794 877,714 46,789 1,548 (227,836) 1,819,597
Noninterest income 351,950 145,110 883,213 174,432 219,713 153,605 1,928,023
Noninterest expense 685,514 255,366 518,488 146,867 188,509 240,359 2,035,103
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before taxes 496,024 181,538 1,242,439 74,354 32,752 (314,590) 1,712,517
Income tax expense (benefit)(a) 187,498 68,478 489,864 28,106 13,139 (187,707) 599,378
- -----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $308,526 $113,060 $ 752,575 $ 46,248 $ 19,613 $(126,883) $ 1,113,139
===================================================================================================================================
Intersegment revenue (expense) $ (1,861) $ 11,621 $ 3,738 $ 3,665 $ 2,784 $ (19,947) $ --
Average assets (in millions) 25,778 31,187 46,814 2,903 538 10,534 117,754
===================================================================================================================================
Six months ended June 30, 2002
Net interest income (expense)(a) $982,549 $502,212 $536,737 $ 50,444 $ 2,448 $ (98,682) $1,975,708
Provision (benefit) for loan losses 153,678 177,679 41,979 10,372 -- (29,592) 354,116
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest income (expense) after
provision 828,871 324,533 494,758 40,072 2,448 (69,090) 1,621,592
Noninterest income 313,828 151,395 451,627 196,083 222,271 182,513 1,517,717
Noninterest expense 693,656 251,933 417,658 152,799 183,195 149,570 1,848,811
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before taxes 449,043 223,995 528,727 83,356 41,524 (36,147) 1,290,498
Income tax expense (benefit) (a) 169,738 84,742 198,162 31,508 17,277 (49,842) 451,585
- -----------------------------------------------------------------------------------------------------------------------------------
Net income $279,305 $139,253 $330,565 $ 51,848 $ 24,247 $ 13,695 $ 838,913
===================================================================================================================================
Intersegment revenue (expense) $ (926) $ 5,975 $ 1,801 $ 6,892 $ 3,847 $ (17,589) $ --
Average assets (in millions) 24,622 31,223 30,354 2,993 446 10,365 100,003
===================================================================================================================================
(a) Includes tax-equivalent adjustment for tax-exempt interest income
42
24. FINANCIAL HOLDING COMPANY
Condensed financial statements of the holding company, which include
transactions with subsidiaries, follow:
BALANCE SHEETS
- ---------------------------------------------------------------------------------------------------------
JUNE 30 December 31 June 30
(In Thousands) 2003 2002 2002
- ---------------------------------------------------------------------------------------------------------
ASSETS
Cash and demand balances due from banks $ 1,508 $ 1,498 $ 1,487
Loans to and receivables from subsidiaries 369,084 699,323 680,968
Securities 206,996 227,223 220,250
Other investments 435,929 556,123 451,492
Investments in:
Subsidiary banks 9,867,882 9,390,979 8,537,155
Nonbank subsidiaries 544,188 545,499 544,905
Goodwill 58,566 58,566 58,566
Derivative assets 198,890 154,905 63,136
Other assets 619,406 644,245 581,588
- ---------------------------------------------------------------------------------------------------------
TOTAL ASSETS $12,302,449 $12,278,361 $11,139,547
========================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Long-term debt $ 2,347,348 $ 2,005,076 $ 1,922,680
Borrowed funds from subsidiaries 185,568 1,205,568 455,568
Derivative liabilities 1,754 7,184 --
Accrued expenses and other liabilities 707,087 752,521 813,514
- ---------------------------------------------------------------------------------------------------------
Total liabilities 3,241,757 3,970,349 3,191,762
Stockholders' equity 9,060,692 8,308,012 7,947,785
- ---------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $12,302,449 $12,278,361 $11,139,547
========================================================================================================
The holding company guarantees commercial paper issued by its subsidiary
National City Credit Corporation and capital securities issued by two subsidiary
trusts. As of June 30, 2003, outstanding commercial paper borrowings totaled
$366 million and outstanding capital securities totaled $180 million -- refer to
Notes 12 and 14. The holding company also guarantees National City Bank of
Kentucky's financial obligations under this subsidiary bank's membership with
VISA(R) up to $600 million and Mastercard(R) up to $400 million. Refer to Note
19 for further discussion of contingent liabilities and guarantees related to
the Corporation's merchant card processing business.
STATEMENTS OF INCOME
- ---------------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30 Six Months Ended June 30
(In Thousands) 2003 2002 2003 2002
- ---------------------------------------------------------------------------------------------------------------------------------
INCOME
Dividends from:
Subsidiary banks $450,000 $ 650,000 $ 450,000 $650,000
Nonbank subsidiaries 4,000 6,000 4,000 6,000
Interest on loans to subsidiaries 224 3,148 515 6,153
Interest and dividends on securities 3,007 2,665 5,125 6,786
Securities gains, net 31,409 43,993 31,409 92,420
Other income 12,350 1,719 12,743 5,443
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL INCOME 500,990 707,525 503,792 766,802
=================================================================================================================================
EXPENSE
Interest on debt and other borrowings 24,571 28,836 49,352 60,408
Other expense 80,031 56,140 81,127 72,626
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL EXPENSE 104,602 84,976 130,479 133,034
=================================================================================================================================
Income before tax (benefit) and equity in undistributed
net income of subsidiaries 396,388 622,549 373,313 633,768
Income tax (benefit) (25,553) (14,543) (44,961) (11,151)
- ---------------------------------------------------------------------------------------------------------------------------------
Income before equity in undistributed net income of
subsidiaries 421,941 637,092 418,274 644,919
Equity in undistributed net income of subsidiaries 194,650 (244,310) 694,865 193,994
- ---------------------------------------------------------------------------------------------------------------------------------
NET INCOME $616,591 $ 392,782 $1,113,139 $838,913
=================================================================================================================================
43
- ----------------------------------------------------------------------------------------------------------
STATEMENTS OF CASH FLOWS Six Months Ended June 30
(In Thousands) 2003 2002
- ----------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 1,113,139 $ 838,913
Adjustments to reconcile net income to net cash provided by
operating activities:
Equity in undistributed net income of subsidiaries (694,865) (193,994)
Depreciation and amortization of properties and equipment 569 1,137
Decrease/(increase) in receivables from subsidiaries 12,905 (6,976)
Securities gains, net (31,409) (92,420)
Other losses, net 22,358 54,550
Amortization of premiums and discounts on securities and debt (698) (478)
(Decrease)/increase in accrued expenses and other liabilities (59,687) 30,980
Other, net 17,722 12,745
- ----------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 380,034 644,457
- ----------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Purchases of securities (417,618) (85,483)
Proceeds from sales and maturities of securities 458,214 355,968
Net decrease/(increase) in other investments 120,194 (156,261)
Principal collected on loans to subsidiaries 687,334 109,249
Loans to subsidiaries (370,000) (84,821)
Investments in subsidiaries (522) (30,023)
Returns of investment from subsidiaries 180,000 284
Net decrease in properties and equipment 10,840 --
- ----------------------------------------------------------------------------------------------------------
Net cash provided by investing activities 668,442 108,913
- ----------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Net decrease in borrowed funds (1,020,000) (362,000)
Issuance of debt 300,000 --
Repayment of debt (880) (100,880)
Dividends paid (373,012) (358,817)
Issuances of common stock 83,055 68,317
Repurchases of common stock (37,629) --
- ----------------------------------------------------------------------------------------------------------
Net cash used in financing activities (1,048,466) (753,380)
- ----------------------------------------------------------------------------------------------------------
Increase/(decrease) in cash and demand balances due from banks 10 (10)
Cash and demand balances due from banks, January 1 1,498 1,497
- ----------------------------------------------------------------------------------------------------------
CASH AND DEMAND BALANCES DUE FROM BANKS, JUNE 30 $ 1,508 $ 1,487
==========================================================================================================
SUPPLEMENTAL INFORMATION
Interest paid $ 45,507 $ 60,716
==========================================================================================================
Retained earnings of the holding company included $6.8 billion, $6.1 billion,
and $5.8 billion of equity in undistributed net income of subsidiaries at June
30, 2003, December 31, 2002, and June 30, 2002, respectively.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This section contains forward-looking statements. Forward-looking statements
give current expectations or forecasts of future events and are not guarantees
of future performance. The forward-looking statements are based on management's
expectations and are subject to a number of risks and uncertainties. Although
management believes the expectations reflected in such forward-looking
statements are reasonable, actual results may differ materially from those
expressed or implied in such statements. Risks and uncertainties that could
cause actual results to differ materially include, without limitation, the
Corporation's ability to execute its business plans; changes in general economic
and financial market conditions; changes in interest rates; changes in
competitive conditions; continuing consolidation in the financial services
industry; new litigation or changes in existing litigation; losses, customer
bankruptcy, claims and assessments; changes in banking regulations or other
regulatory or legislative requirements that impact the Corporation's business;
and changes in accounting policies and procedures as may be required by the
Financial Accounting Standards Board or other regulatory agencies. Additional
information concerning factors that could cause actual results to differ
materially from those expressed or implied in the forward-looking statements is
available in the Corporation's Annual Report on Form 10-K for the year ended
December 31, 2002 and subsequent filings with the United States Securities and
Exchange Commission (SEC). Copies of the Corporation's filings with the SEC are
available at no cost on the SEC's Web Site at www.sec.gov or on the
Corporation's Web Site at www.NationalCity.com.
44
FINANCIAL REVIEW
The financial review section discusses the financial condition and results of
operations of National City Corporation (the Corporation or National City) for
the three and six months ended June 30, 2003 and serves to update the 2002
Annual Report on Form 10-K (Form 10-K). The financial review should be read in
conjunction with the financial information contained in the Form 10-K and in the
accompanying consolidated financial statements and notes presented on pages 4
through 44 of this Form 10-Q.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
National City's consolidated financial statements are prepared in accordance
with accounting principles generally accepted in the United States and follow
general practices within the industries in which it operates. Application of
these principles requires management to make estimates, assumptions, and
judgments that affect the amounts reported in the financial statements and
accompanying notes. These estimates, assumptions, and judgments are based on
information available as of the date of the financial statements; accordingly,
as this information changes, the financial statements could reflect different
estimates, assumptions, and judgments. Certain policies inherently have a
greater reliance on the use of estimates, assumptions, and judgments and as such
have a greater possibility of producing results that could be materially
different than originally reported. Estimates, assumptions, and judgments are
necessary when assets and liabilities are required to be recorded at fair value,
when a decline in the value of an asset not carried on the financial statements
at fair value warrants an impairment write-down or valuation reserve to be
established, or when an asset or liability needs to be recorded contingent upon
a future event. Carrying assets and liabilities at fair value inherently results
in more financial statement volatility. The fair values and the information used
to record valuation adjustments for certain assets and liabilities are based
either on quoted market prices or are provided by other third-party sources,
when available. When third-party information is not available, valuation
adjustments are estimated in good faith by management primarily through the use
of internal cash flow modeling techniques.
The most significant accounting policies followed by the Corporation are
presented in Note 1 to the consolidated financial statements. These policies,
along with the disclosures presented in the other financial statement notes and
in this financial review, provide information on how significant assets and
liabilities are valued in the financial statements and how those values are
determined. Based on the valuation techniques used and the sensitivity of
financial statement amounts to the methods, assumptions, and estimates
underlying those amounts, management has identified the determination of the
allowance for loan losses, the valuation of retained interests, including
mortgage and other servicing assets, the valuation of derivative instruments,
and the valuation of leased asset residuals to be the accounting areas that
require the most subjective or complex judgments, and as such could be most
subject to revision as new information becomes available.
The allowance for loan losses represents management's estimate of probable
credit losses inherent in the loan and lease portfolio. Determining the amount
of the allowance for loan losses is considered a critical accounting estimate
because it requires significant judgment and the use of estimates related to the
amount and timing of expected future cash flows on impaired loans, estimated
losses on pools of homogeneous loans based on historical loss experience, and
consideration of current economic trends and conditions, all of which may be
susceptible to significant change. The loan and lease portfolio also represents
the largest asset type on the consolidated balance sheet. Note 1 to the
consolidated financial statements describes the methodology used to determine
the allowance for loan losses and a discussion of the factors driving changes in
the amount of the allowance for loan losses is included in the Credit Risk
Management section of this financial review.
Retained interests, including mortgage and other servicing assets, are
established and accounted for based on discounted cash flow modeling techniques
which require management to make estimates regarding the amount and timing of
expected future cash flows, including assumptions about loan repayment rates,
credit loss experience, and costs to service, as well as discount rates that
consider the risk involved. Because the values of these assets are sensitive to
changes in assumptions, the valuation of retained interests is considered a
critical accounting estimate. Notes 1, 5 and 11 to the consolidated financial
statements include further discussion on the accounting for these assets and
provide sensitivity analyses showing how the value of these assets is estimated
to change in response to adverse changes in the key assumptions used to
determine their value.
The valuation of derivative instruments is considered critical because the
majority of the derivative instruments held by the Corporation are valued using
discounted cash flow modeling techniques, which require the use of estimates
regarding the amount and timing of future cash flows. Derivative instruments are
carried at fair value on the consolidated balance sheet with changes in value
recorded in the income statement. Notes 1 and 22 to the consolidated financial
statements provide further discussion on the accounting for and the
Corporation's use of derivative instruments.
45
Lease financing arrangements include a residual value component, which
represents the estimated value of the leased asset upon the expiration of the
lease. The Corporation leases to customers various types of equipment under
commercial lease financing arrangements and also has a portfolio of automobile
lease financings, although this portfolio has been declining since the decision
was made in December 2000 to cease originating automobile leases. The valuation
of residual assets is considered critical due to the sensitivity in forecasting
the impact of product and technology changes, consumer behavior, competitor
initiatives, shifts in supply and demand, and economic conditions, among other
factors, on the fair value of residual assets. Notes 1 and 7 to the consolidated
financial statements provide further discussion of the Corporation's lease
financing arrangements.
Any material effect on the financial statements related to these critical
accounting areas is also discussed in this financial review.
RECENT ACCOUNTING PRONOUNCEMENTS AND DEVELOPMENTS
Note 2 to the consolidated financial statements discusses new accounting
policies adopted by the Corporation during 2003 and the expected impact of
accounting policies recently issued or proposed but not yet required to be
adopted. To the extent the adoption of new accounting standards materially
affects the Corporation's financial condition, results of operations, or
liquidity, the impacts are discussed in the applicable section(s) of this
financial review and notes to the consolidated financial statements.
EARNINGS SUMMARY
National City reported net income for the second quarter and first six months of
2003 of $617 million and $1.1 billion, respectively, up from net income of $393
million and $839 million for the same periods in 2002. Net income per diluted
share was $.99 and $1.80 for the second quarter and first six months of 2003,
respectively, up from net income per diluted share of $.63 and $1.36 for the
same 2002 periods. Returns on average common equity and average assets were
28.1% and 2.08%, respectively, for the second quarter of 2003, compared to 20.0%
and 1.61%, respectively, for the second quarter of 2002. Year-to-date returns on
average common equity and average assets in 2003 were 25.8% and 1.91%,
respectively, versus 22.0% and 1.69%, respectively, in 2002.
Record levels of mortgage banking activity resulting from the historically low
interest rate environment, partially offset by higher credit costs, drove
increases in net interest income and fee income and led to strong financial
results for the second quarter and first six months of 2003.
FINANCIAL CONDITION
This section should also be reviewed in conjunction with the average balance
sheets presented on pages 62-63 of this financial review.
AVERAGE EARNING ASSETS
A summary of average earning assets follows:
- ---------------------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
- ---------------------------------------------------------------------------------------------------------------------------
JUNE 30 March 31 June 30 JUNE 30 June 30
(In Millions) 2003 2003 2002 2003 2002
- ---------------------------------------------------------------------------------------------------------------------------
Portfolio loans
Commercial $ 24,319 $ 24,596 $25,127 $ 24,458 $25,628
Real estate -- commercial 9,475 9,420 7,909 9,448 7,796
Real estate -- residential 22,469 21,025 15,161 21,751 15,047
Home equity lines of credit 8,761 8,152 6,679 8,458 6,374
Credit card and other unsecured
lines of credit 2,084 2,033 1,810 2,059 1,795
Other consumer 7,957 7,957 11,244 7,955 11,289
- ---------------------------------------------------------------------------------------------------------------------------
Total portfolio loans 75,065 73,183 67,930 74,129 67,929
Loans held for sale or
securitization 24,118 22,524 10,343 23,325 12,666
Securities (at amortized cost) 7,397 8,295 8,660 7,844 8,745
Other 775 783 864 779 833
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL EARNING ASSETS $107,355 $104,785 $87,797 $106,077 $90,173
===========================================================================================================================
Average earning assets increased to $107.4 billion during the second quarter of
2003, up from $104.8 billion last quarter and $87.8 billion for the second
quarter of 2002. Year-to-date average earning assets also increased to $106.1
billion for the first six months of 2003, up from $90.2 billion for the same
period a year ago. The growth in average earnings assets was principally due to
the continued growth in residential real estate and home equity loan
originations, which have been robust in this low interest rate environment.
46
Average portfolio loans grew 3% and 11% during the second quarter of 2003
compared to the first quarter of 2003, and the second quarter of 2002,
respectively. Average portfolio loans increased 9% on a year-over-year
comparison. The increase in portfolio loans was primarily driven by the
retention of residential real estate loan production from the National City
Mortgage Co. (NCMC) and First Franklin Corporation subsidiaries, and from home
equity loan production generated from the Corporation's National Home Equity
division. First Franklin mortgage loan originations remained strong during the
second quarter and first half of 2003 and amounted to $4.4 billion and $7.9
billion, respectively, compared to $2.4 billion and $4.4 billion originated in
the same periods in 2002. First Franklin originations also increased on a
linked-quarter basis, up from $3.5 billion in the first quarter of 2003. A
portion of First Franklin's mortgage loan production is retained in portfolio
with the remainder sold to third parties. During the second quarter of 2003,
$1.9 billion of First Franklin's production was retained for the residential
real estate portfolio, compared to $1.7 billion a quarter ago and $1.1 billion
in the quarter a year ago. Over the past year, $6.6 billion of First Franklin
loans were retained in portfolio. Period-end First Franklin residential real
estate loans grew to $11.5 billion at June 30, 2003, up from $10.4 billion last
quarter and $7.5 billion at June 30, 2002. Additionally, the residential real
estate portfolio increased as the result of retaining certain adjustable-rate
mortgage loans in portfolio. These loans were originated by NCMC and the total
amount of mortgage loans retained in portfolio during the second quarter of and
first six months of 2003 was $489 million and $1.2 billion, respectively. The
residential real estate portfolio was also affected by the December 31, 2002
reclassification of $3.2 billion of installment loans secured by real estate
from the other consumer portfolio. This loan reclassification was made to make
the balance sheet presentation of loans secured by real estate more consistent
with bank regulatory definitions. Home equity loan production remained strong
due to the low interest rate environment and management's focus on the national
home equity market.
Average commercial loans remained flat on a linked-quarter basis and decreased
during the second quarter and first half of 2003 when compared to the same
periods in 2002. Commercial loan demand continued to be reflective of the weak
economic environment, as corporate borrowers remained cautious in their spending
and borrowing decisions. The year-over-year increase in average commercial real
estate, and to some extent the decrease in average commercial loans, is the
result of a 2002 fourth quarter $1.1 billion reclassification of loans from the
commercial loan portfolio. This reclassification was made to make the
presentation of loans secured by commercial real estate more consistent with
bank regulatory guidelines. The following table summarizes the period-end
commercial and commercial real estate portfolios by major industry and exposure
to individual borrowers as of June 30, 2003.
- ---------------------------------------------------------------------------------------------------------------------
Average Largest Loan
Outstanding % to Loan Balance to a Single
(Dollars in Millions) Balance Total Per Obligor Obligor
- ---------------------------------------------------------------------------------------------------------------------
Real estate $10,154 30% $.8 $ 61
Consumer cyclical 5,054 15 .8 91
Consumer noncyclical 3,898 12 .4 47
Industrial 3,559 10 .9 78
Basic materials 2,952 9 1.4 67
Financial 2,417 7 1.8 60
Services 1,466 4 .4 133(a)
Energy and utilities 676 2 1.1 50
Technology 354 1 3.0 22
Miscellaneous 1,579 5 .2 18
- ---------------------------------------------------------------------------------------------------------------------
32,109 95
Commercial leasing -- all industries 1,533 5
- ---------------------------------------------------------------------------------------------------------------------
TOTAL $33,642 100%
=====================================================================================================================
(a) This loan is secured by government-insured student loans.
Record mortgage loan origination volumes at NCMC and First Franklin drove the
increase in average loans held for sale in the second quarter, up 7% and 133%
over average loans held for sale in the previous quarter and prior year,
respectively. Similarly, 2003 year-to-date average loans held for sale increased
84% over the comparable 2002 period. The sustained increase in mortgage activity
and loans held for sale is the result of the historically low interest rate
environment, which has fueled mortgage refinancings. Refer to the Noninterest
Income section of this financial review for further discussion on NCMC and First
Franklin mortgage loan originations. The higher level of loans held for sale
served as the primary driver of the increase in net interest income and, as a
result of a steeper yield curve, also had a positive impact on the net interest
margin.
Average securities decreased during the second quarter and first half of 2003
over the same 2002 periods primarily due to principal paydowns, particularly in
the mortgage-backed securities portfolio.
47
AVERAGE INTEREST BEARING LIABILITIES AND FUNDING
A summary of average interest bearing liabilities and funding follows:
Three Months Ended Six Months Ended
- ---------------------------------------------------------------------------------------------------------------------------
JUNE 30 March 31 June 30 JUNE 30 June 30
(In Millions) 2003 2003 2002 2003 2002
- ---------------------------------------------------------------------------------------------------------------------------
Noninterest bearing deposits $ 17,596 $ 15,689 $12,760 $ 16,648 $12,564
Interest bearing core deposits 41,464 40,398 37,950 40,934 37,539
- ---------------------------------------------------------------------------------------------------------------------------
Total core deposits 59,060 56,087 50,710 57,582 50,103
Purchased deposits 10,157 9,972 8,834 10,065 10,071
Short-term borrowings 13,480 14,942 8,499 14,207 10,678
Long-term debt and capital securities 23,914 22,826 19,432 23,373 19,026
- ---------------------------------------------------------------------------------------------------------------------------
Total purchased funding 47,551 47,740 36,765 47,645 39,775
Stockholders' equity 8,802 8,600 7,886 8,701 7,709
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL FUNDING $115,413 $112,427 $95,361 $113,928 $97,587
===========================================================================================================================
TOTAL INTEREST BEARING LIABILITIES $ 89,015 $ 88,138 $74,715 $ 88,579 $77,314
===========================================================================================================================
The percentage of each funding source to total funding follows:
Three Months Ended Six Months Ended
- ---------------------------------------------------------------------------------------------------------------------------
JUNE 30 March 31 June 30 JUNE 30 June 30
2003 2003 2002 2003 2002
- ---------------------------------------------------------------------------------------------------------------------------
Noninterest bearing deposits 15.3% 14.0% 13.4% 14.6% 12.9%
Interest bearing core deposits 35.9 35.9 39.8 35.9 38.5
- ---------------------------------------------------------------------------------------------------------------------------
Total core deposits 51.2 49.9 53.2 50.5 51.4
Purchased deposits 8.8 8.9 9.3 8.8 10.3
Short-term borrowings 11.7 13.3 8.9 12.5 10.9
Long-term debt and capital securities 20.7 20.3 20.3 20.5 19.5
- ---------------------------------------------------------------------------------------------------------------------------
Total purchased funding 41.2 42.5 38.5 41.8 40.7
Stockholders' equity 7.6 7.6 8.3 7.7 7.9
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL 100.0% 100.0% 100.0% 100.0% 100.0%
===========================================================================================================================
Average interest bearing liabilities totaled $89.0 billion for the second
quarter of 2003, up from $88.1 billion last quarter and $74.7 billion for second
quarter of 2002. Year-over-year average interest bearing liabilities also
increased to $88.6 billion for the first half of 2003, up from $77.3 billion a
year ago. Core deposits continued to grow during the second quarter of 2003,
continuing a trend that began in late 2000, reflecting new account acquisition
and retention, expanded product offerings such as free checking and online bill
payment, and improved customer service. Core deposit growth was also driven by a
higher level of mortgage banking escrow balances associated with the increase in
mortgage banking activity and, to a lesser extent, a general shift in customer
preference away from the equity markets and into insured bank deposits. Average
short-term borrowings increased during the first half of 2003 to support asset
growth, mainly mortgage loans held for sale. Asset growth was also supported
through the 2003 increase in average long-term debt, principally through the
issuance of senior and subordinated bank notes by the bank subsidiaries and the
issuance of senior notes by the holding company. Refer to Note 13 of the
consolidated financial statements for discussion on the Corporation's long-term
debt.
CAPITAL
The Corporation has consistently maintained regulatory capital ratios at or
above the "well-capitalized" standards. For further detail on capital and
capital ratios, see Notes 15 and 16 to the consolidated financial statements.
Stockholders' equity was $9.1 billion at June 30, 2003, up from $8.3 billion and
$7.9 billion at December 31, 2002 and June 30, 2002, respectively. Equity as a
percentage of assets was 7.34% at June 30, 2003, compared to 7.03% at December
31, 2002 and 8.02% a year ago. Book value per common share rose to $14.77 at
June 30, 2003, up from $13.59 and $13.02 at December 31, 2002 and June 30, 2002,
respectively.
During the first quarter of 2003 and the fourth quarter of 2002, the Corporation
repurchased 1.4 million shares and 1.3 million shares, respectively. There were
no shares repurchased during the second quarter of 2003 or during the first six
months of 2002. As of June 30, 2003, 37.9 million shares remain authorized for
repurchase. Subject to ongoing capital, investment, and acquisition
considerations, management intends to continue share repurchases in 2003 on an
opportunistic basis.
48
National City declared and paid dividends per common share of $.305 during the
second quarter of 2003, up one cent from the quarterly dividend per share
declared and paid in the 2002 second quarter of $.295. On July 1, 2003, National
City's Board of Directors approved an increase in the third quarter dividend to
$.32 per common share, representing the sixteenth increase in the dividend over
the last ten years. The dividend payout ratio, representing dividends per share
divided by earnings per share, was 30.8% and 46.8% for the second quarters of
2003 and 2002, respectively. The dividend payout is under review by management
and the Board of Directors in light of the enactment of new tax laws in 2003.
At June 30, 2003, the Corporation's market capitalization was $20.1 billion.
National City's common stock is traded on the New York Stock Exchange under the
symbol "NCC." Stock price information for National City's common stock is
presented in the following table.
- --------------------------------------------------------------------------------------------------
2003 2002
---------------------------- -------------------------------------------
SECOND First Fourth Third Second
NYSE: NCC QUARTER Quarter Quarter Quarter Quarter
- --------------------------------------------------------------------------------------------------
High $34.97 $29.45 $29.82 $33.49 $33.75
Low 27.92 26.53 24.60 25.58 29.60
Close 32.71 27.85 27.32 28.53 33.25
===================================================================================================
RESULTS OF OPERATIONS
NET INTEREST INCOME
This section should also be reviewed in conjunction with the daily average
balances/net interest income/rates table presented on pages 63-65 of this
financial review.
The primary source of the Corporation's revenue is net interest income. Net
interest income is discussed and presented in this financial review on a
tax-equivalent basis as the interest on certain loans and securities held by the
Corporation is not taxable for Federal income tax purposes. In order to compare
the tax-exempt yields on these assets to taxable yields, the interest earned on
these assets is adjusted to a pretax-equivalent amount based upon the marginal
Federal income tax rate of 35%. The tax-equivalent adjustments to net interest
income were $7 million and $15 million for the second quarter and first six
months of 2003, respectively, and $8 million and $16 million for the same
periods in 2002, respectively.
Tax-equivalent net interest income for the second quarter and first six months
of 2003 was $1.1 billion and $2.2 billion, respectively, up from $971 million
and $2.0 billion for the comparable 2002 periods. The net interest margin was
4.11% in the second quarter of 2003, compared to 4.21% in the first quarter of
this year and 4.42% in last year's second quarter. The 2003 year-to-date net
interest margin was 4.16%, compared to 4.39% for the first six months of 2002.
The growth in net interest income during the second quarter and first half of
2003 was the result of earning asset growth, driven mostly by strong mortgage
loan originations, a more favorable earning asset mix, and lower funding costs.
The lower margin in 2003 was due to reduced asset yields and narrower spreads on
deposits, reflecting the ongoing effect of lower market interest rates.
49
NONINTEREST INCOME
Details of noninterest income follow:
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
- ------------------------------------------------------------------------------------------------------------------------------------
JUNE 30 March 31 June 30 JUNE 30 June 30
(In Millions) 2003 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Mortgage banking revenue $ 476 $394 $248 $870 $ 443
Deposit service charges 142 135 126 277 245
Payment processing revenue 113 105 112 218 221
Trust and investment management fees 78 69 85 147 163
Card-related fees 44 41 32 85 64
Brokerage revenue 34 24 31 58 58
Other service fees 26 28 30 54 52
Other 117 70 65 187 174
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FEES AND OTHER INCOME 1,030 866 729 1,896 1,420
Securities gains, net 32 -- 44 32 98
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL NONINTEREST INCOME $1,062 $866 $773 $1,928 $1,518
====================================================================================================================================
Fees and other income for the second quarter of 2003 totaled $1.0 billion, up
from $866 million in the 2003 first quarter and $729 million in the second
quarter of 2002. Fees and other income for the first half of 2003 reached $1.9
billion, up from $1.4 billion last year. In general, the increase in fees and
other income was primarily driven by the continued growth in mortgage banking
revenue, and to a lesser extent, increases in deposit service charges,
card-related fees, and derivative gains included in other noninterest income. A
discussion of significant changes in fees and other income follows.
Details of mortgage banking revenue follow:
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
- ------------------------------------------------------------------------------------------------------------------------------------
JUNE 30 March 31 June 30 JUNE 30 June 30
(In Millions) 2003 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Servicing revenue:
Net servicing fees $ 92 $ 120 $ 94 $ 212 $ 182
Amortization of mortgage servicing assets (137) (148) (78) (285) (147)
Mortgage servicing asset impairment
(charge) recovery (74) 87 (87) 13 (74)
Mortgage servicing asset ineffective
hedge and other derivative gains, net 185 76 113 261 137
- ------------------------------------------------------------------------------------------------------------------------------------
Net servicing revenue 66 135 42 201 98
National City Mortgage Co. (NCMC)
origination and sales revenue 322 190 163 512 288
- ------------------------------------------------------------------------------------------------------------------------------------
Total NCMC mortgage banking revenue 388 325 205 713 386
First Franklin origination and sales revenue 88 69 43 157 57
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL MORTGAGE BANKING REVENUE $ 476 $ 394 $248 $ 870 $ 443
====================================================================================================================================
Information on residential mortgage loan origination and sales follows:
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
- ------------------------------------------------------------------------------------------------------------------------------------
JUNE 30 March 31 June 30 JUNE 30 June 30
(In Millions) 2003 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Originations
NCMC $32,853 $24,300 $13,605 $57,153 $27,994
First Franklin 2,396 1,732 1,248 4,128 1,874
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL RESIDENTIAL MORTGAGE LOANS
ORIGINATED FOR SALE $35,249 $26,032 $14,853 $61,281 $29,868
====================================================================================================================================
Sales
NCMC $27,277 $25,611 $15,390 $52,888 $32,379
First Franklin 2,164 1,851 1,247 4,015 1,882
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL RESIDENTIAL MORTGAGE LOAN SALES $29,441 $27,462 $16,637 $56,903 $34,261
====================================================================================================================================
50
The continued growth in mortgage banking revenue during the second quarter and
first half of 2003 reflected record mortgage originations driven by the
historically low interest rate environment and the results of successful hedging
strategies to protect the value of mortgage servicing assets. Virtually all
NCMC's mortgage loan production is sold into the secondary market. Approximately
one-half of First Franklin's loan production is also sold to third parties, with
the remainder held in portfolio.
The Corporation typically retains the right to service the mortgage loans sold
by NCMC and recognizes a mortgage servicing asset upon sale of the loans. Notes
1 and 11 of the consolidated financial statements provide further discussion on
the accounting for mortgage servicing assets. As a result of the continued high
volume of mortgage loan origination and sale activity, the unpaid principal
balance of loans serviced for third parties grew to $119.9 billion at June 30,
2003, up from $101.9 billion at December 31, 2002 and $94.6 billion at June 30,
2002. Net servicing fees decreased on a linked-quarter comparison primarily due
to a first quarter 2003 adjustment of approximately $30 million to accrue
servicing fees earned but not collected. Despite the growth in loans serviced
for third parties, net servicing fees remained flat on a year-over-year
comparison, excluding the first quarter of 2003 servicing fee adjustment. This
occurred as the increase in servicing fees associated with the growth of loans
serviced for third parties was more than offset by increases in contractual
expenses paid to third-party investors for loans that prepaid during the period.
The carrying value of mortgage servicing assets at June 30, 2003, December 31,
2002, and June 30, 2002 was $733 million, $615 million, and $1.1 billion,
respectively. The year-over-year decline in the carrying value of the mortgage
servicing assets resulted from increases in actual and expected prepayment
rates, which has resulted in a lower servicing asset capitalized at the time of
sale and reduced the fair value of servicing assets previously capitalized.
During the first half of 2003, a recovery in temporary impairment was recognized
on certain mortgage servicing assets whose value increased due to rising
interest rates during the period but which could not be recognized under SFAS
133. The value of mortgage servicing assets is sensitive to changes in interest
rates. In a low rate environment, as was experienced during the first six months
of 2003 and in fiscal year 2002, mortgage loan refinancings generally increase,
causing actual and expected loan prepayments to increase, which drives down the
estimated value of existing mortgage servicing assets. The Corporation manages
the risk associated with declines in the estimated value of mortgage servicing
assets by using derivative instruments. Mortgage banking revenue in the second
quarter and first half of 2003 benefited from successful hedging strategies
designed to protect the value of mortgage servicing assets. Further detail on
mortgage servicing assets, including a sensitivity analysis of the effect
changes in assumptions have on the estimated value of servicing assets, is
included in Note 11 to the consolidated financial statements.
Deposit service charges remained strong in the second quarter of 2003. The
linked-quarter and year-over-year increase is a result of growth in core
deposits, increased cash management account activity, a higher level of customer
debit card usage, and fewer waived fees. Core deposit balances continued their
sequential quarterly growth trend as a result of new account acquisition,
expanded product offerings, and improved customer service.
Payment processing revenue generated by National Processing, Inc. (NPI),
National City's 85%-owned subsidiary, increased on a linked-quarter basis due to
higher transaction volume and the addition of $1 million in revenue associated
with NPI's purchase of Bridgeview Payment Solutions in June 2003. Refer to Note
10 of the consolidated financial statements for further discussion on NPI's
acquisition of Bridgeview Payment Solutions. The year-over-year decline in
payment processing revenue was primarily due to lower transaction volume
processed for the airline and travel industries. In 2002, NPI decided to
discontinue serving the airline industry yet will continue to process debit and
credit card transactions for airline customers until its existing contractual
obligations expire. The contracts have various expiration dates through 2005.
Refer to Note 19 to the consolidated financial statements for further discussion
on NPI and the airline industry.
Trust and investment management fees increased in the second quarter of 2003
when compared to the previous quarter primarily as a result of fees recognized
in the second quarter for seasonal tax preparation services, and to a lesser
extent, an increase in revenue associated with the value of assets under
administration. Conversely, year-over-year trust and investment management fees
decreased primarily due to lower values of assets under administration caused by
lower equity market values and net asset outflows. At June 30, 2003, assets
under administration totaled $109.1 billion, compared to $133.6 billion at
December 31, 2002, and $140.6 billion at June 30, 2002.
Card-related fees rose on a linked-quarter basis due to an increase in credit
card and ATM interchange income associated with higher transaction volume. The
year-over-year increase was mainly a result of certain excess cash flows,
principally interchange fees, associated with securitized credit card balances
which were recorded in interest income during the first half of 2002, versus
card-related fees during the first half of 2003. During the second quarter of
2003, VISA(R) and Mastercard(R) entered into an agreement to settle merchant
litigation regarding debit card interchange reimbursement fees. Final approval
of the settlement by the District Court is still pending, however, management
does not believe the impact of renegotiated debit card interchange rates will
have a material impact on results of operations, financial position, or
liquidity.
51
The linked-quarter growth in brokerage revenue resulted from increases in
investment banking and retail brokerage equity trading activities fueled by the
recovery in the equity markets during the second quarter of 2003.
Other fee income rose on a linked-quarter basis due to a $72 million second
quarter increase in non-SFAS 133 hedge relationship derivative gains primarily
associated with interest rate swaps used to economically hedge the steep yield
curve; a second quarter gain on the sale of student loans of $6 million; offset
by a second quarter partnership and joint venture loss of $7 million, and an
increase in the amount of principal investment losses realized during the second
quarter. Principal investment losses for the second quarter of 2003 were $16
million, versus a $6 million gain in the first quarter of 2003. Other fee income
also increased on a year-over-year comparison due to the aforementioned increase
in derivative gains, offset by the aforementioned partnership and joint venture
losses, an increase in principal investment losses, a decrease in the amount of
gains realized on the sale of student loans, and securitization gains of $50
million and a $5 million gain recorded for contingent consideration received in
connection with the Corporation's 2001 sale of National Asset Management
Corporation that were realized during the first half of 2002 with no similar
gains recorded in 2003. Principal investment losses and gains on the sale of
student loans were $10 million and $6 million, respectively, for the first six
months of 2003, compared to $4 million and $11 million, respectively, for the
first six months of 2002.
Net securities gains of $32 million were realized for both the second quarter
and first six months of 2003, compared to $44 million for the second quarter of
2002 and $98 million for the first half of 2002. The majority of these gains
were generated from the Corporation's internally-managed equity portfolio
comprised primarily of bank and thrift common stocks (bank stock fund). All
securities gains realized in 2003 were related to the bank stock fund, of which
$15 million represented appreciation on securities donated to the Corporation's
charitable foundation in the second quarter. Bank stock fund gains of $42
million and $91 million were realized in the second quarter and first six months
of 2002, respectively, of which $14 million represented appreciation on
securities donated to the Corporation's charitable foundation in the second
quarter. Net unrealized gains in the bank stock fund are included in other
comprehensive income, net of tax, within stockholders' equity and were $8
million at June 30, 2003.
NONINTEREST EXPENSE
Details of noninterest expense follow:
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
- ------------------------------------------------------------------------------------------------------------------------------------
JUNE 30 March 31 June 30 JUNE 30 June 30
(In Millions) 2003 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Salaries, benefits, and other personnel $ 542 $ 561 $445 $1,103 $ 889
Equipment 62 65 61 127 123
Net occupancy 56 58 55 114 110
Third-party services 71 65 60 136 113
Card processing 52 52 52 104 106
Marketing and public relations 67 17 75 84 101
Postage and supplies 33 33 30 66 62
Goodwill and other intangible asset
amortization 6 5 5 11 10
Telecommunications 19 21 22 40 43
Travel and entertainment 14 13 15 27 29
State and local taxes 14 16 14 30 31
Other real estate owned 6 3 6 9 11
Other 84 100 134 184 221
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL NONINTEREST EXPENSE $1,026 $1,009 $974 $2,035 $1,849
====================================================================================================================================
Noninterest expense was $1.0 billion in both the second and first quarters of
2003 and $974 million in the second quarter of 2002. Noninterest expense for the
first half of 2003 was $2.0 billion, compared to $1.8 billion in the first half
of 2002. A discussion of significant changes in noninterest expense follows.
52
Details of salaries, benefits, and other personnel expense follow:
Three Months Ended Six Months Ended
- --------------------------------------------------------------------------------------------------------------------------------
JUNE 30 March 31 June 30 JUNE 30 June 30
(Dollars in Millions) 2003 2003 2002 2003 2002
- --------------------------------------------------------------------------------------------------------------------------------
Salaries and incentive compensation $426 $403 $384 $ 829 $754
Stock-based compensation 6 4 2 10 4
Medical and other benefits 49 44 40 93 79
Contract labor 23 20 14 43 30
Defined contribution plan - 401(k) 17 23 13 40 33
Defined benefit pension plan (4) (4) (15) (8) (30)
Severance and other 25 71 7 96 19
- --------------------------------------------------------------------------------------------------------------------------------
TOTAL SALARIES, BENEFITS, AND OTHER PERSONNEL $542 $561 $445 $1,103 $889
================================================================================================================================
FULL-TIME-EQUIVALENT EMPLOYEES 32,414 32,633 32,158
================================================================================================================================
Salaries, benefits, and other personnel expense increased in the first half 2003
as a result of the first quarter severance-related charge, increases in
incentive compensation and contract labor, stock option expense, and higher
medical and other benefits costs. Salaries, benefits, and other personnel
expense decreased on a linked-quarter basis due to the first-quarter
severance-related charge, offset primarily by an increase in incentive
compensation. During the first quarter of 2003, the Corporation recorded
severance charges of $71 million in connection with cost-cutting initiatives
designed to improve long-term profitability. Of this charge, $67 million,
recorded as salaries, benefits, and personnel expense, was associated with a
voluntary retirement program and position eliminations made across the
Corporation's lines of business. The remaining $4 million charge was recorded to
third-party services expense and related to outplacement services offered to
employees whose positions were eliminated. Incentive compensation and contract
labor, driven by record mortgage origination and sales at NCMC and First
Franklin, increased in the second quarter and first half of 2003 when compared
to the same 2002 periods. Employee benefit-related expenses increased in 2003
primarily due to the reduction in the defined benefit pension credit,
principally driven by a decline in the long-term rate of return assumption along
with a decline in the value of the pension plan assets. See Note 21 to the
consolidated financial statements for further discussion on the Corporation's
pension plan. Other linked-quarter and year-over-year increases in employee
benefit-related expenses were attributed to increased contributions to
participant 401(k) plans and higher medical benefit costs. As discussed in Note
1 to the consolidated financial statements, the Corporation began expensing
stock options in accordance with SFAS 123 on January 1, 2003. Although stock
option expense increased in the second quarter and first six months of 2003,
this adoption had minimal impact to earnings during the first half as the
majority of stock option grants generally occur during the third quarter of each
fiscal year. Staffing levels on a full-time equivalent basis at June 30, 2003,
decreased on a linked-quarter basis due to the impact of the personnel
reductions associated with the first quarter cost-cutting initiative, offset by
increases in staffing to support the mortgage banking business. Conversely,
staffing levels increased on a year-over-year comparison to support the record
levels of mortgage banking activity, partially offset by the aforementioned
personnel reductions.
Third-party services expense increased on a year-over-year basis due to the
position elimination outplacement service expense of $4 million discussed above,
increases in payment processing referral fees, increases in professional service
fees, and activities outsourced due to the increase in mortgage banking volume.
The linked-quarter increase in third-party services is attributed to the same
factors that drove the increase in the year-over-year comparison, offset by the
outplacement service expense that was recorded in the first quarter of 2003.
Marketing and public relations expense increased on a linked-quarter basis
primarily due to the 2003 second quarter charge of $40 million associated with
the donation of appreciated investment securities to the Corporation's
charitable foundation and, to a lesser extent, an increase in television and
print advertising costs associated with the Corporation's ongoing brand
awareness campaign. The year-over-year decrease in marketing and public
relations expense is attributed to a greater amount of appreciated investment
securities donated to the charitable foundation and an increase in advertising
expenses incurred during the first half of 2002. The amount of the appreciated
investment securities donated in the second quarter of 2002 was $53 million.
Other noninterest expense decreased on both a linked-quarter and year-over-year
basis. Items affecting linked-quarter comparability were first quarter 2003
commercial and automobile lease residual value charges of $17 million and $25
million, respectively, charges associated with the revaluation of community and
civic partnership investments of $21 million and $13 million for the second and
first quarters of 2003, respectively, and a $9 million building lease
termination charge recorded in the second quarter of 2003 for the purchase of
National City Center, the Corporation's headquarters building in Cleveland,
Ohio. Items affecting year-over-year comparability included first half 2003 and
2002 charges of $34 million and $4 million, respectively, for the revaluation of
community and civic partnership investments, commercial and automobile lease
residual value charges of $5 million and $51 million, respectively, for the
first six months of 2002, compared to the aforementioned residual value charges
recorded in the first quarter and first half of 2003, and a $22 million charge
recorded in the first half 2002 to reflect estimated impairment in various other
assets.
53
The efficiency ratio, calculated as noninterest expense divided by the sum of
tax-equivalent net interest income and total fees and other income, was 48.1%
and 49.6% for the second quarter and first six months of 2003, respectively,
down from 57.3% and 54.4% for the comparable periods in 2002.
INCOME TAXES
The Corporation's effective tax rate was 34.5% for the first half of 2003
compared to 34.2% for the first half of 2002.
LINE OF BUSINESS RESULTS
National City is functionally managed along five major business lines. A
description of each business line, including its products, customers and markets
served, and selected financial information for the second quarter and first six
months of 2003 and 2002 is included in Note 23 to the consolidated financial
statements. A discussion of line of business results for the second quarter of
2003 follows.
Net income (loss) by line of business follows:
Three Months Ended Six Months Ended
- ----------------------------------------------------------------------------------------------------------------------------------
JUNE 30 March 31 June 30 JUNE 30 June 30
(In Millions) 2003 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------------------------
Consumer and Small Business Financial Services $168 $141 $140 $309 $279
Wholesale Banking 58 55 77 113 139
National Consumer Finance 400 352 174 752 331
Asset Management 27 19 26 46 52
National Processing 11 9 12 20 24
Parent and Other (47) (79) (37) (127) 14
- ----------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED NET INCOME $617 $497 $392 $1,113 $839
==================================================================================================================================
The improved results for Consumer and Small Business Financial Services during
the second quarter and first half of 2003 reflect strong loan and deposit
growth, which boosted service fees earned on credit card and home equity loans,
deposit accounts, and ATM transactions. Loan growth was driven by higher home
equity loan production, an increase in credit card loans associated with new
product offerings, and growth in small business loans, partially offset by the
continued run off of the automobile lease portfolio. Deposits grew over the
prior year as a result of new product offerings such as free checking accounts,
a new money market management account and online bill payment; better sales
efforts aided by enhanced incentive compensation programs; and an ongoing
emphasis on customer service and account retention. Over the past several years,
the business line has improved customer service through investments in training
and back-office technology. Although net interest income has benefited over the
past year from loan and deposit growth, the sustained low interest rate
environment has reduced the net interest margin on deposits. Noninterest expense
decreased on a linked-quarter and year-over-year comparison mainly due to the
effect of automobile lease residual value write-downs, offset by higher
sales-driven personnel expenses. Pretax automobile lease residual value
write-downs were $25 million and $51 million for the first six months of 2003
and 2002, respectively. The entire automobile lease residual value write-down in
2003 was recorded in the first quarter.
Net income for Wholesale Banking declined during the first half of 2003 as loan
demand remained soft and credit costs rose over the past year. The rise in
credit costs have not been concentrated in any particular industry or geographic
area. Noninterest expense increased primarily due to a pretax $17 million charge
recognized during the first six months of 2003 to write down the values of
certain commercial lease assets, versus a similar charge of $5 million
recognized last year. Noninterest income decreased principally due to lower
syndication fees, pretax principal investment losses of $10 million recognized
during the first half of 2003, versus principal investment losses of $4 million
recognized in the previous year, offset by increases in standby letter of credit
fees, deposit fees, and investment banking revenue. Net interest income
increased as the low interest rate environment widened spreads on loans.
Wholesale Banking's results improved on a linked-quarter basis due to lower
second quarter loan loss provision, higher net interest income, and lower
noninterest expense resulting from the recognition of the aforementioned
commercial lease write-down in the first quarter of 2003. The increases were
somewhat offset by lower noninterest income due to second quarter pretax
principal investment losses of $16 million, versus principal investment gains of
$6 million recorded in the first quarter.
Net income for National Consumer Finance rose significantly during the first six
months of 2003 over the prior year and also increased on a linked-quarter basis.
The business line continued to benefit from the low mortgage interest rate
environment, which fueled record loan origination activity. At the same time,
lower short-term rates resulted in a steep yield curve, which boosted the net
interest margin on the mortgage warehouse and facilitated advantageous mortgage
servicing hedging strategies. Residential mortgage production and sales volume
for the first six months of 2003 increased significantly, up 105% and 66%,
respectively, over the first
54
half of last year. Residential mortgage production and sales volume also
increased during the second quarter of 2003, up 35% and 7%, respectively, over
the 2003 first quarter. Average mortgage loans held for sale were approximately
$24.1 billion for the quarter ended June 30, 2003, compared to $22.5 billion and
$10.3 billion for the quarters ended March 31, 2003 and June 30, 2002,
respectively. Residential mortgage production included nonconforming loans
generated by First Franklin. Over the past year, approximately $6.6 billion of
First Franklin's loan production has been retained in portfolio. As of June 30,
2003, the portfolio of First Franklin loans totaled $11.5 billion, compared to
$10.4 billion last quarter and $7.5 billion at June 30, 2002. Growth in this
portfolio has also contributed to the increase in net interest income and the
provision for loan losses. Growth in home equity loans generated by the National
Home Equity division also contributed to the year-over-year and linked-quarter
increase in net income.
Net income for Asset Management declined in the first half of 2003 principally
due to a lower level of assets under administration resulting from lower equity
market values and net asset outflows. Assets under administration were $109.1
billion, $133.6 billion, and $140.6 billion at June 30, 2003, December 31, 2002,
and June 30, 2002, respectively. Net income increased on a linked-quarter
comparison due to an increase in fee income associated with seasonal tax
preparation fees and to a lesser extent, quarterly increases in trust and
investment management fee income associated with the second quarter recovery in
the equity markets.
National Processing's lower results for the first half of 2003 reflected growth
in transaction volume from existing customers and the addition of new regional
merchants that were more than offset by price compression in the national
merchant base, weak consumer spending, and a decline in transactions processed
for the airline industry. The lower airline volumes are the result of the
strategic decision in 2002 to discontinue serving this customer base as existing
contractual obligations expire. The contracts have various expiration dates
through 2005. The revenue generated from these contracts represented
approximately 8% of National Processing's 2002 annual revenue. National
Processing's results for the first six months of 2002 also included a $2 million
charge associated with the relocation of certain processing operations from
Mexico to the United States. Net income rose on a linked-quarter basis primarily
due to an increase in transaction volume during the second quarter.
The Parent and Other category included the results of investment funding
activities, unallocated corporate income and expense, and intersegment revenue
and expense eliminations. Several significant items affected net income on a
linked-quarter and year-over-year comparison. During the second quarter of 2003,
noninterest expense included a $40 million charge associated with the donation
of appreciated investment securities to the Corporation's charitable foundation,
compared to a second quarter 2002 charge of $53 million, and a $9 million lease
termination penalty associated with the purchase of the Corporation's
headquarters building in Cleveland, Ohio. Additionally, noninterest expense
included $71 million in severance and related charges associated with the
Corporation's first quarter 2003 cost-reduction initiatives. Noninterest income
included first quarter 2002 securitization gains of $50 million and a second
quarter 2002 gain of $5 million for contingent consideration received in
connection with the sale of the Corporation's investment in NAMCO. These items
did not recur in 2003. Fee income included bank stock fund gains in the second
quarter and first half of 2003 in the amount of $32 million, compared to gains
of $42 million and $90 million, respectively, for the same 2002 periods. There
were no bank stock fund gains recorded during the first quarter of 2003. Net
interest expense increased in the second quarter and first half of 2003 mainly
as the result of maintaining an asset sensitive interest rate risk position in
the current low interest rate environment and from internal crediting rates on
new deposits being higher than the immediately available investment
opportunities for those funds.
55
CONTRACTUAL OBLIGATIONS, COMMITMENTS, CONTINGENT LIABILITIES,
AND OFF-BALANCE SHEET ARRANGEMENTS
The following table presents, as of June 30, 2003, the Corporation's significant
fixed and determinable contractual obligations by payment date. The payment
amounts represent those amounts contractually due to the recipient and do not
include accrued interest, unamortized premiums or discounts, hedge basis
adjustments, or other similar carrying value adjustments. The operating lease
amounts represent obligations as of December 31, 2002, adjusted for the
cancellation of the lease associated with the Corporation's headquarters
building. Further discussion of the nature of each obligation is included in the
referenced note to the consolidated financial statements.
- ------------------------------------------------------------------------------------------------------------------------------
PAYMENTS DUE IN
-------------------------------------------------------
ONE TO THREE TO OVER
NOTE ONE YEAR THREE FIVE FIVE
(In Millions) REFERENCE OR LESS YEARS YEARS YEARS TOTAL
- ------------------------------------------------------------------------------------------------------------------------------
Deposits without a stated maturity $50,724 $ -- $ -- $ -- $50,724
Consumer and brokered certificates
of deposits 6,990 6,639 1,478 940 16,047
Federal funds borrowed and security
repurchase agreements 12,112 -- -- -- 12,112
Borrowed funds 12 2,668 -- -- -- 2,668
Long-term debt 13 13,969 7,091 2,616 3,559 27,235
Capital securities 14 -- -- -- 180 180
Operating leases 122 178 112 258 670
===============================================================================================================================
The Corporation also enters into derivative contracts under which the
Corporation is required to either receive cash from or pay cash to
counterparties depending on changes in interest rates. Derivative contracts are
carried at fair value on the consolidated balance sheet with the fair value
representing the net present value of expected future cash receipts or payments
based on market interest rates as of the balance sheet date. The fair value of
the contracts change daily as market interest rates change. Certain contracts,
such as interest rate futures, are cash settled daily, while others, such as
interest rate swaps, require monthly cash settlement. Because the derivative
liabilities recorded on the balance sheet at June 30, 2003 do not represent the
amounts that may ultimately be paid under these contracts, these liabilities are
not included in the table of contractual obligations presented above. Further
discussion of derivative instruments is included in Notes 1 and 22 to the
consolidated financial statements.
A schedule of significant commitments at June 30, 2003 follows:
- ------------------------------------------------------------------------------------------------------------
(In Millions)
- ------------------------------------------------------------------------------------------------------------
Commitments to extend credit:
Revolving home equity and credit card lines $19,489
Other loans 49,538
Standby letters of credit 3,728
Commercial letters of credit 156
Net commitments to sell mortgage loans and mortgage-backed 33,872
Commitments to fund principal investments 232
Commitments to fund civic and community investments 169
============================================================================================================
Further discussion of these commitments is included in Note 19 to the
consolidated financial statements.
The Corporation may also have liabilities under certain contractual agreements
contingent upon the occurrence of certain events. A discussion of significant
contractual arrangements under which National City may be held contingently
liable, including guarantee arrangements, is included in Notes 19 and 24 to the
consolidated financial statements.
The Corporation's significant off-balance sheet arrangements include the use of
special-purpose entities, generally securitization trusts, to diversify its
funding sources. During 2002, 2001 and 2000, National City either sold credit
card receivables and/or automobile loans to securitization trusts, which are
considered qualified special-purpose entities and, accordingly, are not included
in the consolidated balance sheet. The Corporation continues to service the
loans sold to the trusts, for which it receives a servicing fee, and also has
certain retained interests in the assets of the trusts. Further discussion on
the accounting for securitizations is included in Note 1 to the consolidated
financial statements and detail regarding securitization transactions and
retained interests is included in Note 5.
56
RISK MANAGEMENT
The Board of Directors is the foundation for effective corporate governance and
risk management. The Board demands accountability of management, keeps
stockholders' and other constituencies' interests in focus, advocates the
upholding of the Corporation's code of ethics, and fosters a strong internal
control environment. Through its Investment and Audit Committees, the Board
actively reviews critical risk positions, including market, credit, liquidity,
and operational risk. The Corporation's goal in managing risk is to control
exposure to unnecessary risk and ensure appropriate returns for risk assumed.
Senior management actively manages risk at the line of business level,
supplemented with corporate-level oversight through the Asset Liability
Committee, internal audit and quality control functions, and other risk
management groups. Building on these strengths, the Corporation created a Chief
Risk Officer function in late 2002 to reinforce the focus on risk management.
This risk management structure is designed to surface risk issues through a
systematic process, enabling timely and appropriate action to avoid and mitigate
risk. The new risk management organization builds on existing practices by
establishing risk limits and more robust measurement systems, continuing to
focus on risk-reduction strategies, and further refining capital-allocation
practices.
CREDIT RISK MANAGEMENT
The Corporation's loan portfolios are subject to varying degrees of credit risk.
Credit risk is mitigated through portfolio diversification, limiting exposure to
any single industry or customer, collateral protection, and standard lending
policies and underwriting criteria. Note 1 to the consolidated financial
statements describes the accounting policies related to nonperforming loans and
charge-offs and describes the methodologies used to develop the allowance for
loan losses, including both the allocated and unallocated components. The
policies governing nonperforming loans and charge-offs are consistent with
regulatory standards.
The following tables provide information and statistics on the overall quality
of the loan portfolio.
NET CHARGE-OFFS: Net charge-offs by portfolio type follow:
Three Months Ended Six Months Ended
- ------------------------------------------------------------------------------------------------------------------
JUNE 30 March 31 June 30 JUNE 30 June 30
(In Millions) 2003 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------
Commercial $90 $93 $ 67 $183 $ 166
Real estate -- commercial 5 2 7 7 8
Real estate -- residential 25 31 18 56 41
Home equity lines of credit 5 4 4 9 8
Credit card and other
unsecured lines of credit 23 20 19 43 38
Other consumer 16 21 20 37 55
- ------------------------------------------------------------------------------------------------------------------
TOTAL NET CHARGE-OFFS $164 $171 $135 $335 $316
==================================================================================================================
Net charge-offs as a percentage of average loans by portfolio type follow:
- ------------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
- ------------------------------------------------------------------------------------------------------------------
JUNE 30 March 31 June 30 JUNE 30 June 30
2003 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------
Commercial 1.49% 1.53% 1.08% 1.51% 1.31%
Real estate -- commercial .22 .10 .37 .16 .23
Real estate -- residential .45 .59 .49 .52 .56
Home equity lines of credit .19 .20 .21 .20 .23
Credit card and other
unsecured lines of credit 4.46 3.92 3.87 4.19 4.21
Other consumer .80 1.09 .74 .94 .99
==================================================================================================================
TOTAL NET CHARGE-OFFS
TO AVERAGE PORTFOLIO LOANS (ANNUALIZED) .88% .95% .80% .91% .94%
==================================================================================================================
Net charge-offs in the second quarter of 2003 were $164 million, or .88% of
average loans, down from $171 million, or .95% of average loans, last quarter
and up from $135 million, or .80% of average loans, in the second quarter of
2002. For the first six months of 2003, net charge-offs totaled $335 million, or
..91% of average loans, compared to $316 million, or .94% of average loans for
the same period a year ago. The year-over-year increase in commercial loan net
charge-offs was mainly driven by higher commercial loan losses associated with
highly leveraged borrowers, as these loans are especially vulnerable in periods
of prolonged economic weakness, and credit-related losses on certain aircraft
leases. Residential real-estate net charge-offs increased
57
during the first half of 2003 over last year primarily due to the growth and
seasoning of the portfolio through the retention of First Franklin loans. Net
charge-offs for residential real estate decreased on a linked-quarter basis due
to lower levels of losses and delinquencies associated with the run-off of the
former Altegra and Loan Zone portfolios and an increase in recoveries on
previously charged-off loans due to improved loss mitigation efforts. The
linked-quarter and year-over-year increases in net charge-offs on credit card
and other unsecured lines of credit are primarily the result of higher losses
associated with an increase in consumer bankruptcies, and to a lesser extent,
growth in the portfolio. Somewhat offsetting the increase in year-to-date net
charge-offs for credit card and other unsecured lines of credit was the impact
of a change in charge-off policy in 2003 for delinquent credit card balances. In
order to better manage collection efforts, the Corporation extended the period
of time before it charges off delinquent credit card balances from 120 days to
150 days. This policy change decreased 2003 credit card net charge-offs by
approximately $2 million and also contributed to the increase in loans 90 days
past due. The linked-quarter and year-over-year decrease in other consumer net
charge-offs is due to the overall lower balance of the portfolio affected by the
reclassification of certain home equity installment loans to the residential
real estate portfolio in December 2002 and the continued run-off of the
automobile lease portfolio.
NONPERFORMING ASSETS AND DELINQUENT LOANS: Details of nonperforming assets
follow:
- ----------------------------------------------------------------------------------------------------------
JUNE 30 December 31 June 30
(Dollars in Millions) 2003 2002 2002
- ----------------------------------------------------------------------------------------------------------
Commercial $410 $414 $421
Real estate -- commercial 75 60 57
Real estate -- residential 222 228 226
- ----------------------------------------------------------------------------------------------------------
TOTAL NONPERFORMING LOANS 707 702 704
Other real estate owned (OREO) 104 115 89
Mortgage loans held for sale 4 -- --
Other 3 -- --
- ----------------------------------------------------------------------------------------------------------
TOTAL NONPERFORMING ASSETS $818 $817 $793
==========================================================================================================
NONPERFORMING ASSETS AS A PERCENTAGE OF:
PERIOD-END PORTFOLIO LOANS AND OTHER
NONPERFORMING ASSETS 1.08% 1.13% 1.15%
PERIOD-END TOTAL ASSETS .66 .69 .80
==========================================================================================================
Detail of loans 90 days past due accruing interest follows:
- ----------------------------------------------------------------------------------------------------------
JUNE 30 December 31 June 30
(In Millions) 2003 2002 2002
- ----------------------------------------------------------------------------------------------------------
Commercial $ 49 $ 43 $ 64
Real estate- commercial 26 26 30
Real estate - residential 431 449 410
Home equity lines of credit 15 16 15
Credit card and other unsecured lines of credit 14 8 7
Other consumer 19 19 18
Mortgage loans held for sale 18 14 5
Other 21 -- --
- ----------------------------------------------------------------------------------------------------------
TOTAL LOANS 90 DAYS PAST DUE ACCRUING INTEREST $593 $575 $549
==========================================================================================================
In general, the overall increase in nonperforming assets and 90 days past due
can be attributed to the same factors that drove the increases in net
charge-offs. The reduction in commercial nonperforming assets at June 30, 2003
is primarily the result of nonperforming commercial loan sales more than
offsetting the addition of commercial loans to nonperforming status. During the
second quarter and first six months of 2003, $40 million and $72 million of
nonperforming commercial loans were sold to third parties. The decrease in
residential real estate nonperforming assets and 90 days past due since year-end
was mainly due to lower levels of delinquent Altegra and Loan Zone loans, which
more than offset the increase in delinquent mortgage loans associated with the
growth of the residential real estate portfolio. The lower levels of Altegra and
Loan Zone delinquent loans also drove the decrease in OREO balances at June 30,
2003, when compared to year-end. Credit card and other unsecured lines of credit
90 days past due accruing interest increased as a result of the change in the
charge-off policy described above, as past due credit card loans remained in
portfolio longer prior to being charged-off. Mortgage loans held for sale 90
days past due increased in 2003 mainly as a result of the significant increase
in the balance of these loans over the past year.
58
ALLOWANCE FOR LOAN LOSSES: National City maintains an allowance for loan losses
sufficient to absorb estimated probable current losses inherent in the loan
portfolio. The evaluation of each element and the overall allowance are based on
the size and current risk characteristics of the loan portfolio and include an
assessment of individual problem loans, actual loss experience, current economic
events in specific industries and geographical areas, including unemployment
levels, and other pertinent factors, including regulatory guidance and general
economic conditions.
The allowance for loan losses as a percentage of portfolio loans was 1.51% at
June 30, 2003. The provision for loan losses was $183 million for the second
quarter of 2003, down from $200 million last quarter and up from the $165
million recorded in the second quarter of 2002. For the first six months of
2003, the provision for loan losses was $383 million, up from $354 million for
the comparable 2002 period. In general, the loan loss provision is reflective of
higher net charge-offs and higher levels of nonperforming and delinquent assets
during the past year, as well as management's ongoing concern about economic
conditions.
An allocation of the ending allowance for loan losses by portfolio type follows:
- ----------------------------------------------------------------------------------------------------------
JUNE 30 December 31 June 30
(In Millions) 2003 2002 2002
- ----------------------------------------------------------------------------------------------------------
Commercial $439 $ 450 $ 329
Real estate -- commercial 58 58 60
Real estate -- residential 138 126 127
Home equity lines of credit and other
consumer loans 86 124 179
Credit card and other unsecured lines of credit 88 101 93
Unallocated 338 240 242
- ----------------------------------------------------------------------------------------------------------
TOTAL ALLOWANCE FOR LOAN LOSSES $1,147 $1,099 $1,030
==========================================================================================================
The allowance allocated to the commercial portfolio at June 30, 2003, increased
from a year ago due to continued deterioration in the credit quality of
nationally syndicated loans, which are typically characterized by more highly
leveraged borrowers. The decrease in the allowance allocated to the commercial
portfolio since year-end was mainly due to the overall decline in associated
loan balances. The increase in the allowance allocated to the residential real
estate portfolio on both a year-over-year basis and since year-end was
attributable to the growth in this portfolio. Decreases in the allowance
allocated to the remaining consumer loan categories were primarily due to the
refinement of loss allocation factors to reflect a more detailed product mix
and, to a lesser extent, the reclassification of allowance to the residential
real estate portfolio related to the December 2002 reclassification of certain
home equity installment loans. The unallocated allowance, which is maintained to
absorb estimated probable inherent but undetected losses in the loan portfolio,
increased based upon management's judgment and reflects continued uncertainty
surrounding near-term economic conditions.
LIQUIDITY RISK MANAGEMENT
The objective of liquidity management is to ensure the cash flow requirements of
depositors and borrowers, as well as the operating cash needs of the
Corporation, are met, taking into account all on- and off-balance sheet funding
demands. Liquidity management also includes ensuring cash flow needs are met at
a reasonable cost. Liquidity risk arises from the possibility the Corporation
may not be able to satisfy current or future financial commitments, or may
become unduly reliant on alternative funding sources. The Corporation maintains
a liquidity risk management policy to address and manage this risk. The policy
identifies the primary sources of liquidity, establishes procedures for
monitoring and measuring liquidity, and establishes minimum liquidity
requirements in compliance with regulatory guidance. The policy also includes a
contingency funding plan to address liquidity needs in the event of an
institution-specific or a systemic financial market crisis. The liquidity
position is continually monitored and reported on monthly to the Asset/Liability
Management Committee.
Funds are available from a number of sources, including the securities
portfolio, the core deposit base, the capital markets, the Federal Home Loan
Bank, the U.S. Treasury, and through the sale and securitization of various
types of assets. Funding sources did not change significantly during the second
quarter of 2003. Core deposits, the most significant source of funding,
comprised approximately 51% of funding at June 30, 2003, December 31, 2002, and
June 30, 2002. Asset securitization vehicles have been used as a source of
funding over the past several years. During the first quarter of 2003, the
Corporation securitized $44 million of Small Business Administration loans.
During the first three months of 2002, the Corporation securitized $1.1 billion
of automobile loans and $425 million of credit card receivables. In 2001 and
2000, credit card receivables totaling $425 million and $600 million were
securitized, respectively. Further discussion of securitization activities is
included in Note 5 to the consolidated financial statements.
59
At the holding company level, cash is used to pay dividends to stockholders,
repurchase common stock, make selected investments and acquisitions, and service
debt. The main sources of funding for the holding company include dividends and
returns of investment from its subsidiaries, a line of credit with its bank
subsidiaries, the commercial paper market, a revolving credit agreement with a
group of unaffiliated banks, and access to the capital markets.
The primary source of funding for the holding company has been dividends and
returns of investment from its subsidiaries. During the first half of 2003,
dividends totaling $454 million were declared and paid to the holding company
from the subsidiaries. The bank subsidiaries also provided liquidity to the
holding company during the first half of 2003 in the form of returns of capital
totaling $180 million. As discussed in Note 15 to the consolidated financial
statements, subsidiary banks are subject to regulation and, among other things,
may be limited in their ability to pay dividends or transfer funds to the
holding company. Accordingly, consolidated cash flows as presented in the
consolidated statements of cash flows on page 6 may not represent cash
immediately available to the holding company.
Funds raised in the commercial paper market through the Corporation's
subsidiary, National City Credit Corporation, support the short-term cash needs
of the holding company and nonbank subsidiaries. At June 30, 2003, December 31,
2002 and June 30, 2002, $366 million, $1.0 billion and $346 million,
respectively, of commercial paper borrowings were outstanding.
In 2001, the holding company established a $500 million credit line with its
banking subsidiaries to provide additional liquidity support. There were no
borrowings under this agreement at June 30, 2003, December 31, 2002, and June
30, 2002.
The holding company has a $375 million revolving credit agreement with a group
of unaffiliated banks, which serves as a back-up liquidity facility. No
borrowings have occurred under this facility. See Note 13 to the consolidated
financial statements.
In April 2003, the Corporation filed a shelf registration with the SEC to allow
for the sale, over time, of up to $1.5 billion in debt securities, preferred
stock, depositary shares, and common stock issuable in connection with
conversion of the aforementioned securities. During the first quarter of 2003,
the holding company issued $300 million of senior notes under a prior shelf
registration.
MARKET RISK MANAGEMENT
Market risk is the risk of loss arising from adverse changes in the fair value
of financial instruments due to changes in interest rates, currency exchange
rates, or equity prices. Interest rate risk is National City's primary market
risk and results from timing differences in the repricing of assets and
liabilities, changes in relationships between rate indices, and the potential
exercise of explicit or embedded options. The Asset/Liability Management
Committee (ALCO) meets monthly and is responsible for reviewing the
interest-rate-sensitivity position and establishing policies to monitor and
limit exposure to interest rate risk. The guidelines established by ALCO are
reviewed by the Investment Committee of the Corporation's Board of Directors.
The Corporation is also exposed to equity price risk through its internally
managed portfolio of bank and thrift common stock investments. As of June 30,
2003, this portfolio had a cost basis and fair value of $61 million and $69
million, respectively. Price risk is mitigated through active portfolio
management and by limiting the amount invested in any one company. The
Corporation does not have any material foreign currency exchange rate risk
exposure.
ASSET/LIABILITY MANAGEMENT: One of the primary goals of asset/liability
management is to maximize net interest income and the net value of future cash
flows within authorized risk limits.
Interest Rate Risk Measurement: Interest rate risk is monitored primarily
through the use of two complementary measures: earnings simulation modeling and
net present value estimation. Both measures are highly assumption-dependent and
change regularly as the balance sheet and business mix evolve; however, taken
together they represent a reasonably comprehensive view of the magnitude of
interest rate risk, the distribution of risk along the yield curve, the level of
risk through time, and the amount of exposure to changes in certain interest
rate relationships. Both models assume a parallel shift in the yield curve. The
key assumptions employed by these measures are analyzed regularly and reviewed
by ALCO.
Earnings Simulation Modeling: Net income is affected by changes in the absolute
level of interest rates. Net income is also subject to changes in the shape of
the yield curve. In general, a flattening of the yield curve would result in a
decline in earnings due to the compression of earning asset yields and funding
rates, while a steepening would result in increased earnings as investment
margins widen. Earnings are also affected by changes in spread relationships
between certain rate indices, such as the prime rate and the London Interbank
Offering Rate (LIBOR).
The earnings simulation model projects changes in net income caused by the
effect of changes in interest rates on net interest income. The model requires
management to make assumptions about how the balance sheet is likely to evolve
through time in different interest rate environments. Loan and deposit growth
rate assumptions are derived from historical analysis and management's outlook,
as are the assumptions used to project yields and rates for new loans and
deposits. Securities portfolio maturities and prepayments are
60
assumed to be reinvested in similar instruments. Mortgage loan prepayment
assumptions are developed from industry median estimates of prepayment speeds in
conjunction with the historical prepayment performance of the Corporation's own
loans. Noncontractual deposit growth rates and pricing are modeled on historical
patterns.
The most recent earnings simulation model prepared for the July 2003 ALCO
meeting projects net income would increase by approximately 5.1% of stable-rate
net income if rates were to rise gradually by 200 basis points over the next
twelve months. The model also projects a decrease in net income of 9.1% if rates
were to fall gradually by 200 basis points over the same period. The projected
decrease in net income is above the ALCO guideline of minus 4.0%, however,
management believes a sustained 200 basis point decline in market interest rates
from their current low level is highly unlikely.
The earnings simulation model excludes the earnings dynamics related to how fee
income and noninterest expense may be affected by changes in interest rates.
Mortgage banking revenue in particular, which is generated from originating,
selling, and servicing residential mortgage loans, is highly sensitive to
changes in interest rates due to the direct effect changes in interest rates
have on loan demand and the value of mortgage servicing assets. In general, low
or declining interest rates typically lead to increased origination and sales
income but potentially lower servicing-related income due to the impact of
higher loan prepayments on the value of mortgage servicing assets. Conversely,
high or rising interest rates typically reduce mortgage loan demand and hence
origination and sales income while servicing-related income may rise due to
lower prepayments. In addition, net interest income earned on loans held for
sale increases when the yield curve steepens and decreases when the yield curve
flattens. Risk related to mortgage banking activities is also monitored by ALCO.
Net Present Value Estimation: The Net Present Value (NPV) measure is used for
discerning levels of risk present in the balance sheet that might not be taken
into account in the earnings simulation model due to the shorter time horizon
used by that model. The NPV of the balance sheet, at a point in time, is defined
as the discounted present value of asset cash flows minus the discounted value
of liability cash flows. Interest rate risk analysis using NPV involves changing
the interest rates used in determining the cash flows and in discounting the
cash flows. The resulting percentage change in NPV is an indication of the
longer-term repricing risk and options risk embedded in the balance sheet. In
contrast to the earnings simulation model, which assumes rates will experience a
gradual change and then stabilize at a particular level after one year, implied
forward rates are used for the NPV measure. The NPV measure also assumes a
static balance sheet, versus the growth assumptions that are incorporated into
the earnings simulation measure and an unlimited time horizon instead of the
one-year horizon applied in the earnings simulation model. As with earnings
simulation modeling, assumptions about the timing and variability of balance
sheet cash flows are critical in NPV analysis. Particularly important are
assumptions driving mortgage prepayments and changes in the noncontractual
deposit portfolios. These assumptions are applied consistently in both models.
The NPV model prepared for the July 2003 ALCO meeting projects an increase in
NPV of approximately 3.3% if interest rates immediately increased 150 basis
points. If rates immediately decreased by 150 basis points, the model projects
an approximate decrease in NPV of 4.5%. Policy guidelines limit the amount of
the estimated decline in NPV to 7.0%.
At the end of 2002, the interest-rate-risk position, as presented and discussed
in the 2002 Form 10-K, was asset sensitive, meaning net income should increase
as rates rise and decrease as rates fall. During the first half of 2003, the
Corporation maintained an asset sensitive interest-rate-risk position due to
management's expectation that rates will rise.
Interest Rate Risk Management: Financial instruments used to manage interest
rate risk include investment securities and interest rate derivatives, which
include interest rate swaps, interest rate caps and floors, interest rate
forwards, and exchange-traded futures and options contracts. Interest rate
derivatives have characteristics similar to securities but possess the
advantages of customization of the risk-reward profile of the instrument,
minimization of balance sheet leverage, and improvement of the liquidity
position. Further discussion of the use of and the accounting for derivative
instruments is included in Notes 1 and 22 to the consolidated financial
statements.
61
CONSOLIDATED AVERAGE BALANCE SHEETS
Three Months Ended Six Months Ended
- ------------------------------------------------------------------------------------------------------------------------------------
JUNE 30 June 30 JUNE 30 June 30
- ------------------------------------------------------------------------------------------------------------------------------------
(In Millions) 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Earning Assets:
Portfolio loans:
Commercial $ 24,319 $25,127 $ 24,458 $ 25,628
Real estate -- commercial 9,475 7,909 9,448 7,796
Real estate -- residential 22,469 15,161 21,751 15,047
Home equity lines of credit 8,761 6,679 8,458 6,374
Credit card and other unsecured lines of credit 2,084 1,810 2,059 1,795
Other consumer 7,957 11,244 7,955 11,289
- ------------------------------------------------------------------------------------------------------------------------------------
Total portfolio loans 75,065 67,930 74,129 67,929
Loans held for sale or securitization:
Commercial 13 -- 13 2
Mortgage 24,105 10,343 23,312 12,093
Automobile -- -- -- 501
Credit card -- -- -- 70
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans held for sale or securitization 24,118 10,343 23,325 12,666
Securities available for sale, at cost 7,397 8,660 7,844 8,745
Federal funds sold and security resale agreements 142 93 130 90
Other investments 633 771 649 743
- ------------------------------------------------------------------------------------------------------------------------------------
Total earning assets 107,355 87,797 106,077 90,173
Allowance for loan losses (1,127) (1,000) (1,114) (1,011)
Fair value appreciation of securities available for sale 302 208 313 200
Cash and demand balances due from banks 3,465 2,855 3,421 2,896
Properties and equipment 1,049 1,061 1,044 1,073
Other real estate owned 110 77 113 71
Mortgage servicing assets 801 1,224 781 1,224
Goodwill 1,084 1,078 1,081 1,078
Other intangible assets 69 79 70 83
Derivative assets 1,077 520 1,006 452
Accrued income and other assets 4,875 4,022 4,962 3,764
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $119,060 $97,921 $117,754 $100,003
====================================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest bearing $ 17,596 $12,760 $ 16,648 $12,564
NOW and money market 25,045 20,119 24,271 19,766
Savings 2,447 2,622 2,452 2,608
Consumer time 13,972 15,209 14,211 15,165
Brokered retail CDs 2,601 2,644 2,735 3,124
Other 606 818 553 869
Foreign 6,950 5,372 6,777 6,078
- ------------------------------------------------------------------------------------------------------------------------------------
Total deposits 69,217 59,544 67,647 60,174
- ------------------------------------------------------------------------------------------------------------------------------------
Federal funds borrowed and security repurchase agreements 11,953 7,298 12,129 8,344
Borrowed funds 1,527 1,201 2,078 2,334
Long-term debt and capital securities 23,914 19,432 23,373 19,026
Derivative liabilities 680 293 627 303
Accrued expenses and other liabilities 2,967 2,267 3,199 2,113
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 110,258 90,035 109,053 92,294
Stockholders' Equity:
Preferred -- 1 -- 1
Common 8,802 7,885 8,701 7,708
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 8,802 7,886 8,701 7,709
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $119,060 $97,921 $117,754 $100,003
====================================================================================================================================
62
DAILY AVERAGE BALANCES/NET INTEREST INCOME/RATES
(Dollars in Millions) Daily Average Balance
- ------------------------------------------------------------------------------------------------------------------------------------
2003 2002
----------------------------- ----------------------------------------------
SECOND First Fourth Third Second
QUARTER Quarter Quarter Quarter Quarter
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Earning Assets:
Loans(a):
Commercial $ 24,332 $ 24,610 $ 25,345 $ 24,881 $25,127
Real estate -- commercial 9,475 9,420 8,383 8,037 7,909
Real estate -- residential 46,574 43,535 36,372 27,728 25,504
Home equity lines of credit 8,761 8,152 7,857 7,316 6,679
Credit card and other unsecured lines of credit 2,084 2,033 1,958 1,910 1,810
Other consumer 7,957 7,957 11,052 10,924 11,244
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans 99,183 95,707 90,967 80,796 78,273
Securities available for sale, at cost:
Taxable 6,721 7,650 8,825 7,668 7,981
Tax-exempt 676 645 659 668 679
- ------------------------------------------------------------------------------------------------------------------------------------
Total securities available for sale 7,397 8,295 9,484 8,336 8,660
Federal funds sold, security resale
agreements and other investments 775 783 864 882 864
- ------------------------------------------------------------------------------------------------------------------------------------
Total earning assets/total interest
income/rates 107,355 104,785 101,315 90,014 87,797
Allowance for loan losses (1,127) (1,101) (1,079) (1,031) (1,000)
Fair value appreciation of securities
available for sale 302 324 318 299 208
Nonearning assets 12,530 12,425 12,135 11,825 10,916
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $119,060 $116,433 $112,689 $101,107 $97,921
====================================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing liabilities:
NOW and money market accounts $ 25,045 $ 23,489 $22,385 $ 21,006 $20,119
Savings accounts 2,447 2,458 2,488 2,543 2,622
Consumer time deposits 13,972 14,451 14,811 15,122 15,209
Other deposits 3,207 3,370 3,415 3,065 3,462
Foreign deposits 6,950 6,602 7,264 5,781 5,372
Federal funds borrowed 9,054 9,171 7,297 4,482 4,092
Security repurchase agreements 2,899 3,135 3,346 3,316 3,206
Borrowed funds 1,527 2,636 3,169 1,784 1,201
Long-term debt and capital securities 23,914 22,826 21,175 18,985 19,432
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities/
total interest expense/rates 89,015 88,138 85,350 76,084 74,715
Noninterest bearing deposits 17,596 15,689 15,710 13,864 12,760
Accrued expenses and other liabilities 3,647 4,006 3,243 2,941 2,560
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 110,258 107,833 104,303 92,889 90,035
TOTAL STOCKHOLDERS' EQUITY 8,802 8,600 8,386 8,218 7,886
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $119,060 $116,433 $112,689 $101,107 $97,921
====================================================================================================================================
NET INTEREST INCOME
====================================================================================================================================
INTEREST SPREAD
Contribution of noninterest bearing sources of funds
- ------------------------------------------------------------------------------------------------------------------------------------
NET INTEREST MARGIN
====================================================================================================================================
(a) Includes loans held for sale or securitization
63
(Dollars in Millions) Quarterly Interest
- ------------------------------------------------------------------------------------------------------------------------------
2003 2002
--------------------------- ------------------------------------------
SECOND First Fourth Third Second
QUARTER Quarter Quarter Quarter Quarter
- ------------------------------------------------------------------------------------------------------------------------------
ASSETS
Earning Assets:
Loans(a):
Commercial $ 243 $ 245 $ 285 $ 301 $ 309
Real estate -- commercial 146 145 136 133 134
Real estate -- residential 744 730 606 507 481
Home equity lines of credit 95 89 98 92 84
Credit card and other unsecured lines of credit 41 44 42 44 44
Other consumer 143 148 227 232 236
- ------------------------------------------------------------------------------------------------------------------------------
Total loans 1,412 1,401 1,394 1,309 1,288
Securities available for sale, at cost:
Taxable 93 102 124 119 132
Tax-exempt 13 13 13 14 14
- ------------------------------------------------------------------------------------------------------------------------------
Total securities available for sale 106 115 137 133 146
Federal funds sold, security resale
agreements and other investments 10 11 9 9 10
- ------------------------------------------------------------------------------------------------------------------------------
Total earning assets/total interest income/rates $1,528 $1,527 $1,540 $1,451 $1,444
Allowance for loan losses
Fair value appreciation of securities
available for sale
Nonearning assets
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS
==============================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing liabilities:
NOW and money market accounts $ 67 $ 68 $ 77 $ 78 $ 74
Savings accounts 3 3 4 5 6
Consumer time deposits 131 137 149 160 166
Other deposits 10 12 15 15 16
Foreign deposits 25 23 30 27 26
Federal funds borrowed 35 36 34 25 24
Security repurchase agreements 5 6 8 9 9
Borrowed funds 5 9 12 7 5
Long-term debt and capital securities 145 132 130 146 147
- ------------------------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities/
total interest expense/rates $ 426 $ 426 $ 459 $472 $473
Noninterest bearing deposits
Accrued expenses and other liabilities
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES
TOTAL STOCKHOLDERS' EQUITY
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.
==============================================================================================================================
NET INTEREST INCOME $1,102 $1,101 $1,081 $979 $971
==============================================================================================================================
INTEREST SPREAD
Contribution of noninterest bearing sources of funds
- ------------------------------------------------------------------------------------------------------------------------------
NET INTEREST MARGIN
==============================================================================================================================
(a) Includes loans held for sale or securitization
64
- -------------------------------------------------------------------------------------------------------------------------------
(Dollars in Millions) Average Annualized Rate
- -------------------------------------------------------------------------------------------------------------------------------
2003 2002
--------------------------- -----------------------------------------
SECOND First Fourth Third Second
QUARTER Quarter Quarter Quarter Quarter
- -------------------------------------------------------------------------------------------------------------------------------
ASSETS
Earning Assets:
Loans(a):
Commercial 3.99% 4.03% 4.45% 4.80% 4.94%
Real estate -- commercial 6.18 6.25 6.46 6.57 6.81
Real estate -- residential 6.39 6.71 6.66 7.31 7.54
Home equity lines of credit 4.36 4.36 4.97 5.04 5.04
Credit card and other unsecured lines of credit 8.06 8.68 8.53 9.20 9.64
Other consumer 7.19 7.55 8.16 8.44 8.40
- -------------------------------------------------------------------------------------------------------------------------------
Total loans 5.70 5.89 6.10 6.46 6.59
Securities available for sale, at cost:
Taxable 5.47 5.37 5.67 6.18 6.63
Tax-exempt 7.68 8.06 8.14 8.15 8.15
- -------------------------------------------------------------------------------------------------------------------------------
Total securities available for sale 5.68 5.58 5.84 6.33 6.75
Federal funds sold, security resale
agreements and other investments 5.33 5.71 3.88 4.03 4.48
- -------------------------------------------------------------------------------------------------------------------------------
Total earning assets/total interest income/rates 5.70% 5.86% 6.06% 6.42% 6.59%
Allowance for loan losses
Fair value appreciation of securities
available for sale
Nonearning assets
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS
===============================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing liabilities:
NOW and money market accounts 1.07% 1.18% 1.37% 1.47% 1.48%
Savings accounts .46 .58 .71 .80 .85
Consumer time deposits 3.74 3.86 4.00 4.16 4.38
Other deposits 1.26 1.42 1.73 1.89 1.86
Foreign deposits 1.42 1.42 1.62 1.87 1.91
Federal funds borrowed 1.57 1.59 1.83 2.25 2.32
Security repurchase agreements .71 .73 0.95 1.08 1.07
Borrowed funds 1.21 1.38 1.50 1.59 1.66
Long-term debt and capital securities 2.44 2.33 2.44 3.06 3.07
- -------------------------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities/
total interest expense/rates 1.92% 1.96% 2.14% 2.46% 2.54%
Noninterest bearing deposits
Accrued expenses and other liabilities
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES
TOTAL STOCKHOLDERS' EQUITY
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
===============================================================================================================================
NET INTEREST INCOME
===============================================================================================================================
INTEREST SPREAD 3.78% 3.90% 3.92% 3.96% 4.05%
Contribution of noninterest bearing sources of funds .33 .31 .34 .38 .37
- -------------------------------------------------------------------------------------------------------------------------------
NET INTEREST MARGIN 4.11% 4.21% 4.26% 4.34% 4.42%
===============================================================================================================================
(a) Includes loans held for sale or securitization
65
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The disclosures contained in the Market Risk Management section of the
Management Discussion and Analysis of Financial Condition and Results of
Operations on page 60 of this report are incorporated herein by reference.
ITEM 4. CONTROLS AND PROCEDURES
The management of National City Corporation is responsible for establishing and
maintaining effective disclosure controls and procedures, as defined under Rules
13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. As of June 30,
2003, an evaluation was performed under the supervision and with the
participation of management, including the Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of the
Corporation's disclosure controls and procedures. Based on that evaluation,
management concluded the Corporation's disclosure controls and procedures as of
June 30, 2003 were effective in ensuring material information required to be
disclosed in this Quarterly Report on Form 10-Q was recorded, processed,
summarized, and reported on a timely basis. Additionally, there were no changes
in the Corporation's internal control over financial reporting that occurred
during the quarter ended June 30, 2003 that have materially affected, or are
reasonably likely to materially affect, the Corporation's internal control over
financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
National City and its subsidiaries are also involved in a number of legal
proceedings arising out of their businesses and regularly face various claims,
including unasserted claims, which may ultimately result in litigation. It is
management's opinion that the Corporation's financial position, results of
operations, and cash flows would not be materially affected by the outcome of
any pending or threatened legal proceedings, commitments, or claims. For
additional information on the Corporation's contingent liabilities and
guarantees, refer to Note 19 to the Consolidated Financial Statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On April 29, 2003 at the Annual Meeting of Stockholders of the Registrant,
stockholders took the following actions:
1. Elected as directors all nominees designated in the proxy statement dated
March 13, 2003 as follows:
NUMBER OF VOTES
--------------------------------------------------------
FOR WITHHELD
--------------------------- ------------------------
J.E. Barfield 533,649,282 9,203,982
J.S. Broadhurst 533,854,556 8,998,709
J.W. Brown 534,211,925 8,641,340
D.E. Collins 534,014,459 8,838,806
C.M. Connor 533,765,898 9,087,367
D.A. Daberko 531,782,235 11,071,030
D.E. Evans 533,400,289 9,452,976
J.T. Gorman 502,399,885 40,453,380
B.P. Healy, M.D. 528,668,348 14,184,917
P.A. Ormond 529,040,598 13,812,666
R.A. Paul 533,895,547 8,957,717
G.L. Shaheen 533,653,328 9,199,937
J.F. Tatar 534,077,727 8,775,538
J.S. Thornton, Ph.D. 533,685,556 9,167,709
M. Weiss 534,319,073 8,534,191
2. Ratified the Audit Committee's selection of Ernst & Young LLP as independent
auditors for 2003: 522,927,713 votes cast for, 15,360,839 votes cast against,
and 4,564,713 votes abstained.
66
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBIT INDEX
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- -------------------
3.1 Amended and Restated Certificate of Incorporation of
National City Corporation dated April 13, 1999 (filed as
Exhibit 3.2 to Registrant's Quarterly Report on Form 10-Q
for the quarter and nine months ended September 30, 2000,
and incorporated herein by reference).
3.2 National City Corporation First Restatement of By-laws
adopted April 27, 1987 (as Amended through October 28, 2002)
(filed as Exhibit 3.3 to Registrant's Quarterly Report on
Form 10-Q for the quarter and nine months ended September
30, 2002, and incorporated herein by reference).
4.1 The Registrant agrees to furnish upon request to the
Commission a copy of each instrument defining the rights of
holders of Senior and Subordinated debt of the Registrant.
10.1 National City Corporation 1989 Stock Option Plan (filed as
Exhibit 10.1 to Registrant's Quarterly Report on Form 10-Q
for the quarter ended March 31, 2003, and incorporated herein
by reference).
10.2 National City Corporation's 1993 Stock Option Plan (filed as
Exhibit 10.5 to Registration Statement No. 33-49823 and
incorporated herein by reference).
10.3 National City Corporation 150th Anniversary Stock Option
Plan (filed as Exhibit 4 to Registrant's Form S-8
Registration Statement No. 33-58815 dated April 25, 1995,
and incorporated herein by reference).
10.4 National City Corporation Plan for Deferred Payment of
Directors' Fees, as Amended (filed as Exhibit 10.5 to
Registration Statement No. 2-914334 and incorporated herein
by reference).
10.5 National City Corporation Supplemental Executive Retirement
Plan, as Amended and Restated July 1, 2002 (filed as Exhibit
10.7 to Registrant's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2002, and incorporated herein by
reference).
10.6 National City Corporation Amended and Second Restated 1991
Restricted Stock Plan (filed as Exhibit 10.9 to Registration
Statement No. 33-49823 and incorporated herein by
reference).
10.7 Form of grant made under National City Corporation 1991
Restricted Stock Plan in connection with National City
Corporation Supplemental Executive Retirement Plan as
Amended (filed as Exhibit 10.7 to Registrant's Quarterly Report
on Form 10-Q for the quarter ended March 31, 2003, and
incorporated herein by reference).
10.8 Central Indiana Bancorp Option Plan effective March 15, 1991
(filed as Exhibit 10.8 to Registrant's Quarterly Report on Form 10-Q
for the quarter ended March 31, 2003, and incorporated herein
by reference).
10.9 Central Indiana Bancorp 1993 Option Plan effective October
12, 1993 (filed as Exhibit 10.9 to Registrant's Quarterly Report on
Form 10-Q for the quarter ended March 31, 2003, and
incorporated herein by reference).
10.10 Form of contracts with David A. Daberko, William E.
MacDonald III, Jon L. Gorney, Robert G. Siefers, Robert J.
Ondercik, Jeffrey D. Kelly, David L. Zoeller, Thomas A.
Richlovsky, James P. Gulick, John D. Gellhausen, Herbert R.
Martens, Jr., Thomas W. Golonski, Stephen A. Stitle, James
R. Bell III, Peter E. Raskind, Philip L. Rice, Timothy J.
Lathe, Janis E. Lyons, J. Armando Ramirez, Paul G. Clark,
Shelley J. Seifert, and Ted M. Parker (filed as Exhibit
10.29 to Registrant's Form S-4 Registration Statement No.
333-45609 dated February 4, 1998, and incorporated herein
by reference).
10.11 Split Dollar Insurance Agreement effective January 1, 1994,
between National City Corporation and certain key employees
(filed as Exhibit 10.11 to Registrant's Quarterly Report on
Form 10-Q for the quarter ended March 31, 2003, and
incorporated herein by reference).
10.12 Restated First of America Bank Corporation 1987 Stock Option
Plan (filed as Exhibit 4.4 to Registrant's Post-Effective
Amendment No. 2 [on Form S-8] to Form S-4 Registration
Statement No. 333-46571 dated March 19, 1998, and
incorporated herein by reference).
10.13 Amended and Restated First of America Bank Corporation Stock
Compensation Plan (filed as Exhibit 4.5 to Registrant's
Post-Effective Amendment No. 2 [on Form S-8] to Form S-4
Registration Statement No. 333-46571 dated March 19, 1998,
and incorporated herein by reference).
10.14 First of America Bank Corporation Directors Stock
Compensation Plan (filed as Exhibit 4.6 to Registrant's
Post-Effective Amendment No. 2 [on Form S-8] to Form S-4
Registration Statement No. 333-46571 dated March 19, 1998,
and incorporated herein by reference).
10.15 National City Corporation 1997 Stock Option Plan as Amended
and Restated effective October 22, 2001 (filed as Exhibit
10.17 to Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 2001, and incorporated herein
by reference).
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- -------------------
10.16 National City Corporation 1997 Restricted Stock Plan as
Amended and Restated effective October 31, 2001 (filed as
Exhibit 10.18 to Registrant's Annual Report on Form 10-K for
the fiscal year ended December 31, 2001, and incorporated
herein by reference).
10.17 The National City Corporation Retention Plan for Executive
Officers effective April 29, 2003.
10.18 Integra Financial Corporation Employee Stock Option Plan
(filed as Exhibit 4.3 to Registrant's Post-Effective
Amendment No. 1 [on Form S-8] to Form S-4 Registration
Statement No. 333-01697, dated April 30, 1996, and
incorporated herein by reference).
10.19 Integra Financial Corporation Management Incentive Plan
(filed as Exhibit 4.4 to Registrant's Post-Effective
Amendment No. 1 [on Form S-8] to Form S-4 Registration
Statement No. 333-01697, dated April 30, 1996, and
incorporated herein by reference).
10.20 Integra Financial Corporation Non-Employee Directors Stock
Option Plan (filed as Exhibit 4.5 to Registrant's
Post-Effective Amendment No. 1 [on Form S-8] to Form S-4
Registration Statement No. 333-01697, dated April 30, 1996,
and incorporated herein by reference).
10.21 National City Corporation Amended and Restated Long-Term
Incentive Compensation Plan for Senior Officers as Amended
and Restated effective January 1, 2001 (filed as Exhibit
10.32 to Registrant's Quarterly Report on Form 10-Q for the
quarter and nine months ended September 30, 2000, and
incorporated herein by reference).
10.22 National City Corporation Management Incentive Plan for
Senior Officers as Amended and Restated effective January 1,
2001 (filed as Exhibit 10.33 to Registrant's Quarterly
Report on Form 10-Q for the quarter and nine months ended
September 30, 2000, and incorporated herein by reference).
10.23 National City Corporation Supplemental Cash Balance Pension
Plan as Amended and Restated effective November 1, 2001
(filed as Exhibit 10.25 to Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 2001, and
incorporated herein by reference).
10.24 The National City Corporation 2001 Stock Option Plan as
Amended and Restated effective October 22, 2001 (filed as
Exhibit 10.27 to Registrant's Annual Report on Form 10-K for
the fiscal year ended December 31, 2001, and incorporated
herein by reference).
10.25 National City Savings and Investment Plan No. 3 (filed as
Exhibit 4.3 to Registrant's Form S-8 Registration Statement
No. 333-61712 dated as of May 25, 2001, and incorporated
herein by reference).
10.26 Amendment No. 1 to the National City Savings and Investment
Plan No. 3 (filed as Exhibit 4.5 to Registrant's
Post-Effective Amendment No. 1 to Form S-8 Registration
Statement No. 333-61712 and incorporated herein by
reference).
10.27 National City Corporation 2002 Restricted Stock Plan (filed
as Exhibit A to Registrant's Proxy Statement dated March 8,
2002, and incorporated herein by reference).
10.28 The National City Corporation Long-Term Deferred Share
Compensation Plan effective April 22, 2002 (filed as Exhibit
10.33 to Registrant's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2002, and incorporated herein by
reference).
10.29 The National City Corporation Deferred Compensation Plan as
Amended and Restated effective July 23, 2002 (filed as
Exhibit 10.34 to Registrant's Quarterly Report on Form 10-Q
for the quarter ended June 30, 2002, and incorporated herein
by reference).
10.30 Form of Agreement Not To Compete with David A. Daberko,
Robert G. Siefers and William E. MacDonald III (filed as
Exhibit 10.35 to Registrant's Quarterly Report on Form 10-Q
for the quarter ended June 30, 2002, and incorporated herein
by reference).
10.31 Visa(R) U.S.A. Inc. limited guaranty between National City
Corporation and Visa(R) U.S.A. Inc. dated August 6, 2002
(filed as Exhibit 10.36 to Registrant's Quarterly Report on
Form 10-Q for the quarter and nine months ended September
30, 2002, and incorporated herein by reference).
10.32 The National City Corporation Executive Savings Plan, as
Amended and Restated effective January 1, 2003 (filed as
Exhibit 10.32 to Registrant's Annual Report on Form 10-K for
the fiscal year ended December 31, 2002, and incorporated
herein by reference).
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- -------------------
10.33 The National City Corporation Savings and Investment Plan,
as Amended and Restated effective January 1, 2001 (filed as
Exhibit 10.33 to Registrant's Annual Report on Form 10-K for
the fiscal year ended December 31, 2002, and incorporated
herein by reference).
10.34 The National City Corporation Savings and Investment Plan
No. 2, as Amended and Restated effective January 1, 2001
(filed as Exhibit 10.34 to Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 2002, and
incorporated herein by reference).
10.35 Amendment No. 1 to the National City Savings and Investment
Plan, as Amended and Restated effective January 1, 2001
(filed as Exhibit 10.35 to Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 2002, and
incorporated herein by reference).
10.36 Amendment No. 1 to the National City Savings and Investment
Plan No. 2, as Amended and Restated effective January 1,
2001 (filed as Exhibit 10.36 to Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 2002,
and incorporated herein by reference).
10.37 Amendment No. 1 to the Split Dollar Insurance Agreement
effective January 1, 2003 (filed as Exhibit 10.37 to
Registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 2002, and incorporated herein by
reference).
10.38 Credit Agreement dated as of April 12, 2001, by and between
National City and the banks named therein (filed as Exhibit
4.2 to Registrant's Quarterly Report on Form 10-Q for the
quarter ended March 31, 2001, and incorporated herein by
reference) and the Assumption Agreement dated June 11, 2002
(filed as Exhibit 4.2 to Registrant's Quarterly Report on
Form 10-Q for the quarter ended June 30, 2002, and
incorporated herein by reference).
10.39 MasterCard International Incorporated limited guaranty
between National City Corporation and MasterCard
International Incorporated dated April 30, 2003 (filed as
Exhibit 10.39 to Registrant's Quarterly Report on Form 10-Q
for the quarter ended March 31, 2003, and incorporated herein
by reference).
12.1 Computation of Ratio of Earnings to Fixed Charges.
14.1 Code of Ethics (filed as Exhibit 14.1 to Registrant's Current Report
on Form 8-K filed on July 31, 2003, and incorporated herein by
reference).
14.2 Code of Ethics for Senior Financial Officers (filed as Exhibit 14.2
to Registrant's Current Report on Form 8-K filed on July 31, 2003, and
incorporated herein by reference).
31.1 Chief Executive Officer Sarbanes-Oxley Act 302 Certification dated
August 11, 2003 for National City Corporation's Quarterly Report on
Form 10-Q for the quarter ended June 30, 2003.
31.2 Chief Financial Officer Sarbanes-Oxley Act 302 Certification dated
August 11, 2003 for National City Corporation's Quarterly Report on
Form 10-Q for the quarter ended June 30, 2003.
32.1 Chief Executive Officer Sarbanes-Oxley Act 906 Certification dated
August 11, 2003 for National City Corporation's Quarterly Report on
Form 10-Q for the quarter ended June 30, 2003.
32.2 Chief Financial Officer Sarbanes-Oxley Act 906 Certification dated
August 11, 2003 for National City Corporation's Quarterly Report on
Form 10-Q for the quarter ended June 30, 2003.
REPORTS ON FORM 8-K
The following reports were filed by National City Corporation during the
three-month period ended June 30, 2003 through the date of this Form 10-Q
filing:
April - 16, 2003 - National City issued a news release
announcing its financial results for the three-month
period ended March 31, 2003 and the availability of
the March 31, 2003 Financial Supplement on its Web
site at www.NationalCity.com.
June - 12, 2003 - National City announced the posting of its
Mid-Quarter Update to Financial Supplement to the
Corporation's Web site.
July - 16, 2003 - National City issued a news release
announcing its financial results for the three and
six-month periods ended June 30, 2003 and the
availability of the June 30, 2003 Financial Supplement
on its Web site.
July - 30, 2003 - National City provided the amendments to its
Corporate Governance Guidelines, Code of Ethics, and
Code of Ethics for Senior Financial Officers, which
were approved by the Corporation's Board of Directors
on July 29, 2003.
70
CORPORATE INFORMATION
CORPORATE HEADQUARTERS
National City Center
1900 East Ninth Street
Cleveland, Ohio 44114-3484
(216) 222-2000
www.NationalCity.com
TRANSFER AGENT AND REGISTRAR
National City Bank
Corporate Trust Operations
Department 5352
P.O. Box 92301
Cleveland, Ohio 44193-0900
E-mail: shareholder.inquiries@nationalcity.com
Stockholders of record may access their accounts
via the Internet to review account holdings and transaction history through
National City's StockAccess at www.ncstockaccess.com. Stockholders can also
download frequently used forms from this Web site. For log-in assistance or
other inquiries, call 1-800-622-6757.
INVESTOR INFORMATION
Betsy Figgie
Investor Relations
Department 2101
P.O. Box 5756
Cleveland, Ohio 44101-0756
1-800-622-4204
E-mail: investor.relations@nationalcity.com
WEB SITE ACCESS TO UNITED STATES SECURITIES AND EXCHANGE COMMISSION FILINGS
All reports filed electronically by National City Corporation with the United
States Securities and Exchange Commission (SEC), including the Annual Report on
Form 10-K, quarterly reports on Form 10-Q, and current event reports on Form
8-K, as well as any amendments to those reports, are accessible at no cost on
the Corporation's Web site at www.NationalCity.com/investorrelations. These
filings are also accessible on the SEC's Web site at www.sec.gov.
CORPORATE GOVERNANCE
National City's corporate governance practices are described in the following
documents, which are available on the Corporation's Web site or which may be
obtained in print form through the investor relations department: Corporate
Governance Guidelines, Code of Ethics, Code of Ethics for Senior Financial
Officers, Audit Committee Charter, Nominating and Board of Directors Governance
Committee Charter, and Compensation Committee Charter.
COMMON STOCK LISTING
National City Corporation common stock is traded on the New York Stock Exchange
under the symbol NCC. The stock is abbreviated in financial publications as
NTLCITY.
The common stock of National City's 85%-owned payment processing subsidiary,
National Processing, Inc., is traded on the New York Stock Exchange under the
symbol NAP. The stock is abbreviated in financial publications as NTLPROC.
DIVIDEND REINVESTMENT AND STOCK
PURCHASE PLAN
National City Corporation offers stockholders a convenient way to increase their
investment through the National City Corporation Amended and Restated Dividend
Reinvestment and Stock Purchase Plan (the Plan). Under the Plan, investors can
elect to acquire National City shares in the open market by reinvesting
dividends and through optional cash payments. National City absorbs the fees and
brokerage commissions on shares acquired through the Plan. To obtain a Plan
prospectus and authorization card, please call 1-800-622-6757. The Plan
prospectus is also available on the Corporation's Web site.
DIRECT DEPOSIT OF DIVIDENDS
The direct deposit program, which is offered at no charge, provides for
automatic deposit of quarterly dividends directly to a checking or savings
account. For information regarding this program, call 1-800-622-6757.
NAIC
National City is a proud sponsor of the National Association of Investors
Corporation (NAIC) and participates in its Low-Cost Investment Plan. To receive
more information on NAIC, call (248) 583-NAIC.
DEBT RATINGS
- -------------------------------------------------------------
MOODY'S
FITCH INVESTORS STANDARD
RATINGS SERVICE & POOR'S
- -------------------------------------------------------------
National City
Corporation A/B
Commercial paper F1+ P-1 A-1
Senior debt AA- A1 A
Subordinated debt A+ A2 A-
Bank Subsidiaries A/B
Certificates of
deposit AA Aa3 A+
Senior bank notes AA- Aa3 A+
Subordinated bank
notes A+ A1 A
- -------------------------------------------------------------
71
FORM 10-Q -- JUNE 30, 2003
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NATIONAL CITY CORPORATION
--------------------------------------------------
(Registrant)
Date: August 11, 2003
/s/ DAVID A. DABERKO
--------------------------------------------------
David A. Daberko
Chairman and Chief Executive Officer
/s/ JEFFREY D. KELLY
--------------------------------------------------
Jeffrey D. Kelly
Executive Vice President and Chief Financial Officer
72
[NATIONAL CITY LOGO]
National City Center
1900 East Ninth Street
Cleveland, Ohio 44114-3484
73