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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 September 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 October 31, 2003 -- 607,911,948
[NATIONAL CITY(R) LOGO]
QUARTER ENDED SEPTEMBER 30, 2003
FINANCIAL REPORT
AND FORM 10-Q
FINANCIAL REPORT AND FORM 10-Q
QUARTER ENDED SEPTEMBER 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. These filings are also accessible on the SEC's Web site at
www.sec.gov.
TABLE OF CONTENTS
Page
PART I -- FINANCIAL INFORMATION
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 46
Consolidated Average Balance Sheets 65
Daily Average Balances/Net Interest Income/Rates 66
Item 3. Quantitative and Qualitative Disclosures About Market Risk 69
Item 4. Controls and Procedures 69
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings 69
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 (None)
Item 5. Other Information (None)
Item 6. Exhibits and Reports on Form 8-K 70
Signatures 80
2
PART I - FINANCIAL INFORMATION
FINANCIAL HIGHLIGHTS
Three Months Ended Nine Months Ended
September 30 September 30
- ------------------------------------------------------------------------------------------------------------------
(Dollars In Thousands, Except Per Share Amounts) 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------
FOR THE PERIOD
Tax-equivalent net interest income $ 1,150,765 $ 978,851 $ 3,353,741 $ 2,954,558
Provision for loan losses 107,047 169,164 490,427 523,280
Fees and other income 542,102 620,630 2,438,548 2,040,782
Securities gains, net 5,398 157 36,975 97,722
Noninterest expense 1,007,616 870,176 3,042,719 2,718,987
Income tax expense and tax-equivalent adjustment 204,265 186,111 803,642 637,695
- ------------------------------------------------------------------------------------------------------------------
Net income $ 379,337 $ 374,187 $ 1,492,476 $ 1,213,100
==================================================================================================================
Net income per common share
Basic $ .62 $ .61 $ 2.44 $ 1.99
Diluted .62 .61 2.42 1.97
Dividends paid per common share .32 .305 .93 .895
Return on average common equity 16.23% 18.06% 22.44% 20.58%
Return on average assets 1.22 1.47 1.67 1.62
Net interest margin 4.10 4.34 4.14 4.38
Efficiency ratio 59.52 54.40 52.53 54.43
Average equity to average assets 7.49 8.13 7.42 7.85
Annualized net charge-offs to average portfolio
loans .64 .69 .82 .85
Average shares
Basic 613,574,321 611,638,832 612,412,749 609,610,761
Diluted 618,968,822 617,850,460 617,656,351 616,242,513
==================================================================================================================
AT PERIOD END
Assets $121,065,218 $109,346,195
Portfolio loans 77,755,510 71,031,820
Loans held for sale or securitization 23,817,881 15,886,371
Securities (at fair value) 6,755,118 10,487,124
Deposits 70,275,879 60,634,569
Stockholders' equity 9,134,327 8,156,861
Book value per common share $ 15.00 $ 13.32
Market value per common share 29.46 28.53
Equity to assets 7.54% 7.46%
Allowance for loan losses as a percentage of
period-end portfolio loans 1.45 1.52
Nonperforming assets to period-end
portfolio loans and other nonperforming assets .97 1.20
Common shares outstanding 609,136,762 612,180,011
Full-time equivalent employees 33,188 32,099
==================================================================================================================
3
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended Nine Months Ended
September 30 September 30
- ---------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts) 2003 2002 2003 2002
- ---------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans $ 1,456,575 $ 1,306,486 $ 4,264,723 $ 3,942,835
Securities:
Taxable 67,650 109,454 250,583 358,406
Exempt from Federal income taxes 8,424 9,006 25,567 27,440
Dividends 4,425 9,008 15,900 25,845
Federal funds sold and security resale agreements 827 464 1,943 1,456
Other investments 9,272 8,506 29,486 26,484
- ---------------------------------------------------------------------------------------------------------------------
Total interest income 1,547,173 1,442,924 4,588,202 4,382,466
INTEREST EXPENSE
Deposits 213,127 283,800 691,831 872,525
Federal funds borrowed and security repurchase
agreements 30,330 34,511 112,600 108,681
Borrowed funds 2,678 7,147 16,276 25,372
Long-term debt and capital securities 157,067 146,322 434,651 444,590
- ---------------------------------------------------------------------------------------------------------------------
Total interest expense 403,202 471,780 1,255,358 1,451,168
- ---------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 1,143,971 971,144 3,332,844 2,931,298
PROVISION FOR LOAN LOSSES 107,047 169,164 490,427 523,280
- ---------------------------------------------------------------------------------------------------------------------
Net interest income after provision for
loan losses 1,036,924 801,980 2,842,417 2,408,018
NONINTEREST INCOME
Mortgage banking revenue 30,698 177,958 900,980 620,650
Deposit service charges 144,940 132,270 421,802 376,820
Payment processing revenue 124,517 113,513 342,975 334,061
Trust and investment management fees 72,403 73,936 219,072 236,647
Card-related fees 41,827 47,212 126,944 111,221
Brokerage revenue 32,776 24,986 90,680 82,815
Other 94,941 50,755 336,095 278,568
- ---------------------------------------------------------------------------------------------------------------------
Total fees and other income 542,102 620,630 2,438,548 2,040,782
Securities gains, net 5,398 157 36,975 97,722
- ---------------------------------------------------------------------------------------------------------------------
Total noninterest income 547,500 620,787 2,475,523 2,138,504
NONINTEREST EXPENSE
Salaries, benefits, and other personnel 571,059 448,517 1,674,512 1,338,238
Equipment 58,458 56,667 185,913 180,291
Net occupancy 57,323 56,035 171,760 166,193
Third-party services 70,739 54,671 207,121 167,924
Card processing 54,194 50,963 157,714 156,891
Marketing and public relations 22,259 25,402 105,843 126,998
Other 173,584 177,921 539,856 582,452
- ---------------------------------------------------------------------------------------------------------------------
Total noninterest expense 1,007,616 870,176 3,042,719 2,718,987
- ---------------------------------------------------------------------------------------------------------------------
Income before income tax expense 576,808 552,591 2,275,221 1,827,535
Income tax expense 197,471 178,404 782,745 614,435
- ---------------------------------------------------------------------------------------------------------------------
NET INCOME $ 379,337 $ 374,187 $ 1,492,476 $ 1,213,100
=====================================================================================================================
NET INCOME PER COMMON SHARE
Basic $ .62 $ .61 $ 2.44 $ 1.99
Diluted .62 .61 2.42 1.97
AVERAGE COMMON SHARES OUTSTANDING
Basic 613,574,321 611,638,832 612,412,749 609,610,761
Diluted 618,968,822 617,850,460 617,656,351 616,242,513
=====================================================================================================================
See Notes to Consolidated Financial Statements
4
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30 December 31 September 30
(In Thousands) 2003 2002 2002
- ---------------------------------------------------------------------------------------------------------------
ASSETS
Cash and demand balances due from banks $ 3,602,298 $ 3,756,426 $ 4,106,687
Federal funds sold and security resale agreements 131,062 136,343 95,895
Securities available for sale, at fair value 6,755,118 9,211,268 10,487,124
Other investments 769,141 869,147 761,248
Loans held for sale or securitization:
Commercial 15,591 14,840 27,973
Mortgage 23,802,290 24,723,549 15,858,398
- ---------------------------------------------------------------------------------------------------------------
Total loans held for sale or securitization 23,817,881 24,738,389 15,886,371
Portfolio loans:
Commercial 23,458,827 24,722,060 26,024,362
Real estate -- commercial 9,495,261 9,384,851 8,076,473
Real estate -- residential 24,330,916 19,972,549 16,404,069
Home equity lines of credit 10,074,306 8,062,199 7,617,672
Credit card and other unsecured lines of credit 2,178,703 2,030,024 1,915,547
Other consumer 8,217,497 7,962,729 10,993,697
- ---------------------------------------------------------------------------------------------------------------
Total portfolio loans 77,755,510 72,134,412 71,031,820
Allowance for loan losses (1,129,633) (1,098,588) (1,079,773)
- ---------------------------------------------------------------------------------------------------------------
Net portfolio loans 76,625,877 71,035,824 69,952,047
Properties and equipment 1,113,714 1,036,937 1,031,098
Other real estate owned 110,380 114,931 104,587
Mortgage servicing assets 1,041,695 615,193 690,615
Goodwill 1,103,271 1,078,281 1,078,281
Other intangible assets 68,631 74,573 79,438
Derivative assets 1,785,967 1,468,381 1,048,665
Accrued income and other assets 4,140,183 4,122,722 4,024,139
- ---------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 121,065,218 $ 118,258,415 $109,346,195
===============================================================================================================
LIABILITIES
Deposits:
Noninterest bearing $ 16,828,794 $ 16,156,081 $ 15,616,730
NOW and money market 26,256,752 23,022,449 21,325,533
Savings 2,373,289 2,477,067 2,499,922
Consumer time 13,221,476 14,686,005 14,985,661
Other 2,731,341 3,403,827 3,128,856
Foreign 8,864,227 5,373,339 3,077,867
- ---------------------------------------------------------------------------------------------------------------
Total deposits 70,275,879 65,118,768 60,634,569
Federal funds borrowed and security repurchase
agreements 8,637,604 6,528,258 6,068,559
Borrowed funds 1,472,746 11,493,909 9,802,372
Long-term debt 27,118,585 22,550,295 21,018,090
Junior subordinated debentures owed to
unconsolidated subsidiary trusts 185,568 -- --
Corporation-obligated mandatorily redeemable
capital securities of subsidiary trusts holding
solely debentures of the Corporation -- 180,000 180,000
Derivative liabilities 1,246,371 1,243,544 730,231
Accrued expenses and other liabilities 2,994,138 2,835,629 2,755,513
- ---------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 111,930,891 109,950,403 101,189,334
===============================================================================================================
STOCKHOLDERS' EQUITY
Common stock 2,436,547 2,445,966 2,448,721
Capital surplus 1,079,072 989,346 982,552
Retained earnings 5,568,630 4,805,520 4,637,809
Accumulated other comprehensive income 50,078 67,180 87,779
- ---------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 9,134,327 8,308,012 8,156,861
- ---------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 121,065,218 $ 118,258,415 $109,346,195
===============================================================================================================
See Notes to Consolidated Financial Statements
5
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30
- ------------------------------------------------------------------------------------------------------------------------------
(In Thousands) 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 1,492,476 $ 1,213,100
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 490,427 523,280
Depreciation and amortization of properties and equipment 138,200 133,125
Amortization of intangible assets and mortgage servicing assets 492,325 273,053
Accretion of premiums and discounts on securities and debt (17,846) (8,822)
Mortgage servicing asset impairment (recoveries) charges (128,428) 121,137
Ineffective hedge and other derivative losses (gains), net 21,142 (320,783)
Securities gains, net (36,975) (97,722)
Gains on loans sold or securitized, net (882,808) (400,842)
Other losses, net 129,174 178,575
Originations and purchases of loans held for sale or securitization (94,114,360) (51,446,869)
Principal payments on and proceeds from sales of loans held for sale or securitization 94,004,099 49,842,740
(Increase) decrease in accrued interest receivable (10,941) 73,218
Increase in accrued interest payable 2,118 42,065
Other operating activities, net 1,535,098 1,102,940
- ------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 3,113,701 1,228,195
- ------------------------------------------------------------------------------------------------------------------------------
LENDING AND INVESTING ACTIVITIES
Net decrease in federal funds sold, security resale agreements, and other investments 105,287 20,258
Purchases of available-for-sale securities (3,070,223) (3,166,554)
Proceeds from sales of available-for-sale securities 1,567,311 2,117,219
Proceeds from maturities, calls, and prepayments of available-for-sale securities 3,883,162 1,464,956
Net increase in loans (7,689,510) (2,329,398)
Proceeds from sales or securitizations of loans 940,528 1,866,824
Net increase in properties and equipment (219,322) (93,256)
Acquisitions, net of cash received (35,118) --
- ------------------------------------------------------------------------------------------------------------------------------
Net cash used in lending and investing activities (4,517,885) (119,951)
- ------------------------------------------------------------------------------------------------------------------------------
DEPOSIT AND FINANCING ACTIVITIES
Net increase (decrease) in deposits 5,176,349 (2,512,375)
Net increase (decrease) in federal funds borrowed and security repurchase agreements 2,109,346 (524,829)
Net decrease in borrowed funds (10,021,163) (1,447,999)
Repayments of long-term debt (6,238,262) (2,821,770)
Proceeds from issuances of long-term debt, net 10,872,845 6,354,428
Dividends paid (569,494) (545,350)
Issuances of common stock 118,359 92,412
Repurchases of common stock (197,924) --
Redemption of preferred stock -- (36)
- ------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) deposit and financing activities 1,250,056 (1,405,519)
- ------------------------------------------------------------------------------------------------------------------------------
Net decrease in cash and demand balances due from banks (154,128) (297,275)
Cash and demand balances due from banks, January 1 3,756,426 4,403,962
- ------------------------------------------------------------------------------------------------------------------------------
CASH AND DEMAND BALANCES DUE FROM BANKS, SEPTEMBER 30 $ 3,602,298 $ 4,106,687
==============================================================================================================================
SUPPLEMENTAL INFORMATION
Cash paid for:
Interest $ 1,253,240 $ 1,409,103
Income taxes 1,034,656 595,278
Noncash items:
Transfers of loans to other real estate 153,468 129,576
Carrying value of securities donated to the National City Charitable Foundation 25,007 36,306
Consolidation of asset-backed commercial paper conduit
Loans -- 679,451
Securities -- 1,992,178
Other assets -- 1,492
Commercial paper borrowings -- 2,688,757
Other liabilities -- 228
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
Preferred Common Capital Retained Comprehensive
(Dollars in Thousands, Except Per Share 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 1,213,100 1,213,100
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 115,256 115,256
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 (99,754) (99,754)
----------
Total comprehensive income 1,228,602
Common dividends declared, $.895 per share (545,319) (545,319)
Preferred dividends declared (21) (21)
Issuance of 4,785,200 common shares under
stock-based compensation plans,
including related tax effects 19,142 73,271 92,413
Conversion of 13,234 shares of preferred stock
to 40,082 common shares and redemption of
735 shares (698) 160 501 (37)
- --------------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 2002 $ -- $2,448,721 $ 982,552 $4,637,809 $ 87,779 $8,156,861
================================================================================================================================
Balance, January 1, 2003 $ -- $2,445,966 $ 989,346 $4,805,520 $ 67,180 $8,308,012
Comprehensive income:
Net income 1,492,476 1,492,476
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 (70,040) (70,040)
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 52,938 52,938
----------
Total comprehensive income 1,475,374
Common dividends declared, $.93 per share (569,494) (569,494)
Issuance of 4,351,703 common shares under
stock-based compensation plans, including
related tax effects 17,406 100,953 118,359
Repurchase of 6,706,300 common shares (26,825) (11,227) (159,872) (197,924)
- --------------------------------------------------------------------------------------------------------------------------------
BALANCE, SEPTEMBER 30, 2003 $ -- $2,436,547 $1,079,072 $5,568,630 $ 50,078 $9,134,327
================================================================================================================================
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 provides banking
and other financial services through an extensive distribution network in Ohio,
Michigan, Pennsylvania, Indiana, Kentucky, and Illinois and also conducts
selected consumer lending and other financial services activities on a
nationwide basis.
1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
The accompanying unaudited consolidated financial statements include the
accounts of the Corporation and its consolidated subsidiaries. All significant
intercompany transactions and balances have been eliminated. Certain prior
period amounts have been reclassified to conform with the current period
presentation.
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,
7
including the transferor of the assets.
Where the Corporation is a transferor of assets to an SPE, the assets sold to
the SPE are no longer recorded on the 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 balance
sheet. Further discussion regarding these securitization trusts is included in
Note 4.
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.
Uncertainty surrounding the strength and timing of economic cycles also affects
estimates of loss. The historical losses used in the migration analysis may not
be representative of actual unrealized losses inherent in the portfolio.
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 loan obligations. 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 September 30, 2003, December
31, 2002, and September 30, 2002, trading account securities totaled $19
million, $15 million, and $28 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. National City holds 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 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 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. Retained interests in the credit card and automobile loan
securitizations are classified as available-for-sale securities. 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 income 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 4 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 Nine Months Ended
September 30 September 30
-------------------- ------------------------
(In Thousands, Except Per Share Amounts) 2003 2002 2003 2002
- ------------------------------------------- -------- -------- ---------- ----------
Net income, as reported $379,337 $374,187 $1,492,476 $1,213,100
Add: option expense included in reported
net income, net of related tax effects
National City common stock 3,198 -- 5,495 --
National Processing common stock 26 -- 30 --
Less: total option expense determined under
fair value method for all option awards,
net of related tax effects
National City common stock (9,564) (12,586) (33,265) (33,336)
National Processing common stock (1,086) (1,659) (4,285) (4,538)
-------- -------- ---------- ----------
PRO FORMA NET INCOME $371,911 $359,942 $1,460,451 $1,175,226
-------- -------- ---------- ----------
Pro forma net income per share:
Basic -- as reported $ .62 $ .61 $ 2.44 $ 1.99
Basic -- pro forma .60 .59 2.38 1.93
Diluted -- as reported .62 .61 2.42 1.97
Diluted -- pro forma .60 .59 2.36 1.91
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 Nine Months Ended
September 30 September 30
------------------- -----------------
2003 2002 2003 2002
------ ------ ------ ------
Risk-free interest rate 3.30% 3.46% 3.27% 3.49%
Expected dividend yield 4.10 3.84 4.16 3.86
Expected volatility 27.14 26.06 27.16 26.05
Expected option life (in years) 5 5 5 5
Weighted-average grant-date fair value of options $ 6.15 $ 5.02 $ 6.04 $ 5.06
The weighted-average assumptions used to value the National Processing option
grants are disclosed in National Processing, Inc.'s September 30, 2003 Quarterly
Report on Form 10-Q, 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 June 1, 2003, for all
financial instruments created or modified after May 31, 2003, and otherwise
became effective as of July 1, 2003. The adoption of this standard did not have
a material impact on financial condition, the results of operations, or
liquidity.
In early November 2003, the FASB deferred for an indefinite period the
application of the guidance in SFAS 150 to noncontrolling interests that are
classified as equity in the financial statements of a subsidiary but would be
classified as a liability in the parent's financial statements under SFAS 150.
The deferral is limited to mandatorily redeemable noncontrolling interests
associated with finite-lived subsidiaries. Management does not believe any such
applicable entities exist as of September 30, 2003, but will continue to
evaluate the applicability of this deferral to entities which may be
consolidated as a result of FASB Interpretation No. 46 (FIN 46), Consolidation
of Variable Interest Entities.
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 financial condition,
the results of operations, or liquidity.
CONSOLIDATION OF VARIABLE INTEREST ENTITIES: In January 2003, the FASB issued
FIN 46, which 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, or the right to receive the expected residual returns of
the entity if they occur.
In early October 2003, the FASB issued FASB Staff Position FIN 46-6, Effective
Date of FASB Interpretation No. 46, Consolidation of Variable Interest Entities,
which defers the effective date until December 31, 2003 for calendar year-end
companies for applying the provisions of FIN 46 for interests held in entities
created or acquired before February 1, 2003, with partial early adoption
permitted. During the third quarter of 2003, the Corporation applied the
provisions of FIN 46 to two wholly-owned subsidiary trusts that have issued
capital securities to third-party investors and to certain direct and indirect
interests in investment partnerships. The application of FIN 46 resulted in the
deconsolidation of the two wholly-owned subsidiary trusts. The assets and
liabilities of the subsidiary trusts that were deconsolidated totaled $189
million and $183 million, respectively. See Note 14 for further discussion of
these trusts and the Corporation's related obligations. The application of FIN
46 to certain direct and indirect interests in investment partnerships resulted
in the consolidation of assets and liabilities each totaling $73 million. Of the
total $73 million of liabilities consolidated, $72 million represented amounts
owed to minority ownership interests. There was no material impact to results of
operations or liquidity as of and for the quarter ended September 30, 2003 as a
result of applying these provisions of FIN 46.
Management continues to evaluate the applicability of FIN 46 on various other
investments and interests, including low-income housing partnership interests,
small business commercial real estate partnerships, historic tax credit
partnerships, principal investment partnerships, leveraged leasing structures,
certain trust accounts, and restructured loans. The Corporation does not believe
that the application of FIN 46 to any of these investments or interests, if
required, will have a material impact on financial condition, results of
operations, or liquidity.
15
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 guarantees are disclosed
in Note 19. The implementation of the accounting requirements of FIN 45 did not
have a material impact on financial condition, the results of operations, 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 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
financial condition, the results of operations, 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 financial
condition, the results of operations, or liquidity.
NON-GAAP FINANCIAL MEASURES: In January 2003, the SEC issued Regulation G,
Conditions for Use of Non-GAAP Financial Measures. As defined in Regulation G, a
non-GAAP financial measure is a numerical measure of a company's historical or
future performance, financial position, or cash flow that excludes or includes
amounts or adjustments that are included or excluded in the most directly
comparable measure calculated in accordance with generally accepted accounting
principles (GAAP). Companies that present non-GAAP financial measures must
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.
16
3. RESTRUCTURING CHARGES
During the first quarter of 2003, the Corporation implemented various
cost-reduction initiatives focused on improving its long-term profitability. In
connection with cost-reduction initiatives, severance and related charges
recognized totaled $76 million and were recorded as unallocated corporate
charges in the Parent and Other category. Of this amount, $71 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 $5
million was recorded to third-party services expense and was incurred for
outplacement services offered to employees whose positions were eliminated. A
rollforward of the liability for severance and related expenses by line of
business is presented in the table below. Also included in the rollforward is
the accrued liability for severance expenses incurred within the National
Processing line of business.
Three Months Ended Nine Months Ended
September 30, 2003 September 30, 2003
------------------------------------------- -----------------------------------------
Parent and National Parent and National
(In Thousands) Other Processing Consolidated Other Processing Consolidated
- ----------------------------- ---------- ---------- ------------ ---------- ---------- ------------
Beginning balance $24,404 $2,455 $26,859 $13,895 $3,141 $17,036
Severance and related charges
and adjustments 5,504 (65) 5,439 75,834 639 76,473
Payments 11,182 484 11,666 71,003 1,874 72,877
------- ------ ------- ------- ------ -------
ENDING BALANCE $18,726 $1,906 $20,632 $18,726 $1,906 $20,632
======= ====== ======= ======= ====== =======
4. SECURITIZATION ACTIVITY
The Corporation periodically sells assets through securitization transactions.
During the first quarter of 2003, the Corporation securitized four pools of
Small Business Administration (SBA) loans 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 third 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, representing 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.
17
THREE MONTHS ENDED NINE MONTHS ENDED
AS OF SEPTEMBER 30, 2003 SEPTEMBER 30, 2003 SEPTEMBER 30, 2003
--------------------------- ------------------------ ----------------------
Principal Loans Past Due Average Net Credit Average Net Credit
(In Millions) Balance 30 Days or More Balances Losses Balances Losses
- ----------------------------- --------- --------------- -------- ---------- -------- ----------
Type of loan:
Credit card $2,480.4 $ 95.0 $2,475.9 $34.8 $2,422.4 $99.2
Automobile 4,468.1 65.2 4,506.2 11.1 4,433.8 34.1
SBA 38.0 2.9 38.5 -- 32.4 --
-------- ------ -------- ----- -------- -----
Total loans managed or
securitized 6,986.5 163.1 7,020.6 45.9 6,888.6 133.3
Less:
Loans securitized:
Credit card 1,450.0 49.1 1,450.0 19.5 1,450.0 55.7
Automobile 568.1 9.2 609.9 2.2 699.0 7.2
SBA 38.0 2.9 38.5 -- 32.4 --
Loans held for securitization:
Credit card -- -- -- -- -- --
Automobile -- -- -- -- -- --
SBA -- -- -- -- -- --
-------- ------ -------- ----- -------- -----
LOANS HELD IN PORTFOLIO $4,930.4 $101.9 $4,922.2 $24.2 $4,707.2 $70.4
======== ====== ======== ===== ======== =====
Three Months Ended Nine Months Ended
As of September 30, 2002 September 30, 2002 September 30, 2002
--------------------------- ------------------------ ----------------------
Principal Loans Past Due Average Net Credit Average Net Credit
(In Millions) Balance 30 Days or More Balances Losses Balances Losses
- ----------------------------- --------- --------------- -------- ---------- -------- ----------
Type of loan:
Credit card $2,289.1 $ 86.5 $2,296.0 $29.6 $2,241.8 $ 90.6
Automobile 4,449.2 78.4 4,415.0 9.0 4,373.1 31.5
SBA -- -- -- -- -- --
-------- ------ -------- ----- -------- ------
Total loans managed or
securitized 6,738.3 164.9 6,711.0 38.6 6,614.9 122.1
Less:
Loans securitized:
Credit card 1,450.0 47.7 1,450.0 18.3 1,403.3 54.4
Automobile 923.9 8.9 968.7 1.6 691.8 2.3
SBA -- -- -- -- -- --
Loans held for securitization:
Credit card -- -- -- -- 46.7 --
Automobile -- -- -- -- 332.1 --
SBA -- -- -- -- -- --
-------- ------ -------- ----- -------- ------
LOANS HELD IN PORTFOLIO $4,364.4 $108.3 $4,292.3 $18.7 $4,141.0 $ 65.4
======== ====== ======== ===== ======== ======
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.
18
Certain cash flows received from the structured entities associated with the
loan sales described above follow:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2003 SEPTEMBER 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 792.2 -- -- 2,310.6 -- --
Servicing fees received 7.3 1.5 -- 21.8 5.3 --
Other cash flows received on retained interest 21.9 4.0 .3 65.9 13.3 .6
Proceeds from sales of previously charged-off
accounts .2 -- -- .9 -- --
Purchases of delinquent or foreclosed assets -- -- -- -- -- --
Repayments of servicing advances -- -- -- -- -- --
============================================================================================================================
Three Months Ended Nine Months Ended
September 30, 2002 September 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 765.2 -- 2,226.5 --
Servicing fees received 7.3 3.0 21.9 6.2
Other cash flows received on retained interest 23.8 8.8 70.0 10.5
Proceeds from sales of previously charged-off
accounts .3 -- 1.3 --
Purchases of delinquent or foreclosed assets -- .2 -- .2
Repayments of servicing advances -- -- -- --
=======================================================================================================
A summary of the fair values of the credit card and automobile securitization
interest-only strips and servicing assets retained, key economic assumptions
used to arrive at the fair values, and the sensitivity of the September 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.
Variable
Weighted- Annual Monthly Expected
average Coupon Rate Principal Annual Annual
Fair Life To Repayment Credit Discount
(Dollars in Millions) Value (in months)(b) Investors(b) Rate(b) Losses(b) Rate(b) Yield(b)
- -----------------------------------------------------------------------------------------------------------------------------------
CREDIT CARD LOANS
Interest-only strips(a) $ 6.0 3.2 1.34% 18.21% 5.72% 15.00% 10.32%
AS OF SEPTEMBER 30, 2003
Decline in fair value of 10% adverse
change $ .4 $ .4 $ 2.2 -- $ 3.9
Decline in fair value of 20% adverse
change .9 .8 4.3 -- 6.0
===================================================================================================================================
(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
19
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 $ 16.6 15.2 1.40% 2.16% 12.00% 8.71%
AS OF SEPTEMBER 30, 2003
Decline in fair value of 10% adverse
change $ 1.0 $ 2.0 $ .4 $ 5.6
Decline in fair value of 20% adverse
change 1.9 3.9 .7 10.7
Servicing asset $ 5.9 11.4 1.40% 2.16% 12.00% 8.71%
AS OF SEPTEMBER 30, 2003(b)
Decline in fair value of 10% adverse
change $ .3 -- $ .1 --
Decline in fair value of 20% adverse
change .7 -- .1 --
=============================================================================================================================
(a) Absolute prepayment speed
(b) Carrying value of servicing asset at September 30, 2003 was $5.9 million
(c) The expected static pool loss assumption performed consistent with the
expected cumulative credit loss assumptions
5. 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.
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.
6. LOANS AND LEASE FINANCINGS
Total loans outstanding were recorded net of unearned income and deferred loan
fees and costs of $242 million, $390 million, and $431 million at September 30,
2003, December 31, 2002, and September 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 September 30 follows:
(In Thousands) 2003 2002
- ------------------------------------------------------------------------------------------------------------
COMMERCIAL
Direct financings $1,199,587 $1,453,008
Leveraged leases 277,625 329,097
- ------------------------------------------------------------------------------------------------------------
TOTAL COMMERCIAL LEASE FINANCINGS 1,477,212 1,782,105
CONSUMER
Retail automobile lease financings 219,194 712,762
- ------------------------------------------------------------------------------------------------------------
TOTAL NET INVESTMENT IN LEASE FINANCINGS $1,696,406 $2,494,867
============================================================================================================
20
The components of the net investment in lease financings at September 30 follow:
(In Thousands) 2003 2002
- -----------------------------------------------------------------------------------------------------------
COMMERCIAL
Lease payments receivable $ 1,306,325 $ 1,608,552
Estimated residual value of leased assets 483,422 583,163
- -----------------------------------------------------------------------------------------------------------
Gross investment in commercial lease financings 1,789,747 2,191,715
Unearned income (312,535) (409,610)
- -----------------------------------------------------------------------------------------------------------
TOTAL NET INVESTMENT IN COMMERCIAL LEASE FINANCINGS 1,477,212 1,782,105
- -----------------------------------------------------------------------------------------------------------
CONSUMER
Lease payments receivable 58,226 224,617
Estimated residual value of leased assets 175,472 547,817
- -----------------------------------------------------------------------------------------------------------
Gross investment in consumer lease financings 233,698 772,434
Unearned income (14,504) (59,672)
- -----------------------------------------------------------------------------------------------------------
TOTAL NET INVESTMENT IN CONSUMER LEASE FINANCINGS $ 219,194 $ 712,762
===========================================================================================================
A rollforward of the residual value component of lease financings follows:
Three Months Ended Nine Months Ended
September 30 September 30
- -----------------------------------------------------------------------------------------------------------
(In Thousands) 2003 2002 2003 2002
- -----------------------------------------------------------------------------------------------------------
COMMERCIAL
Beginning balance $502,399 $ 589,740 $ 561,438 $ 595,867
Additions 15,064 10,932 26,154 36,959
Maturities and terminations (34,041) (17,509) (66,315) (45,043)
Write-downs -- -- (37,855) (4,620)
- -----------------------------------------------------------------------------------------------------------
ENDING BALANCE $483,422 $ 583,163 $ 483,422 $ 583,163
- -----------------------------------------------------------------------------------------------------------
CONSUMER
Beginning balance $262,889 $ 657,627 $ 446,872 $ 862,428
Additions -- -- -- --
Maturities and terminations (96,991) (109,810) (255,719) (263,759)
Recoveries (write-downs) 9,574 -- (15,681) (50,852)
- -----------------------------------------------------------------------------------------------------------
ENDING BALANCE $175,472 $ 547,817 $ 175,472 $ 547,817
===========================================================================================================
The commercial lease residual value write-downs recorded during the first nine
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.
21
7. ALLOWANCE FOR LOAN LOSSES
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 Nine Months Ended
September 30 September 30
- ----------------------------------------------------------------------------------------------------------
(In Thousands) 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------
BALANCE AT BEGINNING OF PERIOD $1,147,098 $1,030,487 $ 1,098,588 $ 997,331
Provision 107,047 169,164 490,427 523,280
Allowance related to loans sold or
securitized -- -- -- (4,477)
Charge-offs:
Commercial 44,102 66,680 248,885 244,599
Real estate - commercial 9,411 5,723 17,752 16,247
Real estate - residential 48,024 17,095 120,221 60,543
Home equity lines of credit 6,191 4,761 17,715 14,293
Credit cards and other unsecured lines
of credit 24,281 19,804 71,127 61,495
Other consumer 27,177 36,238 91,991 129,607
- ----------------------------------------------------------------------------------------------------------
Total charge-offs 159,186 150,301 567,691 526,784
Recoveries:
Commercial 9,774 7,861 31,497 19,689
Real estate - commercial 799 2,037 1,663 3,788
Real estate - residential 10,741 1,082 26,933 3,064
Home equity lines of credit 1,624 839 4,836 3,048
Credit cards and other unsecured lines
of credit 1,678 2,239 5,723 6,447
Other consumer 10,058 16,365 37,657 54,387
- ----------------------------------------------------------------------------------------------------------
Total recoveries 34,674 30,423 108,309 90,423
Net charge-offs 124,512 119,878 459,382 436,361
- ----------------------------------------------------------------------------------------------------------
BALANCE AT END OF PERIOD $1,129,633 $1,079,773 $ 1,129,633 $1,079,773
==========================================================================================================
Nonperforming loans totaled $629 million, $702 million, and $747 million as of
September 30, 2003, December 31, 2002, and September 30, 2002, respectively. For
loans classified as nonperforming at September 30, 2003, the contractual
interest due and actual interest recognized on those loans for the first nine
months of 2003 was $55 million and $10 million, respectively. Included in
nonperforming loans were impaired loans, as defined under SFAS 114, aggregating
$343 million, $391 million, and $466 million at September 30, 2003, December 31,
2002, and September 30, 2002, respectively. Average impaired loans for the first
nine months of 2003 and 2002 totaled $387 million and $354 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 September 30, 2003, December 31, 2002, and
September 30, 2002 was $50 million, $76 million, and $53 million, respectively.
At September 30, 2003, December 31, 2002, and September 30, 2002, impaired loans
with an associated allowance totaled $185 million, $206 million, and $200
million, respectively, while impaired loans with no associated allowance totaled
$158 million, $185 million, and $266 million, respectively, for these same
period ends. There was no interest recognized during the first nine months of
2003 and 2002 on impaired loans while they were considered impaired.
22
8. SECURITIES
Securities available for sale follow:
AMORTIZED FAIR
(In Thousands) COST VALUE
- ----------------------------------------------------------------------------------------------
SEPTEMBER 30, 2003
U.S. Treasury and Federal agency debentures $ 664,760 $ 717,471
Mortgage-backed securities 3,583,170 3,701,833
Asset-backed and corporate debt securities 1,059,912 1,063,609
States and political subdivisions 674,530 725,300
Other 537,312 546,905
- ----------------------------------------------------------------------------------------------
TOTAL SECURITIES $ 6,519,684 $ 6,755,118
- ----------------------------------------------------------------------------------------------
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
- ----------------------------------------------------------------------------------------------
September 30, 2002
U.S. Treasury and Federal agency debentures $ 991,835 $ 1,062,144
Mortgage-backed securities 5,436,258 5,672,580
Asset-backed and corporate debt securities 2,109,139 2,116,089
States and political subdivisions 665,029 725,343
Other 944,997 910,968
- ----------------------------------------------------------------------------------------------
TOTAL SECURITIES $ 10,147,258 $ 10,487,124
==============================================================================================
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 of bank and thrift common stock investments
(bank stock fund). The bank stock fund had a cost basis and fair value of $33
million and $39 million, respectively, at September 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 $257 million and $217 million,
respectively, at September 30, 2002.
Gross unrealized gains for the total securities portfolio totaled $248 million,
$353 million, and $385 million at September 30, 2003, December 31, 2002, and
September 30, 2002, respectively. Gross unrealized losses for these same periods
totaled $13 million, $10 million, and $45 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 nine months ended September 30, 2003 and 2002, gross securities gains of
$41 million and $98 million, respectively, were recognized. For the nine months
ended September 30, 2003, gross securities losses of $4 million were recognized.
There were no gross securities losses recognized during the first nine months of
2002.
At September 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 $5 billion.
At September 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.
23
9. PRINCIPAL INVESTMENTS
The 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, commercial
services, and building products industries with no single industry constituting
greater than 20% of the total portfolio. A rollforward of principal investments
follows:
Three Months Ended Nine Months Ended
September 30 September 30
- ------------------------------------------------------------------------------------------------------------------------
(In Thousands) 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------
DIRECT INVESTMENTS:
Carrying value at beginning of period $ 324,840 $ 319,451 $ 317,089 $ 286,333
Investments -- new fundings 12,994 11,511 57,157 52,383
Reclassifications -- -- (12,415) --
Returns of capital and write-offs (27,252) (87) (36,921) (5,037)
Fair value adjustments (2,972) (12,717) (17,300) (15,521)
- ------------------------------------------------------------------------------------------------------------------------
Carrying value at end of period $ 307,610 $ 318,158 $ 307,610 $ 318,158
- ------------------------------------------------------------------------------------------------------------------------
INDIRECT INVESTMENTS:
Carrying value at beginning of period $ 284,084 $ 237,654 $ 254,899 $ 209,051
Investments -- new fundings 13,420 17,470 38,412 49,013
Reclassifications -- -- 12,415 --
Returns of capital and write-offs (8,187) (975) (16,568) (3,272)
Fair value adjustments (2,973) (4,818) (2,814) (5,461)
- ------------------------------------------------------------------------------------------------------------------------
Carrying value at end of period $ 286,344 $ 249,331 $ 286,344 $ 249,331
- ------------------------------------------------------------------------------------------------------------------------
TOTAL PRINCIPAL INVESTMENTS:
Carrying value at beginning of period $ 608,924 $ 557,105 $ 571,988 $ 495,384
Investments -- new fundings 26,414 28,981 95,569 101,396
Reclassifications -- -- -- --
Returns of capital and write-offs (35,439) (1,062) (53,489) (8,309)
Fair value adjustments (5,945) (17,535) (20,114) (20,982)
- ------------------------------------------------------------------------------------------------------------------------
CARRYING VALUE AT END OF PERIOD $ 593,954 $ 567,489 $ 593,954 $ 567,489
========================================================================================================================
Three Months Ended Nine Months Ended
September 30 September 30
- ------------------------------------------------------------------------------------------------------------------------
(In Thousands) 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------
PRINCIPAL INVESTMENT REVENUE (a) $ 7,139 $ 5,349 $ 22,674 $ 16,904
- ------------------------------------------------------------------------------------------------------------------------
NET PRINCIPAL INVESTMENT GAINS (LOSSES) (b) 16,860 (17,223) 6,936 (20,990)
========================================================================================================================
(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. A rollforward of goodwill by reporting unit follows:
JANUARY 1 GOODWILL IMPAIRMENT SEPTEMBER 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 261,387 430 -- 261,817
Asset Management 126,207 -- -- 126,207
National Processing 91,227 24,010 -- 115,237
Parent and Other -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------
TOTAL $1,078,281 $ 24,990 -- $1,103,271
========================================================================================================================
24
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.
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.
During the third quarter of 2003, the National City Mortgage Co. division of
National Consumer Finance purchased two retail residential mortgage loan
origination branches and capitalized goodwill of $430 thousand. There were no
other intangible assets capitalized in connection with this transaction.
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
are 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:
SEPTEMBER 30 December 31 September 30
(In Thousands) 2003 2002 2002
- -------------------------------------------------------------------------------------------------
CORE DEPOSIT INTANGIBLES
Gross carrying amount $ 93,328 $ 93,328 $ 93,328
Less: accumulated amortization 74,913 65,169 61,920
- -----------------------------------------------------------------------------------------------
NET CARRYING AMOUNT 18,415 28,159 31,408
- -----------------------------------------------------------------------------------------------
CREDIT CARD INTANGIBLES
Gross carrying amount 17,323 17,323 17,306
Less: accumulated amortization 14,024 12,990 12,630
- -----------------------------------------------------------------------------------------------
NET CARRYING AMOUNT 3,299 4,333 4,676
- -----------------------------------------------------------------------------------------------
MERCHANT PORTFOLIOS AND OTHER INTANGIBLES
Gross carrying amount 74,736 63,577 63,077
Less: accumulated amortization 27,819 21,496 19,723
- -----------------------------------------------------------------------------------------------
NET CARRYING AMOUNT 46,917 42,081 43,354
- -----------------------------------------------------------------------------------------------
TOTAL FINITE-LIVED INTANGIBLES
Gross carrying amount 185,387 174,228 173,711
Less: accumulated amortization 116,756 99,655 94,273
- -----------------------------------------------------------------------------------------------
NET CARRYING AMOUNT $ 68,631 $ 74,573 $ 79,438
===============================================================================================
Amortization expense on finite-lived intangible assets totaled $6 million and $5
million for the three months ended September 30, 2003 and 2002, respectively.
Amortization expense on finite-lived intangible assets totaled $17 million and
$16 million for the nine months ended September 30, 2003 and 2002, respectively.
Amortization expense on finite-lived intangible assets is expected to total $23
million, $23 million, $11 million, $9 million, and $8 million in 2003, 2004,
2005, 2006, and 2007, respectively.
25
11. MORTGAGE SERVICING ASSETS
The unpaid principal balance of residential mortgage loans serviced for third
parties was $129.1 billion at September 30, 2003, compared to $101.9 billion at
December 31, 2002 and $98.4 billion at September 30, 2002.
Changes in the carrying value of mortgage servicing assets and the associated
valuation allowance follow:
Three Months Ended Nine Months Ended
September 30 September 30
- -------------------------------------------------------------------------------------------------------------------------------
(In Thousands) 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------------------
MORTGAGE SERVICING ASSETS
Balance at beginning of period $ 856,261 $ 1,414,584 $ 998,743 $ 1,407,641
Additions 439,337 141,585 964,692 642,123
Amortization (190,209) (110,689) (475,209) (257,275)
SFAS 133 hedge basis adjustments (53,373) (348,149) (181,738) (685,691)
Application of valuation allowance to directly write-down
servicing assets -- -- (247,351) --
Sales (2,550) (13,642) (9,671) (23,109)
- -------------------------------------------------------------------------------------------------------------------------------
CARRYING VALUE BEFORE VALUATION ALLOWANCE AT END
OF PERIOD $ 1,049,466 $ 1,083,689 $ 1,049,466 $ 1,083,689
- -------------------------------------------------------------------------------------------------------------------------------
VALUATION ALLOWANCE
Balance at beginning of period $ (122,841) $ (346,184) $ (383,550) $ (271,937)
Impairment recoveries (charges) 115,070 (46,890) 128,428 (121,137)
Application of valuation allowance to directly write-down
servicing assets -- -- 247,351 --
- -------------------------------------------------------------------------------------------------------------------------------
BALANCE AT END OF PERIOD $ (7,771) $ (393,074) $ (7,771) $ (393,074)
- -------------------------------------------------------------------------------------------------------------------------------
NET CARRYING VALUE OF MORTGAGE SERVICING ASSETS AT END
OF PERIOD $ 1,041,695 $ 690,615 $ 1,041,695 $ 690,615
===============================================================================================================================
FAIR VALUE OF MORTGAGE SERVICING ASSETS AT END OF PERIOD $ 1,139,523 $ 690,615 $ 1,139,523 $ 690,615
===============================================================================================================================
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. At September 30, 2003, the fair
value of mortgage servicing assets exceeded the carrying value reported in the
consolidated balance sheet by $98 million. This difference represents increases
in the fair value of certain mortgage servicing assets accounted for under SFAS
140 that could not be recorded above their cost basis, net of accumulated
amortization and SFAS 133 adjustments.
The key economic assumptions used to estimate the value of the mortgage
servicing assets at September 30, 2003 and September 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 September 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.
26
SEPTEMBER 30 December 31 September 30
(Dollars in Thousands) 2003 2002 2002
- ------------------------------------------------------------------------------------------------------------
Fair value $ 1,139,523 $ 615,193 $ 690,615
Weighted-average life (in years) 3.1 2.2 2.5
Weighted-average constant prepayment rate (CPR) 29.19% 63.07% 39.86%
Weighted-average discount rate 9.49 9.53 9.71
Prepayment rate:
Decline in fair value from 10% adverse change $ 70,477
Decline in fair value from 20% adverse change 132,456
Discount rate:
Decline in fair value from 10% adverse change 28,729
Decline in fair value from 20% adverse change 55,923
===========================================================================================================
The key economic assumptions used in determining the fair value of mortgage
servicing assets capitalized during the three-and nine-month periods ended
September 30, 2003 were as follows:
Three Months Ended Nine Months Ended
September 30 September 30
- ------------------------------------------------------------------------------------------------------------------------
Weighted-average CPR 20.32% 28.47%
Weighted-average life (in years) 5.8 4.2
Weighted-average discount rate 9.54% 9.44%
========================================================================================================================
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 nine month periods ended September 30, 2003, net (losses) gains
totaling $(31) million and $358 million, respectively, were recognized on
derivative instruments used to hedge the value of mortgage servicing assets and
were included in mortgage banking revenue on the income statement.
12. BORROWED FUNDS
Detail of borrowed funds follows:
SEPTEMBER 30 December 31 September 30
(In Thousands) 2003 2002 2002
- ------------------------------------------------------------------------------------------------------
U.S. Treasury notes $ 847,252 $ 8,881,947 $8,364,033
Senior bank notes -- 1,560,000 --
Commercial paper and other 625,494 1,051,962 1,438,339
- ------------------------------------------------------------------------------------------------------
TOTAL BORROWED FUNDS $ 1,472,746 $ 11,493,909 $9,802,372
======================================================================================================
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 September 30, 2003, $847 million of notes were callable on
demand by the U.S. Treasury, compared to $7.9 billion and $8.4 billion at
December 31, 2002 and September 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 were issued by National City's bank subsidiaries and had
maturities of nine months or less.
Commercial paper borrowings are issued by the Corporation's subsidiary, National
City Credit Corporation, and have maturities of nine months or less.
27
13. LONG-TERM DEBT
The composition of long-term debt follows. This note excludes the discussion and
amounts associated with the junior subordinated notes owed to the unconsolidated
subsidiary trusts. See Note 14 for further discussion on these obligations.
- -----------------------------------------------------------------------------------------------------------
SEPTEMBER 30 December 31 September 30
(In Thousands) 2003 2002 2002
- -----------------------------------------------------------------------------------------------------------
3.20% senior notes due 2008 $ 297,909 $ -- $ --
6.625% subordinated notes due 2004 249,946 249,849 249,817
7.75% subordinated notes due 2004 199,786 199,594 199,530
8.50% subordinated notes due 2004 149,958 149,863 149,832
7.20% subordinated notes due 2005 258,333 260,849 260,564
5.75% subordinated notes due 2009 331,328 333,928 330,192
6.875% subordinated notes due 2019 796,445 808,353 802,493
Other 1,760 2,640 12,640
- -----------------------------------------------------------------------------------------------------------
TOTAL HOLDING COMPANY 2,285,465 2,005,076 2,005,068
6.50% subordinated notes due 2003 -- 202,158 203,777
7.25% subordinated notes due 2010 267,804 272,007 269,388
6.30% subordinated notes due 2011 228,089 231,006 228,507
7.25% subordinated notes due 2011 198,411 198,263 198,214
6.25% subordinated notes due 2011 338,353 342,357 338,493
6.20% subordinated notes due 2011 544,927 550,307 543,718
4.63% subordinated notes due 2013 299,216 -- --
4.25% subordinated notes due 2018 224,454 -- --
Senior bank notes 18,732,265 14,998,141 13,480,353
Federal Home Loan Bank advances 3,999,601 3,750,980 3,750,572
- -----------------------------------------------------------------------------------------------------------
TOTAL BANK SUBSIDIARIES 24,833,120 20,545,219 19,013,022
- -----------------------------------------------------------------------------------------------------------
TOTAL LONG-TERM DEBT $ 27,118,585 $ 22,550,295 $ 21,018,090
===========================================================================================================
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 and caps, to manage interest rate risk on its long-term
debt. Interest rate swaps are used to hedge the fair value of certain fixed-rate
debt by converting the debt to variable rate and are also used to hedge the cash
flow variability associated with certain variable-rate debt by converting the
debt to fixed rate. Interest rate caps are used to hedge cash flow variability
by capping the interest payments associated with variable-rate debt issuances.
Interest rate swaps and caps used to convert the Corporation's debt are based on
the one- or three-month London Interbank Offering Rate (LIBOR) rate, the Federal
Funds rate, or the Prime 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.
A summary of par values and weighted-average rates of long-term debt as of
September 30, 2003 follows. The weighted-average effective rate includes the
effects of derivative instruments used to manage interest rate risk.
- ------------------------------------------------------------------------------------------------------
Weighted-average Weighted-average
(Dollars in Thousands) Par Value Contractual Rate Effective Rate
- ------------------------------------------------------------------------------------------------------
Senior notes $ 300,000 3.20% 1.30%
Subordinated notes 3,825,000 6.43 3.19
Senior bank notes 18,646,500 1.40 1.56
FHLB advances 3,989,993 1.27 2.70
Other 1,760 12.95 12.95
- ------------------------------------------------------------------------------------------------------
Total long-term debt $ 26,763,253 2.08% 1.92%
======================================================================================================
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 nine months of 2003. In March 2003, the holding company issued senior
notes with a par value of $300 million.
Senior bank notes are issued by National City's bank subsidiaries. During the
first nine months of 2003, senior bank notes with a par value of $9.5 billion
were issued by the bank subsidiaries. At September 30, 2003, senior bank notes
totaling $1.8 billion were contractually based on a fixed rate of interest and
$16.8 billion were contractually based on a variable rate of interest.
28
FHLB advances at September 30, 2003, contractually consisted of $189 million of
fixed-rate obligations and $3.8 billion of variable-rate obligations. 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 its
long-term debt rating. The fee is currently 10 basis points on the amount of the
credit facility. There have been no borrowings outstanding under this agreement.
14. JUNIOR SUBORDINATED DEBENTURES OWED TO UNCONSOLIDATED SUBSIDIARY TRUSTS AND
CORPORATION-OBLIGATED MANDATORILY REDEEMABLE CAPITAL SECURITIES OF SUBSIDIARY
TRUSTS HOLDING SOLELY DEBENTURES OF THE CORPORATION
National City has sponsored two 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
corporation-obligated mandatorily redeemable capital securities (the capital
securities) to third-party investors and investing the proceeds from the sale of
such capital securities solely in junior subordinated debt securities of the
Corporation (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. 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 the First
of America and Fort Wayne capital trusts are first redeemable, in whole or in
part, by the Corporation on January 31, 2007 and April 15, 2007, respectively.
In the third quarter of 2003, as a result of applying the provisions of FIN 46,
which represents new accounting guidance governing when an equity interest
should be consolidated, the Corporation was required to deconsolidate these
subsidiary trusts from its financial statements. The deconsolidation of the net
assets and results of operations of the trusts had virtually no impact on the
Corporation's financial statements or liquidity position since the Corporation
continues to be obligated to repay the debentures held by the trusts and
guarantees repayment of the capital securities issued by the trusts. The
consolidated debt obligation related to the trusts increased from $180 million
to $186 million upon deconsolidation with the difference representing the
Corporation's common ownership interest in the trusts.
The capital securities held by the trusts qualify as Tier 1 capital for the
Corporation under Federal Reserve Board guidelines. As a result of the issuance
of FIN 46, the Federal Reserve Board is currently evaluating whether
deconsolidation of the trusts will affect the qualification of the capital
securities as Tier 1 capital. If in the future it is determined that the capital
securities can no longer qualify as Tier 1 capital, the effect of such a change
would not have a material impact on National City's capital ratios.
Consolidated debt obligations related to subsidiary trusts holding solely
debentures of the Corporation follows:
- ---------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30 December 31 September 30
(In Thousands) 2003 2002 2002
- ---------------------------------------------------------------------------------------------------------------------------
8.12% junior subordinated debentures owed to First of America
Capital Trust I due January 31, 2027 $ 154,640 -- --
9.85% junior subordinated debentures owed to Fort Wayne
Capital Trust I due April 15, 2027 30,928 -- --
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL JUNIOR SUBORDINATED DEBENTURES OWED TO UNCONSOLIDATED
SUBSIDIARY TRUSTS 185,568 -- --
- ---------------------------------------------------------------------------------------------------------------------------
8.12% capital securities of First of America Capital Trust I
due January 31, 2027 -- $ 150,000 $ 150,000
9.85% capital securities of Fort Wayne Capital Trust I
due April 15, 2027 -- 30,000 30,000
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL CAPITAL SECURITIES OF CONSOLIDATED SUBSIDIARY TRUSTS -- 180,000 180,000
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL CONSOLIDATED DEBT OBLIGATIONS RELATED TO SUBSIDIARY TRUSTS $ 185,568 $ 180,000 $ 180,000
===========================================================================================================================
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
29
discretionary actions by regulators that could have a material effect on
financial position and operations.
Regulatory and other capital measures follow:
SEPTEMBER 30 December 31 September 30
2003 2002 2002
- ---------------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands) AMOUNT RATIO Amount Ratio Amount Ratio
- ---------------------------------------------------------------------------------------------------------------------------------
Total equity/assets $ 9,134,327 7.54% $ 8,308,012 7.03% $ 8,156,861 7.46%
Total common equity/assets 9,134,327 7.54 8,308,012 7.03 8,156,861 7.46
Tangible common equity/tangible assets 7,962,425 6.64 7,155,158 6.11 6,999,142 6.47
Tier 1 capital 8,214,164 8.28 7,263,196 7.60 7,081,522 7.78
Total risk-based capital 12,360,766 12.46 10,996,661 11.51 10,795,857 11.87
Leverage 8,214,164 6.70 7,263,196 6.52 7,081,522 7.09
=================================================================================================================================
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 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 are 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 September 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 September 30, 2002, each of
the subsidiary banks were also categorized as well-capitalized.
As discussed in Note 14, the capital securities held by the First of America and
Fort Wayne subsidiary trusts qualify as Tier 1 capital for the Corporation under
Federal Reserve Board guidelines. As a result of the issuance of FIN 46, the
Federal Reserve Board is currently evaluating whether deconsolidation of the
trusts will affect the qualification of the capital securities as Tier 1
capital. If in the future it is determined that the capital securities can no
longer qualify as Tier 1 capital, the effect of such a change would not have a
material impact on National City's 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
$126 million at September 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 September 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:
SEPTEMBER 30 December 31 September 30
2003 2002 2002
- ---------------------------------------------------------------------------------------------------
Common Stock, $4 par value,
authorized 1,400,000,000 shares 609,136,762 611,491,359 612,180,011
===================================================================================================
30
On August 30, 2002, the Corporation redeemed all 735 of its remaining
outstanding preferred shares, 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%.
A summary of activity in accumulated other comprehensive income follows:
Nine Months Ended
September 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 $(21,931) in 2003 and $99,377 in 2002 (40,728) 184,557
Reclassification adjustment for gains included in net income,
net of tax expense of $7,663 in 2003 and $28,421 in 2002 (29,312) (69,301)
- ----------------------------------------------------------------------------------------------------
Effect on other comprehensive income for the period (70,040) 115,256
- ----------------------------------------------------------------------------------------------------
Accumulated unrealized gains on securities available for sale
at September 30, net of tax $ 153,033 $ 220,912
====================================================================================================
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 $21,534 in 2003 and $98,439 in 2002 (39,991) (182,816)
Reclassification adjustment for losses included in net income,
net of tax benefit of $50,038 in 2003 and $44,726 in 2002 92,929 83,062
- ----------------------------------------------------------------------------------------------------
Effect on other comprehensive income for the period 52,938 (99,754)
- ----------------------------------------------------------------------------------------------------
Accumulated unrealized losses on derivatives used in cash
flow hedging relationships at September 30, net of tax $ (102,955) $ (133,133)
====================================================================================================
Accumulated other comprehensive income at
January 1, net of tax $ 67,180 $ 72,277
Other comprehensive (loss) income, net of tax (17,102) 15,502
- ----------------------------------------------------------------------------------------------------
ACCUMULATED OTHER COMPREHENSIVE INCOME AT SEPTEMBER 30,
NET OF TAX $ 50,078 $ 87,779
====================================================================================================
The Corporation had two share repurchase authorizations outstanding at September
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 these
programs are held for reissue in connection with stock compensation plans and
for general corporate purposes. During the first nine months of 2003, the
Corporation repurchased 6.7 million shares of its common stock. There were no
share repurchases of common stock during the first nine months of 2002. As of
September 30, 2003, 32.6 million shares remain authorized for repurchase.
17. NET INCOME PER COMMON SHARE
Basic and diluted net income per common share calculations follow:
Three Months Ended Nine Months Ended
September 30 September 30
- -------------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts) 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------------------
BASIC
Net income $379,337 $374,187 $1,492,476 $1,213,100
Less preferred dividends -- 1 -- 21
- -------------------------------------------------------------------------------------------------------------------------------
Net income applicable to common stock $379,337 $374,186 $1,492,476 $1,213,079
- -------------------------------------------------------------------------------------------------------------------------------
Average common shares outstanding 613,574 611,639 612,413 609,611
- -------------------------------------------------------------------------------------------------------------------------------
Net income per common share--basic $ .62 $ .61 $ 2.44 $ 1.99
===============================================================================================================================
DILUTED
Net income $379,337 $374,187 $1,492,476 $1,213,100
- -------------------------------------------------------------------------------------------------------------------------------
Average common shares outstanding 613,574 611,639 612,413 609,611
Stock award adjustment 5,395 6,197 5,243 6,599
Preferred stock adjustment -- 14 -- 33
- -------------------------------------------------------------------------------------------------------------------------------
Average common shares outstanding--diluted 618,969 617,850 617,656 616,243
- -------------------------------------------------------------------------------------------------------------------------------
Net income per common share--diluted $ .62 $ .61 $ 2.42 $ 1.97
===============================================================================================================================
31
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.
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. At September 30, 2003 and 2002, options to purchase
23,999,805 and 23,468,309 shares of common stock, respectively, were outstanding
but not included in the computation of diluted net income per share because
the option exercise price exceeded the fair value of the stock and consequently
their inclusion would have had an anti-dilutive effect. 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:
Nine Months Ended
September 30
- ------------------------------------------------------------------------------------------
(In Thousands) 2003 2002
- ------------------------------------------------------------------------------------------
Applicable to income exclusive of securities gains $775,082 $586,014
Applicable to securities gains 7,663 28,421
- ------------------------------------------------------------------------------------------
TOTAL INCOME TAX EXPENSE $782,745 $614,435
==========================================================================================
The effective tax rate was 34.4% and 33.6% for the nine months ended September
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:
SEPTEMBER 30 December 31 September 30
(In Thousands) 2003 2002 2002
- ---------------------------------------------------------------------------------------------------------------
Commitments to extend credit:
Revolving home equity and credit card lines $23,486,660 $ 22,138,518 $21,710,564
Other loans 32,659,155 35,018,220 40,603,912
Standby letters of credit 3,922,038 3,769,894 3,858,785
Commercial letters of credit 155,703 126,775 128,103
Net commitments to sell mortgage loans and
mortgage-backed securities 18,841,648 22,366,679 20,400,908
Commitments to fund principal investments 253,062 241,952 251,661
Commitments to fund civic and community investments 185,598 206,158 177,890
===============================================================================================================
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.
32
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 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 committed to invest in existing and future projects.
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
$36 billion and $93 billion for the third quarter and first nine months of 2003,
respectively, and were $16 billion and $50 billion for the same 2002 periods,
respectively. Total loans repurchased during the third quarter and first nine
months of 2003 were $56 million and $180 million, respectively, and total loans
repurchased for the same 2002 periods were $38 million and $154 million,
respectively. Loans indemnified that remain outstanding as of September 30, 2003
totaled $96 million. In addition, total loans sold of $3.2 billion remained
uninsured as of September 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 September 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 $18 million and $48 million
for the third quarter and first nine months of 2003, respectively. Losses
charged against the liability for the third quarter and first nine months of
2002 were $2 million and $37 million, respectively. At September 30, 2003, the
liability for estimated losses on repurchase and indemnification was $160
million and was included in other liabilities on the balance sheet.
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
September 30, 2003, the current liability, which represents the fair value of
the financial guarantee, and the maximum exposure to loss under these contracts
totaled $417 thousand and $3 million, respectively. As a result of the issuance
of SFAS 149, similar contracts entered into after June 30, 2003 are accounted
for as derivative instruments.
The guarantee liability for standby letters of credit was $7 million at
September 30, 2003, which was recorded in other liabilities on the 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.
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 four-month period from June through September 2003, this
amount totaled approximately $50 billion. At September 30, 2003, the Corporation
had $4 million of unresolved chargebacks that were in process of resolution.
33
For the three months ended September 30, 2003 and 2002, the Corporation
processed $39 million and $40 million, respectively, in chargebacks presented by
issuing banks. For the nine months ended September 30, 2003 and 2002, the
Corporation processed $115 million and $127 million, respectively, in
chargebacks presented by issuing banks. Actual losses recorded for the three
months ended September 30, 2003 and 2002 were each $1 million. Actual losses
recorded for the nine months ended September 30, 2003 and 2002 were $2 million
and $3 million, respectively. The Corporation accrues for probable losses based
on historical experience and at September 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 nine months ended September 30, 2003,
the Corporation processed approximately $10 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 September 30,
2003, the estimated dollar value of tickets purchased, but as yet unflown, under
continuing merchant processing contracts, was approximately $845 million, of
which approximately $480 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 September 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 September
30, 2003, the estimated dollar value of tickets purchased, but as yet unflown,
under these concluding contracts was approximately $24 million. This amount
represents management's best estimate of its maximum potential chargeback
exposure under these concluded contracts. As of September 30, 2003, the
Corporation held cash collateral of $2 million and third-party indemnifications
of $110 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.
34
20. STOCK OPTIONS AND AWARDS
National City maintains various incentive and nonqualified stock option plans
and 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 stock option and restricted stock plans were
approved by stockholders with the exception of the 150th anniversary
commemorative grant in 1995.
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 25% to 50% annually beginning one year from the date of grant and
expire no 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. As of
September 30, 2003, 540,250 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 third quarter and first
nine months of 2003, compensation expense recognized related to National City's
stock option plans totaled $5 million and $8 million, respectively. There was no
expense recognized during the first nine months of 2002.
RESTRICTED STOCK PLANS: National City's restricted stock plans provide for the
issuance of up to eight 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 third quarter and first nine months of 2003 were
$33.78 and $32.49, respectively, and $30.95 and $30.23, respectively, for the
third quarter and first nine months of 2002. Compensation expense recognized for
restricted share plans during the third quarter and first nine months of 2003
was $5 million and $12 million, respectively, and $4 million and $8 million,
respectively, for the third quarter and first nine 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 (88,341) (591,592) 29.61
Exercised (348,183) (4,951,433) 18.50
Granted 1,185,014 10,217,594 27.84
- ----------------------------------------------------------------------------------------
September 30, 2002 2,571,800 53,473,119 $ 26.81
- ----------------------------------------------------------------------------------------
January 1, 2003 2,539,171 52,963,738 $ 26.89
Cancelled (117,103) (662,827) 29.73
Exercised (425,536) (6,043,552) 21.07
Granted 1,695,405 6,313,731 33.47
- ----------------------------------------------------------------------------------------
SEPTEMBER 30, 2003 3,691,937 52,571,090 $ 28.31
========================================================================================
As of September 30, 2003 and 2002, 16,431,684 and 22,278,392 shares,
respectively, were available for grant under the various stock option and
restricted stock plans.
Cancelled activity includes both forfeited and expired awards and options.
35
Information about stock options outstanding at September 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 85,410 $ 9.54 .9 85,410 $ 9.54
12.00-16.99 2,023,311 14.53 1.3 2,023,311 14.53
17.00-21.99 6,209,010 17.78 5.6 6,209,010 17.78
22.00-26.99 1,009,963 25.16 3.3 991,463 25.13
27.00-31.99 28,933,994 28.89 6.8 24,126,475 29.15
32.00-37.81 14,309,402 33.99 6.5 8,398,083 34.12
- -------------------------------------------------------------------------------------------------------
TOTAL 52,571,090 $ 28.31 6.3 41,833,752 $ 27.62
=======================================================================================================
At September 30, 2003 and 2002, options for 41,833,752 and 38,750,289 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 third quarter and nine month
periods ended September 30 follow:
- -------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
- -------------------------------------------------------------------------------------------------------------------------------
(In Thousands) 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------------------
PENSION BENEFITS
Service cost $ 12,790 $ 11,790 $ 38,371 $ 35,371
Interest cost 20,021 18,138 60,063 54,415
Expected return on plan assets (35,861) (39,923) (107,582) (119,771)
Amortization of prior service cost (1,188) (1,280) (3,566) (3,842)
Transition benefit (51) (639) (155) (1,919)
Recognized net actuarial (gain) loss 365 (2,274) 1,096 (6,822)
- -------------------------------------------------------------------------------------------------------------------------------
NET PERIODIC BENEFIT $ (3,924) $ (14,188) $ (11,773) $ (42,568)
===============================================================================================================================
OTHER POSTRETIREMENT BENEFITS
Service cost $ 735 $ 621 $ 2,208 $ 1,865
Interest cost 2,336 2,245 7,007 6,735
Amortization of prior service cost 33 46 100 140
Transition obligation 351 351 1,052 1,052
Recognized net actuarial loss 397 316 1,191 946
- -------------------------------------------------------------------------------------------------------------------------------
NET PERIODIC COST $ 3,852 $ 3,579 $ 11,558 $ 10,738
===============================================================================================================================
36
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 -- --
- ------------------------------------------------------------------------------------------------------
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 September 30,
2003, December 31, 2002, and September 30, 2002, obligations of $87 million, $80
million, and $79 million, respectively, were included in accrued expenses and
other liabilities for these plans. Expenses related to these plans totaled $4
million and $12 million for the third quarter and first nine months of 2003,
respectively, and $4 million and $11 million for the third quarter and first
nine 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 $13 million and $53
million for the third quarter and first nine months of 2003, respectively, and
$13 million and $45 million for the third quarter and first nine 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 September 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 September 30,
2003, the Corporation held cash, U.S. government, and U.S. government-sponsored
agency securities with a fair value of $420 million to
37
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 $35 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 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 September 30, 2003,
December 31, 2002, and September 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 certificates of deposit, long-term
FHLB advances, corporate and subordinated long-term debt, and senior bank notes.
For the three and nine month periods ended September 30, 2003, the Corporation
recognized total net ineffective fair value hedge losses of $139 million and $33
million, respectively. For the same periods in 2002, the Corporation recognized
total net ineffective hedge gains in the amount of $145 million and $311
million, respectively. Of the total losses recognized, net ineffective hedge
losses related to mortgage loans held for sale and servicing assets were $145
million and $52 million for the three and nine month periods ended September 30,
2003, respectively, compared to net ineffective hedge gains of $142 million and
$301 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 $7
million and $19 million for the three and nine month periods ended September 30,
2003, respectively. Net ineffective hedge gains related to these hedged assets
and liabilities were $3 million and $10 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 nine 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 month periods ended September 30, 2003 and 2002, the Corporation
recognized net ineffective cash flow hedge (losses) gains of $(900) thousand and
$300 thousand, respectively. During the first nine months of 2002, the
Corporation recognized net ineffective cash flow hedge losses of $300 thousand.
There were no net ineffective cash flow hedge gains (losses) recognized during
the first nine months of 2003. Net ineffective cash flow hedge gains (losses)
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 nine 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 September 30, 2003, December 31,
2002 and September 30, 2002, accumulated other comprehensive income included a
deferred after-tax net loss of $103 million, $156 million and $133 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 September 30, 2003, is projected to be reclassified
into interest expense in conjunction with the recognition of interest payments
on funding products through September 2013, with $99 million of net loss
expected to be reclassified within the next year. During the three and nine
month periods ended September 30, 2003, pretax losses of $54 million and $143
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 $43 million and $130 million, respectively, were reclassified
into interest expense. Also during the first nine 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 nine months of 2003 and 2002 arising
from the determination that the original forecasted transaction would not occur.
The tables on pages 40-41 provide further information regarding derivative
instruments designated in fair value and cash flow hedges at September 30, 2003,
December 31, 2002, and September 30, 2002.
38
OTHER DERIVATIVE ACTIVITIES: The derivative portfolio also includes derivative
financial instruments not included in SFAS 133 hedge relationships. Those
derivatives include 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)
------------------------------------------------
SEPTEMBER 30 December 31 September 30
(In Millions) 2003 2002 2002
- -----------------------------------------------------------------------------------------------------------------------
OTHER DERIVATIVE INSTRUMENTS
Mortgage-banking-related:
Mortgage servicing asset risk management $ (38.7) $ 12.0 $ (8.3)
Mortgage loan commitments and associated risk management (352.5) (33.2) (20.8)
- --------------------------------------------------------------------------------------------------------------------
Total mortgage-banking related (391.2) (21.2) (29.1)
- --------------------------------------------------------------------------------------------------------------------
Customer risk management 14.5 17.2 23.6
Other 3.8 (5.1) (10.6)
- --------------------------------------------------------------------------------------------------------------------
Total other 18.3 12.1 13.0
- --------------------------------------------------------------------------------------------------------------------
TOTAL OTHER DERIVATIVE INSTRUMENTS $ (372.9) $ (9.1) $(16.1)
====================================================================================================================
Three Months Ended Nine Months Ended
September 30 September 30
----------------------------------------------------------
Net Gains (Losses) Net Gains (Losses)
----------------------------------------------------------
(In Millions) 2003 2002 2003 2002
- ---------------------------------------------------------------------------------------------------------------------
OTHER DERIVATIVE ACTIVITIES
Mortgage-banking-related:
Mortgage servicing asset risk management $ 6.2 $15.3 $ 229.3 $ 23.0
Mortgage loan commitments and associated
risk management (490.9) 10.9 (272.8) (14.7)
- --------------------------------------------------------------------------------------------------------------------
Total mortgage-banking related (484.7) 26.2 (43.5) 8.3
- --------------------------------------------------------------------------------------------------------------------
Customer risk management 2.3 3.1 8.8 7.4
Other (19.2) (7.8) 46.6 (5.1)
- --------------------------------------------------------------------------------------------------------------------
Total other (16.9) (4.7) 55.4 2.3
- --------------------------------------------------------------------------------------------------------------------
TOTAL OTHER DERIVATIVE ACTIVITIES $(501.6) $21.5 $ 11.9 $ 10.6
====================================================================================================================
39
Summary information regarding the interest rate derivatives portfolio used for
interest-rate risk management purposes and designated as accounting hedges under
SFAS 133 at September 30, 2003, December 31, 2002, and September 30, 2002
follows:
SEPTEMBER 30, 2003 December 31, 2002
---------------------------------------------------------------------------------
NET Net
DERIVATIVE INEFFECTIVE Derivative 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 $ 1.5 $ -- $ 60 $ 1.4 $ --
Receive-fixed interest rate swaptions sold 55 -- .2 55 -- .4
Pay-fixed interest rate swaps 3,426 2.1 233.2 3,539 -- 285.1
Callable pay-fixed interest rate swaps 44 -- 4.7 44 -- 5.6
Extendable pay-fixed interest rate swaps -- -- -- 1 -- --
Pay-fixed interest rate swaptions sold 55 -- 5.2 55 -- 4.7
Interest rate caps sold 815 -- 1.3 765 -- 1.3
Interest rate floors sold 360 -- 8.7 260 -- 8.3
Interest rate futures purchased 2,463 -- -- 3,301 -- --
Interest rate futures sold 2,915 -- -- 4,094 -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Total 10,193 3.6 253.3 $ 20.1 12,174 1.4 305.4 $ 10.5
- ----------------------------------------------------------------------------------------------------------------------------------
Mortgage loans held for sale
Forward commitments to sell
mortgage loans and mortgage-
backed securities 20,068 71.1 -- 22,909 -- 375.2
Receive-fixed interest rate swaps 3,110 39.3 39.0 2,490 218.3 --
Pay fixed interest rate swaptions purchased 500 13.3 -- -- -- --
Pay-fixed interest rate swaptions sold 500 -- 10.3 500 -- 7.0
Interest rate caps purchased 13,150 56.9 -- 4,850 15.6 --
Interest rate futures purchased 11,230 -- -- -- -- --
Interest rate futures sold -- -- -- 75 -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Total 48,558 180.6 49.3 .2 30,824 233.9 382.2 30.8
- ----------------------------------------------------------------------------------------------------------------------------------
Available for sale securities
Pay-fixed interest rate swaps -- -- -- 250 -- 4.7 2.6
- ----------------------------------------------------------------------------------------------------------------------------------
Total -- -- -- -- 250 -- 4.7 2.6
- ----------------------------------------------------------------------------------------------------------------------------------
Mortgage servicing assets
Forward commitments to purchase mortgage
loans and mortgage-backed securities 6,700 208.4 -- 4,025 46.5 --
Receive-fixed interest rate swaps 6,630 465.6 38.2 2,920 376.1 --
Receive-fixed interest rate swaptions
purchased 3,600 65.0 -- 670 34.1 --
Receive-fixed interest rate swaptions sold -- -- -- 2,008 -- 56.1
Pay-fixed interest rate swaptions purchased -- -- -- 3,370 55.7 --
Pay-fixed interest rate swaptions sold 795 -- 72.4 3,908 -- 184.3
Principal-only interest rate swaps 168 15.4 -- 726 46.7 .2
Interest rate caps purchased 32,743 95.3 -- 24,340 61.6 --
Interest rate floors purchased -- -- -- 75 .4 --
Interest rate futures purchased -- -- -- 1,308 -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Total 50,636 849.7 110.6 (52.5) 43,350 621.1 240.6 300.6
- ----------------------------------------------------------------------------------------------------------------------------------
Funding
Receive-fixed interest rate swaps 5,005 405.3 25.8 4,395 453.8 --
Callable receive-fixed interest rate swaps 495 12.3 3.7 545 22.9 --
- ----------------------------------------------------------------------------------------------------------------------------------
Total 5,500 417.6 29.5 (.8) 4,940 476.7 -- 1.4
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL DERIVATIVES USED IN FAIR VALUE HEDGES 114,887 1,451.5 442.7 (33.0) 91,538 1,333.1 932.9 345.9
- ----------------------------------------------------------------------------------------------------------------------------------
CASH FLOW HEDGES
Funding
Pay-fixed interest rate swaps 12,975 .6 100.6 7,150 -- 181.2
Interest rate caps purchased 3,515 4.1 -- 8,500 14.9 --
- ----------------------------------------------------------------------------------------------------------------------------------
Total 16,490 4.7 100.6 -- 15,650 14.9 181.2 (.1)
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL DERIVATIVES USED IN CASH FLOW HEDGES 16,490 4.7 100.6 -- 15,650 14.9 181.2 (.1)
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL DERIVATIVES USED FOR INTEREST
RATE RISK MANAGEMENT AND DESIGNATED IN
SFAS 133 RELATIONSHIPS $131,377 $1,456.2 $ 543.3 $ (33.0) $107,188 $ 1,348.0 $1,114.1 $345.8
==================================================================================================================================
(a) Represents net ineffective hedge gain (loss) on hedging strategy for the
nine and twelve-month periods ended September 30, 2003 and December 31, 2002,
respectively
40
September 30, 2002
------------------------------------------------------
Net
Derivative Ineffective
Notional ------------------------ Hedge Gains
(In Millions) Amount Asset Liability (Losses)(a)
- ----------------------------------------------------------------------------------------------------------------
FAIR VALUE HEDGES
Loans
Receive-fixed interest rate swaps $ 60 $ 1.2 $ --
Receive-fixed interest rate swaptions sold 55 -- .7
Pay-fixed interest rate swaps 3,492 -- 261.5
Callable pay-fixed interest rate swaps 50 -- 5.8
Extendable pay-fixed interest rate swaps 1 -- --
Pay-fixed swaptions sold 155 -- 13.7
Interest rate caps sold 765 -- 2.6
Interest rate floors sold 260 -- 7.7
Interest rate futures purchased 4,495 -- --
Interest rate futures sold 4,899 -- --
- --------------------------------------------------------------------------------------------------------------
Total 14,232 1.2 292.0 $ 6.6
- --------------------------------------------------------------------------------------------------------------
Mortgage loans held for sale
Forward commitments to sell mortgage
loans and mortgage-backed securities 15,195 -- 209.8
Receive-fixed interest rate swaps 2,340 198.3 --
Pay-fixed interest rate swaptions sold 1,300 -- 89.0
Interest rate caps purchased 4,250 19.7 --
- --------------------------------------------------------------------------------------------------------------
Total 23,085 218.0 298.8 40.5
- --------------------------------------------------------------------------------------------------------------
Available for sale securities
Pay-fixed interest rate swaps 500 -- 11.2 2.4
- --------------------------------------------------------------------------------------------------------------
Total 500 -- 11.2 2.4
- --------------------------------------------------------------------------------------------------------------
Mortgage servicing assets
Forward commitments to purchase
mortgage loans and mortgage-backed securities 2,240 .3 3.9
Receive-fixed interest rate swaps 4,585 520.9 --
Receive-fixed interest rate swaptions purchased 320 21.5 --
Receive-fixed interest rate swaptions sold 1,645 -- 66.4
Pay-fixed interest rate swaptions purchased 1,270 16.5 --
Pay-fixed interest rate swaptions sold 2,195 -- 145.0
Principal-only interest rate swaps 765 36.4 2.5
Interest rate caps purchased 19,795 64.1 --
Interest rate floors purchased 75 .5 --
Interest rate future options sold 1,700 -- 39.1
Interest rate futures purchased 1,200 -- --
Interest rate futures sold 331 -- --
- --------------------------------------------------------------------------------------------------------------
Total 36,121 660.2 256.9 260.5
- --------------------------------------------------------------------------------------------------------------
Funding
Receive-fixed interest rate swaps 3,860 418.7 --
Callable receive-fixed interest rate swaps 705 21.4 .7
- --------------------------------------------------------------------------------------------------------------
Total 4,565 440.1 .7 .5
- --------------------------------------------------------------------------------------------------------------
TOTAL DERIVATIVES USED IN FAIR VALUE HEDGES 78,503 1,319.5 859.6 310.5
- --------------------------------------------------------------------------------------------------------------
CASH FLOW HEDGES
Funding
Pay-fixed interest rate swaps 7,550 -- 158.8
Interest rate caps purchased 8,500 33.5 --
- --------------------------------------------------------------------------------------------------------------
Total 16,050 33.5 158.8 (.3)
- --------------------------------------------------------------------------------------------------------------
TOTAL DERIVATIVES USED IN CASH FLOW HEDGES 16,050 33.5 158.8 (.3)
- --------------------------------------------------------------------------------------------------------------
TOTAL DERIVATIVES USED FOR INTEREST
RATE RISK MANAGEMENT AND DESIGNATED IN SFAS
133 RELATIONSHIPS $94,553 $1,353.0 $1,018.4 $ 310.2
==============================================================================================================
(a) Represents net ineffective hedge gain (loss) on hedging strategy for the
nine-month period ended September 30, 2002
41
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, CSBFS' activities
also include small business services, dealer finance, education finance, retail
brokerage, and lending-related insurance services. Consumer lending products
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' 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. Expenses include personnel and support
costs, in addition to credit costs.
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. These loans 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 nine months of 2003 and 2002, approximately 55%
of NCMC mortgage loans were originated through wholesale and correspondent
channels, while 45% 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, and
acts as the investment advisor for the Armada(R) mutual funds. 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 related to credit card and automobile loans are also considered
funding activities and the effects of such securitizations are included within
the parent and other category. The credit card and automobile loans 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 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
42
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 SEPTEMBER 30, 2003
Net interest income (expense)(a) $ 497,664 $ 260,809 $552,471 $26,229 $ 787 $(187,195) $ 1,150,765
Provision (benefit) for loan losses 73,408 39,823 14,262 1,286 -- (21,732) 107,047
- ----------------------------------------------------------------------------------------------------------------------------------
Net interest income (expense) after
provision 424,256 220,986 538,209 24,943 787 (165,463) 1,043,718
Noninterest income 184,559 100,000 34,306 86,885 124,881 16,869 547,500
Noninterest expense 337,595 120,857 320,947 72,429 101,548 54,240 1,007,616
- ----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before taxes 271,220 200,129 251,568 39,399 24,120 (202,834) 583,602
Income tax expense (benefit)(a) 102,521 74,722 96,149 14,893 9,811 (93,831) 204,265
- ----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 168,699 $ 125,407 $155,419 $24,506 $ 14,309 $(109,003) $ 379,337
==================================================================================================================================
Intersegment revenue (expense) $ (869) $ 4,173 $ 1,599 $ 1,678 $ 1,236 $ (7,817) $ --
Average assets (in millions) 26,440 30,626 53,111 2,880 691 10,064 123,812
==================================================================================================================================
Quarter ended September 30, 2002
Net interest income (expense)(a) $ 493,576 $ 252,683 $289,311 $25,267 $ 1,346 $ (83,332) $ 978,851
Provision (benefit) for loan losses 63,656 73,905 50,121 1,328 -- (19,846) 169,164
- ----------------------------------------------------------------------------------------------------------------------------------
Net interest income (expense) after
provision 429,920 178,778 239,190 23,939 1,346 (63,486) 809,687
Noninterest income 167,710 50,713 180,816 89,425 114,345 17,778 620,787
Noninterest expense 323,531 122,317 188,503 72,426 97,056 66,343 870,176
- ----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before taxes 274,099 107,174 231,503 40,938 18,635 (112,051) 560,298
Income tax expense (benefit) (a) 103,610 40,272 86,804 15,475 5,949 (65,999) 186,111
- ----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 170,489 $ 66,902 $144,699 $25,463 $ 12,686 $ (46,052) $ 374,187
==================================================================================================================================
Intersegment revenue (expense) $ (476) $ 4,185 $ 715 $ 3,396 $ 2,021 $ (9,841) $ --
Average assets (in millions) 24,382 31,013 32,087 2,934 510 10,181 101,107
==================================================================================================================================
(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
- ----------------------------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, 2003
Net interest income (expense)(a) $1,471,410 $772,671 $1,486,099 $ 77,331 $ 2,335 $(456,105) $ 3,353,741
Provision (benefit) for loan losses 217,634 259,891 70,176 5,603 -- (62,877) 490,427
- ----------------------------------------------------------------------------------------------------------------------------------
Net interest income (expense) after
provision 1,253,776 512,780 1,415,923 71,728 2,335 (393,228) 2,863,314
Noninterest income 536,509 245,110 917,519 261,317 344,594 170,474 2,475,523
Noninterest expense 1,020,668 377,265 839,187 219,356 290,057 296,186 3,042,719
- ----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before taxes 769,617 380,625 1,494,255 113,689 56,872 (518,940) 2,296,118
Income tax expense (benefit)(a) 290,915 142,806 586,106 42,974 22,950 (282,109) 803,642
- ----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 478,702 $237,819 $ 908,149 $ 70,715 $ 33,922 $(236,831) $ 1,492,476
==================================================================================================================================
Intersegment revenue (expense) $ (2,730) $ 15,794 $ 5,337 $ 5,343 $ 4,020 $ (27,764) $ --
Average assets (in millions) 26,001 30,998 48,936 2,895 589 10,376 119,795
==================================================================================================================================
Nine months ended September 30, 2002
Net interest income (expense)(a) $1,475,789 $754,895 $ 826,048 $ 75,702 $ 3,794 $(181,670) $ 2,954,558
Provision (benefit) for loan losses 217,334 251,584 92,100 11,700 -- (49,438) 523,280
- ----------------------------------------------------------------------------------------------------------------------------------
Net interest income (expense) after
provision 1,258,455 503,311 733,948 64,002 3,794 (132,232) 2,431,278
Noninterest income 481,538 202,108 632,443 285,508 336,616 200,291 2,138,504
Noninterest expense 1,017,187 374,250 606,161 225,225 280,251 215,913 2,718,987
- ----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before taxes 722,806 331,169 760,230 124,285 60,159 (147,854) 1,850,795
Income tax expense (benefit) (a) 273,222 125,014 284,966 46,980 23,226 (115,713) 637,695
- ----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 449,584 $206,155 $ 475,264 $ 77,305 $ 36,933 $ (32,141) $ 1,213,100
==================================================================================================================================
Intersegment revenue (expense) $ (1,402) $ 10,160 $ 2,516 $ 10,288 $ 5,868 $ (27,430) $ --
Average assets (in millions) 24,541 31,152 30,938 2,973 467 10,304 100,375
==================================================================================================================================
(a) Includes tax-equivalent adjustment for tax-exempt interest income
43
24. FINANCIAL HOLDING COMPANY
Condensed financial statements of the holding company, which include
transactions with subsidiaries, follow:
BALANCE SHEETS
SEPTEMBER 30 December 31 September 30
(In Thousands) 2003 2002 2002
- ---------------------------------------------------------------------------------------------------------
ASSETS
Cash and demand balances due from banks $ 1,498 $ 1,498 $ 1,487
Loans to and receivables from subsidiaries 828,701 699,323 682,114
Securities 189,208 227,223 292,373
Other investments 450,536 556,123 466,828
Investments in:
Subsidiary banks 9,503,020 9,390,979 8,924,319
Nonbank subsidiaries 579,376 545,499 547,240
Goodwill 58,566 58,566 58,566
Derivative assets 138,689 154,905 145,076
Other assets 609,421 644,245 577,071
- --------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 12,359,015 $ 12,278,361 $11,695,074
========================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Long-term debt $ 2,285,466 $ 2,005,076 $ 2,005,068
Borrowed funds from subsidiaries 185,568 1,205,568 780,568
Derivative liabilities 2,577 7,184 10,751
Accrued expenses and other liabilities 751,077 752,521 741,826
- --------------------------------------------------------------------------------------------------------
Total liabilities 3,224,688 3,970,349 3,538,213
Stockholders' equity 9,134,327 8,308,012 8,156,861
- --------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 12,359,015 $ 12,278,361 $11,695,074
========================================================================================================
The borrowed funds from subsidiaries balance includes the junior subordinated
debt securities payable to the two wholly-owned subsidiary trusts (the trusts)
that were deconsolidated as a result of applying the provisions of FIN 46. The
holding company continues to guarantee the capital securities issued by the
trusts, which totaled $180 million at September 30, 2003. Refer to Note 14 for
further discussion on FIN 46 and the deconsolidation of the trusts. The holding
company also guarantees commercial paper issued by its subsidiary National City
Credit Corporation, which borrowings totaled $633 million at September 30, 2003.
Additionally, the holding company guarantees National City Bank of Kentucky's
financial obligation under this subsidiary'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 Nine Months Ended
September 30 September 30
- -------------------------------------------------------------------------------------------------------------------------------
(In Thousands) 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------------------
INCOME
Dividends from:
Subsidiary banks $454,810 $220,000 $ 904,810 $ 870,000
Nonbank subsidiaries 2,000 2,000 6,000 8,000
Interest on loans to subsidiaries 505 3,211 1,020 9,364
Interest and dividends on securities 1,628 2,459 6,753 9,245
Securities gains, net 1,630 2 33,039 92,422
Other income (losses) 6,639 (10,497) 19,382 (5,054)
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL INCOME 467,212 217,175 971,004 983,977
==============================================================================================================================
EXPENSE
Interest on debt and other borrowings 23,945 26,439 73,297 86,847
Other expense (income) 13,675 (7,886) 94,802 64,740
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL EXPENSE 37,620 18,553 168,099 151,587
==============================================================================================================================
Income before taxes and equity in undistributed
net income of subsidiaries 429,592 198,622 802,905 832,390
Income tax (benefit) 18,323 (7,947) (26,638) (19,098)
- ------------------------------------------------------------------------------------------------------------------------------
Income before equity in undistributed net income of
subsidiaries 411,269 206,569 829,543 851,488
Equity in undistributed net income (loss) of subsidiaries (31,932) 167,618 662,933 361,612
- ------------------------------------------------------------------------------------------------------------------------------
NET INCOME $379,337 $374,187 $1,492,476 $1,213,100
==============================================================================================================================
44
STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30
- -------------------------------------------------------------------------------------------------------
(In Thousands) 2003 2002
- -------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 1,492,476 $ 1,213,100
Adjustments to reconcile net income to net cash provided by
operating activities:
Equity in undistributed net income of subsidiaries (662,933) (361,612)
Depreciation and amortization of properties and equipment 916 1,705
Decrease (increase) in receivables from subsidiaries (471,712) 18,142
Securities gains, net (33,040) (92,422)
Other losses, net 21,281 3,330
Amortization of premiums and discounts on securities and debt (759) (701)
(Decrease) increase in accrued expenses and other liabilities (19,543) (19,783)
Other, net 30,280 69,284
- -------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 356,966 831,043
- -------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Purchases of securities (458,523) (195,990)
Proceeds from sales and maturities of securities 513,481 358,970
Net decrease (increase) in other investments 105,587 (171,597)
Principal collected on loans to subsidiaries 1,027,334 135,750
Loans to subsidiaries (435,000) (137,586)
Investments in subsidiaries (50,746) (230,101)
Returns of investment from subsidiaries 300,000 345
Net decrease in properties and equipment 10,840 --
- -------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 1,012,973 (240,209)
- -------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Net decrease in borrowed funds (1,020,000) (37,000)
Issuance of debt 300,000 --
Repayment of debt (880) (100,880)
Dividends paid (569,494) (545,340)
Conversion of preferred stock -- (36)
Issuances of common stock 118,359 92,412
Repurchases of common stock (197,924) --
- -------------------------------------------------------------------------------------------------------
Net cash used in financing activities (1,369,939) (590,844)
- -------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and demand balances due from banks -- (10)
Cash and demand balances due from banks, January 1 1,498 1,497
- -------------------------------------------------------------------------------------------------------
CASH AND DEMAND BALANCES DUE FROM BANKS, SEPTEMBER 30 $ 1,498 $ 1,487
=======================================================================================================
SUPPLEMENTAL INFORMATION
Cash paid for interest $ 67,901 $ 87,706
Noncash item:
Carrying value of securities donated to the National City 25,007 36,306
Charitable Foundation
=======================================================================================================
Retained earnings of the holding company included $6.7 billion, $6.1 billion,
and $5.9 billion of equity in undistributed net income of subsidiaries at
September 30, 2003, December 31, 2002, and September 30, 2002, respectively.
45
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This section contains forward-looking statements. Forward-looking statements
provide current expectations or forecasts of future events and are not
guarantees of future performance, nor should they be relied upon as representing
management's views as of any subsequent date. The forward-looking statements are
based on management's expectations and are subject to a number of risks and
uncertainties. Although management believes that 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 effectively execute its
business plans; changes in general economic and financial market conditions;
changes in interest rates; changes in the competitive environment; 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
affecting the Corporation's business; and changes in accounting policies or
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
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 these filings
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. Management may elect to update
forward-looking statements at some future point; however, it specifically
disclaims any obligation to do so.
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 nine month periods ended September 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 45 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 or judgments that affect
the amounts reported in the financial statements and accompanying notes. These
estimates 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 or judgments. Certain policies inherently have
a greater reliance on the use of estimates, and as such have a greater
possibility of producing results that could be materially different than
originally reported. Estimates or 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. Management views critical accounting policies to be those which are
highly dependent on subjective or complex judgments, estimates and assumptions,
and where changes in those estimates and assumptions could have a significant
impact on the financial statements. Management currently views the determination
of the allowance for loan losses, the valuation of mortgage servicing assets,
the valuation of derivative instruments, and the valuation of leased asset
residuals to be critical accounting policies.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses represents management's estimate of probable
credit losses inherent in the loan and lease portfolio. Estimating the amount of
the allowance for loan losses 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. 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.
46
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 Statement of Financial Accounting
Standards No. (SFAS) 5, Accounting for Contingencies, or SFAS 114, Accounting by
Creditors for Impairment of a Loan. 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. These analyses involve a
high degree of judgment in estimating the amount of loss associated with
specific loans, including estimating the amount and timing of future cash flows
and collateral values. 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.
Uncertainty surrounding the strength and timing of economic cycles also affects
estimates of loss. The historical losses used in the migration analysis may not
be representative of actual unrealized losses inherent in the portfolio.
There are many factors affecting the allowance for loan losses; some are
quantitative while others require qualitative judgment. Although management
believes its process for determining the allowance adequately considers all of
the potential factors that could potentially result in credit losses, the
process includes subjective elements and may be susceptible to significant
change. To the extent actual outcomes differ from management estimates,
additional provision for credit losses could be required that could adversely
affect earnings or financial position in future periods. The allowance for loan
losses is assigned to the Corporation's business lines based on the nature of
the loan portfolio in each business line. The Wholesale Banking, Consumer and
Small Business Financial Services, and National Consumer Finance business lines
have been assigned the majority of the allocated allowance and accordingly would
be the business lines most affected by actual outcomes differing from management
estimates.
The Credit Risk Management section of this financial review includes a
discussion of the factors driving changes in the allowance for loan losses
during the current period.
MORTGAGE SERVICING ASSETS
Servicing residential mortgage loans for third-party investors represents a
significant business activity of the National Consumer Finance line of business.
As of September 30, 2003, the mortgage servicing asset portfolio totaled $1.0
billion. Mortgage servicing assets do not trade in an active open market with
readily observable market prices. Although sales of mortgage servicing assets do
occur, the precise terms and conditions may not be readily available. As such
mortgage servicing assets are established and valued using discounted cash flow
modeling techniques which require management to make estimates regarding
estimated future net servicing cash flows, taking into consideration actual and
expected mortgage loan prepayment rates, discount rates, servicing costs, and
other economic factors. 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. 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. Management
compares its fair value estimates and assumptions to observable market data
where available and to recent market activity and believes that the fair values
and related assumptions are comparable to those used by other market
participants.
Because the values of these assets are sensitive to changes in the assumptions
used and readily available market pricing does not exist, the valuation of this
portfolio is considered critical.
Note 11 to the consolidated financial statements includes a sensitivity analysis
showing the effects immediate 10% and 20% adverse changes in the mortgage loan
prepayment and discount rate assumptions used to estimate the fair value of the
servicing assets would have on the fair value. Management mitigates risk
associated with declines in the estimated fair value of its mortgage servicing
assets due to increases in mortgage loan prepayments through the use of
derivative instruments that are expected to increase in value when
47
interest rates decline. The effects of recognized changes in the values of the
mortgages servicing assets and the related derivative instruments are include in
mortgage banking revenue on the income statement. Note 11 to the financial
statements and the Noninterest Income section of this financial review include
discussion of the impacts of valuation changes on current period income.
DERIVATIVE INSTRUMENTS
The Corporation regularly uses derivative instruments as part of its risk
management activities to protect the value of certain assets and liabilities and
future cash flows against adverse price or interest rate movements. As of
September 30, 2003, the notional value of the derivative instruments held
totaled $216.4 billion, while derivative assets and liabilities were $1.8
billion and $1.2 billion, respectively. All derivative instruments are carried
at fair value on the balance sheet. The valuation of derivative instruments is
considered critical because most of the derivative instruments held by the
Corporation are valued using discounted cash flow modeling techniques in the
absence of market value quotes. Therefore, management must make estimates
regarding the amount and timing of future cash flows, which are susceptible to
significant change in future periods based on changes in interest rates. The
cash flow projection models were acquired from third parties and the assumptions
used by management are based on yield curves, forward yield curves, and implied
volatilities observable in the cash and derivatives market. The pricing models
are also regularly validated by testing through comparison with other third
parties.
Because the majority of the derivative instruments are used to protect the value
of other assets and liabilities on the balance sheet, changes in the value of
the derivatives instruments are typically offset by changes in the value of the
assets and liabilities being hedged, although income statement volatility can
still occur if the derivative instruments are not effective in hedging changes
in the value of those assets and liabilities. Changes in the fair values of
derivative instruments associated with mortgage banking activities are included
in mortgage banking revenue on the consolidated income statement and affect the
results of the National Consumer Finance line of business. Changes in the fair
values of other derivatives are included in other income on the income statement
and are primarily generated from investment funding activities and are not
allocated to the business lines. The impacts of valuation changes on current
period income are discussed in the Noninterest Income section of this financial
review. Notes 1 and 22 to the consolidated financial statements also provide
further discussion on the accounting and use of derivative instruments.
LEASED ASSET RESIDUALS
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. Lease financing
arrangements include a residual value component, which represents the estimated
value of the leased asset upon the expiration of the lease, and the Corporation
bears the risk of ownership of the leased assets including the risk that the
actual value of the leased assets at the end of the lease term will be less than
the estimated residual value. The valuation of residual assets is considered
critical due to the subjective nature of forecasting the impact of product and
technology changes, consumer behavior, competitor initiatives, shifts in supply
and demand, and general economic conditions, among other factors, on the fair
value of residual assets. Although there were no residual asset write downs
recorded in the current period, over the past several years the Corporation has
experienced losses on lease residual values related to automobiles and aircraft
leases caused by adverse changes in market conditions. The Corporation currently
has leased asset residual value of $483 million and $175 million related to
commercial and automobile leases, respectively (see Note 6 to the consolidated
financial statements). Charges to write down leased residual assets values, when
incurred, are included in other noninterest expense on the income statement. The
commercial lease portfolio is included within the Wholesale Banking business
line while the automobile lease portfolio is contained within Consumer and Small
Business Financial Services.
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 financial condition, the 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 third quarter and first nine months of
2003 of $379 million and $1.5 billion, respectively, up from net income of $374
million and $1.2 billion for the same periods in 2002. Net income per diluted
share was $.62 and $2.42 for the third quarter and first nine months of 2003,
respectively, up from net income per diluted share of $.61 and $1.97 for the
same 2002 periods. Returns on average common equity and average assets were
16.2% and 1.22%, respectively, for the third quarter of 2003, compared to 18.1%
and 1.47%, respectively, for the third quarter of 2002. Year-to-date returns on
average common equity and average assets in 2003 were 22.4% and 1.67%,
respectively, versus 20.6% and 1.62%, respectively, in 2002.
48
Record levels of mortgage banking activity resulting from the historically low
interest rate environment led to strong financial results in 2003.
FINANCIAL CONDITION
This section should also be reviewed in conjunction with the average balance
sheets presented on pages 65-66 of this financial review.
AVERAGE EARNING ASSETS
A summary of average earning assets follows:
Three Months Ended Nine Months Ended
- -------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30 June 30 September 30 SEPTEMBER 30 September 30
(In Millions) 2003 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------------
Portfolio loans
Commercial $ 23,577 $ 24,319 $ 24,863 $ 24,160 $ 25,370
Real estate -- commercial 9,450 9,475 8,037 9,448 7,877
Real estate -- residential 24,088 22,469 15,895 22,539 15,333
Home equity lines of credit 9,612 8,761 7,316 8,847 6,692
Credit card and other
unsecured lines of credit 2,170 2,084 1,910 2,096 1,834
Other consumer 8,167 7,957 10,924 8,028 11,165
- ------------------------------------------------------------------------------------------------------------------------
Total portfolio loans 77,064 75,065 68,945 75,118 68,271
Loans held for sale or
securitization 27,036 24,118 11,851 24,575 12,391
Securities (at amortized cost) 6,667 7,397 8,336 7,447 8,607
Other 1,217 775 882 928 850
- ------------------------------------------------------------------------------------------------------------------------
TOTAL EARNING ASSETS $ 111,984 $ 107,355 $ 90,014 $ 108,068 $ 90,119
========================================================================================================================
The growth in average earning assets was principally driven by the continued
growth in residential real estate and home equity loan originations, which have
been robust in this historically low interest rate environment. This growth
increased the balances in loans held for sale to record levels, and also drove
portfolio growth. Average portfolio loans grew 3% and 12% during the third
quarter of 2003 compared to the second quarter of 2003, and the third quarter of
2002, respectively. Average portfolio loans increased 10% 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 by the Corporation's National Home Equity
division. A portion of First Franklin's mortgage loan production is retained in
portfolio with the remainder sold to third parties. During the third quarter of
2003, $2.8 billion of First Franklin's production was retained for the
residential real estate portfolio, compared to $1.9 billion a quarter ago and
$1.7 billion in the quarter a year ago. Over the past year, $7.7 billion of
First Franklin loans were retained in portfolio. Period-end First Franklin
residential real estate loans grew to $13.2 billion at September 30, 2003, up
from $11.5 billion last quarter and $8.7 billion at September 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 first nine months of 2003 was $1.2 billion. There were no
adjustable-rate mortgage loans retained in portfolio during the third quarter of
2003. 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.
Period-end real estate residential loans reflect the reclassification of $950
million of the former Altegra portfolio to loans held for sale or
securitization. This reclassification had little impact to average balances as
the loans were reclassified on the last day of the fiscal period ended September
30, 2003. Management anticipates the sale of the former Altegra portfolio to
occur in the fourth quarter.
49
Average commercial loans decreased slightly on a linked-quarter basis and
year-over-year comparison as paydowns offset the positive impact of new
commercial borrowings. Commercial loan demand continued to be relatively weak in
2003, as commercial borrowers remained cautious in their spending and investing
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 September 30, 2003.
Average Largest Loan
Outstanding % to Loan Balance to a Single
(Dollars in Millions) Balance Total Per Obligor Obligor
- ---------------------------------------------------------------------------------------------------------
Real estate $10,255 31% $ .8 $ 49
Consumer cyclical 5,039 15 .8 95
Consumer noncyclical 3,868 12 .4 47
Industrial 3,442 10 .9 68
Basic materials 2,795 9 1.3 40
Financial 2,043 6 1.5 54
Services 1,809 6 .5 462 (a)
Energy and utilities 601 2 1.0 24
Technology 265 1 2.4 20
Miscellaneous 1,360 4 .2 20
- --------------------------------------------------------------------------------------------------------
31,477 96
Commercial leasing -- all industries 1,477 4
- --------------------------------------------------------------------------------------------------------
TOTAL $32,954 100%
========================================================================================================
(a) This loan is secured by government-insured student loans.
Record mortgage loan origination volumes for the third quarter and first nine
months of 2003 at NCMC and First Franklin drove the increase in average loans
held for sale. Average loans held for sale increased 12% and 128% during the
third quarter of 2003, 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 98% over the comparable 2002 period. The increase in mortgage
activity and loans held for sale over the past year is the result of the
historically low interest rate environment, which has fueled mortgage
refinancings. Additionally, period-end loans held for sale reflects the
aforementioned reclassification of the former Altegra portfolio on September 30,
2003. 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 steep yield curve,
also had a positive impact on the net interest margin.
The decrease in average securities during the third quarter and first nine
months of 2003 was primarily the result of sales and principal paydowns in the
mortgage-backed securities portfolio.
AVERAGE INTEREST BEARING LIABILITIES AND FUNDING
A summary of average interest bearing liabilities and funding follows:
Three Months Ended Nine Months Ended
- --------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30 June 30 September 30 SEPTEMBER 30 September 30
(In Millions) 2003 2003 2002 2003 2002
- --------------------------------------------------------------------------------------------------------------------------
Noninterest bearing deposits $ 19,408 $ 17,596 $ 13,864 $ 17,578 $ 13,002
Interest bearing core deposits 41,850 41,464 38,671 41,241 37,921
- ------------------------------------------------------------------------------------------------------------------------
Total core deposits 61,258 59,060 52,535 58,819 50,923
Purchased deposits 10,427 10,157 8,846 10,188 9,658
Short-term borrowings 11,747 13,480 9,582 13,380 10,308
Long-term debt(a) 27,569 23,914 18,985 24,786 19,013
- ------------------------------------------------------------------------------------------------------------------------
Total purchased funding 49,743 47,551 37,413 48,354 38,979
Stockholders' equity 9,271 8,802 8,218 8,893 7,880
- ------------------------------------------------------------------------------------------------------------------------
TOTAL FUNDING $ 120,272 $ 115,413 $ 98,166 $ 116,066 $ 97,782
========================================================================================================================
TOTAL INTEREST BEARING LIABILITIES $ 91,593 $ 89,015 $ 76,084 $ 89,595 $ 76,900
========================================================================================================================
(a) Includes debt obligations related to the subsidiary trusts
50
The percentage of each funding source to total funding follows:
Three Months Ended Nine Months Ended
- --------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30 June 30 September 30 SEPTEMBER 30 September 30
2003 2003 2002 2003 2002
- --------------------------------------------------------------------------------------------------------------------------
Noninterest bearing deposits 16.1% 15.3% 14.1% 15.1% 13.3%
Interest bearing core deposits 34.8 35.9 39.4 35.4 38.8
- ----------------------------------------------------------------------------------------------------------------------
Total core deposits 50.9 51.2 53.5 50.5 52.1
Purchased deposits 8.7 8.8 9.0 8.7 9.9
Short-term borrowings 9.8 11.7 9.8 11.5 10.5
Long-term debt(a) 22.9 20.7 19.3 21.3 19.4
- ----------------------------------------------------------------------------------------------------------------------
Total purchased funding 41.4 41.2 38.1 41.5 39.8
Stockholders' equity 7.7 7.6 8.4 8.0 8.1
- ----------------------------------------------------------------------------------------------------------------------
TOTAL 100.0% 100.0% 100.0% 100.0% 100.0%
======================================================================================================================
(a) Includes debt obligations related to the subsidiary trusts
Core deposits continued to grow during the third 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 an
ongoing emphasis on service quality and customer care. Core deposit growth was
primarily driven by higher levels of mortgage banking escrow balances associated
with the increase in mortgage banking activity. Excluding mortgage banking
escrow balances, average core deposits grew 2% and 10% during the third quarter
of 2003, when compared to the previous quarter and the same quarter a year ago.
Similarly, year-to-date average core deposits excluding mortgage banking escrow
deposits grew 9% over the comparable 2002 period. Average purchased deposits and
short-term borrowings increased during the first nine months of 2003 to support
asset growth, mainly mortgage loans held for sale. Asset growth was also
supported through the linked-quarter and year-over-year 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 September 30, 2003, up from $8.3
billion and $8.2 billion at December 31, 2002 and September 30, 2002,
respectively. Equity as a percentage of assets was 7.54% at September 30, 2003,
compared to 7.03% at December 31, 2002 and 7.46% a year ago. Book value per
common share rose to $15.00 at September 30, 2003, up from $13.59 and $13.32 at
December 31, 2002 and September 30, 2002, respectively.
During the third quarter and first nine months of 2003, the Corporation
repurchased 5.3 million and 6.7 million shares of National City common stock,
respectfully, compared to no shares repurchased for the same 2002 periods.
During the fourth quarter of 2002, the Corporation repurchased 1.3 million
shares of common stock. Subject to ongoing capital, investment, and acquisition
considerations, management intends to continue share repurchases in 2003 on an
opportunistic basis.
National City declared and paid dividends per common share of $.32 during the
third quarter of 2003, up one and a half cents from the quarterly dividend per
share declared and paid in the third quarter last year of $.305. The dividend
payout ratio, representing dividends per share divided by earnings per share,
was 51.6% and 50.0% for the third quarters of 2003 and 2002, respectively. The
dividend payout ratio continues to be reviewed by management and the Board of
Directors, particularly in light of new tax laws enacted in 2003.
At September 30, 2003, the Corporation's market capitalization was $17.9
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
---------------------------------- -------------------------
THIRD SECOND First Fourth Third
NYSE: NCC QUARTER QUARTER Quarter Quarter Quarter
- --------- ------- ------- -------- -------- -------
High $ 34.56 $ 34.97 $ 29.45 $ 29.82 $ 33.49
Low 29.03 27.92 26.53 24.60 25.58
Close 29.46 32.71 27.85 27.32 28.53
51
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 66-68 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, because the interest on certain loans and securities 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 $6
million and $21 million for the third quarter and first nine months of 2003,
respectively, and $8 million and $24 million for the same periods in 2002.
Tax-equivalent net interest income for the third quarter and first nine months
of 2003 was $1.2 billion and $3.4 billion, respectively, up from $979 million
and $3.0 billion for the comparable 2002 periods. The net interest margin was
4.10% in the third quarter of 2003, compared to 4.11% in the second quarter of
this year and 4.34% in last year's third quarter. The 2003 year-to-date net
interest margin was 4.14%, compared to 4.38% for the first nine months of 2002.
The growth in net interest income during the third quarter and first half of
2003 was the result of earning asset growth, driven mostly by record mortgage
loan originations, a more favorable earning asset mix, and lower funding costs.
Reduced assed yields and narrower spreads on deposits, reflecting the ongoing
effect of low market interest rates, led to the lower net interest margin in
2003.
NONINTEREST INCOME
Details of noninterest income follow:
Three Months Ended Nine Months Ended
- ----------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30 June 30 September 30 SEPTEMBER 30 September 30
(In Millions) 2003 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------------------------
Mortgage banking revenue $ 31 $ 476 $ 178 $ 901 $ 621
Deposit service charges 145 142 132 422 377
Payment processing revenue 125 113 114 343 335
Trust and investment management fees 72 78 74 219 237
Card-related fees 42 44 47 127 111
Brokerage revenue 33 34 25 91 83
Other service fees 28 26 24 82 76
Other 66 117 26 253 200
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL FEES AND OTHER INCOME 542 1,030 620 2,438 2,040
Securities gains, net 5 32 -- 37 98
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL NONINTEREST INCOME $ 547 $ 1,062 $ 620 $ 2,475 $ 2,138
===============================================================================================================================
The primary factor affecting changes in noninterest income for the third quarter
and first nine months of 2003 was mortgage banking revenue.
52
Details of mortgage banking revenue follow:
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
- ------------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30 June 30 September 30 September 30 September 30
(In Millions) 2003 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Servicing revenue:
Net servicing fees $ 95 $ 92 $ 97 $ 307 $ 279
Amortization of mortgage servicing assets
(MSRs) (190) (137) (111) (475) (258)
MSR impairment (charge) recovery 115 (74) (47) 128 (121)
MSR SFAS 133 hedge and other derivative
gains (losses):
Net ineffective hedge gains (losses) on
MSR SFAS 133 hedging activities (91) 21 132 (53) 260
Gains (losses) on derivative instruments
used to economically hedge MSRs 6 164 16 229 25
- ------------------------------------------------------------------------------------------------------------------------------------
Net servicing revenue (65) 66 87 136 185
National City Mortgage Co. (NCMC)
origination and sales revenue 1 322 64 513 352
- ------------------------------------------------------------------------------------------------------------------------------------
Total NCMC mortgage banking revenue (64) 388 151 649 537
First Franklin origination and sales revenue 95 88 27 252 84
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL MORTGAGE BANKING REVENUE $ 31 $ 476 $178 $ 901 $ 621
====================================================================================================================================
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. Information on residential
mortgage loan origination and sales follows:
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
- ------------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30 June 30 September 30 September 30 September 30
(In Millions) 2003 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Originations
NCMC $31,273 $32,853 $21,615 $88,426 $49,609
First Franklin 2,801 2,396 1,333 6,929 3,207
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL RESIDENTIAL MORTGAGE LOANS
ORIGINATED FOR SALE $34,074 $35,249 $22,948 $95,355 $52,816
====================================================================================================================================
Sales
NCMC $33,462 $27,277 $14,921 $86,350 $47,300
First Franklin 2,543 2,164 867 6,558 2,749
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL RESIDENTIAL MORTGAGE LOAN SALES $36,005 $29,441 $15,788 $92,908 $50,049
====================================================================================================================================
The growth in mortgage banking revenue during the first nine months of 2003 was
reflective of record mortgage originations driven by the historically low
interest rate environment, record sales of mortgages sold into the secondary
market, and successful hedging strategies to protect the value of mortgage
servicing assets (MSRs), partially offset by higher MSR amortization expense.
Additionally, year-to-date mortgage banking revenue rose as net servicing fees
increased primarily due to the adjustment of approximately $30 million to accrue
servicing fees earned but not collected. Conversely, despite the growth in
mortgage originations and sales, mortgage banking revenue declined in the third
quarter of 2003 primarily due to the reduction in NCMC origination and sales
revenue. NCMC origination and sales revenue declined as a sharp increase in
mortgage interest rates in July and August resulted in unfavorable mortgage
warehouse hedging results and lower production margin. Additionally, the decline
in third quarter mortgage banking revenue resulted from higher MSR amortization
and unfavorable MSR hedging results impacted by the aforementioned increase in
mortgage interest rates.
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 MSRs. As a result of the record volume of mortgage loan
origination and sale activity, the unpaid principal balance of loans serviced
for third parties grew to $129.1 billion at September 30, 2003, up from $101.9
billion at December 31, 2002 and $98.4 billion at September 30, 2002. The
carrying value of MSRs at September 30, 2003, December 31, 2002, and September
30, 2002 was $1.0 billion, $615 million, and $691 million, respectively. The
increase in the value of MSRs at September 30, 2003 was the result of an
increase in MSR additions associated with record secondary market sales, a
recovery in temporary impairment, and an increase in the fair value of MSRs
designated in FAS 133 hedge relationships. Offsetting the aforementioned
increases in the carrying value of MSRs was higher amortization expense
recognized to reflect the higher actual and expected prepayment rates
experienced during the first nine months of 2003. The value of MSRs is sensitive
to changes in interest rates. In a low rate environment, as was experienced
during 2003 and in fiscal year 2002, mortgage loan refinancings generally
increase, causing actual and expected loan prepayments to
53
increase, which drives down the estimated value of existing MSRs. Conversely, as
interest rates rise, as was experienced during the third quarter of 2003,
mortgage loan refinancings generally decline, causing actual and expected loan
prepayments to decrease, which drives up the estimated value of existing MSRs.
The Corporation manages the risk associated with declines in the estimated value
of MSRs by using derivative instruments. Further detail on MSRs, 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 third quarter of 2003. The
linked-quarter and year-over-year increase was the 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 and
year-over-year basis due to higher transaction volumes, increased revenue as a
result of NPI's purchase of Bridgeview Payment Solutions (BPS), offset by
revenue declines associated with lower transaction volume processed for the
airline and travel industries. The increase in transaction volume was primarily
due to growth in the existing national customer base and the addition of new
regional merchant customers. The acquisition of BPS added $5 million and $7
million in revenue for the third quarter and first nine months of 2003. Refer to
Note 10 of the consolidated financial statements for further discussion on NPI's
acquisition of BPS. In 2002, NPI decided to discontinue serving the airline
industry but 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 decreased during the third quarter and
first nine months of 2003 when compared to the previous quarter and comparable
2002 periods. The decreases are primarily associated with the value of assets
under administration. The linked-quarter decrease in trust and investment
management fees also reflects seasonal tax preparation fees recognized in the
previous quarter. At September 30, 2003, assets under administration totaled
$108.0 billion, compared to $133.6 billion at December 31, 2002, and $129.2
billion at September 30, 2002.
The year-over-year increase in card-related fees was primarily attributable to
the recognition of a full year of certain excess cash flows associated with
securitized credit card balances (the cash flows) in 2003. During the first half
of 2002, these cash flows were included as interest income recognized on
retained interests as calculated under the effective yield method. A change to
recognize these cash flows as card-related fees was implemented in the second
half 2002 in order to conform the accounting to prevalent industry practice,
based on further evaluation of the applicable accounting guidance, as well as
consultation with other credit card securitizers. The cash flows reported in
card-related fees include overlimit, interchange, cash advance and miscellaneous
fees. The year-over-year increase in card-related fees was also affected by an
increase in credit card and ATM interchange fees associated with increased
transaction volume.
The year-over-year growth in brokerage revenue resulted from increases in
investment banking and retail brokerage equity trading activities fueled by the
recovery in the equity markets in 2003.
The linked-quarter decrease in other fee income was the result of a $90 million
third quarter decline in other derivative gains primarily associated with the
decrease in value of derivative instruments intended to economically hedge the
steep yield curve and deferred compensation liabilities, offset by an increase
in principal investment gains. Principal investment gains of $17 million were
recognized in the third quarter of 2003 versus principal losses of $16 million
in the previous quarter. Other fee income increased on a year-over-year
comparison due to growth in insurance revenue, increases in other derivative and
SFAS 133 net ineffective hedge gains, and increases in principal investment
gains, offset by decreases in student loans gains and gains recorded in 2002 for
securitization transactions and contingent consideration received in connection
with the Corporation's 2001 sale of National Management Corporation (NAMCO).
Insurance revenue grew as a result of increases in title insurance commissions
and private mortgage insurance contract premiums generated by National City's
insurance division. Other derivative gains increased $50 million over the prior
year and primarily resulted from increases in the fair value of derivative
instruments used to economically hedge the steep yield curve and deferred
compensation liabilities. SFAS 133 net ineffective hedge gains increased $14
million over the prior year and related to hedging portions of the fixed-rate
commercial loan portfolio. Principal investment and student loan gains were $7
million for first nine months of 2003 compared to principal investment losses
and student loan gains of $21 million and $12 million, respectively, for the
same 2002 period. Included in other fee income during the first nine months of
2002 with no comparable items recorded in 2003 were asset securitization gains
of $50 million and a $5 million gain recorded for contingent consideration
received in connection with the NAMCO sale.
The majority of net security gains were generated from the Corporation's
internally-managed equity portfolio of bank and thrift common stocks (bank stock
fund). Bank stock fund gains were $1 million for the third quarter of 2003
compared to no bank stock gains recognized in the third quarter of 2002. Bank
stock fund gains for the first nine months of 2003 and 2002 were $33 million and
$91 million, respectively, and included amounts for appreciation on securities
donated to the Corporation's charitable foundation. The securities were donated
in the second quarter of each year and the appreciation included in the bank
stock fund gains were $15 million
54
and $14 million in 2003 and 2002, respectively. Net unrealized gains in the bank
stock fund are included in other comprehensive income, net of tax, within
stockholders' equity and were $6 million at September 30, 2003.
During the second quarter of 2003, VISA(R) and Mastercard(R) (the associations)
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, debit interchange rates were lowered effective
August 1, 2003 by the associations. The reduced debit interchange rates did not
have a material impact on the results of payment processing and card-related
fees during the third quarter and first nine months of 2003. Additionally,
management does not believe the final outcome of the settlement will have a
material impact on financial condition, results of operations, or liquidity.
NONINTEREST EXPENSE
Details of noninterest expense follow:
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
- ------------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30 June 30 September 30 SEPTEMBER 30 September 30
(In Millions) 2003 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Salaries, benefits, and other personnel $ 571 $ 542 $ 449 $ 1,674 $ 1,338
Equipment 59 62 57 186 180
Net occupancy 58 56 56 172 166
Third-party services 71 71 55 207 168
Card processing 54 52 51 158 157
Marketing and public relations 22 67 26 106 127
Postage and supplies 37 33 32 103 94
Goodwill and other intangible asset
amortization 6 6 5 17 15
Telecommunications 22 19 21 62 64
Travel and entertainment 15 14 14 42 43
State and local taxes 16 14 15 46 46
Other real estate owned 4 6 5 13 16
Other 73 84 84 257 305
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL NONINTEREST EXPENSE $1,008 $1,026 $ 870 $ 3,043 $ 2,719
====================================================================================================================================
Details of salaries, benefits, and other personnel expense follow:
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
- ------------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30 June 30 September 30 SEPTEMBER 30 September 30
(Dollars in Millions) 2003 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Salaries and wages $ 310 $ 303 $ 294 $ 912 $ 873
Incentive compensation 264 241 164 676 409
Deferred personnel costs (145) (155) (98) (410) (236)
Stock-based compensation 10 6 3 20 7
Payroll taxes 33 37 28 113 96
Contract labor 29 23 16 72 46
Medical and other benefits 42 49 40 135 119
Defined contribution plans 14 17 14 54 47
Defined benefit pension plan (4) (4) (15) (12) (45)
Market valuation adjustments on deferred
compensation liabilities 3 18 (15) 20 (17)
Severance and other 15 7 18 94 39
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL SALARIES, BENEFITS, AND OTHER PERSONNEL $ 571 $ 542 $ 449 $ 1,674 $ 1,338
====================================================================================================================================
FULL-TIME-EQUIVALENT EMPLOYEES 33,188 32,414 32,099
====================================================================================================================================
Salaries, benefits, and other personnel expense increased in 2003 primarily due
to increases in mortgage-banking related compensation and severance costs. In
connection with cost-reduction initiatives, the Corporation recorded severance
and related charges of $76 million. Of this charge, $71 million, recorded as
salaries, benefits, and personnel expense and included in severance and other
above, was associated with a voluntary retirement program and position
eliminations. The remaining $5 million charge was recorded to third-party
services expense and related to outplacement services offered to employees whose
positions were eliminated. Increases in incentive compensation, contract labor,
and deferred personnel costs were driven by record mortgage origination and
sales at NCMC and First Franklin. Employee benefit-related expenses increased in
2003 primarily due to the reduction in the defined benefit pension credit and an
increase in expense associated with market-based deferred compensation
liabilities. The decline in the defined benefit pension credit was 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. The market valuation
55
adjustments on deferred compensation liabilities reflect changes in the value of
investments to which the liabilities are linked. Other changes in employee
benefit-related expenses resulted from year-over-year increases in contributions
to participant 401(k) plans and higher medical benefit costs. Stock option
expense increased on a linked-quarter and year-over-year basis due to the
adoption of SFAS 123 in 2003 and the granting of stock options during the third
quarter of 2003. See Notes 1, 2 and 20 to the consolidated financial statements
for further discussion on stock options and awards and the adoption of SFAS 123.
Full-time equivalent employees increased on both a linked-quarter and
year-over-year basis due to staffing increases to support the record levels of
mortgage related activity and an acquisition in the payment processing business,
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 $5 million discussed above,
increases in payment processing referral fees, professional service fees, and
outsourcing activities due to the increase in mortgage banking volume.
Marketing and public relations expense decreased on a linked-quarter basis
primarily due to the recognition of a $40 million charge associated with the
donation of appreciated investment securities to the Corporation's charitable
foundation in the second quarter of 2003, and, to a lesser extent, a decrease 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 in 2002 and a decrease in
advertising expenses incurred during the first nine months of 2003. The amount
of the appreciated investment securities donated in 2002 was $53 million.
The linked-quarter decrease in other noninterest expense was affected by a $10
million insurance recovery for automobile lease residual value losses recorded
in the third quarter, a $9 million building lease termination charge recorded in
the second quarter for the purchase of the Corporation's headquarters building,
and a third quarter increase in the amount of charges recognized for the
revaluation of community and civic partnership investments. For the third
quarter and second quarter of 2003, community and civic partnership investment
revaluation charges totaled $25 million and $21 million, respectively.
Significant one-time items affecting year-over-year comparability in other
noninterest income included a $16 million charge recorded in 2002 for the
consolidation of the former asset-backed commercial paper conduit, asset
impairment charges of $22 million recorded in 2002, and the aforementioned
building lease termination charge recorded in 2003. Year-over-year comparability
in other noninterest expense was also affected by current year decreases in the
amount of automobile lease residual value charges and by 2003 increases in
commercial lease residual value charges and revaluation charges associated with
civic and community development investments. Automobile lease residual value
charges for the first nine months of 2003 were $16 million, compared to the $51
million charge recorded last year. Commercial lease residual value and civic and
community development investment revaluation charges were $17 million and $58
million, respectively, for the first nine months of 2003, versus $3 million and
$32 million, respectively, for the first nine months of 2002.
The efficiency ratio, calculated as noninterest expense divided by the sum of
tax-equivalent net interest income and total fees and other income, was 59.5%
and 54.4% for the third quarters of 2003 and 2002, respectively. For the first
nine months of 2003 and 2002, the efficiency ratio was 52.5% and 54.4%,
respectively.
INCOME TAXES
The Corporation's effective tax rate was 34.4% for the first nine months of 2003
compared to 33.6% for the first nine months 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 third quarter and first nine
months of 2003 and 2002 is included in Note 23 to the consolidated financial
statements.
Net income (loss) by line of business follows:
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
- ------------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30 June 30 September 30 SEPTEMBER 30 September 30
(In Millions) 2003 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Consumer and Small Business Financial Services $ 169 $ 168 $ 170 $ 478 $ 450
Wholesale Banking 125 58 67 238 206
National Consumer Finance 155 400 145 908 475
Asset Management 25 27 25 71 77
National Processing 14 11 13 34 37
Parent and Other (109) (47) (46) (237) (32)
- ------------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED NET INCOME $ 379 $ 617 $ 374 $ 1,492 $ 1,213
====================================================================================================================================
56
Results for Consumer and Small Business Financial Services during the third
quarter and first nine months of 2003 reflected strong loan and deposit growth.
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. Deposit growth continued to benefit from attractive 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 service quality and customer
care. 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. Net income for the business line also benefited
from growth in insurance revenue, primarily from increases in title insurance
commissions and private mortgage insurance premiums driven by the strong
mortgage market. Noninterest expense increased on a linked-quarter and
year-over-year comparison mainly due to higher sales-driven personnel expenses,
offset by lower automobile lease residual value write-downs recognized in 2003.
Pretax automobile lease residual value write-downs were $16 million and $51
million for the first nine months of 2003 and 2002, respectively. An insurance
recovery of $10 million for automobile lease residual value losses was
recognized during the third quarter of 2003. There were no automobile lease
residual value recoveries or write-downs recognized during the second quarter of
2003.
The year-over-year growth in net income for Wholesale Banking reflected
increased net interest income and noninterest income. Net interest income
benefited from widened spreads on loans, while noninterest income grew as a
result of increases in investment banking and related revenue, deposit service
charges, standby letter of credit fees, and principal investment gains.
Principal investment gains were $7 million for the first nine months of 2003,
compared to principal investment losses of $21 million for the first nine months
of 2002. Partially offsetting the year-to-date growth in these items were higher
commercial lease residual value write-downs recognized in noninterest expense.
Commercial lease residual value write-downs were $17 million and $3 million for
the first nine months of 2003 and 2002, respectively. Wholesale Banking's
linked-quarter growth in net income was mainly due to lower credit costs and
higher amounts of principal investment gains recognized during the third
quarter. A lower provision for loan losses during the third quarter reflected
lower losses and delinquencies in the commercial loan portfolio. Principal
investment gains were $17 million for the third quarter of 2003, versus
principal investment losses of $17 million for the second quarter of 2003. Wider
spreads on loans, increases in deposit service charges and loan syndication fees
also contributed to the linked-quarter increase in net income.
Net income for National Consumer Finance grew significantly on a year-over-year
basis as 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 and a steep yield curve boosted the net interest
margin on the mortgage warehouse. Residential mortgage production and sales
volume reached record levels in 2003. For the first nine months of 2003,
residential mortgage origination and sales volume increased significantly, up
81% and 86%, respectively, over the same 2002 period. Residential mortgage
production and sales volume also remained at high levels during the third
quarter of 2003, down 3% and up 22%, respectively, over the second quarter of
2003. Mortgage loans held for sale averaged $27.0 billion for the third quarter,
compared to $24.1 billion and $ 11.8 billion for the second quarter of 2003 and
the third quarter of 2002, respectively. Additionally, mortgage loans held for
sale averaged $24.6 billion for the first nine months of 2003, compared to $12.0
billion for the same 2002 period. Residential mortgage production included
nonconforming loans generated by First Franklin. Over the past year,
approximately $7.7 billion of First Franklin's loan production has been retained
in portfolio. As of September 30, 2003, the portfolio of First Franklin loans
totaled $13.2 billion, compared to $11.5 billion last quarter and $8.7 billion
at September 30, 2002. Growth in this portfolio and the home equity portfolio
generated by the National Home Equity division has also contributed to the
increase in net interest income during the third quarter and first nine months
of 2003. The third quarter 2003 decrease in net income is solely attributed to
lower mortgage banking revenue in the National City Mortgage Co. division. A
sharp increase in mortgage rates in July and August resulted in unfavorable
mortgage servicing asset and warehouse hedging results, lower production
margins, and higher mortgage servicing asset amortization expense during the
third quarter of 2003.
Net income for Asset Management declined during the third quarter and first nine
months of 2003 principally due to a lower level of assets under administration.
Assets under administration were $108.0 billion, $133.6 billion, and $129.2
billion at September 30, 2003, December 31, 2002, and September 30, 2002,
respectively.
The growth in National Processing's third quarter 2003 net income reflected
increases in transaction volume, the favorable benefit of rate changes
implemented by VISA(R) and MasterCard(R) in 2003, and severance expense in the
2002 third quarter that did not recur in 2003. These favorable factors were
partially offset by price compression in the national merchant base and the
decline in transactions processed for the airline industry. Conversely, the
year-over-year decrease in National Processing's net income occurred as price
compression in the national customer base and the decline in transactions
processed for the airlines more than offset the growth in transaction volume and
the impact of the rate changes implemented by VISA(R) and MasterCard(R). 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 5% of National
Processing's 2002 annual revenue. National Processing's results for the first
nine months of 2002 also included a $2 million charge associated with the
relocation of certain processing operations from Mexico to the United States.
National Processing's results for the first nine months of 2003 also included a
$1 million charge associated with certain severance costs and the loss on sale
of 14 regional sales offices.
57
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 third quarter of 2003,
noninterest expense included a $25 million charge recognized for the revaluation
of civic and community development investments, versus a $21 million charge
recognized in the previous quarter. Noninterest expense included the following
charges in the second quarter 2003 with no similar charges recognized during the
third quarter: a $40 million charge associated with the donation of appreciated
investment securities to the Corporation's charitable foundation, and a $9
million lease termination penalty associated with the purchase of the
Corporation's headquarters building in Cleveland, Ohio. During the first nine
months of 2003, noninterest expense included the aforementioned second quarter
charges, a $58 million revaluation charge associated with civic and community
development investments, and $76 million of severance and related charges
associated with cost-reduction initiatives. Similar charges recognized in 2002
included a $53 million charge for the charitable donation of appreciated
investment securities, a $32 million revaluation charge associated with civic
and community development investments, and $24 million of severance and related
charges. Noninterest expense for the first nine months of 2002 also included a
$16 million charge associated with the consolidation of the Corporation's former
asset-backed commercial paper conduit. Significant items included in noninterest
income included bank stock fund gains and other derivative and SFAS 133 net
ineffective hedge gains (losses). Bank stock gains of $1 million and $33 million
were recognized during the third quarter and first nine months of 2003,
respectively, compared to $32 million and $90 million for the 2003 second
quarter and first nine months of 2002, respectively. Other derivative gains
reduced linked-quarter noninterest income by $90 million and conversely,
increased year-to-date noninterest income by $49 million due to changes in the
value of derivative instruments used to economically hedge the steep yield curve
and deferred compensation liabilities. Year-to-date noninterest income also
increased by $14 million due to net ineffective hedge gains associated with
hedging portions of the fixed-rate commercial loan portfolio. For the first nine
months of 2002, noninterest income included securitization gains of $50 million
and a 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. Net interest expense increased in the third quarter and first
nine months of 2003 mainly due to the cost 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.
58
CONTRACTUAL OBLIGATIONS, COMMITMENTS, CONTINGENT LIABILITIES,
AND OFF-BALANCE SHEET ARRANGEMENTS
The following table presents, as of September 30, 2003, 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 $ 54,323 $ -- $ -- $ -- $54,323
Consumer and brokered certificates
of deposits 6,905 6,741 1,342 965 15,953
Federal funds borrowed and security
repurchase agreements 8,638 -- -- -- 8,638
Borrowed funds 12 1,473 -- -- -- 1,473
Long-term debt(a) 13, 14 13,082 8,057 2,390 3,419 26,948
Operating leases 122 178 112 258 670
===============================================================================================================================
(a) Includes debt obligations related to the subsidiary trusts
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 September 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 September 30, 2003 follows:
- ------------------------------------------------------------------------------------------------------------
(In Millions)
- ------------------------------------------------------------------------------------------------------------
Commitments to extend credit:
Revolving home equity and credit card lines $ 23,487
Other loans 32,659
Standby letters of credit 3,922
Commercial letters of credit 156
Net commitments to sell mortgage loans and mortgage-backed securities 18,842
Commitments to fund principal investments 253
Commitments to fund civic and community investments 186
============================================================================================================
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 4.
59
RISK MANAGEMENT
National City management, with the oversight of the Board of Directors, has in
place a variety of committees and organizational structures for managing and
mitigating risk. The following discussion addresses the three major risks facing
National City: credit, liquidity, and market.
CREDIT RISK MANAGEMENT
The Corporation's lending activities 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 Nine Months Ended
- ----------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30 June 30 September 30 SEPTEMBER 30 September 30
(In Millions) 2003 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------------------
Commercial $ 35 $ 90 $ 57 $ 218 $ 224
Real estate -- commercial 9 5 4 16 12
Real estate -- residential 37 25 15 93 57
Home equity lines of credit 4 5 3 13 11
Credit card and other
unsecured lines of credit 22 23 20 65 56
Other consumer 17 16 21 54 76
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL NET CHARGE-OFFS $ 124 $ 164 $ 120 $ 459 $ 436
============================================================================================================================
Net charge-offs as a percentage of average loans by portfolio type follow:
- ----------------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
- ----------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30 June 30 September 30 SEPTEMBER 30 September 30
2003 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------------------
Commercial .58% 1.49% .94% 1.20% 1.19%
Real estate -- commercial .36 .22 .18 .23 .21
Real estate -- residential .61 .45 .40 .55 .50
Home equity lines of credit .19 .19 .21 .19 .22
Credit card and other
unsecured lines of credit 4.13 4.46 3.65 4.17 4.01
Other consumer .83 .80 .72 .90 .90
============================================================================================================================
TOTAL NET CHARGE-OFFS TO AVERAGE PORTFOLIO
LOANS (ANNUALIZED) .64% .88% .69% .82% .85%
============================================================================================================================
The linked-quarter and year-over-year decrease in commercial net charge-offs
reflects improving credit quality in this portfolio. Residential real estate net
charge-offs on a linked-quarter and year-over-year comparison increased and were
affected by the $17 million write-down recognized upon the reclassification of
$950 million of the former Altegra portfolio to loans held for sale on September
30, 2003. The increases in residential real estate net charge-offs also reflect
the growth and seasoning of the portfolio through the retention of First
Franklin loans, and to a lesser extent, the reclassification of certain home
equity installment loans to the residential real estate portfolio from the other
consumer portfolio in December 2002. Offsetting the increase in residential real
estate net charge-offs for both periods were increases in recoveries on
previously charged-off loans due to improved mitigation efforts. The
year-over-year increase in net charge-offs on credit card and other unsecured
lines of credit was primarily the result of higher losses associated with an
increase in consumer bankruptcies and growth in the portfolio, offset to some
extent by a change in the charge-off policy for delinquent credit card balances
during the first quarter of 2003. 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 year-over-year
decrease in other consumer net charge-offs is due to the overall lower balance
of the portfolio affected by the aforementioned reclassification of certain home
equity installment loans to the residential real estate portfolio and the
continued run-off of the automobile lease portfolio.
60
NONPERFORMING ASSETS AND DELINQUENT LOANS: Details of nonperforming assets
follow:
- ---------------------------------------------------------------------------------
SEPTEMBER 30 December 31 September 30
(Dollars in Millions) 2003 2002 2002
- ---------------------------------------------------------------------------------
Commercial $350 $ 414 $ 443
Real estate -- commercial 65 60 78
Real estate -- residential 214 228 226
- ---------------------------------------------------------------------------------
TOTAL NONPERFORMING LOANS 629 702 747
Other real estate owned (OREO) 110 115 105
Mortgage loans held for sale 14 -- --
Other 3 -- --
- ---------------------------------------------------------------------------------
TOTAL NONPERFORMING ASSETS $756 $ 817 $ 852
=================================================================================
NONPERFORMING ASSETS AS A PERCENTAGE OF:
PERIOD-END PORTFOLIO LOANS AND OTHER
NONPERFORMING ASSETS .97% 1.13% 1.20%
PERIOD-END TOTAL ASSETS .62 .69 .78
=================================================================================
Detail of loans 90 days past due accruing interest follows:
- ----------------------------------------------------------------------------------------
SEPTEMBER 30 December 31 September 30
(In Millions) 2003 2002 2002
- ----------------------------------------------------------------------------------------
Commercial $ 49 $ 43 $ 77
Real estate - commercial 22 26 17
Real estate - residential 415 449 438
Home equity lines of credit 15 16 15
Credit card and other unsecured lines of credit 15 8 7
Other consumer 11 19 18
Mortgage loans held for sale 50 14 5
Other 21 -- --
- ----------------------------------------------------------------------------------------
TOTAL LOANS 90 DAYS PAST DUE ACCRUING INTEREST $ 598 $ 575 $ 577
========================================================================================
In general, many of the same factors that affected comparability in net
charge-offs also drove changes in nonperforming assets and loans 90 days past
due. The reduction in commercial nonperforming assets at September 30, 2003 was
primarily attributed to loan sales which more than offset the addition of new
loans to nonperforming status. During the third quarter and first nine months of
2003, $28 million and $100 million of nonperforming commercial loans were sold
to third parties. Residential real estate nonperforming assets and loans 90 days
past due at September 30, 2003 decreased as a result of the aforementioned
reclassification of the former Altegra portfolio to loans held for sale, which
more than offset increases in delinquencies associated with growth in the First
Franklin portfolio and the aforementioned home equity installment loan
reclassification. The former Altegra portfolio loan reclassification was also
the primary factor behind the increase nonperforming assets and loans 90 days
past due for loans held for sale. 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. Other consumer 90 days past due
decreased at September 30 primarily due to the aforementioned home equity
installment loan reclassification.
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 of the overall allowance is based
on the size and current risk characteristics of the loan portfolio and includes
an assessment of individual problem loans, actual loss experience, current
economic events in specific industries and geographical areas, and other
pertinent factors, including general economic conditions, unemployment levels,
and regulatory guidance.
The allowance for loan losses as a percentage of portfolio loans was 1.45% at
September 30, 2003. The provision for loan losses was $107 million for the third
quarter of 2003, down from $183 million last quarter and down from the $169
million recorded in the third quarter of 2002. For the first nine months of
2003, the provision for loan losses was $490 million, down from $523 million for
the comparable 2002 period. In general, the lower loan loss provision is
reflective of the overall improvement in credit quality driven mainly by lower
commercial losses and delinquent loans in 2003.
61
An allocation of the ending allowance for loan losses by portfolio type follows:
- ----------------------------------------------------------------------------------------
SEPTEMBER 30 December 31 September 30
(In Millions) 2003 2002 2002
- ----------------------------------------------------------------------------------------
Commercial $ 415 $ 450 $ 308
Real estate -- commercial 55 58 62
Real estate -- residential 117 126 124
Home equity lines of credit and other
consumer loans 90 124 181
Credit card and other unsecured lines of credit 120 101 95
Unallocated 333 240 310
- ----------------------------------------------------------------------------------------
TOTAL ALLOWANCE FOR LOAN LOSSES $1,130 $ 1,099 $ 1,080
========================================================================================
The allowance allocated to the commercial portfolio at September 30, 2003
decreased since year-end due to the overall improvement in credit quality, the
decline in the portfolio balance, and sales of nonperforming commercial loans in
2003. The higher commercial allocated allowance at September 30, 2003 from a
year ago is reflective of higher levels of delinquent nationally syndicated
loans, which are typically characterized by more highly leveraged borrowers. The
decrease in the allowance allocated to the residential real estate portfolio
since year-end was mainly attributed to the effects of the aforementioned former
Altegra portfolio reclassification, which more than offset the increase in the
allocated allowance associated with growth in the portfolio and the
aforementioned home equity installment loan reclassification. The 2003 increase
in credit card and other unsecured lines of credit allocated allowance was
attributed to the increase in delinquent balances coupled with growth in the
portfolio. The lower allowance allocated to home equity lines of credit and
other consumer loans at September 30, 2003 was 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 residential real estate
associated with the aforementioned home equity installment loan
reclassification. 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 and the sustained effects of a weak
economy over the past two years.
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 third
quarter of 2003. Core deposits, the most significant source of funding,
comprised approximately 51% of funding at September 30, 2003 and December 31,
2002, and was approximately 53% of funding at September 30, 2002. Asset
securitization vehicles have also been used as a source of funding over the past
several years. Further discussion of securitization activities is included in
Note 4 to the consolidated financial statements.
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 bank subsidiaries. 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. During the first
nine months of 2003, the bank subsidiaries declared cash dividends totaling $906
million, of which $456 million has been paid to the holding company.
Additionally, during the first nine months of 2003, the bank subsidiaries were
granted regulatory approval to provide liquidity to the holding company in the
form of returns of capital in the amount of $555 million. Of this amount, $300
million has been paid 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 September 30, 2003, December
31, 2002 and September
62
30, 2002, $633 million, $1.0 billion and $1.5 billion, 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
September 30, 2003, December 31, 2002, and September 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 September
30, 2003, this portfolio had a cost basis and fair value of $33 million and $39
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 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 October 2003 ALCO
meeting projects net income would increase by approximately 3.4% 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 9.5% 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
63
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 October 2003 ALCO meeting projects an increase in
NPV of approximately 1.5% if interest rates immediately increased 150 basis
points. If rates immediately decreased by 150 basis points, the model projects
an approximate increase in NPV of 1.1%. 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 nine months 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.
64
CONSOLIDATED AVERAGE BALANCE SHEETS
- ------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
- ------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30 September 30 SEPTEMBER 30 September 30
- ------------------------------------------------------------------------------------------------------------------
(In Millions) 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------
ASSETS
Earning Assets:
Portfolio loans:
Commercial $ 23,577 $ 24,863 $ 24,160 $ 25,370
Real estate -- commercial 9,450 8,037 9,448 7,877
Real estate -- residential 24,088 15,895 22,539 15,333
Home equity lines of credit 9,612 7,316 8,847 6,692
Credit card and other unsecured lines of credit 2,170 1,910 2,096 1,834
Other consumer 8,167 10,924 8,028 11,165
- ----------------------------------------------------------------------------------------------------------------
Total portfolio loans 77,064 68,945 75,118 68,271
Loans held for sale or securitization:
Commercial 13 18 13 7
Mortgage 27,023 11,833 24,562 12,005
Automobile -- -- -- 332
Credit card -- -- -- 47
- ----------------------------------------------------------------------------------------------------------------
Total loans held for sale or securitization 27,036 11,851 24,575 12,391
Securities available for sale, at cost 6,667 8,336 7,447 8,607
Federal funds sold and security resale agreements 272 87 178 89
Other investments 945 795 750 761
- ----------------------------------------------------------------------------------------------------------------
Total earning assets 111,984 90,014 108,068 90,119
Allowance for loan losses (1,144) (1,031) (1,124) (1,018)
Fair value appreciation of securities available for sale 202 299 276 233
Cash and demand balances due from banks 3,554 3,126 3,466 2,974
Properties and equipment 1,115 1,048 1,068 1,065
Other real estate owned 107 97 111 80
Mortgage servicing assets 1,258 1,052 942 1,166
Goodwill 1,103 1,078 1,089 1,078
Other intangible assets 71 81 70 82
Derivative assets 544 739 851 549
Accrued income and other assets 5,018 4,604 4,978 4,047
- ----------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 123,812 $ 101,107 $ 119,795 $ 100,375
================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest bearing $ 19,408 $ 13,864 $ 17,578 $ 13,002
NOW and money market 26,091 21,006 24,884 20,185
Savings 2,422 2,543 2,442 2,586
Consumer time 13,337 15,122 13,915 15,150
Brokered retail CDs 2,502 2,500 2,657 2,913
Other 739 565 616 767
Foreign 7,186 5,781 6,915 5,978
- ----------------------------------------------------------------------------------------------------------------
Total deposits 71,685 61,381 69,007 60,581
- ----------------------------------------------------------------------------------------------------------------
Federal funds borrowed and security repurchase agreements 10,660 7,798 11,634 8,161
Borrowed funds 1,087 1,784 1,746 2,147
Long-term debt(a) 27,569 18,985 24,786 19,013
Derivative liabilities 511 459 588 355
Accrued expenses and other liabilities 3,029 2,482 3,141 2,238
- ----------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 114,541 92,889 110,902 92,495
Stockholders' Equity:
Preferred -- -- -- 1
Common 9,271 8,218 8,893 7,879
- ----------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 9,271 8,218 8,893 7,880
- ----------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 123,812 $ 101,107 $ 119,795 $ 100,375
================================================================================================================
(a) Includes debt obligations related to the subsidiary trusts
65
DAILY AVERAGE BALANCES/NET INTEREST INCOME/RATES
(Dollars in Millions) Daily Average Balance
- -------------------------------------------------------------------------------------------------------------------
2003 2002
--------------------------------------------------------------
THIRD Second First Fourth Third
QUARTER Quarter Quarter Quarter Quarter
- -------------------------------------------------------------------------------------------------------------------
ASSETS
Earning Assets:
Loans(a):
Commercial $ 23,590 $ 24,332 $ 24,610 $ 25,345 $ 24,881
Real estate -- commercial 9,450 9,475 9,420 8,383 8,037
Real estate -- residential 51,111 46,574 43,535 36,372 27,728
Home equity lines of credit 9,612 8,761 8,152 7,857 7,316
Credit card and other unsecured lines of credit 2,170 2,084 2,033 1,958 1,910
Other consumer 8,167 7,957 7,957 11,052 10,924
- -------------------------------------------------------------------------------------------------------------------
Total loans 104,100 99,183 95,707 90,967 80,796
Securities available for sale, at cost:
Taxable 5,988 6,721 7,650 8,825 7,668
Tax-exempt 679 676 645 659 668
- -------------------------------------------------------------------------------------------------------------------
Total securities available for sale 6,667 7,397 8,295 9,484 8,336
Federal funds sold, security resale
agreements and other investments 1,217 775 783 864 882
- -------------------------------------------------------------------------------------------------------------------
Total earning assets/total interest
income/rates 111,984 107,355 104,785 101,315 90,014
Allowance for loan losses (1,144) (1,127) (1,101) (1,079) (1,031)
Fair value appreciation of securities
available for sale 202 302 324 318 299
Nonearning assets 12,770 12,530 12,425 12,135 11,825
- -------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 123,812 $ 119,060 $ 116,433 $ 112,689 $ 101,107
===================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing liabilities:
NOW and money market accounts $ 26,091 $ 25,045 $ 23,489 $ 22,385 $ 21,006
Savings accounts 2,422 2,447 2,458 2,488 2,543
Consumer time deposits 13,337 13,972 14,451 14,811 15,122
Other deposits 3,241 3,207 3,370 3,415 3,065
Foreign deposits 7,186 6,950 6,602 7,264 5,781
Federal funds borrowed 7,632 9,054 9,171 7,297 4,482
Security repurchase agreements 3,028 2,899 3,135 3,346 3,316
Borrowed funds 1,087 1,527 2,636 3,169 1,784
Long-term debt(b) 27,569 23,914 22,826 21,175 18,985
- -------------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities/
total interest expense/rates 91,593 89,015 88,138 85,350 76,084
Noninterest bearing deposits 19,408 17,596 15,689 15,710 13,864
Accrued expenses and other liabilities 3,540 3,647 4,006 3,243 2,941
- -------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 114,541 110,258 107,833 104,303 92,889
TOTAL STOCKHOLDERS' EQUITY 9,271 8,802 8,600 8,386 8,218
- -------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 123,812 $ 119,060 $ 116,433 $ 112,689 $ 101,107
===================================================================================================================
NET INTEREST INCOME
===================================================================================================================
INTEREST SPREAD
Contribution of noninterest bearing sources of funds
- -------------------------------------------------------------------------------------------------------------------
NET INTEREST MARGIN
===================================================================================================================
(a) Includes loans held for sale or securitization
(b) Includes debt obligations to the subsidiary trusts
66
(Dollars in Millions) Quarterly Interest
- ------------------------------------------------------------------------------------------------------
2003 2002
-----------------------------------------------
THIRD Second First Fourth Third
QUARTER Quarter Quarter Quarter Quarter
- ------------------------------------------------------------------------------------------------------
ASSETS
Earning Assets:
Loans(a):
Commercial $ 225 $ 243 $ 245 $ 284 $ 301
Real estate -- commercial 146 146 145 136 133
Real estate -- residential 807 744 730 606 507
Home equity lines of credit 99 95 89 98 92
Credit card and other unsecured lines of credit 43 41 44 43 44
Other consumer 140 143 148 227 232
- ------------------------------------------------------------------------------------------------------
Total loans 1,460 1,412 1,401 1,394 1,309
Securities available for sale, at cost:
Taxable 71 93 102 124 119
Tax-exempt 13 13 13 13 14
- ------------------------------------------------------------------------------------------------------
Total securities available for sale 84 106 115 137 133
Federal funds sold, security resale
agreements and other investments 10 10 11 9 9
- ------------------------------------------------------------------------------------------------------
Total earning assets/total interest income/rates $1,554 $1,528 $1,527 $1,540 $1,451
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 $ 63 $ 67 $ 68 $ 77 $ 78
Savings accounts 3 3 3 5 5
Consumer time deposits 120 131 137 149 160
Other deposits 8 10 12 15 15
Foreign deposits 19 25 23 30 27
Federal funds borrowed 27 35 36 34 25
Security repurchase agreements 4 5 6 8 9
Borrowed funds 2 5 9 12 7
Long-term debt(b) 157 145 132 129 146
- ------------------------------------------------------------------------------------------------------
Total interest bearing liabilities/
total interest expense/rates $ 403 $ 426 $ 426 $ 459 $ 472
Noninterest bearing deposits
Accrued expenses and other liabilities
- ------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES
TOTAL STOCKHOLDERS' EQUITY
- ------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
======================================================================================================
NET INTEREST INCOME $1,151 $1,102 $1,101 $1,081 $ 979
======================================================================================================
INTEREST SPREAD
Contribution of noninterest bearing sources of funds
- ------------------------------------------------------------------------------------------------------
NET INTEREST MARGIN
======================================================================================================
(a) Includes loans held for sale or securitization
(b) Includes debt obligations to the subsidiary trusts
67
- ----------------------------------------------------------------------------------------------------------------------
(Dollars in Millions) Average Annualized Rate
- ----------------------------------------------------------------------------------------------------------------------
2003 2002
----------------------------------------------------------
THIRD Second First Fourth Third
QUARTER Quarter Quarter Quarter Quarter
- ----------------------------------------------------------------------------------------------------------------------
ASSETS
Earning Assets:
Loans(a):
Commercial 3.80% 3.99% 4.03% 4.45% 4.80%
Real estate -- commercial 6.10 6.18 6.25 6.46 6.57
Real estate -- residential 6.31 6.39 6.71 6.66 7.31
Home equity lines of credit 4.11 4.36 4.36 4.97 5.04
Credit card and other unsecured lines of credit 7.81 8.06 8.68 8.53 9.20
Other consumer 6.79 7.19 7.55 8.16 8.44
- ----------------------------------------------------------------------------------------------------------------------
Total loans 5.59 5.70 5.89 6.10 6.46
Securities available for sale, at cost:
Taxable 4.81 5.47 5.37 5.67 6.18
Tax-exempt 7.50 7.68 8.06 8.14 8.15
- ----------------------------------------------------------------------------------------------------------------------
Total securities available for sale 5.08 5.68 5.58 5.84 6.33
Federal funds sold, security resale
agreements and other investments 3.29 5.33 5.71 3.88 4.03
- ----------------------------------------------------------------------------------------------------------------------
Total earning assets/total interest income/rates 5.53% 5.70% 5.86% 6.06% 6.42%
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 .96% 1.07% 1.18% 1.37% 1.47%
Savings accounts .39 .46 .58 .71 .80
Consumer time deposits 3.58 3.74 3.86 4.00 4.16
Other deposits 1.05 1.26 1.42 1.73 1.89
Foreign deposits 1.05 1.42 1.42 1.62 1.87
Federal funds borrowed 1.37 1.57 1.59 1.83 2.25
Security repurchase agreements .53 .71 .73 0.95 1.08
Borrowed funds .98 1.21 1.38 1.50 1.59
Long-term debt(b) 2.26 2.44 2.33 2.44 3.06
- ----------------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities/
total interest expense/rates 1.75% 1.92% 1.96% 2.14% 2.46%
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% 3.78% 3.90% 3.92% 3.96%
Contribution of noninterest bearing sources of funds .32 .33 .31 .34 .38
- ----------------------------------------------------------------------------------------------------------------------
NET INTEREST MARGIN 4.10% 4.11% 4.21% 4.26% 4.34%
======================================================================================================================
(a) Includes loans held for sale or securitization
(b) Includes debt obligations to the subsidiary trusts
68
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 63 of this report are incorporated herein by reference.
ITEM 4. CONTROLS AND PROCEDURES
National City's management 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 September 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 that
disclosure controls and procedures as of September 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 September 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 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. Management
believes that 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 contingent
liabilities and guarantees, refer to Note 19 to the Consolidated Financial
Statements.
69
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).
70
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 (filed as Exhibit 10.17 to
Registrant's Quarterly Report on Form 10-Q for the quarter and six
months ended June 30, 2003, and incorporated herein by reference).
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).
71
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
November 12, 2003 for National City Corporation's Quarterly Report on
Form 10-Q for the quarter ended September 30, 2003.
31.2 Chief Financial Officer Sarbanes-Oxley Act 302 Certification dated
November 12, 2003 for National City Corporation's Quarterly Report on
Form 10-Q for the quarter ended September 30, 2003.
32.1 Chief Executive Officer Sarbanes-Oxley Act 906 Certification dated
November 12, 2003 for National City Corporation's Quarterly Report on
Form 10-Q for the quarter ended September 30, 2003.
32.2 Chief Financial Officer Sarbanes-Oxley Act 906 Certification dated
November 12, 2003 for National City Corporation's Quarterly Report on
Form 10-Q for the quarter ended September 30, 2003.
72
REPORTS ON FORM 8-K
The following reports were filed by National City Corporation during the
three-month period ended September 30, 2003 through the date of this Form 10-Q
filing:
July 15, 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 at
www.NationalCity.com.
July 29, 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 Board of Directors on July 29, 2003.
September 10, 2003 National City announced the posting of its Mid-Quarter
Update to Financial Supplement to its Web site.
October 15, 2003 National City issued a news release announcing its
financial results for the three- and nine-month
periods ended September 30, 2003 and the availability
of the September 30, 2003 Financial Supplement on its
Web site.
October 28, 2003 National City issued a news release announcing the
retirement of Vice Chairman, Robert G. Siefers,
effective the end of 2003.
78
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 available on the Corporation's Web site or 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
The National City Corporation Amended and Restated Dividend Reinvestment and
Stock Purchase Plan (the Plan) offers stockholders a convenient way to increase
their investment. 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 at
www.NationalCity.com.
DIRECT DEPOSIT OF DIVIDENDS
The direct deposit program provides for free 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
79
FORM 10-Q -- SEPTEMBER 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: November 12, 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
80
[NATIONAL CITY(R) LOGO]
National City Center
1900 East Ninth Street
Cleveland, Ohio 44114-3484
81