Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
Commission file number 1-10074
NATIONAL CITY CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE
(State or other jurisdiction of
incorporation or organization)
34-1111088
(I.R.S. Employer
Identification No.)
1900 EAST NINTH STREET
CLEVELAND, OHIO 44114
(Address of principal executive office)
216-222-2000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
YES [X] NO [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES [X] NO [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of Common Stock as of the latest practicable date.
Common stock -- $4.00 Par Value
Outstanding as of July 31, 2004 -- 662,744,926
NATIONALCITY(R)
QUARTER ENDED JUNE 30, 2004
FINANCIAL REPORT
AND FORM 10-Q
FINANCIAL REPORT AND FORM 10-Q
QUARTER ENDED JUNE 30, 2004
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 48
Consolidated Average Balance Sheets 68
Daily Average Balances/Net Interest Income/Rates 69
Item 3. Quantitative and Qualitative Disclosures About Market Risk 72
Item 4. Controls and Procedures 72
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings 72
Item 2. Changes in Securities and Use of Proceeds 72
Item 3. Defaults Upon Senior Securities (None)
Item 4. Submission of Matters to a Vote of Security Holders 72
Item 5. Other Information (None)
Item 6. Exhibits and Reports on Form 8-K 74
Signatures 80
2
PART I - FINANCIAL INFORMATION
FINANCIAL HIGHLIGHTS
Three Months Ended Six Months Ended
June 30 June 30
----------------------------- ----------------------------
(Dollars In Thousands, Except Per Share Amounts) 2004 2003 2004 2003
- ------------------------------------------------ ----------- ----------- ------------ ------------
FOR THE PERIOD
Tax-equivalent net interest income $ 1,066,780 $ 1,102,248 $ 2,091,937 $ 2,202,976
Provision for loan losses 60,788 183,147 143,295 383,380
Noninterest income 866,277 1,011,912 1,983,974 2,115,398
Noninterest expense 1,075,137 1,026,237 2,061,477 2,035,103
Income tax expense and tax-equivalent adjustment 278,086 318,968 641,725 670,580
----------- ----------- ------------ ------------
Net income $ 519,046 $ 585,808 $ 1,229,414 $ 1,229,311
=========== =========== ============ ============
Net income per common share
Basic $ .84 $ .96 $ 2.01 $ 2.01
Diluted .83 .94 1.99 1.99
Dividends paid per common share .32 .305 .64 .61
Return on average common equity 20.13% 26.74% 24.69% 28.63%
Return on average assets 1.80 1.97 2.20 2.11
Net interest margin 4.09 4.11 4.12 4.16
Efficiency ratio 55.77 49.27 50.64 47.47
Average equity to average assets 8.95 7.38 8.89 7.36
Annualized net charge-offs to average portfolio loans .30 .88 .36 .91
Average shares
Basic 619,097,523 612,119,565 612,507,157 611,822,337
Diluted 625,476,357 618,384,192 619,036,496 616,989,238
=========== =========== ============ ============
AT PERIOD END
Assets $116,969,803 $123,342,589
Portfolio loans 84,537,266 75,838,729
Loans held for sale or securitization 12,466,789 26,796,226
Securities, at fair value 6,516,742 7,377,350
Deposits 73,036,089 66,770,788
Stockholders' equity 10,334,984 9,029,909
Book value per common share $ 16.86 $14.72
Market value per common share 35.01 32.71
Equity to assets 8.84% 7.32%
Allowance for loan losses as a percentage of
period-end portfolio loans 1.35 1.51
Nonperforming assets to period-end
portfolio loans and other nonperforming assets .64 1.08
Common shares outstanding 612,880,193 613,426,098
Full-time equivalent employees 34,062 32,414
============ ============
3
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended Six Months Ended
June 30 June 30
--------------------------- ---------------------------
(Dollars in Thousands, Except Per Share Amounts) 2004 2003 2004 2003
- ------------------------------------------------ ------------ ------------ ------------ ------------
INTEREST INCOME
Loans $ 1,305,225 $ 1,409,904 $ 2,554,332 $ 2,808,148
Securities:
Taxable 65,332 85,957 134,625 182,933
Exempt from Federal income taxes 8,544 8,579 16,743 17,143
Dividends 4,670 6,283 8,876 11,475
Federal funds sold and security resale agreements 1,505 612 2,234 1,116
Other investments 9,827 9,698 22,231 20,214
------------ ------------ ------------ ------------
Total interest income 1,395,103 1,521,033 2,739,041 3,041,029
INTEREST EXPENSE
Deposits 201,650 234,353 390,195 478,704
Federal funds borrowed and security
repurchase agreements 19,664 40,685 37,668 82,270
Borrowed funds 3,101 4,600 6,059 13,598
Long-term debt and capital securities 110,303 145,813 226,107 277,584
------------ ------------ ------------ ------------
Total interest expense 334,718 425,451 660,029 852,156
------------ ------------ ------------ ------------
NET INTEREST INCOME 1,060,385 1,095,582 2,079,012 2,188,873
PROVISION FOR LOAN LOSSES 60,788 183,147 143,295 383,380
------------ ------------ ------------ ------------
Net interest income after provision for loan losses 999,597 912,435 1,935,717 1,805,493
NONINTEREST INCOME
Mortgage banking revenue 193,173 426,924 772,571 1,057,657
Deposit service charges 161,549 142,126 308,902 276,862
Payment processing revenue 131,944 113,047 253,563 218,458
Trust and investment management fees 79,803 77,310 155,379 146,669
Card-related fees 37,965 44,036 75,095 85,117
Brokerage revenue 34,167 33,428 66,419 57,904
Other 222,479 143,634 346,709 241,154
------------ ------------ ------------ ------------
Total fees and other income 861,080 980,505 1,978,638 2,083,821
Securities gains, net 5,197 31,407 5,336 31,577
------------ ------------ ------------ ------------
Total noninterest income 866,277 1,011,912 1,983,974 2,115,398
NONINTEREST EXPENSE
Salaries, benefits, and other personnel 594,060 542,291 1,142,951 1,103,453
Equipment 71,728 62,763 141,205 127,455
Net occupancy 59,476 56,081 119,435 114,437
Third-party services 72,346 70,838 140,710 136,382
Card processing 60,396 51,194 117,939 103,520
Marketing and public relations 29,858 66,272 52,118 83,584
Other 187,273 176,798 347,119 366,272
------------ ------------ ------------ ------------
Total noninterest expense 1,075,137 1,026,237 2,061,477 2,035,103
------------ ------------ ------------ ------------
Income before income tax expense 790,737 898,110 1,858,214 1,885,788
Income tax expense 271,691 312,302 628,800 656,477
------------ ------------ ------------ ------------
NET INCOME $ 519,046 $ 585,808 $ 1,229,414 $ 1,229,311
============ ============ ============ ============
NET INCOME PER COMMON SHARE
Basic $ .84 $ .96 $ 2.01 $ 2.01
Diluted .83 .94 1.99 1.99
AVERAGE COMMON SHARES OUTSTANDING
Basic 619,097,523 612,119,565 612,507,157 611,822,337
Diluted 625,476,357 618,384,192 619,036,496 616,989,238
============ ============ ============ ============
See Notes to Consolidated Financial Statements
4
CONSOLIDATED BALANCE SHEETS
JUNE 30 December 31 June 30
(In Thousands) 2004 2003 2003
- -------------- ------------- ------------- -------------
ASSETS
Cash and demand balances due from banks $ 3,171,945 $ 3,595,706 $ 4,042,648
Federal funds sold and security resale agreements 1,087,481 162,347 81,574
Securities available for sale, at fair value 6,516,742 6,865,616 7,377,350
Other investments 568,230 830,887 842,893
Loans held for sale or securitization:
Commercial 26,249 16,300 12,591
Mortgage 12,440,540 14,497,277 26,783,635
Automobile -- 853,982 --
------------- ------------- -------------
Total loans held for sale or securitization 12,466,789 15,367,559 26,796,226
Portfolio loans:
Commercial 19,738,970 19,164,326 21,837,932
Commercial construction 2,284,178 2,289,429 2,341,879
Real estate -- commercial 11,014,482 9,827,877 9,462,072
Real estate -- residential 28,731,664 27,393,711 23,009,187
Home equity lines of credit 13,781,781 10,950,356 9,124,178
Credit card and other unsecured lines of credit 2,198,703 2,324,198 2,124,368
Other consumer 6,787,488 7,328,956 7,939,113
------------- ------------- -------------
Total portfolio loans 84,537,266 79,278,853 75,838,729
Allowance for loan losses (1,144,619) (1,125,329) (1,147,098)
------------- ------------- -------------
Net portfolio loans 83,392,647 78,153,524 74,691,631
Properties and equipment 1,202,100 1,125,526 1,106,705
Other real estate owned 95,470 99,418 103,685
Mortgage servicing assets 1,926,051 1,298,417 733,420
Goodwill 1,423,536 1,103,340 1,102,799
Other intangible assets 68,408 62,475 74,502
Derivative assets 876,243 1,349,259 1,819,917
Accrued income and other assets 4,174,161 3,919,386 4,569,239
------------- ------------- -------------
TOTAL ASSETS $ 116,969,803 $ 113,933,460 $ 123,342,589
============= ============= =============
LIABILITIES
Deposits:
Noninterest bearing $ 17,448,186 $ 16,585,367 $ 19,238,413
NOW and money market 28,153,616 26,849,261 25,415,374
Savings 2,560,288 2,353,721 2,426,424
Consumer time 13,689,154 13,133,909 13,646,875
Other 1,278,431 924,969 2,440,785
Foreign 9,906,414 4,082,803 3,602,917
------------- ------------- -------------
Total deposits 73,036,089 63,930,030 66,770,788
Federal funds borrowed and security repurchase agreements 5,892,472 6,693,916 12,112,317
Borrowed funds 3,903,212 6,615,460 2,667,925
Long-term debt 20,243,182 23,480,724 27,758,252
Junior subordinated debentures owed to unconsolidated
subsidiary trusts 249,210 185,568 --
Corporation-obligated mandatorily redeemable capital securities of
subsidiary trusts holding solely debentures of the Corporation -- -- 180,000
Derivative liabilities 707,349 875,737 1,416,132
Accrued expenses and other liabilities 2,603,305 2,823,354 3,407,266
------------- ------------- -------------
TOTAL LIABILITIES 106,634,819 104,604,789 114,312,680
============= ============= =============
STOCKHOLDERS' EQUITY
Preferred stock, no par value, authorized 5,000,000
shares, no shares outstanding -- -- --
Common stock, par value $4 per share, authorized 1,400,000,000
shares, outstanding 612,880,193 shares, 605,996,120 shares,
and 613,426,098, respectively 2,451,521 2,423,985 2,453,705
Capital surplus 1,607,658 1,116,279 1,057,467
Retained earnings 6,234,266 5,723,720 5,484,430
Accumulated other comprehensive income 41,539 64,687 34,307
------------- ------------- -------------
TOTAL STOCKHOLDERS' EQUITY 10,334,984 9,328,671 9,029,909
------------- ------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 116,969,803 $ 113,933,460 $ 123,342,589
============= ============= =============
See Notes to Consolidated Financial Statements
5
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended
June 30
----------------------------
(In Thousands) 2004 2003
- -------------- ------------ ------------
OPERATING ACTIVITIES
Net income $ 1,229,414 $ 1,229,311
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 143,295 383,380
Depreciation and amortization of properties and equipment 104,743 92,602
Amortization of intangible assets and mortgage servicing assets 253,471 261,392
Accretion of premiums and discounts on securities, deposits, and debt obligations 10,972 (18,880)
Mortgage servicing asset impairment charges 76,242 25,793
Ineffective hedge and other derivative gains, net (191,658) (408,050)
Securities gains, net (5,336) (31,577)
Gains on loans sold or securitized, net (255,349) (149,565)
Other (gains) losses, net (52,241) 119,282
Originations and purchases of loans held for sale or securitization (40,941,975) (60,137,780)
Principal payments on and proceeds from sales of loans held for sale or securitization 42,510,919 56,358,981
Decrease in accrued interest receivable 40,481 19,536
(Decrease) increase in accrued interest payable (26,312) 3,409
Other operating activities, net 38,048 1,338,540
------------ ------------
Net cash provided by (used in) operating activities 2,934,714 (913,626)
------------ ------------
LENDING AND INVESTING ACTIVITIES
Net (increase) decrease in federal funds sold, security resale agreements,
and other investments (662,438) 81,023
Purchases of available-for-sale securities (680,684) (1,831,232)
Proceeds from sales of available-for-sale securities 36,659 1,235,013
Proceeds from maturities, calls, and prepayments of available-for-sale securities 1,301,630 2,404,604
Net increase in loans (4,814,543) (4,533,824)
Proceeds from sales or securitizations of loans 1,837,712 846,551
Net increase in properties and equipment (131,450) (168,527)
Net cash received (paid) for acquisitions 10,582 (33,131)
Cash received for sale of Corporate Trust Bond Administration business 66,500 --
------------ ------------
Net cash used in lending and investing activities (3,036,032) (1,999,523)
------------ ------------
DEPOSIT AND FINANCING ACTIVITIES
Net increase in deposits 7,314,582 1,663,477
Net (decrease) increase in federal funds borrowed and security repurchase agreements (801,444) 5,584,059
Net decrease in borrowed funds (2,922,599) (8,825,984)
Repayments of long-term debt (8,557,601) (5,192,455)
Proceeds from issuances of long-term debt, net 5,306,970 10,297,860
Dividends paid (393,838) (373,012)
Issuances of common stock 122,816 83,055
Repurchases of common stock (391,329) (37,629)
------------ ------------
Net cash (used in) provided by deposit and financing activities (322,443) 3,199,371
------------ ------------
Net (decrease) increase in cash and demand balances due from banks (423,761) 286,222
Cash and demand balances due from banks, January 1 3,595,706 3,756,426
------------ ------------
CASH AND DEMAND BALANCES DUE FROM BANKS, JUNE 30 $ 3,171,945 $ 4,042,648
============ ============
SUPPLEMENTAL INFORMATION
Cash paid for:
Interest $ 686,341 $ 848,747
Income taxes 815,874 666,283
Noncash items:
Transfers of loans to other real estate 147,922 93,296
Trade date purchase of debt securities not yet settled -- 12,813
Common stock and options issued in Allegiant acquisition 469,666 --
============ ============
See Notes to Consolidated Financial Statements
6
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Preferred Common Capital Retained
(Dollars in Thousands, Except Per Share Amounts) Stock Stock Surplus Earnings
- ----------------------------------------------- --------- ------------ ------------ ------------
Balance, January 1, 2003 $ -- $ 2,445,966 $ 989,346 $ 4,658,565
Comprehensive income:
Net income 1,229,311
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
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
Total comprehensive income
Common dividends declared, $.61 per share (373,012)
Issuance of 3,316,039 common shares under stock-based
compensation plans, including related tax effects 13,264 69,791
Repurchase of 1,381,300 common shares (5,525) (1,670) (30,434)
------ ------------ ------------ ------------
Balance, June 30, 2003 $ -- $ 2,453,705 $ 1,057,467 $ 5,484,430
====== ============ ============ ============
Balance, January 1, 2004 $ -- $ 2,423,985 $ 1,116,279 $ 5,723,720
Comprehensive income: --
Net income 1,229,414
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
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
Total comprehensive income
Common dividends declared, $.64 per share (393,838)
Issuance of 3,808,028 common shares under stock-based
compensation plans, including related tax effects 15,232 107,584
Repurchase of 11,195,600 common shares (44,782) (21,517) (325,030)
Issuance of 14,271,645 common shares pursuant to
acquisition 57,086 405,702
Other (390)
====== ============ ============ ============
Balance, June 30, 2004 $ -- $ 2,451,521 $ 1,607,658 $ 6,234,266
====== ============ ============ ============
Accumulated
Other
Comprehensive
(Dollars in Thousands, Except Per Share Amounts) Income Total
- ----------------------------------------------- ------------ ------------
Balance, January 1, 2003 $ 67,180 $ 8,161,057
Comprehensive income:
Net income 1,229,311
Other comprehensive income, net of tax:
Change in unrealized gains and losses on securities,
net of reclassification adjustment for net gains
included in net income (40,027) (40,027)
Change in unrealized gains and losses on derivative
instruments used in cash flow hedging relationships,
net of reclassification adjustment for net losses
included in net income 7,154 7,154
------------
Total comprehensive income 1,196,438
Common dividends declared, $.61 per share (373,012)
Issuance of 3,316,039 common shares under stock-based
compensation plans, including related tax effects 83,055
Repurchase of 1,381,300 common shares (37,629)
------------ ------------
Balance, June 30, 2003 $ 34,307 $ 9,029,909
============ ============
Balance, January 1, 2004 $ 64,687 $ 9,328,671
Comprehensive income:
Net income 1,229,414
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 (87,422) (87,422)
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 64,274 64,274
Total comprehensive income 1,206,266
Common dividends declared, $.64 per share (393,838)
Issuance of 3,808,028 common shares under stock-based --
compensation plans, including related tax effects 122,816
Repurchase of 11,195,600 common shares (391,329)
Issuance of 14,271,645 common shares pursuant to
acquisition 462,788
Other (390)
============ ============
Balance, June 30, 2004 $ 41,539 $ 10,334,984
============ ============
See Notes to Consolidated Financial Statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NATURE OF OPERATIONS
National City Corporation (National City or the Corporation) is a financial
holding company headquartered in Cleveland, Ohio. National City operates through
an extensive branch bank network in Ohio, Indiana, Illinois, Kentucky, Michigan,
Missouri, and Pennsylvania, and also conducts selected consumer lending
businesses and other financial services on a nationwide basis. Primary
businesses include commercial and retail banking, consumer finance, asset
management, mortgage financing and servicing, and payment processing.
1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
The accompanying unaudited consolidated financial statements include the
accounts of the Corporation and its 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 and have been restated to reflect changes in the Corporation's
method of assessing effectiveness of its hedging activities pursuant to
Statement of Financial Accounting Standards No. 133, Accounting for Derivatives
and Hedging Activities.
CONSOLIDATION: Accounting Research Bulletin No. 51 (ARB 51), Consolidated
Financial Statements, requires a company's consolidated financial statements
include subsidiaries in which the company has a controlling financial interest.
This requirement usually has been applied to subsidiaries in which a company has
a majority voting interest. Investments in companies in which the Corporation
controls operating and financing decisions (principally defined as owning a
voting or economic interest greater than 50%) are consolidated. Investments in
companies in which the Corporation has significant influence over operating and
financing decisions (principally defined as owning a voting or economic interest
of 20% to 50%) and limited partnership investments are generally accounted for
by the equity method of accounting. These investments are normally included in
other assets and National City's
7
proportionate share of income or loss is included in other noninterest income.
The voting interest approach defined in ARB 51 is not applicable in identifying
controlling financial interests in entities that are not controllable through
voting interests or in which the equity investors do not bear the residual
economic risks. In such instances, Financial Accounting Standards Board (FASB)
Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities
(VIE), indicates when a company should include in its financial statements the
assets, liabilities and activities of another entity. In general, a VIE is a
corporation, partnership, trust, or any other legal structure used for business
purposes that either does not have equity investors with voting rights or has
equity investors that do not provide sufficient financial resources for the
entity to support its activities. FIN 46 requires a VIE to be consolidated by a
company if that company is subject to a majority of the risk of loss from the
VIE's activities or entitles it to receive a majority of the entity's residual
returns or both. A company that consolidates a VIE is called the primary
beneficiary of that entity. The Corporation's consolidated financial statements
include the assets, liabilities and activities of VIEs for which it is deemed to
be the primary beneficiary.
The Corporation uses special-purpose entities (SPEs), primarily securitization
trusts, to diversify its funding sources. SPEs are not operating entities,
generally have no employees, and usually have a limited life. The basic SPE
structure involves the Corporation transferring assets to the SPE. The SPE funds
the purchase of those assets by issuing asset-backed securities to investors.
The legal documents governing the SPE describe how the cash received on the
assets held in the SPE must be allocated to the investors and other parties that
have rights to these cash flows. National City structures these SPEs to be
bankruptcy remote, thereby insulating investors from the impact of the creditors
of other entities, including the transferor of the assets.
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 5.
USE OF ESTIMATES: 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 2003 Annual Report on Form 10-K (Form 10-K). These
financial statements may not include all information and notes 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.
STATEMENT OF CASH FLOWS: Cash and demand balances due from banks are considered
"cash and cash equivalents" for financial reporting purposes.
BUSINESS COMBINATIONS: Business combinations are accounted for under the
purchase method of accounting. Under the purchase method, assets and liabilities
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. Refer to Note 3 for further discussion
on the Corporation's acquisition activity.
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.
8
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.
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, except for residential real estate loans, 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.
The Corporation, through its subsidiary National City Mortgage Co. (NCMC), sells
mortgage loans to the Government National Mortgage Association (GNMA) in the
normal course of business and retains the servicing rights. The GNMA programs
under which the loans are sold allow the Corporation to repurchase individual
delinquent loans that meet certain criteria from the securitized pool. At the
Corporation's option, and without GNMA's prior authorization, the Corporation
may repurchase the delinquent loan for an amount equal to 100 percent of the
remaining principal balance of the loan. Under SFAS 140, once the Corporation
has the unconditional ability to repurchase the delinquent loan, the Corporation
is deemed to have regained effective control over the loan and is required to
recognize the loan on its balance sheet and record an offsetting liability,
regardless of the Corporation's intent to repurchase the loan. At June 30, 2004
and December 31, 2003, residential real estate portfolio loans included $171
million and $240 million, respectively, of loans available for repurchase under
the GNMA optional repurchase programs with the offsetting liability recorded
within other borrowed funds.
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.
9
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 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.
SECURITIES: Securities purchased with the intention of realizing short-term
profits are considered trading securities, carried at fair value, and included
in other investments. Realized and unrealized gains and losses are included in
securities gains or losses on the income statement. Interest on trading account
securities is recorded in interest income. As of June 30, 2004, December 31,
2003, and June 30, 2003, trading account securities totaled $24 million, $22
million, and $26 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 held no
securities classified as held to maturity at June 30, 2004, December 31, 2003 or
June 30, 2003.
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. The Corporation utilizes 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
investments in this fund are managed. 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.
10
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 is obtained or
requested to be returned as 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. Goodwill is
tested at least annually for impairment. Intangible assets, which have finite
lives, consist of core deposit, credit card, merchant portfolio, and other
intangibles and are subject to impairment testing. Core deposit intangibles are
primarily amortized over a period not to exceed 10 years based upon an
accelerated amortization method. Credit card, merchant portfolios, and other
intangibles are amortized over their estimated useful lives on a straight-line
basis, which range from 1 to 10 years. Note 10 includes a summary of goodwill
and other intangible assets.
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.
11
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. Legal
opinions were also obtained for the automobile loan securitization transactions
in 2004 and 2002, which were structured as two-step securitizations. While
noting each of these transactions fall 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 obtained for each of
these transactions 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.
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 5 for further
analysis of the assumptions used in the determination of fair value.
When the Corporation retains the right to service the loans and receives related
fees that exceed the current market rate to service the receivables, a servicing
asset is recorded and included in other assets on the balance sheet. A servicing
asset is not recognized if the Corporation receives adequate compensation
relative to current market servicing prices to service the receivables sold.
Servicing assets created in a securitization are initially measured at their
allocated carrying amount based upon relative fair values at the date of
securitization and are subsequently carried at the lower of this initial
carrying value, adjusted for amortization, or fair value. Impairment, if any, is
recognized when and in the amount the carrying value exceeds its fair value as
determined by calculating the present value of the expected future net servicing
cash flows using the assumptions described previously. The amortization of
servicing assets occurs in proportion to, and over the period of, the estimated
net servicing income and is recorded in noninterest income on the income
statement.
12
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.
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. 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.
13
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 right (MSR) asset is established, which represents the then
current fair value of future net cash flows expected to be realized for
performing the servicing activities. MSRs, when purchased, are initially
recorded at cost. MSRs are carried at the lower of the initial capitalized
amount, net of accumulated amortization and hedge accounting adjustments, or
fair value. Certain MSRs 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 MSRs.
The fair value of MSRs 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 MSRs. 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 MSRs,
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. Servicing
fees, net of amortization, impairment, and related derivative gains and losses
are recorded in mortgage banking revenue on the income statement.
The carrying values of MSRs (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.
MSRs are evaluated for impairment in accordance with SFAS 140. For purposes of
determining impairment, the MSRs 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.
MSRs 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 MSRs. Unlike a valuation allowance, a
direct write-down permanently reduces the carrying value of the MSR and the
valuation allowance, precluding subsequent recoveries.
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
subsequent to January 1, 2003 were 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 2004 and 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.
14
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 83%-owned payment
processing subsidiary, National Processing, Inc., on its common stock.
Three Months Ended Six Months Ended
June 30 June 30
------- -------
(In Thousands, Except Per Share Amounts) 2004 2003 2004 2003
- ---------------------------------------- --------- --------- ----------- -----------
Net income, as reported $ 519,046 $ 585,808 $ 1,229,414 $ 1,229,311
Add: option expense included in reported
net income, net of related tax effects
National City common stock 3,652 1,980 7,622 2,297
National Processing common stock 34 4 137 4
Less: total option expense determined under
fair value method for all option awards, net
of related tax effects
National City common stock (8,585) (12,527) (17,488) (23,701)
National Processing common stock (878) (1,525) (2,172) (3,199)
--------- --------- ----------- -----------
PRO FORMA NET INCOME $ 513,269 $ 573,740 $ 1,217,513 $ 1,204,712
--------- --------- ----------- -----------
Pro forma net income per share:
Basic -- as reported $ .84 $ .96 $ 2.01 $ 2.01
Basic -- pro forma .83 .94 1.99 1.97
Diluted -- as reported .83 .94 1.99 1.99
Diluted -- pro forma .82 .93 1.97 1.95
The fair values of stock options granted were estimated at the date of grant
using the Black-Scholes option pricing model. The Black-Scholes option pricing
model was originally developed for use in estimating the fair value of traded
options, which have different characteristics from the Corporation's employee
stock options. The model is also sensitive to changes in assumptions, which can
materially affect the fair value estimate. The following weighted-average
assumptions were used to determine the fair value of options granted on National
City common stock:
Three Months Ended Six Months Ended
June 30 June 30
------- -------
2004 2003 2004 2003
---- ---- ---- ----
Risk-free interest rate 2.86% 3.01% 3.01% 3.09%
Expected dividend yield 4.01 4.50 3.95 4.49
Expected volatility 27.02 27.29 27.03 27.25
Expected option life (in years) 5 5 5 5
Weighted-average grant-date fair value of options $ 6.18 $ 5.53 $ 6.28 $ 5.39
The weighted-average assumptions used to value the National Processing option
grants are disclosed in National Processing, Inc.'s June 30, 2004 Quarterly
Report on Form 10-Q, as filed with the United States Securities and Exchange
Commission (SEC) and is accessible at www.sec.gov.
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.
15
2. RECENT ACCOUNTING PRONOUNCEMENTS
LOAN COMMITMENTS: On March 9, 2004, the SEC issued Staff Accounting Bulletin
(SAB) 105, "Application of Accounting Principles to Loan Commitments" stating
that the fair value of loan commitments is to be accounted for as a derivative
instrument under SFAS 133, but the valuation of such commitment should not
consider expected future cash flows related to servicing of the future loan. The
Corporation has historically valued its loan commitments including the change in
value of expected future cash flows related to servicing.
The Corporation adopted the provisions of SAB 105 as of January 1, 2004. The
impact of adopting SAB 105 resulted in a decrease in mortgage banking revenue of
$47 million for the first six months of 2004. This change in accounting may
result in increased volatility in earnings in the future as changes in the value
of derivative instruments utilized to hedge the loan commitments will continue
to be reported currently in earnings, while offsetting changes in certain
components of the fair value of the loan commitment will not be recognized until
the loan is closed or is sold.
ACCOUNTING FOR CERTAIN LOANS OR DEBT SECURITIES ACQUIRED IN A TRANSFER: In
December 2003, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position (SOP)
03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer."
SOP 03-3 addresses the accounting for acquired loans that show evidence of
having deteriorated in terms of credit quality since their origination (i.e.
impaired loans). This SOP states that acquired loans should be recorded at their
fair value defined as the present value of future cash flows. An allowance for
loan losses would not be recognized at acquisition as credit losses would be
considered in future cash flows. Subsequent increases in expected cash flows
would be accounted for as a change in estimate of the accretable yield on a
prospective basis. Subsequent decreases in cash flows would be accounted for as
a loss contingency in the current period. SOP 03-03 is effective for loans that
are acquired in fiscal years beginning after December 15, 2004. Management will
continue to evaluate the applicability of this SOP for prospective acquisitions.
EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT BENEFITS: In
December 2003, the FASB revised SFAS 132 Employers' Disclosures about Pensions
and Other Postretirement Benefits. This Statement retains the disclosures
required by the original SFAS 132 and requires additional disclosures about the
assets, obligations, cash flows and net periodic benefit cost of defined benefit
pension and postretirement plans. In addition, this Statement requires interim
period disclosure of the components of net period benefit cost and contributions
if significantly different from previously reported amounts. See Note 21 for the
interim financial statement disclosures made pursuant to this statement.
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 December 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 June 30, 2004, 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.
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.
During the third quarter of 2003, the Corporation applied the provisions of FIN
46 to two wholly-owned subsidiary trusts that 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.
16
In December 2003, the FASB reissued FIN 46 with certain modifications and
clarifications. Application of this guidance was effective for interests in
certain VIEs commonly referred to as special-purpose entities (SPEs) as of
December 31, 2003. Application for all other types of entities was required as
of March 31, 2004, unless previously applied.
Management evaluated the applicability of the revised FIN 46 to various other
investments and interests as of March 31, 2004, including low-income housing
partnership interests, historic tax credit partnerships, investments in certain
real estate projects, leveraged leasing structures, and certain trust accounts
to determine whether these entities are VIEs and whether the Corporation is
either a primary beneficiary or a significant interest holder in the VIE. The
impact of adopting the revised FIN 46 is described below.
National City invests in low-income housing and historic tax credit projects
primarily through its subsidiary, National City Community Development
Corporation for the purpose of providing a source of private sector financing
for projects to promote economic development, create employment opportunities
and contribute to the enhancement of the community. Investments principally
consist of real estate projects and venture/working capital. The Corporation
accounts for these partnership investments under the equity method of
accounting, with a carrying value of $301 million at June 30, 2004. As a limited
partner in these projects, National City is allocated tax credits and deductions
associated with the underlying projects. The adoption of FIN 46 as of March 31,
2004, resulted in the consolidation of one low-income housing project with
assets and liabilities each totaling $7 million. The Corporation also holds
significant interests in other low-income housing and historic tax credit
projects in which the maximum exposure to loss would be limited to the initial
capital investment contributed.
The Investment Real Estate (IRE) group, a business unit within the Wholesale
Banking line of business, delivers financial services to real estate investors
and developers. National City receives origination fees and fees for credit
administration services. IRE primarily originates collateralized and guaranteed
loan facilities for the acquisition and development of land, construction, and
semi-permanent financing. Property types include multi-family and single family
residential, retail, office, commercial and industrial property. In many cases,
these loans represent variable interests in a VIE of which National City is not
the primary beneficiary. The Corporation's maximum exposure to loss is mitigated
by the underlying collateral and guarantees.
3. ACQUISITIONS & DIVESTITURES
ACQUISITIONS: On April 9, 2004, the National City Corporation completed its
acquisition of Allegiant Bancorp, Inc. (Allegiant), a bank-holding company
operating 36 retail bank branch offices headquartered in the St. Louis, Missouri
metropolitan area. The acquisition of Allegiant allows the Corporation to expand
its product offerings and delivery channels into the St. Louis market. Under the
terms of the merger, each share of Allegiant common stock was exchanged for .833
shares of National City common stock, $27.25 in cash, or a combination cash or
stock. In connection with the transaction, substantially all of Allegiant's
common stock was exchanged, resulting in the issuance of approximately 14
million common shares and a cash payment of $23 million. The total cost of the
transaction was $493 million. The common shares issued were valued at $32.42 per
share representing an average of closing market prices for 2 days before and
after the date the merger terms were agreed to and announced. The assets and
liabilities of Allegiant were recorded on the balance sheet at their respective
estimated fair values as of the merger date. The results of Allegiant's
operations have been included in National City's consolidated statement of
income from the date of acquisition.
Refer to Note 4 for discussion on severance and other restructuring costs
incurred in connection with the Allegiant merger. Additionally, refer to Note 10
for further discussion on goodwill and intangible assets recognized in
connection with the Allegiant merger. Subsequent to April 2004, adjustments were
made to the initial purchase price allocation resulting in a net increase to
goodwill of $15 million. The increase in goodwill was primarily related to
completing the valuation of core deposit intangibles.
17
The following tables summarize the estimated fair values of the net assets
acquired and the computation of the purchase price and goodwill related to the
Allegiant acquisition.
(In Thousands) April 9, 2004
- -------------- -------------
Assets
Cash and cash equivalents $ 33,547
Securities 346,049
Loans, net of allowance for loan losses 1,957,149
Premises and other equipment 40,666
Goodwill and other intangibles 339,569
Other assets 92,762
----------
Total Assets 2,809,742
Liabilities
Deposits 1,799,535
Borrowings 499,400
Other liabilities 18,178
----------
Total Liabilities 2,317,113
----------
NET ASSETS ACQUIRED $ 492,629
==========
(In Thousands) April 9, 2004
- -------------- -------------
Purchase price $ 492,629
Allegiant's carrying value of net assets acquired (142,662)
---------
Excess of purchase price over Allegiant's carrying value of net assets acquired 349,967
Purchase accounting adjustments
Securities 1,765
Portfolio loans (54,356)
Premises and equipment 3,524
Deposits 9,960
Borrowings 16,978
Severance 2,892
Contract termination and other exit costs 450
Deferred tax liabilities 8,388
---------
Total net tangible assets 339,568
---------
Core deposit intangibles (16,112)
Other identifiable intangible assets (3,260)
---------
GOODWILL $ 320,196
=========
The estimated fair values of Allegiant's acquired assets and liabilities,
including identifiable intangible assets, are preliminary and subject to
refinement as additional information becomes available. Any subsequent
adjustments to the fair values of assets and liabilities acquired, identifiable
intangible assets, or other purchase accounting adjustments will result in
adjustments to goodwill.
On July 1, 2004, the Corporation completed its acquisition of Provident
Financial Group, Inc. (Provident), a bank holding company operating 65 branch
banking offices in the Cincinnati and Dayton, Ohio markets. The acquisition of
Provident is intended to expand product offerings and delivery channels into the
southwestern Ohio market. Under the terms of the transaction, each share of
Provident common stock was exchanged into 1.135 shares of National City common
stock and each share of Provident preferred stock was exchanged into 1 share of
National City Series D convertible preferred stock. This transaction resulted in
the issuance of approximately 57 million common shares, 70 thousand convertible
preferred shares and a small cash payment for fractional shares. The total cost
of the transaction was $2.2 billion. The common shares issued were valued at
$34.99 per share, representing an average of closing market prices for 2 days
before and after the date the merger terms were agreed to and announced. The
convertible preferred shares were issued at their common stock equivalent value
as of the merger date. The allocation of the purchase price will be determined
after completion of valuations to determine the estimated fair values of
Provident's assets and liabilities. The results of Provident's operations will
be included in National City's income statement from the date of acquisition. As
this transaction was completed subsequent to June 30, 2004, the accompanying
financial statements as of and for the three- and six-month periods ended June
30, 2004 do not include the effects of this transaction.
In June 2004, the Corporation signed a definitive agreement to acquire Wayne
Bancorp (Wayne), an $825 million asset banking company operating 26 branches in
several northeastern Ohio counties, for a cash price of $180 million. Completion
of this transaction is subject to shareholder and regulatory approvals and is
expected to occur in the fourth quarter.
18
DIVESTITURES: In July 2004, National Processing, Inc. (NPI), the Corporation's
83% owned subsidiary, reached a definitive agreement with Bank of America for
the sale of all of its outstanding shares for $1.4 billion in cash, or $26.60
per National Processing share. Completion of this transaction is expected to
occur in the fourth quarter, subject to shareholder and regulatory approvals. In
conjunction with this agreement, the Corporation, through its bank subsidiary
National City Bank of Kentucky, entered into a Service and Sponsorship Agreement
with NPI. This agreement is effective upon close of the transaction and relates
to the United Airlines charge card processing agreement, whereby Bank of
America, through NPI, has agreed to make a one-time payment of $36 million to
the Corporation in exchange for the Corporation's agreement to release NPI from
its obligation to indemnify the Corporation against any losses or claims arising
from the United Airlines charge card processing agreement. Refer to Note 19 for
the related discussion on the Corporation's chargeback exposure.
On June 30, 2004, the Corporation sold its Corporate Trust Bond Administration
business to U.S. Bancorp for $67 million, resulting in pre-tax gain of $65
million, recorded in other noninterest income. Assets under administration
transferred in this transaction were approximately $11.1 billion.
4. RESTRUCTURING CHARGES
During the three months ended June 30, 2004, the Corporation recognized $6
million of severance and other termination charges, of which approximately $1
million related to retention bonuses provided to Allegiant employees during the
second quarter. Additionally, a $3 million liability was recorded in the
allocation of Allegiant's purchase price to assets and liabilities acquired for
severance and outplacement benefits for terminated Allegiant employees.
Substantially all Allegiant severance benefits will be paid out by March 2005.
The other severance costs recognized in 2004 represent severance expenses
incurred elsewhere in the Corporation in the normal course of business.
During the first quarter of 2003, the Corporation implemented various
cost-reduction initiatives and recognized severance and related charges of $72
million. Of the total charge recognized in the first quarter of 2003, $68
million was recorded to salaries, benefits, and other personnel expense and was
associated with a voluntary retirement program and position eliminations across
all lines of business. The remaining $4 million was recorded to third-party
services expense for outplacement services.
A rollforward of the severance liability for the three- and six-month periods
ended June 30, 2004 and 2003 is presented in the table below. The table below
also includes severance expenses incurred in the normal course of business.
Except for severance charges incurred by the National Processing line of
business, all other severance and related termination expenses were recorded as
unallocated corporate charges within the Parent and Other category.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2004 JUNE 30, 2004
--------------------------------- ---------------------------------
PARENT AND NATIONAL PARENT NATIONAL
(In Thousands) OTHER PROCESSING TOTAL AND OTHER PROCESSING TOTAL
- -------------- ---------- ---------- -------- --------- ----------- --------
Beginning balance $ 11,755 $ 1,455 $ 13,210 $ 14,154 $ 1,773 $ 15,927
Severance and other termination
costs 9,236 -- 9,236 12,569 54 12,623
Payments and adjustments (5,065) (331) (5,396) (10,797) (703) (11,500)
-------- ------- -------- ------- ------- --------
ENDING BALANCE $ 15,926 $ 1,124 $ 17,050 $ 15,926 $ 1,124 $ 17,050
======== ======= ======== ======== ======= ========
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2003 JUNE 30, 2003
--------------------------------- ---------------------------------
PARENT AND NATIONAL PARENT NATIONAL
(In Thousands) OTHER PROCESSING TOTAL AND OTHER PROCESSING TOTAL
- -------------- ---------- ---------- -------- --------- ----------- --------
Beginning balance $ 70,253 $ 2,216 $ 72,469 $ 13,895 $ 3,141 $ 17,036
Severance and other termination
costs (166) 674 508 71,571 704 72,275
Payments and adjustments (45,683) (435) (46,118) (61,062) (1,390) (62,452)
-------- ------- -------- ------- ------- --------
ENDING BALANCE $ 24,404 $ 2,455 $ 26,859 $ 24,404 $ 2,455 $ 26,859
======== ======= ======== ======== ======= ========
19
5. SECURITIZATION ACTIVITY
The Corporation periodically sells assets through securitization transactions.
On February 25, 2004, the Corporation established the National City Auto
Receivables Trust 2004-A into which it sold, through securitization, $890
million of fixed-rate, closed-end automobile loans. A pretax gain of $9 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 $32
million, $46 million, and $1 million, respectively. In addition, a servicing
asset was established in the amount of $10 million. See Note 1 for further
details regarding the accounting for servicing assets.
During 2003, the Corporation securitized five pools of Small Business
Administration (SBA) loans totaling $52 million, and recognized retained
interests in the form of interest-only strips 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.
A summary of the assumptions used to value the credit card retained interests
and automobile retained interests and servicing asset at the time of
securitizations were as follows:
Variable Monthly Expected
Weighted-Average Annual Principal Annual Annual
Life Coupon Rate Repayment Credit Discount
(in months) to Investors Rate Losses Rate Yield
----------- ------------ ---- ------ ---- -----
CREDIT CARD:
Series 2000-1 5.5 6.86% 18.08% 4.17% 15.00% 14.43%
Series 2001-1 5.6 6.06 17.79 4.08 15.00 14.77
Series 2002-1 5.7 2.06 17.41 5.34 15.00 11.99
Weighted- Monthly Expected
Average Prepayment Cumulative Annual Weighted-
Life Speed Credit Discount Average
(in months) (% ABS) Losses Rate Coupon
----------- ------- ------ ---- ------
AUTOMOBILE:
Series 2002-A
Interest only strip 22.9 1.40% 2.25% 12.00% 8.71%
Servicing asset 22.9 1.40 2.25 12.00 8.71
Series 2004-A
Interest only strip 21.8 1.50% 1.75% 12.00% 6.79%
Servicing asset 21.8 1.50 1.75 11.00 6.79
20
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.
THREE MONTHS ENDED SIX MONTHS ENDED
AS OF JUNE 30, 2004 JUNE 30, 2004 JUNE 30, 2004
----------------------- ----------------------- -----------------------
LOANS PAST
DUE 30 NET
PRINCIPAL DAYS OR AVERAGE NET CREDIT AVERAGE CREDIT
(In Millions) BALANCE MORE BALANCES LOSSES BALANCES LOSSES
- ------------- ------- ---- -------- ------ -------- --------
Type of loan:
Credit card $ 2,400.5 $ 89.9 $ 2,446.8 $ 38.8 $ 2,490.2 $ 76.6
Automobile 3,989.4 62.0 4,055.9 9.6 4,127.4 21.5
SBA 39.0 3.7 40.5 -- 41.5 --
---------------------------------------------------------------------------
Total loans managed or
securitized 6,428.9 155.6 6,543.2 48.4 6,659.1 98.1
Less:
Loans securitized:
Credit card 1,450.0 45.6 1,450.0 20.5 1,450.0 37.7
Automobile 1,128.7 13.6 1,196.0 2.7 1,104.0 4.8
SBA 39.0 3.7 40.5 -- 41.5 --
Loans held for securitization:
Automobile -- -- -- -- 264.9 --
---------------------------------------------------------------------------
LOANS HELD IN PORTFOLIO $ 3,811.2 $ 92.7 $ 3,856.7 $ 25.2 $ 3,798.7 $ 55.6
===========================================================================
Three Months Ended Six Months Ended
As of June 30, 2003 June 30, 2003 June 30, 2003
----------------------- ----------------------- -----------------------
Loans Past
Due 30
Principal Days or Average Net Credit Average Credit Net
(In Millions) Balance More Balances Losses Balances Losses
- ------------- ------- ---- -------- ------ -------- --------
Type of loan:
Credit card $ 2,438.3 $ 95.1 $ 2,408.0 $ 36.7 $ 2,395.2 $ 64.4
Automobile 4,461.9 64.1 4,425.0 9.8 4,397.0 23.0
SBA 38.9 6.0 39.1 -- 32.5 --
---------------------------------------------------------------------------
Total loans managed or
securitized 6,939.1 165.2 6,872.1 46.5 6,824.7 87.4
Less:
Loans securitized:
Credit card 1,450.0 51.9 1,450.0 20.8 1,450.0 36.2
Automobile 653.7 9.2 698.2 2.3 744.3 5.0
SBA 38.9 6.0 39.1 -- 32.5 --
Loans held for securitization -- -- -- -- -- --
---------------------------------------------------------------------------
LOANS HELD IN PORTFOLIO $ 4,796.5 $ 98.1 $ 4,684.8 $ 23.4 $ 4,597.9 $ 46.2
===========================================================================
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.
21
Certain cash flows received from the securitization trusts follow:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2004 JUNE 30, 2004
------------------------------------- -------------------------------------
(In Millions) CREDIT CARD AUTOMOBILE SBA CREDIT CARD AUTOMOBILE SBA
- --------------------------------------------------------------------------------------------------------------------------------
Proceeds from new securitizations $ -- $ -- $ -- $ -- $ 811.2 $ --
Proceeds from collections reinvested in
previous securitizations 772.9 -- -- 1,539.2 -- --
Servicing fees received 7.2 3.0 -- 14.5 5.6 --
Other cash flows received on retained interest 22.1 5.4 .2 44.7 8.0 .5
Proceeds from sales of previously charged-off
accounts -- -- -- -- -- --
Purchases of delinquent or foreclosed assets -- -- -- -- -- --
Repayments of servicing advances -- -- -- -- -- --
Three Months Ended Six Months Ended
June 30, 2003 June 30, 2003
------------------------------------- -------------------------------------
(In Millions) Credit Card Automobile SBA Credit Card Automobile SBA
- --------------------------------------------------------------------------------------------------------------------------------
Proceeds from new securitizations $ -- $ -- $ -- $ -- $ -- $ 40.3
Proceeds from collections reinvested in
previous securitizations 760.0 -- -- 1,518.4 -- --
Servicing fees received 7.3 1.8 -- 14.6 3.8 --
Other cash flows received on retained interest 19.7 3.9 .2 44.0 9.3 .3
Proceeds from sales of previously charged-off
accounts .3 -- -- .7 -- --
Purchases of delinquent or foreclosed assets -- -- -- -- -- --
Repayments of servicing advances -- -- -- -- -- --
A summary of the fair values of the interest-only strips and servicing assets
retained, key economic assumptions used to arrive at the fair values, and the
sensitivity of the June 30, 2004 fair values to immediate 10% and 20% adverse
changes in those assumptions follows. Actual credit losses experienced through
June 2004 on the pool of automobile loans securitized have been consistent with
initial projections. As such, the expected static pool loss assumption would
perform consistent with that disclosed in the sensitivity analysis. 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
Annual
Weighted- Coupon Monthly Expected
average 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)
AS OF JUNE 30, 2004 $ 4.3 3.3 1.56% 17.77% 6.04% 15.00% 10.40%
Decline in fair value of 10% adverse
Change $ .5 $ .3 $ 2.3 $ -- $ 4.0
Decline in fair value of 20% adverse
Change 1.1 .6 4.3 -- 4.3
(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
22
Weighted- Monthly Expected
average Prepayment Cumulative Annual Weighted-
Fair Life Speed Credit Discount average
(Dollars in Millions) Value (in months)(b) (% ABS)(b)(c) Losses(b)(d) Rate(b) Coupon(b)
- -----------------------------------------------------------------------------------------------------------------------
AUTOMOBILE LOANS
Interest-only strip(a)
AS OF JUNE 30, 2004 $ 44.0 17.4 1.47% 1.88% 12.00% 7.41%
Decline in fair value of 10% adverse
Change $ 2.2 $ 3.2 $ .8 $ 10.4
Decline in fair value of 20% adverse
Change 4.1 6.4 1.6 20.5
Servicing asset(a)
AS OF JUNE 30, 2004(e) $ 14.0 16.3 1.47% 1.88% 11.32% 7.41%
Decline in fair value of 10% adverse
Change $ .6 $ -- $ .1 $ --
Decline in fair value of 20% adverse
Change 1.2 -- .3 .1
(a) Represents interest-only strips and servicing assets associated with the
automobile securitization series 2004-A and 2002-A
(b) Represents weighted-average assumptions and aggregate declines in fair
value for all automobile securitization series
(c) Absolute prepayment speed
(d) The expected static pool loss assumption performed consistent with the
expected cumulative credit loss assumptions
(e) Carrying value of servicing assets at June 30, 2004 was $10.9 million
6. LOANS AND LEASE FINANCINGS
Total loans outstanding were recorded net of unearned income and deferred loan
fees and costs of $205 million, $209 million, and $291 million at June 30, 2004,
December 31, 2003, and June 30, 2003, respectively.
The loan portfolio includes lease financing receivables consisting of direct
financing and leveraged leases on equipment, which are included in commercial
loans on the consolidated balance sheet, and retail automobile lease financings,
which are included in other consumer loans on the consolidated balance sheet.
The direct financing and leveraged leased equipment consists primarily of
manufacturing and mining equipment, commercial trucks and trailers, railroad
equipment, and airplanes. The Corporation ceased originating retail automobile
leases in December 2000 and the portfolio is running off over time. A summary of
lease financings by type at June 30 follows:
(In Thousands) 2004 2003
- --------------------------------------------------------------------------------------------
COMMERCIAL
Direct financings $1,092,479 $1,228,698
Leveraged leases 276,604 304,796
- --------------------------------------------------------------------------------------------
TOTAL COMMERCIAL LEASE FINANCINGS 1,369,083 1,533,494
CONSUMER
Retail automobile lease financings 65,947 327,312
- --------------------------------------------------------------------------------------------
TOTAL NET INVESTMENT IN LEASE FINANCINGS $1,435,030 $1,860,806
============================================================================================
The components of the net investment in lease financings at June 30 follow:
(In Thousands) 2004 2003
- ---------------------------------------------------------------------------------------------
COMMERCIAL
Lease payments receivable $ 1,189,639 $ 1,360,044
Estimated residual value of leased assets 453,340 502,399
- ---------------------------------------------------------------------------------------------
Gross investment in commercial lease financings 1,642,979 1,862,443
Unearned income (273,896) (328,949)
- ---------------------------------------------------------------------------------------------
TOTAL NET INVESTMENT IN COMMERCIAL LEASE FINANCINGS $ 1,369,083 $ 1,533,494
- ---------------------------------------------------------------------------------------------
CONSUMER
Lease payments receivable $ 14,582 $ 86,381
Estimated residual value of leased assets 54,828 262,889
- ---------------------------------------------------------------------------------------------
Gross investment in consumer lease financings 69,410 349,270
Unearned income (3,463) (21,958)
- ---------------------------------------------------------------------------------------------
TOTAL NET INVESTMENT IN CONSUMER LEASE FINANCINGS $ 65,947 $ 327,312
=============================================================================================
23
A rollforward of the residual value component of lease financings follows:
Three Months Ended Six Months Ended
June 30 June 30
- -----------------------------------------------------------------------------------------------
(In Thousands) 2004 2003 2004 2003
- -----------------------------------------------------------------------------------------------
COMMERCIAL
Beginning balance $ 457,172 $509,556 $ 487,007 $ 561,438
Additions 13,993 9,787 16,590 11,090
Runoff (17,825) (16,483) (50,257) (32,274)
Write-downs -- (461) -- (37,855)
- -----------------------------------------------------------------------------------------------
ENDING BALANCE $ 453,340 $502,399 $ 453,340 $ 502,399
- -----------------------------------------------------------------------------------------------
CONSUMER
Beginning balance $ 86,743 $348,523 $ 121,630 $ 446,872
Additions -- -- -- --
Runoff (31,915) (85,634) (66,802) (158,728)
Write-downs -- -- -- (25,255)
- -----------------------------------------------------------------------------------------------
ENDING BALANCE $ 54,828 $262,889 $ 54,828 $ 262,889
===============================================================================================
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 Six Months Ended
June 30 June 30
- ---------------------------------------------------------------------------------------------------------------------------
(In Thousands) 2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------------------------
BALANCE AT BEGINNING OF PERIOD $1,125,660 $1,128,249 $1,125,329 $1,098,588
Provision 60,788 183,147 143,295 383,380
Allowance related to loans acquired 20,892 -- 20,892 --
Charge-offs:
Commercial 17,376 100,052 47,515 203,536
Commercial construction -- 1,128 1 1,247
Real estate - commercial 7,490 5,540 9,279 8,341
Real estate - residential 34,092 30,985 62,233 72,197
Home equity lines of credit 7,032 5,927 12,931 11,524
Credit cards and other unsecured lines of
credit 27,789 25,036 58,460 46,846
Other consumer 24,324 29,558 51,469 64,814
- ---------------------------------------------------------------------------------------------------------------------------
Total charge-offs 118,103 198,226 241,888 408,505
Recoveries:
Commercial 22,802 10,563 37,136 21,625
Commercial construction 411 79 451 98
Real estate - commercial 3,227 353 6,593 864
Real estate - residential 14,124 5,675 23,660 16,192
Home equity lines of credit 2,810 1,700 4,862 3,212
Credit cards and other unsecured lines of
credit 1,940 1,888 3,753 4,045
Other consumer 10,068 13,670 20,536 27,599
- ---------------------------------------------------------------------------------------------------------------------------
Total recoveries 55,382 33,928 96,991 73,635
Net charge-offs 62,721 164,298 144,897 334,870
- ---------------------------------------------------------------------------------------------------------------------------
BALANCE AT END OF PERIOD $1,144,619 $1,147,098 $1,144,619 $1,147,098
===========================================================================================================================
The $21 million allowance related to loans acquired represents the allowance
recognized in connection with the acquisition of Allegiant Bancorp, Inc.
Nonperforming loans totaled $439 million, $550 million, and $707 million as of
June 30, 2004, December 31, 2003, and June 30, 2003, respectively. For loans
classified as nonperforming at June 30, 2004, the contractual interest due and
actual interest recognized on those loans for the first six months of 2004 was
$26 million and $5 million, respectively. Included in nonperforming loans were
impaired loans, as defined under SFAS 114, aggregating $195 million, $263
million, and $411 million at June 30, 2004, December 31, 2003, and June 30,
2003, respectively. Average impaired loans for the first six months of 2004 and
2003 totaled $222 million and $392 million, respectively. The majority of the
loans deemed impaired were evaluated using the fair value of the collateral as
the
24
measurement method. The related allowance allocated to impaired loans as of June
30, 2004, December 31, 2003, and June 30, 2003 was $27 million, $22 million, and
$57 million, respectively. At June 30, 2004, December 31, 2003, and June 30,
2003, impaired loans with an associated allowance totaled $87 million, $75
million, and $174 million, respectively, while impaired loans with no associated
allowance totaled $108 million, $188 million, and $237 million, respectively,
for these same period ends. There was no interest recognized during the first
six months of 2004 and 2003 on impaired loans while they were considered
impaired.
8. SECURITIES
Securities available for sale follow:
AMORTIZED UNREALIZED UNREALIZED FAIR
(In Thousands) COST GAINS LOSSES VALUE
- ------------------------------------------------------------------------------------------------------------------------------
JUNE 30, 2004
U.S. Treasury and Federal agency debentures $ 549,272 $ 28,668 $ 3,381 $ 574,559
Mortgage-backed securities 3,812,290 52,121 62,574 3,801,837
Asset-backed and corporate debt securities 691,076 4,187 971 694,292
States and political subdivisions 660,811 34,342 447 694,706
Other 734,182 17,825 659 751,348
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL SECURITIES $ 6,447,631 $ 137,143 $ 68,032 $ 6,516,742
- ------------------------------------------------------------------------------------------------------------------------------
December 31, 2003
U.S. Treasury and Federal agency debentures $ 636,800 $ 44,316 $ 11 $ 681,105
Mortgage-backed securities 3,927,888 109,059 9,762 4,027,185
Asset-backed and corporate debt securities 930,894 5,919 2,140 934,673
States and political subdivisions 672,063 49,685 14 721,734
Other 494,405 6,515 1 500,919
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL SECURITIES $ 6,662,050 $ 215,494 $ 11,928 $ 6,865,616
- ------------------------------------------------------------------------------------------------------------------------------
June 30, 2003
U.S. Treasury and Federal agency debentures $ 972,870 $ 64,062 $ -- $ 1,036,932
Mortgage-backed securities 3,654,974 146,379 6,569 3,794,784
Asset-backed and corporate debt securities 1,222,811 8,563 3,629 1,227,745
States and political subdivisions 691,150 62,821 238 753,733
Other 553,933 10,660 437 564,156
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL SECURITIES $ 7,095,738 $ 292,485 $ 10,873 $ 7,377,350
==============================================================================================================================
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 an amortized cost and fair value of
$157 million and $169 million, respectively, at June 30, 2004, compared to an
amortized cost and fair value of $7 million and $8 million, respectively, at
December 31, 2003, and an amortized cost and fair value of $36 million and $44
million, respectively, at June 30, 2003.
The following table presents the age of gross unrealized losses and fair value
by investment category.
JUNE 30, 2004
- ---------------------------------------------------------------------------------------------------------------------------------
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
(In Thousands) VALUE LOSSES VALUE LOSSES VALUE LOSSES
- ---------------------------------------------------------------------------------------------------------------------------------
U.S. Treasury and Federal agency
debentures $ 153,117 $ 3,381 $ -- $ -- $ 153,117 $ 3,381
Mortgage-backed securities 1,994,612 48,248 265,086 14,327 2,259,698 62,575
Asset-backed securities 45,487 261 157,462 709 202,949 970
States and political subdivisions 31,985 433 181 14 32,166 447
Other 27,275 658 3 1 27,278 659
- --------------------------------------------------------------------------------------------------------------------------------
Total $2,252,476 $52,981 $422,732 $15,051 $2,675,208 $68,032
================================================================================================================================
25
Management does not believe any individual unrealized loss as of June 30, 2004
represents an other-than-temporary impairment. The unrealized losses reported
for mortgage-backed securities relate primarily to securities issued by FNMA,
FHLMC and private institutions. These unrealized losses are primarily
attributable to changes in interest rates and individually were 6% or less of
their respective amortized cost basis. The Corporation has both the intent and
ability to hold the securities contained in the previous table for a time
necessary to recover the amortized cost.
At June 30, 2004, the fair value of securities pledged to secure public and
trust deposits, U.S. Treasury notes, security repurchase agreements, and
derivative instruments totaled $5.0 billion.
At June 30, 2004, 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.
For the six months ended June 30, 2004 and 2003, gross securities gains of $5
million and $34 million, respectively, were recognized. There were no gross
securities losses recognized for the six months ended June 30, 2004. For the six
months ended June 30, 2003, gross securities losses of $2 million were
recognized.
9. PRINCIPAL INVESTMENTS
The principal investment portfolio is managed within the Wholesale Banking line
of business. The direct portfolio primarily consists of investments in the
consumer, retail, manufacturing, automotive, commercial services, and building
products industries with the largest industry constituting approximately 24% of
the total portfolio. The indirect portfolio consists of investments in private
equity funds managed by third parties. Each fund is diversified according to the
terms of the fund's agreement and the general partner's direction. A rollforward
of principal investments follows:
Three Months Ended Six Months Ended
June 30 June 30
- ---------------------------------------------------------------------------------------------------------------
(In Thousands) 2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------------
DIRECT INVESTMENTS:
Carrying value at beginning of period $288,454 $328,607 $300,077 $317,089
Investments -- new fundings 51,617 28,441 63,262 44,163
Reclassifications -- (12,415) -- (12,415)
Returns of capital and write-offs (18,405) (5,149) (41,071) (9,669)
Fair value adjustments 1,243 (14,644) 641 (14,328)
- ---------------------------------------------------------------------------------------------------------------
Carrying value at end of period $322,909 $324,840 $322,909 $324,840
- ---------------------------------------------------------------------------------------------------------------
INDIRECT INVESTMENTS:
Carrying value at beginning of period $296,463 $264,638 $294,939 $254,899
Investments -- new fundings 30,814 11,381 40,852 24,992
Reclassifications -- 12,415 -- 12,415
Returns of capital and write-offs (11,281) (4,460) (19,676) (8,381)
Fair value adjustments (2,339) 110 (2,458) 159
- ---------------------------------------------------------------------------------------------------------------
Carrying value at end of period $313,657 $284,084 $313,657 $284,084
- ---------------------------------------------------------------------------------------------------------------
TOTAL PRINCIPAL INVESTMENTS:
Carrying value at beginning of period $584,917 $593,245 $595,016 $571,988
Investments -- new fundings 82,431 39,822 104,114 69,155
Reclassifications -- -- -- --
Returns of capital and write-offs (29,686) (9,609) (60,747) (18,050)
Fair value adjustments (1,096) (14,534) (1,817) (14,169)
- ---------------------------------------------------------------------------------------------------------------
CARRYING VALUE AT END OF PERIOD $636,566 $608,924 $636,566 $608,924
===============================================================================================================
Three Months Ended Six Months Ended
June 30 June 30
- ---------------------------------------------------------------------------------------------------------------
(In Thousands) 2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------------
PRINCIPAL INVESTMENT REVENUE (a) $ 7,699 $ 6,842 $ 18,032 $ 15,535
- ---------------------------------------------------------------------------------------------------------------
NET PRINCIPAL INVESTMENT GAINS (LOSSES) (b) 17,496 (16,388) 40,402 (9,924)
===============================================================================================================
(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.
26
10. GOODWILL AND OTHER INTANGIBLE ASSETS
The carrying value of goodwill at June 30, 2004 was $1.4 billion, and $1.1
billion at December 31, 2003 and June 30, 2003. A rollforward of goodwill by
line of business as of June 30, 2004 follows:
JANUARY 1 GOODWILL IMPAIRMENT JUNE 30
(In Thousands) 2004 ACQUIRED LOSSES 2004
- -------------- ----------- --------- ---------- -----------
Consumer and Small Business Financial Services $ 513,281 $ 55,714 -- $ 568,995
Wholesale Banking 86,729 254,556 -- 341,285
National City Mortgage Co. 55,785 2,241 -- 58,026
National Consumer Finance 206,032 -- -- 206,032
Asset Management 126,207 7,685 -- 133,892
National Processing 115,306 -- -- 115,306
Parent and Other -- -- -- --
----------- --------- ---------- -----------
TOTAL $ 1,103,340 $ 320,196 -- $ 1,423,536
=========== ========= ========== ===========
The goodwill acquired for each line of business above relates to the acquisition
of Allegiant Bancorp, Inc. Refer to Note 3 for further discussion on the
Allegiant acquisition.
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. A summary of core deposit,
credit card, and merchant portfolios, and other intangible assets follows:
JUNE 30 December 31 June 30
(In Thousands) 2004 2003 2003
- -------------- --------- ----------- --------
CORE DEPOSIT INTANGIBLES
Gross carrying amount $ 109,441 $ 93,328 $ 93,328
Less: accumulated amortization 85,451 78,162 71,665
--------- ----------- --------
NET CARRYING AMOUNT 23,990 15,166 21,663
--------- ----------- --------
CREDIT CARD INTANGIBLES
Gross carrying amount 17,323 17,323 17,323
Less: accumulated amortization 14,882 14,321 13,708
--------- ----------- --------
NET CARRYING AMOUNT 2,441 3,002 3,615
--------- ----------- --------
MERCHANT PORTFOLIOS
Gross carrying amount 73,499 73,499 73,199
Less: accumulated amortization 35,248 30,187 25,129
--------- ----------- --------
NET CARRYING AMOUNT 38,251 43,312 48,070
--------- ----------- --------
OTHER INTANGIBLES
Gross carrying amount 4,498 1,237 1,237
Less: accumulated amortization 772 242 83
--------- ----------- --------
NET CARRYING AMOUNT 3,726 995 1,154
--------- ----------- --------
TOTAL FINITE-LIVED INTANGIBLES
Gross carrying amount 204,761 185,387 185,087
Less: accumulated amortization 136,353 122,912 110,585
--------- ----------- --------
NET CARRYING AMOUNT $ 68,408 $ 62,475 $ 74,502
========= =========== ========
At June 30, 2004, core deposit intangibles and other intangibles include $16
million and $3 million, respectively, recognized in connection of the
acquisition of Allegiant Bancorp, Inc. The core deposit intangibles recognized
will be amortized based upon an accelerated method not to exceed 10 years. The
other intangible assets recognized, which represent noncompete agreements to
certain former Allegiant executives, will be amortized over the restricted
period for each executive not to exceed 3 years.
Amortization expense on finite-lived intangible assets totaled $7 million and $6
million for the three months ended June 30, 2004 and 2003, respectively.
Amortization expense on finite-lived intangible assets totaled $13 million and
$11 million for the six months ended June 30, 2004 and 2003, respectively.
Amortization expense on finite-lived intangible assets is expected to total $26
million, $15 million, $12 million, $11 million, and $6 million in 2004, 2005,
2006, 2007, and 2008, respectively. These amounts are exclusive of any changes
in amortization associated with pending acquisitions and dispositions.
27
11. MORTGAGE SERVICING RIGHT (MSR) ASSETS
The unpaid principal balance of residential mortgage loans serviced for third
parties was $147.0 billion at June 30, 2004 compared to $141.1 billion at
December 31, 2003 and $119.9 billion at June 30, 2003.
Changes in the carrying value of MSRs and the associated valuation allowance
follow:
Three Months Ended Six Months Ended
June 30 June 30
-------------------------- --------------------------
(In Thousands) 2004 2003 2004 2003
- -------------- ----------- ----------- ----------- -----------
MORTGAGE SERVICING ASSETS
Balance at beginning of period $ 1,320,235 $ 1,048,041 $ 1,300,612 $ 949,539
Additions 219,293 258,047 359,432 525,356
Amortization (140,133) (124,736) (240,030) (250,447)
SFAS 133 hedge basis adjustments 607,524 (82,978) 589,390 (123,768)
Application of valuation allowance to directly write-down
servicing assets -- (137,874) -- (137,874)
Sales (2,431) (4,815) (4,916) (7,121)
----------- ----------- ----------- -----------
CARRYING VALUE BEFORE VALUATION ALLOWANCE AT END
OF PERIOD $ 2,004,488 $ 955,685 $ 2,004,488 $ 955,685
----------- ----------- ----------- -----------
VALUATION ALLOWANCE
Balance at beginning of period $ (120,317) $ (234,729) $ (2,195) $ (334,346)
Impairment (charges) recoveries 41,880 (125,410) (76,242) (25,793)
Application of valuation allowance to directly write-down
servicing assets -- 137,874 -- 137,874
----------- ----------- ----------- -----------
BALANCE AT END OF PERIOD $ (78,437) $ (222,265) $ (78,437) $ (222,265)
----------- ----------- ----------- -----------
NET CARRYING VALUE OF MSRS AT END OF PERIOD $ 1,926,051 $ 733,420 $ 1,926,051 $ 733,420
=========== =========== =========== ===========
FAIR VALUE OF MSRS AT END OF PERIOD $ 1,955,110 $ 733,420 $ 1,955,110 $ 733,420
=========== =========== =========== ===========
MSRs are evaluated for impairment and a valuation allowance is established
through a charge to income when the carrying value of the MSR, 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 MSRs. Unlike a
valuation allowance, a direct write-down permanently reduces the carrying value
of the MSR and the valuation allowance, precluding subsequent recoveries. There
were no other-than-temporary writedowns recognized during the first six months
of 2004. During the second quarter of 2003, management determined that $138
million of previously established valuation allowance was not recoverable and
reduced both the asset and the valuation allowance.
The fair value of MSRs 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 valuation. 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 MSRs,
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 June 30,
2004, the fair value of MSRs exceeded the carrying value reported in the
consolidated balance sheet by $29 million. This difference represents increases
in the fair value of certain MSRs 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 MSRs at June 30,
2004, December 31, 2003, and June 30, 2003 are presented in the table that
follows. A sensitivity analysis of the current fair value to immediate 10% and
20% adverse changes in those assumptions as of June 30, 2004 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 MSR 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.
28
JUNE 30 December 31 June 30
(Dollars in Thousands) 2004 2003 2003
- ----------------------------------------------- ---------- ----------- --------
Fair value $1,955,110 $ 1,443,629 $733,420
Weighted-average life (in years) 5.3 3.8 1.7
Weighted-average constant prepayment rate (CPR) 16.40% 24.24% 46.69%
Weighted-average discount rate 9.81 9.56 9.30
Prepayment rate:
Decline in fair value from 10% adverse change $ 94,324
Decline in fair value from 20% adverse change 176,304
Discount rate:
Decline in fair value from 10% adverse change 68,270
Decline in fair value from 20% adverse change 131,954
The key economic assumptions used in determining the fair value of MSRs
capitalized during the six-month periods ended June 30, were as follows:
2004 2003
---------- -----------
Weighted-average CPR 20.43% 36.01%
Weighted-average life (in years) 4.7 3.3
Weighted-average discount rate 9.67% 9.36%
Risk associated with declines in the estimated fair value due to increases in
mortgage loan prepayments is managed using derivative instruments that are
expected to increase in value when interest rates decline. The Corporation
typically strives to include the derivative instruments it uses to protect the
value of the MSRs in SFAS 133 hedge relationships in order to record gains and
losses on both the assets and the associated derivative instruments
simultaneously in the income statement. MSRs not included in the SFAS 133
relationships may not be written up above their initial carrying value, adjusted
for amortization, limiting the amount of gains that might otherwise be
recognized to offset losses on the derivative instruments, which are always
carried at fair value. Notes 1 and 22 provide further discussion on how
derivative instruments are accounted for, the nature of the derivative
instruments used by the Corporation, the risks associated with the use of
derivative instruments, and ineffective hedge and other gains and losses
generated by derivative instruments during the current and prior year.
12. BORROWED FUNDS
Detail of borrowed funds follows:
JUNE 30 December 31 June 30
(In Thousands) 2004 2003 2003
- --------------------------- ---------- ----------- ----------
U.S. Treasury notes $2,985,841 $ 5,654,745 $1,549,613
Senior bank notes 100,000 -- 290,000
Commercial paper and other 817,371 960,715 828,312
---------- ----------- ----------
TOTAL BORROWED FUNDS $3,903,212 $ 6,615,460 $2,667,925
========== =========== ==========
WEIGHTED-AVERAGE RATE .84% .78% .96%
========== =========== ==========
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 and are callable on demand.
The senior bank notes are issued by National City's bank subsidiaries and have
maturities of 12 months or less.
Commercial paper is issued by the Corporation's subsidiary, National City Credit
Corporation, and is due in three months or less.
The commercial paper and other category at June 30, 2004 and December 31, 2003
included liabilities totaling $171 million and $240 million, respectively,
related to mortgage loans available for repurchase under GNMA optional
repurchase programs. See further discussion in Note 1.
29
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.
JUNE 30 December 31 June 30
(In Thousands) 2004 2003 2003
- ---------------------------------- ------------ ------------ ------------
3.20% senior notes due 2008 $ 288,597 $ 295,590 $ 303,998
3.125% senior notes due 2009 187,855 -- --
6.625% subordinated notes due 2004 -- 249,978 249,914
8.50% subordinated notes due 2004 -- 149,989 149,926
7.75% subordinated notes due 2004 199,979 199,850 199,722
7.20% subordinated notes due 2005 253,899 256,912 259,705
5.75% subordinated notes due 2009 315,521 326,933 340,763
6.875% subordinated notes due 2019 743,956 785,646 841,560
Other 880 1,760 1,760
------------ ------------ ------------
TOTAL HOLDING COMPANY 1,990,687 2,266,658 2,347,348
7.25% subordinated notes due 2010 252,578 263,790 277,526
6.30% subordinated notes due 2011 215,603 224,940 236,715
7.25% subordinated notes due 2011 198,559 198,461 198,362
6.25% subordinated notes due 2011 319,918 333,766 351,294
6.20% subordinated notes due 2011 515,438 537,793 567,184
4.63% subordinated notes due 2013 299,277 299,237 299,304
4.25% subordinated notes due 2018 210,938 221,969 237,485
Senior bank notes 12,359,723 15,266,153 19,239,182
Federal Home Loan Bank advances 3,880,461 3,867,957 4,003,852
------------ ------------ ------------
TOTAL BANK SUBSIDIARIES 18,252,495 21,214,066 25,410,904
------------ ------------ ------------
TOTAL LONG-TERM DEBT $ 20,243,182 $ 23,480,724 $ 27,758,252
============ ============ ============
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 June
30, 2004 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 $ 500,000 3.17% 1.25%
Subordinated notes 3,425,000 6.32 2.83
Senior bank notes 12,358,500 1.81 1.75
FHLB advances 3,861,196 1.54 2.25
Other 880 12.95 12.95
------------- ----- -----
Total long-term debt $ 20,145,576 2.56% 2.02%
============= ===== =====
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. During the first six
months of 2004, the holding company issued senior notes with a par value of $200
million.
Senior bank notes are issued by National City's bank subsidiaries. For the first
six months of 2004, senior bank notes with a par value of $5.1 billion were
issued by the bank subsidiaries. At June 30, 2004, senior bank notes totaling
$1.9 billion were contractually based on a fixed rate of interest and $10.5
billion were contractually based on a variable rate of interest. Senior bank
notes have maturities ranging from 2004 to 2078.
30
FHLB advances at June 30, 2004, contractually consisted of $331 million of
fixed-rate obligations and $3.5 billion of variable-rate obligations. FHLB
advances are collateralized by qualifying residential real estate loans and have
maturities ranging from 2004 to 2023.
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 sponsors four trusts, First of America Capital Trust I, Fort Wayne
Capital Trust I, Allegiant Capital Trust I, and Allegiant Capital Trust II, of
which 100% of the common equity is owned by the Corporation. The Allegiant
capital trusts were acquired in connection with the acquisition of Allegiant
Bancorp, Inc. These 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 First of
America Capital Trust I and Fort Wayne Capital Trust I are payable semi-annually
at a rate per annum equal to the interest rate being earned by the trust on the
debentures held by these trusts. Distributions on the capital securities issued
by Allegiant Capital Trust I and Allegiant Capital Trust II are payable
quarterly at a rate per annum equal to the interest rate being earned by the
trust on the debentures held by these trusts. The capital securities are subject
to mandatory redemption, in whole or in part, upon repayment of the debentures.
The Corporation has entered into agreements which, taken collectively, fully and
unconditionally guarantee the capital securities subject to the terms of each of
the guarantees. The debentures held by First of America Capital Trust I, Fort
Wayne Capital Trust I, Allegiant Capital Trust I, and Allegiant Capital Trust II
are first redeemable, in whole or in part, by the Corporation on January 31,
2007, April 15, 2007, August 2, 2004, and September 30, 2006, respectively.
In July 2004, the Corporation's Board of Directors approved the redemption of
the Allegiant Capital Trust I capital securities. Redemption will occur 30 days
after notice has been given to the security holders, subject to regulatory
approval.
In the third quarter of 2003, as a result of applying the provisions of FIN 46
governing when an equity interest should be consolidated, the Corporation was
required to deconsolidate the First of America and Fort Wayne 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 Allegiant capital trusts are also not
consolidated in the Corporation's financial statements. The total amount of
capital securities owed to investors and the Corporation's consolidated debt
owed to the Allegiant capital trusts is $57 million and $64 million,
respectively, with the difference representing the Corporation's common
ownership interest in the trusts and a purchase price adjustment recognized in
connection with the Allegiant acquisition.
The capital securities held by the trusts qualify as Tier 1 capital for the
Corporation under Federal Reserve Board guidelines. On May 6, 2004, the Federal
Reserve issued proposed rules that retain Tier 1 capital treatment for trust
preferred securities but with stricter limits. Under the proposal, after a
three-year transition period, the aggregate amount of trust preferred securities
and certain other capital elements will retain its current limit of 25 percent
of Tier 1 capital elements, net of goodwill. The amount of trust preferred
securities and certain other elements in excess of the limit could be included
in Tier 2 capital, subject to restrictions. This proposal would have no impact
on the Corporation's Tier 1 capital.
31
Consolidated debt obligations related to subsidiary trusts holding solely
debentures of the Corporation follows:
JUNE 30 December 31 June 30
(In Thousands) 2004 2003 2003
-------------- ---- ---- ------
8.12% junior subordinated debentures owed to First of America
Capital Trust I due January 31, 2027 $154,640 $ 154,640 --
9.85% junior subordinated debentures owed to Fort Wayne
Capital Trust I due April 15, 2027 30,928 30,928 --
9.875% junior subordinated debentures owned to Allegiant
Capital Trust I due August 2, 2029 18,067 -- --
9.00% junior subordinated debentures owned to Allegiant
Capital Trust II due September 30, 2031 45,575 -- --
TOTAL JUNIOR SUBORDINATED DEBENTURES OWED TO UNCONSOLIDATED
-------- ----------- --------
SUBSIDIARY TRUSTS 249,210 185,568 --
-------- ----------- --------
8.12% capital securities of First of America Capital Trust I
due January 31, 2027 -- -- $150,000
9.85% capital securities of Fort Wayne Capital Trust I
due April 15, 2027 -- -- 30,000
-------- ----------- --------
TOTAL CAPITAL SECURITIES OF CONSOLIDATED SUBSIDIARY TRUSTS -- -- 180,000
-------- ----------- --------
TOTAL CONSOLIDATED DEBT OBLIGATIONS RELATED TO SUBSIDIARY TRUSTS $249,210 $ 185,568 $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
discretionary actions by regulators that could have a material effect on
financial position and operations.
Regulatory and other capital measures follow:
JUNE 30 December 31 June 30
2004 2003 2003
--------------------- ----------------------- ---------------------
(Dollars in Thousands) AMOUNT RATIO Amount Ratio Amount Ratio
---------------------- ------ ----- ------ ----- ------ -----
Total equity/assets $10,334,984 8.84% $ 9,328,671 8.19% $ 9,029,909 7.32%
Total common equity/assets 10,334,984 8.84 9,328,671 8.19 9,029,909 7.32
Tangible common equity/tangible assets 8,843,040 7.66 8,162,856 7.24 7,852,608 6.43
Tier 1 capital 9,017,904 9.02 8,420,382 8.79 7,987,124 8.12
Total risk-based capital 13,073,114 13.07 12,561,061 13.12 12,186,945 12.39
Leverage 9,017,904 7.90 8,420,382 7.43 7,987,124 6.78
The tangible common equity ratio excludes goodwill and other intangible assets
from both the numerator and denominator.
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 and 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 Corporation'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 3.00%, respectively. The capital levels at all of National City's
subsidiary banks are maintained at or above the well-capitalized minimums of
6.00%, 10.00%, and 5.00% for the Tier 1 capital, total risk-based capital, and
leverage ratios, respectively. As of the most recent notification from the
Federal Deposit Insurance Corporation, which was June 15, 2004, 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
32
category. As of December 31, 2003 and June 30, 2003, 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,
Fort Wayne, and Allegiant subsidiary trusts qualify as Tier 1 capital for the
Corporation under Federal Reserve Board guidelines. On May 6, 2004, the Federal
Reserve issued proposed rules that retain Tier 1 capital treatment for trust
preferred securities but with stricter limits. Under the proposal, after a
three-year transition period, the aggregate amount of trust preferred securities
and certain other capital elements will retain its current limit of 25 percent
of Tier 1 capital elements, net of goodwill. The amount of trust preferred
securities and certain other elements in excess of the limit could be included
in Tier 2 capital, subject to restrictions. This proposal would have no impact
on the Corporation's Tier 1 capital.
The Corporation's subsidiary banks are required to maintain noninterest bearing
reserve balances with the Federal Reserve Bank. The required reserve balance was
$139 million at June 30, 2004.
Under current Federal Reserve regulations, the banking subsidiaries are limited
in the amount they may loan to the parent 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 parent company, are also required to be
collateralized.
Dividends paid by subsidiary banks to the parent company are also subject to
certain legal and regulatory limitations. At June 30, 2004, the subsidiary banks
may pay dividends of $1.1 billion, plus an additional amount equal to their net
profits for the remainder of 2004, as defined by statute, up to the date of any
such dividend declaration, without prior regulatory approval.
16. STOCKHOLDERS' EQUITY
A summary of activity in accumulated other comprehensive income follows:
Six Months Ended
June 30
----------------------------
(In Thousands) 2004 2003
-------------- ---- ------
Accumulated unrealized gains on securities
available for sale at January 1, net of tax $ 132,318 $ 223,073
Net unrealized losses for the period, net of tax benefit
of $45,255 in 2004 and $7,658 in 2003 (84,044) (14,223)
Reclassification adjustment for gains included in net income,
net of tax expense of $1,819 in 2004 and $5,773 in 2003 (3,378) (25,804)
--------- ---------
Effect on other comprehensive income for the period (87,422) (40,027)
--------- ---------
Accumulated unrealized gains on securities available for sale
at June 30, net of tax $ 44,896 $ 183,046
========= =========
Accumulated unrealized losses on derivatives used in cash
flow hedging relationships at January 1, net of tax $ (67,631) $(155,893)
Net unrealized gains (losses) for the period, net of tax expense
(benefit) of $11,436 in 2004 and $(27,203) in 2003 21,239 (50,519)
Reclassification adjustment for losses included in net income,
net of tax benefit of $23,172 in 2004 and $31,054 in 2003 43,035 57,673
--------- ---------
Effect on other comprehensive income for the period 64,274 7,154
--------- ---------
Accumulated unrealized losses on derivatives used in cash
flow hedging relationships at June 30, net of tax $ (3,357) $(148,739)
========= =========
Accumulated other comprehensive income at
January 1, net of tax $ 64,687 $ 67,180
Other comprehensive loss, net of tax (23,148) (32,873)
--------- ---------
ACCUMULATED OTHER COMPREHENSIVE INCOME AT JUNE 30, NET OF TAX $ 41,539 $ 34,307
========= =========
In February 2004, the Corporation's Board of Directors authorized the repurchase
of up to 50 million shares of National City common stock, subject to an
aggregate purchase limit of $2.0 billion. This new authorization replaced all
prior share repurchase authorizations. During the first six months of 2004 and
2003, the Corporation repurchased 11.2 million and 1.4 million shares of its
common stock, respectively. As of June 30, 2004, 41.0 million shares remain
authorized for repurchase.
In connection with the acquisition of Provident Group Financial, Inc.
(Provident) on July 1, 2004, 70,272 preferred shares of Provident were exchanged
for one share each of National City Series D convertible preferred stock.
National City Series D preferred stock is convertible at any time by the holder
into 15.96 shares of National City common stock, is nonvoting, and has no par
value.
33
17. NET INCOME PER COMMON SHARE
Basic and diluted net income per common share calculations follow:
Three Months Ended Six Months Ended
June 30 June 30
----------------------------- ----------------------------
(Dollars in Thousands, Except Per Share Amounts) 2004 2003 2004 2003
- ------------------------------------------------ ---- ---- ---- ---------
BASIC
Net income applicable to common stock $ 519,046 $ 585,808 $ 1,229,414 $ 1,229,311
------------ ------------ ------------ ------------
Average common shares outstanding 619,097,523 612,119,565 612,507,157 611,822,337
------------ ------------ ------------ ------------
Net income per common share-- basic $ .84 $ .96 $ 2.01 $ 2.01
============ ============ ============ ============
DILUTED
Net income $ 519,046 $ 585,808 $ 1,229,414 $ 1,229,311
------------ ------------ ------------ ------------
Average common shares outstanding 619,097,523 612,119,565 612,507,157 611,822,337
Stock award adjustment 6,378,834 6,264,627 6,529,339 5,166,901
------------ ------------ ------------ ------------
Average common shares outstanding-- diluted 625,476,357 618,384,192 619,036,496 616,989,238
------------ ------------ ------------ ------------
Net income per common share-- diluted $ .83 $ .94 $ 1.99 $ 1.99
============ ============ ============ ============
Basic net income per common share is calculated by dividing net income 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 certain unvested restricted stock and unexercised stock option
awards were converted or exercised into common shares. For the three- and
six-month periods ended June 30, 2004, options to purchase 1,717,786 and
3,367,677 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. Comparably, for the three- and
six-month periods ended June 30, 2003, options to purchase 11,764,339 and
21,235,434 shares of common stock, respectively, were outstanding but not
included in the computation of diluted net income per share.
18. INCOME TAX EXPENSE
The composition of income tax expense follows:
Three Months Ended Six Months Ended
June 30 June 30
---------------------- -----------------------
(In Thousands) 2004 2003 2004 2003
-------------- ---- ---- ---- ------
Applicable to income exclusive of securities gains $269,929 $306,588 $626,990 $650,704
Applicable to securities gains 1,762 5,714 1,810 5,773
-------- -------- -------- --------
INCOME TAX EXPENSE $271,691 $312,302 $628,800 $656,477
======== ======== ======== ========
The effective tax rate for the three- and six-month periods ended June 30, 2004
was 34.4% and 33.8%, respectively. The effective tax rate was 34.8% for both the
three- and six-month periods ended June 30, 2003. The lower tax rate for the
first half of 2004 reflects a reduction in certain deferred tax liabilities due
to the favorable conclusion of several tax examinations.
19. COMMITMENTS, CONTINGENT LIABILITIES, GUARANTEES, AND RELATED PARTY
TRANSACTIONS
COMMITMENTS: A summary of the contractual amount of significant commitments
follows:
JUNE 30 December 31 June 30
(In Thousands) 2004 2003 2003
-------------- ---- ---- --------
Commitments to extend credit:
Commercial $15,418,477 $15,201,047 $13,901,933
Residential real estate 15,995,940 10,556,066 35,274,256
Revolving home equity and credit card lines 25,518,133 23,936,622 19,488,932
Other 397,362 521,813 362,156
Standby letters of credit 3,760,763 3,765,284 3,727,925
Commercial letters of credit 328,806 150,640 156,418
Net commitments to sell mortgage loans and
mortgage-backed securities 9,733,997 13,126,094 33,871,649
Commitments to fund principal investments 255,676 226,793 231,900
Commitments to fund civic and community investments 206,270 200,477 169,037
34
Commitments to extend credit are agreements to lend. Since many of these
commitments 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. 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
the fair value of these contracts are recorded on the balance sheet as either
derivative assets or derivative liabilities. Further discussion on derivative
instruments is included in Notes 1 and 22.
The Corporation has principal investment commitments to provide equity and
mezzanine capital financing to private and public companies through either
direct investments in specific companies or through investment funds and
partnerships. The timing of future cash requirements to fund such commitments is
generally dependent on the investment cycle. This cycle, 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 commitments to fund civic and community investments
represent funds committed for 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 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 $21.9 billion and $42.1
billion for the second quarter and first six months of 2004, respectively, and
were $29.4 billion and $56.9 billion for the same 2003 periods, respectively.
Total loans repurchased or indemnified during the second quarter and first half
of 2004 were $134 million and $191 million, respectively, and total loans
repurchased or indemnified for the same 2003 period were $47 million and $124
million, respectively. Loans indemnified that remain outstanding as of June 30,
2004 totaled $233 million. In addition, total loans sold of $524 million
remained uninsured as of June 30, 2004. The volume and balance of uninsured
government loans may be affected by processing or notification delays.
Management believes the majority of the uninsured loans at June 30, 2004 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 $33 million and $61 million for the second
quarter and first six months of 2004, respectively. Losses charge against the
liability for the second quarter and first six months of 2003 were $23 million
and $30 million, respectively. At June 30, 2004 and 2003, the liability for
estimated losses on repurchase and indemnification was $176 million and $154
million, respectively, and was included in other liabilities on the balance
sheet.
The guarantee liability for standby letters of credit was $7 million at June 30,
2004 and 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.
35
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, as defined below, transactions and unresolved chargebacks in
the process of resolution. For the four-month period from March through June
2004, this amount totaled approximately $54 billion. At June 30, 2004, the
Corporation had $5 million of unresolved chargebacks that were in process of
resolution.
For the three months ended June 30, 2004 and 2003, the Corporation processed $33
million and $36 million, respectively, in chargebacks presented by issuing
banks. For the six months ended June 30, 2004 and 2003, the Corporation
processed $74 million and $76 million, respectively, in chargebacks presented by
issuing banks. Actual losses recorded for the three months ended June 30, 2004
and 2003 were each $1 million. Actual losses recorded for the six months ended
June 30, 2004 and 2003 were each $2 million. The Corporation accrues for
probable losses based on historical experience and at June 30, 2004 and 2003 had
$1 million recorded in accrued expenses and other liabilities for expected
losses.
In most cases, a contingent liability for chargebacks is unlikely to arise, as
most products or services are delivered when purchased, and credits are issued
on returned items. Where the product or service is not provided, however, until
some time after the purchase (delayed-delivery), the potential for this
contingent liability increases. For the six months ended June 30, 2004, the
Corporation processed approximately $5 billion of merchant transactions related
to delayed-delivery purchases.
The Corporation currently processes card transactions for United Airlines, Inc.,
which is currently operating under Chapter 11 protection. 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 United Airlines but does not intend to renew
the contract when its current term expires. In the event of liquidation of
United Airlines, the Corporation could become financially responsible for
refunding tickets purchased through VISA(R) and MasterCard(R) under the
chargeback rules of those associations. At June 30, 2004, the estimated dollar
value of tickets purchased, but as yet unflown, under the United Airlines
merchant processing contract, was approximately $853 million. Based upon
available information, this amount represents management's best estimate of its
maximum potential chargeback exposure related to United Airlines, Inc. As of
June 30, 2004, the Corporation held no significant collateral under this
contract.
During 2003 and 2004, the Corporation's obligation to process card transactions
for three other airline merchants ceased with these merchants transitioning to
new processors. At June 30, 2004, the estimated dollar value of tickets
purchased, but as yet unflown, under these concluding contracts was
approximately $36 million. This amount represents management's best estimate of
its maximum potential chargeback exposure under these contracts. As of June 30,
2004, the Corporation held cash collateral of $1 million and third-party
indemnifications of $110 million against this remaining chargeback exposure.
In November 2003, Congress passed the Federal Aviation Administration
Reauthorization Act. This legislation included an extension of the airline
ticket re-accommodation provision, which requires airlines to honor tickets
through November 2004 for other airlines that may suspend, interrupt or
discontinue services due to insolvency or liquidation.
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 is unlikely.
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.
36
20. STOCK OPTIONS AND AWARDS
National City maintains various incentive and nonqualified stock option plans
and also maintains various restricted stock plans. These plans provide for the
granting of stock options, stock appreciation rights, and restricted shares to
eligible employees and directors.
On April 27, 2004, stockholders approved the National City Corporation Long-Term
Cash and Equity Incentive Plan (the Long-Term Incentive Plan), which
consolidates and replaces all long-term incentive programs under one plan and
formalizes the use of performance measures in connection with all long-term
awards. Under the Long-Term Incentive Plan no more than 45 million shares of
National City common stock may be made the subject of option rights, stock
appreciation rights, restricted awards, common stock awards, or restricted stock
units, in the aggregate. In addition to the aggregate limit on awards of
National City common stock, the Long-Term Incentive Plan includes the following
limitations: no more than 18 million shares may be awarded in the form of
restricted stock, restricted stock units, or common stock awards; and no more
than 40 million shares may be awarded in the form of incentive stock options.
The existing stock option plans and restricted stock plans will be terminated,
except with respect to additional options that National City is contractually
obligated to issue.
STOCK OPTIONS: Stock options may currently be granted to officers and key
employees 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 not later than 10 years from the date of grant. In addition, stock
options may be granted that include the right to receive additional options if
certain criteria are met. The exercise price of an additional option is equal to
the market price of the common stock on the date the additional option is
granted. Additional options vest six months from the date of grant and have a
contractual term equal to the remaining term of the original option.
On January 1, 2003, the Corporation prospectively adopted the fair value method
of accounting for stock options under SFAS 123. Further discussion of the impact
of this change is included in Note 1. During the second quarter and first six
months of 2004, compensation expense recognized related to National City
Corporation's stock option plans totaled $5 million and $11 million,
respectively, and $3 million for the second quarter and first half of 2003.
RESTRICTED SHARES: Restricted common shares may currently be awarded 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. The
Corporation generally recognized compensation expense over the restricted
period. The weighted-average grant-date fair value of restricted share awards
granted during the second quarter and first half of 2004 were $34.88 and $34.02,
respectively, and $28.45 and $27.96, respectively, for the second quarter and
first half of 2003. Compensation expense recognized for restricted share plans
during the second quarter and first half of 2004 totaled $7 million and $13
million, respectively, and $3 million and $7 million for the second quarter and
first half of 2003, respectively.
OPTION AND RESTRICTED STOCK AWARD ACTIVITY: Stock option and restricted stock
award activity follows:
Weighted-
Average
Shares Outstanding Exercise
-------------------------------- Price Per
Awards Options Share
--------- ---------- ---------
January 1, 2003 2,539,171 52,963,738 $26.89
Cancelled (79,685) (497,673) 29.98
Exercised (238,142) (4,609,625) 20.31
Granted 343,636 961,980 31.66
--------- ---------- ---------
June 30, 2003 2,564,980 48,818,420 $27.57
--------- ---------- ---------
January 1, 2004 3,781,641 50,851,242 $28.52
Acquisition -- 456,754 17.32
Cancelled (113,494) (216,097) 30.01
Exercised (594,516) (5,172,041) 23.84
Granted 480,823 1,140,731 34.79
--------- ---------- ---------
JUNE 30, 2004 3,554,454 47,060,589 $ 29.07
========= ========== =========
Upon consummation of the Allegiant acquisition, all outstanding options issued
by Allegiant were converted into equivalent National City options. Cancelled
activity includes both forfeited and expired awards and options.
37
Information about stock options outstanding at June 30, 2004 follows:
Weighted-
Average
Weighted- Remaining Weighted-
Average Contractual Average
Range of Exercise Life Exercise
Exercise Prices Outstanding Price (in years) Exercisable Price
- --------------- ----------- --------- ----------- ----------- ---------
$4.69-$11.99 87,009 $ 8.49 1.6 87,009 $ 8.49
12.00-16.99 1,043,447 14.79 1.4 1,043,447 14.79
17.00-21.99 4,839,053 17.89 5.1 4,839,053 17.89
22.00-26.99 817,398 25.50 2.9 809,398 25.49
27.00-31.99 24,768,916 28.93 6.2 20,552,800 29.23
32.00-37.81 15,504,766 34.03 5.9 9,154,467 34.07
----------- --------- ----------- ----------- ---------
TOTAL 47,060,589 $ 29.07 5.8 36,486,174 $ 28.40
=========== ========= =========== =========== =========
At June 30, 2004 and 2003, options for 36,486,174 and 34,327,720 shares of
common stock, respectively, were exercisable. As of June 30, 2004, 45 million
shares of National City common stock under the Long-Term Inventive Plan were
available for grant.
21. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS
National City has a noncontributory defined benefit pension plan covering
substantially all employees. Employees retained from the Allegiant and Provident
acquisitions will be eligible to participate in the Corporation's defined
benefit pension plan effective January 1, 2005. Pension benefits are derived
from a cash balance formula, whereby credits based on salary, age, and years of
service are allocated 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, 2003 and 2002, components of
net periodic benefit and net periodic cost for the three- and six-month periods
ended June 30 follow:
Three Months Ended Six Months Ended
June 30 June 30
-------------------------- --------------------------
(In Thousands) 2004 2003 2004 2003
-------------- ---- ---- ---- -------
PENSION BENEFITS
Service cost $ 13,847 $ 12,791 $ 27,694 $ 25,581
Interest cost 20,681 20,021 41,363 40,042
Expected return on plan assets (31,825) (35,861) (63,650) (71,721)
Amortization of prior service cost 418 (1,189) 836 (2,378)
Transition benefit (1,189) (52) (2,378) (104)
Recognized net actuarial loss 325 365 650 731
--------- --------- --------- ---------
NET PERIODIC COST (BENEFIT) $ 2,257 $ (3,925) $ 4,515 $ (7,849)
--------- --------- --------- ---------
OTHER POSTRETIREMENT BENEFITS
Service cost $ 833 $ 736 $ 1,665 $ 1,473
Interest cost 2,354 2,336 4,709 4,671
Amortization of prior service cost 24 33 48 67
Transition obligation 350 351 701 701
Recognized net actuarial loss 498 397 996 794
--------- --------- --------- ---------
NET PERIODIC COST $ 4,059 $ 3,853 $ 8,119 $ 7,706
========= ========= ========= =========
38
Actuarial assumptions used to calculate the net periodic pension benefit and
cost were as follows:
Pension Benefits Other Postretirement Benefits
------------------------ -----------------------------
2004 2003 2004 2003
--------- --------- --------- ---------
WEIGHTED-AVERAGE ASSUMPTIONS
Discount rate 6.25% 6.75% 6.25% 6.75%
Rate of compensation increase 2.75-7.50 2.75-7.50 2.75-7.50 2.75-7.50
Expected long-term return on plan assets 8.50 9.50 -- --
In December 2003, a bill was singed into law that expands Medicare benefits,
primarily adding a prescription drug benefit for Medicare-eligible retirees
beginning in 2006. The law also provides a federal subsidy to companies which
sponsor postretirement benefit plans that provide prescription drug coverage. In
May 2004, FASB Staff Position 106-2, Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and Modernization Act of
2003, was issued which provides guidance on accounting for the federal subsidy.
The provisions of FASB 106-2 became effective for the Corporation as of July 1,
2004. Accordingly, the postretirement benefit obligations and net periodic costs
reported in the accompanying financial statements and notes do not reflect the
impact of this legislation. The Corporation anticipates its benefit costs after
2006 will be somewhat lower as a result of the new Medicare provisions, however,
the adoption of this standard is not expected to have a material impact on
results of operations, financial position, or liquidity.
The Corporation also maintains nonqualified supplemental retirement plans for
certain key employees. All benefits provided under these plans are unfunded, and
payments to plan participants are made by the Corporation. At June 30, 2004,
December 31, 2003, and June 30, 2003, obligations of $86 million, $83 million,
and $85 million, respectively, were included in accrued expenses and other
liabilities for these plans. Expenses related to these plans totaled $4 million
and $7 million for the second quarter and first six months of 2004,
respectively, and $4 million and $8 million for the second quarter and first six
months of 2003, 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 2004 and 2003, the Corporation provided up to a 6.9%
matching contribution. Matching contributions totaled $17 million and $39
million for the second quarter and first six months of 2004, respectively, and
$17 million and $40 million for the second quarter and first six months of 2003,
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.
39
As with any financial instrument, derivative instruments have inherent risks,
primarily market and credit risk. Market risk associated with changes in
interest rates is managed by establishing and monitoring limits as to the degree
of risk that may be undertaken as part of the Corporation's overall market risk
monitoring process carried out by the Asset/Liability Management Committee. See
further discussion of this process in the Market Risk section of the Financial
Review.
Credit risk occurs when a counterparty to a derivative contract with an
unrealized gain fails to perform according to the terms of the agreement. Credit
risk is managed by limiting the aggregate amount of net unrealized gains in
agreements outstanding, monitoring the size and the maturity structure of the
derivative portfolio, applying uniform credit standards to all activities with
credit risk, and collateralizing gains. The Corporation has established
bilateral collateral agreements with its major derivative dealer counterparties
that provide for exchanges of marketable securities or cash to collateralize
either party's net gains. At June 30, 2004, these collateral agreements covered
99.7% of the notional amount of the total derivative portfolio, excluding
futures, forward commitments to sell or purchase mortgage loans or
mortgage-backed securities, and customer derivative contracts. At June 30, 2004,
the Corporation held cash, U.S. government, and U.S. government-sponsored agency
securities with a fair value of $196 million to collateralize net gains with
counterparties and had pledged or delivered to counterparties U.S. government
and U.S. government-sponsored agency securities with a fair value of $87 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 June 30, 2004,
December 31, 2003, and June 30, 2003.
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 and sales commitments to hedge the fair
values of mortgage loans held for sale, mortgage servicing assets, certain
fixed-rate 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 six month periods ended June 30, 2004, the Corporation
recognized total net ineffective fair value hedge losses of $57 million and $80
million, respectively. For the same periods in 2003, the Corporation recognized
total net ineffective hedge gains of $63 million and $95 million, respectively.
Of the total (losses) gains recognized, net ineffective hedge losses related to
servicing assets were $58 million and $52 million for the three and six month
periods ended June 30, 2004, respectively, compared to net ineffective gains of
$56 million and $82 million for the same periods in 2003, respectively. For the
second quarter and first six months of 2004, net ineffective hedge losses
related to mortgage loans held for sale were $7 million and $42 million,
respectively. Mortgage loans held for sale were not designated in a hedge
relationship during 2003. Ineffective hedge gains (losses) for mortgage
servicing assets and mortgage loans held for sale 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
were $7 million and $14 million for the three and six month periods ended June
30, 2004, respectively. Net ineffective hedge gains related to these hedged
assets and liabilities were $6 million and $13 million for the same periods in
2003. There were no components of derivative instruments which were excluded
from the assessment of hedge effectiveness during the first six months of 2004
and 2003.
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 uses forward starting pay-fixed interest rate swaps and
caps to hedge forecasted cash flows associated with debt instruments expected to
be issued subsequent to 2004.
For the three and six month periods ended June 30, 2004, the Corporation
recognized net ineffective cash flow hedge gains of $100 thousand and $200
thousand, respectively. For the same periods in 2003, the Corporation recognized
net ineffective cash flow hedge gains of $1 million and $900 thousand,
respectively. These gains are included in other noninterest income on the income
statement. There were no components of derivative instruments which were
excluded from the assessment of hedge effectiveness during the first six months
of 2004 and 2003.
40
Gains and losses on derivative instruments reclassified from accumulated other
comprehensive income to current-period earnings are included in the line item in
which the hedged cash flows are recorded. At June 30, 2004, December 31, 2003
and June 30, 2003, accumulated other comprehensive income included a deferred
after-tax net loss of $3 million, $68 million and $149 million, respectively,
related to derivatives used to hedge funding cash flows. See Note 16 for further
detail of the amounts included in accumulated other comprehensive income. The
net after-tax derivative loss included in accumulated other comprehensive income
as of June 30, 2004, is projected to be reclassified into interest expense in
conjunction with the recognition of interest payments on funding products
through June 2009, with $58 million of net loss expected to be reclassified
within the next year. During the three and six month periods ended June 30,
2004, pretax losses of $33 million and $63 million, respectively, were
reclassified into interest expense as adjustments to interest payments on
variable-rate funding products. For the same 2003 periods, pretax losses of $50
million and $89 million, respectively, were reclassified into interest expense.
Additionally, during the first six months of 2004, a pretax loss of $4 million
was reclassified from accumulated other comprehensive income into other
noninterest income for cash flow hedges that were discontinued because
forecasted debt issuances originally contemplated were not probable of
occurring. There were no gains or losses reclassified into earnings during the
first six months of 2003 arising from the determination that the original
forecasted transaction would not occur.
The tables on the following pages provide further information regarding
derivative instruments designated in fair value and cash flow hedges at June 30,
2004, December 31, 2003, and June 30, 2003.
41
Summary information regarding the interest rate derivatives portfolio used for
interest-rate risk management purposes and designated as accounting hedges under
SFAS 133 at June 30, 2004, December 31, 2003, and June 30, 2003 follows:
JUNE 30, 2004 December 31, 2003
----------------------------- ------------- -------------------------------------
DERIVATIVE NET INEFFECTIVE Derivative
NOTIONAL ------------------ HEDGE GAINS Notional ---------------------
(In Millions) AMOUNT ASSET LIABILITY (LOSSES)(a) Amount Asset Liability
-------- ------- --------- --------------- -------- -------- ---------
FAIR VALUE HEDGES
Loans
Receive-fixed interest rate swaps $ 60 $ 1.1 $ -- $ 60 $ 1.4 $ --
Receive-fixed interest rate swaptions
sold 25 -- .1 55 -- .2
Pay-fixed interest rate swaps 3,335 25.4 115.9 3,379 3.5 195.0
Callable pay-fixed interest rate swaps 43 -- 2.5 43 -- 4.0
Pay-fixed interest rate swaptions sold 175 -- 2.2 205 -- 7.1
Interest rate caps sold 715 -- 1.0 815 -- 1.4
Interest rate floors sold 360 -- 4.0 360 -- 7.7
Interest rate futures purchased 1,789 -- -- 2,173 -- --
Interest rate futures sold 3,303 -- -- 3,086 -- --
-------- ------- --------- --------- -------- -------- ---------
Total 9,805 26.5 125.7 $ 14.0 10,176 4.9 215.4
-------- ------- --------- --------- -------- -------- ---------
Mortgage loans held for sale
Forward commitments to purchase and
sell mortgage loans and mortgage-backed
securities 10,059 -- 20.4 -- -- --
Receive-fixed interest rate swaps 775 -- 15.0 -- -- --
Pay-fixed interest rate swaps 550 -- 5.9 -- -- --
Pay-fixed interest rate swaptions 450 -- -- -- -- --
purchased
Interest rate caps purchased 9,750 28.0 -- -- -- --
-------- ------- --------- --------- -------- -------- ---------
Total 21,584 28.0 41.3 (42.5) -- -- --
-------- ------- --------- --------- -------- -------- ---------
Mortgage servicing assets
Forward commitments to
purchase mortgage loans and
mortgage-backed securities 5,624 9.6 -- 2,904 31.7 --
Receive-fixed interest rate swaps 7,628 134.7 196.1 10,206 376.2 48.2
Receive-fixed interest rate swaptions 1,500 10.2 -- -- -- --
purchased
Receive-fixed interest rate swaptions 500 -- 7.4 415 -- 8.6
sold
Pay-fixed interest rate swaps -- -- -- 30 -- .1
Pay-fixed interest rate swaptions 4,150 66.2 -- 3,515 62.5 --
purchased
Pay-fixed interest rate swaptions sold 500 -- 2.8 1,295 -- 76.2
Principal-only interest rate swaps 427 2.4 4.0 123 6.9 .5
Interest rate caps purchased 30,898 105.0 30,410 83.5 --
Interest rate caps sold 2,999 -- 10.0 -- -- --
Interest rate floors purchased 1,500 5.4 -- -- -- --
Interest rate futures purchased 700 -- -- -- -- --
-------- ------- --------- --------- -------- -------- ---------
Total 56,426 333.5 220.3 (51.6) 48,898 560.8 133.6
-------- ------- --------- --------- -------- -------- ---------
Funding
Receive-fixed interest rate swaps 5,085 188.6 85.6 4,550 350.8 35.7
Callable receive-fixed interest
rate swaps 358 4.8 11.0 310 9.2 3.2
-------- ------- --------- --------- -------- -------- ---------
Total 5,443 193.4 96.6 .1 4,860 360.0 38.9
-------- ------- --------- --------- -------- -------- ---------
TOTAL DERIVATIVES USED IN FAIR
VALUE HEDGES 93,258 581.4 483.9 (80.0) 63,934 925.7 387.9
-------- ------- --------- --------- -------- -------- ---------
CASH FLOW HEDGES
Funding
Pay-fixed interest rate swaps 9,210 61.8 17.1 10,945 2.1 52.1
Interest rate caps purchased 4,500 40.3 -- 3,500 3.0 --
-------- ------- --------- --------- -------- -------- ---------
Total 13,710 102.1 17.1 .2 14,445 5.1 52.1
-------- ------- --------- --------- -------- -------- ---------
TOTAL DERIVATIVES USED IN CASH FLOW 13,710 102.1 17.1 14,445 5.1 52.1
HEDGES .2
-------- ------- --------- --------- -------- -------- ---------
TOTAL DERIVATIVES USED FOR INTEREST
RATE RISK MANAGEMENT AND DESIG-
NATED IN SFAS 133 RELATIONSHIPS $106,968 $ 683.5 $ 501.0 $ (79.8) $ 78,379 $ 930.8 $ 440.0
======== ======= ========= ========= ======== ======== =========
(a) Represents net ineffective hedge gain (loss) on hedging strategy for
the six-month period ended June 30, 2004.
42
June 30, 2003
-------------------------------------------------------------
Derivative Net Ineffective
Notional ------------------------ Hedge Gains
(In Millions) Amount Asset Liability (Losses)(a)
--------- -------- --------- ---------------
FAIR VALUE HEDGES
Loans
Receive-fixed interest rate swaps $ 60 $ 2.2 $ --
Receive-fixed interest rate swaptions sold 55 -- --
Pay-fixed interest rate swaps 3,422 -- 293.7
Callable pay-fixed interest rate swaps 44 -- 5.5
Pay-fixed interest rate swaptions sold 55 -- 6.4
Interest rate caps sold 815 -- 1.1
Interest rate floors sold 360 -- 11.0
Interest rate futures purchased 2,720 -- --
Interest rate futures sold 3,724 -- --
--------- -------- --------- ---------------
Total 11,255 2.2 317.7 $ 12.6
--------- -------- --------- ---------------
Available for sale securities
Pay fixed interest rate swaps 250 -- 1.2
--------- -------- --------- ---------------
Total 250 -- 1.2 .1
--------- -------- --------- ---------------
Mortgage servicing assets
Forward commitments to purchase
mortgage loans and mortgage-
backed securities 4,525 -- 27.2
Receive-fixed interest rate swaps 2,842 404.4 1.5
Receive-fixed interest rate swaptions sold 188 -- 2.9
Pay-fixed interest rate swaptions purchased 3,600 14.1 --
Pay-fixed interest rate swaptions sold 2,318 41.3 217.6
Principal-only interest rate swaps 257 20.7 4.5
Interest rate caps purchased 22,454 32.8 --
Interest rate futures purchased 400 -- --
--------- -------- --------- ---------------
Total 36,584 513.3 253.7 82.1
--------- -------- --------- ---------------
Funding
Receive-fixed interest rate swaps 4,950 558.7 10.4
Callable receive-fixed interest rate swaps 445 17.5 .9
--------- -------- --------- ---------------
Total 5,395 576.2 11.3 --
--------- -------- --------- ---------------
TOTAL DERIVATIVES USED IN FAIR VALUE HEDGES 53,484 1,091.7 583.9 94.8
--------- -------- --------- ---------------
Funding
Pay-fixed interest rate swaps 14,055 .5 162.7
Interest rate caps purchased 3,500 3.3 --
--------- -------- --------- ---------------
Total 17,555 3.8 162.7 .9
--------- -------- --------- ---------------
TOTAL DERIVATIVES USED IN CASH FLOW HEDGES 17,555 3.8 162.7 .9
--------- -------- --------- ---------------
TOTAL DERIVATIVES USED FOR INTEREST RATE RISK
MANAGEMENT
AND DESIGNATED IN SFAS 133 RELATIONSHIPS $ 71,039 $1,095.5 $ 746.6 $ 95.7
========= ======== ========= ===============
(a) Represents net ineffective hedge gain (loss) on hedging strategy for
the six-month period ended June 30, 2003.
43
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 commercial
banking 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) Net Gains (Losses)
---------------------------------- -------------------------------------------
Three Months Ended Six Months Ended
June 30 June 30
JUNE 30 December 31 June 30 -------------------- ----------------
(In Millions) 2004 2003 2003 2004 2003 2004 2003
------- ----------- ------- -------- ------ ------ ------
OTHER DERIVATIVE INSTRUMENTS
Mortgage-banking-related:
Mortgage servicing asset risk
management $(33.0) $ 36.1 $ 34.3 $ (41.0) $168.0 $365.6 $183.7
------- ----------- ------- -------- ------ ------ ------
Mortgage loan commitments and
commitment and mortgage loan risk
management 2.8 (72.1) (7.9) (242.1) (95.7) (122.8) 56.4
------- ----------- ------- -------- ------ ------ ------
Total mortgage-banking related (30.2) (36.0) 26.4 (283.1) 72.3 242.8 240.1
------- ----------- ------- -------- ------ ------ ------
Customer risk management 10.1 15.0 16.7 4.5 3.2 6.5 6.6
Other 6.5 3.7 11.8 22.9 68.4 22.2 65.7
------- ----------- ------- -------- ------ ------ ------
Total other 16.6 18.7 28.5 27.4 71.6 28.7 72.3
------- ----------- ------- -------- ------ ------ ------
TOTAL OTHER DERIVATIVE INSTRUMENTS $(13.6) $ (17.3) $ 54.9 $(255.7) $143.9 $271.5 $312.4
======= =========== ======= ======== ====== ====== ======
23. LINE OF BUSINESS RESULTS
National City operates six major lines of business: Consumer and Small Business
Financial Services, Wholesale Banking, National City Mortgage Co., National
Consumer Finance, Asset Management, and National Processing. Effective January
1, 2004, National City Mortgage Co., formerly a business unit within National
Consumer Finance, was designated as a separate line of business. Prior periods
have been restated to conform to the current line of business reporting
structure.
Consumer and Small Business Financial Services (CSB) provides banking services
to consumers and small businesses within National City's seven-state footprint.
In addition to deposit gathering and direct lending services provided through
the retail bank branch network, call centers, and the Internet, CSB's 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. CSB's expenses are mainly personnel and
branch network support costs.
Wholesale Banking provides credit-related and treasury management products, as
well as capital markets and international services, to large- and medium-sized
corporations. Major products and services include: lines of credit, term loans,
leases, investment real estate lending, asset-based lending, structured finance,
syndicated lending, equity and mezzanine capital, treasury management services,
and international payment and clearing services. The majority of revenue is
driven by loans to middle-market companies with annual revenue in the $5 million
to $500 million range across a diverse group of industries, generally within
National City's seven-state footprint. Expenses include personnel and support
costs, in addition to credit costs.
National City Mortgage Co. (NCMC) originates conventional residential mortgage
and home equity loans both within National City's banking footprint and
nationally. NCMC's activities also include servicing mortgage loans for
third-party investors. Mortgage loans originated by NCMC generally represent
loans collateralized by one-to-four-family residential real estate and are made
to borrowers in good credit standing. These loans are typically sold to primary
mortgage market aggregators (Fannie Mae, Freddie Mac, Ginnie Mae, or the Federal
Home Loan Banks) and jumbo loan investors. During the first six months of 2004,
approximately 52% of NCMC mortgage loans were originated through wholesale and
correspondent channels, while 48% were originated through retail mortgage
branches operated by NCMC nationally, or through CSB bank branches within
National City's banking footprint. Significant revenue streams for NCMC include
net interest income on loans held for sale and fee income related to the
origination, sale and servicing of loans. Expenses include personnel costs,
branch office costs, third-party outsourcing and loan collection expenses.
National Consumer Finance (NCF) is comprised of three business units and
originates home equity loans and nonconforming residential mortgage loans
nationally through correspondent relationships and a network of brokers.
Nonconforming mortgage loans are originated by First Franklin Financial
Corporation (First Franklin), a business unit within NCF, principally through
wholesale channels, including a national network of brokers and mortgage
bankers. Historically, approximately half of First Franklin originated loans are
retained in portfolio at National City Home Loan Services, another business unit
within NCF; the rest are sold servicing released to secondary market investors.
The percentage of loans sold versus retained in any given period will vary
depending on
44
product mix and market conditions. Nonconforming mortgages are generally not
readily saleable to primary mortgage market aggregators due to the credit
characteristics of the borrower, the underlying documentation, the loan-to-value
ratio, or the size of the loan, among other factors. The National Home Equity
business unit within NCF originates prime-quality home equity loans outside
National City's banking footprint. Significant revenue streams for NCF include
net interest income on loans and fee income related to the origination and sale
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, 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 banking 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
83%-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. In July 2004, a definitive agreement
was executed for the sale of this subsidiary, as described in Note 3 on page 19.
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
attempt to 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 securitizations 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, 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
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 on the following page.
45
CONSUMER AND
SMALL
BUSINESS NATIONAL NATIONAL
(In Thousands) FINANCIAL WHOLESALE CITY CONSUMER ASSET NATIONAL PARENT CONSOLIDATED
SERVICES BANKING MORTGAGE CO. FINANCE MANAGEMENT PROCESSING AND OTHER TOTAL
------------- --------- ----------- -------- ---------- ---------- --------- ------------
QUARTER ENDED JUNE 30, 2004
Net interest income
(expense)(a) $500,475 $ 272,897 $160,732 $278,728 $ 26,583 $ 986 $(173,621) $ 1,066,780
Provision (benefit) for
loan losses 75,017 (6,444) 2,753 10,406 1,421 -- (22,365) 60,788
Net interest income
(expense) after provision 425,458 279,341 157,979 268,322 25,162 986 (151,256) 1,005,992
Noninterest income 214,921 103,655 50,107 157,226 160,199 132,334 47,835 866,277
Noninterest expense 370,589 125,837 181,975 140,276 74,676 109,620 72,164 1,075,137
-------- --------- --------- -------- ---------- ---------- --------- ------------
Income (loss) before taxes 269,790 257,159 26,111 285,272 110,685 23,700 (175,585) 797,132
Income tax expense
(benefit)(a) 101,981 96,325 9,910 107,833 41,839 9,314 (89,116) 278,086
-------- --------- --------- -------- ---------- ---------- --------- ------------
Net income (loss) $167,809 $ 160,834 $ 16,201 $177,439 $ 68,846 $ 14,386 $ (86,469) $ 519,046
-------- --------- --------- -------- ---------- ---------- --------- ------------
Intersegment revenue
(expense) $ (865) $ 5,068 $ 14,357 $ (6,549) $ 1,330 $ 1,191 $ (14,532) $ --
Average assets (in millions) 27,184 31,300 17,494 26,958 3,005 705 9,186 115,832
-------- --------- --------- -------- ---------- ---------- --------- ------------
Quarter ended June 30, 2003
Net interest income
(expense)(a) $492,039 $264,730 $ 281,174 $193,306 $ 25,930 $ 865 $(155,796) $ 1,102,248
Provision (benefit) for
loan losses 73,761 104,384 (3,075) 28,504 2,733 -- (23,160) 183,147
-------- --------- --------- -------- ---------- ---------- --------- ------------
Net interest income
(expense) after provision 418,278 160,346 284,249 164,802 23,197 865 (132,636) 919,101
Noninterest income 180,339 60,132 357,429 87,594 91,588 113,590 121,240 1,011,912
Noninterest expense 328,321 120,820 199,880 74,256 70,952 95,945 136,063 1,026,237
-------- --------- --------- -------- ---------- ---------- --------- ------------
Income (loss) before taxes 270,296 99,658 441,798 178,140 43,833 18,510 (147,459) 904,776
Income tax expense
(benefit) (a) 102,172 38,233 177,698 67,337 16,569 7,444 (90,485) 318,968
-------- --------- --------- -------- ---------- ---------- --------- ------------
Net income (loss) $168,124 $ 61,425 $ 264,100 $110,803 $ 27,264 $ 11,066 $ (56,974) $ 585,808
-------- --------- --------- -------- ---------- ---------- --------- ------------
Intersegment revenue
(expense) $ (911) $ 5,146 $ 13,309 $ (3,651) $ 1,650 $ 1,373 $ (16,916) $ --
Average assets (in millions) 25,700 31,225 30,297 18,008 2,884 542 10,379 119,035
======== ========= ========= ======== ========== ========== ========= ============
(a) Includes tax-equivalent adjustment for tax-exempt interest income
CONSUMER AND
SMALL
BUSINESS NATIONAL NATIONAL
FINANCIAL WHOLESALE CITY CONSUMER ASSET NATIONAL PARENT CONSOLIDATED
(In Thousands) SERVICES BANKING MORTGAGE CO. FINANCE MANAGEMENT PROCESSING AND OTHER TOTAL
- -------------- ------------- --------- ----------- -------- ---------- ---------- --------- ------------
SIX MONTHS ENDED JUNE 30, 2004
Net interest income
(expense)(a) $996,096 $ 529,956 $ 302,370 $536,988 $ 52,854 $ 1,881 $(328,208) $ 2,091,937
Provision (benefit) for
loan losses 150,340 4,212 7,251 21,467 1,649 -- (41,624) 143,295
-------- --------- ---------- -------- ---------- ---------- --------- ------------
Net interest income
(expense) after provision 845,756 525,744 295,119 515,521 51,205 1,881 (286,584) 1,948,642
Noninterest income 395,224 203,090 509,092 292,777 252,851 254,325 76,615 1,983,974
Noninterest expense 723,388 249,713 337,292 259,789 152,146 212,934 126,215 2,061,477
-------- --------- ---------- -------- ---------- ---------- --------- ------------
Income (loss) before taxes 517,592 479,121 466,919 548,509 151,910 43,272 (336,184) 1,871,139
Income tax expense
(benefit)(a) 195,650 179,050 177,404 207,337 57,421 16,922 (192,059) 641,725
-------- --------- ---------- -------- ---------- ---------- --------- ------------
Net income (loss) $321,942 $ 300,071 $ 289,515 $341,172 $ 94,489 $ 26,350 $(144,125) $ 1,229,414
-------- --------- ---------- -------- ---------- ---------- --------- ------------
Intersegment revenue
(expense) $ (1,742) $ 9,024 $ 26,013 $(12,543) $ 2,805 $ 2,569 $ (26,126) $ --
Average assets (in millions) 27,108 30,180 16,940 25,650 2,986 702 9,061 112,627
======== ========= ========== ======== ========== ========== ========= ============
Six months ended June 30,
2003
Net interest income
(expense)(a) $980,764 $ 524,226 $ 565,550 $364,479 $ 50,981 $ 1,548 $(284,572) $ 2,202,976
Provision (benefit) for
loan losses 144,226 220,158 8,073 47,842 4,317 -- (41,236) 383,380
-------- --------- ---------- -------- ---------- ---------- --------- ------------
Net interest income
(expense) after provision 836,538 304,068 557,477 316,637 46,664 1,548 (243,336) 1,819,596
Noninterest income 342,028 146,769 935,031 155,754 174,294 219,713 141,809 2,115,398
Noninterest expense 680,832 257,773 373,038 147,491 146,761 188,509 240,699 2,035,103
-------- --------- ---------- -------- ---------- ---------- --------- ------------
Income (loss) before taxes 497,734 193,064 1,119,470 324,900 74,197 32,752 (342,226) 1,899,891
Income tax expense
(benefit)(a) 188,144 72,788 444,014 122,812 28,046 13,139 (198,363) 670,580
-------- --------- ---------- -------- ---------- ---------- --------- ------------
Net income (loss) $309,590 $ 120,276 $ 675,456 $202,088 $ 46,151 $ 19,613 $(143,863) $ 1,229,311
======== ========= ========== ======== ========== ========== ========= ============
Intersegment revenue
(expense) $ (1,893) $ 11,342 $ 22,587 $ (6,793) $ 3,665 $ 2,784 $ (31,692) $ --
Average assets (in millions) 25,742 31,212 29,586 17,189 2,899 538 10,518 117,684
======== ========= ========== ======== ========== ========== ========= ============
- ------------
(a) Includes tax-equivalent adjustment for tax-exempt interest income
46
24. FINANCIAL HOLDING COMPANY
Condensed financial statements of the holding company, which include
transactions with subsidiaries, follow:
BALANCE SHEETS
JUNE 30 December 31 June 30
(In Thousands) 2004 2003 2003
-------------- -------------- --------------
ASSETS
Cash and demand balances due from banks $ 2 $ 1,521 $
1,508
Loans to and receivables from subsidiaries 1,425,536 819,115 369,084
Securities 333,018 164,179 206,996
Other investments 127,919 479,394 435,929
Investments in:
Subsidiary banks 10,093,241 9,642,417 9,837,099
Nonbank subsidiaries 646,124 608,916 544,188
Goodwill 59,989 58,566 58,566
Derivative assets 70,011 124,901 198,890
Other assets 650,806 668,633 619,406
-------------- -------------- --------------
TOTAL ASSETS $ 13,406,646 $ 12,567,642 $ 12,271,666
============== ============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Long-term debt $ 1,990,687 $ 2,266,658 $ 2,347,348
Borrowed funds from subsidiaries 249,210 185,568 185,568
Derivative liabilities 23,548 4,695 1,754
Accrued expenses and other liabilities 808,217 782,050 707,087
-------------- -------------- --------------
Total liabilities 3,071,662 3,238,971 3,241,757
Stockholders' equity 10,334,984 9,328,671 9,029,909
-------------- -------------- --------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 13,406,646 $ 12,567,642 $ 12,271,666
============== ============== ==============
Securities and other investments totaling $106 million at June 30, 2004, were
restricted for use in certain nonqualified benefit plans. The borrowed funds
from subsidiaries balance includes the junior subordinated debt securities
payable to the wholly-owned subsidiary trusts (the trusts). The holding company
guarantees the capital securities issued by the trusts, which totaled $249
million at June 30, 2004. The holding company also guarantees commercial paper
issued by its subsidiary National City Credit Corporation, which borrowings
totaled $612 million at June 30, 2004. 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 Six Months Ended
June 30 June 30
--------------------------------- ---------------- --------------
(In Thousands) 2004 2003 2004 2003
--------------- ----------------- ---------------- --------------
INCOME
Dividends from:
Subsidiary banks $1,275,000 $450,000 $1,275,000 $ 450,000
Nonbank subsidiaries 4,000 4,000 6,000 4,000
Interest on loans to subsidiaries 818 224 1,708 515
Interest and dividends on securities 1,981 3,007 3,255 5,125
Securities (losses) gains, net (5) 31,409 98 31,409
Other income 4,242 12,351 10,882 12,743
---------- -------- ---------- ----------
TOTAL INCOME 1,286,036 500,991 1,296,943 503,792
========== ======== ========== ==========
EXPENSE
Interest on debt and other borrowings 17,480 24,571 37,918 49,352
Other expense 18,187 80,031 28,883 81,127
---------- -------- ---------- ----------
TOTAL EXPENSE 35,667 104,602 66,801 130,479
========== ======== ========== ==========
Income before taxes and equity in undistributed
net income of subsidiaries 1,250,369 396,389 1,230,142 373,313
Income tax (benefit) (6,213) (25,553) (32,119) (44,961)
---------- -------- ---------- ----------
Income before equity in undistributed net income of
subsidiaries 1,256,582 421,942 1,262,261 418,274
Equity in undistributed net (loss) income of subsidiaries (737,536) 163,866 (32,847) 811,037
---------- -------- ---------- ----------
NET INCOME $ 519,046 $585,808 $1,229,414 $1,229,311
========== ======== ========== ==========
47
STATEMENTS OF CASH FLOWS
Six Months Ended
June 30
--------------------------
(In Thousands) 2004 2003
----------- -----------
Operating Activities
Net income $ 1,229,414 $ 1,229,311
Adjustments to reconcile net income to net cash provided by
operating activities:
Equity in undistributed net income of subsidiaries 32,847 (811,037)
Depreciation and amortization of properties and equipment 943 569
(Increase) decrease in receivables from subsidiaries (782,575) 12,905
Securities gains, net (98) (31,409)
Other gains, net (910) 22,358
Amortization of premiums and discounts on securities and debt (1,055) (698)
Increase (decrease) in accrued expenses and other liabilities 21,335 (59,687)
Other, net 41,468 17,722
----------- -----------
Net cash provided by operating activities 541,369 380,034
----------- -----------
INVESTING ACTIVITIES
Purchases of securities (218,091) (417,618)
Proceeds from sales and maturities of securities 58,583 458,214
Net change in other investments 351,475 120,194
Principal collected on loans to subsidiaries 331,000 687,334
Loans to subsidiaries (405,000) (370,000)
Investments in subsidiaries (15,001) (522)
Returns of investment from subsidiaries 250,005 180,000
Net (increase) decrease in properties and equipment (13,163) 10,840
Cash paid for Allegiant, net of cash acquired (19,465) --
----------- -----------
Net cash provided by investing activities 320,343 668,442
----------- -----------
FINANCING ACTIVITIES
Net decrease in borrowed funds -- (1,020,000)
Issuance of debt 200,000 300,000
Repayment of debt (400,880) (880)
Dividends paid (393,838) (373,012)
Issuances of common stock 122,816 83,055
Repurchases of common stock (391,329) (37,629)
----------- -----------
Net cash used in financing activities (863,231) (1,048,466)
----------- -----------
(Decrease) increase in cash and demand balances due from banks (1,519) 10
Cash and demand balances due from banks, January 1 1,521 1,498
----------- -----------
CASH AND DEMAND BALANCES DUE FROM BANKS, JUNE 30 $ 2 $ 1,508
=========== ===========
SUPPLEMENTAL INFORMATION
Cash paid for interest $ 46,227 $ 45,507
Common stock and options issued in Allegiant acquisition 469,666 --
=========== ===========
Retained earnings of the holding company included $6.8 billion, $6.9 billion,
and $6.7 billion of equity in undistributed net income of subsidiaries at June
30, 2004, December 31, 2003, and June 30, 2003, respectively.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FINANCIAL REVIEW
This Quarterly Report contains forward-looking statements. See page 67 for
further information on the risks and uncertainties associated with
forward-looking statements.
The financial review section discusses the financial condition and results of
operations of National City Corporation (the Corporation or National City) for
the three and six months ended June 30, 2004 and serves to update the 2003
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 48 of this Form 10-Q. Certain prior period amounts have been restated to
reflect changes in the Corporation's method of assessing effectiveness of its
hedging activities pursuant to Statement of Financial Accounting Standards No.
133, Accounting for Derivatives and Hedging Activities.
48
OVERVIEW
The primary source of National City's revenue is net interest income from loans
and deposits, and fees from financial services provided to customers. Business
volumes tend to be influenced by overall economic factors including market
interest rates, business spending, and consumer confidence, as well as
competitive conditions within the marketplace.
National City's second quarter 2004 net income was $519 million, or $.83 per
diluted share, compared to $586 million, or $.94 per diluted share in the second
quarter of 2003. The second quarter includes the results of Allegiant Bancorp,
acquired by National City Corporation on April 9, 2004, from the merger date.
Results for the second quarter of 2004 reflect good loan growth, strong
performance in deposits and fee income and continued improvements in corporate
credit quality. Loan growth was experienced across all business lines but was
particularly strong in the National Home Equity and First Franklin units. Both
of these businesses set records for loan originations during the second quarter.
As expected, earnings at National City Mortgage Co. declined as interest rates
have increased. The second quarter experienced a reversal of the some of the
hedging gains recognized during the first quarter of 2004.
Average portfolio loans increased 5% in comparison to the first quarter and 10%
from the second quarter a year ago. Core deposits, excluding mortgage escrow
balances, grew for the 15th consecutive quarter reflecting an increase of 5%
over the first quarter. The acquisition of Allegiant added $1.6 billion to
average portfolio loans and $1.5 billion to average core deposits, excluding
escrow balances, representing approximately half of the growth in average core
deposits from the first quarter.
Credit quality continued to improve during the second quarter resulting in a
significant decrease in the loan loss provision in comparison to the prior year.
Net charge-offs in the second quarter benefited from some relatively large
commercial recoveries that are not expected to recur. Nonperforming assets at
June 30, 2004 were $544 million in comparison to $657 million at year end and
$818 million a year ago. Overall credit trends are expected to remain favorable.
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 69-71 of this
financial review.
Net interest income is discussed and presented in this financial review on a
tax-equivalent basis, recognizing that 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 $13 million for the second quarter and first six
months of 2004, respectively, and $7 million $15 million for the same periods in
2003, respectively.
Tax-equivalent net interest income for the second quarter and first six months
of 2004 was $1.1 billion and $2.1 billion, respectively, as compared to $1.0
billion and $2.2 billion for the comparable 2003 periods. The year-over-year
decrease in net interest income was primarily the result of lower average
balances in the mortgage warehouse.
Net interest margin was 4.09% in the second quarter of 2004, compared to 4.16%
in the first quarter of 2004 and 4.11% in last year's second quarter. Net
interest margin for the first six months of 2004 was 4.12%, compared to 4.16%
for the same period a year ago. The sustained low interest rate environment,
which results in reduced asset yields and narrower spreads on deposits,
continues to have an unfavorable impact on net interest margin.
Further discussion of trends in the loan and securities portfolios and detail on
the mix of funding sources affecting net interest income and net interest margin
is included in the Financial Condition section of this financial review
beginning on page 54.
49
NONINTEREST INCOME
Details of noninterest income follow:
Three Months Ended Six Months Ended
---------------------------- ------------------
JUNE 30 March 31 June 30 JUNE 30 June 30
(In Millions) 2004 2004 2003 2004 2003
------- -------- ------- ------- --------
Mortgage banking revenue $ 193 $ 579 $ 427 $ 772 $ 1,058
Deposit service charges 162 147 142 309 277
Payment processing revenue 132 122 113 254 218
Trust and investment management fees 79 76 78 155 147
Card-related fees 38 37 44 75 85
Brokerage revenue 34 32 34 66 58
Other service fees 29 23 26 52 54
Other 192 102 117 294 187
------- -------- ------- ------- --------
TOTAL FEES AND OTHER INCOME 861 1,118 981 1,979 2,084
Securities gains, net 5 -- 31 5 31
------- -------- ------- ------- --------
TOTAL NONINTEREST INCOME $ 866 $ 1,118 $ 1,012 $ 1,984 $ 2,115
======= ======== ======= ======= ========
Details of mortgage banking revenue follow:
Three Months Ended Six Months Ended
----------------------------- -----------------
JUNE 30 March 31 June 30 JUNE 30 June 30
(In Millions) 2004 2004 2003 2004 2003
------- -------- ------- ------- -------
Servicing revenue:
Net servicing fees $ 115 $ 120 $ 92 $ 235 $ 212
Amortization of mortgage servicing assets (140) (100) (125) (240) (251)
Mortgage servicing asset impairment (charge)
recovery 42 (118) (125) (76) (25)
Mortgage servicing asset ineffective hedge and
other derivative gains (losses), net (99) 413 224 314 266
Other -- 1 -- 1 --
------- -------- ------- ------- -------
Net servicing revenue (82) 316 66 234 202
NCMC origination and sales revenue 110 122 273 232 699
First Franklin origination and sales revenue 165 141 88 306 157
------- -------- ------- ------- -------
TOTAL MORTGAGE BANKING REVENUE $ 193 $ 579 $ 427 $ 772 $ 1,058
======= ======== ======= ======= =======
Virtually all NCMC's mortgage loan production is sold into the secondary market
with servicing retained. Historically, approximately half of First Franklin's
loan production is sold to third parties servicing released, with the remainder
held in portfolio. The exact percentage of First Franklin loans sold versus
retained will vary based upon product mix and market conditions. Information on
mortgage loan originations and sales follows:
Three Months Ended Six Months Ended
----------------------------- -----------------
JUNE 30 March 31 June 30 JUNE 30 June 30
(In Millions) 2004 2004 2003 2004 2003
------- -------- ------- ------- -------
NCMC loans originated for sale $17,252 $ 14,069 $32,853 $31,321 $57,153
Total First Franklin loan originations 8,782 5,673 4,396 14,455 7,884
Less: First Franklin portfolio loan originations (3,056) (1,113) (2,000) (4,169) (3,756)
------- -------- ------- ------- -------
Total First Franklin loans originated for sale 5,726 4,560 2,396 10,286 4,128
------- -------- ------- ------- -------
TOTAL MORTGAGE LOANS ORIGINATED FOR SALE $22,978 $ 18,629 $35,249 $41,607 $61,281
======= ======== ======= ======= =======
NCMC loan sales $17,047 $ 15,697 $27,277 $32,744 $52,888
First Franklin loan sales 4,887 4,433 2,164 9,320 4,015
------- -------- ------- ------- -------
TOTAL MORTGAGE LOAN SALES $21,934 $ 20,130 $29,441 $42,064 $56,903
======= ======== ======= ======= =======
The decrease in mortgage banking revenue during the second quarter and first
half of 2004 was primarily attributable to lower net hedging results and
origination and sales revenue at NCMC, partially offset by an increase in
origination and sales revenue at First Franklin. Mortgage banking revenue
included $57 million of net hedging losses, net of impairment recoveries, on
mortgage servicing rights during the second quarter of 2004, compared to gains
of $295 million and $99 million for the first quarter of 2004 and the prior
year, respectively. The year-over-year decrease in origination and sales revenue
at NCMC resulted from lower production and sales volume arising from higher
interest rates and an associated reduction in refinancing activity. The
linked-quarter decline in NCMC origination and sales revenue primarily resulted
from unfavorable hedging results in the warehouse and pipeline, also driven by
higher interest rates. The increase in First Franklin origination and sales
revenue resulted from growth in production and sales volumes, which benefited
from new product offerings, expansion into new markets, and an increase in
production sold to third parties. A change in accounting for mortgage loan
commitments made as of January 1, 2004, to conform to the recently issued SEC
Staff Accounting
50
Bulletin 105, also reduced origination and sales revenue recognized for the
first half of 2004 by $47 million as compared to previous accounting practice.
NCMC typically retains the right to service the mortgage loans it sells. Upon
sale, the NCMC recognizes an MSR asset, which represents the present value of
the estimated future net servicing cash flows over the estimated life of the
underlying loan. As a result of the high volume of mortgage loan production and
sales over the past year, the unpaid principal balance of loans serviced for
third parties increased to $147.0 billion at June 30, 2004, up from $141.1
billion at December 31, 2003 and $119.9 billion at June 30, 2003. The carrying
value of MSRs also grew over the past year and was $1.9 billion at June 30,
2004, $1.3 billion at December 31, 2003, and $733 million at June 30, 2003.
The value of MSRs is sensitive to changes in interest rates. In a low rate
environment, as was experienced during the first quarter of 2004 and much of
2003, mortgage loan refinancings generally increase, causing actual and expected
loan prepayments to increase, which drives down the estimated value of existing
MSRs. Conversely, as interest rates rise, as occurred during the second quarter
of 2004, 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
value of MSRs by using derivative instruments. When rates rise, it is somewhat
typical to experience underperformance in MSR hedging results resulting in both
economic and accounting losses. This situation occurred early in the second
quarter of 2004. Further detail on MSRs, including a sensitivity analysis of the
effect changes in assumptions have on the value of servicing assets, is included
in Note 11 to the consolidated financial statements.
The growth in deposit service charges during the second quarter and first half
of 2004 was primarily attributed to increases in overdraft and non-sufficient
funds (NSF) fees resulting from growth in the number of deposit accounts,
increased transaction activity, and higher revenue per transaction.
The linked quarter and year-over-year growth in payment processing revenue
generated by National Processing, Inc. (NPI), National City's 83%-owned
subsidiary, was the result of higher transaction volume, strong customer
retention, and higher rates from various pricing initiatives. The increase in
transaction volume reflects growth both from existing accounts and new business,
as well as from the acquisition of Bridgeview Payment Services in June 2003.
Card-related fees decreased during the first six months of 2004 over the same
2003 period principally due to higher deferrals of origination fees attributable
to the increased production of home equity lines of credit during 2004.
Other noninterest income increased on a linked-quarter comparison mainly due to
a $65 million gain on the sale of the Corporate Trust Bond Administration
business and higher derivative-related gains recognized in the second quarter.
These gains were partially offset by lower principal investment gains and a
first quarter gain of $9 million on the securitization of automobile loans. The
increase in derivative gains resulted from a second quarter $19 million gain
associated with certain cash flow hedging transactions that did not qualify for
special hedge accounting under SFAS 133. Principal investment gains recognized
during the second quarter of 2004 were $17 million, compared to $23 million in
the previous quarter. The increase in other noninterest income during the first
half of 2004 primarily resulted from the aforementioned Corporate Bond
Administration and securitization gains and an increase in principal investment
gains recognized, offset by lower derivative-related gains. Principal investment
gains of $40 million were recognized during the first half of 2004, compared to
principal investment losses of $10 million recognized during the first half of
last year. The decrease in derivative-related gains was primarily associated
with a 2003 gain recognized on interest rate swaps that were used to
economically hedge the steep yield curve, with no similar gain recognized in
2004.
The majority of net security gains recognized during 2003 were generated from
the Corporation's internally-managed equity portfolio of bank and thrift common
stocks (bank stock fund). There were no sales of bank stock fund securities
during the first half of 2004.
51
NONINTEREST EXPENSE
Details of noninterest expense follow:
Three Months Ended Six Months Ended
------------------------------------ -----------------
JUNE 30 March 31 June 30 JUNE 30 June 30
(In Millions) 2004 2004 2003 2004 2003
------- -------- ------- ------- -------
Salaries, benefits, and other personnel $ 594 $ 549 $ 542 $ 1,143 $ 1,103
Third-party services 73 68 71 141 136
Equipment 72 69 62 141 127
Net occupancy 59 60 56 119 114
Card processing 60 58 52 118 104
Postage and supplies 35 34 33 69 66
Marketing and public relations 30 22 67 52 84
Telecommunications 23 19 19 42 40
State and local taxes 13 15 14 28 30
Travel and entertainment 19 16 14 35 27
Goodwill and other intangible asset amortization 7 6 6 13 11
Other 90 70 90 160 193
------- -------- ------- ------- -------
TOTAL NONINTEREST EXPENSE $ 1,075 $ 986 $ 1,026 $ 2,061 $ 2,035
======= ======== ======= ======= =======
Details of salaries, benefits, and other personnel expense follow:
Three Months Ended Six Months Ended
------------------------------------ -----------------
JUNE 30 March 31 June 30 JUNE 30 June 30
(Dollars in Millions) 2004 2004 2003 2004 2003
------- -------- ------- ------- -------
Salaries and wages $ 318 $ 313 $ 303 $ 631 $ 602
Incentive compensation 210 157 241 367 412
Deferred personnel costs (104) (81) (155) (185) (265)
Stock-based compensation 12 12 6 24 10
Payroll taxes 36 44 37 80 80
Contract labor 32 19 23 51 43
Medical and other benefits 48 46 49 94 93
Defined contribution plans 17 22 17 39 40
Defined benefit pension plan 3 2 (4) 5 (8)
Market valuation adjustments on deferred
compensation liabilities 7 3 18 10 17
Severance and other 15 12 7 27 79
------- -------- ------- ------- -------
TOTAL SALARIES, BENEFITS, AND OTHER PERSONNEL $ 594 $ 549 $ 542 $ 1,143 $ 1,103
======= ======== ======= ======= =======
FULL-TIME-EQUIVALENT EMPLOYEES 34,062 33,036 32,414
======= ======== ======= ======= =======
The year-over-year increase in salaries, benefits, and other personnel expense
reflects higher contract labor, stock compensation, defined benefit plan
expenses, and lower deferred personnel costs. Partially offsetting these
increases was lower incentive compensation expense in 2004. The reductions in
deferred personnel and incentive compensation costs were primarily due to lower
mortgage origination volumes in 2004. Contract labor increased due to increases
in temporary personnel utilized to integrate Allegiant's information systems.
The higher stock-based compensation expense resulted from the prospective
application of SFAS 123 to all stock options granted subsequent to January 1,
2003, the date of initial adoption of SFAS 123. The higher defined pension
benefit cost recognized in 2004 resulted primarily from decreases in the
discount rate and expected long-term rate of return assumptions. Also affecting
the year-over-year comparison in salaries, benefits, and other personnel expense
was the $68 million severance charge recognized during the first half of 2003
made in connection with certain cost-reduction initiatives. There was no
comparable charge recognized during the first half of 2004.
The linked-quarter increase in salaries, benefits, and other personnel expense
was primarily due to increases in incentive compensation and contract labor.
Incentive compensation rose in correlation with the record home equity
origination volume experienced during the second quarter of 2004. Contract labor
increased due to the Allegiant integration as discussed above.
The year-over-year and linked-quarter increases in full-time equivalent
employees is attributable to the Allegiant acquisition, higher levels of
staffing to support the home equity business, and continued staff additions in
the retail branch network.
The second quarter and first half of 2004 increase in equipment expense resulted
from higher depreciation expense recognized related to assets placed in service
during 2003 and 2004. In particular, the increase in depreciation expense was
affected by the rollout of Customer Connections (the Corporation's new retail
delivery system), which began last summer and will continue to be implemented in
2004.
52
Card processing expense increased during the second quarter and first half of
2004 over the comparable 2003 periods primarily due to higher processing volumes
at National Processing.
Marketing and public relations expense decreased during the first half of 2004
over the same 2003 period primarily due to a donation of $40 million in
appreciated investment securities to the Corporation's charitable foundation in
the second quarter of last year. This decrease was offset to some extent by
increased spending to promote National City products and services to Allegiant
customers during the second quarter of 2004.
Other noninterest expense decreased during the first half of 2004 from the same
period a year ago mainly due to automobile and commercial lease residual value
charges of $25 million and $16 million, respectively, that were recognized in
2003, with no similar charges recognized in 2004. Partially offsetting this
decrease was a charge of $8 million in the second quarter of 2004 to
recapitalize certain mutual funds.
The efficiency ratio, calculated as noninterest expense divided by the sum of
tax-equivalent net interest income and total fees and other income, was 55.8%
and 50.6% for the second quarter and first six months of 2004, respectively,
compared to 49.3% and 47.5% for the second quarter and first six months of 2003,
respectively.
INCOME TAXES
The effective tax rate was 33.8% for the first six months of 2004 compared to
34.8% for the first six months of 2003. The lower tax rate in 2004 reflects a
reduction in deferred tax balances in the amount of $23 million in the first
quarter due to the favorable conclusion of several tax examinations. The
effective tax rate for 2004 is forecasted to be 34.8% exclusive of that
adjustment.
LINE OF BUSINESS RESULTS
National City is functionally managed along six major business lines as
discussed in Note 23 to the consolidated financial statements.
Net income (loss) by line of business follows:
Three Months Ended Six Months Ended
------------------------------------ -----------------
JUNE 30 March 31 June 30 JUNE 30 June 30
(In Millions) 2004 2004 2003 2004 2003
------- -------- ------- ------- -------
Consumer and Small Business Financial Services $ 168 $ 154 $ 168 $ 322 $ 309
Wholesale Banking 161 139 62 300 121
National City Mortgage Co. 16 273 264 289 675
National Consumer Finance 177 164 111 341 202
Asset Management 69 26 27 94 46
National Processing 14 12 11 26 20
Parent and Other (86) (58) (57) (143) (144)
------- -------- ------- ------- -------
CONSOLIDATED NET INCOME $ 519 $ 710 $ 586 $ 1,229 $ 1,229
======= ======== ======= ======= =======
Consumer and Small Business Financial Services (CSB): CSB results in 2004 have
benefited from loan and deposit growth. Loan growth, both on a linked-quarter
and year-over-year basis, has been greatest in home equity lines and loans.
Deposit volumes have continued to grow, although the effects of lower interest
rates and increased competition have resulted in narrower margins compared to
2003. Noninterest income has grown relative to the prior quarter and past year
principally because of deposit-related service charges and fees, reflecting
growth in the number of deposit accounts, increased transaction activity, and
higher revenue per transaction. Noninterest income for the second quarter also
included a $15 million pre-tax gain on the sale of student loans. First half
2003 results included a $25 million pre-tax charge for automobile lease residual
losses. Noninterest expenses rose on a year-over-year basis primarily from
increased personnel costs, reflecting higher staffing levels, higher incentive
compensation, and the Allegiant acquisition. Noninterest expense increased on a
linked-quarter basis primarily due to the Allegiant acquisition and branch
technology improvements. Credit trends have been stable.
Wholesale Banking: Results for the second quarter and first half benefited from
a sharply lower provision for loan losses, as credit quality continued to
improve. Average loan balances have been on an upward trend since the beginning
of the year, but were still below the comparable periods a year earlier. Deposit
volumes have been strong. Results also benefited from principal investment
gains, with $23 million and $17 million recorded in the first and second
quarters, respectively, compared with losses of $16 million in the second
quarter of 2003 and losses of $10 million for the first half of 2003. Wholesale
Banking recorded losses on commercial lease residuals of $16 million in the
first half of 2003, virtually all in the first quarter, with no comparable
charges in 2004.
National City Mortgage Co. (NCMC): The significant drop in second quarter net
income was mainly from MSR net hedging losses, which were $57 million pre-tax in
the second quarter, compared to net gains of $295 million in the first quarter.
In 2003, NCMC realized net hedging gains of $99 million for the second quarter
and $240 million for the first half. The sharp increase in long-term
53
rates in April 2004, coupled with a tightening of the basis between mortgage
rates and swap rates, was the primary driver of the hedging losses. On a more
fundamental basis, first half 2004 volumes were below those of the first half a
year ago, which saw record activity stimulated by 45-year lows in mortgage
interest rates. As volumes decline, net interest income from loans held for sale
and noninterest expenses associated with incentive compensation and other
production costs tend to decline as well. An additional item affecting
comparisons between periods was a change in accounting made as of the beginning
of 2004 to conform to SEC Staff Accounting Bulletin 105. As a result of this
change, first half revenue was reduced by approximately $47 million.
National Consumer Finance (NCF): Results for 2004 reflected strong growth trends
in origination volumes at both of NCF's major divisions, First Franklin and
National Home Equity, with an associated increase in net interest income from a
larger loan portfolio and in noninterest income from higher gains on the sale of
loans. Sales of First Franklin loans generated revenue of $165 million in the
second quarter of 2004, exceeding the $157 million realized in the entire first
half of 2003. First Franklin loans retained in portfolio grew to $16.7 billion
for the second quarter, up from $11.5 billion a year earlier. First Franklin
production is expected to remain strong in the second half, but margins realized
on sales are expected to decline, which would result in lower noninterest
revenue in the second half relative to the first half. The National Home Equity
portfolio, including both lines and loans, grew to $8.6 billion in the second
quarter, up from $4.3 billion a year earlier. All National Home Equity
production is retained in portfolio.
Asset Management: Net income for the second quarter of 2004 includes a $65
million pre-tax ($42 million after tax) gain on the sale of the Bond
Administration unit within this business line. Revenue associated with this unit
was approximately $6 million in the first half, with no material ongoing effect
on net income. Excluding the gain, net income growth in 2004 reflects fee income
growth from higher assets under management, primarily due to higher market
values.
National Processing: The linked-quarter and year-over-year increases in net
income reflect revenue gains from higher dollar volume and number of
transactions. Transaction growth reflects increased activity from existing
merchant accounts, mainly due to better economic conditions, as well as the
addition of new merchants, and was also aided by the acquisition of Bridgeview
Payment Solutions in June 2003.
Parent and Other: This category includes the results of investment funding
activities, unallocated corporate income and expense, and intersegment revenue
and expense eliminations. The higher loss in the second quarter compared to the
first quarter was mainly due to a tax benefit of $23 million recorded in the
first quarter from the favorable conclusion of several tax examinations. A
number of unusual items in 2003 affect comparisons with the year-ago quarter and
half. The second quarter of 2003 included a contribution of appreciated
securities to the Corporation's charitable foundation in the amount of $40
million, partially offset by bank stock fund gains of $32 million. In addition,
the first half of 2003 included severance and related charges of $72 million,
virtually all in the first quarter, with only $6 million of such costs in the
first half of 2004. In general, net interest expense was higher in 2004 compared
to 2003, due to the cost of maintaining an asset-sensitive interest rate risk
position and from internal crediting rates on new deposits being higher than the
immediately available investment opportunities for those funds.
FINANCIAL CONDITION
This section should also be reviewed in conjunction with the average balance
sheets presented on pages 68-69 of this financial review.
AVERAGE EARNING ASSETS
A summary of average earning assets follows:
Three Months Ended Six Months Ended
-------------------------------------- ------------------
JUNE 30 March 31 June 30 JUNE 30 June 30
(In Millions) 2004 2004 2003 2004 2003
- ------------- --------- -------- -------- --------- --------
Portfolio loans
Commercial $ 19,531 $ 18,860 $ 22,001 $ 19,197 $ 22,208
Commercial construction 2,270 2,245 2,318 2,257 2,250
Real estate-- commercial 10,821 9,819 9,475 10,320 9,448
Real estate-- residential 27,981 27,076 22,469 27,529 21,751
Home equity lines of credit 12,819 11,396 8,761 12,108 8,458
Credit card and other unsecured lines of credit 2,232 2,283 2,084 2,257 2,059
Other consumer 7,209 7,406 7,957 7,306 7,955
--------- -------- -------- --------- --------
Total portfolio loans 82,863 79,085 75,065 80,974 74,129
Loans held for sale or securitization 13,910 12,323 24,118 13,117 23,325
Securities (at amortized cost) 6,646 6,537 7,397 6,591 7,844
Other 1,148 814 775 981 779
--------- -------- -------- --------- --------
TOTAL EARNING ASSETS $ 104,567 $ 98,759 $107,355 $ 101,663 $106,077
========= ======== ======== ========= ========
54
Average portfolio loans grew 5% and 10% during the second quarter of 2004
compared to the first quarter of 2004 and the same quarter a year ago,
respectively. Average portfolio loans grew 9% during the first half of 2004 over
the same comparable period last year. The growth in portfolio loans continues to
be driven by the retention of residential real estate loan production from First
Franklin and home equity production from the National Home Equity division, both
of which achieved record origination levels in the second quarter of 2004.
Portfolio loan growth was also affected to a lesser extent by the April 2004
acquisition of Allegiant. During the second quarter of 2004, $2.7 billion of
First Franklin's production was retained for the residential real estate
portfolio, compared to $1.6 billion last quarter, and $1.9 billion in the
quarter a year ago. Over the past year, $10.2 billion of First Franklin loans
were retained in portfolio. Period-end First Franklin residential real estate
loans grew to $16.7 billion at June 30, 2004, up from $15.6 billion last quarter
and $11.5 billion at June 30, 2003. Additionally, during the first half of 2004
$196 million of adjustable-rate mortgage loans originated by National City
Mortgage Co. (NCMC) were retained in portfolio, compared to $1.2 billion of
these loans retained in portfolio during 2003. Offsetting the growth in the real
estate residential portfolio was the second quarter 2004 and fourth quarter 2003
sale of $116 million and $950 million, respectively, of the former Altegra
portfolio. Home equity production remained strong during the second quarter and
first half of 2004 and continued to benefit from a low interest rate environment
and focus on the national market. The growth in the commercial real estate
portfolio was mainly attributed to the Allegiant acquisition. The acquisition of
Allegiant Bancorp added approximately $1.8 billion in portfolio loans, of which
approximately $273 million, $234 million and $675 million were commercial,
commercial construction and commercial real estate loans, respectively.
Excluding the impact of Allegiant, average balances of commercial loans declined
over the past year, as paydowns have exceeded new volume, but this trend began
to reverse itself in 2004. Commercial loan growth is expected to continue over
the remainder of 2004. Partially offsetting the increases in average portfolio
loans were the securitization of $890 million of automobile loans in the first
quarter of 2004 and the continued run-off of the automobile lease portfolio,
both of which contributed to the decrease in the other consumer portfolio.
The year-over-year decrease in average loans held for sale is mainly attributed
to lower levels of origination volume at NCMC, offset to some extent by mortgage
loan origination activity at First Franklin, which was the main driver behind
the linked-quarter increase in average loans held for sale. The increase in
First Franklin loans held for sale is reflective of expansion of its production
footprint, new product offerings, and a higher percentage of production being
sold to third parties, versus held in portfolio, than in the past.
The year-over-year decrease in average securities was primarily the result of
sales and principal paydowns in the mortgage-backed and asset-backed securities
portfolio. The linked-quarter increase in average securities is primarily due to
investment securities acquired in the Allegiant acquisition.
The following table summarizes the period-end commercial, commercial
construction, and commercial real estate portfolios by major industry and
exposure to individual borrowers as of June 30, 2004.
Average Largest Loan
Outstanding % to Loan Balance to a Single
(Dollars in Millions) Balance Total Per Obligor Obligor
- --------------------- ----------- ----- ------------ ------------
Real estate $ 9,974 30% $ .90 $ 58
Consumer cyclical 5,172 16 .90 93
Consumer noncyclical 3,811 11 .40 38
Industrial 3,297 10 .90 30
Basic materials 2,536 8 1.30 33
Financial 1,717 5 1.30 45
Services 1,231 4 .40 63
Energy and utilities 512 1 .90 20
Technology 266 1 2.30 24
Miscellaneous 1,971 6 .20 19
Other(a) 1,182 4
----------- ----- ------------ ------------
31,669 96
Commercial leasing-- all industries 1,369 4
----------- ----- ------------ ------------
TOTAL $ 33,038 100%
=========== ===== ============ ============
(a) Represents commercial, commercial construction, and commercial real estate
balances acquired in the Allegiant acquisition. Industry data for these
loans was not available at June 30, 2004.
55
AVERAGE INTEREST BEARING LIABILITIES AND FUNDING
A summary of average interest bearing liabilities and funding follows:
Three Months Ended Six Months Ended
--------------------------------- ---------------------
JUNE 30 March 31 June 30 JUNE 30 June 30
(In Millions) 2004 2004 2003 2004 2003
- ------------------------------------------------------- -------- -------- -------- -------- --------
Noninterest bearing deposits $ 17,756 $ 15,658 $ 17,596 $ 16,707 $ 16,648
Interest bearing core deposits 44,664 42,702 41,464 43,683 40,934
-------- -------- -------- -------- --------
Total core deposits 62,420 58,360 59,060 60,390 57,582
Purchased deposits 10,248 7,378 10,157 8,813 10,065
Short-term borrowings 9,801 9,536 13,480 9,668 14,207
Long-term debt 20,031 21,339 23,914 20,686 23,373
-------- -------- -------- -------- --------
Total purchased funding 40,080 38,253 47,551 39,167 47,645
Stockholders' equity 10,370 9,659 8,786 10,014 8,658
-------- -------- -------- -------- --------
TOTAL FUNDING $112,870 $106,272 $115,397 $109,571 $113,885
======== ======== ======== ======== ========
TOTAL INTEREST BEARING LIABILITIES $ 84,744 $ 80,955 $ 89,015 $ 82,850 $ 88,579
======== ======== ======== ======== ========
TOTAL CORE DEPOSITS, EXCLUDING MORTGAGE ESCROW DEPOSITS $ 57,672 $ 54,913 $ 53,411 $ 56,292 $ 52,644
======== ======== ======== ======== ========
The percentage of each funding source to total funding follows:
Three Months Ended Six Months Ended
----------------------------- ------------------
JUNE 30 March 31 June 30 JUNE 30 June 30
2004 2004 2003 2004 2003
----- ----- ----- ----- -----
Noninterest bearing deposits 15.7% 14.7% 15.3% 15.3% 14.6%
Interest bearing core deposits 39.6 40.2 35.9 39.9 35.9
----- ----- ----- ----- -----
Total core deposits 55.3 54.9 51.2 55.2 50.5
Purchased deposits 9.1 6.9 8.8 8.0 8.9
Short-term borrowings 8.7 9.0 11.7 8.8 12.5
Long-term debt 17.7 20.1 20.7 18.9 20.5
----- ----- ----- ----- -----
Total purchased funding 35.5 36.0 41.2 35.7 41.9
Stockholders' equity 9.2 9.1 7.6 9.1 7.6
----- ----- ----- ----- -----
TOTAL 100.0% 100.0% 100.0% 100.0% 100.0%
===== ===== ===== ===== =====
Average core deposits, excluding mortgage escrow deposits, grew for the 15th
consecutive quarter and were up 5% and 8% over average balances in the first
quarter 2004 and second quarter of 2003, respectively. This growth, aided by the
acquisition of approximately $1.7 billion of core deposits from Allegiant,
continues to be reflective of new account acquisition and retention, attractive
product offerings such as free checking and online bill payment, and an ongoing
emphasis on service quality and customer care. Purchased deposits and short-term
borrowings, which are mainly used to fund mortgage loans held for sale,
decreased during the first half of 2004 consistent with lower average balances
of mortgage loans held for sale. The linked-quarter increase in purchased
deposits was to fund asset growth in excess of core deposit growth. The lower
average long-term debt balances in the second quarter and first half of 2004
were primarily attributed paydowns and maturities more than offsetting the
impact of new debt issuances and long-term debt acquired with Allegiant.
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 $10.3 billion at June 30, 2004, up from $9.3 billion
and $9.0 billion at December 31, 2003 and June 30, 2003, respectively. Equity as
a percentage of assets was 8.84% at June 30, 2004, compared to 8.19% at December
31, 2003 and 7.32% a year ago. Book value per common share rose to $16.86 at
June 30, 2004, up from $15.39 and $14.72 at December 31, 2003 and June 30, 2003,
respectively.
56
The following table summarizes share repurchase activity for the second quarter
of 2004.
Total Number of Shares Maximum Number of Shares that
Total Number Average Purchased Under Publicly May Yet Be Purchased Under
of Shares Price Paid Announced Share Repurchase the Share Repurchase
Period Purchased(a) Per Share Authorizations Authorizations(b)
- ------------------------------------- ---------------- -------------- ---------------------------- -----------------------------
April 1 to April 30, 2004 123,975 $ 35.00 -- 50,000,000
May 1 to May 31, 2004 73,795 34.68 -- 50,000,000
June 1 to June 30, 2004 9,347,943 35.06 9,011,600 40,988,400
- ------------------------------------- ----------- ---------- -------------------------- -----------------------------
TOTAL 9,545,713 $ 35.06 9,011,600 40,988,400
===================================== =========== ========== ========================== =============================
(a) Includes shares repurchased under the February 16, 2004 share repurchase
authorization and shares acquired under the Corporation's Long-term Cash
and Equity Compensation Plan (the Plan). Under the terms of the Plan, the
Corporation accepts common shares from employees when they elect to
surrender previously owned shares upon exercise of stock options or awards
to cover the exercise price of the stock options or awards or to satisfy
tax withholding obligations associated with the stock options or awards.
(b) Shares available to be repurchased under the February 16, 2004 share
repurchase authorization.
On February 16, 2004, the Corporation's Board of Directors authorized a share
repurchase program for the repurchase of up to 50 million shares of National
City common stock, subject to an aggregate purchase limit of $2.0 billion. This
new authorization has no date of expiration and replaced all previous share
repurchase authorizations. Shares repurchased under this program and under
previous share repurchase authorizations were purchased on the open market and
are held for reissue in connection with the Corporation's compensation plans and
for general corporate purposes. During the second quarter and first half of
2004, 9.0 million and 11.2 million shares of common stock were repurchased,
respectively. During the first half of 2003, 1.4 million shares of common stock
were repurchased and no common shares were repurchased during the second quarter
of 2003.
The Corporation's businesses typically generate significant amounts of capital
each year in excess of normal dividend and reinvestment requirements. Subject to
ongoing capital, investment, and acquisition considerations, management intends
to acquire all of the remaining shares under the current share repurchase
authorization during the second half of 2004.
National City declared and paid dividends per common share of $.32 during the
second quarter of 2004, up one and a half cents from the quarterly dividend per
share declared and paid in the 2003 second quarter of $.305. The dividend payout
is continually reviewed by management and the Board of Directors. On July 1,
2004, the Board of Directors approved a three cent increase in the third quarter
dividend to $.35 per common share, The dividend payout ratio, representing
dividends per share divided by earnings per share, was 38.6% and 32.5% for the
second quarters of 2004 and 2003, respectively.
At June 30, 2004, the Corporation's market capitalization was $21.5 billion.
National City common stock is traded on the New York Stock Exchange under the
symbol "NCC." Historical stock price information is presented in the following
table.
2004 2003
------------------------------- ----------------------------------------
SECOND First Fourth Third Second
NYSE: NCC QUARTER Quarter Quarter Quarter Quarter
- ------------- --------------- ----------- ---------- ---------- ------------
High $36.10 $37.10 $34.44 $34.56 $34.97
Low 32.60 32.14 29.46 29.03 27.72
Close 35.01 35.58 33.94 29.46 32.71
=============== =========== ========== ========== ============
57
RISK MANAGEMENT
National City management, with the oversight of the Board of Directors, has in
place various management and organizational structures for monitoring and
mitigating risk on an enterprise-wide basis. The following discussion addresses
the three major risks facing National City: credit, market, and liquidity.
CREDIT RISK
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 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. The policies governing nonperforming loans and charge-offs are
consistent with regulatory standards.
The most significant factor affecting the level of net charge-offs and
nonperforming and delinquent loans during the first half of 2004 and the
allowance for loan losses at June 30, 2004 was the overall improvement in the
economy over the past year, which lessened the financial stress on companies
that had manifested itself through increased levels of delinquencies and net
charge-offs in 2003.
There are no particular industry or geographic concentrations in net charge-offs
or nonperforming or delinquent loans.
The following tables provide information and statistics on the overall quality
of the loan portfolio.
NET CHARGE-OFFS:
Three Months Ended Six Months Ended
--------------------------------------- -------------------------
JUNE 30 March 31 June 30 JUNE 30 June 30
(In Millions) 2004 2004 2003 2004 2003
- ------------- ------------ ------------ ------------- ------------ ------------
Commercial $ (6) $16 $ 89 $ 10 $182
Commercial construction -- -- 1 -- 1
Real estate -- commercial 3 (1) 5 2 7
Real estate -- residential 20 18 25 38 56
Home equity lines of credit 4 4 5 8 9
Credit card and other
unsecured lines of credit 25 29 23 54 43
Other consumer 16 16 16 32 37
-------- -------- -------- -------- ----
TOTAL NET CHARGE-OFFS $ 62 $82 $164 $144 $335
======== ======== ======== ======== ====
Net charge-offs as a percentage of average loans by portfolio type follow:
Three Months Ended Six Months Ended
--------------------------------------- -------------------------
JUNE 30 March 31 June 30 JUNE 30 June 30
2004 2004 2003 2004 2003
------------ ------------ ------------- ------------ ------------
Commercial (.11)% .34% 1.63% .11% 1.65%
Commercial construction (.07) (.01) .18 (.04) .10
Real estate -- commercial .16 (.06) .22 .05 .16
Real estate -- residential .29 .28 .45 .28 .52
Home equity lines of credit .13 .14 .19 .13 .20
Credit card and other
unsecured lines of credit 4.66 5.08 4.46 4.87 4.19
Other consumer .80 .91 .80 .85 .94
======== ======== ======== ======== ====
TOTAL NET CHARGE-OFFS
TO AVERAGE PORTFOLIO LOANS (ANNUALIZED) .30% .42% .88% .36% .91%
======== ======== ======== ======== ====
Net charge-offs decreased in the second quarter and first half of 2004 primarily
due to lower commercial losses, reflective of improvement in the economy, lower
levels of nonperforming loans, and loan sales. The linked-quarter and
year-to-date improvement in commercial net charge-offs also reflects unusually
large recoveries, which may not necessarily be repeated in future quarters.
Overall credit quality in the commercial portfolio is expected to remain stable
during the second half of 2004. The decrease in residential real estate net
charge-offs during the first half of 2004 reflects the continued improvement in
the overall credit quality of the portfolio, including the sale of $116 million
and $950 million of the former Altegra portfolio in the second quarter of 2004
and the fourth quarter of 2003, respectively. The increase in credit card and
other unsecured lines of credit net charge-offs for the first half of 2004 was
reflective of higher losses associated with the growth and seasoning of the
portfolio coupled with higher levels of consumer bankruptcies.
58
NONPERFORMING ASSETS:
JUNE 30 December 31 June 30
(Dollars in Millions) 2004 2003 2003
- --------------------- ---------------- ----------------- ----------------
Commercial $164 $257 $402
Commercial construction 2 7 8
Real estate -- commercial 89 67 75
Real estate -- residential 184 219 222
----- ----- ----
TOTAL NONPERFORMING LOANS 439 550 707
Other real estate owned (OREO) 95 99 104
Mortgage loans held for sale 10 8 7
----- ----- ----
TOTAL NONPERFORMING ASSETS $544 $657 $818
===== ===== ====
NONPERFORMING ASSETS AS A PERCENTAGE OF:
PERIOD-END PORTFOLIO LOANS AND OTHER
NONPERFORMING ASSETS .64% .83% 1.08%
PERIOD-END TOTAL ASSETS .47 .58 .66
===== ===== ====
Detail of loans 90 days past due accruing interest follows:
JUNE 30 December 31 June 30
(In Millions) 2004 2003 2003
- ------------- ---------------- ----------------- ----------------
Commercial $ 39 $ 20 $35
Commercial construction 3 3 14
Real estate - commercial 51 32 26
Real estate - residential 383 428 431
Home equity lines of credit 13 15 15
Credit card and other unsecured lines of credit 16 18 14
Other consumer 10 12 19
Mortgage loans held for sale and other 35 37 39
----- ---- ----
TOTAL LOANS 90 DAYS PAST DUE ACCRUING INTEREST $550 $565 $593
===== ===== ====
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. Additionally, the reduction in commercial nonperforming loans benefited
from sales of nonperforming loans to third parties. Over the past year, $67
million in commercial nonperforming loans were sold to third parties, with $1
million and $12 million sold during the second quarter and first six months of
2004, respectively. The linked-quarter and year-over-year increase in real
estate commercial nonperforming assets was primarily associated with delinquent
loans acquired in the Allegiant acquisition.
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 1.35% at
June 30, 2004. The provision for loan losses was $60 million for the second
quarter of 2004, down from $83 million last quarter and down from $183 million
recorded for the same quarter last year. For the first six months of 2004, the
provision for loan losses was $143 million, down from $383 million for the
comparable 2003 period. The lower loss provision in the second quarter and first
half of 2004 is primarily reflective of the overall improvement in the credit
quality of the commercial portfolios.
An allocation of the ending allowance for loan losses by portfolio type follows:
JUNE 30 December 31 June 30
(In Millions) 2004 2003 2003
- ------------- ---------------- ----------------- ----------------
Commercial $ 420 $ 383 $ 439
Commercial construction and real estate -
Commercial 65 56 58
Real estate-- residential 117 125 138
Home equity lines of credit and other consumer loans 99 94 86
Credit card and other unsecured lines of credit 125 129 88
Unallocated 319 338 338
------ ------ ------
TOTAL ALLOWANCE $1,145 $1,125 $1,147
====== ====== ======
59
The allowance allocated to the commercial portfolio at June 30, 2004 decreased
on a year-over-year comparison due to the aforementioned overall improvement in
credit quality and sales of nonperforming commercial loans. The higher allowance
allocated to the commercial portfolio at June 30, 2004 from year-end was
primarily the result of refinements made to the loan loss allocation methodology
in the first quarter of 2004 and growth in the portfolio. The decline in the
allowance allocated to the residential real estate portfolio at June 30, 2004
was reflective of reduced estimated inherent risk in the portfolio due to
improved credit quality and the aforementioned sales of the former Altegra
portfolio. The increase in the allowance allocated to home equity and other
consumer loans at June 30, 2004 was primarily attributed to the growth in the
home equity portfolio over the past year. The year-over-year increase in the
allowance allocated to the credit card and other unsecured lines of credit
resulted from the same factors that drove the increases in net charge-offs
previously discussed. Additionally, the allowance allocated to all portfolios
was affected by loans acquired from Allegiant, with the majority of the impact
affecting the allowance allocated to the commercial, commercial construction and
commercial real estate portfolios.
The unallocated allowance, which is maintained to absorb estimated probable
inherent but undetected losses in the loan portfolio, remained relatively
unchanged at June 30, 2004 based upon management's judgment and reflects
continued uncertainty surrounding economic conditions in the near-term,
including in the primary Midwest geographic region in which the company
operates. Although most observable credit quality indicators have shown
improvement, there are also increased risks that additional undetected losses
exist in light of the severity of the past recession and ongoing uncertainty.
Such uncertainty is evidenced by lagging job creation, volatile commodity and
energy prices, the impacts of terrorism and war, budget shortfalls at all levels
of government, continuing slow demand for capital investments, especially in the
manufacturing sector, and lack of recovery in certain industry sectors, all of
which has led to greater volatility in historical loss rates used in National
City Corporation's credit risk models. Additionally, as the result of
acquisitions and expansion of lending activities into new products and markets,
the portfolio mix has changed in recent years. As a result, historical loss
experience data used in the allowance allocation estimates may not correspond
exactly to the characteristics of the current portfolio. Accordingly, the
unallocated allowance includes an amount of additional imprecision associated
with the newly acquired portfolio loans from Allegiant. Also, in some portfolio
sectors, robust data representative of a complete economic cycle is not
available. In light of these factors, management believes that the actual risk
of loss in the portfolio may be greater than the estimates in the historical
loss allocation models.
MARKET RISK
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 Risk and Public Policy Committee of the Corporation's Board of
Directors. The Corporation is also exposed to equity price risk through its
internally managed portfolio of bank and thrift common stock investments. As of
June 30, 2004, this portfolio had a cost basis and fair value of $157 million
and $169 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
market value modeling. 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. 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.
60
Market implied forward rates over the next 12 months are used as the base rate
scenario in the earnings simulation model. A high rate scenario and a low rate
scenario are also modeled and consist of statistically determined two-standard
deviation moves above and below market implied forward rates over the next 12
months. These rate scenarios are non-parallel in nature and result in short and
long-term rates moving in different magnitudes. Resulting net incomes from the
base, high, and low scenarios are compared and the percentage change from base
net income is limited by ALCO policy to -4.0%.
The most recent earnings simulation model prepared for the July 2004 ALCO
meeting projects net income would be 1.2% higher than base net income if rates
were two standard deviations higher than the implied forward curve over the next
12 months. The model also projects a decrease in net income of 2.5% if rates
were two standard deviations below the implied forward curve over the same
period. Both of the earning simulation projections in net income were within the
ALCO guideline of -4.0%.
The earnings simulation model excludes the earnings dynamics related to how fee
income and noninterest expense may be affected by changes in interest rates.
Mortgage banking revenue in particular, which is generated from originating,
selling, and servicing residential mortgage loans, is highly sensitive to
changes in interest rates due to the direct effect changes in interest rates
have on loan demand and the value of mortgage servicing assets. In general, low
or declining interest rates typically lead to increased origination and sales
income but potentially lower servicing-related income due to the impact of
higher loan prepayments on the value of mortgage servicing assets. Conversely,
high or rising interest rates typically reduce mortgage loan demand and hence
origination and sales income while servicing-related income may rise due to
lower prepayments. In addition, net interest income earned on loans held for
sale increases when the yield curve steepens and decreases when the yield curve
flattens. Risk related to mortgage banking activities is also monitored by ALCO.
Market Value Modeling: Market Value of Equity (MVE) analysis is used to estimate
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 MVE of the balance sheet is defined as the discounted present value
of asset cash flows, minus the discounted present value of liability cash flows,
plus or minus the discounted present value of any off-balance sheet cash flows.
Unlike the earnings simulation model, MVE analysis has no time horizon
limitations. In addition, MVE analysis is performed as of a single point in time
and does not include estimates of future business volumes. As with earnings
simulations, assumptions driving timing and magnitude of balance sheet cash
flows are critical inputs to the model. Particularly important are assumptions
driving loan and security prepayments and noncontractual deposit balance and
rate behavior.
The sensitivity of MVE to changes in interest rates is an indication of the
longer-term interest rate risk embedded in the balance sheet. This risk may not
be present in an earnings simulation due to the short time horizon or the effect
of estimated new business volumes in the earnings simulation model. A primary
measure of the sensitivity of MVE to movements in rates is defined as the
Duration of Equity (DOE). DOE represents the estimated percentage change in MVE
for a 1% instantaneous, parallel shift in the yield curve. Generally, the larger
the DOE the more sensitive the value of the balance sheet is to movements in
rates. A positive DOE indicates the MVE should increase as rates fall, or
decrease as rates rise. A negative DOE indicates that MVE should increase as
rates rise, or decrease as rates fall. Due to the embedded options in the
balance sheet, DOE is not constant and can shift with movements in the level or
shape of the yield curve. ALCO has set limits on the maximum and minimum
acceptable DOE at +3.0 and -1.0, respectively, as measured between +/- 150 basis
point instantaneous, parallel shifts in the yield curve.
The most recent market value model prepared for the July 2004 ALCO meeting
estimated the current DOE at -0.6. DOE would rise to +0.1 given a parallel shift
of the yield curve up 150 basis points and would be within the maximum
constraint of +3.0. DOE would fall to -2.7 given a parallel shift of the yield
curve down 150 basis points and would be out of the minimum constraint of -1.0,
however management believes the likelihood of a sustained 150 basis point fall
in rates from current rate levels to be unlikely.
At the end of 2003, the interest-rate-risk position, as presented and discussed
in the 2003 Form 10-K, was asset sensitive, meaning net income should increase
as rates rise and decrease as rates fall. During the first six months of 2004,
the Corporation maintained an asset sensitive interest-rate-risk position both
from an earnings simulation and DOE perspective due to management's expectation
that rates would rise.
Interest Rate Risk Management: Financial instruments used to manage interest
rate risk include investment securities and interest rate derivatives, which
include interest rate swaps, interest rate caps and floors, interest rate
forwards, and exchange-traded futures and options contracts. Interest rate
derivatives have characteristics similar to securities but possess the
advantages of customization of the risk-reward profile of the instrument,
minimization of balance sheet leverage, and improvement of the liquidity
position. Further discussion of the use of and the accounting for derivative
instruments is included in Notes 1 and 22 to the consolidated financial
statements.
61
LIQUIDITY RISK
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 objective of liquidity risk management is to
ensure that 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 risk management also
includes ensuring cash flow needs are met at a reasonable cost. The Corporation
maintains a liquidity risk management policy which 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 crisis. The liquidity position is continually monitored and reviewed
by the Asset/Liability Management Committee.
Funds are available from a number of sources, including the securities
portfolio, the core deposit base, the capital markets, the Federal Home Loan
Bank, the U.S. Treasury, and through the sale and securitization of various
types of assets. Funding sources did not change significantly during the second
quarter and first half of 2004. Core deposits, the most significant source of
funding, comprised approximately 54% of funding at June 30, 2004 and December
31, 2003, and 51% of funding at June 30, 2003. Asset securitization vehicles
have also been used as a source of funding over the past several years. During
the first half of 2004, the Corporation securitized $890 million of automobile
loans. Further discussion of securitization activities is included in Note 5 to
the consolidated financial statements.
At the holding company level, the Corporation uses cash 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
six months of 2004, the bank subsidiaries declared cash dividends totaling $1.3
billion, of which $206 million has been paid to the holding company. There were
no returns of capital provided to the holding company from the bank subsidiaries
during the first half of 2004.
Funds raised in the commercial paper market through the Corporation's
subsidiary, National City Credit Corporation, support the short-term cash needs
of the holding company and nonbank subsidiaries. At June 30, 2004, December 31,
2003 and June 30, 2003, $612 million, $693 million and $366 million,
respectively, of commercial paper borrowings were outstanding.
The holding company has a $500 million internal line of credit with its banking
subsidiaries to provide additional liquidity support. There were no borrowings
under this agreement at June 30, 2004, December 31, 2003, and June 30, 2003. The
holding company also has a $375 million revolving credit agreement with a group
of unaffiliated financial institutions, which serves as a back-up liquidity
facility. No borrowings have occurred under this facility. This facility expires
in 2005 with a provision to extend the expiration date under certain
circumstances.
The Corporation also has in place a shelf registration with the SEC to allow for
the sale, over time, of up to $1.5 billion in senior subordinated debt
securities, preferred stock, depositary shares, and common stock issuable in
connection with conversion of the aforementioned securities. During the first
half of 2004, the holding company issued $200 million of senior notes under this
shelf registration, leaving $1.3 billion available for future issuance.
62
CONTRACTUAL OBLIGATIONS, COMMITMENTS, CONTINGENT LIABILITIES,
AND OFF-BALANCE SHEET ARRANGEMENTS
The following table presents, as of June 30, 2004, 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. 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(a) $58,069 $ -- $ -- $ -- $58,069
Consumer and brokered certificates
of deposits(b)(c) 5,466 7,581 1,885 1,499 16,431
Federal funds borrowed and security
repurchase agreements(b) 5,893 -- -- -- 5,893
Borrowed funds(b) 12 3,732 -- -- -- 3,732
Long-term debt(b)(c) 13,14 7,895 6,966 3,968 4,597 23,426
Operating leases 120 187 141 282 730
Purchase obligations 151 175 65 6 397
(a) Excludes interest.
(b) Includes interest on both fixed and variable rate obligations. The interest
associated with variable rate obligations is based upon interest rates in
effect at June 30, 2004. The contractual amounts to be paid on variable
rate obligations are affected by changes in market interest rates. Future
changes in market interest rates could materially affect the contractual
amounts to be paid.
(c) Excludes unamortized premiums or discounts, hedge basis adjustments, or
other similar carrying value adjustments.
The Corporation's operating lease obligations represent short and long-term
lease and rental payments for facilities, certain software and data processing
and other equipment. Purchase obligations represent obligations under agreements
to purchase goods or services that are enforceable and legally binding and that
specify all significant terms, including: fixed or minimum quantities to be
purchased; fixed, minimum or variable price provisions; and the approximate
timing of the transaction. The purchase obligation amounts presented above
primarily relate to certain contractual payments for services provided for
information technology, data processing, advertising, and the outsourcing of
certain operational activities.
The Corporation also has obligations under its postretirement plan as described
in Note 21 to the consolidated financial statements. The postretirement benefit
payments represent actuarially determined future benefit payments to eligible
plan participants. The Corporation reserves the right to terminate the
postretirement benefit plan at any time. The Corporation did not have any
commitments or obligations to the defined benefit pension plan at June 30, 2004
due to the funded status of the plan.
The Corporation also enters into derivative contracts under which it either
receives cash from or pays 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,
involve monthly cash settlement. Because the derivative liabilities recorded on
the balance sheet at June 30, 2004 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.
63
Commitments: The following table details the amounts and expected maturities of
significant commitments as of June 30, 2004. Further discussion of these
commitments is included in Note 19 to the consolidated financial statements.
One Year One to Three to Over
(In Millions) or Less Three Years Five Years Five Years Total
- ------------- --------------- --------------- -------------- ------------ ---------
Commitments to extend credit:
Commercial $ 7,855 $4,998 $2,363 $202 $15,418
Residential real estate 15,996 -- -- -- 15,996
Revolving home equity and credit card lines 25,518 -- -- -- 25,518
Other 397 -- -- -- 397
Standby letters of credit 2,006 1,051 584 120 3,761
Commercial letters of credit 322 7 -- -- 329
Net commitments to sell mortgage loans and mortgage-
backed securities 9,734 -- -- -- 9,734
Commitments to fund principal investments 43 110 44 59 256
Commitments to fund civic and community investments 108 43 23 32 206
Commitments to extend credit, including loan commitments, standby letters of
credit, and commercial letters of credit do not necessarily represent future
cash requirements, in that these commitments often expire without being drawn
upon.
The commitments to fund principal investments primarily relate to indirect
investments in various private equity funds managed by third-party general and
limited partners. These estimated commitments were based primarily on the
expiration of each fund's investment period at June 30, 2004. The timing of
these payments could change due to extensions in the investment periods of the
funds or by the rate the commitments are invested, both of which are determined
by either the general and/or limited partners of the funds.
The commitments to fund civic and community investments represent future cash
outlays for the construction and development of properties for low-income
housing, small business real estate, and historic tax credit projects. The
timing and amounts of these commitments are projected based upon the financing
arrangements provided in each project's partnership or operating agreement, and
could change due to variances in the construction schedule, project revisions,
or the cancellation of the project.
Contingent Liabilities: The Corporation may also incur 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
Note 19 to the consolidated financial statements.
Off-Balance Sheet Arrangements: The Corporation's significant off-balance sheet
arrangements include the use of special-purpose entities, generally
securitization trusts, to diversify its funding sources. During the past three
years, National City has sold credit card receivables and automobile loans to
securitization trusts which are considered qualifying special-purpose entities
and, accordingly, are not included in the consolidated balance sheet. The
Corporation continues to service the loans sold to the trusts, for which it
receives a servicing fee, and also has certain retained interests in the assets
of the trusts. Further discussion on the accounting for securitizations is
included in Note 1 to the consolidated financial statements and detail regarding
securitization transactions and retained interests is included in Note 5.
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.
64
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,
and the valuation of derivative instruments 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.
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 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 loss experience 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 section of this financial review includes a discussion of the
factors driving changes in the allowance for loan losses during the current
period.
65
MORTGAGE SERVICING RIGHT (MSR) ASSETS
Servicing residential mortgage loans for third-party investors represents a
significant business activity of the National City Mortgage Co. line of
business. As of June 30, 2004, MSR assets totaled $1.9 billion. MSRs do not
trade in an active open market with readily observable market prices. Although
sales of MSRs do occur, the exact terms and conditions may not be readily
available. As a result, MSRs are established and valued using discounted cash
flow modeling techniques which require management to make estimates regarding
future net servicing cash flows, taking into consideration actual and expected
mortgage loan prepayment rates, discount rates, servicing costs, and numerous
other factors. The expected and actual rates of mortgage loan prepayments are
the most significant factors driving the value of MSRs. 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
MSRs, 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. MSRs are
carried at the lower of the initial capitalized amount, net of accumulated
amortization and hedge accounting adjustments, or fair value. Certain MSRs
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 reasonable and comparable to those used by other market participants.
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 MSRs
would have on the fair value. Management mitigates risk associated with declines
in the estimated fair value of its MSRs due to increases in mortgage loan
prepayments through the use of derivative instruments that are expected to
increase in value when interest rates decline. The effects of recognized changes
in the values of the MSRs and the related derivative instruments are included in
mortgage banking revenue on the income statement. Note 11 to the financial
statements includes 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 June
30, 2004, the recorded fair value of derivative assets and liabilities were $876
million and $707 million, respectively. All derivative instruments are carried
at fair value on the balance sheet. The valuation of derivative instruments is
considered critical because most 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 are 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 City Mortgage Co. 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. Notes 1 and 22 to the consolidated financial
statements also provide further discussion on the accounting and use of
derivative instruments.
Any material effect on the financial statements related to these critical
accounting areas is also discussed in this financial review.
RECENT ACCOUNTING PRONOUNCEMENTS AND DEVELOPMENTS
Note 2 to the consolidated financial statements discusses new accounting
policies adopted by the Corporation during 2004 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, 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.
66
FORWARD LOOKING STATEMENTS
This Quarterly Report 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, 2003, 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.
67
CONSOLIDATED AVERAGE BALANCE SHEETS
Three Months Ended Six Months Ended
--------------------------- ---------------------------
JUNE 30 June 30 JUNE 30 June 30
(In Millions) 2004 2003 2004 2003
-------------- ------------ ------------ ---------
ASSETS
Earning Assets:
Portfolio loans:
Commercial $ 19,531 $ 22,001 $ 19,197 $ 22,208
Commercial construction 2,270 2,318 2,257 2,250
Real estate-- commercial 10,821 9,475 10,320 9,448
Real estate-- residential 27,981 22,469 27,529 21,751
Home equity lines of credit 12,819 8,761 12,108 8,458
Credit card and other unsecured lines of credit 2,232 2,084 2,257 2,059
Other consumer 7,209 7,957 7,306 7,955
--------- --------- --------- ---------
Total portfolio loans 82,863 75,065 80,974 74,129
Loans held for sale or securitization:
Commercial 21 13 17 13
Mortgage 13,889 24,105 12,835 23,312
Automobile -- -- 265 --
--------- --------- --------- ---------
Total loans held for sale or securitization 13,910 24,118 13,117 23,325
Securities available for sale, at cost 6,646 7,397 6,591 7,844
Federal funds sold and security resale agreements 530 142 395 130
Other investments 618 633 586 649
--------- --------- --------- ---------
Total earning assets 104,567 107,355 101,663 106,077
Allowance for loan losses (1,143) (1,127) (1,133) (1,114)
Fair value appreciation of securities available for sale 138 302 179 313
Cash and demand balances due from banks 3,088 3,465 3,052 3,421
Properties and equipment 1,192 1,049 1,160 1,044
Other real estate owned 93 110 96 113
Mortgage servicing assets 1,593 801 1,467 781
Goodwill 1,403 1,084 1,253 1,081
Other intangible assets 72 69 66 70
Derivative assets 573 1,077 678 1,006
Accrued income and other assets 4,256 4,850 4,146 4,892
--------- --------- --------- ---------
TOTAL ASSETS $115,832 $119,035 $112,627 $117,684
========= ========= ========= =========
LIABILITIES
Deposits:
Noninterest bearing $ 17,756 $ 17,596 $ 16,707 $ 16,648
NOW and money market 28,614 25,045 27,970 24,271
Savings 2,576 2,447 2,472 2,452
Consumer time 13,474 13,972 13,241 14,211
Brokered retail CDs 531 2,601 515 2,735
Other 567 606 463 553
Foreign 9,150 6,950 7,835 6,777
--------- --------- --------- ---------
Total deposits 72,668 69,217 69,203 67,647
--------- --------- --------- ---------
Federal funds borrowed and security repurchase agreements 8,254 11,953 8,098 12,129
Borrowed funds 1,547 1,527 1,570 2,078
Long-term debt 20,031 23,914 20,686 23,373
Derivative liabilities 343 680 389 627
Accrued expenses and other liabilities 2,619 2,958 2,667 3,172
--------- --------- --------- ---------
TOTAL LIABILITIES 105,462 110,249 102,613 109,026
STOCKHOLDERS' EQUITY
Preferred -- -- -- --
Common 10,370 8,786 10,014 8,658
--------- --------- --------- ---------
TOTAL STOCKHOLDERS' EQUITY 10,370 8,786 10,014 8,658
--------- --------- --------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $115,832 $119,035 $112,627 $117,684
========= ========= ========= =========
68
DAILY AVERAGE BALANCES/NET INTEREST INCOME/RATES
(Dollars in Millions) Daily Average Balance
-----------------------------------------------------------------------------
2004 2003
------------------------------- ---------------------------------------------
SECOND First Fourth Third Second
QUARTER Quarter Quarter Quarter Quarter
--------------- --------------- --------------- -------------- --------------
ASSETS
Earning Assets:
Loans(a):
Commercial $ 19,552 $ 18,873 $ 20,035 $ 21,165 $ 22,014
Commercial construction 2,270 2,245 2,445 2,425 2,318
Real estate-- commercial 10,821 9,819 9,587 9,450 9,475
Real estate-- residential 41,870 38,856 42,624 51,111 46,574
Home equity lines of credit 12,819 11,396 10,410 9,612 8,761
Credit card and other unsecured lines of credit 2,232 2,283 2,330 2,170 2,084
Other consumer 7,209 7,936 8,150 8,167 7,957
--------- --------- --------- --------- ---------
Total loans 96,773 91,408 95,581 104,100 99,183
Securities available for sale, at cost:
Taxable 5,979 5,879 5,860 5,988 6,721
Tax-exempt 667 658 674 679 676
--------- --------- --------- --------- ---------
Total securities available for sale 6,646 6,537 6,534 6,667 7,397
Federal funds sold, security resale
agreements and other investments 1,148 814 1,103 1,217 775
--------- --------- --------- --------- ---------
Total earning assets/total interest 104,567 98,759 103,218 111,984 107,355
income/rates
Allowance for loan losses (1,143) (1,124) (1,125) (1,144) (1,127)
Fair value appreciation of securities
available for sale 138 220 201 202 302
Nonearning assets 12,270 11,568 12,172 12,609 12,505
--------- --------- --------- --------- ---------
TOTAL ASSETS $ 115,832 $ 109,423 $ 114,466 $ 123,651 $ 119,035
========= ========= ========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing liabilities:
NOW and money market accounts $ 28,614 $ 27,325 $ 26,845 $ 26,091 $ 25,045
Savings accounts 2,576 2,369 2,367 2,422 2,447
Consumer time deposits 13,474 13,008 13,178 13,337 13,972
Other deposits 1,098 858 1,205 3,241 3,207
Foreign deposits 9,150 6,520 7,260 7,186 6,950
Federal funds borrowed 5,548 4,996 5,765 7,632 9,054
Security repurchase agreements 2,706 2,946 2,989 3,028 2,899
Borrowed funds 1,547 1,594 992 1,087 1,527
Long-term debt 20,031 21,339 25,056 27,569 23,914
--------- --------- --------- --------- ---------
Total interest bearing liabilities/
total interest expense/rates 84,744 80,955 85,657 91,593 89,015
Noninterest bearing deposits 17,756 15,658 16,089 19,408 17,596
Accrued expenses and other liabilities 2,962 3,151 3,330 3,479 3,638
--------- --------- --------- --------- ---------
TOTAL LIABILITIES 105,462 99,764 105,076 114,480 110,249
TOTAL STOCKHOLDERS' EQUITY 10,370 9,659 9,390 9,171 8,786
--------- --------- --------- --------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 115,832 $ 109,423 $ 114,466 $ 123,651 $ 119,035
========= ========= ========= ========= =========
TAX-EQUIVALENT NET INTEREST INCOME
INTEREST SPREAD
Contribution of noninterest bearing sources of funds
NET INTEREST MARGIN
(a) Includes loans held for sale or securitization
69
Quarterly Interest
----------------------------------------------------------------------
2004 2003
----------------------------- ----------------------------------------
SECOND First Fourth Third Second
(Dollars in Millions) QUARTER Quarter Quarter Quarter Quarter
-------------- -------------- ------------ ------------- -------------
ASSETS
Earning Assets:
Loans(a):
Commercial $ 179 $ 175 $ 183 $ 198 $ 217
Commercial construction 24 24 25 27 26
Real estate -- commercial 151 143 144 146 146
Real estate -- residential 656 608 683 807 744
Home equity lines of credit 138 123 103 99 95
Credit card and other unsecured lines of credit 45 47 45 43 41
Other consumer 115 131 138 140 143
------ ------- ------- ------- -------
Total loans 1,308 1,251 1,321 1,460 1,412
Securities available for sale, at cost:
Taxable 70 74 73 71 93
Tax-exempt 13 12 12 13 13
------ ------- ------- ------- -------
Total securities available for sale 83 86 85 84 106
Federal funds sold, security resale
agreements and other investments 11 13 10 10 10
------ ------- ------- ------- -------
Total earning assets/total interest income/rates $1,402 $1,350 $1,416 $1,554 $1,528
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 $ 57 $ 57 $ 59 $ 63 $ 67
Savings accounts 2 2 2 3 3
Consumer time deposits 117 112 118 120 131
Other deposits 4 2 4 8 10
Foreign deposits 22 15 17 19 25
Federal funds borrowed 16 14 16 27 35
Security repurchase agreements 4 4 4 4 5
Borrowed funds 3 3 2 2 5
Long-term debt 110 116 153 157 145
------ ------- ------- ------- -------
Total interest bearing liabilities/
total interest expense/rates $ 335 $ 325 $ 375 $ 403 $ 426
Noninterest bearing deposits
Accrued expenses and other liabilities
------ ------- ------- ------- -------
TOTAL LIABILITIES
TOTAL STOCKHOLDERS' EQUITY
------ ------- ------- ------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
====== ======= ======= ======= =======
TAX-EQUIVALENT NET INTEREST INCOME $1,067 $1,025 $1,041 $1,151 $1,102
====== ======= ======= ======= =======
INTEREST SPREAD
Contribution of noninterest bearing sources of funds
------ ------- ------- ------- -------
NET INTEREST MARGIN
====== ======= ======= ======= =======
(a) Includes loans held for sale or securitization
70
Average Annualized Rate
---------------------------------------------------------------------
2004 2003
--------------------------- -----------------------------------------
SECOND First Fourth Third Second
QUARTER Quarter Quarter Quarter Quarter
------------- ------------- ------------- -------------- ------------
ASSETS
Earning Assets:
Loans(a):
Commercial 3.69% 3.72% 3.63% 3.73% 3.94%
Commercial construction 4.34 4.30 4.07 4.48 4.49
Real estate-- commercial 5.61 5.87 5.99 6.10 6.18
Real estate-- residential 6.26 6.26 6.41 6.31 6.39
Home equity lines of credit 4.29 4.33 3.97 4.11 4.36
Credit card and other unsecured lines of credit 8.02 8.30 7.57 7.81 8.06
Other consumer 6.43 6.62 6.76 6.79 7.19
------ ------- ------ ------ -----
Total loans 5.42 5.49 5.52 5.59 5.70
Securities available for sale, at cost:
Taxable 4.69 5.01 4.92 4.81 5.47
Tax-exempt 7.62 7.53 7.50 7.50 7.68
------ ------- ------ ------ -----
Total securities available for sale 4.98 5.26 5.19 5.08 5.68
Federal funds sold, security resale
agreements and other investments 3.97 6.49 3.26 3.29 5.33
------ ------- ------ ------ -----
Total earning assets/total interest income/rates 5.37% 5.48% 5.47% 5.53% 5.70%
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 .80% .83% .88% .96% 1.07%
Savings accounts .35 .35 .36 .39 .46
Consumer time deposits 3.50 3.47 3.55 3.58 3.74
Other deposits 1.13 1.13 1.07 1.05 1.26
Foreign deposits .98 .94 .94 1.05 1.42
Federal funds borrowed 1.15 1.13 1.09 1.37 1.57
Security repurchase agreements .56 .55 .53 .53 .71
Borrowed funds .81 .75 .96 .98 1.21
Long-term debt 2.21 2.18 2.42 2.26 2.44
------ ------- ------ ------ -----
Total interest bearing liabilities/
total interest expense/rates 1.59% 1.62% 1.74% 1.75% 1.92%
Noninterest bearing deposits
Accrued expenses and other liabilities
------ ------- ------ ------ -----
TOTAL LIABILITIES
TOTAL STOCKHOLDERS' EQUITY
------ ------- ------ ------ -----
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
====== ======= ====== ====== =====
TAX-EQUIVALENT NET INTEREST INCOME
====== ======= ====== ====== =====
INTEREST SPREAD 3.78% 3.86% 3.73% 3.78% 3.78%
Contribution of noninterest bearing sources of funds .31 .30 .30 .32 .33
------ ------- ------ ------ -----
NET INTEREST MARGIN 4.09% 4.16% 4.03% 4.10% 4.11%
====== ======= ====== ====== =====
(a) Includes loans held for sale or securitization
71
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 pages 60-61 of this report are incorporated herein by reference.
ITEM 4. CONTROLS AND PROCEDURES
National City Corporation'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 June 30,
2004, 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 June 30, 2004
were effective in ensuring material information required to be disclosed in this
Quarterly Report on Form 10-Q was recorded, processed, summarized, and reported
on a timely basis. Additionally, there were no changes in the Corporation's
internal control over financial reporting that occurred during the quarter ended
June 30, 2004 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.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The share repurchase disclosures contained in the Financial Condition section of
the Management Discussion and Analysis of Financial Condition and Results of
Operations on page 57 of this report are incorporated herein by reference.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On April 27, 2004 at the Annual Meeting of Stockholders of the Registrant,
stockholders took the following actions:
1. Elected as directors all nominees designated in the proxy statement dated
March 11, 2004 as follows:
NUMBER OF VOTES
--------------------------------------------------------
FOR WITHHELD
--------------------------- ------------------------
J.E. Barfield 521,289,025 10,546,406
J.S. Broadhurst 521,682,548 10,152,883
J.W. Brown 497,676,185 34,159,246
C.M. Connor 498,404,512 33,430,919
D.A. Daberko 517,915,731 13,919,700
J.T. Gorman 497,724,561 34,110,870
B.P. Healy, M.D. 522,798,651 9,036,780
P.A. Ormond 494,791,107 37,044,324
R.A. Paul 520,910,576 10,924,855
G.L. Shaheen 498,280,749 33,554,682
J.S. Thornton, Ph.D. 522,668,186 9,167,245
M. Weiss 519,207,263 12,628,168
72
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (CONTINUED)
2. Approved the National City Corporation Long-Term Cash and Equity Incentive
Plan: 343,438,178 votes cast for, 92,021,572 votes cast against, and 7,974,014
votes abstained.
3. Approved the National City Corporation Management Incentive Plan for Senior
Officers, as Amended and Restated: 454,561,116 votes cast for, 67,963,315 votes
cast against, and 9,080,588 votes abstained.
4. Ratified the Audit Committee's selection of Ernst & Young LLP as independent
auditors for National City Corporation for 2004: 517,031,370 votes cast for,
10,100,396 votes cast against, and 4,699,612 votes abstained.
73
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBITS
Any exhibits within exhibit numbers 3, 4, 10 or 14 documented in this index as
being filed with the United States Securities and Exchange Commission (SEC) as
part of the June 30, 2004 Form 10-Q have been filed separately with the SEC and
are available on request from the Secretary of the Corporation at the principal
executive offices or through the SEC at www.sec.gov.
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 National
City'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
National City's Quarterly Report on Form 10-Q for the quarter and nine
months ended September 30, 2002, and incorporated herein by reference).
4.1 Amended and restated Certificate of Incorporation of National City
Corporation dated April 13, 1999 (filed as Exhibit 3.2 to National
City's Quarterly Report on Form 10-Q for the quarter and nine months
ended September 30, 2000, and incorporated herein by reference) related
to capital stock of National City Corporation.
4.2 National City Corporation First Restatement of By-laws adopted April
27, 1987 (as Amended through October 28,2002)(filed as Exhibit 3.3 to
National City's Quarterly Report on Form 10-Q for the quarter and nine
months ended September 30,2002, and incorporated herein by reference)
related to stockholder rights.
4.3 National City agrees to furnish upon request to the Commission a copy
of each instrument defining the rights of holders of Senior and
Subordinated debt of National City.
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 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, 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).
74
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- -------------------
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).
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 The National City Corporation Management Incentive Plan for Senior
Officers, as Amended and Restated effective February 23, 2004 (filed as
Exhibit D to Registrant's Proxy Statement dated March 11, 2004, 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 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).
75
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).
10.40 The National City Corporation Long-Term Cash and Equity Incentive Plan
(filed as Exhibit 99.1 to Registrant's Current Report on Form 8-K filed
April 6, 2004, and incorporated herein by reference).
10.41 Agreement Not to Compete with Robert J. Ondercik (filed as Exhibit
10.41 to Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 2004, and incorporated herein by reference).
10.42 Amendment No. 2 to the National City Savings and Investment Plan, as
Amended and Restated effective January 1, 2001 (filed as Exhibit
10.42 to Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 2004, and incorporated herein by reference).
10.43 Amendment No. 2 to the National City Savings and Investment Plan No. 2,
as Amended and Restated effective January 1, 2001 (filed as Exhibit
10.43 to Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 2004, and incorporated herein by reference).
10.44 Amendment No. 3 to the National City Savings and Investment Plan, as
Amended and Restated effective January 1, 2001 (filed as Exhibit 10.1
to the Registrant's Post-Effective Amendment No. 3 to Form S-8
Registration Statement No. 333-61712 dated April 19, 2004, and
incorporated herein by reference).
10.45 Amendment No. 3 to the National City Savings and Investment Plan No. 2,
as Amended and Restated effective January 1, 2001 (filed as Exhibit
10.2 to the Registrant's Post-Effective Amendment No. 3 to Form S-8
Registration Statement No. 333-61712 dated April 19, 2004, and
incorporated herein by reference).
10.46 Amendment No. 4 to the National City Savings and Investment Plan, as
Amended and Restated effective January 1, 2001 (filed as Exhibit 10.3
to the Registrant's Post-Effective Amendment No. 3 to Form S-8
Registration Statement No. 333-61712 dated April 19, 2004, and
incorporated herein by reference).
10.47 Allegiant Bancorp, Inc. 2002 Stock Incentive Plan (filed as Appendix A
to Allegiant Bancorp, Inc.'s Proxy Statement for its 2002 Annual
Meeting, and incorporated herein by reference).
10.48 Allegiant Bancorp, Inc. 2000 Stock Incentive Plan (filed as Annex A to
Allegiant Bancorp, Inc.'s Proxy Statement for its 2000 Annual Meeting,
and incorporated herein by reference).
10.49 Provident Financial Group, Inc. 1988 Stock Option Plan (filed as
Exhibit 10.18 to Provident Financial Group, Inc.'s Annual Report on
Form 10-K for the fiscal year ended December 31, 2002, and incorporated
herein by reference).
10.50 Provident Financial Group, Inc. 1996 Non-Executive Officer Stock Option
Plan (filed as Exhibit 10.19 to Provident Financial Group, Inc.'s
Annual Report on Form 10-K for the fiscal year ended December 31, 2002,
and incorporated herein by reference).
10.51 Provident Financial Group, Inc. 1997 Stock Option Plan (filed as
Exhibit 10.20 to Provident Financial Group, Inc.'s Annual Report on
Form 10-K for the fiscal year ended December 31, 2002, and incorporated
herein by reference).
10.52 Provident Financial Group, Inc. 2000 Employee Stock Option Plan (filed
as Exhibit 10.21 to Provident Financial Group, Inc.'s Annual Report on
Form 10-K for the fiscal year ended December 31, 2002, and incorporated
herein by reference).
76
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- -------------------
10.53 Provident Financial Group, Inc. 2002 Outside Directors Stock Option
Plan (filed as Exhibit 10.23 to Provident Financial Group, Inc.'s
Annual Report on Form 10-K for the fiscal year ended December 31, 2002,
and incorporated herein by reference).
10.54 Provident Financial Group, Inc. 1992 Outside Directors Stock Option
Plan (filed with Provident Financial Group, Inc.'s Form S-8
Registration Statement No. 33-51230, and incorporated herein by
reference).
10.55 Provident Financial Group, Inc. Retirement Plan (filed with Provident
Financial Group, Inc.'s Form S-8 Registration Statement No. 33-90792,
and incorporated herein by reference).
10.56 Provident Financial Group, Inc. Deferred Compensation Plan (filed as
Exhibit 10.22 to Provident Financial Group, Inc.'s Annual Report on
Form 10-K for the fiscal year ended December 31, 2002, and incorporated
herein by reference).
10.57 Provident Financial Group, Inc. Outside Directors Deferred Compensation
Plan (filed as Exhibit 10.24 to Provident Financial Group, Inc.'s
Annual Report on Form 10-K for the fiscal year ended December 31, 2002,
and incorporated herein by reference).
10.58 Provident Financial Group, Inc. Supplemental Executive Retirement Plan
(filed as Exhibit 10.25 to Provident Financial Group, Inc.'s Annual
Report on Form 10-K for the fiscal year ended December 31, 2002, and
incorporated herein by reference).
12.1 Computation of Ratio of Earnings to Fixed Charges.
14.1 Code of Ethics (filed as Exhibit 14.1 to Registrant's Current Report on
Form 8-K filed on July 31, 2003, and incorporated herein by reference).
14.2 Code of Ethics for Senior Financial Officers (filed as Exhibit 14.2 to
Registrant's Current Report on Form 8-K filed on July 31, 2003, and
incorporated herein by reference).
31.1 Chief Executive Officer Sarbanes-Oxley Act 302 Certification dated
August 6, 2004 for National City Corporation's Quarterly Report on Form
10-Q for the quarter ended June 30, 2004.
31.2 Chief Financial Officer Sarbanes-Oxley Act 302 Certification dated
August 6, 2004 for National City Corporation's Quarterly Report on Form
10-Q for the quarter ended June 30, 2004.
32.1 Chief Executive Officer Sarbanes-Oxley Act 906 Certification dated
August 6, 2004 for National City Corporation's Quarterly Report on Form
10-Q for the quarter ended June 30, 2004.
32.2 Chief Financial Officer Sarbanes-Oxley Act 906 Certification dated
August 6, 2004 for National City Corporation's Quarterly Report on Form
10-Q for the quarter ended June 30, 2004.
77
REPORTS ON FORM 8-K
The following reports were filed or furnished, as indicated in the individual
report, by National City Corporation during the three-month period ended June
30, 2004 and through the date of this Form 10-Q filing:
April 6, 2004 National City announced that the Compensation and Organization
Committee of the Corporation's Board of Directors approved an
amendment to the Long-Term Cash and Equity Incentive Plan (the
plan), which was previously filed as Exhibit D in the
Corporation's Proxy Statement dated March 11, 2004. The
amended plan was also filed in this Form 8-K as Exhibit 99.1.
April 9, 2004 National City issued a news release announcing the completion
of its acquisition of Allegiant Bancorp, Inc.
April 12, 2004 National City filed an amendment to Form 8-K filed on February
17, 2004 stating that financial statements of Provident
Financial Inc. are not required to be filed in a Form 8-K.
April 15, 2004 National City issued a news release announcing its financial
results for the quarterly period ended March 31, 2004 and the
availability of the March 31, 2004 Financial Supplement on its
Web site at www.NationalCity.com.
May 6, 2004 National City filed an updated March 31, 2004 Financial
Supplement and announced the posting of the updated Financial
Supplement on its Web site.
May 20, 2004 National City announced that the shareholders of Provident
Financial Group, Inc. (Provident) approved the merger of
Provident and National City Corporation pursuant to the
Agreement and Plan of Merger.
May 25, 2004 National City announced that it entered into a definitive
agreement with U.S. Bancorp to sell its Corporate Trust Bond
Administration business.
May 26, 2004 National City issued additional information regarding the sale
of its Corporate Trust Bond Administration business to U.S.
Bancorp.
May 27, 2004 National City issued a news release announcing that management
plans to recommend an increase in the quarterly dividend to
the Board of Directors.
June 4, 2004 National City issued a news release announcing that it entered
into a definitive agreement to acquire Wayne Bancorp, Inc.
June 9, 2004 National City announced the approval of the Provident merger
by the Federal Reserve Board.
June 10, 2004 National City announced the posting of its May 31, 2004
Mid-Quarter Update to Financial Supplement to its Web site.
June 30, 2004 National City issued a news release announcing the completion
of the sale of its Corporate Trust Bond Administration
business to U.S. Bancorp.
July 1, 2004 National City issued a news release announcing the completion
of its acquisition of Provident.
July 13, 2004 National City issued a news release announcing the sale of
National Processing Inc., the Corporation's 83% owned payment
processing company, to Bank of America.
July 16, 2004 National City issued a news release announcing its financial
results for the quarterly and year-to-date periods ended June
30, 2004 and the availability of the June 30, 2004 Financial
Supplement on its Web site.
78
CORPORATE INFORMATION
CORPORATE HEADQUARTERS
National City Center
1900 East Ninth Street
Cleveland, Ohio 44114-3484
(216) 222-2000
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
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 NationalCity.com. These filings are also
accessible on the SEC's Web site at www.sec.gov.
CORPORATE GOVERNANCE
National City's corporate governance practices are described in the following
documents, which are available free of charge on the Corporation's Web site at
National City.com 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, Compensation Committee Charter, and Risk and
Public Policy 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 83%-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 -- JUNE 30, 2004
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NATIONAL CITY CORPORATION
--------------------------------------------------
(Registrant)
Date: August 6, 2004
/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