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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 October 31, 2004 -- 655,423,419
[NATIONAL CITY LOGO ]
QUARTER ENDED SEPTEMBER 30, 2004
FINANCIAL REPORT
AND FORM 10-Q
FINANCIAL REPORT AND FORM 10-Q
QUARTER ENDED SEPTEMBER 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 2
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 54
Consolidated Average Balance Sheets 73
Daily Average Balances/Net Interest Income/Rates 74
Item 3. Quantitative and Qualitative Disclosures About Market Risk 77
Item 4. Controls and Procedures 77
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings 77
Item 2. Changes in Securities and Use of Proceeds 77
Item 3. Defaults Upon Senior Securities (None)
Item 4. Submission of Matters to a Vote of Security Holders (None)
Item 5. Other Information (None)
Item 6. Exhibits and Reports on Form 8-K 78
Signatures 84
2
PART I - FINANCIAL INFORMATION
FINANCIAL HIGHLIGHTS
Three Months Ended Nine Months Ended
September 30 September 30
------------ ------------
(Dollars In Thousands, Except Per Share Amounts) 2004 2003 2004 2003
- ------------------------------------------------ ---- ---- ---- ----
FOR THE PERIOD
Tax-equivalent net interest income $ 1,195,824 $ 1,150,765 $ 3,287,761 $ 3,353,741
Provision for loan losses 98,432 107,047 241,727 490,427
Noninterest income 1,026,654 489,919 3,010,628 2,605,317
Noninterest expense 1,232,774 1,007,616 3,294,251 3,042,719
Income tax expense and tax-equivalent adjustment 300,557 182,384 942,282 852,964
------------ ------------ ------------ ------------
Net income $ 590,715 $ 343,637 $ 1,820,129 $ 1,572,948
============ ============ ============ ============
Net income per common share
Basic $ .88 $ .56 $ 2.89 $ 2.57
Diluted .86 .56 2.85 2.55
Dividends paid per common share .35 .32 .99 .93
Return on average common equity 19.00% 14.87% 22.50% 23.81%
Return on average assets 1.76 1.10 2.03 1.76
Net interest margin 4.04 4.10 4.09 4.14
Efficiency ratio 55.54 61.62 52.37 51.38
Average equity to average assets 9.26 7.42 9.03 7.38
Annualized net charge-offs to average portfolio loans .41 .64 .38 .82
Average shares
Basic 663,338,716 613,574,321 629,574,688 612,412,749
Diluted 677,143,218 618,968,822 638,546,781 617,656,351
------------ ----------- ------------ ------------
AT PERIOD END
Assets $136,372,583 $120,957,987
Portfolio loans 97,439,045 77,755,510
Loans held for sale or securitization 10,744,690 23,615,358
Securities, at fair value 9,759,041 6,755,118
Deposits 76,875,411 70,275,879
Stockholders' equity 12,492,474 9,067,844
Book value per common share $ 18.98 $ 14.89
Market value per common share 38.62 29.46
Equity to assets 9.16% 7.50%
Allowance for loan losses as a percentage of
period-end portfolio loans 1.34 1.45
Nonperforming assets to period-end
portfolio loans and other nonperforming assets .64 .97
Common shares outstanding 658,272,817 609,136,762
Full-time equivalent employees 36,392 33,188
------------ ------------
3
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended Nine Months Ended
September 30 September 30
------------ ------------
(Dollars in Thousands, Except Per Share Amounts) 2004 2003 2004 2003
- ------------------------------------------------ ---- ---- ---- ----
INTEREST INCOME
Loans $ 1,478,859 $ 1,456,575 $ 4,033,191 $ 4,264,723
Securities:
Taxable 103,590 67,650 238,215 250,583
Exempt from Federal income taxes 7,820 8,424 24,563 25,567
Dividends 7,528 4,425 16,404 15,900
Federal funds sold and security resale agreements 1,668 827 3,902 1,943
Other investments 12,975 9,272 35,206 29,486
------------ ------------- ------------ ------------
Total interest income 1,612,440 1,547,173 4,351,481 4,588,202
INTEREST EXPENSE
Deposits 230,042 213,127 620,237 691,831
Federal funds borrowed and security
repurchase agreements 25,778 30,330 63,446 112,600
Borrowed funds 3,794 2,678 9,853 16,276
Long-term debt and capital securities 164,343 157,067 390,450 434,651
------------ ------------- ------------ ------------
Total interest expense 423,957 403,202 1,083,986 1,255,358
------------ ------------- ------------ ------------
NET INTEREST INCOME 1,188,483 1,143,971 3,267,495 3,332,844
PROVISION FOR LOAN LOSSES 98,432 107,047 241,727 490,427
------------ ------------- ------------ ------------
Net interest income after provision for loan losses 1,090,051 1,036,924 3,025,768 2,842,417
NONINTEREST INCOME
Mortgage banking revenue 369,765 (26,883) 1,142,336 1,030,774
Deposit service charges 172,526 144,940 481,428 421,802
Payment processing revenue 132,931 124,517 386,494 342,975
Trust and investment management fees 73,146 72,403 228,525 219,072
Card-related fees 35,148 41,827 110,243 126,944
Brokerage revenue 33,476 32,776 99,895 90,680
Leasing revenue 87,522 10,602 99,126 28,639
Other 119,151 84,339 454,256 307,456
------------ ------------- ------------ ------------
Total fees and other income 1,023,665 484,521 3,002,303 2,568,342
Securities gains, net 2,989 5,398 8,325 36,975
------------ ------------- ------------ ------------
Total noninterest income 1,026,654 489,919 3,010,628 2,605,317
NONINTEREST EXPENSE
Salaries, benefits, and other personnel 661,486 571,059 1,804,437 1,674,512
Equipment 72,955 54,646 208,121 172,668
Net occupancy 66,044 57,323 185,479 171,760
Third-party services 82,197 70,739 222,907 207,121
Card processing 58,969 54,194 176,908 157,714
Marketing and public relations 29,640 22,259 81,758 105,843
Leasing expense 63,097 (4,861) 68,617 49,152
Other 198,386 182,257 546,024 503,949
------------ ------------- ------------ ------------
Total noninterest expense 1,232,774 1,007,616 3,294,251 3,042,719
------------ ------------- ------------ ------------
Income before income tax expense 883,931 519,227 2,742,145 2,405,015
Income tax expense 293,216 175,590 922,016 832,067
------------ ------------- ------------ ------------
NET INCOME $ 590,715 $ 343,637 $ 1,820,129 $ 1,572,948
============ ============= ============ ============
NET INCOME PER COMMON SHARE
Basic $ .88 $ .56 $ 2.89 $ 2.57
Diluted .86 .56 2.85 2.55
AVERAGE COMMON SHARES OUTSTANDING
Basic 663,338,716 613,574,321 629,574,688 612,412,749
Diluted 677,143,218 618,968,822 638,546,781 617,656,351
============ ============= ============ ============
See Notes to Consolidated Financial Statements
4
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30 December 31 September 30
(In Thousands) 2004 2003 2003
- -------------- ---- ---- ----
ASSETS
Cash and demand balances due from banks $ 3,629,582 $ 3,595,706 $ 3,602,298
Federal funds sold and security resale agreements 292,554 162,347 131,062
Securities available for sale, at fair value 9,759,041 6,865,616 6,755,118
Other investments 1,415,418 830,887 769,141
Loans held for sale or securitization:
Commercial 16,591 16,300 15,591
Commercial real estate 235,708 -- --
Mortgage 10,492,391 14,497,277 23,599,767
Automobile -- 853,982 --
------------- ------------ -------------
Total loans held for sale or securitization 10,744,690 15,367,559 23,615,358
Portfolio loans:
Commercial 25,075,730 19,164,326 20,934,229
Commercial construction 2,894,973 2,289,429 2,524,598
Real estate -- commercial 12,024,140 9,827,877 9,495,261
Real estate -- residential 30,117,952 27,393,711 24,330,916
Home equity lines of credit 17,267,143 10,950,356 10,074,306
Credit card and other unsecured lines of credit 2,295,173 2,324,198 2,178,703
Other consumer 7,763,934 7,328,956 8,217,497
------------- ------------ -------------
Total portfolio loans 97,439,045 79,278,853 77,755,510
Allowance for loan losses (1,304,386) (1,125,329) (1,129,633)
------------- ------------ -------------
Net portfolio loans 96,134,659 78,153,524 76,625,877
Properties and equipment 1,263,170 1,085,220 1,066,819
Equipment leased to others 1,165,681 48,992 59,345
Other real estate owned 107,296 99,418 110,380
Mortgage servicing assets 1,416,112 1,298,417 1,136,987
Goodwill 3,308,500 1,103,340 1,103,271
Other intangible assets 253,800 62,475 68,631
Derivative assets 1,210,692 1,349,259 1,785,967
Accrued income and other assets 5,671,388 3,910,700 4,127,733
------------- ------------ -------------
TOTAL ASSETS $ 136,372,583 $ 113,933,460 $ 120,957,987
============= ============= =============
LIABILITIES
Deposits:
Noninterest bearing $ 18,339,275 $ 16,585,367 $ 16,828,794
NOW and money market 29,678,397 26,849,261 26,256,752
Savings 2,580,343 2,353,721 2,373,289
Consumer time 16,404,590 13,133,909 13,221,476
Other 4,794,275 924,969 2,731,341
Foreign 5,078,531 4,082,803 8,864,227
------------- ------------ -------------
Total deposits 76,875,411 63,930,030 70,275,879
Federal funds borrowed and security repurchase agreements 6,542,450 6,693,916 8,637,604
Borrowed funds 7,627,340 6,615,460 1,472,746
Long-term debt 27,883,328 23,480,724 27,118,585
Junior subordinated debentures owed to unconsolidated
subsidiary trusts 609,271 185,568 185,568
Derivative liabilities 633,828 875,737 1,246,371
Accrued expenses and other liabilities 3,708,481 2,823,354 2,953,390
------------- ------------ -------------
TOTAL LIABILITIES 123,880,109 104,604,789 111,890,143
============= ============= =============
STOCKHOLDERS' EQUITY
Preferred stock -- -- --
Common stock 2,633,092 2,423,985 2,436,547
Capital surplus 3,666,340 1,116,279 1,079,072
Retained earnings 6,105,769 5,723,720 5,502,147
Accumulated other comprehensive income 87,273 64,687 50,078
------------- ------------ -------------
TOTAL STOCKHOLDERS' EQUITY 12,492,474 9,328,671 9,067,844
------------- ------------ -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 136,372,583 $ 113,933,460 $ 120,957,987
============= ============= =============
See Notes to Consolidated Financial Statements
5
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30
------------
(In Thousands) 2004 2003
- -------------- ---- ----
OPERATING ACTIVITIES
Net income $ 1,820,129 $ 1,572,948
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 241,727 490,427
Depreciation and amortization of properties and equipment 220,045 138,200
Amortization of intangible assets and servicing assets 421,200 457,772
Accretion of premiums and discounts on securities, deposits, and debt obligations (32,675) (17,846)
Servicing asset impairment charges (recoveries) 81,338 (181,171)
Ineffective hedge and other derivative gains, net (527,989) (53,453)
Securities gains, net (8,325) (36,975)
Gains on loans sold or securitized, net (110,077) (882,808)
Other (gains) losses, net (43,890) 129,174
Originations and purchases of loans held for sale or securitization (60,720,528) (94,114,360)
Principal payments on and proceeds from sales of loans held for sale or securitization 64,114,466 94,004,099
Increase in accrued interest receivable (25,105) (10,941)
Increase in accrued interest payable 54,097 2,118
Other operating activities, net 858,833 1,616,517
------------ ------------
Net cash provided by operating activities 6,343,246 3,113,701
------------ ------------
LENDING AND INVESTING ACTIVITIES
Net (increase) decrease in federal funds sold, security resale agreements,
and other investments (60,457) 105,287
Purchases of available-for-sale securities (1,227,870) (3,070,223)
Proceeds from sales of available-for-sale securities 1,194,602 1,567,311
Proceeds from maturities, calls, and prepayments of available-for-sale securities 1,808,653 3,883,162
Net increase in loans (9,038,604) (7,689,510)
Proceeds from sales or securitizations of loans 1,919,370 940,528
Net increase in properties and equipment (108,572) (219,322)
Net cash received (paid) for acquisitions 322,537 (35,118)
Cash received for sale of Corporate Trust Bond Administration business 66,500 --
------------ ------------
Net cash used in lending and investing activities (5,123,841) (4,517,885)
------------ ------------
DEPOSIT AND FINANCING ACTIVITIES
Net increase in deposits 1,002,712 5,176,349
Net (decrease) increase in federal funds borrowed and security repurchase agreements (1,779,259) 2,109,346
Net increase (decrease) in borrowed funds 577,052 (10,021,163)
Repayments of long-term debt (11,733,899) (6,238,262)
Proceeds from issuances of long-term debt, net 12,066,970 10,872,845
Dividends paid (629,269) (569,494)
Issuances of common stock 290,730 118,359
Repurchases of common stock (980,566) (197,924)
------------ ------------
Net cash (used in) provided by deposit and financing activities (1,185,529) 1,250,056
------------ ------------
Net increase (decrease) in cash and demand balances due from banks 33,876 (154,128)
Cash and demand balances due from banks, January 1 3,595,706 3,756,426
------------ ------------
CASH AND DEMAND BALANCES DUE FROM BANKS, SEPTEMBER 30 $ 3,629,582 $ 3,602,298
============ ============
SUPPLEMENTAL INFORMATION
Cash paid for:
Interest $ 1,029,889 $ 1,253,240
Income taxes 852,581 1,034,656
Noncash items:
Transfers of loans to other real estate 246,002 153,468
Carrying value of securities donated to the National City Charitable Foundation -- 25,007
Stock and options issued in Allegiant and Provident acquisitions 2,647,461 --
============ ============
See Notes to Consolidated Financial Statements
6
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Accumulated
Other
Preferred Common Capital Retained Comprehensive
(Dollars in Thousands, Except Per Share Amounts) Stock Stock Surplus Earnings Income Total
- ------------------------------------------------ ----- ----- ------- -------- ------ -----
Balance, January 1, 2003 $ -- $2,445,966 $ 989,346 $4,658,565 $67,180 $ 8,161,057
Comprehensive income:
Net income 1,572,948 1,572,948
Other comprehensive income, net of tax:
Change in unrealized gains and losses on
securities, net of reclassification
adjustment for net gains included
in net income (70,040) (70,040)
Change in unrealized gains and losses on
derivative instruments used in cash flow
hedging relationships, net of
reclassification adjustment for net losses
included in net income 52,938 52,938
-----------
Total comprehensive income 1,555,846
Common dividends declared, $.93 per share (569,494) (569,494)
Issuance of 4,351,703 common shares under
stock-based compensation plans 17,406 100,953 118,359
Repurchase of 6,706,300 common shares (26,825) (11,227) (159,872) (197,924)
------ ---------- ---------- ---------- ------- -----------
Balance, September 30, 2003 $ -- $2,436,547 $1,079,072 $5,502,147 $50,078 $ 9,067,844
====== ========== ========== ========== ======= ===========
Balance, January 1, 2004 $ -- $2,423,985 $1,116,279 $5,723,720 $64,687 $ 9,328,671
Comprehensive income:
Net income 1,820,129 1,820,129
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 5,746 5,746
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 16,840 16,840
-----------
Total comprehensive income 1,842,715
Common dividends declared, $.99 per share (628,876) (628,876)
Preferred dividends declared (393) (393)
Issuance of 8,624,046 common shares under
stock-based compensation plans 32,734 257,996 290,730
Repurchase of 27,193,500 common shares (108,773) (62,982) (808,811) (980,566)
Issuance of 71,286,645 common shares and 70,272
preferred shares pursuant to acquisitions(1) 285,146 2,355,437 2,640,583
Other (390) (390)
====== ========== ========== ========== ======= ===========
BALANCE, SEPTEMBER 30, 2004 $ -- $2,633,092 $3,666,340 $6,105,769 $87,273 $12,492,474
====== ========== ========== ========== ======= ===========
(1) Includes adjustment for fair value of stock options exchanged and forward
purchase contracts assumed of $85 million and $59 million, respectively
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, mortgage financing and
servicing, consumer finance, and asset management.
1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
The accompanying unaudited consolidated financial statements include the
accounts of the Corporation and its consolidated subsidiaries. The Corporation
completed its acquisitions of Allegiant Bancorp, Inc. (Allegiant) and Provident
Financial Group, Inc. (Provident) on April 9, 2004 and July 1, 2004,
respectively. The consolidated financial statements include the results of
operations of these entities from their respective dates of acquisition. 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.
7
CONSOLIDATION: Accounting Research Bulletin 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 principally included
in other assets and National City's 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
Interpretation 46 (FIN 46), Consolidation of Variable Interest Entities (VIE),
provides guidance on 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) 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, automobile loans, nonconforming residential
mortgages, and home equity loans and lines and equipment leases that were sold
to various securitization trusts. 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 (GAAP) 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 GAAP 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.
8
LOANS AND LEASES: 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.
Leases are classified as either direct financing leases or operating leases,
based on the terms of the lease arrangement. To be classified as a direct
financing lease, the lease must have at least one of the following four
characteristics: 1) the lease transfers ownership of the property to the lessee
by the end of the lease term, 2) the lease contains a bargain purchase option,
3) the lease term is equal to 75% or more of the estimated economic life of the
leased property, or 4) the present value of the lease payments and the
guaranteed residual value are at least 90% of the cost of the leased property.
Leases that do not meet any of these four criteria are classified as operating
leases and reported as equipment leased to others on the balance sheet.
Income on operating leases is recognized on a straight-line basis over the lease
term. 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 September 30,
2004 and December 31, 2003, residential real estate portfolio loans included
$214 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.
9
ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is maintained at a
level believed adequate by management to absorb probable losses inherent in the
loan portfolio and is based on the size and current risk characteristics of the
loan portfolio, an assessment of individual problem loans and actual loss
experience, current economic events in specific industries and geographical
areas, including unemployment levels, and other pertinent factors, including
regulatory guidance and general economic conditions. Determination of the
allowance is inherently subjective as it requires significant estimates,
including the amounts and timing of expected future cash flows on impaired
loans, estimated losses on pools of homogeneous loans based on historical loss
experience, and consideration of current economic trends, all of which may be
susceptible to significant change. Loan losses are charged off against the
allowance, while recoveries of amounts previously charged off are credited to
the allowance. A provision for loan losses is charged to operations based on
management's periodic evaluation of the factors previously mentioned, as well as
other pertinent factors. Evaluations are conducted at least quarterly and more
often if deemed necessary. When loans are identified for sale or securitization,
attributed loan loss allowance is reclassified as a direct reduction to the
carrying value of the loans.
The allowance for loan losses consists of an allocated component and an
unallocated component. The components of the allowance for loan losses represent
an estimation done pursuant to either SFAS 5, Accounting for Contingencies, or
SFAS 114. The allocated component of the allowance for loan losses reflects
expected losses resulting from analyses developed through specific credit
allocations for individual loans and historical loss experience for each loan
category. The specific credit allocations are based on regular analyses of all
loans over a fixed-dollar amount where the internal credit rating is at or below
a predetermined classification. The historical loan loss element is determined
statistically using a loss migration analysis that examines loss experience and
the related internal gradings of loans charged off. The loss migration analysis
is performed quarterly and loss factors are updated regularly based on actual
experience. The allocated component of the allowance for loan losses also
includes consideration of concentrations and changes in portfolio mix and
volume.
The unallocated portion of the allowance reflects management's estimate of
probable inherent but undetected losses within the portfolio due to
uncertainties in economic conditions, delays in obtaining information, including
unfavorable information about a borrower's financial condition, the difficulty
in identifying triggering events that correlate perfectly to subsequent loss
rates, and risk factors that have not yet manifested themselves in loss
allocation factors. In addition, the unallocated allowance includes a component
that explicitly accounts for the inherent imprecision in loan loss migration
models. The 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 statement of income. Interest on trading
account securities is recorded in interest income. As of September 30, 2004,
December 31, 2003, and September 30, 2003, trading account securities totaled
$467 million, $22 million, and $19 million, respectively.
Securities are classified as held to maturity when management has the positive
intent and ability to hold the securities to maturity. Securities held to
maturity, when present, are carried at amortized cost. National City held no
securities classified as held to maturity at September 30, 2004, December 31,
2003 or September 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 unrealized losses not deemed other-than-temporary 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 statement of income.
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.
10
PRINCIPAL INVESTMENTS: Principal investments, which include direct investments
in private and public companies and indirect investments in private equity
funds, are carried at estimated fair value with changes in fair value recognized
in other noninterest income.
Direct investments include equity and mezzanine investments in the form of
common stock, preferred stock, limited liability company interests, warrants,
and subordinated debt. Direct mezzanine investments in the form of subordinated
debt and preferred stock, which earn interest or dividends, are included in
other investments on the balance sheet, while the remainder of the direct
investments are included in other assets. Indirect investments include ownership
interests in private equity funds managed by third-party general partners and
are included in other assets on the balance sheet.
The fair values of publicly traded investments are determined using quoted
market prices, subject to various discount factors, sales restrictions, and
regulation, when appropriate. Investments that are not publicly traded are
initially valued at cost and subsequent adjustments to fair value are estimated
in good faith by management. Factors used in determining the fair value of
direct investments include consideration of the company's business model,
current and projected financial performance, liquidity, management team, and
overall economic and market conditions. Factors used in determining the fair
value of indirect investments include evaluation of the general partner's
valuation techniques and overall economic and market conditions. The fair value
estimates of the investments are based upon currently available information and
may not necessarily represent amounts that will ultimately be realized, which
depend on future events and circumstances.
Interest and dividends on principal investments are recorded in interest income
on the statement of income. Principal investment fee income, fair value
adjustments, realized gain and losses on the return of capital, and principal
investment write-offs are recognized in other noninterest income.
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL AND SECURITIES SOLD UNDER
AGREEMENTS TO REPURCHASE: Securities purchased under agreements to resell and
securities sold under agreements to repurchase are generally accounted for as
collateralized financing transactions and are recorded at the amounts at which
the securities were acquired or sold plus accrued interest. Securities,
generally U.S. government and Federal agency securities, pledged as collateral
under these financing arrangements cannot be sold or repledged by the secured
party. The fair value of collateral either received from or provided to a third
party is continually monitored, and additional collateral 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 with finite lives include core deposit, credit card, merchant
portfolio, operating lease, 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 and
merchant portfolio intangibles are amortized over their estimated useful lives
on a straight-line basis, which range from one to 10 years. Operating lease
intangibles are amortized based upon an accelerated amortization method over the
remaining weighted average lease term which approximates 24 months. Other
intangibles, which consist primarily of customer contracts and noncompete
agreements, are amortized over the period benefited ranging from three to nine
years. Amortization expense for core deposits, merchant portfolio, and other
intangibles are recognized in noninterest expense. Amortization expense for
operating lease intangibles is recognized in noninterest income. 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.
11
Equipment leased to others is stated at cost less accumulated depreciation.
Depreciation expense is recorded on a straight-line basis over the life of the
lease considering the estimated residual value. On a periodic basis, a review is
undertaken to determine if the leased equipment is impaired by comparing
expected undiscounted cash flows from rental income to the equipment carrying
value. An impairment loss is recognized if the carrying amount of the equipment
exceeds the expected cash flows.
ASSET SECURITIZATIONS: National City uses the securitization of financial assets
as a source of funding. Financial assets, including pools of credit card
receivables and automobile loans, are transferred into trusts or to SPEs in
transactions which are effective under applicable banking rules and regulations
to legally isolate the assets from National City Bank (the Bank), a subsidiary
of the Corporation. Where the transferor is a depository institution such as a
bank subsidiary of the Corporation, legal isolation is accomplished through
compliance with specific rules and regulations of the relevant regulatory
authorities. In addition, National City purchases the guaranteed portion of
Small Business Administration (SBA) loans from third-party lenders and then
securitizes these loans into SBA guaranteed pooled securities through the use of
a fiscal and transfer agent approved by the SBA. The certificates are then sold
directly to institutional investors, achieving legal isolation.
SFAS 140 requires, for certain transactions completed after the initial adoption
date, a "true sale" analysis of the treatment of the transfer under state law as
if the Corporation was a debtor under the bankruptcy code. A "true sale" legal
analysis includes several legally relevant factors, such as the nature and level
of recourse to the transferor and the nature of retained servicing rights. The
analytical conclusion as to a true sale is never absolute and unconditional, but
contains qualifications based on the inherent equitable powers of a bankruptcy
court, as well as the unsettled state of the common law. Once the legal
isolation test has been met under SFAS 140, other factors concerning the nature
and extent of the transferor's control over the transferred assets are taken
into account in order to determine whether derecognition of assets is warranted,
including whether the SPE has complied with rules concerning qualifying
special-purpose entities.
A legal opinion regarding legal isolation for each credit card securitization
has been obtained by the Bank. The opinion rendered in connection with the 2002
credit card securitization included in its conclusion that the Federal Deposit
Insurance Corporation (FDIC) regulation, Treatment by the Federal Deposit
Insurance Corporation as Conservator or Receiver of Financial Assets Transferred
by an Insured Depository Institution in Connection with a Securitization or
Participation (Securitization Rule) would be applicable to the transfer of such
receivables. The Securitization Rule provides reasonable assurance that neither
the FDIC acting as conservator or receiver for the transferring bank subsidiary,
nor any other creditor of the bank, may reclaim or recover the receivables from
the securitization trust or recharacterize the receivables as property of the
transferring bank subsidiary or of the conservatorship or receivership for the
bank. The opinion further reasoned, even if the Securitization Rule did not
apply, then pursuant to various FDIC pronouncements, the FDIC would uphold the
effectiveness of the security interest granted in the financial assets. 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, automobile loan,
and home equity 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
12
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.
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 will distribute
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. In addition, certain contracts and commitments are defined as derivatives
under GAAP.
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.
13
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.
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. In addition, the Corporation may purchase
the right to service mortgage loans originated by others. 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, particularly for residential
mortgage loans. 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. Prepayment rates have a lesser impact on the value of
MSRs associated with commercial real estate loans as these loans have lockout
and prepayment penalties generally ranging from five to nine years. 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, continue to be accounted for under the recognition and measurement
provisions of Accounting Principles Board Opinion 25 (APB 25), Accounting for
Stock Issued to Employees. Under
14
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.
Compensation expense for restricted share awards is ratably recognized over the
period of service, usually the restricted period, based upon the fair value of
the stock on the date of grant. The adoption of the recognition provisions of
SFAS 123 did not have a significant impact on the determination of compensation
expense for restricted share awards.
The following table illustrates the effect on net income and earnings per share
if the Corporation had applied the fair value recognition provisions of SFAS 123
to all stock option awards. Also included in the pro forma net income and
earnings per share is the after-tax expense, net of minority interest benefit,
related to option awards granted by the Corporation's former 83%-owned payment
processing subsidiary, National Processing, Inc., on its common stock. Refer to
Note 3 for discussion on the sale of this business in October 2004.
Three Months Ended Nine Months Ended
September 30 September 30
------------ ------------
(In Thousands, Except Per Share Amounts) 2004 2003 2004 2003
- ---------------------------------------- ---- ---- ---- ----
Net income, as reported $ 590,715 $ 343,637 $ 1,820,129 $ 1,572,948
Add: option expense included in reported
net income, net of related tax effects
National City common stock 4,619 3,198 12,241 5,495
National Processing common stock 35 26 173 30
Less: total option expense determined under
fair value method for all option awards, net
of related tax effects
National City common stock (4,619) (9,564) (22,107) (33,265)
National Processing common stock (577) (1,086) (2,749) (4,285)
--------- --------- ----------- -----------
PRO FORMA NET INCOME $ 590,173 $ 336,211 $ 1,807,687 $ 1,540,923
--------- --------- ----------- -----------
Pro forma net income per share:
Basic -- as reported $ .88 $ .56 $ 2.89 $ 2.57
Basic -- pro forma .88 .55 2.87 2.52
Diluted -- as reported .86 .56 2.85 2.55
Diluted -- pro forma .86 .54 2.83 2.49
========= ========= =========== ===========
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 Nine Months Ended
September 30 September 30
------------ ------------
2004 2003 2004 2003
---- ---- ---- ----
Risk-free interest rate 3.82% 3.30% 3.70% 3.27%
Expected dividend yield 3.93 4.10 3.93 4.16
Expected volatility 21.70 27.14 22.53 27.16
Expected option life (in years) 6 5 6 5
Weighted-average grant-date fair value of options $ 5.85 $ 6.15 $ 5.92 $ 6.04
The weighted-average assumptions used to value the National Processing option
grants are disclosed in National Processing, Inc.'s December 31, 2003 Annual
Report on Form 10-K, as filed with the United States Securities and Exchange
Commission (SEC) and 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.
15
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized as income or
expense in the period that includes the enactment date.
STOCK REPURCHASES: Acquisitions of the Corporation's common stock are recorded
using the par value method, which requires the cash paid to be allocated to
common stock, capital surplus, and retained earnings.
2. RECENT ACCOUNTING PRONOUNCEMENTS
MEANING OF OTHER THAN TEMPORARY IMPAIRMENT: In March 2004, the Financial
Accounting Standards Board (FASB) Emerging Issues Task Force (EITF) released
Issue 03-01, Meaning of Other Than Temporary Impairment, which addressed
other-than-temporary impairment for certain debt and equity investments. Various
disclosure requirements of Issue 03-01 had been finalized previous to issuance
and were required as of December 31, 2003. The recognition and measurement
requirements of Issue 03-01, and other disclosure requirements not already
implemented, were effective for periods beginning after June 15, 2004. In
September 2004, the FASB staff issued FASB Staff Position (FSP) EITF 03-1-1,
which delayed the effective date for certain measurement and recognition
guidance contained in Issue 03-1. The FSP requires the application of
pre-existing "other-than-temporary" guidance during the period of delay until a
final consensus is reached. The disclosure requirements set forth in Issue 03-01
were not delayed as a result of the issued FSP. Refer to Note 8 of the
consolidated financial statements for these required disclosures. Management
does not anticipate the issuance of the final consensus will have a material
impact on financial condition, the results of operations, or liquidity.
LOAN COMMITMENTS: On March 9, 2004, the SEC issued Staff Accounting Bulletin 105
(SAB 105), Application of Accounting Principles to Loan Commitment" 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
$22 million for the first nine 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 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 requires acquired loans, including
debt securities, to be recorded at the amount of the purchaser's initial
investment and prohibits carrying over valuation allowances from the seller for
those loans that have evidence of deterioration in credit quality since
origination, and it is probable all contractual cash flows on the loan will be
unable to be collected. SOP 03-3 also requires the excess of all undiscounted
cash flows expected to be collected at acquisition over the purchaser's initial
investment to be recognized as interest income on a level-yield basis over the
life of the loan. Subsequent increases in cash flows expected to be collected
are recognized prospectively through an adjustment of the loan's yield over its
remaining life, while subsequent decreases are recognized as impairment. Loans
carried at fair value, mortgage loans held for sale, and loans to borrowers in
good standing under revolving credit agreements are excluded from the scope of
SOP 03-3. The guidance is effective for loans acquired in fiscal years beginning
after December 15, 2004 and is not expected to have a material impact on
financial condition, results of operations, or liquidity.
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 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.
16
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 September 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.
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 $342 million at September 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, National City Corporation completed its
acquisition of Allegiant Bancorp, Inc. (Allegiant), a bank-holding company
operating 36 retail bank branch offices 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 two days before and
after the date the merger terms were agreed to and announced.
17
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 metropolitan areas. The
acquisition of Provident expands National City's 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
two 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 cost of this acquisition also
includes fair value of stock options exchanged and forward purchase contracts
assumed of $85 million and $59 million, respectively.
The assets and liabilities of Allegiant and Provident were recorded on the
balance sheet at their estimated fair values as of their respective acquisition
dates, and their results of operations have been included in the consolidated
statement of income from those dates. Refer to Note 4 for discussion on
severance and other restructuring costs incurred in connection with the these
acquisitions, and to Note 10 for further discussion on goodwill and intangible
assets.
The following table shows the excess purchase price over carrying value of net
assets acquired, purchase price allocations and resulting goodwill for the
Allegiant and Provident acquisitions:
(In Thousands) ALLEGIANT PROVIDENT
- -------------- --------- ---------
Purchase price $ 492,629 $2,181,308
Carrying value of net assets acquired (142,661) (734,519)
--------- ----------
Excess of purchase price over carrying value of net assets acquired 349,968 1,446,789
Purchase accounting adjustments
Securities 1,769 50,260
Portfolio loans (33,389) (38,776)
Premises and equipment 3,730 24,173
Leased equipment -- 26,075
Other assets 862 (19,172)
Deposits 9,960 169,695
Borrowings 18,765 216,450
Severance and exit costs 3,483 328,169
Other liabilities -- 90,768
Deferred taxes 5,052 (220,019)
--------- ----------
Subtotal 360,200 2,074,412
--------- ----------
Core deposit intangibles (31,777) (132,956)
Other identifiable intangible assets (3,261) (64,840)
--------- ----------
GOODWILL $ 325,162 $1,876,616
========= ==========
The following table summarizes the estimated fair value of the net assets
acquired related to these acquisitions:
(In Thousands) ALLEGIANT PROVIDENT
- -------------- --------- ---------
Assets
Cash and cash equivalents $ 33,547 $ 317,247
Securities 346,049 4,863,870
Loans, net of allowance for loan losses 1,936,258 9,202,871
Premises and other equipment 39,693 1,356,655
Goodwill and other intangibles 360,200 2,074,412
Other assets 91,900 715,201
----------- -----------
Total Assets 2,807,647 18,530,256
Liabilities
Deposits 1,799,534 10,059,405
Borrowings 499,399 5,449,845
Other liabilities 16,085 839,698
----------- -----------
Total Liabilities 2,315,018 16,348,948
----------- -----------
FAIR VALUE OF NET ASSETS ACQUIRED $ 492,629 2,181,308
=========== ===========
18
The estimated fair values of the acquired assets and liabilities, including
identifiable intangible assets, are preliminary and subject to refinement as
exit plans are finalized and 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.
The following unaudited pro forma consolidated financial information presents
the combined results of operations of National City, Allegiant, and Provident,
as if the acquisitions of both had occurred as of the beginning of 2003 and
2004, respectively.
Three Months Ended NINE MONTHS ENDED Nine Months Ended
(In Thousands) September 30, 2003 SEPTEMBER 30, 2004 September 30, 2003
- -------------- ------------------ ------------------ ------------------
Net interest income $ 1,259,501 $ 3,490,774 $ 3,712,952
Provision for loan losses 121,321 332,275 577,026
------------ ------------ ------------
Net interest income after provision for loan losses 1,138,180 3,158,499 3,135,926
Noninterest income 674,816 3,304,046 3,191,520
Noninterest expense 1,262,904 3,817,937 3,867,296
------------ ------------ ------------
Income before income tax expense 550,092 2,644,608 2,460,150
Income tax expense 184,846 885,143 848,152
------------ ------------ ------------
Net Income $ 365,246 $ 1,759,465 $ 1,611,998
============ ============ ============
Net Income Per Share
Basic $ .53 $ 2.62 $ 2.36
Diluted $ .53 $ 2.57 $ 2.32
Average Common Shares Outstanding
Basic 684,856,920 672,340,557 683,695,348
Diluted 695,422,245 685,251,163 694,005,165
============ ============ ============
The pro forma results include amortization of fair value adjustments on loans,
deposits and debt, amortization of newly created intangibles and post-merger
acquisition related charges. The pro forma number of average common shares
outstanding includes adjustments for shares issued for the acquisition and the
impact of additional dilutive securities but does not assume any incremental
share repurchases. The pro forma results presented do not reflect cost savings
or revenue enhancements anticipated from the acquisitions and are not
necessarily indicative of what actually would have occurred if the acquisitions
had been completed as of the beginning of each period presented, nor are they
necessarily indicative of future consolidated results.
On October 5, 2004, the Corporation completed its acquisition of Wayne Bancorp
(Wayne), an $825 million asset banking company operating 23 branches in several
northeastern Ohio counties, for a cash price of $181 million.
DIVESTITURES: On October 15, 2004, the Corporation completed the sale of its 83%
owned payment processing subsidiary, National Processing, Inc. (NPI), to Bank of
America. Bank of America purchased all NPI's outstanding common stock for $1.2
billion in cash, or $26.60 per NPI share. The Corporation recognized a gain on
the sale of this subsidiary of approximately $714 million pre-tax ($485 million
after-tax) in October 2004. In conjunction with the sale, the Corporation,
through its bank subsidiary National City Bank of Kentucky, entered into a
Service and Sponsorship Agreement with NPI. This agreement relates to the United
Airlines card processing agreement, whereby Bank of America, through NPI, made 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 card
processing agreement. As a result, the Corporation has retained the contractual
obligation to process card transactions for United Airlines. Refer to Note 19
for the related discussion on the Corporation's chargeback exposure.
On October 5, 2004, the Corporation completed the sale of seven branches located
in the upper peninsula of Michigan. The Corporation recognized a gain on the
sale of these branches of approximately $14 million pre-tax ($9 million
after-tax) in October 2004. Also in October 2004, the Corporation entered into a
definitive agreement to sell its Provident subprime lending and servicing
business (Provident PCFS). The Provident PCFS business was part of the
acquisition of Provident on July 1, 2004. This transaction is expected to close
in the fourth quarter.
On June 30, 2004, the Corporation sold its Corporate Trust Bond Administration
business to U.S. Bancorp for $67 million in cash, 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.
19
4. RESTRUCTURING CHARGES
The Corporation has implemented restructuring plans related to the integration
of Allegiant and Provident. These plans were formulated prior to the acquisition
of these entities and are anticipated to be substantially complete by December
31, 2005. Costs incurred for employee terminations consist of severance,
relocation, retention, and outplacement benefits. Certain costs associated with
severance, relocation, and outplacement benefits were recognized in the
allocation of the purchase price to acquired assets and liabilities. Retention
benefits are expensed over the required service period. Exit and termination
costs relating to the exit of Provident PCFS, facility leases, and other
contract termination costs, were also recognized in the allocation of the
purchase price to acquired assets and liabilities.
In connection with the acquisition of Provident, a severance liability of $59
million and an exit costs liability of $271 million were recognized in the
allocation of the purchase price to acquired assets and liabilities. As these
activities are completed, the associated liabilities will be adjusted to reflect
the actual costs incurred resulting in an increase or decrease to goodwill.
During the three months ended September 30, 2004, the Corporation recorded $17
million of severance and other employee related charges, mainly related to
retention bonuses provided to Provident employees.
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 and restructuring liability for the three- and
nine-month periods ended September 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 severance and related termination expenses were
recorded as unallocated corporate charges within the Parent and Other category.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2004 SEPTEMBER 30, 2004
------------------ ------------------
PARENT AND NATIONAL PARENT AND NATIONAL
(In Thousands) OTHER PROCESSING TOTAL OTHER PROCESSING TOTAL
- -------------- ----- ---------- ----- ----- ---------- -----
Beginning balance $ 15,926 $ 1,124 $ 17,050 $ 14,154 $ 1,773 $ 15,927
Severance and other employee
related costs:
Charged to expense 17,095 - 17,095 26,892 55 26,947
Recognized in purchase price
allocation/acquired liabilities 59,189 - 59,189 62,081 - 62,081
Payments (30,109) (339) (30,448) (41,026) (1,043) (42,069)
Exit costs and other termination costs:
Recognized in purchase price 270,623 - 270,623 270,623 - 270,623
allocation
Payments (43,239) - (43,239) (43,239) - (43,239)
--------- ------- --------- --------- ------- ---------
ENDING BALANCE $ 289,485 $ 785 $ 290,270 $ 289,485 $ 785 $ 290,270
========= ======= ========= ========= ======= =========
Three Months Ended Nine Months Ended
September 30, 2003 September 30, 2003
------------------ ------------------
Parent and National Parent and National
(In Thousands) Other Processing Total Other Processing Total
- -------------- ----- ---------- ----- ----- ---------- -----
Beginning balance $ 24,404 $ 2,455 $ 26,859 $ 13,895 $ 3,141 $ 17,036
Severance and other termination
costs 5,504 (65) 5,439 77,075 639 77,714
Payments and adjustments (11,182) (484) (11,666) (72,244) (1,874) (74,118)
-------- ------- -------- --------- ------- --------
ENDING BALANCE $ 18,726 $ 1,906 $ 20,632 $ 18,726 $ 1,906 $ 20,632
======== ======= ======== ======== ======= ========
Substantially all Allegiant and Provident severance and related employee
benefits will be paid out by March 2005. Substantially all exit and termination
costs will be paid by December 2004 except for certain lease terminations which
are anticipated to occur in the fourth quarter of 2005.
20
5. SECURITIZATION ACTIVITY
The Corporation periodically sells assets through securitization transactions.
In connection with the acquisition of Provident, the Corporation acquired three
home equity securitizations through which Provident sold prime fixed-rate home
equity loans and variable-rate home equity lines of credit. The securitizations
were structured to achieve sale treatment in accordance with SFAS 140, and as a
result, the loans and lines of credit were removed from the balance sheet, a net
gain on sale for each transaction was recognized, and retained interests in the
form of interest-only strips were recorded. The fair value of interest only
strips and the aggregate principal balances of the home equity loans and lines
associated with the securitizations acquired were $3 million and $84 million,
respectively, as of the acquisition date.
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.
A summary of the assumptions used to value the credit card retained interests
and automobile retained interests and servicing asset at the time of each
securitization follows:
Weighted- Variable Monthly Expected
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
==== ==== ==== ===== ====
21
A summary of the assumptions used to value the home equity retained interests at
the time of the Provident acquisition were as follows:
Weighted- Variable Monthly Expected
Average Annual Principal Annual Annual
Life Coupon Rate Repayment Credit Discount
(in months) to Investors Rate/CPR(a) Losses(b) Rate Yield(c)
----------- ------------ ----------- --------- ---- --------
HOME EQUITY:
Series 1998-A 14.1 1.95% 4.42/33.00% 1.25% 6.25% 4.87%
Series 1999-A 17.4 1.88% 4.61/33.00% 2.00% 6.25% 5.38%
Series 2000-A 16.4 1.74% 5.74/33.00% 2.40% 6.25% 5.92%
==== ==== ========== ==== ==== ====
(a) Monthly Principal Repayment Rate assumption relates to home equity lines
of credit and Cumulative Prepayment Rate (CPR) relates to home equity
loans
(b) The home equity securitizations are credit enhanced with cash collateral
accounts that are maintained within the securitization vehicle. The cash
collateral accounts absorb all credit losses with respect to the
securitized loans
(c) Yield represents the weighted-average of fixed-rate loan and variable-rate
lines of credit
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 NINE MONTHS ENDED
AS OF SEPTEMBER 30, 2004 SEPTEMBER 30, 2004 SEPTEMBER 30, 2004
------------------------ ------------------ ------------------
LOANS PAST
PRINCIPAL DUE 30 DAYS AVERAGE NET CREDIT AVERAGE NET CREDIT
(In Millions) BALANCE OR MORE BALANCES LOSSES BALANCES LOSSES
- ------------- ------- ------- -------- ------ -------- ------
Type of loan:
Credit card $ 2,421.5 $ 91.9 $ 2,446.3 $ 35.5 $ 2,475.5 $ 112.1
Automobile 3,912.5 68.8 3,881.0 10.5 4,044.6 32.0
Home Equity 22,997.4 76.3 21,853.1 9.0 18,778.4 25.7
SBA 2.9 2.9 21.0 -- 34.6 --
--------- --------- --------- --------- --------- ---------
Total loans managed or
securitized 29,334.3 239.9 28,201.4 55.0 25,333.1 169.8
Less:
Loans securitized:
Credit card 1,450.0 47.0 1,450.0 19.4 1,450.0 57.1
Automobile 1,002.4 16.4 1,051.4 3.1 1,091.0 7.9
Home Equity 75.9 1.5 79.7 .4 26.8 .4
SBA 2.9 2.9 21.0 -- 34.6 --
Loans held for securitization:
Automobile -- -- -- -- .2 --
--------- --------- --------- --------- --------- ---------
LOANS HELD IN PORTFOLIO $26,803.1 $ 172.1 $25,599.3 $ 32.1 $22,730.5 $ 104.4
========= ========= ========= ========= ========= =========
22
Three Months Ended Nine Months Ended
As of September 30, 2003 September 30, 2003 September 30, 2003
------------------------ ------------------ ------------------
Loans Past
Principal Due 30 Days Average Net Credit Average Net Credit
(In Millions) Balance or More Balances Losses Balances Losses
- ------------- ------- ------- -------- ------ -------- ------
Type of loan:
Credit card $ 2,480.4 $ 95.0 $ 2,475.9 $ 34.8 $ 2,422.4 $ 99.2
Automobile 4,468.1 65.2 4,506.2 11.1 4,433.8 34.1
SBA 38.0 2.9 38.5 -- 32.4 --
--------- --------- --------- --------- --------- ---------
Total loans managed or
securitized 6,986.5 163.1 7,020.6 45.9 6,888.6 133.3
Less:
Loans securitized:
Credit card 1,450.0 49.1 1,450.0 19.5 1,450.0 55.7
Automobile 568.1 9.2 609.9 2.2 699.0 7.2
SBA 38.0 2.9 38.5 -- 32.4 --
Loans held for securitization -- -- -- -- -- --
--------- --------- --------- --------- --------- ---------
LOANS HELD IN PORTFOLIO $ 4,930.4 $ 101.9 $ 4,922.2 $ 24.2 $ 4,707.2 $ 70.4
========= ========= ========= ========= ========= =========
The Corporation's on-balance-sheet credit card receivables are expected to
increase following the revolving period of the securitization, which generally
approximates 48 months.
Certain cash flows received from the securitization trusts follow:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2004 SEPTEMBER 30, 2004
------------------ ------------------
CREDIT HOME CREDIT HOME
CARD AUTOMOBILE EQUITY SBA CARD AUTOMOBILE EQUITY SBA
---- ---------- ------ --- ---- ---------- ------ ---
(In Millions)
Proceeds from new securitizations $ -- $ -- $ -- $ -- $ -- $811.2 $ -- $ --
Proceeds from collections reinvested in
previous securitizations 780.3 -- 3.0 -- 2,319.5 -- 3.0 --
Servicing fees received 7.3 2.7 .1 -- 21.8 8.3 .1 --
Other cash flows received on retained interest 22.2 6.8 .6 2.7 66.9 14.8 .6 3.2
Proceeds from sales of previously
charged-off accounts -- -- -- -- -- -- --
Purchases of delinquent or foreclosed assets -- -- -- -- -- -- --
Repayments of servicing advances -- -- -- -- -- -- --
====== ==== ==== ==== ======== ====== ==== =====
Three Months Ended Nine Months Ended
September 30, 2003 September 30, 2003
------------------ ------------------
Credit Card Automobile SBA Credit Card Automobile SBA
----------- ---------- --- ----------- ---------- ---
(In Millions)
Proceeds from new securitizations $ -- $ -- $ -- $ -- $ -- $40.3
Proceeds from collections reinvested in
previous securitizations 792.2 -- -- 2,310.6 -- --
Servicing fees received 7.3 1.5 -- 21.8 5.3 --
Other cash flows received on retained interest 21.9 4.0 .3 65.9 13.3 .6
Proceeds from sales of previously charged-off
accounts .2 -- -- .9 -- --
Purchases of delinquent or foreclosed assets -- -- -- -- -- --
Repayments of servicing advances -- -- -- -- -- --
======== ====== ==== ========= ===== =====
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 September 30, 2004 fair values to immediate 10% and 20%
adverse changes in those assumptions follows. Actual credit losses experienced
through September 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.
23
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 SEPTEMBER 30, 2004 $4.0 3.3 2.06% 17.81% 5.22% 15.00% 10.40%
Decline in fair value of 10% adverse
Change $ .7 $ .3 $ 2.0 $ -- $ 4.0
Decline in fair value of 20% adverse
Change 1.4 .5 4.0 -- 4.0
==== === ===== ====== ===== ====== ======
(a) Represents interest-only strips recognized in connection with the credit
card securitization series 2000-1, 2001-1 and 2002-1
(b) Represents weighted-average assumptions and aggregate declines in fair value
for all credit card securitization series
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 SEPTEMBER 30, 2004 $39.3 16.5 1.50% 1.87% 12.00% 7.37%
Decline in fair value of 10% adverse
Change $ 1.9 $ 3.3 $ .7 $ 8.7
Decline in fair value of 20% adverse
Change 3.5 6.5 1.5 17.3
Servicing asset(a)
AS OF SEPTEMBER 30, 2004(e) $ 9.6 12.3 1.50% 1.87% 11.30% 7.37%
Decline in fair value of 10% adverse
Change $ .6 $ -- $ .1 $ --
Decline in fair value of 20% adverse
Change 1.2 -- .2 .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 September 30, 2004 was $9.0 million
Variable
Annual
Weighted- Coupon Monthly
average Rate Principal Annual
Fair Life To Repayment Discount
(Dollars in Millions) Value (in months)(b) Investors(b) Rate/CPR(b)(c) Rate(b) Yield(b)(d)
- --------------------- ----- -------------- ------------ -------------- ------- -----------
HOME EQUITY LOANS
Interest-only strips(a)
AS OF SEPTEMBER 30, 2004 $2.3 15.0 2.11% 4.80/33.00% 6.25% 5.52%
Decline in fair value of 10% adverse
Change $ .3 $ .2 $ -- $ .6
Decline in fair value of 20% adverse
Change .5 .4 -- 1.2
(a) Represents interest-only strips recognized in connection with the home
equity securitization series 1998-A,1999-A and 2000-A
(b) Represents weighted-average assumptions and aggregate declines in fair
value for all home equity securitization series
(c) Monthly Principal Repayment Rate assumption relates to home equity lines
of credit and Cumulative Prepayment Rate (CPR) relates to home equity
loans
(d) Yield represents a weighted-average of fixed-rate loans and variable-rate
lines of credit
24
6. LEASES
National City leases commercial equipment and automobiles to customers. The
leases are classified as either lease financings or operating leases based on
the terms of the lease arrangement. When a lease is classified as a lease
financing, the future lease payments, net of unearned income and the estimated
residual value of the leased property at the end of the lease term, are recorded
as an asset within the loan portfolio. The amortization of the unearned income
is recorded as interest income. When a lease is classified as an operating
lease, the cost of the leased property, net of depreciation, is recorded as
equipment leased to others on the balance sheet. Rental income is recorded in
noninterest income while the depreciation on the leased property is recorded in
noninterest expense. At the expiration of a lease, the leased property is either
sold or another lease agreement is initiated.
LEASE FINANCINGS: Lease financings, included in portfolio loans on the
consolidated balance sheet, consist of direct financing and leveraged leases of
commercial equipment, primarily manufacturing and mining equipment, commercial
trucks and trailers, railroad equipment, and airplanes, along with retail
automobile lease financings. Commercial equipment lease financings are included
in commercial loans, while automobile lease financings are included in other
consumer loans. The Corporation ceased originating retail automobile leases in
December 2000, however, additional automobile leases financings were acquired as
part of the acquisition of Provident. No new leases have been originated since
the acquisition date, and this portfolio will run off over time as the leases
expire and the automobiles are sold.
A summary of lease financings by type follows:
SEPTEMBER 30 December 31 September 30
(In Thousands) 2004 2003 2003
- -------------- ---- ---- ----
COMMERCIAL
Direct financings $2,340,299 $1,148,494 $1,199,587
Leveraged leases 340,633 278,772 277,625
---------- ---------- ----------
TOTAL COMMERCIAL LEASE FINANCINGS 2,680,932 1,427,266 1,477,212
CONSUMER
Retail automobile lease financings 570,272 150,864 219,194
---------- ---------- ----------
TOTAL NET INVESTMENT IN LEASE FINANCINGS $3,251,204 $1,578,130 $1,696,406
========== ========== ==========
The components of the net investment in lease financings follow:
SEPTEMBER 30 December 31 September 30
(In Thousands) 2004 2003 2003
- -------------- ---- ---- ----
COMMERCIAL
Lease payments receivable $2,575,908 $1,237,339 $1,306,325
Estimated residual value of leased assets 551,694 487,007 483,422
---------- ---------- ----------
Gross investment in commercial lease financings 3,127,602 1,724,346 1,789,747
Unearned income (446,670) (297,080) (312,535)
---------- ---------- ----------
TOTAL NET INVESTMENT IN COMMERCIAL LEASE FINANCINGS $2,680,932 $1,427,266 $1,477,212
---------- ---------- ----------
CONSUMER
Lease payments receivable $ 360,812 $ 38,820 $ 58,226
Estimated residual value of leased assets 279,439 121,630 175,472
---------- ---------- ----------
Gross investment in consumer lease financings 640,251 160,450 233,698
Unearned income (69,979) (9,586) (14,504)
---------- ---------- ----------
TOTAL NET INVESTMENT IN CONSUMER LEASE FINANCINGS $ 570,272 $ 150,864 $ 219,194
========== ========== ==========
25
A rollforward of the residual value component of lease financings follows:
Three Months Ended Nine Months Ended
September 30 September 30
(In Thousands) 2004 2003 2004 2003
- -------------- ---- ---- ---- ----
COMMERCIAL
Beginning balance $453,340 $502,399 $487,007 $561,438
Additions 120,828 15,064 120,828 26,154
Acquisition 10,213 -- 26,803 --
Runoff (22,869) (34,041) (73,126) (66,315)
Write-downs (9,818) -- (9,818) (37,855)
-------- -------- -------- --------
ENDING BALANCE $551,694 $483,422 $551,694 $483,422
-------- -------- -------- --------
CONSUMER
Beginning balance $ 54,828 $262,889 $121,630 $446,872
Additions -- -- -- --
Acquisition 250,372 -- 250,372 --
Runoff (28,864) (96,991) (96,998) (255,719)
Recoveries (write-downs) 3,103 9,574 4,435 (15,681)
-------- -------- -------- --------
ENDING BALANCE $279,439 $175,472 $279,439 $175,472
======== ======== ======== ========
EQUIPMENT LEASED TO OTHERS: Equipment leased to others represents equipment
owned by National City that is leased to customers under operating leases.
Commercial equipment includes transportation, manufacturing, data processing,
medical, and office equipment leased to commercial customers while consumer
equipment consists of automobiles leased to retail customers. The majority of
the balance of consumer leased equipment at September 30, 2004, was acquired
through the acquisition of Provident. As discussed above with regard to lease
financings, National City ceased originating retail automobile leases in 2000
and plans to let the acquired automobile portfolio run off over time. The totals
below also include the carrying value of any equipment previously leased to
customers under either operating or financing leases that are in the process of
being either re-leased or sold.
A summary of the net carrying value of equipment leased to others by type
follows:
SEPTEMBER 30 December 31 September 30
(In Thousands) 2004 2003 2003
- -------------- ---- ---- ----
COMMERCIAL
Cost $ 342,021 $101,460 $ 113,857
Accumulated depreciation (68,143) (61,154) (66,962)
---------- -------- ---------
NET CARRYING VALUE OF COMMERCIAL LEASED EQUIPMENT 273,878 40,306 46,895
CONSUMER
Cost 938,226 8,686 12,450
Accumulated depreciation (46,423) - -
---------- -------- ---------
NET CARRYING VALUE OF CONSUMER LEASED EQUIPMENT 891,803 8,686 12,450
---------- -------- ---------
TOTAL NET CARRYING VALUE OF EQUIPMENT LEASED TO OTHERS $1,165,681 $ 48,992 $ 59,345
========== ======== =========
26
7. LOANS AND ALLOWANCE FOR LOAN LOSSES
Total portfolio loans outstanding were recorded net of unearned income,
unamortized premiums and discounts, and deferred loan fees and costs of $321
million, $209 million, and $242 million at September 30, 2004, December 31,
2003, and September 30, 2003, respectively.
The allowance for loan losses represents an estimation of probable credit losses
inherent in the loan portfolio. Activity in the allowance for loan losses
follows:
Three Months Ended Nine Months Ended
September 30 September 30
------------ ------------
(In Thousands) 2004 2003 2004 2003
- -------------- ---- ---- ---- ----
BALANCE AT BEGINNING OF PERIOD $1,144,619 $1,147,098 $1,125,329 $1,098,588
Provision 98,432 107,047 241,727 490,427
Allowance related to loans acquired 159,208 -- 180,100 --
Charge-offs:
Commercial 62,427 43,152 109,942 246,688
Commercial construction 2,334 950 2,335 2,197
Real estate - commercial 6,081 9,411 15,360 17,752
Real estate - residential 29,541 48,024 91,774 120,221
Home equity lines of credit 6,388 6,191 19,319 17,715
Credit cards and other unsecured lines of credit 25,134 24,281 83,594 71,127
Other consumer 24,770 27,177 76,239 91,991
---------- ---------- ---------- ----------
Total charge-offs 156,675 159,186 398,563 567,691
Recoveries:
Commercial 22,427 9,584 59,563 31,209
Commercial construction 50 190 501 288
Real estate - commercial 3,515 799 10,108 1,663
Real estate - residential 17,978 10,741 41,638 26,933
Home equity lines of credit 2,592 1,624 7,454 4,836
Credit cards and other unsecured lines of credit 2,134 1,678 5,887 5,723
Other consumer 10,106 10,058 30,642 37,657
---------- ---------- ---------- ----------
Total recoveries 58,802 34,674 155,793 108,309
Net charge-offs 97,873 124,512 242,770 459,382
---------- ---------- ---------- ----------
BALANCE AT END OF PERIOD $1,304,386 $1,129,633 $1,304,386 $1,129,633
========== ========== ========== ==========
The allowance related to loans acquired during the third quarter of 2004
represents the allowance recognized in connection with the acquisition of
Provident. The allowance related to loans acquired during nine months ended
September 30, 2004 represents the allowance recognized in connection with the
acquisitions of Allegiant and Provident.
Nonperforming loans totaled $502 million, $550 million, and $629 million as of
September 30, 2004, December 31, 2003, and September 30, 2003, respectively. For
loans classified as nonperforming at September 30, 2004, the contractual
interest due and actual interest recognized on those loans for the first nine
months of 2004 was $40 million and $8 million, respectively. Included in
nonperforming loans were impaired loans, as defined under SFAS 114, aggregating
$256 million, $263 million, and $343 million at September 30, 2004, December 31,
2003, and September 30, 2003, respectively. Average impaired loans for the first
nine months of 2004 and 2003 totaled $223 million and $387 million,
respectively. The majority of the loans deemed impaired were evaluated using the
fair value of the collateral as the measurement method. The related allowance
allocated to impaired loans as of September 30, 2004, December 31, 2003, and
September 30, 2003 was $39 million, $22 million, and $50 million, respectively.
At September 30, 2004, December 31, 2003, and September 30, 2003, impaired loans
with an associated allowance totaled $130 million, $75 million, and $185
million, respectively, while impaired loans with no associated allowance totaled
$126 million, $188 million, and $158 million, respectively, for these same
period ends. There was no interest recognized during the first nine months of
2004 and 2003 on impaired loans while they were considered impaired.
27
8. SECURITIES
Securities available for sale follow:
AMORTIZED UNREALIZED UNREALIZED FAIR
(In Thousands) COST GAINS LOSSES VALUE
- -------------- ---- ----- ------ -----
SEPTEMBER 30, 2004
U.S. Treasury and Federal agency debentures $ 535,851 $ 37,278 $ 716 $ 572,413
Mortgage-backed securities 6,749,262 124,630 13,873 6,860,019
Asset-backed and corporate debt securities 673,967 8,648 761 681,854
States and political subdivisions 646,603 39,996 10 686,589
Other 940,945 17,814 593 958,166
------------ --------- ---------- ----------
TOTAL SECURITIES $ 9,546,628 $ 228,366 $ 15,953 $9,759,041
------------ --------- ---------- ----------
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
------------ --------- ---------- ----------
September 30, 2003
U.S. Treasury and Federal agency debentures $ 664,760 $ 52,713 $ 2 $ 717,471
Mortgage-backed securities 3,583,170 124,042 5,379 3,701,833
Asset-backed and corporate debt securities 1,059,912 6,507 2,810 1,063,609
States and political subdivisions 674,530 53,260 2,490 725,300
Other 537,312 11,800 2,207 546,905
------------ --------- ---------- ----------
TOTAL SECURITIES $ 6,519,684 $ 248,322 $ 12,888 $6,755,118
============ ========= ========== ==========
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
$187 million and $200 million, respectively, at September 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 $33 million and $39
million, respectively, at September 30, 2003.
The following table presents the age of gross unrealized losses and fair value
by investment category.
SEPTEMBER 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 $ 135,882 $ 716 $ -- $ -- $ 135.882 $ 716
Mortgage-backed securities 1,077,988 7,762 355,511 6,111 1,433,499 13,873
Asset-backed securities 30,205 100 143,291 661 173,496 761
States and political subdivisions 6,853 8 192 2 7,045 10
Other 32,917 591 6 2 32,923 593
----------- ------ -------- ------ ----------- -------
Total $ 1,283,845 $9,177 $499,000 $6,776 $ 1,782,845 $15,953
=========== ====== ======== ====== =========== =======
Management does not believe any individual unrealized loss as of September 30,
2004, represents an other-than-temporary impairment. The unrealized losses
reported for mortgage-backed securities relate primarily to securities issued by
FNMA and FHLMC. These unrealized losses are primarily attributable to changes in
interest rates and individually were 3% or less of their respective amortized
cost basis. The Corporation has both the intent and ability to hold these
securities for the time necessary to recover the amortized cost.
At September 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 $6.7 billion.
28
At September 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 nine months ended September 30, 2004 and 2003, gross securities gains of
$14 million and $41 million, respectively, were recognized. For the nine months
ended September 30, 2004 and 2003, gross securities losses of $6 million and $4
million were recognized, respectively.
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 28% 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 Nine Months Ended
September 30 September 30
------------ ------------
(In Thousands) 2004 2003 2004 2003
- -------------- ---- ---- ---- ----
DIRECT INVESTMENTS:
Carrying value at beginning of period $322,909 $324,840 $300,077 $317,089
Acquisitions(a) 1,847 -- 1,847 --
Investments -- new fundings 34,468 12,994 97,730 57,157
Reclassifications -- -- -- (12,415)
Returns of capital and write-offs (15,356) (27,252) (56,427) (36,921)
Fair value adjustments 545 (2,972) 1,186 (17,300)
-------- -------- -------- --------
Carrying value at end of period $344,413 $307,610 $344,413 $307,610
-------- -------- -------- --------
INDIRECT INVESTMENTS:
Carrying value at beginning of period $313,657 $284,084 $294,939 $254,899
Acquisitions(a) 27,436 -- 27,436 --
Investments -- new fundings 22,794 13,420 63,646 38,412
Reclassifications -- -- -- 12,415
Returns of capital and write-offs (12,888) (8,187) (32,564) (16,568)
Fair value adjustments 76 (2,973) (2,382) (2,814)
-------- -------- -------- --------
Carrying value at end of period $351,075 $286,344 $351,075 $286,344
-------- -------- -------- --------
TOTAL PRINCIPAL INVESTMENTS:
Carrying value at beginning of period $636,566 $608,924 $595,016 $571,988
Acquisitions(a) 29,283 -- 29,283 --
Investments -- new fundings 57,262 26,414 161,376 95,569
Reclassifications -- -- -- --
Returns of capital and write-offs (28,244) (35,439) (88,991) (53,489)
Fair value adjustments 621 (5,945) (1,196) (20,114)
-------- -------- -------- --------
CARRYING VALUE AT END OF PERIOD $695,488 $593,954 $695,488 $593,954
======== ======== ======== ========
Three Months Ended Nine Months Ended
September 30 September 30
------------ ------------
(In Thousands) 2004 2003 2004 2003
- -------------- ---- ---- ---- ----
PRINCIPAL INVESTMENT REVENUE (b) $ 7,586 $ 7,139 $ 25,618 $ 22,674
---------- ---------- --------- ---------
NET PRINCIPAL INVESTMENT GAINS (LOSSES) (c) 18,979 16,860 59,381 6,936
========== ========== ========= =========
(a) Represents principal investments acquired with Provident
(b) Consists primarily of interest, dividends, and fee income
(c) 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.
29
10. GOODWILL AND OTHER INTANGIBLE ASSETS
The carrying value of goodwill at September 30, 2004 was $3.3 billion, and $1.1
billion at December 31, 2003 and September 30, 2003. A rollforward of goodwill
by line of business as of September 30, 2004 follows:
JANUARY 1 GOODWILL IMPAIRMENT SEPTEMBER 30
(In Thousands) 2004 ACQUIRED LOSSES 2004
- -------------- ---- -------- ------ ----
Consumer and Small Business Financial Services $ 513,281 $ 447,602 -- $ 960,883
Wholesale Banking 86,729 1,462,396 -- 1,549,125
National City Mortgage Co. 55,785 2,276 -- 58,061
National Consumer Finance 206,032 252,336 -- 458,368
Asset Management 126,207 40,550 -- 166,757
National Processing 115,306 -- -- 115,306
Parent and Other -- -- -- --
---------- ---------- ------ ----------
TOTAL $1,103,340 $2,205,160 -- $3,308,500
========== ========== ====== ==========
The goodwill acquired in 2004 above relates mainly to the acquisitions of
Allegiant and Provident. Refer to Note 3 for further discussion.
The Corporation has finite-lived intangible assets capitalized on its balance
sheet in the form of core deposit, credit card, merchant portfolios, operating
lease, 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:
SEPTEMBER 30 December 31 September 30
(In Thousands) 2004 2003 2003
- -------------- ---- ---- ----
CORE DEPOSIT INTANGIBLES
Gross carrying amount $258,918 $ 93,328 $ 93,328
Less: accumulated amortization 97,656 78,162 74,913
-------- -------- --------
NET CARRYING AMOUNT 161,262 15,166 18,415
-------- -------- --------
CREDIT CARD INTANGIBLES
Gross carrying amount 17,323 17,323 17,323
Less: accumulated amortization 15,158 14,321 14,024
-------- -------- --------
NET CARRYING AMOUNT 2,165 3,002 3,299
-------- -------- --------
MERCHANT PORTFOLIOS
Gross carrying amount 73,499 73,499 73,499
Less: accumulated amortization 37,778 30,187 27,656
-------- -------- --------
NET CARRYING AMOUNT 35,721 43,312 45,843
-------- -------- --------
OPERATING LEASE
Gross carrying amount 47,205 -- --
Less: accumulated amortization 10,857 -- --
-------- -------- --------
NET CARRYING AMOUNT 36,348 -- --
-------- -------- --------
OTHER INTANGIBLES
Gross carrying amount 22,133 1,237 1,237
Less: accumulated amortization 3,829 242 163
-------- -------- --------
NET CARRYING AMOUNT 18,304 995 1,074
-------- -------- --------
TOTAL FINITE-LIVED INTANGIBLES
Gross carrying amount 419,078 185,387 185,387
Less: accumulated amortization 165,278 122,912 116,756
-------- -------- --------
NET CARRYING AMOUNT $253,800 $ 62,475 $ 68,631
======== ======== ========
Core deposit intangibles and other intangibles in the form of noncompete
agreements of $32 million and $3 million, respectively, were recognized as part
of the acquisition of Allegiant. Core deposit intangibles, operating lease
intangibles, and other intangibles consisting primarily of customer contracts
and noncompete agreements, of $133 million, $47 million, and $18 million,
respectively, were recognized as part of the acquisition of Provident.
Amortization expense on finite-lived intangible assets totaled $28 million and
$6 million for the three months ended September 30, 2004 and 2003, respectively.
Amortization expense on finite-lived intangible assets totaled $41 million and
$17 million for the nine months ended September 30, 2004 and 2003, respectively.
Amortization expense on finite-lived intangible assets is expected to total $63
million, $32 million, $24 million, $21 million, and $17 million for the calendar
years 2005, 2006, 2007, 2008, and 2009, respectively. These amounts exclude
amortization associated with intangibles from National Processing Inc. and are
exclusive of any changes in amortization associated with pending acquisitions or
other dispositions.
30
11. SERVICING ASSETS
MORTGAGE SERVICING RIGHT (MSR) ASSETS: MSRs recognized on conforming residential
real estate loans sold servicing retained are capitalized by the Corporation's
National City Mortgage Co. (NCMC) subsidiary. MSRs associated with nonconforming
residential real estate loans were acquired as part of the acquisition of
Provident, and are expected to be sold during the fourth quarter of 2004 as part
of the Provident PCFS sale. Refer to Note 3 for further discussion.
Changes in the carrying value of MSRs and the associated valuation allowance
follow:
THREE MONTHS ENDED SEPTEMBER 30, 2004 NINE MONTHS ENDED SEPTEMBER 30, 2004
------------------------------------- ------------------------------------
CONFORMING NONCONFORMING CONFORMING NONCONFORMING
(In Thousands) MORTGAGES MORTGAGES TOTAL MORTGAGES MORTGAGES TOTAL
- -------------- --------- --------- ----- --------- --------- -----
MORTGAGE SERVICING ASSETS
Balance at beginning of period $ 2,004,488 $ -- $ 2,004,488 $ 1,300,612 $ -- $ 1,300,612
Acquisition -- 45,000 45,000 -- 45,000 45,000
Additions 130,129 -- 130,129 489,561 -- 489,561
Amortization (124,754) (10,391) (135,145) (364,784) (10,391) (375,175)
SFAS 133 hedge basis adjustments (543,716) -- (543,716) 45,674 -- 45,674
Application of valuation allowance to
directly write-down servicing assets -- -- -- -- -- --
Sales (1,055) -- (1,055) (5,971) -- (5,971)
----------- -------- ----------- ----------- -------- -----------
CARRYING VALUE BEFORE VALUATION ALLOWANCE
AT END OF PERIOD 1,465,092 34,609 1,499,701 1,465,092 34,609 1,499,701
----------- -------- ----------- ----------- -------- -----------
VALUATION ALLOWANCE
Balance at beginning of period (78,437) -- (78,437) (2,195) -- (2,195)
Impairment charges (5,152) -- (5,152) (81,394) -- (81,394)
Application of valuation allowance to
directly write-down servicing assets -- -- -- -- -- --
----------- -------- ----------- ----------- -------- -----------
BALANCE AT END OF PERIOD (83,589) -- (83,589) (83,589) -- (83,589)
----------- -------- ----------- ----------- -------- -----------
NET CARRYING VALUE OF MSRS AT END OF
PERIOD $ 1,381,503 $ 34,609 $ 1,416,112 $ 1,381,503 $ 34,609 $ 1,416,112
=========== ======== =========== =========== ======== ===========
UNPAID PRINCIPAL BALANCE OF LOANS
SERVICED FOR OTHERS (IN MILLIONS) $ 150,329 $ 8,036 $ 158,365
=========== ======== =========== =========== ======== ===========
Three Months Nine Months
Ended September 30, 2003 Ended September 30, 2003
------------------------ ------------------------
Conforming Conforming
(In Thousands) Mortgages Mortgages
- -------------- --------- ---------
MORTGAGE SERVICING ASSETS
Balance at beginning of period $ 955,685 $ 949,539
Additions 439,337 964,693
Amortization (190,209) (440,656)
SFAS 133 hedge basis adjustments (49,975) (173,743)
Application of valuation allowance to directly write-down
servicing assets -- (137,874)
Sales (2,550) (9,671)
----------- -----------
CARRYING VALUE BEFORE VALUATION ALLOWANCE AT END OF PERIOD 1,152,288 1,152,288
----------- -----------
VALUATION ALLOWANCE
Balance at beginning of period (222,265) (334,346)
Impairment recoveries 206,964 181,171
Application of valuation allowance to directly write-down
servicing assets -- 137,874
----------- -----------
BALANCE AT END OF PERIOD (15,301) (15,301)
----------- -----------
NET CARRYING VALUE OF MSRS AT END OF PERIOD $ 1,136,987 $ 1,136,987
=========== ===========
UNPAID PRINCIPAL BALANCE OF LOANS SERVICED FOR OTHERS (IN
MILLIONS) $ 129,127
===========
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 nine 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 conforming MSRs was 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
31
prepayment rates are derived from a third-party model and adjusted to reflect
National City's actual prepayment experience. At September 30, 2004, the fair
value of MSRs exceeded the carrying value reported in the consolidated balance
sheet by $13 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 Corporation has entered into an agreement to sell its nonconforming MSRs.
Accordingly, the fair value of these MSRs was estimated based upon the
anticipated sales proceeds rather than estimated future net servicing cash
flows.
The key economic assumptions used to estimate the value of the conforming MSRs
at September 30, 2004, December 31, 2003, and September 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 September 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.
SEPTEMBER 30 December 31 September 30
(Dollars in Millions) 2004 2003 2003
- --------------------- ---- ---- ----
Fair value $ 1,394.2 $1,443.6 $1,139.5
Weighted-average life (in years) 3.5 3.8 3.1
Weighted-average constant prepayment rate (CPR) 25.07% 24.24% 29.19%
Weighted-average discount rate 9.5 9.56 9.49
Prepayment rate:
Decline in fair value from 10% adverse change $ 83.1
Decline in fair value from 20% adverse change 158.0
Discount rate:
Decline in fair value from 10% adverse change 37.3
Decline in fair value from 20% adverse change 72.5
=========
The key economic assumptions used in determining the fair value of conforming
MSRs capitalized during the nine-month periods ended September 30, were as
follows:
2004 2003
---- ----
Weighted-average CPR 21.44% 28.47%
Weighted-average life (in years) 4.5 4.2
Weighted-average discount rate 9.73% 9.44%
==== ====
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 conforming 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.
OTHER SERVICING RIGHTS: The Corporation also recognizes servicing assets on
commercial real estate loans sold servicing retained through its subsidiaries
Red Capital Mortgage and Capstone Realty. These subsidiaries and their
commercial real estate servicing right assets were acquired as part of the
Provident acquisition. Commercial real estate servicing right assets are
recorded in other assets on the consolidated balance sheet and had a carrying
value of $125 million at September 30, 2004. Total commercial real estate loans
serviced for others were $11.0 billion at September 30, 2004.
32
12. BORROWED FUNDS
Detail of borrowed funds follows:
SEPTEMBER 30 December 31 September 30
(In Thousands) 2004 2003 2003
- -------------- ---- ---- ----
U.S. Treasury notes $6,373,640 $5,654,745 $ 847,252
Senior bank notes 100,000 -- --
Commercial paper and other 1,153,700 960,715 625,494
---------- ---------- ----------
TOTAL BORROWED FUNDS $7,627,340 $6,615,460 $1,472,746
========== ========== ==========
WEIGHTED-AVERAGE RATE 1.50% .78% .78%
========== ========== ==========
U.S. Treasury notes represent secured borrowings from the U.S. Treasury. These
borrowings are collateralized by qualifying securities and commercial loans. The
funds are placed at the discretion of the U.S. Treasury. At September 30, 2004,
$6.3 billon of notes were callable on demand by the U.S. Treasury and $65
million of the notes were term notes with a stated maturity of less than one
month. At December 31, 2003 and September 30, 2003, all U.S. Treasury notes were
callable on demand by the U.S. Treasury.
The senior bank notes are issued by National City's bank subsidiaries and have
maturities of seven months or less.
Commercial paper is issued by the Corporation's subsidiary, National City Credit
Corporation, and is due in seven months or less.
The commercial paper and other category at September 30, 2004 and December 31,
2003 included liabilities totaling $214 million and $240 million, respectively,
related to mortgage loans available for repurchase under GNMA optional
repurchase programs. See further discussion in Note 1.
13. LONG-TERM DEBT
The composition of long-term debt follows. This note excludes the discussion and
amounts associated with the junior subordinated notes owed to the unconsolidated
subsidiary trusts. See Note 14 for further discussion on these obligations.
SEPTEMBER 30 December 31 September 30
(In Thousands) 2004 2003 2003
- -------------- ---- ---- ----
3.20% senior notes due 2008 $ 296,385 $ 295,590 $ 297,909
3.125% senior notes due 2009 194,949 -- --
8.375% senior notes due 2032 74,545 -- --
6.625% subordinated notes due 2004 -- 249,978 249,946
8.50% subordinated notes due 2004 -- 149,989 149,958
7.75% subordinated notes due 2004 -- 199,850 199,786
7.20% subordinated notes due 2005 252,859 256,912 258,333
5.75% subordinated notes due 2009 324,348 326,933 331,328
6.875% subordinated notes due 2019 803,807 785,646 796,445
Other 880 1,760 1,760
----------- ------------ ------------
TOTAL HOLDING COMPANY 1,947,773 2,266,658 2,285,465
Senior bank notes 17,987,170 15,266,153 18,732,265
7.25% subordinated notes due 2010 261,867 263,790 267,804
6.30% subordinated notes due 2011 224,914 224,940 228,089
7.25% subordinated notes due 2011 198,609 198,461 198,411
6.25% subordinated notes due 2011 334,187 333,766 338,353
6.20% subordinated notes due 2011 541,970 537,793 544,927
4.63% subordinated notes due 2013 299,298 299,237 299,216
4.25% subordinated notes due 2018 229,762 221,969 224,454
Federal Home Loan Bank advances 4,964,756 3,867,957 3,999,601
Secured debt financings 893,022 -- --
----------- ------------ ------------
TOTAL BANK SUBSIDIARIES 25,935,555 21,214,066 24,833,120
----------- ------------ ------------
TOTAL LONG-TERM DEBT $27,883,328 $ 23,480,724 $ 27,118,585
=========== ============ ============
33
The amounts above represent the par value of the debt adjusted for any
unamortized discount, other basis adjustments related to hedging the debt with
derivative instruments, or fair value adjustments recognized in connection with
debt acquired through acquisitions. 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 are based on the one- or
three-month London Interbank Offering Rate (LIBOR) rate, the Federal Funds rate,
or the Prime rate. Further discussion on derivative instruments is included in
Notes 1 and 22.
The subordinated notes of the holding company and bank subsidiaries qualify for
Tier 2 capital under the regulatory capital requirements of the federal banking
agencies. Further discussion on regulatory capital requirements is included in
Note 15.
A summary of par values and weighted-average rates of long-term debt as of
September 30, 2004 follows. The weighted-average effective rate includes the
effects of derivative instruments used to manage interest rate risk and
amortization of fair value adjustments associated with acquired debt and
derivative instruments used to manage interest rate risk.
Weighted-Average Weighted-Average
(Dollars in Thousands) Par Value Contractual Rate Effective Rate
- ---------------------- --------- ---------------- --------------
Senior bank notes $17,940,319 2.13% 1.99%
Subordinated notes 3,225,000 6.23 2.89
Senior notes 575,000 3.85 2.05
FHLB advances 4,889,301 2.38 2.66
Secured debt financings 864,000 5.69 5.67
Other 880 12.95 12.95
----------- ----- -----
Total long-term debt $27,494,500 2.80% 2.15%
=========== ===== =====
Senior bank notes are issued by National City's bank subsidiaries. For the first
nine months of 2004, senior bank notes with a par value of $11.4 billion were
issued by the bank subsidiaries. At September 30, 2004, senior bank notes
totaling $2.2 billion were contractually based on a fixed rate of interest and
$15.7 billion were contractually based on a variable rate of interest. Senior
bank notes have maturities ranging from 2004 to 2078.
All subordinated notes of the bank subsidiaries were issued at fixed rates, pay
interest semi-annually and may not be redeemed prior to maturity. The 8.375%
senior note of the holding company was acquired as part of the Provident
acquisition, is fixed-rate, pays interest quarterly, and is callable on July 15,
2007. All remaining senior notes and subordinated notes of the holding company
were issued at fixed rates, pay interest semi-annually and may not be redeemed
prior to maturity. During the first nine months of 2004, the holding company
issued senior notes with a par value of $200 million.
At September 30, 2004, FHLB advances contractually consisted of $909 million of
fixed-rate obligations and $4.0 billion of variable-rate obligations. FHLB
advances are collateralized by qualifying residential real estate loans and have
maturities ranging from 2004 to 2023.
Secured debt financings were acquired as part of the acquisition of Provident.
The obligations acquired arose from auto lease, home equity, and equipment lease
securitization transactions that were structured as secured financings. In July
2004, the Corporation reacquired the securities associated with the obligations
secured by the home equity loans for approximately $1.0 billion, and this
obligation was subsequently extinguished in October 2004. The obligations
outstanding at September 30, 2004 relate to the secured debt financings
collateralized by auto and equipment leases, have fixed rates, pay interest
monthly, and can be redeemed prior to maturity. In connection with these
transactions, the Corporation has pledged $1.1 billion in auto leases, $158
million in cash, and $12 million in equipment leases at September 30, 2004.
Secured debt financings have contractual maturities ranging from 2004 to 2008.
During October 2004, the Corporation exercised an early call option on the
obligations secured by the equipment leases totaling $19 million and also
exercised an early call option on one obligation secured by auto leases totaling
$41 million.
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.
34
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
As of September 30, 2004, National City sponsored six trusts, First of America
Capital Trust I, Fort Wayne Capital Trust I, Allegiant Capital Trust II,
Provident Capital Trust I, Provident Capital Trust III, and Provident Capital
Trust IV, of which 100% of the common equity is owned by the Corporation. The
Allegiant and Provident capital trusts were acquired as part of the acquisitions
of Allegiant Bancorp, Inc. and Provident Financial Group, Inc., respectively.
The trusts were formed for the purpose of issuing corporation-obligated
mandatorily redeemable capital securities (the capital securities) to
third-party investors and investing the proceeds from the sale of such capital
securities solely in junior subordinated debt securities of the Corporation (the
debentures). The debentures held by each trust are the sole assets of that
trust.
Distributions on the capital securities issued by First of America Capital Trust
I, Fort Wayne Capital Trust I, and Provident 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 II, Provident Capital Trust III,
and Provident Capital Trust IV 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 the trusts are first redeemable, in whole or in part, by the
Corporation as follows:
FIRST
CALL DATE
---------
Provident Capital Trust III December 31, 2005
Provident Capital Trust IV March 30, 2006
Allegiant Capital Trust II September 30, 2006
Provident Capital Trust I December 1, 2006
First of America Capital Trust I January 31, 2007
Fort Wayne Capital Trust I April 15, 2007
On September 21, 2004 and September 30, 2004, respectively, the Corporation
redeemed the capital securities of two other trusts, Allegiant Capital Trust I
and Provident Capital Trust II, which had also been acquired as part of the
Allegiant and Provident acquisitions.
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.
Consolidated debt obligations related to subsidiary trusts holding solely
debentures of the Corporation follows. These amounts represent the par value of
the obligations owed to the subsidiary trusts, including the Corporation's
ownership interest in the trusts, plus basis adjustments related to hedging the
obligations with derivative instruments and fair value adjustments recognized at
the acquisition date for the Allegiant and Provident obligations.
SEPTEMBER 30 December 31 September 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 $154,640
9.85% junior subordinated debentures owed to Fort Wayne
Capital Trust I due April 15, 2027 30,928 30,928 30,928
9.00% junior subordinated debentures owed to Allegiant
Capital Trust II due September 30, 2031 45,100 -- --
8.60% junior subordinated debentures owed to Provident Capital
Trust I due December 1, 2026 117,670 -- --
10.25% junior subordinated debentures owed to Provident Capital
Trust III due December 31, 2030 127,464 -- --
9.45% junior subordinated debentures owed to Provident Capital
Trust IV due March 30, 2031 133,469 -- --
TOTAL JUNIOR SUBORDINATED DEBENTURES OWED TO UNCONSOLIDATED
-------- -------- --------
SUBSIDIARY TRUSTS $609,271 $185,568 $185,568
======== ======== ========
35
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:
SEPTEMBER 30 December 31 September 30
2004 2003 2003
---- ---- ----
(Dollars in Thousands) AMOUNT RATIO Amount Ratio Amount Ratio
- ---------------------- ------ ----- ------ ----- ------ -----
Total equity/assets $12,492,474 9.16% $ 9,328,671 8.19% $ 9,067,844 7.50%
Total common equity/assets 12,492,474 9.16 9,328,671 8.19 9,067,844 7.50
Tangible common equity/tangible assets 8,930,174 6.72 8,162,856 7.24 7,895,942 6.59
Tier 1 capital 9,541,848 8.23 8,420,382 8.79 8,052,390 8.11
Total risk-based capital 13,757,844 11.86 12,561,061 13.12 12,198,992 12.29
Leverage 9,541,848 7.35 8,420,382 7.43 8,052,390 6.58
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 September 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 category. As of December 31, 2003 and September
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, Allegiant, and Provident subsidiary trusts qualify as Tier 1 capital
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
$202 million at September 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.
36
Dividends paid by subsidiary banks to the parent company are also subject to
certain legal and regulatory limitations. At September 30, 2004, the subsidiary
banks may pay dividends of $1.2 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 outstanding shares of preferred and common stock follows:
SEPTEMBER 30 December 31 September 30
2004 2003 2003
---- ---- ----
Preferred Stock, no par value,
authorized 5,000,000 shares 70,272 -- --
Common Stock, $4 par value,
authorized 1,400,000,000 shares 658,272,817 605,996,120 609,136,762
=========== =========== ===========
In connection with the acquisition of Provident on July 1, 2004, 70,272 shares
of National City Series D convertible non-voting preferred stock were issued.
Each share of Series D preferred stock is convertible at any time by the holder
into 15.96 shares of National City common stock. The conversion rate is subject
to adjustment in the event the Corporation takes certain actions such as paying
a dividend in stock, splitting its common stock, or combining its common stock
into a smaller number of shares. Common shares deliverable upon conversion of
the preferred stock have been reserved for future issuance. The Corporation has
no right to redeem the preferred stock. Dividends are paid on the preferred
stock when dividends are paid on common stock at the dividend rate per common
share multiplied by the preferred stock conversion ratio. The Series D preferred
stock shall be preferred over the Corporation's common stock in the event of
liquidation or dissolution of the Corporation. In such event, the preferred
holders will be entitled to receive $100 per share plus accrued and unpaid
dividends.
STOCK REPURCHASES: 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 nine months of 2004 and 2003, the Corporation repurchased 27.2 million and
6.7 million shares of its common stock, respectively. As of September 30, 2004,
25.0 million shares remain authorized for repurchase.
PREFERRED SECURITIES OF SUBSIDIARIES: As part of the acquisition of Provident,
PFGI Capital Corporation (PFGI Capital) became a consolidated subsidiary of the
Corporation. PFGI Capital had issued 6.6 million equity units (PRIDES) to
outside investors for $165 million. This ownership by outside investors is
accounted for as a minority interest in the consolidated financial statements.
The principal objective of PFGI Capital is to hold and manage commercial
mortgage loan assets and other authorized investments acquired from the
Corporation to generate net income for distribution to its stockholders. PFGI
Capital has elected to be treated as a real estate investment trust (REIT) for
federal income tax purposes.
Holders of PRIDES are entitled to receive non-cumulative cash distributions at a
dividend rate of 7.75%. Under the forward purchase contract described below, the
Corporation will also make quarterly contract payments to holders at the rate of
1.25% of the stated amount per year. The PRIDES have a liquidation preference of
$25 per share. Under certain regulatory circumstances, the PRIDES will be
automatically exchanged into National City preferred stock.
PRIDES contain a forward purchase contract. Each forward purchase contract
obligates the holder to buy, on August 17, 2005, for $25.00, a number of newly
issued shares of National City Common Stock equal to the settlement rate,
determined as follows:
- - if the applicable market value of National City Common Stock is equal to
or greater than $25.6033, the settlement rate will be 0.9764;
- - if the applicable market value of National City Common Stock is between
$25.6033 and $21.5154, the settlement rate will be equal to the $25.00
stated amount divided by the applicable market value; and
- - if the applicable market value is less than or equal to $21.5154, the
settlement rate will be 1.1620.
Applicable market value is defined as the average of the closing price per share
of National City Common Stock on each of the 20 consecutive trading days ending
on the fifth trading day immediately preceding August 17, 2005.
37
OTHER COMPREHENSIVE INCOME: A summary of activity in accumulated other
comprehensive income follows.
Nine Months Ended
September 30
-----------------------
2004 2003
(In Thousands) --------- ---------
Accumulated unrealized gains on securities
available for sale at January 1, net of tax $ 132,318 $ 223,073
Net unrealized gains (losses) for the period, net of tax expense
(benefit) of $6,008 in 2004 and $(21,931) in 2003 11,157 (40,728)
Reclassification adjustment for gains included in net income,
net of tax expense of $2,914 in 2004 and $7,663 in 2003 (5,411) (29,312)
--------- ---------
Effect on other comprehensive income for the period 5,746 (70,040)
--------- ---------
Accumulated unrealized gains on securities available for sale
at September 30, net of tax $ 138,064 $ 153,033
========= =========
Accumulated unrealized losses on derivatives used in cash
flow hedging relationships at January 1, net of tax $ (67,631) $(155,893)
Net unrealized losses for the period, net of tax benefit
of $26,865 in 2004 and $21,534 in 2003 (49,892) (39,991)
Reclassification adjustment for losses included in net income,
net of tax benefit of $35,933 in 2004 and $50,038 in 2003 66,732 92,929
--------- ---------
Effect on other comprehensive income for the period 16,840 52,938
--------- ---------
Accumulated unrealized losses on derivatives used in cash
flow hedging relationships at September 30, net of tax $ (50,791) $(102,955)
========= =========
Accumulated other comprehensive income at
January 1, net of tax $ 64,687 $ 67,180
Other comprehensive income (loss), net of tax 22,586 (17,102)
--------- ---------
ACCUMULATED OTHER COMPREHENSIVE INCOME AT SEPTEMBER 30,
NET OF TAX $ 87,273 $ 50,078
========= =========
17. NET INCOME PER COMMON SHARE
Basic and diluted net income per common share calculations follow:
Three Months Ended Nine Months Ended
September 30 September 30
---------------------------- ----------------------------
2004 2003 2004 2003
(Dollars in Thousands, Except Per Share Amountse) ------------ ------------ ------------ ------------
BASIC
Net income $ 590,715 $ 343,637 $ 1,820,129 $ 1,572,948
Less preferred dividends 393 -- 393 --
------------ ------------ ------------ ------------
Net income applicable to common stock 590,322 343,637 1,819,736 1,572,948
------------ ------------ ------------ ------------
Average common shares outstanding 663,338,716 613,574,321 629,574,688 612,412,749
------------ ------------ ------------ ------------
Net income per common share -- basic $ .88 $ .56 $ 2.89 $ 2.57
============ ============ ============ ============
DILUTED
Net income $ 590,715 $ 343,637 $ 1,820,129 $ 1,572,948
------------ ------------ ------------ ------------
Average common shares outstanding 663,338,716 613,574,321 629,574,688 612,412,749
Stock awards 10,734,362 5,394,501 7,941,243 5,243,602
Convertible preferred stock 1,121,541 -- 376,576 --
Forward contracts 1,948,599 -- 654,274 --
------------ ------------ ------------ ------------
Average common shares outstanding -- diluted 677,143,218 618,968,822 638,546,781 617,656,351
------------ ------------ ------------ ------------
Net income per common share -- diluted $ .86 $ .56 $ 2.85 $ 2.55
============ ============ ============ ============
Basic net income per common share is calculated by dividing net income, less
dividend requirements on convertible preferred stock, by the weighted-average
number of common shares outstanding for the period.
38
Diluted net income per common share takes into consideration the pro forma
dilution of outstanding convertible preferred stock, commitments to issue
additional shares pursuant to forward contracts, and certain unvested restricted
stock and unexercised stock option awards. During the third quarter of 2004, the
Corporation issued convertible preferred stock and assumed an obligation to
issue additional shares under a forward contract in connection with the
acquisition of Provident (see discussion of forward contracts in Note 16). For
the three- and nine-month periods ended September 30, 2004, options to purchase
1,461,955 and 2,732,436 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 such that their
inclusion would have had an anti-dilutive effect. For the three- and nine-month
periods ended September 30, 2003, options to purchase 16,551,549 and 19,674,139
shares of common stock, respectively, were outstanding but not included in the
computation of diluted net income per share for the same reason.
18. INCOME TAX EXPENSE
The composition of income tax expense (benefit) follows:
Three Months Ended Nine Months Ended
September 30 September 30
2004 2003 2004 2003
(In Thousands) --------- -------- -------- --------
Applicable to income exclusive of securities transactions $ 293,604 $173,701 $920,593 $824,404
Applicable to securities transactions (388) 1,889 1,423 7,663
--------- -------- -------- --------
INCOME TAX EXPENSE $ 293,216 $175,590 $922,016 $832,067
========= ======== ======== ========
The effective tax rate for the three- and nine-month periods ended September 30,
2004 was 33.2% and 33.6%, respectively. The effective tax rate was 33.8% and
34.6% for the three- and nine-month periods ended September 30, 2003,
respectively. The lower tax rate for the first nine months of 2004 reflects a
reduction in certain deferred tax liabilities in 2004 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:
SEPTEMBER 30 December 31 September 30
2004 2003 2003
(In Thousands) ----------- ----------- -----------
Commitments to extend credit:
Commercial $17,860,398 $15,201,047 $15,310,549
Residential real estate 19,244,682 10,556,066 16,956,287
Revolving home equity and credit card lines 30,657,743 23,936,622 23,486,660
Other 723,391 521,813 392,319
Standby letters of credit 4,181,424 3,765,284 3,922,038
Commercial letters of credit 309,823 150,640 155,703
Net commitments to sell mortgage loans and
mortgage-backed securities 7,682,758 13,126,094 18,841,648
Commitments to fund principal investments 237,821 226,793 253,062
Commitments to fund civic and community investments 281,704 200,477 185,598
=========== =========== ===========
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 in accordance with 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 residential real estate loans in the above
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.
39
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 $20.2 billion and $178.4
billion for the third quarter and first nine months of 2004, respectively, and
were $36.0 billion and $92.9 billion for the same 2003 periods, respectively.
Total loans repurchased or indemnified during the third quarter and first nine
months of 2004 were $160 million and $352 million, respectively, and total loans
repurchased or indemnified for the same 2003 period were $56 million and $180
million, respectively. Loans indemnified that remain outstanding as of September
30, 2004 totaled $204 million. In addition, total loans sold of $366 million
remained uninsured as of September 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 September 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 $42 million and $103 million
for the third quarter and first nine months of 2004, respectively. Losses
charged against the liability for the third quarter and first nine months of
2003 were $18 million and $48 million, respectively. At September 30, 2004 and
2003, the liability for estimated losses on repurchase and indemnification was
$197 million and $160 million, respectively, and was included in other
liabilities on the balance sheet.
In connection with the acquisition of Provident, the Corporation assumed a
guarantee made to Fannie Mae on behalf of its acquired subsidiary Red Mortgage,
an approved Fannie Mae Delegated Underwriting and Servicing (DUS) mortgage
lender. Under the Fannie Mae DUS program, Red Mortgage underwrites, funds, and
sells mortgage loans on multifamily rental projects. Red Mortgage then services
these mortgage loans on Fannie Mae's behalf. Participation in the Fannie Mae DUS
program requires Red Mortgage to share the risk of loan losses with Fannie Mae.
Under the loss sharing arrangement, Red Mortgage and Fannie Mae split losses
with one-third assumed by Red Mortgage and two-thirds assumed by Fannie Mae. The
Corporation provides a guarantee to Fannie Mae that it would fulfill all
payments required of Red Mortgage under the loss sharing arrangement if Red
Mortgage fails to meet its obligations. As of September 30, 2004, Red Mortgage
serviced loans with outstanding principal balances aggregating $4.0 billion
under the DUS program. The guarantee will continue until such time as the loss
sharing agreement is amended or Red Mortgage no longer shares the risk of losses
with Fannie Mae. The fair value of the guarantee, in the form of reserves for
losses under the Fannie Mae DUS program, is recorded in accrued expenses and
other liabilities on the balance sheet and totaled $10 million at September 30,
2004.
The guarantee liability for standby letters of credit was $8 million at
September 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.
The Corporation, through its subsidiaries, National Processing, Inc., the
Provident Bank, and National City Bank of Kentucky, has provided merchant card
processing or sponsorship 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
40
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 June through September
2004, this amount totaled approximately $55.6 billion. At September 30, 2004,
the Corporation had $3 million of unresolved chargebacks that were in process of
resolution.
For the three months ended September 30, 2004 and 2003, the Corporation
processed $38 million and $39 million, respectively, in chargebacks presented by
issuing banks. For the nine months ended September 30, 2004 and 2003, the
Corporation processed $111 million and $115 million, respectively, in
chargebacks presented by issuing banks. Actual losses recorded for the three
months ended September 30, 2004 and 2003 were each $1 million. Actual losses
recorded for the nine months ended September 30, 2004 and 2003 were $3 million
and $2 million, respectively. The Corporation accrues for probable losses based
on historical experience and at September 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 nine months ended September 30, 2004,
the Corporation processed approximately $6 billion of merchant transactions
related to delayed-delivery purchases.
Effective October 15, 2004, National Processing, Inc. was sold as described in
Note 3. As a result of this sale, the Corporation has exited the merchant card
processing business and has no continuing or future exposure to potential
chargeback liabilities, except for an immaterial exposure acquired with
Provident and as described in the following paragraph.
The Corporation processes card transactions for United Airlines, Inc., which is
currently operating under Chapter 11 protection. Under the terms of the sale of
National Processing, Inc., as discussed in Note 3, the Corporation has retained
the contractual obligation to process card transactions for United Airlines. 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
November of 2005. 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 September 30, 2004, the estimated dollar value of tickets
purchased, but as yet unflown, under the United Airlines merchant processing
contract, was approximately $716 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 September 30, 2004, the
Corporation held no significant collateral under this contract.
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 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.
41
RELATED PARTY TRANSACTIONS: The Corporation has no material related party
transactions which would require disclosure. In compliance with applicable
banking regulations, the Corporation may extend credit to certain officers and
directors of the Corporation and its banking subsidiaries in the ordinary course
of business under substantially the same terms as comparable third-party lending
arrangements.
20. STOCK OPTIONS AND AWARDS
National City maintains various incentive and nonqualified stock option plans
and also maintains various restricted stock plans. These plans provide for the
granting of stock options, stock appreciation rights, and restricted shares to
eligible employees and directors.
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.
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 third quarter and first nine
months of 2004, compensation expense recognized related to National City
Corporation's stock option plans totaled $7 million and $18 million,
respectively, and $5 million and $8 million for the third quarter and first nine
months of 2003, respectively.
42
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 recognizes compensation expense over the restricted period. The
weighted-average grant-date fair value of restricted share awards granted during
the third quarter and first nine months of 2004 were $35.81 and $35.22,
respectively, and $33.78 and $32.49, respectively, for the third quarter and
first nine months of 2003. Compensation expense recognized for restricted share
plans during the third quarter and first nine months of 2004 totaled $8 million
and $21 million, respectively, and $5 million and $12 million for the third
quarter and first nine months of 2003, respectively.
OPTION AND RESTRICTED STOCK AWARD ACTIVITY: Stock option and restricted stock
award activity follows:
Weighted-
Average
Exercise
Shares Outstanding Price Per
Awards Options Share
--------- ---------- ------
January 1, 2003 2,539,171 52,963,738 $26.89
Cancelled (117,103) (662,827) 29.73
Exercised (425,536) (6,043,552) 21.07
Granted 1,695,405 6,313,731 33.47
--------- ---------- ------
September 30, 2003 3,691,937 52,571,090 28.31
--------- ---------- ------
January 1, 2004 3,781,641 50,851,242 $28.52
Acquisitions -- 9,285,357 26.16
Cancelled (172,658) (325,091) 30.39
Exercised (631,266) (11,076,825) 25.39
Granted 1,919,008 7,321,292 35.83
--------- ---------- ------
SEPTEMBER 30, 2004 4,896,725 56,055,975 $29.69
========= ========== ======
Upon consummation of the Allegiant and Provident acquisitions, all outstanding
options issued by Allegiant and Provident were converted into equivalent
National City options. Cancelled activity includes both forfeited and expired
awards and options.
Information about stock options outstanding at September 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-$12.99 197,768 $10.69 1.0 197,768 $10.69
13.00-19.99 6,185,808 17.74 4.7 6,185,808 17.74
20.00-26.99 4,198,885 24.37 5.8 4,190,885 24.36
27.00-33.99 36,032,120 30.72 6.0 32,077,507 30.35
34.00-40.99 9,010,455 35.99 7.5 2,501,230 36.06
41.00-47.99 430,939 43.36 3.5 430,939 43.36
---------- ------ --- ---------- ------
TOTAL 56,055,975 $29.69 6.1 45,584,137 $28.44
========== ====== === ========== ======
At September 30, 2004 and 2003, options for 45,584,137 and 41,833,752 shares of
common stock, respectively, were exercisable. As of September 30, 2004, 38
million shares of National City common stock under the Long-Term Incentive 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 contribute at least
the minimum amount required by the Employee Retirement Income Security Act of
1974.
43
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, for the
pension benefits, and May 1, 2004 and October 31, 2002, for the postretirement
benefits, components of net periodic benefit and net periodic cost for the
three- and nine-month periods ended September 30 follow:
Three Months Ended Nine Months Ended
September 30 September 30
--------------------- ----------------------
2004 2003 2004 2003
(In Thousands) ---- ---- ---- ----
PENSION BENEFITS
Service cost $ 13,847 $ 12,790 $ 41,541 $ 38,371
Interest cost 20,681 20,021 62,044 60,063
Expected return on plan assets (31,825) (35,861) (95,475) (107,582)
Amortization of prior service cost (1,189) (1,188) (3,566) (3,566)
Transition benefit -- (51) -- (155)
Recognized net actuarial loss 743 365 2,228 1,096
-------- -------- -------- ---------
NET PERIODIC COST (BENEFIT) $ 2,257 $ (3,924) $ 6,772 $ (11,773)
======== ======== ======== =========
POSTRETIREMENT BENEFITS
Service cost $ 849 $ 735 $ 2,514 $ 2,209
Interest cost 2,240 2,336 6,949 7,007
Amortization of prior service cost 24 33 72 100
Transition obligation 351 351 1,051 1,051
Recognized net actuarial loss 340 397 1,336 1,191
-------- -------- -------- ---------
NET PERIODIC COST $ 3,804 $ 3,852 $ 11,922 $ 11,558
======== ======== ======== =========
Actuarial assumptions used to calculate the net periodic pension and the
postretirement benefits and costs were as follows:
Pension Benefits 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 signed 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 that
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 Staff Position 106-2 became effective for the Corporation
as of July 1, 2004 and have been applied prospectively. Accordingly, the
Corporation was required to remeasure its postretirement benefit obligation and
net periodic cost as of May 1, 2004. As a result of the remeasurement, thea
postretirement benefit obligation decreased by $8 million and the net periodic
benefit cost decreased by $1 million for 2004. The Corporation anticipates its
benefit costs will continue to 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 September 30,
2004, December 31, 2003, and September 30, 2003, obligations of $ 89 million,
$83 million, and $87 million, respectively, were included in accrued expenses
and other liabilities for these plans. Expenses related to these plans totaled
$3 million and $10 million for the third quarter and first nine months of 2004,
respectively, and $4 million and $12 million for the third quarter and first
nine 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 $57
million for the third quarter and first nine months of 2004, respectively, and
$13 million and $53 million for the third quarter and first nine months of 2003,
respectively.
44
22. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Corporation uses derivative instruments primarily to protect against the
risk of adverse price or interest rate movements on the value of certain assets
and liabilities and on future cash flows. It also executes derivative
instruments with its commercial banking customers to facilitate their risk
management strategies. Derivative instruments represent contracts between
parties that usually require little or no initial net investment and result in
one party delivering cash or another type of asset to the other party based on a
notional amount and an underlying as specified in the contract. A notional
amount represents the number of units of a specific item, such as currency units
or shares. An underlying represents a variable, such as an interest rate,
security price, or price index. The amount of cash or other asset delivered from
one party to the other is determined based on the interaction of the notional
amount of the contract with the underlying. Derivatives are also implicit in
certain contracts and commitments.
Market risk is the risk of loss arising from an adverse change in interest
rates, exchange rates, or equity prices. The Corporation's primary market risk
is interest rate risk. Management uses derivative instruments to protect against
the risk of interest rate movements on the value of certain assets and
liabilities and on future cash flows. These instruments include interest rate
swaps, interest rate futures, interest rate options, forward agreements, and
interest rate caps and floors with indices that relate to the pricing of
specific assets and liabilities. The nature and volume of the derivative
instruments used to manage interest rate risk depend on the level and type of
assets and liabilities on the balance sheet and the risk management strategies
for the current and anticipated rate environments.
SFAS 133 requires all derivative instruments to be carried at fair value on the
balance sheet. SFAS 133 provides special hedge accounting provisions which
permit the change in the fair value of the hedged item related to the risk being
hedged to be recognized in earnings in the same period and in the same income
statement line as the change in fair value of the derivative. Note 1 provides
further detail on how derivative instruments are accounted for in the financial
statements. The Corporation usually designates derivative instruments used to
manage interest rate risk into SFAS 133 hedge relationships with the specific
assets, liabilities, or cash flows being hedged. Some derivative instruments
used for interest rate risk management are not designated in an SFAS 133 hedge
relationship. Such will be the case if the derivative instrument is being used
to offset risk related to an asset or liability that is accounted for at fair
value in the financial statements, if the derivative instrument has been moved
out of an SFAS 133 relationship because the hedge was deemed not effective, or
if operational or cost constraints make it prohibitive to apply hedge
accounting.
As with any financial instrument, derivative instruments have inherent risks,
primarily market and credit risk. Market risk associated with changes in
interest rates is managed by establishing and monitoring limits as to the degree
of risk that may be undertaken as part of the Corporation's overall market risk
monitoring process carried out by the Asset/Liability Management Committee. See
further discussion of this process in the Market Risk section of the Financial
Review.
Credit risk occurs when a counterparty to a derivative contract with an
unrealized gain fails to perform according to the terms of the agreement. Credit
risk is managed by limiting the aggregate amount of net unrealized gains in
agreements outstanding, monitoring the size and the maturity structure of the
derivative portfolio, applying uniform credit standards to all activities with
credit risk, and collateralizing gains. The Corporation has established
bilateral collateral agreements with its major derivative dealer counterparties
that provide for exchanges of marketable securities or cash to collateralize
either party's net gains. At September 30, 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 September 30,
2004, the Corporation held cash, U.S. government, and U.S. government-sponsored
agency securities with a fair value of $427 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
$44 million to collateralize net losses with counterparties. The Corporation
typically does not have collateral agreements covering open forward commitments
to sell or purchase mortgage loans or mortgage-backed securities due to the fact
these contracts usually mature within 90 days. Open futures contracts are also
not covered by collateral agreements because the contracts are cash settled with
counterparties daily. The credit risk associated with derivative instruments
executed with the Corporation's commercial banking customers is essentially the
same as that involved in extending loans and is subject to normal credit
policies. Collateral may be obtained based on management's assessment of the
customer.
Derivative contracts are valued using observable market prices, if available, or
cash flow projection models acquired from third parties. Pricing models used for
valuing derivative instruments are regularly validated by testing through
comparison with other third parties. The valuations presented in the following
tables are based on yield curves, forward yield curves, and implied volatilities
that were observable in the cash and derivatives markets on September 30, 2004,
December 31, 2003, and September 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.
45
The Corporation also uses receive-fixed interest rate swaps to hedge the fair
values of certain fixed-rate funding products against changes in interest rates.
The funding products hedged include purchased certificates of deposit, long-term
FHLB advances, corporate and subordinated long-term debt, and senior bank notes.
For the three and nine month periods ended September 30, 2004, the Corporation
recognized total net ineffective fair value hedge gains (losses) of $(2) million
and $(82) million, respectively. For the same periods in 2003, the Corporation
recognized total net ineffective hedge gains (losses) of $(28) million and $67
million, respectively. Of the total gains (losses) recognized, net ineffective
hedge gains (losses) related to servicing assets were $(6) million and $(58)
million for the three and nine month periods ended September 30, 2004,
respectively, compared to $(34) million and $48 million for the same periods in
2003, respectively. For the third quarter and first nine months of 2004, net
ineffective hedge gains (losses) related to mortgage loans held for sale were
$(3) million and $(45) 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 (losses) 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 $21 million for the three
and nine month periods ended September 30, 2004, respectively. Net ineffective
hedge gains (losses) related to these hedged assets and liabilities were $6
million and $19 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 nine 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 month periods ended September 30, 2004 and 2003, the Corporation
recognized net ineffective cash flow hedge gains (losses) of $100 thousand and
$(900) thousand, respectively. During the first nine months of 2004, the
Corporation recognized net ineffective cash flow hedge gains (losses) of $200
thousand. There were no net ineffective cash flow hedge gains (losses)
recognized during the first nine months of 2003. These gains (losses) are
included in other noninterest income on the income statement. There were no
components of derivative instruments which were excluded from the assessment of
hedge effectiveness during the first nine months of 2004 and 2003.
Gains and losses on derivative instruments reclassified from accumulated other
comprehensive income to current-period earnings are included in the line item in
which the hedged cash flows are recorded. At September 30, 2004, December 31,
2003, and September 30, 2003, accumulated other comprehensive income included a
deferred after-tax net loss of $51 million, $68 million and $103 million,
respectively, related to derivatives used to hedge funding cash flows. See Note
16 for further detail of the amounts included in accumulated other comprehensive
income. The net after-tax derivative loss included in accumulated other
comprehensive income as of September 30, 2004 is projected to be reclassified
into interest expense in conjunction with the recognition of interest payments
on funding products through November 2014, with $47 million of net loss expected
to be reclassified within the next year. During the three and nine month periods
ended September 30, 2004, pretax losses of $36 million and $99 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 $54 million and $143 million, respectively, were reclassified into
interest expense. Additionally, during the first nine 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 nine 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
September 30, 2004, December 31, 2003, and September 30, 2003.
46
Summary information regarding the interest rate derivatives portfolio used for
interest-rate risk management purposes and designated as accounting hedges under
SFAS 133 at September 30, 2004, December 31, 2003, and September 30, 2003
follows:
SEPTEMBER 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 $ 2.3 $ -- $ 60 $ 1.4 $ --
Receive-fixed interest rate swaptions
sold 25 -- .1 55 -- .2
Pay-fixed interest rate swaps 3,367 4.0 144.1 3,379 3.5 195.0
Callable pay-fixed interest rate swaps 16 -- 1.5 43 -- 4.0
Pay-fixed interest rate swaptions sold 175 -- 4.7 205 -- 7.1
Interest rate caps sold 715 -- .4 815 -- 1.4
Interest rate floors sold 360 -- 5.3 360 -- 7.7
Interest rate futures purchased 1,928 -- -- 2,173 -- --
Interest rate futures sold 2,550 -- -- 3,086 -- --
-------- ------ ------ ------ ------- ------ ------
Total 9,196 6.3 156.1 $ 20.1 10,176 4.9 215.4
-------- ------ ------ ------ ------- ------ ------
Mortgage loans held for sale
Forward commitments to purchase and sell
mortgage loans and mortgage-backed
securities 5,014 -- 52.7 -- -- --
Receive-fixed interest rate swaps 425 12.9 -- -- -- --
Pay-fixed interest rate swaps 800 -- 80.1 -- -- --
Pay-fixed interest rate swaptions 500 4.1 -- -- -- --
purchased
Pay-fixed interest rate swaptions sold 250 -- 8.5 -- -- --
Interest rate caps purchased 9,000 14.0 -- -- -- --
Interest rate futures purchased 900 -- -- -- -- --
-------- ------ ------ ------ ------- ------ ------
Total 16,889 31.0 141.3 (45.4) -- -- --
-------- ------ ------ ------ ------- ------ ------
Mortgage servicing assets
Forward commitments to
purchase mortgage loans and
mortgage-backed securities 6,148 49.6 -- 2,904 31.7 --
Receive-fixed interest rate swaps 9,002 366.8 32.1 10,206 376.2 48.2
Receive-fixed interest rate swaptions
purchased 1,500 26.2 -- -- -- --
Receive-fixed interest rate swaptions 500 -- 3.5 415 -- 8.6
sold
Pay-fixed interest rate swaps -- -- -- 30 -- .1
Pay-fixed interest rate swaptions
purchased 7,148 31.2 -- 3,515 62.5 --
Pay-fixed interest rate swaptions sold 1,635 -- 25.7 1,295 -- 76.2
Principal-only interest rate swaps 461 3.0 3.4 123 6.9 .5
Interest rate caps purchased 29,390 40.2 -- 30,410 83.5 --
Interest rate caps sold 2,999 -- 3.2 -- -- --
Interest rate floors purchased 1,500 8.0 -- -- -- --
-------- ------ ------ ------ ------- ------ ------
Total 60,283 525.0 67.9 (58.0) 48,898 560.8 133.6
-------- ------ ------ ------ ------- ------ ------
Funding
Receive-fixed interest rate swaps 6,709 350.4 6.2 4,550 350.8 35.7
Callable receive-fixed interest
rate swaps 3,067 19.7 5.0 310 9.2 3.2
-------- ------ ------ ------ ------- ------ ------
Total 9,776 370.1 11.2 1.0 4,860 360.0 38.9
-------- ------ ------ ------ ------- ------ ------
TOTAL DERIVATIVES USED IN FAIR
VALUE HEDGES 96,144 932.4 376.5 (82.3) 63,934 925.7 387.9
-------- ------ ------ ------ ------- ------ ------
CASH FLOW HEDGES
Funding
Receive-fixed interest rate swaps 169 3.3 -- -- -- --
Pay-fixed interest rate swaps 8,273 17.6 50.8 10,945 2.1 52.1
Interest rate caps purchased 4,875 13.9 -- 3,500 3.0 --
-------- ------ ------ ------ ------- ------ ------
Total 13,317 34.8 50.8 .2 14,445 5.1 52.1
-------- ------ ------ ------ ------- ------ ------
TOTAL DERIVATIVES USED IN CASH FLOW
HEDGES 13,317 34.8 50.8 .2 14,445 5.1 52.1
-------- ------ ------ ------ ------- ------ ------
TOTAL DERIVATIVES USED FOR INTEREST
RATE RISK MANAGEMENT AND DESIG-
NATED IN SFAS 133 RELATIONSHIPS $109,461 $967.2 $427.3 $(82.1) $78,379 $930.8 $440.0
======== ====== ====== ====== ======= ====== ======
(a) Represents net ineffective hedge gain (loss) on hedging strategy for
the nine-month period ended September 30, 2004.
47
September 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 $ 1.5 $ --
Receive-fixed interest rate swaptions sold 55 -- .2
Pay-fixed interest rate swaps 3,426 2.1 233.2
Callable pay-fixed interest rate swaps 44 -- 4.7
Pay-fixed interest rate swaptions sold 55 -- 5.2
Interest rate caps sold 815 -- 1.3
Interest rate floors sold 360 -- 8.7
Interest rate futures purchased 2,463 -- --
Interest rate futures sold 2,915 -- --
------- -------- ------ ---------
Total 10,193 3.6 253.3 $ 20.1
------- -------- ------ ---------
Mortgage servicing assets
Forward commitments to purchase
mortgage loans and mortgage-
backed securities 6,479 203.3 --
Receive-fixed interest rate swaps 6,463 453.9 37.2
Receive-fixed interest rate swaptions purchased 3,600 65.0 --
Pay-fixed interest rate swaptions sold 795 -- 72.4
Principal-only interest rate swaps 166 15.2 --
Interest rate caps purchased 32,725 95.3 --
------- -------- ------ ---------
Total 50,228 832.7 109.6 47.9
------- -------- ------ ---------
Funding
Receive-fixed interest rate swaps 5,005 405.3 26.3
Callable receive-fixed interest rate swaps 495 12.3 3.7
------- -------- ------ ---------
Total 5,500 417.6 30.0 (.7)
------- -------- ------ ---------
TOTAL DERIVATIVES USED IN FAIR VALUE HEDGES 65,921 1,253.9 392.9 67.3
------- -------- ------ ---------
Funding
Pay-fixed interest rate swaps 12,975 .6 100.6
Interest rate caps purchased 3,515 4.1 --
------- -------- ------ ---------
Total 16,490 4.7 100.6 --
------- -------- ------ ---------
TOTAL DERIVATIVES USED IN CASH FLOW HEDGES 16,490 4.7 100.6 --
------- -------- ------ ---------
TOTAL DERIVATIVES USED FOR INTEREST RATE RISK
MANAGEMENT AND DESIGNATED IN SFAS 133 RELATIONSHIPS $82,411 $1,258.6 $493.5 $ 67.3
======= ======== ====== =========
(a) Represents net ineffective hedge gain (loss) on hedging strategy for
the nine-month period ended September 30, 2003.
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 Nine Months Ended
September 30 September 30
SEPTEMBER 30 December 31 September 30 -------------------- ------------------
(In Millions) 2004 2003 2003 2004 2003 2004 2003
- ------------- ---- ---- ---- ---- ---- ---- ----
OTHER DERIVATIVE INSTRUMENTS
Mortgage-banking-related:
Mortgage servicing asset risk
management $ 6.1 $ 36.1 $ (22.5) $ 171.6 $ (46.8) $537.2 $ 136.8
Mortgage loan commitments and
commitment and mortgage loan risk
management (12.9) (72.1) (221.3) 172.2 (262.5) 49.4 (206.0)
------ ------ -------- -------- ------- ------ -------
Total mortgage-banking related (6.8) (36.0) (243.8) 343.8 (309.3) 586.6 (69.2)
------ ------ -------- -------- ------- ------ -------
Customer risk management 12.2 15.0 14.5 2.4 2.3 8.9 8.8
Other 31.6 3.7 3.8 (7.6) (19.2) 14.6 46.6
------ ------ -------- -------- ------- ------ -------
Total other 43.8 18.7 18.3 (5.2) (16.9) 23.5 55.4
------ ------ -------- -------- ------- ------ -------
TOTAL OTHER DERIVATIVE INSTRUMENTS $ 37.0 $(17.3) $ (225.5) $ 338.6 $(326.2) $610.1 $ (13.8)
====== ====== ======== ======== ======= ====== =======
48
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 banking 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 services, 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, 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 nine months of 2004,
approximately 49% of NCMC mortgage loans were originated through wholesale and
correspondent channels, while 51% 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 four 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. During the first nine months of 2004, 32% of First Franklin originated
loans were retained in portfolio at NCF's National City Home Loan Services
business unit compared to 50% for the same period in 2003. The remaining loans
sold during 2004 and 2003 were sold servicing released. The percentage of loans
sold versus retained in any given period will vary depending on 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. The National City Warehouse Resources business unit provides emerging
mortgage bankers across the country with lines of credit for loan funding
purposes. 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
former 83%-owned payment processing subsidiary. In October 2004, this business
was sold to Bank of America. Refer to Note 3 for further discussion. National
Processing's business consisted of the authorization, processing, financial
settlement, and reporting of debit and credit card transactions, and financial
settlement and reporting solutions for large and mid-size corporate customers in
the travel and health care industries.
49
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. 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.
50
CONSUMER AND
SMALL BUSINESS NATIONAL
FINANCIAL WHOLESALE NATIONAL CITY CONSUMER ASSET NATIONAL PARENT AND CONSOLIDATED
(In Thousands) SERVICES BANKING MORTGAGE CO. FINANCE MANAGEMENT PROCESSING OTHER TOTAL
-------- ------- ------------ ------- ---------- ---------- ----- -----
QUARTER ENDED SEPTEMBER
30, 2004
Net interest income $532,126 $347,180 $124,538 $ 321,303 $ 29,755 $ 1,340 $(160,418) $1,195,824
(expense)(a)
Provision (benefit) for
loan losses 71,517 31,244 (1,324) 20,099 (135) -- (22,969) 98,432
-------- -------- -------- --------- --------- --------- --------- -----------
Net interest income
(expense) after 460,609 315,936 125,862 301,204 29,890 1,340 (137,449) 1,097,392
provision
Noninterest income 285,166 140,816 258,053 125,293 83,156 133,481 689 1,026,654
Noninterest expense 455,368 186,890 160,256 149,858 71,447 107,079 101,876 1,232,774
-------- -------- -------- --------- --------- --------- --------- -----------
Income (loss) before taxes 290,407 269,862 223,659 276,639 41,599 27,742 (238,636) 891,272
Income tax expense 111,939 102,110 84,978 104,570 15,724 10,979 (129,743) 300,557
(benefit)(a)
-------- -------- -------- --------- --------- --------- --------- -----------
Net income (loss) $178,468 $167,752 $138,681 $ 172,069 $ 25,875 $ 16,763 $(108,893) $ 590,715
======== ======== ======== ========= ========= ========= ========= ===========
Intersegment revenue
(expense) $ (850) $ 3,396 $ 15,542 $ (7,057) $ 1,784 $ 1,892 $ (14,707) $ --
Average assets (in millions) 31,169 40,118 14,822 31,502 3,283 744 11,836 133,474
======== ======== ======== ========= ========= ========= ========= ===========
Quarter ended September
30, 2003
Net interest income
(expense)(a) $497,354 $266,758 $327,452 $ 220,393 $ 26,144 $ 787 $(188,123) $ 1,150,765
Provision (benefit) for
loan losses 73,408 39,820 (2,520) 16,753 1,286 -- (21,700) 107,047
-------- -------- -------- --------- --------- --------- --------- -----------
Net interest income
(expense) after 423,946 226,938 329,972 203,640 24,858 787 (166,423) 1,043,718
provision
Noninterest income 180,240 100,833 101,885) 91,938 86,870 124,881 7,042 489,919
Noninterest expense 335,946 121,604 229,127 93,156 72,406 101,548 53,829 1,007,616
-------- -------- -------- --------- --------- --------- --------- -----------
Income (loss) before taxes 268,240 206,167 (1,040) 202,422 39,322 24,120 (213,210) 526,021
Income tax expense
(benefit) (a) 101,395 76,703 722 76,515 14,864 9,811 (97,626) 182,384
-------- -------- -------- --------- --------- --------- --------- -----------
Net income (loss) $166,845 $129,464 $ (1,762) $ 125,907 $ 24,458 $ 14,309 $(115,584 $ 343,637
======== ======== ======== ========= ========= ========= ========= ===========
Intersegment revenue
(expense) $ (891) $ 4,035 $ 14,002 $ (4,340) $ 1,678 $ 1,236 $ (15,720) $ --
Average assets (in millions) 26,420 30,646 32,778 20,216 2,873 691 10,027 123,651
======== ======== ======== ========= ========= ========= ========= ===========
(a) Includes tax-equivalent adjustment for tax-exempt interest income
CONSUMER AND
SMALL BUSINESS NATIONAL
FINANCIAL WHOLESALE NATIONAL CITY CONSUMER ASSET NATIONAL PARENT AND CONSOLIDATED
(In Thousands) SERVICES BANKING MORTGAGE CO. FINANCE MANAGEMENT PROCESSING OTHER TOTAL
-------- ------- ------------ ------- ---------- ---------- ----- -----
NINE MONTHS ENDED
SEPTEMBER 30, 2004
Net interest income $1,529,534 $881,356 $ 426,908 $858,296 $ 82,609 $ 3,221 $(494,163) $3,287,761
(expense)(a)
Provision (benefit) for
loan losses 221,857 35,397 5,927 41,566 1,514 -- (64,534) 241,727
---------- -------- ---------- -------- --------- --------- --------- ----------
Net interest income
(expense) after 1,307,677 845,959 420,981 816,730 81,095 3,221 (429,629) 3,046,034
provision
Noninterest income 680,389 343,907 767,145 418,070 336,007 387,806 77,304 3,010,628
Noninterest expense 1,178,756 436,852 497,548 409,464 231,193 320,013 220,425 3,294,251
---------- -------- ---------- -------- --------- --------- --------- ----------
Income (loss) before taxes 809,310 753,014 690,578 825,336 185,909 71,014 (572,750) 2,762,411
Income tax expense
(benefit)(a) 308,384 282,682 262,382 311,977 70,272 27,901 (321,316) 942,282
---------- -------- ---------- -------- --------- --------- --------- ----------
Net income (loss) $ 500,926 $470,332 $ 428,196 $513,359 $ 115,637 $ 43,113 $(251,434) $1,820,129
========== ======== ========== ======== ========= ========= ========= ==========
Intersegment revenue
(expense) $ (2,592) $ 12,420 $ 41,555 $(19,600) $ 4,589 $ 4,460 $ (40,832) $ --
Average assets (in millions) 28,470 33,519 16,229 27,683 3,085 716 9,925 119,627
========== ======== ========== ======== ========= ========= ========= ==========
Nine months ended
September 30, 2003
Net interest income $1,478,118 $790,982 $ 893,002 $584,873 $ 77,125 $ 2,335 $(472,694) $3,353,741
(expense)(a)
Provision (benefit) for
loan losses 217,634 259,930 5,553 64,595 5,603 -- (62,888) 490,427
---------- -------- ---------- -------- --------- --------- --------- ----------
Net interest income
(expense) after 1,260,484 531,052 887,449 520,278 71,522 2,335 (409,806) 2,863,314
provision
Noninterest income 522,268 247,602 833,146 247,692 261,164 344,594 148,851 2,605,317
Noninterest expense 1,016,778 379,396 602,165 240,459 219,167 290,057 294,697 3,042,719
---------- -------- ---------- -------- --------- --------- --------- ----------
Income (loss) before taxes 765,974 399,258 1,118,430 527,511 113,519 56,872 (555,652) 2,425,912
Income tax expense 289,539 149,501 444,736 199,399 42,910 22,950 (296,071) 852,964
(benefit)(a)
---------- -------- ---------- -------- --------- --------- --------- ----------
Net income (loss) $ 476,435 $249,757 $ 673,694 $328,112 $ 70,609 $ 33,922 $(259,581) $1,572,948
========== ======== ========== ======== ========= ========= ========= ==========
Intersegment revenue
(expense) $ (2,784) $ 15,377 $ 36,588 $(11,133) $ 5,343 $ 4,020 $ (47,411) $ --
Average assets (in millions) 25,971 31,022 30,662 18,209 2,890 589 10,352 119,695
========== ======== ========== ======== ========= ========= ========= ==========
(a) Includes tax-equivalent adjustment for tax-exempt interest income
51
24. FINANCIAL HOLDING COMPANY
Condensed financial statements of the holding company, which include
transactions with subsidiaries, follow:
BALANCE SHEETS
SEPTEMBER 30 December 31 September 30
(In Thousands) 2004 2003 2003
- -------------- ---- ---- ----
ASSETS
Cash and demand balances due from banks $ 3,569 $ 1,521 $ 1,498
Loans to and receivables from subsidiaries 497,716 819,115 828,701
Securities 367,883 164,179 189,208
Other investments 99,549 479,394 450,536
Investments in:
Subsidiary banks 13,059,741 9,642,417 9,436,537
Nonbank subsidiaries 840,657 608,916 579,376
Goodwill 125,675 58,566 58,566
Derivative assets 153,464 124,901 138,689
Other assets 726,306 668,633 609,421
----------- ----------- -----------
TOTAL ASSETS $15,874,560 $12,567,642 $12,292,532
=========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Long-term debt $ 1,947,773 $ 2,266,658 $ 2,285,465
Borrowed funds from subsidiaries 609,271 185,568 185,568
Derivative liabilities 11,326 4,695 2,577
Accrued expenses and other liabilities 813,716 782,050 751,078
----------- ----------- -----------
Total liabilities 3,382,086 3,238,971 3,224,688
Stockholders' equity 12,492,474 9,328,671 9,067,844
----------- ----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $15,874,560 $12,567,642 $12,292,532
=========== =========== ===========
Securities and other investments totaling $114 million at September 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 $558
million at September 30, 2004. The holding company also guarantees commercial
paper issued by its subsidiary National City Credit Corporation, which
borrowings totaled $896 million at September 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 United Airlines contract.
STATEMENTS OF INCOME
Three Months Ended Nine Months Ended
September 30 September 30
---------------------- ---------------------------
(In Thousands) 2004 2003 2004 2003
- -------------- ---- ---- ---- ----
INCOME
Dividends from:
Subsidiary banks $425,000 $454,810 $1,700,000 $904,810
Nonbank subsidiaries 48 2,000 6,048 6,000
Interest on loans to subsidiaries 6,866 505 8,574 1,020
Interest and dividends on securities 2,760 1,628 6,015 6,753
Securities gains, net 298 1,630 396 33,039
Other income (639) 6,639 10,243 19,382
-------- -------- ---------- ----------
TOTAL INCOME 434,333 467,212 1,731,276 971,004
======== ======== ========== ==========
EXPENSE
Interest on debt and other borrowings 22,312 23,945 60,230 73,297
Other expense 42,732 13,675 71,615 94,802
-------- -------- ---------- ----------
TOTAL EXPENSE 65,044 37,620 131,845 168,099
======== ======== ========== ==========
Income before taxes and equity in undistributed
net income of subsidiaries 369,289 429,592 1,599,431 802,905
Income tax (benefit) expense (76,590) 18,323 (108,709) (26,638)
-------- -------- ---------- ----------
Income before equity in undistributed net income of
subsidiaries 445,879 411,269 1,708,140 829,543
Equity in undistributed net income (loss) of subsidiaries 144,836 (67,631) 111,989 743,406
-------- -------- ---------- ----------
NET INCOME $590,715 $343,638 $1,820,129 $1,572,949
======== ======== ========== ==========
52
STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30
----------------------------
(In Thousands) 2004 2003
- -------------- ---- ----
OPERATING ACTIVITIES
Net income $1,820,129 $1,572,949
Adjustments to reconcile net income to net cash provided by
operating activities:
Equity in undistributed net income of subsidiaries (111,989) (743,405)
Depreciation and amortization of properties and equipment 1,595 916
Decrease (increase) in receivables from subsidiaries 268,721 (471,712)
Securities gains, net (396) (33,040)
Other (gains) losses, net (1,325) 21,281
Amortization of premiums and discounts on securities and debt (4,321) (759)
Decrease in accrued expenses and other liabilities (31,227) (19,543)
Other, net 63,790 30,279
---------- ----------
Net cash provided by operating activities 2,004,977 356,966
---------- ----------
INVESTING ACTIVITIES
Purchases of securities (298,501) (458,523)
Proceeds from sales and maturities of securities 113,411 513,481
Net change in other investments 433,394 105,587
Principal collected on loans to subsidiaries 666,000 1,027,334
Loans to subsidiaries (624,000) (435,000)
Investments in subsidiaries (590,178) (50,746)
Returns of investment from subsidiaries 250,005 300,000
Net (increase) decrease in properties and equipment (20,259) 10,840
Cash paid for acquisitions, net of cash acquired (19,465) --
---------- ----------
Net cash (used in) provided by investing activities (89,593) 1,012,973
---------- ----------
FINANCING ACTIVITIES
Net decrease in borrowed funds (46,562) (1,020,000)
Issuance of debt 200,000 300,000
Repayment of debt (747,669) (880)
Dividends paid (629,269) (569,494)
Issuances of common stock 290,730 118,359
Repurchases of common stock (980,566) (197,924)
---------- ----------
Net cash used in financing activities (1,913,336) (1,369,939)
---------- ----------
Increase in cash and demand balances due from banks 2,048 --
Cash and demand balances due from banks, January 1 1,521 1,498
---------- ----------
CASH AND DEMAND BALANCES DUE FROM BANKS, SEPTEMBER 30 $ 3,569 $ 1,498
========== ==========
SUPPLEMENTAL INFORMATION
Cash paid for interest $ 61,170 $ 67,901
Noncash items:
Carrying value of securities donated to the National City
Charitable Foundation -- 25,007
Stock and options issued in Allegiant and Provident
acquisitions 2,647,461 --
========== ==========
Retained earnings of the holding company included $7.0 billion, $6.9 billion,
and $6.7 billion of equity in undistributed net income of subsidiaries at
September 30, 2004, December 31, 2003, and September 30, 2003, respectively.
53
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 72 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 nine months ended September 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 53 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.
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 company's geographic areas and business lines.
National City's third quarter 2004 net income was $591 million, or $.86 per
diluted share, compared to $344 million, or $.56 per diluted share in the third
quarter of 2003. The 2004 third quarter includes the results of Provident
Financial Group, Inc. (Provident) acquired on July 1, 2004.
Results for the third quarter of 2004 reflect good performance in corporate and
consumer businesses. Corporate loan growth has been slower than expected but
improved from last year. Home equity and nonconforming mortgage volumes continue
to be strong. Net interest margin decreased in the third quarter of 2004
compared to prior periods. The decrease in margin is due to lower balances of
mortgages held for sale and the ongoing impact of low market interest rates
which have compressed deposit spreads. Mortgage banking revenue increased in the
third quarter primarily due to increased gains on hedging mortgage servicing
rights.
Average portfolio loans and average core deposits, excluding mortgage escrow
balances, increased in the third quarter reflecting the acquisition of
Provident, which added $9.0 billion to average loans and $5.6 billion to average
core deposits during the quarter. Continued strong production of home equity and
nonconforming mortgages retained in portfolio also contributed to higher average
portfolio loan balances.
Credit quality, particularly consumer credit, continues to be sound.
Nonperforming assets and net charge-offs increased in the third quarter compared
to the second quarter mainly arising from loan portfolios associated with recent
acquisitions.
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 74-76 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 $7 million and $20 million for the third quarter and first nine
months of 2004, respectively, and $6 million $21 million for the same periods in
2003, respectively.
Tax-equivalent net interest income for the third quarter and first nine months
of 2004 was $1.2 billion and $3.3 billion, respectively, as compared to $1.2
billion and $3.4 billion for the comparable 2003 periods. Net interest margin
was 4.04% in the third quarter of 2004, compared to 4.09% in the second quarter
of 2004 and 4.10% in last year's third quarter. Net interest margin for the
first nine months of 2004 was 4.09%, compared to 4.14% for the same period a
year ago. The sustained low interest rate environment, which results in reduced
asset yields and narrower spreads on deposits, and lower balances of mortgages
held for sale continue to have an unfavorable impact on net interest margin
trends.
54
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 60.
NONINTEREST INCOME
Details of noninterest income follow:
Three Months Ended Nine Months Ended
-------------------------------------------- -----------------------------
SEPTEMBER 30 June 30 September 30 SEPTEMBER 30 September 30
(In Millions) 2004 2004 2003 2004 2003
- ------------- ---- ---- ---- ---- ----
Mortgage banking revenue $ 370 $ 193 $ (27) $1,142 $1,031
Deposit service charges 172 162 145 481 422
Payment processing revenue 132 132 125 386 343
Trust and investment management fees 74 79 72 229 219
Card-related fees 35 38 42 110 127
Brokerage revenue 34 34 33 100 91
Leasing revenue 87 6 11 99 29
Other service fees 28 29 28 80 82
Other 91 188 55 375 224
------ ------ ------ ------ ------
TOTAL FEES AND OTHER INCOME 1,023 861 484 3,002 2,568
Securities gains, net 3 5 5 8 37
------ ------ ------ ------ ------
TOTAL NONINTEREST INCOME $1,026 $ 866 $ 489 $3,010 $2,605
====== ====== ====== ====== ======
Details of mortgage banking revenue follow:
Three Months Ended Nine Months Ended
-------------------------------------------- -----------------------------
SEPTEMBER 30 June 30 September 30 SEPTEMBER 30 September 30
(In Millions) 2004 2004 2003 2004 2003
- ------------- ---- ---- ---- ---- ----
Servicing revenue:
Net servicing fees $ 122 $ 115 $ 94 $ 357 $ 306
Amortization of mortgage servicing assets (125) (140) (190) (365) (441)
Mortgage servicing asset impairment
(charge) recovery (5) 42 207 (81) 182
Mortgage servicing asset ineffective
hedge 165 (99) (81) 479 185
and other derivative gains (losses), net
Other -- -- -- 1 --
------ ------ ----- ------ ------
Net servicing revenue 157 (82) 30 391 232
NCMC origination and sales revenue 80 110 (152) 312 547
First Franklin origination and sales revenue 128 165 95 434 252
Provident PCFS mortgage banking revenue 5 -- -- 5 --
------ ------ ----- ------ ------
TOTAL MORTGAGE BANKING REVENUE $ 370 $ 193 $ (27) $1,142 $1,031
====== ====== ===== ====== ======
Substantially all NCMC's mortgage loan production is sold into the secondary
market with servicing retained. During the first nine months of 2004, 32% of
First Franklin originated loans were retained in portfolio, compared to 50% for
the same period in 2003. The remaining loans sold during 2004 and 2003 were sold
servicing released. The 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 Nine Months Ended
-------------------------------------------- ------------------------------
SEPTEMBER 30 June 30 September 30 SEPTEMBER 30 September 30
(In Millions) 2004 2004 2003 2004 2003
- ------------- ---- ---- ---- ---- ----
NCMC loans originated for sale $14,119 $17,276 $30,599 $45,474 $86,812
Total First Franklin loan originations 7,743 8,782 6,051 22,198 13,935
Less: First Franklin portfolio loan
originations (2,835) (3,056) (3,250) (7,004) (7,006)
------- ------- ------- ------- -------
Total First Franklin loans originated
for sale 4,908 5,726 2,801 15,194 6,929
------- ------- ------- ------- -------
TOTAL MORTGAGE LOANS ORIGINATED
FOR SALE $19,027 $23,002 $33,400 $60,668 $93,741
======= ======= ======= ======= =======
NCMC loan sales $14,459 $17,047 $33,462 $47,203 $86,350
First Franklin loan sales 5,566 4,887 2,543 14,886 6,558
------- ------- ------- ------- -------
TOTAL MORTGAGE LOAN SALES $20,025 $21,934 $36,005 $62,089 $92,908
======= ======= ======= ======= =======
Provident PCFS is a subprime lending and servicing business acquired with
Provident. This business is expected to be sold during the fourth quarter of
2004.
55
The increase in mortgage banking revenue during the third quarter was primarily
attributable to net hedging gains. On a year-to-date basis, in addition to
hedging, First Franklin origination and sales revenue increased due to higher
volumes, partially offset by lower origination and sales volume from NCMC.
Mortgage banking revenue included $160 million of net hedging gains on mortgage
servicing rights during the third quarter of 2004, compared to net losses of $57
million and gains of $126 million for the second quarter of 2004 and the prior
year, respectively. The year-over-year and linked quarter decreases in
origination and sales revenue at NCMC resulted from lower production and sales
volume arising from a higher interest rate environment in 2004 and the
associated reduction in refinancing activity. First Franklin origination revenue
peaked during the second quarter of 2004 and has slowed somewhat in the third
quarter, although at levels above the prior year.
NCMC generally retains the right to service the mortgage loans it sells. Upon
sale, 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 at NCMC, the unpaid principal balance of loans serviced
for third parties increased to $150.3 billion at September 30, 2004, up from
$141.1 billion at December 31, 2003 and $129.1 billion at September 30, 2003.
The carrying value of NCMC MSRs also grew over the past year and was $1.4
billion at September 30, 2004, $1.3 billion at December 31, 2003, and $1.1
billion at September 30, 2003.
The value of MSRs is sensitive to changes in interest rates. In a low or
declining 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 and third quarters 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. 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 increase in deposit service charges during the third quarter compared to the
prior quarter was mainly due to fee revenue on deposit accounts acquired with
the Provident acquisition. Fee revenue on newly acquired accounts also factors
into the increase in deposit service charges in comparison to the prior year
third quarter. In addition, the year-over year increase is also attributable to
increases in overdraft and non-sufficient funds (NSF) fees resulting from growth
in the number of transaction accounts and increased transaction activity.
The year-over-year growth in payment processing revenue generated by National
Processing, Inc. (NPI) was the result of higher transaction volume, strong
customer retention, and higher rates from various pricing initiatives in 2004.
National Processing was sold in October 2004 as discussed in Note 3.
Leasing revenue represents rental income and fees related to the portfolio of
commercial equipment and automobile leases acquired with Provident, which have
been accounted for as operating leases. In December 2000, the Corporation made a
strategic decision to cease originations of automobile leases. Auto leases are
no longer being originated for the Provident portfolios, which will result in a
decline in this revenue in future periods. However, with plans to grow the
commercial leasing business acquired with Provident, management anticipates the
growth in commercial lease revenue will more than offset the decline in auto
lease revenue.
Card-related fees decreased during the first nine 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 on a linked-quarter comparison reflects a $65 million
gain on the sale of the Corporate Trust Bond Administration business in the
second quarter and lower derivative-related gains recognized in the third
quarter. The higher derivative gains in the second quarter resulted from a $19
million gain associated with certain cash flow hedging transactions that did not
qualify for special hedge accounting under SFAS 133.
Other noninterest income increased on a year-over-year basis due to the $65
million gain on the sale of the Corporate Trust Bond Administration business
described above, $52 million of higher gains on principal investments, $15
million of higher insurance fees, and commercial mortgage servicing fees of $10
million. The commercial mortgage servicing fees relate to businesses acquired
with Provident; therefore, there were no similar fees in prior periods.
Securities gains recognized during the first nine months of 2003 related
primarily to the Corporation's internally managed bank stock fund. Sales of such
securities were limited in the current year resulting in minimal gains
recognized in 2004.
56
NONINTEREST EXPENSE
Details of noninterest expense follow:
Three Months Ended Nine Months Ended
---------------------------------------------- ------------------------------
SEPTEMBER 30 June 30 September 30 SEPTEMBER 30 September 30
(In Millions) 2004 2004 2003 2004 2003
- ------------- ---- ---- ---- ---- ----
Salaries, benefits, and other personnel $ 661 $ 594 $ 571 $1,804 $1,674
Third-party services 82 73 71 223 207
Equipment 73 69 55 208 173
Net occupancy 66 59 58 185 172
Card processing 59 60 54 177 158
Postage and supplies 39 35 37 108 103
Marketing and public relations 30 30 22 82 106
Leasing expense 63 2 (5) 69 49
Telecommunications 21 23 22 63 62
State and local taxes 16 13 16 44 46
Travel and entertainment 22 19 15 57 42
Goodwill and other intangible 17 7 6 30 17
asset amortization
Other 84 91 86 244 234
------ ------ ------ ------ ------
TOTAL NONINTEREST EXPENSE $1,233 $1,075 $1,008 $3,294 $3,043
====== ====== ====== ====== ======
Details of salaries, benefits, and other personnel expense follow:
Three Months Ended Nine Months Ended
----------------------------------------------- ------------------------------
SEPTEMBER 30 June 30 September 30 SEPTEMBER 30 September 30
(Dollars in Millions) 2004 2004 2003 2004 2003
- --------------------- ---- ---- ---- ---- ----
Salaries and wages $ 363 $ 318 $ 310 $ 994 $ 912
Incentive compensation 198 210 264 565 676
Deferred personnel costs (99) (104) (145) (284) (410)
Stock-based compensation 15 12 10 39 20
Payroll taxes 37 36 33 117 113
Contract labor 36 32 29 87 72
Medical and other benefits 54 48 42 148 135
Defined contribution plans 18 17 14 57 54
Defined benefit pension plan 2 3 (4) 7 (12)
Market valuation adjustments on deferred 4 7 3 14 20
compensation liabilities
Severance and other 33 15 15 60 94
-------- ------- -------- ------ ------
TOTAL SALARIES, BENEFITS, AND OTHER
PERSONNEL $ 661 $ 594 $ 571 $1,804 $1,674
======== ======= ======== ====== ======
FULL-TIME-EQUIVALENT EMPLOYEES 36,392 34,062 33,188
======== ======= ========
The linked quarter and year-over-year increases in salaries, benefits and other
personnel costs were mainly due to lower deferred personnel costs and additional
compensation and benefit costs related to employees added with the Allegiant and
Provident acquisitions. Mortgage originations have continued to slow in
comparison to prior periods resulting in lower costs levels of deferred
personnel costs. The acquisitions of Allegiant and Provident added approximately
3,300 full-time employees in comparison to the prior year. Allegiant and
Provident employees who work in certain back office functions are generally
retained through system conversion dates. System conversion was completed for
Allegiant on July 31, 2004 and is planned for Provident in March 2005.
Accordingly, salary and benefit costs will generally be higher during this
transition period than on a going forward basis.
Also contributing to the increase in salaries, benefits and other personnel
costs are increases in contract labor, stock based compensation and severance
expense. Contract labor increased on linked quarter and year-over-year basis due
to temporary personnel hired to assist with integration of Allegiant and
Provident's systems. Stock based compensation has increased in 2004 in
comparison to the prior period as the Corporation began expensing stock options
for grants subsequent to January 1, 2003, the date of initial application of
SFAS 123. Incentives to retain acquired employees through systems conversion,
which approximated $17 million in the third quarter of 2004, accounted for most
of the increase in severance and other costs.
Partially offsetting the increases described above are lower levels of incentive
compensation expense in the third quarter of 2004. Incentive compensation costs
have decreased as mortgage originations have slowed in 2004 in comparison to the
origination volume experienced in the prior year.
57
On a year-to-date basis, severance and other costs decreased, reflecting a large
severance charge recognized in the first quarter of 2003. Severance of $68
million was recognized in the prior year in connection with the various cost
reduction initiatives. In comparison, severance of $26 million was charged to
expense on a year-to-date basis in 2004. Severance and related expense in 2004
consisted of severance incurred in the normal course of business, plus
incentives to retain employees of acquired companies. Severance costs for
planned terminations of acquired employees was recognized in the allocation of
the purchase price to the assets and liabilities acquired.
Other elements of noninterest expense that have increased in comparison to prior
periods are third party services, equipment and lease expense, marketing and
public relations, travel and entertainment, and amortization of intangibles.
These increases are primarily attributable to the effects of recent
acquisitions.
The increase in third party services on both a linked quarter and year-over-year
basis is due to consultants hired to assist with the conversion of Provident's
systems. The increase in equipment and lease expense on both a linked quarter
and year-over-year basis resulted is related to depreciation expense on owned
and leased assets acquired with Provident and the continued implementation of
Customer Connections, the Corporation's new retail delivery system, which began
during 2003.
Marketing and public relations expense increased in the third quarter of 2004 in
comparison to the third quarter of 2003 due to increased promotional activities
in both the St. Louis and Cincinnati markets to introduce National City's
products and services to former Allegiant and Provident customers. On a
year-to-date basis, marketing and public relations expense decreased $24
million, reflecting a $40 million donation of appreciated investment securities
to the Corporation's charitable foundation in 2003.
Travel and entertainment costs increased in 2004 due to employee travel
associated with integration activities. Intangible asset amortization increased
$10 million on a linked quarter basis and $13 million on a year-to-date basis as
a result of intangibles recognized in connection with the acquisitions of
Allegiant and Provident. See Note 10 for further information on intangible
assets and their useful lives.
The efficiency ratio, calculated as noninterest expense divided by the sum of
tax-equivalent net interest income and total fees and other income, was 55.54%
and 52.37% for the third quarter and first nine months of 2004, respectively,
compared to 61.62% and 51.38% for the third quarter and first nine months of
2003, respectively.
INCOME TAXES
The effective tax rate was 33.6% for the first nine months of 2004 compared to
34.6% for the first nine 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 34.7% 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 Nine Months Ended
-------------------------------------------- -----------------------------
SEPTEMBER 30 June 30 September 30 SEPTEMBER 30 September 30
(In Millions) 2004 2004 2003 2004 2003
- ------------- ---- ---- ---- ---- ----
Consumer and Small Business Financial Services $ 178 $ 168 $ 167 $ 501 $ 476
Wholesale Banking 168 163 129 470 250
National City Mortgage Co. 139 16 (2) 428 674
National Consumer Finance 172 178 126 513 328
Asset Management 26 64 24 116 71
National Processing 17 14 14 43 34
Parent and Other (109) (84) (114) (251) (260)
------ ------ ------ ------- -------
CONSOLIDATED NET INCOME $ 591 $ 519 $ 344 $ 1,820 $ 1,573
====== ====== ====== ======= =======
Consumer and Small Business Financial Services (CSB): CSB results in 2004 have
benefited from loan and deposit growth, both internally generated and arising
from acquisitions. Loan growth, both on a linked-quarter and year-over-year
basis, has been greatest in home equity lines and loans. Deposit balance growth
on a linked-quarter basis is due solely to acquisitions, as management has made
decisions to make less use of promotional pricing to grow deposit volumes. In
addition, the sustained effects of lower interest rates have continued to keep
pressure on deposit margins. Noninterest income has grown relative to the prior
quarter and past year due to deposit-related service charges and fees,
reflecting growth in the number of transaction accounts and increased
transaction activity, and to auto lease rental income acquired with the
Provident acquisition. Noninterest expenses rose on a year-over-year and
linked-quarter basis primarily due to acquisitions, most notably leasing expense
arising from the Provident acquisition. In addition, year-to-
58
date results for 2004 included recoveries of previously accrued auto lease
residual losses (unrelated to Provident) of $4 million, compared to net losses
of $16 million in the first nine months of 2003. Credit trends have been stable.
Wholesale Banking: In general, results for 2004 reflect continuing improvements
in credit quality, driving a lower provision for loan losses versus 2003.
Average loan balances have grown mainly due to acquisitions, despite increased
business activity and the addition of new customers, as paydowns have tended to
offset the effect of new borrowings. Deposit volumes have been strong, and
revenues from treasury management and capital markets activities have also shown
improvement in 2004. Results also benefited from principal investment gains,
with $23 million, $17 million, and $19 million recorded in the first through
third quarters, respectively, compared with gains of $17 million in the third
quarter of 2003 and $7 million for the first nine months of 2003. Wholesale
Banking also recorded losses on commercial lease residuals of $16 million in the
first nine months of 2003, virtually all in the first quarter, with virtually no
comparable charges in 2004.
National City Mortgage Co. (NCMC): The significant improvement in third quarter
net income over the preceding quarter was mainly from MSR net hedging gains,
which were $160 million pre-tax compared to net losses of $57 million in the
second quarter. In 2003, NCMC realized net hedging gains of $126 million for the
third quarter. For the first nine months, net hedging gains were $398 million
pre-tax, compared to $367 million for the first nine months of 2003. A widening
of the basis between mortgage rates and swap rates and the continuation of an
upsloping yield curve were the primary drivers of the hedging gains. On a more
fundamental basis, origination volumes have been trending down from the record
levels of 2003. Loans originated for sale were $14.1 billion in the third
quarter of 2004, down from $17.3 billion in the second quarter and $30.6 billion
in the third quarter a year ago. As volume and therefore production revenue
declines, net interest income from loans held for sale will decline as well,
with some offset from reduced noninterest expenses associated with incentive
compensation and other variable costs of production. 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, revenue for the first nine months of 2004 was reduced by
approximately $22 million.
National Consumer Finance (NCF): Results for 2004 versus 2003 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 gains on the
sale of loans. First Franklin loans retained in portfolio grew to $18.1 billion
at the end of the third quarter, up from $15.1 billion at the beginning of the
year and $13.2 billion a year earlier. First Franklin loan originations declined
slightly in the third quarter relative to the second quarter, but were
significantly above the levels of a year ago. However, margins realized on sales
declined, as expected, in the third quarter, resulting in lower noninterest
revenue compared to the second quarter. The National Home Equity portfolio,
including both lines and loans, grew to $10.5 billion at the end of the third
quarter, up from $5.1 billion a year earlier. All National Home Equity
production is retained in portfolio.
Asset Management: Net income for the first nine months of 2004 included a $65
million pre-tax ($42 million after tax) gain realized in the second quarter 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, and acquisitions.
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 reflected 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. As discussed in Note 3, this business unit was
sold in October 2004.
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 third quarter compared to the
second quarter reflects higher severance and related charges and intangibles
amortization arising from the Provident acquisition. Total severance and related
charges were $17 million in the third quarter versus only $6 million in the
second quarter. In addition, the second quarter included a gain of $19 million
associated with certain cash flow hedging transactions that did not qualify for
special hedge accounting under FAS 133. Third quarter results also include $11
million of amortization of an operating lease intangible, recognized in
connection with the Provident acquisition, with no such expense in the prior
quarter. In terms of current year results versus the prior year, there were a
number of unusual items in 2003 affecting comparisons. 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 nine months of 2003
included severance and related charges of $77 million, mainly in the first
quarter, compared to $26 million of such costs in the first nine months 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.
59
FINANCIAL CONDITION
This section should also be reviewed in conjunction with the average balance
sheets presented on pages 73-74.
AVERAGE EARNING ASSETS
A summary of average earning assets follows:
Three Months Ended Nine Months Ended
------------------------------------------- -----------------------------
SEPTEMBER 30 June 30 September 30 SEPTEMBER 30 September 30
(In Millions) 2004 2004 2003 2004 2003
- ------------- ---- ---- ---- ---- ----
Portfolio loans
Commercial $ 24,784 $ 19,531 $ 21,152 $ 21,073 $ 21,851
Commercial construction 2,815 2,270 2,425 2,445 2,309
Real estate -- commercial 11,993 10,821 9,450 10,881 9,448
Real estate -- residential 29,639 27,981 24,088 28,238 22,539
Home equity lines of credit 16,247 12,819 9,612 13,498 8,847
Credit card and other unsecured lines of credit 2,281 2,232 2,170 2,265 2,096
Other consumer 7,565 7,209 8,167 7,392 8,028
--------- --------- --------- --------- --------
Total portfolio loans 95,324 82,863 77,064 85,792 75,118
Loans held for sale or securitization 11,861 13,910 27,036 12,695 24,575
Securities (at amortized cost) 9,670 6,646 6,667 7,625 7,447
Other 1,477 1,148 1,217 1,148 928
--------- --------- --------- --------- --------
TOTAL EARNING ASSETS $ 118,332 $ 104,567 $ 111,984 $ 107,260 $108,068
========= ========= ========= ========= ========
Average portfolio loans grew 15% and 24% during the third quarter of 2004
compared to the second quarter of 2004 and the same quarter a year ago,
respectively. Average portfolio loans grew 14% during the first nine months of
2004 over the same comparable period last year. This growth resulted from
portfolio loans acquired in the Provident acquisition during the third quarter
of 2004, as well as the retention of residential real estate loan production
from First Franklin, and home equity production from the National Home Equity
division. Total portfolio loans acquired with Provident totaled $8.8 billion at
September 30, 2004, including $5.2 billion, $834 million, $395 million, and $1.6
billion of commercial, commercial real estate, commercial construction and home
equity loans, respectively. First Franklin production retained in the
residential real estate portfolio totaled $2.8 billion during the third quarter
of 2004, compared to $3.1 billion last quarter and $3.3 billion for the third
quarter of 2003. Over the past twelve months, $10.2 billion of First Franklin
loans were retained in portfolio. Period-end First Franklin residential real
estate loans grew to $18.1 billion at September 30, 2004, up from $16.7 billion
last quarter and $13.2 billion at September 30, 2003. Additionally, during the
first nine months 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
reclassification of $124 million of the former Loan Zone portfolio to loans held
for sale during the third quarter of 2004, coupled with the sales from the
former Altegra portfolio of $1.1 billion over the past twelve months. Home
equity growth, other than the aforementioned loans acquired from Provident,
reflects sustained growth in production during the third quarter and first nine
months of 2004, and continues to benefit from a low interest rate environment
and focus on the national market. The growth in the commercial and commercial
real estate portfolio was mainly attributed to the aforementioned loans acquired
from Provident. Excluding the impact from Provident, commercial borrowing
activity has increased, however, the impact of new borrowings has been more than
offset by paydowns in the portfolio. Commercial loan borrowings are expected to
grow over the remainder of 2004.
The linked quarter and 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, the
aforementioned reclassification of the former Lone Zone portfolio to held for
sale, and commercial real estate loans held for sale balances generated by the
Red Capital Mortgage and Capstone Realty. 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 primary driver behind the linked-quarter increase in the securities
portfolio is the addition of $3.1 billion of securities acquired with Provident.
The lower increase in average securities during the first nine months of 2004
resulted from sales and principal paydowns in the portfolio, specifically
mortgage-backed and asset-backed securities, offsetting the effects of
securities acquired with Provident.
60
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 September 30, 2004.
Average Largest Loan
Outstanding % to Loan Balance to a Single
(Dollars in Millions) Balance Total Per Obligor Obligor
- --------------------- ------- ----- ----------- -------
Real estate $ 10,816 27% $ .9 $58
Consumer cyclical 5,583 14 .9 94
Consumer noncyclical 3,912 9 .4 58
Industrial 3,346 8 .9 35
Basic materials 2,615 7 1.4 32
Financial 1,920 5 1.4 37
Services 1,286 3 .4 54
Energy and utilities 545 1 1.0 20
Technology 267 1 2.2 24
Miscellaneous 1,930 5 .2 19
Other(a) 5,095 13
--------- -------
37,315 93
Commercial leasing -- all industries 2,681 7
--------- -------
TOTAL $ 39,996 100%
========= =======
(a) Represents commercial, commercial construction, and commercial real estate
balances acquired in the Provident acquisition not yet integrated
into National City's systems.
AVERAGE INTEREST BEARING LIABILITIES AND FUNDING
A summary of average interest bearing liabilities and funding follows:
Three Months Ended Nine Months Ended
---------------------------------------------- ----------------------------
SEPTEMBER 30 June 30 September 30 SEPTEMBER 30 September 30
(In Millions) 2004 2004 2003 2004 2003
- ------------- ---- ---- ---- ---- ----
Noninterest bearing deposits $ 18,731 $ 17,756 $ 19,408 $ 17,387 $ 17,578
Interest bearing core deposits 48,775 44,664 41,850 45,393 41,241
--------- --------- --------- --------- ---------
Total core deposits 67,506 62,420 61,258 62,780 58,819
Purchased deposits 15,010 10,248 10,427 10,893 10,188
Short-term borrowings 9,153 9,801 11,747 9,496 13,380
Long-term debt 25,744 20,031 27,569 22,383 24,786
--------- --------- --------- --------- ---------
Total purchased funding 49,907 40,080 49,743 42,772 48,354
Stockholders' equity 12,359 10,370 9,171 10,802 8,831
--------- --------- --------- --------- ---------
TOTAL FUNDING $ 129,772 $ 112,870 $ 120,172 $ 116,354 $ 116,004
========= ========= ========= ========= =========
TOTAL INTEREST BEARING LIABILITIES $ 98,682 $ 84,744 $ 91,593 $ 88,165 $ 89,595
========= ========= ========= ========= =========
TOTAL CORE DEPOSITS, EXCLUDING
MORTGAGE ESCROW DEPOSITS $ 63,099 $ 57,672 $ 54,470 $ 58,578 $ 53,257
========= ========= ========= ========= =========
The percentage of each funding source to total funding follows:
Three Months Ended Nine Months Ended
--------------------------------------------- -----------------------------
SEPTEMBER 30 June 30 September 30 SEPTEMBER 30 September 30
2004 2004 2003 2004 2003
---- ---- ---- ---- ----
Noninterest bearing deposits 14.4% 15.7% 16.2% 14.9% 15.2%
Interest bearing core deposits 37.6 39.6 34.8 39.0 35.5
----- ----- ----- ----- -----
Total core deposits 52.0 55.3 51.0 53.9 50.7
Purchased deposits 11.6 9.1 8.7 9.4 8.8
Short-term borrowings 7.1 8.7 9.8 8.2 11.5
Long-term debt 19.8 17.7 22.9 19.2 21.4
----- ----- ----- ----- -----
Total purchased funding 38.5 35.5 41.4 36.8 41.7
Stockholders' equity 9.5 9.2 7.6 9.3 7.6
----- ----- ----- ----- -----
TOTAL 100.0% 100.0% 100.0% 100.0% 100.0%
===== ===== ===== ===== =====
The linked-quarter increases in average core deposits and purchased deposits
were primarily attributed to deposit balances acquired with the acquisition of
Provident in the third quarter of 2004. Provident core deposit and purchased
deposits balances totaled approximately $6.9 billion and $5.6 billion,
respectively, at September 30, 2004. Short-term borrowings, which are mainly
used to fund mortgage loans held for sale, decreased during the first nine
months of 2004 consistent with lower average balances of mortgages held for
sale. The lower average long-term debt balances for the first nine months of
2004 were primarily attributed to paydowns and
61
maturities more than offsetting the impact of new debt issuances and long-term
debt acquired with Provident. The increase in average long-term debt on a
linked-quarter comparison resulted the issuance of senior and subordinated bank
notes by the bank subsidiaries and the addition of approximately $1.6 billion of
debt with Provident.
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 $12.5 billion at September 30, 2004, up from $9.3
billion and $9.1 billion at December 31, 2003 and September 30, 2003,
respectively. Equity as a percentage of assets was 9.16% at September 30, 2004,
compared to 8.19% at December 31, 2003 and 7.50% a year ago. Book value per
common share rose to $18.98 at September 30, 2004, up from $15.39 and $14.89 at
December 31, 2003 and September 30, 2003, respectively.
The following table summarizes share repurchase activity for the third 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)
- ------ ------------ --------- -------------- -----------------
July 1 to July 31, 2004 8,200,456 $35.72 8,032,700 32,955,700
August 1 to August 31, 2004 2,942,950 37.09 2,358,200 30,597,500
September 1 to September 30, 2004 5,908,292 38.31 5,607,000 24,990,500
---------- ------ ---------- ----------
TOTAL 17,051,698 $36.86 15,997,900 24,990,500
========== ====== ========== ==========
(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 acquired on the open market and
are held for reissue in connection with the Corporation's compensation plans and
for general corporate purposes. During the third quarter and first nine months
of 2004, 16.0 million and 27.2 million shares of common stock were repurchased,
respectively. During the third quarter and first nine months of 2003, 5.3
million and 6.7 million shares of common stock were repurchased, respectively.
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 by the end of the first quarter of 2005.
National City declared and paid dividends per common share of $.35 during the
third quarter of 2004, up three cents from the quarterly dividend per share
declared and paid in the 2003 third quarter of $.32. The dividend payout ratio,
representing dividends per share divided by earnings per share, was 40.7% and
57.1% for the third quarters of 2004 and 2003, respectively. The dividend payout
ratio is continually reviewed by management and the Board of Directors.
At September 30, 2004, the Corporation's market capitalization was $25.4
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
--------------------------------------- -----------------------
THIRD Second First Fourth Third
NYSE: NCC QUARTER Quarter Quarter Quarter Quarter
- --------- ------- ------- ------- ------- -------
High $ 39.35 $ 36.10 $37.10 $34.44 $34.56
Low 34.35 32.60 32.14 29.46 29.03
Close 38.62 35.01 35.58 33.94 29.46
======= ======= ====== ====== ======
62
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 nine months of 2004 and the
allowance for loan losses at September 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 Nine Months Ended
----------------------------------------------- ------------------------------
SEPTEMBER 30 June 30 September 30 SEPTEMBER 30 September 30
(In Millions) 2004 2004 2003 2004 2003
- ------------- ---- ---- ---- ---- ----
Commercial $40 $ (6) $ 34 $ 50 $216
Commercial construction 2 -- 1 2 2
Real estate -- commercial 3 3 9 5 16
Real estate -- residential 12 20 37 50 93
Home equity lines of credit 4 4 4 12 13
Credit card and other
unsecured lines of credit 23 25 22 78 65
Other consumer 14 16 17 46 54
--- ---- ---- ---- ----
TOTAL NET CHARGE-OFFS $98 $ 62 $124 $243 $459
=== ==== ==== ==== ====
Net charge-offs as a percentage of average loans by portfolio type follow:
Three Months Ended Nine Months Ended
SEPTEMBER 30 June 30 September 30 SEPTEMBER 30 September 30
2004 2004 2003 2004 2003
---- ---- ---- ---- ----
Commercial .64% (.11)% .63% .32% 1.32%
Commercial construction .32 (.07) .12 .10 .11
Real estate -- commercial .09 .16 .36 .06 .23
Real estate -- residential .16 .29 .61 .24 .55
Home equity lines of credit .09 .13 .19 .12 .19
Credit card and other
unsecured lines of credit 4.01 4.66 4.13 4.58 4.17
Other consumer .77 .80 .83 .82 .90
==== ==== ==== ==== ====
TOTAL NET CHARGE-OFFS
TO AVERAGE PORTFOLIO LOANS (ANNUALIZED) .41% .30% .64% .38% .82%
==== ==== ==== ==== ====
The linked-quarter increase in net charge-offs is mainly attributed to losses
associated with the commercial, commercial construction, and real estate
commercial portfolios acquired with Provident, amounting to $26 million of the
$48 million increase, including $7 million in net charge-offs recognized with
airline leases acquired with Provident. The decrease in net charge-offs during
the first nine months of 2004 is primarily due to overall lower commercial
losses, aided by lower levels of nonperforming loans and by loan sales, which
taken together more than offset the impact to net charge-offs associated with
the Provident acquisition. The decrease in residential real estate net
charge-offs during the third quarter and first nine months of 2004 reflects
sustained improvement in the overall credit quality of the portfolio, including
the effects of selling $1.1 billion of the former Altegra portfolio over the
past twelve months. The increase in credit card and other unsecured lines of
credit net charge-offs for the nine months of 2004 was reflective of
63
higher losses associated with the seasoning of the portfolio and higher levels
of consumer bankruptcies. The decrease in other consumer net charge-offs during
the first nine months of 2004 resulted from improvement in the overall credit
quality of the portfolio coupled with runoff in the auto lease and certain
product segments of the direct and indirect portfolios.
NONPERFORMING ASSETS:
SEPTEMBER 30 December 31 September 30
(Dollars in Millions) 2004 2003 2003
- --------------------- ---- ---- ----
Commercial $212 $257 $341
Commercial construction 13 7 9
Real estate -- commercial 101 67 65
Real estate -- residential 176 219 214
---- ---- ----
TOTAL NONPERFORMING LOANS 502 550 629
Other real estate owned (OREO) 107 99 110
Mortgage loans held for sale and other 19 8 17
---- ---- ----
TOTAL NONPERFORMING ASSETS $628 $657 $756
==== ==== ====
NONPERFORMING ASSETS AS A PERCENTAGE OF:
PERIOD-END PORTFOLIO LOANS AND OTHER
NONPERFORMING ASSETS .64% .83% .97%
PERIOD-END TOTAL ASSETS .46 .58 .62
==== ==== ====
Detail of loans 90 days past due accruing interest follows:
SEPTEMBER 30 December 31 September 30
(In Millions) 2004 2003 2003
- ------------- ---- ---- ----
Commercial $51 $ 20 $38
Commercial construction 16 3 10
Real estate - commercial 46 32 22
Real estate - residential 423 428 416
Home equity lines of credit 9 15 15
Credit card and other unsecured lines of credit 22 18 15
Other consumer 13 12 11
Mortgage loans held for sale and other 48 37 71
---- ---- ----
TOTAL LOANS 90 DAYS PAST DUE ACCRUING INTEREST $628 $565 $598
==== ==== ====
In general, many of the same factors that affected comparability in net
charge-offs also drove changes in nonperforming assets and loans 90 days past
due. The lower balance of commercial nonperforming loans at September 30, 2004
was primarily attributed to improved credit quality and sales of nonperforming
loans, which more than offset $56 million of nonperforming loans acquired as
part of the Provident acquisition. During the first nine months of 2004, $12
million in commercial nonperforming loans were sold to third parties. Over the
past twelve months, commercial nonperforming loans sold were $39 million.
Commercial, commercial construction and real estate commercial nonperforming
assets and loans 90 days past due increased primarily due to delinquent loans
acquired as part of the acquisitions of both Allegiant and Provident.
Nonperforming loans and loans 90 days past due for these acquired portfolios
totaled $96 million and $42 million, respectively, at September 30, 2004.
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.
64
The allowance for loan losses as a percentage of portfolio loans was 1.34% and
1.45% at September 30, 2004 and 2003, respectively. The provision for loan
losses was $98 million for the third quarter of 2004, compared to $61 million
last quarter, and $107 million recorded for the same quarter last year. For the
first nine months of 2004, the provision for loan losses was $242 million, down
from $490 million for the comparable 2003 period. The lower loss provision
recognized during the first nine months of 2004 is primarily reflective of the
overall improvement in the credit quality of the commercial portfolio. The
linked-quarter increase in the loan loss provision is primarily attributed to
loan portfolios acquired with Provident.
An allocation of the ending allowance for loan losses by portfolio type follows:
SEPTEMBER 30 December 31 September 30
(In Millions) 2004 2003 2003
- ------------- ------------ ----------- ------------
Commercial $ 564 $ 383 $ 415
Commercial construction and real estate -
Commercial 80 56 55
Real estate-- residential 136 125 117
Home equity lines of credit and other consumer loans 90 94 90
Credit card and other unsecured lines of credit 125 129 120
Unallocated 309 338 333
------ ------ ------
TOTAL ALLOWANCE $1,304 $1,125 $1,130
====== ====== ======
The increase in the allowance allocated to the commercial portfolio at September
30, 2004 was reflective of higher allocations to the leveraged lease aircraft
portfolio due to deterioration in the financial condition and outlook within
specific airlines and across the industry, and to the commercial portfolio
acquired with Provident. The increase in the allowance allocated to the
commercial construction and real estate commercial portfolios was primarily
attributed to portfolio loans acquired as part of the Allegiant and Provident
acquisitions. The increase in the allowance allocated to the real estate
residential portfolio was due to the continued growth in this portfolio.
The unallocated allowance, which is maintained to absorb estimated probable
inherent but undetected losses in the loan portfolio, decreased at September 30,
2004 primarily due to the increased allocation to the aircraft portfolio as
described above. The unallocated allowance is 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'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 and Provident. 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
September 30, 2004, this portfolio had a cost basis and fair value of $187
million and $200 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.
65
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.
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 October 2004 ALCO
meeting projects net income would remain unchanged from 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 1.2% 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 potential effects on fee income and
noninterest expense associated with 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.
66
The most recent market value model prepared for the October 2004 ALCO meeting
estimated the current DOE at -0.2. DOE would rise to +0.8 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 -3.1 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 nine 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.
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 or securitization of various types
of assets. Funding sources did not change significantly during the third quarter
and first nine months of 2004. Core deposits, the most significant source of
funding, comprised approximately 51% of funding at September 30, 2004, 54% of
funding at December 31, 2003, and 50% of funding at September 30, 2003. Asset
securitization vehicles have also been used as a source of funding over the past
several years. During the nine months 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
otherwise transfer funds to the holding company. Accordingly, consolidated cash
flows as presented in the consolidated statements of cash flows on page 6 may
not represent cash immediately available to the holding company. During the
first nine months of 2004, the bank subsidiaries declared and paid cash
dividends totaling $1.7 billion. There were no returns of capital provided to
the holding company from the bank subsidiaries during the first nine months 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 September 30, 2004, December
31, 2003 and September 30, 2003, $896 million, $693 million and $633 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 September 30, 2004, December 31, 2003, and September 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
nine months of 2004, the holding company issued $200 million of senior notes
under this shelf registration, leaving $1.3 billion available for future
issuance.
67
CONTRACTUAL OBLIGATIONS, COMMITMENTS, CONTINGENT LIABILITIES, AND OFF-BALANCE
SHEET ARRANGEMENTS
The following table presents, as of September 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. This table excludes contractual
obligations associated with National Processing, Inc., as this business was sold
in October 2004. Refer to Note 3 for further discussion on this sale. 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) $55,676 $ -- $ -- $ -- $55,676
Consumer and brokered certificates
of deposits(b)(c) 7,663 9,405 2,636 4,870 24,574
Federal funds borrowed and security
repurchase agreements(b) 6,543 -- -- -- 6,543
Borrowed funds(b) 12 7,414 -- -- -- 7,414
Long-term debt(b)(c) 13, 14 8,875 12,120 5,441 6,159 32,595
Operating leases 133 217 168 335 853
Purchase obligations 137 137 47 13 334
(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 September 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, fair
value 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 September 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 September 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.
68
Commitments: The following table details the amounts and expected maturities of
significant commitments as of September 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 $ 7,803 $5,850 $3,835 $372 $17,860
Residential real estate 19,245 -- -- -- 19,245
Revolving home equity and credit card lines 30,658 -- -- -- 30,658
Other 723 -- -- -- 723
Standby letters of credit 2,036 1,379 646 120 4,181
Commercial letters of credit 298 11 1 -- 310
Net commitments to sell mortgage loans and mortgage-
backed securities 7,650 33 -- -- 7,683
Commitments to fund principal investments 28 104 40 66 238
Commitments to fund civic and community investments 156 69 26 31 282
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 September 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 pertain to 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. In
addition, the Corporation acquired nonconforming residential real estate and
home equity securitizations as part of the acquisition of Provident. 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.
69
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.
70
MORTGAGE SERVICING RIGHT (MSR) ASSETS
Servicing residential mortgage loans for third-party investors represents a
significant business activity of the National City Mortgage Co. (NCMC) line of
business. As of September 30, 2004, NCMC MSR assets totaled $1.4 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
September 30, 2004, the recorded fair value of derivative assets and liabilities
were $1.2 billion and $634 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.
71
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.
72
CONSOLIDATED AVERAGE BALANCE SHEETS
Three Months Ended Nine Months Ended
------------------------------------------------------
SEPTEMBER 30 September 30 SEPTEMBER 30 September 30
(In Millions) 2004 2003 2004 2003
------------- ------------ ------------ ------------ ------------
ASSETS
Earning Assets:
Portfolio loans:
Commercial $ 24,784 $ 21,152 $ 21,073 $ 21,851
Commercial construction 2,815 2,425 2,445 2,309
Real estate -- commercial 11,993 9,450 10,881 9,448
Real estate -- residential 29,639 24,088 28,238 22,539
Home equity lines of credit 16,247 9,612 13,498 8,847
Credit card and other unsecured lines of credit 2,281 2,170 2,265 2,096
Other consumer 7,565 8,167 7,392 8,028
--------- --------- --------- ---------
Total portfolio loans 95,324 77,064 85,792 75,118
Loans held for sale or securitization:
Commercial 61 13 32 13
Commercial real estate 328 -- 110 --
Mortgage 11,472 27,023 12,377 24,562
Automobile -- -- 176 --
--------- --------- --------- ---------
Total loans held for sale or securitization 11,861 27,036 12,695 24,575
Securities available for sale, at cost 9,670 6,667 7,625 7,447
Federal funds sold and security resale agreements 284 272 358 178
Other investments 1,193 945 790 750
--------- --------- --------- ---------
Total earning assets 118,332 111,984 107,260 108,068
Allowance for loan losses (1,309) (1,144) (1,192) (1,124)
Fair value appreciation of securities available for sale 82 202 146 276
Cash and demand balances due from banks 3,354 3,554 3,153 3,466
Properties and equipment 1,259 1,059 1,169 1,068
Equipment leased to others 1,248 68 446 74
Other real estate owned 112 107 101 111
Mortgage servicing assets 1,842 1,225 1,592 931
Goodwill 3,315 1,103 1,946 1,089
Other intangible assets 225 71 119 70
Derivative assets 330 544 561 851
Accrued income and other assets 4,684 4,878 4,326 4,815
--------- --------- --------- ---------
TOTAL ASSETS $ 133,474 $ 123,651 $ 119,627 $ 119,695
========= ========= ========= =========
LIABILITIES
Deposits:
Noninterest bearing $ 18,731 $ 19,408 $ 17,387 $ 17,578
NOW and money market 29,778 26,091 28,577 24,884
Savings 2,679 2,422 2,542 2,442
Consumer time 16,318 13,337 14,274 13,915
Brokered retail CDs 4,373 2,502 1,810 2,657
Other 828 739 585 616
Foreign 9,809 7,186 8,498 6,915
--------- --------- --------- ---------
Total deposits 82,516 71,685 73,673 69,007
--------- --------- --------- ---------
Federal funds borrowed and security repurchase agreements 8,033 10,660 8,076 11,634
Borrowed funds 1,120 1,087 1,420 1,746
Long-term debt 25,744 27,569 22,383 24,786
Derivative liabilities 364 511 381 588
Accrued expenses and other liabilities 3,338 2,968 2,892 3,103
--------- --------- --------- ---------
TOTAL LIABILITIES 121,115 114,480 108,825 110,864
STOCKHOLDERS' EQUITY
Preferred -- -- -- --
Common 12,359 9,171 10,802 8,831
--------- --------- --------- ---------
TOTAL STOCKHOLDERS' EQUITY 12,359 9,171 10,802 8,831
--------- --------- --------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 133,474 $ 123,651 $ 119,627 $ 119,695
========= ========= ========= =========
73
DAILY AVERAGE BALANCES/NET INTEREST INCOME/RATES
Daily Average Balance
-----------------------------------------------------------------
2004 2003
------------------------------------- -----------------------
THIRD Second First Fourth Third
(Dollars in Millions) QUARTER Quarter Quarter Quarter Quarter
- --------------------- -------- -------- -------- -------- --------
ASSETS
Earning Assets:
Loans(a):
Commercial $ 24,845 $ 19,552 $ 18,873 $ 20,035 $ 21,165
Commercial construction 2,815 2,270 2,245 2,445 2,425
Real estate-- commercial 12,321 10,821 9,819 9,587 9,450
Real estate-- residential 41,111 41,870 38,856 42,624 51,111
Home equity lines of credit 16,247 12,819 11,396 10,410 9,612
Credit card and other unsecured lines of credit 2,281 2,232 2,283 2,330 2,170
Other consumer 7,565 7,209 7,936 8,150 8,167
--------- --------- --------- --------- ---------
Total loans 107,185 96,773 91,408 95,581 104,100
Securities available for sale, at cost:
Taxable 9,023 5,979 5,879 5,860 5,988
Tax-exempt 647 667 658 674 679
--------- --------- --------- --------- ---------
Total securities available for sale 9,670 6,646 6,537 6,534 6,667
Federal funds sold, security resale
agreements and other investments 1,477 1,148 814 1,103 1,217
--------- --------- --------- --------- ---------
Total earning assets/total interest income/rates 118,332 104,567 98,759 103,218 111,984
Allowance for loan losses (1,309) (1,143) (1,124) (1,125) (1,144)
Fair value appreciation of securities
available for sale 82 138 220 201 202
Nonearning assets 16,369 12,270 11,568 12,172 12,609
--------- --------- --------- --------- ---------
TOTAL ASSETS $ 133,474 $ 115,832 $ 109,423 $ 114,466 $ 123,651
========= ========= ========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing liabilities:
NOW and money market accounts $ 29,778 $ 28,614 $ 27,325 $ 26,845 $ 26,091
Savings accounts 2,679 2,576 2,369 2,367 2,422
Consumer time deposits 16,318 13,474 13,008 13,178 13,337
Other deposits 5,201 1,098 858 1,205 3,241
Foreign deposits 9,809 9,150 6,520 7,260 7,186
Federal funds borrowed 5,156 5,548 4,996 5,765 7,632
Security repurchase agreements 2,877 2,706 2,946 2,989 3,028
Borrowed funds 1,120 1,547 1,594 992 1,087
Long-term debt 25,744 20,031 21,339 25,056 27,569
--------- --------- --------- --------- ---------
Total interest bearing liabilities/
total interest expense/rates 98,682 84,744 80,955 85,657 91,593
Noninterest bearing deposits 18,731 17,756 15,658 16,089 19,408
Accrued expenses and other liabilities 3,702 2,962 3,151 3,330 3,479
--------- --------- --------- --------- ---------
TOTAL LIABILITIES 121,115 105,462 99,764 105,076 114,480
TOTAL STOCKHOLDERS' EQUITY 12,359 10,370 9,659 9,390 9,171
--------- --------- --------- --------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 133,474 $ 115,832 $ 109,423 $ 114,466 $ 123,651
========= ========= ========= ========= =========
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
74
Quarterly Interest
------------------------------------------------
2004 2003
---------------------------- ------------------
THIRD Second First Fourth Third
(Dollars in Millions) QUARTER Quarter Quarter Quarter Quarter
- --------------------- -------- -------- -------- -------- --------
ASSETS
Earning Assets:
Loans(a):
Commercial $ 273 $ 179 $ 175 $ 183 $ 198
Commercial construction 33 24 24 25 27
Real estate-- commercial 173 151 143 144 146
Real estate-- residential 664 656 608 683 807
Home equity lines of credit 169 138 123 103 99
Credit card and other unsecured lines of credit 46 45 47 45 43
Other consumer 124 115 131 138 140
-------- -------- -------- -------- --------
Total loans 1,482 1,308 1,251 1,321 1,460
Securities available for sale, at cost:
Taxable 111 70 74 73 71
Tax-exempt 12 13 12 12 13
-------- -------- -------- -------- --------
Total securities available for sale 123 83 86 85 84
Federal funds sold, security resale
agreements and other investments 15 11 13 10 10
-------- -------- -------- -------- --------
Total earning assets/total interest income/rates $ 1,620 $ 1,402 $ 1,350 $ 1,416 $ 1,554
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 $ 61 $ 57 $ 57 $ 59 $ 63
Savings accounts 3 2 2 2 3
Consumer time deposits 114 117 112 118 120
Other deposits 19 4 2 4 8
Foreign deposits 34 22 15 17 19
Federal funds borrowed 20 16 14 16 27
Security repurchase agreements 5 4 4 4 4
Borrowed funds 4 3 3 2 2
Long-term debt 164 110 116 153 157
-------- -------- -------- -------- --------
Total interest bearing liabilities/
total interest expense/rates $ 424 $ 335 $ 325 $ 375 $ 403
Noninterest bearing deposits
Accrued expenses and other liabilities
-------- -------- -------- -------- --------
TOTAL LIABILITIES
TOTAL STOCKHOLDERS' EQUITY
-------- -------- -------- -------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
======== ======== ======== ======== ========
TAX-EQUIVALENT NET INTEREST INCOME $ 1,196 $ 1,067 $ 1,025 $ 1,041 $ 1,151
======== ======== ======== ======== ========
INTEREST SPREAD
Contribution of noninterest bearing sources of funds
-------- -------- -------- -------- --------
NET INTEREST MARGIN
======== ======== ======== ======== ========
(a) Includes loans held for sale or securitization
75
Average Annualized Rate
-----------------------------------------------------------------
2004 2003
------------------------------------- -----------------------
THIRD Second First Fourth Third
QUARTER Quarter Quarter Quarter Quarter
--------- --------- --------- --------- ---------
ASSETS
Earning Assets:
Loans(a):
Commercial 4.36% 3.69% 3.72% 3.63% 3.73%
Commercial construction 4.64 4.34 4.30 4.07 4.48
Real estate-- commercial 5.58 5.61 5.87 5.99 6.10
Real estate-- residential 6.47 6.26 6.26 6.41 6.31
Home equity lines of credit 4.16 4.29 4.33 3.97 4.11
Credit card and other unsecured lines of credit 8.16 8.02 8.30 7.57 7.81
Other consumer 6.51 6.43 6.62 6.76 6.79
--------- --------- --------- --------- ---------
Total loans 5.52 5.42 5.49 5.52 5.59
Securities available for sale, at cost:
Taxable 4.92 4.69 5.01 4.92 4.81
Tax-exempt 7.28 7.62 7.53 7.50 7.50
--------- --------- --------- --------- ---------
Total securities available for sale 5.08 4.98 5.26 5.19 5.08
Federal funds sold, security resale
agreements and other investments 3.94 3.97 6.49 3.26 3.29
--------- --------- --------- --------- ---------
Total earning assets/total interest income/rates 5.46% 5.37% 5.48% 5.47% 5.53%
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 .82% .80% .83% .88% .96%
Savings accounts .34 .35 .35 .36 .39
Consumer time deposits 2.78 3.50 3.47 3.55 3.58
Other deposits 1.46 1.13 1.13 1.07 1.05
Foreign deposits 1.35 .98 .94 .94 1.05
Federal funds borrowed 1.56 1.15 1.13 1.09 1.37
Security repurchase agreements .77 .56 .55 .53 .53
Borrowed funds 1.35 .81 .75 .96 .98
Long-term debt 2.54 2.21 2.18 2.42 2.26
--------- --------- --------- --------- ---------
Total interest bearing liabilities/
total interest expense/rates 1.71% 1.59% 1.62% 1.74% 1.75%
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 3.75% 3.78% 3.86% 3.73% 3.78%
Contribution of noninterest bearing sources of funds .29 .31 .30 .30 .32
--------- --------- --------- --------- ---------
NET INTEREST MARGIN 4.04% 4.09% 4.16% 4.03% 4.10%
========= ========= ========= ========= =========
(a) Includes loans held for sale or securitization
76
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 65-67 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 September
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 September 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 September 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 62 of this report are incorporated herein by reference.
77
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 September 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, 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).
78
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).
79
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 the 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 the 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 the 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).
80
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 November 8, 2004 for National City Corporation's Quarterly
Report on Form 10-Q for the quarter ended September 30, 2004.
31.2 Chief Financial Officer Sarbanes-Oxley Act 302 Certification
dated November 8, 2004 for National City Corporation's Quarterly
Report on Form 10-Q for the quarter ended September 30, 2004.
32.1 Chief Executive Officer Sarbanes-Oxley Act 906 Certification
dated November 8, 2004 for National City Corporation's Quarterly
Report on Form 10-Q for the quarter ended September 30, 2004.
32.2 Chief Financial Officer Sarbanes-Oxley Act 906 Certification
dated November 8, 2004 for National City Corporation's Quarterly
Report on Form 10-Q for the quarter ended September 30, 2004.
81
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
September 30, 2004 and through the date of this Form 10-Q filing:
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 an
agreement to sell 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 at
www.NationalCity.com.
September 13, 2004 National City announced the posting of its August 31,
2004, Mid-Quarter Update to Financial Supplement to its
Web site.
October 5, 2004 National City issued a news release announcing the
completion of its acquisition of Wayne Bancorp, Inc.
October 8, 2004 National City announced that the shareholders of
National Processing, Inc. (NPI) approved the sale of NPI
to Bank of America pursuant to the Agreement and Plan of
Merger.
October 14, 2004 National City issued a news release announcing its
financial results for the quarterly and year-to-date
periods ended September 30, 2004, and the availability
of the September 30, 2004, Financial Supplement on its
Web site.
October 14, 2004 National City filed a Form 8-K/A to the October 14,
2004, Form 8-K, furnishing an updated news release
announcing its financial results for the quarterly and
year-to-date periods ended September 30, 2004.
October 18, 2004 National City announced the completion of the sale of
National Processing, Inc. to Bank of America.
82
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
Jennifer Hammarlund
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.
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
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FORM 10-Q -- SEPTEMBER 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: November 8, 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
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NATIONAL CITY (R)
National City Center
1900 East Ninth Street
Cleveland, Ohio 44114-3484
85